Internal Revenue Bulletin 2013-51 (PDF rendition): IRS Notices

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# Internal Revenue bulletin
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## 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. 2013-27, page 676.

This revenue ruling holds that a covered entity must include in
gross income amounts it collects from policyholders to offset
the cost of the fee imposed under § 9010 of the Affordable
Care Act.

### T.D. 9644, page 676.

Section 1411 imposes a 3.8 percent tax on certain individuals,
estates, and trusts (the "Net Investment Income Tax"). The tax
is imposed on the lesser of the taxpayer's (A) Net Investment
Income for such taxable year, or (B) the excess of taxpayer
adjusted gross income over certain statutorily defined thresh-
old amounts. The regulations provide guidance on the general
application of the Net Investment Income Tax to individuals,
estates, and trusts, and the computation of Net Investment
Income.

### REG-130843-13, page 771.

These regulations provide guidance on the computation of net
investment income under section 1411 of the Code. The reg-
ulations affect individuals, estates, and trusts whose incomes
meet certain income thresholds. Comments on this proposed
rule are requested by March 3, 2014.

## EMPLOYMENT TAX

### T.D. 9645, page 738.

Final regulations under section 3101 of the Code provide guid-
ance on the Additional Hospital Insurance Tax on income above
threshold amounts ("Additional Medicare Tax"), as added by the
Affordable Care Act. Specifically, these final regulations provide
guidance for employers and individuals relating to the implemen-
tation of Additional Medicare Tax, relating to the requirement to

Finding Lists begin on page ii.

Department of the Treasury
Internal Revenue Service

file a return reporting Additional Medicare Tax, the employer
process for making adjustments of underpayments and overpay-
ments of Additional Medicare Tax, and the employer and em-
ployee processes for filing a claim for refund for an overpayment
of Additional Medicare Tax.

## SELF-EMPLOYMENT TAX

### T.D. 9645, page 738.

Final regulations under section 3101 of the Code provide guid-
ance on the Additional Hospital Insurance Tax on income above
threshold amounts ("Additional Medicare Tax"), as added by the
Affordable Care Act. Specifically, these final regulations provide
guidance for employers and individuals relating to the implemen-
tation of Additional Medicare Tax, relating to the requirement to
file a return reporting Additional Medicare Tax, the employer
process for making adjustments of underpayments and overpay-
ments of Additional Medicare Tax, and the employer and em-
ployee processes for filing a claim for refund for an overpayment
of Additional Medicare Tax.

(Continued on the next page)

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## EXCISE TAX

### T.D. 9643, page 750.

These final regulations provide guidance on the annual fee
imposed on covered entities engaged in the business of pro-
viding health insurance for United States health risks. This fee
was enacted by section 9010 of the Patient Protection and
Affordable Care Act. The final regulations affect persons en-
gaged in the business of providing health insurance. The final
regulations provide an explanation of terms, a description of
the reporting requirements, the calculation and notification of a
preliminary fee, an error correction process, the final fee
calculation and notification, and instructions regarding how to
claim a refund.

### Notice 2013-76, page 769.

This notice provides guidance on the health insurance providers
fee related to (1) the time and manner for submitting Form 8963,
Report of Health Insurance Provider Information, (2) the time and
manner for notifying covered entities of their preliminary fee
calculation, (3) the time and manner for submitting a corrected
Form 8963 for the error correction process, and (4) the time for
notifying covered entities of their final fee calculation.

## ADMINISTRATIVE

### T.D. 9642, page 747.

These final regulations require information reporting by per-
sons who receive mortgage insurance premiums aggregating
$600 or more during any calendar year.

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## The IRS Mission

Provide America's taxpayers top-quality service by helping
them understand and meet their tax responsibilities and en-
force the 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.

It is the policy of the Service to publish in the Bulletin all
substantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of internal
management are not published; however, statements of inter-
nal practices and procedures that affect the rights and duties
of taxpayers are published.

Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings to
taxpayers or technical advice to Service field offices, identify-
ing details and information of a confidential nature are deleted
to prevent unwarranted invasions of privacy and to comply with
statutory requirements.

Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned

against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

### Part I .- 1986 Code.

This part includes rulings and decisions based on provisions of
the Internal Revenue Code of 1986.

### Part II .- Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A, Tax
Conventions and Other Related Items, and Subpart B, Legisla-
tion and Related Committee Reports.

Part III .- Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury's Office of the Assistant Sec-
retary (Enforcement).

### Part IV .- Items of General Interest.

This part includes notices of proposed rulemakings, disbar-
ment and 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 contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

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## Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

### Section 61 .- Gross Income Defined

#### Rev. Rul. 2013-27 ISSUE

Are amounts a covered entity collects
from policyholders to offset the cost of the
annual fee imposed on health insurance
providers under § 9010 of the Affordable
Care Act included in the covered entity's
gross income under § 61(a) of the Internal
Revenue Code?

#### FACTS

M is a United States corporation that is
engaged in the business of providing
health insurance for United States health
risks. Section 9010 of the Patient Protec-
tion and Affordable Care Act (PPACA),
Public Law No. 111-148 (124 Stat. 119
(2010)), as amended by section 10905 of
PPACA, and as further amended by sec-
tion 1406 of the Health Care and Educa-
tion Reconciliation Act of 2010, Public
Law 111-152 (124 Stat. 1029) (2010))
(collectively, the Affordable Care Act or
ACA), imposes an annual fee on each
covered entity engaged in the business of
providing health insurance (annual fee).
M is a "covered entity" within the mean-
ing of § 9010(c)(1).

In Taxable Year X, the annual fee im-
posed on M pursuant to § 9010 is $10x.
To offset part of the cost of the annual fee,
M imposes a surcharge totaling $6x on
certain of M's health insurance policy-
holders that is separately stated from the
premium billed to them. To offset the
remaining cost of the annual fee, M in-
creases by a total of $4x the amount
charged for health insurance premiums to
M's remaining policyholders. The addi-
tional charge is not stated separately on
the policyholders' bills. M collects from
policyholders the total amount of the $10x
cost of the annual fee imposed by § 9010.

LAW

Section 61(a) provides that, except as
otherwise provided in subtitle A, gross

income means all income from whatever
source derived.

Section 9010(a) of the ACA imposes
an annual fee on each covered entity en-
gaged in the business of providing health
insurance. Under § 9010(c)(1), a covered
entity is generally an entity that provides
health insurance for a United States health
risk. A covered entity is liable for the
annual fee in each calendar year begin-
ning after 2013.

Section 9010(f)(2) treats the annual fee
as a tax described in § 275(a)(6), which
denies a deduction for certain taxes.

#### ANALYSIS

Unless a specific exclusion from in-
come applies, an amount a taxpayer col-
lects from a third party to cover the cost of
a liability, including deductible and non-
deductible liabilities incurred in a trade or
business, is included in the taxpayer's
gross income under § 61. Amounts a tax-
payer charges customers for goods and
services typically offset the taxpayer's
costs of doing business. No provision of
the Code or other law excludes these
amounts from a taxpayer's gross income
simply because the taxpayer is passing
overhead costs and other business ex-
penses to its customers. As discussed be-
low, these amounts consistently have been
found to be includible in income.

Rev. Rul. 79-27, 1979-1 C.B. 217,
involves a taxpayer engaged in mining
and selling coal, on which a federal excise
tax was imposed. The taxpayer separately
stated the excise tax on invoices to its
customers. Noting that the excise tax was
the liability of the taxpayer and could not
be assessed on the customer, the ruling
holds that additional amounts the taxpayer
received from its customers on account of
the separately stated excise tax were in-
cluded in the taxpayer's gross income. See
also Iowa Southern Utilities Co. v. United
States, 841 F.2d 1108 (Fed. Cir. 1988)
(surcharge utility collected from custom-
ers to offset specific expense is includable
in gross income); Hinshaw's Inc. v. Com-
missioner, T.C. Memo. 1994-327 (1994)
(recoupment from customers of cost of
insurance that state law required taxpayer

to purchase is included in taxpayer's gross
income).

Section 9010 of the ACA imposes the
annual fee on a covered entity, not on the
covered entity's health insurance policy-
holders. The fee is part of the covered
entity's cost of doing business. No exemp-
tion or exclusion from gross income ap-
plies to additional amounts that the cov-
ered entity charges its policyholders to
cover the cost of this fee. Accordingly, M
charging and collecting from its policy-
holders the $10x, whether or not sepa-
rately stated, is no different than M pass-
ing other business expenses on to its
customers as part of M's charges for pro-
viding health insurance. As a result, M
must include the $10x in gross income.

#### HOLDING

Amounts a covered entity collects from
policyholders to offset the cost of the an-
nual fee imposed on health insurance pro-
viders under § 9010 of the ACA are in-
cluded in the covered entity's gross
income under § 61(a).

#### DRAFTING INFORMATION

The principal author of this revenue
ruling is Edward C. Schwartz of the Office
of Associate Chief Counsel (Income Tax
and Accounting). For further information
regarding this revenue ruling, contact Mr.
Schwartz at (202) 317-7006 (not a toll-
free call).

Section 1411 .- Imposition
of Tax

T.D. 9644

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602

Net Investment Income Tax

AGENCY: Internal Revenue Service
(IRS), Treasury.

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ACTION: Final Regulations.

SUMMARY: This document contains fi-
nal regulations under section 1411 of the
Internal Revenue Code (Code). These reg-
ulations provide guidance on the general
application of the Net Investment Income
Tax and the computation of Net Invest-
ment Income. The regulations affect indi-
viduals, estates, and trusts whose incomes
meet certain income thresholds.

DATES: Effective Date: These regula-
tions are effective on December 2, 2013.

Applicability Dates: For dates of applica-
bility, see §§1.469-11(b)(3)(iv)(D);1.1411-
1(g);1.1411-2(e);1.1411-3(f);1.1411-4(i);
1.1411-5(d);1.1411-6(c);1.1411-8(c);1.1411-
9(d); and 1.1411-10(i).

FOR FURTHER INFORMATION
CONTACT: David H. Kirk or Adrienne
M. Mikolashek at (202) 317-6852 (not a
toll-free number).

### SUPPLEMENTARY INFORMATION: Paperwork Reduction Act

The collection of information con-
tained in these regulations has been re-
viewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507) under control num-
ber 1545-2227. The collection of informa-
tion in these final regulations is in
§1.1411-10(g). The collection of informa-
tion in §1.1411-10(g) is necessary for the
IRS to determine whether a taxpayer has
made an election pursuant to §1.1411-
10(g) and to determine whether the
amount of tax has been reported and cal-
culated correctly.

An agency may not conduct or spon-
sor, and a person is not required to re-
spond to, a collection of information un-
less it displays a valid control number
assigned by the Office of Management
and Budget.

Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
return information are confidential, as re-
quired by section 6103.

#### Background

##### I. In General

This document contains final amend-
ments to 26 CFR part 1 under sections 469
and 1411 of the Internal Revenue Code
(Code). Section 1402(a)(1) of the Health
Care and Education Reconciliation Act of
2010 (Public Law 111-152, 124 Stat.
1029) (HCERA) added section 1411 to a
new chapter 2A of subtitle A (Income
Taxes) of the Code effective for taxable
years beginning after December 31, 2012.

On December 5, 2012, the Treasury De-
partment and the IRS published a notice of
proposed rulemaking in the Federal Regis-
ter (REG-130507-11; 77 FR 72612) relat-
ing to the Net Investment Income Tax. On
January 31, 2013, corrections to the pro-
posed regulations were published in the
Federal Register (78 FR 6781). The Trea-
sury Department and the IRS received nu-
merous comments in response to the pro-
posed regulations. All comments are
available at www.regulations.gov or upon
request. The Treasury Department and the
IRS held a public hearing on the proposed
regulations on April 2, 2013.

In addition to these final regulations,
the Treasury Department and the IRS are
contemporaneously publishing a notice of
proposed rulemaking in the Federal Reg-
ister (REG-130843-13) relating to the
Net Investment Income Tax. Public com-
ments on the 2012 proposed regulations
identified two issues that the IRS and the
Treasury Department will study further
and on which the IRS and the Treasury
Department request additional comments.
Those issues, the treatment of accumula-
tion distributions from foreign trusts and
material participation of estates and trusts,
are discussed in parts 4.D and 4.F of this
preamble, respectively. Comments on
those issues should be submitted in writ-
ing by March 3, 2014, and can be mailed
to the Office of Associate Chief Counsel
(Passthroughs and Special Industries), Re:
REG-130507-11 - Estates/Trusts, CC:
PSI:B02, Room 5011, 1111 Constitution
Avenue NW., Washington, DC 20224. All
comments received will be available for
public inspection at www.regulations.gov
(IRS REG-130507-11).

### II. Statutory Provisions

Section 1402(a)(1) of the HCERA
added section 1411 to a new chapter 2A of
subtitle A (Income Taxes) of the Code
effective for taxable years beginning after
December 31, 2012. Section 1411 im-
poses a 3.8 percent tax on certain individ-
uals, estates, and trusts. See section
1411(a)(1) and (a)(2). The tax does not
apply to a nonresident alien or to a trust all
of the unexpired interests in which are
devoted to one or more of the purposes
described in section 170(c)(2)(B). See
section 1411(e).

In the case of an individual, section
1411(a)(1) imposes a tax (in addition to
any other tax imposed by subtitle A) for
each taxable year equal to 3.8 percent of
the lesser of: (A) the individual's net in-
vestment income for such taxable year, or
(B) the excess (if any) of: (i) the individ-
ual's modified adjusted gross income for
such taxable year, over (ii) the threshold
amount. Section 1411(b) provides that the
threshold amount is: (1) in the case of a
taxpayer making a joint return under sec-
tion 6013 or a surviving spouse (as de-
fined in section 2(a)), $250,000; (2) in the
case of a married taxpayer (as defined in
section 7703) filing a separate return,
$125,000; and (3) in the case of any other
individual, $200,000. Section 1411(d) de-
fines modified adjusted gross income as
adjusted gross income increased by the
excess of: (1) the amount excluded from
gross income under section 911(a)(1),
over (2) the amount of any deductions
(taken into account in computing adjusted
gross income) or exclusions disallowed
under section 911(d)(6) with respect to the
amount excluded from gross income un-
der section 911(a)(1). Section 1.1411-2 of
the final regulations provides guidance on
the computation of the net investment in-
come tax for individuals.

In the case of an estate or trust, section
1411(a)(2) imposes a tax (in addition to
any other tax imposed by subtitle A) for
each taxable year equal to 3.8 percent of
the lesser of: (A) the estate's or trust's
undistributed net investment income, or
(B) the excess (if any) of: (i) the estate's
or trust's adjusted gross income (as de-
fined in section 67(e)) for such taxable
year, over (ii) the dollar amount at which
the highest tax bracket in section 1(e) be-

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gins for such taxable year. Section
1.1411-3 of the final regulations provides
guidance on the computation of the net
investment income tax for estates and
trusts.

Section 1411(c)(1) provides that net
investment income means the excess (if
any) of: (A) the sum of (i) gross income
from interest, dividends, annuities, royal-
ties, and rents, other than such income
derived in the ordinary course of a trade or
business to which the tax does not apply,
(ii) other gross income derived from a
trade or business to which the tax applies,
and (iii) net gain (to the extent taken into
account in computing taxable income) at-
tributable to the disposition of property
other than property held in a trade or
business to which the tax does not apply;
over (B) the deductions allowed by subti-
tle A that are properly allocable to such
gross income or net gain. Sections
1.1411-4 and 1.1411-10 of the final reg-
ulations provide guidance on the calcula-
tion of net investment income under sec-
tion 1411(c)(1).

Section 1411(c)(1)(A) defines net in-
vestment income, in part, by reference to
trades or businesses described in section
1411(c)(2). A trade or business is de-
scribed in section 1411(c)(2) if such trade
or business is: (A) a passive activity
(within the meaning of section 469) with
respect to the taxpayer, or (B) a trade or
business of trading in financial instru-
ments or commodities (as defined in sec-
tion 475(e)(2)). Section 1.1411-5 of the
final regulations provides guidance on the
trades or businesses described in section
1411(c)(2).

Section 1411(c)(3) provides that income
on the investment of working capital is not
treated as derived from a trade or business
for purposes of section 1411(c)(1) and is
subject to tax under section 1411. Section
1.1411-6 of the final regulations provides
guidance on working capital under section
1411(c)(3).

In the case of the disposition of an
interest in a partnership or an S corpo-
ration, section 1411(c)(4) provides that
gain or loss from such disposition is
taken into account for purposes of sec-
tion 1411(c)(1)(A)(iii) only to the extent
of the net gain or net loss that would be
so taken into account by the transferor if
all property of the partnership or S cor-

poration were sold at fair market value
immediately before the disposition of
such interest. Section 1.1411-7 of the
final regulations is reserved for guid-
ance under section 1411(c)(4). How-
ever, regulations are being proposed
contemporaneously with these final reg-
ulations that address the application of
section 1411(c)(4) to dispositions of in-
terests in partnerships or S corporations.

Section 1411(c)(5) provides that net
investment income does not include dis-
tributions from a plan or arrangement de-
scribed in section 401(a), 403(a), 403(b),
408, 408A, or 457(b). Section 1.1411-8
of the final regulations provides guidance
on distributions from qualified plans un-
der section 1411(c)(5).

Section 1411(c)(6) provides that net
investment income also does not include
any item taken into account in determin-
ing self-employment income for a taxable
year on which a tax is imposed by section
1401(b). Section 1.1411-9 of the final
regulations provides guidance regarding
self-employment income under section
1411(c)(6).

#### Summary of Comments and Explanation of Provisions

The Treasury Department and the IRS
received numerous written and electronic
comments regarding the proposed regula-
tions. The comments included requests for
clarification and recommendations relat-
ing to: (1) the calculation of net invest-
ment income; (2) the treatment of several
special types of trusts; (3) the interaction
between various aspects of section 469
and the regulations thereunder with the
calculation of net investment income; (4)
the method of gain calculation regarding a
sale of an interest in a partnership or S
corporation; and (5) multiple areas where
the proposed regulations could be simpli-
fied. After consideration of all of the com-
ments, the proposed regulations are ad-
opted as amended by this Treasury
decision. In general, the final regulations
follow the approach of the proposed reg-
ulations with some modifications in re-
sponse to comments and questions that
have arisen with respect to the application
of the proposed regulations. This pream-
ble describes comments received by the
Treasury Department and the IRS on the
most significant issues.

#### 1. Comments of General Applicability

A. Confirmation in the regulation text
of certain statements made in the
preamble

The Treasury Department and the IRS
received a number of comments noting
that some of the rules set forth in the
preamble were not contained in the regu-
lation text itself. In response to these com-
ments, the final regulations provide addi-
tional guidance within the regulation text.
For example, §1.1411-1(d) of the final
regulations contains additional guidance
related to various definitions applicable to
multiple sections of the regulations, which
had appeared only in the preamble to the
proposed regulations. In addition, the final
regulations contain supplemental clarifi-
cations and examples.

In addition, one commentator stated
that the preamble to the proposed regula-
tions acknowledges that certain types of
income may not be subject to tax under
section 1411, even if such income is not
explicitly excepted from the tax under
section 1411(c)(1)(A)(i) or (c)(1)(A)(iii),
or is earned in a trade or business that is
not a passive activity or in a trade or
business of trading in financial instru-
ments or commodities. Multiple commen-
tators suggested that the final regulations
confirm that there are types of income that
are not included in net investment income.
One commentator suggested the best way
to illustrate principles of income that are
not net investment income is inclusion of
one or more examples of income not sub-
ject to tax under section 1411. Another
commentator requested that the final reg-
ulations include a non-exhaustive list of
items of income that are not net invest-
ment income.

The final regulations do not provide a
list of income or deduction items that are
excluded from the calculation of net in-
vestment income. However, the final reg-
ulations provide, in certain instances, ad-
ditional guidance on items of income that
are or are not included in net investment
income. For example, pursuant to one
comment asking whether distributions
from foreign pension plans are included in
net investment income, the definition of
"annuity" in §1.1411-1(d) of the final reg-
ulations clarifies that the term annuities, as

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used in section 1411(c) and §1.1411-
4, does not include amounts paid in con-
sideration for services rendered even if
such amounts are subject to the rules of
section 72. This is consistent with United
States income tax treaties that prescribe
one set of rules for "annuities" that are not
paid in exchange for services, but another
set of rules for pension distributions paid
in the form of an annuity. See, for exam-
ple, paragraphs 1 and 3 of Article 17 (Pen-
sions, Social Security, Annuities, Ali-
mony, and Child Support) of the 2006
United States Model Income Tax Conven-
tion. In addition, the final regulations pro-
vide examples of items excluded from net
investment income in §1.1411-1(d)(4).

Furthermore, these final regulations, as
with the notice of proposed rulemaking,
re-confirm the application of chapter 1
provisions in the absence of special rules
for purposes of the net investment income
tax. The Treasury Department and the IRS
may issue other guidance in the future, as
necessary, to address the treatment of par-
ticular income items whose treatment is
not apparent from the general rules of
section 1411 and these final regulations or
from chapter 1.

### B. Section 1411 and estimated taxes

Two commentators stated that, because
many investors do not know until the end
of the year if a passthrough investment
will generate net investment income for
that year, the Treasury Department and
the IRS should not penalize taxpayers for
failure to include net investment income
in their calculation of estimated tax pay-
ments. One commentator suggested that
the estimated tax calculation fully exempt
the tax imposed by section 1411. Another
commentator urged the Treasury Depart-
ment and the IRS to grant penalty relief
for failure to pay the appropriate esti-
mated tax payments due to the impact of
section 1411.

Section 1402(a)(2) of the HCERA
amended section 6654 of the Code to pro-
vide that the tax imposed under chapter
2A (which includes section 1411) is sub-
ject to the estimated tax provisions. To
assist taxpayers with their compliance ob-
ligations for taxable years beginning after
December 31, 2012, the notice of pro-
posed rulemaking extended reliance upon

the proposed regulations for this first tax-
able year in which section 1411 was in
effect. Although the Treasury Department
and IRS recognize that the actual tax lia-
bility of a taxpayer may not be known at
the time that an estimated tax payment is
due, a similar issue is present for chapter
1 purposes. Moreover, taxpayers subject
to estimated tax payments may not be
subject to a penalty under certain circum-
stances. See section 6654(b). After con-
sideration of these comments, the Trea-
sury Department and IRS decline to
extend penalty relief.

### C. Availability of tax credits to reduce section 1411 tax

The Treasury Department and the IRS
received comments asking whether for-
eign income, war profits, and excess prof-
its taxes ("foreign income taxes") are al-
lowed under sections 27(a) and 901 as a
credit against the section 1411 tax. Under
the express language of sections 27(a) and
901(a), foreign income taxes are not cred-
itable against United States taxes other
than those imposed by chapter 1 of the
Code. Section 1.1411-1(e) of the final
regulations clarifies that amounts that are
allowed as credits only against the tax
imposed by chapter 1 of the Code, includ-
ing credits for foreign income taxes, may
not be credited against the section 1411
tax, which is imposed by chapter 2A of
the Code. This limitation is similar to the
limitation applicable to a number of other
credits that are allowed only against the
tax imposed by chapter 1 of the Code.
See, for example, section 38.

The Treasury Department and the IRS
also received comments asking whether
United States income tax treaties may pro-
vide an independent basis to credit foreign
income taxes against the section 1411 tax.
The Treasury Department and the IRS do
not believe that these regulations are an
appropriate vehicle for guidance with re-
spect to specific treaties. An analysis of
each United States income tax treaty
would be required to determine whether
the United States would have an obliga-
tion under that treaty to provide a credit
against the section 1411 tax for foreign
income taxes paid to the other country. If,
however, a United States income tax
treaty contains language similar to that in

paragraph 2 of Article 23 (Relief from
Double Taxation) of the 2006 United
States Model Income Tax Convention,
which refers to the limitations of United
States law (which include sections 27(a)
and 901), then such treaty would not pro-
vide an independent basis for a credit
against the section 1411 tax.

#### 2. Comments Regarding Regrouping under Section 469

Section 1.469-4(e)(1) provides that,
except as provided in §§1.469-
4(e)(2) and 1.469-11, after a taxpayer has
grouped activities, the taxpayer may not
regroup those activities in subsequent tax-
able years. The preamble to the proposed
regulations acknowledged that the enact-
ment of section 1411 may cause taxpayers
to reconsider their previous grouping de-
terminations.

The proposed regulations provided tax-
payers an opportunity to regroup their ac-
tivities in the first taxable year beginning
after December 31, 2012, in which: (1) the
taxpayer met the applicable income
threshold under section 1411, and (2) had
net investment income. The determination
in the preceding sentence was to be made
without regard to the effect of the re-
grouping. Pursuant to proposed §1.469-
11(b)(3)(iv)(A), a taxpayer may regroup
his or her activities once, and any such
regrouping applies to the taxable year for
which the regrouping is made and all sub-
sequent years. Furthermore, the disclosure
requirements of §1.469-4(e) and Reve-
nue Procedure 2010-13 (2010-1 CB 329)
require taxpayers who regroup their activ-
ities pursuant to proposed §1.469-
11(b)(3)(iv) to report their regroupings to
the IRS.

The Treasury Department and the
IRS received several comments regard-
ing proposed amendments to §1.469-
11(b)(3)(iv). One commentator suggested
that all individuals, trusts, and estates -
regardless of whether they have net in-
vestment income or modified adjusted
gross income above the threshold - be
permitted a "fresh start" with respect to
their section 469 groupings. The commen-
tator stated that restricting the fresh start
only to taxpayers subject to section 1411
places lower income taxpayers at a disad-
vantage. In addition, multiple commenta-

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tors recommended that S corporations and
partnerships be permitted to change their
groupings in light of the application of
section 1411 for any tax year that begins
during 2013 or 2014. These commentators
acknowledged that section 1411 does not
apply to partnerships and S corporations
directly, but stated that the Treasury De-
partment and the IRS have regulatory au-
thority to allow these entities to change
the groupings reported to their owners and
that the disclosure required under Reve-
nue Procedure 2010-13 may operate to
improve tax administration in this com-
plex area.

Multiple commentators suggested that,
in the case of a failure to make regrouping
elections in 2013 or 2014, the final regu-
lations should allow taxpayers to make
their regrouping election on an amended
return. These commentators noted that de-
nying regrouping on an amended return
where there is an adjustment to income
after a return has been filed may be unfair.

The final regulations retain the require-
ment that regrouping under §1.469-
11(b)(3)(iv) may occur only during the
first taxable year beginning after Decem-
ber 31, 2012, in which (1) the taxpayer
meets the applicable income threshold un-
der section 1411, and (2) has net invest-
ment income. The Treasury Department
and the IRS believe that the interaction
between section 1411 and section 469 jus-
tifies the section 1411 regrouping rule,
and that, if a taxpayer does not have a
section 1411 tax liability, the reason for
allowing the regrouping does not apply.
The Treasury Department and the IRS ac-
knowledge that, in the case of regrouping
elections by partnerships and S corpora-
tions, one commentator's implied asser-
tion is correct that imposition of section
1411 on a passthrough entity's owner(s) is
the same change in law that precipitated
the proposed regulation's allowance of re-
grouping in the first instance. However, if
the Treasury Department and the IRS
were to expand the scope of the regula-
tions to allow regrouping by partnerships
and S corporations, then taxpayers with no
tax liability under section 1411 indirectly
would be allowed to regroup. Accord-
ingly, the final regulations do not adopt
this suggestion.

However, after considering the com-
ments, the Treasury Department and the

IRS agree with the commentators' con-
cerns regarding the potential unfairness to
taxpayers who become subject to section
1411 after adjustments to, for example,
income or deduction items after an origi-
nal return has been filed. Therefore, the
final regulations allow a taxpayer to re-
group under §1.469-11(b)(3)(iv) on an
amended return, but only if the taxpayer
was not subject to section 1411 on his or
her original return (or previously amended
return), and if, because of a change to the
original return, the taxpayer owed tax un-
der section 1411 for that taxable year.
This rule applies equally to changes to
modified adjusted gross income or net in-
vestment income upon an IRS examina-
tion. However, if a taxpayer regroups on
an original return (or previously amended
return) under these rules, and then subse-
quently determines that the taxpayer is not
subject to section 1411 in that year, such
regrouping is void in that year and all
subsequent years until a valid regrouping
is done. The voiding of the regrouping
may cause additional changes to the tax-
payer's current year return and may war-
rant corrections to future year returns to
restore the taxpayer's original groupings.
The final regulations contain two excep-
tions to such voided elections. First, the
final regulations allow a taxpayer to adopt
the voided grouping in a subsequent year
without filing an amended return if the
taxpayer is subject to section 1411 in such
year. Second, if the taxpayer is subject to
section 1411 in a subsequent year, the
taxpayer may file an amended return to
regroup in a manner that differs from the
previous year's voided regrouping. The
final regulations provide four new exam-
ples on the amended return regrouping
rules. Furthermore, §1.1411-
2(a)(2)(iii) of the final section 1411 regu-
lations also contains a similar rule appli-
cable to section 6013(g) elections.

### 3. Comments Regarding the Application of Section 1411 to Individuals

Section 1411(a)(1) imposes a tax on
individuals, but section 1411(e)(1) pro-
vides that section 1411 does not apply to a
nonresident alien. The proposed regula-
tions provided that the term individual for
purposes of section 1411 is any natural
person, except for natural persons who are

nonresident aliens. The final regulations
retain this position.

### A. Dual-resident individuals

During the consideration of comments
concerning the application of section 1411
to foreign individuals, the Treasury De-
partment and the IRS considered how sec-
tion 1411 applies to a dual-resident indi-
vidual, within the meaning of
§301.7701(b)-7(a)(1), who determines
that he or she is a resident of a foreign
country for tax purposes pursuant to an
income tax treaty between the United
States and that foreign country and claims
benefits of the treaty as a nonresident of
the United States. Consistent with
§301.7701(b)-7(a)(1), which provides
that such an individual will be treated as a
nonresident alien of the United States for
purposes of computing that individual's
United States income tax liability, the fi-
nal regulations provide that the individual
is treated as a nonresident for purposes of
section 1411.

### B. Dual-Status individuals

The Treasury Department and the IRS
also considered how section 1411 should
apply to a dual-status individual who is a
resident of the United States for part of the
year and a nonresident for the other part of
the year. The Treasury Department and
the IRS believe that a dual-status resident
should be subject to section 1411 only
with respect to the portion of the year
during which the individual is a United
States resident, and the final regulations
clarify this. However, consistent with the
rule for taxable years of less than 12
months in §1.1411-2(d)(2), the threshold
amount under §1.1411-2(d)(1) is not re-
duced or prorated for a dual-status resi-
dent. The Treasury Department and the
IRS may reconsider this rule if taxpayers
are applying it inappropriately.

### C. Section 6013(h) elections

During the consideration of comments
concerning the application of section 1411
to foreign individuals, the Treasury De-
partment and the IRS considered whether
the final regulations should provide an
election with respect to section 6013(h)

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that is similar to the election that §1.1411-
2(a)(2)(i)(B) of the proposed regulations
provided for section 6013(g). Section
6013(h) allows a dual-status individual
who is a nonresident alien at the begin-
ning of any taxable year but at the close of
such taxable year is a United States resi-
dent, and who is married to a United
States citizen or resident, to make a joint
election with his or her spouse to be
treated as a United States resident for
purposes of chapters 1 and 24 for such
taxable year. The Treasury Department
and the IRS believe that such an election
is appropriate. Accordingly, §1.1411-
2(a)(2)(iv)(B) of the final regulations
provides that a dual-status individual
who makes a section 6013(h) election
with his or her spouse for purposes of
chapters 1 and 24 also may make a
section 6013(h) election for purposes of
chapter 2A. For purposes of calculating
the tax imposed under section
1411(a)(1), the effect of such an election
is to include the combined income of the
United States citizen or resident spouse
and the dual-status spouse in the section
1411(a)(1) calculation and subject the
income of both spouses to the $250,000
threshold amount in section 1411(b)(1)
for taxpayers filing a joint return. Sec-
tion 1.1411-2(a)(2)(iv)(B)(2) of the fi-
nal regulations provides procedural re-
quirements for making this election.

If the spouses do not make a section
6013(h) election for purposes of chapter
2A (whether or not they make the election
for purposes of chapters 1 and 24), the
final regulations require each spouse to
determine his or her own net investment
income and modified adjusted gross in-
come (MAGI), and subjects each spouse
to the $125,000 threshold amount for
spouses filing separately. Consistent with
the rule for taxable years of less than 12
months in §1.1411-2(d)(2), the threshold
amount under §1.1411-2(d)(1) is not re-
duced or prorated in the case of the dual-
status resident spouse for the portion of
the year that he or she is treated as a
United States resident. The Treasury De-
partment and the IRS may reconsider this
rule if taxpayers are applying it inappro-
priately.

4\. Comments Regarding the Application
of Section 1411 to Estates and Trusts

In general, section 1411(a)(2) imposes
on estates and trusts a tax of 3.8 percent
on the lesser of their undistributed net
investment income or the excess of their
adjusted gross income (as defined in sec-
tion 67(e)) over the dollar amount at
which the highest tax bracket in section
1(e) begins for such taxable year.

A. Exclusion of certain estates and
trusts from the application of section
1411

The preamble to the proposed regula-
tions stated that section 1411 applies to
ordinary trusts described in §301.7701-
4(a) that are subject to the provisions of
part 1 of subchapter J of chapter 1 of
subtitle A of the Code, even if the trusts
have special computational rules within
part 1 of subchapter J. The proposed reg-
ulation preamble identified four such
trusts to which section 1411 will apply:
(1) pooled income funds described in sec-
tion 642(c)(5), (2) cemetery perpetual care
funds described in section 642(i), (3) qual-
ified funeral trusts described in section
685, and (4) Alaska Native settlement
trusts described in section 646. The Trea-
sury Department and the IRS requested
public comments as to whether there may
be administrative reasons to exclude one
or more of these types of trusts from sec-
tion 1411. In response, numerous com-
mentators advocated for exclusion or in-
clusion of the trusts identified above.

### i. Pooled Income Funds (PIFs)

Commentators recommended that the
final regulations provide that section 1411
not apply to PIFs because doing so would
be tantamount to taxing a charity that ul-
timately receives the property after the
expiration of the income interest. Specif-
ically, only the PIF's undistributed short-
term gains are subject to tax under chapter
1, and those gains are held for ultimate
distribution to charity. The commentators
stated that the provisions of the Code
dealing with charitable organizations, and
contributions to them, should be broadly
construed in favor of charitable organiza-
tions and their donors and, thus, section
1411 should not apply to PIFs. Further-

more, one commentator stated that treat-
ing PIFs in a manner significantly differ-
ent from charitable remainder trusts is
inequitable. The commentator analogized
PIFs, operationally, to charitable remain-
der trusts. However, the commentator ac-
knowledged that, unlike charitable re-
mainder trusts, PIFs, by being taxable on
undistributed short-term capital gains, do
not escape all instances of federal income
taxation. The commentators recom-
mended that the final regulations either:
(1) provide that a PIF's short-term capital
gains be excluded from net investment
income, or (2) exclude PIFs from the ap-
plication of section 1411 altogether.

The final regulations do not adopt these
suggestions. The Treasury Department
and the IRS recognize that imposing tax
on the PIF will reduce the amount of
property the charitable remainderman will
receive after the expiration of the income
interest. However, section 1411 limits its
exclusion to wholly charitable trusts; this
group of trusts does not include either
charitable remainder trusts or PIFs. While
charitable remainder trusts are excluded
from section 1411 by the express lan-
guage of section 664, there is no compa-
rable provision excluding PIFs.

Another commentator recommended
that the final regulations provide that the
section 642(c) charitable set-aside deduc-
tion that is available for a PIF's long-term
capital gains for income tax purposes also
reduce a PIF's net investment income. For
purposes of taxation under chapter 1 of
the Code, the taxable income of the PIF is
limited, generally, to the undistributed
short-term capital gains because the PIF
will receive an income distribution deduc-
tion for the income paid to the income
beneficiaries and any long-term capital
gains will be offset by the section
642(c)(3) charitable set aside deduction.
As is generally true throughout these reg-
ulations, the final regulations mirror this
treatment under chapter 1 for purposes of
section 1411.

### ii. Cemetery Perpetual Care Funds

One commentator stated that there is
no administrative reason why Cemetery
Perpetual Care Funds (Cemetery Trusts)
should not be treated the same as other
trusts for purposes of section 1411, and

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accordingly recommended taxing such
trusts under section 1411.

Two other commentators advocated for
the exclusion of Cemetery Trusts from
section 1411 because inclusion of such
trusts would be inconsistent with the pol-
icy behind section 1411. They stated that
Cemetery Trusts are established for con-
sumer protection, and also to ensure that
cemetery properties are maintained in per-
petuity and do not become an obligation
of the government. They noted that, as is
the case with a qualified funeral trust, a
cemetery perpetual care trust is essentially
a collection of many small, individual
trusts held for the benefit of unrelated
gravesite owners whose only common in-
terest is that they are owed the same
promise of future services from the fu-
neral provider or cemetery company.
Thus, under section 642(i), the only "ben-
eficiary" is a taxable cemetery company.
Therefore, the commentators stated that
the imposition of section 1411 tax on the
aggregate income of a perpetual care fund
would effectively be a tax on an operating
business, which directly conflicts with the
terms of section 1411.

The Treasury Department and the IRS
agree that cemetery trusts should be ex-
cluded from section 1411. By benefitting
an operating company, these trusts are
similar to the business trusts that are ex-
cluded from the operation of section 1411.
Accordingly, §1.1411-3(b)(1) of the final
regulations exclude Cemetery Perpetual
Care Funds described in section 642(i)
from the application of section 1411.

### iii. Electing Alaska Native Settlement Trusts (ANSTs)

Several commentators argued that
ANSTs should be excepted from the net
investment income tax as a matter of stat-
utory construction and as a matter of tax
policy.

Some commentators explained that the
usual rules regarding the income taxation
of trusts and their beneficiaries do not
apply to ANSTs and their beneficiaries,
and accordingly, ANSTs should not be
viewed as trusts for purposes of section
1411. Specifically, section 646 provides
special rules for the taxation of ANSTs at
the lowest individual tax rate. Further-
more, section 646 treats all distributions,

to the extent of the trust's current and
accumulated taxable income, as amounts
excludable from the gross income of the
recipient beneficiaries. Additionally, sec-
tion 646 prohibits the trust from claiming
a distribution deduction, which is a deduc-
tion allowed in computing a trust's in-
come under chapter 1 and also a deduction
allowable for purposes of section 1411.

Commentators further explained that
the statutory framework for the taxation of
ANSTs reflects important policy consid-
erations relating to the beneficiaries of
ANSTs, which were expressed in the Con-
gressional findings and declaration of pol-
icy in the Alaska Native Claims Settle-
ment Act (Public Law 92-203, 85 Stat.
688) ("ANCSA"). See 43 U.S.C.
§1601. The commentators said that those
policies include the following: Alaska Na-
tives have long been recognized as being
among the poorest inhabitants of our na-
tion, with poverty rates significantly
higher than the national average; ANSTs
are not vehicles wealthy individuals might
use to avoid the reach of section 1411 by
employing a trust to reinvest investment
income rather than making distributions;
rather, ANSTs are entities created to pro-
vide for "the real economic and social
needs of Natives" by making distributions
and/or reinvesting trust income to grow
the trust to better provide for the future
needs of its beneficiaries.

The Treasury Department and the IRS
agree with the commentators that ANSTs
should not be subject to section 1411, and
that this exclusion is consistent with the
chapter 1 taxation of these entities at the
lowest individual tax rate. Therefore, the
final regulations modify §1.1411-
3(b)(1) to exclude from section 1411 all
ANSTs that have made an election under
section 646.

### iv. Qualified Funeral Trusts (QFTs) Taxable under Section 685

One commentator stated that it was
illogical for section 1411 to apply to QFTs
because Congress intended to impose sec-
tion 1411 on "private trusts," which high-
income individuals often establish as ve-
hicles for the management and
intergenerational transfer of wealth. An-
other commentator stated that there is no
administrative reason why QFTs should

not be treated the same as other trusts for
purposes of section 1411.

Three commentators noted that a
QFT's regular tax liability is calculated on
a per-contract basis and then consolidated
into a single return. Specifically, section
685(c) provides that the tax imposed on
the QFT is calculated by treating each
beneficiary's interest in his or her contract
as a separate trust. The commentators
stated that, because the individual con-
tracts are generally under $10,000, the
annual investment income on them like-
wise is generally well under $10,000.
Thus, as a practical matter, the commen-
tators believed that QFTs would not incur
this tax (due to the investment income on
each contract being below the section
1411(a)(2)(B)(ii) threshold amount).

The final regulations do not exclude
QFTs from the application of the net in-
vestment income tax. However, the final
regulations do confirm that the calculation
of the section 1411 tax will be consistent
with the taxation of QFTs in chapter 1. As
a result, §1.1411-3(b)(2)(i) of the final
regulations provides that section 1411 is
applied to the QFT by treating each ben-
eficiary's interest in that beneficiary's
contract as a separate trust.

### v. Charitable Purpose Estates

Section 1411(e)(2) and proposed
§1.1411-3(b)(1) exclude from the appli-
cation of section 1411 a trust all of the
unexpired interests in which are devoted
to one or more of the purposes described
in section 170(c)(2)(B) (referred to as
"Charitable Purpose Trusts"). The final
regulations retain this rule in §1.1411-
3(b)(1).

One commentator pointed out that pro-
posed §1.1411-3(d) does not have an ex-
clusion comparable to proposed §1.1411-
3(b)(1) to exempt an estate all of the
unexpired interests in which are devoted
to one or more of the purposes described
in section 170(c)(2)(B) (referred to as
"Charitable Purpose Estates"). The com-
mentator noted that, although Charitable
Purpose Trusts are statutorily exempt
from the net investment income tax, Char-
itable Purpose Estates are subject to sec-
tion 1411 but may achieve the same result
through the use of the charitable deduc-
tion in section 642(c). Thus, through the

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operation of provisions outside of section
1411, it is expected that Charitable Pur-
pose Estates typically will not have a sec-
tion 1411 tax liability.

The commentator also pointed out that
a Charitable Purpose Estate's need to rely
on the section 642(c) deduction to achieve
this result (and thus, this inconsistency
between Charitable Purpose Trusts and
Charitable Purpose Estates) could have an
inadvertent and adverse impact on both
Charitable Purpose Estates and Charitable
Purpose Trusts for chapter 1 purposes -
specifically, on their decision to make an
election under section 645 (a "645 Elec-
tion"). Section 645 was enacted to elimi-
nate the differences in income tax treat-
ment between the disposition of a
decedent's property by will (through an
estate) and by a revocable trust (that be-
comes irrevocable on the decedent's
death). See H.R. Rep. No. 148, 105th
Cong., 1st Sess. 618 (1997).

Assuming a wholly-charitable disposi-
tion by a decedent, the commentator
stated that a trustee of the decedent's for-
merly revocable trust and the executor of
the related estate would normally join in a
645 Election to minimize the cost and
burden of administration and to achieve
consistency in the income tax treatment of
the estate and trust. However, unless an
estate and trust have the same exemption
from section 1411, the trustees of a Char-
itable Purpose Trust may be reluctant to
join in an otherwise useful election.

The Treasury Department and the
IRS agree with the commentator's rec-
ommendation. Given that, whether un-
der section 1411(e)(2) or section 642(c),
no section 1411 tax is imposed on a
wholly charitable trust or estate, respec-
tively, the Treasury Department and the
IRS believe it is consistent with the
Congressional intent of both section
1411 and section 645 to treat both types
of entities as exempt from section 1411.
Accordingly, §1.1411-3(b)(1) of the fi-
nal regulations excludes from the appli-
cation of section 1411 an estate in which
all of the unexpired interests are devoted
to one or more of the purposes described
in section 170(c)(2)(B).

B. Application of section 1411 to
Electing Small Business Trusts (ESBTs)

The proposed regulations preserved the
chapter 1 treatment of the ESBT as two
separate trusts for computational purposes
but consolidated the ESBT into a single trust
for determining the adjusted gross income
threshold in section 1411(a)(2)(B)(ii). This
is consistent with the chapter 1 treatment of
ESBTs, which are entitled to only a single
personal exemption, rather than one per
ESBT portion, notwithstanding the fact that
the income for each portion is computed
separately. Moreover, this rule in the pro-
posed regulations put ESBTs on the same
footing as other taxable trusts by applying a
single section 1(e) threshold to ESBTs sim-
ilar to other taxable trusts. Proposed
§1.1411-3(c)(1)(ii) described the method to
determine the ESBT's section 1411 tax
base. First, the ESBT separately calculates
the undistributed net investment income of
the S portion and non-S portion in accor-
dance with the general rules for trusts under
chapter 1, and then combines the undistrib-
uted net investment income of the S portion
and the non-S portion. Second, the ESBT
determines its adjusted gross income, solely
for purposes of section 1411, by adding the
net income or net loss from the S portion to
the adjusted gross income of the non-S por-
tion as a single item of income or loss.
Finally, to determine whether the ESBT is
subject to section 1411, the ESBT compares
the combined undistributed net investment
income with the excess of its adjusted gross
income over the section 1(e) threshold.

One commentator challenged the au-
thority of the Treasury Department and
the IRS to issue regulations that require
the use of chapter 1's separate trust treat-
ment of the S portion and non-S portion of
an ESBT for purposes of section 1411.
The commentator also stated that the lack
of any mention of ESBTs in section 1411
or its legislative history means that there
is no regulatory authority for the treatment
of an ESBT as detailed in the proposed
regulations.

The preamble to the proposed regula-
tions stated, in relevant part, that "[s]ec-
tion 1411 (which constitutes chapter 2A
of the Code) contains terms commonly
used in Federal income taxation and
cross-references certain provisions of
chapter 1 such as sections 67(e), 469,

401(a), and 475(e)(2)." However, the pre-
amble also stated that "there is no indica-
tion in the legislative history of section
1411 that Congress intended, in every
event, that a term used in section 1411
would have the same meaning ascribed to
it for other Federal income tax purposes
(such as chapter 1)." The Treasury De-
partment and the IRS believe that the
ESBT regulations under section 1411,
which generally conform to the chapter 1
framework but with certain modifications
needed for section 1411 compliance pur-
poses, fall well within the general regula-
tory authority pursuant to section 7805.

Two other commentators addressed the
inability to offset net investment income
losses (capital, ordinary, and/or passive)
from one portion of the ESBT with net
investment income from the other portion.
The commentators recommended that, if
one portion has income or a net capital
gain and the other has a net capital loss,
the ESBT should be able to offset one
against the other in the same manner as a
non-ESBT nongrantor trust. Both com-
mentators focused on the annual calcula-
tion of net investment income, but neither
addressed the potential problems from al-
lowing income and losses to offset: (1)
loss duplication in carryover years (be-
cause loss would offset gain across por-
tions in year 1 and also be a carryover to
year 2 within the originating portion), or
(2) differences in loss carryforwards for
purposes of chapters 1 and 2A.

The Treasury Department and the IRS
agree with the commentators' observa-
tions that the method of consolidation in
the proposed regulations, in certain in-
stances, may put ESBTs at a computa-
tional disadvantage, from a section 1411
perspective, to similarly situated non-
grantor trusts in the case of netting of
income and losses. However, this compu-
tational disadvantage exists with regard to
the tax imposed under chapter 1, and the
rules regarding ESBTs (and the final reg-
ulations generally) adopt chapter 1 princi-
ples. The Treasury Department and the
IRS believe a full integration of the S
portion and non-S portion into a single
trust for purposes of section 1411 is ad-
ministratively burdensome to both taxpay-
ers and the IRS because it would cause the
section 1411 calculations to deviate sig-
nificantly from the calculations for pur-

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poses of chapter 1, resulting in the need
for additional rules to address the compu-
tational differences and treatment of sep-
arate carryover regimes. For example, a
full integration of the S and non-S portion
would allow passive income and passive
losses from each portion to offset each
other, which would result in different loss
carryforwards for regular tax and section
1411 purposes. A similar outcome would
occur if capital gains and losses could offset
between the portions in a manner inconsis-
tent with chapter 1. Therefore, the final reg-
ulations retain the calculation of an ESBT's
undistributed net investment income and
modified adjusted gross income without
change, but have relocated the operative
ESBT rules to §1.1411-3(c).

One commentator recommended that
the final regulations clarify that, when an
ESBT disposes of S corporation stock, the
rules under §§1.641(c)-1(d)(3) and
1.1361-1(m)(5)(ii) that permit the use of
the installment method on the sale or dis-
position of stock in an S corporation by an
ESBT, also should apply for purposes of
section 1411. The Treasury Department
and the IRS believe that the general ad-
ministrative principles enumerated in
§1.1411-1(a) accomplish this result for
section 1411 purposes. Accordingly, a
special rule within §1.1411-3(c) is not
necessary to achieve what the commenta-
tor requested.

#### C. Application of section 1411 to Charitable Remainder Trusts (CRTs)

The proposed regulations provided
special computational rules for the classi-
fication of the income of and the distribu-
tions from charitable remainder trusts,
solely for section 1411 purposes. Pro-
posed §1.1411-3(c)(2)(i) provided that
distributions from a CRT to a beneficiary
for a taxable year consist of net invest-
ment income in an amount equal to the
lesser of the total amount of the distribu-
tions for that year, or the current and ac-
cumulated net investment income of the
CRT. Proposed §1.1411-3(c)(2)(iii) de-
fined the term accumulated net investment
income (ANII) as the total amount of net
investment income received by a CRT for
all taxable years beginning after Decem-
ber 31, 2012, less the total amount of net
investment income distributed for all prior

taxable years beginning after December
31, 2012.

The Treasury Department and the IRS
acknowledged in the preamble to the pro-
posed regulations that the classification of
income as net investment income or non-
net investment income would be separate
from, and in addition to, the four tiers
under section 664(b), which would con-
tinue to apply for chapter 1 purposes. The
Treasury Department and the IRS also
stated in the preamble that they consid-
ered an alternative method for determin-
ing the distributed amount of net invest-
ment income under which net investment
income would be determined on a class-
by-class basis within each of the §1.664-
1(d)(1) enumerated categories. The Trea-
sury Department and the IRS
acknowledged that, although differentiat-
ing between net investment income and
non-net investment income within each
class and category might be more consis-
tent with the structure created for CRTs
by section 664 and the corresponding reg-
ulations, the Treasury Department and the
IRS were concerned that the apparent re-
cordkeeping and compliance burden on
trustees would outweigh the benefits of
this alternative.

Multiple commentators asked that the
final regulations follow the existing rules
under section 664 that create subclasses in
each category of income as the tax rates
on certain types of income are changed
from time to time. They said that CRT
trustees are already maintaining the ap-
propriate records and are familiar with the
existing rules, so compliance would be
less complicated than under the new sys-
tem described in the proposed regulations.
Some of the commentators suggested that
the final regulations allow the trustee to
elect between the method described in the
proposed regulations and the existing
rules under section 664.

Section 1.1411-3(d)(2) of the final reg-
ulations adopts the commentators' request
to categorize and distribute net investment
income based on the existing section 664
category and class system. The provisions
of §1.1411-3(d)(2), as discussed in this
preamble, will apply to taxable years of
CRTs that begin after December 31, 2012,
provided however that, for CRTs that re-
lied on the proposed regulations for re-
turns filed before the publication of these

final regulations in the Federal Register,
the CRT and its beneficiary (as applica-
ble) do not have to amend their returns to
comply with rules set forth in these final
regulations. For such a CRT, when tran-
sitioning from the method in the proposed
regulations to the method in these final
regulations, the CRT may use any reason-
able method to allocate the remaining un-
distributed net investment income for that
year to the categories and classes under
section 664.

The final regulations retain the concept
of ANII. ANII is defined as the total
amount of net investment income received
by a charitable remainder trust for all tax-
able years beginning after December 31,
2012, less the total amount of net invest-
ment income distributed for all prior tax-
able years beginning after December 31,
2012. The final regulations apply the sec-
tion 664 category and class system to
ANII by providing that the Federal in-
come tax rate applicable to an item of
ANII, for purposes of allocating that item
of ANII to the appropriate class within a
category of income as described in
§1.664-1(d)(1), is the sum of the income
tax rate imposed on that item under chap-
ter 1 and the rate of the tax imposed under
section 1411. Thus, if a charitable remain-
der trust has both excluded income (such
as income received by the trust prior to
January 1, 2013, or other income received
after December 31, 2012, but excluded
from net investment income) and ANII in
an income category, such excluded in-
come and ANII will constitute separate
classes of income for purposes of §1.664-
1(d)(1)(i)(b).

The Treasury Department and the IRS
believe special rules are necessary to ap-
ply the section 664 category and class
system contained in §1.664-1(d) to cer-
tain distributions made to charitable re-
mainder trusts that own interests in CFCs
and PFICs not making the §1.1411-
10(g) election to account for the differ-
ence between the income inclusion for
chapter 1 and for section 1411 purposes.
Accordingly, the final regulations reserve
paragraph §1.1411-3(d)(2)(ii) for special
rules in this case. The companion notice
of proposed rulemaking (REG-130843-
13) contains special rules relating to CFCs
and PFICs and are proposed to be effec-

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tive for tax years beginning after Decem-
ber 31, 2013.

The final regulations reserve paragraph
§1.1411-3(d)(3) for rules allowing the
CRT to elect between the simplified
method contained in the proposed regula-
tions and the section 664 method con-
tained in these final regulations. The com-
panion notice of proposed rulemaking
(REG-130843-13) provides rules to en-
able a CRT to choose between the simpli-
fied method described in the proposed
regulations (with the modification noted
in the companion notice) and the existing
rules under section 664. The rules con-
tained in the companion proposed regula-
tion are proposed to be effective for tax-
able years beginning after December 31,
2012.

#### D. Application of section 1411 to foreign estates and trusts

Section 1411 does not address specifi-
cally the treatment of foreign estates and
foreign nongrantor trusts. Proposed
§§1.1411-3(d)(2)(i) and 1.1411-3(b)(6)
provided, as a general rule, that foreign
estates and foreign trusts are not subject to
section 1411.

##### i. Foreign Estates

The proposed regulations requested
comments as to whether section 1411
should apply to foreign estates with United
States beneficiaries. The Treasury Depart-
ment and the IRS received several com-
ments recommending that the section 1411
tax not apply to foreign estates, even those
with United States beneficiaries, as there is
little potential abuse in this context. Al-
though some commentators recommended
providing special rules for foreign estates
with United States beneficiaries, the Trea-
sury Department and the IRS continue to
believe that section 1411 should not apply to
foreign estates that often have little or no
connection to the United States. Accord-
ingly, §1.1411-3(b)(1)(ix) of the final regu-
lations provides that the section 1411 tax
does not apply to foreign estates. This rule,
however, does not exempt United States
beneficiaries of foreign estates from the ap-
plication of section 1411 to distributions
from foreign estates. The taxation under
section 1411 of United States beneficiaries

receiving distributions of net investment in-
come from a foreign estate will be consis-
tent with the general operation of subparts A
through D of part I of subchapter J and will
be subject to section 1411. See §§1.1411-
3(e)(3)(ii) and 1.1411-4(e)(1).

#### ii. Foreign Trusts

The preamble to proposed §1.1411-
3(c)(3) requested comments on the appli-
cation of section 1411 to net investment
income of foreign trusts that is earned or
accumulated for the benefit of United
States beneficiaries, including whether
section 1411 should apply to the foreign
trust, or to the United States beneficiaries
upon an accumulation distribution. Com-
mentators recommended that section 1411
should not apply to foreign trusts that ac-
cumulate income for the benefit of United
States beneficiaries, but rather, that United
States beneficiaries should be subject to
section 1411 upon the receipt of an accu-
mulation distribution from a foreign trust.

The Treasury Department and the IRS
agree that section 1411 should apply to
United States beneficiaries that receive
distributions of accumulated net invest-
ment income from a foreign trust rather
than to the foreign trust itself. The Trea-
sury Department and the IRS continue to
study how section 1411 should apply to
accumulation distributions from foreign
trusts to United States beneficiaries and
intend to issue subsequent guidance on
this issue. Pending the issuance of such
guidance, section 1411 will not apply to
distributions of accumulated income from
a foreign trust to United States benefi-
ciary. Therefore, §1.1411-4(e)(1)(ii) of
the final regulations is reserved.

The Treasury Department and the IRS
request additional comments concerning
this issue, including recommendations on
methods by which to identify accumula-
tion distributions as net investment in-
come. In particular, the Treasury Depart-
ment and the IRS are interested in
possible methods by which to determine
the "additional tax" imposed under sec-
tion 667(b) when the distribution is
"thrown back" to the relevant past tax
year, possible methods by which to iden-
tify and exclude the "additional tax" im-
posed under section 667(b) from years
prior to the effective date of section 1411,

whether a default rule similar to that con-
tained in Notice 97-34 may be a viable
approach for section 1411 purposes, and
other specific technical recommendations
(accompanied by numerical examples, if
possible) for applying section 1411 to ac-
cumulation distributions.

##### E. Calculation of undistributed net investment income

The proposed regulations provided that
undistributed net investment income of an
estate or trust is its net investment income
(as determined under proposed §1.1411-
4), reduced by the net investment income
included in the distribution to beneficia-
ries deductible by the estate or trust under
section 651 or section 661, and by the net
investment income for which the estate or
trust was entitled to a section 642(c) de-
duction, in each case as computed in ac-
cordance with §1.642(c)-2 and the alloca-
tion and ordering rules under §1.662(b)-
2. The proposed regulations adopted the
class system of income categorization,
generally embodied in sections 651
through 663 and the regulations thereun-
der, to arrive at the trust's net investment
income reduction in the case of distribu-
tions that are comprised of both net in-
vestment income and net excluded income
items. Section 1.1411-3(e) of the final
regulations retain this approach.

Proposed §1.1411-3(f) provided exam-
ples of the calculation of undistributed net
investment income. One commentator
noted that Example 1 and Example 2 of
the proposed regulations contain incorrect
computations of distributable net income,
which consequently causes an incorrect
calculation of undistributed net invest-
ment income. The final regulations correct
the computational error in these examples.

Some commentators recommended
that the final regulations allow fiduciaries
to reconsider a previous decision to in-
clude capital gains in the distributable net
income (DNI) of an estate or trust. Section
1.643(a)-3(b)(1) provides that a fiduciary
may allocate capital gains between corpus
and DNI as long as such decision is a
reasonable and impartial exercise of dis-
cretion and part of a consistent practice
over time. In general, the commentators
noted that, because section 1411 causes
many capital gains to be included in net

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investment income, an estate or trust that
does not include capital gains in DNI
causes such net investment income to be
retained in the estate or trust and thus,
because of the low income threshold ap-
plicable to estates and trusts, to be sub-
jected to the section 1411 tax more readily
than if it had been distributed. The com-
mentators note that, when a fiduciary con-
siders whether capital gains are to be
treated as part of DNI pursuant to section
643, as part of its duty to the trust or estate
and its beneficiaries, a fiduciary takes into
account any tax that would be imposed,
including any tax imposed pursuant to
section 1411. If the tax imposed by sec-
tion 1411 had existed in the year that an
existing trust or estate had first incurred
capital gains, the fiduciary may have ex-
ercised its discretion differently. The com-
mentators request that the final regulations
allow a fiduciary a "fresh start" to deter-
mine whether capital gains are to be
treated as part of DNI.

The final regulations do not adopt this
suggestion. A fiduciary's decision regard-
ing the inclusion of capital gains in DNI is
comparable to other elections under chap-
ter 1 that only indirectly impact the com-
putation of net investment income. In ad-
dition, the potential for fluctuations in the
effective tax rate on capital gains is a
factor that is foreseeable by fiduciaries
making these elections.

#### F. Material participation of estates & trusts

Several commentators noted that the
enactment of section 1411 has created an
additional and compelling reason for the
need to determine how an estate or a trust
materially participates in an activity. An
estate's or a trust's income or gain from a
trade or business activity in which the
entity materially participates does not
constitute income from a passive activity
under section 469 or section 1411. One
commentator noted that, in the case of
estates or trusts that have not incurred
losses from a passive activity, those es-
tates and trusts previously have not had to
characterize either losses or income under
section 469.

Commentators stated that the legisla-
tive history of section 469 suggests that
only a fiduciary's participation should

control in determining whether an estate
or a trust materially participates in a trade
or business activity. In certain situations,
case law has concluded that the participa-
tion of beneficiaries and employees also
should be considered. One commentator
noted that case law and IRS guidance con-
flict, leaving taxpayers with uncertainty in
determining the material participation of a
trust.

A number of commentators requested
that the Treasury Department and the IRS
provide guidance on material participation
of estates and trusts. However, the com-
mentators acknowledged that guidance on
material participation would apply under
both sections 469 and 1411, and conse-
quently suggested the initiation of a guid-
ance project to propose the rules for which
§1.469-5T(g) has been reserved.

The Treasury Department and the IRS
believe that the commentators have raised
valid concerns. The Treasury Department
and the IRS considered whether the scope
of these regulations should be broadened
to include guidance on material participa-
tion of estates and trusts. The Treasury
Department and the IRS, however, believe
that this guidance would be addressed
more appropriately in the section 469 reg-
ulations. Further, because the issues inher-
ent in drafting administrable rules under
section 469 regarding the material partic-
ipation of estates and trusts are very com-
plex, the Treasury Department and the
IRS believe that addressing material par-
ticipation of trusts and estates at this time
would significantly delay the finalization
of these regulations. However, the issue of
material participation of estates and trusts
is currently under study by the Treasury
Department and the IRS and may be ad-
dressed in a separate guidance project is-
sued under section 469 at a later date. The
Treasury Department and the IRS wel-
come any comments concerning this is-
sue, including recommendations on the
scope of any such guidance and on spe-
cific approaches to the issue.

### 5. Comments Regarding the Calculation of Net Investment Income

Section 1411(c)(1) defines net invest-
ment income as the excess (if any) of (A)
the sum of: (i) gross income from interest,
dividends, annuities, royalties, and rents,

other than such income derived in the
ordinary course of a trade or business to
which the tax does not apply, (ii) other
gross income from trades or businesses to
which the tax applies, and (iii) net gain (to
the extent taken into account in computing
taxable income) attributable to the dispo-
sition of property other than property held
in a trade or business to which the tax
does not apply, over (B) deductions al-
lowed by subtitle A that are properly al-
locable to such gross income or net gain.
Section 1.1411-4 of the proposed regula-
tions provided guidance on the calculation
of net investment income. The final regu-
lations retain the general structure of pro-
posed §1.1411-4 with some modifica-
tions as discussed in this part.

### A. Interaction with section 469

Section 469 and the regulations there-
under provide several rules that restrict
the ability of taxpayers to artificially gen-
erate passive income from certain types of
passive activities. The preamble to the
proposed regulations provided a summary
of the section 469 rules applicable for
purposes of section 1411. The preamble
identified certain aspects of the section
469 regulations that would apply for sec-
tion 1411 purposes (such as the various
types of recharacterization rules), and
other areas where certain section 469 rules
were not applicable for purposes of sec-
tion 1411 (for example, the scope of a
passive activity under section 469 is
broader than the section 1411(c)(2)(A)
definition of passive activity).

The preamble to the proposed regula-
tions identified a series of section 469
rules that recharacterize income from a
passive activity as income not from a pas-
sive activity (income recharacterization
rules). Commentators requested the final
regulations clarify the interaction between
certain aspects of the income recharacter-
ization rules and items of gross income
included in section 1411(c)(1)(A). One
such income recharacterization involves
section 469(e)'s definition of portfolio in-
come versus working capital. The com-
ments regarding portfolio income are dis-
cussed in this part of the preamble and
comments regarding working capital are
discussed in part 7 of this preamble. Part 6

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discusses comments regarding the net in-
come recharacterization rules.

#### B. Gross income items described in section 1411(c)(1)(a)(i)

##### i. Portfolio Income

The Treasury Department and the
IRS received several comments regard-
ing the interaction between section
1411(c)(1)(A)(i) and the portfolio income
items described in section 469(e)(1)(A)
and the regulations thereunder. One com-
mentator suggested that the final regula-
tions cross reference the definition of port-
folio income so that items included in
portfolio income for section 469 purposes
are net investment income under section
1411(c)(1)(A)(i).

In general, section 469(e)(1)(A)(i)(I) de-
fines portfolio income as interest, dividends,
annuities, or royalties not derived in the
ordinary course of a trade or business. The
Treasury Department and the IRS recognize
that this definition is similar to section
1411(c)(1)(A)(i). However, pursuant to the
specific grant of authority to promulgate
regulations under section 469 provided to
the Treasury Department and the IRS in
section 469(1), §1.469-2T(c)(3) expands the
definition of portfolio income to include, for
example, income from controlled foreign
corporations and qualified electing funds.

Furthermore, §1.469-1T(d)(1) pro-
vides that the characterization of items of
income or deduction as passive activity
gross income (within the meaning of
§1.469-2T(c)) does not affect the treat-
ment of any item of income or gain under
any provision of the Code other than sec-
tion 469. Therefore, the characterization
of certain types of income, gain, loss, and
deduction as portfolio income under
§1.469-2T(c)(3) is expressly limited to
the section 469 context. While many of
the provisions of section 469 impact the
classification of income, gain, loss, and
deduction for net investment income pur-
poses within section 1411, such interac-
tion with section 469 is generally limited
to the determination of whether those
items are attributable to a passive activity
within the meaning of section
1411(c)(2)(A). Accordingly, because the
scope of portfolio income as defined in the
regulations under section 469 does not

match the scope of net investment income
items in section 1411(c)(1)(A)(i), the final
regulations do not adopt this recommen-
dation.

### ii. Definition of "Derived in the Ordinary Course of a Trade or Business"

The preamble to the proposed regula-
tions stated that the ordinary course of a
trade or business exception is a two-part
test. First, the item must be "derived in" a
trade or business not described in section
1411(c)(2). Second, such item must be
derived in the "ordinary course" of such
trade or business. The preamble to the
proposed regulations provided that a trade
or business refers to a trade or business
within the meaning of section 162 but the
phrase was not defined in the proposed
regulations. The proposed regulations did
not provide guidance on the meaning of
"ordinary course."

### a. Definition of a trade or business

Several commentators requested guid-
ance concerning the meaning of "trade or
business." Commentators suggested that
the regulations include references to rele-
vant case law and administrative guid-
ance. A commentator requested that the
regulations expand upon existing guid-
ance by including bright-line examples of
what constitutes a trade or business to aid
taxpayers in determining if income is de-
rived in the ordinary course of a trade or
business and thus is excluded from net
investment income.

As noted in part 6.A. of the preamble to
the proposed regulations, the rules under
section 162 have long existed as guidance
for determining the existence of a trade or
business and are applied in many circum-
stances. Whether an activity constitutes a
trade or business for purposes of section
162 is generally a factual question. For
example, in Higgins v. Commissioner, 312
U.S. 212 (1941), the Supreme Court stated
that the determination of "whether the ac-
tivities of a taxpayer are 'carrying on a
trade or business' requires an examination
of the facts in each case." 312 U.S. at 217.
Except for certain clarifications made in
response to the proposed regulations, fur-
ther guidance concerning the definition of

trade or business is beyond the scope of
these regulations.

In response to these commentators,
§1.1411-1(d) of the final regulations pro-
vides that the term trade or business,
when used in section 1411 and the final
regulations, describes a trade or business
within the meaning of section 162. The
section 162 reference incorporates case
law and administrative guidance applica-
ble to section 162.

One commentator noted that determin-
ing whether income is earned in a section
162 trade or business under a separate
entity approach, as reflected in proposed
§1.1411-4(b), will yield unexpected re-
sults that are inconsistent with section
162. For purposes of determining whether
income is earned under section 162, the
commentator noted that §1.183-1(d) pro-
vides that activities are determined and
their section 162 trade or business status is
evaluated by aggregating undertakings in
any reasonable manner determined by the
taxpayer.

The Treasury Department and the IRS
do not believe that the determination of a
trade or business under section 162 man-
dates the use of the definition of "activity"
within the meaning of §1.183-1(d). Sec-
tion 183 disallows expenses in excess of
income attributable to activities not en-
gaged in for profit. Section 1.183-1(a)
provides that section 162 and section 212
activities are not subject to section 183
limitations. The definition of activity
within §1.183-1(d) allows taxpayers lati-
tude to combine different activities into a
single activity to establish that the tax-
payer is engaged in an activity for profit,
and thus is not subject to the section 183
limitation. However, once the taxpayer
determines that section 183 is not appli-
cable, the taxpayer then must determine
whether the activity is a section 162 trade
or business or a section 212 for-profit ac-
tivity. Furthermore, different definitions
of "activity" can be found in sections 465
and 469. Therefore, the Treasury Depart-
ment and the IRS do not believe that de-
termining whether a trade or business ex-
ists using the activity determinations of
Code provisions unrelated to section 162
is appropriate.

The Treasury Department and the IRS
received multiple comments regarding the
determination of a trade or business

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within the context of rental real estate.
Specifically, commentators stated that Ex-
ample 1 of proposed §1.1411-5(b)(2) is
inconsistent with existing case law regard-
ing the definition of a trade or business of
rental real estate. Commentators cited
cases such as Fackler v. Commissioner,
45 BTA 708 (1941), aff'd, 133 F.2d 509
(6th Cir. 1943); Hazard v. Commissioner,
7 T.C. 372 (1946); and Lagreide v. Com-
missioner, 23 T.C. 508 (1954), for the
proposition that the activities of a single
property can rise to the level of a trade or
business.

The Treasury Department and the IRS
agree with commentators that, in certain
circumstances, the rental of a single prop-
erty may require regular and continuous
involvement such that the rental activity is
a trade or business within the meaning of
section 162. However, the Treasury De-
partment and the IRS do not believe that
the rental of a single piece of property
rises to the level of a trade or business in
every case as a matter of law. For exam-
ple, §1.212-1(h) provides that the rental
of real property is an example of a for-
profit activity under section 212 and not a
trade or business.

Within the scope of a section 162 de-
termination regarding a rental activity,
key factual elements that may be relevant
include, but are not limited to, the type of
property (commercial real property versus
a residential condominium versus per-
sonal property), the number of properties
rented, the day-to-day involvement of the
owner or its agent, and the type of rental
(for example, a net lease versus a tradi-
tional lease, short-term versus long-term
lease). Therefore, due to the large number
of factual combinations that exist in de-
termining whether a rental activity rises to
the level of a section 162 trade or busi-
ness, bright-line definitions are impracti-
cal and would be imprecise. The same is
true wherever the section 162 trade or
business standard is used and is not
unique to section 1411. The Treasury De-
partment and the IRS decline to provide
guidance on the meaning of trade or busi-
ness solely within the context of section
1411. However, the Treasury Department
and the IRS have modified Example 1 in
§1.1411-5(b)(3) to explicitly state that the
rental property in question is not a trade or

business under applicable section 162
standards.

In cases where other Code provisions
use a trade or business standard that is the
same or substantially similar to the section
162 standard adopted in these final regu-
lations, the IRS will closely scrutinize sit-
uations where taxpayers take the position
that an activity is a trade or business for
purposes of section 1411, but not a trade
or business for such other provisions. For
example, if a taxpayer takes the position
that a certain rental activity is a trade or
business for purposes of section 1411, the
IRS will take into account the facts and
circumstances surrounding the taxpayer's
determination of a trade or business for
other purposes, such as whether the tax-
payer complies with any information re-
porting requirements for the rental activity
imposed by section 6041.

#### b. Definition of "derived in the ordinary course"

Section 1411 does not define the phrase
"derived in the ordinary course" within the
context of a trade or business. The preamble
to the proposed regulations stated that other
regulation sections and case law provide
guidance on whether an item of gross in-
come is derived in the ordinary course of a
trade or business and specifically referenced
§1.469-2T(c)(3)(ii) as an example.

The Treasury Department and the
IRS received comments regarding the
meaning of the phrase "derived in the
ordinary course" within the context of
section 1411(c)(1)(A)(i) and proposed
§1.1411-4(b).

Within the context of section 469, in-
come from interest, dividends, royalties,
and annuities is classified as portfolio in-
come unless such income is derived in the
ordinary course of a trade or business.
Section 1.469-2T(c)(3)(ii)(A) through
(c)(3)(ii)(G), which implements section
469(e)(1)(B), identifies several situations
where interest, dividends, royalties, or an-
nuities are derived in the ordinary course
of a trade or business, and therefore are
not portfolio income. If the interest, divi-
dends, royalties, or annuities do not fall
into one of these situations, then they con-
stitute working capital because they are
not derived in the ordinary course of a
trade or business. If the assets that gener-

ate the interest, dividends, royalties, and
annuities are not held in a trade or busi-
ness, however, then the classification of
the income as working capital by refer-
ence to §1.469-2T(c)(3)(ii) is irrelevant.

Proposed §1.1411-6 defined working
capital by reference to section 469(e)(1)(B)
and §1.469-2T(c)(3)(ii). The definition of
working capital in §1.1411-6(a) of the final
regulations continues to reference §1.469-
2T(c)(3)(ii). If a trade or business receives
interest, dividends, royalties, or annuities,
and the income is working capital under
§1.1411-6(a), then it is not derived in the
ordinary course of a trade or business for
purposes of section 1411(c)(1)(A)(i) and
§1.1411-4(b). Conversely, if a trade or
business receives interest, dividends, royal-
ties, or annuities, and the income is not
working capital under §1.1411-6(a) be-
cause it falls within one of the situations in
§1.469-2T(c)(3)(ii), then such income is
derived in the ordinary course of a trade or
business for both section 469 and section
1411(c)(1)(A)(i) and §1.1411-4(b). As a re-
sult of the interaction between §1.1411-
6(a) and §1.469-2T(c)(3)(ii), the Treasury
Department and the IRS do not believe that
any special rules are necessary within
§1.1411-4(b) defining "derived in the ordi-
nary course" or, conversely, "working cap-
ital" with respect to section 1411(c)(1)(A)(i)
income other than rents. In the case of rents,
which are not covered by §1.469-
2T(c)(3), case law will provide guidance on
whether rents are derived in the ordinary
course of a trade or business. Additional
public comments pertaining to the definition
of working capital are discussed in part 7 of
this preamble.

### iii. Income from Annuities

The preamble of the proposed regula-
tions provided that gross income from an-
nuities includes the amount received as an
annuity under an annuity, endowment, or
life insurance contract that is includible in
gross income as a result of the application
of section 72(a) and section 72(b), and an
amount not received as an annuity under
an annuity contract that is includible in
gross income under section 72(e).

The Code does not define the term an-
nuity. Section 72(a) provides that gross
income includes any amount received as
an annuity under an annuity, endowment,

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or life insurance contract. Section 72(b),
however, excludes from gross income that
part of an amount received as annuity that
bears the same ratio to that amount as the
investment in the contract bears to the
expected return under the contract (deter-
mined as of the annuity starting date).

Section 72(e) governs the treatment of
amounts received under an annuity con-
tract that are not received as an annuity
(such as lump sum distributions or surren-
ders). Section 72(e)(2) provides in general
that such amounts received on or after the
annuity starting date are included in gross
income, and that amounts received before
the annuity starting date are included in
gross income to the extent allocable to
income on the contract on an income-first
basis.

The preamble to the proposed regula-
tions provided that gain or loss from the
sale of an annuity is treated as net invest-
ment income for purposes of section 1411.
To the extent the sales price of an annuity
does not exceed its surrender value, the
gain recognized is treated as gross income
described in section 1411(c)(1)(A)(i) and
§1.1411-4(a)(1)(i). If the sales price of
the annuity exceeds its surrender value,
the seller treats the gain equal to the dif-
ference between the basis in the annuity
and the surrender value as gross income
described in section 1411(c)(1)(A)(i) and
§1.1411-4(a)(1)(i), and treats the excess
of the sales price over the surrender value
as gain from the disposition of property
under section 1411(c)(1)(A)(iii) and
§1.1411-4(a)(1)(iii). The final regulations
generally retain this approach.

One commentator stated that the defi-
nition of the term "annuity" provided in
the preamble of the proposed regulations
is too expansive. The commentator re-
quested that the final regulations clarify
that only items of income for which a
taxpayer is liable under section 72(a) are
subject to the net investment income tax.
The final regulations do not adopt the re-
quested change. The principles and rules
under chapter 1 of the Code generally
apply, where appropriate, in interpreting
the statutory language of section 1411.
Section 1411(c)(1)(A)(i) provides that net
investment income includes "gross in-
come from ... annuities." Amounts re-
ceived as an annuity under an annuity
contract are includible in gross income

under section 72(a) and section 72(b).
However, there are other types of distri-
butions from annuity contracts that are
includible in gross income under section
72(e). Such amounts may include, for ex-
ample, dividends received from an annu-
ity contract. See section 72(e)(1)(B). We
believe it is appropriate to apply these
same rules in determining what consti-
tutes gross income from annuities for pur-
poses of section 1411. Therefore, amounts
received under annuity contracts that are
includible in income under section 72(a),
(b), and (e) are subject to the net invest-
ment income tax.

One commentator requested that the
final regulations clarify that net invest-
ment income from charitable gift annui-
ties established post-2012 will be spread
over the annuitant's life expectancy, sim-
ilar to other items of income, pursuant to
§1.1011-2(c), Example 8. The commen-
tator also requested that the final regula-
tions clarify that the income recognized
and distributed from charitable gift annu-
ities established prior to 2013 is not sub-
ject to the net investment income tax. The
commentator asked that the final regula-
tion extend the benefit afforded to CRTs
with regard to pre-2013 gifts to pre-2013
funded charitable gift annuities.

Charitable gift annuities, like installment
sales and other tax deferral transactions, de-
fer the recognition of income to a future
year. Charitable gift annuities share more
characteristics with installment sales than
with CRTs. In the case of installment sales,
amounts received in taxable years beginning
after December 31, 2012, on installment
sales made prior to the effective date of
section 1411 are included in net investment
income, unless an exception applies. See
§1.1411-4(d)(4)(i)(C), Example 2. A CRT,
as defined in section 664, must provide for
the distribution of a specified payment, at
least annually, to one or more persons (at
least one of which is a noncharitable bene-
ficiary). Upon the termination of the non-
charitable interest or interests, the remainder
must either be held in continuing trust for
charitable purposes or be paid to or for the
use of one or more organizations described
in section 170(c). During its operation, a
CRT is a tax-exempt entity. Unlike charita-
ble gift annuities, the Federal income tax
character of the income received by a
CRT's annuity or unitrust beneficiary is de-

pendant on the Federal income tax character
of the income received by the CRT in the
year of distribution and, in many cases, in-
come received in year(s) prior to the distri-
bution. In the case of charitable gift annui-
ties, the amount and character of the income
paid to the annuity recipient generally is
known at the inception of the annuity. Fur-
thermore, the amount and character of the
income paid to the annuity recipient is not
dependent on the charity's use (or sale) of
the property exchanged for the annuity. The
section 1411 policy reason behind the ex-
clusion of pre-2013 accumulated income
within a CRT from net investment income is
that the character is passed through from the
CRT to the recipient, and pre-2013 income
is not net investment income. Because the
character of the distribution to the recipient
of a charitable gift annuity is not dependent
on its character in the hands of the payor, the
final regulations do not adopt the requested
change.

### B. Gross income items described in section 1411(c)(1)(a)(ii)

Net investment income also includes
other gross income derived from a trade
or business described in section
1411(c)(2). For a trade or business de-
scribed in section 1411(c)(2)(A), that is,
a trade or business that is a passive
activity with respect to the taxpayer,
proposed §1.1411-4(c) provided that
section 1411(c)(1)(A)(ii) includes other
gross income that is not included in sec-
tion 1411(c)(1)(A)(i) or section
1411(c)(1)(A)(iii). For a trade or busi-
ness described in section 1411(c)(2)(B),
that is, a trade or business of trading in
financial instruments or commodities (a
"trading business"), proposed §1.1411-
4(c) provided that section
1411(c)(1)(A)(ii) includes all other
gross income from such trade or busi-
ness that is not included in section
1411(c)(1)(A)(i). See part 5.b.ii.a of this
preamble for a discussion of the defini-
tion of a trade or business for purpose of
section 1411.

The Treasury Department and the IRS
received a number of comments regarding
the proper treatment of gains and losses
from a trade or business of trading in finan-
cial instruments or commodities described
in section 1411(c)(2)(B). For chapter 1

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purposes, a taxpayer engaged in a trading
business combines gains and losses from
trading activities to arrive at a net amount
of gain or loss from the trading business.
Under proposed §1.1411-4(c)(2), all
gross income from a trading business is
included in net investment income under
section 1411(c)(1)(A)(ii), except for inter-
est, dividends, rents, royalties, and annu-
ities included in net investment income
under section 1411(c)(1)(A)(i). Under
proposed §1.1411-4(f)(4), section 165
losses are taken into account under section
1411(c)(1)(A)(iii) and are subject to a limit
on net losses. Commentators interpreted
these proposed regulations to mean that all
gains from the trading activities of a trading
business are included in net investment in-
come under section 1411(c)(1)(A)(ii), while
the offsetting trading losses would be under
section 1411(c)(1)(A)(iii). As a result, the
section 1411(c)(1)(A)(iii) loss limitation
would prevent a trading business from net-
ting the gains and losses for purposes of the
net investment income tax. Multiple com-
mentators recommended that trading losses
generated by a trading business should be
allocated to the same category as trading
gains. Some commentators recommended
that proposed §1.1411-4(f)(4) not apply to
trading gains, which would allow trading
losses to offset trading gains under section
1411(c)(1)(A)(ii). Other commentators rec-
ommended that trading gains should be in-
cluded in net investment income under sec-
tion 1411(c)(1)(A)(iii) rather than under
section 1411(c)(1)(A)(ii).

The Treasury Department and the IRS
agree that trading gains and losses should
be assigned to the same category of net
investment income. Because section
1411(c)(2)(B) does not distinguish be-
tween a trader who has made a section
475(f) mark-to-market election (a "section
475 trader") and a trader who has not
made a section 475(f) mark-to-market
election (a "non-section 475 trader"),
aligning gains and losses from a trading
business requires rules that apply equally
to a section 475 trader and to a non-
section 475 trader. Chapter 1, however,
provides different timing and character
rules for the two types of traders. For a
section 475 trader, all securities and com-
modities held in a trading business are
marked to market on the last day of the tax
year, both realized and mark-to-market

gains or losses have ordinary character,
and any net trading loss may be used to
offset other income under chapter 1. In
contrast, a non-section 475 trader gener-
ally does not mark securities and com-
modities to market, gains and losses rec-
ognized from trading are capital in
character, and any net trading loss would
be subject to chapter 1 capital loss limita-
tions. One possible solution is to assign
the trading gains and losses from both
section 475 traders and non-section 475
traders to section 1411(c)(1)(A)(ii), which
would permit a non-section 475 trader to
use net trading losses to offset other net
investment income. Another possible so-
lution is to assign the trading gains and
losses from both section 475 traders and
non-section 475 traders to section
1411(c)(1)(A)(iii), thereby making a sec-
tion 475 trader subject to the loss limita-
tions of that section. Under either sce-
nario, some traders would be treated
differently for purposes of section 1411
and chapter 1. This would have required
those traders to maintain a separate set of
books and records specifically to comply
with section 1411.

To minimize the inconsistencies be-
tween chapter 1 and section 1411 for
traders, the final regulations assign all
trading gains and trading losses to sec-
tion 1411(c)(1)(A)(iii). The final regula-
tions also permit a taxpayer to deduct
excess losses from the trading business
of a section 475 trader from other cate-
gories of income. Part 5.C of this pre-
amble describes the treatment of those
excess losses. Section 1.1411-4(c) of the
final regulations provides that gross in-
come from a trading business is included
in net investment income under section
1411(c)(1)(A)(ii) only to the extent that
income is not included in section
1411(c)(1)(A)(i) or (c)(1)(A)(iii). This
change aligns the categorization of in-
come between section 1411(c)(1)(A)(i),
(c)(1)(A)(ii), and (c)(1)(A)(iii) in a manner
consistent with income from a passive ac-
tivity trade or business described in section
1411(c)(2)(A). As a result, the final regula-
tions now categorize gross gains from the
disposition of property associated with a
trading business as net investment income
under section 1411(c)(1)(A)(iii), which may
be offset by losses from trading dispositions.
However, see part 5.C of this preamble for a

discussion of additional changes relative to
section 1411(c)(1)(A)(iii) and section
1411(c)(1)(B) that impact the calculation of
net investment income for items of gain and
loss attributable to a trading business.

### C. Calculation of net gain in section 1411(c)(1)(a)(iii)

The proposed regulations provided that
net investment income includes net gain (to
the extent taken into account in computing
taxable income) attributable to the sale, ex-
change, transfer, conversion, cash settle-
ment, cancellation, termination, lapse, expi-
ration, or other disposition (collectively,
referred to as the disposition) of property
other than property held in a trade or busi-
ness not described in section 1411(c)(2).
The proposed regulations provided that, be-
cause section 1411(c)(1)(A)(iii) uses the
term "net gain" and not the term "net gain or
loss," the amount of net gain included in net
investment income may not be less than
zero. However, the proposed regulations
also provided that losses allowable under
section 1211(b)(1) and (b)(2) are permitted
to offset gain from the disposition of assets
other than capital assets that are subject to
section 1411.

#### i. Overall Limits on Losses

Several commentators suggested that, in-
stead of limiting net gain to zero, losses in
excess of gains should offset other net in-
vestment income in order to reflect the true
economic net investment income for any
given year. One commentator acknowl-
edged that the position taken by the pro-
posed regulations appears consistent with
the statutory definition of net investment
income because section 1411(c)(1)(A)(iii)
appears to preclude the possibility of a net
loss. Another commentator observed that
the proposed regulations place excessive
stress on the word "gain" in section
1411(c)(1)(A)(iii), and insufficient stress on
the word "net." Stressing the word "gain"
prevents a taxpayer from deducting a $3,000
capital loss limit against other investment
income (such as interest). Another commen-
tator stated that, because chapter 1 imposes
significant constraints on deducting capital
losses against non-capital income (such as
the prohibition on carrybacks of such losses
for individuals), and imposes a variety of

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limitations on deducting ordinary losses
under section 165, including losses that
become section 165 deductions through
the operation of other provisions such as
section 475, 988, or 1231, there does not
appear to be any reason to impose addi-
tional limitations on those deductions for
section 1411 purposes. A number of com-
mentators recommended that losses in ex-
cess of gains be allowed as a properly
allocable deduction that may offset other
net investment income from section
1411(c)(1)(A)(i) or (c)(1)(A)(ii). Some
commentators suggested that section
1411(c)(1)(B) properly allocable deduc-
tions include any capital losses allowed
for chapter 1 purposes. Several other com-
mentators suggested that there should be
no limit imposed on losses, capital or or-
dinary.

