Internal Revenue Bulletin 2000-2 (PDF rendition): IRS Revenue Procedures

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

INCOME TAX
Rev. Rul. 2000–1, page 250.
Federal rates; adjusted federal rates; adjusted federal
long-term rate, and the long-term exempt rate. For
purposes of sections 1274, 1288, 382, and other sections
of the Code, tables set forth the rates for January 2000.
T.D. 8849, page 245.
Final regulations under section 663(c) of the Code relate to
the separate share rules applicable to estates.
T.D. 8850, page 265.
Final regulations under section 6038 of the Code relate to
the reporting requirements of U.S. persons owning interests
in controlled foreign partnerships or corporations. Also, cer-
tain amendments to the final regulations under section
6038B govern reporting of transfers to foreign partnerships
and corporations.
T.D. 8851, page 275.
Final regulations under section 6046A of the Code relate to
the reporting requirements of U.S. persons that acquire or
dispose of an interest in a foreign partnership, or whose pro-
portional interest in a foreign partnership changes.
T.D. 8852, page 253.
Final regulations under sections 1366, 1367, and 1368 of
the Code relate to the passthrough of items of an S corpora-
tion to its shareholders, the adjustments to the basis of
stock of the shareholders, and the treatment of distributions
by an S corporation.
REG–106012–98, page 290.
Proposed regulations under section 118 of the Code re-
late to the exclusion from gross income for a contribu-
tion in aid of construction (CIAC) from any person
(whether or not a shareholder) to a required public utility
that provides water or sewerage disposal services. The
regulations define what constitutes a CIAC and provides
rules for adjusting the basis of water or sewerage dis-
posal facilities acquired as, or acquired or constructed
with any money received as, a CIAC. The regulations also
provide the time and manner for taxpayers to notify the
Secretary of amounts treated as a contribution to capital
under this provision. A public hearing is scheduled for
April 27, 2000.
Rev. Proc. 2000–10, page 287.
Qualified Zone Academy Bond limitations for 2000.
This procedure sets forth the maximum face amount of Qual-
ified Zone Academy Bonds that may be issued for each
state in 2000. For this purpose, “state” includes the District
of Columbia and U.S. possessions.
Notice 2000–1, page 288.
Effective date of proposed regulations under section
1.368–2(d)(4). Proposed regulations relating to the solely
for voting stock requirement in reorganizations under sec-
tion 368(a)(1)(C) of the Code, when finalized, will be modified
to generally apply to transactions occurring after December
31, 1999. But in certain cases, taxpayers will be able to re-
quest a private letter ruling permitting them to apply the pro-
posed regulations to transactions occuring before the pro-
posed effective date.
EMPLOYEE PLANS
Announcement 2000–1, page 294.
This document provides interim information about the re-
porting requirements applicable to certain plans of state and
local government employers for amounts provided under
section 457. Comments are also requested regarding types
of plans that should be treated as bona fide severance plans
for purposes of section 457.
Internal Revenue
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Bulletin No. 2000–2
January 10, 2000
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
Department of the Treasury
Internal Revenue Service
Finding Lists begin on page ii.
(Continued on the page following the Introduction)

The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing offi-
cial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents 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 published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of in-
ternal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Service
personnel in the disposition of other cases. In applying pub-
lished rulings and procedures, the effect of subsequent leg-
islation, regulations, court decisions, rulings, and proce-
dures must be considered, and Service personnel and oth-
ers concerned are cautioned against reaching the same con-
clusions in other cases unless the facts and circumstances
are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Sub-
parts. Also included in this part are Bank Secrecy Act Admin-
istrative Rulings. Bank Secrecy Act Administrative Rulings
are issued by the Department of the Treasury’s Office of the
Assistant Secretary (Enforcement).
Part IV.—Items of General Interest.
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 semi-
annual period, respectively.
The IRS Mission
Provide America’s taxpayers top quality service by help-
ing them understand and meet their tax responsibilities
and by applying the tax law with integrity and fairness to
all.
Introduction
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.

ESTATE TAX
Announcement 2000–3, page 296.
This document contains corrections to T.D. 8846, 1999-51
I.R.B. 679, relating to the effect of certain administration ex-
penses on the valuation of property for marital and charita-
ble deduction purposes.
ADMINISTRATIVE
Rev. Proc. 2000–9, page 280.
Per diem allowances.This procedure provides optional
rules for substantiating the amount of certain reimbursed
travel expenses of an employee and for determining the
amount of deductible meals while traveling away from
home. Rev. Proc. 98–64 superseded.
Announcement 2000–2, page 295.
Information letters written by the national office of Chief
Counsel and by the Office of the Commissioner, Tax Ex-
empt and Government Entities Division, to the public in re-
sponse to inquiries postmarked or, if not mailed, received
after January 1, 2000, will be available for public inspec-
tion quarterly beginning March 31, 2000, and on a contin-
uing quarterly basis.
2000–2 I.R.B.January 10, 2000
insert photo
here

January 10, 20002442000–2 I.R.B.
Section 42.—Low-Income
Housing Credit
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 62.—Adjusted Gross
Income Defined
26 CFR 1.62–2: Reimbursements and other expense
allowance arrangements.
Rules are set forth under which a reimbursement
or other expense allowance arrangement for the cost
of lodging, meal, and incidental expenses or meal
and incidental expenses incurred by an employee
while traveling away from home will satisfy the re-
quirements of § 62(c) of the Code as to substantia-
tion of the amount of the expenses. See. Rev. Proc.
2000–9, page 280.
26 CFR 1.62–2T: Reimbursements and other
expense allowance arrangements (temporary).
Rules are set forth under which a reimbursement
or other expense allowance arrangement for the cost
of lodging, meal, and incidental expenses or meal
and incidental expenses incurred by an employee
while traveling away from home will satisfy the re-
quirements of § 62(c) of the Code as to substantia-
tion of the amount of expenses. See Rev. Proc.
2000–9, page 280.
Section 162.—Trade or Business
Expense
26 CFR 1.162–17: Reporting and substantiation of
certain business expenses of employees.
Rules are set forth for substantiating the amount
of a deduction or an expense for lodging, meal, and
incidental expenses or meal and incidental expenses
incurred while traveling away from home that most
nearly represents current costs. See Rev. Proc.
2000–9, page 280.
Section 267.—Losses,
Expenses, and Interest With
Respect to Transactions
Between Related Taxpayers
26 CFR 1.267(a)–1: Deductions disallowed.
When a payor provides a per diem allowance to
an employee who is a related party, the rules set
forth for the deemed substantiation to the payor of
the amount of the employee’s ordinary and neces-
sary business expenses for lodging, meal, and inci-
dental expenses or meal and incidental expenses in-
curred while traveling away from home do not
apply. See Rev. Proc. 2000–9, page 280.
Section 274.—Disallowance of
Certain Entertainment, Etc.,
Expenses
26 CFR 1.274–5T: Substantiation requirements
(temporary).
Rules are set forth for an optional method for
substantiating the amount of ordinary and necessary
business expenses of an employee for lodging, meal,
and incidental expenses or meal and incidental ex-
penses incurred while traveling away from home
when a payor provides a per diem allowance under a
reimbursement or other expense allowance arrange-
ment to pay for such expenses. Rules are also set
forth for an optional method for employees and self-
employed individuals to use in computing the de-
ductible costs of business meal and incidental ex-
penses paid or incurred while traveling away from
home. See Rev. Proc. 2000–9, page 280.
26 CFR 1.274(d)–1T: Substantiation requirements
(temporary).
Rules are set forth for an optional method for
substantiating the amount of ordinary and neces-
sary business expenses of an employee for lodg-
ing, meal, and incidental expenses or meal, and in-
cidental expenses incurred while traveling away
from home when a payor provides a per diem al-
lowance under a reimbursement or other expense
allowance arrangement to pay for such expenses.
See Rev. Proc. 2000–9, page 280.
Section 280G.—Golden
Parachute Payments
Federal short-term, mid-term, and long-term
rates are set forth for the month of January 2000. See
Rev. Rul. 2000–1, page 250.
Section 382.—Limitation on Net
Operating Loss Carryforwards
and Certain Built-In Losses
Following Ownership Change
The adjusted applicable federal long-term rate is
set forth for the month of January 2000. See Rev.
Rul. 2000–1, page 250.
Section 412.—Minimum Funding
Standards
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 467.—Certain Payments
for the Use of Property or
Services
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 468.—Special Rules for
Mining and Solid Waste
Reclamation and Closing Costs
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 482.—Allocation of
Income and Deductions Among
Taxpayers
Federal short-term, mid-term, and long-term
rates are set forth for the month of Janyary 2000. See
Rev. Rul. 2000–1, page 250.
Section 483.—Interest on Certain
Deferred Payments
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 642.—Special Rules for
Credits and Deductions
Federal short-term, mid-term, and long-term
rates are set forth for the month of January 2000. See
Rev. Rul. 2000–1, page 250.
Section 663.—Special Rules
Applicable to Sections 661
and 662
26 CFR 1.663(a)–1: Special rules applicable to
sections 661 and 662; exclusion; gifts, bequests, etc.
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

2000–2 I.R.B.245January 10, 2000
T.D. 8849
DEPARTMENT OF TREASURY
Internal Revenue Service
26 CFR Part 1
Section 663(c); Separate Share
Rules Applicable to Estates
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations concerning
separate share rules applicable to estates
under section 663(c) of the Internal Rev-
enue Code. These regulations provide
that substantively separate and indepen-
dent shares of different beneficiaries are
to be treated as separate estates for pur-
poses of computing distributable net in-
come and applying the distribution provi-
sions of sections 661 and 662. These
regulations also provide that a surviving
spouse’s statutory elective share of a
decedent’s estate and a pecuniary formula
bequest are separate shares. Further, a re-
vocable trust that elects to be treated as
part of a decedent’s estate is a separate
share.
DATES: Effective Date: December 28,
1999.
Applicability Dates: For dates of ap-
plicability of these regulations, see
§1.663(c)-6.
FOR FURTHER INFORMATION CON-
TACT: Laura Howell, (202) 622-3060
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On January 6, 1999, a notice of pro-
posed rulemaking was published in the
Federal Register(64 FR 790
(REG–114841–98, 1999–11 I.R.B., 41))
relating to the application of the separate
share rules to estates under section
663(c). Written comments were received
on the proposed regulations, and a public
hearing was held on April 22, 1999. After
consideration of all the comments, the
proposed regulations under section 663(c)
are adopted as revised by this Treasury
decision.
Explanation of Provisions
General Separate Share Rules
The proposed regulations define a sep-
arate share as a separate economic interest
in one beneficiary or class of beneficiaries
of the decedent’s estate such that the eco-
nomic interests of the beneficiary or class
of beneficiaries (for example, rights to in-
come or gains from specified items of
property) are not affected by economic in-
terests accruing to another beneficiary or
class of beneficiaries. The proposed regu-
lations conclude that there are separate
shares in an estate when a beneficiary or
class of beneficiaries has an interest in a
decedent’s estate (whether corpus or in-
come, or both) that no other beneficiary
or class of beneficiaries has.
Two commentators suggested a nar-
rower definition of a separate share. One
commentator suggested that separate
shares exist only when the estate is ad-
ministered as two or more well-defined
shares that could be separate estates. An-
other commentator suggested that sepa-
rate share treatment should apply only
where the existence of separate shares is
clear and the funding thereof does not re-
quire burdensome adjustments due to dis-
proportionate distributions.
Generally, the final regulations clarify
the definition and narrow the application
of the separate share rules that are in the
proposed regulations. The final regula-
tions generally define a separate share as
a separate economic interest in one bene-
ficiary or class of beneficiaries of the
decedent’s estate such that the economic
interests of the beneficiary or class of
beneficiaries neither affect nor are af-
fected by economic interests accruing to
another beneficiary or class of beneficia-
ries. The final regulations add “nor are
affected by” to clarify the definition of a
separate share. Under this revised defini-
tion, a separate share generally exists only
if it includes both corpus and the income
attributable thereto and is independent
from any other share. Thus, income
earned on assets in one share (first share)
and appreciation and depreciation in the
value of those assets have no effect on
any other share. Similarly, the income
and changes in value of any other share
have no effect on the first share.
Effect on Section 663(a)(1)
The proposed regulations provide that
the separate share rules do not change the
rules involving bequests of specific sums
of money or specific property described
in section 663(a)(1).
Commentators asked for clarification
concerning whether the separate share
rules apply to bequests described in sec-
tion 663(a)(1). One commentator recom-
mended that separate share treatment
should apply to these bequests. Another
commentator suggested that while revis-
ing §1.663(c) to apply to estates, the IRS
and the Treasury Department should re-
consider and amend §1.663(a)-1(b)(1) to
permit principal distributions that are
made to fund both pecuniary formula be-
quests and surviving spouses’ elective
shares to be recognized as coming within
the definition of excluded gifts or be-
quests described in section 663(a)(1).
The final regulations provide that be-
quests described in section 663(a)(1) are
not separate shares. The separate share
rules are applicable only to determine the
distributable net income of each share
when applying the distribution provisions
of sections 661 and 662 to the trust or es-
tate and its beneficiaries. Bequests de-
scribed in section 663(a)(1) are not sub-
ject to the distribution provisions and
therefore are not separate shares.
Surviving Spouse’s Elective Share
The proposed regulations provide that a
surviving spouse’s statutory elective share
constitutes a separate share of an estate.
As a result, the surviving spouse may be
taxed on the estate’s gross income only to
the extent of the surviving spouse’s share
of that income under state law.
One commentator recommended that
separate share treatment for a surviving
spouse’s elective share should be recon-
sidered. Elective shares should be a mat-
ter of further study because they are
forced by state law, differ from state to
state, and usually are part of an acrimo-
nious conflict. Another commentator re-
quested clarification of whether a surviv-
ing spouse’s statutory elective share is
included in the subchapter J estate. Fur-
ther, this commentator recommended that
an elective share that is not entitled to in-
come or appreciation should be excluded
from the subchapter J estate, but an elec-
tive share that is entitled to income and
appreciation should be included in the
subchapter J estate.
Conversely, other commentators agreed
that separate share treatment should apply

January 10, 20002462000–2 I.R.B.
to a surviving spouse’s statutory elective
share regardless of whether the surviving
spouse is entitled to income and shares in
appreciation or depreciation. One com-
mentator suggested that the separate share
examples in the proposed regulations be
revised to track more closely the Uniform
Probate Code model because it will likely
be adopted by most states.
These final regulations do not change
the result of the proposed regulations.
However, under these final regulations, a
surviving spouse’s elective share that
under local law is entitled to income and
to share in appreciation or depreciation
constitutes a separate share under the gen-
eral definition. Further, under a special
rule in the final regulations, a surviving
spouse’s elective share that is not entitled
to income or does not share in apprecia-
tion or depreciation is also a separate
share.
Revocable Trust as a Part Of Estate
The proposed regulations provide that a
qualified revocable trust that elects under
section 645 to be treated as part of the
decedent’s estate for income tax purposes
constitutes a separate share. In response
to comments, these final regulations in-
clude a reference that the electing revoca-
ble trust itself may have two or more sep-
arate shares. These final regulations
further provide that qualified revocable
trusts within the definition of section
645(b)(1) are subject to the separate share
rules applicable to estates rather than
trusts whether or not an election is made
to be part of the estate.
Pecuniary Formula Bequests
The preamble to the proposed regula-
tions requests comments concerning the
treatment of pecuniary formula bequests
as separate shares. Several commenta-
tors, noting that pecuniary formula be-
quests are similar to a surviving spouse’s
statutory elective share, suggested that
such bequests be treated as separate
shares. Commentators disagreed, how-
ever, on whether pecuniary formula be-
quests not entitled to income should be
separate shares.
Under these final regulations, any pe-
cuniary formula bequest that is entitled to
income and to share in appreciation or de-
preciation under the governing instrument
or local law constitutes a separate share
under the general definition. Further,
under a special rule, a pecuniary formula
bequest that is not entitled to income or to
share in appreciation or depreciation is
also a separate share if the governing in-
strument does not provide that it is to be
paid or credited in more than three install-
ments. This provision regarding three or
fewer installments parallels the specific
bequest requirements in section
663(a)(1).
Administrative Rules
Commentators requested guidance con-
cerning several administrative matters.
Commentators asked for guidance con-
cerning when separate shares come into
existence. The final regulations provide
that separate shares come into existence at
the earliest moment that a fiduciary may
reasonably determine, based upon the
known facts, that a separate share exists.
Two commentators expressed concern
about the need to readjust the separate
shares as a result of an IRS examination.
One commentator suggested that separate
share treatment should apply to pecuniary
formula bequests only if no amended re-
turns and no adjustments to any tax peri-
ods would be required when the tax re-
turns were filed in good faith. Another
commentator recommended that separate
share treatment should not apply to resid-
uary bequests unless or until the regula-
tions provide simple and practical meth-
ods of compliance for possible
adjustments made during IRS examina-
tions.
These final regulations do not adopt ei-
ther suggestion. The regulations provide
that the fiduciary must use a reasonable
and equitable method to determine the
value of each separate share and the allo-
cation of taxable income to each share.
This approach gives the fiduciary flexibil-
ity, within limits, in applying the separate
share rules. However, redeterminations in
value of those separate shares must be
taken into account.
Commentators asked for a clarification
of whether gross income of an estate must
be allocated to a separate share based
upon the amount of income each share is
entitled to under the terms of the govern-
ing instrument or applicable local law.
These final regulations clarify that, in
computing the distributable net income
for each separate share, the portion of
gross income that is income within the
meaning of section 643(b) must be allo-
cated to each share based upon the
amount of income each share is entitled to
under the terms of the governing instru-
ment or applicable local law. A similar al-
location rule is provided for the amount of
gross income that is not attributable to
cash received by a trust or estate, such as
a distributive share of a partnership’s tax
items, or the pro rata share of an S corpo-
ration’s tax items.
Commentators asked whether the gen-
eral rule for allocating gross income is ap-
plicable for income in respect of a dece-
dent under section 691(a). These final
regulations clarify that such gross income
is allocated among the separate shares
that could potentially be funded with
these amounts irrespective of whether a
share is entitled to receive any income
under the terms of the governing instru-
ment or applicable local law. The amount
allocated to each share is based upon the
relative value of each of those shares that
could potentially be funded with such
amounts.
One commentator requested clarifica-
tion concerning the allocation of expenses
to a separate share. These final regula-
tions do not change the long standing rule
under §1.663(c)-2 of the Income Tax Reg-
ulations that any expense which is applic-
able solely to one separate share of a trust
is not available as a deduction to any
other share of the same trust. The IRS
and the Treasury Department are not
aware of any issues that have arisen in ap-
plying this rule.
Interest on Pecuniary Bequests or De-
layed Estate Distributions
Commentators questioned why the pro-
posed regulations take the position that
interest, imposed by state law, on a pecu-
niary bequest or a delayed estate distribu-
tion is a payment of interest by the estate
and not a distribution for purposes of sec-
tions 661 and 662. These same commen-
tators indicated that alternatively such in-
terest payments should be deductible
administrative expenses if the interest was
required to be paid by state law as part of
the distribution and settlement of the es-
tate. The final regulations retain the posi-
tion taken in the proposed regulations be-
cause the IRS and the Treasury
Department view this result as compelled
by section 163(h) which disallows a de-
duction for personal interest as described
in section 163(h)(2).
Requests Concerning Applicable Dates

2000–2 I.R.B.247January 10, 2000
One commentator suggested that either
the applicable date of these final regula-
tions should be retroactive to the date that
section 1307 of the Tax Reform Act of
1997 became applicable, or the regula-
tions should provide that during the in-
terim period before final regulations are
published, the IRS will accept any reason-
able interpretation of the separate share
rules, including those rules provided in
the proposed regulations.
Another commentator requested that
the final regulations, to the extent applica-
ble to trusts, apply prospectively and
apply either only to trusts that become ir-
revocable after the date the regulations
are finalized or only to taxable years of
trusts beginning after the date the regula-
tions are finalized.
The final regulations have taken these
comments into account as noted below.
Effective Dates
These final regulations are applicable
for estates and qualified revocable trusts
within the meaning of section 645(b)(1)
with respect to decedents who die after
December 28, 1999. However, for estates
and qualified revocable trusts with respect
to decedents who died after the date that
section 1307 of the Tax Reform Act of
1997 became effective but before Decem-
ber 28, 1999, the IRS will accept any rea-
sonable interpretation of the separate
share provisions, including those provi-
sions provided in 1999-11 I.R.B. 41 (see
§601.601(d)(2)(ii)(b)). For trusts other
than qualified revocable trusts, §1.663(c)-
2 is applicable for taxable years of such
trusts beginning after December 28, 1999.
Effect on Other Documents
The following publications are obsolete
as of December 28, 1999:
Rev. Rul. 64-101 (1964-1 C.B. 77).
Rev. Rul. 71-167 (1971-1 C.B. 163).
Special Analyses
It has been determined that these final
regulations are not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assess-
ment is not required. It also has been de-
termined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions and, because these final regulations
do not impose a collection of information
requirement on small entities, the Regula-
tory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Pursuant to section
7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding
these regulations was submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
Drafting Information
The principal author of these regula-
tions is Laura Howell of the Office of As-
sistant Chief Counsel (Passthroughs and
Special Industries). However, other per-
sonnel from the IRS and Treasury Depart-
ment participated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Sections 1.663(c)-1, 1.663(c)-2, 1.663(c)-
3, 1.663(c)-4, 1.663(c)-5, and 1.663(c)-6
also issued under 26 U.S.C. 663(c).
* * *
Par. 2. In §1.663(a)-1, paragraph (b)(3)
is amended by revising Example 1, Exam-
ple 2, and Example 3to read as follows:
§1.663(a)-1 Special rules applicable to
sections 661 and 662; exclusion; gifts, be-
quests, etc.
* * * * *
(b) * * *
(3) * * *
Example 1. Under the terms of a will, a legacy
of $5,000 was left to A, 1,000 shares of X com-
pany stock was left to W, and the balance of the es-
tate was to be divided equally between W and B.
No provision was made in the will for the disposi-
tion of income of the estate during the period of
administration. The estate had income of $25,000
during the taxable year 1954, which was accumu-
lated and added to corpus for estate accounting
purposes. During the taxable year, the executor
paid the legacy of $5,000 in a lump sum to A,
transferred the X company stock to W, and made
no other distributions to beneficiaries. The distrib-
utions to A and W qualify for the exclusion under
section 663(a)(1).
Example 2. Under the terms of a will, the testa-
tor’s estate was to be distributed to A. No provi-
sion was made in the will for the distribution of
the estate’s income during the period of adminis-
tration. The estate had income of $50,000 for the
taxable year. The estate distributed to A stock with
a basis of $40,000 and with a fair market value of
$40,000 on the date of distribution. No other dis-
tributions were made during the year. The distrib-
ution does not qualify for the exclusion under sec-
tion 663(a)(1), because it is not a specific gift to A
required by the terms of the will. Accordingly, the
fair market value of the property ($40,000) repre-
sents a distribution within the meaning of sections
661(a) and 662(a) (see §1.661(a)-2(c)).
Example 3. Under the terms of a trust instru-
ment, trust income is to be accumulated for a pe-
riod of 10 years. During the eleventh year, the
trustee is to distribute $10,000 to B, payable from
income or corpus, and $10,000 to C, payable out
of accumulated income. The trustee is to distrib-
ute the balance of the accumulated income to A.
Thereafter, A is to receive all the current income
until the trust terminates. Only the distribution to
B would qualify for the exclusion under section
663(a)(1).
* * * * *
Par. 3. Section 1.663(c)-1 is amended
as follows:
1. The section heading is revised.
2. Paragraph (a) is amended by revis-
ing the words “trust” and “trusts” to read
“trust (or estate)” and “trusts (or estates)”,
respectively, in the first through fourth
sentences.
3. Paragraph (b)(2) is removed and
paragraphs (b)(3) and (b)(4) are redesig-
nated as paragraphs (b)(2) and (b)(3), re-
spectively.
4. Paragraphs (b) through (d) are
amended by revising the words “trust”
and “trusts” to read “trust (or estate)” and
“trusts (or estates)”, respectively.
The revision reads as follows:
§1.663(c)-1 Separate shares treated as
separate trusts or as separate estates; in
general.
* * * * *
Par. 4. Section 1.663(c)-2, is revised to
read as follows:
§1.663(c)-2 Rules of administration.
(a) When separate shares come into
existence.A separate share comes into
existence upon the earliest moment that a
fiduciary may reasonably determine,
based upon the known facts, that a sepa-
rate economic interest exists.

January 10, 20002482000–2 I.R.B.
(b) Computation of distributable net
income for each separate share—(1)
General rule. The amount of distributable
net income for any share under section
663(c) is computed as if each share consti-
tuted a separate trust or estate. Accord-
ingly, each separate share shall calculate its
distributable net income based upon its por-
tion of gross income that is includible in
distributable net income and its portion of
any applicable deductions or losses.
(2) Section 643(b) income. This para-
graph (b)(2) governs the allocation of the
portion of gross income includible in dis-
tributable net income that is income
within the meaning of section 643(b).
Such gross income is allocated among the
separate shares in accordance with the
amount of income that each share is enti-
tled to under the terms of the governing
instrument or applicable local law.
(3) Income in respect of a decedent.
This paragraph (b)(3) governs the allo-
cation of the portion of gross income in-
cludible in distributable net income that
is income in respect of a decedent within
the meaning of section 691(a) and is not
income within the meaning of section
643(b). Such gross income is allocated
among the separate shares that could po-
tentially be funded with these amounts
irrespective of whether the share is enti-
tled to receive any income under the
terms of the governing instrument or ap-
plicable local law. The amount of such
gross income allocated to each share is
based on the relative value of each share
that could potentially be funded with
such amounts.
(4) Gross income not attributable to
cash.This paragraph (b)(4) governs the
allocation of the portion of gross income
includible in distributable net income
that is not attributable to cash received
by the estate or trust (for example, origi-
nal issue discount, a distributive share of
partnership tax items, and the pro rata
share of an S corporation’s tax items).
Such gross income is allocated among
the separate shares in the same propor-
tion as section 643(b) income from the
same source would be allocated under
the terms of the governing instrument or
applicable local law.
(5) Deductions and losses. Any de-
duction or any loss which is applicable
solely to one separate share of the trust or
estate is not available to any other share
of the same trust or estate.
(c) Computations and valuations.For
purposes of calculating distributable net
income for each separate share, the fidu-
ciary must use a reasonable and equitable
method to make the allocations, calcula-
tions, and valuations required by para-
graph (b) of this section.
Par. 5. Section 1.663(c)-3 is amended
by revising the section heading and the
first sentence of paragraph (a), and re-
moving paragraph (f) to read as follows:
§1.663(c)-3 Applicability of separate
share rule to certain trusts.
(a) The applicability of the separate
share rule provided by section 663(c) to
trusts other than qualified revocable trusts
within the meaning of section 645(b)(1)
will generally depend upon whether dis-
tributions of the trust are to be made in
substantially the same manner as if sepa-
rate trusts had been created.
* * * * *
§1.663(c)-4 [Redesignated as §1.663(c)-5]
Par. 6. Section 1.663(c)-4 is redesig-
nated as §1.663(c)-5.
Par. 7. A new §1.663(c)-4 is added to
read as follows:
§1.663(c)-4 Applicability of separate
share rule to estates and qualified revoca-
ble trusts.
(a) General rule. The applicability of
the separate share rule provided by sec-
tion 663(c) to estates and qualified revo-
cable trusts within the meaning of sec-
tion 645(b)(1) will generally depend
upon whether the governing instrument
and applicable local law create separate
economic interests in one beneficiary or
class of beneficiaries of such estate or
trust. Ordinarily, a separate share exists
if the economic interests of the benefi-
ciary or class of beneficiaries neither af-
fect nor are affected by the economic in-
terests accruing to another beneficiary
or class of beneficiaries. Separate
shares include, for example, the income
on bequeathed property if the recipient
of the specific bequest is entitled to such
income and a surviving spouse’s elec-
tive share that under local law is entitled
to income and appreciation or deprecia-
tion. Furthermore, a qualified revocable
trust for which an election is made under
section 645 is always a separate share of
the estate and may itself contain two or
more separate shares. Conversely, a gift
or bequest of a specific sum of money or
of property as defined in section
663(a)(1) is not a separate share.
(b) Special rule for certain types of bene-
ficial interests. Notwithstanding the provi-
sions of paragraph (a) of this section, a sur-
viving spouse’s elective share that under
local law is determined as of the date of the
decedent’s death and is not entitled to in-
come or any appreciation or depreciation is
a separate share. Similarly, notwithstand-
ing the provisions of paragraph (a) of this
section, a pecuniary formula bequest that,
under the terms of the governing instru-
ment or applicable local law, is not entitled
to income or to share in appreciation or de-
preciation constitutes a separate share if the
governing instrument does not provide that
it is to be paid or credited in more than
three installments.
(c) Shares with multiple beneficiaries
and beneficiaries of multiple shares.A
share may be considered as separate
even though more than one beneficiary
has an interest in it. For example, two
beneficiaries may have equal, dispropor-
tionate, or indeterminate interests in one
share which is economically separate
and independent from another share in
which one or more beneficiaries have an
interest. Moreover, the same person
may be a beneficiary of more than one
separate share.
Par. 8. Newly designated §1.663(c)-5
is amended by:
1. Revising the section heading and
introductory text.
2. Redesignating the Exampleas Ex-
ample 1and, in newly designated Exam-
ple 1, redesignating paragraphs (a)
through (e) as paragraphs (i) through
(v), respectively.
3. Adding Example 2,Example 3,Ex-
ample 4,Example 5,Example 6,Example
7,Example 8,Example 9,Example 10,
and Example 11.
The revisions and additions read as fol-
lows:
§1.663(c)-5 Examples.
Section 663(c) may be illustrated by
the following examples:
Example 1. * * *
Example 2(i) Facts. Testator, who dies in
2000, is survived by a spouse and two children.
Testator’s will contains a fractional formula be-
quest dividing the residuary estate between the
surviving spouse and a trust for the benefit of the
children. Under the fractional formula, the marital

2000–2 I.R.B.249January 10, 2000
bequest constitutes 60% of the estate and the chil-
dren’s trust constitutes 40% of the estate. During
the year, the executor makes a partial proportion-
ate distribution of $1,000,0000, ($600,000 to the
surviving spouse and $400,000 to the children’s
trust) and makes no other distributions. The estate
receives dividend income of $20,000, and pays ex-
penses of $8,000 that are deductible on the estate’s
federal income tax return.
(ii) Conclusion. The fractional formula be-
quests to the surviving spouse and to the children’s
trust are separate shares. Because Testator’s will
provides for fractional formula residuary bequests,
the income and any appreciation in the value of the
estate assets are proportionately allocated between
the marital share and the trust’s share. Therefore,
in determining the distributable net income of each
share, the income and expenses must be allocated
60% to the marital share and 40% to the trust’s
share. The distributable net income is $7,200
(60% of income less 60% of expenses) for the
marital share and $4,800 (40% of income less 40%
of expenses) for the trust’s share. Because the
amount distributed in partial satisfaction of each
bequest exceeds the distributable net income of
each share, the estate’s distribution deduction
under section 661 is limited to the sum of the dis-
tributable net income for both shares. The estate is
allowed a distribution deduction of $12,000
($7,200 for the marital share and $4,800 for the
trust’s share). As a result, the estate has zero tax-
able income ($20,000 income less $8,000 ex-
penses and $12,000 distribution deduction).
Under section 662, the surviving spouse and the
trust must include in gross income $7,200 and
$4,800, respectively.
Example 3. The facts are the same as in Exam-
ple 2, except that in 2000 the executor makes the
payment to partially fund the children’s trust but
makes no payment to the surviving spouse. The
fiduciary must use a reasonable and equitable
method to allocate income and expenses to the
trust’s share. Therefore, depending on when the
distribution is made to the trust, it may no longer
be reasonable or equitable to determine the distrib-
utable net income for the trust’s share by allocat-
ing to it 40% of the estate’s income and expenses
for the year. The computation of the distributable
net income for the trust’s share should take into
consideration that after the partial distribution the
relative size of the trust’s separate share is reduced
and the relative size of the spouse’s separate share
is increased.
Example 4(i) Facts. Testator, who dies in
2000, is survived by a spouse and one child. Tes-
tator’s will provides for a pecuniary formula be-
quest to be paid in not more than three install-
ments to a trust for the benefit of the child in the
amount needed to reduce the estate taxes to zero
and a bequest of the residuary to the surviving
spouse. The will provides that the bequest to the
child’s trust is not entitled to any of the estate’s in-
come and does not participate in appreciation or
depreciation in estate assets. During the 2000 tax-
able year, the estate receives dividend income of
$200,000 and pays expenses of $15,000 that are
deductible on the estate’s federal income tax re-
turn. The executor partially funds the child’s trust
by distributing to it securities that have an adjusted
basis to the estate of $350,000 and a fair market
value of $380,000 on the date of distribution. As a
result of this distribution, the estate realizes long-
term capital gain of $30,000.
(ii) Conclusion.The estate has two separate
shares consisting of a formula pecuniary bequest
to the child’s trust and a residuary bequest to the
surviving spouse. Because, under the terms of the
will, no estate income is allocated to the bequest to
the child’s trust, the distributable net income for
that trust’s share is zero. Therefore, with respect
to the $380,000 distribution to the child’s trust, the
estate is allowed no deduction under section 661,
and no amount is included in the trust’s gross in-
come under section 662. Because no distributions
were made to the spouse, there is no need to com-
pute the distributable net income allocable to the
marital share. The taxable income of the estate for
the 2000 taxable year is $214,400 ($200,000 (divi-
dend income) plus $30,000 (capital gain) minus
$15,000 (expenses) and minus $600 (personal ex-
emption)).
Example 5. The facts are the same as in Exam-
ple 4, except that during 2000 the estate reports on
its federal income tax return a pro rata share of an
S corporation’s tax items and a distributive share
of a partnership’s tax items allocated on Form K-
1s to the estate by the S corporation and by the
partnership, respectively. Because, under the
terms of the will, no estate income from the S cor-
poration or the partnership would be allocated to
the pecuniary bequest to child’s trust, none of the
tax items attributable to the S corporation stock or
the partnership interest is allocated to the trust’s
separate share. Therefore, with respect to the
$380,000 distribution to the trust, the estate is al-
lowed no deduction under section 661, and no
amount is included in the trust’s gross income
under section 662.
Example 6. The facts are the same as in Exam-
ple 4, except that during 2000 the estate receives a
distribution of $900,000 from the decedent’s indi-
vidual retirement account that is included in the
estate’s gross income as income in respect of a
decedent under section 691(a). The entire
$900,000 is allocated to corpus under applicable
local law. Both the separate share for the child’s
trust and the separate share for the surviving
spouse may potentially be funded with the pro-
ceeds from the individual retirement account.
Therefore, a portion of the $900,000 gross income
must be allocated to the trust’s separate share. The
amount allocated to the trust’s share must be based
upon the relative values of the two separate shares
using a reasonable and equitable method. The es-
tate is entitled to a deduction under section 661 for
the portion of the $900,000 properly allocated to
the trust’s separate share, and the trust must in-
clude this amount in income under section 662.
Example 7 (i) Facts. Testator, who dies in
2000, is survived by a spouse and three adult chil-
dren. Testator’s will divides the residue of the es-
tate equally among the three children. The surviv-
ing spouse files an election under the applicable
state’s elective share statute. Under this statute, a
surviving spouse is entitled to one-third of the
decedent’s estate after the payment of debts and
expenses. The statute also provides that the sur-
viving spouse is not entitled to any of the estate’s
income and does not participate in appreciation or
depreciation of the estate’s assets. However,
under the statute, the surviving spouse is entitled
to interest on the elective share from the date of
the court order directing the payment until the ex-
ecutor actually makes payment. During the es-
tate’s 2001 taxable year, the estate distributes to
the surviving spouse $5,000,000 in partial satisfac-
tion of the elective share and pays $200,000 of in-
terest on the delayed payment of the elective
share. During that year, the estate receives divi-
dend income of $3,000,000 and pays expenses of
$60,000 that are deductible on the estate’s federal
income tax return.
(ii) Conclusion. The estate has four separate
shares consisting of the surviving spouse’s elective
share and each of the three children’s residuary be-
quests. Because the surviving spouse is not entitled
to any estate income under state law, none of the es-
tate’s gross income is allocated to the spouse’s sepa-
rate share for purposes of determining that share’s
distributable net income. Therefore, with respect to
the $5,000,000 distribution, the estate is allowed no
deduction under section 661, and no amount is in-
cluded in the spouse’s gross income under section
662. The $200,000 of interest paid to the spouse
must be included in the spouse’s gross income under
section 61. Because no distributions were made to
any other beneficiaries during the year, there is no
need to compute the distributable net income of the
other three separate shares. Thus, the taxable in-
come of the estate for the 2000 taxable year is
$2,939,400 ($3,000,000 (dividend income) minus
$60,000 (expenses) and $600 (personal exemption)).
The estate’s $200,000 interest payment is a nonde-
ductible personal interest expense described in sec-

