Internal Revenue Bulletin 2002-44 (PDF rendition): IRS Announcements

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing. Whole bulletin rendition: numbered items are identified below; other legal material and publisher context remain included. This is not a new standalone advance release.

# Internal Revenue bulletin

## 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.

## SPECIAL ANNOUNCEMENT

### Announcement 2002-101, page 800.

This announcement solicts applications from potential part-
ners to participate in the 2003 IRS Individual e-file Partner-
ship Program. The partnership opportunities are a result of
RRA 98, which requires the IRS to receive 80 percent of all
returns electronically by 2007. RRA 98 authorized the IRS
Commissioner to promote the benefits of and encourage the
use of e-file services through partnerships with various en-
tities that offer low cost tax preparation and electronic fil-
ing of income tax returns for qualified taxpayers. Those
applicants that are accepted as partners will have a link(s)
and description(s) of their services placed on the IRS web-
site at www.irs.gov (IRS e-file Partners Page).

## INCOME TAX

Rev. Rul. 2002-69, page 760.
Business expenses; interest; lease-in/lease-out transac-
tions. A taxpayer may not deduct currently, under sections 162
and 163 of the Code, rent and interest paid or incurred in con-
nection with a lease-in/lease-out (LILO) transaction that prop-
erly is characterized as conferring only a future interest in
property. Rev. Rul. 99-14 modified and superseded.

Rev. Rul. 2002-71, page 763.

Notional principal contract (NPC). This ruling provides guid-
ance on the timing of recognition of gain or loss on the termi-
nation of a notional principal contract that hedges a portion of
the term of a debt instrument issued by the taxpayer.

Rev. Rul. 2002-72, page 759.
Low-income housing credit; satisfactory bond; "bond fac-
tor" amounts for the period October through December
2002. This ruling announces the monthly bond factor amounts
to be used by taxpayers who dispose of qualified low-income
buildings or interests therein during the period October through

December 2002. This ruling also provides a summary of the bond
factor amounts for dispositions occurring during the period Janu-
ary through September 2002.

### REG-112306-00, page 767.

Proposed regulations under section 1296 of the Code contain
procedures for certain United States persons holding market-
able stock in a passive foreign investment company (PFIC) to elect
mark to market treatment for that stock. A public hearing is
scheduled for November 6, 2002.

### REG-150313-01, page 777.

Proposed regulations under sections 302, 304, and other sec-
tions of the Code provide guidance regarding the treatment of
the basis of redeemed stock when a distribution in redemption
of such stock is treated as a dividend. The regulations also pro-
vide guidance regarding certain acquisitions of stock by re-
lated corporations that are treated as distributions in redemption
of stock. A public hearing is scheduled for February 20, 2003.

### Notice 2002-70, page 765.

This notice alerts taxpayers and their representatives about cer-
tain reinsurance transactions intended to shift income to off-
shore related companies purported to be insurance companies
that are subject to little or no U.S. federal income tax. These trans-
actions often do not generate the federal tax benefits that tax-
payers claim are allowable for federal income tax purposes. This
notice also alerts taxpayers, their representatives, and promot-
ers of these transactions, to certain reporting and record keep-
ing obligations and penalties that they may be subject to with
respect to these transactions.

Announcement 2002-100, page 799.

This document contains corrections to proposed regulations un-
der section 1503(d) of the Code (REG-106879-00, 2002-34
I.R.B. 402) relating to the events that require the recapture of dual
consolidated losses.

Finding Lists begin on page ii.
Index for July through October begins on page v.

Department of the Treasury
Internal Revenue Service

### Announcement 2002-102, page 802.

This document changes the date of a scheduled public hearing
and extends the public comment period on proposed regula-
tions (REG-136311-01, 2002-36 I.R.B. 485) that relate to when
a foreign corporation engaged in the international operation of
ships or aircraft may exclude its U.S. source income from gross
income for U.S. federal income tax purposes. The hearing is re-
scheduled from November 12, 2002, to November 25, 2002.

## EMPLOYEE PLANS

### REG-124667-02, page 791.

Proposed regulations under section 417 of the Code would con-
solidate the content requirements applicable to explanations of
qualified joint and survivor annuities and qualified preretire-
ment survivor annuities payable from certain retirement plans.
In addition, these regulations would specify requirements for dis-
closing the relative value of optional forms of benefit that are pay-
able from certain retirement plans in lieu of a qualified joint and
survivor annuity. A public hearing is scheduled for January 14,
2003.

## 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 rul-
ings and procedures of the Internal Revenue Service and for pub-
lishing Treasury Decisions, Executive Orders, Tax Conventions,
legislation, court decisions, and other items of general inter-
est. It is published weekly and may be obtained from the Super-
intendent of Documents on a subscription basis. Bulletin contents
are consolidated semiannually into Cumulative Bulletins, which
are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke, modify,
or amend any of those previously published in the Bulletin. All pub-
lished rulings apply retroactively unless otherwise indicated. Pro-
cedures relating solely to matters of internal management are
not published; however, statements of internal practices and pro-
cedures that affect the rights and duties of taxpayers are pub-
lished.

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 taxpay-
ers or technical advice to Service field offices, identifying de-
tails 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 re-
lied on, used, or cited as precedents by Service personnel in the
disposition of other cases. In applying published rulings and pro-
cedures, the effect of subsequent legislation, regulations, court

decisions, rulings, and procedures must be considered, and Ser-
vice personnel and others concerned are cautioned against reach-
ing the same conclusions in other cases unless the facts and
circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

### Part I. - 1986 Code.

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

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

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

Part III .- Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these sub-
jects are contained in the other Parts and Subparts. Also in-
cluded in this part are Bank Secrecy Act Administrative Rulings.
Bank Secrecy Act Administrative Rulings are issued by the De-
partment of the Treasury's Office of the Assistant Secretary (En-
forcement).

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

This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.

The first Bulletin for each month includes a cumulative index for
the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the first Bulletin of the succeeding semiannual pe-
riod, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

## 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 October through December 2002.
This ruling announces the monthly bond
factor amounts to be used by taxpayers who
dispose of qualified low-income build-
ings or interests therein during the period
October through December 2002. This rul-
ing also provides a summary of the bond
factor amounts for dispositions occuring
during the period January through Septem-
ber 2002.

#### Rev. Rul. 2002-72

In Rev. Rul. 90-60, 1990-2 C.B. 3, the
Internal Revenue Service provided guid-

ance to taxpayers concerning the general
methodology used by the Treasury Depart-
ment in computing the bond factor amounts
used in calculating the amount of bond con-
sidered satisfactory by the Secretary un-
der § 42(j)(6) of the Internal Revenue Code.
It further announced that the Secretary
would publish in the Internal Revenue Bul-
letin a table of "bond factor" amounts for
dispositions occurring during each calen-
dar month.

Rev. Proc. 99-11, 1999-1 C.B. 275, es-
tablished a collateral program as an alter-
native 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 calculating the
amount of bond considered satisfactory un-
der § 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 dur-
ing the period October through December
2002. Table 1 also provides a summary of
the bond factor amounts for dispositions oc-
curring during the period January through
September 2002.

Table 1 Rev. Rul. 2002-72 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

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Jan '02

17.76

32.73

45.44

56.24

65.46

65.92

66.46

66.99

67.63

68.35

69.24

Feb '02

17.76

32.73

45.44

56.24

65.46

65.75

66.28

66.80

67.44

68.16

69.05

Mar '02

17.76

32.73

45.44

56.24

65.46

65.57

66.10

66.62

67.26

67.98

68.86

Apr '02

17.76

32.73

45.44

56.24

65.46

65.40

65.93

66.45

67.08

67.80

68.68

May '02

17.76

32.73

45.44

56.24

65.46

65.23

65.76

66.27

66.91

67.62

68.50

Jun '02

17.76

32.73

45.44

56.24

65.46

65.06

65.59

66.11

66.74

67.46

68.33

Jul '02

17.76

32.73

45.44

56.24

65.46

64.90

65.42

65.94

66.58

67.29

68.17

Aug '02

17.76

32.73

45.44

56.24

65.46

64.74

65.26

65.78

66.42

67.13

68.01

Sep '02

17.76

32.73

45.44

56.24

65.46

64.58

65.10

65.62

66.26

66.98

67.86

Oct '02

17.76

32.73

45.44

56.24

65.46

64.43

64.95

65.47

66.11

66.83

67.72

Nov '02

17.76

32.73

45.44

56.24

65.46

64.27

64.80

65.32

65.96

66.68

67.58

Dec '02

17.76

32.73

45.44

56.24

65.46

64.12

64.65

65.17

65.81

66.54

67.44

# Table 1 (cont'd) Rev. Rul. 2002-72 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

1999

2000

2001

2002

Jan '02

70.13

70.98

72.28

72.55

Feb '02

69.92

70.77

72.05

72.55

Mar '02

69.73

70.58

71.84

72.55

Apr '02

69.55

70.40

71.67

72.55

May '02

69.38

70.24

71.51

72.55

Jun '02

69.21

70.09

71.37

72.55

Jul '02

69.05

69.94

71.25

72.55

Aug '02

68.90

69.81

71.14

72.55

Sep '02

68.76

69.68

71.04

72.55

Oct '02

68.62

69.57

70.94

72.55

Nov '02

68.49

69.45

70.86

72.55

Dec '02

68.37

69.35

70.78

72.55

For a list of bond factor amounts appli-
cable 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; and Rev. Rul. 2001-53, 2001-2 C.B.
488.

## DRAFTING INFORMATION

The principal author of this revenue rul-
ing is Gregory N. Doran of the Office of
Associate Chief Counsel (Passthroughs and
Special Industries). For further informa-
tion regarding this revenue ruling, con-
tact Mr. Doran at (202) 622-3040 (not a
toll-free call).

## Section 162 .- Trade or Business Expenses

26 CFR 1.162-11: Rentals.
(Also § 163; 1.163-1.)

Business expenses; interest; lease-in/
lease-out transactions. A taxpayer may not
deduct currently, under sections 162 and 163
of the Code, rent or interest paid or in-
curred in connection with a lease-in/lease-
out (LILO) transaction that properly is
characterized as conferring only a future in-
terest in property.

## Rev. Rul. 2002-69

### ISSUE

May a taxpayer deduct currently, un-
der §§ 162 and 163 of the Internal Rev-
enue Code, rent and interest paid or incurred
in connection with a "lease-in/lease-out"
("LILO") transaction?

FACTS

X is a U.S. corporation. FM is a for-
eign municipality that has historically owned
and used certain property. As of 1997, it is
estimated that the property has a remain-
ing useful life of 50 years and a fair mar-
ket value of $100 million. BK1 and BK2 are
banks. None of these four parties is re-
lated to any of the others.

On January 1, 1997, X and FM entered
into a LILO transaction under which FM
leased the property to X under a "Head-
lease," and X immediately leased the prop-
erty back to FM under a "Sublease." The
term of the Headlease is 40 years. The pri-
mary term of the Sublease is 20 years.
Moreover, as described below, the Sub-
lease also may be renewed for a term of 10
years ("put renewal term") at the option of
X. X's right to possess the property under

the Headlease for the first 20 years is sub-
stantially the same as FM's right to pos-
session under the Sublease for the primary
term.

The Headlease requires X to make two
rental payments to FM during its 40-year
term: (1) an $89 million prepayment at the
beginning of year 1; and (2) a postpay-
ment at the end of year 40 that has a dis-
counted present value of $8 million. For
federal income tax purposes, X and FM al-
locate the prepayment ratably to the first 6
years of the Headlease and the future value
of the postpayment ratably to the remain-
ing 34 years of the Headlease.

The Sublease requires FM to make fixed,
annual rental payments over both the pri-
mary term and, if exercised, the put re-
newal term. The fixed, annual payments
during the put renewal term are equal to 90
percent of the amounts that (as of Janu-
ary 1, 1997) are projected to be the fair
market value rental amounts for that term.

To partially fund the $89 million Head-
lease prepayment, X borrows $54 million
from BK1 and $6 million from BK2. Both
loans are nonrecourse, have fixed interest
rates, and provide for annual debt service
payments that fully amortize the loans over
the 20-year primary term of the Sublease.
The amount and timing of the debt ser-

vice payments mirror the amount and tim-
ing of the Sublease payments due during
the primary term of the Sublease. The re-
maining $29 million of the Headlease pre-
payment is provided by X.

Upon receiving the $89 million Head-
lease prepayment, FM deposits $54 mil-
lion into a deposit account with an affiliate
of BK1 and $6 million into a deposit ac-
count with an affiliate of BK2. The depos-
its with the affiliates of BK1 and BK2 earn
interest at the same rates as the loans from
BK1 and BK2. FM directs the affiliate of
BK1 to pay BK1 annual amounts equal to
90 percent of FM's annual rent obliga-
tion under the Sublease (that is, amounts
sufficient to satisfy X's debt service obli-
gation to BK1). The parties treat these
amounts as having been paid from the af-
filiate to FM, then from FM to X as rental
payments, and finally from X to BK1 as
debt service payments. In addition, FM
pledges the deposit account to X as secu-
rity for FM's obligations under the Sub-
lease, while X, in turn, pledges its interest
in FM's pledge to BKI as security for X's
obligations under the loan from BK1. Simi-
larly, FM directs the affiliate of BK2 to pay
BK2 annual amounts equal to 10 percent of
FM's annual rent obligation under the Sub-
lease (that is, amounts sufficient to sat-
isfy X's debt service obligation to BK2). The
parties treat these amounts as having been
paid from the affiliate to FM, then from FM
to X as rental payments, and finally from
X to BK2 as debt service payments. Al-
though FM's deposit with the BK2 affili-
ate is not pledged, the parties understand
that FM will use the account to pay the re-
maining 10 percent of FM's annual rent ob-
ligation under the Sublease.

As a result of the foregoing arrange-
ment, X's obligation to make the property
available under the 20-year primary term
of the Sublease is completely offset by X's
right to use the property under the Head-
lease. X's obligation to make debt service
payments on the loans from BK1 and BK2
is completely offset by X's right to re-
ceive Sublease rentals from FM. More-
over, X's exposure to the risk that FM will
not make the rent payments is further lim-
ited by the arrangements with the affili-
ates of BK1 and BK2. In the case of the
loan from BK1, X's economic risk is elimi-
nated through the defeasance arrangement.
In the case of the $6 million loan from BK2,
X's economic risk, although not elimi-

nated, is substantially reduced through the
deposit arrangement. As a result, neither
bank requires an independent source of
funds to make the loans, or bears signifi-
cant risk of nonpayment. In short, during
the primary Sublease term, the transac-
tion is characterized by reciprocal and cir-
cular obligations that offset one another.

At the end of the Sublease primary term,
FM has a fixed-payment option to pur-
chase from X the Headlease residual (the
right to use the property beyond the Sub-
lease primary term subject to the obliga-
tion to make the rent postpayment) for a
fixed exercise price equal to 105 percent of
the amount that (as of January 1, 1997) is
projected to be the future fair market value
of the Headlease residual. If FM exercises
the option, the transaction is terminated at
that point, and X receives the exercise price
of the option and is not required to make
any portion of the postpayment due un-
der the Headlease. If FM does not exer-
cise the option, X may elect to (1) use the
property itself for the remaining term of the
Headlease, (2) lease the property to an-
other person for the remaining term of the
Headlease, or (3) compel FM to lease the
property for the 10-year put renewal term
of the Sublease. If FM does not exercise the
fixed-payment option and X exercises its put
renewal option, X will receive rents that are
equal to 90 percent of the amounts that are
(as of January 1, 1997) projected to be the
fair market rents for that term. If the ac-
tual fair market rents in 20 years turn out
to be less than the amount specified in the
put renewal option and FM does not ex-
ercise the fixed-payment option, X will be
able to compel FM to lease the property for
rents that are greater than the then fair mar-
ket rental value. Thus, as a practical mat-
ter, the fixed-payment option and put
renewal option operate to "collar" the value
of the Headlease residual during the pri-
mary term.

In addition, X has nominal exposure to
FM's credit under the fixed-payment op-
tion and, if exercised, the put renewal term.
At the inception of the transaction, X re-
quires FM to invest $15 million of the
Headlease prepayment in highly-rated debt
securities that will mature in an amount suf-
ficient to fund the fixed amount due un-
der the fixed-payment option, and to pledge
these debt securities to X. This arrange-
ment ensures that FM is able to make the
payment under the fixed-payment option.

Having economically defeased both its
rental obligations under the Sublease and
its fixed-payment under the fixed-payment
option, FM keeps the remaining portion of
the Headlease prepayment as its return on
the transaction. If FM does not exercise the
fixed-payment option and X exercises the
put renewal option, X can require FM to
purchase a letter of credit guaranteeing the
put renewal rents. If FM does not obtain the
letter of credit, FM must exercise the fixed-
payment option.

For tax purposes, X claims deductions
for interest on the loans and for the allo-
cated rents on the Headlease. X includes in
gross income the rents received on the Sub-
lease. If the fixed-payment option is exer-
cised, X also includes the option price and
recaptures rent deductions taken during the
primary Sublease term that are attribut-
able to the postpayment it is no longer re-
quired to make.

## LAW AND ANALYSIS

X and FM's allocations of the prepay-
ment and the postpayment for federal in-
come tax purposes meet the uneven rent test
contained in proposed § 467 regulations
(§ 1.467-3(c)(2)(i)), and under those regu-
lations the Headlease would not be treated
as a disqualified leaseback or long-term
agreement subject to constant rental ac-
crual. Because this LILO transaction was
entered into after June 3, 1996, and on or
before May 18, 1999, the provisions of the
proposed regulations are available. See
§ 1.467-9(c). For later years, however, fi-
nal § 467 regulations effective May 18,
1999, treat the prepayment of rent as re-
sulting in a deemed loan from X to FM and
require the imputation of interest income to
X. § 1.467-4. Moreover, X's rent deduc-
tion would be subject to proportional rent
rules that reflect the time value of money
concept. See § 1.467-2(c).

The substance of a transaction, not its
form, governs its tax treatment. Gregory v.
Helvering, 293 U.S. 465 (1935). In Frank
Lyon Co. v. United States, 435 U.S. 561,
573 (1978), the United States Supreme
Court stated, "In applying the doctrine of
substance over form, the Court has looked
to the objective economic realities of a
transaction rather than to the particular form
the parties employed." The Court evalu-
ated the substance of the transaction in
Frank Lyon to determine that it was in-
deed a sale/leaseback, as it was structured,

rather than a financing. The Court subse-
quently relied on its approach in Frank Lyon
to recharacterize a sale and repurchase of
federal securities as a loan, finding that the
economic realities of the transaction did not
support the form chosen by the taxpayer.
Nebraska Dep't of Revenue v. Loewen-
stein, 513 U.S. 123 (1994).

Where parties have in form entered into
two separate transactions that result in off-
setting obligations, the courts often have
collapsed the offsetting obligations and re-
characterized the two transactions as a single
transaction. In Rogers v. United States, 281
F.3d 1108 (10th Cir. 2002), the part-owner
(Fogelman) of a professional baseball team
that was organized as an S corporation bor-
rowed money from the S corporation. The
nonrecourse loan was secured by Fogel-
man's ownership interest in the corpora-
tion and his existing option to purchase the
rest of the shares from the taxpayer (Kauff-
man), the other owner of the team. Fogel-
man also granted the corporation an option
to purchase both his shares and his exist-
ing option to buy Kauffman's shares. The
option price was an amount equal to the
outstanding loan balance. The corpora-
tion exercised its option immediately but de-
ferred closing until the due date of
Fogelman's loan, five months later. On that
date, Fogelman transferred his shares in the
corporation to the corporation in lieu of its
foreclosure on the loan. The corporation
claimed that the shares had no value at that
time and deducted the loan amount as a bad
debt, which was passed through to Kauff-
man.

The court in Rogers applied the sub-
stance over form doctrine to collapse the
loan and the option transaction into a re-
demption of Fogelman's stock in exchange
for cash. Fogelman had no incentive to re-
pay the loan because any reduction in the
loan balance would reduce the option price.
The immediate exercise of the option pre-
cluded any attempt by Fogelman to repay
the loan and keep the stock. On the basis
of those facts, among others, the court held
that the substance of the transaction was a
sale of Fogelman's stock to the corpora-
tion.

In Bussing v. Commissioner, 88 T.C. 449,
reconsideration denied, 89 T.C. 1050
(1987), a Swiss subsidiary of a computer
leasing company (AG) purchased com-
puter equipment in a sale/leaseback trans-
action involving a five-year lease.

Subsequently, AG purportedly sold the
equipment to a domestic corporation
(Sutton), which in turn purportedly sold in-
terests in the equipment to the taxpayer
(Bussing) and four other individual inves-
tors. Bussing acquired his interest in the
computer equipment subject to the under-
lying lease by paying cash, short-term
promissory notes, and a long-term prom-
issory note to Sutton. Bussing then leased
his interest in the equipment back to AG for
nine years. The rents due Bussing from AG
equaled Bussing's annual payments on the
long-term promissory note to Sutton for the
first three years and were supposed to gen-
erate nominal annual cash flow thereaf-
ter.

The court first disregarded Sutton's par-
ticipation in the transactions on substance
over form grounds. It then held that
Bussing's long-term indebtedness also must
be disregarded because it was completely
offset by AG's rent payments in a "pur-
ported sale-leaseback pursuant to which the
respective lease and debt obligations flow
between only two parties." Id. at 458. The
court stated,

The respective obligations between AG
and Bussing cancel each other out. Any
possible claim by AG with respect to the
note is fully offset by AG's rental obli-
gation to Bussing. .. . Bussing, effec-
tively, will never be required to make any
payments on his debt obligation, a fea-
ture of the transaction that we believe the
parties intended to achieve.

Id. After collapsing the offsetting loan and
lease, the court concluded that Bussing had
acquired an interest in a joint venture with
AG and the other investors to the extent of
his cash payment only.

Courts have similarly disregarded the
parties' obligations in purported install-
ment sales where the taxpayer received an
installment note that was offset by some
other arrangement between the two par-
ties, indicating that the maker of the note
would not be called upon to pay the in-
stallment obligation. See Rickey v. Com-
missioner, 502 F.2d 748 (9th Cir. 1974),
aff'g 54 T.C. 680 (1970). Although tax-
payers are entitled to arrange the terms of
a sale in order to qualify for the install-
ment method, "the arrangements must have
substance and must reflect the true situa-
tion rather than being merely the formal
documentation of the terms of the sale." Id.
at 752-53, quoting 54 T.C. 680 at 694. See

also United States v. Ingalls, 399 F.2d 143
(5th Cir. 1968); Blue Flame Gas Co. v.
Commissioner, 54 T.C. 584 (1970); Green-
field v. Commissioner, T.C. Memo. 1982-
617; Big "D" Development Corp. v.
Commissioner, T.C. Memo. 1971-148, aff'd
per curiam, 453 F.2d 1365 (5th Cir.1972).

Similarly, the Headlease and Sublease
impose offsetting obligations that must be
disregarded, regardless of whether other
components of the LILO transaction are re-
spected. During the first 20 years of its
term, the Headlease confers to X a right to
use the property that is immediately re-
versed by the Sublease grant to FM of sub-
stantially the same right to use property. In
the LILO transaction, the Sublease inter-
est retained by FM is of the same nature
as the Headlease interest conveyed to X. Be-
cause the transfer and retransfer of the right
to possess the property for the first 20 years
are disregarded as offsetting obligations, the
transaction that remains is, at best, a trans-
fer of funds from X to FM in exchange for
FM's obligation to repay those funds and
provide X the right to begin to lease the
property in 20 years.

An analogous situation occurs when the
conveyance of property is accompanied by
the retention of some interest in the same
property. If the interest retained is of sub-
stantially the same nature as the interest
conveyed, only a future interest is con-
veyed. In McCully Ashlock v. Commis-
sioner, 18 T.C. 405 (1952), acq., 1952-2
C.B. 1, taxpayer had acquired property
through a deed dated June 6, 1945. The
seller, however, had retained the right to
possession and rentals through August 15,
1947. The court found that taxpayer had ac-
quired only a future interest in the prop-
erty because "the trustees [sellers] not only
retained the rents legally but they also re-
tained control and benefits of ownership."
Id. at 411. Consequently, rentals from the
property were income to the seller.

Similarly, in Kruesel v. United States,
63-2 U.S. Tax Cas. (CCH) 1 9714 (D.
Minn. 1963), the court concluded that tax-
payer had transferred only a future, re-
mainder interest in property and reserved
a life estate. The government had unsuc-
cessfully argued that taxpayer had sold its
entire interest in the property and the tax-
payer's amount realized on the sale in-
cluded the value of a right to occupancy
provided to the taxpayer by the buyer.

In contrast, in Alstores Realty Corp. v.
Commissioner, 46 T.C. 363 (1966), acq.,
1967-2 C.B.1, the court held that a sale of
property accompanied by the reservation of
a right of occupancy did not result in the
transfer of only a future interest because the
seller's right of occupancy was in the na-
ture of a leasehold interest, because the pur-
chaser acquired the benefits and burdens of
ownership of the property.

Alstores can be distinguished from
McCully Ashlock and Kruesel. McCully
Ashlock and Kruesel conclude that where
a retained interest is of the same nature as
the interest conveyed, only a future inter-
est has been transferred. In Alstores, the in-
terests were not of the same nature.

Similarly, the LILO transaction is dis-
tinguishable from the transaction involved
in Comdisco, Inc. v. Commissioner, 756
F.2d 569 (7th Cir. 1985). In that case, equip-
ment was subject to end user leases, and the
lessor of that equipment assigned an inter-
est to taxpayer in a transaction designed to
give the taxpayer investment tax credits. The
taxpayer's entitlement to the credits de-
pended on whether it had the status of
lessee/sublessor. In concluding that it did,
the court noted a number of factors that
supported taxpayer's claim that it had ac-
quired a leasehold interest. The taxpayer
was obligated to the lessor in the event of
a default by the sublessee. The taxpayer re-
let certain equipment after one sublease had
expired. In connection with another sub-
lease, the taxpayer was responsible for rent
to its assignor in excess of amounts paid by
the sublessee directly to the assignor. The
court also emphasized the regulatory re-
strictions on direct leases between the as-
signor and the end users. Id. at 576-77.
Unlike Comdisco, in the LILO transac-
tion the headlessor and the sublessee are the
same party. Further, in the LILO transac-
tion the headlessee/sublessor is not mate-
rially exposed to the risk that the sublessee
will fail to make rent payments.

Section 162(a)(3) permits a deduction for
rentals and other payments required to be
made as a condition to the continued use
or possession, for purposes of the trade or
business, of property. Because X does not
acquire a current leasehold interest in the
property, it is not entitled to current de-
ductions for rent. The $29 million "eq-
uity" portion of the Headlease prepayment
is, effectively, a payment for at most X's
right under the Headlease to lease the prop-

erty 20 years hence for a term of 20 years.
(Economically, $29 million is an overpay-
ment for the value of any right that X ob-
tains to lease the property in the future. X
was willing to overpay in this manner, how-
ever, in order to induce FM to participate
in the transaction.). In accordance with
§ 467, the $29 million "equity" portion of
the Headlease prepayment is deductible over
the 20-year residual term of the Head-
lease (the 10-year put renewal term and the
10-year "shirttail" period). Alternatively, in
the event FM exercises its fixed-price op-
tion at the end of the primary term of the
Sublease, X will have gain or loss equal to
the difference between the option price and
X's cost of acquiring a right to the Head-
lease residual term. Section 1001.

The remainder of the Headlease pre-
payment, $60 million, must be disregarded,
because the "loans" that purportedly fi-
nance this portion of the Headlease pre-
payment are without substance. In Bridges
v. Commissioner, 39 T.C. 1064, aff'd 325
F.2d 180 (4th Cir. 1963), taxpayer "bor-
rowed" funds from banks and used the
funds to purchase Treasury notes, which the
banks held as collateral and ultimately sold
to satisfy taxpayer's debts. The court's ra-
tionale for disallowing taxpayer's deduc-
tions of prepaid interest is equally applicable
here:

[P]etitioner at no time had the uncon-
trolled use of any additional money, of the
bonds, or of the interest on the bonds. He
assumed no risk of a rise or fall in the
market price of the bonds and could not
take advantage of such. His payment to
the bank was not for the use or forbear-
ance of money; it was for the purchase
of a rigged sales price for the bonds and
for a tax deduction. Petitioner incurred no
genuine indebtedness, within the mean-
ing of the statute, and as a payment of in-
terest, this transaction was also a sham.
Id. at 1078-79. Neither X nor FM obtain
use of the "borrowed" funds. The "loans"
purportedly are made to finance X's acqui-
sition of the Headlease interest. But that
leasehold interest is substantially offset by
an interdependent Sublease with the Head-
lessor. What remains can only be enjoyed
after 20 years and after the loans have been
"repaid" using "rents" from a Sublease that
itself lacks substance. Under the circum-
stances, the loans are disregarded.

Although this ruling refers to a for-
eign municipality and its property, the analy-

sis and holding apply as well to LILO
transactions that involve or include domes-
tic tax-exempt or tax-indifferent entities.

HOLDING

A taxpayer may not deduct currently, un-
der §§ 162 and 163, rent or interest paid or
incurred in connection with a LILO trans-
action that properly is characterized as con-
ferring only a future interest in property.

Where appropriate, the Service will con-
tinue to disallow the tax benefits claimed
in connection with LILO transactions upon
other grounds, including that the substance
over form doctrine requires their rechar-
acterization as financing arrangements and
that they are to be disregarded for lack of
economic substance.

## EFFECT ON OTHER DOCUMENTS

Rev. Rul. 99-14, 1999-1 C.B. 835, is
modified and superseded.

### DRAFTING INFORMATION

The principal author of this revenue rul-
ing is John Aramburu of the Office of As-
sociate Chief Counsel (Income Tax &
Accounting). For further information re-
garding this revenue ruling, contact Mr.
Aramburu at (202) 622-4960 (not a toll-
free call).

### Section 163 .- Interest

26 CFR 1.162-17: Interest deduction in general.

May a taxpayer deduct currently, under § 163, in-
terest paid or incurred in connection with a lease-in/
lease-out (LILO) transaction that properly is
characterized as conferring only a future interest in
property. See Rev. Rul. 2002-69, page 760.

#### Section 446 .- General Rule for Methods of Accounting

(Also 26 CFR 1.446-4)

Notional principal contract (NPC).
This ruling provides guidance on the tim-
ing of recognition of gain or loss on the ter-
mination of a notional principal contract that
hedges a portion of the term of a debt in-
strument issued by the taxpayer.

##### ISSUE

When should a taxpayer take into ac-
count gain or loss on the termination of a
notional principal contract (NPC) that
hedges a portion of the term of a debt in-
strument issued by the taxpayer?

##### FACTS

###### Situation 1

Taxpayer TP uses the calendar year as
its taxable year. On the first day of Year 1,
TP issues a debt instrument. The debt in-
strument has a 10-year term and provides
for interest to be paid annually at a fixed
rate. Contemporaneously with the issu-
ance of the debt instrument, TP also en-
ters into an NPC with a 5-year term that
converts the fixed rate payments under the
debt instrument into floating rate payments.
That is, the NPC provides for TP to re-
ceive payments equal to the product of the
fixed rate on the debt instrument and a no-
tional amount equal to the principal amount
of the debt instrument in exchange for pay-
ments by TP equal to the product of a float-
ing rate and the same notional amount.
Pursuant to § 1.1221-2(f), TP properly iden-
tifies the NPC as a hedging transaction cov-
ering Year 1 through Year 5 of the debt
instrument and complies with the other re-
quirements necessary for the NPC to be
treated as a hedge under §§ 1.1221-2 and
1.446-4. TP terminates the NPC on the last
day of Year 2 and either receives or makes
a termination payment.

###### Situation 2

The facts are the same as Situation 1,
but, in addition, TP retires the debt instru-
ment in Year 4.

##### LAW

Section 1.446-4(a) provides that a hedg-
ing transaction as defined in § 1.1221-
2(b) must be accounted for under the rules
set forth in § 1.446-4.

Section 1.446-4(b) provides that the
method of accounting used by a taxpayer

for a hedging transaction must clearly re-
flect income. Section 1.446-4(b) further
provides that to clearly reflect income, the
method used for a hedging transaction must
reasonably match the timing of income, de-
duction, gain, or loss from the hedging
transaction with the timing of income, de-
duction, gain, or loss from the item being
hedged.

Section 1.446-4(e)(4) provides that gain
or loss from a transaction that hedges a debt
instrument issued or to be issued by a tax-
payer, or a debt instrument held or to be
held by a taxpayer, must be accounted for
by reference to the terms of the debt in-
strument and the period or periods to which
the hedge relates. A hedge of an instru-
ment that provides for interest to be paid
at a fixed rate or a qualified floating rate,
for example, generally is accounted for us-
ing constant yield principles. Thus, assum-
ing that a fixed rate or qualified floating rate
instrument remains outstanding, hedging
gain or loss is taken into account in the
same periods in which it would be taken
into account if it adjusted the yield of the
instrument over the term to which the hedge
relates. Section 1.446-4(e)(4) provides, as
an example, that gain or loss realized on a
transaction that hedged an anticipated fixed
rate borrowing for its entire term is ac-
counted for, solely for purposes of
§ 1.446-4, as if it decreased or increased
the issue price of the debt instrument. How-
ever, in all events, the taxpayer's method,
as actually applied to the taxpayer's hedg-
ing transactions, must clearly reflect in-
come by meeting the matching requirement
of § 1.446-4(b). See § 1.446-4(e) (intro-
ductory sentences).

##### ANALYSIS

###### Situation 1

Unlike the hedging transaction described
in § 1.446-4(e)(4) that hedges a fixed rate
borrowing over its entire term, TP's NPC
does not hedge the entire term of the debt
instrument. Rather, TP's NPC hedges, and
relates only to, Year 1 through Year 5 of the
10-year term of the debt instrument. Prior
to its termination on the last day of Year 2,
the NPC would have continued to hedge
Year 3 through Year 5 of the debt instru-

ment, and TP generally would have been
required to take into account the remain-
ing income, deduction, gain, or loss over
the period from Year 3 through Year 5. The
termination payment made or received by
TP represents the present value of the ex-
tinguished rights and obligations under the
NPC for Year 3 through Year 5. There-
fore, the gain or loss from the hedging
transaction relates to Year 3 through Year
5. To clearly reflect income in accordance
with the matching requirement of § 1.446-
4(b), TP must take into account the gain or
loss from terminating the NPC over the pe-
riod from Year 3 through Year 5.

###### Situation 2

Following the analysis from Situation 1,
TP would have already taken into account
in Year 3 a portion of the gain or loss from
termination of the NPC in Year 2. How-
ever, upon retiring the debt instrument in
Year 4, TP's remaining gain or loss from
the termination of the NPC should be rec-
ognized in order to match the timing of in-
come, deduction, gain, or loss from the
hedging transaction with the timing of in-
come, deduction, gain, or loss from the item
being hedged.

###### HOLDING

(1) In Situation 1, TP must account for
the gain or loss arising from terminating the
NPC over the period from Year 3 through
Year 5, the remaining period to which the
terminated hedge relates.

(2) In Situation 2, TP takes into ac-
count in Year 3 a portion of the gain or loss
arising from the termination of the NPC and
takes into account in Year 4 the remain-
ing balance of the gain or loss from the ter-
minated hedge.

##### DRAFTING INFORMATION

The principal authors of this revenue rul-
ing are K. Scott Brown and Clay
Littlefield of the Office of Associate Chief
Counsel (Financial Institutions and Prod-
ucts). For further information regarding this
revenue ruling, contact Messrs. Brown or
Littlefield at (202) 622-3920 (not a toll-
free call).

# Part III. Administrative, Procedural, and Miscellaneous

## Certain Reinsurance Arrangements

### Notice 2002-70

The Internal Revenue Service and Trea-
sury Department have become aware of a
type of transaction, described below, that
is being used by taxpayers to shift income
from taxpayers to related companies pur-
ported to be insurance companies that are
subject to little or no U.S. federal income
tax. This notice alerts taxpayers and their
representatives that these transactions of-
ten do not generate the federal tax ben-
efits that taxpayers claim are allowable for
federal income tax purposes. This notice
also alerts taxpayers, their representatives,
and promoters of these transactions, to cer-
tain reporting and record keeping obliga-
tions and penalties that they may be subject
to with respect to these transactions.

The transaction generally involves a tax-
payer ("Taxpayer") (typically a service pro-
vider, automobile dealer, lender, or retailer)
that offers its customers the opportunity to
purchase an insurance contract through Tax-
payer in connection with the products or
services being sold. The insurance pro-
vides coverage for repair or replacement
costs if the product breaks down or is lost,
stolen, or damaged, or coverage for the cus-
tomer's payment obligations in case the cus-
tomer dies, or becomes disabled or
unemployed.

Taxpayer offers the insurance to its cus-
tomers by acting as an insurance agent for
an unrelated insurance company ("Com-
pany X"). Taxpayer receives a sales com-
mission from Company X equal to a
percentage of the premiums paid by Tax-
payer's customers. Taxpayer forms a
wholly-owned corporation ("Company Y"),
typically in a foreign country, to reinsure
the policies sold by Taxpayer. Promoters
sometimes refer to these companies as pro-
ducer owned reinsurance companies or
"PORCs". If Company Y is a foreign cor-
poration, it typically elects to be treated as
a domestic insurance company under
§ 953(d) of the Internal Revenue Code.
Company Y takes the position that it is en-
titled to the benefits of § 501(c)(15) (pro-
viding that non-life insurance companies are
tax exempt if premiums written for the tax-

able year do not exceed $350,000), § 806
(providing a deduction for certain life in-
surance companies with life insurance com-
pany taxable income not in excess of
$15,000,000), or § 831(b) (allowing quali-
fying non-life insurance companies whose
net written premiums are between $350,000
and $1,200,000 to elect to be taxed solely
on investment income).

Taxpayer receives premiums from its
customers and remits those premiums (typi-
cally net of its sales commission) to Com-
pany X. Company X pays any claims and
state premium taxes due and retains an
amount from the premiums received from
Taxpayer. Under Company Y's reinsur-
ance agreement with Company X, Com-
pany Y reinsures all insurance policies that
Taxpayer sells to its customers. Company
X transfers the remainder of the premi-
ums to Company Y as reinsurance premi-
ums.

### ANALYSIS

Many of the transactions described in
this notice have been designed to use a re-
insurance arrangement to divert income
properly attributable to Taxpayer to Com-
pany Y, Taxpayer's wholly-owned reinsur-
ance company that is subject to little or no
federal income tax. The Service intends to
challenge the purported tax benefits from
these transactions on a number of grounds.

