Internal Revenue Bulletin 2001-16 (PDF rendition): IRS Announcements

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

INCOME TAX
T.D. 8944, page 1067.
Final regulations and amendments to temporary regulations
under section 925 of the Code provide guidance to taxpay-
ers that have made an election to be treated as a foreign
sales corporation (FSC). These regulations permit the
grouping of transactions for purposes of applying the admin-
istrative pricing (including marginal costing) rules to deter-
mine FSC transfer prices and provide a time for filing for the
election to group transactions.
REG–105946–00, page 1069.
Proposed regulations under section 460 of the Code provide
guidance regarding changes in the taxpayer accounting for
a long-term contract that has been accounted for under a
long-term contract method. A public hearing is scheduled
for June 13, 2001.
REG–106513–00, page 1076.
Proposed regulations under section 643 of the Code and
related sections relate to the definition of income for trust
purposes. A public hearing is scheduled for June 8, 2001.
REG–107101–00, page 1083.
Proposed regulations under section 894 of the Code relate
to the eligibility for treaty benefits of items of income paid by
domestic entities that are not fiscally transparent under U.S.
law but are fiscally transparent under the laws of the juris-
diction of the person claiming treaty benefits (a domestic
reverse hybrid entity). This is the corrected version of what
was published in the Federal Register on February 27, 2001.
A public hearing is scheduled for June 26, 2001.
EMPLOYEE PLANS
Announcement 2001–37, page 1090.
These regulations delay the effective date, by 60 days, of
regulations previously published in T.D. 8931, 2001-7 I.R.B.
542, providing guidance on the HIPAA requirements for
group health plans not to establish any rule of eligibility
based on a health factor of any individual and not to charge
any individual a greater premium or contribution based on a
health factor than any similarly situated individual.
EXEMPT ORGANIZATIONS
Announcement 2001–35, page 1087.
A list is provided of organizations now classified as private
foundations.
Announcement 2001–36, page 1089.
A list is provided of organizations that no longer qualify as
organizations to which contributions are deductible under
section 170 of the Code.
ESTATE TAX
REG–106513–00, page 1076.
Proposed regulations under section 643 of the Code and
related sections relate to the definition of income for trust
purposes. A public hearing is scheduled for June 8, 2001.
Internal Revenue
bbuulllleettiinn
Bulletin No. 2001–16
April 16, 2001
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 next page)

GIFT TAX
REG–106513–00, page 1076.
Proposed regulations under section 643 of the Code and
related sections relate to the definition of income for trust
purposes. A public hearing is scheduled for June 8, 2001.
ADMINISTRATIVE
Announcement 2001-34, page 1087.
This announcement sets forth the mutual agreement pur-
suant to Article 27 of the U.S.—Republic of Korea Income
Tax Convention regarding gains from the disposition of
shares of certain Korean real property corporations by U.S.
persons.
April 16, 20012001–16 I.R.B.

2001–16 I.R.B.April 16, 2001
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
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Revenue rulings represent the conclusions of the Service on
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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.
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This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
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To the extent practicable, pertinent cross references to
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Provide America’s taxpayers top quality service by help-
ing them understand and meet their tax responsibilities
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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.

Section 925.—Transfer Pricing
Rules
26 CFR 1.925(a)-1: Transfer pricing rules for FSCs.
T.D. 8944
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Grouping Rules for Foreign
Sales Corporation Transfer
Pricing
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations and removal
of temporary regulations.
SUMMARY: This document contains
final regulations and amendments to
temporary regulations that provide
guidance to taxpayers that have made an
election to be treated as a foreign sales
corporation (FSC). These regulations
permit the grouping of transactions for
purposes of applying the administrative
pricing (including marginal costing) rules
to determine FSC transfer prices and
provide a time for filing for the election
to group transactions.
DATES: Effective date: These
regulations are effective March 2, 2001.
Applicability: For dates of applicabil-
ity, see §1.925(a)–1(c)(8)(i).
FOR FURTHER INFORMATION
CONTACT: Christopher J. Bello (202)
874–1490 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On March 3, 1987, the IRS and Trea-
sury published temporary regulations
(T.D. 8126, 1987–1 C.B. 184) in the Fed-
eral Register(52 FR 6428) to provide
(among other things) rules for grouping
transactions for purposes of applying the
FSC transfer pricing rules. A notice of
proposed rulemaking (INTL–153–86,
1987–1 C.B. 799) cross-referencing the
temporary regulations and inviting com-
ments and requests for a public hearing
was published on the same day in the
Federal Register(52 FR 6467). Written
comments concerning the proposed regu-
lations were received and a public hearing
was held.
On March 3, 1998, the IRS and Trea-
sury amended the above temporary regu-
lations by publishing temporary regula-
tions (T.D. 8764, 1998–1 C.B. 844) in the
Federal Register(63 FR 10305) that
(among other things) modified the time
for filing the election to group transac-
tions for purposes of applying the admin-
istrative pricing (including marginal cost-
ing) rules to determine FSC transfer
prices. A notice of proposed rulemaking
(REG–102144–98, 1998–1 C.B. 860)
cross-referencing the temporary regula-
tions and notice of public hearing was
published on the same day in the Federal
Register(63 FR 10351). Written com-
ments concerning the proposed regula-
tions were received and, on June 24,
1998, a public hearing was held.
After consideration of all the com-
ments, certain proposed regulations relat-
ing to grouping of transactions for FSC
transfer pricing are adopted as revised by
this Treasury decision.
Explanation of Provisions
Section 927(d)(2)(B) of the Internal
Revenue Code provides generally that
FSCs and their related suppliers may, to
the extent provided in regulations, elect to
apply the FSC transfer pricing provisions
under section 925 on the basis of groups
of transactions based on product lines or
recognized industry or trade usage, rather
than on a transaction-by-transaction basis.
Sections 1.925(a)–1T(c)(8)(i) and
1.925(b)–1T(b)(3)(i) of the temporary
regulations permit taxpayers, at their an-
nual choice, to group transactions in ap-
plying the administrative pricing (includ-
ing marginal costing) rules to determine
FSC transfer prices. Such grouping elec-
tions must be evidenced on a Schedule P
of the FSC’s timely filed (including ex-
tensions) U.S. income tax return for the
taxable year. No untimely or amended re-
turns are allowed to make a grouping
election, change a grouping basis, or
change from a grouping basis to a transac-
tion-by-transaction basis (collectively
“grouping redeterminations”).
Section 1.925(a)–1T(c)(8)(i) of the
temporary regulations also contains a
transition rule that requires grouping re-
determinations for any taxable year be-
ginning before January 1, 1998, to be
made no later than the due date of the
FSC’s timely filed (including extensions)
U.S. income tax return for the FSC’s first
taxable year beginning after December
31, 1997 (transition rule).
Conforming changes are reflected in
§§1.925(a)–1T(e)(4) and 1.925(b)–
1T(b)(3)(i) of the temporary regulations.
Commentators requested that the rule
limiting grouping elections to timely filed
returns be removed to allow taxpayers to
maximize FSC benefits and correct
grouping errors. Other commentators re-
quested that the time limit for grouping
elections be replaced by a case-by-case
analysis that would disallow only those
grouping redeterminations that are abu-
sive. Commentators also suggested alter-
native time limits that would allow tax-
payers to file amended returns to reflect
grouping redeterminations within a speci-
fied time limit (for example, one year
from the extended due date of the original
return). In response to these comments,
the Treasury and the IRS have revised the
time limits for filing grouping elections
under §1.925(a)–1T(c)(8)(i). Accord-
ingly, these regulations permit grouping
redeterminations no later than one year
after the due date of the FSC’s timely
filed (including extensions) U.S. income
tax return for taxable years beginning
after December 31, 1999. For any taxable
year beginning before January 1, 2000, a
grouping redetermination may be made
no later than the due date of the FSC’s
timely filed (including extensions) U.S.
income tax return for the FSC’s first tax-
able year beginning on or after
January 1, 2000.
Commentators also suggested that the
transition rule be extended by two or
more years to enable taxpayers to assem-
ble data and determine the most advanta-
geous groupings for taxable years begin-
ning before January 1, 1998. In response,
the IRS on May 17, 1999, published No-
tice 99–24 (1999–1 C.B. 1069). Notice
99–24 notified taxpayers that the IRS and
Treasury intended to extend by one year
the transition rule for such years. These
2001–16 I.R.B.1067April 16, 2001
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

April 16, 200110682001–16 I.R.B.
regulations provide a further extension of
the transition rule time limit.
These regulations also provide an addi-
tional time period for certain taxpayers to
make grouping redeterminations notwith-
standing the time limits for filing group-
ing redeterminations otherwise specified
in these regulations. In particular, a
grouping redetermination may be made at
any time during the one-year period com-
mencing upon notification of the related
supplier by the Internal Revenue Service
of an examination, provided that both the
FSC and the related supplier agree to ex-
tend their respective statutes of limita-
tions for assessment by one year. The
IRS and Treasury anticipate the IRS and
taxpayers to plan and conduct examina-
tions in a manner consistent with the fore-
going provision so as to facilitate efficient
and fair administration of the FSC group-
ing rules for transfer pricing.
Finally, these regulations provide that
the requirements under §1.925(a)–
1T(e)(4) with respect to redeterminations
other than grouping also apply to group-
ing redeterminations.
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, and because the regulation does not
impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Internal
Revenue Code, the temporary regulations
and notice of proposed rule-making pre-
ceding these regulations were submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on their impact on small business.
Drafting Information
The principal author of these regula-
tions is Christopher J. Bello of the Office
of the Associate Chief Counsel (Interna-
tional). Other personnel from the IRS and
Treasury Department also participated in
the development of these regulations.
* * * * *
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 for section 1.925(a)–1 to
read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.925(a)–1 also issued under
26 U.S.C. 925(b)(1) and (2) and
927(d)(2)(B). * * *
Par. 2. Section 1.925(a)–1 is added to
read as follows:
§1.925(a)–1 Transfer pricing rules for
FSCs.
(a) through (c)(7) [Reserved] For fur-
ther guidance, see §1.925(a)–1T(a)
through (c)(7).
(c)(8) Grouping transactions. (i) The
determinations under this section are to be
made on a transaction-by-transaction
basis. However, at the annual choice
made by the related supplier if the admin-
istrative pricing methods are used, some
or all of these determinations may be
made on the basis of groups consisting of
products or product lines. The election to
group transactions shall be evidenced on
Schedule P of the FSC’s U.S. income tax
return for the taxable year. No untimely
or amended returns filed later than one
year after the due date of the FSC’s timely
filed (including extensions) U.S. income
tax return will be allowed to elect to
group, to change a grouping basis, or to
change from a grouping basis to a transac-
tion-by-transaction basis (collectively
“grouping redeterminations”). The rule
of the previous sentence is applicable to
taxable years beginning after December
31, 1999. For any taxable year beginning
before January 1, 2000, a grouping rede-
termination may be made no later than the
due date of the FSC’s timely filed (includ-
ing extensions) U.S. income tax return for
the FSC’s first taxable year beginning on
or after January 1, 2000. Notwithstanding
the time limits for filing grouping redeter-
minations otherwise specified in the pre-
vious three sentences, a grouping redeter-
mination may be made at any time during
the one-year period commencing upon
notification of the related supplier by the
Internal Revenue Service of an examina-
tion, provided that both the FSC and the
related supplier agree to extend their re-
spective statutes of limitations for assess-
ment by one year. In addition, any group-
ing redeterminations made under this
paragraph must meet the requirements
under §1.925(a)–1T(e)(4) with respect to
redeterminations other than grouping.
The language “or grouping of transac-
tions” is removed from the fourth sen-
tence of §1.925(a)–1T(e)(4), applicable to
taxable years beginning after December
31, 1997. See also §1.925(b)–1T(b)(3)(i).
(c)(8)(ii) through (f) [Reserved] For
further guidance, see §1.925(a)–
1T(c)(8)(ii) through (f).
(g) Effective date. The provisions of
this section apply on or after March 2,
2001.
Par. 3. Section 1.925(a)–1T is amended
as follows:
1. Paragraph (c)(8)(i) is revised.
2. The last sentence of paragraph (e)(4)
is removed.
The revision reads as follows:
§1.925(a)–1T Temporary regulations;
transfer pricing rules for FSCs.
* * * * *
(c) * * *
(8) * * * (i) * * * [Reserved] For fur-
ther guidance, see §1.925(a)–1(c)(8)(i).
§1.925(b)–1T [Amended]
Par. 4. Section 1.925(b)–1T is
amended by removing the last sentence of
paragraph (b)(3)(i).
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved February 28, 2001.
Pamela F. Olson,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on
March 2, 2001, 8:45 a.m., and published in the issue
of the Federal Register for March 6, 2001, 66 F.R.
13427)

2001–16 I.R.B.1069April 16, 2001
Notice of Proposed Rulemaking
and Notice of Public Hearing
Mid-Contract Change in
Taxpayer
REG–105946–00
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations concerning a mid-
contract change in taxpayer of a contract
that has been accounted for under a long-
term contract method of accounting. A
taxpayer that is a party to such a contract
will be affected by these proposed regula-
tions. This document also provides notice
of a public hearing on the proposed regu-
lations.
DATES: Written comments must be re-
ceived by May 17, 2001. Outlines of oral
comments to be presented at the public
hearing scheduled for June 13, 2001, at 10
a.m. must be received by May 30, 2001.
ADDRESSES: Send submissions to
CC:M&SP:RU (REG–105946–00), room
5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand de-
livered Monday through Friday between
the hours of 8 a.m. and 5 p.m. to:
CC:M&SP:RU (REG–105946–00),
Courier’s Desk, Internal Revenue Ser-
vice, 1111 Constitution Avenue, NW,
Washington, DC. Alternatively, taxpayers
may submit comments electronically via
the Internet by selecting the “Tax Regs”
option on the IRS Home Page, or by sub-
mitting comments directly to the IRS In-
ternet site at http://www.irs.gov/prod/
tax_regs/regslist.html. The public hear-
ing will be held in room 6718, Internal
Revenue Building, 1111 Constitution Av-
enue, NW, Washington, DC.
FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions, John Aramburu or Leo F. Nolan II
at (202) 622-4960; concerning submis-
sions of comments, the hearing, and/or to
be placed on the building access list to at-
tend the hearing, Guy Traynor of the Reg-
ulations Unit at (202) 622-7180 (not toll-
free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information con-
tained in this notice of proposed rulemak-
ing have 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 collections 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,
W:CAR:MP:FP:S:O, Washington, DC
20224. Comments on the collections of
information should be received by April
16, 2001. Comments are specifically re-
quested concerning:
Whether the proposed collections of in-
formation are necessary for the proper
performance of the functions of the Inter-
nal Revenue Service, including whether
the information will have practical utility;
The accuracy of the estimated burden
associated with the proposed collections
of information (see below);
How the quality, utility, and clarity of
the information to be collected may be en-
hanced;
How the burden of complying with the
proposed collections 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
purchase of services to provide informa-
tion.
The collection of information in this
proposed regulation is in §1.460–6(g)
(3)(ii)(C). The information collected in
§1.460–6(g)(3)(ii)(C) is required to pro-
vide certain recipients of long-term con-
tracts with the information needed to
make look-back calculations. This collec-
tion of information is mandatory. The
likely respondents are for-profit entities.
Estimated total reporting burden:
10,000 hours.
Estimated average burden per respon-
dent: 2 hours.
Estimated number of respondents:
5000.
Estimated annual frequency of re-
sponses: On occasion.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
control number.
Books or records relating to a 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
Section 460 of the Internal Revenue
Code was enacted by section 804 of the
Tax Reform Act of 1986, Public Law
99–514 (100 Stat. 2085, 2358–2361).
Section 460 was amended by section
10203 of the Omnibus Budget Reconcili-
ation Act of 1987, Public Law 100–203
(101 Stat. 1330, 1330–394); by sections
1008(c) and 5041 of the Technical and
Miscellaneous Revenue Act of 1988, Pub-
lic Law 100–647 (102 Stat. 3342,
3438–3439 and 3673–3676); by sections
7621 and 7811(e) of the Omnibus Budget
Reconciliation Act of 1989, Public Law
101–239 (103 Stat. 2106, 2375–2377 and
2408–2409); by section 11812 of the Om-
nibus Budget Reconciliation Act of 1990,
Public Law 101–508 (104 Stat. 1388,
1388–534 to 1388–536); by sections
1702(h)(15) and 1704(t)(28) of the Small
Business Job Protection Act of 1996, Pub-
lic Law 104–188 (110 Stat. 1755, 1874,
1888); and by section 1211 of the Tax-
payer Relief Act of 1997, Public Law
105–34 (111 Stat. 788, 998–1000).
Section 460(h) directs the Secretary to
prescribe regulations to the extent neces-
sary or appropriate to carry out the pur-
pose of section 460, including regulations
to prevent a taxpayer from avoiding sec-
tion 460 by using related parties, pass-
through entities, intermediaries, options,
and other similar arrangements.
Part IV. Items of General Interest

April 16, 200110702001–16 I.R.B.
Explanation of Provisions
Overview
Generally, manufacturing and construc-
tion contracts not completed within the
taxable year they are entered into are
long-term contracts. A manufacturing
contract, however, is not a long-term con-
tract unless it requires the manufacture of
a unique item or an item normally requir-
ing more than 12 months to complete.
Section 460 generally requires that long-
term contracts be accounted for under the
percentage-of-completion method (PCM)
and that taxpayers make a look-back com-
putation of interest to compensate the
government (or the taxpayer) for any un-
derestimation (overestimation) of income
from the contract. However, home con-
struction contracts and certain contracts
of smaller construction contractors are ex-
empt from these requirements. Moreover,
residential builders are entitled to use the
70/30 percentage-of-completion/capital-
ized cost method (PCCM), and certain
shipbuilders are entitled to use the 40/60
PCCM. A long-term contract or a portion
of a long-term contract that is exempt
from the PCM may be accounted for
under any permissible method, including
the completed contract method (CCM) or
the exempt percentage-of-completion
method (EPCM). These long-term con-
tract methods of accounting (i.e., the
PCM, PCCM, CCM and EPCM) are de-
scribed in proposed §1.460–4. These pro-
posed regulations address the Federal in-
come tax treatment of a change in
taxpayer prior to completion of a long-
term contract accounted for under a long-
term contract method of accounting.
Existing Guidance on Transfers of Long-
term Contracts
In the case of transactions not governed
by section 381, such as those occurring
prior to its effective date, numerous cases
have required a taxpayer to take into in-
come items that under its method of ac-
counting would be deferred past the date
of the transaction. These cases have in-
volved both taxable and nontaxable trans-
actions, e.g., liquidations and reorganiza-
tions. For example, in the case of a
disposition of a long-term contract ac-
counted for under the CCM, the transferor
was required to recognize income earned
on the contract prior to its transfer, with
the amount earned determined under
some variant of the PCM. These cases
generally relied on section 446(b), section
482 and/or the assignment of income doc-
trine to allocate income to the transferor.
See e.g., Jud Plumbing and Heating, Inc.
v. Commissioner, 153 F.2d 681 (5th Cir.
1946); Standard Paving Co. v. Commis-
sioner, 190 F.2d 330 (10th Cir.), cert. de-
nied, 342 U.S. 860 (1951); Central Cuba
Sugar Co. v. Commissioner, 198 F.2d 214
(2nd Cir.),cert. denied, 344 U.S. 874
(1952); Dillard-Waltermire, Inc. v. Camp-
bell, 255 F.2d 433 (5th Cir. 1958); and
Midland-Ross Corp. v. United States, 485
F.2d 110 (6th Cir. 1973). In addition,
§1.451–5(f) of the regulations has been
cited as support for taxing a transferor
who has deferred advance payments
under its long-term contract method of ac-
counting. See Rotolo v. Commissioner,
88 T.C. 1500 (1987).
Under section 381(c)(4), in the case of
a section 381 transaction, an acquiring
corporation generally must use the
method of accounting used by the trans-
feror. Further, regulations under
§1.381(c)(4)–1 require the acquiring cor-
poration to take into account the trans-
feror’s items of income or deduction
which, because of its method of account-
ing, were not required or permitted to be
included or deducted by the transferor in
computing taxable income prior to the
date of the transfer. Consistent with sec-
tion 381, the IRS has held that section 381
generally requires a transferee to account
for a long-term contract transferred pur-
suant to a section 381 transaction using
the CCM used by the transferor and, thus,
to report the entire gain or loss from the
contract. Accordingly, the decisions in
the Standard Pavingline of cases are gen-
erally not applicable to transactions to
which section 381 applies. Rev. Rul.
70–83 (1970–1 C.B. 85). In addition, sec-
tion 351 generally has been interpreted to
prevent recognition of gain or loss by a
transferor from a section 351 transfer of
partially completed long-term contracts
accounted for by the transferor using the
CCM. See GCM 39258 (July 13, 1984)
applying Rev. Rul. 80–198 (1980–2 C.B.
113) (no gain or loss is recognized to a
cash basis transferor with respect to unre-
alized accounts receivable and unrecog-
nized accounts payable transferred in a
section 351 transaction).
In 1990, the IRS issued proposed regu-
lations (REG–20930–86) (55 FR 23755)
that addressed the treatment of a mid-con-
tract change in taxpayer of a contract ac-
counted for using PCM for purposes of
applying the look-back method. Gener-
ally, these proposed regulations provided
that the successor to the contract “stepped
into the shoes” of the predecessor with re-
spect to the PCM. Thus, the successor
was to continue to use the same PCM
used by the predecessor both for purposes
of reporting income under the contract
and recomputing income under the look-
back method. No look-back calculation
was to be made until the successor com-
pleted the contract, and the successor was
liable for look-back interest attributable to
both pre- and post-transaction years. On
the other hand, except in the case of tax-
able dispositions to unrelated parties, the
successor could not recover look-back in-
terest owed by the government that was
attributable to pre-transaction years.
These proposed regulations were with-
drawn. One criticism of the regulations
was that step-in-the-shoes treatment was
inappropriate in the case of taxable dispo-
sitions.
Proposed Provisions
Consistent with the existing guidance
described above and in response to com-
ments received on the 1990 proposed reg-
ulations, these proposed regulations di-
vide the rules regarding a mid-contract
change in taxpayer of a long-term con-
tract accounted for under a long-term con-
tract method into two categories — con-
structive completion transactions and
step-in-the-shoes transactions. For this
purpose, the step-in-the-shoes rules apply
to the following transactions —
(1) Transactions described in section
381 (i.e., liquidations under section
332 and reorganizations described
in section 368(a)(1)(A), (C), (D),
(F), or (G));
(2) Transactions described in section
351;
(3) Transactions described in section
368(a)(1)(D) with respect to which
the requirements of section 355 (or
so much of section 356 as relates to
section 355) are met (divisive “D”
reorganization);
(4) Transfers (e.g. sales) of S corpora-
tion stock;

