us-irs-revenue-rulings-irb-2005-43-pdf•Internal Revenue Bulletin 2005-43 (PDF rendition): IRS Revenue Rulings
Internal Revenue Bulletin 2005-43 (PDF rendition): IRS Revenue Rulings
us-irs-revenue-rulings-irb-2005-43-pdfInternal Revenue Bulletin 2005-43 (PDF rendition): IRS Revenue RulingsGuidance
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Bulletin No. 200 5-43 October 24, 2005 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. 2005–67, page 771. Low-income housing credit; satisfactory bond; “bond factor” amounts for the period January through De- cember 2005.This ruling provides the monthly bond factor amounts to be used by taxpayers who dispose of qualified low-income buildings or interests therein during the period January through December 2005. T.D. 9226 , page 772. Final regu lations under section 864 of the Code relate to the applicat ion of the asset-use test to stock held by foreign in- surance c ompanies. The regulations provide that income from stock may , in some circumstances, be effectively connected income. REG–158080–04, page 786. Proposed regulations under new section 409A of the Code, added as part of the American Jobs Creation Act of 2004, pro- vide certain rules relating to nonqualified deferred compensa- tion plans, which generally are effective as of January 1, 2005. These regulations provide general guidance with respect to what arrangements are covered by section 409A, and the re- quirements that must be met under section 409A with respect to initial deferral elections, subsequent deferral elections and payments. A public hearing is scheduled for January 25, 2006. ADMINI STRATIVE REG–15 0088–02, page 774. Propos ed regulations under section 6320 of the Code relate to a tax payer’s right to a hearing after the filing of a notice of feder al tax lien (NFTL). The regulations make certain clarifying chang es in the way collection due process hearings are con- ducted and specify the period during which a taxpayer may re- questanequivalenthearing.Theregulationsaffecttaxpayers against whose property or rights to property the Service files an NFTL. A public hearing is scheduled for January 19, 2006. REG–150091–02, page 780. Proposed regulations under section 6330 of the Code relate to a taxpayer’s right to a hearing before or after levy. The regula- tions make certain clarifying changes in the way collection due process hearings are conducted and specify the period dur- ing which a taxpayer may request an equivalent hearing. The regulations affect taxpayers against whose property or rights to property the Service proposes to levy. A public hearing is scheduled for January 19, 2006. Announcements of Disbarments and Suspensions begin on page 846. Fi nding Lists begin on page ii. The IRS Mission Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all. Introduction The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conven- tions, legislation, court decisions, and other items of general interest. It is published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin contents are compiled semiannually into Cumulative Bulletins, which are sold on a single-copy basis. It is the policy of the Service to publish in the Bulletin all sub- stantive rulings necessary to promote a uniform application of the tax laws, including all rulings that supersede, revoke, mod- ify, or amend any of those previously published in the Bulletin. All published rulings apply retroactively unless otherwise indi- cated. Procedures relating solely to matters of internal man- agement are not published; however, statements of internal practices and procedures that affect the rights and duties of taxpayers are published. Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts stated in the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices, identifying details and information of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory requirements. Rulings and procedures reported in the Bulletin do not have the force and effect of Treasury Department Regulations, but they may be used as precedents. Unpublished rulings will not be relied on, used, or cited as precedents by Service personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances are substantially the same. The Bulletin is divided into four parts as follows: Part I.—19 86 Code. This part i ncludes rulings and decisions based on provisions of the Intern al Revenue Code of 1986. Part II.—Treaties and Tax Legislation. This part is divided into two subparts as follows: Subpart A, Tax Conventions and Other Related Items, and Subpart B, Leg- islation and Related Committee Reports. Part III.—Administrative, Procedural, and Miscellaneous. To the extent practicable, pertinent cross references to these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rul- ings. Bank Secrecy Act Administrative Rulings are issued by the Department of the Treasury’s Office of the Assistant Sec- retary (Enforcement). Part IV .—Items of General Interest. This par t includes notices of proposed rulemakings, disbar- ment an d suspension lists, and announcements. The last Bulletin for each month includes a cumulative index for the matters published during the preceding months. These monthly indexes are cumulated on a semiannual basis, and are published in the last Bulletin of each semiannual period. The c ontents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate. For sale by the Superintendent of Documents, U.S.Government Printing Office, Washington, DC 20402. October 24, 20052005–43 I.R.B. Part I. Rulings and Decisions Under the Internal Revenue Code of 1986 Section 42.—Low-Income Housing Credit Low-income housing credit; satisfac- tory bond; “bond factor” amounts for the period January through December 2005.This ruling provides the monthly bond factor amounts to be used by taxpay- ers who dispose of qualified low-income buildings or interests therein during the pe- riod January through December 2005. Rev. Rul. 2005–67 In Rev. Rul. 90–60, 1990–2 C.B. 3, the Internal Revenue Service provided guidance to taxpayers concerning the gen- eral methodology used by the Treasury Department in computing the bond factor amounts used in calculating the amount of bond considered satisfactory by the Secre- tary under § 42(j)(6) of the Internal Rev- enue Code. It further announced that the Secretary would publishintheInternal Revenue Bulletin a table of bond factor amounts for dispositions occurring during each calendar month. Rev. Proc. 99–11, 1999–1 C.B. 275, established a collateral program as an al- ternative to providing a surety bond for taxpayers to avoid or defer recapture of the low-income housing tax credits under § 42(j)(6). Under this program, taxpayers may establish a Treasury Direct Account and pledge certain United States Treasury securities to the Internal Revenue Service as security. This revenue ruling provides in Table 1 the bond factor amounts for calculat- ing the amount of bond considered satis- factory under § 42(j)(6) or the amount of United States Treasury securities to pledge in a Treasury Direct Account under Rev. Proc. 99–11 for dispositions of qualified low-income buildings or interests therein during the period January through Decem- ber 2005. Table 1 Rev. Rul. 2005–67 Monthly Bond Factor Amounts for Dispositions Expressed As a Percentage of Total Credits Calendar Year Building Placed in Service or, if Section 42(f)(1) Election Was Made, the Succeeding Calendar Year Month of Disposition 19911992199319941995199619971998199920002001 Jan ’0514.9927.9239.0348.5556.7756.7156.8657.1557.5258.0058.83 Feb ’0514.9927.9239.0348.5556.7756.5956.7457.0457.4157.8958.72 Mar ’0514.9927.9239.0348.5556.7756.4756.6356.9357.3057.7958.61 Apr ’0515.8529.5241.2751.3360.0360.1860.9561.8962.9264.1065.66 May ’0515.8529.5241.2751.3360.0360.0560.8361.7762.8063.9865.54 Jun ’0515.8529.5241.2751.3360.0359.9360.7161.6562.6963.8765.42 Jul ’0515.8529.5241.2751.3360.0359.8160.5961.5462.5763.7665.32 Aug ’0515.8529.5241.2751.3360.0359.7060.4861.4262.4663.6565.21 Sep ’0515.8529.5241.2751.3360.0359.5860.3661.3162.3663.5565.11 Oct ’0516.6831.0643.4254.0163.1663.1864.6566.3368.1470.1472.58 Nov ’0516.6831.0643.4254.0163.1663.0664.5466.2168.0270.0272.47 Dec ’0516.6831.0643.4254.0163.1662.9464.4266.1067.9169.9272.36 2005–43 I.R.B.771October 24, 2005 Table 1 (cont’d) Rev. Rul. 2005–67 Monthly Bond Factor Amounts for Dispositions Expressed As a Percentage of Total Credits Calendar Year Building Placed in Service or, if Section 42(f)(1) Election Was Made, the Succeeding Calendar Year Month of Disposition 2002200320042005 Jan ’0559.9261.2262.4962.68 Feb ’0559.8061.0962.3362.68 Mar ’0559.6960.9762.1962.68 Apr ’0567.5269.6271.6472.55 May ’0567.4069.4871.4972.55 Jun ’0567.2869.3671.3572.55 Jul ’0567.1769.2471.2372.55 Aug ’0567.0669.1271.1272.55 Sep ’0566.9669.0271.0272.55 Oct ’0575.3878.4581.4983.98 Nov ’0575.2778.3481.3883.98 Dec ’0575.1678.2381.2983.98 For a list of bond factor amounts ap- plicable to dispositions occurring during other calendar years, see: Rev. Rul. 98–3, 1998–1 C.B. 248; Rev. Rul. 2001–2, 2001–1 C.B. 255; Rev. Rul. 2001–53, 2001–2 C.B. 488; Rev. Rul. 2002–72, 2002–2 C.B. 759; Rev. Rul. 2003–117, 2003–2 C.B. 1051; and Rev. Rul. 2004–100, 2004–2 C.B. 718. DRAFTING INFORMATION The principal author of this revenue ruling is David McDonnell of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further in- formation regarding this revenue ruling, contact Mr. McDonnell at (202) 622–3040 (not a toll-free call). Section 864.—Definitions and Special Rules 26 CFR 1.864–4: U.S. source income effectively con- nected with U.S. business. T.D. 9226 DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 Stock Held by Foreign Insurance Companies AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final regulations. SUMMARY: This document contains final regulations relating to the determi- nation of income of foreign insurance companies that is effectively connected with the conduct of a trade or business within the United States. The regulations provide that the exception to the asset-use test for stock shall not apply in determin- ing whether the income, gain, or loss from portfolio stock held by foreign insurance companies constitutes effectively con- nected income. DATES:Effective Date: These regulations are effective on October 3, 2005. FOR FURTHER INFORMATION CONTACT: Sheila Ramaswamy, (202) 622–3870 (not a toll-free number). SUPPLEMENTARY INFORMATION: Background On June 25, 2004, a notice of proposed rulemaking (REG–117307–04, 2004–2 C.B. 39) was published in theFederal Register(69 FR 35543). No requests for a public hearing were received, and no public hearing was held. The IRS received one written comment in response to the notice of proposed rulemaking. After con- sideration of the comment, the proposed regulation is adopted without change. Explanation of Provisions and Summary of Comments This Treasury decision adopts the lan- guage of the proposed regulation without change. The IRS received one comment in re- sponse to the proposed regulation. The commentator requested further clarifica- tion regarding what constitutes an insur- ance company for federal income tax pur- poses.TheIRSbelievestheissueofwhat October 24, 20057722005–43 I.R.B. constitutes an insurance company is out- side the scope of this regulation, which solely relates to the application of the as- set-use test to stock held by foreign insur- ance companies. The commentator also expressed con- cern about the interaction of the proposed regulation with §1.864–5(a), which pro- vides, generally, that foreign source in- come, such as a foreign-source dividend or gain, cannot constitute U.S. effectively connected income in circumstances in which a U.S.-source dividend or gain would not constitute U.S. effectively connected income. Accordingly, the com- mentator is concerned that the rule in the regulations will also expand the cate- gory of foreign-source dividends or gains that may constitute effectively connected income. That is true and the Treasury Department and the IRS believe this is the appropriate result. The IRS invited comments whether the 10 percent threshold provided in the pro- posed regulation was an appropriate stan- dard for determining whether stock is a portfolio investment. The commentator stated that it was possible for insurance companies to make a strategic investment in a corporation at a level below 10 percent of the vote or value of the corporation, such as by purchasing a special class of shares that conveyed the power to elect directors. The commentator recommended creating a rebuttable presumption of portfolio status. We do not believe that treating the 10 percent threshold as a rebuttable presump- tion is appropriate. The 10 percent thresh- old provides a reasonable method for iden- tifying portfolio stock held by a branch of a foreign life insurance company. Special Analyses It has been determined that this Trea- sury decision is not a significant regula- tory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been deter- mined that section 553(b) of the Admin- istrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because these regulations do not impose a collection of information on small entities, the provisions of the Regulatory Flexibil- ity Act (5 U.S.C. chapter 6) do not apply. Pursuant to section 7805(f) of the Inter- nal Revenue Code, the notice of proposed rulemaking preceding this regulation was submitted to the Chief Counsel for Advo- cacy of the Small Business Administration for comment on its impact on small busi- ness. Drafting Information The principal author of this regulation is Sheila Ramaswamy, Office of Associate Chief Counsel (International). However, other personnel from the IRS and Treasury Department participated in their develop- ment. ***** Proposed Amendment to the Regulations Accordingly, 26 CFR part 1 is amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read, in part, as follows: Authority: 26 U.S.C. 7805 * * * Par. 2. In §1.864–4, paragraph (c)(2)(iii)(b) is revised to read as follows: §1.864–4 U.S. source income effectively connected with U.S. business. ***** (c) * * * (2) * * * (iii) * * * (b)Stock held by foreign insurance companies. This paragraph (c)(2)(iii) shall not apply to stock of a corporation (whether domestic or foreign) held by a foreign insurance company unless the for- eign insurance company owns 10 percent or more of the total voting power or value of all classes of stock of such corpora- tion. For purposes of this section, section 318(a) shall be applied in determining ownership, except that in applying section 318(a)(2)(C), the phrase “10 percent” is used instead of the phrase “50 percent.” ***** Mark E. Matthews, Deputy Commissioner for Services and Enforcement. Approved August 9, 2005. Eric Solomon, Acting Deputy Assistant Secretary for Tax Policy. (Filed by the Office of the Federal Register on September 30, 2005, 8:45 a.m., and published in the issue of the Federal Register for October 3, 2005, 70 F.R. 57509) 2005–43 I.R.B.773October 24, 2005 Part IV. Items of General Interest Notice of Proposed Rulemaking and Notice of Public Hearing Miscellaneous Changes to Collection Due Process Procedures Relating to Notice and Opportunity for Hearing Upon Filing of Notice of Federal Tax Lien REG–150088–02 AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Notice of proposed rulemaking and notice of public hearing. SUMMARY: This document contains pro- posed amendments to the regulations relat- ing to a taxpayer’s right to a hearing under section 6320 of the Internal Revenue Code of 1986 after the filing of a notice of Fed- eral tax lien (NFTL). The proposed reg- ulations make certain clarifying changes in the way collection due process (CDP) hearings are held and specify the period during which a taxpayer may request an equivalent hearing. The proposed regula- tions affect taxpayers against whose prop- erty or rights to property the Internal Rev- enue Service (IRS) files a NFTL on or af- ter January 19, 1999. This document also contains a notice of public hearing on these proposed regulations. DATES: Written and electronic comments must be received by December 15, 2005. Outlines of topics to be discussed at the public hearing scheduled for 10 a.m. on January 19, 2006 must be received by De- cember 29, 2005. ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG–150088–02), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washing- ton, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–150088–02), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Wash- ington, DC, or sent electronically, via the IRS Internet site atwww.irs.gov/regsor via the Federal eRulemaking Portal at www.regulations.gov(indicate IRS and REG–150088–02). The public hearing will be held in the IRS Auditorium, In- ternal Revenue Building (7th Floor), 1111 Constitution Avenue, NW, Washington, DC. FOR FURTHER INFORMATION CONTACT: Concerning the regulations, call Laurence K. Williams, 202–622–3600 (not a toll-free number); concerning submissions and/or to be placed on the building access list to attend the hearing, call Robin Jones, 202–622–7180 (not a toll-free number). SUPPLEMENTARY INFORMATION: Background This document contains proposed amendments to the Regulations on Pro- cedure and Administration (26 CFR part 301) relating to the provision of notice under section 6320 of the Internal Rev- enue Code to taxpayers of a right to a CDP hearing (CDP Notice) after the IRS files a NFTL. Final regulations (T.D. 8979, 2002–1 C.B. 466) were published on Jan- uary 18, 2002 in theFederal Register(67 FR 2558). The final regulations imple- mented certain changes made by section 3401 of the Internal Revenue Service Re- structuring and Reform Act of 1998 (Pub- lic Law 105–206, 112 Stat. 685) (RRA 1998), including the addition of section 6320 to the Internal Revenue Code. The final regulations affected taxpayers against whose property or rights to property the IRS files a NFTL. Section 3401 of RRA 1998 also added section 6330 to the Internal Revenue Code. That statute provides for notice to taxpay- ers of a right to a hearing before or, in lim- ited cases, after levy. A number of the provisions in section 6330 concerning the conduct and judicial review of a CDP hear- ing are incorporated by reference in sec- tion 6320. On January 18, 2002, final regulations (T.D. 8980, 2002–1 C.B. 477) under section 6330 were published in the Federal Register(67 FR 2549) along with the final regulations under section 6320. Explanation of Provisions A taxpayer is entitled to one CDP hear- ing with respect to the tax and tax period covered by a CDP Notice concerning a levy or a CDP Notice concerning the fil- ing of a NFTL. The IRS Office of Appeals (Appeals) has conducted over 92,000 CDP hearings and more than 30,000 equivalent hearings since sections 6320 and 6330 be- came effective for collection actions initi- ated on and after January 19, 1999. In general, the experience of the past six years with CDP hearings has demonstrated that there is a need for changes to allow Appeals to effectively and fairly handle the cases of taxpayers who raise issues of sub- stance. Appeals has instituted many im- provements in its processing of CDP cases and has conducted extensive training in an effort to provide careful, but timely, review of CDP cases, which currently are filed at a rate of approximately 2,450 per month. The proposed regulations, if adopted as final regulations, will increase efficiency without compromising the quality and fair- ness of review. In many CDP cases, significant time is spent merely identifying the issues. Al- though the Form 12153 used to request a CDP hearing requires a taxpayer to state a reason or reasons for disagreeing with the NFTL filing, many taxpayers either do not supply that information, or raise new issues during the CDP hearing process not identified on the hearing request. De- lays result while taxpayers provide new supporting documentation and Appeals personnel reconsider prior conclusions in light of the new information. Cases of other taxpayers pending in Appeals are delayed because other work must be con- stantly rescheduled. Cases are also delayed when taxpayers propose collection alternatives for which they are not eligible. The IRS does not consider offers in compromise or install- ment agreements from taxpayers who have failed to file required returns as of the date the offer or the proposed installment agree- ment is submitted. See Publication 594, “What You Should Know About the IRS Collection Process(Rev. 2–2004).” Sim- ilarly, the IRS will not consider an offer in compromise from an in-business taxpayer unless the taxpayer has timely filed all re- October 24, 20057742005–43 I.R.B. turns and timely made all Federal tax de- posits for two consecutive quarters. See Form 656, “Offer in Compromise(Rev. 7–2004).” The resources of Appeals are in- effectively utilizedarranging and conduct- ing face-to-face conferences requested by non-compliant taxpayers whose only com- plaint is the rejection of an offer to compro- mise or installment agreement for which they are not eligible. Frivolous cases also cause unneces- sary delays. During fiscal year 2004, 5.4 percent of the 32,226 CDP and equiva- lent-hearing cases Appeals handled in- volved taxpayers who were non-filers or raised only frivolous issues. Cases raising frivolous issues, in particular, consume a disproportionately large amount of time, because Appeals personnel must often read lengthy, frivolous submissions in search of any substantive issue buried within. Delays also result when taxpayers use face-to-face conferences as a venue for frivolous oration and harassment of Appeals personnel. The proposed regulations attempt to ad- dress these and other problems that have become apparent during the first six years of CDP practice. The proposed changes are aimed at creating a more focused pro- cedure that will allow Appeals to continue to provide careful review of NFTL filings as the volume of cases increases. A taxpayer must request a CDP hearing in writing. The current regulations require that a request for a CDP hearing include the taxpayer’s name, address, and daytime telephone number, and that the request be dated and signed by either the taxpayer or the taxpayer’s authorized representa- tive. Section 301.6320–1(c)(2), Q&A-C1. A Form 12153, “Request for a Collection Due Process Hearing,” is included with the CDP Notice sent to the taxpayer pur- suant to section 6320. The Form 12153 requests (1) the taxpayer’s name, address, daytime telephone number, and taxpayer identification number (SSN or EIN), (2) the type of tax involved, (3) the tax period at issue, (4) a statement that the taxpayer requests a hearing with Appeals concern- ing the filing of the NFTL, and (5) the rea- son or reasons why the taxpayer disagrees with the NFTL filing. Although taxpay- ers are encouraged to use a Form 12153 in requesting a CDP hearing, the current regulations do not require the use of Form 12153. Section 301.6320–1(c)(2), A-C1, of the proposed regulations requires taxpayers to state their reasons for disagreement with the NFTL filing whether or not a Form 12153 is used to request a CDP hearing. In addition, a taxpayer who fails to sign a timely CDP hearing request because the request is made by a spouse or other unau- thorized representative must affirm in writ- ing that the request was originally submit- ted on the taxpayer’s behalf. Failure to provide the written affirmation within a reasonable time after a request from Ap- peals will result in the denial of a CDP hearing for that taxpayer. ACDPhearingistobeconductedbyan Appeals officer or employee who has had no “prior involvement” with respect to the taxforthetaxperiodstobecoveredbythe hearing, unless the taxpayer waives this requirement. Section 301.6320–1(d)(2), A-D4 of the current regulations provides that “prior involvement” by an Appeals officer or employee includes participation or involvement in an Appeals hearing that the taxpayer may have had with respect to the tax and tax period shown on the CDP Notice, other than a CDP hearing held under either section 6320 or section 6330. It is important that “prior involvement” be construed in a manner that reasonably protects against predisposition but at the same time does not disqualify too broad a range of Appeals personnel. A broad standard of “prior involvement” would lead to uncertain application, could result in the disqualification of an entire Appeals office, many of which have small staffs, and could make it difficult to conduct the CDP hearing. Section 301.6320–1(d)(2), A-D4 of the proposed regulations pro- vides that prior involvement exists only when the taxpayer, the tax liability and the tax period shown on the CDP Notice also were at issue in the prior non-CDP hearing or proceeding, and the Appeals officer or employee actually participated in the prior hearing or proceeding. Exam- ples are provided in §301.6320–1(d)(3) of the proposed regulations. Section 301.6320–1(d)(2), A-D7, of the proposed regulations clarifies that a face-to-face conference is merely one aspect of a CDP hearing under section 6320 and is not by itself the entire CDP hearing. A-D7 of the proposed regulations also provides that, in all cases, the Appeals officer or employee will review the tax- payer’s request for a CDP hearing, the case file, other written communications from the taxpayer, and any notes of oral com- munications with the taxpayer or the tax- payer’s representative. If no face-to-face or telephonic conference is held, review of those documents will constitute the CDP hearing for purposes of section 6320(b). A-D7 of the proposed regulations fur- ther clarifies that when a business taxpayer is offered an opportunity for a face-to-face conference it will be held at the Appeals office closest to the taxpayer’s principal place of business. The current regulations have been misinterpreted by some taxpay- ers as requiring the IRS to hold a face-to- face conference at the taxpayer’s principal place of business. Q&A-D8 of the pro- posed regulations is new. It describes spe- cific circumstances in which Appeals will not hold a face-to-faceconference with the taxpayer or the taxpayer’s representative because a conference will serve no use- ful purpose. The experience of Appeals is that although most taxpayers request face-to-face conferences, they are some- times difficult to schedule on a date and at a time that is convenient for the taxpayer. In some of these cases, taxpayers or their rep- resentatives have used the scheduling of a face-to-face conference as a tactic to de- lay the IRS’s collection efforts. In other cases, taxpayers have requested a face-to- face conference merely to raise frivolous arguments concerning the Federal tax sys- tem or to request collection alternatives for which they do not qualify. Q&A-D8 of the proposed regulations provides that a face-to-face conference need not be of- fered if the taxpayer or the taxpayer’s rep- resentative raises only frivolous arguments concerning the Federal tax system. See the IRS Internet site,www.irs.gov/pub/irs- utl/friv_tax.pdf, for examples of frivolous arguments. A face-to-face conference also will not be granted if the taxpayer proposes collection alternatives that would not be available to other taxpayers in similar cir- cumstances. A face-to-face conference need not be granted if the taxpayer does not provide in the written request for a CDP hearing, as perfected, the required infor- mation set forth in A-C1(ii)(E) of para- graph (c)(2) of the proposed regulations. In addition, a face-to-face conference will not be held at the location closest to the taxpayer’s residence or principal place of business if all Appeals officers or 2005–43 I.R.B.775October 24, 2005 employees at that location are considered to have prior involvement as provided in A-D4. In this case, the taxpayer will be of- fered a hearing by telephone or correspon- dence, or some combination thereof. The taxpayer may be able to obtain a face-to- face conference at the Appeals office clos- est to the taxpayer’s residence or princi- pal place of business under these circum- stances if the taxpayer waives the require- ment of section 6320(b)(3) concerning im- partiality of the Appeals officer or em- ployee. Appeals will offer the taxpayer a face-to-face conference at another Appeals office if in the exercise of its discretion Ap- peals would have offered the taxpayer a face-to-face conference at the original lo- cation. With the foregoing exceptions, it is anticipated that a face-to-face conference will ordinarily be offered with respect to any relevant issues or collection alterna- tives for which the taxpayer qualifies. Sections 301.6320–1(e)(1) and 301.6320–1(e)(3), A-E2 and A-E7 have been changed to more closely follow the language of section 6330(c)(2)(B), made applicable to section 6320 by section 6320(c). These changes are necessary because these regulations have been mis- interpreted as defining the underlying tax liability that may be considered at the CDP hearing under section 6330(c)(2)(B) to be the tax liability listed on the CDP Notice. The intent of the existing regu- lations, which refer to tax liability on the CDP Notice, is thattaxpayers may only challenge taxes or tax periods listed on the CDP Notice, not to supply a substan- tive definition of underlying tax liability. Section 301.6320–1(e)(3), A-E6 has been amended to clarify that taxpayers who receive CDP hearings can only qualify for collection alternatives available generally to taxpayers in similar circumstances. The experience of the past six years has revealed that many taxpayers raise an is- sue with Appeals but fail to furnish any documentation or evidence with respect to the issue despite being given a reason- able period to do so. For example, a tax- payer may request an installment agree- ment, but when an Appeals officer or em- ployee requests financial data necessary to determine eligibility for the installment agreement, the taxpayer may not comply with the request. Or a taxpayer may dis- pute liability for a tax period by claim- ing entitlement to deductions, but provide no substantiation for the deductions in re- sponse to requests from Appeals. Current §301.6320–1(f)(2), A-F5 provides that a taxpayer may not seek judicial review of an issue that he has not raised during the CDP hearing. A-F5 is revised to clarify that in order to obtain judicial review, a taxpayer must not only bring the issue to the attention of Appeals but must also sub- mit, if requested, evidence with respect to that issue. Under revised A-F5, if the tax- payer does not provide Appeals any evi- dence with respect to the issue after being given a reasonable opportunity to submit such evidence, then he may not ask a court to consider the issue. There has been some confusion about what documents Appeals should retain, and what notations the Appeals officer or employee conducting the hearing should make, in order to provide a judicially re- viewable administrative record. A new Q&A-F6 has been added to specify the contents of the administrative record re- quired for court review. The IRS receives a number of tardy requests for CDP hearings. The changes to §301.6320–1(i)(2) explain how these requests will be treated. The proposed amendments to the regulations add a new Q&A-I1 to §301.6320–1(i)(2) to explain that a taxpayer must request an equiva- lent hearing in writing. A taxpayer may obtain an equivalent hearing if the 30-day period described in section 6320(a)(3) for requesting a CDP hearing has expired. Unlike an Appeals determination in a CDP hearing, the Appeals decision in an equivalent hearing is not reviewable in court. Under new Q&A-I1, the IRS is not required to treat a late-filed CDP request as a request for an equivalent hearing. Section 301.6320–1(c)(2), A-C7 has been amended to require that the taxpayer be notified of the right to an equivalent hear- ing in all cases in which a tardy request for a CDP hearing is received. It is expected that the IRS will either send the taxpayer a letter or orally inform the taxpayer that the CDP hearing request is untimely and ask if the taxpayer wishes to have an equivalent hearing. If the taxpayer elects to have an equivalent hearing, the IRS will treat the CDP hearing request as a request for an equivalent hearing without requiring the taxpayer to make an additional written request. Current Q&A-I1 through I5 are renumbered Q&A-I2 through I6. The proposed regulations add Q&A-I7 to §301.6320–1(i)(2) to clarify that the pe- riod during which a taxpayer may obtain an equivalent hearing is not indefinite. The equivalent hearing procedure is not provided by statute but, consistent with the legislative history of RRA 1998, was adopted in order to accommodate tax- payerswhofailedtimelytoexercisetheir right to a CDP hearing. The equivalent hearing was meant to occur near the time a CDP hearing held pursuant to a timely request would have occurred, because it was meant to address the same matters that would have been addressed at a CDP hearing. The procedure was not meant to provide a hearing right that could be exercised months or years after the cir- cumstances that precipitated the filing of the NFTL have passed. A hearing before Appeals at a later time may be obtained under the Collection Appeals Program. Therefore, proposed Q&A-I7 limits to one year the period during which a taxpayer may request an equivalent hearing. The period commences the day after the end of the five business day period following the filing of the NFTL, described in section 6320(a)(2). Because the time for requesting an equivalent hearing will be limited, the proposed regulations add new Q&A-I8, Q&A-I9, Q&A-I10 and Q&A-I11 to §301.6320–1(i)(2) to provide the same rules governing mailing, delivery and de- termination of timeliness that apply to requests for CDP hearings. Unlike exist- ing §301.6320–1(c)(2), A-C6, new A-I10 does not identify the officials to whom to send an equivalent hearing request if the CDP Notice does not specify where to send the request. Because the identity and the address of the person to whom the request should be sent may change in the future, taxpayers will be able to obtain more current information by calling the 1–800 number listed in A-I10. Section 301.6320–1(c)(2), A-C6 also has been revised in the proposed regulations to pro- vide that taxpayers should call the 1–800 number to obtain the address to which the CDP hearing request should be sent. The proposed regulations are effective the date 30 days after final regulations are published in theFederal Registerwith respect to requests for CDP hearings or October 24, 20057762005–43 I.R.B. equivalent hearings made on or after the date 30 days after final regulations are pub- lished in theFederal Register. 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. Therefore, a regula- tory assessment is not required. It also has been determined thatsection 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these reg- ulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Inter- nal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Busi- ness Administration for comment on its impact on small business. Comments and Public Hearing Before these proposed regulations are adopted as final regulations, consideration will be given to any electronic and writ- ten comments that are submitted timely to the IRS. The IRS and Treasury Department specifically request comments on the clar- ity of the proposed regulations and how they may be made easier to understand. All comments will be available for public inspection and copying. A public hearing has been scheduled for January 19, 2006, at 10 a.m. in the IRS Auditorium, Internal Revenue Building (7th Floor), 1111 Constitution Avenue, NW, Washington, DC. All visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediateentranceareamorethan30 minutes before the hearing starts. For in- formation about having a visitor’s name placed on the building access list to attend the hearing, see the FOR FURTHER IN- FORMATION CONTACT caption. An outline of the topics to be discussed and the time to be devoted to each topic must be submitted by any person who wishes to present oral comments at the hearing. Outlines must be received by December 29, 2005. The rules of 26 CFR 601.601(a)(3) ap- ply to the hearing. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving requests to speak has passed. Copies of the agenda will be available free of charge at the hearing. Drafting Information The principal author of these regula- tions is Laurence K. Williams, Office of Associate Chief Counsel, Procedure and Administration (Collection, Bankruptcy and Summonses Division). ***** Proposed Amendments to the Regulations Accordingly, 26 CFR part 301 is pro- posed to be amended as follows: PART 301—PROCEDURE AND ADMINISTRATION Paragraph 1. The authority citation for part 301 continues to read, in part, as fol- lows: Authority: 26 U.S.C. 7805 * * * Par. 2. Section 301.6320–1 is proposed to be amended as follows: 1. Paragraph (c)(2) A-C1, Q&A-C6 and A-C7 are revised. 2. Paragraph (d)(2) A-D4 and A-D7 are revised. 3. Paragraph (d)(2) Q&A-D8 is added. 4. Paragraph (d)(3) is added. 5. Paragraph (e)(1) is revised. 6. Paragraph (e)(3) A-E2, A-E6 and A-E7 are revised. 7. Paragraph (f)(2) A-F5 is revised 8. Paragraph (f)(2) Q&A-F6 is added. 9. Paragraph (i)(2) Q&A-I1 through Q&A-I5 are renumbered Q&A-I2 through Q&A-I6, a new paragraph (i)(2) Q&A-I1 and new paragraphs Q&A-I7 through Q&A-I11 are added. 10. Paragraph (j) is revised. §301.6320–1 Notice and opportunity for hearing upon filing of notice of Federal tax lien. ***** (c) * * * (2) * * * A-C1. (i) The taxpayer must make a request in writing for a CDP hearing. The request for a CDP hearing shall include the information specified in A-C1(ii) of this paragraph (c)(2). See A-D7 and A-D8 of paragraph (d)(2). (ii) The written request for a CDP hear- ing must be dated and must include the fol- lowing information: (A) The taxpayer’s name, address, day- time telephone number (if any), and tax- payer identification number (SSN or EIN). (B) The type of tax involved. (C) The tax period at issue. (D) A statement that the taxpayer re- quests a hearing with Appeals concerning the filing of the NFTL. (E) The reason or reasons why the taxpayer disagrees with the filing of the NFTL. (F) The signature of the taxpayer or the taxpayer’s authorized representative. (iii) The taxpayer must perfect any timely written request for a CDP hearing that does not provide the required informa- tion set forth in A-C1(ii) of this paragraph within a reasonable period of time after a request from the IRS. (iv) Taxpayers are encouraged to use a Form 12153, “Request for a Collection Due Process Hearing,” in requesting a CDP hearing so that the request can be readily identified and forwarded to Ap- peals. Taxpayers may obtain a copy of Form 12153 by contacting the IRS office that issued the CDP Notice, by down- loading a copy from the IRS Internet site, www.irs.gov/pub/irs-pdf/f12153.pdf,orby calling, toll-free, 1–800–829–3676. (v) The taxpayer must affirm any timely written request for a CDP hearing which is signed or alleged to have been signed on the taxpayer’s behalf by the taxpayer’s spouse or other unauthorized representa- tive by filing, within a reasonable period of time after a request from the IRS, a signed, written affirmation that the request was originally submitted on the taxpayer’s behalf. If the affirmation is not filed within a reasonable period of time after a request, the CDP hearing request will be denied with respect to the non-signing taxpayer. ***** Q-C6. Where must the written request for a CDP hearing be sent? A-C6. The written request for a CDP hearing must be sent, or hand delivered (if permitted), to the IRS office and address as directed on the CDP Notice. If the ad- 2005–43 I.R.B.777October 24, 2005 dress of that office does not appear on the CDP Notice, the taxpayer should obtain the address of the office to which the writ- ten request should be sent or hand deliv- ered by calling, toll-free, 1–800–829–1040 and providing the taxpayer’s identification number (SSN or TIN). ***** A-C7. If the taxpayer does not request a CDP hearing in writing within the 30-day period that commences on the day after the end of the five business day notifi- cation period, the taxpayer foregoes the right to a CDP hearing under section 6320 with respect to the unpaid tax and tax pe- riods shown on the CDP Notice. If the re- quest for CDP hearing is received after the 30-day period, the taxpayer will be notified of the untimely request and of the right to an equivalent hearing. See paragraph (i) of this section. ***** (d) * * * (2) * * * A-D4. Prior involvement by an Ap- peals officer or employee includes partici- pation or involvement in an Appeals hear- ing(otherthanaCDPhearingheldun- der either section 6320 or section 6330) that the taxpayer may have had with re- spect to the tax and tax period shown on the CDP Notice. Prior involvement exists only when the taxpayer, the tax liability and the tax period at issue in the CDP hear- ing also were at issue in the prior non-CDP hearing or proceeding, and the Appeals of- ficer or employee actually participated in the prior hearing or proceeding. ***** A-D7. Except as provided in A-D8 of this paragraph (d)(2), a taxpayer who presents in the CDP hearing request rel- evant, non-frivolous reasons for disagree- ment with the NFTL filing will ordinarily be offered an opportunity for a face-to-face conference at the Appeals office closest to the taxpayer’s residence. A business taxpayer will ordinarily be offered an op- portunity for a face-to-face conference at the Appeals office closest to the taxpayer’s principal place of business. If that is not satisfactory to the taxpayer, the taxpayer will be given an opportunity for a hear- ing by telephone or by correspondence. In all cases, the Appeals officer or employee will review the case file, which includes the taxpayer’s request for a CDP hearing, any other written communications from the taxpayer or the taxpayer’s authorized representative, and any notes made by Ap- peals officers or employees of any oral communications with the taxpayer or the taxpayer’s authorized representative. If no face-to-face or telephonic conference or correspondence hearing is held, review of those documents will constitute the CDP hearing for purposes of section 6320(b). Q-D8. In what circumstances will a face-to-face CDP conference not be granted? A-D8. A taxpayer is not entitled to a face-to-face CDP conference at a loca- tion other than as provided in A-D7 of this paragraph (d)(2) and this A-D8. If all Ap- peals officers or employees at the loca- tion provided for in A-D7 of this paragraph have had prior involvement with the tax- payerasprovidedinA-D4ofthispara- graph, the taxpayer will not be offered a face-to-face meeting at that location, un- less the taxpayer elects to waive the re- quirement of section 6320(b)(3). The tax- payer will be offered a face-to-face confer- ence at another Appeals office if Appeals in the exercise of its discretion would have offered the taxpayer a face-to-face confer- ence at the location provided in A-D7. A face-to-face CDP conference concerning a taxpayer’s underlying liability will not be granted if the request for a hearing or other taxpayer communication indicates that the taxpayer wishes only to raise irrelevant or frivolous issues concerning that liability. A face-to-face CDP conference concern- ing a collection alternative, such as an in- stallment agreement or an offer to compro- mise liability, will not be granted unless the alternative would be available to other taxpayers in similar circumstances. For example, because the IRS does not con- sider offers to compromise from taxpay- ers who have not filed required returns or have not made certain required deposits of tax, as set forth in Form 656, “Offer in Compromise,” no face-to-face conference will be offered to a taxpayer who wishes to make an offer to compromise but has not fulfilled those obligations. A face-to-face conference need not be granted if the tax- payer does not provide the required infor- mation set forth in A-C1(ii)(E) of para- graph (c)(2). See also A-C1(iii) of para- graph (c)(2). (3)Examples. The following examples illustrate the principles of this paragraph (d): Example 1. Individual A timely requests a CDP hearing concerning a NFTL filed with respect to A’s 1998 income tax liability. Appeals employee B previ- ously conducted a CDP hearing regarding a proposed levy for the 1998 income tax liability assessed against individual A. Because employee B’s only prior in- volvement with individual A’s 1998 income tax li- ability was in connection with a section 6330 CDP hearing, employee B may conduct the CDP hearing under section 6320 involving the NFTL filed for the 1998 income tax liability. Example 2. Individual C timely requests a CDP hearing concerning a NFTL filed with respect to C’s 1998 income tax liability assessed against individ- ual C. Appeals employeeD previously conducted a Collection Appeals Program(CAP) hearing regard- ing a NFTL filed with respect to C’s 1998 income tax liability. Because employee D’s prior involve- ment with individual C’s 1998 income tax liability was in connection with a non-CDP hearing, employee D may not conduct the CDP hearing under section 6320 unless individual C waives the requirement that the hearing will be conducted by an Appeals officer or employee who has had no prior involvement with respect to C’s 1998 income tax liability. Example 3. Same facts as inExample 2, except that the prior CAP hearing only involved individual C’s 1997 income tax liability and employment tax li- abilities for 1998 reported on Form 941. Employee D would not be considered to have prior involvement because the prior CAP hearing in which she partici- pated did not involve individual C’s 1998 income tax liability. Example 4. Appeals employee F is assigned to a CDP hearing concerning a NFTL filed with respect to a trust fund recovery penalty (TFRP) assessed pur- suant to section 6672 against individual E. Appeals employee F participated in a prior CAP hearing in- volving individual E’s 1999 income tax liability, and participated in a CAP hearing involving the employ- ment taxes of business entity X, which incurred the employment tax liability to which the TFRP assessed against individual E relates. Appeals employee F would not be considered to have prior involvement because the prior CAP hearings in which he partici- pated did not involve the TFRP assessed against in- dividual E. Example 5. Appeals employee G is assigned to a CDP hearing concerning a NFTL filed with respect to a TFRP assessed pursuant to section 6672 against individual H. In preparing for the CDP hearing, Ap- peals employee G reviews the Appeals case file con- cerning the prior CAP hearing involving the TFRP assessed pursuant to section 6672 against individual H. Appeals employee G is not deemed to have par- ticipated in the previous CAP hearing involving the TFRP assessed against individual H by such review. (e)Matters considered at CDP hear- ing—(1)In general. Appeals has the authority to determine the validity, suffi- ciency, and timeliness of any CDP Notice given by the IRS and of any request for a CDP hearing that is made by a taxpayer. Prior to issuance of a determination, Ap- October 24, 20057782005–43 I.R.B. peals is required to obtain verification from the IRS office collecting the tax that the requirements of any applicable law or administrative procedure have been met. The taxpayer may raise any relevant issue relating to the unpaid tax at the hearing, including appropriate spousal defenses, challenges to the appropriateness of the NFTL filing, and offers of collection al- ternatives. The taxpayer also may raise challenges to the existence or amount of the underlying liability for any tax period specified on the CDPNotice if the tax- payer did not receive a statutory notice of deficiency for that tax liability or did not otherwise have an opportunity to dis- pute the tax liability. Finally, the taxpayer maynotraiseanissuethatwasraisedand considered at a previous CDP hearing un- der section 6330 or in any other previous administrative or judicial proceeding if the taxpayer participated meaningfully in such hearing or proceeding. Taxpayers will be expected to provide all relevant in- formation requested by Appeals, including financial statements, for its consideration of the facts and issues involved in the hearing. ***** (3) * * * A-E2. A taxpayer is entitled to chal- lenge the existence or amount of the under- lying liability for any tax period specified on the CDP Notice if the taxpayer did not receive a statutory notice of deficiency for such liability or didnot otherwise have an opportunity to dispute such liability. Re- ceipt of a statutory notice of deficiency for this purpose means receipt in time to peti- tion the Tax Court for a redetermination of the deficiency determined in the notice of deficiency. An opportunity to dispute the underlying liability includes a prior oppor- tunity for a conference with Appeals that was offered either before or after the as- sessment of the liability. ***** A-E6. Collection alternatives include, for example, a proposal to withdraw the NFTL in circumstances that will facilitate the collection of the tax liability, an in- stallment agreement, an offer to compro- mise, the posting of a bond, or the sub- stitution of other assets. A collection al- ternative is not available unless the alter- native would be available to other taxpay- ers in similar circumstances. For example, the IRS does not consider an offer to com- promise made by a taxpayer who, at the time of the CDP hearing, has not filed re- quired returns or has not made certain re- quired deposits of tax, as set forth in Form 656, “Offer in Compromise.” The collec- tion alternative of an offer to compromise would not be available to such a taxpayer in a CDP hearing. ***** A-E7. The taxpayer may raise appro- priate spousal defenses, challenges to the appropriateness of the NFTL filing, and of- fers of collection alternatives. The exis- tence or amount of the underlying liability for any tax period specified in the CDP No- tice may be challenged only if the taxpayer did not already have an opportunity to dis- pute the tax liability. If the taxpayer previ- ously received a CDP Notice under section 6330 with respect to the same tax and tax period and did not request a CDP hearing with respect to that earlier CDP Notice, the taxpayer has already had an opportunity to dispute the existence or amount of the un- derlying tax liability. ***** (f) * * * (2) * * * A-F5. In seeking Tax Court or district court review of a Notice of Determination, the taxpayer can only ask the court to con- sider an issue, including a challenge to the underlying tax liability, that was properly raised in the taxpayer’s CDP hearing. An issue is not properly raised if the taxpayer fails to request consideration of the issue by Appeals, or if consideration is requested but the taxpayer fails to present to Appeals any evidence with respect to that issue af- ter being given a reasonable opportunity to present such evidence. Q-F6. What is the administrative record for purposes of court review? A-F6. The case file, including written communications and information from the taxpayer or the taxpayer’s authorized representative submitted in connection with the CDP hearing, notes made by an Appeals officer or employee of any oral communications with the taxpayer or the taxpayer’s authorized representative and memoranda created by the Appeals officer or employee in connection with the CDP hearing, and any other documents or ma- terials relied upon by the Appeals officer or employee in making the determination under section 6330(c)(3), will constitute the record in any court review of the No- tice of Determination issued by Appeals. ***** (i) * * * (2) * * * Q-I1. What must a taxpayer do to ob- tain an equivalent hearing? A-I1. (i) A request for an equivalent hearing must be made in writing. A writ- ten request in any form that requests an equivalent hearing will be acceptable if it includes the information required in para- graph (ii) of this A-I1. (ii) The request must be dated and must include the following information: (A) The taxpayer’s name, address, day- time telephone number (if any), and tax- payer identification number (SSN or EIN). (B) The type of tax involved. (C) The tax period at issue. (D) A statement that the taxpayer is re- questing an equivalent hearing with Ap- peals concerning the filing of the NFTL. (E) The reason or reasons why the taxpayer disagrees with the filing of the NFTL. (F) The signature of the taxpayer or the taxpayer’s authorized representative. (iii) The taxpayer must perfect any timely written request for an equivalent hearing that does not provide the required information set forth in paragraph (ii) of this A-I1 within a reasonable period of time after a request from the IRS. If the re- quested information is not provided within a reasonable period of time, the taxpayer’s equivalent hearing request will be denied. (iv) The taxpayer must affirm any timely written request for an equivalent hearing that is signed or alleged to have been signed on the taxpayer’s behalf by the taxpayer’s spouse or other unauthorized representative, and that otherwise meets the requirements set forth in paragraph (ii) of this A-I1, by the taxpayer’s spouse or any other representative, by filing, within a reasonable time after a request from the IRS, a signed written affirmation that the request was originally submitted on the taxpayer’s behalf. If the affirmation is not filed within a reasonable period of time, the equivalent hearing request will be denied with respect to the non-signing taxpayer. ***** 2005–43 I.R.B.779October 24, 2005 Q-I7. When must a taxpayer request an equivalent hearing with respect to a CDP Notice issued under section 6320? A-I7. A taxpayer must submit a written request for an equivalent hearing within the one-year period commencing the day after the end of the five-business-day pe- riod following the filing of the NFTL. This period is slightly different from the pe- riod for submitting a written request for an equivalent hearing with respect to a CDP Notice issued under section 6330. For a CDP Notice issued under section 6330, a taxpayer must submit a written request for an equivalent hearing within the one-year period commencing the day after the date of the CDP Notice issued under section 6330. Q-I8. How will the timeliness of a tax- payer’s written request for an equivalent hearing be determined? A-I8. The rules and regulations under section 7502 and section 7503 will apply to determine the timeliness of the taxpayer’s request for an equivalent hearing, if prop- erly transmitted and addressed as provided in A-I10 of this paragraph (i)(2). Q-I9. Is the one-year period within which a taxpayer must make a request for an equivalent hearing extended because the taxpayer resides outside the United States? A-I9. No. All taxpayers who want an equivalent hearing concerning the filing of the NFTL must request the hearing within the one-year period commencing the day after the end of the five-business-day pe- riod following the filing of the NFTL. Q-I10. Where must the written request for an equivalent hearing be sent? A-I10. The written request for an equivalent hearing must be sent, or hand delivered (if permitted), to the IRS office and address as directed on the CDP Notice. If the address of the issuing office does not appear on the CDP Notice, the taxpayer should obtain the address of the office to which the written request should be sent or hand delivered by calling, toll-free, 1–800–829–1040 and providing the tax- payer’s identification number (SSN or EIN). Q-I11. What will happen if the tax- payer does not request an equivalent hear- ing in writing within the one-year period commencing the day after the end of the five-business-day period following the fil- ing of the NFTL? A-I11. If the taxpayer does not request an equivalent hearing with Appeals within the one-year period commencing the day after the end of the five-business-day pe- riod following the filing of the NFTL, the taxpayer foregoes the right to an equiva- lent hearing with respect to the unpaid tax and tax periods shown on the CDP Notice. The taxpayer, however, may seek recon- sideration by the IRS office collecting the tax, assistance from the National Taxpayer Advocate, or an administrative hearing be- fore Appeals under its Collection Appeals Program or any successor program. ***** (j)Effective date.Thissectionisappli- cable the date 30 days after final regula- tions are published in theFederal Regis- terwith respect to requests made for CDP hearings or equivalent hearings on or after the date 30 days after final regulations are published in theFederal Register. Mark E. Matthews, Deputy Commissioner for Services and Enforcement. (Filed by the Office of the Federal Register on September 15, 2005, 8:45 a.m., and published in the issue of the Federal Register for September 16, 2005, 70 F.R. 54681) Notice of Proposed Rulemaking and Notice of Public Hearing Miscellaneous Changes to Collection Due Process Procedures Relating to Notice and Opportunity for Hearing Prior to Levy REG–150091–02 AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Notice of proposed rulemaking and notice of public hearing. SUMMARY: This document contains pro- posed amendments to the regulations relat- ingtoataxpayer’srighttoahearingbe- fore or after levy under section 6330 of the Internal Revenue Code of 1986. The pro- posed regulations make certain clarifying changes in the way collection due process (CDP) hearings are held and specify the period during which a taxpayer may re- quest an equivalent hearing. The proposed regulations affect taxpayers against whose property or rights to property the Internal Revenue Service (IRS) intends to levy on or after January 19, 1999. This document also contains a notice of public hearing on these proposed regulations. DATES: Written and electronic comments must be received by December 15, 2005. Outlines of topics to be discussed at the public hearing scheduled for 10 a.m. on January 19, 2006, must be received by De- cember 29, 2005. ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG–150091–02), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washing- ton, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–150091–02), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Wash- ington, DC, or sent electronically, via the IRS Internet site atwww.irs.gov/regsor via the Federal eRulemaking Portal at www.regulations.gov(indicate IRS and REG–150091–02). The public hearing will be held in the IRS Auditorium, In- ternal Revenue Building (7th Floor), 1111 Constitution Avenue, NW, Washington, DC. FOR FURTHER INFORMATION CONTACT: Concerning the regulations, call Laurence K. Williams, 202–622–3600 (not a toll-free number). Concerning submissions and/or to be placed on the building access list to attend the hearing, call Robin Jones, 202–622–7180 (not a toll-free number). SUPPLEMENTARY INFORMATION: Background This document contains proposed amendments to the Regulations on Pro- cedure and Administration (26 CFR part 301) relating to the provision of notice under section 6330 of the Internal Rev- enue Code to taxpayers of a right to a CDP hearing (CDP Notice) before levy. Final regulations (T.D. 8980, 2002–1 C.B. 477) were published on January 18, 2002 in the Federal Register(67 FR 2549). The final October 24, 20057802005–43 I.R.B. regulations implemented certain changes made by section 3401 of the Internal Rev- enue Service Restructuring and Reform Act of 1998 (Public Law 105–206, 112 Stat. 685) (RRA 1998), including the addition of section 6330 to the Internal Revenue Code. The final regulations af- fected taxpayers against whose property or rights to property the IRS intends to levy. Section 3401 of RRA 1998 also added section 6320 to the Internal Revenue Code. That statute provides for notice to taxpay- ers of a right to a hearing after the filing of a notice of Federal tax lien (NFTL). A number of the provisions in section 6330 concerning the conduct and judicial review of a CDP hearing are incorporated by refer- ence in section 6320. On January 18, 2002, final regulations (T.D. 8979, 2002–1 C.B. 466) under section 6320 were published in theFederal Register(67 FR 2558) along with the final regulations under section 6330. Explanation of Provisions A taxpayer is entitled to one CDP hear- ing with respect to the tax and tax period covered by a CDP Notice concerning a levy or a CDP Notice concerning the fil- ing of a NFTL. The IRS Office of Appeals (Appeals) has conducted over 92,000 CDP hearings and more than 30,000 equivalent hearings since sections 6320 and 6330 be- came effective for collection actions initi- ated on and after January 19, 1999. In general, the experience of the past six years with CDP hearings has demonstrated that there is a need for changes to allow Appeals to effectively and fairly handle the cases of taxpayers who raise issues of sub- stance. Appeals has instituted many im- provements in its processing of CDP cases and has conducted extensive training in an effort to provide careful, but timely, review of CDP cases, which currently are filed at a rate of approximately 2,450 per month. The proposed regulations, if adopted as final regulations, will increase efficiency without compromising the quality and fair- ness of review. In many CDP cases, significant time is spent merely identifying the issues. Al- though the Form 12153 used to request a CDP hearing requires a taxpayer to state a reason or reasons for disagreeing with the proposed levy, many taxpayers either do not supply that information, or raise new issues during the CDP hearing process not identified on the hearing request. De- lays result while taxpayers provide new supporting documentation and Appeals personnel reconsider prior conclusions in light of the new information. Cases of other taxpayers pending in Appeals are delayed because other work must be con- stantly rescheduled. Cases are also delayed when taxpayers propose collection alternatives for which they are not eligible. The IRS does not consider offers in compromise or install- ment agreements from taxpayers who have failed to file required returns as of the date the offer or the proposed installment agree- ment is submitted. See Publication 594, “What You Should Know About the IRS Collection Process(Rev. 2–2004).” Sim- ilarly, the IRS will not consider an offer in compromise from an in-business taxpayer unless the taxpayer has timely filed all re- turns and timely made all Federal tax de- posits for two consecutive quarters. See Form 656, “Offer in Compromise(Rev. 7–2004).” The resources of Appeals are in- effectively utilized arranging and conduct- ing face-to-face conferences requested by non-compliant taxpayers whose only com- plaint is the rejection of an offer to compro- mise or installment agreement for which they are not eligible. Frivolous cases also cause unneces- sary delays. During fiscal year 2004, 5.4 percent of the 32,226 CDP and equiva- lent-hearing cases Appeals handled in- volved taxpayers who were non-filers or raised only frivolous issues. Cases raising frivolous issues, in particular, consume a disproportionately large amount of time, because Appeals personnel must often read lengthy, frivolous submissions in search of any substantive issue buried within. Delays also result when taxpayers use face-to-face conferences as a venue for frivolous oration and harassment of Appeals personnel. The proposed regulations attempt to ad- dress these and other problems that have become apparent during the first six years of CDP practice. The proposed changes are aimed at creating a more focused pro- cedure that will allow Appeals to continue to provide careful review of proposed levies as the volume of cases increases. A taxpayer must request a CDP hearing in writing. The current regulations require that a request for a CDP hearing include the taxpayer’s name, address, and daytime telephone number, and that the request be dated and signed by either the taxpayer or the taxpayer’s authorized representa- tive. Section 301.6330–1(c)(2), Q&A-C1. A Form 12153, “Request for a Collection Due Process Hearing,” is included with the CDP Notice sent to the taxpayer pur- suant to section 6330. The Form 12153 requests (1) the taxpayer’s name, address, daytime telephone number, and taxpayer identification number (SSN or EIN), (2) the type of tax involved, (3) the tax pe- riod at issue, (4) a statement that the tax- payer requests a hearing with Appeals con- cerning the proposed levy, and (5) the rea- son or reasons why the taxpayer disagrees with the proposed levy. Although taxpay- ers are encouraged to use a Form 12153 in requesting a CDP hearing, the current regulations do not require the use of Form 12153. Section 301.6330–1(c)(2), A-C1, of the proposed regulations requires taxpayers to state their reasons for disagreement with the proposed levy whether or not a Form 12153 is used to request a CDP hearing. In addition, a taxpayer who fails to sign a timely CDP hearing request because the request is made by a spouse or other unau- thorized representative must affirm in writ- ing that the request was originally submit- ted on the taxpayer’s behalf. Failure to provide the written affirmation within a reasonable time after a request from Ap- peals will result in the denial of a CDP hearing for that taxpayer. ACDPhearingistobeconductedbyan Appeals officer or employee who has had no “prior involvement” with respect to the tax for the tax periods to be covered by the hearing, unless the taxpayer waives this requirement. Section 301.6330–1(d)(2), A-D4 of the current regulations provides that “prior involvement” by an Appeals officer or employee includes participation or involvement in an Appeals hearing that the taxpayer may have had with respect to the tax and tax period shown on the CDP Notice, other than a CDP hearing held under either section 6320 or section 6330. It is important that “prior involvement” be construed in a manner that reasonably protects against predisposition but at the same time does not disqualify too broad a range of Appeals personnel. A broad standard of “prior involvement” would lead to uncertain application, could result 2005–43 I.R.B.781October 24, 2005 in the disqualification of an entire Appeals office, many of which have small staffs, and could make it difficult to conduct the CDP hearing. Section 301.6330–1(d)(2), A-D4 of the proposed regulations pro- vides that prior involvement exists only when the taxpayer, the tax liability and the tax period shown on the CDP Notice also were at issue in the prior non-CDP hearing or proceeding, and the Appeals officer or employee actually participated in the prior hearing or proceeding. Examples are provided in §301.6330–1(d)(3) of the proposed regulations. Section 301.6330–1(d)(2), A-D7, of the proposed regulations clarifies that a face- to-face conference is merely one aspect of aCDPhearingundersection6330andis not by itself the entire CDP hearing. A-D7 of the proposed regulations also provides that, in all cases, the Appeals officer or employee will review the tax- payer’s request for a CDP hearing, the case file, other written communications from the taxpayer, and any notes of oral com- munications with the taxpayer or the tax- payer’s representative. If no face-to-face or telephonic conference is held, review of those documents will constitute the CDP hearing for purposes of section 6330(b). A-D7 of the proposed regulations fur- ther clarifies that when a business taxpayer is offered an opportunity for a face-to-face conference it will be held at the Appeals office closest to the taxpayer’s principal place of business. The current regula- tions have been misinterpreted by some taxpayers as requiring the IRS to hold a face-to-face conference at the taxpayer’s principal place of business. Q&A-D8 of the proposed regulations is new. It describes specific circum- stances in which Appeals will not hold a face-to-face conference with the tax- payer or the taxpayer’s representative because a conference will serve no use- ful purpose. The experience of Appeals is that although most taxpayers request face-to-face conferences, they are some- times difficult to schedule on a date and at a time that is convenient for the taxpayer. In some of these cases, taxpayers or their representatives have used the scheduling of a face-to-face conference as a tactic to delay the IRS’s collection efforts. In other cases, taxpayers have requested a face-to-face conference merely to raise frivolous arguments concerning the Fed- eral tax system or to request collection alternatives for which they do not qual- ify. Q&A-D8 of the proposed regulations provides that a face-to-face conference need not be offered if the taxpayer or the taxpayer’s representative raises only frivolous arguments concerning the Fed- eral tax system. See the IRS Internet site,www.irs.gov/pub/irs-utl/friv_tax.pdf, for examples of frivolous arguments. A face-to-face conference also will not be granted if the taxpayer proposes collection alternatives that would not be available to other taxpayers in similar circumstances. A face-to-face conference need not be granted if the taxpayer does not provide in the written request for a CDP hearing, as perfected, the required information set forth in A-C1(ii)(E) of paragraph (c)(2) of the proposed regulations. In addition, a face-to-face conference will not be held at the location closest to the taxpayer’s residence or principal place of business if all Appeals officers or employees at that location are considered to have prior involvement as provided in A-D4. In this case, the taxpayer will be of- fered a hearing by telephone or correspon- dence, or some combination thereof. The taxpayer may be able to obtain a face-to- face conference at the Appeals office clos- est to the taxpayer’s residence or princi- pal place of business under these circum- stances if the taxpayer waives the require- ment of section 6330(b)(3) concerning im- partiality of the Appeals officer or em- ployee. Appeals will offer the taxpayer a face-to-face conference at another Appeals office if in the exercise of its discretion Ap- peals would have offered the taxpayer a face-to-face conference at the original lo- cation. With the foregoing exceptions, it is anticipated that a face-to-face conference will ordinarily be offered with respect to any relevant issues or collection alterna- tives for which the taxpayer qualifies. Sections 301.6330–1(e)(1) and 301.6330–1(e)(3), A-E2 and A-E7 have been changed to more closely follow the language of section 6330(c)(2)(B). These changes are necessary because these regu- lations have been misinterpreted as defin- ing the underlying tax liability that may be considered at the CDP hearing under section 6330(c)(2)(B) to be the tax liabil- ity listed on the CDP Notice. The existing regulations, which refer to tax liability on the CDP Notice, were intended merely to make clear that taxpayers may only challenge taxes or tax periods listed on the CDP Notice, not to supply a substan- tive definition of underlying tax liability. Section 301.6330–1(e)(3), A-E6 has been amended to clarify that taxpayers who receive CDP hearings can only qualify for collection alternatives available generally to taxpayers in similar circumstances. The experience of the past six years has revealed that many taxpayers raise an is- sue with Appeals but fail to furnish any documentation or evidence with respect to the issue despite being given a reason- able period to do so. For example, a tax- payer may request an installment agree- ment, but when an Appeals officer or em- ployee requests financial data necessary to determine eligibility for the installment agreement, the taxpayer may not comply with the request. Or a taxpayer may dis- pute liability for a tax period by claim- ing entitlement to deductions, but provide no substantiation for the deductions in re- sponse to requests from Appeals. Current §301.6330–1(f)(2), A-F5 provides that a taxpayer may not seek judicial review of an issue that he has not raised during the CDP hearing. A-F5 is revised to clarify that in order to obtain judicial review, a taxpayer must not only bring the issue to the attention of Appeals but must also sub- mit, if requested, evidence with respect to that issue. Under revised A-F5, if the tax- payer does not provide Appeals any evi- dence with respect to the issue after being given a reasonable opportunity to submit such evidence, then he may not ask a court to consider the issue. There has been some confusion about what documents Appeals should retain, and what notations the Appeals officer or employee conducting the hearing should make, in order to provide a judicially re- viewable administrative record. A new Q&A-F6 has been added to specify the contents of the administrative record re- quired for court review. The IRS receives a number of tardy requests for CDP hearings. The changes to §301.6330–1(i)(2) explain how these requests will be treated. The proposed amendments to the regulations add a new Q&A-I1 to §301.6330–1(i)(2) to explain that a taxpayer must request an equiva- lent hearing in writing. A taxpayer may obtain an equivalent hearing if the 30-day October 24, 20057822005–43 I.R.B. period described in section 6330(a)(3) for requesting a CDP hearing has expired. Unlike an Appeals determination in a CDP hearing, the Appeals decision in an equivalent hearing is not reviewable in court. Under new Q&A-I1, the IRS is not required to treat a late-filed CDP request as a request for an equivalent hearing. Section 301.6330–1(c)(2), A-C7 has been amended to require that the taxpayer be notified of the right to an equivalent hear- ing in all cases in which a tardy request for a CDP hearing is received. It is expected that the IRS will either send the taxpayer a letter or orally inform the taxpayer that the CDP hearing request is untimely and ask if the taxpayer wishes to have an equivalent hearing. If the taxpayer elects to have an equivalent hearing, the IRS will treat the CDP hearing request as a request for an equivalent hearing without requiring the taxpayer to make an additional written request. Current Q&A-I1 through I5 are renumbered Q&A-I2 through I6. The proposed regulations add Q&A-I7 to §301.6330–1(i)(2) to clarify that the pe- riod during which a taxpayer may obtain an equivalent hearing is not indefinite. The equivalent hearing procedure is not provided by statute but, consistent with the legislative history of RRA 1998, was adopted in order to accommodate tax- payerswhofailedtimelytoexercisetheir right to a CDP hearing. The equivalent hearing was meant to occur near the time a CDP hearing held pursuant to a timely request would have occurred, because it was meant to address the same matters that would have been addressed at a CDP hearing. The procedure was not meant to provide a hearing right that could be exercised months or years after the cir- cumstances that precipitated the proposed levy have passed. A hearing before Ap- peals at a later time may be obtained under the Collection Appeals Program. There- fore, proposed Q&A-I7 limits to one year the period during which a taxpayer may request an equivalent hearing. The period commences the day after the date of the CDP Notice issued under section 6330. Because the time for requesting an equivalent hearing will be limited, the proposed regulations add new Q&A-I8, Q&A-I9, Q&A-I10 and Q&A-I11 to §301.6330–1(i)(2) to provide the same rules governing mailing, delivery and de- termination of timeliness that apply to requests for CDP hearings. Unlike exist- ing §301.6330–1(c)(2), A-C6, new A-I10 does not identify the officials to whom to send an equivalent hearing request if the CDP Notice does not specify where to send the request. Because the identity and the address of the person to whom the request should be sent may change in the future, taxpayers will be able to obtain more current information by calling the 1–800 number listed in A-I10. Section 301.6330–1(c)(2), A-C6 also has been revised in the proposed regulations to pro- vide that taxpayers should call the 1–800 number to obtain the address to which the CDP hearing request should be sent. The proposed regulations are effective the date 30 days after final regulations are published in theFederal Registerwith respect to requests for CDP hearings or equivalent hearings made on or after the date 30 days after final regulations are pub- lished in theFederal Register. 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. Therefore, a regula- tory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these reg- ulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Inter- nal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Busi- ness Administration for comment on its impact on small business. Comments and Public Hearing Before these proposed regulations are adopted as final regulations, consideration will be given to any electronic and writ- ten comments that are submitted timely to the IRS. The IRS and Treasury Department specifically request comments on the clar- ity of the proposed regulations and how they may be made easier to understand. All comments will be available for public inspection and copying. A public hearing has been scheduled for January 19, 2006, at 10 a.m. in the IRS Auditorium, Internal Revenue Building (7th Floor), 1111 Constitution Avenue, NW, Washington, DC. All visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediateentranceareamorethan30 minutes before the hearing starts. For in- formation about having a visitor’s name placed on the building access list to attend the hearing, see the FOR FURTHER IN- FORMATION CONTACT caption. An outline of the topics to be discussed and the time to be devoted to each topic must be submitted by any person who wishes to present oral comments at the hearing. Outlines must be received by December 29, 2005. The rules of 26 CFR 601.601(a)(3) ap- plytothehearing.Aperiodof10minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving requests to speak has passed. Copies of the agenda will be available free of charge at the hearing. Draftin g Information The principal author of these regula- tions is Laurence K. Williams, Office of Associate Chief Counsel, Procedure and Administration (Collection, Bankruptcy and Summonses Division). ***** Proposed Amendments to the Regulations Accordingly, 26 CFR part 301 is pro- posed to be amended as follows: PART 301—PROCEDURE AND ADMINISTRATION Paragraph 1. The authority citation for part 301 continues to read, in part, as fol- lows: Authority: 26 U.S.C. 7805 * * * Par. 2. Section 301.6330–1 is proposed to be amended as follows: 1. Paragraph (c)(2) A-C1, Q&A-C6 andA-C7arerevised. 2. Paragraph (d)(2) A-D4 and A-D7 are revised. 3. Paragraph (d)(2) Q&A-D8 is added. 2005–43 I.R.B.783October 24, 2005 4. Paragraph (d)(3) is added. 5. Paragraph (e)(1) is revised 6. Paragraph (e)(3)A-E2,A-E6and A-E7 are revised. 7. Paragraph (f)(2) A-F5 is revised. 8. Paragraph (f)(2) Q&A-F6 is added. 9. Paragraph (i)(2) Q&A-I1 through Q&A-I5 are renumbered Q&A-I2 through Q&A-I6, a new paragraph (i)(2) Q&A-I1 and new paragraphs Q&A-I7 through Q&A-I11 are added. 10. Paragraph (j) is revised. §301.6330–1 Notice and opportunity for hearing prior to levy. ***** (c) * * * (2) * * * A-C1. (i) The taxpayer must make a request in writing for a CDP hearing. The request for a CDP hearing shall include the information specified in A-C1(ii) of this paragraph (c)(2). See A-D7 and A-D8 of paragraph (d)(2). (ii) The written request for a CDP hear- ing must be dated and must include the fol- lowing information: (A) The taxpayer’s name, address, day- time telephone number (if any), and tax- payer identification number (SSN or EIN). (B) The type of tax involved. (C) The tax period at issue. (D) A statement that the taxpayer re- quests a hearing with Appeals concerning the proposed levy. (E) The reason or reasons why the tax- payer disagrees with the proposed levy. (F) The signature of the taxpayer or the taxpayer’s authorized representative. (iii) The taxpayer must perfect any timely written request for a CDP hearing that does not provide the required informa- tion set forth in A-C1(ii) of this paragraph within a reasonable period of time after a request from the IRS. (iv) Taxpayers are encouraged to use a Form 12153, “Request for a Collection Due Process Hearing,” in requesting a CDP hearing so that the request can be readilyidentifiedandforwardedtoAp- peals. Taxpayers may obtain a copy of Form 12153 by contacting the IRS office that issued the CDP Notice, by down- loading a copy from the IRS Internet site, www.irs.gov/pub/irs-pdf/f12153.pdf,orby calling, toll-free, 1–800–829–3676. (v) The taxpayer must affirm any timely written request for a CDP hearing which is signed or alleged to have been signed on the taxpayer’s behalf by the taxpayer’s spouse or other unauthorized representa- tive by filing, within a reasonable time af- ter a request from the IRS, a signed, writ- ten affirmation that the request was orig- inally submitted on the taxpayer’s behalf. If the affirmation is not filed within a rea- sonable period of time after a request, the CDP hearing request will be denied with respect to the non-signing taxpayer. ***** Q-C6. Where must the written request for a CDP hearing be sent? A-C6. The written request for a CDP hearing must be sent, or hand delivered (if permitted), to the IRS office and address as directed on the CDP Notice. If the ad- dress of that office does not appear on the CDP Notice, the taxpayer should obtain the address of the office to which the writ- ten request should be sent or hand deliv- ered by calling, toll-free, 1–800–829–1040 and providing the taxpayer’s identification number (SSN or TIN). ***** A-C7. If the taxpayer does not request a CDP hearing in writing within the 30-day period that commences on the day after the date of the CDP Notice, the taxpayer foregoes the right to a CDP hearing under section 6330 with respect to the unpaid tax and tax periods shown on the CDP Notice. If the request for CDP hearing is received after the 30-day period, the taxpayer will be notified of the untimely request and of the right to an equivalent hearing. See paragraph (i) of this section. ***** (d) * * * (2) * * * A-D4. Prior involvement by an Ap- peals officer or employee includes partici- pation or involvement in an Appeals hear- ing(otherthanaCDPhearingheldun- der either section 6320 or section 6330) that the taxpayer may have had with re- spect to the tax and tax period shown on the CDP Notice. Prior involvement exists only when the taxpayer, the tax liability and the tax period at issue in the CDP hear- ing also were at issue in the prior non-CDP hearing or proceeding,and the Appeals of- ficer or employee actually participated in the prior hearing or proceeding. ***** A-D7. Except as provided in A-D8 of this paragraph (d)(2), a taxpayer who presents in the CDP hearing request rel- evant, non-frivolous reasons for disagree- ment with the proposed levy will ordinar- ily be offered an opportunity for a face-to- face conference at the Appeals office clos- est to the taxpayer’s residence. A busi- ness taxpayer will ordinarily be offered an opportunity for a face-to-face confer- ence at the Appeals office closest to the taxpayer’s principal place of business. If that is not satisfactory to the taxpayer, the taxpayer will be given an opportunity for a hearing by telephone or by correspon- dence. In all cases, the Appeals officer or employee will review the case file, which includes the taxpayer’s request for a CDP hearing, any other written communications from the taxpayer or the taxpayer’s autho- rized representative, and any notes made by Appeals officers or employees of any oral communications with the taxpayer or the taxpayer’s authorized representative. If no face-to-face or telephonic conference is held, review of those documents will constitute the CDP hearing for purposes of section 6330(b). Q-D8. In what circumstances will a face-to-face CDP conference not be granted? A-D8. A taxpayer is not entitled to a face-to-face CDP conference at a loca- tion other than as provided in A-D7 of this paragraph (d)(2) and this A-D8. If all Ap- peals officers or employees at the loca- tion provided for in A-D7 of this paragraph have had prior involvement with the tax- payer as provided in A-D4 of this para- graph, the taxpayer will not be offered a face-to-face meeting at that location, un- less the taxpayer elects to waive the re- quirement of section 6330(b)(3). The tax- payer will be offered a face-to-face confer- ence at another Appeals office if Appeals in the exercise of its discretion would have offered the taxpayer a face-to-face confer- ence at the location provided in A-D7. A face-to-face CDP conference concerning a taxpayer’s underlying liability will not be granted if the request for a hearing or other taxpayer communication indicates that the taxpayer wishes only to raise irrelevant or frivolous issues concerning that liability. A face-to-face CDP conference concern- ing a collection alternative, such as an in- stallment agreement or an offer to compro- October 24, 20057842005–43 I.R.B. mise liability, will not be granted unless the alternative would be available to other taxpayers in similar circumstances. For example, because the IRS does not con- sider offers to compromise from taxpay- ers who have not filed required returns or have not made certain required deposits of tax, as set forth in Form 656, “Offer in Compromise,” no face-to-face conference will be offered to a taxpayer who wishes to make an offer to compromise but has not fulfilled those obligations. A face-to-face conference need not be granted if the tax- payer does not provide the required infor- mation set forth in A-C1(ii)(E) of para- graph (c)(2). See also A-C1(iii) of para- graph C–2. (3)Examples. The following examples illustrate the principles of this paragraph (d): Example 1. Individual A timely requests a CDP hearing concerning a proposed levy for the 1998 income tax liability assessed against individual A. Appeals employee B previously conducted a CDP hearing regarding a NFTL filed with respect to A’s 1998 income tax liability. Because employee B’s only prior involvement with individual A’s 1998 income tax liability was in connection with a sec- tion 6320 CDP hearing, employee B may conduct the CDP hearing under section 6330 involving the proposed levy for the 1998 income tax liability. Example 2. Individual C timely requests a CDP hearing concerning a proposed levy for the 1998 in- come tax liability assessed against individual C. Ap- peals employee D previously conducted a Collection Appeals Program (CAP) hearing regarding a NFTL filed with respect to C’s 1998 income tax liability. Because employee D’s prior involvement with indi- vidual C’s 1998 income tax liability was in connec- tion with a non-CDP hearing, employee D may not conduct the CDP hearing under section 6330 unless individual C waives the requirement that the hearing will be conducted by an Appeals officer or employee who has had no prior involvement with respect to C’s 1998 income tax liability. Example 3. Same facts as inExample 2, except that the prior CAP hearing only involved individual C’s 1997 income tax liability and employment tax li- abilities for 1998 reported on Form 941. Employee D would not be considered to have prior involvement because the prior CAP hearing in which she partici- pated did not involve individual C’s 1998 income tax liability. Example 4. Appeals employee F is assigned to a CDP hearing concerning a proposed levy for a trust fund recovery penalty (TFRP) assessed pursuant to section 6672 against individual E. Appeals employee F participated in a prior CAP hearing involving indi- vidual E’s 1999 income tax liability, and participated in a CAP hearing involving the employment taxes of business entity X, which incurred the employment tax liability to which the TFRP assessed against individ- ual E relates. Appeals employee F would not be con- sidered to have prior involvement because the prior CAP hearings in which he participated did not di- rectly involve the TFRP assessed against individual E. Example 5. Appeals employee G is assigned to a CDP hearing concerning a proposed levy for a TFRP assessed pursuant to section 6672 against individual H. In preparing for the CDP hearing, Appeals em- ployee G reviews the Appeals case file concerning the prior CAP hearing involving the TFRP assessed pur- suant to section 6672 against individual H. Appeals employee G is not deemed to have participated in the previous CAP hearing involving the TFRP assessed against individual H by such review. (e)Matters considered at CDP hear- ing—(1)In general. Appeals has the authority to determine the validity, suffi- ciency, and timeliness of any CDP Notice given by the IRS and of any request for a CDP hearing that is made by a taxpayer. Prior to issuance of a determination, Ap- peals is required to obtain verification from the IRS office collecting the tax that the requirements of any applicable law or administrative procedure have been met. The taxpayer may raise any relevant issue relating to the unpaid tax at the hearing, including appropriate spousal defenses, challenges to the appropriateness of the proposed levy, and offers of collection alternatives. The taxpayer also may raise challenges to the existence or amount of the underlying liability for any tax period specified on the CDP Notice if the tax- payer did not receive a statutory notice of deficiency for that tax liability or did not otherwise have an opportunity to dis- pute the tax liability. Finally, the taxpayer may not raise an issue that was raised and considered at a previous CDP hearing un- der section 6320 or in any other previous administrative or judicial proceeding if the taxpayer participated meaningfully in such hearing or proceeding. Taxpayers will be expected to provide all relevant in- formation requested by Appeals, including financial statements, for its consideration of the facts and issues involved in the hearing. ***** (3) * * * A-E2. A taxpayer is entitled to chal- lenge the existence or amount of the under- lying liability for any tax period specified on the CDP Notice if the taxpayer did not receive a statutory notice of deficiency for such liability or did not otherwise have an opportunity to dispute such liability. Re- ceipt of a statutory notice of deficiency for this purpose means receipt in time to peti- tion the Tax Court for a redetermination of the deficiency determined in the notice of deficiency. An opportunity to dispute the underlying liability includes a prior oppor- tunity for a conference with Appeals that was offered either before or after the as- sessment of the liability. ***** A-E6. Collection alternatives include, for example, a proposal to withhold the proposed levy or future collection action in circumstances that will facilitate the col- lection of the tax liability, an installment agreement, an offer to compromise, the posting of a bond, or the substitution of other assets. A collection alternative is not available unless thealternative would be available to other taxpayers in similar cir- cumstances. For example, the IRS does not consider an offer to compromise made by a taxpayer who, at the time of the CDP hearing, has not filed required returns or has not made certain required deposits of tax, as set forth in Form 656, “Offer in Compromise.” The collection alternative of an offer to compromise would not be available to such a taxpayer in a CDP hear- ing. ***** A-E7. The taxpayer may raise appro- priate spousal defenses, challenges to the appropriateness of the proposed collection action, and offers of collection alterna- tives. The existence or amount of the un- derlying liability for any tax period speci- fied in the CDP Notice may be challenged only if the taxpayer did not already have an opportunity to dispute the tax liability. If the taxpayer previously received a CDP Notice under section 6320 with respect to the same tax and tax period and did not re- quest a CDP hearing with respect to that earlier CDP Notice, the taxpayer has al- ready had an opportunity to dispute the ex- istence or amount of the underlying tax li- ability. ***** (f) * * * (2) * * * A-F5. In seeking Tax Court or district court review of a Notice of Determination, the taxpayer can only ask the court to con- sider an issue, including a challenge to the underlying tax liability, that was properly raised in the taxpayer’s CDP hearing. An issue is not properly raised if the taxpayer fails to request consideration of the issue 2005–43 I.R.B.785October 24, 2005 by Appeals, or if consideration is requested but the taxpayer fails to present to Appeals any evidence with respect to that issue af- ter being given a reasonable opportunity to present such evidence. Q-F6. What is the administrative record for purposes of court review? A-F6. The case file, including written communications and information from the taxpayer or the taxpayer’s authorized representative submitted in connection with the CDP hearing, notes made by an Appeals officer or employee of any oral communications with the taxpayer or the taxpayer’s authorized representative and memoranda created by the Appeals officer or employee in connection with the CDP hearing, and any other documents or ma- terials relied upon by the Appeals officer or employee in making the determination under section 6330(c)(3), will constitute the record in any court review of the No- tice of Determination issued by Appeals. (i) * * * (2) * * * Q-I1. What must a taxpayer do to ob- tain an equivalent hearing? A-I1. (i) A request for an equivalent hearing must be made in writing. A writ- ten request in any form that requests an equivalent hearing will be acceptable if it includes the information required in para- graph(ii)ofthisA-I1. (ii) The request must be dated and must include the following information: (A) The taxpayer’s name, address, day- time telephone number (if any), and tax- payer identification number (SSN or EIN). (B) The type of tax involved. (C) The tax period at issue. (D) A statement that the taxpayer is re- questing an equivalent hearing with Ap- peals concerning the levy. (E) The reason or reasons why the tax- payer disagrees with the proposed levy. (F) The signature of the taxpayer or the taxpayer’s authorized representative. (iii) The taxpayer must perfect any timely written request for an equivalent hearing that does not provide the required information set forth in paragraph (ii) of this A-I1 within a reasonable period of time after a request from the IRS. If the re- quested information is not provided within a reasonable period of time, the taxpayer’s equivalent hearing request will be denied. (iv) The taxpayer must affirm any timely written request for an equivalent hearing that is signed or alleged to have been signed on the taxpayer’s behalf by the taxpayer’s spouse or other unautho- rized representative, and that otherwise meets the requirements set forth in para- graph (ii) of this A-I1, by filing, within a reasonable time after a request from the IRS, a signed written affirmation that the request was originally submitted on the taxpayer’s behalf. If the affirmation is not filed within a reasonable period of time, the equivalent hearing request will be denied with respect to the non-signing taxpayer. ***** Q-I7. When must a taxpayer request an equivalent hearing with respect to a CDP Notice issued under section 6330? A-I7. A taxpayer must submit a written request for an equivalent hearing within the one-year period commencing the day after the date of the CDP Notice issued un- der section 6330. This period is slightly different from the period for submitting a written request for an equivalent hearing with respect to a CDP Notice issued under section 6320. For a CDP Notice issued un- der section 6320, a taxpayer must submit a written request for an equivalent hear- ing within the one-year period commenc- ing the day after the end of the five-busi- ness-day period following the filing of the NFTL. Q-I8. How will the timeliness of a tax- payer’s written request for an equivalent hearing be determined? A-I8. The rules and regulations under section7502andsection7503willapplyto determine the timeliness of the taxpayer’s request for an equivalent hearing, if prop- erly transmitted and addressed as provided in A-I10 of this paragraph (i)(2). Q-I9. Is the one-year period within which a taxpayer must make a request for an equivalent hearing extended because the taxpayer resides outside the United States? A-I9. No. All taxpayers who want an equivalent hearing must request the hear- ing within the one-year period commenc- ing the day after the date of the CDP Notice issued under section 6330. Q-I10. Where must the written request for an equivalent hearing be sent? A-I10. The written request for an equivalent hearing must be sent, or hand delivered (if permitted), to the IRS office and address as directed on the CDP Notice. If the address of the issuing office does not appear on the CDP Notice, the taxpayer should obtain the address of the office to which the written request should be sent or hand delivered by calling, toll-free, 1–800–829–1040 and providing the tax- payer’s identification number (SSN or EIN). Q-I11. What will happen if the taxpayer does not request an equivalent hearing in writing within the one-year period com- mencing the day after the date of the CDP Notice issued under section 6330? A-I11. If the taxpayer does not request an equivalent hearing with Appeals within the one-year period commencing the day after the date of the CDP Notice issued un- der section 6330, the taxpayer foregoes the right to an equivalent hearing with respect to the unpaid tax and tax periods shown on the CDP Notice. The taxpayer, how- ever, may seek reconsideration by the IRS office collecting the tax, assistance from the National Taxpayer Advocate, or an ad- ministrative hearing before Appeals under its Collection Appeals Program or any suc- cessor program. ***** (j)Effective date. This section is appli- cable the date 30 days after final regula- tions are published in theFederal Regis- terwith respect to requests made for CDP hearings or equivalent hearings on or after the date 30 days after final regulations are published in theFederal Register. Mark E. Matthews, Deputy Commissioner for Services and Enforcement. (Filed by the Office of the Federal Register on September 15, 2005, 8:45 a.m., and published in the issue of the Federal Register for September 16, 2005, 70 F.R. 54687) Notice of Proposed Rulemaking and Notice of Public Hearing Application of Section 409A to Nonqualified Deferred Compensation Plans REG–158080–04 AGENCY: Internal Revenue Service (IRS), Treasury. October 24, 20057862005–43 I.R.B. ACTION: Notice of proposed rulemaking and notice of public hearing. SUMMARY: This document contains proposed regulations regarding the appli- cation of section 409A to nonqualified deferred compensation plans. The regu- lations affect service providers receiving amounts of deferred compensation, and the service recipients for whom the service providers provide services. This document also provides a notice of public hearing on these proposed regulations. DATES: Written or electronic comments must be received by January 3, 2006. Out- lines of topics to be discussed at the pub- lic hearing scheduled for January 25, 2006, must be received by January 4, 2006. ADDRESSES: Send submissions to: CC:PA:LPD:PR(REG–158080–04), room 5203, Internal Revenue Ser- vice, PO Box 7604, Ben Franklin Sta- tion, Washington, DC 20044. Submis- sions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–158080–04), Courier’s Desk, In- ternal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, or sent electronically, via the IRS Internet site at www.irs.gov/regsor via the Federal eRule- making Portal atwww.regulations.gov (IRS REG–158080–04). The public hear- ing will be held in the Auditorium, Internal Revenue Building, 1111 Constitution Av- enue, NW, Washington, DC. FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Stephen Tackney, at (202) 927–9639; concerning submissions of comments, the hearing, and/or to be placed on the building access list to at- tend the hearing, Richard A. Hurst at (202) 622–7116 (not toll-free numbers). SUPPLEMENTARY INFORMATION: Background Section 409A was added to the Internal Revenue Code (Code) by section 885 of the American Jobs Creation Act of 2004, Public Law 108–357 (118 Stat. 1418). Section 409A generally provides that un- less certain requirements are met, amounts deferred under a nonqualified deferred compensation plan forall taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously in- cluded in gross income. Section 409A also includes rules applicable to certain trusts or similar arrangements associated with nonqualified deferred compensation, where such arrangements are located out- side of the United States or are restricted to the provision of benefits in connection with a decline in the financial health of the sponsor. On December 20, 2004, the IRS issued Notice 2005–1, 2005–2 I.R.B. 274 (pub- lished as modified on January 6, 2005), setting forth initial guidance with respect to the application of section 409A, and supplying transition guidance in accor- dance with the terms of the statute. Notice 2005–1 requested comments on all aspects of the application of section 409A, includ- ing certain specified topics. Numerous comments were submitted and all were considered by the Treasury Department and the IRS in formulating these regula- tions. In general, these regulations incor- porate the guidance provided in Notice 2005–1 and provide substantial additional guidance. For a discussion of the contin- ued applicability of Notice 2005–1, see theEffect on Other Documentssection of this preamble. Explanation of Provisions I.Definition of Nonqualified Deferred Compensation Plan A.In general Section 409A applies to amounts de- ferred under a nonqualified deferred compensation plan. For this purpose a nonqualified deferred compensation plan means any plan that provides for the de- ferral of compensation, with specified exceptions such as qualified retirement plans, tax-deferred annuities, simplified employee pensions, SIMPLEs and sec- tion 501(c)(18) trusts. In addition, section 409A does not apply to certain welfare benefit plans, includingbona fidevaca- tion leave, sick leave,compensatory time, disability pay, and death benefit plans. In certain instances, these regulations cross reference the regulations under sec- tion 3121(v)(2), which provide a special timing rule under the Federal Insurance Contributions Act (FICA) for nonqualified deferred compensation, as defined in sec- tion 3121(v)(2) and the regulations there- under. However, unless explicitly cross- referenced in these regulations, the regula- tions under section 3121(v)(2) do not ap- ply for purposes of section 409A and under no circumstances do these proposed reg- ulations affect the application of section 3121(v)(2). B.Section 457 plans Section 409A does not apply to eligible deferred compensation plans under sec- tion 457(b). However, section 409A ap- plies to nonqualified deferred compensa- tion plans to which section 457(f) applies, separately and in addition to the require- ments applicable to such plans under sec- tion 457(f). Section 409A(c) provides that nothing in section 409A prevents the in- clusion of amounts in gross income under any other provision of the Code. Section 409A(c) further provides that any amount included in gross income under section 409A will not be required to be included in gross income under any other Code pro- vision later than the time provided in sec- tion 409A. Accordingly, if in a taxable year an amount subject to section 409A (but not required to be included in income under section 409A) is required to be included in gross income under section 457(f), that amount must be included in gross income under section 457(f) for that taxable year. Correspondingly, if in a taxable year an amount that would otherwise be required to be included in gross income under sec- tion 457(f) has been included previously in gross income under section 409A, that amount will not be required to be included in gross income under section 457(f) for that taxable year. These proposed regulations are in- tended solely as guidance with respect to theapplicationofsection409Atosuchar- rangements, and should not be relied upon with respect to the application of section 457(f). Thus, state and local govern- ment and tax exempt entities may not rely upon the definition of a deferral of com- pensation under §1.409A–1(b) of these proposed regulations in applying section 457(f). For example, for purposes of sec- tion 457(f), a deferral of compensation includes a stock option and an arrange- ment in which an employee or independent 2005–43 I.R.B.787October 24, 2005 contractor of a state or local government or tax-exempt entity earns the right to fu- ture payments for services, even if those amounts are paid immediately upon vest- ing and would qualify for the exclusion from the definition of deferred compensa- tion under §1.409A–1(b)(4) or (5) of these proposed regulations. However, until fur- ther guidance is issued, state and local government and tax exempt entities may rely on the definitions ofbona fidevaca- tion leave, sick leave, compensatory time, disability pay, and death benefit plans for purposes of section 457(f) as applicable for purposes of applying section 409A and §1.409A–1(a)(5) of these proposed regulations to nonqualified deferred com- pensation plans under section 457(f). C. Arrangements with independent contractors Consistent with Notice 2005–1, Q&A–8, these regulations exclude from coverage under section 409A certain ar- rangements between service providers and service recipients. Under these regula- tions, amounts deferred in a taxable year with respect to a service provider using an accrual method of accounting for that year are not subject to section 409A. In addition, section 409A generally does not apply to amounts deferred pursuant to an arrangement between a service recipient and an unrelated independent contractor (other than a director of a corporation), if during the independent contractor’s tax- able year in which theamount is deferred, the independent contractor is providing significant services to each of two or more service recipients that are unrelated, both to each other and to the independent con- tractor. In response to comments, these regulations clarify that the determination is made based upon the independent con- tractor’s taxable year in which the amount is deferred. Commentators also requested clarifica- tion of the circumstances in which services to each service recipient will be deemed to be significant, as required for the ex- clusion. Determining whether services provided to a service recipient are signifi- cant generally will involve an examination of all relevant facts and circumstances. However, two clarifications have been provided. First, the analysis applies sep- arately to each trade or business in which the service provider is engaged. For ex- ample, a taxpayer providing computer programming services for one service re- cipient will not meetthe exception if, as a separate trade or business, the taxpayer paints houses for another unrelated service recipient. To provide certainty to many independent contractors engaged in an ac- tive trade or business with multiple service recipients, a safe harbor has been provided under which an independent contractor with multiple unrelated service recipients, to whom the independent contractor also is not related, will be treated as providing significant services to more than one of those service recipients, if not more than 70 percent of the total revenue generated by the trade or business in the particular taxable year is derived from any particu- lar service recipient (or group of related service recipients). Commentators also requested clarifica- tion with respect to the application of sec- tion 409A to directors. As provided in these regulations, an individual will not be excluded from coverage under section 409A merely because the individual pro- vides services as a director to two or more unrelated service recipients. However, the provisions of section 409A apply sepa- rately to arrangements between the service provider director and each service recipi- ent. Accordingly, the inclusion of income duetoafailuretomeettherequirements of section 409A with respect to an arrange- ment to serve as a director of one service recipient will not cause an inclusion of in- come with respect to arrangements to serve as a director of an unrelated service recip- ient. In addition, the continuation of ser- vices as a director with one service recip- ient will not cause the termination of ser- vices as a director with an unrelated ser- vice recipient to fail to constitute a sepa- ration from service for purposes of section 409A, if the termination would otherwise qualify as a separation from service. Commentators also requested clarifica- tion with respect to the application of the rule to directors whoare also employees of the service recipient. In general, the pro- visions of section 409A will apply sepa- rately to the arrangements between the ser- vice recipient and the service provider for services as a director and the arrangements between the service recipient and the ser- vice provider for services as an employee. However, the distinction is not intended to permit employee directors to limit the ag- gregation of arrangements in which the in- dividual participates as an employee by la- beling such arrangements as arrangements for services as a director. Accordingly, an arrangement with an employee direc- tor will be treated as an arrangement for services as a director only to the extent that another non-employee director defers compensation under the same, or a sub- stantially similar, arrangement on similar terms. Moreover, the separate application of section 409A to arrangements for ser- vices as a director and arrangements for services as an employee does not extend to a service provider’s services for the ser- vice recipient as an independent contrac- tor in addition to the service provider’s ser- vices as a director of the service recipient. Under those circumstances, both arrange- ments are treated as services provided as an independent contractor. Commentators also requested clarifica- tion of the application of the exclusion to independent contractors who provide ser- vices to only one service recipient, when that service recipient itself has multiple clients. Specifically a commentator re- quested that the rule be applied on a look through basis, so that the independent contractor will be deemed to be providing services for multiple service recipients. The Treasury Department and the IRS do not believe that such a rule is appropri- ate. Where multiple persons have come together and formed an entity that is it- self a service recipient of the independent contractor, the independent contractor is performing services for the single entity service recipient. The Treasury Department and the IRS believe that where the service recipient is purchasing an independent contractor’s management services, amounts deferred with respect to the independent contrac- tor’s performance of services should not be excluded from coverage under section 409A. Among the many objectives under- lying the enactment of section 409A is to limit the ability of a service provider to retain the benefits of the deferral of com- pensation while having excessive control over the timing of the ultimate payment. Where the independent contractor is man- aging the service recipient, there is a sig- nificant potential for the independent con- tractor to have such influence or control over compensation matters so that categor- October 24, 20057882005–43 I.R.B. ical exclusion from coverage under section 409A is not appropriate. Accordingly, the regulations provide that compensation ar- rangements between an independent con- tractor and a service recipient that involve the provision of management services are not excluded from coverage under section 409A, and in such cases, the service recip- ient is not treated as unrelated for purposes of determining whether arrangements with other service recipients are excluded from coverage under section 409A under the general rule addressing independent con- tractors providing services to multiple un- related service recipients. For this pur- pose, management services include ser- vices involving actual or de facto direction or control of the financial or operational aspects of the client’s trade or business, or investment advisory services that are inte- gral to the trade or business of a service re- cipient whose primary trade or business in- volves the management of investments in entities other than the entities comprising the service recipient, such as a hedge fund or real estate investment trust. II.Definition of Nonqualified Deferred Compensation A.In general Consistent with Notice 2005–1, Q&A–4, these regulations provide that a plan provides for the deferral of com- pensation only if, under the terms of the plan and the relevant facts and circum- stances, the service provider has a legally binding right during a taxable year to compensation that has not been actually or constructively received and included in gross income, and that, pursuant to the terms of the plan, is payable to (or on be- half of) the service provider in a later year. A legally binding right to compensation may exist even where the right is subject to conditions, including conditions that constitute a substantial risk of forfeiture. For example, an employee that in Year 1 is promised a bonus equal to a set percent- age of employer profits, to be paid out in Year 3 if the employee has remained in employment through Year 3, has a legally binding right to the payment of the com- pensation, subject to the conditions being met. The right thus may be subject to a substantial risk of forfeiture, and accord- ingly be nonvested; however, the promise constitutes a legally binding right subject to a condition. In contrast, a service provider does not have a legally binding right to compen- sation if that compensation may be uni- laterally reduced or eliminated by the ser- vice recipient or other person after the ser- vices creating the right to the compensa- tion have been performed. Notice 2005–1, Q&A–4 provides that, if the facts and cir- cumstances indicate that the discretion to reduce or eliminate the compensation is available or exercisable only upon a con- dition that is unlikely to occur, or the dis- cretion to reduce or eliminate the compen- sation is unlikely to be exercised, a ser- vice provider will be considered to have a legally binding right to the compensa- tion. Commentators criticized the provi- sion as being difficult to apply, because the standard is too vague, requiring a sub- jective judgment as to whether the discre- tion is likely to be exercised. The intent of this provision was to eliminate the pos- sibility of taxpayers avoiding the applica- tion of section 409A through the use of plan provisions providing negative discre- tion, where such provisions are not mean- ingful. In response to the comments, these regulations adopt a standard under which the negative discretion will be recognized unless it lacks substantive significance, or is available or exercisable only upon a con- dition. Thus, where a promise of com- pensation may be reduced or eliminated at the unfettered discretion of the service re- cipient, that promise generally will not re- sult in a legally binding right to compen- sation. However, where the negative dis- cretion lacks substantive significance, or the discretion is available or exercisable only upon a condition, the discretion will be ignored and the service provider will be treated as having a legally binding right. In addition, where the service provider has control over, or is related to, the person grantedthediscretiontoreduceorelimi- nate the compensation, or has control over all or any portion of such person’s com- pensation or benefits, the discretion also will be ignored and the service provider will be treated as having a legally binding right to the compensation. B.Short-term deferrals Notice 2005–1, Q&A–4(c), set forth an exception from coverage under section 409A under which certain arrangements, referred to as short-term deferrals, would not be treated as resulting in the defer- ral of compensation. Specifically, Notice 2005–1, Q&A–4 provided that until fur- ther guidance a deferral of compensation would not occur if, absent an election to otherwise defer the payment to a later pe- riod, at all times the terms of the plan re- quire payment by, and an amount is actu- ally or constructively received by the ser- vice provider by, the later of (i) the date that is 2 1 /2months from the end of the ser- vice provider’s first taxable year in which the amount is no longer subject to a sub- stantial risk of forfeiture, or (ii) the date that is 2 1 /2months from the end of the ser- vice recipient’s year in which the amount is no longer subject to a substantial risk of forfeiture. For these purposes, an amount that is never subject to a substantial risk of forfeiture is considered to be no longer subject to a substantial risk of forfeiture on the date the service provider first has a legally binding right to the amount. Under this rule, many multi-year bonus arrange- ments that require payments promptly af- ter the amount vests would not be subject to section 409A. The exception from coverage under section 409A for short-term deferrals set forth in Notice 2005–1, Q&A–4, has been incorporated into these proposed regula- tions. Commentators questioned whether a written provision in the arrangement requiring the payment to be made by the relevant deadline is necessary, or whether the customary practice of the service re- cipient is sufficient.These regulations do not require that the arrangement provide in writing that the payment must be made by the relevant deadline. Accordingly, where an arrangement does not otherwise defer compensation, an amount will qualify as a short-term deferral, and not be subject to section 409A, if the amount is actually paid out by the appropriate deadline. However, where an arrangement does not provide in writing that a payment must be paid by a specified date on or before the relevant deadline, and the payment is not made by the appropriate deadline (except due to unforeseeable administrative or solvency issues, as discussed below), the payment will result in automatic violation of sec- tion 409A due to the failure to specify the payment date or a permissible payment event. In addition, the rules permitting 2005–43 I.R.B.789October 24, 2005 the service recipient limited discretion to delay payments of amounts subject to section 409A (for example, where the service recipient reasonably anticipates that payment of the amount would not be deductible due to application of section 162(m), or where the service recipient reasonably anticipates that payment of the amount would violate a loan covenant or similar contractual provision) would not be available, because the arrangement would not have specified a payment date subject to the delay. In contrast, where an arrangement provides in writing that a payment must be made by a specified date on or before the relevant deadline, and the payment is not made by the ap- propriate deadline so that section 409A becomes applicable, the rules contained in these regulations generally permitting the payment to be made in the same calendar year as the fixed payment date become applicable. In addition, the rules permit- tingaplantoprovideforadelayinthe payment in certain circumstances and the relief applicable to disputed payments and refusals to pay would also be available. Accordingly, it will often be appropriate to include a date or year for payment even when it is intended that the payment will be made within the short-term deferral period. The short-term deferral rule does not provide a method to avoid application of section 409A if the legally binding right creates a right to deferred compensation from the outset. For example, if a legally binding right to payment in Year 10 arises in Year 1, but the right is subject to a sub- stantial risk of forfeiture through Year 3, paying the amount at the end of Year 3 would not result in the payment failing to be subject to section 409A, but rather gen- erally would be an impermissible accelera- tion of the payment from the originally es- tablished right to payment in Year 10. Commentators also questioned whether the 2 1 /2month deadline for payment could be extended where the payment was not administratively practicable, or where the payment was made late due to error. These regulations provide that a payment made after the 2 1 /2month deadline may continue to be treated as meeting the requirements of the exception from the definition of a deferral of compensation if the taxpayer establishes that it was impracticable, either administratively or economically, to avoid the deferral of the receipt by a service provider of the payment beyond the appli- cable 2 1 /2monthperiodandthat,asofthe time the legally binding right to the amount arose, such impracticability was unfore- seeable, and the payment is made as soon as practicable. Some commentators had asked for a rule permitting delays due to unintentional error to satisfy the standard for the exclusion. However, the excep- tion is based upon the longstanding posi- tion set forth in §1.404(b)–1T, Q&A–2(b) regarding the timing of the deduction with respect to a payment under a nonqualified deferred compensation plan. Similar to the deduction rule, the exclusion from cover- age under section 409A treats a payment made within the appropriate 2 1 /2month pe- riod as made within such a short period following the date the substantial risk of forfeiture lapses that it may be treated as paid when earned (and not deferred to a subsequent period). Also similar to the rule governing the timing of deductions, the exclusion from coverage under section 409A permits only limited exceptions to the requirement that the amount actually be paid by the relevant deadline. Pending further study, the Treasury Department and the IRS believe that providing further flex- ibility with respect to meeting the deadline would create the potential for abuse and enforcement difficulty. C.Stock options and stock appreciation rights 1.In general The legislative history states that sec- tion 409A does not cover grants of stock options where the exercise price can never be less than the fair market value of the underlying stock at the date of grant (a non-discounted option). See H.R. Conf. Rep. No. 108–755, at 735 (2004). Thus an option with an exercise price that is or may be below the fair market value of the underlying stock at the date of grant (a dis- counted option) is subject to the require- ments of section 409A. Consistent with the legislative history and with Notice 2005–1, Q&A–4, these regulations provide that a non-discounted stock option, that has no other feature for the deferral of compen- sation, generally is not covered by section 409A. However, a stock option granted with an exercise price below the fair mar- ket value of the underlying shares of stock on the date of grant generally would be subject to section 409A except to the ex- tent the terms of the option only permit ex- ercise of the option during the short-term deferral period. Commentators stressed that in many respects, a stock appreciation right can be the economic equivalent of a stock op- tion, especially a stock option that allows the holder to exercise in a manner other than by the payment of cash (a cashless exercise feature). Accordingly, Notice 2005–1, Q&A–4 exempted from coverage certain non-discounted stock appreciation rights that most closely resembled stock options — stock appreciation rights settled in stock. The Treasury Department and the IRS were concerned that the manip- ulation of the purported stock valuation for purposes of determining whether the stock appreciation right was issued at a discount or settled at a premium could lead to a stock appreciation right being used to circumvent section 409A. Accordingly, the exception was limited to stock appre- ciation rights issued with respect to stock traded on an established securities market. Commentators criticized the distinction between public corporations and non-pub- lic corporations, asserting that this dis- tinction is not meaningful and unfairly discriminated against the latter corpora- tions and placed such corporations at a severe competitive disadvantage. In ad- dition, commentators questioned whether the distinction between stock-settled and cash-settled stock appreciation rights was relevant, where the amount of income generated would be identical. In response to the comments, these regulations treat stock appreciation rights similarly to stock options, regardless of whether the stock appreciation right is settledincashandregardlessofwhether the stock appreciation right is based upon service recipient stock that is not readily tradable on an established securities mar- ket. The Treasury Department and the IRS remain concerned that manipulation of stock valuations, and manipulation of the characteristics ofthe underlying stock, may lead to abuses with respect to stock options and stock appreciation rights (col- lectively referred to as stock rights). To that end, these regulations contain more detailed provisions with respect to the identification of service recipient stock October 24, 20057902005–43 I.R.B. that may be subject to, or used to deter- mine the amount payable under, stock rights excluded from the application of section 409A, and the valuation of such service recipient stock, discussed below. 2.Definition of service recipient stock The legislative history of section 409A states that the exception from coverage un- der section 409A for certain nonstatutory stock options was intended to cover op- tions granted on service recipient stock. H.R. Conf. Rep. No. 108–755, at 735 (2004). Section 409A(d)(6) provides that, for purposes of determining the identity of the service recipient under section 409A, aggregation rules similar to the rules in section 414(b) and (c) apply. Taxpayers re- quested that the definition of service recip- ient be expanded for purposes of the ex- ception for stock rights to cover entities that would not otherwise be treated as part of the service recipient applying the rules under section 414(b) and (c). The Treasury Department and the IRS agree that the ex- clusion for nonstatutory stock rights was not meant to apply so narrowly. Accord- ingly, for purposes of the provisions ex- cluding certain stock rights on service re- cipient stock, the stock right, or the plan or arrangement under which the stock right is granted, may provide that section 414(b) and (c) be applied by modifying the lan- guage and using “50 percent” instead of “80 percent” where appropriate, such that stock rights granted to employees of enti- ties in which the issuing corporation owns a 50 percent interest generally will not be subject to section 409A. Commentators also requested that the threshold be dropped below 50 percent to cover joint ventures and other similar ar- rangements, where the participating cor- poration does not have a majority interest. These regulations provide for such a lower threshold, allowing for the stock right, or the plan or arrangement under which the stock right is granted, to provide for the modification of the language and use of “20 percent” instead of “80 percent” in ap- plying section 414(b) and (c), where the use of such stock with respect to stock rights is due to legitimate business crite- ria. For example, the use of such stock with respect to stock rights issued to em- ployees of a joint venture that were for- mer employees of a corporation with at least a 20 percent interest in the joint ven- ture generally would be due to legitimate business criteria, and accordingly would be treated as service recipient stock for purposes of determining whether the stock right was subject to section 409A. A des- ignation by a service recipient to use either the 50 percent or the 20 percent threshold must be applied consistently to all com- pensatory stock rights, and any designa- tion of a different permissible ownership threshold percentage may not be made ef- fective until 12 months after the adoption of such change. The increased ability to issue stock rights with respect to a related corporation for whom the service provider does not directly perform services could increase the potential for service recipients to ex- ploit the exclusion for certain stock rights by establishing a corporation within the group of related corporations, the pur- pose of which is to serve as an investment vehicle for nonqualified deferred com- pensation. Accordingly, these regulations provide that other than with respect to ser- vice providers who are primarily engaged in providing services directly to such cor- poration, the term service recipient for purposes of the definition of service recip- ient stock does not include a corporation whose primary purpose is to serve as an investment vehicle with respect to the cor- poration’s interest in entities other than the service recipient (including entities aggregated with the corporation under the definition of service recipient incorporat- ingsection414(b)and(c)). Commentators also questioned whether the exception for certain stock rights could apply where a servicerecipient provides a stock right with respect to preferred stock or a separate class of common stock. The Treasury Department and the IRS believe this exception was intended to cover stock rights with respect to service recipient stock the fair market value of which meaningfully relates to the poten- tial future appreciation in the enterprise value of the corporation. The use of a separate class of common stock created for the purpose of compensating service providers, or the use of preferred stock with substantial characteristics of debt, could create an arrangement that more closely resembles traditional nonquali- fied deferred compensation arrangements rather than an interest in appreciation of the value of the service recipient. An exception that excluded these arrange- ments from coverage under section 409A would undermine the effectiveness of the statute to govern nonqualified deferred compensation arrangements, contrary to the legislative intent. Accordingly, these regulations clarify that service recipient stock includes only common stock, and only the class of common stock that as of the date of grant has the highest aggre- gate value of any class of common stock of the corporation outstanding, or a class of common stock substantially similar to such class of stock (ignoring differences in voting rights). In addition, service re- cipient stock does not include any stock that provides a preference as to dividends or liquidation rights. With respect to the foreign aspects of such arrangements, commentators re- quested clarification that service recipient stock may include American Depositary Receipts (ADRs). These regulations clar- ify that stock of the service recipient may include ADRs, provided that the stock to which the ADRs relate would otherwise qualify as service recipient stock. Commentators also requested that cer- tain equity appreciation rights issued by mutual companies, intended to mimic stock appreciation rights, be excluded from coverage under section 409A. These regulations expand the exclusion for stock appreciation rights to include equity ap- preciation rights with respect to mutual company units. A mutual company unit is defined as a specified percentage of the fair market value of the mutual company. For this purpose, a mutual company may value itself under the same provisions applicable to the valuation of stock of a corporation that is not readily tradable on an established securities market. The Treasury Department and the IRS request comments as to the practicability of this provision, and whether such a provision should be expanded to cover equity appre- ciation rights issued by other entities that do not have outstanding shares of stock. 