Internal Revenue Bulletin 2007-5 (PDF rendition): IRS Announcements

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Bulletin No. 200
7-5
January 29, 2007
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
Rev. Rul. 2007–5, page 378.
Low-income housing credit; satisfactory bond; “bond
factor” amounts for the period January through March
2007.This ruling provides the monthly bond factor amounts
to be used by taxpayers who dispose of qualified low-income
buildings or interests therein during the period January through
March 2007.
Rev. Rul.
2007–6, page 393.
LIFO; pric
e indexes; department stores.The November
2006 Bure
au of Labor Statistics price indexes are accepted
for use by
department stores employing the retail inventory
and last-
in, first-out inventory methods for valuing inventories
for tax ye
ars ended on, or with reference to, November 30,
2006.
T.D. 9303, page 379.
REG–125632–06, page 415.
Final, temporary, and proposed regulations under section 368
of the Code provide guidance regarding the qualification of
certaintransactionsasreorganizationsdescribedinsection
368(a)(1)(D) where no stock and/or securities of the acquir-
ing corporation is issued and distributed in the transaction.
Notice 2007–9, page 401.
This notice provides guidance under section 954(c)(6) of the
Code on dividend, interest, rent and royalty payments that may
be excluded from foreign personal holding company income.
Notice
2007–13, page 410.
This not
ice announces that the Treasury Department and the
Servic
e will amend the regulations addressing substantial as-
sistan
ce rendered by a related person or persons to a con-
trolled foreign corporation (CFC). These amended regulations
will limit the types of activities that constitute substantial assis-
tance to certain assistance rendered, directly or indirectly, by a
United States person or persons to a related CFC. In addition,
in light of the repeal of the foreign base company shipping in-
come rules under subpart F, this notice confirms that income
that previously was foreign base company shipping income will
continue to be foreign base company income to the extent that
it is within the definition of a remaining category of foreign base
company income.
EMPLOYEE PLANS
T.D. 9302, page 382.
Final regulations under section 409(p) of the Code provide guid-
ance concerning requirements for employee stock ownership
plans (ESOPs) holding stock of Subchapter S corporations.
Notice 2007–7, page 395.
Distribution issues; multiple issues; Pension Protection
Act of 2006.This notice provides guidance in the form of
questions and answers with respect to certain provisions con-
tained in the Pension Protection Act of 2006, Pub. L. No.
109–280 (PPA ’06), that are effective in 2007 or earlier and
are primarily related to distributions described in sections 303,
826, 828, 829, 845, 904, 1102, and 1201 of the statute.
Notice 2007–12, page 409.
Weighted average interest rate update; corporate bond
indices; 30-year Treasury securities.The weighted aver-
age interest rate for January 2007 and the resulting permissi-
ble range of interest rates used to calculate current liability and
to determine the required contribution are set forth.
(Continued on the next page)
Finding Lists begin on page ii.
Index for January begins on page iv.

EXCISE TAX
Notice 2007–11, page 405.
This notice answers questions raised by Notice 2006–50,
2006–25 I.R.B. 1141. It also provides guidance regarding
the standard amounts for individuals and provides rules for
the Business and Nonprofit Estimation Method (EM). Notice
2006–50 amplified, clarified, and modified.
ADMINISTRATIVE
Rev. Proc. 2007–18, page 413.
Pursuant to section 1397E(e)(2) of the Code, this procedure
sets forth the maximum face amount of Qualified Zone Acad-
emy Bonds that may be issued for each state for each of the
calendar years 2006 and 2007. For this purpose, “State”
includes the District of Columbia and the possessions of the
United States.
Announcement 2007–8, page 416.
This document contains corrections to temporary regulations
(T.D. 9286, 2006–43 I.R.B. 750) providing rules for claiming
the railroad track maintenance credit under section 45G of the
Code for qualified railroad track maintenance expenditures paid
or incurred by a Class II or Class III railroad and other eligible
taxpayers during the taxable year.
Announcem
ent 2007–9, page 417.
This docum
ent contains corrections to final and temporary reg-
ulations (
T.D. 9278, 2006–34 I.R.B. 256) regarding the treat-
ment of con
trolled services transactions under section 482 of
theCodean
d the allocation of income from intangibles, in par-
ticular w
ith respect to contributions by a controlled party to the
value of a
n intangible owned by another controlled party.
January 29, 20072007–5 I.R.B.

The IRS Mission
Provide America’s taxpayers top quality service by helping
them understand and meet their tax responsibilities and by
applying the tax law with integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument of
the Commissioner of Internal Revenue for announcing official
rulings and procedures of the Internal Revenue Service and for
publishing Treasury Decisions, Executive Orders, Tax Conven-
tions, legislation, court decisions, and other items of general
interest. It is published weekly and may be obtained from the
Superintendent of Documents on a subscription basis. Bulletin
contents are compiled semiannually into Cumulative Bulletins,
which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke, mod-
ify, or amend any of those previously published in the Bulletin.
All published rulings apply retroactively unless otherwise indi-
cated. Procedures relating solely to matters of internal man-
agement are not published; however, statements of internal
practices and procedures that affect the rights and duties of
taxpayers are published.
Revenue rulings represent the conclusions of the Service on the
application of the law to the pivotal facts stated in the revenue
ruling. In those based on positions taken in rulings to taxpayers
or technical advice to Service field offices, identifying details
and information of a confidential nature are deleted to prevent
unwarranted invasions of privacy and to comply with statutory
requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned
against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—19
86 Code.
This part i
ncludes rulings and decisions based on provisions of
the Intern
al Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions and Other Related Items, and Subpart B, Leg-
islation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury’s Office of the Assistant Sec-
retary (Enforcement).
Part IV
.—Items of General Interest.
This par
t includes notices of proposed rulemakings, disbar-
ment an
d suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.
The c
ontents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S.Government Printing Office, Washington, DC 20402.
2007–5 I.R.B.January 29, 2007

Place missing child here.
January 29, 20072007–5 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 42.—Low-Income
Housing Credit
Low-income housing credit; satis-
factory bond; “bond factor” amounts
for the period January through March
2007.This ruling provides the monthly
bond factor amounts to be used by taxpay-
ers who dispose of qualified low-income
buildings or interests therein during the
period January through March 2007.
Rev. Rul. 2007–5
In Rev. Rul. 90–60, 1990–2 C.B.
3, the Internal Revenue Service provided
guidance to taxpayers concerning the gen-
eral methodology used by the Treasury
Department in computing the bond factor
amounts used in calculating the amount of
bond considered satisfactory by the Secre-
tary under § 42(j)(6) of the Internal Rev-
enue Code. It further announced that the
Secretary would publishintheInternal
Revenue Bulletin a table of bond factor
amounts for dispositions occurring during
each calendar month.
Rev. Proc. 99–11, 1999–1 C.B. 275,
established a collateral program as an al-
ternative to providing a surety bond for
taxpayers to avoid or defer recapture of
the low-income housing tax credits under
§ 42(j)(6). Under this program, taxpayers
may establish a Treasury Direct Account
and pledge certain United States Treasury
securities to the Internal Revenue Service
as security.
This revenue ruling provides in Table
1 the bond factor amounts for calculating
the amount of bond considered satisfactory
under § 42(j)(6) or the amount of United
States Treasury securities to pledge in a
Treasury Direct Account under Rev. Proc.
99–11 for dispositions of qualified low-in-
come buildings or interests therein during
the period January through March 2007.
Table 1
Rev. Rul. 2007–5
Monthly Bond Factor Amounts for Dispositions Expressed
As a Percentage of Total Credits
Calendar Year Building Placed in Service
or, if Section 42(f)(1) Election Was Made,
the Succeeding Calendar Year
Month of
Disposition
19931994199519961997199819992000200120022003
Jan ’0717.3932.4445.5256.9766.9569.2371.8674.7478.0981.8285.82
Feb ’0717.3932.4445.5256.9766.9569.0871.7074.5677.8981.6085.57
Mar ’0717.3932.4445.5256.9766.9568.9271.5374.3977.7181.4085.33
Table 1 (cont’d)
Rev. Rul. 2007–5
Monthly Bond Factor Amounts for Dispositions Expressed
As a Percentage of Total Credits
Calendar Year Building Placed in Service
or, if Section 42(f)(1) Election Was Made,
the Succeeding Calendar Year
Month of
Disposition
2004200520062007
Jan ’0789.7993.4196.7097.21
Feb ’0789.5093.0796.2797.21
Mar ’0789.2292.7595.8997.21
For a list of bond factor amounts ap-
plicable to dispositions occurring during
other calendar years, see: Rev. Rul. 98–3,
1998–1 C.B. 248; Rev. Rul. 2001–2,
2001–1 C.B. 255; Rev. Rul. 2001–53,
2001–2 C.B. 488; Rev. Rul. 2002–72,
2002–2 C.B. 759; Rev. Rul. 2003–117,
2003–2 C.B. 1051; Rev. Rul. 2004–100,
2004–2 C.B. 718; Rev. Rul. 2005–67,
2005–2 C.B. 771; and Rev. Rul. 2006–51,
2006–41 I.R.B. 632.
DRAFTING INFORMATION
The principal author of this revenue
ruling is David McDonnell of the Office
of Associate Chief Counsel (Passthroughs
and Special Industries). For further in-
formation regarding this revenue ruling,
2007–5 I.R.B.378January 29, 2007

contact Mr. McDonnell at (202) 622–3040
(not a toll-free call).
Section 368.—Definitions
Relating to Corporate
Reorganizations
26 CFR 1.368–2: Definition of terms.
T.D. 9303
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Part 1
Corporate Reorganizations;
Distributions Under Sections
368(a)(1)(D) and 354(b)(1)(B)
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final and temporary regula-
tions.
SUMMARY: This document contains
temporary regulations under section 368
of the Internal Revenue Code of 1986
(Code). The temporary regulations pro-
vide guidance regarding the qualification
of certain transactions as reorganizations
describedinsection368(a)(1)(D) where
no stock and/or securities of the acquiring
corporation is issued and distributed in
the transaction. These regulations affect
corporations engaging in such transac-
tions and their shareholders. The text
of the temporary regulations also serves
as the text of the proposed regulations
(REG–125632–06) set forth in the notice
of proposed rulemaking on this subject in
this issue of the Bulletin.
DATES:Effective Date:These regulations
are effective on December 19, 2006.
Applicability Date:For dates of appli-
cability, see §1.368–2T(l)(4)(i).
FOR FURTHER INFORMATION
CONTACT: Bruce A. Decker at (202)
622–7550 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
The IRS and Treasury Department have
received requests for immediate guidance
regarding whether certain acquisitive
transactions can qualify as reorganizations
described in section 368(a)(1)(D) where
no stock of the transferee corporation
is issued and distributed in the transac-
tion. Currently, the IRS and Treasury
Department are undertaking a broad study
of issues related to acquisitive section
368(a)(1)(D) reorganizations. In the in-
terest of efficient tax administration, the
IRS and Treasury Department are issuing
these temporary regulations to provide the
requested certainty for taxpayers regard-
ing these acquisitive transactions pending
the broader study of issues. Although
these rules also are being proposed in this
issue of the Bulletin, the IRS and Treasury
Department contemplate that the proposed
rules may change upon completion of this
broader study and the comments received.
The Code provides general nonrecogni-
tion treatment for reorganizations specif-
ically described in section 368(a). Sec-
tion 368(a)(1)(D) describes as a reorgani-
zation a transfer by a corporation (trans-
ferorcorporation)ofallorapartofitsas-
sets to another corporation (transferee cor-
poration) if, immediately after the transfer,
the transferor corporation or one or more
of its shareholders (including persons who
were shareholders immediately before the
transfer), or any combination thereof, is in
control of the transferee corporation; but
only if stock or securities of the controlled
corporation are distributed in pursuance of
a plan of reorganization in a transaction
that qualifies under section 354, 355, or
356.
Section 354(a)(1) provides that no gain
or loss shall be recognized if stock or se-
curities in a corporation a party to a reor-
ganization are, in pursuance of the plan of
reorganization, exchanged solely for stock
or securities in such corporation or in an-
other corporation a party to the reorgani-
zation. Section 354(b)(1)(B) provides that
section 354(a)(1) shall not apply to an ex-
change in pursuance of a plan of reorga-
nization described in section 368(a)(1)(D)
unless the transferee corporation acquires
substantially all of the assets of the trans-
feror corporation, and the stock, securi-
ties, and other properties received by such
transferor corporation, as well as the other
properties of such transferor corporation,
are distributed in pursuance of the plan of
reorganization.
Further, section 356 provides that if sec-
tion 354 or 355 would apply to an ex-
change but for the fact that the property re-
ceived in the exchange consists not only of
property permitted by section 354 or 355
without the recognition of gain or loss but
also of other property or money, then the
gain, if any, to the recipient shall be recog-
nized, but not in excess of the amount of
money and fair market value of such other
property. Accordingly, in the case of an
acquisitive transaction, there can only be
a distribution to which section 354 or 356
applies where the target shareholder(s) re-
ceive at least some property permitted to
be received by section 354.
Notwithstanding the requirement in
section 368(a)(1)(D) that “stock or securi-
ties of the corporation to which the assets
are transferred are distributed in a trans-
action which qualifies under section 354,
355, or 356”, the IRS and the courts have
not required the actual issuance and dis-
tribution of stock and/or securities of the
transferee corporation in circumstances
where the same person or persons own
all the stock of the transferor corporation
and the transferee corporation. In such
circumstances, the IRS and the courts
have viewed an issuance of stock to be a
“meaningless gesture” not mandated by
sections 368(a)(1)(D) and 354(b).
In Revenue Ruling 70–240, 1970–1
C.B. 81 (see §601.601(d)(2) of this chap-
ter), B owned all of the stock of both
corporation X and corporation Y. X sold
its operating assets to Y for $34x dollars,
which represented the fair market value
of X’s assets. X had $33x of other assets,
consisting generally of cash, accounts re-
ceivables, and investments in stocks and
bonds, so that the assets sold by X to Y
constituted approximately 51% of X’s
total assets. Following the sale to Y, X
paid its debts, which amounted to $38x,
and then liquidated, distributing $29x to
B, while Y continued to conduct the busi-
ness formerly operated by X. The IRS
concluded that “although no actual shares
of the stock of Y were distributed to B as
a result of the transaction, B is treated as
having received Y stock since he already
owned all the stock of Y.” Accordingly,
January 29, 20073792007–5 I.R.B.

the IRS held that the sale of the oper-
atingassetsbyXtoY,followedbythe
liquidation and distribution of X’s assets
to B, resulted in a reorganization under
section 368(a)(1)(D) and a distribution
under section 356(a), despite the absence
of an actual issuance and distribution of Y
stock.
When considering a similar transaction
between two corporations owned in identi-
cal proportions by a husband and wife, the
Tax Court concluded that there was in sub-
stance an exchange of stock which meets
the requirements of section 354 and 356,
and stated, “[t]he issuance of further stock
would have been a meaningless gesture,
and we cannot conclude that the statute
requires such a vain act.”James Armour,
Inc. v. Commissioner, 43 T.C. 295, 307
(1964). See alsoWilson v. Commissioner,
46 T.C. 334 (1966). The IRS has also ap-
plied this meaningless gesture doctrine to
circumstances where the transferor corpo-
ration and the transferee corporation are
wholly owned by a single party directly or
indirectly through subsidiaries, or as a re-
sult of family attribution pursuant to sec-
tion 318(a)(1).
However, the application of this mean-
ingless gesture doctrine has generally been
limited to situations in which there is iden-
tical shareholder identity and proportion-
ality of interest in the transferor corpora-
tion and the transferee corporation. For
example, inWarsaw Photographic Asso-
ciates, Inc. v. Commissioner,84T.C.21
(1985), there was no issuance of stock by
the transferee corporation to the transferor
corporation, and the stock ownership in the
two corporations was not identical. On the
basis of these facts, the Tax Court con-
cluded that the distribution of stock would
notbeamereformalityandrefusedtoap-
ply the meaningless gesture doctrine. Ac-
cordingly, the transaction failed to qual-
ify as a section 368(a)(1)(D) reorganiza-
tion because there was no distribution of
stock of the transferee corporation under
sections 368(a)(1)(D) and 354(b)(1)(B).
Explanation of Provisions
These temporary regulations provide
guidance regarding the circumstances in
which the distribution requirement under
sections 368(a)(1)(D) and 354(b)(1)(B) is
deemed satisfied despite the fact that no
stock and/or securities are actually issued
in a transaction otherwise described in sec-
tion 368(a)(1)(D). In cases where the same
person or persons own, directly or indi-
rectly, all of the stock of the transferor and
transferee corporations in identical propor-
tions, these temporary regulations provide
that the distribution requirement under
sections 368(a)(1)(D) and 354(b)(1)(B)
will be treated as satisfied even though no
stock is actually issued in the transaction.
For purposes of determining whether the
same person or persons own all of the
stock of the transferor and transferee cor-
porations in identical proportions, these
temporary regulations provide that an in-
dividual and all members of his family that
have a relationship described in section
318(a)(1) will be treated as one individual.
The temporary regulations also provide
that the distribution requirement under
sections 368(a)(1)(D) and 354(b)(1)(B)
will be treated as satisfied in the absence
of any issuance of stock and/or securities
where there is ade minimisvariation in
shareholder identity or proportionality of
ownership in the transferor and transferee
corporations. Further, stock described in
section 1504(a)(4) is disregarded for pur-
poses of determining whether the same
person or persons own all of the stock of
the transferor and transferee corporations
in identical proportions.
Under these temporary regulations, in
each case where it is determined that the
same person or persons own all of the stock
of the transferor and transferee corpora-
tions in identical proportions, a nominal
shareofstockofthetransfereecorpora-
tion will be deemed issued in addition to
the actual consideration exchanged in the
transaction. The nominal share of stock
in the transferee corporation will then be
deemed distributed by the transferor cor-
poration to its shareholders and, in appro-
priate circumstances, further transferred to
the extent necessary to reflect the actual
ownership of the transferor and transferee
corporations.
These temporary regulations are being
issued in response to requests for imme-
diate guidance regarding whether trans-
actions otherwise described in section
368(a)(1)(D) qualify as reorganizations
where no stock and/or securities of the
transferee corporation are actually issued
in the transaction. The IRS and Treasury
Department currently are undertaking a
broad study of issues related to acquis-
itive reorganizations, including issues
addressed by these temporary regulations.
The IRS and Treasury Department are is-
suing these temporary regulations in order
to provide certainty for taxpayers while
these issues are under study.
The IRS and Treasury Department
believe that these temporary regulations
are a reasonable interpretation of section
368(a)(1)(D) and section 354(b)(1)(B)
given the history of those provisions and
the manner in which they have previously
been interpreted by the courts and the
IRS. However, no inference should be
drawn from these temporary regulations
regarding the law prior to the effective
date of these temporary regulations. In
this issue of the Bulletin, the IRS and
Treasury Department are requesting com-
ments on several issues relating to acquis-
itive reorganizations described in section
368(a)(1)(D).
In addition, the IRS and Treasury
Department note that these temporary
regulations do not expressly implement
Prop. Reg. §1.368–1(f)(4) (FR 70,
11903–11912), which provides that there
must be an exchange of net value except
in the case of a transaction that would
otherwise qualify as a reorganization de-
scribed in section 368(a)(1)(D), provided
that the fair market value of the property
transferred to the acquiring corporation by
the target corporation exceeds the amount
of liabilities of the target corporation im-
mediately before theexchange (including
any liabilities cancelled, extinguished,
orassumedinconnectionwiththeex-
change), and the fair market value of the
assets of the acquiringcorporation equals
or exceeds the amount of its liabilities
immediately after the exchange. The sol-
vency requirement remains the IRS’s and
Treasury Department’s proposal but the
IRS and Treasury Department continue to
consider whether this solvency require-
ment should be applied to the transactions
described in these temporary regulations.
Special Analyses
It has been determined that this Trea-
sury decision is not asignificant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It also has been deter-
mined that section 553(b) of the Admin-
istrative Procedure Act (5 U.S.C. chapter
2007–5 I.R.B.380January 29, 2007

5) does not apply to these regulations. For
the applicability of the Regulatory Flexi-
bility Act, please refer to the cross-refer-
ence notice of proposed rulemaking pub-
lished elsewhere in this Bulletin. Pursuant
to section 7805(f) of the Internal Revenue
Code, 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 Bruce A. Decker of the Office of
the Associate Chief Counsel (Corporate).
*****
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 continues to read as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.368–2 is amended by
revising paragraph (l) to read as follows:
§1.368–2 Definition of terms.
*****
(l) [Reserved]. For further guidance,
see §1.368–2T(l).
Par. 3. Section 1.368–2T is added to
read as follows:
§1.368–2T Definition of terms
(temporary).
(a)through(k)[Reserved].Forfurther
guidance, see §1.368–2(a) through (k).
(l)Certain transactions treated as
reorganizations described in section
368(a)(1)(D)—(1)General rule.Inor-
der to qualify as a reorganization under
section 368(a)(1)(D), a corporation (trans-
feror corporation) must transfer all or
part of its assets to another corporation
(transferee corporation) and immediately
after the transfer the transferor corpora-
tion, or one or more of its shareholders
(including persons who were shareholders
immediately before the transfer), or any
combination thereof, must be in control of
the transferee corporation; but only if, in
pursuance of the plan, stock or securities
of the transferee are distributed in a trans-
action which qualifies under section 354,
355, or 356.
(2)Distribution requirement—(i)In
general. For purposes of paragraph (l)(1)
of this section, a transaction otherwise
described in section 368(a)(1)(D) will be
treated as satisfying the requirements of
sections 368(a)(1)(D) and 354(b)(1)(B)
notwithstanding that there is no actual
issuance of stock and/or securities of the
transferee corporation if the same person
or persons own, directly or indirectly, all
of the stock of the transferor and transferee
corporations in identical proportions. In
such cases, the transferee corporation
will be deemed to issue a nominal share
of stock to the transferor corporation in
addition to the actual consideration ex-
changed for the transferor corporation’s
assets. The nominal share of stock in the
transferee corporation will then be deemed
distributed by the transferor corporation
to its shareholders and, where appropriate,
further transferred through chains of own-
ership to the extent necessary to reflect
the actual ownership of the transferor and
transferee corporations.
(ii)Attribution. For purposes of para-
graph (l)(2)(i) of this section, ownership
of stock will be determined by applying
the principles of section 318(a)(2) with-
out regard to the 50 percent limitation in
section 318(a)(2)(C). In addition, an indi-
vidual and all members of his family de-
scribed in section 318(a)(1) shall be treated
as one individual.
(iii)De minimis variations in owner-
ship and certain stock not taken into ac-
count. For purposes of paragraph (l)(2)(i)
of this section, the same person or persons
will be treated as owning, directly or indi-
rectly, all of the stock of the transferor and
transferee corporations in identical propor-
tions notwithstanding the fact that there is
ade minimisvariation in shareholder iden-
tity or proportionality of ownership. Addi-
tionally, for purposes of paragraph (l)(2)(i)
of this section, stock described in section
1504(a)(4) is not taken into account.
(3)Examples.The following examples
illustrate the principles of paragraph (l) of
this section. For purposes of these exam-
ples, each of A, B, C, and D is an indi-
vidual, T is the acquired corporation, S
is the acquiring corporation, P is the par-
ent corporation, and each of S1, S2, S3,
and S4 is a direct or indirect subsidiary of
P. Further, all of the requirements of sec-
tion 368(a)(1)(D) other than the require-
ment that stock or securities be distributed
in a transaction to which section 354 or 356
applies are satisfied. The examples are as
follows:
Example 1.A owns all the stock of T and S. The
T stock has a fair market value of $100x. T sells
all of its assets to S in exchange for $100x of cash
and immediately liquidates. Because there is com-
plete shareholder identity and proportionality of own-
ership in T and S, under paragraph (l)(2)(i) of this sec-
tion, the requirements of sections 368(a)(1)(D) and
354(b)(1)(B) are treated as satisfied notwithstanding
the fact that no S stock is issued. Pursuant to para-
graph (l)(2)(i) of this section, S will be deemed to is-
sue a nominal share of S stock to T in addition to the
$100x of cash actually exchanged for the T assets, and
T will be deemed to distribute all such consideration
to A. The transaction qualifies as a reorganization de-
scribed in section 368(a)(1)(D).
Example 2.The facts are the same as inExam-
ple 1except that C, A’s son, owns all of the stock of
S. Under paragraph (l)(2)(ii) of this section, A and
C are treated as one individual. Accordingly, there
is complete shareholder identity and proportionality
of ownership in T and S. Therefore, under paragraph
(l)(2)(i) of this section, the requirements of sections
368(a)(1)(D) and 354(b)(1)(B) are treated as satisfied
notwithstanding the fact that no S stock is issued. Pur-
suant to paragraph (l)(2)(i) of this section, S will be
deemed to issue a nominal share of S stock to T in
addition to the $100x of cash actually exchanged for
the T assets, and T will be deemed to distribute all
such consideration to A. Awill be deemed to trans-
fer the nominal share of S stock to C. The transac-
tion qualifies as a reorganization described in section
368(a)(1)(D).
Example 3.P owns all of the stock of S1 and S2.
S1 owns all of the stock of S3, which owns all of the
stock of T. S2 owns all of the stock of S4, which owns
all of the stock of S. The T stock has a fair market
value of $70x. T sells all of its assets to S in exchange
for $70x of cash and immediately liquidates. Under
paragraph (l)(2)(ii) of this section, there is indirect,
complete shareholder identity and proportionality of
ownership in T and S. Accordingly, the requirements
of sections 368(a)(1)(D) and 354(b)(1)(B)are treated
as satisfied notwithstanding the fact that no S stock is
issued. Pursuant to paragraph (l)(2)(i) of this section,
S will be deemed to issue a nominal share of S stock to
T in addition to the $70x of cash actually exchanged
for the T assets, and T will be deemed to distribute all
such consideration to S3. S3 will be deemed to dis-
tribute the nominal share of S stock to S1, which, in
turn, will be deemed to distribute the nominal share of
S stock to P. P will be deemed to transfer the nominal
share of S stock to S2, which, in turn, will be deemed
to transfer such share of S stock to S4. The transac-
tion qualifies as a reorganization described in section
368(a)(1)(D).
Example 4.A, B, and C own 34%, 33%, and 33%,
respectively, of the stock of T. The T stock has a fair
market value of $100x. A, B, and C each own 33% of
the stock of S. D owns the remaining 1% of the stock
of S. T sells all of its assets to S in exchange for $100x
of cash and immediately liquidates. For purposes of
January 29, 20073812007–5 I.R.B.

determining whether the distribution requirement of
sections 368(a)(1)(D) and 354(b)(1)(B) is met, under
paragraph (l)(2)(iii) of this section, D’s ownership of
ade minimisamount of stock of S is disregarded and
the transaction is treated as if there is complete share-
holder identity and proportionality of ownership in T
and S. Because there is complete shareholder identity
and proportionality of ownership in T and S, under
paragraph (l)(2)(i) of this section, the requirements
of sections 368(a)(1)(D) and 354(b)(1)(B) are treated
as satisfied notwithstanding the fact that no S stock
is issued. Pursuant to paragraph (l)(2)(i) of this sec-
tion, S will be deemed to issue a nominal share of S
stock to T in addition to the $100x of cash actually
exchanged for the T assets, T will be deemed to dis-
tribute all such consideration to A, B, and C, and the
nominal S stock will be deemed transferred among
the S shareholders to the extent necessary to reflect
their actual ownership of S. The transaction qualifies
as a reorganization described in section 368(a)(1)(D).
Example 5.ThefactsarethesameasinEx-
ample 4except that A, B, and C own 34%, 33%,
and 33%, respectively, of the common stock of T
and S. D owns preferred stock in S described in sec-
tion 1504(a)(4). For purposes of determining whether
the distribution requirement of sections 368(a)(1)(D)
and 354(b)(1)(B) is met, under paragraph (l)(2)(iii)
of this section, D’s ownership of S stock described
in section 1504(a)(4) is ignored and the transaction
is treated as if there is complete shareholder iden-
tity and proportionality of ownership in T and S. Be-
cause there is complete shareholder identity and pro-
portionality of ownership in T and S, under paragraph
(l)(2)(i) of this section, the requirements of sections
368(a)(1)(D) and 354(b)(1)(B) are treated as satis-
fied notwithstanding the fact that no S stock is issued.
Pursuant to paragraph (l)(2)(i) of this section, S will
be deemed to issue a nominal share of S stock to T
in addition to the $100x of cash actually exchanged
for the T assets, and T will be deemed to distribute
all such consideration to A, B, and C. The transac-
tion qualifies as a reorganization described in section
368(a)(1)(D).
Example 6. AandBeachown50%ofthestock
of T. The T stock has a fair market value of $100x. B
and C own 90% and 10%, respectively, of the stock of
S. T sells all of its assetsto S in exchange for $100x of
cash and immediately liquidates. Because complete
shareholder identity and proportionality of ownership
in T and S does not exist, paragraph (l)(2)(i) of this
section does not apply. The requirements of sections
368(a)(1)(D) and 354(b)(1)(B) are not satisfied, and
the transaction does not qualify as a reorganization
described in section 368(a)(1)(D).
(4)Effective date.(i)In general.This
section applies to transactions occurring
on or after March 19, 2007, except that
they do not apply to any transaction occur-
ring pursuant to a written agreement which
is binding before December 19, 2006, and
at all times thereafter. A taxpayer may
apply the provisions of these temporary
regulations to transactions occurring be-
fore March 19, 2007. However, the trans-
feror corporation, the transferee corpora-
tion, any direct or indirect transferee of
transferred basis property from either of
the foregoing, and any shareholder of the
transferor or transferee corporation may
not apply the provisions of these tempo-
rary regulations unless all such taxpayers
apply the provisions of the temporary reg-
ulations.
(ii)Expiration.This section expires on
or before December 18, 2009.
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
Approved December 6, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary
oftheTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on December 18,
2006, 8:45 a.m., and published in the issue of the Federa
l
Register for December 19, 2006, 71 F.R. 75879)
Section 409.—Qualifi-
cations for Tax Credit
Employee Stock Own-
ership Plans
26 CFR 1.409(p)–1: Prohibited allocation of securi-
ties in an S corporation.
T.D. 9302
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Part 1
Prohibited Allocations of
Securities in an S Corporation
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations that provide guidance
concerning requirements under section
409(p) of the Internal Revenue Code
for employee stock ownership plans
(ESOPs) holding stock of Subchapter
S corporations. These final regulations
generally affect plan sponsors of, and
participants in, ESOPs holding stock of
Subchapter S corporations.
DATES:Effective Date:These regulations
are effective December 20, 2006.
Applicability Dates:These regulations
are generally applicable with respect to
plan years beginning on or after January 1,
2006. See the Effective Date section of the
preamble for specific information.
FOR FURTHER INFORMATION
CONTACT: John T. Ricotta or
Veronica A. Rouse at (202) 622–6090 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains final regula-
tions (26 CFR Part 1) under section 409(p)
of the Internal Revenue Code (Code).
Section 409(p)(1) requires an ESOP
holding employer securities consisting of
stockinanScorporationtoprovidethat,
during an allocationyear,noportionof
the assets of the plan attributable to, or
allocable in lieu of, the employer securi-
ties may accrue (or be allocated directly
or indirectly under any plan of the em-
ployer meeting the requirements of section
401(a)) for the benefitof any disqualified
person. Section 409(p)(3)(A) provides
that a nonallocation year includes any plan
year during which the ownership of the
S corporation is so concentrated among
disqualified persons that they own or are
deemed to own at least 50 percent of its
shares. Section 409(p)(4) provides, in gen-
eral, that a disqualified person is any per-
son whose deemed-owned ESOP shares
(allocated ESOP shares and proportion of
suspense account shares) are at least 10
percent of the number of deemed-owned
shares of S corporation stock held by an
ESOP or for whom the aggregate num-
ber of shares owned by such person and
the members of such person’s family
is at least 20 percent of deemed-owned
ESOP shares. Under section 409(p)(5),
the determination of whether a person is
a disqualified person and whether a plan
year is a nonallocation year is also made
separately taking into account synthetic
equity if such treatment results in treating
the person as a disqualified person or the
year as a nonallocation year.
Temporary regulations (T.D. 9081,
2003–2 C.B. 420) under section 409(p)
were issued on July 21, 2003, (68 FR
42970). The text of those temporary regu-
lations also served as the text of a notice of
proposed rulemaking (REG–129709–03,
2007–5 I.R.B.382January 29, 2007