Section 1.1411-4(d)(2) of the final reg-
ulations retains the overall limitation of the
proposed regulations on allowable losses
that the calculation of net gain within sec-
tion 1411(c)(1)(A)(iii) cannot be less than
zero. The Treasury Department and the IRS
believe that provision follows the statutory
language of section 1411(c)(1)(A)(iii).
However, §1.1411-4(f)(4) of the final reg-
ulations provides that losses described in
section 165, whether described in section 62
or section 63(d), are allowed as a properly
allocable deduction to the extent such losses
exceed the amount of gain described in sec-
tion 61(a)(3) and are not taken into account
in computing net gain by reason of
§1.1411-4(d). Thus, although §1.1411-
4(d)(2) imposes an overall limitation on net
gain included in net investment income by
reason of section 1411(c)(1)(A)(iii),
§1.1411-4(f)(4) allows losses in excess of
gains as a properly allocable deduction to
the extent the losses would be allowable in
computing taxable income under chapter 1.
Losses are first applied to calculate net gain
under §1.1411-4(d), and then §1.1411-
4(f)(4) applies to the excess losses. This
ordering rule prevents taxpayers from de-
ducting the same loss twice: first in calcu-
lating net gain under §1.1411-4(d), and
then again in §1.1411-4(f)(4). As a result,
final §1.1411-4(f)(4) allows, as a properly
allocable deduction, the $3,000 capital loss
($1,500 in the case of an individual filing as
married filing separately) allowed by section
1211(b) in all cases. Furthermore, a tax-
payer, such as a section 475 trader, that has

ordinary losses in excess of ordinary gains
and net capital gains, may claim those ex-
cess losses as a §1.1411-4(f)(4) properly
allocable deduction.

Furthermore, the final regulations re-
tain the definition of disposition as the
sale, exchange, transfer, conversion, cash
settlement, cancellation, termination,
lapse, expiration, or other disposition of
property.

A commentator suggested that section
1411 does not apply to a deemed sale
resulting from section 877A. Section
877A(a)(1) provides, in relevant part, that
"For purposes of this subtitle, all property
of a covered expatriate shall be treated as
sold on the day before the expatriation
date for its fair market value." The Trea-
sury Department and the IRS believe that
any gain taken into account in computing
a covered expatriate's taxable income is
also included in net investment income
because the operative provision of section
877A(a)(1) treats the property as sold for
purposes of subtitle A, which includes
section 1411. Accordingly, the final regu-
lations clarify that a deemed sale under
section 877A, which applies for purposes
of subtitle A, is a disposition of property
subject to section 1411.

### ii. Treatment of Certain Capital Loss Carryforwards

The proposed regulations provided,
and the final regulations retain, the provi-
sion that except as otherwise expressly
provided in regulations, the income tax
gain and loss recognition rules in chapter
1 apply for purposes of determining net
gain under section 1411. Losses properly
taken into account in determining net gain
include all losses deductible under section
165 to the extent they are attributable to
property that is either: (1) not held in a
trade or business, or (2) held in a trade or
business described in proposed §1.1411-
5. Therefore, under the proposed regula-
tions, net gain took into account capital
losses carried over from prior years by
reason of section 1212(b)(1) (including
years preceding the effective date of sec-
tion 1411). The final regulations retain
this position.

The Treasury Department and the IRS
received several comments and inquiries
regarding the treatment of capital loss car-

ryforwards. The final regulations reserve
paragraph §1.1411-4(d)(4)(iii) for special
rules that the Treasury Department and
the IRS believe are necessary to properly
address capital loss carryforwards. The
companion notice of proposed rulemaking
(REG-130843-13) contains an explana-
tion of the proposed rule and the proposed
regulation text.

### D. Properly allocable deductions described in section 1411(c)(1)(b)

Section 1411(c)(1)(B) provides that net
investment income includes deductions
allowed by subtitle A that are properly
allocable to gross income or net gain de-
scribed in section 1411(c)(1)(A). Section
1.1411-4(f)(1)(i) of the proposed regula-
tions provided that "[u]nless specifically
stated otherwise, only properly allocable
deductions described in this paragraph (f)
may be taken into account in determining
net investment income." Specifically, pro-
posed §1.1411-4(f)(3) provided that
properly allocable deductions include: (A)
investment interest expense, (B) invest-
ment expenses described in section
163(d)(4)(C), and (C) state, local, and for-
eign income taxes described in section
164(a)(3). The Treasury Department and
the IRS intend this rule to limit the deduc-
tions against net investment income to
those specifically enumerated in para-
graph (f).

One commentator recommended that
the final regulations provide that the
phrase "properly allocable deductions"
comprise all of the chapter 1 deductions
that are allowed against chapter 1 gross
income from rent, dividends, royalties, an-
nuities and interest, other gross income
derived from a trade or business, and net
gains attributable to the disposition of
property other than property held in a
trade or business.

The Treasury Department and the
IRS believe the recommended language
would permit taxpayers to argue that
they can take deductions that have no
direct relation to net investment income,
and it would lead to uncertainty and to
disputes between taxpayers and the IRS
over what constitutes properly allocable
deductions. However, the Treasury De-
partment and the IRS acknowledge that
flexibility is needed within §1.1411-

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4(f) so that future changes in law or
circumstances can be more easily inte-
grated into the regulations. Although the
cross-references in §1.1411-4(f)(2) to
deductions described in section 62(a)
provide section 1411(c)(1)(B) flexibility
to automatically take into account addi-
tions or changes to chapter 1 deductions
attributable to trades or business, rents,
and royalties, these regulations would
have to be amended to expand properly
allocable deductions in the event of such
changes not captured by section 62(a)(1)
or 62(a)(4). To strike a balance between
the intent of the proposed rule (to pro-
vide a specific list of deductions to limit
uncertainty and controversy) and the
recognized value of future flexibility in-
herent in the commentators' recommen-
dation, §1.1411-4(f)(6) of the final reg-
ulations allows the Treasury Department
and the IRS to publish additional guid-
ance in the Internal Revenue Bulletin
that expands the list of properly alloca-
ble deductions.

### i. Inclusion of Additional Properly Allocable Deductions

Commentators requested that properly
allocable deductions also include amounts
described in sections 72(b)(3), 642(h),
691(b), 691(c), 1341, and 7518 (c)(1)(A).

Section 72(b)(3) allows a deduction for
unrecovered basis in an annuity when an
annuitant dies with unrecovered basis in
the annuity contract. Section 72(b)(3) al-
lows the deduction on the decedent's final
income tax return. The Treasury Depart-
ment and the IRS believe that, because an
annuity contract would have produced in-
come subject to tax under section 1411
had the annuitant continued living, it is
appropriate to allow the deduction under
section 72(b)(3) in calculating the net in-
vestment income for the decedent's final
taxable year. Accordingly, §1.1411-
4(f)(3)(iv) of the final regulations pro-
vides that the section 72(b)(3) deduction
for unrecovered annuity basis is a prop-
erly allocable deduction.

Section 642(h) provides "[i]f on the
termination of an estate or trust, the estate
or trust has (1) a net operating loss carry-
over under section 172 or a capital loss
carryover under section 1212, or (2) for
the last taxable year of the estate or trust

deductions (other than the deductions al-
lowed under subsections (b) or (c)) in
excess of gross income for such year, then
such carryover or such excess shall be
allowed as a deduction . .. to the benefi-
ciaries succeeding to the property of the
estate or trust."

Section 691(b) provides that an estate
(or successor to property) may take de-
ductions described in section 162, 163,
164, 212, or 611 in respect of a decedent,
which are not properly allowable to the
decedent in the taxable period prior to or
in which falls the date of the decedent's
death (these items are often referred to as
Deductions in Respect of a Decedent, or
"DRD"). Section 691(b) is the statutory
mechanism that allows a deduction to the
estate (or other successor to property) be-
cause, under the normal accounting rules,
the decedent would have been entitled to
the deduction but failed to live long
enough to take it. The section 691(b) list-
ing of deductions is an exclusive list. If a
deduction is not listed (such as suspended
capital losses), then it is not deductible
under this provision.

The Treasury Department and the IRS
believe that it is appropriate to provide a
special rule that allows a beneficiary to
succeed to the deductions of a terminating
estate or trust in the same fashion as that
provided by section 642(h) for chapter 1
purposes. In addition, the Treasury De-
partment and the IRS believe that it is
appropriate to provide a special rule that
allows for deductions described in section
691(b) to be claimed by an estate or a
successor to the estate. However, to limit
the deductions to those that would have
been deductible had the predecessor been
able to deduct the expenses, the scope of
allowable deductions under these special
rules is limited to only those deductions
allowed under §1.1411-4(f), and only to
the extent that the terminating estate or
trust has negative net investment income
upon termination.

Section 691(c) allows a deduction for
estate taxes imposed on items of income
that are Income in Respect of a Decedent
(IRD) under section 691(a). The section
691(c) deduction allowed for estate tax
attributable to IRD that is ordinary income
must be claimed as an itemized deduction,
and not as a deduction from gross income
in arriving at adjusted gross income

(AGI), because it is not among the deduc-
tions listed in section 62. However, the
section 691(c) deduction is not subject to
the 2-percent floor under section 67.

In the case of IRD that is capital gain,
section 691(c)(4) provides that "[f]or pur-
poses of section 1(h), 1201, 1202, and
1211, the amount taken into account with
respect to any item described in subsec-
tion (a)(1) shall be reduced (but not below
zero) by the amount of the deduction al-
lowable under paragraph (1) of this sub-
section with respect to such item."

Net investment income may include
items of IRD (such as annuities and
outstanding installment sale payments)
that may carry with it a deduction under
section 691(c) for chapter 1 purposes.
Therefore, the Treasury Department and
the IRS believe it is consistent with the
general principles of section 691 also to
allow the section 691(c) deduction to
reduce net investment income. Section
1.1411-4(f)(3)(v) of the final regula-
tions provides that the deduction de-
scribed in section 691(c) is a properly
allocable deduction, except to the extent
that the section 691(c) deduction is
taken into account in determining net
gain (within the meaning of §1.1411-
4(d)) by reason of section 691(c)(4).

Generally, section 1341 applies if: (1) a
taxpayer included an item in gross income
in a prior taxable year because it appeared
that the taxpayer had a claim of right to
the item, and (2) a deduction is allowable
for the repayment of the item in a later
taxable year under some provision of the
Code other than section 1341 because it is
established that the taxpayer did not have
a right to the item. If section 1341 applies,
a taxpayer's tax liability for the year of
repayment (or the taxable year in which
the obligation to make repayment other-
wise gives rise to a deduction) is based on
the lesser of: (A) the tax for the taxable
year, computed with a deduction of the
repayment amount ("section 1341 deduc-
tion amount"), or (B) the tax for the year
of repayment computed without the re-
payment deduction, less the decrease in
tax imposed by chapter 1 in the prior
taxable year(s) that would result solely
from the exclusion of the restored item
from gross income in the prior taxable
year(s) ("section 1341 credit amount").
The section 1341 credit amount is in-

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tended to compensate the taxpayer for the
tax paid in the year of income inclusion
(for example, if the tax rates were higher
in the year of inclusion).

One commentator recommended that
the final regulations contain certain provi-
sions similar to section 1341 to the extent
that section 1341 would apply for chapter
1 in a particular year. The commentator
noted that, because some types of income
that might be restored under section 1341
might have been subjected to tax under
section 1411 when included in a prior
year, it would be equitable for the section
1411 regulations to contain a mechanism
similar to section 1341 to allow a deduc-
tion under section 1411(c)(1)(B) for re-
payment of the income in a later year.

To the extent that a deduction is allow-
able under a provision of chapter 1 that
specifically is allowed under section
1411(c)(1)(B) and §1.1411-4(f), that
amount also would be a deduction for
section 1411 purposes in the year of the
repayment (or the taxable year in which
the obligation to make repayment other-
wise gives rise to a deduction). For exam-
ple, if the repayment constituted a section
165 loss that was a properly allocable
deduction, then that deduction also would
be available for section 1411 purposes.

However, if the section 1341 credit
amount produces a lower tax for the re-
payment year when compared to the sec-
tion 1341 deduction amount, section
1341(b)(3) denies the taxpayer a deduc-
tion in the year of repayment in favor of
the alternative credit for the tax cost. In
this instance, the deduction is not allowed
by subtitle A (which includes chapter 1,
chapter 2, and chapter 2A) in the recovery
year, and therefore would not be a prop-
erly allocable deduction under section
1411(c)(1)(B) and §1.1411-4(f). There-
fore, the final regulations do not incorpo-
rate this recommendation.

One commentator recommended that
the final regulations include amounts de-
posited in capital construction funds de-
scribed in section 7518 as a properly al-
locable deduction under section
1411(c)(1)(B). Section 7518(c)(1)(A),
which is in chapter 77 of subtitle F of the
Code, provides that taxable income is re-
duced by certain amounts described in
section 7518(a)(1)(A) that a taxpayer de-
posits into the fund. The final regulations

do not adopt this recommendation. Sec-
tion 1411(c)(1)(B) provides that net in-
vestment income includes deductions al-
lowed by subtitle A that are properly
allocable to such gross income or net gain
described in section 1411(c)(1)(A). The
reduction in taxable income provided by
section 7518(c)(1)(A) is not a deduction
allowed by subtitle A of the Code. There-
fore, these deductible amounts are outside
of the scope of section 1411(c)(1)(B).

Section 1.1411-4(f) of the final regu-
lations also provides that properly alloca-
ble deductions include amounts described
in section 212(3). Section 212(3) allows a
deduction for all the ordinary and neces-
sary expenses paid or incurred during the
taxable year in connection with the deter-
mination, collection, or refund of any tax.
Section 1.212-1(1) provides, in relevant
part, that expenses paid or incurred by a
taxpayer for tax counsel or expenses paid
or incurred in connection with the prepa-
ration of tax returns or in connection with
any proceedings involved in determining
or contesting a tax liability are deductible.
Section 1.1411-4(f)(3)(vi) of the final
regulations provides that amounts de-
scribed in section 212(3) and §1.212-
1(l) that are allocable to net investment
income using any reasonable method are
properly allocable deductions.

Section 1.1411-4(f) also includes two
additional properly allocable deductions
attributable to investments in certain types
of debt instruments. In the case of a con-
tingent payment debt instrument, the
holder may receive a payment that is less
than the corresponding projected payment
determined under the noncontingent bond
method, resulting in a negative adjustment
under §1.1275-4(b)(6). In general, a
holder treats a negative adjustment as a
reduction in interest income otherwise in-
cludible for the taxable year and, if there
is any excess, as an ordinary loss for the
taxable year to the extent of prior interest
inclusions. The loss, in effect, reverses the
holder's prior interest over-inclusions on
the debt instrument. One commentator
recommended that the final regulations
provide that a holder's negative adjust-
ment treated as an ordinary loss under
§1.1275-4(b)(6) be a properly allocable
deduction. The final regulations adopt this
recommendation and treat the loss as a
properly allocable deduction because it

accurately reflects the taxpayer's eco-
nomic net investment income attributable
to the debt instrument and is otherwise
allowed by chapter 1. The final regula-
tions also provide a similar rule for a
deflation adjustment on an inflation-
indexed debt instrument subject to
§1.1275-7.

If a taxpayer purchases a taxable debt
instrument at a premium, the taxpayer can
elect under section 171 to amortize the
bond premium. In general, the amount of
amortizable bond premium for a period
offsets the interest income allocable to the
period and the taxpayer includes the net
amount of interest in taxable income. In
certain circumstances, however, the tax-
payer is entitled to deduct all or a portion
of the bond premium under section
171(a)(1). For example, if an electing tax-
payer acquires a Treasury bill at a pre-
mium and holds the bill until maturity, the
taxpayer can deduct the premium at ma-
turity under section 171(a)(1). See
§1.171-2T(a)(4)(i)(C). In these circum-
stances, the final regulations provide that a
deduction under section 171(a)(1) is a
properly allocable deduction.

### ii. Deduction for Income Taxes Described in Section 164(a)(3)

The Treasury Department and the IRS
received comments on multiple aspects of
proposed §1.1411-4(f)(3)(i)(C), which
pertains to itemized deductions for state
and local, and foreign income, war profits,
and excess profits taxes described in sec-
tion 164(a)(3) ("section 164(a)(3) taxes").
Proposed §1.1411-4(f)(3)(i)(C) provided
that income taxes imposed on investment
income that are described in section
164(a)(3) are deductible in determining
net investment income. In the case of
taxes imposed on both investment income
and non-investment income, the proposed
regulations provided that the portion of
taxes properly allocable to investment in-
come may be determined by taxpayers
using any reasonable method. The pro-
posed regulations further provided that al-
locating the deduction based on the ratio
of investment income to total gross in-
come is an example of a reasonable
method.

Commentators recommended that the
final regulations provide additional ex-

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amples of reasonable methods of alloca-
tion of taxes between net investment
income and non-net investment income.
One commentator recommended that the
final regulations provide that state in-
come tax reported on the state income
tax return, rather than the actual state
income tax payments made during the
year, should be used in calculating a
trust or estate's deduction under pro-
posed §1.1411-4(f)(3)(i)(C) for taxes
under section 164(a)(3). One commen-
tator requested alignment between the
reasonable method of allocating section
164(a)(3) taxes in proposed §1.1411-
4(f)(3)(i)(C) with the existing allocation
rules in chapter 1 for estates and trusts.
One commentator stated that the pro-
posed method of allocation creates a
problem because a trust or estate de-
ducts state and local taxes for DNI pur-
poses in a different manner. Another
commentator recommended that the fi-
nal regulations follow the long-standing
state and local tax allocation rules of
§1.652(b)-3(b).

The final regulations generally retain
the position of the proposed regulations.
Although the regulations provide an ex-
ample of a reasonable method of alloca-
tion, it is not the only reasonable method.
The final regulations do not provide other
examples of generally applicable reason-
able allocation methods because the Trea-
sury Department and the IRS believe that
providing multiple examples of reason-
able methods may lead to taxpayers to
incorrectly conclude that the methods
listed are the only acceptable methods.
Therefore, the Treasury Department and
the IRS believe that the final regulations
allow taxpayers flexibility to determine a
method of allocation that best applies to
their specific facts. The final regulations
do provide, however, that for estates and
trusts, an allocation between classes of
income under §1.652(b)-3 is a reasonable
allocation.

Several commentators suggested that
foreign taxes should be a properly allocable
deduction under section 1411(c)(1)(B),
without reference to any election made by
the taxpayer for chapter 1 purposes. Another
commentator, however, suggested that the
final regulations confirm that foreign taxes
included in the foreign tax credit computa-
tion are not taxes included in section

164(a)(3) and, therefore, would not be al-
lowed as a deduction allocable to net invest-
ment income. Section 1.1411-4(f)(3)(iii) of
the final regulations provides that foreign
income, war profits, and excess profits taxes
may be allowable as deductions in deter-
mining net investment income only if the
taxpayer does not choose to take any foreign
tax credits under section 901 with respect to
the same taxable year. This rule is consistent
with the limitation in section 275(a)(4) on
deductibility of those taxes.

Several commentators requested that
the final regulations address the proper
treatment of refunds of taxes deductible
under section 164(a)(3). In response to
this request, §1.1411-4(g)(2) of the final
regulations provides guidance on refunds
and recoveries of amounts deducted under
section 1411(c)(1)(B) and §1.1411-4 in
prior taxable years. In general, the final
regulations provide that the recovery or
refund of a previously deducted item shall
reduce the total amount of properly allo-
cable deductions in the year of the recov-
ery. The final regulations first determine
the recovered amount without regard to
the application of the tax benefit rule in
section 111 for chapter 1 purposes. For
example, if a taxpayer receives a refund of
state income taxes from a prior year, such
a refund would be included in the taxpay-
er's gross income. However, if the tax-
payer was subject to the alternative mini-
mum tax in the year of the payment, the
taxpayer may not have received any tax
benefit under chapter 1, and therefore sec-
tion 111 may exclude some, or all, of the
refund from gross income. However, the
deductibility of state income taxes for sec-
tion 1411 purposes is independent of the
deductibility of the taxes for alternative
minimum tax purposes. Therefore, the ap-
plicability of the recovery rule in
§1.1411-4(g)(2) is determined without
regard to whether the recovered amount
was excluded from gross income by rea-
son of section 111.

The final regulations contain two excep-
tions to the general rule. The two exceptions
apply the tax benefit rule of section 111
within the section 1411 system, and there-
fore operate independently of the applica-
tion of section 111 for chapter 1 purposes.
First, properly allocable deductions are not
reduced in the year of the recovery if the
amount deducted in the prior year did not

reduce the amount of section 1411 liability.
For example, the receipt in 2014 of a refund
of income taxes paid in 2012 would not
reduce a taxpayer's section 1411(c)(1)(B)
deduction because section 1411 was not in
effect in 2012 and thus the 2012 taxes were
not properly allocable to net investment in-
come. Second, properly allocable deduc-
tions are not reduced in the year of the
recovery if the amount deducted in the prior
year is included in net investment income
by reason of section 1411(c)(1)(A). For ex-
ample, a reimbursement of a deduction from
a passive activity trade or business that is
gross income for chapter 1 purposes is in-
cluded as gross income from a passive ac-
tivity under section 1411(c)(1)(A)(ii).
Therefore, the recovery is already reflected
in the recovery year's net investment in-
come calculation.

In addition, §1.1411-4(g)(2) of the fi-
nal regulations provides a special rule in
the case of a recovery of a deduction that
was allocated between net investment in-
come and non-net investment income
(such as section 164(a)(3) taxes). The final
regulations provide that the amount taken
into account under the recovery rule is
based on the ratio used to allocate the item
in the year of the deduction. For example,
if a taxpayer allocated 45 percent of its
total section 164(a)(3) taxes to net invest-
ment income in the year of the deduction,
45 percent of the recovery of such taxes
will reduce the total amount of properly
allocable deductions in the year of the
recovery even though the taxpayer's allo-
cation of section 164(a)(3) taxes to net
investment income in the year of recovery
may be, for example, 30 percent.

### iii. Treatment of Estate and Trust Administration Expenses

Several commentators requested that the
final regulations explicitly provide that sec-
tion 1411(c)(1)(B) properly allocable de-
ductions include fiduciary commissions, le-
gal and accounting fees, and other estate and
trust administration expenses. Subject to the
limitations pursuant to section 67(e), the fi-
nal regulations adopt this comment by
amending proposed §1.1411-4(f)(3) to pro-
vide that properly allocable deductions in-
clude amounts described in §1.212-1(i) (al-
lowing a deduction for reasonable amounts
paid or incurred by the fiduciary of an estate

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or trust on account of administration ex-
penses, including fiduciaries' fees and ex-
penses of litigation) to the extent they are
allocable to net investment income. The fi-
nal regulations require that estates and trusts
apportion any §1.212-1(i) expenses be-
tween net investment income and excluded
income using any reasonable method.

### iv. Limitations on Properly Allocable Deductions

Under the proposed regulations, prop-
erly allocable deductions that are itemized
deductions subject to the 2-percent floor
on miscellaneous itemized deductions un-
der section 67 or to the overall limitation
on itemized deductions under section 68
are deducted in determining net invest-
ment income only to the extent that they
are deductible for income tax purposes
after the application of both limitations.
The proposed regulations provided a
method for apportioning these limitations
to determine the amount of deductions
allowed in computing net investment in-
come after applying sections 67 and 68.
This method first applies section 67 to all
deductions subject to the 2-percent floor.
The disallowance is applied proportion-
ately to each deduction subject to section
67. The proposed regulations then apply a
similar process to deductions subject to
section 68.

One commentator argued that applying
general limitations on deductions under sec-
tions 67 and 68 is inconsistent with congres-
sional intent, and that it may cause "taxable"
net investment income to exceed "eco-
nomic" net investment income. The com-
mentator recommended that the final regu-
lations allow the full amount of properly
allocable itemized deductions to offset in-
come items comprising net investment in-
come without regard to the limitations im-
posed under sections 67 and 68.

Section 1411(c)(1)(B) provides that
only those deductions that are allowed
under subtitle A and properly allocable to
component items of net investment in-
come are deducted in determining net in-
vestment income. Sections 67 and 68 limit
the amount of certain itemized deductions
in determining taxable income for pur-
poses of subtitle A and, therefore, also
apply to limit the amount of those item-
ized deductions in determining net invest-

ment income. Accordingly, properly allo-
cable deductions that are subject to
section 67 or 68 are deducted in determin-
ing net investment income only to the
extent that they are deductible after the
application of the limitations.

Another commentator agreed that the
limitations on itemized deductions under
sections 67 and 68 should apply for sec-
tion 1411 purposes, but suggested that
these limitations only reduce the amount
of properly allocable itemized deductions
if such deductions exceed the aggregate
amount of the deductions, whether prop-
erly allocable or not, that would be al-
lowed after application of these limita-
tions. In other words, the commentator
requested an ordering approach to the sec-
tion 67 and 68 limitations, instead of the
pro-rata approach in the proposed regula-
tions. Both the commentator's recommen-
dation and the proposed regulation
method are reasonable interpretations of
section 1411(c)(1)(B), accordingly, the fi-
nal regulations adopt the commentator's
recommendation.

Under §1.1411-4(f)(7) of the final reg-
ulations, the amount of miscellaneous
itemized deductions allowed under sec-
tion 67 in determining net investment in-
come (but before the application of sec-
tion 68) is the lesser of: (1) the amount of
miscellaneous itemized deductions before
applying section 67 that are properly allo-
cable to net investment income, or (2) the
amount of all miscellaneous itemized de-
ductions allowed after the application of
section 67. The amount of itemized de-
ductions subject to limitation under sec-
tion 68 that are deducted in determining
net investment income is the lesser of: (1)
the amount of such deductions that are prop-
erly allocable to net investment income al-
lowed after the application of section 67 but
before the application of section 68, or (2)
the amount of all deductions allowed after
the application of section 68.

### v. Treatment of Properly Allocable Deductions in Excess of Investment Income

Proposed §1.1411-4(f)(1)(ii) pro-
vided that any deductions described in
§1.1411-4(f) in excess of gross income
and net gain are not taken into account in
determining net investment income in any

other taxable year, except as allowed un-
der chapter 1. Many commentators recom-
mended that the final regulations provide
that negative net investment income
(when section 1411(c)(1)(B) deductions
exceed section 1411(c)(1)(A) income) be
carried over and become a section
1411(c)(1)(B) deduction in the subsequent
year.

The final regulations do not adopt this
recommendation. Section 1411(c)(1)(B)
provides that, in order for a deduction to
be allowed, it must be: (1) allowed by
subtitle A, and (2) be properly allocable to
section 1411(c)(1)(A) income. Section
1411(c)(1)(B) only allows deductions al-
lowed by other Code sections; it does not
establish a basis for a deduction that does
not exist elsewhere in the Code. However,
as discussed in the following part of this
preamble, the final regulations do permit
deductions of net operating losses other-
wise allowed by subtitle A that are prop-
erly allocable to section 1411(c)(1)(A) in-
come.

### vi. Net Operating Losses as a Properly Allocable Deduction

Proposed §1.1411-4(f)(1)(ii) provided
that, in no event, will a net operating loss
(NOL) deduction allowed under section
172 be taken into account in determining
net investment income for any taxable
year. The proposed regulations requested
comments on whether a deduction should
be allowed for an NOL in determining net
investment income. Several commenta-
tors argued that, for purposes of section
1411(c)(1)(B), at least some portion of an
NOL deduction should be a deduction
properly allocable to gross income in-
cluded in net investment income and
therefore allowed in determining net in-
vestment income. Three commentators
recommended that taxpayers be allowed
to keep track of the portions of an NOL
attributable to investment income for the
loss year. One commentator recom-
mended that the IRS adopt a simple rule
for determining a portion of an NOL that
is attributable to a "net investment loss"
for a loss year (for example, using a ratio
of the portion of the loss attributable to
"net investment loss" to the NOL) and
allow taxpayers to take a prorated portion
of the NOL deduction into account in de-

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termining net investment income for a
taxable year to which the NOL is carried.

The final regulations adopt a modified
version of the commentator's approach in
§1.1411-4(f)(2)(iv) and (h). Because
NOLs are computed and carried over
year-by-year, a separate ratio must be de-
termined for each year. Thus, the final
regulations provide that taxpayers may
deduct a portion of an NOL deduction in
determining their net investment income.
The portion of an NOL deduction for a
taxable year that may be deducted for
section 1411 purposes is calculated by
first determining the applicable portion of
the NOL for each loss year. The applica-
ble portion of the NOL is the lesser of: (1)
the amount of the NOL for the loss year
that the taxpayer would have incurred if
only items of gross income that are used
to determine net investment income and
only properly allocable deductions were
taken into account in determining the
NOL in accordance with section 172(c)
and (d), or (2) the amount of the taxpay-
er's NOL for the loss year. Next, the
amount of the NOL carried from each loss
year and deducted in the taxable year is
multiplied by a fraction. The numerator of
this fraction is the applicable portion of
the NOL for the loss year as determined
above. The denominator of the fraction is
the total NOL for the loss year. A separate
fraction is determined for each loss year.
The result of this multiplication is the
amount of the NOL deduction from the
loss year that is allowed as a section
1411(c)(1)(B) deduction in the taxable
year, referred to as the section 1411 NOL
amount. The sum of the section 1411
NOL amounts for each NOL carried to
and deducted in the taxable year, referred
to as the total section 1411 NOL amount,
is the amount of the NOL deduction for
the taxable year that is properly allocable
to net investment income.

E. Calculation of net investment income
in special situations

Section 1411(c)(1)(A)(i) provides that
net investment income does not include
(among other things) items of interest,
dividend, annuity, royalty or rent derived
in the ordinary course of a trade or busi-
ness that is not a passive activity with
respect to the taxpayer within the meaning

of section 469. Section 1411(c)(1)(A)(iii)
provides that net investment income does
not include (among other things) gain or
loss from the disposition of property used
in a trade or business that is not a passive
activity of the taxpayer. In general, sec-
tion 469 and the regulations thereunder
provide four ways for an item of income
to be nonpassive - grouping, activity re-
characterization, income recharacteriza-
tion, and material participation.

In the case of certain types of net in-
vestment income, such as rent and inter-
est, commentators recommended that the
final regulations exclude certain nonpas-
sive net income, gain, or loss and self-
charged interest from net investment in-
come. Other commentators recommended
that the final regulations provide a deduc-
tion that offsets the income.

As discussed in part 5.D.v. of this pre-
amble, section 1411(c)(1)(B) only allows
deductions allowed by other Code sec-
tions; it does not establish a basis for a
deduction that does not exist elsewhere in
the Code. Therefore, the Treasury Depart-
ment and the IRS do not adopt the recom-
mendation that the final regulations con-
tain an offsetting deduction (or a reversal
of a net loss item) that is subject to section
1411. Nevertheless, the Treasury Depart-
ment and the IRS recognize that in some
cases it is appropriate to exclude certain
nonpassive items of income from net in-
vestment income. Accordingly, in the lim-
ited and specific situations described in
this part of the preamble, the final regula-
tions deem a particular item of income to
be "derived in the ordinary course of a
trade or business" for purposes of section
1411(c)(1)(A) and therefore excluded
from net investment income. However,
the Treasury Department and the IRS em-
phasize that these specific rules contained
in these final regulations are for section
1411 purposes only, and thus taxpayers
should not draw any inference regarding
the treatment of these items for any pur-
pose other than section 1411. See
§1.1411-1(c).

#### i. Treatment of Self-Charged Interest

Commentators noted that, under the
proposed regulations, a taxpayer who is
not engaged in the trade or business of
lending would have net investment in-

come when it receives interest income at-
tributable to a loan made to a passthrough
entity in which it materially participates
because the offsetting interest expense al-
locable to the taxpayer from the nonpas-
sive activity would not be a properly al-
locable deduction under section
1411(c)(1)(B) and §1.1411-4(f). An anal-
ogous situation was identified during the
1986 enactment of section 469, which re-
sulted in the promulgation of the self-
charged interest rules in §1.469-7.

In response to these comments, the fi-
nal regulations include a special rule that
addresses self-charged interest. The spe-
cial rule provides that, in the case of self-
charged interest received from a nonpas-
sive entity, the amount of interest income
excluded from net investment income will
be the taxpayer's allocable share of the
nonpassive deduction. The rule cross-
references the self charged interest rule of
§1.469-7 for the operative mechanics.
The mathematical result of the special rule
is to exclude an amount of interest income
from net investment income that is equal
to the amount of interest income that
would have been considered passive in-
come under §1.469-7 if the nonpassive
activity was considered passive activity.
However, the special rule contains an ex-
ception. The special rule will not apply to
a situation where the interest deduction is
taken into account in determining self-
employment income that is subject to tax
under section 1401(b).

### ii. Treatment of Certain Nonpassive Rental Activities

With regard to grouping and rechar-
acterizations, commentators recom-
mended that the final regulations clarify
that determining whether income is net
investment income should be based
solely on its recharacterized or grouped
status as nonpassive under section 469
and the regulations thereunder. Al-
though the Treasury Department and the
IRS recognize the administrative sim-
plicity of this rule, the Treasury Depart-
ment and the IRS believe that this rule is
too broad as it would 'deem' certain
items to be derived in a trade or business
when it is unlikely that a section 162
trade or business is present. For exam-
ple, see §§1.469-1T(e)(3)(ii)(D) (rental

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of property incidental to an investment
activity) and 1.469-2T(f)(3) (rental of
nondepreciable property). Therefore,
the final regulations do not adopt this
broad approach.

Another option advanced by some
commentators is a special rule for self-
charged rents similar to §1.469-7 pertain-
ing to self-charged interest. However, a
proposed rule for self-charged rents would
be more complex than the rule for self-
charged interest because the amount of the
net investment income exclusion must take
into account the deductions allowed (depre-
ciation, taxes, interest, etc.) that are not pres-
ent in self-charged interest. A self-charged
rent rule would have to exclude from gross
income rents in the same way as self-
charged interest, and would also exclude a
share of the deductions attributable to earn-
ing the income. In addition, a rule based on
§1.469-7 would cover only rents within the
context of section 1411(c)(1)(A)(i) and
would not provide relief from the inclusion
of the gain upon the sale of the property
from net investment income. Accordingly,
the final regulations do not adopt this rec-
ommendation.

However, the Treasury Department and
the IRS appreciate the concerns raised by
the commentators. Therefore, the final reg-
ulations provide special rules for self-
charged rental income. The final regulations
provide that, in the case of rental income
that is treated as nonpassive by reason of
§1.469-2(f)(6) (which generally recharac-
terizes what otherwise would be passive
rental income from a taxpayer's property as
nonpassive when the taxpayer rents the
property for use in an activity in which the
taxpayer materially participates) or because
the rental activity is properly grouped with a
trade or business activity under §1.469-
4(d)(1) and the grouped activity is a nonpas-
sive activity, the gross rental income is
deemed to be derived in the ordinary course
of a trade or business. Furthermore, in both
of these instances, the final regulations pro-
vide that any gain or loss from the assets
associated with that rental activity that are
treated as nonpassive gain or loss will also
be treated as gain or loss attributable to the
disposition of property held in a nonpassive
trade or business.

iii. Treatment of Section 469(c)(7)
Real Estate Professionals

With regard to real estate professionals,
many commentators recommended that the
final regulations provide that, if a real estate
professional materially participates in his or
her rental real estate activities, then the
rental income should be excluded from net
investment income. The general theory be-
hind the commentators' recommendation
was that such rental income must be derived
in the ordinary course of a trade or business
because a taxpayer that qualifies as a real
estate professional under section 469 is nec-
essarily engaged in a real property trade or
business. In certain situations, the Treasury
Department and the IRS agree that some
real estate professionals derive rental in-
come in the ordinary course of the real prop-
erty trade or business. However, for several
reasons, the Treasury Department and the
IRS do not believe that every real estate
professional is necessarily engaged in the
trade or business of rental real estate.

Section 469(c)(7)(C) provides 11 types
of activities that constitute a real property
trade or business. Only a few of the 11
enumerated activities may be relevant in
determining whether rents are derived in
the ordinary course of a trade or business,
such as the activities of "rental" and "leas-
ing." Some of the other enumerated items
have little, if any, relation to rental activ-
ities. For example, an individual engaged
in real property construction could satisfy
the two tests enumerated in section
469(c)(7)(B) to qualify as a real estate
professional, but the construction activi-
ties may not have any relation to whether
the individual's rental income is derived
in the ordinary course of a trade or busi-
ness. In addition, the scope of activities
that a taxpayer may consider in determin-
ing whether a real property trade or busi-
ness exists is broader than the definition of
a trade or business for section 1411 pur-
poses. Section 1.469-9(b)(1) states "[a]
trade or business is any trade or business
determined by treating the types of activ-
ities in §1.469-4(b)(1) as if they involved
the conduct of a trade or business, and any
interest in rental real estate, including any
interest in rental real estate that gives rise
to deductions under section 212." There-
fore, under §1.469-9(b)(1), individuals
may establish real estate professional sta-
tus by combining non-trade or business
activities (such as multiple section 212
rental activities) for determining a taxpay-

er's real property trade or business. Be-
cause the analysis under section 469(c)(7)
and the regulations thereunder to deter-
mine whether a taxpayer is a real estate
professional differs from the analysis to
determine whether rental income is de-
rived in the ordinary course of a trade or
business under section 1411(c)(1)(A)(i),
the use of a taxpayer's real estate profes-
sional status as a proxy to determine
whether rental income is derived in the
ordinary course of a trade or business is
not appropriate.

Once an individual establishes real es-
tate professional status, that status only
allows the taxpayer to treat rental real
estate activities as nonpassive if the tax-
payer satisfies at least one of the tests for
material participation in §1.469-5T in the
rental real estate activities. The status as a
real estate professional alone does not es-
tablish that those rental real estate activi-
ties rise to the level of a trade or business
within the meaning of section 162. Sec-
tion 1.469-5T(a) provides seven tests to
establish material participation. However,
not all of the material participation tests
provide conclusive evidence that a tax-
payer is regularly, continuously, and sub-
stantially involved in a rental trade or
business within the meaning of section
162. For example, a real estate broker that
satisfies the section 469(c)(7) real estate pro-
fessional requirements by reason of hours
devoted to brokerage could classify his or
her real property rental activity as nonpas-
sive by satisfying §1.469-5T(a)(2). Under
this test, the taxpayer needs to establish only
that the taxpayer's participation in the activ-
ity was substantially all of the activity (tak-
ing into account all other persons involved
in the activity) to establish material partici-
pation. As a result, and similar to the case of
establishing real estate trade or business, the
Treasury Department and the IRS believe
that reliance on the §1.469-5T material par-
ticipation tests as a proxy to establish regu-
lar, continuous, and substantial activity
within the meaning of section 162 for sec-
tion 1411 purposes is not appropriate.

The final regulations do, however, pro-
vide a safe harbor test for certain real estate
professionals in §1.1411-4(g)(7). The safe
harbor test provides that, if a real estate
professional (within the meaning of section
469(c)(7)) participates in a rental real estate
activity for more than 500 hours per year,

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the rental income associated with that activ-
ity will be deemed to be derived in the
ordinary course of a trade or business. Al-
ternatively, if the taxpayer has participated
in a rental real estate activity for more than
500 hours per year in five of the last ten
taxable years (one or more of which may be
taxable years prior to the effective date of
section 1411), then the rental income asso-
ciated with that activity will be deemed to
be derived in the ordinary course of a trade
or business. The safe harbor test also pro-
vides that, if the hour requirements are met,
the real property is considered as used in a
trade or business for purposes of calculating
net gain under section 1411(c)(1)(A)(iii).
The Treasury Department and the IRS rec-
ognize that some real estate professionals
with substantial rental activities may derive
such rental income in the ordinary course of
a trade or business, even though they fail to
satisfy the 500 hour requirement in the safe
harbor test. As a result, the final regulations
specifically provide that such failure will not
preclude a taxpayer from establishing that
such gross rental income and gain or loss
from the disposition of real property, as ap-
plicable, is not included in net investment
income.

### iv. Treatment of Former Passive Activities

Losses disallowed by section 469 stem
from (1) expenses incurred in the passive
activity or (2) a sale of a portion of the
passive activity or property used in the
activity, in excess of passive income from
any source. Section 1.469-1T(f)(2)(i) and
(ii) require taxpayers to trace disallowed
losses back to the activities giving rise to
the losses and to further trace the losses
allocated to a particular activity back to
the deductions from the activity giving
rise to the net loss. When a taxpayer dis-
poses of a partial interest in a passive
activity or disposes of assets used within a
passive activity, any losses realized from
the disposition are treated as arising from
the passive activity and are allocated to
that activity. Sections 469(b), (g), and
§1.469-1(f)(4) provide that, generally,
passive losses that are disallowed in the
current year carry forward to the succeed-
ing tax year and remain suspended until
the taxpayer has sufficient passive income
to offset those losses or otherwise dis-

poses of the entire activity in a fully tax-
able transaction with an unrelated party.

In cases where a taxpayer materially par-
ticipates in an activity that was formerly a
passive activity, the deductions produced by
the activity in the current year are not
subject to section 469. However, the car-
ryover (or "suspended") passive losses in-
curred in prior years when the activity was
a passive activity remain disallowed pas-
sive losses subject to carryover. Section
469(f)(1)(A) allows the suspended passive
losses when the former passive activity
produces current-year net income (even
though that income is technically from a
nonpassive activity). To the extent the tax-
payer has passive losses allocable to a
former passive activity in excess of the
current year nonpassive income from that
activity (the section 469(f)(1)(A)
amount), section 469(f)(1)(C) allows ex-
cess passive losses to offset net passive
income from other passive activities of the
taxpayer. Any suspended passive losses
not allowed by section 469(f)(1)(A) or (C)
remain suspended and are carried over to
the following year.

Section 469 does not alter the character
or nature of the items that make up the
suspended passive loss. If the suspended
losses are attributable to operating deduc-
tions in excess of operating income, such
suspended losses retain that character as
deductions described in section 62(a)(1)
or 62(a)(4) when ultimately allowed by
section 469. To the extent the suspended
losses are comprised of losses originating
from the disposition of property (such as
ordinary section 1231 losses or capital
losses), those losses also retain their char-
acter as section 165 losses when they are
ultimately allowed by section 469.

If a taxpayer materially participates in a
former passive trade or business activity, the
gross income produced by that activity (and
associated section 1411(c)(1)(B) properly
allocable deductions) in the current year
generally would not be net investment in-
come because the activity is no longer a
trade or business that is a passive activity
within the meaning of section 469. How-
ever, in the case of rental income not de-
rived in the ordinary course of a trade or
business, a classification of the rental in-
come as nonpassive for purposes of section
469 will not result automatically in the ex-
clusion of such rental income and associated

deductions from net investment income.
Furthermore, it is possible that a section 469
former passive activity may still generate
net investment income on its disposition to
the extent the gain is included in section
1411(c)(1)(A)(iii) and not entirely excluded
by, for example, section 1411(c)(4).

Suspended losses that are allowed by
reason of section 469(f)(1)(A) or (C) may
constitute properly allocable deductions
under section 1411(c)(1)(B) and §1.1411-
4(f)(2) (to the extent those losses would
be described in section 62(a)(1) or
62(a)(4)) or may be included within the
calculation of net gain in section
1411(c)(1)(A)(iii) and §1.1411-4(d) (to
the extent those losses would be described
in section 62(a)(3) in the year they are
allowed, depending on the underlying
character and origin of such losses). The
treatment of excess suspended losses of a
former passive activity upon a fully tax-
able disposition is discussed in the next
section of this preamble.

The final regulations clarify, for section
1411 purposes, the treatment of income, de-
ductions, gains, losses, and the use of sus-
pended losses from former passive activi-
ties. The Treasury Department and the IRS
considered three alternatives. One approach
is the complete disallowance of all sus-
pended losses once the activity is no longer
a passive activity (in other words, becomes
a former passive activity or a nonpassive
activity). The rationale behind this approach
is that the income from the activity would
not be includable in net investment in-
come, thus the suspended losses become
irrelevant. Another approach is the unre-
stricted allowance of all suspended losses
in the year in which they are allowed by
section 469(f), regardless of whether the
nonpassive income is included in net in-
vestment income. The rationale behind
this approach is that the losses were gen-
erated during a period when the activity
was a passive activity, and if such losses
were allowed in full, they would have
potentially reduced net investment in-
come, and therefore the losses should con-
tinue to retain their character as net invest-
ment income deductions. The third
approach is a hybrid approach that allows
suspended losses from former passive ac-
tivities in calculation of net investment
income (as properly allocable deductions
under section 1411(c)(1)(B) or in section

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1411(c)(1)(A)(iii) in the case of losses)
but only to the extent of the nonpassive
income from such former passive activity
that is included in net investment income
in that year. The final regulations adopt
this hybrid approach.

For example, in the case of a former
passive trade or business activity with
suspended losses of $10,000 that gener-
ates $3,000 of net nonpassive income,
section 469(c)(1)(A) allows $3,000 of
the $10,000 suspended loss to offset the
nonpassive income in the current year.
Since the gross nonpassive income is
not included in section 1411(c)(1)(A)(ii)
(or in section 1411(c)(1)(A)(iii) in the
case of gains from the disposition of
property in such trade or business), none
of the deductions and losses associated
with such income are properly allocable
deductions under section 1411(c)(1)(B)
(or in section 1411(c)(1)(A)(iii) in the
case of losses from the disposition of
property in such trade or business). Thus,
under the facts of this example, the final
regulations provide that the $3,000 is not
a properly allocable deduction (or a loss
included in section 1411(c)(1)(A)(iii)).
However, to the extent that the remaining
suspended passive loss deduction of
$7,000 is allowed by section 469(f)(1)(C)
to offset other net passive activity income
(which is included in net investment in-
come by reason of section 1411(c)(1)(A)
less deductions allowed by section
1411(c)(1)(B)), such amounts are consid-
ered properly allocable deductions under
section 1411(c)(1)(B), or as a loss in-
cluded in section 1411(c)(1)(A)(iii), as ap-
propriate.

### v. Treatment of Losses and Deductions Described in Section 469(g)(1)

Section 469(g)(1) provides, in relevant
part, that if all gain or loss realized on a
disposition is recognized, the excess of any
loss from that activity for such taxable year
(determined after the application of section
469(b)), over any net income or gain for that
taxable year from all other passive activities
(determined after the application of section
469(b)), shall be treated as a loss which is
not from a passive activity. The preamble to
the proposed regulations requested com-
ments on "whether the losses triggered un-
der section 469(g)(1) upon the disposition

should be taken into account in determining
the taxpayer's net gain on the disposition of
the activity under section 1411(c)(1)(A)(iii)
or whether the losses should be considered
properly allocable deductions to gross in-
come and net gain described in section
1411(c)(1)(A)(i) through (iii)." Because sec-
tion 469(g)(1) provides that the allowed loss
is treated as a loss "which is not from a
passive activity," there is a question whether
this language prevents the allowed losses
from being treated as "properly allocable
deductions" from passive activities for pur-
poses of section 1411.

Commentators recommended that
losses allowed under section 469(g) be
taken into account in computing net gain
under section 1411(c)(1)(A)(iii), and that
any net loss in section 1411(c)(1)(A)(iii)
resulting from the use of such losses
should be treated as a properly allocable
deduction under section 1411(c)(1)(B).
One commentator suggested that, to the
extent a taxpayer has a net loss under
section 1411(c)(1)(A)(iii) that is attribut-
able to the allowed loss under section
469(g), the excess section 469(g) loss
should continue to be suspended and car-
ried forward to offset future gain resulting
from the disposition of other passive as-
sets subject to inclusion in section
1411(c)(1)(A)(iii).

The final regulations provide that sec-
tion 469(g) losses, which are treated as
losses from a nonpassive activity, are
taken into account for net investment in-
come purposes in the same manner in
which they are taken into account for
chapter 1 purposes. As discussed in the
context of section 469(f), section 469 does
not alter the character or nature of the
suspended passive loss. If the suspended
losses allowed as a current year deduction
by reason of section 469(g)(1) are attrib-
utable to operating deductions in excess of
operating income, such suspended losses
retain that character as, in most cases,
deductions described in section 62(a)(1)
or 62(a)(4). However, to the extent the
suspended losses are comprised of losses
originating from the disposition of prop-
erty (such as ordinary section 1231 losses
or capital losses), those losses also retain
their character when they are ultimately
allowed by section 469. Therefore, losses
that are allowed by reason of section
469(g) may constitute properly allocable

deductions under section 1411(c)(1)(B) or
may be included within the calculation of
net gain in section 1411(c)(1)(A)(iii) in
the year they are allowed, depending on
the underlying character and origin of
such losses. The recommendations pro-
posed by the commentators depart from
the general operating principles in chapter
1 and add additional complexity. There-
fore, the final regulations do not adopt the
positions advanced by commentators that
section 469(g)(1) suspended losses should
offset the gain first, then be allowed as a
properly allocable deduction or that it
should continue to be suspended and car-
ried forward.

Furthermore, section 469(g)(1) losses
that are allowed by reason of a fully tax-
able disposition of a former passive activ-
ity are also fully taken into account for net
investment income. As a result of the or-
dering rules in sections 469(f)(1) and
(g)(1), any nonpassive gain realized on the
disposition that causes passive losses to
be allowed would be excluded from net
investment income under the general
former passive activity rules discussed
in part 5.E.iv of this preamble. How-
ever, to the extent that any of the non-
passive gain is included in net invest-
ment income (for example, a portion of
the gain remaining after the application
of section 1411(c)(4)), the final regula-
tions allow the same amount of sus-
pended losses described in section
469(f)(1)(A) to be included in net in-
vestment income to offset the gain. The
section 469(g)(1) losses allowed by rea-
son of the disposition of the former pas-
sive activity are allowed in full because
they relate to a period of time when the
activity was a passive activity and rep-
resent true economic losses from a pas-
sive activity that do not materially differ
from other section 469(g)(1) losses from
non-former passive activities.

#### F. Other comments relating to the calculation of net investment income

The Treasury Department and the IRS
received comments requesting that these
final regulations address the treatment for
section 1411 purposes of section 707(c)
guaranteed payments for capital, section
736 payments to retiring or deceased part-
ners, Real Estate Mortgage Investment

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Conduits (REMICs), and certain notional
principal contracts. After consideration of
these comments, the Treasury Department
and the IRS believe that it is appropriate
to address the treatment of these payments
in regulations. However, because such
guidance was not included in the proposed
regulations, these items are addressed in a
companion notice of proposed rulemaking
(REG-130843-13) relating to the Net In-
vestment Income Tax.

#### 6. Section 1411 Trades or Businesses

Section 1411(c)(1)(A) defines net in-
vestment income, in part, by reference
to trades or businesses described in sec-
tion 1411(c)(2). The trades or busi-
nesses described in section 1411(c)(2)
are: (A) a passive activity (within the
meaning of section 469) with respect to
the taxpayer, and (B) trading in financial
instruments or commodities (as defined
in section 475(e)(2)).

#### A. Passive activities

The preamble to the proposed regula-
tions stated that "the statutory language in
sections 1411(c)(1)(A) and 1411(c)(2)(A)
is intended to take into account only gross
income from and net gain attributable to a
passive activity that involves the conduct
of a trade or business." The preamble to
the proposed regulations acknowledged
that, due to the differences in the defini-
tions for purposes of section 1411 and
section 469, gross income from some ac-
tivities that are passive activities under
section 469 will not be taken into account
for purposes of section 1411(c)(1)(A)(ii)
because the gross income is derived from
an activity that does not rise to the level of
a trade or business (within the meaning of
section 162). In such cases, the gross in-
come will not be taken into account under
section 1411 unless it is taken into ac-
count under section 1411(c)(1)(A)(i) or
section 1411(c)(1)(A)(iii).

The Treasury Department and the
IRS have received several comments
and inquiries regarding the conse-
quences of the income recharacteriza-
tion rules. The regulations under section
469 provide special rules that treat in-
come from certain passive activities as
not from a passive activity. See §1.469-

2T(f)(2) (special rule for significant par-
ticipation); §1.469-2T(f)(3) (rental of
nondepreciable property); §1.469-
2T(f)(4) (net interest income from pas-
sive equity-financed lending activity);
§1.469-2(f)(5) (net income from certain
property rented incidental to develop-
ment activity); §1.469-2(f)(6) (property
rented to a nonpassive activity);
§1.469-2T(f)(7) (special rules applica-
ble to the acquisition of an interest in a
passthrough entity engaged in the trade
or business of licensing intangible prop-
erty). In addition, the preamble to the
proposed regulations highlighted a spe-
cial gain recharacterization rule in
§1.469-2(c)(2)(iii) applicable to gains
attributable to the disposition of sub-
stantially appreciated property formerly
used in a nonpassive activity.

In order for these section 469 rechar-
acterization rules to apply, the income or
gain subject to recharacterization must be
passive activity income under the general
section 469 operating rules. If the income
is nonpassive by reason of some other
provision of section 469 (such as a tax-
payer materially participating in the activ-
ity), the recharacterization rules are not
applicable because there is no passive in-
come to recharacterize.

In general, commentators had different
opinions regarding the treatment under
section 1411(c)(1) of income that is re-
characterized under the rules in section
469. In the case of income from a passive
activity trade or business, some commen-
tators stated that net investment income
does not include any amount of income or
gain that is recharacterized as "not from a
passive activity," either because it satisfies
the ordinary course exception (derived in
the ordinary course of a trade or business
not described in section 1411(c)(2)) in
section 1411(c)(1)(A)(i) or (iii), or be-
cause such income is not income within
the scope of section 1411(c)(1)(A)(ii).
Other commentators stated that such non-
passive income qualifies as net investment
income under section 1411(c)(1)(A) be-
cause the activity's status as a passive
activity trade or business described in sec-
tion 1411(c)(2)(A) is unchanged, despite
section 469's recharacterization of a por-
tion of the income or gain to income "not
from a passive activity."

Another commentator recommended
that the final regulations not apply a single
rule to all income recharacterization situa-
tions because the underlying section 469
rationale differs for each one. The commen-
tator stated that the various income rechar-
acterization rules do not recharacterize all
the income and gains in the same way. In
the case of income recharacterizations cov-
ered by §§1.469-2T(f)(3), 1.469-2T(f)(4),
and 1.469-2T(f)(7), such income is further
characterized as portfolio income (within
the meaning of section 469(e)(1)(A)) by
§1.469-2T(f)(10). In the case of the rechar-
acterization of gains under §1.469-
2(c)(2)(iii), the characterization of the gain
as portfolio income is determined under
§1.469-2(c)(2)(iii)(F) based on whether the
property was held in an investment activity
before it was used in a passive activity. The
commentator recommended that the final
regulations distinguish recharacterized in-
come treated as portfolio income from re-
characterized income not treated as portfolio
income.

Section 1.1411-5(b)(2) of the final regu-
lations provides clarification regarding the
interaction between the net income rechar-
acterization rules under section 469 and the
section 1411 rules. For purposes of section
1411, the final regulations generally follow
the section 469 characterization of the in-
come and gain, particularly the treatment of
the items as portfolio income. Section
1.1411-5(b)(2) of the final regulations pro-
vides that, to the extent that income or gain
from a trade or business is subject to a net
income recharacterization rule described in
§§1.469-2T(f)(2), §1.469-2(f)(5), or
§1.469-2(f)(6), the gross income or gain
treated as "not from a passive activity" will
not be considered derived from a trade or
business described in section 1411(c)(2)(A).
In addition, any gain recharacterized as
"not from a passive activity" by reason of
§1.469-2(c)(2)(iii) is not derived from a
trade or business described in section
1411(c)(2)(A) if the gain does not consti-
tute portfolio income under §1.469-
2(c)(2)(iii)(F). In the case of recharacter-
ization rules covered by §1.469-
2T(f)(10) and §1.469-2(c)(2)(iii)(F), the
underlying trade or business remains a pas-
sive activity within the meaning of section
1411(c)(1)(A) and §1.1411-5(a)(1).

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B. Trading in financial instruments or
commodities

The proposed regulations provided
that, for purposes of section
1411(c)(2)(B), to determine whether gross
income is derived from a section 162 trade
or business of trading in financial instru-
ments or commodities, the gross income
must be derived from an activity that
would constitute trading for purposes of
chapter 1. Section 1.1411-5(c)(1) of the
proposed regulations defined the term fi-
nancial instrument to include stocks and
other equity interests, evidences of indebt-
edness, options, forward or futures con-
tracts, notional principal contracts, any
other derivatives, or any evidence of an
interest in any of the listed items. An
evidence of an interest in any of these
listed items includes, but is not limited to,
short positions or partial units in any of
these listed items.

Two comments were received regard-
ing the definition of a financial instrument
in the proposed regulations. One commen-
tator asked for explicit language that fi-
nancial instruments that are used in a trade
or business and produce foreign currency
gain are exempt from section 1411. The
same commentator requested that the pro-
posed definition of a financial instrument
be narrowed so that it would exclude
"non-financial instruments," such as con-
tracts that reference electricity or weather.
Another commentator suggested that the
term "stock" in the definition of a finan-
cial instrument be replaced with the
phrase "security as defined in section
2(a)(1) of the Securities Act of 1933" to
broaden the scope of the definition.

With respect to the first comment, for-
eign currency gain or loss that otherwise
is not subject to the Self-Employment
Contribution Act is appropriately treated
as net investment income. Regarding the
definition of a financial instrument, the
Treasury Department and the IRS believe
that Congress chose that term to capture a
broader class of instruments than the se-
curities described in section 475. The sug-
gestion to limit the definition of a "finan-
cial instrument" to exclude a derivative
that is referenced to non-financial infor-
mation, such as electricity or weather,
would not be consistent with the intention
to include in net investment income the

income from all types of investment prop-
erty. With respect to the second comment,
there is no indication that Congress in-
tended the definition of the term "financial
instrument" to be coextensive with the
definition of the term "security" used by
the SEC, as evidenced by the fact that
section 1411(c)(2)(B) uses the term "fi-
nancial instrument," not "security." Ac-
cordingly, after consideration of both
comments, neither suggestion was ad-
opted in the final regulations.

##### 7. Comments Regarding Working Capital

Section 1411(c)(3) provides that a rule
similar to the rule of section 469(e)(1)(B)
(the working capital rule) applies for pur-
poses of section 1411. Section 469(e)(1)(B)
provides that, for purposes of determining
whether income is treated as from a pas-
sive activity, any income or gain attribut-
able to an investment of working capital is
treated as not derived in the ordinary
course of a trade or business. Section
1.469-2T(c)(3)(iii) provides an exception
to the portfolio income characterization
rule for items that are derived in the ordi-
nary course of a trade or business. Section
1.1411-6(a) of the proposed regulations
provided that, for purposes of section
1411(c)(3), working capital and the in-
come generated therefrom will be deter-
mined under principles similar to those
described in §1.469-2T(c)(3)(ii).

Several commentators noted that the
proposed regulations lack an adequate
definition of "working capital" for pur-
poses of section 1411. One commentator
stated that the application of section 1411
is too restrictive because it taxes all work-
ing capital as income not derived in the
ordinary course of business. Another com-
mentator noted that the regulations should
clearly define what property is considered
working capital, particularly where capital
is invested in a trade or business that
either does not rise to the level of a trade
or business under section 1411(c)(2)(A)
or a trading business described in section
1411(c)(2)(B) that generates nonpassive
income. One commentator noted that the
cross-reference to working capital in sec-
tion 469 does not account for the different
purposes of the two statutory schemes.
Commentators also stated that, if the final

regulations do not elaborate on the defini-
tion of working capital, taxpayers must
speculate where the dividing line is be-
tween active business assets and working
capital.

Several commentators requested that
the final regulations include a more com-
prehensive definition of working capital.
One commentator recommended that pro-
posed §1.1411-6 be withdrawn and re-
placed with industry-specific guidelines
for a safe harbor. Another commentator
suggested the final regulations exclude in-
come generated from liquid, short-term
investments, such as interest-bearing bank
accounts, from the definition of working
capital and further exclude a reasonable
amount of working capital.

The specific cross-reference in section
1411(c)(3) to section 469(e)(1)(B) indicates
Congress' intent that the definition of work-
ing capital in §1.1411-6 be consistent with
the rules in section 469(e)(1)(B) and
§1.469-2T(c)(3)(ii). Accordingly, the pro-
posed regulations intentionally aligned the
section 1411 treatment of working capital
with the section 469 rules. In addition, the
rule in the proposed regulations avoids com-
plexity that divergent definitions would
have on tax administration and compliance.
The Treasury Department and the IRS ap-
preciate that certain businesses require dif-
ferent amounts of working capital based on
their industries or general business prac-
tices, but the Treasury Department and the
IRS do not believe that the promulgation of
working capital definitions based on
industry-specific characteristics would be
administrable. Further, if the rules on work-
ing capital were materially different for sec-
tion 469 and section 1411 purposes, such
items would have to be reevaluated annually
and would require detailed accounting and
reporting burdens for both the IRS and tax-
payers. As a result, the final regulations re-
tain the provisions in proposed §1.1411-
6 without change. However, see part
5.A.ii.(b) of this preamble for a discussion
of changes to the proposed regulations re-
garding items derived in the ordinary course
of a trade or business.

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##### 8. Comments Regarding the Calculation of Gain or Loss Attributable to the Disposition of Interests in Partnerships and S Corporations

The proposed regulations described the
method for adjusting a transferor's gain or
loss from the disposition of a partnership
interest or S corporation stock based on
the entity's ownership of assets that are
nonpassive with respect to the transferor.
Under that method, a transferor first com-
putes its gain (or loss) on disposition of its
interest in the entity, and then reduces that
gain (or loss) by the amount of nonpassive
gain (or loss) that would have been allo-
cated to the transferor upon a hypothetical
sale of all of the entity's assets for fair
market value immediately before the
transfer.

Several commentators questioned the
proposed regulations' methodology for
adjusting a transferor's gain or loss on
the disposition of its partnership interest
or S corporation stock. These commen-
tators noted that section 1411(c)(4) re-
quires that gain (or loss) from such dis-
positions be taken into account under
section 1411(c)(1)(A)(iii) "only to the
extent of the net gain [or loss] which
would be taken into account by the trans-
feror if all property of the partnership or S
corporation were sold for fair market
value immediately before the disposition
of such interest." The commentators sug-
gested that section 1411(c)(4) therefore
includes gain/loss from the disposition of
a partnership interest or S corporation
stock only to the extent of the transferor's
share of gain/loss from the entity's pas-
sive assets. Thus, under the commenta-
tor's approach, the amount of gain or loss
included in section 1411(c)(A)(iii) is the
lesser of a taxpayer's gain on the disposi-
tion of the interest or the taxpayer's share
of gain or loss on the deemed sale of the
entity's assets that would be included in
calculating the taxpayer's net investment
income. Commentators also discussed the
complexity of the proposed regulations,
stating that the regulations imposed a high
compliance burden, including requiring a
transferor to obtain information from the
entity regarding valuation and tax basis.

After considering these comments, the
Department of Treasury and the IRS are
withdrawing the proposed regulations that

address this issue and are issuing new
proposed regulations under §1.1411-
7 adopting the commentators' suggestion,
which are being published contemporane-
ously with these final regulations (REG-
130843-13).

##### 9. Comments Regarding the Exclusion of Certain Income under Section 1411(c)(5)

Section 1411(c)(5) provides that net
investment income does not include any
distribution from the following plans or
arrangements:

(1) A qualified pension, stock bonus, or
profit-sharing plan under section 401(a);

(2) A qualified annuity plan under sec-
tion 403(a);

(3) A tax-sheltered annuity under sec-
tion 403(b);

(4) An individual retirement account
(IRA) under section 408;

(5) A Roth IRA under section 408A; or

(6) A deferred compensation plan of a
State and local government or a tax-
exempt organization under section 457(b).

Section 1.1411-8(a) of the proposed
regulations provided that, for purposes of
section 1411, any amount actually distrib-
uted from a qualified plan or arrangement
is a distribution within the meaning of
section 1411(c)(5), and thus is not in-
cluded in net investment income. The final
regulations generally retain the rules in
the proposed regulations relating to
whether an amount is a distribution from a
plan within the meaning of section
1411(c)(5) and, thus, excluded from net
investment income. In addition, the final
regulations retain the rule that, for pur-
poses of section 1411, amounts that are
deemed distributions under the Code for
income tax purposes are distributions for
purposes of section 1411(c)(5), even if
these distributions are not treated as actual
distributions for purposes of the qualifica-
tion requirements under section 401(a).
The final regulations also retain the rule in
the proposed regulations that any amount
that is not treated as a distribution for
purposes of the qualification requirements
under the Code, but is otherwise includ-
ible in gross income pursuant to a rule
relating to amounts held in a qualified
plan or arrangement is a distribution
within the meaning of section 1411(c)(5),

and thus is not included in net investment
income.

One commentator asked for clarifica-
tion on the application of section 1411 to
employer securities. The commentator
specifically asked for clarification on
whether section 1411 applies to dividends
on employer securities held by an em-
ployee stock ownership plan (as defined in
section 4975(e)(7) of the Code) that are
paid directly to plan participants. A-3 of
§1.404(k)-1T provides that a deductible
dividend under section 404(k) that is paid
directly to a plan participant or beneficiary
is treated as a distribution under the plan
for purposes of sections 72, 401, and 402
of the Code. The final regulations clarify
that any dividend that is deductible under
section 404(k) and is paid in cash directly
to a plan participant or beneficiary is a
distribution within the meaning of section
1411(c)(5), and thus is not included in net
investment income. This rule does not ap-
ply to amounts paid as a dividend after the
employer securities have been distributed
from a qualified plan. Those amounts paid
as dividends are included in net invest-
ment income.

The commentator also asked for clar-
ification on whether section 1411 ap-
plies to the net unrealized appreciation
realized on a disposition of employer
securities that occurs after the securities
were distributed from a qualified plan.
Section 402(e)(4) provides that the net
unrealized appreciation in employer secu-
rities that are distributed from a qualified
plan is excluded from gross income in the
year of the distribution in certain circum-
stances. In the case of a lump-sum distri-
bution (within the meaning of section
402(e)(4)(D)), the net unrealized appreci-
ation in the employer securities distrib-
uted is excluded from gross income. In the
case of any other distribution (other than a
distribution that is not currently taxable
under the rollover rules), the net unreal-
ized appreciation in the employer securi-
ties distributed is generally excluded from
gross income only to the extent that it is
attributable to after-tax employee contri-
butions. Net unrealized appreciation is de-
fined in §1.402(a)-1(b)(2)(i) as the excess
of the market value of employer securities
at the time of distribution over the cost or
other basis of such securities to the trust.
The final regulations clarify that any such

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net unrealized appreciation in employer
securities that is realized in a disposition
of those employer securities is a distribu-
tion within the meaning of section
1411(c)(5), and thus is not included in net
investment income. The regulations also
provide that any appreciation in value that
occurs subsequent to the distribution of
the employer securities from a qualified
plan is included in net investment income
when realized.

##### 10. Comments Regarding the Interaction between Section 1411 and Self- Employment Tax

Section 1411(c)(6) provides that net in-
vestment income does not include items
taken into account in determining self-
employment income for such taxable year
on which a tax is imposed by section
1401(b). Several commentators, in consid-
ering the interaction of self-employment tax
and section 1411, suggested that the regula-
tions clarify that a taxpayer who is fully
employed by a limited liability company
(LLC) or a limited liability partnership
(LLP) materially participates in that entity,
and, therefore, the taxpayer's distributive
share of income from the LLC or LLP is
self-employment income for which a tax is
imposed by section 1401. The final regula-
tions do not adopt this suggestion because
the imposition of self-employment taxes on
LLC members and partners of an LLP is
outside the scope of these regulations.

Proposed §1.1411-9(b) provided a spe-
cial rule for traders; specifically that de-
ductions described in proposed §1.1411-
4(f)(2)(ii) that do not reduce a taxpayer's
net earnings from self-employment (after
aggregating the net earnings from self-
employment from all of the taxpayer's
trades or business) are not considered
taken into account for purposes of section
1411(c)(6) and may be considered in de-
termining the taxpayer's net investment
income under section 1411. One commen-
tator suggested that this rule be amended
to provide that a taxpayer can elect
whether properly allocable deductions re-
lated to the taxpayer's trade or business of
trading in financial instruments or com-
modities reduce net earnings from self-
employment. The expenses of a trader
maintaining a trade or business of trading
in financial instruments or commodities

are taken into account for purposes of
determining self-employment income.
Thus, such expenses, but for the special
rule in §1.1411-9(b), could not be used to
reduce net investment income. The Trea-
sury Department and the IRS believe that
a trader should be able to reduce net in-
vestment income by amounts not used to
reduce net earnings from self-employment
income. Thus, the special rule is an ex-
ception under section 1411 for the benefit
of taxpayers. The special rule was not
intended to alter the result under the self-
employment tax provisions. Accordingly,
the final regulations do not adopt the com-
mentator's suggestion.

11\. Comments Regarding the Section
1411 Treatment of Controlled Foreign
Corporations and Passive Foreign
Investment Companies

A. Income derived from a trade or
business described in section 1411(c)(2)

Pursuant to section 1411(c)(1)(A)(ii),
gross income derived from a trade or busi-
ness described in section 1411(c)(2) is net
investment income. A trade or business is
described in section 1411(c)(2) if it is a
passive activity (within the meaning of
section 469) with respect to the taxpayer
or a trade or business of trading in finan-
cial instruments or commodities (as de-
fined in section 475(e)(2)). Proposed
§1.1411-10(b), which applies to certain
owners of controlled foreign corporations
(CFCs) and passive foreign investment
companies (PFICs), provides that the spe-
cial rules in proposed §1.1411-10 do not
apply to income derived by those taxpay-
ers from a trade or business described in
section 1411(c)(2) and §1.1411-5. Instead,
such income is included in net investment
income under section 1411(c)(1)(A)(ii) and
§1.1411-4(a)(1)(ii).

A commentator asked if the determina-
tion of whether income is "derived from"
a trade or business described in section
1411(c)(2) for §1.1411-10(b) purposes is
made by reference to the trade or business
of the CFC or the PFIC, or the trade or
business of the taxpayer (or passthrough
entity in which the taxpayer invests) that
holds the CFC or PFIC. The commentator
noted that the rules in proposed §1.1411-
4(b) provided guidance on determining
whether income is derived in a trade or

business for purposes of section
1411(c)(1)(A)(ii). However, the commen-
tator stated that the rule in proposed
§1.1411-10(b) may be of limited applica-
bility if the rules in §1.1411-4(b) apply
for purposes of proposed §1.1411-
10(b). Section 1.1411-10(b)(1) of these
final regulations clarifies that the trade or
business determination for purposes of
§1.1411-10(b) is made pursuant to the
rules set forth in §1.1411-4(b)(2), which
provide that the determination is either
based on the taxpayer's trade or business
or the trade or business of the passthrough
entity in which the taxpayer invests.

Commentators also recommended that
guidance be provided regarding the appli-
cation of §1.1411-10(b) to income de-
rived from a trade or business that is a
passive activity within the meaning of
section 469 because of a concern that tax-
payers may not be treated as engaged in a
passive activity with respect to a CFC or
qualified electing fund (QEF). Although
theoretically the definition of "passive ac-
tivity" under section 469 could include
holding an interest in a CFC or PFIC, the
commentators pointed out that amounts
included in income under sections 951(a)
(section 951 inclusions) and 1293(a) (sec-
tion 1293 inclusions) are excluded from
the definition of "passive income" for sec-
tion 469 purposes, and, instead, are treated
as portfolio income under §1.469-
2T(c)(3)(i)(A). The commentators stated
that the exclusion of these items from
"passive income" may mean that income
derived from CFCs and QEFs would
never be treated as income derived from a
"passive activity." In such a case,
§1.1411-10(b) would never apply to a
section 951 inclusion or section 1293 in-
clusion even if the inclusion was derived
from a CFC or QEF held in a trade or
business that is a passive activity. After
consideration of the comments, the Trea-
sury Department and the IRS do not be-
lieve that the final regulations need to be
clarified in order for §1.1411-10(b) to ap-
ply to a taxpayer that holds a CFC or QEF
in a trade or business that is a passive
activity with respect to the taxpayer. Sec-
tion 1411(c)(2)(A) and the regulations
promulgated thereunder cross-reference
section 469 solely for purposes of defining
"passive activity." Section 1.1411-10 does
not cross-reference the section 469(e) rules,

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which provide guidance on whether income
is treated as income from a passive activity,
or the rule in §1.469-2T(c)(3)(i)(A), which
addresses portfolio income. In addition,
§1.469-1T(d)(1) provides that the charac-
terization of items of income as passive ac-
tivity gross income (within the meaning of
§1.469-2T(c)) applies only for purposes of
section 469. The rule in §1.1411-10(b) does
not incorporate the section 469 rules on
portfolio income, and, thus, applies to in-
come derived by a taxpayer from a CFC or
QEF that is held in a trade or business that is
a passive activity within the meaning of
section 469.

The Treasury Department and the IRS
also received a comment that addressed
the application of the rules in §1.1411-
10(b) when a taxpayer holds a CFC or
PFIC in connection with a trade or busi-
ness described in section 1411(c)(2) in
some, but not all, years. The commentator
explained that the trade or business deter-
mination is made on an annual basis,
which creates the potential for taxpayers
to alternate between being subject to the
rules in §1.1411-10(b) and the other ap-
plicable rules in §1.1411-10 on an annual
basis. As a result, when a taxpayer does
not make an election under §1.1411-
10(g), a taxpayer could either be subject to
double taxation under section 1411, or
could avoid tax under section 1411, de-
pending on the facts and circumstances.
The commentator suggested that the trade
or business determination that was in ef-
fect in the year in which the taxpayer
acquired an interest in a CFC or PFIC
should apply to all years in which the
taxpayer holds the CFC or PFIC. Al-
though the Treasury Department and the
IRS do not adopt the commentator's sug-
gested approach, the final regulations co-
ordinate the application of the rules in
§1.1411-10 when a taxpayer's trade or
business determination, either as a trader
or for passive activity purposes, causes the
taxpayer to alternate between being sub-
ject to §1.1411-10(b) and the other appli-
cable rules in §1.1411-10, to eliminate
both the possibility of double taxation and
the avoidance of taxation.

B. Income derived from CFCs and
QEFs

In general, the proposed regulations
provided that distributions of previously
taxed earnings and profits attributable to
section 951 inclusions and section 1293
inclusions are dividends for purposes of
section 1411, absent an election under
§1.1411-10(g). If a taxpayer made the
§1.1411-10(g) election, the proposed reg-
ulations provided that section 951 inclu-
sions and section 1293 inclusions (rather
than the distributions of previously taxed
earnings and profits) are treated as divi-
dends for purposes of section 1411.

Commentators recommended that the
Treasury Department and the IRS revise
the final regulations to treat section 951
inclusions and section 1293 inclusions as
dividends for purposes of section 1411
(without regard to any election by the
taxpayer), rather than treating the distri-
butions of previously taxed earnings and
profits attributable to section 951 inclu-
sions or section 1293 inclusions (that were
included in chapter 1 income in a taxable
year beginning after December 31, 2012)
as dividends. The commentators stated
that the rules in the proposed regulations
applicable to CFCs and QEFs when an
election under §1.1411-10(g) is not in
effect are unduly complicated and impose
significant administrative burdens on tax-
payers. A commentator also recom-
mended modifying the regulations to gen-
erally impose section 1411 when section
951 inclusions and section 1293 inclu-
sions are taxed for purposes of chapter 1,
and permit taxpayers to elect to defer such
tax until the distribution of the earnings
and profits that previously were taxed pur-
suant to sections 951(a) or 1293(a) (in a
taxable year beginning after December 31,
2012).

As set forth in the preamble to the
proposed regulations, section 951 inclu-
sions and section 1293 inclusions are not
treated as dividends except when ex-
pressly provided for in the Code. See Ro-
driguez v. Commissioner, 137 T.C. 174
(2011), aff'd. 722 F.3d 306 (5th Cir.
2013). Accordingly, the Treasury Depart-
ment and the IRS do not adopt the com-
mentators' recommendations to treat sec-
tion 951 inclusions and section 1293
inclusions as dividends for purposes of

section 1411. For the same reason, the
Treasury Department and the IRS do not
adopt the recommendation to provide a
default rule that would treat section 951
inclusions and section 1293 inclusions as
subject to section 1411 when the inclu-
sions are taken into account for purposes
of chapter 1, unless the taxpayer affirma-
tively elected to defer taxation under sec-
tion 1411 until the distribution of earnings
and profits related to the inclusions.

The Treasury Department and the IRS
also received a comment that recom-
mended the application of a look-through
approach for determining whether income
derived with respect to a CFC or QEF is
included in net investment income. Pursu-
ant to a look-through approach, taxpayers
would determine whether section 1411
applied to a section 951 inclusion or sec-
tion 1293 inclusion by analyzing the in-
come earned directly by the CFC or QEF
that gave rise to the inclusion. The Trea-
sury Department and the IRS do not adopt
this recommendation because the ap-
proach raises administrative and compli-
ance concerns, including concerns regard-
ing the ability of QEF shareholders to
compel a QEF to provide them with the
information necessary to comply with a
look-through rule.

A commentator pointed out that the
same earnings could be subject to section
1411 tax twice if a taxpayer that made an
election under §1.1411-10(g) subse-
quently transfers CFC or QEF shares to a
taxpayer that does not make the election.
The Treasury Department and the IRS
agree with the commentator that the earn-
ings and profits of a CFC or QEF should
be subject to tax under section 1411 only
once. Accordingly, these final regulations
provide that if earnings and profits of a
CFC or QEF were included in the net
investment income of an individual, es-
tate, or trust pursuant to a §1.1411-
10(g) election, then a subsequent distribu-
tion of those earnings is excluded from the
net investment income of any transferee,
provided that the transferee can establish
entitlement to the exclusion under rules
similar to the rules in §1.959-1(d) (which
establish a successor in interest's ability to
exclude from chapter 1 income the previ-
ously taxed earnings and profits with re-
spect to an interest in a CFC acquired
from another person).

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In addition, the commentator noted a
separate double counting issue with re-
spect to earnings and profits that are in-
cluded in income as a dividend under sec-
tion 1248. For example, a seller would be
subject to tax under section 1411 when it
includes the earnings and profits in in-
come as a dividend under section 1248,
and a purchaser who did not make an
election under §1.1411-10(g) also would
be subject to tax under section 1411 on a
subsequent distribution of the earnings
and profits because the distribution would
be treated as a dividend for purposes of
section 1411. The Treasury Department
and the IRS agree that it is appropriate to
prevent double taxation in the section
1248 context, and these final regulations
include a rule that prevents double taxa-
tion with respect to amounts treated as a
dividend under section 1248 for purposes
of section 1411.

The final regulations include a new
rule that applies when a taxpayer makes
an election under §1.1411-10(g) effective
for taxable years beginning after Decem-
ber 31, 2013, but does not make an elec-
tion under §1.1411-10(g)(4)(iii) for a tax-
able year beginning before January 1,
2014 (2013 taxable year), and the tax-
payer is subject to section 1411 in the
2013 taxable year. Under the new rule,
any distributions of previously taxed earn-
ings and profits during taxable years be-
ginning after December 31, 2013, that are
attributable to section 951 and 1293 inclu-
sions in the 2013 taxable year, will be
treated as dividends for purposes of sec-
tion 1411 notwithstanding the election un-
der §1.1411-10(g). Without this rule, it
may be possible to avoid taxation under
section 1411 for any section 951 and 1293
inclusions during the 2013 taxable year.
This is so because those inclusions would
not be subject to tax under section 1411
during the 2013 taxable year in the ab-
sence of an election under §1.1411-
10(g) and, as a result of the election under
§1.1411-10(g) for taxable years begin-
ning after December 31, 2013, distribu-
tions of previously taxed earnings and
profits accrued in the 2013 taxable year
would not be subject to section 1411. In
order to simplify taxpayer record-keeping,
for purposes of applying this special rule,
distributions of previously taxed earnings
and profits from the CFC or QEF during

taxable years beginning after December
31, 2013, will be deemed to first come out
of previously taxed earnings and profits
attributable to section 951 and 1293 inclu-
sions in the 2013 taxable year.

The Treasury Department and the IRS
received a comment that suggested adding
an example to the final regulations to illus-
trate a situation in which the earnings and
profits of a CFC are never subject to section
1411 under section 1411(c)(1)(A)(i) and
§1.1411-4(a)(1)(i). The suggested example
would include a fact pattern in which a
taxpayer that did not make an election under
§1.1411-10(g) includes a section 951 inclu-
sion in income for chapter 1 purposes. In the
next year, and before the distribution of
earnings and profits attributable to the sec-
tion 951 inclusion, the taxpayer sells the
CFC shares for no gain or loss (as computed
for purposes of section 1411) to a taxpayer
that makes an election under §1.1411-
10(g) with respect to the CFC. Under these
facts, the earnings and profits related to the
section 951 inclusion are never subject to
tax under section 1411. The Treasury De-
partment and the IRS believe that the appli-
cation of §1.1411-10 to this fact pattern is
clear, and that an example is not necessary
to illustrate the relevant provisions of
§1.1411-10. The commentator also asked
that the final regulations clarify the meaning
of the phrase "with respect to which an
election under paragraph (g) of this section
is not in effect." The final regulations clarify
that the references in §1.1411-10 to an elec-
tion under paragraph (g) not being in effect
refer to the person that is determining the
section 1411 consequences with respect to
holding a particular CFC or QEF.

The Treasury Department and the IRS
requested comments on whether guidance
is necessary to determine the deductions
that are properly allocable to items of net
investment income if the election under
§1.1411-10(g) is not made. One such
comment was received regarding the allo-
cation of interest expense under section
163(d)(1). Section 1.1411-4(f)(3)(i) al-
lows interest expense as a deduction
against net investment income only to the
extent allowed under section 163(d)(1),
which limits investment interest expense
in part based on a taxpayer's investment
income. In the absence of an election un-
der §1.1411- 10(g), differences may oc-
cur in the timing of income derived with

respect to CFCs and QEFs for chapter 1
and chapter 2A purposes. The commenta-
tor suggested that, where differences in
timing occur, taxpayers should be allowed
to calculate their section 163(d)(1) invest-
ment interest expense deduction based on
amounts included in income for section
1411 purposes, in determining the amount
of investment interest expense allocable to
net investment income under section
1411. The Treasury Department and the
IRS agree with this comment and these
final regulations provide that the section
163(d)(1) investment interest expense de-
duction related to items of net investment
income described in §1.1411-10(c) may
be calculated for purposes of section 1411
by adjusting section 163(d)(1)(B) "invest-
ment income" for purposes of section
1411 to reflect the inclusions under sec-
tion 951 and section 1293 that are not
included in section 1411 net investment
income, and the distributions of previ-
ously taxed earnings and profits that are
included in section 1411 net investment
income. To the extent that the taxpayer
chooses to calculate any of these deduc-
tions based on the amount of net invest-
ment income described in §1.1411-
10(c), that method of calculation must be
consistently applied for purposes of sec-
tion 1411 and may only be changed with
the consent of the IRS.

##### C. CFCs and QEFs held through domestic partnerships and S corporations

A comment was received on the con-
forming basis adjustment rules in
§1.1411-10(d)(2) that apply to a taxpayer
that owns an interest in a CFC or QEF
through a domestic partnership and that
does not make an election under §1.1411-
10(g). The commentator stated that it was
unclear whether basis adjustments pass
through for both section 951 inclusions
and distributions of previously taxed earn-
ings and profits. The Treasury Department
and the IRS believe that the rules in
§1.1411-10(d), which apply only for pur-
poses of section 1411, adequately address
the basis consequences specific to section
1411 that occur when a domestic partner-
ship receives a distribution of previously
taxed earnings and profits. The Treasury
Department and the IRS believe that gen-

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eral questions about basis adjustments in
the context of CFCs and QEFs held
through passthrough entities would be
more appropriately addressed in guidance
under chapter 1.

The Treasury Department and the IRS
received a comment that recommended
issuing proposed rules regarding adjust-
ments to basis under section 743 for sec-
tion 1411 purposes. The commentator re-
quested that the regulations clarify that
basis adjustments under section 743 relate
solely to the transferee and that transferee
partners be permitted to adjust the basis of
partnership property for purposes of sec-
tion 1411 regardless of whether the part-
nership has elected under section 754 or
has a substantial built-in loss. Under these
regulations, except as otherwise provided,
chapter 1 principles and rules apply in
determining the tax under section 1411.
Therefore, the Treasury Department and
the IRS have determined that it is unnec-
essary to clarify that basis adjustments
under section 743 relate solely to the
transferee partner because this result is
clear under existing law for purposes of
chapter 1. The Treasury Department and
the IRS have further determined that al-
lowing a transferee partner to adjust its
basis in partnership property when the
partnership is not otherwise required to do
so could create unnecessary administra-
tive complexity for the partnership. Thus,
the Treasury Department and the IRS
have decided that additional rules relating
to section 743 for section 1411 purposes
are not necessary.

A comment was received that recom-
mended that a rule be added to the final
regulations to require partnerships to pro-
vide their partners with the information
needed by the partners to compute their
tax under section 1411 with respect to
CFCs and PFICs held by the partnerships.
The Treasury Department and the IRS do
not adopt this recommendation. Rather,
the IRS is in the process of revising the
relevant IRS forms and instructions (such
as Form 1065, U.S. Return of Partnership
Income, and the associated Schedule K-1)
to require partnerships and S corporations
to provide to their partners and sharehold-
ers the information necessary to compute
their tax under section 1411 with respect
to CFCs and PFICs held by partnerships
and S corporations.

A commentator recommended that the
final regulations include a rule to treat a
section 751(c) amount corresponding to
the amount included in income as a divi-
dend under section 1248 for section 1411
purposes as net investment income under
section 1411(c)(1)(A)(i) rather than under
section 1411(c)(1)(A)(iii). In the alterna-
tive, the commentator requested that an
example be added to the final regulations
to illustrate the operation of section 751
(taking into account section 1248) when a
partner sells an interest in a partnership
that holds CFC stock. The Treasury De-
partment and the IRS believe that the sec-
tion 1411 characterization of the section
751(c) amount that corresponds to a sec-
tion 1248 dividend should be consistent
with the chapter 1 characterization and not
treated as a dividend, and thus do not
adopt the recommendation to treat the
amount as net investment income under
section 1411(c)(1)(A)(i) or add an exam-
ple to the final regulation.

### D. Section 1.1411-10(g) election applicable to CFCs and QEFs

The proposed regulations permitted in-
dividuals, estates, and trusts to make an
election pursuant to §1.1411-10(g) to in-
clude section 951 inclusions and section
1293 inclusions in net investment income
in the same manner and in the same tax-
able year as the amounts are included in
income for chapter 1 purposes. Under the
proposed regulations, the election was re-
quired to be made on or before the due
date for filing the individual's, estate's, or
trust's income tax return for the first tax-
able year that the individual, estate, or
trust holds stock of a CFC or QEF and
was subject to tax under section 1411 or
would be subject to tax under section
1411 if the election were made. Under the
proposed regulations the election, if made,
applied to all CFCs and QEFs held di-
rectly or indirectly by the individual, es-
tate, or trust, regardless of whether the
interest in the CFC or QEF is held in the
year the election is made or is acquired
subsequently.

Commentators suggested that the
§1.1411- 10(g) election should be permit-
ted to be made on an entity-by-entity ba-
sis, rather than to all CFCs and QEFs held
by the taxpayer, or subsequently acquired.

The Treasury Department and the IRS
adopt this recommendation, and these fi-
nal regulations provide that the §1.1411-
10(g) election is made on an entity-by-
entity basis.

The Treasury Department and the IRS
received comments recommending that
domestic partnerships and S corporations
be allowed to make the §1.1411-
10(g) election. The commentators stated
that the partner (or shareholder) level
election would create an administrative
burden for the partnership (or S corpora-
tion) because it would require the partner-
ship (or S corporation) to maintain two
sets of records with respect to its CFC and
QEF investments: one for chapter 1 pur-
poses and one for section 1411 purposes.
In response to these comments, the final
regulations include a rule that allows a
domestic partnership, S corporation, or
common trust fund to make the election in
§1.1411-10(g) for taxable years that begin
after December 31, 2013. In addition, a
domestic partnership, S corporation, or
common trust fund can make the election
in §1.1411-10(g) for a taxable year begin-
ning before January 1, 2014, if all of the
partners, shareholders, or participants (as
the case may be) consent to the election.
The final regulations also provide that a
§1.1411-10(g) election may be made with
respect to interests in CFCs or QEFs held
indirectly through certain domestic enti-
ties such as domestic partnerships or S
corporations if the domestic entity does
not make a §1.1411-10(g) election.