3.Valuation Notice 2005–1, Q&A–4(d)(ii) provides that for purposes of determining whether the requirements for exclusion of a non- statutory stock option have been met, any reasonable valuation method may be used. 2005–43 I.R.B.791October 24, 2005 Commentators expressed concern that the standard was too vague, given the potential consequences of a failure to comply with the requirements of section 409A. These regulations provide that with re- spect to service recipient stock that is read- ily tradable on an established securities market, a valuation of such stock may be based on the last sale before or the first sale after the grant, or the closing price on the trading day before or the trading day of the grant, or any other reasonable basis using actual transactions in such stock as reported by such market and consistently applied. Commentators pointed out that certain service recipients, generally cor- porations in certain foreign jurisdictions, would not be able to meet this requirement because the service recipient is subject to foreign laws requiring pricing based on an average over a period of time. To allow compliance with these requirements, these regulations further provide that service re- cipients (including U.S. service recipients) maysettheexercisepricebasedonanav- erage of the price of the stock over a spec- ifiedperiodprovidedsuchperiodoccurs within the 30 days before and 30 days af- ter the grant date, and provided further that the terms of the grant are irrevocably es- tablished before the beginning of the mea- surement period used to determine the ex- ercise price. Commentators asked for clarification of the definition of stock that is readily trad- able on an established securities market. Specifically, commentators requested clar- ification of the scope of an established se- curities market, and whether that term in- cludes over-the-counter markets and for- eign markets. The regulations adopt the definition of an established securities mar- ket set forth in §1.897–1(m). Under that definition, over-the-counter markets gen- erally are treated as established securities markets, as well as many foreign markets. However, the stock must also be readily tradable within suchmarkets to qualify as stock readily tradable on an established se- curities market. With respect to corporations whose stockisnotreadilytradableonanestab- lished securities market, these regulations provide that fair market value may be determined through the reasonable appli- cation of a reasonable valuation method. The regulations contain a description of the factors that will be taken into account in determining whether a given valuation method is reasonable. In addition, in an effort to provide more certainty, certain presumptions with respect to the reason- ableness of a valuation method have been set forth. Provided one such method is applied reasonably and used consistently, the valuation determined by applying such method will be presumed to equal the fair market value of the stock, and such presumption will be rebuttable only by a showing that the valuation is grossly unreasonable. A method will be treated as used consistently where the same method is used for all equity-based compensation granted to service providers by the service recipient, including for purposes of de- termining the amount due upon exercise or repurchase where the stock acquired is subject to an obligation of the service re- cipient to repurchase, or a put or call right providing for the potential repurchase by the service recipient, as applicable. Commentators specifically requested clarification as to whether a valuation method based upon an appraisal will be treated as reasonable, and if so with re- spect to what period. These regulations provide that the use of an appraisal will be presumed reasonable if the appraisal satisfies the requirements of the Code with respect to the valuation of stock held in an employee stock ownership plan. If those requirements are satisfied, the val- uation will be presumed reasonable for a one-year period commencing on the date as of which the appraisal values the stock. Commentators also specifically re- quested clarification of whether a valua- tion method based on a nonlapse restric- tion addressed in §1.83–5(a) will be treated as reasonable. Under §1.83–5(a), in the case of property subject to a nonlapse re- striction (as defined in §1.83–3(h)), the price determined under the formula price is considered to be the fair market value of the property unless established to the contrary by the Commissioner, and the burden of proof is on the Commissioner with respect to such value. If stock in a corporation is subject to a nonlapse re- striction that requires the transferee to sell such stock only at a formula price based on book value, a reasonable multiple of earn- ings or a reasonable combination thereof, the price so determined ordinarily is re- garded as determinative of the fair market value of such property for purposes of section 83. The Treasury Department and the IRS do not believe that this standard, in and of itself, is appropriate with respect to the application of section 409A. The Treasury Department and the IRS are not confident that a formula price determined pursuant to a nonlapse restriction will, in every case, adequately approximate the value of the underlying stock. The Treasury Depart- ment and the IRS are also concerned that such formula valuations, in the absence of other criteria, may be subject to manipula- tion or to the provision of predictable re- sults that are inconsistent with a true eq- uity appreciation right. Further, the Trea- sury Department and the IRS do not be- lieve that the burden of proof with respect to valuation should be shifted to the Com- missioner in all cases where such formulas have been utilized. Accordingly, the use of a valuation method based on a nonlapse restriction that meets the requirements of §1.83–5(a) does not by itself result in a presumption of reasonableness. However, where the method is used consistently for both compensatory and noncompensatory purposes in all transactions in which the service recipient is either the purchaser or seller of such stock, such that the nonlapse restriction formula acts as a substitute for the value of the underlying stock, the for- mula will qualify for the presumption that the valuation method is reasonable for pur- poses of section 409A. In addition, de- pending on the facts and circumstances of the individual case, the use of a nonlapse restriction to determine value may be rea- sonable, taking into account other relevant valuation criteria. Commentators also expressed concern about the valuation of illiquid stock of cer- tain start-up corporations. These commen- tators argued that the value of such stock is often highly speculative, rendering ap- praisals of limited value. Commentators also noted that such stock often is not sub- ject to put rights or call rights that could be viewed as a nonlapse restriction. Given the illiquidity and speculative value, com- mentators argued that the risk that taxpay- ers would use rights on such shares as a de- vice to pay deferred compensation is low. In response, these regulations propose ad- ditional conditions under which the val- uation of illiquid stock in a start-up cor- poration will be presumed to be reason- October 24, 20057922005–43 I.R.B. able. A valuation of an illiquid stock of a start-up corporation will be presumed rea- sonable if the valuation is made reason- ably and in good faith and evidenced by a written report that takes into account the relevant factors prescribed for valuations generally under these regulations. For this purpose, illiquid stock of a start-up corpo- ration refers to service recipient stock of a service recipient that is in the first 10 years of the active conduct of a trade or busi- ness and has no class of equity securities that are traded on an established securities market, where such stock is not subject to any put or call right or obligation of the ser- vice recipient or other person to purchase such stock (other than a right of first re- fusal upon an offer to purchase by a third party that is unrelated to the service re- cipient or service provider), provided that this rule does not apply to the valuation of any stock if the service recipient or service provider reasonablymay anticipate, as of the time the valuation is applied, that the service recipient will undergo a change in control event or participate in a public of- fering of securities within the 12 months following the event to which the valuation is applied (for example, the grant date of an award). A valuation will not be treated as made reasonably and in good faith un- less the valuation is performed by a person or persons with significant knowledge and experience or trainingin performing simi- lar valuations. As stated in the preamble to Notice 2005–1, the Treasury Department and the IRS are concerned about the treatment of stock rights where the service recipient is obligated to repurchase the stock acquired pursuant to the stock right, or the service provider retains a put or call right with respect to the stock. Where the service provider retains such a right, the ability to receive a purchase price that differs from the fair market value of the stock could be used to circumvent the application of sec- tion 409A. Accordingly, these regulations generally require that where someone is obligated to purchase the stock received upon the exercise of a stock right, or the stock is subject to a put or call right, the purchase price must also be set at fair market value, the determination of which is also subject to the consistency require- ments for the methods used in determining fair market value. 4.Modification Commentators asked under what condi- tions a modification, extension, or renewal of a stock right will be treated as a new grant. The treatment as a new grant is relevant because although the original grant may have been excluded from cov- erage under section 409A, if the new grant has an exercise price that is less than the fair market value of the underlying stock on the date of the new grant, the new grant would not qualify for the exclusion from coverage under section 409A. Ac- cordingly, the regulations set forth rules governing the types of modifications, ex- tensions or renewals that will result in treatment as a new grant. The regulations provide that the termmodificationmeans any change in the terms of the stock right that may provide the holder of the right with a direct or indirect reduction in the exercise price of the stock right, or an additional deferral feature, or an extension or renewal of the stock right, regardless of whether the holder in fact benefits from the change in terms. Under this defini- tion, neither the addition of a provision permitting the transfer of the stock right nor a provision permitting the service provider to exchange the stock right for a cash amount equal to the amount that would be available if the stock right were exercised would be modifications of the stock right. In addition, these regulations explicitly provide that both a change in thetermsofastockrighttoallowfor payment of the exercise price through the use of pre-owned stock, and a change in the terms of a stock right to facilitate the payment of employment taxes or re- quired withholding taxes resulting from the exercise of the right, are not treated as modifications of the stock right for pur- poses of section 409A. Generally, a change to the exercise price of the stock right (other than in connection with certain assumptions or substitutions of a stock right in connec- tion with a corporate transaction or certain adjustments resulting from a stock split, stock dividend or similar change in cap- italization) is treated as a modification, resulting in a new grant that may be ex- cluded from section 409A if it satisfies the requirements in these regulations as of the new grant date. However, depending upon the facts and circumstances, a series of repricings of the exercise price may in- dicate that the original right had a floating or adjustable exercise price and did not meet the requirements of the exclusion at the time of the original grant. Generally, an extension granting the holder an additional periodwithinwhich to exercise the stock right beyond the time originally prescribed will be treated as evidencing an additional deferral feature meaning that the stock right was subject to section 409A from the date of grant. Commentators stated that it is not uncom- mon upon a termination of employment to extend the exercise period for some brief period of time to allow the terminated em- ployee a chance to exercise the stock right. In response, these regulations provide that it is not an extension of a stock right if the exercise period is extended to a date no laterthanthelaterofthefifteenthdayof the third month following the date, or De- cember 31 of the calendar year in which, the right would otherwise have expired if the stock right had not been extended, based on the terms of the stock right at the original grant date. The regulations further provide that it is not an extension of a stock right if at the time the stock right would otherwise expire, the stock right is subject to a restriction prohibiting the exercise of the stock right because such exercise would violate applicable securities laws and the expiration date of the stock right is extended to a date no later than 30 days after the restrictions on exercise are no longer required to avoid a violation of applicable securities laws. These regulations also provide that if the requirements of §1.424–1 (providing rules under which an eligible corporation may, by reason of a corporate transaction, substitute a new statutory option for an outstanding statutory option or assume an old option without such substitution or assumption being considered a modi- fication of the old option) would be met if the right were a statutory option, the substitution of a new right pursuant to a corporate transaction for an outstanding right or the assumption of an outstanding right will not be treated as the grant of a new right or a change in the form of payment for purposes of section 409A. Section 1.424–1 applies several require- ments. Among them is the requirement under §1.424–1(a)(5)(ii) that the excess of the aggregate fair market value of the 2005–43 I.R.B.793October 24, 2005 shares subject to the new option over the exercise price immediately after the sub- stitution must not exceed the excess of the fair market value of the shares subject to the old option over the exercise price immediately before the substitution. In addition, §1.424–1(a)(5)(iii) requires that on a share by share comparison, the ratio of the exercise price to the fair market value of the shares subject to the option immediately after the substitution not be more favorable than the ratio of the exer- cise price to the fair market value of the shares subject to the old option immedi- ately before the substitution. Commentators expressed concern that the use of the regulations contained in §1.424–1, and specifically the ratio test prescribed in §1.424–1(a)(5)(iii), would prove difficult to apply in circumstances where, to reduce dilution, the acquiring corporation wished to issue a smaller num- ber of shares than the shares underlying the old option, but also wished to retain the entire aggregate difference between the fair market value of the shares and the exercise price that had been available to the service provider before the substitu- tion. In response, Notice 2005–1, Q&A–4 and these regulations provide that the re- quirement of §1.424–1(a)(5)(iii) will be deemed to be satisfied if the ratio of the exercise price to the fair market value of the shares subject to the right immediately after the substitution or assumption is not greater than the ratio of the exercise price to the fair market value of the shares sub- ject to the right immediately before the substitution or assumption. For example, if an employee had an option to purchase 25 shares for $2 per share, and imme- diately prior to a substitution by reason of a corporate transaction the fair market value of a share was $5, then the aggregate spread amount would be $75 (25 shares multiplied by ($5 - $2) = $75). The ratio of the exercise price to the fair market value would be $2/$5 = .40. As a part of the transaction, new employer wishes to substitute for the option an option to pur- chase 5 shares of new employer, when the shares have a fair market value of $20 per share. To maintain the aggregate spread of $75, the new grant has an exercise price of $5 (5 shares multiplied by ($20 - $5) = $75). The ratio of the exercise price to the fair market value immediately after the substitution is $5/$20 = .25, which is not greater than the ratioimmediately before the substitution. Provided that the other requirements of §1.424–1 were met, this substitution would not be considered a modification of the original stock option for purposes of section 409A. One commentator asked for more flex- ible rules concerning adjustments to and substitutions of options following a spinoff or similar transaction because short-term trading activity in the period immediately following such a transaction frequently does not accurately reflect the relative long-term fair market values of the stock of the distributing and distributed cor- porations. To address this problem, the regulations provide that such adjustments or substitutions may be made based on market quotations as of a predetermined date not more than 60 days after the trans- action, or based on an average of such market prices overa period of not more than 30 days ending not later than 60 days after the transaction. These provisions addressing substitu- tions and assumptions of rights apply to stock appreciation rights, as well as stock options. However, the guidance provided in these regulations with respect to the as- sumption of stock appreciation right lia- bilities should not be interpreted as guid- ance with respect to issues raised under any other provision of the Code or com- monlawtaxdoctrine. D.Restricted property Consistent with Notice 2005–1, Q&A–4(e), these regulations provide that if a service provider receives property from, or pursuant to, a plan maintained by a service recipient, there is no defer- ral of compensation merely because the value of the property is not includible in income in the year of receipt by reason of the property being nontransferable and subject to a substantial risk of forfeiture, or is includible in income solely due to a valid election under section 83(b). How- ever, a plan under which a service provider obtains a legally binding right to receive property (whether or not the property is restricted property) in a future year may provide for the deferral of compensation and, accordingly, may constitute a non- qualified deferred compensation plan. Commentators asked for clarification with respect to how this provision applies to a promise to transfer restricted property in a subsequent tax year. Specifically, commentators questioned how section 409A would apply to a bonus program offering a choice between a payment in cash and a payment in substantially non- vested property. Because the promise grants the service recipient a legally bind- ing right to receive property in a future year, this promise generally could not con- stitute property for section 83 purposes under §1.83–3(e), and could constitute deferred compensation for purposes of section 409A. However, the regulations provide that the vesting of substantially nonvested property subject to section 83 may be treated as a payment for purposes of section 409A, including for purposes of applying the short-term deferral rule. Accordingly, where the promise to trans- fer the substantially nonvested property and the right to retain the substantially nonvested property after the transfer are both subject to a substantial risk of for- feiture (as defined for purposes of section 409A), the arrangement generally would constitute a short-term deferral because the payment would occur simultaneously with the vesting of the right to the prop- erty. For example, where an employee participates in a two-year bonus program such that, if the employee continues in employment for two years, the employee is entitled to either the immediate payment of a $10,000 cash bonus or the grant of restricted stock with a $15,000 fair mar- ket value subject to a vesting requirement of three additional years of service, the arrangement generally would constitute a short-term deferral because under either alternative the payment would be received within the short-term deferral period. E.Arrangements between partnerships and partners The statute and legislative history to section 409A do not specifically address arrangements between partnerships and partners providing services to a partner- ship, and do not explicitly exclude such ar- rangements from the application of section 409A. The application of section 409A to such arrangements raises a number of issues,relatingbothtothescopeofthe arrangements subjectto section 409A, and the coordination of the provisions of sub- chapter K and section 409A with respect October 24, 20057942005–43 I.R.B. to those arrangements that are subject to section 409A. The Treasury Department and the IRS continue to analyze the issues raised in this area, and accordingly these regulations do not address arrangements between partnerships and partners. Notice 2005–1, Q&A–7 provides interim guid- ance regarding the application of section 409A to arrangements between partner- ships and partners. Until further guidance is issued, taxpayers may continue to rely on Notice 2005–1, Q&A–7. Commentators have asked whether sec- tion 409A applies to guaranteed payments for services described in section 707(c). Until further guidance is issued, section 409A will apply to guaranteed payments described in section 707(c) (and rights to receive such guaranteed payments in the future), only in cases where the guaran- teed payment is for services and the part- ner providing services does not include the payment in income by the 15 th day of the third month following the end of the tax- able year of the partner in which the part- ner obtained a legally binding right to the guaranteed payment or, if later, the taxable year in which the right to the guaranteed payment is first no longer subject to a sub- stantial risk of forfeiture. The Treasury Department and the IRS continue to request comments with respect to the application of section 409A to ar- rangements between partnerships and part- ners. F.Foreign arrangements The regulations provide guidance with respect to the application of section 409A to various foreign arrangements. As an initial matter, the regulations provide that an arrangement does not provide for a de- ferral of compensation subject to section 409A where the compensation subject to the arrangement would not have been in- cludible in gross income for Federal tax purposes if it had been paid to the service provider at the time that the legally binding right to the compensation first arose or, if later, the first time that the legally binding right was no longer subject to a substan- tial risk of forfeiture, if the service provider was a nonresident alien at such time. Ac- cordingly, if, for example, a foreign citizen works outside the United States and then retires to the United States, the compensa- tion deferred and vested while working in the foreign country generally will not be subject to section 409A. With respect to U.S. citizens or resident aliens working abroad, the regulations pro- vide that an arrangement does not provide for a deferral of compensation subject to section 409A where the compensation sub- ject to the arrangement would have con- stituted foreign earned income (within the meaning of section 911) paid to a qualified individual (as definedin section 911(d)(1)) and the amount of the compensation is less than or equal to the difference between the maximum section 911 exclusion amount and the amount actually excludible from gross income under section 911 for the tax- able year for the individual. This hypo- thetical exclusion is applied at the time that the legally binding right to the compensa- tion first exists or, if later, the time that the legally binding right is no longer subject to a substantial risk of forfeiture. Under section 911, a U.S. citizen or resident alien who resides in a foreign jurisdiction gener- ally may exclude up to $80,000 of foreign earned income (to be adjusted for infla- tion after 2007). For example, an individ- ual with $70,000 of foreign earned income excluded under section 911 in 2006 could also defer up to $10,000 of additional com- pensation that would not be subject to sec- tion 409A, if the additional compensation would qualify as foreign earned income if paid to the individual in 2006. This excep- tion to coverage under section 409A is in- tended to be applied on an annual basis, so that individuals will not be entitled to carry over any unused portion of the exclusion under section 911 to a future year. This ex- ception also is not intended to modify the rules under section 911 or the regulations thereunder. Similarly, these regulations also ad- dress deferrals of compensation income that would be excluded from gross income for Federal income tax purposes under section 893 (generally covering compen- sation paid to foreign workers of a foreign government or international organization working in the United States), section 872 (generally coveringcertain compensation earned by nonresident alien individuals), section 931 (generally covering certain compensation earned bybona fideresi- dents of Guam, American Samoa, or the Northern Mariana Islands) and section 933 (generally coveringcertain compensation earned bybona fideresidents of Puerto Rico). The regulations provide that an ar- rangement does not provide for a deferral of compensation subject to section 409A where the compensation subject to the arrangement would have been excluded from gross income for Federal tax pur- poses under any of these sections, if the compensation had been paid to the service provider at the time that the legally bind- ing right to the compensation first arose or, if later, the time that the legally binding right was no longer subject to a substantial risk of forfeiture. The Treasury Department and the IRS understand that nonresident aliens may work for very limited periods in the United States. Many deferrals of the compensa- tion earned by nonresident aliens for ser- vices rendered in the United States will not be covered by section 409A, because under an applicable treaty the amount of com- pensation deferred would not be includible in gross income for Federal tax purposes if paid at the time the legally binding right to the compensation deferred was no longer subject to a substantialrisk of forfeiture. However, certain compensation earned in the United States by a nonresident alien might be includible in gross income un- der such circumstances, where there is no applicable treaty or where the treaty does not provide an exclusion. Where a non- resident alien defers such compensation earned in the United States under a foreign nonqualified deferred compensation plan — for example because the service in the United States is credited under the plan — the application of section 409A to the deferrals of the compensation subject to Federal income tax could be exceedingly burdensome in light of the relatively small amounts attributable to the service in the United States. Accordingly, these regula- tions adopt ade minimisexception, under which section 409A will not apply to an amount of compensation deferred under a foreign nonqualified deferred compensa- tion plan for a given calendar year where the individual service provider is a nonres- ident alien for that calendar year and the amount deferred does not exceed $10,000. Commentators requested clarification of the application of section 409A to participation by U.S. citizens and res- ident aliens in foreign plans. In this context, it should be noted that under these regulations, transfers that are taxable under section 402(b) of the Code gener- 2005–43 I.R.B.795October 24, 2005 ally are not subject to section 409A. See §1.409A–1(b)(6) of these regulations and Notice 2005–1, Q&A–4. Such transfers may consist of contributions to an employ- ees’ trust, where the trust does not qualify under section 501(a). Many foreign plans that hold contributions in a trust will con- stitute funded plans. To the extent that a contribution to the trust is subject to inclu- sion in income for Federal tax purposes under section 402(b), such a contribution will not be subject to section 409A. These regulations also provide that sec- tion 409A does not override treaty provi- sions that govern the U.S. Federal taxation of participation in particular foreign plans. Where a treaty provides that amounts con- tributed to a foreign plan by or on behalf of a service provider are not subject to U.S. Federal income tax, section 409A will not cause such amounts to be subject to inclu- sion in gross income. Some commentators requested that any participation in a foreign plan be exempted from section 409A, or that only deferrals of U.S. source compensation income be subject to section 409A. However, with respect to U.S. citizens working abroad, and with respect to resident aliens in the United States, compensation income gen- erally is subject to U.S. Federal income tax absent an applicable treaty provision. Ac- cordingly, the provisions of section 409A generally are applicable to this type of deferred compensation. In addition, the Treasury Department and the IRS are con- cerned that providing a broad exception for foreign plans or foreign source income would create opportunities for U.S. citi- zens and resident aliens to avoid applica- tion of section 409A through participation in a foreign plan, or through reallocations of deferrals among U.S. source and foreign source income. The regulations provide, however, that with respect to non-U.S. citizens who are not lawful permanent residents of the United States, amounts deferred under certain broad-based foreign retirement plans are not subject to section 409A. This exception is intended to allow a worker who is not a green card holder to continue to participate in a broad-based foreign retirement plan that does not comply with section 409A without incurring adverse tax consequences due solely to the worker earning some income in the United States that is in some manner credited under the plan. Commentators expressed concerns as to U.S. citizens and lawful permanent res- idents working abroad, and their ability to participate in broad-based plans of for- eign employers. Generally, these workers’ incomes are subject to Federal income tax, including section 409A. However, when U.S. citizens and lawful permanent residents work abroad for employers who sponsor broad-based foreign retirement plans providing relatively low levels of retirement benefits and such plans are nonelective, the worker’s ability to con- trol the timing of the income is limited. In such cases, the concerns with respect to the potential manipulation of the tim- ing of compensation income addressed by section 409A are also limited, and do not outweigh the administrative burdens that would arise if a foreign employer’s failure to amend these plans to be consis- tent with the provisions of section 409A would result in substantial adverse tax consequences to U.S. citizens and lawful permanent residents working abroad who are covered by such plans. Accordingly, an exception for foreign broad-based re- tirement plans also applies with respect to U.S. citizens and lawful permanent resi- dents, but only with respect to nonelective deferrals of foreign earned income and only to the extent that the amount deferred in a given year does not exceed the amount of contributions or benefits that may be provided by a qualified plan under section 415 (calculated by treating the foreign source income as compensation for pur- poses of section 415). Commentators also requested that cer- tain types of payments, referred to as expatriate allowances, be exempted from coverage under section 409A. These pay- ments were defined broadly to include many types of payments to U.S. citizens working abroad, intended to put the ser- vice providers in substantially the same economic position as the service providers would have been in had the services been provided in the United States. One very common arrangement involves pay- ments intended to compensate the service provider for any differences in tax rates, often referred to as tax equalization plans. With respect to these plans, the Treasury Department and the IRS recognize that such payments often must be delayed be- cause of the need to calculate foreign tax liabilities after the end of the year. In addition, where the amounts are limited to the amounts necessary to make up for difference in tax rates, the potential for abuse with respect to the timing of com- pensation income is not great, since the compensation will directly relate to taxes that the service provider has paid to a foreign jurisdiction. Accordingly, these regulations exempt tax equalization plans from coverage under section 409A pro- vided that the payment is made no later than the end of the second calendar year beginning after the calendar year in which the individual’s U.S. Federal income tax return is required to be filed (including extensions) for the year to which the tax equalization payment relates. Other payments are not excluded from section 409A merely because they are de- nominated as expatriate allowances. The Treasury Department and the IRS believe that the rules provided in these regulations with respect to setting and meeting pay- ment dates under a nonqualified deferred compensation plan will provide sufficient flexibility to permit arrangements involv- ing expatriate allowances to satisfy the re- quirements of section 409A. For example, as discussed more fully below, these reg- ulations generally provide that to meet the requirement that a payment be made upon a permissible payment event or a fixed date, the service recipient may make the payment by the later of the earliest date administratively practicable following, or December 31 of the calendar year in which occurs, the permissible payment event or fixed date. At the minimum, this should offer almost 12 months of flexibility with respect to a payment scheduled for January 1 of a calendar year. The Treasury De- partment and the IRS request comments, however, as to circumstances in which this flexibility will not be sufficient. Commentators also requested a grace period during which arrangements with persons who have become resident aliens during a calendar year may be amended to comply with the requirements of sec- tion 409A. These regulations generally provide such relief. With respect to the initial year in which the service provider becomes a resident alien, the plan may be amended with respect to the service provider through the end of that year to comply with (or be excluded from cover- October 24, 20057962005–43 I.R.B. age under) section 409A, including allow- ing the service provider the right to change the time and form of a payment. Provided that the election is made before the amount is paid or payable, initial deferral elections may also be made with respect to com- pensation related to services in that initial year, if the election is made by the end of the year or, if later, the 15 th day of the third month after the service provider meets the requirements to be a resident alien. The relief generally does not extend further because a service recipient and service provider should reasonably anticipate the potential application of section 409A af- ter the initial year in which the service provider attains the status of a resident alien. However, the Treasury Department and the IRS also recognize that there may be significant gaps between the years in which the service provider is treated as a resident alien. Accordingly, the grace period is available in a subsequent year, provided that the service provider has been a nonresident alien for at least five consecutive calendar years immediately preceding the year in which the service provider is again a resident alien. Commentators also requested that amounts contributed or benefits paid un- der a foreign social security system that is the subject of a totalization agreement be exempted from coverage under section 409A. Totalization agreements refer to bilateral agreements between the United States and foreign jurisdictions intended to coordinate coverage under the Social Security system in the United States and similar systems of the foreign jurisdic- tions. These agreements are intended to minimize the potential for application of two different employment taxes, and cor- respondingly to coordinate the benefits under the two different social security systems. The Treasury Department and the IRS believe that section 409A was not intended to apply to benefits to which the service provider is entitled under the foreign jurisdiction social security system. Accordingly, these types of plans have been excluded from the definition of a nonqualified deferred compensation plan for purposes of section 409A. Similarly, for jurisdictions not covered by a totaliza- tion agreement, these regulations provide that amounts deferred under a government mandated social security system are not subject to section 409A. G.Separation pay arrangements 1.In general Many commentators requested clarifi- cation of the application of section 409A to plans or arrangements providing pay- ments upon a termination of services, generally described as severance plans. Some commentators requested that all such arrangements be excluded from coverage under section 409A. However, section 409A(d)(1)(B) contains a list of welfare benefits that are specifically ex- cluded from coverage under section 409A, includingbona fidevacation leave, sick leave, compensatory time, disability pay and death benefit plans. Noticeably absent from this list is an exception for severance plans. This is particularly noteworthy because section 457(e)(11) contains the identical list of exclusions, with the one exception that the list of excluded plans under section 457(e)(11) includes sever- ance pay plans, while the list of excluded plans under section 409A(d)(1)(B) does not. Therefore, it appears that Congress intended that severance payments could constitute deferred compensation under section 409A. To avoid confusion with other Code provisions, such as the specific exclusion from coverage under section 457(e)(11) for severance plans or the treat- ment of such arrangements under section 3121(v)(2), these regulations generally refer to such arrangements as separation pay arrangements. With respect to payments available upon a voluntary termination of services, there is no substantive distinction be- tween a plan labeled a severance plan or separation pay plan and a nonqualified deferred compensation plan that provides for payments upon a separation from ser- vice. If, as is often the case, the service recipient reserves the right to eliminate such arrangement at any time, the service provider may not have a legally binding right to the payment until payment ac- tually occurs, or such other time as the service recipient’s discretion to eliminate the right to the payments lapses. However, as provided in these regulations, where such negative discretion lacks substantive significance, or the person granted the discretion is controlled by, or related to, the service provider to whom the payment will be made, the service provider will be considered to have a legally binding right to the compensation. Commentators requested that the ex- clusion from coverage under section 409A contained in Notice 2005–1, Q&A–19(d) for payments during the calendar year 2005 to non-key employees pursuant to severance plans that are classified as wel- fare plans, rather than pension plans, in accordance with the Department of Labor regulations, be made a permanent exclu- sion. This approach generally would be consistent with the regulations under sec- tion 3121(v)(2) of the Code. However, the Department of Labor regulations re- flect different concerns with respect to separation pay arrangements from the concerns addressed in section 409A. The Department of Labor regulations focus on whether an arrangement sufficiently resembles a retirement plan to require funding of the obligations under such a plan, or rather is a welfare plan that would not require funding. In contrast, section 409A focuses on the manipulation of the timing of inclusion of compensation in- come. Accordingly, these regulations do not categorically exclude these arrange- ments from coverage under section 409A, although a modified version of this ex- ception has been provided, as discussed below. Some commentators requested that the Treasury Department and the IRS adopt an exclusion for all amounts payable upon an involuntary separation. This request is based upon the position under certain other Code provisions, and stated in cer- tain court cases, that payments to which an individual becomes entitled upon an involuntary separation from service do not constitute nonqualified deferred com- pensation. SeeKraft Foods North Amer- ica v. U.S., 58 Fed. Cl. 507 (2003); §31.3121(v)(2)–1(b)(4)(iv). As discussed above, the statutory language and struc- ture of section 409A strongly suggest that separation pay arrangements, including ar- rangements providing separation pay upon an involuntary separation, were meant to be covered by section 409A. Furthermore, the Treasury Department and the IRS be- lieve that section 409A was not intended to be applied so narrowly. Section 409A addresses the manipulation of the timing of inclusion of compensation. Payments due to a separation from service, regard- less of whether voluntary or involuntary, 2005–43 I.R.B.797October 24, 2005 constitute a payment of compensation. Accordingly, the ability to manipulate the timing of the inclusion of income related to the receipt of those amounts is within the scope of section 409A. Much of the discussion above relates to predetermined arrangements, where the right to the payment upon an invol- untary termination of services arises as part of an arrangement covering multi- ple service providers, often covering a service provider from the time the ser- vice provider begins performing services. Where the separation pay arrangement involves an agreement negotiated with a specific service provider at the time of the involuntary separation from service, commentators asked how deferral elec- tions could be provided that would meet the requirement that the election be made in the year before the year in which the services were performed. Commenta- tors pointed out that even if the service provider does not already participate in any involuntary separation pay arrange- ment, the rule in section 409A(a)(4)(B) that allows an initial deferral election to be made within 30 days of initial eligibility under a plan applies only with respect to services performed after the election. To address these concerns, these regulations provide that where separation pay due to an involuntary termination has been the subject ofbona fide, arm’s length negotia- tions, the election as to the time and form of payment may be made on or before the date the service provider obtains a legally binding right to the payment. The Treasury Department and the IRS recognize that separation pay arrange- ments providing for short-term payments upon an involuntary separation from ser- vice are common arrangements, and that compliance with the provisions of section 409A may be burdensome. In addition, the Treasury Department and the IRS recognize that where both the amount of the payments and the time over which such payments may be made are limited, these arrangements create fewer concerns with respect to manipulation of the timing of compensation income. Accordingly, these regulations generally exempt such arrangements where the entire amount of payments does not exceed two times the service provider’s annual compensation or, if less, two times the limit on annual compensation that may be taken into ac- count for qualified plan purposes under section 401(a)(17) ($210,000 for calendar year 2005), each for the calendar year be- fore the year in which the service provider separates from service, and provided fur- ther that the arrangement requires that all payments be made by no later than the end of the second calendar year following the year in which the service provider termi- nates service. These limitations generally are consistent with the safe harbor under which severance plans may be treated as welfare plans under the applicable De- partment of Labor regulations, and should allow most of these arrangements to avoid coverage under section 409A. The Treasury Department and the IRS further recognize that separation pay ar- rangements often occur in the context of a window program, where certain groups of service providers are identified as being subject to a separation from service, and the service recipient provides the iden- tified service providers an incentive to voluntarily separate from service and ob- tain a benefit. Although technically these programs involve a voluntary separation from service, these regulations generally treat separations due to participation in a window arrangement the same as ar- rangements with respect to involuntary separations from service for purposes of the exceptions to coverage from section 409A. These exclusions for separation pay are not intended to allow for rights to pay- ments that would otherwise be deferred compensation subjectto section 409A to avoid application of section 409A by being recharacterized as separation pay. Accord- ingly, the exclusions for separation pay do not apply to the extent the separation pay acts as a substitute for, or a replacement of, amounts that would otherwise be sub- ject to section 409A. For example, a right to separation pay obtained in exchange for the relinquishment of a right to a payment of deferred compensation subject to sec- tion 409A will not be excluded from cover- age under section 409A, but rather will be treated as a payment of the original amount of deferred compensation. 2.Treatment as a separate plan Commentators have stated that arrange- ments involving payments due to an in- voluntary separation often operate sepa- rately from more traditional types of non- qualified deferred compensation plans. In addition, especially in the case of agree- ments covering an individual, the involun- tary separation pay agreement may involve many different types of payments that are of a much smaller magnitude than amounts deferred under other types of nonqualified deferred compensation plans. Commen- tators expressed concerns that inadvertent violations of section 409A with respect to these unique arrangements could lead to much larger amounts being included in in- come and subject to the additional tax un- der section 409A due to the aggregation of such involuntary separation pay arrange- ments with other arrangements under the definition of a plan. The Treasury Depart- ment and the IRS have concluded that a nonqualified deferred compensation plan providing separation pay due to an invol- untary separation from service, or partic- ipation in a window program, should be treated as a separate type of plan from ac- count balance plans, nonaccount balance plans, and other types of plans (generally equity-based compensation arrangements) in which the service provider may partici- pate that do not provide separation pay due to an involuntary separation from service, or participation in a window program. 3.Application of the short-term deferral rule to separation pay arrangements Many commentators asked for a clari- fication with respect to the application of the short-term deferral rule to separation pay arrangements. The right to a payment that will only be paid upon an involuntary termination of services generally would be viewed as a nonvested right. Accordingly, an involuntary separation pay arrangement maybestructuredtomeettherequirements of the short-term deferral exception. Some commentators also requested that arrangements involving rights to payments upon termination of services for good rea- son be treated as a right subject to a sub- stantial risk of forfeiture. These arrange- ments are common, especially following a transaction resulting in a change in con- trol of the service recipient. The Trea- sury Department and the IRS are not con- fident that amounts payable upon a volun- tary separation from service, and amounts payable only upon a termination of ser- vices for good reason, always may be ad- October 24, 20057982005–43 I.R.B. equately distinguished. Furthermore, even if the types of good reasons sufficient to constitute a substantial risk of forfeiture could be elucidated, the application of such a rule would involve intensive factual de- terminations, leaving taxpayers uncertain in their planning and creating a significant potential for abuse. Accordingly, the reg- ulations do not treat the right to a payment upon a separation from service for good reason categorically as a right subject to a substantial risk of forfeiture. However, the Treasury Department and the IRS re- quest comments as to what further guid- ance may be useful with respect to arrange- ments containing these types of provisions. 4.Reimbursement arrangements Many commentators requested clar- ification with respect to the application of section 409A to reimbursement agree- ments, involving the service recipient reimbursing expenses of the terminated service provider. Because the promise to reimburse the former service provider is not contingent on the provision of any sub- stantial services for the service provider, the right to the payment generally would not be treated as subject to a substantial risk of forfeiture. Accordingly, if the period in which expenses incurred will be reimbursed extends beyond the year in which the legally binding right arises, the right to the amount generally would constitute deferred compensation. The Treasury Department and the IRS rec- ognize that reimbursement arrangements following a termination of services are common, and that requiring the service re- cipient to designatean amount at the time of the termination conflicts with the ser- vice recipient’s desire to pay only amounts that the former service provider has actu- ally incurred as an expense. However, a categorical exclusion for reimbursement arrangements is not tenable, because such an exclusion would allow for a limitless amount of deferred compensation to be paid without regard to the rules of section 409A, where such compensation took the form of the reimbursement of personal expenses (for example, reimbursements of home mortgage payments). These regula- tions provide that certain reimbursement arrangements related to a termination of services are not covered by section 409A, to the extent that the reimbursement ar- rangement covers only expenses incurred and reimbursed before the end of the sec- ond calendar year following the calendar year in which the termination occurs. The types of reimbursement arrangements ex- cluded include reimbursements that are otherwise excludible from gross income, reimbursements for expenses that the ser- vice provider can deduct under section 162 or section 167, as business expenses in- curred in connection with the performance of services (ignoring any applicable lim- itation based on adjusted gross income), outplacement expenses, moving expenses, medical expenses, as well as any other types of payments that do not exceed $5,000 in the aggregate during any given taxable year. For purposes of this provision, re- imbursement arrangements include the provision of in-kind benefits, or direct payments by the service recipient to the person providing the goods or services to the terminated service provider, if the provision of such in-kind benefits or direct payments would be treated as reimburse- ment arrangements if the service provider had paid for such in-kind benefits or such goods or services and received reimburse- ment from the service recipient. H.Split-dollar life insurance arrangements Commentators suggested that split-dol- lar life insurance arrangements should be excluded from the requirements of section 409A. However, the Treasury Depart- ment and the IRS believe that in applying the general definition of deferred com- pensation to split-dollar life insurance arrangements, the requirements of section 409A may apply to certain types of such arrangements (as described in §1.61–22). Split-dollar life insurance arrangements that provide only death benefits (as de- fined in these proposed regulations) to or for the benefit of the service provider may be excluded from coverage under section 409A under the exception from the definition of a nonqualified deferred compensationplanprovidedinthesepro- posed regulations for death benefit plans. Also, split-dollar life insurance arrange- ments treated as loan arrangements under §1.7872–15 generally will not give rise to deferrals of compensation within the meaning of section 409A, provided that there is no agreement under which the service recipient will forgive the related indebtedness and no obligation on the part of the service recipient to continue to make premium payments without charging the service provider a market interest rate on the funds advanced. However, policies structured under the endorsement method, where the service recipient is the owner of the policy but where the service provider obtains a legally binding right to compen- sation includible in income in a taxable year after the year in which a substantial risk of forfeiture (if any) lapses, may pro- vide for a deferral of compensation. Just as a promise to transfer property in a future year may provide for a deferral of com- pensation (even though the transfer itself is subject to section 83), an endorsement method split-dollar life insurance arrange- ment that grants the service provider a legally binding right to a future transfer of interests in a policy owned by the ser- vice recipient may provide for a deferral of compensation subject to section 409A. For example, where a service recipient enters into an endorsement method split-dollar life insurance arrangement with respect to a service provider, and irrevocably promises to pay premiums in future years, the arrangement may provide for a defer- ral of compensation within the meaning of section 409A. Commentators raised concerns about the impact of changes to a split-dollar life insurance arrangement to comply with sec- tion 409A, where the split-dollar life insur- ance arrangement was entered into on or before September 17, 2003, and is not oth- erwise subject to the regulations set forth in §1.61–22 (a grandfathered split-dol- lar life insurance arrangement). Pur- suant to §1.61–22(j)(2), if a grandfathered split-dollar life insurance arrangement is materially modified after September 17, 2003, the arrangement is treated as a new arrangement enteredinto on the date of the modification. Commentators expressed concern that modifications necessary to comply with section 409A may cause the split-dollar life insurance arrangement to be treated as materially modified for pur- poses of §1.61–22(j)(2). Comments are requested as to the scope of changes that may be necessary to comply with, or avoid application of, section 409A, and under what conditions those changes should not 2005–43 I.R.B.799October 24, 2005 be treated as material modifications for purposes of §1.61–22(j)(2). III.Definition of Plan A.Plan aggregation rules These regulations generally retain the plan aggregation rules set forth in No- tice 2005–1, Q&A–9. Under the notice, all amounts deferred under an account balance plan are treated as deferred un- der a single plan, all amounts deferred under a nonaccount balance are treated as deferred under a single plan, and all amounts deferred under any other type of plan (generally equity-based compen- sation) are treated as deferred under a single plan. As discussed above, these regulations expand this rule so that all amounts deferred under certain separation pay arrangements are treated as a single plan. The purposes behind these aggre- gation rules are two-fold. First, because the provisions of section 409A are applied on an individual participant basis, rather than disqualifying the arrangement as to all participants, planaggregation rules are necessary to implement the compliance incentives intended under the provision. Without such rules, multitudes of separate arrangements could be established for a single participant. Should the participant want access to an amount of cash, the participant would amend one or more of these separate arrangements and receive payments. The participant would argue that only those separate arrangements un- der which the amounts were paid failed to meet the requirements of section 409A and were subject to the income inclusion and additional tax, although in fact amounts were also available under the additional separate arrangements. Under that analy- sis, section 409A essentially would act as a 20 percent penalty required to receive a payment, similar to the haircut provisions that were intended to be prohibited by section 409A. The Treasury Department and the IRS do not believe that Congress intended that the consequences of section 409Acouldbelimitedinsuchamanner. However, the Treasury Department and the IRS also believe that complex plan aggregation rules, especially rules reliant on the particular facts and circumstances underlying each arrangement, would lead to unwarranted complexities and burdens with respect to service recipient planning and IRS enforcement. Accordingly, these regulations adopt rules intended to be simple and relatively easy to administer that retain the integrity of the compliance incentives inherent in the statute. Commentators asked whether an iso- lated violation of a term of an arrange- ment with respect to one participant will be treated as a violation of the same arrange- ment term with respect to other partici- pants covered by the same arrangement. First, the terms of the arrangement with respect to each participant must be deter- mined, based upon the rights the individ- ual participant has under the plan. Gener- ally, these rights will be determined based upon the written provisions applicable un- der a particular arrangement, as evidenced by a plan document, agreement, or some combination of documents that specify the terms of the contract under which the com- pensation is to be paid. However, where the terms of a plan or arrangement com- ply with section 409A, but the service re- cipient does not follow such terms, an in- dividual participant’s actual rights under the arrangement may be unclear. Where a violation of a provision is not an isolated incident, or involves a number of partici- pants or an identifiable subgroup of partic- ipants under the arrangement, the violation mayresultinafindingthatevenwithre- spect to a participant who did not directly benefit from the violation, the actual terms of the arrangement differ from the written terms of the arrangement. For example, if a plan document provides for installment payments upon a separation from service, but participants in the arrangement repeat- edly are offered theopportunity to receive a lump sum payment, the facts and circum- stances may indicate that the arrangement provides for an election of a lump sum pay- ment for all participants. An analogous analytical framework ap- plies where the service recipient offers dif- ferent benefits to separate participants in the same plan or arrangement. Under the terms of the overall arrangement, the ser- vice provider may grant many different types of rights, including some rights that would not be subject to the requirements of section 409A and some rights that would be subject to those requirements. With re- spect to the application of section 409A, a plan or arrangement is analyzed as con- sisting of the rights and benefits that have actually been granted to a particular ser- vice provider. For example, with respect to an equity-based omnibus plan that per- mits the grant of discounted stock options that would be subject to the requirements of section 409A, as well as other types of stock options which would be excluded from coverage under section 409A, only those service providers actually granted the discounted stock options will be treated as having deferred an amount of compen- sation subject to section 409A, and then only with respect to the stock options sub- ject to section 409A. B.Written plan requirement Although the statute does not explicitly state that a plan or arrangement must be in writing, the statute requires that a plan con- tain certain provisions in order to comply with section 409A. For example, section 409A(a)(2)(A) requires that a plan provide that compensation deferred under the plan may not be distributed earlier than certain specific events. Section 409A(a)(4)(B) re- quires that a plan provide certain restric- tions with respect to initial deferral elec- tions. Section 409A(a)(4)(C) requires that, if a plan permits under a subsequent elec- tion a delay in a payment or a change in the form of payment, the plan must require certain limits on the scope of such a delay or change. The clear implication of these provisions of section 409A is that the plan or arrangement must be set forth in writ- ing and these regulations incorporate that requirement. IV. Definition of Substantial Risk of Forfeiture The scope of the definition of a substan- tial risk of forfeiture is central to the ap- plication of section 409A. In addition to the timing of the potential inclusion of in- come under section 409A, the existence of a substantial risk of forfeiture may also de- termine whether an amount is subject to section 409A or whether it qualifies for the exclusion under the short-term defer- ral rule. These regulations generally adopt the same definition as provided in Notice 2005–1, Q&A–10. This definition reflects the concerns of the Treasury Department and the IRS that the use of plan terms that purport to prescribe a substantial risk of forfeiture but, in fact, do not put the right to the payment at a substantial risk, October 24, 20058002005–43 I.R.B. may be used to circumvent the applica- tion of section 409A in a manner inconsis- tent with the legislative intent. The defi- nition of a substantial risk of forfeiture in these regulations contains certain restric- tions. Certain amendments of an arrange- ment to extend a substantial risk of forfei- ture will not be recognized. The ability to periodically extend, or roll, the risk of for- feiture is sufficiently suspect to question whether the parties ever intended that the right be subject to any true substantial risk, or rather whether the period is being ex- tended through periods in which the ser- vice recipient can be reasonably assured that the forfeiture condition will not occur. Similarly, the risk that a right will be for- feited due to the violation of a noncompete agreement can be illusory, such as where the service provider has no intent to com- pete or to provide such services. In addi- tion, a rational service provider normally would not agree to subject amounts that have already been earned, such as salary payments, to a condition that creates a real possibility of forfeiture, unless the service provider is offered a material inducement to do so, such as an additional amount of compensation. Accordingly, these provi- sions will not be treated as creating a sub- stantial risk of forfeiture for purposes of section 409A. V.Initial Deferral Election Rules A.In general Section 409A(a)(4)(B)(i) provides that in general, a plan must provide that com- pensation for services performed during a taxable year may be deferred at the partici- pant’s election only if the election to defer such compensation is made not later than the close of the preceding taxable year or at such other time as provided in regula- tions. The legislative history indicates that the taxable year to which the statute refers is the service provider’s taxable year, as it indicates that the Secretary may issue guidance “providing coordination rules, as appropriate, regarding the timing of elec- tions in the case when the fiscal year of the employer and the taxable year of the individual are different.” H.R. Conf. Rep. No. 108–755, at 732 (2004). Accordingly, these regulations provide as a general rule that a service provider must make a defer- ral election in his or her taxable year be- fore the year in which the services are per- formed. As discussed below, certain co- ordination rules for fiscal year employers have been provided. An election to defer an amount includes an election both as to the time and form of the payment. An election is treated as made as of the date the election becomes irrevocable. Changes may be made to an initial deferral election, provided that the election becomes irrevocable (except to the extent the plan permits a subse- quent deferral election consistent with these regulations) no later than the last date that such an election may be made. Commentators had questioned whether an evergreen deferral election, or a de- ferral election as to future compensation that remains in place unless the service provider changes the election, would be effective for purposes of section 409A. Such an election satisfies the initial de- ferral election requirements only if the election becomes irrevocable with respect to future compensation no later than the last permissible date an affirmative initial deferral election could have been made with respect to such compensation. For example, with respect to a salary defer- ral program under which an employee makes an initial deferral election to defer 10 percent of the salary earned during the subsequent calendar year, a plan may provide that the deferral election remains effective unless and until changed by the employee, provided that with respect to salary earned during any future taxable year, the election to defer 10 percent of such salary becomes irrevocable no later than the December 31 of the preceding calendar year. B.Nonelective arrangements Some commentators asked whether the initial deferral election rules apply to non- elective arrangements. The requirement that the election be made in the year before the services are performed is not applica- ble where the participant is not provided any election with respect to the amount de- ferred, or the time and form of the pay- ment. However, as stated in the legislative history, “[t]he time and form of distribu- tion must be specified at the time of initial deferral.” H.R. Conf. Rep. No. 