2001–16 I.R.B.1071April 16, 2001
(5) Conversion to or from an S corpo-
ration;
(6) Members joining or leaving a con-
solidated group; and
(7) Any other transaction designated in
the Internal Revenue Bulletin by
the Internal Revenue Service. See
26 CFR 601.601(d)(2)(ii).
The constructive completion rules
apply to all other transactions.
A constructive completion transaction
results in the taxpayer originally reporting
income under the long-term contract (old
taxpayer) recognizing income from the
contract based on a contract price that
takes into account any amounts realized
from the transaction or paid by the old
taxpayer to the taxpayer subsequently re-
porting income under the long-term con-
tract (new taxpayer) that are allocable to
the contract. Similarly, the new taxpayer
in a constructive completion transaction is
treated as though it entered into a new
contract as of the date of the transaction,
with the contract price taking into account
the purchase price and any amount paid
by the old taxpayer that is allocable to the
contract.
In the case of a step-in-the-shoes trans-
action, the old taxpayer’s obligation to ac-
count for the contract terminates on the
date of the transaction and is assumed by
the new taxpayer. The new taxpayer must
assume the old taxpayer’s methods of ac-
counting for the contract, with both the
contract price and allocable contract costs
based on amounts taken into account by
both parties. However, in the case of a
tax avoidance transaction, the IRS may
allocate income with respect to a trans-
ferred long-term contract between the old
and new taxpayers. Section §1.451–5(f)
will not be applied to a mid-contract
change in taxpayer of a contract ac-
counted for under a long-term contract
method.
In the case of a step-in-the-shoes trans-
action in which the transferor’s basis in
the stock of the transferee is determined
by reference to its basis of the property
transferred, the basis in the stock of the
transferee attributable to the transfer of a
long-term contract will not be appropriate
unless the amount previously received by
the transferor under the long-term con-
tract equates to the amount previously
recognized as gross receipts by the trans-
feror. Under both the PCM and the CCM,
however, it is common for the amount re-
ceived with respect to a long-term con-
tract to differ from the amount recognized
because the receipt of progress payments
does not affect the recognition of income.
To address this situation, the proposed
regulations provide that, in the case of a
section 351 transaction or a divisive “D”
reorganization, the old taxpayer must ad-
just its basis in the stock of the new tax-
payer by the difference between the
amount the old taxpayer has recognized
with respect to the contract and the
amount the old taxpayer has received or
reasonably expects to receive under the
contract. The IRS and Treasury Depart-
ment specifically request comments with
respect to this rule.
The proposed regulations also provide
rules for applying the look-back method
in the case of a mid-contract change in
taxpayer. For constructive completion
transactions, the look-back method is ap-
plied by the old taxpayer with respect to
pre-transaction years upon the transac-
tion date and, if applicable, by the new
taxpayer with respect to post-transaction
years upon contract completion. For
step-in-the-shoes transactions, the look-
back method is applied only by the new
taxpayer upon contract completion. The
new taxpayer must account for pre- and
post-transaction years, with special rules
governing the calculation of look-back
interest in the case of pre-transaction
years. The proposed regulations also re-
quire the old taxpayer in such cases to
provide certain information to the new
taxpayer in order to enable the new tax-
payer to make the necessary look-back
calculations.
The proposed regulations reserve on
whether a mid-contract change in tax-
payer that results from a partnership
transaction, including a transaction de-
scribed in section 721, a transaction de-
scribed in section 731, and a transfer (e.g.,
sale) of a partnership interest, should be
treated as a constructive completion, or a
step-in-the-shoes, transaction. Although
these transactions are similar to other
step-in-the-shoes transactions, such as
nonrecognition transactions (e.g., sections
351 and 332) and transactions where the
party responsible for performing the con-
tract has not changed (e.g., sales of S cor-
poration stock and members joining or
leaving consolidated groups), the IRS and
Treasury Department are concerned that
step-in-the-shoes treatment for these part-
nership transactions could more readily
facilitate the shifting of income to tax in-
different parties than in other situations
and thus are concerned about monitoring
such activities solely through an anti-
abuse rule. In addition, other issues, such
as the treatment of long-term contracts
under section 704(c), 751, and 752, sig-
nificantly complicate, and could thwart,
the application of the step-in-the-shoes
rule with respect to mid-contract changes
involving partnership transactions. The
IRS and Treasury Department request
comments on the appropriate treatment
for mid-contract changes in taxpayer re-
sulting from these partnership transac-
tions.
Proposed Effective Date
These regulations are proposed to be
applicable for transactions on or after the
date they are published in the Federal
Register as final regulations.
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 also
has been determined that section 553(b)
of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these
regulations. 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 busi-
ness.
It is hereby certified that the collection
of information in these regulations will
not have a significant economic impact on
a substantial number of small entities.
This certification is based on the fact that
the relevant information is already main-
tained by taxpayers. Therefore, a Regula-
tory Flexibility Analysis under the Regu-
latory Flexibility Act (5 U.S.C. chapter 6)
is not required.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, considera-
tion will be given to any electronic or

April 16, 200110722001–16 I.R.B.
written comments (a signed original and
eight (8) copies) that are submitted
timely to the IRS. The IRS and Trea-
sury Department specifically request
comments on the clarity of the proposed
rule and how it could be made easier to
understand. All comments will be
available for public inspection and
copying.
A public hearing has been scheduled
for June 13, 2001, at 10 a.m. in room
6718, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington,
DC. Due to building security proce-
dures, visitors must enter at the 10th
Street entrance, located between Consti-
tution and Pennsylvania Avenue, NW, In
addition, all visitors must present photo
identification to enter the building. Be-
cause of access restrictions, visitors will
not be admitted beyond the immediate
entrance area more than 15 minutes be-
fore the hearing starts. For information
about having your name placed on the
building access list to attend the hearing,
see the “FOR FURTHER INFORMA-
TION CONTACT” section of this pre-
amble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons who wish
to present oral comments at the hearing
must submit written comments and an
outline of the topics to be discussed and
the time to be devoted to each topic
(signed original and eight (8) copies) by
May 30, 2001. A period of 10 minutes
will be allotted to each person for mak-
ing comments. An agenda showing the
scheduling of the speakers will be pre-
pared after the deadline for receiving
outlines has passed. Copies of the
agenda will be available free of charge at
the hearing.
Drafting Information
The principal author of these proposed
regulations is John Aramburu, Office of
Associate Chief Counsel (Income Tax
and Accounting). However, other per-
sonnel from the IRS and Treasury De-
partment participated in their develop-
ment.
* * * * *
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In §1.381(c)(4)–1, a sentence is
added at the end of paragraph (a)(2) to
read as follows:
§1.381(c)(4)–1 Method of accounting.
(a) * * *
(2) * * *See §1.460–4(k) for rules re-
lating to transfers of contracts accounted
for using a long-term contract method of
accounting in a transaction to which sec-
tion 381 applies.
* * * * *
Par. 3. Section 1.460–0 is amended by:
1. Revising the entry for paragraph (k)
of §1.460–4.
2. Adding entries for paragraphs (k)(1)
through (k)(6) of §1.460–4.
3. Revising the entry for paragraph (g)
of §1.460–6.
4. Adding entries for paragraphs (g)
through (g)(3) of §1.460–6.
The revisions and additions read as fol-
lows:
§1.460–0 Outline of regulations under
section 460.
* * * * *
§1.460–4 Methods of accounting for
long-term contracts.
* * * * *
(k) Mid-contract change in taxpayer.
(1) In general.
(2) Constructive completion transactions.
(i) Scope.
(ii) Old taxpayer.
(iii) New taxpayer.
(3) Step-in-the-shoes transactions.
(i) Scope.
(ii) Old taxpayer.
(iii) New taxpayer.
(A) Method of accounting.
(B) Contract price.
(C) Contract costs.
(4) Anti-abuse rule.
(5) Examples.
(6) Effective date.
* * * * *
§1.460–6 Look-back method.
* * * * *
(g) Mid-contract change in taxpayer.
(1) In general.
(2) Constructive completion transactions.
(3) Step-in-the-shoes transactions.
(i) General rules.
(ii) Application of look-back method to
pre-transaction period.
(A) Method.
(B) Interest accrual period.
(C) Information old taxpayer must pro-
vide.
(iii) Application of look-back method
to post-transaction years.
* * * * *
Par. 4. Section 1.460–4 is amended by:
1. Adding a sentence at the end of
paragraph (a).
2. Revising paragraph (k).
The revision and addition read as fol-
lows:
§1.460–4 Methods of accounting for
long-term contracts.
(a) * * * Finally, paragraph (k) of this
section provides rules relating to a mid-
contract change in taxpayer of a contract
accounted for using a long-term contract
method of accounting.
* * * * *
(k) Mid-contract change in taxpayer—
(1) In general. The rules in this paragraph
(k) apply if prior to the completion of a
long-term contract accounted for using a
long-term contract method by a taxpayer
(old taxpayer), there is a transaction that
makes another taxpayer (new taxpayer) re-
sponsible for reporting income from the
same contract. For purposes of this para-
graph (k) and §1.460–6(g), an old taxpayer
also includes any old taxpayer(s) (e.g., pre-
decessors) of the old taxpayer. In addition,
a change in status from taxable to tax ex-
empt or from domestic to foreign, and vice
versa,will be considered a change in tax-
payer. Finally, a contract will be treated as
the same contract if the terms of the con-
tract are not substantially changed in con-
nection with the transaction, whether or not
the customer agrees to release the old tax-
payer from any or all of its obligations
under the contract. The rules governing
constructive completion transactions are
provided in paragraph (k)(2) of this section,
while the rules governing step-in-the-shoes
transactions are provided in paragraph
(k)(3) of this section. For application of the
look-back method to mid-contract changes
in taxpayers for contracts accounted for
using the PCM, see §1.460–6(g).
(2) Constructive completion transac-
tions— (i) Scope. The constructive com-

2001–16 I.R.B.1073April 16, 2001
pletion rules in this paragraph (k)(2)
apply to transactions that result in a
change in the taxpayer responsible for
reporting income from a contract and
that are not described in paragraph
(k)(3)(i) of this section (constructive
completion transactions). Constructive
completion transactions generally in-
clude, for example, taxable sales under
section 1001 and deemed asset sales
under section 338.
(ii) Old taxpayer. The old taxpayer is
treated as completing the contract on the
date of the transaction. The total contract
price (or, gross contract price in the case
of a long-term contract accounted for
under the CCM) for the old taxpayer is
the sum of any amounts realized from the
transaction that are allocable to the con-
tract and any amounts the old taxpayer
has received or reasonably expects to re-
ceive under the contract after the transac-
tion. Total contract price (gross contract
price) is reduced by any amount paid by
the old taxpayer to the new taxpayer, and
by any transaction costs, that are allocable
to the contract. Thus, the old taxpayer’s
allocable contract costs do not include
any consideration paid, or costs incurred,
as a result of the transaction that are allo-
cable to the contract. In the case of a
transaction subject to sections 338 or
1060, the amount realized from the trans-
action allocable to the contract is deter-
mined by using the residual method under
§§1.338–6T and 1.338–7T.
(iii) New taxpayer. The new taxpayer
is treated as entering into a new contract
on the date of the transaction. The new
taxpayer must evaluate whether the new
contract should be classified as a long-
term contract within the meaning of
§1.460–1(b) and account for the contract
under a permissible method of account-
ing. For a new taxpayer who accounts for
a contract using the PCM, the total con-
tract price is any amount the new taxpayer
reasonably expects to receive under the
contract consistent with paragraph (b)(4)
of this section. Total contract price is re-
duced in the amount of any consideration
paid as a result of the transaction, and by
any transaction costs, that are allocable to
the contract and is increased in the
amount of any consideration received as a
result of the transaction that is allocable to
the contract. Similarly, the gross contract
price for a contract accounted for using
the CCM is all amounts the new taxpayer
is entitled by law or contract to receive
consistent with paragraph (d)(3) of this
section, adjusted for any consideration
paid (or received) as a result of the trans-
action that is allocable to the contract.
Thus, the new taxpayer’s allocable con-
tract costs do not include any considera-
tion paid, or costs incurred, as a result of
the transaction that are allocable to the
contract. In the case of a transaction sub-
ject to sections 338 or 1060, the amount
of consideration paid that is allocable to
the contract is determined by using the
residual method under §§1.338–6T and
1.338–7T.
(3) Step-in-the-shoes transactions—
(i) Scope. The step-in-the-shoes rules in
this paragraph (k)(3) apply to the follow-
ing transactions that result in a change in
the taxpayer responsible for reporting in-
come from a contract (step-in-the-shoes
transactions) —
(A) Transactions described in section
381 (i.e., liquidations under section 332
and reorganizations described in section
368(a)(1)(A), (C), (D), (F), or (G));
(B) Transactions described in section
351;
(C) Transactions described in section
368(a)(1)(D) with respect to which the re-
quirements of section 355 (or so much of
section 356 as relates to section 355) are
met;
(D) Transfers (e.g., sales) of S corpora-
tion stock;
(E) Conversion to or from an S corpo-
ration;
(F) Members joining or leaving a con-
solidated group; and
(G) Any other transaction designated in
the Internal Revenue Bulletin by the In-
ternal Revenue Service. See
§601.601(d)(2)(ii) of this chapter.
(ii) Old taxpayer– (A) In general. The
new taxpayer will “step into the shoes” of
the old taxpayer with respect to the con-
tract. Thus, consistent with §1.381(c)
(4)–1(a)(1)(ii), the old taxpayer’s obliga-
tion to account for the contract terminates
on the date of the transaction and is as-
sumed by the new taxpayer, as set forth in
paragraph (k)(3)(iii) of this section. As a
result, an old taxpayer using the PCM is
required to recognize income from the
contract based on the cumulative alloca-
ble contract costs incurred as of the date
of the transaction. Similarly, an old tax-
payer using the CCM is not required to
recognize any revenue and may not
deduct allocable contract costs incurred
with respect to the contract.
(B) Basis adjustment. In the case of
transactions described in paragraph
(k)(3)(i)(B) or (C) of this section, the old
taxpayer must adjust its basis in the stock
of the new taxpayer by reducing such
basis to the extent the amount the old tax-
payer has received or reasonably expects
to receive under the contract exceeds the
amount recognized by the old taxpayer
with respect to the contract or by increas-
ing such basis to the extent the amount the
old taxpayer has recognized with respect
to the contract exceeds the amount the old
taxpayer has received or reasonably ex-
pects to receive under the contract. How-
ever, the old taxpayer may not reduce its
basis in the stock of the new taxpayer
below zero. If the old and new taxpayer
do not join in the filing of a consolidated
Federal income tax return, the old tax-
payer must recognize income to the extent
the basis in the stock of the new taxpayer
otherwise would be reduced below zero.
If the old and new taxpayer join in the fil-
ing of a consolidated Federal income tax
return, the old taxpayer must create an (or
increase an existing) excess loss account
to the extent the basis in the stock of the
new taxpayer otherwise would be reduced
below zero. See §§1.1502–19 and
1.1502–32(a)(3)(ii).
(iii) New taxpayer— (A) Method of ac-
counting. Beginning on the date of the
transaction, the new taxpayer must ac-
count for the long-term contract by using
the same method of accounting used by
the old taxpayer prior to the transaction
consistent with §1.381(c)(4)–1(b)(4). The
same method of accounting must be used
for such contract regardless of whether the
old taxpayer’s method is the new tax-
payer’s principal method of accounting
under §1.381(c)(4)–1(b)(3) or whether the
new taxpayer is otherwise eligible to use
the old taxpayer’s method. Thus, if the
old taxpayer uses the PCM to account for
the contract, the new taxpayer steps into
the shoes of the old taxpayer with respect
to its completion factor and percentage of
completion methods (such as the 10-per-
cent method), even if the new taxpayer has
not elected such methods for similarly
classified contracts. Similarly, if the old
taxpayer uses the CCM, the new taxpayer