First, depending upon the facts and cir-
cumstances, the Service may assert that
Company Y is not an insurance company
for federal income tax purposes. For fed-
eral income tax purposes, an insurance com-
pany is a company whose primary and
predominant business activity during the
taxable year is the issuing of insurance or
annuity contracts or the reinsuring of risks
underwritten by insurance companies.
§ 1.801-3(a) of the Income Tax Regula-
tions; § 816(a) (which provides that a com-
pany will be treated as an insurance
company for federal income tax purposes
only if "more than half of the business" of
that company is the issuing of insurance or
annuity contracts or the reinsuring of risks
underwritten by insurance companies).
While a taxpayer's name, charter powers,
and state regulation help to indicate the ac-
tivities in which it may properly engage,
whether the taxpayer qualifies as an insur-
ance company for tax purposes depends on

its actual activities during the year. Inter-
American Life Ins. Co. v. Commissioner, 56
T.C. 497, 506-08 (1971), aff'd per cu-
riam, 469 F.2d 697 (9th Cir. 1972) (tax-
payer whose predominant source of income
was from investments did not qualify as an
insurance company); see also Bowers v.
Lawyers Mortgage Co., 285 U.S. 182, 188
(1932). To qualify as an insurance com-
pany, a taxpayer "must use its capital and
efforts primarily in earning income from the
issuance of contracts of insurance." In-
dus. Life Ins. Co. v. United States, 344 F.
Supp. 870, 877 (D. S.C. 1972), aff'd per
curiam, 481 F.2d 609 (4th Cir. 1973). To
determine whether Company Y qualifies as
an insurance company, all of the relevant
facts will be considered, including but not
limited to, the size and activities of any
staff, whether Company Y engages in other
trades or businesses, and its sources of in-
come. See generally Lawyers Mortgage Co.
at 188-90; Indus. Life Ins. Co., at 875-
77; Cardinal Life Ins. Co. v. United States,
300 F. Supp. 387, 391-92 (N.D. Tex. 1969),
rev'd on other grounds, 425 F. 2d 1328 (5th
Cir. 1970); Serv. Life Ins. Co. v. United
States, 189 F. Supp. 282, 285-86 (D. Neb.
1960), aff'd on other grounds, 293 F.2d 72
(8th Cir. 1961); Inter-Am. Life Ins. Co., at
506-08 ; Nat'l. Capital Ins. Co. of the Dist.
of Columbia v. Commissioner, 28 B.T.A.
1079, 1085-86 (1933).

If Company Y is not an insurance com-
pany, it is not entitled to the benefits of
§§ 501(c)(15), 806, or 831(b). Further, if
Company Y is a foreign corporation and is
not an insurance company, any election
Company Y made under § 953(d) is not
valid and Company Y will be treated as a
controlled foreign corporation as defined in
§ 957. In such a case, Taxpayer will be
treated as a U.S. shareholder of Company
Y and generally will include in its gross in-
come on a current basis any subpart F in-
come of Company Y. See § 951(a) and (b).
In addition, Company Y will not qualify for
the exceptions from subpart F income un-
der §§ 953(a)(2) and 954(i) for certain in-
surance income because those exceptions
are only available to a foreign corpora-
tion that, among other requirements, is en-
gaged in the insurance business and would
be subject to tax under subchapter L if such
corporation were a domestic corporation.
See § 953(e)(3)(C).

Second, the Service may apply §§ 482
or 845 to allocate income from Company
Y to Taxpayer if necessary clearly to re-
flect the income of Taxpayer and Com-
pany Y. Section 482 provides the Secretary
with authority to allocate gross income, de-
ductions, credits or allowances among per-
sons owned or controlled directly or
indirectly by the same interests, if such al-
location is necessary to prevent evasion of
taxes or clearly to reflect income. The § 482
regulations provide that in determining the
taxable income of a controlled person, the
standard to be applied is that of a person
dealing at arm's length with an uncon-
trolled person. § 1.482-1(b)(1). Section 482
may apply to a transaction between two or
more controlled persons notwithstanding
that an uncontrolled person participates in
the transaction as an intermediary. See GAC
Produce Co. v. Commissioner, T.C.M.
1999-134. If, as a result of the reinsur-
ance transaction, Taxpayer's income is not
consistent with the arm's length standard,
then § 482 authorizes the Secretary to al-
locate income from Company Y to Tax-
payer. Section 845(a) allows the Service to
reallocate income, deductions, assets, re-
serves, credits, and other items between two
or more related parties who are parties to
a reinsurance agreement. Thus, such items
may be reallocated from Company Y to
Taxpayer under the authority of § 845(a).

Third, in appropriate cases, the Ser-
vice may disregard the insurance and re-
insurance arrangements, and thereby require
Taxpayer to recognize an additional por-
tion of premiums received from its cus-
tomers as its income, if the arrangements
are shams in fact or shams in substance. See
Kirchman v. Commissioner, 862 F.2d 1486,
1492 (11th Cir. 1989). Courts have distin-
guished between "shams in fact" where the
reported transactions never occurred and
"shams in substance" which actually oc-
curred but lack the substance their form rep-
resents. ACM Partnership v. Commissioner,
157 F.3d 231, 247 n. 30 (3ª Cir. 1998), cert.
denied, 526 U.S. 1017 (2002) (citations
omitted). In determining whether a trans-
action constitutes a sham in substance, both
a majority of the Courts of Appeals and the
Tax Court consider two related factors, eco-
nomic substance apart from tax conse-
quences, and business purpose. See ACM
Partnership; Karr v. Commissioner, 924
F.2d 1018, 1023 (11th Cir. 1991), cert. de-
nied, 502 U.S. 1082 (1992); James v. Com-

missioner, 899 F.2d 905, 908-09 (10th Cir.
1990); Shriver v. Commissioner, 899 F.2d
724, 727 (8th Cir. 1990); Rose v. Commis-
sioner, 868 F.2d 851, 853 (6th Cir. 1989);
Kirchman. Although a taxpayer has the right
to arrange its affairs to reduce its tax li-
ability, the substance of a transaction must
govern its tax consequences regardless of
the form in which the transaction is cast.
See Gregory v. Helvering, 293 U.S. 465,
469 (1935). If the transactions involving
Taxpayer, Company X, and Company Y are
disregarded, the income of Company Y is
income of Taxpayer. See Wright v. Com-
missioner, T.C.M. 1993-328.

Transactions that are the same as, or sub-
stantially similar to, the transaction de-
scribed in this notice that involve taxpayers
claiming entitlement to the benefits of
§§ 501(c)(15), 806, or 831(b) are identi-
fied as "listed transactions" for purposes of
§ 1.6011-4T(b)(2) of the temporary In-
come Tax Regulations and § 301.6111-
2T(b)(2) of the temporary Procedure and
Administration Regulations. See also
§ 301.6112-1T, A-4. Independent of their
classification as "listed transactions" for pur-
poses of §§ 1.6011-4T(b)(2) and 301.6111-
2T(b)(2), transactions that are the same as,
or substantially similar to, the transaction
described in this notice may already be sub-
ject to the disclosure requirements of
§ 6011, the tax shelter registration require-
ments of § 6111, or the list maintenance re-
quirements of § 6112 (§§ 1.6011-4T,
301.6111-1T, 301.6111-2T and 301.6112-
1T, A-3 and A-4).

Persons who are required to satisfy the
registration requirement of § 6111 with re-
spect to the transactions described in this
notice and who fail to do so may be sub-
ject to the penalty under § 6707(a). Per-
sons who are required to satisfy the list-
keeping requirement of § 6112 with respect
to the transactions described in this no-
tice and who fail to do so may be subject
to the penalty under § 6708(a). In addi-
tion, the Service may impose penalties on
participants in these transactions or sub-
stantially similar transactions involving tax-
payers claiming entitlement to the benefits
of §§ 501(c)(15), 806, or 831(b) or, as ap-
plicable, on persons who participate in the
promotion or reporting of such transac-
tions, including the accuracy-related pen-
alty under § 6662, the return preparer
penalty under § 6694, the promoter pen-

alty under § 6700, and the aiding and abet-
ting penalty under § 6701.

The principal authors of this notice are
John Glover of the Office of Associate
Chief Counsel (Financial Institutions and
Products) and Theodore Setzer and Sheila
Ramaswamy of the Office of Associate
Chief Counsel (International). For further
information regarding this notice, contact
Mr. Glover at (202) 622-3970 or
Mr. Setzer or Ms. Ramaswamy (202) 622-
3870 (not a toll-free call).

## Part IV. Items of General Interest

Notice of Proposed
Rulemaking and Notice of
Public Hearing

Electing Mark to Market for
Marketable Stock

REG-112306-00

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Notice of proposed
rulemaking and notice of public hearing.

SUMMARY: This document contains pro-
cedures for certain United States persons
holding marketable stock in a passive for-
eign investment company (PFIC) to elect
mark to market treatment for that stock un-
der section 1296 and related provisions of
sections 1291 and 1295. These proposed
regulations affect United States persons
owning marketable stock in a PFIC. This
document also provides notice of a pub-
lic hearing on these proposed regulations.

DATES: Written comments and outlines of
oral comments to be presented at the pub-
lic hearing scheduled for November 6, 2002,
at 10 a.m., must be received by October 16,
2002.

ADDRESSES: Send submissions to:
CC:IT&A:RU (REG-112306-00), room
5226, Internal Revenue Service, POB 7604,
Ben Franklin Station, Washington, DC
20044. In the alternative, submissions may
be hand delivered between the hours of
8 a.m. and 5 p.m. to: CC:IT&A:RU (REG-
112306-00), Courier's Desk, Internal Rev-
enue Building, 1111 Constitution Avenue,
NW, Washington, DC. Alternatively, tax-
payers may submit comments electroni-
cally directly to the IRS Internet site at:
www.irs.gov/regs. The public hearing will
be held in room 4718, Internal Revenue
Service Building, 1111 Consitiution Av-
enue, NW, Washington, DC.

FOR FURTHER INFORMATION
CONTACT: Concerning the regulations,
Mark Pollard at (202) 622-3850, concern-
ing submissions and the hearing, Ms. Lanita

Vandyke (202) 622-7180 (not toll-free num-
bers).

SUPPLEMENTARY INFORMATION:

### Background

Since the enactment of the Tax Reform
Act of 1986, United States persons that own
PFIC stock have been subject to two al-
ternative tax regimes: the interest charge
rules under section 1291 of the Internal
Revenue Code (Code) and the qualified
electing fund (QEF) rules under section
1293. Congress recognized that the inter-
est charge rules are a substantial source of
complexity for PFIC shareholders and that
some shareholders would prefer the cur-
rent inclusion method afforded by the QEF
regime, but are unable to obtain the nec-
essary information from the PFIC. See H.R.
Rep. No. 105-148, at 533 (1997); S. Rep.
No. 105-33 at 94 (1997). Accordingly, Con-
gress enacted new section 1296 in the Tax-
payer Relief Act of 1997 to provide
shareholders with an alternative method to
include income currently with respect to
their interest in a PFIC by allowing them
to elect to mark to market their PFIC stock
provided the stock is marketable. In 1998,
Congress enacted certain technical correc-
tions to section 1296 and related provi-
sions, including rules to address the overlap
between the PFIC and other mark to mar-
ket provisions in the Code. IRS Restruc-
turing and Reform Act of 1998, section
6011(c).

Proposed § 1.1291-8 (INTL-656-87,
1992-1 C.B. 1124) had been published on
April 1, 1992 (57 FR 11024). This pro-
posed regulation would have provided an
election for certain regulated investment
companies (RICs) to use a mark to mar-
ket method for their PFIC stock. Although
§ 1.1291-8 was originally proposed to be
effective prospectively, the IRS subse-
quently notified taxpayers that the pro-
posed regulations, when finalized, would
permit this limited mark to market elec-
tion to be made only for taxable years end-
ing after March 31, 1992, and before April
1, 1993. Notice 92-53, 1992-2 C.B. 384.
As a result of the enactment of section
1296, proposed § 1.1291-8 was withdrawn
(64 FR 5015); see also Notice 99-14,
1999-1 C.B. 736.

On January 25, 2000, final regulations
were published under section 1296(e) (2000
final regulations). T.D. 8867, 2000-1 C.B.
620 [65 FR 3817]. The 2000 final regula-
tions provide guidance regarding the defi-
nition of marketable stock for purposes of
section 1296.

#### In General

United States persons who own market-
able stock (as defined in section 1296(e))
in a PFIC may elect to mark to market that
stock annually pursuant to section 1296
(section 1296 election). United States per-
sons making a section 1296 election with
respect to PFIC stock (section 1296 stock)
are not subject to the generally applicable
interest charge regime of section 1291. The
section 1296 election is available to United
States persons and controlled foreign cor-
porations (CFCs) that own, or are treated
as owning, marketable stock in a PFIC.

### Explanation of Provisions

A. Changes to Proposed § 1.1291-1(c):
Coordination of PFIC Rules and other
Mark to Market Provisions

Except for the coordination rules dis-
cussed herein, section 1291(d)(1) provides
that the interest charge regime does not ap-
ply in the case of PFIC stock that is marked
to market under (i) section 1296, or (ii) sec-
tion 475 or any other provision of chap-
ter 1 of the Code. This regulation revises
§ 1.1291-1(c), 57 FR 11024, proposed April
1, 1992, to incorporate this coordination rule
and to clarify that the interest charge re-
gime does not apply to a United States per-
son that marks to market its PFIC stock
under any provision of chapter 1 of the
Code, without regard to whether such re-
gime is mandatory or elective. Proposed
§ 1.1295-1(i)(3) and proposed § 1.1296-
1(h)(3)(i) further clarify that, with respect
to taxation under a mark to market provi-
sion other than under section 1296, this co-
ordination rule applies without regard to
whether the taxpayer also has made a sec-
tion 1296 election or a QEF election with
respect to such stock, by providing that ei-
ther election is automatically terminated im-
mediately following the close of the
taxpayer's taxable year preceding the first
taxable year for which the stock of the PFIC

is subject to the mark to market regime un-
der another provision of chapter 1 of the
Code.

The proposed regulations also provide
a special rule for situations where a tax-
payer owns PFIC stock that becomes sub-
ject to a mark to market regime other than
section 1296 after the first taxable year of
the taxpayer's holding period. In such in-
stances, the taxpayer must apply the coor-
dination rules of § 1.1291-1(c)(3)(ii) for the
first taxable year that such other mark to
market regime applies. Thereafter, the gen-
eral rule above, overriding the applica-
tion of the section 1291, QEF and PFIC
mark to market regimes, applies for all sub-
sequent taxable years provided that the
PFIC stock continues to be marked to mar-
ket under another provision of chapter 1 of
the Code.

B. Changes to § 1.1295-1

#### 1. Revocation of QEF election

The proposed regulations also provide
guidance on the coordination of the mark
to market provisions under section 1296
with the existing rules for QEFs. In gen-
eral, the Service considered the circum-
stances in which a taxpayer would be
permitted to switch from one regime to an-
other in light of the relative administra-
tive burdens imposed under each set of
rules, and the stated intent of Congress that
one of the purposes for enacting section
1296 was to provide another alternative to
the interest charge rules of section 1291 that
would be available in instances where tax-
payers cannot obtain sufficient informa-
tion to make a QEF election. See H.R. Rep.
No. 105-148, at 533 (1997); S. Rep. No.
105-33 at 94 (1997). Accordingly, the pro-
posed regulations are structured to facili-
tate an election for mark to market treatment
by permitting a taxpayer with an existing
QEF election to make a section 1296 elec-
tion and terminate the existing QEF elec-
tion without requiring consent of the
Commissioner. In instances where a tax-
payer has an existing section 1296 elec-
tion, it is permitted to make a QEF election
only if the section 1296 election is termi-
nated as provided by section 1296 and the
regulations thereunder (e.g., if the PFIC
stock ceases to be marketable) or is re-
voked with consent of the Commissioner.

#### 2. Re-election of QEF regime

The proposed regulations further pro-
vide that if the section 1296 election is sub-
sequently terminated or revoked, other than
because the taxpayer marks to market un-
der another provision of the Code, (e.g., be-
cause the stock is no longer marketable),
the shareholder will be subject to tax un-
der section 1291, unless a new QEF elec-
tion is made. Section 1.1295-1(i)(4)
currently provides that without the Com-
missioner's consent, a shareholder whose
QEF election was invalidated, terminated,
or revoked may not make a new QEF elec-
tion with respect to the PFIC before the
sixth taxable year ending after the tax-
able year in which the invalidation, termi-
nation, or revocation became effective. The
regulations propose to amend § 1.1295-
1(i) to provide an exception for situations
where a United States person's QEF elec-
tion was terminated because it elected to
mark to market such stock under section
1296, and the 1296 election was subse-
quently terminated because the stock ceased
to be marketable. A similar exception is pro-
vided for situations where a United States
person's QEF election is terminated be-
cause its PFIC stock is marked to market
under another provision of chapter 1 of the
Code, and such provision subsequently
ceases to apply. In either circumstance, con-
sent of the Commissioner will not be re-
quired for the United States person to re-
elect QEF status prior to the sixth taxable
year ending after the taxable year that its
QEF election was terminated. In situa-
tions where a QEF election is terminated
because a United States person makes a sec-
tion 1296 election, and then this election ter-
minates for some reason other than the
stock ceasing to be marketable (e.g., pur-
suant to the consent of the Commissioner
under proposed § 1.1296-1(h)(3)(A)), a tax-
payer may request consent under § 1.1295-
1(i) to make a new QEF election prior to
such sixth taxable year.

Special issues arise in situations where
a taxpayer makes a QEF election with re-
spect to stock that was previously marked
to market under section 1296 (or where a
taxpayer re-elects QEF treatment after a ter-
mination of mark-to-market treatment). In
such situations, the taxpayer shifts from an-
nual inclusions under the mark to market
rules that are based on the amount of un-
realized gain (or loss) in the stock of the
PFIC, to annual inclusions of a pro rata

share of the ordinary earnings and long-
term capital gain of a PFIC under the QEF
rules. For example, unrealized items that
were reflected in annual mark to market in-
clusions could be taken into account sub-
sequently under the QEF rules when
realized. These issues presently are ad-
dressed through the respective basis ad-
justments provided for under the QEF and
mark to market rules. See sections 1293(d)
and 1296(b). Comments are requested on
possible alternative approaches for address-
ing this situation with a view toward en-
suring administrability and avoiding
additional complexity.

#### C. Addition of § 1.1296-1

##### 1. Effect of election

The proposed regulations provide that,
on the last day of a taxable year to which
a section 1296 election applies, the United
States person recognizes gain to the ex-
tent that the fair market value of section
1296 stock exceeds its adjusted basis. Any
such gain shall be treated as ordinary in-
come. To the extent that the adjusted ba-
sis of section 1296 stock exceeds its fair
market value, the United States person may
take a deduction equal to the lesser of the
amount of such excess or the unreversed in-
clusions with respect to such stock. Any
such deduction will be treated as an ordi-
nary loss.

Under former proposed § 1.1291-8, cer-
tain RICs were permitted to mark to mar-
ket PFIC stock. For RICs that elect to mark
to market their PFIC stock under section
1296, the unreversed inclusions include
amounts that were included in gross in-
come under former proposed § 1.1291-8
with respect to that stock for prior tax-
able years. See Notice 92-53, 1992-2 C.B.
384.

The proposed regulations also address
the application of section 1296 in taxable
years in which the foreign corporation has
ceased to be a PFIC under section 1297(a),
and is not treated as a PFIC under sec-
tion 1298(b)(1) (the once a PFIC, always
a PFIC rule). The proposed regulations
clarify that there will be no mark to mar-
ket inclusions or deductions for taxable
years in which the foreign corporation is not
a PFIC. The suspension of mark to mar-
ket treatment while the foreign corpora-
tion is not a PFIC is consistent with
§ 1.1295-1(c)(2)(ii), which provides that a
shareholder that has made a QEF election

with respect to stock of a foreign corpo-
ration is not required to include its pro rata
share of ordinary income and capital gains
under section 1293 for years in which the
foreign corporation is not a PFIC.

In order to accomplish this suspension
of mark to market treatment, the proposed
regulations start a new holding period, for
all purposes of the PFIC rules, in stock that
is marked to market under section 1296 be-
ginning on the first day of the first tax-
able year beginning after the last taxable
year for which section 1296 applied. Ac-
cordingly, prior periods during which the
foreign corporation was a PFIC, but for
which the shareholder had a section 1296
election in effect, are not included in such
shareholder's holding period for purposes
of applying section 1298(b)(1).

Cessation of a foreign corporation's sta-
tus as a PFIC will not, however, termi-
nate a section 1296 election (although a
shareholder may request consent of the
Commissioner to revoke the election in such
instance, as discussed below). Thus, if the
foreign corporation once again becomes a
PFIC in any taxable year after a year in
which it is not treated as a PFIC, the share-
holder's original section 1296 election con-
tinues to apply and the shareholder must
mark to market the PFIC stock for such
year.

##### 2. Adjustment to basis

The proposed regulations provide that a
United States person will increase the ad-
justed basis of its section 1296 stock by the
amount of mark to market gain recognized.
Conversely, if the United States person is
entitled to a deduction under this section,
the adjusted basis of its section 1296 stock
is decreased by the amount of such deduc-
tion.

If a United States person owns section
1296 stock through a foreign partnership,
foreign trust, or foreign estate, the basis
rules apply to both the United States per-
son and the entity or entities through which
the United States person is considered to
own the stock. The increase or decrease in
the adjusted basis of the stock in the hands
of the foreign partnership, foreign trust, or
foreign estate will be solely attributable to
the electing United States person (in a man-
ner similar to an adjustment under sec-
tion 743(b)), and will apply only for
purposes of determining the subsequent U.S.
income tax treatment of the United States

person with respect to such stock. The IRS
considered imposing reporting and record
keeping requirements on the foreign enti-
ties to track the adjustments to the ad-
justed basis of any section 1296 stock they
held directly or indirectly. The IRS de-
cided not to adopt this approach in the pro-
posed regulations because one of the
motivations for the enactment of section
1296 was to provide an alternative tax re-
gime to section 1291 for taxpayers that
could not obtain sufficient information from
a PFIC to make a QEF election. Com-
ments are requested about other approaches
for satisfying the compliance obligations of
U.S. persons making a section 1296 elec-
tion and the intervening entity or entities
through which such stock is owned.

The taxpayer and the entity through
which the taxpayer owns section 1296 stock
may have different taxable years. Consis-
tent with the general approach of sections
706(a), 652(c), and 662(c), a United States
person who owns stock in a PFIC through
any foreign partnership, foreign trust, or for-
eign estate determines the mark to mar-
ket gain or mark to market loss with
reference to the last day of the taxable year
of the foreign partnership, foreign trust or
foreign estate and then includes that gain
or loss in the taxable year of such United
States person that includes the last day of
the taxable year of the entity.

Finally, if PFIC stock is acquired from
a decedent by bequest, devise, or inherit-
ance (or by the decedent's estate) and a
mark to market election was in effect on the
decedent's date of death, the adjusted ba-
sis of such stock in the hands of the re-
cipient will be equal to the lesser of the
basis determined under section 1014 or the
adjusted basis of the stock in the hands of
the decedent immediately prior to his or her
death.

#### 3. Rule for individuals that become subject to United States income taxation

The proposed regulations provide that if
any individual becomes a United States per-
son in a taxable year beginning after De-
cember 31, 1997, the adjusted basis (before
any adjustments resulting from the mark to
market election are made) of any stock in
a PFIC owned by such individual on the
first day of such taxable year shall be
treated as being the greater of its fair mar-
ket value on such first day or its adjusted
basis on such first day. This special rule for

determining the taxpayer's adjusted basis
will apply only for purposes of section 1296
and the regulations thereunder. Accord-
ingly, any gain or loss recognized on the
disposition of section 1296 stock that is at-
tributable to the period before the indi-
vidual became a United States person will
be subject to the general rules of the Code,
including any limitation on the deductibil-
ity of a loss, for example, under section
1211.

#### 4. Indirect ownership of PFIC stock

Except as discussed below in the case
of eligible RICs, the proposed regulations
apply the specific attribution rules of sec-
tion 1296(g) in determining whether PFIC
stock is considered owned by a taxpayer for
purposes of section 1296 and, therefore,
with respect to which the taxpayer is per-
mitted to make a section 1296 election.
Thus, a United States person will be per-
mitted to make a section 1296 election with
respect to stock owned through a foreign
partnership, foreign trust, or foreign es-
tate. In general, stock owned by or for such
entities will be considered as being owned
proportionately by its partners or benefi-
ciaries. For purposes of this rule, stock
owned, directly or indirectly, by or for a for-
eign trust described in sections 671 through
679, shall be considered as being owned
proportionately by its grantors or other per-
sons treated as owners under sections 671
through 679 of any portion of the trust that
includes the stock.

The section 1296(g) attribution rules do
not attribute ownership through foreign cor-
porations. Accordingly, a United States per-
son will not be permitted to make a section
1296 election with respect to stock owned
indirectly through a foreign corporation.
However, as discussed below, in instances
where the foreign corporation is a CFC, the
foreign corporation is permitted to make a
section 1296 election directly.

Special attribution rules for eligible RICs
are provided in § 1.1296(e)-1(f). There is
a different attribution rule for RICs be-
cause section 1296(e)(2), which provides a
special rule for RICs, states that stock
owned, directly or indirectly, by the RIC,
without reference to the ownership attri-
bution rules in section 1296(g), shall be
treated as marketable stock. This approach
is consistent with former proposed
§ 1.1291-8, which permitted certain RICs
to mark to market PFIC stock that it owned

directly or indirectly.

An issue not addressed in these pro-
posed regulations is the treatment of cer-
tain situations involving multiple tiers of
PFICs. For example, assume a United States
person owns marketable stock in a PFIC,
that itself owns stock in a second PFIC, the
ownership of which is attributable to the
United States person under section
1298(a)(2). If the United States person
makes a section 1296 election with re-
spect to stock of the upper-tier PFIC, the
annual mark to market inclusions of in-
come under section 1296 will be based on
the fair market value of the upper-tier PFIC
stock, whose value should reflect the value
of the lower-tier PFIC, as such stock is an
asset of the upper-tier PFIC. However, un-
der current law, the United States person
continues to be subject to taxation with re-
spect to its indirect ownership of the lower-
tier PFIC under section 1291 on any excess
distributions from the lower-tier PFIC or
gain from an indirect disposition of the
lower-tier PFIC stock (although the con-
sequences from the tiered ownership may
be ameliorated by adjustments to the ba-
sis of the upper-tier PFIC stock). See pro-
posed §§ 1.1291-2(f), and 1.1291-3(e).
Similar issues arise if the United States per-
son makes a QEF election with respect to
the lower-tier PFIC. Comments are re-
quested regarding coordination rules or other
adjustments that may be appropriate to ad-
dress this situation and similar structures in-
volving a United States person that owns
stock directly and indirectly in tiers of
PFICs.

#### 5. Treatment of CFCs as United States persons

A CFC that owns PFIC stock is treated
as a United States person for purposes of
section 1296 and, as noted above, is per-
mitted to make a section 1296 election di-
rectly. If a section 1296 election is made
with respect to PFIC stock owned by a CFC
directly, or treated as owned by a CFC ap-
plying the section 1296(g) attribution rules,
then any mark to market gains are included
in the gross income of the CFC as for-
eign personal holding company income un-
der section 954(c)(1)(A) and any mark to
market losses are treated as deductions al-
locable to such foreign personal holding
company income for purposes of comput-
ing net foreign base company income un-
der § 1.954-1(c).

Under the proposed regulations, if a sec-
tion 1296 election is made for a CFC with
respect to its PFIC stock, the PFIC rules do
not also apply separately to any United
States shareholder, as defined in section
951(b), with respect to its pro rata share of
the PFIC stock held by the CFC. Instead,
the United States shareholder generally will
recognize the mark to market gain as an in-
clusion of income under section 951(a).
Thus, United States shareholders of CFCs
are appropriately excluded from the appli-
cation of section 1291 if a section 1296
election is made by the CFC. This rule,
however, does not apply to United States
persons who own stock of the CFC but are
not United States shareholders within the
meaning of section 951(b). Those United
States persons continue to be subject to the
PFIC provisions with respect to the stock
of such foreign corporation, and may avail
themselves of a QEF election. This rule is
consistent with the CFC/PFIC overlap rule
in section 1297(e), which eliminates the ap-
plication of the PFIC provisions solely for
United States shareholders of the entity that
is both a PFIC and a CFC. Finally, com-
ments are requested about whether simi-
lar rules should apply to United States
persons that are United States sharehold-
ers of a CFC solely by application of sec-
tion 953(c)(1)(A).

#### 6. Elections

The proposed regulations provide that a
United States person may make a section
1296 election for a taxable year begin-
ning after December 31, 1997, by the due
date (including extensions) of the United
States person's federal income tax return.
The proposed regulations further provide
that a section 1296 election of a CFC is
made by its controlling United States share-
holders by the due date (including exten-
sions) of their federal income tax returns
in accordance with the general rules for
elections by a CFC under § 1.964-1(c)(5).

The proposed regulations provide that a
section 1296 election applies to the year for
which made and to each succeeding year
unless the election is terminated or re-
voked. A section 1296 election automati-
cally terminates when (i) the PFIC stock
ceases to be marketable, or (ii) when the
PFIC stock is marked to market under an-
other provision of chapter 1 of the Code.
A section 1296 election also may be re-
voked with the consent of the Commis-

sioner. Such consent will only be granted,
however, upon a showing of a substantial
change in circumstances. Similar rules ap-
ply in the case of the revocation of a QEF
election.

#### 7. Coordination rules for first year of election

Finally, the proposed regulations pro-
vide coordination rules that apply to the first
taxable year to which section 1296 ap-
plies. A United States person (other than a
RIC) whose holding period includes a pe-
riod when the foreign corporation was a
PFIC and for which a QEF election had not
been made generally will be subject to sec-
tion 1291 in the year of the election and
subject to section 1296 in subsequent years.
Special rules also apply to RICs for the first
year in which a section 1296 election ap-
plies.

#### D. Changes to § 1.1296(e)-1(b)

As discussed above, a section 1296 elec-
tion is only available for marketable stock
of a PFIC. Section 1296(e) defines mar-
ketable stock to include any stock which is
regularly traded on certain securities ex-
changes or other markets. The 2000 final
regulations provide guidance regarding the
definition of marketable stock for pur-
poses of section 1296. In particular, the
2000 final regulations define regularly
traded for these purposes to require that a
class of stock be traded on at least 15 days
during each calendar quarter for any cal-
endar year. Taxpayers have noted that this
rule would exclude stock issued as a re-
sult of an initial public offering (IPO) from
qualifying as marketable stock for the year
of issuance in many instances (e.g., stock
issued through a public offering occur-
ring other than during the first quarter of
the year). Therefore, these regulations pro-
pose modifying the current rule in such in-
stances.

The proposed regulations provide that the
stock issued in a public offering will qualify
as regularly traded if the stock is traded on
one or more qualified exchanges or other
markets, other than in de minimis quanti-
ties, on 1/6 of the days remaining in the
quarter in which the offering occurs, and
on at least 15 days during each remain-
ing quarter of the calendar year. If the pub-
lic offering occurs in the fourth quarter of
the calendar year, the stock will qualify as
regularly traded if it is traded on such ex-

changes or markets, other than in de mini-
mis quantities, on the greater of 1/6 of the
days remaining in the quarter in which the
offering occurs, or 5 days. The proposed
regulations also modify the anti-abuse rule
in § 1.1296(e)-1(b)(2) to apply to these
changes to the definition of regularly traded.

##### E. Amendment of § 1.6031(a)-1

In general, a foreign partnership that has
U.S. source income is required to file a U.S.
Federal income tax return pursuant to
§ 1.6031(a)-1(b)(1). An issue arises whether
a filing obligation is created on behalf of
a foreign partnership where a U.S. part-
ner of the foreign partnership makes a sec-
tion 1296 election with respect to the U.S.
partner's share of the PFIC stock held by
the partnership. The income of the part-
ner arising as a result of the section 1296
election generally will be U.S. source. See
sections 1296(c)(2) and 865(a), (i)(5). The
proposed regulations resolve this issue by
modifying § 1.6031(a)-1(b)(1) such that a
foreign partnership will not be required to
file a partnership return if the only rea-
son for filing a return, but for this special
rule, would be U.S. source income result-
ing from a direct or indirect partner's sec-
tion 1296 election.

### Special Analysis

It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Ex-
ecutive Order 12866. Therefore, a regulatory
assessment is not required. It has also been
determined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C. chap-
ter 5) does not apply to these regulations,
and, because the regulations do not im-
pose a collection of information on small
entities, the Regulatory Flexibility Act (5
U.S.C. chapter 6) does not apply. Pursu-
ant to section 7805(f) of the Code, this no-
tice of proposed rulemaking will be
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administra-
tion 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 written comments (a
signed original and eight (8) copies) that are
submitted timely (in a manner described in
the "ADDRESSES" portion of this pre-
amble) to the IRS. The IRS and Treasury
request comments on the clarity of the pro-
posed rules and how they can be made
easier to understand. All comments will be
available for public inspection and copy-
ing.

A public hearing is scheduled for No-
vember 6, 2002, beginning at 10:00 a.m. in
room 4718, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington, DC.
Due to building security procedures, visi-
tors must enter at the Constitution Av-
enue entrance. In addition, all visitors must
present photo identification to enter the
building. Because of access restrictions, visi-
tors will not be admitted beyond the im-
mediate 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 INFORMATION
CONTACT" portion of this preamble.

The rules of 26 CFR 601.601(a)(3) ap-
ply to this hearing. Persons who wish to
present oral comments must submit writ-
ten comments and an outline of the top-
ics to be discussed and the time to be
devoted to each topic (a signed original and
eight (8) copies) by October 16, 2002. 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 review-
ing outlines has passed. Copies of the
agenda will be available free of charge at
the hearing.

### Drafting Information

The principal authors of this regula-
tion are Mark Pollard and Laurie Hatten-
Boyd, Office of Associate Chief Counsel
(International). However, other personnel
from the IRS and Treasury Department par-
ticipated in their development.

* * * * *

### Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed
to be amended as follows:

## PART 1-INCOME TAXES

Paragraph 1. The authority citation for
part 1 is amended by adding an entry in nu-
merical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *

Section 1.1296-1 also issued under 26
USC 1296(g) and 26 USC 1298(f).

Par. 2. Section 1.1291-1, as proposed on
April 1, 1992, at 57 FR 11024, is amended
by:

1\. Revising the headings to paragraphs
(c) and (c)(1).

2\. Redesignating the text of paragraphs
(c)(1) and (c)(2) as (c)(1)(i) and (c)(1)(ii),
respectively.

3\. Adding new paragraphs (c)(2) and
(c)(3).

4\. Revising paragraph (j)(1).

5\. Removing paragraph (j)(3).
The revisions and addition read as
follows:

§ 1.1291-1 Taxation of U.S. persons that
are shareholders of section 1291 funds.

* * * * *

(2) Coordination with section 1296: dis-
tributions and dispositions. If PFIC stock
is marked to market under section 1296 for
any taxable year, then, except as provided
in § 1.1296-1(i), section 1291 and the regu-
lations thereunder shall not apply to any dis-
tribution with respect to section 1296 stock
(as defined in § 1.1296-1(a)(2)), or to any
disposition of such stock, for such tax-
able year.

(3) Coordination with mark to market
rules under chapter 1 of the Internal Rev-
enue Code other than section 1296-(i) In
general. If PFIC stock is marked to mar-
ket for any taxable year under section 475
or any other provision of chapter 1 of the
Internal Revenue Code, other than sec-
tion 1296, regardless of whether the appli-
cation of such provision is mandatory or
results from an election by the taxpayer or
another person, then, except as provided in
paragraph (c)(3)(ii) of this section, sec-
tion 1291 and the regulations thereunder
shall not apply to any distribution with re-
spect to such PFIC stock or to any dispo-
sition of such PFIC stock for such taxable
year. See §§ 1.1295-1(i)(3) and 1.1296-
1(h)(3)(i) for rules regarding the automatic
termination of an existing election under
section 1295 or section 1296 when a tax-

payer marks to market PFIC stock under
section 475 or any other provision of chap-
ter 1 of the Internal Revenue Code.

(ii) Coordination rule-(A) Notwith-
standing any provision in this section to the
contrary, the rule of paragraph (c)(3)(ii)(B)
of this section shall apply to the first tax-
able year in which a United States person
marks to market its PFIC stock under a pro-
vision of chapter 1 of the Internal Rev-
enue Code, other than section 1296, if such
foreign corporation was a PFIC for any tax-
able year, prior to such first taxable year,
during the United States person's holding
period (as defined in section 1291(a)(3)(A)
and § 1.1296-1(f)) in such stock, and for
which such corporation was not treated as
a QEF with respect to such United States
person.

(B) For the first taxable year of a United
States person that marks to market its PFIC
stock under any provision of chapter 1 of
the Internal Revenue Code, other than sec-
tion 1296, such United States person shall,
in lieu of the rules under which the United
States person marks to market, apply the
rules of § 1.1296-1(i)(2) and (3) as if the
United States person had made an elec-
tion under section 1296 for such first tax-
able year.

(j) Effective date-(1) In general. Ex-
cept as otherwise provided in this para-
graph (j), §§ 1.1291-1 through 1.1291-7
apply on April 11, 1992. Section 1.1291-
1(c)(2) and (3) apply as of the date final
regulations are published in the Federal
Register. Shareholders of 1291 funds, in de-
termining their liability under sections 1291
through 1297 beginning after December 31,
1986, and before the effective date of these
regulations, must apply reasonable inter-
pretations of the statute and legislative his-
tory and employ reasonable methods to
apply the interest charge.

Par. 3. Section 1.1295-1 is amended by:
1\. Redesignating paragraphs (i)(3) and
(i)(4) as paragraphs (i)(4) and (i)(5), re-
spectively.

2\. Adding a new paragraph (i)(3).

3\. Revising newly designated paragraph
(i)(5).

4\. Revising paragraph (k).

The revisions and addition read as
follows:

§ 1.1295-1 Qualified electing funds

* * * * *

(i)* * *

(3) Automatic termination. If a United
States person, or the United States share-
holder on behalf of a controlled foreign cor-
poration, makes an election pursuant to
section 1296 and the regulations thereun-
der with respect to PFIC stock for which
a QEF election is in effect, or marks to mar-
ket such stock under another provision of
chapter 1 of the Internal Revenue Code, the
QEF election is automatically terminated
with respect to such stock that is marked
to market under section 1296 or another
provision of Chapter 1 of the Internal Rev-
enue Code. Such termination shall be ef-
fective on the last day of the shareholder's
taxable year preceding the first taxable year
for which the section 1296 election is in ef-
fect or such stock is marked to market un-
der another provision of chapter 1 of the
Internal Revenue Code.

Example. A, a U.S. corporation, owns directly 100
shares of marketable stock in foreign corporation X,
a PFIC. A also owns a 50 percent interest in Y, a for-
eign partnership that owns 200 shares of X. Accord-
ingly, under section 1298(a)(3) and § 1.1296-1(e)(1),
A is treated as indirectly owning 100 shares of X. A
also owns 100 percent of the stock of Z, a foreign cor-
poration that is not a PFIC. Z owns 100 shares of X,
and therefore under section 1298(a)(2)(A), A is treated
as owning the 100 shares of X owned by Z. For tax-
able year 2003, A has a QEF election in effect with
respect to X that applies to all 300 shares of X stock
owned directly or indirectly by A. See generally
§ 1.1295-1(c)(1). For taxable year 2004, A makes a
timely election pursuant to section 1296 and the regu-
lations thereunder. For purposes of section 1296, A
is treated as owning stock held indirectly through a
partnership, but not through a foreign corporation. Sec-
tion 1296(g); § 1.1296-1(e)(1). Accordingly, A's sec-
tion 1296 election covers the 100 shares it owns
directly and the 100 shares it owns indirectly through
Y, but not the 100 shares owned by Z. With respect
to the first 200 shares, A's QEF election is automati-
cally terminated effective December 31, 2003. With
respect to the 100 shares A owns through foreign cor-
poration Z, A's QEF election remains in effect un-
less invalidated, terminated, or revoked pursuant to this
paragraph (i).