108–755, at 732 (2004). In addition, the application of the subsequent deferral rules becomes problematic if the original time and form of deferred payment established by the ser- vice recipient is not viewed as an initial de- ferral election. Therefore, in order to avoid application of the initial deferral rules, a plan may not provide a service provider or service recipient with ongoing discre- tion as to the time and form of payment, but rather must set the time and form of payment no later than the time the service provider obtains a legally binding right to the compensation. C.Performance-based compensation Section 409A(a)(4)(B)(iii) provides that in the case of any performance-based compensation based on services per- formed over a period of at least 12 months, a participant’s initial deferral election may be made no later than six months before the end of the period. The legislative his- tory indicates that the performance-based compensation should be required to meet certain requirements similar to those under section 162(m), but not all requirements under that section. H.R. Conf. Rep. No. 108–755, at 732 (2004). An example in the legislative history, adopted in these regulations, is that the requirement of a determination by the compensation com- mittee of the board of directors is not required. Notice 2005–1 did not provide a defini- tion of performance-based compensation. Rather, Notice 2005–1, Q&A–22 provided a definition of bonus compensation that, until further guidance was issued, could be used for purposes of applying the excep- tion to the general rule regarding initial de- ferral elections. Under these regulations, performance- based compensation is defined as compen- sation the payment of which or the amount of which is contingent on the satisfaction of preestablished organizational or indi- vidual performance criteria. Performance- based compensation does not include any amount or portion of any amount that will be paid either regardless of performance, or based upon a level of performance that is substantially certain to be met at the time the criteria are established. Performance-based compensation gen- erally may include payments based upon subjective performancecriteria, provided that the subjective performance criteria relate to the performance of the partici- 2005–43 I.R.B.801October 24, 2005 pant service provider, a group of service providers that includes the participant ser- vice provider, or a business unit for which the participant service provider provides services (which may include the entire or- ganization), and the determination that the subjective performance criteria have been met is not made by the service provider or amemberoftheserviceprovider’sfamily, or a person the service provider supervises or over whose compensation the service provider has any control. Commentators requested that, sim- ilar to the provision contained in §1.162–27(e)(2) governing the require- ments for establishing performance crite- ria for purposes of applying the deduction limitation under section 162(m), service recipients be allowed to establish per- formance criteria within 90 days of the commencement of a performance period of 12 months or more, rather than hav- ingtoestablishsuchcriteriabeforethe commencement of the period. These reg- ulations adopt a similar provision with re- spect to the establishment of performance criteria for purposes of the exception un- der the deferral election rules, permitting the criteria to be established up to 90 days after the commencement of the period of service to which the criteria relates, pro- vided that the outcome is not substantially certain at the time the criteria are estab- lished. The legislative history indicates that to constitute performance-based com- pensation, the amount must be (1) vari- able and contingent on the satisfaction of preestablished organizational or indi- vidual performance criteria and (2) not readily ascertainable at the time of the election. H.R. Conf. Rep. No. 108–755, at 732 (2004). These regulations clarify that where the right to receive a specified amount is itself not substantially certain, the amount is not readily ascertainable as the amount paid could either be the spec- ified amount or zero. Accordingly, these regulations provide that at the time of the initial deferral election, either the amount must not be readily ascertainable, or the right to the amount must not be substan- tially certain. So, for example, the right to a $10,000 bonus that otherwise quali- fies as performance-based compensation could be deferred by an employee up to six months before the end of the perfor- mance period, provided that at the time of the deferral election the employee is not substantially certain to meet the criteria and receive the $10,000 payment. Under the definition of bonus com- pensation provided in Notice 2005–1, Q&A–22, bonus compensation does not include any amount or portion of any amount that is based solely on the value of, or appreciation in value of, the ser- vice recipient or the stock of the service recipient. Commentators criticized this limitation as inconsistent with the provi- sions of §1.162–27 governing application of the deduction limitation under section 162(m), and the legislative history to sec- tion 409A indicating that the definition of performance-based compensation for purposes of section 409A would be simi- lar to that provided under section 162(m) and the regulations thereunder. These pro- posed regulations eliminate this limitation, so that performance-based compensation may be based solely upon an increase in the value of the service recipient, or the stock of the service recipient, after the date of grant or award. However, if an amount of compensation the service provider will receive pursuant to a grant or award is not basedsolelyonanincreaseinthevalueof the stock after the grant or award (for ex- ample, in the case of restricted stock units or a stock right granted with an exercise price that is less than the fair market value of the stock as of the date of grant), and that other amount would not otherwise qualify as performance-based compensa- tion, none of the compensation attributable to the grant or award is performance-based compensation. Nonetheless, an award of equity-based compensation may consti- tute performance-based compensation if entitlement to the compensation is sub- ject to a condition that would cause a non-equity-based award to qualify as per- formance-based compensation, such as a performance-based vesting condition. The Treasury Department and the IRS are concerned that the inclusion of such amounts in the definition of performance- based compensation could lead to a con- clusion that an election to defer amounts payable under a stock right will necessarily comply with section 409A if the initial de- ferral election is made at least 6 months be- fore the date of exercise. However, under these proposed regulations, a stock right with a deferral feature is subject to section 409A from the date of grant. To comply with section 409A, the arrangement would be required to specify a permissible pay- ment time and a form of payment. The requirement would not be met if, at some point during the term of the stock right, the stock right becomes immediately exercis- able and the holder may decide whether andwhentoexercisethestockright.Inad- dition, where a deferral feature is added to an existing stock right the stock right gen- erally would violatesection 409A because the stock right wouldhave a deferral fea- ture and would not have specified a per- missible payment time or event. D.First year of eligibility Section 409A and these proposed regu- lations contain an exception to the general rule regarding initial deferral elections, un- der which a service provider newly eligible for participation in a plan may make a de- ferral election within the first 30 days of participation in the plan, provided that the election may only apply to compensation with respect to services performed after the election. These regulations further provide that for compensation that is earned based upon a specified performance period (for example, an annual bonus), where a defer- ral election is made in the first year of eligi- bility but after the beginning of the service period, the election is deemed to apply to compensation paid for service performed subsequent to the election if the election applies to the portion of the compensation that is no greater than the total amount of compensation for the performance period multiplied by the ratio of the number of days remaining in the performance period after the election over the total number of days in the performance period. Commentators had requested that the plan aggregation rules not apply in de- termining whether a service provider is newly eligible for participation in a plan. The concern is that a mid-year promotion, or management reorganization or other corporate event may make the service provider eligible for an arrangement that is of the same type as an arrangement in which the service provider already partic- ipates. For example, an employee partici- pating in a salary deferral account-balance plan may become eligible for a bonus and a bonus deferral arrangement that would also be an account-balance plan. October 24, 20058022005–43 I.R.B. The Treasury Department and the IRS believe that the plan aggregation rules are necessary in this context. Without such a rule, service providers may attempt to take advantage of the new eligibility exception by establishing serial arrangements. For example, an employer may argue that a 2007 salary deferral program is a new pro- gram, and not a continuation of the 2006 salary deferral program. Commentators argue that standards should be provided comparing the terms of the two plans to distinguish new arrangements from those that are merely continuations of existing arrangements. However, such rules would by necessity be complicated and burden- some, generally relying on the facts and circumstances of the individual arrange- ments and resulting in administrative burden and uncertainties. Accordingly, these regulations retain the plan aggrega- tion rules. However, as discussed below, certain other initial deferral election rules have been provided that address many of the situations in which service recipients de- sire to grant service providers the opportu- nity to make initial deferral elections due to eligibility in new programs. For ex- ample, the rule governing initial deferral elections with respect to certain forfeitable rights discussed below allows initial de- ferral elections upon eligibility for many bonus programs andad hocequity-based compensation grants. The Treasury De- partment and the IRS request comments as to whether these rules adequately address the concerns raised with respect to the def- inition of plan for purposes of applying the initial eligibility exception. E.Initial deferral election with respect to short-term deferrals As discussed above, an amount that is paid by the 15 th day of the third month following the end of the first taxable year in which the payment is no longer subject to a substantial risk of forfeiture generally will not constitute a deferral of compen- sation. Commentators asked how the de- ferral election rules applytoanelectionto defer such an amount. Generally, once the service provider has begun performing the services required to vest, no election to de- fer could be made that would meet the tim- ing requirements for initial deferral elec- tions. Commentators suggested that the rules governing subsequent changes to the time and form of payment could be ap- plied to elections to defer these amounts. The regulations provide that for purposes of an election to defer amounts that would not otherwise be subject to section 409A due to the short-term deferral rule, the date the substantial risk of forfeiture lapses is treated as the original time of payment es- tablished by an initial deferral election, and the form in which the payment would be made absent a deferral election is treated as the original form of payment established by an initial deferral election. Accord- ingly, the service provider may elect to de- fer the payment beyond the time at which the payment originally was scheduled to be made, in accordance with the rules gov- erning subsequent changes in the time and form of payment. In general, this means that the service provider must make the election at least 12 months before the right to the payment vests, and must defer the payment for a period of not less than 5 years from the date the right to the pay- ment could vest. Thus, no payment could be made within 5 years of the date the right to the payment vests (including upon a sep- aration from service), except for instances of a change in control of the corporation, death, disability or an unforeseeable emer- gency. This would also mean that if the right to the payment actually vests within 12 months of the election, and the election is given effect so that the payment is not made within the short-term deferral period, the deferral of the payment would violate the requirements of section 409A. For example, an employee may be enti- tled to the immediate payment of a bonus upon the occurrence ofan initial public of- fering, where such a condition qualifies as a substantial risk of forfeiture so that the arrangement would constitute a short-term deferral. At some point after obtaining the right to the payment but before the initial public offering, the employee elects to de- fer any potential bonus payment to a date 5 years from the date of the initial public offering. To comply with the initial de- ferral election rules, that deferral election must not be given effect for 12 months. Accordingly, if the initial public offering occurred within 12 months of the deferral election, the payment must be made at the time of the initial public offering in accor- dance with the short-term deferral rules. If the payment is not made at such time, but rather is made, for example, 5 years from the date of the initial public offering, the payment would be deemed deferred pur- suant to an invalid initial deferral election effective before the required lapse of 12 months and the arrangement would violate section 409A. F.Initial deferral election with respect to certain forfeitable rights Commentators asked how the initial deferral election rules would apply with respect to grants of nonqualified deferred compensation that occur in the middle of a taxable year, especially where such grants were unforeseeable by the service provider. Under these circumstances, an initial deferral election could not be made by the service provider during the taxable year before the year in which the award was granted, unless the service recipi- ent had the foresight to request such an election in the prior year. The Treasury Department and the IRS do not believe that a categorical exclusion from the ini- tial deferral election rules is appropriate, because such a rule would encourage the characterization of all grants of nonqual- ified deferred compensation as occurring in the middle of the year and in large part render ineffective the initial deferral election rules set forth in section 409A. However, these regulations provide that where a grant of nonqualified deferred compensation is subject to a forfeiture condition requiring the continued perfor- mance of services for a period of at least 12 months, the initial deferral election may be made no later than 30 days after the date of grant, provided that the election is made at least 12 months in advance of the end of the service period. Under these circumstances, the election still must be made in all cases at least 12 months before the service provider has fully earned the amount of compensation, analogous to the general requirement that the election be made no later than the end of the year before the services are performed. The Treasury Department and the IRS believe that such a rule will provide a reason- able accommodation to service recipients granting certainad hocawards, such as restricted stock units, that often are subject to a requirement that the service provider continue to perform services for at least 12 months. 2005–43 I.R.B.803October 24, 2005 G.Initial deferral election with respect to fiscal year compensation The legislative history to section 409A indicates that the Treasury Department and the IRS are to provide guidance coordinat- ing the initial deferral election rules with respect to compensation paid by service recipients with fiscal years other than the calendar year. H.R. Conf. Rep. No. 108–755, at 732 (2004). These regula- tions provide such a rule, generally per- mitting an initial election to defer fiscal year compensation on or before the end of the fiscal year immediately preceding the first fiscal year in which any services are performed for which the compensation is paid. For these purposes, fiscal year com- pensation does not encompass all compen- sation paid by a fiscal year service recipi- ent. Where the compensation is not specif- ically based upon the service recipient’s fiscal year as the measurement period, the timing requirements applicable to an ini- tial deferral election are unchanged. Ac- cordingly, the rule applies to compensation based on service periods that are coexten- sive with one or more of the service recip- ient’s consecutive fiscal years, where no amount of such compensation is payable during the service period. For example, a bonus based upon a service period of two consecutive fiscal years payable after the completion of the second fiscal year would be fiscal year compensation. In contrast, periodic salary payments or bonuses based on service periods other than the service recipient’s fiscal year would not be fis- cal year compensation, and the deferral of such amounts would be subject to the gen- eral rule. H.Deferral elections with respect to commissions Commentators requested clarification with respect to the application of section 409A to commissions. These regulations address commissions earned by a service provider where a substantial portion of the services provided bythe service provider consists of the direct sale of a product or service to a customer, each payment of compensation by the service recipient to the service provider consists of a portion of the purchase price for the product or service (for example, 10 percent of the purchase price), or an amount calculated solely by reference to the volume of sales (for example, $100 per item sold), and each compensation payment is contin- gent upon the service recipient receiving payment from an unrelated customer for the product or services. In that case, the service provideris treated as having performed the services to which the com- mission compensation relates during the service provider’s taxable year in which the unrelated customer renders payment for such goods or services. Accordingly, under the general initial deferral election rule an individual service provider could make an initial deferral election with respect to such compensation through De- cember 31 of the calendar year preceding the year in which the customer renders the payment from which the commission is derived. VI.Time and Form of Payment A.In general The regulations incorporate the statu- tory requirement that payments be made at a fixed date or under a fixed schedule, or upon any of five events: a separation from service, death, disability, change in the ownership or effective control of a cor- poration (to the extent provided by the Sec- retary), or unforeseeable emergency. As requested by commentators, these regula- tions provide guidance on what it means for a payment to be made upon one of these events. Where the time of payment is based upon the occurrence of a speci- fied event (such as one of the five events listed above or upon the lapse of a substan- tial risk of forfeiture as discussed below), the plan must designate an objectively de- terminable date or year following the event upon which the payment is to be made. For example, the plan may designate the payment date as 30 days following a sep- aration from service, or the first calendar year following a service provider’s death. The Treasury Department and the IRS rec- ognize that it may not be administratively feasible to make a payment upon the exact date or year designated. Furthermore, the Treasury Department and the IRS recog- nize that certain minimal delays that do not meaningfully affect the timing of the inclu- sion of income should not result in a viola- tion of the requirements of section 409A. Accordingly, a payment will be treated as made upon the designated date if the pay- ment is made by the later of the first date it is administratively feasible to make such payment on or after the designated date, or the end of the calendar year containing the designated date (or the end of the calen- dar year if only a year is designated). This relaxation of the timing rules for admin- istrative necessity is not intended to pro- vide a method for the service provider to further defer the payment. Accordingly, any inability to make the payment that is caused by an action or inaction of the ser- vice provider, or any person related to, or under the control of, the service provider, will not be treated as causing the making of the payment to be administratively in- feasible. Once an event upon which a payment is to be made has occurred, the desig- nated date generally is treated as the fixed date on which, or the fixed schedule un- der which, the payment is to be made (but not for purposes of the application of sec- tion 409A(a)(2)(B) generally requiring a six month delay in any payment upon a separation from service to a key employee of a corporation whose stock is traded on an established securities market). Accord- ingly, the recipient may change the time and form of payment after the event has occurred, provided that the change would otherwise be timely and permissible un- der these regulations. For example, a plan provides for payment of a lump sum on the third anniversary following a separa- tion from service. A service provider has a separation from service on July 1, 2010. The July 1, 2013, payment date is now treated as the fixed date upon which the payment is to be made. Accordingly, the service provider generally could elect to defer the time and form of payment pro- vided that the election were made on or be- fore June 30, 2012, and deferred the pay- ment to at least July 1, 2018. For a discus- sion of the application of the subsequent deferral rules when only a calendar year of payment is specified, see section VI.B of this preamble. B.Specified time or fixed schedule of payments Generally a plan will be deemed to pro- vide for a specified time or fixed sched- ule of payments where, at the time of the deferral, the specific date upon which the October 24, 20058042005–43 I.R.B. payment or payments will be made may be objectively determined. As requested by commentators, these regulations permit plans to specify simply the calendar year or years in which the payments are scheduled to be made, without specifying the partic- ular date within such year on which the payment will be made. Although this pro- vision would be consistent with the flexi- bility allowed with respect to meeting the specified time or fixed schedule of pay- ments requirement, the provision must be coordinated with the subsequent deferral rules. Section 409A(a)(4)(C)(iii) requires that if a plan permits under a subsequent election a delay in a payment or a change in the form of payment with respect to a pay- ment payable at a specified time or a fixed schedule, the plan must require that the election be made not less than 12 months prior to the date of the first scheduled pay- ment. Application of such a provision re- quiresaspecificdateforthefirstsched- uled payment. For a plan that does not des- ignate a specific date, but rather only the year in which the payment is to be made, the first scheduled payment is deemed to be scheduled to be paid as of January 1 of such year for this purpose. Commentators asked whether a speci- fied time or fixed schedule of payments could be determined based upon the date the service provider vests in the amount of deferred compensation, where the vesting is based upon the occurrence of an event. These regulations provide that a plan pro- vides for payment at a specified time or fixed schedule of payments if the plan pro- vides at the time of the deferral that the paymentwillbemadeatadateordatesthat are objectively determinable based upon the date of the lapsing of a substantial risk of forfeiture, disregarding any acceleration of the vesting other than due to death or disability. So, for example, a plan that pro- vides at the time the service provider ob- tains a legally binding right to the payment that the payment will be made in three in- stallment payments, payable each Decem- ber 31 following an initial public offering, where the condition that an initial public offering occur before the service provider is entitled to a payment constitutes a sub- stantial risk of forfeiture, would satisfy the requirement that the plan provide for pay- ments at a specified time or pursuant to a fixed schedule. C.Separation from service Section 409A(a)(2)(A)(i) provides that a plan may permit a payment to be made upon a separation from service as deter- mined by the Secretary (except a payment to a specified employee, in which case the payment must be made subject to a six-month delay, discussed more fully be- low). These regulations provide guidance as to the circumstances under which ser- vice providers, including employees and independent contractors, will be treated as separating from service for purposes of section 409A. These rules are intended solely as guidance with respect to section 409A(a)(2)(A)(i), and should not be relied upon with respect to any other Code pro- visions, such as provisions with respect to distributions under qualified plans and provisions related to the service recipients’ employment tax and information reporting obligations. 1.Employees These regulations provide that an em- ployee experiences a separation from ser- vice if the employee dies, retires, or oth- erwise has a termination of employment with the employer. However, the employ- ment relationship is treated as continuing intact while the individual is on military leave, sick leave, or otherbona fideleave of absence (such as temporary employ- ment by the Government) if the period of such leave does not exceed six months, or if longer, so long as the individual’s right to reemployment with the service recipi- ent is provided either by statute or by con- tract. If the period of leave exceeds six months and the individual’s right to reem- ployment is not provided either by statute or by contract, the employment relation- ship is deemed to terminate on the first date immediately following such six-month pe- riod. Whether the employee has experi- enced a termination of employment is determined based on the facts and circum- stances. The Treasury Department and the IRS do not intend for this standard to al- low for the extension of deferrals through the use of consulting agreements or other devices under which the service provider technically agrees to perform services as demanded, but for which there is no in- tent that the service provider perform any significant services. Accordingly, the reg- ulations provide an anti-abuse rule stating that where an employee either actually or purportedly continues in the capacity as an employee, such as through the execution of an employment agreement under which the service provider agrees to be available to perform services if requested, but the facts and circumstances indicate that the employer and the service provider did not intend for the service provider to provide more than insignificant services for the employer, an employee will be treated as having a termination of employment and a separation from service. For these pur- poses, an employer and employee will be deemed to have intended for the employee to provide more than insignificant services if the employee provides services at an an- nual rate equal to at least 20 percent of the services rendered and the annual remuner- ation for such services is equal to at least 20 percent of the average remuneration earned during the immediately preceding three full calendar years of employment (or, if the employee was employed for less than three years, such lesser period). In addition, the Treasury Department and the IRS do not intend for this standard to be circumvented to create a separation from service where the service provider continues to performsignificant services for the service recipient. For these pur- poses, the regulations provide that where an employee continues to provide services to a previous employer in a capacity other than as an employee, a separation from ser- vice will be treated as not having occurred if the former employee provides services at an annual rate that is 50 percent or more of the services rendered, on average, during the final three full calendar years of em- ployment (or, if less, such lesser period) and the annual remuneration for such ser- vices is 50 percent or more of the aver- age annual remuneration earned during the immediately preceding three full calendar years of employment (or if less, such lesser period). Commentators asked whether the pre- vious positions of the Treasury Depart- ment and the IRS with respect to a sepa- ration from service for purposes of section 401(k), generally referred to as the same desk rule, would apply in these circum- stances. Under that rule, in certain situa- tions where the identity of the employee’s employer changed, such as with respect to 2005–43 I.R.B.805October 24, 2005 a sale of substantiallyall of the assets of the original employer to a new employer who hired the employee, the employee would not be treated as having a separation from service where the duties and responsibil- ities of the employee had not materially changed. These regulations do not incor- porate this standard. Commentators had requested the abil- ity to elect whether to apply the same desk rule in the case of a corporate transaction, such as a sale of substantially all of the as- sets of the original employer. The Treasury Department and the IRS do not believe that such a rule would be consistent with the provisions of section 409A, which gener- ally restrict such control over the time and form of payment. 2.Independent contractors The definition of a separation from ser- vice of an independent contractor in these proposed regulations generally is derived from the definition of severance from employment provided in §1.457–6(b)(2). Comments are requested with respect to any changes that may be necessary to ad- dress issues arising under section 409A. 3.Delay for key employees Section 409A(a)(2)(B)(i) provides that payments upon a separation from ser- vice to a key employee of a corporation whose stock is publicly traded on an estab- lished securities market must be delayed at least six months following the separa- tion from service. For these purposes, a key employee is defined in accordance with section 416(i), disregarding sec- tion 416(i)(5). Commentators asked for guidance on when a determination as to whether an individual is a key employee must be made. Section 416 relies upon plan year concepts, which generally are not relevant to the application of section 409A. In addition, the Treasury Depart- ment and the IRS wish to establish rules that minimize the administrative burden, while implementing the legislative intent. Accordingly, the regulations provide that the identification of key employees is based upon the 12-month period ending on an identification date chosen by the service recipient. Persons who meet the requirements of section 416(i)(1)(A)(i), (ii) or (iii) during that 12-month period are considered key employees for the 12-month period commencing on the first day of the 4 th month following the end of the 12-month period. For example, if an employer chose December 31 as an identification date, any key employees identified during the calendar year ending December 31 would be treated as speci- fied employees for the 12-month period commencing the following April 1. In this manner, service recipients generally may know in advance whether the person to whom a payment is scheduled to be made will be subject to the provision. In addition, service recipients may choose an identification date other than December 31, provided that the date must be used consistently and provided that any change in the identification date may not be effec- tive for a period of at least 12 months. Some commentators had requested that certain types of payments, generally life annuities or longer-term installment pay- ments, be excepted from the six-month delay requirement. The statutory language does not contemplate such an exception. Where an executive is aware that the source of funds to pay for his nonqualified deferred compensation are at significant risk, the executive may separate from ser- vice to obtain initial annuity or installment payments while such funds exist. Com- mentators argue that annuity payments or long-term installment payments generally would be less significant in amount. How- ever, the Treasury Department and the IRS are not inclined to establish arbitrary limits, where such amounts may actually be quite significant due to the overall amount of the entire benefit, the number of installment payments, or the age of the participant, especially where the statutory language does not contemplate the cre- ation of such an exception. Rather, the Treasury Department and the IRS believe that the provisions with respect to separa- tion pay should provide service recipients the ability to provide reasonably signif- icant amounts of benefits to terminating executives, that may respond to many of the concerns underlying the request to relax the six-month delay requirement. To meet the six-month delay require- ment, a plan may provide that any pay- ment pursuant to a separation of service due within the six-month period is delayed until the end of the six-month period, or that each scheduled payment that becomes payable pursuant to a separation from ser- vice is delayed six months, or a combi- nation thereof. For example, a nonquali- fied deferred compensation plan of a cor- poration whose stock is publicly traded on an established securities market may pro- vide that a participant is entitled to 60 monthly installment payments upon sep- aration from service, payable commenc- ing the first day of the first month fol- lowing the date of separation from ser- vice. To comply with the requirement of a six-month delay for payments to key em- ployees, the plan may provide that in the case of an affected participant, the aggre- gate amount of the first seven months of installments is paid at the beginning of the seventh month following the date of sepa- ration from service, or may provide that the commencement date of the 60 months of installment payments is the first day of the seventh month following the date of sepa- ration from service, or may provide for a combination of these provisions. A plan may be amended to specify or change the manner in which the delay will be imple- mented, provided that the amendment may not be effective for at least 12 months. Be- cause the delay requirement applies only to certain public corporations, a corporation or other entity not covered by the require- ment may have failed to include a pro- vision in its plans at the time the corpo- ration is contemplating becoming a pub- lic corporation. These regulations pro- vide that where the stock of the service recipient is not publicly traded on an es- tablished securities market, a plan may be amended to specify or change the manner in which the delay will be implemented, ef- fective immediately upon adoption of the amendment. A plan may provide a service provider an election as to the manner in which the six-month delay is to be imple- mented, provided that such election is sub- ject to otherwise applicable deferral elec- tion rules. D.Death or disability Asprovidedinsection 409A(a)(2)(A)(ii) and (iii), these regula- tions state that the death or disability of the service provider are permissible payment events. The regulations incorporate the definition of disability provided in section 409A(a)(2)(C). These regulations clarify that a plan that provides for a payment October 24, 20058062005–43 I.R.B. upon a disability need not provide for a payment upon all disabilities identified in section 409A(a)(2)(C), as long as any disability upon which a payment would be made is contained within the definition provided in section 409A(a)(2)(C). In addition, these regulations provide that a service recipient may rely upon a determination of the Social Security Ad- ministration with respect to the existence of a disability. E.Change in ownership or effective control of the corporation The provisions defining a change in ownership or effective control of a cor- poration remain substantially unchanged from Notice 2005–1, Q&As–11 through 14. These provisions are based largely upon the discussion in the legislative his- tory, indicating that the guidance should provide a similar, but more restrictive, definition of a change in the ownership or effective control of a corporation as compared to the definition used for pur- poses of the golden parachute provisions of section 280G. H.R. Conf. Rep. No. 108–755, at 730 (2004). Accordingly, the provisions largely mirror the regulations under section 280G, though the percentage changes in ownership necessary to qual- ify as permissible payment events have increased. However, unlike the golden parachute provisions, a change in control event may occur that does not relate to the entire group of affiliated corporations. Rather, the relevant analysis for purposes of section 409A generally is whether the corporation for whom the service provider performed services at the time of the event, the corporation or corporations liable for the payment at the time of the event, or a corporate majority shareholder of one of these corporations, experienced a change in control event. Commentators asked whether the pro- visions relating to the change in ownership or effective control of a corporation will be extended to non-corporate entities. Specif- ically, some commentators asked whether change in control provisions could be ap- plied in the case of a partnership or other pass-through entity. Neither the statute nor the legislative history refers to a permissi- ble distribution upon a change in owner- ship or effective control of any type of en- tity other than a corporation. However, the Treasury Department and the IRS plan to issue regulations un- der section 409A(a)(3) that will allow an acceleration of payments upon a change in the ownership of a partnership or in the ownership of a substantial portion of the assets of the partnership. Until further guidance is issued, the section 409A rules regarding permissible distri- butions upon a change in the ownership of a corporation (as described in proposed §1.409A–3(g)(5)(v)) or a change in the ownership of a substantial portion of the assets of a corporation (as described in proposed §1.409A–3(g)(5)(vii)) may be applied by analogy to changes in the own- ership of a partnership and changes in the ownership of a substantial portion of the assets of a partnership. For purposes of this paragraph, any references in pro- posed §1.409A–3(g)(5) to corporations, shareholders, and stock shall be treated as referring also to partnerships, partners, and partnership interests, respectively, and any reference to “majority shareholder” as applied by analogy to the owner of a partnership shall be treated as referring to a partner that (a) owns more than 50 per- cent of the capital and profits interests of such partnership, and (b) alone or together with others is vested with the continuing exclusive authorityto make the manage- ment decisions necessary to conduct the business for which the partnership was formed. The Treasury Department and the IRS request comments with respect to the application of a change in con- trol provision to partnerships and other non-corporate entities, as well as sug- gestions with respect to the formulation of which types of events should qualify and would be analogous to the corporate events described in the regulations. Commentators also raised questions re- garding the application of section 409A to earn-out provisions where an acquirer con- tracts to make an immediate payment at the closing of the transaction with additional amounts payable at a later date, subject to the satisfaction of specified conditions. In such situations, the later payments could create delays in payments of compensa- tion calculated by reference to the value of target corporation shares. These regu- lations address this situation by providing that compensation payable pursuant to the purchase by the servicerecipient of service recipient stock or a stock right held by a service provider, or payment of amounts of deferred compensation calculated by refer- ence to the value of service recipient stock, may be treated as paid at a specified time or pursuant to a fixed schedule in con- formity with the requirements of section 409A if paid on the same schedule and un- der the same terms and conditions as pay- ments to shareholders generally pursuant to a change in the ownership of a corpo- ration that qualifies as a change in control event or as payments to the service recipi- ent pursuant to a change in the ownership of a substantial portion of a corporation’s assets that qualifies as a change in control event, and any amounts paid pursuant to such a schedule and such terms and condi- tions will not be treated as violating the ini- tial or subsequent deferral election rules, to the extent that such amounts are paid not later than five years after the change in control event. F.Unforeseeable emergency The regulations contain provisions defining the types of circumstances that constitute an unforeseeable emergency, and the amounts that may be paid due to the unforeseeable emergency. Generally these provisions are derived directly from section 409A(a)(2)(B)(ii). Commentators requested that in the case of an unfore- seeable emergency, a service provider be permitted to cancel future deferrals. This issue is discussed in this preamble at para- graph VII.D. G.Multiple payment events The regulations permit a plan to pro- vide that payments may be made upon the earlier of, or the later of, two or more specified permissible payment events or times. In addition, the regulations pro- vide that a different form of payment may be elected for each potential payment event. For example, a plan may provide that a service provider will receive an in- stallment payment upon separation from service or, if earlier, a lump sum payment upon death. The application of the rules governing changes in time and form of payment and the anti-acceleration rules to amounts subject to multiple payment events, is discussed below. 2005–43 I.R.B.807October 24, 2005 H.Delay in payment by the service recipient Commentators notedthat for certain compelling reasons, a service recipient may be unwilling or unable to make a pay- ment of an amount due under a nonqual- ified deferred compensation plan. These regulations generally provide that in the case of payments the deduction for which would be limited or eliminated by the application of section 162(m), payments that would violate securities laws, or pay- ments that would violate loan covenants or other contractual terms to which the service recipient is a party, where such a violation would result in material harm to the service recipient, the plan may pro- vide that the payment will be delayed. In addition, plans may be amended to add such provisions, but such an amendment cannot be effective for a period of at least 12 months. However, if a plan is amended to remove such a provision with respect to amounts deferred previously, the amend- ment will constitute an acceleration of the payment. In the case of amounts for which the deduction would be limited or reduced by the application of section 162(m), these regulations require that the payment be deferred either to a date in the first year in which the service recipient reasonably anticipates that a payment of such amount would not result in a limitation of a deduc- tion with respect to the payment of such amount under section 162(m) or the year in which the service provider separates from service. In the case of amounts that would violate loan covenants or similar contracts, or would result in a violation of Federal securities laws or other applicable laws, the arrangement must provide that the payment will be made in the first cal- endar year in which the service recipient reasonably anticipates that the payment would not violate the loan contractual terms, the violation would not result in material harm to the service recipient, or the payment would not result in a violation of Federal securities law or other applica- ble laws. These regulations also provide that the Commissioner may prescribe through guidance published in the Internal Revenue Bulletin other circumstances in which a plan may provide for the delay of a payment of a deferred amount. The Treasury Department and the IRS specif- ically request comments as to what other circumstances may be appropriate to in- clude in such guidance. I.Disputed payments and refusals to pay In addition to situations in which a plan may delay payment due to certain business circumstances, commentators expressed concern about the possibility that a service recipient will refuse to pay deferred com- pensation when the payment is due, and whether such refusal to pay would result in taxation of the service provider under section 409A. Generally these situations will arise where either the obligation to make the payment, or the amount of the payment, is subject to dispute. But this situation may also arise where the service recipient simply refuses to pay. In either situation, these proposed regulations gen- erally provide that the payment will be deemed to be made upon the date sched- uled under the terms of the arrangement, provided that the service provider is acting in good faith and makes reasonable, good faith efforts to collect the amount. Factors relevant in determining whether a service provider is acting in good faith and mak- ing reasonable, good faith efforts to collect the amount include both the amount of the payment, or portion of a payment, in dis- pute, as well as the size of the disputed portioninrelationtotheentirepayment. Although a payment may be delayed un- der this provision without violating section 409A because the service recipient refuses to make the payment, the payment may not be made subject to a subsequent deferral election because the payment was delayed. Rather, the payment must be made by the later of the end of the calendar year in which, or the 15 th day of the third month following the date that, the service recip- ient and the service provider enter into a legally binding settlement of such dispute, the service recipient concedes that the full amount is payable, or the service recipient is required to make such payment pursuant to a final and nonappealable judgment or other binding decision. This paragraph is not intended to serve as a means of deferring payments without application of section 409A, by feigning a dispute or surreptitiously requesting that the service recipient refuse to pay the amount at the due date. Where the service provider is not acting in good faith, for example cre- ating a dispute with no or tenuous basis, or where the service provider is not making reasonable, good faith efforts to collect the amount, the failure to receive the pay- ment at the date originally scheduled may result in a violation of the permissible payment requirements. Among the factors to be considered is the practice of the ser- vice recipient with respect to payments of nonqualified deferred compensation. In addition, these regulations provide that the service provider is treated as having re- quested that a payment not be made, rather than the service recipient having refused to make such payment, where the decision that the service recipient will not make the payment is made by the service provider, or any person or group of persons under the supervision of the service provider at the time the decision is made. VII.Anti-acceleration Provision A.In general Under section 409A(a)(3), a payment of deferred compensation may not be ac- celerated except as provided in regulations by the Secretary. Certain permissible pay- ment accelerations were listed in Notice 2005–1, Q&A–15, including payments necessary to comply with a domestic rela- tions order, payments necessary to comply with certain conflict of interest rules, pay- ments intended to pay employment taxes, and certainde minimispayments related to the participant’s termination of his or her interest in the plan. All the permissible payment accelerations contained in Notice 2005–1, Q&A–15, are included in these regulations. B.Payments upon income inclusion under section 409A These regulations provide that a plan may permit the acceleration of the time or schedule of a payment to a service provider to pay the amount the service provider includes inincome as a result of the plan failing to meet the requirements of section 409A. For this purpose, a service provider will be deemed to have included the amount in income if the amount is timely reported on a Form W–2, “Wage and Tax Statement”, or Form 1099–MISC, “Miscellaneous Income”, as appropriate. October 24, 20058082005–43 I.R.B. C.Plan terminations Some commentators requested that service recipients be allowed to retain the right to accelerate payments upon a termination of the arrangement, where the termination is at the discretion of the service recipient. A general ability of a service recipient to make such payments raises the potential for abuse, especially with respect to arrangements with indi- vidual service providers. Where a service provider retains sufficient influence to ob- tain a termination of the arrangement, the service recipient’s discretion to terminate the plan in substance would mean that amounts deferred were available to the service provider upon demand. Such a condition would be inconsistent with the provisions of and legislative intent behind section 409A. Some commentators requested that ser- vice recipients be permitted to terminate arrangements where the arrangements are broad-based, covering a significant num- ber of service providers. Due to concerns about administrability and equity, the reg- ulations do not adopt the suggestion. Some commentators also suggested that service recipients be permitted to termi- nate arrangements due tobona fidebusi- ness reasons. However, the Treasury De- partment and the IRS are not confident that such a standard could be applied on a consistent and coherent basis, leaving ser- vice recipients unable to plan with confi- dence and creating the potential for abuse. The Treasury Department and the IRS are considering further guidance establishing criteria or circumstances under which a plan could be terminated. For that pur- pose, these regulations provide authority to the Commissioner to establish such crite- ria or circumstances in generally applica- ble guidance published in the Internal Rev- enue Bulletin. These proposed regulations provide three circumstances under which a plan may be terminated at the discretion of the service recipient in accordance with the terms of the plan. The first addresses a ser- vice recipient that wants to cease providing a certain category of nonqualified deferred compensation, such as account balance plans, entirely. A plan may be terminated provided that all arrangements of the same type (account balance plans, nonaccount balance plans, separation pay plans or other arrangements) are terminated with respect to all participants, no payments other than those otherwise payable under the terms of the plan absent a termination of the plan are made within 12 months of the termination of the arrangement, all payments are made within 24 months of the termination of the arrangement, and the service recipient does not adopt a new arrangement that would be aggregated with any terminated arrangement under the plan aggregation rules at any time for aperiodoffiveyearsfollowingthedateof termination of the arrangement. The remaining two exceptions relate to events that are both objectively deter- minable to have occurred-and so may be determined consistently-and are of such independent significance that they are unlikely to be related to any attempt to accelerate payments under a nonqualified deferred compensation plan in a manner inconsistent with the intent of the statute. These regulations provide that during the 12 months following a change in control of a corporation, the service recipient may elect to terminate a plan and make pay- ments to the participants. In addition, a plan may provide that the plan terminates upon a corporate dissolution taxed under section 331, or with the approval of a bankruptcy court pursuant to 11 U.S.C. §503(b)(1)(A), provided that the amounts deferred under the plan are included in the participants’ gross incomes by the latest of (i) the calendar year in which the plan termination occurs, (ii) the calendar year in which the amount is no longer subject to a substantial risk of forfeiture, or (iii) the first calendar year in which the payment is administratively practicable. D.Terminations of deferral elections following an unforeseeable emergency or a hardship distribution Commentators noted that although sec- tion 409A provides that a service provider may receive a payment upon an unforesee- able emergency, there is no provision ex- plicitly permitting or requiring the service provider to halt all elective deferrals to re- ceive such a payment. In addition, com- mentators noted thatto receive a hardship distribution under a qualified plan with a qualified cash or deferred arrangement un- der section 401(k), a participant generally would be required pursuant to the regula- tions under section 401(k) to halt any elec- tive deferrals of compensation into a non- qualified deferred compensation plan. In response, these regulations provide that a plan may provide that a deferral election terminates if a service provider obtains a payment upon an unforeseeable emer- gency. Similarly, these regulations pro- vide that a plan may provide that a deferral election is terminated if required for a ser- vice provider to obtain a hardship distribu- tion under a qualified plan with a qualified cash or deferred arrangement under sec- tion 401(k). In each case, the deferral elec- tion must be terminated, and not merely suspended. A deferral election under the arrangement made after a termination of a deferral election due to a hardship distri- bution or an unforeseeable emergency will be treated as an initial deferral election. E.Distributions to avoid a nonallocation year under section 409(p) Commentators noted that in the case of an S corporation sponsoring an employee stock ownership plan, under certain condi- tions distributions from a nonqualified de- ferred compensation plan may be neces- sary to avoid a nonallocation year (within the meaning of section 409(p)(3)). These regulations provide rules under which such distributions may be made to avoid such a nonallocation year. VIII.Subsequent Changes in the Time and Form of Payment A.In general Section 409A(a)(4)(C) and these regu- lations provide that, in the case of a plan that permits a service provider to make a subsequent election to delay a payment or to change the form of a payment (provided that any such payment is the subject of an initial deferral election), the following conditions must be met: (1) The plan must require that such election not take effect until at least 12 months after the date on which the elec- tion is made, (2) In the case of an election related to a payment other than a payment on account of death, disability or the occurrence of an unforeseeable emergency, the plan re- quires that the firstpayment with respect to which such election is made be deferred for a period of not less than 5 years from 2005–43 I.R.B.809October 24, 2005 the date such payment would otherwise have been made (the 5-year rule), and (3) The plan requires that any election related to a payment at a specified time or pursuant to a fixed schedule may not be made less than 12 months prior to the date of the first scheduled payment. B.Definition of payment Commentators requested clarification whether the individual amounts paid in a defined stream of payments, such as in- stallment payments, are treated as separate payments or as one payment. This affects the application of the rules governing sub- sequent deferral elections, particularly the 5-year rule. These proposed regulations provide generally that each separately identified amount to which a service provider is entitled to payment under a plan on a determinable date is a separate payment. Accordingly, if an amount is separately identified as a payment, either because the right arises under a separate arrangement or because the arrangement identifies the amount as a separate payment, the amount will not be aggregated with other amounts for purposes of the rules relating to sub- sequent changes in the time and form of payment and the anti-acceleration rule. For example, an arrangement may provide that 50 percent of the benefit is paid as a lump sum at separation from service, and that the remainder of the benefit is paid as a lump sum at age 60, which would iden- tify each amount as a separate payment. However, once a payment has been iden- tified separately, the payment may only be aggregated with another payment if the aggregation would otherwise comply with the rules relating to subsequent changes in the time and form of payment and the anti-acceleration rule. The Treasury Department and the IRS recognize that most taxpayers view the ability to elect installment payments as a choice of a single form of payment. Ac- cordingly, the entitlement to a series of in- stallment payments under a particular ar- rangement generallyis treated as a sin- gle payment for purposes of the subse- quent deferral rules. However, taxpayers could also view each individual payment in the series of payments as a separate pay- ment. Accordingly, these regulations pro- vide that an arrangement may specify that a series of installment payments is to be treated as a series of separate payments. An installment payment must be treated consistently both with respect to the rules governing subsequent changes in the time and form of payment, and with respect to the anti-acceleration rules. For exam- ple, if a 5-year installment payment is treated as a single payment and is sched- uled to commence on July 1, 2010, then consistent with the 5-year rule a service provider generally could change the time and form of the payment to a lump sum payment on July 1, 2015, provided the other conditions related to a change in the time and form of payment were met. In contrast, if a 5-year installment payment is designated as five separate payments scheduled for the years 2010 through 2014, then the service provider could not change the time and form of the payment to a lump sum payment to be made on July 1, 2015, because the separate payments scheduled for the years 2011 through 2014 would not have been deferred at least 5 years. Rather, the service provider gen- erally could change the time and form of payment to a lump sum payment only if the payment were scheduled to occur no earlier than 2019 (5 years after the last of the originally scheduled payments). One exception to this rule is a life annu- ity, the entitlement to which is treated as a single payment. The Treasury Department and the IRS believe that taxpayers gener- ally view an entitlement to a life annuity as a single form of payment, rather than a series of separate payments. In addition, treating a life annuity as a series of pay- ments would lead to difficulty in applying the rules governing subsequent changes in the time and form of payment, because the aggregate amount of the payments and the duration of the payments are unknown, as their continuation depends on the contin- ued life of the service provider or other in- dividual. For example, if a single life an- nuity were treated as a series of separate payments, an election to change a form of payment to a lump sum payment could be made only if the lump sum payment were deferred to a date no earlier than five years after the death of the participant. C.Application to multiple payment events As discussed above, a plan may provide that a payment will be made upon the ear- lier of, or the later of, multiple specified permissible payment events. In addition, a plan may provide for a different form of payment depending upon the payment event. For example, a plan may provide that a service providerisentitledtoanan- nuity at age 65 or, if earlier, a lump sum payment upon separation from service. Thequestionthenarisesastohowthe provisions governing changes in the time and form of payment and the anti-accelera- tion provision apply where there are multi- ple potential payment events, and possibly multiple forms of payment as well. The regulations provide that these provisions are to apply to each payment event sepa- rately. In the example above, these provi- sions would apply separately to the entitle- ment to the installment payment at age 65, and the entitlement to the lump sum pay- ment at separation from service. Accord- ingly, the service provider generally would be able to delay the annuity payment date subject to the rules governing changes in the time and form of payment, while re- taining a separate right to receive a lump sum payment at separation from service if that occurred at an earlier date. In other words, the 5-year rule would apply to the annuity payment date (delaying payment from age 65 to at least age 70) but not to the unchanged lumpsum payment avail- able upon separation from service before age 70. Similarly, a plan may provide that an in- tervening event that is a permissible pay- ment event under section 409A may over- ride an existing payment schedule already in payment status. For example, a plan could provide that a participant would re- ceive six installment payments commenc- ing at separation from service, but also pro- vide that if the participant died after the payments commenced, all remaining ben- efitswouldbepaidinalumpsum. An additional question arises where a new payment event, or a fixed time or fixed schedule of payments, is added to the plan. Generally, the addition of the pay- ment event or date will be subject to the rules governing changes in the time and form of payment and the anti-acceleration rules. Accordingly, no fixed time of pay- ment could be added that did not defer the payment at least five years from the date the fixed time was added. In addition, no payment due to any other added permissi- bleeventcouldbemadewithinfiveyears October 24, 20058102005–43 I.R.B. of the addition of the event. For example, a service provider entitled to a payment only on January 1, 2050, could not make a sub- sequent deferral election to be paid on the later of January 1, 2050, or separation from service, but could make a subsequent de- ferral election to be paid at the later of sep- aration from service or January 1, 2055. IX.Application of Rules to Nonqualified Deferred Compensation Plans Linked to Qualified Plans A.In general Commentators raised many issues con- cerning the application of section 409A to nonqualified deferred compensation plans linked to qualified plans. These linked plans exist in a variety of formats, and are referred to under various labels such as excess plans, wrap plans, and supplemental employee retirement plans (SERPs). Typically the purpose of such plans is to replace the benefits that would have been provided under the qualified plan absent the application of certain lim- its contained in the Code (for example, section 415, section 401(a)(17) or section 402(g)). Often the amounts deferred under the nonqualified deferred compensation plan are established through an offset for- mula, where the amount deferred equals an amount determined under a formula, offset by any benefits credited under the qualified plan. Because of the close rela- tionship between the qualified plan and the nonqualified deferred compensation plan, sponsor and participant actions under the qualified plan may affect the calculation or payment of the amounts deferred under the nonqualified deferred compensation plan. Commentators asked for guidance regarding the circumstances under which an action (or failure to act) under the qualified plan may betreated as violating section 409A, to the extent the action (or failure to act) also affects the amounts deferred under the nonqualified deferred compensation plan. These proposed regulations generally adopt rules under which nonqualified de- ferred compensation plans linked to quali- fied plans may continue to operate, though certain changes may be required. The in- tent of these rules generally is to permit the qualified plan to be established, amended and operated under the rules governing qualified plans, without causing the linked nonqualified deferred compensation plan to violate the rules of section 409A. How- ever, the relief provided under certain rules to accommodate the linked plan structure is not intended to relax the rules generally with respect to all of the amounts deferred under the nonqualified deferred compen- sation plan, simply because a limited por- tion of the amounts deferred may be af- fected by actions under the qualified plan. Accordingly, in certain circumstances the relief provided relates solely to amounts deferred under the nonqualified deferred compensation plan that do not exceed the applicable limit on the qualified plan ben- efit for the taxable year. B.Actions that do not constitute deferral elections or accelerations Where amounts deferred under a non- qualified deferred compensation plan are linked to the benefits under a qualified plan, certain participant actions taken with respect to the benefit accrued under the qualified plan may affect the amounts deferred under the