April 16, 200110742001–16 I.R.B.
steps into the shoes of the old taxpayer
with respect to the CCM, even if the new
taxpayer is not otherwise eligible to use
the CCM. However, the new taxpayer is
not necessarily bound by the old tax-
payer’s method for similarly classified
contracts entered into by the new taxpayer
subsequent to the transaction and must
apply general tax principles, including
section 381, to determine the appropriate
method to account for these subsequent
contracts. To the extent that general tax
principles allow the taxpayer to account
for similarly classified contracts using a
method other than the old taxpayer’s
method, the taxpayer is not required to ob-
tain the consent of the Commissioner to
begin using such other method.
(B) Contract price. The total contract
price for the new taxpayer is the sum of
any amounts the old taxpayer or new tax-
payer have received or reasonably expect
to receive under the contract consistent
with paragraph (b)(4) of this section.
Similarly, the gross contract price in the
case of a long-term contract accounted for
under the CCM includes all amounts the
old taxpayer or new taxpayer are entitled
by law or by contract to receive consistent
with paragraph (d)(3) of this section.
(C) Contract costs. Total allocable
contract costs for the new taxpayer are
the allocable contract costs as defined
under paragraph (b)(5) of this section in-
curred by either the old taxpayer prior to
or the new taxpayer after the transaction.
Thus, any payments between the old tax-
payer and the new taxpayer with respect
to the contract are not treated as part of
contract price or an allocable contract
cost.
(4) Anti-abuse rule. Notwithstanding
this paragraph (k), in tax avoidance cases,
the Commissioner may allocate to the old
(or new) taxpayer the income from a
long-term contract properly allocable to
the old (or new) taxpayer. For example,
the Commissioner may scrutinize a trans-
action in which a long-term contract ac-
counted for using the CCM, or using the
PCM where the old taxpayer has received
advance payments in excess of its contri-
bution to the contract, is transferred to a
tax indifferent party.
(5) Examples. The following examples
illustrate the rules of this paragraph (k).
For purposes of these examples, it is as-
sumed that the contracts are long-term
construction contracts accounted for
using the PCM prior to the transaction un-
less stated otherwise and the contracts are
not transferred in tax avoidance cases.
The examples are as follows:
Example 1. Constructive completion — PCM. (i)
Facts. In Year 1, X enters into a contract. The total
contract price is $1,000,000 and the estimated total al-
locable contract costs are $800,000. In Year 1, X in-
curs costs of $200,000. In Year 2, X incurs additional
costs of $400,000 before selling the contract as part of
the sale of its business in Year 2 to Y, an unrelated
party. At the time of sale, X has received $650,000 in
progress payments under the contract. The considera-
tion allocable to the contract under section 1060 is
$150,000. Pursuant to the sale, the new taxpayer Y
immediately assumes X’s contract obligations and
rights. Y is required to account for the contract using
the PCM. In Year 2, Y incurs additional allocable con-
tract costs of $50,000. Y correctly estimates at the
end of Year 2 that it will have to incur an additional
$75,000 of allocable contract costs in Year 3 to com-
plete the contract.
(ii) Old taxpayer. For Year 1, X reports receipts
of $250,000 (the completion factor multiplied by
total contract price ($200,000/$800,000 x
$1,000,000)) and costs of $200,000, for a profit of
$50,000. X is treated as completing the contract in
Year 2 because it sold the contract. For purposes of
applying the PCM in Year 2, the total contract price
is $800,000 (the sum of the amounts received under
the contract and the amount realized in the sale
($650,000 + $150,000)) and the total allocable con-
tract costs are $600,000 (the sum of the costs in-
curred in Year 1 and Year 2 ($200,000 + $400,000)).
Thus, in Year 2, X reports receipts of $550,000 (total
contract price minus receipts already reported
($800,000 - $250,000)) and costs incurred in year 2
of $400,000, for a profit of $150,000.
(iii) New taxpayer. Y is treated as entering into a
new contract in Year 2. The total contract price is
$200,000 (the amount remaining to be paid under the
terms of the contract less the consideration paid allo-
cable to the contract ($1,000,000 - $650,000 -
$150,000)). The estimated total allocable contract
costs at the end of Year 2 are $125,000 (the allocable
contract costs that Y reasonably expects to incur to
complete the contract ($50,000 + $75,000)). In Year
2, Y reports receipts of $80,000 (the completion factor
multiplied by the total contract price
[($50,000/$125,000) x $200,000] and costs of $50,000
(the costs incurred after the purchase), for a profit of
$30,000. For Year 3, Y reports receipts of $120,000
(total contract price minus receipts already reported
($200,000 - $80,000)) and costs of $75,000, for a
profit of $45,000.
Example 2. Constructive completion — CCM. (i)
Facts. The facts are the same as in Example 1, except
that X and Y properly account for the contract under
the CCM.
(ii) Old taxpayer. X does not report any income or
costs from the contract in Year 1. In Year 2, the con-
tract is deemed complete for X, and X reports its gross
contract price of $800,000 (the sum of the amounts re-
ceived under the contract and the amount realized in
the sale ($650,000 + $150,000)) and its total allocable
contract costs of $600,000 (the sum of the costs in-
curred in Year 1 and Year 2 ($200,000 + $400,000)) in
that year.
(iii) New taxpayer. Y is treated as entering into a
new contract in Year 2. Under the CCM, Y reports no
gross receipts or costs in Year 2. Y reports its gross
contract price of $200,000 (the amount remaining to
be paid under the terms of the contract less the consid-
eration paid allocable to the contract ($1,000,000 -
$650,000 - $150,000)) and its total allocable contract
costs of $125,000 (the allocable contract costs that Y
incurred to complete the contract ($50,000 +
$75,000)) in Year 3, the completion year, for a profit of
$75,000.
Example 3. Step-in-the-shoes — PCM. (i) Facts.
The facts are the same as in Example 1, except that X
transfers the contract to Y in exchange for stock of Y
in a transaction that qualifies as a statutory merger de-
scribed in section 368(a)(1)(A) and does not result in
gain or loss to X under section 361(a).
(ii) Old taxpayer. For Year 1, X reports receipts of
$250,000 (the completion factor multiplied by total
contract price ($200,000/$800,000 x $1,000,000))
and costs of $200,000, for a profit of $50,000. Be-
cause the mid-contract change in taxpayer results from
a transaction described in paragraph (k)(3)(i) of this
section, X is not treated as completing the contract in
Year 2. In Year 2, X reports receipts of $500,000 (the
completion factor multiplied by the total contract price
and minus the Year 1 gross receipts
[($600,000/$800,000 x $1,000,000) - $250,000]) and
costs of $400,000, for a profit of $100,000.
(iii) New taxpayer. Because the mid-contract
change in taxpayer results from a step-in-the-shoes
transaction, Y must account for the contract using the
same methods of accounting used by X prior to the
transaction. Total contract price is the sum of any
amounts that X and Y have received or reasonably ex-
pect to receive under the contract, and total allocable
contract costs are the allocable contract costs of X and
Y. Thus, the estimated total allocable contract costs at
the end of Year 2 are $725,000 (the cumulative alloca-
ble contract costs of X and the estimated total alloca-
ble contract costs of Y ($200,000 + $400,000 +
$50,000 + $75,000)). In Year 2, Y reports receipts of
$146,552 (the completion factor multiplied by the
total contract price minus receipts reported by the old
taxpayer ([($650,000/$725,000) x $1,000,000] -
$750,000) and costs of $50,000, or a profit of $96,552.
For Year 3, Y reports receipts of $103,448 (the total
contract price minus prior year receipts ($1,000,000 -
$896,552)) and costs of $75,000, for a profit of
$28,448.
Example 4. Step-in-the-shoes — CCM. (i) Facts.
The facts are the same as in Example 3, except that X
properly accounts for the contract under the CCM.
(ii) Old taxpayer. X reports no income or costs
from the contract in Years 1, 2 or 3.
(iii) New taxpayer. Because the mid-contract
change in taxpayer results from a step-in-the-shoes
transaction, Y must account for the contract using the
same methods of accounting used by X prior to the
transaction. Thus, in Year 3, the completion year, Y
reports receipts of $1,000,000 and total contract costs
of $725,000, for a profit of $275,000.
Example 5. Step-in-the-shoes — Basis adjustment.
The facts are the same as in Example 1, except that X
transfers the contract (including the uncompleted
property with a basis of $0) and $125,000 of cash to a
new corporation, Z, in exchange for all of the stock of
Z in a section 351 transaction. Thus, under section
358(a), X’s basis in Z is $125,000. X must increase its
basis in Z by $100,000 pursuant to paragraph

2001–16 I.R.B.1075April 16, 2001
(k)(3)(ii)(B) of this section because the amount X rec-
ognized with respect to the contract, $750,000
($250,000 receipts in Year 1 + $500,000 receipts in
Year 2), exceeds the amount X received under the con-
tract, the $650,000 in progress payments, by
$100,000.
Example 6. Step-in-the-shoes — Basis adjustment.
The facts are the same as in Example 2, except that X
receives progress payments of $800,000 (rather than
$650,000) and transfers the contract (including the un-
completed property with a basis of $600,000) and
$125,000 of cash to a new corporation, Z, in exchange
for all of the stock of Z in a section 351 transaction.
Thus, under section 358(a), X’s basis in Z is $725,000.
X and Z do not join in filing a consolidated Federal in-
come tax return. X must reduce its basis in the stock
of Z by $725,000 to zero pursuant to paragraph
(k)(3)(ii)(B) of this section because the amount X re-
ceived under the contract, $800,000 in progress pay-
ments, exceeds the amount recognized by X with re-
spect to the contract, $0. In addition, X must
recognize income of $75,000 because X’s basis in the
stock of Z otherwise would have been reduced below
zero by $75,000 (800,000 unrecognized progress pay-
ments - 725,000 basis).
(6) Effective date. This paragraph (k) is
applicable for transactions on or after the
date they are published in the Federal
Registeras final regulations.
Par. 5. In §1.460–6, paragraph (g) is
revised to read as follows:
§1.460–6 Look-back method.
* * * * *
(g) Mid-contract change in taxpayer—
(1) In general.The rules in this paragraph
(g) apply if, as described in §1.460–4(k),
prior to the completion of a long-term con-
tract accounted for using the PCM or the
PCCM by a taxpayer (old taxpayer), there
is a transaction that makes another taxpayer
(new taxpayer) responsible for reporting in-
come from the same contract. The rules
governing constructive completion transac-
tions are provided in paragraph (g)(2) of
this section, while the rules governing step-
in-the-shoes transactions are provided in
paragraph (g)(3) of this section. For pur-
poses of this paragraph, pre-transaction
years are all taxable years of the old tax-
payer in which the old taxpayer reported
(or should have reported) gross receipts
from the contract, and post-transaction
years are all taxable years of the new tax-
payer in which the new taxpayer reported
(or should have reported) gross receipts
from the contract.
(2) Constructive completion transac-
tions. In the case of a transaction described
in §1.460–4(k)(2)(i) (constructive comple-
tion transaction), the look-back method is
applied by the old taxpayer with respect to
pre-transaction years upon the date of the
transaction and, if the new taxpayer uses
the PCM or the PCCM to account for the
contract, by the new taxpayer with respect
to post-transaction years upon completion
of the contract. The contract price and allo-
cable contract costs to be taken into account
by the old taxpayer or the new taxpayer in
applying the look-back method are de-
scribed in §1.460–4(k)(2).
(3) Step-in-the-shoes transactions— (i)
General rules. In the case of a transaction
described in §1.460–4(k)(3)(i) (step-in-the-
shoes transaction), the look-back method is
not applied at the time of the transaction,
but is instead applied for the first time when
the contract is completed by the new tax-
payer. Upon completion of the contract,
the look-back method is applied by the new
taxpayer with respect to both pre-transac-
tion years and post-transaction years, tak-
ing into account all amounts reasonably
expected to be received by either the old or
new taxpayer and all allocable contract
costs incurred during both periods as de-
scribed in §1.460–4(k)(3). The new tax-
payer is liable for filing the Form 8697 and
for interest computed on hypothetical un-
derpayments of tax, and is entitled to re-
ceive interest with respect to hypothetical
overpayments of tax, for both pre- and
post-transaction years. Pursuant to section
6901, the old taxpayer will be secondarily
liable for any interest required to be paid
with respect to pre-transaction years re-
duced by any interest on pre-transaction
overpayments.
(ii) Application of look-back method to
pre-transaction period— (A) Method. The
new taxpayer must apply the look-back
method to each pre-transaction year that is
a redetermination year using the simplified
marginal impact method described in para-
graph (d) of this section (regardless of
whether or not the old taxpayer would have
actually used that method and without re-
gard to the tax liability ceiling).
(B) Interest accrual period. With re-
spect to any hypothetical underpayment or
overpayment of tax for a pre-transaction
year, interest accrues from the due date of
the old taxpayer’s tax return (not including
extensions) for the taxable year of the un-
derpayment or overpayment until the due
date of the new taxpayer’s return (not in-
cluding extensions) for the completion year
or the year of a post-completion adjust-
ment, whichever is applicable.
(C) Information old taxpayer must pro-
vide. In order to help the new taxpayer to
apply the look-back method with respect to
pre-transaction taxable years, any old tax-
payer that reported income from a long-
term contract under the PCM or PCCM for
either regular or alternative minimum tax
purposes is required to provide the infor-
mation described in this paragraph to the
new taxpayer by the due date (not including
extensions) of the old taxpayer’s income
tax return for the taxable year ending with,
or the first taxable year ending after, a step-
in-the-shoes transaction described in
§1.460–4(k)(3)(i). The required informa-
tion is as follows - -
(1) The portion of the contract reported
by the old taxpayer under PCM for regular
and alternative minimum tax purposes (i.e.,
whether the old taxpayer used PCM, the
40/60 PCCM method, or the 70/30 PCCM
method);
(2) The submethod used to apply PCM
(e.g., the simplified cost-to-cost method or
the 10-percent method);
(3) The amount of total contract price re-
ported by year;
(4) The numerator and the denominator
of the completion factor by year;
(5) The due date (not including exten-
sions) of the old taxpayer’s income tax re-
turns for each taxable year in which income
was required to be reported;
(6) Whether the old taxpayer was a corpo-
rate or a noncorporate taxpayer by year; and
(7) Any other information required by
the Commissioner by administrative pro-
nouncement.
(iii) Application of look-back method to
post-transaction years. With respect to
post-transaction taxable years, the new tax-
payer must use the same look-back method
it uses for other contracts (i.e., the simpli-
fied marginal impact method or the actual
method) to determine the amount of any
hypothetical overpayment or underpay-
ment of tax and the time period for comput-
ing interest on these amounts.
* * * * *
David A. Mader,
Acting Deputy Commissioner
of Internal Revenue.
(Filed by the Office of the Federal Register on
February 15, 2001, 8:45 a.m., and published in
the issue of the Federal Register for February 16,
2001, 66 FR 10643)

April 16, 200110762001–16 I.R.B.
Notice of Proposed Rulemaking
and Notice of Public Hearing
Definition of Income for Trust
Purposes
REG–106513–00
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations revising the defini-
tion of income under section 643(b) of
the Internal Revenue Code to take into
account changes in the definition of trust
accounting income under state laws.
The proposed regulations also clarify
the situations in which capital gains are
included in distributable net income
under section 643(a)(3). Conforming
amendments are made to regulations af-
fecting ordinary trusts, pooled income
funds, charitable remainder trusts, trusts
that qualify for the gift and estate tax
marital deduction, and trusts that are ex-
empt from generation-skipping transfer
taxes. This document also provides no-
tice of a public hearing on these pro-
posed regulations.
DATES: Written and electronic com-
ments must be received by May 18, 2001.
Outlines of topics to be discussed at the
public hearing scheduled for June 8, 2001
must be received by May 18, 2001.
ADDRESSES: Send submissions to:
CC:M&SP:RU (REG–106513–00),
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:M&SP:RU (REG–106513–00),
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.
ustreas.gov/tax_regs/regslist.html. The
public hearing will be held in the IRS
Auditorium, Internal Revenue Building,
1111 Constitution Avenue, NW, Wash-
ington, DC.
FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions, Bradford Poston at (202) 622–3060
(not a toll-free number); concerning sub-
missions of comments, the hearing,
and/or to be placed on the building access
list to attend the hearing, Guy R. Traynor,
202-622-8452 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
Section 643(b) provides a definition of
the term income for purposes of subparts
A through D of part I of subchapter J of
the Internal Revenue Code (Code) . The
term income, when not modified by any
other term, means the amount of income
of the trust or estate determined under the
terms of the governing instrument and ap-
plicable local law. Section 1.643(b)–1
further provides that trust provisions that
depart fundamentally from the concepts
of local law in determining what consti-
tutes income will not be recognized.
These statutory and regulatory provi-
sions date back to a time when, under
state statutes, dividends and interest were
considered income and were allocated to
the income beneficiary while capital gains
were allocated to the principal of the trust.
Changes in the types of available invest-
ments and in investment philosophies
have caused states to revise, or to con-
sider revising, these traditional concepts
of income and principal.
The prudent investor standard for man-
aging trust assets has been enacted by
many states and encourages fiduciaries to
adopt an investment strategy designed to
maximize the total return on trust assets.
Under this investment strategy, trust as-
sets should be invested for total positive
return, that is, ordinary income plus ap-
preciation, in order to maximize the value
of the trust. Thus, under certain economic
circumstances, equities, rather than
bonds, would constitute a greater portion
of the trust assets than they would under
traditional investment standards.
One of the concerns with shifting trust
investments toward equities and away
from bonds is the potential adverse im-
pact on the income beneficiary. Based on
the traditional concepts of income and
principal, the income beneficiary is enti-
tled only to the dividends and interest
earned by the trust assets. The dividend
return on equities as a percentage of their
value traditionally has been substantially
less than the interest return on bonds.
To ensure that the income beneficiary
is not penalized if a trustee adopts a total
return investment strategy, many states
have made, or are considering making, re-
visions to the definitions of income and
principal. Some state statutes permit the
trustee to make an equitable adjustment
between income and principal if neces-
sary to ensure that both the income bene-
ficiary and the remainder beneficiary are
treated impartially, based on what is fair
and reasonable to all of the beneficiaries.
Thus, a receipt of capital gains that previ-
ously would have been allocated to prin-
cipal may be allocated by the trustee to in-
come if necessary to treat both parties
impartially. Conversely, a receipt of divi-
dends or interest that previously would
have been allocated to income may be al-
located by the trustee to principal if nec-
essary to treat both parties impartially.
Other states are proposing legislation
that would allow the trustee to pay a uni-
trust amount to the income beneficiary in
satisfaction of that beneficiary’s right to
the income from the trust. This unitrust
amount will be a fixed percentage, some-
times required to be within a range set by
state statute, of the fair market value of
the trust assets determined annually.
Questions have arisen concerning how
these state statutory changes affect the de-
finition of income provided in section
643(b) and the other Code provisions that
rely on the section 643(b) definition of in-
come. This definition of income affects
trusts including, but not limited to, ordi-
nary trusts, charitable remainder trusts,
pooled income funds, and qualified sub-
chapter S trusts.
In addition, trusts that qualify for the
gift or estate tax marital deduction must
pay to the spouse all the income from the
property. All the income is considered
paid to the spouse if the effect of the trust
is to give the spouse substantially that de-
gree of beneficial enjoyment of the trust
property that the principles of trust law
accord to a person who is unqualifiedly
designated as the life beneficiary of a
trust. Section 25.2523(e)–1(f) of the Gift
Tax Regulations and §20.2056(b)–5(f) of
the Estate Tax Regulations. Questions
have arisen whether the spouse is entitled