January 10, 20002502000–2 I.R.B.
tion 163(h).
Example 8. The will of Testator, who dies in
2000, directs the executor to distribute the X stock
and all dividends therefrom to child A and the
residue of the estate to child B. The estate has two
separate shares consisting of the income on the X
stock bequeathed to A and the residue of the estate
bequeathed to B. The bequest of the X stock meets
the definition of section 663(a)(1) and therefore is
not a separate share. If any distributions, other than
shares of the X stock, are made during the year to ei-
ther A or B, then for purposes of determining the dis-
tributable net income for the separate shares, gross
income attributable to dividends on the X stock must
be allocated to A’s separate share and any other in-
come must be allocated to B’s separate share.
Example 9. The will of Testator, who dies in
2000, directs the executor to divide the residue of
the estate equally between Testator’s two children, A
and B. The will directs the executor to fund A’s
share first with the proceeds of Testator’s individual
retirement account. The date of death value of the
estate after the payment of debts, expenses, and es-
tate taxes is $9,000,000. During 2000, the $900,000
balance in Testator’s individual retirement account
is distributed to the estate. The entire $900,000 is
allocated to corpus under applicable local law. This
amount is income in respect of a decedent within the
meaning of section 691(a). The estate has two sepa-
rate shares, one for the benefit of A and one for the
benefit of B. If any distributions are made to either
A or B during the year, then, for purposes of deter-
mining the distributable net income for each sepa-
rate share, the $900,000 of income in respect of a
decedent must be allocated to A’s share.
Example 10. The facts are the same as in Exam-
ple 9, except that the will directs the executor to
fund A’s share first with X stock valued at
$3,000,000, rather than with the proceeds of the in-
dividual retirement account. The estate has two sep-
arate shares, one for the benefit of A and one for the
benefit of B. If any distributions are made to either
A or B during the year, then, for purposes of deter-
mining the distributable net income for each sepa-
rate share, the $900,000 of gross income attributable
to the proceeds from the individual retirement ac-
count must be allocated between the two shares to
the extent that they could potentially be funded with
those proceeds. The maximum amount of A’s share
that could potentially be funded with the income in
respect of decedent is $1,500,000 ($4,500,000 value
of share less $3,000,000 to be funded with stock)
and the maximum amount of B’s share that could
potentially be funded with income in respect of
decedent is $4,500,000. Based upon the relative val-
ues of these amounts, the gross income attributable
to the proceeds of the individual retirement account
is allocated $225,000 (or one-fourth) to A’s share
and $675,000 (or three-fourths) to B’s share.
Example 11. The will of Testator, who dies in
2000, provides that after the payment of specific be-
quests of money, the residue of the estate is to be di-
vided equally among the Testator’s three children,
A, B, and C. The will also provides that during the
period of administration one-half of the income
from the residue is to be paid to a designated charita-
ble organization. After the specific bequests of
money are paid, the estate initially has three equal
separate shares. One share is for the benefit of the
charitable organization and A, another share is for
the benefit of the charitable organization and B, and
the last share is for the benefit of the charitable orga-
nization and C. During the period of administration,
payments of income to the charitable organization
are deductible by the estate to the extent provided in
section 642(c) and are not subject to the distribution
provisions of sections 661 and 662.
Par. 9. Section 1.663(c)-6 is added to
read as follows:
§1.663(c)-6 Effective dates.
Sections 1.663(c)-1 through 1.663(c)-5
are applicable for estates and qualified re-
vocable trusts within the meaning of sec-
tion 645(b)(1) with respect to decedents
who die after December 28, 1999. How-
ever, for estates and qualified revocable
trusts with respect to decedents who died
after the date that section 1307 of the Tax
Reform Act of 1997 became effective but
before December 28, 1999, the IRS will
accept any reasonable interpretation of
the separate share provisions, including
those provisions provided in 1999-11
I.R.B. 41 (see §601.601(d)(2)(ii)(b) of
this chapter). For trusts other than quali-
fied revocable trusts, §1.663(c)-2 is ap-
plicable for taxable years of such trusts
beginning after December 28, 1999.
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
Approved December 13, 1999.
Jonathan Talisman,
Acting Assistant Secretary
for the Treasury.
(Filed by the Office of the Federal Register on
December 27, 1999, 8:45 a.m., and published in
the issue of the Federal Register for December 28,
1999, 64 F.R. 72540)
Section 807.—Rules for Certain
Reserves
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul 2000–1, page 250.
Section 846.—Discounted
Unpaid Losses Defined
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 1274.—Determination
of Issue Price in the Case of
Certain Debt Instruments Issued
for Property
(Also Sections 42, 280G, 382, 412, 467, 468, 482,
483, 642, 807, 846, 1288, 7520, 7872.)
Federal rates; adjusted federal rates;
adjusted federal long-term rate, and
the long-term exempt rate.For purposes
of sections 1274, 1288, 382, and other
section of the Code, tables set forth the
rates for January 2000.
Rev. Rul. 2000-1
This revenue ruling provides various
prescribed rates for federal income tax
purposes for January 2000 (the current
month.) Table 1 contains the short-term,
mid-term, and long-term applicable fed-
eral rates (AFR) for the current month for
purposes of section 1274(d) of the Inter-
nal Revenue Code. Table 2 contains the
short-term, mid-term, and long-term ad-
justed applicable federal rates (adjusted
AFR) for the current month for purposes
of section 1288(b). Table 3 sets forth the
adjusted federal long-term rate and the
long-term tax-exempt rate described in
section 382(f). Table 4 contains the ap-
propriate percentages for determining the
low-income housing credit described in
section 42(b)(2) for buildings placed in
service during the current month. Table 5
contains the federal rate for determining
the present value of an annuity, an interest
for life or for a term of years, or a remain-
der or a reversionary interest for purposes
of section 7520. Finally, Table 6 contains
the deemed rate of return for transfers
made during calendar year 2000 to pooled
income funds described in § 642(c)(5)
that have been in existence for less than 3
taxable years immediately preceding the
taxable year in which the transfer is made.

2000–2 I.R.B.251January 10, 2000
REV. RUL. 2000-1 TABLE 1
Applicable Federal Rates (AFR) for January 2000
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-Term
AFR5.88%5.80%5.76%5.73%
110% AFR6.48%6.38%6.33%6.30%
120% AFR7.08%6.96%6.90%6.86%
130% AFR7.68%7.54%7.47%7.42%
Mid-Term
AFR6.21%6.12%6.07%6.04%
110% AFR6.84%6.73%6.67%6.64%
120% AFR7.47%7.34%7.27%7.23%
130% AFR8.12%7.96%7.88%7.83%
150% AFR9.39%9.18%9.08%9.01%
175% AFR11.00%10.71%10.57%10.48%
Long-Term
AFR6.45%6.35%6.30%6.27%
110% AFR7.11%6.99%6.93%6.89%
120% AFR7.77%7.62%7.55%7.50%
130% AFR8.43%8.26%8.18%8.12%
REV. RUL. 2000-1 TABLE 2
Adjusted AFR for January 2000
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-term
adjusted AFR4.01%3.97%3.95%3.94%
Mid-term
adjusted AFR4.66%4.61%4.58%4.57%
Long-term
adjusted AFR5.59%5.51%5.47%5.45%

January 10, 20002522000–2 I.R.B.
REV. RUL. 2000-1 TABLE 3
Rates Under Section 382 for January 2000
Adjusted federal long-term rate for the current month5.59%
Long-term tax-exempt rate for ownership changes during the current month (the highest of the
adjusted federal long-term rates for the current month and the prior two months.)5.72%
REV. RUL. 2000-1 TABLE 4
Appropriate Percentages Under Section 42(b)(2)
for January 2000
Appropriate percentage for the 70% present
value low-income housing credit8.48%
Appropriate percentage for the 30% present
value low-income housing credit3.64%
REV. RUL. 2000-1 TABLE 5
Rate Under Section 7520 for January 2000
Applicable federal rate for determining the present
value of an annuity, an interest for life or a term
of years, or a remainder or reversionary interest7.4%
Rev. Rul. 2000-1 TABLE 6
Deemed Rate of Transfers to New Pooled Income Funds During 2000
Deemed rate of return for transfers during 2000 to pooled
income funds that have been in existence for less than 3
taxable years6.80%

2000–2 I.R.B.253January 10, 2000
Section 1288.—Treatment of
Original Issue Discounts on Tax-
Exempt Obligations
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 1366.—Pass-Thru of
Items to Shareholders
26 CFR 1.1366–1: Shareholder’s share of items of
an S corporation.
T.D. 8852
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Passthrough of Items of an S
Corporation to its Shareholders
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains final
regulations relating to the passthrough of
items of an S corporation to its shareholders,
the adjustments to the basis of stock of the
shareholders, and the treatment of distribu-
tions by an S corporation. Changes to the
applicable law were made by the Subchapter
S Revision Act of 1982, the Tax Reform Act
of 1984, the Tax Reform Act of 1986, the
Technical and Miscellaneous Revenue Act
of 1988, and the Small Business Job Protec-
tion Act of 1996. These regulations provide
the public with guidance needed to comply
with the applicable law and will affect S cor-
porations and their shareholders.
DATES: Effective Date: These regula-
tions are effective August 18, 1998.
Applicability Dates: For dates of ap-
plicability, see §1.1366-5, §1.1367-3,
and §1.1368-4, plus Transition Rule and
Effective Date under
SUPPLEMENTARY INFORMATION.
FOR FURTHER INFORMATION
CONTACT: Concerning the regulations
under section 1366, Martin Schäffer,
Deane M. Burke, or David Shulman
(202) 622-3070; concerning the regula-
tions under sections 1367 and 1368,
Brenda Stewart, (202) 622-3120.
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in these final regulations has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507) under control
number 1545-1613. Responses to this
collection of information are mandatory.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
control number.
The burden for this requirement is re-
flected in the burden of Form 1040, “U.S.
Individual Income Tax Return”, and Form
1120S, “U.S. Income Tax Return for an S
corporation”.
Suggestions for reducing this burden
should be sent to the Internal Revenue
Service, Attn: IRS Reports Clearance Of-
ficer, OP:FS:FP, Washington, DC 20224,
and to the Office of Management and
Budget, Attn: Desk Officer for the De-
partment of the Treasury, Office of Infor-
mation and Regulatory Affairs, Washing-
ton, DC 20503.
Books or records relating to this collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
This document amends 26 CFR part 1 to
provide additional rules under sections 1366,
1367, and 1368 relating to the passthrough
of items of an S corporation to its sharehold-
ers, the adjustments to the basis of stock of
the shareholders, and the treatment of distri-
butions by an S corporation.
On August 18, 1998, the IRS published
in the Federal Register(63 FR 44181), a
notice of proposed rulemaking (REG-
209446-82) regarding sections 1366,
1367, and 1368. Comments responding
to the proposed regulations were re-
ceived. The public hearing was canceled
because there were no requests to speak.
After considering the comments received,
the proposed regulations are adopted as
amended by this Treasury decision.
Explanation of Revisions and
Summary of Comments
1. Aggregation of deductions from an S
corporation with deductions from other
sources.
The proposed regulations provide that a
shareholder of an S corporation must ag-
gregate its separate deductions and exclu-
sions with the shareholder’s pro rata share
of the S corporation’s separately stated
deductions or exclusions in determining
the allowable amount of any deduction or
exclusion that is subject to a limitation in
the Code.
The proposed regulations provide an
example of this rule for property ex-
pensed under section 179. A commenta-
tor suggested that the example implies
that a shareholder must expense its pro
rata share of section 179 expense from the
S corporation before it can expense any
separately acquired property.
The example is intended to illustrate
that a shareholder may expense only up to
the amount allowable under section 179
in any given year regardless of whether
the property is owned individually or
through an S corporation. The example is
not intended to imply that a shareholder
must elect to expense property held in an
S corporation before it can expense any
separately acquired property. However,
once an S corporation elects to expense
property under section 179, a shareholder
will generally elect to expense personal
property only to the extent the share-
holder’s pro rata share of the corpora-
tion’s section 179 expense does not ex-
ceed the shareholder’s individual
limitation under section 179(b). Accord-
ingly, no modifications have been made
to the example in the final regulations.
The commentator also requested that
the final regulations provide additional
examples that illustrate the aggregation of
the shareholder’s pro rata share of deduc-
tions and exclusions from an S corpora-
tion with deductions and exclusions from
other sources and the operation of any
limitations on those aggregated deduc-
tions and exclusions. Specifically, the
commentator requested that the final reg-
ulations include an example in which the
shareholder’s aggregate section 179 ex-
penses from several passthrough sources
exceeds the maximum section 179 ex-
pense allowable. The allocation of the
section 179 expense among the various

January 10, 20002542000–2 I.R.B.
sources is more appropriately addressed
in the regulations under section 179 and is
beyond the scope of these regulations.
Accordingly, the final regulations do not
adopt this comment.
2. Recharacterization of gains and losses
at the shareholder level.
Generally, the items of an S corpora-
tion that are passed through, and reported
by, a shareholder are characterized at the
corporate level in the same manner that
partnership items are characterized at the
partnership level.
However, the proposed regulations also
contain exceptions to this general rule for
contributions of either noncapital gain
property or capital loss property if an S
corporation is formed or availed of by any
shareholder or shareholders for a princi-
pal purpose of selling or exchanging the
property that in the hands of the share-
holder or shareholders would have pro-
duced a different character of gain or loss.
The character of the gain or loss will be
the same as it would have been if the
property were in the hands of the share-
holder or shareholders at the time of the
sale or exchange.
Commentators suggested that, in the
absence of a statutory provision like sec-
tion 724 in the partnership context, the
IRS lacked the authority to recharacterize
gain or loss at the shareholder level.
Thus, the commentators asserted that the
final regulations should not adopt the
recharacterization rules.
Alternatively, the commentators sug-
gested limiting the recharacterization rule
to sales or exchanges occurring within a
specified time period.
Unlike the partnership rules, the
recharacterization rules in the proposed
regulations are limited to transactions in
which an S corporation is used for a prin-
cipal purpose of changing the character of
the gain or loss of contributed property.
These rules are reasonable approaches to
remedying any improper attempts to uti-
lize section 1366(b) to avoid tax. The
length of time between the contribution of
the property to the S corporation and the S
corporation’s sale or exchange of the
property will be a factor considered in
evaluating whether the S corporation was
availed of for a principal purpose of
changing the character of the gain or loss.
However, the final regulations do not
adopt any particular time period. Thus,
the final regulations retain the recharac-
terization rules as proposed.
3. Gross income reporting requirement.
Section 1366(c), like section 702(c) in
the partnership context, provides for the
passthrough of gross income to a share-
holder for federal income tax purposes.
Thus, where it is necessary to determine
the amount or character of the gross in-
come of a shareholder, the proposed regu-
lations provide that a shareholder’s gross
income includes the shareholder’s pro
rata share of the gross income of the S
corporation. This amount is the amount
of gross income of the corporation used to
derive the shareholder’s pro rata share of
S corporation taxable income or loss.
A commentator suggested that the rule
in the proposed regulations attempts to
narrow the disclosure exception under
section 6501(e) by applying a pro rata
concept with respect to a shareholder’s
gross income. The commentator recom-
mended that the final regulations not
adopt the gross income reporting rules or,
alternatively, provide a de minimis excep-
tion to the rule for certain shareholders
who own minority interests in an S corpo-
ration.
The rule in the proposed regulations
parallels the rules for determining the
amount of gross income reported by a
partner in a partnership. See section
702(c); §1.702-1(c)(2). Accordingly,
the final regulations do not adopt this
suggestion.
4. Carryover of disallowed losses under
section 1366(d).
Section 1366(d) provides that a share-
holder’s disallowed losses and deductions
for any taxable year shall be treated as in-
curred by the corporation in the succeed-
ing taxable year with respect to that share-
holder. The proposed regulations provide
that a shareholder’s losses and deductions
disallowed under section 1366(d) are per-
sonal to the shareholder and cannot in any
manner be transferred to another person.
A commentator requested that the final
regulations provide an exception to this
rule for transferees that have an identity
of investment interest or common basis
with the transferor, such as when stock is
transferred incident to divorce under sec-
tion 1041.
Under section 1366(d), the carryover of
disallowed losses and deductions is with
respect to the shareholder whose invest-
ment limited the items of loss or deduc-
tion. Thus, the carryover is not available
to a transferee who acquires the stock
whether by sale, death, gift, or otherwise.
Accordingly, the final regulations retain
the rule that disallowed losses and deduc-
tions are nontransferable.
The proposed regulations also provide
that if a shareholder transfers all of the
shareholder’s stock in the corporation,
any disallowed loss or deduction is per-
manently disallowed. A commentator
suggested that the final regulations permit
a former shareholder of an S corporation
who subsequently reacquires stock in the
S corporation to utilize the losses and de-
ductions previously disallowed to the
shareholder.
Losses and deductions that are disal-
lowed in any taxable year carry over
under section 1366(d) to the succeeding
taxable year of the corporation with re-
spect to a particular shareholder. If a
shareholder completely terminates its in-
terest in the corporation, the shareholder
will not be a shareholder in the succeed-
ing taxable year of the corporation and the
disallowed losses would not carry over.
There is no statutory authority for the car-
ryover of disallowed items if a share-
holder is not a shareholder in the year suc-
ceeding the disallowance. The disallowed
items of loss and deduction are amounts
that exceed the shareholder’s economic
investment in the corporation. Once the
shareholder terminates its interest in the
corporation, it is not necessary to preserve
the shareholder’s position in the corpora-
tion. Thus, the final regulations do not
adopt this commentator’s suggestion.
5. Basis in S corporation stock received
as a gift.
Section 1366(d)(1) limits the amount of
corporate losses and deductions that can
pass through to, and be deducted by, a
shareholder to the shareholder’s adjusted
basis in the corporation’s stock and debt
of the corporation to the shareholder.
The proposed regulations provide that,
for purposes of section 1366(d)(1), a
shareholder’s basis in stock acquired by
gift is the basis of the stock used for pur-
poses of determining loss under section
1015. Thus, if the fair market value of the
stock exceeds the donor’s adjusted basis
on the date of the gift, for purposes of sec-
tion 1366(d)(1), the adjusted basis of the
stock in the hands of the donee is its ad-

2000–2 I.R.B.255January 10, 2000
justed basis in the hands of the donor.
However, if the donor’s adjusted basis in
the stock exceeds the stock’s fair market
value on the date of the gift, for purposes
of section 1366(d)(1), the adjusted basis
of the stock in the hands of the donee is
the stock’s fair market value on the date
of the gift.
One commentator argued that the
basis for determining loss under section
1015 is applicable only on the disposi-
tion of the gifted asset. The basis for de-
termining loss in section 1015 generally
does not affect the basis for depreciation
or the deductibility of net expenses aris-
ing out of the use or operation of the
gifted asset.
The proposed regulations, however,
apply the loss basis rule in section 1015
not for purposes of determining the de-
preciable basis of a gifted asset, but
rather for purposes of determining the
amount of passthrough losses and de-
ductions (including depreciation deduc-
tions and operating losses) that are al-
lowable to a shareholder under section
1366. The donee of loss stock cannot
dispose of the stock and recognize the
loss inherent in the stock on the date of
gift. If the donee could use the donor’s
basis to take depreciation deductions
and operating losses of the S corpora-
tion, the donee in effect would realize
the benefit of the loss inherent in the
stock.
Another commentator agreed that the
basis for determining loss in section
1015 ought to be the basis of gifted
stock for purposes of section 1366.
Thus, the final regulations continue to
provide that for purposes of section
1366, the basis of stock acquired by gift
is the basis for determining loss under
section 1015.
6. Allocation of disallowed losses in cer-
tain corporate separations.
The proposed regulations provide
rules for the carryover of disallowed
losses and deductions in the case of cer-
tain corporate reorganizations. In the
case of an S corporation that transfers a
part of its assets constituting an active
trade or business to another corporation
in a transaction to which section
368(a)(1)(D) applies, and immediately
thereafter the stock and securities of the
controlled corporation are distributed in
a distribution or exchange to which sec-
tion 355 (or so much of section 356 as
relates to section 355) applies, any disal-
lowed loss or deduction with respect to a
shareholder of the distributing corpora-
tion immediately before the transaction
is allocated between the distributing cor-
poration and the controlled corporation
with respect to the shareholder. The
proposed regulations provide that the
amount of disallowed loss or deduction
allocated to the distributing (or con-
trolled) corporation with respect to the
shareholder is an amount that bears the
same ratio to each item of disallowed
loss or deduction as the value of the
shareholder’s stock in the distributing
(or controlled) corporation bears to the
total value of the shareholder’s stock in
the distributing and controlled corpora-
tions, in each case as determined imme-
diately after the distribution.
A commentator suggested that the
term value as used in the proposed regu-
lations is ambiguous and that the final
regulations should specifically state
“fair market value.” The commentator
also recommended that because the
computation of fair market value intro-
duces a host of valuation issues into the
transaction, the final regulations should
permit an allocation of disallowed losses
and deductions based on the relative ad-
justed bases of the assets of the distrib-
uting and controlled corporations. Fi-
nally, the commentator requested that
the final regulations allow S corpora-
tions to allocate disallowed losses and
deductions to the controlled or distribut-
ing corporation based upon the source of
those losses and deductions. The final
regulations permit shareholders to allo-
cate disallowed losses and deductions
according to any reasonable method, in-
cluding a method based on the relative
fair market value of the shareholder’s
stock in the distributing and controlled
corporations immediately after the dis-
tribution, a method based on the relative
adjusted bases of the assets in the dis-
tributing and controlled corporations
immediately after the distribution, or, in
the case of losses and deductions clearly
attributable to either the distributing or
controlled corporation, a method that al-
locates such losses and deductions ac-
cordingly.
7. Allocation of tax on passive invest-
ment income under section 1366(f)(3).
Section 1366(f)(3) provides that if
any tax is imposed under section 1375
for a taxable year, each item of passive
investment income is reduced by an
amount which bears the same ratio to
the amount of the tax as the amount of
the item bears to the total passive invest-
ment income for the taxable year.
A commentator requested guidance in
the final regulations on whether the allo-
cation of any tax imposed under section
1375 is made based on the total gross or
total net passive investment income.
Under section 1375, the amount of ex-
cess passive investment income is allo-
cated to the items of passive investment
income based on the net passive invest-
ment income of the corporation. The al-
location of the tax imposed on the ex-
cess passive investment income should
be similarly allocated. Accordingly, the
final regulations clarify that the alloca-
tion of any tax under section 1375 is
based on the total net passive investment
income for the taxable year.
8. Accrual of charitable contribution de-
ductions under section 170(a)(2).
The proposed regulations under sec-
tion 1366 provide that each shareholder
must take into account the shareholder’s
pro rata share of any charitable contribu-
tions paid by the corporation during the
corporation’s taxable year. A commen-
tator requested that the final regulations
clarify that separately stated items in-
clude charitable contributions paid or
deemed to be paid. The commentator
suggested that an accrual basis S corpo-
ration may elect under section 170(a)(2)
to treat charitable contributions as paid
in the year prior to the year in which the
charitable contribution is actually paid.
Under section 1363(b), S corporations
generally compute their taxable income
in the same manner as in the case of an
individual. However, S corporations are
not permitted to take charitable contri-
bution deductions by virtue of the cross
reference in section 1363(b)(2) to sec-
tion 703(a)(2). Instead, the deductions
for charitable contributions pass through
to the shareholders of the S corporation.
Individuals cannot make the election
under section 170(a)(2). Treasury and
the Service believe that an S corporation
also cannot make the election under sec-
tion 170(a)(2). Accordingly, the final
regulations do not adopt this suggestion.

January 10, 20002562000–2 I.R.B.
9. Treatment of section 108 income
The regulations enumerate items of
income (including tax-exempt income),
loss, deduction, or credit of an S corpo-
ration that must be taken into account
separately by each shareholder pursuant
to section 1366(a)(1)(A). “Tax-exempt
income” does not include income from
discharge of indebtedness excluded
from income under section 108 because
such income is not permanently excludi-
ble from income in all circumstances in
which section 108 applies. One com-
mentator objected to this treatment of
section 108 income, arguing that such
income is tax-exempt and that applica-
tion of section 108 at the S corporation
level pursuant to section 108(d)(7)(A)
does not preclude the pass-through of
section 108 income. Another commen-
tator, however, agreed with the approach
taken by the regulations.
Treasury and the Service continue to
believe that the absence of a stock basis
increase for income of an S corporation
excluded under section 108(a) is consis-
tent with the legislative history of sec-
tion 108 and the specific rules that apply
to the discharge of indebtedness income
of S corporations. Accordingly, the
treatment of section 108 income is un-
changed in the final regulations.
10. Adjustment to Basis of Stock
Section 1367(a) and §1.1367-1 of the
proposed regulations prescribe the order
of adjustments required by subchapter S
to the basis of a shareholder’s stock in
an S corporation and the manner in
which those adjustments are made.
A commentator suggested that the
final regulations should provide that life
insurance premiums on policies owned
by the S corporation do not affect either
a shareholder’s basis in stock/debt or the
corporation’s accumulated adjustments
account (AAA). The commentator fur-
ther suggested that §1.1367-1(c)(2) (re-
lating to noncapital, nondeductible ex-
penses) be amended to make special
provision for accounts receivable when
debt is restored.
Because these comments relate to
provisions in §1.1367-1 that were not
affected by the amendments contained
in the proposed regulations, the com-
ments are not reflected in the final regu-
lations.
11. Adjustments Required Before Deter-
mining Tax Effect of Distribution.
Section 1.1368-2 of the proposed reg-
ulations provides rules for determining
the source of a distribution made by an S
corporation with respect to its stock and
the tax effect of the distribution to the
shareholders for taxable years of the
corporation beginning on or after Au-
gust 18, 1998.
One commentator interpreted
§1.1368-2(a)(5) of the proposed regula-
tions, which prescribes the order in
which adjustments are made to the AAA
for purposes of determining the source
of a distribution, as providing that the
AAA is adjusted in the same order as the
adjustments to the basis of a share of
stock under §1.1367-1 of the proposed
regulations. The commentator stated
that although the Small Business Job
Protection Act of 1996 (1996 Act)
changed the order of the adjustments to
the basis of a share of stock, the 1996
Act did not change the order of the ad-
justments to the AAA except in situa-
tions involving a net negative adjust-
ment (where the reductions in the
account for the taxable year exceed the
increases for the taxable year). When a
net negative adjustment occurs, the
AAA is adjusted to take into account
distributions before the AAA is adjusted
to take into account any net negative ad-
justment.
Consistent with the comment re-
ceived, the final regulations make clear
that except in situations involving a net
negative adjustment, the order of adjust-
ments to the AAA is not changed. Exam-
ples are added to the final regulations to
illustrate the effect of the 1996 Act on
the AAA ordering rules.
12. Transition Rule and Effective Date
sections 1367 and 1368.
Sections 1.1367-3 and 1.1368-4 of the
proposed regulations provide that the
amendments to the final regulations
under section 1367 and 1368 apply only
to taxable years of the corporation be-
ginning on or after August 18, 1998.
Commentators suggested that because
the amendments to sections 1367 and
1368 under the 1996 Act are effective
for taxable years beginning after De-
cember 31, 1996, the final regulations
should be effective, at least on an elec-
tive basis, for the period beginning from
the effective date of the 1996 Act and
ending on the effective date of the final
regulations.
Sections 1.1367-3 and 1.1368-4 of the
final regulations reflect this comment
and provide that for taxable years begin-
ning on or after January 1, 1997, and be-
fore August 18, 1998, the adjustments to
the basis of a shareholder’s stock and
the treatment of distributions by an S
corporation, respectively, must be deter-
mined in a reasonable manner, taking
into account the statute and the legisla-
tive history. Return positions consistent
with the final regulations will be consid-
ered reasonable.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assess-
ment is not required. It has also been de-
termined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions. It is hereby certified that the collec-
tion of information in these regulations
will not have a significant economic im-
pact on a substantial number of small en-
tities. This certification is based upon the
fact that these regulations do not impose a
collection of information that is not al-
ready required by the underlying statute
or the current regulations and reflected in
the appropriate forms. Therefore, a Regu-
latory Flexibility Analysis under the Reg-
ulatory Flexibility Act (5 U.S.C. chapter
6) is not required. Pursuant to section
7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding
these regulations was submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
Drafting Information
The principal authors of these final
regulations are Terri A. Belanger, Deane
M. Burke, and Brenda Stewart of the
Office of Chief Counsel (Passthroughs
and Special Industries), Internal Rev-
enue Service. However, other personnel
from the IRS and Treasury Department
participated in their development.
* * * * *

2000–2 I.R.B.257January 10, 2000
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Sections 1.1366-0 and 1.1366-1
are added, §1.1366-2 is revised, and
§§1.1366-3 through 1.1366-5 are added to
read as follows:
§1.1366-0 Table of contents.
The following table of contents is pro-
vided to facilitate the use of §§1.1366-1
through 1.1366-5:
§1.1366-1 Shareholder’s share of items
of an S corporation.
(a) Determination of shareholder’s tax li-
ability.
(1) In general.
(2) Separately stated items of income,
loss, deduction, or credit.
(3) Nonseparately computed income or
loss.
(4) Separate activities requirement.
(5) Aggregation of deductions or exclu-
sions for purposes of limitations.
(b) Character of items constituting pro
rata share.
(1) In general.
(2) Exception for contribution of noncap-
ital gain property.
(3) Exception for contribution of capital
loss property.
(c) Gross income of a shareholder.
(1) In general.
(2) Gross income for substantial omis-
sion of items.
(d) Shareholders holding stock subject to
community property laws.
(e) Net operating loss deduction of share-
holder of S corporation.
(f) Cross-reference.
§1.1366-2 Limitations on deduction of
passthrough items of an S corporation to
its shareholders.
(a) In general.
(1) Limitation on losses and deductions.
(2) Carryover of disallowance.
(3) Basis limitation amount.
(i) Stock portion.
(ii) Indebtedness portion.
(4) Limitation on losses and deductions
allocated to each item.
(5) Nontransferability of losses and de-
ductions.
(6) Basis of stock acquired by gift.
(b) Special rules for carryover of disal-
lowed losses and deductions to post-ter-
mination transition period described in
section 1377(b).
(1) In general.
(2) Limitation on losses and deductions.
(3) Limitation on losses and deductions
allocated to each item.
(4) Adjustment to the basis of stock.
(c) Carryover of disallowed losses and
deductions in the case of liquidations, re-
organizations, and divisions.
(1) Liquidations and reorganizations.
(2) Corporate separations to which sec-
tion 368(a)(1)(D) applies.
§1.1366-3 Treatment of family groups.
(a) In general.
(b) Examples.
§1.1366-4 Special rules limiting the
passthrough of certain items of an S cor-
poration to its shareholders.
(a) Passthrough inapplicable to section
34 credit.
(b) Reduction in passthrough for tax im-
posed on built-in gains.
(c) Reduction in passthrough for tax im-
posed on excess net passive income.
§1.1366-5 Effective date. §1.1366-1
Shareholder’s share of items of an S cor-
poration.
(a) Determination of shareholder’s tax
liability—(1) In general.An S corpora-
tion must report, and a shareholder is re-
quired to take into account in the share-
holder’s return, the shareholder’s pro rata
share, whether or not distributed, of the S
corporation’s items of income, loss, de-
duction, or credit described in paragraphs
(a)(2), (3), and (4) of this section. A
shareholder’s pro rata share is determined
in accordance with the provisions of sec-
tion 1377(a) and the regulations thereun-
der. The shareholder takes these items
into account in determining the share-
holder’s taxable income and tax liability
for the shareholder’s taxable year with or
within which the taxable year of the cor-
poration ends. If the shareholder dies (or
if the shareholder is an estate or trust and
the estate or trust terminates) before the
end of the taxable year of the corporation,
the shareholder’s pro rata share of these
items is taken into account on the share-
holder’s final return. For the limitation
on allowance of a shareholder’s pro rata
share of S corporation losses or deduc-
tions, see section 1366(d) and §1.1366-2.
(2) Separately stated items of income,
loss, deduction, or credit.Each share-
holder must take into account separately
the shareholder’s pro rata share of any
item of income (including tax-exempt in-
come), loss, deduction, or credit of the S
corporation that if separately taken into
account by any shareholder could affect
the shareholder’s tax liability for that tax-
able year differently than if the share-
holder did not take the item into account
separately. The separately stated items of
the S corporation include, but are not lim-
ited to, the following items—
(i) The corporation’s combined net
amount of gains and losses from sales or
exchanges of capital assets grouped by
applicable holding periods, by applicable
rate of tax under section 1(h), and by any
other classification that may be relevant
in determining the shareholder’s tax lia-
bility;
(ii) The corporation’s combined net
amount of gains and losses from sales or
exchanges of property described in sec-
tion 1231 (relating to property used in the
trade or business and involuntary conver-
sions), grouped by applicable holding pe-
riods, by applicable rate of tax under sec-
tion 1(h), and by any other classification
that may be relevant in determining the
shareholder’s tax liability;
(iii) Charitable contributions, grouped
by the percentage limitations of section
170(b), paid by the corporation within the
taxable year of the corporation;
(iv) The taxes described in section 901
that have been paid (or accrued) by the
corporation to foreign countries or to pos-
sessions of the United States;
(v) Each of the corporation’s separate
items involved in the determination of
credits against tax allowable under part
IV of subchapter A (section 21 and fol-
lowing) of the Internal Revenue Code,
except for any credit allowed under sec-
tion 34 (relating to certain uses of gaso-
line and special fuels);
(vi) Each of the corporation’s separate
items of gains and losses from wagering
transactions (section 165(d)); soil and