* * * * *

(5) Effect after invalidation, termina-
tion, or revocation- (i) In general. With-
out the Commissioner's consent, a
shareholder whose section 1295 election
was invalidated, terminated, or revoked un-
der this paragraph (i) may not make the sec-
tion 1295 election with respect to the PFIC
before the sixth taxable year in which the
invalidation, termination, or revocation be-
came effective.

(ii) Special rule. Notwithstanding para-
graph (i)(5)(i) of this section, a shareholder
whose section 1295 election was termi-
nated pursuant to paragraph (i)(3) of this
section, and either whose section 1296 elec-
tion has subsequently been terminated be-
cause its PFIC stock ceased to be
marketable or who no longer marks to mar-
ket such stock under another provision of
chapter 1 of the Internal Revenue Code,
may make a section 1295 election with re-
spect to its PFIC stock before the sixth tax-
able year in which its prior section 1295
election was terminated.

* * * * *

(k) Effective dates. Except as other-
wise provided, paragraphs (b)(2)(iii), (b)(3),
(b)(4), and (c) through (j) of this section are
applicable to taxable years of sharehold-
ers beginning after December 31, 1997.
However, taxpayers may apply the rules un-
der paragraphs (b)(4), (f) and (g) of this sec-
tion to a taxable year beginning before
January 1, 1998, provided the statute of
limitations on the assessment of tax has not
expired as of April 27, 1998, and, in the
case of paragraph (b)(4) of this section, the
taxpayers who filed the joint return have
consistently applied the rules of that sec-
tion to all taxable years following the year
the election was made. Paragraph (b)(3)(v)
of this section is applicable as of Febru-
ary 7, 2000, however, a taxpayer may ap-
ply the rules to a taxable year prior to the
applicable date provided the statute of limi-
tations on the assessment of tax for that tax-
able year has not expired. Paragraphs (i)(3)
and (i)(5)(ii) of this section are applicable
as of the date final regulations are pub-
lished in the Federal Register.

Par. 4. Section 1.1296-1 is added to read
as follows:

§ 1.1296-1 Mark to market election for
marketable stock.

(a) Definitions-(1) Eligible RIC. An eli-
gible RIC is a regulated investment com-
pany that offers for sale, or has outstanding,
any stock of which it is the issuer and
which is redeemable at net asset value, or
that publishes net asset valuations at least
annually.

(2) Section 1296 stock. The term sec-
tion 1296 stock means marketable stock in
a passive foreign investment company
(PFIC), including any PFIC stock owned
directly or indirectly by an eligible RIC, for
which there is a valid section 1296 elec-
tion. Section 1296 stock does not include

stock of a foreign corporation that previ-
ously had been a PFIC, and for which a
section 1296 election remains in effect.

(3) Unreversed inclusions-(i) Gen-
eral rule. The term unreversed inclusions
means with respect to any section 1296
stock, the excess, if any, of-

(A) The amount of mark to market gain
included in gross income of the United
States person under paragraph (c)(1) of this
section with respect to such stock for prior
taxable years; over

(B) The amount allowed as a deduc-
tion to the United States person under para-
graph (c)(3) of this section with respect to
such stock for prior taxable years.

(ii) Section 1291 adjustment. The amount
referred to in paragraph (a)(3)(i)(A) of this
section shall include any amount subject to
section 1291 under the coordination rule of
paragraph (i)(2)(ii) of this section.

(iii) Example. An example of the com-
putation of unreversed inclusions is as
follows:

Example. A, a United States person, acquired stock
in D, a foreign corporation, on January 1, 2003, for
$150. At such time and at all times thereafter, D was
a PFIC and A's stock in D was marketable. For tax-
able years 2003 and 2004, D was a nonqualified fund
subject to taxation under section 1291. A made a timely
section 1296 election with respect to the D stock, ef-
fective for tax year 2005. The fair market value of the
D stock was $200 as of December 31, 2004, and $240
as of December 31, 2005. Additionally, D made no
distribution with respect to its stock for the taxable
years at issue. In 2005, pursuant to paragraph (i)(2)(ii)
of this section, A must include the $90 gain in the D
stock in accordance with the rules of section 1291 for
purposes of determining the deferred tax amount and
any applicable interest. Nonetheless, for purposes of
determining the amount of the unreversed inclu-
sions pursuant to paragraph (a)(3)(ii) of this sec-
tion, A will include the $90 of gain that was taxed
under section 1291 and not the interest thereon.

(iv) Special rule for regulated invest-
ment companies. In the case of a regu-
lated investment company which had
elected to mark to market the PFIC stock
held by such company as of the last day of
the taxable year preceding such compa-
ny's first taxable year for which such com-
pany makes a section 1296 election, the
amount referred to in paragraph (a)(3)(i)(A)
of this section shall include amounts pre-
viously included in gross income by the
company pursuant to such mark to mar-
ket election with respect to such stock for
prior taxable years. See Notice 92-53,
1992-2 C.B. 384.

(b) Application of section 1296
election-(1) In general. Any United States
person and any controlled foreign corpo-

ration (CFC) that owns directly, or is treated
as owning under this section, marketable
stock, as defined in § 1.1296(e)-1, in a
PFIC may make an election to mark to mar-
ket such stock in accordance with the pro-
visions of section 1296 and this section.

(2) Election applicable to specific United
States person. A section 1296 election ap-
plies only to the United States person (or
CFC that is treated as a U.S. person un-
der paragraph (g)(2) of this section) that
makes the election. Accordingly, a United
States person's section 1296 election will
not apply to a transferee of section 1296
stock.

(3) Election applicable to specific cor-
poration only. A section 1296 election is
made with respect to a single foreign cor-
poration, and thus a separate section 1296
election must be made for each foreign cor-
poration that otherwise meets the require-
ments of this section. A United States
person's section 1296 election with re-
spect to stock in a foreign corporation ap-
plies to all marketable stock of the
corporation that the person owns directly,
or is treated as owning under paragraph (e)
of this section, at the time of the election
or that is subsequently acquired.

(c) Effect of election-(1) Recognition
of gain. If the fair market value of sec-
tion 1296 stock on the last day of the
United States person's taxable year ex-
ceeds its adjusted basis, the United States
person shall include in gross income for its
taxable year the excess of the fair market
value of such stock over its adjusted ba-
sis (mark to market gain).

(2) Character of gain. (i) Mark to mar-
ket gain, and any gain on the sale or other
disposition of section 1296 stock, shall be
treated as ordinary income.

(ii) Example. The following example il-
lustrates this paragraph (c)(2):

Example. A, a United States person, purchases
stock in C, a foreign corporation that is not a PFIC,
in 1990 for $1,000. On January 1, 2003, when the fair
market value of the C stock is $1,100, foreign cor-
poration C becomes a PFIC. A makes a timely sec-
tion 1296 election for year 2003. On December 31,
2003, the fair market value of the C stock is $1,200.
For taxable year 2003, A includes $200 of mark to
market gain (the excess of the fair market value of C
stock ($1,200) over A's adjusted basis ($1,000)) in
gross income as ordinary income.

(3) Recognition of loss. If the adjusted
basis of section 1296 stock exceeds its fair
market value on the last day of the United
States person's taxable year, such person
shall be allowed a deduction for such tax-

able year equal to the lesser of the amount
of such excess or the unreversed inclu-
sions with respect to such stock (mark to
market loss).

(4) Character of loss-(i) Losses not in
excess of unreversed inclusions. Any mark
to market loss allowed as a deduction un-
der paragraph (c)(3) of this section, and any
loss on the sale or other disposition of sec-
tion 1296 stock, to the extent that such loss
does not exceed the unreversed inclusions
attributable to such stock, shall be treated
as an ordinary loss, deductible in comput-
ing adjusted gross income.

(ii) Losses in excess of unreversed in-
clusions. (A) Any loss recognized on the
sale or other disposition of section 1296
stock in excess of any prior unreversed in-
clusions will be subject to the rules gen-
erally applicable to losses provided
elsewhere in the Internal Revenue Code and
the regulations thereunder.

(B) The following example illustrates the
treatment of losses in excess of unreversed
inclusions:

Example. A, a United States person and a calen-
dar year taxpayer, purchased marketable stock in FC,
a foreign corporation that was a PFIC, for $1,000 on
January 31, 2003. A made a section 1296 election with
respect to the stock of FC for 2003. At the close of
2003, the fair market value of A's stock in FC was
$1,200. Under paragraph (c)(1) and (2) of this sec-
tion, A included $200 of mark to market gain as or-
dinary income for 2003, and pursuant to paragraph
(d)(1) of this section, increased his basis in the stock
by that amount. On June 15, 2004, A sold his stock
in FC for $900. At that time, A's unreversed inclu-
sions with respect to the stock in FC were $200. Ac-
cordingly, A may deduct the amount equal to his
unreversed inclusions, $200, as an ordinary loss. The
$100 loss in excess of A's unreversed inclusions will
be treated as a long term capital loss because A has
held the FC stock for more than one year.

(5) Application of election to separate
lots of stock. (i) In the case in which a
United States person purchased or acquired
shares of stock in a PFIC at different prices,
the rules of this section shall be applied in
a manner consistent with the rules of
§ 1.1012-1.

(ii) Example. The following example il-
lustrates this paragraph (c)(5):

Example. On January 1, 2003, United States cor-
poration A purchased 100 shares (first lot) of stock in
foreign corporation X, a PFIC, for $500 ($5 per share).
On June 1, 2003, A purchased 100 shares (second lot)
of stock in X for $1,000 ($10 per share). A made a
timely section 1296 election with respect to its stock
in X for taxable year 2003. On December 31, 2003,
the fair market value of X stock was $8 per share. For
taxable year 2003, A recognizes $300 of gross in-
come under paragraph (c)(1) of this section with re-
spect to the first lot, and adjusts its basis in that lot

to $800 pursuant to paragraph (d)(1) of this section.
With respect to the second lot, A is not permitted to
recognize a loss under paragraph (c)(3) of this sec-
tion for taxable year 2003. Although A's adjusted ba-
sis in that stock exceeds its fair market value by $200,
A has no unreversed inclusions with respect to that
particular lot of stock. On July 1, 2004, A sells 100
shares of X stock for $900. Assuming that A ad-
equately identifies (in accordance with the rules of
§ 1.1012-1(c)) the shares of X corporation stock sold
as being from the second lot, A recognizes $100 of
long term capital loss pursuant to paragraph (c)(4)(ii)
of this section.

(6) Source rules. The source of any
amount included in gross income under
paragraph (c)(1) of this section, or the al-
location and apportionment of any amount
allowed as a deduction under paragraph
(c)(3) of this section, shall be determined
in the same manner as if such amounts were
gain or loss (as the case may be) from the
sale of stock in the PFIC.

(d) Adjustment to basis-(1) Stock held
directly. The adjusted basis of the section
1296 stock shall be increased by the amount
included in the gross income of the United
States person under paragraph (c)(1) of this
section with respect to such stock, and de-
creased by the amount allowed as a de-
duction to the United States person under
paragraph (c)(3) of this section with re-
spect to such stock.

(2) Stock owned through certain for-
eign entities. (i) In the case of section 1296
stock that a United States person is treated
as owning through certain foreign entities
pursuant to paragraph (e) of this section, the
basis adjustments under paragraph (d)(1) of
this section shall apply to such stock in the
hands of the foreign entity actually hold-
ing such stock, but only for purposes of de-
termining the subsequent treatment under
chapter 1 of the Internal Revenue Code of
the United States person with respect to
such stock. Such increase or decrease in the
adjusted basis of the section 1296 stock
shall constitute an adjustment to the basis
of partnership property only with respect to
the partner making the section 1296 elec-
tion. Corresponding adjustments shall be
made to the adjusted basis of the United
States person's interest in the foreign en-
tity and in any intermediary entity described
in paragraph (e) of this section through
which the United States person holds the
PFIC stock.

(ii) Example. The following example il-
lustrates this paragraph (d)(2):

Example. FP is a foreign partnership. A, a U.S. cor-
poration, owns a 20% interest in FP. B, a U.S. cor-
poration, owns a 30% interest in FP. C, a foreign

corporation, with no direct or indirect shareholders that
are U.S. persons, owns a 50% interest in FP. A, B, C,
and FP are all calendar year taxpayers. In 2002, FP
purchases stock in a PFIC for $1,000. A makes a
timely section 1296 election for taxable year 2003. On
December 31, 2003, the fair market value of the PFIC
stock is $1,100. A includes $20 of ordinary income
in 2003 under paragraphs (c)(1) and (2) of this sec-
tion. A increases its basis in its FP partnership inter-
est by $20. FP increases its basis in the stock to $1,020
solely for purposes of determining the subsequent treat-
ment of A, under chapter 1 of the Internal Revenue
Code, with respect to such stock. In 2004, FP sells the
stock for $1,200. For purposes of determining the
amount of gain of A, FP will be treated as having $180
in gain of which $20 is allocated to A. A's $20 of gain
will be treated as ordinary income under paragraph
(c)(2) of this section. For purposes of determining the
amount of gain attributable to B, FP will be treated
as having $200 gain, $60 of which will be allocated
to B.

(3) Stock owned indirectly by an eli-
gible RIC. Paragraph (d)(2) of this sec-
tion shall also apply to an eligible RIC
which is an indirect shareholder under
§ 1.1296(e)-1(f) of stock in a PFIC and has
a valid section 1296 election in effect.

(4) Stock acquired from a decedent. In
the case of stock of a PFIC which is ac-
quired by bequest, devise, or inheritance (or
by the decedent's estate) and with respect
to which a section 1296 election was in ef-
fect as of the date of the decedent's death,
notwithstanding section 1014, the basis of
such stock in the hands of the person so ac-
quiring it shall be the adjusted basis of such
stock in the hands of the decedent imme-
diately before his death (or, if lesser, the ba-
sis which would have been determined
under section 1014 without regard to this
paragraph).

(5) Transition rule for individuals be-
coming subject to United States income
taxation-(i) In general. If any individual
becomes a United States person in a tax-
able year beginning after December 31,
1997, solely for purposes of this section, the
adjusted basis, before adjustments under this
paragraph (d), of any section 1296 stock
owned by such individual on the first day
of such taxable year shall be treated as be-
ing the greater of its fair market value or
its adjusted basis on such first day.

(ii) An example of the transition rule for
individuals becoming subject to United
States income taxation is as follows:

Example. X, a nonresident alien individual, pur-
chases marketable stock in a PFIC for $50 in 1995.
On January 1, 2003, X becomes a United States per-
son and makes a timely section 1296 election with re-
spect to the stock in accordance with paragraph (h)
of this section. The fair market value of the stock on
January 1, 2003, is $100. The fair market value of the

stock on December 31, 2003, is $110. Under para-
graph (d)(5)(i) of this section, X computes the amount
of mark to market gain or loss in 2003 by reference
to an adjusted basis of $100, and therefore X in-
cludes $10 in gross income as mark to market gain
under paragraph (c)(1) of this section. Additionally,
under paragraph (d)(1) of this section, X's adjusted
basis in the stock for purposes of this section is in-
creased to $110 (or to $60 for all other tax purposes).
X sells the stock in 2004 for $120. For purposes of
applying section 1001, X must use its original basis
of $50, with any adjustments under paragraph (d)(1)
of this section, $10 in this case, and therefore X rec-
ognizes $60 of gain. Under paragraph (c)(2) of this
section (which is applied using an adjusted basis of
$110), $10 of such gain is treated as ordinary in-
come. The remaining $50 of gain from the sale of the
stock is long-term capital gain because X held such
stock for more than one year.

(e) Stock owned through certain for-
eign entities-(1) In general. Except as pro-
vided in paragraph (e)(2) of this section, the
following rules shall apply in determin-
ing stock ownership for purposes of this
section. PFIC stock owned, directly or in-
directly, by or for a foreign partnership, for-
eign trust (other than a foreign trust
described in sections 671 through 679), or
foreign estate shall be considered as be-
ing owned proportionately by its partners
or beneficiaries. PFIC stock owned, di-
rectly or indirectly, by or for a foreign trust
described in sections 671 through 679 shall
be considered as being owned proportion-
ately by its grantors or other persons treated
as owners under sections 671 through 679
of any portion of the trust that includes the
stock. The determination of a person's pro-
portionate interest in a foreign partner-
ship, foreign trust or foreign estate will be
made on the basis of all the facts and cir-
cumstances. Stock considered owned by
reason of this paragraph shall, for pur-
poses of applying the rules of this sec-
tion, be treated as actually owned by such
person.

(2) Stock owned indirectly by eligible
RICs. The rules for attributing ownership
of stock contained in § 1.1296(e)-1(f) will
apply to determine the indirect ownership
of PFIC stock by an eligible RIC.

(f) Holding period. Solely for purposes
of sections 1291 through 1298, if section
1296 applied to stock with respect to the
taxpayer for any prior taxable year, the tax-
payer's holding period in such stock shall
be treated as beginning on the first day of
the first taxable year beginning after the last
taxable year for which section 1296 so ap-
plied.

(g) Special rules-(1) Certain disposi-
tions of stock. To the extent a United States

person is treated as actually owning stock
in a PFIC under paragraph (e) of this sec-
tion, any disposition which results in the
United States person being treated as no
longer owning such stock, and any dispo-
sition by the person owning such stock,
shall be treated as a disposition by the
United States person of the stock in the
PFIC.

(2) Treatment of CFC as a United States
person. In the case of a CFC that owns, or
is treated as owning under paragraph (e) of
this section, section 1296 stock:

(i) Other than with respect to the sourc-
ing rules in paragraph (c)(6) of this sec-
tion, this section shall apply to the CFC in
the same manner as if such corporation
were a United States person. The CFC will
be treated as a foreign person for purposes
of applying the source rules of paragraph
(c)(6).

(ii) For purposes of subpart F of part III
of subchapter N of the Internal Revenue
Code-

(A) Amounts included in the CFC's
gross income under paragraph (c)(1) or
(i)(2)(ii) of this section shall be treated as
foreign personal holding company income
under section 954(c)(1)(A); and

(B) Amounts allowed as a deduction un-
der paragraph (c)(3) of this section shall be
treated as a deduction allocable to for-
eign personal holding company income for
purposes of computing net foreign base
company income under § 1.954-1(c).

(iii) A United States shareholder, as de-
fined in section 951(b), of the CFC shall
not be subject to section 1291 with re-
spect to any stock of the PFIC for the pe-
riod during which the section 1296 election
is in effect for that stock, and the holding
period rule of paragraph (f) of this sec-
tion shall apply to such United States share-
holder.

(iv) The rules of this paragraph (g)(2)
shall not apply to a United States person
that is a shareholder of the PFIC for pur-
poses of section 1291, but is not a United
States shareholder under section 951(b) with
respect to the CFC making a section 1296
election.

(3) Timing of inclusions for stock owned
through certain foreign entities. In the case
of section 1296 stock that a United States
person is treated as owning through cer-
tain foreign entities pursuant to paragraph
(e) of this section, the mark to market gain
or mark to market loss is determined in ac-

cordance with paragraphs (c) and (i)(2)(ii)
of this section as of the last day of the tax-
able year of the foreign partnership, for-
eign trust or foreign estate and then included
in the taxable year of such United States
person that includes the last day of the tax-
able year of the entity.

(h) Elections-(1) Timing and manner
for making a section 1296 election-(i)
United States persons. A United States per-
son that owns marketable stock in a PFIC,
or is treated as owning marketable stock un-
der paragraph (e) of this section, on the last
day of the taxable year of such person, and
that wants to make a section 1296 elec-
tion, must make a section 1296 election for
such taxable year on or before the due date
(including extensions) of the United States
person's income tax return for that year. The
section 1296 election must be made on the
Form 8621, "Return by a Shareholder of
a Passive Foreign Investment Company or
Qualified Electing Fund", included with the
original tax return of the United States per-
son for that year, or on an amended re-
turn, provided that the amended return is
filed on or before the election due date.

(ii) Controlled foreign corporations. A
section 1296 election by a CFC shall be
made by its controlling United States share-
holders, as defined in § 1.964-1(c)(5), and
shall be included with the Form 5471, “In-
formation Return of U.S. Persons With Re-
spect To Certain Foreign Corporations", for
that CFC by the due date (including ex-
tensions) of the original income tax re-
turns of the controlling United States
shareholders for that year. A section 1296
election by a CFC shall be binding on all
United States shareholders of the CFC.

(iii) Retroactive elections for PFIC stock
held in prior years. A late section 1296
election may be permitted only in accor-
dance with § 301.9100 of this chapter.

(2) Effect of section 1296 election-(i)
In General. A section 1296 election will ap-
ply to the taxable year for which such elec-
tion is made and remain in effect for each
succeeding taxable year unless such elec-
tion is revoked or terminated pursuant to
paragraph (h)(3) of this section.

(ii) Cessation of a foreign corporation
as a PFIC. A United States person will not
include mark to market gain or loss pur-
suant to paragraph (c) of this section with
respect to any stock of a foreign corpora-
tion for any taxable year that such for-
eign corporation is not a PFIC under section

1297 or treated as a PFIC under section
1298(b)(1) (taking into account the hold-
ing period rule of paragraph (f) of this sec-
tion). Cessation of a foreign corporation's
status as a PFIC will not, however, termi-
nate a section 1296 election. Thus, if a for-
eign corporation is a PFIC in a taxable year
after a year in which it is not treated as a
PFIC, the United States person's original
election (unless revoked or terminated in ac-
cordance with paragraph (h)(3) of this sec-
tion) continues to apply and the shareholder
must include any mark to market gain or
loss in such year.

(3) Revocation or termination of
election-(i) In general. A United States
person's section 1296 election is termi-
nated if the section 1296 stock ceases to be
marketable; if the United States person
elects, or is required, to mark to market the
section 1296 stock under another provi-
sion of chapter 1 of the Internal Revenue
Code; or if the Commissioner, in the Com-
missioner's discretion, consents to the
United States person's request to revoke its
section 1296 election upon a finding of a
substantial change in circumstances. A sub-
stantial change in circumstances for this pur-
pose may include a foreign corporation
ceasing to be a PFIC.

(ii) Timing of termination or revoca-
tion. Where a section 1296 election is ter-
minated automatically (e.g., the stock ceases
to be marketable), section 1296 will cease
to apply beginning with the taxable year in
which such termination occurs. Where a
section 1296 election is revoked with the
consent of the Commissioner, section 1296
will cease to apply beginning with the first
taxable year of the United States person af-
ter the revocation is granted unless other-
wise provided by the Commissioner.

(4) Examples. The operation of the rules
of this paragraph (h) are illustrated by the
following examples:

Example 1. X, a United States person, owns stock
in a PFIC. X makes a QEF election in 1996 with re-
spect to such stock. For taxable year 1999, X makes
a timely section 1296 election with respect to its stock,
and thus its QEF election is automatically termi-
nated pursuant to § 1.1295-1(i)(3). In 2000, X's stock
ceases to be marketable, and therefore its section 1296
election is automatically terminated under paragraph
(h)(3) of this section. Beginning with taxable year
2000, X is subject to the rules of section 1291 with
respect to its stock in the PFIC unless it makes a new
QEF election. See § 1.1295-1(i)(5).

Example 2. The facts are the same as in Example
1, except that X's stock in the PFIC becomes mar-
ketable again in 2001. X may make a new section
1296 election with respect to such stock for its tax year

2001, or thereafter. X will be subject to the coordi-
nation rules under paragraph (i) of this section un-
less it made a new QEF election in 2000.

(i) Coordination rules for first year of
election-(1) In general. Notwithstand-
ing any provision in this section to the con-
trary, the rules of this paragraph (i) shall
apply to the first taxable year in which a
section 1296 election is effective with re-
spect to marketable stock of a PFIC if such
foreign corporation was a PFIC for any tax-
able year, prior to such first taxable year,
during the United States person's holding
period (as defined in paragraph (f) of this
section) in such stock, and for which such
corporation was not treated as a QEF with
respect to such United States person.

(2) Shareholders other than regulated in-
vestment companies. For the first taxable
year of a United States person (other than
a regulated investment company) for which
a section 1296 election is in effect with re-
spect to the stock of a PFIC, such United
States person shall, in lieu of the rules of
paragraphs (c) and (d) of this section-

(i) Apply the rules of section 1291 to any
distributions with respect to, or disposi-
tion of, section 1296 stock;

(ii) Apply section 1291 to the amount of
the excess, if any, of the fair market value
of such section 1296 stock on the last day
of the United States person's taxable year
over its adjusted basis, as if such amount
were gain recognized from the disposi-
tion of stock on the last day of the taxpay-
er's taxable year; and

(iii) Increase its adjusted basis in the sec-
tion 1296 stock by the amount of excess,
if any, subject to section 1291 under para-
graph (i)(2)(ii) of this section.

(3) Shareholders that are regulated in-
vestment companies. For the first taxable
year of a regulated investment company for
which a section 1296 election is in effect
with respect to the stock of a PFIC, such
regulated investment company shall in-
crease its tax under section 852 by the
amount of interest that would have been im-
posed under section 1291(c)(3) for such tax-
able year if such regulated investment
company were subject to the rules of para-
graph (i)(2) of this section, and not this
paragraph (i)(3). No deduction or increase
in basis shall be allowed for the increase
in tax imposed under this paragraph (i)(3).

(4) The operation of the rules of this
paragraph (i) is illustrated by the follow-
ing examples.

Example 1. A, a United States person and a cal-
endar year taxpayer, owns marketable stock in a PFIC
that it acquired on January 1, 1995. At all times, A's
PFIC stock was a nonqualified fund subject to taxa-
tion under section 1291. A made a timely section 1296
election effective for taxable year 2003. At the close
of taxable year 2003, the fair market value of A's PFIC
stock exceeded its adjusted basis by $10. Pursuant to
paragraph (i)(2)(ii) of this section, A must treat the $10
gain under section 1291 as if the stock were dis-
posed of on December 31, 2003. Further, A will in-
crease its adjusted basis in the PFIC stock by the $10
in accordance with paragraph (i)(2)(iii) of this sec-
tion.

Example 2. Assume the same facts as in Example
1, except that A is a RIC. In taxable year 2003, A
would include $10 of ordinary income under para-
graph (c)(1) of this section, and such amount will not
be subject to section 1291. A also must increase its
tax imposed under section 852 by the amount of in-
terest that would have been determined under sec-
tion 1291(c)(3), and no deduction will be permitted
for such amount. Finally, under paragraph (d)(1) of
this section, A will increase its adjusted basis in the
PFIC stock by $10.

(j) Effective Date. The provisions is this
section are applicable as of the date final
regulations are published in the Federal
Register.

* * * * *

Par. 5. Section 1.1296(e)-1 is amended
by:

1\. Revising paragraph (b)(2).

2\. Adding paragraph (b)(3).

3\. Revising both references to "sec-
tions 958(a)(1) and (2)" in paragraph (f)(1)
to read "section 1298(a)".

The revision and addition reads as
follows:

§ 1.1296(e)-1 Definition of marketable
stock.

* * * * *

(b) * * *

(2) Special rule for year of initial pub-
lic offering. For the calendar year in which
a corporation initiates a public offering of
a class of stock for trading on one or more
qualified exchanges or other markets, as de-
fined in paragraph (c) of this section, such
class of stock meets the requirements of
paragraph (b)(1) of this section for such year
if the stock is regularly traded on such ex-
changes or markets, other than in de mini-
mis quantities, on 1/6 of the days remaining
in the quarter in which the offering oc-
curs, and on at least 15 days during each
remaining quarter of the taxpayer's calen-
dar year. In cases where a corporation ini-
tiates a public offering of a class of stock

in the fourth quarter of the calendar year,
such class of stock meets the requirements
of paragraph (b)(1) of this section in the cal-
endar year of the offering if the stock is
regularly traded on such exchanges or mar-
kets, other than in de minimis quantities, on
the greater of 1/6 of the days remaining in
the quarter in which the offering occurs, or
5 days.

(3) Anti-abuse rule. Trades that have as
one of their principal purposes the meet-
ing of the trading requirements of para-
graph (b)(1) or (2) of this section shall be
disregarded. Further, a class of stock shall
not be treated as meeting the trading re-
quirement of paragraph (b)(1) or (2) of this
section if there is a pattern of trades con-
ducted to meet the requirement of para-
graph (b)(1) or (2) of this section. Similarly,
paragraph (b)(2) of this section shall not ap-
ply to a public offering of stock that has as
one of its principal purposes to avail it-
self of the reduced trading requirements un-
der the special rule for the calendar year of
an initial public offering. For purposes of
applying the immediately preceding sen-
tence, consideration will be given to
whether the trading requirements of para-
graph (b)(1) of this section are satisfied in
the subsequent calendar year.

* * * * *

Par. 6. Section 1.6031(a)-1 is amended
by:

1\. Redesignating the text of paragraph
(b)(1) as (b)(1)(i).

2\. Adding a heading to newly desig-
nated paragraph (b)(1)(i).

3\. Adding paragraph (b)(1)(ii).
The additions read as follows:

§ 1.6031(a)-1 Return of Partnership in-
come.

* * * * *

(b) * * * (1) * * * (i) Filing require-
ment. * * *

(ii) Special rule. For purposes of this
paragraph (b)(1) and paragraph (b)(3)(iii)
of this section, a foreign partnership will not
be considered to have derived income from
sources within the United States solely be-
cause a U.S. partner marks to market his
pro rata share of PFIC stock held by the
foreign partnership pursuant to an elec-
tion under section 1296.

* * * * *

Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue

(Filed by the Office of the Federal Register on July 30, 2002,
8:45 a.m., and published in the issue of the Federal Regis-
ter for July 31, 2002, 67 F.R. 49634)

## Notice of Proposed Rulemaking and Notice of Public Hearing

## Redemptions Taxable as Dividends

### REG-150313-01

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Notice of proposed
rulemaking and notice of public hearing.

SUMMARY: This document contains pro-
posed regulations that provide guidance re-
garding the treatment of the basis of
redeemed stock when a distribution in re-
demption of such stock is treated as a divi-
dend, as well as guidance regarding certain
acquisitions of stock by related corpora-
tions that are treated as distributions in re-
demption of stock. The proposed regulations
affect shareholders whose stock in a cor-
poration is redeemed or is acquired by a
corporation related to the issuer of the stock,
and are necessary to provide such share-
holders with guidance regarding the treat-
ment of the basis of such stock. This
document also provides notice of a pub-
lic hearing on these proposed regulations.

DATES: Written or electronic comments
must be received by January 16, 2003. Re-
quests to speak and outlines of topics to be
discussed at the public hearing scheduled
for February 20, 2003, at 10 a.m. must be
received by January 30, 2003.

ADDRESSES: Send submissions to:
CC:ITA:RU (REG-150313-01), room 5226,
Internal Revenue Service, POB 7604, Ben
Franklin Station, Washington, DC 20044.
Submissions may be hand delivered Mon-
day through Friday between the hours of
8 a.m. and 5 p.m. to: CC:ITA:RU (REG-
150313-01), Courier's desk, Internal Rev-
enue Service, 1111 Constitution Avenue,

NW, Washington, DC 20224. Alternatively,
taxpayers may submit electronic comments
directly to the IRS Internet site at
www.irs.gov/regs. The public hearing will
be held in Room 4718, Internal Revenue
Building, 1111 Constitution Avenue, NW,
Washington, DC.

FOR FURTHER INFORMATION
CONTACT: Concerning the proposed regu-
lations generally, Lisa K. Leong, (202) 622-
7530; concerning issues under sections 367,
861 and 864 of the Internal Revenue Code,
Aaron A. Farmer, (202) 622-3860; con-
cerning submissions of comments, the hear-
ing, and/or to be placed on the building
access list to attend the hearing, Treena V.
Garrett, (202) 622-7180 (not toll-free num-
bers).

SUPPLEMENTARY INFORMATION:

## Paperwork Reduction Act

The collection of information contained
in this notice of proposed rulemaking has
been submitted to the Office of Manage-
ment and Budget for review in accordance
with the Paperwork Reduction Act of 1995
(44 U.S.C. 3507(d)). Comments on the col-
lection of information should be sent to the
Office of Management and Budget, Attn:
Desk Officer for the Department of the
Treasury, Office of Information and Regu-
latory Affairs, Washington, DC 20503, with
copies to the Internal Revenue Service,
Attn: IRS Reports Clearance Officer,
W:CAR:MP:FP:S, Washington, DC 20224.
Comments on the collection of informa-
tion should be received by December 17,
2002. Comments are specifically requested
concerning:

Whether the proposed collection of in-
formation is necessary for the proper per-
formance of the functions of the IRS,
including whether the information will have
practical utility;

The accuracy of the estimated burden as-
sociated with the proposed collection of in-
formation (see below);

How the quality, utility, and clarity of the
information to be collected may be en-
hanced;

How the burden of complying with the
proposed collection of information may be
minimized, including through the applica-
tion of automated collection techniques or
other forms of information technology; and

Estimates of capital or start-up costs and
costs of operation, maintenance, and pur-
chase of services to provide information.

The collection of information in these
proposed regulations is in § 1.302-5(e) and
§ 1.1502-19(b)(5)(v). This collection of in-
formation is required by the IRS to verify
compliance with section 302. This infor-
mation will be used to determine whether
the amount of tax has been calculated cor-
rectly. The collection of information is re-
quired to properly determine the amount
permitted to be taken into account as a loss.
The respondents are shareholders (includ-
ing individuals, corporations and pass-
through entities) whose stock in a
corporation is redeemed or is treated as re-
deemed.

Estimated total annual reporting burden:
1,500 hours.

Estimated average annual burden per
respondent: 30 minutes.

Estimated number of respondents: 3,000.
Estimated annual frequency of responses:
On occasion.

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

Books or records relating to a collec-
tion of information must be retained as long
as their contents may become material in
the administration of any internal revenue
law. Generally, tax returns and tax return
information are confidential, as required by
26 U.S.C. 6103.

## Background

This document contains proposed revi-
sions and amendments to the Income Tax
Regulations (26 CFR part 1) under sec-
tions 302, 304, 704, 861, 1371, 1374, and
1502 of the Internal Revenue Code (Code).
The proposed regulations would amend the
temporary and final regulations under sec-
tions 302, 304, 704, 861, 1371, 1374, and
1502 to provide guidance concerning the
treatment of the basis of stock redeemed or
treated as redeemed where the redemp-
tion proceeds are treated as a dividend dis-
tribution. These proposed regulations would
also amend the final regulations under sec-
tion 304 to conform them to certain of the
amendments made to section 304 by leg-
islation, including section 226 of the Tax
Equity and Fiscal Responsibility Act of

1982, Public Law 97-248 (96 Stat. 325,
490) (September 3, 1982), section 712(l) of
the Deficit Reduction Act of 1984, Public
Law 98-369 (98 Stat. 494, 953-55) (July
18, 1984), section 1875(b) of the Tax Re-
form Act of 1986, Public Law 99-514 (100
Stat. 2085, 2894) (October 22, 1986), and
section 1013 of the Taxpayer Relief Act of
1997, Public Law 105-34 (111 Stat. 788,
918) (August 5, 1997).

### A. The Character of Property Received in Redemption of Stock

Section 302 of the Code governs the tax
treatment of distributions in redemption of
stock. The rules of section 302 attempt to
distinguish between distributions that "may
have capital-gain characteristics because
they are not made pro rata among the vari-
ous shareholders" and distributions "char-
acterized by what happens solely at the
corporate level by reason of the assets dis-
tributed." S. Rep. No. 1622, 83d Cong., 2d
Sess. 49 (1954). Section 302(a) provides
that a corporation's redemption of its stock
is treated as a distribution in part or full
payment in exchange for the stock if the re-
demption satisfies any one of the follow-
ing criteria: (1) the redemption is not
essentially equivalent to a dividend (sec-
tion 302(b)(1)); (2) the redemption is sub-
stantially disproportionate (section
302(b)(2)); (3) the redemption completely
terminates the redeemed shareholder's in-
terest (section 302(b)(3)); or (4) the re-
demption is in connection with a qualifying
partial liquidation (section 302(b)(4)). If a
redemption satisfies none of these crite-
ria, pursuant to section 302(d), the redemp-
tion is treated as a distribution of property
to which section 301 applies.

Under sections 301(c)(1) and 316(a), a
distribution is treated as a dividend to the
extent of the redeeming corporation's earn-
ings and profits. Any portion of the distri-
bution that is not treated as a dividend is
first applied against the adjusted basis of
the redeemed stock to the extent of such ba-
sis under section 301(c)(2), and then treated
as gain from the sale or exchange of prop-
erty under section 301(c)(3).

### B. The Character of Property Received in Certain Stock Acquisitions

The redemption rules of section 302 are
implicated not only when an issuing cor-
poration acquires its own stock, but also in
the case of certain stock acquisitions by cor-

porations related to the issuer of the ac-
quired stock. Pursuant to section 304(a)(1),
an acquisition of stock by a corporation
from one or more persons that are in con-
trol of both the acquiring and issuing cor-
porations is treated as if the property
received in respect of the acquired stock
were a distribution in redemption of the
stock of the acquiring corporation. Prior to
the amendments made by the Taxpayer Re-
lief Act of 1997, section 304 provided that,
to the extent that the deemed distribution
was treated as a distribution to which sec-
tion 301 applies, the stock acquired was
treated as having been transferred by the
person from whom acquired and as hav-
ing been received by the corporation ac-
quiring it, as a contribution to the capital
of such corporation. The Taxpayer Relief
Act of 1997 amended section 304(a)(1) to
provide that, to the extent that this deemed
distribution is treated as a distribution to
which section 301 applies, the shareholder
and the acquiring corporation are treated as
if the shareholder had transferred the stock
of the issuing corporation to the acquir-
ing corporation in exchange for stock of the
acquiring corporation in a transaction to
which section 351(a) applies, and then the
acquiring corporation had redeemed the
stock it was treated as issuing in that trans-
action. Pursuant to section 304(a)(2), an ac-
quisition of stock by a corporation
controlled by the issuer of the acquired
stock is treated as if the property received
in respect of the acquired stock was a dis-
tribution in redemption of the stock of the
issuing corporation.

For purposes of section 304, control
means the ownership of stock possessing
at least 50 percent of either the total com-
bined voting power of all classes of stock
entitled to vote or the total value of shares
of all classes of stock. The determination
of the amount and source of the distribu-
tion that is treated as a dividend is made
as if the property received in respect of the
redeemed stock were distributed by the ac-
quiring corporation to the extent of its earn-
ings and profits and then by the issuing
corporation to the extent of its earnings and
profits. Because section 304 recharacter-
izes certain stock acquisition transactions
as redemptions of stock, transactions to
which section 304 applies implicate the re-
demption rules of section 302.