2001–16 I.R.B.1077April 16, 2001
to all the income from the property in a
state that permits equitable adjustments or
unitrust payments.
Similarly, questions have arisen as to
whether an otherwise exempt trust which
uses equitable adjustments or unitrust
payments will be subject to the genera-
tion-skipping transfer tax provisions of
chapter 13 of the Code.
Explanation of provisions
Definition of Income
The proposed regulations will amend the
definition of income under §1.643(b)–1 to
take into account certain state statutory
changes to the concepts of income and
principal. Under the proposed regulations,
trust provisions that depart fundamentally
from traditional concepts of income and
principal (that is, allocating ordinary in-
come to income and capital gains to princi-
pal) will generally continue to be disre-
garded, as they are under the current
regulations. However, amounts allocated
between income and principal pursuant to
applicable state law will be respected if
state law provides for a reasonable appor-
tionment between the income and remain-
der beneficiaries of the total return of the
trust for the year, taking into account ordi-
nary income, capital gains, and, in some sit-
uations, unrealized appreciation. For ex-
ample, a state law that provides for the
income beneficiary to receive each year a
unitrust amount of between 3% and 5% of
the annual fair market value of the trust as-
sets is a reasonable apportionment of the
total return of the trust. Similarly, a state
law that permits the trustee to make equi-
table adjustments between income and
principal to fulfill the trustee’s duty of im-
partiality between the income and remain-
der beneficiaries is a reasonable apportion-
ment of the total return of the trust.
In addition, an allocation of capital
gains to income will be respected under
certain circumstances. Such an allocation
will be respected if directed by the terms
of the governing instrument and applica-
ble local law. Similarly, if a trustee, pur-
suant to a discretionary power granted to
the trustee by local law or by the govern-
ing instrument (if not inconsistent with
local law), allocates capital gains to in-
come, the allocation will be respected,
provided the power is exercised in a rea-
sonable and consistent manner.
The proposed changes to the regula-
tions will permit trustees to implement a
total return investment strategy and to fol-
low the applicable state statutes designed
to treat the income and remainder benefi-
ciaries impartially. At the same time, the
limitations imposed by the proposed regu-
lations ensure that the Code provisions re-
lying on the definition of income under
section 643(b) are not undermined by an
unlimited ability of the trustee to allocate
between income and principal.
Pooled Income Funds
A special rule is proposed to be added
to the regulations covering pooled income
funds to address the problems arising
from the potential application of the new
state statutes to these funds. A pooled in-
come fund as defined in section 642(c)(5)
is a split-interest trust created and main-
tained by certain types of charitable orga-
nizations. Noncharitable beneficiaries re-
ceive the income from the commingled
fund during their lives and the charitable
organization receives the remainder inter-
ests. The income that is to be paid to the
noncharitable beneficiaries is income as
defined in section 643(b). §1.642(c)–5(i).
A pooled income fund is a trust subject
to taxation under section 641. It is enti-
tled to a distribution deduction under sec-
tion 661 for income distributed to the
noncharitable beneficiaries. In addition,
it receives a charitable deduction under
section 642(c)(3) for any amount of net
long-term capital gain which pursuant to
the terms of the governing instrument is
permanently set aside for charitable pur-
poses. A pooled income fund is taxed on
any net short-term capital gain that is not
required to be distributed to the income
beneficiaries pursuant to the terms of the
governing instrument and applicable local
law.
Under traditional principles of income
and principal, ordinary income would be
paid to the income beneficiaries. Any net
long-term capital gain would be allocated
to principal to be held for the ultimate
benefit of the charitable remainderman
and therefore would qualify for the chari-
table deduction under section 642(c)(3).
If a pooled income fund were to pay the
income beneficiaries a unitrust amount in
satisfaction of their right to income, as
provided by proposed state statutes, long-
term capital gains would no longer qual-
ify for the charitable deduction. Any net
long-term capital gain not required to be
distributed during the current year would
be added to principal. However, the
amount of the gain would not be perma-
nently set aside for charitable purposes
because this amount may be used in the
future to make the unitrust payment to the
income beneficiaries. A similar situation
arises if the trustee is permitted under
state law to make equitable adjustments
with respect to unrealized appreciation in
the value of the trust assets. A portion of
any subsequently realized capital gain
may already have been treated as distrib-
uted to the income beneficiaries in accor-
dance with an equitable adjustment distri-
bution.
The proposed regulations will amend
§1.642(c)–2(c) to address these issues for
pooled income funds. Thus, no net long-
term capital gain qualifies for the charita-
ble deduction if, under the terms of the
governing instrument and applicable state
law, income may be a unitrust amount or
may include an equitable adjustment with
respect to unrealized appreciation in the
value of the trust assets.
Charitable Remainder Unitrusts
A charitable remainder unitrust is a
split-interest trust that provides for a spec-
ified distribution to one or more nonchari-
table beneficiaries for life or a term of
years, with an irrevocable remainder in-
terest held for the benefit of a charitable
organization. Under section 664(d)(2),
the amount distributed to the noncharita-
ble beneficiaries is a fixed percentage (not
less than 5% and not more than 50%) of
the annual fair market value of the trust
assets. Alternatively, under section
664(d)(3), the unitrust amount may be the
lesser of this fixed percentage amount or
trust income (with or without a make-up
amount). For this purpose, trust income
means income as defined under section
643(b) and the applicable regulations.
§1.664–3(a)(1)(i)(b).
Under proposed state statutes, trust in-
come could be a fixed percentage of the
annual fair market value of the trust as-
sets, and the fixed percentage may be less
than 5%. A net income charitable remain-
der unitrust using such a state statutory
definition of income would in substance
be a fixed percentage unitrust with a per-
centage less than the 5% required by sec-

April 16, 200110782001–16 I.R.B.
tion 664(d)(2). Therefore, the proposed
regulations will amend §1.664–3(a)
(1)(i)(b) to provide that income under the
terms of the governing instrument and ap-
plicable local law may not be determined
by reference to a fixed percentage of the
annual fair market value of the trust prop-
erty. If the applicable state law defines
income as a unitrust amount, the govern-
ing instrument of a net income charitable
remainder unitrust must provide its own
definition of trust income. In addition,
the proposed regulations will provide that
capital gains attributable to appreciation
in the value of assets after the date con-
tributed to the trust or purchased by the
trust may be allocated to income under
the terms of the governing instrument and
applicable local law. Such an allocation,
however, may not be discretionary with
the trustee. The section 664 regulations
already prohibit the allocation of pre-con-
tribution gains to income.
Capital Gains and Distributable Net
Income
Section 643(a)(3) provides that gains
from the sale or exchange of capital assets
are excluded from distributable net in-
come to the extent that these gains are al-
located to corpus and they are not either
paid, credited, or required to be distrib-
uted, to a beneficiary during the year, or
paid, permanently set aside, or to be used
for a charitable purpose. The circum-
stances in which capital gains are consid-
ered paid or credited to a beneficiary dur-
ing the year, and therefore included in
distributable net income, are not entirely
clear. In addition, the revisions to state
law definitions of income have precipi-
tated additional questions in this area.
The question arises, for example, whether
realized capital gains are included in the
unitrust amount distributed to the income
beneficiary under local law, if the unitrust
amount exceeds the trust’s ordinary in-
come.
The proposed regulations will amend
§1.643(a)–3(a) to clarify the circum-
stances in which capital gains are includi-
ble in distributable net income for the
year. In general, capital gains are in-
cluded in distributable net income to the
extent they are, pursuant to the terms of
the governing instrument or local law, or
pursuant to a reasonable and consistent
exercise of discretion by the fiduciary (in
accordance with a power granted to the
fiduciary by the governing instrument or
local law): allocated to income; allocated
to corpus but treated by the fiduciary on
the trust’s books, records, and tax returns
as part of a distribution to a beneficiary;
or allocated to corpus but utilized by the
fiduciary in determining the amount
which is distributed or required to be dis-
tributed to a beneficiary. As is the case
under the current regulations, capital
gains that are paid, permanently set aside,
or to be used for the purposes specified in
section 642(c) are included in the distrib-
utable net income. Capital losses are net-
ted at the trust level against any capital
gains, except for a capital gain that is uti-
lized in determining the amount that is
distributed or required to be distributed to
a particular beneficiary.
Under the proposed regulations, capital
gains will be included in distributable net
income under certain circumstances that
are directed by the terms of the governing
instrument and applicable local law.
Thus, any capital gain that is included in
the section 643(b) definition of income is
included in distributable net income.
Similarly, any capital gain that is used to
determine the amount or the timing of a
distribution to a beneficiary is included in
distributable net income.
Capital gains are also included in dis-
tributable net income if the fiduciary, pur-
suant to a discretionary power granted by
local law or by the governing instrument
(if not inconsistent with local law), treats
the capital gains as distributed to a benefi-
ciary, provided the power is exercised in a
reasonable and consistent manner. Thus,
if a trustee exercises a discretionary
power by consistently treating any distrib-
ution in excess of ordinary income as
being made from realized capital gains,
any capital gain so distributed is included
in distributable net income.
The provisions of sections 643(b) and
643(a)(3) are further intertwined when
consideration is given to the new state
statutory provisions defining income. If,
under the terms of the governing instru-
ment or applicable local law, realized cap-
ital gains are treated as income to the ex-
tent the unitrust amount or the equitable
adjustment amount exceeds ordinary in-
come, capital gains so treated are in-
cluded in distributable net income. A
similar result is achieved for capital gains
consistently allocated to income by the
fiduciary pursuant to a discretionary
power. In any other situation, capital
gains will be excluded from distributable
net income and will be taxed to the trust.
Distributions in Kind
The proposed regulations will clarify
the consequences of certain distributions
of property in kind for purposes of the
distribution deductions under sections
651 and 661. Thus, if property is distrib-
uted to a beneficiary in satisfaction of the
beneficiary’s right to income, the trust
will be treated as having sold the property
for its fair market value on the date of dis-
tribution.
Trusts Qualifying for Gift and Estate Tax
Marital Deduction
Certain transfers of property in trust for
the benefit of the spouse qualify for the
marital deduction for gift and estate tax
purposes. These transfers include a life
estate with a general power of appoint-
ment described in sections 2523(e) and
2056(b)(5) and qualified terminal interest
property described in sections 2523(f) and
2056(b)(7). One of the requirements of
these provisions is that the spouse must be
entitled for life to all the income from the
trust property. The rules for determining
whether the spouse is entitled to all the in-
come from either a life estate with a gen-
eral power of appointment trust or a qual-
ified terminable interest trust are set forth
in §20.2056(b)–5(f) of the Estate Tax
Regulations and §25.2523(e)–1(f) of the
Gift Tax Regulations. These rules pro-
vide that if an interest is transferred in
trust, the spouse is entitled for life to all
the income from the entire interest or a
specific portion of the entire interest if the
effect of the trust is to give the spouse
substantially that degree of beneficial en-
joyment of the trust property during the
spouse’s life which the principles of the
law of trusts accord a person who is un-
qualifiedly designated as the life benefi-
ciary of a trust.
The proposed regulations will provide
that a spouse’s interest satisfies the income
standard set forth in §§20.2056(b)–
5(f) and 25.2523(e)–1(f) if the spouse is en-
titled to income as defined under a state
statute that provides for a reasonable appor-
tionment between the income and remain-
der beneficiaries of the total return of the

2001–16 I.R.B.1079April 16, 2001
trust and that meets the requirements of
§1.643(b)–1(a). As the examples under
§1.643(b)–1(a) make clear, reasonable ap-
portionment can be accomplished through a
unitrust definition of income or by giving
the trustee the power to make equitable ad-
justments between income and principal. In
addition, a conforming amendment is made
to §20.2056A–5(c)(2) providing rules re-
garding distributions of income from a qual-
ified domestic trust.
Trusts Exempt From Generation-Skipping
Transfer Tax
In general, under the effective date
rules accompanying the generation-skip-
ping transfer (GST) tax statutory provi-
sions, a trust that was irrevocable on Sep-
tember 25, 1985, is not subject to the GST
tax provisions, unless a GST transfer is
made out of corpus added to the trust after
that date. Section 1433(b)(2)(A) of the
Tax Reform Act of 1986 (TRA), Public
Law 99–514 (100 Stat. 2085, 2731),
1986–3 (Vol. 1) C.B. 1, 634. The regula-
tions provide guidance on when certain
changes made to the terms of an exempt
trust will not be treated as causing the
trust to lose its exempt or grandfathered
status. One safe-harbor in §26.2601–
1(b)(4)(i)(D) is for modifications that will
not shift a beneficial interest in the trust to
a lower generation beneficiary or increase
the amount of a GST transfer.
Under the proposed regulations, the ad-
ministration of a pre-September 25, 1985,
trust in conformance with a state law that
defines income as a unitrust amount, or
permits equitable adjustments between in-
come and principal to ensure impartiality,
and that meets the requirements of
§1.643(b)–1(a) will not be treated as a
modification that shifts a beneficial inter-
est to a lower generation beneficiary, or
increases the amount of a generation-
skipping transfer.
Proposed Effective Date
The regulations are proposed to apply
to trusts and estates for taxable years that
begin on or after the date that final regula-
tions are published in the Federal Regis-
ter.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Exec-
utive Order 12866. Therefore, a regula-
tory assessment is not required. It also
has been determined that section 553(b)
of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these
regulations, and, because these regula-
tions do not impose a collection of infor-
mation on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does
not apply. Therefore, a Regulatory Flexi-
bility Analysis is not required. Pursuant
to section 7805(f) of the Code, this notice
of proposed rulemaking will be submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written comments
(preferably a signed original and eight (8)
copies) and comments sent via the Internet
that are submitted timely to the IRS. The
IRS and Treasury request comments on the
clarity of the proposed regulations and how
they may be made easier to understand. All
comments will be available for public in-
spection and copying. A public hearing has
been scheduled for June 8, 2001, in the IRS
Auditorium, Internal Revenue Service,
1111 Constitution Avenue, NW, Washing-
ton, DC. Owing to building security proce-
dures, visitors must enter at the 10
th
Street
entrance, located between Constitution and
Pennsylvania Avenues, NW. Because of
access restrictions, visitors will not be ad-
mitted 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
attend the hearing, see the “FOR FUR-
THER INFORMATION CONTACT” sec-
tion of this preamble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons who wish to
present oral comments at the hearing must
submit written or electronic comments
and an outline of the topics to be dis-
cussed and the time to be devoted to each
topic (preferably a signed original and
eight (8) copies) by May 18, 2001. A pe-
riod of 10 minutes will be allotted to each
person 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
Various personnel from offices of the
IRS and the Treasury Department partici-
pated in the development of these pro-
posed regulations.
* * * * *
Proposed Amendments to the
Regulations
Accordingly, 26 CFR parts 1, 20, 25,
and 26 are proposed to be amended as fol-
lows:
PART 1—–INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In §1.642(c)–2, paragraph (c) is
amended by adding a sentence after the
first sentence to read as follows:
§1.642(c)–2 Unlimited deduction for
amounts permanently set aside for a
charitable purpose.
* * * * *
(c) * * * No amount of net long-term
capital gain shall be considered perma-
nently set aside for charitable purposes if
it is possible, under the terms of the
fund’s governing instrument or applicable
local law, that the income beneficiaries’
right to income may, at any time, be satis-
fied by the payment of either an amount
equal to a fixed percentage of the annual
fair market value of the trust property or
any amount based on unrealized apprecia-
tion in the value of the trust property. * *
*
* * * * *
Par. 3. Section 1.643(a)–3 is revised to
read as follows:
§1.643(a)–3 Capital gains and losses.
(a) In general. Except as provided in
§1.643(a)–6 and in paragraph (b) of this
section, gains from the sale or exchange
of capital assets are ordinarily excluded
from distributable net income and are not
ordinarily considered as paid, credited, or
required to be distributed to any benefi-
ciary.
(b) Capital gains included in distrib-
utable net income. Gains from the sale or
exchange of capital assets are included in

April 16, 200110802001–16 I.R.B.
distributable net income to the extent they
are, pursuant to the terms of the govern-
ing instrument and applicable local law,
or pursuant to a reasonable and consistent
exercise of discretion by the fiduciary (in
accordance with a power granted to the
fiduciary by local law or by the governing
instrument, if not inconsistent with local
law)—
(1) Allocated to income;
(2) Allocated to corpus but treated by
the fiduciary on the trust’s books, records,
and tax returns as part of a distribution to
a beneficiary; or
(3) Allocated to corpus but utilized by
the fiduciary in determining the amount
which is distributed or required to be dis-
tributed to a beneficiary.
(c) Charitable contributions included
in distributable net income. If capital
gains are paid, permanently set aside, or
to be used for the purposes specified in
section 642(c), so that a charitable deduc-
tion is allowed under that section in re-
spect of the gains, they must be included
in the computation of distributable net in-
come.
(d) Capital losses. Losses from the sale
or exchange of capital assets shall first be
netted at the trust level against any gains
from the sale or exchange of capital assets,
except for a capital gain that is utilized
under paragraph (b)(3) of this section in de-
termining the amount that is distributed or
required to be distributed to a particular
beneficiary. See §1.642(h)–1 with respect
to capital loss carryovers in the year of final
termination of an estate or trust.
(e) Examples. The following examples
illustrate the rules of this section:
Example 1. Under the terms of Trust’s governing
instrument, all income is to be paid to Afor life.
Trustee is given discretionary powers to invade prin-
cipal for A’s benefit and to deem discretionary distri-
butions to be made from capital gains realized dur-
ing the year. During Trust’s first taxable year, Trust
has $5,000 of dividend income and $10,000 of capi-
tal gain from the sale of securities. Pursuant to the
terms of the governing instrument and applicable
local law, Trustee allocates the $10,000 capital gain
to principal. During the year, Trustee distributes to
A$5,000, representing A’s right to trust income. In
addition, Trustee distributes to A$12,000, pursuant
to the discretionary power to distribute principal.
Trustee does not exercise the discretionary power to
deem the discretionary distributions of principal as
being paid from capital gains realized during the
year. Therefore, the capital gains realized during the
year are not included in distributable net income and
the $10,000 of capital gain is taxed to the trust.
Example 2. The facts are the same as in Example
1, except that Trustee intends to follow a regular
practice of treating discretionary distributions as
being paid first from any net capital gains realized
by Trust during the year. Trustee evidences this
treatment by including the $10,000 capital gain in
distributable net income on Trust’s federal income
tax return so that it is taxed to A. This treatment of
the capital gains is a reasonable exercise of Trustee’s
discretion. In future years Trustee must treat all dis-
cretionary distributions as being made first from any
realized capital gains.
Example 3. The facts are the same as in Example
1, except that pursuant to the terms of the governing
instrument (in a provision not inconsistent with ap-
plicable local law), capital gains realized by Trust
are allocated to income. Because the capital gains
are allocated to income pursuant to the terms of the
governing instrument, the $10,000 capital gain is in-
cluded in Trust’s distributable net income for the
taxable year.
Example 4. The facts are the same as in Example
1, except that Trustee decides that discretionary dis-
tributions will be made only to the extent Trust has
realized capital gains during the year and thus the
discretionary distribution to Ais $10,000, rather
than $12,000. Because Trustee will consistently use
the amount of any realized capital gain to determine
the amount of the discretionary distribution to the
beneficiary, the $10,000 capital gain is included in
Trust’s distributable net income for the taxable year.
Example 5. Trust’s assets consist of Blackacre
and other property. Under the terms of Trust’s gov-
erning instrument, Trustee is directed to hold Black-
acre for ten years and then sell it and distribute all
the sales proceeds to A. Because Trustee uses the
amount of the sales proceeds that includes any real-
ized capital gain to determine the amount required to
be distributed to A, any capital gain realized from
the sale of Blackacre is included in Trust’s distrib-
utable net income for the taxable year.
Example 6. Under the terms of Trust’s governing
instrument, all income is to be paid to Aduring the
Trust’s term. When Areaches 35, Trust is to termi-
nate and all the principal is to be distributed to A.
All capital gains realized in the year of termination
are included in distributable net income. See
§1.641(b)–3 for the determination of the year of
final termination and the taxability of capital gains
realized after the terminating event and before final
distribution.
Example 7.The facts are the same as Example 6,
except Trustee is directed to distribute only one-half
of the principal to Awhen Areaches 35. Trust assets
consist entirely of stock in corporation M. If Trustee
sells one-half of the stock and distributes the sales
proceeds to A, all the capital gain attributable to that
sale is included in distributable net income. If
Trustee sells all the stock and distributes one-half of
the sales proceeds to A, one-half of the capital gain
attributable to that sale is included in distributable
net income.
Example 8. The facts are the same as Example 6,
except Trustee is directed to pay B$10,000 before
distributing the remainder of Trust assets to A. No
portion of the capital gains is allocable to Bbecause
the distribution to Bis a gift of a specific sum of
money within the meaning of section 663(a)(1).
Example 9. State law provides that a trustee may
make an election to pay an income beneficiary an
amount equal to four percent of the annual fair mar-
ket value of the trust assets in full satisfaction of that
beneficiary’s right to income. State law provides
that this unitrust amount shall be considered paid
first from ordinary income, then from net short–term
capital gain, then from net long-term capital gain,
and finally from return of principal. Trust’s govern-
ing instrument provides that Ais to receive each
year income as defined under State law. Trustee
makes the unitrust election under State law. At the
beginning of the taxable year, Trust assets are valued
at $500,000. During the year, Trust receives $5,000
of dividend income and realizes $80,000 of net long-
term gain from the sale of capital assets. Trustee
distributes to A$20,000 (4% of $500,000) in satis-
faction of A’s right to income. Net long-term capital
gain in the amount of $15,000 is allocated to income
pursuant to the State law ordering rule and is in-
cluded in distributable net income for the taxable
year.
Example 10. The facts are the same as in Exam-
ple 9, except that neither State law nor Trust’s gov-
erning instrument has an ordering rule for the char-
acter of the unitrust amount, but leaves such a
decision to the discretion of Trustee. Trustee intends
to follow a regular practice of treating principal as
distributed to the beneficiary to the extent that the
unitrust amount exceeds Trust’s ordinary income.
Trustee evidences this treatment by not including
any capital gains in distributable net income on
Trust’s Federal income tax return so that the entire
$80,000 capital gain is taxed to Trust. This treat-
ment of the capital gains is a reasonable exercise of
Trustee’s discretion. In future years Trustee must
consistently follow this treatment with respect to all
realized capital gains.
Example 11. The facts are the same as in Exam-
ple 9, except that neither State law nor Trust’s gov-
erning instrument has an ordering rule for the char-
acter of the unitrust amount, but leaves such a
decision to the discretion of Trustee. Trustee intends
to follow a regular practice of treating net capital
gains as distributed to the beneficiary to the extent
the unitrust amount exceeds Trust’s ordinary in-
come. Trustee evidences this treatment by including
$15,000 of the capital gain in distributable net in-
come on Trust’s Federal income tax return. This
treatment of the capital gains is a reasonable exer-
cise of Trustee’s discretion. In future years Trustee
must consistently treat realized capital gain, if any,
as distributed to the beneficiary to the extent that the
unitrust amount exceeds ordinary income.
Par. 4. Section 1.643(b)–1 is revised to
read as follows:
§1.643(b)–1 Definition of income.
For purposes of subparts A through D,
part I, subchapter J, chapter 1 of the Inter-
nal Revenue Code, income, when not pre-
ceded by the words “taxable,” “distrib-
utable net,” “undistributed net,” or
“gross,” means the amount of income of
an estate or trust for the taxable year de-
termined under the terms of the governing
instrument and applicable local law.
Trust provisions that depart fundamen-
tally from traditional principles of income
and principal, that is, allocating ordinary
income to income and capital gains to