nonqualified deferred compensation plan.Where the amounts deferred under the nonqualified deferred compensation plan increase, the issue is whether the action taken with respect to the benefit accrued under the qualified plan constitutes a deferral election. Where the amounts deferred under the nonquali- fied deferred compensation plan decrease, the issue is whether the action taken with respect to the benefit accrued under the qualified plan constitutes an impermissi- ble acceleration of a payment under the nonqualified deferred compensation plan. With respect to the benefits provided under the qualified plan, these regulations provide generally that neither the amend- ment of the qualified plan to increase or decrease such benefits under the qualified plan nor the cessation of future accruals under the qualified plan is treated as a de- ferral election or an acceleration of a pay- ment under the nonqualified deferred com- pensation plan. Similarly, the addition, removal, increase or reduction of a sub- sidized benefit or ancillary benefit under the qualified plan, or a participant elec- tion with respect to a subsidized benefit or ancillary benefit under the qualified plan, will not constitute either a deferral election or an acceleration of a payment under the nonqualified deferred compensation, even where such action results in an increase or decrease in amounts deferred under the nonqualified deferred compensation plan. Additional relief is provided with re- spect to nonqualified deferred compensa- tion plans linked to defined contribution plans that include a 401(k) or similar cash or deferred arrangement. Specifically, the regulations provide that a service provider’s action or inaction under a qual- ified plan that is subject to section 402(g), including an adjustment to a deferral elec- tion under such qualified plan, will not be treated as either a deferral election or an acceleration of a payment under the linked nonqualified deferred compensation plan, provided that for any given calendar year, the service provider’s actions or inactions under the qualified plan do not result in an increase in the amounts deferred under all nonqualified deferred compensation plans in which the service provider partic- ipates in excess of the limit with respect to elective deferrals under section 402(g) in effect for the year in which such actions or inactions occur. The Treasury Department and the IRS intend for this provision to ad- dress common arrangements whereby the amounts deferred under the nonqualified deferred compensation plan are linked to amounts deferred under a 401(k) arrange- ment (often referred to as 401(k) wrap plans), but only to the extent the amount of affected deferrals under the nonquali- fied deferred compensation plan does not exceed the maximum amount that ever could have been electively deferred under the qualified plan. Similar relief is provided with respect to plans involving matching contributions. The regulations provide that a service provider’s action or inaction under a qual- ified plan with respect to elective deferrals or after-tax contributions by the service provider to the qualified plan that affects the amounts that are credited under a nonqualified deferred compensation ar- rangement as matching amounts or other amounts contingent on service provider elective deferrals orafter-tax contribu- tions will not be treated as either a deferral election or an acceleration of payment, provided that such matching or contingent amounts, as applicable, are either forfeited or never credited under the nonqualified deferred compensation arrangement in the absence of such service provider’s elec- 2005–43 I.R.B.811October 24, 2005 tive deferral or after-tax contribution, and provided the service provider’s actions or inactions under the qualified plan do not result in an increase or decrease in the amounts deferred under all nonqualified deferred compensation plans in which the service provider participates in excess of the limit with respect to elective deferrals under section 402(g) in effect for the year in which such actions or inactions occur. Although the section 402(g) limit applies to elective deferrals, rather than matching contributions, the Treasury Department and the IRS believe that matching con- tributions in excess of 100 percent of the elective deferrals of pre-tax contributions or after-tax contributions will be rare. X.Statutory Effective Dates A.Effective dates — earned and vested amounts Consistent with Notice 2005–1, Q&A–16, these regulations provide that an amount is considered deferred before January 1, 2005, and thus is not subject to section 409A, if the service provider had a legally binding right to be paid the amount and the right to the amount was earned and vested as of December 31, 2004. For these purposes, a right to an amount is earned and vested only if the amount is not sub- ject to either a substantial risk of forfeiture or a requirement to perform further ser- vices. Some commentators questioned the application of section 409A to contrac- tual arrangements entered into before the enactment of the statute. However, the statutory effective date is tied to the date the amount is deferred and the legislative history states that for these purposes, “an amount is considered deferred before Jan- uary 1, 2005, if the amount is earned and vested before such date.” H.R. Conf. Rep. No. 108–755, at 737 (2004). Accordingly, these regulations are consistent with the legislative intent that deferred amounts that were not earned, or were not vested, as of December 31, 2004, are subject to the provisions of section 409A. Clarification has been provided with re- spect to when a stock right or similar right to compensation will be treated as earned and vested. The issue arises because of- ten a stock right terminates upon a sepa- ration from service. Taxpayers questioned whether this meant that the right had not been earned and vested, because future ser- vices would be required to retain the right. These regulations clarify that a stock right or similar right will be treated as earned and vested by December 31, 2004, if on or before such date the right was either immediately exercisable for a payment of cash or substantially vested property, or was not forfeitable. Accordingly, stock op- tions that on or before December 31, 2004, were immediately exercisable for substan- tially vested stock generally would not be subject to section 409A. In contrast, a non- statutory stock option that was immedi- ately exercisable on or before December 31, 2004, but only for substantially non- vested stock, generally would be subject to section 409A. B.Effective dates — calculation of grandfathered amount For account balance plans and plans that are neither account balance plans nor nonaccount balance plans (generally equity-based compensation), these reg- ulations generally retain the method of calculating the grandfathered amount set forth in Notice 2005–1, Q&A–17. Ac- cordingly, for account balance plans the grandfathered amount generally will equal the vested account balance as of December 31, 2004, plus any earnings with respect to such amounts. For equity-based com- pensation, the grandfathered amount gen- erally will equal the payment that would be available if the right were exercised on December 31, 2004, and any earnings with respect to such amount. For this purpose, the earnings generally would include the increase in the payment available due to appreciation in theunderlying stock. Commentators argued that the defi- nition of the grandfathered amount con- tained in Notice 2005–1, Q&A–17 with respect to nonaccount balance plans was not sufficiently flexible to account for subsequent increases in benefits unrelated to any further performance of services or increases in compensation after December 31, 2004. For example, a participant’s benefit may increase if the participant be- comes eligible for a subsidized benefit at a specified age that the participant reaches after December 31, 2004. In response, these proposed regulations provide that for nonaccount balanceplans, the grand- fathered amount specifically equals the present value as of December 31, 2004, of the amount to which the service provider would be entitled under the plan if the service provider voluntarily terminated services without cause on December 31, 2004, and received a payment of the ben- efits with the maximum value available from the plan on the earliest possible date allowed under the plan to receive a pay- ment of benefits following the termination of services. Notwithstanding the fore- going, for any subsequent calendar year, the grandfathered amount may increase to equal the present value of the benefit the service provider actually becomes enti- tled to, determined under the terms of the plan (including applicable limits under the Code), as in effect on October 3, 2004, without regard to any further services rendered by the service provider after December 31, 2004, or any other events affecting the amount of or the entitlement to benefits (other than the participant’s survival or a participant election under the terms of the plan with respect to the time or form of an available benefit). Because separation pay plans with re- spect to involuntary terminations and win- dow programs are now treated as separate plans, these regulations provide a rule for calculating the grandfathered amount un- der such plans. For these purposes, the principles used to calculate the grandfa- thered amounts under a nonaccount bal- ance plan and an account balance plan are to be applied by analogy, depending upon the structure of the separation pay plan. C.Material modifications Commentators have pointed out that a grandfathered plan may become subject to section 409A upon any material modifi- cation, even if such modification occurs many years after 2004. Given the substan- tial amounts of compensation that are de- ferred under grandfathered plans, as well as the potential for these amounts to grow through accumulated grandfathered earn- ings, the consequences of such a modifi- cation could be significant. Commenta- tors expressed concern that as long as these plans exist, there will be the potential for a change to the plan to mistakenly cause the plan to become subject to section 409A. In response, these regulations include a pro- vision stating that to the extent a modi- fication is rescinded before the earlier of October 24, 20058122005–43 I.R.B. thedateanyadditional right granted under the modification is exercised or the end of the calendar year in which the modifica- tion was made, the modification will not be treated as a material modification of the plan. For example, if a subsequent deferral feature is added that would allow partici- pants to extend the time and form of pay- ment of a grandfathered deferred amount, and if the right is removed before the ear- lier of the time the participant exercises the right or the end of the calendar year, then the modification will not be treated as a material modification of the plan. How- ever, this provision is not intended to cover material modifications that are made with the knowledge that the modification will subject the amounts to section 409A, but are then rescinded. Consistent with Notice 2005–1, Q&A–18(a), these regulations also pro- vide that it is not a material modification to change a notional investment mea- sure to, or to add, an investment mea- sure that qualifies as a predetermined actual investment within the meaning of §31.3121(v)(2)–1(d)(2) of this chapter. Commentators requested similar flexibil- ity with respect to investment measures re- flecting reasonable rates of interest. These regulations provide such flexibility, gen- erally adopting a modified version of the rules contained in §31.3121(v)(2)–1(d)(2) of this chapter. Under these regulations, it is not a material modification to change a notional investment measure to, or to add, an investment measure that qualifies as a predetermined actual investment within the meaning of §31.3121(v)(2)–1(d)(2) of this chapter or, for any given taxable year, reflects a reasonable rate of interest. For this purpose, if with respect to an amount deferred for a period, a plan provides for a fixed rate of interest to be credited, and the rate is to be reset under the plan at a specified future datethat is not later than the end of the fifth calendar year that be- gins after the beginning of the period, the rate is reasonable at the beginning of the period, and the rate is not changed before the reset date, then the rate will be treated as reasonable in all future periods before the reset date. These proposed regulations also contain other clarifications of the ap- plication of the material modification rule. XI.Transition Relief A.In general Until the effective date of these regula- tions, Notice 2005–1 generally remains in effect. Notice 2005–1, Q&As–18 through 23, provided transition relief that was lim- ited to the 2005 calendar year. Commen- tators generally reacted favorably to the scope of the transition rules. The Treasury Department and the IRS intended for the transition rules to be generous during the calendar year 2005, both to enable taxpay- ers to familiarize themselves with the new provisions, and also to provide a period during which the Treasury Department and the IRS could develop regulations and tax- payers generally could be confident that ei- ther their plans were not in violation of sec- tion 409A, or could be corrected to avoid additional tax under the statute. Because final regulations are not yet in place, the IRS and the Treasury Depart- ment are hereby extending through 2006 certain aspects of the transition relief pro- vided for 2005 by Notice 2005–1. In ad- dition, in response to questions, certain provisions of Notice 2005–1 are clarified below. However, because taxpayers will have had, by the end of 2005, over a year to implement the statute, certain other tran- sition relief is not being extended through 2006. B.Amendment and operation of plans adopted on or before December 31, 2006 Pursuant to Notice 2005–1, Q&A–19, a plan adopted on or before December 31, 2005, will not be treated as violating sec- tion 409A(a)(2), (3) or (4) only if the plan is operated in good faith compliance with the provisions of section 409A and No- tice 2005–1 during the calendar year 2005, and the plan is amended on or before De- cember 31, 2005, to conform to the pro- visions of section 409A with respect to amounts subject to section 409A. To allow time to finalize these regulations, and for practitioners to implement the final regu- lations, the deadline by which plan docu- ments must be amended to comply with the provisions of section 409A and the regula- tions is hereby extended to December 31, 2006. Accordingly, in order to be treated as complying with section 409A(a)(2), (3) or (4), a plan adopted before December 31, 2006, must be amended on or before De- cember 31, 2006, either to conform to the provisions of section 409A with respect to amounts subject to section 409A, or to provide a compensation arrangement that does not provide for a deferral of compen- sation for purposes of section 409A. The good faith compliance period pro- vided under Q&A–19 of Notice 2005–1 is also hereby extended through December 31, 2006. Accordingly, a plan adopted on or before December 31, 2006, will be treated as complying with section 409A(a)(2), (3) or (4) only if the plan is operated through December 31, 2006, in good faith compliance with the provisions of section 409A and Notice 2005–1. If any other guidance of general applicabil- ity under section 409A is published in the Internal Revenue Bulletin with an effec- tive date prior to January 1, 2007, the plan must also comply with such published guidance as of its effective date. To the extent an issue is not addressed in Notice 2005–1 or such other published guidance, the plan must follow a good faith, reason- able interpretation of section 409A, and, to the extent not inconsistent therewith, the plan’s terms. These regulations are not proposed to become effective prior to January 1, 2007, and, accordingly, a plan is not required to comply with either these proposed regula- tions or the final regulations prior to Jan- uary 1, 2007. However, compliance with either these proposed regulations or the fi- nal regulations will be good faith compli- ance with the statute. In general, these pro- posed regulations expand upon, and should be read consistently with, the provisions of Notice 2005–1. However, to the ex- tent that a provision of either these pro- posed regulations or the final regulations is inconsistent with a provision of Notice 2005–1, the plan may comply with the pro- vision of the proposed or final regulations in lieu of the corresponding provision of Notice 2005–1. A plan will not be operating in good faith compliance if the plan sponsor ex- ercises discretion under the terms of the plan, or a service provider exercises discre- tion with respect to that service provider’s benefits, in a manner that causes the plan to fail to meet the requirements of section 409A. For example, if an employer retains the discretion under the terms of the plan to delay or extend payments under the plan 2005–43 I.R.B.813October 24, 2005 and exercises such discretion, the plan will notbeconsideredtobeoperatedingood faith compliance with section 409A with regard to any plan participant. However, an exercise of a right under the terms of theplanbyaserviceprovidersolelywith respect to that service provider’s benefits under the plan, in a manner that causes the plan to fail to meet the requirements of sec- tion 409A, will not be considered to result in the plan failing to be operated in good faith compliance with respect to other par- ticipants. For example, the request for and receipt of an immediate payment permit- ted under the terms of the plan if the par- ticipant forfeits 20 percent of the partici- pant’s benefits (a haircut) will be consid- ered a failure of the plan to meet the re- quirements of section 409A with respect to that service provider, but not with re- spect to all other service providers under the plan. C.Change in payment elections or conditions on or before December 31, 2006 Notice 2005–1, Q&A–19(c) provided generally that with respect to amounts subject to section 409A, a plan could be amended to provide for new payment elections without violating the subsequent deferral and anti-acceleration rules, pro- vided that the plan was amended and the participant made the election on or before December 31, 2005. The period during which a plan may be amended and a ser- vice provider may be permitted to change payment elections, without resulting in an impermissible subsequent deferral or acceleration, is hereby extended through December 31, 2006, except that a service provider cannot in 2006 change payment elections with respect to payments that the service provider would otherwise receive in 2006, or to cause payments to be made in 2006. Other provisions of the Internal Revenue Code and common law doctrines continue to apply to any such election. Accordingly, with respect to amounts subject to section 409A and amounts that would be treated as a short-term deferral within the meaning of §1.409A–1(b)(4), a plan may provide, or be amended to provide, for new payment elections on or before December 31, 2006, with respect to both the time and form of payment of such amounts and the election will not be treated as a change in the form and tim- ing of a payment under section 409A(a)(4) or an acceleration of a payment under sec- tion 409A(a)(3), provided that the plan is so amended and the service provider makes any applicable election on or be- fore December 31, 2006, and provided that the amendment and election applies only to amounts that would not otherwise be payable in 2006 and does not cause an amount to be paid in 2006 that would not otherwise be payable in such year. Simi- larly, an outstanding stock right that pro- vides for a deferral of compensation sub- ject to section 409A may be amended to provide for fixed payment terms consis- tent with section 409A, or to permit hold- ers of such rights to elect fixed payment terms consistent with section 409A, and such amendment or election will not be treated as a change in the time and form of a payment under section 409A(a)(4) or an acceleration of a payment under sec- tion 409A(a)(3), provided that the option or right is so amended and any elections are made, on or before December 31, 2006. D.Payments based upon an election under aqualifiedplanforperiodsendingonor before December 31, 2006 For calendar year 2005, Notice 2005–1 Q&A–23 provides relief for nonqualified deferred compensation plans where the time and form of payment is controlled by the time and form of payment elected by the service provider under a qualified plan. Commentators indicated that this is a common arrangement with respect to nonqualified deferred compensation plans providing benefits calculated in relation to benefits accrued under a defined benefit qualified plan. Generally, the provisions with respect to the election of a time and form of a payment with respect to a qual- ified plan benefit would not comply with the requirements of section 409A were the plan subject to section 409A. Accordingly, election provisions under a nonqualified plan that mirrored or depended upon an election under a qualified plan generally would not comply with section 409A. The Treasury Department and the IRS were concerned that serviceproviders, service recipients and plan administrators would not have sufficient time to solicit, retain and process new elections from service providers to comply with section 409A in 2005. Accordingly, relief was provided in Notice 2005–1, Q&A–23, under which an election under a nonqualified deferred compensation plan that was controlled by an election under a qualified plan could continue in effect during the calendar year 2005. Commentators requested that this re- lief be a permanent provision in the reg- ulations. Although the Treasury Depart- ment and the IRS understand that such a provision would make the coordination of benefits under a qualified plan and ben- efits under a nonqualified deferred com- pensation plan calculated by reference to the qualified plan benefits easier to admin- ister, the provisions of section 409A are not as flexible with respect to the timing of such elections as the qualified plan pro- visions. Given that the benefits under a nonqualified deferred compensation plan often dwarf the benefits provided under a qualified plan, the Treasury Department and the IRS do not believe that the impor- tation of the more flexible qualified plan rules would be consistent with the legisla- tive intent behind the enactment of sec- tion 409A. Accordingly, the transition re- lief has not been made permanent. How- ever, because other transition relief grant- ing a participant the ability to change a time and form of payment through the end of the calendar year 2006 would, in many instances, allow a participant to elect the same time and form of payment that had been elected under the qualified plan, the relief is hereby extended through the cal- endar year 2006. Accordingly, for periods ending on or before December 31, 2006, an election as to the timing and form of a payment under a nonqualified deferred compensa- tion plan that is controlled by a payment election made by the service provider or beneficiary of the service provider under a qualified plan will not violate section 409A, provided that the determination of the timing and form of the payment is made in accordance with the terms of the nonqualified deferred compensation plan as of October 3, 2004, that govern pay- ments. For this purpose, a qualified plan means a retirement plan qualified under section 401(a). For example, where a non- qualified deferred compensation plan pro- vides as of October 3, 2004, that the time and form of payment to a service provider or beneficiary will be the same time and October 24, 20058142005–43 I.R.B. form of payment elected by the service provider or beneficiary under a related qualified plan, it will not be a violation of section 409A for the plan administrator to make or commence payments under the nonqualified deferred compensation plan on or after January 1, 2005, and on or be- fore December 31, 2006, pursuant to the payment election under the related quali- fied plan. Notwithstanding the foregoing, other provisions of the Internal Revenue Code and common law tax doctrines con- tinue to apply to any election as to the timing and form of a payment under a nonqualified deferred compensation plan. E.Initial deferral elections Notice 2005–1, Q&A–21 provides re- lief with respect to initial deferral elec- tions, generally permitting initial deferral elections with respect to deferrals relating all or in part to services performed on or before December 31, 2005, to be made on or before March 15, 2005. No extension is provided with respect to this relief with respect to initial elections to defer com- pensation. The Treasury Department and the IRS believe that sufficient guidance has been provided so that timely elections may be solicited and received from plan partic- ipants. In combination with the extension of flexibility with respect to amending the time and form of payments, the Treasury Department and the IRS believe that par- ticipants should be sufficiently informed to make a decision with respect to defer- ral elections. F.Cancellation of deferrals and termination of participation in a plan Notice 2005–1, Q&A–20 provides a limited time during which a plan adopted before December 31, 2005, may provide a participant a right to terminate participa- tion in the plan, or cancel an outstanding deferral election with regard to amounts subject to section 409A. Generally to qual- ify for this relief, if a plan amendment is necessary to permit the participant to ter- minate participation or cancel a deferral election, the plan amendment must be en- acted and effective on or before December 31, 2005, and whether or not the plan is amended, the amount subject to the termi- nation or cancellation must be includible in income of the participant in the calendar year 2005 or, if later, in the taxable year in which the amounts are earned and vested. The period during which a service provider may cancel a deferral election or terminate participation in the plan is not extended. This relief was intended as a temporary period during which ser- vice providers could decide whether to continue to participate in an arrangement subject to section 409A. The Treasury Department and the IRS believe that the statute and existing guidance provide suf- ficient information for service providers to determine by December 31, 2005, whether to continue to participate in a particular arrangement, and that the further exten- sion of this relief, and the relaxation of constructive receipt rules it entails, is not appropriate. A termination or cancellation pursuant to Notice 2005–1, Q&A–20 is treated as effective as of January 1, 2005, for pur- poses of section 409A, and may apply in whole or in part to one or more plans in which a service provider participates and to one or more outstanding deferral elec- tions the service provider has made with regard to amounts subject to section 409A. The exercise of a stock option, stock ap- preciation right or similar equity appreci- ation right that provides for a deferral of compensation, on or before December 31, 2005, will be treated as a cancellation of a deferral. G.Terminations of grandfathered plans Notice 2005–1, Q&A–18(c) provides that amending an arrangement on or be- fore December 31, 2005, to terminate the arrangement and distribute the amounts of deferred compensation thereunder will not be treated as a material modification, pro- vided that all amounts deferred under the plan are included in income in the taxable year in which the termination occurs. For the same reasons discussed above with re- spect to the period during which plans may allow participants to terminate participa- tion in a plan, the relief provided in Notice 2005–1, Q&A–18(c) is not extended. To qualify for the relief provided in No- tice 2005–1, Q&A–18(c), the amendment to the plan must result in the termination of the arrangement and the distribution of all amounts deferred under the arrangement in the taxable year of such termination. An amendment to a plan to provide a partic- ipant a right to elect whether to terminate participation in the plan or to continue to defer amounts under the plan would not be covered by Q&A–18(c), and therefore would constitute a material modification of the plan. Accordingly, amounts that were not distributed pursuant to such an election and continued to be deferred un- der the plan would be subject to section 409A. H.Substitutions of non-discounted stock options and stock appreciation rights for discounted stock options and stock appreciation rights Notice 2005–1, Q&A–18(d) provides that it will not be a material modification to replace a stock option or stock appre- ciation right otherwise providing for a de- ferral of compensation under section 409A with a stock option or stock appreciation right that would not have constituted a de- ferral of compensation under section 409A if it had been granted upon the original date of grant of the replaced stock op- tion or stock appreciation right, provided that the cancellationand reissuance occurs on or before December 31, 2005. The period during which the cancellation and reissuance may occur is extended until De- cember 31, 2006, but only to the extent such cancellation and reissuance does not result in the cancellation of a deferral in ex- change for cash or vested property in 2006. For example, a discounted option gener- ally may be replaced through December 31, 2006, with an option that would not have provided for a deferral of compensa- tion, although the exercise of such a dis- counted option in 2006 before the cancel- lation and replacement generally would re- sult in a violation of section 409A. Commentators pointed out that this re- lief could be interpreted as failing to cover discounted stock options or stock appreci- ation rights that were not earned and vested before January 1, 2005. Where replace- ment stock options or stock appreciation rights that would not constitute deferred compensation subject to section 409A are issued in accordancewith the conditions set forth in Notice 2005–1, Q&A–18(d) and this preamble, such replacement stock options or stock appreciation rights will be treated for purposes of section 409A as if granted on the grant date of the original stock option or stock appreciation right. 2005–43 I.R.B.815October 24, 2005 For example, provided that the conditions of Notice 2005–1, Q&A–18(d) and this preamble are met, a discounted stock op- tion granted in 2003 that was not earned and vested before January 1, 2005, may be replaced with a stock option with an exercise price that would not have been discounted as of the original 2003 grant date, and the substituted stock option will be treated for purposes of section 409A as granted on the original 2003 grant date. Accordingly, if the substituted stock op- tion would not have been subject to section 409A had it been granted on the original 2003 grant date, the substituted stock op- tion will not be subject to section 409A. Commentators noted that some service recipients may wish to compensate the ser- vice provider for the lost discount. Com- mentators proposed three methods to pro- vide such compensation. First, the ser- vice recipient may wish to pay the amount of the discount in 2005 in cash. As a cancellation of a deferral of compensa- tion on or before December 31, 2005 pur- suant to Notice 2005–1, Q&A–20(a), this payment would not be subject to section 409A. Note that as a payment due to the cancellation of a deferral, such a payment could not be made in 2006 as this relief has not been extended beyond December 31, 2005. Where the stock option re- mains nonvested during the year of the op- tion substitution, the service recipient may wish to make the compensation for the lost discount also subject to a vesting require- ment. In that case, commentators also pro- posed granting restricted stock with a fair market value equal to the lost discount, subject to a vesting schedule parallel to the vesting schedule of the substituted option. As a transfer of property subject to sec- tion 83 that becomes substantially vested after the year of substitution, this grant would not be subject to section 409A. Fi- nally, commentators proposed establishing a separate plan, promising a payment of the lost discount (plus earnings) subject to a vesting schedule parallel to the vesting schedule of the substituted option. Pro- vided the right to the payment becomes substantially vested in a future year and otherwise meets the requirement of the short-term deferral exception in these reg- ulations, the right to this payment would not constitute deferred compensation sub- ject to section 409A. Alternatively, such an arrangement could itself provide for de- ferral of compensation beyond the year of substantial vesting and be subject to the re- quirements of section 409A, but if such re- quirements are met, would not affect the exclusion of the amended stock option or stock appreciation right from the treatment as a deferral of compensation subject to section 409A. XII.Calculation and Timing of Income Inclusion Amounts To more rapidly issue guidance neces- sary to allow service recipients to com- ply with section 409A, the Treasury De- partment and the IRS have not included in these regulations guidance with respect to the calculation of the amounts of defer- rals, or of the amounts of income inclu- sion upon the violation of the provisions of section 409A and these regulations, or the timing of the inclusion of income and related withholding obligations. The Trea- sury Department and the IRS anticipate that these topics will be addressed in sub- sequent guidance. The Treasury Depart- ment and the IRS request comments with respect to the calculation and timing of the income inclusion under section 409A, and specifically request comments in two ar- eas. First, section 409A generally requires that for any taxable year in which an amount is deferred under a plan that fails to meet certain requirements, all amounts deferred must be included in income. This provision generally treats earnings (whether actual or notional) as amounts deferred subject to the inclusion provision. Service providers may experience nega- tive earnings in a calendar year, such that the amounts to which a service provider has a right in a particular year are less than the amounts to which a service provider had a right in a previous year, even where no actual payments have been made. The Treasury Department and the IRS request comments with respect to whether and how such negative earnings may be ac- counted for in determining the amount of deferrals and the amount of income inclu- sion for a given taxable year, particularly where continuing violations of section 409A extend to successive tax years. Second, the Treasury Department and the IRS understand that a method of calcu- lation of current deferrals and of amounts to be included in income is needed for service recipients tomeet their reporting and withholding obligations. Comments are requested as to what transitional re- lief may be appropriate depending upon when such future guidance is released. For interim guidance regarding the infor- mation reporting and wage withholding requirements applicable to deferrals of compensation within the meaning of sec- tion 409A, see Notice 2005–1, Q&A–24 through Q&A–38. Until further guidance is provided, taxpayers may rely on Notice 2005–1 regarding information reporting and wage withholding obligations. XIII.Funding Arrangements Section 409A(b)(1) provides certain tax consequences for the funding of de- ferrals of compensation in offshore trusts (or other arrangements determined by the Secretary) or pursuant to a change in the financial health of the employer. The con- sequences of such funding are generally consistent with a violation of section 409A with respect to funded amounts. The Trea- sury Department and the IRS intend to ad- dress these provisions in future guidance. Commentators have requested guidance with respect to when assets will be treated as set aside, especially with respect to ser- vice recipients that are, or include, foreign corporations. Comments are requested as to what types of arrangements, other than actual trusts, should be treated similarly to trusts. In addition, these proposed reg- ulations provide guidance with respect to the types of arrangements that constitute deferred compensation subject to section 409A. Because the funding rules of section 409A(b) apply only to amounts set aside to fund deferred compensation subject to section 409A, many issues raised by commentators with respect to foreign ar- rangements and funding may be addressed or limited through the definition of de- ferred compensation contained in these proposed regulations. Proposed Effective Date These regulations are proposed to be generally applicable for taxable years be- ginning on or after January 1, 2007. As discussed, taxpayers may rely on these proposed regulations until the effective date of the final regulations. October 24, 20058162005–43 I.R.B. Effect on Other Documents These proposed regulations do not af- fect the applicability of other guidance issued with respect to section 409A, in- cluding Notice 2005–1, 2005–2 I.R.B. 274 (published as modified on January 6, 2005). However, upon the effective date of the final regulations, the Treasury Department and the IRS anticipate that Notice 2005–1 and certain other published guidance will become obsolete for periods after the effective date of the final regula- tions. 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. Therefore, a regula- tory assessment is not required. It has also been determined thatsection 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regu- lations, and because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advo- cacy of the Small Business Administration for comment on its impact on small busi- ness. Comments and Public Hearing Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed origi- nal and eight (8) copies) or electronic com- ments that are submitted timely to the IRS. The IRS and Treasury Department request comments on the clarity of the proposed rules and how they can be made easier to understand. All comments will be avail- able for public inspection and copying. A public hearing has been scheduled for January 25, 2006, beginning at 10 a.m. in the Auditorium of the Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Due to building security procedures, visitors must enter at the Con- stitution Avenue entrance. In addition, all visitors must presentphoto identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER IN- FORMATION CONTACT” section of this preamble. The rules of 26 CFR 601.601(a)(3) ap- ply to the hearing. Persons who wish to present oral comments at the hearing must submit written or electronic comments and an outline of the topics to be discussed and the time to be devoted to each topic (a signed original and eight (8) copies) by January 4, 2006. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the sched- uling of the speakers will be prepared af- ter the deadline for receiving outlines has passed. Copies of the agenda will be avail- able free of charge at the hearing. Drafting I nformation The principal author of these regula- tions is Stephen Tackney of the Office of Division Counsel/Associate Chief Coun- sel(TaxExemptandGovernmentEnti- ties). However, other personnel from the IRS and the Treasury Department partici- pated in their development. ***** Proposed Amendment to the Regulations Paragraph 1. The authority citation for part 1 continues to read in part as follows: Authority: 26 U.S.C. 7805 * * * Par. 2. Sections 1.409A–1 through 1.409A–6 are added to read as follows: §1.409A–1 Definitions and covered arrangements. (a)Nonqualified deferred compen- sation plan—(1)In general. Except as otherwise provided in this paragraph (a), the termnonqualified deferred compen- sation planmeans any plan (within the meaning of paragraph (c) of this section) that provides for the deferral of compen- sation (within the meaning of paragraph (b)ofthissection). (2)Qualified employer plans.Theterm nonqualified deferred compensation plan does not include— (i) Any plan described in section 401(a) that includes a trust exempt from tax under section 501(a); (ii) Any annuity plan described in sec- tion 403(a); (iii) Any annuity contract described in section 403(b); (iv) Any simplified employee pension (within the meaning of section 408(k)); (v) Any simple retirement account (within the meaning of section 408(p); (vi) Any arrangement under which an active participant makes deductible con- tributions to a trust described in section 501(c)(18); (vii) Any eligible deferred compensa- tion plan (within the meaning of section 457(b)); and (viii) Any plan described in section 415(m). (3)Certain foreign plans—(i)Partici- pationaddressedbytreaty. With respect to an individual for a taxable year, the term nonqualified deferred compensation plan does not include any scheme, trust or ar- rangement maintained with respect to such individual, where contributions made by or on behalf of such individual to such scheme, trust or arrangement are exclud- able by such individual for Federal income tax purposes pursuant to any bilateral in- come tax convention to which the United States is a party. (ii)Participation by nonresident aliens and certain resident aliens.Withre- spect to an alien individual for a taxable year during which such individual is a nonresident alien or a resident alien clas- sified as a resident alien solely under section 7701(b)(1)(A)(ii) (and not section 7701(b)(1)(A)(i)), the termnonqualified deferred compensation plandoes not in- clude any broad-based foreign retirement plan (within the meaning of paragraph (a)(3)(v) of this section) maintained by a person that is not a United States person. (iii)Participation by U.S. citizens and lawful permanent residents. With respect to an individual for a given taxable year during which such individual is a U.S. cit- izen or a resident alien classified as a resi- dent alien under section 7701(b)(1)(A)(i), and is not eligible to participate in a quali- fied employer plan described in paragraph (a)(2) of this section, the termnonquali- fied deferred compensation plandoes not include a broad-based foreign retirement 2005–43 I.R.B.817October 24, 2005 plan (within the meaning of paragraph (a)(3)(v) of this section) maintained by a service recipient that is not a United States person, but only with respect to nonelec- tive deferrals of foreign earned income (as defined in section 911(b)(1)) and only to the extent that the amounts deferred un- der such plan in such taxable year do not exceed the applicable limits under section 415(b) and (c) that would be applicable if such plan were a plan subject to section 415 and the foreign earned income of such individual were treated as compensation for purposes of applying section 415(b) and (c). (iv)Plans subject to a totalization agreement and similar plans.Theterm nonqualified deferred compensation plan does not include any social security system of a jurisdiction to the extent that benefits provided under or contributions made to the system are subject to an agreement entered into pursuant to section 233 of the Social Security Act with any foreign juris- diction. In addition, the termnonqualified deferred compensation plandoes not in- clude a social security system of a foreign jurisdiction to the extent that benefits are provided under or contributions are made to a government-mandated plan as part of that foreign jurisdiction’s social security system. (v)Broad-based retirement plan.For purposes of this paragraph (a)(3), the termbroad-based retirement plan means a scheme, trust or arrangement that— (A) Is written; (B)Inthecaseofanemployer-main- tained plan, is nondiscriminatory insofar as it (alone or in combination with other comparable plans)covers a wide range of employees, substantially all of whom are nonresident aliens or resident aliens classified as resident aliens solely under section 7701(b)(1)(A)(ii) (and not section 7701(b)(1)(A)(i)), including rank and file employees, and actually provides signifi- cant benefits for the range of covered em- ployees; (C)Inthecaseofanemployer-main- tained plan, contains provisions that gen- erally limit the employees’ ability to use plan benefits for purposes other than re- tirement or restrict access to plan benefits prior to separation from service, such as re- stricting in-service distributions except in events similar to an unforeseeable emer- gency (as defined in §1.409A–3(g)(3)(i)) or hardship (as defined for purposes of sec- tion 401(k)(2)(B)(i)(IV)), and in all cases is subject to tax or plan provisions that dis- courage participants from using the assets for purposes other than retirement; and (D) Provides for payment of a reason- able level of benefits at death, a stated age, or an event related to work status, and oth- erwise requires minimum distributions un- der rules designed to ensure that any death benefits provided to the participants’ sur- vivors are merely incidental to the retire- ment benefits provided to the participants. (vi)Participation by a nonresident alien — de minimis amounts. With respect to a nonresident alien, the termnonqualified deferred compensation plandoes not in- clude any foreign plan maintained by a ser- vice recipient that is not a United States person for a taxable year, to the extent that the amounts deferred under the foreign plan based upon the nonresident alien’s services performed in the United States (including compensation received due to services performed in the United States) do not exceed $10,000 in the taxable year. (4)Section 457 plans. A nonqualified deferred compensation plan under sec- tion 457(f) may constitute a nonqualified deferred compensation plan for purposes of this paragraph (a). The rules of sec- tion 409A apply to nonqualified deferred compensation plans separately and in ad- dition to any requirements applicable to such plans under section 457(f). In addi- tion, nonelective deferred compensation of nonemployees described in section 457(e)(12) and a grandfathered plan or arrangement described in §1.457–2(k)(4) may constitute a nonqualified deferred compensation plan for purposes of this paragraph (a). The termnonqualified de- ferred compensation plandoes not include a length of service award to abona fide volunteer under section 457(e)(11)(A)(ii). (5)Certain welfare benefits.Theterm nonqualified deferred compensation plan does not include anybona fidevacation leave, sick leave, compensatory time, dis- ability pay, or death benefit plan. For these purposes, the termdisability pay has the same meaning as provided in §31.3121(v)(2)–1(b)(4)(iv)(C) of this chapter, and the termdeath benefit plan refers to a plan providing death benefits as defined in §31.3121(v)(2)–1(b)(4)(iv)(C) of this chapter. The termnonqualified deferred compensation planalso does not include any Archer Medical Savings Ac- count as described in section 220, any Health Savings Account as described in section 223, or any other medical reim- bursement arrangement, including a health reimbursement arrangement, that satisfies the requirements of section 105 and sec- tion 106. (b)Deferral of compensation—(1)In general. Except as otherwise provided in paragraphs (b)(3) through (b)(9) of this section, a plan provides for the deferral of compensation if, under the terms of the plan and the relevant facts and circum- stances, the service provider has a legally binding right during a taxable year to com- pensation that has not been actually or con- structively received and included in gross income, and that, pursuant to the terms of the plan, is payable to (or on behalf of) the service provider in a later year. A service provider does not have a legally binding right to compensation if that compensation may be reduced unilaterally or eliminated by the service recipient or other person af- ter the services creating the right to the compensation have been performed. How- ever, if the facts andcircumstances indi- cate that the discretion to reduce or elimi- nate the compensation is available or exer- cisable only upon a condition, or the dis- cretion to reduce or eliminate the com- pensation lacks substantive significance, a service provider will be considered to have a legally binding right to the compen- sation. Whether the negative discretion lacks substantive significance depends on the facts and circumstances of the particu- lar arrangement. However, where the ser- vice provider to whom the compensation may be paid has effective control of the person retaining the discretion to reduce or eliminate the compensation, or has effec- tive control over any portion of the com- pensation of the person retaining the dis- cretion to reduce or eliminate the compen- sation, or is a member of the family (as de- finedinsection267(c)(4)appliedasifthe family of an individual includes the spouse of any member of the family) of the person retaining the discretion to reduce or elim- inate the compensation, the discretion to reduce or eliminate the compensation will not be treated as having substantive signif- icance. For this purpose, compensation is not considered subject to unilateral reduc- tion or elimination merely because it may be reduced or eliminated by operation of October 24, 20058182005–43 I.R.B. the objective terms of the plan, such as the application of an objective provision cre- ating a substantial risk of forfeiture. Sim- ilarly, a service provider does not fail to have a legally binding right to compensa- tion merely because the amount of com- pensation is determined under a formula that provides for benefits to be offset by benefits provided under a plan that is qual- ified under section 401(a), or because ben- efits are reduced due to actual or notional investment losses, or in a final average pay plan, subsequent decreases in compensa- tion. (2)Earnings. References to the defer- ral of compensation include references to earnings. When the right to earnings is specified under the terms of the arrange- ment, the legally binding right to earn- ings arises at the time of the deferral of the compensation to which the earnings re- late. However, a plan may provide that the right to the earnings is treated separately from the right to the underlying compen- sation. For example, provided that the rules of section 409A are otherwise met, a plan may provide that earnings will be paid at a separate time or in a separate form from the payment of the underlying com- pensation. For the application of the de- ferral election rules to current payments of earnings and dividend equivalents, see §1.409A–2(a)(13). (3)Compensation payable pursuant to the service recipient’s customary pay- ment timing arrangement.Adeferralof compensation does not occur solely be- cause compensation is paid after the last day of the service provider’s taxable year pursuant to the timing arrangement un- der which the service recipient normally compensates service providers for ser- vices performed during a payroll period described in section 3401(b), or with re- spect to a non-employee service provider, a period not longer than the payroll pe- riod described in section 3401(b) or if no such payroll period exists, a period not longer than the earlier of the normal tim- ing arrangement under which the service provider normally compensates non-em- ployee service providers or 30 days after the end of the service provider’s taxable year. (4)Short-term deferrals—(i)In gen- eral. A deferral of compensation does not occur if, absent an election by the ser- vice provider (including an election under §1.409A–2(a)(3)) to otherwise defer the payment of the compensation to a later pe- riod, an amount of compensation is actu- ally or constructively received by the ser- vice provider by the later of the 15 th day of the third month following the service provider’s first taxable year in which the amount is no longer subject to a substan- tial risk of forfeiture or the 15 th day of the third month following the end of the ser- vice recipient’s first taxable year in which the amount is no longer subject to a sub- stantial risk of forfeiture. In addition, the arrangement must not otherwise defer the payment to a later period. For example, an arrangement that deferred a payment until 5 years after the lapsing of a condition that constituted a substantial risk of forfeiture would constitute a deferral of compensa- tion even if the amount were actually paid on the date the substantial risk of forfeiture lapsed. For these purposes, an amount that is never subject to a substantial risk of for- feiture is considered to be no longer sub- ject to a substantial risk of forfeiture on the first date the service provider has a legally binding right to the amount. For example, an employer with a calendar year taxable year who on November 1, 2008, awards a bonus so that the employee is considered to have a legally binding right to the pay- ment as of November 1, 2008, will not be considered to have provided for a deferral of compensation if, absent an election to otherwise defer the payment, the amount is paid or made available to the employee on or before March 15, 2009. An employer with a taxable year ending August 31 who on November 1, 2008, awards a bonus so that the employee is considered to have a legally binding right to the payment as of November 1, 2008, will not be considered to have provided for a deferral of compen- sation if, absent an election to otherwise defer the payment, the amount is paid or made available to the employee on or be- fore November 15, 2009. (ii)Delayed payments due to unfore- seeable events. A payment that other- wise qualifies as a short-term deferral un- der paragraph (b)(4)(i) of this section but is made after the 15 th day of the third month following the end of the relevant taxable year (the applicable 2 1 /2month pe- riod) may continue to qualify as a short- term deferral if the taxpayer establishes that it was administratively impracticable to make the payment by the end of the ap- plicable 2 1 /2monthperiodorthatmaking the payment by the end of the applicable 2 1 /2month period would have jeopardized the solvency of the service recipient, and, as of the date upon which the legally bind- ing right to the compensation arose, such impracticability or insolvency was unfore- seeable, and also the payment is made as soon as reasonably practicable. For exam- ple, an amount that would otherwise qual- ify as a short-term deferral except that the payment is made after the applicable 2 1 /2 month period may continue to qualify as a short-term deferral under this paragraph (b)(4) to the extent that the delay is caused either because the funds of the service re- cipient were not sufficient to make the pay- ment before the end of the applicable 2 1 /2 month period without jeopardizing the sol- vency of the service recipient, or because it was not reasonably possible to determine by the end of the applicable 2 1 /2month pe- riod whether payment of such amount was to be made, and the circumstance causing the delay was unforeseeable as of the date upon which the legally binding right to the compensation arose. Thus, the amount will not continue to qualify as a short-term deferral to the extent it was foreseeable, as of date upon which the legally binding right to the compensation arose, that the amount would not be paid within the appli- cable 2 1 /2month period. For purposes of this paragraph (b)(4)(ii), an action or fail- ure to act of the service provider or a per- son under the service provider’s control, such as a failure to provide necessary in- formation or documentation, is not an un- foreseeable event. (5)Stock options, stock appreciation rights and other equity-based compensa- tion—(i)Stock rights—(A)Nonstatutory stock options not providing for the deferral of compensation. Anoptiontopurchase service recipient stockdoes not provide for a deferral of compensation if— (1) The amount required to purchase stock under the option (the exercise price) may never be less than the fair market value of the underlying stock (disregarding lapse restrictions as defined in §1.83–3(i)) on the date the option is granted and the number of shares subject to the option is fixed on the original date of grant of the option; (2) The transfer or exercise of the option is subject to taxation under section 83 and §1.83–7; and 2005–43 I.R.B.819October 24, 2005 (3) The option does not include any fea- ture for the deferral of compensation other than the deferral of recognition of income until the later of exercise or disposition of the option under §1.83–7, or the time the stock acquired pursuant to the exercise of the option first becomes substantially vested (as definedin §1.83–3(b)). (B)Stock appreciation rights not pro- viding for the deferral of compensation.A right to compensation equal to the appre- ciation in value of a specified number of shares of stock of the service recipient oc- curring between the date of grant and the date of exercise of such right (a stock ap- preciation right) does not provide for a de- ferral of compensation if— (1) Compensation payable under the stock appreciation right cannot be greater than the difference between the fair mar- ket value of the stock (disregarding lapse restrictions as defined in §1.83–3(i)) on the date of grant of the stock appreciation right and the fair market value of the stock (disregarding lapse restrictions as defined in §1.83–3(i)) on the date the stock appre- ciation right is exercised, with respect to a number of shares fixed on or before the date of grant of the right; (2) The stock appreciation right exer- cise price may never be less than the fair market value of the underlying stock (dis- regarding lapse restrictions as defined in §1.83–3(i)) on the date the right is granted; and (3) The stock appreciation right does not include any feature for the deferral of compensation other than the deferral of recognition of income until the exercise of the stock appreciation right. (C)Stock rights that may provide for the deferral of compensation.Anoption to purchase stock other than service recipi- ent stock, or a stock appreciation right with respect to stock other than service recipi- ent stock, generally will provide for the de- ferral of compensation within the meaning of this paragraph (b). If under the terms of an option to purchase service recipient stock (other than an incentive stock option described in section 422 or a stock option granted under an employee stock purchase plan described in section 423), the amount required to purchase the stock is or could become less than the fair market value of the stock (disregarding lapse restrictions as defined in §1.83–3(i)) on the date of grant, the grant of the option may provide for the deferral of compensation within the mean- ing of this paragraph (b). If under the terms of a stock appreciation right with respect to service recipient stock, the compensa- tion payable under the stock appreciation right is or could be any amount greater than, with respect to a predetermined num- ber of shares, the difference between the stock value (disregarding lapse restrictions as defined in §1.83–3(i)) on the date of grant of the stock appreciation right and the stock value (disregarding lapse restric- tions as defined in §1.83–3(i)) on the date the stock appreciation right is exercised, the grant of the stock appreciation right may provide for a deferral of compensa- tion within the meaning of this paragraph (b). (D)Feature for the deferral of compen- sation. To the extent a stock right grants the recipient a right other than to receive cash or stock on the date of exercise and such additional rights allow for the defer- ral of compensation, the entire arrange- ment (including the underlying stock right) provides for the deferral of compensation. For purposes of this paragraph (b)(5)(i), neither the right to receive substantially nonvested stock (as defined in §1.83–3(b)) upon the exercise of a stock right, nor the right to pay the exercise price with previ- ously acquired shares, constitutes a feature for the deferral of compensation. (E)Rights to dividends declared.For purposes of this paragraph (b)(5)(i), the right to receive, upon the exercise of a stock right, an amount equal to all or part of the dividends declared and paid on the number of shares underlying the stock right between the date of grant and the date of exercise of the stock right consti- tutes an offset to the exercise price of the stock option or an increase in the amount payable under the stock appreciation right (generally causing such stock rights to be subject to section 409A), unless the right to the dividends declared and paid on the number of shares underlying the stock right is explicitly set forth as a separate arrangement. If set forth as a separate ar- rangement, the arrangement may provide for deferred compensation for purposes of section 409A. However, the existence of a separate arrangement to receive such an amount that complies with the require- ments of section 409A would not cause a stock right to fail to satisfy the require- ments of the exclusion from the definition of deferred compensation provided in paragraphs (b)(5)(i)(A) and (B) of this section. (ii)Statutory stock options.Thegrant of an incentive stockoption as described in section 422, or the grant of an option under an employee stock purchase plan described in section 423 (including the grant of an option with an exercise price discounted in accordance with section 423(b)(6) and the accompanying regula- tions), does not constitute a deferral of compensation. However, this paragraph (b)(5)(ii) does not apply to a modification, extension, or renewal of a statutory op- tion that is treated as the grant of a new option that is not a statutory option. See §1.424–1(e). In such event, the option is treated as if it were a nonstatutory stock option at the date of the original grant, so that the modification, extension or re- newal of the stock option that caused the stock option to be treated as the grant of a new option under §1.424–1(e) is treated as causing the option to be treated as the grant of a new option for purposes of this paragraph (b)(5) only if such modification, extension or renewal of the stock option would have been treated as resulting in the grant of a new option under paragraph (b)(5)(v) of this section. (iii)Stock of the service recipient—(A) In general. Except as otherwise provided in paragraphs (b)(5)(iii)(B) and (C) of this section, for purposes of this section, stock of the service recipient means stock that, as of the date of grant, is common stock of a corporation that is a service recipient (in- cluding any member of a group of corpo- rations or other entities treated as a single service recipient) that is readily tradable on an established securities market, or if none, that class of common stock of such corpo- ration having the greatest aggregate value of common stock issued and outstanding of such corporation, or common stock with substantially similar rights to stock of such class (disregarding any difference in vot- ing rights). However, under no circum- stances does stock of the service recipient include stock that is preferred as to liquida- tion or dividend rights or that includes or is subject to a mandatory repurchase obliga- tion or a put or call right that is not a lapse restriction as defined in §1.83–3(i) and is based on a measure other than the fair mar- ket value (disregarding lapse restrictions as defined in §1.83–3(i)) of the equity in- October 24, 20058202005–43 I.R.B. terest in the corporation represented by the stock. (B)American depositary receipts.For purposes of this section, an American depositary receipt or American deposi- tary share may constitute service recipient stock, to the extent that the stock traded on a foreign securities market to which the American depositary receipt or American depositary share relates qualifies as ser- vice recipient stock. (C)Mutual company units. For pur- poses of this section, mutual company units may constitute service recipient stock. For this purpose, the termmutual company unitmeans a fixed percentage of the overall value of a non-stock mutual company. For purposes of determining the value of the mutual company unit, the unit may be valued in accordance with the rules set forth in paragraph (b)(5)(iv)(B) of this section governing valuation of ser- vice recipient stock the shares of which are not traded on an established securities market, applied as if the mutual company were a stock corporation with one class of common stock and the number of shares of such stock determined according to the fixed percentage. For example, an appre- ciation right based on the appreciation of 10 mutual company units, where each unit is defined as 1 percent of the overall value of the mutual company, would be valued as if the appreciation right were based upon 10 shares of a corporation with 100 shares of common stock and no other class of stock, whose shares are not readily trad- able on an established securities market. (D)Definition of service recipient—(1) In general. For purposes of this para- graph (b)(5)(iii), the termservice recipient generally has the same meaning as pro- vided in paragraph (g) of this section, provided that a stock right, or the plan or arrangement under which the stock right is granted, may specify that in applying sec- tion 1563(a)(1), (2) and (3) for purposes of determining a controlled group of corpo- rations under section 414(b), the language “at least 50 percent” is used instead of “at least 80 percent” each place it appears in section 1563(a)(1), (2) and (3), and in applying §1.414(c)–2 for purposes of de- termining trades or businesses (whether or not incorporated) that are under common control for purposes of section 414(c), the language “at least 50 percent” is used instead of “at least 80 percent” each place it appears in §1.414(c)–2. In addition, where the use of such stock with respect to the grant of a stock right to such service provider is based upon legitimate business criteria, the termservice recipienthas