C. The Unutilized Basis of Stock
Redeemed in Certain Transactions

While sections 301 and 302 clearly set
forth the character of property received in
a redemption (whether actual or deemed)
of stock, they do not prescribe the tax treat-
ment of the unutilized basis of the redeemed
stock or the stock treated as redeemed. In
1955, the IRS and Treasury promulgated
regulations under section 302 that pro-
vide guidance in this regard in the case of
an actual redemption of stock. Section
1.302-2(c) of the Income Tax Regulations
states that "[i]n any case in which an
amount received in redemption of stock is
treated as a distribution of a dividend,
proper adjustment of the basis of the re-
maining stock will be made with respect to
the stock redeemed." The regulation con-
tains examples illustrating what consti-
tutes a proper adjustment. In Example 1 and
Example 3, the redeemed shareholder ac-
tually owns stock of the redeeming corpo-
ration immediately after a redemption that
is treated as a distribution of a dividend. In
those cases, the basis of the shares of the
redeeming corporation that the shareholder
owns after the redemption is increased by
the basis of the redeemed shares. See also
United States v. Davis, 397 U.S. 301 (1970)
(interpreting § 1.302-2(c) to shift the ba-
sis of redeemed stock to other shares held
by the redeemed shareholder, even where
those other shares are of a different class
of stock than those redeemed); Rev. Rul.
66-37, 1966-1 C.B. 209 (same). In Ex-
ample 2, although the redeemed share-
holder actually owns no stock of the
redeeming corporation immediately after a
redemption that is treated as a distribu-
tion of a dividend, he does constructively
own stock of the redeeming corporation im-
mediately after the redemption by reason
of his wife's continuing ownership of stock
of the redeeming corporation. The example
concludes that the redeemed sharehold-
er's basis in the redeemed shares shifts to
his wife's basis in her shares of stock of the
redeeming corporation.

In addition, on December 2, 1955, the
IRS and Treasury promulgated §§ 1.304-
2(a) and 1.304-3(a). With respect to an ac-
quisition of stock by a related corporation
(other than a subsidiary), § 1.304-2(a) pro-
vides that the transferor's basis for his stock
in the acquiring corporation is increased by
the basis of the stock of the issuing cor-
poration surrendered by him. Similarly, with

respect to an acquisition of stock by a sub-
sidiary, § 1.304-3(a) provides that the trans-
feror's basis in his remaining stock in the
parent corporation is increased by the ba-
sis of the stock deemed redeemed by the
parent corporation. The treatment of the
transferor's unutilized basis in stock of the
issuing corporation as a result of transac-
tions subject to section 304(a) is the sub-
ject of Revenue Ruling 70-496, 1970-2
C.B. 74, and Revenue Ruling 71-563,
1971-2 C.B. 175.

In Revenue Ruling 70-496, a first-tier
subsidiary (Y) of a parent corporation (X)
sold all of its stock in a second-tier sub-
sidiary of X (S) to another first-tier sub-
sidiary of X (Z). The ruling concludes that
the transaction is governed by sections
304(a)(1) and 302(d). Accordingly, the rul-
ing holds that the sales proceeds consti-
tute dividends to the extent of Z's earnings
and profits and, to the extent in excess of
such amount, constitute gain under sec-
tion 301(c)(3). With respect to Y's basis in
the sold S stock, the ruling holds that be-
cause Y had no direct stock ownership in
Z before or after the sale, Y's basis in the
S stock surrendered disappears and can-
not be used to increase the basis of any as-
set of Y.

In Revenue Ruling 71-563, A, an indi-
vidual, owned all the stock of X. C, A's son,
owned all of the outstanding stock of Y. A
sold 25 percent of its stock in X to Y for
cash. The ruling states that, under section
304(a)(1), the sale is treated as a contri-
bution by A of the stock of X to the capi-
tal of Y and a distribution to A by Y in
redemption of its stock. Because the deemed
redemption is governed by section 302(d),
the cash received is taxable as a dividend
to A under section 301(c)(1). Furthermore,
the ruling reasons that, because A owns no
stock in Y directly after the transaction, the
basis of the X stock should be added to the
basis of the remaining stock of X that A
continues to own after the transaction.

The current regulatory regime preserves,
and prevents the elimination of, basis in
transactions subject to section 302 where
a proper adjustment may be made to the ba-
sis of the remaining stock of the redeem-
ing corporation and in transactions subject
to section 304 where, immediately after the
transaction, the seller owns stock of the ac-
quiring corporation. In certain transac-
tions, however, taxpayers have taken the
position that certain adjustments are proper,

even if they shift basis from a person that
is not subject to U.S. tax to a person that
is subject to U.S. tax or to stock other than
stock of the redeeming corporation. No-
tice 2001-45, 2001-2 C.B. 129, describes
a type of transaction with respect to which
taxpayers have taken the position that, un-
der § 1.302-2(c), all or a portion of the ba-
sis of stock redeemed from a person that
is not subject to U.S. tax or is otherwise in-
different to the Federal income tax conse-
quences of the redemption of the stock is
added to the basis of other stock in the re-
deeming corporation owned by a taxpayer
that is subject to U.S. tax to create a loss
on the disposition of the other stock. Al-
though the IRS intends to challenge the ad-
justments claimed in such transactions, the
IRS and Treasury believe it is desirable to
revise the rules that govern accounting for
unutilized basis attributable to redeemed
stock to better reflect the purposes of the
relevant Code provisions.

## Explanation of Provisions

### A. Rules Under Section 302

This notice of proposed rulemaking pro-
poses a replacement for the "proper ad-
justment" regime of current § 1.302-2(c) for
taking into account the unutilized basis at-
tributable to redeemed stock in any case in
which a redemption of stock is treated as
a distribution of property to which sec-
tion 301 applies. The rules are proposed to
apply both where the redeemed shareholder
actually owns no stock of the redeeming
corporation immediately after the redemp-
tion (a complete redemption) and where the
redeemed shareholder actually owns stock
of the redeeming corporation immediately
after the redemption (a partial redemp-
tion). While consideration was given to re-
taining the "proper adjustment" rule of
current § 1.302-2(c) where only a por-
tion of the shareholder's interest in the re-
deeming corporation is redeemed, the IRS
and Treasury believe the two situations are
similar enough to warrant the same rules,
and that the rules proposed herein best carry
out the purposes of section 302 even where
the redeemed shareholder continues di-
rectly to own stock in the redeeming cor-
poration because, even in that case, dividend
treatment under section 302 may have re-
sulted from shares owned by attribution
rather than directly. The following para-
graphs describe the proposed rules.

### 1. General description of the proposed rules

Certain transactions that, in form, in-
volve the redemption of shares are eco-
nomically identical or similar to distributions
to shareholders that do not involve any re-
demption of shares. For example, if a single
shareholder owns all of the stock of the re-
deeming corporation, the redemption of
some shares from that shareholder for cash
is economically indistinguishable from the
mere distribution of corporate cash to the
shareholder. In recognition of this, sec-
tion 302 taxes these transactions as corpo-
rate distributions notwithstanding their form
as redemptions. The underlying premise of
section 302 is that distribution treatment is
called for in these cases because, in ef-
fect, the redeemed shareholder still owns (or
is treated as owning) its stock in the cor-
poration, even if it may have turned in some
physical shares.

Although section 302 does not provide
any explicit guidance regarding the share-
holder's basis of the shares redeemed, in de-
riving a regulatory regime to address the
treatment of the unutilized basis of re-
deemed stock, it is appropriate to con-
sider what happens when a shareholder
receives a distribution and keeps its shares,
because that analogy underlies distribu-
tion treatment under section 302. Because
the Code does not permit basis to offset any
portion of the redemption distribution that
is treated as a dividend, and because such
an offset is not available when a corpora-
tion distributes a dividend and the share-
holder retains its shares, the redemption date
is not the appropriate time to recover the
unutilized basis of the redeemed stock.
However, if the shareholder receives a dis-
tribution and retains its shares, it also re-
tains its basis, which it can recover later in
situations other than dividends, such as the
sale of the shares. Accordingly, the unuti-
lized basis of the redeemed stock should not
disappear and should be taken into ac-
count for Federal income tax purposes at
some time. In addition, any tax benefit as-
sociated with the unutilized basis of re-
deemed stock should remain with the
taxpayer that made, or succeeded to, the in-
vestment that gave rise to the unutilized ba-
sis. Accordingly, these regulations propose
that, in any case where a redemption of
stock is treated as a distribution of a divi-
dend, an amount equal to the adjusted ba-
sis of the redeemed stock is treated as a loss

recognized on the disposition of the re-
deemed stock on the date of the redemp-
tion. That loss is taken into account as
described below.

Once the facts and circumstances that
caused the redemption distribution to be
treated as a distribution subject to section
301 no longer exist (i.e., the redeemed
shareholder has sufficiently reduced its ac-
tual and constructive ownership interest in
the redeeming corporation), these regula-
tions permit the loss attributable to the un-
utilized basis of redeemed stock that has not
previously been taken into account to be
taken into account. The first date on which
the redeemed shareholder would satisfy the
criteria of section 302(b)(1), (2) or (3) if the
facts and circumstances that exist on such
date had existed immediately after the re-
demption is referred to as the "final inclu-
sion date." In addition, a date is the final
inclusion date if there is no later date on
which the redeemed shareholder could take
the loss into account. For example, if the
redeemed shareholder is an individual, the
final inclusion date includes the date of
death of such individual. If the redeemed
shareholder is a corporation, the final in-
clusion date includes the date such corpo-
ration transfers its assets in a liquidation
described in section 331. If the redeemed
shareholder is a foreign corporation, the fi-
nal inclusion date includes the date such
corporation transfers its assets to a domes-
tic corporation in either a liquidation de-
scribed in section 332 or a reorganization
described in section 368(a)(1) to which sec-
tion 381 applies. If the redeemed share-
holder is a foreign corporation that is not
a controlled foreign corporation, within the
meaning of section 957(a), on the date of
the redemption, the term final inclusion date
includes the date such corporation trans-
fers its assets to a controlled foreign cor-
poration in a liquidation described in section
332 or a reorganization described in sec-
tion 368(a)(1) to which section 381 ap-
plies.

These proposed regulations also pro-
vide that the redeemed shareholder is per-
mitted to take into account the loss
attributable to the unutilized basis of re-
deemed stock when the redeemed share-
holder recognizes a gain on stock of the
redeeming corporation to the extent of the
gain recognized. Any date on which the re-
deemed shareholder must take into ac-
count gain recognized pursuant to section

301(c)(3) or gain recognized on a dispo-
sition of stock of the redeeming corpora-
tion is referred to as an "accelerated loss
inclusion date." Although there can be only
one final inclusion date, there can be sev-
eral accelerated loss inclusion dates.

Because the loss attributable to the ba-
sis of the redeemed stock is treated as rec-
ognized on a disposition of the redeemed
stock on the redemption date, the attributes
(e.g., character and source) of that loss are
fixed on the redemption date, even if such
loss is not taken into account until after the
redemption date. For example, if a corpo-
ration redeems its stock from a shareholder
within one year after the shareholder's ac-
quisition of such stock and the proceeds of
the redemption are treated as a dividend dis-
tribution, the character of any amount of the
loss that is taken into account is treated as
short-term capital loss (assuming the re-
deemed shareholder held the redeemed
stock as a capital asset), even if such loss
is taken into account more than one year
after the redeemed shareholder's acquisi-
tion of the redeemed stock. Nonetheless, for
purposes of the carryforward and carry-
back provisions of sections 172 and 1212,
such loss is treated as a loss for the tax-
able year in which it is taken into account
rather than for the taxable year of the stock
redemption that gave rise to such loss.

Because a redemption of stock may give
rise to, or increase, an excess loss account
in redeemed stock where the redeemed
shareholder and the redeeming corpora-
tion are members of the same consoli-
dated group, these regulations propose rules
similar to those described above where the
redeemed shareholder has an excess loss ac-
count in the redeemed stock.

These proposed regulations do not ap-
ply on the redemption of stock described
in section 306(c). Pursuant to section
306(a)(2), a redemption of stock described
in section 306(c) is treated as a distribu-
tion of property to which section 301 ap-
plies. Example 2 of § 1.306-1 suggests that
the unutilized basis of redeemed section 306
stock is added back to the basis of the stock
with respect to which the section 306 stock
was distributed. The IRS and Treasury re-
quest comments on whether such treat-
ment of the unutilized basis of redeemed
section 306 stock is appropriate or whether
an alternative regime should apply when
such a redemption is treated as a distribu-
tion to which section 301 applies.

### 2. Special issues related to certain pass-through entities

Where stock is redeemed from a part-
nership and all or a portion of the distri-
bution in redemption of such stock is treated
as a dividend, any loss attributable to the
basis of redeemed stock is treated as a cur-
rent loss to the partnership on the date of
the redemption. To the extent of the lesser
of the amount of such distribution that is
treated as a dividend and such loss that is
not allocated pursuant to section 704(c) and
the regulations thereunder, the dividend and
the loss must be allocated in equal amounts.
Such amounts must be allocated in accor-
dance with the partners' interests in the part-
nership. An allocation will be deemed to be
in accordance with a partner's interest in the
partnership if the allocation is in the same
proportion as the allocation of (i) the ex-
cess of the dividend income over the loss
attributable to the basis of the redeemed
stock, if any, (ii) the excess of the loss at-
tributable to the basis of the redeemed stock
over the dividend income, if any, or, (iii)
if neither, in the same proportion as the part-
nership's net taxable income or loss for the
year is allocated. This rule ensures that the
benefit of the loss may be realized by the
person to whom the dividend income was
allocated. The excess dividend or loss at-
tributable to the basis of redeemed stock
must be allocated in a manner that takes
into account the requirements of section
704.

The loss attributable to the basis of re-
deemed stock allocated to a partner under
the rules of this section is not taken into ac-
count at the partner level until the final in-
clusion date or an accelerated loss inclusion
date, as applicable. For purposes of deter-
mining whether a particular date is the fi-
nal inclusion date with respect to such a
loss, if the partner is a partner of the part-
nership on such date, the partnership is
treated as the redeemed shareholder. Oth-
erwise, the former partner is treated as the
redeemed shareholder and the determina-
tion of whether a particular date is the fi-
nal inclusion date is made by comparing
such former partner's actual and construc-
tive ownership of the redeeming corpora-
tion immediately prior to the redemption to
such former partner's actual and construc-
tive ownership of the redeeming corpora-
tion at the end of such particular date. For
purposes of determining whether a particu-
lar date is an accelerated loss inclusion date

with respect to a loss attributable to the ba-
sis of redeemed stock that is allocated to
a partner from a partnership, the partner is
treated as the redeemed shareholder. Simi-
lar rules are proposed to apply where stock
is redeemed from an S corporation.

The proposed regulations provide that
where stock is redeemed from a C corpo-
ration, and the C corporation subsequently
elects to be taxed as an S corporation, any
loss attributable to the basis of redeemed
stock that has not been taken into account
at the time of the election is treated as a car-
ryforward arising in a taxable year for
which the corporation was a C corpora-
tion. Such loss is allowed as a deduction
against net recognized built-in gain under
section 1374 in the year of the final inclu-
sion date or an accelerated loss inclusion
date.

To the extent that a trust from which
stock is redeemed is wholly or partially a
grantor trust, the proposed rules treat the re-
deemed stock as having been owned di-
rectly by the grantor. When stock is
redeemed from an estate or from a trust that
is not a wholly grantor trust, and all or a
portion of a distribution in redemption of
such stock is treated as a dividend, any loss
attributable to the basis of redeemed stock
that is not attributable to the basis of re-
deemed stock treated as owned by the
grantor is not taken into account by such
estate or trust until the final inclusion date
or an accelerated loss inclusion date. In that
case, whether a particular date is the final
inclusion date or an accelerated loss inclu-
sion date is determined by treating such es-
tate or trust, not its beneficiaries, as the
redeemed shareholder. In the event that the
trust or estate terminates before it has been
permitted to take into account all of the loss
attributable to the basis of redeemed stock,
any remaining loss is treated as a loss un-
der section 172 or section 1212 for pur-
poses of section 642(h) (regarding the
availability to beneficiaries of unused loss
carryovers and excess deductions of an es-
tate or trust upon termination). Each ben-
eficiary's interest in the loss distributed
under section 642(h), however, shall be lim-
ited to the proportion of that loss that is
equal to the proportion of the total amount
of the distribution treated as a dividend that
is represented by that beneficiary's benefi-
cial interest in that dividend. Once all or a
portion of such a loss is distributed to a ben-

eficiary, whether a particular date is the fi-
nal inclusion date or an accelerated loss
inclusion date with respect to such a loss
is determined by treating such beneficiary
as the redeemed shareholder.

### 3. Special rules related to apportionment of interest and other expenses

Under section 864(e), taxpayers appor-
tion interest expense between U.S. and for-
eign source income on the basis of the
relative values of their U.S. and foreign as-
sets. For this purpose, taxpayers may choose
to value their assets using either fair mar-
ket value or tax book value (adjusted ba-
sis). If the taxpayer apportions interest
expense using tax book value, the adjusted
basis of stock in any nonaffiliated 10 per-
cent owned corporation (as defined in sec-
tion 864(e)(4)(B)) is increased by the
amount of earnings and profits (and re-
duced by any deficits in earnings and prof-
its) attributable to such stock that
accumulated during the period the tax-
payer held such stock. The proposed regu-
lations provide that for purposes of
apportioning expenses on the basis of the
tax book value of assets, the adjusted ba-
sis in any remaining shares of the redeem-
ing corporation that are owned by the
redeemed shareholder or certain affiliated
corporations will be increased by the
amount of the unutilized basis of redeemed
stock. This adjustment is intended to pro-
vide consistent interest allocation conse-
quences in the case of dividends and
redemptions treated as dividends by non-
affiliated 10 percent owned corporations.

### B. Revisions to Regulations Under Section 304

The current regulations under section 304
do not reflect all of the legislative amend-
ments that have been made to section 304.
This notice of proposed rulemaking pro-
poses certain revisions to the current regu-
lations under section 304 to incorporate
these legislative amendments to the ex-
tent that those legislative amendments are
relevant to the issues that are subject to the
proposed regulations under section 302. In
particular, these revisions reflect the amend-
ments to section 304 made by section 1013
of the Taxpayer Relief Act of 1997, Pub-
lic Law 105-34 (111 Stat. 788, 918) (Au-
gust 5, 1997), that provide that, to the extent
that a stock acquisition to which section

304(a)(1) applies is treated as a distribu-
tion to which section 301 applies, the trans-
feror and the acquiring corporation are
treated as if (1) the transferor transferred the
stock of the target corporation to the ac-
quiring corporation in exchange for stock
of the acquiring corporation in a transac-
tion to which section 351(a) applies, and (2)
the acquiring corporation then redeemed the
stock it is treated as having issued. The
same rules that govern an actual redemp-
tion govern a deemed redemption.

In transactions under section 304 that in-
volve one or more foreign corporations, fur-
ther consequences may apply under the
international provisions of the Code. For ex-
ample, where target corporation stock is
transferred to a foreign corporation in the
deemed section 351 transaction, section 367
and the regulations promulgated thereun-
der apply to the transfer. See Rev. Rul.
91-5, 1991-1 C.B. 114, (holding that sec-
tion 367 applied to the deemed contribu-
tion to capital of the target corporation stock
under prior law because section 367(c)(2)
resulted in the stock transfer constituting a
section 351 transaction). The IRS intends
to issue guidance on the application of the
international provisions to section 304 trans-
actions and requests comments on such
transactions, including what changes, if any,
to existing published guidance may be ap-
propriate in light of the 1997 amendments
to section 304.

## Proposed Effective Date

These regulations are proposed to ap-
ply to transactions occurring after the date
these regulations are published as final regu-
lations in the Federal Register.

## Special Analyses

It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Ex-
ecutive Order 12866. It is hereby certified
that the collection of information in this No-
tice of Proposed Rulemaking will not have
a significant economic impact on a sub-
stantial number of small entities. This cer-
tification is based upon the fact that the IRS
and Treasury estimate that at most 3,000
taxpayers will be subject to these require-
ments and most of those taxpayers will be
individuals or large businesses. There-
fore, a Regulatory Flexibility Analysis un-
der the Regulatory Flexibility Act (5 U.S.C.

chapter 6) is not required. Pursuant to sec-
tion 7805(f), this notice of proposed rule-
making will be submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comment on its im-
pact on small business.

## 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
February 20, 2003, beginning at 10 a.m. in
Room 4718 of the Internal Revenue Build-
ing, 1111 Constitution Avenue, NW, Wash-
ington, DC. Due to building security
procedures, visitors must enter at the Con-
stitution Avenue entrance. In addition, all
visitors must present photo identification to
enter the building. Because of access re-
strictions, visitors will not be admitted be-
yond the immediate entrance area more than
30 minutes before the hearing starts. For in-
formation about having your name placed
on the building access list to attend the hear-
ing, see the FOR FURTHER INFORMA-
TION CONTACT portion of this preamble.

The rules of 26 CFR 601.601(a)(3) ap-
ply to the hearing. Persons who wish to
present oral comments must submit writ-
ten or electronic comments and an out-
line of the topics to be discussed and the
time to be devoted to each topic (a signed
original and eight (8) copies) by January 30,
2003. A period of 10 minutes will be al-
lotted to each person for making com-
ments. An agenda showing the scheduling
of the speakers will be prepared after the
deadline for receiving outlines has passed.
Copies of the agenda will be available free
of charge at the hearing.

## Drafting Information

The principal author of these proposed
regulations is Lisa K. Leong of the Of-
fice of the Associate Chief Counsel (Cor-
porate), IRS. However, other personnel from
the IRS and Treasury participated in their
development.

* * * * *

## Proposed Amendments to the Regula- tions

Accordingly, 26 CFR part 1 is proposed
to be amended as follows:

### PART 1- INCOME TAXES

Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * *

#### § 1.302-2 [Amended]

Par. 2. In § 1.302-2, paragraph (c) is re-
moved.

Par. 3. Section 1.302-5 is added to read
as follows:

§ 1.302-5 Redemptions taxable as
dividends.

(a) In general. In any case in which an
amount received in redemption of stock is
treated as a distribution of a dividend, an
amount equal to the basis of the redeemed
stock, after adjusting such basis to reflect
the application of section 301(c)(2), 961(b),
1059, § 1.1502-32, or any other appli-
cable provision of the Internal Revenue
Code or the regulations thereunder, is treated
as a loss recognized on a disposition of the
redeemed stock on the date of the redemp-
tion. The redeemed shareholder (as de-
fined in paragraph (b)(1) of this section)
shall be permitted to take such loss into ac-
count pursuant to the provisions of this sec-
tion. Although such loss may be taken into
account on a date later than the date of the
redemption, the attributes (e.g., character
and source) of such loss are determined on
the date of the redemption of the stock that
gave rise to such loss. See § 1.1502-
19(b)(5) for rules that apply where an
amount received in redemption of stock is
treated as a dividend and such amount ei-
ther increases or creates an excess loss ac-
count in the redeemed stock.

(b) Definitions-(1) Redeemed share-
holder. Except as provided in paragraphs
(d)(6), (7), and (8) of this section, the re-
deemed shareholder is the person whose
stock is redeemed in a transaction in which
a portion or all of the redemption pro-
ceeds are treated as a dividend. If the as-
sets of the redeemed shareholder are
acquired in a transaction described in sec-

tion 381(a), the acquiring corporation
(within the meaning of section 381) there-
after is treated as the redeemed shareholder.
For rules concerning the person that is
treated as the redeemed shareholder where
the redeemed stock is held by a partner-
ship or an S corporation at the time of the
redemption, see paragraphs (d)(6) and (7)
of this section. For rules concerning the per-
son that is treated as the redeemed share-
holder where the redeemed stock is held by
an estate or a trust not treated as wholly
owned by the grantor or another person at
the time of the redemption and a loss at-
tributable to the basis of such redeemed
stock is distributed to a beneficiary of such
estate or trust, see paragraph (d)(8) of this
section.

(2) Redeeming corporation. Except as
provided in paragraph (d)(5) of this sec-
tion, the redeeming corporation is the cor-
poration that issued the stock that is
redeemed. For rules concerning the entity
that is treated as the redeeming corpora-
tion where the redeeming corporation ceases
to exist in a transaction described in sec-
tion 381(a) or where the redeeming cor-
poration distributes to its shareholders stock
of one or more controlled corporations in
a distribution described in section 355(a),
see paragraph (d)(5) of this section.

(3) Final inclusion date. Except as oth-
erwise provided in paragraphs (d)(5), (6),
(7), and (8) of this section, the final inclu-
sion date is the first date on which the re-
deemed shareholder would satisfy the
criteria of section 302(b)(1), (2), or (3) if
the facts and circumstances that exist at the
end of such day had existed immediately
after the redemption. In addition, a date is
the final inclusion date if there is no later
date on which the redeemed shareholder
could take the loss into account. For pur-
poses of the preceding sentence, the exist-
ence or creation of a limitation under section
382 is not treated as preventing the loss
from being taken into account. For ex-
ample, if the redeemed shareholder is an in-
dividual, the final inclusion date includes
the date of death of such individual. If the
redeemed shareholder is a corporation, the
final inclusion date includes the date such
corporation transfers its assets in a liqui-
dation described in section 331. If the re-
deemed shareholder is a foreign corporation,
the final inclusion date includes the date
such corporation transfers its assets to a do-

mestic corporation in either a liquidation de-
scribed in section 332 or a reorganization
described in section 368(a)(1) to which sec-
tion 381 applies. If the redeemed share-
holder is a foreign corporation that is not
a controlled foreign corporation, within the
meaning of section 957(a), on the date of
the redemption, the term final inclusion date
includes the date such corporation trans-
fers its assets to a controlled foreign cor-
poration in a liquidation described in section
332 or a reorganization described in sec-
tion 368(a)(1) to which section 381 ap-
plies.

(4) Accelerated loss inclusion date. An
accelerated loss inclusion date is a date
other than the final inclusion date on which
the redeemed shareholder must take into ac-
count gain from an actual or deemed sale
or exchange of stock of the redeeming cor-
poration. For example, the redeemed share-
holder must take into account gain from an
actual or deemed sale or exchange of stock
of the redeeming corporation when such
shareholder receives a distribution with re-
spect to stock of the redeeming corpora-
tion to which section 301(c)(3) applies,
recognizes gain on stock of the redeem-
ing corporation as a result of the applica-
tion of section 475, recognizes gain on a
sale or exchange of stock of the redeem-
ing corporation (even if such gain is char-
acterized as a dividend under section 1248),
recognizes gain in connection with a con-
structive sale of stock of the redeeming cor-
poration within the meaning of section
1259, or is a partner of a partnership or a
shareholder of an S corporation that is al-
located, and must take into account, gain
recognized on the partnership's or S cor-
poration's sale or exchange of stock of the
redeeming corporation.

(c) Inclusion of loss attributable to ba-
sis of redeemed stock-(1) Amount taken
into account on final inclusion date. On the
final inclusion date, the redeemed share-
holder is permitted to take into account the
loss attributable to the basis of redeemed
stock, reduced by the amount of such loss
that was previously taken into account pur-
suant to paragraph (c)(2) of this section.

(2) Amount taken into account on ac-
celerated loss inclusion date. On an accel-
erated loss inclusion date, the redeemed
shareholder is permitted to take into ac-
count the loss attributable to the basis of re-
deemed stock in the amount of the lesser
of-

(i) The amount of such loss reduced by
the amount of such loss previously taken
into account pursuant to this paragraph
(c)(2); and

(ii) The amount of gain recognized with
respect to stock of the redeeming corpo-
ration that must be taken into account by
the redeemed shareholder on such accel-
erated loss inclusion date.

(d) Special rules-(1) Treatment of loss
attributable to basis of redeemed stock. Ex-
cept as otherwise provided in this sec-
tion, for purposes of applying the provisions
of the Internal Revenue Code and the regu-
lations thereunder, any loss attributable to
the basis of redeemed stock that has not
been permitted to be taken into account
shall be treated as a net operating loss car-
ryforward or a capital loss carryforward, as
applicable. For example, for purposes of de-
termining under sections 382 and 383
whether the redeemed shareholder is a loss
corporation that has an ownership change
and whether the loss attributable to the ba-
sis of redeemed stock is a pre-change loss,
any loss attributable to the basis of re-
deemed stock that the redeemed share-
holder is not permitted to take into account
before a testing date shall be treated as a
net operating loss carryforward or a capi-
tal loss carryforward, as applicable, that
arose in the taxable year in which the re-
demption that gave rise to such loss oc-
curred and that can be carried forward to
the taxable year that includes the testing
date. If such loss is treated as a pre-change
loss because of an ownership change on the
testing date, it is subject to the section 382
limitation (and the other rules of section 382
or 383) for any post-change year in which
it is taken into account under paragraph (c)
of this section and any other post-change
year to which it is carried pursuant to sec-
tion 172 or 1212, as applicable, and para-
graph (d)(2) of this section. The order in
which the loss is absorbed (and in which
it absorbs the section 382 limitation (see
§ 1.383-1(d)(2), however, is determined in
a manner consistent with the principles of
section 172 or 1212, as applicable, and
paragraph (d)(2) of this section.

(2) Net operating loss deduction and
capital loss carrybacks and carryovers. For
purposes of sections 172 and 1212, any por-
tion of a loss attributable to the basis of re-
deemed stock shall be treated as occurring
in the taxable year in which the redeemed
shareholder is permitted to take such loss

into account, not the taxable year of the re-
demption that gave rise to such loss. If an
estate or trust terminates before it is per-
mitted to take into account all of the loss
attributable to the basis of redeemed stock,
such loss that it has not been permitted to
take into account is treated as a loss un-
der section 172 or 1212 for purposes of sec-
tion 642(h), provided, however, that the
identification of carryover years of the ben-
eficiaries will be determined in accordance
with the preceding sentence. Notwithstand-
ing the preceding sentence, each benefi-
ciary's interest in the loss distributed under
section 642(h) shall be limited to the pro-
portion of that loss that is equal to the pro-
portion of the total amount of the
distribution treated as a dividend that is rep-
resented by that beneficiary's beneficial in-
terest in that dividend. If a deduction for
any portion of such loss is disallowed by
section 382 or 383 for the taxable year in
which the redeemed shareholder is permit-
ted to take such loss into account, such por-
tion shall be carried forward to subsequent
taxable years under rules similar to the rules
for the carrying forward of net operating
losses or capital losses, as applicable, but
shall be subject to the section 382 limita-
tion (and the other rules of sections 382 and
383) for any post-change year to which it
is carried.

(3) Expenses apportioned on the basis
of assets. For special rules regarding ad-
justments in the case of taxpayers appor-
tioning expenses on the basis of the tax
book value of assets, see § 1.861-
12(c)(2)(vi).

(4) Effect of loss attributable to basis of
redeemed stock on earnings and profits. If
the redeemed shareholder is a corpora-
tion, any loss attributable to the basis of re-
deemed stock is not reflected in such
corporation's earnings and profits before it
is taken into account pursuant to the rules
of paragraph (c) of this section. See, for ex-
ample, §§ 1.312-6(a), 1.312-7, and 1.1502-
33(c)(2).

(5) Successors to the redeeming
corporation-(i) Acquisitive transactions.
If the assets of the redeeming corporation
are acquired by another corporation in a
transaction described in section 381(a), the
determination of whether a particular date
is the final inclusion date or an acceler-
ated loss inclusion date is made by treat-
ing the facts and circumstances that exist
at the end of such day (including the ac-

quisition of the assets of the redeeming cor-
poration) as existing immediately after the
redemption and treating the acquiring cor-
poration (within the meaning of section 381)
as the redeeming corporation.

(ii) Divisive transactions. In general, if
the redeeming corporation distributes to its
shareholders the stock of one or more con-
trolled corporations in a distribution to
which section 355 (or so much of section
356 as relates to section 355) applies, the
loss attributable to the basis of redeemed
stock is allocated among the stock of the
distributing and any controlled corpora-
tions that the redeemed shareholder owns,
actually and constructively pursuant to the
rules of section 318, immediately after the
distribution in proportion to the fair mar-
ket value of the stock of the distributing cor-
poration that the redeemed shareholder is
treated as so owning and the distributed
stock of the controlled corporation that the
redeemed shareholder is treated as so own-
ing. To the extent that such loss is allo-
cated to the stock of the distributing
corporation, the distributing corporation will
be treated as the redeeming corporation for
purposes of determining whether a particu-
lar date is the final inclusion date or an ac-
celerated loss inclusion date with respect to
such loss. To the extent that such loss is al-
located to the stock of a controlled corpo-
ration, such controlled corporation will be
treated as the redeeming corporation for pur-
poses of determining whether a particular
date is the final inclusion date or an accel-
erated loss inclusion date with respect to
such loss. Where the controlled corpora-
tion was wholly owned by the distribut-
ing corporation and all of the stock of the
controlled corporation was distributed to the
shareholders of the distributing corpora-
tion in a distribution to which section 355
(or so much of section 356 as relates to sec-
tion 355) applies, the determination of
whether a particular date is the final inclu-
sion date with respect to a loss that is al-
located to a controlled corporation is made
by treating the redeemed shareholder as
owning a percentage of stock of the con-
trolled corporation immediately prior to the
redemption equal to the percentage of stock
of the distributing corporation the redeemed
shareholder actually and constructively
owned immediately prior to the redemp-
tion. In all other cases, appropriate calcu-
lations shall apply to determine whether a
particular date is the final inclusion date.

(6) Redeemed shareholder is a
partnership-(i) Treatment and alloca-
tion of loss attributable to basis of re-
deemed stock. Where stock is redeemed
from a partnership and all or a portion of
the distribution in redemption of such stock
is treated as a dividend, any loss attribut-
able to the basis of redeemed stock is
treated as a current loss to the partner-
ship on the date of the redemption. To the
extent of the lesser of the amount of such
distribution that is treated as a dividend and
such loss that is not allocated pursuant to
section 704(c) and the regulations there-
under, the dividend and the loss must be al-
located in equal amounts. Such amounts
must be allocated in accordance with the
partners' interests in the partnership. An al-
location will be deemed to be in accor-
dance with a partner's interest in the
partnership if the allocation is in the same
proportion as the allocation of the excess
of the dividend income over the loss at-
tributable to the basis of the redeemed stock,
if any, the excess of the loss attributable to
the basis of the redeemed stock over the
dividend income, if any, or, if neither, in the
same proportion as the partnership's net tax-
able income or loss for the year is allo-
cated. The excess dividend or loss
attributable to the basis of redeemed stock
must be allocated to the partners in a man-
ner that takes into account the require-
ments of section 704. The loss attributable
to the basis of redeemed stock allocated to
a partner under the rules of this section is
not taken into account until the final in-
clusion date or an accelerated loss inclu-
sion date, as provided in this section.

(ii) Identification of redeemed share-
holder. For purposes of determining whether
a particular date is the final inclusion date
with respect to a loss that is allocated to a
partner, if the partner is a partner of the
partnership at the end of such day, the part-
nership is treated as the redeemed share-
holder. If the partner is not a partner of the
partnership at the end of such day, the
former partner is treated as the redeemed
shareholder and the determination of
whether such date is the final inclusion date
is made by comparing such former part-
ner's actual and constructive ownership of
the redeeming corporation immediately prior
to the redemption to such former part-
ner's actual and constructive ownership of
the redeeming corporation at the end of
such particular day. For purposes of deter-

mining whether a particular date is an ac-
celerated loss inclusion date with respect to
a loss attributable to the basis of redeemed
stock that is allocated to a partner from a
partnership, the partner is treated as the re-
deemed shareholder.

(7) Redeemed shareholder is an S
corporation-(i) Treatment and alloca-
tion of loss attributable to basis of re-
deemed stock. Where stock is redeemed
from an S corporation and all or a por-
tion of the distribution in redemption of
such stock is treated as a dividend, any loss
attributable to the basis of redeemed stock
is treated as a current loss to the S corpo-
ration on the date of the redemption and is
allocated to the S corporation's sharehold-
ers under section 1366(a). The portion of
such loss that is allocated to an S corpo-
ration shareholder from the S corporation
is not permitted to be taken into account by
such shareholder until the final inclusion
date or an accelerated loss inclusion date,
as provided in this section.

(ii) Identification of redeemed share-
holder. For purposes of determining whether
a particular date is the final inclusion date
with respect to a loss attributable to the ba-
sis of redeemed stock that is allocated to
a shareholder of an S corporation from an
S corporation, if the S corporation share-
holder is a shareholder of the S corpora-
tion at the end of such day, the S
corporation is treated as the redeemed share-
holder. If the S corporation shareholder is
not a shareholder of the S corporation at the
end of such day, the former S corporation
shareholder is treated as the redeemed
shareholder and the determination of
whether such date is the final inclusion date
is made by comparing such former S cor-
poration shareholder's actual and construc-
tive ownership of the redeeming corporation
immediately prior to the redemption to such
former S corporation shareholder's actual
and constructive ownership of the redeem-
ing corporation at the end of such particu-
lar day; provided, however, that for purposes
of computing such former S corporation
shareholder's ownership of the redeem-
ing corporation immediately prior to the re-
demption, section 318(a)(2)(C) shall be
applied without regard to the 50 percent
limitation contained therein. For purposes
of determining whether a particular date is
an accelerated loss inclusion date with re-
spect to a loss attributable to the basis of
redeemed stock that is allocated to an S cor-

poration shareholder from an S corpora-
tion, the S corporation shareholder is treated
as the redeemed shareholder.

(8) Redeemed shareholder is an estate
or trust. To the extent that a trust from
which stock is redeemed is treated as owned
(in part or in whole) by the grantor or an-
other person under subpart E of part I of
subchapter J of the Internal Revenue Code,
the rules of this section are applied as
though the redeemed stock were owned di-
rectly by such grantor or other person.
Where stock is redeemed from an estate or
from a trust not treated as wholly owned
by the grantor or another person under sub-
part E of part I of subchapter J of the In-
ternal Revenue Code, and all or a portion
of the distribution in redemption of such
stock is treated as a dividend, any loss at-
tributable to the basis of redeemed stock,
except any loss attributable to the basis of
redeemed stock treated as owned by the
grantor or another person, is not taken into
account by such estate or trust until the fi-
nal inclusion date or an accelerated loss in-
clusion date, and whether a particular date
is the final inclusion date or an acceler-
ated loss inclusion date is determined by
treating such estate or trust, not its benefi-
ciaries, as the redeemed shareholder. How-
ever, if all or a portion of such loss is
distributed to a beneficiary of such estate
or trust pursuant to section 642(h) and para-
graph (d)(2) of this section, the determi-
nation of whether a particular date is the
final inclusion date or an accelerated in-
clusion date shall be made by treating each
such beneficiary as the redeemed share-
holder with respect to the loss distributed
to such beneficiary.

(9) Redeemed shareholder is a C cor-
poration that converts to an S corpora-
tion. For rules regarding the treatment of
a loss attributable to the basis of redeemed
stock when the redeemed shareholder is a
C corporation on the date of the redemp-
tion and elects to be taxed as an S corpo-
ration prior to the final inclusion date or an
accelerated loss inclusion date, see
§§ 1.1371-1(a)(1) and 1.1374-5(b)(2).