2003–2 C.B. 506) published at 68 FR
43058. The 2003 regulations provided
guidance on identifying disqualified per-
sons, determining whether an ESOP has
a nonallocation year, and defining syn-
thetic equity under section 409(p)(5), and
reserved some issues, including the def-
inition of a prohibited allocation, the tax
effect of a prohibited allocation, and cer-
tain issues relating to the definition of
synthetic equity.
A public hearing on the 2003 regula-
tions was held on November 17, 2003.
New temporary regulations under section
409(p) (T.D. 9164, 2005–1 C.B. 320) were
published in theFederal Registeron De-
cember 17, 2004, (69 FR 75455). The
new temporary regulations (2004 tempo-
rary regulations) addressed certain issues
raised in the comments, as well as address-
ing the topics reserved in the 2003 tem-
porary regulations. The text of the 2004
temporary regulations also served as the
text for a notice of proposed rulemaking
(REG–129709–03, 2005–1 C.B. 351) pub-
lished at 69 FR 75492.
A public hearing on the 2004 proposed
regulations was held on April 20, 2005.
After consideration of the comments re-
ceived, these final regulations adopt the
provisions of the proposed regulations
with certain modifications discussed in
this preamble.
Explanation of Provisions
Definition of Prohibited Allocation
These regulations retain the rule of
the 2004 temporary regulations concern-
ing prohibited allocations under which
there is an impermissible accrual to the
extent employer securities consisting of
stock in an S corporation are held under
the ESOP for the benefit of a disquali-
fied person during a nonallocation year.
Thus, in the event of a nonallocation year,
S corporation shares held in a disquali-
fied person’s account and all other ESOP
assets attributable to S corporation stock,
including distributions, sales proceeds,
and earnings, are treated as an imper-
missible accrual whether attributable to
contributions in the current year or a prior
year. A commentatorquestioned whether
the definition of prohibited allocation in
the 2004 temporary regulations should
include account balances of disqualified
persons from prior years. The rule of
the 2004 temporary regulations has been
retained because it is consistent with the
intent of the statute, and the IRS and Trea-
sury Department believe it is necessary
to prevent the concentration of ownership
interests that section 409(p) was intended
to prevent.
A commentator also questioned the
treatment of proceeds from the sale of
stock previously allocated to a disqual-
ified person’s account under the 2004
temporary regulations. The commenta-
tor expressed concern that treating the
sales proceeds as an impermissible accrual
when the original allocation of stock is
already a prohibitedallocation is a dou-
ble penalty. The final regulations do not
change this rule in the 2004 temporary
regulations. An allocation of sales pro-
ceeds from stock held for the benefit of a
disqualified person back into the account
of the disqualified person is as valuable
an accrual for the disqualified person as
an investment in employer stock. This
treatment is also consistent with the pro-
hibition in section 409(p)(1) with respect
to amounts that are “allocable in lieu of”
employer stock.
Effect of a Prohibited Allocation
These regulations retain the rule of the
2004 regulations that if there is a prohib-
ited allocation during anonallocation year,
the ESOP fails to satisfy the requirements
of section 4975(e)(7) and ceases to be an
ESOP. As a result, the exemption from
the excise tax on prohibited transactions
for loans to leveraged ESOPs contained in
section 4975(d)(3) would cease to apply to
any loan (with the result that the employer
would owe an excise tax with respect to the
previously exempt loan). These regula-
tions clarify that an additional result would
be the plan’s failure to satisfy the qualifica-
tion requirements under section 401(a) for
not operating the plan in accordance with
its terms to reflect section 409(p). Other
consequences include imposition of an ex-
cise tax on the S corporation under sec-
tion 4979A. An example has been added
to these final regulations to illustrate the
impact of these rules on an S corporation
ESOP.
These regulations include the rule from
the 2004 regulations under which a pro-
hibited allocation is a deemed distribution
that is not an eligible rollover distribution.
These regulations also add that same rule
to the list of distributions that are not el-
igible rollover distributions in the regula-
tions under section 402(c) (at §1.402(c)–2
of the Treasury Regulations). As a result,
under recently proposedregulations relat-
ing to designated Roth contributions under
section 402A, a deemed distribution as a
result of a section 409(p) prohibited alloca-
tion with respect to a designated Roth ac-
count would not constitute a qualified dis-
tribution for purposes of section 402A. See
proposed §1.402A–1, A–11, at 71 FR 4320
(January 26, 2006).
Prevention of Nonallocation Year
The preamble to the 2004 regulations
described methods that a plan might use
to prevent the occurrence of a nonalloca-
tion year, including (1) a reduction of syn-
thetic equity (for example, through can-
cellation or distribution), (2) a sale of the
S corporation securities held in the partic-
ipant’s ESOP account before a nonalloca-
tion year occurs so that the account is not
invested in S corporation stock, or (3) a
transfer of the S corporation securities held
for the participant under the ESOP into a
separate portion of the plan that is not an
ESOP or to another qualified plan of the
employer that is not an ESOP.
Any methods of preventing a nonallo-
cation year must satisfy applicable legal
and qualification requirements, including
the nondiscrimination requirements of
section 401(a)(4) (including the rules at
§1.401(a)(4)–4 relating to benefits, rights
and features), and implementation of these
methods must be completed before a non-
allocation year occurs. These regulations
retain the special rule provided in the
2004 regulations for applying the nondis-
crimination requirements under section
401(a)(4) for a plan that uses the transfer
method. Thus, these regulations provide
that, if a transfer is made from an ESOP to
a separate portion of the plan (or to another
qualified plan of the employer) that is not
an ESOP in order to prevent a nonalloca-
tion year, then both the ESOP and the plan
that is not an ESOP will not fail to satisfy
the requirements of §1.401(a)(4)–4 merely
because of the transfer. Similarly, these
regulations provide that, subsequent to the
transfer, the plan will not fail to satisfy the
requirements of §1.401(a)(4)–4 merely be-
January 29, 20073832007–5 I.R.B.

cause of the benefits, rights, and features
with respect to the transferred benefits if
those benefits, rights, and features would
satisfy the requirements of §1.401(a)(4)–4
if the mandatory disaggregation rule for
ESOPs at §1.410(b)–7(c)(2) did not ap-
ply. These regulations clarify that any
such transfers must be effectuated by an
affirmative action taken no later than the
date of the transfer, and all subsequent ac-
tions (including benefit statements) must
be consistent with the transfer having oc-
curred on that date. Further, in order to
use the transfer method to prevent a non-
allocation year, the plan must provide for
the transfer of the stock to the non-ESOP
portion of the plan.
A commentator described another
method of preventing a nonallocation
year under which stock of a participant is
exchanged for cash or other assets, which
are already in the accounts of other partici-
pants in order to change the stock holdings
among participants before a nonallocation
year occurs, but which does not change
the overall stock holding of the ESOP
trust. This method has been referred to as
reshuffling. The commentator requested
that relief from the nondiscriminatory
availability requirements be extended to
this method.
Absent a special rule for applying
the nondiscrimination requirements of
section 401(a)(4), it will be difficult for
a plan to prevent a nonallocation year
through reshuffling without violating
section 401(a)(4). The right of each par-
ticipant to have or not have a particular
investment in his or her account (either as
a participant-directed investment or as a
trustee-directed investment) is a plan right
or feature that is subject to the current
and effective availability requirements of
§1.401(a)(4)–4. Accordingly, if assets in
the accounts of one or more non-highly
compensated employees (NHCEs) are
mandatorily exchanged, then, in the ab-
sence of other relevant factors, the plan
would generally be expected to fail to
satisfy the nondiscriminatory availability
requirements of §1.401(a)(4)–4.
The IRS and Treasury Department do
not believe that it would be appropriate to
provide a special rule that would materi-
ally weaken the standard for nondiscrim-
inatory availability of participant rights
to a particular investment under the plan.
By contrast, the special nondiscrimina-
tion rules for stock transferred out of the
ESOP do not change the rights of NHCEs
to any particular investment in the plan
as a whole, but simply allow the transfer
and allow the rights of participants whose
stock is transferred out of the ESOP to be
taken into account in determining whether
the rights of participants whose stock
remains in the ESOP satisfy the nondis-
criminatory availability requirements of
§1.401(a)(4)–4.
An S corporation may be able to
achieve the same result as reshuffling
by reducing contributions for HCEs who
are or may become disqualified persons,
by providing additional benefits to NHCEs
who are not disqualified persons, by ex-
panding coverage to include all employ-
ees, or by diversifying out of employer
stock for HCEs who are or may become
disqualified persons and who are qualified
participants within the meaning of section
401(a)(28)(B)(iii) (that is, by mandating
diversification using one of the diver-
sification options that are offered to all
qualified participants, for which there is
an existing special nondiscrimination rule
at §1.401(a)(4)–4(d)(6)). Thus, in addi-
tion to plan transfers, any of these actions
may help prevent the concentration of
deemed-owned ESOP shares that section
409(p) prohibits, without the nondiscrimi-
nation problems otherwise associated with
reshuffling. Of course, any transfer or
other method used to ensure compliance
with section 409(p) must also satisfy any
other legal requirements that may apply,
including section 407(b)(2) of the Em-
ployee Retirement Income Security Act of
1974 (ERISA) (88 Stat. 829) Public Law
93–406 (which, in relevant part, generally
prohibits a plan from investing more than
10 percent of elective deferral accounts
in employer stock, unless the plan is an
ESOP, the investment is at the direction
of the participant, or another exception
applies).
Treatment of Family Members as
Disqualified Persons
The 2004 regulations included a num-
ber of attribution rules, which these regu-
lations retain, including the application of
the section 318 attribution rules to own-
ership of synthetic equity in determining
who is a disqualified person. Section
409(p) contains references to the sec-
tion 318 rules in certain cases, such as
in determining a nonallocation year, but
commentators pointed out that the section
318 rules did not apply for purposes of
the disqualified person definition, which
was not reflected in an example. Another
commentator pointed out that the rules
for determining whether family members
are disqualified persons varies accord-
ing to the individual being tested. For
example, the technical language of sec-
tion 409(p)(4)(D) treats parents-in-law as
members of a married child’s family when
testing whether a child is a disqualified
person, but not as members of the same
family as the child’s parents when testing
whether the child’s parents are disquali-
fied persons. In response to comments, the
regulations have been modified to clarify
these rules, including revisions in the ex-
amples to illustrate the application of the
rules to specific factual patterns.
Determination of Number of Shares of
Non-Stock-Based Synthetic Equity
These regulations retain the rules from
both the 2003 and the 2004 regulations
regarding calculation of the number of
shares of synthetic equity that are not de-
termined by reference to shares of stock
of the S corporation. These regulations
provide that the person who is entitled
to the synthetic equity is treated as own-
ing a number of shares of stock in the
S corporation equal to the present value
of the synthetic equity (with such value
determined without regard to any lapse
restriction as defined under the section
83 regulations) divided by the fair market
value of a share of the S corporation’s
stock as of the same date. These regula-
tions also retain the special rule under the
2004 regulations that permits the ESOP
to provide, on a reasonable and consistent
basis for all persons, for the number of
synthetic equity shares treated as owned
on a determination date to remain constant
for up to a 3-year period from that date
(triennial method). This rule addresses
concerns raised in comments to the 2003
regulations regarding the volatility of the
number of shares of synthetic equity where
that calculation is based on the value of an
S corporation share.
A commentator questioned whether the
triennial method of the 2004 regulations
should be expanded to permit a more flex-
2007–5 I.R.B.384January 29, 2007

ible triennial period that allows for the ac-
celeration or delay of the triennial determi-
nation date. The commentator argued that,
since the triennial method’s purpose is to
eliminate the risk attributable to volatility
of the present value of the nonqualified de-
ferred compensation stock and the risk at-
tributable to the fair market value of com-
pany stock, the inability to delay or ac-
celerate the date, automatically and daily
if necessary, weakens the purpose of the
method.
These regulations include changes in
the triennial methodology to permit the
ability, during the 3-year period, to accel-
erate a determination date prospectively
in the event of a change in the plan year
or any merger, consolidation, or trans-
fer of ESOP assets under section 414(l).
However, a determination date may not
be changed retroactively and the change
must be effectuated by a plan amendment
adopted before the new determination
date.
1
A commentator also requested clar-
ification regarding how shares of syn-
thetic equity are calculated with respect
to nonqualified deferred compensation.
Specifically, the commentator wanted to
know what discount rate should be used
to calculate the present value of nonqual-
ified deferred compensation, and how to
determine the number of equivalent shares
for a split-dollar life insurance arrange-
ment. These regulations do not mandate
a specific discount rate for calculating
the present value of nonqualified deferred
compensation or a specific method for de-
termining the equivalent number of shares
for a split dollar arrangement. However,
any assumptions used for such purposes
must be reasonable.
Finally, a commentator asked whether
an individual S corporation share-
holder’s right of first refusal to acquire
S corporation stock from an ESOP for
its fair market value is considered syn-
thetic equity. The regulations have been
revised to clarify that the right of first re-
fusal to acquire stock held by an ESOP is
not treated as a right to acquire stock of an
S corporation under these regulations if the
right to acquire stock would not be taken
into account under §1.1361–1(l)(2)(iii)(A)
in determining whether an S corporation
has a second class of stock and the price
at which the stock is acquired under the
right of first refusal is not less than the
price determined for purposes of the put
right required by section 409(h). See
§54.4975–11(d)(5) of the Excise Tax Reg-
ulations. Of course, any right of first
refusal must comply with the require-
ments of §54.4975–7(b)(9) of the Excise
Tax Regulations. In addition, these regula-
tions give the Commissioner the authority
to treat a right of first refusal as synthetic
equity if the Commissioner determines,
based on the facts and circumstances,
that the right to acquire stock held by the
ESOP constitutes an avoidance or evasion
of section 409(p).
Effective Dates
These regulations generally are appli-
cable for plan years beginning on or after
January 1, 2006. However, these regula-
tions retain, by cross reference, the 2004
regulations for plan years beginning before
January 1, 2006.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Or-
der 12866. Therefore, a regulatory assess-
ment is not required. It also has been de-
termined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C. chap-
ter 5) does not apply to these regulations,
and because the regulation does not im-
pose a collection of information require-
ment upon 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 tem-
porary and proposed regulations preced-
ing these final regulations were submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on its impact on small business.
Drafting Information
The principal authors of these
regulations are John T. Ricotta and
Veronica A. Rouse of the Office of the Di-
vision Counsel/Associate Chief Counsel
(Tax Exempt and Government Entities);
however, other personnel from the IRS
and Treasury participated in their devel-
opment.
*****
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 to
read, in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.409(p)–1 is also issued under
26 U.S.C. 409(p)(7). * * *
Par. 2. Section 1.402(c)–2, A–4, is
revised by redesignating paragraph (g) as
(h) and adding a new paragraph (g) to read
as follows:
§1.402(c)–2 Eligible rollover
distributions; questions and answers.
*****
A–4. ***
(g) Prohibited allocations that are
treated as deemed distributions pursuant
to section 409(p). * * *
Par. 3. Section1.409(p)–1isaddedto
read as follows:
§1.409(p)–1 Prohibited allocation of
securities in an S corporation.
(a)Organization of this section and def-
inition—(1)Organization of this section.
Section 409(p) applies if a nonallocation
year occurs in an ESOP that holds shares
of stock of an S corporation that are em-
ployer securities. Paragraph (b) of this sec-
tion sets forth the general rule under sec-
tion 409(p)(1) and (2) prohibiting any ac-
crual or allocation to a disqualified per-
son in a nonallocation year. Paragraph (c)
of this section sets forth rules under sec-
tion 409(p)(3), (5), and (7) for determining
whether a year is a nonallocation year, gen-
erally based on whether disqualified per-
sons own at least 50 percent of the shares
of the S corporation,either taking into ac-
count only the outstanding shares of the
S corporation (including shares held by the
1
As indicated in Notice 2005–95,2005–2 C.B. 1172, dated December 19, 2005, the general deadline for discretionary amendments in Rev. Proc. 2005–66, 2005–2 C.B. 509, does not apply
if a statute or regulation specifically provides an earlier deadline. These regulations provide such an earlier deadline.
January 29, 20073852007–5 I.R.B.

ESOP) or taking into account both the out-
standing shares and synthetic equity of the
S corporation. Paragraphs (d), (e), and (f)
of this section contain definitions of dis-
qualified person under section 409(p)(4)
and (5), deemed-owned ESOP shares un-
der section 409(p)(4)(C), and synthetic eq-
uity under section 409(p)(6)(C). Paragraph
(g) of this section contains a standard for
determining when the principal purpose of
the ownership structure of an S corporation
constitutes an avoidance or evasion of sec-
tion 409(p).
(2)Definitions. The following defini-
tions apply for purposes of section 409(p)
and this section, as well as for purposes of
section 4979A, which imposes an excise
tax on certain events.
(i)Deemed-owned ESOP shareshas the
meaning set forth in paragraph (e) of this
section.
(ii)Disqualified personhas the mean-
ing set forth in paragraph (d) of this sec-
tion.
(iii)Employerhas the meaning set forth
in §1.410(b)–9.
(iv)Employer securitiesmeans em-
ployer securities within the meaning of
section 409(l).
(v)ESOPmeans an employee stock
ownership plan within the meaning of
section 4975(e)(7).
(vi)Prohibited allocationhas the mean-
ing set forth in paragraph (b)(2) of this sec-
tion.
(vii)S corporationmeans S corporation
within the meaning of section 1361.
(viii)Synthetic equityhas the meaning
set forth in paragraph (f) of this section.
(b)Prohibited allocation in a nonallo-
cation year—(1)General rule. Section
409(p)(1) provides that an ESOP holding
employer securities consisting of stock in
an S corporation must provide that no por-
tion of the assets of the plan attributable to
(or allocable in lieu of) such employer se-
curities may, during a nonallocation year,
accrue under the ESOP, or be allocated di-
rectly or indirectly under any plan of the
employer (including the ESOP) meeting
the requirements of section 401(a), for the
benefit of any disqualified person.
(2)Additional rules—(i)Prohibited
allocation definition. For purposes of
section 409(p) and this section, aprohib-
ited allocationmeans an impermissible
accrual or an impermissible allocation.
Whether there is impermissible accrual
is determined under paragraph (b)(2)(ii)
of this section and whether there is an
impermissible allocation is determined
under paragraph (b)(2)(iii) of this section.
The amount of the prohibited allocation
is equal to the sum of the amount of the
impermissible accrual plus the amount of
the impermissible allocation.
(ii)Impermissible accrual.Thereisan
impermissible accrual to the extent that
employer securities consisting of stock
in an S corporation owned by the ESOP
and any assets attributable thereto are held
under the ESOP for the benefit of a dis-
qualified person during a nonallocation
year. For this purpose,assets attributable
to stock in an S corporation owned by an
ESOP include any distributions, within
the meaning of section 1368, made on
S corporation stock held in a disqualified
person’s account in the ESOP (including
earnings thereon), plus any proceeds from
the sale of S corporation securities held
for a disqualified person’s account in the
ESOP (including any earnings thereon).
Thus, in the event of a nonallocation year,
all S corporation shares and all other ESOP
assets attributable toS corporation stock,
including distributions, sales proceeds,
and earnings on either distributions or
proceeds, held for the account of such dis-
qualifiedpersonintheESOPduringthat
year are an impermissible accrual for the
benefit of that person, whether attributable
to contributions in the current year or in
prior years.
(iii)Impermissible allocation.Anim-
permissible allocation occurs during a
nonallocation year to the extent that a con-
tribution or other annual addition (within
the meaning of section 415(c)(2)) is made
with respect to the account of a disqual-
ified person, or the disqualified person
otherwise accrues additional benefits, di-
rectly or indirectly under the ESOP or any
other plan of the employer qualified under
section 401(a) (including a release and al-
location of assets from a suspense account,
as described at §54.4975–11(c) and (d) of
this chapter) that, for the nonallocation
year, would have been added to the ac-
count of the disqualified person under the
ESOP and invested in employer securities
consisting of stock in an S corporation
owned by the ESOP but for a provision in
the ESOP that precludes such addition to
the account of the disqualified person, and
investment in employer securities during
a nonallocation year.
(iv)Effects of prohibited alloca-
tion—(A)Deemed distribution.Ifaplan
year is a nonallocation year, the amount
of any prohibited allocation in the account
of a disqualified person as of the first day
of the plan year, as determined under this
paragraph (b)(2), istreated as distributed
from the ESOP (or other plan of the em-
ployer) to the disqualified person on the
first day of the plan year. In the case of
an impermissible accrual or impermissible
allocation that is not in the account of the
disqualified person as of the first day of
the plan year, the amount of the prohibited
allocation, as determined under this para-
graph (b)(2), is treated as distributed on
the date of the prohibited allocation. Thus,
the fair market value of assets in the dis-
qualified person’s account that constitutes
an impermissible accrual or allocation is
included in gross income (to the extent in
excess of any investment in the contract
allocable to such amount) and is subject
to any additional income tax that applies
under section 72(t). Adeemed distribution
under this paragraph (b)(2)(iv)(A) is not an
actual distribution from the ESOP. Thus,
the amount of the prohibited allocation is
not an eligible rollover distribution under
section 402(c). However, for purposes of
applying sections 72 and 402 with respect
to any subsequent distribution from the
ESOP, the amount that the disqualified
person previously took into account as in-
come as a result of the deemed distribution
is treated as investment in the contract.
(B)Other effects. If there is a prohib-
ited allocation, then the plan fails to satisfy
the requirements of section 4975(e)(7) and
ceases to be an ESOP. In such a case, the
exemption from the excise tax on prohib-
ited transactions for loans to leveraged
ESOPs contained in section 4975(d)(3)
would cease to apply to any loan (with
the result that the employer would owe an
excise tax with respect to the previously
exempt loan). As a result of these failures,
the plan would lose the prohibited trans-
actionexemptionforloanstoanESOP
under section 4975(d)(3) of the Code and
section 408(b)(3) of Title I of the Em-
ployee Retirement Income Security Act
of 1974, as amended (ERISA). Finally, a
plan that does not operate in accordance
with its terms to reflectsection 409(p) fails
to satisfy the qualification requirements
2007–5 I.R.B.386January 29, 2007

of section 401(a), which would cause the
corporation’s S election to terminate under
section 1362. See also section 4979A(a)
which imposes an excise tax in certain
events, including a prohibited allocation
under section 409(p).
(C)Example. Therulesofthispara-
graph (b)(2)(iv) are illustrated by the fol-
lowing example:
Example.(i)Facts. CorporationM,an
S corporation under section 1361, establishes Plan P
as an ESOP in 2006, with a calendar plan year. Plan
P is a qualified plan that includes terms providing
that a prohibited allocation will not occur during a
nonallocation year in accordance with section 409(p).
On December 31, 2006, all of the 1,000 outstanding
shares of stock of Corporation M, with a fair market
value of $30 per share, are contributed to Plan P and
allocated among accounts established within Plan P
for the benefit of Corporation M’s three employees,
individuals A, B, and C, based on their compensa-
tion for 2006. As a result, on December 31, 2006,
participant A’s account includes 800 of the shares
($24,000); participant B’s account includes 140 of
the shares ($4,200); and participant C’s account
includes the remaining 60 shares ($1,800). The plan
year 2006 is a nonallocation year, participants A and
B are disqualified persons on December 31, 2006,
and a prohibited allocation occurs for A and B on
December 31, 2006.
(ii)Conclusion. On December 31, 2006, par-
ticipants A and B each have a deemed distribution
as a result of the prohibited allocation, resulting in
income of $24,000 for participant A and $4,200 for
participant B. Corporation M owes an excise tax
under section 4979A, based on an amount involved
of $28,200. Plan P ceases to be an ESOP on the date
of the prohibited allocation (December 31, 2006) and
also fails to satisfy the qualification requirements of
section 401(a) on that date due to the failure to com-
ply with the provisions requiring compliance with
section 409(p). As a result of having an ineligible
shareholder under section 1361(b)(1)(B), Corpora-
tion M ceases to be an S corporation under section
1361 on December 31, 2006.
(v)Prevention of prohibited allo-
cation—(A)Transfer of account to
non-ESOP. An ESOP may prevent a non-
allocation year or a prohibited allocation
during a nonallocation year by providing
for assets (including S corporation secu-
rities) allocated to the account of a dis-
qualified person (ora person reasonably
expected to become a disqualified person
absent a transfer described in this para-
graph (b)(2)(v)(A)) to be transferred into
a separate portion of the plan that is not an
ESOP, as described in §54.4975–11(a)(5)
of this chapter, or to another plan of the
employer that satisfies the requirements
of section 401(a) and that is not an ESOP.
Any such transfer must be effectuated by
an affirmative action taken no later than
the date of the transfer, and all subsequent
actions (including benefit statements) gen-
erally must be consistent with the transfer
having occurred on that date. In the event
of such a transfer involving S corporation
securities, the recipient plan is subject to
tax on unrelated business taxable income
under section 512.
(B)Relief from nondiscrimination re-
quirement. Pursuant to this paragraph
(b)(2)(v)(B), if a transfer described in
paragraph (b)(2)(v)(A) of this section is
made from an ESOP to a separate portion
of the plan or to another qualified plan of
the employer that is not an ESOP, then
both the ESOP and the plan or portion of
a plan that is not an ESOP do not fail to
satisfy the requirements of §1.401(a)(4)–4
merely because of the transfer. Further,
subsequent to the transfer, that plan will
not fail to satisfy the requirements of
§1.401(a)(4)–4 merely because of the
benefits, rights, and features with respect
to the transferred benefits if those ben-
efits, rights, and features would satisfy
the requirements of §1.401(a)(4)–4 if the
mandatory disaggregation rule for ESOPs
at §1.410(b)–7(c)(2) did not apply.
(c)Nonallocation year. A year is a non-
allocation year if it is described in the gen-
eral definition in paragraph (c)(1) of this
section or if the special rule of paragraph
(c)(3) of this section applies.
(1)General definition. For purposes of
section 409(p) and this section, anonallo-
cation yearmeans a plan year of an ESOP
during which, at any time, the ESOP holds
any employer securities that are shares of
an S corporation and either—
(i) Disqualified persons own at least
50 percent of the number of outstanding
shares of stock in the S corporation (in-
cluding deemed-owned ESOP shares); or
(ii) Disqualified persons own at least 50
percent of the sum of:
(A) The outstanding shares of
stock in the S corporation (including
deemed-owned ESOP shares); and
(B) The shares of synthetic equity in
the S corporation owned by disqualified
persons.
(2)Attribution rules. For purposes of
this paragraph (c), the rules of section
318(a) apply to determine ownership of
shares in the S corporation (including
deemed-owned ESOP shares) and syn-
thetic equity. However, for this purpose,
section 318(a)(4) (relating to options to
acquire stock) is disregarded and, in ap-
plying section 318(a)(1), the members of
an individual’s family include members
of the individual’s family under paragraph
(d)(2) of this section. In addition, an indi-
vidual is treated as owning deemed-owned
ESOP shares of that individual notwith-
standing the employee trust exception in
section 318(a)(2)(B)(i). If the attribution
rules in paragraph (f)(1) of this section
apply, then the rules of paragraph (f)(1)
of this section are applied before (and in
addition to) the rules of this paragraph
(c)(2).
(3)Special rule for avoidance or eva-
sion. (i) Any ownership structure de-
scribed in paragraph (g)(3) of this section
results in a nonallocation year. In addition,
each individual referred to in paragraph
(g)(3) of this section is treated as a disqual-
ified person and the individual’s interest in
the separate entity described in paragraph
(g)(3) of this section is treated as synthetic
equity.
(ii) Pursuant to section 409(p)(7)(B),
the Commissioner, in revenue rulings,
notices, and other guidance published
in the Internal Revenue Bulletin (see
§601.601(d)(2)(ii)(b) of this chapter), may
provide that a nonallocation year occurs
in any case in which the principal pur-
pose of the ownership structure of an
S corporation constitutes an avoidance or
evasion of section 409(p). For any year
that is a nonallocation year under this para-
graph (c)(3), the Commissioner may treat
any person as a disqualified person. See
paragraph (g) of this section for guidance
regarding when the principal purpose of
an ownership structure of an S corporation
involving synthetic equity constitutes an
avoidance or evasion of section 409(p).
(4)Special rule for certain stock rights.
(i) For purposes of paragraph (c)(1) of
this section, a person is treated as own-
ing stock if the person has an exercisable
right to acquire the stock, the stock is both
issued and outstanding, and the stock is
held by persons other than the ESOP, the
S corporation, or a related entity (as de-
fined in paragraph (f)(3) of this section).
(ii) This paragraph (c)(4) applies
only if treating persons as owning the
shares described in paragraph (c)(4)(i)
of this section results in a nonalloca-
tion year. This paragraph (c)(4) does not
applytoarighttoacquirestockofan
S corporation held by a shareholder that is
subject to Federal income tax that, under
January 29, 20073872007–5 I.R.B.

