Internal Revenue Bulletin 2002-33 (PDF rendition): IRS Announcements

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

HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be re-
lied upon as authoritative interpretations.
INCOME TAX
Rev. Rul. 2002–51, page 327.
Low-income housing credit; satisfactory bond; “bond
factor” amounts for the period July through September
2002. This ruling announces the monthly bond factor amounts
to be used by taxpayers who dispose of qualified low-income
buildings or interests therein during the period July through
September 2002.
T.D. 9004, page 331.
Final regulations under section 860E of the Code detail safe
harbor conditions under which the transfer of a REMIC noneco-
nomic residual interest or FASIT ownership interest is presumed
to be accomplished without an intention to impede the assess-
ment or collection of tax. Rev. Proc. 2001–12 obsoleted.
T.D. 9008, page 335.
Final regulations under sections 702, 952, 954, and 956 of the
Code provide guidance necessary to clarify the treatment by a
controlled foreign corporation (CFC) of its distributive share of
partnership income under subpart F of the Code.
T.D. 9009, page 328.
Final regulations under section 706 of the Code provide guid-
ance on determining the taxable year of a partnership with
certain foreign partners and tax-exempt partners.
REG–115781–01, page 380.
Proposed regulations under section 2055 of the Code conform
the income, gift, and estate tax regulations to the Tax Court’s
decision inEstate of Boeshore v. Commissioner, 78 T.C. 523
(1982),acq. in result, 1987–2 C.B. 1, holding portions of
section 20.2055(e)(2)(vi)(e) of the estate tax regulations invalid.
Rev. Rul. 76–225 revoked. A public hearing is scheduled for
October 16, 2002.
EMPLOYEE PLANS
REG–124256–02, page 383.
Proposed regulations under sections 408 and 408A of the Code
provide a new method for determining the earnings allocable to
IRA contributions that are returned or recharacterized before
the applicable tax return due date.
Notice 2002–57, page 379.
Weighted average interest rate update. The weighted aver-
age interest rate for August 2002 and the resulting permissible
range of interest rates used to calculate current liability for
purposes of the full funding limitation of section 412(c)(7) of the
Code are set forth.
ESTATE TAX
REG–115781–01, page 380.
Proposed regulations under section 2055 of the Code conform
the income, gift, and estate tax regulations to the Tax Court’s
decision inEstate of Boeshore v. Commissioner, 78 T.C. 523
(1982),acq. in result, 1987–2 C.B. 1, holding portions of
section 20.2055(e)(2)(vi)(e) of the estate tax regulations invalid.
Rev. Rul. 76–225 revoked. A public hearing is scheduled for
October 16, 2002.
GIFT TAX
REG–115781–01, page 380.
Proposed regulations under section 2055 of the Code conform
the income, gift, and estate tax regulations to the Tax Court’s
decision inEstate of Boeshore v. Commissioner, 78 T.C. 523
(1982),acq. in result, 1987–2 C.B. 1, holding portions of
section 20.2055(e)(2)(vi)(e) of the estate tax regulations invalid.
Rev. Rul. 76–225 revoked. A public hearing is scheduled for
October 16, 2002.
Bulletin No. 2002–33
August 19, 2002
Finding Lists begin on page ii.(Continued on the next page)

ADMINISTRATIVE
T.D. 9007, page 349.
Final regulations under sections 7122, 6331, and 6103 of the
Code provide procedures for the compromise of Internal Rev-
enue tax and provide expanded compromise authority for the
IRS. The regulations will permit compromise of liabilities when
there is doubt as to the amount of the liability owed, when there
is doubt whether the full amount of the tax can be collected, and
when compromise would promote effective tax administration.
The IRS may compromise to promote effective tax administra-
tion when it determines that collection of the full amount of the
tax liability would create economic hardship or that compelling
public policy or equity considerations identified by the taxpayer
provide a sufficient basis for compromise.
T.D. 9010, page 341.
Final regulations under sections 6041 and 6045 of the Code
concern information reporting requirements for certain pay-
ments made on behalf of another person, payments to joint
payees, and payments of gross proceeds from sales involving
investment advisors. Rev. Ruls. 54–571, 55–606, 59–328,
64–36, 65–129, 67–197, 73–232, 77–53, 85–50, and 93–70
obsoleted as of January 1, 2003. Rev. Ruls. 69–595 and
70–608 obsoleted in part as of January 1, 2003.
T.D. 9011, page 356.
Final regulations provide clarifying guidance with respect to and
modify the regulations governing practice before the Internal
Revenue Service (Circular 230).
Announcement 2002–73, page 387.
The Service announces that a supplement to Publication 590,
Individual Retirement Arrangements (IRAs), is now available.
Announcement 2002–74, page 387.
The Service announces that an updated edition, revised June
2002, of Publication 971,Innocent Spouse Relief (And
Separation of Liability and Equitable Relief)is currently
available.
August 19, 20022002–33 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 consolidated semiannually into Cumulative Bulle-
tins, which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all
substantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of internal
management are not published; however, statements of internal
practices and procedures that affect the rights and duties of
taxpayers are published.
Revenue rulings represent the conclusions of the Service on the
application of the law to the pivotal facts stated in the revenue
ruling. In those based on positions taken in rulings to taxpayers
or technical advice to Service field offices, identifying details
and information of a confidential nature are deleted to prevent
unwarranted invasions of privacy and to comply with statutory
requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying 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.—1986 Code.
This part includes rulings and decisions based on provisions of
the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A, Tax
Conventions and Other Related Items, and Subpart B, Legisla-
tion and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
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 Secretary
(Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbarment
and suspension lists, and announcements.
The first Bulletin for each month includes a cumulative index for
the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the first Bulletin of the succeeding semiannual
period, respectively.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402
2002–33 I.R.B.August 19, 2002

This page is reserved for missing child Maricela Rumbo
August 19, 20022002–33 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 July through September
2002. This ruling announces the monthly
bond factor amounts to be used by
taxpayers who dispose of qualified low-
income buildings or interests therein
duringtheperiodJulythrough
September 2002.
Rev. Rul. 2002–51
In Rev. Rul. 90–60, 1990–2 C.B. 3, the
Internal Revenue Service provided guid-
ance to taxpayers concerning the general
methodology used by the Treasury De-
partment in computing the bond factor
amounts used in calculating the amount of
bond considered satisfactory by the Sec-
retary under § 42(j)(6) of the Internal
Revenue Code. It further announced that
the Secretary would publish in the Internal
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
alternative 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 satisfac-
tory under § 42(j)(6) or the amount of
United States Treasury securities to pledge
in a Treasury Direct Account under Rev.
Proc. 99–11 for dispositions of qualified
low-income buildings or interests therein
during the period July through September
2002.
Table 1
Rev. Rul. 2002–51
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
19881989199019911992199319941995199619971998
Jul ’0217.7632.7345.4456.2465.4664.9065.4265.9466.5867.2968.17
Aug ’0217.7632.7345.4456.2465.4664.7465.2665.7866.4267.1368.01
Sep ’0217.7632.7345.4456.2465.4664.5865.1065.6266.2666.9867.86
Table 1 (cont’d)
Rev. Rul. 2002–51
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
1999200020012002
Jul ’0269.0569.9471.2572.55
Aug ’0268.9069.8171.1472.55
Sep ’0268.7669.6871.0472.55
For a list of bond factor amounts appli-
cable to dispositions occurring during
other calendar years, see: Rev. Rul.
98–3, 1998–1 C.B. 248; Rev. Rul.
2001–2, 2001–2 C.B. 255; and Rev. Rul.
2001–53,2001–46I.R.B.489.For
2002–33 I.R.B.327August 19, 2002

dispositions occurring during the period
January through March 2002, see Rev.
Rul. 2002–8, 2002-9 I.R.B. 564. For
dispositions occurring during the period
April through June 2002, see Rev. Rul.
2002–24, 2002–19 I.R.B. 848.
DRAFTING INFORMATION
The principal author of this revenue
ruling is Gregory N. Doran of the Office
of Associate Chief Counsel (Passthroughs
and Special Industries). For further infor-
mation regarding this revenue ruling, con-
tact Mr. Doran at (202) 622–3040 (not a
toll-free number).
Section 706.—Taxable Years
of Partner and Partnership
26 CFR 1.706–1: Taxable years of partner and
partnership.
T.D. 9009
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Taxable Years of Partner and
Partnership; Foreign Partners
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations and removal
of temporary regulations.
SUMMARY: This document contains fi-
nal regulations on the taxable year of a
partnership with foreign partners and tax-
exempt partners. The final regulations
provide that in certain circumstances the
taxable year of a partnership will be de-
termined without regard to the taxable
year of certain foreign partners and certain
tax-exempt partners.
DATES:Effective date:These regulations
are effective on July 23, 2002.
Applicability date:For dates of appli-
cabilityoftheseregulations,see
§§1.706–1(b)(5)(iii), (b)(6)(v), and (b)
(11)(ii).
FOR FURTHER INFORMATION CON-
TACT: Dan Carmody, (202) 622–3080
(not a toll-free number). For specific in-
formation regarding international issues,
contact Ronald M. Gootzeit, (202) 622–
3860 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Introduction
This document finalizes portions of
§1.706–1(b) of the Income Tax Regula-
tions (26 CFR part 1) relating to the
determination of the taxable year of a
partnership with tax-exempt partners and
foreign partners. This document also with-
draws§1.706–3T (26 CFR part 1).
Background
On May 24, 1988, Treasury and the
Internal Revenue Service (IRS) issued
temporary regulations (§1.706–3T, pro-
mulgated as part of T.D. 8205 (1998–1
C.B. 56 [53 FR 19688])) with a contem-
poraneous notice of proposed rulemaking
(LR–53–88, 1988–1 C.B. 935 [53 FR
19715]) relating to the determination of
the taxable year of a partnership with
tax-exempt partners (the 1988 Proposed
Regulations). On January 17, 2001, Trea-
sury and the IRS published in theFederal
Registera notice of proposed rulemaking
(REG–104876–00, 2001–1 C.B. 998 [66
FR 3920]) to provide guidance relating to
the determination of the taxable year of a
partnership with foreign partners (the
2001 Proposed Regulations). In that notice
of proposed rulemaking, Treasury and the
IRS also indicated that the 1988 Proposed
Regulations would be finalized. A public
hearing was held on June 6, 2001. After
consideration of the comments, the pro-
posed regulations are adopted as revised
by this Treasury decision.
Explanation of Revisions and
Summary of Comments
I.In General
Section 706 provides rules relating to
the taxable years of a partnership and its
partners. Under section 706(a), in comput-
ing the taxable income of a partner for a
taxable year, the partner must include the
partner’s share of any income, gain, loss,
deduction, or credit of the partnership for
the partnership’s taxable year that ends
within or with the partner’s taxable year.
Section 706(b)(1)(B) provides that, un-
less the partnership establishes a business
purpose for a different taxable year, a
partnership cannot have a taxable year
other than: (i) the majority interest taxable
year; (ii) if there is no majority interest
taxable year, the taxable year of all the
principal partners of the partnership; or
(iii) if there is no taxable year described in
(i) or (ii), the calendar year unless the
Secretary by regulation prescribes another
period. Section 1.706–1(b)(2) of the In-
come Tax Regulations provides that, if
neither section 706(b)(1)(B)(i) nor (ii) ap-
ply, the partnership’s taxable year will be
the taxable year that results in the least
aggregate deferral of partnership income.
As part of a larger guidance project on
accounting periods, the regulations under
section 706 were restructured on May 17,
2002 (T.D. 8996, 2002–24 I.R.B. 1127 [67
FR 35009]). To conform with the restruc-
turing, the regulations finalized by this
document will be finalized as amendments
to§1.706–1 even though they were pro-
posed under§§1.706–3 and 1.706–4. A
small portion of the proposed regulation
under§1.706–3 dealing with the effect of
partner elections under section 444 has
been finalized as§1.706–1(b)(11).
II.Treatment of Tax-Exempt Partners
The 1988 Proposed Regulations pro-
vide that, in determining the taxable year
(the current year) of a partnership under
section 706(b) and the regulations there-
under, a partner that is tax-exempt under
section 501(a) is disregarded if such part-
ner was not subject to tax, under chapter 1
of the Internal Revenue Code (Code), on
any income attributable to its investment
in the partnership during the partnership’s
taxable year immediately preceding the
current year. This Treasury decision final-
izes the 1988 Proposed Regulations with-
out substantive change and withdraws the
temporary regulations.
III.Treatment of Foreign Partners
A.General rule
The 2001 Proposed Regulations gener-
ally provide that a foreign partner that is
not subject to U.S. taxation on a net basis
on income earned through the partnership
is disregarded for purposes of section
706(b). For these purposes, a foreign part-
ner will be considered subject to U.S.
taxation on a net basis only if the partner
is allocated gross income of the partner-
ship that is effectively connected (or
August 19, 20023282002–33 I.R.B.

treated as effectively connected) with the
conduct of a trade or business within the
United States (effectively connected in-
come or ECI). In the case of a foreign
partner claiming benefits under a U.S.
income tax treaty, such partner is disre-
garded unless it is allocated any gross
income that is attributable to a permanent
establishment in the United States.
The final regulations follow the same
approach as the proposed regulations, but
the general rule has been clarified to
provide that a foreign partner is disre-
garded unless such partner is allocated any
gross income that is ECI, and the taxation
of the income is not otherwise precluded
under any U.S. income tax treaty. Gross
income for these purposes does not in-
clude income that is excluded under an-
other Code provision (e.g., the exclusion
from gross income under section 883 for
certain transportation income). Further, as
the preamble to the proposed regulations
(REG–104876–00, 2001–1 C.B. 998 [66
FR 3920, 3922]) states, the Commissioner
may challenge an arrangement that, while
conforming to these rules, is undertaken
with a principal purpose of achieving a tax
result that is inconsistent with the intent of
section 706.§1.701–2.
A commentator questioned the statu-
tory authority for regulations that disre-
gard the interest in a partnership held by
certain foreign partners in determining a
partnership’s taxable year under section
706(b). Treasury and the IRS believe that
they have the authority to adopt these final
regulations in order to resolve ambiguity
in the statutory provisions in a manner that
is consistent with the objectives of section
706(b) to eliminate or reduce the amount
of deferral available on income earned
through a partnership.
B.Application of the minority interest
rule
Treasury and the IRS recognize that
requiring a partnership taxable year to be
determined without regard to certain for-
eign partners may present difficulties for
minority partners in some cases. For this
reason, the proposed regulations include a
“minority interest rule”which provides
that the taxable years of foreign partners
are not disregarded for purposes of section
706(b) if no single partner (other than a
disregarded foreign partner) holds a
10-percent or greater interest in the capital
or profits of the partnership, and if, in the
aggregate, the partners that are not disre-
garded foreign partners do not hold a
20-percent or greater interest in the capital
or profits of the partnership.
The 2001 Proposed Regulations pro-
vide that, for purposes of determining a
partner’s ownership in the partnership, the
constructive ownership rules of section
318 apply (substituting“10 percent”for
“50 percent”in section 318(a)(2)(C) and
(3)(C)) and the attribution rules of section
267(c) also apply to the extent that those
rules attribute ownership to persons to
whom section 318 does not attribute own-
ership. These regulations replace this at-
tribution rule with an attribution rule
based on the principles of sections 267(b)
and 707(b). Attribution under sections
267(b) and 707(b) is more commonly
applied in the partnership context than is
attribution under section 318, which is
generally used to determine constructive
ownership of stock.
Commentators expressed concern that
the 10- and 20-percent thresholds were too
low. They explained that U.S. minority
partners would have difficulty reporting
partnership income timely under these
rules, because a U.S. minority partner
typically lacks the practical or legal ability
to cause a foreign partnership to close its
books and conduct a mid-year accounting.
Treasury and the IRS believe that partners
can generally negotiate with the partner-
ship to obtain the information needed to
comply with their reporting obligations
under these regulations. Recognizing,
though, that partners in existing partner-
ships may not be in a position to renego-
tiate for partnership information, Treasury
and the IRS have made these regulations
applicable on a mandatory basis only to
partnerships formed on or after September
23, 2002. Partnerships formed before Sep-
tember 23, 2002, however, may elect to
change their taxable years to conform with
these regulations. Such a change will be
treated as a change to a required taxable
year under§4 of Rev. Proc. 2002–38,
2002–22 I.R.B. 1037, or any successor,
and the partnership will then be subject to
the requirements of§1.706–1(b)(6).
Moreover, if an existing partnership termi-
natesundertherulesofsection
708(b)(1)(B), the resulting partnership
will be subject to the requirements of
these regulations. Treasury and the IRS
request comments on additional ways in
which the administrative burdens associ-
ated with these regulations may be re-
duced.
The preamble to the 2001 Proposed
Regulationsrequestscommentson
whether tax-exempt partners should be
excluded for purposes of the minority
interest rule. As no comments were re-
ceived, the final regulations consider tax-
exempt partners in determining whether
the minority interest rule applies.
IV.Effective Date
The regulations under§1.706–1(b)(5)
relating to the taxable year of a partner-
ship with tax-exempt partners apply to
taxable years beginning on or after July
23, 2002. For taxable years beginning
before July 23, 2002, see§1.706–3T as
contained in 26 CFR part 1 revised April
1, 2002.
The regulations under§1.706–1(b)(6)
relating to the taxable year of a partner-
ship with foreign partners are applicable
for taxable years of partnerships (other
than existing partnerships as defined in
§1.706–1(b)(6)(v)) beginning on or after
July 23, 2002.
The regulations under§1.706–1(b)(11)
relating to the effect of partner elections
under section 444 are applicable for tax-
able years of partnerships beginning on or
after July 23, 2002. For taxable years
beginning before July 23, 2002, see
§1.706–3T as contained in 26 CFR part 1
revised April 1, 2002.
V.Transitional Relief for Existing
Partnerships with Foreign Partners.
The 2001 Proposed Regulations recog-
nize that a potential hardship exists for
partners of an existing partnership that
changes its taxable year to comply with
§1.706–1(b)(6). If the change results in
two partnership taxable years ending
within a partner’s single taxable year, that
partner could experience a bunching of
more than 12 months of partnership in-
come in a single taxable year. In order to
avoid potential hardships, the 2001 Pro-
posed Regulations incorporate the transi-
tional rules of§1.702–3T to allow the
gain recognition to be spread over a four-
year period. A partnership that uses this
transitional rule is required to take into
2002–33 I.R.B.329August 19, 2002