(e) Statement to be filed with returns.
With or as part of the income tax return for
the year in which a redeemed shareholder
takes into account any loss pursuant to this
section, the redeemed shareholder shall pro-
vide a statement entitled "Claim of Loss At-
tributable to Basis of Redeemed Stock." The
statement shall specify the amount of the

loss that is taken into account on such re-
turn pursuant to this section and shall iden-
tify the shares to which such amounts relate.

(f) Examples. For purposes of the ex-
amples in this section, each of corpora-
tion X, corporation Y, corporation Z,
corporation D, and corporation C is a do-
mestic corporation that files U.S. tax re-
turns on a calendar-year basis. The
principles of this section are illustrated by
the following examples:

Example 1. (i) Facts. A and B, husband and wife,
each own 100 shares (50 percent) of the stock of cor-
poration X and hold the corporation X stock as a capi-
tal asset. A purchased his corporation X shares on
February 1, Year 1, for $200. On December 31, Year
1, corporation X redeems all of A's 100 shares of its
stock for $300. At the end of Year 1, corporation X
has current and accumulated earnings and profits of
$200. In connection with the redemption transac-
tion, A does not file an agreement described in sec-
tion 302(c)(2) waiving the application of the family
attribution rules. The redemption proceeds, there-
fore, are treated under section 301(c)(1) as a divi-
dend to the extent of corporation X's earnings and
profits of $200, and under section 301(c)(2) as a re-
covery of basis in the amount of $100. On July 1, Year
2, B sells all of her shares of corporation X stock to
G, her mother.

(ii) Analysis. Under this section, an amount equal
to A's basis in the corporation X stock ($100 after ap-
plication of section 301(c)(2)) is treated as a loss rec-
ognized on a disposition of the redeemed stock on
December 31, Year 1, the date of the redemption.
When B sells her shares to G, A no longer owns, ac-
tually or constructively, any shares of corporation X
stock. Thus, if the facts that existed at the end of July
1, Year 2, had existed immediately after the redemp-
tion, A would have been treated as having received
a distribution in part or full payment in exchange for
the redeemed stock pursuant to section 302(a). Un-
der this section, therefore, July 1, Year 2, is the fi-
nal inclusion date and, on that date, A is permitted to
take into account the loss of $100 attributable to his
basis in the redeemed stock. Because that loss is treated
as having been recognized on a disposition of the re-
deemed stock on the date of the redemption, Decem-
ber 31 of Year 1, such loss is treated as a short-term
capital loss.

Example 2. (i) Facts. The facts are the same as
in Example 1, except that, instead of selling all of her
100 shares of corporation X stock to G on July 1, Year
2, B sells only 75 shares of corporation X stock to G
on that date.

(ii) Analysis. As in Example 1, an amount equal
to A's basis in the redeemed stock ($100 after appli-
cation of section 301(c)(2)) is treated as a loss rec-
ognized on a disposition of the redeemed stock on
December 31, Year 1, the date of the redemption. Im-
mediately after B's sale of 75 shares of corporation
X stock to G, A constructively owns 25 percent of the
shares of corporation X stock. Thus, if the facts that
existed at the end of July 1, Year 2, had existed im-
mediately after the redemption, A would have been
treated as receiving a distribution in part or full pay-
ment in exchange for the redeemed stock pursuant to
section 302(a). Under this section, therefore, July 1,
Year 2, is the final inclusion date and, on that date,

A is permitted to take into account the loss of $100
attributable to his basis in the redeemed stock. Be-
cause that loss is treated as having been recognized
on a disposition of the redeemed stock on the re-
demption date, December 31 of Year 1, such loss is
treated as a short-term capital loss.

Example 3. (i) Facts. Corporation Y has 200 shares
of common stock outstanding. L, an individual, owns
150 shares of common stock in corporation Y and has
owned these shares for several years. The remain-
ing 50 shares are owned by K, L's father. In Year 1,
corporation Y redeems 50 shares of L's corporation
Y stock, which have a basis of $75, for $200. At the
end of Year 1, corporation Y's current and accumu-
lated earnings and profits exceed $200. The redemp-
tion of L's stock is treated as a distribution to which
section 301 applies. L recognizes dividend income in
the amount of $200. In Year 4, L sells 25 of his re-
maining shares of corporation Y stock, which have a
basis of $50, to K for $100 and recognizes $50 of
long-term capital gain.

(ii) Analysis. Under this section, an amount equal
to L's basis in the corporation Y stock that is re-
deemed, $75, is treated as a loss recognized on a dis-
position of the redeemed stock on the date of the
redemption. The date on which L sells 25 shares of
corporation Y stock to K is not the final inclusion date
under paragraph (b)(3) of this section because L does
not satisfy the criteria of section 302(b)(1), (2), or (3)
at the end of such day. Under paragraph (b)(4) of this
section, however, that date is an accelerated loss in-
clusion date because, on that date, L recognizes gain
of $50 on a disposition of stock of corporation Y, the
redeeming corporation. Thus, on that date, L is per-
mitted to take into account $50 of the loss attribut-
able to his basis in the redeemed stock. The remaining
$25 of such loss is taken into account on the earlier
of the final inclusion date or the next accelerated loss
inclusion date (to the extent of gain recognized).

Example 4. (i) Facts. The facts are the same as
in Example 3, except that L does not sell any shares
of corporation Y to K in Year 4. Instead, in Year 4,
corporation Y distributes $75 to L with respect to his
remaining 100 shares of corporation Y stock. L's ba-
sis in these shares is only $30, and at the end of Year
4, corporation Y's current and accumulated earn-
ings and profits are $20, instead of $200. Under sec-
tion 301(c)(1), $20 of the distribution is treated as a
dividend, under section 301(c)(2), $30 of the distri-
bution is treated as a recovery of basis, and, under sec-
tion 301(c)(3), $25 of the distribution is treated as gain
from the sale or exchange of stock.

(ii) Analysis. As in Example 3, an amount equal
to L's basis in the corporation Y stock redeemed in
Year 1, $75, is treated as a loss recognized on a dis-
position of the redeemed stock on the date of the re-
demption. Because L recognizes gain under section
301(c)(3) upon the receipt of the Year 4 distribu-
tion, the date of that distribution is an accelerated loss
inclusion date. Accordingly, on that date, L is per-
mitted to take into account $25 of the loss attribut-
able to the basis of the redeemed stock. The remaining
$50 of such loss is taken into account on the earlier
of the final inclusion date or the next accelerated loss
inclusion date (to the extent of gain recognized).

Example 5. (i) Facts. Corporation Z has 100 shares
of stock outstanding, 50 shares of which are owned
by each of A and his son, B. A's basis in each of his
shares of corporation Z stock is $1. During Year 1,
corporation Z redeems from A 25 shares of corpora-

tion Z stock for $200. At the end of Year 1, corpo-
ration Z has current and accumulated earnings and
profits in excess of $200. The redemption is treated
as a distribution to which section 301 applies. Ac-
cordingly, A recognizes dividend income of $200. In
Year 2, corporation Y acquires all of corporation Z's
assets in exchange solely for voting stock in a reor-
ganization described in section 368(a)(1)(C). In the
reorganization, A and B surrender their shares of cor-
poration Z stock. A receives 2,500 shares of com-
mon stock of corporation Y and B receives 5,000
shares of common stock of corporation Y. Immedi-
ately after the reorganization, corporation Y has out-
standing one million shares of common stock.

(ii) Analysis. Under this section, an amount equal
to A's basis in the redeemed stock after the Year 1 re-
demption, $25, is treated as a loss recognized on a dis-
position of the redeemed stock on the date of the
redemption. Under paragraph (d)(5) of this section, for
purposes of determining whether a particular date on
or after the date of the reorganization is the final in-
clusion date or an accelerated loss inclusion date, cor-
poration Y, the acquiring corporation, is treated as the
redeeming corporation. If the facts and circumstances
that exist at the end of the day of the reorganization
had existed on the date of the redemption, the re-
demption would have been treated as a distribution
in part or full payment in exchange for the redeemed
stock pursuant to section 302(a). Therefore, the date
of the reorganization is the final inclusion date and
A is permitted to take into account the loss of $25 at-
tributable to his basis in the redeemed stock.

Example 6. (i) Facts. Corporation D has 300 shares
of stock outstanding. J and her two daughters, M and
N, each own 100 shares of corporation D stock. J's
basis in her corporation D shares is $400. In Year 1,
corporation D redeems all of J's shares for $1,000. At
the end of Year 1, corporation D has current earn-
ings and profits exceeding $1,000. The redemption is
treated as a distribution to which section 301 ap-
plies. Accordingly, J recognizes dividend income in
the amount of $1,000. Subsequently, M and N de-
cide to separate corporation D's business. Accord-
ingly, they cause corporation D to contribute one-
half of its assets to corporation C, a newly formed
corporation, in exchange for all of corporation C's
stock and to distribute all of the corporation C stock
to N in exchange for all of her corporation D stock.
Immediately after the distribution, the value of cor-
poration D is equal to the value of corporation C. In
Year 6, M sells her shares in corporation D to an un-
related person.

(ii) Analysis. Under this section, an amount equal
to J's basis in the corporation D stock redeemed, $400,
is treated as a loss recognized on a disposition of the
redeemed stock on the date of the redemption. Upon
corporation D's distribution of the stock of corpora-
tion C in Year 2, J's loss attributable to the basis of
the redeemed corporation D stock is allocated among
the stock of corporation D and corporation C that J
owns, actually and constructively, immediately after
the distribution in proportion to the fair market value
of the stock of each such corporation. Although J does
not actually own any stock of corporation D or cor-
poration C, because J constructively owns all of the
stock of both corporation D and corporation C and
each of the stock of corporation D and the stock of
corporation C have the same value immediately af-
ter the distribution, $200 of the loss is allocated to each
of the stock of corporation D and the stock of cor-

poration C that J is treated as so owning. Accord-
ingly, each of corporation D and corporation C is
treated as the redeeming corporation for purposes of
determining whether a particular date after the date
of the distribution is an accelerated loss inclusion date
or the final inclusion date with respect to $200 of the
loss. In this case, the date in Year 6 on which M sells
her corporation D stock to an unrelated person is the
final inclusion date with respect to J's loss allocated
to J's constructively owned corporation D stock, be-
cause had corporation D's distribution of corpora-
tion C stock occurred immediately after the redemption
of J's stock and M's Year 6 sale of corporation D stock
occurred immediately thereafter in Year 1, the re-
demption of J's corporation D stock would have been
treated as a distribution in part or full payment in ex-
change for the redeemed stock pursuant to section
302(a). Accordingly, on that date in Year 6, J is per-
mitted to take into account the $200 loss allocated to
the corporation D stock. The $200 loss allocated to
the corporation C stock is taken into account on the
earlier of the final inclusion date or the next accel-
erated loss inclusion date (to the extent of gain rec-
ognized) with respect to the corporation C stock.

Example 7. (i) Facts. In Year 1, A and B, two un-
related individuals, each contribute $100 to form a
50-50 general partnership, PS. A and B share in the
income of PS equally. PS buys 100 shares of corpo-
ration Z stock for $200. A owns the remaining 400
outstanding shares of corporation Z stock directly. In
Year 2, corporation Z redeems all of PS's shares for
$300. At that time, the basis of A's interest in PS is
$100 and the basis of B's interest in PS is $100. At
the end of Year 2, corporation Z has current and ac-
cumulated earnings and profits of $150. Because A's
ownership of the Z stock is attributed to PS under sec-
tion 318(a)(3)(A), the redemption is treated as a dis-
tribution to which section 301 applies. The redemption
proceeds, therefore, are treated as a dividend to the
extent of corporation Z's earnings and profits, $150,
and as a recovery of basis in the amount of $150. As-
sume that PS's only items of income, gain, loss, de-
duction, and credit for Year 2 arise from the redemption
of the corporation Z stock. On January 1 of Year 4,
A sells his entire interest in PS to C, an unrelated in-
dividual.

(ii) Analysis. Under this section, an amount equal
to PS's basis in the corporation Z stock, ($50 after ap-
plication of section 301(c)(2)), is treated as a cur-
rent loss recognized by the partnership on a disposition
of the redeemed stock on the date of the redemp-
tion. Under this section, $50 of the dividend and $50
of the loss must be allocated in equal amounts in ac-
cordance with A's and B's interests in PS. Accord-
ingly, if the remaining $100 of the dividend is allocated
$50 to A and $50 to B under section 704 and the regu-
lations thereunder, $25 of each of the dividend and
the loss is allocated to each of A and B. A's and B's
basis in their PS interests are increased by their shares
of the dividend and decreased by their shares of the
loss attributable to the basis of the redeemed stock.
A and B will not be able to take that loss into ac-
count until the final inclusion date or an accelerated
loss inclusion date. When A sells his PS interest to C,
an unrelated individual, PS and A are no longer re-
lated. Therefore, PS no longer owns, actually or con-
structively, any shares of corporation Z stock. Because
B remains a partner in PS after January 1, Year 4, PS
is treated as the redeemed shareholder for purposes
of determining if January 1, Year 4, is the final in-

clusion date for B. If the facts that exist at the end
of the day of A's sale of his PS interest to C had ex-
isted immediately after the redemption, PS would have
been treated as receiving a distribution in part or full
payment in exchange for the redeemed stock pursu-
ant to section 302(a). Therefore, B is permitted to take
into account the $25 loss attributable to the basis of
the redeemed stock that was allocated to him. Be-
cause A is no longer a partner in PS after January 1,
Year 4, A is treated as the redeemed shareholder for
purposes of determining if January 1, Year 4, is the
final inclusion date for A. Immediately prior to the re-
demption, A actually and constructively owns 90 per-
cent of the corporation Z stock. After the sale of the
PS interest, A actually owns 100 percent of the cor-
poration Z stock. If these facts had existed immedi-
ately after the redemption, A would not have been
treated as receiving a distribution in part or full pay-
ment in exchange for the redeemed stock pursuant to
section 302(a). Therefore, January 1, Year 4, is not the
final inclusion date for A.

Example 8. (i) Facts. H, I, and J are sharehold-
ers in corporation S, a corporation that has made a
valid election to be taxed as an S corporation. H, I,
and J respectively hold 60 percent, 20 percent, and 20
percent of the stock in corporation S. H, I, and J have
no relation to each other apart from their ownership
interests in corporation S. Corporation S owns 20 per-
cent of the outstanding shares of corporation X with
a $100 adjusted basis. H owns the remaining out-
standing shares of corporation X. In Year 1, all of cor-
poration S's shares of corporation X stock are
redeemed for their fair market value, $200. Corpo-
ration X has current and accumulated earnings and
profits of $300 at the end of Year 1. Because H's own-
ership of X stock is attributed to corporation S un-
der section 318(a)(2)(C), the redemption is treated as
a distribution to which section 301 applies and is
treated as a dividend. H, I, and J will be allocated
$120, $40, and $40 of dividend income, respectively.
In Year 2, J sells his stock of corporation S to K, an
unrelated person. In Year 3, H sells his stock of cor-
poration X to L, an unrelated person.

(ii) Analysis. Under this section, an amount equal
to corporation S's basis in the redeemed stock ($100)
is treated as a loss recognized on a disposition of the
redeemed stock on the date of the disposition. H, I,
and J will be allocated $60, $20, and $20 of the loss,
respectively, in the year of the redemption. Both the
allocation of dividend income and the allocation of
the loss give rise to adjustments to each sharehold-
er's basis in corporation S. H, I, and J, however, will
not be able to take into account this loss until the fi-
nal inclusion date or an accelerated loss inclusion date.
In Year 2, when J sells his stock of corporation S to
K, J is no longer a shareholder in corporation S and
will be treated as the redeemed shareholder for pur-
poses of determining whether a particular date is the
final inclusion date or an accelerated loss inclusion
date. In addition, the determination of whether the date
of the Year 2 sale is the final inclusion date for J is
made by comparing J's actual and constructive own-
ership of corporation S stock immediately prior to the
redemption to J's actual and constructive ownership
of corporation S stock at the end of the date of the
Year 2 sale. However, for purposes of computing J's
ownership of the redeeming corporation immedi-
ately prior to the redemption, section 318(a)(2)(C) is
applied without regard to the 50 percent limitation con-
tained therein. Immediately prior to the redemption,

therefore, J is treated as owning actually and con-
structively 4 percent of the stock of corporation X and,
at the end of the day of J's sale of corporation S stock,
J owns, actually and constructively, no corporation X
stock. Therefore, if the facts that existed on the date
of the Year 2 sale had existed immediately after the
redemption, J would have been treated as having re-
ceived a distribution in part or full payment in ex-
change for the redeemed stock pursuant to section
302(a). Therefore, the date of J's sale of corporation
S stock to K is the final inclusion date. J is permit-
ted to take into account J's share of the loss attrib-
utable to the basis of the redeemed stock as of that
date. While H and I remain shareholders of corpora-
tion S, whether a particular date is the final inclu-
sion date will be determined by treating corporation
S as the redeemed shareholder. Thus, in Year 3 when
H disposes of his shares of corporation X, corpora-
tion S actually and constructively owns no stock of
corporation X. As of that date, therefore, H and I will
be permitted to take into account their respective shares
of the loss attributable to the basis of the redeemed
stock.

(g) Effective date. This section applies
to transactions occurring after the date these
regulations are published as final regula-
tions in the Federal Register.

Par. 4. Section 1.304-1 is revised to read
as follows:

§ 1.304-1 In general.

(a) In general. Section 304 is appli-
cable where a shareholder sells stock of one
corporation to a related corporation as de-
fined in section 304. Sales to which sec-
tion 304 is applicable shall be treated as
redemptions subject to sections 302 and
303.

(b) Effective date. This section applies
to transactions occurring after the date these
regulations are published as final regula-
tions in the Federal Register.

Par. 5. Section 1.304-2 is amended as
follows:

1\. Paragraphs (a) and (c) are revised.

2\. Paragraph (d) is added.

The revisions and addition read as
follows:

§ 1.304-2 Acquisition by related
corporation (other than subsidiary).

(a) In general. (1) If a corporation (the
acquiring corporation), in return for prop-
erty, acquires stock of another corpora-
tion (the issuing corporation) from one or
more persons, and the person or persons
from whom the stock was acquired were in
control of both such corporations, then such
property shall be treated as received in re-
demption of stock of the acquiring corpo-
ration. As to each person transferring stock,
the amount received shall be treated as a

distribution to which section 301 applies if
section 302(a) or 303 does not apply. For
rules regarding the amount constituting a
dividend in such cases, see § 1.304-6.

(2) In applying section 302(b), refer-
ence shall be had to the shareholder's own-
ership of stock in the issuing corporation
and not to its ownership of stock in the ac-
quiring corporation (except for purposes of
applying section 318(a)), section 318(a) (re-
lating to the constructive ownership of
stock) shall be applied without regard to the
50 percent limitation contained in section
318(a)(2)(C) and (3)(C), and a series of re-
demptions referred to in section
302(b)(2)(D) shall include acquisitions by
either of the corporations of stock of the
other and stock redemptions by both cor-
porations.

(3) If, pursuant to section 302(d), sec-
tion 301 applies to the property treated as
received in redemption of stock of the ac-
quiring corporation pursuant to paragraph
(a)(1) of this section, the transferor and the
acquiring corporation shall be treated, for
all Federal income tax purposes, in the same
manner as if the transferor had transferred
the stock of the issuing corporation to the
acquiring corporation in exchange for stock
of the acquiring corporation in a transac-
tion to which section 351(a) applies, and
then the acquiring corporation had redeemed
the stock it was treated as issuing in the
transaction in exchange for the property. Ac-
cordingly, under section 362, the acquir-
ing corporation's basis in the stock of the
issuing corporation is equal to the basis the
transferor had in that stock and, under sec-
tion 358, the transferor's basis in the stock
of the acquiring corporation deemed is-
sued to the transferor in the deemed trans-
action to which section 351(a) applies is
equal to the transferor's basis in the stock
of the issuing corporation it surrendered.
Section 1.302-5 applies to the transfer-
or's unutilized basis, if any, in the stock of
the acquiring corporation treated as re-
deemed in connection with an acquisition
described in paragraph (a)(1) of this sec-
tion by treating the acquiring corporation
as the redeeming corporation and the trans-
feror as the redeemed shareholder.

(4) If section 301 does not apply to the
property treated as received in redemp-
tion of stock of the acquiring corporation
pursuant to paragraph (a)(1) of this sec-
tion, the property received by the trans-
feror shall be treated as received in a

distribution in full payment in exchange for
stock of the acquiring corporation under
section 302(a). The basis and holding pe-
riod of the stock of the acquiring corpora-
tion that is treated as having been redeemed
shall be the same as the basis and hold-
ing period of the stock of the issuing cor-
poration actually surrendered. The acquiring
corporation shall take a cost basis in the
stock of the issuing corporation that it ac-
quires. See section 1012.

* * * * *

(c) Examples. For purposes of the ex-
amples in this section, each of corpora-
tion X and corporation Y is a domestic
corporation that files U.S. tax returns on a
calendar-year basis. The principles of this
section are illustrated by the following
examples:

Example 1. (i) Facts. Corporation X and corpo-
ration Y each have outstanding 100 shares of com-
mon stock. A, an individual, owns one-half of the stock
of each corporation, B owns one-half of the stock of
corporation X, and C owns one-half of the stock of
corporation Y. A, B, and C are unrelated. A sells 30
shares of the stock of corporation X, which have an
adjusted basis of $10,000, to corporation Y for $50,000.

(ii) Analysis. Because before the sale A owns 50
percent of the stock of corporation X and after the sale
A owns only 35 percent of such stock (20 shares di-
rectly and 15 constructively because one-half of the
30 shares owned by corporation Y are attributed to A),
the redemption is substantially disproportionate as to
A pursuant to the provisions of section 302(b)(2). A,
therefore, realizes a gain of $40,000 ($50,000 mi-
nus $10,000). If the stock surrendered is a capital as-
set, such gain is long-term or short-term capital gain
depending on the period of time that such stock was
held. The basis to A for the stock of corporation Y is
not changed as a result of the sale. Under section 1012,
the basis that corporation Y takes in the acquired stock
of corporation X is its cost of $50,000.

Example 2. (i) Facts. Corporation X and corpo-
ration Y each have outstanding 200 shares of com-
mon stock, all of which are owned by H, an individual.
H has a basis in his corporation X stock of $60 and
in his corporation Y stock of $30. Corporation X has
$80 of current and accumulated earnings and profits
and corporation Y has $80 of current and accumu-
lated earnings and profits. H sells his 200 shares of
corporation X stock to corporation Y for $150.

(ii) Analysis. Because H is in control of both cor-
poration X and corporation Y and receives property
from corporation Y in exchange for the corporation
X stock, H's sale of 200 shares of corporation X stock
to corporation Y is subject to section 304(a)(1). Ac-
cordingly, H is treated as receiving $150 as a distri-
bution in redemption of corporation Y stock. Because
H actually owns 100 percent of corporation X be-
fore the sale and is treated as owning 100 percent of
corporation X after the sale, pursuant to section 302(d),
section 302(a) does not apply to the deemed redemp-
tion distribution and the proceeds of the deemed re-
demption are treated as a distribution to which section
301 applies. Therefore, H is treated as transferring the
corporation X stock to corporation Y in exchange for

corporation Y stock in a transaction to which sec-
tion 351(a) applies. Corporation Y's basis in the cor-
poration X stock acquired is $60, the same basis that
H had in the corporation X stock surrendered. H takes
a basis of $60 in the corporation Y stock he is treated
as receiving in the deemed section 351 exchange. That
corporation Y stock is then treated as redeemed by cor-
poration Y for $150. Under section 302, that redemp-
tion is treated as a distribution to which section 301
applies because H owns directly 100 percent of cor-
poration Y both before and after the redemption of the
corporation Y stock that was deemed issued. Thus, the
deemed redemption proceeds are treated as a distri-
bution to which section 301 applies. Pursuant to
§ 1.304-6(a), H is treated as receiving a dividend of
$150 ($80 from the current and accumulated earn-
ings and profits of corporation Y and then $70 from
the current and accumulated earnings and profits of
corporation X). An amount equal to the basis in the
corporation Y stock that H is deemed to receive and
that is deemed redeemed, $60 is treated as a loss rec-
ognized on a disposition of the stock deemed re-
deemed on the date of the deemed redemption and is
taken into account under rules set forth in § 1.302-5.
H's basis in the 200 shares of corporation Y stock that
H owned before the sale and continues to own im-
mediately after the sale remains $30.

Example 3. (i) Facts. The facts are the same as
in Example 2, except that corporation X has $5 of cur-
rent and accumulated earnings and profits and cor-
poration Y has $25 of current and accumulated
earnings and profits.

(ii) Analysis. As in Example 2, H takes a basis of
$60 in the corporation Y stock he is treated as re-
ceiving and $150 is treated as a distribution to which
section 301 applies. Pursuant to § 1.304-6(a), H is
treated as receiving a dividend of $30 ($25 from the
current and accumulated earnings and profits of cor-
poration Y and $5 from the current and accumu-
lated earnings and profits of corporation X). In
addition, $60 of the distribution is treated as a re-
turn of basis and $60 of the distribution is treated as
gain from the sale or exchange of corporation Y stock.
H's basis in the 200 shares of corporation Y stock that
he owned before and continues to own immediately
after the sale remains $30. Corporation Y's basis in
the corporation X stock acquired is $60, the same ba-
sis that H had in the corporation X stock surren-
dered.

Example 4. (i) Facts. A, an individual, owns 100
shares of corporation X stock, which is all of the out-
standing stock of corporation X. A has a basis of $1
in each share of his corporation X stock. B, the son
of A, owns all the outstanding stock of corporation
Y. A sells 25 shares of the stock of corporation X to
corporation Y for $50. For that year, the current and
accumulated earnings and profits of corporation Y ex-
ceed $50.

(ii) Analysis. Because A is in control of both cor-
poration X and corporation Y (corporation X di-
rectly and corporation Y through attribution from B)
and receives property in exchange for the corpora-
tion X stock, A's sale of corporation X stock to cor-
poration Y is subject to section 304(a)(1).
Consequently, A is treated as transferring the corpo-
ration X stock to corporation Y in exchange for cor-
poration Y stock in a transaction to which section
351(a) applies. That corporation Y stock is then treated
as redeemed by corporation Y for $50. Before the
deemed redemption of the corporation Y stock, A

owned 100 percent of corporation Y directly and con-
structively. After the deemed redemption, A owns 100
percent of corporation Y constructively by attribu-
tion from B. Accordingly, the redemption distribu-
tion is treated as a distribution to which section 301
applies. Because the earnings and profits of corpo-
ration Y exceed the amount of cash paid by corpo-
ration Y to A for the corporation X stock, pursuant to
§ 1.304-6(a), the entire amount is a dividend. An
amount equal to the basis in the corporation Y stock
that A was deemed to receive and that was then
deemed redeemed, $25, is treated as a loss recog-
nized on a disposition of the stock deemed redeemed
on the date of the deemed redemption and is taken into
account under rules set forth in §1.302-5. A's basis
in the 75 shares that he continues to hold remains $1
per share for an aggregate basis of $75.

(d) Effective date. This section, except
for paragraph (b) of this section, applies to
transactions occurring after the date these
regulations are published as final regula-
tions in the Federal Register. Paragraph (b)
of this section applies on and after Decem-
ber 2, 1955.

Par. 6. Section 1.304-3 is amended as
follows:

1\. Paragraph (a) is revised.

2\. Paragraph (c) is added.

The revision and addition read as
follows:

§ 1.304-3 Acquisition by a subsidiary.

(a) In general. If a subsidiary, in re-
turn for property, acquires stock of its par-
ent corporation from a shareholder of the
parent corporation, the acquisition of such
stock shall be treated as if the parent cor-
poration had redeemed its own stock in ex-
change for the property. For purposes of this
section, a corporation is a parent corpora-
tion if it meets the 50 percent ownership re-
quirements of section 304(c). The
determination of whether the amount re-
ceived shall be treated as an amount re-
ceived in payment in exchange for the stock
shall be made by applying section 303, or
by applying section 302(b) with reference
to the stock of the issuing parent corpora-
tion. For rules regarding the amount that
constitutes a dividend in a redemption
treated as a distribution subject to section
301, see § 1.304-6. For the treatment of the
redeemed shareholder's basis in the re-
deemed stock in such cases, see § 1.302-5.
Section 1.302-5 applies to the sharehold-
er's unutilized basis, if any, in the stock of
the parent corporation treated as redeemed
in connection with an acquisition described
in this paragraph (a) by treating the par-

ent corporation as the redeeming corpora-
tion and the shareholder as the redeemed
shareholder.

* * * * *

(c) Effective date. This section applies
on and after December 2, 1955, except for
paragraph (a) of this section, which ap-
plies to transactions occurring after the date
these regulations are published as final regu-
lations in the Federal Register.

Par. 7. Section 1.304-5 is amended as
follows:

1\. Paragraph (a) is amended by adding
a sentence at the end of the paragraph.

2\. Paragraph (c) is revised.

The revision and addition read as
follows:

§ 1.304-5 Control.

(a) * * * Specifically, section 318(a)
shall be applied by using the language "5
percent" instead of "50 percent" in sec-
tion 318(a)(2)(C) and by using the lan-
guage "5 percent" instead of "50 percent"
in section 318(a)(3)(C), except that if sec-
tion 318(a)(3)(C) would not have applied
but for this substitution, by considering a
corporation as owning the stock (other than
stock in such corporation) owned by or for
any shareholder of such corporation in that
proportion which the value of the stock
which such shareholder owned in such cor-
poration bears to the value of all stock in
such corporation.

* * * * *

(c) Effective date. This section applies
on and after January 20, 1994, except the
last sentence of paragraph (a) of this sec-
tion applies to transactions occurring af-
ter the date these regulations are published
as final regulations in the Federal Regis-
ter.

Par. 8. Section 1.304-6 is added to read
as follows:

§ 1.304-6 Amount constituting a
dividend.

(a) In general. The determination of the
amount of the property that is a dividend
is made as if the property were distrib-
uted by the acquiring corporation to the ex-
tent of its earnings and profits and then by
the issuing corporation to the extent of its
earnings and profits. Where, however, the
acquiring corporation is a foreign corpo-
ration, for purposes of the preceding sen-
tence, the earnings and profits of the

acquiring corporation are taken into ac-
count only to the extent that they-

(1) Are attributable to stock of the ac-
quiring corporation owned (within the
meaning of section 958(a)) by a corpora-
tion or individual that is-

(i) A United States shareholder (within
the meaning of section 951(b)) of the ac-
quiring corporation; and

(ii) The transferor or a person who bears
a relationship to the transferor described in
section 267(b) or 707(b); and

(2) Were accumulated during the pe-
riod or periods such stock was owned by
such person while the acquiring corpora-
tion was a controlled foreign corporation.

(b) Effective date. This section applies
to transactions occurring after the date these
regulations are published as final regula-
tions in the Federal Register.

Par. 9. Section 1.704-1 is amended by
adding paragraph (b)(4)(viii) to read as
follows:

§ 1.704-1 Partner's distributive share.

(b)

(4) * * *

(viii) Loss attributable to basis of re-
deemed stock under § 1.302-5. For rules re-
garding allocations on a redemption of stock
all or a portion of which is treated as a divi-
dend, see § 1.302-5(d)(6)(i).

Par. 10. Section 1.861-12 is added to
read as follows:

§ 1.861-12 Characterization rules and
adjustments for certain assets.

(a) through (c)(2)(v) [Reserved]. For fur-
ther guidance, see § 1.861-12T(a) through
(c)(2)(v).

(c)(2)(vi) Adjustments in respect of re-
deemed stock for taxpayers using the tax
book value method. Solely for purposes of
apportioning expenses on the basis of the
tax book value of assets, the adjusted ba-
sis of any stock in a 10 percent owned cor-
poration owned directly by a taxpayer that
is a redeemed shareholder (as defined in
§ 1.302-5(b)(1)) with respect to such cor-
poration shall be increased by the amount
of any loss that has not been taken into ac-
count under § 1.302-5(c) as of the close of
the redeemed shareholder's taxable year
(unrecovered loss). If the redeemed share-

holder does not own directly any shares in
the 10 percent owned corporation as of the
end of the taxable year, but is treated for
purposes of section 302(b) as owning shares
actually owned by another member of the
redeemed shareholder's affiliated group, as
defined in section 1504(a), or by a corpo-
ration that is either an affiliate described in
§ 1.904(i)-1(b)(1) or an affiliated corpo-
ration described in § 1.861-11T(d)(6) with
respect to the redeemed shareholder, then
the adjusted basis of the shares in the 10
percent owned corporation, if any, that are
owned by such other corporation or cor-
porations shall be increased by the amount
of the redeemed shareholder's unrecov-
ered loss (and allocated among such cor-
porations, if applicable, in proportion to their
relative adjusted bases (as adjusted pursu-
ant to this paragraph and § 1.861-12T(c)(2))
in the stock of the redeeming corpora-
tion). These adjustments are to be made an-
nually and are noncumulative.

(vii) Examples. [Reserved]. Certain of the
rules of this paragraph (c)(2) may be illus-
trated by the following examples:

Examples 1 and 2. [Reserved]. For further guid-
ance, see § 1.861-12T(c)(2)(vii), Examples 1 and 2.

Example 3. The facts are the same as in § 1.861-
12T(c)(2)(vii) Example 2, except that the taxable year
is 2003, and during the taxable year Y redeems some
of the shares of its stock held by X for $100,000. X's
adjusted basis in the redeemed shares is $50,000. Be-
cause X still owns all of the outstanding stock of Y,
the redemption is treated as a distribution with re-
spect to the stock of Y under section 301. Under
§ 1.302-5, X's $50,000 adjusted basis in the re-
deemed shares is treated as a loss recognized on the
date of the redemption, none of which is taken into
account in 2003. X invests the $100,000 of redemp-
tion proceeds in assets that generate foreign source gen-
eral limitation income. Under paragraph (c)(2)(vi) of
this section, X's adjusted basis in its remaining Y stock
is considered to be $2,000,000 ($1,950,000 adjusted
basis in the Y stock plus $50,000 unrecovered loss in
the redeemed shares). X's adjusted basis of assets that
generate foreign source general limitation income is
considered to be $2,500,000 ($2,000,000 adjusted ba-
sis in the Y stock plus $500,000 other assets), and the
resulting apportionment of interest expense is the same
as in § 1.861-12T(c)(2)(vii) Example 2.

(c)(3) through (j) [Reserved]. For fur-
ther guidance, see § 1.861-12T(c)(3)
through (j).

Par. 11. Section 1.861-12T is amended
as follows:

1\. Paragraph (c)(2)(vi) is redesignated as
paragraph (c)(2)(vii).

2\. New paragraph (c)(2)(vi) is added.

The addition reads as follows:

§ 1.861-12T Characterization rules and
adjustments for certain assets
(temporary regulations.)

* * * * *

(2) * * *

(vi) [Reserved]. For further guidance, see
§ 1.861-12(c)(2)(vi).

* * * * *
Par. 12. Section 1.1371-1 is added to
read as follows:

§ 1.1371-1 Coordination with
subchapter C.

(a) No carryover between C and S
years-(1) Loss attributable to basis of re-
deemed stock. A loss described in § 1.302-
5(a) is treated as a carryforward arising in
a taxable year for which a corporation is a
C corporation. Therefore, it may not be car-
ried to a taxable year for which such cor-
poration is an S corporation.

(2)[Reserved].

(b) Effective date. This section applies
to transactions occurring after the date these
regulations are published as final regula-
tions in the Federal Register.

Par. 13. In § 1.1374-5, paragraph (a) is
amended by adding a sentence at the end
of the paragraph.

§ 1.1374-5 Loss carryforwards.

(a) In general. * * * However, for re-
demptions of stock occurring after the date
these regulations are published as final regu-
lations in the Federal Register, a loss at-
tributable to the basis of redeemed stock that
is taken into account pursuant to the rules
of § 1.302-5 is allowed for purposes of sec-
tion 1374(b)(2) as a deduction against net
recognized built-in gain of the S corpora-
tion for the taxable year, provided that the
loss arose in a year in which the corpora-
tion was a C corporation.

* * * * *

Par. 14. In § 1.1374-10, paragraph (a)
is revised to read as follows:

§ 1.1374-10 Effective date and
additional rules.

(a) In general. Except as provided
in § 1.1374-5(a), §§ 1.1374-1 through

1.1374-9 apply for taxable years ending on
or after December 27, 1994, but only in
cases where the S corporation's return for
the taxable year is filed pursuant to an S
election or a section 1374(d)(8) transac-
tion occurring on or after December 27,
1994.

Par. 15. In § 1.1502-13, paragraph (f)(7)
Example 3(b) is revised to read as follows:

§ 1.1502-13 Intercompany transactions.

(f)

(7)

Example 3.

(b) Treatment as a section 301 distribution. The
merger of S into B is a transaction to which para-
graph (f)(3) of this section applies. P is treated as re-
ceiving additional B stock with a fair market value of
$500 and, under section 358, a basis of $250. Imme-
diately after the merger, $150 of the stock received
is treated as redeemed, and the redemption is treated
under section 302(d) as a distribution to which sec-
tion 301 applies. Because the $150 distribution is
treated as not received as part of the merger, sec-
tion 356 does not apply and no basis adjustments are
required under section 358(a)(1)(A) and (B). Be-
cause B is treated under section 381(c)(2) as receiv-
ing S's earnings and profits and the redemption is
treated as occurring after the merger, $100 of the dis-
tribution is treated as a dividend under section 301 and
P's basis in the B stock is reduced correspondingly
under § 1 .1502-32. Under paragraph (f)(2)(ii) of this
section, P's $100 of dividend income is not included
in gross income. Accordingly, P has a $75 excess loss
account in the redeemed stock. That excess loss ac-
count is treated as income recognized on a disposi-
tion of the redeemed stock on the date of the
redemption and is taken into account under the rules
of § 1.1502-19(b)(5).

Par. 16. Section 1.1502-19 is amended
as follows:

1\. Paragraph (b)(2)(i) is amended by
adding a sentence at the end of the para-
graph.

2\. Paragraph (b)(5) is added.

3\. Paragraph (g) Example 7 is added.

4\. The heading for paragraph (h) is re-
vised.

5\. The first sentence of paragraph (h)(1)
is removed and two new sentences are
added in its place.

The revisions and additions read as
follows:

§ 1.1502-19 Excess loss accounts.

(b)

(2) * * * (i) * * * As another example,
if S redeems (or is treated as redeeming)

P's S stock and, as a result, an excess loss
account is either increased or created in such
redeemed stock, P takes into account such
excess loss account under the rules of para-
graph (b)(5) of this section.

(5) Redemptions of member stock; treat-
ment of excess loss account in redeemed
stock-(i) In general. In any case in which
an amount received in redemption of S
stock is treated as a distribution to P to
which section 301 applies and such amount
either increases or creates an excess loss ac-
count in the redeemed S stock, after ad-
justing such basis or excess loss account to
reflect the application of section 301(c)(2),
section 1059, § 1.1502-32, or any other ap-
plicable provision of the Internal Rev-
enue Code or the regulations thereunder,
such excess loss account is treated as in-
come (ordinary income or gain) recog-
nized on a disposition of the redeemed stock
on the date of the redemption. Such in-
come shall be taken into account by P un-
der the provisions of this paragraph (b)(5).