§1.1361–1(l)(2)(iii)(A) or (l)(4)(iii)(C),
would not be taken into account in deter-
mining if an S corporation has a second
class of stock, provided that a principal
purpose of the right is not the avoidance
or evasion of section 409(p). Under the
last sentence of paragraph (f)(2)(i) of this
section, this paragraph (c)(4)(ii) does not
apply for purposes of determining own-
ership of deemed-owned ESOP shares or
whether an interest constitutes synthetic
equity.
(5)Application with respect to shares
treated as owned by more than one person.
For purposes of applying paragraph (c)(1)
of this section, if, by application of the
rules of paragraph (c)(2), (c)(4), or (f)(1) of
this section, any share is treated as owned
by more than one person, then that share is
counted as a single share and that share is
treated as owned by disqualified persons if
any of the owners is a disqualified person.
(6)Effect of nonallocation year.See
paragraph (b) of this section for a pro-
hibition applicable during a nonallocation
year. See also section 4979A for an ex-
cise tax applicable in certain cases, includ-
ing section 4979A(a)(3) and (4) which ap-
plies during a nonallocation year (whether
or not there is a prohibited allocation dur-
ing the year).
(d)Disqualified persons. A person
is a disqualified person if the person is
described in paragraph (d)(1), (d)(2), or
(d)(3) of this section.
(1)General definition. For purposes of
section 409(p) and this section, adisquali-
fied personmeans any person for whom—
(i) The number of such person’s
deemed-owned ESOP shares of the
S corporation is at least 10 percent of
the number of the deemed-owned ESOP
shares of the S corporation;
(ii) The aggregate number of such
person’s deemed-owned ESOP shares and
synthetic equity shares of the S corporation
is at least 10 percent of the sum of—
(A) The total number of deemed-owned
ESOP shares of the S corporation; and
(B) The person’s synthetic equity
shares of the S corporation;
(iii) The aggregate number of the
S corporation’s deemed-owned ESOP
shares of such person and of the mem-
bers of such person’s family is at least 20
percent of the number of deemed-owned
ESOP shares of the S corporation; or
(iv) The aggregate number of the
S corporation’s deemed-owned ESOP
shares and synthetic equity shares of such
person and of the members of such per-
son’s family is at least 20 percent of the
sum of—
(A) The total number of deemed-owned
ESOP shares of the S corporation; and
(B) The synthetic equity shares of the
S corporation owned by such person and
the members of such person’s family.
(2)Treatment of family members; defi-
nition—(i)Rule. Each member of the fam-
ily of any person who is a disqualified per-
son under paragraph (d)(1)(iii) or (iv) of
this section and who owns any deemed-
owned ESOP shares or synthetic equity
shares is a disqualified person.
(ii)General definition. For purposes of
section 409(p) and this section,member
of the familymeans, with respect to an
individual—
(A) The spouse of the individual;
(B) An ancestor or lineal descendant of
the individual or the individual’s spouse;
(C) A brother or sister of the individual
or of the individual’s spouse and any lineal
descendant of the brother or sister; and
(D) The spouse of any individual de-
scribed in paragraph (d)(2)(ii)(B) or (C) of
this section.
(iii)Spouse. A spouse of an individual
who is legally separated from such individ-
ual under a decree of divorce or separate
maintenance is not treated as such individ-
ual’s spouse under paragraph (d)(2)(ii) of
this section.
(3)Special rule for certain nonalloca-
tion years. See paragraph (c)(3) of this
section (relating to avoidance or evasion
of section 409(p)) for special rules under
which certain persons are treated as dis-
qualified persons.
(4)Example. The rules of this para-
graph (d) are illustrated by the following
examples:
Example 1.(i)Facts. AnScorporationhas800
outstanding shares, of which 100 are owned by in-
dividual O and 700 are held in an employee stock
ownership plan (ESOP) during 2006, including 200
shares held in the ESOP account of O, 65 shares held
in the ESOP account of participant P, 65 shares held in
the ESOP account of participant Q who is P’s spouse,
and14sharesheldintheESOPaccountofR,whois
the daughter of P and Q. There are no unallocated sus-
pense account shares in the ESOP. The S corporation
has no synthetic equity.
(ii)Conclusion. Under paragraph (d)(1)(i) of this
section, O is a disqualified person during 2006 be-
cause O’s account in the ESOP holds at least 10%
of the shares owned by the ESOP (200 is 28.6% of
700). During 2006, neither P, Q, nor R is a disquali-
fied person under paragraph (d)(1)(i) of this section,
because each of their accounts holds less than 10%
of the shares owned by the ESOP. However, each of
P, Q, and R is a disqualified person under paragraph
(d)(1)(iii) of this section because P and members of
P’s family own at least 20% of the deemed-owned
ESOP shares (144 (the sum of 65, 65 and 14) is 20.6%
of 700). As a result, disqualified persons own at least
50% of the outstanding shares of the S corporation
during 2006 (O’s 100 directly owned shares, O’s 200
deemed-owned shares, P’s65 deemed-owned shares,
Q’s 65 deemed-owned shares, and R’s 14 deemed-
owned shares are 55.5% of 800).
Example 2.(i)Facts. An S corporation has shares
that are owned by an ESOP and various individuals.
Individuals S and T are married and have a son, U. In-
dividuals V and W are married and have a daughter,
X. Individuals U and X are married. Individual V has
a brother Y. Their percentages of the deemed-owned
ESOP shares of the S corporation are as follows: T
has 6%; U has 7%; and V has 8%. Neither S, W,
X, nor Y has any deemed-owned ESOP shares and
the S corporation has no synthetic equity. However,
individual S and individual Y each own directly a
number of shares of the outstanding shares of the
S corporation.
(ii)Conclusion. In this example, individual U is a
disqualified person under paragraph (d)(1) of this sec-
tion (because U’s family consists of S, T, U, V, W, and
X, and, in the aggregate, those persons own more than
20% of the deemed-owned ESOP shares) and individ-
ual X is also a disqualified person under paragraph
(d)(1) of this section (because X’s family consists of
S, T, U, V, W, and X, and, in the aggregate, those
persons own more than 20% of the deemed-owned
ESOP shares). Further, individuals T and V are each
a disqualified person under paragraph (d)(2) of this
section because each is a member of a family that in-
cludes one or more disqualified persons and each has
deemed-owned ESOP shares. However, individuals
S, W, and Y are not disqualified persons under this
paragraph (d). For example, S does not own more
than 10% of the deemed-owned ESOP shares, and
S’s family, which consists of S, T, U, and X, owns, in
the aggregate, only 13% of the deemed-owned ESOP
shares (X’s parents are not members of S’s family be-
cause the family members of a person do not include
the parents-in-law of the person’s descendants). Fur-
ther, note that, for purposes of determining whether
the ESOP has a nonallocation year under paragraph
(c) of this section, the shares directly owned by S
and Y would be taken intoaccount as shares owned
by disqualified persons under the attribution rules in
paragraph (c)(2) of this section.
(e)Deemed-owned ESOP shares.For
purposes of section 409(p) and this section,
a person is treated as owning his or her
deemed-owned ESOP shares. Deemed-
owned ESOP shares owned by a person
mean, with respect to any person—
(1) Any shares of stock in the
S corporation constituting employer secu-
rities that are allocated to such person’s
account under the ESOP; and
2007–5 I.R.B.388January 29, 2007

(2) Such person’s share of the stock in
the S corporation that is held by the ESOP
but is not allocated to the account of any
participant or beneficiary (with such per-
son’s share to be determined in the same
proportion as the shares released and al-
located from a suspense account, as de-
scribed at §54.4975–11(c) and (d) of the
Excise Tax Regulations, under the ESOP
for the most recently ended plan year for
which there were shares released and allo-
cated from a suspense account, or if there
has been no such prior release and alloca-
tion from a suspense account, then deter-
mined in proportion to a reasonable esti-
mate of the shares that would be released
and allocated in the first year of a loan re-
payment).
(f)Synthetic equity and rights to ac-
quire stock of the S corporation—(1)Own-
ership of synthetic equity. For purposes of
section 409(p) and this section, synthetic
equity means the rights described in para-
graph (f)(2) of this section. Synthetic eq-
uity is treated as owned by the person that
has any of the rights specified in paragraph
(f)(2) of the section. In addition, the attri-
bution rules as set forth in paragraph (c)(2)
of this section apply for purposes of at-
tributing ownershipof synthetic equity.
(2)Synthetic equity—(i)Rights to ac-
quire stock of the S corporation—(A)Gen-
eral rule. Synthetic equity includes any
stock option, warrant, restricted stock, de-
ferred issuance stock right, stock appre-
ciation right payable in stock, or similar
interest or right that gives the holder the
right to acquire or receive stock of the
S corporation in the future. Rights to ac-
quire stock in an S corporation with respect
to stock that is, at all times during the pe-
riod when such rights are effective, both
issued and outstanding, and held by a per-
son other than the ESOP, the S corporation,
or a related entity are not synthetic equity
but only if that person is subject to federal
income taxes. (See also paragraph (c)(4)
of this section.)
(B)Exception for certain rights of first
refusal. A right of first refusal to acquire
stock held by an ESOP is not treated as a
right to acquire stock of an S corporation
under this paragraph if the right to acquire
stock would not be taken into account un-
der §1.1361–1(l)(2)(iii)(A) in determining
if an S corporation has a second class of
stockandthepriceatwhichthestockis
acquired under the right of first refusal
is not less than the price determined un-
der section 409(h). See §54.4975–11(d)(5)
of the Excise Tax Regulations. The right
of first refusal must also comply with the
requirements of §54.4975–7(b)(9) of the
Excise Tax Regulations. This paragraph
(f)(2)(i)(B) does not apply if, based on
the facts and circumstances, the Commis-
sioner finds that the right to acquire stock
held by the ESOP constitutes an avoidance
or an evasion of section 409(p). See also
section 408(d) of ERISA, under which the
exemption provided by section 408(e) of
ERISA (and the related exemption at sec-
tion 4975(d)(13) of the Code) does not ap-
ply to an owner-employee, including an
employee or officer of an S corporation
who is a 5 percent owner.
(ii)Special rule for certain stock rights.
Synthetic equity also includes a right
to a future payment (payable in cash or
any other form other than stock of the
S corporation) from an S corporation that
is based on the value of the stock of the
S corporation, such as appreciation in such
value. Thus, for example, synthetic equity
includes a stock appreciation right with
respect to stock of an S corporation that
is payable in cash or a phantom stock unit
with respect to stock of an S corporation
that is payable in cash.
(iii)Rights to acquire interests in or as-
sets of an S corporation or a related entity.
Synthetic equity includes a right to acquire
stock or other similar interests in a related
entity to the extent of the S corporation’s
ownership. Synthetic equity also includes
a right to acquire assets of an S corporation
or a related entity other than either rights
to acquire goods, services, or property at
fair market value in the ordinary course of
business or fringe benefits excluded from
gross income under section 132.
(iv)Special rule for nonqualified de-
ferred compensation. (A) Synthetic equity
also includes any of the following with re-
spect to an S corporation or a related en-
tity: any remuneration to which section
404(a)(5) applies; remuneration for which
a deduction would be permitted under sec-
tion 404(a)(5) if separate accounts were
maintained; any right to receive property,
as defined in §1.83–3(e) of the Income
Tax Regulations (including a payment to
a trust described in section 402(b) or to
an annuity described in section 403(c))
in a future year for the performance of
services; any transfer of property in con-
nection with the performance of services
to which section 83 applies to the extent
that the property is not substantially vested
within the meaning of §1.83–3(i) by the
end of the plan year in which transferred;
and a split-dollar life insurance arrange-
ment under §1.61–22(b) entered into in
connection with the performance of ser-
vices (other than one under which, at all
times, the only economic benefit that will
be provided under the arrangement is cur-
rent life insurance protection as described
in §1.61–22(d)(3)). Synthetic equity also
includes any other remuneration for ser-
vices under a plan, method, or arrangement
deferring the receipt of compensation to a
date that is after the 15th day of the 3
rd
cal-
endar month after the end of the entity’s
taxable year in which the related services
are rendered. However, synthetic equity
does not include benefits under a plan that
is an eligible retirement plan within the
meaning of section 402(c)(8)(B).
(B) For purposes of applying paragraph
(f)(2)(iv)(A) of this section with respect to
an ESOP, synthetic equity does not include
any interest described in such paragraph
(f)(2)(iv)(A) of this section to the extent
that—
(1) The interest is nonqualified deferred
compensation (within the meaning of sec-
tion 3121(v)(2)) that was outstanding on
December 17, 2004;
(2) The interest is an amount that was
taken into account (within the meaning of
§31.3121(v)(2)–1(d) of this chapter) prior
to January 1, 2005, for purposes of taxation
under chapter 21 of the Internal Revenue
Code (or income attributable thereto); and
(3) The interest was held before the first
date on which the ESOP acquires any em-
ployer securities.
(v)No overlap among shares of
deemed-owned ESOP shares or synthetic
equity. Synthetic equity under this para-
graph (f)(2) does not include shares that
are deemed-owned ESOP shares (or any
rights with respect to deemed-owned
ESOP shares to the extent such rights
are specifically provided under section
409(h)). In addition, synthetic equity
under a specific subparagraph of this para-
graph (f)(2) does not include anything that
is synthetic equity under a preceding pro-
vision of paragraph (f)(2)(i), (ii), (iii), or
(iv) of this section.
(3)Related entity. For purposes of this
paragraph (f),related entitymeans any en-
January 29, 20073892007–5 I.R.B.

tity in which the S corporation holds an in-
terest and which is a partnership, a trust,
an eligible entity that is disregarded as an
entity that is separate from its owner un-
der §301.7701–3 of this chapter, or a qual-
ified subchapter S subsidiary under section
1361(b)(3).
(4)Number of synthetic shares—(i)
Synthetic equity determined by reference
to S corporation shares. In the case
of synthetic equity that is determined
by reference to shares of stock of the
S corporation, the person who is entitled
to the synthetic equity is treated as owning
the number of shares of stock deliverable
pursuant to such synthetic equity. In the
case of synthetic equity that is determined
by reference to shares of stock of the
S corporation, but for which payment is
made in cash or other property (besides
stock of the S corporation), the number of
shares of synthetic equity treated as owned
is equal to the number of shares of stock
having a fair market value equal to the
cash or other property (disregarding lapse
restrictions as described in §1.83–3(i)).
Where such synthetic equity is a right to
purchase or receive S corporation shares,
the corresponding number of shares of
synthetic equity is determined without
regard to lapse restrictions as described in
§1.83–3(i) or to any amount required to
be paid in exchange for the shares. Thus,
for example, if a corporation grants an
employee of an S corporation an option
to purchase 100 shares of the corpora-
tion’s stock, exercisable in the future
only after the satisfaction of certain per-
formance conditions, the employee is
the deemed owner of 100 synthetic eq-
uity shares of the corporation as of the
date the option is granted. If the same
employee were granted 100 shares of re-
stricted S corporation stock (or restricted
stock units), subject to forfeiture until the
satisfaction of performance or service con-
ditions, the employee would likewise be
the deemed owner of 100 synthetic equity
shares from the grant date. However, if the
same employee were granted a stock ap-
preciation right with regard to 100 shares
of S corporation stock (whether payable in
stock or in cash), the number of synthetic
equity shares the employee is deemed to
own equals the number of shares having
a value equal to the appreciation at the
time of measurement (determined without
regard to lapse restrictions).
(ii)Synthetic equity determined by ref-
erence to shares in a related entity.Inthe
case of synthetic equity that is determined
by reference to shares of stock (or simi-
lar interests) in a related entity, the per-
son who is entitled to the synthetic eq-
uity is treated as owning shares of stock
of the S corporation with the same aggre-
gate value as the number of shares of stock
(or similar interests) of the related entity
(with such value determined without re-
gard to any lapse restriction as defined at
§1.83–3(i)).
(iii)Other synthetic equity—(A)Gen-
eral rule. In the case of any synthetic eq-
uity to which neither paragraph (f)(4)(i) of
this section nor paragraph (f)(4)(ii) of this
section apply, the person who is entitled to
the synthetic equity is treated as owning
on any date a number of shares of stock
in the S corporation equal to the present
value (on that date) of the synthetic eq-
uity (with such value determined without
regard to any lapse restriction as defined
at §1.83–3(i)) divided by the fair market
value of a share of the S corporation’s
stock as of that date.
(B)Use of annual or more frequent
determination dates. A year is a non-
allocation year if the thresholds in para-
graph (c) of this section are met at any
time during that year. However, for pur-
poses of this paragraph (f)(4)(iii), an ESOP
may provide that the number of shares of
S corporation stock treated as owned by a
person who is entitledto synthetic equity
to which this paragraph (f)(4)(iii) applies is
determined annually (or more frequently),
as of the first day of the ESOP’s plan year
or as of any other reasonable determina-
tion date or dates during a plan year. If the
ESOP so provides, the number of shares
of synthetic equity to which this paragraph
(f)(4)(iii) applies that are treated as owned
by that person for any period from a given
determination date through the date imme-
diately preceding the next following de-
termination date is the number of shares
treated as owned on the given determina-
tion date.
(C)Use of triennial recalculations.(1)
Although an ESOP must have a determina-
tion date that is no less frequent than annu-
ally, if the terms of the ESOP so provide,
thenthenumberofsharesofsyntheticeq-
uity with respect to grants of synthetic eq-
uity to which this paragraph (f)(4)(iii) ap-
plies may be fixed for a specified period
from a determination date identified un-
der the ESOP through the day before a de-
termination date that is not later than the
third anniversary of the identified determi-
nation date. Thus, the ESOP must pro-
vide for the number of shares of synthetic
equity to which this paragraph (f)(4)(iii)
applies to be re-determined not less fre-
quently than every three years, based on
the S corporation share value on a deter-
mination date that is not later than the
third anniversary of the identified deter-
mination date and the aggregate present
value of the synthetic equity to which this
paragraph (f)(4)(iii) applies (including all
grants made during the three-year period)
on that determination date.
(2) However, additional accruals, al-
locations, or grants (to which this para-
graph (f)(4)(iii) applies) that are made dur-
ing such three-year period are taken into
account on each determination date during
that period, based on the number of syn-
thetic equity shares resulting from the ad-
ditional accrual, allocation, or grant (deter-
mined as of the determination date on or
next following the date of the accrual, al-
location, or grant). SeeExample 3of para-
graph (h) of this section for an example il-
lustrating this paragraph (f)(4)(iii)(C).
(3) If, as permitted under this paragraph
(f)(4)(iii)(C), an ESOP provides for the
number of shares of synthetic equity to be
fixed for a specified period from a deter-
mination date to a subsequent determina-
tion date, then that subsequent determina-
tion date can be changed to a new determi-
nation date, subject to the following con-
ditions:
(i) The change in the subsequent deter-
mination date must be effectuated through
a plan amendment adopted before the new
determination date;
(ii) The new determination date must
be earlier than the prior determination date
(that is, the new determination date must
be earlier than the determination date ap-
plicable in the absence of the plan amend-
ment);
(iii) The conditions in paragraph
(f)(4)(iii)(C)(2)ofthissectionmustbe
satisfied measured from the new determi-
nation date; and
(iv) Except to the extent permitted
by the Commissioner in revenue rul-
ings, notices, or other guidance published
in the Internal Revenue Bulletin (see
§601.601(d)(2)(ii)(b) of this chapter), the
2007–5 I.R.B.390January 29, 2007

change must be adopted in connection
with either a change in the plan year of
the ESOP or a merger, consolidation, or
transfer of plan assets of the ESOP under
section 414(l) (and the new determination
date must be consistent with that plan year
change or section 414(l) event).
(4)Conditions for application of rules.
This paragraph (f)(4)(iii)(C) only applies
with respect to grants of synthetic equity
to which this paragraph (f)(4)(iii) applies.
In addition, paragraph (f)(4)(iii)(C) of
this section applies only if the fair mar-
ket value of a share of the S corporation
securities on any determination date is
not unrepresentative of the value of the
S corporation securities throughout the
rest of the plan year and only if the terms
of the ESOP include provisions conform-
ing to paragraph (f)(4)(iii)(C)(1)ofthis
section which are consistently used by
the ESOP for all persons. In addition,
paragraph (f)(4)(iii)(C)(1) of this section
applies only if the terms of the ESOP in-
clude provisions conforming to paragraphs
(f)(4)(iii)(C)(1) of this section which are
consistently used by the ESOP for all per-
sons.
(iv)Adjustment of number of synthetic
equity shares where ESOP owns less than
100 Percent of S corporation.Thenum-
ber of synthetic shares otherwise deter-
mined under this paragraph (f)(4) is de-
creased ratably to the extent that shares of
the S corporation are owned by a person
who is not an ESOP and who is subject to
Federal income taxes. For example, if an
S corporation has 200 outstanding shares,
of which individual A owns 50 shares and
the ESOP owns the other 150 shares, and
individual B would be treated under this
paragraph (f)(4) as owning 100 synthetic
equity shares of the S corporation but for
this paragraph (f)(4)(iv), then, under the
rule of this paragraph (f)(4)(iv), the num-
ber of synthetic shares treated as owned by
B under this paragraph (f)(4) is decreased
from 100 to 75 (because the ESOP only
owns 75 percent of the outstanding stock
of the S corporation, rather than 100 per-
cent).
(v)Special rule for shares with greater
voting power than ESOP shares. Notwith-
standing any other provision of this para-
graph (f)(4), if a synthetic equity right
includes (directly or indirectly) a right to
purchase or receive shares of S corporation
stock that have per-share voting rights
greater than the per-share voting rights of
one or more shares of S corporation stock
held by the ESOP, then the number of
shares of deemed owned synthetic equity
attributable to such right is not less than
the number of shares that would have the
same voting rights if the shares had the
same per-share voting rights as shares held
by the ESOP with the least voting rights.
For example, if shares of S corporation
stock held by the ESOP have one voting
right per share, thenan individual who
holds an option to purchase one share with
100 voting rights is treated as owning 100
shares of synthetic equity.
(g)Avoidance or evasion of section
409(p) involving synthetic equity—(1)
General rule. Paragraph (g)(2) of this
section sets forth a standard for determin-
ing whether the principal purpose of the
ownership structure of an S corporation
involving synthetic equity constitutes an
avoidance or evasion of section 409(p).
Paragraph (g)(3) of this section identi-
fies certain specific ownership structures
that constitute an avoidance or evasion of
section 409(p). See also paragraph (c)(3)
of this section for a rule under which the
ownership structures in paragraph (g)(3)
of this section result in a nonallocation
year for purposes of section 409(p).
(2)Standard for determining when
there is an avoidance or evasion of sec-
tion 409(p) involving synthetic equity.For
purposes of section 409(p) and this sec-
tion, whether the principal purpose of the
ownership structure of an S corporation
involving synthetic equity constitutes an
avoidance or evasion of section 409(p)
is determined by taking into account all
the surrounding facts and circumstances,
including all features of the ownership of
the S corporation’s outstanding stock and
related obligations (including synthetic
equity), any shareholders who are taxable
entities, and the cash distributions made
to shareholders, to determine whether,
to the extent of the ESOP’s stock own-
ership, the ESOP receives the economic
benefits of ownership in the S corporation
that occur during the period that stock
of the S corporation is owned by the
ESOP. Among the factors indicating that
the ESOP receives those economic ben-
efits include shareholder voting rights,
the right to receive distributions made to
shareholders, and the right to benefit from
the profits earned by the S corporation,
including the extent to which actual dis-
tributions of profits are made from the
S corporation to the ESOP and the extent
to which the ESOP’s ownership interest in
undistributed profits and future profits is
subject to dilution as a result of synthetic
equity. For example, the ESOP’s owner-
ship interest is not subject to dilution if the
total amount of synthetic equity is a rel-
atively small portion of the total number
of shares and deemed-owned shares of the
S corporation.
(3)Specific transactions that constitute
an avoidance or evasion of section 409(p)
involving segregated profits.Takinginto
account the standard in paragraph (g)(2)
of this section, the principal purpose of
the ownership structure of an S corporation
constitutes an avoidance or evasion of sec-
tion 409(p) in any case in which—
(i) The profits of the S corporation gen-
erated by the business activities of a spe-
cific individual or individuals are not pro-
vided to the ESOP, but are instead substan-
tially accumulated and held for the ben-
efit of the individual or individuals on a
tax-deferred basis within an entity related
to the S corporation, such as a partner-
ship, trust, or corporation (such as in a sub-
sidiary that is a disregarded entity), or any
other method that has the same effect of
segregating profits for the benefit of such
individual or individuals (such as nonqual-
ified deferred compensation described in
paragraph (f)(2)(iv) of this section);
(ii) The individual or individuals for
whom profits are segregated have rights to
acquire 50 percent or more of those profits
directly or indirectly (for example, by pur-
chase of the subsidiary); and
(iii) A nonallocation year would oc-
cur if this section were separately applied
with respect to either the separate entity
or whatever method has the effect of seg-
regating profits of the individual or indi-
viduals, treating such entity as a separate
S corporation owned by an ESOP (or in the
case of any other method of segregation of
profits by treating those profits as the only
assets of a separate Scorporation owned
by an ESOP).
(h)Examples. The rules of this section
are illustrated by the following examples:
Example 1.Relating to determination of disquali-
fied persons and nonallocation year if there is no syn-
thetic equity.(i)Facts. Corporation X is a calendar
year S corporation that maintains an ESOP. X has a
single class of common stock, of which there are a
total of 1,200 shares outstanding. X has no synthetic
January 29, 20073912007–5 I.R.B.

equity. In 2006, individual A, who is not an employee
of X (and is not related to any employee of X), owns
100 shares directly, B, who is an employee ofX,owns
100 shares directly, and the remaining 1,000 shares
are owned by an ESOP maintained by X for its em-
ployees. The ESOP’s 1,000 shares are allocated to
the accounts of individuals who are employees of X
(none of whom are related), as set forth in columns 1
and 2 in the following table:
1
Shareholders
2
Deemed-Owned ESOP Shares
(total of 1,000)
3
Percentage Deemed-Owned ESOP
Shares
4
Disqualified Person
B33033%Yes
C
14514.5%
Yes
D
757.5%
No
E303%No
F202%No
Other participants400 (none exceed 10 shares)1% or lessNo
(ii)Conclusion with respect to disqualified per-
sons. As shown in column 4 in the table contained in
paragraph (i) ofExample 1, individuals B and C are
disqualified persons for 2006 under paragraph (d)(1)
of this section because each owns at least 10% of
X’s deemed-owned ESOP shares. However, the syn-
thetic equity shares owned by any person do not af-
fect the calculation for any other person’s ownership
of shares.
(iii)Conclusion with respect to nonallocation
year. 2006 is not a nonallocation year under section
409(p) because disqualified persons do not own at
least 50% of X’s outstanding shares (the 100 shares
owned directly by B, B’s 330 deemed-owned ESOP
shares, plus C’s 145 deemed-owned ESOP shares
equal only 47.9% of the 1,200 outstanding shares of
X).
Example 2.Relating to determination of disqual-
ified persons and nonallocation year if there is syn-
thetic equity.(i)Facts. The facts are the same as in
Example 1, except that, as shown in column 4 of the
table in thisExample 2, individuals E and F have op-
tions to acquire 110 and 130 shares, respectively, of
the common stock of X from X:
1
Shareholder
2
Deemed-Owned ESOP
Shares
(total of 1,000)
3
Percentage Deemed-
Owned ESOP Shares
4
Options (240)
5
Shareholder Percentage
of Deemed-Owned
ESOP plus Synthetic
Equity Shares
6
Disqualified Person
B33033%Yes (col. 3)
C
14514.5%
Yes (col. 3)
D
757.5%
No
E303%11011.1% ([30+ 91.7]
divided by 1,091.7)
Yes (col. 5)
F202%13011.6% ([20 +108.3]
divided by 1,108.3)
Yes (col. 5)
Other participants400 (none exceeds 10
shares)
1% or lessNo
(ii)Conclusion with respect to disqualified per-
s
ons. Individual E’s synthetic equity shares are
counted in determining whether E is a disqualified
person for 2006, and individual F’s synthetic equity
s
hares are counted in determining whether F is a
disqualified person for 2006. Applying the rule of
paragraph (f)(4)(iv) of this section, E’s option to
acquire 110 shares of the S corporation converts
under paragraph (f)(4)(iv) of this section, into 91.7
shares of synthetic equity (110 times the ratio of the
1,000 deemed-owned ESOP shares to the sum of
the 1,000 deemed-owned ESOP shares plus the 200
shares held outside the ESOP by A and B). Similarly,
F’s option to acquire 130 shares of the S corporation
converts into 108.3 shares of synthetic equity (130
times the ratio of the 1,000 deemed-owned ESOP
shares to the sum of the 1,000 deemed-owned ESOP
shares plus the 200 shares held outside the ESOP
by A and B). However, the synthetic equity shares
owned by any person do not affect the calculation
for any other person’s ownership of shares. Accord-
ingly, as shown in column 6 in the table contained in
p
aragraph (i) ofExample 2, individuals B, C, E, and
F are disqualified persons for 2006.
(iii)Conclusion with respect to nonalloca-
t
ion year. The 100 shares owned directly by B,
B’s 330 deemed-owned ESOP shares, C’s 145
deemed-owned ESOP shares, E’s 30 deemed-owned
E
SOP shares, E’s 91.7 synthetic equity shares, F’s
20 deemed-owned ESOP shares, plus F’s 108.3 syn-
thetic equity shares total 825, which equals 58.9%
of 1,400, which is the sum of the 1,200 outstanding
shares of X and the 200 shares of synthetic equity
shares of X held by disqualified persons. Thus, 2006
is a nonallocation year for X’s ESOP under section
409(p) because disqualified persons own at least
50% of the total shares of outstanding stock of X
and the total synthetic equity shares of X held by
disqualified persons. In addition, independent of
the preceding conclusion, 2006 would be a nonal-
location year because disqualified persons own at
least 50% of X’s outstanding shares because the 100
shares owned directly byB, B’s 330 deemed-owned
E
SOP shares, C’s 145 deemed-owned ESOP shares,
E’s 30 deemed-owned ESOP shares, plus F’s 20
deemed-owned ESOP shares equal 52.1% of the
1
,200 outstanding shares of X.
Example 3.Relating to determination of number
of shares of synthetic equity.(i)Facts. Corporation
Y
is a calendar year S corporation that maintains an
ESOP. Y has a single class of common stock, of which
there are a total of 1,000 shares outstanding, all of
which are owned by the ESOP. Y has no synthetic
equity, except for four grants of nonqualified deferred
compensation that are made to an individual during
the period from 2005 through 2011, as set forth in
column 2 in the following table. The ESOP provides
for the rules in paragraph (f)(4)(iii) of this section to
determine the number of shares of synthetic equity
owned by that individual with a determination date of
January 1 and the triennial rule redetermining value,
as shown in columns 4 and 5:
2007–5 I.R.B.392January 29, 2007

1
Determination Date
2
Present Value of Nonqualified
Deferred Compensation on
Determination Date
3
Share Value on Determination
Date
4
New Shares of Synthetic
Equity on Determination Date
5
Aggregate Number of
Synthetic Equity Shares on
Determination Date
January 1, 2005
A grant is made on January
1, 2005, with a present value
of $1,000. An additional
grant of nonqualified deferred
compensation with a present
value of $775 is made on
March 1, 2005.
$10 per share
100100
January 1, 2006An additional grant is made
on December 31, 2005, which
has a present value of $800 on
January 1, 2006. The March
1, 2005, grant has a present
value on January 1, 2006, of
$800.
$8 per share
200300
January 1, 2007No new grants made.
$12 per share
300
January 1, 2008An additional grant is made
on December 31, 2007,
which has a present value of
$3,000 on January 1, 2008.
The grants made during
2005 through 2007 have an
aggregate present value on
January 1, 2008, of $3,750.
$15 per share
200
450
January 1, 2009No new grants are made.
$11 per share
450
January 1, 2010No new grants are made.
$22 per share
450
January 1, 2011No new grants are made.
The grants made during
2005 through 2008 have an
aggregate present value on
January 1, 2011, of $7,600.
$20 per share
380
(ii
)Conclusion. The grant made on January 1,
2005, is treated as 100 shares until the determination
date in 2008. The grant made on March 1, 2005, is
no
t taken into account until the 2006 determination
date and its present value on that date, along with the
then present value of the grant made on December
31
, 2005, is treated as a number of shares that are
based on the $8 per share value on the 2006 determi-
nation date, with the resulting number of shares con-
t
inuing to apply until the determination date in 2008.
On the January 1, 2008, determination date, the grant
made on the preceding day is taken into account at
i
ts present value of $3,000 on January 1, 2008 and
the $15 per share value on that date with the resulting
number of shares (200) continuing to apply until the
n
ext determination date. In addition, on the January
1, 2008, determination date, the number of shares de-
termined under other grants made between January
1, 2005 and December 31, 2007, must be revalued.
Accordingly, the aggregate value of all nonqualified
deferred compensation granted during that period is
determined to be $3750 on January 1, 2008, and the
corresponding number of shares of synthetic equity
based on the $15 per share value is determined to be
250 shares on the 2008 determination date, with the
resulting aggregate number of shares (450) continu-
ing to apply until the determination date in 2011. On
the January 1, 2011, determination date, the aggregate
value of all nonqualified deferred compensation is de-
ter
mined to be $7,600 and the corresponding num-
ber of shares of synthetic equity based on the $20 per
share value on the 2011 determination date is deter-
mi
ned to be 380 shares (with the resulting number of
shares continuing to apply until the day before the de-
termination date in 2014, assuming no further grants
ar
e made).
(i
)Effective dates—(1)Statutory effec-
ti
ve date. (i) Except as otherwise provided
in
paragraph (i)(1)(ii) of this section, sec-
ti
on 409(p) applies for plan years ending
a
fter March 14, 2001.
(i
i) If an ESOP holding stock in an
S
corporation was established on or be-
f
ore March 14, 2001, and the election un-
d
er section 1362(a) with respect to that
S
corporation was in effect on March 14,
2
001, section 409(p) applies for plan years
b
eginning on or after January 1, 2005.
(
2)Regulatory effective date.This
s
ection applies for plan years beginning
on or after January 1, 2006. For plan
years beginning before January 1, 2006,
§1.409(p)–1T (as it appeared in the April
1, 2005, edition of 26 CFR part 1) applies.
Mar
k E. Matthews,
Dep
uty Commissioner for
Se
rvices and Enforcement.
Approved November 30, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary
oftheTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on December 19,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 20, 2006, 71 F.R. 76134)
Section 472.—Last-in,
First-out Inventories
26 CFR 1.472–1: Last-in, first-out inventories.
LIFO; price indexes; department
stores.The November 2006 Bureau of
Labor Statistics price indexes are accepted
for use by department stores employing
the retail inventory and last-in, first-out
inventory methods for valuing inventories
January 29, 20073932007–5 I.R.B.