2001–16 I.R.B.1081April 16, 2001
principal, will generally not be recog-
nized. However, amounts allocated be-
tween income and principal pursuant to
applicable local law will be respected if
local law provides for a reasonable appor-
tionment between the income and remain-
der beneficiaries of the total return of the
trust for the year, including ordinary in-
come, capital gains, and appreciation.
For example, a state law that provides for
the income beneficiary to receive each
year a unitrust amount of between 3% and
5% of the annual fair market value of the
trust assets is a reasonable apportionment
of the total return of the trust. Similarly, a
state law that permits the trustee to make
equitable adjustments between income
and principal to fulfill the trustee’s duty of
impartiality between the income and re-
mainder beneficiaries is generally a rea-
sonable apportionment of the total return
of the trust. These adjustments are per-
mitted when the trustee invests and man-
ages the trust assets under the state’s pru-
dent investor standard, the trust describes
the amount that shall or must be distrib-
uted to a beneficiary by referring to the
trust’s income, and the trustee after apply-
ing the state statutory rules regarding allo-
cation of income and principal is unable
to administer the trust impartially. In ad-
dition, an allocation of capital gains to in-
come will be respected if the allocation is
made either pursuant to the terms of the
governing instrument and local law, or
pursuant to a reasonable and consistent
exercise of a discretionary power granted
to the fiduciary by local law or by the
governing instrument, if not inconsistent
with local law.
Par. 5. In §1.651(a)–2, paragraph (d) is
added to read as follows:
§1.651(a)–2 Income required to be
distributed currently.
* * * * *
(d) If a trust distributes property in kind
as part of its requirement to distribute cur-
rently all the income as defined under sec-
tion 643(b) and the applicable regulations,
the trust shall be treated as having sold the
property for its fair market value on the
date of distribution. If no amount in excess
of the amount of income as defined under
section 643(b) and the applicable regula-
tions is distributed by the trust during the
year, the trust will qualify for treatment
under section 651 even though property in
kind was distributed as part of a distribution
of all such income.
Par. 6. In §1.661(a)–2, paragraph (f) is
revised to read as follows:
§1.661(a)–2 Deduction for distributions
to beneficiaries.
* * * * *
(f) Gain or loss is realized by the trust
or estate (or the other beneficiaries) by
reason of a distribution of property in
kind if the distribution is in satisfaction of
a right to receive a distribution of a spe-
cific dollar amount, of specific property
other than that distributed, or of income
as defined under section 643(b) and the
applicable regulations, if income is re-
quired to be distributed currently. In ad-
dition, gain or loss is realized if the
trustee or executor makes the election to
recognize gain or loss under section
643(e).
Par. 7. In §1.664–3, paragraph
(a)(1)(i)(b)(3) is revised to read as fol-
lows:
§1.664–3 Charitable remainder unitrust.
(a) * * *
(1) * * *
(i) * * *
(b) * * *
(3) For purposes of this paragraph
(a)(1)(i)(b), trust income generally means
income as defined under section 643(b)
and the applicable regulations. However,
trust income may not be determined by
reference to a fixed percentage of the an-
nual fair market value of the trust prop-
erty. If applicable state law provides that
income is a unitrust amount, the trust’s
governing instrument must contain its
own definition of trust income. In addi-
tion, capital gain attributable to apprecia-
tion in the value of a trust asset after the
date it was contributed to the trust or pur-
chased by the trust may be allocated to in-
come pursuant to applicable local law and
the terms of the governing instrument but
not pursuant to a discretionary power
granted the trustee.
* * * * *
PART 20—ESTATE TAX; ESTATES OF
DECEDENTS DYING AFTER
AUGUST 16, 1954
Par. 8. The authority citation for part
20 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 9. Section 20.2056(b)–5 is
amended by adding a new sentence to the
end of paragraph (f)(1) to read as fol-
lows:
§20.2056(b)–5 Marital deduction; life
estate with power of appointment in
surviving spouse.
* * * * *
(f) * * * (1) * * * In addition, the sur-
viving spouse’s interest shall meet the
condition set forth in paragraph (a)(1) of
this section, if the spouse is entitled to in-
come as defined by a state statute that
provides for a reasonable apportionment
between the income and remainder bene-
ficiaries of the total return of the trust and
that meets the requirements of
§1.643(b)–1 of the this chapter.
* * * * *
Par. 10. Section 20.2056(b)–7 is
amended by adding a new sentence to the
end of paragraph (d)(1) to read as follows:
§20.2056(b)–7 Election with respect to
life estate for surviving spouse.
* * * * *
(d) * * * (1) * * * A power under applic-
able state law that permits the trustee to ad-
just between income and principal to fulfill
the trustee’s duty of impartiality between
the income and remainder beneficiaries that
meets the requirements of §1.643(b)–1 of
this chapter will not be considered a power
to appoint trust property to a person other
than the surviving spouse.
* * * * *
Par. 11. Section 20.2056(b)–10 is
amended by adding a new sentence at the
end of the section to read as follows:
§20.2056(b)–10 Effective dates.
* * * In addition, the rule in the last
sentence of §20.2056(b)–5(f)(1) and the
rule in the last sentence of
§20.2056(b)–7(d)(1) regarding the
spouse’s right to income if the state
statute provides for the reasonable appor-
tionment between the income and remain-
der beneficiaries of the total return of the
trust are applicable with respect to trusts
for taxable years that begin on or after the
date that final regulations are published in
the Federal Register.
Par. 12. Section 20.2056A–5 is
amended by adding a new sentence in

April 16, 200110822001–16 I.R.B.
paragraph (c)(2) after the third sentence
to read as follows:
§20.2056A–5 Imposition of section
2056A estate tax.
* * * * *
(c) * * *
(2) * * * However, distributions made
to the surviving spouse as the income
beneficiary in conformance with applica-
ble state law that defines the term income
as a unitrust amount, or permits the
trustee to adjust between principal and in-
come to fulfill the trustee’s duty of impar-
tiality between income and principal ben-
eficiaries, will be considered distributions
of trust income, if the state statute pro-
vides for a reasonable apportionment be-
tween the income and remainder benefi-
ciaries of the total return of the trust and
meets the requirements of §1.643(b)–1 of
this chapter.* * *
* * * * *
Par. 13. Section 20.2056A–13 is re-
vised to read as follows:
§20.2056A–13 Effective dates.
Except as provided in this section, the
provisions of §§20.2056A–1 through
20.2056A–12 are applicable with respect
to estates of decedents dying after August
22, 1995. The rule in the fourth sentence
of §20.2056A–5(c) regarding unitrusts
and distributions of income to the surviv-
ing spouse in conformance with applica-
ble state law that provides for the reason-
able apportionment between the income
and remainder beneficiaries of the total
return of the trust is applicable with re-
spect to trusts for taxable years that begin
on or after the date that final regulations
are published in the Federal Register.
PART 25—GIFT TAX; GIFTS MADE
AFTER DECEMBER 31, 1954
Par. 14. The authority citation for part
25 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 15. Section 25.2523(e)–1 is
amended by adding a new sentence to
the end of paragraph (f)(1) to read as
follows:
§25.2523(e)–1 Marital deduction; life
estate with power of appointment in
donee spouse.
* * * * *
(f) * * * (1) * * * In addition, the
spouse’s interest shall meet the condition
set forth in paragraph (a)(1) of this sec-
tion, if the spouse is entitled to income as
defined by a state statute that provides for
a reasonable apportionment between the
income and remainder beneficiaries of the
total return of the trust and that meets the
requirements of §1.643(b)–1(a) of this
chapter.
* * * * *
Par. 16. Section 25.2523(h)–2 is
amended by adding a new sentence to the
end of the section to read as follows:
§25.2523(h)–2 Effective dates.
* * * In addition, the rule in the fourth
sentence of §25.2523(e)–1(f)(1) regard-
ing the spouse’s right to income if the
state statute provides for reasonable ap-
portionment between the income and re-
mainder beneficiaries of the total return of
the trust is applicable with respect to
trusts and estates for taxable years that
begin on or after the date the final regula-
tions are published in the Federal Regis-
ter.
PART 26—GENERATION-SKIPPING
TRANSFER TAX REGULATIONS
UNDER THE TAX REFORM ACT OF
1986
Par. 17. The authority citation for part
26 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 18. Section 26.2601–1 is amended
as follows:
1. Paragraph (b)(4)(i)(D)(2) is
amended by adding a new sentence to the
end of the paragraph.
2. Paragraph (b)(4)(i)(E) is amended
by adding Examples 11and 12.
3. Paragraph (b)(4)(ii) is revised to
read as follows.
The additions and revisions read as fol-
lows:
§26.2601–1 Effective dates.
* * * * *
(b) * * *
(4) * * *
(i) * * *
(D) * * *
(2) * * * In addition, administration of
a trust in conformance with applicable
state law that defines the term income as a
unitrust amount, or permits the trustee to
adjust between principal and income to
fulfill the trustee’s duty of impartiality be-
tween income and principal beneficiaries,
will not be considered to shift a beneficial
interest in the trust, if the state statute pro-
vides for a reasonable apportionment be-
tween the income and remainder benefi-
ciaries of the total return of the trust and
meets the requirements of §1.643(b)–1 of
this chapter.
(E) * * *
Example 11. Conversion of income interest to
unitrust interest under state statute. In 1980,
Grantor, a resident of State X, established an irrevo-
cable trust for the benefit of Grantor’s child, A, and
A’s issue. The trust provides that trust income is
payable to Afor life and upon A’s death the remain-
der is to pass to A’s issue, per stirpes. In 2002, State
X amends its income and principal statute to define
“income” as a unitrust amount of 4% of the fair mar-
ket value of the trust assets valued annually. For a
trust established prior to 2002, the statute provides
that the new definition of income will apply only if
all the beneficiaries who have an interest in the trust
consent to the change within two years after the ef-
fective date of the statute. The statute provides spe-
cific procedures to establish the consent of the bene-
ficiaries. Aand A’s issue consent to the change in
the definition of income within the time period, and
in accordance with the procedures, prescribed by the
state statute. The administration of the trust, in ac-
cordance with the state statute defining income to be
a 4% unitrust amount, will not be considered to shift
any beneficial interest in the trust. Therefore, the
trust will not be subject to the provisions of chapter
13 of the Internal Revenue Code.
Example 12. Equitable adjustments under state
statute. The facts are the same as in Example 11, ex-
cept that in 2002, State X amends its income and
principal statute to permit the trustee to make equi-
table adjustments between income and principal
when the trustee invests and manages the trust assets
under the state’s prudent investor standard, the trust
describes the amount that shall or must be distrib-
uted to a beneficiary by referring to the trust’s in-
come, and the trustee after applying the state statu-
tory rules regarding allocation of income and
principal is unable to administer the trust impar-
tially. The provision permitting the trustees to make
these equitable adjustments is effective in 2002 for
trusts created at any time. The trustee invests and
manages the trust assets under the state’s prudent in-
vestor standard, and pursuant to authorization in the
state statute, the trustee allocates receipts between
the income and principal accounts in a manner to en-
sure the impartial administration of the trust. The
administration of the trust in accordance with the
state statute will not be considered to shift any bene-
ficial interest in the trust. Therefore, the trust will
not be subject to the provisions of chapter 13 of the
Internal Revenue Code.
(ii) Effective dates. The rules in this
paragraph (b)(4) are applicable on and
after December 20, 2000. However, the
rule in the last sentence of paragraph
(b)(4)(i)(D)(2) of this section regarding
the administration of a trust in confor-

2001–16 I.R.B.1083April 16, 2001
mance with applicable state law providing
for a reasonable apportionment between
the income and remainder beneficiaries of
the total return of the trust is applicable
with respect to trusts for taxable years that
begin on or after the date that final regula-
tions are published in the Federal Regis-
ter.
* * * * *
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
(Filed by the Office of the Federal Register on Feb-
ruary 14, 2001, 8:45 a.m., and published in the issue
of the Federal Register for February 15, 2001, 66
F.R. 10396)
Notice of Proposed Rulemaking
and Notice of Public Hearing
Treaty Guidance Regarding
Payments With Respect to
Domestic Reverse Hybrid
Entities
REG–107101–00
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations under section 894 of
the Internal Revenue Code relating to the
eligibility for treaty benefits of items of
income paid by domestic entities that are
not fiscally transparent under U.S. law but
are fiscally transparent under the laws of
the jurisdiction of the person claiming
treaty benefits (a domestic reverse hybrid
entity). The proposed regulations affect
the determination of tax treaty benefits
with respect to U.S. source income of for-
eign persons. This document also pro-
vides notice of a public hearing on these
proposed regulations.
DATES: Written or electronic com-
ments must be received by May 28,
2001. Requests to speak (with outlines
of oral comments to be discussed) at the
public hearing scheduled for June 26,
2001, at 10 a.m., must be submitted by
June 5, 2001.
ADDRESSES: Send submissions to:
CC:M&SP:RU (REG–107101–00), room
5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand de-
livered between the hours of 8 a.m. and 5
p.m. to: CC:M&SP:RU (REG–107101–
00), Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW,
Washington, DC. Alternatively, taxpayers
may submit comments electronically via
the Internet by selecting the “Tax Regs”
option on the IRS Home Page, or by sub-
mitting comments directly to the IRS In-
ternet site at http://www.irs.gov/tax_regs
/regslist.html.The public hearing will be
held in the auditorium, Internal Revenue
Building, 1111 Constitution Avenue, NW,
Washington, DC.
FOR FURTHER INFORMATION
CONTACT: Concerning the regula-
tions, Elizabeth U. Karzon or Karen
Rennie-Quarrie at (202) 622-3880; con-
cerning submissions and the hearing,
Guy R. Traynor at (202) 622-7180 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
On June 30, 1997, the IRS and Treasury
issued temporary regulations (T.D. 8722,
1997–2 C.B. 81) in the Federal Register
(62 FR 35673, as corrected at 62 FR
46876, 46877) under section 894 of the In-
ternal Revenue Code relating to eligibility
for benefits under income tax treaties for
payments to certain entities. These regu-
lations addressed, among other matters,
the eligibility for treaty benefits of U.S.
source payments made to domestic re-
verse hybrid entities, concluding that
treaty benefits were not available for such
payments. A notice of proposed rulemak-
ing (REG–104893–97, 1997–2 C.B. 646)
cross-referencing the temporary regula-
tions was also published in the same issue
of the Federal Register(62 FR 35755).
On July 3, 2000, the IRS and Treasury is-
sued final regulations (T.D. 8889,
2000–30 I.R.B. 124), reaffirming the posi-
tion taken in the temporary regulations
with respect to payments made to domes-
tic reverse hybrid entities. The final regu-
lations, however, did not address the ques-
tion of whether payments made by
domestic reverse hybrid entities to their
interest holders are eligible for treaty ben-
efits. Section 1.894–1(d)(2)(ii) was re-
served for further guidance on that issue.
Explanation of Provisions
These proposed regulations provide
guidance with respect to the previously
reserved paragraph. They provide rules
on the character of such payments for
treaty purposes and the extent to which
such payments are eligible for a reduced
rate of U.S. tax under a U.S. income tax
treaty. The use of domestic reverse hy-
brid entities may give rise to inappropri-
ate and unintended results under income
tax treaties, such as double non-taxation
or double taxation, unless the income tax
treaties are interpreted to resolve the con-
flict of laws. These regulations provide
guidance regarding how to apply U.S. in-
come tax treaties under these circum-
stances.
Section 1.894–1T(d)(3) provided guid-
ance on the appropriate treatment of items
of income paid to a domestic reverse hy-
brid entity. That section provided that
§1.894–1T(d)(1) may not be applied to
reduce the amount of Federal income tax
on U.S. source income received by a do-
mestic reverse hybrid entity through ap-
plication of an income tax treaty. Thus,
neither the domestic reverse hybrid entity
nor its interest holders could claim a re-
duction under an income tax treaty with
respect to a payment to a domestic reverse
hybrid entity, notwithstanding that the in-
terest holder might otherwise derive the
income as a resident of a treaty jurisdic-
tion under §1.894–1T(d)(1). The ratio-
nale for the rule was the U.S. tax treaty
principle that the United States retains
taxing jurisdiction over items of U.S.
source income paid to its residents. The
final regulations published in the Federal
Registeron July 3, 2000, retain the rule
that a domestic reverse hybrid entity re-
mains subject to the taxing jurisdiction of
the United States on U.S. source pay-
ments, but reserve with respect to the
treatment of payments made by domestic
reverse hybrid entities.
Commentators on the previously issued
temporary and proposed regulations noted
that it was unclear how items of income
paid by a domestic reverse hybrid entity
to its interest holders should be treated.
In particular, the general rule contained
in §1.894–1T(d)(1) required the item of
income to be “received by” a person resi-
dent in a treaty jurisdiction and for that
item of income to be “subject to tax” in
the hands of the person deriving the item