(ii) Inclusion of gain attributable to ex-
cess loss account in redeemed stock-(A)
Amount taken into account on final inclu-
sion date. On the final inclusion date (as
defined in § 1.302-5(b)(3)), P must in-
clude in income as ordinary income or gain
the excess loss account in the redeemed
stock, reduced by any amounts of such ex-
cess loss account that are taken into ac-
count pursuant to the provisions of
paragraph (b)(5)(ii)(B) of this section.

(B) Amount taken into account on ac-
celerated income inclusion date. (1) On an
accelerated income inclusion date (as de-
fined in paragraph (b)(5)(ii)(B)(2) of this
section), P must include in income as or-
dinary income or gain the excess loss ac-
count of the redeemed stock to the extent
of the lesser of-

(i) The amount of such excess loss ac-
count reduced by the amount of such ex-
cess loss account previously taken into
account pursuant to this paragraph (b)(5)(ii);
and

(ii) The amount of loss recognized on the
disposition of stock of S that the group of
which P is a member is permitted to take
into account on such accelerated income in-
clusion date without regard to the applica-
tion of § 1.337(d)-2T.

(2) An accelerated income inclusion date
is a date on which P is permitted to take
into account a loss recognized on a dispo-

sition of S stock without regard to the ap-
plication of § 1.337(d)-2T.

(iii) Application of other rules. In ad-
dition to the rules set forth in this para-
graph (b)(5), the rules of § 1.302-5(d) apply
for purposes of determining the appropri-
ate time to take into account any portion of
an excess loss account in redeemed stock
by treating P as the redeemed shareholder
and S as the redeeming corporation. How-
ever, the rules of § 1.302-5(d) shall be ap-
plied by using the language "accelerated
income inclusion date" instead of "accel-
erated loss inclusion date" each time that
term appears.

(iv) Statement to be filed with returns.
With or as part of the income tax return for
the year in which P takes into account any
income attributable to an excess loss ac-
count in redeemed stock, P shall provide a
statement entitled "Inclusion of Income At-
tributable to Excess Loss Account in Re-
deemed Stock." The statement shall specify
the amount of the income that is taken into
account on such return pursuant to this para-
graph (b)(5) and shall identify the shares
to which such amounts relate.

##### (g)

Example 7.Redemption of member stock. (a) Facts.
P directly owns all of the outstanding stock of S1 and
S2. S1 and S2 each own 50 shares of S3's outstand-
ing 100 shares of stock. P is the common parent of
the consolidated group. S1's adjusted basis in the S3
stock is $50. In Year 1, S3 redeems all of its stock
from S1 for $100. In Year 2, P sells all of its shares
of S1 stock to an unrelated party.

(b) Analysis. In Year 1, because S1 actually and
constructively owns 100 percent of stock of S3 im-
mediately before and immediately after the redemp-
tion, the redemption is treated as a distribution to which
section 301 applies. S3's distribution is an intercom-
pany distribution under § 1.1502-13(f)(2)(ii) and ex-
cluded from SI's gross income. Under § 1.1502-32,
S1's basis in S3's stock is reduced by the amount of
the distribution, creating an excess loss account of $50.
Pursuant to paragraph (b)(5)(i) of this section, that ex-
cess loss account is treated as income recognized on
a disposition of the redeemed stock on the date of the
redemption. That income, however, is not taken into
account on such date. Instead, it is taken into ac-
count on the date on which S1 departs from the con-
solidated group as that date is the final inclusion date
because, if the facts that exist at the end of that day
had existed immediately after the redemption, the re-
demption would have been treated as a distribution
in part or full payment in exchange for the redeemed
stock pursuant to section 302(b)(3). Accordingly, S1
must include in its income as gain an amount equal
to the excess loss account in the redeemed S3 stock.

(h) Effective dates-(1) Application. This
section, except for the last sentence of para-
graph (b)(2)(i), and paragraphs (b)(5) and

(g) Example 7 of this section, applies with
respect to determinations of the basis of (in-
cluding an excess loss account in) the stock
of a member in consolidated return years
beginning on or after January 1, 1995. The
last sentence of paragraph (b)(2)(i), and
paragraphs (b)(5) and (g) Example 7 of this
section apply to transactions occurring af-
ter the date these regulations are published
as final regulations in the Federal Regis-
ter. * * *

* * * * *

David A. Mader,
Acting Deputy Commissioner
of Internal Revenue.

(Filed by the Office of the Federal Register on
October 17, 2002, 8:45 a.m., and published in the is-
sue of the Federal Register for October 18, 2002, 67
F.R. 64331)

## Notice of Proposed Rulemaking and Notice of Public Hearing

Disclosure of Relative Values
of Optional Forms of Benefit

REG-124667-02

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Notice of proposed
rulemaking and notice of public hearing.

SUMMARY: This document contains pro-
posed regulations that would consolidate the
content requirements applicable to expla-
nations of qualified joint and survivor an-
nuities and qualified preretirement survivor
annuities payable under certain retirement
plans, and would specify requirements for
disclosing the relative value of optional
forms of benefit that are payable from cer-
tain retirement plans in lieu of a qualified
joint and survivor annuity. These regula-
tions would affect retirement plan spon-
sors and administrators, and participants in
and beneficiaries of retirement plans. This
document also provides notice of a pub-
lic hearing on these proposed regulations.

DATES: Written comments, requests to
speak and outlines of oral comments to be
discussed at the public hearing scheduled

for January 14, 2003, at 10 a.m., must be
received by January 2, 2003.

ADDRESSES: Send submissions to:
CC:ITA:RU (REG-124667-02), room 5226,
Internal Revenue Service, POB 7604, Ben
Franklin Station, Washington, DC 20044.
In the alternative, submissions may be hand
delivered to: CC:ITA:RU (REG-124667-
02), room 5226, Internal Revenue Ser-
vice, 1111 Constitution Avenue, NW,
Washington, DC. Alternatively, taxpayers
may submit comments electronically via the
Internet by submitting comments directly
to the IRS Internet site at: www.irs.gov/
regs. The public hearing will be held in
room 4718 of the Internal Revenue Build-
ing, 1111 Constitution Avenue, NW, Wash-
ington, DC.

FOR FURTHER INFORMATION
CONTACT: Concerning the regulations,
Linda S. F. Marshall, 202-622-6090; con-
cerning submissions and the hearing, and/or
to be placed on the building access list to
attend the hearing, Guy Traynor, 202-622-
7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

## Paperwork Reduction Act

The collections of information contained
in this notice of proposed rulemaking have
been submitted to the Office of Manage-
ment and Budget for review in accordance
with the Paperwork Reduction Act of 1995
(44 U.S.C. 3507(d)). Comments on the col-
lections of information should be sent to the
Office of Management and Budget, Attn:
Desk Officer for the Department of the
Treasury, Office of Information and Regu-
latory Affairs, Washington, DC 20503, with
copies to the Internal Revenue Service, Attn:
IRS Reports Clearance Officer, W:CAR:
MP:FP:S, Washington, DC 20224. Com-
ments on the collections of information
should be received by December 6, 2002.
Comments are specifically requested
concerning:

Whether the proposed collections of in-
formation are necessary for the proper per-
formance of the functions of the IRS,
including whether the information will have
practical utility;

The accuracy of the estimated burden as-
sociated with the proposed collection of in-
formation (see below);

How the quality, utility, and clarity of the
information to be collected may be en-
hanced;

Estimates of capital or start-up costs and
costs of operation, maintenance, and pur-
chase of services to provide information.

The collections of information in this
proposed regulation are in § 1.417(a)(3)-1.
This information is required by the IRS to
comply with the requirements of section
417(a)(3) regarding explanations that must
be provided to participants in a qualified
plan prior to a waiver of a qualified joint
and survivor annuity (QJSA) or a quali-
fied preretirement survivor annuity (QPSA).
This information will be used by partici-
pants and spouses of participants to deter-
mine whether to waive a QJSA or QPSA,
and by the IRS to confirm that the plan
complies with applicable qualification re-
quirements to avoid adverse tax conse-
quences. The collections of information are
mandatory. The respondents are nonprofit
institutions.

Estimated total annual reporting burden:
375,000 hours.

The estimated annual burden per re-
spondent varies from .01 to .99 hours, de-
pending on individual circumstances, with
an estimated average of .5 hours.

Estimated number of respondents:
750,000.

The estimated annual frequency of
responses: on occasion.

## Background

This document contains proposed
amendments to 26 CFR part 1 under sec-
tion 417(a)(3) of the Internal Revenue Code
of 1986 (Code).

A qualified retirement plan to which sec-
tion 401(a)(11) applies must pay a vested
participant's retirement benefit under the
plan in the form of a qualified joint and sur-
vivor annuity (QJSA), except as provided
in section 417. Section 401(a)(11) applies
to defined benefit plans, money purchase
pension plans, and certain other defined
contribution plans. A QJSA is defined in
section 417(b) as an annuity for the life of
the participant with a survivor annuity for
the life of the spouse (if the participant is
married) that is not less than 50 percent of
(and is not greater than 100 percent of) the
amount of the annuity that is payable dur-
ing the joint lives of the participant and the
spouse. Under section 417(b)(2), a QJSA
for a married participant generally must be
the actuarial equivalent of the single life an-
nuity benefit payable for the life of the par-
ticipant. However, a plan is permitted to
subsidize the QJSA for a married partici-
pant. If the plan fully subsidizes the QJSA
for a married participant so that failure to
waive the QJSA would not result in re-
duced payments over the life of the par-
ticipant compared to the single life annuity
benefit, then the plan need not provide an
election to waive the QJSA. See section
417(a)(5).

For a married participant, the QJSA must
be at least as valuable as any other op-
tional form of benefit payable under the
plan at the same time. See § 1.401(a)-20,
Q&A-16. Further, the anti-forfeiture rules
of section 411(a) prohibit a participant's
benefit under a defined benefit plan from
being satisfied through payment that is ac-
tuarially less valuable than the value of the
participant's accrued benefit expressed in
the form of an annual benefit commenc-
ing at normal retirement age. These deter-
minations must be made using reasonable
actuarial assumptions. However, see
§ 1.417(e)-1(d) for actuarial assumptions re-
quired for use in certain present value cal-
culations.

If a plan provides a subsidy for one op-
tional form of benefit (i.e., the payments un-
der an optional form of benefit have an
actuarial present value that is greater than
the actuarial present value of the accrued
benefit), there is no requirement to ex-
tend a similar subsidy (or any subsidy) to
every other optional form of benefit. Thus,
for example, a participant might be en-
titled to receive a single-sum distribution
upon early retirement that does not re-

flect any early retirement subsidy in lieu of
a QJSA that reflects a substantial early re-
tirement subsidy. As a further example, a
participant might be entitled to receive a
single-sum distribution at normal retire-
ment age in lieu of a QJSA that is subsi-
dized as described in section 417(a)(5).

Section 417(a) provides rules under
which a participant (with spousal consent)
may waive payment of the participant's ben-
efit in the form of a QJSA. Section
417(a)(3) provides that a plan must pro-
vide to each participant, within a reason-
able period before the annuity starting date
(and consistent with such regulations as the
Secretary may prescribe) a written expla-
nation of the terms and conditions of the
QJSA, the participant's right to make, and
the effect of, an election to waive the QJSA
form of benefit, the rights of the partici-
pant's spouse, and the right to revoke (and
the effect of the revocation of) an elec-
tion to waive the QJSA form of benefit.

Section 205 of the Employee Retire-
ment Income Security Act of 1974
(ERISA), Public Law 93-406 (88 Stat. 829)
as subsequently amended, provides paral-
lel rules to the rules of sections 401(a)(11)
and 417 of the Internal Revenue Code. In
particular, section 205(a)(3) of ERISA pro-
vides a parallel rule to section 417(a)(3) of
the Code. Treasury regulations issued un-
der section 417(a)(3) of the Code apply as
well for purposes of section 205(a)(3) of
ERISA.

Regulations governing the requirements
for waiver of a QJSA were published in the
Federal Register on August 19, 1988 (T.D.
8219, 1988-2 C.B. 48 [53 FR 31837]). Sec-
tion 1.401(a)-20, Q&A-36, provides rules
for the explanation that must be provided
under section 417(a)(3) as a prerequisite to
waiver of a QJSA. Section 1.401(a)-20,
Q&A-36, requires that such a written ex-
planation must contain a general descrip-
tion of the eligibility conditions and other
material features of the optional forms of
benefit and sufficient additional informa-
tion to explain the relative values of the op-
tional forms of benefit available under the
plan (e.g., the extent to which optional
forms are subsidized relative to the nor-
mal form of benefit or the interest rates used
to calculate the optional forms). In addi-
tion, § 1.401(a)-20, Q&A-36, provides that
the written explanation must comply with
the requirements set forth in § 1.401(a)-
11(c)(3). Section 1.401(a)-11(c)(3) was is-

sued prior to the enactment of section 417,
and provides rules relating to written ex-
planations that were required prior to a par-
ticipant's election of a preretirement survivor
annuity or election to waive a joint and sur-
vivor annuity. Section 1.401(a)-11(c)
(3)(i)(C) provides that such a written ex-
planation must contain a general explana-
tion of the relative financial effect of these
elections on a participant's annuity.

In addition, under section 411 and
§ 1.411(a)-11(c), so long as a benefit is im-
mediately distributable (within the mean-
ing of § 1.411(a)-11(c)(4)), a participant
must be informed of his or her right to de-
fer that distribution. This requirement is in-
dependent of the section 417 requirements
addressed in these proposed regulations.

Concerns have been expressed that, in
certain cases, the information provided to
participants under section 417(a)(3) regard-
ing the available distribution forms does not
adequately enable them to compare those
distribution forms without professional ad-
vice. In particular, participants who are eli-
gible for both subsidized annuity
distributions and unsubsidized single-sum
distributions may be receiving notices that
do not adequately explain the value of the
subsidy that is foregone if the single-sum
distribution is elected. In such a case,
merely disclosing the amount of the single-
sum distribution and the amount of annu-
ity payments may not adequately enable
those participants to make an informed
comparison of the relative values of those
distribution forms, even if the interest rate
used to derive the single sum is disclosed.
Furthermore, questions have been raised as
to how the relative values of optional forms
of benefit are required to be expressed un-
der current regulations. Accordingly, these
proposed regulations are being issued to
propose disclosure requirements that would
enable participants to compare the rela-
tive values of the available distribution
forms using more readily understandable in-
formation.

## Explanation of Provisions

The proposed regulations would con-
solidate the content requirements appli-
cable to explanations of QJSAs and QPSAs
under section 417(a)(3), and would specify
rules for disclosing the relative value of op-
tional forms of benefit as part of the QJSA
explanation. Similar to the requirements in
the current regulations, the required expla-

November 4, 2002

nation must contain, with respect to each
of the optional forms of benefit presently
available to the participant, a description of
the optional form of benefit, a descrip-
tion of the eligibility conditions for the op-
tional form of benefit, a description of the
financial effect of electing the optional form
of benefit, a description of the relative value
of the optional form of benefit, and a de-
scription of any other material features of
the optional form of benefit. Further, as un-
der the current regulations, the QJSA ex-
planation would be permitted to be made
either by providing the participant with in-
formation specific to the participant, or by
providing the participant with generally ap-
plicable information and offering the par-
ticipant the opportunity to request additional
information specifically applicable to the
participant with respect to any optional
forms of benefit available to the partici-
pant. The proposed regulations would clarify
that a defined contribution plan is not re-
quired to provide a description of the rela-
tive values of optional forms of benefit
compared to the value of the QJSA.

The proposed regulations would pro-
vide additional guidance regarding the re-
quired description of the relative values of
optional forms of benefit compared to the
value of the QJSA and the content of the
required disclosure of relative values. Un-
der the proposed regulations, the descrip-
tion of the relative value of an optional form
of benefit compared to the value of the
QJSA must be expressed in a manner that
provides a meaningful comparison of the
relative economic values of the two forms
of benefit without the participant having to
make calculations using interest or mor-
tality assumptions. In order to make this
comparison, the benefit under one or both
optional forms of benefit must be con-
verted, taking into account the time value
of money and life expectancies, so that both
are expressed in the same form. The pro-
posed regulations give several examples of
techniques that may be used for this
comparison: expressing the actuarial present
value of the optional form of benefit as a
percentage or factor of the actuarial present
value of the QJSA; stating the amount of
an annuity payable at the same time and un-
der the same conditions as the QJSA that
is the actuarial equivalent of the optional
form of benefit; or stating the actuarial
present value of both the QJSA and the op-
tional form of benefit. For purposes of pro-

viding a description of the relative value of
an optional form of benefit compared to the
value of the QJSA (and also for purposes
of comparing the financial effect of the dis-
tribution forms available to a participant),
a plan would be permitted to provide rea-
sonable estimates (e.g., estimates based on
data as of an earlier date than the annuity
starting date or an estimate of the spouse's
age). If estimates are used, the participant
has a right to a more precise calculation
upon request.

Since disclosing the relative value of ev-
ery optional form of benefit regardless of
the degree of subsidy may be too burden-
some, and may provide participants with in-
formation that appears more precise than is
warranted based on the inexact nature of the
actuarial assumptions used, the proposed
regulations would provide some ways to
simplify this disclosure of relative values
of optional forms of benefit. One way in
which this disclosure would be simplified
is through a banding rule under which two
or more optional forms of benefit that have
approximately the same value could be
grouped for purposes of disclosing rela-
tive value. Under these proposed regula-
tions, two or more optional forms of benefit
would be treated as having approximately
the same value if those optional forms of
benefit vary in relative value in compari-
son to the value of the QJSA by 5 percent-
age points or less when the relative value
comparison is made by expressing the ac-
tuarial present value of each of those op-
tional forms of benefit as a percentage of
the actuarial present value of the QJSA. For
such a group of optional forms of ben-
efit, the requirement relating to disclos-
ing the relative value of each optional form
of benefit compared to the value of the
QJSA could be satisfied by disclosing the
relative value of any one of the optional
forms in the group compared to the value
of the QJSA, and disclosing that the other
optional forms of benefit in the group are
of approximately the same value. If a single-
sum distribution is included in such a group
of optional forms of benefit, the single-
sum distribution must be the distribution
form that is used for purposes of this com-
parison. The relative value of all optional
forms of benefit that have an actuarial
present value that is at least 95% of the ac-
tuarial present value of the QJSA may be
described by stating that those optional
forms of benefit are of approximately equal

value to the value of the QJSA. Thus, these
rules would permit a plan that provides no
subsidized forms of benefit to state the com-
parison of relative values simply by stat-
ing that all distribution forms are
approximately equal in value to the QJSA.

Another way in which this disclosure
may be simplified is through the use of rep-
resentative values: if, under the banding
rule, two or more optional forms of ben-
efit are grouped, a representative relative
value for all of the grouped options could
be used as the approximate relative value
for all of the grouped options, in lieu of us-
ing the relative value of one of the op-
tional forms of benefit in the group. For this
purpose, a representative relative value is
any relative value that is not less than the
relative value of the member of the group
of optional forms of benefit with the low-
est relative value and is not greater than the
relative value of the member of that group
with the highest relative value when mea-
sured on a consistent basis. For example,
if three optional forms have relative val-
ues of 87.5%, 89%, and 91% of the value
of the QJSA, all three optional forms can
be treated as having a relative value of ap-
proximately 90% of the value of the QJSA.

The proposed regulations would also per-
mit the disclosure of the financial effect and
relative value of optional forms of ben-
efit to be made in the form of generally ap-
plicable information rather than information
specific to the participant, provided that in-
formation specific to the participant re-
garding the optional form of benefit must
be furnished at the participant's request.
Thus, under the proposed regulations, in lieu
of providing a QJSA explanation that de-
scribes each optional form that is pres-
ently available to the participant, the
generalized QJSA explanation need only re-
flect the generally available optional forms
of benefits, along with a reference to where
a participant can obtain the information for
any other optional forms of benefits (such
as optional forms from prior benefit struc-
tures for limited groups of employees) that
are presently available to the participant.

With respect to the generally available
optional forms of benefits, in lieu of pro-
viding a statement of financial effect and
relative value comparison that is specific to
the participant, the generalized QJSA ex-
planation is permitted to include a chart or
other comparable device showing a series
of examples of financial effects and rela-

tive value comparisons for hypothetical par-
ticipants. The examples in the chart should
reflect a representative range of ages for the
hypothetical participants and use reason-
able assumptions for the age of the hypo-
thetical participant's spouse and any other
variable that affects the financial effect, or
relative value, of the optional form of ben-
efit. The chart must be accompanied by a
general statement describing the effect of
significant variations between the assumed
ages or other variables on the financial ef-
fect of electing the optional form of ben-
efit and the comparison of the relative value
of the optional form of benefit to the value
of the QJSA. A generalized QJSA expla-
nation that includes this chart must also in-
clude the amount payable to the participant
under the normal form of benefit, either at
normal retirement age, or payable imme-
diately. In addition, this chart must be ac-
companied by a statement that includes an
offer to provide, upon the participant's re-
quest, a statement of financial effect along
with a comparison of relative values that
is specific to the participant for one or more
presently available optional forms of ben-
efit, and a description of how a partici-
pant may obtain this additional information.
Thus, with respect to those optional forms
of benefit for which additional informa-
tion is requested, the participant must re-
ceive a QJSA explanation specific to the
participant that is based on the partici-
pant's actual age and benefit.

The proposed regulations would pro-
vide rules governing the actuarial assump-
tions to be used in comparing the value of
an optional form of benefit to the QJSA.
If an optional form of benefit is subject to
the requirements of section 417(e)(3) and
§ 1.417(e)-1(d) (e.g., a single-sum distri-
bution), any comparison of the value of the
optional form of benefit to the value of the
QJSA must be made using the applicable
mortality table and the applicable interest
rate as defined in § 1.417(e)-1(d)(2) and (3)
(or, at the option of the plan, another rea-
sonable interest rate and reasonable mor-
tality table used under the plan to calculate
the amount payable under the optional form
of benefit). All other optional forms of ben-
efit payable to the participant must be com-
pared with the QJSA using a single set of
interest rates and mortality tables that are
reasonable and that are applied uniformly
for this purpose with respect to all such
other optional forms payable to the par-

ticipant. The uniform interest and mortal-
ity assumptions should be used regardless
of whether those assumptions are actu-
ally used to determine the amount of ben-
efit payments under any particular optional
form.

The proposed regulations would also re-
quire disclosure of information to help a
participant understand the significance of
a disclosure of the relative value of an op-
tional form of benefit. Under the proposed
regulations, the notice would be required to
provide an explanation of the concept of
relative value. Specifically, the notice would
be required to explain that the relative value
comparison is intended to allow the par-
ticipant to compare the total value of dis-
tributions paid in different forms, that the
relative value comparison is made by con-
verting the value of the optional forms of
benefit currently available to a common
form (such as the QJSA or single-sum dis-
tribution), and that this conversion uses in-
terest and life expectancy assumptions.

Under the proposed regulations, a re-
quired numerical comparison of the value
of the optional form of benefit to the value
of the QJSA under the plan generally would
be required to disclose the interest rate that
is used to develop a required numerical
comparison. However, if all optional forms
of benefit are permitted to be treated as hav-
ing approximately the same value after ap-
plication of the banding rule described
above, then the plan would not be required
to disclose the interest rate used to de-
velop a required numerical comparison to
the QJSA for optional form of benefit that
is not subject to the requirements of sec-
tion 417(e)(3). In addition, the proposed
regulations would require the plan to pro-
vide a general statement that all numeri-
cal comparisons of relative value provided
are based on average life expectancies, and
that the relative value of payments ulti-
mately made under an annuity optional form
of benefit will depend on actual longev-
ity.

Under the proposed regulations, both the
QPSA explanation and the QJSA explana-
tion must be written in a manner calcu-
lated to be understood by the average
participant. A plan may wish to provide ad-
ditional information beyond the minimum
information that would be required under
these proposed regulations, in order to help
an employee to evaluate the form of ben-
efit that would be most desirable under the

employee's individual circumstances. For
example, the plan may wish to add fur-
ther explanation of the effects of ill health
or other factors influencing expected lon-
gevity on the desirability of electing an-
nuity forms of distribution.

The proposed regulations contain rules
regarding the method for providing the
QJSA explanation and the QPSA explana-
tion. Under the proposed regulations, these
explanations must be written explanations.
First class mail to the last known address
of the party is an acceptable delivery
method for a section 417(a)(3) explana-
tion. Likewise, hand delivery is accept-
able. However, the posting of the
explanation is not considered provision of
the section 417(a)(3) explanation.

These proposed regulations do not ad-
dress the extent to which the QJSA expla-
nation or the QPSA explanation can be
provided through electronic media. The IRS
and the Treasury Department are consid-
ering the extent to which the QJSA expla-
nation and the QPSA explanation, as well
as other notices under the various Inter-
nal Revenue Code requirements relating to
qualified retirement plans, can be provided
electronically, taking into account the ef-
fect of the Electronic Signatures in Glo-
bal and National Commerce Act (ESIGN),
Public Law 106-229, 114 Stat. 464 (2000).
The IRS and the Treasury Department an-
ticipate issuing proposed regulations re-
garding these issues, and invite comments
on these issues.

## Proposed Effective Date

The regulations are proposed to be ap-
plicable to QJSA explanations with re-
spect to distributions with annuity starting
dates on or after January 1, 2004, and to
QPSA explanations provided on or after
January 1, 2004.

## Special Analyses

It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Ex-
ecutive Order 12866. Therefore, a regulatory
assessment is not required. It is hereby cer-
tified that the collection of information in
these regulations will not have a signifi-
cant economic impact on a substantial num-
ber of small entities. This certification is
based upon the fact that qualified retire-
ment plans of small businesses typically
commence distribution of benefits to few,

if any, plan participants in any given year
and, similarly, only offer elections to waive
a QPSA to few, if any, participants in any
given year. Thus, the collection of infor-
mation in these regulations will only have
a minimal economic impact on most small
entities. Therefore, an analysis under the
Regulatory Flexibility Act (5 U.S.C. chap-
ter 6) is not required. Pursuant to section
7805(f) of the Code, this notice of pro-
posed rulemaking will be submitted to the
Chief Counsel for Advocacy of the Small
Business 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 written comments (pref-
erably a signed original and eight (8) cop-
ies) that are submitted timely to the IRS.
Alternatively, taxpayers may submit com-
ments electronically to the IRS Internet site
at www.irs.gov/regs. All comments will be
available for public inspection and copy-
ing. The IRS and Treasury request com-
ments on the clarity of the proposed rules
and how they may be made easier to un-
derstand or to implement.

A public hearing has been scheduled for
January 14, 2003, at 10 a.m. in room 4718
of the Internal Revenue Building, 1111 Con-
stitution Avenue, NW, Washington, DC. All
visitors must present photo identification to
enter the building. Because of access re-
strictions, visitors will not be admitted be-
yond the immediate entrance area more than
30 minutes before the hearing starts at the
Constitution Avenue entrance. For infor-
mation about having your name placed on
the building access list to attend the hear-
ing, see the "FOR FURTHER INFORMA-
TION 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 comments and an outline of
the topics to be discussed and the time to
be devoted to each topic (signed original
and eight (8) copies) by January 2, 2003.
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 dead-
line for receiving outlines has passed. Cop-
ies of the agenda will be available free of
charge at the hearing.

## Drafting Information

The principal author of these proposed
regulations is Linda S. F. Marshall of the
Office of the Division Counsel/Associate
Chief Counsel (Tax Exempt and Govern-
ment Entities). However, other personnel
from the IRS and Treasury participated in
their development.

* * * * *

## Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed
to be amended as follows:

PART 1 - INCOME TAX; TAXABLE
YEARS BEGINNING AFTER
DECEMBER 31, 1986.

Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *

Par. 2. Paragraph (c)(3) of § 1.401(a)-11
is revised to read as follows:

§ 1.401(a)-11 Qualified joint and
survivor annuities.

* * * * *

(3) Information to be provided by plan.
For rules regarding the information re-
quired to be provided with respect to the
election to waive a QJSA or a QPSA, see
§ 1.417(a)(3)-1.

* * * * *

Par. 3. A-36 of § 1.401(a)-20 is re-
vised to read as follows:

§ 1.401 (a)-20 Requirements of qualified
joint and survivor annuity and qualified
preretirement survivor annuity.

* * * * *

A-36. For rules regarding the explana-
tion of QPSAs and QJSAs required under
section 417(a)(3), see § 1.417(a)(3)-1.

* * * * *

Par. 4. Section 1.417(a)(3)-1 is added to
read as follows:

§ 1.417(a)(3)-1 Required explanation of
qualified joint and survivor annuity and
qualified preretirement survivor annuity.

(a) Written explanation requirement-
(1) General rule. A plan meets the survi-
vor annuity requirements of section

401(a)(11) only if the plan meets the re-
quirements of section 417(a)(3) and this sec-
tion regarding the written explanation
required to be provided a participant with
respect to a QJSA or a QPSA. A written ex-
planation required to be provided to a par-
ticipant with respect to either a QJSA or a
QPSA under section 417(a)(3) and this sec-
tion is referred to in this section as a sec-
tion 417(a)(3) explanation. See § 1.401(a)-
20, Q&A-37, for exceptions to the written
explanation requirement in the case of a
fully subsidized QPSA or QJSA, and
§ 1.401(a)-20, Q&A-38, for the defini-
tion of a fully subsidized QPSA or QJSA.

(2) Time for providing section 417(a)(3)
explanation-(i) QJSA explanation. See
§ 1.417(e)-1(b)(3)(ii) for rules governing the
timing of the QJSA explanation.

(ii) QPSA explanation. See § 1.401(a)-
20, Q&A-35, for rules governing the tim-
ing of the QPSA explanation.

(3) Required method for providing sec-
tion 417(a)(3) explanation. A section
417(a)(3) explanation must be a written ex-
planation. First class mail to the last known
address of the participant is an acceptable
delivery method for a section 417(a)(3) ex-
planation. Likewise, hand delivery is ac-
ceptable. However, the posting of the
explanation is not considered provision of
the section 417(a)(3) explanation.

(4) Understandability. A section
417(a)(3) explanation must be written in a
manner calculated to be understood by the
average participant.

(b) Required content of section 417(a)(3)
explanation-(1) Content of QPSA expla-
nation. The QPSA explanation must con-
tain a general description of the QPSA, the
circumstances under which it will be paid
if elected, the availability of the election of
the QPSA, and, except as provided in para-
graph (d)(3) of this section, a description
of the financial effect of the election of the
QPSA on the participant's benefits (i.e., an
estimate of the reduction to the partici-
pant's estimated normal retirement ben-
efit that would result from an election of
the QPSA).

(2) Content of QJSA explanation. The
QJSA explanation must satisfy either para-
graph (c) or paragraph (d) of this section.
Under paragraph (c) of this section, the
QJSA explanation must contain certain spe-
cific information relating to the benefits
available under the plan to the particular
participant. Alternatively, under paragraph

(d) of this section, the QJSA explanation
can contain generally applicable informa-
tion in lieu of specific participant informa-
tion, provided that the participant has the
right to request additional information re-
garding the participant's benefits under the
plan.

(c) Participant-specific information re-
quired to be provided-(1) In general. A
QJSA explanation satisfies this paragraph
(c) if it provides the following informa-
tion with respect to each of the optional
forms of benefit presently available to the
participant-

(i) A description of the optional form of
benefit;

(ii) A description of the eligibility con-
ditions for the optional form of benefit;

(iii) A description of the financial ef-
fect of electing the optional form of ben-
efit (i.e., the amount payable under the form
of benefit);

(iv) In the case of a defined benefit plan,
a description of the relative value of the op-
tional form of benefit compared to the value
of the QJSA, in the manner described in
paragraph (c)(2) of this section; and

(v) A description of any other material
features of the optional form of benefit.

(2) Requirement for numerical compari-
son of relative values-(i) In general. The
description of the relative value of an op-
tional form of benefit compared to the value
of the QJSA under paragraph (c)(1)(iv) of
this section must be expressed to the par-
ticipant in a manner that provides a mean-
ingful comparison of the relative economic
values of the two forms of benefit with-
out the participant having to make calcu-
lations using interest or mortality
assumptions. Thus, in performing the cal-
culations necessary to make this compari-
son, the benefits under one or both optional
forms of benefit must be converted, tak-
ing into account the time value of money
and life expectancies, so that the values of
both optional forms of benefit are expressed
in the same form. For example, such a com-
parison may be expressed to the partici-
pant using any of the following
techniques-

(A) Expressing the actuarial present
value of the optional form of benefit as a
percentage or factor of the actuarial present
value of the QJSA;

(B) Stating the amount of the annuity
that is the actuarial equivalent of the op-
tional form of benefit and that is payable

at the same time and under the same con-
ditions as the QJSA; or

(ii) Simplified presentations permitted-
(A) Grouping of certain optional forms.
Two or more optional forms of benefit that
have approximately the same value may be
grouped for purposes of a required numeri-
cal comparison described in this paragraph
(c)(2). For this purpose, two or more op-
tional forms of benefit have approximately
the same value if those optional forms of
benefit vary in relative value in compari-
son to the value of the QJSA by 5 percent-
age points or less when the relative value
comparison is made by expressing the ac-
tuarial present value of each of those op-
tional forms of benefit as a percentage of
the actuarial present value of the QJSA. For
such a group of optional forms of ben-
efit, the requirement relating to disclos-
ing the relative value of each optional form
of benefit compared to the value of the
QJSA can be satisfied by disclosing the
relative value of any one of the optional
forms in the group compared to the value
of the QJSA, and disclosing that the other
optional forms of benefit in the group are
of approximately the same value. If a single-
sum distribution is included in such a group
of optional forms of benefit, the single-
sum distribution must be the distribution
form that is used for purposes of this com-
parison. In addition, the relative value of
all optional forms of benefit that have an
actuarial present value that is at least 95%
of the actuarial present value of the QJSA
is permitted to be described by stating that
those optional forms of benefit are approxi-
mately equal in value to the QJSA, or that
all of those forms of benefit and the QJSA
are approximately equal in value.

(B) Representative relative value for
grouped optional forms. If, in accordance
with paragraph (c)(2)(ii)(A) of this sec-
tion, two or more optional forms of ben-
efits are grouped, the relative values for all
of the optional forms of benefit in the group
can be stated using a representative rela-
tive value as the approximate relative value
for the entire group. For this purpose, a rep-
resentative relative value is any relative
value that is not less than the relative value
of the member of the group of optional
forms of benefit with the lowest relative
value and is not greater than the relative

value of the member of that group with the
highest relative value when measured on a
consistent basis. For example, if three op-
tional forms have relative values of 87.5%,
89%, and 91% of the value of the QJSA,
all three optional forms can be treated as
having a relative value of approximately
90% of the value of the QJSA. As required
under paragraph (c)(2)(ii)(A) of this sec-
tion, if a single-sum distribution is included
in the group of optional forms of benefit,
the 90% relative factor of the value of the
QJSA must be disclosed as the approxi-
mate relative value of the single sum, and
the other forms can be described as hav-
ing the same approximate value as the
single sum.

(iii) Actuarial assumptions used to de-
termine relative values. For the purpose of
providing a numerical comparison of the
value of an optional form of benefit to the
value of the immediately commencing
QJSA, the following rules apply-

(A) If an optional form of benefit is sub-
ject to the requirements of section 417(e)(3)
and § 1.417(e)-1(d), any comparison of the
value of the optional form of benefit to the
value of the QJSA must be made using the
applicable mortality table and the appli-
cable interest rate as defined in § 1.417(e)-
1(d)(2) and (3) (or, at the option of the plan,
another reasonable interest rate and rea-
sonable mortality table used under the plan
to calculate the amount payable under the
optional form of benefit); and

(B) All other optional forms of benefit
payable to the participant must be com-
pared with the QJSA using a single set of
interest and mortality assumptions that are
reasonable and that are applied uniformly
with respect to all such optional forms pay-
able to the participant (regardless of whether
those assumptions are actually used un-
der the plan for purposes of determining
benefit payments).

(iv) Required disclosure of
assumptions-(A) Explanation of concept
of relative value. The notice must pro-
vide an explanation of the concept of rela-
tive value, communicating that the relative
value comparison is intended to allow the
participant to compare the total value of dis-
tributions paid in different forms, that the
relative value comparison is made by con-
verting the value of the optional forms of
benefit presently available to a common
form (such as the QJSA or a single-sum dis-
tribution), and that this conversion uses in-

terest and life expectancy assumptions. The
explanation of relative value must include
a general statement that all comparisons
provided are based on average life expect-
ancies, and that the relative value of pay-
ments ultimately made under an annuity
optional form of benefit will depend on ac-
tual longevity.

(B) Disclosure of interest assumptions.
A required numerical comparison of the
value of the optional form of benefit to the
value of the QJSA under the plan is re-
quired to disclose the interest rate that is
used to develop the comparison. If all op-
tional forms of benefit are permitted to be
grouped under paragraph (c)(2)(ii)(A) of this
section, then the requirement of this para-
graph (c)(2)(iv)(B) does not apply for any
optional form of benefit not subject to the
requirements of section 417(e)(3) and
§ 1.417(e)-1(d)(3).

(3) Permitted estimates of financial ef-
fect and relative value-(i) General rule.
For purposes of providing a description of
the financial effect of the distribution forms
available to a participant as required un-
der paragraph (c)(1)(iii) of this section, and
for purposes of providing a description of
the relative value of an optional form of
benefit compared to the value of the QJSA
for a participant as required under para-
graph (c)(1)(iv) of this section, the plan is
permitted to provide reasonable estimates
(e.g., estimates based on data as of an ear-
lier date than the annuity starting date, a rea-
sonable assumption for the age of the
participant's spouse, or, in the case of a de-
fined contribution plan, reasonable esti-
mates of amounts that would be payable
under a purchased annuity contract), in-
cluding reasonable estimates of the appli-
cable interest rate under section 417(e)(3).

(ii) Right to more precise calculation. If
a QJSA notice uses a reasonable estimate
under paragraph (c)(3)(i) of this section, the
QJSA explanation must identify the esti-
mate and explain that the plan will, upon
the request of the participant, provide a
more precise calculation and the plan must
provide the participant with a more pre-
cise calculation if so requested. Thus, for
example, if a plan provides an estimate of
the amount of the QJSA that is based on
a reasonable assumption concerning the age
of the participant's spouse, the participant
can request a calculation that takes into ac-
count the actual age of the spouse, as pro-
vided by the participant.

(iii) Revision of prior information. If a
more precise calculation described in para-
graph (c)(3)(ii) of this section materially
changes the relative value of an optional
form compared to the value of the QJSA,
the revised relative value of that optional
form must be disclosed, regardless of
whether the financial effect of selecting the
optional form is affected by the more pre-
cise calculation.