account all items of income, gain, loss,
deduction and credit ratably over the four-
year period.
Unlike the 2001 Proposed Regulations,
these regulations do not require that exist-
ing partnerships change their taxable years
to conform to the regulations. Because the
regulations do not require existing partner-
ships to change their taxable years, the
need for transitional relief is less impera-
tive. Nevertheless, to encourage existing
partnerships to change their taxable years
to conform to these regulations, Treasury
and the IRS have retained the transitional
rule for any partnership that elects to
apply the regulations in its first taxable
year beginning on or after July 23, 2002.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It also has been deter-
mined that section 553(b) of the Adminis-
trative Procedure Act (5 U.S.C. chapter 5)
and the Regulatory Flexibility Act (5
U.S.C. chapter 6) do not apply to these
regulations and, therefore, a Regulatory
Flexibility Analysis is not required. Pur-
suant to section 7805(f) of the Code, the
notice of proposed rulemaking preceding
these regulations was submitted to the
Small Business Administration for com-
ment on its impact on small business.
Drafting Information
The principal author of these regula-
tions is Dan Carmody, Office of the As-
sociate Chief Counsel (Passthroughs and
Special Industries). However, other per-
sonnel from the IRS and Treasury depart-
ment participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PA RT 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805***
Par.2.In§1.706–1, paragraphs (b)(5)
and (b)(6) are revised and paragraph
(b)(11) is added to read as follows:
§1.706–1 Taxable years of partner and
partnership.
*****
(b)***
(5)Taxable year of a partnership with
tax-exempt partners—(i)Certain tax-
exempt partners disregarded. In determin-
ing the taxable year (the current year) of a
partnership under section 706(b) and the
regulations thereunder, a partner that is
tax-exempt under section 501(a) shall be
disregarded if such partner was not subject
to tax, under chapter 1 of the Internal
Revenue Code, on any income attributable
to its investment in the partnership during
the partnership’s taxable year immediately
preceding the current year. However, if a
partner that is tax-exempt under section
501(a) was not a partner during the part-
nership’s immediately preceding taxable
year, such partner will be disregarded for
the current year if the partnership reason-
ably believes that the partner will not be
subject to tax, under chapter 1 of the
Internal Revenue Code, on any income
attributable to such partner’s investment in
the partnership during the current year.
(ii)Example. The provisions of para-
graph (b)(5)(i) of this section may be
illustrated by the following example:
Example. Assume that partnership A has histori-
cally used the calendar year as its taxable year. In
addition, assume that A is owned by 5 partners, 4
calendar year individuals (each owning 10 percent of
A’s profits and capital) and a tax-exempt organiza-
tion (owning 60 percent of A’s profits and capital).
The tax-exempt organization has never had unrelated
business taxable income with respect to A and has
historically used a June 30 fiscal year. Finally,
assume that A desires to retain the calendar year for
its taxable year beginning January 1, 2003. Under
these facts and but for the special rule in paragraph
(b)(5)(i) of this section, A would be required under
section 706(b)(1)(B)(i) to change to a year ending
June 30, for its taxable year beginning January 1,
2003. However, under the special rule provided in
paragraph (b)(5)(i) of this section the partner that is
tax-exempt is disregarded, and A must retain the
calendar year, under section 706(b)(1)(B)(i), for its
taxable year beginning January 1.
(iii)Effective date. The provisions of
this paragraph (b)(5) are applicable for
taxable years beginning on or after July
23, 2002. For taxable years beginning
before July 23, 2002, see§1.706–3T as
contained in 26 CFR part 1 revised April
1, 2002.
(6)Certainforeignpartners
disregarded—(i)Interests of disregarded
foreign partners not taken into account.In
determining the taxable year (the current
taxable year) of a partnership under sec-
tion 706(b) and the regulations thereunder,
any interest held by a disregarded foreign
partner is not taken into account. A foreign
partner is a disregarded foreign partner
unless such partner is allocated any gross
income of the partnership that was effec-
tively connected (or treated as effectively
connected) with the conduct of a trade or
business within the United States during
the partnership’s taxable year immediately
preceding the current taxable year (or, if
such partner was not a partner during the
partnership’s immediately preceding tax-
able year, the partnership reasonably be-
lieves that the partner will be allocated
any such income during the current tax-
able year) and taxation of that income is
not otherwise precluded under any U.S.
income tax treaty.
(ii)Definition of foreign partner. For
purposes of this paragraph (b)(6), a for-
eign partner is any partner that is not a
U.S. person (as defined in section 7701
(a)(30)), except that a partner that is a
controlled foreign corporation (as defined
in section 957(a)) or a foreign personal
holding company (as defined in section
552) shall not be treated as a foreign
partner.
(iii)Minority interest rule. If each part-
ner that is not a disregarded foreign part-
ner under paragraph (b)(6)(i) of this
section (regarded partner) holds less than
a 10-percent interest, and the regarded
partners, in the aggregate, hold less than a
20-percent interest in the capital or profits
of the partnership, then paragraph (b)(6)(i)
of this section does not apply. In determin-
ing ownership in a partnership for pur-
poses of this paragraph (b)(6)(iii), each
regarded partner is treated as owning any
interest in the partnership owned by a
related partner. For this purpose, partners
are treated as related if they are related
within the meaning of sections 267(b) or
707(b) (using the language“10 percent”
instead of“50 percent”each place it
appears). However, for purposes of deter-
mining if partners hold less than a
20-percent interest in the aggregate, the
same interests will not be considered as
August 19, 20023302002–33 I.R.B.

being owned by more than one regarded
partner.
(iv)Example. The provisions of para-
graph (b)(6) of this section may be illus-
trated by the following example:
Example. Partnership B is owned by two part-
ners, F, a foreign corporation that owns a 95-percent
interest in the capital and profits of partnership B,
and D, a domestic corporation that owns the remain-
ing 5-percent interest in the capital and profits of
partnership B. Partnership B is not engaged in the
conduct of a trade or business within the United
States, and, accordingly, partnership B does not earn
any income that is effectively connected with a U.S.
trade or business. F uses a March 31 fiscal year, and
causes partnership B to maintain its books and
records on a March 31 fiscal year as well. D is a
calendar year taxpayer. Under paragraph (b)(6)(i) of
this section, F would be disregarded and partnership
B’s taxable year would be determined by reference to
D. However, because D owns less than a 10-percent
interest in the capital and profits of partnership B, the
minority interest rule of paragraph (b)(6)(iii) of this
section applies, and partnership B must adopt the
March 31 fiscal year for Federal tax purposes.
(v)Effective date—(A)Generally. The
provisions of this paragraph (b)(6) are
applicable for the first taxable year of a
partnership other than an existing partner-
ship that begins on or after July 23, 2002.
For this purpose, an existing partnership is
a partnership that was formed prior to
September 23, 2002.
(B)Voluntary change in taxable year.
An existing partnership may change its
taxable year to a year determined in ac-
cordance with this section. An existing
partnership that makes such a change will
cease to be exempted from the require-
ments of paragraph (b)(6) of this section.
(C)Subsequent sale or exchange of
interests. If an existing partnership termi-
nates under section 708(b)(1)(B), the re-
sulting partnership is not an existing
partnership for purposes of paragraph
(b)(6)(v)(A) of this section.
(D)Transition rule. If, in the first
taxable year beginning on or after July 23,
2002, an existing partnership voluntarily
changes its taxable year to a year deter-
mined in accordance with this paragraph
(b)(6), then the partners of that partnership
may apply the provisions of§1.702–3T to
take into account all items of income,
gain, loss, deduction, and credit attribut-
able to the partnership year of change
ratably over a four-year period.
*****
(11)Effect of partner elections under
section 444—(i)Election taken into ac-
count.Forpurposesofsection
706(b)(1)(B), any section 444 election by
a partner in a partnership shall be taken
into account in determining the taxable
year of the partnership. See§1.7519–1T
(d),Example (4).
(ii)Effective date. The provisions of
this paragraph (b)(11) are applicable for
taxable years beginning on or after July
23, 2002. For taxable years beginning
before July 23, 2002, see§1.706–3T as
contained in 26 CFR part 1 revised April
1, 2002.
*****
§1.706–3T [Removed]
Par. 3. Section 1.706–3T is removed.
David A. Mader,
Acting Deputy Commissioner
of Internal Revenue.
Approved July 16, 2002.
Pamela F. Olson,
Acting Assistant Secretary of the Treasury.
(Filed by the Office of the Federal Register on July
22, 2002, 8:45 a.m., and published in the issue of the
Federal Register for July 23, 2002, 67 F.R. 48017)
Section 860E.—Treatment of
Income in Excess of Daily
Accruals on Residual Interests
26 CFR 1.860E–1: Treatment of taxable income of
a residual interest holder in excess of daily
accruals.
T.D. 9004
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Real Estate Mortgage
Investment Conduits
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains fi-
nal regulations relating to safe harbor
transfers of noneconomic residual inter-
ests in real estate mortgage investment
conduits (REMICs). The final regulations
provide additional limitations on the cir-
cumstances under which transferors may
claim safe harbor treatment.
DATES:Effective date:These regulations
are effective July 19, 2002.
Applicability date:For dates of appli-
cability of these regulations, see§1.860
E–(1)(c)(10).
FOR FURTHER INFORMATION CON-
TACT: Courtney Shepardson at (202)
622–3940 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information in this
final rule has been reviewed and, pending
receipt and evaluation of public com-
ments, approved by the Office of Manage-
ment and Budget (OMB) under 44 U.S.C.
3507 and assigned control number 1545–
1675.
The collection of information in this
regulation is in§1.860E–1(c)(5)(ii). This
information is required to enable the IRS
to verify that a taxpayer is complying with
the conditions of this regulation. The col-
lection of information is mandatory and is
required. Otherwise, the taxpayer will not
receive the benefit of safe harbor treat-
ment as provided in the regulation. The
likely respondents are businesses and
other for-profit institutions.
Comments on the collection of infor-
mation should be sent to theOffice of
Management and Budget, Attn: Desk
Officer for the Department of the Trea-
sury, Office of Information and Regula-
tory Affairs, Washington, DC, 20503, with
copies to theInternal Revenue Service,
Attn: IRS Reports Clearance Officer,
W:CAR:MP:FP:S,Washington,DC
20224. Comments on the collection of
information should be received by Sep-
tember 17, 2002. Comments are specifi-
cally requested concerning:
Whether the collection of information
is necessary for the proper performance of
the functions of the Internal Revenue Ser-
vice, including whether the information
will have practical utility;
The accuracy of the estimated burden
associated with the collection of informa-
tion (see below);
2002–33 I.R.B.331August 19, 2002

How the quality, utility, and clarity of
the information to be collected may be
enhanced;
How the burden of complying with the
collection of information may be mini-
mized, including through the application
of automated collection techniques or
other forms of information technology;
and
Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of service to provide informa-
tion.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.
The estimated total annual reporting
burden is 470 hours, based on an esti-
mated number of respondents of 470 and
an estimated average annual burden hours
per respondent of one hour.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and tax
return information are confidential, as re-
quired by 26 U.S.C. 6103.
Background
This document contains final regula-
tions regarding the proposed amendments
to 26 CFR part 1 under section 860E of
the Internal Revenue Code (Code). The
regulations provide the circumstances un-
der which a transferor of a noneconomic
REMIC residual interest meeting the in-
vestigation and representation require-
ments may avail itself of the safe harbor
by satisfying either the formula test or the
asset test.
Final regulations governing REMICs,
issued in 1992, contain rules governing
the transfer of noneconomic REMIC re-
sidual interests. In general, a transfer of a
noneconomic residual interest is disre-
garded for all tax purposes if a significant
purpose of the transfer is to enable the
transferor to impede the assessment or
collection of tax. A purpose to impede the
assessment or collection of tax (a wrong-
ful purpose) exists if the transferor, at the
time of the transfer, either knew or should
have known that the transferee would be
unwilling or unable to pay taxes due on its
share of the REMIC’s taxable income.
Under a safe harbor, the transferor of a
REMIC noneconomic residual interest is
presumed not to have a wrongful purpose
if two requirements are satisfied: (1) the
transferor conducts a reasonable investi-
gation of the transferee’s financial condi-
tion (the investigation requirement); and
(2) the transferor secures a representation
from the transferee to the effect that the
transferee understands the tax obligations
associated with holding a residual interest
and intends to pay those taxes (the repre-
sentation requirement).
The IRS and Treasury have been con-
cerned that some transferors of noneco-
nomic residual interests claim they satisfy
the safe harbor even in situations where
the economics of the transfer clearly indi-
cate the transferee is unwilling or unable
to pay the tax associated with holding the
interest. For this reason, on February 7,
2000, the IRS published in theFederal
Registera notice of proposed rulemak-
ing (REG–100276–97; REG–122450–98,
2000–1 C.B. 682 [65 FR 5807]) designed
to clarify the safe harbor by adding the
“formula test,”an economic test. The
proposed regulation provides that the safe
harbor is unavailable unless the present
value of the anticipated tax liabilities as-
sociated with holding the residual interest
does not exceed the sum of: (1) the present
value of any consideration given to the
transferee to acquire the interest; (2) the
present value of the expected future dis-
tributions on the interest; and (3) the
present value of the anticipated tax sav-
ings associated with holding the interest as
the REMIC generates losses.
The notice of proposed rulemaking also
contained rules for FASITs. Section
1.860H–6(g) of the proposed regulations
provides requirements for transfers of
FASIT ownership interests and adopts a
safe harbor by reference to the safe harbor
provisions of the REMIC regulations.
In January 2001, the IRS published
Rev. Proc. 2001–12, 2001–1 C.B. 335, to
set forth an alternative safe harbor that
taxpayers could use while the IRS and the
Treasury considered comments on the pro-
posed regulations. Under the alternative
safe harbor, if a transferor meets the in-
vestigation requirement and the represen-
tation requirement but the transfer fails to
meet the formula test, the transferor may
invoke the safe harbor if the transferee
meets a two-prong test (the asset test). A
transferee generally meets the first prong
of this test if, at the time of the transfer,
and in each of the two years preceding the
year of transfer, the transferee’s gross
assets exceed $100 million and its net
assets exceed $10 million. A transferee
generally meets the second prong of this
test if it is a domestic, taxable corporation
and agrees in writing not to transfer the
interest to any person other than another
domestic, taxable corporation that also
satisfies the requirements of the asset test.
A transferor cannot rely on the asset test if
the transferor knows, or has reason to
know, that the transferee will not comply
with its written agreement to limit the
restrictions on subsequent transfers of the
residual interest.
Rev. Proc. 2001–12 provides that the
asset test fails to be satisfied in the case of
a transfer or assignment of a noneconomic
residual interest to a foreign branch of an
otherwise eligible transferee. If such a
transfer or assignment were permitted, a
corporate taxpayer might seek to claim
that the provisions of an applicable in-
come tax treaty would resource excess
inclusion income as foreign source in-
come, and that, as a consequence, any
U.S. tax liability attributable to the excess
inclusion income could be offset by for-
eign tax credits. Such a claim would
impede the assessment or collection of
U.S. tax on excess inclusion income, con-
trary to the congressional purpose of as-
suring that such income will be taxable in
all events. See,e.g., sections 860E(a)(1),
(b), (e) and 860G(b) of the Code.
The Treasury and the IRS have learned
that certain taxpayers transferring noneco-
nomicresidualintereststoforeign
branches have attempted to rely on the
formula test to obtain safe harbor treat-
ment in an effort to impede the assessment
or collection of U.S. tax on excess inclu-
sion income. Accordingly, the final regu-
lations provide that if a noneconomic
residual interest is transferred to a foreign
permanent establishment or fixed base of
a U.S. taxpayer, the transfer is not eligible
for safe harbor treatment under either the
asset test or the formula test. The final
regulations also require a transferee to
represent that it will not cause income
from the noneconomic residual interest to
be attributable to a foreign permanent
establishment or fixed base.
August 19, 20023322002–33 I.R.B.