the same meaning as provided in paragraph (g) of this section, provided that the stock right, or the plan or arrangement under which the stock right is granted, may spec- ify that in applying sections 1563(a)(1), (2) and (3) for purposes of determining a controlled group of corporations under section 414(b), the language “at least 20 percent” is used instead of “at least 80 per- cent” at each place it appears in sections 1563(a)(1), (2) and (3), and in applying §1.414(c)–2 for purposes of determining trades or businesses (whether or not incor- porated) that are under common control for purposes of section 414(c), the lan- guage “at least 20 percent” is used instead of “at least 80 percent” at each place it ap- pears in §1.414(c)–2. For example, stock of a corporation participating in a joint venture involving an operating business, used with respect to stock rights granted to employees of the joint venture who are former employees of such corporation, generally will constitute use of such stock based upon legitimate business criteria, and therefore could constitute service recipient stock with respect to such em- ployees if the corporation owns at least 20 percent of the joint venture and the other requirements of this paragraph (b)(5)(iii) are met. A designation by a service re- cipient to use the 50 percent or 20 percent thresholds described in this paragraph (b)(5)(iii)(D) must be applied consistently as to all compensatory stock rights for purposes of this paragraph (b)(5)(iii), and any designation of a different permissible ownership threshold percentage may not be made effective until 12 months after the adoption of such change. (2)Investment vehicles. Notwith- standing the provisions of paragraph (b)(5)(iii)(D)(1) of this section, except as to a service provider providing services directly to such corporation, for purposes of this paragraph (b)(5) the termservice recipientdoes not include any corpora- tion whose primary purpose is to serve as an investment vehicle with respect to the corporation’s interest in entities other than the service recipient. (3)Substitutions and assumptions by reason of a corporate transaction.Ifthe requirements of paragraph (b)(5)(v)(D) of this section are met such that the substitu- tion of a new stock right pursuant to a cor- porate transaction for an outstanding stock right, or the assumption of an outstanding stock right pursuant to a corporate transac- tion, would not be treated as the grant of a new stock right or a change in the form of payment for purposes of section 409A, the stock underlying the stock right that is substituted or assumed will be treated as service recipient stock for purposes of ap- plying this paragraph (b)(5) to the replace- ment stock rights. For example, where by reason of a spinoff transaction under which a subsidiary corporation is spun off from a distributing corporation, a distributing cor- poration employee’s stock option to pur- chase distributing corporation stock is re- placed with a stock option to purchase dis- tributing corporation stock and a stock op- tion to purchase the spun off subsidiary corporation’s stock, and where such sub- stitution is not treated as a modification of the original stock option pursuant to para- graph (b)(5)(v)(D) of this section, both the distributing corporation stock and the sub- sidiary corporation stock are treated as ser- vice recipient stock for purposes of apply- ing this paragraph (b)(5) to the replace- ment stock options. (E)Stock rights granted on or before December 31, 2004. Notwithstanding the requirements of paragraph (b)(5)(iii)(A) of this section, any class of common stock of the service recipient with respect to which stock rights were granted to service providers on or before December 31, 2004, is treated as service recipient stock for pur- poses of this paragraph (b)(5)(iii), but only with respect to stock rights granted on or before December 31, 2004. (iv)Determination of the fair market value of service recipient stock—(A)Stock readily tradable on an established securi- ties market. For purposes of (b)(5)(i) of this section, in the case of service recipi- ent stock that is readily tradable on an es- tablished securities market, the fair mar- ket value of the stock may be determined based upon the last sale before or the first sale after the grant, the closing price on the trading day before or the trading day of the grant, or any other reasonable basis using actual transactions in such stock as reported by such market and consistently applied. The determination of fair market value also may be based upon an average 2005–43 I.R.B.821October 24, 2005 selling price during a specified period that is within 30 days before or 30 days after the grant, provided that the commitment to grant the stock right based on such val- uationmethodmustbeirrevocable before the beginning of the specified period, and such valuation method must be used con- sistently for grants of stock rights under the same and substantially similar programs. (B)Stock not readily tradable on an established securities market—(1)In gen- eral. For purposes of paragraph (b)(5)(i) of this section, in the case of service recip- ient stock that is not readily tradable on an established securities market, the fair mar- ket value of the stock as of a valuation date means a value determined by the reason- able application of a reasonable valuation method. The determination of whether a valuation method is reasonable, or whether an application of a valuation method is rea- sonable, is made based on the facts and cir- cumstances as of the valuation date. Fac- tors to be considered under a reasonable valuation method include, as applicable, the value of tangible and intangible assets of the corporation, the present value of future cash-flows of the corporation, the market value of stock or equity interests in similar corporations and other entities engaged in trades or businesses substan- tially similar to those engaged in by the corporation whose stock is to be valued, the value of which can be readily deter- mined through objective means (such as through trading prices on an established securities market or an amount paid in an arm’s length private transaction), and other relevant factors such as control premiums or discounts for lack of marketability and whether the valuation method is used for other purposes that have a material eco- nomic effect on the service recipient, its stockholders or its creditors. The use of a valuation method is not reasonable if such valuation method does not take into con- sideration in applying its methodology, all available information material to the value of the corporation. Similarly, the use of a value previously calculated under a valua- tion method is not reasonable as of a later date if such calculation fails to reflect in- formation available after the date of the calculation that may materially affect the value of the corporation (for example, the resolution of material litigation or the is- suance of a patent) or the value was cal- culated with respect to a date that is more than 12 months earlier than the date for which the valuation is being used. The ser- vice recipient’s consistent use of a valua- tion method to determine the value of its stock or assets for other purposes, includ- ing for purposes unrelated to compensa- tion of service providers, is also a factor supporting the reasonableness of such val- uation method. (2)Presumption of reasonableness.For purposes of this paragraph (b)(5)(iv)(B), the consistent use of any of the following methods of valuation is presumed to result in a reasonable valuation, provided that the Commissioner may rebut such a presump- tion upon a showing that either the val- uation method or the application of such method was grossly unreasonable: (i) A valuation of a class of stock de- termined by an independent appraisal that meets the requirements of section 401(a)(28)(C) and the regulations there- under as of a date that is no more than 12 months before the relevant transaction to which the valuation is applied (for exam- ple, the grant date of a stock option). (ii) A valuation based upon a formula that, if used as part of a nonlapse restric- tion (as defined in §1.83–3(h)) with re- spect to the stock, would be considered to be the fair market value of the stock pur- suant to §1.83–5, provided that such stock is valued in the same manner for purposes of any nonlapse restriction applicable to the transfer of any shares of such class of stock (or substantially similar class of stock), and all noncompensatory purposes requiring the valuation of such stock, in- cluding regulatory filings, loan covenants, issuances to and repurchases of stock from persons other than service providers, and other third-party arrangements, and such valuation method is used consistently for all such purposes, and provided further that this paragraph (b)(5)(iv)(B)(2)(ii)doesnot apply with respect to stock subject to a stock right payable in stock, where the stock acquired pursuant to the exercise of the stock right is transferable other than through the operation of a nonlapse restric- tion. (iii) A valuation, made reasonably and in good faith and evidenced by a written report that takes into account the relevant factors described in paragraph (b)(5)(iv)(B)(1) of this section, of an illiq- uid stock of a start-up corporation. For this purpose, an illiquid stock of a start-up corporation is service recipient stock of a service recipient corporation that has no trade or business that it or any pre- decessor to it has conducted for a period of 10 years or more and has no class of equity securities that are traded on an es- tablished securities market (as defined in paragraph (k) of this section), where such stock is not subject to any put or call right or obligation of the service recipient or other person to purchase such stock (other than a right of first refusal upon an offer to purchase by a third party that is unre- lated to the service recipient or service provider and other than a right or obliga- tion that constitutes a lapse restriction as defined in §1.83–3(i)), and provided that this paragraph (b)(5)(iv)(B)(2)(iii)does not apply to the valuation of any stock if the service recipient or service provider may reasonably anticipate, as of the time the valuation is applied, that the service recipient will undergo a change in control event as described in§1.409A–3(g)(5)(v) or §1.409A–3(g)(5)(vii) or make a public offering of securities within the 12 months following the event to which the valu- ationisapplied(forexample,thegrant of a stock option or exercise of a stock appreciation right). For purposes of this paragraph (b)(5)(iv)(B)(2)(iii), a valuation will not be treated as made reasonably and in good faith unless the valuation is performed by a person or persons with significant knowledge and experience or training in performing similar valuations. (3)Consistent use of a method.For purposes of paragraph (b)(5)(iv)(B)(2)of this section, the consistent use of a valu- ation method means the consistent use of the method for all equity-based compensa- tion arrangements, including with respect to stock rights, for purposes of determining the exercise price, and with respect to stock appreciation rights not paid in stock, for purposes of determining the payment at the date of exercise, and for stock appreciation rights or stock options paid in stock sub- ject to a put or call right providing for the potential repurchase by the service recipi- ent, or other obligation of the service recip- ient or other person to purchase such stock, for purposes of determining the payment at the date of the purchase of such stock. Notwithstanding the foregoing, a service recipient may change the method prospec- tively for purposes of new grants of eq- uity-based compensation, including stock October 24, 20058222005–43 I.R.B. rights. In addition, where after the date of grant, but before the date of exercise, of the stock right, the service recipient stock to which the stock right relates becomes readily tradable on an established securi- ties market, the service recipient must use the valuation method set forth in paragraph (b)(5)(iv)(A) of this section for purposes of determining the payment at the date of ex- ercise or the purchase of the stock, as ap- plicable. (v)Modifications, extensions, re- newals, substitutions and assumptions of stock rights—(A)Treatment of modified stock right as a new grant. Any modifi- cation of the terms of a stock right, other than an extension or renewal of the stock right, is considered the granting of a new stock right. The new stock right may or may not constitute a deferral of compen- sation under paragraph (b)(5)(i) of this section, determined at the date of grant of the new stock right. Where a stock right is extended or renewed, the stock right is treated as having had an additional defer- ral feature from the date of grant. (B)Modification in general.Theterm modificationmeans any change in the terms of the stock right (or change in the terms of the arrangement pursuant to which the stock right was granted or in the terms of any other agreement governing the stock right) that may provide the holder of the stock right with a direct or indirect reduction in the exercise price of the stock right, or an additional deferral feature, or an extension or renewal of the stock right, regardless of whether the holder in fact benefits from the change in terms. In contrast, a change in the terms of the stock right shortening the period during which the stock right is exercisable is not a modification. It is not a modification to add a feature providing the ability to ten- der previously acquired stock for the stock purchasable under the stock right, or to withhold or have withheld shares of stock to facilitate the payment of employment taxes or required withholding taxes result- ing from the exercise of the stock right. In addition, it is not a modification for the grantor to exercise discretion specifically reserved under a stock right with respect to the transferability of the stock right. (C)Extensions and renewals.Anexten- sion of a stock right refers to the granting to the holder of an additional period of time within which to exercise the stock right be- yond the time originally prescribed, pro- vided that it is not an extension if the ex- ercise period of the stock right is extended to a date no later than the later of the 15 th day of the third month following the date at which, or December 31 of the calendar year in which, the stock right would oth- erwise have expired if the stock right had not been extended, based on the terms of the stock right at the original grant date. For example, an option granted January 1, 2011, that expires upon the earlier of Jan- uary 1, 2021, or 30 days after separation from service will not be considered to be modified if, upon the holder’s separation from service on July 1, 2015, the term is extended to December 31, 2015. Notwith- standing the foregoing, it is not an exten- sion of a stock right if the expiration of the stock right is tolled while the stock right is unexercisable because an exercise of the stock right would violate applicable secu- rities laws, provided that the period during which the stock right may be exercised is not extended more than 30 days after the exercise of the stock right first would no longer violate applicable securities laws. A renewal of a stock right is the granting by the corporation of the same rights or privileges contained in the original stock right on the same terms and conditions. (D)Substitutions and assumptions of stock rights by reason of a corporate trans- action. If the requirements of §1.424–1 would be met if the stock right were a statutory option, the substitution of a new stock right pursuant to a corporate transac- tion for an outstanding stock right or the assumption of an outstanding stock right pursuant to a corporate transaction will not be treated as the grant of a new stock right or a change in the form of payment for purposes of section 409A. For purposes of the preceding sentence, the requirement of §1.424–1(a)(5)(iii) will be deemed to be satisfied if the ratio of the exercise price to the fair market value of the shares sub- ject to the stock right immediately after the substitution or assumption is not greater than the ratio of the exercise price to the fair market value of the shares subject to the stock right immediately before the sub- stitution or assumption. In the case of a transaction described in section 355 in which the stock of the distributing cor- poration and the stock distributed in the transaction are both readily tradable on an established securities market immedi- ately after the transaction, for purposes of this paragraph (b)(5)(v), the requirements of §1.424–1(a)(5) may be satisfied by us- ing market quotations for the stock of the distributing corporation and the stock dis- tributed in the transaction as of a predeter- mined date not more than 60 days after the transaction or based on an average of such market prices over a predetermined period of not more than 30 days ending not later than 60 days after the transaction. (E)Acceleration of date when exercis- able. If a stock right is not immediately exercisable in full, a change in the terms of the right to accelerate the time at which the stock right (or any portion thereof) may be exercised is not a modification for pur- poses of this section. With respect to a stock right subject to section 409A, how- ever, such an acceleration may constitute an impermissible acceleration of a pay- ment date under §1.409A–3(h). Addition- ally, no modification occurs if a provision accelerating the time when a stock right may first be exercised is removed before the year in which it would otherwise be triggered. (F)Discretionary added benefits.Ifa change to a stock right provides, either by its terms or in substance, that the holder may receive an additional benefit under the stock right at the future discretion of the grantor, and the addition of such ben- efit would constitute a modification, then the addition of such discretion is a modi- fication at the time that the stock right is changed to provide such discretion. (G)Change in underlying stock in- creasing value. A change in the terms of the stock subject to a stock right that increases the value of the stock is a mod- ification of such stock right, except to the extent that a new stock right is sub- stituted for such stock right by reason of the change in the terms of the stock in accordance with paragraph (b)(5)(v)(D) of this section. (H)Change in the number of shares purchasable. If a stock right is amended solely to increase the number of shares subject to the stock right, the increase is not considered a modification of the stock right but is treated as the grant of a new additional stock right to which the addi- tional shares are subject. Notwithstand- ing the previous sentence, if the exercise price and number of shares subject to a stock right are proportionally adjusted to 2005–43 I.R.B.823October 24, 2005 reflect a stock split (including a reverse stock split) or stock dividend, and the only effect of the stock split or stock dividend is to increase (or decrease) on apro rata basis the number of shares owned by each shareholder of the class of stock subject to the stock right, then the stock right is not modified if it is proportionally adjusted to reflect the stock split or stock dividend and the aggregate exercise price of the stock right is not less than the aggregate exercise price before the stock split or stock divi- dend. (I)Rescission of changes. Any change to the terms of a stock right (or change in the terms of the plan pursuant to which the stock right was granted or in the terms of any other agreement governing the right) that would inadvertently result in treat- ment as a modification under paragraph (b)(5)(v)(A) of this section is not consid- ered a modification of the stock right to the extent the change in the terms of the stock right is rescinded by the earlier of the date the stock right is exercised or the last day of the calendar year during which such change occurred. Thus, for example, if the terms of a stock right are changed on March 1 to extend the exercise period and the change is rescinded on Novem- ber 1, then if the stock right is not exer- cised before the change is rescinded, the stock right is not considered modified un- der paragraph (b)(5)(v)(A) of this section. (J)Successive modifications.Therules of this paragraph (b)(5)(v) apply as well to successive modifications, including suc- cessive extensions or renewals. (6)Restricted Property—(i)In general. If a service provider receives property from, or pursuant to, a plan maintained by a service recipient, there is no defer- ral of compensation merely because the value of the property is not includible in income in the year of receipt by reason of the property being substantially nonvested (as defined in §1.83–3(b)), or is includible in income solely due to a valid election under section 83(b). For purposes of this paragraph (b)(6)(i), a transfer of property includes the transfer of a beneficial inter- est in a trust or annuity plan, or a transfer to or from a trust or under an annuity plan, to the extent such a transfer is subject to section 83, section 402(b) or section 403(c). (ii)Promises to transfer property.A plan under which a service provider ob- tains a legally binding right to receive property (whether or not the property will be substantially nonvested (as defined in §1.83–3(b)) at the time of grant) in a fu- ture year may provide for the deferral of compensation and, accordingly, may con- stitute a nonqualified deferred compen- sation plan. The vesting of substantially nonvested property subject to section 83 may be treated as a payment for purposes of section 409A, including for purposes of applying the short-term deferral rules under paragraph (b)(4) of this section. Accordingly, where the promise to trans- fer the substantially nonvested property and the right to retain the substantially nonvested property are both subject to a substantial risk of forfeiture (as defined under paragraph (d) of this section), the arrangement generally would constitute a short-term deferral under paragraph (b)(4) of this section because the payment would occur simultaneously with the vesting of the right to the property. For exam- ple, where an employee participates in a two-year bonus program such that, if the employee continues in employment for two years, the employee is entitled to ei- ther the immediate payment of a $10,000 cash bonus or the grant of restricted stock with a $15,000 fair market value subject to a vesting requirement of three additional years of service, the arrangement gener- ally would constitute a short-term deferral under paragraph (b)(4) of this section be- cause under either alternative the payment would be received within the short-term deferral period. (7)Arrangements between partnerships and partners. [Reserved.] (8)Certain foreign arrangements—(i) Arrangements with respect to compensa- tion covered by treaty or other interna- tional agreement. An arrangement with a service provider does not provide for a deferral of compensation for purposes of this paragraph (b) to the extent that the compensation under the arrangement would have been excluded from gross in- come for Federal income tax purposes un- der the provisions of any bilateral income tax convention or other bilateral or mul- tilateral agreement to which the United States is a party if the compensation had been paid to the service provider at the time that the legally binding right to the compensation first arose or, if later, the time that the legally binding right was no longer subject to a substantial risk of for- feiture. (ii)Arrangements with respect to cer- tain other compensation. An arrangement with a service provider does not provide for a deferral of compensation for pur- poses of this paragraph (b) to the extent that compensation under the arrangement would not have been includible in gross income for Federal tax purposes if it had been paid to the service provider at the time that the legally binding right to the compensation first arose or, if later, the time that the legally binding right was no longer subject to a substantial risk of for- feiture, due to one of the following— (A) The service provider was a nonres- ident alien at such time and the compen- sation would not have been includible in gross income under section 872; (B) The service provider was a qualified individual (as definedin section 911(d)(1)) at such time and the compensation would have been foreign earned income within the meaning of section 911(b)(1) if paid at such time, and the compensation would have been foreign earned income within the meaning of section 911(b)(1) that is less than the difference between the max- imum exclusion amount under section 911(b)(2)(D) for such taxable year and the amount of foreign earned income actually excludible from gross income by such qualified individual for such taxable year under section 911(a)(1); (C) The compensation would have been excludible from gross income under sec- tion 893; or (D) The compensation would have been excludible from gross income under sec- tion 931 or section 933. (iii)Tax equalization arrangements. Compensation paid under a tax equaliza- tion arrangement does not provide for a de- ferral of compensation, provided that any payment made under such arrangement is paid no later than the end of the second calendar year beginning after the calendar year in which the service provider’s U.S. Federal income tax return is required to be filed (including extension) for the year to which the tax equalization payment relates. For purposes of this paragraph (b)(8)(iii), the termtax equalization ar- rangementrefers to an arrangement that provides payments intended to compen- sate the service provider for the excess of the taxes actually imposed by a for- October 24, 20058242005–43 I.R.B. eign jurisdiction on the compensation paid (other than the compensation under the tax equalization agreement) by the service recipient to the service provider over the taxes that would be imposed if the com- pensation were subject solely to United States Federal income tax, and provided that the payments made under such ar- rangement may not exceed such excess and the amount necessary to compensate for the additional taxes on the amounts paid under the arrangement. (iv)Additional foreign arrangements. An arrangement with a service provider does not provide for a deferral of com- pensation for purposes of this paragraph (b) to the extent designated by the Com- missioner in revenue procedures, notices, or other guidance published in the Inter- nal Revenue Bulletin (see §601.601(d)(2) of this chapter). (v)Earnings. Earnings on compen- sation excluded from the definition of deferral of compensation pursuant to this paragraph (b)(8) are also not treated as a deferred compensation. However, amounts that would be recharacter- ized as deferred compensation under §31.3121(v)(2)–1(d)(2)(iii)(B) of this chapter (nonaccount balance plans), §31.3121(v)(2)–1(d)(2)(iii)(A) of this chapter (account balance plans), or sim- ilar principles with respect to plans that are neither nonaccount balance plans nor account balance plans, will not be treated as earnings for purposes of this paragraph (b)(8)(v). (9)Separation pay arrangements—(i) In general. An arrangement that other- wise provides for a deferral of compen- sation under this paragraph (b) does not fail to provide a deferral of compensation merely because the right to payment of the compensation is conditioned upon a sep- aration from service. However, see para- graphs (b)(9)(ii), (iii) and (iv) of this sec- tion for separation pay arrangements that do not provide for the deferral of com- pensation. Notwithstanding any other pro- vision of this paragraph (b)(9), any pay- ment or benefit, or entitlement to a pay- ment or benefit, that acts as a substitute for, or replacement of, amounts deferred by the service recipient under a separate nonqualified deferred compensation plan constitutes a payment or a deferral of com- pensation under the separate nonqualified deferred compensation plan, and does not constitute a payment or deferral of com- pensation under a separation pay arrange- ment. (ii)Collectively bargained separation pay arrangements. A separation pay ar- rangement does not provide for a deferral of compensation if the arrangement is a collectively bargained separation pay arrangement that provides for separation pay upon an actual involuntary separation from service or pursuant to a window pro- gram. Only the portion of the separation pay arrangement attributable to employees covered by a collective bargaining agree- ment is considered to be provided under a collectively bargained separation pay arrangement. A collectively bargained separation pay arrangement is a separation pay arrangement that meets the following conditions: (A) The separation pay arrangement is contained within an agreement that the Secretary of Labor determines to be a col- lective bargaining agreement. (B) The separation pay provided by the collective bargaining agreement was the subject of arms-length negotiations be- tween employee representatives and one or more employers, and the agreement between employee representatives and one or more employers satisfies section 7701(a)(46). (C) The circumstances surrounding the agreement evidence good faith bargaining between adverse parties over the separa- tion pay to be provided under the agree- ment. (iii)Separation pay plans due to invol- untary separation from service or partici- pation in a window program. A separation pay plan that is not described in paragraph (b)(9)(ii) of this section and that provides for separation pay upon an actual involun- tary separation from service or pursuant to a window program does not provide for a deferral of compensation if the plan pro- vides that— (A) The separation pay (other than amounts described in paragraph (b)(9)(iv) of this section) may not exceed two times the lesser of— (1) The sum of the service provider’s annual compensation (as defined in §1.415–2(d)) for services provided to the service recipient as an employee and the service provider’s net earnings from self-employment (as defined in section 1402(a)) for services provided to the ser- vice recipient as an independent contrac- tor, each for the calendar year preceding the calendar year in which the service provider has a separation from service from such service recipient; or (2) The maximum amount that may be taken into account under a qualified plan pursuant to section 401(a)(17) for such year; and (B) The separation pay must be paid no later than December 31 of the second cal- endar year following the calendar year in which occurs the separation from service. (iv)Reimbursements and certain other separation payments—(A)In general.To the extent a separation pay arrangement entitles a service provider to payment by the service recipient for a limited period of time of reimbursements that are oth- erwise excludible from gross income, of reimbursements for expenses that the ser- vice provider can deduct under section 162 or section 167 as business expenses in- curred in connection with the performance of services (ignoring any applicable lim- itation based on adjusted gross income), or of reasonable outplacement expenses and reasonable moving expenses actually incurred by the service provider and di- rectly related to the termination of ser- vices for the service recipient, such ar- rangement does not provide for a defer- ral of compensation. To the extent a sep- aration pay arrangement (including an ar- rangement involving payments due to a voluntary separation from service) entitles a service provider to reimbursement by the service recipient for a limited period of time of payments of medical expenses in- curred and paid by the service provider but not reimbursed and allowable as a deduc- tion under section 213 (disregarding the re- quirement of section 213(a) that the deduc- tion is available only to the extent that such expenses exceed 7.5 percent of adjusted gross income), such arrangement does not provide for a deferral of compensation. (B)In-kind benefits and direct service recipient payments. A service provider’s entitlement to in-kind benefits from the service recipient, or a payment by the ser- vice recipient directly to the person pro- viding the goods or services to the service provider, will also be treated as not pro- viding for a deferral of compensation for purposes of this paragraph (b), if a right to reimbursement by the service recipient for a payment for such benefits, goods or ser- 2005–43 I.R.B.825October 24, 2005 vices by the service provider would not be treated as providing for a deferral of com- pensation under this paragraph (b)(9)(iv). (C)De minimis payments. In addition, if not otherwise excluded, to the extent a separation pay arrangement entitles a ser- vice provider to reimbursements or other payments or benefits that do not exceed $5,000 in the aggregate, such arrangement does not provide for a deferral of compen- sation. (D)Limitedperiodoftime. For pur- poses of paragraphs (b)(9)(iv)(A) and (B), a limited period of time refers to both the period during which applicable expenses may be incurred, and the period during which reimbursements must be paid, and may not extend beyond the December 31 of the second calendar year following the calendar year in which the separation from service occurred. (v)Window programs — definition. The termwindow programrefers to a pro- gram established by the service recipient to provide for separation pay in connec- tion with a separation from service, for a limited period of time (no greater than one year), to service providers who separate from service during that period or to ser- vice providers who separate from service during that period under specified circum- stances. A program will not be considered a window program if a service recipient es- tablishes a pattern of repeatedly providing for similar separation pay in similar situa- tions for substantially consecutive, limited periods of time. Whether the recurrence of these programs constitutes a pattern is determined based on the facts and cir- cumstances. Although no one factor is determinative, relevant factors include whether the benefits are on account of a specific business event or condition, the degree to which the separation pay relates to the event or condition, and whether the event or condition is temporary or discrete or is a permanent aspect of the employer’s business. (c)Plan—(1)In general.Theterm planincludes any agreement, method or arrangement, including an agreement, method or arrangement that applies to one person or individual. A plan may be adopted unilaterally by the service recip- ient or may be negotiated or agreed to by the service recipient and one or more service providers or service provider rep- resentatives. An agreement, method or arrangement may constitute a plan re- gardless of whether it is an employee benefit plan under section 3(3) of the Em- ployee Retirement Income Security Act of 1974 (ERISA), as amended (29 U.S.C. 1002(3)). The requirements of section 409A are applied as if a separate plan or plans is maintained for each service provider. (2)Plan aggregation rules—(i)In gen- eral. Except as provided in paragraph (c)(2)(ii) of this section, with respect to arrangements between a service provider and a service recipient— (A) All amounts deferred with respect to that service provider under all account balance plans of the service recipient (as defined in §31.3121(v)(2)–1(c)(1)(ii)(A) of this chapter) other than a separation pay arrangement described in paragraph (c)(2)(i)(C) of this section are treated as deferred under a single plan; (B) All amounts deferred with respect to that service provider under all nonac- count balance plans of the service recipient (as defined in §31.3121(v)(2)–1(c)(2)(i) of this chapter) other than a separation pay arrangement described in paragraph (c)(2)(i)(C) of this section are treated as deferred under a separate single plan; (C) All amounts deferred with respect to that service provider under all separa- tion pay arrangements (as defined in para- graph (m) of this section) of the service re- cipient due to an involuntary termination or participation in a window program are treated as deferred under a single plan; and (D) All amounts deferred with respect to that service provider under all plans of the service recipient that are not described in paragraph (c)(2)(i)(A), (B) or (C) of this section (for example, discounted stock options, stock appreciation rights or other equity-based compensation described in §31.3121(v)(2)–1(b)(4)(ii) of this chapter) are treated as deferred under a separate single plan. (ii)Dual status. Arrangements in which a service provider participates are not ag- gregated to the extent the service provider participates in one set of arrangements due to status as an employee of the service re- cipient (employee arrangements) and an- other set of arrangements due to status as an independent contractor of the service recipient (independent contractor arrange- ments). For example, where a service provider deferred amounts under an ar- rangement while providing services as an independent contractor, and then becomes eligible for and defers amounts under a separate arrangement after being hired as an employee, the two arrangements will not be aggregated for purposes of this para- graph (c)(2). Where an employee also serves as a director of the service recipi- ent (or a similar position with respect to a non-corporate service recipient), the ar- rangements under which the employee par- ticipates as a directorof the service recip- ient (director arrangements) are not aggre- gated with employee arrangements, pro- vided that the director arrangements are substantially similar to arrangements pro- vided to service providers providing ser- vices only as directors (or similar positions with respect to non-corporate service re- cipients). For example, an employee di- rector who participates in an employee ar- rangement and a director arrangement gen- erally may treat the two arrangements as separate plans, provided that the director arrangement is substantially similar to an arrangement providing benefits to a non- employee director. Director arrangements and independent contractor arrangements are aggregated for purposes of this para- graph (c)(2). (3)Establishment of arrangement—(i) In general. To satisfy the requirements of section 409A, an arrangement must be established and maintained by a service recipient, in both form and operation, in accordance with the requirements of section 409A and these regulations. For purposes of this paragraph (c)(3), an ar- rangement is established on the latest of the date on which it is adopted, the date on which it is effective, and the date on which the material terms of the plan are set forth in writing. For purposes of this paragraph (c)(3)(i), an arrangement will be deemed to be set forth in writing if it is set forth in any other form that is approved by the Commissioner. The material terms of the arrangement include the amount (or the method or formula for determining the amount) of deferred compensation to be provided under the arrangement and the time when it will be paid. Notwithstand- ing the foregoing, anarrangement will be deemed to be established as of the date the participant obtains a legally binding right to deferred compensation, provided that the arrangement is otherwise established under the rules of this paragraph (c)(3)(i) October 24, 20058262005–43 I.R.B. by the end of the calendar year in which the legally binding right arises, or with respect to an amount not payable in the year immediately following the year in which the legally binding right arises (the subsequent year), the 15 th day of the third month of the subsequent year. (ii)Amendments to the arrangement.In the case of an amendment that increases the amount deferred under an arrangement providing for the deferral of compensa- tion, the arrangement is not considered established with respect to the additional amount deferred until the arrangement, as amended, is established in accordance with paragraph (c)(3)(i) of this section. (iii)Transition rule for written plan re- quirement. For purposes of this section, an unwritten arrangement that was adopted and effective before December 31, 2006, is treated as established under this section as of the later of the date on which it was adopted or became effective, provided that the material terms of the arrangement are set forth in writing on or before December 31, 2006. (iv)Plan aggregation rules.Theplan aggregation rules of paragraph (c)(2)(i) of this section do not apply to the require- ments of paragraphs (c)(3)(i) and (ii) of this section. Accordingly, an arrangement that fails to meet the requirements of sec- tion 409A solely due to a failure to meet the requirements of paragraph (c)(3)(i) or (ii) is not aggregated with other arrange- ments that meet such requirements. (d)Substantial risk of forfeiture—(1)In general. Compensation is subject to a sub- stantial risk of forfeiture if entitlement to the amount is conditioned on the perfor- mance of substantial future services by any person or the occurrence of a condition re- lated to a purpose of the compensation, and the possibility of forfeiture is substantial. For purposes of this paragraph (d), a con- dition related to a purpose of the compen- sation must relate to the service provider’s performance for the service recipient or the service recipient’s business activities or organizational goals (for example, the attainment of a prescribed level of earn- ings, equity value or an initial public of- fering). Any addition of a substantial risk of forfeiture after the legally binding right to the compensation arises, or any exten- sion of a period during which compensa- tion is subject to a substantial risk of forfei- ture, in either case whether elected by the service provider, service recipient or other person (or by agreement of two or more of such persons), is disregarded for pur- poses of determining whether such com- pensation is subject to a substantial risk of forfeiture. An amount is not subject to a substantial risk of forfeiture merely because the right to the amount is condi- tioned, directly or indirectly, upon the re- fraining from performance of services. For purposes of section 409A, an amount will not be considered subject to a substantial risk of forfeiture beyond the date or time at which the recipient otherwise could have elected to receive the amount of compen- sation, unless the amount subject to a sub- stantial risk of forfeiture (ignoring earn- ings) is materially greater than the amount the recipient otherwise could have elected to receive. For example, a salary defer- ral generally may not be made subject to a substantial risk offorfeiture. But, for example, where a bonus arrangement pro- vides an election between a cash payment of a certain amount or restricted stock units with a materially greater value that will be forfeited absent continued services for a period of years, the right to the restricted stock units generally will be treated as sub- ject to a substantial risk of forfeiture. (2)Stock rights. A stock right will be treated as not subjectto a substantial risk of forfeiture at the earlier of the first date the holder may exercise the stock right and receive cash or property that is substan- tially vested (as defined in §1.83–3(b)) or the first date that the stock right is not sub- ject to a forfeiture condition that would constitute a substantial risk of forfeiture. Accordingly, a stock option that the ser- vice provider may exercise immediately and receive substantially vested stock will be treated as not subject to a substantial risk of forfeiture, even if the stock option automatically terminates upon the service provider’s separation from service. (3)Enforcement of forfeiture con- dition—(i)In general. In determining whether the possibility of forfeiture is substantial in the case of rights to com- pensation granted by a service recipient to a service provider that owns a signifi- cant amount of the total combined voting power or value of all classes of equity of the service recipient or of its parent, all relevant facts and circumstances will be taken into account in determining whether the probability of the service recipient enforcing such condition is substantial, including— (A) The service provider’s relationship to other equity holders and the extent of their control, potential control and possible loss of control of the service recipient; (B) The position of the service provider in the service recipient and the extent to which the service provider is subordinate to other service providers; (C) The service provider’s relationship to the officers and directors of the service recipient (or similar positions with respect to a noncorporate service recipient); (D) The person or persons who must approve the service provider’s discharge; and (E) Past actions of the service recipient in enforcing the restrictions. (ii)Examples. The following examples illustrate the rules of paragraph (d)(3)(i) of this section: Example 1. A service provider would be con- sidered as having deferred compensation subject to a substantial risk of forfeiture, but for the fact that the service provider owns 20 percent of the single class of stockinthetransferorcorporation. If the remaining 80 percent of the class of stock is owned by an unre- lated individual (or members of such an individual’s family) so that the possibility of the corporation en- forcing a restriction on such rights is substantial, then such rights are subject to a substantial risk of forfei- ture. Example 2. A service provider would be con- sidered as having deferred compensation subject to a substantial risk of forfeiture, but for the fact that the service provider who is president of the corpora- tion, also owns 4 percent of the voting power of all the stock of a corporation. If the remaining stock is so diversely held by the public that the president, in effect, controls the corporation, then the possibility of the corporation enforcing a restriction on the right to deferred compensation of the president is not sub- stantial, and such rights are not subject to a substantial risk of forfeiture. (e)Performance-based compensa- tion—(1)In general.Thetermperfor- mance-based compensationmeans com- pensation where the amount of, or entitle- ment to, the compensation is contingent on the satisfaction of preestablished or- ganizational or individual performance criteria relating to a performance period of at least 12 consecutive months in which the service provider performs services. Organizational or individual performance criteria are considered preestablished if established in writing by not later than 90 days after the commencement of the pe- riod of service to which the criteria relates, provided that the outcome is substantially 2005–43 I.R.B.827October 24, 2005 uncertain at the time the criteria are estab- lished. Performance-based compensation may include payments based on perfor- mance criteria that are not approved by a compensation committee of the board of directors (or similar entity in the case of a non-corporate servicerecipient) or by the stockholders or members of the service recipient. Notwithstanding the foregoing, performance-based compensation does not include any amount or portion of any amount that will be paid either regardless of performance, or based upon a level of performance that is substantially certain to be met at the time the criteria is estab- lished. Except as provided in paragraph (e)(3) of this section, compensation is not performance-based compensation merely because the amount of such compensation is based on the value of, or increase in the value of, the service recipient or the stock of the service recipient. (2)Payments based upon subjective performance criteria.Thetermperfor- mance-based compensationmay include payments based upon subjective perfor- mance criteria, provided that— (i) The subjective performance criteria relate to the performance of the partici- pant service provider, a group of service providers that includes the participant ser- vice provider, or a business unit for which the participant service provider provides services (which may include the entire or- ganization); and (ii) The determination that any sub- jective performancecriteria have been met is not made by the participant ser- vice provider or a family member of the participant service provider (as defined in section 267(c)(4) applied as if the family of an individual includes the spouse of any member of the family), or a person under the supervision of the participant service provider or such a family member, or where any amount of the compensation of the person making such determination is controlled in whole or in part by the service provider or such a family member. (3)Equity-based compensation.Com- pensation is performance-based compen- sation if it is based solely on an increase in the value of the service recipient, or stock of the service recipient, after the date of a grant or award. If the amount of com- pensation the service provider will receive under a grant or award is not based solely on an increase in the value of the service recipient, or stock of the service recipient, after the date of the grant or award (for ex- ample, a stock appreciation right granted with an exercise price that is less than the fair market value of the stock as of the date of grant), and that other amount would not otherwise qualify as performance-based compensation, the compensation attrib- utable to the grant or award does not qualify as performance-based compensa- tion. Notwithstanding the foregoing, an award of equity-based compensation may constitute performance-based compensa- tion if entitlement to the compensation is subject to a condition that would cause the award to otherwise qualify as per- formance-based compensation, such as a performance-based vesting condition. The eligibility to defer compensation under an equity-based compensation award consti- tutes an additional deferral feature with respect to the award for purposes of the definition of a deferral of compensation under paragraph (b)(5) of this section. (f)Service provider—(1)In general. The termservice providerincludes— (i) An individual, corporation, subchap- ter S corporation or partnership; (ii) A personal service corporation (as defined in section 269A(b)(1)), or a non- corporate entity that would be a personal service corporation if it were a corpora- tion; or (iii) A qualified personal service corpo- ration (as defined in section 448(d)(2)), or a noncorporate entity that would be a qual- ified personal service corporation if it were a corporation. (2)Service providers using an accrual method of accounting. Section 409A does not apply to a deferral under an arrange- ment between taxpayers if, for the taxable year in which the service provider taxpayer obtains a legally binding right to the com- pensation, the service provider uses an ac- crual method of accounting for Federal tax purposes. (3)Independent contractors—(i)In general. Except as otherwise provided in paragraph (f)(3)(iv) of this section, sec- tion 409A does not apply to an amount deferred under an arrangement between a service provider and service recipient with respect to a particular trade or business in which the service provider participates, if during the service provider’s taxable year in which the service provider obtains a legally binding right to the payment of the amount deferred— (A) The service provider is actively en- gaged in the trade or business of providing services, other than as an employee or as a director of a corporation; (B) The service provider provides sig- nificant services to two or more service re- cipients to which the service provider is not related and that are not related to one another (as defined in paragraph (f)(3)(ii) of this section); and (C) The service provider is not related to the service recipient, applying the defi- nition of related person contained in para- graph (f)(3)(ii) of this section subject to the modification that the language “50 per- cent” is used instead of “20 percent” each place it appears in sections 267(b) and 707(b)(1). (ii)Related person. For purposes of this paragraph (f)(3), a person is related to another person if the persons bear a re- lationship to each other that is specified in section 267(b) or 707(b)(1), subject to the modifications that the language “20 percent” is used instead of “50 percent” each place it appears in sections 267(b) and 707(b)(1), and section 267(c)(4) is applied as if the family of an individual includes the spouse of any member of the family; or the persons are engaged in trades or busi- nesses under common control (within the meaning of section 52(a) and (b)). In addi- tion, an individual is related to an entity if the individual is an officer of an entity that is a corporation, or holds a position sub- stantially similar to an officer of a corpora- tion with an entity that is not a corporation. (iii)Significant services. Whether a ser- vice provider is providing significant ser- vices depends on the facts and circum- stances of each case. However, for pur- poses of paragraph (f)(3)(i) of this section, a service provider who provides services to two or more service recipients to which the service provider is not related and that are not related to one another is deemed to be providing significant services to two or more of such service recipients for a given taxable year, if the revenues gen- erated from the services provided to any service recipient or group of related ser- vice recipients during such taxable year do not exceed 70 percent of the total revenue generated by the service provider from the trade or business of providing such ser- vices. October 24, 20058282005–43 I.R.B. (iv)Management services.Aservice provider is treated as related to a service re- cipient for purposes of paragraph (f)(3)(i) of this section if the service provider pro- vides management services to the service recipient. For purposes of this paragraph (f)(3)(iv), the termmanagement services means services that involve the actual or de facto direction or control of the financial or operational aspects of a trade or busi- ness of the service recipient, or investment advisory services provided to a service re- cipient whose primary trade or business in- cludes the management of financial assets (including investments in real estate) for its own account, such as a hedge fund or a real estate investment trust. (g)Service recipient. Except as other- wise specifically provided in these regu- lations, the termservice recipientmeans the person for whom the services are per- formed and with respect to whom the legally binding right to compensation arises, and all persons with whom such person would be considered a single em- ployer under section 414(b) (employees of a controlled group of corporations), and all persons with whom such person would be considered a single employer under section 414(c) (employees of part- nerships, proprietorships, etc., under com- mon control). For example, where the service provider is an employee, the ser- vice recipient generally is the employer. Notwithstanding the foregoing, section 409A applies to a plan that provides for the deferral of compensation, even though the payment of the compensation is not made by the person for whom services are performed. (h)Separation from service—(1)Em- ployees—(i)In general.Anemployeesep- arates from service with the service recip- ient if the employee dies, retires, or oth- erwise has a termination of employment with the employer. However, for purposes of this paragraph (h)(1), the employment relationship is treatedas continuing intact while the individual is on military leave, sick leave, or otherbona fideleave of ab- sence (such as temporary employment by the government) if the period of such leave does not exceed six months, or if longer, so long as the individual’s right to reemploy- ment with the service recipient is provided either by statute or by contract. If the pe- riod of leave exceeds six months and the individual’s right to reemployment is not provided either by statute or by contract, the employment relationship is deemed to terminate on the first date immediately fol- lowing such six-month period. (ii)Termination of employment. Whether a termination of employment has occurred is determined based on the facts and circumstances. Where an employee either actually or purportedly continues in the capacity as an employee, such as through the execution of an employment agreement under which the employee agrees to be available to perform services if requested, but the facts and circum- stances indicate that the employer and the employee did not intend for the employee to provide more than insignificant services for the employer, an employee will be treated as having a separation from service for purposes of this paragraph (h)(1). For purposes of the preceding sentence, an employer and employee will not be treated as having intended for the employee to provide insignificant services where the employee continues to provide services as an employee at an annual rate that is at least equal to 20 percent of the services rendered, on average, during the immedi- ately preceding three full calendar years of employment (or, if employed less than three years, such lesser period) and the annual remuneration for such services is at least equal to 20 percent of the average an- nual remuneration earned during the final three full calendar years of employment (or, if less, such lesser period). Where an employee continues to provide ser- vices to a previous employer in a capacity other than as an employee, a separation from service will not be deemed to have occurred for purposes of this paragraph (h)(1) if the former employee is providing services at an annual rate that is 50 percent or more of the services rendered, on av- erage, during the immediately preceding three full calendar years of employment (or if employed less than three years, such lesser period) and the annual remuneration for such services is 50 percent or more of the annual remuneration earned during the final three full calendar years of employ- ment(orifless,suchlesserperiod). For purposes of this paragraph (h)(1)(ii), the annual rate of providing services is deter- mined based upon the measurement used to determine the service provider’s base compensation (for example, amounts of time required to earn salary, hourly wages, or payments for specific projects). (2)Independent contractors—(i)In general. An independent contractor is considered to have a separation from ser- vice with the service recipient upon the expiration of the contract (or in the case of more than one contract, all contracts) under which servicesare performed for the service recipient if the expiration constitutes a good-faith and complete ter- mination of the contractual relationship. An expiration does not constitute a good faith and complete termination of the con- tractual relationship if the service recipient anticipates a renewal of a contractual re- lationship or the independent contractor becoming an employee. For this pur- pose, a service recipient is considered to anticipate the renewal of the contractual relationship with an independent contrac- tor if it intends to contract again for the services provided under the expired con- tract, and neither the service recipient nor the independent contractor has eliminated the independent contractor as a possible provider of services under any such new contract. Further, a service recipient is considered to intend to contract again for the services provided under an expired contract if the servicerecipient’s doing so is conditioned only upon incurring a need for the services, the availability of funds, or both. (ii)Special rule. Notwithstanding para- graph (h)(2)(i) of this section, the plan is considered to satisfy the requirement de- scribed in §1.409A–3(a)(1) that amounts deferred under the plan may be paid or made available to the participant upon a separation from service with the service re- cipient if, with respect to amounts payable to a participant who is an independent con- tractor, a plan provides that— (A) No amount will be paid to the par- ticipant before a date at least 12 months af- ter the day on which the contract expires under which services are performed for the service recipient (or, in the case of more than one contract, all such contracts ex- pire); and (B) No amount payable to the partici- pant on that date will be paid to the partic- ipant if, after the expiration of the contract (or contracts) and before that date, the par- ticipant performs services for the service recipient as an independent contractor or an employee. 