for tax years ended on, or with reference
to, November 30, 2006.
Rev. Rul. 2007–6
The following Department Store In-
ventory Price Indexes for November 2006
were issued by the Bureau of Labor Sta-
tistics (BLS). The indexes are accepted
by the Internal Revenue Service, under
§ 1.472–1(k) of the Income Tax Regula-
tions and Rev. Proc. 86–46, 1986–2 C.B.
739, for appropriate application to inven-
tories of department stores employing the
retail inventory and last-in, first-out in-
ventory methods for tax years ended on,
or with reference to, November 30, 2006.
The Department Store Inventory Price
Indexes are prepared on a national basis
and include (a) 23 major groups of depart-
ments, (b) three special combinations of
the major groups — soft goods, durable
goods, and miscellaneous goods, and (c) a
store total, which covers all departments,
including some not listed separately, ex-
cept for the following: candy, food, liquor,
tobacco, and contract departments.
BUREAU OF LABOR STATISTICS, DEPARTMENT STORE
INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS
(January 1941 = 100, unless otherwise noted)
GroupsNov. 2005Nov. 2006
Percent Change
from Nov. 2005
to Nov. 2006
1
1. PieceGoods .............................................480.6471.2-2.0
2. DomesticsandDraperies..................................508.2478.1-5.9
3. Women’sandChildren’sShoes ............................684.7678.1-1.0
4. Men’sShoes.............................................868.9894.22.9
5. Infants’Wear ............................................564.1573.31.6
6. Women’sUnderwear......................................548.8560.22.1
7. Women’sHosiery ........................................339.8346.52.0
8. Women’sandGirls’Accessories ...........................582.1542.0-6.9
9. Women’sOuterwearandGirls’Wear .......................368.3373.51.4
10. Men’sClothing ..........................................542.1529.6-2.3
11. Men’sFurnishings........................................574.9574.90.0
12. Boys’ClothingandFurnishings............................403.5411.31.9
13. Jewelry..................................................861.4893.33.7
14. Notions .................................................803.1817.91.8
15. ToiletArticlesandDrugs..................................1001.01005.10.4
16. FurnitureandBedding ....................................596.7596.90.0
17. FloorCoverings..........................................612.3623.21.8
18. Housewares..............................................701.9689.7-1.7
19. MajorAppliances.........................................204.3208.92.3
20. RadioandTelevision......................................38.134.4-9.7
21. Recreation and Education
2
.................................77.676.7-1.2
22. Home Improvements
2
.....................................137.2141.33.0
23. Automotive Accessories
2
..................................116.5122.24.9
Groups1–15:SoftGoods .......................................561.0561.90.2
Groups16–20:DurableGoods...................................376.2371.2-1.3
Gro
ups 21–23: Misc. Goods
2
....................................
93.194.21.2
Store Total
3
..............................................495.4495.30.0
1
Absence of a minus sign before the percentage change in this column signifies a price increase.
2
I
ndexes on a January 1986 = 100 base.
3
The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor,
tobacco, and contract departments.
DRAFTING INFORMATION
The principal author of this revenue rul-
ingisJohnRomanFaronoftheOffice
of Associate Chief Counsel (Income Tax
and Accounting). For further informa-
tion regarding this revenue ruling, con-
tact Mr. Faron at (202) 622–8142 (not a
toll-free call).
2007–5 I.R.B.394January 29, 2007

Part III. Administrative, Procedural, and Miscellaneous
Miscellaneous Pension
Protection Act Changes
Notice 2007–7
I. PURPOSE
This notice provides guidance in the
form of questions and answers with re-
spect to certain provisions of the Pension
Protection Act of 2006, P.L. 109–280
(“PPA ’06”), that are effective in 2007
or earlier. The sections of PPA ’06 ad-
dressed in this notice, which are primarily
related to distributions, are § 303 (relating
to interest rate assumptions for lump sum
distributions), § 826 (relating to hardship
distributions), § 828 (relating to early
distributions to public safety employees),
§ 829 (relating to rollovers for nonspouse
beneficiaries), § 845 (relating to dis-
tributions to pay for accident or health
insurance for public safety officers), § 904
(relating to vesting of nonelective con-
tributions), § 1102 (relating to the notice
and consent period for distributions), and
§ 1201 (relating to distributions from IRAs
to charitable organizations).
II. SECTION 303 OF PPA ’06
Section 415(b) of the Code provides
limitations on annual benefits under a de-
fined benefit plan. Under § 415(b)(2)(B),
if a benefit is payable in a form other than a
straight life annuity, the benefit is adjusted
to an actuarially equivalent straight life an-
nuity for purposes of determining whether
the limitations of § 415(b) have been sat-
isfied. Section 415(b)(2)(E) provides lim-
itations on the actuarial assumptions that
can be used in making the adjustment un-
der § 415(b)(2)(B). Prior to the enactment
of PPA ’06, for purposes of adjusting a
benefit payable in a form that is subject to
the minimum present value requirements
of § 417(e)(3), § 415(b)(2)(E)(ii) provided
that the interest rate assumption must not
be less than the greater of the applicable
interest rate as defined in § 417(e)(3) or
the rate specified in the plan. However,
§ 101(b)(4) of the Pension Funding Eq-
uity Act of 2004, P.L. 108–218, amended
§ 415(b)(2)(E)(ii) to provide that, for plan
years beginning in 2004 and 2005, 5.5%
must be used in lieu of the applicable in-
terest rate (as defined in § 417(e)(3)) for
purposes of adjusting the benefit.
Section 303(a) of PPA ’06 amended
§ 415(b)(2)(E)(ii) to provide that the in-
terest rate assumption for purposes of ad-
justing a benefit payable in a form that is
subject to the minimum present value re-
quirements of § 417(e)(3) must not be less
than the greatest of (i) 5.5%, (ii) the rate
that provides a benefit of not more than
105% of the benefit that would be provided
if the applicable interest rate (as defined
in § 417(e)(3)) were the interest rate as-
sumption, or (iii) the rate specified under
the plan.
Q–1. What is the effective date of the
changes made to § 415 of the Code by
§ 303(a) of PPA ’06?
A–1. The changes to § 415 of the
Code made by § 303(a) of PPA ’06 ap-
ply to distributions made in plan years be-
ginning after December 31, 2005. How-
ever, the changes do not apply to a plan
with a termination date that is on or before
August 17, 2006, the date of enactment of
PPA ’06.
Q–2. May a plan be amended retroac-
tively to comply with the requirements of
§ 303(a) of PPA ’06 without violating the
anti-cutback rules provided in § 411(d)(6)
of the Code?
A–2. Yes. Under § 1107 of PPA ’06,
a plan does not violate the anti-cutback
rules of § 411(d)(6) of the Code if it is
amended retroactively to comply with
§ 303(a) of PPA ’06, provided the amend-
ment is adopted on or before the last day
of the first plan year beginning on or after
January 1, 2009 (2011 in the case of a gov-
ernmental plan), and the plan is operated
as if such amendment were in effect as of
the first date the amendment is effective.
Q–3. If a plan made a distribution in a
plan year beginning in 2006 that satisfied
the limitations of § 415(b) prior to the en-
actment of PPA ’06 but which is in excess
of the limitations of § 415(b) taking into
account the amendments to § 415 made by
§ 303(a) of PPA ’06 (a “§ 303 excess distri-
bution”), does the distribution violate the
requirements of § 415(b)?
A–3. Yes. However, three methods
are available for correcting a § 303 excess
distribution. First, Q&A–4 of this notice
sets forth a special correction method that
is available for a § 303 excess distribution
made prior to September 1, 2006, pro-
vided that the correction is completed by
March 15, 2007. Second, if correction is
completed by December 31, 2007 (even if
the § 303 excess distribution occurs after
September 1, 2006), a plan may correct
a § 303 excess distribution by using the
correction method for a § 415(b) excess
distribution described in the Employee
Plans Compliance Resolution System
(“EPCRS”) (see section 2.04(1) in Appen-
dix B in Rev. Proc. 2006–27, 2006–22
I.R.B. 945) even if the plan does not meet
the requirements specified in Rev. Proc.
2006–27, including the special require-
ments for self correction under Part IV
of Rev. Proc. 2006–27. Finally, a plan
that meets the requirements of Rev. Proc.
2006–27 may correct § 303 excess dis-
tributions by using the correction method
for § 415(b) excess distributions under
EPCRS even after December 31, 2007. A
plan that is amended retroactively to com-
ply with § 303(a) of PPA ’06 will not fail to
satisfy the requirement in § 1107(b)(2)(A)
of PPA ’06 (that the plan be operated in
accordance with the terms of the amend-
ment) merely because it made a § 303
excess distribution, provided the § 303
excess distribution is corrected using one
of these three correction methods.
Q–4. What special correction method is
available to correct a § 303 excess distribu-
tion made prior to September 1, 2006?
A–4. A special correction method is
available for a § 303 excess distribution
made prior to September 1, 2006, provided
the correction is completed by March
15, 2007. Under the special correction
method, a plan may use the EPCRS cor-
rection method for a § 415(b) excess dis-
tribution(asdescribedinsection2.04(1)
in Appendix B in Rev. Proc. 2006–27,
even if the plan does not otherwise meet
the requirements of Rev. Proc. 2006–27,
including the special requirements for
self correction) with the following mod-
ifications. The excess amount (i.e.,the
amount by which the distribution actually
made exceeds the distribution permitted
using the interest assumption specified
in § 415(b) as amended by PPA ’06) is
not required to be returned to the plan
January 29, 20073952007–5 I.R.B.

(as otherwise required under the EPCRS
correction method). Instead, a plan must
issue two Forms 1099–R (Distributions
From Pensions, Annuities, Retirement or
Profit-Sharing Plans, IRAs, Insurance
Contracts, etc.) to a participant who has
received a § 303 excess distribution. The
first Form 1099–R should include only the
amount that would have been distributed
had the benefit payable been adjusted us-
ing the interest assumptions specified in
§ 415(b) as amended by PPA ’06. The
second Form 1099–R should include only
the excess amount that was distributed,
and should include code “E” in box 7
to identify the amount as an excess dis-
tribution. As provided in the EPCRS
correction, this excess amount is not an
eligible rollover distribution, and therefore
must be included in gross income in the
year distributed from the plan.
III. SECTION 826 OF PPA ’06
An employee’s elective contributions
under a cash or deferred arrangement can
only be distributed upon the occurrence of
certain events, one of which is the em-
ployee’s hardship. A distribution is made
on account of hardship only if the distri-
bution both is made on account of an im-
mediate and heavy financial need of the
employee and is necessary to satisfy the
financial need. A distribution made for
any of the expenses listed in Regulation
§ 1.401(k)–1(d)(3)(iii)(B) is deemed to be
on account of an immediate and heavy fi-
nancial need of the employee. Several of
these listed expenses can be expenses of
the employee’s spouse or dependents.
Section 826 of PPA ’06 directs the Sec-
retary of the Treasury to modify the rules
relating to distributions from § 401(k),
§ 403(b), § 409A, and § 457(b) plans
on account of a participant’s hardship
or unforeseeable financial emergency to
permit such plans to treat a participant’s
beneficiary under the plan the same as
the participant’s spouse or dependent in
determining whether the participant has
incurred a hardship or unforeseeable fi-
nancial emergency.
Q–5. What changes are being made
pursuant to § 826 of PPA ’06 in the rules
relating to hardship distributions from
§ 401(k) plans and § 403(b) plans and
relating to distributions on account of an
unforeseeable financial emergency from a
plan described in § 457(b) or § 409A?
A–5. (a)Hardship distributions from
§ 401(k) plans and § 403(b) plans.A
§ 401(k) plan that permits hardship dis-
tributions of elective contributions to a
participant only for expenses described
in § 1.401(k)–1(d)(3)(iii)(B) may, be-
ginning August 17, 2006, permit dis-
tributions for expenses described in
§ 1.401(k)–1(d)(3)(iii)(B)(1), (3), or (5)
(relating to medical, tuition, and funeral
expenses, respectively) for a primary ben-
eficiary under the plan. For this purpose, a
“primary beneficiary under the plan” is an
individual who is named as a beneficiary
under the plan and has an unconditional
right to all or a portion of the participant’s
account balance under the plan upon the
death of the participant. A plan that adopts
these expanded hardship provisions must
still satisfy all the other requirements ap-
plicable to hardship distributions, such as
the requirement that the distribution be
necessary to satisfy the financial need.
These rules also apply to § 403(b) plans.
(b)Distributions on account of
an unforeseeable financial emer-
gency from a plan described in
§ 457(b) or § 409A. In applying
§ 457(d)(1)(A)(iii), § 1.457–6(c)(2)(i),
§ 409A(a)(2)(A)(vi), and Proposed Reg-
ulation § 1.409A–3(g)(3)(i), a plan de-
scribed in § 457(b) or § 409A may treat
a participant’s beneficiary under the plan
thesameastheparticipant’sspouseor
dependent in determining whether the
participant has incurred an unforeseeable
financial emergency. This will be reflected
in the upcoming final regulations under
§ 409A.
IV. SECTION 828 OF PPA ’06
Section 72(t)(1) of the Code provides
for a 10% additional tax on an early dis-
tribution from a qualified retirement plan
(as defined in § 4974(c)), unless the early
distribution qualifies for one of the ex-
ceptions listed in § 72(t)(2). For exam-
ple, § 72(t)(2)(A)(v) provides an exception
to the 10% additional tax for distributions
made to an employee who separates from
service after attainment of age 55. Under
§ 72(t)(3)(A), § 72(t)(2)(A)(v) does not ap-
ply to individual retirement plans.
Section 828 of PPA ’06 amended § 72
of the Code by adding § 72(t)(10), which
provides that in the case of a distribu-
tion to a qualified public safety employee
from a governmental defined benefit plan,
§ 72(t)(2)(A)(v) is applied by substituting
age 50 for age 55. Thus, the 10% ad-
ditional tax on early distributions under
§ 72(t)(1) does not apply to a distribution
from a governmental defined benefit plan
made to a qualified public safety employee
who separates from service after attain-
ment of age 50. This exception to the 10%
additional tax applies to distributions made
after August 17, 2006 (the date of enact-
ment of PPA ’06).
Q–6. Who is a qualified public safety
employee?
A–6. For purposes of § 72(t)(10), the
term “qualified public safety employee”
means an employee of a State or of a politi-
cal subdivision of a State (such as a county
or city) whose principal duties include ser-
vices requiring specialized training in the
area of police protection, firefighting ser-
vices, or emergency medical services for
any area within the jurisdiction of the State
or the political subdivision of the State.
Q–7. How does a qualified public
safety employee qualify for the excep-
tion to the 10% additional tax under
§ 72(t)(10)?
A–7. In order to qualify for the ex-
ception to the 10% additional tax under
§ 72(t)(10), a qualified public safety em-
ployee (i) must have received the distri-
bution from a governmental defined ben-
efit plan after separating from service with
the employer maintaining the plan and (ii)
the separation from service must have oc-
curred during or after the calendar year
in which the qualified public safety em-
ployee attained age 50. For example, a
qualified public safety employee who sep-
arated from service on June 30, 2006, and
attained age 50 on December 12, 2006, is
eligible for the exception under § 72(t)(10)
with respect to distributions made after
August 17, 2006.
Q–8. What are the consequences if, be-
fore August 18, 2006, a qualified public
safety employee began receiving substan-
tially equal periodic payments that qual-
ify for the exception to the 10% additional
tax described in § 72(t)(2)(A)(iv) and then
modified the periodic payments after Au-
gust 17, 2006?
A–8. If the payments satisfy the re-
quirements in Q&A–7 of this notice,
payments received by the qualified public
2007–5 I.R.B.396January 29, 2007

safety employee after August 17, 2006,
would qualify for the exception to the 10%
additional tax under § 72(t)(10). However,
if the modification would result in the im-
position of the recapture tax under the
rules of § 72(t)(4), then the recapture tax
applies to the payments made before Au-
gust 18, 2006.
Q–9. Does the exception to the 10% ad-
ditional tax under § 72(t)(10) apply if the
qualified public safety employee rolls over
distributions from agovernmental defined
benefitplanintoanIRAoradefinedcon-
tribution plan and subsequently takes an
early distribution from the IRA or defined
contribution plan?
A–9. No. The exception to the 10% ad-
ditional tax under § 72(t)(10) applies only
to amounts distributed from a governmen-
tal defined benefit plan and does not apply
to distributions from a defined contribu-
tion plan or an individual retirement plan.
Q–10. How does a payer report distri-
butions that qualify for the exception to the
10% additional tax under § 72(t)(10) on
Form 1099–R?
A–10. A payer is permitted to use
distribution code 2 (early distribution, ex-
ception applies) in box 7 of Form 1099–R.
However, a payer is also permitted to
use distribution code 1 (early distribu-
tion, no known exception) in box 7 of
Form 1099–R, if the payer does not know
whether the exception under § 72(t)(10)
applies. For further information on report-
ing, see Instructions for Forms 1099–R
and 5498.
V. SECTION 829 OF PPA ’06
Under § 402(c)(11) of the Code, which
was added by § 829 of PPA ’06, if a di-
rect trustee-to-trustee transfer of any por-
tion of a distribution from an eligible re-
tirement plan is made to an individual re-
tirement plan described in § 408(a) or (b)
(an “IRA”) that is established for the pur-
pose of receiving the distribution on be-
half of a designated beneficiary who is
a nonspouse beneficiary, the transfer is
treated as a direct rollover of an eligi-
ble rollover distribution for purposes of
§ 402(c). The IRA of the nonspouse bene-
ficiary is treated as an inherited IRA within
the meaning of § 408(d)(3)(C). Section
402(c)(11) applies to distributions made
after December 31, 2006.
Q–11. Can a qualified plan described in
§ 401(a) offer a direct rollover of a distri-
bution to a nonspouse beneficiary?
A–11.Yes.Under§402(c)(11),a
qualified plan described in § 401(a) can
offer a direct rollover of a distribution
to a nonspouse beneficiary who is a des-
ignated beneficiary within the meaning
of § 401(a)(9)(E), provided that the dis-
tributed amount satisfies all the require-
ments to be an eligible rollover distribution
other than the requirement that the distri-
bution be made to the participant or the
participant’s spouse. (See § 1.401(a)(9)–4
for rules regarding designated beneficia-
ries.) The direct rollover must be made to
an IRA established on behalf of the desig-
nated beneficiary that will be treated as an
inherited IRA pursuant to the provisions of
§ 402(c)(11). If a nonspouse beneficiary
elects a direct rollover, the amount directly
rolled over is not includible in gross in-
come in the year of the distribution. See
§ 1.401(a)(31)–1, Q&A–3 and–4, for pro-
cedures for making a direct rollover.
Q–12. Can other types of plans offer a
direct rollover of a distribution to a non-
spouse beneficiary?
A–12. Yes. Section 402(c)(11) also ap-
plies to annuity plans described in § 403(a)
or (b) and to eligible governmental plans
under § 457(b).
Q–13. How must the IRA be estab-
lished and titled?
A–13. The IRA must be established in
a manner that identifies it as an IRA with
respect to a deceased individual and also
identifies the deceasedindividual and the
beneficiary, for example, “Tom Smith as
beneficiary of John Smith.”
Q–14. Is a plan required to offer a direct
rollover of a distribution to a nonspouse
beneficiary pursuant to § 402(c)(11)?
A–14. No. A plan is not required to
offer a direct rollover of a distribution to
a nonspouse beneficiary. If a plan does
offer direct rollovers to nonspouse bene-
ficiaries of some, but not all, participants,
such rollovers must be offered on a nondis-
criminatory basis because the opportunity
to make a direct rollover is a benefit, right,
or feature that is subject to § 401(a)(4).
In the case of distributions from a termi-
nated defined contribution plan pursuant to
29 C.F.R. § 2550.404a–3(d)(1)(ii), the plan
will be considered to offer direct rollovers
pursuant to § 402(c)(11) with respect to
such distributions without regard to plan
terms.
Q–15. For what purposes is the direct
rollover of a distribution by a nonspouse
beneficiary treated as a rollover of an eli-
gible rollover distribution?
A–15. Section 402(c)(11) provides that
a direct rollover of a distribution by a non-
spouse beneficiary is a rollover of an eligi-
ble rollover distribution only for purposes
of § 402(c). Accordingly, the distribution
is not subject to the direct rollover require-
ments of § 401(a)(31), the notice require-
ments of § 402(f), or the mandatory with-
holding requirements of § 3405(c). If an
amount distributed from a plan is received
by a nonspouse beneficiary, the distribu-
tion is not eligible for rollover.
Q–16. If the named beneficiary of a
decedent is a trust, is a plan permitted to
make a direct rollover to an IRA estab-
lished with the trust as beneficiary?
A–16. Yes. A plan may make a di-
rect rollover to an IRA on behalf of a trust
where the trust is the named beneficiary of
a decedent, provided the beneficiaries of
thetrustmeettherequirementstobedes-
ignated beneficiaries within the meaning
of § 401(a)(9)(E). The IRA must be es-
tablished in accordance with the rules in
Q&A–13 of this notice, with the trust iden-
tified as the beneficiary. In such a case,
the beneficiaries of the trust are treated as
having been designated as beneficiaries of
the decedent for purposes of determining
the distribution period under § 401(a)(9),
if the trust meets the requirements set forth
in § 1.401(a)(9)–4, Q&A–5, with respect
to the IRA.
Q–17. How is the required minimum
distribution (an amount not eligible for
rollover) determined with respect to a non-
spouse beneficiary if the employee dies
before his or her required beginning date
within the meaning of § 401(a)(9)(C)?
A–17. (a)General rule.Iftheem-
ployee dies before his or her required be-
ginning date, the required minimum dis-
tributions for purposes of determining the
amount eligible for rollover with respect
to a nonspouse beneficiary are determined
under either the 5-year rule described in
§ 401(a)(9)(B)(ii) or the life expectancy
rule described in § 401(a)(9)(B)(iii). See
Q&A–4 of § 1.401(a)(9)–3 to determine
which rule applies to a particular desig-
nated beneficiary. Under either rule, no
amount is a required minimum distribution
January 29, 20073972007–5 I.R.B.

for the year in which the employee dies.
The rule in Q&A–7(b) of § 1.402(c)–2 (re-
lating to distributions before an employee
has attained age 70½) does not apply to
nonspouse beneficiaries.
(b)Five-year rule. Under the 5-year
rule described in § 401(a)(9)(B)(ii), no
amount is required to be distributed until
the fifth calendar year following the year
of the employee’s death. In that year, the
entire amount to which the beneficiary is
entitled under the plan must be distributed.
Thus, if the 5-year rule applies with re-
spect to a nonspouse beneficiary who is a
designated beneficiary within the meaning
of § 401(a)(9)(E), for the first 4 years after
the year the employee dies, no amount
payable to the beneficiary is ineligible
for direct rollover as a required minimum
distribution. Accordingly, the beneficiary
is permitted to directly roll over the bene-
ficiary’s entire benefit until the end of the
fourth year (but, as described in Q&A–19
of this notice, the 5-year rule must also
apply to the IRA to which the rollover
contribution is made). On or after Jan-
uary1ofthefifthyearfollowingtheyear
in which the employee died, no amount
payable to the beneficiary is eligible for
rollover.
(c)Life expectancy rule.(1)General
rule. If the life expectancy rule described
in § 401(a)(9)(B)(iii) applies, in the year
following the year of death and each
subsequent year, there is a required min-
imum distribution. See Q&A–5(c)(1) of
§ 1.401(a)(9)–5 to determine the applica-
ble distribution period for the nonspouse
beneficiary. The amount not eligible for
rollover includes all undistributed re-
quired minimum distributions for the year
in which the direct rollover occurs and any
prior year (even if the excise tax under
§ 4974 has been paid with respect to the
failure in the prior years). See the last
sentence of § 1.402(c)–2, Q&A–7(a).
(2)Special rule. If, under paragraph
(b) or (c) of Q&A–4 of § 1.401(a)(9)–3,
the 5-year rule applies, the nonspouse
designated beneficiary may determine
the required minimum distribution under
the plan using the life expectancy rule in
the case of a distribution made prior to
the end of the year following the year of
death. However, in order to use this rule,
the required minimum distributions under
the IRA to which the direct rollover is
made must be determined under the life
expectancy rule using the same designated
beneficiary.
Q–18. How is the required minimum
distribution with respect to a nonspouse
beneficiary determined if the employee
dies on or after his or her required begin-
ning date?
A–18. If an employee dies on or after
his or her required beginning date, within
the meaning of § 401(a)(9)(C), for the year
of the employee’s death, the required min-
imum distribution not eligible for rollover
is the same as the amount that would have
applied if the employee were still alive
and elected the direct rollover. For the
year after the year of the employee’s death
and subsequent years, see Q&A–5 of
§ 1.401(a)(9)–5 to determine the applica-
ble distribution period to use in calculating
the required minimum distribution. As in
the case of death before the employee’s
required beginning date, the amount not
eligible for rollover includes all undis-
tributed required minimum distributions
for the year in which the direct rollover
occurs and any prior year, including years
before the employee’s death.
Q–19. After a direct rollover by a
nonspouse designated beneficiary, how is
the required minimum distribution deter-
mined with respect to the IRA to which
the rollover contribution is made?
A–19. Under § 402(c)(11), an IRA
established to receive a direct rollover on
behalf of a nonspouse designated ben-
eficiary is treated as an inherited IRA
within the meaning of § 408(d)(3)(C).
The required minimum distribution re-
quirements set forth in § 401(a)(9)(B) and
the regulations thereunder apply to the
inherited IRA. The rules for determin-
ing the required minimum distributions
under the plan with respect to the non-
spouse beneficiary also apply under the
IRA. Thus, if the employee dies before
his or her required beginning date and the
5-year rule in § 401(a)(9)(B)(ii) applied
to the nonspouse designated beneficiary
under the plan making the direct rollover,
the 5-year rule applies for purposes of
determining required minimum distribu-
tionsundertheIRA.If the life expectancy
rule applied to the nonspouse designated
beneficiary under the plan, the required
minimum distribution under the IRA must
be determined using the same applicable
distribution period as would have been
used under the plan if the direct rollover
had not occurred. Similarly, if the em-
ployee dies on or after his or her required
beginning date, the required minimum dis-
tribution under the IRA for any year after
the year of death must be determined using
the same applicable distribution period as
would have been used under the plan if the
direct rollover had not occurred.
VI. SECTION 845 OF PPA ’06
Code § 402(l), which was added by
§ 845(a) of PPA ’06, provides for an
exclusion from gross income for dis-
tributions from certain retirement plans
(referred to in this notice as “Eligible
Government Plans”) used to pay qualified
health insurance premiums of an eligible
retired public safety officer. The exclu-
sion applies with respect to an eligible
retired public safety officer who elects to
have qualified health insurance premiums
deducted from amounts distributed from
an Eligible Government Plan and paid
directly to the insurer. Qualified health
insurance premiums include premiums for
accident and health insurance or qualified
long-term care insurance contracts for the
eligible retired public safety officer and
his or her spouse and dependents. The dis-
tribution is excluded from gross income to
the extent that the aggregate amount of the
distributions does not exceed the amount
used to pay the qualified health insurance
premiums of the eligible retired public
safety officer and his or her spouse and
dependents. An “Eligible Government
Plan” is a governmental plan described in
§ 414(d) that is either: a § 401(a), § 403(a),
or § 403(b) plan; or an eligible govern-
mental plan under § 457(b). Section 402(l)
applies to distributions in taxable years be-
ginning after December 31, 2006.
Q–20. Who is an eligible retired public
safety officer for purposes of the exclusion
under § 402(l)?
A–20. An employee is an eligible re-
tired public safety officer for purposes of
the exclusion under § 402(l) only if the
employee is an individual who separated
from service, either by reason of disabil-
ity or after attainment of normal retirement
age, as a public safety officer with the em-
ployer who maintains the Eligible Gov-
ernment Plan from which the distributions
to pay qualified health insurance premi-
ums are made. Thus, a public safety of-
ficer who retires before attainment of nor-
2007–5 I.R.B.398January 29, 2007

mal retirement age is not an eligible re-
tired public safety officer unless the pub-
lic safety officer retires by reason of dis-
ability. The terms of the Eligible Govern-
ment Plan from which the participant will
be receiving the distributions apply in de-
termining whether a public safety officer
has separated from service by reason of
disability or after attainment of normal re-
tirement age.
Q–21. Who is a public safety officer?
A–21. For purposes of § 402(l), the
term “public safety officer” means an in-
dividual serving a public agency in an
official capacity, with or without com-
pensation, as a law enforcement officer,
a firefighter, a chaplain, or as a member
of a rescue squad or ambulance crew.
See § 1204(9)(A) of the Omnibus Crime
Control and Safe Streets Act of 1968 (42
U.S.C. 3796b(9)(A)).
Q–22. Under what circumstances are
the provisions of § 402(l) available for el-
igible retired public safety officers?
A–22. The favorable tax treatment un-
der § 402(l) is available only when an el-
igible retired public safety officer elects
to have an amount subtracted from his or
her distributions from an Eligible Govern-
mentPlanandsuchamountisusedtopay
qualified health insurance premiums. The
employer sponsoring the Eligible Govern-
ment Plan is not required to offer such an
election.
Q–23. Can the accident or health plan
receiving the payments of qualified health
insurancepremiumsbeaself-insured
plan?
A–23. No. The accident or health plan
must be an accident or health insurance
plan. Thus, the plan must be providing
insurance issued by an insurance company
regulated by a State (including a managed
care organization that is treated as issuing
insurance).
Q–24. Will an eligible retired public
safety officer be entitled to favorable tax
treatment under § 402(l) with respect to
benefits attributable to service other than
as a public safety officer?
A–24. Yes. Benefits attributable to ser-
vice other than as a public safety officer are
eligible for favorable tax treatment under
§ 402(l), as long as the individual separates
from service as a public safety officer, by
reason of disability or after attainment of
normal retirement age, with the employer
maintaining the Eligible Government Plan.
Q–25. If an eligible retired public
safety officer dies, are amounts subtracted
from distributions made to the decedent’s
surviving spouse or dependents eligible
for favorable tax treatment under § 402(l)?
A–25. No. Section 402(l) provides
that the distribution is not includible in the
gross income of an employee who is an el-
igible retired public safety officer. Thus,
the exclusion would not extend to amounts
subtracted from distributions to other dis-
tributees.
Q–26. Is an eligible retired public
safety officer limited in the amount that
the officer can exclude from gross income
for distributions from an Eligible Gov-
ernment Plan used to pay qualified health
insurance premiums?
A–26. Yes. The aggregate amount that
is permitted to be excluded, with respect
to any taxable year, from an eligible re-
tired public safety officer’s gross income
by reason of § 402(l) is limited to $3,000.
For purposes of applying this $3,000 limi-
tation, distributions with respect to the el-
igible retired public safety officer that are
used to pay for qualified health insurance
premiums from all Eligible Government
Plans are aggregated.
Q–27. Are amounts used to pay quali-
fied health insurance premiums that are ex-
cluded from gross income under § 402(l)
taken into account for purposes of deter-
mining the itemized deduction for medical
care expenses under § 213?
A–27. No. Amounts used to pay quali-
fied health insurance premiums that are ex-
cluded from gross income under § 402(l)
are not taken into account in determining
the itemized deduction for medical care
expenses under § 213.
VII. SECTION 904 OF PPA ’06
Prior to the effective date of PPA ’06
§ 904, a defined contribution plan satis-
fied the minimum vesting requirements of
Code § 411(a) with respect to employer
nonelective contributions if it maintained
a 5-year vesting schedule or a 3 to 7 year
vesting schedule. Section 904 of PPA ’06
amended the minimum vesting require-
ments to require faster vesting of employer
nonelective contributions to a defined con-
tribution plan. Under Code § 411(a)(2)(B)
as amended by § 904 of PPA ’06, a defined
contribution plan satisfies the minimum
vesting requirements with respect to em-
ployer nonelective contributions if it has
a 3-year vesting schedule or a 2 to 6 year
vesting schedule. Code § 411(a)(2)(B) as
amended by § 904 of PPA ’06 generally
applies to contributions for plan years be-
ginning after December 31, 2006.
Q–28. If a plan amendment changes
the plan’s vesting schedule to satisfy Code
§ 411(a)(2)(B) as amended by § 904 of
PPA ’06, is the plan amendment required
to satisfy § 411(a)(10)?
A–28. Yes. A plan amendment
that changes the vesting schedule must
satisfy Code § 411(a)(10). Although
§ 411(a)(10)(B) would require a partic-
ipant with at least 3 years of service to
elect to have the nonforfeitable percentage
of his accrued benefit determined without
regard to the amendment, the plan must
ensure that any such election satisfies the
vesting requirements of § 411(a)(2)(B),
as amended by § 904 of PPA ’06. Thus,
such a participant must be provided, at
all times, a vesting percentage that is no
less than the minimum under a vesting
schedule that satisfies § 904 and the vest-
ing percentage determined under the plan
without regard to the amendment. Under
Temporary Regulation § 1.411(a)–8T, no
election need be provided for any par-
ticipant whose nonforfeitable percentage
under the plan, as amended, at any time
cannot be less than such percentage deter-
mined without regard to such amendment.
Q–29. Can a plan have separate vesting
schedules for employer nonelective contri-
butions that are and are not subject to Code
§ 411(a)(2)(B), as amended by § 904 of
PPA ’06?
A–29. Yes. A plan can have a vesting
schedule for employer nonelective con-
tributions for plan years beginning after
December 31, 2006, and another vesting
schedule for other employer nonelective
contributions under the plan, provided that
the plan separately accounts for the contri-
butions made under the vesting schedule
in effect prior to the first day of the first
plan year beginning after December 31,
2006, and the vesting schedule for em-
ployer nonelective contributions for plan
years beginning after December 31, 2006,
satisfies Code § 411(a)(2)(B), as amended
by § 904 of PPA ’06.
Q–30. If a plan maintains a bifurcated
vesting schedule, how is it determined
whether a contribution is for a plan year
beginning before January 1, 2007?
January 29, 20073992007–5 I.R.B.