Section 1.860E–1(c)(8) provides com-
putational rules that a taxpayer may use to
qualify for safe harbor status under the
formula test. Section 1.860E–1(c)(8)(i)
provides that the transferee is presumed to
pay tax at a rate equal to the highest rate of
tax specified in section 11(b). Some com-
mentators were concerned that this pre-
sumed rate of taxation was too high
because it does not take into consideration
taxpayers subject to the alternative mini-
mum tax rate. In light of the comments
received, this provision has been amended
in the final regulations to allow certain
transferees that compute their taxable in-
come using the alternative minimum tax
rate to use the alternative minimum tax
rate applicable to corporations.
Additionally,§1.860E–1(c)(8)(iii) pro-
vides that the present values in the for-
mula test are to be computed using a
discount rate equal to the applicable Fed-
eral short-term rate prescribed by section
1274(d). This is a change from the pro-
posed regulation and Rev. Proc. 2001–12.
In those publications the provision stated
that“present values are computed using a
discount rate equal to the applicable Fed-
eral rate prescribed in section 1274(d)
compounded semiannually”and that“[a]
lower discount rate may be used if the
transferee can demonstrate that it regu-
larly borrows, in the course of its trade or
business, substantial funds at such lower
rate from an unrelated third party.”The
IRS and the Treasury Department have
learned that, based on this provision, cer-
tain taxpayers have been attempting to use
unrealistically low or zero interest rates to
satisfy the formula test, frustrating the
intent of the test. Furthermore, the Trea-
sury Department and the IRS believe that
a rule allowing for a rate other than a rate
based on an objective index would add
unnecessary complexity to the safe harbor.
As a result, the rule in the proposed
regulations that permits a transferee to use
a lower discount rate, if the transferee can
demonstrate that it regularly borrows sub-
stantial funds at such lower rate, is not
included in the final regulations; and the
Federal short-term rate has been substi-
tuted for the applicable Federal rate. To
simplify taxpayers’computations, the fi-
nal regulations allow use of any of the
published short-term rates, provided that
the present values are computed with a
corresponding period of compounding.
With the exception of the provisions relat-
ing to transfers to foreign branches, these
changes generally have the proposed ap-
plicability date of February 4, 2000, but
taxpayers may choose to apply the interest
rate formula set forth in the proposed
regulation and Rev. Proc. 2001–12 for
transfers occurring before August 19,
2002.
It is anticipated that when final regula-
tions are adopted with respect to FASITs,
§1.860H–6(g) of the proposed regulations
will be adopted in substantially its present
form, with the result that the final regula-
tions contained in this document will also
govern transfers of FASIT ownership in-
terests with substantially the same appli-
cability date as is contained in this
document.
Effect on Other Documents
Rev. Proc. 2001–12, 2001–1 C.B. 335,
is obsolete for transfers of noneconomic
residual interests in REMICs occurring on
or after August 19, 2002.
Special Analyses
It is hereby certified that these regula-
tions will not have a significant economic
impact on a substantial number of small
entities. This certification is based on the
fact that it is unlikely that a substantial
number of small entities will hold REMIC
residual interests. Therefore, a Regulatory
Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not
required. It has been determined that this
Treasury decision is not a significant regu-
latory action as defined in Executive Or-
der12866.Therefore,aregulatory
assessment is not required. It also has been
determined that sections 553(b) and
553(d) of the Administrative Procedure
Act (5 U.S.C. chapter 5) do not apply to
these regulations.
Drafting Information
The principal author of these regula-
tions is Courtney Shepardson. However,
other personnel from the IRS and Treasury
department participated in their develop-
ment.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PA RT 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805***
Par.2.In§1.860A–0, entries in the
outline for§1.860E–1 (c)(5) through
(c)(10) are added to read as follows:
§1.860A–0 Outline of REMIC provisions.
*****
§1.860E–1 Treatment of taxable income
of a residual interest holder in excess of
daily accruals.
*****
(c)***
(5) Asset test.
(6) Definitions for asset test.
(7) Formula test.
(8) Conditions and limitations on formula
test.
(9) Examples.
(10) Effective dates.
*****
Par. 3. Section 1.860E-1 is amended as
follows:
1. Paragraph (c)(4)(i) is amended by
removing the language“and”at the end of
the paragraph.
2. Paragraph (c)(4)(ii) is amended by
removing the period at the end of the
paragraph and adding a semicolon in its
place.
3. Paragraphs (c)(4)(iii) and (c)(4)(iv)
are added.
4. Paragraphs (c)(5) through (c)(10) are
added.
The additions read as follows:
§1.860E–1 Treatment of taxable income
of a residual interest holder in excess of
daily accruals.
*****
(c)***
(4)***
(iii) The transferee represents that it
will not cause income from the noneco-
nomic residual interest to be attributable
to a foreign permanent establishment or
fixed base (within the meaning of an
applicable income tax treaty) of the trans-
feree or another U.S. taxpayer; and
2002–33 I.R.B.333August 19, 2002

(iv) The transfer satisfies either the
asset test in paragraph (c)(5) of this sec-
tion or the formula test in paragraph (c)(7)
of this section.
(5)Asset test. The transfer satisfies the
asset test if it meets the requirements of
paragraphs (c)(5)(i), (ii) and (iii) of this
section.
(i) At the time of the transfer, and at the
close of each of the transferee’s two fiscal
years preceding the transferee’s fiscal year
of transfer, the transferee’s gross assets for
financial reporting purposes exceed $100
million and its net assets for financial
reporting purposes exceed $10 million.
For purposes of the preceding sentence,
the gross assets and net assets of a trans-
feree do not include any obligation of any
related person (as defined in paragraph
(c)(6)(ii) of this section) or any other asset
if a principal purpose for holding or ac-
quiring the other asset is to permit the
transferee to satisfy the conditions of this
paragraph (c)(5)(i).
(ii) The transferee must be an eligible
corporation (defined in paragraph (c)(6)(i)
of this section) and must agree in writing
that any subsequent transfer of the interest
will be to another eligible corporation in a
transactionthatsatisfiesparagraphs
(c)(4)(i), (ii), and (iii) and this paragraph
(c)(5). The direct or indirect transfer of the
residual interest to a foreign permanent
establishment (within the meaning of an
applicable income tax treaty) of a domes-
tic corporation is a transfer that is not a
transfer to an eligible corporation. A trans-
fer also fails to meet the requirements of
this paragraph (c)(5)(ii) if the transferor
knows, or has reason to know, that the
transferee will not honor the restrictions
on subsequent transfers of the residual
interest.
(iii) A reasonable person would not
conclude, based on the facts and circum-
stances known to the transferor on or
before the date of the transfer, that the
taxes associated with the residual interest
will not be paid. The consideration given
to the transferee to acquire the noneco-
nomic residual interest in the REMIC is
only one factor to be considered, but the
transferor will be deemed to know that the
transferee cannot or will not pay if the
amount of consideration is so low com-
pared to the liabilities assumed that a
reasonable person would conclude that the
taxes associated with holding the residual
interest will not be paid. In determining
whether the amount of consideration is too
low, the specific terms of the formula test
in paragraph (c)(7) of this section need not
be used.
(6)Definitions for asset test. The fol-
lowing definitions apply for purposes of
paragraph (c)(5) of this section:
(I)Eligible corporationmeans any do-
mestic C corporation (as defined in sec-
tion 1361(a)(2)) other than—
(A) A corporation which is exempt
from, or is not subject to, tax under section
11;
(B) An entity described in section
851(a) or 856(a);
(C) A REMIC; or
(D) An organization to which part I of
subchapter T of chapter 1 of subtitle A of
the Internal Revenue Code applies.
(ii)Related personis any person that-–
(A) Bears a relationship to the trans-
feree enumerated in section 267(b) or
707(b)(1), using“20 percent”instead of
“50 percent”where it appears under the
provisions; or
(B) Is under common control (within
the meaning of section 52(a) and (b)) with
the transferee.
(7)Formula test. The transfer satisfies
the formula test if the present value of the
anticipated tax liabilities associated with
holding the residual interest does not ex-
ceed the sum of-–
(i) The present value of any consider-
ation given to the transferee to acquire the
interest;
(ii) The present value of the expected
future distributions on the interest; and
(iii) The present value of the antici-
pated tax savings associated with holding
the interest as the REMIC generates
losses.
(8)Conditions and limitations on for-
mula test. The following rules apply for
purposes of the formula test in paragraph
(c)(7) of this section.
(i) The transferee is assumed to pay tax
at a rate equal to the highest rate of tax
specified in section 11(b)(1). If the trans-
feree has been subject to the alternative
minimum tax under section 55 in the
preceding two years and will compute its
taxable income in the current taxable year
using the alternative minimum tax rate,
then the tax rate specified in section
55(b)(1)(B) may be used in lieu of the
highest rate specified in section 11(b)(1).
(ii) The direct or indirect transfer of the
residual interest to a foreign permanent
establishment or fixed base (within the
meaning of an applicable income tax
treaty) of a domestic transferee is not
eligible for the formula test.
(iii) Present values are computed using
a discount rate equal to the Federal short-
term rate prescribed by section 1274(d)
for the month of the transfer and the
compounding period used by the taxpayer.
(9)Examples. The following examples
illustrate the rules of this section:
Example 1.Transfer to partnership.Xtransfers a
noneconomic residual interest in a REMIC to Part-
nershipPin a transaction that does not satisfy the
formula test of paragraph (c)(7) of this section.Yand
Zare the partners ofP. Even ifYandZare eligible
corporations that satisfy the requirements of para-
graph (c)(5)(i) of this section, the transfer fails to
satisfy the asset test requirements found in paragraph
(c)(5)(ii) of this section becausePis a partnership
rather than an eligible corporation within the mean-
ing of (c)(6)(i) of this section.
Example 2.Transfer to a corporation without
capacity to carry additional residual interests. Dur-
ing the first ten months of a year, Bank transfers five
residual interests to CorporationUunder circum-
stances meeting the requirements of the asset test in
paragraph (c)(5) of this section. Bank is the major
creditor ofUand consequently has access toU’s
financial records and has knowledge ofU’s financial
circumstances. During the last month of the year,
Bank transfers three additional residual interests toU
in a transaction that does not meet the formula test of
paragraph (c)(7) of this section. At the time of this
transfer,U’s financial records indicate it has retained
the previously transferred residual interests.U’s
financial circumstances, including the aggregate tax
liabilities it has assumed with respect to REMIC
residual interests, would cause a reasonable person to
conclude thatUwill be unable to meet its tax
liabilities when due. The transfers in the last month
of the year fail to satisfy the investigation require-
ment in paragraph (c)(4)(i) of this section and the
asset test requirement of paragraph (c)(5)(iii) of this
section because Bank has reason to know thatUwill
not be able to pay the tax due on those interests.
Example 3.Transfer to a foreign permanent
establishment of an eligible corporation.Rtransfers
a noneconomic residual interest in a REMIC to the
foreign permanent establishment of CorporationT.
Solely because of paragraph (c)(8)(ii) of this section,
the transfer does not satisfy the formula test of
paragraph (c)(7) of this section. In addition, even ifT
is an eligible corporation, the transfer does not
satisfy the asset test because the transfer fails the
requirements of paragraph (c)(5)(ii) of this section.
(10)Effective dates. Paragraphs (c)(4)
through (c)(9) of this section are appli-
cable to transfers occurring on or after
February 4, 2000, except for paragraphs
August 19, 20023342002–33 I.R.B.

(c)(4)(iii) and (c)(8)(iii) of this section,
which are applicable for transfers occur-
ring on or after August 19, 2002. For the
dates of applicability of paragraphs (a)
through (c)(3) and (d) of this section, see
§1.860A–1.
*****
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 4. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par.5.In§602.101, paragraph (b) is
amended by adding an entry in numerical
order to the table to read in part as
follows:
§602.101 OMB Control numbers.
*****
(b)***
CFR part or section where
identified and described
Current OMB
control No.
*****
1.860E–1 ................................................................................................................................................................ 1545–1675
*****
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
Approved July 10, 2002.
Pamela F. Olson,
Acting Assistant Secretary of the Treasury.
(Filed by the Office of the Federal Register on July
18, 2002, 8:45 a.m., and published in the issue of the
Federal Register for July 19, 2002, 67 F.R. 47451)
Section 952.—Subpart F
Income Defined
26 CFR 1.952–1: Subpart F income defined.
T.D. 9008
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Guidance Under Subpart F
Relating to Partnerships
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains fi-
nal regulations providing guidance under
subpart F relating to partnerships. The
final regulations are necessary in order to
clarify the treatment of a controlled for-
eign corporation’s (CFC) distributive
share of partnership income under subpart
F. The final regulations will affect United
States shareholders of CFCs that have an
interest in a partnership.
DATES:Effective dates:July 23, 2002.
Applicability date:For dates of appli-
cability of these regulations, see§1.702–1
(a)(8)(ii), 1.952–1(g)(3), 1.954–1(g)(4),
1.954–2(a)(5)(v),1.954–3(a)(6)(iii),
1.954–4(b)(2)(iii), 1.956–2(a)(3).
FOR FURTHER INFORMATION CON-
TACT: Jonathan A. Sambur at (202) 622–
3840 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On September 20, 2000, the IRS and
Treasury published in theFederal Regis-
terproposed amendments to the regula-
tions (REG–112502–00, 2000–2 C.B. 316
[65 FR 56836]) under section 702 and
subpart F of the Internal Revenue Code
(Code). Those proposed regulations sub-
stantially restated rules in former pro-
posedregulations,REG–104537–97
(1998–2 C.B. 892 [63 FR 14613]), that
werewithdrawninREG–113909–98
(1999–2 C.B. 125 [64 FR 37727]). Written
comments were solicited and a public
hearing was scheduled for December 5,
2000. Several comments were received
and are discussed below. No public hear-
ing was requested, therefore the hearing
was cancelled. After consideration of all
the comments, the proposed regulations
under section 702 and subpart F are
adopted as revised by this Treasury deci-
sion.
Summary of Public Comments and
Explanation of Revisions
A.§1.702–1(a)(8)(ii) Characterization
and Determination of Subpart F Income
Under the proposed regulations, gross
income is characterized at the partnership
level. If any part of the partnership’s gross
income is a type of income that would be
subpart F income if received directly by
partners that are CFCs, that part of the
partnership’s gross income must be sepa-
rately taken into account by each partner
under section 702. To the extent that the
separately stated income results in subpart
F income to the CFC partner, it will be
taken into account in determining the
CFC’s total subpart F income for the
taxable year.
The proposed regulations under section
702 clarify that an item must be separately
taken into account when, if separately
taken into account by any partner, the item
would result in an income tax liability for
that partner, or any other person, different
from that which would result if the partner
did not take the item into account sepa-
rately.
One commentator noted that the pro-
posed regulations are inconsistent with
section 702(b), which requires that the
character and source of an item of gross
income be determined at the partnership
level, because the proposed regulations
2002–33 I.R.B.335August 19, 2002

require the determination of subpart F
income as if the income had been earned
by the CFC. That commentator asserted
further that the addition of the phrase“or
for any other person”in the first sentence
of§1.702–1(a)(8)(ii) goes beyond the
regulatory authority provided in section
702(a)(7).
The IRS and Treasury believe there is
ample statutory authority for these regula-
tions. The regulations are based upon the
authority of subchapter K and subpart F
and the policies underlying those provi-
sions. The legislative history of subchap-
ter K provides that, for purposes of
interpreting Internal Revenue Code provi-
sions outside of subchapter K, a partner-
ship may be treated as either an entity
separate from its partners or an aggregate
of its partners, depending on which char-
acterization is more appropriate to carry
out the purpose of the particular Internal
Revenue Code or regulation section under
consideration.H.R. Conf. Rep. No. 2543,
83rd Cong. 2d. Sess. 59 (1954).
To allow a CFC to avoid subpart F
treatment for items of income through the
simple expedient of receiving them as
distributive shares of partnership income,
rather than directly, is contrary to the
intent of subpart F. Subpart F was in-
tended to limit deferral of U.S. income tax
on certain types of income received by
CFCs. The IRS and Treasury believe that
the approach set out in these regulations
(which treats the partnership as an entity
for certain purposes and as an aggregate
for certain purposes) best achieves the
purposes of subpart F and is consistent
with the policies underlying subchapter K.
Another commentator stated that the
requirement of a separate statement of
subpart F income by the partnership
would be difficult to administer because a
foreign partnership generally is not re-
quired to prepare a Schedule K for its
foreign partners.
The IRS and Treasury do not believe
that applying the rules in the regulations
will cause significant problems. Because
the rules of subpart F target certain spe-
cific types of income (e.g., passive in-
come,certainincomeearnedfrom
transactions with related persons), the IRS
and Treasury believe that, in most cases,
either the partnership, the CFC partner, or
both, will be able to determine without
significant difficulty the income earned by
the partnership that must be separately
stated by the CFC partner.
B.§1.952–1(g) Treatment of
Distributive Share of Partnership Income
by a CFC Partner
The proposed regulations clarify that
the definition of subpart F income in-
cludes a CFC’s distributive share of any
item of gross income of a partnership to
the extent the income would have been
subpart F income if received directly by
the CFC partner. The proposed regulations
apply to all partnership interests owned by
CFC partners. In the preamble to the
proposed regulations, comments were re-
quested about whether these rules should
apply for ownership interests that fall
below a minimum threshold. This com-
ment was requested because the IRS and
Treasury were considering whether to pro-
vide that CFCs with ade minimisinterest
in a partnership should not be subject to
the regulations (e.g., by analogy to the 10
percent ownership threshold that is used to
determine a U.S. shareholder of a CFC).
One comment was received in response
to this request. The commentator sug-
gested that the proposed regulations
should apply only to controlling partners,
i.e.partners that hold more than a 50
percent interest. The commentator stated
further that this result would be consistent
with the subpart F ownership rules and
would limit the rule to circumstances
where the CFC partner could easily obtain
the necessary information to determine
whether its distributive share was subpart
F income.
The commentator’s suggestion of lim-
iting the application of these rules to
controlled partnerships was not adopted.
The IRS and Treasury do not believe that
the objective of the regulations (which, as
noted above, is to prevent CFCs from
avoiding subpart F by receiving items of
income as distributive shares of partner-
ship income, rather than directly) can be
achieved by limiting the application of
these rules only to controlled partnerships.
Further, upon additional consideration, the
IRS and Treasury believe that requiring all
partnership interests held by a CFC to be
subject to the rules of these regulations
best effectuates the legislative intent of
subpart F and generally should not give
rise to significant difficulties for the CFC
partner.
C.§1.954–1(g) Test for Activity and
Related Persons
Section 1.954–1(g) of the proposed
regulations provides that, generally, in
determining whether a distributive share
of partnership income is subpart F income,
whether an entity is a related person and
whether an activity takes place in or out-
side the country under the laws of which
the CFC is organized (e.g., for purposes of
determining whether the income qualifies
for a“same country”exception to subpart
F), shall be determined with respect to the
CFC partner and not the partnership.
One commentator objected to the rules
in§1.954–1(g)(1). This commentator
stated that the rule represented a“reverse”
application of the aggregate theory of
partnerships, and was inconsistent with
the principles of subchapter K. The IRS
and Treasury disagree with this comment.
As noted above, subchapter K contem-
plates applying either an aggregate theory
or an entity theory of partnerships, based
on the approach that best serves the un-
derlying purposes of the Code or regula-
tions at issue. For purposes of applying the
policies of subpart F, which focus in part
on whether income is being shifted be-
tween a CFC and a related entity in a
different country, the IRS and Treasury
believe it is appropriate to make the deter-
mination of whether an entity is a related
person with respect to the CFC, and
whether an activity takes place in or out-
side a CFC’s country of incorporation, at
the CFC partner level.
The IRS and Treasury also have be-
come aware that some uncertainty exists
under the proposed regulations with re-
spect to the application of the related
person test to certain purchase and sales
transactions occurring between a partner-
ship and its CFC partner. Specifically,
where a purchase or sales transaction oc-
curs between the partnership and its CFC
partner, including sales or purchases on
behalf of the CFC by the partnership, the
general rule fails to provide guidance on
whether the CFC partner’s distributive
share of the partnership income is derived
from a transaction with a related person.
August 19, 20023362002–33 I.R.B.