April 16, 200110842001–16 I.R.B.
of income. Commentators expressed con-
cern that an item of income paid by a do-
mestic reverse hybrid entity could be
viewed as neither “received by” the inter-
est holder nor “subject to tax” because the
interest holder’s jurisdiction treats the do-
mestic reverse hybrid entity as fiscally
transparent. The interest holder’s juris-
diction views the interest holder as “re-
ceiving” the items of income paid to the
domestic reverse hybrid entity and as
being “subject to tax” on those items of
income on an immediate basis. The inter-
est holder’s jurisdiction does not recog-
nize the items of income paid by the do-
mestic reverse hybrid entity to the interest
holder. Based on this analysis, commen-
tators questioned whether the items of in-
come paid by the domestic reverse hybrid
entity to an interest holder in that entity
would be subject to a 30-percent tax
under the Code. The IRS and Treasury
believe similar questions may also arise
under the recently issued final regula-
tions.
Accordingly, these proposed regula-
tions provide rules on the treatment of
payments made by domestic reverse hy-
brid entities. Paragraph (d)(2)(ii) of this
section provides a general rule that an
item of income paid by a domestic reverse
hybrid entity to an interest holder shall be
characterized under U.S. tax law. This
means that U.S. tax principles are first ap-
plied to characterize the item of income
paid by the domestic reverse hybrid entity
to the interest holder for purposes of ap-
plying an applicable income tax treaty
provision. Once the item of income is so
characterized, it is necessary to determine
if the interest holder derives the item of
income. In determining whether the in-
terest holder derives the item of income,
paragraph (d)(2)(ii)(A) of this section
provides a special rule for determining
whether the interest holder is fiscally
transparent with respect to the item of in-
come. Under that rule, whether the inter-
est holder is fiscally transparent with re-
spect to the item of income for purposes
of §1.894–1(d)(3)(ii) is made based on
the treatment that would have resulted
had the item of income been paid by an
entity that was not fiscally transparent
under the laws of the interest holder’s ju-
risdiction with respect to any item of in-
come. Accordingly, if the interest holder
is not fiscally transparent, then it will be
considered to have derived the item of in-
come, even if, for example, the item of in-
come were characterized differently or
treated as received at an earlier date under
the laws of the interest holder’s jurisdic-
tion than the item of income paid by the
domestic reverse hybrid entity.
The IRS and Treasury have learned,
however, that domestic reverse hybrid en-
tities are being established by related par-
ties to manipulate differences in U.S. and
foreign entity classification rules to re-
duce inappropriately the amount of tax
imposed on items of income paid from the
United States to related foreign interest
holders. In a typical scenario, a foreign
investor, resident in a treaty jurisdiction,
establishes a domestic reverse hybrid
holding company with a combination of
debt and equity contributions. The do-
mestic reverse hybrid entity holds the
stock of a wholly-owned U.S. operating
company. The operating company pays a
dividend to the domestic reverse hybrid
entity, but the domestic reverse hybrid en-
tity primarily pays interest to its foreign
owner within the earning stripping limits
of section 163(j). The foreign jurisdiction
views the foreign owner as receiving divi-
dends, but the United States views the do-
mestic reverse hybrid entity as receiving
the dividends and making deductible in-
terest payments. In circumstances when
the income tax treaty between the United
States and the applicable foreign jurisdic-
tion applies a zero withholding rate on in-
terest and a 5-percent rate on related party
dividends, the domestic reverse hybrid
entity treats its payment to the foreign
owner as an interest payment and the for-
eign owner avoids the withholding tax on
the dividends that its jurisdiction treats it
as receiving. In addition, the domestic re-
verse hybrid entity receives the benefit of
an interest deduction in the United States
while the foreign interest holder receives
either a tax credit or exclusion on the div-
idend amount in its jurisdiction.
The IRS and Treasury believe that it is
inappropriate for related parties to use do-
mestic reverse hybrid entities for the pur-
pose of converting higher taxed U.S.
source items of income to lower taxed, or
untaxed, U.S. source items of income. To
do so defeats the expectation of the
United States and its treaty partners that
treaties should be used to reduce or elimi-
nate double taxation for legitimate trans-
actions, not to reward the manipulation of
inconsistencies in the laws of the treaty
partners. The legislative history of sec-
tion 894(c) supports this analysis. Con-
gress specifically expressed its concern
about the potential tax avoidance opportu-
nities available for foreign persons that
invest in the United States through hybrid
entities that are designed to avoid both
U.S. and foreign income taxes. See H.R.
Conf. Rep. No 220, 105th Cong, 1st Sess.
573 (1997); Joint Committee on Taxation,
105th Cong., 1st Sess., General Explana-
tion of Tax Legislation Enacted in 1997
(JCS–23–97), at 249 (December 17,
1997). The approach contained in
§1.894–1(d)(2), as revised, is also consis-
tent with the general tax treaty principle
that contracting states may adopt provi-
sions in their domestic laws to counter
structures and transactions intended to
take advantage of the differences in the
tax laws of the contracting states. See
Commentaries to Article 1 of The 1998
OECD Model Tax Convention on Income
and Capital; S. Rep. No. 445, 100th Cong.
2d Sess. 322–23 (1988)
The IRS and Treasury are further con-
cerned by the ability of foreign acquiring
entities to obtain tax advantaged financ-
ing through domestic reverse hybrid enti-
ties by exploiting differences between
U.S. and foreign law. Such financing un-
fairly disadvantages similarly situated
U.S. domestic acquiring entities. Con-
gress has expressed concern about the use
of analogous hybridized structures that
were effected to provide foreign acquiring
entities with tax advantaged acquisition
financing not available to similarly situ-
ated domestic companies. See Joint
Committee on Taxation, 100th Congress,
1st Sess., General Explanation of the Tax
Reform Act of 1986 (JCS–10–87), at
1064, 1065 (May 4, 1987).
For these reasons, the proposed regula-
tions provide a special rule in paragraph
(d)(2)(ii)(B) of the regulations, such that
if: (1) a domestic entity makes a payment
to a related domestic reverse hybrid en-
tity that is considered to be a dividend ei-
ther under the laws of the United States
or under the laws of the jurisdiction of a
related foreign interest holder in the do-
mestic reverse hybrid entity, and the re-
lated foreign interest holder is treated as
deriving its proportionate share of the
payment to the domestic reverse hybrid

2001–16 I.R.B.1085April 16, 2001
entity under the laws of the related for-
eign interest holder’s jurisdiction; and (2)
the domestic reverse hybrid entity makes
a payment to the related foreign interest
holder of a type that is deductible for
U.S. tax purposes and for which a reduc-
tion in the U.S. withholding tax rate
would be allowed under the general rule,
but for this exception, then to the extent
the amount of the payment by the domes-
tic reverse hybrid entity to the related for-
eign interest holder does not exceed the
total amount of the interest holder’s pro-
portionate share of any payments by the
domestic entity to the domestic reverse
hybrid entity treated as dividends under
either jurisdiction’s laws, the payment by
the domestic reverse hybrid entity shall
be treated as a dividend for all purposes
of the Code and the applicable income
tax treaty.
For purposes of determining the
amount of the payment from the domes-
tic reverse hybrid entity to the related for-
eign interest holder to be recharacterized
as a dividend, the portion of the pay-
ments treated as derived by the related
foreign interest holder shall be reduced
by the amount of any prior actual divi-
dend payments, under U.S. law, made by
the domestic reverse hybrid entity to the
related foreign interest holder and by the
amount of any payments from the domes-
tic reverse hybrid entity to the related for-
eign interest holder previously recharac-
terized under this special rule. The tax
withheld from the payment from the do-
mestic reverse hybrid entity to the related
foreign interest holder shall be deter-
mined based on the appropriate rate of
withholding that would be applicable to
dividends paid by the domestic reverse
hybrid entity to the related foreign inter-
est holder under the U.S. treaty with the
related foreign interest holder’s jurisdic-
tion had that jurisdiction viewed the do-
mestic reverse hybrid entity as not fis-
cally transparent. Because any payment
subject to the provisions of this special
rule is treated as a dividend for all pur-
poses of the Code and the applicable
treaty, the domestic reverse hybrid entity
will not be able to claim a deduction on
the payment to the related foreign interest
holder.
The regulations provide an 80% own-
ership test to determine if the parties are
related to one another and a special rule
that treats accommodation parties as re-
lated foreign interest holders. The fore-
going rules also apply to recharacterize
payments when more than one domestic
reverse hybrid entity or other fiscally
transparent entity is involved.
The proposed regulations further pro-
vide that a taxpayer may not affirma-
tively use the rules of paragraph (d)(2) of
this section if a principal purpose for
using such rules is the avoidance of any
tax imposed by the Code. Thus, with re-
spect to such a taxpayer, the Commis-
sioner may depart from the rules of this
section and recharacterize (for all pur-
poses of the Code) the arrangement in ac-
cordance with its form or its economic
substance. The regulations further pro-
vide that, if a taxpayer enters into an
arrangement the effect of which is to cir-
cumvent the principles of this paragraph
(d)(2), the Commissioner may recharac-
terize (for all purposes of the Code) the
arrangement in accordance with the prin-
ciples of this paragraph (d)(2).
Comments are requested on potential
rules with respect to transaction when the
domestic reverse hybrid entity is sold to
unrelated parties who later receive distri-
butions.
Proposed Effective Dates
These proposed regulations apply to
items of income paid by a domestic re-
verse hybrid entity on or after the date
these regulations are published as final
regulations in the Federal Registerwith
respect to amounts received by the do-
mestic reverse hybrid entity on or after
the date these regulations are published
as final regulations in the Federal Regis-
ter. No inference is intended as to the
treatment of transactions entered into
prior to the date of applicability of the
final regulations.
Special Analysis
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Exec-
utive Order 12866. Therefore, a regula-
tory assessment is not required. It has
also been determined that section 553(b)
of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these
regulations and, because these regula-
tions do not impose on small entities a
collection of information requirement,
the Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Therefore, a
Regulatory Flexibility Analysis is not re-
quired. Pursuant to section 7805(f) of the
Code, this notice of proposed rulemaking
will be submitted to the Chief Counsel
for Advocacy of the Small Business Ad-
ministration 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 (preferably a signed original and
eight (8) copies) that are submitted
timely to the IRS. The IRS and Treasury
Department specifically request com-
ments on the clarity of the proposed regu-
lations and how they can be made easier
to understand. All comments will be
available for public inspection and copy-
ing.
A public hearing has been scheduled
for June 26, 2001, at 10 a.m. in the audi-
torium, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington,
DC. Because of access restriction, visi-
tors will not be admitted beyond the In-
ternal Revenue Building lobby more than
15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing.
Persons that wish to present oral com-
ments at the hearing must submit written
comments by May 28, 2001, and submit
an outline of the topics to be discussed
and the time to be devoted to each topic
(preferably a signed original and eight (8)
copies) by June 5, 2001.
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 Shawn R. Pringle of the Office of
the Associate Chief Counsel (Interna-
tional). However, other personnel from
the IRS and Treasury Department partici-
pated in their development.
* * * * *

April 16, 200110862001–16 I.R.B.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority for part 1
continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.894–1(d)(2) also issued
under 26 U.S.C. 894 and 7701(l).* * *
Par. 2. In §1.894–1, paragraph
(d)(2)(ii) is revised and paragraphs
(d)(2)(iii) and (d)(2)(iv) are added to read
as follows:
§1.894–1 Income affected by treaty.
* * * * *
(d) * * *
(2) * * *
(ii) Payments by domestic reverse hy-
brid entities—(A) General rule. Except
as otherwise provided in paragraph
(d)(2)(ii)(B) of this section, an item of in-
come paid by a domestic reverse hybrid
entity to an interest holder in such entity
shall have the character of such item of
income under U.S. law and shall be con-
sidered to be derived by the interest
holder, provided the interest holder is not
fiscally transparent in its jurisdiction, as
defined in paragraph (d)(3)(iii) of this
section, with respect to the item of in-
come. In determining whether the inter-
est holder is fiscally transparent with re-
spect to the item of income under this
paragraph (d)(2)(ii)(A), the determination
under paragraph (d)(3)(ii) of this section
shall be made based on the treatment that
would have resulted had the item of in-
come been paid by an entity that is not fis-
cally transparent under the laws of the in-
terest holder’s jurisdiction with respect to
any item of income.
(B) Payment made to related foreign
interest holder—(1) General rule. If—
(i) A domestic entity makes a payment
to a related domestic reverse hybrid entity
that is treated as a dividend under either
the laws of the United States or the laws
of the jurisdiction of a related foreign in-
terest holder in the domestic reverse hy-
brid entity, and under the laws of the ju-
risdiction of the related foreign interest
holder in the domestic reverse hybrid en-
tity, the related foreign interest holder is
treated as deriving its proportionate share
of the payment under the principles of
paragraph (d)(1) of this section; and
(ii) The domestic reverse hybrid entity
makes a payment of a type that is de-
ductible for U.S. tax purposes to the re-
lated foreign interest holder and for which
a reduction in the U.S. withholding tax
rate would be allowed under paragraph
(d)(2)(ii)(A) of this section but for this
paragraph (d)(2)(ii)(B), then
(iii) To the extent the amount of the
payment described in paragraph
(d)(2)(ii)(B)(1)(ii) of this section does not
exceed the sum of the portion of the pay-
ment described in paragraph
(d)(2)(ii)(B)(1)(i) of this section treated as
derived by the related foreign interest
holder and the portion of any other prior
payments described in paragraph (d)(2)
(ii)(B)(1)(i) of this section treated as de-
rived by the related foreign interest
holder, the amount of the payment de-
scribed in (d)(2)(ii)(B)(1)(ii) of this sec-
tion will be treated for all purposes of the
Internal Revenue Code and the applicable
income tax treaty as a dividend, and the
tax to be withheld from the payment de-
scribed in paragraph (d)(2)(ii)(B)(1)(ii) of
this section shall be determined based on
the appropriate rate of withholding that
would be applicable to dividends paid
from the domestic reverse hybrid entity to
the related foreign interest holder under
the U.S. treaty with the related foreign in-
terest holder’s jurisdiction had that juris-
diction viewed the domestic reverse hy-
brid entity as not fiscally transparent; and
(iv) For purposes of determining the
amount to be recharacterized under para-
graph (d)(2)(ii)(B)(1)(iii) of this section,
the portion of the payments described in
paragraph (d)(2)(ii)(B)(1)(i) of this sec-
tion treated as derived by the related for-
eign interest holder shall be reduced by
the amount of any prior actual dividend
payments made by the domestic reverse
hybrid entity to the related foreign interest
holder and by the amount of any pay-
ments from the domestic reverse hybrid
entity to the related foreign interest holder
previously rechacterized under paragraph
(d)(2)(ii)(B)(1)(iii) of this section.
(2) Tiered entities. The principles of
this paragraph (d)(2)(ii)(B) shall also
apply to payments referred to in this para-
graph (d)(2)(ii)(B) made among related
entities when there is more than one do-
mestic reverse hybrid entity or other fis-
cally transparent entities involved.
(3) Definition of related. Related shall
mean any entity satisfying the ownership
requirements of section 267(b) or
707(b)(1), except that 80 percent shall be
substituted for 50 percent. For purposes
of determining whether a person is related
to another person, the constructive owner-
ship rules of section 318 shall apply, and
the attribution rules of section 267(c) also
shall apply to the extent they attribute
ownership to persons to whom section
318 does not attribute ownership. If a
person enters into a transaction (or series
of transactions) with the domestic reverse
hybrid entity, its related interest holders,
or its related entities, and the effect of the
transaction (or series of transaction) is to
avoid the principles of this paragraph
(d)(2)(ii)(B), then that person shall be
treated as related to the domestic reverse
hybrid entity for purposes of this section.
(C) Commissioner’s discretion. The
Commissioner may, as the Commissioner
determines to be appropriate, recharacter-
ize for all purposes of the Internal Rev-
enue Code all or part of any transaction
(or series of transactions) between related
parties if the effect of the transaction (or
series of transactions) is to avoid the prin-
ciples of this paragraph (d)(2).
(iii) Examples. The rules of this para-
graph (d)(2) are illustrated by the follow-
ing examples:
Example 1. Treatment of payment by unrelated
entity to domestic reverse hybrid entity. (i) Facts.
Entity A is a domestic reverse hybrid entity, as de-
fined in paragraph (d)(2)(i) of this section, with re-
spect to the U.S. source dividends it receives from
B, a domestic corporation to which A is not related,
within the meaning of paragraph (d)(2)(ii)(B)(3) of
this section. A’s 85-percent shareholder FC is a cor-
poration organized under the laws of Country X,
which has an income tax treaty in effect with the
United States. Under Country X law, FC is not fis-
cally transparent with respect to the dividend, as de-
fined in paragraph (d)(3)(ii) of this section. In year
1, A receives a $100 of dividend income from B.
Under Country X law, FC is treated as deriving $85
of the $100 dividend payment received by A. The
applicable rate of tax on dividends under the U.S.-
Country X income tax treaty is 5 percent with re-
spect to a 10-percent or more corporate shareholder.
(ii) Analysis. Under paragraph (d)(2)(i) of this
section, the U.S.-Country X income tax treaty does
not apply to the dividend income received by A be-
cause the income is paid by B, a domestic corpora-
tion, to A, another domestic corporation. A remains
fully taxable under the U.S. tax laws as a domestic
corporation with regard to that item of income. Fur-
ther, pursuant to paragraph (d)(2)(i) of this section,
notwithstanding the fact that under the laws of Coun-
try X A is treated as fiscally transparent with respect