A commentator requested that the rule
regarding the time for making an election
under §1.1411-10(g) election be revised
so that taxpayers would not have to make
an election until the first year in which
they have a section 951 inclusion or sec-
tion 1293 inclusion. The commentator
stated that a rule based on ownership of a
CFC or QEF, rather than a chapter 1 in-
come inclusion, created a trap for the un-
wary because taxpayers may not consider
the rules in §1.1411-10 until they have a
chapter 1 income inclusion. The Treasury
Department and the IRS adopt this com-
ment, and the final regulations revise the
rules for making a §1.1411-10(g) election
to provide, in relevant part, that the elec-
tion must be made no later than the first
taxable year beginning after December 31,
2013, in which a person both has a section

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951 or section 1293 inclusion under chap-
ter 1 with respect to a CFC or QEF and is
subject to section 1411 (or would be sub-
ject to tax under section 1411 if the elec-
tion were made with respect to the CFC or
QEF). Therefore, the final regulations per-
mit a taxpayer to make the election in a
year before the first year in which there is
a chapter 1 inclusion under sections 951
or 1293 and the person is subject to tax
under section 1411 (or would be subject to
tax under section 1411 if the election were
made). In addition, the final regulations
provide that individuals, estates and trusts
may make the election for a taxable year
beginning before January 1, 2014.

A commentator suggested that the reg-
ulations be revised to allow taxpayers to
make the §1.1411-10(g) election on an
amended return. The Treasury Depart-
ment and the IRS adopt this suggestion,
and these final regulations provide that the
initial election can be made on an original
or an amended return, provided that the
year of the election, and all years affected
by the election, are not closed by the pe-
riod of limitations under section 6501.

The Treasury Department and the IRS
also received comments suggesting the ad-
dition of certain procedural rules related to
making §1.1411-10(g) elections. A com-
ment requested that the final regulations set
forth a procedure for taxpayers to make pro-
tective §1.1411-10(g) elections. In addition,
a comment suggested that rules for making
untimely §1.1411-10(g) elections should be
added to the final regulations, and recom-
mended that the rules be consistent with the
rules for making untimely QEF elections.
Moreover, a comment suggested that purg-
ing elections, similar to QEF purging elec-
tions, should be allowed with respect to
§1.1411-10(g) elections. The Treasury De-
partment and the IRS do not adopt these
suggestions because they are not necessary
in light of the changes these final regulations
provide to increase the opportunities for the
election to be made.

The §1.1411-10(g) election generally
will be made by individuals, estates, and
trusts on Form 8960, Net Investment In-
come Tax - Individuals, Estates, and
Trusts. Domestic partnerships, S corpora-
tions, and common trust funds will make
the election on attachments to their rele-
vant partnership or income tax returns.

#### 12. Taxpayer Reliance on Proposed and Final Regulations

These regulations are effective for tax-
able years beginning after December 31,
2013, except that §1.1411-3(d) applies to
taxable years beginning after December
31, 2012. Taxpayers are reminded that
section 1411 is effective for taxable years
beginning after December 31, 2012.

Part 12 of the preamble to the proposed
regulations stated that taxpayers may rely
on the proposed regulations for purposes
of compliance with section 1411 until the
effective date of the final regulations. Fur-
thermore, the preamble stated that any
election made in reliance on the proposed
regulations will be in effect for the year of
the election, and will remain in effect for
subsequent taxable years. In addition, tax-
payers who opt not to make an election in
reliance on the proposed regulations are
not precluded from making that election
pursuant to these final regulations.

For taxable years beginning before
January 1, 2014, taxpayers may rely on
either the proposed regulations or these
final regulations for purposes of compli-
ance with section 1411. See §1.1411-
1(f). However, to the extent that taxpayers
take a position in a taxable year beginning
before January 1, 2014 that is inconsistent
with these final regulations, and such po-
sition affects the treatment of one or more
items in a taxable year beginning after
December 31, 2013, then such taxpayer
must make reasonable adjustments to en-
sure that their section 1411 tax liability in
the taxable years beginning after Decem-
ber 31, 2013, is not inappropriately dis-
torted. For example, reasonable adjust-
ments may be required to ensure that no
item of income or deduction is taken into
account in computing net investment in-
come more than once, and that carryfor-
wards, basis adjustments, and other simi-
lar items are adjusted appropriately.

### Effective/Applicability Date

These final regulations apply to taxable
years beginning after December 31, 2013,
except that §1.1411-3(d) applies to tax-
able years beginning after December 31,
2012.

### Special Analyses

It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866, as supplemented by Executive Or-
der 13563. Therefore, a regulatory assess-
ment is not required. It is hereby certified
that the collection of information in
§1.1411-10(g) of these final regulations
will not have a significant economic im-
pact on a substantial number of small en-
tities. Although a number of small entities
may be subject to the requirements of this
rule, any economic impact is minimal.
This certification is based on the fact that
the time required to secure and maintain
the required information is minimal and
taxpayers would ordinarily already collect
and retain much of this information for
other income tax and business purposes.
The minimal information should be read-
ily available to the parties and the profes-
sional skills that would be necessary to
make the election would be the same as
those required to prepare a return for the
small business. Accordingly, a Regulatory
Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not
required.

Pursuant to section 7805(f) of the
Code, the notice of proposed rulemaking
preceding these regulations was submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on its impact on small businesses,
and no comments were received.

### Drafting Information

The principal authors of these regula-
tions are David H. Kirk and Adrienne M.
Mikolashek of the Office of the Associate
Chief Counsel (Passthroughs and Special
Industries). However, other personnel
from the IRS and the Treasury Depart-
ment participated in their development.
* * * * *

### Adoption of the Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602
are amended as follows:

PART 1-INCOME TAXES

Paragraph 1. The authority citation for
part 1 continues to read in part as follows:

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Authority: 26 U.S.C. 7805

Par 2. Section 1.469-0 is amended by
adding an entry for paragraph (b)(3)(iv) to
the §1.469-11 the table of contents to
read as follows:

§1.469-0 Table of contents.

* * * * *

§1.469-11 Effective date and transition
rules.

* * * * *

(b) * * *

(3) * * *

(iv) Regrouping for taxpayers subject
to section 1411.

(A) In general.

(B) Eligibility criteria.

(C) Consequences of amended returns
and examination adjustments.

(1) Taxpayers first subject to section
1411.

(2) Taxpayers ceasing to be subject to
section 1411.

(3) Examples.

(D) Effective/applicability date.

* * * * *

Par 3. Section 1.469-11 is amended by
adding paragraph (b)(3)(iv) to read as fol-
lows:

§1.469-11 Effective date and transition
rules.

* * * * *

(b) * * *

(3) * * *

(iv) Regrouping for taxpayers subject
to section 1411-(A) In general. If an
individual, estate, or trust meets the Eligi-
bility Criteria, as defined in paragraph
(b)(3)(iv)(B) of this section, such individ-
ual, estate, or trust, in the first taxable year
beginning after December 31, 2013, in
which section 1411 would apply to such
taxpayer, may regroup its activities with-
out regard to the manner in which the
activities were grouped in the preceding
taxable year. For this purpose, the deter-
mination of whether a taxpayer meets the
Eligibility Criteria is made without regard
to the effect of regrouping. The regroup-
ing must be made in the manner pre-
scribed by forms, instructions, or in other
guidance on an original return for the tax-
able year for which the regrouping is

done. A taxpayer that is an individual,
estate, or trust may regroup its activities
for any taxable year that begins during
2013, if the individual, estate, or trust
meets the Eligibility Criteria for such
year. A taxpayer may regroup activities
only once pursuant to this paragraph
(b)(3)(iv), and a regrouping made pursu-
ant to this paragraph (b)(3)(iv) will apply
to the taxable year for which the regroup-
ing is done and all subsequent years.

(B) Eligibility criteria. The term Eligibil-
ity Criteria means that an individual, estate,
or trust has net investment income (as de-
fined in §1.1411-4) and such individual's
(as defined in §1.1411-2(a)) modified ad-
justed gross income (as defined in §1.1411-
2(c)) exceeds the applicable threshold in
§1.1411-2(d) or such estate's or trust's (as
defined in §1.1411-3(a)(1)(i)) adjusted
gross income exceeds the amount described
in §1.1411-3(a)(1)(ii)(B)(2).

(C) Consequences of amended returns
and examination adjustments-(1) Tax-
payers first subject to section 1411. An
individual, estate, or trust also may re-
group activities, in the matter described in
paragraph (b)(3)(iv)(A) of this section, on
an amended return only if the changes
reported on such amended return cause
the taxpayer to meet the Eligibility Crite-
ria for the first time beginning in the tax-
able year for which the amended return is
applicable and the taxable year is not
closed by the period of limitations on as-
sessments under section 6501. If the
amended return is for a tax year that pre-
cedes a tax year for which a taxpayer had
regrouped its activities pursuant to para-
graph (b)(3)(iv)(A) of this section, the re-
grouping on such amended return must be
consistent with the taxpayer's subsequent
year's regrouping. If a regrouping on an
amended return is inconsistent with a sub-
sequent year's grouping, the subsequent
year's grouping is invalid under §1.469-
4(e)(1) unless a material change in facts
and circumstances occurred in the subse-
quent year such that the subsequent year's
grouping constitutes a permissible re-
grouping under §1.469-4(e)(2). Similar
rules also apply for any taxable year that
begins during 2013.

(2) Taxpayers ceasing to be subject to
section 1411. In the event a taxpayer re-
groups activities pursuant to paragraphs
(b)(3)(iv)(A) or (C) of this section and it is

subsequently determined that such tax-
payer does not meet the Eligibility Crite-
ria for the year of such regrouping, such
regrouping will have no effect for that
year and all future years. Appropriate ad-
justments should be made to reflect the
voiding of the ineffective regrouping.
However, notwithstanding the previous
sentence, if an individual, estate, or trust
meets the Eligibility Criteria in a subse-
quent year, such taxpayer is deemed to
treat such regrouping as being made in
such subsequent year unless the taxpayer
either regroups in a different manner (so
long as such alternative regrouping is per-
missible under §1.469-4) or properly re-
flects the ineffective regrouping in the
previous year. The subsequent year's re-
grouping may be made on an original or
on an amended return for that year. This
paragraph (b)(3)(iv)(C)(2) shall not apply
if a taxpayer does not meet the Eligibility
Criteria for the year of such regrouping as
a result of the carryback of a net operating
loss pursuant to section 172. Similar rules
also apply for any taxable year that begins
during 2013.

(3) Examples. The following examples
illustrate the principles of paragraph
(b)(3)(iv)(C) of this section. In each ex-
ample, unless otherwise indicated, the tax-
payer uses a calendar taxable year, the
taxpayer is a United States citizen, and
Year 1 is a taxable year in which section
1411 is in effect:

Example 1. In Year 1, X, a single individual,
reports modified adjusted gross income (as defined
in §1.1411-2(c)) of $198,000 (including $12,000 of
net investment income (as defined in §1.1411-4));
thus is not subject to 1411. After X filed his original
return, X receives a corrected Form 1099-DIV,
which increases his modified adjusted gross income
(as defined in §1.1411-2(c)) and his net investment
income by $2,500. X files an amended return for
Year 1 in Year 2 reporting modified adjusted gross
income of $200,500 and net investment income of
$14,500. Pursuant to paragraph (b)(3)(iv)(C)(1) of
this section, X may regroup his passive activities on
an amended return, because X now has MAGI above
the applicable threshold amount and net investment
income.

Example 2. Same facts as Example 1, except that
the $2,500 increase to modified adjusted gross in-
come and net investment income was a result of an
examination of X's Year 1 return. Pursuant to para-
graph (b)(3)(iv)(C)(1) of this section, X may regroup
his passive activities on an amended return.

Example 3. In Year 1, Y, a single individual
reported modified adjusted gross income (as defined
in §1.1411-2(c)) of $205,000 and net investment
income (as defined in §1.1411-4) of $500. Pursuant

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to paragraph (b)(3)(iv)(A) of this section, Y re-
grouped his four passive activities, A, B, C, and D,
into a single activity group. Prior to the Year 1
regrouping, Y had grouped A and B into one group,
and treated each of C and D as separate activities. Y
did not meet the Eligibly Criteria in any year prior to
Year 1 or Year 2. In Year 3, Y's employer issued Y
a corrected Year 1 Form W-2, which reduced Y's
taxable wages by $6,000. As a result, Y no longer
meets the Eligibility Criteria in Year 1 because Y's
modified adjusted gross income is now $199,000.
Therefore, Y's Year 1 regrouping is no longer effec-
tive and the prior groupings are in effect (that is,
Activity A and B are one group and Activity C and
Activity D separately). Appropriate adjustments
should be made to reflect the ineffective regrouping.
However, if Y had a material change in facts and
circumstances such that Y could regroup in Year 1 or
a subsequent year, as applicable, by reason of
§1.469-4(e)(2), then the regrouping will be deemed
to occur. Y could designate a different regrouping
for the year of the material change in facts and
circumstances.

Example 4. Same facts as Example 3, except that Y
met the Eligibly Criteria in Year 2. In this case, Y's
Year 1 regrouping is no longer effective and Y must
report his income consistent with the pre-Year 1 group-
ings. In Year 2, Y has three options. First, without any
action by Y, Y's activities are regrouped as originally
reported in Year 1. In this case, the regrouping from the
Year 1 return is deemed to occur on the Year 2 return.
This option is the default option. Second, pursuant to
paragraph (b)(3)(iv)(C)(2) of this section, Y may file an
amended return to report his income consistent with
groupings in effect prior to Year 1. Third, Y may file an
original or an amended return to regroup in a manner
different from groupings in effect prior to Year 1 and
different from the Year 1 groupings (for example, Y
could choose to group Activity C and D into single
activity, thus causing Y to have two groups; Group
A-B and Group C-D).

(D) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012.
* * * * *

Par. 4. An undesignated center heading
and §1.1411-0 are added immediately
following §1.1403-1 to read as follows:
Net Investment Income Tax

§1.1411-0 Table of contents of
provisions applicable to section 1411.

This section lists the table of contents
for §§1.1411-1 through 1.1411-10.

§1.1411-1 General rules.

(a) General rule.

(b) Adjusted gross income.

(c) Effect of section 1411 and the reg-

ulations thereunder for other purposes.

(d) Definitions.

(e) Disallowance of certain credits
against the section 1411 tax.

(f) Application to taxable years begin-
ning before January 1, 2014.

(1) Retroactive application of regula-
tions.

(2) Reliance and transitional rules.

(g) Effective/applicability date.

§1.1411-2 Application to individuals.

(a) Individual to whom tax applies.

(1) In general.

(2) Special rules.

(i) Dual-resident individuals treated as
residents of a foreign country under an
income tax treaty.

(ii) Dual-status resident aliens.

(iii) Joint returns in the case of a non-
resident alien individual married to a
United States citizen or resident.

(A) Default treatment.

(B) Taxpayer election.

(1) Effect of election.

(2) Procedural requirements for mak-
ing election.

(3) Ineffective elections.

(iv) Joint returns for a year in which
nonresident alien married to a United
States citizen or resident becomes a
United States resident.

(A) Default treatment.

(B) Taxpayer election.

(1) Effect of election.

(2) Procedural requirements for mak-
ing election.

(v) Grantor trusts.

(vi) Bankruptcy estates.

(vii) Bona fide residents of United
States territories.

(A) Applicability.

(B) Coordination with exception for
nonresident aliens.

(C) Definitions.

(1) Bona fide resident.

(2) United States territory.

(b) Calculation of tax.

(1) In general.

(2) Example.

(c) Modified adjusted gross income.

(1) General rule.

(2) Rules with respect to CFCs and
PFICs.

(d) Threshold amount.

(1) In general.

(2) Taxable year of less than twelve
months.

(i) General rule.

(ii) Change of annual accounting pe-
riod.

(e) Effective/applicability date.

§1.1411-3 Application to estates and
trusts.

(a) Estates and trusts to which tax ap-
plies.

(1) In general.

(i) General application.

(ii) Calculation of tax.

(2) Taxable year of less than twelve
months.

(i) General rule.

(ii) Change of annual accounting pe-
riod.

(3) Rules with respect to CFCs and
PFICs.

(b) Application to certain trusts and
estates.

(1) Exception for certain trusts and es-
tates.

(2) Special rules for certain taxable
trusts and estates.

(i) Qualified funeral trusts.

(ii) Bankruptcy estates.

(c) Application to electing small busi-
ness trusts (ESBTs).

(1) General application.

(2) Computation of tax.

(i) Step one.

(ii) Step two.

(ii) Step three.

(3) Example.

(d) Application to charitable remainder
trusts (CRTs).

(1) Operational rules.

(i) Treatment of annuity or unitrust dis-
tributions.

(ii) Apportionment among multiple
beneficiaries.

(iii) Accumulated net investment in-
come.

(2) Application of section 664.

(i) General rule.

(ii) Special rules for CRTs with income
from CFCs or PFICs [Reserved]

(iii) Examples.

(3) Elective simplified method. [Re-
served]

(e) Calculation of undistributed net in-
vestment income.

(1) In general.

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(2) Undistributed net investment in-

(2) Properly allocable deductions de-

(ii) Gain or loss from the disposition of property.

come.

scribed in section 62.

(3) Distributions of net investment in-

(i) Deductions allocable to gross in-

(7) Treatment of certain real estate pro-

come to beneficiaries.

come from rents and royalties.

fessionals.

(4) Deduction for amounts paid or per-

(ii) Deductions allocable to gross in-

(i) Safe harbor.

manently set aside for a charitable pur-

come from trades or businesses described

(ii) Definitions.

pose.

in §1.1411-5.

(A) Participation.

(5) Examples.

(iii) Penalty on early withdrawal of

(B) Rental real estate activity.

(f) Effective/applicability date.

savings.

(iii) Effect of safe harbor.

(iv) Net operating loss.

(8) Treatment of former passive activ-

§1.1411-4 Definition of net investment

(v) Examples.

ities.

income.

(3) Properly allocable deductions de-

(i) Section 469(f)(1)(A) losses.

scribed in section 63(d).

(ii) Section 469(f)(1)(C) losses.

(a) In general.

(i) Investment interest expense.

(iii) Examples.

(b) Ordinary course of a trade or busi-

(ii) Investment expenses.

(9) Treatment of section 469(g)(1)

ness exception.

(iii) Taxes described in section

losses.

(c) Other gross income from a trade or

164(a)(3).

(10) Treatment of section 707(c) guar-

business described in §1.1411-5.

(iv) Items described in section

anteed payments. [Reserved]

(d) Net gain.

72(b)(3).

(11) Treatment of section 736 pay-

(1) Definition of disposition.

(v) Items described in section 691(c).

ments. [Reserved]

(2) Limitation.

(vi) Items described in section 212(3).

(12) Income and deductions from cer-

(3) Net gain attributable to the dispo-

(vii) Amortizable bond premium.

tain notional principal contracts. [Re-

sition of property.

(viii) Fiduciary expenses.

served]

(i) General rule.

(4) Loss deductions.

(13) Treatment of income or loss from

(ii) Examples.

(i) General rule.

REMIC residual interests. [Reserved]

(4) Gains and losses excluded from net

(ii) Examples.

(h) Net operating loss.

investment income.

(5) Ordinary loss deductions for certain

(1) In general.

(i) Exception for gain or loss attribut-

debt instruments.

(2) Applicable portion of a net operat- ing loss.

able to property held in a trade or business

(6) Other deductions.

not described in §1.1411-5.

(7) Application of limitations under

(3) Section 1411 NOL amount of a net

(A) General rule.

sections 67 and 68.

operating loss carried to and deducted in a

(B) Special rules for determining

(i) Deductions subject to section 67.

taxable

whether property is held in a trade or

(ii) Deductions subject to section 68.

year. (4) Total section 1411 NOL amount of

business.

(iii) Itemized deductions.

(C) Examples.

(iv) Example.

a net operating loss deduction. (5) Examples.

(ii) Other gains and losses excluded

(g) Special rules.

from net investment income.

(1) Deductions allocable to both net

(i) Effective/applicability date.

(iii) Adjustment for capital loss carry-

investment income and excluded income.

forwards for previously excluded income.

(2) Recoveries of properly allocable

§1.1411-5 Trades and businesses to

[Reserved]

deductions.

which tax applies.

(e) Net investment income attributable

(i) General rule.

to certain entities.

(ii) Recoveries of items allocated be-

(a) In general.

(1) Distributions from estates and

tween net investment income and ex-

(b) Passive activity.

trusts.

cluded income.

(1) In general.

(i) In general.

(iii) Recoveries with no prior year ben-

(2) Application of income recharacter-

(ii) Distributions of accumulated net

efit.

ization rules.

investment income from foreign non-

(iv) Examples.

(i) Income and gain recharacterization.

grantor trusts to United States beneficia-

(3) Deductions described in section

(ii) Gain recharacterization.

ries. [Reserved]

691(b).

(iii) Exception for certain portfolio re-

(2) CFCs and PFICs.

(4) Amounts described in section

characterizations.

(3) Treatment of income from common

642(h).

(3) Examples.

trust funds. [Reserved]

(5) Treatment of self-charged interest

(c) Trading in financial instruments or

(f) Properly allocable deductions.

income.

commodities.

(1) General rule.

(6) Treatment of certain nonpassive

(1) Definition of financial instruments.

(i) In general.

rental activities.

(2) Definition of commodities.

(ii) Limitations.

(i) Gross income from rents.

(d) Effective/applicability date.

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§1.1411-6 Income on investment of
working capital subject to tax.

(a) General rule.

(b) Example.

(c) Effective/applicability date.

§1.1411-7 Exception for dispositions of
certain active interests in partnerships
and S corporations. [Reserved]

§1.1411-8 Exception for distributions
from qualified plans.

(a) General rule.

(b) Rules relating to distributions.

(1) Actual distributions.

(2) Amounts treated as distributed.

(3) Amounts includible in gross in-
come.

(4) Amounts related to employer secu-
rities.

(i) Dividends related to employer secu-
rities.

(ii) Amounts related to the net unreal-
ized appreciation in employer securities.

(c) Effective/applicability date.

§1.1411-9 Exception for self-
employment income.

(a) General rule.

(b) Special rule for traders.

(c) Examples.

(d) Effective/applicability date.

§1.1411-10 Controlled foreign
corporations and passive foreign
investment companies.

(a) In general.

(b) Amounts derived from a trade or
business described in §1.1411-5.

(1) In general.

(2) Coordination rule for changes in
trade or business status.

(c) Calculation of net investment in-
come.

(1) Dividends.

(i) Distributions of previously taxed
earnings and profits.

(A) Rules when an election under para-
graph (g) of this section is not in effect
with respect to the shareholder.

(1) General rule.

(2) Exception for distributions attribut-
able to earnings and profits previously

taken into account for purposes of section
1411.

(B) Rule when an election under para-
graph (g) of this section is in effect with
respect to the shareholder.

(C) Special rule for certain distribu-
tions related to 2013 taxable years.

(1) Scope.

(2) Rule.

(3) Ordering rule.

(ii) Excess distributions that constitute
dividends.

(2) Net gain.

(i) Gains treated as excess distribu-
tions.

(ii) Inclusions and deductions with re-
spect to section 1296 mark to market elec-
tions.

(iii) Gain or loss attributable to the
disposition of stock of CFCs and QEFs.

(iv) Gain or loss attributable to the
disposition of interests in domestic part-
nerships or S corporations that own di-
rectly or indirectly stock of CFCs or
QEFs.

(3) Application of section 1248.

(4) Amounts distributed by an estate or
trust.

(5) Properly allocable deductions.

(i) General rule.

(ii) Additional rules.

(d) Conforming basis adjustments.

(1) Basis adjustments under sections
961 and 1293.

(i) Stock held by individuals, estates,
or trusts.

(ii) Stock held by domestic partner-
ships or S corporations.

(A) Rule when an election under para-
graph (g) of this section is not in effect.

(B) Rules when an election under para-
graph (g) of this section is in effect.

(2) Special rules for partners that own
interests in domestic partnerships that
own directly or indirectly stock of CFCs
or QEFs.

(3) Special rules for S corporation
shareholders that own interests in S cor-
porations that own directly or indirectly
stock of CFCs or QEFs.

(4) Special rules for participants in
common trust funds.

(e) Conforming adjustments to modi-
fied adjusted gross income and adjusted
gross income.

(1) Individuals.

(2) Estates and trusts.

(f) Application to estates and trusts.

(g) Election with respect to CFCs and
QEFs.

(1) Effect of election.

(2) Years to which election applies.

(i) In general.

(ii) Termination of interest in CFC or
QEF.

(iii) Termination of partnership.

(3) Who may make the election.

(4) Time and manner for making the
election.

(i) Individuals, estates, and trusts.

(A) General rule.

(B) Special rule for charitable remain-
der trusts (CRTs).

(ii) Certain domestic passthrough enti-
ties.

(iii) Taxable years that begin before
January 1, 2014.

(A) Individuals, estates, or trusts.

(B) Certain domestic passthrough enti-
ties.

(iv) Time for making election.

(h) Examples.

(i) Effective/applicability date.

Par. 5. Sections 1.1411-1 through

1.1411-10 are added to read as follows:
* * * * *

Sec.

1.1411-1 General rules.

1.1411-2 Application to individuals.

1.1411-3 Application to estates and
trusts.

1.1411-4 Definition of net investment
income.

1.1411-5 Trades or businesses to
which tax applies.

1.1411-6 Income on investment of
working capital subject to tax.

1.1411-7 [Reserved]

1.1411-8 Exception for distributions
from qualified plans.

1.1411-9 Exception for self-
employment income.

1.1411-10 Controlled foreign corpora-
tions and passive foreign investment com-
panies.

* * * * *

§1.1411-1 General rules.

(a) General rule. Except as otherwise
provided, all Internal Revenue Code
(Code) provisions that apply for chapter 1
purposes in determining taxable income
(as defined in section 63(a)) of a taxpayer

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also apply in determining the tax imposed
by section 1411.

(b) Adjusted gross income. All refer-
ences to an individual's adjusted gross
income are treated as references to ad-
justed gross income as defined in section
62, and all references to an estate's or
trust's adjusted gross income are treated
as references to adjusted gross income as
defined in section 67(e). However, there
may be additional adjustments to adjusted
gross income because of investments in
controlled foreign corporations (CFCs) or
passive foreign investment companies
(PFICs). See §1.1411-10(e).

(c) Effect of section 1411 and the reg-
ulations thereunder for other purposes.
The inclusion or exclusion of items of
income, gain, loss, or deduction in deter-
mining net investment income for pur-
poses of section 1411, and the assignment
of items of income, gain, loss, or deduc-
tion to a particular category of net invest-
ment income under section 1411(c)(1)(A),
does not affect the treatment of any item
of income, gain, loss, or deduction under
any provision of the Code other than sec-
tion 1411.

(d) Definitions. The following defini-
tions apply for purposes of calculating net
investment income under section 1411
and the regulations thereunder-

(1) The term gross income from an-
nuities under section 1411(c)(1)(A) in-
cludes the amount received as an annu-
ity under an annuity, endowment, or life
insurance contract that is includible in
gross income as a result of the application
of section 72(a) and section 72(b), and an
amount not received as an annuity under
an annuity contract that is includible in
gross income under section 72(e). In the
case of a sale of an annuity, to the extent
the sales price of the annuity does not
exceed its surrender value, the gain rec-
ognized would be treated as gross income
from an annuity within the meaning of
section 1411(c)(1)(A)(i) and §1.1411-
4(a)(1)(i). However, if the sales price of
the annuity exceeds its surrender value,
the seller would treat the gain equal to
the difference between the basis in the
annuity and the surrender value as gross
income from an annuity described in
section 1411(c)(1)(A)(i) and §1.1411-
4(a)(1)(i) and the excess of the sales
price over the surrender value as gain

from the disposition of property in-
cluded in section 1411(c)(1)(A)(iii) and
§1.1411-4(a)(1)(iii). The term gross in-
come from annuities does not include
amounts paid in consideration for services
rendered. For example, distributions from
a foreign retirement plan that are paid in
the form of an annuity and include invest-
ment income that was earned by the re-
tirement plan does not constitute income
from an annuity within the meaning of
section 1411(c)(1)(A)(i).

(2) The term controlled foreign corpo-
ration (CFC) is as defined in section
953(c)(1)(B) or 957(a).

(3) The term gross income from divi-
dends includes any item treated as a div-
idend for purposes of chapter 1. See also
§1.1411- 10 for additional amounts that
constitute gross income from dividends.
The term gross income from dividends
includes, but is not limited to, amounts
treated as dividends-

(i) Pursuant to subchapter C that are
included in gross income (including con-
structive dividends);

(ii) Pursuant to section 1248(a), other
than as provided in §1.1411-10;

(iii) Pursuant to §1.367(b)-2(e)(2);

(iv) Pursuant to section 1368(c)(2); and

(v) Substitute dividends that represent
payments made to the transferor of a se-
curity in a securities lending transaction or
a sale-repurchase transaction.

(4) The term excluded income means:

(i) Items of income excluded from
gross income in chapter 1. For example,
interest on state and local bonds excluded
from gross income under section 103 and
gain from the sale of a principal residence
excluded from gross income under section
121.

(ii) Items of income not included in net
investment income, as determined under
§§1.1411-4 and 1.1411-10. For example,
wages, unemployment compensation,
Alaska Permanent Fund Dividends, ali-
mony, and Social Security Benefits.

(iii) Items of gross income and net gain
specifically excluded by section 1411, the
regulations thereunder, or other guidance
published in the Internal Revenue Bulle-
tin. For example, gains from the disposi-
tion of property used in a trade of business
not described in section 1411(c)(2) under
§1.1411-4(d)(4)(i), distributions from
certain Qualified Plans described in sec-

tion 1411(c)(5) and §1.1411-8, income
taken into account in determining self-
employment income that is subject to tax
under section 1401(b) described in section
1411(c)(6) and §1.1411-9, and section
951(a) inclusions from a CFC for which a
§1.1411-10(g) election is not in effect.

(5) The term individual means any nat-
ural person.

(6) The term gross income from inter-
est includes any item treated as interest
income for purposes of chapter 1 and sub-
stitute interest that represents payments
made to the transferor of a security in a
securities lending transaction or a sale-
repurchase transaction.

(7) The term married and married tax-
payer has the same meaning as in section
7703.

(8) The term net investment income
(NII) means net investment income as de-
fined in section 1411(c) and §1.1411-
4, as adjusted pursuant to the rules de-
scribed in §1.1411-10(c).

(9) The term passive foreign invest-
ment company (PFIC) is as defined in
section 1297(a).

(10) The term gross income from rents
includes amounts paid or to be paid prin-
cipally for the use of (or the right to use)
tangible property.

(11) The term gross income from royal-
ties includes amounts received from min-
eral, oil, and gas royalties, and amounts re-
ceived for the privilege of using patents,
copyrights, secret processes and formulas,
goodwill, trademarks, tradebrands, fran-
chises, and other like property.

(12) The term trade or business refers
to a trade or business within the meaning
of section 162.

(13) The term United States person is
as defined in section 7701(a)(30).

(14) The term United States share-
holder is as defined in section 951(b).

(e) Disallowance of certain credits
against the section 1411 tax. Amounts
that may be credited against only the tax
imposed by chapter 1 of the Code may not
be credited against the section 1411 tax
imposed by chapter 2A of the Code unless
specifically provided in the Code. For ex-
ample, the foreign income, war profits,
and excess profits taxes that are allowed
as a foreign tax credit by section 27(a),
section 642(a), and section 901, respec-

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tively, are not allowed as a credit against
the section 1411 tax.

(f) Application to taxable years begin-
ning before January 1, 2014-(1) Retro-
active application of regulations. Taxpay-
ers that are subject to section 1411, and
any other taxpayer to which these regula-
tions may apply (such as partnerships and
S corporations), may apply §§1.1411-
1 through 1.1411-10 (including the ability
to make any election(s) contained therein)
in any taxable year that begins after De-
cember 31, 2012, but before January 1,
2014, for which the period of limitation
under section 6501 has not expired.

(2) Reliance and transitional rules. For
taxable years beginning before January 1,
2014, the Internal Revenue Service will
not challenge a taxpayer's computation of
tax under section 1411 if the taxpayer has
made a reasonable, good faith effort to
comply with the requirements of section
1411. For example, a taxpayer's compli-
ance with the provisions of the proposed
and final regulations under section 1411
(REG-130507-11 or REG-130843-13),
generally, will be considered a reasonable,
good faith effort to comply with the re-
quirements of section 1411 if reliance on
such regulation projects under section
1411 are applied in their entirety, and the
taxpayer makes reasonable adjustments to
ensure that their section 1411 tax liability
in the taxable years beginning after De-
cember 31, 2013, is not inappropriately
distorted by the positions taken in taxable
years beginning after December 31, 2012,
but before January 1, 2014. A similar rule
applies to any other taxpayer to which
these regulations may apply (such as part-
nerships and S corporations).

(g) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012,
in accordance with paragraph (f) of this
section.

§1.1411-2 Application to individuals.

(a) Individual to whom tax applies-
(1) In general. Section 1411 applies to an
individual who is a citizen or resident of
the United States (within the meaning of
section 7701(a)(30)(A)). Section 1411
does not apply to nonresident alien indi-
viduals (within the meaning of section
7701(b)(1)(B)). See paragraph (a)(2)(vi)

of this section for special rules regarding
bona fide residents of United States terri-
tories.

(2) Special rules-(i) Dual-resident in-
dividuals treated as residents of a foreign
country under an income tax treaty. A
dual-resident taxpayer (as defined in
§301.7701(b)-7(a)(1)) who determines
that he or she is a resident of a foreign
country for treaty purposes pursuant to an
income tax treaty between the United
States and the foreign country and who
claims benefits of the treaty as a nonresi-
dent of the United States will be treated as
a nonresident alien of the United States
for purposes of paragraph (a)(1) of this
section.

(ii) Dual-status resident aliens. A dual-
status individual who is a resident of the
United States for a portion of a taxable
year and a nonresident alien for the other
portion of the taxable year will not be
subject to section 1411 with respect to the
portion of the year for which that individ-
ual is treated as a nonresident alien. The
only income the individual must take into
account for purposes of section 1411 is
the income he or she receives during the
portion of the year for which he or she is
treated as a resident of the United States.
The threshold amount under paragraph
(d)(1) of this section applies.

(iii) Joint returns in the case of a non-
resident alien individual married to a
United States citizen or resident-(A) De-
fault treatment. In the case of a United
States citizen or resident who is married to
a nonresident alien individual, the spouses
will be treated as married filing separately
for purposes of section 1411. For purposes
of calculating the tax imposed under sec-
tion 1411(a)(1), the United States citizen
or resident spouse will be subject to the
threshold amount for a married taxpayer
filing a separate return in paragraph
(d)(1)(ii) of this section, and the nonresi-
dent alien spouse will not be subject to tax
under section 1411. In accordance with
the rules for married individuals filing
separate returns, the spouse that is a
United States citizen or resident must de-
termine his or her own net investment
income and modified adjusted gross in-
come.

(B) Taxpayer election. Married taxpay-
ers who file a joint Federal income tax
return pursuant to a section 6013(g) elec-

tion for purposes of chapter 1 and chapter
24 also may elect to be treated as making
a section 6013(g) election for purposes of
chapter 2A (relating to the tax imposed by
section 1411).

(1) Effect of election. For purposes of
calculating the tax imposed under section
1411(a)(1), the effect of an election under
section 6013(g) is to include the combined
income of the United States citizen or
resident spouse and the nonresident
spouse in the section 1411(a)(1) calcula-
tion and to apply the threshold amount for
a taxpayer making a joint return as set out
in paragraph (d)(1)(i) of this section.

(2) Procedural requirements for mak-
ing election. Taxpayers with a section
6013(g) election in effect for chapter 1
and chapter 24 purposes for any taxable
year beginning after December 31, 2012,
or taxpayers making a section 6013(g)
election for chapter 1 and chapter 24 pur-
poses in any taxable year beginning after
December 31, 2012, who want to apply
their section 6013(g) election for purposes
of chapter 2A must make the election for
the first taxable year beginning after De-
cember 31, 2013, in which the United
States taxpayer is subject to tax under
section 1411. The determination of
whether the United States taxpayer is sub-
ject to tax under section 1411 is made
without regard to the effect of the section
6013(g) election described in paragraph
(a)(2)(iii)(B) of this section. The election,
if made, must be made in the manner
prescribed by forms, instructions, or in
other guidance on an original or amended
return for the taxable year for which the
election is made. An election can be made
on an amended return only if the taxable
year for which the election is made, and
all taxable years that are affected by the
election, are not closed by the period of
limitations on assessments under section
6501. Further, once made, the duration
and termination of the section 6013(g)
election for chapter 2A is governed by the
rules of section 6013(g)(2) through (g)(6)
and the regulations thereunder.

(3) Ineffective elections. In the event a
taxpayer makes an election described in
paragraph (a)(2)(iii)(B) of this section and
subsequently determines that such tax-
payer does not meet the criteria for mak-
ing such election in such tax year de-
scribed in paragraph (a)(2)(iii)(B)(2) of

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this section, then such original election
will have no effect for that year and all
future years. In such a case, the taxpayer
should make appropriate adjustments to
properly reflect the ineffective election.
However, notwithstanding the previous
sentence, if a taxpayer meets the criteria
for the same election in a subsequent year,
such taxpayer is deemed to treat such
original election as being made in that
subsequent year unless the taxpayer files
(or amends) the return for such subse-
quent year to report the taxpayer's net
investment income tax without the origi-
nal election. Furthermore, this paragraph
(a)(2)(iii)(B)(3) shall not apply if a tax-
payer does not meet the criteria described
in paragraph (a)(2)(iii)(B)(2) of this sec-
tion for making such election in such tax
year solely as a result of the carryback of
a net operating loss pursuant to section
172.

(iv) Joint returns for a year in which
nonresident alien married to a United
States citizen or resident becomes a
United States resident-(A) Default treat-
ment. In the case of a United States citizen
or resident who is married to an individual
who is a nonresident alien individual at
the beginning of any taxable year, but is a
United States resident at the close of such
taxable year, each spouse will be treated
as married filing separately for the entire
year for purposes of section 1411. For
purposes of calculating the tax imposed
under section 1411(a)(1), each spouse will
be subject to the threshold amount for a
married taxpayer filing a separate return in
paragraph (d)(1)(ii) of this section. The
spouse who becomes a United States res-
ident during the tax year will be subject to
section 1411 only with respect to income
received for the portion of the year for
which he or she is treated as a United
States resident. Each spouse must deter-
mine his or her own net investment in-
come and modified adjusted gross income.

(B) Taxpayer election. Married taxpay-
ers who file a joint Federal income tax
return pursuant to a section 6013(h) elec-
tion for purposes of chapter 1 and chapter
24 also may elect to be treated as making
a section 6013(h) election for purposes of
chapter 2A for such tax year.

(1) Effect of election. For purposes of
calculating the tax imposed under section
1411(a)(1), the effect of an election under

section 6013(h) is to include the combined
income of the United States citizen or
resident spouse and the dual-status resi-
dent spouse in the section 1411(a)(1) cal-
culation and to apply the threshold
amount for a taxpayer making a joint re-
turn as set out in paragraph (d)(1)(i) of
this section.

(2) Procedural requirements for mak-
ing election. Taxpayers who make a sec-
tion 6013(h) election for purposes of
chapter 1 and chapter 24 for any taxable
year beginning after December 31, 2012,
may elect to have their section 6013(h)
election apply for purposes of chapter 2A.
The election, if made, must be made in the
manner prescribed by forms, instructions,
or in other guidance on an original or
amended return for the taxable year for
which the election is made. An election
can be made on an amended return only if
the taxable year for which the election is
made, and all taxable years that are af-
fected by the election, are not closed by
the period of limitations on assessments
under section 6501. Further, in all cases,
once made, the section 6013(h) election is
governed by the rules of section
6013(h)(2) and the regulations thereunder.

(iv) Grantor trusts. For rules regarding
the treatment of owners of grantor trusts,
see §1.1411-3(b)(1)(v).

(v) Bankruptcy estates. A bankruptcy
estate administered under chapter 7 (relat-
ing to liquidations) or chapter 11 (relating
to reorganizations) of the Bankruptcy
Code (Title 11 of the United States Code)
of a debtor who is an individual is treated
as a married taxpayer filing a separate
return for purposes of section 1411. See
§1.1411-2(d)(1)(ii).

(vi) Bona fide residents of United
States territories-(A) Applicability. An
individual who is a bona fide resident of a
United States territory is subject to the tax
imposed by section 1411(a)(1) only if the
individual is required to file an income tax
return with the United States upon appli-
cation of section 931, 932, 933, or 935 and
the regulations thereunder. With respect to
an individual described in this paragraph
(a)(2)(vi)(A), the amount excluded from
gross income under section 931 or 933
and any deduction properly allocable or
chargeable against amounts excluded
from gross income under section 931 or
933, respectively, is not taken into ac-

count in computing modified adjusted
gross income under paragraph (c) of this
section or net investment income (within
the meaning of §1.1411- 1(d)).

(B) Coordination with exception for
nonresident aliens. An individual who is
both a bona fide resident of a United
States territory and a nonresident alien
individual with respect to the United
States is not subject to taxation under sec-
tion 1411(a)(1).

(C) Definitions. For purposes of this
section-

(1) Bona fide resident. The term bona
fide resident has the meaning provided
under section 937(a).

(2) United States territory. The term
United States territory means American
Samoa, Guam, the Northern Mariana Is-
lands, Puerto Rico, or the United States
Virgin Islands. (b) Calculation of tax-(1)
In general. In the case of an individual
described in paragraph (a)(1) of this sec-
tion, the tax imposed by section
1411(a)(1) for each taxable year is equal
to 3.8 percent of the lesser of-

(i) Net investment income for such tax-
able year; or

(ii) The excess (if any) of-

(A) The modified adjusted gross in-
come (as defined in paragraph (c) of this
section) for such taxable year; over

(B) The threshold amount (as defined
in paragraph (d) of this section).

(2) Example. During Year 1 (at year in which
section 1411 is in effect), A, an unmarried United
States citizen, has modified adjusted gross income
(as defined in paragraph (c) of this section) of
$190,000, which includes $50,000 of net investment
income. A has a zero tax imposed under section 1411
because the threshold amount for a single individual
is $200,000 (as provided in paragraph (d)(1)(iii) of
this section). If during Year 2, A has modified ad-
justed gross income of $220,000, which includes
$50,000 of net investment income, then the individ-
ual has a section 1411 tax of $760 (3.8% multiplied
by $20,000, the lesser of $50,000 net investment
income or $20,000 excess of modified adjusted gross
income over the threshold amount).

(c) Modified adjusted gross income-
(1) General rule. For purposes of section
1411, the term modified adjusted gross
income means adjusted gross income in-
creased by the excess of-

(i) The amount excluded from gross
income under section 911(a)(1); over

(ii) The amount of any deductions
(taken into account in computing adjusted
gross income) or exclusions disallowed
under section 911(d)(6) with respect to the

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amounts described in paragraph (c)(1)(i)
of this section.

(2) Rules with respect to CFCs and
PFICs. Additional rules in §1.1411-
10(e)(1) apply to an individual that is a
United States shareholder of a controlled
foreign corporation (CFC) or that is a
United States person that directly or indi-
rectly owns an interest in a passive foreign
investment company (PFIC).

(d) Threshold amount-(1) In general.
The term threshold amount means-

(i) In the case of a taxpayer making a
joint return under section 6013 or a sur-
viving spouse (as defined in section 2(a)),
$250,000;

(ii) In the case of a married taxpayer
filing a separate return, $125,000; and

(iii) In the case of any other individual,
$200,000.

(2) Taxable year of less than twelve
months-(i) General rule. In the case of an
individual who has a taxable year consisting
of less than twelve months (short taxable
year), the threshold amount under paragraph
(d)(1) of this section is not reduced or pro-
rated. For example, in the case of an unmar-
ried decedent who dies on June 1, the
threshold amount is $200,000 for the dece-
dent's short taxable year that begins on Jan-
uary 1 and ends on June 1.

(ii) Change of annual accounting pe-
riod. Notwithstanding paragraph (d)(2)(i)
of this section, an individual who has a
short taxable year resulting from a change
of annual accounting period reduces the
threshold amount to an amount that bears
the same ratio to the full threshold amount
provided under paragraph (d)(1) of this
section as the number of months in the
short taxable year bears to twelve.

(e) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012,
in accordance with §1.1411- 1(f).

§1.1411-3 Application to estates and
trusts.

(a) Estates and trusts to which tax ap-
plies-(1) In general-(i) General appli-
cation. Section 1411 and the regulations
thereunder apply to all estates and trusts
that are subject to the provisions of part I
of subchapter J of chapter 1 of subtitle A

of the Internal Revenue Code, unless spe-
cifically exempted under paragraph (b) of
this section.

(ii) Calculation of tax. The tax imposed
by section 1411(a)(2) for each taxable year
is equal to 3.8 percent of the lesser of-

(A) The estate's or trust's undistributed
net investment income for such taxable
year; or

(B) The excess (if any) of-

(1) The estate's or trust's adjusted
gross income (as defined in section 67(e)
and as adjusted under §1.1411- 10(e)(2),
if applicable) for such taxable year; over

(2) The dollar amount at which the
highest tax bracket in section 1(e) begins
for such taxable year.

(2) Taxable year of less than twelve
months-(i) General rule. In the case of
an estate or trust that has a taxable year
consisting of less than twelve months
(short taxable year), the dollar amount
described in paragraph (a)(1)(ii)(B)(2) of
this section is not reduced or prorated.

(ii) Change of annual accounting pe-
riod. Notwithstanding paragraph (a)(2)(i)
of this section, an estate or trust that has
a short taxable year resulting from a
change of annual accounting period (but
not from an individual's death) reduces
the dollar amount described in para-
graph (a)(1)(ii)(B)(2) of this section to
an amount that bears the same ratio to
that dollar amount as the number of
months in the short taxable year bears to
twelve.

(3) Rules with respect to CFCs and
PFICs. Additional rules in §1.1411- 10
apply to an estate or trust that holds an
interest in a controlled foreign corporation
(CFC) or a passive foreign investment
company (PFIC).

(b) Application to certain trusts and es-
tates-(1) Exception for certain trusts and
estates. The following trusts are not subject
to the tax imposed by section 1411:

(i) A trust or decedent's estate all of the
unexpired interests in which are devoted
to one or more of the purposes described
in section 170(c)(2)(B).

(ii) A trust exempt from tax under sec-
tion 501.

(iii) A charitable remainder trust de-
scribed in section 664. However, see para-
graph (d) of this section for special rules
regarding the treatment of annuity or uni-

trust distributions from such a trust to
persons subject to tax under section 1411.

(iv) Any other trust, fund, or account that
is statutorily exempt from taxes imposed in
subtitle A. For example, see sections
220(e)(1), 223(e)(1), 529(a), and 530(a).

(v) A trust, or a portion thereof, that is
treated as a grantor trust under subpart E of
part I of subchapter J of chapter 1. However,
in the case of any such trust or portion
thereof, each item of income or deduction
that is included in computing taxable in-
come of a grantor or another person under
section 671 is treated as if it had been re-
ceived by, or paid directly to, the grantor or
other person for purposes of calculating
such person's net investment income.

(vi) Electing Alaska Native Settlement
Trusts subject to taxation under section 646.
(vii) Cemetery Perpetual Care Funds to
which section 642(i) applies.

(viii) Foreign trusts (as defined in sec-
tion 7701(a)(31)(B) and §301.7701-
7(a)(2)) (but see §§1.1411-3(e)(3)(ii) and
1.1411-4(e)(1)(ii) for rules related to dis-
tributions from foreign trusts to United
States beneficiaries).

(ix) Foreign estates (as defined in sec-
tion 7701(a)(31)(A)) (but see §1.1411-
3(e)(3)(ii) for rules related to distributions
from foreign estates to United States ben-
eficiaries).

(2) Special rules for certain taxable
trusts and estates-(i) Qualified funeral
trusts. For purposes of the calculation of
any tax imposed by section 1411, section
1411 and the regulations thereunder are
applied to each qualified funeral trust
(within the meaning of section 685) by
treating each beneficiary's interest in each
such trust as a separate trust.

(ii) Bankruptcy estates. A bankruptcy
estate in which the debtor is an individual
is treated as a married taxpayer filing a
separate return for purposes of section
1411. See §1.1411-2(a)(2)(v) and
(d)(1)(ii).

(c) Application to electing small busi-
ness trusts (ESBTs)-(1) General appli-
cation. The S portion and non-S portion
(as defined in §1.641(c)-1(b)(2) and (3),
respectively) of a trust that has made an
ESBT election under section 1361(e)(3)
and §1.1361-1(m)(2) are treated as sepa-
rate trusts for purposes of the computation
of undistributed net investment income in
the manner described in paragraph (e) of

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this section, but are treated as a single
trust for purposes of determining the
amount subject to tax under section 1411.
If a grantor or another person is treated as
the owner of a portion of the ESBT, the
items of income and deduction attribut-
able to the grantor portion (as defined in
§1.641(c)-1(b)(1)) are included in the
grantor's calculation of net investment in-
come and are not included in the ESBT's
computation of tax described in paragraph
(c)(1)(ii) of this section.

(2) Computation of tax. This paragraph
(c)(2) provides the method for an ESBT to
compute the tax under section 1411.

(i) Step one. The S portion and non-S
portion computes each portion's undis-
tributed net investment income as separate
trusts in the manner described in para-

graph (e) of this section and then combine
these amounts to calculate the ESBT's
undistributed net investment income.

(ii) Step two. The ESBT calculates its
adjusted gross income (as defined in para-
graph (a)(1)(ii)(B)(1) of this section). The
ESBT's adjusted gross income is the ad-
justed gross income of the non-S portion,
increased or decreased by the net income
or net loss of the S portion, after taking
into account all deductions, carryovers,
and loss limitations applicable to the S
portion, as a single item of ordinary in-
come (or ordinary loss).

(iii) Step three. The ESBT pays tax on
the lesser of-

(A) The ESBT's total undistributed net
investment income; or

(B) The excess of the ESBT's adjusted
gross income (as calculated in paragraph
(c)(2)(ii) of this section) over the dollar
amount at which the highest tax bracket in
section 1(e) begins for the taxable year.

(3) Example. (i) In Year 1 (a year that section
1411 is in effect), the non-S portion of Trust, an
ESBT, has dividend income of $15,000, interest
income of $10,000, and capital loss of $5,000.
Trust's S portion has net rental income of $21,000
and a capital gain of $7,000. The Trustee's annual
fee of $1,000 is allocated 60% to the non-S portion
and 40% to the S portion. Trust makes a distribution
from income to a single beneficiary of $9,000.

(ii) Step one. (A) Trust must compute the undis-
tributed net investment income for the S portion and
non-S portion in the manner described in paragraph
(c) of this section.

The undistributed net investment income for the S portion is $20,600 and is determined as follows:

Net Rental Income

$21,000

Capital Gain

$7,000

Trustee Annual Fee

($400)

Total S portion undistributed net investment income

$27,600

(B) The undistributed net investment income for the non-S portion is $12,400 and is determined as follows:

Dividend Income

$15,000

Interest Income

$10,000

Deductible Capital Loss

($3,000)

Trustee Annual Fee

($600)

Distributable net income distribution

($9,000)

Total non-S portion undistributed net investment income

$12,400

(C) Trust combines the undistributed net investment income of the S portion and non-S portion from (ii)(A) and (B) to arrive at Trust's combined undistributed
net investment income.

S portion's undistributed net investment income

$27,600

Non-S portion's undistributed net investment income

$12,400

Combined undistributed net investment income

$40,000

(iii) Step two. (A) The ESBT calculates its adjusted gross income. Pursuant to paragraph (c)(2)(ii) of this section, the ESBT's adjusted gross income is the non-S
portion's adjusted gross income increased or decreased by the net income or net loss of the S portion.

Dividend Income

$15,000

Interest Income

$10,000

Deductible Capital Loss

($3,000)

Trustee Annual Fee

($600)

Distributable net income distribution

($9,000)

S Portion Income

$27,600

Adjusted gross income

$40,000

(B) The adjusted gross income for the ESBT is $38,000 and is determined as follows:

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(C) The S portion's single item of ordinary in-
come used in the ESBT's adjusted gross income
calculation is $27,600. This item of income is deter-
mined by starting with net rental income of $21,000
and capital gain of $7,000 and reducing it by the S
portion's $400 share of the annual trustee fee.

(iv) Step three. Trust pays tax on the lesser of-

(A) The combined undistributed net investment
income ($40,000); or

(B) The excess of adjusted gross income
($40,000) over the dollar amount at which the high-
est tax bracket in section 1(e) applicable to a trust
begins for the taxable year.

(d) Application to charitable remainder
trusts (CRTs)-(1) Operational rules-(i)
Treatment of annuity or unitrust distribu-
tions. If one or more items of net investment
income comprise all or part of an annuity or
unitrust distribution from a CRT, such items
retain their character as net investment in-
come in the hands of the recipient of that
annuity or unitrust distribution.

(ii) Apportionment among multiple
beneficiaries. In the case of a CRT with

more than one annuity or unitrust benefi-
ciary, the net investment income is appor-
tioned among such beneficiaries based on
their respective shares of the total annuity
or unitrust amount paid by the CRT for
that taxable year.

(iii) Accumulated net investment in-
come. The accumulated net investment in-
come of a CRT is the total amount of net
investment income received by a CRT for
all taxable years that begin after Decem-
ber 31, 2012, less the total amount of net
investment income distributed for all prior
taxable years of the trust that begin after
December 31, 2012.

(2) Application of Section 664-(i)
General rule. The Federal income tax rate
of the item of net investment income, to
be used to determine the proper classifi-
cation of that item within the appropriate
income category as described in §1.664-
1(d)(1)(i)(b), is the sum of the income tax

rate applicable to that item under chapter
1 and the tax rate under section 1411.
Thus, the accumulated net investment in-
come and excluded income (as defined in
§1.1411-1(d)(4)) of a CRT in the same
income category constitute separate
classes of income within that category as
described in §1.664-1(d)(1)(i)(b).

(ii) Special rules for CRTs with income
from CFCs or PFICs. [Reserved]

(iii) Examples. The following exam-
ples illustrate the provisions of this para-
graph (d)(2).

Example 1. (i) In 2009, A formed CRT as a
charitable remainder annuity trust. The trust docu-
ment requires an annual annuity payment of $50,000
to A for 15 years. For purposes of this example,
assume that CRT is a valid charitable remainder trust
under section 664 and has not received any unrelated
business taxable income during any taxable year.

(ii) As of January 1, 2013, CRT has the follow-
ing items of undistributed income within its §1.664-
1(d)(1) categories and classes:

Category

Class

Tax Rate

Amount

Ordinary Income

Interest

39.6%

$4,000

Net Rental Income

39.6%

$8,000

Non-Qualified Dividend Income

39.6%

$2,000

Qualified Dividend Income

20.0%

$10,000

Capital Gain

Short-Term

39.6%

$39,000

Unrecaptured Section 1250 Gain

25.0%

$1,000

Long-Term

20.0%

$560,000

Other Income

None

Total undistributed income as of January 1, 2013

$624,000

Pursuant to §1.1411- 3(d)(1)(iii), none of the
$624,000 of undistributed income is accumulated net
investment income (ANII) because none of it was
received by CRT after December 31, 2012. Thus, the

entire $624,000 of undistributed income is excluded
income (as defined in §1.1411- 1(d)(4)).

(iii) During 2013, CRT receives $7,000 of inter-
est income, $9,000 of qualified dividend income,
$4,000 of short-term capital gain, and $11,000 of

long-term capital gain. Prior to the 2013 distribution
of $50,000 to A, CRT has the following items of
undistributed income within its §1.664-1(d)(1) cat-
egories and classes after the application of paragraph
(d)(2) of this section:

Category

Class

Excluded / ANII

Tax Rate

Amount

Ordinary Income

Interest

NII

43.4%

$7,000

Interest

Excluded

39.6%

$4,000

Net Rental Income

Excluded

39.6%

$8,000

Non-Qualified Dividend Income

Excluded

39.6%

$2,000

Qualified Dividend Income

NII

23.8%

$9,000

Qualified Dividend Income

Excluded

20.0%

$10,000

Capital Gain

Short-Term

NII

43.4%

$4,000

Short-Term

Excluded

39.6%

$39,000

Unrecaptured Section 1250 Gain

Excluded

25.0%

$1,000

Long-Term

NII

23.8%

$11,000

Long-Term

Excluded

20.0%

$560,000

Other Income

None

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(iv) The $50,000 distribution to A for 2013 will include the following amounts:

Category

Class

Excluded / ANII

Tax Rate

Amount

Ordinary Income

Interest

NII

43.4%

$7,000

Interest

Excluded

39.6%

$4,000

Net Rental Income

Excluded

39.6%

$8,000

Non-Qualified Dividend Income

Excluded

39.6%

$2,000

Qualified Dividend Income

NII

23.8%

$9,000

Capital Gain

Qualified Dividend Income

Excluded

20.0%

$10,000

Short-Term

NII

43.4%

$4,000

Short-Term

Excluded

39.6%

$6,000

Unrecaptured Section 1250 Gain

Excluded

25.0%

None

Long-Term

NII

23.8%

None

Long-Term

Excluded

20.0%

None

The amount included in A's 2013 net investment income is $20,000. This amount is comprised of $7,000 of interest income, $9,000 of qualified dividend income,
and $4,000 of short-term capital gain.

(v) As a result, as of January 1, 2014, CRT has the following items of undistributed income within its §1.664-1(d)(1) categories and classes:

Category

Class

Excluded / ANII

Tax Rate

Amount

Ordinary Income

Interest

None

Net Rental Income

None

Non-Qualified Dividend Income

None

Qualified Dividend Income

None

Capital Gain

Short-Term

Excluded

39.6%

$33,000

Unrecaptured Section 1250 Gain

Excluded

25.0%

$1,000

Long-Term

ANII

23.8%

$11,000

Long-Term

Excluded

20.0%

$560,000

Other Income

None

Example 2 [Reserved].

# (3) Elective simplified method. [Re- served]

(e) Calculation of undistributed net in-
vestment income-(1) In general. This
paragraph (e) provides special rules for
the computation of certain deductions and
for the allocation of net investment in-
come between an estate or trust and its
beneficiaries. Generally, an estate's or
trust's net investment income is calculated
in the same manner as that of an individ-
ual. See §1.1411-10(c) for special rules
regarding CFCs, PFICs, and estates and
trusts holding interests in such entities.

(2) Undistributed net investment in-
come. An estate's or trust's undistributed
net investment income is the estate's or
trust's net investment income reduced by

distributions of net investment income to
beneficiaries and by deductions under sec-
tion 642(c) in the manner described in
paragraphs (e)(3) and (e)(4) of this sec-
tion.

(3) Distributions of net investment in-
come to beneficiaries. (i) In computing the
estate's or trust's undistributed net invest-
ment income, net investment income is
reduced by distributions of net investment
income made to beneficiaries. The deduc-
tion allowed under this paragraph (e)(3) is
limited to the lesser of the amount deduct-
ible to the estate or trust under section 651
or section 661, as applicable, or the net
investment income of the estate or trust. In
the case of a deduction under section 651
or section 661 that consists of both net
investment income and excluded income

(as defined in §1.1411-1(d)(4)), the distri-
bution must be allocated between net in-
vestment income and excluded income in
a manner similar to §1.661(b)-1 as if net
investment income constituted gross in-
come and excluded income constituted
amounts not includible in gross income.
See §1.661(c)-1 and Example 1 in para-
graph (e)(5) of this section.

(ii) If one or more items of net invest-
ment income comprise all or part of a
distribution for which a deduction is al-
lowed under paragraph (e)(3)(i) of this
section, such items retain their character
as net investment income under section
652(b) or section 662(b), as applicable,
for purposes of computing net investment
income of the recipient of the distribution
who is subject to tax under section 1411.

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The provisions of this paragraph (e)(3)(ii)
also apply to distributions to United States
beneficiaries of current year income de-
scribed in section 652 or section 662, as
applicable, from foreign estates and for-
eign nongrantor trusts.

(4) Deduction for amounts paid or per-
manently set aside for a charitable pur-
pose. In computing the estate's or trust's
undistributed net investment income, the
estate or trust is allowed a deduction for
amounts of net investment income that are
allocated to amounts allowable under sec-
tion 642(c). In the case of an estate or trust
that has items of income consisting of
both net investment income and excluded
income, the allowable deduction under
this paragraph (e)(4) must be allocated
between net investment income and ex-
cluded income in accordance with
§1.642(c)-2(b) as if net investment in-
come constituted gross income and ex-
cluded income constituted amounts not
includible in gross income. For an estate
or trust with deductions under both sec-
tions 642(c) and 661, see §1.662(b)-2 and
Example 2 in paragraph (e)(5) of this sec-
tion.

(5) Examples. The following examples
illustrate the provisions of this paragraph
(e). In each example, Year 1 is a year in
which section 1411 is in effect and the
taxpayer is not a foreign estate or trust:

Example 1. Calculation of undistributed net in-
vestment income (with no deduction under section
642(c)). (i) In Year 1, Trust has dividend income of
$15,000, interest income of $10,000, capital gain of
$5,000, and $75,000 of taxable income relating to a
distribution from an individual retirement account
(as defined under section 408). Trust has no ex-
penses. Trust distributes $10,000 of its current year
trust accounting income to A, a beneficiary of Trust.

(ii) Trust's distributable net income is $100,000
($15,000 in dividends plus $10,000 in interest plus
$75,000 of taxable income from an individual retire-
ment account), from which the $10,000 distribution
to A is paid. Trust's deduction under section 661 is
$10,000. Under §1.662(b)-1, the deduction reduces
each class of income comprising distributable net
income on a proportional basis. The $10,000 distri-
bution equals 10% of distributable net income
($10,000 divided by $100,000). Therefore, the dis-
tribution consists of dividend income of $1,500, in-
terest income of $1,000, and ordinary income attrib-
utable to the individual retirement account of $7,500.
Because the $5,000 of capital gain allocated to prin-
cipal for trust accounting purposes did not enter into
distributable net income, no portion of that amount is
included in the $10,000 distribution, nor does it
qualify for the deduction under section 661.

(iii) Trust's net investment income is $30,000
($15,000 in dividends plus $10,000 in interest plus

$5,000 in capital gain). Trust's $75,000 of taxable
income attributable to the individual retirement ac-
count is excluded income under §1.1411-
1(d)(4). Trust's undistributed net investment income
under paragraph (e)(2) of this section is $27,500,
which is Trust's net investment income ($30,000)
less the amount of dividend income ($1,500) and
interest income ($1,000) distributed to A. The
$27,500 of undistributed net investment income is
comprised of the capital gain allocated to principal
($5,000), the remaining undistributed dividend in-
come ($13,500), and the remaining undistributed
interest income ($9,000).

(iv) Under paragraph (e)(3) of this section and
pursuant to §1.1411-4(a)(1), A's net investment in-
come includes dividend income of $1,500 and inter-
est income of $1,000, but does not include the
$7,500 of ordinary income attributable to the indi-
vidual retirement account because it is excluded
from net investment income under §1.1411-8.

Example 2. Calculation of undistributed net in-
vestment income (with deduction under section
642(c)). (i) Same facts as Example 1, except Trust is
required to distribute $30,000 to A. In addition, Trust
has a $10,000 deduction under section 642(c) (de-
duction for amounts paid for a charitable purpose).
Trust also makes an additional discretionary distri-
bution of $20,000 to B, a beneficiary of Trust. As in
Example 1, Trust's net investment income is $30,000
($15,000 in dividends plus $10,000 in interest plus
$5,000 in capital gain). In accordance with
§§1.661(b)-2 and 1.662(b)-2, the items of income
must be allocated between the mandatory distribu-
tion to A, the discretionary distribution to B, and the
$10,000 distribution to a charity.

(ii) For purposes of the mandatory distribution to
A, Trust's distributable net income is $100,000. See
§1.662(b)-2, Example 1(b). Trust's deduction under
section 661 for the distribution to A is $30,000.
Under §1.662(b)-1, the deduction reduces each class
of income comprising distributable net income on a
proportional basis. The $30,000 distribution equals
30% of distributable net income ($30,000 divided by
$100,000). Therefore, the distribution consists of
dividend income of $4,500, interest income of
$3,000, and ordinary income attributable to the in-
dividual retirement account of $22,500. A's manda-
tory distribution thus consists of $7,500 of net in-
vestment income and $22,500 of excluded income.

(iii) Trust's remaining distributable net income is
$70,000. Trust's remaining undistributed net invest-
ment income is $22,500. The $10,000 deduction
under section 642(c) is allocated in the same manner
as the distribution to A, where the $10,000 distribu-
tion equals 10% of distributable net income ($10,000
divided by $100,000). For purposes of determining
undistributed net investment income, Trust's net in-
vestment income is reduced by $2,500 under para-
graph (e)(4) of this section (dividend income of
$1,500, interest income of $1,000, but with no re-
duction for amounts attributable to the individual
retirement account of $7,500).

(iv) With respect to the discretionary distribution
to B, Trust's remaining distributable net income is
$60,000. Trust's remaining undistributed net invest-
ment income is $20,000. Trust's deduction under
section 661 for the distribution to B is $20,000. The
$20,000 distribution equals 20% of distributable net

income ($20,000 divided by $100,000). Therefore,
the distribution consists of dividend income of
$3,000, interest income of $2,000, and ordinary in-
come attributable to the individual retirement ac-
count of $15,000. B's distribution consists of $5,000
of net investment income and $15,000 of excluded
income.

(v) Trust's undistributed net investment income
is $15,000 after taking into account distribution de-
ductions and section 642(c) in accordance with para-
graphs (e)(3) and (e)(4) of this section, respectively.
To arrive at Trust's undistributed net investment
income of $15,000, Trust's net investment income of
$30,000 is reduced by $7,500 of the mandatory dis-
tribution to A, $2,500 of the section 642(c) deduc-
tion, and $5,000 of the discretionary distribution to
B. The undistributed net investment income consists
of the remaining dividend income of $6,000
($15,000 less $4,500 less $1,500 less $3,000), inter-
est income of $4,000 ($10,000 less $1,000 less
$3,000 less $2,000), and the $5,000 of undistributed
capital gain.

Example 3. Fiscal Year Estate. (i) D died in
2011. D's estate (Estate) filed its first return that
established its fiscal year ending October 31, 2011.
During Estate's fiscal year ending October 31, 2013,
it earned $10,000 of interest, $1,000 of dividends,
and $15,000 of short-term gains. The Estate distrib-
uted its interest and dividends to S, D's spouse and
sole beneficiary, on a quarterly basis; the last quar-
ter's payment for that taxable year was made to S on
December 5, 2013. Pursuant to §1.662(c)-1, S is
deemed to have received the first three payments for
that taxable year, regardless of the actual payment
dates, on October 31, 2013, the last day of Estate's
taxable year. Estate makes a timely section 663(b)
election to treat the fourth quarter distribution to S as
having been made on October 31, 2013, the last day
of Estate's preceding taxable year. Accordingly, S is
deemed to have received $10,000 of interest and
$1,000 of dividends on October 31, 2013.

(ii) Because Estate's fiscal year ending October
31, 2013, began on November 1, 2012, the Estate is
not subject to section 1411 on income received dur-
ing that taxable year. Therefore, none of the income
received by Estate during its fiscal year ending Oc-
tober 31, 2013, is net investment income. Pursuant to
paragraph (e)(3)(ii) of this section, because none of
the distributed interest or dividend income consti-
tuted net investment income to Estate, the $10,000 of
interest and $1,000 of dividends that Estate distrib-
uted to S does not constitute net investment income
to S.

(f) Effective/applicability date. This sec-
tion applies to taxable years beginning after
December 31, 2013, except that paragraph
(d) of this section applies to taxable years of
CRTs that begin after December 31, 2012.
However, taxpayers other than CRTs may
apply this section to taxable years beginning
after December 31, 2012, in accordance
with §1.1411-1(f).

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§1.1411-4 Definition of net investment
income.

(a) In general. For purposes of section
1411 and the regulations thereunder, net
investment income means the excess (if
any) of-

(1) The sum of-

(i) Gross income from interest, divi-
dends, annuities, royalties, and rents, ex-
cept to the extent excluded by the ordinary
course of a trade or business exception
described in paragraph (b) of this section;

(ii) Other gross income derived from a
trade or business described in §1.1411-5;
and

(iii) Net gain (to the extent taken into
account in computing taxable income) at-
tributable to the disposition of property,
except to the extent excluded by the ex-
ception described in paragraph
(d)(4)(i)(A) of this section for gain or loss
attributable to property held in a trade or
business not described in §1.1411-5; over

(2) The deductions allowed by subtitle
A that are properly allocable to such gross
income or net gain (as determined in para-
graph (f) of this section).

(b) Ordinary course of a trade or busi-
ness exception. Gross income described in
paragraph (a)(1)(i) of this section is ex-
cluded from net investment income if it is
derived in the ordinary course of a trade or
business not described in §1.1411-5. See
§1.1411-6 for rules regarding working
capital. To determine whether gross in-
come described in paragraph (a)(1)(i) of
this section is derived in a trade or busi-
ness, the following rules apply.

(1) In the case of an individual, estate,
or trust that owns or engages in a trade or
business directly (or indirectly through
ownership of an interest in an entity that is
disregarded as an entity separate from its
owner under §301.7701-3), the determi-
nation of whether gross income described
in paragraph (a)(1)(i) of this section is
derived in a trade or business is made at
the individual, estate, or trust level.

(2) In the case of an individual, estate,
or trust that owns an interest in a pass-
through entity (for example, a partnership
or S corporation), and that entity is en-
gaged in a trade or business, the determi-
nation of whether gross income described
in paragraph (a)(1)(i) of this section is-

(i) Derived in a trade or business de-
scribed in §1.1411-5(a)(1) is made at the
owner level; and

(ii) Derived in a trade or business de-
scribed in §1.1411-5(a)(2) is made at the
entity level.

(3) The following examples illustrate
the provisions of this paragraph (b). For
purposes of these examples, assume that
the taxpayer is a United States citizen,
uses a calendar taxable year, and Year 1
and all subsequent years are taxable years
in which section 1411 is in effect:

Example 1. Multiple passthrough entities. A, an
individual, owns an interest in UTP, a partnership,
which is engaged in a trade or business. UTP owns
an interest in LTP, also a partnership, which is not
engaged in a trade or business. LTP receives $10,000
in dividends, $5,000 of which is allocated to A
through UTP. The $5,000 of dividends is not derived
in a trade or business because LTP is not engaged in
a trade or business. This is true even though UTP is
engaged in a trade or business. Accordingly, the
ordinary course of a trade or business exception
described in paragraph (b) of this section does not
apply, and A's $5,000 of dividends is net investment
income under paragraph (a)(1)(i) of this section.

Example 2. Multiple passthrough entities. B, an
individual, owns an interest in UTP2, a partnership,
which is not engaged in a trade or business. UTP2
owns an interest in LTP2, also a partnership, which
is engaged in a commercial lending trade or busi-
ness. LTP2 is not engaged in a trade or business
described in §1.1411-5(a)(2). LTP2's trade or busi-
ness is not a passive activity (within the meaning of
section 469) with respect to B. LTP2 earns $10,000
of interest income from its trade or business which is
allocated to B through UTP2. Although UTP2 is not
engaged in a trade or business, the $10,000 of inter-
est income is derived in the ordinary course of
LTP2's lending trade or business. Because LTP2 is
not engaged in a trade or business described in
§1.1411-5(a)(2) and because LTP2's trade or busi-
ness is not a passive activity with respect to B (as
described in §1.1411-5(a)(1)), the ordinary course of
a trade or business exception described in paragraph
(b) of this section applies, and B's $10,000 of inter-
est is not included as net investment income under
paragraph (a)(1)(i) of this section.

Example 3. Entity engaged in trading in financial
instruments. C, an individual, owns an interest in
PRS, a partnership, which is engaged in a trade or
business of trading in financial instruments (as de-
fined in §1.1411-5(a)(2)). PRS' trade or business is
not a passive activity (within the meaning of section
469) with respect to C. In addition, C is not directly
engaged in a trade or business of trading in financial
instruments or commodities. PRS earns interest of
$50,000, and C's distributive share of the interest is
$25,000. Because PRS is engaged in a trade or
business described in §1.1411-5(a)(2), the ordinary
course of a trade or business exception described in
paragraph (b) of this section does not apply, and C's
$25,000 distributive share of the interest is net in-
vestment income under paragraph (a)(1)(i) of this
section.

Example 4. Application of ordinary course of a
trade or business exception. D, an individual, owns
stock in S corporation, S. S is engaged in a banking
trade or business (that is not a trade or business of
trading in financial instruments or commodities), and
S's trade or business is not a passive activity (within
the meaning of section 469) with respect to D be-
cause D materially participates in the activity. S
earns $100,000 of interest in the ordinary course of
its trade or business, of which $5,000 is D's pro rata
share. For purposes of paragraph (b) of this section,
the interest income is derived in the ordinary course
of S's banking business because it is not working
capital under section 1411(c)(3) and §1.1411-
6(a) (because it is considered to be derived in the
ordinary course of a trade or business under the
principles of §1.469-2T(c)(3)(ii)(A)). Because S is
not engaged in a trade or business described in
§1.1411-5(a)(2) and because S's trade or business is
not a passive activity with respect to D (as described
in §1.1411-5(a)(1)), the ordinary course of a trade or
business exception described in paragraph (b) of this
section applies, and D's $5,000 of interest is not
included under paragraph (a)(1)(i) of this section.

(c) Other gross income from a trade or
business described in §1.1411-5. For a
trade or business described in §1.1411-
5, paragraph (a)(1)(ii) of this section in-
cludes all other gross income (within the
meaning of section 61) that is not gross
income described in paragraph (a)(1)(i) of
this section or net gain described in para-
graph (a)(1)(iii) of this section.

(d) Net gain. This paragraph (d) de-
scribes special rules for purposes of para-
graph (a)(1)(iii) of this section.

(1) Definition of disposition. For pur-
poses of section 1411 and the regulations
thereunder, the term disposition means a
sale, exchange, transfer, conversion, cash
settlement, cancellation, termination,
lapse, expiration, or other disposition (in-
cluding a deemed disposition, for exam-
ple, under section 877A).

(2) Limitation. The calculation of net
gain may not be less than zero. Losses
allowable under section 1211(b) are per-
mitted to offset gain from the disposition
of assets other than capital assets that are
subject to section 1411.

(3) Net gain attributable to the dispo-
sition of property-(i) General rule. Net
gain attributable to the disposition of
property is the gain described in section
61(a)(3) recognized from the disposition
of property reduced, but not below zero,
by losses deductible under section 165,
including losses attributable to casualty,
theft, and abandonment or other worth-
lessness. The rules in subchapter O of
chapter 1 and the regulations thereunder

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apply. See, for example, §1.61-6(b). For
purposes of this paragraph, net gain in-
cludes, but is not limited to, gain or loss
attributable to the disposition of property
from the investment of working capital (as
defined in §1.1411-6); gain or loss attrib-
utable to the disposition of a life insurance
contract; and gain attributable to the dis-
position of an annuity contract to the ex-
tent the sales price of the annuity exceeds
the annuity's surrender value.

(ii) Examples. The following examples
illustrate the provisions of this paragraph
(d)(3). For purposes of these examples,
assume that the taxpayer is a United States
citizen, uses a calendar taxable year, and
Year 1 and all subsequent years are tax-
able years in which section 1411 is in
effect:

Example 1. Calculation of net gain. (i) In Year 1,
A, an unmarried individual, realizes a capital loss of
$40,000 on the sale of P stock and realizes a capital
gain of $10,000 on the sale of Q stock, resulting in a
net capital loss of $30,000. Both P and Q are C
corporations. A has no other capital gain or capital
loss in Year 1. In addition, A receives wages of
$300,000 and earns $5,000 of gross income from
interest. For income tax purposes, under section
1211(b), A may use $3,000 of the net capital loss
against other income. Under section 1212(b)(1), the
remaining $27,000 is a capital loss carryover. For
purposes of determining A's Year 1 net gain under
paragraph (a)(1)(iii) of this section, A's gain of
$10,000 on the sale of the Q stock is reduced by A's
loss of $40,000 on the sale of the P stock. In addi-
tion, A may reduce net investment income by the
$3,000 of the excess of capital losses over capital
gains allowed for income tax purposes under section
1211(b).

(ii) In Year 2, A has a capital gain of $30,000 on
the sale of Y stock. Y is a C corporation. A has no
other capital gain or capital loss in Year 2. For
income tax purposes, A may reduce the $30,000 gain
by the Year 1 section 1212(b) $27,000 capital loss
carryover. For purposes of determining A's Year 2
net gain under paragraph (a)(1)(iii) of this section,
A's $30,000 gain may also be reduced by the
$27,000 capital loss carryover from Year 1. There-
fore, in Year 2, A has $3,000 of net gain for purposes
of paragraph (a)(1)(iii) of this section.

Example 2. Calculation of net gain. The facts are
the same as in Example 1, except that in Year 1, A
also realizes a gain of $20,000 on the sale of Rental
Property D, all of which is treated as ordinary in-
come under section 1250. For income tax purposes,
under section 1211(b), A may use $3,000 of the net
capital loss against other income. Under section
1212(b)(1) the remaining $27,000 is a capital loss
carryover. For purposes of determining A's net gain
under paragraph (a)(1)(iii) of this section, A's gain
of $10,000 on the sale of the Q stock is reduced by
A's loss of $40,000 on the sale of the P stock. A's
$20,000 gain on the sale of Rental Property D is
reduced to the extent of the $3,000 loss allowed
under section 1211(b). Therefore, A's net gain for

Year 1 is $17,000 ($20,000 gain treated as ordinary
income on the sale of Rental Property D reduced by
$3,000 loss allowed under section 1211).

Example 3. Section 121(a) exclusion. (i) In Year
1, A, an unmarried individual, sells a house that A
has owned and used as A's principal residence for
the five years preceding the sale and realizes
$200,000 in gain. In addition to the gain realized
from the sale of A's principal residence, A also
realizes $7,000 in long-term capital gain. A has a
$5,000 short-term capital loss carryover from a year
preceding the effective date of section 1411.

(ii) For income tax purposes, under section
121(a), A excludes the $200,000 gain realized from
the sale of A's principal residence from A's Year 1
gross income. In determining A's Year 1 adjusted
gross income, A also reduces the $7,000 capital gain
by the $5,000 capital loss carryover allowed under
section 1211(b).

(iii) For section 1411 purposes, under section
121(a), A excludes the $200,000 gain realized from
the sale of A's principal residence from A's Year 1
gross income and, consequently, from A's net in-
vestment income. In determining A's Year 1 net gain
under paragraph (a)(1)(iii) of this section, A reduces
the $7,000 capital gain by the $5,000 capital loss
carryover allowed under section 1211(b).

Example 4. Section 1031 like-kind exchange. (i)
In Year 1, A, an unmarried individual who is not a
dealer in real estate, purchases Greenacre, a piece of
undeveloped land, for $10,000. A intends to hold
Greenacre for investment.

(ii) In Year 3, A enters into an exchange in which
A transfers Greenacre, now valued at $20,000, and
$5,000 cash for Blackacre, another piece of undevel-
oped land, which has a fair market value of $25,000.
The exchange is a transaction for which no gain or
loss is recognized under section 1031.

(iii) In Year 3, for income tax purposes, A does
not recognize any gain from the exchange of Greena-
cre for Blackacre. A's basis in Blackacre is $15,000
($10,000 substituted basis in Greenacre plus $5,000
additional cost of acquisition). For purposes of sec-
tion 1411, A's net investment income for Year 3
does not include any realized gain from the exchange
of Greenacre for Blackacre.

(iv) In Year 5, A sells Blackacre to an unrelated
party for $35,000 in cash.

(v) In Year 5, for income tax purposes, A recog-
nizes capital gain of $20,000 ($35,000 sale price
minus $15,000 basis). For purposes of section 1411,
A's net investment income includes the $20,000 gain
recognized from the sale of Blackacre.

(4) Gains and losses excluded from net
investment income-(i) Exception for
gain or loss attributable to property held
in a trade or business not described in
§1.1411-5-(A) General rule. Net gain
does not include gain or loss attributable
to property (other than property from the
investment of working capital (as de-
scribed in §1.1411-6)) held in a trade or
business not described in §1.1411-5.

(B) Special rules for determining
whether property is held in a trade or
business. To determine whether net gain

described in paragraph (a)(1)(iii) of this
section is from property held in a trade or
business-

(1) A partnership interest or S corpo-
ration stock generally is not property held
in a trade or business. Therefore, gain
from the sale of a partnership interest or S
corporation stock is generally gain de-
scribed in paragraph (a)(1)(iii) of this sec-
tion. However, net gain does not include
certain gain or loss attributable to the dis-
position of certain interests in partnerships
and S corporations as provided in
§1.1411-7.

(2) In the case of an individual, estate,
or trust that owns or engages in a trade or
business directly (or indirectly through
ownership of an interest in an entity that is
disregarded as an entity separate from its
owner under §301.7701-3), the determi-
nation of whether net gain described in
paragraph (a)(1)(iii) of this section is at-
tributable to property held in a trade or
business is made at the individual, estate,
or trust level.

(3) In the case of an individual, estate,
or trust that owns an interest in a pass-
through entity (for example, a partnership
or S corporation), and that entity is en-
gaged in a trade or business, the determi-
nation of whether net gain described in
paragraph (a)(1)(iii) of this section from
such entity is attributable to-

(i) Property held in a trade or business
described in §1.1411-5(a)(1) is made at
the owner level; and

(ii) Property held in a trade or business
described in §1.1411-5(a)(2) is made at
the entity level.

(C) Examples. The following examples
illustrate the provisions of this paragraph
(d)(4)(i). For purposes of these examples,
assume the taxpayer is a United States
citizen, uses a calendar taxable year, and
Year 1 and all subsequent years are tax-
able years in which section 1411 is in
effect:

Example 1. Gain from rental activity. A, an un-
married individual, rents a boat to B for $100,000 in
Year 1. A's rental activity does not involve the
conduct of a section 162 trade or business, and under
section 469(c)(2), A's rental activity is a passive
activity. In Year 2, A sells the boat to B, and A
realizes and recognizes taxable gain attributable to
the disposition of the boat of $500,000. Because the
exception provided in paragraph (d)(4)(i)(A) of this
section requires a trade or business, this exception is
inapplicable, and therefore, A's $500,000 gain will
be taken into account under §1.1411-4(a)(1)(iii).

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Example 2. Installment sale. (i) PRS, partnership
for Federal income tax purposes, operates an auto-
mobile dealership. B and C, unmarried individuals,
each own a 40% interest in PRS and both materially
participate in the activities of PRS for all relevant
years. Therefore, with respect to B and C, PRS is not
a trade or business described in section 1411(c)(2)
and §1.1411-5. D owns the remaining 20% of PRS.
Assume, for purposes of this example, that PRS is a
passive activity with respect to D, and therefore is a
trade or business described in section 1411(c)(2)(A)
and §1.1411-5(a)(1).

(ii)(A) In Year 0, a year preceding the effective
date of section 1411, PRS relocates its dealership to
a larger location. As a result of the relocation, PRS
sells its old dealership facility to a real estate devel-
oper in exchange for $1,000,000 cash and a
$4,500,000 promissory note, fully amortizing over
the subsequent 15 years, and bearing adequate stated
interest. PRS reports the sale transaction under sec-
tion 453. PRS's adjusted tax basis in the old dealer-
ship facility is $1,075,000. Assume for purposes of
this example that PRS has $300,000 of recapture
income (within the meaning of section 453(i)); the
buyer is not related to PRS, B, C, or D; and the buyer
is not assuming any liabilities of PRS in the trans-
action.

(B) For chapter 1 purposes, PRS has realized
gain on the transaction of $4,425,000 ($5,500,000
less $1,075,000). Pursuant to section 453(i), PRS
will take into account $300,000 of the recapture
income in Year 0, and the gain in excess of the
recapture income ($4,125,000) will be taken into
account under the installment method. For purposes
of section 453, PRS's profit percentage is 75%
($4,125,000 gain divided by $5,500,000 gross sell-
ing price). In Year 0, PRS will take into account
$750,000 of capital gain attributable to the
$1,000,000 cash payment. In the subsequent 15
years, PRS will receive annual payments of
$300,000 (plus interest). Each payment will result in
PRS recognizing $225,000 of capital gain (75% of
$300,000).

(iii)(A) In Year 1, PRS receives a payment of
$300,000 plus the applicable amount of interest. For
purposes of chapter 1, PRS recognizes $225,000 of
capital gain. B and C's distributive share of the gain
is $90,000 each and D's distributive share of the gain
is $45,000.

(B) The old dealership facility constituted prop-
erty held in PRS's trade or business. In the case of
section 453 installment sales, section 453 governs
the timing of the gain recognition, but does not alter
the character of the gain. See §1.1411- 1(a). The
determination of whether the gain is attributable to
the disposition of property used in a trade or business
described in paragraph (d)(4)(i) of this section con-
stitutes an element of the gain's character for Federal
tax purposes. As a result, the applicability of para-
graph (d)(4)(i) of this section is determined in Year
0 and applies to all gain received on the promissory
note during the 15 year payment period. This result
is consistent with the section 469 determination of
the passive or nonpassive classification of the gain
under §1.469-2T(c)(2)(i)(A).

(C) In the case of D, PRS's trade or business is
described in section 1411(c)(2)(A) and §1.1411-
5(a)(1). Therefore, the exclusion in paragraph (d)(4)(i)

of this section does not apply, and D must include the
$45,000 of gain in D's net investment income.

(D) In the case of B and C, PRS's trade or
business is not described in section 1411(c)(2) or
§1.1411-5. Therefore, B and C exclude the $90,000
gain from net investment income pursuant to para-
graph (d)(4)(i) of this section.

(iv) In Year 2, C dies and C's 40% interest in
PRS passes to Estate.

(v)(A) In Year 3, PRS receives a payment of
$300,000 plus the applicable amount of interest. For
purposes of chapter 1, PRS recognizes $225,000 of
capital gain. B and Estate each have a distributive
share of the gain equal to $90,000 and D's distribu-
tive share of the gain is $45,000.

(B) The calculation of net investment income for
B and D in Year 3 is the same as in (iii) for Year 1.

(C) In the case of Estate, the distributive share of
the $90,000 gain constitutes income in respect of a
decedent (IRD) under section 691(a)(4) and sub-
chapter K. See §1.1411-1(a). Assume that Estate
paid estate taxes of $5,000 that were attributable to
the $90,000 of IRD. Pursuant to section 691(c)(4),
the amount of gain taken into account in computing
Estate's taxable income in Year 3 is $85,000
($90,000 reduced by the $5,000 of allocable estate
taxes). Pursuant to section 691(a)(3) and §1.691(a)-
3(a), the character of the gain to the Estate is the
same character as the gain would have been if C had
survived to receive it. Although the amount of tax-
able gain for chapter 1 has been reduced, the remain-
ing $85,000 retains its character attributable to the
disposition of property used in a trade or business
described in paragraph (d)(4)(i) of this section.
Therefore, Estate may exclude the $85,000 gain
from net investment income pursuant to paragraph
(d)(4)(i) of this section.