As a result, the final regulations add a new
rule for purposes of making that determi-
nation. In general, the final regulations
provide that where the partnership enters
into a purchase or sales transaction with
the CFC partner, the transaction will be
treated as a purchase or sales transaction
with a related person where the CFC
purchased the property that it sells to the
partnership from a person related to the
CFC or sells the property that it purchased
from the partnership to such a related
person. This rule also applies to purchases
or sales by the CFC on behalf of a related
person.
For example, if a partnership sells
goods to its CFC partner that it bought
from a person unrelated to the CFC, and
the CFC partner then sells the goods to a
person related to the CFC partner, the sale
of goods by the partnership to the CFC
will be treated as the sale of personal
property to a related person for purposes
of determining whether the CFC’s dis-
tributive share of the partnership income
relating to the sale of goods by the part-
nership is foreign base company sales
income. An example has been included in
the final regulations to illustrate this rule.
In addition, the final regulations provide
that when the CFC partner manufactures
property that it sells to the partnership and
the CFC conducts sales or manufacturing
activities through a branch, if the CFC’s
income from the sale of property to the
partnership is foreign base company sales
income under the branch rule of section
954(d)(2), the partnership’s purchase of
this property from the CFC will be treated
as the purchase of personal property from
a related person. The effect of these two
rules is to treat the CFC partner’s distribu-
tive share of the income earned by the
partnership as income earned from a re-
lated person transaction if it would have
been so treated if the CFC had purchased
or sold the property directly, rather than
through a partnership.
D.§1.954–2(a)(5)(ii) Exceptions
Applicable to Foreign Personal Holding
Company Income
Section 1.954–2(a)(5)(ii) of the pro-
posed regulations provide that only the
activities of, and property owned by, the
partnership will be taken into account in
determining whether the exceptions from
foreign personal holding company income
contained in section 954(c)(2), (h) and (i)
apply.
One commentator argued that applying
§1.954–2(a)(5)(ii) to a CFC with a quali-
fied business unit (QBU) partnership that
is seeking to qualify for the active financ-
ing exception under section 954(h) pro-
duces a result that is inconsistent with the
intent of section 954(h). Specifically, sec-
tion 954(h)(2)(B)(i) provides that a CFC
that is engaged in a lending or finance
business will be considered an“eligible
controlled foreign corporation”for pur-
poses of the active financing exception if
the CFC derives more than 70 percent of
its gross income directly from the active
and regular conduct of a lending or fi-
nance business from transactions with un-
related customers. In addition, section
954(h)(3)(B) provides that, in the case of a
CFC that conducts a lending or finance
business (other than a banking or securi-
ties business), no income of the CFC (or
QBU of the CFC) will qualify for the
active financing exception unless more
than 30 percent of the CFC’sorQBU’s
gross income is derived directly from the
active conduct of a financing business
from transactions with unrelated custom-
ers in the CFC or QBU’s home country.
The commentator stated that section
954(h) appears to provide that the 70
percent test must be applied at the CFC
level based on the CFC’s income (includ-
ing branches and partnerships) and the 30
percent test must be applied at the partner-
ship or QBU level.
The proposed regulations, however, re-
quire that the determination of whether the
70 percent test and the 30 percent test are
met is based solely by reference to the
activities of the partnership. The commen-
tator concluded that the proposed regula-
tions are inconsistent with the two-part
test in section 954(h) and that applying the
rule of the proposed regulations poten-
tially could place a CFC that conducts a
financial services business through a part-
nership in a significantly worse situation
than a CFC that conducts a similar busi-
ness through a branch or disregarded en-
tity.
In response to this comment, the IRS
and Treasury have included a new rule in
the final regulations that applies the“eli-
gible controlled foreign corporation”re-
quirementundersection954(h)(2),
including the 70 percent test of section
954(h)(2)(B)(i), at the CFC partner level
(by including in the gross income of the
CFC partner any gross income earned by
partnerships or other QBUs of the CFC
partner), and applies the qualified banking
and financing income test (the 30 percent
test) under section 954(h)(3) at the part-
nership level (by including only the gross
income of the partnership). In addition, a
newrulehasbeenaddedunder
§1.954–2(a)(5)(ii) to clarify that for pur-
poses of applying the special rule for
income derived in the active conduct of an
insurance business under section 954(i),
the exception will apply only if the CFC
partner is a qualifying insurance company,
as defined in section 953(e)(3) (deter-
mined by examining premiums written by
the CFC partner and any partnerships or
other QBUs of the CFC partner), and the
partnership generates qualified insurance
income, as defined in section 954(i)(2)
(determined by examining only the in-
come earned by the partnership). Two
examples have been included in the final
regulations that illustrate the operation of
these rules.
Another comment was received sug-
gesting that the proposed regulations in-
appropriately require the partnership, not
the CFC partner, to satisfy the active trade
or business tests to qualify for the excep-
tions to the foreign personal holding com-
pany rules. The commentator stated that
such a rule allows a purely passive inves-
tor in a partnership to qualify for the
exceptions, contrary to the purposes of
subpart F. The commentator argued that,
instead, the regulations should apply the
active trade or business tests at the CFC
partner level, but should provide a rule
that limits the attribution of partnership
activities to the CFC partners.
This suggestion was not adopted. In
general, the IRS and Treasury believe that
the policies underlying subpart F are best
served by applying the relevant active
trade or business tests at the level of the
entity that actually earns the income (i.e.,
the partnership). As noted above, how-
ever, the IRS and Treasury believe that,
for purposes of determining whether a
CFC qualifies for the active financing
exception, applying the 70 percent test of
section 954(h)(2) (and determining a
CFC’s qualification as a qualifying insur-
ance company under section 954(i)(2)) at
2002–33 I.R.B.337August 19, 2002

the CFC partner level is consistent with
the statutory language of these provisions
and best effectuates the legislative intent
behind these provisions.
E.§1.954–4(b)(2)(iii) Application of the
Substantial Assistance Rule
The proposed regulations describe how
thesubstantialassistancerulesof
§1.954–4(b)(1)(iv) apply when the CFC
partner earns services income through the
partnership. When the partnership is per-
forming services for a person unrelated to
the CFC partner, but the CFC partner, or a
related person, provides substantial assis-
tance to the partnership, the CFC partner
and the partnership are regarded as sepa-
rate entities and the substantial assistance
provided to the partnership by the CFC
partner, or a related person, cause the CFC
partner’s distributive share of the services
income to be treated as foreign base com-
pany services income.
Commentators argued that the pro-
posed regulations should not treat the
distributive share of the partnership’s in-
come as subpart F income if only the CFC
partner provides substantial assistance to
the partnership because, in that case, un-
der an aggregate theory the CFC does not
receive substantial assistance from a re-
lated person. This suggestion has not been
adopted because the IRS and Treasury
believe that excluding the CFC partner
from the substantial assistance rule could
potentially allow the CFC partner to cir-
cumvent the foreign base company service
rules with respect to the services it is
performing.
Special Analyses
It has been determined that this final
regulation is not a significant regulatory
action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It has also been deter-
mined that section 553(b) and (d) of the
Administrative Procedures Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions and, because the regulation does not
impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Code,
the proposed regulations preceding these
regulations were submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comment on its
impact on small business.
Drafting Information
The principal author of these regula-
tions is Jonathan A. Sambur of the Office
of the Associate Chief Counsel (Interna-
tional), IRS. However, other personnel
from the IRS and Treasury Department
participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PA RT 1—INCOME TAXES
Paragraph 1. The authority citation for
26 CFR part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805***
Par. 2 Section 1.702–1 is amended as
follows:
1. Paragraph (a)(8)(ii) is revised.
2. Paragraph (c)(1)(iii) is amended by
removing the word“and”.
3. Paragraph (c)(1)(iv) is amended by
removing the period at the end and adding
“; and”in its place.
4. Paragraph (c)(1)(v) is added.
The addition and revision read as fol-
lows:
§1.702–1 Income and credits of partner.
(a)***
(8)***
(ii) Each partner must also take into
account separately the partner’s distribu-
tive share of any partnership item which,
if separately taken into account by any
partner, would result in an income tax
liability for that partner, or for any other
person, different from that which would
result if that partner did not take the item
into account separately. Thus, if any part-
ner is a controlled foreign corporation, as
defined in section 957, items of income
that would be gross subpart F income if
separately taken into account by the con-
trolled foreign corporation must be sepa-
rately stated for all partners. Under section
911(a), if any partner is abona fide
resident of a foreign country who may
exclude from gross income the part of the
partner’s distributive share which quali-
fies as earned income, as defined in sec-
tion 911(b), the earned income of the
partnership for all partners must be sepa-
rately stated. Similarly, all relevant items
of income or deduction of the partnership
must be separately stated for all partners
in determining the applicability of section
183 (relating to activities not engaged in
for profit) and the recomputation of tax
thereunder for any partner. This paragraph
(a)(8)(ii) applies to taxable years begin-
ning on or after July 23, 2002.
*****
(c)***
(1)***
(v) In determining whether thede mini-
misor full inclusion rules of section
954(b)(3) apply.
*****
Par.3.In§1.952–1, paragraph (g) is
added to read as follows:
§1.952–1 Subpart F income defined.
*****
(g)Treatment of distributive share of
partnership income—(1)In general.A
controlled foreign corporation’s distribu-
tive share of any item of income of a
partnership is income that falls within a
category of subpart F income described in
section 952(a) to the extent the item of
income would have been income in such
category if received by the controlled
foreign corporation directly. For specific
rules regarding the treatment of a distribu-
tive share of partnership income under
certain provisions of subpart F, see
§§1.954–1(g),1.954–2(a)(5),1.954–
3(a)(6), and 1.954–4(b)(2)(iii).
(2)Example. The application of this
paragraph (g) may be illustrated by the
following example:
Example. CFC, a controlled foreign corporation,
is an 80-percent partner in PRS, a foreign partner-
ship. PRS earns $100 of interest income that is not
export financing interest as defined in section
954(c)(2)(B), or qualified banking or financing in-
come as defined in section 954(h)(3)(A), from a
person unrelated to CFC. This interest income would
have been foreign personal holding company income
to CFC, under section 954(c), if it had received this
income directly. Accordingly, CFC’s distributive
share of this interest income, $80, is foreign personal
holding company income.
(3)Effective date. This paragraph (g)
applies to taxable years of a controlled
foreign corporation beginning on or after
July 23, 2002.
August 19, 20023382002–33 I.R.B.

Par.4.In§1.954–1, paragraph (g) is
added to read as follows:
§1.954–1Foreignbasecompany
income.
*****
(g)Distributive share of partnership
income—(1)Application of related person
and country of organization tests. Unless
otherwise provided, to determine the ex-
tent to which a controlled foreign corpo-
ration’s distributive share of any item of
gross income of a partnership would have
been subpart F income if received by it
directly, under§1.952–1(g), if a provision
of subpart F requires a determination of
whether an entity is a related person,
within the meaning of section 954(d)(3),
or whether an activity occurred within or
outside the country under the laws of
which the controlled foreign corporation
is created or organized, this determination
shall be made by reference to such con-
trolled foreign corporation and not by
reference to the partnership.
(2)Application of related person test
for sales and purchase transactions be-
tween a partnership and its controlled
foreign corporation partner. For purposes
of determining whether a controlled for-
eign corporation’s distributive share of
any item of gross income of a partnership
is foreign base company sales income
under section 954(d)(1) when the item of
income is derived from the sale by the
partnership of personal property pur-
chased by the partnership from (or sold by
the partnership on behalf of) the con-
trolled foreign corporation; or the sale by
the partnership of personal property to (or
the purchase of personal property by the
partnership on behalf of) the controlled
foreigncorporation(CFC-partnership
transaction), the CFC-partnership transac-
tion will be treated as a transaction with an
entity that is a related person, within the
meaning of section 954(d)(3), under para-
graph (g)(1) of this section, if—
(i) The controlled foreign corporation
purchased such personal property from (or
sold it to the partnership on behalf of), or
sells such personal property to (or pur-
chases it from the partnership on behalf
of), a related person with respect to the
controlled foreign corporation (other than
the partnership), within the meaning of
section 954(d)(3); or
(ii) Thebranchruleofsection
954(d)(2) applies to treat as foreign base
company sales income the income of the
controlled foreign corporation from sell-
ing to the partnership (or a third party)
personal property that the controlled for-
eign corporation has manufactured, in the
case where the partnership purchases per-
sonal property from (or sells personal
property on behalf of) the controlled for-
eign corporation.
(3)Examples. The application of this
paragraph (g) is illustrated by the follow-
ing examples:
Example 1. CFC, a controlled foreign corporation
organized in Country A, is an 80-percent partner in
Partnership, a partnership organized in Country A.
All of the stock of CFC is owned by USP, a U.S.
corporation. Partnership earns commission income
from purchasing Product O on behalf of USP, from
unrelated manufacturers in Country B, for sale in the
United States. To determine whether CFC’s distribu-
tive share of Partnership’s commission income is
foreign base company sales income under section
954(d), CFC is treated as if it purchased Product O
on behalf of USP. Under section 954(d)(3), USP is a
related person with respect to CFC. Thus, with
respect to CFC, the sales income is deemed to be
derived from the purchase of personal property on
behalf of a related person. Because the property
purchased is both manufactured and sold for use
outside of Country A, CFC’s country of organization,
CFC’s distributive share of the sales income is
foreign base company sales income.
Example 2. (i) CFC1, a controlled foreign corpo-
ration organized in Country A, is an 80-percent
partner in Partnership, a partnership organized in
Country B. CFC2, a controlled foreign corporation
organized in Country B, owns the remaining 20
percent interest in Partnership. CFC1 and CFC2 are
owned by a common U.S. parent, USP. CFC2 manu-
factures Product A in Country B. Partnership earns
sales income from purchasing Product A from CFC2
and selling it to third parties located in Country B
that are not related persons with respect to CFC1 or
CFC2. To determine whether CFC1’s distributive
share of Partnership’s sales income is foreign base
company sales income under section 954(d), CFC1 is
treated as if it purchased Product A from CFC2 and
sold it to third parties in Country B. Under section
954(d)(3), CFC2 is a related person with respect to
CFC1. Thus, with respect to CFC1, the sales income
is deemed to be derived from the purchase of
personal property from a related person. Because the
property purchased is both manufactured and sold for
use outside of Country A, CFC1’s country of orga-
nization, CFC1’s distributive share of the sales
income is foreign base company sales income.
(ii) Because Product A is both manufactured and
sold for use within CFC2’s country of organization,
CFC2’s distributive share of Partnership’s sales in-
come is not foreign base company sales income.
Example 3. CFC, a controlled foreign corporation
organized in Country A, is an 80-percent partner in
MJK Partnership, a Country B partnership. CFC
purchased goods from J Corp, a Country C corpora-
tion that is a related person with respect to CFC. CFC
sold the goods to MJK Partnership. In turn, MJK
Partnership sold the goods to P Corp, a Country D
corporation that is unrelated to CFC. P Corp sold the
goods to unrelated customers in Country D. The
goods were manufactured in Country C by persons
unrelated to J Corp . CFC’s distributive share of the
income of MJK Partnership from the sale of goods to
P Corp will be treated as income from the sale of
goods purchased from a related person for purposes
of section 954(d)(1) because CFC purchased the
goods from J Corp, a related person. Because the
goods were both manufactured and sold for use
outside of Country A, CFC’s distributive share of the
income attributable to the sale of the goods is foreign
base company sales income. Further, CFC’s income
from the sale of the goods to MJK Partnership will
also be foreign base company sales income.
Example 4. The facts of are the same asExample
3, except that MJK Partnership purchased the goods
from P Corp and sold those goods to CFC. CFC sold
the goods to J Corp. J Corp sold the goods to
unrelated customers in Country C. CFC’s distribu-
tive share of the income of MJK Partnership from the
sale of the goods by the partnership to itself will be
treated as income from the sale of goods to a related
person, for purposes of section 954(d)(1). Because
the goods were both manufactured and sold for use
outside of Country A, CFC’s distributive share of
income attributable to the sale of the goods is foreign
base company sales income. Further, CFC’s income
from the sale of the goods to J Corp is also foreign
base company sales income.
(4)Effective date. This paragraph (g)
applies to taxable years of a controlled
foreign corporation beginning on or after
July 23, 2002.
Par.5.In§1.954–2, paragraph (a)(5) is
added to read as follows:
§1.954–2 Foreign personal holding
company income.
(a)***
(5)Special rules applicable to distribu-
tive share of partnership income—(i)
[Reserved].
(ii)Certain other exceptions applicable
to foreign personal holding company in-
come. To determine the extent to which a
controlled foreign corporation’s distribu-
tive share of an item of income of a
partnership is foreign personal holding
company income—
(A) The exceptions contained in sec-
tion 954(c) that are based on whether the
controlled foreign corporation is engaged
in the active conduct of a trade or busi-
2002–33 I.R.B.339August 19, 2002