January 10, 20002582000–2 I.R.B.
water conservation expenditures (sec-
tion 175); deduction under an election to
expense certain depreciable business ex-
penses (section 179); medical, dental,
etc., expenses (section 213); the addi-
tional itemized deductions for individu-
als provided in part VII of subchapter B
(section 212 and following) of the Inter-
nal Revenue Code; and any other item-
ized deductions for which the limita-
tions on itemized deductions under
sections 67 or 68 applies;
(vii) Any of the corporation’s items of
portfolio income or loss, and expenses re-
lated thereto, as defined in the regulations
under section 469;
(viii) The corporation’s tax-exempt in-
come. For purposes of subchapter S, tax-
exempt income is income that is perma-
nently excludible from gross income in all
circumstances in which the applicable
provision of the Internal Revenue Code
applies. For example, income that is ex-
cludible from gross income under section
101 (certain death benefits) or section 103
(interest on state and local bonds) is tax-
exempt income, while income that is ex-
cludible from gross income under section
108 (income from discharge of indebted-
ness) or section 109 (improvements by
lessee on lessor’s property) is not tax-ex-
empt income;
(ix) The corporation’s adjustments de-
scribed in sections 56 and 58, and items
of tax preference described in section 57;
and
(x) Any item identified in guidance (in-
cluding forms and instructions) issued by
the Commissioner as an item required to
be separately stated under this paragraph
(a)(2).
(3) Nonseparately computed income or
loss.Each shareholder must take into ac-
count separately the shareholder’s pro
rata share of the nonseparately computed
income or loss of the S corporation. For
this purpose, nonseparately computed in-
come or loss means the corporation’s
gross income less the deductions allowed
to the corporation under chapter 1 of the
Internal Revenue Code, determined by
excluding any item requiring separate
computation under paragraph (a)(2) of
this section.
(4) Separate activities requirement. An
S corporation must report, and each
shareholder must take into account in the
shareholder’s return, the shareholder’s
pro rata share of an S corporation’s items
of income, loss, deduction, or credit de-
scribed in paragraphs (a)(2) and (3) of this
section for each of the corporation’s activ-
ities as defined in section 469 and the reg-
ulations thereunder.
(5) Aggregation of deductions or exclu-
sions for purposes of limitations—(i) In
general.A shareholder aggregates the
shareholder’s separate deductions or ex-
clusions with the shareholder’s pro rata
share of the S corporation’s separately
stated deductions or exclusions in deter-
mining the amount of any deduction or
exclusion allowable to the shareholder
under subtitle A of the Internal Revenue
Code as to which a limitation is imposed.
(ii) Example. The provisions of para-
graph (a)(5)(i) of this section are illus-
trated by the following example:
Example. In 1999, Corporation M, a calendar
year S corporation, purchases and places in service
section 179 property costing $10,000. Corporation
M elects to expense the entire cost of the property.
Shareholder A owns 50 percent of the stock of Cor-
poration M. Shareholder A’s pro rata share of this
item after Corporation M applies the section 179(b)
limitations is $5,000. Because the aggregate amount
of Shareholder A’s pro rata share and separately ac-
quired section 179 expense may not exceed $19,000
(the aggregate maximum cost that may be taken into
account under section 179(a) for the applicable tax-
able year), Shareholder A may elect to expense up to
$14,000 of separately acquired section 179 property
that is purchased and placed in service in 1999, sub-
ject to the limitations of section 179(b).
(b) Character of items constituting pro
rata share—(1) In general. Except as
provided in paragraph (b)(2) or (3) of this
section, the character of any item of in-
come, loss, deduction, or credit described
in section 1366(a)(1)(A) or (B) and para-
graph (a) of this section is determined for
the S corporation and retains that charac-
ter in the hands of the shareholder. For
example, if an S corporation has capital
gain on the sale or exchange of a capital
asset, a shareholder’s pro rata share of
that gain will also be characterized as a
capital gain regardless of whether the
shareholder is otherwise a dealer in that
type of property. Similarly, if an S corpo-
ration engages in an activity that is not for
profit (as defined in section 183), a share-
holder’s pro rata share of the S corpora-
tion’s deductions will be characterized as
not for profit. Also, if an S corporation
makes a charitable contribution to an or-
ganization qualifying under section
170(b)(1)(A), a shareholder’s pro rata
share of the S corporation’s charitable
contribution will be characterized as
made to an organization qualifying under
section 170(b)(1)(A).
(2) Exception for contribution of non-
capital gain property. If an S corporation
is formed or availed of by any shareholder
or group of shareholders for a principal
purpose of selling or exchanging con-
tributed property that in the hands of the
shareholder or shareholders would not
have produced capital gain if sold or ex-
changed by the shareholder or sharehold-
ers, then the gain on the sale or exchange
of the property recognized by the corpora-
tion is not treated as a capital gain.
(3) Exception for contribution of cap-
ital loss property.If an S corporation is
formed or availed of by any shareholder
or group of shareholders for a principal
purpose of selling or exchanging con-
tributed property that in the hands of the
shareholder or shareholders would have
produced capital loss if sold or ex-
changed by the shareholder or share-
holders, then the loss on the sale or ex-
change of the property recognized by
the corporation is treated as a capital
loss to the extent that, immediately be-
fore the contribution, the adjusted basis
of the property in the hands of the share-
holder or shareholders exceeded the fair
market value of the property.
(c) Gross income of a shareholder—(1)
In general
. Where it is necessary to de-
termine the amount or character of the
gross income of a shareholder, the share-
holder’s gross income includes the share-
holder’s pro rata share of the gross in-
come of the S corporation. The
shareholder’s pro rata share of the gross
income of the S corporation is the amount
of gross income of the corporation used in
deriving the shareholder’s pro rata share
of S corporation taxable income or loss
(including items described in section
1366(a)(1)(A) or (B) and paragraph (a) of
this section). For example, a shareholder
is required to include the shareholder’s
pro rata share of S corporation gross in-
come in computing the shareholder’s
gross income for the purposes of deter-
mining the necessity of filing a return
(section 6012(a)) and the shareholder’s
gross income derived from farming (sec-
tions 175 and 6654(i)).

2000–2 I.R.B.259January 10, 2000
(2) Gross income for substantial omis-
sion of items—(i) In general.For pur-
poses of determining the applicability of
the 6- year period of limitation on assess-
ment and collection provided in section
6501(e) (relating to omission of more
than 25 percent of gross income), a share-
holder’s gross income includes the share-
holder’s pro rata share of S corporation
gross income (as described in section
6501(e)(1)(A)(i)). In this respect, the
amount of S corporation gross income
used in deriving the shareholder’s pro rata
share of any item of S corporation in-
come, loss, deduction, or credit (as in-
cluded or disclosed in the shareholder’s
return) is considered as an amount of
gross income stated in the shareholder’s
return for purposes of section 6501(e).
(ii) Example. The following example
illustrates the provisions of paragraph
(c)(2)(i) of this section:
Example.Shareholder A, an individual, owns 25
percent of the stock of Corporation N, an S corpora-
tion that has $10,000 gross income and $2,000 taxable
income. A reports only $300 as A’s pro rata share of
N’s taxable income. A should have reported $500 as
A’s pro rata share of taxable income, derived from A’s
pro rata share, $2,500, of N’s gross income. Because
A’s return included only $300 without a disclosure
meeting the requirements of section 6501(e)(1)(A)(ii)
describing the difference of $200, A is regarded as
having reported on the return only $1,500 ($300/$500
of $2,500) as gross income from N.
(d) Shareholders holding stock subject
to community property laws.If a share-
holder holds S corporation stock that is
community property, then the share-
holder’s pro rata share of any item or
items listed in paragraphs (a)(2), (3), and
(4) of this section with respect to that
stock is reported by the husband and wife
in accordance with community property
rules.
(e) Net operating loss deduction of
shareholder of S corporation.For pur-
poses of determining a net operating loss
deduction under section 172, a share-
holder of an S corporation must take into
account the shareholder’s pro rata share
of items of income, loss, deduction, or
credit of the corporation. See section
1366(b) and paragraph (b) of this section
for rules on determining the character of
the items. In determining under section
172(d)(4) the nonbusiness deductions al-
lowable to a shareholder of an S corpora-
tion (arising from both corporation
sources and any other sources), the share-
holder separately takes into account the
shareholder’s pro rata share of the deduc-
tions of the corporation that are not attrib-
utable to a trade or business and combines
this amount with the shareholder’s non-
business deductions from any other
sources. The shareholder also separately
takes into account the shareholder’s pro
rata share of the gross income of the cor-
poration not derived from a trade or busi-
ness and combines this amount with the
shareholder’s nonbusiness income from
all other sources. See section 172 and the
regulations thereunder.
(f)Cross-reference. For rules relating
to the consistent tax treatment of subchap-
ter S items, see section 6037(c).
§1.1366-2 Limitations on deduction of
passthrough items of an S corporation to
its shareholders.
(a) In general—(1) Limitation on
losses and deductions.The aggregate
amount of losses and deductions taken
into account by a shareholder under
§1.1366-1(a)(2), (3), and (4) for any tax-
able year of an S corporation cannot ex-
ceed the sum of—
(i) The adjusted basis of the share-
holder’s stock in the corporation (as de-
termined under paragraph (a)(3)(i) of this
section); and
(ii) The adjusted basis of any indebted-
ness of the corporation to the shareholder
(as determined under paragraph (a)(3)(ii)
of this section).
(2) Carryover of disallowance.A
shareholder’s aggregate amount of losses
and deductions for a taxable year in ex-
cess of the sum of the adjusted basis of
the shareholder’s stock in an S corpora-
tion and of any indebtedness of the S cor-
poration to the shareholder is not allowed
for the taxable year. However, any disal-
lowed loss or deduction retains its charac-
ter and is treated as incurred by the corpo-
ration in the corporation’s first succeeding
taxable year, and subsequent taxable
years, with respect to the shareholder. For
rules on determining the adjusted bases of
stock of an S corporation and indebted-
ness of the corporation to the shareholder,
see paragraphs (a)(3)(i) and (ii) of this
section.
(3) Basis limitation amount—(i)
Stock portion. A shareholder generally
determines the adjusted basis of stock for
purposes of paragraphs (a)(1)(i) and (2) of
this section (limiting losses and deduc-
tions) by taking into account only in-
creases in basis under section 1367(a)(1)
for the taxable year and decreases in basis
under section 1367(a)(2)(A), (D) and (E)
(relating to distributions, noncapital,
nondeductible expenses, and certain oil
and gas depletion deductions) for the tax-
able year. In so determining this loss lim-
itation amount, the shareholder disregards
decreases in basis under section
1367(a)(2)(B) and (C) (for losses and de-
ductions, including losses and deductions
previously disallowed) for the taxable
year. However, if the shareholder has in
effect for the taxable year an election
under §1.1367-1(g) to decrease basis by
items of loss and deduction prior to de-
creasing basis by noncapital, nonde-
ductible expenses and certain oil and gas
depletion deductions, the shareholder also
disregards decreases in basis under sec-
tion 1367(a)(2)(D) and (E). This basis
limitation amount for stock is determined
at the time prescribed under §1.1367-
1(d)(1) for adjustments to the basis of
stock.
(ii)Indebtedness portion. A share-
holder determines the shareholder’s ad-
justed basis in indebtedness of the corpo-
ration for purposes of paragraphs
(a)(1)(ii) and (2) of this section (limiting
losses and deductions) without regard to
any adjustment under section
1367(b)(2)(A) for the taxable year. This
basis limitation amount for indebtedness
is determined at the time prescribed under
§1.1367-2(d)(1) for adjustments to the
basis of indebtedness.
(4) Limitation on losses and deductions
allocated to each item.If a shareholder’s
pro rata share of the aggregate amount of
losses and deductions specified in
§1.1366-1(a)(2), (3), and (4) exceeds the
sum of the adjusted basis of the share-
holder’s stock in the corporation (deter-
mined in accordance with paragraph
(a)(3)(i) of this section) and the adjusted
basis of any indebtedness of the corpora-
tion to the shareholder (determined in ac-
cordance with paragraph (a)(3)(ii) of this
section), then the limitation on losses and
deductions under section 1366(d)(1) must
be allocated among the shareholder’s pro
rata share of each loss or deduction. The
amount of the limitation allocated to any
loss or deduction is an amount that bears
the same ratio to the amount of the limita-

January 10, 20002602000–2 I.R.B.
tion as the loss or deduction bears to the
total of the losses and deductions. For
this purpose, the total of losses and de-
ductions for the taxable year is the sum of
the shareholder’s pro rata share of losses
and deductions for the taxable year, and
the losses and deductions disallowed and
carried forward from prior years pursuant
to section 1366(d)(2).
(5)Nontransferability of losses and de-
ductions.Any loss or deduction disal-
lowed under paragraph (a)(1) of this sec-
tion is personal to the shareholder and
cannot in any manner be transferred to an-
other person. If a shareholder transfers
some but not all of the shareholder’s stock
in the corporation, the amount of any dis-
allowed loss or deduction under this sec-
tion is not reduced and the transferee does
not acquire any portion of the disallowed
loss or deduction. If a shareholder trans-
fers all of the shareholder’s stock in the
corporation, any disallowed loss or de-
duction is permanently disallowed.
(6) Basis of stock acquired by gift.For
purposes of section 1366(d)(1)(A) and
paragraphs (a)(1)(i) and (2) of this sec-
tion, the basis of stock in a corporation
acquired by gift is the basis of the stock
that is used for purposes of determining
loss under section 1015(a).
(b) Special rules for carryover of disal-
lowed losses and deductions to post-ter-
mination transition period described in
section 1377(b)—(1) In general. If, for
the last taxable year of a corporation for
which it was an S corporation, a loss or
deduction was disallowed to a share-
holder by reason of the limitation in para-
graph (a) of this section, the loss or de-
duction is treated under section
1366(d)(3) as incurred by that shareholder
on the last day of any post-termination
transition period (within the meaning of
section 1377(b)).
(2) Limitation on losses and deduc-
tions. The aggregate amount of losses
and deductions taken into account by a
shareholder under paragraph (b)(1) of this
section cannot exceed the adjusted basis
of the shareholder’s stock in the corpora-
tion determined at the close of the last day
of the post-termination transition period.
For this purpose, the adjusted basis of a
shareholder’s stock in the corporation is
determined at the close of the last day of
the post-termination transition period
without regard to any reduction required
under paragraph (b)(4) of this section. If
a shareholder disposes of a share of stock
prior to the close of the last day of the
post-termination transition period, the ad-
justed basis of that share is its basis as of
the close of the day of disposition. Any
losses and deductions in excess of a
shareholder’s adjusted stock basis are per-
manently disallowed. For purposes of
section 1366(d)(3)(B) and this paragraph
(b)(2), the basis of stock in a corporation
acquired by gift is the basis of the stock
that is used for purposes of determining
loss under section 1015(a).
(3) Limitation on losses and deductions
allocated to each item. If the aggregate
amount of losses and deductions treated
as incurred by the shareholder under para-
graph (b)(1) of this section exceeds the
adjusted basis of the shareholder’s stock
determined under paragraph (b)(2) of this
section, the limitation on losses and de-
ductions under section 1366(d)(3)(B)
must be allocated among each loss or de-
duction. The amount of the limitation al-
located to each loss or deduction is an
amount that bears the same ratio to the
amount of the limitation as the amount of
each loss or deduction bears to the total of
all the losses and deductions.
(4) Adjustment to the basis of stock.
The shareholder’s basis in the stock of the
corporation is reduced by the amount al-
lowed as a deduction by reason of this
paragraph (b). For rules regarding adjust-
ments to the basis of a shareholder’s stock
in an S corporation, see §1.1367-1.
(c) Carryover of disallowed losses and
deductions in the case of liquidations, re-
organizations, and divisions—(1)Liqui-
dations and reorganizations.If a corpora-
tion acquires the assets of an S
corporation in a transaction to which sec-
tion 381(a) applies, any loss or deduction
disallowed under paragraph (a) of this
section with respect to a shareholder of
the distributor or transferor S corporation
is available to that shareholder as a share-
holder of the acquiring corporation.
Thus, where the acquiring corporation is
an S corporation, a loss or deduction of a
shareholder of the distributor or transferor
S corporation disallowed prior to or dur-
ing the taxable year of the transaction is
treated as incurred by the acquiring S cor-
poration with respect to that shareholder
if the shareholder is a shareholder of the
acquiring S corporation after the transac-
tion. Where the acquiring corporation is a
C corporation, a post-termination transi-
tion period arises the day after the last day
that an S corporation was in existence and
the rules provided in paragraph (b) of this
section apply with respect to any share-
holder of the acquired S corporation that
is also a shareholder of the acquiring C
corporation after the transaction. See the
special rules under section 1377 for the
availability of the post-termination transi-
tion period if the acquiring corporation is
a C corporation.
(2) Corporate separations to which
section 368(a)(1)(D) applies. If an S cor-
poration transfers a portion of its assets
constituting an active trade or business to
another corporation in a transaction to
which section 368(a)(1)(D) applies, and
immediately thereafter the stock and se-
curities of the controlled corporation are
distributed in a distribution or exchange
to which section 355 (or so much of sec-
tion 356 as relates to section 355) applies,
any loss or deduction disallowed under
paragraph (a) of this section with respect
to a shareholder of the distributing S cor-
poration immediately before the transac-
tion is allocated between the distributing
corporation and the controlled corpora-
tion with respect to the shareholder. Such
allocation shall be made according to any
reasonable method, including a method
based on the relative fair market value of
the shareholder’s stock in the distributing
and controlled corporations immediately
after the distribution, a method based on
the relative adjusted basis of the assets in
the distributing and controlled corpora-
tions immediately after the distribution,
or, in the case of losses and deductions
clearly attributable to either the distribut-
ing or controlled corporation, any method
that allocates such losses and deductions
accordingly.
§1.1366-3 Treatment of family groups.
(a) In general.Under section 1366(e),
if an individual, who is a member of the
family of one or more shareholders of an
S corporation, renders services for, or fur-
nishes capital to, the corporation without
receiving reasonable compensation, the
Commissioner shall prescribe adjust-
ments to those items taken into account
by the individual and the shareholders as
may be necessary to reflect the value of
the services rendered or capital furnished.
For these purposes, in determining the

2000–2 I.R.B.261January 10, 2000
reasonable value for services rendered, or
capital furnished, to the corporation, con-
sideration will be given to all the facts and
circumstances, including the amount that
ordinarily would be paid in order to ob-
tain comparable services or capital from a
person (other than a member of the fam-
ily) who is not a shareholder in the corpo-
ration. In addition, for purposes of sec-
tion 1366(e), if a member of the family of
one or more shareholders of the S corpo-
ration holds an interest in a passthrough
entity (e.g., a partnership, S corporation,
trust, or estate), that performs services for,
or furnishes capital to, the S corporation
without receiving reasonable compensa-
tion, the Commissioner shall prescribe
adjustments to the passthrough entity and
the corporation as may be necessary to re-
flect the value of the services rendered or
capital furnished. For purposes of section
1366(e), the term familyof any share-
holder includes only the shareholder’s
spouse, ancestors, lineal descendants, and
any trust for the primary benefit of any of
these persons.
(b) Examples.The provisions of this
section may be illustrated by the follow-
ing examples:
Example 1. The stock of an S corporation is
owned 50 percent by F and 50 percent by T, the
minor son of F. For the taxable year, the corporation
has items of taxable income equal to $70,000. Com-
pensation of $10,000 is paid by the corporation to F
for services rendered during the taxable year, and no
compensation is paid to T, who rendered no services.
Based on all the relevant facts and circumstances,
reasonable compensation for the services rendered
by F would be $30,000. In the discretion of the In-
ternal Revenue Service, up to an additional $20,000
of the $70,000 of the corporation’s taxable income,
for tax purposes, may be allocated to F as compensa-
tion for services rendered. If the Internal Revenue
Service allocates $20,000 of the corporation’s tax-
able income to F as compensation for services, tax-
able income of the corporation would be reduced by
$20,000 to $50,000, of which F and T each would be
allocated $25,000. F would have $30,000 of total
compensation paid by the corporation for services
rendered.
Example 2. The stock of an S corporation is
owned by A and B. For the taxable year, the corpo-
ration has paid compensation to a partnership that
rendered services to the corporation during the tax-
able year. The spouse of A is a partner in that part-
nership. Consequently, if based on all the relevant
facts and circumstances the partnership did not re-
ceive reasonable compensation for the services ren-
dered to the corporation, the Internal Revenue Ser-
vice, in its discretion, may make adjustments to
those items taken into account by the partnership
and the corporation as may be necessary to reflect
the value of the services rendered.
§1.1366-4 Special rules limiting the
passthrough of certain items of an S cor-
poration to its shareholders.
(a) Passthrough inapplicable to section
34 credit. Section 1.1366-1(a) does not
apply to any credit allowable under sec-
tion 34 (relating to certain uses of gaso-
line and special fuels).
(b) Reduction in passthrough for tax
imposed on built-in gains.For purposes
of §1.1366-1(a), if for any taxable year of
the S corporation a tax is imposed on the
corporation under section 1374, the
amount of the tax imposed is treated as a
loss sustained by the S corporation during
the taxable year. The character of the
deemed loss is determined by allocating
the loss proportionately among the net
recognized built-in gains giving rise to the
tax and attributing the character of each
net recognized built-in gain to the alloca-
ble portion of the loss.
(c) Reduction in passthrough for tax
imposed on excess net passive income.
For purposes of §1.1366-1(a), if for any
taxable year of the S corporation a tax is
imposed on the corporation under section
1375, each item of passive investment in-
come shall be reduced by an amount that
bears the same ratio to the amount of the
tax as the amount of the item bears to the
total net passive investment income for
that taxable year.
§1.1366-5 Effective date.
Sections 1.1366-1 through 1.1366-4
apply to taxable years of an S corporation
beginning on or after August 18, 1998.
Par. 3. Section 1.1367-0 is amended in
the table as follows:
1. The entries for §1.1367-1(e) through
(g) are revised.
2. The entries for §1.1367-1(h)
through (j) are added.
The additions and revisions read as fol-
lows:
§1.1367-0 Table of contents.
* * * * *
§1.1367-1 Adjustments to basis of share-
holder’s stock in an S corporation.
* * * * *
(e) Ordering rules for taxable years begin-
ning before January 1, 1997.
(f) Ordering rules for taxable years begin-
ning on or after
August 18, 1998.
(g) Elective ordering rule.
(h) Examples.
(i) [Reserved]
(j) Adjustments for items of income in re-
spect of a decedent.
* * * * *
Par. 4. Section 1.1367-1 is amended as
follows:
1. The paragraph heading and intro-
ductory text of paragraph (e) are revised.
2. Paragraphs (f) and (g) are redesig-
nated as paragraphs (g) and (h), respec-
tively.
3. New paragraph (f) is added.
4. The first and second sentences of
newly designated paragraph (g) are re-
vised.
5. Newly designated paragraph (h) is
amended as follows:
a. The heading for Example 1is re-
vised.
b. Example 2and Example 3are redes-
ignated as Example 3and Example 4,re-
spectively.
c. New Example 2is added.
d. The heading of newly designated
Example 4is revised.
e. Example 5is added.
6. Paragraph (i) is added and reserved
and paragraph (j) is added.
The additions and revisions read as fol-
lows:
§1.1367-1 Adjustments to basis of share-
holder’s stock in an S corporation.
* * * * *
(e) Ordering rules for taxable years be-
ginning before January 1, 1997. For any
taxable year of a corporation beginning
before January 1, 1997, except as pro-
vided in paragraph (g) of this section, the
adjustments required by section 1367(a)
are made in the following order—
* * * * *
(f) Ordering rules for taxable years be-
ginning on or after August 18, 1998. For
any taxable year of a corporation begin-
ning on or after August 18, 1998, except
as provided in paragraph (g) of this sec-
tion, the adjustments required by section
1367(a) are made in the following
order—
(1) Any increase in basis attributable to
the income items described in section
1367(a)(1)(A) and (B), and the excess of
the deductions for depletion described in
section 1367(a)(1)(C);

January 10, 20002622000–2 I.R.B.
(2) Any decrease in basis attributable to
a distribution by the corporation de-
scribed in section 1367(a)(2)(A);
(3) Any decrease in basis attributable
to noncapital, nondeductible expenses de-
scribed in section 1367(a)(2)(D), and the
oil and gas depletion deduction described
in section 1367(a)(2)(E); and
(4) Any decrease in basis attributable to
items of loss or deduction described in
section 1367(a)(2)(B) and (C).
(g) Elective ordering rule.A share-
holder may elect to decrease basis under
paragraph (e)(3) or (f)(4) of this section,
whichever applies, prior to decreasing
basis under paragraph (e)(2) or (f)(3) of
this section, whichever applies. If a
shareholder makes this election, any
amount described in paragraph (e)(2) or
(f)(3) of this section, whichever applies,
that is in excess of the shareholder’s basis
in stock and indebtedness is treated,
solely for purposes of this section, as an
amount described in paragraph (e)(2) or
(f)(3) of this section, whichever applies,
in the succeeding taxable year. * * *
(h) * * *
Example 1. Adjustments to basis of stock for tax-
able years beginning before January 1, 1997.* * *
Example 2. Adjustments to basis of stock for tax-
able years beginning on or after August 18, 1998.(i)
On December 31, 2001, A owns a block of 50 shares
of stock with an adjusted basis per share of $6 in
Corporation S. On December 31, 2001, A purchases
for $400 an additional block of 50 shares of stock
with an adjusted basis of $8 per share. Thus, A
holds 100 shares of stock for each day of the 2002
taxable year. For S’s 2002 taxable year, A’s pro rata
share of the amount of items described in section
1367(a)(1)(A) (relating to increases in basis of
stock) is $300, A’s pro rata share of the amount of
the items described in section 1367(a)(2)(B) (relat-
ing to decreases in basis of stock attributable to
items of loss and deduction) is $300, and A’s pro rata
share of the amount of the items described in section
1367(a)(2)(D) (relating to decreases in basis of stock
attributable to noncapital, nondeductible expenses)
is $200. S makes a distribution to A in the amount
of $100 during 2002.
(ii) Pursuant to the ordering rules of paragraph (f)
of this section, A first increases the basis of each
share of stock by $3 ($300/100 shares) and then de-
creases the basis of each share by $1 ($100/100
shares) for the distribution. A next decreases the
basis of each share by $2 ($200/100 shares) for the
noncapital, nondeductible expenses and then de-
creases the basis of each share by $3 ($300/100
shares) for the items of loss. Thus, on January 1,
2003, A has a basis of $3 per share in the original
block of 50 shares ($6 + $3 - $1 - $2 - $3) and a
basis of $5 per share in the second block of 100
shares ($8 + $3 - $1 - $2 - $3).
* * * * *
Example 4. Effects of section 1377(a)(2) election
and distribution on basis of stock for taxable years
beginning before January 1, 1997.* * *
Example 5. Effects of section 1377(a)(2) election
and distribution on basis of stock for taxable years
beginning on or after August 18, 1998.(i) The facts
are the same as in Example 4, except that all of the
events occur in 2001 rather than in 1994 and except
as follows: On June 30, 2001, B sells 25 shares of
her stock for $5,000 to D and 25 shares back to Cor-
poration S for $5,000. Under section 1377(a)(2)(B)
and §1.1377-1(b)(2), B and C are affected share-
holders because B has transferred shares to Corpora-
tion S. Pursuant to section 1377(a)(2)(A) and
§1.1377-1(b)(1), B and C, the affected shareholders,
and Corporation S agree to treat the taxable year
2001 as if it consisted of two separate taxable years
for all affected shareholders for the purposes set
forth in §1.1377-1(b)(3)(i).
(ii) On June 30, 2001, B and C, pursuant to the
ordering rules of paragraph (f)(1) of this section, in-
crease the basis of each share by $60 ($6,000/100
shares) for the nonseparately computed income.
Then B and C reduce the basis of each share by $120
($12,000/100 shares) for the distribution. Finally, B
and C decrease the basis of each share by $40
($4,000/100 shares) for the separately stated deduc-
tion item.
(iii) The basis of the stock of B is reduced from
$120 to $20 per share ($120 + $60 - $120 - $40).
Prior to accounting for the separately stated deduc-
tion item, the basis of the stock of C is reduced from
$80 to $20 ($80 + $60 - $120). Finally, because the
period from January 1 through June 30, 2001 is
treated under §1.1377-1(b)(3)(i) as a separate tax-
able year for purposes of making adjustments to the
basis of stock, under section 1366(d) and §1.1366-
2(a)(2), C may deduct only $20 per share of the re-
maining $40 of the separately stated deduction item,
and the basis of the stock of C is reduced from $20
per share to $0 per share. Under section 1366 and
§1.1366-2(a)(2), C’s remaining separately stated de-
duction item of $20 per share is treated as having
been incurred in the first succeeding taxable year of
Corporation S, which, for this purpose, begins on
July 1, 2001.
(i) [Reserved]
(j) Adjustments for items of income in
respect of a decedent.The basis deter-
mined under section 1014 of any stock in
an S corporation is reduced by the portion
of the value of the stock that is attribut-
able to items constituting income in re-
spect of a decedent. For the determina-
tion of items realized by an S corporation
constituting income in respect of a dece-
dent, see sections 1367(b)(4)(A) and 691
and applicable regulations thereunder.
For the determination of the allowance of
a deduction for the amount of estate tax
attributable to income in respect of a
decedent, see section 691(c) and applica-
ble regulations thereunder.
Par. 5. §1.1367-3 is revised to read as
follows:
§1.1367-3 Effective date and transition
rule.
Except for §1.1367-1(f), (h) Example 2
and Example 5, and (j), §§1.1367-1 and
1.1367-2 apply to taxable years of the
corporation beginning on or after January
1, 1994. Section 1.1367-1(f), (h) Exam-
ple 2and Example 5, and (j) apply only to
taxable years of the corporation beginning
on or after August 18, 1998. For taxable
years beginning before January 1, 1994,
and taxable years beginning on or after
January 1, 1997, and before August 18,
1998, the basis of a shareholder’s stock
must be determined in a reasonable man-
ner, taking into account the statute and
legislative history. Except for §1.1367-
1(f), (h) Example 2and Example 5, and
(j), return positions consistent with
§§1.1367-1 and 1.1367-2 are reasonable
for taxable years beginning before Janu-
ary 1, 1994. Return positions consistent
with §1.1367-1(f), (h) Example 2and Ex-
ample 5, and (j) are reasonable for taxable
years beginning on or after January 1,
1997, and before August 18, 1998.
Par. 6. Section 1.1368-0 is amended in
the table as follows:
1. The entry for §1.1368-1(e) is re-
vised and entries for §1.1368-1(e)(1) and
(2) are added.
2. The entry for §1.1368-2(a)(4) is re-
vised.
3. An entry for §1.1368-2(a)(5) is
added.
4. The entry for §1.1368-2(d) is re-
vised.
The additions and revisions read as fol-
lows:
§1.1368-0 Table of contents.
* * * * *
§1.1368-1 Distributions by S corpora-
tions.
* * * * *
(e) Certain adjustments taken into ac-
count.