(ii) Other gains and losses excluded
from net investment income. Net gain, as
determined under paragraph (d) of this
section, does not include gains and losses
excluded from net investment income by
any other provision in §§1.1411-
1 through 1.1411-10. For example, see
§1.1411-7 (certain gain or loss attribut-
able to the disposition of certain interests
in partnerships and S corporations) and
§1.1411-8(b)(4)(ii) (net unrealized appre-
ciation attributable to employer securities
realized on a disposition of those em-
ployer securities).

(iii) Adjustment for capital loss carry-
forwards for previously excluded income.
[Reserved]

(e) Net investment income attributable
to certain entities-(1) Distributions from
estates and trusts-(i) In general. Net in-
vestment income includes a beneficiary's
share of distributable net income, as de-
scribed in sections 652(a) and 662(a), to
the extent that, under sections 652(b) and
662(b), the character of such income con-
stitutes gross income from items de-

scribed in paragraphs (a)(1)(i) and (ii) of
this section or net gain attributable to
items described in paragraph (a)(1)(iii) of
this section, with further computations
consistent with the principles of this sec-
tion, as provided in §1.1411-3(e).

(ii) Distributions of accumulated net
investment income from foreign non-
grantor trusts to United States beneficia-
ries. [Reserved]

(2) CFCs and PFICs. For purposes of
calculating net investment income, addi-
tional rules in §1.1411-10(c) apply to an
individual, an estate, or a trust that is a
United States shareholder that owns an
interest in a controlled foreign corporation
(CFC) or that is a United States person
that directly or indirectly owns an interest
in a passive foreign investment company
(PFIC).

(3) Treatment of income from common
trust funds. [Reserved]

(f) Properly allocable deductions-(1)
General rule-(i) In general. Unless pro-
vided elsewhere in §§1.1411-1 through
1.1411-10, only properly allocable deduc-
tions described in this paragraph (f) may
be taken into account in determining net
investment income.

(ii) Limitations. Any deductions de-
scribed in this paragraph (f) in excess of
gross income and net gain described in
section 1411(c)(1)(A) are not taken into
account in determining net investment in-
come in any other taxable year, except as
allowed under chapter 1.

(2) Properly allocable deductions de-
scribed in section 62-(i) Deductions al-
locable to gross income from rents and
royalties. Deductions described in section
62(a)(4) allocable to rents and royalties
described in paragraph (a)(1)(i) of this
section are taken into account in determin-
ing net investment income.

(ii) Deductions allocable to gross in-
come from trades or businesses described
in §1.1411-5. Deductions described in
section 62(a)(1) allocable to income from
a trade or business described in §1.1411-
5 are taken into account in determining
net investment income to the extent the
deductions have not been taken into ac-
count in determining self-employment in-
come within the meaning of §1.1411-9.

(iii) Penalty on early withdrawal of
savings. Deductions described in section

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62(a)(9) are taken into account in deter-
mining net investment income.

(iv) Net operating loss. The total sec-
tion 1411 NOL amount of a net operating
loss deduction allowed under section 172
is allowed as a properly allocable deduc-
tion in determining net investment income
for any taxable year. See paragraph (h) of
this section for the calculation of the total
section 1411 NOL amount of a net oper-
ating loss deduction.

(v) Examples. The following examples
illustrate the provisions of this paragraph
(f)(2). For purposes of these examples, as-
sume the taxpayer is a United States citizen,
uses a calendar taxable year, and Year 1 and
all subsequent years are taxable years in
which section 1411 is in effect:

Example 1. (i) A, an individual, is a 40% share-
holder in SCo, an S corporation. SCo is engaged in
a trade or business described in section
1411(c)(2)(A). SCo is the only passive activity
owned by A. In Year 1, SCo reported a loss of
$11,000 to A which was comprised of gross operat-
ing income of $29,000 and operating deductions of
$40,000. A's at risk amount at the beginning of Year
1 is $7,000. There were no other events that affected
A's at risk amount in Year 1.

(ii) For purposes of calculating A's net invest-
ment income, A's $29,000 distributive share of
SCo's gross operating income is income within the
meaning of section 1411(c)(1)(A)(ii).

(iii) As a result of A's at risk limitation, for
chapter 1 purposes, A may only deduct $7,000 of the
operating deductions in excess of the gross operating
income. The remaining $4,000 deductions are sus-
pended because A's amount at risk at the end of Year
1 is zero.

(iv) For purposes of section 469, A has passive
activity gross income of $29,000 and passive activity
deductions of $36,000 ($40,000 of operating deduc-
tions allocable to A less $4,000 suspended under
section 465). Because A has no other passive activity
income from any other source, section 469 limits A's
passive activity deductions to A's passive activity
gross income. As a result, section 469 allows A to
deduct $29,000 of SCo's operating deduction and
suspends the remaining $7,000.

(v) For purposes of calculating A's net invest-
ment income, A has $29,000 of properly allocable
deductions allowed by section 1411(c)(1)(B) and
paragraph (f)(2)(ii) of this section.

Example 2. (i) Same facts as Example 1. In Year 2,
SCo reported net income of $13,000 to A, which was
comprised of gross operating income of $43,000 and
operating deductions of $30,000. There were no other
events that affected A's at risk amount in Year 2.

(ii) For purposes of calculating A's net invest-
ment income, A's $43,000 distributive share of gross
operating income is income within the meaning of
section 1411(c)(1)(A)(ii).

(iii) Pursuant to section 465(a)(2), A's deduc-
tions attributable to the gross income of SCo include
the $30,000 deduction allocable to A in Year 2 plus
the $4,000 loss that was suspended and carried over

to Year 2 from Year 1 pursuant to section 465(a)(2).
Under section 465(a)(2), the $4,000 of losses from
Year 1 are treated as deductions from the activity in
Year 2. As a result, A net operating income from
SCo in Year 2 is $9,000 ($43,000 - $30,000 -
$4,000) in Year 2. A's amount at risk at the end of
Year 2 is $9,000.

(iv) For purposes of section 469, A has passive
activity gross income of $43,000. A's passive activ-
ity deductions attributable to SCo are the sum of the
Year 2 operating deductions allocable to A from S
($30,000), deductions formerly suspended by section
465 ($4,000), and passive activity losses suspended
by section 469 ($7,000). Therefore, in Year 2, A has
passive activity deductions of $41,000. Because A's
passive activity gross income exceeds A's passive
activity deductions, section 469 does not limit any of
the deductions in Year 2. At the end of Year 2, A has
no suspended passive activity losses.

(v) Although A's distributive share of Year 2
deductions allocable to SCo's operating income was
$30,000; the operative provisions of sections 465
and 469 do not change the character of the deduc-
tions when such amounts are suspended under either
section. Furthermore, section 465(a)(2) and §§1.469-
1(f)(4) and 1.469-2T(d)(1) treat amounts suspended
from prior years as deductions in the current year.
See §1.1411-1(a). Therefore, for purposes of calcu-
lating A's net investment income, A has $41,000 of
properly allocable deductions allowed by section
1411(c)(1)(B) and paragraph (f)(2)(ii) of this section.

(3) Properly allocable deductions de-
scribed in section 63(d). In determining net
investment income, the following itemized
deductions are taken into account:

(i) Investment interest expense. Invest-
ment interest (as defined in section
163(d)(3)) to the extent allowed under
section 163(d)(1). Any investment interest
not allowed under section 163(d)(1) is
treated as investment interest paid or ac-
crued by the taxpayer in the succeeding
taxable year. The following example illus-
trates the provisions of this paragraph. For
purposes of this example, assume that the
taxpayer uses a calendar taxable year, and
Year 1 and all subsequent years are tax-
able years in which section 1411 is in
effect:

(A) In Year 1, A, an unmarried indi-
vidual, pays interest of $4,000 on debt
incurred to purchase stock. Under §1.163-
8T, this interest is allocable to the stock
and is investment interest within the
meaning of section 163(d)(3). A has no
investment income as defined by section
163(d)(4). A has $10,000 of income from
a trade or business that is a passive activ-
ity (as defined in §1.1411-5(a)(1)) with
respect to A. For income tax purposes,
under section 163(d)(1), A may not deduct
the $4,000 investment interest in Year 1

because A does not have any section
163(d)(4) net investment income. Under
section 163(d)(2), the $4,000 investment
interest is a carryforward of disallowed
interest that is treated as investment inter-
est paid by A in the succeeding taxable
year. Similarly, for purposes of determin-
ing A's Year 1 net investment income, A
may not deduct the $4,000 investment in-
terest.

(B) In Year 2, A has $5,000 of section
163(d)(4) net investment income. For both
income tax purposes and for determining
section 1411 net investment income, A's
$4,000 carryforward of interest expense
disallowed in Year 1 may be deducted in
Year 2.

(ii) Investment expenses. Investment ex-
penses (as defined in section 163(d)(4)(C)).

(iii) Taxes described in section
164(a)(3). Taxes imposed on income de-
scribed in section 164(a)(3) that are allo-
cable to net investment income pursuant
to paragraph (g)(1) of this section. Foreign
income, war profits, and excess profits
taxes are allowable as deductions under
section 164(a)(3) in determining net in-
vestment income only if the taxpayer does
not choose to take any foreign tax credits
under section 901 with respect to the same
taxable year. See section 275(a)(4). For
rules applicable to refunds of taxes de-
scribed in this paragraph, see paragraph
(g)(2) of this section.

(iv) Items described in section 72(b)(3).
In the case of an amount allowed as a de-
duction to the annuitant for the annuitant's
last taxable year under section 72(b)(3),
such amount is allowed as a properly allo-
cable deduction in the same taxable year if
the income from the annuity (had the annu-
itant lived to receive such income) would
have been included in net investment in-
come under paragraph (a)(1)(i) of this sec-
tion (and not excluded from net investment
income by reason of §1.1411-8).

(v) Items described in section 691(c).
Deductions for estate and generation-
skipping taxes allowed by section 691(c)
that are allocable to net investment in-
come; provided, however, that any portion
of the section 691(c) deduction described
in section 691(c)(4) is taken into account
instead in computing net gain under para-
graph (d) and not under this paragraph
(f)(3)(v).

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(vi) Items described in section 212(3).
Amounts described in section 212(3) and
§1.212-1(1) to the extent they are alloca-
ble to net investment income pursuant to
paragraph (g)(1) of this section.

(vii) Amortizable bond premium. A de-
duction allowed under section 171(a)(1)
for the amortizable bond premium on a
taxable bond (for example, see §1.171-
2T(a)(4)(i)(C) for the treatment of a bond
premium carryforward as a deduction un-
der section 171(a)(1)).

(viii) Fiduciary expenses. In the case of
an estate or trust, amounts described in
§1.212-1(i) to the extent they are allocable
to net investment income pursuant to
paragraph (g)(1) of this section.

(4) Loss deductions-(i) General rule.
Losses described in section 165, whether
described in section 62 or section 63(d),
are allowed as properly allocable deduc-
tions to the extent such losses exceed the
amount of gain described in section
61(a)(3) and are not taken into account in
computing net gain by reason of para-
graph (d) of this section.

(ii) Examples. The following examples
illustrate the provisions of this paragraph
(f)(4). For purposes of these examples, as-
sume the taxpayer is a United States citizen,
uses a calendar taxable year, and Year 1 and
all subsequent years are taxable years in
which section 1411 is in effect:

Example 1. (i) A, an unmarried individual, owns
an interest in PRS, a partnership for Federal income
tax purposes. PRS is engaged in a trading business
described in section 1411(c)(2)(B) and §1.1411-
5(a)(2) and has made a valid and timely election
under section 475(f)(2). A's distributive share from
PRS in Year 1 consists of $125,000 of interest and
dividends and $60,000 of ordinary losses from the
trading business. In addition to A's investment in
PRS, A sold undeveloped land in Year 1 for a
long-term capital gain of $50,000. A has no capital
losses carried over from a preceding year.

(ii) For purposes of chapter 1, A includes the
$125,000 of interest and dividends, $60,000 of ordi-
nary loss, and $50,000 of long-term capital gain in
the computation of A's adjusted gross income.

(iii) For purposes of calculating net investment
income, A includes the $125,000 of interest and
dividends. Pursuant to paragraph (d) of this section,
A takes into account the $60,000 ordinary loss from
PRS and the $50,000 of long-term capital gain in the
computation of A's net gain. A's losses ($60,000)
exceed A's gains ($50,000). Therefore, A's net gain
under paragraph (d) of this section is zero. Addition-
ally, A is allowed a deduction under paragraph
(f)(4)(i) of this section for $10,000 (the amount of
ordinary losses that were allowable under chapter 1
in excess of the amounts taken into account in com-

puting net gain). A's net investment income in Year
1 is $115,000.

Example 2. (i) In Year 1, T, a nongrantor trust,
incurs a capital loss of $5,000 on the sale of publicly
traded stocks. In addition, T receives $17,000 of
interest and dividend income. T has no capital losses
carried over from a preceding year.

(ii) For purposes of chapter 1, T includes the
$17,000 of interest and dividends and only $3,000 of
the capital loss in the computation of adjusted gross
income. The remaining $2,000 capital loss is carried
over to Year 2.

(iii) For purposes of calculating net investment
income, T includes the $17,000 of interest and divi-
dends in net investment income. Pursuant to paragraph
(d) of this section, T takes into account the $3,000
capital loss allowed by chapter 1. T's losses ($3,000)
exceed T's gains ($0). Therefore, T's net gain under
paragraph (d) of this section is zero. However, T is
allowed a deduction under paragraph (f)(4)(i) of this
section for $3,000 (the amount of losses that were
allowable under chapter 1 in excess of the amounts
taken into account in computing net gain). T's net
investment income in Year 1 is $14,000.

Example 3. (i) In Year 1, B, an unmarried indi-
vidual, incurs a short-term capital loss of $15,000 on
the sale of publicly traded stocks. B also receives
annuity income of $50,000. In addition, B disposes
of property used in his sole proprietorship (which is
not a trade or business described in section
1411(c)(2) or §1.1411-5(a) for a gain of $21,000.
Pursuant to section 1231, the gain of $21,000 is
treated as a long-term capital gain for purposes of
chapter 1. B has no capital losses carried over from
a preceding year.

(ii) For purposes of chapter 1, B includes the
$50,000 of annuity income in the computation of
adjusted gross income. The $21,000 long-term cap-
ital gain is offset by the $15,000 short-term capital
loss, so B includes $6,000 of net long-term capital
gain in the computation of adjusted gross income.

(iii) For purposes of calculating net investment
income, B includes the $50,000 of annuity income in
net investment income. Pursuant to paragraph (d)(4)(i)
of this section, B's net gain does not include the
$21,000 long-term capital gain because it is attributable
to property held in B's sole proprietorship (a nonpas-
sive activity). Pursuant to paragraph (d) of this section,
T takes into account the $15,000 capital loss allowed
by chapter 1. B's losses ($15,000) exceed B's gains
($0). Therefore, A's net gain under paragraph (d) of
this section is zero. However, B is allowed a deduction
under paragraph (f)(4)(i) of this section for $15,000
(the amount of losses that were allowable under chapter
1 in excess of the amounts taken into account in com-
puting net gain). B's net investment income in Year 1
is $35,000.

(5) Ordinary loss deductions for cer-
tain debt instruments. An amount treated
as an ordinary loss by a holder of a con-
tingent payment debt instrument under
§1.1275-4(b) or an inflation-indexed debt
instrument under §1.1275-7(f)(1).

(6) Other deductions. Any other deduc-
tion allowed by subtitle A that is identified
in published guidance in the Federal Reg-
ister or in the Internal Revenue Bulletin

(see §601.601(d)(2)(ii)(b) of this chapter)
as properly allocable to gross income or
net gain under this section.

(7) Application of limitations under
sections 67 and 68. Any deductions de-
scribed in this paragraph (f) that are sub-
ject to section 67 (the 2-percent floor on
miscellaneous itemized deductions) or
section 68 (the overall limitation on item-
ized deductions) are allowed in determin-
ing net investment income only to the
extent the items are deductible for chapter
1 purposes after the application of sec-
tions 67 and 68. For this purpose, section
67 applies before section 68. The amount
of deductions subject to sections 67 and
68 that may be deducted in determining
net investment income after the applica-
tion of sections 67 and 68 is determined as
described in paragraph (f)(7)(i) and
(f)(7)(ii) of this section.

(i) Deductions subject to section 67.
The amount of miscellaneous itemized de-
ductions (as defined in section 67(b)) ten-
tatively deductible in determining net in-
vestment income after applying section 67
(but before applying section 68) is the
lesser of:

(A) The portion of the taxpayer's mis-
cellaneous itemized deductions (before
the application of section 67) that is prop-
erly allocable to items of income or net
gain included in determining net invest-
ment income, or

(B) The taxpayer's total miscellaneous
itemized deductions allowed after the ap-
plication of section 67, but before the ap-
plication of section 68.

(ii) Deductions subject to section 68.
The amount of itemized deductions al-
lowed in determining net investment in-
come after applying sections 67 and 68 is
the lesser of:

(A) The sum of the amount determined
under paragraph (f)(7)(i) of this section
and the amount of itemized deductions not
subject to section 67 that are properly
allocable to items of income or net gain
included in determining net investment
income, or

(B) The total amount of itemized de-
ductions allowed after the application of
sections 67 and 68.

(iii) Itemized deductions. For purposes
of paragraph (f)(7)(ii), itemized deduc-
tions do not include any deduction de-
scribed in section 68(c).

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Example. The following example illustrates the
provisions of this paragraph (f)(7). For purposes of
these examples, assume the taxpayer is a United
States citizen, uses a calendar taxable year, and Year
1 and all subsequent years are taxable years in which
section 1411 is in effect:

(A) A, an unmarried individual, has adjusted
gross income in Year 1 as follows:

Wages

$1,600,000

Interest income

400,000

Adjusted gross income

$2,000,000

In addition, A has the following items of expense
qualifying as itemized deductions:

Investment expenses

$70,000

Job-related expenses

30,000

Investment interest expense

75,000

State income taxes

120,000

A's investment expenses and job-related ex-
penses are miscellaneous itemized deductions. In
addition, A's investment interest expense and invest-
ment expenses are properly allocable to net invest-
ment income (within the meaning of this section).
A's job-related expenses are not properly allocable
to net investment income. Of the state income tax
expense, A applied a reasonable method pursuant to
paragraph (g)(1) of this section to properly allocate
$20,000 to net investment income.

(B) A's 2-percent floor under section 67 is
$40,000 (2% of $2,000,000). For Year 1, assume the
section 68 limitation starts at adjusted gross income
of $200,000. The section 68 overall limitation disal-
lows $54,000 of A's itemized deductions that are
subject to section 68 (3% of the excess of the
$2,000,000 adjusted gross income over the $200,000
limitation threshold).

(C)(1) A's total miscellaneous itemized deduc-
tions allowable before the application of section 67
is $100,000 ($70,000 in investment expenses plus
$30,000 in job-related expenses), and the total mis-
cellaneous deductions allowed after the application
of section 67 is $60,000 ($100,000 minus $40,000).

(2) The amount of the miscellaneous itemized
deductions properly allocable to net investment in-
come after the application of section 67 is $60,000
(the lesser of $70,000 in investment expenses that
are deductible as a miscellaneous itemized deduction
and properly allocable to net investment income or
$60,000 of miscellaneous itemized deductions allo-
cable to net investment income allowed after the
application of section 67).

(D)(1) The amount of itemized deductions allo-
cable to net investment income after applying sec-
tion 67 to deductions that are also miscellaneous
itemized deductions but before applying section 68
is $155,000. This amount is the sum of $60,000 of
miscellaneous itemized deductions determined in
(C)(2), plus $20,000 in state income tax properly

allocable to net investment income, plus $75,000 of
investment interest expense. However, under section
68(c)(2), the $75,000 deduction for investment in-
terest expenses is not subject to the section 68 lim-
itation on itemized deductions and is excluded from
the computation under §1.1411-4(f)(7). Thus, the
amount of itemized deductions allocable to net in-
vestment income and subject to section 68, after
applying section 67 but before applying section 68,
is $80,000.

(2) A's total itemized deductions allowed subject
to the limitation under section 68 and after applica-
tion of section 67, but before the application of
section 68, are the following:

Miscellaneous itemized deductions

$60,000

State income tax

$120,000

Deductions subject to section 68

$180,000

(3) Of A's itemized deductions that are subject to
the limitation under section 68, the amount allowed
after the application of section 68 is $126,000
($180,000 minus the $54,000 disallowed in (B)).

(E) Under paragraph (f)(7)(ii) of this section, the
amount of itemized deductions allowed in determin-
ing net investment income after applying sections 67
and 68 is the lesser of $80,000 (the sum of $60,000
determined under paragraph (C)(2) and $20,000 state
income tax allocable to net investment income) or
$126,000 (determined under (D)(3)). Therefore, A's
itemized deductions that are properly allocable to net
investment income are $155,000 ($80,000 of prop-
erly allocable itemized deductions subject to section
67 or 68 plus $75,000 of investment interest expense
(which is not subject to either section 67 or section
68 limitations)).

(g) Special rules-(1) Deductions allo-
cable to both net investment income and
excluded income. In the case of a properly
allocable deduction described in section
1411(c)(1)(B) and paragraph (f) of this sec-
tion that is allocable to both net investment
income and excluded income, the portion of
the deduction that is properly allocable to
net investment income may be determined
by taxpayers using any reasonable method.
Examples of reasonable methods of alloca-
tion include, but are not limited to, an allo-
cation of the deduction based on the ratio of
the amount of a taxpayer's gross income
(including net gain) described in §1.1411-
4(a)(1) to the amount of the taxpayer's ad-
justed gross income (as defined under sec-
tion 62 (or section 67(e) in the case of an
estate or trust)). In the case of an estate or
trust, an allocation of a deduction pursuant
to rules described in §1.652(b)-3(b) (and
§1.641(c)-1(h) in the case of an ESBT) is
also a reasonable method.

(2) Recoveries of properly allocable
deductions-(i) General rule. If a tax-
payer is refunded, reimbursed, or other-
wise recovers any portion of an amount
deducted as a section 1411(c)(1)(B) prop-
erly allocable deduction in a prior year,
and such amount is not otherwise included
in net investment income in the year of
recovery under section 1411(c)(1)(A), the
amount of the recovery will reduce the
taxpayer's total section 1411(c)(1)(B)
properly allocable deductions in the year
of recovery (but not below zero). The
preceding sentence applies regardless of
whether the amount of the recovery is
excluded from gross income by reason of
section 111.

(ii) Recoveries of items allocated be-
tween net investment income and excluded
income. In the case of a refund of any item
that was deducted under section
1411(c)(1)(B) in a prior year and the gross
amount of the deduction was allocated
between items of net investment income
and excluded income pursuant to para-
graph (g)(1) of this section, the amount of
the reduction in section 1411(c)(1)(B)
properly allocable deductions in the year
of receipt under this paragraph (g)(2) is
the total amount of the refund multiplied
by a fraction. The numerator of the frac-
tion is the amount of the total deduction
allocable to net investment income in the
prior year to which the refund relates. The
denominator of the fraction is the total
amount of the deduction in the prior year
to which the refund relates.

(iii) Recoveries with no prior year ben-
efit. For purposes of this paragraph (g)(2),
section 111 applies to reduce the amount
of any reduction required by paragraph
(g)(2)(i) of this section to the extent that
such previously deducted amount did not
reduce the tax imposed by section 1411. To
the extent a deduction is taken into account
in computing a taxpayer's net operating loss
deduction under paragraph (h) of this sec-
tion, section 111(c) applies. Except as pro-
vided in the preceding sentence, for pur-
poses of this paragraph (g)(2), no reduction
of section 1411(c)(1)(B) properly allocable
deductions is required in a year when such
recovered item is attributable to an amount
deducted in a taxable year-

(A) Preceding the effective date of sec-
tion 1411, or

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(B) In which the taxpayer was not sub-
ject to section 1411 solely because that
individual's (as defined in §1.1411-
2(a)) modified adjusted gross income (as
defined in §1.1411-2(c)) does not exceed
the applicable threshold in §1.1411-
2(d) or such estate's or trust's (as defined
in §1.1411-3(a)(1)(i)) adjusted gross in-
come does not exceed the amount de-
scribed in section 1411(a)(2)(B)(ii) and
§1.1411-3(a)(1)(ii)(B)(2).

(iv) Examples. The following examples
illustrate the provisions of this paragraph
(g)(2). For purposes of these examples,
assume the taxpayer is a United States
citizen, uses a calendar taxable year, and
Year 1 and all subsequent years are tax-
able years in which section 1411 is in
effect:

Example 1. Recovery of amount included in in-
come. A, an individual, is a 40% limited partner in LP.
LP is a passive activity to A. In Year 1, A's distribut-
able share of section 1411(c)(1)(A)(ii) income and
properly allocable deductions described in §1.1411-
4(f)(2)(ii) were $50,000 and $37,000, respectively. In
Year 2, LP received a refund of a properly allocable
deduction described in §1.1411-4(f)(2)(ii). A's distrib-
utable share of the recovered deduction is $2,000. Since
the $2,000 recovery constitutes gross income described
in section 1411(c)(1)(A)(ii) in Year 2, A does not
reduce any properly allocable deductions attributable to
Year 2.

Example 2. State income tax refund. In Year 1,
D, an individual, allocated $15,000 of taxes out of a
total of $75,000 to net investment income under
paragraph (f)(3)(iii) of this section. D received no tax
benefit from the deduction in Year 1 for chapter 1
purposes due to the alternative minimum tax, but it
did reduce D's section 1411 tax. In Year 3, D re-
ceived a refund of $5,000. For chapter 1 purposes, D
excludes the $5,000 refund from gross income in
Year 3 by reason of section 111. In Year 3, D
allocated $30,000 of state income taxes out of a total
of $90,000 to net investment income under para-
graph (f)(3)(iii) of this section. Although the refund
is excluded from D's gross income, D must none-
theless reduce Year 3's section 1411(c)(1)(B) prop-
erly allocable deductions by $1,000 ($5,000 x
($15,000/$75,000)). D's allocation of 33 1/3% of
section 164(a)(3) taxes in Year 3 to net investment
income is irrelevant to the calculation of the amount
of the reduction required by this paragraph (g)(2).

Example 3. State income tax refund with no prior
year benefit. Same facts as Example 2, except in
Year 1, D's section 1411(c)(1)(B) properly allocable
deductions exceeded D's section 1411(c)(1)(A) in-
come by $300. As a result, D was not subject to
section 1411 in Year 1. Pursuant to paragraph
(g)(2)(iii) of this section, D does not reduce Year 3's
section 1411(c)(1)(B) properly allocable deductions
for recoveries of amounts to the extent that such
deductions did not reduce the tax imposed by section
1411. Therefore, D must reduce Year 3's section
1411(c)(1)(B) properly allocable deductions by $700
($1,000 less $300).

(3) Deductions described in section
691(b). For purposes of paragraph (f) of
this section, properly allocable deductions
include items of deduction described in
section 691(b), provided that the item oth-
erwise would have been deductible to the
decedent under §1.1411-4(f). For exam-
ple, an estate may deduct the decedent's
unpaid investment interest expense in
computing its net investment income be-
cause section 691(b) specifically allows
the deduction under section 163, and
§1.1411-4(f)(3)(i) allows those deduc-
tions as well. However, an estate or trust
may not deduct a payment of real estate
taxes on the decedent's principal resi-
dence that were unpaid at death in com-
puting its net investment income because,
although real estate taxes are deductible
under section 164 and specifically are al-
lowed by section 691(b), the real estate
taxes would not have been a properly al-
locable deduction of the decedent under
§1.1411-4(f).

(4) Amounts described in section
642(h). For purposes of the calculation of
net investment income under this section,
one or more beneficiaries succeeding to
the property of the estate or trust, within
the meaning of section 642(h), shall-

(i) Treat excess capital losses of the
estate or trust described in section
642(h)(1) as capital losses of the benefi-
ciary in the calculation of net gain in
paragraph (d) and paragraph (f)(4) of this
section, as applicable, in a manner consis-
tent with section 642(h)(1);

(ii) Treat excess net operating losses of
the estate or trust described in section
642(h)(1) as net operating losses of the
beneficiary in the calculation of net in-
vestment income in paragraphs (f)(2)(iv)
and (h) of this section in a manner con-
sistent with section 642(h)(1); and

(iii) Treat the deductions described in
paragraph (f) of this section (other than
those taken into account under paragraph
(g)(4)(i) or (ii) of this section) that exceed
the gross investment income described in
paragraph (a)(1) of this section (after tak-
ing into account any modifications, ad-
justments, and special rules for calculating
net investment income in section 1411
and the regulations thereunder) of a ter-
minating estate or trust as a section
1411(c)(1)(B) deduction of the benefi-

ciary in a manner consistent with section
642(h)(2).

(5) Treatment of self-charged interest in-
come. Gross income from interest (within
the meaning of section 1411(c)(1)(A)(i) and
paragraph (a)(1)(i) of this section) that is
received by the taxpayer from a nonpassive
activity of such taxpayer, solely for pur-
poses of section 1411, is treated as derived
in the ordinary course of a trade or business
not described in §1.1411-5. The amount of
interest income that is treated as derived in
the ordinary course of a trade or business
not described in §1.1411-5, and thus ex-
cluded from the calculation of net invest-
ment income, under this paragraph (g)(5) is
limited to the amount that would have been
considered passive activity gross income
under the rules of §1.469-7 if the payor was
a passive activity of the taxpayer. For pur-
poses of this rule, the term nonpassive ac-
tivity does not include a trade or business
described in §1.1411-5(a)(2). However, this
rule does not apply to the extent the corre-
sponding deduction is taken into account in
determining self-employment income that is
subject to tax under section 1401(b).

(6) Treatment of certain nonpassive
rental activities-(i) Gross income from
rents. To the extent that gross rental in-
come described in paragraph (a)(1)(i) of
this section is treated as not derived from
a passive activity by reason of §1.469-
2(f)(6) or as a consequence of a taxpayer
grouping a rental activity with a trade or
business activity under §1.469-
4(d)(1), such gross rental income is
deemed to be derived in the ordinary
course of a trade or business within the
meaning of paragraph (b) of this section.

(ii) Gain or loss from the disposition of
property. To the extent that gain or loss
resulting from the disposition of property
is treated as nonpassive gain or loss by
reason of §1.469-2(f)(6) or as a conse-
quence of a taxpayer grouping a rental
activity with a trade or business activity
under §1.469-4(d)(1), then such gain or
loss is deemed to be derived from prop-
erty used in the ordinary course of a trade
or business within the meaning of para-
graph (d)(4)(i) of this section.

(7) Treatment of certain real estate
professionals-(i) Safe Harbor. In the
case of a real estate professional (as de-
fined in section 469(c)(7)(B)) that partic-
ipates in a rental real estate activity for

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more than 500 hours during such year, or
has participated in such real estate activity
for more than 500 hours in any five tax-
able years (whether or not consecutive)
during the ten taxable years that immedi-
ately precede the taxable year, then-

(A) Such gross rental income from that
rental activity is deemed to be derived in
the ordinary course of a trade or business
within the meaning of paragraph (b) of
this section; and

(B) Gain or loss resulting from the
disposition of property used in such rental
real estate activity is deemed to be derived
from property used in the ordinary course
of a trade or business within the meaning
of paragraph (d)(4)(i) of this section.

(ii) Definitions-(A) Participation. For
purposes of establishing participation un-
der this paragraph (g)(7), any participation
in the activity that would count towards
establishing material participation under
section 469 shall be considered.

(B) Rental real estate activity. The
term rental real estate activity used in this
paragraph (g)(7) is a rental activity within
the meaning of §1.469-1T(e)(3). An elec-
tion to treat all rental real estate as a single
rental activity under §1.469-9(g) also ap-
plies for purposes of this paragraph (g)(7).
However, any rental real estate that the
taxpayer grouped with a trade or business
activity under §1.469-4(d)(1)(i)(A) or
(d)(1)(i)(C) is not a rental real estate ac-
tivity.

(iii) Effect of safe harbor. The inability
of a real estate professional to satisfy the
safe harbor in this paragraph (g)(7) does
not preclude such taxpayer from establish-
ing that such gross rental income and gain
or loss from the disposition of property, as
applicable, is not included in net invest-
ment income under any other provision of
section 1411.

(8) Treatment of former passive activ-
ities-(i) Section 469(f)(1)(A) losses.
Losses allowed in computing taxable in-
come by reason of the rules governing
former passive activities in section
469(f)(1)(A) are taken into account in
computing net gain under paragraph (d) of
this section or as properly allocable de-
ductions under paragraph (f) of this sec-
tion, as applicable, in the same manner as
such losses are taken into account in com-
puting taxable income (as defined in sec-
tion 63). The preceding sentence applies

only to the extent the net income or net
gain from the former passive activity (as
defined in section 469(f)(3)) is included in
net investment income.

(ii) Section 469(f)(1)(C) losses. Losses
allowed in computing taxable income by
reason of section 469(f)(1)(C) are taken
into account in computing net gain under
paragraph (d) of this section or as properly
allocable deductions under paragraph (f)
of this section, as applicable, in the same
manner as such losses are taken into ac-
count in computing taxable income (as
defined in section 63).

(iii) Examples. The following exam-
ples illustrate the provisions of this para-
graph (g)(8). For purposes of these exam-
ples, assume the taxpayer is a United
States citizen, uses a calendar taxable
year, and Year 1 and all subsequent years
are taxable years in which section 1411 is
in effect:

Example 1. (i) B, an individual taxpayer, owns a
50% interest in SCorp, an S corporation engaged in
the trade or business of retail clothing sales. B also
owns a single family rental property, a passive ac-
tivity. B materially participates in the retail sales
activity of SCorp, but B has $10,000 of suspended
losses from prior years when the retail sales activity
of SCorp was a passive activity of B. Therefore, the
retail sales activity of SCorp is a former passive
activity within the meaning of section 469(f)(3).

(ii) In Year 1, B reports $205,000 of wages, $7,000
of nonpassive net income, $500 of interest income
(attributable to working capital) from SCorp's retail
sales activity, and $1,000 of net rental income from the
single family rental property. B's Year 1 modified
adjusted gross income (as defined in §1.1411-2(c)) is
$205,500; which includes $205,000 of wages, $500 of
interest income, $7,000 of nonpassive income from
SCorp, $7,000 of section 469(f)(1)(A) losses, $1,000 of
passive income from the single family rental property
and $1,000 of section 469(f)(1)(C) losses.

(iii) For purposes of the calculation of B's Year
1 net investment income, B includes the $500 of
interest income and $1,000 of net passive income
from the single family rental property. The $7,000 of
nonpassive income from SCorp's retail sales activity
is excluded from net investment income because the
income is not attributable to a trade or business
described in §1.1411-5. Therefore, pursuant to the
rules of paragraph (g)(8)(i) of this section, the
$7,000 of section 469(f)(1)(A) losses are not taken
into account in computing B's net investment in-
come. However, pursuant to the rules of paragraph
(g)(8)(ii) of this section, the $1,000 of passive losses
allowed by reason of section 469(f)(1)(C), which are
allowed as a deduction in Year 1 by reason of B's
$1,000 of passive income from the single family
rental property are allowed in computing B's net
investment income. As a result, B's net investment
income is $500 ($500 of interest income plus $1,000
of passive rental income less $1,000 of section
469(f)(1)(C) losses). Although the $500 of interest

income is attributable to SCorp and includable in B's
net investment income, such income is not taken into
account when calculating the amount of section
469(f)(1)(A) losses allowed in the current year.
Therefore, such income is not taken into account in
computing the amount of section 469(f)(1)(A) losses
allowed by reason of paragraph (g)(8)(i) of this sec-
tion. Pursuant to section 469(b), B carries forward
$2,000 of suspended passive losses attributable to
SCorp's retail sales activity to Year 2.

Example 2. Same facts as Example 1. In Year 2,
B materially participates in the retail sales activity of
SCorp, and disposes of his entire interest in SCorp
for a $9,000 long-term capital gain. Pursuant to
§1.469-2T(e)(3), the $9,000 gain is characterized as
nonpassive income. Pursuant to section
469(f)(1)(A), the remaining $2,000 of suspended
passive loss is allowed because the $9,000 gain is
treated as nonpassive income. Assume that under
section 1411(c)(4) and §1.1411-7, B takes into ac-
count only $700 of the $9,000 gain in computing net
investment income for Year 2. Pursuant to paragraph
(g)(8)(i) of this section, B may take into account
$700 of the $2,000 loss allowed by section
469(f)(1)(A) in computing net investment income
for Year 2. Pursuant to paragraph (g)(8)(i) of this
section, B may not deduct the remaining $1,300
passive loss allowed for chapter 1 in calculating net
investment income for Year 2.

(9) Treatment of section 469(g)(1)
losses. Losses allowed in computing tax-
able income by reason of section 469(g)
are taken into account in computing net
gain under paragraph (d) of this section or
as properly allocable deductions under
paragraph (f) of this section, as applicable,
in the same manner as such losses are
taken into account in computing taxable
income (as defined in section 63).

(10) Treatment of section 707(c) guar-
anteed payments. [Reserved]

(11) Treatment of section 736 pay-
ments. [Reserved]

(12) Income and deductions from cer-
tain notional principal contracts. [Re-
served]

(13) Treatment of income or loss from
REMIC residual interests. [Reserved]

(h) Net operating loss-(1) General
rule. For purposes of paragraph (f)(2)(iv)
of this section, the total section 1411 NOL
amount of a net operating loss deduction
for a taxable year is calculated by first
determining the applicable portion of the
taxpayer's net operating loss for each loss
year under paragraph (h)(2) of this sec-
tion. Next, the applicable portion for each
loss year is used to determine the section
1411 NOL amount for each net operating
loss carried from a loss year and deducted
in the taxable year as provided in para-
graph (h)(3) of this section. The section

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1411 NOL amounts of each net operating
loss carried from a loss year and deducted
in the taxable year are then added together
as provided in paragraph (h)(4) of this
section. This sum is the total section 1411
NOL amount of the net operating loss
deduction for the taxable year that is al-
lowed as a properly allocable deduction in
determining net investment income for the
taxable year. For purposes of this para-
graph (h), both the amount of a net oper-
ating loss for a loss year and the amount
of a net operating loss deduction refer to
such amounts as determined for purposes
of chapter 1.

(2) Applicable portion of a net operat-
ing loss. In any taxable year beginning
after December 31, 2012 in which a tax-
payer incurs a net operating loss, the ap-
plicable portion of such loss is the lesser
of:

(i) The amount of the net operating loss
for the loss year that the taxpayer would
incur if only items of gross income that
are used to determine net investment in-
come and only properly allocable deduc-
tions are taken into account in determin-
ing the net operating loss in accordance
with section 172(c) and (d); or

(ii) The amount of the taxpayer's net
operating loss for the loss year.

(3) Section 1411 NOL amount of a net
operating loss carried to and deducted in
a taxable year. The section 1411 NOL
amount of each net operating loss that is
carried from a loss year that is allowed as
a deduction is the total amount of such net
operating loss carried from the loss year
allowed as a deduction under section
172(a) in the taxable year multiplied by a
fraction. The numerator of the fraction is
the applicable portion of the net operating
loss for that loss year, as determined under
paragraph (h)(2) of this section. The de-
nominator of the fraction is the total
amount of the net operating loss for the
same loss year.

(4) Total section 1411 NOL amount of
a net operating loss deduction. The sec-
tion 1411 NOL amounts of each net op-
erating loss carried to and deducted in the
taxable year as determined under para-
graph (h)(3) of this section are added to-
gether to determine the total section 1411
NOL amount of the net operating loss
deduction for the taxable year that is prop-
erly allocable to net investment income.

(5) Examples. The following examples
illustrate the provisions of this paragraph
(h). For purposes of these examples, as-
sume the taxpayer is a United States citi-
zen, uses a calendar taxable year, and
Year 1 and all subsequent years are tax-
able years in which section 1411 is in
effect:

Example 1. (i)(A) In Year 1, A, an unmarried
individual, has the following items of income and
deduction: $200,000 in wages, $50,000 in gross in-
come from a trade or business of trading in financial
instruments or commodities (as defined in §1.1411-
5(a)(2)) (trading activity), $10,000 of dividends,
$1,000,000 in loss from his sole proprietorship
(which is not a trade or business described in
§1.1411-5), $12,000 of non-business investment ex-
penses, and $250,000 in trading loss deductions. As
a result, for income tax purposes A sustains a section
172(c) net operating loss of $1,000,000. A makes an
election under section 172(b)(3) to waive the carry-
back period for this net operating loss.

(B) For purposes of section 1411, A's net invest-
ment income for Year 1 is the excess (if any) of
$60,000 ($50,000 trading activity gross income plus
$10,000 dividend income) over $262,000 ($250,000
trading loss deductions plus $12,000 nonbusiness
expenses).

(C) The amount of the net operating loss for Year
1 determined under section 172 that A would incur if
only items of gross income that are used to deter-
mine net investment income and only properly allo-
cable deductions are taken into account is $200,000.
This amount is the excess of $250,000 trading loss
deductions, over $50,000 trading activity gross in-
come. Under section 172(d)(4), in determining the
net operating loss, the $12,000 nonbusiness expenses
are allowed only to the extent of the $10,000 divi-
dend income. The $200,000 net operating loss de-
termined using only properly allocable deductions
and gross income items used in determining net
investment income is less than A's actual net oper-
ating loss for Year 1 of $1,000,000, and accordingly
the applicable portion for Year 1 is $200,000. The
ratio used to calculate section 1411 NOL amounts of
A's Year 1 net operating loss is $200,000 (net op-
erating loss determined using only properly allocable
deductions and gross income items used in determin-
ing net investment income)/$1,000,000 (net operat-
ing loss), or 0.2.

(ii) For Year 2, A has $250,000 of wages, no
gross income from the trading activity, $300,000 of
income from his sole proprietorship, and $10,000 in
trading loss deductions. For income tax purposes, A
deducts $540,000 of the net operating loss carried
over from Year 1. In addition, under §1.1411-
2(c), the $540,000 net operating loss will be allowed
as a deduction in computing A's Year 2 modified
adjusted gross income. Because A's modified ad-
justed gross income is $0, A is not subject to net
investment income tax. For purposes of A's net
investment income calculation, the section 1411
NOL amount of the $540,000 net operating loss from
Year 1 that A deducts in Year 2 is $108,000
($540,000 multiplied by .2 (the fraction determined
based on the applicable portion of the net operating
loss in the loss year)). The amount of the Year 1 net

operating loss carried over to Year 3 is $460,000.
For purposes of A's net investment income calcula-
tion, this net operating loss carryover amount in-
cludes a section 1411 NOL amount of $92,000
($460,000 multiplied by 0.2). The section 1411 NOL
amount may be applied in determining A's net in-
vestment income in Year 3.

(iii)(A) For Year 3, A has $400,000 of wages,
$200,000 in trading gains which are gross income
from the trading activity, $250,000 of income from
his sole proprietorship, and $10,000 in trading loss
deductions. For income tax purposes, A deducts the
remaining $460,000 of the net operating loss from
Year 1. In addition, under §1.1411-2(c), the
$460,000 net operating loss deduction reduces A's
Year 3 modified adjusted gross income to $380,000.

(B) A's section 1411 NOL amount of the net
operating loss deduction for Year 3 is $92,000,
which is the $460,000 net operating loss deduction
for Year 3 multiplied by 0.2.

(C) A's net investment income for Year 3 before
the application of paragraph (f)(2)(iv) of this section is
$190,000 ($200,000 in gross income from the trading
activity, minus $10,000 in trading loss deductions).
After the application of paragraph (f)(2)(iv) of this
section, A's net investment income for Year 3 is
$98,000 ($190,000 minus $92,000, the total section
1411 NOL amount of the net operating loss deduction).

Example 2. (i) The facts for Year 1 are the same
as in Example 1.

(ii) (A) For Year 2, A has $100,000 in wages,
$200,000 in gross income from the trading activity,
$15,000 of dividends, $250,000 in losses from the
sole proprietorship, $10,000 of non-business invest-
ment expenses, and $355,000 in trading loss deduc-
tions. As a result, for income tax purposes A sustains
a section 172(c) net operating loss of $300,000. A
makes an election under section 172(b)(3) to waive
the carryback period for the Year 2 net operating
loss.

(B) For purposes of section 1411, A's net invest-
ment income for Year 2 is the excess (if any) of
$215,000 ($200,000 trading activity gross income
plus $15,000 dividend income) over $365,000
($355,000 trading loss deductions plus $10,000 non-
business expenses).

(C) The amount of the net operating loss for Year
2 determined under section 172 that A would incur if
only items of gross income that are used to deter-
mine net investment income and only properly allo-
cable deductions are taken into account is $150,000.
This amount is the excess of $365,000 ($355,000
trading loss deductions plus $10,000 nonbusiness
expenses) over $215,000 ($200,000 trading activity
gross income plus $15,000 dividend income). Under
section 172(d)(4), in determining the net operating
loss, the $10,000 nonbusiness expenses are allowed
in full against the $15,000 dividend income. The
$150,000 net operating loss determined using only
properly allocable deductions and gross income
items used in determining net investment income is
less than A's actual net operating loss for Year 2 of
$300,000, and accordingly the applicable portion is
$150,000. The ratio used to calculate the section
1411 NOL amount of A's Year 2 net operating loss
is $150,000 (the applicable portion)/$300,000 (net
operating loss), or 0.5.

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(iii) For Year 3, A has $250,000 of wages, no
gross income from the trading activity, $300,000 of
income from his sole proprietorship, and $10,000 in
trading loss deductions. For income tax purposes, A
deducts $540,000 of the net operating loss from Year
1\. In addition, under §1.1411-2(c), the $540,000 net
operating loss will be allowed as a deduction in
computing A's Year 3 modified adjusted gross in-
come. Because A's modified adjusted gross income
is $0, A is not subject to net investment income tax.
The section 1411 NOL amount of the $540,000 net
operating loss from Year 1 that A deducts in Year 3
is $108,000 ($540,000 multiplied by 0.2 (the fraction
used to calculate the section 1411 NOL amount of
the net operating loss)), and this is also the total
section 1411 NOL amount for Year 3. The amount of
the Year 1 net operating loss carried over to Year 4
is $460,000. This net operating loss carryover
amount includes a section 1411 NOL amount of
$92,000 ($460,000 multiplied by 0.2) that may be
applied in determining net investment income in
Year 4. None of the Year 2 net operating loss is
deducted in Year 3 so that the $300,000 Year 2 net
operating loss (including the section 1411 NOL
amount of $150,000) is carried to Year 4.

(iv)(A) For Year 4, A has $150,000 of wages,
$450,000 in trading gains which are gross income
from the trading activity, $250,000 of income from
his sole proprietorship, and $10,000 in trading loss
deductions. For income tax purposes, A deducts the
remaining $460,000 of the net operating loss carry-
over from Year 1 and the $300,000 net operating loss
carryover from Year 2, for a total net operating loss
deduction in Year 4 of $760,000. In addition, under
§1.1411-2(c), the $760,000 net operating loss de-
duction reduces A's Year 4 modified adjusted gross
income to $80,000.

(B) A's total section 1411 NOL amount of the
net operating loss deduction for Year 4 is $242,000,
which is the sum of the $92,000 ($460,000 net
operating loss carryover from Year 1 and deducted
in Year 4 multiplied by 0.2 (the ratio used to calcu-
late the section 1411 NOL amount of the Year 1 net
operating loss)) plus $150,000 ($300,000 net oper-
ating loss carryover from Year 2 and deducted in
Year 4 multiplied by 0.5 (the ratio used to calculate
the section 1411 NOL amount of the Year 2 net
operating loss)).

(C) A's net investment income for Year 4 before
the application of paragraph (f)(2)(iv) of this section is
$440,000 ($450,000 in gross income from the trading
activity, minus $10,000 in trading loss deductions).
After the application of paragraph (f)(2)(iv) of this
section, A's net investment income for Year 4 is
$198,000 ($440,000 minus $242,000, the total section
1411 NOL amount of the Year 4 net operating loss
deduction).

(i) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012,
in accordance with §1.1411-1(f).

§1.1411-5 Trades or businesses to
which tax applies.

(a) In general. A trade or business is
described in this section if such trade or
business involves the conduct of a trade or
business, and such trade or business is
either-

(1) A passive activity (within the
meaning of paragraph (b) of this section)
with respect to the taxpayer; or

(2) The trade or business of a trader
trading in financial instruments (as de-
fined in paragraph (c)(1) of this section) or
commodities (as defined in paragraph
(c)(2) of this section).

(b) Passive activity-(1) In general. A
passive activity is described in this section
if-

(i) Such activity is a trade or business;
and

(ii) Such trade or business is a passive
activity with respect to the taxpayer
within the meaning of section 469 and the
regulations thereunder.

(2) Application of income recharacter-
ization rules-(i) Income and gain rechar-
acterization. To the extent that any income
or gain from a trade or business is rechar-
acterized as "not from a passive activity" by
reason of §§1.469-2T(f)(2), §1.469-
2(f)(5), or §1.469-2(f)(6), such trade or
business does not constitute a passive activ-
ity within the meaning of paragraph
(b)(1)(ii) of this section solely with respect
to such recharacterized income or gain.

(ii) Gain recharacterization. To the ex-
tent that any gain from a trade or business is
recharacterized as "not from a passive ac-
tivity" by reason of §1.469-2(c)(2)(iii) and
does not constitute portfolio income under
§1.469-2(c)(2)(iii)(F), such trade or busi-
ness does not constitute a passive activity
within the meaning of paragraph (b)(1)(ii)
of this section solely with respect to such
recharacterized gain.

(iii) Exception for certain portfolio re-
characterizations. To the extent that any
income or gain from a trade or business is
recharacterized as "not from a passive ac-
tivity" and is further characterized as port-
folio income under §1.469-2T(f)(10) or
§1.469-2(c)(2)(iii)(F), then such trade or
business constitutes a passive activity
within the meaning of paragraph (b)(1)(ii)
of this section solely with respect to such
recharacterized income or gain.

(3) Examples. The following examples
illustrate the principles of paragraph
(b)(1) of this section and the ordinary
course of a trade or business exception in
§1.1411-4(b). In each example, unless
otherwise indicated, the taxpayer uses a
calendar taxable year, the taxpayer is a
United States citizen, and Year 1 and all
subsequent years are taxable years in
which section 1411 is in effect:

Example 1. Rental activity. A, an unmarried in-
dividual, rents a commercial building to B for
$50,000 in Year 1. A is not involved in the activity
of the commercial building on a regular and contin-
uous basis, therefore, A's rental activity does not
involve the conduct of a trade or business, and under
section 469(c)(2), A's rental activity is a passive
activity. Because paragraph (b)(1)(i) of this section
is not satisfied, A's rental income of $50,000 is not
derived from a trade or business described in para-
graph (b)(1) of this section. However, A's rental
income of $50,000 still constitutes gross income
from rents within the meaning of §1.1411-
4(a)(1)(i) because rents are included in the determi-
nation of net investment income under §1.1411-
4(a)(1)(i) whether or not derived from a trade or
business described in paragraph (b)(1) of this sec-
tion.

Example 2. Application of grouping rules under
section 469. In Year 1, A, an unmarried individual,
owns an interest in PRS, a partnership for Federal
income tax purposes. PRS is engaged in two activi-
ties, X and Y, which constitute trades or businesses,
and neither of which constitute trading in financial
instruments or commodities (within the meaning of
paragraph (a)(2) of this section). Pursuant to §1.469-
4, A has properly grouped X and Y together as one
activity (the grouped activity). A participates in X
for more than 500 hours during Year 1 and would be
treated as materially participating in activity X
within the meaning of §1.469-5T(a)(1) if A's mate-
rial participation were determined only with respect
to activity X. A only participates in Y for 50 hours
during Year 1. If not for the grouping of the X and
Y activities together, A would not be treated as
materially participating in Y within the meaning of
§1.469-5T(a). However, pursuant to §§1.469-4 and
1.469-5T(a)(1), A materially participates in the
grouped activity. Therefore, for purposes of para-
graph (b)(1)(ii) of this section, neither X nor Y is a
passive activity with respect to A. Accordingly, with
respect to A, neither X nor Y is a trade or business
described in paragraph (b)(1) of this section.

Example 3. Application of the rental activity
exceptions. B, an unmarried individual, is a partner
in PRS, which is engaged in an equipment leasing
activity. The average period of customer use of the
equipment is seven days or less (and therefore meets
the exception in §1.469-1T(e)(3)(ii)(A)). B materi-
ally participates in the equipment leasing activity
(within the meaning of §1.469-5T(a)). The equip-
ment leasing activity constitutes a trade or business.
In Year 1, B has modified adjusted gross income (as
defined in §1.1411- 2(c)) of $300,000, all of which
is derived from PRS. All of the income from PRS is
derived in the ordinary course of the equipment

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leasing activity, and all of PRS's property is held in
the equipment leasing activity. Of B's allocable
share of income from PRS, $275,000 constitutes
gross income from rents (within the meaning of
§1.1411-4(a)(1)(i)). While $275,000 of the gross
income from the equipment leasing activity meets
the definition of rents in §1.1411-4(a)(1)(i), the ac-
tivity meets one of the exceptions to rental activity in
§1.469-1T(e)(3)(ii) and B materially participates in
the activity. Therefore, the trade or business is not a
passive activity with respect to B for purposes of
paragraph (b)(1)(ii) of this section. Because the rents
are derived in the ordinary course of a trade or
business not described in paragraph (a) of this sec-
tion, the ordinary course of a trade or business ex-
ception in §1.1411-4(b) applies, and the rents are
not described in §1.1411-4(a)(1)(i). Furthermore,
because the equipment leasing trade or business is
not a trade or business described in paragraph (a)(1)
or (a)(2) of this section, the $25,000 of other gross
income is not net investment income under §1.1411-
4(a)(1)(ii). However, the $25,000 of other gross in-
come may be net investment income by reason of
section 1411(c)(3) and §1.1411-6 if it is attributable to
PRS's working capital. Finally, gain or loss from the
sale of the property held in the equipment leasing
activity will not be subject to §1.1411-4(a)(1)(iii) be-
cause, although it is attributable to a trade or business,
it is not a trade or business to which the section 1411
tax applies.

Example 4. Application of section 469 and other
gross income under §1.1411-4(a)(1)(ii). Same facts
as Example 3, except B does not materially partici-
pate in the equipment leasing trade or business and
therefore the trade or business is a passive activity
with respect to B for purposes of paragraph (b)(1)(ii)
of this section. Accordingly, the $275,000 of gross
income from rents is described in §1.1411-
4(a)(1)(i) because the rents are derived from a trade
or business that is a passive activity with respect to
B. Furthermore, the $25,000 of other gross income
from the equipment leasing trade or business is de-
scribed in §1.1411-4(a)(1)(ii) because the gross in-
come is derived from a trade or business described in
paragraph (a)(1) of this section. Finally, gain or loss
from the sale of the property used in the equipment
leasing trade or business is subject to §1.1411-
4(a)(1)(iii) because the trade or business is a passive
activity with respect to B, as described in paragraph
(b)(1)(ii) of this section.

Example 5. Application of the portfolio income
rule and section 469. C, an unmarried individual, is
a partner in PRS, a partnership engaged in a trade or
business that does not involve a rental activity. C
does not materially participate in PRS within the
meaning of §1.469-5T(a). Therefore, the trade or
business of PRS is a passive activity with respect to
C for purposes of paragraph (a)(1) of this section.
C's $500,000 allocable share of PRS's income con-
sists of $450,000 of gross income from a trade or
business and $50,000 of gross income from divi-
dends and interest (within the meaning of §1.1411-
4(a)(1)(i)) that is not derived in the ordinary course
of the trade or business of PRS. Therefore, C's
$500,000 allocable share of PRS's income is subject
to section 1411. C's $50,000 allocable share of
PRS's income from dividends and interest is subject
to §1.1411-4(a)(1)(i) because the share is gross in-

come from dividends and interest that is not derived
in the ordinary course of a trade or business (that is,
the ordinary course of a trade or business exception
in §1.1411-4(b) is inapplicable). C's $450,000 allo-
cable share of PRS's income is subject to §1.1411-
4(a)(1)(ii) because it is gross income from a trade or
business that is a passive activity.

(c) Trading in financial instruments or
commodities-(1) Definition of financial
instruments. For purposes of section 1411
and the regulations thereunder, the term
financial instruments includes stocks and
other equity interests, evidences of indebt-
edness, options, forward or futures con-
tracts, notional principal contracts, any
other derivatives, or any evidence of an
interest in any of the items described in
this paragraph (c)(1). An evidence of an
interest in any of the items described in
this paragraph (c)(1) includes, but is not
limited to, short positions or partial units
in any of the items described in this para-
graph (c)(1).

(2) Definition of commodities. For pur-
poses of section 1411 and the regulations
thereunder, the term commodities refers to
items described in section 475(e)(2).

(d) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012,
in accordance with §1.1411-1(f).

## §1.1411-6 Income on investment of working capital subject to tax.

(a) General rule. For purposes of sec-
tion 1411, any item of gross income from
the investment of working capital will be
treated as not derived in the ordinary
course of a trade or business, and any net
gain that is attributable to the investment
of working capital will be treated as not
derived in the ordinary course of a trade or
business. In determining whether any item
is gross income from or net gain attribut-
able to an investment of working capital,
principles similar to those described in
§1.469-2T(c)(3)(ii) apply. See §1.1411-
4(f) for rules regarding properly allocable
deductions with respect to an investment
of working capital and §1.1411-7 for
rules relating to the adjustment to net gain
on the disposition of interests in a partner-
ship or S corporation.

(b) Example. The following example
illustrates the principles of this section.

Assume for purposes of the example that
the taxpayer uses a calendar taxable year,
the taxpayer is a United States citizen, and
Year 1 and all subsequent years are tax-
able years in which section 1411 is in
effect:

Example. (i) A, an unmarried individual, oper-
ates a restaurant, which is a section 162 trade or
business but is not a trade or business described in
§1.1411-5(a)(1) with respect to A. A owns and con-
ducts the restaurant business through S, an S corpo-
ration wholly-owned by A. S is able to pay all of the
restaurant's current obligations with cash flow gen-
erated by the restaurant. S utilizes an interest-bearing
checking account at a local bank to make daily
deposits of cash receipts generated by the restaurant,
and also to pay the recurring ordinary and necessary
business expenses of the restaurant. The average
daily balance of the checking account is approxi-
mately $2,500, but at any given time the balance
may be significantly more or less than this amount
depending on the short-term cash flow needs of the
business. In addition, S has set aside $20,000 for the
potential future needs of the business in case the
daily cash flow into and from the checking account
becomes insufficient to pay the restaurant's recurring
business expenses. S does not currently need to
spend or use the $20,000 capital to conduct the
restaurant business, and S deposits and maintains the
$20,000 in an interest-bearing savings account at a
local bank.

(ii) Both the $2,500 average daily balance of the
checking account and the $20,000 savings account
balance constitute working capital under §1.469-
2T(c)(3)(ii) and, pursuant to paragraph (a) of this
section, the interest generated by this working capital
will not be treated as derived in the ordinary course
of S's restaurant business. Accordingly, the interest
income derived by S from its checking and savings
accounts and allocated to A under section 1366 con-
stitutes gross income from interest under §1.1411-
4(a)(1)(i).

(c) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012,
in accordance with §1.1411-1(f).

§1.1411-7 [Reserved]

§1.1411-8 Exception for distributions
from qualified plans.

(a) General rule. Net investment in-
come does not include any distribution
from a qualified plan or arrangement. For
this purpose, the term qualified plan or
arrangement means any plan or arrange-
ment described in section 401(a), 403(a),
403(b), 408, 408A, or 457(b).

(b) Rules relating to distributions. This
paragraph (b) provides rules for purposes

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of paragraph (a) of this section. For pur-
poses of section 1411(c)(5) and this sec-
tion, a distribution means the following:

(1) Actual distributions. Any amount
actually distributed from a qualified plan
or arrangement, as defined in paragraph
(a) of this section, is a distribution within
the meaning of section 1411(c)(5), and
thus is not included in net investment in-
come. Examples include a rollover to an
eligible retirement plan within the mean-
ing of section 402(c)(8)(B), a distribution
of a plan loan offset amount within the
meaning of Q&A-13(b) of §1.72(p)-1, and
certain corrective distributions under the
Internal Revenue Code (Code).

(2) Amounts treated as distributed.
Any amount that is treated as distributed
from a qualified plan or arrangement un-
der the Code for purposes of income tax is
a distribution within the meaning of sec-
tion 1411(c)(5), and thus is not included in
net investment income. Examples include
a conversion to a Roth IRA described in
section 408A and a deemed distribution
under section 72(p).

(3) Amounts includible in gross in-
come. Any amount that is not treated as a
distribution but is otherwise includible in
gross income pursuant to a rule relating to
amounts held in a qualified plan or ar-
rangement described in paragraph (a) of
this section is a distribution within the
meaning of section 1411(c)(5), and thus is
not included in net investment income.
For example, any income of the trust of a
qualified plan or arrangement that is ap-
plied to purchase a participant's life insur-
ance coverage (the P.S. 58 costs) is a
distribution within the meaning of section
1411(c)(5), and thus is not included in net
investment income.

(4) Amounts related to employer secu-
rities-(i) Dividends related to employer
securities. Any dividend that is deductible
under section 404(k) and is paid in cash
directly to plan participants or beneficia-
ries is a distribution within the meaning of
section 1411(c)(5), and thus is not in-
cluded in net investment income. How-
ever, any amount paid as a dividend after
the employer securities have been distrib-
uted from a qualified plan is not a distri-
bution within the meaning of section
1411(c)(5), and thus is included in net
investment income.

(ii) Amounts related to the net unreal-
ized appreciation in employer securities.
The amount of any net unrealized appre-
ciation attributable to employer securities
(within the meaning of section 402(e)(4))
realized on a disposition of those em-
ployer securities is a distribution within
the meaning of section 1411(c)(5), and
thus is not included in net investment in-
come. However, any appreciation in value
of the employer securities after the distri-
bution from the qualified plan is not a
distribution within the meaning of section
1411(c)(5), and is included in net invest-
ment income.

(c) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012,
in accordance with §1.1411-1(f).

§1.1411-9 Exception for self-
employment income.

(a) General rule. Except as provided in
paragraph (b) of this section, net invest-
ment income does not include any item
taken into account in determining self-
employment income that is subject to tax
under section 1401(b) for such taxable
year. For purposes of section 1411(c)(6)
and this section, taken into account means
income included and deductions allowed
in determining net earnings from self-
employment. However, amounts excepted
in determining net earnings from self-
employment under section 1402(a)(1)-
(17), and thus excluded from self-
employment income under section
1402(b), are not taken into account in
determining self-employment income and
thus may be included in net investment
income if such amounts are described in
§1.1411-4. Except as provided in para-
graph (b) of this section, if net earnings
from self-employment consist of income
or loss from more than one trade or busi-
ness, all items taken into account in deter-
mining the net earnings from self-
employment with respect to these trades
or businesses (see §1.1402(a)-2(c)) are
considered taken into account in deter-
mining the amount of self-employment
income that is subject to tax under section
1401(b) and therefore not included in net
investment income.

(b) Special rule for traders. In the case
of gross income described in §§1.1411-
4(a)(1)(ii) and (a)(1)(iii) derived from a
trade or business of trading in financial
instruments or commodities (as described
in §1.1411-5(a)(2)), the deductions de-
scribed in §1.1411-4(f)(2)(ii) properly al-
locable to the taxpayer's trade or business
of trading in financial instruments or com-
modities are taken into account in deter-
mining the taxpayer's self-employment
income only to the extent that such deduc-
tions reduce the taxpayer's net earnings
from self-employment (after aggregating
under §1.1402(a)-2(c) the net earnings
from self-employment from any trade or
business carried on by the taxpayer as an
individual or as a member of a partnership).
Any deductions described in §1.1411-
4(f)(2)(ii) that exceed the amount of net
earnings from self-employment, in the ag-
gregate (if applicable), are allowed in deter-
mining the taxpayer's net investment in-
come under section 1411 and the
regulations thereunder.

(c) Examples. The following examples
illustrate the provisions of this section.
For purposes of these examples, assume
the taxpayer is a United States citizen,
uses a calendar taxable year, and Year 1
and all subsequent years are taxable years
in which section 1411 is in effect:

Example 1. Exclusion from self-employment in-
come. A is a general partner in PRS, a partnership
carrying on a trade or business that is not a trade or
business of trading in financial instruments or com-
modities (within the meaning of §1.1411-
5(a)(2)). During Year 1, A's distributive share from
PRS is $1 million, $300,000 of which is attributable to
the gain on the sale of PRS's capital assets. Section
1402(a)(3)(A) provides an exclusion from net earnings
from self-employment for any gain or loss from the
sale or exchange of a capital asset. For Year 1, A has
$700,000 self-employment income subject to self-
employment tax. This $700,000 subject to self-
employment tax is not included as part of net invest-
ment income under paragraph (a) of this section.
However, the $300,000 attributable to the gain on
PRS's sale of a capital asset is excluded from net
earnings from self-employment, and from self-
employment income, and thus is not covered by the
exception in section 1411(c)(6). Therefore, the
$300,000 attributable to the gain on PRS's sale of a
capital asset is included as net investment income if the
other requirements of section 1411 are satisfied.

Example 2. Two trades or businesses. B is an
individual engaged in two trades or businesses, Busi-
ness X and Business Y, neither of which is the trade
or business of trading in financial instruments or
commodities (as described in §1.1411-5(a)(2)). B
carries on Business X as a sole proprietor and B is
also a general partner in a partnership that carries on

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Business Y. Business Y is a nonpassive activity of B.
During Year 1, B had net earnings from self-
employment consisting of the aggregate of a $50,000
loss (that is, after application of the exclusions under
section 1402(a)(1)-(17)) from Business X, and
$70,000 in income (after application of the exclu-
sions under section 1402(a)(1)-(17)) from B's dis-
tributive share from the partnership from carrying on
Business Y. Thus, B's net earnings from self-
employment in Year 1 are $20,000. For Year 1, all of
B's income, deductions, gains, and losses from Busi-
ness X and distributive share from the partnership
carrying on Business Y, other than those amounts
excluded due to application of section 1402(a)(1)-
(17), are taken into account in determining B's net
earnings from self-employment and self-
employment income for such taxable year. Accord-
ingly, in calculating B's net investment income (as
defined in §1.1411-4) for Year 1, B will not take
into account the items of income, loss, gain, and
deduction that comprise B's $50,000 loss attribut-
able to Business X (after application of the exclu-
sions under section 1402(a)(1)-(17)), and the items
of income, loss, gain, and deduction that comprise
B's $70,000 distributable share attributable to B's
general partnership interest (after application of the
exclusions under section 1402(a)(1)-(17)). Rather,
only items of income, loss, gain, and deduction from
the two separate businesses that were excluded from
the calculation of B's net earnings from self-
employment income due to the application of the
exclusions under section 1402(a)(1)-(17), such as
any capital gains and losses excluded under section
1402(a)(3), are considered for purposes of calculat-
ing B's net investment income for Year 1 in connec-
tion with these two trades or businesses.

Example 3. Special rule for trader with single trade
or business. D is an individual engaged in the trade or
business of trading in commodities (as described in
§1.1411-5(a)(2). D made a valid and timely election
under section 475(f)(2). D derives $400,000 of trading
gains, which are gross income described in §1.1411-
4(a)(1) and $15,000 of expenses described in §1.1411-
4(f)(2)(ii) from carrying on the trade or business. Pur-
suant to sections 475(f)(1)(D) and 1402(a)(3)(A), none
of the gross income is taken into account in determin-
ing D's net earnings from self-employment and self-
employment income. Therefore, under paragraph (a) of
this section, the $400,000 of gross income is not cov-
ered by the exception in section 1411(c)(6). Because D
had $0 net earnings from self-employment, the $15,000
of deductions did not reduce D's net earnings from
self-employment under paragraph (b) of this section
and §1.1411-(4)(f)(2)(ii). Therefore, the $15,000 of
deductions may reduce D's gross income of $400,000
for purposes of section 1411.

Example 4. Special rule for trader with multiple
trades or businesses. E is an individual engaged in
two trades or businesses, Business X (which is not a
trade or business of trading in financial instruments
or commodities) and Business Y (which is a trade or
business of trading in financial instruments or com-
modities (as described in §1.1411-5(a)(2)). E made a
valid and timely election under section 475(f) with
respect to Business Y. During Year 1, E had net
earnings from self-employment from Business X of
$35,000. During Year 1, E also had $300,000 of
trading gains, which are gross income described in

§1.1411-4(a)(1) and $40,000 of expenses described
in §1.1411-4(f)(2)(ii) from Business Y. E's
$300,000 of gross income from Business Y is ex-
cluded from net earnings from self-employment and
self-employment income pursuant to sections
475(f)(1)(D) and 1402(a)(3)(A). E's $40,000 of de-
ductions from Business Y reduce E's $35,000 of net
earnings from self-employment from Business X to
$0. Pursuant to paragraph (b) of this section and
§1.1411-4(f)(2)(ii), the remaining $5,000 of deduc-
tions from Business Y are taken into account in
determining E's net investment income (by reducing
E's gross income of $300,000 from Business Y to
$295,000) for purposes of section 1411.

(d) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012,
in accordance with §1.1411-1(f).

§1.1411-10 Controlled foreign
corporations and passive foreign
investment companies.

(a) In general. This section provides
rules that apply to an individual, estate, or
trust that is a United States shareholder of
a controlled foreign corporation (CFC), or
that is a United States person that directly
or indirectly owns an interest in a passive
foreign investment company (PFIC). In
addition, this section provides rules that
apply to an individual, estate, or trust that
owns an interest in a domestic partnership
or an S corporation that is either a United
States shareholder of a CFC or that has
made an election under section 1295 to
treat a PFIC as a qualified electing fund
(QEF). References in this section to an
election under paragraph (g) of this sec-
tion being in effect relate to an election
that is applicable to the person that is
determining the section 1411 conse-
quences with respect to holding a partic-
ular CFC or QEF.

(b) Amounts derived from a trade or
business described in §1.1411-5-(1) In
general. Except as provided in paragraph
(b)(2) of this section, an amount included
in gross income under section 951(a) or
section 1293(a) that is also income de-
rived from a trade or business described in
section 1411(c)(2) and §1.1411-5 (apply-
ing the relevant rules in §1.1411-4(b)) is
taken into account as net investment in-
come under section 1411(c)(1)(A)(ii) and
§1.1411-4(a)(1)(ii) for purposes of sec-
tion 1411 and the regulations thereunder
when it is taken into account for purposes

of chapter 1, and the rules in paragraphs
(c) through (g) of this section do not apply
to that amount. For purposes of section
1411 and the regulations thereunder, an
amount included in gross income under
section 1296(a) that is also income de-
rived from a trade or business described in
section 1411(c)(2) and §1.1411-5 (apply-
ing the relevant rules in §1.1411-4(b)), is
net investment income within the meaning
of section 1411(c)(1)(A)(ii) and §1.1411-
4(a)(1)(ii), and the rules in paragraph
(c)(2)(ii) of this section do not apply to
that amount.

(2) Coordination rule for changes in
trade or business status. With respect to
stock of a CFC or QEF for which an
election under paragraph (g) of this sec-
tion is not in effect, the rules in paragraphs
(c) through (f) of this section apply to a
distribution of earnings and profits de-
scribed in paragraph (c)(1)(i)(A) of this
section that was not taken into account as
net investment income under paragraph
(b) of this section.

(c) Calculation of net investment in-
come-(1) Dividends. For purposes of
section 1411(c)(1)(A)(i) and §1.1411-
4(a)(1)(i), net investment income is cal-
culated by taking into account the
amount of dividends described in this
paragraph (c)(1).

(i) Distributions of previously taxed
earnings and profits-(A) Rules when an
election under paragraph (g) of this sec-
tion is not in effect with respect to the
shareholder-(1) General rule. Except
as otherwise provided in this paragraph
(c)(1)(i), with respect to stock of a CFC
or QEF for which an election under
paragraph (g) of this section is not in
effect, a distribution of earnings and
profits that is not treated as a dividend
for chapter 1 purposes under section
959(d) or section 1293(c) is a dividend
for purposes of section 1411(c)(1)(A)(i)
and §1.1411-4(a)(1)(i) if the distribu-
tion is attributable to amounts that are or
have been included in gross income for
chapter 1 purposes under section 951(a)
or section 1293(a) in a taxable year be-
ginning after December 31, 2012.
Solely, for this purpose, distributions of
earnings and profits attributable to
amounts that are or have been included
in gross income for chapter 1 purposes
under section 951(a) or section 1293(a)

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are considered first attributable to those
earnings and profits, if any, derived
from the current taxable year, and then
from prior taxable years beginning with
the most recent prior taxable year, and
with respect to amounts included under
section 951(a), without regard to
whether the earnings and profits are de-
scribed in section 959(c)(1) or section
959(c)(2).

(2) Exception for distributions attribut-
able to earnings and profits previously taken
into account for purposes of section 1411. A
distribution of earnings and profits that is
not treated as a dividend for chapter 1 pur-
poses under section 959(d) or section
1293(c) is not treated as a dividend for pur-
poses of section 1411(c)(1)(A)(i) and
§1.1411-4(a)(1)(i), to the extent that an in-
dividual, estate, or trust establishes, by pro-
viding information that is similar to, and in
the same manner as, the information de-
scribed in §1.959-1(d) (relating to previ-
ously taxed earnings and profits), that the
distribution is attributable to-

(i) Amounts included in gross income
by any person for chapter 1 purposes un-
der section 951(a) or section 1293(a) that
have been taken into account by any per-
son as net investment income by reason of
paragraph (b) of this section or an election
under paragraph (g) of this section; or

(ii) Amounts included in gross income
by any person as a dividend pursuant to
section 1248(a) that, by reason of paragraph
(c)(3)(ii) of this section, have been taken
into account by any person as net invest-
ment income under section 1411(c)(1)(A)(i)
and §1.1411-4(a)(1)(i).

(B) Rule when an election under para-
graph (g) of this section is in effect with
respect to the shareholder. Except as oth-
erwise provided in this paragraph
(c)(1)(i), if an election under paragraph
(g) of this section is in effect, a distribu-
tion of earnings and profits that is not
treated as a dividend for chapter 1 pur-
poses under section 959(d) or section
1293(c) is not treated as a dividend for
purposes of section 1411(c)(1)(A)(i) and
§1.1411-4(a)(1)(i).

(C) Special rule for certain distribu-
tions related to 2013 taxable years-(1)
Scope. The rule in this paragraph
(c)(1)(i)(C) applies to individuals, estates,
and trusts that were subject to section 1411
during a taxable year that began after De-

cember 31, 2012, and before January 1,
2014, and that satisfy all of the conditions
set forth in paragraph (c)(1)(i)(C)(2) of this
section. This rule also applies to all domes-
tic partnerships and S corporations that sat-
isfy all of the conditions set forth in para-
graph (c)(1)(i)(C)(2) of this section.

(2) Rule. A distribution of earnings and
profits from a CFC or QEF, with respect
to which an election under paragraph (g)
is in effect, that is not treated as a dividend
for chapter 1 purposes under section
959(d) or section 1293(c) is a dividend for
purposes of section 1411(c)(1)(A)(i) and
§1.1411-4(a)(1)(i) to the extent that-

(i) The distribution of earnings and
profits is attributable to an amount in-
cluded by an individual, estate, trust, do-
mestic partnership, S corporation or com-
mon trust fund in gross income for chapter
1 purposes under section 951(a) or section
1293(a) with respect to the CFC or QEF
for a taxable year that began after Decem-
ber 31, 2012, and before January 1, 2014;

(ii) The individual, estate, trust, domes-
tic partnership, S corporation, or common
trust fund made the election under para-
graph (g) of this section with respect to
the CFC or QEF in a taxable year that
began after December 31, 2013; and

(iii) The individual, estate, trust, do-
mestic partnership, S corporation, or com-
mon trust fund did not make the election
described in paragraph (g)(4)(iii) of this
section (concerning making an election
under paragraph (g) of this section for a
taxable year that begins before January 1,
2014).

(3) Ordering rule. Solely, for purposes
of this paragraph (c)(1)(i)(C)(3), distribu-
tions of earnings and profits attributable to
amounts that have been included in gross
income for chapter 1 purposes under sec-
tion 951(a) or section 1293(a) are consid-
ered first attributable to the earnings and
profits derived from a taxable year that
began after December 31, 2012, and be-
fore January 1, 2014.

(ii) Excess distributions that constitute
dividends. To the extent an excess distri-
bution within the meaning of section
1291(b) constitutes a dividend within the
meaning of section 316(a), the amount is
included in net investment income for
purposes of section 1411(c)(1)(A)(i) and
§1.1411-4(a)(1)(i).

(2) Net gain. For purposes of section
1411(c)(1)(A)(iii) and §1.1411-
4(a)(1)(iii), the rules in this paragraph
(c)(2) apply in determining net gain at-
tributable to the disposition of property.

(i) Gains treated as excess distribu-
tions. Gains treated as excess distributions
under section 1291(a)(2) are included in
determining net gain attributable to the
disposition of property for purposes of
section 1411(c)(1)(A)(iii) and §1.1411-
4(a)(1)(iii).

(ii) Inclusions and deductions with re-
spect to section 1296 mark to market elec-
tions. Amounts included in gross income
under section 1296(a)(1) and amounts al-
lowed as a deduction under section
1296(a)(2) are taken into account in de-
termining net gain attributable to the dis-
position of property for purposes of sec-
tion 1411(c)(1)(A)(iii) and §1.1411-
4(a)(1)(iii).

(iii) Gain or loss attributable to the
disposition of stock of CFCs and QEFs.
With respect to stock of a CFC or QEF for
which an election under paragraph (g) of
this section is not in effect, for purposes of
calculating the net gain under §§1.1411-
4(a)(1)(iii) and 1.1411-4(d) that is attrib-
utable to the direct or indirect disposition
of that stock (including for purposes of
determining gain or loss on the direct or
indirect disposition of that stock by a do-
mestic partnership, S corporation, or com-
mon trust fund), basis is determined in
accordance with the provisions of para-
graph (d) of this section.

(iv) Gain or loss attributable to the
disposition of interests in domestic part-
nerships or S corporations that own di-
rectly or indirectly stock of CFCs or
QEFs. With respect to stock of a CFC or
QEF for which an election under para-
graph (g) of this section is not in effect,
for purposes of calculating the net gain
under §§1.1411-4(a)(1)(iii) and 1.1411-
4(d) that is attributable to the disposition
of an interest in a domestic partnership or
S corporation that directly or indirectly
owns that stock, basis is determined in
accordance with the provisions of para-
graph (d) of this section.

(3) Application of section 1248. With
respect to stock of a CFC or QEF for
which an election under paragraph (g) of
this section is not in effect, for purposes of
section 1411 and §1.1411-4-

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(i) In determining the gain recognized
on the sale or exchange of stock of a
foreign corporation for section 1248(a)
purposes, basis is determined in accor-
dance with the provisions of paragraph (d)
of this section; and

(ii) Section 1248(a) applies without re-
gard to the exclusion for certain earnings
and profits under sections 1248(d)(1) and
(d)(6), except that those exclusions will
apply with respect to the earnings and
profits of a foreign corporation that are
attributable to:

(A) Amounts taken into account as net
investment income under paragraph (b) of
this section; and

(B) Amounts previously included in
gross income for chapter 1 purposes under
section 951(a) or section 1293(a) in a tax-
able year beginning before December 31,
2012, and that have not yet been distrib-
uted. For this purpose, the determination
of whether earnings and profits that are
attributable to amounts previously taxed
in a taxable year beginning before Decem-
ber 31, 2012, have been distributed is de-
termined based on the rules described in
paragraph (c)(1)(i) of this section.

(4) Amounts distributed by an estate or
trust. Net investment income of a benefi-
ciary of an estate or trust includes the
beneficiary's share of distributable net in-
come, as described in sections 652 and
662 and as modified by paragraph (f) of
this section, to the extent that the benefi-
ciary's share of distributable net income
includes items that, if they had been re-
ceived directly by the beneficiary, would
have been described in this paragraph (c).

(5) Properly allocable deductions-(i)
General rule. For purposes of section
1411(c)(1)(B) and §1.1411-4(f), the sec-
tion 163(d)(1) investment expense deduc-
tion may be calculated by-

(A) Increasing the amount of invest-
ment income determined for chapter 1
purposes under section 163(d)(4)(B) by
the amount of dividends described in
§1.1411- 10(c) that are derived from a
CFC or QEF with respect to which an
election under paragraph (g) of this sec-
tion is not in effect;

(B) Decreasing the amount of invest-
ment income for determined chapter 1
purposes under section 163(d)(4)(B) by
the amount included in gross income for
chapter 1 purposes under section 951(a) or

section 1293(a) that is attributable to a
CFC or QEF with respect to which an
election under paragraph (g) of this sec-
tion is not in effect; and

(C) Increasing or decreasing, as appli-
cable, the amount of investment income
for chapter 1 purposes under section
163(d)(4)(B) by the difference between
the amount calculated with respect to a
disposition under paragraphs (c)(2)(iii)
and (c)(2)(iv) of this section and the
amount of the gain or loss attributable to
the relevant disposition as calculated for
chapter 1 purposes.

(ii) Additional rules. For purposes of
section 1411(c)(1)(B) and §1.1411-
4(f), if the method of calculation de-
scribed in paragraph (c)(5)(i) of this sec-
tion is applied:

(A) The amount of investment interest
not allowed as a deduction under section
163(d)(2) must be calculated consistent
with the method of calculation described
in paragraph (c)(5)(i).

(B) The method of calculation must be
adopted by an individual, estate, or trust
no later than the first year in which the
individual, estate, or trust is subject to
section 1411.

(C) The method of calculation must be
applied with respect to all CFCs and QEFs
for all taxable years with respect to which
an election under paragraph (g) of this
section is not in effect.

(D) A method of calculation under this
paragraph is a method of accounting,
which must be applied consistently, and
may only be changed by the taxpayer by
securing the consent of the Commissioner
in accordance with §1.446-1(e) and fol-
lowing the administrative procedures is-
sued under §1.446-1(e)(3)(ii).

(d) Conforming basis adjustments-(1)
Basis adjustments under sections 961 and
1293-(i) Stock held by individuals, es-
tates, or trusts. With respect to stock of a
CFC or QEF which is held by an individ-
ual, estate, or trust, either directly or indi-
rectly through one or more entities each of
which is foreign, for which an election
under paragraph (g) of this section is not
in effect-

(A) The basis increases made pursuant
to sections 961(a) and 1293(d) for
amounts included in gross income for
chapter 1 purposes under sections 951(a)
and 1293(a) in taxable years beginning

after December 31, 2012, are not taken
into account for purposes of section 1411
and the regulations thereunder; and

(B) The basis decreases made pursuant
to sections 961(b) and 1293(d) attribut-
able to amounts treated as dividends for
purposes of section 1411 under paragraph
(c)(1)(i) of this section are not taken into
account for purposes of section 1411 and
the regulations thereunder.

(ii) Stock held by domestic partner-
ships or S corporations-(A) Rule when
an election under paragraph (g) of this
section is not in effect. The rules of this
paragraph (d)(1)(ii)(A) apply with respect
to stock of a CFC or QEF held directly by
a domestic partnership or S corporation,
or indirectly through one or more entities
each of which is foreign, for which an
election under paragraph (g) of this sec-
tion is not in effect. If an individual, es-
tate, or trust is a shareholder of an S
corporation, or if an individual, estate, or
trust directly, or through one or more tiers
of passthrough entities (including an S
corporation), owns an interest in a domes-
tic partnership, the S corporation or do-
mestic partnership, as the case may be,
will not take into account for purposes of
section 1411 and the regulations thereun-
der the basis increases made by the do-
mestic partnership or S corporation pursu-
ant to sections 961(a) and 1293(d) for
amounts included in gross income for
chapter 1 purposes under sections 951(a)
and 1293(a) for taxable years beginning
after December 31, 2012, and the basis
decreases made by the domestic partner-
ship or S corporation pursuant to sections
961(b) and 1293(d) attributable to
amounts treated as dividends for purposes
of section 1411 under paragraph (c)(1)(i)
of this section (the section 1411 recalcu-
lated basis). If the domestic partnership or
S corporation disposes of the stock of a
CFC or QEF, the section 1411 recalcu-
lated basis will be used to determine the
distributive share or pro rata share of the
gain or loss for purposes of section 1411
for partners or shareholders.

(B) Rules when an election under
paragraph (g) of this section is in effect. If
an election under paragraph (g) of this
section is in effect with respect to stock of
a CFC or QEF held directly or indirectly
by a domestic partnership or S corpora-
tion, the partner's distributive share or the

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shareholder's pro rata share of the gain or
loss for purposes of section 1411 is the
same as the distributive share or pro rata
share of the gain or loss for purposes of
chapter 1. See Example 6 of paragraph (h)
of this section.

(2) Special rules for partners that own
interests in domestic partnerships that
own directly or indirectly stock of CFCs
or QEFs. The rules of this paragraph
(d)(2) apply with respect to stock of a
CFC or QEF for which an election under
paragraph (g) of this section is not in
effect, and that is held by a domestic part-
nership, either directly or indirectly
through one or more entities each of
which is foreign. In such a case, the basis
increases provided under section
705(a)(1)(A) to the partners for purposes
of chapter 1 that are attributable to
amounts that the domestic partnership in-
cludes or included in gross income under
section 951(a) or section 1293(a) for a
taxable year beginning after December 31,
2012, are not taken into account for pur-
poses of section 1411. Instead, each part-
ner's adjusted basis in the partnership in-
terest is increased by its share of any
distributions to the partnership from the
CFC or QEF that are treated as dividends
for purposes of section 1411 under para-
graph (c)(1)(i) of this section. Similar
rules apply when the stock of the CFC or
QEF is held in a tiered partnership struc-
ture. For purposes of determining net in-
vestment income under section 1411 and
the regulations thereunder, the partner's
adjusted basis in the partnership interest
as calculated under this paragraph (d)(2)
is used to determine all tax consequences
related to tax basis (for example, loss lim-
itation rules and the characterization of
partnership distributions).

(3) Special rules for S corporation share-
holders that own interests in S corporations
that own directly or indirectly stock of CFCs
or QEFs. The rules of this paragraph (d)(3)
apply with respect to stock of a CFC or QEF
for which an election under paragraph (g) of
this section is not in effect, and that is held
by an S corporation, directly or indirectly
through one or more entities each of which
is foreign. In such case, the basis increases
provided in section 1367(a)(1)(A) to its
shareholders for chapter 1 purposes that are
attributable to amounts that the S corpora-
tion includes or included in gross income for

chapter 1 purposes under section 951(a) or
section 1293(a) for taxable years beginning
after December 31, 2012, are not taken into
account for purposes of section 1411. In-
stead, each shareholder's adjusted basis of
stock in the S corporation is increased by its
share of the distributions to the S corpora-
tion from the CFC or QEF that are treated as
dividends for purposes of section 1411 un-
der paragraph (c)(1)(i) of this section. Sim-
ilar rules apply when the S corporation
holds an interest in a CFC or QEF through a
partnership. For purposes of determining net
investment income under section 1411 and
the regulations thereunder, the shareholder's
adjusted basis in the stock of the S corpora-
tion as calculated under this paragraph
(d)(3) is used to determine all tax conse-
quences related to tax basis (for example,
loss limitation rules and the characterization
of S corporation distributions).