2005–43 I.R.B.829October 24, 2005 (i)Specified employee—(1)In general. The termspecified employeemeans a key employee (as defined in section 416(i) without regard to section 416(i)(5)) of a service recipient any stock of which is publicly traded on an established securi- ties market or otherwise. For purposes of this paragraph (i)(1), an employee is a key employee if the employee meets the requirements of section 416(i)(1)(A)(i), (ii) or (iii) (applied in accordance with the regulations thereunder and disregarding section 416(i)(5)) at any time during the 12-month period ending on an identifica- tion date. If a person is a key employee as of an identification date, the person is treated as a specified employee for the 12-month period beginning on the first day of the fourth month following the iden- tification date. A service recipient may designate any date in a calendar year as the identification date provided that a service recipient must use the same identification date with respect to all arrangements, and any change to the identification date may not be effective for a period of 12 months. If no identification date is designated, the identification date is December 31. The service recipient may designate an iden- tification date through inclusion in each plan document or through a separate doc- ument, provided that the service recipient will not be treated as having designated an identification date on any date before the execution of the document contain- ing the designation. Notwithstanding the foregoing, any designation of an identifi- cation date made on or before December 31, 2006, may be applied to any separa- tion from service occurring on or after January 1, 2005. Whether any stock of a service recipient is publicly traded on an established securities market or otherwise must be determined as of the date of the employee’s separation from service. (2)Spinoffs and mergers.Whereanew corporation or entity (new corporation) is established as part of a corporate division governed by section 355 from a corpora- tion that is publicly traded on an estab- lished securities market or otherwise (old corporation), any employee of the new cor- poration who was a key employee of the old corporation immediately prior to the spinoff is a key employee of the new cor- poration until the end of the 12-month pe- riod beginning on the first day of the fourth month following the old corporation’s last identification date preceding the spinoff transaction. Where twocorporations (pre- merger corporations) are merged or be- come part of the same controlled group of corporations so as to be treated as a sin- gle service recipientunder paragraph (g) of this section, any employee of the merged corporation who was a key employee of either of the pre-merger corporations im- mediately before the merger is a key em- ployee of the merged corporation until the first day of the fourth month after the iden- tification date of the merged corporation next following the merger. (3)Nonresident alien employees.For purposes of determining key employees, a service recipient generally must include all employees, including employees who are nonresident aliens. However, a plan may provide without causing an amount to be treated as an additional deferral as to any affected participant that for purposes of applying the six-month delay to specified employees, all employees that are nonresi- dent aliens during the entire 12-month pe- riod ending with the relevant identifica- tion date are excluded for purposes of de- termining which employees meet the re- quirements of section 416(i)(1)(A)(i), (ii) or (iii) (applied in accordance with the reg- ulations thereunder and disregarding sec- tion 416(i)(5)); provided that a service re- cipient must apply such exclusion with re- spect to all arrangements of the service re- cipient, and any change to include such nonresident alien employees may not be effective for a period of 12 months. (j)Nonresident alien—(1) Except as provided in paragraph (j)(2) of this sec- tion, for purposes of this section the term nonresident alienmeans an individual who is— (i) A nonresident alien within the mean- ing of section 7701(b)(1)(B); or (ii) A dual resident taxpayer within the meaning of §301.7701(b)–7(a)(1) of this chapter with respect to any taxable year in which such individual is treated as a non- resident alien for purposes of computing the individual’s U.S. income tax liability. (2) The termnonresident aliendoes not include— (i) A nonresident alien with respect to whom an election is in effect for the taxable year under section 6013(g) to be treated as a resident of the United States; (ii) A former citizen or long-term resident (within the meaning of section 877(e)(2)) who expatriated after June 3, 2004, and has not complied with the re- quirements of section 7701(n); or (iii) An individual who is treated as a citizen or resident of the United States for the taxable year under section 877(g). (k)Established securities market.For purposes of section 409A and the regu- lations thereunder, the termestablished securities marketmeans an established securities market within the meaning of §1.897–1(m). (l)Stock right. For purposes of section 409A and these regulations, the termstock rightmeans a stock option (other than an incentive stock option described in section 422oranoptiongrantedpursuanttoan employee stock purchase plan described in section 423) or a stock appreciation right. (m)Separation pay arrangement.For purposes of section 409A and the regula- tions thereunder, the termseparation pay arrangementmeans any arrangement that provides separation pay or, where an ar- rangement provides both amounts that are separation pay and that are not separation pay, that portion of the arrangement that provides separation pay. For purposes of this paragraph (m), the termseparation paymeans any amount of compensation where one of the conditions to the right to the payment is a separation from service, whether voluntary or involuntary, includ- ing payments in the form of reimburse- ments of expenses incurred, and the provi- sion of other taxable benefits. Separation pay includes amounts payable due to a sep- aration from service, regardless of whether payment is conditioned upon the execu- tion of a release of claims, noncompeti- tion or nondisclosure provisions, or other similar requirement. Notwithstanding the foregoing, any amount, or entitlement to any amount, that acts as a substitute for, or replacement of, amounts deferred by the service recipient under a separate nonqual- ified deferred compensation plan consti- tutes a payment of compensation or de- ferral of compensation under the separate nonqualified deferred compensation plan, and does not constitute separation pay. §1.409A–2 Deferral elections. (a)Initial elections as to the time and form of payment—(1)In general.An arrangement that is, or constitutes part of, a nonqualified deferred compensation October 24, 20058302005–43 I.R.B. plan meets the requirements of section 409A(a)(4)(B) only if the arrangement provides that compensation for services performed during a service provider’s taxable year (the service year) may be deferred at the service provider’s election only if the election to defer such compen- sation is made and becomes irrevocable not later than the end of such period as may be permitted in this paragraph (a). An election will not be considered to be revocable merely because the service provider may make an election to change the time and form of payment pursuant to paragraph (b) of this section. Whether an arrangement provides a service provider an opportunity to elect the time or form of payment of compensation is determined based upon all the facts and circumstances surrounding the determination of the time and form of payment of the compensation. For purposes of this section, an election to defer includes an election as to the time ofthepayment,anelectionastotheform of the payment or an election as to both the time and the form of the payment, but does not include an election as to the medium of payment (for example, an election between a payment of cash or a payment of property). Except as otherwise provided in these regulations, an election will not be considered made until such election becomes irrevocable under the terms of the relevant arrangement. Thus, a plan may provide that an election to defer may be changed at any time prior to the last permissible date for making such an election. Where an arrangement provides the service provider a right to make an initial deferral election, and fur- ther provides that the election remains in effect until terminated or modified by the service provider, the election will be treated as made as of the date such election becomes irrevocable as to compensation for services performed during the rele- vant service year. For example, where an arrangement provides that a service provider’s election to defer a set percent- age will remain in effect until changed or revoked, but that as of each December 31 the election becomes irrevocable with respect to salary payable with respect to services performed in the immediately following year, the initial deferral election with respect to salary payable with respect to services performed in the immediately following year will be deemed to have been made as of the December 31 upon which the election became irrevocable. (2)General rule. An arrangement that is, or constitutes part of, a nonqualified deferred compensation plan meets the requirements of section 409A(a)(4)(B) if the plan provides that compensation for services performed during a service provider’s taxable year (the service year) may be deferred at the service provider’s election only if the election to defer such compensation is made not later than the close of the service provider’s taxable year next preceding the service year. (3)Initial deferral election with respect to short-term deferrals. With respect to a legally binding right to a payment of com- pensation in a subsequent taxable year that, absent a deferral election, would not be treated as a deferral of compensation pur- suant to §1.409A–1(b)(4), an election to defer such compensation may be made in accordance with the requirements of para- graph (b) of this section, applied as if the amount were a deferral of compensation and the scheduled payment date for the amount were the date the substantial risk of forfeiture lapses. Notwithstanding the requirements of paragraph (b) of this sec- tion, such a deferral election may provide that the deferred amounts will be payable upon a change in control event (as defined in §1.409A–3(g)(5)) without regard to the 5-year additional deferral requirement. (4)Initial deferral election with respect to certain forfeitable rights. With respect to a legally binding right to a payment in a subsequent year that is subject to a forfeiture condition requiring the service provider’s continued services for a period of at least 12 months from the date the ser- vice provider obtains the legally binding right, an election to defer such compen- sation may be made on or before the 30 th day after the serviceprovider obtains the legally binding right to the compensation, provided that the election is made at least 12 months in advance of the earliest date at which the forfeiture condition could lapse. (5)Initial deferral election with respect to a service recipient with a fiscal year other than the calendar year. In the case of a service recipient with a fiscal year other than the calendar year, a plan may pro- vide that fiscal year compensation may be deferred at the service provider’s election only if the election to defer such compen- sation is made not later than the close of the service recipient’s fiscal year next pre- ceding the first fiscal year in which are per- formed any services for which such com- pensation is payable. For purposes of this paragraph (a)(5), the termfiscal year com- pensationmeans compensation relating to a period of service coextensive with one or more consecutive fiscal years of the ser- vice recipient, of which no amount is paid or payable during the service period. For example, fiscal year compensation gener- ally would include a bonus based on a ser- vice period of the two consecutive fiscal years ending September 30, 2009, where the amount will be paid after the comple- tion of the service period, but would not include either a bonus based on a calen- dar year service period or salary that would otherwise be paid during the service recip- ient’s fiscal year. (6)First year of eligibility. In the case of the first year in which a service provider becomes eligible to participate in a plan (as defined in §1.409A–1(c)), the service provider may make an initial deferral elec- tion within 30 days after the date the ser- vice provider becomes eligible to partici- pate in such plan, with respect to compen- sation paid for services to be performed subsequent to the election. In the case of a plan that does not provide for service provider elections with respect to the time or form of a payment, the time and form of the payment must be specified on or before the date that is 30 days after the date the service provider becomes eligible to par- ticipate in such plan. For compensation that is earned based upon a specified per- formance period (for example, an annual bonus), where a deferral election is made in the first year of eligibility but after the beginning of the service period, the elec- tion will be deemed to apply to compen- sation paid for services performed subse- quent to the election if the election applies to the portion of the compensation equal to the total amount of the compensation for the service period multiplied by the ratio of the number of days remaining in the per- formance period after the election over the total number of days in the performance period. (7)Performance-based compensation. In the case of any performance-based com- pensation based upon a performance pe- riod of at least 12 months, provided that the service provider performed services con- tinuously from a date no later than the date 2005–43 I.R.B.831October 24, 2005 upon which the performance criteria are established through a date no earlier than the date upon which the service provider makes an initial deferral election, an initial deferral election may be made with respect to such performance-based compensation no later than the date that is six months before the end of the performance period, provided that in no event may an election to defer performance-based compensation be made after such compensation has be- come both substantially certain to be paid and readily ascertainable. (8)Nonqualified deferred compen- sation arrangements linked to qualified plans. With respect to an amount de- ferred under an arrangement that is, or constitutes part of, a nonqualified deferred compensation plan, where under the terms of the nonqualified deferred compensation arrangement the amount deferred under the plan is the amount determined under the formula under which benefits are de- termined under a qualified employer plan (as defined in §1.409A–1(a)(2)) applied without respect to one or more limita- tions applicable to qualified employer plans under the Internal Revenue Code or other applicable law, or is determined as an amount offset by some or all of the benefits provided under the qualified em- ployer plan, the operation of the qualified employer plan with respect to changes in benefit limitations applicable to qual- ified employer plans under the Internal Revenue Code or other applicable law does not constitute a deferral election even if such operation results in an increase of amounts deferred under the nonquali- fied deferred compensation arrangement, provided that such operation does not oth- erwise result in a change in the time or form of a payment under the nonqualified deferred compensation plan. In addi- tion, with respect to such a nonqualified deferred compensation arrangement, the following actions or failures to act will not constitute a deferral election under the nonqualified deferred compensation arrangement even if in accordance with the terms of the nonqualified deferred compensation arrangement, the actions or inactions result in an increase in the amounts deferred under the arrangement, provided that such actions or inactions do not otherwise affect the time or form of payment under the nonqualified deferred compensation plan: (i) A service provider’s action or inac- tion under the qualified plan with respect to whether to elect to receive a subsidized benefit or an ancillary benefit under the qualified plan. (ii) The amendment of a qualified plan to add or remove a subsidized benefit or an ancillary benefit, or to freeze or limit future accruals of benefits under the qual- ified plan. (iii) A service provider’s action or in- action under a qualified plan subject to section 402(g), including an adjustment to a deferral election under the qualified plan subject to section 402(g), provided that for any given calendar year, the ser- vice provider’s action or inaction does not result in an increase in the amounts deferred under all nonqualified deferred compensation arrangements in which the service provider participates in excess of the limit with respect to elective deferrals under section 402(g) in effect for the tax- able year in which such action or inaction occurs. (iv) A service provider’s action or in- action under a qualified plan with respect to elective deferrals or after-tax contri- butions by the service provider to the qualified plan that affects the amounts that are credited under a nonqualified deferred compensation arrangement as matching amounts or other amounts contingent on service provider elective deferrals or af- ter-tax contributions, provided that such matching or contingent amounts, as appli- cable, are either forfeited or never credited under the nonqualified deferred compen- sation arrangement in the absence of such service provider’s elective deferral or af- ter-tax contribution, and provided further that all of the service provider’s actions or inactions do not result in an increase during such taxable year in the amounts deferred under all nonqualified deferred compensation arrangements in which the service provider participates in excess of the limit with respect to elective deferrals under section 402(g) in effect for the tax- able year in which such action or inaction occurs. See paragraph (b)(6) of this sec- tion,Example 12andExample 13. (9)Separation pay. In the case of sep- aration pay (as defined in §1.409A–1(m) due to an actual involuntary separation from service, where such separation pay is the subject ofbona fide, arm’s length nego- tiations, the initial deferral election may be made at any time up to the time the service provider obtains a legally binding right to the payment. In the case of separation pay due to participation in a window program (as defined in §1.409A–1(b)(9)(v)), the initial deferral election may be made at anytimeuptothetimetheelectiontopar- ticipate in the window program becomes irrevocable. (10)Commissions. For purposes of this paragraph (a), in the case of commission compensation, a service provider earning such compensation is treated as providing the services to which such compensation relates only in the year in which the cus- tomer remits payment to the service recipi- ent. For purposes of this paragraph (a)(10), the termcommission compensationmeans compensation or portions of compensation earned by a service provider if a substan- tial portion of the services provided by such service provider to a service recipi- ent consist of the direct sale of a product or service to a customer, the compensation paid by the service recipient to the service provider consists of either a portion of the purchase price for the product or service or an amount calculated solely by refer- ence to the volume of sales, and payment of the compensation is contingent upon the service recipient receiving payment from an unrelated customer for the product or services. For this purpose, a customer is treated as an unrelated customer only if the customer is not related to either the service provider or the servicerecipient. A person is treated as related to another person if the person would be treated as related to the other person under §1.409A–1(f)(3)(ii) or the person would be treated as providing management services to the other person under §1.409A–1(f)(3)(iv). (11)Initial deferral elections with respect to compensation paid for final payroll period—(i)In general.Unless an arrangement provides otherwise, com- pensation payable after the last day of the service provider’s taxable year solely for services performed during the final pay- roll period described in section 3401(b) containing the last day of the service provider’s taxable year or, with respect to a non-employee service provider, a period not longer than the payroll period described in section 3401(b), where such amount is payable pursuant to the tim- ing arrangement under which the service recipient normally compensates service October 24, 20058322005–43 I.R.B. providers for services performed dur- ing a payroll period described in section 3401(b), or with respect to a non-employee service provider, a period not longer than the payroll period described in section 3401(b), is treatedas compensation for services performed in the subsequent tax- able year. The preceding sentence does not apply to any compensation paid during such period for services performed during any period other than such final payroll period, such as a payment of an annual bonus. Any amendment of an arrange- ment after December 31, 2006, to add a provision providing for a differing treat- ment of such compensation may not be effective for 12 months from the date the amendment is executed and enacted. (ii)Transition rule. For purposes of this paragraph (a)(11), an arrangement that was adopted and effective before December 31, 2006, whether written or unwritten, will be treated as designating such compensation for service performed in the taxable year in which the payroll period ends, unless oth- erwise set forth in writing before Decem- ber 31, 2006. (12)Designation of time and form of payment with respect to a nonelective ar- rangement. An arrangement that provides for a deferral of compensation for services performed during a service provider’s tax- able year that does not provide the ser- vice provider with an opportunity to elect the time of payment of such compensa- tion must specify the time of payment no later than the time the service provider first has a legally binding right to the com- pensation. Similarly, an arrangement that provides for a deferral of compensation for services performed during a service provider’s taxable year that does not pro- vide the service provider with an opportu- nity to elect the form of payment of such compensation must specify the form of payment no later than the time the service provider first has a legally binding right to the compensation. Such designation shall be treated as an initial deferral election for purposes of this section. (13)Designation of time and form of payment with respect to earnings.An arrangement that provides for actual or no- tional earnings to be credited on amounts of deferred compensation may specify, in accordance with the requirements of this paragraph (a), that such earnings will be paid by a date not later than the 15 th day of the third month following the calendar year for which the earnings are credited. To satisfy the requirements of this para- graph (a)(13), actual or notional earnings must be credited at least annually and the measure for such earnings must be either a specified, nondiscretionary inter- est rate (or a specified, nondiscretionary formula describing an interest rate such as, for example, the interest on a Trea- sury bond + 2 percent) or a predetermined actual investment within the meaning of §31.3121(v)(2)–1(d)(2) of this chapter. For these purposes, a right to dividend equivalents with respect to a specified number of shares of service recipient stock (as defined in §1.409A–1(b)(5)(iii)) may be treated as a right to actual or no- tional earnings on an amount of deferred compensation. (b)Subsequent changes in time and form of payment—(1)In general.The requirements of section 409A(a)(4)(C) are met if, in the case of a plan that permits a subsequent election to delay a payment or to change the form of payment of an amount of deferred compensation, the fol- lowing conditions are met: (i) The plan requires that such elec- tion may not take effect until at least 12 months after the date on which the election is made. (ii) In the case of an election re- lated to a payment not described in §1.409A–3(a)(2) (payment on account of disability), §1.409A–3(a)(3) (payment on account of death) or §1.409A–3(a)(6) (payment on account of the occurrence of an unforeseeable emergency), the plan requires that the payment with respect to which such election is made be deferred for a period of not less than 5 years from the date such payment would otherwise have been paid (or in the case of a life annuity or installment payments treated as a single payment, 5 years from the date the first amount was scheduled to be paid). (iii) The plan requires that any elec- tion related to a payment described in §1.409A–3(a)(4) (payment at a specified time or pursuant to a fixed schedule) may notbemadelessthan12monthspriorto the date the payment is scheduled to be paid (or in the case of a life annuity or installment payments treated as a single payment, 12 months prior to the date the first amount was scheduled to be paid). (2)Definition of payments for purposes of subsequent changes in the time or form of payment—(i)In general. Except as pro- vided in paragraphs (b)(2)(ii) and (iii) of this section, the termpaymentrefers to each separately identified amount to which a service provider is entitled to payment under a plan on a determinable date, and includes amounts applied for the benefit of the service provider. An amount is separately identified only if the amount may be objectively determined. For ex- ample, an amount identified as 10 percent of the account balance as of a specified payment date would be a separately iden- tified amount. A payment includes the provision of any taxable benefit, includ- ing payment in cash or in kind. In addi- tion, a payment includes, but is not limited to, the transfer, cancellation or reduction of an amount of deferredcompensation in ex- change for benefits under a welfare benefit plan, fringe benefit excludible under sec- tion 119 or section 132, or any other bene- fit that is excluded from gross income. (ii)Life annuities. The entitlement to a life annuity is treated as the entitlement to a single payment. For purposes of this paragraph (b)(2)(ii), the termlife annu- itymeans a series of substantially equal periodic payments, payable not less fre- quently than annually, for the life (or life expectancy) of the service provider or the joint lives (or life expectancies) of the ser- vice provider and the service provider’s designated beneficiary. A change in the form of a payment from one type of life annuity to another type of life annuity be- fore any annuity payment has been made is not considered a change in the time and form of a payment, provided that the an- nuities are actuariallyequivalent applying reasonable actuarial assumptions. (iii)Installment payments. The entitle- ment to a series of installment payments that is not a life annuity is treated as the entitlement to a single payment, unless the arrangement provides at all times with re- spect to the amount deferred that the right to the series of installment payments is to be treated as a right to a series of separate payments. For purposes of this paragraph (b)(2)(iii), a series ofinstallment payments refers to an entitlement to the payment of a series of substantially equal periodic amounts to be paid over a predetermined period of years, except to the extent any increase in the amount reflects reasonable 2005–43 I.R.B.833October 24, 2005 earnings through the date the amount is paid. (iv)Transition rule. For purposes of this section, an arrangement that was adopted and effective before December 31, 2006, whether written or unwritten, that fails to make a designation as to whether the entitlement to a series of pay- ments is to be treated as an entitlement to a series of separate payments under para- graph (b)(2)(iii) of this section is treated as having made such designation as of the later of the date on which the arrangement was adopted or became effective, provided that such designation is set forth in writing before December 31, 2006. (3)Coordination with prohibition against acceleration of payments. For pur- poses of applying the prohibition against the acceleration of payments contained in §1.409A–3(h), the definition of payment is the same as the definition provided in paragraph (b)(2) of this section. However, even though a change in the form of a pay- ment that results in a more rapid schedule for payments generally may not constitute an acceleration of a payment, the change in the form of payment must comply with the subsequent deferral rules. For exam- ple, although a change in form from a 10-year installment payment treated as a single payment to a lump-sum payment would not constitutean acceleration, the change in the form of the payment must still comply with the requirements of paragraph (b)(1) of this section, generally meaning that the election to change to a lump-sum payment could not be effective for 12 months and the lump-sum payment could not be made until at least 5 years after the date the installment payments were scheduled to commence. (4)Application to multiple payment events. In the case of a plan that permits a payment upon each of a number of po- tential permissible payment events, such as the earlier of a fixed date or separation from service, the requirements of para- graph (b)(1) of this section are applied separately to each payment (as defined in paragraph (b)(2) of this section) due upon each payment event. Notwithstanding the foregoing, the addition of a permissi- ble payment event to amounts previously deferred is subject to the rules of this paragraph (b) where the addition of the permissible payment event may result in a change in the time or form of payment of the amount deferred. For application of the rules governing accelerations of payments to the addition of a permissible payment event to amounts deferred, see §1.409A–3. (5)Delay of payments under certain circumstances. A plan may provide, or be amended to provide, that a payment will be delayed to a date after the designated pay- ment date under any of the following cir- cumstances, and the provision will not fail to meet the requirements of establishing a permissible payment event and the delay in the payment will not constitute a subse- quent deferral election, provided that once such a provision is applicable to an amount of deferred compensation, any failure to apply such a provision or modification of the plan to remove such a provision will constitute an acceleration of any payment to which such provision applied: (i)Payments subject to section 162(m). A plan may provide that a payment will be delayed where the service recipient rea- sonably anticipates that the service recip- ient’s deduction with respect to such pay- ment otherwise would be limited or elim- inated by application of section 162(m); provided that the terms of the arrangement require the payment to be made either at the earliest date at which the service re- cipient reasonably anticipates that the de- duction of the payment of the amount will not be limited or eliminated by application of section 162(m) or the calendar year in which the service provider separates from service. (ii)Payments that would violate a loan covenant or similar contractual require- ment. A plan may provide that a payment will be delayed where the service recipient reasonably anticipates that the making of the payment will violate a term of a loan agreement to which the service recipient is a party, or other similar contract to which the service recipient isaparty,andsuchvi- olation will cause material harm to the ser- vice recipient; provided that the terms of the arrangement require the payment to be made at the earliest date at which the ser- vice recipient reasonably anticipates that the making of the payment will not cause such violation, or such violation will not cause material harm to the service recipi- ent, and provided that the facts and circum- stances indicate that the service recipient entered into such loan agreement (includ- ing such covenant) or other similar con- tract for legitimate business reasons, and not to avoid the restrictions on deferral elections and subsequent deferral elections under section 409A. (iii)Payments that would violate Fed- eral securities laws or other applicable law. A plan may provide that a payment will be delayed where the service recip- ient reasonably anticipates that the mak- ing of the payment will violate Federal se- curities laws or other applicable law; pro- vided that the terms of the arrangement re- quire the payment to be made at the earli- est date at which the service recipient rea- sonably anticipates that the making of the payment will not cause such violation. For purposes of this paragraph (b)(5)(iii), the making of a payment that would cause in- clusion in gross income or the application of any penalty provision or other provision of the Internal Revenue Code is not treated as a violation of applicable law. (iv)Other events and conditions.Aser- vice recipient may delay a payment upon such other events and conditions as the Commissioner may prescribe in generally applicable guidance published in the Inter- nal Revenue Bulletin. (6)Examples. The following examples illustrate the application of the provisions of this section: Example 1.Initial election to defer salary.Em- ployee A is an individual employed by Employer X. Employer X sponsors an arrangement under which Employee A may elect to defer a percentage of Em- ployee A’s salary. Employee A has participated in the arrangement in prior years. To satisfy the require- ments of this section with respect to salary earned in calendar year 2008, if Employee A elects to defer any amount of such salary, the deferral election (includ- ing an election as to the time and form of payment) must be made no later than December 31, 2007. Example 2.Designation of time and form of pay- ment where an initial deferral election is not pro- vided. Employee A is an individual employed by Employer X. Employer X has a fiscal year ending September 30. On July 1, 2007, Employer X enters into a legally binding obligation to pay Employee A a $10,000 bonus. The amount is not subject to a sub- stantial risk of forfeiture. Employer X does not pro- vide Employee A an election as to the time and form of payment. Unless the amount is paid in accordance with the short-term deferral rule of §1.409A–1(b)(4), to satisfy the requirements of this section, Employer X must specify the time and form of payment on or before July 1, 2007. Example 3.Initial election to defer bonus payable based on services during calendar year. Employee A is an individual employed by Employer X. Employer X has a fiscal year ending September 30. Employee A participates in a bonus plan under which Employee A is entitled to a bonus for services performed dur- ing the calendar year that, absent an election by Em- October 24, 20058342005–43 I.R.B. ployee A, will be paid on March 15 of the follow- ing year. The amount is not subject to a substantial risk of forfeiture and does not qualify as performance based compensation. If Employee A elects to defer the payment of the bonus with respect to calendar year 2008, to satisfy the requirements of this para- graph, Employee A must elect the time and form of payment not later than December 31, 2007. Example 4.Initial election to defer bonus payable based on services during fiscal year other than cal- endar year. Employee A is an individual employed by Employer X. Employer X has a fiscal year ending September 30. Employee A participates in a bonus plan under which Employee A is entitled to a bonus for services performed during Employer X’s fiscal year that, absent an election by Employee A, will be paid on December 15 of the calendar year in which the fiscal year ends. The amount is not subject to a substantial risk of forfeiture and does not qualify as performance based compensation as described in §1.409A–1(e). The amount qualifies as fiscal year compensation. If Employee A elects to defer the pay- ment of the amount related to the fiscal year ending September 30, 2008, to satisfy the requirements of this section Employee A must elect the time and form of payment not later than September 30, 2007. Example 5.Initial election to defer bonus payable only if service provider completes at least 12 months of services after the election. Employee A is an individual employed by Employer X. Employer X has a calendar year fiscal year. On March 1, 2006, Employer X grants Employee A a $10,000 bonus, payable on March 1, 2008, provided that Employee A continues performing services as an employee of Employer X through March 1, 2008. The amount does not qualify as performance-based compensa- tion as described in §1.409A–1(e), and Employee A already participates in another account balance nonqualified deferred compensation plan. Employee A may make an initial deferral election on or before March 31, 2006 (within 30 days after obtaining a legally binding right), because at least 12 months of additional services are required after the date of election for the risk of forfeiture to lapse. Example 6.Initial election to defer bonus that would otherwise constitute a short-term deferral. The same facts asExample 5,exceptthatEmployee A does not make an initial deferral election on or before March 31, 2006. Because the right to the compensation would not be treated as a deferral of compensation pursuant to §1.409A–1(b)(4) absent a deferral election (because the arrangement would be treated as a short-term deferral), Employee A may make an initial deferral election provided that the election may not become effective for 12 months and must defer the payment at least 5 years from March 1, 2008 (the first date the payment could become substantially vested). Accordingly, Employee A may make an election before March 1, 2007, provided that the election defers the payment to a date on or after March 1, 2013 (other than a payment due to death, disability, unforeseeable emergency, or a change in control event). Example 7.Initial election to defer commissions. Employee A is an individual employed by Employer X. Employer X has a calendar year fiscal year. As part of Employee A’s services for Employer X, Em- ployee A sells refrigerators. Under the employment arrangement, Employee A is entitled to 10 percent of the sales price of any refrigerator Employee A sells, payable only upon the receipt of payment from the customer who purchased the refrigerator. For purposes of the initial deferral rule, Employee A is treated as performing the services related to each re- frigerator sale in the taxable year in which each cus- tomer pays for the refrigerator. Example 8.Initial election to defer renewal com- missions. The same facts asExample 7, except that Employee A also sells warranties related to the re- frigerators sold. Under the warranty arrangement, re- frigerator warranty customers are entitled in a future year to extend the warranty for an additional cost to be paid at the time of the extension. Under Employee A’s arrangement with Employer X, Employee A is entitled to 10 percent of the amount paid for an ex- tension of any warranty, payable upon the receipt of payment from the customer extending the warranty. For purposes of the initial deferral rule, Employee A is treated as performing the services related to the amount paid for the extension of the warranty in the taxable year in which the customer pays for the war- ranty extension. Example 9.Initial election to defer negotiated separation pay. Employee A is an individual em- ployed by Employer X. Under the terms of a sepa- ration pay arrangement, Employee A is entitled upon an involuntary separation from service to an amount equal to two weeks of pay for every year of service at Employer X. Employer X decides to terminate Em- ployee A’s employment involuntarily. As part of the process of terminating Employee A, Employer X en- ters intobona fide, arm’s length negotiations with re- spect to the terms of Employee A’s termination of em- ployment. As part of the process, Employer X of- fers Employee A an amount that is in addition to any amounts to which Employee A is otherwise entitled, payable either as a lump sum payment at the end of three years or in three annual payments starting at the date of termination of employment. The election of the time and form of payment by Employee A may be made at any time before Employee A accepts the offer and obtains a legally binding right to the addi- tional amount. Example 10.Election of time and form of pay- ments under a window program. Employee A is an individual employed by Employer X. Employer X establishes a window program, as defined in §1.409A–1(b)(9)(v). Individuals who elect to ter- minate employment under the window program are entitled to receive an amount equal to two weeks pay multiplied by every year of service with Employer X. The individuals participating in the window program may elect to receive the payment as either a lump sum payment payable on the first day of the month after making the election to participate in the win- dow program, or as a payment of two equal annual installments on each January 1 of the first two years following the election to participate in the window program. Employee A is eligible to participate in the window program. Employee A may make the election as to the time and form of payment on or before the date Employee A’s election to participate in the window program becomes irrevocable. Example 11.Initial election to defer salary earned during final payroll period beginning in one calendar year and ending in the subsequent calendar year. Employee A performs services as an employee of Employer X. Employer X pays the salary of its employees, including Employee A, on a bi-weekly basis. One bi-weekly payroll period runs from De- cember 24, 2006, through January 6, 2007, with a scheduled payment date of January 13, 2001. Em- ployer X sponsors, and Employee A participates in, a nonqualified deferred compensation arrangement under which Employee A may defer a specified per- centage of his annual salary. The arrangement does not specify that any salary compensation paid for the payroll period in which falls January 1 is to be treated as compensation for services performed during the year preceding the year in which falls that January 1. For purposes of applying the initial deferral election rules, Employee A is deemed to have performed the services for the payroll period December 24, 2006, through January 6, 2007, during the calendar year 2007. Example 12.Application of deferral election rules and anti-acceleration rules to a section 401(k) wrap plan. Employee A participates in a qualified retirement plan under section 401(a) with a qualified cash or deferred arrangement under section 401(k). Employee A also participates in a nonqualified de- ferred compensation arrangement. Under the terms of the nonqualified deferred compensation arrange- ment, Employee A elects, on or before December 31, to defer a specified percentage of his salary for the subsequent calendar year. Under the terms of the nonqualified deferred compensation arrangement and the qualified plan, as of the earliest date adminis- tratively practicable following the end of the year in which the salary is earned, the maximum amount that may be deferred under the qualified cash or deferred arrangement (not in excess of the amount specified under section 402(g) for the plan year) is credited to Employee A’s account under the qualified plan, and Employee A’s deferral under the nonqualified deferred compensation arrangement is reduced by a corresponding amount. Thereduction has no effect on any other nonqualified deferred compensation arrangement in which Employee A participates. The reduction of Employee A’s account under the nonqualified deferred compensation arrangement is not treated as an accelerated payment of deferred compensation for purposes of section 409A. Example 13.Application of deferral election rules and anti-acceleration rules to a nonqualified deferred compensation arrangement linked to a qual- ified defined benefit plan. Employee A participates in a qualified retirement plan that is a defined benefit plan. Employee A also participates in a nonqualified deferred compensation arrangement, under which the benefit payable is calculated under a formula, with that benefit then reduced by any benefit which Employee A has accrued under the qualified re- tirement plan. In 2007, Employee A fails to elect a subsidized benefit under the qualified retirement plan, with the effect that the amounts payable under the nonqualified deferred compensation arrangement are increased relative to the lesser benefit payable under the qualified plan. Also, in 2007, Employer X amends the qualified retirement plan to increase ben- efits under the plan, resulting in a relative decrease in the amounts payable under the nonqualified deferred compensation arrangement relative to the greater benefit payable under the qualified plan. Neither of these actions constitute a deferral election or an acceleration of a payment under the nonqualified deferred compensation arrangement. 2005–43 I.R.B.835October 24, 2005 Example 14.Subsequent deferral election.Em- ployee A participates in a nonqualified deferred com- pensation arrangement. Employee A elects to be paid in a lump sum payment at the earlier of age 65 or sep- aration from service. Employee A anticipates that he will work after age 65, and wishes to defer payment to a later date. Provided that Employee A continues in employment and makes the election by his 64 th birth- day, Employee A may elect to receive a lump sum payment at the earlier of age 70 or separation from service. Example 15.Grant of right to current payment of dividends paid with respect to restricted stock.Em- ployer X grants Employee A stock that is not sub- stantially vested for purposes of section 83, and Em- ployee A does not make an election under section 83(b). As part of the restricted stock grant, Employee A receives the right to payments in an amount equal to the dividends payable with respect to the restricted stock. At the time Employer B grants Employee A the right to the dividend payments, the grant also speci- fies that each dividend payment will be made no later than the end of the calendar year in which the divi- dends are paid to shareholders of that class of stock or, if later, the 15 th day of the third month following the date the dividends are paid to shareholders of that class of stock. The grant of the rights to dividend pay- ments satisfies the requirement that deferred amounts be paid at a specified time or pursuant to a specified schedule. Example 16.Subsequent deferral election rule — change in form of payment from lump sum payment to life annuity. Employee A participates in a nonquali- fied deferred compensation arrangement. Employee A elects to be paid in a lump sum payment at age 65. Employee A wishes to change the payment form to a life annuity. Provided that Employee A makes the election on or before his 64 th birthday, Employee A may elect to receive a life annuity commencing at age 70. Example 17.Subsequent deferral election rule — change in form of payment from life annuity to lump sum payment. Employee A participates in a non- qualified deferred compensation arrangement. Em- ployee A elects to be paid in a life annuity at age 65. Employee A wishes to change the payment form to a lump sum payment. Provided that Employee A makes the election on or before his 64 th birthday, Em- ployee A may elect to receive a lump sum payment at age 70. Example 18.Subsequent deferral election rule — installment payments designated as separate pay- ments. Employee A participates in a nonqualified deferred compensation arrangement that provides for payment in a series of 5 equal annual amounts, each designated as a separate payment. The first payment is scheduled to be made on January 1, 2008. Provided that Employee A makes the election on or before Jan- uary 1, 2007, Employee A may elect for the first pay- ment to be made on January 1, 2013. If Employee A makes that election, the remaining payments may continue to be due upon January 1 of the four calen- dar years commencing on January 1, 2009. Example 19.Subsequent deferral election rule — change in form of payment from installment pay- ments to lump sum payment. Employee A participates in a nonqualified deferred compensation arrangement that provides for payment in a series of 5 equal an- nual amounts that are not designated as a series of 5 separate payments. The first amount is scheduled to be paid on January 1, 2008. Employee A wishes to receive the entire amount equal to the sum of all five of the amounts to be paid as a lump sum pay- ment. Provided that Employee A makes the election on or before January 1, 2007, Employee A may elect to receive a lump sum payment on or after January 1, 2013. Example 20.Subsequent deferral election rule — change in time of payment from payment at specified age to payment at later of specified age or separation from service. Employee A participates in a nonqual- ified deferred compensation arrangement that pro- vides for a lump sum payment at age 65. Employee A wishes to add a payment provision such that the pay- ment is payable upon the later of a predetermined age or separation from service. Provided that Employee A makes such election on or before his 64 th birthday, Employee A may elect to receive a lump sum pay- ment upon the later of age 70 or separation from ser- vice. (c)Special rules for certain resident aliens. For the first calendar year in which an individual is classified as a resident alien, a nonqualified deferred compensa- tion arrangement is deemed to meet the re- quirements of paragraph (a) of this section if, with respect to compensation payable for services performed during that first cal- endar year or with respect to compensation the right to which is subject to a substantial risk of forfeiture as of January 1 of that first calendar year, an initial deferral election is made by the end of such first calendar year, provided that the initial deferral elec- tion may not apply to amounts paid or first payable on or before the date of such ini- tial deferral election. For any year subse- quent to the first calendar year in which an individual is classified as a resident alien, this paragraph (c) does not apply, provided that a calendar year may again be treated as the first calendar year in which an in- dividual is classified as a resident alien if such individual has not been classified as a resident alien for at least five consecutive calendar years immediately preceding the year in which the individual is again clas- sified as a resident alien. §1.409A–3 Permissible payments. (a)In general. The requirements of this section are met only if the arrangement provides that an amount of deferred com- pensation may be paid only on account of one or more of the following: (1) The service provider’s separation from service (as defined in §1.409A–1(h)). (2) The service provider becoming dis- abled (in accordance with paragraph (g)(4) of this section). (3) The service provider’s death. (4) A time (or pursuant to a fixed sched- ule) specified under the plan (in accor- dance with paragraph (g)(1) of this sec- tion). (5) A change in the ownership or effec- tive control of the corporation, or in the ownership of a substantial portion of the assets of the corporation (in accordance with paragraph (g)(5) of this section). (6) The occurrence of an unforeseeable emergency (in accordance with paragraph (g)(3) of this section). (b)Designation of payment upon a per- missible payment event. Except as other- wise specified in this section, an arrange- ment provides for the payment upon an event described in paragraph (a)(1), (2), (3), (5) or (6) of this section if the arrange- ment provides for a payment date that is objectively determinable at the time the event occurs (for example, 3 months fol- lowing the date of initial disability or De- cember 31 of the calendar year in which the disability first occurs). In addition, an arrangement may provide that a pay- ment is to be made during an objectively determinable calendar year following the year in which the event occurs (for exam- ple, the calendar year following the year in which the service provider dies), provided that where no specific date within such calendar year is objectively determinable, the payment date is deemed to be Jan- uary 1 of such calendar year for purposes of applying the subsequent deferral elec- tion rules of §1.409A–2(b). An arrange- ment may provide for payment upon the earliest or latest of more than one event, provided that each event is described in paragraphs (a)(1) through (6) of this sec- tion. An arrangement may also provide that a payment upon an event described in paragraph (a)(1), (2), (3), (5) or (6) of this section is to be made in accor- dance with a fixed schedule that is ob- jectively determinable based on the date of the event, provided that the schedule must be fixed at the time the permissi- ble payment event is designated, and any change in the fixed schedule will consti- tute a change in the time and form of pay- ment. For example, an arrangement may provide that a service provider is entitled to three substantially equal payments payable October 24, 20058362005–43 I.R.B. on each of the first three anniversaries of the date of the service provider’s separa- tion from service. In addition, an arrange- ment may provide that payments are to be made pursuant to a schedule of payments based upon objectively determinable cal- endar years following the year in which the event occurs, (for example, three sub- stantially equal payments to be made dur- ing the three calendar years following the year in which the service provider dies), provided that where payment dates within such calendar years are not specified un- der the terms of the arrangement, the pay- ment dates are deemed to be January 1 of such calendar years for purposes of apply- ing the subsequent deferral election rules of §1.409A–2(b). (c)Designation of alternative specified dates or payment schedules based upon date of permissible event. In general, in the case of an arrangement that provides that a payment upon an event described in paragraph (a)(1), (2), (3), (5) or (6) of this section is to be made on an objectively de- terminable date or year in accordance with paragraph (b) of this section, or in accor- dance with a fixed schedule that is objec- tively determinable based on the date of the event in accordance with paragraph (b) of this section, the objectively determined date or fixed schedule must apply consis- tently regardless of the date on which the specified event occurs. However, an ar- rangement may allow for an alternative payment schedule if the event occurs on or before one (but not more than one) spec- ified date. For example, an arrangement may provide that a service provider will re- ceive a lump sum payment of the service provider’s entire benefit under the arrange- ment on the first day of the month follow- ing a separation from service before age 55, but will receive 5 substantially equal annual payments commencing on the first day of the month following a separation from service on or after age 55. (d)Whenapaymentistreatedasmade upon the designated payment date.Ex- cept as otherwise specified in this section, a payment is treated as made upon the date specified under the arrangement (includ- ing a date specified under paragraph (a)(4) of this section) if the payment is made at such date or a later date within the same calendar year or, if later, by the 15 th day of the third calendar month following the date specified under the arrangement. If calculation of the amount of the payment is not administratively practicable due to events beyond the control of the service provider (or service provider’s estate), the payment will be treated as made upon the date specified under the arrangement if the payment is made during the first calendar year in which the payment is administra- tively practicable. Similarly, if the funds of the service recipient are not sufficient to make the payment at the date specified un- der the plan without jeopardizing the sol- vency of the service recipient, the payment will be treated as made upon the date spec- ified under the arrangement if the payment is made during the first calendar year in which the funds of the service recipient are sufficient to make the payment without jeopardizing the solvency of the service re- cipient. (e)Disputed payments and refusals to pay. If a payment is not made, in whole or in part, as of the date specified under the arrangement because the service recipient refuses to make such payment, the pay- ment will be treated as made upon the date specified under the arrangement if the ser- vice provider accepts the portion (if any) of the payment that the service recipient is willing to make (unless such acceptance will result in a forfeiture of the claim to the remaining amount), makes prompt and reasonable, good faith efforts to collect the payment, and the payment is made dur- ing the first calendar year in which the ser- vice recipient and the service provider en- ter into a legally binding settlement of such dispute, the service recipient concedes that the amount is payable, or the service re- cipient is required to make such payment pursuant to a final and nonappealable judg- ment or other binding decision. For pur- poses of this paragraph (e), a service re- cipient is not treated as having refused to make a payment where pursuant to the terms of the plan the service provider is required to request payment, or otherwise provide information or take any other ac- tion, and the service provider has failed to take such action. In addition, for purposes of this paragraph (e), the service provider is deemed to have requested that a pay- ment not be made, rather than the service recipient having refused to make such pay- ment, where the service recipient’s deci- sion to refuse to make the payment is made by the service provider or a member of the service provider’s family (as defined in section 267(c)(4) applied as if the fam- ily of an individual includes the spouse of any member of the family), or any person or group of persons over whom the ser- vice provider or service provider’s family member has effective control, or any per- son any portion of whose compensation is controlled by the service provider or ser- vice provider’s family member. (f)Special rule for certain resident aliens. An arrangement that is, or con- stitutes part of, a nonqualified deferred compensation plan is deemed to meet the requirements of this section with respect to any amount payable in the first cal- endar year in which a service provider is classified as a resident alien, and with respect to any amount payable in a sub- sequent calendar year if no later than the December 31 of the first calendar year in which the service provider is classified as a resident alien, the plan is amended as necessary so that the times and forms of payment of amounts payable in a sub- sequent year comply with the provisions of this section. For any year subsequent to the first calendar year in which an in- dividual is classified as a resident alien, this paragraph (f) does not apply, provided that a calendar year may again be treated as the first calendar year in which an in- dividual is classified as a resident alien if such individual has not been classified as a resident alien for at least five consecutive calendar years immediately preceding the year in which the service provider is again classified as a resident alien. (g)Definitions and special rules—(1) Specified time or fixed schedule. Amounts are payable at a specified time or pursuant to a fixed schedule if objectively deter- minable amounts are payable at a date or dates that are objectively determinable at the time the amount is deferred. An amount is objectively determinable for this purpose if the amount is specifically identified or if the amount may be de- termined pursuant to a nondiscretionary formula (for example, 50 percent of an ac- count balance). A specified time or fixed schedule also includes the designation of a calendar year or years that are objectively determinable at the time the amount is deferred, provided that for purposes of the application of the subsequent deferral rules contained in §1.409A–2(b), the spec- ified time or fixed schedule of payments is deemed to refer to January 1 of the relevant 2005–43 I.R.B.837October 24, 2005 calendar year or years. An arrangement may provide that a payment upon the lapse of a substantial risk of forfeiture is to be made in accordance with a fixed schedule that is objectively determinable based on the date the substantial risk of forfeiture lapses (disregarding any acceleration of the lapsing of the substantial risk of for- feiture other than due to the occurrence of a condition applicable as of the date the legally binding right to the payment arose that itself would constitute a sub- stantial risk of forfeiture), provided that theschedulemustbefixedatthetimethe time and form of payment are designated, and any change in the fixed schedule will constitute a change in the time and form of payment. For example, an arrangement that provides for a bonus payment subject to the condition that the service provider complete three years of service, but pro- vided further that such requirement of continued services would lapse upon the occurrence of an initial public offering that if applied alone would subject the right to the payment to a substantial risk of forfei- ture, may provide that a service provider is entitled to substantially equal payments on each of the first three anniversaries of the date the substantial risk of forfeiture lapses (the earlier of three years of service or the date of an initial public offering). (2)Required delay in payment to a specified employeepursuant to a sep- aration from service. In the case of any specified employee (as defined in §1.409A–1(i)), the requirements of para- graph (a)(1) of this section permitting a payment upon a separation from service are satisfied only if payments may not be made before the date that is six months af- ter the date of separation from service (or, if earlier, the date of death of the specified employee). The arrangement must pro- vide the manner in which the six-month delay will be implemented in the case of a service provider who is a specified em- ployee. For example, an arrangement may provide that payments to which a speci- fied employee would otherwise be entitled during the first six months following the date of separation from service are accu- mulated and paid at another specified date or specified schedule, such as the first date of the seventh month following the date of separation from service. The arrangement may also provide that each installment payment to which a specified employee is entitled upon a separation from service is delayed by six months. A service recipient mayamendaplanatanytimetochange the method for applying the six-month delay, provided that the amendment may not be effective for a period of 12 months. Notwithstanding the foregoing, an amend- ment to a plan may be effective imme- diately in the case of a service recipient that amends the arrangement prior to the date upon which the service recipient’s stock first becomes readily tradable on an established securities market. Notwith- standing the foregoing, this paragraph (g)(2) also does not apply to a payment made under the circumstances described in paragraph (h)(2)(i) (domestic relations order), (h)(2)(ii) (conflicts of interest), or (h)(2)(v) (payment of employment taxes) of this section. (3)Unforeseeable Emergency—(i) Definition. For purposes of paragraph (a)(6) of this section, an unforeseeable emergency is a severe financial hardship of the service provider or beneficiary re- sulting from an illness or accident of the service provider or beneficiary, the service provider’s or beneficiary’s spouse, or the service provider’s or beneficiary’s depen- dent (as defined in section 152(a)); loss of the service provider’s or beneficiary’s property due to casualty (including the need to rebuild a home following damage to a home not otherwise covered by insur- ance, for example, as a result of a natural disaster); or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the service provider or beneficiary. For example, the imminent foreclosure of or eviction from the service provider’s or beneficiary’s primary residence may constitute an unforeseeable emergency. In addition, the need to pay for medi- cal expenses, including non-refundable deductibles, as well as for the costs of prescription drug medication, may consti- tute an unforeseeable emergency. Finally, the need to pay for the funeral expenses of a spouse or a dependent (as defined in section 152(a)) may also constitute an unforeseeable emergency. Except as oth- erwise provided in this paragraph (g)(3)(i), the purchase of a home and the payment of college tuition are not unforeseeable emergencies. Whether a service provider or beneficiary is faced with an unforesee- able emergency permitting a distribution under this paragraph is to be determined based on the relevant facts and circum- stances of each case, but, in any case, a distribution on account of unforeseeable emergency may not be made to the extent that such emergency is or may be relieved through reimbursement or compensation from insurance or otherwise, by liquida- tion of the service provider’s assets, to the extent the liquidation of such assets would not cause severe financial hardship, or by cessation of deferrals under the arrange- ment. An arrangement may provide for a payment upon any unforeseeable emer- gency, but does not have to provide for a payment upon all unforeseeable emergen- cies, provided that any event upon which apaymentmaybemadequalifiesasan unforeseeable emergency. (ii)Amount of payment permitted upon an unforeseeable emergency. Distribu- tions because of an unforeseeable emer- gency must be limited to the amount reasonably necessary to satisfy the emer- gency need (which may include amounts necessary to pay any Federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution). Determinations of amounts reasonably necessary to satisfy the emergency need must take into account any additional compensation that is available if the plan provides for cancellation of a deferral election upon a payment due to an un- foreseeable emergency. See paragraph (h)(2)(vii) of this section. The payment may be made from any arrangement in which the service provider participates that provides for payment upon an un- foreseeable emergency, provided that the arrangement under which the payment was made must be designated at the time of payment. (4)Disability—(i)In general.Forpur- poses of this section, a service provider is considered disabled if the service provider meets one of the following requirements: (A) The service provider is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be ex- pected to last for a continuous period of not less than 12 months. (B) The service provider is, by rea- son of any medically determinable physi- cal or mental impairment that can be ex- pected to result in death or can be ex- October 24, 20058382005–43 I.R.B. pected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than 3 months under an accident and health plan covering employees of the ser- vice provider’s employer. (ii)Limited plan definition of disabil- ity. An arrangement may provide for a payment upon any disability, and need not provide for a payment upon all disabilities, provided that any disability upon which a payment may be made under the arrange- ment complies with the provisions of this paragraph (g)(4). (iii)Determination of disability.An arrangement may provide that a service provider will be deemed disabled if deter- mined to be totally disabled by the Social Security Administration. An arrangement may also provide that a service provider will be deemed disabled if determined to be disabled in accordance with a disability insurance program, provided that the defi- nition of disability applied under such dis- ability insurance program complies with the requirements of this paragraph (g)(4). (5)Change in the ownership or ef- fective control of a corporation, or a change in the ownership of a substan- tial portion of the assets of a corpora- tion—(i)In general. Pursuant to section 409A(a)(2)(A)(v), an arrangement may permit a payment upon the occurrence of a change in the ownership of the corporation (as defined in paragraph (g)(5)(v) of this section), a change in effective control of the corporation (as defined in paragraph (g)(5)(vi) of this section), or a change in the ownership of a substantial portion of the assets of the corporation (as defined in paragraph (g)(5)(vii) of this section) (collectively referred to as a change in control event). To qualify as a change in control event, the occurrence of the event must be objectively determinable and any requirement that any other person, such as a plan administrator or board of directors compensation committee, certify the oc- currence of a change in control event must be strictly ministerial and not involve any discretionary authority. The arrangement may provide for a payment on any change in control event, and need not provide for a payment on all such events, provided that each event upon which a payment is provided qualifies as a change in control event. For rules regarding the ability of the service recipient to terminate the ar- rangement and pay amounts of deferred compensation upon a change in control event, see paragraph (h)(2)(viii)(B) of this section. (ii)Identification of relevant corpo- ration—(A)In general. To constitute a change in control event as to the service provider, the change in control event must relate to— (1) The corporation for whom the ser- vice provider is performing services at the time of the change in control event; (2) The corporation that is liable for the payment of the deferred compensation (or all corporations liable for the payment if more than one corporation is liable); or (3) A corporation that is a majority shareholder of a corporation identified in paragraph (g)(5)(ii)(A)(1)or(2)ofthis section, or any corporation in a chain of corporations in which each corporation is a majority shareholder of another corpora- tion in the chain, ending in a corporation identified in paragraph (g)(5)(ii)(A)(1)or (2)ofthissection. (B)Majority shareholder. For pur- poses of this paragraph (g)(5)(ii), a ma- jority shareholder is a shareholder owning more than 50 percent of the total fair mar- ket value and total voting power of such corporation. (C)Example. The following exam- ple illustrates the rules of this paragraph (g)(5)(ii): Example. Corporation A is a majority share- holder of Corporation B, which is a majority share- holder of Corporation C. A change in ownership of Corporation B constitutes a change in control event to service providers performing services for Corpo- ration B or Corporation C, and to service providers for which Corporation B or Corporation C is solely liable for payments under the plan (for example, former employees), but is not a change in control event as to Corporation A or any other corporation of which Corporation A is a majority shareholder. Notwithstanding