2000–2 I.R.B.263January 10, 2000
(1) Taxable years beginning before Janu-
ary 1, 1997.
(2) Taxable years beginning on or after
August 18, 1998.
* * * * *
§1.1368-2 Accumulated adjustments ac-
count (AAA).
(a) * * *
(4) Ordering rules for the AAA for taxable
years beginning before January 1, 1997.
(5) Ordering rules for the AAA for taxable
years beginning on or after August 18,
1998.
* * * * *
(d) Adjustment in the case of redemp-
tions, liquidations, reorganizations, and
divisions.
* * * * *
Par. 7. Section 1.1368-1 is amended by
revising paragraphs (d)(1) and (e) to read
as follows:
§1.1368-1 Distributions by S corpora-
tions.
* * * * *
(d) S corporation with earnings and
profits—(1) General treatment of distrib-
ution.Except as provided in paragraph
(d)(2) of this section, a distribution made
with respect to its stock by an S corpora-
tion that has accumulated earnings and
profits as of the end of the taxable year of
the S corporation in which the distribution
is made is treated in the manner provided
in section 1368(c). See section 316 and
§1.316-2 for provisions relating to the al-
location of earnings and profits among
distributions.
* * * * *
(e) Certain adjustments taken into ac-
count—(1) Taxable years beginning be-
fore January 1, 1997. For any taxable
year of the corporation beginning before
January 1, 1997, paragraphs (c) and (d) of
this section are applied only after taking
into account—
(i) The adjustments to the basis of the
shares of a shareholder’s stock described
in section 1367 (without regard to section
1367(a)(2)(A) (relating to decreases at-
tributable to distributions not includible in
income)) for the S corporation’s taxable
year; and
(ii) The adjustments to the AAA re-
quired by section 1368(e)(1)(A) (but
without regard to the adjustments for dis-
tributions under §1.1368-2(a)(3)(iii)) for
the S corporation’s taxable year.
(2) Taxable years beginning on or after
August 18, 1998. For any taxable year of
the corporation beginning on or after Au-
gust 18, 1998, paragraphs (c) and (d) of
this section are applied only after taking
into account—
(i) The adjustments to the basis of the
shares of a shareholder’s stock described
in section 1367(a)(1) (relating to in-
creases in basis of stock) for the S corpo-
ration’s taxable year; and
(ii) The adjustments to the AAA re-
quired by section 1368(e)(1)(A) (but
without regard to the adjustments for dis-
tributions under §1.1368-2(a)(3)(iii)) for
the S corporation’s taxable year. Any net
negative adjustment (as defined in section
1368(e)(1)(C)(ii)) for the taxable year
shall not be taken into account.
* * * * *
Par. 8. Section 1.1368-2 is amended as
follows:
1. Paragraphs (a)(1) and (a)(3)(ii), and
the paragraph heading and introductory
text of paragraph (a)(4) are revised.
2. Paragraph (a)(5) is added.
3. The paragraph heading for para-
graph (d) is revised.
The additions and revisions read as fol-
lows:
§1.1368-2 Accumulated adjustments ac-
count (AAA).
(a) Accumulated adjustments
account—(1) In general. The accumu-
lated adjustments account is an account of
the S corporation and is not apportioned
among shareholders. The AAA is rele-
vant for all taxable years beginning on or
after January 1, 1983, for which the cor-
poration is an S corporation. On the first
day of the first year for which the corpo-
ration is an S corporation, the balance of
the AAA is zero. The AAA is increased in
the manner provided in paragraph (a)(2)
of this section and is decreased in the
manner provided in paragraph (a)(3) of
this section. For the adjustments to the
AAA in the case of redemptions, liquida-
tions, reorganizations, and corporate sep-
arations, see paragraph (d) of this section.
* * * * *
(3) * * *
(ii) Extent of allowable reduction. The
AAA may be decreased under paragraph
(a)(3)(i) of this section below zero. The
AAA is decreased by noncapital, nonde-
ductible expenses under paragraph
(a)(3)(i)(C) of this section even though a
portion of the noncapital, nondeductible
expenses is not taken into account by a
shareholder under §1.1367-1(g) (relating
to the elective ordering rule). The AAA is
also decreased by the entire amount of
any loss or deduction even though a por-
tion of the loss or deduction is not taken
into account by a shareholder under sec-
tion 1366(d)(1) or is otherwise not cur-
rently deductible under the Internal Rev-
enue Code. However, in any subsequent
taxable year in which the loss, deduction,
or noncapital, nondeductible expense is
treated as incurred by the corporation
with respect to the shareholder under sec-
tion 1366(d)(2) or §1.1367-1(g) (or in
which the loss or deduction is otherwise
allowed to the shareholder), no further ad-
justment is made to the AAA.
* * * * *
(4) Ordering rules for the AAA for tax-
able years beginning before January 1,
1997. For any taxable year beginning be-
fore January 1, 1997, the adjustments to
the AAA are made in the following
order—
* * * * *
(5) Ordering rules for the AAA for tax-
able years beginning on or after August
18, 1998.For any taxable year of the S
corporation beginning on or after August
18, 1998, the adjustments to the AAA are
made in the following order—
(i) The AAA is increased under para-
graph (a)(2) of this section before it is de-
creased under paragraph (a)(3)(i) of this
section for the taxable year;
(ii) The AAA is decreased under para-
graph (a)(3)(i) of this section (without
taking into account any net negative ad-
justment (as defined in section
1368(e)(1)(C)(ii)) before it is decreased
under paragraph (a)(3)(iii) of this section;
(iii) The AAA is decreased (but not
below zero) by any portion of an ordinary
distribution to which section 1368(b) or
(c)(1) applies;
(iv) The AAA is decreased by any net
negative adjustment (as defined in section
1368(e)(1)(C)(ii)); and
(v) The AAA is adjusted (whether neg-
ative or positive) for redemption distribu-
tions under paragraph (d)(1) of this sec-
tion.
* * * * *
(d) Adjustment in the case of redemp-
tions, liquidations, reorganizations, and
divisions* * *
* * * * *

January 10, 20002642000–2 I.R.B.
Par. 9. Section 1368-3 is amended as
follows:
1. The heading for Example 1is re-
vised.
2. Example 3through Example 6are re-
designated as Example 6 through Exam-
ple 9, respectively.
3. Example 2is redesignated as Exam-
ple 3.
4. The heading for newly redesignated
Example 3is revised.
5. New Example 2, Example 4, and Ex-
ample 5are added.
The revisions and additions read as fol-
lows:
§1.1368-3 Examples.
* * * * *
Example 1. Distributions by S corporations
without C corporation earnings and profits for tax-
able years beginning before January 1, 1997.* * *
Example 2. Distributions by S corporations
without earnings and profits for taxable years begin-
ning on or after August 18, 1998. (i) Corporation S,
an S corporation, has no earnings and profits as of
January 1, 2001, the first day of its 2001 taxable
year. S’s sole shareholder, A, holds 10 shares of S
stock with a basis of $1 per share as of that date. On
March 1, 2001, S makes a distribution of $38 to A.
The balance in Corporation S’s AAA is $100. For
S’s 2001 taxable year, A’s pro rata share of the
amount of the items described in section 1367(a)(1)
(relating to increases in basis of stock) is $50. A’s
pro rata share of the amount of the items described
in sections 1367(a)(2)(B) through (D) (relating to
decreases in basis of stock for items other than dis-
tributions) is $26, $20 of which is attributable to
items described in section 1367(a)(2)(B) and (C)
and $6 of which is attributable to items described in
section 1367(a)(2)(D) (relating to decreases in basis
attributable to noncapital, nondeductible expenses).
(ii) Under section 1368(d)(1) and §1.1368-
1(e)(1) and (2), the adjustments to the basis of A’s
stock in S described in sections 1367(a)(1) are made
before the distribution rules of section 1368 are ap-
plied. Thus, A’s basis per share in the stock is $6.00
($1 + [$50/10]) before taking into account the distri-
bution. Under section 1367(a)(2)(A), the basis of
A’s stock is decreased by distributions to A that are
not includible in A’s income. Under §1.1367-
1(c)(3), the amount of the distribution that is attrib-
utable to each share of A’s stock is $3.80 ($38 distri-
bution/10 shares). Thus, A’s basis per share in the
stock is $2.20 ($6.00 - $3.80), after taking into ac-
count the distribution. Under section 1367(a)(2)(D),
the basis of each share of A’s stock in S after taking
into account the distribution, $2.20, is decreased by
$.60 ($6 noncapital, nondeductible expenses/10).
Thus, A’s basis per share after taking into account
the nondeductible, noncapital expenses is $1.60.
Under section 1367(a)(2)(B) and (C), A’s basis per
share is further decreased by $2 ($20 items de-
scribed in section 1367(a)(2)(B) and (C)/10 shares).
However, basis may not be reduced below zero.
Therefore, the basis of each share of A’s stock is re-
duced to zero. As of January 1, 2002, A has a basis
of $0 in his shares of S stock. Pursuant to section
1366(d)(2), the $.40 of loss in excess of A’s basis in
each of his shares of S stock is treated as incurred by
the corporation in the succeeding taxable year with
respect to A.
Example 3. Distributions by S corporations with
C corporation earnings and profits for taxable years
beginning before January 1, 1997.* * *
Example 4. Distributions by S corporations with
earnings and profits and no net negative adjustment
for taxable years beginning on or after August 18,
1998.(i) Corporation S, an S corporation, has accu-
mulated earnings and profits of $1,000 and a balance
in the AAA of $2,000 on January 1, 2001. S’s sole
shareholder B holds 100 shares of stock with a basis
of $20 per share as of January 1, 2001. On April 1,
2001, S makes a distribution of $1,500 to B. B’s pro
rata share of the income earned by S during 2001 is
$2,000 and B’s pro rata share of S’s losses is $1,500.
For the taxable year ending December 31, 2001, S
does not have a net negative adjustment as defined
in section 1368(e)(1)(C). S does not make the elec-
tion under section 1368(e)(3) and §1.1368-1(f)(2) to
distribute its earnings and profits before its AAA.
(ii) The AAA is increased from $2,000 to $4,000
for the $2,000 of income earned during the 2001 tax-
able year. The AAA is decreased from $4,000 to
$2,500 for the $1,500 of losses. The AAA is de-
creased from $2,500 to $1,000 for the portion of the
distribution ($1,500) to B that does not exceed the
AAA.
(iii) As of December 31, 2001, B’s basis in his
stock is $10 ($20 + $20 ($2,000 income/100 shares)
- $15 ($1,500 distribution/100 shares) - $15 ($1,500
loss/100 shares).
Example 5. Distributions by S corporations with
earnings and profits and net negative adjustment for
taxable years beginning on or after August 18, 1998.
(i) Corporation S, an S corporation, has accumulated
earnings and profits of $1,000 and a balance in the
AAA of $2,000 on January 1, 2001. S’s sole share-
holder B holds 100 shares of stock with a basis of
$20 per share as of January 1, 2001. On April 1,
2001, S makes a distribution of $2,000 to B. B’s pro
rata share of the income earned by S during 2001 is
$2,000 and B’s pro rata share of S’s losses is $3,500.
For the taxable year ending December 31, 2001, S
has a net negative adjustment as defined in section
1368(e)(1)(C). S does not make the election under
section 1368(e)(3) and §1.1368-1(f)(2) to distribute
its earnings and profits before its AAA.
(ii) The AAA is increased from $2,000 to $4,000
for the $2,000 of income earned during the 2001 tax-
able year. Because under section
1368(e)(1)(C)(ii)and §1.1368-2(a)(ii), the net nega-
tive adjustment is not taken into account, the AAA is
decreased from $4,000 to $2,000 for the portion of
the losses ($2,000) that does not exceed the income
earned during the 2001 taxable year. The AAA is re-
duced from $2,000 to zero for the portion of the dis-
tribution to B ($2,000) that does not exceed the
AAA. The AAA is decreased from zero to a negative
$1,500 for the portion of the $3,500 of loss that ex-
ceeds the $2,000 of income earned during the 2001
taxable year.
(iii) Under §1.1367-1(c)(1), the basis of a share-
holder’s share in an S corporation stock may not be
reduced below zero. Accordingly, as of December
31, 2001, B’s basis per share in his stock is zero ($20
+ $20 income - $20 distribution - $35 loss). Pur-
suant to section 1366(d)(2), the $15 of loss in excess
of B’s basis in each of his shares of S stock is treated
as incurred by the corporation in the succeeding tax-
able year with respect to B.
* * * * *
Par. 10. §1.1368-4 is revised to read as
follows:
§1.1368-4 Effective date and transition
rule.
Except for §§1.1368-1(e)(2), 1.1368-
2(a)(5), and 1.1368-3 Example 2, Exam-
ple 4, and Example 5, §§1.1368-1,
1.1368-2, and 1.1368-3 apply to taxable
years of the corporation beginning on or
after January 1, 1994. Section 1.1368-
1(e)(2), §1.1368-2(a)(5), and §1.1368-3
Example 2, Example 4, and Example 5
apply only to taxable years of the corpora-
tion beginning on or after August 18,
1998. For taxable years beginning before
January 1, 1994, and taxable years begin-
ning on or after January 1, 1997, and be-
fore August 18, 1998, the treatment of
distributions by an S corporation to its
shareholders must be determined in a rea-
sonable manner, taking into account the
statute and legislative history. Except
with regard to the deemed dividend rule
under §1.1368-1(f)(3), §1.1368-1(e)(2),
§1.1368-2(a)(5), and §1.1368-3 Example
2, Example 4, and Example 5, return posi-
tions consistent with §§1.1368-1, 1.1368-
2, and 1.1368-3 are reasonable for taxable
years beginning before January 1, 1994.
Return positions consistent with
§§1.1368-1(e)(2), 1.1368-2(a)(5), and
1.1368-3 Example 2, Example 4, and Ex-
ample 5are reasonable for taxable years
beginning on or after January 1, 1997, and

2000–2 I.R.B.265January 10, 2000
before August 18, 1998.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 11. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 12. In §602.101, paragraph (b) is
amended by adding the entry for 1.1366-1
to the table as follows:
§602.101 OMB Control numbers.
* * * * *
(b) * * *
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
Approved December 13, 1999.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the office of the Federal Register on De-
cember 21, 1999, 8:45 a.m., and published in the
issue of the Federal Register for December 22, 1999,
64 F.R. 71641)
CFR part or section whereCurrent OMB
identified and describedcontrol No.
* * * * *
1.1366-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1613
* * * * *
Section 1397E.—Credit to
Holders of Qualified Zone
Academy Bonds
What is the 2000 qualified zone academy bond
national limitation for each State, the District of Co-
lumbia, and the possessions of the United States?
See Rev. Proc. 2000–10, page 287.
Section 6038.—Information
Reporting With Respect to
Certain Foreign Corporations and
Partnerships
26 CFR 1.6038–2: Information returns required of
United States persons with respect to annual
accounting periods of certain foreign corporations
beginning after December 31, 1962.
T.D. 8850
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Information Reporting With
Respect to Certain Foreign
Partnerships and Certain
Foreign Corporations
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations under section 6038 of
the Internal Revenue Code relating to
information reporting requirements for
United States persons owning interests
in controlled foreign partnerships
(CFPs). This document also contains
amendments to the final regulations
under section 6038 relating to the re-
porting requirements of U.S. sharehold-
ers of certain foreign corporations and
amendments to the final regulations
under section 6038B relating to the re-
porting requirements with respect to
transfers of property to foreign partner-
ships and to foreign corporations.
DATES: Effective Dates:These regula-
tions are effective December 29, 1999,
except that §1.6038B-2(a)(5) is effective
January 1, 2000.
Applicability Dates: For dates of ap-
plicability, see §§1.6038-2(l), 1.6038-3(l),
and 1.6038B-2(c)(4) and (j)(3).
FOR FURTHER INFORMATION CON-
TACT: Eliana Dolgoff, (202) 622-3860
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information con-
tained in these final regulations have been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control
numbers 1545-1615, 1545-1617, and
1545-1317. Responses to these collec-
tions of information are mandatory.
An agency may not conduct or spon-
sor, and a person is not required to re-
spond to, a collection of information un-
less it displays a valid control number
assigned by the Office of Management
and Budget.
The burden of complying with the col-
lection of information required to be re-
ported on Form 8865 is reflected in the
burden for Form 8865.
The burden of complying with the col-
lection of information required to be re-
ported on Form 5471 is reflected in the
burden for Form 5471.
The burden of complying with the col-
lection of information required to be re-
ported on Form 926 is reflected in the
burden for Form 926.
The estimated annual burden per respon-
dent of complying with the collection of in-
formation in §1.6038-3(c)(1)(ii)(B) and
(2)(ii)(B) varies from .5 hours to 1.5 hours,
depending on individual circumstances,
with an estimated average of 1 hour.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to the
Internal Revenue Service, Attn: IRS Re-
ports Clearance Officer, OP:FS:FP, Wash-
ington, DC 20224, and to the Office of

January 10, 20002662000–2 I.R.B.
Management and Budget, Attn: Desk
Officer of the Department of the Treasury,
Office of Information and Regulatory Af-
fairs, Washington, DC 20503.
Books or records relating to this collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
On September 9, 1998, the IRS pub-
lished in the Federal Register(63 FR
48144 (REG–118966–97, 1998–39 I.R.B.
29)) proposed regulations relating to the re-
porting requirements under section 6038 of
United States persons that are direct or indi-
rect partners of CFPs. A public hearing on
the proposed regulations was held on No-
vember 10, 1998, even though no requests
to speak at the hearing were received.
Though no comments were made at the
hearing, written comments were received.
After consideration of all of the written
comments, the proposed regulations under
section 6038 are adopted as revised by this
Treasury decision. The revisions are dis-
cussed in the Summary of Public Com-
ments and Explanation of Revisions section
of this preamble. This document also con-
tains amendments to certain other final reg-
ulations. These amendments are also dis-
cussed below.
Summary of Public Comments and
Explanation of Revisions
A. General Comments Regarding the
Proposed Section 6038 CFP Regulations
Some commentators suggested that the
final regulations should exempt state and
local government employee retirement
plans from the section 6038 reporting re-
quirements. The final regulations provide
that trusts relating to state and local govern-
ment employee retirement plans are not re-
quired to report under section 6038, unless
required to do so in the instructions to Form
8865, “Return of U.S. Persons with Re-
spect to Certain Foreign Partnerships.”
One commentator asserted that the rea-
sonable cause exception to the section
6038 penalties appears to apply only to
failures to file Form 8865 and therefore
would not protect a taxpayer who files an
incomplete Form 8865 because the tax-
payer was unable to obtain all the re-
quired information from the foreign part-
nership. The reasonable cause exception
has been modified to make clear that it
applies to both a failure to file Form 8865
and to a failure to submit all information
required to be submitted.
Commentators requested that the final
regulations provide that the section 6038
penalties do not apply when there is
minor noncompliance with the reporting
requirements under section 6038. The
commentators expressed concern that tax-
payers will be subject to penalties for
small discrepancies in the information re-
ported and suggested that the penalties
apply only if there is a substantial failure
to report the required information, or if
materially false or inaccurate information
is submitted. Because the IRS and Trea-
sury believe adding such a standard might
encourage taxpayers to submit incomplete
Forms 8865, the standard was not added
to the final regulations. A taxpayer may,
nonetheless, avoid application of the sec-
tion 6038 penalties because of minor non-
compliance with the section 6038 report-
ing requirements by demonstrating
reasonable cause. See §1.6038-3(k)(4).
Commentators also requested that the
IRS add additional, specific reasonable
cause exceptions to the section 6038 penal-
ties. For example, one commentator re-
quested a specific exception be provided
for controlling ten-percent partners (see de-
finition in §1.6038-3(a)(2)) that are unable
to obtain all information required to be re-
ported by controlling ten-percent partners.
The final regulations do not contain addi-
tional, specific reasonable cause excep-
tions. Whether there is reasonable cause
depends on all the facts and circumstances
of the particular case. Any person who is
unable to obtain information may apply for
a reasonable cause determination specific
to that person’s situation.
Finally, a commentator asked that in
the case of an affiliated group of corpora-
tions filing a consolidated income tax re-
turn, the final regulations not require the
members to file separate Forms 8865 if
one member of the group files Form
8865. The final regulations adopt this
recommendation. The common parent
corporation of an affiliated group of cor-
porations filing a consolidated income tax
return may file one Form 8865 on behalf
of all other members of the group re-
quired to file Form 8865 pursuant to sec-
tion 6038 with respect to a particular for-
eign partnership.
B. Section 6038/Section 6031 Overlap.
Some commentators requested that the
final regulations address the potential over-
lap between section 6031 and section 6038.
In general, section 6031(e) provides that a
foreign partnership must file Form 1065,
“U.S. Partnership Return of Income,” if it
has gross income derived from sources
within the United States or gross income
that is effectively connected with the con-
duct of a trade or business within the United
States. Section 6038 provides generally that
a U.S. partner of a foreign partnership must
file Form 8865 with respect to that partner-
ship if the partner individually, or collec-
tively with other ten- percent or greater U.S.
partners, owns more than a fifty-percent in-
terest in the partnership. Therefore, in some
cases, both Forms 1065 and 8865 would be
required to be filed with regard to the same
partnership for the same tax year of the part-
nership. Although the two forms are not
identical, and one is filed by the partnership
while the other is filed by the relevant part-
ners, the information required by the two
forms is substantially the same.
Additionally, some confusion may re-
sult from the fact that the two forms con-
tain similarly titled schedules. In particu-
lar, each form has a Schedule K-1 on
which information about a partner’s dis-
tributive share of partnership income, de-
ductions, etc., is to be reported. The IRS
is working to eliminate discrepancies be-
tween the two schedules. However, even
if the discrepancies are eliminated, it is
still possible the two schedules will not
contain identical information because one
schedule will be prepared by a partner and
one will be prepared by the partnership.
In response to the comments that the
overlap between section 6031 and section
6038 reporting will be burdensome to tax-
payers when both sets of requirements
apply, and to help avoid any confusion on
the part of taxpayers with respect to
which Schedule K-1 they should use to
compute their tax liabilities, the final sec-
tion 6038 regulations reduce the burden
imposed by section 6038 in the case of an
overlap. They provide that if a foreign
partnership completes and files Form
1065, a U.S. person required to report
under section 6038 must use a copy of the
filed Form 1065, including the Schedules
K-1, in conjunction with fulfilling the

2000–2 I.R.B.267January 10, 2000
person’s section 6038 reporting obliga-
tion. Specifically, the instructions to
Form 8865 will state which schedules on
Form 1065 are considered equivalent to
schedules on Form 8865. A U.S. partner
must attach to the partner’s Form 8865 a
copy of the Form 1065 schedules that are
considered equivalent to the schedules the
partner is required to complete on Form
8865 as a controlling fifty-percent partner
(see definition in §1.6038-3(a)(1)) or as a
controlling ten-percent partner. A partner
should not complete a schedule on Form
8865 when the partner attaches a copy of
the equivalent Form 1065 schedule to its
Form 8865. Should a schedule on Form
8865 ask for information that is not re-
quired to be reported on the equivalent
Form 1065 schedule, the partner is not re-
quired to report that information on its
Form 8865 if a copy of the completed
equivalent Form 1065 schedule is at-
tached to its Form 8865. A partner attach-
ing copies of schedules from Form 1065
to its Form 8865 must still complete the
parts of Form 8865 that the person is re-
quired to complete as a controlling fifty-
percent partner, or as a controlling ten-
percent partner, and for which there is no
equivalent Form 1065 schedule (for ex-
ample, a partner must still complete the
first page of Form 8865 and certain
schedules on page two of the form).
An example of how a person will use a
completed Form 1065 to fulfill its section
6038 filing obligation is as follows. Section
1.6038-3(g)(2)(iii) requires a controlling
fifty-percent partner to report aggregate in-
formation about the partners’ distributive
shares of income, gain, losses, deductions
and credits. Such information is reported on
Schedule K of Form 8865. The same infor-
mation is also required to be submitted on
Schedule K of Form 1065. The instructions
to Form 8865 will provide that Schedules K
on Forms 1065 and 8865 are equivalent.
Accordingly, if the partnership completes
and files a Form 1065, a controlling fifty-
percent partner filing Form 8865 must attach
a copy of the Schedule K from the Form
1065 to the partner’s Form 8865 and should
not complete Schedule K on Form 8865.
The partner must also attach all other Form
1065 schedules that are considered equiva-
lent to Form 8865 schedules that the partner
must complete as a controlling fifty-percent
partner. Additionally, the partner must still
complete page one of Form 8865 and Sched-
ules A ”Constructive Ownership of Partner-
ship Interest,” A-1 “Certain Partners of For-
eign Partnership,” A-2 “Affiliation Sched-
ule,” and N “Transactions Between
Controlled Foreign Partnership and Partners
or Other Related Entities” of Form 8865.
Similarly, a controlling ten-percent
partner must submit on Schedule K-1 of
Form 8865 a statement of the income,
gain, losses, deductions and credits allo-
cated to the partner’s direct interest in the
partnership. See §1.6038-3(g)(1)(i). The
same information is also required to be re-
ported on Schedule K-1 of Form 1065.
Therefore, if the partnership completes
and files Form 1065, the partner must at-
tach to its Form 8865 a copy of its Sched-
ule K-1 from the Form 1065 completed
by the partnership and should not com-
plete Schedule K-1 on Form 8865. The
partner is still required to complete the
portions of pages one and two of Form
8865 applicable to controlling ten-percent
partners, as well as Schedule N.
Another comment asserted that the pro-
posed regulations imposed an excessive
reporting burden on taxpayers and that
they had the effect of nullifying the sec-
tion 6031(e) limitation on reporting re-
quired of foreign partnerships. The com-
ment suggested that the IRS require only
those items specifically enumerated in
section 6038(a)(1) to be reported under
section 6038.
Section 6038 grants the IRS authority
to require taxpayers to submit more than
the items enumerated in section
6038(a)(1). Section 6038 provides that
the Secretary may require the furnishing
of any other information that is similar or
related in nature to that specified in the
first sentence of section 6038(a)(1), or
which the Secretary determines to be ap-
propriate to carry out the provision of
Title 26. The IRS has determined that all
of the information that the final section
6038 regulations require taxpayers to sub-
mit is necessary for the IRS to carry out
the provisions of Title 26.
Additionally, as explained above, section
6031(e) and section 6038 differ with re-
spect to whom they require to report and
when the reporting obligation applies. Sec-
tion 6031(e) applies only to the require-
ment that a Form 1065 be filed, to the ap-
plication of the TEFRA partnership-level
audit procedures, and to the requirement
that a partnership report information about
its operations, even when there is limited
U.S. ownership in the partnership. In con-
trast, section 6038 requires certain U.S.
partners to report information when the for-
eign partnership in which they own an in-
terest has substantial U.S. ownership. Sec-
tion 6031(e) was added to the Internal
Revenue Code at the same time that section
6038 was amended to apply to CFPs. See
Taxpayer Relief Act of 1997, Public Law
105-34, sections 1141-1142 (111 Stat.
983)(1997). Therefore, rather than intend-
ing section 6031(e) to limit the amount of
information required to be reported pur-
suant to section 6038, Congress intended
the two provisions to work together to en-
sure that the IRS receives sufficient infor-
mation about foreign partnerships.
C. Tiered Partnerships
Commentators requested that section
6038 reporting apply only to first-tier
CFPs, i.e., section 6038 reporting should
only be required of U.S. persons with re-
spect to foreign partnerships in which they
own a direct interest. However, section
6038(e)(3)(B) provides that rules similar to
the rules of section 267(c) shall apply when
determining whether a person owns a fifty-
percent interest in a foreign partnership.
Additionally, the statute does not require
that a U.S. person own its interest in the
CFP directly. Therefore, the final regula-
tions require section 6038 reporting of
United States persons whose ownership in-
terests are entirely the result of constructive
ownership from other persons.
Nevertheless, certain exceptions and
modifications to this rule may apply. Per-
sons that do not own direct interests may
qualify for a reduced reporting obligation
pursuant to the exception for constructive
owners in §1.6038-3(c)(2). Additionally,
certain information required by the final
section 6038 regulations must be submit-
ted only if the partner owns a direct inter-
est in the foreign partnership. For exam-
ple, §1.6038-3(g)(1)(i) provides that the
person reporting under section 6038 must
provide a statement of the income, gain,
losses, deductions and credits allocated to
that person’s direct interest in the partner-
ship. Accordingly, if a person is reporting
under section 6038 but owns no direct in-
terest in the partnership, that person will
not have to submit information under
§1.6038-3(g)(1)(i). Finally, the final reg-
ulations require attribution from nonresi-
dent alien family members only if the per-

January 10, 20002682000–2 I.R.B.
son to whom the interest is being attrib-
uted already owns a direct or indirect
(under the rules of section 267(c)(1) or
(5)) interest in the partnership. See
§1.6038-3(b)(4).
D. Failure to Recognize That an Arrange-
ment is a Partnership or That a Partner-
ship is a Foreign Partnership
Commentators expressed concern that
taxpayers might fail to report under sec-
tion 6038 because they failed to recognize
that their arrangement constituted a part-
nership. Additionally, if no entity is
formed under foreign law, but a partner-
ship is determined to exist, it may be dif-
ficult to determine whether the partner-
ship is foreign or domestic. Some
commentators recommended that the IRS
exclude partnerships not formed under a
foreign law statute from the reporting re-
quirements, subject to an anti-abuse rule.
The final regulations do not adopt this
recommendation and additional guidance
on these issues is beyond the scope of this
document. They do, however, provide
that the section 6038 reporting require-
ments do not apply to any United States
person with respect to a foreign partner-
ship that has validly elected (or is deemed
to have elected) to be excluded from the
application of subchapter K. See
§1.6038-3(e). Additionally, a taxpayer
that does not comply with section 6038
because it mistakenly concluded that its
arrangement was not a partnership, or that
it was not a foreign partnership, may
apply for a reasonable cause determina-
tion. See §1.6038-3(k)(4).
E. Section 6038 (CFPs) Effective Date.
Section 1.6038-3 is applicable to CFP
tax years ending on or after December 31,
2000. United States persons are not re-
quired to report under section 6038 for
CFP tax years ending before December
31, 2000.
F. Availability of Form 8865.
A United States person required to re-
port information pursuant to section 6038
must do so by completing and filing Form
8865. A final version of Form 8865 will
be released prior to January 1, 2000. Tax-
payers will be able to download a copy of
the form and its instructions from the IRS
Internet website located at www.irs.us-
treas.gov.
G. Clarification of Section 6501(c)(8).
Section 6501(c)(8) provides that in the
case of information required to be re-
ported under section 6038, 6038A,
6038B, 6046, 6046A, or 6048, the time
for assessment of any tax imposed by
Title 26 with respect to any event or pe-
riod to which such information relates
shall not expire before the date that is
three years after the date on which the
Secretary is furnished the information re-
quired to be reported under such section.
Taxpayers have expressed uncertainty
about the application of this rule in the
context of a failure to properly report in-
formation required under sections 6038,
6038B, or 6046A, with respect to an inter-
est in a foreign corporation or a foreign
partnership, as applicable. The IRS and
Treasury wish to clarify that if a U.S. per-
son fails to comply with sections 6038,
6038B, or 6046A, the extended statute of
limitations provided by section
6501(c)(8) shall apply only to the tax con-
sequences related to the information re-
quired to be reported under the relevant
reporting section and not to all transac-
tions within the U.S. person’s tax year at
issue. For example, if a U.S. person with
a calendar tax year fails to comply with
section 6038 for a controlled foreign part-
nership’s 2001 calendar tax year, section
6501(c)(8) will only extend the statute of
limitations applicable to the U.S. person’s
2001 tax year with respect to any tax con-
sequences associated with the U.S. per-
son’s interest in the foreign partnership
during the partnership’s 2001 tax year.
H. Amendment to Final Section 6038
Foreign Corporation Regulations
In order to reduce the burden that sec-
tion 6038 imposes on taxpayers, this doc-
ument also amends the final regulations
under section 6038 applicable to share-
holders of certain foreign corporations.
The regulations provide that if a United
States person does not own a direct or in-
direct interest in the foreign corporation,
but is attributed an interest from a nonres-
ident alien, the person is not required to
report under section 6038. This amend-
ment is effective for tax years of foreign
corporations ending on or after December
29, 1999.
I. Amendments to Final Section 6038B
Regulations Applicable to Transfers of
Property to Foreign Partnerships
On February 5, 1999, the IRS pub-
lished in the Federal Registerfinal regu-
lations under section 6038B relating to
the information reporting requirements
for certain contributions of property by
United States persons to foreign partner-
ships. See T.D. 8817, 1999–8 I.R.B. 51
(64 FR 5713). This document makes sev-
eral amendments to those final regula-
tions. Each amendment either reduces the
burden that section 6038B imposes on
taxpayers, or does not affect the burden
imposed by section 6038B.
First, the amount of information re-
quired to be submitted by a person report-
ing a transfer of property to a foreign part-
nership is reduced. Rather than submit
the names and addresses of all the foreign
partnership’s partners, the person report-
ing the transfer (the transferor) must pro-
vide only the names and addresses of the
United States partners that owned a ten-
percent or greater direct interest in the
foreign partnership during the transferor’s
tax year in which the reportable transfer
occurred, and the names and addresses of
any other United States or foreign persons
that were direct partners in the partnership
during that tax year and that were related
to the transferor under section 6038B dur-
ing that tax year. A person who trans-
ferred solely cash and who did not own a
ten-percent or greater interest after the
transfer is still not required to report the
names and addresses of any of the foreign
partnership’s other partners. This amend-
ment applies to tax years of U.S. persons
required to report under section 6038B
beginning on or after January 1, 2000.
Second, this document changes the time
for filing Form 8865 to report a transfer to a
foreign partnership in certain instances.
Currently, §1.6038B-2(a)(5)(ii) provides
that if a United States person required to re-
port a transfer to a foreign partnership is
also required to report pursuant to section
6038 for the period in which the transfer oc-
curred, then the United States person must
report the transfer on the Form 8865 com-
pleted for the partnership’s tax year in
which the transfer occurred. This document
deletes the section 6038B/section 6038
overlap rule, so that a United States person
must always report with its tax return for a
particular tax year all of its section 6038B
transfers that took place during that year, re-
gardless of whether any of the transfers oc-
curred during a period for which section
6038 reporting is also required. This
amendment applies to tax years of U.S. per-
sons required to report under section 6038B
beginning on or after January 1, 2000.