(4) Special rules for disclosure of fi-
nancial effect for defined contribution plans.
For a written explanation provided by a de-
fined contribution plan, a description of fi-
nancial effect required by paragraph
(c)(1)(iii) of this section with respect to an
annuity form of benefit must include a state-
ment that the annuity will be provided by
purchasing an annuity contract from an in-
surance company with the participant's ac-
count balance under the plan. If the
description of the financial effect of the op-
tional form of benefit is provided using es-
timates rather than by assuring that an
insurer is able to provide the amount dis-
closed to the participant, the written ex-
planation must also disclose this fact.

(d) Substitution of generally applicable
information for participant information in
the section 417(a)(3) explanation-(1)
Forms of benefit available. In lieu of pro-
viding the information required under para-
graphs (c)(1)(i) through (v) of this section
for each optional form of benefit pres-
ently available to the participant as de-
scribed in paragraph (c) of this section, the
QJSA explanation may contain the infor-
mation required under paragraphs (c)(1)(i)
through (v) of this section for the QJSA and
each other optional form of benefit gener-
ally available under the plan, along with a
reference to where a participant may readily
obtain the information required under para-
graphs (c)(1)(i) through (v) of this sec-
tion for any other optional forms of benefit
that are presently available to the partici-
pant.

(2) Financial effect and comparison of
relative values-(i) General rule. In lieu of
providing a statement of the financial ef-
fect of electing an optional form of ben-
efit as required under paragraph (c)(1)(iii)
of this section, or a comparison of rela-
tive values as required under paragraph
(c)(1)(iv) of this section, based on the ac-
tual age and benefit of the participant, the
QJSA explanation is permitted to include
a chart (or other comparable device) show-

ing the financial effect and relative value
of optional forms of benefit in a series of
examples specifying the amount of the op-
tional form of benefit payable to a hypo-
thetical participant at a representative range
of ages and the comparison of relative val-
ues at those same representative ages. Each
example in this chart must show the finan-
cial effect of electing the optional form of
benefit pursuant to the rules of paragraph
(c)(1)(iii) of this section, and a compari-
son of the relative value of the optional
form of benefit to the value of the QJSA
pursuant to the rules of paragraph (c)(2) of
this section, using reasonable assumptions
for the age of the hypothetical participant's
spouse and any other variables that affect
the financial effect, or relative value, of the
optional form of benefit. The requirement
to show the financial effect of electing an
optional form can be satisfied through the
use of other methods (e.g., expressing the
amount of the optional form as a percent-
age or a factor of the amount payable un-
der the normal form of benefit), provided
that the method provides sufficient infor-
mation so that a participant can determine
the amount of benefits payable in the op-
tional form. The chart or other compa-
rable device must be accompanied by the
disclosures described in paragraph (c)(2)(iv)
of this section explaining the concept of
relative value and disclosing certain inter-
est assumptions. In addition, the chart or
other comparable device must be accom-
panied by a general statement describing the
effect of significant variations between the
assumed ages or other variables on the fi-
nancial effect of electing the optional form
of benefit and the comparison of the rela-
tive value of the optional form of benefit
to the value of the QJSA.

(ii) Actual benefit must be disclosed. The
generalized notice described in this para-
graph (d)(2) will satisfy the requirements
of paragraph (b)(2) of this section only if
the notice includes either the amount pay-
able to the participant under the normal
form of benefit or the amount payable to
the participant under the normal form of
benefit adjusted for immediate commence-
ment. For this purpose, the normal form of
benefit is the form under which payments
due to the participant under the plan are ex-
pressed under the plan, prior to adjust-
ments for form of benefit. For example,
assuming that a plan's benefit accrual for-
mula is expressed as a straight life annu-

ity, the generalized notice must provide the
amount of either the straight life annuity
commencing at normal retirement age or the
straight life annuity commencing immedi-
ately.

(iii) Ability to request additional infor-
mation. The generalized notice described in
this paragraph (d)(2) must be accompa-
nied by a statement that includes an offer
to provide, upon the participant's request,
a statement of financial effect and a com-
parison of relative values that is specific to
the participant for any presently available
optional form of benefit, and a descrip-
tion of how a participant may obtain this
additional information.

(3) Financial effect of QPSA election. In
lieu of providing a specific description of
the financial effect of the QPSA election,
the QPSA explanation may provide a gen-
eral description of the financial effect of the
election. Thus, for example, the descrip-
tion can be in the form of a chart show-
ing the reduction to a hypothetical
participant's normal retirement benefit at a
representative range of participant ages as
a result of the QPSA election (using a rea-
sonable assumption for the age of the hy-
pothetical participant's spouse relative to the
age of the hypothetical participant). In ad-
dition, this chart must be accompanied by
a statement that includes an offer to pro-
vide, upon the participant's request, an es-
timate of the reduction to the participant's
estimated normal retirement benefit, and a
description of how a participant may ob-
tain this additional information.

(4) Additional information required to be
furnished at the participant's request-(i)
Explanation of QJSA. If, as permitted un-
der paragraphs (d)(1) and (2) of this sec-
tion, the content of a QJSA explanation does
not include all the items described in para-
graph (c) of this section, then, upon a timely
request from the participant for any of the
information required under paragraphs
(c)(1)(i) through (v) of this section for one
or more presently available optional forms
(including a request for all optional forms
presently available to the participant), the
plan must furnish the information required
under paragraphs (c)(1)(i) through (v) of this
section with respect to those optional forms.
Thus, with respect to those optional forms
of benefit, the participant must receive a
QJSA explanation specific to the partici-
pant that is based on the participant's ac-

tual age and benefit. In addition, the plan
must comply with paragraph (c)(3)(iii) of
this section.

(ii) Explanation of QPSA. If, as permit-
ted under paragraph (d)(3) of this sec-
tion, the content of a QPSA explanation
does not include all the items described in
paragraph (b)(1) of this section, then, upon
a timely request from the participant for an
estimate of the reduction to the partici-
pant's estimated normal retirement ben-
efit that would result from a QPSA election,
the plan must furnish such an estimate.

(e) Examples. The following examples
illustrate the application of this section.
Solely for purposes of these examples, the
applicable interest rate that applies to any
distribution that is subject to the rules of
section 417(e)(3) is assumed to be 51/2%,
and the applicable mortality table under sec-
tion 417(e)(3) and § 1.417(e)-1(d)(2) is as-
sumed to be the table that applies as of
January 1, 2003. In addition, solely for pur-
poses of these examples, assume that a plan
which determines actuarial equivalence us-
ing 6% interest and the applicable mortal-
ity table under section 417(e)(3) and
§ 1.417(e)-1(d)(2) that applies as of Janu-
ary 1, 1995, is using reasonable actuarial
assumptions. The examples are as follows:

Example 1. (i) Participant M participates in Plan
A, a qualified defined benefit plan. Under Plan A, the
QJSA is a joint and 100% survivor annuity, which is
actuarially equivalent to the single life annuity de-
termined using 6% interest and the section 417(e)(3)
applicable mortality table that applies as of January
1, 1995. On January 1, 2004, M will terminate em-
ployment at age 55. When M terminates employ-
ment, M will be eligible to elect an unreduced early
retirement benefit, payable as either a life annuity or
the QJSA. M will also be eligible to elect a single-
sum distribution equal to the actuarial present value
of the single life annuity payable at normal retire-
ment age (age 65), determined using the applicable
mortality table and the applicable interest rate under
section 417(e)(3).

(ii) Participant M is provided with a QJSA ex-
planation that describes the single life annuity, the
QJSA, and single-sum distribution option under the
plan, and any eligibility conditions associated with
these options. The explanation indicates that, if Par-
ticipant M commenced benefits at age 55 and had a
spouse age 55, the monthly benefit under an imme-
diately commencing single life annuity is $3,000, the
monthly benefit under the QJSA is estimated to be
89.96% of the monthly benefit under the immedi-
ately commencing single life annuity or $2,699, and
the single sum is estimated to be 74.7645 times the
monthly benefit under the immediately commenc-
ing single life annuity or $224,293.

(iii) The QJSA explanation indicates that the single
life annuity and the QJSA are of approximately the
same value, but that the single-sum option is equiva-

lent in value to a QJSA of $1,215. (This amount is
45% of the value of the QJSA at age 55 ($1,215 di-
vided by 89.96% of $3,000 equals 45%).) The ex-
planation states that the relative value comparison
converts the value of the single life annuity and the
single-sum options to the value of each if paid in the
form of the QJSA and that this conversion uses in-
terest and life expectancy assumptions. The explana-
tion specifies that the calculations relating to the single-
sum distribution were prepared using 5.5% interest and
average life expectancy, that the other calculations were
prepared using a 6% interest rate and that the rela-
tive value of actual annuity payments for an indi-
vidual can vary depending on how long the individual
and spouse live. The explanation notes that the cal-
culation of the QJSA assumed that the spouse was age
55, that the amount of the QJSA will depend on the
actual age of the spouse (for example, annuity pay-
ments will be significantly lower if the spouse is sig-
nificantly younger than the participant), and that the
amount of the single-sum payment will depend on the
interest rates that apply when the participant actu-
ally takes a distribution. The explanation also in-
cludes an offer to provide a more precise calculation
to the participant taking into account the spouse's ac-
tual age.

(iv) Participant M requests a more precise calcu-
lation of the financial effect of choosing a QJSA, tak-
ing into the actual age of Participant M's spouse. Based
on the fact that M's spouse is age 50, Plan A deter-
mines that the monthly payments under the QJSA are
87.62% of the monthly payments under the single life
annuity, or $2,628.60 per month, and provides this in-
formation to M. Plan A is not required to provide an
updated calculation of the relative value of the single
sum because the value of single sum continues to be
45% of the value of the QJSA.

Example 2. (i) The facts are the same as in Ex-
ample 1, except that under Plan A, the single-sum dis-
tribution is determined as the actuarial present value
of the immediately commencing single life annuity.
In addition, Plan A provides a joint and 75% survi-
vor annuity that is reduced from the single life an-
nuity and that is the QJSA under Plan A. For purposes
of determining the amount of the QJSA, the reduc-
tion is only half of the reduction that would nor-
mally apply under the actuarial assumptions specified
in Plan A for determining actuarial equivalence of op-
tional forms.

(ii) In lieu of providing information specific to Par-
ticipant M in the QJSA notice as set forth in para-
graph (c) of this section, Plan A satisfies the QJSA
explanation requirement in accordance with para-
graph (d)(2) of this section by providing M with a
statement that M's monthly benefit under an imme-
diately commencing single life annuity (which is the
normal form of benefit under Plan A, adjusted for im-
mediate commencement) is $3,000, along with the fol-
lowing chart showing the financial effect and the
relative value of the optional forms of benefit com-
pared to the QJSA for a hypothetical participant with
a $1,000 benefit and a spouse who is three years
younger than the participant. For each optional form
generally available under the plan, the chart shows the
financial effect and the relative value, using the group-
ing rules of paragraph (c)(2)(ii) of this section. Sepa-
rate charts are provided for ages 55, 60, and 65.

## Age 55 Commencement

Optional Form

Amount of distribution per $1,000 of immediate single life annuity

Relative Value

Life Annuity

$1,000 per month

approximately the same value as the QJSA

QJSA (joint and 75% survivor annuity)

$956 per month

n/a

Joint and 100% survivor annuity

$886 per month

approximately the same value as the QJSA

Lump sum

$165,959

approximately the same value as the QJSA

Age 60 Commencement

Optional Form

Amount of distribution per $1,000 of immediate single life annuity

Relative Value

Life Annuity

$1,000 per month

approximately 94% of the value of the QJSA

QJSA (joint and 75% survivor annuity)

$945 per month

n/a

Joint and 100% survivor annuity

$859 per month

approximately 94% of the value of the QJSA

Lump sum

$151,691

approximately the same value as the QJSA

Age 65 Commencement

Optional Form

Amount of distribution per $1,000 of immediate single life annuity

Relative Value

Life Annuity

$1,000 per month

approximately 93% of the value of the QJSA

QJSA (joint and 75% survivor annuity)

$932 per month

n/a

Joint and 100% survivor annuity

$828 per month

approximately 93% of the value of the QJSA

Lump sum

$135,759

approximately 93% of the value of the QJSA

(iii) The chart disclosing the financial effect
and relative value of the optional forms specifies
that the calculations were prepared assuming that
the spouse is three years younger than the
participant, that the calculations relating to the
single-sum distribution were prepared using 5.5%
interest and average life expectancy, that the other
calculations were prepared using a 6% interest rate,
and that the relative value of actual payments for
an individual can vary depending on how long the
individual and spouse live. The explanation states
that the relative value comparison converts the
QJSA, the single life annuity, the joint and 100%
survivor annuity, and the single-sum options to an
equivalent present value and that this conversion
uses interest and life expectancy assumptions. The
explanation notes that the calculation of the QJSA
depends on the actual age of the spouse (for
example, annuity payments will be significantly
lower if the spouse is significantly younger than
the participant), and that the amount of the single-
sum payment will depend on the interest rates that
apply when the participant actually takes a
distribution. The explanation also includes an offer
to provide a calculation specific to the participant
upon request.

(iv) Participant M requests information regard-
ing the amounts payable under the QJSA, the joint and
100% survivor annuity, and the single sum.

(v) Based on the information about the age of Par-
ticipant M's spouse, Plan A determines that M's QJSA
is $2,856.30 per month, the joint and 100% survi-
vor annuity is $2,628.60 per month, and the single sum
is $497,876. The actuarial present value of the QJSA
(determined using the 5.5% interest and the section
417(e)(3) applicable mortality table, the actuarial as-
sumptions required under section 417) is $525,091.
Accordingly, the value of the single-sum distribu-
tion available to M at January 1, 2004, is 94.8% of
the actuarial present value of the QJSA. In addition,
the actuarial present value of the life annuity and the
100% joint and survivor annuity are 95.0% of the ac-
tuarial present value of the QJSA.

(vi) Plan A provides M with a QJSA explana-
tion that incorporates these more precise calcula-
tions of the financial effect and relative value of the
optional forms for which M requested information.

(f) Effective date. This section applies to
QJSA explanations provided with respect
to distributions with annuity starting dates
on or after January 1, 2004, and to QPSA
explanations provided on or after January
1, 2004.

### § 1.417(e)-1 [Amended]

Par. 5. In § 1.417(e)-1, paragraph (b)(2)
is amended by removing the language
"§ 1.401(a)-20 Q&A-36" and adding
"§ 1.417(a)(3)-1" in its place.

Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.

(Filed by the Office of the Federal Register on October 4,
2002, 8:45 a.m., and published in the issue of the Federal Reg-
ister for October 7, 2002, 67 F.R. 62417)

## Dual Consolidated Loss Recapture Events; Correction

### Announcement 2002-100

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Notice of proposed
rulemaking and notice of public hearing.

SUMMARY: This document contains cor-
rections to proposed regulations (REG-
106879-00, 2002-34 I.R.B. 402) as
published in the Internal Revenue Bulle-
tin. These regulations under section 1503(d)
relate to the events that require the recap-
ture of dual consolidated losses.

DATES: These corrections are effective
August 26, 2002.

FOR FURTHER INFORMATION
CONTACT: Kenneth D. Allison or
Kathryn T. Holman at (202) 622-3860 (not
a toll-free number).

#### SUPPLEMENTARY INFORMATION:

##### Background

The notice of proposed rulemaking that
is the subject of these corrections is un-
der section 1503(d).

##### Need for Correction

As published in the Internal Revenue
Bulletin, this notice of proposed rulemak-
ing contains errors which may prove to be
misleading and are in need of clarifica-
tion.

##### Correction of Publication

Accordingly, the notice of proposed rule-
making (REG-106879-00) as published in
the Internal Revenue Bulletin is corrected
as follows:

1\. On page 404 of the Internal Rev-
enue Bulletin (I.R.B.), column 1, under
"Proposed Effective Date", the language
"These regulations amending the dual con-
solidated loss rules under § 1.1503-2 are
proposed to apply to transactions other-
wise constituting triggering events occur-
ring on or after August 1, 2002." is
corrected to read "These regulations amend-
ing the dual consolidated loss rules under
§ 1.1503-2 are proposed to apply to trans-
actions otherwise constituting triggering
events occurring on or after [DATE THE
FINAL REGULATIONS ARE PUB-
LISHED IN THE FEDERAL REGIS-
TERJ."

2\. On page 405 of the I.R.B., column
2, the language "Paragraphs (g)(2)(iv)(A)(4)
and (5) of this section, and paragraphs
(g)(2)(iv)(B)(l)(ii) and (iii) of this sec-
tion, shall apply with respect to transac-
tions otherwise constituting triggering events
occurring on or after August 1, 2002." is
corrected to read “Paragraphs
(g)(2)(iv)(A)(4) and (5) of this section, and
paragraphs (g)(2)(iv)(B)(!)(ii) and (iii) of this
section, shall apply with respect to trans-
actions otherwise constituting triggering
events occurring on or after [DATE THE
FINAL REGULATIONS ARE PUB-
LISHED IN THE FEDERAL REGIS-
TERJ."

The corrections made herein will be re-
flected in the notice of proposed rulemak-
ing published in the Cumulative Bulletin.

# Request for Applications to Participate in the 2003 IRS Individual e-file Partnership Program

## Announcement 2002-101

The Stakeholder Partnerships, Educa-
tion and Communication (SPEC) func-
tion within the Internal Revenue Service
(IRS) is continuing its efforts to establish
IRS e-file partnerships with various enti-
ties. The IRS is seeking non-monetary e-file
partnerships for Filing Season 2003. No ap-
plications for funding (monetary compen-
sation) will be considered. Applications may
be submitted by a commercial business,
non-profit organization, state government
or local government. Applications are not
solicited from other Federal government
agencies. The program is an annual pro-
gram and covers the period January 2003
through October 15, 2003. All prior year
partners must reapply for Filing Sea-
son 2003.

## BACKGROUND

The IRS Restructuring and Reform Act
of 1998 (RRA 98) requires the IRS to re-
ceive 80 percent of all returns electroni-
cally by 2007. RRA 98 authorized the IRS
Commissioner to promote the benefits of
and encourage the use of e-file services. As
a result of RRA 98, the IRS enters into non-
monetary partnerships with businesses to of-
fer low cost income tax preparation and
electronic filing for qualified taxpayers.

Continued opportunities for growth in
electronic tax administration are evident. For
Filing Season 2002, the IRS received over
46 million electronically filed returns, an in-
crease of 16% over the previous year. Visit
the IRS web site, www.irs.gov, "IRS e-file
for Tax Professionals, Software Develop-
ers, and Transmitters" for the most cur-
rent results from market research on
individual taxpayers: demographic data and
psychographic studies. This includes atti-
tudinal surveys, customer satisfaction sur-
veys, Public Service Announcements
(PSAs)/Paid Advertising Tracking Stud-
ies and any focus group results.

The IRS currently accepts 115 forms and
schedules for electronic filing. Visit the IRS

web site (www.irs.gov) for a complete list-
ing of accepted forms and schedules.

## FILING SEASON 2003

For Filing Season 2003, the IRS will fo-
cus on the 1040 series income tax returns
covering "IRS e-file Using a Tax Preparer"
and "IRS e-file Using a Personal Com-
puter." Additional emphasis is being placed
on the following features: "Self-Select Per-
sonal Identification Number (PIN) for e-file;
"Using e-file for Federal/State Returns", and
"Electronic Payment Options" for balance
due and estimated payment options.

Emphasis should also be placed on the
first-time filer population. IRS research in-
dicates that this segment of the popula-
tion continues to lag behind other segments
of the population that e-file. In addition, re-
search indicates that e-file is still lagging
in the self-prepared simple segment. An-
other area of emphasis is to reach those tax-
payers who continue to file computer
prepared paper returns (v-code). Research
indicates that the number of v-code re-
turns continues to increase (76% of all
v-code returns are prepared by paid pre-
parers). Emphasis should be placed on en-
couraging v-code filers to electronically file
their returns through the marketing and pro-
motion of the benefits of e-file.

The IRS expects all accepted partners to
aggressively market, promote and offer e-file
services through October 15, 2003. The IRS
will supply the partners with the Filing Sea-
son and post April 15 e-file campaign mes-
sage(s), if available, to target additional
qualified taxpayers, i.e., extensions, mili-
tary returns, etc. Pending the passage of leg-
islation, Participants are encouraged to offer
the April 30 due date extension for e-file.

For additional information on the vari-
ous e-file programs, features, and market re-
search, visit our web site at www.irs.gov.
For a listing of our current partners and the
services they offer, refer to the IRS e-file
Partners Page at www.irs.gov.

Participants will receive hyperlinks from
the IRS web site to the Participant's web
site. Potential Participants may request links
for the following categories: IRS e-file
Partners for Taxpayers, IRS e-file Part-
ners for Tax Professionals, IRS e-file
Partners for Financial Institutions/
Employers, and IRS e-file Partners for
Credit Card Payment Options.

## PARTICIPATION REQUIREMENTS

· The Participant (Electronic Return
Originator, Intermediate Service Pro-
vider, Software Developer, and Trans-
mitter) must be in good standing with
the IRS, comply with the e-file re-
quirements stated in the IRS Rev-
enue Procedure 2000-31, 2000-2 C.B.
146, Publications 1345 and 1345A, 26
U.S.C. 7216, U.S.C. 6103, and pass
the annual Suitability and Participants
Acceptance Testing (PATS) conducted
by the IRS. All other Participants are
exempt from these requirements.

· The Participant will offer their prod-
ucts and services to filers of the 1040
Series returns, including complicated
returns, balance due returns, Federal/
State returns, and 1040EZ returns. The
Participant is encouraged to reach first-
time filers and v-coders. The partici-
pant will offer a variety of e-file
features including the Self-Select PIN,
Electronic Payment Options, Direct
Deposit of Refunds, etc.

· The Participant will aggressively mar-
ket, promote and offer e-file services
through October 15, 2003. The Par-
ticipant will use the current Filing Sea-
son e-file marketing/promotional
messages developed by the IRS. In ad-
dition, the Participant will use the post
April 15 e-file campaign message(s)
and other promotional tools, if avail-
able, to target qualified taxpayers, i.e.,
extensions, military returns, etc.

· The Participant is encouraged to of-
fer the April 30 due date extension for
e-file, upon passage of authorizing leg-
islation.

· The Participant will have a hyper-
link(s) from the IRS web site to their
site. Participants will not have a
URL(s) containing the word "IRS".

· The Participant will place the IRS
e-file logo on its web site.

· The Participant will provide a descrip-
tion (350 characters or less) for each
hyperlink placed on the IRS e-file
Partners Page. The Participant will
have a link(s) to the IRS web site.

· The Participant will not offer its ser-
vices and/or products based on the
condition in obtaining an eligible tax-
payer's consent to solicitations of ad-
ditional business.

· The Participant's web site will not con-
tain inappropriate content nor will the
Participant provide links to inappro-
priate content.

· The Participant will clearly disclose to
users its customer service support op-
tions and privacy policy.

· The Participant should submit writ-
ten notification, i.e., email, to the IRS
of changes/additions/deletions to
URLs, link descriptions, etc.

· The Participant will submit a Perfor-
mance Report to the IRS Point of
Contact by May 30, 2003. The re-
port will cover Filing Season activi-
ties (i.e., statistical information, web
site activity, etc.). The IRS Point of
Contact will provide written report-
ing instructions and requirements to
accepted participants.

## PERFORMANCE STANDARDS

· The IRS will have the accepted par-
ticipant's hyperlink(s) available on the
IRS web site by December 31, 2002,
or before the start of electronic fil-
ing, subject to the participant's pass-
ing of the annual Suitability and PATS
testing. Hyperlinks will remain on the
IRS e-file Partners Page at least
through October 15, 2003, or later.

· The IRS will rotate on a daily basis
the hyperlinks that exist on the IRS
e-file Partners Page.

· The IRS may establish a link from the
IRS e-file Partners Page to the Free In-
ternet Filing Consortium web page.

· The IRS will accept, if appropriate, the
Participant's written request for
changes/additions/deletions to a URL,
link description, etc.

· The IRS has a right to review the Par-
ticipant's web site(s) to ensure that
participation requirements are met.

· The IRS will not endorse specific of-
ferings or products, but will promote
the IRS e-file Partners Page. A "Site
Disclaimer" will exist on the IRS web
site before the user enters the Partici-
pant's web site.

## PARTICIPATION TERMS

· The IRS Individual e-file Partner-
ship Program is an annual program,
and all prospective Participants, in-
cluding returning Participants, must re-
apply each year following the

guidelines in the announcement ad-
vertised on www.irs.gov.

· If the IRS determines that the partici-
pant is not meeting the “Participa-
tion Requirements," the IRS may
terminate its partnership with the Par-
ticipant and remove the participant's
hyperlink(s) from the IRS e-file Part-
ners Page.

· The Participant should notify the IRS
immediately if it wishes to terminate
its partnership with the IRS. The no-
tification should be submitted through
email to the IRS Point of Contact or
sent to the Point of Contact's address.

## APPLICATION PROCESS

### Applications should contain the following:

· Include the Applicant's Point of Con-
tact information (name, title, address,
telephone number, fax number and
e-mail address) for discussion of your
application.

· Identify the Applicant's secure web
site.

· Identify the Applicant's tax prepara-
tion software (if applicable).

· Include the Applicant's Electronic Filer
Identification Number (EFIN) and/or
Electronic Transmitter Identification
Number (ETIN) (if applicable).

· Identify the Applicant's hyperlink(s)
and provide a short description (350
characters or less) of the services and
products to be promoted on the IRS
e-file Partners Page. In addition, the
Applicant should provide the associ-
ated URL(s). The URL(s) address
cannot contain the word "IRS." In-
dicate the category for each
hyperlink(s): IRS e-file Partners for
Taxpayers, IRS e-file Partners for
Tax Professionals, IRS e-file Part-
ners for Financial Institutions/
Employers, and IRS e-file Partners
for Electronic Payment Options. Re-
fer to the IRS e-file Partners Page
(www.irs.gov) for examples of link de-
scriptions.

· Identify the Applicant's communica-
tion vehicle(s) (i.e., web site,
marketing/promotional products, etc.)
to market and promote your prod-
ucts and services and IRS e-file. De-
scribe the incentives, discounts, offers,
benefits to taxpayers or other spe-
cific approaches to increase e-file vol-
umes.

· Certify the Applicant's compliance
with the privacy and disclosure pro-
visions of 26 U.S.C. 7216 and 26
U.S.C. 6103 (if applicable).

## IRS POINT OF CONTACT/ APPLICATION SUBMISSION

Applications to participate in the IRS In-
dividual e-file Partnership Program should
be submitted as a Word document through
email at *WIe-filepartners@irs.gov (Please
make sure there is an asterisk before the WI
(Wage and Investment) when submitting an
application.) An application may also be
sent to Karen Bradley at the following
address:

Internal Revenue Service
5000 Ellin Road
Lanham, MD 20706
Attention: Karen Bradley
W:CAR:SPEC:FO:IMS
C5-351

If you wish to have a hyperlink(s) on the
IRS e-file Partners Page by December 31,
2002, or before the start of electronic fil-
ing, your application must be submitted by
December 4, 2002, otherwise, there is no
deadline for your application.

Illustrations of marketing materials may
be submitted in Adobe Acrobat Portable
Document (PDF) or other appropriate files.

Any questions regarding the develop-
ment of applications, the submission of Per-
formance Reports, or any other type of
contact for this program should be directed
to Karen Bradley at (202) 283-7034 or
through email to *WIe-filepartners
@irs.gov (Please make sure there is an as-
terisk before the WI (Wage and Invest-
ment) for any type of email contact.)

## APPLICATION EVALUATION

All applications will be evaluated based
on the required information provided to the
IRS and the applicant's ability to fulfill their
responsibilities. Prior year performance will
also be considered when evaluating appli-
cations from returning partners.

## ACCEPTANCE/DENIAL OF APPLICATION

If your application is accepted, you will
receive written notification from the IRS.

If your application is denied, you will re-
ceive written notification from the IRS with
an explanation of the denial.

### Exclusions From Gross Income of Foreign Corporations; Hearing

Announcement 2002-102

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Change of date of public
hearing, extension of time for submitting
public comments and outlines of oral
comments.

SUMMARY: This document changes the
date of a public hearing on proposed regu-
lations (REG-208280-86; REG-136311-
01, 2002-36 I.R.B. 485) relating to
exclusions from gross income of foreign
corporations under section 883 of the In-
ternal Revenue Code, and extends the time
for submitting public comments and out-
lines of oral comments.

DATES: The public hearing originally
scheduled for Tuesday, November 12, 2002,
at 10 a.m. is rescheduled for Monday, No-
vember 25, 2002, at 10 a.m. The due date
for written or electronic public comments
and outlines of topics to be discussed, is
November 5, 2002.

ADDRESSES: The public hearing is be-
ing held in room 4718, Internal Revenue
Building, 1111 Constitution Avenue, NW,
Washington, DC. Due to building secu-
rity procedures, visitors must enter at the
Constitution Avenue entrance. Send sub-
missions to: CC:ITA:RU (REG-208280-
86; REG-136311-01), room 5226, Internal
Revenue Service, POB 7604, Ben
Franklin Station, Washington, DC 20044.
Submissions may be hand delivered Mon-
day through Friday between the hours of
8 a.m. and 5 p.m. to: CC:ITA:RU (REG-
208280-86; REG-136311-01), Courier's
Desk, Internal Revenue Service, 1111 Con-
stitution Avenue, NW, Washington, DC. Al-
ternatively, comments may be transmitted

electronically via the Internet by submit-
ting comments directly to the IRS Inter-
net site at: http://www.irs.gov/regs.

FOR FURTHER INFORMATION
CONTACT: Guy Traynor of the Regula-
tions Unit, Associate Chief Counsel (In-
come Tax & Accounting), at (202) 622-
7180 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

A notice of proposed rulemaking and no-
tice of public hearing appearing in the Fed-
eral Register on Friday, August 2, 2002 (67
FR 50510), announced that a public hear-
ing on proposed regulations relating to ex-
clusions from gross income of foreign
corporations under section 883 of the In-
ternal Revenue Code would be held on
Tuesday, November 12, 2002, beginning at
10 a.m. in room 4718 of the Internal Rev-
enue Building, 1111 Constitution Avenue,
NW, Washington, DC. The deadline for sub-
mitting public comments and outlines of
topics to be discussed, is October 22, 2002.

The date of the hearing and deadline for
submitting public comments has changed.
The hearing is scheduled for Monday, No-
vember 25, 2002, beginning at 10 a.m. in
room 4718, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington, DC.
We must receive written and electronic pub-
lic comments and outlines of topics to be
discussed, by November 5, 2002. Because
of the controlled access restrictions, atten-
dants will not be admitted beyond the lobby
area of the Internal Revenue Building un-
til 9:30 a.m. The IRS will prepare an agenda
showing the scheduling of the speakers af-
ter the outlines are received from the per-
sons testifying and make copies available
free of charge at the hearing.

Cynthia E. Grigsby,
Chief, Regulations Unit,
Associate Chief Counsel
(Income Tax & Accounting).

(Filed by the Office of the Federal Register on October 17,
2002, 8:45 a.m., and published in the issue of the Federal Reg-
ister for October 18, 2002, 67 F.R. 64331)

# 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
effect:

Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus, if
an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).

Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.

Distinguished describes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.

Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to 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 pub-
lished position. (Compare with amplified
and clarified, above).

Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. A ruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.

Revoked describes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.

Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a
period of time in separate rulings. If the

new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example, modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case,
the previously published ruling is first
modified and then, as modified, is super-
seded.

Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names
in subsequent rulings. After the original
ruling has been supplemented several
times, a new ruling may be published that
includes the list in the original ruling and
the additions, and supersedes all prior rul-
ings in the series.

Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.

# Abbreviations

The following abbreviations in current
use and formerly used will appear in
material published in the Bulletin.

A-Individual.

Acq .- Acquiescence.

B-Individual.

BE-Beneficiary.

FPH Foreign Personal Holding Company.

F.R .- Federal Register.

FUTA-Federal Unemployment Tax Act.

FX-Foreign Corporation.

G.C.M .- Chief Counsel's Memorandum.

GE-Grantee.

GP-General Partner.

COOP-Cooperative.

GR-Grantor.

Ct.D .- Court Decision.

IC-Insurance Company.

I.R.B .- Internal Revenue Bulletin.

D-Decedent.

LE-Lessee.

DC-Dummy Corporation.

LP-Limited Partner.

LR-Lessor.

TT-Trustee.

U.S.C .- United States Code.

DISC-Domestic International Sales Corporation.

DR-Donor.

E-Estate.

P-Parent Corporation.

PHC-Personal Holding Company.

PO-Possession of the U.S.
PR-Partner.

PRS Partnership.

PTE-Prohibited Transaction Exemption.

Pub. L .- Public Law.

REIT-Real Estate Investment Trust.

Rev. Proc .- Revenue Procedure.

Rev. Rul .- Revenue Ruling.

S Subsidiary.

S.P.R .- Statements of Procedural Rules.
Stat .- Statutes at Large.

T-Target Corporation.

T.C .- Tax Court.

T.D .- Treasury Decision.

TFE-Transferee.

TFR-Transferor.

T.I.R .- Technical Information Release.

TP-Taxpayer.

TR-Trust.

DE-Donee.

Del. Order-Delegation Order.

M-Minor.

Nonacq .- Nonacquiescence.

X-Corporation.

O- Organization.

Y-Corporation.

Z-Corporation.

EE-Employee.

E.O .- Executive Order.

ER-Employer.

ERISA-Employee Retirement Income Security Act.

EX-Executor.

F-Fiduciary.

FC-Foreign Country.

FICA-Federal Insurance Contributions Act.

FISC-Foreign International Sales Company.

BK-Bank.

B.T.A .- Board of Tax Appeals.

C-Individual.

C.B .- Cumulative Bulletin.

CFR-Code of Federal Regulations.

CI-City.

CY-County.

Numerical Finding List1

Notices-Continued:

Revenue Procedures-Continued:

Bulletin 2002-26 through 2002-43

2002-54, 2002-30 I.R.B. 189

2002-62, 2002-40 I.R.B. 683

2002-55, 2002-36 I.R.B. 481

2002-63, 2002-41 I.R.B. 691

Announcements:

2002-56, 2002-32 I.R.B. 319

2002-64, 2002-42 I.R.B. 718

2002-57, 2002-33 I.R.B. 379

2002-65, 2002-41 I.R.B. 700

2002-59, 2002-26 I.R.B. 28

2002-58, 2002-35 I.R.B. 432

2002-66, 2002-42 I.R.B. 725

2002-60, 2002-26 I.R.B. 28

2002-59, 2002-36 I.R.B. 481

2002-67, 2002-43 I.R.B. 733

2002-61, 2002-27 I.R.B. 72

2002-60, 2002-36 I.R.B. 482

2002-68, 2002-43 I.R.B. 753

2002-62, 2002-27 I.R.B. 72

2002-61, 2002-38 I.R.B. 563

2002-63, 2002-27 I.R.B. 72

2002-62, 2002-39 I.R.B. 574

Revenue Rulings:

2002-64, 2002-27 I.R.B. 72

2002-63, 2002-40 I.R.B. 644

2002-38, 2002-26 I.R.B. 4

2002-65, 2002-29 I.R.B. 182

2002-64, 2002-41 I.R.B. 690

2002-39, 2002-27 I.R.B. 33

2002-66, 2002-29 I.R.B. 183

2002-65, 2002-41 I.R.B. 690

2002-40, 2002-27 I.R.B. 30

2002-67, 2002-30 I.R.B. 237

2002-66, 2002-42 I.R.B. 716

2002-41, 2002-28 I.R.B. 75

2002-68, 2002-31 I.R.B. 283

2002-67, 2002-42 I.R.B. 716

2002-42, 2002-28 I.R.B. 76

2002-69, 2002-31 I.R.B. 283

2002-68, 2002-43 I.R.B. 730 2002-69, 2002-43 I.R.B. 730

2002-43, 2002-28 I.R.B. 85

2002-70, 2002-31 I.R.B. 284

2002-44, 2002-28 I.R.B. 84

2002-71, 2002-32 I.R.B. 323

Proposed Regulations:

2002-45, 2002-29 I.R.B. 116

2002-72, 2002-32 I.R.B. 323

2002-46, 2002-29 I.R.B. 117

2002-73, 2002-33 I.R.B. 387

REG-248110-96, 2002-26 I.R.B. 19

2002-47, 2002-29 I.R.B. 119

2002-74, 2000-33 I.R.B. 387

REG-110311-98, 2002-28 I.R.B. 109

2002-48, 2002-31 I.R.B. 239

2002-75, 2002-34 I.R.B. 416

REG-103823-99, 2002-27 I.R.B. 44

2002-49, 2002-32 I.R.B. 288

2002-76, 2002-35 I.R.B. 471

REG-103829-99, 2002-27 I.R.B. 59

2002-50, 2002-32 I.R.B. 292

2002-77, 2002-35 I.R.B. 471

REG-103735-00, 2002-28 I.R.B. 109

2002-51, 2002-33 I.R.B. 327

2002-78, 2002-36 I.R.B. 514

REG-106457-00, 2002-26 I.R.B. 23

2002-52, 2002-34 I.R.B. 388

2002-79, 2002-36 I.R.B. 515

REG-106871-00, 2002-30 I.R.B. 190

2002-53, 2002-35 I.R.B. 427

2002-80, 2002-36 I.R.B. 515

REG-106876-00, 2002-34 I.R.B. 392

2002-54, 2002-37 I.R.B. 527

2002-81, 2002-37 I.R.B. 533

REG-106879-00, 2002-34 I.R.B. 402

2002-55, 2002-37 I.R.B. 529

2002-82, 2002-37 I.R.B. 533

REG-107524-00, 2002-28 I.R.B. 110

2002-56, 2002-37 I.R.B. 526

2002-83, 2002-38 I.R.B. 564

REG-115285-01, 2002-27 I.R.B. 62

2002-57, 2002-37 I.R.B. 526

2002-84, 2002-37 I.R.B. 533

REG-115781-01, 2002-33 I.R.B. 380

2002-58, 2002-38 I.R.B. 541

2002-85, 2002-39 I.R.B. 624

REG-116644-01, 2002-31 I.R.B. 268

2002-59, 2002-38 I.R.B. 557

2002-86, 2002-39 I.R.B. 624

REG-123345-01, 2002-32 I.R.B. 321

2002-60, 2002-40 I.R.B. 641

2002-87, 2002-39 I.R.B. 624

REG-126024-01, 2002-27 I.R.B. 64

2002-61, 2002-40 I.R.B. 639

2002-88, 2002-38 I.R.B. 564

REG-136311-01, 2002-36 I.R.B. 485

2002-62, 2002-42 I.R.B. 710

2002-89, 2002-39 I.R.B. 626

REG-164754-01, 2002-30 I.R.B. 212

2002-64, 2002-41 I.R.B. 688

2002-90, 2002-40 I.R.B. 684

REG-165868-01, 2002-31 I.R.B. 270

2002-65, 2002-43 I.R.B. 729

2002-91, 2002-40 I.R.B. 685

REG-106359-02, 2002-34 I.R.B. 405

2002-92, 2002-41 I.R.B. 709

REG-122564-02, 2002-26 I.R.B. 25

Treasury Decisions:

2002-93, 2002-41 I.R.B. 709

REG-123305-02, 2002-26 I.R.B. 26

8997, 2002-26 I.R.B. 6

2002-94, 2002-42 I.R.B. 728

REG-124256-02, 2002-33 I.R.B. 383

8998, 2002-26 I.R.B. 1

2002-95, 2002-42 I.R.B. 728

REG-133254-02, 2002-34 I.R.B. 412

8999, 2002-28 I.R.B. 78

2002-96, 2002-43 I.R.B. 756

REG-134026-02, 2002-40 I.R.B. 684

9000, 2002-28 I.R.B. 87

2002-97, 2002-43 I.R.B. 757

Revenue Procedures:

9001, 2002-29 I.R.B. 128

2002-98, 2002-43 I.R.B. 758

9002, 2002-29 I.R.B. 120

2002-99, 2002-43 I.R.B. 758

2002-43, 2002-28 I.R.B. 99

9003, 2002-32 I.R.B. 294

2002-44, 2002-26 I.R.B. 10

9004, 2002-33 I.R.B. 331

Court Decisions:

2002-45, 2002-27 I.R.B. 40

9005, 2002-32 I.R.B. 290

2075, 2002-38 I.R.B. 548

2002-46, 2002-28 I.R.B. 105

9006, 2002-32 I.R.B. 315

2002-47, 2002-29 I.R.B. 133

9007, 2002-33 I.R.B. 349

Notices:

2002-48, 2002-37 I.R.B. 531

9008, 2002-33 I.R.B. 335

2002-49, 2002-29 I.R.B. 172

9009, 2002-33 I.R.B. 328

2002-42, 2002-27 I.R.B. 36

2002-50, 2002-29 I.R.B. 173

9010, 2002-33 I.R.B. 341

2002-43, 2002-27 I.R.B. 38

2002-51, 2002-29 I.R.B. 175

9011, 2002-33 I.R.B. 356

2002-44, 2002-27 I.R.B. 39

2002-52, 2002-31 I.R.B. 242

9012, 2002-34 I.R.B. 389

2002-45, 2002-28, I.R.B. 93

2002-53, 2002-31 I.R.B. 253

9013, 2002-38 I.R.B. 542

2002-46, 2002-28 I.R.B. 96

2002-54, 2002-35 I.R.B. 432

9014, 2002-35 I.R.B. 429

2002-47, 2002-28 I.R.B. 97

2002-55, 2002-35 I.R.B. 435

9015, 2002-40 I.R.B. 642

2002-48, 2002-29 I.R.B. 130

2002-56, 2002-36 I.R.B. 483

9016, 2002-40 I.R.B. 628

2002-49, 2002-29 I.R.B. 130

2002-57, 2002-39 I.R.B. 575

2002-50, 2002-28 I.R.B. 98

2002-58, 2002-40 I.R.B. 644

2002-51, 2002-29 I.R.B. 131

2002-59, 2002-39 I.R.B. 615

2002-52, 2002-30 I.R.B. 187

2002-60, 2002-40 I.R.B. 645

2002-53, 2002-30 I.R.B. 187

2002-61, 2002-39 I.R.B. 616

1 A cumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 2002-1 through 2002-25 is
in Internal Revenue Bulletin 2002-26, dated July 1, 2002.