ness, including section 954(c)(2) and para-
graphs (b)(2) and (6), (e)(1)(ii) and (3)(ii),
(iii) and (iv), (f)(1)(ii), (g)(2)(ii), and
(h)(3)(ii) of this section, shall apply only if
any such exception would have applied to
exclude the income from foreign personal
holding company income if the controlled
foreign corporation had earned the income
directly, determined by taking into ac-
count only the activities of, and property
owned by, the partnership and not the
separate activities or property of the con-
trolled foreign corporation or any other
person;
(B) A controlled foreign corporation’s
distributive share of partnership income
will not be excluded from foreign personal
holding company income under the excep-
tion contained in section 954(h) unless the
controlled foreign corporation is an eli-
giblecontrolledforeigncorporation
within the meaning of section 954(h)(2)
(taking into account the income of the
controlled foreign corporation and any
partnerships or other qualified business
units, within the meaning of section
989(a), of the controlled foreign corpora-
tion, including the controlled foreign cor-
poration’s distributive share of partnership
income) and the partnership, of which the
controlled foreign corporation is a partner,
generates qualified banking or financing
income within the meaning of section
954(h)(3) (taking into account only the
income of the partnership);
(C) A controlled foreign corporation’s
distributive share of partnership income
will not be excluded from foreign personal
holding company income under the excep-
tion contained in section 954(i) unless the
controlled foreign corporation partner is a
qualifying insurance company, as defined
in section 953(e)(3) (determined by exam-
ining premiums written by the controlled
foreign corporation and any partnerships
or other qualified business units, within
the meaning of section 989(a), of the CFC
partner), and the partnership, of which the
controlled foreign corporation is a partner,
generates qualified insurance income
within the meaning of section 954(i)(2)
(taking into account only the income of
the partnership).
(iii)Examples. The application of para-
graph (a)(5)(ii) is demonstrated by the
following examples:
Example 1. B Corp, a Country C corporation, is
a controlled foreign corporation within the meaning
of section 957(a). B Corp is an 80-percent partner of
RKS Partnership, a Country D partnership whose
principal office is located in Country D. RKS Part-
nership is a qualified business unit of B Corp, within
the meaning of section 989(a). B Corp, including
income earned through RKS Partnership, derives
more than 70 percent of its gross income directly
from the active and regular conduct of a lending or
finance business, within the meaning of section
954(h)(4), from transactions in various countries
with customers which are not related persons. Thus,
B Corp is predominantly engaged in the active
conduct of a banking, financing, or similar business
within the meaning of section 954(h)(2)(A)(i). B
Corp conducts substantial activity with respect to
such business within the meaning of section
954(h)(2)(A)(ii). RKS Partnership derives more than
30 percent of its income from the active and regular
conduct of a lending or finance business, within the
meaning of section 954(h)(4), from transactions with
customers which are not related persons and which
are located solely within the home country of RKS
Partnership, Country D. B Corp’s distributive share
of RKS Partnership’s income from its lending or
finance business will satisfy the special rule for
income derived in the active conduct of banking,
financing, or similar business of section 954(h). B
Corp is an eligible controlled foreign corporation
within the meaning of section 954(h)(2) and RKS
Partnership generates qualified banking or financing
income within the meaning of section 954(h)(3). B
Corp does not have any foreign personal holding
company income with respect to its distributive share
of RKS Partnership income attributable to its lending
or finance business income earned in Country D.
Example 2. D Corp, a Country F corporation, is a
controlled foreign corporation within the meaning of
section 957(a). D Corp satisfies the requirements of
section 953(e)(3) and is a qualifying insurance com-
pany. D Corp is a 40-percent partner of DJ Partner-
ship, a Country G partnership. DJ Partnership is a
qualified business unit of D Corp, within the mean-
ing of section 989(a), and is licensed by the appli-
cable insurance regulatory body for Country G to sell
insurance to persons other than related persons in its
home country within the meaning of section
953(e)(4)(A). DJ Partnership receives income from
persons who are not related persons, within the
meaning of section 954(d)(3), from investments that
satisfy the requirements of section 954(i)(2). D
Corp’s distributive share of DJ Partnership’s income
from investments that satisfy the requirements of
section 954(i)(2) will not be treated as foreign
personal holding company income because D Corp
will satisfy the special rule of section 954(i) for
income derived in the active conduct of insurance
business. DJ Partnership is a qualifying insurance
company branch within the meaning of section
953(e)(4) and its income is qualified insurance in-
come within the meaning of section 954(i)(2). D
Corp does not have any foreign personal holding
company income as a result of its distributive share
of DJ Partnership income that is attributable to the
partnership’s qualifying insurance income.
(iv) [Reserved].
(v)Effective date. This paragraph
(a)(5) applies to taxable years of a con-
trolled foreign corporation beginning on
or after July 23, 2002.
*****
Par.6.In§1.954–3, paragraph (a)(6) is
added to read as follows:
§1.954–3 Foreign base company sales
income.
(a)***
(6)Special rule applicable to distribu-
tive share of partnership income—(i)In
general. To determine the extent to which
a controlled foreign corporation’s dis-
tributive share of any item of gross in-
come of a partnership would have been
foreign base company sales income if
received by it directly, under§1.952–1(g),
the property sold will be considered to be
manufactured, produced or constructed by
the controlled foreign corporation, within
the meaning of paragraph (a)(4) of this
section, only if the manufacturing excep-
tion of paragraph (a)(4) of this section
would have applied to exclude the income
from foreign base company sales income
if the controlled foreign corporation had
earned the income directly, determined by
taking into account only the activities of,
and property owned by, the partnership
and not the separate activities or property
of the controlled foreign corporation or
any other person.
(ii)Example. The application of para-
graph (a)(6)(i) of this section is illustrated
by the following example:
Example. CFC, a controlled foreign corporation
organized under the laws of Country A, is an 80-
percent partner in Partnership X, a partnership orga-
nized under the laws of Country B. Partnership X
performs activities in Country B that would consti-
tute the manufacture of Product O, within the mean-
ing of paragraph (a)(4) of this section, if performed
directly by CFC. Partnership X, through its sales
offices in Country B, then sells Product O to Corp D,
a corporation that is a related person with respect to
CFC, within the meaning of section 954(d)(3), for
use within Country B. CFC’s distributive share of
Partnership X’s sales income is not foreign base
company sales income because the manufacturing
exception of paragraph (a)(4) of this section would
have applied to exclude the income from foreign
base company sales income if CFC had earned the
income directly.
(iii)Effective date. This paragraph
(a)(6) applies to taxable years of a con-
trolled foreign corporation beginning on
or after July 23, 2002.
August 19, 20023402002–33 I.R.B.

*****
Par.7.In§1.954–4, paragraph
(b)(2)(iii) is added to read as follows:
§1.954–4 Foreign base company
services income.
*****
(b)***
(2)***
(iii)Special rule applicable to distribu-
tive share of partnership income. A con-
trolled foreign corporation’s distributive
share of a partnership’s services income
will be deemed to be derived from ser-
vices performed for or on behalf of a
related person, within the meaning of
section 954(e)(1)(A), if the partnership is
a related person with respect to the con-
trolled foreign corporation, under section
954(d)(3), and, in connection with the
services performed by the partnership, the
controlled foreign corporation, or a person
that is a related person with respect to the
controlled foreign corporation, provided
assistance that would have constituted
substantial assistance contributing to the
performance of such services, under para-
graph (b)(2)(ii) of this section, if furnished
to the controlled foreign corporation by a
related person. This paragraph (b)(2)(iii)
applies to taxable years of a controlled
foreign corporation beginning on or after
July 23, 2002.
*****
Par.8.In§1.956–2, paragraph (a)(3) is
added to read as follows:
§1.956–2 Definition of United States
property.
(a)***
(3)Property owned through partner-
ship. For purposes of section 956, if a
controlled foreign corporation is a partner
in a partnership that owns property that
would be United States property, within
the meaning of paragraph (a)(1) of this
section, if owned directly by the con-
trolled foreign corporation, the controlled
foreign corporation will be treated as
holding an interest in the property equal to
its interest in the partnership and such
interest will be treated as an interest in
United States property. This paragraph
(a)(3) applies to taxable years of a con-
trolled foreign corporation beginning on
or after July 23, 2002.
*****
David A. Mader,
Acting Deputy Commissioner of
Internal Revenue.
Approved July 16, 2002.
Pamela F. Olson,
Acting Assistant Secretary of the Treasury.
(Filed by the Office of the Federal Register on July
22, 2002, 8:45 a.m., and published in the Federal
Register for July 23, 2002, 67 F.R. 48020)
Section 6041.—Information at
Source
26 CFR 1.6041–1: Return of information as to
payments of $600 or more.
T.D. 9010
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1, 5f, 31, and
602
Information Reporting
Requirements for Certain
Payments Made on Behalf of
Another Person, Payments to
Joint Payees, and Payments
of Gross Proceeds from Sales
Involving Investment Advisors
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations and removal
of temporary regulations
SUMMARY: This document contains
regulations under section 6041 that pro-
vide information reporting requirements
for escrow agents and other persons mak-
ing payments on behalf of another person,
clarify who is the payee for information
reporting purposes if a check or other
instrument is made payable to joint pay-
ees, and clarify the amount to be reported.
This document also contains regulations
under section 6045 that incorporate the
provisionsoftemporaryregulations,
which are removed, and that remove in-
vestment advisors from the list of exempt
recipients.
DATES:Effective date:These regulations
are effective January 1, 2003.
Applicability date:For dates of appli-
cability of these regulations, see§§1.6041
–1(j), 1.6045–1(c)(3)(C)(xii), 1.6049–4(a)
(2), and 31.3406(a)–2(d).
FOR FURTHER INFORMATION CON-
TACT: Nancy L. Rose at (202) 622–4910
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information require-
ment contained in these final regulations
has been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)) under
control number 1545–1705. Responses to
this collection of information are manda-
tory.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.
The estimate of the reporting burden in
§1.6041–1 is reflected in the burden of
Form 1099-MISC. The estimate of the
reporting burden in§1.6045–1 is reflected
in the burden of Form 1099-B.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to the
Internal Revenue Service, Attn: IRS Re-
portsClearanceOfficer,W:CAR:
MP:FP:S, Washington, DC 20224, and to
theOffice of Management and Budget,
Attn: Desk Officer for the Department of
the Treasury, Office of Information and
Regulatory Affairs,Washington,DC
20503.
Books or records relating to the collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally tax returns and tax
return information are confidential, as re-
quired by 26 U.S.C. 6103.
Background
This document contains amendments to
the Income Tax Regulations (26 CFR parts
1 and 5f) and Employment Tax Regula-
tions (26 CFR part 31). These regulations
finalize proposed regulations relating to
2002–33 I.R.B.341August 19, 2002

payments to joint payees, payments made
on behalf of another person, and payments
of gross proceeds from sales involving
investment advisors. A notice of proposed
rulemaking (REG–246249–96, 2000–2
C.B. 439 [65 FR 61292]) was published in
theFederal Registeron October 17,
2000. A public hearing was held on Feb-
ruary 7, 2001, at which two commentators
presented oral comments. The IRS also
received other written comments respond-
ing to the notice of proposed rulemaking.
After consideration of all the comments,
the proposed regulations are adopted as
amended by this Treasury decision. The
revisions are discussed below.
Explanation of Provisions and
Summary of Comments
1. Payments Made on Behalf of Another
Person
Comments were received requesting
further clarification as to the meaning of
the termsmanagement or oversight func-
tionsandsignificant economic interestin
§1.6041–1(e)(1) of the proposed regula-
tions. In response to these comments, the
final regulations add language that was
included in the preamble to the proposed
regulations, explaining that a person who
merely writes checks at another’s direc-
tion is not exercising management or over-
sight with respect to the payment and that
a person has a significant economic inter-
est in a payment when such interest would
be compromised if the payment were not
made.
One commentator stated that an agent
cannot perform management or oversight
functions in connection with payments it
receives and remits to its principal, and,
therefore, an agent for a payee could never
be required to report a payment to the
payee under this standard. The commen-
tator recommended that§1.6041–1(e)(1)
of the proposed regulations be revised to
apply only to payments made by agents to
third parties.
The determination of whether a person
performs management or oversight func-
tions with respect to a payment made on
behalf of another, or has a significant
economic interest in connection with such
payment, is a factual one. Whether an
agent has a reporting obligation under
these standards must, therefore, be deter-
mined in each instance based on the par-
ticular facts and circumstances. The
standards set forth in the proposed regu-
lations are intended to apply to all persons
making payments on behalf of another,
whether they are making such payments
on behalf of the payor or payee in a
transaction. In keeping with the need for
uniformity and consistency in this regard,
the regulations also amend§31.3406(a)–2
to eliminate the current distinction be-
tween payor agents and payee agents with
respect to the obligation to backup with-
hold on payments. Therefore, while in
some cases an agent for a payee may not
be required to report a payment to its
principal, the final regulation does not
adopt the commentator’s suggestion to
eliminate the potential applicability of the
regulation to all such payments.
With respect to one type of payee
agent, however, the final regulation does
contain an exception to the rules set forth
in paragraph (e)(1). The final regulation
adds paragraph (e)(3) exempting from in-
formation reporting payments made by an
employee to his employer, in recognition
of the principle that the employee received
such payment from a third party and
remitted it to his employer in the course of
his employment.Example 11is added to
illustrate this exception.
Comments were also received with re-
spect to special reporting exceptions. One
commentator asked that the current rule
with respect to financial institutions be
retained. The proposed regulations re-
moved§1.6041–3(n), which provided
that banks making payments on an infre-
quent and isolated basis would not be
subject to the reporting requirements.
Banks will therefore now be subject to the
same standards as other persons in deter-
mining whether they have an obligation to
report payments. If a bank exercises man-
agement or oversight functions over a
payment, or has a significant economic
interest in the payment, it will have a
reporting obligation regardless of how
frequently it makes such payments. Al-
though this is a change that imposes a new
reporting burden on financial institutions,
the burden is no different than the one that
applies to other persons, and the final
regulations therefore do not adopt this
suggestion.
Another commentator asked that we
eliminate the reporting requirements for
real estate agents, found in§1.6041–3(d),
as they conflict with the proposed regula-
tions under§1.6041–1. The proposed
regulations made conforming amend-
ments to§1.6041–3(d), but retained the
existing provision that rent paid by real
estate agents is reportable, by cross-
reference to the provisions of§1.6041–1
(a). We believe it is appropriate to require
such agents to report under these regula-
tions; therefore, we decline to adopt this
comment. The final regulations do, how-
ever, change the termreal estate agentsto
rental agentsto more accurately describe
the type of person who would be collect-
ing rent from a tenant and remitting it to a
landlord.
One commentator asked that the regu-
lations clarify that insurance companies
do not have a“significant economic inter-
est”in payments they make to third parties
pursuant to contracts with policyholders.
Because this is a factual determination
which should be made on a case by case
basis, this suggestion was not adopted in
the final regulations.
Several commentators expressed con-
cern that more than one person might
report the same payment pursuant to these
rules. One commentator stated that a
service-recipient might be obligated to
report the payment made on his behalf,
while the person making the payment
might also report it. Another commentator
described a situation where funds were
transferred through several parties in-
volved in a construction project before
reaching the ultimate payee and each of
the parties might meet the management or
oversight/significant economic interest
standard for reporting the payments.
Several of the examples illustrate the
correct reporting of a payment by the
parties to a transaction. In the event that
several parties might be viewed as meet-
ing the tests for reporting under§1.6041
–1(e) of the regulations, the final regula-
tions set forth the rule that the party
closest in the chain to the payee must
report the payment, unless the parties
agree, in writing, that one of the other
parties meeting the test for reporting will
report the payment.Example 12has been
added to§1.6041–1(e) of the regulations
to illustrate this rule. This provision is not
intended to preclude the optional method
to report under§1.6041–1(e)(4) of the
regulations.
A commentator suggested that inEx-
August 19, 20023422002–33 I.R.B.

ample 3, dealing with an agent who per-
forms real estate closings, we clarify that
the termsettlement agentcan include a
number of different persons who perform
real estate closings, such as title compa-
nies or title insurance underwriters. Since
these examples are meant to be illustrative
only, and since any person making a
payment on behalf of another person is
subject to these regulations, it is not nec-
essary to list all possible individuals who
may be performing the functions de-
scribed in this example. Therefore, the
final regulations do not adopt this sugges-
tion.
2. Amount to be Reported
One commentator objected to the rule
in§1.6041–1(f) of the proposed regula-
tions that the amount to be reported is the
gross amount, before fees and other ex-
penses are deducted. The commentator
pointed out the conflicting case law with
respect to the issue of whether attorneys
fees are income to the client. The final
regulations provide that in cases in which
the gross amount is income, the gross
amount should be reported regardless of
any expenses, commissions or other obli-
gations, including backup withholding,
that were deducted from the amount be-
fore the check was issued. To assist tax-
payers in determining whether the gross
amount or some lesser amount is includ-
ible in a particular payee’s income, the
Commissioner may provide guidance in
the Internal Revenue Bulletin with ex-
amples. Example 1 in§1.6041–1(f) has
been modified to illustrate this rule.
In response to a comment, we have
added a cross-reference to section 6045(f)
of the Internal Revenue Code and the
regulations thereunder in the examples in
§1.6041–1(f).
3. Obsolescence of Revenue Rulings
One commentator asked that we in-
clude a statement in the regulations or
commentary that the regulations render
obsolete any revenue rulings that are fac-
tually encompassed by the proposed rules
and that all other revenue rulings pertain-
ing to third party payments would remain
in effect unless specifically deemed obso-
lete.
The preamble to the proposed regula-
tions stated that“Rulings that are factually
encompassed by the proposed regulations
will be obsoleted.”A list of revenue rul-
ings to become obsolete was included.
The notice of proposed rulemaking also
requested comments that identified other
factually relevant rulings. No such com-
ments were received. As the proposed
regulations made clear that revenue rul-
ings factually encompassed by the pro-
posed regulations would be obsoleted and
enumerated those rulings, there is no need
to include this commentator’s suggestion.
Another commentator recommended
that Rev. Rul. 69–595, 1969–2 C.B. 242,
and Rev. Rul. 70–608, 1970–2 C.B. 286,
both of which were listed in the notice of
proposed rulemaking as obsoleted by the
proposed regulations, be obsoleted only to
the extent they are inconsistent with the
proposed regulations. The two revenue
rulings cited contain guidance relating to
the definition of medical service pay-
ments, which the commentator felt should
be retained.
Rev. Rul. 70–608 is listed in the notice
of proposed rulemaking as obsoleted only
with respect to Situations 1, 2, and 5.
Therefore, Situation 4 of the revenue rul-
ing, which includes a description of medi-
cal service payments, was not obsoleted.
Rev. Rul. 69–595 will likewise not be
obsoleted with respect to the definition of
medical service payments.
Effect on Other Documents
The following revenue rulings are ob-
solete as of January 1, 2003:
Rev. Rul. 93–70, 1993–2 C.B. 294
Rev. Rul. 85–50, 1985–1 C.B. 345
Rev. Rul. 77–53, 1977–1 C.B. 368
Rev. Rul. 73–232, 1973–1 C.B. 541
Rev. Rul. 70–608, 1970–2 C.B. 286,
Situations 1, 2, and 5
Rev. Rul. 69–595, 1969–2 C.B. 242,
except with respect to the definition of
medical service payments.
Rev. Rul. 67–197, 1967–1 C.B. 319
Rev. Rul. 65–129, 1965–1 C.B. 519
Rev. Rul. 64–36, 1964–1 C.B. 446
Rev. Rul. 59–328, 1959–2 C.B. 379
Rev. Rul. 55–606, 1955–2 C.B. 489
Rev. Rul. 54–571, 1954–2 C.B. 235
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It has also been deter-
mined that section 553(b) of the Adminis-
trative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations. A final
regulatory flexibility analysis under 5
U.S.C. section 604 has been prepared for
the collection of information in this Trea-
sury decision. This analysis is set forth in
this preamble under the heading“Final
Regulatory Flexibility Analysis.”Pursuant
to section 7805(f), the notice of proposed
rulemaking preceding these regulations
was submitted to the Chief Counsel for
Advocacy of the Small Business Admin-
istration for comment on its impact on
small business.
Final Regulatory Flexibility Analysis
The collection of information con-
tained in§1.6041–1(e) is needed to
clarify the requirements for filing an in-
formation return under section 6041 when
a person makes a payment on behalf of
another person or to joint payees. The
objectives of the proposed regulations are
to provide uniform, practicable, and ad-
ministrable rules under section 6041 for
persons making payments on behalf of
another person or to joint payees. The
types of small entities to which the regu-
lations may apply are small businesses. An
estimate of the number of small entities
affected is not feasible because of the
large variety of entities and transactions to
which the regulations may apply.
There are no known Federal rules that
duplicate, overlap or conflict with these
regulations. The regulations are consid-
ered to have the least economic impact on
small entities of all alternatives consid-
ered.
The collection of information con-
tained in§1.6045–1(c)(3) will not have a
significant economic impact on a substan-
tial number of small entities. The regula-
tions will relieve investment advisors of
the requirement to make information re-
turns under section 6045(a), and few, if
any, financial custodians that maybe af-
fected by the regulations are small entities.
2002–33 I.R.B.343August 19, 2002