(4) Special rules for participants in
common trust funds. Rules similar to the
rules in paragraphs (d)(2) and (3) of this
section apply to ownership interests in
common trust funds (as defined in section
584).

(e) Conforming adjustments to modi-
fied adjusted gross income and adjusted
gross income-(1) Individuals. Solely for
purposes of section 1411(a)(1)(B)(i) and
the regulations thereunder, the term mod-
ified adjusted gross income means modi-
fied adjusted gross income as defined in
§1.1411-2(c)(1)-

(i) Increased by amounts included in
net investment income under paragraphs
(c)(1)(i), (c)(1)(ii), (c)(2)(i), and (c)(4) of
this section that are not otherwise in-
cluded in gross income for chapter 1 pur-
poses;

(ii) Increased or decreased, as applica-
ble, by the difference between the amount
calculated with respect to a disposition
under paragraphs (c)(2)(iii) and (iv) of
this section and the amount of the gain or
loss attributable to the relevant disposition
as calculated for chapter 1 purposes;

(iii) Decreased by any amount included
in gross income for chapter 1 purposes
under section 951(a) or section 1293(a)
attributable to a CFC or QEF with respect
to which no election under paragraph (g)
of this section is in effect; and

(iv) To the extent the section 163(d)(1)
investment interest expense deduction is
calculated using the method of calculation

set forth in paragraph (c)(5) of this section
and the deduction is taken into account
under §1.1411-4(f)(2), increased or de-
creased, as appropriate, by the difference
between the amount of the section
163(d)(1) investment interest expense de-
duction calculated under paragraph (c)(5)
of this section and the amount calculated
for chapter 1 purposes.

(2) Estates and trusts. Solely for pur-
poses of section 1411(a)(2)(B)(i) and
the regulations thereunder, the term ad-
justed gross income means adjusted
gross income as defined in §1.1411-
3(a)(1)(ii)(B)(1) adjusted by the follow-
ing amounts to the extent those amounts
are not distributed by the estate or
trust-

(i) Increased by amounts included in
net investment income under paragraphs
(c)(1)(i), (c)(1)(ii), (c)(2)(i), and (c)(4) of
this section that are not otherwise in-
cluded in gross income for chapter 1 pur-
poses;

(ii) Increased or decreased, as applica-
ble, by the difference between the amount
calculated with respect to a disposition
under paragraphs (c)(2)(iii) and (iv) of
this section and the amount of the gain or
loss attributable to the relevant disposition
as calculated for chapter 1 purposes;

(iii) Decreased by any amount included
in gross income for chapter 1 purposes
under section 951(a) or section 1293(a)
attributable to a CFC or QEF with respect
to which no election under paragraph (g)
of this section is in effect; and

(iv) To the extent the section 163(d)(1)
investment interest expense deduction is
calculated using the method of calculation
set forth in paragraph (c)(5) of this section
and taken into account under §1.1411-
4(f)(2), increased or decreased, as appro-
priate, by the difference between the
amount of the section 163(d)(1) invest-
ment interest expense deduction calcu-
lated under paragraph (c)(5) of this sec-
tion and the amount calculated for chapter
1 purposes.

(f) Application to estates and trusts.
All of the items described in paragraph (c)
of this section are included in the net
investment income of an estate or trust or
its beneficiaries. The amounts described in
paragraphs (e)(2)(i) through (iv) of this
section, regardless of whether the estate or
trust receives those amounts directly or

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indirectly through another estate or trust,
increase or decrease, as applicable, the
estate's or trust's distributable net income
for purposes of section 1411. The estate or
trust, or the beneficiaries thereof, must
take those amounts into account in a man-
ner reasonably consistent with the general
operating rules for estates and trusts in
§1.1411-3 and subchapter J in computing
the undistributed net investment income
of the estate or trust and the net invest-
ment income of the beneficiaries.

(g) Election with respect to CFCs
and QEFs-(1) Effect of election. If an
election under paragraph (g) of this sec-
tion is made with respect to a CFC or
QEF, amounts included in gross income
for chapter 1 purposes under section
951(a) or section 1293(a)(1)(A) with re-
spect to the CFC or QEF in taxable
years beginning with the taxable year
for which the election is made are
treated as net investment income for
purposes of §1.1411-4(a)(1)(i), and
amounts included in gross income under
section 1293(a)(1)(B) with respect to
the QEF in taxable years beginning with
the taxable year for which the election is
made are taken into account in calculat-
ing net gain attributable to the disposi-
tion of property under §1.1411-
4(a)(1)(iii). See paragraphs (c)(1)(i)(B)
and (c)(1)(i)(C) of this section for the
effect of this election on certain distri-
butions of previously taxed earnings and
profits.

(2) Years to which election applies-
(i) In general. An election under para-
graph (g) of this section applies to the
taxable year for which it is made and all
subsequent taxable years, and applies to
all subsequently acquired interests in the
CFC or QEF. An election under paragraph
(g) of this section is irrevocable.

(ii) Termination of interest in CFC or
QEF. Complete termination of a person's
interest in the CFC or QEF does not ter-
minate the person's election under para-
graph (g) of this section with respect to
the CFC or QEF. Thus, if the person re-
acquires stock of the CFC or QEF, that
stock is considered to be stock for which
an election under paragraph (g) of this
section has been made and is in effect.

(iii) Termination of partnership. If a do-
mestic partnership that makes the election
under paragraph (g) of this section is termi-

nated pursuant to section 708(b)(1)(B), the
election is binding on the new partnership.

(3) Who may make the election. An
individual, estate, trust, domestic partner-
ship, S corporation, or common trust fund
may make an election under paragraph (g)
of this section with respect to each CFC or
QEF that it holds directly or indirectly
through one or more entities, each of
which is foreign. In addition, an individ-
ual, estate, trust, domestic partnership, S
corporation, or common trust fund may
make an election under paragraph (g) of
this section with respect to a CFC or QEF
that it holds indirectly through a domestic
partnership, S corporation, estate, trust, or
common trust fund if the domestic part-
nership, S corporation, estate, trust, or
common trust fund does not make the
election. The election, if made, for an
estate or trust must be made by the fidu-
ciary of that estate or trust.

(4) Time and manner for making the
election-(i) Individuals, estates, and
trusts-(A) General rule. Except as oth-
erwise provided in this paragraph, in order
for an election under paragraph (g) of this
section by an individual, estate, or trust
(other than a CRT) with respect to a CFC
or QEF to be effective, the election must
be made no later than the first taxable year
beginning after December 31, 2013, dur-
ing which the individual, estate, or trust-

(1) Includes an amount in gross income
for chapter 1 purposes under section
951(a) or section 1293(a) with respect to
the CFC or QEF; and

(2) Is subject to tax under section 1411
or would be subject to tax under section
1411 if the election were made with re-
spect to the stock of the CFC or QEF.

(B) Special rule for charitable remain-
der trusts (CRTs). Except as otherwise
provided in this paragraph, in order for an
election under paragraph (g) of this sec-
tion by a CRT with respect to a CFC or
QEF to be effective, the election must be
made no later than the first taxable year
beginning after December 31, 2013, dur-
ing which the CRT includes an amount in
gross income for chapter 1 purposes under
section 951(a) or section 1293(a) with re-
spect to the CFC or QEF.

(ii) Certain domestic passthrough enti-
ties. Except as otherwise provided in this
paragraph, in order for an election under
paragraph (g) of this section by a domestic

partnership, S corporation, or common
trust fund with respect to a CFC or a QEF
to be effective, the election must be made
no later than the first taxable year begin-
ning after December 31, 2013, during
which the domestic partnership S corpo-
ration, or common trust fund-

(A) Includes an amount in gross in-
come for chapter 1 purposes under section
951(a) or section 1293(a) with respect to
the CFC or QEF; and

(B) Has a direct or indirect owner that
is subject to tax under section 1411 or
would be subject to tax under section
1411 if the election were made.

(iii) Taxable years that begin before
January 1, 2014-(A) Individuals, es-
tates, or trusts. An individual, estate, or
trust may make an election under para-
graph (g) of this section for a taxable year
that begins before January 1, 2014.

(B) Certain domestic passthrough en-
tities. A domestic partnership, S corpora-
tion, or common trust fund may make an
election under paragraph (g) of this sec-
tion for a taxable year that begins before
January 1, 2014, provided that all of its
partners, shareholders, or participants, as
the case may be, consent to the election.
In the case of a partner, shareholder, or
participant that is a partnership, S corpo-
ration, or common trust fund, all of the
partners, shareholders, and participants
also must consent to the election.

(iv) Time for making election. In all
cases, the election under paragraph (g) of
this section must be made in the manner
prescribed by forms, instructions, or in
other guidance on the individual's, es-
tate's, trust's, domestic partnership's, S
corporation's, or common trust fund's
original or amended return for the taxable
year for which the election is made. An
election can be made on an amended re-
turn only if the taxable year for which the
election is made, and all taxable years that
are affected by the election, are not closed
by the period of limitations on assess-
ments under section 6501. An individual,
estate, trust, domestic partnership, S cor-
poration, or common trust fund may not
seek an extension of time to make the
election under any other provision of the
law, including §301.9100 of this chapter.

(h) Examples. The following examples
illustrate the rules of this section. In each
example, unless otherwise indicated, the

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individuals, the foreign corporation (FC),
the QEF (QEF), and the partnership (PRS)
use a calendar taxable year. Further, the
gross income or gain with respect to an
interest in FC is not derived in a trade or
business described in §1.1411-5.

Example 1. (i) Facts. A, a United States citizen,
is the sole shareholder of FC, a controlled foreign
corporation (within the meaning of section 957). A is
a United States shareholder (within the meaning of
section 951(b)) with respect to FC. In 2012, A in-
cludes $40,000 in gross income for chapter 1 pur-
poses under section 951(a)(1)(A) with respect to FC.
On December 31, 2012, A's basis in the stock of FC
for chapter 1 purposes is $500,000, which includes
an increase to basis under section 961(a) of $40,000.
The amount of FC's earnings and profits that are
described in section 959(c)(2) is $40,000, the
amount of FC's earnings and profits that are de-
scribed in section 959(c)(3) is $20,000, and FC does
not have any earnings and profits that are described
in section 959(c)(1). No election is made under para-
graph (g) of this section. During 2013, A does not
include any amounts in income under section 951(a)
with respect to FC, A does not receive any distribu-
tions from FC, and there is no change in the amount
of FC's earnings and profits. In 2014, A includes
$10,000 in gross income for chapter 1 purposes
under section 951(a)(1)(A) with respect to FC. As a
result, A's basis in the stock of FC for chapter 1
purposes increases by $10,000 to $510,000 pursuant
to section 961(a). During 2015, FC distributes
$30,000 to A, which is not treated as a dividend for
purposes of chapter 1 under section 959(d). As a
result, A's basis in the stock of FC for chapter 1
purposes is decreased by $30,000 to $480,000 pur-
suant to section 961(b).

(ii) Results for section 1411 purposes. In 2014, A
does not include the $10,000 section 951(a) income
inclusion in A's net investment income under section
1411(c)(1)(A)(i) and §1.1411-4(a)(1)(i). Pursuant to
paragraph (e)(1)(iii) of this section, A decreases A's
modified adjusted gross income for section 1411
purposes by $10,000 in 2014, and pursuant to para-
graph (d)(1)(i) of this section, A's adjusted basis is
not increased by $10,000 and remains at $500,000.
In 2015, pursuant to paragraph (c)(2)(i) of this sec-
tion, A includes $10,000 of the distribution of pre-
viously taxed earnings and profits as a dividend for
purposes of determining A's net investment income
because $10,000 of the $30,000 distribution is attrib-
utable to amounts that A included in gross income
for chapter 1 purposes under section 951(a) in a tax
year that began after December 31, 2012. Pursuant to
paragraph (e)(1)(i) of this section, A increases A's
modified adjusted gross income for section 1411
purposes by $10,000 in 2015. Under paragraph
(d)(1)(i) of this section, A's adjusted basis is not
decreased by the $10,000 that is treated as a dividend
for section 1411 purposes, and thus, A's adjusted
basis in FC for section 1411 purposes is decreased
under section 961 only by $20,000 to $480,000.

Example 2. (i) Facts. Same facts as Example 1.
In addition, during 2016, A includes $15,000 in
gross income for chapter 1 purposes under section
951(a)(1)(A) with respect to FC. As a result, A's
basis in the stock of FC for chapter 1 purposes

increases by $15,000 to $495,000 pursuant to section
961(a). During 2017, A sells all of A's shares of FC
for $550,000 and, prior to the application of section
1248, recognizes $55,000 ($550,000 minus
$495,000) of long-term capital gain for chapter 1
purposes. For purposes of calculating the amount
included in income as a dividend pursuant to section
1248(a) for chapter 1 purposes, the earnings and
profits of FC attributable to A's shares in FC which
were accumulated after December 31,1962 and dur-
ing the period which A held the stock while FC was
a controlled foreign corporation is $55,000, $35,000
of which is excluded pursuant to section 1248(d)(1).
Therefore, after the application of section 1248, for
chapter 1 purposes, upon the sale of the FC stock, A
recognizes $35,000 of long-term capital gain and a
$20,000 dividend.

(ii) Results for section 1411 purposes. (A) In
2016, A does not include the $15,000 section
951(a)(1)(A) income inclusion in A's net investment
income under section 1411(c)(1)(A)(i) and
§1411(c)(1)(A)(i). Pursuant to paragraph (e)(1)(ii) of
this section, A decreases A's modified adjusted gross
income for section 1411 purposes by $15,000, and,
pursuant to paragraph (d)(1)(i) of this section, A's
adjusted basis remains at $480,000.

(B) During 2017, prior to the application of sec-
tion 1248, A recognizes $70,000 ($550,000 minus
$480,000) of gain for section 1411 purposes. Pursu-
ant to paragraph (c)(3) of this section, for section
1411 purposes, section 1248(a) applies to the gain on
the sale of FC calculated for section 1411 purposes
($70,000) and section 1248(d)(1) does not apply,
except with respect to the $20,000 of earnings and
profits of FC that are attributable to amounts previ-
ously included in income for chapter 1 purposes
under section 951 for a taxable year beginning be-
fore December 31, 2012. Accordingly, for purposes
of calculating the amount of income includible as a
dividend under section 1248(a), A has $55,000 of
earnings and profits, $20,000 of which is excluded
pursuant to section 1248(d)(1). Therefore, after the
application of section 1248, for section 1411 pur-
poses A has $35,000 of long-term capital gain and a
$35,000 dividend. For purposes of calculating net
investment income in 2017, A includes $35,000 as a
dividend under section 1411(c)(1)(A)(i) and
§1.1411-4(a)(1)(i) and $35,000 as a gain under sec-
tion 1411(c)(1)(A)(iii) and §1.1411-4(a)(1)(iii).

Example 3. (i) Facts. Same facts as Example 2,
except that A timely makes an election under para-
graph (g)(4)(i) of this section for 2014 (and thus for
all subsequent years).

(ii) Results for section 1411 purposes. A does not
have any adjustments to A's modified adjusted gross
income for section 1411 purposes for 2014, 2015,
2016 or 2017 because the election under paragraph
(g)(4)(i) of this section was timely made. Pursuant to
paragraph (g)(2) of this section, for purposes of calcu-
lating A's net investment income in 2014, the $10,000
that A included in income for chapter 1 purposes under
section 951(a) is net investment income for purposes of
section 1411(c)(1)(A)(i) and §1.1411-4(a)(1)(i). A has
no amount of net investment income with respect to FC
in 2015. Pursuant to paragraph (g)(2) of this section, for
purposes of calculating A's net investment income in
2016, the $15,000 that A included in income for chap-
ter 1 purposes under section 951(a) is net investment

income for purposes of section 1411(c)(1)(A)(i) and
§1.1411-4(a)(1)(i). For purposes of calculating A's net
investment income in 2017, the amount of gain on the
disposition of the FC shares is the same as the amount
calculated for chapter 1 purposes. Applying section
1248, A includes $35,000 as a gain under section
1411(c)(1)(A)(iii) and §1.1411-4(a)(1)(iii), and
$20,000 as a dividend under section 1411(c)(1)(A)(i)
and §1.1411-4(a)(1)(i).

Example 4. Domestic partnership holding QEF
stock. (i) Facts. (A) C, a United States citizen, owns
a 50% interest in PRS, a domestic partnership. D, a
United States citizen, and E, a United States citizen,
each own a 25% interest in PRS. All allocations of
partnership income and losses are pro rata based on
ownership interests. PRS owns an interest in QEF, a
foreign corporation that is a passive foreign invest-
ment company (within the meaning of section
1297(a)). PRS, a United States person, made an
election under section 1295 with respect to QEF
applicable to the first year of its holding period in
QEF. As of December 31, 2012, for chapter 1 pur-
poses, C's basis in his partnership interest is
$100,000, D's basis in his partnership interest is
$50,000, E's basis in his partnership interest is
$50,000, and PRS's adjusted basis in its QEF stock
is $80,000, which includes an increase in basis under
section 1293(d) of $40,000. As of December 31,
2012, the amount of QEF's earnings that have been
included in income by PRS under section 1293(a),
but have not been distributed by QEF, is $40,000.
PRS also has cash of $60,000 and domestic C cor-
poration stock with an adjusted basis of $60,000.
During 2013, PRS does not include any amounts in
income under section 1293(a) with respect to QEF,
PRS does not receive any distributions from QEF,
and there are no adjustments to the basis of C, D, or
E in their interests in PRS.

(B) During 2014, PRS has income of $40,000
under section 1293(a) with respect to QEF and has
no other partnership income. PRS does not make an
election under paragraph (g) of this section.

(C) During 2015, QEF distributes $60,000 to
PRS. PRS has no income for the year.

(ii) Results for 2014. (A) For chapter 1 purposes,
as a result of the $40,000 income inclusion under
section 1293(a), PRS's basis in its QEF stock is
increased by $40,000 under section 1293(d)(1) to
$120,000. Under §1.1293-1(c)(1) and section 702,
C's, D's, and E's distributive shares of the section
1293(a) income inclusion are $20,000, $10,000, and
$10,000, respectively. Under section 705(a)(1)(A), C
increases his adjusted basis in his partnership interest
by $20,000 to $120,000, and D and E each increase
his adjusted basis in his partnership interest by
$10,000 to $60,000.

(B) For section 1411 purposes, pursuant to para-
graph (d)(1)(ii) of this section, PRS's basis in QEF is
not increased by the $40,000 income inclusion (it
remains at $80,000). Because PRS did not make an
election under paragraph (g) of this section, C, D and
E do not have net investment income with respect to
the income inclusion, and pursuant to paragraph
(d)(2) of this section, they do not increase their
adjusted bases in their interests in PRS (each remains
at $50,000). Pursuant to paragraph (e)(1)(ii) of this
section, C reduces his modified adjusted gross in-

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come by $20,000, and D and E each reduce their
modified adjusted gross income by $10,000.

(iii) Results for 2015. (A) For chapter 1 purposes,
the distribution of $60,000 from QEF to PRS is not
a dividend under section 1293(c), and PRS decreases
its basis in QEF by $60,000 under section 1293(d)(2)
to $60,000.

(B) Pursuant to paragraph (c)(1)(i) of this section,
$40,000 of the distribution is a dividend for section
1411 purposes because PRS included $40,000 in gross
income for chapter 1 purposes under section 1293(a) in
a tax year that began after December 31, 2012. For
section 1411 purposes, pursuant to paragraph (d)(1)(ii)
of this section, section 1293(d) will not apply to reduce
PRS's basis in QEF to the extent of the $40,000 of the
distribution that is treated as a dividend under para-
graph (c)(2)(i) of this section. Thus, PRS's basis in
QEF is decreased only by $20,000 for purposes of
section 1411 and is $60,000. The $40,000 distribution
of previously taxed earnings and profits that is treated
as a dividend for section 1411 purposes is allocated
$20,000 to C, $10,000 to D, and $10,000 to E. Because
PRS did not make an election under paragraph (g) of
this section, pursuant to paragraph (c)(2)(i) of this sec-
tion, C has $20,000 of net investment income, and D
and E each has $10,000 of net investment income as a
result of the distribution by QEF, and pursuant to
paragraph (d)(2) of this section, C increases his ad-
justed basis in PRS by $20,000 to $120,000, and D and
E each increases his adjusted basis in PRS by $10,000
to $60,000. Pursuant to paragraph (e)(1)(i) of this sec-
tion, C increases his modified adjusted gross income by
$20,000, and D and E each increases his modified
adjusted gross income by $10,000.

Example 5. Sale of partnership interest. (i) Facts.
Same facts as Example 4. In addition, in 2016, D
sells his entire interest in PRS to F for $100,000.

(ii) Results for 2016. For chapter 1 purposes, D
has a gain of $40,000 ($100,000 minus $60,000). For
section 1411 purposes, D has a gain of $40,000
($100,000 minus $60,000), and thus, has net invest-
ment income of $40,000. No adjustments to modi-
fied adjusted gross income are necessary under para-
graph (e) of this section.

Example 6. Domestic partnership's sale of QEF
stock. (i) Facts. Same facts as Example 4. In addi-
tion, in 2016 PRS has income of $60,000 under
section 1293(a) with respect to QEF, and in 2017,
PRS sells its entire interest in QEF for $170,000.

(ii) Results for 2016. (A) For chapter 1 purposes,
as a result of the $60,000 income inclusion under
section 1293(a), PRS's basis in its QEF stock is
increased by $60,000 under section 1293(d)(1) to
$120,000. Under §1.1293-1(c)(1) and section 702,
C's, D's, and E's distributive shares of the section
1293(a) income inclusion are $30,000, $15,000, and
$15,000 respectively. Under section 705(a)(1)(A), C
increases his adjusted basis in his partnership interest
by $30,000 to $150,000, and D and E each increases
his adjusted basis in his partnership interest by
$15,000 to $75,000.

(B) For section 1411 purposes, pursuant to para-
graph (d)(1)(ii) of this section, PRS's basis in QEF is
not increased by the $60,000 income inclusion (it
remains at $60,000). Because PRS did not make an
election under paragraph (g) of this section, C, D and
E do not have net investment income with respect to
the income inclusion, and pursuant to paragraph

(d)(2) of this section, they do not increase their
adjusted bases in their interests in PRS (C remains at
$120,000, and D and E each remain at $60,000).
Pursuant to paragraph (e)(1)(ii) of this section, C
reduces his modified adjusted gross income by
$30,000, and D and E each reduce their modified
adjusted gross income by $15,000.

(iii) Results for 2017. (A) For chapter 1 purposes,
PRS has a gain of $50,000 ($170,000 minus
$120,000), which is allocated 50% ($25,000) to C,
25% ($12,500) to D, and 25% ($12,500) to E.

(B) Based on PRS's basis in the stock of QEF for
section 1411 purposes, PRS has a gain for section
1411 purposes of $110,000 ($170,000 minus
$60,000), which in the absence of an election by
PRS under paragraph (g) of this section, results in
gain of $55,000 to C, $27,500 to D, and $27,500 to
E. Therefore, C has net investment income of
$55,000, and D and E each have net investment
income of $27,500. Pursuant to paragraph (e)(1)(ii)
of this section, C increases his modified adjusted
gross income by $30,000, and D and E each increase
their modified adjusted gross income by $15,000.

(i) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012,
in accordance with §1.1411-1(f).

# 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 the following entry to the
table in numerical order to read as follows:

§ 602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section

where identified and described

Current OMB control No.

* * * * * * *

1.1411-10(g)

1545-2227

* * * * * * *

John Dalrymple,
Deputy Commissioner for
Services and Enforcement.

Approved November 14, 2013

Mark J. Mazur,
Assistant Secretary of the Treasury
(Tax Policy).

(Filed by the Office of the Federal Register on November
26, 2013, 4:15 p.m., and published in the issue of the Federal
Register for December 2, 2013, 78 F.R. 72394)

# Section 3101 .- Rate of Tax

## T.D. 9645

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1 and 31

## Rules Relating to Additional Medicare Tax

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains fi-
nal regulations relating to Additional Hos-
pital Insurance Tax on income above
threshold amounts ("Additional Medicare
Tax"), as added by the Affordable Care
Act. Specifically, these final regulations
provide guidance for employers and indi-
viduals relating to the implementation of
Additional Medicare Tax, including the
requirement to withhold Additional Medi-
care Tax on certain wages and compensa-
tion, the requirement to file a return re-
porting Additional Medicare Tax, the
employer process for adjusting underpay-
ments and overpayments of Additional
Medicare Tax, and the employer and in-
dividual processes for filing a claim for
refund for an overpayment of Additional
Medicare Tax.

DATES: Effective date: These regulations
are effective on November 29, 2013.

Applicability date: For dates of applicabil-
ity, see §§1.1401-1(e), 31.3101-2(d),
31.3102-1(f), 31.3102-4(d), 31.3202-1(h),
31.6011(a)-1(h), 31.6011(a)-2(e), 31.6205-
1(e), 31.6402(a)-2(c), 31.6413(a)-1(c), and
31.6413(a)-2(e).

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FOR FUTHER INFORMATION
CONTACT:

Andrew K. Holubeck at (202) 317-
4774 (not a toll-free number).

### SUPPLEMENTARY INFORMATION

#### Paperwork Reduction Act

The collection of information contained
in these final regulations has been reviewed
and approved by the Office of Management
and Budget in accordance with the Paper-
work Reduction Act (PRA) of 1995 (44
U.S.C. 3507(d)) under control number
1545-2097. The collection of information in
these regulations is in §§31.6011(a)-
1, 31.6011(a)-2, 31.6205-1, 31.6402(a)-2,
31.6413(a)-1, and 31.6413(a)-2. This infor-
mation is required by the IRS to verify com-
pliance with return requirements under sec-
tion 6011, employment tax adjustments
under sections 6205 and 6413, and claims
for refund of overpayments under section
6402. This information will be used to de-
termine whether the amount of tax has been
reported and calculated correctly. The likely
respondents are employers and individuals.

An agency may not conduct or spon-
sor, and a person is not required to re-
spond to, a collection of information un-
less it displays a valid control number
assigned by the Office of Management
and Budget.

Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.

#### Background

These final regulations are issued in
connection with the Additional Hospital
Insurance Tax on income above threshold
amounts ("Additional Medicare Tax"), as
added by section 9015 of the Patient Pro-
tection and Affordable Care Act
(PPACA), Public Law 111-148 (124 Stat.
119 (2010)), and as amended by section
10906 of the PPACA and section 1402(b)
of the Health Care and Education Recon-
ciliation Act of 2010, Public Law 111-
152 (124 Stat. 1029 (2010)) (collectively,
the "Affordable Care Act"). The final reg-
ulations include amendments to §1.1401-

1 of the Income Tax Regulations, and
§§31.3101-2, 31.3102-1, 31.3102-4,
31.3202-1, 31.6011(a)-1, 31.6011(a)-2,
31.6205-1, 31.6402(a)-2, 31.6413(a)-1,
and 31.6413(a)-2 of the Employment Tax
Regulations. The final regulations provide
guidance for employers and individuals
relating to the implementation of Addi-
tional Medicare Tax, including the re-
quirement to withhold Additional Medi-
care Tax on certain wages and
compensation, the requirement to file a
return reporting Additional Medicare Tax,
the employer process for adjusting under-
payments and overpayments of Additional
Medicare Tax, and the employer and in-
dividual processes for filing a claim for
refund of Additional Medicare Tax.

A notice of proposed rulemaking
(REG-130074-11) was published in the
Federal Register (77 FR 72268) on De-
cember 5, 2012. A public hearing was
scheduled for April 4, 2013. The IRS did
not receive any requests to testify at the
public hearing, and therefore the public
hearing was cancelled. Comments re-
sponding to the proposed regulations were
received. All comments were considered
and are available for public inspection and
copying at http://www.regulations.gov or
upon request. After consideration of all
the comments, the proposed regulations
are adopted as amended by this Treasury
decision. The public comments and revi-
sions are discussed in this preamble.

## Summary of Comments and Explanation of Revisions

The IRS received five comments in
response to the proposed regulations. One
commenter expressed concern that the
2013 Old Age, Survivors and Disability
Insurance (OASDI) tax rate for employees
of 6.2 percent was applied to wages for
services performed in the last two weeks
of 2012, when the OASDI tax rate for
employees was 4.2 percent. This comment
is outside the scope of these regulations.

Another commenter requested that the
comment period for the proposed regula-
tions be extended by 60 days. The Admin-
istrative Procedure Act does not set a time
frame for a comment period on regula-
tions. However, Executive Order (E.O.)
12866 provides that generally a comment
period should be no less than 60 days. The
public was given 90 days to comment on

the proposed regulations, which exceeds
the period required by E.O. 12866. The
IRS received only five comments during
the 90-day comment period, no comments
were received after the 90-day comment
period expired, and there is no indication
that more comments would have been re-
ceived if the comment period had been
extended. Therefore, an extension of the
comment period beyond the 90 days pro-
vided in the proposed regulations was not
warranted.

One commenter noted that because
Additional Medicare Tax will involve
new recordkeeping and withholding pro-
cedures for employers and certain em-
ployees, there may be inadvertent errors
involved with implementing the tax, espe-
cially in the first year of implementation.
Therefore, the commenter requested that
the IRS grant employers flexibility in cor-
recting overpayments and underpayments
of Additional Medicare Tax by allowing
additional time to correct errors, allowing
corrections for a certain period without
penalty, and granting an exemption from
penalties for de minimis errors.

No such changes were made in these
final regulations. The regulations under
§§31.6205-1(a) and 31.6413(a)-2 already
allow employers flexibility in making
interest-free adjustments of underpay-
ments and overpayments and, to the extent
an employer discovers an error in with-
holding, paying, or reporting Additional
Medicare Tax, the regulations provide
procedures for correcting that error on an
adjusted employer return generally with-
out imposition of interest. Further, under
sections 6651 and 6656, penalties for fail-
ure to pay or deposit Additional Medicare
Tax do not apply to the extent the failure
is due to reasonable cause and not willful
neglect.

To correct an overpayment of income
tax or Additional Medicare Tax, an em-
ployer may make an adjustment only if it
repays or reimburses the employee prior
to the end of the calendar year in which
the wages or compensation was paid. Sim-
ilarly, to correct an underpayment of in-
come tax or Additional Medicare Tax, an
employer may make an interest-free ad-
justment only if the error is ascertained
within the calendar year in which the
wages or compensation was paid. Because
employees will report Additional Medi-

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care Tax on Form 1040, U.S. Individual
Tax Return, allowing employers time be-
yond the end of the calendar year in which
the error was made to correct overpay-
ments and underpayments would create
complexity and confusion for individuals
filing individual income tax returns and
would adversely affect tax administration.
Accordingly, these final regulations do not
include additional procedures specifically
for correcting Additional Medicare Tax
errors, but rather generally rely on exist-
ing procedures for correcting income tax
withholding errors.

One commenter questioned how em-
ployers should treat repayment by an em-
ployee of wage payments received by the
employee in a prior year for Additional
Medicare Tax purposes (for example, sign
on bonuses paid to employees that are
subject to repayment if certain conditions
are not satisfied). Employers cannot make
an adjustment or file a claim for refund for
Additional Medicare Tax withholding
when there is a repayment of wages re-
ceived by an employee in a prior year
because the employee determines liability
for Additional Medicare Tax on the em-
ployee's income tax return for the prior
year; however, the employee may be able
to file an amended return claiming a re-
fund of the Additional Medicare Tax.

More specifically, under current em-
ployment tax adjustment procedures, if
the repayment occurs within the period of
limitations for refund, the employer can
repay or reimburse the social security and
Medicare taxes withheld from the wage
payment to the employee and file a refund
claim, or make an interest-free adjust-
ment, for the social security and Medicare
tax overwithholding. However, under
§31.6413(a)-1(a)(2)(ii) of these regula-
tions, an employer may adjust overpaid
Additional Medicare Tax withheld from
employees only in the calendar year in
which the wages or compensation are
paid, and only if the employer repays or
reimburses the employee the amount of
the overcollection prior to the end of the
calendar year. Further, under

§31.6402(a)-2(a)(1)(iii) of these regula-
tions, employers may claim a refund of
overpaid Additional Medicare Tax only if
the employer did not deduct or withhold
the overpaid Additional Medicare Tax
from the employee's wages or compensa-
tion. Accordingly, these regulations at
§31.6402(a)-2(b)(3)(ii) provide that, in
the case of an overpayment of Additional
Medicare Tax for a year for which an
individual has filed Form 1040, a claim
for refund should be made by the individ-
ual on Form 1040X, Amended U.S. Indi-
vidual Income Tax Return. Since a wage
repayment reduces the wages subject to
Additional Medicare Tax for the period
during which the wages were originally
paid, the employee is entitled to file an
amended return (on Form 1040X) to re-
cover Additional Medicare Tax with re-
spect to the repaid wages.1

Finally, one commenter expressed con-
cern about the impact of the regulations
on the small business and individual com-
munity. The commenter disagreed with
the conclusion in the proposed regulations
that no regulatory assessment was re-
quired under E.O. 12866 because the rule-
making is not a significant regulatory ac-
tion. The commenter also disagreed with
the conclusion in the proposed regulations
that a regulatory flexibility analysis was
not required under the Regulatory Flexi-
bility Act (5 U.S.C. 601) (RFA) because
the collection of information contained in
the proposed regulations will not have a
significant economic impact on a substan-
tial number of small entities.

Section 3(a)(4)(B) of E.O. 12866 re-
quires agencies to prepare a regulatory
assessment for "significant regulatory ac-
tions" as defined in section 3(f) of E.O.
12866. As part of its definition of signif-
icant regulatory actions, section 3(f) in-
cludes economically significant regula-
tions, that is, regulatory actions that are
likely to have an annual effect on the
economy of $100 million or more. The
commenter contends that the skills equiv-
alent to a junior associate accountant
would be needed to comply with the reg-

ulations. The commentator contends that,
assuming a junior associate reasonably
bills for services at the rate of $100 per
hour, and using the estimated annual re-
porting or recordkeeping burden for these
regulations of 1,900,000 hours, the esti-
mated annual effect on the economy is
$190 million.

The Treasury Department and the IRS
do not agree with the commenter's asser-
tion that all individuals and entities sub-
ject to these regulations will require the
services of an accountant. Many employ-
ers utilize payroll service providers that
are equipped to comply with these regu-
lations and that will include Additional
Medicare Tax as part of the payroll ser-
vices they provide. Other employers and
individuals will be able to comply with
these regulations without assistance by
following the instructions that accompany
tax forms and by utilizing other informa-
tion provided by the IRS. Therefore, nei-
ther the proposed regulations, nor these
final regulations, are significant regulatory
actions within the meaning of E.O. 12866,
and a regulatory assessment is not re-
quired.

The RFA requires agencies to prepare a
regulatory flexibility analysis addressing
the impact of proposed or final regulations
on small entities. The proposed regula-
tions certified that a regulatory flexibility
analysis is not required because the col-
lection of information contained in the
regulations will not have a significant eco-
nomic impact on a substantial number of
small entities. The commenter challenged
this certification.

A "collection of information" is de-
fined in the RFA as a requirement that a
small entity report information to the Fed-
eral Government, or maintain specified re-
cords, regardless of whether the informa-
tion in those records is reported to the
Federal Government. The regulations
contain a collection of information re-
quirement.

The RFA does not define "substantial
number." In general, for purposes of the
RFA, regulations with a broad effect on

1In this situation, Additional Medicare Tax is treated differently than federal income tax. For federal income tax purposes, wages paid in a year are considered income to the employee in
that year, even when the wages are repaid by the employee to the employer in a subsequent year. If an employee repays wages to an employer in a year following the year in which the
wages were originally paid, the employee cannot reduce the federal income tax for the prior year (i.e., the employee cannot file an amended income tax return for the prior year using Form
1040X). Instead, depending on the circumstances, the employee may be entitled to a deduction for the repaid wages (or in some cases, if the requirements of section 1341 are satisfied, a
reduction of tax) on his or her income tax return for the year of repayment. By contrast, the Additional Medicare Tax is part of FICA and, similar to social security tax and Medicare tax,
the repayment of wages reduces the employee's liability for Additional Medicare Tax for the prior year.

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business are presumed to have an impact
on a substantial number of small entities.
Since these regulations have a broad ef-
fect on business, these regulations will
have an impact on a substantial number of
small entities.

The RFA also does not define "signif-
icant economic impact." As stated in con-
nection with the discussion of E.O. 12866,
the commenter assumed a billing rate of
$100 per hour, and multiplied that rate by
the estimated aggregate annual PRA re-
porting or recordkeeping burden for these
regulations of 1,900,000 hours, to esti-
mate the annual effect on the economy to
be $190 million. Based on this calcula-
tion, the commenter concluded that the
collection of information had a significant
economic impact on a substantial number
of small entities.

The commenter's approach is not an ap-
propriate measure of the economic impact
of these regulations on small entities. The
1,900,000 hours estimated to be the aggre-
gate annual PRA burden for these regula-
tions represents an estimated 1,900,000 re-
spondents with an estimated average annual
burden per respondent of 1 hour. The num-
ber of respondents comprises all respon-
dents affected by these regulations, includ-
ing individuals as well as entities. It is not an
estimated number of affected entities only.
The IRS estimates that approximately
325,000 entities report Medicare wages to
one or more individuals in excess of the
$200,000 Additional Medicare Tax with-
holding threshold. Thus, approximately
325,000 entities, encompassing both large
and small entities, are affected by these reg-
ulations. Therefore, the reporting or record-
keeping burden of these regulations on
small entities is estimated to be significantly
less than 1,900,000 hours. The commenter's
use of this number to assess the annual eco-
nomic impact of these regulations on small
entities is incorrect.

In addition, to the extent that there is a
significant economic impact, the eco-
nomic impact principally results directly
from the underlying statutes. For example,
the statute imposing Additional Medicare
Tax requires the employer to withhold the
tax from wages paid to the employee.
Other provisions of the Internal Revenue
Code (Code) require the employer to re-
port and pay the correct amount of with-
held tax to the government. Similarly, the

collection of information required with re-
gard to interest-free adjustments and
claims for refund apply existing statutory
rules to Additional Medicare Tax. The
regulations implement the underlying stat-
utes and provide guidance for employers
and individuals relating to the requirement
to file a return reporting Additional Medi-
care Tax, the employer process for mak-
ing adjustments of underpayments and
overpayments of Additional Medicare
Tax, and the employer and individual pro-
cesses for filing a claim for refund for an
overpayment of Additional Medicare Tax.
As a result, the estimated annual PRA
burden per taxpayer for these regulations
is very low. Consequently, the economic
impact of these regulations is not expected
to be significant, and neither the proposed
regulations nor these final regulations will
have a significant economic impact on a
substantial number of small entities within
the meaning of the RFA. Therefore a reg-
ulatory flexibility analysis is not required.

The proposed regulations provided that
if the employer deducts less than the cor-
rect amount of Additional Medicare Tax,
it is nevertheless liable for the correct
amount of tax that it was required to with-
hold, unless and until the employee pays
the tax. Consistent with section 3102(f)(3)
of the Code, the proposed regulations also
provided that if an employee subsequently
pays the tax that the employer failed to
deduct, the tax will not be collected from
the employer. These final regulations fur-
ther provide that an employer is not re-
lieved of its liability for payment of any
Additional Medicare Tax required to be
withheld unless it can show that the tax
has been paid by the employee. Section
3102(f)(3) contains language similar to
section 3402(d) of the Code, and this pro-
vision of the final regulations is consistent
with the approach used in the regulations
under section 3402(d). Employers will use
Form 4669, Statement of Payments Re-
ceived, and Form 4670, Request for Relief
from Payment of Income Tax Withholding,
the same forms used for requesting federal
income tax withholding relief, to request
relief from paying Additional Medicare
Tax that has already been paid by the
employee.

The final regulations also amend the
proposed regulations to comply with for-

matting requirements of the Office of the
Federal Register.

## Special Analyses

It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in E.O. 12866, and
supplemented by E.O. 13653. The regula-
tions implement the underlying statutes
and the economic impact is principally a
result of the underlying statutes, rather
than the regulations. Therefore, a regula-
tory assessment is not required. It has also
been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions.

Sections 603 and 604 of the RFA (5
U.S.C. chapter 6) generally require agen-
cies to prepare a regulatory flexibility
analysis addressing the impact of pro-
posed and final regulations, respectively,
on small entities. Section 605(b) of the
RFA, however, provides that sections 603
and 604 shall not apply if the head of the
agency certifies that the rule will not have
a significant economic impact on a sub-
stantial number of small entities. For the
reasons discussed in the Summary of
Comments section of the preamble, as
well as the reasons set forth in the suc-
ceeding paragraphs, it is hereby certified
that the collection of information require-
ments contained in these regulations will
not have a significant economic impact on
a substantial number of small entities.

The regulations under sections 6205,
6402, and 6413 affect all taxpayers that
file employment tax returns or claims for
refund of employment taxes. Many small
entities fall into this category. Therefore,
it has been determined that these regula-
tions will affect a substantial number of
small entities. It also has been determined,
however, that the economic impact on en-
tities affected by these regulations will not
be significant.

As stated above, the regulations imple-
ment the underlying statutes and the eco-
nomic impact is principally a result of the
underlying statutes, rather than the regu-
lations. The regulations require taxpayers
that file employment tax returns and that
make interest-free adjustments to the re-
turns for underpayments or overpayments
of Additional Medicare Tax, or that file
claims for refund of an overpayment of

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Additional Medicare Tax, to provide an
explanation setting forth the basis for the
correction or the claim in detail, designat-
ing the return period in which the error
was ascertained and the return period be-
ing corrected, and setting forth such other
information as may be required by the in-
structions to the form. In addition, for ad-
justments of overpayments of Additional
Medicare Tax, employers must obtain and
retain the written receipt of the employee
showing the date and amount of the repay-
ment to the employee or retain evidence of
reimbursement. The requirement to collect
this information is not newly imposed by
these regulations. The regulations merely
apply procedures from existing regulations,
with appropriate modifications, to correc-
tions of Additional Medicare Tax.

It is estimated that the annual PRA bur-
den per taxpayer to comply with the collec-
tion of information requirements in these
regulations is one hour. This minimal bur-
den does not constitute a significant eco-
nomic impact. Accordingly, a regulatory
flexibility analysis is not required.

Pursuant to section 7805(f) of the
Code, the proposed regulations preceding
these regulations were submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.

## Drafting Information

The principal author of the regulations
is Andrew Holubeck of the Office of the
Division Counsel/Associate Chief Coun-
sel (Tax Exempt and Government Enti-
ties). However, other personnel from the
IRS and the Treasury Department partic-
ipated in their development.

* * * * *

## Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 31
are amended as follows:

## PART 1-INCOME TAXES

Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.1401-1 is amended by
revising paragraph (b) and adding para-
graphs (d) and (e) to read as follows:

§1.1401-1 Tax on self-employment
income.

* * * * *

(b) The rates of tax on self-
employment income are as follows (these
regulations do not reflect off-Code revi-
sions to the following rates):

(1) For Old-age, Survivors, and Dis-
ability Insurance:

Taxable year

Percent

Beginning after December 31, 1983 and before January 1, 1988

11.40

Beginning after December 31, 1987 and before January 1, 1990

12.12

Beginning after December 31, 1989

12.40

(2) (i) For Hospital Insurance:

Taxable year

Percent

Beginning after December 31, 1983 and before January 1, 1985

2.60

Beginning after December 31, 1984 and before January 1, 1986

2.70

Beginning after December 31, 1985

2.90

(ii) For Additional Medicare Tax:

Taxable year

Percent

Beginning after December 31, 2012

0.9

* * * * *

(d) Special rules regarding Additional
Medicare Tax. (1) General rule. An indi-
vidual is liable for Additional Medicare
Tax to the extent that his or her self-
employment income exceeds the follow-
ing threshold amounts.

Filling Status

Threshold

Married individual

$250,000

filing a joint return

Married individual

$125,000

filing a separate return

Any other case

$200,000

Note: These threshold amounts are
specified under section 1401(b)(2)(A).

(2) Coordination with Federal Insur-
ance Contributions Act. (i) General rule.
Under section 1401(b)(2)(B), the applica-
ble threshold specified under section
1401(b)(2)(A) is reduced (but not below
zero) by the amount of wages (as defined
in section 3121(a)) taken into account in
determining Additional Medicare Tax un-
der section 3101(b)(2) with respect to the
taxpayer. This rule does not apply to Rail-
road Retirement Tax Act (RRTA) com-
pensation (as defined in section 3231(e)).
(ii) Examples. The rules provided in
paragraph (d)(2)(i) of this section are il-
lustrated by the following examples:

Example 1. A, a single filer, has $130,000 in
self-employment income and $0 in wages. A is not
liable to pay Additional Medicare Tax.

Example 2. B, a single filer, has $220,000 in
self-employment income and $0 in wages. B is liable
to pay Additional Medicare Tax on $20,000
($220,000 in self-employment income minus the
threshold of $200,000).

Example 3. C, a single filer, has $145,000 in
self-employment income and $130,000 in wages.
C's wages are not in excess of $200,000 so C's
employer did not withhold Additional Medicare Tax.
However, the $130,000 of wages reduces the self-
employment income threshold to $70,000 ($200,000
threshold minus the $130,000 of wages). C is liable
to pay Additional Medicare Tax on $75,000 of self-
employment income ($145,000 in self-employment
income minus the reduced threshold of $70,000).

Example 4. E, who is married and files a joint
return, has $140,000 in self-employment income. F,
E's spouse, has $130,000 in wages. F's wages are
not in excess of $200,000 so F's employer did not
withhold Additional Medicare Tax. However, the
$130,000 of F's wages reduces E's self-employment
income threshold to $120,000 ($250,000 threshold
minus the $130,000 of wages). E and F are liable to
pay Additional Medicare Tax on $20,000 of E's
self-employment income ($140,000 in self-
employment income minus the reduced threshold of
$120,000).

Example 5. D, who is married and files married
filing separately, has $150,000 in self-employment
income and $200,000 in wages. D's wages are not in
excess of $200,000 so D's employer did not with-
hold Additional Medicare Tax. However, the
$200,000 of wages reduces the self-employment in-
come threshold to $0 ($125,000 threshold minus the
$200,000 of wages). D is liable to pay Additional
Medicare Tax on $75,000 of wages ($200,000 in

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wages minus the $125,000 threshold for a married
filing separately return) and on $150,000 of self-
employment income ($150,000 in self-employment
income minus the reduced threshold of $0).

(e) Effective/applicability date. Para-
graphs (b) and (d) of this section apply to
quarters beginning on or after November 29,
2013.

## PART 31-EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT THE SOURCE

Par. 3. The authority citation for part
31 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 4. Revise §31.3101-2 to read as
follows:

§31.3101-2 Rates and computation of
employee tax.

(a) Old-Age, Survivors, and Disability
Insurance. The rates of employee tax for
Old-Age, Survivors, and Disability Insur-
ance (OASDI) with respect to wages re-
ceived in calendar years after 1983 are as
follows (these regulations do not reflect
off-Code revisions to the following rates):

Calendar year

Percent

1984, 1985, 1986, or 1987

5.7

1988 or 1989

6.06

1990 and subsequent years

6.2

(b)(1) Hospital Insurance. The rates of
employee tax for Hospital Insurance (HI)
with respect to wages received in calendar
years after 1973 are as follows:

Calendar year

Percent

1974, 1975, 1976, or 1977

0.90

1978

1.00

1979 or 1980

1.05

1981, 1982, 1983, or 1984

1.30

1985

1.35

1986 and subsequent years

1.45

(2) Additional Medicare Tax. (i) The rate
of Additional Medicare Tax with respect to
wages received in taxable years beginning
after December 31, 2012, is as follows:

Taxable year
Beginning after
December 31, 2012

Percent
0.9

(ii) Individuals are liable for Additional
Medicare Tax with respect to wages re-
ceived in taxable years beginning after De-
cember 31, 2012, which are in excess of:

Filling Status

Threshold

Married individual

$250,000

filing a joint return

Married individual

$125,000

filing a separate return

Any other case

$200,000

(c) Computation of employee tax. The
employee tax is computed by applying to
the wages received by the employee the
rates in effect at the time such wages are
received.

Example. In 1989, A performed services for X
which constituted employment (see §31.3121(b)-
2). In 1990 A receives from X $1,000 as remunera-
tion for such services. The tax is payable at the 6.2
percent OASDI rate and the 1.45 percent HI rate in
effect for the calendar year 1990 (the year in which
the wages are received) and not at the 6.06 percent
OASDI rate and the 1.45 percent HI rate which were
in effect for the calendar year 1989 (the year in
which the services were performed).

(d) Effective/applicability date. Para-
graphs (a), (b), and (c) of this section
apply to quarters beginning on or after
November 29, 2013.

Par. 5. Section 31.3102-1 is amended
by adding a sentence at the end of para-
graph (a) and adding paragraph (f) to read
as follows:

§31.3102-1 Collection of, and liability
for, employee tax; in general.

(a) * * * For special rules relating to
Additional Medicare Tax imposed under
section 3101(b)(2), see §31.3102-4.
* * * * *

(f) Effective/applicability date. Para-
graph (a) of this section applies to quarters
beginning on or after November 29, 2013.

Par. 6. Section 31.3102-4 is added to
read as follows:

§31.3102-4 Special rules regarding
Additional Medicare Tax.

(a) Collection of tax from employee.
An employer is required to collect from
each of its employees the tax imposed by
section 3101(b)(2) (Additional Medicare
Tax) with respect to wages for employ-
ment performed for the employer by the
employee only to the extent the employer
pays wages to the employee in excess of
$200,000 in a calendar year. This rule
applies regardless of the employee's filing
status or other income. Thus, the em-
ployer disregards any amount of wages or
Railroad Retirement Tax Act (RRTA)
compensation paid to the employee's
spouse. The employer also disregards any
RRTA compensation paid by the em-
ployer to the employee or any wages or
RRTA compensation paid to the em-
ployee by another employer.

Example. H, who is married and files a joint
return, receives $100,000 in wages from his em-
ployer for the calendar year. I, H's spouse, receives
$300,000 in wages from her employer for the same
calendar year. H's wages are not in excess of
$200,000, so H's employer does not withhold Addi-
tional Medicare Tax. I's employer is required to
collect Additional Medicare Tax only with respect to
wages it pays which are in excess of the $200,000
threshold (that is, $100,000) for the calendar year.

(b) Collection of amounts not withheld.
To the extent the employer does not col-
lect Additional Medicare Tax imposed on
the employee by section 3101(b)(2), the
employee is liable to pay the tax.

Example. J, who is married and files a joint
return, receives $190,000 in wages from his em-
ployer for the calendar year. K, J's spouse, receives
$150,000 in wages from her employer for the same
calendar year. Neither J's nor K's wages are in
excess of $200,000, so neither J's nor K's employers
are required to withhold Additional Medicare Tax. J
and K are liable to pay Additional Medicare Tax on
$90,000 ($340,000 minus the $250,000 threshold for
a joint return).

(c) Employer's liability for tax. If the
employer deducts less than the correct
amount of Additional Medicare Tax, or if
it fails to deduct any part of Additional
Medicare Tax, it is nevertheless liable for
the correct amount of tax that it was re-
quired to withhold, unless and until the
employee pays the tax. If an employee
subsequently pays the tax that the em-
ployer failed to deduct, the tax will not be
collected from the employer. The em-
ployer will not be relieved of its liability
for payment of the tax required to be
withheld unless it can show that the tax

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under section 3101(b)(2) has been paid.
The employer, however, will remain sub-
ject to any applicable penalties or addi-
tions to tax resulting from the failure to
withhold as required.

(d) Effective/applicability date. This
section applies to quarters beginning on or
after November 29, 2013.

Par. 7. Section 31.3202-1 is amended
by adding paragraphs (g) and (h) to read
as follows:

§31.3202-1 Collection of, and liability
for, employee tax.

* * * * *

(g) Special rules regarding Additional
Medicare Tax. (1) An employer is re-
quired to collect from each of its employ-
ees the portion of the tax imposed by
section 3201(a) (as calculated under sec-
tion 3101(b)(2)) (Additional Medicare
Tax) with respect to compensation for em-
ployment performed for the employer by
the employee only to the extent the em-
ployer pays compensation to the em-
ployee in excess of $200,000 in a calendar
year. This rule applies regardless of the
employee's filing status or other income.
Thus, the employer disregards any amount
of compensation or Federal Insurance
Contributions Act (FICA) wages paid to
the employee's spouse. The employer also
disregards any FICA wages paid by the
employer to the employee or any compen-
sation or FICA wages paid to the em-
ployee by another employer.

Example. A, who is married and files a joint
return, receives $100,000 in compensation from her
employer for the calendar year. B, A's spouse, re-
ceives $300,000 in compensation from his employer
for the same calendar year. A's compensation is not
in excess of $200,000, so A's employer does not
withhold Additional Medicare Tax. B's employer is
required to collect Additional Medicare Tax only
with respect to compensation it pays to B that is in
excess of the $200,000 threshold (that is, $100,000)
for the calendar year.

(2) To the extent the employer does not
collect Additional Medicare Tax imposed
on the employee by section 3201(a) (as
calculated under section 3101(b)(2)), the
employee is liable to pay the tax.

Example. C, who is married and files a joint
return, receives $190,000 in compensation from her
employer for the calendar year. D, C's spouse, re-
ceives $150,000 in compensation from his employer
for the same calendar year. Neither C's nor D's
compensation is in excess of $200,000, so neither
C's nor D's employers are required to withhold

Additional Medicare Tax. C and D are liable to pay
Additional Medicare Tax on $90,000 ($340,000 mi-
nus the $250,000 threshold for a joint return).

(3) If the employer deducts less than
the correct amount of Additional Medi-
care Tax, or if it fails to deduct any part of
Additional Medicare Tax, it is neverthe-
less liable for the correct amount of tax
that it was required to withhold, unless
and until the employee pays the tax. If an
employee subsequently pays the tax that
the employer failed to deduct, the tax will
not be collected from the employer. The
employer will not be relieved of its liabil-
ity for payment of the tax required to be
withheld unless it can show that the tax
under section 3201(a) (as calculated under
section 3101(b)(2)) has been paid. The
employer, however, will remain subject to
any applicable penalties or additions to
tax resulting from the failure to withhold
as required.

(h) Effective/applicability date. Para-
graph (g) of this section applies to quar-
ters beginning on or after November 29,
2013.

Par. 8. Section 31.6011(a)-1 is
amended by:

1\. Designating paragraph (g) as para-
graph (h) and adding a sentence to the
end.

2\. Adding new paragraph (g).
The additions read as follows:

§31.6011(a)-1 Returns under Federal
Insurance Contributions Act.

* * * * *

(g) Returns by employees in respect of
Additional Medicare Tax. An employee
who is paid wages, as defined in section
3121(a), subject to the tax under section
3101(b)(2) (Additional Medicare Tax),
must make a return for the taxable year in
respect of such tax. The return shall be
made on Form 1040, U.S. Individual In-
come Tax Return. The form to be used by
residents of the U.S. Virgin Islands,
Guam, American Samoa, or the Northern
Mariana Islands is Form 1040-SS, U.S.
Self-Employment Tax Return (Including
Additional Child Tax Credit for Bona
Fide Residents of Puerto Rico). The form
to be used by residents of Puerto Rico is
either Form 1040-SS or Form 1040-PR,
Planilla para la Declaración de la Con-
tribución Federal sobre el Trabajo por
Cuenta Propia (Incluyendo el Crédito

Tributario Adicional por Hijos para Resi-
dentes Bona Fide de Puerto Rico).

(h) * * * Paragraph (g) of this section
applies to taxable years beginning on or
after November 29, 2013.

Par. 9. Section 31.6011(a)-2 is
amended by adding paragraphs (d) and (e)
to read as follows:

§31.6011(a)-2 Returns under Railroad
Retirement Tax Act.

* * * * *

(d) Returns by employees and em-
ployee representatives in respect of Addi-
tional Medicare Tax. An employee or em-
ployee representative who is paid
compensation, as defined in section
3231(e), subject to the tax under sections
3201(a) (as calculated under section
3101(b)(2)) or section 3211(a) (as calcu-
lated under section 3101(b)(2)) (Addi-
tional Medicare Tax), must make a return
for the taxable year in respect of such tax.
The return shall be made on Form 1040,
U.S. Individual Income Tax Return. The
form to be used by residents of the U.S.
Virgin Islands, Guam, American Samoa,
or the Northern Mariana Islands is Form
1040-SS, U.S. Self-Employment Tax Re-
turn (Including Additional Child Tax
Credit for Bona Fide Residents of Puerto
Rico). The form to be used by residents of
Puerto Rico is either Form 1040-SS or
Form 1040-PR, Planilla para la De-
claración de la Contribución Federal so-
bre el Trabajo por Cuenta Propia (Incluy-
endo el Crédito Tributario Adicional por
Hijos para Residentes Bona Fide de
Puerto Rico).

(e) Effective/applicability date. Para-
graph (d) of this section applies to taxable
years beginning on or after November 29,
2013.

Par. 10. Section 31.6205-1 is amended
by:

1\. Revising the first sentence in para-
graph (b)(2)(i).

2\. Adding a sentence after the first sen-
tence in paragraphs (b)(2)(ii) and (iii).

3\. Adding two sentences after the sixth
sentence in paragraph (b)(3).

4\. Adding paragraphs (b)(4) and (e).

5\. Revising paragraph (d)(1).

The revisions and additions read as fol-
lows:

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§31.6205-1 Adjustments of
underpayments.

* * * * *

(b) * * *

(2) * * * (i) If an employer files a return
on which FICA tax or RRTA tax is required
to be reported, and reports on the return less
than the correct amount of employee or em-
ployer FICA or RRTA tax with respect to a
payment of wages or compensation, and if
the employer ascertains the error after filing
the return, the employer shall correct the
error through an interest-free adjustment as
provided in this section, except as provided
in paragraph (b)(4) of this section for Addi-
tional Medicare Tax. * * *

(ii) * * * However, if the employer also
reported less than the correct amount of
Additional Medicare Tax, the employer
shall correct the underwithheld and under-
paid Additional Medicare Tax in accor-
dance with paragraph (b)(4) of this sec-
tion. * * *

(iii) * * * However, if the employer
also reported less than the correct amount
of Additional Medicare Tax, the employer
shall correct the underwithheld and under-
paid Additional Medicare Tax in accor-
dance with paragraph (b)(4) of this sec-
tion. * * *

(3) * * * However, an adjustment of
Additional Medicare Tax required to be
withheld under section 3101(b)(2) or sec-
tion 3201(a) may only be reported pursu-
ant to this section if the error is ascer-
tained within the same calendar year that
the wages or compensation were paid to
the employee, or if section 3509 applies to
determine the amount of the underpay-
ment, or if the adjustment is reported on a
Form 2504 or Form 2504-WC. See para-
graph (b)(4) of this section. * * *

(4) Additional Medicare Tax. If an em-
ployer files a return on which FICA tax or
RRTA tax is required to be reported, and
reports on the return less than the correct
amount of Additional Medicare Tax re-
quired to be withheld with respect to a
payment of wages or compensation, and if
the employer ascertains the error after fil-
ing the return, the employer shall correct
the error through an interest-free adjust-
ment as provided in this section. An ad-
justment of Additional Medicare Tax may
only be reported pursuant to this para-
graph (b)(4) if the error is ascertained

within the same calendar year that the
wages or compensation were paid to the
employee, unless the underpayment is at-
tributable to an administrative error (that
is, an error involving the inaccurate re-
porting of the amount actually withheld),
section 3509 applies to determine the
amount of the underpayment, or the ad-
justment is reported on a Form 2504 or
Form 2504-WC. The employer shall ad-
just the underpayment of Additional
Medicare Tax by reporting the additional
amount due on an adjusted return for the
return period in which the wages or com-
pensation were paid, accompanied by a
detailed explanation of the amount being
reported on the adjusted return and any
other information as may be required by
this section and by the instructions relat-
ing to the adjusted return. The reporting of
the underpayment on an adjusted return
constitutes an adjustment within the
meaning of this section only if the ad-
justed return is filed within the period of
limitations for assessment for the return
period being corrected, and by the due
date for filing the return for the return
period in which the error is ascertained.
For purposes of the preceding sentence,
the due date for filing the adjusted return
is determined by reference to the return
being corrected, without regard to the em-
ployer's current filing requirements. For
example, an employer with a current an-
nual filing requirement who is correcting
an error on a previously filed quarterly
return must file the adjusted return by the
due date for filing a quarterly return for
the quarter in which the error is ascer-
tained. The amount of the underpayment
adjusted in accordance with this section
must be paid to the IRS by the time the
adjusted return is filed. If an adjustment is
reported pursuant to this section, but the
amount of the adjustment is not paid when
due, interest accrues from that date (see
section 6601).

* * * * *

(d) * * *

(1) * * * If an employer collects less
than the correct amount of employee
FICA or RRTA tax from an employee
with respect to a payment of wages or
compensation, the employer must collect
the amount of the undercollection by de-
ducting the amount from remuneration of
the employee, if any, paid after the em-

ployer ascertains the error. If an employer
collects less than the correct amount of
Additional Medicare Tax required to be
withheld under section 3101(b)(2) or sec-
tion 3201(a), the employer must collect
the amount of the undercollection on or
before the last day of the calendar year by
deducting the amount from remuneration
of the employee, if any, paid after the
employer ascertains the error. Such de-
ductions may be made even though the
remuneration, for any reason, does not
constitute wages or compensation. The
correct amount of employee tax must be
reported and paid, as provided in para-
graph (b) of this section, whether or not
the undercollection is corrected by a de-
duction made as prescribed in this para-
graph (d)(1), and even if the deduction is
made after the return on which the em-
ployee tax must be reported is due. If such
a deduction is not made, the obligation of
the employee to the employer with respect
to the undercollection is a matter for set-
tlement between the employee and the
employer. If an employer makes an erro-
neous collection of employee tax from
two or more of its employees, a separate
settlement must be made with respect to
each employee. An overcollection of em-
ployee tax from one employee may not be
used to offset an undercollection of such
tax from another employee. For provi-
sions relating to the employer's liability
for the tax, whether or not it collects the
tax from the employee, see §§31.3102-
1(d), 31.3102-4(c), and 31.3202-1. This
paragraph (d)(1) does not apply if section
3509 applies to determine the employer's
liability.

* * * * *

(e) Effective/applicability date. Para-
graphs (b) and (d) of this section apply to
adjusted returns filed on or after Novem-
ber 29, 2013.

Par. 11. Section 31.6402(a)-2 is
amended by:

1\. Revising paragraph (a)(1)(i) and the
first sentence in paragraph (a)(1)(ii).

2\. Redesignating paragraphs (a)(1)(iii)
through (vi), as paragraphs (a)(1)(iv)
through (vii), respectively.

3\. Revising newly-redesignated para-
graphs (a)(1)(iv) and (a)(1)(v).

4\. Adding new paragraph (a)(1)(iii).

5\. Revising paragraph (b).

6\. Adding paragraph (c).

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The revisions and additions read as fol-
lows:

§31.6402(a)-2 Credit or refund of tax
under Federal Insurance Contributions
Act or Railroad Retirement Tax Act.

(a) * * *

(1) * * *

(i) Except as provided in paragraph
(a)(1)(iii) of this section, any person may
file a claim for credit or refund for an
overpayment (except to the extent that the
overpayment must be credited pursuant to
§31.3503-1) if the person paid to the In-
ternal Revenue Service (IRS) more than
the correct amount of employee Federal
Insurance Contributions Act (FICA) tax
under section 3101 or employer FICA tax
under section 3111, employee Railroad
Retirement Tax Act (RRTA) tax under
section 3201, employee representative
RRTA tax under section 3211, or em-
ployer RRTA tax under section 3221, or
interest, addition to the tax, additional
amount, or penalty with respect to any
such tax.

(ii) Except as provided in paragraph
(a)(1)(iii) of this section, the claim for
credit or refund must be made in the man-
ner and subject to the conditions stated in
this section. * * *

(iii) Additional Medicare Tax. No re-
fund or credit to the employer will be
allowed for the amount of any overpay-
ment of Additional Medicare Tax im-
posed under section 3101(b)(2) or section
3201(a) (as calculated under section
3101(b)(2)), which the employer deducted
or withheld from an employee.

(iv) For adjustments without interest of
overpayments of FICA or RRTA taxes,
including Additional Medicare Tax, see
§31.6413(a)-2.

(v) For corrections of FICA and RRTA
tax paid under the wrong chapter, see
§31.6205-1(b)(2)(ii) and (b)(2)(iii) and
§31.3503-1.

* * * * *

(b) Claim by employee-(1) In gen-
eral. Except as provided in (b)(3) of this
section, if more than the correct amount of
employee tax under section 3101 or sec-
tion 3201 is collected by an employer
from an employee and paid to the IRS, the
employee may file a claim for refund of
the overpayment if-

(i) The employee does not receive re-
payment or reimbursement in any manner
from the employer and does not authorize
the employer to file a claim and receive
refund or credit,

(ii) The overcollection cannot be cor-
rected under §31.3503-1, and

(iii) In the case of overpaid employee
social security tax due to having received
wages or compensation from multiple em-
ployers, the employee has not taken the
overcollection into account in claiming a
credit against, or refund of, his or her
income tax, or if so, such claim has been
rejected. See §31.6413(c)-1.

(2) Statements supporting employee's
claim. (i) Except as provided in (b)(3) of
this section, each employee who makes a
claim under paragraph (b)(1) of this sec-
tion shall submit with such claim a state-
ment setting forth (a) the extent, if any, to
which the employer has repaid or reim-
bursed the employee in any manner for
the overcollection, and (b) the amount, if
any, of credit or refund of such overpay-
ment claimed by the employer or autho-
rized by the employee to be claimed by
the employer. The employee shall obtain
such statement, if possible, from the em-
ployer, who should include in such state-
ment the fact that it is made in support of
a claim against the United States to be
filed by the employee for refund of em-
ployee tax paid by such employer to the
IRS. If the employer's statement is not
submitted with the claim, the employee
shall make the statement to the best of his
or her knowledge and belief, and shall
include therein an explanation of his or
her inability to obtain the statement from
the employer.

(ii) Except as provided in paragraph
(b)(3) of this section, each individual who
makes a claim under paragraph (b)(1) of
this section also shall submit with such
claim a statement setting forth whether the
individual has taken the amount of the
overcollection into account in claiming a
credit against, or refund of, his or her
income tax, and the amount, if any, so
claimed (see §31.6413(c)-1).

(3) Additional Medicare Tax. (i) If more
than the correct amount of Additional Medi-
care Tax under section 3101(b)(2) or section
3201(a) (as calculated under section
3101(b)(2)), is collected by an employer
from an employee and paid to the IRS, the

employee may file a claim for refund of the
overpayment and receive a refund or credit
if the overcollection cannot be corrected un-
der §31.3503-1 and if the employee has not
received repayment or reimbursement from
the employer in the context of an interest-
free adjustment. The claim for refund shall
be made on Form 1040, U.S. Individual
Income Tax Return, by taking the overcol-
lection into account in claiming a credit
against, or refund of, tax. The form to be
used by residents of the U.S. Virgin Islands,
Guam, American Samoa, or the Northern
Mariana Islands is Form 1040-SS, U.S. Self-
Employment Tax Return (Including Addi-
tional Child Tax Credit for Bona Fide Res-
idents of Puerto Rico). The form to be used
by residents of Puerto Rico is either Form
1040-SS or Form 1040-PR, Planilla para la
Declaración de la Contribución Federal so-
bre el Trabajo por Cuenta Propia (Incluy-
endo el Crédito Tributario Adicional por
Hijos para Residentes Bona Fide de Puerto
Rico). The employee may not authorize the
employer to claim the credit or refund for
the employee. See §31.6402(a)-2(a)(1)(iii).

(ii) In the case of an overpayment of
Additional Medicare Tax under section
3101(b)(2) or section 3201(a) for a tax-
able year of an individual for which a
Form 1040 (or other applicable return in
the Form 1040 series) has been filed, a
claim for refund shall be made by the
individual on Form 1040X, Amended U.S.
Individual Income Tax Return.

(c) Effective/applicability date. This
section applies to claims for refund filed
on or after November 29, 2013.

Par. 12. Section 31.6413(a)-1 is
amended by:

1\. Revising the first sentence in para-
graph (a)(2)(i).

2\. Redesignating paragraphs (a)(2)(ii)
through (vii) as paragraphs (a)(2)(iii)
through (viii), respectively.

3\. Revising newly-designated para-
graph (a)(2)(viii).

3\. Adding paragraph (a)(2)(ii).

4\. Adding a sentence after the first sen-
tence in newly-redesignated paragraph
(a)(2)(iv).

5\. Adding a sentence at the end of
newly-redesignated paragraph (a)(2)(v).
6\. Adding paragraph (c).

The revisions and additions read as fol-
lows:

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§31.6413(a)-1 Repayment or
reimbursement by employer of tax
erroneously collected from employee.

(a) * * *

(2) * * * (i) Except as provided in
paragraph (a)(2)(ii) of this section, if an
employer files a return for a return period
on which FICA tax or RRTA tax is re-
ported, collects from an employee and
pays to the IRS more than the correct
amount of the employee FICA or RRTA
tax, and if the employer ascertains the
error after filing the return and within the
applicable period of limitations on credit
or refund, the employer shall repay or
reimburse the employee in the amount of
the overcollection prior to the expiration
of such limitations period. * * *

(ii) If an employer files a return for a
return period on which Additional Medi-
care Tax under section 3101(b)(2) or sec-
tion 3201(a) is reported, collects from an
employee and pays to the IRS more than
the correct amount of Additional Medi-
care Tax required to be withheld from
wages or compensation, and if the em-
ployer ascertains the error after filing the
return but before the end of the calendar
year in which the wages or compensation
were paid, the employer shall repay or
reimburse the employee in the amount of
the overcollection prior to the end of the
calendar year. However, this paragraph
does not apply to the extent that, after
reasonable efforts, the employer cannot
locate the employee.

* * * * *

(iv) * * * However, for purposes of
overcollected Additional Medicare Tax
under section 3101(b)(2) or section
3201(a), the employer shall reimburse the
employee by applying the amount of the
overcollection against the employee FICA
or RRTA tax which attaches to wages or
compensation paid by the employer to the
employee in the calendar year in which
the overcollection is made. * * *

(v) * * * This paragraph (a)(2)(v) does
not apply for purposes of overcollected
Additional Medicare Tax under section
3101(b)(2) or section 3201(a) which must
be repaid or reimbursed to the employee
in the calendar year in which the overcol-
lection is made.

* * * * *

(viii) For corrections of FICA and
RRTA tax paid under the wrong chapter,
see §31.6205-1(b)(2)(ii) and (iii) and
§31.3503-1.

* * * * *

(c) Effective/applicability date. Para-
graph (a) of this section applies to ad-
justed returns filed on or after November
29, 2013.

Par. 13. Section 31.6413(a)-2 is
amended by:

1\. Adding a sentence after the first sen-
tence in paragraph (a)(1).

2\. Adding a sentence after the second
sentence in paragraph (b)(2)(i).

3\. Adding paragraph (e).

The additions read as follows:

§31.6413(a)-2 Adjustments of
overpayments.

(a) * * *

(1) * * * However, this section only
applies to overcollected or overpaid Ad-
ditional Medicare Tax under section
3101(b)(2) or section 3201(a) if the em-
ployer has repaid or reimbursed the
amount of the overcollection of such tax
to the employee in the year in which the
overcollection was made. *

* * * * *

(b) * * *

(2) * * *

(i) * * * However, for purposes of
Additional Medicare Tax under section
3101(b)(2) or section 3201(a), if the
amount of the overcollection is not repaid
or reimbursed to the employee under
§31.6413(a)-1(a)(2)(ii), there is no over-
payment to be adjusted under this section
and the employer may only adjust an
overpayment of such tax attributable to an
administrative error, that is, an error in-
volving the inaccurate reporting of the
amount withheld, pursuant to this section.
* * *

* * * * *

(e) Effective/applicability date. Para-
graphs (a) and (b) of this section apply to
adjusted returns filed on or after Novem-
ber 29, 2013.

John Dalrymple,
Deputy Commissioner
for Services and Enforcement.

<!-- PageHeader="Approved November 18, 2013" -->

Mark J. Mazur,
Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on November
26, 2013, 4:15 p.m., and published in the issue of the Federal
Register for November 29, 2013, 78 F.R. 71468)

Section 6050H .- Returns
Relating to Mortgage
Interest Received in Trade
or Business from
Individuals
T.D. 9642

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1

# Information Reporting of Mortgage Insurance Premiums

AGENCY: Internal Revenue Service (IRS),
Treasury.

ACTION: Final regulations and removal
of temporary regulations.

SUMMARY: This document contains fi-
nal regulations that require information
reporting by persons who receive mort-
gage insurance premiums, including pre-
paid premiums, aggregating $600 or more
during any calendar year. The final regu-
lations implement reporting requirements
that result from the extension of the treat-
ment of mortgage insurance premiums
made by the American Taxpayer Relief
Act of 2012. These regulations will affect
any person who, in the course of a trade or
business, receives from an individual
mortgage insurance premiums that in the
aggregate total $600 or more during a
calendar year.

DATES: Effective Date: These regula-
tions are effective on November 27, 2013.

Applicability Date: For dates of appli-
cability, see §1.6050H-3(g).

FOR FURTHER INFORMATION
CONTACT: Janet Engel Kidd at (202)
317-6844 (not a toll-free number).

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# SUPPLEMENTARY INFORMATION:

## Background

This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) under section 6050H(h) of the In-
ternal Revenue Code (Code) relating to
reporting requirements for mortgage in-
surance premiums. Section 6050H(h)(1),
enacted on December 20, 2006, by section
419(c) of the Tax Relief and Health Care
Act of 2006, Public Law 109-432 (120
Stat. 2967), provides that the Secretary
may, by regulations, require any person
who, in the course of a trade or business,
receives payments of mortgage insurance
premiums from an individual aggregating
$600 or more during any calendar year to
file a return regarding those payments in
the form, at the time, and containing the
information prescribed by the Secretary.
Under section 6050H(h)(2), on or before
January 31 of the year following the year
in which the premium is received, a per-
son required to file an information return
under section 6050H(h)(1) must send a
written statement to the individual to
whom the information return relates
showing the information prescribed by the
Secretary. Section 6050H(h)(3)(A) pro-
vides that rules similar to the rules in
section 6050H(c), relating to the applica-
bility of the section 6050H reporting re-
quirements to governmental units, will ap-
ply with respect to mortgage insurance
premiums. Section 6050H(h)(3)(B) de-
fines the term "mortgage insurance" to
mean mortgage insurance provided by the
Veterans Administration (the predecessor
to the Department of Veterans Affairs),
the Federal Housing Administration, or
the Rural Housing Administration (the
predecessor to the Rural Housing Ser-
vice), and private mortgage insurance (as
defined by section 2 of the Homeowners
Protection Act of 1998) (12 U.S.C. 4901),
as in effect on the date of enactment of
section 6050H(h), which is the same def-
inition as "qualified mortgage insurance"
in section 163(h)(4)(E).

In general, section 163(h)(3)(E) treats
premiums paid for qualified mortgage in-
surance by a taxpayer during the taxable
year in connection with acquisition in-
debtedness with respect to a qualified res-
idence as qualified residence interest.
Prior to amendment in 2013, section

163(h)(3)(E) was effective for amounts
paid or accrued between January 1, 2007,
and December 31, 2011, or properly allo-
cable to any period ending on or before
December 31, 2011, on mortgage insur-
ance contracts issued on or after January
1, 2007. Section 204 of the American
Taxpayer Relief Act of 2012 (ATRA),
Public Law No. 112-240, 126 Stat. 2313,
enacted on January 2, 2013, retroactively
applied the tax treatment of qualified
mortgage insurance premiums as qualified
residence interest for 2012, and it ex-
tended that treatment to premiums paid or
accrued on or before December 31, 2013,
or properly allocable to any period ending
on or before December 31, 2013, on mort-
gage insurance contracts issued on or after
January 1, 2007. Unless extended or made
permanent by further legislation, section
163(h)(3)(E) will not apply to amounts
paid or accrued after 2013 or properly
allocable to any period after 2013.

On May 7, 2009, the Treasury Depart-
ment and the IRS published temporary
regulations (TD 9449) under section 163
in the Federal Register (74 FR 21256)
that explained how to allocate prepaid
qualified mortgage insurance premiums to
determine the amount of the prepaid pre-
mium that is treated as qualified residence
interest each taxable year. The temporary
regulations also provided guidance as to
reporting requirements under section
6050H(h) to reporting entities receiving
premiums, including prepaid premiums,
for mortgage insurance. On the same day,
the Treasury Department and the IRS pub-
lished a notice of proposed rulemaking
(REG-107271-08) cross-referencing the
temporary regulations in the Federal
Register (74 FR 21295). No public hear-
ing was requested or held. No comments
responding to the notice of proposed rule-
making were received.

On May 7, 2012, the Treasury Depart-
ment and the IRS published final regula-
tions (TD 9588) in the Federal Register
(77 FR 26698) adopting the proposed reg-
ulations under section 163 relating to the
allocation of prepaid qualified mortgage
insurance premiums, as amended. Those
final regulations did not finalize the pro-
posed regulations relating to the reporting
requirements under section 6050H(h) for
entities receiving mortgage insurance pre-
miums. At that time, the deduction for

qualified mortgage insurance premiums
under section 163 did not apply to
amounts paid or accrued after December
31, 2011, and the Treasury Department
and the IRS determined not to require the
reporting of nondeductible premiums. The
temporary regulations on the reporting re-
quirements, which were in §1.6050H-
3T, expired on May 4, 2012.

## Explanation of Revisions

The final regulations adopt the pro-
posed regulations under §1.6050H-3 with
two minor revisions. The first is the addi-
tion of new paragraph (d), which cross-
references §1.6050H-2 regarding the
time, form, and manner of reporting qual-
ified mortgage interest. The addition of
this cross-reference is intended to clarify
that rules similar to the rules applicable to
the time, form, and manner of reporting
interest received on qualified mortgages
apply to amounts required to be reported
under §1.6050H-3(a) . For instance, mort-
gage insurance premiums are reported on
a Form 1098, Mortgage Interest State-
ment, if the premiums received from that
individual in the aggregate total $600 or
more.

The second revision relates to the effec-
tive date and applicability of these final reg-
ulations. On January 2, 2013, ATRA ex-
tended section 163(h) for premiums paid or
accrued on or before December 31, 2013, or
properly allocable to any period ending on
or before December 31, 2013, on mort-
gage insurance contracts issued on or after
January 1, 2007. In addition, ATRA ex-
tended section 163(h) retroactively for
qualified mortgage insurance premiums
paid or accrued during 2012. These final
regulations under §1.6050H-3 require in-
formation reporting for mortgage insur-
ance premiums received on or after Janu-
ary 1, 2013, and during periods to which
section 163(h)(3)(E) is applicable. How-
ever, there were no final or temporary
regulations requiring information report-
ing with respect to qualified mortgage in-
surance premiums paid or accrued during
2012. Therefore, information reporting
with respect to qualified mortgage insur-
ance premiums was not required for pre-
miums paid or accrued during 2012.

Because information reporting with re-
spect to mortgage insurance premiums re-
ceived during 2012 was not required, no

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penalty under section 6721 or section
6722 will apply with respect to the failure
to report mortgage insurance premiums
received during 2012.

Further, the fact that an individual did
not receive a Form 1098 reporting the
amount of mortgage insurance premiums
paid for 2012 does not affect whether the
individual satisfied the requirements under
section 163(h) to treat qualified mortgage
insurance premiums as qualified residence
interest. Accordingly, any individual who
paid or accrued qualified mortgage insur-
ance premiums in the calendar year ending
December 31, 2012, or properly allocated
these premiums to the calendar year ending
December 31, 2012, on mortgage insurance
contracts issued on or after January 1, 2007,
and who did not previously treat those
amounts as qualified residence interest, may,
within the applicable period of limitations, file
a Form 1040X, Amended U.S. Individual In-
come Tax Return, for 2012 to claim a refund
based on the treatment of those amounts as
qualified residence interest.

## Special Analyses

It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866, as supplemented by Executive Or-
der 13563. Therefore, a regulatory assess-
ment is not required. It also has been
determined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions. It is hereby certified that this rule
will not have a significant economic im-
pact on a substantial number of small en-
tities. This certification is based on the
fact that this rule merely reinstates the
mortgage insurance information reporting
requirements on the Form 1098 that pre-
viously existed from 2007 through 2011.
In addition, persons receiving mortgage
insurance premiums already are required
to file the Form 1098 to report interest
received on qualified mortgages and com-
pleting the mortgage insurance premiums
box imposes little or no incremental bur-
den in time or expense. Therefore, a Reg-
ulatory Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C.
Chapter 6) is not required. Pursuant to
section 7805(f) of the Code, the notice of
proposed rulemaking that preceded these
final regulations was submitted to the

Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business, and no com-
ments were received.

## Drafting Information

The principal author of these regula-
tions is Janet Engel Kidd, Office of the
Associate Chief Counsel, Procedure and
Administration.

* * * * *

## Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is
amended as follows:

PART 1-INCOME TAXES

Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *

Section 1.6050H-3 is also issued under
26 U.S.C. 6050H(h) .* * *

Par. 2. Section 1.6050H-3 is added to
read as follows:

### §1.6050H-3 Information reporting of mortgage insurance premiums.

(a) Information reporting require-
ments. Any person who, in the course of a
trade or business, receives premiums, in-
cluding prepaid premiums, for mortgage
insurance (as described in paragraph (b)
of this section) from any individual aggre-
gating $600 or more for any calendar year,
must make an information return setting
forth the total amount received from that
individual during the calendar year.

(b) Scope. Paragraph (a) of this section
applies to mortgage insurance provided by
the Federal Housing Administration, De-
partment of Veterans Affairs, or the Rural
Housing Service (or their successor organi-
zations), or to private mortgage insurance
(as defined by section 2 of the Homeowners
Protection Act of 1998 (12 U.S.C. 4901) as
in effect on December 20, 2006). The rule
stated in paragraph (a) of this section applies
to the receipt of all payments of mortgage
insurance premiums, by cash or financing,
without regard to source.

(c) Aggregation. Whether a person re-
ceives $600 or more of mortgage insurance
premiums is determined on a mortgage-by-

mortgage basis. A recipient need not aggre-
gate mortgage insurance premiums received
on all of the mortgages of an individual to
determine whether the $600 threshold is
met. Therefore, a recipient need not report
mortgage insurance premiums of less than
$600 received on a mortgage, even though it
receives a total of $600 or more of mortgage
insurance premiums on all of the mortgages
for an individual for a calendar year.

(d) Time, form, and manner of reporting.
Mortgage insurance premiums required to
be reported under paragraph (a) of this sec-
tion must be reported on the Form 1098 or
successor form that is filed pursuant to
§1.6050H-2(a) with respect to the mortgage
of the individual who paid the mortgage
insurance premiums. For the requirements
for furnishing statements with respect to
Forms 1098 filed with the Internal Revenue
Service, see §1.6050H-2(b).

(e) Cross reference. For rules concern-
ing the allocation of certain prepaid qual-
ified mortgage insurance premiums, see
§1.163-11 of this chapter.

(f) Limitation on the reporting of mort-
gage insurance premiums. This section
applies to mortgage insurance premiums
described in paragraph (b) of this section
that are paid or accrued on or after Janu-
ary 1, 2013, and during periods to which
section 163(h)(3)(E) applies. This section
does not apply to any amounts of mort-
gage insurance premiums that are alloca-
ble to any periods to which section
163(h)(3)(E) does not apply.

(g) Effective/applicability date. This sec-
tion applies to mortgage insurance premi-
ums received on or after January 1, 2013.
For regulations applicable before May 5,
2012, see §1.6050H-3T as contained in 26
CFR part 1 (revised as of April 1, 2012).

## §1.6050H-3T [Removed]

Par. 3. Section 1.6050H-3T is removed.

John M. Dalrymple,
Deputy Commissioner for
Services and Enforcement.

Approved October 1, 2013

Mark J. Mazur,
Assistant Secretary of the Treasury
(Tax Policy).

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(Filed by the Office of the Federal Register on November
26, 2013, 8:45 a.m., and published in the issue of the Federal
Register for November 27, 2013, 78 F.R. 70856)

# Section 9010 of the Affordable Care Act .- Imposition of Annual Fee on Health Insurance Providers

T.D. 9643

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 57 and 602
Health Insurance Providers
Fee

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains fi-
nal regulations relating to the annual fee
imposed on covered entities engaged in
the business of providing health insurance
for United States health risks. This fee is
imposed by section 9010 of the Patient
Protection and Affordable Care Act, as
amended. The regulations affect persons
engaged in the business of providing
health insurance for United States health
risks.

DATES: Effective Date: These regula-
tions are effective on November 29, 2013.
Applicability Date: For dates of appli-
cability see §§57.10 and 57.6302-1.

FOR FURTHER INFORMATION
CONTACT: Charles J. Langley, Jr. at
(202) 317-6855 (not a toll-free number).

SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act

The collection of information con-
tained in these final regulations has been
reviewed and approved by the Office of
Management and Budget under control
number 1545-2249. The collection of in-
formation in these final regulations is in
§57.2(e)(2)(i). The information is required
to be maintained, in the case of a con-
trolled group, by the designated entity and

each member of the controlled group. An
agency may not conduct or sponsor, and a
person is not required to respond to, a
collection of information unless the col-
lection of information displays a valid
control number. 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 con-
fidential, as required by section 6103.

## Background

This document adds the Health Insur-
ance Providers Fee Regulations to the
Code of Federal Regulations (26 CFR part
57) under section 9010 of the Patient Pro-
tection and Affordable Care Act
(PPACA), Public Law 111-148 (124 Stat.
119 (2010)), as amended by section 10905
of PPACA, and as further amended by
section 1406 of the Health Care and Ed-
ucation Reconciliation Act of 2010, Pub-
lic Law 111-152 (124 Stat. 1029 (2010))
(collectively, the Affordable Care Act or
ACA). All references in this preamble to
section 9010 are references to the ACA.
Section 9010 did not amend the Internal
Revenue Code (Code) but contains cross-
references to specified Code sections.

A notice of proposed rulemaking
(REG-118315-12, 78 FR 14034) was
published in the Federal Register on
March 4, 2013 (the proposed regulations).
The Department of the Treasury (Treasury
Department) and the IRS received over 80
written comments from the public in re-
sponse to the proposed regulations. A
public hearing was held on June 21, 2013.
After considering the public written com-
ments and hearing testimony, the pro-
posed regulations are adopted as final reg-
ulations by this Treasury decision with
certain changes as described in this pre-
amble.

Unless otherwise indicated, all other
references to subtitles, chapters, subchap-
ters, and sections in this preamble are
references to subtitles, chapters, subchap-
ters, and sections in the Code and related
regulations. All references to "fee" in the
final regulations are references to the fee
imposed by section 9010.

Explanation of Provisions and Sum-
mary of Comments

# Covered Entities and Exclusions

## In General

Section 9010(a) imposes an annual fee,
beginning in 2014, on each covered entity
engaged in the business of providing
health insurance. Section 9010(c) pro-
vides that a covered entity is any entity
that provides health insurance for any
United States health risk during each year,
subject to certain exclusions. The pro-
posed regulations defined the term cov-
ered entity generally to mean any entity
with net premiums written for United
States health risks during the fee year that
is: (1) a health insurance issuer within the
meaning of section 9832(b)(2); (2) a
health maintenance organization within
the meaning of section 9832(b)(3); (3) an
insurance company subject to tax under
part I or II of subchapter L, or that would
be subject to tax under part I or II of sub-
chapter L but for the entity being exempt
from tax under section 501(a); (4) an entity
that provides health insurance under Medi-
care Advantage, Medicare Part D, or Med-
icaid; or (5) a non-fully insured multiple
employer welfare arrangement (MEWA).