2000–2 I.R.B.269January 10, 2000
The following example illustrates this
amendment. Assume the tax year of
FPS, a foreign partnership, ends on Sept
30. US, a United States person and cal-
endar year taxpayer, owns a sixty- per-
cent interest in FPSand therefore is a
controlling fifty- percent partner of FPS.
Accordingly, USmust report under sec-
tion 6038 with respect to FPS. On Octo-
ber 15, 2001, UStransfers property to
FPSin a section 721 transaction. USis
required to report this transfer under
section 6038B because USowns at least
a ten-percent interest in the partnership
immediately after the transfer. See
§1.6038B-2(a)(1)(i). Under the existing
section 6038B regulations, USis re-
quired to report the October 15, 2001
property transfer on the Form 8865 for
FPS’s tax year ending September 30,
2002, that will be filed with US’s 2002
income tax return.
Under the amendments to section
6038B contained in this document, US
must attach to its 2001 income tax return
a Form 8865 on which is reported the
October 15, 2001 property transfer and
information about FPSfor FPS’s tax
year ending September 30, 2001. As-
suming USis also a controlling fifty-
percent partner during FPS’s tax year
ending September 30, 2002, when US
files its 2002 income tax return, US
must attach to that return Form 8865 on
which is reported information about
FPSfor FPS’s tax year ending Septem-
ber 30, 2002. USshould not report the
October 15, 2001, property transfer on
the Form 8865 filed with US’s 2002 in-
come tax return.
The third and final amendment to the
section 6038B regulations provides an
additional opportunity for United States
persons to timely report certain transfers
to foreign partnerships. Even if not re-
ported in accordance with the rules pro-
vided in §1.6038B-2(a)(5) or (j)(1) or
(2), a transfer to a foreign partnership
that occurred before January 1, 2000,
will nevertheless be considered timely
reported if the transferor reports it on a
Form 8865 attached to an amended tax
return for the transferor’s tax year in
which the transfer occurred, provided
such amended return is filed no later
than September 15, 2000.
Additionally, since issuing the section
6038B regulations in February 1999,
certain tax-exempt organizations have
contacted the IRS and Treasury to re-
quest that they be specifically excluded
from the obligation under section 6038B
to report their property transfers to for-
eign partnerships. The IRS and Trea-
sury invite comments regarding the ex-
tent to which section 6038B reporting
should be required of tax-exempt orga-
nizations.
J.Amendment to Final Section 6038B
Regulations Applicable to Transfers of
Property to Foreign Corporations
This document makes one amendment
to the final section 6038B regulations
governing the reporting requirements
with respect to transfers to foreign cor-
porations. The amendment reduces the
burden that section 6038B imposes on
taxpayers.
Pursuant to §1.367(a)-3(c)(8), section
367(a) does not apply to a domestic cor-
poration’s transfer of its own stock or se-
curities in connection with the perfor-
mance of services, if the transfer is
considered to be to a foreign corporation
solely by reason of §1.83-6(d)(1). Sec-
tion 1.83-6(d)(1) provides that if a share-
holder of a corporation transfers property
to an employee of such corporation in
consideration of services performed for
the corporation, the transaction is consid-
ered to be a contribution of such property
to the capital of such corporation by the
shareholder, and immediately thereafter a
transfer of such property by the latter cor-
poration to the employee.
The final regulations under section
6038B do not contain an exception to
the reporting requirements that corre-
sponds to the rule in §1.367(a)-3(c)(8).
Therefore, a transfer by a domestic cor-
poration of its stock or securities to an
employee of the domestic corporation’s
foreign subsidiary may be excluded
from the application of section 367(a),
yet still reportable under section 6038B.
This document provides that such a
transfer is not required to be reported
under section 6038B if the transfer is
considered to be to a foreign corporation
solely by reason of §1.83-6(d)(1) and
the fair market value of the property
transferred did not exceed $100,000.
This amendment is effective as if it had
been included in TD 8770 (63 FR
33550), and therefore applies to trans-
fers occurring on or after July 20, 1998.
Special Analyses
It has been determined that these
final regulations are not a significant
regulatory action as defined in Execu-
tive Order 12866. Therefore, a regula-
tory assessment is not required. It has
also been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these final regulations. It is hereby
certified that the collections of infor-
mation contained in these final regula-
tions will not have a significant eco-
nomic impact on a substantial number
of small entities. This certification is
based on the fact that the number of
small entities that will be required to
file the form is not substantial. Accord-
ingly, a Regulatory Flexibility Analysis
under the Regulatory Flexibility Act (5
U.S.C. chapter 6) is not required. Pur-
suant to section 7805(f) of the Internal
Revenue Code, these regulations were
submitted to the Chief Counsel for Ad-
vocacy of the Small Business Adminis-
tration for comment on their impact on
small business.
Drafting Information
The principal author of these regula-
tions is Eliana Dolgoff, Office of the As-
sociate Chief Counsel (International).
However, other personnel from the IRS
and the Treasury Department participated
in their development.
* * * * *
Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Par. 1. The authority citation for part 1
is amended by adding entries in numerical
order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.6038-2 also issued under 26
U.S.C. 6038.
Section 1.6038-3 also issued under 26
U.S.C. 6038. * * *
Par. 2. In §1.367(a)-3, paragraph (c)(8)
is amended by adding a sentence to the
end of the paragraph to read as follows:
§1.367(a)-3 Treatment of transfers of
stock or securities to foreign corpora-
tions.
* * * * *

January 10, 20002702000–2 I.R.B.
(c) * * *
(8) * * * The transfer may still, how-
ever, be reportable under section 6038B.
See §1.6038B-1(b)(2)(i)(A)(4) and
(b)(2)(i)(B)(4).
* * * * *
Par. 3. Section 1.6038-2 is amended as
follows:
1. A sentence is added to the end of
paragraph (j)(2)(i)(C).
2. Paragraph (l) is added.
The revised and added provisions read
as follows:
§1.6038-2 Information returns required of
United States persons with respect to an-
nual accounting periods of certain for-
eign corporations beginning after Decem-
ber 31, 1962.
* * * * *
(j) * * *
(2) * * *
(i) * * *
(C) * * * (For a rule regarding attribu-
tion from a nonresident alien, see para-
graph (l) of this section).
* * * * *
(l) Other persons excepted from filing.
For tax years of foreign corporations end-
ing on or after December 29, 1999, any
person required to furnish information
under this section with respect to a for-
eign corporation does not have to furnish
that information if the following condi-
tions are met—
(1) Such person does not own a direct
or indirect interest in the foreign corpora-
tion; and
(2) Such person is required to furnish
information solely by reason of attribu-
tion of stock ownership from a nonresi-
dent alien(s) under paragraph (c) of this
section.
Par. 4. Section 1.6038-3 is added to
read as follows:
§1.6038-3 Information returns required of
certain United States persons with respect
to controlled foreign partnerships
(CFPs).
(a) Persons required to make return—
(1) Controlling fifty- percent partners.
The term controlling fifty-percent partner
means a United States person that con-
trolled (as defined in paragraph (b)(1) of
this section) the foreign partnership at any
time during the partnership’s tax year (as
defined in paragraph (b)(8) of this sec-
tion). Except as provided in paragraph
(c), (d), or (e) of this section, for each tax
year of a foreign partnership during which
the partnership has one or more control-
ling fifty-percent partners, each control-
ling fifty-percent partner must complete
and file Form 8865, “Return of U.S. Per-
sons With Respect To Certain Foreign
Partnerships,” containing the information
described in paragraph (g) of this section.
(2) Controlling ten-percent partners. If
at any point during a foreign partnership’s
tax year (as defined in paragraph (b)(8)
of this section) a United States person
owned a ten- percent or greater interest in
the partnership while the partnership was
controlled by United States persons own-
ing ten- percent or greater interests, such
United States person is a controlling ten-
percent partner. See paragraph (b)(1) of
this section for the definition of control.
However, a United States person is not a
controlling ten-percent partner with re-
spect to a particular foreign partnership
for a particular tax year of the foreign
partnership if at any point during that year
the partnership had a controlling fifty-per-
cent partner, as defined in paragraph
(a)(1) of this section. Except as provided
in paragraph (c), (d), or (e) of this section,
for each tax year of a partnership during
which the partnership has controlling ten-
percent partners, each controlling ten-per-
cent partner must complete and file Form
8865 containing the information de-
scribed in paragraph (g)(1) of this section.
(3) Separate returns for each partner-
ship.A United States person required to
report under this paragraph (a) must file a
separate Form 8865 for each foreign part-
nership with respect to which the person
is a controlling fifty-percent partner or a
controlling ten-percent partner.
(b) Ownership determinations and def-
initions—(1) Control. Control of a for-
eign partnership is ownership of more
than a fifty-percent interest in the partner-
ship.
(2) Fifty-percent interest. A fifty-per-
cent interest in a partnership is an interest
equal to fifty percent of the capital inter-
est in such partnership, an interest equal
to fifty percent of the profits interest in
such partnership, or an interest to which
fifty percent of the deductions or losses of
such partnership are allocated.
(3) Ten-percent interest. A ten-percent
interest in a partnership is an interest
equal to ten percent of the capital interest
in such partnership, an interest equal to
ten percent of the profits interest in such
partnership, or an interest to which ten
percent of the deductions or losses of such
partnership are allocated.
(4) Constructive ownership rules. For
purposes of determining an interest in a
partnership, the constructive ownership
rules of section 267(c) (other than section
267(c)(3)) apply, taking into account that
such rules refer to corporations and not to
partnerships. However, an interest will be
attributed from a nonresident alien under
the family attribution rules of section
267(c)(2) and (4) only if the person to
whom the interest is attributed owns a di-
rect or indirect (under the rules of
267(c)(1) or (5)) interest in the foreign
partnership.
(5) Determination of amount of interest.
Whether a person owns a fifty-percent in-
terest, or a ten-percent interest, as de-
scribed in paragraphs (b)(2) and (3) of this
section, is determined for each tax year of
the foreign partnership by reference to the
agreement of the partners relating to such
interests during that tax year.
(6) Definition of United States person.
The term United States personis defined
in section 7701(a)(30).
(7) Definition of a foreign partnership.
A foreign partnership is a partnership de-
scribed in section 7701(a)(5).
(8) Tax year of a foreign partnership.
The tax year of a foreign partnership is
determined under section 706.
(9) Examples. The rules of paragraph
(a) of this section and this paragraph (b)
are illustrated by the following examples:
Example 1. Sole U.S. partner does not own more
than a fifty-percent interest.No United States per-
son owns any interest (directly or constructively) in
FPS, a foreign partnership whose tax year under sec-
tion 706 is the calendar year. On January 1, 2001,
US, a United States person with the calendar year as
its tax year, contributes property to FPSin exchange
for a 40% interest in a section 721 transaction. No
United States persons acquire directly or construc-
tively any other interests in FPSduring FPS’s 2001
tax year. USis not a controlling fifty-percent partner
during FPS’s 2001 tax year. USdid not own during
that tax year, either directly or constructively, more
than a 50% interest in the partnership under para-
graphs (b)(2) and (4) of this section. Also, USis not
a controlling ten-percent partner; although US
owned a 10% or greater interest, USpersons owning
at least 10% interests did not control FPS. There-
fore, USdoes not have to file with its 2001 income
tax return a Form 8865 with respect to FPSunder

2000–2 I.R.B.271January 10, 2000
section 6038. (But see section 6038B for the report-
ing obligations of USwith respect to its transfer of
property to FPSand section 6046A for the reporting
obligation of USwith respect to its acquisition of an
interest in FPS. See also §1.6046A- 1(e)(1) regard-
ing the overlap between sections 6038B and
6046A).
Example 2. Controlling ten-percent partners.
Assume the same facts as in Example 1. In addition,
on January 1, 2002, US1, a United States person un-
related to USand a calendar year taxpayer, pur-
chases a 15% interest in FPSfrom a foreign partner
of FPS. Neither USnor US1is a controlling fifty-
percent partner during FPS’s 2002 tax year because
neither one owns more than a 50% percent interest
in FPSduring that year. However, USand US1are
controlling ten-percent partners for that year be-
cause each owns at least a 10% interest (USowns a
40% interest and US1owns a 15% interest) and to-
gether they control FPSbecause collectively they
own more than a 50% interest in FPS. As control-
ling ten-percent partners, under section 6038, each is
required to file a Form 8865 with its 2002 income
tax return. (US1must also report its acquisition of
the 15% interest in FPSunder section 6046A on its
Form 8865 filed with its 2002 income tax return.)
Example 3. Constructive ownership rules. As-
sume the same facts as in Example 2. In addition, on
January 1, 2003, US2, a United States person and the
brother of US, purchases 50% of the stock of FC, a
foreign corporation. FCowns a 20% interest in
FPS. Thus, under sections 6038(e)(3) and
267(c)(1), US2indirectly owns a 10% interest in
FPS(10% is US2’s proportionate share of FC’s 20%
interest in FPS), and under sections 6038(e)(3) and
267(c)(2), US2is attributed US’s 40% interest. Ad-
ditionally, USdirectly owns a 40% interest in FPS
and is attributed US2’s 10% interest pursuant to sec-
tion 6038(e)(3) and section 267(c)(2). Therefore,
US2is considered to own a 50% interest (10% indi-
rectly and 40% from US) in FPS, and USis consid-
ered to own a 50% interest in FPS(40% directly and
10% from US2). FPShas no controlling fifty-per-
cent partners, because neither US, US1, nor US2,
owns a greater than 50% interest. However, US,
US1, and US2are each controlling ten- percent part-
ners and each must file Form 8865 pursuant to sec-
tion 6038 for FPS’s 2003 tax year ending December
31, 2003. Each must attach Form 8865 to its tax re-
turn for its 2003 tax year.
Example 4. Controlling fifty-percent partners.
Assume the same facts as in Example 3. In addition,
on June 1, 2004, USacquires an additional 1% direct
interest in FPS. US is now a controlling fifty-per-
cent partner of FPS, because USowns a 41% inter-
est directly and a 10% interest constructively from
US2. US2is also a controlling fifty-percent partner,
because US2owns 10% indirectly and 41% con-
structively from US. Both USand US2are required
to file Form 8865 containing all the information re-
quired to be submitted by controlling fifty-percent
partners. (But see paragraph (c)(1) of this section,
which contains filing exceptions when there are
multiple controlling fifty-percent partners). US1is
no longer a controlling ten-percent partner because
FPSnow has at least one controlling fifty-percent
partner, and US1does not qualify as a controlling
fifty-percent partner. Therefore, US1is not required
to file Form 8865 under section 6038.
Example 5. Constructive ownership from a non-
resident alien. US, a United States person, does not
own directly or constructively an interest in FPS, a
foreign partnership. The tax year of FPSis the calen-
dar year. NRA, a nonresident alien, is the mother of
US. In 2002, NRAacquires a 55% interest in FPS.
Because USowns neither a direct nor a constructive
interest in FPSunder sections 6038(e)(3) and
267(c)(1) or (5), NRA’s interest is not attributed to
USunder sections 6038(e)(3) and 267(c)(2). If in
2003 NRAbecomes a United States person, NRA’s
interest will be attributed to US. However, USis ex-
cused from filing Form 8865 if USsatisfies the re-
quirements of the constructive owners exception in
paragraph (c)(2) of this section. In 2003, NRAis a
controlling fifty-percent partner and must file a Form
8865 under section 6038 for FPS’s 2003 tax year.
(c) Exceptions when more than one
United States person is required to file
Form 8865 pursuant to section 6038—(1)
Multiple controlling fifty-percent
partners—(i) In general. If, with respect
to the same foreign partnership for the
same tax year, more than one United
States person is a controlling fifty- per-
cent partner, then in lieu of each control-
ling fifty-percent partner filing a separate
Form 8865, only one Form 8865 from one
of the controlling fifty-percent partners is
required, provided all of the requirements
of paragraph (c)(1)(ii) of this section are
satisfied. A person that is a controlling
fifty-percent partner solely because of an
interest to which deductions or losses are
allocated may file the single return only if
there is no United States person that is a
controlling fifty-percent partner by reason
of an interest in capital or profits.
(ii) Requirements—(A) The person un-
dertaking the filing obligation must file
Form 8865 with that person’s income tax
return in the manner provided by Form
8865 and the accompanying instructions.
The return must contain all of the infor-
mation that would have been required to
be reported by this section if each control-
ling fifty-percent partner had filed its own
Form 8865.
(B) Any controlling fifty-percent part-
ner not filing Form 8865 must file with its
income tax return a statement titled “Con-
trolled Foreign Partnership Reporting”
containing the following information—
(1) A statement that the person quali-
fied as a controlling fifty-percent partner,
but is not submitting Form 8865 pursuant
to the multiple controlling fifty-percent
partners exception;
(2) The name, address, and taxpayer
identification number (if any) of the for-
eign partnership of which the person qual-
ified as a controlling fifty-percent partner;
(3) A representation that the filing re-
quirement has been or will be satisfied;
(4) The name and address of the person
filing the single return;
(5) The Internal Revenue Service Cen-
ter where the single return is required to
be filed; and
(6) Any additional information that
Form 8865 and the accompanying in-
structions require.
(iii) Penalties. If the requirements
listed in paragraph (c)(1)(ii) of this section
are not satisfied, a United States person
that did not file a Form 8865 pursuant to
this paragraph will be subject to the penal-
ties in paragraph (k) of this section, unless
the reasonable cause provision in para-
graph (k)(4) of this section is satisfied.
(2) Certain constructive owners ex-
cepted from furnishing information—(i) In
general. A United States person that does
not own a direct interest in the foreign part-
nership and that is required to file Form
8865 under this section solely by reason of
constructive ownership from a United
States person(s) pursuant to paragraph
(b)(4) of this section (an indirect partner) is
not required to file Form 8865 if all of the
requirements listed in paragraph (c)(2)(ii)
of this section are met.
(ii) Requirements—(A) The United
States person(s) whose interest the indi-
rect partner constructively owns reports
all the information such person(s) is re-
quired to submit under this section, unless
such person also is required to file solely
by reason of constructive ownership from
a United States person(s) pursuant to
paragraph (b)(4) of this section, or an-
other person reports the information pur-
suant to paragraph (c)(1) of this section.
(B) The indirect partner files with its
income tax return a statement titled “Con-

January 10, 20002722000–2 I.R.B.
trolled Foreign Partnership Reporting”
containing the following information—
(1) A representation that the indirect
partner was required to file Form 8865,
but is not doing so pursuant to the con-
structive owners exception;
(2) The names and addresses of the
United States persons whose interests the
indirect partner constructively owns;
(3) The name and address of the foreign
partnership with respect to which the indi-
rect partner would have had to have filed
Form 8865 but for this exception; and
(4) Any additional information that
Form 8865 and the accompanying in-
structions require.
(iii) Penalties. A United States person
that pursuant to this paragraph (c)(2)
does not file a return will be subject to the
penalties in paragraph (k) of this section if
the requirements listed in paragraph
(c)(2)(ii) of this section are not satisfied,
unless such failure is due to reasonable
cause, as defined in paragraph (k)(4) of
this section.
(iv) Overlap with multiple controlling
fifty-percent partners exception—(A) If a
United States person qualifies for both the
exception in paragraph (c)(1) of this sec-
tion and the exception in this paragraph
(c)(2), such person may only utilize the
multiple controlling fifty-percent partners
exception in paragraph (c)(1) of this sec-
tion to avoid filing Form 8865.
(B) Example. The following example
illustrates the operation of this paragraph
(c)(2)(iv):
Example. USis a U.S. citizen. USowns 100% of
the stock of DC, a domestic corporation. DCowns a
60% direct interest in FPS, a foreign partnership.
DCand USare the only U.S. persons that own inter-
ests directly or constructively in FPS. DCowns di-
rectly a greater than 50% interest in FPS. UScon-
structively owns DC’s interest pursuant to sections
6038(e)(3) and 267(c)(1). Therefore, both DCand
USare controlling fifty-percent partners. USquali-
fies for both the exception in paragraph (c)(1) of this
section (multiple controlling fifty-percent partners)
and the exception in paragraph (c)(2) of this section
(constructive owner exception). USmay only utilize
the paragraph (c)(1) exception to avoid its filing
obligation. Accordingly, DCmay file a single Form
8865 on behalf of USand itself. However, that form
must contain all the information that would have
been submitted had DCand USeach submitted a
separate Form 8865.
(3) Members of an affiliated group of
corporations filing a consolidated return.
If one or more members of an affiliated
group of corporations filing a consoli-
dated return are required under section
6038 to file a Form 8865 for a particular
foreign partnership, the common parent
corporation may file one Form 8865 on
behalf of all of the members of the group
required to report under section 6038.
Except with respect to group members
who also qualify under the exception in
paragraph (c)(2) of this section, the Form
8865 must contain all the information that
would have been required to be submitted
if each group member were required to
file its own Form 8865.
(d) Exception for certain trusts. Trusts
relating to state and local government em-
ployee retirement plans are not required
to report under this section, unless the in-
structions to Form 8865 provide other-
wise.
(e) Reporting under this section not re-
quired with respect to partnerships ex-
cluded from the application of subchapter
K. The reporting requirements of this sec-
tion will not apply to any United States
person in respect of an eligible partner-
ship as described in §1.761-2(a) if such
partnership has validly elected to be ex-
cluded from all of the provisions of sub-
chapter K of chapter 1 of the Internal
Revenue Code in the manner specified in
§1.761-2(b)(2)(i), or such partnership is
deemed to have elected to be excluded
from all of the provisions of subchapter K
of chapter 1 of the Internal Revenue Code
in accordance with the provisions of
§1.761-2(b)(2)(ii).
(f) Period covered by return. The in-
formation required under this section
must be furnished for the tax year of the
foreign partnership ending with or within
the United States person’s tax year. See
section 706 for rules regarding tax years
of partnerships.
(g) Contents of return—(1) Informa-
tion required to be submitted by control-
ling fifty-percent partners and controlling
ten-percent partners. All controlling
fifty-percent partners and all controlling
ten-percent partners must submit the fol-
lowing information on Form 8865 in the
form and manner and to the extent pre-
scribed by Form 8865 and its instruc-
tions—
(i) A statement of the income, gain,
losses, deductions and credits allocated to
the direct interest in the partnership of the
person reporting under section 6038;
(ii) A list of all partnerships (foreign or
domestic) in which the foreign partner-
ship owned a direct interest, or owned a
constructive interest of ten percent of
more under the rules of section 267(c)(1)
or (5), during the partnership’s tax year
for which the Form 8865 is being filed;
(iii) Information about all foreign enti-
ties that were disregarded as entities sepa-
rate from their owner under §§301.7701-2
and 301.7701-3 that were owned by the
foreign partnership during the partner-
ship’s tax year for which the Form 8865 is
being filed;
(iv) A summary of the transactions that
took place during the partnership’s tax
year between the partnership and the per-
son filing the return, between the partner-
ship and any other partnership of which
the person filing the return is a controlling
fifty-percent partner, and between the
partnership and any corporation con-
trolled (under section 6038(e)(2) and the
regulations thereunder) by the person fil-
ing the return; and
(v) Any other information that Form
8865 or its accompanying instructions re-
quire to be submitted.
(2) Additional information required to
be submitted by controlling fifty-percent
partners. In addition to the information
required pursuant to paragraph (g)(1) of
this section, controlling fifty-percent part-
ners must also submit the following infor-
mation in the form and manner and to the
extent required by Form 8865 and its in-
structions—
(i) A list of the names, addresses and tax
identification numbers (if any) of each
United States person that owned a direct in-
terest of ten percent or more in the partner-
ship during the partnership’s tax year, and
of each United States and foreign person
whose interests in the partnership the con-
trolling fifty-percent partner constructively
owned under paragraph (b)(4) of this sec-
tion during the partnership’s tax year;
(ii) A list of transactions between the
partnership and any United States person
owning at the time of the transaction at
least a 10-percent direct interest (as de-
fined in paragraph (b)(3) of this section)
in the foreign partnership;
(iii) A statement of the aggregate of the
partners’ distributive shares of items of in-
come, gain, losses, deductions and credits;
(iv) A statement of income, gain,

2000–2 I.R.B.273January 10, 2000
losses, deductions and credits allocated to
each United States person holding a direct
interest in the foreign partnership of ten
percent or more; and
(v) Any other information
Form 8865 or its accompanying instruc-
tions require controlling fifty-percent
partners to submit.
(h) Method of reporting. Except as
otherwise provided on Form 8865 or the
accompanying instructions, all amounts
required to be furnished on Form 8865
must be expressed in United States dol-
lars. All statements required on or with
Form 8865 pursuant to this section must
be in English.
(i) Time and place for filing return—
(1) In general. Form 8865 must be filed
with the United States person’s income
tax return on or before the due date (in-
cluding extensions) of that return. If the
United States person is not required to file
an income tax return for its tax year with
which or within which the foreign part-
nership’s tax year ends, but is required to
file an information return for that year
(for example, Form 1065, “U.S. Partner-
ship Return of Income,” or Form 990,
“Return of Organization Exempt from In-
come Tax”), the Form 8865 must be filed
with the United States person’s informa-
tion return filed on or before the due date
(including extensions) of that return.
(2) Duplicate return. If required by
the instructions to Form 8865, a duplicate
Form 8865 (including attachments and
schedules) must also be filed.
(j) Overlap with section 6031—(1) In
general. A partner may be required to file
Form 8865 under this section and the for-
eign partnership in which it is a partner
may also be required to file a Form 1065
under section 6031(e) for the same part-
nership tax year. However, if a foreign
partnership completes and files Form
1065, the United States partner must use a
copy of the relevant parts of Form 1065 to
fulfill certain of its filing obligations
under section 6038. Specifically, instead
of completing the Form 8865 schedules
that the person would otherwise be re-
quired to complete as a controlling fifty-
percent or a controlling ten-percent part-
ner, the person must instead attach to its
Form 8865 copies of the relevant sched-
ules from Form 1065 that the instructions
to Form 8865 state are considered equiva-
lent to schedules on Form 8865. Should a
schedule on Form 8865 ask for informa-
tion that is not required to be reported on
the equivalent Form 1065 schedule, the
partner is not required to report that infor-
mation on its Form 8865 if a copy of the
completed equivalent Form 1065 sched-
ule is attached to its Form 8865. A person
attaching copies of schedules from Form
1065 to its Form 8865 must still complete
the parts of Form 8865 that the person is
required to complete as a controlling
fifty-percent partner, or a controlling ten-
percent partner, and for which there is no
equivalent Form 1065 schedule (for ex-
ample, the first page of Form 8865).
(2) Example. The following example
illustrates the application of this para-
graph (j):
Example. US, a United States citizen, owns a 55%
interest in FPS, a foreign partnership and calendar
year taxpayer. Because USowns more than a 50% in-
terest in FPS, USis a controlling fifty-percent partner
of FPSand must file a Form 8865 with respect to FPS.
During 2001, FPSearns gross income that is effec-
tively connected with the conduct of a trade or busi-
ness within the United States. Therefore, pursuant to
section 6031(e)(2)(B), FPSmust file Form 1065 for
its 2001 tax year. If FPScompletes and files Form
1065, USmust use copies of the relevant schedules
from Form 1065 to complete US’s Form 8865 for
FPS’s 2001 tax year. If FPSinstead had a September
30 tax year pursuant to section 706, then USmust at-
tach to its Form 1040 for US’s 2001 tax year a Form
8865 completed with respect to FPS’s tax year ending
September 30, 2001. If FPSfiled a Form 1065 for its
tax year ending September 30, 2001, then USmust use
that Form 1065 to fulfill in part its reporting obliga-
tions under section 6038 by attaching the relevant
schedules from the Form 1065 to US’s Form 8865.
(k) Failure to comply with reporting re-
quirement—(1) In general. Any United
States person required to file Form 8865
under Section 6038 and this section that
fails to comply (as defined in paragraph
(k)(2) of this section) with the reporting
requirements of this section, will be sub-
ject to the penalties described in para-
graph (k)(3) of this section.
(2) Failure to comply. A failure to
comply is separately determined for each
foreign partnership for which a United
States person has a section 6038 reporting
obligation. A failure to comply with the
requirements of section 6038 includes the
following—
(i) The failure to report at the proper
time and in the proper manner any infor-
mation required to be reported under the
rules of this section; or
(ii) The provision of false or inaccurate
information in purported compliance with
the requirements of this section.
(3) Penalties. A United States person
that fails to comply (as defined in para-
graph (k)(2) of this section) with the re-
porting requirements of this section must
pay the following penalties, subject to the
reasonable cause exception in paragraph
(k)(4) of this section:
(i) Dollar amount penalty—(A)
$10,000 penalty.A penalty of $10,000
shall be imposed for each tax year of each
foreign partnership with respect to which
a failure to comply occurs.
(B) Increase in penalty. If a failure to
comply with the applicable reporting re-
quirements of section 6038 and this sec-
tion continues for more than 90 days after
the date on which the Commissioner or
the Commissioner’s delegate mails notice
of the failure to the United States person
required to file Form 8865, the person
must pay an additional penalty of $10,000
for each 30-day period (or fraction
thereof) during which the failure contin-
ues after the 90-day period has expired.
(C) Limitation. The additional penalty
imposed on any United States person by
section 6038(b)(2) and paragraph
(k)(3)(i)(B) of this section is limited to a
maximum of $50,000 for each partnership
for each tax year with respect to which the
failure occurs.
(ii) Penalty of reducing foreign tax
credit—(A) Effect on foreign tax credit.
Failure to comply with the reporting re-
quirements of section 6038 and this sec-
tion may cause a reduction of foreign tax
credits under section 901 (taxes of foreign
countries and of possessions of the United
States). In applying section 901 to a
United States person for any tax year with
or within which its foreign partnership’s
tax year ended, the amount of taxes paid
(and deemed paid under sections 902 and
960) by the United States person will be
reduced by 10 percent if the person fails
to comply. However, no tax deemed paid
under section 904(c) will be reduced
under the provisions of this paragraph
(k)(3)(ii).
(B) Reduction for continued failure. If
a failure to comply with the reporting re-
quirements of section 6038 and this sec-
tion continues for more than 90 days after
the date on which the Commissioner or

January 10, 20002742000–2 I.R.B.
the Commissioner’s delegate mails notice
of the failure to the person required to file
Form 8865, then the amount of the reduc-
tion in paragraph (k)(3)(ii)(A) of this sec-
tion will be 10 percent, plus an additional
5 percent for each 3-month period (or
fraction thereof) during which the failure
continues after the 90-day period has ex-
pired.
(C) Limitation on reduction. The
amount of the reduction under paragraphs
(k)(3)(ii)(A) and (B) of this section for
each failure to furnish information re-
quired under this section will not exceed
the greater of $10,000, or the gross in-
come of the foreign partnership for its tax
year with respect to which the failure oc-
curred.
(D) Offset for dollar amount penalty
imposed. The total amount of the reduc-
tion which, but for this paragraph
(k)(3)(ii)(D), may be made under this
paragraph (k)(3)(ii) with respect to any
separate failure, may not exceed the max-
imum amount of the reductions that may
be imposed, reduced (but not below zero)
by the dollar amount penalty imposed by
paragraph (k)(3)(i) of this section with re-
spect to the failure.
(4) Reasonable cause limitation. The
time prescribed for filing a complete
Form 8865, and the beginning of the 90-
day period after the Commissioner or the
Commissioner’s delegate mails notice
under paragraphs (k)(3)(i)(B) and (ii)(B)
of this section, will be treated as being not
earlier than the last day on which reason-
able cause existed for failure to furnish
the information. The United States per-
son may show reasonable cause by pro-
viding a written statement to the Commis-
sioner’s delegate having jurisdiction over
the person’s return to which the Form
8865 should have been attached, setting
forth the reasons for the failure to comply.
Whether a failure to comply was due to
reasonable cause will be determined by
the Commissioner, or the Commissioner’s
delegate, under all the facts and circum-
stances.
(5) Statute of limitations.For excep-
tions to the limitations on assessment in
the event of a failure to provide informa-
tion under section 6038, see section
6501(c)(8).
(l) Effective date. This section applies
to tax years of a foreign partnership end-
ing on or after December 31, 2000.
Par. 5. Section 1.6038B-1 is amended
as follows:
1. The heading is revised.
2. The first three sentences of para-
graph (b)(1)(i) are removed and four sen-
tences are added in their place.
3. Paragraph (b)(2)(i)(A)(4) is added.
4. Paragraph (b)(2)(i)(B)(3) is revised.
5. Paragraph (b)(2)(i)(B)(4) is added.
6. Paragraph (g) is revised.
The added and revised provisions read
as follows:
§1.6038B-1 Reporting of certain trans-
fers to foreign corporations.
* * * * *
(b) * * * (1) * * * (i) Reporting proce-
dure. Except for stock or securities quali-
fying under the special reporting rule of
paragraph (b)(2) of this section, and cer-
tain exchanges described in section 354
(listed below), any U.S. person that
makes a transfer described in section
6038B(a)(1)(A), 367(d) or (e), is required
to report pursuant to section 6038B and
the rules of this section and must attach
the required information to Form 926,
“Return by Transferor of Property to a
Foreign Corporation.” For special rules
regarding cash transfers made in tax years
beginning after February 5, 1999, see
paragraphs (b)(3) and (g) of this section.
For purposes of determining a U.S. trans-
feror that is subject to section 6038B, the
rules of §1.367(a)-1T(c) and §1.367(a)-
3(d) shall apply with respect to a transfer
described in section 367(a), and the rules
of §1.367(a)-1T(c) shall apply with re-
spect to a transfer described in section
367(d). Additionally, if in an exchange
described in section 354, a U.S. person
exchanges stock of a foreign corporation
in a reorganization described in section
368(a)(1)(E), or a U.S. person exchanges
stock of a domestic or foreign corporation
for stock of a foreign corporation pur-
suant to an asset reorganization described
in section 368(a)(1)(C),(D), or (F), that is
not treated as an indirect stock transfer
under section 367(a), then the U.S. person
exchanging stock is not required to report
under section
6038B. * * *
* * * * *
(2) * * *
(i) * * *
(A) * * *
(4) The transfer is considered to be to a
foreign corporation solely by reason of
§1.83-6(d)(1) and the fair market
value of the property transferred did
not exceed $100,000; or
(B) * * *
(3) The transferor properly reported the
income from the transfer on its timely-
filed (including extensions) Federal in-
come tax return for the taxable year that
includes the date of the transfer; or
(4) The transfer is considered to be to a
foreign corporation solely by reason of
§1.83-6(d)(1) and the fair market value of
the property transferred did not exceed
$100,000.
* * * * *
(g) This section applies to transfers oc-
curring on or after July 20, 1998, except
for transfers of cash made in tax years be-
ginning on or before February 5, 1999,
which are not required to be reported
under section 6038B, and except for para-
graph (e) of this section, which applies to
transfers that are subject to §§1.367(e)-
1(f) and 1.367(e)-2(e). See §1.6038B-1T
for transfers occurring prior to July 20,
1998. See also §1.6038B-1T(e) in effect
prior to August 9, 1999, (as contained in
26 CFR part 1 revised April 1, 1999) for
transfers described in section 367(e) that
are not subject to §§1.367(e)-1(f) and
1.367(e)-2(e).
Par. 6. Section 1.6038B-2 is amended
as follows:
1. Paragraph (a)(5) is revised.
2. Paragraph (c)(4) is revised.
3. Paragraph (c)(6) is amended by re-
moving the period at the end and adding
“; and” in its place.
4. Paragraph (j)(1) introductory text is
amended by revising the first sentence.
5. Paragraph (j)(3) is added.
The revised and added provisions read
as follows:
§1.6038B-2 Reporting of certain transfers
to foreign partnerships.
(a) * * *
(5) Time for filing Form 8865. The
Form 8865 on which a transfer is reported
must be attached to the transferor’s timely
filed (including extensions) income tax
return for the tax year that includes the
date of the transfer. If the person required
to report under this section is not required
to file an income tax return for its tax year
during which the transfer occurred, but is
required to file an information return for
that year (for example, Form 1065, “U.S.
Partnership Return of Income,” or Form

2000–2 I.R.B.275January 10, 2000
990, “Return of Organization Exempt
from Income Tax”), the person should at-
tach the Form 8865 to its information re-
turn.
* * * * *
(c) * * *
(4) The names and addresses of the
other partners in the foreign partnership,
unless the transfer is solely of cash and
the transferor holds less than a ten-percent
interest in the transferee foreign partner-
ship immediately after the transfer. How-
ever, for tax years of U.S. persons begin-
ning on or after January 1, 2000, the
person reporting pursuant to section
6038B (the transferor) must provide the
names and addresses of each United
States person that owned a ten-percent or
greater direct interest in the foreign part-
nership during the transferor’s tax year in
which the transfer occurred, and the
names and addresses of any other United
States or foreign persons that were direct
partners in the foreign partnership during
that tax year and that were related to the
transferor during that tax year. See para-
graph (i)(4) of this section for the defini-
tion of a related person;
* * * * *
(j) * * * (1) In general. Except as oth-
erwise provided in this section, this sec-
tion applies to transfers made on or after
January 1, 1998. * * *
* * * * *
(3) Special rule for transfers made be-
fore January 1, 2000. Even if not re-
ported in accordance with the rules pro-
vided in paragraph (a)(5) of this section,
or paragraph (j)(1) or (2) of this section, a
transfer that occurred before January 1,
2000 will nevertheless be considered
timely reported if the transferor reports it
on a Form 8865 attached to an amended
tax return for the transferor’s tax year in
which the transfer occurred, provided
such amended return is filed no later than
September 15, 2000.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 7. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 8. In §1.602.101, paragraph (b) is
amended by revising the entries for
§1.6038-2, §1,6038(B)-1, and §1.6038B-
2 and adding an entry in numerical order
to the table to read as follows:
§602.101 OMB Control numbers.
* * * * *
(b) * * *
Robert Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved December 9, 1999.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on De-
cember 27, 1999, 8:45 a.m., and published in the
issue of the Federal Register for December 28,1999,
64 F.R. 72545)
CFR part or section whereCurrent OMB
identified and describedcontrol No.
* * * * *
1.6038-2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1617
1.6038-3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1617
* * * * *
1.6038B-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1617
* * * * *
1.6038B-2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1617
* * * * *
Section 6046A.—Returns As To
Interests In Foreign Partnerships
26 CFR 1.6046A–1:Return requirement for United
States persons who acquire or dispose of an interest
in a foreign partnership, or whose proportional
interest in a foreign partnership changes
substantially.
T.D. 8851
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Return Requirement for United
States Persons Acquiring or
Disposing of an Interest in a
Foreign Partnership, or Whose
Proportional Interest in a
Foreign Partnership Changes
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations under section 6046A of
the Internal Revenue Code relating to the
requirement that United States persons, in
certain circumstances, file a return if they
acquire or dispose of an interest in a for-
eign partnership, or if their proportional
interest in a foreign partnership changes.
DATES: Effective Date:December 29,
1999.
Applicability Dates:For dates of ap-
plicability of §1.6046A-1, see §1.6046A-
1(j).