the foregoing, a sale of Corporation B may constitute an independent change in control event for Corporation A, Corporation B and Cor- poration C if the sale constitutes a change in the ownership of a substantial portion of Corporation A’s assets (see paragraph (g)(5)(vii) of this section). (iii)Attribution of stock ownership. For purposes of paragraph (g)(5) of this section, section 318(a) applies to deter- mine stock ownership. Stock underlying a vested option is considered owned by the individual who holds the vested op- tion (and the stock underlying an unvested option is not considered owned by the in- dividual who holds the unvested option). For purposes of the preceding sentence, however, if a vested option is exercisable for stock that is not substantially vested (as defined by §1.83–3(b) and (j)), the stock underlying the option is not treated as owned by the individual who holds the option. (iv)Special rule for certain delayed payments pursuant to a change in control event. Compensation payable pursuant to the purchase by the service recipient of service recipient stock or a stock right held by a service provider, or payment of amounts of deferred compensation calcu- lated by reference to the value of service recipient stock, may be treated as paid at a specified time or pursuant to a fixed schedule in conformity with the require- ments of section 409A if paid on the same schedule and under the same terms and conditions as payments to shareholders generally pursuant to a change in control event described in paragraph (g)(5)(v) of this section (change in the ownership of a corporation) or as payments to the service recipient pursuant to a change in control event described in paragraph (g)(5)(vii) of this section (change in the ownership of a substantial portion of a corporation’s assets), and any amounts paid pursuant to such a schedule and such terms and conditions will not be treated as violating the initial or subsequent deferral elections rules, to the extent that such amounts are paid not later than five years after the change in control event. (v)Change in the ownership of a cor- poration—(A)In general. For purposes of section 409A, a change in the ownership of a corporation occurs on the date that any one person, or more than one person acting as a group (as defined in paragraph (g)(5)(v)(B) of this section), acquires own- ership of stock of the corporation that, to- gether with stock held by such person or group, constitutes more than 50 percent of the total fair market value or total vot- ing power of the stock of such corpora- tion. However, if any one person, or more than one person acting as a group, is con- sidered to own more than 50 percent of the total fair market value or total vot- ing power of the stock of a corporation, the acquisition of additional stock by the same person or persons is not considered to cause a change in the ownership of the corporation (or to cause a change in the ef- fective control of the corporation (within the meaning of paragraph (g)(5)(vi) of this 2005–43 I.R.B.839October 24, 2005 section)). An increase in the percentage of stock owned by any one person, or persons acting as a group, as a result of a trans- action in which the corporation acquires its stock in exchange for property will be treated as an acquisition of stock for pur- poses of this section. This section applies only when there is a transfer of stock of a corporation (or issuance of stock of a corporation) and stockin such corporation remains outstanding after the transaction (see paragraph (g)(5)(vii) of this section for rules regarding the transfer of assets of a corporation). (B)Persons acting as a group. For pur- poses of paragraph (g)(5)(v)(A) of this sec- tion, persons will not be considered to be acting as a group solely because they pur- chase or own stock of the same corpora- tion at the same time, or as a result of thesamepublicoffering. However,per- sons will be considered to be acting as a group if they are owners of a corporation that enters into a merger, consolidation, purchase or acquisition of stock, or simi- lar business transaction with the corpora- tion. If a person, including an entity, owns stock in both corporations that enter into a merger, consolidation, purchase or acqui- sition of stock, or similar transaction, such shareholder is considered to be acting as a group with other shareholders in a corpo- ration prior to the transaction giving rise to the change and not with respect to the ownership interest in the other corporation. See §1.280G–1, Q&A–27(d),Example 4. (vi)Change in the effective control of a corporation—(A)In general.For purposes of section 409A, notwithstand- ing that a corporation has not undergone a change in ownership under paragraph (g)(5)(v) of this section, a change in the effective control of a corporation occurs only on the date that either— (1) Any one person, or more than one person acting as a group (as determined under paragraph (g)(5)(v)(B) of this sec- tion), acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) ownership of stock of the corpo- ration possessing 35 percent or more of the total voting power of the stock of such cor- poration; or (2) A majority of members of the cor- poration’s board of directors is replaced during any 12-month period by directors whose appointment or election is not en- dorsed by a majority of the members of the corporation’s board of directors prior to the date of the appointment or elec- tion, provided that for purposes of this paragraph (g)(5)(vi)(A) the term corpora- tion refers solely to the relevant corpora- tion identified in paragraph (g)(5)(ii) of this section, for which no other corpora- tion is a majority shareholder for purposes of that paragraph (for example, if Corpora- tion A is a publicly held corporation with no majority shareholder, and Corporation A is the majority shareholder of Corpora- tion B, which is the majority shareholder of Corporation C, the term corporation for purposes of this paragraph (g)(5)(vi)(A)(2) would refer solely to Corporation A). (B)Multiple change in control events. A change in effective control also may oc- cur in any transaction in which either of the two corporations involved in the trans- action has a change in control event un- der paragraphs (g)(5)(v) or (g)(5)(vii) of this section. Thus, for example, assume Corporation P transfersmorethan40per- cent of the total gross fair market value of its assets to Corporation O in exchange for 35 percent of O’s stock. P has un- dergone a change in ownership of a sub- stantial portion of its assets under para- graph (g)(5)(vii) of this section and O has a change in effective control under this para- graph (g)(5)(vi) of this section. (C)Acquisition of additional control. If any one person, or more than one per- son acting as a group, is considered to ef- fectively control a corporation (within the meaning of this paragraph (g)(5)(vi)), the acquisition of additional control of the cor- poration by the same person or persons is not considered to cause a change in the effective control of the corporation (or to cause a change in the ownership of the cor- poration within the meaning of paragraph (g)(5)(v) of this section). (D)Persons acting as a group.Per- sons will not be considered to be acting as a group solely because they purchase or own stock of the same corporation at the same time, or as a result of the same pub- lic offering. However, persons will be con- sideredtobeactingasagroupiftheyare owners of a corporation that enters into a merger, consolidation, purchase or acqui- sition of stock, or similar business transac- tion with the corporation. If a person, in- cluding an entity, owns stock in both cor- porations that enter into a merger, consol- idation, purchase or acquisition of stock, or similar transaction, such shareholder is considered to be acting as a group with other shareholders in a corporation only with respect to the ownership in that cor- poration prior to the transaction giving rise to the change and not with respect to the ownership interest in the other corporation. See §1.280G–1, Q&A–27(d),Example 4. (vii)Change in the ownership of a substantial portion of a corporation’s assets—(A)In general. Change in the ownership of a substantial portion of a corporation’s assets. For purposes of sec- tion 409A, a change in the ownership of a substantial portion of a corporation’s as- sets occurs on the date that any one person, or more than one person acting as a group (as determined in paragraph (g)(5)(v)(B) of this section), acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) assets from the corpo- ration that have a total gross fair market value equal to or more than 40 percent of the total gross fair market value of all of the assets of the corporation immediately prior to such acquisition or acquisitions. For this purpose, gross fair market value means the value of the assets of the cor- poration, or the value of the assets being disposed of, determined without regard to any liabilities associated with such assets. (B)Transfers to a related person—(1) There is no change in control event un- der this paragraph (g)(5)(vii) when there is a transfer to an entity that is controlled by the shareholders of the transferring cor- poration immediately after the transfer, as provided in this paragraph (g)(5)(vii)(B). A transfer of assets by a corporation is not treated as a change in the ownership of such assets if the assets are transferred to— (i) A shareholder of the corporation (immediately before the asset transfer) in exchange for or with respect to its stock; (ii) An entity, 50 percent or more of the total value or voting power of which is owned, directly or indirectly, by the cor- poration; (iii) A person, or more than one person acting as a group, that owns, directly or indirectly, 50 percent or more of the total value or voting power of all the outstand- ing stock of the corporation; or (iv) An entity, at least 50 percent of the total value or voting power of which is owned, directly or indirectly, October 24, 20058402005–43 I.R.B. by a person described in paragraph (g)(5)(vii)(B)(1)(iii)ofthissection. (2) For purposes of this paragraph (g)(5)(vii)(B) and except as otherwise provided, a person’s status is determined immediately after the transfer of the assets. For example, a transfer to a corporation in which the transferor corporation has no ownership interest before the transaction, but which is a majority-owned subsidiary of the transferor corporation after the transaction is not treated as a change in the ownership of the assets of the transferor corporation. (C)Persons acting as a group. Persons will not be considered to be acting as a group solely because they purchase assets of the same corporation at the same time. However, persons will be considered to be acting as a group if they are owners of a corporation that enters into a merger, con- solidation, purchase or acquisition of as- sets, or similar business transaction with the corporation. If a person, including an entity shareholder, owns stock in both cor- porations that enter into a merger, consol- idation, purchase or acquisition of assets, or similar transaction, such shareholder is considered to be acting as a group with other shareholders in a corporation only to the extent of the ownership in that corpo- ration prior to the transaction giving rise to the change and not with respect to the ownership interest in the other corporation. See 1.280G–1, Q&A–27(d),Example 4. (6)Certain back-to-back arrange- ments—(i)In general. Notwithstanding the generally applicable limitations on payments described under paragraph (a) of this section, an arrangement between a service recipient and a service provider that is also a service recipient (a service provider/service recipient) may provide for payment upon the occurrence of a pay- ment event described in paragraph (a)(1), (2), (3), (5) or (6) of this section, where the time and form of payment is defined as the same time and form of payment provided under an arrangement subject to section 409A between the service provider/service recipient and a specified service provider to the service provider/service recipient, if the arrangement between the service provider/service recipient and the service recipient expressly provides for such time and form of payment and otherwise satis- fies the requirements of section 409A. (ii)Example. The provisions of this paragraph (g)(6) are illustrated by the fol- lowing example: Example. Company B (service provider/service recipient) provides services to Company C (service recipient). Employee A (service provider) provides services to Company B. Pursuant to a nonqualified deferred compensation plan meeting the require- ments of section 409A, Employee A is entitled to a payment of deferred compensation upon a sep- aration from service from Company B. Under an arrangement between Company B and Company C, Company C agrees to pay an amount of deferred compensation to Company B upon Employee A’s separation from servicefrom Company B, in accor- dance with the time and form of payment provided in the nonqualified deferred compensation plan be- tween Employee A and Company B. Provided that the arrangement between Company B and Company C and the arrangement between Employee A and Company B otherwise comply with the requirements of section 409A, Company C’s payment to Company B of the amount due upon the separation from service of Employee A from Company B may constitute a permissible payment event for purposes of paragraph (a)ofthissection. (h)Prohibition on acceleration of pay- ments—(1)In general. Except as pro- vided in paragraph (h)(2) of this section, an arrangement that is, or constitutes part of, a nonqualified deferred compensation plan may not permit the acceleration of the time or schedule of any payment or amount scheduledtobepaidpursuanttoapayment under the arrangement. For purposes of this paragraph (h), an impermissible accel- eration does not occur if payment is made in accordance with plan provisions or an election as to the time and form of payment in effect at the time of initial deferral (or added in accordance with the rules appli- cable to subsequent deferral elections un- der §1.409A–2(b)) pursuant to which pay- ment is required to be made on an accel- erated schedule as a result of an interven- ing event that is an event described in para- graph (a)(1), (2), (3), (5) or (6) of this sec- tion. For example, a plan may provide that a participant will receive six install- ment payments commencing at separation from service, and also provide that if the participant dies after such payments com- mence but before all payments have been made, all remaining amounts will be paid in a lump sum payment. Additionally, it is not an acceleration of the time or sched- ule of payment of a deferral of compensa- tion if a service recipient waives or accel- erates the satisfaction of a condition con- stituting a substantial risk of forfeiture ap- plicable to such deferral of compensation, provided that the requirements of section 409A (including the requirement that the payment be made upon a permissible pay- ment event) are otherwise satisfied with respect to such deferral of compensation. For example, if a nonqualified deferred compensation arrangement provides for a lump sum payment of the vested benefit upon separation from service, and the ben- efit vests under the plan only after 10 years of service, it is not a violation of the re- quirements of section 409A if the service recipient reduces the vesting requirement to 5 years of service, even if a service provider becomes vested as a result and receives a payment in connection with a separation from service before the service provider would have completed 10 years of service. (2)Exceptions—(i)Domestic relations order. An arrangement may permit such acceleration of the time or schedule of a payment under the arrangement to an in- dividual other than the service provider as may be necessary to fulfill a domes- tic relations order (as defined in section 414(p)(1)(B)). (ii)Conflicts of interest. An arrange- ment may permit such acceleration of the time or schedule of a payment under the ar- rangement as may be necessary to comply with a certificate of divestiture (as defined in section 1043(b)(2)). (iii)Section 457 plans. An arrangement subject to section 457(f) may permit an acceleration of the time or schedule of a payment to a service provider to pay Fed- eral, state, local and foreign income taxes due upon a vesting event, provided that the amount of such payment is not more than an amount equal to the Federal, state, local and foreign income tax withholding that would have been remitted by the employer if there had been a payment of wages equal to the income includible by the service provider under section 457(f) at the time of the vesting. (iv)De minimis and specified amounts —(A)In general. An arrangement that does not otherwise provide for mandatory lump sum payments of benefits that do not exceed a specified amount may be amended to permit the acceleration of the time or schedule of a payment to a service provider under the arrangement, provided that— (1) The payment accompanies the ter- mination of the entirety of the service provider’s interest in the arrangement, and 2005–43 I.R.B.841October 24, 2005 all similar arrangements that would consti- tute a nonqualified deferred compensation plan under §1.409A–1(c); (2) The payment is made on or before the later of December 31 of the calendar year in which occurs the service provider’s separation from service from the service recipient, or the 15 th day of the third month following the service provider’s separation from service from the service recipient; (3) The payment is not greater than $10,000; and (4) The participant is provided no elec- tion with respect to receipt of the lump sum payment. (B)Prospective deferrals.Anamend- ment described in paragraph (h)(2)(iv)(A) of this section may be made with respect to previously deferred amounts under the arrangement as well as amounts to be de- ferred in the future. In addition, a nonqual- ified deferred compensation arrangement that otherwise complies with section 409A may provide, or be amended with regard to future deferrals to provide, that, if a ser- vice provider’s interest under the arrange- ment has a value below an amount speci- fied by the plan at the time that amounts are payable under the plan, then the ser- vice provider’s entire interest under the plan must be distributed as a lump sum payment. However, once such a payment feature applies to an amount deferred, any change or elimination of such feature is subject to the rules governing changes in the time and form of payment. (v)Payment of employment taxes.An arrangement may permit the acceleration of the time or schedule of a payment to pay the Federal Insurance Contributions Act (FICA) tax imposed under section 3101, section 3121(a) and section 3121(v)(2), where applicable, on compensation de- ferred under the arrangement (the FICA Amount). Additionally, an arrangement may permit the acceleration of the time or schedule of a payment to pay the in- come tax at source on wages imposed under section 3401 or the corresponding withholding provisions of applicable state, local, or foreign tax laws as a result of the payment of the FICA Amount, and to pay the additional income tax at source on wages attributable to the pyramiding section 3401 wages and taxes. However, the total payment under this acceleration provision must not exceed the aggregate of the FICA Amount, and the income tax withholding related to such FICA Amount. (vi)Payments upon income inclusion under section 409A. An arrangement may permit the acceleration of the time or schedule of a payment to a service provider under the plan at any time the arrangement fails to meet the requirements of section 409A and these regulations. Such pay- ment may not exceed the amount required to be included in income as a result of the failure to comply with the requirements of section 409A and the regulations. (vii)Cancellation of deferrals fol- lowing an unforeseeable emergency or hardship distribution. An arrangement may permit a cancellation of a service provider’s deferral election due to an un- foreseeable emergency or a hardship dis- tribution pursuant to §1.401(k)–1(d)(3). The deferral election must be cancelled, and not postponed or otherwise delayed, such that any later deferral election will be subject to the provisions governing initial deferral elections. See §1.409A–2(a). (viii)Arrangement terminations.An arrangement may permit an acceleration of the time and form of a payment where the right to the payment arises due to a ter- mination of the arrangement in accordance with one of the following: (A) The service recipient’s discretion under the terms of the arrangement to ter- minate the arrangement within 12 months of a corporate dissolution taxed under section 331, or with the approval of a bankruptcy court pursuant to 11 U.S.C. §503(b)(1)(A), provided that the amounts deferred under the plan are included in the participants’ gross incomes in the latest of— (1) The calendar year in which the plan termination occurs; (2) The calendar year in which the amount is no longer subject to a substan- tial risk of forfeiture; or (3) The first calendar year in which the payment is administratively practicable. (B) The service recipient’s discretion under the terms of the arrangement to terminate the arrangement within the 30 days preceding or the 12 months following a change in control event (as defined in §1.409A–3(g)(5)(i)). For purposes of this paragraph (h)(2)(viii), an arrangement will be treated as terminated only if all sub- stantially similar arrangements sponsored by the service recipient are terminated, so that the participant inthe arrangement and all participants under substantially similar arrangements are required to receive all amounts of compensation deferred under the terminated arrangements within 12 months of the date of termination of the arrangements. (C) The service recipient’s discretion under the terms of the arrangement to ter- minate the arrangement, provided that— (1) All arrangements sponsored by the service recipient that would be aggregated with any terminated arrangement under §1.409A–1(c) if the same service provider participated in all of the arrangements are terminated; (2) No payments other than payments that would be payable under the terms of the arrangements if the termination had not occurred are made within 12 months of the termination of the arrangements; (3) All payments are made within 24 months of the termination of the arrange- ments; and (4) The service recipient does not adopt a new arrangement that would be aggregated with any terminated arrange- ment under §1.409A–1(c) if the same service provider participated in both ar- rangements, at any time within five years following the date of termination of the arrangement. (D) Such other events and conditions as the Commissioner may prescribe in generally applicable guidance published in the Internal Revenue Bulletin (see §601.601(d)(2) of this chapter). (ix)Certain distributions to avoid a nonallocation year under section 409(p). An arrangement may provide for an ac- celeration of payment to prevent the oc- currence of a nonallocation year (within the meaning of section 409(p)(3)) in the plan year of the employee stock owner- ship plan next following the current plan year, provided that the amount distributed may not exceed 125 percent of the mini- mum amount of distribution necessary to avoid the occurrenceof a nonallocation year. Solely for purposes of determining permissible distributions under this para- graph (h)(2)(ix), synthetic equity (within the meaning of section 409(p)(6)(C)) granted during the current employee stock ownership plan plan year is disregarded for purposes of determining whether the subsequent plan year would result in a nonallocation year. October 24, 20058422005–43 I.R.B. (3)Nonqualified deferred compen- sation arrangements linked to qualified plans. With respect to amounts deferred under an arrangement that is, or con- stitutes part of, a nonqualified deferred compensation plan, where under the terms of the nonqualified deferred compensation arrangement the amount deferred under the plan is the amount determined under the formula determining benefits under a qualified employer plan (as defined in §1.409A–1(a)(2)) applied without respect to one or more limitations applicable to qualified employer plans under the In- ternal Revenue Code or other applicable law, or is determined as an amount offset by some or all of the benefits provided under the qualified employer plan, the operation of the qualified employer plan with respect to changes in benefit limi- tations applicable to qualified employer plans under the Internal Revenue Code or other applicable law, does not consti- tute an acceleration of a payment under the nonqualified deferred compensation arrangement regardless of whether such operation results in a decrease of amounts deferred under the nonqualified deferred compensation arrangement. In addition, with respect to such nonqualified deferred compensation arrangements, the following actions or failures to act will not consti- tute an acceleration of a payment under the nonqualified deferred compensation arrangement regardless of whether in accordance with the terms of the nonqual- ified deferred compensation arrangement, the actions or inactions result in a decrease in the amounts deferred under the arrange- ment: (i) A service provider’s action or in- action under the qualified employer plan with respect to whether to elect to receive a subsidized benefit or an ancillary benefit under the qualified employer plan. (ii) The amendment of a qualified em- ployer plan to increase benefits provided under the qualified plan, or to add or re- move a subsidized benefit or an ancillary benefit. (iii) A service provider’s action or inaction with respect to an elective de- ferral election under a qualified employer plan subject to section 402(g), includ- ing an adjustment to a deferral election made during a calendar year, provided that for any given calendar year, the service provider’s actions or inactions do not re- sult in a decrease in the amounts deferred under all nonqualified deferred compen- sation plans in which the service provider participates in excess of an amount equal to the limit with respect to elective de- ferrals under section 402(g) in effect for the taxable year in which such action or inaction occurs. (iv) A service provider’s action or inac- tion under a qualified employer plan with respect to elective deferrals or after-tax contributions by the service provider to the qualified employer plan that affects the amounts that are credited under a nonqual- ified deferred compensation arrangement as matching amounts or other amounts contingent on service provider elective deferrals or after-taxcontributions, pro- vided that such matching or contingent amounts, as applicable, are either forfeited or never credited under the nonqualified deferred compensation arrangement in the absence of such service provider’s elec- tive deferral or after-tax contribution, and provided further that for any given cal- endar year, the service provider’s actions and inactions do not result in a decrease in the amounts deferred under all non- qualified deferred compensation plans in which the service provider participates in excess of an amount equal to the limit with respect to elective deferrals under section 402(g) in effect for the taxable year in which such action or inaction occurs. See §1.409A–2(b)(6),Example 12andExam- ple 13. §1.409A–4 Calculation of income inclusion. [Reserved]. §1.409A–5 Funding. [Reserved]. §1.409A–6 Statutory effective dates. (a)Statutory effective dates—(1)In general. Except as otherwise provided in this section, section 409A is effective with respect to amounts deferred in tax- able years beginning after December 31, 2004, and amounts deferred in taxable years beginning before January 1, 2005, if the plan under which the deferral is made is materially modified after October 3, 2004. Section 409A is effective with re- spect to earnings on amounts deferred only to the extent that section 409A is effec- tive with respect to the amounts deferred. Accordingly, section 409A is not effec- tive with respect to earnings on amounts deferred before January 1, 2005, unless section 409A is effective with respect to the amounts deferred. (2)Identification ofdate of deferral for statutory effective date purposes.For purposes of determining whether section 409A is applicable with respect to an amount, the amount is considered deferred before January 1, 2005, if before January 1, 2005, the service provider had a legally binding right to be paid the amount, and the right to the amount was earned and vested. For purposes of this paragraph (a)(2), a right to an amount was earned and vested only if the amount was not sub- ject to a substantial risk of forfeiture (as defined in §1.83–3(c)) or a requirement to perform further services. Amounts to which the service provider did not have a legally binding right before January 1, 2005 (for example because the service recipient retained discretion to reduce the amount), will not be considered de- ferred before January 1, 2005. In addition, amounts to which the service provider had a legally binding right before January 1, 2005, but the right to which was subject to a substantial risk of forfeiture or a re- quirement to perform further services after December 31, 2004, are not considered de- ferred before January 1, 2005, for purposes of the effective date. Notwithstanding the foregoing, an amount to which the ser- vice provider had a legally binding right before January 1, 2005, but for which the service provider was required to continue performing services to retain the right only through the completion of the payroll period (as defined in §1.409A–1(b)(3)) that includes December 31, 2004, is not treated as subject to a requirement to per- form further services (or a substantial risk of forfeiture) for purposes of the effec- tive date. For purposes of this paragraph (a)(2), a stock option, stock appreciation right or similar compensation that on or before December 31, 2004, was immedi- ately exercisable for cash or substantially vested property (as defined in §1.83–3(b)) is treated as earned and vested, regardless of whether the right would terminate if the service provider ceased providing services for the service recipient. (3)Calculation of amount of compen- sation deferred for statutory effective date purposes—(i)Nonaccount balance plans. The amount of compensation deferred before January 1, 2005, under a nonqual- 2005–43 I.R.B.843October 24, 2005 ified deferred compensation plan that is a nonaccount balance plan (as defined in §31.3121(v)(2)–1(c)(2)(i) of this chapter) equals the present value as of December 31, 2004, of the amount to which the ser- vice provider would be entitled under the plan if the service provider voluntarily terminated services without cause on De- cember 31, 2004, and received a payment of the benefits with the maximum value available from the plan on the earliest possible date allowed under the plan to re- ceive a payment of benefits following the termination of services. Notwithstanding the foregoing, for any subsequent calen- dar year, the grandfathered amount may increase to equal the present value of the benefit the service provider actually be- comes entitled to, determined under the terms of the plan (including applicable limits under the Internal Revenue Code), as in effect on October 3, 2004, without regard to any further services rendered by the service provider after December 31, 2004, or any other events affecting the amount of or the entitlement to benefits (other than a participant election with re- spect to the time or form of an available benefit). (ii)Account balance plans.The amount of compensation deferred be- fore January 1, 2005, under a nonqual- ified deferred compensation plan that is an account balance plan (as defined in §31.3121(v)(2)–1(c)(1)(ii) of this chapter) equals the portion of the service provider’s account balance as of December 31, 2004, the right to which is earned and vested (as defined in paragraph (a)(2) of this section) as of December 31, 2004. (iii)Equity-based compensation plans. For purposes of determining the amounts deferred before January 1, 2005, under an equity-based compensation plan, the rules of paragraph (a)(3)(ii) of this section gov- erning account balance plans are applied except that the account balance is deemed to be the amount of the payment available to the service provider on December 31, 2004 (or that would be available to the ser- vice provider if the right were immediately exercisable) the right to which is earned and vested (as defined in paragraph (a)(2) of this section) as of December 31, 2004. For this purpose, the payment available to the service provider excludes any exercise price or other amount that must be paid by the service provider. (iv)Earnings. Earnings on amounts de- ferred under a plan before January 1, 2005, include only income (whether actual or no- tional) attributable to the amounts deferred under a plan as of December 31, 2004, or such income. For example, notional inter- est earned under the plan on amounts de- ferred in an account balance plan as of De- cember 31, 2004, generally will be treated as earnings on amounts deferred under the plan before January 1, 2005. Similarly, an increase in the amount of payment avail- able pursuant to a stock option, stock ap- preciation right or other equity-based com- pensation above the amount of payment available as of December 31, 2004, due to appreciation in the underlying stock af- ter December 31, 2004, or accrual of other earnings such as dividends, is treated as earnings on the amount deferred. In the case of a nonaccount balance plan, earn- ings include the increase, due solely to the passage of time, in the present value of the future payments to which the ser- vice provider has obtained a legally bind- ing right, the present value of which consti- tuted the amounts deferred under the plan before January 1, 2005. Thus, for each year, there will be an increase (determined using the same interest rate used to deter- mine the amounts deferred under the plan before January 1, 2005) resulting from the shortening of the discount period before thefuturepaymentsaremade,plus,ifap- plicable, an increase in the present value resulting from the service provider’s sur- vivorship during the year. However, an increase in the potential benefits under a nonaccount balance plan due to, for exam- ple, an application of an increase in com- pensation after December 31, 2004, to a fi- nal average pay plan or subsequent eligi- bility for an early retirement subsidy, does not constitute earnings on the amounts de- ferred under the plan before January 1, 2005. (v)Definition of plan. For purposes of this paragraph (a), the termplanhas the same meaning provided in §1.409A–1(c), except that the provisions treating all nonaccount balance plans under which compensation is deferred as a single plan does not apply for purposes of the actuarial assumptions used in paragraph (a)(3)(ii) of this section. Accordingly, different reasonable actuarial assumptions may be used to calculate the amounts deferred by a service provider in two different ar- rangements each of which constitutes a nonaccount balance plan. (4)Material modifications—(i)In gen- eral. Except as otherwise provided, a mod- ification of a plan is a material modifica- tion if a benefit or right existing as of Oc- tober 3, 2004, is materially enhanced or a new material benefit or right is added, and such material enhancement or addition affects amounts earned and vested before January 1, 2005. Such material benefit en- hancement or addition is a material mod- ification whether it occurs pursuant to an amendment or the service recipient’s ex- ercise of discretion under the terms of the plan. For example, an amendment to a plan to add a provision that payments of deferred amounts earned and vested before January 1, 2005, may be allowed upon re- quest if service providers are required to forfeit 20 percent of the amount of the pay- ment (a haircut) would be a material mod- ification to the plan. Similarly, a material modification would occur if a service re- cipient exercised discretion to accelerate vesting of a benefit under the plan to a date on or before December 31, 2004. How- ever, it is not a material modification for a service recipient to exercise discretion over the time and manner of payment of a benefit to the extent such discretion is pro- vided under the terms of the plan as of Oc- tober 3, 2004. It is not a material modi- fication for a service provider to exercise a right permitted under the plan as in ef- fect on October 3, 2004. The amendment of a plan to bring the plan into compliance with the provisions of section 409A will not be treated as a material modification. However, a plan amendment or the exer- cise of discretion under the terms of the plan that materiallyenhances an existing benefit or right or adds a new material ben- efit or right will be considered a material modification even if the enhanced or added benefit would be permitted under section 409A. For example, the addition of a right to a payment upon an unforeseeable emer- gency of an amount earned and vested be- fore January 1, 2005, would be considered a material modification. The reduction of an existing benefit is not a material mod- ification. For example, the removal of a haircut provision generally would not con- stitute a material modification. The estab- lishment of or contributions to a trust or other arrangement from which benefits un- der the plan are to be paid is not a material October 24, 20058442005–43 I.R.B. modification of the plan, provided that the contribution to the trust or other arrange- ment would not otherwise cause an amount to be includible in the service provider’s gross income. (ii)Adoptions of new arrangements.It is presumed that the adoption of a new arrangement or the grant of an additional benefit under an existing arrangement af- ter October 3, 2004, and before January 1, 2005, constitutes a material modifica- tion of a plan. However, the presumption mayberebuttedbydemonstratingthatthe adoption of the arrangement or grant of the additional benefit is consistent with the service recipient’s historical compensation practices. For example, the presumption that the grant of a discounted stock op- tion on November 1, 2004, is a material modification of a plan may be rebutted by demonstrating that the grant was consis- tent with the historic practice of granting substantially similar discounted stock options (both as to terms and amounts) each November for a significant num- ber of years. Notwithstanding paragraph (a)(4)(i) and this paragraph (a)(4)(ii), the grant of an additional benefit under an existing arrangement that consists of a deferral of additional compensation not otherwise provided under the plan as of October 3, 2004, will be treated as a mate- rial modification of the plan only as to the additional deferral of compensation, if the plan explicitly identifies the additional de- ferral of compensation and provides that the additional deferral of compensation is subject to section 409A. Accordingly, amendments to conform a plan to the re- quirements of section 409A with respect to deferrals under a plan occurring after December 31, 2004, will not constitute a material modification of the plan with re- spect to amounts deferred that are earned and vested on or before December 31, 2004, provided that there is no concurrent material modification with respect to the amount of, or rights to, amounts deferred that were earned and vested on or before December 31, 2004. Similarly, a grant of an additional benefit under a new ar- rangement adopted after October 3, 2004, and before January 1, 2005, will not be treated as a material modification of an existing plan to the extent that the new ar- rangement explicitly identifies additional deferrals of compensation and provides that the additional deferrals of compensa- tion are subject to section 409A. (iii)Suspension or termination of a plan. A cessation of deferrals under, or termination of, a plan, pursuant to the provisions of such plan, is not a material modification. Amending an arrangement to stop future deferrals thereunder is not a material modification of the arrangement or the plan. Amending an arrangement to provide participants an election whether to terminate participation in a plan consti- tutes a material modification of the plan. (iv)Changes to investment mea- sures—account balance plans.With respect to an account balance plan (as de- fined in §31.3121(v)(2)–1(c)(1)(ii) of this chapter), it is not a material modification to change a notional investment measure to, or to add to existing investment measures, an investment measure that qualifies as a predetermined actual investment within the meaning of §31.3121(v)(2)–1(d)(2) of this chapter or, for any given tax- able year, reflects a reasonable rate of interest (determined in accordance with §31.3121(v)(2)–1(d)(2)(i)(C) of this chap- ter). For this purpose, if with respect to an amount deferred for a period, a plan provides for a fixed rate of interest to be credited, and the rate is to be reset under the plan at a specified future date that is not later than the end of the fifth calendar year that begins after the beginning of the period, the rate is reasonable at the beginning of the period, and the rate is not changed before the reset date, then the rate will be treated as reasonable in all future periods before the reset date. (v)Rescission of modifications.Any modification to the terms of a plan that would inadvertently result in treatment as a material modification under this section is not considered a material modification of the plan to the extent the modification in the terms of the plan is rescinded by the earlier of a date before the right is exer- cised (if the change grants a discretionary right) or the last day of the calendar year during which such change occurred. Thus, for example, if a service recipient mod- ifies the terms of a plan on March 1 to allow an election of a new change in the time or form of payment without realizing that such a change constituted a material modification that would subject the plan to the requirements of section 409A, and the modification is rescinded on Novem- ber 1, then if no change in the time or form of payment has been made pursuant to the modification before November 1, the plan is not considered materially modified un- der this section. (vi)Definition of plan. For purposes of this paragraph (a)(4), the termplanhas the same meaning provided in §1.409A–1(c), except that the provision treating all ac- count balance plans under which com- pensation is deferred as a single plan, all nonaccount balance plans under which compensation is deferred as a separate sin- gle plan, all separation pay arrangements due to an actual involuntary separation from service or participation in a window program as a separate single plan, and all other nonqualified deferred compensation plans as a separate single plan, does not apply. (b) [Reserved]. Mark E. Matthews, Deputy Commissioner for Services and Enforcement. (Filed by the Office of the Federal Register on September 29, 2005, 8:45 a.m., and published in the issue of the Federal Register for October 4, 2005, 70 F.R. 57929) 2005–43 I.R.B.845October 24, 2005 Announcement of Disciplinary Actions Involving Attorneys, Certified Public Accountants, Enrolled Agents, and Enrolled Actuaries — Suspensions, Censures, Disbarments, and Resignations Announcement 2005-76 Under Title 31, Code of Federal Regu- lations, Part 10, attorneys, certified public accountants, enrolled agents, and enrolled actuaries may not accept assistance from, or assist, any person who is under disbar- ment or suspension from practice before the Internal Revenue Service if the assis- tance relates to a matter constituting prac- tice before the Internal Revenue Service and may not knowingly aid or abet another person to practice before the Internal Rev- enue Service during a period of suspen- sion, disbarment, or ineligibility of such other person. To enable attorneys, certified public accountants, enrolled agents, and enrolled actuaries to identify persons to whom these restrictions apply, the Director, Of- fice of Professional Responsibility, will announce in the Internal Revenue Bulletin their names, their city and state, their pro- fessional designation, the effective date of disciplinary action, and the period of suspension. This announcement will ap- pear in the weekly Bulletin at the earliest practicable date after such action and will continue to appear in the weekly Bulletins for five successive weeks. Consent Suspensions From Practice Before the Internal Revenue Service Under Title 31, Code of Federal Regu- lations, Part 10, an attorney, certified pub- lic accountant, enrolled agent, or enrolled actuary, in order to avoid the institution or conclusion of a proceeding for his or her disbarment or suspension from prac- tice before the Internal Revenue Service, may offer his or her consent to suspension from such practice. The Director, Office of Professional Responsibility, in his dis- cretion, may suspend an attorney, certified public accountant, enrolled agent, or en- rolled actuary in accordance with the con- sent offered. The following individuals have been placed under consent suspension from practice before the Internal Revenue Ser- vice: NameAddressDesignationDate of Suspension Reagan, JohnCortland, NYCPAIndefinite from June 24, 2005 Harris, Alexander W.Chicago, ILAttorneyJuly 1, 2005 to December 31, 2005 Belush, Glen J.Monroe, CTCPAIndefinite from July 15, 2005 Lamont, AliceAtlanta, GACPAIndefinite from July 15, 2005 Morse, Kyle K.Bedford, TXCPAIndefinite from July 22, 2005 Duggan Jr., Joseph A.Jacksonville, OREnrolled AgentIndefinite from August 1, 2005 October 24, 20058462005–43 I.R.B. NameAddressDesignationDate of Suspension Harper, IvanBrooklyn, NYCPAIndefinite from August 15, 2005 Bandy, Robert M.Tyler, TXAttorneyIndefinite from August 24, 2005 Peterson, StanleySpringfield, PACPAIndefinite from August 26, 2005 Shorten, JudyVacaville, CAEnrolled AgentIndefinite from September 1, 2005 Watkins, David E.Shelbyville, INEnrolled AgentIndefinite from September 1, 2005 Expedited Suspensions From Practice Before the Internal Revenue Service Under Title 31, Code of Federal Regu- lations, Part 10, the Director, Office of Pro- fessional Responsibility, is authorized to immediately suspend from practice before the Internal RevenueService any practi- tioner who, within five years from the date the expedited proceeding is instituted (1) has had a license to practice as an attor- ney, certified public accountant, or actuary suspended or revoked for cause or (2) has been convicted of certain crimes. The following individuals have been placed under suspension from practice be- fore the Internal Revenue Service by virtue of the expedited proceeding provisions: NameAddressDesignationDate of Suspension Leong, Thomas S.Honolulu, HIAttorneyIndefinite from July 11, 2005 Clark, Mark S.Tucson, AZAttorneyIndefinite from July 11, 2005 Hudspeth, George E.St. Louis, MOAttorneyIndefinite from July 11, 2005 Dodd, Alan F.Westborough, MAAttorneyIndefinite from July 11, 2005 Crews, James F.Tipton, MOAttorneyIndefinite from July 11, 2005 Luparella, JosephHoboken, NJCPAIndefinite from July 13, 2005 2005–43 I.R.B.847October 24, 2005 NameAddressDesignationDate of Suspension Deutchman, MurrayBarnesville, MDAttorneyIndefinite from July 13, 2005 Cozier, Clifford G.Englewood, COAttorneyIndefinite from July 13, 2005 Segall, Steven M.Denver, COAttorneyIndefinite from July 14, 2005 Richardson, BruceReisterstown, MDAttorneyIndefinite from July 15, 2005 Parsley, Jeffrey A.Englewood, COAttorneyIndefinite from July 15, 2005 Wyrick, Richard L.Hanford, CAAttorneyIndefinite from July 15, 2005 Coates, Marsden S.Baltimore, MDAttorneyIndefinite from July 15, 2005 McCampbell, DanielChico, CAAttorneyIndefinite from July 15, 2005 Ralston, Ronald G.Fairmount, GACPAIndefinite from July 18, 2005 Friemann, Robert F.Huntington Bay, NYCPAIndefinite from July 18, 2005 Friedman, Milton G.Ft. Lauderdale, FLCPAJuly 25, 2005 to January 24, 2007 Acheampong, RobertColumbus, OHCPAIndefinite from July 26, 2005 Elias, Robert F.Canfield, OHAttorneyIndefinite from July 27, 2005 Stover, Kathy A.Topeka, KSAttorneyIndefinite from July 29, 2005 Leffler, Fredric D.Columbia, MDAttorneyIndefinite from July 29, 2005 October 24, 20058482005–43 I.R.B. NameAddressDesignationDate of Suspension Harmon, Anthony N.Batavia, ILAttorneyIndefinite from July 29, 2005 Hames, David H.Dallas, TXCPAIndefinite from August 2, 2005 Au, Ronald G.S.Honolulu, HIAttorneyIndefinite from August 9, 2005 Tilton Jr., George H.Denver, COAttorneyIndefinite from August 12, 2005 Spalsbury Jr., ClarkEstes Park, COAttorneyIndefinite from August 12, 2005 Brockman, Louis R.Dallas, TXCPAIndefinite from August 12, 2005 Hill, Richard B.Kernersville, NCCPAIndefinite from August 12, 2005 Rosenberg, Jeffrey P.Morgan Hill, CAAttorneyIndefinite from August 12, 2005 Link, Robert A.Waupaca, WICPAIndefinite from August 15, 2005 Halcrow, David S.Taft, CACPAIndefinite from September 9, 2005 Lieber, Daniel M.Edna, MOAttorneyIndefinite from September 9, 2005 Kirchoff, William W.Jefferson City, MOAttorneyIndefinite from September 9, 2005 Lauby, Gregory C.Lexington, NEAttorneyIndefinite from September 9, 2005 Early, Michael J.Newburyport, MAAttorneyIndefinite from September 9, 2005 Mickiewicz, RobertDorchester, MAAttorneyIndefinite from September 9, 2005 Conant, Jon F.Gloucester, MAAttorneyIndefinite from September 9, 2005 2005–43 I.R.B.849October 24, 2005 NameAddressDesignationDate of Suspension Pennington, JillChevy Chase, MDAttorneyIndefinite from September 9, 2005 Randolph, Robert E.Denham Springs, LAAttorneyIndefinite from September 9, 2005 Carillo, DonaldChicago, ILAttorneyIndefinite from September 9, 2005 Sloan Jr., DeweySioux City, IAAttorneyIndefinite from September 9, 2005 Vogel, GarrettDallas, TXCPAIndefinite from September 13, 2005 Becker, JosephHouston, TXCPAIndefinite from September 13, 2005 Winick, Robert M.Sarasota, FLAttorneyIndefinite from September 19, 2005 Hunsaker Jr., WilliamGolden, COAttorneyIndefinite from September 19, 2005 Wheatley, Jay D.Boca Raton,FLAttorneyIndefinite from September 19, 2005 Clark, Carroll A.Mesa, AZAttorneyIndefinite from September 19, 2005 Suspensions From Practice Before the Internal Revenue Service After Notice and an Opportunity for a Proceeding Under Title 31, Code of Federal Reg- ulations, Part 10, after notice and an op- portunity for a proceeding before an ad- ministrative law judge, the following indi- viduals have been placed under suspension from practice before the Internal Revenue Service: NameAddressDesignationEffective Date Sobel, Herbert L.Elkins Park, PACPAMay 4, 2005 to February 3, 2007 Rubesh, LelandGillette, WYCPAAugust 1, 2005 to January 31, 2007 October 24, 20058502005–43 I.R.B. NameAddressDesignationEffective Date Gregory, Carolyn S.Cathedral City, CAEnrolled AgentAugust 12, 2005 to November 11, 2007 Censure Issued by Consent Under Title 31, Code of Federal Reg- ulations, Part 10, in lieu of a proceeding being instituted or continued, an attorney, certified public accountant, enrolled agent, or enrolled actuary, may offer his or her consent to the issuance of a censure. Cen- sure is a public reprimand. The following individuals have con- sented to the issuance of a Censure: NameAddressDesignationDate of Censure Pugno, ThomasRockwood, MIEnrolled AgentJune 29, 2005 Barrett, RichardTyler, TXCPAAugust 1, 2005 Kelly, Michael G.Odessa, TXAttorneyAugust 1, 2005 Volstad, Paul S.Plymouth, MNCPAAugust 18, 2005 Quackenbush, Gary A.San Diego, CAAttorneySeptember 2, 2005 Flores, Fred A.Laredo, TXCPASeptember 2, 2005 Velasquez, FelixLaredo, TXCPASeptember 2, 2005 2005–43 I.R.B.851October 24, 2005 Definition of Terms Revenue rulings and revenue procedures (hereinafter referred to as “rulings”) that have an effect on previous rulings use the following defined terms to describe the ef- fect: Amplifieddescribes a situation where no change is being made in a prior pub- lished position, but the prior position is be- ingextendedtoapplytoavariationofthe fact situation set forth therein. Thus, if an earlier ruling held that a principle ap- plied to A, and the new ruling holds that the same principle also applies to B, the earlier ruling is amplified. (Compare withmodi- fied,below). Clarifiedis used in those instances where the language in a prior ruling is be- ing made clear because the language has caused, or may cause, some confusion. It is not used where a position in a prior ruling is being changed. Distinguisheddescribes a situation where a ruling mentions a previously pub- lished ruling and points out an essential difference between them. Modifiedis used where the substance of a previously published position is being changed. Thus, if a prior ruling held that a principle applied to A but not to B, and the new ruling holds that it applies to both A and B, the prior ruling is modified because it corrects a published position. (Compare withamplifiedandclarified, above). Obsoleteddescribes a previously pub- lished ruling that is not considered deter- minative with respect to future transac- tions. This term is most commonly used in a ruling that lists previously published rul- ings that are obsoleted because of changes in laws or regulations. A ruling may also be obsoleted because the substance has been included in regulations subsequently adopted. Revokeddescribes situations where the position in the previously published ruling is not correct and the correct position is beingstatedinanewruling. Supersededdescribes a situation where the new ruling does nothing more than re- state the substance and situation of a previ- ously published ruling (or rulings). Thus, the term is used to republish under the 1986 Code and regulations the same po- sition published under the 1939 Code and regulations. The term is also used when it is desired to republish in a single rul- ing a series of situations, names, etc., that were previously published over a period of time in separate rulings. If the new rul- ing does more than restate the substance of a prior ruling, a combination of terms is used. For example,modifiedandsu- persededdescribes a situation where the substance of a previously published ruling is being changed in part and is continued without change in part and it is desired to restate the valid portion of the previously published ruling in a new ruling that is self contained. In this case, the previously pub- lished ruling is first modified and then, as modified, is superseded. Supplementedis used in situations in which a list, such as a list of the names of countries, is published in a ruling and that list is expanded by adding further names in subsequent rulings. After the original rul- ing has been supplemented several times, a new ruling may be published that includes the list in the original ruling and the ad- ditions, and supersedes all prior rulings in the series. Suspendedis used in rare situations to show that the previous published rul- ings will not be applied pending some future action such as the issuance of new or amended regulations, the outcome of cases in litigation, or the outcome of a Service study. Abbreviations The fol lowing abbreviations in current use and for merly used will appear in material publis hedintheBulletin. A—Individual. Acq.—A cquiescence. B—Individual. BE—Beneficiary. BK—Bank . B.T.A.—Board of Tax Appeals. C—Individual. C.B.—Cu mulative Bulletin. CFR—Code of Federal Regulations. CI—City. COOP—Coo perative. Ct.D.—Court Decision. CY—County. D—Decede nt. DC—Dummy Corporation. DE—Donee. Del. Order —Delegation Order. DISC—Domestic International Sales Corporation. DR—Donor. E—Estate. EE—Employee. E.O.—Executive Order. ER—Emp loyer. ERISA—Employee Retirement Income Security Act. EX—Executor. F—Fiduc iary. FC—Foreign Country. FICA—Federal Insurance Contributions Act. FISC—Fo reign International Sales Company. FPH—Foreign Personal Holding Company. F.R.—Federal Register. FUTA—Fed eral Unemployment Tax Act. FX—Foreign corporation. G.C.M.—Chief Counsel’s Memorandum. GE—Grante e. GP—General Partner. GR—Grantor. IC—Insura nce Company. I.R.B.—Internal Revenue Bulletin. LE—Lessee. LP—Limited Partner. LR—Lessor. M—Minor. Nonacq.—No nacquiescence. O—Organization. P—Parent Corporation. PHC—Persona l Holding Company. PO—Possession of the U.S. PR—Partner. PRS—Pa rtnership. PTE—Prohibited Transaction Exemption. Pub. L.—Public Law. REIT—Re al Estate Investment Trust. Rev. Proc.—Revenue Procedure. Rev. Rul.—Revenue Ruling. S—Subsi diary. S.P.R.—Statement of Procedural Rules. Stat.—Statutes at Large. T—Target Corporation. T.C.—Tax Court. T.D.—Treasury Decision. TFE—Trans feree. TFR—Transferor. T.I.R.—Technical Information Release. TP—Taxpay er. TR—Trust. TT—Trustee. U.S.C.—Uni ted States Code. X—Corporation. Y—Corporation. Z—Corporat ion. October 24, 2005i2005–43 I.R.B. Numerical Finding List 1 Bulletins 2005–27 through 2005–43 Announcements: 2005-46, 2005-27 I.R.B.63 2005-47, 2005-28 I.R.B.71 2005-48, 2005-29 I.R.B.111 2005-49, 2005-29 I.R.B.119 2005-50, 2005-30 I.R.B.152 2005-51, 2005-32 I.R.B.283 2005-52, 2005-31 I.R.B.257 2005-53, 2005-31 I.R.B.258 2005-54, 2005-32 I.R.B.283 2005-55, 2005-33 I.R.B.317 2005-56, 2005-33 I.R.B.318 2005-57, 2005-33 I.R.B.318 2005-58, 2005-33 I.R.B.319 2005-59, 2005-37 I.R.B.524 2005-60, 2005-35 I.R.B.455 2005-61, 2005-36 I.R.B.495 2005-62, 2005-36 I.R.B.495 2005-63, 2005-36 I.R.B.496 2005-64, 2005-37 I.R.B.537 2005-65, 2005-38 I.R.B.587 2005-66, 2005-39 I.R.B.613 2005-67, 2005-40 I.R.B.678 2005-68, 2005-39 I.R.B.613 2005-69, 2005-40 I.R.B.681 2005-70, 2005-40 I.R.B.682 2005-71, 2005-41 I.R.B.714 2005-72, 2005-41 I.R.B.692 2005-73, 2005-41 I.R.B.715 2005-74, 2005-42 I.R.B.764 2005-75, 2005-42 I.R.B.764 2005-76, 2005-42 I.R.B.765 Notices: 2005-48, 2005-27 I.R.B.9 2005-49, 2005-27 I.R.B.14 2005-50, 2005-27 I.R.B.14 2005-51, 2005-28 I.R.B.74 2005-52, 2005-28 I.R.B.75 2005-53, 2005-32 I.R.B.263 2005-54, 2005-30 I.R.B.127 2005-55, 2005-32 I.R.B.265 2005-56, 2005-32 I.R.B.266 2005-57, 2005-32 I.R.B.267 2005-58, 2005-33 I.R.B.295 2005-59, 2005-35 I.R.B.443 2005-60, 2005-39 I.R.B.606 2005-61, 2005-39 I.R.B.607 2005-62, 2005-35 I.R.B.443 2005-63, 2005-35 I.R.B.448 2005-64, 2005-36 I.R.B.471 2005-65, 2005-39 I.R.B.607 Notices— Continued: 2005-66, 2005-40 I.R.B.620 2005-67, 2005-40 I.R.B.621 2005-68, 2005-40 I.R.B.622 2005-69, 2005-40 I.R.B.622 2005-70, 2005-41 I.R.B.694 2005-73, 2005-42 I.R.B.723 2005-74, 2005-42 I.R.B.726 Proposed Regulations: REG-106030-98, 2005-42 I.R.B.739 REG-144615-02, 2005-40 I.R.B.625 REG-150088-02, 2005-43 I.R.B.774 REG-150091-02, 2005-43 I.R.B.780 REG-131739-03, 2005-36 I.R.B.494 REG-130241-04, 2005-27 I.R.B.18 REG-138362-04, 2005-33 I.R.B.299 REG-138647-04, 2005-41 I.R.B.697 REG-149436-04, 2005-35 I.R.B.454 REG-156518-04, 2005-38 I.R.B.582 REG-158080-04, 2005-43 I.R.B.786 REG-104143-05, 2005-41 I.R.B.708 REG-111257-05, 2005-42 I.R.B.759 REG-121584-05, 2005-37 I.R.B.523 REG-122857-05, 2005-39 I.R.B.609 REG-129782-05, 2005-40 I.R.B.675 REG-133578-05, 2005-39 I.R.B.610 Revenue Procedures: 2005-35, 2005-28 I.R.B.76 2005-36, 2005-28 I.R.B.78 2005-37, 2005-28 I.R.B.79 2005-38, 2005-28 I.R.B.81 2005-39, 2005-28 I.R.B.82 2005-40, 2005-28 I.R.B.83 2005-41, 2005-29 I.R.B.90 2005-42, 2005-30 I.R.B.128 2005-43, 2005-29 I.R.B.107 2005-44, 2005-29 I.R.B.110 2005-45, 2005-30 I.R.B.141 2005-46, 2005-30 I.R.B.142 2005-47, 2005-32 I.R.B.269 2005-48, 2005-32 I.R.B.271 2005-49, 2005-31 I.R.B.165 2005-50, 2005-32 I.R.B.272 2005-51, 2005-33 I.R.B.296 2005-52, 2005-34 I.R.B.326 2005-53, 2005-34 I.R.B.339 2005-54, 2005-34 I.R.B.353 2005-55, 2005-34 I.R.B.367 2005-56, 2005-34 I.R.B.383 2005-57, 2005-34 I.R.B.392 2005-58, 2005-34 I.R.B.402 2005-59, 2005-34 I.R.B.412 2005-60, 2005-35 I.R.B.449 2005-61, 2005-37 I.R.B.507 Revenue Procedures— Continued: 2005-62, 2005-37 I.R.B.507 2005-63, 2005-36 I.R.B.491 2005-64, 2005-36 I.R.B.492 2005-65, 2005-38 I.R.B.564 2005-66, 2005-37 I.R.B.509 2005-67, 2005-42 I.R.B.729 2005-68, 2005-41 I.R.B.694 Revenue Rulings: 2005-38, 2005-27 I.R.B.6 2005-39, 2005-27 I.R.B.1 2005-40, 2005-27 I.R.B.4 2005-41, 2005-28 I.R.B.69 2005-42, 2005-28 I.R.B.67 2005-43, 2005-29 I.R.B.88 2005-44, 2005-29 I.R.B.87 2005-45, 2005-30 I.R.B.123 2005-46, 2005-30 I.R.B.120 2005-47, 2005-32 I.R.B.261 2005-48, 2005-32 I.R.B.259 2005-49, 2005-30 I.R.B.125 2005-50, 2005-30 I.R.B.124 2005-51, 2005-31 I.R.B.163 2005-52, 2005-35 I.R.B.423 2005-53, 2005-35 I.R.B.425 2005-54, 2005-33 I.R.B.289 2005-55, 2005-33 I.R.B.284 2005-56, 2005-35 I.R.B.427 2005-57, 2005-36 I.R.B.466 2005-58, 2005-36 I.R.B.465 2005-59, 2005-37 I.R.B.505 2005-60, 2005-37 I.R.B.502 2005-61, 2005-38 I.R.B.538 2005-62, 2005-38 I.R.B.557 2005-63, 2005-39 I.R.B.603 2005-64, 2005-39 I.R.B.600 2005-65, 2005-41 I.R.B.684 2005-66, 2005-41 I.R.B.686 2005-67, 2005-43 I.R.B.771 Tax Conventions: 2005-47, 2005-28 I.R.B.71 2005-72, 2005-41 I.R.B.692 Treasury Decisions: 9208, 2005-31 I.R.B.157 9209, 2005-31 I.R.B.153 9210, 2005-33 I.R.B.290 9211, 2005-33 I.R.B.287 9212, 2005-35 I.R.B.429 9213, 2005-35 I.R.B.440 9214, 2005-35 I.R.B.435 9215, 2005-36 I.R.B.468 9216, 2005-36 I.R.B.461 9217, 2005-37 I.R.B.498 1 A cumulative list of all revenue rulings, revenueprocedures, Treasury decisions, etc., publishedin Internal Revenue Bulletins 2005–1 through 2005–26 is in Internal Revenue Bulletin 2005–26, dated June 27, 2005. 2005–43 I.R.B.iiOctober 24, 2005 Treasury Decisions— Continued: 9218, 2005-37 I.R.B.503 9219, 2005-38 I.R.B.538 9220, 2005-39 I.R.B.596 9221, 2005-39 I.R.B.604 9222, 2005-40 I.R.B.614 9223, 2005-39 I.R.B.591 9224, 2005-41 I.R.B.688 9225, 2005-42 I.R.B.716 9226, 2005-43 I.R.B.772 October 24, 2005iii2005–43 I.R.B. Finding List of Current Actions on Previously Published Items 1 Bulletins 2005–27 through 2005–43 Announcements: 84-26 Obsoleted by REG-149436-04, 2005-35 I.R.B.454 2004-72 Updated and superseded by Ann. 2005-59, 2005-37 I.R.B.524 2005-36 Modified by Rev. Proc. 2005-66, 2005-37 I.R.B.509 2005-53 Corrected by Ann. 2005-61, 2005-36 I.R.B.495 Notices: 89-111 Amplified by Notice 2005-61, 2005-39 I.R.B.607 2001-42 Modified by Rev. Proc. 2005-66, 2005-37 I.R.B.509 2005-4 Modified by Notice 2005-62, 2005-35 I.R.B.443 2005-10 Clarified by Notice 2005-64, 2005-36 I.R.B.471 2005-38 Modified by Notice 2005-64, 2005-36 I.R.B.471 2005-51 Modified and superseded by Notice 2005-57, 2005-32 I.R.B.267 Proposed Regulations: REG-108524-00 Corrected by Ann. 2005-68, 2005-39 I.R.B.613 REG-142686-01 Withdrawn by Ann. 2005-55, 2005-33 I.R.B.317 REG-100420-03 Corrected by Ann. 2005-57, 2005-33 I.R.B.318 REG-102144-04 Corrected by Ann. 2005-56, 2005-33 I.R.B.318 Revenue Procedures: 64-54 Obsoleted by Rev. Rul. 2005-43, 2005-29 I.R.B.88 66-33 Obsoleted by Rev. Rul. 2005-43, 2005-29 I.R.B.88 69-13 Obsoleted by Rev. Rul. 2005-43, 2005-29 I.R.B.88 70-8 Modified by Rev. Proc. 2005-46, 2005-30 I.R.B.142 71-1 Obsoleted by Rev. Rul. 2005-43, 2005-29 I.R.B.88 72-22 Obsoleted by Rev. Rul. 2005-43, 2005-29 I.R.B.88 83-77 Superseded by Rev. Proc. 2005-63, 2005-36 I.R.B.491 87-8 Obsoleted by Rev. Proc. 2005-44, 2005-29 I.R.B.110 87-9 Obsoleted by Rev. Proc. 2005-44, 2005-29 I.R.B.110 89-20 Superseded by Rev. Proc. 2005-52, 2005-34 I.R.B.326 90–11 Modified by Rev. Proc. 2005-40, 2005-28 I.R.B.83 90-30 Section4supersededby Rev. Proc. 2005-54, 2005-34 I.R.B.353 Section5supersededby Rev. Proc. 2005-55, 2005-34 I.R.B.367 Section6supersededby Rev. Proc. 2005-56, 2005-34 I.R.B.383 Section7supersededby Rev. Proc. 2005-58, 2005-34 I.R.B.402 Section8supersededby Rev. Proc. 2005-59, 2005-34 I.R.B.412 90-31 Section4supersededby Rev. Proc. 2005-52, 2005-34 I.R.B.326 Section5supersededby Rev. Proc. 2005-54, 2005-34 I.R.B.353 Section6supersededby Rev. Proc. 2005-55, 2005-34 I.R.B.367 Revenue Procedures— Continued: Section7supersededby Rev. Proc. 2005-56, 2005-34 I.R.B.383 Section8supersededby Rev. Proc. 2005-58, 2005-34 I.R.B.402 Section9supersededby Rev. Proc. 2005-59, 2005-34 I.R.B.412 93-22 Obsoleted by Rev. Proc. 2005-44, 2005-29 I.R.B.110 98-18 Obsoleted by Rev. Proc. 2005-45, 2005-30 I.R.B.141 99-39 Superseded by Rev. Proc. 2005-60, 2005-35 I.R.B.449 2000-27 Modified and superseded by Rev. Proc. 2005-66, 2005-37 I.R.B.509 2000-31 Superseded by Rev. Proc. 2005-60, 2005-35 I.R.B.449 2000-49 Superseded by Rev. Proc. 2005-41, 2005-29 I.R.B.90 2001-9 Superseded by Rev. Proc. 2005-60, 2005-35 I.R.B.449 2001-16 Superseded by Rev. Proc. 2005-42, 2005-30 I.R.B.128 2002-9 Modified and amplified by Rev. Rul. 2005-42, 2005-28 I.R.B.67 Rev. Proc. 2005-35, 2005-28 I.R.B.76 Rev. Proc. 2005-43, 2005-29 I.R.B.107 Rev. Proc. 2005-47, 2005-32 I.R.B.269 2002-49 Modified, amplified, and superseded by Rev. Proc. 2005-62, 2005-37 I.R.B.507 2004-50 Superseded by Rev. Proc. 2005-49, 2005-31 I.R.B.165 2004-54 Superseded by Rev. Proc. 2005-65, 2005-38 I.R.B.564 2004-64 Modified by Ann. 2005-71, 2005-41 I.R.B.714 2005-1 Amplified by Rev. Proc. 2005-68, 2005-41 I.R.B.694 1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2005–1 through 2005–26 is in Internal Revenue Bulletin 2005–26, dated June 27, 2005. 2005–43 I.R.B.ivOctober 24, 2005 Revenue Procedures— Continued: 2005-3 Amplified by Rev. Proc. 2005-61, 2005-37 I.R.B.507 Rev. Proc. 2005-68, 2005-41 I.R.B.694 2005-6 Modified by Rev. Proc. 2005-66, 2005-37 I.R.B.509 2005-10 Superseded by Rev. Proc. 2005-67, 2005-42 I.R.B.729 2005-16 Modified by Rev. Proc. 2005-66, 2005-37 I.R.B.509 Revenue Rulings: 65-109 Obsoleted by Rev. Rul. 2005-43, 2005-29 I.R.B.88 68-549 Obsoleted by Rev. Rul. 2005-43, 2005-29 I.R.B.88 74-203 Revoked by Rev. Rul. 2005-59, 2005-37 I.R.B.505 82-29 Modified and clarified by Rev. Proc. 2005-39, 2005-28 I.R.B.82 2005-41 Corrected by Ann. 2005-50, 2005-30 I.R.B.152 Treasury Decisions: 9149 Removed by T.D. 9221, 2005-39 I.R.B.604 9186 Corrected by Ann. 2005-53, 2005-31 I.R.B.258 9193 Corrected by Ann. 2005-62, 2005-36 I.R.B.495 9205 Corrected by Ann. 2005-63, 2005-36 I.R.B.496 9206 Corrected by Ann. 2005-49, 2005-29 I.R.B.119 9207 Corrected by Ann. 2005-52, 2005-31 I.R.B.257 9210 Corrected by Ann. 2005-64, 2005-37 I.R.B.537 October 24, 2005v2005–43 I.R.B. U.S. GPO: 2005—320–797/20028
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