A–30. A contribution is for a plan year
that begins before January 1, 2007, if it is
allocated under the terms of the plan as of
a date in that plan year and is not subject
to any conditions that have not been satis-
fied by the end of that plan year. This ap-
plies even if the contribution is not made
until the next plan year. Thus, for exam-
ple, if a plan with a calendar-year plan year
makes a contribution as of December 31,
2006, based on compensation and service
in 2006, and the contribution is not con-
tingent on the occurrence of an event af-
ter 2006, then the contribution is treated as
made for the 2006 plan year and is not sub-
ject to Code § 411(a)(2)(B), as amended
by § 904 of PPA ’06, even if it is not con-
tributed until 2007. Forfeitures and ESOP
allocations from a suspense account are
treated in the same manner for this pur-
pose.
VIII. SECTION 1102 OF PPA ’06
Section 1102 of PPA ’06 makes certain
changes to the notice requirements related
to distributions. Section 1102(a) provides
that a notice required to be provided un-
der § 402(f), § 411(a)(11), or § 417 may be
provided to a participant as much as 180
days before the annuitystarting date. Sec-
tion 1102(b) directs the Secretary to mod-
ify the regulations under § 411(a)(11) of
the Code and § 205 of ERISA to provide
that the description ofa participant’s right
to defer a distribution must also include
a description of the consequences of fail-
ing to defer receipt of a distribution. The
modifications made by § 1102 apply to
years beginning after December 31, 2006.
However, § 1102(b)(2)(B) provides that a
plan will not be treated as failing to meet
the new requirements under § 1102(b) if
the plan administrator makes a reasonable
attempt to comply with the new require-
ments under that section during the period
that is within 90 days of the issuance of
regulations required by § 1102(b).
Q–31. How does the effective date of
§1102operate?
A–31. The provisions of § 1102 ap-
ply to plan years that begin after Decem-
ber 31, 2006. This means that the new
rules relating to the content of the notices
apply only to notices issued in those plan
years, without regard to the annuity start-
ing date for the distributions. Similarly, the
180-day period for distributing notices ap-
plies to notices distributed in a plan year
that begins after December 31, 2006. This
change to the 180-day period also modi-
fies the definition of the maximum QJSA
explanation period under § 1.411(d)–3(g),
whichisusedinapplyingthetimingrules
for the effective date of a plan amendment
under the rules of § 1.411(d)–3(c) and (f) in
the case of an amendment that is adopted
in a plan year that begins after Decem-
ber 31, 2006.
Q–32. Is a plan required to revise the
notice under § 411 pursuant to the modifi-
cations made by § 1102(b) before the regu-
lations are amended to reflect the require-
ment?
A–32. Yes. A plan administrator is
required to revise the notice under § 411
to reflect the modifications to the require-
ments made by § 1102(b) for notices pro-
vided in plan years beginning after De-
cember 31, 2006. However, pursuant to
§ 1102(b)(2)(B) of PPA ’06, a plan will
not be treated as failing to meet the new
requirements under § 1102(b) if the plan
administrator makesa reasonable attempt
to comply with the new requirements un-
der that section in the case of a notice that
is provided prior to the 90th day after the
issuance of regulations reflecting the mod-
ifications required by § 1102(b).
Q–33. Is there a safe harbor available to
a plan administrator that would be consid-
ered a reasonable attempt to comply with
the requirement in § 1102(b)(1) that a de-
scription of a participant’s right to defer re-
ceipt of a distribution include a description
of the consequences of failing to defer?
A–33. Yes. A description that is writ-
ten in a manner reasonably calculated to
be understood by the average participant
and that includes the following informa-
tion is a reasonable attempt to comply with
the requirements of § 1102(b)(2)(B): (a)
in the case of a defined benefit plan, a
description of how much larger benefits
will be if the commencement of distribu-
tions is deferred; (b) in the case of a de-
fined contribution plan, a description in-
dicating the investment options available
under the plan (including fees) that will
be available if distributions are deferred;
and (c) the portion of the summary plan
description that contains any special rules
that might materially affect a participant’s
decision to defer. For purposes of clause
(a), a plan administrator can use a de-
scription that includes the financial effect
of deferring distributions, as described in
§ 1.417(a)(3)–1(d)(2)(i), based solely on
the normal form of benefit.
IX. SECTION 1201 OF PPA ’06
Section 1201(a) of PPA ’06 adds
§ 408(d)(8) to the Code, which is ap-
plicable to distributions made in taxable
years 2006 and 2007. Under § 408(d)(8),
generally, if a distribution from an IRA
owned by an individual after the individ-
ual has attained age 70½ is made directly
by the trustee to certain organizations
described in § 170(b)(1)(A), the distri-
bution is excluded from gross income.
The exclusion is only available to the ex-
tent that the distribution would otherwise
have been includible in gross income, and
§ 408(d)(8)(D) provides a special rule for
determining the amount that would oth-
erwise be includible in gross income. In
addition, the exclusion applies only if the
contribution would otherwise qualify for
a charitable contribution deduction under
§ 170 (without regard to the percentage
limitations of § 170(b)). A distribution
that is eligible for this exclusion is called
a qualified charitable distribution.
Q–34. Is there an overall limit on the
amount that may be excluded from gross
income for qualified charitable distribu-
tions that are made in a year?
A–34. Yes. The income exclusion
for qualified charitable distributions only
applies to the extent that the aggregate
amount of qualified charitable distribu-
tions made during any taxable year with
respect to an IRA owner does not exceed
$100,000. Thus, if an IRA owner main-
tains multiple IRAs in a taxable year, and
qualified charitable distributions are made
from more than one of these IRAs, the
maximum total amount that may be ex-
cluded for that year by the IRA owner is
$100,000. For married individuals filing
a joint return, the limit is $100,000 per
individual IRA owner.
Q–35. Is the exclusion for qualified
charitable distributions available for a dis-
tribution made to any organization eligible
to receive charitable contributions that are
deductible by the donor for income tax pur-
poses?
A–35. No. Qualified charitable distri-
butionsmaybemadetoanorganization
described in § 170(b)(1)(A), other than
supporting organizations described in
2007–5 I.R.B.400January 29, 2007

§ 509(a)(3) or donor advised funds that
are described in § 4966(d)(2).
Q–36. Is the exclusion for qualified
charitable distributionsavailable for distri-
butions from any type of IRA?
A–36. Generally, the exclusion for
qualified charitable distributions is avail-
able for distributions from any type of
IRA (including a Roth IRA described in
§ 408A and a deemed IRA described in
§ 408(q)) that is neither an ongoing SEP
IRA described in § 408(k) nor an ongoing
SIMPLE IRA described in § 408(p). For
this purpose, a SEP IRA or a SIMPLE IRA
is treated as ongoing if it is maintained un-
der an employer arrangement under which
an employer contribution is made for the
plan year ending with or within the IRA
owner’s taxable year in which the charita-
ble contributions would be made.
Q–37. Is the exclusion for qualified
charitable distributionsavailable for distri-
butions from an IRA maintained for a ben-
eficiary if the beneficiary has attained age
70½ before the distribution is made?
A–37. Yes. The exclusion from gross
income for qualified charitable distribu-
tions is available for distributions from an
IRA maintained for the benefit of a bene-
ficiary after the death of the IRA owner if
the beneficiary has attained age 70½ be-
fore the distribution is made.
Q–38. If a 2006 distribution satisfies all
the requirements under § 408(d)(8), but it
was made before August 17, 2006 (the date
PPA ’06 was enacted), is the amount dis-
tributed excludable as a qualified charita-
ble distribution?
A–38. Yes. Section 408(d)(8) is ap-
plicable to distributions made at any time
in 2006. Thus, a distribution made in
2006 that satisfies the requirements under
§ 408(d)(8) is a qualified charitable distri-
bution even if it was made before August
17, 2006.
Q–39. Is the amount of a qualified char-
itable distribution deductible as a charita-
ble contribution under § 170?
A–39. No. For purposes of determin-
ing the amount of charitable contributions
that may be deducted under § 170, quali-
fied charitable distributions which are ex-
cluded from income under § 408(d)(8) are
not taken into account. However, qualified
charitable distributions must still satisfy
the requirements to be deductible charita-
ble contributions under § 170 (other than
the percentage limits of § 170(b)), includ-
ing the substantiation requirements under
§ 170(f)(8).
Q–40. Is a qualified charitable distribu-
tion subject to withholding under § 3405?
A–40. No. A qualified charitable dis-
tribution is not subject to withholding
under § 3405 because an IRA owner that
requests such a distribution is deemed
to have elected out of withholding under
§ 3405(a)(2). For purposes of determin-
ing whether a distribution requested by
an IRA satisfies the requirements under
§ 408(d)(8), the IRA trustee, custodian, or
issuer may rely upon reasonable represen-
tations made by the IRA owner.
Q–41. Is a check from an IRA made
payable to a charitable organization de-
scribed in § 408(d)(8) and delivered by the
IRA owner to the charitable organization a
direct payment to such organization?
A–41. Yes. If a check from an IRA is
made payable to a charitable organization
described in § 408(d)(8) and delivered by
the IRA owner to the charitable organiza-
tion, the payment to the charitable organi-
zation will be considered a direct payment
by the IRA trustee to the charitable organ-
ization for purposes of § 408(d)(8)(B)(i).
Q–42. Will a qualified charitable dis-
tribution be taken into account in deter-
mining whether the required minimum
distribution requirements of §§ 408(a)(6),
408(b)(3), and 408A(c)(5) have been sat-
isfied?
A–42. Yes. The amount distributed
in a qualified charitable distribution is
an amount distributed from the IRA for
purposes of §§ 408(a)(6), 408(b)(3), and
408A(c)(5).
Q–43. What are the tax consequences
of a direct payment of an amount from
an IRA to a charity where the transaction
is intended to satisfy the requirements of
§ 408(d)(8) but fails to do so?
A–43. If an amount intended to be a
qualified charitable distribution is paid to
a charitable organization but fails to sat-
isfy the requirements of § 408(d)(8), the
amount paid is treated as (1) a distribution
from the IRA to the IRA owner that is in-
cludible in gross income under the rules
of § 408 or § 408A, as applicable; and
(2) a contribution from the IRA owner to
the charitable organization that is subject
to the rules under § 170 (including the per-
centage limits of § 170(b)).
Q–44. Will a distribution made directly
by the trustee to a § 170(b)(1)(A) organi-
zation (as permitted by § 408(d)(8)(B)(i))
be treated as a receipt by the IRA owner
under § 4975(d)(9)?
A–44. Yes. The Department of La-
bor, which has interpretive jurisdiction
with respect to § 4975(d), has advised
Treasury and the IRS that a distribution
made by an IRA trustee directly to a
§ 170(b)(1)(A) organization (as permit-
ted by § 408(d)(8)(B)(i)) will be treated
as a receipt by the IRA owner under
§ 4975(d)(9), and thus would not consti-
tute a prohibited transaction. This would
be true even if the individual for whose
benefit the IRA is maintained had an out-
standing pledge to the receiving charitable
organization.
DRAFTING INFORMATION
The principal author of this notice is
Angelique V. Carrington of the Employee
Plans, Tax Exempt and Government Enti-
ties Division. For further information re-
garding this notice, please contact the Em-
ployee Plans taxpayer assistance telephone
service at (877) 829–5500 (a toll-free num-
ber) between the hours of 8:30 am and
4:30 pm Eastern Time, Monday through
Friday. Ms. Carrington may be reached at
(202) 283–9888 (not a toll-free number).
Look-thru Rule for
Related Controlled Foreign
Corporations
Notice 2007–9
SECTION 1. OVERVIEW
This notice provides guidance under
section 954(c)(6) of the Internal Revenue
Code (Code) enacted by the Tax Increase
Prevention and Reconciliation Act of
2005 and amended by the Tax Relief and
Health Care Act of 2006. In general,
and subject to certain limitations, section
954(c)(6) provides that dividends, interest,
rents, and royalties received or accrued by
one controlled foreign corporation (CFC)
from another CFC which is a related per-
son shall not be treated as foreign personal
holding company income to the extent at-
tributable or properly allocable to income
of the related person which is neither
subpart F income nor income treated as
effectively connected with the conduct of
January 29, 20074012007–5 I.R.B.

a trade or business in the United States
(ECI). The provisions of section 954(c)(6)
apply to taxable years of foreign corpora-
tions beginning after December 31, 2005,
and before January 1, 2009, and to taxable
years of United States shareholders with
or within which such taxable years of the
foreign corporations end.
The Internal Revenue Service (IRS)
and the Treasury Department intend to
issue additional guidance concerning sec-
tion 954(c)(6). The IRS and the Treasury
Department expect to issue regulations
that incorporate the guidance provided in
this notice and in any subsequent guid-
ance.
SECTION 2. BACKGROUND
Section 951(a)(1) provides that if a for-
eign corporation is a CFC for an uninter-
rupted period of 30 days or more during
any taxable year, every person who is a
United States shareholder of such corpora-
tion and who owns stock in such corpora-
tion on the last day, in such year, on which
such corporation is a CFC shall include
in its gross income, for its taxable year
in which or with which such taxable year
of the corporation ends, itspro ratashare
of the corporation’s subpart F income for
such year.
Section 957(a) defines a CFC as any
foreign corporation if more than 50 per-
cent of the total combined voting power
of all classes of stock of such corporation
entitled to vote, or more than 50 percent
of the total value of the stock of such cor-
poration, is owned (within the meaning of
section 958(a)), or is considered as owned
by applying the rules of ownership of sec-
tion 958(b), by United States sharehold-
ers on any day during the taxable year of
such corporation. Section 951(b) defines
a United States shareholder as a United
States person who owns (within the mean-
ing of section 958(a)), or is considered as
owning by applying the rules of ownership
of section 958(b), 10 percent or more of the
total combined voting power of all classes
ofstockentitledtovoteofsuchforeign
corporation.
Section 952(a)(2) provides that subpart
F income includes foreign base company
income (FBCI). Subject to certain ex-
ceptions, section 954(a)(1) provides that
FBCI includes foreign personal holding
company income (FPHCI) for the taxable
year. Section 954(c)(1)(A) provides that
FPHCI includes dividends, interest, royal-
ties, rents, and annuities. Section 954(c)
also provides special rules and exceptions
to the definition of FPHCI (e.g., sections
954(c)(2) and (3)).
Section 103(b) of the Tax Increase Pre-
vention and Reconciliation Act of 2005
(TIPRA) (P.L. 109–222), enacted on May
17, 2006, added section 954(c)(6) to the
Code. Section 426(a) of Division A of the
Tax Relief and Health Care Act of 2006
(P.L. 109–432), enacted on December 20,
2006, made technicalcorrections to sec-
tion 954(c)(6).
Section 954(c)(6)(A) provides that for
purposes of section 954(c), dividends, in-
terest, rents, and royalties received or ac-
crued from a CFC which is a related per-
son shall not be treated as FPHCI to the ex-
tent attributable or properly allocable (de-
termined under rules similar to the rules
of subparagraphs (C) and (D) of section
904(d)(3)) to income of the related person
which is neither subpart F income nor ECI
(section 954(c)(6) exception). For this pur-
pose, interest includes factoring income
which is treated as income equivalent to in-
terest for purposes of section 954(c)(1)(E).
Section 954(c)(6)(A) also provides that the
Secretary shall prescribe such regulations
as may be necessary or appropriate to carry
out the provision, including regulations to
prevent the abuse of the purposes of the
provision.
Section 954(c)(6)(B) provides that sub-
paragraph (A) applies to taxable years of
foreign corporations beginning after De-
cember 31, 2005, and before January 1,
2009, and to taxable years of United States
shareholders with or within which such
taxable years of the foreign corporations
end.
For purposes of section 954(c)(6), a
related person has the meaning provided
in section 954(d)(3) and Treas. Reg.
§ 1.954–1(f). The CFCs must be related
persons only at the time the particular
dividend, interest, rent, or royalty in ques-
tion is received or accrued. The section
954(c)(6) exceptionis not elective, and so
applies to all covered transactions.
SECTION 3. DIVIDENDS
For purposes of section 954(c)(6), the
term “dividend” has the meaning provided
in section 316(a), including any amount
treated as a section 301(c)(1) distribution
as a result of a redemption described in ei-
ther section 302 or section 304. That term
also includes gains treated as dividends
pursuant to sections 964(e) and 356(a)(2).
If a CFC is an exchanging share-
holder and includes in income as a
deemed dividend the all earnings and
profits amount pursuant to Treas. Reg.
§ 1.367(b)–3(b)(3)(i), such inclusion is
not eligible for the section 954(c)(6) ex-
ception.
With respect to the types of dividends
above that are eligible for the section
954(c)(6) exception, the earnings and
profits of the distributing CFC need not be
accumulated during a period when it was
a CFC, or during a period when the CFC
receiving the dividend was a related per-
son. The key requirement in this regard is
that the relevant CFCs are related persons
at the time the dividend is received.
Dividends are not eligible for the sec-
tion 954(c)(6) exception to the extent they
are distributed out of earnings and profits
that are attributable to subpart F income
or income that is (or is treated as) ECI.
Because of the way the subpart F rules
operate, distributions of earnings from a
CFC to a related CFC typically will not be
attributable to subpart F income for pur-
poses of the section 954(c)(6) exception.
Such a distribution will be attributable ei-
ther to earnings and profits which are, or
have been, included in a United States
shareholder’s gross income under section
951(a) (i.e., previously taxed income) or,
to the extent the distributions are attrib-
utable to earnings and profits that are not
PTI, to income that is not subpart F in-
come. Dividends that are attributable to
income that is (or is treated as) ECI are
not eligible for the section 954(c)(6) ex-
ception.
SECTION 4. PARTNERSHIPS
If interest is received or accrued from a
partnership with one or more partners that
are CFCs, such interest will be treated as
received or accrued from a CFC for pur-
poses of section 954(c)(6) to the extent that
such CFC partner would be treated as the
payor of the interest under Treas. Reg.
§ 1.954–2(b)(4)(i)(B). Similarly, if rents
or royalties are received or accrued from
a partnership with one or more partners
that are CFCs, such rents or royalties will
2007–5 I.R.B.402January 29, 2007

be treated as received or accrued from a
CFC for purposes of section 954(c)(6) to
the extent that such CFC partner would be
treated as the payor of the rents or royalties
under Treas. Reg. § 1.954–2(b)(5)(i)(B).
If dividends, interest, rents, or royalties
are received by a partnership with one or
more partners that are CFCs, such amounts
will be treated as received or accrued by
a CFC for purposes of section 954(c)(6)
to the extent provided under Treas. Reg.
§§ 1.702–1(a)(8)(ii), 1.952–1(g), and
1.954–1(g), as applicable.
SECTION 5. ALLOCATION AND
ATTRIBUTION RULES FOR
INTEREST
This section applies for purposes of de-
termining the extent to which interest is at-
tributable or properly allocable to income
of the related person which is neither sub-
part F income nor ECI.
(a)Interest properly allocable or
apportionable to non-subpart F income
Interest is not eligible for the sec-
tion 954(c)(6) exception to the extent the
deduction for the interest payment is al-
located and apportioned under section
954(b)(5) and Treas. Reg. § 1.954–1(a)(4)
and (c) to reduce the related CFC payor’s
adjusted gross FBCI (as defined in Treas.
Reg. § 1.954–1(a)(3)), adjusted gross in-
surance income (as defined in Treas. Reg.
§ 1.954–1(a)(6)), or any other category
of income included in subpart F income
under section 952(a).
In general, interest that is allocated and
apportioned to income that is not sub-
part F income is eligible for the section
954(c)(6) exception (subject to the rules
below for ECI), even if interest deductions
exceed the gross income of the related
CFC payor in the year paid or accrued.
However, interest is not eligible for the
section 954(c)(6) exception to the extent
interest deductions create (or increase) a
deficit which under section 952(c) may
reduce the subpart F income of the related
CFC payor or another CFC.
(b)Interest properly allocable or
apportionable to non-ECI
Interest is not eligible for the sec-
tion 954(c)(6) exception to the extent
the deduction for the interest payment is
allocated and apportioned under section
882(c) and Treas. Reg. § 1.882–5, to gross
income of the related CFC payor that is
(or is treated as) ECI, or as expressly pro-
vided by or pursuant to a U.S. income tax
treaty or accompanying documents (such
as an exchange of notes), is allocated and
apportioned to gross income of the related
CFC payor that is attributable to a U.S.
permanent establishment.
This paragraph applies if, in a single
taxable year, the related CFC payor incurs
both interest expense that, but for the ap-
plication of section 5(b) of this notice, is
eligible for the section 954(c)(6) exception
(section 954(c)(6) interest expense), and
other interest expense. In such a case, the
amount of interest expense that is treated
as allocated and apportioned to gross in-
come of the related CFC payor that is (or
is treated as) ECI, or under an applicable
treaty, that is allocated and apportioned to
gross income of the related CFC payor that
is attributable to a U.S. permanent estab-
lishment, is the related CFC payor’s in-
terest expense for the taxable year multi-
plied by a fraction equal to the amount of
section 954(c)(6) interest expense over the
related CFC payor’s total interest expense
incurred during the taxable year.
Interest is not eligible for the section
954(c)(6) exception to the extent interest
deductions create (or increase) a net oper-
ating loss carryover that is effectively con-
nected with the conduct of a trade or busi-
ness within the United States (or that is at-
tributable to a permanent establishment, in
the context of an applicable U.S. income
tax treaty).
SECTION 6. ALLOCATION AND
ATTRIBUTION RULES FOR RENTS
AND ROYALTIES
This section applies for purposes of de-
termining the extent to which rents and
royalties are attributable or properly al-
locable to income of the related person
which is neither subpart F income nor ECI.
(a)Rents and royalties properly allocable
or apportionable to non-subpart F income
Rents and royalties are not eligible for
the section 954(c)(6) exception to the ex-
tent the deductions for the rent or royalty
payments are allocated and apportioned
under section 954(b)(5) and Treas. Reg.
§ 1.954–1(a)(4) and (c) to reduce the re-
lated CFC payor’s adjusted gross FBCI (as
defined in Treas. Reg. § 1.954–1(a)(3)),
adjusted gross insurance income (as de-
fined in Treas. Reg. § 1.954–1(a)(6)), or
any other category of income included in
subpart F income under section 952(a).
In general, rents and royalties that are
allocated and apportioned to income that
is not subpart F income are eligible for
the section 954(c)(6) exception (subject to
the rules below for ECI), even if deduc-
tions for such amounts exceed the gross
income of the related CFC payor in the
year paid or accrued. However, rents and
royalties are not eligible for the section
954(c)(6) exception to the extent deduc-
tions for such amounts create (or increase)
a deficit which under section 952(c) may
reduce the subpart F income of the related
CFC payor or another CFC.
(b)Rents and royalties properly allocable
or apportionable to non-ECI
Rents and royalties are not eligible for
the section 954(c)(6) exception to the ex-
tent the deductions for the rent or royalty
payments are allocated and apportioned
under section 882(c) and Treas. Reg.
§ 1.861–8, to gross income of the related
CFC payor that is (or is treated as) ECI.
Rents and royalties are not eligible for
the section 954(c)(6) exception to the ex-
tent deductions for such amounts create
(or increase) a net operating loss carry-
over that is effectively connected with the
conduct of a trade or business within the
United States.
SECTION 7. ANTI-ABUSE RULES
(a)Overview
In addition to the general grant of reg-
ulatory authority, section 954(c)(6)(A)
specifically grants the Secretary the au-
thority to prescribe regulations to pre-
vent the abuse of the purposes of section
954(c)(6). The transactions described be-
low are abusive of the purposes of section
954(c)(6). However, the IRS and the Trea-
sury Department do not intend this to be
an exclusive list of abusive transactions
and expect to provide further anti-abuse
rules in subsequent guidance. For exam-
ple, the IRS and the Treasury Department
January 29, 20074032007–5 I.R.B.

are considering a rule similar to the one
described in section 7(d) of this notice for
principal purpose domestic partnerships.
(b)Amounts that reduce the U.S. income
tax base, including factoring income
Transactions abuse the purposes of sec-
tion 954(c)(6) if they reduce income from
the U.S. income tax base by having the net
effect of creating a deduction of a payment,
accrual, or loss of a person subject to U.S.
tax without a corresponding inclusion in
the subpart F income of the CFC recipient,
where such inclusion would have resulted
in the absence of section 954(c)(6).
For purposes of section 954(c)(6), in-
terest includes factoring income which is
treated as income equivalent to interest for
purposes of section 954(c)(1)(E) and in-
terest described in section 864(d) (collec-
tively, factoring income). However, cer-
tain factoring income is not eligible for
the section 954(c)(6) exception. Any fac-
toring income derived from a transaction
which has the net effect of creating a de-
duction of a payment, accrual, or loss of
a person subject to U.S. tax without a cor-
responding inclusion in the subpart F in-
come of the CFC recipient, where such in-
clusion would have resulted in the absence
of section 954(c)(6), is not eligible for the
section 954(c)(6) exception. The follow-
ing example illustrates the application of
this paragraph:
Example.(i)Facts. USP, a domestic corporation,
owns 100% of the stock of CFC1 and CFC2. USP
sells inventory to CFC1 in exchange for receivables.
USP sells the CFC1 receivables to CFC2 at a dis-
count, and CFC2 generates income on the collection
of the CFC1 receivables.
(ii)Analysis. The income earned by CFC2 on the
collection of receivables is related person factoring
income as defined in section 864(d) and, therefore,
is treated as interest income received on a loan from
CFC2 to CFC1. However, because CFC2 acquired
the CFC1 receivables from USP at a discount, result-
ing in a current loss for USP, such interest income is
not eligible for the section 954(c)(6) exception.
(c)Avoidance of section 956
If a dividend reduces or eliminates
the applicable earnings of a CFC, within
the meaning of section 956(b)(1), such
that it reduces a U.S. shareholder’s in-
clusion pursuant to section 951(a)(1)(B),
the dividend is not eligible for the sec-
tion 954(c)(6) exception. See also Treas.
Reg. § 1.956–1T(b)(4). The following
example illustrates theapplication of this
paragraph:
Example.(i)Facts. USP, a domestic corporation,
owns 100% of the stock of CFC1 which, in turn, owns
100% of the stock of CFC2. At the beginning of Year
1, at a time when the stock of CFC2 has a value of
$300 and CFC2 has zero applicable earnings (within
the meaning of section 956(b)(1)), CFC2 loans $100
to USP in exchange for a note. During Year 1, CFC2
generates $100 of non-subpart F earnings and profits.
Shortly before the end of Year 1, CFC2 distributes
$100 to CFC1 that results in a $100 dividend to CFC1
and, as a result, CFC2 takes the position that it’s ap-
plicable earnings under section 956(b)(1) are reduced
from $100 to $0.
(ii)Analysis. TheUSPnoteheldbyCFC2is
United States property (within the meaning of section
956(c)(1)(C)), and CFC2 generated $100 of earnings
and profits during Year 1. As a result, USP would
have an income inclusion of $100 pursuant to section
951(a)(1)(B), but for the applicable earnings limita-
tion under section 956(b)(1). However, as a result
oftheYear1dividendCFC2paidtoCFC1,CFC2
does not have any applicable earnings and USP, there-
fore, would not have a section 951(a)(1)(B) inclusion.
Thus, the dividend income of CFC1 is not eligible for
the section 954(c)(6) exception.
(d)Use of options or similar interests
When the use of options or similar in-
terests causes a foreign corporation to be-
come a CFC payor, and a principal pur-
pose for the use of the options or similar
interests is to qualify dividends, interest,
rents, or royalties paid by the foreign cor-
poration for the section 954(c)(6) excep-
tion, the dividends, interest, rents, or royal-
ties received or accrued from such foreign
corporation will not be treated as being re-
ceived or accrued from a CFC payor and,
therefore, will not be eligible for the sec-
tion 954(c)(6) exception. For purposes of
this paragraph, an interest that is similar to
an option includes, but is not limited to, a
warrant, a convertible debt instrument, an
instrument other than debt that is convert-
ible into stock, a put, a stock interest sub-
ject to risk of forfeiture, and a contract to
acquire or sell stock.
(e)Change of character of income through
the use of a conduit entity
When a transaction changes the charac-
ter of the underlying income, is effected
through the use of a conduit entity, and a
principal purpose for the use of the con-
duit entity is to qualify the underlying in-
come for the section 954(c)(6) exception,
the dividends, interest, rents, or royalties
received or accrued will not be treated as
being received or accrued from a related
CFC and, therefore, will not be eligible for
the section 954(c)(6) exception. The fol-
lowing example illustrates the application
of this paragraph:
Example.(i)Facts. USP, a domestic corporation,
owns 100% of the stock of CFC1, a country Y cor-
poration, and CFC2, a country Z corporation. FC,
a country Z corporation, is not a CFC, but is a re-
lated person under section 954(d)(3). In year 1, FC
leases property from CFC1 for $100. USP causes
the rental payment to be made through CFC2. Thus,
CFC2 receives a payment from FC that is excluded
from FPHCI under section 954(c)(3)(A)(i). CFC2
then makes a payment to CFC1, in satisfaction of the
rent owed by FC, which is intended to qualify for the
section 954(c)(6) exception. A principal purpose for
the involvement of CFC2 in the transaction is to qual-
ify the rental payment from FC to CFC1 as eligible for
the section 954(c)(6) exception.
(ii)Analysis. If the rental payment had been
made directly from FC to CFC1, it would have been
included as FPHCI under section 954(c)(1)(A). By
causing the payment to be made through CFC2, USP
sought to convert the character of the income from
FPHCI to income excluded from FPHCI. However,
because a principal purpose of including CFC2 in
the transaction as a conduit entity was to avoid in-
clusion of the rental payment from FC to CFC1 as
FPHCI,thepaymentfromCFC2toCFC1willbe
treated as being made from FC to CFC1. Therefore,
the payment is not eligible for the section 954(c)(6)
exception.
SECTION 8. EFFECTIVE DATE
Sections 3, 4, 5, 6, 7(b) and 7(c) of this
notice are effective for taxable years of for-
eign corporations beginning after Decem-
ber 31, 2005. Sections 7(d) and 7(e) of this
notice are effective for taxable years of for-
eign corporations beginning after Decem-
ber 31, 2006.
SECTION 9. DRAFTING
INFORMATION
The principal author of this notice is
Paul J. Carlino of the Office of Associate
Chief Counsel (International). For further
information regarding this notice, contact
Mr. Carlino at (202) 622–3840 (not a toll-
free call).
Request for Comments
Comments may be submitted to
CC:PA:LPD:PR (Notice 2007–9), Room
5203, Internal Revenue Service, PO Box
7604, Washington, DC 20044. Submis-
sions may also be hand-delivered Monday
through Friday between the hours of 8 a.m.
and4p.m. totheCourier’sDeskat1111
2007–5 I.R.B.404January 29, 2007