Drafting Information
The principal author of these regula-
tions is Nancy L. Rose of Office of the
Associate Chief Counsel (Procedure and
Administration).
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1, 5f, 31,
and 602 are amended as follows:
PA RT 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805***
Section 1.6041–1 also issued under 26
U.S.C. 6041(a).***
Par. 2. Section 1.6041–1 is amended as
follows:
1. In paragraph (b)(1), the second sen-
tence is amended by removing the lan-
guage“paragraph (g)”and adding the
language“paragraph (i)”in its place.
2. Paragraph (c) is amended by add-
ing two sentences after the penultimate
sentence.
3. Paragraphs (e), (f), and (g) are re-
designated as paragraphs (g), (h), and (i),
respectively.
4. Adding new paragraphs (e), (f), and
(j).
The additions read as follows:
§1.6041–1 Return of information as to
payments of $600 or more.
*****
(c)***A payment made jointly to two
or more payees may be fixed and deter-
minable income to one payee even though
the payment is not fixed and determinable
income to another payee. For example,
property insurance proceeds paid jointly
to the owner of damaged property and to a
contractor that repairs the property may be
fixed and determinable income to the
contractor but not fixed and determinable
income to the owner, and should be re-
ported to the contractor.***
*****
(e)Payment made on behalf of another
person—(1)In general. A person that
makes a payment in the course of its trade
or business on behalf of another person is
the payor that must make a return of
information under this section with re-
spect to that payment if the payment is
described in paragraph (a) of this section
and, under all the facts and circumstances,
that person—
(i) Performs management or oversight
functions in connection with the payment
(this would exclude, for example, a person
who performs mere administrative or min-
isterial functions such as writing checks at
another’s direction); or
(ii) Has a significant economic interest
in the payment (i.e., an economic interest
that would be compromised if the pay-
ment were not made, such as by creation
of a mechanic’s lien on property to which
the payment relates, or a loss of collat-
eral).
(2)Determination of payor obligated to
report. If two or more persons meet the
requirements for making a return of infor-
mation with respect to a payment, as set
forth in paragraph (e)(1) of this section,
the person obligated to report the payment
is the person closest in the chain to the
payee, unless the parties agree in writing
that one of the other parties meeting the
requirements set forth in paragraph (e)(1)
of this section will report the payment.
(3)Special rule for payment by em-
ployee to employer. Notwithstanding the
provisions of paragraph (e)(1) of this sec-
tion, an employee acting in the course of
his employment who makes a payment to
his employer on behalf of another person
is not required to make a return of infor-
mation with respect to that payment.
(4)Optional method to report. A person
that makes a payment on behalf of another
person but is not required to make an
information return under paragraph (e)(1)
of this section may elect to do so pursuant
to the procedures established by the Com-
missioner. See,e.g., Rev. Proc. 84–33,
1984–1 C.B. 502, (optional method for a
paying agent to report and deposit
amounts withheld for payors under the
statutory provisions of backup withhold-
ing) (see§601.601(d)(2) of this chapter).
(5)Examples. The provisions of this
paragraph (e) are illustrated by the follow-
ing examples:
Example 1. Bank B provides financing to C, a
real estate developer, for a construction project. B
makes disbursements from the account for labor,
materials, services, and other expenses related to the
construction project. In connection with the pay-
ments, B performs the following functions: approves
payments to the general contractor or subcontractors;
ensures that loan proceeds are properly applied and
that all approved bills are properly paid to avoid
mechanics’or materialmen’s liens; conducts site
inspections to determine whether work has been
completed (but does not check the quality of the
work). B is performing management or oversight
functions in connection with the payments and is
subject to the information reporting requirements of
section 6041 with respect to payments.
Example 2. Mortgage company D holds a mort-
gage on business property owned by E. When the
property is damaged by a storm, E’s insurance
company issues a check payable to both D and E in
settlement of E’s claim. Pursuant to the contract
between D and E, D holds the insurance proceeds in
an escrow account and makes disbursements, accord-
ing to E’s instructions, to contractors and subcon-
tractors performing repairs on the property. D is not
performing management or oversight functions, but
D has a significant economic interest in the payments
because the purpose of the arrangement is to ensure
that property on which D holds a mortgage is
repaired or replaced. D is subject to the information
reporting requirements of section 6041 with respect
to the payments to contractors.
Example 3. Settlement agent F provides real
estate closing services to real estate brokers and
agents. F deposits money received from the buyer or
lender in an escrow account and makes payments
from the account to real estate agents or brokers,
appraisers, land surveyors, building inspectors, or
similar service providers according to the provisions
of the real estate contract and written instructions
from the lender. F may also make disbursements
pursuant to oral instructions of the seller or purchaser
at closing. F is not performing management or
oversight functions and does not have a significant
economic interest in the payments, and is not subject
to the information reporting requirements of section
6041. For the rules relating to F’s obligation to report
the gross proceeds of the sale, see section 6045(e)
and§1.6045–4.
Example 4. Assume the same facts as inExample
3. In addition, the seller instructs F to hire a
contractor to perform repairs on the property. F
selects the contractor, negotiates the cost, monitors
the progress of the project, and inspects the work to
ensure it complies with the contract. With respect to
the payments to the contractor, F is performing
management or oversight functions and is subject to
the information reporting requirements of section
6041.
Example 5. G is a rental agent who manages
certain rental property on behalf of property owner
H. G finds tenants, arranges leases, collects rent,
responds to tenant inquiries regarding maintenance,
and hires and makes payments to repairmen. G
subtracts her commission and any maintenance pay-
ments from rental payments and remits the remainder
to H. With respect to payments to repairmen, G is
performing management or oversight functions and
is subject to the information reporting requirements
of section 6041. With respect to the payment of rent
August 19, 20023442002–33 I.R.B.

to H, G is subject to the information reporting
requirements of section 6041 regardless of whether
she performs management or oversight functions or
has a significant economic interest in the payment.
See§1.6041–3(d) for rules relating to rental agents.
See§1.6041–1(f) to determine the amount that G
should report to H as rent.
Example 6. Literary agent J receives a payment
from publisher L of fees earned by J’s client, author
K. J deposits the payment into a bank account in J’s
name. From time to time and as directed by K, J
makes payments from these funds to attorneys,
managers, and other third parties for services ren-
dered to K. After subtracting J’s commission, J pays
K the net amount. J does not order or direct the
provision of services by the third parties to K, and J
exercises no discretion in making the payments to the
third parties or to K. J is not performing management
or oversight functions and does not have a significant
economic interest in the payments and is not subject
to the information reporting requirements of section
6041 in connection with the payments to K or to the
third parties. For the rules relating to L’s obligation
to report the payment of the fees to K, see paragraphs
(a)(1)(i) and (f) of this section. For the rules relating
to K’s obligation to report the payment of the
commission to J and the payments to the third parties
for services, see paragraphs (a)(1)(i) and (d)(2) of
this section.
Example 7. Attorney P deposits into a client trust
fund a settlement payment from R, the defendant in
a breach of contract action for lost profits in which P
represented plaintiff Q. P makes payments from the
client trust fund to service providers such as expert
witnesses and private investigators for expenses
incurred in the litigation. P decides whom to hire,
negotiates the amount of payment, and determines
that the services have been satisfactorily performed.
In the event of a dispute with a service provider, P
withholds payment until the dispute is settled. With
respect to payments to the service providers, P is
performing management or oversight functions and
is subject to the information reporting requirements
of section 6041.
Example 8. Assume the same facts as inExample
7. In addition, assume that after paying the service
providers and deducting his legal fee, P pays Q the
remaining funds that P had received from the settle-
ment with R. With respect to the payment to Q, P is
not performing management or oversight functions,
does not have a significant economic interest in the
payment, and is not subject to the information
reporting requirements of section 6041. For the rules
relating to R’s obligation to report the payment of the
settlement proceeds to P, see section 6045(f) and the
regulations thereunder. For the rules relating to R’s
obligation to report the payment of the settlement
proceeds to Q, see paragraphs (a)(1)(i) and (f) of this
section. For the rules relating to Q’s obligation to
report the payment of attorney fees to P, see para-
graphs (a)(1)(i) and (d)(2) of this section.
Example 9. Medical insurer S operates as the
administrator of a health care program under a
contract with a state. S makes payments of govern-
ment funds to health care providers who provide care
to eligible patients. S receives and reviews claims
submitted by patients or health care providers, deter-
mines if the claims meet all the requirements of the
program (e.g., that the care is authorized and that the
patients are eligible beneficiaries), and determines
the amount of payment. S is performing management
or oversight functions and is subject to the informa-
tion reporting requirements of section 6041 with
respect to the payments.
Example 10. Race track employee T holds depos-
its made by horse owner U in a special escrow
account in U’s name. U enters into a contract with
jockey V to ride U’s horse in a race at the track. As
directed by U, T pays V the fee for riding U’s horse
from U’s escrow account. T is not performing
management or oversight functions, does not have a
significant economic interest in the payment, and is
not subject to the information reporting requirements
of section 6041. For the rules relating to U’s obliga-
tion to report the payment of the fee to V, see
paragraph (a)(1)(i) of this section.
Example 11. X is a certified public accountant
employed by Firm Y, and is not a partner. Client Z
pays X directly for accounting services. X remits the
amount received to Y, as required by the terms of his
employment. X does not have any reporting obliga-
tion with respect to the payment to Y. For the rules
relating to Z’s obligation to report the payment to Y
for services, see paragraphs (a)(1)(i) and (d)(2) of
this section.
Example 12. Bank contracts with Title Company
with respect to the disbursement of funds on a
construction loan. Pursuant to their arrangement, the
contractor sends draw requests to Title Company,
which inspects the work, verifies the amount re-
quested, and then sends the draw request to Bank
with supporting documents. Bank pays Title Com-
pany the amount of the draw request, and Title
Company insures Bank against any loss if it cannot
obtain the necessary lien waivers. Bank has a sig-
nificant economic interest in the payment as a
mortgagee, and Title Company exercises manage-
ment or oversight over the payment. Since Title
Company is closest in the chain to the contractor,
Title Company should report the payment, unless the
parties agree in writing that Bank will report the
payment.
(f)Amount to be reported when fees,
expenses or commissions are deducted—
(1)In general.The amount to be reported
as paid to a payee is the amount includible
in the gross income of the payee (which in
many cases will be the gross amount of
the payment or payments before fees,
commissions, expenses, or other amounts
owed by the payee to another person have
been deducted), whether the payment is
made jointly or separately to the payee
and another person. The Commissioner
may, by guidance published in the Internal
Revenue Bulletin, illustrate the circum-
stances under which the gross amount or
less than the gross amount may be re-
ported.
(2)Examples. The provisions of this
paragraph (f) are illustrated by the follow-
ing examples:
Example 1. Attorney P represents client Q in a
breach of contract action for lost profits against
defendant R. R settles the case for $100,000 damages
and $40,000 for attorney fees. Under applicable law,
the full $140,000 is includible in Q’s gross taxable
income. R issues a check payable to P and Q in the
amount of $140,000. R is required to make an
information return reporting a payment to Q in the
amount of $140,000. For the rules with respect to R’s
obligation to report the payment to P, see section
6045(f) and the regulations thereunder.
Example 2. Assume the same facts as inExample
1, except that R issues a check to Q for $100,000 and
a separate check to P for $40,000. R is required to
make an information return reporting a payment to Q
in the amount of $140,000. For the rules with respect
to R’s obligation to report the payment to P, see
section 6045(f) and the regulations thereunder.
*****
(j)Effective date. The provisions of
paragraphs (b), (c), (e), and (f) apply to
payments made after December 31, 2002.
Par. 3. Section 1.6041–3 is amended as
follows:
1. Revising paragraph (d).
2. Removing paragraph (n) and redes-
ignating paragraphs (o), (p) and (q) as
paragraphs (n), (o) and (p), respectively.
The revisions read as follows:
§1.6041–3 Payments for which no
return of information is required under
section 6041.
*****
(d) Payments of rent made to rental
agents (but the agent is required to report
payments of rent to the landlord in accor-
dance with§1.6041–1(a)(1)(i)(B) and
(2)).
*****
Par. 4. Section 1.6045–1 is amended as
follows:
1. Revising paragraph (a) introduc-
tory text.
2. Revising paragraphs (c)(3) and
(c)(4).
3. In paragraph (g)(3)(iv), first and
third sentences, removing the language
“§5f.6045–1(c)(3) of this chapter”and
adding“paragraph (c)(3) of this section”
in its place.
4. In paragraph (g)(4)Examples 1,4,
2002–33 I.R.B.345August 19, 2002

5,6,7(i),8(i), and9(i), removing the
language“§5f.6045–1(c)(3)(ii) of this
chapter”and adding“paragraph (c)(3)(iii)
of this section”in its place in each place it
appears.
The revisions read as follows:
§1.6045–1 Returns of information of
brokers and barter exchanges.
(a)Definitions. The following defini-
tions apply for purposes of this section
and§1.6045–2:
*****
(c)***
(3)Exceptions—(i)Sales effected for
exempt recipients—(A)In general.No
return of information is required with
respect to a sale effected for a customer
that is an exempt recipient under para-
graph (c)(3)(i)(B) of this section.
(B)Exempt recipient defined. The term
exempt recipientmeans—
(1) A corporation as defined in section
7701(a)(3), whether domestic or foreign;
(2) An organization exempt from taxa-
tion under section 501(a) or an individual
retirement plan;
(3) The United States or a State, the
District of Columbia, a possession of the
United States, a political subdivision of
any of the foregoing, a wholly owned
agency or instrumentality of any one or
more of the foregoing, or a pool or part-
nership composed exclusively of any of
the foregoing;
(4) A foreign government, a political
subdivision thereof, an international orga-
nization, or any wholly owned agency or
instrumentality of the foregoing;
(5) A foreign central bank of issue as
defined in§1.895–1(b)(1) (i.e., a bank
that is by law or government sanction the
principal authority, other than the govern-
ment itself, issuing instruments intended
to circulate as currency);
(6) A dealer in securities or commodi-
ties registered as such under the laws of
the United States or a State;
(7) A futures commission merchant
registered as such with the Commodity
Futures Trading Commission;
(8) A real estate investment trust (as
defined in section 856);
(9) An entity registered at all times
during the taxable year under the Invest-
ment Company Act of 1940 (15 U.S.C.
80a–1,et seq.);
(10) A common trust fund (as defined
in section 584(a)); or
(11) A financial institution such as a
bank, mutual savings bank, savings and
loan association, building and loan asso-
ciation, cooperative bank, homestead as-
sociation, credit union, industrial loan
association or bank, or other similar orga-
nization.
(C)Exemption certificate. A broker
may treat a person described in paragraph
(c)(3)(i)(B) of this section as an exempt
recipient based on a properly completed
exemption certificate (as provided in
§31.3406(h)–3) of this chapter, on the
broker’s actual knowledge that the payee
is a person described in paragraph
(c)(3)(i)(B), or on the applicable indica-
tors described in§1.6049–4(c)(1)(ii)(A)
through (M). A broker may require an
exempt recipient to file a properly com-
pleted exemption certificate and may treat
an exempt recipient that fails to do so as a
recipient that is not exempt.
(ii)Excepted sales. No return of infor-
mation is required with respect to a sale
effected by a broker for a customer if the
sale is an excepted sale. For this purpose,
a sale is an excepted sale if it is so
designated by the Internal Revenue Ser-
vice in a revenue ruling or revenue proce-
dure (see§601.601(d)(2) of this chapter).
(iii)Multiple brokers. If a broker is
instructed to initiate a sale by a person that
is an exempt recipient described in para-
graph (c)(3)(i)(B)(6), (7), or (11) of this
section, no return of information is re-
quired with respect to the sale by that
broker. In a redemption of stock or retire-
ment of securities, only the broker respon-
sible for paying the holder redeemed or
retired, or crediting the gross proceeds on
the sale to that holder’s account, is re-
quired to report the sale.
(iv)Cash on delivery transactions.In
the case of a sale of securities through a
cash on delivery account, a delivery ver-
sus payment account, or other similar
account or transaction, only the broker
that receives the gross proceeds from the
sale against delivery of the securities sold
is required to report the sale. If, however,
the broker’s customer is another broker
(second-party broker) that is an exempt
recipient, then only the second-party bro-
ker is required to report the sale.
(v)Fiduciaries and partnerships.No
return of information is required with
respect to a sale effected by a custodian or
trustee in its capacity as such or a redemp-
tion of a partnership interest by a partner-
ship, provided the sale is otherwise
reported by the custodian or trustee on a
properly filed Form 1041, or the redemp-
tion is otherwise reported by the partner-
ship on a properly filed Form 1065, and all
Schedule K-1 reporting requirements are
satisfied.
(vi)Sales at issue price. No return of
information is required with respect to a
sale of an interest in a regulated invest-
ment company that can hold itself out as a
money market fund under Rule 2a–7 un-
der the Investment Company Act of 1940
that computes its current price per share
for purposes of distributions, redemptions,
and purchases so as to stabilize the price
per share at a constant amount that ap-
proximates its issue price or the price at
which it was originally sold to the public.
(vii)Obligor payments on certain ob-
ligations. No return of information is re-
quiredwithrespecttopayments
representing obligor payments on—
(A) Nontransferable obligations (in-
cluding savings bonds, savings accounts,
checking accounts, and NOW accounts);
(B) Obligations as to which the entire
gross proceeds are reported by the broker
on Form 1099 under provisions of the
Internal Revenue Code other than section
6045 (including stripped coupons issued
prior to July 1, 1982); or
(C) Retirement of short-term obliga-
tions (i.e., obligations with a fixed matu-
rity date not exceeding 1 year from the
date of issue) that have original issue
discount, as defined in section 1273(a)(1),
with or without application of thede
minimisrule.
(D) Demand obligations that also are
callable by the obligor and that have no
premium or discount.
(viii)Foreign currency. No return of
information is required with respect to a
sale of foreign currency other than a sale
pursuant to a forward contract or regulated
futures contract that requires delivery of
foreign currency.
(ix)Fractional share. No return of
information is required with respect to a
sale of a fractional share of stock if the
gross proceeds on the sale of the fractional
share are less than $20.
(x)Certain retirements. No return of
information is required from an issuer or
its agent with respect to the retirement of
August 19, 20023462002–33 I.R.B.