January 10, 20002762000–2 I.R.B.
FOR FURTHER INFORMATION CON-
TACT: Eliana Dolgoff, (202) 622-3860
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in these final regulations has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control
number 1545-1646. Responses to this
collection of information are mandatory.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.
The burden of complying with the col-
lection of information required to be re-
ported on Form 8865 is reflected in the
burden for Form 8865, “Return of U.S.
Persons With Respect to Certain Foreign
Partnerships.”
Suggestions for reducing the burden as-
sociated with this rule should be sent to
the Internal Revenue Service, Attn: IRS
Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and to the Office
of Management and Budget, Attn: Desk
Officer of the Department of the Treasury,
Office of Information and Regulatory Af-
fairs, Washington, DC 20503.
Books or records relating to this collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
On September 9, 1998, the IRS pub-
lished in the Federal Register(63 FR
48154(REG–209060–86, 1998–39 I.R.B.
18)) proposed regulations under section
6046A. A public hearing on the proposed
regulations was held on November 10,
1998, even though no requests to speak at
the hearing were received. Though no
comments were made at the hearing, writ-
ten comments were received. After consid-
eration of all of the written comments, the
proposed regulations under section 6046A
are adopted as revised by this Treasury de-
cision. The revisions are discussed below.
Explanation of Provisions and
Summary of Comments
Commentators requested that section
6046A reporting not be required of United
States persons that are indirect partners in
a partnership. For example, a United
States person would not be required to re-
port under section 6046A with respect to
an interest in a foreign partnership that the
person owned indirectly through another
partnership. Unlike section 6038, section
6046A reporting may apply with respect
to any foreign partnership, not just for-
eign partnerships controlled by U.S. per-
sons. Accordingly, the IRS agrees that re-
porting should not be required for indirect
acquisitions, dispositions, and changes in
proportional foreign partnership interests,
because it would be burdensome and dif-
ficult for some partners to discover and
keep track of such events. Additionally, if
section 6046A reporting were required for
changes in indirectly owned foreign part-
nership interests, then a transfer of an in-
terest in one entity in a chain of entities at
the bottom of which is a foreign partner-
ship could result in multiple, duplicative,
section 6046A reporting obligations.
Thus, the final regulations substantially
reduce the burden section 6046A would
have imposed on taxpayers under the pro-
posed regulations. The final regulations
provide that under §1.6046A-1(a)(1), a
United States person is only required to
report pursuant to section 6046A if that
person has a “reportable event.” A person
can only have a reportable event with re-
spect to a particular foreign partnership if
that person owns a direct interest in the
partnership. More specifically, the United
States person must acquire or dispose of a
direct interest in the foreign partnership,
or have a change in its direct proportional
interest, in order to have a reportable
event under section 6046A. See
§1.6046A-1(b)(1).
Some commentators also requested that
the final regulations exempt state and local
government employee retirement plans
from the section 6046A reporting require-
ments. The final regulations provide that
trusts relating to state and local govern-
ment employee retirement plans are not
required to report under section 6046A,
unless required to do so in the instructions
to Form 8865, “Return of U.S. Persons
With Respect To Certain Foreign Partner-
ships.” The IRS and Treasury invite com-
ments regarding whether the section
6046A reporting obligation should also be
reduced for other tax-exempt entities.
A United States person required to re-
port information pursuant to section
6046A must do so by completing and fil-
ing Form 8865. A final version of Form
8865 will be released prior to January 1,
2000. Taxpayers will be able to download
a copy of the form and its instructions
from the IRS Internet website located at
www.irs.ustreas.gov.
The final regulations apply to re-
portable events that occur on or after Jan-
uary 1, 2000. Acquisitions and disposi-
tions of foreign partnership interests, and
changes in proportional foreign partner-
ship interests, occurring before January 1,
2000, are not required to be reported
under section 6046A.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assess-
ment is not required.
This Treasury decision finalizes a no-
tice of proposed rulemaking published
September 9, 1998. It has been deter-
mined that section 553(b) of the Adminis-
trative Procedure Act (5 U.S.C. chapter 5)
does not apply to the final regulations is-
sued pursuant to the notice of proposed
rulemaking published on September 9,
1998. It is hereby certified that this Trea-
sury decision will not have a significant
economic impact on a substantial number
of small entities. This certification is
based on the fact that the amount of time
required to complete the form and file the
information required under these regula-
tions is brief and will not have a signifi-
cant impact on those small entities that
are required to provide notification. Fur-
thermore, the number of small entities
that will be required to file the form is not
substantial. Accordingly, a Regulatory
Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not
required.
Pursuant to section 7805(f) of the Inter-
nal Revenue Code, the notice of proposed
rulemaking preceding these regulations
was submitted to the Small Business Ad-
ministration for comment on its impact on
small business.

2000–2 I.R.B.277January 10, 2000
Drafting Information
The principal author of these final reg-
ulations is Eliana Dolgoff of the Office of
Associate Chief Counsel (International).
However, other personnel from the IRS
and the Treasury Department participated
in their development.
* * * * *
Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Par. 1. The authority citation for part 1
is amended by adding an entry in numeri-
cal order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.6046A-1 also issued under
26 U.S.C. 6046A. * * *
Par. 2. Section 1.6046A-1 is added to
read as follows:
§1.6046A-1 Return requirement for
United States persons who acquire or dis-
pose of an interest in a foreign partner-
ship, or whose proportional interest in a
foreign partnership changes
substantially.
(a) Return requirement—(1) General
rule. If a United States person has a re-
portable event (as defined in paragraph
(b)(1) of this section) during the person’s
tax year, then, except as provided in para-
graph (f) of this section, the United States
person is required to complete and file
Form 8865, “Return of U.S. Persons With
Respect To Certain Foreign Partnerships,”
containing the information described in
paragraph (c) of this section.
(2) Separate return for each partner-
ship. If a United States person has a re-
portable event with respect to an interest
in more than one foreign partnership, the
United States person must file a separate
Form 8865 for each foreign partnership.
(b) Definitions—(1) Reportable event.
There are three categories of reportable
events under section 6046A: acquisi-
tions, dispositions, and changes in propor-
tional interests.
(i) Acquisitions. A United States per-
son that acquires a foreign partnership in-
terest has a reportable event if—
(A) The person did not own a ten-per-
cent or greater direct interest in the part-
nership and as a result of the acquisition
the person owns a ten-percent or greater
direct interest in the partnership. For pur-
poses of this paragraph (b)(1)(i)(A), an
acquisition includes an increase in a per-
son’s direct proportional interest; or
(B) Subject to paragraph (b)(2) of this
section, compared to the person’s direct
interest when the person last had a re-
portable event, after the acquisition the
person’s direct interest has increased by at
least a ten-percent interest.
(ii) Dispositions.A United States per-
son that disposes of a foreign partnership
interest has a reportable event if—
(A) The person owned a ten-percent or
greater direct interest in the partnership
before the disposition and as a result of
the disposition the person owns less than
a ten-percent direct interest. For purposes
of this paragraph (b)(1)(ii)(A), a disposi-
tion includes a decrease in a person’s di-
rect proportional interest; or
(B) Subject to paragraph (b)(2) of this
section, compared to the person’s direct
interest when the person last had a re-
portable event, after the disposition the
person’s direct interest has decreased by
at least a ten-percent interest.
(iii) Changes in proportional interests
not otherwise reportable as acquisitions
or dispositions under paragraph
(b)(1)(i)(A) or (b)(1)(ii)(A) of this section.
A United States person has a reportable
event if, subject to paragraph (b)(2) of
this section, compared to the person’s di-
rect proportional interest the last time the
person had a reportable event, the per-
son’s direct proportional interest has in-
creased or decreased by at least the equiv-
alent of a ten-percent interest.
(2) Special rule for foreign partnership
interests owned on December 31, 1999.
If a United States person owned a ten-per-
cent or greater direct interest in a foreign
partnership on December 31, 1999, then
to determine whether the person has a re-
portable event under paragraph
(b)(1)(i)(B), (b)(1)(ii)(B), or (b)(1)(iii) of
this section, the comparison should be
made to the person’s direct interest on De-
cember 31, 1999. Once the person has a
reportable event after December 31, 1999,
future comparisons should be made by
reference to the last reportable event.
(3) Change in a proportional interest.
A partner’s proportional interest in a for-
eign partnership may change for a number
of reasons, for example, the change may
be caused by changes in other partners’
interests resulting from a partner with-
drawing from the partnership. A propor-
tional change may also occur by operation
of the partnership agreement, for exam-
ple, if the partnership agreement provides
that a partner’s interest in profits will
change on a set date or when the partner-
ship has earned a specified amount of
profits and one of those events occurs.
(4) Ten-percent interest. Under section
6046A(d) and this section, a ten-percent
interestin a foreign partnership, as de-
scribed in section 6038(e)(3)(C) and the
regulations thereunder, means an interest
equal to ten percent of the capital interest
in such partnership, an interest equal to
ten percent of the profits interest in such
partnership, or an interest to which ten
percent of the deductions or losses of such
partnership are allocated.
(5) United States person. United States
personmeans a person described in sec-
tion 7701(a)(30).
(6) Foreign partnership. Foreign part-
nershipmeans any partnership that is a
foreign partnership under sections
7701(a)(2) and (5).
(7) Examples. The rules of paragraph
(a) of this section and this paragraph (b)
are illustrated by the following examples:
Example 1. Acquisition of an indirect interest. FP,
a foreign partnership, has two partners, FC1and FC2,
both foreign corporations. FC1owns a 40% interest
in FP, and FC2owns a 60% interest in FP. No United
States person owns an interest in FP, either directly, or
constructively under section 6038(e)(3)(C) and section
267(c). On January 1, 2001, US, a United States per-
son and calendar year taxpayer, acquires by purchase
100% of FC2’s stock. UShas acquired an indirect in-
terest of 60% in FP. See sections 6038(e)(3)(C) and
267(c)(1). However, USis not required to report the
January 1, 2001 indirect acquisition under section
6046A. USdid not own a 10% or greater direct inter-
est in FPbefore the acquisition, and USdoes not own
a 10% or greater direct interest as a result of the acqui-
sition. (US
must, however, comply with the reporting
requirements under section 6038 (controlled foreign
corporation and controlled foreign partnership report-
ing) with respect to FC2and FP.)
Example 2. Acquisition of direct interests. (i)
Assume the same facts as Example 1. In addition,
on June 1, 2001, USpurchases a 5% direct interest
in FPfrom FC1. USdid not own a 10% or greater
direct interest in FPbefore the acquisition. After the
acquisition, USdoes not own a direct interest of
10% or more. USowns a 10% or greater total inter-
est (direct and indirect), but only a 5% direct inter-
est. Therefore, USis not required to report the June

January 10, 20002782000–2 I.R.B.
1, 2001, acquisition under section 6046A.
(ii) On September 1, 2001, USpurchases a 7%
direct interest in FPfrom FC1. The September 1,
2001 acquisition constitutes a reportable event under
paragraph (b)(1)(i)(A) of this section. Before the
September 1 acquisition, USdid not own a 10% or
greater direct interest in FP. After the September 1
acquisition, USowns a 12% direct interest, and
therefore, as a result of the September 1 acquisition,
USnow owns a 10% or greater direct interest in FP.
Consequently, USmust report its September 1 ac-
quisition under section 6046A on Form 8865 filed
with US’s 2001 income tax return.
(iii) On December 1, 2001, USacquires an addi-
tional 4% direct interest in FPfrom FC1, so that
US’s total direct interest has increased from 12% to
16%. This acquisition does not constitute a re-
portable event. Compared to US’s direct interest
when USlast had a reportable event (12% on Sep-
tember 1, 2001), after acquiring the 4% interest US’s
direct interest has not increased by at least a 10% di-
rect interest (i.e., its direct interest increased by only
4%). Therefore, USdoes not have to report the De-
cember 1, 2001, acquisition under section 6046A.
On April 1, 2002, FC2distributes a 6% direct inter-
est in FPto US. USnow owns a 22% direct interest
in FP. Compared to US’s direct interest when US
last had a reportable event (12% on September 1,
2001), after the April 1 acquisition US’s direct inter-
est has increased by at least a 10% interest (12% to
22%). USmust report the April 1, 2002 acquisition
on a Form 8865 attached to US’s 2002 income tax
return.
Example 3. Change in proportional interest re-
sulting from withdrawal of a partner.Assume the
same facts as Example 3. In addition, on January 5,
2003, FC2withdraws entirely from FP. As a result,
the direct interests of USand FC1in FPeach in-
crease by at least the equivalent of 10% interests.
Compared to US’s direct interest the last time US
had a reportable event (22% on April 1, 2002), US’s
direct interest has increased by at least the equiva-
lent of a ten percent interest. Therefore, UShas had
a reportable event pursuant to paragraph (b)(1)(iii)
of this section, and USmust report the change in its
interest resulting from FC2’s withdrawal from the
partnership on US’s Form 8865 filed with US’s 2003
tax year income tax return.
Example 4. Change in proportional interest con-
stituting an acquisition. FPis a foreign partnership
that has no United States persons as direct or con-
structive partners. USis a United States person and
a calendar year taxpayer. On January 1, 2001, US
purchases an 8% direct interest in FP. USis not re-
quired to report this acquisition. USdid not own a
10% or greater direct interest in FP, and USdoes not
own a 10% or greater direct interest as a result of the
acquisition. On March 1, 2001, FC, a foreign part-
ner of FP, withdraws from FP, and as result, US’s
direct interest in FPincreases by a 7% interest. The
increase in US’s direct interest is considered an ac-
quisition of an interest under paragraph (b)(1)(i)(A)
of this section. USdid not own a 10% or greater di-
rect interest in FPbefore FCwithdrew, and as a re-
sult of the increase in US’s direct interest because of
FC’s withdrawal from FP, USnow owns a 10% or
greater direct interest in FP. Therefore, USmust re-
port under section 6046A the increase in US’s direct
interest resulting from the withdrawal of FCfrom
FPon Form 8865 filed with US’s tax return for US’s
2001 tax year.
(c) Content of return. The Form 8865
that must be filed under paragraph (a)(1)
of this section must contain the following
information in such form and manner and
to the extent that Form 8865 and its in-
structions prescribe—
(1) The name, address, and taxpayer
identification number of the United States
person required to file the return;
(2) Information about other persons
(foreign or domestic) whose interests in
the foreign partnership the person report-
ing under section 6046A is considered to
own under section 6038(e)(3)(C) and sec-
tion 267(c);
(3) Information about all foreign enti-
ties that were disregarded as entities sepa-
rate from their owners under §§301.7701-
2 and 301.7701-3 of this chapter that were
owned by the foreign partnership during
the partnership’s tax year ending with or
within the tax year of the person filing
Form 8865 pursuant to section 6046A;
(4) For each reportable event, the date
of the event, the type of event (acquisi-
tion, disposition, or change in propor-
tional interest), and the United States per-
son’s direct percentage interest in the
foreign partnership immediately before
and immediately after the event;
(5) The fair market value of the interest
acquired or disposed of;
(6) Information about partnerships (for-
eign and domestic) in which the foreign
partnership owned a direct interest, or a
constructive interest of ten percent or
more under sections section 267(c)(1) and
(5) and the regulations thereunder, during
the partnership’s tax year ending with or
within the tax year of the person filing
Form 8865 pursuant to section 6046A;
and
(7) Any other information required to
be submitted by Form 8865 and its in-
structions.
(d) Time and manner for filing returns.
The Form 8865 must be filed with the
timely filed (including extensions) in-
come tax return of the United States per-
son for the tax year in which the re-
portable event occurs. If the United
States person is not required to file an in-
come tax return for its tax year in which
the reportable event occurs, but is re-
quired to file an information return for
that year (for example, Form 1065, “U.S.
Partnership Return of Income,” or Form
990, “Return of Organization Exempt
from Income Tax”), the United States per-
son should attach the Form 8865 to its in-
formation return filed for that tax year.
(e) Duplicate returns. If required by
the instructions to Form 8865, a duplicate
Form 8865 (including attachments and
schedules) must also be filed.
(f) Persons excepted from filing
return—(1) Section 6038B overlap. If a
United States person acquires an interest
in a foreign partnership as a result of a
section 721 contribution required to be re-
ported under section 6038B, and the per-
son properly reports the contribution
under section 6038B, then the United
States person is not required to report the
acquisition of the partnership interest
under section 6046A(a) should it consti-
tute a reportable event under paragraph
(b)(1) of this section. The acquisition will
still constitute a reportable event for pur-
poses of making future comparisons pur-
suant to paragraphs (b)(1)(i)(B),
(b)(1)(ii)(B) and (b)(1)(iii) of this section.
A person that fails to properly report the
section 721 contribution under section
6038B and the regulations thereunder and
that fails to properly report the acquisition
of the partnership interest under section
6046A may be subject to the penalties ap-
plicable to a failure to comply with the re-
quirements of section 6038B, as well as
the penalties applicable for a failure to
comply with the requirements of section
6046A. See paragraph (h) of this section
for more information about the penalties
for failure to comply with the require-
ments of section 6046A.
(2) Trusts relating to state and local
government employee retirement plans.
The return requirement of section 6046A
does not apply to trusts relating to state
and local government employee retire-
ment plans, unless the instructions to
Form 8865 provide otherwise.

2000–2 I.R.B.279January 10, 2000
(3) Reporting under this section not
required of partnerships excluded from
the application of subchapter K. The re-
porting requirements of this section will
not apply to any United States person in
respect of an eligible partnership as de-
scribed in §1.761-2(a) in which that
United States person is a partner, if such
partnership has validly elected to be ex-
cluded from all of the provisions of sub-
chapter K of chapter 1 of the Internal
Revenue Code in the manner specified
in §1.761-2(b)(2)(i), or is deemed to
have elected to be excluded from all of
the provisions of subchapter K of chap-
ter 1 of the Internal Revenue Code in ac-
cordance with the provisions of §1.761-
2(b)(2)(ii).
(4) Exclusion for satellite organiza-
tions. The return requirement of section
6046A does not apply to the International
Telecommunications Satellite Organiza-
tion (or a successor organization) or the
International Maritime Satellite Organiza-
tion (or a successor organization).
(g) Method of reporting. Except as oth-
erwise provided on Form 8865, or the ac-
companying instructions, any amounts re-
quired to be reported under section 6046A
and this section must be expressed in
United States dollars, with a statement of
the exchange rates used. All statements
required on or with Form 8865 pursuant
to this section must be in English.
(h) Penalties for violating section
6046A. For penalties for violating section
6046A, see sections 6679 and 7203.
(i) Statute of limitations. For excep-
tions to the limitations on assessment in
the event of a failure to provide informa-
tion under section 6046A, see section
6501(c)(8).
(j) Effective date. This section applies
to reportable events occurring after De-
cember 31, 1999. No reporting under sec-
tion 6046A is required for reportable
events occurring on or before December
31, 1999.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 3 The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 4 In §602.101, paragraph (b) is
amended by adding an entry in numerical
order to the table to read as follows:
§602.101 OMB Control numbers.
* * * * *
(b) * * *
Robert Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved December 9, 1999.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on
December 27, 1999, 8:45 a.m., and published in the
issue of the Federal Register for December 28, 1999,
64 F.R. 72555)
CFR part or section whereCurrent OMB
identified and describedcontrol No.
* * * * *
1.6046A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1646
* * * * *
Section 7520.—Valuation Tables
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 7872.—Treatment of
Loans with Below-Market
Interest Rates
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.

January 10, 20002802000–2 I.R.B.
26 CFR 601.105: Examination of returns and
claims for refund, credit, or abatement;
determination of correct tax liability.
(Also Part I, §§ 62, 162, 267, 274; 1.62-2, 1.162-17,
1.267(a)-1, 1.274-5T, 1.274(d)-1T.)
Rev. Proc. 2000-9
SECTION 1. PURPOSE
This revenue procedure updates Rev.
Proc. 98-64, 1998-52 I.R.B. 32, by pro-
viding rules under which the amount of
ordinary and necessary business expenses
of an employee for lodging, meal, and in-
cidental expenses or for meal and inciden-
tal expenses incurred while traveling
away from home will be deemed substan-
tiated under § 1.274-5T of the temporary
Income Tax Regulations when a payor
(the employer, its agent, or a third party)
provides a per diem allowance under a re-
imbursement or other expense allowance
arrangement to pay for such expenses.
This revenue procedure also provides an
optional method for employees and self-
employed individuals to use in computing
the deductible costs of business meal and
incidental expenses paid or incurred while
traveling away from home. Use of a
method described in this revenue proce-
dure is not mandatory and a taxpayer may
use actual allowable expenses if the tax-
payer maintains adequate records or other
sufficient evidence for proper substantia-
tion. This revenue procedure does not
provide rules under which the amount of
an employee’s lodging expenses will be
deemed substantiated when a payor pro-
vides an allowance to pay for those ex-
penses but not meal and incidental ex-
penses.
SECTION 2. BACKGROUND AND
CHANGES
.01 Section 162(a) of the Internal Rev-
enue Code allows a deduction for all the
ordinary and necessary expenses paid or
incurred during the taxable year in carry-
ing on any trade or business. Under that
provision, an employee or self-employed
individual may deduct expenses paid or
incurred while traveling away from home
in pursuit of a trade or business. How-
ever, under § 262, no portion of such
travel expenses that is attributable to per-
sonal, living, or family expenses is de-
ductible.
.02 Section 274(n) generally limits the
amount allowable as a deduction under §
162 for any expense for food, beverages,
or entertainment to 50 percent of the
amount of the expense that otherwise
would be allowable as a deduction. In the
case of any expenses for food or bever-
ages consumed while away from home
(within the meaning of § 162(a)(2)) by an
individual during, or incident to, the pe-
riod of duty subject to the hours of service
limitations of the Department of Trans-
portation, § 274(n)(3) gradually increases
the deductible percentage to 80 percent
for taxable years beginning in 2008. For
taxable years beginning in 2000, the de-
ductible percentage for these expenses is
60 percent.
.03 Section 274(d) provides, in part,
that no deduction shall be allowed under §
162 for any traveling expense (including
meals and lodging while away from
home) unless the taxpayer complies with
certain substantiation requirements. The
section further provides that regulations
may prescribe that some or all of the sub-
stantiation requirements do not apply to
an expense that does not exceed an
amount prescribed by such regulations.
.04 Section 1.274(d)-1T(a) of the reg-
ulations, in part, grants the Commis-
sioner the authority to prescribe rules re-
lating to reimbursement arrangements or
per diem allowances for ordinary and
necessary expenses paid or incurred
while traveling away from home. Pur-
suant to this grant of authority, the Com-
missioner may prescribe rules under
which such arrangements or allowances,
if in accordance with reasonable busi-
ness practice, will be regarded (1) as
equivalent to substantiation, by ade-
quate records or other sufficient evi-
dence, of the amount of such travel ex-
penses for purposes of § 1.274-5T(c),
and (2) as satisfying the requirements of
an adequate accounting to the employer
of the amount of such travel expenses
for purposes of § 1.274-5T(f).
.05 For purposes of determining ad-
justed gross income, § 62(a)(2)(A) allows
an employee a deduction for expenses al-
lowed by Part VI (§ 161 and following),
subchapter B, chapter 1 of the Code, paid
or incurred by the employee in connection
with the performance of services as an
employee under a reimbursement or other
expense allowance arrangement with a
payor.
.06 Section 62(c) provides that an
arrangement will not be treated as a reim-
bursement or other expense allowance
arrangement for purposes of §
62(a)(2)(A) if it—
(1) does not require the employee to
substantiate the expenses covered by the
arrangement to the payor, or
(2) provides the employee with the
right to retain any amount in excess of the
substantiated expenses covered under the
arrangement.
Section 62(c) further provides that the
substantiation requirements described
therein shall not apply to any expense to
the extent that, under the grant of regula-
tory authority prescribed in § 274(d), the
Commissioner has provided that substan-
tiation is not required for such expense.
.07 Under § 1.62-2(c)(1) a reimburse-
ment or other expense allowance arrange-
ment satisfies the requirements of § 62(c)
if it meets the requirements of business
connection, substantiation, and returning
amounts in excess of expenses as speci-
fied in the regulations. Section 1.62-
2T(e)(2) specifically provides that sub-
stantiation of certain business expenses in
accordance with rules prescribed under
the authority of § 1.274(d)-1T(a) or
1.274-5T(j) will be treated as substantia-
tion of the amount of such expenses for
purposes of § 1.62-2. Under § 1.62-
2(f)(2), the Commissioner may prescribe
rules under which an arrangement provid-
ing per diem allowances will be treated as
satisfying the requirement of returning
amounts in excess of expenses, even
though the arrangement does not require
the employee to return the portion of such
an allowance that relates to days of travel
substantiated and that exceeds the amount
of the employee’s expenses deemed sub-
stantiated pursuant to rules prescribed
under § 274(d), provided the allowance is
reasonably calculated not to exceed the
amount of the employee’s expenses or an-
ticipated expenses and the employee is re-
quired to return any portion of such an al-
lowance that relates to days of travel not
substantiated.
.08 Section 1.62-2(h)(2)(i)(B) provides
Part III. Administrative, Procedural, and Miscellaneous

2000–2 I.R.B.281January 10, 2000
that if a payor pays a per diem allowance
that meets the requirements of § 1.62-
2(c)(1), the portion, if any, of the al-
lowance that relates to days of travel sub-
stantiated in accordance with § 1.62-2(e),
that exceeds the amount of the em-
ployee’s expenses deemed substantiated
for such travel pursuant to rules pre-
scribed under § 274(d) and § 1.274(d)-
1(a) or § 1.274-5T(j), and that the em-
ployee is not required to return, is subject
to withholding and payment of employ-
ment taxes. See §§ 31.3121(a)-3,
31.3231(e)-1(a)(5), 31.3306(b)-2, and
31.3401(a)-4. Because the employee is
not required to return this excess portion,
the reasonable period of time provisions
of § 1.62-2(g) (relating to the return of ex-
cess amounts) do not apply to this por-
tion.
.09 Under § 1.62-2(h)(2)(i)(B)(4), the
Commissioner may, in his or her discre-
tion, prescribe special rules regarding the
timing of withholding and payment of
employment taxes on per diem al-
lowances.
.10 Section 1.274-5T(j) grants the
Commissioner the authority to establish a
method under which a taxpayer may elect
to use a specified amount for meals paid
or incurred while traveling away from
home in lieu of substantiating the actual
cost of meals.
.11 Section 5.04 of this revenue proce-
dure contains revisions to the list of high-
cost localities and to the high-low rates
for purposes of section 5.
SECTION 3. DEFINITIONS
.01 Per diem allowance.The term “per
diem allowance” means a payment under
a reimbursement or other expense al-
lowance arrangement that meets the re-
quirements specified in § 1.62-2(c)(1) and
that is
(1) paid with respect to ordinary and
necessary business expenses incurred, or
which the payor reasonably anticipates
will be incurred, by an employee for lodg-
ing, meal, and incidental expenses or for
meal and incidental expenses for travel
away from home in connection with the
performance of services as an employee
of the employer,
(2) reasonably calculated not to ex-
ceed the amount of the expenses or the
anticipated expenses, and
(3) paid at or below the applicable
Federal per diem rate, a flat rate or stated
schedule, or in accordance with any other
Service-specified rate or schedule.
.02 Federal per diem rate.
(1) General rule. The Federal per
diem rate is equal to the sum of the Fed-
eral lodging expense rate and the Federal
meal and incidental expense (M&IE) rate
for the locality of travel. Each of these
rates for a particular locality in the conti-
nental United States (“CONUS”) is set
forth in Appendix A of 41 C.F.R., Chapter
301, as amended. See 41 C.F.R. Part 301-
7 (1999), as amended, for specific rules
regarding these Federal rates. Each of
these rates is established by the Secretary
of Defense for a particular nonforeign lo-
cality outside the continental United
States (“OCONUS”) (including Alaska,
Hawaii, Puerto Rico, the Northern Mari-
ana Islands, and the possessions of the
United States), and by the Secretary of
State for a particular foreign OCONUS
locality. Each of these OCONUS rates is
published in the Per Diem Supplement to
the Standardized Regulations (Govern-
ment Civilians, Foreign Areas). See, e.g.,
Maximum Travel Per Diem Allowances
for Foreign Areas, PD Supplement 427,
issued December 1, 1999.
(2) Locality of travel.The term “lo-
cality of travel” means the locality where
an employee traveling away from home in
connection with the performance of ser-
vices as an employee of the employer
stops for sleep or rest.
(3) Incidental expenses. The term
“incidental expenses” includes, but is not
limited to, expenses for laundry, cleaning
and pressing of clothing, and fees and tips
for services, such as for porters and bag-
gage carriers. The term “incidental ex-
penses” does not include taxicab fares,
lodging taxes, or the costs of telegrams or
telephone calls.
.03 Flat rate or stated schedule.
(1)In general. Except as provided
in section 3.03(2) of this revenue proce-
dure, an allowance is paid at a flat rate or
stated schedule if it is provided on a uni-
form and objective basis with respect to
the expenses described in section 3.01 of
this revenue procedure. Such allowance
may be paid with respect to the number of
days away from home in connection with
the performance of services as an em-
ployee or on any other basis that is consis-
tently applied and in accordance with rea-
sonable business practice. Thus, for ex-
ample, an hourly payment to cover meal
and incidental expenses paid to a pilot or
flight attendant who is traveling away
from home in connection with the perfor-
mance of services as an employee is an al-
lowance paid at a flat rate or stated sched-
ule. Likewise, a payment based on the
number of miles traveled (e.g., cents per
mile) to cover meal and incidental ex-
penses paid to an over- the-road truck dri-
ver who is traveling away from home in
connection with the performance of ser-
vices as an employee is an allowance paid
at a flat rate or stated schedule.
(2) Limitation. For purposes of this
revenue procedure, an allowance that is
computed on a basis similar to that used
in computing the employee’s wages or
other compensation (e.g., the number of
hours worked, miles traveled, or pieces
produced) does not meet the business
connection requirement of § 1.62-2(d), is
not a per diem allowance, and is not paid
at a flat rate or stated schedule, unless, as
of December 12, 1989, (a) the allowance
was identified by the payor either by mak-
ing a separate payment or by specifically
identifying the amount of the allowance,
or (b) an allowance computed on that
basis was commonly used in the industry
in which the employee is employed. See
§ 1.62-2(d)(3)(ii).
SECTION 4. PER DIEM
SUBSTANTIATION METHOD
.01 Per diem allowance. If a payor
pays a per diem allowance in lieu of reim-
bursing actual expenses for lodging, meal,
and incidental expenses incurred or to be
incurred by an employee for travel away
from home, the amount of the expenses
that is deemed substantiated for each cal-
endar day is equal to the lesser of the per
diem allowance for such day or the
amount computed at the Federal per diem
rate for the locality of travel for such day
(or partial day, see section 6.04 of this
revenue procedure).
.02 Meals only per diem allowance. If
a payor pays a per diem allowance only
for meal and incidental expenses in lieu of
reimbursing actual expenses for meal and
incidental expenses incurred or to be in-
curred by an employee for travel away
from home, the amount of the expenses
that is deemed substantiated for each cal-
endar day is equal to the lesser of the per