2001–16 I.R.B.1087April 16, 2001
to the dividend income, FC may not claim a reduced
rate of taxation on its share of the U.S. source divi-
dend income received by A.
Example 2. Treatment of payment by domestic re-
verse hybrid entity to related foreign interest holder
involving unrelated party. (i) Facts. The facts are
the same as in Example 1. Both the United States
and Country X characterize the payment by B in year
1 as a dividend. In addition, in year 2, A makes a
payment of $25 to FC that is characterized under
U.S. tax laws as an interest payment to FC on a loan
from FC to A. Under the U.S.-Country X income tax
treaty, the rate of tax on interest is zero. Under
Country X laws, had the interest been paid by an en-
tity that is not fiscally transparent under Country X’s
laws with respect to any item of income, FC would
not be fiscally transparent as defined in paragraph
(d)(2)(ii) of this section with respect to the interest.
(ii) Analysis. The analysis is the same as in Exam-
ple 1with respect to the $100 payment from B to A.
With respect to the $25 payment from A to FC, para-
graph (d)(2)(ii)(B) of this section will not apply be-
cause, although FC is related to A, A is not related to
the payor of the dividend income it received. Under
paragraph (d)(2)(ii)(A) of this section, the $25 interest
income paid from A to FC in year 2 will be character-
ized under U.S. law as interest . Accordingly, in year
2, FC may obtain the reduced rate of withholding ap-
plicable to interest under the U.S.-Country X income
tax treaty, assuming all other requirements for claim-
ing treaty benefits are met.
Example 3. Treatment of payment by domestic re-
verse hybrid entity to related foreign interest holder.
(i) Facts. The facts are the same as in Example 2, ex-
cept the $100 dividend income received by A in year 1
is from A’s wholly owned subsidiary S.
(ii) Analysis. The analysis is the same as in Ex-
ample 1with respect to the $100 dividend payment
from S to A. However, the $25 interest payment in
year 2 by A to FC will be treated as a dividend for all
purposes of the Internal Revenue Code and the U.S.-
Country X income tax treaty because $25 does not
exceed FC’s share of the $100 dividend payment
made by S to A ($85). Since FC is not fiscally trans-
parent with respect to the payment as determined
under paragraph (d)(2)(ii)(A) of this section, FC will
be entitled to obtain the reduced rate applicable to
dividends under the U.S.-Country X income tax
treaty with respect to the $25 payment. Because the
$25 payment in year 2 is recharacterized as a divi-
dend for all purposes of the Internal Revenue Code
and the U.S.-Country X income tax treaty, A would
not be entitled to an interest deduction with respect
to that payment and FC would not be entitled to
claim the reduced rate of withholding applicable to
interest.
(iv) Effective date. This paragraph
(d)(2) applies to items of income paid by
a domestic reverse hybrid entity on or
after the date these regulations are pub-
lished as final regulations in the Federal
Registerwith respect to amounts re-
ceived by the domestic reverse hybrid en-
tity on or after the date these regulations
are published as final regulations in the
Federal Register.
* * * * *
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on Feb-
ruary 26, 2001, 8:45 a.m., and published in the issue
of the Federal Register for February 27, 2001, 66 FR
12445)
U.S.— Korean Agreement
Announcement 2001–34
On June 23, 1999, the Internal Revenue
Service and the Korean Ministry of Fi-
nance and Economy entered into a mutual
agreement pursuant to Article 27 of the
U.S. – Republic of Korea Income Tax
Convention regarding gains from the dis-
position of shares of certain Korean real
property corporations by U.S. persons.
Under the Individual Income Tax Act
and Corporate Income Tax Act of Korea,
the income from the disposition of shares
of a corporation are treated as derived
from the transfer of real property if three
conditions are met. The three conditions
that must exist are: (1) that the value of
the real property held by the corporation
in the country equals or exceeds 50 per-
cent of the value of all the property held
by the corporation; (2) that the share-
holder (and related parties) hold at least
50 percent of the shares of the corpora-
tion; and (3) that the shareholder transfers
at least 50 percent of the corporation.
Korea treats the income attributable to the
gain on such transfers of a Korean corpo-
ration as Korean source, for both nonresi-
dent aliens and foreign corporations.
The U.S. and Korea have agreed that
gains derived from the disposition of
shares of such a Korean corporation
would be sourced in the situscountry of
the real property in order to prevent dou-
ble taxation for purposes of Article 6(9)
and Article 27(2)(9)(c) of the Convention.
Foundations Status of Certain
Organizations
Announcement 2001–35
The following organizations have
failed to establish or have been unable to
maintain their status as public charities or
as operating foundations. Accordingly,
grantors and contributors may not, after
this date, rely on previous rulings or des-
ignations in the Cumulative List of Orga-
nizations (Publication 78), or on the pre-
sumption arising from the filing of notices
under section 508(b) of the Code. This
listing does notindicate that the organiza-
tions have lost their status as organiza-
tions described in section 501(c)(3), eligi-
ble to receive deductible contributions.
Former Public Charities.The following
organizations (which have been treated as
organizations that are not private founda-
tions described in section 509(a) of the
Code) are now classified as private foun-
dations:
Acceptance Communications Network,
Edgewood, NM
Adams-Johnson Community Outreach,
Inc., Fayetteville, NC
Adopt A Horse Program, Inc.,
Palermo, ME
Afterschool Publishing Company, Inc.,
Detroit, MI
Agape Youth Homeless Ministry Circuit,
Decatur, GA
Alleghany Foundation, Covington, VA
Allman, Inc., Fresno, CA
Almobarak Cultural Center,
Hot Springs, AR
American Elite Runners, Inc.,
Alamogordo, NM
American Friends of the Institute of
Advocacy Training, Inc.,
New York, NY
American Opera Company, Inc.,
Centerville, UT
American Sign Language Resource
Corp., Marietta, GA
Animal Aid Association, Inc.,
Springfield, VA
Animal League of Nevada,
Las Vegas, NV
Another Level, Montclair, CA
Arizona Equal Justice Foundation,
Phoenix, AZ
Army Retirement Residence Foundation
Potomac, Fort Belvoir, VA
As He Is Ministries, Inc.,
Knoxville, TN
Association for the Historic Restoration
and Preservation of Lives,
Jamaica, NY
Atlantic Health Services, Inc.,
Lynwood, CA
Attica Housing Development Fund
Company, Inc., Buffalo, NY
Avec Amis With Friends, Inc.,
Orlando, FL
Babycare, Inc., Colorado Springs, CO

April 16, 200110882001–16 I.R.B.
Baltimore Senior Care, Inc.,
Baltimore, MD
Barkley Art Center, Inc.,
Annandale, MN
BECU Foundation, Tukwila, WA
Bolshoi Ballet and Opera Foundation,
Inc., New York, NY
Bright Path, Inc., West Newbury, MA
Calls for Help Foundation, Fullerton, CA
Caloptima Health Partnership,
Orange, CA
Cameron Cunningham Foundation,
Oakwood, IL
Carmel Health Network, Mobile, AL
Carol and Arnold Wolowitz Foundation,
Inc., Hauppauge, NY
Casa de Milagro, Inc., McKinney, TX
Central Oregon District Hospital
Foundation, Inc., Redmond, OR
Changing Perspectives, Inc.,
Mount Kisco, NY
Charles E. Peterson Institute for
Preservation of French Heritage,
Ste Genevieve, MO
Cherith Ministries, Inc., Fayetteville, GA
Children’s Enrichment Program,
Los Angeles, CA
Christ House, Inc., Chi,
Temple Hills, MD
Citizens for Humane Animal Treatment,
Inc., Ellicott, NY
Cleveland Forum for the Arts, Inc.,
Cleveland, OH
Cochise Center for the Blind and Visually
Impaired, Hereford, AZ
Cohasset Conservation Trust, Inc.,
Cohasset, MA
Community Revitalization Foundation,
Inc., Baltimore, MD
Community Threads, Columbus, OH
Concerned Coaches & Athletes Against
Drugs, Sedona, AZ
Connecticut Professional Society on the
Abuse of Children, Inc., New Haven, CT
Contemporary Dance Company of Boca
Raton, Inc., Boca Raton, FL
Copper Communities Housing
Corporation, Kearney, AZ
Creative Resources Network, Inc.,
Bonner Springs, KS
Dance Et Vous, Mesquite, TX
David J. Patterson Institute for the
Advancement of Ethics, Inc.,
Missoula, MT
Deacon & Brothers Foundation,
Bryan, TX
Delavan Historic Foundation, Inc.,
Delavan, WI
Detriot Three Dimensional Community
Development Corporation, Detroit, MI
Donna P. Jackson Ministries, Inc.,
Tulsa, OK
Dr. Grover C. Hunter University of North
Carolina Dental Trust Fund,
Atlanta, GA
Educational Association for Family Child
Care, Inc., Lodi, NJ
Edutech Fideiicomiso Educativo P T,
Bayamon, PR
Electronic Alexandria Community
Forum, Alexandria, VA
Elishama Imbi Timbwa Memorial Merit
Scholarship Award, Inc.,
New York, NY
Emerald Eyes Children’s Foundation,
Sherman Oaks, CA
Encore Chamber Music Society, Ltd.,
Jersey City, NJ
FAHD Foundation, Monroe, MI
Families United of Iowa, Ames, IA
Far and Away Missions, Inc.,
Florence, KY
Farm Relief Fund, Inc., of Wisconsin,
Marshfield, WI
Father Paul Wolf Foundation,
Winsted, MN
First African Housing Development
Corporation at Darby Township,
Sharon Hill, PA
Fishers of Men Ministries, Fairfield, OH
Food Closet of the Isaiah 58,
Modesto, CA
Fort Hill Housing Development Fund
Company, Inc., Rochester, NY
Foundation for Musculoskeletal Research
and Education, Little Rock, AR
Foundation for O.C. Private School
Opportunities, Inc., Anaheim, CA
Four H International Ministries, Corp.,
Hayden, ID
Friends of Hill-Stead, Inc.,
Farmington, CT
Friends of Son Shine Ministries
Foundation, Corpus Christi, TX
Gerald Hanus Share the Spirit
Scholarship, Omaha, NE
Gift of Green, Branson, MO
Gods Temple, St. Louis, MO
Grace Harbour Ministries, Inc.,
Bois Darc, MO
Grace HOPE Development Corporation,
Baltimore, MD
Grand Valley Beautification Council,
Grand Junction, CO
Great American Flag Association, Inc.,
Largo, FL
Gulf Marine Institute of Technology,
Gulf Breeze, FL
Hands Extended Ministries, Inc.,
Maple Grove, MN
Happy Voice, Inc., Medford, OR
Hasbrouck Family Association, Inc.,
New Paltz, NY
Hawaii Society for Prevention of Cruelty
to Children & Animals, Pahoa, HI
Henry E. Hardin Education Fund, Inc.,
South Plainfield, NJ
Hidden Ponds Foundation, Inc.,
Larchmont, NY
Hire a Teen for a Brighter Tomorrow,
Park Forest, IL
Homeland of the Heart School,
Olivia, MN
Institute for Health Care Research, Inc.,
Hialeah, FL
Institute for Health Improvement in
Southeast Michigan, Southfield, MI
International Foundation for the
Conservation of Natural Resources,
Vienna, VA
Irish and American Repertory Theatre,
Inc., Columbus, OH
Jeff Colby Charitable Foundation,
Long Beach, IN
Keren Tefert Yaacov, Monsey, NY
Kids With Special Needs Day Care
Center, Buffalo, NY
King of Glory Ministries, Inc.,
Avondale, AZ
L.A.M.B., Inc., Baltimore, MD
Lancaster Love, Inc., Lititz, PA
Legacy Ministries, Inc., California, MO
Liaison of Arkansas, Inc., Nashville, TN
Liechty-Windows Family Organization,
Provo, UT
Life Care Management Services, Inc.,
St. Petersburg, FL
Light Years, LTD., Bayfield, CO
Lindstrom Foundation for Archaeological
Research & Development,
San Leandro, CA
Lov A Second Chance Foundation,
Bois Darc, MO
Luci Di Speranza A New Jersey Non-Profit
Corporation, West Long Branch, NJ
MARIA Multi-Behavioral Autism
Rehabilitation & Intervention Assn.,
Eugene, OR
McMastersville Village Volunteer Fire
Department, Ann Arbor, MI
Medical Research Scholarship
Foundation, St. Louis, MO
Memphis Rock-N-Soul, Inc.,
Memphis, TN

2001–16 I.R.B.1089April 16, 2001
Men Against Breast Cancer, Inc.,
Hollywood, FL
Menemsha Pond Preservation Trust, Inc.,
Boston, MA
Mentor and Associated Services,
Robbinsdale, MN
Ministry of Love, Sterling Heights, MI
Mount Zion Non-Profit Housing
Corporation, Detroit, MI
Native Fish Society, Inc., Portland, OR
Ndigbo Development Foundation, Inc.,
New Orleans, LA
Neighborhood Rehabilitation Center,
Inc., Arlington, TX
Net Ministries, Inc., Carrollton, TX
Newcorp, Inc., New Orleans, LA
New Pisgah Haven Homes, Ltd.,
Chicago, IL
Noble African American Boys, Inc.,
Atlanta, GA
North American Community Health
Foundation, Inc., Jackson, MS
North Las Vegas Chamber of Commerce
Foundation, N. Las Vegas, NV
Northeast Commonworks, Inc.,
Newbury, MA
Northside Plaza, Inc., Houston, TX
Northwest Endurance Center, Bend, OR
Nutrition Art Music and Technology
Therapy, Inc., Washington, DC
Oh-Za-H-Dah-Zay-Lee, Inc., Lapwai, ID
Omaha Volunteers for Handicapped
Children, Omaha, NE
Omega Point Foundation, Portland, OR
Omega Psi Phi Development Corp.,
Decatur, GA
Oregonians for Environmental Rights,
Sisters, OR
Out Reach Ministries Community Street
Ministries, Ft. Lauderdale Lakes, FL
Oz Nidberu Trust, Brooklyn, NY
Phoenix Development, Inc.,
Memphis, TN
Pikes Peak Minority Business
Foundation, Colorado Springs, CO
Pioneering Partners Foundation, Inc.,
Noblesville, IN
PLAY, Grass Valley, CA
Positive People, Inc., Chicago, IL
Pride Foundation, Inc., Banks, AL
Pride of the Carolina’s, Incorporated,
Manchester, NH
Raksha, Inc., Atlanta, GA
Ralph and Billie Howard Foundation for
Scholarship and Technology, Tyler, TX
Red Arce Farm, Inc., Stow, MA
Reflections A True Gospel Ministry,
Stockton, CA
Richland Affordable Housing
Corporation, Sidney, MT
Roanoke Chowan Foundation, Inc.,
Ahoskie, NC
Rogue Wave Foundation, Boulder, CO
Ronald McDonald House Charities of
South Dakota, Inc., Sioux Falls, SD
Rowlett Animal Adoption Center,
Fort Worth, TX
Rural School and Community Trust,
Washington, DC
Safety & Firearms Education, Inc.,
Westbury, NY
Saint Martin’s Place, Hazelton, PA
Seek & Save Ministries, Inc.,
Thurmont, MD
Shade for the Children, Black Hawk, SD
Shiloh Development for Community
Home Care, Inc., Fayetteville, NC
Solutions An Education and Mediation
Project, Laguna Niguel, CA
South Central Pennsylvania Sickle Cell
Council, Harrisburg, PA
Southwest Academy for Conservation
and Ecology, Forest Falls, CA
Spectrum Delta, Inc., Tinley Park, IL
Spirit of Truth Ministry, Columbus, OH
Sport Education and Values Foundation,
Salt Lake City, UT
Springhill Community Childcare Center,
Inc., Gainesville, FL
St. Francis County Family Resources,
Inc., Forrest City, AZ
Steps, Inc., Winchester, IN
Syracuse Rescue Mission Foundation,
Inc., Syracuse, NY
Tewksbury Ice Arena Authority, Inc.,
Tewskbury, MA
Thorntown Businessmen’s Educational
Foundation, Inc., Lebanon, IN
Tjo Fowroe-Haven Homes,
Escondido, CA
To Life Foundation, Woodcliff Lakes, NJ
Toledo Homes, Inc., Toledo, OH
Townsmen Jazz Orchestra,
Bedford Hts., OH
Treme Community Education Program,
Inc., New Orleans, LA
Tri-Counties Special Services, Inc.,
Hopkinsville, KY
Trulove Charities for the Promotion of
Family Literacy, Champaign, IL
Union Street Foundation, Decatur, IL
United Communal Services Foundation,
Los Angeles, CA
United Debt Counseling, Inc.,
Wilmington, DE
Uplift Foundation, New York, NY
US Friends of English National Opera,
Inc., Minneapolis, MN
Vallecito Schools Foundation, Avery, CA
Viarts, Providence, RI
Victory Lakes Village, Waukegan, IL
Voice of Youth, Seattle, WA
Washington Metropolitan Area Affiliate
of the American Geriatrics Society,
Takoma Park, MD
Wilson-Fleetwood Development
Foundation, Alton, IL
Womanhood, Inc., Detroit, MI
Women in Need of Growth Services, Inc.,
Naples, FL
World Against Racism Foundation,
Washington, DC
World Dance Day Foundation,
Monterey Park, CA
Worldpeace Communities, St. Paul, MN
If an organization listed above submits
information that warrants the renewal of
its classification as a public charity or as a
private operating foundation, the Internal
Revenue Service will issue a ruling or de-
termination letter with the revised classi-
fication as to foundation status. Grantors
and contributors may thereafter rely upon
such ruling or determination letter as pro-
vided in section 1.509(a)–7 of the Income
Tax Regulations. It is not the practice of
the Service to announce such revised clas-
sification of foundation status in the Inter-
nal Revenue Bulletin.
Deletions From Cumulative List
of Organizations Contributions
to Which are Deductible Under
Section 170 of the Code
Announcement 2001–36
The name of an organization that no
longer qualifies as an organization de-
scribed in section 170(c)(2) of the Internal
Revenue Code of 1986 is listed below.
Generally, the Service will not disallow
deductions for contributions made to a
listed organization on or before the date
of announcement in the Internal Revenue
Bulletin that an organization no longer
qualifies. However, the Service is not
precluded from disallowing a deduction
for any contributions made after an orga-
nization ceases to qualify under section
170(c)(2) if the organization has not
timely filed a suit for declaratory judg-
ment under section 7428 and if the con-

April 16, 200110902001–16 I.R.B.
tributor (1) had knowledge of the revoca-
tion of the ruling or determination letter,
(2) was aware that such revocation was
imminent, or (3) was in part responsible
for or was aware of the activities or omis-
sions of the organization that brought
about this revocation.
If on the other hand a suit for declara-
tory judgment has been timely filed, con-
tributions from individuals and organiza-
tions described in section 170(c)(2) that
are otherwise allowable will continue to
be deductible. Protection under section
7428(c) would begin on April 16, 2001,
and would end on the date the court first
determines that the organization is not de-
scribed in section 170(c)(2) as more par-
ticularly set forth in section 7428 (c)(1).
For individual contributors, the maximum
deduction protected is $1,000, with a hus-
band and wife treated as one contributor.
This benefit is not extended to any indi-
vidual, in whole or in part, for the acts or
omissions of the organization that were
the basis for revocation.
Friends of High Point Drug Action
Council, Inc., High Point, NC
Interim Final Rules for
Nondiscrimination in Health
Coverage in the Group Market;
Technical Amendment
Announcement 2001-37
AGENCIES: Internal Revenue Service,
Department of the Treasury; Pension and
Welfare Benefits Administration, Depart-
ment of Labor; Health Care Financing
Administration, Department of Health
and Human Services.
ACTION: Interim final rules; delay of ef-
fective date and conforming amendments.
SUMMARY: Consistent with the memo-
randum of January 20, 2001, from the As-
sistant to the President and Chief of Staff,
entitled “Regulatory Review Plan,” pub-
lished in the Federal Registeron January
24, 2001 (66 FR 7702), this action delays
for 60 days the effective date for the rules
entitled “Interim Final Rules for Nondis-
crimination in Health Coverage in the
Group Market,” published in the Federal
Registeron January 8, 2001 (66 FR 1378
[T.D. 8931, 2001–7 I.R.B. 542]). This
document also makes conforming amend-
ments to reflect the delay in effective date.
DATES: The effective date of the Interim
Final Rules amending 26 CFR Part 54, 29
CFR Part 2590, and 45 CFR Part 146,
published in the Federal Registeron Jan-
uary 8, 2001, at 66 FR 1378, is delayed for
60 days, from March 9, 2001, until May 8,
2001. The conforming amendments in
this document are effective May 8, 2001.
FOR FURTHER INFORMATION CON-
TACT: Russ Weinheimer, Internal Rev-
enue Service, Department of the Treasury,
at (202) 622-6080; Amy J. Turner, Pen-
sion and Welfare Benefits Administration,
Department of Labor, at (202) 219-7006;
or Ruth A. Bradford, Health Care Financ-
ing Administration, Department of Health
and Human Services, at (410) 786-1565.
SUPPLEMENTARY INFORMATION:
Consistent with the memorandum of
January 20, 2001, from the Assistant to
the President and Chief of Staff, entitled
“Regulatory Review Plan,” published in
the Federal Registeron January 24, 2001
(66 FR 7702), this action delays for 60
days the effective date and, for consis-
tency, certain applicability dates for the
rules entitled “Interim Final Rules for
Nondiscrimination in Health Coverage in
the Group Market,” published in the Fed-
eral Registeron January 8, 2001 (66 FR
1378). These rules implement statutory
provisions prohibiting discrimination
based on a health factor by group health
plans and issuers offering health insur-
ance coverage in connection with a group
health plan. The rules implement changes
made to the Internal Revenue Code of
1986, the Employee Retirement Income
Security Act of 1974, and the Public
Health Service Act, enacted as part of the
Health Insurance Portability and Account-
ability Act of 1996 (HIPAA), and most of
the guidance contained in these rules re-
mains applicable for plan years beginning
on or after July 1, 2001. This document
also makes conforming amendments to
reflect the delay in effective date.
To the extent that 5 U.S.C. 553 applies
to this action, it is exempt from notice
and comment because it constitutes a rule
of procedure under 5 U.S.C.
553(b)(3)(A). Alternatively, the Depart-
ments’ implementation of this rule with-
out opportunity for public comment, ef-
fective immediately upon publication
today (March 9, 2001) in the Federal
Register, is based on the good cause ex-
ceptions in 5 U.S.C. 553(b)(3)(B) and
553(d)(3), in that seeking public com-
ment is impracticable, unnecessary, and
contrary to the public interest. The 60-
day delay in effective date is necessary to
give Department officials the opportunity
for further review and consideration of
new regulations, consistent with the As-
sistant to the President’s memorandum of
January 20, 2001. Given the imminence
of the effective date, seeking prior public
comment on this delay would have been
impractical, unnecessary, and contrary to
the public interest in the orderly promul-
gation and implementation of regula-
tions. Because the delay is only for 60
days, a 30-day comment period before
the delay could be effective would ex-
haust a substantial amount of time that
group health plans, health insurance is-
suers, and State insurance commis-
sioner’s offices could otherwise use to re-
view their plan documents, insurance
policies, and State laws for purposes of
the orderly implementation of the interim
regulations. In addition, it would create
confusion among State agencies, employ-
ers, plan administrators, issuers, and third
party administrators as to the effective
date of certain provisions, impeding their
compliance and enforcement efforts
List of Subjects
26 CFR Part 54
Excise taxes, Health care, Health insur-
ance, Pensions, Reporting and record-
keeping requirements.
29 CFR Part 2590
Employee benefit plans, Employee Re-
tirement Income Security Act, Health
care, Health insurance, Reporting and
recordkeeping requirements.
45 CFR Part 146
Health care, Health insurance, Report-
ing and recordkeeping requirements, and
State regulation of health insurance.
Conforming Amendments to the
Regulations
Internal Revenue Service
26 CFR Chapter I
Accordingly, the publication on January
8, 2001, of the temporary and final rules,
26 CFR Part 54, is amended as follows:

2001–16 I.R.B.1091April 16, 2001
PART 54 — PENSION EXCISE TAXES
Paragraph 1. The authority citation for
part 54 continues to read in part as fol-
lows:
Authority: 26 U.S.C. 7805 * * *
§54.9802–1 [Amended]
Par. 2. Section 54.9802–1 is amended
by removing the date “March 9, 2001” in
each place it appears in paragraph (i)(1)
and adding in its place “May 8, 2001”.
§54.9802–1T [Amended]
Par. 3. Section 54.9802–1T is amended
by:
1. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
paragraph (i)(1).
2. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
paragraph (i)(3)(ii)(A) introductory text.
3. Removing the date “March 9,
2001” and adding in its place “May 8,
2001” in paragraph (i)(3)(ii)(C) Example
2(ii).
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved March 2, 2001.
Pamela F. Olsen,
Deputy Assistant Secretary
of the Treasury.
Pension and Welfare Benefits
Administration
29 CFR Chapter XXV
For the reasons set forth above, the
publication on January 8, 2001, of the
interim final rule, 29 CFR Part 2590, is
amended as follows:
PART 2590 – RULES AND
REGULATIONS FOR HEALTH
INSURANCE PORTABILITY AND
RENEWABILITY FOR GROUP
HEALTH PLANS
Paragraph 1. The authority citation for
Part 2590 continues to read as follows:
Authority:Secs. 107, 209, 505,
701–703, 711–713, and 731–734 of
ERISA (29 U.S.C. 1027, 1059, 1135,
1171–1173, 1181–1183, and 1191–1194),
as amended by HIPAA (Public Law
104–191, 110 Stat. 1936), MHPA and
NMHPA (Public Law 104–204, 110 Stat.
2935), and WHCRA (Public Law
105–277, 112 Stat. 2681–436), section
101(g)(4) of HIPAA, and Secretary of
Labor’s Order No. 1–87, 52 FR 13139,
April 21, 1987.
§ 2590.702 [Amended]
Par. 2. Section 2590.702 is amended
by:
1. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
the heading to paragraph (i)(1).
2. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
paragraph (i)(1).
3. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
paragraph (i)(3)(ii)(A) introductory text.
4. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
paragraph (i)(3)(ii)(C) Example 2(ii).
Signed at Washington, DC, this 16th day
of February 2001.
Alan D. Lebowitz,
Acting Assistant Secretary, Pension and
Welfare Benefits Administration,
U.S. Department of Labor.
Health Care Financing Administration
45 CFR Subtitle A
For the reasons set forth above, the
publication on January 8, 2001, of the
interim final rule, 45 CFR Part 146, is
amended as follows:
PART 146 – RULES AND
REGULATIONS FOR HEALTH
INSURANCE PORTABILITY AND
RENEWABILITY FOR GROUP
HEALTH PLANS
Paragraph 1. The authority citation for
Part 146 continues to read as follows:
Authority:Secs. 2701 through 2763,
2791 and 2792 of the Public Health Ser-
vice Act, 42 U.S.C. 300gg through
300gg–63, 300gg–91, 300gg–92 as
amended by HIPAA (Public Law
104–191, 110 Stat. 1936), MHPA and
NMHPA (Public Law 104–204, 110 Stat.
2935), and WHCRA (Public Law
105–277, 112 Stat. 2681–436), and sec-
tion 102(c)(4) of HIPAA.
§ 146.121 [Amended]
Par. 2. Section 146.121 is amended by:
1. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
the heading to paragraph (i)(1).
2. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
paragraph (i)(1).
3. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
paragraph (i)(3)(ii)(A) introductory text.
4. Removing the date “March 9, 2001”
and adding in its place “May 8, 2001” in
paragraph (i)(3)(ii)(C) Example 2(ii).
Dated February 20, 2001.
Michael McMullan,
Acting Deputy Administrator,
Health Care Financing Administration.
Approved March 5, 2001.
Tommy G. Thompson,
Secretary,
Health and Human Services.
(Filed by the Office of the Federal Register on
March 8, 2001, 8:45 a.m., and published in the issue
of the Federal Register for March 9, 2001, 66 F.R.
14076)

April 16, 2001i2001–16 I.R.B.
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”)
that have an effect on previous rulings
use the following defined terms to de-
scribe 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 Contributions 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 Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
Definition of Terms

2001–16 I.R.B.iiApril 16, 2001
Numerical Finding List
1
Bulletins 2001–1 through 2001–15
Announcements:
2001–1, 2001–2 I.R.B. 277
2001–2, 2001–2 I.R.B. 277
2001–3, 2001–2 I.R.B. 278
2001–4, 2001–2 I.R.B. 286
2001–5, 2001–2 I.R.B. 286
2001–6, 2001–3 I.R.B. 357
2001–7, 2001–3 I.R.B. 357
2001–8, 2001–3 I.R.B. 357
2001–9, 2001–3 I.R.B. 357
2001–10, 2001–4 I.R.B. 431
2001–11, 2001–4 I.R.B. 432
2001–12, 2001–6 I.R.B. 526
2001–13, 2001–96 I.R.B. 752
2001–14, 2001–7 I.R.B. 648
2001–15, 2001–8 I.R.B. 715
2001–16, 2001–8 I.R.B. 715
2001–17, 2001–8 I.R.B. 716
2001–18, 2001–10 I.R.B. 791
2001–19, 2001–10 I.R.B. 791
2001–20, 2001–8 I.R.B. 716
2001–21, 2001–9 I.R.B. 752
2001–22, 2001–11 I.R.B. 895
2001–23, 2001–10 I.R.B. 791
2001–24, 2001–10 I.R.B. 793
2001–25, 2001–11 I.R.B. 895
2001–26, 2001–11 I.R.B. 896
2001–27, 2001–11 I.R.B. 897
2001–28, 2001–13 I.R.B. 975
2001–29, 2001–14 I.R.B. 1014
2001–30, 2001–15 I.R.B. 1065
Notices:
2001–1, 2001–2 I.R.B. 261
2001–2, 2001–2 I.R.B. 265
2001–3, 2001–2 I.R.B. 267
2001–4, 2001–2 I.R.B. 267
2001–5, 2001–3 I.R.B. 327
2001–6, 2001–3 I.R.B. 327
2001–7, 2001–4 I.R.B. 374
2001–8, 2001–4 I.R.B. 374
2001–9, 2001–4 I.R.B. 375
2001–10, 2001–5 I.R.B. 459
2001–11, 2001–5 I.R.B. 464
2001–12, 2001–3 I.R.B. 328
2001–13, 2001–6 I.R.B. 514
2001–14, 2001–6 I.R.B. 516
2001–15, 2001–7 I.R.B. 589
2001–16, 2001–9 I.R.B. 730
2001–17, 2001–9 I.R.B. 730
2001–18, 2001–9 I.R.B. 731
2001–19, 2001–10 I.R.B. 784
2001–20, 2001–11 I.R.B. 818
2001–21, 2001–11 I.R.B. 818
2001–22, 2001–12 I.R.B. 911
2001–23, 2001–12 I.R.B. 911
2001–24, 2001–12 I.R.B. 912
2001–25, 2001–13 I.R.B. 941
2001–26, 2001–13 I.R.B. 942
2001–27, 2001–13 I.R.B. 942
2001–28, 2001–13 I.R.B. 944
2001–29, 2001–14 I.R.B. 989
2001–30, 2001–14 I.R.B. 989
Proposed Regulations:
LR–230–76, 2001–13 I.R.B. 945
REG–209461–79, 2001–8 I.R.B. 712
REG–246256–96, 2001–8 I.R.B. 713
REG–251701–96, 2001–4 I.R.B. 396
REG–101520–97, 2001–15 I.R.B. 1057
REG–106030–98, 2001–11 I.R.B. 820
REG–106446–98, 2001–13 I.R.B. 945
REG–106542–98, 2001–5 I.R.B. 473
REG–121928–98, 2001–6 I.R.B. 520
REG–109481–99, 2001–13 I.R.B. 961
REG–111835–99, 2001–11 I.R.B. 834
REG–114998–99, 2001–14 I.R.B. 992
REG–115560–99, 2001–14 I.R.B. 993
REG–101739–00, 2001–14 I.R.B. 996
REG–103320–00, 2001–8 I.R.B. 714
REG–104683–00, 2001–4 I.R.B. 407
REG–104876–00, 2001–14 I.R.B. 998
REG–105801–00, 2001–13 I.R.B. 965
REG–106702–00, 2001–4 I.R.B. 424
REG–106791–00, 2001–6 I.R.B. 521
REG–106892–00, 2001–15 I.R.B. 1060
REG–107047–00, 2001–14 I.R.B. 1002
REG–107175–00, 2001–13 I.R.B. 971
REG–107176–00, 2001–4 I.R.B. 428
REG–107186–00, 2001–13 I.R.B. 973
REG–107566–00, 2001–3 I.R.B. 346
REG–110374–00, 2001–12 I.R.B. 915
REG–110659–00, 2001–12 I.R.B. 917
REG–114082–00, 2001–7 I.R.B. 629
REG–114083–00, 2001–7 I.R.B. 630
REG–114084–00, 2001–7 I.R.B. 633
REG–116468–00, 2001–6 I.R.B. 522
REG–119352–00, 2001–6 I.R.B. 525
REG–121109–00, 2001–15 I.R.B. 1064
REG–125237–00, 2001–12 I.R.B. 919
REG–126100–00, 2001–11 I.R.B. 862
REG–129608–00, 2001–14 I.R.B. 1011
REG–130477–00, 2001–11 I.R.B. 865
REG–130481–00, 2001–11 I.R.B. 865
Railroad Retirement Quarterly Rates:
2001–2, I.R.B. 258
2001–15, I.R.B. 1054
Revenue Procedures:
2001–1, 2001–1 I.R.B. 1
2001–2, 2001–1 I.R.B. 79
2001–3, 2001–1 I.R.B. 111
2001–4, 2001–1 I.R.B. 121
2001–5, 2001–1 I.R.B. 164
2001–6, 2001–1 I.R.B. 194
2001–7, 2001–1 I.R.B. 236
2001–8, 2001–1 I.R.B. 239
2001–9, 2001–3 I.R.B. 328
2001–10, 2001–2 I.R.B. 272
2001–11, 2001–2 I.R.B. 275
2001–12, 2001–3 I.R.B. 335
2001–13, 2001–3 I.R.B. 337
2001–14, 2001–3 I.R.B. 343
2001–15, 2001–5 I.R.B. 465
2001–16, 2001–4 I.R.B. 376
2001–17, 2001–7 I.R.B. 589
2001–18, 2001–8 I.R.B. 708
2001–19, 2001–9 I.R.B. 732
2001–20, 2001–9 I.R.B. 738
2001–21, 2001–9 I.R.B. 742
Revenue Procedures—Continued:
2001–22, 2001–9 I.R.B. 745
2001–23, 2001–10 I.R.B. 784
2001–24, 2001–10 I.R.B. 788
2001–25, 2001–12 I.R.B. 913
Revenue Rulings:
2001–1, 2001–9 I.R.B. 726
2001–2, 2001–2 I.R.B. 255
2001–3, 2001–3 I.R.B. 319
2001–4, 2001–3 I.R.B. 295
2001–5, 2001–5 I.R.B. 451
2001–6, 2001–6 I.R.B. 491
2001–7, 2001–7 I.R.B. 541
2001–8, 2001–9 I.R.B. 726
2001–9, 2001–8 I.R.B. 652
2001–10, 2001–10 I.R.B. 755
2001–11, 2001–10 I.R.B. 780
2001–12, 2001–11 I.R.B. 811
2001–13, 2001–12 I.R.B. 898
2001–14, 2001–12 I.R.B. 898
2001–15, 2001–13 I.R.B. 922
2001–16, 2001–13 I.R.B. 936
2001–17, 2001–15 I.R.B. 1052
Treasury Decisions:
8910, 2001–2 I.R.B. 258
8911, 2001–3 I.R.B. 321
8912, 2001–5 I.R.B. 452
8913, 2001–3 I.R.B. 300
8914, 2001–8 I.R.B. 653
8915, 2001–4 I.R.B. 359
8916, 2001–4 I.R.B. 360
8917, 2001–7 I.R.B. 538
8918, 2001–4 I.R.B. 372
8919, 2001–6 I.R.B. 505
8920, 2001–8 I.R.B. 654
8921, 2001–7 I.R.B. 532
8922, 2001–6 I.R.B. 508
8923, 2001–6 I.R.B. 485
8924, 2001–6 I.R.B. 489
8925, 2001–6 I.R.B. 496
8926, 2001–6 I.R.B. 492
8927, 2001–11 I.R.B. 807
8928, 2001–8 I.R.B. 685
8929, 2001–10 I.R.B. 756
8930, 2001–5 I.R.B. 433
8931, 2001–7 I.R.B. 542
8932, 2001–11 I.R.B. 813
8933, 2001–11 I.R.B. 794
8934, 2001–12 I.R.B. 904
8935, 2001–8 I.R.B. 702
8937, 2001–11 I.R.B. 806
8938, 2001–13 I.R.B. 929
8939, 2001–12 I.R.B. 899
8940, 2001–15 I.R.B. 1016
8941, 2001–14 I.R.B. 977
8942, 2001–13 I.R.B. 929
8943, 2001–15 I.R.B. 1054
1
A cumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 2000–27 through
2000–52 is in Internal Revenue Bulletin 2001–1,
dated January 2, 2001.

April 16, 2001iii2001–16 I.R.B.
Finding List of Current Actions on
Previously Published Items
1
Bulletins 2001–1 through 2001–15
Announcement:
98–99
Modified by
Ann. 2001–9, 2001–3 I.R.B. 357
99–79
Superseded by
Ann. 2001–3, 2001–2 I.R.B. 278
2000–78
Obsoleted by
T.D. 8933, 2001–11 I.R.B. 794
2000–97
Corrected by
Ann. 2001–7, 2001–3 I.R.B. 357
Cumulative Bulletin:
1998–2
Corrected by
Ann. 2001–5, 2001–2 I.R.B. 286
Notices:
94–3
Modified by
T.D. 8933, 2001–11 I.R.B. 794
98–39
Modified by
Notice 2001–9, 2001–4 I.R.B. 375
98–40
Modified by
Notice 2001–9, 2001–4 I.R.B. 375
99–53
Modified and superseded by
Notice 2001–7, 2001–4 I.R.B. 374
2000–21
Superseded by
Notice 2001–1, 2001–2 I.R.B. 261
2000–22
Modified and superseded by
Notice 2001–8, 2001–4 I.R.B. 374
2000–26
Modified by
Notice 2001–22, 2001–12 I.R.B. 911
2000–43
Extended by
Notice 2001–13, 2001–6 I.R.B. 514
Proposed Regulations:
EE–130–86
Partially withdrawn by
REG–209461–79, 2001–8 I.R.B. 712
REG–106030–98
Corrected by
Ann. 2001–30, 2001–15 I.R.B. 1065
REG–106542–98
Corrected by
Ann. 2001–24, 2001–13 I.R.B. 793
Proposed Regulations—Continued:
REG–116733–98
Withdrawn by
Ann. 2001–11, 2001–4 I.R.B. 432
REG–116048–99
Withdrawn by
Ann. 2001–27, 2001–11 I.R.B. 897
REG–106702–00
Corrected by
Ann. 2001–28, 2001–13 I.R.B. 975
Revenue Procedures:
83–87
Superseded by
Rev. Proc. 2001–15, 2001–5 I.R.B. 465
90–18
Amplified and superseded by
Rev. Proc. 2001–18, 2001–8 I.R.B. 708
92–19
Superseded by
Rev. Proc. 2001–15, 2001–5 I.R.B. 465
96–15
Modified by
Ann. 2001–22, 2001–11 I.R.B. 895
96–17
Modified by
Rev. Proc. 2001–9, 2001–3 I.R.B. 328
99–18
Modified and superseded by
Rev. Proc. 2001–21, 2001–9 I.R.B. 742
99–47
Superseded by
Rev. Proc. 2001–16, 2001–4 I.R.B. 376
99–49
Modified and amplified by
Notice 2001–23, 2001–12 I.R.B. 911
Rev. Proc. 2001–10, 2001–2 I.R.B. 272
Rev. Proc. 2001–23, 2001–10 I.R.B. 784
Rev. Proc. 2001–24, 2001–10 I.R.B. 788
Rev. Proc. 2001–25, 2001–12 I.R.B. 913
Rev. Rul. 2001–8, 2001–9 I.R.B. 762
2000–1
Superseded by
Rev. Proc. 2001–1, 2001–1 I.R.B. 1
2000–2
Superseded by
Rev. Proc. 2001–2, 2001–1 I.R.B. 79
2000–3
Superseded by
Rev. Proc. 2001–3, 2001–1 I.R.B. 111
2000–4
Superseded by
Rev. Proc. 2001–4, 2001–1 I.R.B. 121
2000–5
Superseded by
Rev. Proc. 2001–5, 2001–1 I.R.B. 164
2000–6
Superseded by
Rev. Proc. 2001–6, 2001–1 I.R.B. 194
Revenue Procedures—Continued:
2000–7
Superseded by
Rev. Proc. 2001–7, 2001–1 I.R.B. 236
2000–8
Superseded by
Rev. Proc. 2001–8, 2001–1 I.R.B. 239
2000–16
Modified and superseded by
Rev. Proc. 2001–17, 2001–7 I.R.B. 589
2000–22
Modified and superseded by
Rev. Proc. 2001–10, 2001–2 I.R.B. 272
2001–3
Corrected by
Ann. 2001–25, 2001–11 I.R.B. 895
2001–13
Clarified by
Notice 2001–12, 2001–3 I.R.B. 328
Revenue Rulings:
64–328
Modified by
Notice 2001–10, 2001–5 I.R.B. 459
66–110
Modified by
Notice 2001–10, 2001–5 I.R.B. 459
85–30
Clarified by
Rev. Rul. 2001–8, 2001–9 I.R.B. 762
88–95
Clarified by
Rev. Rul. 2001–8, 2001–9 I.R.B. 762
92–19
Supplemented in part by
Rev. Rul. 2001–11, 2001–10 I.R.B. 780
2000–56
Corrected by
Ann. 2001–19, 2001–10 I.R.B. 791
2001–4
Modified by
Notice 2001–23, 2001–12 I.R.B. 911
Treasury Decisions:
7530
Removed by
T.D. 8938, 2001–13 I.R.B. 929
8757
Revised by
T.D. 8941, 2001–14 I.R.B. 977
8889
Corrected by
Ann. 2001–14, 2001–2 I.R.B. 286
8913
Corrected by
Ann. 2001–26, 2001–11 I.R.B. 896
1
A cumulative list of current actions on previously
published items in Internal Revenue Bulletins
2000–27 through 2000–52 is in Internal Revenue
Bulletin 2001–1, dated January 2, 2001.

INTERNAL REVENUE BULLETIN
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