book entry or registered form obligations
as to which the relevant books and records
indicate that no interim transfers have
occurred.
(xi)Cross reference. For an exception
for certain sales of agricultural commodi-
ties and certificates issued by the Com-
modity Credit Corporation after January 1,
1993, see paragraph (c)(7) of this section.
(xii)Effective date. The provisions of
this paragraph (c)(3) apply for sales ef-
fected after December 31, 2002.
(4)Examples. The following examples
illustrate the application of the rules in
paragraph (c)(3) of this section:
Example 1. P, an individual who is not an exempt
recipient, places an order with B, a person generally
known in the investment community to be a federally
registered broker/dealer, to effect a sale of P’s stock
in a publicly traded corporation. B, in turn, places an
order to sell the stock with C, a second broker, who
will execute the sale. B discloses to C the identity of
the customer placing the order. C is not required to
make a return of information with respect to the sale
because C was instructed by B, an exempt recipient
as defined in paragraph (c)(3)(i)(B)(6) of this sec-
tion, to initiate the sale. B is required to make a
return of information with respect to the sale because
PisB’s customer and is not an exempt recipient.
Example 2. Assume the same facts as inExample
1except that B has an omnibus account with C so
that B does not disclose to C whether the transaction
is for a customer of B or for B’s own account. C is
not required to make a return of information with
respect to the sale because C was instructed by B, an
exemptrecipientasdefinedinparagraph
(c)(3)(i)(B)(6) of this section, to initiate the sale. B is
required to make a return of information with respect
to the sale because P is B’s customer and is not an
exempt recipient.
Example 3. D, an individual who is not an
exempt recipient, enters into a cash on delivery stock
transaction by instructing K, a federally registered
broker/dealer, to sell stock owned by D, and to
deliver the proceeds to L, a custodian bank. Concur-
rently with the above instructions, D instructs L to
deliver D’s stock to K (or K’s designee) against
delivery of the proceeds from K. The records of both
K and L with respect to this transaction show an
account in the name of D. Pursuant to paragraph
(h)(1) of this section, D is considered the customer of
K and L. Under paragraph (c)(3)(iv) of this section,
K is not required to make a return of information
with respect to the sale because K will pay the gross
proceeds to L against delivery of the securities sold.
L is required to make a return of information with
respect to the sale because D is L’s customer and is
not an exempt recipient.
Example 4. Assume the same facts as inExample
3except that E, a federally registered investment
advisor, instructs K to sell stock owned by D and to
deliver the proceeds to L. Concurrently with the
above instructions, E instructs L to deliver D’s stock
to K (or K’s designee) against delivery of the
proceeds from K. The records of both K and L with
respect to the transaction show an account in the
name of D. Pursuant to paragraph (h)(1) of this
section, D is considered the customer of K and L.
Under paragraph (c)(3)(iv) of this section, K is not
required to make a return of information with respect
to the sale because K will pay the gross proceeds to
L against delivery of the securities sold. L is required
to make a return of information with respect to the
sale because D is L’s customer and is not an exempt
recipient.
Example 5. Assume the same facts as inExample
4except that the records of both K and L with respect
to the transaction show an account in the name of E.
Pursuant to paragraph (h)(1) of this section, E is
considered the customer of K and L. Under para-
graph (c)(3)(iv) of this section, K is not required to
make a return of information with respect to the sale
because K will pay the gross proceeds to L against
delivery of the securities sold. L is required to make
a return of information with respect to the sale
because E is L’s customer and is not an exempt
recipient. E is required to make a return of informa-
tion with respect to the sale because D is E’s
customer and is not an exempt recipient.
Example 6. F, an individual who is not an exempt
recipient, owns bonds that are held by G, a federally
registered broker/dealer, in an account for F with G
designated as nominee for F. Upon the retirement of
the bonds, the gross proceeds are automatically
credited to the account of F. G is required to make a
return of information with respect to the retirement
because G is the broker responsible for making
payments of the gross proceeds to F.
*****
Par.5.In§1.6045–2, paragraph
(b)(2)(ii), is amended by removing the
language“§5f.6045–1(c)(3)(i)(B) of the
Temporary Income Tax Regulations under
the Tax Equity and Fiscal Responsibility
Act of 1982”and adding the language
“§1.6045–1(c)(3)(i)(B)”in its place.
Par.6.In§1.6049–4, paragraph (a)(2)
is revised to read as follows:
§1.6049–4 Return of information as to
interest paid and original issue discount
includible in gross income after
December 31, 1982.
(a)***
(2)Payor. For payments made after
December 31, 2002, a payor is a person
described in paragraph (a)(2)(i) or (ii) of
this section.
(i) Every person who makes a payment
of the type and of the amount subject to
reporting under this section (or under an
applicable section under this chapter) to
any other person during a calendar year.
(ii) Every person who collects on be-
half of another person payments of the
type and of the amount subject to report-
ing under this section (or under an appli-
cable section under this chapter), or who
otherwise acts as a middleman (as defined
in paragraph (f)(4) of this section) with
respect to such payment.
*****
PA RT 5 f—TEMPORARY INCOME
TAX REGULATIONS UNDER THE
TAX EQUITY AND FISCAL
RESPONSIBILITY ACT OF 1982
Par. 7. The authority citation for part 5f
is amended by removing the authority
citation for“Sec. 5f.6045–1”to read in
part as follows:
Authority: 26 U.S.C. 7805***
Par. 8. Section 5f.6045–1 is removed.
PA RT 3 1—EMPLOYMENT TAXES
AND COLLECTION OF INCOME TAX
AT SOURCE
Par. 9. The authority citation for part 31
continues to read in part as follows:
Authority: 26 U.S.C. 7805***
Par. 10. Section 31.3406–0 is amended
by:
1. Revising the entry in the table for
§31.3406(a)–2, paragraph (b).
2. Adding an entry to the table for
§31.3406(a)–2, paragraph (d).
The revision and addition read as fol-
lows:
§31.3406–0 Outline of the backup
withholding regulations.
*****
§31.3406(a)–2 Definition of payors
obligated to backup withhold.
*****
(b) Persons treated as payors.
*****
(d) Effective date.
*****
Par. 11. Section 31.3406(a)–2 is revised
to read as follows:
§31.3406(a)–2 Definition of payors
obligated to backup withhold.
(a)In general.Payormeans the per-
2002–33 I.R.B.347August 19, 2002

son that is required to make an informa-
tion return under section 6041, 6041A(a),
6042, 6044, 6045, 6049, 6050A, or
6050N, with respect to any reportable
payment (as described in section 3406(b)),
or that is described in paragraph (b) of this
section.
(b)Persons treated as payors. The
following persons are treated as payors for
purposes of section 3406—
(1) A grantor trust established after
December 31, 1995, all of which is owned
by two or more grantors (treating for this
purpose spouses filing a joint return as one
grantor);
(2) A grantor trust with ten or more
grantors established on or after January 1,
1984, but before January 1, 1996;
(3) A common trust fund; and
(4) A partnership or an S corporation
that makes a reportable payment.
(c)Persons not treated as payors.A
person on the following list is not treated
as a payor for purposes of section 3406 if
the person does not have a reporting
obligation under the section on informa-
tion reporting to which the payment
relates—
(1) A trust (other than a grantor trust
as described in paragraph (b)(1) or (2) of
this section) that files a Form 1041 con-
taining information required to be shown
on an information return, including
amounts withheld under section 3406; or
(2) A partnership making a payment
of a distributive share or an S corporation
making a similar distribution.
(d)Effective date. The provisions of
this section apply to payments made after
December 31, 2002.
Par. 12. Section 31.3406(a)–4is
amended as follows:
1. In paragraph (c)(1), first sentence,
removing the language“Any middleman
(as defined in§31.3406(a)–2(b))”and
adding“A person that is a middleman and
is a person defined in§31.3406(a)–2(b) or
in the section on information reporting to
which the payment relates”in its place.
2. In paragraph (c)(3), first sentence,
removing the language“§31.3406(a)–
2(b)(4)”and adding“§31.3406(a)–2(b)(1)
or (2)”in its place.
Par. 13. In§31.3406(b)(3)–2, para-
graph (b)(5) is amended by removing the
language“§5f.6045–1(c)(3)(ix)”and add-
ing“§1.6045–1(c)(3)(x)”in its place.
Par. 14. In§31.3406(d)–4, paragraph
(a)(1) introductory text is amended by
removing the language“the payor of the
instrument (as defined in§31.3406
(a)–2(b)(3)),”and adding“a broker hold-
ing a security (including stock) for a
customer in street name,”in its place.
Par. 15. In§31.3406(h)–1, paragraph
(c), second sentence, is amended by re-
movingthelanguage“§5f.6045–1
(c)(3)(ii) and (iii)”and adding“§1.6045
–1(c)(3)(iii) and (iv)”in its place.
Par. 16. Section 31.3406(h)–2is
amended as follows:
1. In paragraph (c), third sentence,
removing the language“with two or more
grantors described in§31.3406(a)–2(b)
(4), which is treated as a middle-
man payor”and adding“described in
§31.3406(a)–2(b)(1) or (2), which is
treated as a payor”in its place.
2. In paragraph (d), first sentence, re-
moving the language“A middleman payor
(as defined in§31.3406(a)–2(b))”and
adding“A middleman payor (as defined in
§31.3406(a)–2(b) or in the section on
information reporting to which the pay-
ment relates)”in its place.
3. In paragraph (f)(6), removing the
language§31.3406(a)–2(a)”and adding
“§31.3406(a)–2”in its place.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 17. The authority citation for part
602 continues to read in part as follows:
Authority: 26 U.S.C. 7805***
Par. 18. In section 602.101, paragraph
(b) is amended by adding the following
OMB Control numbers in numerical order
to the table to read as follows:
§602.101 OMB Control numbers
****
(b)***
CFR part or section where
identified and described
Current OMB
control No.
*****
1.6041–1 ............................................................................................................................................................. 1545–1705
*****
1.6045–1 ............................................................................................................................................................. 1545–1705
*****
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved July 17, 2002.
Pamela F. Olson,
Acting Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on July
25, 2002, 8:45 a.m., and published in the Federal
Register for July 26, 2002, 67 F.R. 48754)
August 19, 20023482002–33 I.R.B.

Section 7122.—Compromises
26 CFR 301.7122–1: Compromises.
T.D. 9007
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 301
Compromise of Tax Liabilities
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations and removal
of temporary regulations.
SUMMARY: This document contains fi-
nal regulations relating to the compromise
of internal revenue taxes. The regulations
adopt the rules of the temporary regula-
tions and reflect changes to the law made
by the Internal Revenue Service Restruc-
turing and Reform Act of 1998 and the
Taxpayer Bill of Rights 2.
EFFECTIVE DATE: These regulations
are effective July 18, 2002.
FOR FURTHER INFORMATION CON-
TACT: Frederick W. Schindler at (202)
622–3620 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains final regula-
tions amending the Procedure and Admin-
istration Regulations (26 CFR part 301)
under section 7122 of the Internal Rev-
enue Code (Code). The regulations reflect
the amendment of section 7122 by section
3462 of the Internal Revenue Service
Restructuring and Reform Act of 1998
(RRA 1998), Public Law 105–206 (112
Stat. 685, 764) and by section 503 of the
Taxpayer Bill of Rights II, Public Law
104–168 (110 Stat. 1452, 1461).
As amended by RRA 1998, section
7122 provides that the Secretary will de-
velop guidelines to determine when an
offer to compromise is adequate and
should be accepted to resolve a dispute.
The legislative history accompanying
RRA 1998 explains that Congress in-
tended that, in certain circumstances, fac-
tors such as equity, hardship, and public
policy be taken into account by the IRS in
evaluating whether the compromise of
individual tax liabilities would promote
effective tax administration. H. Conf. Rep.
599, 105th Cong., 2d Sess. 289 (1998). On
July 21, 1999, temporary regulations (T.D.
8829, 1999–2 C.B. 235 [64 FR 39020])
and a notice of proposed rulemaking
(REG-116991–98, 1999–2 C.B. 242 [64
FR 39106]) reflecting these changes were
published in theFederal Register. Four
written comments on the temporary and
proposed regulations were received. A
public hearing on the regulations was
requested but that request was later with-
drawn. No public hearing was scheduled
or held. The final regulations adopt the
rules of the temporary regulations with
minor changes.
Explanation of Provisions
A compromise is an agreement be-
tween a taxpayer and the Government that
settles a tax liability for payment of less
than the total amount determined and
assessed. Consistent with its mission of
applying the tax laws with integrity and
fairness to all, the IRS generally expects
that all taxpayers will pay the total amount
due, regardless of amount. See Policy
Statement P-5-2, Collecting Principles
(Approved February 17, 2000), reprinted
at IRM 1.2.1.5.2. When attempting to
resolve a tax delinquency, the IRS will
work with taxpayers to achieve full pay-
ment of all tax, penalties, and interest
imposed by Congress. Where payment in
full cannot immediately be achieved, the
IRS may, at its discretion, allow taxpayers
to pay over time through installment
agreements.
The IRS recognizes that it is both
sound business practice and good tax
policy to settle some cases for less than
the total amount due. Prior to issuance of
the temporary regulations, the IRS had a
longstanding practice of compromising
where there was doubt as to the existence
or amount of the tax liability or doubt that
the total amount due could be collected.
The final regulations continue these tradi-
tional grounds for compromise. In addi-
tion, to reflect the changes made by RRA
1998, the final regulations allow compro-
mise where there is no doubt as to liability
or as to collectibility, but where compro-
mise would promote effective tax admin-
istration because either (1) collection of
the liability would create economic hard-
ship, or (2) compelling public policy or
equity considerations provide a sufficient
basis for compromising the liability. Com-
promise based on these hardship and pub-
lic policy/equity bases, however, may not
be authorized if compromise would under-
mine compliance with the tax laws.
Effective Tax Administration—
Economic Hardship
The final regulations retain the refer-
ence in the temporary regulations to the
economic hardship standard of§301.
6343–1, which defines economic hardship
as the inability to pay reasonable basic
living expenses. In determining reason-
able basic living expenses,§301.6343–1
directs the IRS to consider relevant infor-
mation such as the taxpayer’s age, em-
ployment status and history, number of
dependents, and other“unique circum-
stances.”The final regulations supplement
this standard by providing a non-exclusive
list of factors which support a finding of
economic hardship, and by providing ex-
amples to illustrate application of the stan-
dard.
The fourth example of economic hard-
ship in the temporary regulations, involv-
ing a business taxpayer, has been removed
in order to eliminate an inconsistency. The
economic hardship standard of§301.
6343–1 specifically applies only to indi-
viduals. The fourth example was included
in the temporary regulations in the event
that a standard for evaluating economic
hardship with respect to non-individuals
could be developed. After evaluating this
issue further, the IRS and Treasury De-
partment have concluded that an eco-
nomichardshipstandardfor
non-individuals does not necessarily pro-
mote effective tax administration. Permit-
ting compromise in non-individual cases
where there is no doubt as to collectibility,
for instance, would raise the issue of
whether the Government should be fore-
going the collection of taxes to support a
nonviable business.
Although economic hardship therefore
is not a basis for compromise for non-
individuals under the final regulations,
IRS experience has shown that the doubt
as to collectibility standard often may
permit the resolution of cases involving
businesses and other non-individual tax-
payers. In addition, even if a business or
2002–33 I.R.B.349August 19, 2002

other non-individual is unable to compro-
mise on liability or collectibility grounds,
compelling public policy or equity consid-
erations (discussed below) may provide
sufficient grounds to compromise the
case.
A commenting party suggested that the
economic hardship standard and examples
were not inclusive enough, specifically
stating that the first two examples of
economic hardship in the temporary regu-
lations were drawn too narrowly. The first
example illustrating economic hardship
described a taxpayer whose assets and
income are likely to be exhausted caring
for a dependent child. The commenting
party believed that the regulations would
better promote effective tax administration
if the example were expanded to include
care of a dependent parent or other family
member. The second example described a
retired taxpayer whose only income is
from a pension and whose only asset is a
retirement account. The taxpayer could
pay the tax liability in full by liquidating
his retirement account, but doing so would
leave the taxpayer without adequate
means of support. The commenting party
suggested that the example should specifi-
cally state that the age of the taxpayer
should be taken into account. Otherwise, a
taxpayer close to retirement age may feel
compelled to retire so as to eliminate other
sources of income and qualify under this
example since retirement funds would
then be the only source of income. A
second commenting party also suggested
that the moral or legal obligation to sup-
port others be listed as a factor supporting
a finding of economic hardship.
The final regulations adopt these sug-
gestions, in part, by stating that one factor
supporting a finding of economic hardship
might be that all available funds are used
for the care of a dependent. Although the
final regulations include examples to illus-
trate the application of the economic hard-
ship standard, the central inquiry is
whether full collection of the liability
would render the taxpayer unable to pro-
vide for reasonable basic living expenses.
Facts such as the number of dependents
and the age and health of taxpayers and
theirdependentsarefactorswhich
§301.6343–1 provides should be consid-
ered when making that economic hardship
determination. Furthermore, the examples
in the final regulations are not intended to
be exclusive and should not be read to
suggest that all of the facts discussed in a
given example must be present in a case in
order for compromise to be authorized.
Effective Tax Administration—Public
Policy and Equity
The temporary regulations provided
that the IRS may compromise a liability to
promote effective tax administration even
if no other basis for compromise is avail-
able. (As discussed above, compromise on
the basis of economic hardship is not
available to non-individuals under the fi-
nal regulations.) The temporary regula-
tionsprovidedthattheIRSmay
compromise under the non-hardship effec-
tive tax administration standard to pro-
mote effective tax administration when,
“[r]egardless of the taxpayer’s financial
circumstances, exceptional circumstances
exist such that collection of the full liabil-
ity will be detrimental to voluntary com-
pliance by taxpayers.”
The“detrimental to voluntary compli-
ance”standard in the temporary regula-
tions was intended to indicate that the IRS
may compromise in those rare cases
where collection of the full liability would
adversely affect the overall tax system.
Based on public comments and on IRS
experience in implementing the temporary
regulations, this standard has been restated
in the final regulations to clarify the types
of cases that may qualify for compromise
on these grounds. Compromise under the
non-hardship effective tax administration
standard in the final regulations, however,
still is expected to be appropriate only in
those rare cases where collection would
adversely affect the overall tax system.
Under the final regulations, a taxpayer
seeking to compromise a liability on this
basis must identify compelling public
policy or equity considerations providing
a sufficient basis for compromising the
liability. The circumstances must be such
that compromise is justified even though a
similarly situated taxpayer may have paid
his liability in full. Before accepting an
offer based on equity and public policy
considerations, the IRS must conclude that
collection of the full liability would un-
dermine public confidence that the tax
laws are being administered in a fair and
equitable manner.
The clarification to the non-hardship
effective tax administration standard in the
final regulations recognizes that compro-
mise on these grounds raises the issue of
disparate treatment of taxpayers who are
able to pay the full amount of their liabili-
ties without economic hardship. Some tax-
payers will pay less than the full amount
owed, while others must pay in full.
(Some taxpayers who pay in full also may
be in situations similar to that of the
taxpayer requesting compromise.) Ac-
cordingly, the final regulations specify
that a taxpayer must demonstrate that the
circumstances of the taxpayer’s liability
implicate public policy or equity concerns
compelling enough to justify compromise
notwithstanding this inherent inequity. As
noted earlier, the cases satisfying the eq-
uity and public policy standard are ex-
pected to be rare. In applying this
standard, the IRS will presume that the
correct application of the tax laws pro-
duces a fair and equitable result, absent
exceptional circumstances.
The notice of proposed rulemaking
specifically encouraged the public to
make comments or provide examples re-
garding the particular types of cases or
situations in which the Secretary’s author-
ity to compromise should be used be-
cause: (1) collection of the full amount of
tax liability would be detrimental to vol-
untary compliance (i.e., may be appropri-
ateforcompromiseunderthe
non-hardship effective tax administration
standard) or (2) IRS delay in determining
the tax liability has resulted in the accu-
mulation of significant interest and penal-
ties.Partiesprovidingcomments
regarding delay in interest and penalty
cases were asked to consider the possible
interplay between cases compromised un-
der this provision and the relief accorded
taxpayers under section 6404(e).
Two parties submitted comments in
response to this request. Both suggested
that the regulations be expanded to autho-
rize compromise in situations where delay
in determining the taxpayer’s liability
caused substantial interest and penalties to
accrue. The first suggested that compro-
mise on the basis that collection in full
would be detrimental to voluntary compli-
ance was warranted when any undue delay
by the IRS resulted in the accumulation of
penalties and interest. The commenting
party suggested that the regulations in-
clude delay by the IRS in determining the
taxpayer’s liability, issuing a revenue
August 19, 20023502002–33 I.R.B.