January 10, 20002822000–2 I.R.B.
diem allowance for such day or the
amount computed at the Federal M&IE
rate for the locality of travel for such day
(or partial day, see section 6.04 of this
revenue procedure). A per diem al-
lowance is treated as paid only for meal
and incidental expenses if (1) the payor
pays the employee for actual expenses for
lodging based on receipts submitted to the
payor, (2) the payor provides the lodging
in kind, (3) the payor pays the actual ex-
penses for lodging directly to the provider
of the lodging, (4) the payor does not
have a reasonable belief that lodging ex-
penses were or will be incurred by the
employee, or (5) the allowance is com-
puted on a basis similar to that used in
computing the employee’s wages or other
compensation (e.g., the number of hours
worked, miles traveled, or pieces pro-
duced).
.03 Optional method for meals only de-
duction. In lieu of using actual expenses,
employees and self-employed individu-
als, in computing the amount allowable as
a deduction for ordinary and necessary
meal and incidental expenses paid or in-
curred for travel away from home, may
use an amount computed at the Federal
M&IE rate for the locality of travel for
each calendar day (or partial day, see sec-
tion 6.04 of this revenue procedure) the
employee or self-employed individual is
away from home. Such amount will be
deemed substantiated for purposes of
paragraphs (b)(2) (travel away from
home) and (c) of § 1.274-5T, provided the
employee or self-employed individual
substantiates the elements of time, place,
and business purpose of the travel ex-
penses in accordance with those regula-
tions.
.04 Special rules for transportation in-
dustry.
(1) In general. This section 4.04 ap-
plies to (a) a payor that pays a per diem
allowance only for meal and incidental
expenses for travel away from home as
described in section 4.02 of this revenue
procedure to an employee in the trans-
portation industry, or (b) an employee or
self-employed individual in the trans-
portation industry who computes the
amount allowable as a deduction for meal
and incidental expenses for travel away
from home in accordance with section
4.03 of this revenue procedure.
(2) Rates. A taxpayer described in
section 4.04(1) of this revenue procedure
may treat $38 as the Federal M&IE rate
for any locality of travel in CONUS,
and/or $42 as the Federal M&IE rate for
any locality of travel OCONUS. A payor
that uses either (or both) of these special
rates with respect to an employee must
use the special rate(s) for all amounts sub-
ject to section 4.02 of this revenue proce-
dure paid to that employee for travel away
from home within CONUS and/or
OCONUS, as the case may be, during the
calendar year. Similarly, an employee or
self-employed individual that uses either
(or both) of these special rates must use
the special rate(s) for all amounts com-
puted pursuant to section 4.03 of this rev-
enue procedure for travel away from
home within CONUS and/or OCONUS,
as the case may be, during the calendar
year.
(3) Periodic rule. A payor described
in section 4.04(1) of this revenue proce-
dure may compute the amount of the em-
ployee’s expenses that is deemed substan-
tiated under section 4.02 of this revenue
procedure periodically (not less fre-
quently than monthly), rather than daily,
by comparing the total per diem al-
lowance paid for the period to the sum of
the amounts computed at the Federal
M&IE rate(s) for the localities of travel
for the days (or partial days, see section
6.04 of this revenue procedure) the em-
ployee is away from home during the pe-
riod. For example, assume an employee
in the transportation industry travels away
from home within CONUS on 17 days
(including partial days, see section 6.04 of
this revenue procedure) during a calendar
month and receives a per diem allowance
only for meal and incidental expenses
from a payor that uses the special rule
under section 4.04(2) of this revenue pro-
cedure. The amount deemed substanti-
ated under section 4.02 of this revenue
procedure is equal to the lesser of the total
per diem allowance paid for the month or
$646 (17 days at $38 per day).
(4) Transportation industry defined.
For purposes of this section 4.04 of this
revenue procedure, an employee or self-
employed individual is “in the transporta-
tion industry” only if the employee’s or
individual’s work (a) is of the type that di-
rectly involves moving people or goods
by airplane, barge, bus, ship, train, or
truck, and (b) regularly requires travel
away from home which, during any single
trip away from home, usually involves
travel to localities with differing Federal
M&IE rates. For purposes of the preced-
ing sentence, a payor must determine that
an employee or a group of employees is
“in the transportation industry” by using a
method that is consistently applied and in
accordance with reasonable business
practice.
SECTION 5. HIGH-LOW
SUBSTANTIATION METHOD
.01 General rule. If a payor pays a per
diem allowance in lieu of reimbursing ac-
tual expenses for lodging, meal, and inci-
dental expenses incurred or to be incurred
by an employee for travel away from
home and the payor uses the high-low
substantiation method described in this
section 5 for travel within CONUS, the
amount of the expenses that is deemed
substantiated for each calendar day is
equal to the lesser of the per diem al-
lowance for such day or the amount com-
puted at the rate set forth in section 5.02
of this revenue procedure for the locality
of travel for such day (or partial day, see
section 6.04 of this revenue procedure).
This high-low substantiation method may
be used in lieu of the per diem substantia-
tion method provided in section 4.01 of
this revenue procedure, but may not be
used in lieu of the meals only substantia-
tion method provided in section 4.02 or
4.03 of this revenue procedure.
.02 Specific high-low rates. The per
diem rate set forth in this section 5.02 is
$201 for travel to any “high-cost locality”
specified in section 5.03 of this revenue
procedure, or $124 for travel to any other
locality within CONUS. Whichever per
diem rate applies, it is applied as if it were
the Federal per diem rate for the locality
of travel. For purposes of applying the
high-low substantiation method and the §
274(n) limitation on meal expenses (see
section 6.05 of this revenue procedure),
the Federal M&IE rate shall be treated as
$42 for a high-cost locality and $34 for
any other locality within CONUS.
.03 High-cost localities. The following
localities have a Federal per diem rate of
$163 or more for all or part of the calen-
dar year, and are high-cost localities for
all of the calendar year or the portion of
the calendar year specified in parenthesis
under the key city name:

Key cityCounty or other defined location
California
San FranciscoSan Francisco
Sunnyvale/Palo Alto/San JoseSanta Clara
Tahoe CityPlacer
Colorado
AspenPitkin
(December 1-June 30)
Silverthorne/KeystoneSummit
TellurideSan Miguel
(November 1-March 31)
VailEagle
(December 1-March 31)
District of Columbia
Washington, D.C.Washington, D.C.; the cities of Alexandria, Fairfax, and
Falls Church, and the counties of Arlington, Fairfax, and
Loudoun, in Virginia; and the counties of Montgomery and
Prince George’s in Maryland
Florida
Key WestMonroe
(December 15-April 30)
Idaho
Sun ValleyCity limits of Sun Valley
(June 1-September 30)
Illinois
ChicagoCook and Lake
Maryland
(For the counties of Montgomery and Prince George’s, see District of Columbia)
Ocean City Worcester
(June 1-September 15)
Massachusetts
BostonSuffolk
CambridgeMiddlesex County (except Lowell)
Martha’s VineyardDukes
(June 1-September 30)
Michigan
CharlevoixCharlevoix
(July 1-September 30)
Mackinac IslandMackinac
Montana
Big SkyGallatin (except West Yellowstone Park)
New Jersey
Cape MayCape May (except Ocean City)
(June 1-September 30)
Ocean CityCity limits of Ocean City
(June 15-September 15)
Piscataway/BellemeadSomerset and Middlesex
PrincetonCity limits of Princeton
Union CountyUnion County
2000–2 I.R.B.283January 10, 2000

January 10, 20002842000–2 I.R.B.
New York
The Bronx/Brooklyn/QueensThe boroughs of The Bronx, Brooklyn, and Queens
ManhattanManhattan
Nassau County/Great NeckNassau County
Suffolk CountySuffolk County
White PlainsCity limits of White Plains
Pennsylvania
HersheyCity limits of Hershey
(June 1-September 15)
PhiladelphiaPhiladelphia
Utah
Park CitySummit
(December 20-March 31)
Virginia
(For the cities of Alexandria, Fairfax, and Falls Church, and the counties of Arlington, Fairfax, and Loudoun, see
District of Columbia)
.04 Changes in high-cost localities.
The list of high-cost localities in section
5.03 of this revenue procedure differs
from the list of high-cost localities in sec-
tion 5.03 of Rev. Proc. 98-64.
(1) The following localities (gener-
ally listed by key cities) have been added
to the list of high-cost localities: Santa
Clara County, California; Tahoe City, Cal-
ifornia; Silverthorne/Keystone, Colorado;
Prince George’s County, Maryland; Mid-
dlesex County, Massachusetts (except the
city limits of Lowell); Big Sky, Montana;
Bellemead, New Jersey; Middlesex
County, New Jersey; Princeton, New Jer-
sey; Nassau County/Great Neck, New
York; Suffolk County, New York; and
Loudoun County, Virginia.
(2) The portion of the year for which
the following are high-cost localities
(listed by key cities) has been changed:
Aspen, Colorado; Vail, Colorado; Key
West, Florida; Sun Valley, Idaho, Ocean
City, Maryland; Ocean City, New Jersey;
Hershey, Pennsylvania; and Park City,
Utah.
(3) The following localities (gener-
ally listed by key cities) have been re-
moved from the list of high-cost locali-
ties: Gulf Shores, Alabama; Gualala,
California; Yosemite National Park, Cali-
fornia; Delray Beach, Florida; Jupiter,
Florida; Palm Beach, Florida; Singer Is-
land, Florida; Bar Harbor, Maine; Balti-
more, Maryland; Stateline, Nevada;
Saratoga Springs, New York; Westchester
County, New York (except the city limits
of White Plains); West Point, New York;
Kill Devil Hills, North Carolina; Bala
Cynwyd, Pennsylvania; Newport, Rhode
Island; Hilton Head, South Carolina;
Myrtle Beach, South Carolina; Winter-
green, Virginia; and Seattle, Washington.
.05 Specific limitation.
(1) Except as provided in section
5.05(2) of this revenue procedure, a payor
that uses the high-low substantiation
method with respect to an employee must
use that method for all amounts paid to
that employee for travel away from home
within CONUS during the calendar year.
(2) With respect to an employee de-
scribed in section 5.05(1) of this revenue
procedure, the payor may reimburse ac-
tual expenses or use the meals only per
diem method described in section 4.02 of
this revenue procedure for any travel
away from home, and may use the per
diem substantiation method described in
section 4.01 of this revenue procedure for
any OCONUS travel away from home.
SECTION 6. LIMITATIONS AND
SPECIAL RULES
.01 In general. The Federal per diem
rate and the Federal M&IE rate described
in section 3.02 of this revenue procedure
for the locality of travel will be applied in
the same manner as applied under the
Federal Travel Regulations, 41 C.F.R.
Part 301-7 (1999), except as provided in
sections 6.02 through 6.04 of this revenue
procedure.
.02 Federal per diem rate. A receipt
for lodging expenses is not required in de-
termining the amount of expenses deemed
substantiated under section 4.01 or 5.01
of this revenue procedure. See section
7.01 of this revenue procedure for the re-
quirement that the employee substantiate
the time, place, and business purpose of
the expense.
.03 Federal per diem or M&IE rate.A
payor is not required to reduce the Federal
per diem rate or the Federal M&IE rate
for the locality of travel for meals pro-
vided in kind, provided the payor has a
reasonable belief that meal and incidental
expenses were or will be incurred by the
employee.
.04 Proration of the Federal per diem
or M&IE rate. Pursuant to the Federal
Travel Regulations, in determining the
Federal per diem rate or the Federal
M&IE rate for the locality of travel, the
full applicable Federal M&IE rate is
available for a full day of travel from
12:01 a.m. to 12:00 midnight. For pur-
poses of determining the amount deemed
substantiated under section 4 or 5 of this
revenue procedure with respect to partial
days of travel away from home, either of
the following methods may be used to
prorate the Federal M&IE rate to deter-
mine the Federal per diem rate or the Fed-
eral M&IE rate for the partial days of
travel:
(1) Such rate may be prorated using
the method prescribed by the Federal
Travel Regulations. Currently the Federal
Travel Regulations allow three-fourths of
the applicable Federal M&IE rate for each
partial day during which the employee or
self-employed individual is traveling
away from home in connection with the
performance of services as an employee
or self-employed individual; or

2000–2 I.R.B.285January 10, 2000
(2) Such rate may be prorated using
any method that is consistently applied
and in accordance with reasonable busi-
ness practice. For example, if an em-
ployee travels away from home from 9
a.m. one day to 5 p.m. the next day, a
method of proration that results in an
amount equal to 2 times the Federal
M&IE rate will be treated as being in ac-
cordance with reasonable business prac-
tice (even though only 1 _ times the Fed-
eral M&IE rate would be allowed under
the Federal Travel Regulations).
.05 Application of the appropriate §
274(n) limitation on meal expenses.All
or part of the amount of an expense
deemed substantiated under this revenue
procedure is subject to the appropriate
limitation under § 274(n) (see section
2.02 of this revenue procedure) on the de-
ductibility of food and beverage ex-
penses.
(1) When an amount for meal and in-
cidental expenses is computed pursuant to
section 4.03 of this revenue procedure,
the taxpayer must treat such amount as an
expense for food and beverages.
(2) When a per diem allowance is
paid only for meal and incidental ex-
penses, the payor must treat an amount
equal to the lesser of the allowance or the
Federal M&IE rate for the locality of
travel for such day (or partial day, see sec-
tion 6.04 of this revenue procedure) as an
expense for food and beverages.
(3) When a per diem allowance is
paid for lodging, meal, and incidental ex-
penses, the payor must treat an amount
equal to the Federal M&IE rate for the lo-
cality of travel for each calendar day (or
partial day, see section 6.04 of this rev-
enue procedure) the employee is away
from home as an expense for food and
beverages. For purposes of the preceding
sentence, when a per diem allowance for
lodging, meal, and incidental expenses is
paid at a rate that is less than the Federal
per diem rate for the locality of travel for
such day (or partial day, see section 6.04
of this revenue procedure), the payor may
treat an amount equal to 40 percent of
such allowance as the Federal M&IE rate
for the locality of travel for such day (or
partial day, see section 6.04 of this rev-
enue procedure).
.06 No double reimbursement or de-
duction. If a payor pays a per diem al-
lowance in lieu of reimbursing actual ex-
penses for lodging, meal, and incidental
expenses or for meal and incidental ex-
penses in accordance with section 4 or 5
of this revenue procedure, any additional
payment with respect to such expenses is
treated as paid under a nonaccountable
plan, is included in the employee’s gross
income, is reported as wages or other
compensation on the employee’s Form
W-2, and is subject to withholding and
payment of employment taxes. Similarly,
if an employee or self-employed individ-
ual computes the amount allowable as a
deduction for meal and incidental ex-
penses for travel away from home in ac-
cordance with section 4.03 or 4.04 of this
revenue procedure, no other deduction is
allowed to the employee or self-employed
individual with respect to such expenses.
For example, assume an employee re-
ceives a per diem allowance from a payor
for lodging, meal, and incidental expenses
or for meal and incidental expenses in-
curred while traveling away from home.
During that trip, the employee pays for
dinner for the employee and two business
associates. The payor reimburses as a
business entertainment meal expense the
meal expense for the employee and the
two business associates. Because the
payor also pays a per diem allowance to
cover the cost of the employee’s meals,
the amount paid by the payor for the em-
ployee’s portion of the business entertain-
ment meal expense is treated as paid
under a nonaccountable plan, is reported
as wages or other compensation on the
employee’s Form W-2, and is subject to
withholding and payment of employment
taxes.
.07 Related parties.Sections 4.01,
4.02, 4.04 (to the extent it relates to sec-
tion 4.02), and 5 of this revenue proce-
dure will not apply in any case in which a
payor and an employee are related within
the meaning of § 267(b), but for this pur-
pose the percentage of ownership interest
referred to in § 267(b)(2) shall be 10 per-
cent.
SECTION 7. APPLICATION
.01 If the amount of travel expenses is
deemed substantiated under the rules pro-
vided in section 4 or 5 of this revenue pro-
cedure, and the employee actually sub-
stantiates to the payor the elements of
time, place, and business purpose of the
travel expenses in accordance with para-
graphs (b)(2) (travel away from home)
and (c) (other than subparagraph
(2)(iii)(A) thereof) of § 1.274-5T, the em-
ployee is deemed to satisfy the adequate
accounting requirements of § 1.274-5T(f)
as well as the requirement to substantiate
by adequate records or other sufficient ev-
idence for purposes of § 1.274-5T(c). See
§ 1.62-2(e)(1) for the rule that an arrange-
ment must require business expenses to
be substantiated to the payor within a rea-
sonable period of time.
.02 An arrangement providing per diem
allowances will be treated as satisfying
the requirement of § 1.62-2(f)(2) with re-
spect to returning amounts in excess of
expenses if the employee is required to re-
turn within a reasonable period of time (as
defined in § 1.62-2(g)) any portion of
such an allowance that relates to days of
travel not substantiated, even though the
arrangement does not require the em-
ployee to return the portion of such an al-
lowance that relates to days of travel sub-
stantiated and that exceeds the amount of
the employee’s expenses deemed substan-
tiated. For example, assume a payor pro-
vides an employee an advance per diem
allowance for meal and incidental ex-
penses of $200, based on an anticipated 5
days of business travel at $40 per day to a
locality for which the Federal M&IE rate
is $34, and the employee substantiates 3
full days of business travel. The require-
ment to return excess amounts will be
treated as satisfied if the employee is re-
quired to return within a reasonable pe-
riod of time (as defined in § 1.62-2(g)) the
portion of the allowance that is attribut-
able to the 2 unsubstantiated days of
travel ($80), even though the employee is
not required to return the portion of the al-
lowance ($18) that exceeds the amount of
the employee’s expenses deemed substan-
tiated under section 4.02 of this revenue
procedure ($102) for the 3 substantiated
days of travel. However, the $18 excess
portion of the allowance is treated as paid
under a nonaccountable plan as discussed
in section 7.04 of this revenue procedure.
.03 An employee is not required to in-
clude in gross income the portion of a per
diem allowance received from a payor
that is less than or equal to the amount
deemed substantiated under the rules pro-
vided in section 4 or 5 of this revenue pro-
cedure if the employee substantiates the
business travel expenses covered by the

January 10, 20002862000–2 I.R.B.
per diem allowance in accordance with
section 7.01 of this revenue procedure.
See § 1.274-5T(f)(2)(i). In addition, such
portion of the allowance is treated as paid
under an accountable plan, is not reported
as wages or other compensation on the
employee’s Form W-2, and is exempt
from the withholding and payment of em-
ployment taxes. See § 1.62-2(c)(2) and
(c)(4).
.04 An employee is required to include
in gross income only the portion of the
per diem allowance received from a payor
that exceeds the amount deemed substan-
tiated under the rules provided in section
4 or 5 of this revenue procedure if the em-
ployee substantiates the business travel
expenses covered by the per diem al-
lowance in accordance with section 7.01
of this revenue procedure. See § 1.274-
5T(f)(2)(ii). In addition, the excess por-
tion of the allowance is treated as paid
under a nonaccountable plan, is reported
as wages or other compensation on the
employee’s Form W-2, and is subject to
withholding and payment of employment
taxes. See § 1.62-2(c)(3)(ii), (c)(5), and
(h)(2)(i)(B).
.05 If the amount of the expenses that is
deemed substantiated under the rules pro-
vided in section 4.01, 4.02, or 5 of this
revenue procedure is less than the amount
of the employee’s business expenses for
travel away from home, the employee
may claim an itemized deduction for the
amount by which the business travel ex-
penses exceed the amount that is deemed
substantiated, provided the employee sub-
stantiates all the business travel expenses,
includes on Form 2106, Employee Busi-
ness Expenses, the deemed substantiated
portion of the per diem allowance re-
ceived from the payor, and includes in
gross income the portion (if any) of the
per diem allowance received from the
payor that exceeds the amount deemed
substantiated. See § 1.274-5T(f)(2)(iii).
However, for purposes of claiming this
itemized deduction with respect to meal
and incidental expenses, substantiation of
the amount of the expenses is not required
if the employee is claiming a deduction
that is equal to or less than the amount
computed under section 4.03 of this rev-
enue procedure minus the amount deemed
substantiated under sections 4.02 and 7.01
of this revenue procedure. The itemized
deduction is subject to the appropriate
limitation (see section 2.02 of this rev-
enue procedure) on meal and entertain-
ment expenses provided in § 274(n) and
the 2-percent floor on miscellaneous
itemized deductions provided in § 67.
.06 An employee who does not receive
a per diem allowance for meal and inci-
dental expenses may deduct an amount
computed pursuant to section 4.03 of this
revenue procedure only as an itemized de-
duction. This itemized deduction is sub-
ject to the appropriate limitation (see sec-
tion 2.02 of this revenue procedure) on
meal and entertainment expenses pro-
vided in § 274(n) and the 2-percent floor
on miscellaneous itemized deductions
provided in § 67.
.07 A self-employed individual may
deduct an amount computed pursuant to
section 4.03 of this revenue procedure in
determining adjusted gross income under
§ 62(a)(1). This deduction is subject to
the appropriate limitation (see section
2.02 of this revenue procedure) on meal
and entertainment expenses provided in §
274(n).
.08 If a payor’s reimbursement or other
expense allowance arrangement evi-
dences a pattern of abuse of the rules of §
62(c) and the regulations thereunder, all
payments under the arrangement will be
treated as made under a nonaccountable
plan. Thus, such payments are included
in the employee’s gross income, are re-
ported as wages or other compensation on
the employee’s Form W-2, and are subject
to withholding and payment of employ-
ment taxes. See § 1.62-2(c)(3), (c)(5),
and (h)(2).
SECTION 8. WITHHOLDING AND
PAYMENT OF EMPLOYMENT
TAXES.
.01 The portion of a per diem al-
lowance, if any, that relates to the days of
business travel substantiated and that ex-
ceeds the amount deemed substantiated
for those days under section 4.01, 4.02, or
5 of this revenue procedure is subject to
withholding and payment of employment
taxes. See § 1.62-2(h)(2)(i)(B).
.02 In the case of a per diem allowance
paid as a reimbursement, the excess de-
scribed in section 8.01 of this revenue
procedure is subject to withholding and
payment of employment taxes in the pay-
roll period in which the payor reimburses
the expenses for the days of travel sub-
stantiated. See § 1.62-2(h)(2)(i)(B)(2).
.03 In the case of a per diem al-
lowance paid as an advance, the excess
described in section 8.01 of this revenue
procedure is subject to withholding and
payment of employment taxes no later
than the first payroll period following
the payroll period in which the days of
travel with respect to which the advance
was paid are substantiated. See § 1.62-
2(h)(2)(i)(B)(3). If some or all of the
days of travel with respect to which the
advance was paid are not substantiated
within a reasonable period of time and
the employee does not return the portion
of the allowance that relates to those
days within a reasonable period of time,
the portion of the allowance that relates
to those days is subject to withholding
and payment of employment taxes no
later than the first payroll period follow-
ing the end of the reasonable period.
See § 1.62-2(h)(2)(i)(A).
.04 In the case of a per diem allowance
only for meal and incidental expenses for
travel away from home paid to an em-
ployee in the transportation industry by a
payor that uses the rule in section 4.04(3)
of this revenue procedure, the excess of
the per diem allowance paid for the period
over the amount deemed substantiated for
the period under section 4.02 of this rev-
enue procedure (after applying section
4.04(3) of this revenue procedure), is sub-
ject to withholding and payment of em-
ployment taxes no later than the first pay-
roll period following the payroll period in
which the excess is computed. See §
1.62-2(h)(2)(i)(B)(4).
.05 For example, assume that an em-
ployer pays an employee a per diem al-
lowance to cover business expenses for
meals and lodging for travel away from
home at a rate of 120 percent of the Fed-
eral per diem rate for the localities to
which the employee travels. The em-
ployer does not require the employee to
return the 20 percent by which the reim-
bursement for those expenses exceeds the
Federal per diem rate. The employee sub-
stantiates 6 days of travel away from
home: 2 days in a locality in which the
Federal per diem rate is $100 and 4 days
in a locality in which the Federal per diem
rate is $125. The employer reimburses
the employee $840 for the 6 days of travel
away from home (2 x (120% x $100) + 4
x (120% x $125)), and does not require

2000–2 I.R.B.287January 10, 2000
the employee to return the excess payment
of $140 (2 days x $20 ($120-$100) + 4
days x $25 ($150-$125)). For the payroll
period in which the employer reimburses
the expenses, the employer must withhold
and pay employment taxes on $140. See
section 8.02 of this revenue procedure.
SECTION 9. EFFECT ON OTHER
DOCUMENTS
Rev. Proc. 98-64 is hereby superseded
for per diem allowances that are paid both
(1) to an employee on or after January 1,
2000, and (2) with respect to lodging,
meal, and incidental expenses or with re-
spect to meal and incidental expenses
paid or incurred for travel while away
from home on or after January 1, 2000.
Rev. Proc. 98-64 is also hereby super-
seded for purposes of computing the
amount allowable as a deduction for meal
and incidental expenses paid or incurred
by an employee or self-employed individ-
ual for travel while away from home on or
after January 1, 2000.
DRAFTING INFORMATION
The principal author of this revenue
procedure is Edwin B. Cleverdon of the
Office of Assistant Chief Counsel (In-
come Tax and Accounting). For further
information regarding this revenue proce-
dure, contact Mr. Cleverdon at (202) 622-
4920 (not a toll-free call).
26 CFR 601.601: Rules and regulations.
(Also Part I, § 1397E)
Rev. Proc. 2000-10
SECTION 1. PURPOSE
This revenue procedure sets forth the
maximum face amount of Qualified Zone
Academy Bonds (“Bond” or “Bonds”)
that may be issued for each State during
2000. For this purpose “State” includes
the District of Columbia and the posses-
sions of the United States.
SECTION 2. BACKGROUND
.01 Section 226 of the Taxpayer Relief
Act of 1997, Pub. L. 105-34, 111 Stat. 821
(1997), added § 1397E to the Internal Rev-
enue Code to provide a credit to holders of
Bonds under certain circumstances so that
the Bonds generally can be issued without
discount or interest. Ninety-five percent of
Bond proceeds are to be used for qualified
purposes, as defined by § 1397E(d)(5),
with respect to a qualified zone academy, as
defined by § 1397E(d)(4).
.02 Section 1397E(e)(1), as amended
by § 509 of the Tax Relief Extension Act
of 1999, Pub. L. 106-170, 113 Stat. 1860
(1999) provides that the aggregate
amount of Bonds that may be issued for
the States is limited to $400 million for
each of the years, 1998, 1999, 2000, and
2001 (the “national limitation”). This
amount is to be allocated among the
States by the Secretary on the basis of
their respective populations below the
poverty level (as defined by the Office of
Management and Budget) and is to be fur-
ther allocated by the State to qualified
zone academies within the State or pos-
session.
.03 Section 1397E(e)(4), as amended,
by § 509 of the Tax Relief Extension Act
of 1999, Pub. L. 106-170, 113 Stat. 1860
(1999) provides that any carryforward of
a limitation amount may be carried only
to the first 2 years (3 years for carryfor-
wards from 1998 or 1999) following the
unused limitation year. For this purpose a
limitation amount shall be treated as used
on a first–in first–out basis.
.04 Rev. Proc. 98-9, 1998-3 I.R.B. 56,
and Rev. Proc. 98-57, 1998-48 I.R.B. 5,
respectively, allocated the national limita-
tion for 1998 and 1999 among the States
and possessions.
SECTION 3. SCOPE
This revenue procedure applies to
Bonds issued under § 1397E during 2000.
SECTION 4. NATIONAL QUALIFIED
ZONE ACADEMY BOND
LIMITATION FOR 2000
The total face amount of Bonds that
may be issued in 2000 is $400 million.
This amount is allocated among the States
as follows:
MAXIMUM FACE AMOUNT OF
BONDS THAT MAY BE
ISSUED DURING 2000
STATE(thousands of dollars)
ALABAMA$ 6,612
ALASKA651
ARIZONA8,816
ARKANSAS4,093
CALIFORNIA55,570
COLORADO3,941
CONNECTICUT3,366
DELAWARE869
DISTRICT OF COLUMBIA1,238
FLORIDA20,879
GEORGIA11,227
HAWAII1,422
IDAHO1,792
ILLINOIS13,398
INDIANA5,939
IOWA2,790
KANSAS2,714

January 10, 20002882000–2 I.R.B.
MAXIMUM FACE AMOUNT OF
BONDS THAT MAY BE
ISSUED DURING 2000
STATE(thousands of dollars)
KENTUCKY$ 5,657
LOUISIANA8,914
MAINE1,422
MARYLAND3,898
MASSACHUSETTS5,733
MICHIGAN11,911
MINNESOTA5,407
MISSISSIPPI5,277
MISSOURI5,765
MONTANA1,661
NEBRASKA2,291
NEVADA2,117
NEW HAMPSHIRE1,292
NEW JERSEY7,524
NEW MEXICO4,028
NEW YORK33,311
NORTH CAROLINA11,281
NORTH DAKOTA1,053
OHIO13,605
OKLAHOMA4,973
OREGON5,461
PENNSYLVANIA14,528
RHODE ISLAND1,216
SOUTH CAROLINA5,722
SOUTH DAKOTA836
TENNESSEE8,132
TEXAS32,508
UTAH2,063
VERMONT630
VIRGINIA6,395
WASHINGTON5,559
WEST VIRGINIA3,388
WISCONSIN4,875
WYOMING554
AMERICAN SAMOA389
GUAM229
NORTHERN MARIANAS360
PUERTO RICO24,378
VIRGIN ISLANDS337
SECTION 6. EFFECTIVE DATE
This revenue procedure applies to
Bonds issued after December 31, 1999.
DRAFTING INFORMATION
The principal author of this revenue
procedure is Allan Seller of the Office of
Assistant Chief Counsel (Financial Insti-
tutions & Products). For further informa-
tion regarding this revenue procedure
contact Mr. Seller on (202) 622-3980 (not
a toll free call).
Effective Date of Proposed
Regulations under § 1.368-
2(d)(4)
Notice 2000-1
This document contains information re-
garding a Notice of Proposed Rulemaking
relating to the solely for voting stock re-
quirement in reorganizations under §
368(a)(1)(C) of the Internal Revenue
Code, which was published in the Federal
Register on June 14, 1999 (64 Fed. Reg.
31770 (1999)) (the “proposed regula-
tions”). See 1999-26 I.R.B. 6. The pro-
posed regulations, under § 1.368-2(d)(4),
provide that preexisting ownership of a
portion of a target corporation’s stock by
an acquiring corporation will not, in and
of itself, prevent the solely for voting
stock requirement in a “C” reorganization
from being satisfied. The regulations
propose to reverse the Internal Revenue
Service’s previous position that the acqui-
sition of assets of a partially controlled
subsidiary does not qualify as a tax-free
“C” reorganization. See Rev. Rul. 54-

2000–2 I.R.B.289January 10, 2000
396, 1954-2 C.B. 147. This position sub-
sequently was sustained in litigation in
Bausch & Lomb Optical Co. v. Commis-
sioner, 267 F.2d 75 (2d Cir.), cert. denied,
361 U.S. 835 (1959). The regulations are
proposed to apply to transactions occur-
ring after the date that a Treasury decision
adopting the regulations is published in
the Federal Register, except that they do
not apply to any transactions occurring
pursuant to a written agreement which is
(subject to customary conditions) binding
on the date that the regulations are pub-
lished as final regulations in the Federal
Register, and at all times thereafter.
Comments were received requesting
that taxpayers be allowed to apply the
proposed regulations to transactions oc-
curring before the proposed regulations
are published as final regulations. The In-
ternal Revenue Service and Treasury De-
partment have determined that the in-
creased flexibility that results from the
proposed regulations should be available
to taxpayers in structuring transactions
before the publication as final regulations.
Accordingly, the proposed regulations,
when finalized, will be modified to pro-
vide that the regulations apply to transac-
tions occurring after December 31, 1999,
unless the transaction occurs pursuant to a
written agreement that is (subject to cus-
tomary conditions) binding on that date
and at all times thereafter. Taxpayers may
rely on this Notice until final regulations
are issued.
In addition, taxpayers may request a
private letter ruling permitting them to
apply the final regulations to transactions
occurring on or after June 11, 1999 (the
date the proposed regulations were filed
with the Federal Register) to which the
final regulations would not otherwise
apply, and for which there was not a writ-
ten agreement (subject to customary con-
ditions) binding on June 11, 1999 and at
all times thereafter. A private letter ruling
will not be issued unless the taxpayer es-
tablishes to the satisfaction of the Service
that there is not a significant risk of differ-
ent parties to the transaction taking incon-
sistent positions, for U.S. tax purposes,
with respect to the applicability of the
final regulations to the transaction.
The principal author of this notice is
Marnie Rapaport of the Office of the As-
sistant Chief Counsel (Corporate) For
further information regarding this notice,
contact Ms. Rapaport on (202) 622- 7550
(not toll-free call).