Constitution Avenue, NW, Washington,
DC 20224, Attn: CC:PA:LPD:PR (No-
tice 2007–9) Room 5203. Submissions
may also be sent electronically via the
internet to the following email address:
Notice.comments@irscounsel.treas.gov.
Include the notice number (Notice
2007–9) in the subject line.
Communications Excise Tax;
Toll Telephone Service
Notice 2007–11
SECTION 1. PURPOSE
This notice amplifies, clarifies, and
modifies Notice 2006–50, 2006–25 I.R.B.
1141. That notice provides that the tax
imposedby§4251oftheInternalRev-
enue Code (relating to communications
excise tax) does not apply to amounts paid
for long distance service and bundled ser-
vice (collectively, nontaxable service) and
also provides that taxpayers may request a
credit or refund of tax on nontaxable ser-
vice that was billed to the taxpayer after
February 28, 2003, and before August 1,
2006, only on their 2006 federal income
tax returns. This notice—
(a) Provides the conditions under which
individual taxpayers may use the standard
amounts announced in IR–2006–137 (Au-
gust 31, 2006) on their 2006 federal in-
come tax returns to request a credit or re-
fund of the excise tax paid on nontaxable
service;
(b) Provides guidance regarding the
Business and Nonprofit Estimation
Method, announced in IR–2006–179
(November 16, 2006);
(c) Answers questions that have
been raised since the issuance of No-
tice 2006–50; and
(d) Modifies the requirement for claims
filed on or before May 25, 2006.
SECTION 2. BACKGROUND
For the statutory background of the tax
imposedby§4251,seesection2ofNo-
tice 2006–50. When used in this notice,
local-only service,long distance service,
andnontaxable servicehave the meaning
giventothetermsinsection3ofNotice
2006–50.Bundled servicehas the mean-
ing given to the term by section 5 of this
notice.
SECTION 3. STANDARD AMOUNT
(a)Conditions to allowance of standard
amount. A request for credit or refund of
the standard amount, instead of the actual
amount of federal communications excise
tax paid for nontaxable service, may be
made on a 2006 Form 1040 Series,U.S. In-
dividual Income Tax Return, if any person
filing the return, or any dependent listed on
the return—
(1) Paid for any nontaxable service
(other than for a prepaid telephone card or
prepaid cellular telephone) that was billed
to the taxpayer after February 28, 2003,
and before August 1, 2006;
(2) Paid all federal communications ex-
cise taxes billed by their telecommunica-
tions provider after February 28, 2003, and
before August 1, 2006;
(3) Has not received a credit or refund
of these taxes from the telecommunica-
tions provider;
(4) Has not requested a credit or refund
from the telecommunications provider or,
if so requested, has withdrawn any such
request; and
(5) Did not file any other claim or re-
quest for credit or refund with the IRS for
the federal communications excise tax for
a period after February 28, 2003.
(b)Calculating standard amounts—(1)
In general—(i)2006 Form 1040 Series
(other than EZ). To determine the standard
amount, taxpayers must first determine
the number of exemptions for which they
are entitled on their 2006 Form 1040 Se-
ries federal income tax return (other than
the 2006 Form 1040 EZ). The Instruc-
tions to the 2006 Form 1040 Series federal
income tax return and Publication 501,
Exemptions, Standard Deduction, and
Filing Information, provide guidance on
determining the correct number of exemp-
tions. Once the individual determines the
number of exemptions, the individual can
select the appropriate standard amount
based upon the number of those exemp-
tions. Individuals should refer to the 2006
federal income tax return instructions to
ensure that the standard amount is entered
on the appropriate part of the return.
(ii)2006 Form 1040 EZ.Online5,a
taxpayer that checks the box for “you” is
treated as having one exemption. A tax-
payer that checks the boxes for “you” and
“spouse” is treated as having two exemp-
tions.
(2)Amounts—(i) For each 2006 Form
1040 Series federal income tax return filed
showing one exemption for purposes of
determining the standard amount, the stan-
dard amount allowed on that return is $30.
(ii) For each 2006 Form 1040 Series
federal income tax return filed showing
two exemptions for purposes of deter-
mining the standard amount, the standard
amount allowed on that return is $40.
(iii) For each 2006 Form 1040 Series
federal income tax return filed showing
three exemptions for purposes of deter-
mining the standard amount, the standard
amount allowed on that return is $50.
(iv) For each 2006 Form 1040 Series
federal income tax return filed showing
four or more exemptions for purposes of
determining the standard amount, the stan-
dard amount allowed on that return is $60.
(c)Interest. The standard amount rep-
resents both the overpayment of the fed-
eral communications excise tax paid on
nontaxable service and the interest on that
overpayment.
(d)Actual Amounts. To request a credit
or refund for the actual amount of federal
communications excise tax paid, taxpayers
must complete Form 8913,Credit for Fed-
eral Telephone Excise Tax Paid, and attach
that form to their 2006 Form 1040 Series
federal income tax return.
(e)Examples. The following examples
illustrate the application of this section.
Example 1. A, an individual, files a joint return
with Z, A’s spouse. A meets the conditions to al-
lowance described in paragraph (a) of this section. A
used the 2006 federal income tax return instructions
to determine that their correct number of exemptions
is two. A may request the credit or refund of the fed-
eral communications excise tax under § 4251 for $40.
Example 2. B, an individual, used the 2006 fed-
eral income tax return instructions to determine that
she had one exemption. B further used her telephone
bills for the period March 1, 2003, through July 31,
2006, to determine that the total amount paid for fed-
eral communications excise tax under § 4251 for non-
taxable service to all telecommunications providers
was $45. Completing Form 8913 and attaching it to
her 2006 Form 1040 Series federal income tax return,
B may request a credit or refund of $45, the actual
amount she paid in federal communications excise
tax on nontaxable service under § 4251. As an alter-
native, B may request a credit or refund of the stan-
dard amount of $30 without having to complete Form
8913.
January 29, 20074052007–5 I.R.B.

SECTION 4. DISTINCTION BETWEEN
LOCAL-ONLY SERVICE AND
BUNDLED SERVICE
(a)Technology for transmitting tele-
phone call. The method for sending or
receiving a call, such as on a landline
telephone, wireless (cellular) telephone
or some other method, does not affect
whether a service is local-only or bundled.
(b)Combined local exchanges.Iftwo
or more telecommunications providers
combine their resources to expand the ge-
ographic area that each treats as “local”
service and each bills its customers for
that service as local-only service, then that
service is local-only service.
(c)Billing method.Section3(a)ofNo-
tice 2006–50 and section 5 of this no-
tice provide that bundled service is lo-
cal and long distance service provided un-
der a plan that does not separately state
the charge for the local telephone service.
Thus, if local and long distance service
is billed to a customer on a single bill
but the telecommunications company sep-
arately states the amount paid for local-
only service and the amount paid for long
distance service, the amount paid for lo-
cal-only service is subject to federal com-
munications excise tax.
(d)Examples. The following examples
illustrate the application of this section.
Example 1. Customer A purchases telecom-
munications service from B, a telecommunications
provider. Such service includes both local-only ser-
vice and long distance service. B’s bill to A states
$X for telecommunications service. The bill does not
separately state a charge for either local-only service
or long distance service. Since the bill does not
separately state the charge for local-only service, the
service is a bundled service. Thus, the entire amount
of A’s telecommunications service is bundled service
and thus nontaxable service.
Example 2. Customer C purchases telecom-
munications service from D, a telecommunications
provider. Such service includes both local-only ser-
vice and long distance service. D’s bill to C states
$X amount for telecommunications service. The
bill further states $Y amount for local-only service
and $Z amount for long distance service. Since the
charges for local-only service and long distance ser-
vice are separately stated,the service is not bundled
service. Accordingly, only the amounts charged for
long distance service are for nontaxable service; tax
is imposed on the amounts paid for the local-only
service.
SECTION 5. CLARIFICATION OF
DEFINITION OF BUNDLED SERVICE
(a)Present definition. Section 3(a) of
Notice 2006–50 defines bundled ser-
vice as local and long distance service
provided under a planthat does not sep-
arately state the charge for the local
telephone service. Bundled service in-
cludes, for example, Voice over Inter-
net Protocol service, prepaid telephone
cards, and plans that provide both lo-
cal and long distance service for either a
flat monthly fee or a charge that varies
with the elapsed transmission time for
which the service is used. Telecommu-
nications companies provide bundled
service for both landline and wireless
(cellular) service.
(b)Reason for clarification.Theex-
ample in the second sentence of the def-
inition of bundled service incorrectly as-
sumes that all Voice over Internet Proto-
col (VoIP) service would provide both lo-
cal and long distance service and that the
charges for the two services would not be
separately stated. As noted in section 4(a)
of this notice, the method of transmitting a
call is not a factor in determining whether
a service is local-only or bundled. Ac-
cordingly, a VoIP service that provides lo-
cal-only service is treated as local-only ser-
vice.
(c)Revised definition. Accordingly, the
definition of bundled service is clarified to
read as follows:
Bundled service is local and long dis-
tance service provided under a plan
that does not separately state the charge
for the local telephone service. Bun-
dled service includes plans that provide
both local and long distance service for
either a flat monthly fee or a charge
that varies with the elapsed transmis-
sion time for which the service is used.
Telecommunications companies pro-
vide bundled service for both landline
and wireless (cellular) service. If Voice
over Internet Protocol service provides
both local and long distance service and
the charges are not separately stated,
such service is bundled service.
SECTION 6. PREPAID TELEPHONE
CARDS (PTC)
(a)In general—(1)Prepaid telephone
cards. Section 4251(d) and § 49.4251–4
of the Facilities and Services Excise Taxes
Regulations provide rules for prepaid tele-
phone cards (PTC). Section 49.4251–4(b)
defines PTC as a card or similar arrange-
ment that permits its holder to obtain a
fixed amount of communications services
by means of a code (such as a personal
identification number (PIN)) or other ac-
cess device provided by the carrier and to
pay for those services in advance. The
amount paid for PTCs is determined un-
der the rules of §§ 4251(d)(1) and (2) and
§ 49.4251–4(c). Under this notice, the
PTC will be treated as nontaxable service
unless a PTC expressly states it is for lo-
cal-only service.
(2)Other cards. This section does
not address cards that permit the holder
to purchase various services in addition
to telecommunications services. Such
services include, but are not limited to,
ring tone downloads, music downloads,
text messaging, picture messaging, web
browsing, game downloads, or screen
saver downloads.
(b)Application of the tax—(1)Defi-
nitions. Section 49.4251–4(b) provides
that—
(i)Carriermeans a telecommunica-
tions carrier as defined in 47 U.S.C. 153.
(ii)Holdermeans a person that pur-
chases other than for resale.
(iii)Transfereemeans the first person
that is not a carrier to whom a PTC is trans-
ferred by a carrier.
(2)Imposition, liability, and collection.
Section 4251(d) provides that the § 4251
tax is imposed on the transfer of a PTC to
a transferee; § 49.4251–4(d)(1) provides
that the person liable for the tax is the
transferee and that the person responsi-
ble for collecting the tax generally is the
carrier transferring the PTC to the trans-
feree. Section 49.4251–4(d)(1) further
provides that if a holder purchases a PTC
from a transferee reseller, the amount the
holder pays for the PTC is not treated as
an amount paid for communications ser-
vices and thus tax is not imposed on that
payment.
(c)Person eligible to request credit or
refund. The transferee is the person liable
for the tax paid on a PTC and thus gener-
ally is the person eligible to request a credit
or refund of the tax it paid. The carrier is
eligible to request a credit or refund only
if it meets the conditions of section 5(d)(4)
of Notice 2006–50. The holder is not li-
2007–5 I.R.B.406January 29, 2007

able for the tax and thus cannot request a
credit or refund.
SECTION 7. PREPAID CELLULAR
TELEPHONES
(a)In general—(1)Prepaid cellular
telephones. Certain telecommunications
providers offer wireless (cellular) telecom-
munications service on a prepaid service
basis (prepaid telephones) whereby a cus-
tomer purchases the cellular telephone
with a set number of minutes available
for telecommunications. When the cus-
tomer exhausts the number of minutes on
the prepaid telephone, the customer may
purchase additional minutes. The cus-
tomer does not enter into a contract with
the telecommunications provider; there
are no service charges after the additional
purchase and no monthly bills. Under
this notice, the prepaid telephone will be
treated as nontaxable service unless the
terms of the prepaid telephone service
expressly state it is for local-only service.
(2)Other prepaid cellular telephones.
This section does not address arrange-
ments that permit the holder to purchase
various services in addition to telecommu-
nications services. Such services include,
but are not limited to, ring tone down-
loads, music downloads, text messaging,
picture messaging, web browsing, game
downloads, or screen saver downloads.
(b)Application of the tax.Rulessim-
ilar to the rules for PTCs, as described in
section 6 of this notice, apply to prepaid
telephones. Thus, the person liable for
tax is the person (transferee) that buys the
prepaid telephone from the telecommuni-
cations provider (carrier) and the carrier
is responsible for collecting the tax. Any
holder of a prepaid telephone (that is, a per-
son that buys the prepaid telephone other
than for resale) is not liable for tax.
(c)Person eligible to request credit or
refund. The transferee is the person liable
for the tax paid on a prepaid telephone and
thus generally is the person eligible to re-
quest a credit or refund of the tax it paid.
The carrier is eligible to request a credit
or refund only if it meets the conditions
of section 5(d)(4) of Notice 2006–50. The
holder is not liable for the tax and thus can-
not request a credit or refund.
SECTION 8. CHARGES IN
CONNECTION WITH LOCAL-ONLY
SERVICE
(a)Background. Section3(b)ofNo-
tice 2006–50 defines local-only service
as including certain services and facilities
provided in connection with local tele-
phone service, even though these services
mayalsobeusedinconnectionwithlong
distance service. As examples, the no-
tice cites to Rev. Rul. 72–537, 1972–2
C.B. 574 (telephone amplifier), Rev. Rul.
73–171, 1973–1 C.B. 445 (automatic call
distributing equipment), and Rev. Rul.
73–269, 1973–1 C.B. 444 (special tele-
phone).
(b)Subscriber line charges. In addi-
tion to the examples in paragraph (a) of
this section, amounts paid for subscriber
line charges, which are described in Rev.
Rul. 87–108, 1987–2 C.B. 260, are also
amounts paid for local telephone service.
This charge may appear on a bill as “Fed-
eral Access Charge,” “Customer or Sub-
scriber Line Charge,” or “Interstate Access
Charge.”
(c)Universal service fees—(1)Back-
ground. All telecommunications compa-
nies that provide interstate and interna-
tional telecommunications service con-
tribute to the federal Universal Service
Fund (USF). Their contributions support
four Universal Service programs estab-
lished and overseen by the Federal Com-
munications Commission (FCC). Some
telecommunications companies recover
their contribution to the USF directly
from their customers by billing them for
this charge. The FCC does not require
companies to pass on these costs to their
customers. Each company makes a busi-
ness decision about whether and how to
recover USF costs. A company that sepa-
rately states this charge on a bill may call
it a “Federal Universal Service Fee” or
“Universal Connectivity Fee.”
(2)Application. Because telecommu-
nications providers charge the USF to
their customers in connection with their
customers’ long distance service, amounts
paid for separately stated USF amounts are
not amounts paid forlocal-only service.
SECTION 9. PERSON TO MAKE
REQUEST IF TAXPAYER IS
NO LONGER IN BUSINESS OR
DECEASED
Neither Notice 2006–50 nor this notice
create any special rules regarding the per-
son to request a credit or refund of tax for
a taxpayer that no longer exists or is de-
ceased. The same rules that apply to re-
quests for credits or refunds of other fed-
eral taxes also apply to similar requests of
the tax imposed under § 4251. These rules
depend upon the facts and circumstances
relating to the reasons that the taxpayer no
longer exists. The Form 8913 Instructions
and Publication 559,Survivors, Executors,
and Administrators, provide general guid-
ance for taxpayers regarding deceased tax-
payers.
SECTION 10. EFFECT OF NOTICE
2006–50 ON STATE AND LOCAL
TELECOMMUNICATIONS TAXES
Neither Notice 2006–50 nor this notice
affect the ability of state or local govern-
ments to impose or collect telecommuni-
cation taxes under the respective statutes
of those governments.
SECTION 11. NO OBLIGATION
OF TELECOMMUNICATIONS
PROVIDERS TO SUPPLY RECORDS
TO CUSTOMERS
The IRS has been asked to require
telecommunications providers to supply
their customers with those customers’
telecommunications bills for periods after
February 28, 2003, and before August
1, 2006. Neither Notice 2006–50 nor
this notice requires telecommunications
providers to supply billing records to their
customers.
SECTION 12. BUSINESS AND
NONPROFIT ESTIMATION METHOD
(a)In general. This section provides
rules for the Business and Nonprofit Esti-
mation Method (EM) that eligible entities
may use to determine the amount of their
credit or refund for nontaxable service. El-
igible entities may, but are not required to,
use the EM instead of the actual amount
of federal communications excise tax they
paid on nontaxable service to calculate the
amount of their credit or refund.
January 29, 20074072007–5 I.R.B.

(b)Definitions. The following defini-
tions apply to this section.
(1)Eligible entitymeans—
(i) Any—
(A) Business entity (including a corpo-
ration or partnership);
(B) Trust or estate;
(C) Tax-exempt organization; and
(D) Individual owner of rental property
and any self-employed individual (includ-
ing an independent contractor, sole propri-
etor, or farmer) but only if the individual
(including a married couple filing a joint
return) reports gross rental and business in-
come totaling more than $25,000 on his or
her 2006 federal income tax return;
(ii) That was in operation during any
time from March 1, 2003 through July 31,
2006; and
(iii) That received and paid for telecom-
munications service that was reflected on
bills dated in April 2006 and September
2006.
(2)Total telephone expensesmeans all
amounts paid to every telecommunications
provider used by the eligible entity for tele-
phone service that werebilled after Febru-
ary 28, 2003, and before August 1, 2006.
These amounts include, but are not lim-
ited to, amounts paid for long distance ser-
vice, local-only service, bundled service,
900 number service, universal service fees,
federal, state, and local taxes. If an eligible
entity is billed for telephone and non-tele-
phone services on one bill each month and
does not separately track non-telephone
services in its books and records, the en-
tire amount of that bill is included in to-
tal telephone expenses. An eligible en-
tity may determine the amount of its to-
tal telephone expenses by examining its
books and records, including, for example,
its general ledger, check register, and can-
celed checks.
(3)Employeemeans any person work-
ing for the taxpayer full or part time as re-
ported on the eligible entity’s Form 941,
Employer’s Quarterly Federal Tax Return,
for the 2
nd
quarter of 2006, other than
any person employed as a household em-
ployee, in a non-pay status, on a pension,
or an active member of the Armed Forces.
(c)Using the EM to determine the
amount of the credit or refund—(1)De-
termining the federal excise tax as a
percentage of the telephone bill—(i) First,
determine the amount of federal commu-
nications excise tax on all telephone bills
dated in April 2006 and all telephone bills
dated in September 2006. The amount is
generally separately stated on the bill as
“FET” or “federal tax”.
(ii) Next, for all the April telephone
bills and all the September telephone bills,
divide the amount of federal communica-
tions excise tax included on the bills by
the total telephone expenses on the bills.
The resulting amounts are the April and
September percentages, respectively.
(iii) Next, subtractthe September per-
centage from the April percentage. For
purposes of this notice, this amount is the
federal excise tax percentage (FETP).
(2)Capping the FETP—(i) Determine
the number of employees.
(ii) For taxpayers with 250 or fewer em-
ployees, the FETP is capped at 2 percent.
(iii) For taxpayers with more than 250
employees, the FETP is capped at 1 per-
cent.
(d)Calculating the amount of the credit
or refund—(1)Records kept on a monthly
basis. If the entity has maintained its tele-
phone expense records on a monthly ba-
sis, multiply the FETP amount by the tax-
payer’s monthly total telephone expenses
for each month of the 41 month period
from March 2003 through July 2006. The
product of this calculation is the taxpayer’s
credit or refund amount.
(2)Records kept on an annual basis.
If the entity has maintained its telephone
expense records on an annual basis rather
than a monthly basis, prorate its annual
amount equally to each month of that year.
Thus, for example, a taxpayer maintaining
annual telephone expense records for 2003
would divide its total telephone expenses
by 12. Next, the taxpayer would use that
monthly amount to complete the calcula-
tions for the credit or refund amount for
2003.
(e)Actual Amounts.UseoftheEMis
optional. Taxpayers may use the actual
amounts paid for federal communications
excise tax for nontaxable service to deter-
mine the amount of their credit or refund.
(f)Examples. The following examples
illustrate the application of this section.
Example 1—(i)Facts. Business A has 250 em-
ployees. A’s April 2006 telephone bill is $1,700, in-
cluding federal communications excise tax of $47.60.
A’s September 2006 telephone bill is $1,600, includ-
ing federal communications excise tax of $24.00. A’s
total telephone expenses, for which it does not have
monthly records, are as follows:
2003 — $10,800.00
2004 — $16,000.00
2005 — $20,000.00
2006 — $20,571.37.
(ii)Determining the April and September percent-
ages. A’s April percentage is 2.8 percent (47.60 ÷
1,700). A’s September percentage is 1.5 percent (24
÷ 1,600).
(iii)Determining the FETP. The difference be-
tween A’s April percentage and September percent-
age is 1.3 percent (2.8 - 1.5). Thus, the FETP is 1.3
percent.
(iv)Capping the FETP. Because A’s number of
employees does not exceed 250, A’s FETP is not
capped at 1 percent.
(v)Prorating. Because A did not maintain its
total telephone expense records by month, it prorates
those amounts equally to each month within the
March 2003 — July 2006 period for each particular
year. For 2003, A divides its total telephone expense
of $10,800 by 12 and multiplies that result by 10 (the
number of months between March and December).
([10,800 ÷ 12] x 10 = 9,000.) For 2006, A divides
its total telephone expense of $20,571.37 by 12 and
multiplies that result by 7 (the number of months
between January and July). ([20,571.37 ÷ 12] x 7 =
12,000.)
(vi)Calculating the amount of the credit or re-
fund. Using the EM, the amount of A’s credit or re-
fund is calculated as follows:
2003: $9,000 x .013 = $117 (117÷10 = 11.7)
Monthly amount $11.70
2004: $16,000 x .013 = $208 (208÷12 = 17.33)
Monthly amount $17.33
2005: $20,000 x .013 = $260 (260÷12 = 21.67)
Monthly amount $21.67
2006: $12,000 x .013 = $156 (156÷7 = 22.29)
Monthly amount $22.29
(vii)Reporting the credit or refund amounts on
Form 8913—(A) Because the credit or refund pe-
riod does not align with the calendar quarters, Form
8913 requires taxpayers to report the credit or re-
fund amounts in 13 three-month intervals and one
two-month interval. Thus, A would report credit or
refund amounts on Form 8913 as follows:
March,April,May2003—$35.10(11.70x3=
35.10)
June, July, August 2003 — $35.10 (11.70 x 3 =
35.10)
September, October, November 2003 — $35.10
(11.70 x 3 = 35.10)
December 2003, January, February 2004 —
$46.36 (11.70 + [17.33 x 2] = 46.36)
March, April, May 2004 — $51.99 (17.33 x 3 =
51.99)
June,July,August2004—$51.99(17.33x3=
51.99)
September, October, November 2004 — $51.99
(17.33 x 3 = 51.99)
December 2004, January, February 2005 —
$60.67 (17.33 + [21.67 x 2] = 60.67)
March, April, May 2005 — $65.01 (21.67 x 3 =
65.01)
June,July,August2005—$65.01(21.67x3=
65.01)
September, October, November 2005 — $65.01
(21.67 x 3 = 65.01)
December 2005, January, February 2006 —
$66.25 (21.67 + [22.29 x 2] = 66.25)
2007–5 I.R.B.408January 29, 2007

March, April, May 2006 — $66.87 (22.29 x 3 =
66.87)
June, July 2006 — $44.58 (22.29 x 2 = 44.58)
(B) After determining the amount of credit or re-
fund using the EM, A reports the amounts on Form
8913, and attaches the Form 8913 to A’s 2006 federal
income tax return.
Example 2. The same facts asExample 1except
that A has 500 employees. A’s FETP is capped at 1
percent. Thus, A must make the same calculation as
inExample 1to determine the proper amount of A’s
credit or refund of federal communications excise tax
using the FETP of 1 percent, rather than 1.3 percent.
SECTION 13. FORM 1040EZ–T,
REQUEST FOR REFUND OF
FEDERAL TELEPHONE EXCISE TAX
Individuals who do not have to file a
federal income tax return and who meet
the conditions for requesting a refund of
the federal communications excise tax
may file Form 1040EZ–T to request the
refund. Individuals requesting a refund
of actual amounts of federal communica-
tions excise tax paid must complete Form
8913 and attach that form to the Form
1040EZ–T.
SECTION 14. MODIFICATION OF
PROVISION REGARDING REQUESTS
FOR CREDIT OR REFUND
(a)Present requirement. Section 5(g) of
Notice 2006–50 provides as follows:
Requests that do not follow the pro-
visions of this notice. Requests that do
not follow the provisions of this notice
(whether filed before or after its publi-
cation)—
(1) Will not be processed to the
extent they relate to the tax paid on
nontaxable service that was billed after
February 28, 2003; and
(2) Will be processed normally to the
extent they relate to the tax paid on non-
taxable service that was billed before
March 1, 2003.
(b)Reason for modification.Manyof
the pending refund claims that were filed
on or before May 25, 2006, include re-
fund claims for nontaxable service that
was billed before March 1, 2003, and after
February 28, 2003. In the interest of sound
tax administration and efficiency, the IRS
will process all claims for credit or refund
that were filed on or before May 25, 2006.
(c)Revised requirement. Accordingly,
section 5(g) of Notice 2006–50 is modified
to read as follows:
(1) Requests that do not follow the
provisions of Notice 2006–50 and that
were filed on or before May 25, 2006,
will be processed normally.
(2) Requests that were filed on or af-
ter May 26, 2006, and do not follow the
provisions of Notice 2006–50, will not
be processed to the extent they relate to
the tax paid on nontaxable service that
was billed after February 28, 2003.
SECTION 15. EFFECT ON OTHER
DOCUMENTS
Notice 2006–50 is amplified, clarified,
and modified.
SECTION 16. DRAFTING
INFORMATION
The principal author of this notice is
Barbara B. Franklin of the Office of the
Associate Chief Counsel (Passthroughs
and Special Industries). For further in-
formation regarding this notice, contact
202–622–3130 (not a toll-free number).
Weighted Average Interest
Rates Update
Notice 2007–12
This notice provides guidance as to the
corporate bond weighted average interest
rate and the permissible range of interest
rates specified under §412(b)(5)(B)(ii)(II)
of the Internal Revenue Code. In addi-
tion, it provides guidance as to the interest
rate on 30-year Treasury securities under
§ 417(e)(3)(A)(ii)(II).
CORPORATE BOND WEIGHTED
AVERAGE INTEREST RATE
Sections 412(b)(5)(B)(ii) and 412(l)(7)
(C)(i), as amended by the Pension Funding
EquityActof2004andbythePensionPro-
tection Act of 2006, provide that the inter-
est rates used to calculate current liability
and to determine the required contribution
under § 412(l) for plan years beginning in
2004 through 2007 must be within a per-
missible range based on the weighted av-
erage of the rates of interest on amounts
invested conservativelyinlongtermin-
vestment grade corporate bonds during the
4-year period ending on the last day before
the beginning of the plan year.
Notice 2004–34, 2004–1 C.B. 848, pro-
vides guidelines for determining the cor-
porate bond weighted average interest rate
and the resulting permissible range of in-
terest rates used to calculate current liabil-
ity. That notice establishes that the corpo-
rate bond weighted average is based on the
monthly composite corporate bond rate de-
rived from designated corporate bond in-
dices. The methodology for determining
the monthly composite corporate bond rate
as set forth in Notice 2004–34 continues to
apply in determining that rate. See Notice
2006–75, 2006–36 I.R.B. 366.
The composite corporate bond rate for
December 2006 is 5.75 percent. Pursuant
to Notice 2004–34, the Service has de-
termined this rate as the average of the
monthly yields for the included corporate
bond indices for that month.
The following corporate bond weighted
average interest rate was determined for
plan years beginning in the month shown
below.
For Plan Years
Corporate
Bond90% to 110%
Beginning in:WeightedPermissible
MonthYearAverageRange
January20075.785.21 to 5.78
January 29, 20074092007–5 I.R.B.