Finding List of Current Actions
on Previously Published Items1
Bulletin 2002-26 through 2002-43

## Announcements:

98-99
Superseded by
Rev. Proc. 2002-44, 2002-26 I.R.B. 10

2000-4
Modified by
Ann. 2002-60, 2002-26 I.R.B. 28
2001-9
Superseded by
Rev. Proc. 2002-44, 2002-26 I.R.B. 10

Notices:

89-25
Modified by
Rev. Rul. 2002-62, 2002-42 I.R.B. 710
97-26
Modified and superseded by
Notice 2002-62, 2002-39 I.R.B. 574
2001-6
Superseded by
Notice 2002-63, 2002-40 I.R.B. 644

2001-62
Modified and superseded by
Notice 2002-62, 2002-39 I.R.B. 574

Proposed Regulations:

REG-208280-86
Withdrawn by
REG-136311-01, 2002-36 I.R.B. 485

REG-209114-90
Corrected by
Ann. 2002-65, 2002-29 I.R.B. 182

REG-209813-96
Withdrawn by
REG-106871-00, 2002-30 I.R.B. 190

REG-103823-99

Corrected by

Ann. 2002-67, 2002-30 I.R.B. 237
Ann. 2002-79, 2002-36 I.R.B. 515

REG-103829-99
Corrected by
Ann. 2002-82, 2002-37 I.R.B. 533
Ann. 2002-95, 2002-42 I.R.B. 728

REG-105885-99
Corrected by
Ann. 2002-67, 2002-30 I.R.B. 237

REG-105369-00
Clarified by
Notice 2002-52, 2002-30 I.R.B. 187
Corrected by
Ann. 2002-67, 2002-30 I.R.B. 237

REG-118861-00

Corrected by
Ann. 2002-67, 2002-30 I.R.B. 237

Proposed Regulations-Continued:

REG-126100-00
Withdrawn by
REG-133254-02, 2002-34 I.R.B. 412

REG-136193-01
Corrected by
Ann. 2002-67, 2002-30 I.R.B. 237

REG-136311-01
Corrected by
Ann. 2002-94, 2002-42 I.R.B. 728
REG-161424-01
Corrected by
Ann. 2002-67, 2002-30 I.R.B. 237

REG-165706-01
Corrected by
Ann. 2002-67, 2002-30 I.R.B. 237

REG-165868-01
Corrected by
Ann. 2002-93, 2002-41 I.R.B. 709

REG-102740-02
Corrected by
Ann. 2002-67, 2002-30 I.R.B. 237
REG-106359-02
Corrected by
Ann. 2002-81, 2002-37 I.R.B. 533

REG-108697-02
Corrected by
Ann. 2002-84, 2002-37 I.R.B. 533

REG-123305-02
Corrected by
Ann. 2002-69, 2002-31 I.R.B. 283

Revenue Procedures:

88-10
Superseded by
Rev. Proc. 2002-48, 2002-37 I.R.B. 531

91-23
Modified and superseded by
Rev. Proc. 2002-52, 2002-31 I.R.B. 242

91-26
Modified and superseded by
Rev. Proc. 2002-52, 2002-31 I.R.B. 242

95-18
Superseded by
Rev. Proc. 2002-51, 2002-29 I.R.B. 175

96-13
Modified and superseded by
Rev. Proc. 2002-52, 2002-31 I.R.B. 242

96-14
Modified and superseded by
Rev. Proc. 2002-52, 2002-31 I.R.B. 242
96-53
Amplified by
Rev. Proc. 2002-52, 2002-31 I.R.B. 242

Revenue Procedures-Continued:

2001-12
Obsoleted by
T.D. 9004, 2002-33 I.R.B. 331

2001-15
Superseded by
Rev. Proc. 2002-64, 2002-42 I.R.B. 718
2001-17
Modified and superseded by
Rev. Proc. 2002-47, 2002-29 I.R.B. 133
2001-26
Superseded by
Rev. Proc. 2002-53, 2002-31 I.R.B. 253

2001-45
Superseded by
Rev. Proc. 2002-60, 2002-40 I.R.B. 645
2001-46
Modified and amplified by
Rev. Proc. 2002-65, 2002-41 I.R.B. 700
2001-47
Superseded by
Rev. Proc. 2002-63, 2002-41 I.R.B. 691

2001-50
Superseded by
Rev. Proc. 2002-57, 2002-39 I.R.B. 575
2001-52
Updated by
Rev. Proc. 2002-66, 2002-42 I.R.B. 725

2001-54
Superseded by
Rev. Proc. 2002-61, 2002-39 I.R.B. 616

2002-9
Modified and amplified by
Rev. Proc. 2002-46, 2002-28 I.R.B. 105
Rev. Proc. 2002-65, 2002-41 I.R.B. 700
Amplified, clarified, and modified by
Rev. Proc. 2002-54, 2002-35 I.R.B. 432

2002-13
Modified by
Rev. Proc. 2002-45, 2002-27 I.R.B. 40

2002-15
Modified and superseded by
Rev. Proc. 2002-59, 2002-39 I.R.B. 615

2002-16
Modified and superseded by
Rev. Proc. 2002-68, 2002-43 I.R.B. 753
2002-19
Amplified and clarified by
Rev. Proc. 2002-54, 2002-35 I.R.B. 432

1 A cumulative list of current actions on previously published
items in Internal Revenue Bulletins 2002-1 through 2002-25 is
in Internal Revenue Bulletin 2002-26, dated July 1, 2002.

## Revenue Rulings:

54-571
Obsoleted by
T.D. 9010, 2002-33 I.R.B. 341

55-534
Distinguished by
Rev. Rul. 2002-60, 2002-40 I.R.B. 641

55-606
Obsoleted by

T.D. 9010, 2002-33 I.R.B. 341

59-328
Obsoleted by

T.D. 9010, 2002-33 I.R.B. 341

64-36
Obsoleted by
T.D. 9010, 2002-33 I.R.B. 341
65-129
Obsoleted by
T.D. 9010, 2002-33 I.R.B. 341
67-197
Obsoleted by

T.D. 9010, 2002-33 I.R.B. 341

69-259
Modified and superseded by
Rev. Rul. 2002-50, 2002-32 I.R.B. 292

69-595
Obsoleted in part by
T.D. 9010, 2002-33 I.R.B. 341

70-608
Obsoleted in part by
T.D. 9010, 2002-33 I.R.B. 341

73-232
Obsoleted by
T.D. 9010, 2002-33 I.R.B. 341
76-225
Revoked by
REG-115781-01, 2002-33 I.R.B. 380
77-53
Obsoleted by
T.D. 9010, 2002-33 I.R.B. 341

85-50
Obsoleted by
T.D. 2002-33 I.R.B. 341
92-17
Amplified by
Rev. Rul. 2002-49, 2002-32 I.R.B. 288
92-75
Clarified by
Rev. Proc. 2002-52, 2002-31 I.R.B. 242
93-70
Obsoleted by
T.D. 9010, 2002-33 I.R.B. 341

94-76
Amplified by
Rev. Rul. 2002-42, 2002-28 I.R.B. 76

## Treasury Decisions:

8925
Corrected by
Ann. 2002-89, 2002-39 I.R.B. 626

8997
Corrected by
Ann. 2002-68, 2002-31 I.R.B. 283

8999
Corrected by
Ann. 2002-71, 2002-32 I.R.B. 323

9013
Corrected by
Ann. 2002-83, 2002-38 I.R.B. 564

# INDEX Internal Revenue Bulletins 2002-26 through 2002-43

The abbreviation and number in paren-
thesis following the index entry refer to
the specific item; numbers in roman and
italic type following the parenthesis refer
to the Internal Revenue Bulletin in which
the item may be found and the page num-
ber on which it appears.

Key to Abbreviations:

Announcement

Ann
CD
Court Decision

DO
Delegation Order

EO
Executive Order

PL
Public Law

PTE
Prohibited Transaction
Exemption
Revenue Procedure

RP
RR

Revenue Ruling

SPR

Statement of Procedural
Rules

TC
Tax Convention

TD
Treasury Decision

TDO

Treasury Department Order

## EMPLOYEE PLANS

Accident and health plans, amounts
received (RR 58) 38, 541

Defined benefit plans, elimination of
optional forms of benefit (Notice 46)
28, 96

Employee Plans Compliance Resolution
System (EPCRS) update (RP 47) 29,
133

Full funding limitations:

Weighted average interest rate for:
July 2002 (Notice 49) 29, 130

August 2002 (Notice 57) 33, 379

September 2002 (Notice 61) 38,
563

October 2002 (Notice 68) 43, 730
Health reimbursement arrangements
(HRAs) (RR 41) 28, 75; (Notice 45)
28, 93

Individual retirement arrangements, earn-
ings calculation for returned or rechar-
acterized IRA contributions (REG-
124256-02) 33, 383

## EMPLOYEE PLANS- Cont.

Practice before the Internal Revenue Ser-
vice (TD 9011) 33, 356

Premature distributions, substantially
equal periodic payments (RR 62) 42,
710

Proposed Regulations:

26 CFR 1.401(a)(9)-6, added; required
distributions from retirement plans,
notice of public hearing (Ann 84)
37, 533

26 CFR 1.408-4, amended; 1.408-11,
added; 1.408A-5, revised; earnings
calculation for returned or recharac-
terized IRA contributions (REG-
124256-02) 33, 383

26 CFR 1.419A(f)(6)-1, added; 10-or-
more employer plans (REG-
165868-01) 31, 270; correction
(Ann 93) 41, 709

Publications:

590, Individual Retirement Arrange-
ments (IRAs), Supplement to (Ann
73) 33, 387

Qualified retirement plans:
Deductions:

Contributions (Notice 48) 29, 130
Timing (RR 46) 29, 117

Defined benefit plan, phased retire-
ment (Notice 43) 27, 38

Money purchase pension plan, partial
termination (RR 42) 28, 76

Notice to interested parties require-
ment (TD 9006) 32, 315

Required minimum distributions,
notice of public hearing (Ann 84)
37, 533

Restorative payments (RR 45) 29, 116
Refund of mistaken contributions and
withdrawal liability payments (TD
9005) 32, 290

Regulations:

26 CFR 1.401(a)(2)-1, added; refund
of mistaken contributions and with-
drawal liability payments (TD 9005)
32, 290

26 CFR 1.7476-1, -2, amended;
601.201, amended; notice to inter-
ested parties (TD 9006) 32, 315

31 CFR Part 10, amended; regulations
governing practice before the Inter-
nal Revenue Service (TD 9011)
33, 356

Ten-or-more employer plans (REG-
165868-01) 31, 270; correction (Ann
93) 41, 709

## EMPLOYMENT TAX

Compromise of tax liabilities (TD 9007)
33, 349

Effective date of Rev. Proc. 2002-41
(Notice 55) 36, 481

Information reporting, payments made on
behalf of another person, to joint pay-
ees, and of gross proceeds from sales
involving investment advisors (TD
9010) 33, 341

Practice before the Internal Revenue Ser-
vice (TD 9011) 33, 356

Proposed Regulations:

26 CFR 1.61-2, amended; 1.61-22,
added; 1.83-1, -3, -6, amended;
1.301-1(q), added; 1.1402(a)-18,
added; 1.7872-15, added;
31.3121(a), 31.3231(e), 31.3306(b),
31.3401(a), amended; split-dollar
life insurance arrangements (REG-
164754-01) 30, 212

26 CFR 31.3406(d)-5, revised;
301.6724-1, amended; receipt of
multiple notices with respect to
incorrect taxpayer identification
numbers (REG-116644-01) 31, 268

Publications:

1141, General Rules and Specifica-
tions for Substitute Forms W-2 and
W-3, revised (RP 53) 31, 253

1223, General Rules and Specifica-
tions for Substitute Forms W-2c and
W-3c, revised (RP 51) 29, 175
Regulations:

26 CFR 1.6041-1, -3, amended;
1.6045-1, -2, amended; 1.6049-4,
revised; 5f.6045-1, removed;
31.3406, amended; 602.101,
amended; information reporting
requirements for certain payments
made on behalf of another person,
payments to joint payees, and pay-
ments of gross proceeds from sales
involving investment advisors (TD
9010) 33, 341

26 CFR 301.7122-0, -1, added;
301.7122-0T, -1T, removed; com-
promise of tax liabilities (TD 9007)
33, 349

31 CFR Part 10, amended; regulations
governing practice before the Inter-
nal Revenue Service (TD 9011)
33, 356

Split-dollar life insurance arrangements
(REG-164754-01) 30, 212
Statutory stock options, application of
employment taxes (Notice 47) 28, 97

# EMPLOYMENT TAX- Cont.

Substitute Forms:

W-2 and W-3, general rules and
specifications (RP 53) 31, 253
W-2c and W-3c, general rules and
specifications (RP 51) 29, 175

Taxpayer identification numbers, backup
withholding, waiver of information
reporting penalties (REG-116644-01)
31, 268

# ESTATE TAX

Annuities, death benefits (RR 39) 27, 33
Compromise of tax liabilities (TD 9007)
33, 349

Guaranteed annuity and lead unitrust
interests, definition (REG-115781-01)
33, 380

Practice before the Internal Revenue Ser-
vice (TD 9011) 33, 356
Proposed Regulations:

26 CFR 20.2055-2, amended; defini-
tion of guaranteed annuity and lead
unitrust interests (REG-115781-01)
33, 380

Regulations:

26 CFR 301.7122-0, -1, added;
301.7122-0T, -1T, removed; com-
promise of tax liabilities (TD 9007)
33, 349

31 CFR Part 10, amended; regulations
governing practice before the Inter-
nal Revenue Service (TD 9011)
33, 356

Split-dollar life insurance arrangements,
standards for valuing current life insur-
ance protection (Notice 59) 36, 481
Tax conventions, competent authority
procedures (RP 52) 31, 242

# EXCISE TAX

Air transportation, mileage awards:
Sales of frequent flyer miles (Notice
63) 40, 644

Taxation rules (RR 60) 40, 641
Compromise of tax liabilities (TD 9007)
33, 349

Diesel fuel, blended taxable fuel (REG-
106457-00) 26, 23

## EXCISE TAX- Cont.

Golden parachute payments:

Excess payments (Ann 65) 29, 181
Valuation of options (RP 45) 27, 40
Highway vehicle, definition (REG-
103829-99) 27, 59; correction (Ann
82) 37, 533; hearing (Ann 95) 42, 727
Practice before the Internal Revenue Ser-
vice (TD 9011) 33, 356
Prohibited transactions, excise tax com-
putation (RR 43) 28, 85

Proposed Regulations:

26 CFR 1.280G-1, golden parachute
payments; correction (Ann 65) 29,
181

26 CFR 41.4482(a)-1, amended;
48.4041-8, amended; 48.4051-1,
added; 48.4072-1, amended;
48.4081-1, amended; 48.6421-4,
revised; 145.4051-1, amended; defi-
nition of highway vehicle (REG-
103829-99) 27, 59; correction (Ann
82) 37, 533; hearing (Ann 95)
42, 727

26 CFR 48.4081-1, -3, amended; die-
sel fuel, blended taxable fuel (REG-
106457-00) 26, 23

Regulations:

26 CFR 301.7122-0, -1, added;
301.7122-0T, -1T, removed; com-
promise of tax liabilities (TD 9007)
33, 349

31 CFR Part 10, amended; regulations
governing practice before the Inter-
nal Revenue Service (TD 9011)
33, 356

Tax-free sales of articles for use by pur-
chaser as supplies for vessels or aircraft
(RR 50) 32, 292

## EXEMPT ORGANIZATIONS

Forms:

990, request for comments on possible
changes (Ann 87) 39, 624

1023, Application for Recognition of
Exemption Under Section 501(c)(3)
of the Internal Revenue Code,
request for comments (Ann 92)
41, 709

## EXEMPT ORGANIZATIONS- Cont.

Indian tribal governments treated as
states, list (RP 64) 42, 717

List of organizations classified as private
foundations (Ann 64) 27, 72; (Ann 66)

29, 183; (Ann 70) 31, 284; (Ann 72)

32, 323; (Ann 75) 34, 416; (Ann 77)

35, 471; (Ann 80) 36, 515; (Ann 88)
38, 564

Practice before the Internal Revenue Ser-
vice (TD 9011) 33, 356

Regulations:

31 CFR Part 10, amended; regulations
governing practice before the Inter-
nal Revenue Service (TD 9011)
33, 356

Revocations (Ann 99) 43, 758

Tax-exempt electric cooperatives, pro-
pane distribution and sale (RR 54) 37,
527

Treatment of subsidiary income under the
85 percent member income test (RR
55) 37, 529

# GIFT TAX

Compromise of tax liabilities (TD 9007)
33, 349

Guaranteed annuity and lead unitrust
interests, definition (REG-115781-01)
33, 380

Net gift treatment under section 2519
(REG-123345-01) 32, 321

Practice before the Internal Revenue Ser-
vice (TD 9011) 33, 356

Proposed Regulations:

26 CFR 25.2207A-1, amended;
25.2519-1, amended; net gift treat-
ment under section 2519 (REG-
123345-01) 32, 321

26 CFR 25.2522(c)-3, amended; defi-
nition of guaranteed annuity and
lead unitrust interests (REG-
115781-01) 33, 380

# GIFT TAX-Cont.

Regulations:

26 CFR 301.7122-0, -1, added;
301.7122-0T, -1T, removed; com-
promise of tax liabilities (TD 9007)
33, 349

31 CFR Part 10, amended; regulations
governing practice before the Inter-
nal Revenue Service (TD 9011)
33, 356

Split-dollar life insurance arrangements:
Income, employment, and gift taxation
of (REG-164754-01) 30, 212

Standards for valuing current life
insurance protection (Notice 59) 36,
481

Tax conventions, competent authority
procedures (RP 52) 31, 242

# INCOME TAX

Accident and health plans, amounts
received (RR 58) 38, 541

Alternative identifying number of income
tax return preparer (TD 9014) 35, 429
Appeals:

Arbitration procedures, extension of
test (Ann 60) 26, 28

Mediation procedure (RP 44) 26, 10

Settlement initiative for section 302/
318 basis-shifting transactions (Ann
97) 43, 757

Termination of settlement initiative for
corporate owned life insurance
(COLI) cases (Ann 96) 43, 756

Archer MSAs, 2002 not a cut-off year
(Ann 90) 40, 684

Business and traveling expenses, per
diem allowances, 2003 (RP 63)
41, 691

Capital gains and losses (Notice 58) 35,
432

Capital gains, qualified empowerment
zone (QEZ) asset (RP 62) 40, 682

Classification of newly formed entity (RP
59) 39, 615
Compromise of tax liabilities (TD 9007)
33, 349

Consolidated income tax return:
Agent for the group (RP 43) 28, 99

Common parent as agent for consoli-
dated group, substitute agent, tenta-
tive carryback adjustments (TD
9002) 29, 120

Contingent liability tax shelter cases,
settlement (RP 67) 43, 733

# INCOME TAX- Cont.

Corporations:

Carryback of consolidated net operat-
ing losses to separate return years
(TD 8997) 26, 6; correction (Ann
68) 31, 283; (REG-122564-02)
26, 25

Exclusions from gross income of for-
eign corporations (REG-136311-
01\) 36, 485; correction (Ann 94)
42, 727

Foreign loss payment patterns (Notice
69) 43, 730

Spin-offs, mergers and acquisitions
(RR 49) 32, 288

Treatment of a controlled foreign cor-
poration's distributive share of part-
nership income under subpart F (TD
9008) 33, 335

Credits:

Enhanced oil recovery credit, 2002
inflation adjustment (Notice 53) 30,
187

Increasing research activities credit
(Notice 44) 27, 39

Low-income housing credit:
Carryovers to qualified states, 2002
National Pool (RP 56) 36, 483

Rental assistance payments (RR 65)
43, 729

Satisfactory bond, "bond factor"
amounts for the period:
July through September 2002
(RR 51) 33, 327

New markets tax credit, other federal
tax benefits (Notice 64) 41, 690
Definition of income tax return preparer,
low-income taxpayer clinics (REG-
115285-01) 27, 62

Depreciation, income forecast method
(REG-103823-99) 27, 44; correction
(Ann 79) 36, 515

Designated private delivery services,
2002 (Notice 62) 39, 574

Designation of persons before whom a
summoned person shall appear (TD
9015) 40, 642; (REG-134026-02) 40,
684

Disaster relief for September 11, 2001,
terrorist attacks; exclusion of gain from
the sale or exchange of a taxpayer's
principal residence (Notice 60) 36, 482
Disclosure of return information, Census
of Agriculture (TD 9001) 29, 128

# INCOME TAX- Cont.

Domestic reverse hybrid entity, eligibility
for treaty benefits (TD 8999) 28, 78;
correction (Ann 71) 32, 323

Dual consolidated loss recapture events
(REG-106879-00) 34, 402
Effective date of Rev. Proc. 2002-41
(Notice 55) 36, 481

Entity classification rules (TD 9012)
34, 389

"Excepted sale" for information reporting
on Form 1099-B for certain sales of
stock (RP 50) 29, 173

Extension of time to file, or for amending
the statement of information required
under section 149(e) of the Code (RP
48) 37, 531

Foreign insurance companies, minimum
effectively connected net investment
income (RP 58) 40, 644

Forms:

1096, 1098, 1099, 5498, W-2G, and
1042-S, substitute form specifica-
tions (RP 57) 39, 575

1099-B, information reporting for cer-
tain sales of stock, exception (RP
50) 29, 173

Golden parachute payments:

Excess payments (Ann 65) 29, 181

Valuation of options (RP 45) 27, 40

Guaranteed annuity and lead unitrust
interests, definition (REG-115781-01)
33, 380

Health reimbursement arrangements
(HRAs) (RR 41) 28, 75; (Notice 45)
28, 93

Information reporting:

Investment trusts (REG-106871-00)
30, 190

Payments made on behalf of another
person, to joint payees, and of gross
proceeds from sales involving
investment advisors (TD 9010)
33, 341

Information returns, discharges of indebt-
edness (REG-107524-00) 28, 110

Insurance company interest rates (REG-
248110-96) 26, 19

Interest:

Bank deposit interest paid to nonresi-
dent aliens (REG-133254-02)
34, 412

Investment:
Federal short-term, mid-term, and
long-term rates for:
July 2002 (RR 40) 27, 30

# INCOME TAX- Cont.

August 2002 (RR 48) 31, 239
September 2002 (RR 53) 35, 427
October 2002 (RR 61) 40, 639

Rates:

Underpayments and overpayments,
quarter beginning:
October 1, 2002 (RR 59) 38, 557

Inventory:

LIFO:

Price indexes used by department
stores for:

May 2002 (RR 47) 29, 119

June 2002 (RR 52) 34, 388

July 2002 (RR 57) 37, 526
August 2002 (RR 64) 41, 688

Joint return, relief from joint and several
liability (TD 9003) 32, 294; correction
(Ann 83) 38, 564

Loss limitation rules (TD 8998) 26, 1;
(REG-123305-02) 26, 26; correction
(Ann 69) 31, 283

Marginal properties, oil and gas produc-
tion, depletion, 2002 percentages
(Notice 54) 30, 189

Methods of accounting:

Automatic consent to change certain
methods of accounting (RP 54) 35,
432

Safe harbor method for premium
acquisition expenses, non-life insur-
ance companies (RP 46) 28, 105

New York Liberty Zone, tax benefits
(Notice 42) 27, 36

Noncustomary services provided to ten-
ants of a REIT (RR 38) 26, 4

Optional standard mileage rates for 2003
(RP 61) 39, 616

Partnerships:

Mergers and divisions (Ann 89)
39, 626

Optional election to make monthly
section 706(a) computations (RP 68)
43, 753

Straddle tax shelter (Notice 50) 28, 98
Taxable year, foreign and tax-exempt
partners (TD 9009) 33, 328

Withholding tax on nonresident aliens,
Qualified Intermediaries (Notice 66)
42, 715

Passive activity losses and credits, limita-
tions (TD 9013) 38, 542

Penalties, substantial understatement (RP
66) 42, 724

November 4, 2002

# INCOME TAX- Cont.

Practice before the Internal Revenue Ser-
vice (TD 9011) 33, 356

Private foundations, organizations now
classified as (Ann 64) 27, 72; (Ann 66)
29, 183; (Ann 70) 31, 284; (Ann 72)
32, 323; (Ann 75) 34, 416; (Ann 77)
35, 471; (Ann 80) 36, 515; (Ann 88)
38, 564

Proposed Regulations:

26 CFR 1.167(n)-0 through -7, added;
guidance on cost recovery under the
income forecast method (REG-
103823-99) 27, 44; correction (Ann
79) 36, 515

26 CFR 1.170A-6, amended; defini-
tion of guaranteed annuity and lead
unitrust interests (REG-115781-01)
33, 380

26 CFR 1.280G-1; golden parachute
payments; correction (Ann 65)
29, 181

26 CFR 1.337(d)-2, amended; 1.1502-
20, amended; loss limitation rules
(REG-123305-02) 26, 26; correc-
tion (Ann 69) 31, 283

26 CFR 1.482-0, -1, -5, -7, amended;
compensatory stock options in quali-
fied cost sharing arrangements
(REG-106359-02) 34, 405; correc-
tion (Ann 81) 37, 533

26 CFR 1.671-4, amended; 1.671-5,
added; 1.6041-9, added; 1.6042-5,
added; 1.6045-1, amended;
1.6049-4, -5, amended; 1.6050N-2,
added; 301.6109-1, amended;
602.101, amended; reporting for
widely held fixed investment trusts
(REG-106871-00) 30, 190

26 CFR 1.807-2, added; 1.811-3,
added; 1.812-9, added; 1.817A-0,
-1, added; guidance regarding modi-
fied guaranteed contracts (REG-
248110-96) 26, 19

# INCOME TAX- Cont.

26 CFR 1.883-0 through -5, added;
exclusions from gross income of for-
eign corporations (REG-136311-
01\) 36, 485; correction (Ann 94) 42,
727

26 CFR 1.897 -1, -2, -3, -5T, -6T,
amended; 1.897-5, added; 1.1445-1
through -6, amended; 1.1445-9T,
removed; 301.6109-1, amended; use
of taxpayer identifying numbers on
submissions under sections 897 and
1445 (REG-106876-00) 34, 392

26 CFR 1.1502-21, amended; carry-
back of consolidated net operating
losses to separate return years
(REG-122564-02) 26, 25

26 CFR 1.1503-2, amended; dual con-
solidated loss recapture events
(REG-106879-00) 34, 402

26 CFR 1.6011-4, amended;
301.6111-2, amended; modification
of tax shelter rules III (REG-
103735-00, REG-110311-98) 28,
109

26 CFR 1.6041-1(a)(1)(ii), -3,
amended; 1.6045-5, added; report-
ing of gross proceeds payments to
attorneys (REG-126024-01) 27, 64
26 CFR 1.6049-4, -6, -8, revised;
31.3406(g)-1, revised; guidance on
reporting of deposit interest paid to
nonresident aliens (REG-133254-
02) 34, 412

26 CFR 1.6050P-0, -1, amended;
1.6050P-2, added; guidance regard-
ing cancellation of indebtedness
(REG-107524-00) 28, 110

26 CFR 31.3406(d)-5, revised;
301.6724-1, amended; receipt of
multiple notices with respect to
incorrect taxpayer identification
numbers (REG-116644-01) 31, 268

26 CFR 301.7602-1, revised; desig-
nated IRS officer or employee under
section 7602(a)(2) of the Internal
Revenue Code (REG-134026-02)
40, 684

26 CFR 301.7701-15, amended; low-
income taxpayer clinics -- definition
of income tax return preparer (REG-
115285-01) 27, 62

Public hearings, correction of dates
and/or locations (Ann 67) 30, 237
Public hearings for proposed regulations,
correction of dates and locations (Ann
67) 30, 237

# INCOME TAX- Cont.

Publications:

463, Travel, Entertainment, Gift, and
Car Expenses, Supplement to (Ann
59) 26, 28

520, Scholarships and Fellowships,
revised (Ann 86) 39, 624

536, Net Operating Losses (NOLs) for
Individuals, Estates, and Trusts,
Supplement to (Ann 59) 26, 28

551, Basis of Assets, revised (Ann 61)
27, 71

555, Community Property, revised
(Ann 85) 39, 624

583, Starting a Business and Keeping
Records, revised (Ann 62) 27, 72

590, Individual Retirement Arrange-
ments (IRAs), Supplement to (Ann
73) 33, 387

946, How To Depreciate Property,
Supplement to (Ann 59) 26, 28

971, Innocent Spouse Relief (And
Separation of Liability and Equi-
table Relief), revised (Ann 74)
33, 387

1141, General Rules and Specifica-
tions for Substitute Forms W-2 and
W-3, revised (RP 53) 31, 253

1167, substitute forms, general
requirements (RP 60) 40, 645

1179, substitute forms 1096, 1098,
1099, 5498, W-2G, and 1042-S,
specifications (RP 57) 39, 575

1187, Specifications for Filing Form
1042-S, Foreign Person's U.S.
Source Income Subject to Withhold-
ing, Magnetically or Electronically,
2002 updates (Ann 98) 43, 758

1220, Specifications for Filing Forms
1098, 1099, 5498, and W-2G Elec-
tronically of Magnetically, changes
(Ann 76) 35, 471

1223, General Rules and Specifica-
tions for Substitute Forms W-2c and
W-3c, revised (RP 51) 29, 175

3991, Highlights of the Job Creation
and Worker Assistance Act, new
(Ann 59) 26, 28

Qualified cost sharing arrangements,
costs attributable to stock options
(REG-106359-02) 34, 405; correction
(Ann 81) 37, 533

Railroad track maintenence costs,
accounting methods (RP 65) 41, 700

## INCOME TAX- Cont.

Real estate mortgage investment conduits
(REMICs) (TD 9004) 33, 331
Regulations:

26 CFR 1.141-0, -2, -15, amended;
1.141-7, -8, added; 1.141-7T, -8T,
-15T, removed; obligations of states
and political subdivisions (TD 9016)
40, 628

26 CFR 1.337(d)-2T, amended;
1.1502-20T, amended; loss limita-
tion rules (TD 8998) 26, 1

26 CFR 1.338-1, amended; 1.1502-6,
amended; 1.1502-77, redesignated
as 1.1502-77A and amended;
1.1502-77, added; 1.1502-77T(a),
redesignated as 1.1502-77A(e) and
amended; 1.1502-77T, removed;
1.1502-78, amended; 602.101,
amended; agent for consolidated
group (TD 9002) 29, 120

26 CFR 1.469-0, -7, -11, amended;
602.101, amended; limitations on
passive activity losses and credits-
treatment of self-charged items of
income and expense (TD 9013) 38,
542

26 CFR 1.702-1, amended; 1.952-
1(g), added; 1.954-1(g), -2(a)(5),
-3(a)(6), -4(b)(2)(iii), added; 1.956-
2(a)(3), added; guidance under sub-
part F relating to partnerships (TD
9008) 33, 335

26 CFR 1.706-1, revised; 1.706-3T,
removed; taxable years of partner
and partnership, foreign partners
(TD 9009) 33, 328

26 CFR 1.708-1, amended; 1.752-1,

-5, amended; partnership mergers
and divisions; correction (Ann 89)
39, 626

26 CFR 1.860A-0, amended;
1.860E-1, amended; 602.101,
amended; real estate mortgage
investment conduits (TD 9004)
33, 331

26 CFR 1.892-5, added; 1.892-5T,
amended; 301.7701-2, amended;
clarification of entity classification
rules (TD 9012) 34, 389

26 CFR 1.894-1(d), amended; treaty
guidance regarding payments with
respect to domestic reverse hybrid
entities (TD 8999) 28, 78; correc-
tion (Ann 71) 32, 323

# INCOME TAX- Cont.

26 CFR 1.1502-21, amended; 1.1502-
21T, added; 602.101, amended; car-
ryback of consolidated net operating
losses to separate return years (TD
8997) 26, 6; correction (Ann 68)
31, 283

26 CFR 1.6011-4T, amended;
1.6031(a)-1, amended; 1.6037-1,
amended; 301.6111-2T, amended;
modification of tax shelter rules III
(TD 9000) 28, 87

26 CFR 1.6013-4(d), added;
1.6013-5, removed; 1.6015-0
through -9, added; relief from joint
and several liability (TD 9003) 32,
294; correction (Ann 83) 38, 564

26 CFR 1.6109-2, redesignated as
1.6109-2A; 1.6109-2, added;
1.6109-2T, removed; furnishing
identifying number of income tax
return preparer (TD 9014) 35, 429

26 CFR 301.6103(j)(5)-1, amended;
disclosure of return information to
officers and employees of the
Department of Agriculture for cer-
tain statistical purposes and related
activities (TD 9001) 29, 128

26 CFR 301.7122-0, -1, added;
301.7122-0T, -1T, removed; com-
promise of tax liabilities (TD 9007)
33, 349

26 CFR 301.7602-1, revised;
301.7602-1T, added; designated IRS
officer or employee under section
7602(a)(2) of the Internal Revenue
Code (TD 9015) 40, 642

31 CFR Part 10, amended; regulations
governing practice before the Inter-
nal Revenue Service (TD 9011)
33, 356

Reporting of gross proceeds payments to
attorneys (REG-126024-01) 27, 64
Reprint, Internal Revenue Bulletin
2002-33 (Ann 78) 36, 514

# INCOME TAX- Cont.

Revocations, exempt organizations (Ann
99) 43, 758

Split-dollar life insurance arrangements:
Income, employment, and gift taxation
of (REG-164754-01) 30, 212

Standards for valuing current life
insurance protection (Notice 59) 36,
481

Standard Industry Fare Level (SIFL) for-
mula (RR 56) 37, 526

Stock gain or loss, short sale (RR 44)
28, 84

Substitute Forms:

W-2 and W-3, general rules and
specifications (RP 53) 31, 253

W-2c and W-3c, general rules and
specifications (RP 51) 29, 175
1096, 1098, 1099, 5498, W-2G, and
1042-S, rules and specifications (RP
57) 39, 575

General requirements (RP 60) 40, 645
Tax accrual and other financial audit
workpapers, request for (Ann 63)
27, 72

Tax conventions, competent authority
procedures (RP 52) 31, 242

Tax-exempt bonds:

Exempt facility bonds, population fig-
ures (Notice 56) 32, 319

Guidance regarding mixed use output
facilities (Ann 91) 40, 685

Investment-type property and private
loan (prepayments) (Notice 52)
30, 187

Output facilities and the $15 million
limitation (TD 9016) 40, 628

Solid waste disposal facilities, recy-
cling facilities (Notice 51) 29, 131

Tax-exempt electric cooperatives, pro-
pane distribution and sale (RR 54) 37,
527

Tax liens (CD 2075) 38, 548
Tax shelters:

Disclosure and registration (TD 9000)
28, 87; (REG-103735-00, REG-
110311-98) 28, 109

Partnership straddle (Notice 50) 28,
98

Passthrough entity straddle (Notice 65)
41, 690

Taxpayer identification numbers:

Backup withholding, waiver of infor-

mation reporting penalties (REG-

116644-01) 31, 268

# INCOME TAX- Cont.

Used on submissions under sections
897 and 1445 (REG-106876-00)
34, 392

USDA Peanut Quota Buyout Program,
gain or loss (Notice 67) 42, 715

Utility companies, non-recognition treat-
ment of stranded costs (RP 49) 29, 172
Withholdings, qualified intermediaries,
audit guidelines, nonresident aliens,
foreign financial institutions (RP 55)
35, 435

# SELF-EMPLOYMENT TAX

Compromise of tax liabilities (TD 9007)
33, 349

Practice before the Internal Revenue Ser-
vice (TD 9011) 33, 356

Regulations:
26 CFR 301.7122-0, -1, added;
301.7122-0T, -1T, removed; com-
promise of tax liabilities (TD 9007)
33, 349

31 CFR Part 10, amended; regulations
governing practice before the Inter-
nal Revenue Service (TD 9011)
33, 356

x
☒

Internal Revenue Bulletin 2002-44 (PDF rendition): IRS Announcements

Poursuivez vos recherches dans ChatGPT ou Claude