With respect to the first category of
covered entity, the proposed regulations
provided that a health insurance issuer
within the meaning of section 9832(b)(2)
means an insurance company, insurance
service, or insurance organization that is
required to be licensed to engage in the
business of insurance in a State and that is
subject to State law that regulates insur-
ance. A commenter suggested that the fi-
nal regulations eliminate any State licens-
ing requirement for a covered entity
because an entity may provide health in-
surance for a United States health risk and
not be licensed. The final regulations do
not adopt this suggestion. The final regu-
lations modify this category of covered
entity to more closely align with section
9832(b)(2), which provides that a health
insurance issuer must be licensed to en-
gage in the business of insurance in a
State and not merely required to be li-
censed as stated in the proposed regula-
tions. A health insurance issuer within the
meaning of section 9832(b)(2) cannot
lawfully engage in the business of selling

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insurance in a State unless it is licensed to
engage in the business of insurance in that
State.

Notwithstanding this licensing limitation
for the first category of covered entity, the
term covered entity is not limited to an en-
tity that is a health insurance issuer within
the meaning of section 9832(b)(2). An in-
surance company subject to tax under sub-
chapter L, an entity providing health insur-
ance under Medicare Advantage, Medicare
Part D, or Medicaid, or a MEWA may also
be a covered entity under these regulations,
whether or not that entity is licensed to
engage in the business of insurance in a
State.

## Multiple Employer Welfare Arrangements (MEWAs)

The proposed regulations provided that
the term covered entity includes a MEWA
within the meaning of section 3(40) of the
Employee Retirement Income Security
Act of 1974 (29 U.S.C. chapter 18)
(ERISA), to the extent that the MEWA is
not a fully-insured MEWA, regardless of
whether the MEWA is subject to regula-
tion under State insurance law. In the case
of a fully-insured MEWA, the MEWA is
not a covered entity because, even though
the MEWA receives premiums, it applies
those premiums to pay an insurance com-
pany to provide the coverage it purchases.
If the MEWA is not fully insured, how-
ever, the MEWA is a covered entity to the
extent that it uses the premiums it receives
to provide the health coverage rather than
to pay an insurance company to provide
the coverage.

Commenters suggested that a MEWA
not be treated as a covered entity, stating
that Federal and State law do not support
the interpretation that a MEWA offers
"insurance." Commenters also stated that
an employer who participates in a non-
fully insured MEWA should be treated the
same as an employer who offers a self-
insured plan. The final regulations do not
adopt these suggestions. By participating
in a non-fully insured MEWA, a partici-
pating employer generally is pooling its
health insurance risks, transferring those
risks to the MEWA, or both, similar to the
way an employer pools and transfers those
risks by purchasing a group insurance pol-
icy from an insurance company. In a non-

fully insured MEWA, the responsibility
for a claim that a participant makes
against it lies with the MEWA, and pos-
sibly with all of the contributing employ-
ers. Therefore, a MEWA is different from
a self-insured plan in which responsibility
for a participant's claim lies solely with
the claimant's employer.

Moreover, section 514(b)(6) of ERISA
provides that a MEWA is subject to
State insurance law and regulation as an
insurance provider, unlike non-MEWA
ERISA-covered employee benefit plans
which are not subject to State insurance law
and regulation due to Federal preemption.
For example, a non-fully insured multiem-
ployer plan, defined under section 3(37) of
ERISA, generally would not be subject to
State insurance law, whereas an ERISA-
covered MEWA, within the meaning of sec-
tion 3(40) of ERISA, that is not fully insured
(as defined in section 514(b)(6)(D) of
ERISA) generally would be subject to State
insurance law.

The Joint Committee on Taxation Gen-
eral Explanation also indicates that a
MEWA is intended to be a covered entity
under section 9010: "A covered entity
does not include an organization that qual-
ifies as a VEBA [voluntary employees'
beneficiary association] under section
501(c)(9) that is established by an entity
other than the employer (i.e., a union) for
the purpose of providing health care ben-
efits. This exclusion does not apply to
multi-employer [sic] welfare arrange-
ments ('MEWAs')." See General Expla-
nation of Tax Legislation Enacted by the
111th Congress, JCS-2-11 (March 2011)
(JCT General Explanation) at 330.

For these reasons, the Treasury Depart-
ment and the IRS have concluded that a
MEWA within the meaning of section
3(40) of ERISA is an entity that provides
health insurance for purposes of section
9010 to the extent that the MEWA is not
a fully-insured MEWA and regardless of
whether the MEWA is subject to regula-
tion under State insurance law. In addi-
tion, such a MEWA is not eligible for the
exception from the fee under section
9010(c)(2)(A) for self-insured employers.

The proposed regulations excluded a
MEWA that is exempt from Department
of Labor (DOL) reporting requirements
under 29 CFR 2520.101-2(c)(2)(ii)(B).
This section of the DOL regulations gen-

erally excludes a MEWA that provides
coverage to the employees of two or more
employers due to a change in control of
businesses (such as a merger or acquisi-
tion) that occurs for a purpose other than
to avoid the reporting requirements and
does not extend beyond a limited time. A
commenter suggested that the final regu-
lations also exclude a MEWA that is ex-
empt from reporting under 29 CFR
2520.101-2(c)(2)(ii)(A), which generally
applies to an entity that would not be a
MEWA but for the fact that it provides
coverage to two or more trades or busi-
nesses that share a common control inter-
est of at least 25 percent (applying prin-
ciples similar to the principles of section
414(c)) at any time during the plan year.
The commenter also suggested that the
final regulations exclude a MEWA that is
exempt from reporting under 29 CFR
2520.101-2(c)(2)(ii)(C), which generally
applies to an entity that would not be a
MEWA but for the fact that it provides
coverage to persons who are not employ-
ees or former employees of the plan spon-
sor (such as non-employee members of
the board of directors or independent con-
tractors), if coverage of such persons does
not exceed one percent of the total number
of employees or former employees cov-
ered by the arrangement, determined as of
the last day of the year to be reported, or
determined as of the 60th day following
the date the MEWA began operating in a
manner such that a filing is required pur-
suant to 29 CFR 2520.101-2(e)(2) or (3).

The final regulations adopt these sug-
gestions and follow the DOL rules except-
ing these entities from the DOL reporting
requirements under 29 CFR 2520.101-2
governing MEWAs. The reasons support-
ing the DOL's filing exemption also jus-
tify exempting these arrangements from
section 9010 as more akin to health cov-
erage provided by a self-insured em-
ployer. Similar to the filing exemption for
certain temporary MEWAs, these two fil-
ing exemptions are intended to address
situations in which the status as a MEWA
derives not from the design of the arrange-
ment but instead from the limited partici-
pation by individuals who are not the em-
ployees of a single employer or from a
desire to have a single plan for entities
sharing substantial common ownership
(though not sufficient to be treated as a

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single employer under the controlled
group rules). Accordingly, a MEWA will
not be considered a covered entity if it
satisfies the requirements of 29 CFR
2520.101-2(c)(2)(ii)(A), (B), or (C) for
the plan year ending with or within the
section 9010 data year.

The proposed regulations provided
that, solely for purposes of section 9010,
an Entity Claiming Exception (ECE)1 is
subject to the same regime addressing
MEWAs. Commenters requested that an
ECE not categorically be treated as a
MEWA for purposes of section 9010.
Commenters pointed out that some ECEs
are multiemployer plans and coverage
during the period of their status as an ECE
would not be consistent with this status. In
addition, as a practical matter, an entity's
status as an ECE is only relevant for re-
porting during a limited period of time.
For these reasons, the final regulations
adopt this suggestion so that whether an
entity is or is not an ECE is not relevant to
whether the entity is subject to section
9010.

Voluntary Employees' Beneficiary
Associations (VEBAs)

In accordance with section 9010(c)(2)(D),
the proposed regulations explicitly ex-
cluded any VEBA that is established by
an entity other than an employer or em-
ployers for the purpose of providing
health care benefits. Further, the preamble
to the proposed regulations stated that, if
an employer provides self-insured em-
ployee health benefits through a VEBA,
the VEBA is not a covered entity because
the exclusion for employers with self-
insured arrangements under section
9010(c)(2)(A) applies. The preamble also
stated that, if a VEBA purchases health
insurance to cover the beneficiaries of the
VEBA, the VEBA is not a covered entity
because the issuer providing the health
insurance that the VEBA purchases is the
covered entity subject to the fee rather
than the VEBA. The preamble stated that
the Treasury Department and the IRS
were not aware of any VEBAs that would
be covered entities under the proposed

regulations and invited comments on the
types of VEBAs, if any, that do not fall
within the exclusions and therefore would
be covered entities.

A commenter requested that the final
regulations clarify that a VEBA estab-
lished by a union qualifies for the section
9010(c)(2)(D) exclusion. Commenters
also asked for clarification that the section
9010(c)(2)(D) exclusion applies to any
VEBA established by a joint board of
trustees in the case of a multiemployer
plan within the meaning of section 3(37)
of ERISA. The final regulations adopt
these suggestions with respect to plans
established by unions and joint boards of
trustees because the union or joint board
of trustees is an entity other than the em-
ployer or employers. Thus, in the case of
a multiemployer plan that maintains a
VEBA, neither the plan nor the VEBA is
a covered entity.

Commenters also requested that the fi-
nal regulations clarify the application of
the section 9010(c)(2)(D) exclusion to a
VEBA that is part of a single-employer
plan established pursuant to a collective
bargaining agreement and having a joint
board of trustees. As in the case of a
multiemployer plan, a VEBA that is, for
example, part of a single-employer plan
established by a joint board of trustees
pursuant to section 302(c)(5) of the Labor
Management Relations Act of 1947, is
considered to be established by an entity
other than the employer or employers and
so is eligible for the section 9010(c)(2)(D)
exclusion.

The preamble to the proposed regula-
tions stated that, if a MEWA provides
health benefits through a VEBA, the
VEBA is not a covered entity. A com-
menter asked whether the section
9010(c)(2)(D) exclusion applies to a non-
fully insured MEWA that is also a VEBA.
The section 9010(c)(2)(D) exclusion does
not apply to an entity that is both a non-
fully insured MEWA and a VEBA be-
cause, for section 9010 purposes, the en-
tity has been established by the employers
whose employees participate in the
MEWA, and the section 9010(c)(2)(D)
exclusion does not apply to an employer-

established VEBA. Additionally, the en-
tity does not qualify as a self-insured ar-
rangement that is eligible for the
exclusion for self-insured employers un-
der section 9010(c)(2)(A) because, as pre-
viously described in the section of this
preamble titled "Multiple Employer Wel-
fare Arrangements (MEWAs)," a non-
fully insured MEWA is not a self-insured
employer. Accordingly, a MEWA that is
also a VEBA is a covered entity.

Section 9010(c)(2)(C) Exclusion

In accordance with section 9010(c)(2)(C)(i)-
(iii), the proposed regulations excluded any
entity (i) that is incorporated as a nonprofit
corporation under State law; (ii) no part of the
net earnings of which inures to the benefit of
any private shareholder or individual, no sub-
stantial part of the activities of which is carry-
ing on propaganda, or otherwise attempting to,
influence legislation (except as provided in
section 501(h)), and that does not participate
in, or intervene in (including the publishing or
distributing of statements), any political cam-
paign on behalf of (or in opposition to) any
candidate for public office; and (iii) that re-
ceives more than 80 percent of its gross reve-
nues from government programs that target
low-income, elderly, or disabled populations
under titles XVIII, XIX, and XXI of the Social
Security Act (which include Medicare, Med-
icaid, the Children's Health Insurance Plan
(CHIP), and dual eligible plans).

Commenters suggested that the final
regulations exclude a for-profit entity that
meets the section 9010(c)(2)(C)(ii) and
(iii) requirements. According to the com-
menters, imposing the fee on these for-profit
entities will effectively reduce benefits pro-
vided under Medicare and Medicaid, re-
quire the entities to pass the cost of the fee
back to the government, and competitively
disadvantage these entities in favor of ex-
cluded nonprofit corporations. Another
commenter suggested that the final regula-
tions permit an entity that is treated as a
nonprofit entity under State law to satisfy
the section 9010(c)(2)(C)(i) requirement
even if it is not incorporated as a nonprofit
corporation. Commenters also suggested
that the final regulations exclude an entity

1An ECE is defined in 29 CFR 2520.101-2(b) as an entity that claims it is not a MEWA on the basis that the entity is established or maintained pursuant to one or more agreements that
the Secretary of Labor finds to be collective bargaining agreements within the meaning of section 3(40)(A)(i) of ERISA and 29 CFR 2510.3-40. We also note that ERISA section 501(b)
imposes criminal penalties on any person who is convicted of violating the prohibition in ERISA section 519 against making false statements or representations of fact in connection with
the marketing or sale of a MEWA.

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that meets the section 9010(c)(2)(C)(i) and
(ii) requirements and that targets low-
income, elderly, or disabled populations de-
scribed in section 9010(c)(2)(C)(iii), but
whose income is not derived from title
XVIII, XIX, or XXI programs, but rather
from similar types of programs that do not
come under those titles. The final regula-
tions do not adopt these suggested changes.
The statutory language sets forth specific
requirements for an entity to qualify for the
exception, including that the entity be a non-
profit corporation and that the entity receive
the required portion of its gross income
from the enumerated Federal government
programs.

Commenters suggested that the final
regulations interpret the requirement set
forth in section 9010(c)(2)(C)(iii), that the
entity receive more than 80 percent of its
gross revenues from enumerated Federal
government programs to qualify for that
exception, to apply only to revenues that
relate to net premiums written. Because
gross revenues include all revenues of the
covered entity without taking into account
their source, the final regulations do not
adopt this suggestion.

As explained in the preamble to the pro-
posed regulations, an entity is not required
to be exempt from tax under section 501(a)
to qualify for the section 9010(c)(2)(C) ex-
clusion. However, because the provisions of
section 9010(c)(2)(C)(ii) relating to private
inurement, lobbying, and political campaign
activity are the same as those provisions
applicable to organizations described in sec-
tion 501(c)(3), for purposes of applying
these requirements, the proposed regula-
tions adopted the standards set forth under
section 501(c)(3) and the related regula-
tions. Commenters generally agreed with
this approach, which is adopted in the final
regulations.

One commenter suggested that the fi-
nal regulations incorporate a "safe harbor"
under which a transaction will not violate
the private inurement prohibition under
section 9010(c)(2)(C)(ii) if either the
transaction complies with applicable State
insurance laws governing the reasonable-
ness of transactions between a health in-
surance provider and its affiliates or the
transaction is approved in accordance
with certain procedures set forth in the
regulations under section 4958 (relating to
taxes on excess benefit transactions). The

final regulations do not adopt this sugges-
tion. The private inurement prohibition
under section 501(c)(3) contains no ex-
ception for transactions that comply with
State insurance laws or other applicable
State or Federal laws. Similarly, while
most situations that constitute inurement
will also violate the general rules of sec-
tion 4958, the two standards are not the
same. See §1.501(c)(3)-1(f)(2) of the In-
come Tax Regulations and §53.4958-
8(a) of the Foundation and Similar Excise
Tax Regulations.

## Agencies and Instrumentalities as Governmental Entities

Section 9010(c)(2)(B) excludes any gov-
ernmental entity from the definition of cov-
ered entity. In defining the term governmen-
tal entity, the proposed regulations did not
include instrumentalities. The preamble to
the proposed regulations requested com-
ments on the types of instrumentalities, if
any, that would be considered covered enti-
ties under the general definition of covered
entity and the extent to which those entities
would qualify for other exclusions consis-
tent with the statute.

Commenters suggested that the final
regulations define governmental entity to
include an instrumentality, citing statutory
language that excludes "any" governmen-
tal entity and arguing that, in certain in-
stances, an instrumentality that provides
health insurance performs a governmental
function and therefore should be ex-
cluded. For those reasons, the final regu-
lations adopt this suggestion and define
governmental entity to include any agency
or instrumentality of the United States, a
State, a political subdivision of a State, an
Indian tribal government, or a subdivision
of an Indian tribal government.

The final regulations also revise the
governmental entity definition to delete
the specific provision relating to any pub-
lic agency that is created by a State or
political subdivision thereof and contracts
with the State to administer State Medic-
aid benefits through local providers or
health maintenance organizations
(HMOs). The Treasury Department and
the IRS intend that such a public agency
would qualify as an agency or instrumen-
tality of a State or political subdivision
thereof for purposes of the governmental

entity definition. See JCT General Expla-
nation at 330.

Determinations of whether an entity is
an agency or instrumentality have typi-
cally been analyzed on a facts and circum-
stances basis. In determining whether an
entity is an agency or instrumentality,
courts have applied a test similar to the
six-factor test in Revenue Ruling 57-128
(1957-1 CB 311), which generally pro-
vides guidance on whether an entity is an
instrumentality for purposes of the ex-
emption from employment taxes under
sections 3121(b)(7) and 3306(c)(7). See,
for example, Bernini v. Federal Reserve
Bank of St. Louis, Eighth District, 420
F.Supp. 2d 1021 (E.D. Mo. 2005) and
Rose v. Long Island Railroad Pension
Plan, 828 F.2d 910, 918 (2d Cir. 1987),
cert. denied, 485 U.S. 936 (1988). For
further background information relating to
agency or instrumentality determinations,
see the "Background" section of the pream-
ble in the section 414(d) draft general reg-
ulations in the Appendix to the ANPRM
(REG-157714-06) relating to governmen-
tal plan determinations, 76 FR 69172 (No-
vember 8, 2011).

Applying principles similar to those
described in Revenue Ruling 57-128, in
determining whether an entity is an
agency or instrumentality for purposes of
section 9010, factors taken into consider-
ation include whether the entity is used for
a governmental purpose and performs a
governmental function. The Treasury De-
partment and the IRS question whether
providing health insurance on a commer-
cial market in direct competition with
non-governmental commercial entities is
a governmental function, absent particular
circumstances. Accordingly, an entity
may jeopardize its status as an agency or
instrumentality if it engages in the busi-
ness of providing insurance on the com-
mercial market on a continuing and regu-
lar basis.

Further, section 9010(i) authorizes the
IRS to prescribe such regulations as are nec-
essary or appropriate to prevent avoidance
of the purposes of section 9010, including
inappropriate actions taken to qualify as an
excluded entity under section 9010(c)(2). If
the Treasury Department and the IRS con-
clude that agencies or instrumentalities have
entered the commercial market in competi-
tion with commercial entities in a manner

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that makes it inappropriate to apply the gov-
ernmental entity exclusion under section
9010(c)(2)(B), the Treasury Department and
the IRS may reconsider the exclusion of
agencies and instrumentalities and exercise
the authority under section 9010(i) to ad-
dress particular concerns in this area.

## Educational Institutions

A commenter suggested that the final
regulations exclude educational institu-
tions from the definition of covered entity.
The final regulations do not adopt this
request. The statute does not exclude ed-
ucational institutions from the definition
of covered entity, but as noted in the pre-
amble to the proposed regulations, other
exceptions may apply. For example, if an
educational institution uses the premiums
it receives from students to purchase in-
surance from a separate, unrelated issuer,
the issuer, and not the educational institu-
tion, will be the covered entity for pur-
poses of section 9010. If an educational
institution provides students with health
coverage through a self-insured arrange-
ment, the exclusion for self-insuring em-
ployers does not apply because the insti-
tution is not providing health coverage as
an employer. However, other exclusions
may apply. For example, the exclusion for
governmental entities applies if an educa-
tional institution is a wholly-owned in-
strumentality of a State. In addition, al-
though an educational institution that is a
covered entity must report to the IRS its net
premiums written, it will not be subject to
the fee unless the institution (or its con-
trolled group that is treated as a single cov-
ered entity) has net premiums written for
United States health risks of more than $25
million pursuant to section 9010(b)(2)(A).

## Other Entities

Commenters suggested that the final reg-
ulations exclude certain section 501(c)(5)
labor organizations that provide health cov-
erage under the Federal Employees Health
Benefit Plan (FEHBP) on the basis that pro-
viding health coverage is part of their ex-
empt function as a section 501(c)(5) entity.
The commenters asserted that, although a
section 501(c)(5) entity is not organized as a
VEBA, it operates like a VEBA because of
the various FEHBP rules (including, for ex-

ample, on use of reserves) and therefore
should be treated as a VEBA for section
9010 purposes. The final regulations do not
adopt this suggestion. Congress identified
specific exclusions from section 9010 and
there is no statutory exclusion for section
501(c)(5) entities.

Another commenter suggested that the
final regulations exclude high risk pools
under section 1101 of the ACA, which
will expire on December 31, 2013. Sec-
tion 9010(c)(1) defines a covered entity to
mean any entity that provides health in-
surance for a United States health risk in
the year that the fee is due. The first year
the fee is due is 2014. Therefore, for the
first fee year, an entity is not a covered
entity unless it provides health insurance
for United States health risks in 2014.
Because high risk pools will expire on
December 31, 2013, they will not provide
health insurance in 2014 and will not be
covered entities. In the event a high risk
pool provides health insurance for United
States health risks in 2014, it will be a
covered entity if it does not meet one of
the exclusions described in section
9010(c)(2).

A commenter requested that the final
regulations provide an exclusion for an
entity that is selling or otherwise failing to
continue the majority of its health insur-
ance business by December 31, 2013, but
is contractually required to provide some
residual health insurance. The entity's fee
liability for 2014 based on the 2013 data
year will be significantly larger than the
total amount of net premiums written that
the entity will collect in 2014. The final
regulations do not adopt this request be-
cause it is inconsistent with the statute,
which bases the fee liability on net premi-
ums written during the data year.

The proposed regulations defined the
term covered entity to include an HMO, as
defined in section 9832(b)(3). A com-
menter requested that the final regulations
exclude an HMO that is a tax-exempt or-
ganization described in section 501(c)(3)
or (4) on the basis that Congress did not
intend to subject a tax-exempt HMO to
the fee. The final regulations do not adopt
this suggestion. Section 9010(c)(2) de-
scribes the entities that are excluded from
the definition of covered entity. While sec-
tion 9010(c)(2)(D) excludes certain types of
VEBAs described in section 501(c)(9), there

is no similar exclusion for an entity that
qualifies as a tax-exempt organization under
either section 501(c)(3) or (4). However,
such a tax-exempt organization would be
eligible for the partial exclusion under sec-
tion 9010(b)(2)(B).

## Disregarded Entities

Two commenters requested further
guidance on how to treat disregarded en-
tities for purposes of section 9010. One
commenter suggested that the final regu-
lations specifically state that the general
rules for disregarded entities apply. A sec-
ond commenter suggested that, solely for
section 9010 purposes, a disregarded en-
tity should always be regarded as a cor-
poration. The final regulations do not
adopt any special entity classification
rules. Thus, if a covered entity is an eli-
gible entity under §301.7701-3(a) of the
Procedure and Administration Regula-
tions, has a single owner, and does not
elect to be classified as a corporation un-
der §301.7701-3(c), then the covered en-
tity is disregarded as an entity separate
from its owner and its activities are treated
in the same manner as a branch or division
of its owner pursuant to §301.7701-
2(a). Additionally, although §301.7701-
2(c)(2)(v) treats a disregarded entity as a
corporation for certain enumerated excise
taxes, the fee under section 9010 is not
among the enumerated excise taxes. How-
ever, an insurance company is a corpora-
tion under §301.7701-2(b)(4) and cannot
be disregarded as an entity separate from
its owner. See also Rev. Rul. 83-132
(1983-2 CB 270). Under sections 816(a)
and 831(c), a company is an insurance
company if more than half of its business
during the taxable year is the issuing of
insurance or annuity contracts or the rein-
suring of risks underwritten by insurance
companies. Therefore, if the covered en-
tity is an insurance company under sec-
tions 816(a) and 831(c), then it is a cor-
poration and cannot be disregarded as an
entity separate from its owner.

## Controlled Groups

In accordance with section 9010(c)(3),
the proposed regulations treated a con-
trolled group as a single covered entity,
and defined a controlled group as a group

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of two or more persons, including at least
one person that is a covered entity, that are
treated as a single employer under section
52(a), 52(b), 414(m), or 414(o).

Section 52(a) and (b) provide rules that
treat all organizations that are members of
a controlled group as a single entity. Gen-
erally, section 52(a) provides that the term
controlled group of corporations has the
meaning given to such term by section
1563(a), except that "more than 50 per-
cent" is substituted for "at least 80 per-
cent" each place it appears in section
1563(a)(1) and the determination is made
without regard to section 1563(a)(4) (re-
lating to special rules for certain insurance
companies) and 1563(e)(3)(C) (relating to
attribution rules for ownership interest
held under a trust described in section
401(a) that is exempt from tax under sec-
tion 501). Section 52(b) provides similar
rules for determining whether trades or
businesses (whether or not incorporated)
are under common control. Section
414(m) requires that all members of an
affiliated service group be treated as a
single organization, and section 414(o)
provides authority for additional rules that
may be necessary to prevent the avoid-
ance of certain requirements related to
employee benefits.

A commenter suggested that the final
regulations clarify the circumstances un-
der which nonprofit organizations are in-
cluded in controlled groups under section
9010(c)(3). The Treasury Department and
the IRS are considering whether further
guidance is needed under section 52(a) or
(b) to address either organizations exempt
from tax under section 501(a) or nonprofit
organizations that, although not exempt
from tax under section 501(a), do not have
members or shareholders that are entitled
to receive distributions of the organiza-
tion's income or assets (including upon
dissolution) or that otherwise retain equity
interests similar to those generally held by
owners of for-profit entities. Until further
guidance is issued, those two types of
organizations may either rely on a reason-
able, good-faith application of section
52(a) and (b) (taking into account the
reasons for which the controlled group
rules are incorporated into section 9010)
or apply the rules set forth in §1.414(c)-
5(a) through (d) (but substituting “more
than 50 percent" in place of "at least 80

percent" each place it appears in
§1.414(c)-5).

# Health Insurance

## In General

Section 9010 does not define health
insurance, providing in section 9010(h)(3)
only that health insurance does not in-
clude coverage only for accident, or dis-
ability income insurance, or any combina-
tion thereof as described in section
9832(c)(1)(A); coverage only for a speci-
fied disease or illness and hospital indem-
nity or other fixed indemnity insurance as
described in section 9832(c)(3); insurance
for long-term care; or Medicare supple-
mental health insurance (as defined in sec-
tion 1882(g)(1) of the Social Security
Act). The proposed regulations generally
defined the term health insurance, subject
to certain exclusions, by reference to sec-
tion 9832(b)(1)(A) to mean benefits con-
sisting of medical care (provided directly,
through insurance or reimbursement, or
otherwise) under any hospital or medical
service policy or certificate, hospital or
medical service plan contract, or HMO
contract offered by a health insurance is-
suer. The final regulations clarify that
these benefits constitute health insurance
when they are offered by any type of
covered entity, and not solely by a health
insurance issuer within the meaning of
section 9832(b)(2).

## Stop-Loss Coverage

Several comments requested that the
final regulations clarify the treatment of
stop-loss coverage. Employers that self-
insure their employees' health benefits
frequently purchase stop-loss coverage to
mitigate risk. The stop-loss provider as-
sumes the risk of claims above a certain
agreed-upon threshold known as the at-
tachment point. Some commenters sug-
gested including stop-loss coverage in the
definition of health insurance for purposes
of section 9010, whereas other comment-
ers suggested excluding it. The DOL, the
Department of Health and Human Ser-
vices (HHS), and the Treasury Depart-
ment are concerned that more employers
in small group markets with healthier em-
ployees may pursue self-insured arrange-
ments with stop-loss arrangements that

have low attachment points as a function-
ally equivalent alternative to an insured
group health plan. As a result, the three
agencies issued a Request for Information
(RFI) regarding such practices, with a fo-
cus on the prevalence and consequences
of stop-loss coverage at low attachment
points. See 77 FR 25788 (May 1, 2012).
Because the scope of stop-loss coverage
that may constitute health insurance, if
any, has not been determined, the final
regulations do not expressly include stop-
loss coverage in the definition of health
insurance. Accordingly, section 9010 will
not apply to stop-loss coverage until such
time and only to the extent that future
guidance addresses the issue of whether,
and if so under what circumstances, stop-
loss coverage constitutes health insurance.

## Limited Scope Dental and Vision Benefits

The proposed regulations defined
health insurance to include limited scope
dental and vision benefits under section
9832(c)(2)(A). Commenters suggested re-
vising the definition of health insurance to
exclude limited scope dental and vision
benefits (sometimes referred to as stand-
alone dental and vision benefits). Alterna-
tively, commenters suggested including
only those dental and vision policies that
can be offered on an Exchange, such as
pediatric dental plans. The final regula-
tions do not adopt these suggestions. The
JCT General Explanation indicates that
dental and vision benefits are intended to
be included as health insurance for pur-
poses of section 9010 and the comments
received do not compel a different conclu-
sion. See JCT General Explanation at 331.
Accordingly, the final regulations retain
the rule in the proposed regulations and
provide that limited scope dental and vi-
sion benefits, including arrangements that
may be sold on an Exchange (for example,
pediatric dental coverage), are health in-
surance for purposes of section 9010.

## Coverage Funded by Targeted Government Programs

Commenters suggested that the final
regulations exclude coverage funded by
government programs that target low-
income, elderly, or disabled populations

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under titles XVIII, XIX, and XXI of the
Social Security Act (which include Medi-
care, Medicaid, CHIP, and dual eligible
plans) from the definition of health insur-
ance or exclude revenues received from
these government programs from net pre-
miums written. The final regulations do
not adopt these suggestions. A full exclu-
sion for these types of coverage or asso-
ciated revenues would not be consistent
with section 9010. Section 9010(c)(2)(C)
excludes a limited subset of entities that
provide coverage funded by these govern-
mental programs, which indicates that en-
tities providing such coverage are other-
wise providing health insurance that is
subject to the fee. The JCT General Ex-
planation further indicates that Medicare
and Medicaid coverage is health insurance
that is subject to the fee. Thus, an entity
providing this type of coverage is a cov-
ered entity unless it qualifies for a statu-
tory exclusion from the definition of a
covered entity, such as the section
9010(c)(2)(C) exclusion. See JCT General
Explanation at 330 and 331.

## Indemnity Reinsurance

The proposed regulations provided
that, solely for purposes of section 9010,
health insurance does not include indem-
nity reinsurance, defined as an agreement
between two or more insurance compa-
nies under which the reinsuring company
agrees to accept, and to indemnify the
issuing company for, all or part of the risk
of loss under policies specified in the
agreement and the issuing company re-
tains its liability to, and its contractual
relationship with, the individuals whose
health risks are insured under the policies
specified in the agreement. A commenter
suggested that the final regulations clarify
that the definition of indemnity reinsur-
ance extends to reinsurance obtained by
HMOs. The final regulations adopt this
suggestion and clarify that the issuer of
the policies specified in the indemnity re-
insurance agreement may be any covered
entity.

Commenters asked about the treatment
of a "carve-out" arrangement or similar
types of arrangement in which one insurer
accepts responsibility for all or part of the
health risk within a defined category of
medical benefits that another insurer is

obligated to provide. For example, a full-
service insurer that includes dental bene-
fits as part of its health insurance plan may
contract with a dental insurer to provide
those benefits to plan members, but still
retain an exclusive contractual relation-
ship with plan members and liability for
benefits. The commenters expressed con-
cern that premiums received by both the
full-service insurer and the secondary ser-
vices insurer for these benefits could be
subject to the fee. Although the final reg-
ulations do not expressly address a carve-
out arrangement, the secondary services
insurer in such an arrangement is not pro-
viding health insurance for purposes of
section 9010 to the extent the arrangement
meets the definition of indemnity reinsur-
ance.

## Subcapitation

A commenter requested that the final
regulations clarify the treatment of a sub-
capitation arrangement. Under a typical
subcapitation arrangement, a Medicaid
plan provider contracts with a separate
service provider to provide certain ser-
vices to the Medicaid plan participants
and share some of the provider's risk. A
Medicaid plan provider that enters into a
subcapitation arrangement remains fully
liable on the underlying plans, and any
amounts paid to compensate the service
provider for the subcapitation arrange-
ment are not considered premiums for
State regulatory purposes or reported as
such. Therefore, although the final regu-
lations do not directly address a subcapi-
tation arrangement, amounts paid to a ser-
vice provider under such an arrangement
are not included in net premiums written
for health insurance to the extent they are
not treated as premiums for State regula-
tory and reporting purposes.

## Employee Assistance Programs

Commenters requested that the final
regulations exclude benefits under an em-
ployee assistance program (EAP) from the
definition of health insurance, including
an EAP that is treated as insurance in
California or Nevada. Generally, an EAP
does not exhibit the risk pooling and risk
transferring characteristics of insurance,
but certain States regulate benefits under

an EAP as insurance in some situations.
The Treasury Department, DOL, and
HHS currently are considering guidance
that would treat benefits under an EAP as
an excepted benefit under section 9832(c)
(as well as corresponding provisions of
ERISA and the Public Health Service Act
(42 U.S.C. chapter 6A) (PHSA)), and pro-
vided in Q&A 9 of Notice 2013-54
(2013-40 IRB 287; September 30, 2013)
that until that separate rulemaking is final-
ized in other guidance, and through at
least 2014, a taxpayer may treat an EAP
that does not provide significant benefits
in the nature of medical care or treatment
as constituting excepted benefits. Whether
and under what conditions an EAP pro-
vides health insurance coverage has been
a longstanding issue that this other guid-
ance is intended to address by defining an
EAP and setting forth the conditions un-
der which the benefits under an EAP will
be treated as excepted benefits.

Because the extent to which benefits
under an EAP may constitute health insur-
ance has not been determined, the final
regulations do not expressly define health
insurance to include benefits under an
EAP. If an EAP provides significant ben-
efits in the nature of medical care or treat-
ment, those benefits would meet the defi-
nition of health insurance for section 9010
purposes. Otherwise, benefits under an
EAP will not be treated as health insur-
ance for section 9010 purposes until such
time and only to the extent that the Trea-
sury Department, DOL and HHS deter-
mine such benefits do not qualify as an
excepted benefit.

Commenters also requested that the fi-
nal regulations exclude coverage under a
disease management program or a well-
ness program from the definition of health
insurance. The final regulations do not
specifically address the treatment of a
stand-alone wellness plan or disease man-
agement program. These programs gener-
ally do not exhibit the risk shifting and
risk distribution characteristics of insur-
ance. Additionally, a program of this type
may be contained within an EAP that sat-
isfies the standard in Q&A 9 of Notice
2013-54 for being an excepted benefit
(taking into account the benefits provided
under the programs in determining
whether the EAP provides substantial
benefits in the nature of medical treat-

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ment). For these reasons, the final regula-
tions do not expressly define health insur-
ance to include coverage under a disease
management program or wellness pro-
gram. If these programs provide signifi-
cant benefits in the nature of medical care
or treatment, those benefits would meet
the definition of health insurance for sec-
tion 9010 purposes. Otherwise, coverage
under these programs will not be treated
as health insurance for section 9010 pur-
poses until such time and only to the ex-
tent that the three agencies determine
these benefits do not qualify as an ex-
cepted benefit.

## Long-Term Care

The proposed regulations excluded
from the definition of health insurance any
benefits for long-term care, nursing home
care, home health care, community-based
care, or any combination thereof, within
the meaning of section 9832(c)(2)(B), and
such other similar, limited benefits to the
extent such benefits are specified in regu-
lations under section 9832(c)(2)(C). A
commenter questioned whether this exclu-
sion applies to Medicaid managed long-
term care premiums, such as those pro-
vided to covered entities that may
participate in State Medicaid managed
long-term care programs. To the extent
Medicaid plan providers can separately
identify premiums received for long-term
care, these amounts are not for health in-
surance and are not included in net pre-
miums written.

## Medicare Advantage and Medicare Part D Plans

Some employers or unions provide
Medicare Advantage or Medicare Part D
benefits in connection with an Employer
Group Waiver Plan (EGWP) for employees
and retirees who are Medicare beneficiaries.
According to commenters, an employer or
union can provide these benefits on a self-
insured basis. Commenters requested that
the final regulations clarify whether a union
or employer that provides Medicare Advan-
tage and Medicare part D benefits under an
EGWP or similar arrangement is a covered
entity subject to section 9010 with respect to
premiums received for the coverage. No
change was made in the final regulations to

specifically address this issue. However,
while the benefits provided by these ar-
rangements may constitute health insurance
within the meaning of section 9010, an em-
ployer or union that provides benefits under
an EGWP or similar arrangement is not a
covered entity to the extent the arrangement
is eligible for the self-insuring employer ex-
ception under section 9010(c)(2)(A).

## Medicare Cost Contract Plans

A commenter asked that the final reg-
ulations clarify how section 9010 applies
to the Medicare cost contract portion of an
entity's business. A Medicare cost con-
tract plan is a type of plan established by
section 1876 of Title XVIII of the Social
Security Act. Cost contract plans are paid
based on the reasonable costs incurred by
delivering Medicare-covered services to
plan members. Although the final regula-
tions do not specifically address the treat-
ment of a Medicare cost contract plan,
benefits under a Medicare cost contract
plan are health insurance for section 9010
purposes if they meet the general defini-
tion of health insurance and do not qualify
for a specific exclusion.

# Section 9010(b)(2)(B) Partial Exclusion

After applying section 9010(b)(2)(A) to
determine the amount of net premiums writ-
ten for health insurance of United States
health risks that are taken into account, the
proposed regulations excluded under sec-
tion 9010(b)(2)(B) 50 percent of the remain-
ing net premiums written for health insur-
ance of United States health risks that are
attributable to the activities (other than ac-
tivities of an unrelated trade or business as
defined in section 513) of any covered entity
qualifying under section 501(c)(3), (4), (26),
or (29) and exempt from tax under section
501(a). Commenters requested that the final
regulations apply this exclusion to a for-
profit hospital health plan (HHP) that is
owned and controlled by an entity exempt
from tax under section 501(a) and further
described in section 501(c). According to
the commenters, an HHP functions like a
nonprofit entity because it reinvests what-
ever profits it produces each year in its par-
ent owner's charitable mission. The final
regulations do not adopt this request. By
statute, the partial exclusion only applies to

a covered entity that is a section 501(c)(3),
(4), (26), or (29) entity, and even then only
with respect to premium revenue from its
exempt activities.

One commenter suggested that the fi-
nal regulations require any covered entity
claiming the partial exclusion to submit an
IRS determination letter recognizing it as
tax-exempt under section 501(c)(3), (4),
(26), or (29). Another commenter ob-
jected to this suggestion on the basis that
the Code does not require all tax-exempt
entities to apply to the IRS for recognition
of tax-exempt status. The final regulations
do not impose any additional require-
ments on entities claiming the partial ex-
clusion. For purposes of section 9010,
whether an entity qualifies as exempt from
Federal income tax under section 501(a)
as an organization described in section
501(c)(3), (4), (26), or (29) will be deter-
mined under the Code provisions applica-
ble to those organizations. To provide
greater certainty, the final regulations pro-
vide that an entity is eligible for the sec-
tion 9010(b)(2)(B) partial exclusion if it
meets the requirements for that exclusion
as of December 31st of the data year.

# Reporting and Penalties

Section 9010(g)(1) requires each cov-
ered entity to report to the IRS its net
premiums written for health insurance for
United States health risks during the data
year. The proposed regulations required
that this information be reported on Form
8963, Report of Health Insurance Pro-
vider Information. Commenters suggested
that the final regulations require an entity
that qualifies for an exclusion from the
definition of covered entity to report its
net premiums written to claim the exclu-
sion. The final regulations do not adopt
this suggestion. The required reporting
under section 9010(g)(1) only applies to
covered entities.

A commenter requested that each cov-
ered entity be required to report even if it
receives no more than $25 million in net
premiums written and therefore is not li-
able for the fee. The proposed regulations
already imposed this requirement in ac-
cordance with the statute. The final regu-
lations retain this requirement.

Section 9010(g)(2) imposes a penalty for
failing to timely submit a report containing
the required information unless the covered

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entity can show that the failure is due to
reasonable cause. Section 9010(g)(3) im-
poses an accuracy-related penalty for any
understatement of a covered entity's net pre-
miums written. Commenters requested that
the final regulations provide a reasonable
cause exception for the accuracy-related
penalty similar to the reasonable cause ex-
ception for the failure to report penalty. Un-
like section 9010(g)(2), section 9010(g)(3)
does not contain a reasonable cause excep-
tion. Therefore, the final regulations do not
create a reasonable cause exception for the
accuracy-related penalty. However, the final
regulations require a covered entity to sub-
mit a corrected Form 8963 during the error
correction period if the entity believes there
are any errors in the preliminary fee calcu-
lation. The corrected Form 8963 will re-
place the original Form 8963 for all pur-
poses, including for the purpose of
determining whether an accuracy-related
penalty applies, except that a covered entity
remains subject to the failure to report pen-
alty if it fails to timely submit the original
Form 8963.

The proposed regulations clarified that
the failure to report penalty and the
accuracy-related penalty apply in addition
to the fee. The final regulations retain this
clarification and further clarify that a cov-
ered entity may be liable for both penal-
ties.

A commenter suggested that the final
regulations create a safe harbor for the
failure to report penalty imposed by sec-
tion 9010(g)(2) and waive or reduce the
penalty for small businesses, or exclude
small businesses altogether from the def-
inition of covered entity so that the pen-
alty does not apply. The final regulations
do not adopt this suggestion. The statute
does not exclude small businesses from
either the definition of covered entity or
the requirement to report. However, cer-
tain statutory provisions will mitigate the
impact on small business. Although a
small business that is a covered entity
must report its net premiums written, it
will not be subject to the fee if its net
premiums written are $25 million or less
pursuant to section 9010(b)(2)(A). Fur-
ther, section 9010(g)(2) allows the IRS to
waive the failure to report penalty if there
is reasonable cause for such failure. The
IRS will determine whether reasonable
cause exists for a covered entity's failure

to report based on the facts and circum-
stances.

Commenters requested that the IRS
wait to assess the accuracy-related penalty
until the error correction process is com-
plete. Under section 9010(g)(3)(A), the
amount of the accuracy-related penalty is
equal to the excess of the amount of the
covered entity's fee determined in the ab-
sence of the understatement (that is, the
correct fee amount) over the amount of
the fee determined based on the under-
statement (that is, the amount of the fee
based on understated reporting). Because
the fee is allocated among covered entities
based on each entity's net premiums writ-
ten, the IRS must determine the correct
amount of net premiums written for all
covered entities before it can determine
the correct fee amount for a covered en-
tity. Therefore, the IRS cannot compute
and assess any accuracy-related penalties
until the conclusion of the error correction
process when the IRS computes the final
bills. As stated earlier in this preamble, if
the covered entity timely submits a cor-
rected Form 8963 during the error correc-
tion period, the corrected Form 8963 will
replace the original Form 8963 for the
purpose of determining whether an
accuracy-related penalty applies.

## Fee Calculation and Error Correction Process

### In General

The proposed regulations required
each covered entity to report annually its
net premiums written for health insurance
of United States health risks during the
data year to the IRS on Form 8963 by
May 1st of the fee year. The proposed
regulations also required the IRS to send
each covered entity its final fee calcula-
tion no later than August 31st, and re-
quired the covered entity to pay the fee by
September 30th by electronic funds trans-
fer. In addition, the proposed regulations
required the IRS to send preliminary fee
calculations and give covered entities an
opportunity to submit error correction re-
ports, with the time and manner of error
correction reporting to be specified in
other guidance published in the Internal
Revenue Bulletin.

The final regulations adopt April 15th
as the date on which the Form 8963 is due,

rather than May 1st, to provide additional
time to prepare the preliminary fee calcu-
lation for each covered entity. Also, to
ensure that any errors are timely cor-
rected, the final regulations require a cov-
ered entity to review its preliminary fee
calculation and, if it believes there are any
errors, to timely submit to the IRS a cor-
rected Form 8963 during the error correc-
tion period. As stated earlier in this pre-
amble, the corrected Form 8963 will
replace the original Form 8963. In the
case of a controlled group, if the prelimi-
nary fee calculation for the controlled
group contains one or more errors, the
corrected Form 8963 must include all of
the required information for the entire
controlled group, including members that
do not have corrections. Further rules re-
garding the manner for submitting Form
8963, the time and manner for notifying
covered entities of their preliminary fee
calculation, and the time and manner for
submitting error correction reports for the
error correction process are contained in
other guidance in the Internal Revenue
Bulletin being published concurrently
with these final regulations.

Commenters suggested that the final
regulations create a "true-up" process by
which the fee will be continually adjusted
from year to year. Because the fee is an
allocated fee, allowing a true-up process
for one covered entity will result in ad-
justments to the fee for all covered enti-
ties. In the interest of providing finality
and certainty to fee liability, the final reg-
ulations do not adopt this suggestion.

Source of Data Used to Calculate the
Fee

The proposed regulations defined the
term net premiums written to mean pre-
miums written, including reinsurance pre-
miums written, reduced by reinsurance
ceded, and reduced by ceding commis-
sions and medical loss ratio (MLR) re-
bates with respect to the data year. The
preamble to the proposed regulations ex-
plained that, for covered entities that file
the Supplemental Health Care Exhibit
(SHCE) with the National Association of
Insurance Commissioners (NAIC), net
premiums written for health insurance
generally will equal the amount reported
on the SHCE as direct premiums written

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minus MLR rebates with respect to the
data year, subject to any applicable exclu-
sions under section 9010 such as exclu-
sions from the term health insurance.

Commenters suggested that the final
regulations require a covered entity to use
the SHCE and any equivalent forms as the
basis for determining net premiums writ-
ten if it is required to file the SHCE and
any equivalent forms pursuant to State
reporting requirements. The final regula-
tions do not adopt this suggestion because
forms can change. The instructions to
Form 8963 provide additional information
on how to determine net premiums written
using the SHCE and any equivalent forms
as the source of data, and can be updated
to reflect changes in forms.

### Medical Loss Ratio (MLR) Rebates

The proposed regulations invited com-
ments on how to compute MLR rebates
with respect to the data year using data
reported on the SHCE. Commenters sug-
gested that MLR rebates be computed on
an accrual basis using lines 5.3, 5.4, and
5.5 of the 2012 SHCE. In response to this
comment, the final regulations clarify that
MLR rebates are computed on an accrual
basis. The final regulations do not desig-
nate specific SHCE line numbers as the
source of data for computing MLR rebates
because forms can change. Instead, the
instructions to Form 8963 provide this
information.

### Medicaid Bonuses

A commenter requested that the final
regulations address the treatment of Med-
icaid bonuses in determining net premi-
ums written. According to the commenter,
Medicaid plans sometimes receive bo-
nuses for meeting plan goals. In some
cases, the bonuses are paid up front and
must be returned if the plan does not meet
its goals, and in other cases, bonuses are
paid only after the plan meets its goals.
The final regulations do not create a spe-
cial rule for the treatment of Medicaid
bonuses. The treatment of Medicaid bo-
nuses in determining net premiums writ-
ten depends on whether and when these
amounts are treated as premiums written
for State or other Federal regulatory and
reporting purposes.

Amounts Taken Into Account

In accordance with section 9010(b)(2)(A),
the proposed regulations provided that, for
each covered entity (or each controlled
group treated as a single covered entity),
the IRS will not take into account the first
$25 million of net premiums written. The
IRS will take into account 50 percent of
the net premiums written for amounts
over $25 million and up to $50 million,
and 100 percent of the net premiums writ-
ten that are over $50 million. Thus, for
any covered entity with net premiums
written of $50 million or more, the IRS
will not take into account the first $37.5
million of net premiums written. Addi-
tionally, after this reduction, the proposed
regulations provided that, in accordance
with section 9010(b)(2)(B), if the covered
entity (or any member of the controlled
group treated as a single covered entity) is
exempt from tax under section 501(a) and
is described in section 501(c)(3), (4), (26),
or (29), the IRS will take into account
only 50 percent of the remaining net pre-
miums written of that entity (or member)
that are attributable to its exempt activi-
ties.

A commenter asked how the fee will be
calculated for a controlled group that is
treated as a single covered entity when
some but not all of the group's members
qualify for the 50-percent exclusion under
section 9010(b)(2)(B). The final regula-
tions clarify that, in this circumstance, the
section 9010(b)(2)(A) exclusion applies
first to each member of the controlled
group on a pro rata basis, and then the
section 9010(b)(2)(B) exclusion applies
only to eligible members of the group.

For example, if a controlled group con-
sists of one member with $100 million in
net premiums written and a second mem-
ber with $50 million in net premiums
written, two-thirds of the group's total
$37.5 million reduction under section
9010(b)(2)(A), or $25 million, applies to
the first member, and the remaining one-
third, or $12.5 million, applies to the sec-
ond member. Therefore, after this initial
reduction, the first member has $75 mil-
lion of net premiums written ($100 mil-
lion minus $25 million), and the second
member has $37.5 million of net premi-
ums written ($50 million minus $12.5 mil-
lion). If the second member is eligible for

the 50-percent exclusion under section
9010(b)(2)(B), the 50-percent exclusion
applies to this member's remaining net
premiums written, resulting in $18.75 mil-
lion (50 percent of $37.5 million) being
taken into account. Thus, total net premi-
ums written taken into account for this
controlled group are $93.75 million ($150
million minus $37.5 million minus $18.75
million).

# Designated Entities

The proposed regulations required
each controlled group to have a desig-
nated entity, defined as a person within the
controlled group that is designated to act
on behalf of the controlled group with
regard to the fee. The proposed regula-
tions further provided that if the con-
trolled group, without regard to foreign
corporations included under section
9010(c)(3)(B), is also an affiliated group
that files a consolidated return for Federal
income tax purposes, the designated entity
is the common parent of the affiliated
group identified on the tax return filed for
the data year. If the controlled group is not
a part of an affiliated group that files a
consolidated return, the proposed regula-
tions allowed the controlled group to se-
lect its designated entity but did not re-
quire it to do so. The proposed regulations
also required each member of a controlled
group to maintain a record of its consent
to the designated entity selection and re-
quired the designated entity to maintain a
record of all member consents. Under the
proposed regulations, if the controlled
group did not select a person as its desig-
nated entity, the IRS would select a person
as a designated entity for the controlled
group and advise the designated entity
accordingly.

The final regulations modify the pro-
posed regulations, which provided that the
common parent of a consolidated group
was the designated entity in all cases. To
better coordinate with the consolidated re-
turn regulations, the final regulations pro-
vide that the designated entity of a con-
trolled group, without regard to foreign
corporations included under section
9010(c)(3)(B), that is a consolidated
group (within the meaning of §1.1502-
1(h)) is the agent for the group (within the
meaning of §1.1502-77). In the case of a
controlled group that is not a part of an

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affiliated group that files a consolidated
return, the Treasury Department and the
IRS believe that the controlled group
members are in the best position to deter-
mine which of its members should be the
designated entity. To promote greater cer-
tainty and ease of administration in the fee
reporting and determination process, the
final regulations thus require, rather than
permit, a controlled group that is not also
a consolidated group to select its desig-
nated entity. The final regulations further
provide that the IRS will select a member
of the controlled group to be the desig-
nated entity for the controlled group if a
controlled group fails to do so, but the
controlled group may be liable for penal-
ties for failure to meet its filing require-
ments. In the event the controlled group
fails to select a designated entity and the
IRS selects a designated entity for the
controlled group, the final regulations
deem all members of the controlled group
that provide health insurance for a United
States health risk to have consented to the
IRS's selection of the designated entity.

# Disclosure

Section 9010(g)(4) provides that sec-
tion 6103 (relating to the confidentiality
and disclosure of returns and return infor-
mation) does not apply to any information
reported by the covered entities under sec-
tion 9010(g). The preamble to the pro-
posed regulations stated that the Treasury
Department and the IRS are considering
making available to the public the infor-
mation reported on Form 8963, including
the identity of the covered entity and the
amount of its net premiums written, at the
time the notice of preliminary fee calcu-
lation is sent, and invited comments on
which reported information the IRS
should make publicly available. Numer-
ous commenters requested that the IRS
make all information reported on Form
8963 available to the public, and several
commenters requested that this informa-
tion be reported on the IRS website no
later than 15 days after the reporting dead-
line to promote transparency and assist
health insurers in determining whether an
error correction request is necessary. One
commenter requested that consumers have
access to the information that shows how
much each covered entity will pay. In
response to comments, the final regula-

tions provide that the information reported
on each Form 8963 will be open for public
inspection or available upon request. The
Treasury Department and the IRS expect
that, at a time to be determined, certain
information will be made available on
www.irs.gov, including the identity of
each reporting entity and the amount of its
reported net premiums written.

# Expatriate Policies

In accordance with section 9010(d), the
proposed regulations defined the term
United States health risk to mean the
health risk of any individual who is (1) a
United States citizen, (2) a resident of the
United States (within the meaning of sec-
tion 7701(b)(1)(A)), or (3) located in the
United States, with respect to the period
such individual is so located. The pream-
ble to the proposed regulations requested
comments on how the final regulations
should apply to expatriate policies. The
medical loss ratio final rule issued by
HHS (MLR final rule) defines expatriate
policies as predominantly group health in-
surance policies that provide coverage to
employees, substantially all of whom are:
(1) working outside their country of citi-
zenship; (2) working outside their country
of citizenship and outside the employer's
country of domicile; or (3) non-U.S. citi-
zens working in their home country. 45
CFR 158.120(d)(4). The NAIC tracks the
definition in the MLR final rule for pur-
poses of State reporting requirements.

The proposed regulations did not pro-
vide specific rules for expatriate policies.
However, the definitions of covered entity
and health insurance in the proposed reg-
ulations only extended to entities and pol-
icies that are subject to State or Federal
regulation. Commenters expressed the
concern that the proposed regulations pro-
vided an unfair advantage to foreign
health insurers. Not all foreign insurers
issuing expatriate policies on United
States health risks are subject to State
regulation or to Federal regulation under
ERISA. As a result, commenters asserted
that a foreign insurance company that is
not a covered entity will be able to charge
less than a U.S. insurance company for
nearly identical expatriate policies. Com-
menters suggested that the final regula-
tions exclude expatriate policies (or defer
their inclusion until more facts can be

gathered). Alternatively, commenters sug-
gested broadening the definition of cov-
ered entity to include a foreign insurer
regardless of whether it is subject to State
or Federal regulation.

The final regulations do not adopt these
suggestions. Section 9010 defines a
United States health risk to include the
health risk of a U.S. citizen or a resident
alien. An insurer that issues a policy to a
U.S. citizen or resident living abroad is
still providing coverage for a United
States health risk, despite the fact that the
individual may not be currently residing
in the United States. Thus, excluding ex-
patriate policies is inconsistent with the
language of section 9010(d).

Alternatively, broadening the defini-
tion of covered entity to include a foreign
insurer that does not do business in the
United States is not in the interest of
sound tax administration. Legal and prac-
tical restrictions significantly limit the
ability of the IRS to compel an entity that
does not do business in the United States
to file a report and pay a tax or fee. Fur-
ther, the Treasury Department and the IRS
expect that, in the overwhelming majority
of cases, foreign insurers that do not do
business in the United States will not have
more than $25 million in net premiums
written for United States health risks and
thus will not be subject to liability for the
fee. Therefore, the final regulations do not
expand the definition of covered entity to
include a foreign insurer that does not do
business in the United States.

The proposed regulations created a pre-
sumption under which the entire amount
reported on the SHCE filed with the NAIC
pursuant to State reporting requirements
will be considered to be for United States
health risks unless the covered entity can
demonstrate otherwise. Commenters ex-
pressed concern that the data necessary to
affirmatively establish that an individual is
not a United States health risk will be diffi-
cult for covered entities to obtain because
they will need to know the location of each
insured individual at all times and that indi-
vidual's nationality. Moreover, commenters
contended that such information may not be
clear or accurate because location or nation-
ality can vary among multiple members of
the same family (some of whom may hold
dual citizenship), and that covered entities
may simply be unable to obtain such infor-

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mation because of the constant mobility of
those covered. Commenters suggested al-
lowing a covered entity to determine expa-
triate net premiums written for United States
health risks by multiplying its total expatri-
ate net premiums written by the ratio of
claims paid in the United States to claims
paid worldwide. The final regulations do not
adopt this suggestion. A ratio based on
claims paid in the United States would not
accurately represent the relative proportion
of United States health risks because a
United States health risk includes the health
risks of U.S. citizens who are living abroad.
The Treasury Department and the IRS also
considered alternative methods for a cov-
ered entity to account for its expatriate pol-
icies, but were unable to identify any that
would be verifiable and administrable.
Therefore, the final regulations retain the
presumption in the proposed regulations and
allow a covered entity to demonstrate that
certain net premiums written are not for a
United States health risk.

## United States Possessions

Commenters suggested that the fee
should not apply to health insurance pro-
viders in Puerto Rico and Guam. The final
regulations do not adopt this suggestion.
Section 9010(h)(2) specifically states that
the term United States includes the U.S.
possessions. Section 9010(c)(1) defines a
covered entity as any entity that provides
health insurance for any United States
health risk, and under section 9010(d)(3),
a United States health risk includes cov-
erage of the health risk of any individual
located in the U.S. possessions. To aid in
determining whether an entity qualifies as
a covered entity, the proposed regulations
incorporated the definition of health insur-
ance issuer under section 9832(b)(2) as
one category of covered entity. The only
definition of health insurance issuer in the
Code is the definition of health insurance
issuer in section 9832(b)(2), and the lan-
guage of this provision is substantially
similar to the only definition of health
insurance issuer referenced in the ACA.2
Section 9832(b)(2) defines a health insur-
ance issuer as an insurance company, in-
surance service, or insurance organization
that is licensed to engage in the business

of insurance in a State and that is subject
to State laws that regulate insurance
within the meaning of section 514(b)(2) of
ERISA. Under section 514(b)(2) of
ERISA, State law that regulates insurance
generally means any State regulation. Sec-
tion 3(10) of ERISA defines State for pur-
poses of ERISA to include the U.S. pos-
sessions. Accordingly, the references to
State and State law in section 9832(b)(2)
encompass the 50 States, the District of
Columbia, and the U.S. possessions.

## Taxability and Other Treatment of the Fee

Section 9010(f)(2) treats the fee as a
tax described in section 275(a)(6) (relat-
ing to taxes for which no deduction is
allowed). Before issuing the proposed reg-
ulations, the Treasury Department and the
IRS received comments stating that cov-
ered entities may attempt to pass on the
cost of the fee to policyholders, either by
a corresponding increase in premiums or
by separately charging policyholders for a
portion of the fee. The preamble to the
proposed regulations stated that, under
section 61(a), gross income means all in-
come from whatever source derived un-
less a provision of the Code or other law
specifically excludes the payment from
gross income. Therefore, a covered enti-
ty's gross income includes amounts re-
ceived from policyholders to offset the
cost of the fee, whether or not separately
stated on any bill. The preamble requested
comments on whether the text of the reg-
ulations should be revised to clarify that
recovered fee amounts are included in a
covered entity's gross income. Numerous
commenters disagreed with the preamble
statement and requested that the final reg-
ulations permit covered entities to exclude
from income any amounts collected from
policyholders to offset the cost of the fee.
One commenter alternatively suggested
that the payment of income taxes on the
fee should count towards the payment of
the fee itself. The final regulations do not
adopt these suggestions. The Treasury De-
partment and the IRS will issue separate
guidance to clarify that covered entities
must include in income under section

61(a) any amounts they collect from pol-
icyholders to offset the cost of the fee.

Commenters suggested that the final
regulations prohibit a covered entity from
collecting amounts to offset the cost of the
fee when they collect premiums from ex-
cluded entities such as governmental en-
tities and VEBAs. The final regulations do
not adopt this suggestion. The health in-
surance provider, and not the payor of
premiums, is liable for the fee. Therefore,
any exclusions apply at the health insur-
ance provider level.

A commenter asked if a covered entity
must disclose to its policyholders the ex-
tent to which the cost of the fee is in-
cluded in a policyholder's premium. Be-
cause the health insurance provider, and
not the policyholder, is liable for the fee,
the final regulations do not require a cov-
ered entity to disclose to its policyholders
any amounts included in premiums to off-
set the cost of the fee, although nothing in
the final regulations prohibits a covered
entity from disclosing these amounts.
However, a covered entity may be subject
to State or other Federal rules, if any,
regarding disclosures of these amounts.

# Availability of IRS Documents

The IRS revenue rulings cited in this
preamble are published in the Internal
Revenue Cumulative Bulletin and are
available from the superintendent of Doc-
uments, United States Government Print-
ing Office, Washington, D.C. 20402. The
IRS notice cited in this preamble is avail-
able at www.irs.gov.

# Special Analyses

It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866, as supplemented by Executive Or-
der 13563. Therefore, a regulatory assess-
ment is not required. This regulation
merely implements the fee imposed by
section 9010 and does not impose the fee
itself. It also has been determined that
section 553(b) of the Administrative Pro-
cedure Act (5 U.S.C. chapter 5) does not
apply to these regulations. It is hereby
certified that the collection of information

2See ACA section 1301(b)(2), referencing section 2791(b) of the PHSA (42 USC 300gg-91). The definition of health insurance issuer in section 2791(b) of the PHSA is substantially similar
to the definition in section 9832(b)(2) of the Code.

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in these regulations will not have a signif-
icant economic impact on a substantial
number of small entities. This certification
is based on the fact that the only collection
burden imposed by these regulations is the
requirement to maintain a record of con-
sent to the selection of a designated entity,
and this collection burden applies only to
designated entities of controlled groups,
which tend to be large corporations, and
their members. Therefore, a Regulatory
Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not
required. Pursuant to section 7805(f), the
notice of proposed rulemaking was sub-
mitted to the Chief Counsel for Advocacy
of the Small Business Administration for
comment on its impact on small business,
and no comments were received.

## Drafting Information

The principal author of these regula-
tions is Charles J. Langley, Jr., Office of
the Associate Chief Counsel (Pass-
throughs and Special Industries). How-
ever, other personnel from the Treasury
Department and the IRS participated in
their development.

* * * * *

## Adoption of Amendments to the Regulations

Accordingly, 26 CFR chapter 1 is
amended by adding part 57 to subchapter
D and amending part 602 to read as fol-
lows:

Paragraph 1. Part 57 is added to read as
follows:

## Part 57 - Health Insurance Providers Fee

Sec.

57.1 Overview.

57.2 Explanation of terms.

57.3 Reporting requirements and asso-
ciated penalties.

57.4 Fee calculation.

57.5 Notice of preliminary fee calcula-
tion.

57.6 Error correction process.

57.7 Notification and fee payment.

57.8 Tax treatment of fee.

57.9 Refund claims.

57.10 Effective/applicability date.

57.6302-1 Method of paying the health
insurance providers fee.

Authority: 26 U.S.C. 7805; sec. 9010,
Public Law 111-148 (124 Stat. 119
(2010)).

Section 57.3 also issued under 26 U.S.C.
6071(a)

Section 57.7 also issued under 26 U.S.C.
6302(a).

Section 57.6302-1 also issued under 26
U.S.C. 6302(a).

### §57.1 Overview.

(a) The regulations in this part 57 are
designated "Health Insurance Providers
Fee Regulations."

(b) The regulations in this part 57 pro-
vide guidance on the annual fee imposed
on covered entities engaged in the busi-
ness of providing health insurance by sec-
tion 9010 of the Patient Protection and
Affordable Care Act (PPACA), Public
Law 111-148 (124 Stat. 119 (2010)), as
amended by section 10905 of PPACA,
and as further amended by section 1406 of
the Health Care and Education Reconcil-
iation Act of 2010, Public Law 111-152
(124 Stat. 1029 (2010)) (collectively, the
Affordable Care Act or ACA). All refer-
ences to section 9010 in this part 57 are
references to section 9010 of the ACA.
Unless otherwise indicated, all other ref-
erences to subtitles, chapters, subchapters,
and sections are references to subtitles,
chapters, subchapters and sections in the
Internal Revenue Code and the related
regulations.

(c) Section 9010(e)(1) sets an applica-
ble fee amount for each year, beginning
with 2014, that will be apportioned among
covered entities with aggregate net premi-
ums written over $25 million for health
insurance for United States health risks.
Generally, each covered entity is liable for
a fee in each fee year that is based on its
net premiums written during the data year
in an amount determined by the Internal
Revenue Service (IRS) under the rules of
this part.

§57.2 Explanation of terms.

(a) In general. This section explains
the terms used in this part 57 for purposes
of the fee.

(b) Covered entity-(1) In general. Ex-
cept as provided in paragraph (b)(2) of
this section, the term covered entity means

any entity with net premiums written for
health insurance for United States health
risks in the fee year if the entity is-

(i) A health insurance issuer within the
meaning of section 9832(b)(2), defined in
section 9832(b)(2) as an insurance com-
pany, insurance service, or insurance or-
ganization that is licensed to engage in the
business of insurance in a State and that is
subject to State law that regulates insur-
ance (within the meaning of section
514(b)(2) of the Employee Retirement In-
come Security Act of 1974 (ERISA));

(ii) A health maintenance organization
within the meaning of section 9832(b)(3),
defined in section 9832(b)(3) as-

(A) A Federally qualified health main-
tenance organization (as defined in section
1301(a) of the Public Health Service Act);

(B) An organization recognized under
State law as a health maintenance organi-
zation; or

(C) A similar organization regulated
under State law for solvency in the same
manner and to the same extent as such a
health maintenance organization;

(iii) An insurance company subject to
tax under part I or II of subchapter L, or
that would be subject to tax under part I or
II of subchapter L but for the entity being
exempt from tax under section 501(a);

(iv) An entity that provides health in-
surance under Medicare Advantage,
Medicare Part D, or Medicaid; or

(v) A multiple employer welfare ar-
rangement (MEWA), within the meaning
of section 3(40) of ERISA, to the extent
not fully insured, provided that for this
purpose a covered entity does not include
a MEWA that with respect to the plan
year ending with or within the section
9010 data year satisfies the requirements
to be exempt from reporting under 29
CFR 2520.101-2(c)(2)(ii)(A), (B), or (C).

(2) Exclusions-(i) Self-insured em-
ployer. The term covered entity does not
include any entity (including a voluntary
employees' beneficiary association under
section 501(c)(9) (VEBA)) that is part of a
self-insured employer plan to the extent
that such entity self-insures its employees'
health risks. The term self-insured em-
ployer means an employer that sponsors a
self-insured medical reimbursement plan
within the meaning of §1.105-
11(b)(1)(i) of this chapter. Self-insured
medical reimbursement plans include

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plans that do not involve shifting risk to
an unrelated third party as described in
§1.105-11(b)(1)(ii) of this chapter. A self-
insured medical reimbursement plan may
use an insurance company or other third
party to provide administrative or book-
keeping functions. For purposes of this
section, the term self-insured employer
does not include a MEWA.

(ii) Governmental entity. The term cov-
ered entity does not include any govern-
mental entity. For this purpose, the term
governmental entity means-

(A) The government of the United
States;

(B) Any State or a political subdivision
thereof (as defined for purposes of section
103) including, for example, a State health
department or a State insurance commission;

(C) Any Indian tribal government (as
defined in section 7701(a)(40)) or a sub-
division thereof (determined in accor-
dance with section 7871(d)); or

(D) Any agency or instrumentality of
any of the foregoing.

(iii) Certain nonprofit corporations.
The term covered entity does not include
any entity-

(A) That is incorporated as a nonprofit
corporation under a State law;

(B) No part of the net earnings of which
inures to the benefit of any private share-
holder or individual (within the meaning of
§§1.501(a)-1(c) and 1.501(c)(3)-1(c)(2) of
this chapter);

(C) No substantial part of the activities
of which is carrying on propaganda, or
otherwise attempting, to influence legisla-
tion (within the meaning of §1.501(c)(3)-
1(c)(3)(ii) of this chapter) (or which is
described in section 501(h)(3) and is not
denied exemption under section 501(a) by
reason of section 501(h));

(D) That does not participate in, or inter-
vene in (including the publishing or distrib-
uting of statements), any political campaign
on behalf of (or in opposition to) any can-
didate for public office (within the meaning
of §1.501(c)(3)-1(c)(3)(iii) of this chapter);
and

(E) More than 80 percent of the gross
revenues of which is received from gov-
ernment programs that target low-income,
elderly, or disabled populations under ti-
tles XVIII, XIX, and XXI of the Social
Security Act.

(iv) Certain voluntary employees' ben-
eficiary associations (VEBAs). The term
covered entity does not include any entity
that is described in section 501(c)(9) that
is established by an entity (other than by
an employer or employers) for purposes
of providing health care benefits. This ex-
clusion applies to a VEBA that is estab-
lished by a union or established pursuant
to a collective bargaining agreement and
having a joint board of trustees (such as in
the case of a multiemployer plan within
the meaning of section 3(37) of ERISA or
a single-employer plan described in sec-
tion 302(c)(5) of the Labor Management
Relations Act, 29 U.S.C. 186(c)(5)). This
exclusion does not apply to a MEWA.

(3) State. Solely for purposes of para-
graph (b) of this section, the term State
means any of the 50 States, the District of
Columbia, or any of the possessions of the
United States, including American Sa-
moa, Guam, the Northern Mariana Is-
lands, Puerto Rico, and the Virgin Islands.

(c) Controlled groups-(1) In general.
The term controlled group means a group
of two or more persons, including at least
one person that is a covered entity, that is
treated as a single employer under section
52(a), 52(b), 414(m), or 414(o).

(2) Treatment of controlled group. A
controlled group (as defined in paragraph
(c)(1) of this section) is treated as a single
covered entity for purposes of the fee.

(3) Special rules. For purposes of para-
graph (c)(1) of this section (related to con-
trolled groups)-

(i) A foreign entity subject to tax under
section 881 is included within a controlled
group under section 52(a) or (b); and

(ii) A person is treated as being a mem-
ber of the controlled group if it is a mem-
ber of the group at the end of the day on
December 31st of the data year.

(d) Data year. The term data year
means the calendar year immediately be-
fore the fee year. Thus, for example, 2013
is the data year for fee year 2014.

(e) Designated entity-(1) In general.
The term designated entity means the per-
son within a controlled group that is des-
ignated to act on behalf of the controlled
group regarding the fee with respect to-

(i) Filing Form 8963, Report of Health
Insurance Provider Information;

(ii) Receiving IRS communications
about the fee for the group;

(iii) Filing a corrected Form 8963 for
the group, if applicable, as described in
§57.6; and

(iv) Paying the fee for the group to the
government.

(2) Selection of designated entity-(i) In
general. Except as provided in paragraph
(e)(2)(ii) of this section, each controlled
group must select a designated entity by
having that entity file the Form 8963 in
accordance with the form instructions. The
designated entity must state under penalties
of perjury that all persons that provide
health insurance for United States health
risks that are members of the group have
consented to the selection of the designated
entity. Each member of a controlled group
must maintain a record of its consent to the
controlled group's selection of the desig-
nated entity. The designated entity must
maintain a record of all member consents.

(ii) Requirement for consolidated
groups; common parent. If a controlled
group, without regard to foreign corpora-
tions included under section 9010(c)(3)(B),
is also an affiliated group the common par-
ent of which files a consolidated return for
Federal income tax purposes, the designated
entity is the agent for the group (within the
meaning of §1.1502-77 of this chapter) for
the data year.

(iii) Failure to select a designated en-
tity. Excepted as provided in paragraph
(e)(2)(ii) of this section, if a controlled
group fails to select a designated entity as
provided in paragraph (e)(2)(i) of this sec-
tion, then the IRS will select a member of
the controlled group to be the designated
entity. If the IRS selects the designated
entity, then all members of the controlled
group that provide health insurance for a
United States health risk will be deemed
to have consented to the IRS's selection of
the designated entity.

(f) Fee. The term fee means the fee
imposed by section 9010 on each covered
entity engaged in the business of provid-
ing health insurance.

(g) Fee year. The term fee year means
the calendar year in which the fee must be
paid to the government. The first fee year
is 2014.

(h) Health insurance-(1) In general.
Except as provided in paragraph (h)(2) of
this section, the term health insurance gen-
erally has the same meaning as the term
health insurance coverage in section

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9832(b)(1)(A), defined to mean benefits
consisting of medical care (provided di-
rectly, through insurance or reimbursement,
or otherwise) under any hospital or medical
service policy or certificate, hospital or med-
ical service plan contract, or health mainte-
nance organization contract, when these
benefits are offered by an entity that is one
of the types of entities described in para-
graph (b)(1)(i) through (b)(1)(v) of this sec-
tion. The term health insurance includes
limited scope dental and vision benefits un-
der section 9832(c)(2)(A) and retiree-only
health insurance.

(2) Exclusions. The term health insur-
ance does not include-

(i) Coverage only for accident, or dis-
ability income insurance, or any combina-
tion thereof, within the meaning of section
9832(c)(1)(A);

(ii) Coverage issued as a supplement to
liability insurance within the meaning of
section 9832(c)(1)(B);

(iii) Liability insurance, including gen-
eral liability insurance and automobile li-
ability insurance, within the meaning of
section 9832(c)(1)(C);

(iv) Workers' compensation or similar
insurance within the meaning of section
9832(c)(1)(D);

(v) Automobile medical payment in-
surance within the meaning of section
9832(c)(1)(E);

(vi) Credit-only insurance within the
meaning of section 9832(c)(1)(F);

(vii) Coverage for on-site medical clin-
ics within the meaning of section
9832(c)(1)(G);

(viii) Other insurance coverage that is
similar to the insurance coverage in para-
graph (h)(2)(i) through (vii) of this section
under which benefits for medical care are
secondary or incidental to other insurance
benefits, within the meaning of section
9832(c)(1)(H), to the extent such insur-
ance coverage is specified in regulations
under section 9832(c)(1)(H);

(ix) Benefits for long-term care, nurs-
ing home care, home health care,
community-based care, or any combina-
tion thereof, within the meaning of section
9832(c)(2)(B), and such other similar,
limited benefits to the extent such benefits
are specified in regulations under section
9832(c)(2)(C);

(x) Coverage only for a specified dis-
ease or illness within the meaning of sec-
tion 9832(c)(3)(A);

(xi) Hospital indemnity or other fixed
indemnity insurance within the meaning
of section 9832(c)(3)(B);

(xii) Medicare supplemental health in-
surance (as defined under section
1882(g)(1) of the Social Security Act),
coverage supplemental to the coverage
provided under chapter 55 of title 10,
United States Code, and similar supple-
mental coverage provided to coverage un-
der a group health plan, within the mean-
ing of section 9832(c)(4);

(xiii) Coverage under an employee assis-
tance plan, a disease management plan, or a
wellness plan, if the benefits provided under
the plan constitute excepted benefits under
section 9832(c)(2) (or do not otherwise pro-
vide benefits consisting of health insurance
under paragraph (h)(1) of this section);

(xiv) Student administrative health fee ar-
rangements, as defined in paragraph (h)(3);

(xv) Travel insurance, as defined in
paragraph (h)(4) of this section; or

(xvi) Indemnity reinsurance, as defined
in paragraph (h)(5)(i) of this section.

(3) Student administrative health fee
arrangement. For purposes of paragraph
(h)(2)(xiv) of this section, the term student
administrative health fee arrangement
means an arrangement under which an
educational institution, other than through
an insured arrangement, charges student
administrative health fees to students on a
periodic basis to help cover the cost of
student health clinic operations and care
delivery (regardless of whether the stu-
dent uses the clinic and regardless of
whether the student purchases any avail-
able student health insurance coverage).

(4) Travel insurance. For purposes of
paragraph (h)(2)(xv) of this section, the
term travel insurance means insurance
coverage for personal risks incident to
planned travel, which may include, but is
not limited to, interruption or cancellation
of trip or event, loss of baggage or per-
sonal effects, damages to accommoda-
tions or rental vehicles, and sickness, ac-
cident, disability, or death occurring
during travel, provided that the health
benefits are not offered on a stand-alone
basis and are incidental to other coverage.
For this purpose, the term travel insurance
does not include major medical plans that

provide comprehensive medical protec-
tion for travelers with trips lasting 6
months or longer, including, for example,
those working overseas as an expatriate or
military personnel being deployed.

(5) Reinsurance-(i) Indemnity reinsur-
ance. For purposes of paragraphs (h)(2)(xvi)
and (k) of this section, the term indemnity
reinsurance means an agreement between
one or more reinsuring companies and a
covered entity under which-

(A) The reinsuring company agrees to
accept, and to indemnify the issuing com-
pany for, all or part of the risk of loss under
policies specified in the agreement; and

(B) The covered entity retains its lia-
bility to, and its contractual relationship
with, the individuals whose health risks
are insured under the policies specified in
the agreement.

(ii) Assumption reinsurance. For pur-
poses of paragraph (k) of this section, the
term assumption reinsurance means rein-
surance for which there is a novation and
the reinsurer takes over the entire risk of
loss pursuant to a new contract.

(i) Located in the United States. The term
located in the United States means present
in the United States (within the meaning of
paragraph (m) of this section) under section
7701(b)(7) (for presence in the 50 States and
the District of Columbia) or §1.937-
1(c)(3)(i) of this chapter (for presence in a
possession of the United States).

(j) NAIC. The term NAIC means the
National Association of Insurance Com-
missioners.

(k) Net premiums written-The term
net premiums written means premiums
written, including reinsurance premiums
written, reduced by reinsurance ceded,
and reduced by ceding commissions and
medical loss ratio (MLR) rebates with re-
spect to the data year. For this purpose,
MLR rebates are computed on an accrual
basis in determining net premiums writ-
ten. Because indemnity reinsurance
within the meaning of paragraph (h)(5)(i)
of this section is not health insurance un-
der paragraph (h)(1) of this section, the
term net premiums written does not in-
clude premiums written for indemnity re-
insurance and is not reduced by indemnity
reinsurance ceded. However, in the case
of assumption reinsurance within the
meaning of paragraph (h)(5)(ii) of this
section, the term net premiums written

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does include premiums written for as-
sumption reinsurance and is reduced by
assumption reinsurance premiums ceded.

(l) SHCE. The term SHCE means the
Supplemental Health Care Exhibit. The
SHCE is a form published by the NAIC
that most covered entities are required to
file annually under State law.

(m) United States. For purposes of
paragraph (i) of this section, the term
United States means the 50 States, the
District of Columbia, and any possession
of the United States, including American
Samoa, Guam, the Northern Mariana Is-
lands, Puerto Rico, and the Virgin Islands.

(n) United States health risk. The term
United States health risk means the health
risk of any individual who is-

(1) A United States citizen;

(2) A resident of the United States (within
the meaning of section 7701(b)(1)(A)); or

(3) Located in the United States
(within the meaning of paragraph (i) of
this section) during the period such indi-
vidual is so located.

#### §57.3 Reporting requirements and associated penalties.

(a) Reporting requirement-(1) In gen-
eral. Annually, each covered entity, in-
cluding each controlled group that is
treated as a single covered entity, must
report its net premiums written for health
insurance of United States health risks
during the data year to the IRS by April
15th of the fee year on Form 8963, Report
of Health Insurance Provider Informa-
tion, in accordance with the instructions
for the form. A covered entity that has net
premiums written during the data year is
subject to this reporting requirement even
if it does not have any amount taken into
account as described in §57.4(a)(4). If an
entity is not in the business of providing
health insurance for any United States
health risk in the fee year, it is not a
covered entity and does not have to report.

(2) Manner of reporting. The IRS may
provide rules in guidance published in the
Internal Revenue Bulletin for the manner
of reporting by a covered entity under this
section, including rules for reporting by a
designated entity on behalf of a controlled
group that is treated as a single covered
entity.

(3) Disclosure of reported information.
Pursuant to section 9010(g)(4), the infor-
mation reported on each original and cor-
rected Form 8963 will be open for public
inspection or available upon request.

(b) Penalties-(1) Failure to report-
(i) In general. A covered entity that fails
to timely submit a report containing the
information required by paragraph (a) of
this section is liable for a failure to report
penalty in the amount described in para-
graph (b)(1)(ii) of this section in addition
to its fee liability and any other applicable
penalty, unless the failure is due to rea-
sonable cause as defined in paragraph
(b)(1)(iii) of this section.

(ii) Amount. The amount of the failure
to report penalty described in paragraph

(b)(1)(i) of this section is-

(A) $10,000, plus

(B) The lesser of-

(1) An amount equal to $1,000 multi-
plied by the number of days during which
such failure continues; or

(2) The amount of the covered entity's
fee for which the report was required.

(iii) Reasonable cause. The failure to re-
port penalty described in paragraph (b)(1)(i)
of this section is waived if the failure is due
to reasonable cause. A failure is due to rea-
sonable cause if the covered entity exercised
ordinary business care and prudence and
was nevertheless unable to submit the report
within the prescribed time. In determining
whether the covered entity was unable to
submit the report timely despite the exercise
of ordinary business care and prudence, the
IRS will consider all the facts and circum-
stances surrounding the failure to submit the
report.

(iv) Treatment of penalty. The failure
to report penalty described in this para-
graph (b)(1)-

(A) Is treated as a penalty under subti-
tle F;

(B) Must be paid on notice and demand
by the IRS and in the same manner as a
tax under the Internal Revenue Code; and

(C) Is a penalty for which only civil
actions for refund under procedures of
subtitle F apply.

(2) Accuracy-related penalty-(i) In
general. A covered entity that understates
its net premiums written for health insur-
ance of United States health risks in the
report required under paragraph (a)(1) of
this section is liable for an accuracy-

related penalty in the amount described in
paragraph (b)(2)(ii) of this section, in ad-
dition to its fee liability and any other
applicable penalty.

(ii) Amount. The amount of the
accuracy-related penalty described in
paragraph (b)(2)(i) of this section is the
excess of-

(A) The amount of the covered entity's
fee for the fee year that the IRS deter-
mines should have been paid in the ab-
sence of any understatement; over

(B) The amount of the covered entity's
fee for the fee year that the IRS deter-
mined based on the understatement.

(iii) Understatement. An understatement
of a covered entity's net premiums written
for health insurance of United States health
risks is the difference between the amount
of net premiums written that the covered
entity reported and the amount of net pre-
miums written that the IRS determines the
covered entity should have reported.

(iv) Treatment of penalty. The accuracy-
related penalty is subject to the provisions of
subtitle F that apply to assessable penalties
imposed under chapter 68.

(3) Controlled groups. Each member of a
controlled group that is required to provide
information to the controlled group's desig-
nated entity for purposes of the report re-
quired to be submitted by the designated
entity on behalf of the controlled group is
jointly and severally liable for any penalties
described in this paragraph (b) for any re-
porting failures by the designated entity.

§57.4 Fee calculation.

(a) Fee components-(1) In general.
For every fee year, the IRS will calculate
a covered entity's allocated fee as de-
scribed in this section.

(2) Calculation of net premiums writ-
ten. Each covered entity's allocated fee
for any fee year is equal to an amount that
bears the same ratio to the applicable
amount as the covered entity's net premi-
ums written for health insurance of United
States health risks during the data year
taken into account bears to the aggregate
net premiums written for health insurance
of United States health risks of all covered
entities during the data year taken into
account.

(3) Applicable amount. The applicable
amounts for fee years are-

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Fee year

Applicable amount

2014

$ 8,000,000,000

2015

$ 11,300,000,000

2016

$ 11,300,000,000

2017

$ 13,900,000,000

2018

$ 14,300,000,000

2019 and thereafter

The applicable amount in the preceding fee year increased by the rate of premium growth (within the meaning of section 36B(b)(3)(A)(ii)).

(4) Net premiums written taken into ty's net premiums written for health insur- any data year are taken into account as
account-(i) In general. A covered enti-
ance of United States health risks during
follows:

Covered entity's net premiums written during the data year that are:

Percentage of net premiums written taken into account is:

Not more than $25,000,000

0

More than $25,000,000 but not more than $50,000,000

50

More than $50,000,000

100

(ii) Controlled groups. In the case of a
controlled group, paragraph (a)(4)(i) of
this section applies to all net premiums
written for health insurance of United
States health risks during the data year, in
the aggregate, of the entire controlled
group, except that any net premiums writ-
ten by any member of the controlled
group that is a nonprofit corporation meet-
ing the requirements of §57.2(b)(2)(iii) or
a voluntary employees' beneficiary asso-
ciation meeting the requirements of
§57.2(b)(2)(iv) are not taken into account.

(iii) Partial exclusion for certain ex-
empt activities. After the application of
paragraph (a)(4)(i) of this section, if the
covered entity (or any member of a con-
trolled group treated as a single covered
entity) is exempt from Federal income tax
under section 501(a) and is described in
section 501(c)(3), (4), (26), or (29) as of
December 31st of the data year, then only
50 percent of its remaining net premiums
written for health insurance of United
States health risks that are attributable to
its exempt activities (and not to activities
of an unrelated trade or business as de-
fined in section 513) during the data year
are taken into account. If an entity to
which this partial exclusion applies is a
member of a controlled group, then the
partial exclusion applies to that entity af-
ter first applying paragraph (a)(4)(i) on a

pro rata basis to all members of the con-
trolled group.

(b) Determination of net premiums
written-(1) In general. The IRS will de-
termine net premiums written for health
insurance of United States health risks for
each covered entity based on the Form
8963, Report of Health Insurance Pro-
vider Information, submitted by each cov-
ered entity, together with any other source
of information available to the IRS. Other
sources of information that the IRS may
use to determine net premiums written for
each covered entity include the SHCE,
which supplements the annual statement
filed with the NAIC pursuant to State law,
the annual statement itself or the Accident
and Health Policy Experience filed with
the NAIC, the MLR Annual Reporting
Form filed with the Center for Medicare &
Medicaid Services' Center for Consumer
Information and Insurance Oversight of
the U.S. Department of Health and Hu-
man Services, or any similar statements
filed with the NAIC, with any State gov-
ernment, or with the Federal government
pursuant to applicable State or Federal
requirements.

(2) Presumption for United States
health risks. For any covered entity that
files the SHCE with the NAIC, the entire
amount reported on the SHCE as direct
premiums written will be considered to be
for health insurance of United States

health risks as described in §57.2(n) (sub-
ject to any applicable exclusions for
amounts that are not health insurance as
described in §57.2(h)(2)) unless the cov-
ered entity can demonstrate otherwise.

(c) Determination of amounts taken
into account. (1) For each fee year and for
each covered entity, the IRS will calculate
the net premiums written for health insur-
ance of United States health risks taken
into account during the data year. The
resulting number is the numerator of the
fraction described in paragraph (d)(1) of
this section.

(2) For each fee year, the IRS will
calculate the aggregate net premiums
written for health insurance of United
States health risks taken into account for
all covered entities during the data year.
The resulting number is the denominator
of the fraction described in paragraph
(d)(2) of this section.

(d) Allocated fee calculated. For each
covered entity for each fee year, the IRS
will calculate the covered entity's allo-
cated fee by multiplying the applicable
amount from paragraph (a)(3) of this sec-
tion by a fraction-

(1) The numerator of which is the cov-
ered entity's net premiums written for
health insurance of United States health
risks during the data year taken into ac-
count (described in paragraph (c)(1) of
this section); and

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(2) The denominator of which is the
aggregate net premiums written for health
insurance of United States health risks for
all covered entities during the data year
taken into account (described in paragraph
(c)(2) of this section).