January 10, 20002902000–2 I.R.B.
Notice of Proposed Rulemaking
and Notice of Public Hearing
Definition of Contribution in Aid
of Construction Under Section
118(c)
REG-106012-98
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations concerning the defi-
nition of a contribution in aid of construc-
tion under section 118(c) and the adjusted
basis of any property acquired with a con-
tribution in aid of construction. The pro-
posed regulations affect a regulated pub-
lic utility that provides water or sewerage
services because a qualifying contribution
in aid of construction is treated as a con-
tribution to the capital of the utility and
excluded from gross income. This docu-
ment also provides notice of a public
hearing on these proposed regulations.
DATES: Written and electronic comments
must be received by March 22, 2000.
Outlines of topics to be discussed at the
public hearing scheduled for April 27,
2000, must be received by April 6, 2000.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG-106012-98),
room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. Submissions may be
hand delivered Monday through Friday
between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG-106012-98),
Courier’s Desk, Internal Revenue Ser-
vice, 1111 Constitution Avenue, NW.,
Washington, DC. Alternatively, taxpay-
ers may submit comments electronically
via the Internet by selecting the “Tax
Regs” option on the IRS Home Page, or
by submitting comments directly to the
IRS Internet site at http://www.irs.us-
treas.gov/tax_regs/regslist.html. The
public hearing will be held in room 2615,
Internal Revenue Building, 1111 Consti-
tution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CON-
TACT: Concerning the regulations, Paul
Handleman, (202) 622-3040; concerning
submissions, the hearing, and/or to be
placed on the building access list to attend
the hearing, LaNita Van Dyke, (202) 622-
7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in this notice of proposed rulemak-
ing has been submitted to the Office of
Management and Budget for review in ac-
cordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)). Com-
ments on the collection of information
should be sent to the Office of Manage-
ment and Budget, Attn: Desk Officer for
the Department of the Treasury, Office of
Information and Regulatory Affairs,
Washington, DC 20503, with copies to
the Internal Revenue Service, Attn: IRS
Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224. Comments on
the collection of information should be re-
ceived by February 18, 2000. Comments
are specifically requested concerning:
Whether the proposed collection of infor-
mation is necessary for the proper perfor-
mance of the functions of the IRS, includ-
ing whether the information will have
practical utility;
The accuracy of the estimated burden as-
sociated with the proposed collection of
information (see below);
How the quality, utility, and clarity of the in-
formation to be collected may be enhanced;
How the burden of complying with the
proposed collection of information may
be minimized, including through the ap-
plication of automated collection tech-
niques or other forms of information tech-
nology; and
Estimates of capital or start-up costs and
costs of operation, maintenance, and pur-
chase of services to provide information.
The requirement for the collection of in-
formation in this notice of proposed rule-
making is in §1.118-2(e). The information
is required by the IRS to establish that a
taxpayer has notified the IRS of amounts
to be treated as a contribution to capital
under section 118(c). This information
will be used to determine when the statu-
tory period for the assessment of any defi-
ciency attributable to any contribution to
capital under section 118(c) expires. The
collection of information is mandatory.
The likely respondents are businesses and
other for-profit organizations.
Estimated total annual reporting burden:
100 hours.
The estimated annual burden per respon-
dent varies from .5 hours to 5 hours, de-
pending on individual circumstances,
with an estimated average of 1 hour.
Estimated number of respondents : 100.
Estimated annual frequency of responses:
annually.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
control number assigned by the Office of
Management and Budget.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
This document contains proposed
amendments to the Income Tax Regula-
tions (26 CFR part 1) to provide regulations
under section 118(c) of the Internal Rev-
enue Code of 1986. Section 118(c) was
added to the Code by section 1613(a)(1)(B)
of the Small Business Job Protection Act of
1996 (SBJPA of 1996), 1996-3 C.B. 155,
248-250. Under section 1613(a)(3) of the
SBJPA of 1996, the amendments made by
section 1613(a) apply to amounts received
after June 12, 1996.
Explanation of Provisions
Contribution to Capital
Section 118(a) generally provides that,
in the case of a corporation, gross income
does not include any contribution to the
capital of the taxpayer. Under section
118(b), a contribution in aid of construc-
tion generally is not a contribution to the
capital of the taxpayer and is not excluded
from gross income under section 118(a).
Part IV. Items of General Interest

2000–2 I.R.B.291January 10, 2000
However, for amounts received after June
12, 1996, section 118(c) provides an ex-
ception to this rule.
Under section 118(c)(1), the term “con-
tribution to the capital of the taxpayer” in-
cludes any amount of money or other
property received from any person
(whether or not a shareholder) by a regu-
lated public utility that provides water or
sewerage disposal services if the amount
is a contribution in aid of construction. In
the case of a contribution of property
other than water or sewerage disposal fa-
cilities, the amount must meet the require-
ments of the expenditure rule of section
118(c)(2) (which generally requires that
the amount is expended to acquire or con-
struct water or sewerage disposal facili-
ties within the specified time period).
Moreover, the amount (or any property
acquired or constructed with the amount)
cannot be included in the taxpayer’s rate
base for rate-making purposes.
Contribution in Aid of Construction
Section 118(c)(3)(A) provides that, for
purposes of section 118(c), the term “con-
tribution in aid of construction” shall be
defined by regulations prescribed by the
Secretary, except that such term shall not
include amounts paid as service charges
for starting or stopping services.
Section 118(c) was added by the
SBJPA of 1996 “to restore the contribu-
tion in aid of construction provision that
was repealed by the Tax Reform Act of
1986 (1986 Act) for regulated public utili-
ties that provide water or sewerage dis-
posal services.” H.R. Conf. Rep. No.
737, 104th Cong., 2d Sess. 316 (1996),
1996-3 C.B. 741, 1056. Before the 1986
Act, former section 118(b) generally pro-
vided that a contribution in aid of con-
struction received by a regulated public
utility was treated as a contribution to the
capital of the taxpayer and was excluded
from gross income. However, former
section 118(b)(3)(A) provided that the
term “contribution in aid of construction”
did not include amounts paid as customer
connection fees (including amounts paid
to connect the customer’s line to an elec-
tric line, a gas main, a steam line, or a
main water or sewer line and amounts
paid as service charges for starting or
stopping services). The legislative history
of the SBJPA of 1996 also states that
“[p]rior to the enactment of the Tax Re-
form Act of 1986 ... [a nontaxable] contri-
bution in aid of construction did not in-
clude a connection fee.” Id.
The nontaxable contribution in aid of
construction provision in former section
118(b) is derived from a line of cases, in-
cluding several Supreme Court cases, be-
ginning with Edwards v. Cuba R.R., 268
U.S. 628 (1925), IV-2 C.B. 122. In Ed-
wards,the Supreme Court held that sub-
sidy payments by the Republic of Cuba to
a railroad company to induce the con-
struction and operation of a railroad in
Cuba were not included in the recipient
corporation’s gross income because the
payments were not made for services ren-
dered or to be rendered. In Detroit Edison
Co. v. Commissioner, 319 U.S. 98 (1943),
1943 C.B. 1019, the Supreme Court
looked at the contributors’ motivation to
determine whether payments by cus-
tomers for extending electrical service
lines were nonshareholder contributions
to capital. Because the transferors re-
ceived direct benefits in the form of ser-
vices as a result of the contributions, the
Court held that the payments were not
contributions to capital, but the price for
receiving service.
The Supreme Court elaborated on the
contributor’s motivation in Brown Shoe
Co. v. Commissioner,339 U.S. 583
(1950), 1950-1 C.B. 38, when it held that,
if the transferor did not anticipate any di-
rect benefit from the contribution, such as
the receipt of services, but expected only
that the transaction would benefit the
community at large, the funds were con-
tributions to capital. The lack of a direct
benefit to the transferor was considered
indicative of an intent to increase the
transferee’s capital. In United States v.
Chicago, Burlington & Quincy R.R., 412
U.S. 401 (1973), 1973-2 C.B. 428, the
Supreme Court held that government pay-
ments received by a railroad company for
improvements at grade crossing and inter-
sections were not contributions to capital.
In reaching its holding, the Court set forth
five characteristics of a nonshareholder
contribution to capital, including that the
amounts received must not constitute pay-
ments for specific, quantifiable services
provided for the transferor by the trans-
feree.
Consistent with the above Supreme
Court cases, a customer connection fee
would not have qualified as a nonshare-
holder contribution to the capital of the
utility under section 118(a) because the
fee clearly is paid as a prerequisite for ob-
taining services. In addition, the IRS’ po-
sition prior to the enactment of former
section 118(b) as articulated in Rev. Rul.
75-557, 1975-2 C.B. 33, was that cus-
tomer connection fees charged by a water
utility were not excludable from income.
In 1976, Congress enacted former section
118(b) to treat contributions in aid of con-
struction to water or sewerage disposal fa-
cilities as excludable contributions to cap-
ital. This legislation specifically excluded
customer connection fees from the defini-
tion of nontaxable contributions in aid of
construction. As explained by the court in
Florida Progress Corp. v. United States,
M.D. Fla., No. 93-246-CIV-T-25A,
9/2/98, Congress enacted former section
118(b) in 1976 to codify the already exist-
ing case law with regard to contributions
in aid of construction to water and sewer-
age disposal facilities. Thereafter, pay-
ments made to a utility to encourage the
extension of facilities into new areas ben-
efitting a large number of people would
be given tax free status; however, as held
by the Supreme Court in Detroit Edison,
payments made to a utility as a prerequi-
site to receiving water or sewerage ser-
vice would be treated as taxable income
to the utility.
The proposed regulations define the
term “contribution in aid of construction,”
for purposes of section 118(c), as mean-
ing any amount of money or other prop-
erty contributed to a regulated public util-
ity that provides water or sewerage
disposal services to the extent that the
purpose of the contribution is to provide
for the expansion, improvement, or re-
placement of the utility’s water or sewer-
age disposal facilities. However, to re-
store the contribution in aid of
construction provision that existed before
the 1986 Act for regulated public utilities
providing water and sewerage disposal
services as well as to be consistent with
the Supreme Court cases discussed above,
the proposed regulations exclude cus-
tomer connection fees from the definition
of contribution in aid of construction.
A customer connection fee is defined in
the proposed regulations as any amount of
money or property contributed to the util-
ity representing the cost of installing a
connection or service line (including the

January 10, 20002922000–2 I.R.B.
cost of meters and piping) from the util-
ity’s main water or sewer lines to the line
owned by the customer or potential cus-
tomer. However, money or property con-
tributed for a connection or service line
from the utility’s main line to the cus-
tomer ’s or potential customer’s line is not
a customer connection fee if the connec-
tion or service line does serve, or is de-
signed to serve, more than one customer.
The proposed regulations also define a
customer connection fee as including any
amount paid as a service charge for stop-
ping or starting service.
The proposed regulations indicate that
a contribution in aid of construction may
include an amount of money or other
property contributed to a regulated pub-
lic utility for a water or sewerage dis-
posal facility subject to a contingent
obligation to repay, in whole or in part,
the amount to the contributor (com-
monly referred to as an “advance”).
However, no inference is intended as to
whether an amount subject to such a re-
payment obligation is a contribution or
loan. Whether an advance is a contribu-
tion or a loan is determined under gen-
eral principles of federal tax law based
on all the facts and circumstances.
Adjusted Basis
Section 118(c)(4) provides that
notwithstanding any other provision of
subtitle A, no deduction or credit shall be
allowed for, or by reason of, any expendi-
ture which constitutes a contribution in
aid of construction to which section
118(c) applies. The adjusted basis of any
property acquired with a contribution in
aid of construction to which section
118(c) applies shall be zero.
Consistent with section 118(c)(4), the
proposed regulations provide rules for ad-
justing the basis of water or sewerage dis-
posal facilities acquired as, or acquired or
constructed with any money received as,
a contribution in aid of construction.
Statute of Limitations
Section 118(d)(1) provides that if the
taxpayer for any taxable year treats an
amount as a contribution to the capital of
the taxpayer described in section 118(c),
then the statutory period for the assess-
ment of any deficiency attributable to
any part of the amount does not expire
before the expiration of 3 years from the
date the Secretary is notified by the tax-
payer (in such manner as the Secretary
may prescribe) of the amount of the ex-
penditure referred to in section
118(c)(2)(A), of the taxpayer’s intention
not to make the expenditures referred to
in section 118(c)(2)(A), or of a failure to
make the expenditure within the period
described in section 118(c)(2)(B). Sec-
tion 118(d)(2) provides that the defi-
ciency may be assessed before the expi-
ration of such 3-year period
notwithstanding the provisions of any
other law or rule of law which would
otherwise prevent assessment. The pro-
posed regulations provide the time and
manner for taxpayers to notify the Secre-
tary with respect to its contributions in
aid of construction under section
118(d)(1).
Proposed Effective Date
The regulations are proposed to be ap-
plicable for any money or other property
received by a regulated public utility that
provides water or sewerage disposal ser-
vices on or after the date final regulations
are published 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. Therefore, a regu-
latory assessment is not required. It is
hereby certified that the collection of in-
formation in these regulations will not
have a significant economic impact on a
substantial number of small entities.
This certification is based upon the fact
that any burden on taxpayers is minimal.
Accordingly, a Regulatory Flexibility
Analysis under the Regulatory Flexibil-
ity Act (5 U.S.C. chapter 6) is not re-
quired. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice
of proposed rulemaking will be submit-
ted 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, considera-
tion will be given to any written com-
ments (a signed original and eight (8)
copies) or electronic comments that are
submitted timely to the IRS. The IRS and
Treasury Department specifically request
comments on the clarity of the proposed
rule and how it may be made easier to un-
derstand. All comments will be available
for public inspection and copying.
A public hearing has been scheduled
for Thursday, April 27, 2000, at 10 a.m.
in room 2615, Internal Revenue Build-
ing, 1111 Constitution Avenue, NW.,
Washington DC. Due to building secu-
rity procedures, visitors must enter at
the 10
th
Street entrance, located between
Constitution and Pennsylvania Avenues,
NW. In addition, all visitors must pre-
sent photo identification to enter the
building. Because of access restrictions,
visitors will not be admitted beyond the
immediate entrance area more than 15
minutes before the hearing starts. For
information about having your name
placed on the building access list to at-
tend the hearing, see the “FOR FUR-
THER INFORMATION CONTACT”
section of this preamble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing.
Persons who wish to present oral com-
ments at the hearing must submit an out-
line of the topics to be discussed and the
time to be devoted to each topic (signed
original and eight (8) copies) by April 6,
2000.
A period of 10 minutes will be allotted
to each person for making comments.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal author of these regula-
tions is Paul F. Handleman, Office of the
Assistant Chief Counsel (Passthroughs
and Special Industries), IRS. However,
other personnel from the IRS and Trea-
sury Department participated in their de-
velopment.
* * * * *
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:

2000–2 I.R.B.293January 10, 2000
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.118-2 also issued under 26
U.S.C. 118(c)(3)(A); * * *
Par. 2. Section 1.118-2 is added to read
as follows:
§1.118-2 Contribution in aid of construc-
tion.
(a) Special rule for water and sewer-
age disposal utilities—(1) In general.
For purposes of section 118, the term
“contribution to the capital of the tax-
payer” includes any amount of money or
other property received from any person
(whether or not a shareholder) by a regu-
lated public utility that provides water or
sewerage disposal services if—
(i) The amount is a contribution in aid
of construction under paragraph (b) of
this section;
(ii) In the case of a contribution of
property other than water or sewerage dis-
posal facilities, the amount satisfies the
expenditure rule under paragraph (c) of
this section; and
(iii) The amount (or any property ac-
quired or constructed with the amount) is
not included in the taxpayer’s rate base
for ratemaking purposes.
(2) Definitions—(i) Regulated public
utilityhas the meaning given such term by
section 7701(a)(33), except that such term
does not include any utility which is not
required to provide water or sewerage dis-
posal services to members of the general
public in its service area.
(ii) Water or sewerage disposal facility
is defined as tangible property described
in section 1231(b) that is used predomi-
nately (i.e., 80% or more) in the trade or
business of furnishing water or sewerage
disposal services.
(b) Contribution in aid of
construction—(1) In general.For pur-
poses of section 118(c) and this section,
the term “contribution in aid of construc-
tion” means any amount of money or
other property contributed to a regulated
public utility that provides water or sew-
erage disposal services to the extent that
the purpose of the contribution is to pro-
vide for the expansion, improvement, or
replacement of the utility’s water or sew-
erage disposal facilities.
(2) Advances. A contribution in aid of
construction may include an amount of
money or other property contributed to a
regulated public utility for a water or sew-
erage disposal facility subject to a contin-
gent obligation to repay the amount, in
whole or in part, to the contributor (com-
monly referred to as an “advance”). For
example, an amount received by a utility
from a developer to construct a water fa-
cility pursuant to an agreement under
which the utility will pay the developer a
percentage of the receipts from the facil-
ity over a fixed period may constitute a
contribution in aid of construction.
Whether an advance is a contribution or a
loan is determined under general princi-
ples of federal tax law based on all the
facts and circumstances. For the treat-
ment of any amount of a contribution in
aid of construction that is repaid by the
utility to the contributor, see paragraphs
(c)(2)(ii) and (d)(2) of this section.
(3) Customer connection fee.A cus-
tomer connection fee is not a contribution
in aid of construction under this para-
graph (b) and is includible in income.
The term “customer connection fee” in-
cludes any amount of money or other
property transferred to the utility repre-
senting the cost of installing a connection
or service line (including the cost of me-
ters and piping) from the utility’s main
water or sewer lines to the line owned by
the customer or potential customer. How-
ever, money or other property contributed
for a connection or service line from the
utility’s main line to the customer’s or po-
tential customer’s line is not a customer
connection fee if the connection or ser-
vice line does serve, or is designed to
serve, more than one customer. A cus-
tomer connection fee also includes any
amount paid as a service charge for stop-
ping or starting service.
(4) Binding agreement to reimburse
utility for a facility previously placed in
service. If a water or sewerage disposal
facility is placed in service by the utility
before an amount is contributed to the
utility, the contribution is not a contribu-
tion in aid of construction under this para-
graph (b) with respect to the cost of the
facility unless, at the time the facility is
placed in service by the utility, there is an
agreement, binding under local law be-
tween the prospective contributor and the
utility, that the utility is to receive the
amount as reimbursement for the cost of
acquiring or constructing the facility. If
such an agreement exists, the basis of the
facility must be reduced by the amount of
the contribution at the time the facility is
placed in service.
(5) Classification by ratemaking au-
thority. The fact that the applicable
ratemaking authority classifies any
money or other property received by a
utility as a contribution in aid of construc-
tion is not conclusive as to its treatment
under this paragraph (b).
(c) Expenditure rule—(1) In general.
An amount satisfies the expenditure rule
of section 118(c)(2) if the amount is ex-
pended for the acquisition or construction
of property described in section
118(c)(2)(A), the amount is paid or in-
curred before the end of the second tax-
able year after the taxable year in which
the amount was received as required by
section 118(c)(2)(B), and accurate records
are kept of contributions and expenditures
as provided in section 118(c)(2)(C).
(2) Excess amount—(i) Includible in
the utility’s income. An amount received
by a utility as a contribution in aid of con-
struction that is not expended for the ac-
quisition or construction of water or sew-
erage disposal facilities as required by
paragraph (c)(1) of this section (the ex-
cess amount) is not a contribution to the
capital of the taxpayer under paragraph
(a) of this section. Except as provided in
paragraph (c)(2)(ii) of this section, such
excess amount is includible in the utility’s
income in the taxable year in which the
amount was received.
(ii) Repayment of excess amount. If
the excess amount described in paragraph
(c)(2)(i) of this section is repaid, in whole
or in part, either—
(A) Before the end of the time period
described in paragraph (c)(1) of this sec-
tion, the repayment amount is not includi-
ble in the utility’s income; or
(B) After the end of the time period de-
scribed in paragraph (c)(1) of this section,
the repayment amount may be deducted
by the utility in the taxable year in which
it is paid or incurred to the extent such
amount was included in income.
(3) Example.The application of this
paragraph (c) is illustrated by the follow-
ing example:
Example. M, a calendar year regulated public
utility that provides water services, received a
$1,000,000 contribution in aid of construction in

January 10, 20002942000–2 I.R.B.
1999 for the purpose of constructing a water facility.
To the extent that the $1,000,000 exceeded the ac-
tual cost of the facility, the contribution was subject
to being returned. In 2000, M built the facility at a
cost of $700,000 and returned $200,000 to the con-
tributor. As of the end of 2001, M had not returned
the remaining $100,000. Assuming accurate records
are kept, the requirement under section 118(c)(2) is
satisfied for $700,000 of the contribution. Because
$200,000 of the contribution was returned within the
time period during which qualifying expenditures
could be made, this amount is not includible in M’s
income. However, the remaining $100,000 is in-
cludible in M’s income for its 1999 taxable year (the
taxable year in which the amount was received) be-
cause the amount was neither spent nor repaid dur-
ing the prescribed time period. To the extent M re-
pays the remaining $100,000 after year 2001, M
would be entitled to a deduction in the year such re-
payment is paid or incurred.
(d) Adjusted basis—(1) Exclusion
from basis. Except for a repayment de-
scribed in paragraph (d)(2) of this section,
to the extent that a water or sewerage dis-
posal facility is acquired or constructed
with an amount received as a contribution
to the capital of the taxpayer under para-
graph (a) of this section, the basis of the
facility is reduced by the amount of the
contribution. To the extent the water or
sewerage disposal facility is acquired as a
contribution to the capital of the taxpayer
under paragraph (a) of this section, the
basis of the contributed facility is zero.
(2) Repayment of contribution. If a
contribution to the capital of the taxpayer
under paragraph (a) of this section is re-
paid to the contributor, either in whole or
in part, then the repayment amount is a
capital expenditure in the taxable year in
which it is paid or incurred, resulting in
an increase in the property’s adjusted
basis in such year.
(3) Allocation of contributions.An
amount treated as a capital expenditure
under this paragraph (d) is to be allocated
proportionately to the adjusted basis of
each property acquired or constructed
with the contribution based on the relative
cost of such property.
(4) Example.The application of this
paragraph (d) is illustrated by the follow-
ing example:
Example. A, a calendar year regulated public
utility that provides water services, received a
$1,000,000 contribution in aid of construction in
1999 as an advance from B, a developer, for the pur-
pose of constructing a water facility. To the extent
that the $1,000,000 exceeds the actual cost of the fa-
cility, the contribution is subject to being returned.
Under the terms of the advance, A agrees to pay to B
a percentage of the receipts from the facility over a
fixed period, but limited to the cost of the facility. In
2000, A builds the facility at a cost of $700,000 and
returns $300,000 to B. In 2001, A pays $20,000 to B
out of the receipts from the facility. Assuming accu-
rate records are kept, the $700,000 advance is a con-
tribution to the capital of A under paragraph (a) of
this section and is excludable from A’s income. The
basis of the $700,000 facility constructed with this
contribution to capital is zero. The $300,000 excess
amount is not a contribution to the capital of A under
paragraph (a) of this section because it does not
meet the expenditure rule described in paragraph
(c)(1) of this section. However, this excess amount
is not includible in A’s income pursuant to paragraph
(c)(2)(ii) of this section since the amount is repaid to
B within the required time period. The repayment of
the $300,000 excess amount to B in 2000 is not
treated as a capital expenditure by A. The $20,000
payment to B in 2001 is treated as a capital expendi-
ture by A in 2001 resulting in an increase in the ad-
justed basis of the water facility from zero to
$20,000.
(e) Statute of limitations—(1) Exten-
sion of statute of limitations.Under sec-
tion 118(d)(1), the statutory period for as-
sessment of any deficiency attributable to
a contribution to capital under paragraph
(a) of this section does not expire before
the expiration of 3 years after the date the
taxpayer notifies the Secretary in the time
and manner prescribed in paragraph (e)(2)
of this section.
(2) Time and manner of notification.
Notification is made by attaching a state-
ment to the taxpayer’s federal income tax
return for the taxable year in which any of
the reportable items in paragraphs
(e)(2)(i) through (iii) of this section occur.
The statement must contain the taxpayer’s
name, address, employer identification
number, taxable year and the following
information with respect to contributions
of property other than water or sewerage
disposal facilities that are subject to the
expenditure rule described in paragraph
(c) of this section:
(i) The amount of contributions in aid
of construction expended during the tax-
able year for property described in section
118(c)(2)(A) (qualified property) as re-
quired under paragraph (c)(1) of this sec-
tion, identified by taxable year in which
the contributions were received.
(ii) The amount of contributions in aid
of construction that the taxpayer does not
intend to expend for qualified property as
required under paragraph (c)(1) of this
section, identified by taxable year in
which the contributions were received.
(iii) The amount of contributions in aid
of construction that the taxpayer failed to
expend for qualified property as required
under paragraph (c)(1) of this section,
identified by taxable year in which the
contributions were received.
(f) Effective date. This section is ap-
plicable for any money or other property
received by a regulated public utility that
provides water or sewerage disposal ser-
vices on or after the date final regulations
are published in the Federal Register.
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on De-
cember 17, 1999, 8:45 a.m., and published in the
issue of the Federal Register for December 20, 1999,
64 F.R. 71082)
Announcement and Request for
Comments on Certain Plans of
State and Local Government
Employers under Section 457
Announcement 2000-1
Purpose
The Internal Revenue Service (IRS) is
considering the proper treatment of
amounts under certain plans of state and
local governments. This announcement
provides interim information about the re-
porting requirements that apply to these
plans. The information contained in this
announcement will apply until further
guidance is issued by the Service.
Background
Section 457 plans are nonqualified de-
ferred compensation plans established by
state and local government and tax-exempt
employers. Under section 457(e)(11) of the
Internal Revenue Code, certain bona fide
sick, vacation, compensatory time, sever-
ance pay, disability pay or death benefit
plans are treated as not providing for the
deferral of compensation and are therefore
excluded from section 457.

2000–2 I.R.B.295January 10, 2000
If a plan is not a bona fide plan described
in section 457(e)(11), the proper reporting
of amounts under the plan generally de-
pends on whether the plan is an eligible
plan that meets the requirements of section
457(b) or an ineligible section 457(f) plan
that does not meet these requirements. In
order to be an eligible plan under section
457(b), the plan must meet a number of re-
quirements, including the requirement that
the amounts deferred for each year must
generally not exceed the lesser of $8000
(for 1999) or 33 1/3 percent of compensa-
tion and must be subject to restrictions on
the time of distribution.
Under section 457(a), compensation de-
ferred under an eligible plan, and the in-
come attributable to that deferred compen-
sation, is not includible in gross income
until the taxable year in which the amounts
are actually paid or made available to the
plan participant or other beneficiary. Simi-
larly, if a plan is a bona fide severance pay
plan described in section 457(e)(11),
amounts under the plan are generally not
includible in gross income until paid or
made available. In contrast, amounts under
a plan described in section 457(f) are in-
cluded in the participant or beneficiary’s
gross income for the first taxable year in
which there is no substantial risk of forfei-
ture of the rights to the compensation.
Timing of reporting of payments under
certain plans
Under this interim guidance by the Ser-
vice, state and local governments should
not report amounts, on either a Form 1099
or a Form W-2, for any year prior to the
year in which the participant or benefi-
ciary is in actual or constructive receipt of
these amounts, if the amounts are pro-
vided under the following type of plan:
• The plan was in existence on December
22, 1999.
• The plan is a broad-based plan main-
tained by a state or local government em-
ployer primarily for non-highly compen-
sated employees.
• The plan is nonelective. That is, the
plan must not provide the participant with
a choice between current and future com-
pensation.
• The plan has been treated by the state or
local government as a bona fide severance
pay plan under section 457(e)(11) for
those years before calendar year 1999 in
which the plan was in existence.
• The plan satisfies the following three re-
quirements:
a. Payments under the plan are
designed to provide supplemental
income for a transitional period, rather
than to provide retirement income.
b. Payments under the plan are made
only after separation from service with
the employer, including retirement.
c. Payments are completed within a
short period of time, not to exceed 5
years, after separation from service.
Solely for purposes of this announce-
ment, a plan that provides severance pay
benefits as described in §31.3121(v)(2)-
1(b)(4)(iv)(B) of the Regulations will be
treated as satisfying (a), (b) and (c) above.
REQUEST FOR PUBLIC COMMENT
The Service and the Treasury Depart-
ment understand that, in the absence of for-
mal guidance, many state and local gov-
ernments maintain plans with the above
characteristics under the belief that these
plans are “bona fide severance pay plans”
within the meaning of section 457(e)(11),
and accordingly would not be subject to
the income inclusion provisions applicable
to ineligible section 457(f) plans. The Ser-
vice and the Treasury Department are now
considering guidance under section 457
with respect to certain plans of state and
local government and tax-exempt employ-
ers and are requesting comments on what
types of plans maintained by state and
local government and tax exempt employ-
ers are properly considered bona fide sev-
erance pay plans for purposes of section
457. Send written comments to: Internal
Revenue Service, Attn:
CC:DOM:CORP:R (Section 457 Plans),
Room 5201, P.O. Box 7604, Ben Franklin
Station, Washington, D.C. 20044. Written
comments may be hand delivered Monday
through Friday between the hours of 8 a.m.
and 5 p.m. to: Internal Revenue Service,
Courier’s Desk, Attn: CC:DOM:CORP:R
(Section 457 Plans), 1111 Constitution Av-
enue, N.W., Washington, D.C. 20224. Al-
ternatively, written comments may be sub-
mitted electronically via the Internet by
selecting the “Tax Regs” option on the IRS
Home Page, or by submitting them directly
to the IRS Internet site at:
http://www.irs.gov/tax_regs/regslist.html.
Comments should be received by Febru-
ary 20, 2000.
FOR FURTHER INFORMATION
CONTACT: Cheryl Press
of the Office
of Associate Chief Counsel (Em-
ployee Benefits and Exempt Organi-
zations)
at (202) 622-4606 (not a toll-
free number).
Internal Revenue Service to
Make Information Letters
Available for Public Inspection
Announcement 2000-2
The Internal Revenue Service will make
information letters written by the National
Office of Chief Counsel and the Commis-
sioner, Tax Exempt and Government Enti-
ties Division, to members of the public in re-
sponse to inquiries postmarked or, if not
mailed, received after January 1, 2000, avail-
able for public inspection quarterly begin-
ning March 31, 2000, and on a continuing
quarterly basis. These documents provide
general statements of well-defined law with-
out applying them to a specific set of facts.
Before any information letter is made avail-
able for public inspection, the Service will
delete any name, address, and other identify-
ing information as appropriate under the
Freedom of Information Act (FOIA) (for ex-
ample, FOIA personal privacy exemption of
5 U.S.C. § 552(b)(6) and tax details exempt
pursuant to I.R.C. § 6103, as incorporated
into FOIA by 5 U.S.C. § 552(b)(3)). This
approach appropriately balances various pri-
vacy interests and the public’s interest in un-
derstanding the internal revenue laws. Be-
cause information letters do not constitute
written determinations (including Chief
Counsel Advice) as defined in I.R.C. § 6110,
these documents are not subject to disclosure
under § 6110.
Information letters are advisory only
and have no binding effect on the Service.
Information letters will be found in the
Freedom of Information Room, 1111 Con-
stitution Ave., N.W., Washington, DC
20224, where they may be read and copied
by the public during the hours 9:00 a.m. to
4:00 p.m, and posted to the Service Website
at www.irs.gov/prod/news/efoia.
The principal author of this announce-
ment is Andrea Tucker of the Office of the
Associate Chief Counsel (Domestic). For
further information regarding this an-
nouncement contact Andrea Tucker on
(202) 622-4940 (not a toll-free call).

January 10, 20002962000–2 I.R.B.
Deductions for Transfers for
Public, Charitable, and Religious
Uses; In General Marital
Deduction; Valuation of Interest
Passing to Surviving Spouse;
Correction
Announcement 2000–3
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correction to final regulations.
SUMMARY: This document contains cor-
rections to final regulations (T.D. 8846,
1999–51 I.R.B. 679) which were published
in the Federal Registeron Friday, Decem-
ber 3, 1999, 64 FR 67763, relating to the ef-
fect of certain administration expenses on
the valuation of property for marital and
charitable deduction purposes.
DATES: This correction is effective De-
cember 3, 1999.
FOR FURTHER INFORMATION CON-
TACT: Deborah Ryan, (202) 622-3090
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
The final regulations that are subject to
these corrections are under section 2055
and 2056 of the Internal Revenue Code.
Need for Correction
As published, final regulations (TD
8846) contain errors that may prove to be
misleading and are in need of clarification.
Correction of Publication
Accordingly, the publication of the
final regulations (TD 8846), which were
the subject of FR Doc. 99-31094, is cor-
rected as follows:
§20.2055-3 [Corrected]
1. On page 67765, column 1,
§20.2055-3(b)(1)(ii), line 5 from bottom
of the paragraph, the language “related to
investment, preservation, and” is cor-
rected to read “related to investment,
preservation, or”.
§20.2056(b)-4 [Corrected]
2. On page 67765, column 3,
§20.2056(b)-4(d)(1)(ii), line 5 from the
bottom of the paragraph, the language
“related to investment, preservation, and”
is corrected to read “related to invest-
ment, preservation, or”.
3. On page 67766, column 3,
§20.2056(b)-4(d)(5), Example 5, line 6
from the bottom of the paragraph, the lan-
guage “remains $1,800,000. The applica-
ble” is corrected to read “is $2,000,000.
The applicable”.
4. On page 67766, column 3,
§20.2056(b)-4(d)(5), Example 5, lines 2
and 3 from the bottom of the paragraph,
the language “trust and $200,000 of the
$2,000,000 passing to the marital trust so
that the amount of” is corrected to read
“trust so that the amount of”.
5. On page 67766, column 3,
§20.2056(b)-4(d)(5), Example 7, line 7,
the language “decedent’s child. Under
the terms of the” is corrected to read
“decedent’s child. Under the terms of the
governing instrument and”.
Cynthia E. Grigsby,
Chief, Regulations Unit
Assistant Chief Counsel (Corporate).
(Filed by the Office of the Federal Register on
December 17, 1999, 8:45 a.m., and published in the
issue of the Federal Register for December 20, 1999,
64 F.R. 71021)

2000–2 I.R.B.iJanuary 10, 2000
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus,
if an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but not
to B, and the new ruling holds that it ap-
plies to both A and B, the prior ruling is
modified because it corrects a published
position. (Compare with amplified and
clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
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 pe-
riod of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example, modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is super-
seded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be pub-
lished that includes the list in the original
ruling and the additions, and supersedes
all prior rulings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current use and for-
merly used will appear in material published in the
Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C.—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedral Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
Definition of Terms

January 10, 2000ii2000–2 I.R.B.
Numerical Finding List
1
Bulletin 2000–1
Revenue Procedures:
2000–1, 2000–1 I.R.B. 4
2000–2, 2000–1 I.R.B. 73
2000–3, 2000–1 I.R.B. 103
2000–4, 2000–1 I.R.B. 115
2000–5, 2000–1 I.R.B. 158
2000–6, 2000–1 I.R.B. 187
2000–7, 2000–1 I.R.B. 227
2000–8, 2000–1 I.R.B. 230
1
A cumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 1999–27 through
1999–52 is in Internal Revenue Bulletin 2000–1,
dated January 3, 2000.

2000–2iiiJanuary 10, 2000
Finding List of Current Action on
Previously Published Items
1
Bulletin 2000–1
Notices:
97–19
Modified by
Rev. Proc. 2000–1, 2000–1 I.R.B. 4
Revnue Procedures:
96–13
Modified by
Rev. Proc. 2000–1, 2000–1 I.R.B. 4
99–1
Superseded by
Rev. Proc. 2000–1, 2000–1 I.R.B. 4
99–2
Superseded by
Rev. Proc. 2000–2, 2000–1 I.R.B. 73
99–3
Superseded by
Rev. Proc. 2000–3, 2000–1 I.R.B. 103
99–4
Superseded by
Rev. Proc. 2000–4, 2000–1 I.R.B. 115
99–5
Superseded by
Rev. Proc. 2000–5, 2000–1 I.R.B. 158
99–6
Superseded by
Rev. Proc. 2000–6, 2000–1 I.R.B. 187
99–7
Superseded by
Rev. Proc. 2000–7, 2000–1 I.R.B. 227
99–8
Superseded by
Rev. Proc. 2000–8, 2000–1 I.R.B. 230
99–51
Superseded by
Rev. Proc. 2000–3, 2000–1 I.R.B. 103
1
A cumulative list of previously published items in
Internal Revenue Bulletins 1999–27 through
1999–52 is in Internal Revenue Bulletin 2000–1,
dated January 3, 2000.

INTERNAL REVENUE BULLETIN
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