30-YEAR TREASURY SECURITIES
INTEREST RATE
Section 417(e)(3)(A)(ii)(II) defines
the applicable interest rate, which must
be used for purposes of determining the
minimum present value of a participant’s
benefit under § 417(e)(1) and (2), as the
annual rate of interest on 30-year Treasury
securities for the month before the date
of distribution or such other time as the
Secretary may by regulations prescribe.
Section 1.417(e)–1(d)(3) of the Income
Tax Regulations provides that the applica-
ble interest rate for a month is the annual
interest rate on 30-year Treasury securi-
ties as specified by the Commissioner for
that month in revenue rulings, notices or
other guidance published in the Internal
Revenue Bulletin.
The rate of interest on 30-year Treasury
securities for December 2006 is 4.68 per-
cent. The Service has determined this rate
as the monthly average of the daily deter-
mination of yield on the 30-year Treasury
bond maturing in February 2036.
Drafting Information
The principal authors of this notice are
Paul Stern and Tony Montanaro of the Em-
ployee Plans, Tax Exempt and Govern-
ment Entities Division. For further infor-
mation regarding this notice, please con-
tact the Employee Plans’ taxpayer assis-
tance telephone service at 877–829–5500
(a toll-free number), between the hours of
8:30 a.m. and 4:30 p.m. Eastern time,
Monday through Friday. Mr. Stern may be
reached at 202–283–9703. Mr. Montanaro
may be reached at 202–283–9714. The
telephone numbers in the preceding sen-
tences are not toll-free.
Modification of the Substantial
Assistance Rules
Notice 2007–13
SECTION 1. OVERVIEW
This notice announces that the Trea-
sury Department and the Internal Revenue
Service (the IRS) will amend Treas. Reg.
§ 1.954–4(b)(1)(iv) and (b)(2)(ii) and the
examples thereunder, which provide that
substantial assistance rendered by a related
person or persons to a controlled foreign
corporation (“CFC”) is included within
the definition of foreign base company
services income under section 954(e) of
the Internal Revenue Code (Code). These
amended regulations will limit the types
of activities that constitute substantial as-
sistance to certain assistance rendered,
directly or indirectly, by a United States
person or persons (as the term is defined
in section 957(c) of the Code) to a related
CFC. Until regulations reflecting these
changes are issued, taxpayers may rely on
this notice.
In addition, in light of the repeal of
the foreign base company shipping income
rules under subpart F, this notice confirms
that income that previously was foreign
base company shipping income will con-
tinue to be foreign base company income
to the extent that it is within the definition
of a remaining category of foreign base
company income. This notice also clari-
fies that Treas. Reg. § 1.954–6, which pro-
vides rules addressing foreign base com-
pany shipping income, is effective only for
purposes of applying the rules for the with-
drawal of previously excluded subpart F
income from qualified investments under
section 955.
SECTION 2. SUBSTANTIAL
ASSISTANCE RULES
A. BACKGROUND
Under section 951(a)(1)(A)(i) of the
Code, a United States shareholder of a
CFC includes in gross income each year
itspro ratashare of the CFC’s subpart F
income for the taxable year of the CFC
which ends with or within such taxable
year of the shareholder. Section 952(a)(2)
defines the term “subpart F income” to
mean, in part, foreign base company in-
come (as defined under section 954).
Section 954(a)(3) of the Code defines
“foreign base company income” to include
“foreign base company services income”
for the taxable year. Section 954(e)(1) de-
fines “foreign base company services in-
come” for purposes of section 954(a)(3) to
mean income derived in connection with
the performance of services which are per-
formed (1) for, or on behalf of, any re-
lated person and (2) outside the country
under the laws of which the CFC is cre-
ated or organized. The statute does not ex-
plicitly provide for substantial assistance
rules under section 954(e). Those rules are
promulgated under the Secretary’s author-
ity under section 7805(a) to issue regula-
tions interpreting the term “for, or on be-
half of, any related person” under section
954(a)(3).
Treas. Reg. § 1.954–4(b)(1)(iv) de-
fines “services which are performed for,
or on behalf of, a related person” to in-
clude substantial assistance contributing to
the performance of services by a CFC that
hasbeenfurnishedbyarelatedpersonor
persons. Treas. Reg. § 1.954–4(b)(2)(ii)
sets forth the rules for the application
of the substantial assistance test. Treas.
Reg. § 1.954–4(b)(2)(ii)(a) states, in
general, that assistance “shall include,
but shall not be limited to, direction, su-
pervision, services, know-how, financial
assistance (other than contributions to
capital), and equipment, material, or sup-
plies.” Treas. Reg. § 1.954–4(b)(2)(ii)(b)
and (c) then provide separate tests depend-
ing on whether the assistance provided
by the related person or persons is in the
form of (1) direction, supervision, services
or know-how, or (2) financial assistance,
equipment, material or supplies.
Treas. Reg. § 1.954–4(b)(2)(ii)(b) pro-
vides that assistance in the form of direc-
tion, supervision, services or know-how
may be substantial under either a subjec-
tive or an objective test. Under the subjec-
tive test, assistance in the form of direc-
tion, supervision, services or know-how
will be considered substantial if the assis-
tance provides the CFC with skills which
are a principal element in producing the
income from the performance of such ser-
vices by such CFC (the principal element
test). For example, a CFC enters into a
contract with an unrelated person to drill
an oil well. The technical and supervi-
sory personnel who oversee the drilling of
the well are employees of M, a person re-
latedtoCFC.Insuchaninstance,theser-
vices performed by CFC for the unrelated
party are considered foreign base company
services because the services performed
by M substantially assist CFC in the per-
formance of the contract and the services
performed by M are a principal element
in producing the income from the perfor-
mance of the drilling contract.Cf. Treas.
Reg. § 1.954–4(b)(3), Ex. 2.
Alternatively, under the objective test,
assistance in the form of direction, super-
vision, services or know-how may be sub-
2007–5 I.R.B.410January 29, 2007

stantial if the cost to the CFC of the assis-
tance furnished by persons related to the
CFC equals 50 percent or more of the total
cost to the CFC of performing the services
performed by such CFC (the cost test). For
these purposes, costs are determined af-
ter taking into account adjustments (if any)
made under section 482.SeeTreas. Reg.
§ 1.954–4(b)(2)(ii)(b).
Treas. Reg. § 1.954–4(b)(2)(ii)(c)
states, in general, that financial assistance,
equipment, material, or supplies furnished
by a person related to the CFC shall be
considered assistance only in the amount,
after taking into account adjustments (if
any) made under section 482, by which the
consideration actually paid by the CFC to
the related person for the purchase or use
of such item is less than the arm’s length
charge for such purchase or use. The total
of all such amounts from all related per-
sons is compared with the profits derived
by the CFC from the performance of the
services to determine whether the related
party’s contributions qualify as substantial
assistance.
Treas. Reg. § 1.954–4(b)(2)(ii)(d)
expands on the tests in Treas. Reg.
§ 1.954–4(b)(2)(ii)(b) and (c) by pro-
viding that, even if assistance furnished by
a related person or persons to a CFC is not
considered substantial under paragraphs
(b) or (c) in isolation, it may neverthe-
less constitute substantial assistance when
taken together or in combination with
other assistance furnished by a related
person or persons to the CFC. Treas. Reg.
§ 1.954–4(b)(2)(ii)(e) provides that, in ap-
plying Treas. Reg. § 1.954–4(b)(2)(ii)(b)
and (d), assistance in the form of direc-
tion, supervision, services, or know-how
shall not be taken into account, unless the
assistance so furnished assists the CFC
directly in the performance of the services
performed. Treas. Reg. § 1.954–4(b)(3)
sets forth examples, including examples
addressing the application of the substan-
tial assistance test.
B. DISCUSSION
The substantial assistance rules were
published as final regulations in 1968
(T.D. 6981, 1968–2 C.B. 314). The pur-
pose of the substantial assistance rules is
to treat as foreign base company services
income, income received by a CFC from
rendering services to an unrelated person
where in rendering those services a re-
latedpersonsubstantially contributes to
the CFC’s performance of such services
in a manner that suggests that the CFC,
rather than the related party, entered into
the contract to obtain a lower rate of tax on
the service income. Since the regulations
were published in 1968, there has been a
substantial expansion in the reach of the
global economy, particularly in the provi-
sion of global services. As a result, many
of the U.S. multinationals that provide ser-
vices outside of the United States currently
have globally integrated businesses with
support capabilities for unrelated customer
projects in different geographic locations,
largely based on factors such as expertise
and cost efficiencies.
For example, a CFC may contract with
an unrelated person to provide installa-
tion and subsequent repair services. A re-
lated CFC, however, is the foreign corpo-
ration that provides the repair services. Al-
though the foreign related CFC that is pro-
viding the support services will continue
to have foreign base company services in-
cometotheextentthatitperformsthose
services outside of its country of incor-
poration, it does not seem appropriate in
the current global economy to continue to
treat the profits of the CFC contracting to
furnish services to the unrelated person as
foreign base company services income be-
cause of the support services provided by
a related foreign person. If the substantial
assistance regulations are not amended to
deal with these types of businesses struc-
tures, the regulations may cause taxpay-
erstochangethewaytheydobusiness
or structure their operations in light of the
substantial assistance rules, even if such
a structure would be less efficient from a
business perspective by, for example, re-
quiring a taxpayer to duplicate a full ser-
vice infrastructure in each country.
The Treasury Department and the IRS,
however, remain concerned about the abil-
ity of related United States persons to shift
profits offshore to CFCs organized in low
tax jurisdictions in cases where the related
United States person or persons provides
so much assistance to the CFC that the
CFC cannot be said to be providing ser-
vices on its own account and thus acting
as an independent entity. Accordingly, the
Treasury Department and the IRS will re-
vise the regulations to eliminate the sub-
stantial assistance rules, except in certain
limited instances in which a United States
person or persons provide sufficient as-
sistance directly or indirectly to a related
CFC.
C. PROPOSED GUIDANCE
The Treasury Department and
the IRS will amend Treas.Reg.
§ 1.954–4(b)(1)(iv) and (b)(2)(ii) and
the examples thereunder. Treas. Reg.
§ 1.954–4(b)(1)(iv) as amended will pro-
vide that services performed by a CFC in
a case where substantial assistance by a
related United States person or persons
(as the term is defined in section 957(c)
of the Code) contributes to the perfor-
mance of such service will constitute
“services which are performed for, or on
behalf of, a related person.” Treas. Reg.
§ 1.954–4(b)(2)(ii) as amended will pro-
vide that “substantial assistance” consists
of assistance furnished (directly or indi-
rectly) by a related United States person or
persons to the CFC if the assistance satis-
fies an objective cost test. The subjective
“principal element” test will no longer
apply to determine substantial assistance.
For purposes of the objective cost test, the
definition of the term “assistance” will in-
clude, but will not be limited to, direction,
supervision, services, know-how, finan-
cial assistance (other than contributions
to capital), and equipment, material, or
supplies provided directly or indirectly by
a related United States person to a CFC.
The cost test will be satisfied if the cost
to the CFC of the assistance furnished by
the related United States person or persons
equals or exceeds 80 percent of the total
cost to the CFC of performing the ser-
vices. The term “cost” will be determined
after taking into account adjustments, if
any, made under section 482 of the Code.
Taxpayers may apply the cost test either
by demonstrating that the assistance pro-
vided, directly or indirectly, by related
United States persons is below the 80 per-
cent cost threshold, or, alternatively, by
demonstrating that the cost of the services
provided by the CFC itself, and/or by a
relatedCFC,ismorethan20percentof
the total cost to the CFC of performing
the services. For this purpose, services
provided by a CFC itself are not assistance
provided “indirectly” by a related United
States person (or persons). However, em-
ployees, officers, or directors of the CFC
January 29, 20074112007–5 I.R.B.

who are concurrently employees, officers,
or directors of a related United States per-
son during a taxable year of the CFC will
be considered employees, officers or di-
rectors solely of the related United States
person for such taxable year for purposes
of this notice.
The examples under Treas. Reg.
§ 1.954–4(b)(2)(ii) will be amended to
reflect the amendments to the regulations.
The application of the proposed cost test
is illustrated by the following examples.
Example 1: USP, a U.S. corporation, wholly owns
CFC1 and CFC2, each a foreign corporation. CFC1
enters into a contract with FP, an unrelated foreign
person,todesignabridgeforFPinCountryY,afor-
eign country that is not CFC1’s country of organiza-
tion. CFC1 incurs a total of $100x of costs to design
the bridge for FP. USP performs supervisory services
in Country Y for CFC1 with respect to the contract
for which CFC1 pays USP a fee. CFC1 directly per-
forms services related to the performance of that con-
tract that cost CFC1 $15x. CFC2 performs central-
ized support services related to the performance of
that contract in Country X, its country of organiza-
tion, for which CFC1 pays CFC2 $10x. CFC1 is not
treated as receiving substantial assistance in the per-
formance of that contract because more than 20% of
thecostofthatcontractisattributabletoservicesfur-
nished directly by CFC1 or a related CFC (CFC2).
Example 2: USP, a U.S. corporation, wholly owns
CFC1 and CFC2, each a foreign corporation. CFC2
enters into a contract with FP, an unrelated person, to
design a bridge in Country Y, a foreign country that is
not CFC2’s country of organization. With respect to
the contract with FP, USP performs services in Coun-
tryYforCFC1intheformofdesignandtechnical
services for which CFC1 pays USP $85x. CFC1 con-
tracts with CFC2 to provide those services and others
to CFC2 for $90x. CFC2 uses those services together
with services it performs itself that cost CFC2 $10x
to design the bridge for FP. Pursuant to the cost test,
USP provides substantial assistance to CFC2 in the
performance of its contract for FP because USP indi-
rectly furnishes assistance to CFC2 (through CFC1)
that exceeds 80 percent of the total cost to CFC2 for
performing the contract.
Example 3: USP, a U.S. corporation, wholly owns
CFC1 and CFC2, each a foreign corporation. CFC2
enters into a contract with FP, an unrelated person, to
design a bridge in Country Y, a foreign country that is
not CFC2’s country of organization. With respect to
the contract with FP, USP performs services in Coun-
tryYforCFC1intheformofdesignandtechnical
services for which CFC1 pays USP $60x. CFC1 con-
tracts with CFC2 to provide those services and others
to CFC2 for $70x. CFC2 uses those services together
with services it performs itself that cost CFC2 $30x
to design the bridge for FP. CFC2 is not treated as re-
ceiving substantial assistance in the performance of
that contract because more than 20% of the cost of
that contract is attributable to services furnished di-
rectly by CFC2.
D. EFFECTIVE DATE
Regulations to be issued incorporating
the guidance set forth in this notice will
apply to taxable years of foreign corpora-
tions beginning on or after January 1, 2007
and to taxable years of United States share-
holders in which or with which such tax-
able years of the foreign corporations end.
Until such regulations are issued, taxpay-
ers may rely on this notice.
SECTION 3. FOREIGN BASE
COMPANYSHIPPINGRULES
Section 415 of the American Jobs Cre-
ations Act (“AJCA”) repealed sections
954(a)(4) and 954(f) of the Code, (the
foreign base company shipping rules). It
also made conforming amendments by
repealing sections 954(b)(6) and (b)(7)
and striking a reference to foreign base
company shipping income in section
954(b)(5). These changes are effective
for taxable years of foreign corporations
beginning after December 31, 2004, and
taxable years of U.S. shareholders in
which or with which such taxable years
of the foreign corporations end. Further,
section 415 of the AJCA enacted a special
safe harbor for certain leasing activities
under section 954(c)(2)(A). The special
safe harbor rule has been addressed in a
separate published guidance project.See
Notice 2006–48, 2006–21 I.R.B. 922.
As a result of, and as of the effective
date of, the repeal of the foreign base
company shipping income rules, Treas.
Reg. § 1.954–1(e)(4)(i)(A), which pro-
vides that income that qualifies as foreign
base company shipping income will not be
considered insurance income or income in
any other category of foreign base com-
pany income, is obsolete and Treas. Reg.
§ 1.954–6, which prescribes rules for de-
termining foreign base company shipping
income, is only effective for purposes of
applying the rules for the withdrawal of
previously excluded subpart F income
from qualified investments under section
955. Accordingly, Treas. Reg. § 1.954–6
will be amended to include new applica-
bility language.
Moreover, the repeal of sections
954(a)(4) and 954(f) of the Code was only
intended to eliminate the separate category
of foreign base company shipping income.
It was not intended to exclude income
from subpart F that would otherwise qual-
ify under another category of foreign base
company income. Income that might have
been described in sections 954(a)(4) and
956(f) before the AJCA still must be tested
under the remaining categories of foreign
base company income. Consequently, this
notice confirms that income described in
section 954(f) as it existed before its re-
peal will continue to constitute subpart F
income to the extent that it falls within
another category of foreign base company
income.
SECTION 4. REQUEST FOR
COMMENTS
The Treasury Department and the IRS
request comments on the new substantial
assistance rules proposed in this notice.
Comments are requested on whether the
new rules are appropriately targeted and
whether any modifications to the rules
should be made before they are pro-
mulgated as regulations. In particular,
comments are requested on whether the
proposed cost test is appropriate for cer-
tain industries, and if not, how the rules
could be modified or supplemented to
properly address those industries while
still addressing the Treasury Department’s
and the IRS’ concerns about shifting prof-
its offshore to CFCs organized in low
tax jurisdictions. In addition, the Trea-
sury Department and the IRS understand
that taxpayers are also concerned with
the special rule concerning a guaranty of
performance contained in Treas. Reg.
§ 1.954–4(b)(2)(i). The Treasury De-
partment and the IRS are reviewing this
rule, particularly in light of Treas. Reg.
§ 1.482–9T, and request comments on
whether changes to this rule are warranted
and, if so, how it should be modified.
Written comments on the issues ad-
dressed in this notice may be submit-
ted to the Office of Associate Chief
Counsel International, Attention: No-
tice 2007–13, room 4710, CC:INTL:BR2,
Internal Revenue Service, 1111 Consti-
tution Avenue, NW, Washington, DC
20224. Alternatively, taxpayers may
submit comments electronically toNo-
tice.Comments@m1.irscounsel.treas.gov.
2007–5 I.R.B.412January 29, 2007

Comments will be available for public
inspection and copying.
SECTION 5. DRAFTING
INFORMATION
The principal author of this notice is
Ethan Atticks of the Office of Associate
Chief Counsel (International). For further
information regarding this notice, contact
Ethan Atticks at (202) 622–3840 (not a
toll-free call).
26 CFR 601.601: Rules and regulations.
(Also Part 1, § 1397E.)
Rev. Proc. 2007–18
SECTION 1. PURPOSE
Pursuant to § 1397E(e)(2) of the Inter-
nal Revenue Code, this revenue procedure
sets forth the maximum face amount of
Qualified Zone Academy Bonds (“Bond”
or “Bonds”) that may be issued for each
State for each of the calendar years 2006
and 2007. For this purpose, “State” in-
cludes the District of Columbia and the
possessions of the United States.
SECTION 2. BACKGROUND
.01 Section 226 of the Taxpayer Relief
Act of 1997, Pub. L. 105–34, 111 Stat. 821
(1997), added § 1397E to the Internal Rev-
enue Code to provide a credit to holders of
Bonds under certain circumstances so that
the Bonds generally can be issued without
discount or interest. Ninety-five percent of
Bond proceeds are to be used for qualified
purposes, as defined by § 1397E(d)(5),
with respect to a qualified zone academy,
as defined by § 1397E(d)(4).
.02 Section 1397E(e)(1), as amended
by § 107 of the Tax Relief and Health
Care Act of 2006, Pub. L. 109–432, 120
Stat. 2922 (2006), provides that the na-
tional Bond limitation is $400 million for
each of the years 1998, 1999, 2000, 2001,
2002, 2003, 2004, 2005, 2006, and 2007.
This amount is to be allocated among the
States by the Secretary on the basis of their
respective populations below the poverty
level (as defined by the Office of Manage-
ment and Budget) and is to be further allo-
cated by each State to qualified zone acad-
emies within the State.
.03 Section 1397E(e)(4), as amended
by § 509 of the Tax Relief Extension Act
of 1999, Pub. L. 106–170, 113 Stat. 1860
(1999), provides that any carryforward of a
limitation amount may be carried forward
only to the first 2 years (3 years for carry-
forwards from 1998 or 1999) following the
unused limitation year. For this purpose, a
limitation amount shall be treated as used
on a first-in, first-out basis.
.04 Rev. Proc. 98–9, 1998–1 C.B. 341;
Rev. Proc. 98–57, 1998–2 C.B. 682; Rev.
Proc. 2000–10, 2000–1 C.B. 287; Rev.
Proc. 2001–14, 2001–1 C.B. 343; Rev.
Proc. 2002–25, 2002–1 C.B. 800; Rev.
Proc. 2002–72, 2002–2 C.B. 931; Rev.
Proc. 2004–61, 2004–2 C.B. 707; and Rev.
Proc. 2004–72, 2004–2 C.B. 1033, allo-
cated among the States the national limi-
tation for 1998, 1999, 2000, 2001, 2002,
2003, 2004, and 2005, respectively.
SECTION 3. NATIONAL QUALIFIED
ZONE ACADEMY BOND LIMITATION
FOR 2006 AND 2007
The national limitation for Bonds for
each of the calendar years 2006 and 2007
is $400 million. This amount is allocated
among the States as follows:
STATE
MAXIMUM FACE AMOUNT OF
BONDS THAT MAY BE ISSUED FOR
EACH OF THE CALENDAR YEARS
2006 AND 2007 (thousands of dollars)
Alaba
ma
7,698
Alaska677
Arizona9,412
Arka
nsas
3,92
1
California48,404
Colorado5,440
Con
necticut
3,3
46
Delaware801
District of Columbia1,180
Fl
orida
20
,271
Georgia13,322
Hawaii1,129
Id
aho
1,
468
Illinois14,790
Indiana7,944
I
owa
3
,356
Kansas3,459
Kentucky6,148
Louisiana7,677
Maine1,704
Maryland5,563
Massachusetts6,579
Michigan12,275
Minnesota4,229
Mississippi5,861
January 29, 20074132007–5 I.R.B.

STATE
MAXIMUM FACE AMOUNT OF
BONDS THAT MAY BE ISSUED FOR
EACH OF THE CALENDAR YEARS
2006 AND 2007 (thousands of dollars)
Missouri6,764
Montana1,314
Nebraska1,714
Nevada2,669
New Hampshire749
New Jersey6,076
New Mexico3,562
New York28,328
North Carolina11,444
North Dakota718
Ohio14,287
Oklahoma5,573
Oregon4,475
Pennsylvania14,082
Rhode Island1,304
South Carolina6,425
South Dakota924
Tennessee8,950
Texas37,781
Utah2,381
Vermont482
Virginia7,020
Washington6,528
West Virginia2,833
Wisconsin5,676
Wyoming554
American Samoa363
Guam397
Northern Marianas380
Puerto Rico19,230
Virgin Islands363
Total
$400,000
SECTION 4. EFFECTIVE DATE
This revenue procedure is effective for
Bonds issued pursuant to the national lim-
itation for calendar year 2006 on or after
January 1, 2006, and Bonds issued pur-
suant to the national limitation for calendar
year 2007 on or after January 1, 2007.
SECTION 5. DRAFTING
INFORMATION
The principal author of this revenue
procedure is David White of the Office of
Division Counsel/Associate Chief Coun-
sel (Tax Exempt & Government Entities).
For further information regarding this
revenue procedure, contact Mr. White at
(202) 622–3980 (not a toll-free call).
2007–5 I.R.B.414January 29, 2007

Part IV. Items of General Interest
Notice of Proposed
Rulemaking by
Cross-Reference to
Temporary Regulations
Corporate Reorganizations;
Distributions Under Sections
368(a)(1)(D) and 354(b)(1)(B)
REG–125632–06
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking
by cross-reference to temporary regula-
tions.
SUMMARY: In this issue of the Bulletin,
the IRS is issuing temporary regulations
(T.D. 9303) that provide guidance regard-
ing the qualification of certain transactions
as reorganizations described in section
368(a)(1)(D) where no stock and/or secu-
rities of the acquiring corporation is issued
and distributed in the transaction. These
regulations affect corporations engaging in
such transactions and their shareholders.
The text of those regulations also serves
as the text of these proposed regulations.
DATES: Written or electronic comments
and requests for a public hearing must be
received by March 19, 2007.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR (REG–125632–06), In-
ternal Revenue Service, PO Box 7604, Ben
Franklin Station, Washington, DC 20044.
Submissions may be hand delivered
to CC:PA:LPD:PR (REG–147144–06),
Courier Desk, Internal Revenue Ser-
vice, Crystal Mall 4, 1901 South Bell
Street, Arlington, Virginia, or sent elec-
tronically, via the IRS Internet site at
www.irs.gov/regsor via the Federal eRule-
making Portal atwww.regulations.gov
(IRS REG–125632–06).
FOR FURTHER INFORMATION
CONTACT: Concerning the proposed
regulations, Bruce A. Decker, (202)
622–7550; concerning submission of
comments, requests for a public hearing,
and/or a publication and regulations spe-
cialist, Treena Garrett, (202) 622–7180.
SUPPLEMENTARY INFORMATION:
Background
Temporary regulations in this issue of
the Bulletin amend 26 CFR part 1. The
temporary regulations provide guidance
on circumstances where the distribution
of stock and/or securities under section
354(b)(1)(B) will be deemed satisfied in
the absence of an actual issuance of stock
and/or securities pursuant to a reorgani-
zation described in section 368(a)(1)(D).
The text of those regulations also serves
as the text of these proposed regulations.
The preamble to the temporary regulations
explains the amendments.
Explanation of Provisions
These temporary regulations provide
guidance regarding the circumstances in
which the distribution requirement under
sections 368(a)(1)(D) and 354(b)(1)(B) is
deemed satisfied despite the fact that no
stock and/or securities are actually issued
in a transaction otherwise described in
section 368(a)(1)(D). These regulations
will affect certain cash sales of assets be-
tween two corporations that have the same
direct or indirect shareholders or ade min-
imisvariation in shareholder identity and
proportionality.
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 regu-
lations, and because the regulation does
not impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Inter-
nal Revenue Code, this notice of proposed
rulemaking will be submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comment on its
impact on small business.
Comments and Requests for a Public
Hearing
Before these proposed regulations are
adopted as final regulations, considera-
tion will be given to any written (a signed
original and eight (8) copies) or electronic
comments that are submitted timely to the
IRS. The IRS and Treasury Department
request comments on the clarity of the pro-
posed rules and how they can be made eas-
ier to understand. The IRS and Treasury
Department request comments on several
issues relating to acquisitive reorganiza-
tions described in section 368(a)(1)(D).
Specifically, the IRS and Treasury Depart-
ment request comments on whether the
meaningless gesture doctrine is inconsis-
tent with the distribution requirement in
sections 368(a)(1)(D) and 354(b)(1)(B),
especially in situations in which the cash
consideration received equals the full fair
market value of the property transferred
such that there is no missing considera-
tion for which the nominal share of stock
deemed received and distributed could
substitute. The IRS and Treasury Depart-
ment also request comments on the extent,
if any, to which the continuity of interest
requirement should apply to a reorgani-
zation described in section 368(a)(1)(D).
The IRS and Treasury Department request
comments on whether these temporary
regulations should apply when the parties
to the reorganization are members of a
consolidated group. Finally, the IRS and
Treasury Department request comments
on the continued vitality of various liq-
uidation-reincorporation authorities after
the enactment of the Tax Reform Act of
1986, Public Law 99–514 (100 Stat. 2085
(1986)). All comments will be available
for public inspection and copying. A pub-
lic hearing will be scheduled if requested
in writing by any person that timely sub-
mits written comments. If a public hearing
is scheduled, notice of the date, time, and
place for the public hearing will be pub-
lished in theFederal Register.
Drafting Information
The principal author of these regula-
tions is Bruce A. Decker, Office of Asso-
ciate Chief Counsel (Corporate).
*****
January 29, 20074152007–5 I.R.B.

Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is proposed
to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.368–2 is amended by
revising paragraph (l) to read as follows:
§1.368–2 Definition of terms.
*****
(l) [The text of this proposed amend-
ment to §1.368–2(l) is the same as the text
of §1.368–2T(l)(1) through (l)(4)(i) pub-
lished elsewhere in this issue of the Bul-
letin.
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on December 18,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 18, 2006, 71 F.R. 75898)
Railroad Track Maintenance
Credit; Correction
Announcement 2007–8
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correction to temporary regula-
tions.
SUMMARY: This document contains cor-
rections to temporary regulations (T.D.
9286, 2006–43 I.R.B. 750) that were pub-
lished in theFederal Registeron Friday,
September 8, 2006 (71 FR 53009) provid-
ing rules for claiming the railroad track
maintenance credit under section 45G of
the Internal Revenue Code for qualified
railroad track maintenance expenditures
paid or incurred by a Class II railroad or
Class III railroad and other eligible tax-
payers during the taxable year.
DATES: This correction is effective
September 8, 2006.
FOR FURTHER INFORMATION
CONTACT: Winston H. Douglas, (202)
622–3110 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
The correction notice that is the subject
of this document is under section 45G of
the Internal Revenue Code.
Need for Correction
As published, temporary regulations
(T.D. 9286) contain errors that may prove
to be misleading and are in need of clarifi-
cation.
Correction of Publication
Accordingly, the publication of the tem-
porary regulations (T.D. 9286), which was
the subject of FR Doc. E6–14858, is cor-
rected as follows:
1. On page 53010, column 1, in the pre-
amble, under the paragraph heading “Gen-
eral Overview”, first and second lines from
the bottom of the second paragraph, the
language “assigned to such person by such
a railroad.” is corrected to read “assigned
to such person by a Class II railroad or a
Class III railroad.”.
2. On page 53010, column 2, in the
preamble, under the paragraph heading
“Scope”, first paragraph of the column,
last line of the paragraph, the language
“of controlled groups under section 45G.”
is corrected to read “of controlled groups
under section 45G with respect to the
RTMC.”.
3. On page 53010, column 2, in the pre-
amble, under the paragraph heading “El-
igible Taxpayer”, fourth line of the first
paragraph, the language “defined in the
temporary regulations as:” is corrected to
read “defined as:”.
4. On page 53010, column 2, in the pre-
amble, under the paragraph heading “Eli-
gible Taxpayer”, third line from the bottom
of the first paragraph, the language “rail-
road track assigned to the person for” is
corrected to read “railroad track assigned
to the taxpayer for”.
5. On page 53010, column 2, in the pre-
amble, under the paragraph heading “Eli-
gible Taxpayer”, second through the sixth
line from the bottom of the second para-
graph, the language “Price Index)). 49
CFR part 1201, subpart A, §1–1(a). In
general, Class III railroads have annual
carrier operating revenues of $20 million
or less after applying the railroad revenue
deflator formula. 49” is corrected to read
“Price Index)). See 49 CFR part 1201, sub-
part A, §1–1(a). In general, Class III rail-
roads have annual carrier operating rev-
enues of $20 million or less after applying
the railroad revenue deflator formula. See
49”.
6. On page 53010, column 3, in the
preamble, under the paragraph heading
“Eligible Taxpayer”, second paragraph of
the column, tenth to seventeenth lines,
the language “services are the transport of
freight by rail, the loading and unloading
of freight transported by rail, locomotive
leasing or rental, and maintenance of a
railroad’s right-of-way (including veg-
etation control). Examples of services
that are not railroad-related services are
general business services,” is corrected
to read “services include the transport of
freight by rail, the loading and unloading
of freight transported by rail, locomotive
leasing or rental, and maintenance of a
railroad’s right-of-way (including vegeta-
tion control). Examples of services that
are not railroad-related services include
general business services,”.
7. On page 53011, column 1, in the pre-
amble, under the paragraph heading “De-
termination of QRTME Paid or Incurred”,
second paragraph, third and fourth lines,
the language “to a taxpayer using an ac-
crual method of accounting. In this case,
paid or” is corrected to read “to taxpay-
ers using an accrual method of accounting.
For such taxpayers, paid or”.
8. On page 53011, column 1, in the
preamble, under the paragraph heading
“Determination of QRTME Paid or In-
curred”, second paragraph, fifteenth to
twentieth lines, the language “any such
expenditures. The temporary regulations
provide that reimbursements may con-
sist of amounts paid either directly or
indirectly to the taxpayer. Examples of
indirect reimbursements are discounted
freight shipping rates,” is corrected to read
“any expenditures that would otherwise
qualify as QRTME. The temporary regu-
lations provide that reimbursements may
consist of amounts paid either directly or
indirectly to the taxpayer. Examples of in-
direct reimbursements include discounted
freight shipping rates,”.
9. On page 53011, column 1, in the pre-
amble, under the paragraph heading “De-
termination of QRTME Paid or Incurred”,
third paragraph, first line, the language
2007–5 I.R.B.416January 29, 2007

“If an eligible taxpayer (assignee) pays” is
corrected to read “The IRS and Treasury
believe that the statute is intended to allow
suppliers and shippers to claim the credit
for providing the funding for the QRTME
performed on railroad track owned by, or
leased to, a Class II railroad or Class III
railroad. However, the suppliers and ship-
pers may not have the necessary exper-
tise to perform the repairs and improve-
ments. The IRS and Treasury believe that
these eligible taxpayers should be able to
claim the credit for providing the funding
to the extent that the Class II railroads and
Class III railroads use such funding to per-
form the repairs and improvements to the
track. Therefore, if an eligible taxpayer
(assignee) pays”.
10. On page 53011, column 1, in the
preamble, under the paragraph heading
“Determination of QRTME Paid or In-
curred”, third paragraph, fifth line from
the bottom of the column, the language
“paragraph, this QRTME would be” is
corrected to read “paragraph, QRTME
would be”.
11. On page 53011, column 2, in
the preamble, under the paragraph head-
ing “Assignment of Railroad Track Miles”,
first paragraph, first through fifth lines, the
language “For purposes of section 45G,
the temporary regulations provide that an
assignment of a mile of railroad track is
not a legal transfer of title, but merely a
designation. This designation must be”
is corrected to read “The temporary reg-
ulations provide that an assignment of a
mile of railroad track is not a legal transfer
of title, but merely a designation made
solely for purposes of section 45G. This
designation must be”.
12. On page 53011, column 2, in the
preamble, under the paragraph heading
“Assignment of Railroad Track Miles”,
second paragraph, fifth line, the language
“track. Thus, if a Class II railroad or
Class” is corrected to read “track. If a
Class II railroad or Class”.
13. On page 53011, column 2, in the
preamble, under the paragraph heading
“Assignment of Railroad Track Miles”,
fourth paragraph, second line, the lan-
guage “that a taxpayer must file Form
8900,” is corrected to read “that a taxpayer
file Form 8900,”.
14. On page 53011, column 3, in the
preamble, last paragraph of the column,
first line, the language “The temporary
regulations also” is corrected to read “The
temporary regulations”.
15. On page 53012, column 1, in the
preamble, first paragraph of the column,
first line, the language “assignment is
properly reported.” is corrected to read
“assignment is reported.”.
16. On page 53012, column 1, in the
preamble, under the paragraph heading
“Special Rules”, first paragraph, second
through fourth lines from the bottom of the
paragraph, the language “structure (rail-
road track, roadbed, bridges, and related
track structures) and intangible assets to
which the” is corrected to read “structure
and intangible assets to which the”.
17. On page 53012, column 1, in the
preamble, under the paragraph heading
“Special Rules”, second paragraph, sixth
line, the language “of the RTMC allow-
able. This reduction” is corrected to read
“of the RTMC allowable. The basis re-
duction”.
18. On page 53012, column 1, in the
preamble, under the paragraph heading
“Special Rules”, third paragraph, first line,
the language “The temporary regulations
also” is corrected to read “The temporary
regulations do not”.
19. On page 53012, column 2, in the
preamble, under the paragraph heading
“Special Rules”, first paragraph of the
column, fourth line to the last of the para-
graph, the language “legislative history
does not refer to, any exception to this
rule. Accordingly, pursuant to section 61
and the regulations under section 61, the
owner of the tangible assets (for example,
railroad track and roadbed) with respect
to which the QRTME is paid or incurred
by another person that does not have a de-
preciable interest in those assets has gross
income in the amount of that QRTME.
However, the application of section 61 to
QRTME paid or incurred with respect to
eligible railroad track that is leased by a
Class II railroad or Class III railroad raises
a question as to under what circumstances
the owner or lessee should recognize gross
income with respect to QRTME. The IRS
and Treasury Department request com-
ments on this issue.” is replaced to read
“legislative history does not refer to, any
exception to this rule for an owner of tan-
gible assets (for example, railroad track
and roadbed) for the value of the repairs or
improvements to such assets with respect
to which QRTME is paid or incurred by
another person that does not have a depre-
ciable interest in such assets.”
LaNita Van Dyke,
Chief, Publications and
Regulations Branch,
Legal Processing Division,
Associate Chief Counsel
(Procedure and Administration).
(Filed by the Office of the Federal Register on December 7,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 8, 2006, 71 F.R. 710
45)
Treatment of Services Under
Section 482; Allocation of
Income and Deductions From
Intangibles; Stewardship
Expense; Correction
Announcement 2007–9
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correcting amendments.
SUMMARY: This document contains cor-
rections to final and temporary regulations
(T.D. 9278, 2006–34 I.R.B. 256) that was
published in theFederal Registeron Fri-
day, August 4, 2006 (71 FR 44466) regard-
ing the treatment of controlled services
transactions under section 482 and the al-
location of income from intangibles, in
particular with respect to contributions by
a controlled party to the value of an intan-
gible owned by another controlled party.
This document also contains corrections to
final and temporary regulations that mod-
ify the regulations under section 861 con-
cerning stewardship expenses to be consis-
tent with the changes made to the regula-
tions under section 482.
EFFECTIVE DATE: The amendments are
effective on January 1, 2007.
FOR FURTHER INFORMATION
CONTACT: Thomas A. Vidano, (202)
435–5265, or Carol B. Tan (202)
435–5159, for matters relating to sec-
tion 482, and David F. Bergkuist, (202)
622–3850, for matters relating to steward-
ship expenses (not toll-free numbers).
January 29, 20074172007–5 I.R.B.

SUPPLEMENTARY INFORMATION:
Background
The final and temporary regulations
that are the subject of these corrections are
under sections 482 and 861 of the Internal
Revenue Code.
Need for Correction
As published, the final and temporary
regulations (T.D. 9278) contains errors that
may prove to be misleading and are in need
of clarification.
*****
Correction of Publication
Accordingly, 26 CFR part 1 is cor-
rected by making the following correcting
amendments:
PART 1—INCOME TAXES
Paragraph 1. T
he authority citation for
part 1 continu
es to read in part as follows:
Authority: 26
U.S.C.7805***
Par. 2. Sectio
n 1.482–0T is amended
by removing th
e entries for paragraphs
(i)(1) throu
gh (i)(10), (j)(1), (j)(2) and
(j)(3) from §
1.482–1T.
Par. 3. Secti
on 1.482–1 is amended by
revising par
agraph (i) introductory text to
read as follo
ws:
§1.482–1 Allocation of income and
deductions among taxpayers.
*****
(i) [Reserved]. For further guidance,
see §1.482–1T(i) introductory text.
*****
Par. 4. Section 1.482–1T is amended as
follows:
1. Paragraphs (i)(1) through (i)(10) are
added and reserved.
2. Paragraphs (j)(1) through (j)(5) are
amended by adding “§” before the lan-
guage “1.482–1(j)(1)”.
The addition reads as follows:
§1.482–1T Allocation of income and
deductions among taxpayers (temporary).
*****
(i)(1) through (i)(10) [Reserved]. For
further guidance, see §1.482–1(i)(1)
through (i)(10).
*****
Par. 5. Section 1.482–8T is amended
by revising paragraph (b)Example 12.
(iv), second sentenceto read as follows:
§1.482–8T Example of the best method
rule (temporary).
*****
(b) * * *
Example 12.(i)***
(iv) * * * USP contributed the long-term endorse-
ment contracts with professional athletes. * * *
*****
Par. 6. Section 1.482–9T is amended as
follows:
1. Paragraph (b)(6),Example 22.(vi),
introductory text is revised.
2. Paragraph (g)(2),Example 2.(iv),
fifth sentence is revised.
3. Paragraph (i)(2) is revised.
4. Paragraph (i)(5),Example 1.(iii),
first sentence is revised.
5. Paragraph (i)(5),Example 3.(ii),
first sentence is revised.
6. Paragraph (l)(5),Example 20.(i),
second sentence is revised.
7. Paragraph (m)(5),Example 1.(ii),
fourth sentence is revised.
The revisions read as follows:
§1.482–9T Methods to determine taxable
income in connection with a controlled
services transaction (temporary).
*****
(b) * * *
(6) * * *
Example 22.(i)***
(vi) In contrast, if aggregated services AB were
allocated by reference to the total U.S. dollar value
of sales to uncontrolled parties (trade sales) by each
company, the following results would obtain:
*****
(g) * * *
(2) * * *
Example 2.***
(iv) * * * In the bid on the Country 2 contract for
Level 1 waste remediation, Company B proposes to
use a multidisciplinary team of specialists from Com-
panyAandCompanyB.***
*****
(i) * * *
(2) * * * For purposes of this para-
graph (i), an arrangement will be treated
as a contingent-payment arrangement if it
meets all of the requirements in paragraph
(i)(2)(i) of this section and is consistent
with the economic substance and conduct
requirement in paragraph (i)(2)(ii) of this
section.
*****
(5) * * *
Example 1.(i) * * *
(iii) The years under examination are years 6
through 9. ***
*****
Example 3.(i) * * *
(ii) The years under examination are years 6
through9. ***
*****
(l) * * *
(5) * * *
Example 20.(i) * * * Y, a Country B corporation,
is a distribution and marketing company that also per-
forms clinical trials for X in Country B. * * *
*****
(m)***
(5) * * *
Example 1.(i) * * *
(ii)***Thecomparableprofitsmethodmaypro-
vide the most reliable measure of an arm’s length re-
sult if uncontrolled parties are identified that perform
similar, combined functions of maintaining and pro-
viding spare parts for similar equipment. * * *
*****
Par. 7. Section 1.861–8T is amended as
follows:
1. Paragraph (b)(3) is revised.
2. Paragraph (g), paragraph (i) follow-
ingExample 30. (i)(C) is redesignated as
paragraph (ii) and the paragraph designa-
tion forExample 30. (i)(C) is removed.
3. Paragraph (h)(1), first three sen-
tences are revised.
4. Paragraph (h)(3) is revised.
The revisions read as follows:
§1.861–8T Computation of taxable
income from sources within the United
States and from other sources and
activities (temporary).
*****
(b) * * *
(3)Supportive functions. Deductions
which are supportive in nature (such as
overhead, general and administrative, and
supervisory expenses) may relate to other
deductions which can more readily be al-
located to gross income. In such instance,
such supportive deductions may be allo-
cated and apportioned along with the de-
ductions to which they relate. On the
other hand, it would be equally accept-
able to attribute supportive deductions on
2007–5 I.R.B.418January 29, 2007

some reasonable basis directly to activi-
ties or property which generate, have gen-
erated or could reasonably be expected to
generate gross income. This would ordi-
narily be accomplished by allocating the
supportive expenses to all gross income
or to another broad class of gross income
and apportioning the expenses in accor-
dance with paragraph (c)(1) of this section.
For this purpose, reasonable departmental
overhead rates may be utilized. For ex-
amples of the application of the principles
of this paragraph (b)(3) to expenses other
than expenses attributable to stewardship
activities, seeExamples 19through21of
paragraph (g) of this section. See para-
graph (e)(4)(ii) of this section for the allo-
cation and apportionment of deductions at-
tributable to stewardship expenses. How-
ever, supportive deductions that are de-
scribed in §1.861–14T(e)(3) shall be allo-
cated and apportioned in accordance with
the rules of §1.861–14T and shall not be al-
located and apportioned by reference only
to the gross income of a single member of
an affiliated group of corporations as de-
fined in §1.861–14T(d).
*****
(h)***(1)***Ingeneral,the
rules of this section, as well as the rules
of §§1.861–9T, 1.861–10T, 1.861–11T,
1.861–12T, and 1.861–14T apply for tax-
able years beginning after December 31,
1986, except for paragraphs (a)(5)(ii),
(b)(3), (e)(4), (f)(4)(i), and paragraph (g)
Example 17,Example 18,andExample
30of this section, which are generally
applicable for taxable years beginning
after December 31, 2006. Also, see
§§1.861–8(e)(12)(iv) and 1.861–14(e)(6)
for rules concerning the allocation and
apportionment of deductions for charita-
ble contributions. In the case of corpo-
rate taxpayers, transition rules set forth
in §1.861–13T provide for the gradual
phase-in of certain provisions of this and
the foregoing sections. * * *
(3)Expiration date. The applicability
of the paragraphs (a)(5)(ii), (b)(3), (e)(4),
(f)(4)(i), and paragraph (g)Example 17,
Example 18,andExample 30of this sec-
tion, expires on or before July 31, 2009.
Par. 8. Section 1.6662–6T is amended
by revising paragraph (d)(2)(ii)(B), first
sentence to read as follows:
§1.6662–6T Transactions between
parties described in section 482 and net
section 482 transfer price adjustments
(temporary).
*****
(d)(2)(ii)(B) A taxpayer’s selection of
the services cost method for certain ser-
vices, described in §1.482–9T(b), and its
application of that method to a controlled
services transaction will be considered
reasonable for purposes of the specified
method requirement only if the taxpayer
reasonably allocated and apportioned
costs in accordance with §1.482–9T(k),
reasonably concluded that the controlled
services transaction meets the conditions
of §1.482–9T(b)(3), and reasonably con-
cluded that the controlled services transac-
tion is not described in §1.482–9T(b)(2).
***
*****
Cynthia Grigsby,
Senior Federal Register Liaison Officer,
Legal Processing Division,
Associate Chief Counsel
(Procedure and Administration).
(Filed by the Office of the Federal Register on December 21,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 22, 2006, 71 F.R. 76902)
January 29, 20074192007–5 I.R.B.

Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the ef-
fect:
Amplifieddescribes a situation where
no change is being made in a prior pub-
lished position, but the prior position is be-
ingextendedtoapplytoavariationofthe
fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that the
same principle also applies to B, the earlier
ruling is amplified. (Compare withmodi-
fied,below).
Clarifiedis used in those instances
where the language in a prior ruling is be-
ing made clear because the language has
caused, or may cause, some confusion.
It is not used where a position in a prior
ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.
Modifiedis used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to A but not to B, and the
new ruling holds that it applies to both A
and B, the prior ruling is modified because
it corrects a published position. (Compare
withamplifiedandclarified, above).
Obsoleteddescribes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used in
a ruling that lists previously published rul-
ings that are obsoleted because of changes
in laws or regulations. A ruling may also
be obsoleted because the substance has
been included in regulations subsequently
adopted.
Revokeddescribes situations where the
position in the previously published ruling
is not correct and the correct position is
beingstatedinanewruling.
Supersededdescribes a situation where
the new ruling does nothing more than re-
state the substance and situation of a previ-
ously published ruling (or rulings). Thus,
the term is used to republish under the
1986 Code and regulations the same po-
sition published under the 1939 Code and
regulations. The term is also used when
it is desired to republish in a single rul-
ing a series of situations, names, etc., that
were previously published over a period of
time in separate rulings. If the new rul-
ing does more than restate the substance
of a prior ruling, a combination of terms
is used. For example,modifiedandsu-
persededdescribes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previously
published ruling in a new ruling that is self
contained. In this case, the previously pub-
lished ruling is first modified and then, as
modified, is superseded.
Supplementedis used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names in
subsequent rulings. After the original rul-
ing has been supplemented several times, a
new ruling may be published that includes
the list in the original ruling and the ad-
ditions, and supersedes all prior rulings in
the series.
Suspendedis used in rare situations
to show that the previous published rul-
ings will not be applied pending some
future action such as the issuance of new
or amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The fol
lowing abbreviations in current use
and for
merly used will appear in material
publis
hedintheBulletin.
A—Individual.
Acq.—A
cquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank
.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cu
mulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Coo
perative.
Ct.D.—Court Decision.
CY—County.
D—Decede
nt.
DC—Dummy Corporation.
DE—Donee.
Del. Order
—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Emp
loyer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduc
iary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Fo
reign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Fed
eral Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grante
e.
GP—General Partner.
GR—Grantor.
IC—Insura
nce Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited
Partner.
LR—Lessor.
M—Minor.
Nonacq.—No
nacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Persona
l Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Pa
rtnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Re
al Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsi
diary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target
Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Trans
feree.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpay
er.
TR—Trust.
TT—Trustee.
U.S.C.—Uni
ted States Code.
X—Corporation.
Y—Corporation.
Z—Corporat
ion.
2007–5 I.R.B.iJanuary 29, 2007

Numerical Finding List
1
Bulletins 2007–1 through 2007–5
Announcements:
2007-1, 2007-1 I.R.B.243
2007-2, 2007-2 I.R.B.263
2007-3, 2007-4 I.R.B.376
2007-5, 2007-4 I.R.B.376
2007-6, 2007-4 I.R.B.376
2007-7, 2007-4 I.R.B.377
2007-8, 2007-5 I.R.B.416
2007-9, 2007-5 I.R.B.417
Notices:
2007-1, 2007-2 I.R.B.254
2007-2, 2007-2 I.R.B.254
2007-3, 2007-2 I.R.B.255
2007-4, 2007-2 I.R.B.260
2007-5, 2007-3 I.R.B.269
2007-6, 2007-3 I.R.B.272
2007-7, 2007-5 I.R.B.395
2007-8, 2007-3 I.R.B.276
2007-9, 2007-5 I.R.B.401
2007-10, 2007-4 I.R.B.354
2007-11, 2007-5 I.R.B.405
2007-12, 2007-5 I.R.B.409
2007-13, 2007-5 I.R.B.410
Proposed Regulations:
REG-152043-05, 2007-2 I.R.B.263
REG-125632-06, 2007-5 I.R.B.415
Revenue Procedures:
2007-1, 2007-1 I.R.B.1
2007-2, 2007-1 I.R.B.88
2007-3, 2007-1 I.R.B.108
2007-4, 2007-1 I.R.B.118
2007-5, 2007-1 I.R.B.161
2007-6, 2007-1 I.R.B.189
2007-7, 2007-1 I.R.B.227
2007-8, 2007-1 I.R.B.230
2007-9, 2007-3 I.R.B.278
2007-10, 2007-3 I.R.B.289
2007-11, 2007-2 I.R.B.261
2007-12, 2007-4 I.R.B.354
2007-13, 2007-3 I.R.B.295
2007-14, 2007-4 I.R.B.357
2007-15, 2007-3 I.R.B.300
2007-16, 2007-4 I.R.B.358
2007-17, 2007-4 I.R.B.368
2007-18, 2007-5 I.R.B.413
Revenue Rulings:
2007-1, 2007-3 I.R.B.265
2007-2, 2007-3 I.R.B.266
Revenue Rulings— Continued:
2007-3, 2007-4 I.R.B.350
2007-4, 2007-4 I.R.B.351
2007-5, 2007-5 I.R.B.378
2007-6, 2007-5 I.R.B.393
Treasury Decisions:
9300, 2007-2 I.R.B.246
9301, 2007-2 I.R.B.244
9302, 2007-5 I.R.B.382
9303, 2007-5 I.R.B.379
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2006–27 through 2006–52 is in Internal Revenue Bulletin
2006–52, dated December 26, 2006.
January 29, 2007ii2007–5 I.R.B.

Finding List of Current Actions on
Previously Published Items
1
Bulletins 2007–1 through 2007–5
Notices:
2005-29
Modified and superseded by
Notice 2007-4, 2007-2 I.R.B.260
2006-2
Modified and superseded by
Notice 2007-4, 2007-2 I.R.B.260
2006-50
Amplified, clarified, and modified by
Notice 2007-11, 2007-5 I.R.B.405
Proposed Regulations:
REG-141901-05
Corrected by
Ann. 2007-7, 2007-4 I.R.B.377
REG-142270-05
Corrected by
Ann. 2007-2, 2007-2 I.R.B.263
REG-127819-06
Corrected by
Ann. 2007-5, 2007-4 I.R.B.376
REG-136806-06
Corrected by
Ann. 2007-6, 2007-4 I.R.B.376
Revenue Procedures:
98-20
Superseded by
Rev. Proc. 2007-12, 2007-4 I.R.B.354
2000-38
Modified by
Rev. Proc. 2007-16, 2007-4 I.R.B.358
2000-50
Modified by
Rev. Proc. 2007-16, 2007-4 I.R.B.358
2002-9
Modified by
Rev. Proc. 2007-16, 2007-4 I.R.B.358
Modified and amplified by
Rev. Proc. 2007-14, 2007-4 I.R.B.357
2004-11
Superseded by
Rev. Proc. 2007-16, 2007-4 I.R.B.358
2005-12
Superseded by
Rev. Proc. 2007-17, 2007-4 I.R.B.368
Revenue Procedures— Continued:
2005-69
Superseded by
Rev. Proc. 2007-15, 2007-3 I.R.B.300
2006-1
Superseded by
Rev. Proc. 2007-1, 2007-1 I.R.B.1
2006-2
Superseded by
Rev. Proc. 2007-2, 2007-1 I.R.B.88
2006-3
Superseded by
Rev. Proc. 2007-3, 2007-1 I.R.B.108
2006-4
Superseded by
Rev. Proc. 2007-4, 2007-1 I.R.B.118
2006-5
Superseded by
Rev. Proc. 2007-5, 2007-1 I.R.B.161
2006-6
Superseded by
Rev. Proc. 2007-6, 2007-1 I.R.B.189
2006-7
Superseded by
Rev. Proc. 2007-7, 2007-1 I.R.B.227
2006-8
Superseded by
Rev. Proc. 2007-8, 2007-1 I.R.B.230
Revenue Rulings:
2003-43
Modified by
Notice 2007-2, 2007-2 I.R.B.254
2005-76
Supplemented and superseded by
Rev. Rul. 2007-4, 2007-4 I.R.B.351
Treasury Decisions:
9278
Corrected by
Ann. 2007-9, 2007-5 I.R.B.417
9286
Corrected by
Ann. 2007-8, 2007-5 I.R.B.416
1
A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2006–27 through 2006–52 is in Internal Revenue Bulletin 2006–52, dated December 26,
2006.
2007–5 I.R.B.iiiJanuary 29, 2007

INDEX
Internal Revenue Bulletins 2007–1 through
2007–5
The abbreviation and number in parenthesis following the index entry
refer to the specific item; numbers in roman and italic type following
the parenthesis refers to the Internal Revenue Bulletin in which the item
may be found and the page number on which it appears.
Key to Abbreviations:
AnnAnnouncement
CDCourt Decision
DODelegation Order
EOExecutive Order
PLPublic Law
PTEProhibited Transaction Exemption
RPRevenue Procedure
RRRevenue Ruling
SPRStatement of Procedural Rules
TCTax Convention
TDTreasury Decision
TDOTreasury Department Order
EMPLOYEE PLANS
Corporations, prohibited allocations of securities in an S corpo-
ration (TD 9302) 5,382
Determination letters, issuing procedures (RP 6) 1,189
Full funding limitations, weighted average interest rate for:
January 2007 (Notice 12) 5,409
Letter rulings:
And determination letters, areas which will not be issued
from:
Associates Chief Counsel and Division Counsel (TE/GE)
(RP 3) 1,108
Associate Chief Counsel (International) (RP 7) 1,227
And general information letters, procedures (RP 4) 1,118
User fees, request for letter rulings (RP 8) 1,230
Qualified retirement plans:
Defined benefit pension plans, cash balance and other hybrid
plans (Notice 6) 3,272
Distribution issues, multiple issues (Notice 7) 5,395
Pension plans, in-service distributions (Notice 8) 3,276
Remedial amendment period (Notice 3) 2,255
Regulations:
26 CFR 1.402(c)–2, revised; 1.409(p)–1, added; prohibited
allocations of securities inan S corporation (TD 9302) 5,
382
Technical advice to IRS employees (RP 5) 1,161
EMPLOYMENT TAX
Letter rulings and information letters issued by Associate Of-
fices, determination letters issued by Operating Divisions (RP
1) 1,1
Technical Advice Memoranda (TAMs) (RP 2) 1,88
ESTATE TAX
Letter rulings and information letters issued by Associate Of-
fices, determination letters issued by Operating Divisions (RP
1) 1,1
Technical Advice Memoranda (TAMs) (RP 2) 1,88
EXCISE TAX
Communications excise tax (Notice 11) 5,405
Letter rulings and information letters issued by Associate Of-
fices, determination letters issued by Operating Divisions (RP
1) 1,1
Technical Advice Memoranda (TAMs) (RP 2) 1,88
EXEMPT ORGANIZATIONS
Annual notice to donors regarding pending and settled declara-
tory judgment suits (Ann 1) 1,243
Letter rulings:
And determination letters, areas which will not be issued from
Associates Chief Counsel and Division Counsel (TE/GE)
(RP 3) 1,108
And general information letters, procedures (RP 4) 1,118
User fees, request for letter rulings (RP 8) 1,230
Revocations (Ann 3) 4,376
Technical advice to IRS employees (RP 5) 1,161
GIFT TAX
Letter rulings and information letters issued by Associate Of-
fices, determination letters issued by Operating Divisions (RP
1) 1,1
Technical Advice Memoranda (TAMs) (RP 2) 1,88
INCOME TAX
Accounting methods:
Automatic consent to change accounting method for execu-
tory contract liabilities (RP 14) 4,357
Changes in accounting methods (RP 16) 4,358
Executory contract liabilities (RR 3) 4,350
Annual notice to donors regarding pending and settled declara-
tory judgment suits (Ann 1) 1,243
Annuities, exchanges of property for an annuity contract, change
in hearing location for REG–141901–05 (Ann 7) 4,377
Communications excise tax (Notice 11) 5,405
Consumer Price Index (CPI) adjustments, certain loans under
section 1274A for 2007 (RR 4) 4,351
Controlled services transactions under section 482, treatment, al-
location of income and deductions from intangibles, and stew-
ardship expense, correction to TD 9278 (Ann 9) 5,417
Corporations:
Bulgarian per se entity (Notice 10) 4,354
Controlled foreign corporation (CFC):
Subpart F income (Notice 9) 5,401
January 29, 2007iv2007–5 I.R.B.

INCOME TAX—Cont.
Substantial assistance, shipping income (Notice 13) 5,410
Corporate reorganizations, distributions under sections
368(a)(1)(D) and 354(b)(1)(B) (TD 9303) 5,379;
(REG–125632–06) 5,415
Foreign corporation interest expense allocations, branch prof-
its tax, election for liability reduction (Notice 1) 2,254
Credits:
Low-income housing credit, satisfactory bond, “bond factor”
amounts for the period:
January through March 2007 (RR 5) 5,378
Railroad track maintenance credit, hearing cancellation for
REG–142270–05 (Ann 2) 2,263;correctiontoTD9286
(Ann 8) 5,416
Disaster relief, reduction in taxable income for housing Hur-
ricane Katrina displacedindividuals (TD 9301) 2,244;
(REG–152043–05) 2,263
Electronic filing, elimination of regulatory impediments to filing
certain business income tax returns and other forms (TD 9300)
2,246
Employer-provided vehicles, cents-per-mile valuation rule, max-
imum vehicle values (RP 11) 2,261
Forms 1096, 1098, 1099, 5498, W-2G, and 1042-S, substitute
form specifications (RP 15) 3,300
Health reimbursement arrangements (HRAs), debit cards (Notice
2) 2,254
Information reporting requirements, exclusion of the sale or ex-
change of a principle residence (RP 12) 4,354
Insurance companies:
Loss payment patterns and discount factors for the 2006 acci-
dent year (RP 9) 3,278
Salvage discount factors forthe 2006 accident year (RP 10)
3,289
Interest:
Investment:
Federal short-term, mid-term, and long-term rates for:
January 2007 (RR 2) 3,266
Inventory:
LIFO, price indexes used by department stores for:
November 2006 (RR 6) 5,393
Leases, tax-exempt use property (Notice 4) 2,260
Letter rulings:
And determination letters, areas which will not be issued
from:
Associates Chief Counsel and Division Counsel (TE/GE)
(RP 3) 1,108
Associate Chief Counsel (International) (RP 7) 1,227
And information letters issued by Associate Offices, determi-
nation letters issued by Operating Divisions (RP 1) 1,1
Nonsufficient funds (NSF) fees, accounting for credit card NSF
fees that are not interest (RR 1) 3,265
Pre-Filing Agreement (PFA) program, continued (RP 17) 4,368
Proposed Regulations:
26 CFR 1.45G–0, –1, added; railroad track maintenance
credit, hearing cancellation for REG–142270–05 (Ann 2)
2,263
INCOME TAX—Cont.
26 CFR 1.368–2, amended; corporate reorganizations, dis-
tributions under sections 368(a)(1)(D) and 354(b)(1)(B)
(REG–125632–06) 5,415
26 CFR 1.9300–1, added; reduction in taxable income
for housing Hurricane Katrina displaced individuals
(REG–152043–05) 2,263
Qualified Zone Academy Bonds, allocations for years 2006 and
2007 (RP 18) 5,413
Regulations:
26 CFR 1.45G–0T, –1T, added; railroad track maintenance
credit; correction to TD 9286 (Ann 8) 5,416
26 CFR 1.368–2, amended; 1.368–2T, added; corporate reor-
ganizations, distributions under sections 368(a)(1)(D) and
354(b)(1)(B) (TD 9303) 5,379
26 CFR 1.170A–11, amended; 1.170A–11T, removed;
1.556–2, amended; 1.556–2T, removed; 1.565–1,
amended; 1.565–1T, removed; 1.936–7, amended;
1.936–7T, removed; 1.1017–1, amended; 1.1017–1T,
removed; 1.1368–1, amended; 1.1368–1T, removed;
1.1377–1, amended; 1.1377–1T, removed; 1.1502–21,
amended; 1.1502–21T, amended; 1.1502–75, amended;
1.1502–75T, removed; 1.1503–2, amended; 1.1503–2T,
removed; 1.6038B–1, amended; 1.6038B–1T, amended;
301.7701–3, amended; 301.7701–3T, removed; 602.101,
amended; guidance necessary to facilitate business elec-
tronic filing (TD 9300) 2,246
26 CFR 1.482; 1.861; 1.6038; 1.6038A; 1.6662; treatment of
services under section 482, allocation of income and deduc-
tions from intangibles, stewardship expense, correction to
TD9278(Ann9)5,417
26 CFR 1.9300–1T, added; reduction in taxable income for
housing Hurricane Katrina displaced individuals (TD 9301)
2,244
Revocations, exempt organizations (Ann 3) 4,376
Services cost method:
And other issues under section 482 temporary regulations,
partial modification of effective date and clarification (No-
tice 5) 3,269
Under section 482 regulations, specified covered services el-
igible (RP 13) 3,295
Substitute Forms 1096, 1098, 1099, 5498, W-2G, and 1042-S,
rules and specifications (RP 15) 3,300
Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA)
amendments to section 199, change in hearing location for
REG–127819–06 (Ann 5) 4,376
Technical Advice Memoranda (TAMs) (RP 2) 1,88
Treatment of payments in lieu of taxes under section 141, change
in hearing location for REG–136806–06 (Ann 6) 4,376
SELF-EMPLOYMENT TAX
Letter rulings and information letters issued by Associate Of-
fices, determination letters issued by Operating Divisions (RP
1) 1,1
Technical Advice Memoranda (TAMs) (RP 2) 1,88
2007–5 I.R.B.vJanuary 29, 2007

January 29, 20072007–5 I.R.B.

2007–5 I.R.B.January 29, 2007

January 29, 20072007–5 I.R.B.

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