#### §57.5 Notice of preliminary fee calculation.

(a) Content of notice. Each fee year, the
IRS will make a preliminary calculation
of the fee for each covered entity as de-
scribed in §57.4. The IRS will notify each
covered entity of its preliminary fee cal-
culation for that fee year. The notification
to a covered entity of its preliminary fee
calculation will include-

(1) The covered entity's allocated fee;

(2) The covered entity's net premiums
written for health insurance of United
States health risks;

(3) The covered entity's net premiums
written for health insurance of United
States health risks taken into account after
the application of §57.4(a)(4);

(4) The aggregate net premiums writ-
ten for health insurance of United States
health risks taken into account for all cov-
ered entities; and

(5) Instructions for how to submit a
corrected Form 8963, Report of Health
Insurance Provider Information, to cor-
rect any errors through the error correc-
tion process.

(b) Timing of notice. The IRS will
specify in other guidance published in the
Internal Revenue Bulletin the date by
which it will send each covered entity a
notice of its preliminary fee calculation.

#### §57.6 Error correction process.

(a) In general. Upon receipt of its pre-
liminary fee calculation, each covered en-
tity must review this calculation during
the error correction period. If the covered
entity identifies one or more errors in its
preliminary fee calculation, the covered
entity must timely submit to the IRS a
corrected Form 8963, Report of Health
Insurance Provider Information, during
the error correction period. The corrected
Form 8963 will replace the original Form
8963 for all purposes, including for the
purpose of determining whether an
accuracy-related penalty applies, except

that a covered entity remains subject to
the failure to report penalty if it fails to
timely submit the original Form 8963. In
the case of a controlled group, if the pre-
liminary fee calculation for the controlled
group contains one or more errors, the
corrected Form 8963 must include all of
the required information for the entire
controlled group, including members that
do not have corrections.

(b) Time and manner. The IRS will
specify in other guidance published in the
Internal Revenue Bulletin the time and
manner by which a covered entity must
submit a corrected Form 8963. The IRS
will provide its final determination regard-
ing the covered entity's submission no
later than the time the IRS provides a
covered entity with a final fee calculation.

(c) Finality. Covered entities must as-
sert any basis for contesting their prelim-
inary fee calculation during the error cor-
rection period. In the interest of providing
finality to the fee calculation process, the
IRS will not accept a corrected Form 8963
after the end of the error correction period
or alter final fee calculations on the basis
of information provided after the end of
the error correction period.

### §57.7 Notification and fee payment.

(a) Content of notice. Each fee year, the
IRS will make a final calculation of the
fee for each covered entity as described in
§57.4. The IRS will base its final fee cal-
culation on each covered entity's original
or corrected Form 8963, Report of Health
Insurance Provider Information, as ad-
justed by other sources of information de-
scribed in §57.4(b)(1). The notification to
a covered entity of its final fee calculation
will include-

(1) The covered entity's allocated fee;

(2) The covered entity's net premiums
written for health insurance of United
States health risks;

(3) The covered entity's net premiums
written for health insurance of United
States health risks taken into account after
the application of §57.4(a)(4);

(4) The aggregate net premiums writ-
ten for health insurance of United States
health risks taken into account for all cov-
ered entities; and

(5) The final determination on the cov-
ered entity's corrected Form 8963, Report

of Health Insurance Provider Informa-
tion, if any.

(b) Timing of notice. The IRS will send
each covered entity a notice of its final fee
calculation by August 31st of the fee year.

(c) Differences in preliminary fee cal-
culation and final calculation. A covered
entity's final fee calculation may differ
from the covered entity's preliminary fee
calculation because of changes made pur-
suant to the error correction process de-
scribed in §57.6 or because the IRS dis-
covered additional information relevant to
the fee calculation through other informa-
tion sources as described in
§57.4(b)(1). Even if a covered entity did
not file a corrected Form 8963 described
in §57.6, a covered entity's final fee may
differ from a covered entity's preliminary
fee because of information discovered
about that covered entity through other
information sources. In addition, a change
in aggregate net premiums written for
health insurance of United States health
risks can affect every covered entity's fee
because each covered entity's fee is equal
to a fraction of the aggregate fee collected
from all covered entities.

(d) Payment of final fee. Each covered
entity must pay its final fee by September
30th of the fee year. For a controlled
group, the payment must be made using
the designated entity's Employer Identifi-
cation Number as reported on Form 8963.
The fee must be paid by electronic funds
transfer as required by §57.6302-1. There
is no tax return to be filed with the pay-
ment of the fee.

(e) Controlled groups. In the case of a
controlled group that is liable for the fee,
all members of the controlled group are
jointly and severally liable for the fee.
Accordingly, if a controlled group's fee is
not paid, the IRS may separately assess
each member of the controlled group for
the full amount of the controlled group's
fee.

§57.8 Tax treatment of fee.

(a) Treatment as an excise tax. The fee
is treated as an excise tax for purposes of
subtitle F (sections 6001-7874). Thus, ref-
erences in subtitle F to "taxes imposed by
this title," "internal revenue tax," and sim-
ilar references, are also references to the
fee. For example, the fee is assessed (sec-

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tion 6201), collected (sections 6301,
6321, and 6331), enforced (section 7602),
and subject to examination and summons
(section 7602) in the same manner as
taxes imposed by the Code.

(b) Deficiency procedures. The defi-
ciency procedures of sections 6211-6216
do not apply to the fee.

(c) Limitation on assessment. The IRS
must assess the amount of the fee for any
fee year within three years of September
30th of that fee year.

(d) Application of section 275. The fee
is treated as a tax described in section
275(a)(6) (relating to taxes for which no
deduction is allowed).

§57.9 Refund claims.

Any claim for a refund of the fee must
be made by the entity that paid the fee to
the government and must be made on
Form 843, Claim for Refund and Request
for Abatement, in accordance with the in-
structions for that form.

### §57.10 Effective/applicability date.

Sections 57.1 through 57.9 apply to
any fee that is due on or after September
30, 2014.

§57.6302-1 Method of paying the health
insurance providers fee.

(a) Fee to be paid by electronic funds
transfer. Under the authority of section
6302(a), the fee imposed on covered en-
tities engaged in the business of providing
health insurance for United States health
risks under section 9010 and §57.4 must
be paid by electronic funds transfer as
defined in §31.6302-1(h)(4)(i) of this
chapter, as if the fee were a depository
tax. For the time for paying the fee, see
§57.7.

(b) Effective/Applicability date. This
section applies with respect to any fee that
is due on or after September 30, 2014.

# PART 602 - OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 2. The authority citation for part
602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 3. In §602.101, paragraph (b) is
amended by adding the following entry in
numerical order to the table to read as
follows:

§602.101 OMB Control numbers.

* ** * *

(b) * * *

CFR part or section where identified and described

Current OMB control No.

* * * * * 57.2(e)(2)(i) * * * * *

1545-2249

John Dalrymple,
Deputy Commissioner for
Services and Enforcement.

Approved November 13, 2013

Mark J. Mazur,
Assistant Secretary of the Treasury
(Tax Policy).

(Filed by the Office of the Federal Register on November
26, 2013, 4:15 p.m., and published in the issue of the Federal
Register for November 29, 2013, 78 F.R. 71476)

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# Part III. Administrative, Procedural, and Miscellaneous

## Health Insurance Providers Fee; Procedural and Administrative Guidance

Notice 2013-76

### Purpose

This notice provides guidance on the
health insurance providers fee related to
(1) the time and manner for submitting
Form 8963, Report of Health Insurance
Provider Information, (2) the time and
manner for notifying covered entities of
their preliminary fee calculation, (3) the
time and manner for submitting a cor-
rected Form 8963 for the error correction
process, and (4) the time for notifying
covered entities of their final fee calcula-
tion.

### Background

Section 9010 of the Patient Protection
and Affordable Care Act (PPACA), Pub-
lic Law 111-148 (124 Stat. 119 (2010)),
as amended by section 10905 of PPACA,
and as further amended by section 1406 of
the Health Care and Education Reconcil-
iation Act of 2010, Public Law 111-152
(124 Stat. 1029 (2010)) (collectively, the
Affordable Care Act or ACA), imposes an
annual fee on covered entities engaged in
the business of providing health insurance
for United States health risks.

The Health Insurance Providers Fee
Regulations in 26 CFR Part 57, issued on
November 29, 2013, provide the method
by which each covered entity's annual fee
is calculated. Those regulations provide
that the Internal Revenue Service (IRS)
will issue additional guidance in the Inter-
nal Revenue Bulletin relating to the re-
porting and fee determination processes.
This notice provides that guidance.

Section 57.3(a)(1) provides that each
covered entity, including each controlled
group that is treated as a single covered
entity, must report its net premiums writ-
ten for health insurance of United States
health risks during the data year to the IRS
by April 15th of the fee year on Form
8963 in accordance with the instructions
for the form. Section 57.2(g) defines fee
year as the calendar year in which the fee

must be paid to the government, and
§ 57.2(d) defines data year as the calendar
year immediately before the fee year.

Section 57.3(a)(2) authorizes the IRS
to provide rules in guidance published in
the Internal Revenue Bulletin for the man-
ner of reporting by a covered entity under
this section, including rules for reporting
by a designated entity on behalf of a con-
trolled group that is treated as a single
covered entity. Section 57.2(c)(1) defines
controlled group as a group of two or
more persons, including at least one per-
son that is a covered entity, that is treated
as a single employer under § 52(a), 52(b),
414(m), or 414(o). Section 57.2(c)(2) pro-
vides that a controlled group is treated as
a single covered entity for purposes of the
fee. Section 57.2(e)(1) defines a desig-
nated entity as the person within the con-
trolled group that is designated to act on
behalf of the controlled group regarding
the fee with respect to filing Form 8963,
receiving IRS communications about the
fee for the group, filing a corrected Form
8963 for the group, if applicable, and pay-
ing the fee for the group to the govern-
ment.

Section 57.3(a)(3) provides that, pursu-
ant to section 9010(g)(4), the information
reported on each Form 8963 will be open
for public inspection or available upon
request.

Section 57.5 provides that, for each fee
year, the IRS will make a preliminary fee
calculation for each covered entity and
will notify each covered entity of this cal-
culation by the date prescribed in guid-
ance published in the Internal Revenue
Bulletin. Section 57.5(a) provides that the
notification will include (1) the covered
entity's allocated fee; (2) the covered en-
tity's net premiums written for health in-
surance of United States health risks; (3)
the covered entity's net premiums written
for health insurance of United States
health risks taken into account after appli-
cation of § 57.4(a)(4); (4) the aggregate
net premiums written for health insurance
of United States health risks taken into
account for all covered entities; and (5)
instructions for how to submit a corrected
Form 8963 to correct any errors through
the error correction process. Section
57.6(a) requires each covered entity to

review the preliminary fee calculation and
submit a corrected Form 8963 if there are
any errors. Section 57.6(b) provides that
the IRS will specify in other guidance
published in the Internal Revenue Bulletin
the time and manner by which a covered
entity must submit a corrected Form 8963.

Section 57.7(b) requires the IRS to
send each covered entity its final fee cal-
culation no later than August 31st of each
fee year. Section 57.7(d) requires each
covered entity to pay its fee by September
30th of each fee year.

Time and manner for submitting Form
8963

In accordance with § 57.3(a)(1), each
covered entity (or, in the case of a con-
trolled group, each designated entity)
must file its Form 8963 by April 15th of
each fee year. The Form 8963 must be
filed in accordance with the instructions
to the form. The form and the instruc-
tions will be electronically available at
www.irs.gov.

Time and manner for notifying covered
entities of their preliminary fee
calculation

The IRS will mail each covered entity
(or, in the case of a controlled group, each
designated entity) a notice of its prelimi-
nary fee calculation by June 15th of each
fee year. The notice of preliminary fee
calculation will include all of the informa-
tion required by § 57.5(a).

Time and manner for submitting an
error correction report

If the covered entity believes that the
notice of preliminary fee calculation con-
tains one or more errors in the mathemat-
ical calculation of the fee, the net premi-
ums written data, the net premiums
written after taking into account the appli-
cation of § 57.4(a)(4), or any other error,
the covered entity (or, in the case of a
controlled group, the designated entity)
must provide a corrected report to the IRS
by July 15th of each fee year. The covered
entity will make an error correction report
by completing in full a new Form 8963
and checking the "Corrected Report" box
on the form. The corrected Form 8963

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will replace the original Form 8963.
Therefore, the corrected report must con-
tain all of the information required by the
form's instructions. In the case of a con-
trolled group, if the notice of preliminary
fee calculation contains one or more er-
rors, the corrected Form 8963 must in-
clude all of the information required by
the form's instructions for the entire con-
trolled group, including members that do
not have corrections. Additionally, a cov-
ered entity may include attachments with
the corrected Form 8963 if any corrected
item requires further explanation.

The IRS will validate the data submit-
ted on the corrected Form 8963 to ensure
accuracy and completeness. Section
9010(b)(3) authorizes the IRS to use any
other source of information to determine
each covered entity's net premiums writ-
ten for health insurance of United States
health risks in addition to the information
reported by each covered entity. Section
57.4(b)(1) provides that other sources of
information that the IRS may use to de-
termine net premiums written include the
Supplemental Health Care Exhibit, which
supplements the annual statement filed
with the National Association of Insur-
ance Commissioners (NAIC) pursuant to

State law, the annual statement itself or
the Accident and Health Policy Experi-
ence filed with the NAIC, the Medical
Loss Ratio Annual Reporting Form filed
with the Center for Medicare & Medicaid
Services' Center for Consumer Informa-
tion and Insurance Oversight of the U.S.
Department of Health and Human Ser-
vices, or any similar statements filed with
the NAIC, with any State government, or
with the Federal government pursuant to
applicable State or Federal requirements.
To the extent any covered entity's prelim-
inary fee calculation changes as a result of
the error correction process, the final fee
calculation for one or more covered enti-
ties may differ from the preliminary fee
calculations that those entities previously
received. Any such changes will be re-
flected in each covered entity's final fee
calculation.

### Notification and Payment of Final Fee Calculation

In accordance with § 57.7(b), the IRS
will notify each covered entity (or each
designated entity of a controlled group
that is treated as a single covered entity)
of its final fee calculation on or before
August 31st of each fee year. In accor-

dance with § 57.7(d), each covered entity
(or designated entity, if applicable) must
pay this fee by September 30th of each fee
year.

### Disclosure

The information submitted on both
original and corrected Forms 8963 is not
confidential. Although, generally, tax re-
turns and return information are confiden-
tial, as required by § 6103, in accordance
with § 57.3(a)(3), the information on
Form 8963 is not subject to § 6103. All
information on Form 8963 will be open
for public inspection or available upon
request. Do not include personal informa-
tion other than that requested on Form
8963.

#### Drafting Information

The principal author of this notice is
Charles J. Langley, Jr. of the Office of
Associate Chief Counsel (Passthroughs &
Special Industries). For further informa-
tion regarding this notice, please contact
Mr. Langley at (202) 317-6855 (not a
toll-free call).

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# Part IV. Items of General Interest

## Notice of Proposed Rulemaking

## Net Investment Income Tax

### REG .- 130843-13

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Withdrawal of notice of pro-
posed rulemaking and notice of proposed
rulemaking.

SUMMARY: This document contains
proposed regulations under section 1411
of the Internal Revenue Code (Code).
These regulations provide guidance on the
computation of net investment income.
The regulations affect individuals, estates,
and trusts whose incomes meet certain
income thresholds.

DATES: The proposed rule published De-
cember 5, 2012 (77 FR 72612), is with-
drawn as of December 2, 2013. Com-
ments on this proposed rule must be
received by March 3, 2014. Comments on
the collection of information for this pro-
posed rule should be received by February
3, 2014.

ADDRESSES: Send submissions to: CC:
PA:LPD:PR (REG-130843-13), room
5205, Internal Revenue Service, PO Box
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand-
delivered Monday through Friday be-
tween the hours of 8 a.m. and 4 p.m. to
CC:PA:LPD:PR (REG-130843-13), Cou-
rier's Desk, Internal Revenue Service,
1111 Constitution Avenue, NW., Wash-
ington, DC, or sent electronically, via the
Federal eRulemaking portal at www.regu-
lations.gov (IRS REG-130843-13).

FOR FURTHER INFORMATION
CONTACT: Concerning the proposed reg-
ulations, David H. Kirk or Adrienne M.
Mikolashek at (202) 317-6852; concerning
submissions of comments or to request a
hearing, Oluwafunmilayo Taylor, (202)
317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

## Paperwork Reduction Act

The collection of information con-
tained in this notice of proposed rulemak-
ing has been submitted to the Office of
Management and Budget for review in
accordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)) under
control number 1545-2227. Comments on
the collection of information should be
sent to the Office of Management and
Budget, Attn: Desk Officer for the De-
partment of the Treasury, Office of Infor-
mation and Regulatory Affairs, Washing-
ton, DC 20503, with copies to the
Internal Revenue Service, Attn: IRS Re-
ports Clearance Officer, SE:W:CAR:MP:
T:T:SP, Washington, DC 20224. Com-
ments on the collection of information
should be received by February 3, 2014.
Comments are specifically requested con-
cerning:

Whether the proposed collection of in-
formation is necessary for the proper per-
formance of the functions of the IRS, in-
cluding whether the information will have
practical utility;

The accuracy of the estimated burden
associated with the proposed collection of
information; and

Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of services to provide informa-
tion.

The collection of information in these
proposed regulations is in §1.1411-7(g).

The information collected in proposed
§1.1411-7(g) is required by the IRS to
verify the taxpayer's reported adjustment
under section 1411(c)(4). This informa-
tion will be used to determine whether the
amount of tax has been reported and cal-
culated correctly. The likely respondents
are owners of interests in partnerships and
S corporations.

The burden for the collection of infor-
mation contained in these proposed regu-
lations will be reflected in the burden on
Form 8960 or another form that the IRS
designates, which will request the infor-
mation in the proposed regulations.

An agency may not conduct or spon-
sor, and a person is not required to re-

spond to, a collection of information un-
less it displays a valid control number
assigned by the Office of Management
and Budget.

Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by section 6103.

## Background

### I. Statutory Background

Section 1402(a)(1) of the Health Care
and Education Reconciliation Act of 2010
(Public Law 111-152, 124 Stat. 1029)
added section 1411 to a new chapter 2A of
subtitle A (Income Taxes) of the Code
effective for taxable years beginning after
December 31, 2012. Section 1411 im-
poses a 3.8 percent tax on certain individ-
uals, estates, and trusts.

In the case of an individual, section
1411(a)(1) imposes a tax (in addition to
any other tax imposed by subtitle A) for
each taxable year equal to 3.8 percent of
the lesser of: (A) the individual's net in-
vestment income for such taxable year, or
(B) the excess (if any) of: (i) the individ-
ual's modified adjusted gross income for
such taxable year, over (ii) the threshold
amount. Section 1411(b) provides that the
threshold amount is: (1) in the case of a
taxpayer making a joint return under sec-
tion 6013 or a surviving spouse (as de-
fined in section 2(a)), $250,000; (2) in the
case of a married taxpayer (as defined in
section 7703) filing a separate return,
$125,000; and (3) in the case of any other
individual, $200,000. Section 1411(d) de-
fines modified adjusted gross income as
adjusted gross income increased by the
excess of: (1) the amount excluded from
gross income under section 911(a)(1),
over (2) the amount of any deductions
(taken into account in computing adjusted
gross income) or exclusions disallowed
under section 911(d)(6) with respect to the
amount excluded from gross income un-
der section 911(a)(1).

In the case of an estate or trust, section
1411(a)(2) imposes a tax (in addition to

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any other tax imposed by subtitle A) for
each taxable year equal to 3.8 percent of
the lesser of: (A) the estate's or trust's
undistributed net investment income, or
(B) the excess (if any) of (i) the estate's or
trust's adjusted gross income (as defined
in section 67(e)) for such taxable year,
over (ii) the dollar amount at which the
highest tax bracket in section 1(e) begins
for such taxable year.

Section 1411(c)(1) provides that net
investment income means the excess (if
any) of: (A) the sum of (i) gross income
from interest, dividends, annuities, royal-
ties, and rents, other than such income
derived in the ordinary course of a trade or
business to which the tax does not apply,
(ii) other gross income derived from a
trade or business to which the tax applies,
and (iii) net gain (to the extent taken into
account in computing taxable income) at-
tributable to the disposition of property
other than property held in a trade or
business to which the tax does not apply;
over (B) the deductions allowed by subti-
tle A that are properly allocable to such
gross income or net gain.

### II. Regulatory Background

This document contains proposed
amendments to 26 CFR part 1 under sec-
tion 1411 of the Code. On December 5,
2012, the Treasury Department and the
IRS published a notice of proposed rule-
making in the Federal Register (REG-
130507-11; 77 FR 72612) relating to the
Net Investment Income Tax. On January
31, 2013, corrections to the proposed reg-
ulations were published in the Federal
Register (78 FR 6781) (collectively, the
"2012 Proposed Regulations"). Final reg-
ulations, issued contemporaneously with
these proposed regulations in this issue of
the Bulletin, contain amendments to the
Income Tax Regulations (26 CFR Part 1),
which finalize the 2012 Proposed Regula-
tions (the "2013 Final Regulations").
However, the Treasury Department and
the IRS also are proposing amendments to
the 2013 Final Regulations to provide ad-
ditional clarification and guidance with
respect to the application of section 1411
to certain specific types of property. Fur-
thermore, the Treasury Department and
the IRS are also interested in receiving
comments about other aspects of section

1411 that are not addressed in the 2013
Final Regulations or these proposed reg-
ulations. If such comments are received,
the Treasury Department and the IRS will
consider them for inclusion on future
Guidance Priority Lists.

The Treasury Department and the IRS
received comments on the 2012 Proposed
Regulations requesting that they address
the treatment of section 707(c) guaranteed
payments for capital, section 736 pay-
ments to retiring or deceased partners for
section 1411 purposes, and certain capital
loss carryovers. After consideration of all
comments received, the Treasury Depart-
ment and the IRS believe that it is appro-
priate to address the treatment of these
items in regulations. Because such guid-
ance had not been proposed in the 2012
Proposed Regulations, it is being issued
for notice and comment in these new pro-
posed regulations.

The Treasury Department and the IRS
also received comments on the simplified
method for applying section 1411 to in-
come recipients of charitable remainder
trusts (CRTs) that was proposed in the
2012 Proposed Regulations. The com-
ments recommended that the section 1411
classification incorporate the existing cat-
egory and class system under section 664.
These proposed regulations provide spe-
cial rules for the application of the section
664 system to CRTs that derive income
from controlled foreign corporations
(CFCs) or passive foreign investment
companies (PFICs) with respect to which
an election under §1.1411-10(g) is not in
place. Specifically, these proposed regula-
tions coordinate the application of the
rules applicable to shareholders of CFCs
and PFICs in §1.1411-10 with the section
664 category and class system adopted in
§1.1411-3(d)(2) of the 2013 Final Regu-
lations.

Furthermore, these proposed regula-
tions allow CRTs to elect to apply the
section 664 system adopted in the 2013
Final Regulations or the simplified
method set forth in the 2012 Proposed
Regulations. Some comments responding
to the 2012 Proposed Regulations re-
quested that we provide an election. The
Treasury Department and the IRS request
comments with regard to whether or not
taxpayers believe this election is prefera-
ble to the section 664 system adopted in

the 2013 Final Regulations. If it appears
that there is no significant interest in hav-
ing the election, the Treasury Department
and the IRS may omit it from the regula-
tions when finalized, and the simplified
method contained in the 2012 Proposed
Regulations would no longer be an option.

These proposed regulations also ad-
dress the net investment income tax char-
acterization of income and deductions at-
tributable to common trust funds (CTFs),
residual interests in real estate mortgage
investment conduits (REMICs), and cer-
tain notional principal contracts.

The Treasury Department and the IRS
also received comments on the 2012 Pro-
posed Regulations questioning the pro-
posed regulation's methodology for ad-
justing a transferor's gain or loss on the
disposition of its partnership interest or S
corporation stock. In view of these com-
ments, the 2013 Final Regulations re-
moved §1.1411-7 of the 2012 Proposed
Regulations and reserved §1.1411-7 in
the 2013 Final Regulations. This notice of
proposed rulemaking proposes revised
rules regarding the calculation of net gain
from the disposition of a partnership in-
terest or S corporation stock (each a
"Passthrough Entity") to which section
1411(c)(4) may apply.

## Explanation of Provisions

### 1. Overview of Proposed Regulations

These proposed regulations propose
additions and modifications to the 2013
Final Regulations, including guidance
with respect to certain paragraphs that
were reserved in the 2013 Final Regula-
tions.

To coordinate these proposed regula-
tions with the 2013 Final Regulations, the
proposed regulations are proposed to have
the same effective date as the 2013 Final
Regulations. However, any provisions ad-
opted when these proposed regulations are
finalized that are more restrictive than
these proposed regulations would apply
prospectively only. Taxpayers may rely
on these proposed regulations for pur-
poses of compliance with section 1411
until the issuance of these regulations as
final regulations. See §1.1411-1(f).

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### 2. Special Rules for Certain Partnership Payments

Section 731(a) treats gain from distri-
butions as gain from the sale or exchange
of a partnership interest. In general, the
section 1411 treatment of gain to a partner
under section 731 is governed by the rules
of section 1411(c)(1)(A)(iii). Such gain is
thus generally treated as net investment
income for purposes of section 1411
(other than as determined under section
1411(c)(4)). However, certain partnership
payments to partners are treated as not
from the sale or exchange of a partnership
interest. These payments include section
707(c) guaranteed payments for services
or the use of capital and certain section
736 distributions to a partner in liquida-
tion of that partner's partnership interest.
Because these payments are not treated as
from the sale or exchange of a partnership
interest, their treatment under section
1411 may differ from the general rule of
section 1411(c)(1)(A)(iii). The proposed
regulations therefore provide rules for the
section 1411 treatment of these payments.

### A. Section 707(c) payments

Section 707(c) provides that a partner-
ship payment to a partner is a "guaranteed
payment" if the payment is made for ser-
vices or the use of the capital, and the pay-
ment amount does not depend on partner-
ship income. Section 1.707-1(c) provides
that guaranteed payments to a partner for
services are considered as made to a person
who is not a partner, but only for the pur-
poses of section 61(a) (relating to gross in-
come) and, subject to section 263, section
162(a) (relating to trade or business ex-
penses). Section 1.704-1(b)(2)(iv)(o) pro-
vides that guaranteed payments are not part
of a partner's distributive share for purposes
of section 704(b).

The proposed regulations' treatment of
section 707(c) guaranteed payments under
section 1411 depends on whether the part-
ner receives the payment for services or
the use of capital. The proposed regula-
tions exclude all section 707(c) payments
received for services from net investment
income, regardless of whether these pay-
ments are subject to self-employment tax,
because payments for services are not in-
cluded in net investment income.

The Treasury Department and the IRS
believe that guaranteed payments for the use
of capital share many of the characteristics
of substitute interest, and therefore should
be included as net investment income. This
treatment is consistent with existing guid-
ance under section 707(c) and other sections
of the Code in which guaranteed payments
for the use of capital are treated as interest.
See, for example, §§1.263A-9(c)(2)(iii) and
1.469-2(e)(2)(ii).

### B. Treatment of section 736 payments

#### i. In General

Section 736 applies to payments made
by a partnership to a retiring partner or to a
deceased partner's successor in interest in
liquidation of the partner's entire interest in
the partnership. Section 736 does not apply
to distributions made to a continuing part-
ner, distributions made in the course of liq-
uidating a partnership entirely, or to pay-
ments received from persons other than the
partnership in exchange for the partner's
interest. Section 736 categorizes liquidating
distributions based on the nature of the pay-
ment as in consideration for either the part-
ner's share of partnership property or the
partner's share of partnership income. Sec-
tion 736(b) generally treats a payment in
exchange for the retiring partner's share of
partnership property as a distribution gov-
erned by section 731. Section 736(a) treats
payments in exchange for past services or
use of capital as either distributive share or a
guaranteed payment. Section 736(a) pay-
ments also include payments to retiring gen-
eral partners of service partnerships in ex-
change for unrealized receivables (other
than receivables described in the flush lan-
guage of section 751(c)) or for goodwill
(other than payments for goodwill provided
for in the partnership agreement) (collec-
tively, "Section 736(a) Property").

Because the application of section
1411 depends on the underlying nature of
the payment received, the section 736 cat-
egorization controls whether a liquidating
distribution is treated as net investment
income for purposes of section 1411.
Thus, the treatment of the payment for
purposes of section 1411 differs depend-
ing on whether the distribution is a section
736(b) distribution in exchange for part-
nership property or a section 736(a) dis-

tribution in exchange for past services, use
of capital, or Section 736(a) Property.
Among section 736(a) payments, the pro-
posed regulations further differentiate the
treatment of payments depending on: (i)
whether or not the payment amounts are
determined with regard to the income of
the partnership and (ii) whether the pay-
ment relates to Section 736(a) Property or
relates to services or use of capital.

Section 1.469-2(e)(2)(iii) contains
rules pertaining to whether section 736
liquidating distributions paid to a partner
will be treated as income or loss from a
passive activity. Where payments to a re-
tiring partner are made over a period of
years, the composition of the assets and
the status of the partner as passive or
nonpassive may change. Section 1.469-
2(e)(2)(iii) contains rules on the extent to
which those payments are classified as
passive or nonpassive for purposes of sec-
tion 469. The proposed regulations gener-
ally align the section 1411 characteriza-
tion of section 736 payments with the
treatment of the payments as passive or
nonpassive under §1.469-2(e)(2)(iii).

ii. Treatment of Section 736(b) Pay-
ments

Section 736(b) payments to retiring
partners in exchange for partnership prop-
erty (other than payments to retiring gen-
eral partners of service partnerships in ex-
change for Section 736(a) Property) are
governed by the rules generally applicable
to partnership distributions. Thus, gain or
loss recognized on these distributions is
treated as gain or loss from the sale or
exchange of the distributee partner's part-
nership interest under section 731(a).

The proposed regulations provide that
section 736(b) payments will be taken into
account as net investment income for sec-
tion 1411 purposes under section
1411(c)(1)(A)(iii) as net gain or loss from
the disposition of property. If the retiring
partner materially participates in a part-
nership trade or business, then the retiring
partner must also apply §1.1411-7 of
these proposed regulations to reduce ap-
propriately the net investment income un-
der section 1411(c)(4). Gain or loss relat-
ing to section 736(b) payments is included
in net investment income under section
1411(c)(1)(A)(iii) regardless of whether

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the payments are classified as capital gain
or ordinary income (for example, by rea-
son of section 751).

In the case of section 736(b) payments
that are paid over multiple years, the pro-
posed regulations provide that the charac-
terization of gain or loss as passive or
nonpassive is determined for all payments
as though all payments were made at the
time that the liquidation of the exiting
partner's interest commenced and is not
retested annually. The proposed regula-
tions thus adopt for section 1411 purposes
the section 469 treatment of section
736(b) payments paid over multiple years
as set forth in §1.469-2(e)(2)(iii)(A).

### iii. Treatment of Section 736(a) Payments

As described in part 2.B.i., section 736
provides for several different categories of
liquidating distributions under section
736(a). Payments received under section
736(a) may be an amount determined with
regard to the income of the partnership
taxable as distributive share under section
736(a)(1) or a fixed amount taxable as a
guaranteed payment under section
736(a)(2). The categorization of the pay-
ment as distributive share or guaranteed
payment will govern the treatment of the
payment for purposes of section 1411.

The determination of whether section
736(a) payments received over multiple
years are characterized as passive or non-
passive depends on whether the payments
are received in exchange for Section 736(a)
Property. With respect to section 736(a)(1)
payments in exchange for Section 736(a)
Property, §1.469-2(e)(2)(iii)(B) provides a
special rule that computes a percentage of
passive income that would result if the part-
nership sold the retiring partner's entire
share of Section 736(a) Property at the time
that the liquidation of the partner's interest
commenced. The percentage of passive in-
come is then applied to each payment re-
ceived. See §1.469-2(e)(2)(iii)(B)(1).
These rules apply to section 736(a)(1) and
section 736(a)(2) payments for Section
736(a) Property. The proposed regulations
adopt this treatment as set forth in section
469 for purposes of section 1411.

a. Section 736(a)(1) payments taxable
as distributive share

Section 736(a)(1) provides that if the
amount of a liquidating distribution (other

than a payment for partnership property
described in section 736(b)) is determined
with regard to the partnership's income,
then the payment is treated as a distribu-
tive share of income to the retiring part-
ner. For purposes of section 1411, the
items of income, gain, loss, and deduction
attributable to the distributive share are
taken into account in computing net in-
vestment income under section 1411(c)(1)
in a manner consistent with the item's
chapter 1 character and treatment. For ex-
ample, if the partner's distributive share
includes income from a trade or business
not described in section 1411(c)(2), that
income will be excluded from net invest-
ment income. However, if the distributive
share includes, for example, interest in-
come from working capital, then that in-
come is net investment income.

The proposed regulations treat section
736(a)(1) payments unrelated to Section
736(a) Property as characterized annually
as passive or nonpassive by applying the
general rules of section 469 to each pay-
ment in the year received. To the extent
that any payment under section 736(a)(1)
is characterized as passive income under
the principles of section 469, that payment
also will be characterized as passive in-
come for purposes of section 1411.

b. Section 736(a)(2) payments taxable
as guaranteed payments

Section 736(a)(2) provides that if the
amount of a liquidating distribution (other
than a payment for partnership property
described in section 736(b)) is determined
without regard to the partnership's in-
come, then the payment is treated as a
guaranteed payment as described in sec-
tion 707(c). Payments under section
736(a)(2) might be in exchange for ser-
vices, use of capital, or Section 736(a)
Property. The section 1411 treatment of
guaranteed payments for services or the
use of capital follows the general rules for
guaranteed payments set forth in part 2.A
of this preamble. Thus, section 736(a)(2)
payments for services are not included as
net investment income, and section
736(a)(2) payments for the use of capital
are included as net investment income.

Section 736(a)(2) payments in ex-
change for Section 736 Property are
treated as gain or loss from the disposition
of a partnership interest, which is gener-
ally included in net investment income

under section 1411(c)(1)(A)(iii). If the re-
tiring partner materially participates in a
partnership trade or business, then the re-
tiring partner must also apply §1.1411-
7 of these proposed regulations to reduce
appropriately the net investment income
under section 1411(c)(4). To the extent
that section 736(a)(2) payments exceed
the fair market value of Section 736(a)
Property, the proposed regulations pro-
vide that the excess will be treated as
either interest income or as income in
exchange for services, in a manner con-
sistent with the treatment under §1.469-
2(e)(2)(iii).

iv. Application of Section 1411(c)(4)
to Section 736 Payments

The proposed regulations provide that
section 1411(c)(4) applies to section
736(a)(2) and section 736(b) payments.
Thus, the inclusion of these payments as net
investment income may be limited if the
retiring partner materially participated in all
or a portion of the partnership's trade or
business. The extent of any limitation is
determined under the rules of §1.1411-7.

The proposed regulations provide that,
when section 736 payments are made over
multiple years, the characterization of
gain or loss as passive or nonpassive and
the values of the partnership assets are
computed for all payments as though all
payments were made at the time that the
liquidation of the exiting partner's interest
commenced, similar to the treatment in
§1.469-2(e)(2)(iii)(A).

If a partner's net investment income is
reduced pursuant to section 1411(c)(4), then
the difference between the amount of gain
recognized for chapter 1 and the amount
includable in net investment income after
the application of section 1411(c)(4) is
treated as an addition to basis, in a manner
similar to an installment sale for purposes of
calculating the partner's net investment in-
come attributable to these payments.

## v. Additional Public Comments

Commentators to the 2012 Proposed
Regulations requested that the Treasury
Department and the IRS issue guidance
under section 1411 regarding the treat-
ment of section 736 payments to retiring
and deceased partners. Some commenta-
tors sought clarification regarding the in-

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teraction between section 736 payments
and the net investment income exclusions
in sections 1411(c)(5) and 1411(c)(6).

Section 1411(c)(5) provides that net
investment income shall not include cer-
tain items of income attributable to distri-
butions from specifically enumerated
qualified plans. One commentator sug-
gested that section 736 payments should
be excluded from net investment income
under section 1411(c)(5) as analogous to
qualified plan distributions. The Treasury
Department and the IRS believe that sec-
tion 1411(c)(5) does not apply to section
736 payments because these payments do
not originate from a qualified plan de-
scribed in section 1411(c)(5). Therefore,
section 736 payments are not excluded by
reason of section 1411(c)(5).

Section 1411(c)(6) provides that net
investment income does not include any
item taken into account in determining
self-employment income for a taxable
year on which a tax is imposed by section
1401(b). In the context of section
1411(c)(6), §1.1411-9(a) of the 2013 Fi-
nal Regulations provides that the term
"taken into account" for self-employment
tax purposes does not include amounts
excluded from net earnings from self-
employment under sections 1402(a)(1)-
(17). Commentators suggested that certain
section 736 payments are excluded from
net earnings from self-employment by
reason of section 1402(a)(10) and
§1.1402(a)-17, and therefore should be
excluded from net investment income un-
der section 1411(c)(6) for similar policy
reasons. The Treasury Department and the
IRS believe that section 1411(c)(6) does
not apply to section 736 payments, except
to the extent that such payments are taken
into account, within the meaning of
§1.1411-9(a), in determining net earnings
from self-employment. In such a case, the
section 736 payment would be subject to
self-employment tax and therefore is not
included in net investment income by rea-
son of section 1411(c)(6) and §1.1411-
9(a).

Commentators also recommended spe-
cial rules for the interaction between sec-
tion 736 payments and the section 469
material participation rules solely for pur-
poses of section 1411. As discussed in this
part of the preamble, the proposed section
1411 rules rely heavily on the chacteriza-

tion of the section 736 payments under
section 469. Therefore, the Treasury De-
partment and the IRS do not believe that
special section 469 rules are necessary
solely for purposes of section 1411.

### 3. Treatment of Certain Capital Loss Carryforwards

In general, under chapter 1, capital
losses that exceed capital gains are al-
lowed as a deduction against ordinary in-
come only to the extent allowed by sec-
tion 1211(b). In the case of capital losses
in excess of the amounts allowed by sec-
tion 1211(b), section 1212(b)(1) treats
these losses as incurred in the following
year. Section 1.1411-4(d) adopts these
principles when computing net gain under
section 1411(c)(1)(A)(iii). Therefore, cap-
ital losses incurred in a year prior to the
effective date of section 1411 may be taken
into account in the computation of section
1411(c)(1)(A)(iii) net gain by reason of
the mechanics of section 1212(b)(1).
However, certain capital losses may not
be taken into account in determining net
investment income within the meaning of
section 1411(c)(1)(A)(iii) or by reason of
the exception in section 1411(c)(4)(B)
(generally, an "excluded capital loss"). In
the case of section 1411(c)(1)(A)(iii),
§1.1411-4(d)(4)(i) provides that capital
losses attributable to the disposition of
property used in a trade or business not
described in section 1411(c)(2) and
§1.1411-5 are excluded from the compu-
tation of net gain. In the case of section
1411(c)(4)(B), some or all of a capital loss
resulting from the disposition of certain
partnerships or S corporations is excluded
from the determination of net gain. Al-
though these capital losses are excluded
from the calculation of net gain in the year
of recognition by reason of §1.1411-
4(d)(4), such losses may not be fully off-
set by capital gains for chapter 1 purposes
in the same year. In that case, some (or
all) of the capital loss carryforward will
constitute excluded capital losses in the
subsequent year(s) by reason of the me-
chanics of section 1212(b)(1). Several
commentators identified this issue and re-
quested that the Treasury Department and
the IRS provide guidance on the identifi-
cation, tracking, and use of embedded,

excluded capital losses within a capital
loss carryforward.

In response to these comments, pro-
posed §1.1411-4(d)(4)(iii) creates an an-
nual adjustment to capital loss carryfor-
wards to prevent capital losses excluded
from the net investment income calcula-
tion in the year of recognition from be-
coming deductible losses in future years.
The annual adjustment in §1.1411-
4(d)(4)(iii) provides a method of identifi-
cation and an ordering rule that eliminate
the need for taxpayers to maintain a sep-
arate set of books and records for this item
to comply with section 1411. However,
the rule requires that taxpayers perform
the calculation annually, regardless of
whether they have a section 1411 tax lia-
bility in a particular year, to maintain the
integrity of the rule's carryforward adjust-
ment amounts for a subsequent year in
which they are subject to liability under
section 1411.

The rule provides that, for purposes of
computing net gain in §1.1411-4(d) and
any properly allocable deduction for ex-
cess losses in §1.1411-4(f)(4) (if any), the
taxpayer's capital loss carryforward from
the previous year is reduced by the lesser
of: (A) the amount of capital loss taken
into account in the current year by reason
of section 1212(b)(1), or (B) the amount
of net capital loss excluded from net in-
vestment income in the immediately pre-
ceding year. For purposes of (B), the
amount of net capital loss excluded from
net investment income in the previous
year includes amounts excluded by reason
of §1.1411-4(d)(4) (amount of capital
losses recognized in the preceding year)
plus the amount of the previous year's
adjustment required by this rule. Section
1.1411-4(d)(4)(iii) provides a multi-year
example to illustrate the application of the
rule.

The mechanics of the capital loss ad-
justment accomplishes several objectives.
First, the rule causes all capital losses
incurred prior to 2013 to be allowable
losses for the computation of net gain
under §1.1411-4(d) and any properly al-
locable deduction for excess losses in
§1.1411-4(f)(4) (if any). This result is
accomplished by the application of part
(B) of the rule described in the preceding
paragraph. Since the adjustment is based
on the lesser of (A) or (B), the amount of

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excluded capital losses in the year imme-
diately before the effective date of section
1411 is zero, so the loss adjustment in the
year following the effective date of sec-
tion 1411 will also be zero. Second, the
rule only requires an adjustment when a
taxpayer has excluded losses embedded
within a capital loss carryforward. There-
fore, taxpayers with no excluded capital
losses do not have to make any adjust-
ment. Third, the rule also provides a
mechanism for ordering the use of capital
losses to offset gains. The rule causes
excluded capital gains recognized in the
current year to be offset by excluded cap-
ital losses that are embedded in the capital
loss carryforward from the previous year.
This matching is accomplished by the use
of the term "net capital loss" in §1.1411-
4(d)(4)(iii)(B). If the excluded gain ex-
ceeds the amount of excluded capital loss
included in the carryforward amount and
any excluded capital loss amounts recog-
nized in the current year, the amount of
adjustment will be zero in the subsequent
year because there was no "net capital
loss" in the preceding year. In this situa-
tion, no adjustment is required because the
previous year's excluded gains were fully
absorbed by the excluded losses. Finally,
the rule allows taxpayers to use capital
non-excluded losses for purposes of the
excess loss deduction in §1.1411-
4(f)(4) before subjecting excluded losses
to the limitation.

### 4. Treatment of Income and Deductions from Common Trust Funds (CTFs)

Section 584(c) provides that each par-
ticipant in a CTF shall include in its tax-
able income, whether or not distributed
and whether or not distributable, its pro-
portionate share of: (1) short-term capital
gain or loss, (2) long-term capital gain or
loss, and (3) ordinary taxable income or
the ordinary net loss of the CTF. The flush
language of section 584(c) further pro-
vides that "the proportionate share of each
participant in the amount of dividends re-
ceived by the CTF and to which section
1(h)(11) applies shall be considered for
purposes of such paragraph as having
been received by such participant."

Section 584(d) provides, in relevant
part, that "[t]he taxable income of a com-
mon trust fund shall be computed in the

same manner and on the same basis as in
the case of an individual, except . . . after
excluding all items of gain and loss from
sales or exchanges of capital assets, there
shall be computed (A) an ordinary taxable
income which shall consist of the excess
of the gross income over deductions; or
(B) an ordinary net loss which shall con-
sist of the excess of the deductions over
the gross income."

The Treasury Department and the IRS
have become aware that taxpayers may be
considering the use of CTFs to recharac-
terize income items that otherwise would
be includable in net investment income
under section 1411. Because section
584(c)(3) simply requires the participant
to include in its income its share of "net
ordinary income or loss," taxpayers may
attempt to claim that section 584(c)(3)
ordinary income or loss inclusions are not
explicitly section 1411(c)(1)(A)(i) net in-
vestment income, and therefore escape
taxation under section 1411.

Using a CTF to recharacterize the un-
derlying character of CTF income for sec-
tion 1411 purposes is closely analogous to
the past use of CTFs to cleanse unrelated
business taxable income (UBTI) for tax-
exempt participants. In 1984, the Treasury
Department and the IRS promulgated
§1.584-2(c)(3), which created a special
look-through rule to prevent taxpayers
from using CTFs to recharacterize UBTI.
Section 1.584-2(c)(3) provides, in rele-
vant part, that "any amount of income or
loss of the common trust fund which is
included in the computation of a partici-
pant's taxable income for the taxable year
shall be treated as income or loss from an
unrelated trade or business to the extent
that such amount would have been income
or loss from an unrelated trade or business
if such participant had made directly the
investments of the common trust fund."

Similarly, proposed §1.1411-4(e)(3) in-
cludes a rule that provides income or loss
from a CTF is net investment income or
deduction to the extent that such amount
would have been net investment income or
deduction if the participant had made di-
rectly the investments of the CTF.

5\. Treatment of Income and Deductions
Related to Residual Interests in REMICs

The 2012 Proposed Regulations did
not explicitly address income and deduc-
tions related to residual interests in RE-
MICs. A REMIC residual interest repre-
sents an equity-like interest in a REMIC.
A REMIC is not treated as carrying on a
trade or business for purposes of section
162, and a REMIC's taxable income or
net loss generally is derived from dispo-
sitions of qualified mortgages or permitted
investments, interest income from the
mortgages, and interest expense from the
regular interests (treated as debt) issued
by the REMIC. Section 860C(a)(1) gen-
erally requires the holder of a REMIC
residual interest to take into account the
daily portion of the REMIC's taxable in-
come or net loss. One commentator sug-
gested that the regulations expressly in-
clude income from a REMIC residual
interest in determining net investment in-
come. The Treasury Department and the
IRS agree with this comment because, if a
taxpayer directly held the underlying as-
sets of the REMIC, the items of income,
gain, loss, and deductions attributable to
those assets would be taken income ac-
count in computing net investment in-
come. Therefore, the proposed regulations
provide that a holder of a residual interest
in a REMIC takes into account the daily
portion of taxable income (or net loss)
under section 860C in determining net
investment income.

6\. Treatment of Income and Deductions
from Certain Notional Principal
Contracts (NPCs)

Under the 2012 Proposed Regulations
(and the 2013 Final Regulations), gain on
the disposition of an NPC is included in
net investment income, and any other
gross income from an NPC (including net
income attributable to periodic payments
on an NPC) is included in net investment
income if it is derived from a trade or
business described in §1.1411-5. Several
commentators on the 2012 Proposed Reg-
ulations suggested that the proper treat-
ment of periodic payments on an NPC
should not turn solely upon whether the
NPC was entered into as part of a trading
business and recommended that NPC pe-

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riodic payments should be included in net
investment income. One commentator in-
dicated that the omission of NPC periodic
income seems unusual and inconsistent
with the portions of the 2012 Proposed
Regulations (and 2013 Final Regulations)
that provide for the inclusion in net invest-
ment income of substitute interest and
substitute dividends.

After consideration of the comments,
the Treasury Department and the IRS
agree that periodic payments on an NPC
should be included in net investment in-
come even if the net income from such
payments is not derived in a trade or busi-
ness described in §1.1411-5. As a result,
the proposed regulations provide that net
income (or net deduction) attributable to
periodic and nonperiodic payments on an
NPC under §1.446-3(d) is taken into ac-
count in determining net investment in-
come. However, the proposed regulations
only apply to the net income (or net de-
duction) on an NPC described in §1.446-
3(c)(1) that is referenced to property (in-
cluding an index) that produces (or would
produce if the property were to produce
income) interest, dividends, royalties, or
rents if the property were held directly by
the taxpayer. The proposed regulations
would not affect the treatment of net in-
come attributable to periodic and nonpe-
riodic payments on any NPC derived in a
trade or business described in §1.1411-
5, that is net investment income under
section 1411(c)(1)(A)(ii).

7\. Charitable Remainder Trusts (CRTs)
with Income from Controlled Foreign
Corporations (CFCs) or Passive Foreign
Investment Companies (PFICs)

Section 1.1411-3(d)(2) of the 2013 Fi-
nal Regulations provides rules on the cat-
egorization and distribution of net invest-
ment income from a CRT based on the
existing section 664 category and class
system. In general, §1.1411-3(d)(2) pro-
vides that, if a CRT has both excluded
income and accumulated net investment
income (ANII) in an income category,
such excluded income and ANII consti-
tute separate classes of income for pur-
poses of §1.664-1(d)(1)(i)(b). Section
1.1411-10 of the 2013 Final Regulations
provides rules for calculating net invest-
ment income when a taxpayer owns a

direct or indirect interest in a CFC or
PFIC.

The 2013 Final Regulations reserve
paragraph §1.1411-3(d)(2)(ii) for special
rules that the Treasury Department and
the IRS believe are necessary to apply the
section 664 category and class system
contained in §1.664-1(d), and adopted by
§1.1411-3(d)(2), to CRTs that own inter-
ests in certain CFCs or PFICs. The special
rules generally apply to taxpayers that: (i)
own CFCs or qualified electing funds
(QEFs) with respect to which an election
under §1.1411-10(g) is not in place; or (ii)
are subject to the rules of section 1291
with respect to a PFIC. These proposed
regulations provide those special rules and
are proposed to apply to taxable years
beginning after December 31, 2013. There
are no special rules necessary for a United
States person that has elected to mark to
market its PFIC stock under section 1296.
See §1.1411-10(c)(2)(ii).

### A. CFCs and QEFs

For purposes of chapter 1, a United
States shareholder (as defined in section
951(b)) of a CFC is required to include
certain amounts in income currently under
section 951(a) (section 951 inclusions).
Similarly, a U.S. person that owns shares
of a PFIC also is required to include
amounts in income currently under sec-
tion 1293(a) (section 1293 inclusions) if
the person makes a QEF election under
section 1295 with respect to the PFIC.

For purposes of chapter 1, a CRT's
section 951 inclusions and section 1293
inclusions are included in the appropriate
section 664 category and class for the year
in which those amounts are includable in
the CRT's income for purposes of chapter
1\. The application of the ordering rules in
§1.664-1(d)(1) determines the tax charac-
ter of the annuity or unitrust distributions
to the CRT's income beneficiary. These
ordering rules are equally applicable for
purposes of section 1411 under the 2013
Final Regulations. In the case of a CRT
that directly or indirectly owns an interest
in a CFC or QEF, some portion of the
annual distribution(s) may consist of cur-
rent or previous years' section 951 inclu-
sions or section 1293 inclusions.

As discussed in the preamble to the
2013 Final Regulations, §1.1411-10 gen-

erally provides that distributions of previ-
ously taxed earnings and profits attribut-
able to section 951 inclusions and section
1293 inclusions that are not treated as
dividends for purposes of chapter 1 under
section 959(d) or section 1293(c) are div-
idends for purposes of section 1411, ab-
sent an election under §1.1411-10(g).
Without that election, taxpayers generally
do not include section 951 inclusions or
section 1293 inclusions in net investment
income for purposes of section 1411. As a
result, the timing of income derived from
an investment in a CFC or QEF may be
different for purposes of chapter 1 and
section 1411. Thus, §1.1411-10(e) pro-
vides adjustments to a taxpayer's modi-
fied adjusted gross income (MAGI), or to
the adjusted gross income (AGI) of an
estate or trust, when the taxpayer owns a
CFC or QEF with respect to which an elec-
tion is not in place to coordinate the rules
in §1.1411-10 with the calculation of the
section 1411 tax, the applicability of
which is based, in part, on MAGI or AGI.

### B. Section 1291 funds

The Final 2013 Regulations also pro-
vide special rules that apply to a United
States shareholder of a PFIC who is sub-
ject to the tax and interest charge applica-
ble to excess distributions under section
1291. Accordingly, §1.1411-10(e) also
provides adjustments to a taxpayer's
MAGI, or to the AGI of an estate or trust,
when the taxpayer owns a PFIC and is
subject to these special rules. In particular,
MAGI (or AGI for an estate or trust) is
increased by: (i) the amount of any excess
distribution to the extent the distribution is
a dividend under section 316(a) and is not
otherwise included in income for purposes
of chapter 1 under section 1291(a)(1)(B),
and (ii) any gain treated as an excess dis-
tribution under section 1291(a)(2) to the
extent not otherwise included in income
for purposes of chapter 1 under section
1291(a)(1)(B).

#### C. Rules in proposed regulation §1.1411-3(d)(2)(ii)

The rules in proposed §1.1411-
3(d)(2)(ii) coordinate the rules of
§1.1411-10 with the section 664 category
and class system. These proposed regula-

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tions contain three rules that generally ap-
ply when a CRT directly or indirectly
owns an interest in a CFC or QEF and a
§1.1411-10(g) election is not in effect
with respect to the CFC or QEF. First,
§1.1411-3(d)(2)(ii)(A) provides that sec-
tion 951 inclusions and section 1293 in-
clusions that are included in gross income
for purposes of chapter 1 for a calendar
year and in one or more categories de-
scribed in §1.664-1(d)(1) are considered
excluded income (within the meaning of
§1.1411-1(d)) in the year the amount is
included in income for purposes of chap-
ter 1.

Second, proposed §1.1411-
3(d)(2)(ii)(B) provides that, when a CRT
receives a distribution of previously taxed
earnings and profits that is not treated as a
dividend for purposes of chapter 1 under
section 953(d) and 1293(c) but that is taken
into account as net investment income for
purposes of section 1411 (referred to as an
NII Inclusion Amount), the CRT must allo-
cate such amounts among the categories de-
scribed in section 664(b)(1)-(3). For this
purpose, the NII Inclusion Amount includes
net investment income described in
§1.1411-10(c)(1)(i) (certain distributions
from a CFC or QEF), §1.1411-
10(c)(1)(ii) (certain distributions from a sec-
tion 1291 fund), §1.1411-10(c)(2)(i) (gain
derived from the disposition of a section
1291 fund), and §1.1411-10(c)(4) (distribu-
tions from an estate or trust attributable to
income or gain derived from a CFC or QEF
with respect to which an election under
§1.1411-10(g) is not in effect). Specifically,
proposed §1.1411-3(d)(2)(ii)(B) provides
that, to the extent the CRT has amounts of
excluded income in the Ordinary Income
Category and the Capital Gain Category un-
der §1.664-1(d)(1), the NII Inclusion
Amount is allocated to the CRT's classes of
excluded income in the Ordinary Income
Category, and then to the classes of ex-
cluded income in the Capital Gain Category,
in turn, until exhaustion of each such class,
beginning with the class of excluded income
within a category with the highest Federal
income tax rate. Any remaining NII Inclu-
sion Amount not so allocated to classes
within the Ordinary Income and Capital
Gain Categories shall be placed in the cate-
gory described in section 664(b)(3) (the
Other Income Category). To the extent the
CRT distributes amounts from this Other

Income Category, that distribution shall
constitute a distribution described in
§1.1411-10(c)(4) and thus §1.1411-
10(e)(1) causes the beneficiary to increase
its MAGI (or AGI for an estate or trust) by
the same amount.

The third rule in proposed §1.1411-
3(d)(2)(ii) addresses the differential in
gain or loss associated with tax basis dis-
parities between chapter 1 and section
1411 that are caused by the recognition of
income under chapter 1 and of the corre-
sponding net investment income in differ-
ent taxable years. See §1.1411-10(d) for
special basis calculation rules for CFC,
QEFs, and partnerships and S corpora-
tions that own interests in CFCs or QEFs.
The proposed rules for the allocation of
such gain or loss within the section 664
categories and classes generally are con-
sistent with the allocation rules for NII
Inclusions Amounts, except that the Cap-
ital Gain Category is the first category to
which the gain or loss is to be allocated,
and then the Ordinary Income Category.
The order of the categories is changed for
gains and losses to more closely match the
adjustments to the income that produced
the net investment income, and to mini-
mize the need for adjustments to MAGI or
AGI.

Proposed §1.1411-3(d)(2)(ii)(C)(1) pro-
vides rules similar to proposed §1.1411-
3(d)(2)(ii)(B) for gains that are higher for
section 1411 purposes than they are for
chapter 1 purposes. The difference be-
tween the rule for gains in proposed
§§1.1411-3(d)(2)(ii)(C)(1) and 1.1411-
3(d)(2)(ii)(B) is that proposed §1.1411-
3(d)(2)(ii)(C)(1) requires this additional
gain to be allocated within the Capital
Gain Category before any allocation
within the Ordinary Income Category.
The Treasury Department and the IRS be-
lieve this difference more accurately re-
flects the nature of the net investment in-
come within the section 664 category and
class system because this NII Inclusion
Amount is attributable to a transaction
that generated capital gain or loss (rather
than ordinary income inclusions and div-
idends attributable to proposed §1.1411-
3(d)(2)(ii)(B) items).

Proposed §1.1411-3(d)(2)(ii)(C)(2) pro-
vides rules similar to proposed §1.1411-
3(d)(2)(ii)(C)(1) for losses (and gains
that are lower for section 1411 purposes

than they are for chapter 1), but with a
different ordering rule. In these cases,
the tax basis is higher for section 1411
(generating a smaller gain or larger loss
for 1411 purposes). However, unlike
dividends and gains addressed in pro-
posed §§1.1411-3(d)(2)(ii)(B) and
1.1411-3(d)(2)(ii)(C)(1), respectively,
which can require an increase in MAGI
(or AGI for an estate or trust), losses are
accompanied by a reduction in MAGI
(or AGI for an estate or trust) under
§1.1411-10(e). Therefore, proposed
§1.1411-3(d)(2)(ii)(C)(2) generally fol-
lows the ordering rule for gains with one
exception. The loss ordering rule in pro-
posed §1.1411-3(d)(2)(ii)(C)(2) begins
with allocating the decrease to the Other
Income Category that was created or
increased in the current or previous
year, presumably due to an allocation
under §1.1411-3(d)(2)(ii)(B). The pur-
pose of the different ordering rule is to
eliminate the ANII within Other Income
Category first in an effort to reduce the
incidence of required MAGI (or AGI for
an estate or trust) adjustments by the
beneficiary. Once this income is elimi-
nated, the CRT or beneficiary will not
have to separately account for a MAGI
(or AGI for an estate or trust) increase
because the timing differences caused
by §1.1411-10 may have been corrected
within the 664 class and category sys-
tem before such income is distributed to
the beneficiary.

### 8. Simplified Method for Charitable Remainder Trusts

The 2012 Proposed Regulations pro-
vided a method for the CRT to track net
investment income received after Decem-
ber 31, 2012, and later distributed to the
beneficiary. Section 1.1411-3(c)(2)(i) of
the 2012 Proposed Regulations provided
that distributions from a CRT to a bene-
ficiary for a taxable year consist of net
investment income in an amount equal to
the lesser of the total amount of the dis-
tributions for that year, or the current and
accumulated net investment income of the
CRT.

As discussed in part 4.C of the pream-
ble to the 2013 Final Regulations, multi-
ple commentators asked that the final reg-
ulations follow the existing rules under

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section 664 that create subclasses in each
category of income as the tax rates on
certain types of income are changed from
time to time. However, some of the com-
mentators suggested that the final regula-
tions allow the trustee to elect between the
method described in the 2012 Proposed
Regulations and the existing rules under
section 664.

These proposed regulations provide
CRTs with a choice of methods. Section
1.1411-3(d)(2) of the 2013 Final Regula-
tions, along with the proposed additions in
these proposed regulations, provide guid-
ance on the application of the section 664
method of tracking net investment in-
come. Proposed §1.1411-3(d)(3) allows
the CRT to elect to use the simplified
method included in the 2012 Proposed
Regulations, with one modification. Pro-
posed §1.1411-3(d)(3)(ii) provides that a
CRT that elects to use the simplified
method is not limited by the general ex-
cess deduction rule in §1.1411-
4(f)(1)(ii). Section 1.1411-4(f)(1)(ii)
provides that section 1411(c)(1)(B) de-
ductions in excess of gross income and net
gain described in section 1411(c)(1)(A)
are not taken into account in determining
net investment income in any other tax-
able year, except as allowed under chapter
1\. In the case of CRTs, for chapter 1
purposes, the section 664(d) regulations
allow for losses within each income class
to be carried forward to offset income
earned by the CRT within the same class
in a future year. Therefore, this provision
of the simplified method retains the chap-
ter 1 principle that a CRT's losses are
carried forward and offset income in fu-
ture years. For example, if a CRT has a
long-term capital loss of $10,000 in year 1
and a $11,000 long-term capital gain in
year 2, the section 664(d) regulations pro-
vide that the CRT will have $1,000 of
long-term gain available for distribution
in year 2. Proposed §1.1411-3(d)(3)(ii) is
intended to provide the same result such
that the CRT would have $1,000 of accu-
mulated net investment income available
for distribution in year 2.

In the case of a CRT established after
December 31, 2012, the CRT's election
must be made on its income tax return for
the taxable year in which the CRT is es-
tablished. In the case of a CRT established
before January 1, 2013, the CRT's elec-

tion must be made on its income tax return
for its first taxable year beginning on or
after January 1, 2013. Additionally, the
CRT may make the election on an
amended return for that year only if nei-
ther the taxable year for which the elec-
tion is made, nor any taxable year that is
affected by the election, for both the CRT
and its beneficiaries, is closed by the pe-
riod of limitations on assessments under
section 6501. Once made, the election is
irrevocable.

If, after consideration of all comments
received in response to these proposed
regulations, it appears that there is no sig-
nificant interest among taxpayers in hav-
ing the option of using the simplified
method, the Treasury Department and the
IRS may omit this election from the reg-
ulations when finalized.

9\. Calculation of Gain or Loss
Attributable to the Disposition of
Certain Interests in Partnerships and S
Corporations

Section 1411(c)(4)(A) provides that, in
the case of a disposition of an interest in a
partnership or of stock in an S corporation
(either, a "Passthrough Entity"), gain
from the disposition shall be taken into
account under section 1411(c)(1)(A)(iii)
only to the extent of the net gain which
would be taken into account by the trans-
feror if the Passthrough Entity sold all of
its property for fair market value immedi-
ately before the disposition of the interest.
Section 1411(c)(4)(B) provides a similar
rule for losses from dispositions.

The 2012 Proposed Regulations re-
quired that a transferor of a partnership
interest or S corporation stock first com-
pute its gain (or loss) from the disposition
of the interest in the Passthrough Entity to
which section 1411(c)(4) may apply, and
then reduce that gain (or loss) by the
amount of non-passive gain (or loss) that
would have been allocated to the trans-
feror upon a hypothetical sale of all of the
Passthrough Entity's assets for fair market
value immediately before the transfer. The
Treasury Department and the IRS re-
ceived several comments questioning this
approach based on the commentators'
reading of section 1411(c)(4) to include
gain/loss from the disposition of a part-
nership interest or S corporation stock

only to the extent of the transferor's share
of gain/loss from the Passthrough Entity's
passive assets.

The 2013 Final Regulations do not pro-
vide rules regarding the calculation of net
gain from the disposition of an interest in
a Passthrough Entity to which section
1411(c)(4) may apply. After considering
the comments received, the Treasury De-
partment and the IRS have withdrawn the
2012 Proposed Regulations implementing
section 1411(c)(4) and are issuing this no-
tice of proposed rulemaking to propose
revised rules for the implementation of
section 1411(c)(4) adopting the commen-
tators' suggestion. Accordingly, the 2013
Final Regulations reserve on this issue.

Proposed §1.1411-7(b) provides a cal-
culation to determine how much of the
gain or loss that is recognized for chapter
1 purposes is attributable to property
owned, directly or indirectly, by the Pass-
through Entity that, if sold, would give
rise to net gain within the meaning of
section 1411(c)(1)(A)(iii) ("Section 1411
Property"). Section 1411 Property is any
property owned by, or held through, the
Passthrough Entity that, if sold, would
result in net gain or loss allocable to the
partner or shareholder that is includable in
determining the partner or shareholder's
net investment income under §1.1411-
4(a)(1)(iii). This definition recognizes
that the items of property inside the Pass-
through Entity that constitute Section
1411 Property might vary among transfer-
ors because a transferor may or may not
be "passive" with respect to the property.

Proposed §1.1411-7(c) provides an op-
tional simplified reporting method that qual-
ified transferors may use in lieu of the cal-
culation described in proposed §1.1411-
7(b). Proposed §1.1411-7(d) contains
additional rules that apply when a transferor
disposes of its interest in the Passthrough
Entity in a deferred recognition transaction
to which section 1411 applies. Proposed
§1.1411-7(f) provides rules for adjusting
the amount of gain or loss computed under
this paragraph for transferors subject to ba-
sis adjustments required by §1.1411-10(d).
Proposed §1.1411-7(g) provides rules for
information disclosures by a Passthrough
Entity to transferors and for information re-
porting by individuals, trusts, and estates.

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A. Applicability of section 1411(c)(4)

In the case of an individual, trust, or
estate, the proposed regulations provide
that section 1411(c)(4) applies to "Section
1411(c)(4) Dispositions." A Section
1411(c)(4) Disposition is the disposition
of an interest in a Passthrough Entity by
an individual, estate, or trust if: (i) the
Passthrough Entity is engaged in one or
more trades or businesses, or owns an
interest (directly or indirectly) in another
Passthrough Entity that is engaged in one
or more trades or businesses, other than
the business of trading in financial instru-
ments or commodities (within the mean-
ing of §1.1411-5(a)(2)); and (ii) one or
more of the trades or businesses of the
Passthrough Entity is not a passive activ-
ity (within the meaning of §1.1411-
5(a)(1)) of the transferor. Thus, if the
transferor materially participates in one or
more of the Passthrough Entity's trades or
businesses (other than a trade or business
of trading in financial instruments or com-
modities), then the transferor must use
section 1411(c)(4) to calculate how much
of the chapter 1 gain or loss from the
disposition to include under section
1411(c)(1)(A)(iii). Section 1411(c)(4)
only applies to dispositions of equity in-
terests in partnerships and stock in S cor-
porations, and does not apply to gain or
loss recognized on, for example, indebt-
edness owed to the taxpayer by a partner-
ship or S corporation.

Proposed §1.1411-7(a)(3) also ad-
dresses dispositions by Passthrough Enti-
ties of interests in lower-tier Passthrough
Entities (a "Subsidiary Passthrough En-
tity"). Proposed §1.1411-7(a)(3)(ii) pro-
vides a "look through rule" that treats a
partner or shareholder as owning a pro-
portionate share of any Subsidiary Pass-
through Entity, as if the partner or share-
holder owned the interest directly. Thus,
each partner of the upper-tier Passthrough
Entity must determine whether the dispo-
sition of the Subsidiary Passthrough En-
tity is a Section 1411(c)(4) Disposition
based on whether the disposition would
qualify as a Section 1411(c)(4) Disposi-
tion if that owner owned its interest in the
Subsidiary Passthrough Entity directly.

The Treasury Department and the IRS
anticipate that taxpayers who dispose of
an interest in a partial recognition trans-

action or partial disposition transaction
will apply the principles of this section by
including a pro rata amount of gain or loss
from the Passthrough Entity's Section
1411 Property. In addition, the Treasury
Department and the IRS believe that the
application of section 1411(c)(4) to gain
or loss on distributions from a Pass-
through Entity is adequately addressed in
section 469, which is incorporated into
section 1411(c)(4) through the general
definition of passive activity contained in
section 1411(c)(2)(A). Thus, the proposed
regulations do not include special rules on
partial recognition, partial disposition, and
distribution transactions. However, the
Treasury Department and the IRS request
comments on whether additional rules on
these topics are required.

### B. Definitions and special rules

Proposed §1.1411-7(a)(2) contains
certain definitions and special rules that
are unique to determining gain or loss
under section 1411(c)(4) and apply only
for purposes of proposed §1.1411-7.

#### i. Definitions

Proposed §1.1411-7 refers to partner-
ships or S corporations collectively as
"Passthrough Entities" and the disposition
of an interest in one of these entities is
referred to as a "Section 1411(c)(4) Dispo-
sition." The purpose of section 1411(c)(4) is
to allow gain attributable to non-passive ac-
tivities to be excluded from the calculation
of section 1411 tax upon the disposition of
an interest in a Passthrough Entity. To ac-
complish this, section 1411(c)(4)(A) pro-
vides that gain from the disposition of an
interest in a Passthrough Entity shall be
taken into account in computing net invest-
ment income only to the extent of the
amount of gain the transferor would have
included under section 1411(c)(1)(A)(iii) if
the Passthrough Entity sold all of its assets
immediately before the Section 1411(c)(4)
Disposition. The proposed regulations refer
to the property that would generate gain for
inclusion in section 1411(c)(1)(A)(iii) as
"Section 1411 Property."

### ii. Rules for Certain Liquidations

Proposed §1.1411-7(a)(4)(i) provides
that if a fully taxable disposition of the

Passthrough Entity's assets is followed by
the liquidation of the Passthrough Entity
as part of a single plan, then the disposi-
tion will be treated as an asset sale for
purposes of section 1411. Thus, no addi-
tional gain or loss is included in net in-
vestment income under §1.1411-
4(a)(1)(iii) on the subsequent liquidation
of the Passthrough Entity by any trans-
feror provided that the transferor would
have satisfied proposed §1.1411-
7(a)(3) prior to the sale. The proposed
regulations also state that, when an S cor-
poration makes a section 336(e) or section
338(h)(10) election on the sale of its
stock, the transaction will be treated under
section 1411 as a fully taxable asset sale
by the Passthrough Entity followed by a
liquidation of the entity. Thus, no addi-
tional gain or loss is included in net in-
vestment income on the subsequent liqui-
dation of the S corporation stock,
provided a section 336(e) or section
338(h)(10) election is in effect.

## iii. Rules for S Corporation Shareholders

Proposed §1.1411-7(a)(4) provides two
special rules for S corporation shareholders.
First, proposed §1.1411-7(a)(4)(ii) provides
that the Passthrough Entity will be consid-
ered an S corporation for purposes of sec-
tion 1411 and proposed §1.1411-7 even
though §1.1362-3(a) treats the day of the
transfer as the first date of the Passthrough
Entity's C corporation short year (as defined
therein). Second, proposed §1.1411-
7(a)(4)(iii) provides that the calculation un-
der proposed §1.1411-7(b) does not take
into account any adjustment resulting from
the hypothetical imposition of tax under sec-
tion 1374 as a result of the proposed
§1.1411-7(b) deemed sale. This provision
was also included in the 2012 Proposed
Regulations. See also part 9.H of this pre-
amble for a discussion of the application of
section 1411(c)(4) to Qualified Subchapter
S Trusts.

C. Calculation of gain or loss includable
in net investment income

i. Primary Method - Proposed
§1.1411-7(b)

Proposed §1.1411-7(b) provides the
calculation for determining the amount of
the transferor's gain or loss under section

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1411(c)(1)(A)(iii) from the disposition of
an interest in a Passthrough Entity. For
dispositions resulting in chapter 1 gain,
the transferor's gain equals the lesser of:
(i) the amount of gain the transferor rec-
ognizes for chapter 1 purposes, or (ii) the
transferor's allocable share of net gain
from a deemed sale of the Passthrough
Entity's Section 1411 Property (in other
words, property which, if sold, would give
rise to gain or loss that is includable in
determining the transferor's net invest-
ment income under §1.1411-4(a)(1)(iii)).
The proposed regulations contain a simi-
lar rule when a transferor recognizes a
loss for chapter 1 purposes.

The 2012 Proposed Regulations required
that a transferor of an interest in a Pass-
through Entity in which the transferor ma-
terially participated value each asset held by
the Passthrough Entity to determine the total
amount of gain or loss to include under
section 1411(c)(4). Commentators indicated
that this valuation requirement imposed un-
due administrative burdens on the trans-
feror. The Treasury Department and the IRS
acknowledge that for transferors of certain
active interests in Passthrough Entities this
property-by-property valuation requirement
could be burdensome. Accordingly, these
proposed regulations instead direct the
transferor to rely on the valuation require-
ments under §1.469-2T(e)(3), which the
materially participating transferor should al-
ready be applying for purposes of chapter 1.
These valuation requirements allow the
transferor to compute gain or loss activity-
by-activity.

Section 1.469-2T(e)(3) addresses dispo-
sitions of partnership interests and S corpo-
ration stock in the context of the passive
activity loss rules for purposes of chapter 1.
Section 1.469-2T(e)(3) provides guidance
on allocating disposition gains or losses
among the activities of the entity. These
rules require the taxpayer to determine the
overall gain or loss from each activity (re-
gardless of whether or not the taxpayer ma-
terially participates in the activity). For this
purpose, §1.469-2T(e)(3)(ii)(B)(1)(i) re-
quires the taxpayer to compute for each ac-
tivity "the amount of net gain. . . that would
have been allocated to the holder of such
interest with respect thereto if the pass-
through entity had sold its entire interest in
such activity for its fair market value on the
applicable valuation date." Section 1.469-

2T(e)(3)(ii)(B)(2)(i) contains a corollary
rule for dispositions at a loss.

Thus, the proposed regulations require
a materially participating transferor to cal-
culate its section 1411(c)(4) gain or loss
by reference to the activity gain and loss
amounts computed for chapter 1 purposes
under §§1.469-2T(e)(3)(ii)(B)(1)(i) and
(e)(3)(ii)(B)(2)(i). Specifically for pur-
poses of section 1411, the transferor's al-
locable share of gain or loss from a
deemed sale of the Passthrough Entity's
Section 1411 Property equals the sum of
the transferor's allocable shares of net
gains and net losses (as determined under
the section 469 principles described
above) from a hypothetical deemed sale of
the activities in which the transferor does
not materially participate.

Because section 1411(c)(4) applies to
all activities in which a transferor in a
Section 1411(c)(4) Disposition does not
materially participate (whether held at a
gain or a loss), certain provisions under
469 do not apply for purposes of these
rules. Proposed §1.1411-7(b)(1)(i)(B) and
(b)(1)(ii)(B) both apply §1.469-
2T(e)(3) without the recharacterization
rule of §1.469-2T(e)(3)(iii) because the
recharacterization rule in §1.469-
2T(e)(3)(iii) is intended to recharacterize
gains in certain circumstances as not be-
ing from a passive activity, and is thus not
relevant in the context of section 1411.

The Treasury Department and the IRS re-
quest comments on other possible methods
that would implement section 1411(c)(4) for
dispositions described in proposed §1.1411-
7(a)(3)(i) (individuals, estates, and trusts) and
proposed §1.1411-7(a)(3)(ii) (tiered Pass-
through Entity structures) in a manner consis-
tent with the statute while reducing the admin-
istrative burden to the transferor and the
Passthrough Entity.

### ii. Optional Simplified Reporting Method - Proposed §1.1411-7(c)

The proposed regulations also allow
certain transferors to apply an optional
simplified method in proposed §1.1411-
7(c) for calculating gain or loss for pur-
poses of §1.1411-4(a)(1)(iii). The Trea-
sury Department and the IRS believe a
simplified method is warranted when the
amount of gain associated with passive
assets owned by the Passthrough Entity is

likely to be relatively small. To use the
optional simplified reporting method, the
transferor must meet certain qualifications
under proposed §1.1411-7(c)(2) and not
be otherwise excluded under proposed
§1.1411-7(c)(3). Use of this simplified
method is not mandatory for qualifying
transferors. However, as discussed in part
10.G of this preamble, the Passthrough
Entity may not be required under pro-
posed §1.1411-7(g) to provide (but is not
precluded from providing) a transferor
who qualifies to use the simplified method
with information that the transferor would
need to report under the primary method
described in proposed §1.1411-7(g).

The simplified reporting method is in-
tended to limit the information sharing
burden on Passthrough Entities by allow-
ing transferors to rely on readily available
information to calculate the amount of
gain or loss included in net investment
income under section 1411(c)(4). For this
purpose, the optional simplified method
relies on historic distributive share
amounts received by the transferor from
the Passthrough Entity to extrapolate a
percentage of the assets within the Pass-
through Entity that are passive with re-
spect to the transferor for purposes of sec-
tion 1411(c)(4). For example, if ten
percent of the income reported on the ap-
plicable Schedules K-1 is of a type that
would be included in net investment in-
come, then the simplified reporting
method presumes that ten percent of the
chapter 1 gain on the disposition of the
transferor's interest relates to Section
1411 Property of the Passthrough Entity
for purposes of section 1411(c)(4).

## a. Qualifications

To qualify for the optional simplified
reporting method, a transferor in a Section
1411(c)(4) Disposition must meet at least
one of two requirements. A transferor sat-
isfies the first requirement if: (i) the sum
of the transferor's allocable share during
the "Section 1411 Holding Period" (as
defined in the following paragraph, but
generally the year of the disposition and
the preceding two years) of separately
stated items of income, gain, loss, and
deduction (with any separately stated loss
and deduction items included as positive
numbers) of a type that the transferor

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would take into account in calculating net
investment income is five percent or less
of the sum of all separately stated items of
income, gain, loss, and deduction (with
any separately stated loss and deduction
items included as positive numbers) allo-
cated to the transferor during the Section
1411 Holding Period, and (ii) the gain
recognized under chapter 1 by the trans-
feror from the disposition of the Pass-
through Entity is $5 million or less (in-
cluding gains from multiple dispositions
as part of a plan). A transferor satisfies the
second alternative requirement if the gain
recognized under chapter 1 by the trans-
feror from the disposition of the Pass-
through Entity is $250,000 or less (includ-
ing gains from multiple dispositions as
part of a plan). All dispositions of interests
in the Passthrough Entity that occur dur-
ing the transferor's taxable year will be
presumed to be part of a plan.

Section 1411 Holding Period is defined
to mean the year of disposition and the
transferor's two taxable years preceding the
disposition or the time period the transferor
held the interest, whichever is less. Where
the transferor acquires its interest from an-
other Passthrough Entity in a nonrecogni-
tion transaction during the year of disposi-
tion or the prior two taxable years, the
transferor must include in its Section 1411
Holding Period the period that the previous
owner or owners held the interest. Also,
where the transferor transferred an interest
in a Subsidiary Passthrough Entity to a Pass-
through Entity in a nonrecognition transac-
tion during the year of the disposition or the
prior two taxable years, the transferor must
include in its Section 1411 Holding Period
that period that it held the interest in the
Subsidiary Passthrough Entity.

b. Nonavailability of optional simpli-
fied reporting method

Proposed §1.1411-7(c)(4) provides cer-
tain exceptions for situations in which a
transferor is ineligible to use the optional
simplified reporting method. These excep-
tions include situations in which the trans-
feror's historical distributive share amounts
are less likely to reflect the gain in the Pass-
through Entity's Section 1411 Property on
the date of the transferor's disposition. The
proposed regulations provide five excep-
tions for this purpose: (i) transferors that

have held the interest for less than 12
months, (ii) certain contributions and distri-
butions during the Section 1411 Holding
Period, (iii) Passthrough Entities that have
significantly modified the composition of
their assets, (iv) S corporations that have
recently converted from C corporations, and
(v) partial dispositions.

The first exception requires that the trans-
feror has held directly the interest in the Pass-
through Entity (or held the interest indirectly
in the case of a Subsidiary Passthrough Entity)
for the twelve-month period preceding the
Section 1411(c)(4) Disposition.

The second exception provides that a
transferor is ineligible to use the optional
simplified reporting method if the trans-
feror transferred Section 1411 Property
(other than cash or cash equivalents) to
the Passthrough Entity, or received a dis-
tribution of property (other than Section
1411 property) from the Passthrough En-
tity, as part of a plan that includes the
transfer of the interest in the Passthrough
Entity. A transferor who contributes, di-
rectly or indirectly, Section 1411 Property
(other than cash or cash equivalents)
within 120 days of the disposition of the
interest in the Passthrough Entity is pre-
sumed to have made the contribution as
part of a plan that includes the transfer of
the interest in the Passthrough Entity.

The third exception focuses on changes
to the composition of the Passthrough Enti-
ty's assets during the Section 1411 Holding
Period. Under this exception, the transferor
is ineligible to use the optional simplified
reporting method if the transferor knows or
has reason to know that the percentage of
the Passthrough Entity's gross assets that
consists of Section 1411 Property (other
than cash or cash equivalents) has increased
or decreased by 25 percentage points or
more during the transferor's Section 1411
Holding Period due to contributions, distri-
butions, or asset acquisitions or dispositions
in taxable or nonrecognition transactions.

The fourth exception provides that the op-
tional simplified reporting method is not avail-
able if the Passthrough Entity was a C corpo-
ration during the Section 1411 Holding
Period, and elected under section 1361 during
that period to be taxed as an S corporation.

The final exception provides that a
transferor partner cannot use the optional
simplified reporting method if the trans-
feror transfers only a partial interest that

does not represent a proportionate share of
all of the partner's economic rights in the
partnership. For example, a partner who
transfers a preferred interest in a partner-
ship while retaining a common interest in
that partnership cannot use the optional
simplified reporting method.

## iii. Request for Comments

The Treasury Department and the IRS
request comments on the proposed section
1411(c)(4) calculation and on the optional
simplified reporting method, including rec-
ommendations for other simplified means of
calculating the gain or loss under section
1411(c)(4). The Treasury Department and
the IRS also request comments regarding all
aspects of the provisions relating to eligibil-
ity for the simplified method, including
whether the 25 percentage point threshold
for changes in the asset composition of a
Passthrough Entity is appropriate.

### D. Tiered passthrough dispositions

The Treasury Department and the IRS
have reserved proposed §1.1411-7(e) to
further consider a simplified method for
determining the section 1411(c)(4) gain
resulting from the disposition by a Pass-
through Entity of an interest in a Subsid-
iary Passthrough Entity as illustrated by
the following example: A holds an interest
in UTP, a Passthrough Entity that owns a
50-percent interest in LTP, a Subsidiary
Passthrough Entity that is a real estate
development company. A is a real estate
developer and elected to group his real
estate activities under §1.469-9. When
UTP sells its interest in LTP, any gain
from the sale of that interest allocable to A
through UTP may qualify under proposed
§1.1411-7(a)(2). However, A lacks ac-
cess to the books of LTP that would allow
A to compute its section 1411(c)(4) inclu-
sion under the general rule of proposed
§1.1411-7(b). Additionally, A receives
insufficient information from UTP to al-
low A to determine whether A qualifies to
apply the Optional Simplified Reporting
Method of proposed §1.1411-7(c) or to
undertake that computation. The Treasury
Department and the IRS request com-
ments regarding a simplified method for
determining the section 1411(c)(4) gain

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resulting in such cases, including a de-
tailed technical analysis with examples.

### E. Deferred recognition transactions

To address the application of proposed
§1.1411-7 to deferred recognition transac-
tions, such as installment sales and certain
private annuities, the proposed regulations
provide that the calculations under proposed
§§1.1411-7(b)(1), 1.1411-7(c)(2) and
1.1411-7(c)(4) (as applicable) are performed
in the year of disposition as though the entire
gain was recognized and taken into account in
that year. For this purpose, it is assumed that
any contingencies potentially affecting consid-
eration to the transferor that are reasonably
expected to occur will occur, and in the case of
annuities based on the life expectancy of one
or more individuals, the present value of the
annuity (using existing Federal tax valuation
methods) is used to determine the estimated
gain. This approach allows the transferor to
determine its section 1411 inclusion for each
future installment. If under this approach no
gain or loss from the disposition would be
included in net investment income, then the
transferor excludes each payment received
from the deferred recognition transaction from
net investment income. If under this approach
only a portion of the chapter 1 gain on the
disposition would be included in net invest-
ment income, then the difference between the
gain recognized for chapter 1 purposes and the
gain recognized for section 1411 purposes is
considered an addition to basis, and after tak-
ing those basis adjustments into account, gain
amounts are included in net investment in-
come under §1.1411-4(a)(1)(iii) as payments
are received in accordance with the existing
rules for installment sales or private annuities.

### F. Adjustment to gain or loss due to section 1411 basis differences

In addition to the calculation of gain or
loss included in net investment income by
reason of section 1411(c)(4) and proposed
§1.1411-7, proposed §1.1411-7(f)(2) ad-
justs the gain or loss to take into account any
disparities in the transferor's interest in the
Passthrough Entity as a result of §1.1411-
10(d) (relating to certain income from con-
trolled foreign corporations and passive for-
eign investment companies where no
§1.1411-10(g) election is made). These ad-
justments apply after applying the calcula-

tions set forth in paragraphs (b) through (e)
of proposed §1.1411-7. Because the pro-
posed §1.1411-7(f)(2) adjustments operate
independently of the rules in paragraphs (b)
through (e) of proposed §1.1411-7, they
may result in gain for section 1411 purposes
that exceeds chapter 1 gain (or a loss that
exceeds the chapter 1 loss), or may result in
a section 1411 loss when the transferor rec-
ognizes a chapter 1 gain (or vice versa).

## G. Information reporting

Several commentators to the 2012 Pro-
posed Regulations requested revisions to the
proposed information reporting require-
ments. Other commentators expressed con-
cern that 2012 Proposed Regulations lacked
provisions to compel a Passthrough Entity
to provide the transferor with information
required to comply with the 2012 Proposed
Regulations §1.1411-7. In response, these
proposed regulations simplify the informa-
tion reporting requirements for transferors
of interests in Passthrough Entities and im-
pose information reporting requirements on
certain Passthrough Entities to ensure that
the transferor has sufficient information to
comply with the computational require-
ments of proposed §1.1411-7.

### i. Information Reporting by the Pass- through Entity

To compute the amount of gain or loss
under proposed §1.1411-7(b), the transfer-
ors that compute section 1411(c)(4) gain or
loss under the primary computation method
of proposed §1.1411-7(b) must generally
obtain from the Passthrough Entity the
transferor's allocable share of the net gain or
loss from the deemed sale of the Pass-
through Entity's Section 1411 Property.
However, the proposed regulations only re-
quire the Passthrough Entity to provide this
information to transferors that are ineligible
for the optional simplified reporting method
in proposed §1.1411-7(c).

If a transferor qualifies to use the op-
tional simplified reporting method in pro-
posed §1.1411-7(c), but prefers to deter-
mine net gain or loss under proposed
§1.1411-7(b), then the transferor must ne-
gotiate with the Passthrough Entity the
terms under which the information will be
supplied.

## ii. Information Reporting by the Seller

Any transferor applying proposed
§1.1411-7, including in reliance on the
proposed regulations, must attach a state-
ment to the transferor's income tax return
for the year of disposition. That statement
must include: (1) the taxpayer's name and
taxpayer identification number; (2) the
name and taxpayer identification number
of the Passthrough Entity in which the
interest was transferred; (3) the amount of
the transferor's gain or loss on the dispo-
sition of the interest under chapter 1; and
(4) the amount of adjustment to gain or
loss by reason of basis differences for
chapter 1 and section 1411 purposes. The
transferor must also attach a copy of any
information provided by the Passthrough
Entity to the transferor relating to the
transferor's allocable share of gain or loss
from the deemed sale of the Passthrough
Entity's Section 1411 Property.

### H. Qualified subchapter S trusts (QSSTs)

The preamble to the 2012 Proposed
Regulations requested comments on
whether special coordination rules are
necessary to address dispositions of stock
in an S corporation held by a QSST. Spe-
cifically, the request for comments deals
with the application of section 1411(c)(4)
to the existing QSST stock disposition
mechanics in §1.1361-1(j)(8).

In general, if an income beneficiary of
a trust that meets the QSST requirements
under section 1361(d)(3) makes a QSST
election, the income beneficiary is treated
as the section 678 owner with respect to
the S corporation stock held by the trust.
Section 1.1361-1(j)(8), however, pro-
vides that the trust, rather than the income
beneficiary, is treated as the owner of the
S corporation stock in determining the
income tax consequences of the disposi-
tion of the stock by the QSST. Section
1361(d)(1)(C) and the last sentence of
§1.1361-1(j)(8) provide that, solely for
purposes of applying sections 465 and 469
to the income beneficiary, a disposition of
S corporation stock by a QSST is treated
as a disposition by the income beneficiary.
However, in this special case, the QSST
beneficiary, for chapter 1 purposes, does
not have any passive activity gain from
the disposition. Therefore, the entire sus-
pended loss (to the extent not allowed by
reason of the beneficiary's other passive

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net income in the disposition year) is a
section 469(g)(1) loss, and is considered a
loss from a nonpassive activity.

For purposes of section 1411, the in-
clusion of the operating income or loss of
an S corporation in the beneficiary's net
investment income is determined in a
manner consistent with the treatment of a
QSST beneficiary in chapter 1 (as ex-
plained in the preceding paragraph),
which includes the determination of
whether the S corporation is a passive
activity of the beneficiary under section
469. However, because gain or loss result-
ing from the sale of S corporation stock by
the QSST will be reported by the QSST
and taxed to the trust by reason of
§1.1361-1(j)(8), it is not clear whether the
beneficiary's section 469 status with re-
spect to the S corporation is attributed to
the trust.

One commentator recommended that
the disposition of S corporation stock by a
QSST should be treated as a disposition of
the stock by the income beneficiary for
purposes of determining material partici-
pation for purposes of section 1411. In
addition, the commentator recommended
that the final regulations confirm that the
special rule stated in the last sentence of
§1.1361-1(j)(8) applies for purposes of
section 1411 as it does for section 469 and
465.

After consideration of the comments,
these proposed regulations provide that, in
the case of a QSST, the application of
section 1411(c)(4) is made at the trust
level. This treatment is consistent with the
chapter 1 treatment of the QSST by reason
of §1.1361-1(j)(8). However, these pro-
posed regulations do not provide any spe-
cial computational rules for QSSTs within
the context of section 1411(c)(4) for two
reasons. First, the treatment of the stock
sale as passive or nonpassive income is
determined under section 469, which in-
volves the issue of whether there is mate-
rial participation by the trust. As discussed
in part 4.F of the preamble to the 2013
Final Regulations, the Treasury Depart-
ment and the IRS believe that the issue of
material participation by estates and
trusts, including QSSTs, is more appropri-
ately addressed under section 469.

Additionally, one commentator noted
that the IRS has addressed the treatment
of certain asset sales as the functional

equivalent of stock sales for purposes of
§1.1361-1(j)(8) in a limited number of
private letter rulings. In these cases, the
private letter rulings held that gain from
the sale of assets, which was followed by
a liquidation, would be taxed at the trust
level under §1.1361-1(j)(8) rather than
being taxed at the beneficiary level. The
commentator recommended that an asset
sale followed by a liquidation, within the
context of §1.1361-1(j)(8), should have a
similar result under section 1411(c)(4).
Similar to the issue of material participa-
tion by QSSTs discussed in the preceding
paragraph, the Treasury Department and
the IRS believe that the issue of whether
an asset sale (deemed or actual) is the
equivalent of a stock sale for purpose of
the QSST rules should be addressed under
the §1.1361-1(j) QSST regulations, rather
than in §1.1411-7. However, the Trea-
sury Department and the IRS believe that
proposed §1.1411-7(a)(4)(i), which pro-
vides that asset sales followed by a liqui-
dation is a disposition of S corporation
stock for purposes of section 1411(c)(4),
address the commentator's QSST issue.

Second, with respect to the section
1411 treatment of the disposition by the
beneficiary by reason of section
1361(d)(1)(C) and the last sentence of
§1.1361-1(j)(8), the Treasury Department
and the IRS believe that the general ad-
ministrative principles enumerated in
§1.1411-1(a), when combined with the
general treatment of section 469(g) losses
within §1.1411-4, provide an adequate
framework for the treatment of QSSTs
beneficiaries without the need for a spe-
cial computational rule within §1.1411-7.

## Proposed Applicability Date

These regulations are proposed to ap-
ply for taxable years beginning after De-
cember 31, 2013, except that §1.1411-
3(d)(3) is proposed to apply to taxable
years beginning after December 31, 2012.

## Special Analyses

It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Exec-
utive Order 12866, as supplemented by
Executive Order 13563. Therefore, a reg-
ulatory 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 the
proposed regulations. Pursuant to the Reg-
ulatory Flexibility Act (RFA) (5 U.S.C.
chapter 6), it is hereby certified that the
proposed regulations will not have a sig-
nificant economic impact on a substantial
number of small entities. The applicability
of the proposed regulations are limited to
individuals, estates, and trusts, that are not
small entities as defined by the RFA (5
U.S.C. 601). Accordingly, the RFA does
not apply. Therefore, a regulatory flexibil-
ity analysis is not required. Pursuant to
section 7805(f) of the Code, the proposed
regulations have been submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.

## Comments and Requests for a Public Hearing

Before these proposed regulations are
adopted as final regulations, consideration
will be given to any comments that are
submitted timely to the IRS as prescribed in
this preamble under the "Addresses" head-
ing. The Treasury Department and the IRS
specifically request comments on all aspects
of the proposed rules. All comments will be
available at www.regulations.gov or upon
request. A public hearing will be scheduled
if requested in writing by any person that
timely submits written comments. If a pub-
lic hearing is scheduled, notice of the date,
time, and place for the public hearing will be
published in the Federal Register.

## Drafting Information

The principal authors of the proposed
regulations are David H. Kirk and Adri-
enne M. Mikolashek, IRS Office of the
Associate Chief Counsel (Passthroughs
and Special Industries). However, other
personnel from the Treasury Department
and the IRS participated in their develop-
ment.

* * * * *

## Partial Withdrawal of Notice of Proposed Rulemaking

Accordingly, under the authority of 26
U.S.C. 7805, §1.1411-7 of the notice of
proposed rulemaking (REG-130507-11)
that was published in the Federal Regis-

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ter on December 5, 2012 (77 FR 72612) is
withdrawn.

### Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:

#### PART 1-INCOME TAXES

Paragraph 1. The authority citation for
part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * *

Par. 2. Section 1.1411-0 is amended
by:

1\. Revising the entries under §1.1411-
3 for paragraphs (d)(2)(ii), (d)(3) and
adding entries (d)(3)(i) through (iii).

2\.
Revising the entries under §1.1411-
4 for paragraphs (d)(4)(iii), (e)(3),
and (g)(10) through (13).

3\. Adding entries to §1.1411-7.

The revisions and additions to read as
follows:

§1.1411-0 Table of contents.
* * * * *

§1.1411-3 Application to estates and
trusts.

* * * * *

(d) * * *

(2) * * *

(ii) Special rules for CRTs with income
from certain CFCs or PFICs.

(3) Elective simplified method.

(i) Treatment of annuity or unitrust dis-
tributions.

(ii) Properly allocable deductions in
excess of gross income.

(iii) Procedural requirements for mak-
ing election.

* * * * *

§1.1411-4 Definition of net investment
income.

* * * * *

(d) * * *

(4) * * *

(iii) Adjustment for capital loss carry-
forwards for previously excluded income
* * * *

(e) * * *

(3) Treatment of income from common
trust funds.

* * * * *

(g) * * *

(10) Treatment of section 707(c) guar-
anteed payments.

(11) Treatment of section 736 pay-
ments.

(i) In general.

(ii) Treatment of section 736(a)(1) pay-
ments.

(A) General rule.

(B) Examples.

(iii) Treatment of section 736(a)(2)
payments.

(A) Payments for unrealized receiv-
ables and goodwill.

(B) Payments not for unrealized re-
ceivables or goodwill.

(iv) Treatment of section 736(b) pay-
ments.

(v) Application of section 1411(c)(4)
to section 736 payments.

(12) Income and deductions from cer-
tain notional principal contracts.

(i) In general.

(ii) Notional principal contracts.

(13) Treatment of income or loss from

REMIC residual interests.

* * * * *

§1.1411-7 Exception for dispositions of
certain active interests in partnerships
and S corporations

(a) In general.

(1) General application.

(2) Definitions.

(3) Section 1411(c)(4) dispositions.

(i) Transfers by individuals, estates,
and trusts.

(ii) Transfers by passthrough entities.

(4) Special rules.

(i) Certain liquidations.

(ii) Excluded gain or loss.

(iii) Rules applicable to S corporation
shareholders.

(A) Certain S corporation dispositions.

(B) S corporations subject to section
1374.

(C) Treatment of Qualified Subchapter
S Trusts (QSSTs).

(b) Calculation.

(1) In general.

(i) Gain on disposition of interest.

(ii) Loss on disposition of interest.
(2) Examples.

(c) Optional simplified reporting.

(1) In general.

(2) Qualifications.

(i) Minimal section 1411 property.

(ii) Minimal gain or loss.

(3) Nonapplicability.

(4) Optional simplified reporting calcu-
lation.

(5) Examples.

(d) Deferred recognition transactions.

(e) Disposition of tiered Passthrough

Entities. [Reserved]

(f) Adjustment to net gain or loss.

(g) Information reporting.

(1) Information to be provided by pass-
through entity to transferor.

(2) Information reporting by transferors.

(h) Effective/applicability date.

Par 3. Section 1.1411-3 is amended by:

1\. Revising paragraph (d)(2)(ii).

2\.
Revising paragraph (d)(2)(iii) by add-
ing Example 2 through Example 5.

3\.
Revising paragraph (d)(3).

4\. Revising paragraph (f).

The revisions and additions read as fol-
lows:

§1.1411-3 Application to estates and
trusts.

* * * * *

(d) * * *

(2) * * *

(ii) Special rules for CRTs with income
from certain CFCs or PFICs. If a CRT is
a trust described in §1.1411-10(a), and
the CRT includes an amount in gross in-
come under section 951(a) or section
1293(a) from a CFC or QEF that is not
also income derived from a trade or busi-
ness described in section 1411(c)(2) and
§1.1411-5 (except as provided in
§1.1411-10(b)(2)) and an election under
§1.1411-10(g) is not in effect with respect
to the CFC or QEF, or the CRT is treated
as receiving an excess distribution within
the meaning of section 1291(b) or recog-
nizing gain treated as an excess distribu-
tion under section 1291(a)(2), then the
following rules apply for purposes of sec-
tion 1411 with regard to income derived
from the CFC, QEF, or PFIC-

(A) Amounts included in gross income
for chapter 1 purposes under section
951(a) or section 1293(a) in a calendar
year with respect to the CFC or QEF, and
in one or more categories described in

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§1.664-1(d)(1) are considered excluded
income in that calendar year;

(B) For the year in which the CRT is
treated as receiving any of the items of net
investment income described in para-
graphs (c)(1)(i), (c)(1)(ii), (c)(2)(i), and
(c)(4) of §1.1411-10 that otherwise are
not included in gross income for purposes
of chapter 1 for that year ("NII Inclusion
Amount") with respect to the CFC, QEF,
or PFIC, the rules of this paragraph
(d)(2)(ii)(B) apply; and

(1) For purposes of determining the char-
acter under section 664 of a distribution to
the unitrust or annuity recipient of a CRT,
the NII Inclusion Amount treated as re-
ceived by the CRT shall be allocated among
the categories described in section 664(b)(1)
through (b)(3), and among the classes
within each category as described in
§1.664-1(d)(1), in the manner described in
this paragraph (d)(2)(ii)(B). Specifically, to
the extent the CRT has amounts of excluded
income in the categories described in sec-
tion 664(b)(1) (the Ordinary Income Cate-
gory) or section 664(b)(2) (the Capital Gain
Category), the NII Inclusion Amount shall
be allocated to the CRT's classes of ex-
cluded income in the Ordinary Income Cat-
egory, and then to the classes of excluded
income in the Capital Gain Category, in
turn, until exhaustion of each such class,
beginning with the class of excluded income
within a category with the highest Federal
income tax rate.

(2) Any remaining NII Inclusion
Amount not so allocated to classes within
the Ordinary Income and Capital Gain
Categories shall be placed in the category
described in section 664(b)(3) (the Other

Income Category). To the extent the CRT
distributes amounts from this Other In-
come Category, that distribution shall
constitute a distribution described in
§1.1411-10(c)(4).

(3) A distribution by the CRT of ex-
cluded income first is deemed to carry out
net investment income to the extent of the
NII Inclusion Amount that has been allo-
cated to excluded income in that class.

(4) As a result, a distribution of ex-
cluded income will carry out to the uni-
trust or annuity recipient net investment
income attributable to the items described
in this paragraph (d)(2)(ii)(B).

(C) In the case of a difference between
the amount calculated with respect to a
disposition under paragraph (c)(2)(iii) or
(c)(2)(iv) of §1.1411-10 and the amount
attributable to the relevant disposition for
purposes of chapter 1, the following rules
apply-

(1) If the amount of the gain from the
disposition for purposes of section 1411 is
higher (or the loss smaller) than the
amount of the gain (or loss) calculated for
purposes of chapter 1, such difference
shall be considered an NII Inclusion
Amount and shall be allocated as de-
scribed in paragraph (d)(2)(ii)(B) of this
section. However, in applying paragraph
(d)(2)(ii)(B) of this section to this in-
crease, the order of the classes and cate-
gories to which the allocation is made
shall be changed as follows: the increase
shall be allocated first to the class in the
Capital Gain Category that reflects the
nature of the increase (short-term or long-
term), then to other classes in that cate-
gory, in turn until exhausted, then to the

classes in the Ordinary Income Category,
and finally to the Other Income Category.

(2) If the amount of the gain from the
disposition for purposes of section 1411 is
smaller (or the loss higher) than the
amount of the gain (or loss) calculated for
purposes of chapter 1, such difference
shall reduce accumulated net investment
income in the CRT's categories and their
respective classes as follows-

(i) To the extent that the CRT has
amounts in the Other Income Category by
reason of the application of paragraph
(d)(2)(ii)(B) or (d)(2)(ii)(C)(1) of this sec-
tion for the current or prior years, to the
Other Income Category; and

(ii) Any excess difference in the same
order as specified in paragraph
(d)(2)(ii)(C)(1) of this section.

(iii) * * *

Example 2. (i) In 2010, A creates a net income
with makeup CRT (NIMCRUT). A is the sole in-
come beneficiary of the NIMCRUT for 15 years. As
of December 31, 2012, the NIMCRUT had $2,000 of
dividend income and $180,000 of long-term capital
gain within the Ordinary Income and Capital Gain
Categories, respectively. Because both of these
amounts were received by the NIMCRUT during a
taxable year beginning before 2013, both constitute
excluded income within the meaning of §1.1411-
1(d). In Year 1, the NIMCRUT acquires an interest
in a CFC. The NIMCRUT does not make the
§1.1411-10(g) election with respect to the CFC. In
Year 1, the NIMCRUT receives a section 951(a)
inclusion of $5,000 and makes no distributions to A.
For all years, income derived with respect to the
CFC is not income derived in a trade or business
described in section 1411(c)(2) and §1.1411-5.

(ii) In Year 1, §1.1411-3(d)(2)(ii)(A) treats the
section 951 inclusion as excluded income and allocates
it to the class of non-NII with a 39.6% tax rate in the
Ordinary Income Category under §1.664-1(d)(1).

Year 1 ending Category and Class Balances

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest and Other Income (including section 951 Inclusions)

Excluded

39.6%

$5,000

Qualified Dividends

Excluded

20.0%

$2,000

Capital Gain

Long-Term

$ 0

NII

23.8%

Long-Term

Excluded

20.0%

$180,000

Other Income

None

(iii) The NIMCRUT makes no distributions to its
sole income beneficiary in Year 2. In Year 3, the
CFC distributes $4,000 to the NIMCRUT (which

constitutes net investment income under §1.1411-
10(c)(1)(i)), the NIMCRUT has a total of $800 of

post-2012 interest, and the NIMCRUT distributes
$4,000 to the beneficiary.

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Category and Class Balances immediately before both the CFC distribution and the NIMCRUT's Year 3 distribution to A

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest (post-2012)

NII

43.4%

$800

Interest and Other Income (including section 951 Inclusions)

Excluded

39.6%

$5,000

Qualified Dividends

Excluded

20.0%

$2,000

Capital Gain

Long-Term

NII

23.8%

$ 0

Long-Term

Excluded

20.0%

$180,000

Other Income

None

Section 1.1411-3(d)(2)(ii)(B) will cause the $4,000 distribution from the CFC to be allocated first to the class of excluded income within the Ordinary Income
Category with the highest Federal tax rate (the Interest and Other Income class). The distribution to A consists of $800 of post-2012 interest (subject to section 1411)
and $3,200 from the Interest and Other Income class, of which all $3,200 constitutes NII by reason of the allocation under §1.1411-3(d)(2)(ii)(B). Of the $1,800
remaining in that category after the distribution to A, $800 will carry out NII to A, and will be includable in A's net investment income, when it is distributed to
A in the future. Because the $3,200 distributed to A from this class is subject to both income tax and tax under section 1411 for Year 3, the timing differential
attributable to the rules in §1.1411-10 has been corrected within the NIMCRUT before the income is distributed to A.

Year 3 ending Category and Class Balances (immediately following the distribution to A)

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest (post-2012)

NII

43.4%

$0

Interest &amp; Other Income

Excluded

39.6%

$1,800*

(including section 951 Inclusions)

Qualified Dividends

Excluded

20.0%

$2,000

Capital Gain

Long-Term

NII

23.8%

$0

Long-Term

Excluded

20.0%

$180,000

Other Income

None

*Of which $800 will carry out NII to A when distributed

Example 3. (i) Assume the same facts as in Example 2, except that, in Year 2, the NIMCRUT has a section 951 inclusion in the amount of $4,000, taxable interest
income of $800, tax exempt interest of $4,000. Assume the CRT has $1,100 undistributed capital gain from a taxable year ending before December 31, 2012.

Category and Class Balances immediately before the Year 2 distribution to A

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest (post-2012)

NII

43.4%

$800

Interest and Other Income (including section 951 Inclusions)

Excluded

39.6%

$9,000

Qualified Dividends

Excluded

20.0%

$2,000

Capital Gain

Long-Term

23.8%

NII

$ 0

Long-Term

Excluded

20.0%

$1,100

Other Income

Excluded

$4,000

(ii) In Year 2, the NIMCRUT made a $4,800 distribution to A in that same year (leaving a net balance in the Interest and Other Income class of $5,000 at the
end of Year 2).

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Category and Class Balances as of December 31, Year 2 (immediately following the distribution to A)

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest (post-2012)

NII

43.4%

$0

Interest and Other Income (including section 951 Inclusions)

Excluded

39.6%

$5,000

Qualified Dividends

Excluded

20.0%

$2,000

Capital Gain

Long-Term

NII

23.8%

$0

Long-Term

Excluded

20.0%

$1,100

Other Income

Excluded

$4,000

A's net investment income in Year 2 will include $800 of taxable interest income, but will not include the $4,000 of other ordinary income.

(iii) In Year 3, the NIMCRUT received a distribution from the CFC of $9,000, and assume, for purposes of this example, that the NIMCRUT distributes $6,000
to A. Section 1.1411-3(d)(2)(ii)(B) will cause the $9,000 distribution from the CFC to be allocated first to the class of excluded income within the Ordinary Income
Category with the highest Federal tax rate (thus, $5,000 to the Other Income class and $2,000 to Qualified Dividends). The $2,000 balance of the Year 3 distribution
from the CFC is allocated under §1.1411-3(d)(2)(ii)(B) as follows: $1,100 to the Long-Term Capital Gain class of non-NII (so the distribution to A from this class
in the future will carry out $1,100 of NII to A), and the remaining $900 to the Other Income Category (so the distribution to A from this class in the future will carry
out $900 of NII to A).

The distribution to A consists of $5,000 of Interest and Other Income class and $1,000 of Qualified Dividends, all of which constitutes NII by reason of the
allocation under §1.1411-3(d)(2)(ii)(B).

Category and Class Balances as of December 31, Year 3 (immediately following the distribution to A)

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest (post-2012)

NII

43.4%

$0

Interest &amp; Other Income (section 951 inclusion)

Excluded

39.6%

$0

Qualified Dividends

Excluded

20.0%

$1,000*

Capital Gain

Long-Term

NII

23.8%

$0

Long-Term

Excluded

20.0%

$1,100*

Other Income

NII

3.8%

$900

Other Income

Excluded

0.0%

$3,100

*All of which will carry out NII to A when distributed in the future

A's net investment income in Year 3 will include $5,000 of other ordinary income and $1,000 of qualified dividend income.

Example 4. (i) Same facts as in Example 2, except that the NIMCRUT distributes $7,000 to A in Year 2. This distribution consists of the section 951 inclusion
and the accumulated qualified dividends.

(ii) In Year 2, the NIMCRUT will report $5,000 of ordinary income and $2,000 of qualified dividends to A. Both amounts will constitute excluded income to
A. In this case, A does not have to adjust MAGI because the section 951 inclusion is treated in the same way as any other type of excluded income within the Ordinary
Income Category.

Year 2 ending Category and Class Balances (immediately following the distribution to A)

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest and Other Income (including section 951 Inclusions)

Excluded

39.6%

$0

Qualified Dividends

Excluded

20.0%

$0

Capital Gain

Long-Term

NII

23.8%

$0

Long-Term

Excluded

20.0%

$180,000

Other Income

None

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(iii) When the CFC distributes $4,000 to the NIMCRUT in Year 3, §1.1411-3(d)(2)(ii)(B)(1) requires the NIMCRUT to allocate that $4,000 to the NIMCRUT's
accumulated balance of long-term capital gains recognized by the NIMCRUT prior to December 31, 2012, so that the first $4,000 of the NIMCRUT's long-term
capital gains distributed to A in the future will carry out NII to A.

Category and Class Balances immediately before the Year 3 distribution to A

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest and Other Income (including section 951 Inclusions)

Excluded

39.6%

$0

Qualified Dividends

Excluded

20.0%

$0

Capital Gain

Long-Term

Excluded

20.0%

$180,000*

Other Income

None

*Of which $4,000 will carry out NII to A when distributed in the future

When the NIMCRUT distributes the $4,000 to A in the future, the NIMCRUT will report $4,000 of long-term capital gain to A that also constitutes net investment
income. No MAGI adjustments associated with that distribution will be required by A.

Year 3 ending Category and Class Balances (immediately following the distribution to A)

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest and Other Income (including section 951 Inclusions)

Excluded

39.6%

$0

Qualified Dividends

Excluded

20.0%

$0

Capital Gain

Long-Term

Excluded

20.0%

$176,000

Other Income

None

Example 5. (i) Same facts as in Example 4, except that the NIMCRUT's entire balance of accumulated long-term capital gain was received after 2012 and thus
is ANII.

(ii) When the CFC distributes $4,000 to the NIMCRUT in Year 3, §1.1411-3(d)(2)(ii)(B)(1) requires the NIMCRUT to allocate that $4,000 to excluded income
within the Ordinary Income or Capital Gain Categories. In this case, the NIMCRUT does not have any excluded income remaining within those categories. As a result,
§1.1411-3(d)(2)(ii)(B)(2) requires the excess portion of the CFC distribution not allocable to excluded income in the Ordinary Income or Capital Gain Categories
($4,000 in this case) to be allocated to the Other Income Category.

Category and Class Balances immediately before the Year 3 distribution to A

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest and Other Income (including section 951 Inclusions)

Excluded

39.6%

$0

Qualified Dividends

Excluded

20.0%

$0

Capital Gain

Long-Term

NII

23.8%

$180,000

Long-Term

Excluded

20.0%

$0

Other Income

NII

3.8%

$4,000

When the NIMCRUT distributes the $4,000 to A, the NIMCRUT will report $4,000 of long-term capital gains to A that also constitute net investment income.
No MAGI adjustments associated with the distribution are required by A.

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Year 3 ending Category and Class Balances (immediately following the distribution to A)

Category

Class

Excluded / NII

Tax Rate

Amount

Ordinary Income

Interest and Other Income (including section 951 Inclusions)

Excluded

39.6%

$0

Qualified Dividends

Excluded

20.0%

$0

Capital Gain

Long-Term

NII

23.8%

$176,000

Long-Term

Excluded

20.0%

$0

Other Income

NII

3.8%

$4,000

After the NIMCRUT distributes all income within the Ordinary and Capital Gain categories, the NIMCRUT will distribute the $4,000 of Other Income to
A. Such income will have a zero percent tax rate for chapter 1 purposes but will constitute net investment income. In this case, §1.1411-3(d)(2)(ii)(B)(2) pro-
vides that the future distribution will be considered a distribution of net investment income from a trust within the meaning of §1.1411-10(c)(4). As a result,
§1.1411-10(e) requires A to increase MAGI for the year of that distribution.

(3) Elective simplified method-(i)
Treatment of annuity or unitrust distribu-
tions. If a CRT makes a valid election
under this paragraph (d)(3), the rules of
paragraph (d)(2) of this section shall not
apply, and the net investment income of
the beneficiary attributable to the benefi-
ciary's annuity or unitrust distribution
from the CRT shall include an amount
equal to the lesser of-

(A) The beneficiary's share of the total
amount of the distributions for that year;
or

(B) The beneficiary's same share of the
accumulated net investment income (as
defined in paragraph (d)(1)(iii) of this sec-
tion) of the CRT.

(ii) Properly allocable deductions in ex-
cess of gross income. In computing the
amount described in paragraph (d)(3)(i)(B)
of this section, notwithstanding §1.1411-
4(f)(1)(ii) (limitations on deductions in ex-
cess of income), if in a taxable year a CRT's
properly allocable deductions described in
section 1411(c)(1)(B) and the regulations
thereunder exceed the gross investment in-
come and net gain described in section
1411(c)(1)(A) and the regulations thereun-
der, then such excess deductions shall re-
duce the amount described in paragraph
(d)(3)(i)(B) of this section for that taxable
year and, to the extent of any remaining
excess deductions, for subsequent taxable
years of the CRT.

(iii) Procedural requirements for mak-
ing election. In the case of a CRT estab-
lished after December 31, 2012, a CRT
wanting to make the election under para-
graph (d)(3) of this section must do so on
its income tax return for the taxable year
in which the CRT is established. In the

case of a CRT established before January
1, 2013, the CRT wanting to make the
election under paragraph (d)(3) of this
section must do so on the return for its
first taxable year beginning on or after
January 1, 2013. Once made, the election
is irrevocable. In lieu of the relief provi-
sions under §301.9100-3, the CRT may
make the election on an amended return
for that year only if the taxable year for
which the election is made, and all taxable
years that are affected by the election, for
both the CRT and its beneficiaries, are not
closed by the period of limitations on as-
sessments under section 6501.

* * * * *

(f) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013, except that
paragraphs (d)(1), (d)(2)(i), Example 1 of
(d)(2)(iii), and (d)(3) of this section ap-
plies to taxable years of CRTs that begin
after December 31, 2012. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012,
in accordance with §1.1411-1(f).

* * * * *

Par 4. Section 1.1411-4 is amended by
revising paragraphs (d)(4)(iii), (e)(3), and
(g)(10) through (13) to read as follows:

§1.1411-4 Definition of net investment
income.

* * * * *

(d) * * *

(4) * * *

(iii) Adjustment for capital loss carry-
forwards for previously excluded in-
come-(A) General rule. For purposes of
calculating net gain in paragraph (d) of

this section (and any allowable loss de-
scribed in paragraph (f)(4) of this section,
if applicable), capital losses are reduced
by the lesser of-

(1) The amount of capital loss taken
into account in the current year by reason
of section 1212(b)(1); or

(2) The amount of net capital loss ex-
cluded from net investment income in the
preceding year by reason of paragraph
(d)(4) of this section.

(B) Example. The following example
illustrates the provisions of this paragraph
(d)(4)(iii). For purposes of this example,
assume the taxpayer is a United States
citizen, uses a calendar taxable year, and
Year 1 and all subsequent years are tax-
able years in which section 1411 is in
effect:

Example. (i)(A) In Year 1, A, an unmarried in-
dividual, disposes of 100 shares of publicly traded
stock for a short-term capital gain of $4,000. In
addition, A disposes of a partnership interest and
recognizes a long-term capital loss of $19,000. As-
sume that the entire amount of $19,000 loss is not
allowed against net investment income pursuant to
section 1411(c)(4)(B), §1.1411-7, and paragraph
(d)(4)(ii) of this section. A has no capital loss car-
ryovers from the year preceding Year 1.

(B) For purposes of chapter 1, A reports net
capital loss of $15,000, of which $3,000 is allowed
as a deduction in computing taxable income under
section 1211(b)(1), and the remaining $12,000 is
carried forward into Year 2 as a long-term capital
loss pursuant to section 1212(b)(1).

(C) For purposes of calculating net investment
income, A reports $4,000 of net gain. The $19,000
loss taken into account in computing A's taxable
income in Year 1 is not taken into account in com-
puting net gain. Therefore, there are no losses in
excess of gains in Year 1 for which a deduction is
allowed under paragraph (f)(4) of this section.

(ii)(A) In Year 2, A has no capital gain or loss
transactions.

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(B) For purposes of chapter 1, A reports net
capital loss of $12,000, of which $3,000 is allowed
as a deduction in computing taxable income under
section 1211(b)(1), and the remaining $9,000 is car-
ried forward into Year 3 as a long-term capital loss
pursuant to section 1212(b)(1).

(C) For purposes of calculating net investment
income, A must adjust the $12,000 capital loss car-
ryover from Year 1 pursuant to paragraph (d)(4)(iii)
of this section. The amount of the adjustment is the
lesser of-

(1) The amount of capital loss taken into account
in the current year by reason of section 1212(b)(1)
($12,000), or

(2) The amount of net capital loss excluded from
net investment income in Year 1 by reason of para-
graph (d)(4) of this section ($19,000). The $19,000
loss was the amount disallowed by reason of para-
graph (d)(4)(ii) of this section, and there were no
other adjustments under paragraphs (d)(4)(i) or
(d)(4)(iii) of this section in Year 1.

(D) The amount of capital loss carryover that is
taken into account by A in computing net investment
income in Year 2 is $0 ($12,000 carryover amount
less the adjustment of $12,000). Accordingly, when
calculating net investment income, A has no losses
in excess of gains, and no deduction is available to A
under paragraph (f)(4) of this section.

(iii)(A) In Year 3, A recognizes a $5,000 short-
term capital gain from the disposition of property
described in paragraph (d)(4)(i) of this section, and a
$1,000 short-term capital loss from the disposition of
publicly traded stock.

(B) For purposes of chapter 1, A reports net
capital loss carryover from Year 2 of $9,000. In
addition, the short-term capital gain of $5,000 and
$1,000 short-term capital loss net to produce $4,000
of short-term capital gain. A reports a net capital loss
of $5,000 ($5,000 - $1,000 - $9,000), of which
$3,000 is allowed as a deduction in computing tax-
able income under section 1211(b)(1), and the re-
maining $2,000 is carried forward into Year 4 as a
long-term capital loss pursuant to section 1212(b)(1).

(C) For purposes of calculating net investment
income, A may exclude the $5,000 capital gain from
the calculation of net gain pursuant to paragraph
(d)(4)(i) of this section. In addition, A must adjust
the $9,000 capital loss carryover from Year 2 pur-
suant to paragraph (d)(4)(iii) of this section. The
amount of the adjustment is the lesser of-

(1) The amount of capital loss taken into account
in the current year by reason of section 1212(b)(1)
($9,000); or

(2) The amount of net capital loss excluded from
net investment income in Year 2 by reason of para-
graph (d)(4) of this section ($12,000). The $12,000
loss was the amount disallowed by reason of para-
graph (d)(4)(iii) of this section, and there were no
other adjustments under paragraphs (d)(4)(i) or
(d)(4)(ii) of this section in Year 2.

(D) The amount of capital loss carryover that is
taken into account by A in computing net investment
income in Year 3 is $0 ($9,000 carryover amount
less the adjustment of $9,000). Accordingly, when
calculating net investment income, A excludes
$5,000 of gain under paragraph (d)(4)(i) of this sec-
tion and the $9,000 capital loss carryover under
paragraph (d)(4)(iii) of this section. The amount of

losses taken into account for purposes of computing
net gain is $1,000 (attributable to the $1,000 short-
term capital loss from the disposition of publicly
traded stock). Pursuant to paragraph (f)(4) of this
section, A is entitled to a deduction of $1,000 be-
cause the $1,000 capital loss exceeds the gains, and
the loss is less than the amount of allowable loss for
chapter 1 purposes ($3,000).

(iv)(A) In Year 4, A recognizes a $8,000 long-
term capital loss on the disposition of raw land to
which paragraph (d)(4)(i) of this section does not
apply.

(B) For purposes of chapter 1, A reports net
capital loss carryover from Year 3 of $2,000. The
$8,000 long-term capital loss is added to the $2,000
capital loss carryforward to produce a $10,000 long-
term capital loss, of which $3,000 is allowed as a
deduction in computing taxable income under sec-
tion 1211(b)(1), and the remaining $7,000 is carried
forward into Year 5 as a long-term capital loss
pursuant to section 1212(b)(1).

(C) For purposes of calculating net investment
income, A takes into account the $8,000 capital loss
from the sale of the land. In addition, A must adjust
the $2,000 capital loss carryover from Year 3 pur-
suant to paragraph (d)(4)(iii) of this section. The
amount of the adjustment is the lesser of-

(1) The amount of capital loss taken into account
in the current year by reason of section 1212(b)(1)
($2,000); or

(2) The amount of net capital loss excluded from
net investment income in Year 3 by reason of para-
graph (d)(4) of this section ($4,000). The $4,000 loss
is the sum of the $5,000 gain disallowed by reason of
paragraph (d)(4)(i) of this section and the $9,000 loss
disallowed by reason of paragraph (d)(4)(iii) of this
section, and there were no other adjustments under
paragraph (d)(4)(ii) of this section in Year 3.

(D) The amount of capital loss carryover that is
taken into account by A in computing net investment
income in Year 3 is $0 ($2,000 carryover amount
less the adjustment of $2,000). The amount of losses
taken into account for purposes of computing net
gain is $8,000 (attributable to the $8,000 capital loss
from the disposition of raw land). Pursuant to para-
graph (f)(4) of this section, A is entitled to a deduc-
tion of $3,000 because the $8,000 capital loss ex-
ceeds the gains, and only $3,000 of the loss is
allowable for chapter 1 purposes under section
1211(b)(1).

(v)(A) In Year 5, A has no capital gain or loss
transactions.

(B) For purposes of chapter 1, A reports net
capital loss carryover from Year 4 of $7,000: $3,000
is allowed as a deduction in computing taxable in-
come under section 1211(b)(1), and the remaining
$4,000 is carried forward into Year 6 as a long-term
capital loss pursuant to section 1212(b)(1).

(C) For purposes of calculating net investment
income, A must adjust the $7,000 capital loss carry-
over from Year 4 pursuant to paragraph (d)(4)(iii) of
this section. The amount of the adjustment is the
lesser of-

(1) The amount of capital loss taken into account
in the current year by reason of section 1212(b)(1)
($7,000); or

(2) The amount of net capital loss excluded from
net investment income in Year 4 by reason of para-

graph (d)(4) of this section ($2,000). The $2,000 loss
was the amount disallowed by reason of paragraph
(d)(4)(iii) of this section, and there were no other
adjustments under paragraphs (d)(4)(i) or (d)(4)(ii)
of this section in Year 4.

(D) The amount of capital loss carryover that is
taken into account by A in computing net investment
income in Year 5 is $5,000 ($7,000 carryover
amount less the adjustment of $2,000). The amount
of losses taken into account for purposes of comput-
ing net gain is $5,000 carried over from Year 4.
Pursuant to paragraph (f)(4) of this section, A is
entitled to a deduction of $3,000 because the $5,000
capital loss exceeds the gains, and only $3,000 of the
loss is allowable for chapter 1 purposes under sec-
tion 1211(b)(1).

(vi)(A) In Year 6, A has no capital gain or loss
transactions.

(B) For purposes of chapter 1, A reports net
capital loss carryover from Year 5 of $4,000: $3,000
is allowed as a deduction in computing taxable in-
come under section 1211(b)(1), and the remaining
$1,000 is carried forward into Year 7 as a long-term
capital loss pursuant to section 1212(b)(1).

(C) For purposes of calculating net investment
income, A must adjust the $4,000 capital loss carry-
over from Year 5 pursuant to paragraph (d)(4)(iii) of
this section. The amount of the adjustment is the
lesser of-

(1) The amount of capital loss taken into account
in the current year by reason of section 1212(b)(1)
($4,000); or

(2) The amount of net capital loss excluded from
net investment income in Year 5 by reason of para-
graph (d)(4) of this section ($2,000). The $2,000 loss
was the amount disallowed by reason of paragraph
(d)(4)(iii) of this section, and there were no other
adjustments under paragraphs (d)(4)(i) or (d)(4)(ii)
of this section in Year 5.

(D) The amount of capital loss carryover that is
taken into account by A in computing net investment
income in Year 6 is $2,000 ($4,000 carryover
amount less the adjustment of $2,000). The amount
of losses taken into account for purposes of comput-
ing net gain is $2,000 carried over from Year 5.
Pursuant to paragraph (f)(4) of this section, A is
entitled to a deduction of $2,000 because the $2,000
capital loss exceeds the gains, and the loss is less
than the amount of allowable loss for chapter 1
purposes ($3,000). As a result, the entire $8,000 loss
from the raw land has been taken into account in
computing A's net investment income ($3,000 in
Years 4 and 5, and $2,000 in Year 6).

(vii)(A) In Year 7, A has no capital gain or loss
transactions.

(B) For purposes of chapter 1, A reports net
capital loss carryover from Year 6 of $1,000. The
entire $1,000 is allowed as a deduction in computing
taxable income under section 1211(b)(1). A has no
capital losses to carry over to Year 8.

(C) For purposes of calculating net investment
income, A must adjust the $1,000 capital loss carry-
over from Year 6 pursuant to paragraph (d)(4)(iii) of
this section. The amount of the adjustment is the
lesser of-

(1) The amount of capital loss taken into account
in the current year by reason of section 1212(b)(1)
($1,000); or

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(2) The amount of net capital loss excluded from
net investment income in Year 6 by reason of para-
graph (d)(4) of this section ($2,000). The $2,000 loss
was the amount disallowed by reason of paragraph
(d)(4)(iii) of this section, and there were no other
adjustments under paragraphs (d)(4)(i) or (d)(4)(ii)
of this section in Year 6.

(D) The amount of capital loss carryover that is
taken into account by A in computing net investment
income in Year 6 is $0 ($1,000 carryover amount
less the adjustment of $1,000). Therefore, when cal-
culating net investment income, A has no losses in
excess of gains, and no deduction is available to A
under paragraph (f)(4) of this section.

(e) * * *

(3) Treatment of income from common
trust funds. If a taxpayer is a participant in
a common trust fund and the taxpayer
includes under section 584 any item of
income, deduction, gain, or loss, then sec-
tion 1411 and the regulations thereunder
apply to that item to the same extent as if
the participant had made directly the in-
vestments of the common trust fund to
which the items are attributable.

* * * * *

(g) * * *

(10) Treatment of section 707(c) guar-
anteed payments. Net investment income
does not include section 707(c) payments
received for services. Except to the extent
provided in paragraph (g)(11)(iii)(A) of
this section, section 707(c) payments re-
ceived for the use of capital are net invest-
ment income within the meaning of sec-
tion 1411(c)(1)(A)(i) and paragraph
(a)(1)(i) of this section.

(11) Treatment of section 736 pay-
ments-(i) In general. The treatment of
payments received by a retiring partner or
a deceased partner's successor in interest
described in section 736 is determined
under the rules of this paragraph (g)(11).
Section 736 payments are not distribu-
tions from a plan or arrangement de-
scribed in section 1411(c)(5) and
§1.1411-8. To the extent that any portion
of a section 736 payment is taken into
account in computing a taxpayer's net
earnings from self-employment (within
the meaning of §1.1411-9), then such
amount is not taken into account in com-
puting net investment income by reason of
section 1411(c)(6) and §1.1411-9.

(ii) Treatment of section 736(a)(1) pay-
ments-(A) General rule. In the case of a
payment described in section 736(a)(1) as
a distributive share of partnership income,
the items of income, gain, loss, and de-

duction attributable to such distributive
share are taken into account in computing
net investment income in section 1411(c)
in a manner consistent with the item's
character and treatment for chapter 1 pur-
poses. See §1.469-2(e)(2)(iii) for rules
concerning the item's character and treat-
ment for chapter 1.

(B) Examples. The following examples
illustrate the provisions of this paragraph
(g)(11)(ii). For purposes of these exam-
ples, assume the taxpayer is a United
States citizen, uses a calendar taxable
year, and Year 1 and all subsequent years
are taxable years in which section 1411 is
in effect:

Example 1. Distributive share for goodwill. (i) A
retires from PRS, a business entity classified as a
partnership for Federal income tax purposes, and is
entitled, pursuant to the partnership agreement, to
receive 10% of PRS's net income for 60 months
commencing immediately following A's retirement
in exchange for A's fair market value share of PRS's
unrealized receivables. PRS is not engaged in a trade
or business described in section 1411(c)(2)(B) (a
trading business). A will provide no services to PRS
for the 60-month period following A's retirement.
Prior to A's retirement, A materially participated in
PRS's trade or business within the meaning of
§1.469-5T. As a result, PRS is characterized by A
as a nonpassive activity for section 469 purposes.
For purposes of section 1411, PRS was not a trade or
business described in section 1411(c)(2)(A) prior to
A's retirement.

(ii) In Year 3, pursuant to the partnership agree-
ment, A received a cash payment of $20,000. A's
distributive share of PRS income in Year 3 included
$70,000 of gross income from operations and
$50,000 of deductions from operations. PRS's status
as a passive or nonpassive activity is determined
under §1.469-2(e)(2)(iii) at the time the liquidation
of A's partnership interest commenced, and remains
fixed for the duration of A's liquidation payments.
Therefore, PRS is a nonpassive activity with respect
to A in Year 3 pursuant to §1.469-2(e)(2)(iii). As a
result, the gross income is not attributable to a trade
or business described in section 1411(c)(2)(A) or
§1.1411-5(a)(1). Accordingly, A's distributive share
of $70,000 of gross income and $50,000 of associ-
ated deductions are not includable in A's net invest-
ment income in Year 3.

(iii) If PRS's distributive share of operational
income and deductions was attributable to a trade or
business described in section 1411(c)(2)(B) or
§1.1411-5(a)(2), the $70,000 of gross income
amounts would be included in A's net investment
income under section 1411(c)(1)(A)(ii) and para-
graph (c) of this section and the $50,000 of associ-
ated deductions would be properly allocable to such
income under section 1411(c)(1)(B) and §1.1411-
4(f)(2)(ii).

Example 2. Excess distributive share payments.
Assume the same facts as in Example 1 except that
PRS provides A an additional 2% of PRS's net
income for 48 months commencing immediately fol-

lowing A's retirement as an incentive for A to retire
earlier than planned. In the case of the additional 2%
distributive share, the section 736(a) income charac-
terization rule in §1.469-2(e)(2)(iii) does not apply
because the payment exceeds the value of PRS's
unrealized receivables (which was established to
equal 10% of PRS's income for 60 months in Ex-
ample 1). As a result, A must determine whether
PRS is a trade of business described in section
1411(c)(2)(A) and §1.1411-5(a)(1) in Year 3 in or-
der to determine whether the distributive share of
operating income and deductions is includable in net
investment income. If PRS is engaged in a trade or
business described in section 1411(c)(2)(A) and
§1.1411-5(a)(1) with respect to A in Year 3, then the
distributive share will be taken into account in com-
puting A's net investment income.

(iii) Treatment of section 736(a)(2)
payments-(A) Payments for unrealized re-
ceivables and goodwill. In the case of a pay-
ment described in section 736(a)(2), the por-
tion (if any) of the payment that is allocable to
the unrealized receivables (within the meaning
of section 751(c)) and goodwill of the partner-
ship (as described and calculated in §1.469-
2(e)(2)(iii)(B)) is included in net investment
income under section 1411(c)(1)(A)(iii) and
paragraphs (a)(1)(iii) and (d) of this section as
gain from the disposition of a partnership in-
terest.

(B) Payments not for unrealized re-
ceivables or goodwill. In the case of a
section 736(a)(2) payment not described
in paragraph (g)(11)(iii)(A) of this sec-
tion, the payment is characterized as a
payment for services or as the payment of
interest in a manner consistent with the
payment's characterization under §1.469-
2(e)(2)(ii). See paragraph (g)(9) of this
section.

(iv) Treatment of section 736(b) payments.
Gain or loss attributable to section 736(b) pay-
ments is included in net investment income
under section 1411(c)(1)(A)(iii) and para-
graphs (a)(1)(iii) and (d) of this section as gain
or loss from the disposition of a partnership
interest. A taxpayer who elects under §1.736-
1(b)(6) must apply the principles that are ap-
plied to installment sales in §1.1411-7(d).

(v) Application of section 1411(c)(4) to
section 736 payments. Section 1411(c)(4)
and §1.1411-7 apply to gain or loss attrib-
utable to section 736 payments described
in paragraphs (g)(11)(iii)(A) and
(g)(11)(iv) of this section. In the case of
section 736 payments that are received in
more than one taxable year, the rules for
calculating gain or loss under section
1411(c)(4) and §1.1411-7 are applied at
the time the liquidation of the partner's

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interest commenced. The principles that
are applied to installment sales in
§1.1411-7(d) also apply for purposes of
this section.

(12) Income and deductions from cer-
tain notional principal contracts-(i) In
general. Net income for a taxable year
taken into account by a taxpayer under
§1.446-3(d) that is attributable to a no-
tional principal contract described in para-
graph (g)(12)(ii) of this section is net in-
vestment income described in section
1411(c)(1)(A) and paragraph (a)(1) of this
section. A net deduction for a taxable year
taken into account by a taxpayer under
§1.446-3(d) that is attributable to a no-
tional principal contract described in para-
graph (g)(12)(ii) of this section is a prop-
erly allocable deduction described in
section 1411(c)(1)(B) and paragraph (f) of
this section.

(ii) Notional principal contracts. For
purposes of paragraph (g)(12)(i) of this
section, a notional principal contract is
any notional principal contract described
in §1.446-3(c)(1) that is referenced to
property (including an index) that pro-
duces (or would produce if the property
were to produce income) interest, divi-
dends, royalties, or rents if the property
were held directly by the taxpayer. For
purposes of the preceding sentence, an
interest rate swap, cap, or floor is treated
as a notional principal contract that is ref-
erenced to a debt instrument.

(13) Treatment of income or loss from
REMIC residual interests. The daily por-
tion of taxable income determined under
section 860C(a)(2) taken into account in
determining tax under chapter 1 by the
holder of a residual interest in a REMIC
and any inducement fee included in in-
come under §1.446-6(a) are treated as net
investment income under section
1411(c)(1)(A) and paragraph (a)(1) of this
section. The daily portion of net loss de-
termined under section 860C(a)(2) taken
into account in determining tax under
Chapter 1 by the holder of a residual in-
terest in a REMIC is a properly allocable
deduction described in section
1411(c)(1)(B) and paragraph (f) of this
section.

* * * * *

Par. 5. Section 1.1411-7 is added to
read as follows:

§1.1411-7 Exception for dispositions of
certain active interests in partnerships
and S corporations

(a) In general-(1) General applica-
tion. In the case of a transferor that dis-
poses of an interest in a partnership or S
corporation described in paragraph (a)(3)
of this section (transferor), the gain or loss
from the disposition recognized under
chapter 1 that is taken into account under
§1.1411-4(a)(1)(iii) shall be calculated in
accordance with this section. The calcula-
tion in paragraph (b) of this section re-
flects the net gain or net loss that the
transferor would take into account if the
partnership or S corporation sold all of its
Section 1411 Property (as defined in para-
graph (a)(2)(iv) of this section) for fair
market value immediately before the dis-
position of such interest. In certain in-
stances, transferors may qualify to use an
alternative calculation described in para-
graph (c) of this section in lieu of the
calculation described in paragraph (b) of
this section. Paragraph (d) of this section
contains additional rules for Section
1411(c)(4) Dispositions (as defined in
paragraph (a)(2)(ii) of this section) in de-
ferred recognition transactions. Paragraph
(f) of this section provides rules for ad-
justing the amount of gain or loss com-
puted under this paragraph (a)(1) for
transferors subject to basis adjustments
required by §1.1411-10(d). Paragraph (g)
of this section provides rules for informa-
tion disclosures by a partnership or S cor-
poration to transferors and for information
reporting by individuals, trusts, and es-
tates. If a transferor disposes of an interest
in a partnership or S corporation not de-
scribed in paragraph (a)(3) of this section,
then this section does not apply and the
full amount of the gain or loss, as com-
puted under chapter 1 and adjusted by
§1.1411-10(d) (if applicable), is taken
into account in computing the transferor's
net investment income.

(2) Definitions. For purposes of this
section-

(i) The term Passthrough Entity means
an entity taxed as a partnership or an S
corporation. For purposes of this section,
a reference to an interest in any S corpo-
ration shall mean a reference to stock in
such S corporation.

(ii) The term Section 1411(c)(4) Dis-
position means a disposition of an interest
in a Passthrough Entity described in para-
graph (a)(3) of this section.

(iii) The term Section 1411 Holding
Period means the year of disposition and
the transferor's two taxable years preced-
ing the disposition or the time period the
transferor held the interest, whichever is
less; provided, however, that for purposes
of applying this paragraph (a)(2)(iii), the
transferor will-

(A) Include the period that a previous
owner or owners held the interest trans-
ferred if the transferor acquired its interest
from another Passthrough Entity in a non-
recognition transaction during the year of
disposition or the prior two taxable years;

(B) Include the period that the trans-
feror held an interest in a Subsidiary Pass-
through Entity if the transferor transferred
that interest to a Passthrough Entity in a
nonrecognition transaction during the year
of disposition or the prior two taxable
years; and

(C) Include the period that a previous
owner or owners held the interest trans-
ferred if the transferor acquired its interest
by gift.

(iv) The term Section 1411 Property
means property owned by or held through
the Passthrough Entity that, if disposed of
by the entity, would result in net gain or
loss allocable to the transferor of a type
that is includable in determining net in-
vestment income of the transferor under
§1.1411-4(a)(1)(iii).

(v) The term Subsidiary Passthrough
Entity means an interest in a Passthrough
Entity owned, directly or indirectly, by
another Passthrough Entity.

(3) Section 1411(c)(4) Dispositions-
(i) Transfers by individuals, estates, and
trusts. The disposition by a transferor of
an interest in a Passthrough Entity is a
Section 1411(c)(4) Disposition only if-

(A) The Passthrough Entity is engaged
in one or more trades or businesses
(within the meaning of section 162), or
owns an interest (directly or indirectly) in
a Subsidiary Passthrough Entity that is
engaged in one or more trades or busi-
nesses (within the meaning of section
162), that is not described in §1.1411-
5(a)(2) (trading in financial instruments or
commodities); and

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(B) One or more of the trades or busi-
nesses of the Passthrough Entity described
in paragraph (a)(3)(i)(A) of this section is
not a §1.1411-5(a)(1) (passive activity)
trade or business of the transferor.

(ii) Transfers by Passthrough Entities.
Where a Passthrough Entity (the "holder")
disposes of an interest in a Subsidiary
Passthrough Entity, that disposition qual-
ifies as a Section 1411(c)(4) Disposition
with respect to a partner or shareholder of
the Passthrough Entity if the partner or
shareholder would satisfy the require-
ments of paragraph (a)(3)(i) of this section
if it held the interest in the Subsidiary
Passthrough Entity directly. For this pur-
pose, the partner or shareholder shall be
treated as owning a proportionate share of
any Subsidiary Passthrough Entity in
which the partner or shareholder owns an
indirect interest through one or more tiers
of Passthrough Entities.

(4) Special rules-(i) Certain liquida-
tions. If a fully taxable disposition of all of
the Passthrough Entity's assets is fol-
lowed by the complete liquidation of the
Passthrough Entity as part of a single plan,
then the disposition will be treated as an
asset sale for purposes of section 1411,
and no additional gain or loss will be
included in net investment income under
§1.1411-4(a)(1)(iii) on the subsequent
liquidation of the Passthrough Entity by
any transferor who would have satisfied
paragraph (a)(3) of this section prior to the
sale. A sale of stock in an S corporation
with respect to which an election under
section 336(e) or section 338(h)(10) is
made shall be treated as a fully taxable
disposition of the Passthrough Entity's as-
sets followed by the liquidation of the
Passthrough Entity for purposes of this
paragraph (a)(4)(i).

(ii) Excluded gain or loss. The differ-
ence between the amount of gain or loss
taken into account in computing taxable
income for purposes of chapter 1 and the
amount of gain or loss taken into account
after the application of this section shall
constitute excluded income or excluded
loss, as applicable, for purposes of
§1.1411-4(d)(4)(ii).

(iii) Rules applicable to S corporation
shareholders-(A) Certain S corporation
dispositions. If the transfer of an interest
in an S corporation causes the S election
to terminate on the day of the transfer,

then the corporation shall continue to be
treated as an S corporation for purposes of
applying the rules of this section to the
transferor notwithstanding that §1.1362-
3(a) treats the day of the transfer as the
first day of the corporation's C corpora-
tion short year (as defined therein).

(B) S corporations subject to section
1374. For purposes of the calculation un-
der paragraph (b) of this section, the
amount of gain or loss allocated to the
transferor is determined under section
1366(a), and the allocation does not take
into account any reduction in the transfer-
or's pro rata share of gains under section
1366(f)(2) resulting from the hypothetical
imposition of tax under section 1374 as a
result of the deemed sale.

(C) Treatment of Qualified Subchapter
S Trusts (QSSTs). In the case of a dispo-
sition of S corporation stock by a QSST,
the rules of this section are applied by
treating the QSST as the owner of the S
corporation stock.

(b) Calculation-(1) In general. A
transferor of an interest in a Passthrough
Entity who disposes of that interest in a
Section 1411(c)(4) Disposition may use
the simplified calculation in paragraph (c)
of this section if it meets the eligibility
requirements set forth in paragraph (c)(2)
of this section. Any other transferor who
disposes of an interest in a Passthrough
Entity in a Section 1411(c)(4) Disposition
must include gain or loss under §1.1411-
4(a)(1)(iii) determined in accordance with
this paragraph (b).

(i) Gain on disposition of interest. If
the transferor recognized a gain from the
disposition, the amount of the net gain
included in §1.1411-4(a)(1)(iii) is the
lesser of-

(A) the transferor's gain on the dispo-
sition of the interest in the Passthrough
Entity as determined in accordance with
chapter 1; or

(B) the transferor's allocable share of the
chapter 1 net gain from a deemed sale of the
Passthrough Entity's Section 1411 Property as
determined using the principles of §1.469-
2T(e)(3) (allocation of gain or loss to activities
of the Passthrough Entity) where the net gain
is the sum of the amounts of net gain and net
loss allocable to the transferor as determined
under §§1.469-2T(e)(3)(ii)(B)(1)(i) and
1.469-2T(e)(3)(ii)(B)(2)(i) that would con-
stitute income to the transferor for purposes

of section 1411 if sold by the Passthrough
Entity. The general rules of §1.469-
2T(e)(3) apply in calculating the transferor's
allocable share of the net gain under this
section; however, the gain recharacteriza-
tion rule of §1.469-2T(e)(3)(iii) shall not
apply in any case. The calculation of net
gain in this paragraph (b)(1)(i) shall not be
less than zero.

(ii) Loss on disposition of interest. If
the transferor recognizes a loss from the
disposition, the amount of the net loss
included in §1.1411-4(a)(1)(iii) is the
lesser of-

(A) The transferor's loss (expressed as
a positive number) on the disposition of
the interest in the Passthrough Entity as
determined in accordance with chapter 1;
or

(B) The transferor's allocable share
of the chapter 1 net loss (expressed as a
positive number) from the deemed sale
of the entity's Section 1411 Property as
determined in accordance with §1.469-
2T(e)(3) (allocation of gain or loss to
activities of the Passthrough Entity)
where the net loss is the sum of the
amounts of net gain and net loss alloca-
ble to the transferor as determined under
§§1.469-2T(e)(3)(ii)(B)(1)(i) and 1.469-
2T(e)(3)(ii)(B)(2)(i) that would constitute
income or loss to the transferor for purposes
of section 1411 if sold by the Passthrough
Entity. The general rules of §1.469-
2T(e)(3) apply in calculating the transferor's
allocable share of the net gain under this
section; however, the gain recharacteriza-
tion rule of §1.469-2T(e)(3)(iii) shall not
apply in any case. The calculation of net
gain in this paragraph (b)(1)(ii) shall not be
less than zero. For purposes of this para-
graph (b)(1)(ii), the loss limitation provi-
sions imposed by sections 704(d) and
1366(d) shall not apply.

(2) Examples. The following examples
illustrate the principles of paragraph
(b)(1) of this section. For purposes of
these examples, assume that the taxpayer
is a United States citizen, uses a calendar
taxable year, and Year 1 and all subse-
quent years are taxable years in which
section 1411 is in effect:

Example 1. (i) Facts. A owns a one-half interest
in P, a calendar year partnership. In Year 1, A sells
its interest for $200,000. A's adjusted basis for the
interest sold is $120,000. Thus, A recognizes
$80,000 of gain from the sale (chapter 1 gain). P is
engaged in three trade or business activities, X, Y,

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and Z, none of which are §1.1411-5(a)(2) (trading in
financial instruments or commodities) trades or busi-
nesses. P also owns marketable securities. For Year
1, A materially participates in activity Z, thus it is
not a §1.1411-5(a)(1) (passive activity) trade or
business of A. A, however, does not materially par-
ticipate in activities X and Y, so these activities are

§1.1411-5(a)(1) trades or businesses of A. Because
P is engaged in at least one trade or business and at
least one of those trades or businesses is not passive
to the transferor A, A determines its amount of
§1.1411-4(a)(1)(iii) gain or loss from net invest-
ment income under §1.1411-7. Assume for pur-
poses of this example, A is not eligible to compute

its §1.1411-4(a)(1)(iii) gain or loss under the op-
tional simplified reporting method discussed in para-
graph (c) of this section. The fair market value and
adjusted basis of the gross assets used in P's activ-
ities are as follows:

Adjusted basis

Fair market value

Gain/Loss

A's Share Gain/Loss

X (Passive as to A)

$136,000

$96,000

($40,000)

($20,000)

Y (Passive as to A)

60,000

124,000

64,000

32,000

Z (Non-passive as to A)

40,000

160,000

120,000

60,000

Marketable securities

4,000

20,000

16,000

8,000

Total

240,000

400,000

160,000

80,000

(ii) Analysis. Under paragraph (b)(1) of this sec-
tion, A must determine the portion of gain or loss
from the sale of P's Section 1411 Property allocable
to A. Under paragraph (b)(1)(ii) of this section, A's
allocable share of gain from P's Section 1411 Prop-
erty is $20,000 (($20,000) from X + $32,000 from Y
\+ $8,000 from the marketable securities). Because
the $20,000 allocable to A from a deemed sale of P's
Section 1411 Property is less than A's $80,000 chap-
ter 1 gain, A will include $20,000 under §1.1411-
4(a)(1)(iii).

Example 2. Assume the same facts as Example 1,
but A materially participates in activities Y and Z
and does not materially participate in activity X.
Under paragraph (b)(1)(i) of this section, A's allo-
cable share of P's Section 1411 Property is ($12,000)
(($20,000) from X + $8,000 from the marketable
securities). Because A sold its interest for a chapter
1 gain, the amount allocable to A from a deemed sale
of P's Section 1411 Property cannot be less than
zero. Accordingly, A includes no gain or loss under
§1.1411-4(a)(1)(iii).

(c) Optional simplified reporting-(1)
In general. A transferor of an interest in a
Passthrough Entity in a Section
1411(c)(4) Disposition may use the sim-
plified reporting rules of paragraph (c)(4)
of this section if it satisfies the eligibility
requirements set forth in paragraph (c)(2)
of this section and is not described in
paragraph (c)(3) of this section. All other
transferors of interests in Passthrough En-
tities in Section 1411(c)(4) Dispositions
must use the calculation set forth in para-
graph (b) of this section. Paragraph (d) of
this section contains additional rules for
Section 1411(c)(4) Dispositions in de-
ferred recognition transactions.

(2) Qualifications. Unless described in
paragraph (c)(3) of this section, a trans-
feror of an interest in a Passthrough Entity
in a Section 1411(c)(4) Disposition may
determine the amount of net gain or net
loss that is taken into account under

§1.1411-4(a)(1)(iii) in accordance with
paragraph (c)(4) of this section if either or
both of the requirements in paragraph
(c)(2)(i) or (c)(2)(ii) of this section are
satisfied:

(i) Five percent threshold. The sum of
separately stated income, gain, loss, and
deduction items (with any separately
stated loss and deduction items included
as positive numbers) of a type the trans-
feror would take into account in calculat-
ing net investment income (as defined in
§1.1411-1(d)) that are allocated to the
transferor in respect of the transferred in-
terest is five percent or less of the sum of
all separately stated items of income, gain,
loss, and deduction (with any separately
stated loss and deduction items included
as positive numbers) allocated to the
transferor in respect of the transferred in-
terest during the Section 1411 Holding
Period, and the total amount of chapter 1
gain or loss recognized by the transferor
from the disposition of interests in the
Passthrough Entity does not exceed $5
million (including gains or losses from
multiple dispositions as part of a plan). All
dispositions of interests in the Pass-
through Entity that occur during the tax-
able year will be presumed to be part of a
plan. In calculating the percentage de-
scribed in the first sentence of this para-
graph (c)(2)(i), if the transferor acquired
the transferred interest in a transaction
described in paragraph (a)(2)(iii)(A) or
(a)(2)(iii)(C) of this section, then items of
income, gain, loss, or deduction allocated
to the transferor include any such items
allocated to the transferor's predecessor
(or predecessors) in interest during the
Section 1411 Holding Period. If the trans-

feror transferred an interest in a Subsid-
iary Passthrough Entity to the Passthrough
Entity in a transaction described in para-
graph (a)(2)(iii)(B) of this section, then
items of income, gain, loss or deduction
allocated to the transferor include any
items allocated to the transferor during the
Section 1411 Holding Period in respect of
the interest in the Subsidiary Passthrough
Entity.

(ii) $250,000 gain or loss threshold.
The total amount of chapter 1 gain or loss
recognized by the transferor from the dis-
position of interests in the Passthrough
Entity does not exceed $250,000 (includ-
ing gains or losses from multiple disposi-
tions as part of a plan). All dispositions of
interests in the Passthrough Entity that
occur during the taxable year will be pre-
sumed to be part of a plan.

(3) Nonapplicability. A transferor is
not eligible to use the simplified reporting
method of paragraph (c)(4) of this section
if any of the following conditions are met:

(i) The transferor has held directly the
interest in the Passthrough Entity (or held
the interest indirectly in the case of a
Subsidiary Passthrough Entity) for less
than twelve months preceding the Section
1411(c)(4) Disposition.

(ii) The transferor transferred, directly
or indirectly, Section 1411 Property (other
than cash or cash equivalents) to the Pass-
through Entity (or a Subsidiary Pass-
through Entity described in paragraph
(a)(2)(v) of this section), or received a
distribution of property (other than Sec-
tion 1411 property) from the Passthrough
Entity (or a Subsidiary Passthrough Entity
described in paragraph (a)(2)(v) of this
section), during the Section 1411 Holding

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Period as part of a plan that includes the
transfer of the transferor's interest in the
Passthrough Entity. A transferor who con-
tributed, directly or indirectly, Section
1411 Property (other than cash or cash
equivalents) within 120 days of the dispo-
sition of the interest in the Passthrough
Entity is presumed to have made the con-
tribution as part of a plan that includes the
transfer of the interest in the Passthrough
Entity.

(iii) The Passthrough Entity is a part-
nership, and the transferor transfers a par-
tial interest that represents other than a
proportionate share of all of the transfer-
ring partner's economic rights in the part-
nership.

(iv) The transferor knows or has reason
to know that the percentage of the Pass-
through Entity's gross assets that consist
of Section 1411 Property has increased or
decreased by 25 percentage points or
more during the transferor's Section 1411
Holding Period due to contributions, dis-
tributions, or asset acquisitions or dispo-
sitions in taxable or nonrecognition trans-
actions.

(v) The Passthrough Entity, which is
the subject of the Section 1411(c)(4) Dis-
position, was taxable as a C corporation
during the Section 1411 Holding Period,
but during that period elects under section
1362 to be taxable as an S corporation
under section 1361.

(4) Optional simplified reporting cal-
culation. The amount of net gain or loss
from the transferor's Section 1411(c)(4)
Disposition that is includable in §1.1411-
4(a)(1)(iii) is determined by multiplying
the transferor's chapter 1 gain on the dis-
position by a fraction, the numerator of
which is the sum of income, gain, loss,
and deduction items (with any separately
stated loss and deduction items netted as
negative numbers) of a type that are taken
into account in the calculation of net in-
vestment income (as defined in §1.1411-
1(d)) that are allocated to the transferor
during the Section 1411 Holding Period
and the denominator of which is the sum
of all items of income, gain, loss, and
deduction allocated to the transferor dur-
ing the Section 1411 Holding Period (with
any separately stated loss and deduction
items netted as negative numbers). If the
quotient of the fraction is either greater
than one or less than zero, then the frac-

tion shall be one; provided, however, that
if the numerator is a negative amount in
connection with a computation of overall
chapter 1 gain on the sale or a positive
amount in connection with a computation
of overall chapter 1 loss on the sale, then
the fraction shall be zero. In calculating
the fraction described in the first sentence
of this paragraph (c)(4), if the transferor
acquired the transferred interest in a trans-
action described in paragraph
(a)(2)(iii)(A) or (C) of this section, then
items of income, gain, loss, or deduction
allocated to the transferor include any
such items allocated to the transferor's
predecessor (or predecessors) in interest
during the Section 1411 Holding Period.
If the transferor transferred an interest in a
Subsidiary Passthrough Entity to the Pass-
through Entity in a transaction described
in paragraph (a)(2)(iii)(B) of this section,
then items of income, gain, loss or deduc-
tion allocated to the transferor include any
items allocated to the transferor during the
Section 1411 Holding Period in respect of
the interest in the Subsidiary Passthrough
Entity.

(5) Examples. The following examples
illustrate the principles of paragraph (c)(4)
of this section. For purposes of these ex-
amples, assume that the taxpayer is a
United States citizen, uses a calendar tax-
able year, and Year 1 and all subsequent
years are taxable years in which section
1411 is in effect:

Example 1. Facts. A owns a one-half interest in
P, a partnership. In Year 1, A sells the interest for
$2,000,000. A's adjusted basis for the interest sold is
$1,100,000. Because P is engaged in at least one
trade or business and at least one of those trades or
businesses is not passive to the transferor A, A
determines its amount of §1.1411-4(a)(1)(iii) gain
or loss from net investment income under §1.1411-
7. None of the nonapplicability conditions set forth
in section 1.1411-7(c)(3) apply. The aggregate net
income from P's activities allocable to A for the year
of disposition and the two preceding tax years are as
follows:

Aggregate Income/ (loss)

X (Non-Passive as to A)

$1,800,000

Y (Passive as to A)

(10,000)

Marketable securities

20,000

(ii) Analysis. During A's Section 1411 Holding
Period, A was allocated $30,000 of gross items of a
type taken into account in the calculation of net

investment income ($10,000 of loss from activity Y
and $20,000 of income from marketable securities).
The total amount of A's allocated net items during
the Section 1411 Holding Period equals $1,830,000
($1,800,000 income from activity X, $10,000 loss
from activity Y, and $20,000 income from market-
able securities). Thus, less than 5% ($30,000/
1,830,000) of A's allocations during the Section
1411 Holding Period are of a type that are taken into
account in the computation of net investment in-
come, and because A's chapter 1 gain recognized of
$2,000,000 is less than $5,000,000, A qualifies under
§1.1411-7(c)(2)(ii) to use the optional simplified
method.

(iii) Under paragraph (c)(4) of this section, A's
percentage of Section 1411 Property is determined
by dividing A's allocable shares of income and loss
of a type that are taken into account in the calcula-
tion of net investment income (as defined in
§1.1411-1(d)) that are allocated to the transferor by
the Passthrough Entity during the Section 1411
Holding Period is $10,000 ($10,000 loss from Y +
$20,000 income from marketable securities) by
$1,830,000, which is the sum of A's share of income
and loss from all of P's activities ($1,800,000 +
($10,000) + 20,000). Thus, A's gain for purposes of
§1.1411-4(a)(1)(iii) is $4,972.32 ($900,000 chapter
1 gain multiplied by the fraction 10,000/1,830,000).

Example 2. Assume the same facts as Example 1,
but A sells the interest in P for $900,000. Under
paragraph (c)(3) of this section, A's percentage of
Section 1411 Property is determined by dividing A's
allocable share of income and loss of a type that are
taken into account in the calculation of net invest-
ment income (as defined in §1.1411-1(d) that are
allocated to the transferor by the Passthrough Entity
during the Section 1411 Holding Period is $10,000
($10,000 loss from Y + $20,000 income from mar-
ketable securities) by $1,810,000, which is the sum
of A's share of income and loss from all of P's
activities ($1,800,000 + ($10,000) + 20,000). Be-
cause A's allocable share during the Section 1411
Holding Period of income and loss of a type that is
taken into account in calculating net investment in-
come was a positive amount, and A sells its interest
for an overall chapter 1 loss, A uses a fraction of 0 to
compute its net investment income under paragraph
(c)(4) of this section. Thus, A has no gain or loss for
purposes of §1.1411-4(a)(1)(iii) ($200,000 chapter
1 loss multiplied by a fraction of 0).

(d) Deferred recognition transactions.
In the case of a disposition of a Pass-
through Entity in an installment sale under
section 453 (or in exchange for an annuity
contract), the calculations described in
paragraphs (b) and (c) of this section shall
be applied in the year of the disposition as
if the entire amount of gain recognized for
chapter 1 is taken into account by the
transferor in the year of the disposition.
For this purpose, it is assumed that any
contingencies potentially affecting con-
sideration to the transferor that are reason-
ably expected to occur will occur, and in
the case of annuities based on the life

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expectancy of one or more individuals, the
present value of the annuity (using exist-
ing Federal tax valuation methods) is used
to determine the estimated gain. If the
calculations in this section result in a
transferor excluding only a portion of the
chapter 1 gain from net investment in-
come, the amount of excluded gain will
constitute an addition to basis for pur-
poses of applying section 453 to deter-
mine the amount of gain is includable in
net investment income under §1.1411-
4(a)(1)(iii) as payments are received.

(e) Disposition of tiered Passthrough
Entities. [Reserved]

(f) Adjustment to net gain or loss. In
the case of a disposition of an interest in a
Passthrough Entity where the transferor's
basis in the interest for section 1411 pur-
poses does not equal the transferor's basis
for chapter 1 purposes due to basis adjust-
ments required by §1.1411-10(d), then
the following rules apply:

(i) If the transferor's basis for section
1411 purposes is higher than the transfer-
or's basis for chapter 1 purposes, then the
difference reduces the amount of gain or
increases the amount of loss, as applica-
ble, that is includable in net investment
income under this section.

(ii) If the transferor's basis for section
1411 purposes is lower than the transfer-
or's basis for chapter 1 purposes, then the
difference increases the amount of gain or
reduces the amount of loss, as applicable,

that is includable in net investment in-
come under this section.

(iii) The adjustments to gain or loss
includable in net investment income under
this paragraph (f) are taken into account
by the transferor immediately following
the calculation of gain or loss under para-
graphs (a)(4)(i), (b)(1) or (c)(4) of this
section, as applicable.

(g) Information reporting-(1) Infor-
mation to be provided by passthrough en-
tity to transferor. Where the Passthrough
Entity knows, or has reason to know, that
the transferor satisfies paragraph (a)(3)(i)
of this section but does not satisfy para-
graph (c) of this section, then the Pass-
through Entity shall provide the transferor
with information as to the transferor's al-
locable share of the net gain or loss from
the deemed sale of the Passthrough Enti-
ty's Section 1411 Property as described in
paragraph (b)(1) of this section and such
other information as may be required by
forms, instructions, or in other guidance to
allow the transferor to compute gain or
loss under this section.

(2) Information reporting by transfer-
ors. Any transferor making a calculation
under this section must attach a statement
to the transferor's return for the year of
disposition containing certain information
as required by this paragraph (g)(2) and
any other information required by guid-
ance and applicable forms and instruc-
tions issued by the Commissioner to allow
the transferor to compute gain or loss un-

der this section. In the case of a disposi-
tion in a transaction described in para-
graph (d) of this section, the information
required by this paragraph (g)(2) shall ap-
ply in the year of the disposition, or in the
first year the taxpayer is subject to section
1411 (determined without regard to the
effect of this section), whichever is later.
The statement must include-

(i) The name and taxpayer identifica-
tion number of the Passthrough Entity of
which the interest was transferred;

(ii) The amount of the transferor's gain
or loss on the disposition of the interest
for purposes of chapter 1;

(iii) The information provided by the
Passthrough Entity to the transferor by
reason of paragraph (g)(1) of this section;
and

(iv) The amount of adjustment to gain
or loss by reason of paragraph (f) of this
section, if any.

(h) Effective/applicability date. This
section applies to taxable years beginning
after December 31, 2013. However, tax-
payers may apply this section to taxable
years beginning after December 31, 2012
in accordance with §1.1411-1(f).

John Dalrymple,
Deputy Commissioner for Services and
Enforcement.

(Filed by the Office of the Federal Register on November
26, 2013, 4:15 p.m., and published in the issue of the Federal
Register for December 2, 2013, 78 F.R. 72451)

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# Definition of Terms

Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.

Revenue rulings and revenue proce-
dures (hereinafter referred to as “rul-
ings") that have an effect on previous
rulings use the following defined terms to
describe the effect:

Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that
the same principle also applies to B, the
earlier ruling is amplified. (Compare with
modified, below).

Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.

Distinguished describes a situation
where a ruling mentions a previously pub-

lished ruling and points out an essential
difference between them.

Modified is used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to 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
with amplified and clarified, above).

Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used in
a ruling that lists previously published 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.

Revoked describes situations where the
position in the previously published ruling
is not correct and the correct position is
being stated in a new ruling.

Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same

position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the new
ruling does more than restate the sub-
stance of a prior ruling, a combination of
terms is used. For example, modified and
superseded describes 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
published ruling is first modified and then,
as modified, is superseded.

Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names
in subsequent rulings. After the original
ruling has been supplemented several
times, a new ruling may be published that
includes the list in the original ruling and
the additions, and supersedes all prior rul-
ings in the series.

# Abbreviations

The following abbreviations in current
use and formerly used will appear in ma-
terial published in the Bulletin.

A-Individual.

Acq .- Acquiescence.

B-Individual.

BE-Beneficiary.

F.R .- Federal Register.

FUTA-Federal Unemployment Tax Act.

FX-Foreign corporation.

G.C.M .- Chief Counsel's Memorandum.

GE-Grantee.

TFE-Transferee.

TFR-Transferor.

CI-City.

COOP-Cooperative.

IC-Insurance Company.

TP-Taxpayer.

Ct.D .- Court Decision.

I.R.B .- Internal Revenue Bulletin.

LE-Lessee.

TT-Trustee.

D-Decedent.

LP-Limited Partner.

LR-Lessor.

M-Minor.

Nonacq .- Nonacquiescence.

O Organization.

P-Parent Corporation.

PHC-Personal Holding Company.

PO Possession of the U.S.

PR-Partner.

PRS-Partnership.

PTE-Prohibited Transaction Exemption.
Pub. L .- Public Law.

REIT-Real Estate Investment Trust.

Rev. Proc .- Revenue Procedure.

Rev. Rul .- Revenue Ruling.

S Subsidiary.

S.P.R .- Statement of Procedural Rules.

Stat .- Statutes at Large.

BK-Bank.

B.T.A .- Board of Tax Appeals.

C-Individual.

C.B .- Cumulative Bulletin.

CFR-Code of Federal Regulations.

GP-General Partner.

GR-Grantor.

T.I.R .- Technical Information Release.

TR-Trust.

CY-County.

DC-Dummy Corporation.

DE-Donee.

Del. Order-Delegation Order.

DISC-Domestic International Sales Corporation.

DR-Donor.

E-Estate.

EE-Employee.

E.O .- Executive Order.

ER-Employer.

ERISA-Employee Retirement Income Security Act.
EX-Executor.

F-Fiduciary.

FC-Foreign Country.

FICA-Federal Insurance Contributions Act.

FISC-Foreign International Sales Company.

FPH-Foreign Personal Holding Company.

T-Target Corporation.

T.C .- Tax Court.

T.D .- Treasury Decision.

U.S.C .- United States Code.

X-Corporation.

Y-Corporation.

Z-Corporation.

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Numerical Finding List1

Proposed Regulations

Treasury Decisions-Continued

Bulletins 2013-27 through 2013-51

REG-124148-05, 2013-44 I.R.B. 444 REG-161948-05, 2013-44 I.R.B. 449

9629, 2013-37 I.R.B. 188 9630, 2013-38 I.R.B. 199

Announcements

REG-148659-07, 2013-45 I.R.B. 473

9631, 2013-38 I.R.B. 205

2013-35, 2013-27 I.R.B. 46

REG-132251-11, 2013-37 I.R.B. 191

9632, 2013-39 I.R.B. 241

2013-36, 2013-33 I.R.B. 142

REG-148812-11, 2013-45 I.R.B. 484

9633, 2013-39 I.R.B. 227

2013-37, 2013-34 I.R.B. 155

REG-111753-12, 2013-40 I.R.B. 302

9634, 2013-40 I.R.B. 272

2013-38, 2013-36 I.R.B. 185

REG-112815-12, 2013-35 I.R.B. 162

9635, 2013-40 I.R.B. 273

2013-39, 2013-35 I.R.B. 167

REG-114122-12, 2013-35 I.R.B. 163

9636, 2013-43 I.R.B. 331

2013-40, 2013-38 I.R.B. 226

REG-136630-12, 2013-40 I.R.B. 303

9637, 2013-44 I.R.B. 427

2013-41, 2013-40 I.R.B. 322

REG-140789-12, 2013-32 I.R.B. 136

9638, 2013-46 I.R.B. 487

2013-42, 2013-44 I.R.B. 464

REG-144990-12, 2013-39 I.R.B. 264

9639, 2013-48 I.R.B. 588

2013-43, 2013-46 I.R.B. 524

REG-110732-13, 2013-43 I.R.B. 405

9640, 2013-48 I.R.B. 548

2013-44, 2013-47 I.R.B. 545

REG-111837-13, 2013-39 I.R.B. 266

9641, 2013-50 I.R.B. 622

2013-45, 2013-47 I.R.B. 546

REG-113792-13, 2013-38 I.R.B. 211

9642, 2013-51 I.R.B. 747

2013-46, 2013-48 I.R.B. 593

REG-115300-13, 2013-37 I.R.B. 197

9643, 2013-51 I.R.B. 750

2013-47, 2013-49 I.R.B. 620

REG-120927-13, 2013-49 I.R.B. 618

9644, 2013-51 I.R.B. 676

2013-48, 2013-49 I.R.B. 620

REG-130843-13, 2013-51 I.R.B. 771

9645, 2013-51 I.R.B. 738

2013-49, 2013-49 I.R.B. 621

REG-146620-13, 2013-50 I.R.B. 674

9646, 2013-50 I.R.B. 630

## Notices

2013-41, 2013-29 I.R.B. 60
2013-42, 2013-29 I.R.B. 61
2013-43, 2013-31 I.R.B. 113
2013-44, 2013-29 I.R.B. 62
2013-45, 2013-31 I.R.B. 116
2013-46, 2013-31 I.R.B. 117
2013-47, 2013-31 I.R.B. 120
2013-48, 2013-31 I.R.B. 120
2013-49, 2013-32 I.R.B. 127
2013-50, 2013-32 I.R.B. 133
2013-51, 2013-34 I.R.B. 153
2013-52, 2013-35 I.R.B. 159
2013-53, 2013-36 I.R.B. 173
2013-54, 2013-40 I.R.B. 287
2013-55, 2013-38 I.R.B. 207
2013-56, 2013-39 I.R.B. 262
2013-57, 2013-40 I.R.B. 293
2013-58, 2013-40 I.R.B. 294
2013-59, 2013-40 I.R.B. 297
2013-60, 2013-44 I.R.B. 431
2013-61, 2013-44 I.R.B. 432
2013-62, 2013-45 I.R.B. 466
2013-63, 2013-44 I.R.B. 436
2013-64, 2013-44 I.R.B. 438
2013-65, 2013-44 I.R.B. 440
2013-66, 2013-46 I.R.B. 498
2013-67, 2013-45 I.R.B. 470
2013-68, 2013-46 I.R.B. 501
2013-69, 2013-46 I.R.B. 503
2013-70, 2013-47 I.R.B. 528
2013-71, 2013-47 I.R.B. 532

2013-72, 2013-48 I.R.B. 592
2013-73, 2013-49 I.R.B. 598
2013-75, 2013-49 I.R.B. 599
2013-76, 2013-51 I.R.B. 769
2013-77, 2013-50 I.R.B. 632
2013-78, 2013-50 I.R.B. 633
2013-79, 2013-50 I.R.B. 653

## Revenue Procedures

2013-28, 2013-27 I.R.B. 28

2013-29, 2013-33 I.R.B. 141

2013-30, 2013-36 I.R.B. 173

2013-31, 2013-38 I.R.B. 208

2013-32, 2013-28 I.R.B. 55

2013-33, 2013-38 I.R.B. 209

2013-34, 2013-43

I.R.B. 398

2013-35, 2013-47 I.R.B. 537

2013-36, 2013-49 I.R.B. 602

2013-37, 2013-49 I.R.B. 612

## Revenue Rulings

2013-13, 2013-32 I.R.B. 124
2013-15, 2013-28 I.R.B. 47
2013-16, 2013-40 I.R.B. 275
2013-17, 2013-38 I.R.B. 201
2013-18, 2013-37 I.R.B. 186
2013-19, 2013-39 I.R.B. 240
2013-20, 2013-40 I.R.B. 272
2013-21, 2013-43 I.R.B. 396
2013-22, 2013-46 I.R.B. 496
2013-23, 2013-48 I.R.B. 590
2013-24, 2013-49 I.R.B. 594
2013-26, 2013-50 I.R.B. 628
2013-27, 2013-51 I.R.B. 676

## Treasury Decisions

9620, 2013-27 I.R.B. 1

9621, 2013-28 I.R.B. 49

9622, 2013-30 I.R.B. 64

9623, 2013-30 I.R.B. 73

9624, 2013-31 I.R.B. 86
9625, 2013-34 I.R.B. 147
9626, 2013-34 I.R.B. 149
9627, 2013-35 I.R.B. 156
9628, 2013-36 I.R.B. 169

1A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2013-1 through 2013-26 is in Internal Revenue Bulletin
2013-26, dated June 24, 2013.

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## Finding List of Current Actions on Previously Published Items1

## Revenue Procedures:

Revenue Procedures-Continued:

81-60

2011-18

Bulletins 2013-27 through 2013-51

Modified by

Modified and clarified by

Notices:

Rev. Proc. 2013-32, 2013-28 I.R.B. 55

Rev. Proc. 2013-29, 2013-33 I.R.B. 141

2004-23

83-59

2011-49

Clarified by

Modified by

Modified by

Notice 2013-57, 2013-40 I.R.B. 293

Rev. Proc. 2013-32, 2013-28 I.R.B. 55

Ann. 2013-37, 2013-34 I.R.B. 155

2004-50

86-42

2012-25

Clarified by

Modified by

Obsoleted in part by

Notice 2013-57, 2013-40 I.R.B. 293

Rev. Proc. 2013-32, 2013-28 I.R.B. 55

Rev. Proc. 2013-28, 2013-27 I.R.B. 28

2005-70

Obsoleted by

90-52

2013-1

T.D. 9633 2013-39 I.R.B. 227

Modified by

Amplified and modified by Rev. Proc. 2013-32, 2013-28 I.R.B. 55

Rev. Proc. 2013-32, 2013-28 I.R.B. 55

2006-09

Modified and superseded by

96-30

2013-3

Notice 2013-79, 2013-50 I.R.B. 653

Modified by

Amplified and modified by

2006-40

Rev. Proc. 2013-32, 2013-28 I.R.B. 55

Rev. Proc. 2013-32, 2013-28 I.R.B. 55

Superseded by

Proposed Regulations:

Notice 2013-68, 2013-46 I.R.B. 501

97-48 Situation 1 superseded, Situation 2 obsoleted by

112815-12

2006-54

Rev. Proc. 2013-30, 2013-36 I.R.B. 173

Corrected by

Proposed update and supersession to by

Ann. 2013-45, 2013-47 I.R.B. 546

Notice 2013-78, 2013-50 I.R.B. 633

2003-43

Modified and superseded by

Revenue Rulings:

2008-31

Rev. Proc. 2013-30, 2013-36 I.R.B. 173

Modified and superseded by

Notice 2013-79, 2013-50 I.R.B. 653

2003-48

58-66 Amplified and clarified by

2009-41

Obsoleted in part and superseded in part by

Rev. Rul. 2013-17, 2013-38 I.R.B. 201

Clarified and amplified by

Rev. Proc. 2013-32, 2013-28 I.R.B. 55

Notice 2013-70,

2012-33

2003-61

Supplemented and superseded by

2009-53

Superseded by

Rev. Rul. 2013-23, 2013-48 I.R.B. 590

Clarified and amplified by

Rev. Proc. 2013-34, 2013-43 I.R.B. 398

Notice 2013-70,

2013-17

2012-74

2004-34

Supplemented by

Obsoleted by

Modified and clarified by

Notice 2013-61, 2013-44 I.R.B. 432

Notice 2013-51, 2013-34 I.R.B. 153

Rev. Proc. 2013-29, 2013-33 I.R.B. 141

Treasury Decisions:

2013-16

2004-48

Superseded by

Modified and superseded by

9610

Notice 2013-55, 2013-38 I.R.B. 207

Rev. Proc. 2013-30, 2013-36 I.R.B. 173

Corrected by Ann. 2013-41, 2013-40 I.R.B. 322

2013-29

2004-49

Clarified by

Sections 4.01 &amp; 4.02 modified and superseded,

9612 Corrected by

Notice 2013-60, 2013-44 I.R.B. 431

Section 4.03 obsoleted by

Ann. 2013-35, 2013-27 I.R.B. 46

2013-36

Rev. Proc. 2013-30, 2013-36 I.R.B. 173

Appendix updated by

Notice 2013-55, 2013-38 I.R.B. 207

2007-44

9622

Modified by

Corrected by Ann. 2013-39, 2013-35 I.R.B. 167

Superseded by

Ann. 2013-37, 2013-34 I.R.B. 155

Notice 2013-55, 2013-38 I.R.B. 207

2013-39

2007-62

9627

Amplified by

Modified and superseded by

Corrected by Ann. 2013-44, 2013-37 I.R.B. 545

Notice 2013-47, 2013-31 I.R.B. 120

Rev. Proc. 2013-30, 2013-36 I.R.B. 173

2013-40

2009-25

Amplified by

Pilot program discontinued by

Notice 2013-47, 2013-31 I.R.B. 120

Rev. Proc. 2013-32, 2013-28 I.R.B. 55

1A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2013-1 through 2013-26 is in Internal Revenue Bulletin 2013-26, dated June 24, 2013.

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