agent’s report or notice of deficiency, or
litigating the issues as factors and ex-
amples supporting compromise on these
grounds. The commenting party did not
suggest a standard for determining“undue
delay”and did not discuss whether this
kind of expansion of the compromise
regulations would undermine the interest
abatement provisions of section 6404(e).
The second party to comment on this
provision in the regulations suggested
compromise should be authorized where a
liability results from factors beyond the
taxpayer’s control and the accumulation
of interest and penalties is disproportion-
ately large compared to the initial liability.
The specific example suggested by the
commenting party was one in which the
Tax Matters Partner (TMP) in a partner-
ship subject to the unified audit proce-
dures of the Tax Equity and Fiscal
Responsibility Act of 1982 (TEFRA)
fraudulently sells shares in a sham busi-
ness to other partners and those partners
incur substantial interest and penalties at-
tributable to partnership items. According
to the commenting party, the failure of the
IRS to remove a TMP being investigated
for fraud relating to the partnership, and to
allow the TMP to continue to represent the
partnership during the audit, creates“ex-
ceptional circumstances”warranting com-
promisewithotherpartners.The
commenting party acknowledged that sec-
tion 6404(e) would not usually authorize
the abatement of interest under such cir-
cumstances because the interest does not
result from an unreasonable error or delay
by an IRS official in performing a minis-
terial or managerial act. The commenting
party also acknowledged that it would be
unwise to craft a rule that would make the
Government an insurer of individual tax-
payer liabilities attributable to the mis-
deeds of a tax shelter promoter. However,
the commenting party believed that where
the IRS’s failure to remove the TMP
contributed to the problem, compromise is
warranted.
The IRS and Treasury Department do
not believe that it would promote effective
tax administration to authorize compro-
mise solely on the basis of an asserted
delay by the IRS, particularly delay that
does not support relief under section
6404(e) with respect to accrued interest, or
on the basis that a third party, such as the
taxpayer’s partner, is claimed to have
defrauded or otherwise caused financial
harm to the taxpayer. Nevertheless, cases
in which a taxpayer believes the liability
was caused, in whole or in part, by delay
on the part of the IRS or by the actions of
third parties may be appropriate for com-
promise under the public policy and eq-
uity standard. Such cases, however, are
expected to be rare, as the taxpayer must
identify compelling public policy or eq-
uity concerns that satisfy the standard set
forth above.
The IRS and Treasury Department are
mindful that the Congressional Confer-
enceCommittee,inaddingsection
7122(c) as part of RRA 1998, anticipated
that the IRS may use the authority pro-
vided in section 7122(c) to resolve long-
standing cases by foregoing penalties and
interest resulting from delays in determin-
ing a taxpayer’s liability. See H. Conf.
Rep. 599, 105th Cong., 2d Sess. 289
(1998). The IRS’experience in applying
the temporary regulations is that these
regulations have given effect to the intent
of Congress, as expressed in the Confer-
ence Report, since cases involving sub-
stantial interest and penalties often can be
compromised under the standards of doubt
as to collectibility and economic hardship.
Similarly, although a taxpayer is in the
best position to anticipate, and protect
himself or herself from, the risks of busi-
ness associations and transactions, the
misdeeds of third parties that may have
contributed to a tax liability may be taken
into account when determining whether to
accept a compromise based on doubt as to
collectibility or on a finding that collec-
tion would cause economic hardship.
Amount of Compromise if Basis for
Compromise Exists
The final regulations set forth the per-
missible bases for compromise, one of
which must be established in order to
accept an offer to compromise liabilities
arising under the internal revenue laws.
They do not, however, prescribe the
amount which must be offered in order for
an offer to be acceptable. The amount to
be paid, future compliance, or other con-
ditions precedent to satisfaction of a liabil-
ity for less than the full amount due are
matters left to the discretion of the Secre-
tary. For the sake of clarity, the final
regulations now expressly state this prin-
ciple, which was stated only in the pre-
amble to the temporary regulations.
As required by section 7122(c)(2)(A)
and (B), added by RRA 1998, the final
regulations provide for the development
and publication of national and local liv-
ing allowances that permit taxpayers en-
tering into offers to compromise to have
an adequate means to provide for their
basic living expenses. The determination
of whether the published standards should
be applied in any particular case must be
based upon an evaluation of the individual
facts and circumstances presented. The
Secretary will continue to determine the
appropriate means to publish these na-
tional and local living allowances.
A commenting party suggested that the
national and local living allowance stan-
dards be eliminated in favor of a rule
requiring all offer specialists to look only
to an individual taxpayer’s actual facts
and circumstances to determine the
amount necessary to provide for reason-
able basic living expenses. According to
the commenting party, IRS employees
rarely depart from the national and local
standards, which, in practice, serve as a
“cap”on expenses, rather than as a general
guide to be applied based on the specific
facts of a case.
Because publication of the national and
local standards is required by section
7122(c)(2)(A), the suggestion that the
standards be eliminated has not been
adopted. In accordance with section
7122(c)(2)(B), the final regulations re-
quire that the IRS consider the facts and
circumstances of the case when determin-
ing basic living expenses. Consistent with
this requirement in the statute and regula-
tions, the IRS has issued internal guidance
requiring that the particular facts and cir-
cumstance of a taxpayer’s case be consid-
ered whenever the expense standards are
applied, and that expense allowances be-
yond the standards be used whenever use
of the standards would result in a taxpayer
not having adequate means to provide for
basic living expenses.
Other Provisions
Section 7122(c)(3)(A) prohibits the re-
jection of an offer to compromise by a low
income taxpayer based solely on the
amount of the offer. The final regulations
expand this rule to apply to all taxpayers
regardless of income level. The final regu-
2002–33 I.R.B.351August 19, 2002

lations state that no offer may be rejected
based solely on the amount of the offer.
Offers will only be rejected when the IRS
determines that no basis for compromise
under this section is present or that the
offer is unacceptable under the Secretary’s
policies and procedures.
In accordance with section 7122(d)(1),
the final regulations provide that all pro-
posed rejections of offers to compromise
will receive independent administrative
review prior to final rejection. Section
7122(d)(2) requires and the regulations
also provide that the taxpayer may appeal
any rejection of an offer to compromise to
the IRS Office of Appeals. The final
regulations provide, however, that when
the IRS returns an offer to compromise
because the offer was submitted solely to
delay collection, or because the taxpayer
failed to provide requested information
required by the IRS to evaluate or process
the offer under IRS procedures, the return
of the offer does not constitute a rejection
and, thus, is not subject to appeal. In the
event that the IRS institutes collection
action following the return of an offer to
compromise, the taxpayer may have the
right to consideration of the whole of his
collection case under other provisions of
the Code.
Although not required by any provision
of the Code, the temporary regulations
provided that an offer could not be re-
turned to a taxpayer for failure to submit
requested financial information until an
independent administrative review of the
proposed return was completed. The re-
quirement of an independent administra-
tive review of proposed returns was the
source of significant delays and was re-
dundant because an IRS manager must
review and approve all returns of offers
for failure to submit requested financial
information. The final regulations there-
fore require review only by an IRS man-
ager in these cases.
Pursuant to section 6331(k), the final
regulations also provide that the IRS may
not levy to collect a liability while an offer
to compromise is pending, or for the 30
days following any rejection of an offer to
compromise, or during any period that an
appeal of any rejection is being consid-
ered, when such appeal is instituted within
the 30 days following rejection. Levy will
not, however, be precluded in any case
where collection is in jeopardy or the offer
to compromise was submitted solely to
delay collection. The regulations also cor-
rect for an omission in the temporary
regulations by providing that the IRS may
not refer a case to the Department of
Justice to collect an unpaid tax through a
judicial proceeding while an offer to com-
promise that tax is pending or while a
rejection of such an offer is being consid-
ered by the IRS Office of Appeals. The
IRS may, however, authorize the Depart-
ment of Justice to file a counterclaim in
any refund proceeding commenced by a
taxpayer, participate in bankruptcy or in-
solvency cases commenced by or against
the taxpayer, or join a taxpayer in any
other proceeding in which liability for the
tax at issue may be established or dis-
puted.
The final regulations also implement
section 503(a) of the Taxpayer Bill of
Rights II by specifying that Chief Counsel
review of an accepted offer to compromise
is required only for offers in compromise
involving $50,000 or more in unpaid li-
abilities.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It also has been deter-
mined that section 553(b) of the Adminis-
trative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and
because these regulations do not impose a
collection of information on small entities,
the Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Code, the preceding
temporary 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 Frederick W. Schindler of the
Office of Associate Chief Counsel (Proce-
dure and Administration), Collection,
Bankruptcy & Summonses Division.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 301 is
amended as follows:
PART 301—PROCEDURE AND
ADMINISTRATION
Paragraph 1. The authority citation for
part 301 continues to read in part as
follows:
Authority: 26 U.S.C. 7805***
Par. 2. Sections 301.7122–0 and
301.7122–1 are added to read as follows:
§301.7122–0 Table of contents.
This section lists the major captions
that appear in the regulations under§301.
7122–1.
§301.7122–1 Compromises.
(a) In general.
(b) Grounds for compromise.
(c) Special rules for the evaluation of
offers to compromise.
(d) Procedures for submission and consid-
eration of offers.
(e) Acceptance of an offer to compromise
a tax liability.
(f) Rejection of an offer to compromise.
(g) Effect of offer to compromise on
collection activity
(h) Deposits.
(i) Statute of limitations.
(j) Inspection with respect to accepted
offers to compromise.
(k) Effective date.
§301.7122–1 Compromises.
(a)In general—(1) If the Secretary
determines that there are grounds for com-
promise under this section, the Secretary
may, at the Secretary’s discretion, com-
promise any civil or criminal liability
arising under the internal revenue laws
prior to reference of a case involving such
a liability to the Department of Justice for
prosecution or defense.
August 19, 20023522002–33 I.R.B.

(2) An agreement to compromise may
relate to a civil or criminal liability for
taxes, interest, or penalties. Unless the
terms of the offer and acceptance ex-
pressly provide otherwise, acceptance of
an offer to compromise a civil liability
does not remit a criminal liability, nor
does acceptance of an offer to compromise
a criminal liability remit a civil liability.
(b)Grounds for compromise—(1)
Doubt as to liability. Doubt as to liability
exists where there is a genuine dispute as
to the existence or amount of the correct
tax liability under the law. Doubt as to
liability does not exist where the liability
has been established by a final court
decision or judgment concerning the ex-
istence or amount of the liability. See
paragraph (f)(4) of this section for special
rules applicable to rejection of offers in
cases where the Internal Revenue Service
(IRS) is unable to locate the taxpayer’s
return or return information to verify the
liability.
(2)Doubt as to collectibility. Doubt as
to collectibility exists in any case where
the taxpayer’s assets and income are less
than the full amount of the liability.
(3)Promote effective tax administra-
tion. (i) A compromise may be entered
into to promote effective tax administra-
tion when the Secretary determines that,
although collection in full could be
achieved, collection of the full liability
would cause the taxpayer economic hard-
ship within the meaning of§301.6343–1.
(ii) If there are no grounds for compro-
mise under paragraphs (b)(1), (2), or (3)(i)
of this section, the IRS may compromise
to promote effective tax administration
where compelling public policy or equity
considerations identified by the taxpayer
provide a sufficient basis for compromis-
ing the liability. Compromise will be jus-
tified only where, due to exceptional
circumstances, collection of the full liabil-
ity would undermine public confidence
that the tax laws are being administered in
a fair and equitable manner. A taxpayer
proposing compromise under this para-
graph (b)(3)(ii) will be expected to dem-
onstratecircumstancesthatjustify
compromise even though a similarly situ-
ated taxpayer may have paid his liability
in full.
(iii) No compromise to promote effec-
tive tax administration may be entered
into if compromise of the liability would
undermine compliance by taxpayers with
the tax laws.
(c)Special rules for evaluating offers
to compromise—(1)In general. Once a
basis for compromise under paragraph (b)
of this section has been identified, the
decision to accept or reject an offer to
compromise, as well as the terms and
conditions agreed to, is left to the discre-
tion of the Secretary. The determination
whether to accept or reject an offer to
compromise will be based upon consider-
ation of all the facts and circumstances,
including whether the circumstances of a
particular case warrant acceptance of an
amount that might not otherwise be ac-
ceptable under the Secretary’s policies
and procedures.
(2)Doubt as to collectibility—(i)Al-
lowable Expenses. A determination of
doubt as to collectibility will include a
determination of ability to pay. In deter-
mining ability to pay, the Secretary will
permit taxpayers to retain sufficient funds
to pay basic living expenses. The determi-
nation of the amount of such basic living
expenses will be founded upon an evalu-
ation of the individual facts and circum-
stances presented by the taxpayer’s case.
To guide this determination, guidelines
published by the Secretary on national and
local living expense standards will be
taken into account.
(ii)Nonliable spouses—(A)In general.
Where a taxpayer is offering to compro-
mise a liability for which the taxpayer’s
spouse has no liability, the assets and
income of the nonliable spouse will not be
considered in determining the amount of
an adequate offer. The assets and income
of a nonliable spouse may be considered,
however, to the extent property has been
transferred by the taxpayer to the nonli-
able spouse under circumstances that
would permit the IRS to effect collection
of the taxpayer’s liability from such prop-
erty (e.g., property that was conveyed in
fraud of creditors), property has been
transferred by the taxpayer to the nonli-
able spouse for the purpose of removing
the property from consideration by the
IRS in evaluating the compromise, or as
provided in paragraph (c)(2)(ii)(B) of this
section. The IRS also may request infor-
mation regarding the assets and income of
the nonliable spouse for the purpose of
verifying the amount of and responsibility
for expenses claimed by the taxpayer.
(B)Exception. Where collection of the
taxpayer’s liability from the assets and
income of the nonliable spouse is permit-
ted by applicable state law (e.g., under
state community property laws), the assets
and income of the nonliable spouse will be
considered in determining the amount of
an adequate offer except to the extent that
the taxpayer and the nonliable spouse
demonstrate that collection of such assets
and income would have a material and
adverse impact on the standard of living of
the taxpayer, the nonliable spouse, and
their dependents.
(3)Compromises to promote effective
tax administration—(i) Factors supporting
(but not conclusive of) a determination
that collection would cause economic
hardship within the meaning of paragraph
(b)(3)(i) of this section include, but are not
limited to—
(A) Taxpayer is incapable of earning a
living because of a long term illness,
medical condition, or disability, and it is
reasonably foreseeable that taxpayer’s fi-
nancial resources will be exhausted pro-
viding for care and support during the
course of the condition;
(B) Although taxpayer has certain
monthly income, that income is exhausted
each month in providing for the care of
dependents with no other means of sup-
port; and
(C) Although taxpayer has certain as-
sets, the taxpayer is unable to borrow
against the equity in those assets and
liquidation of those assets to pay outstand-
ing tax liabilities would render the tax-
payer unable to meet basic living
expenses.
(ii) Factors supporting (but not conclu-
sive of) a determination that compromise
would undermine compliance within the
meaning of paragraph (b)(3)(iii) of this
section include, but are not limited to—
(A) Taxpayer has a history of noncom-
pliance with the filing and payment re-
quirements of the Internal Revenue Code;
(B) Taxpayer has taken deliberate ac-
tions to avoid the payment of taxes; and
(C) Taxpayer has encouraged others to
refuse to comply with the tax laws.
(iii) The following examples illustrate
the types of cases that may be compro-
mised by the Secretary, at the Secretary’s
2002–33 I.R.B.353August 19, 2002

discretion, under the economic hardship
provisions of paragraph (b)(3)(i) of this
section:
Example 1. The taxpayer has assets sufficient to
satisfy the tax liability. The taxpayer provides full
time care and assistance to her dependent child, who
has a serious long-term illness. It is expected that the
taxpayer will need to use the equity in his assets to
provide for adequate basic living expenses and
medical care for his child. The taxpayer’s overall
compliance history does not weigh against compro-
mise.
Example 2. The taxpayer is retired and his only
income is from a pension. The taxpayer’s only asset
is a retirement account, and the funds in the account
are sufficient to satisfy the liability. Liquidation of
the retirement account would leave the taxpayer
without an adequate means to provide for basic
living expenses. The taxpayer’s overall compliance
history does not weigh against compromise.
Example 3. The taxpayer is disabled and lives on
a fixed income that will not, after allowance of basic
living expenses, permit full payment of his liability
under an installment agreement. The taxpayer also
owns a modest house that has been specially
equipped to accommodate his disability. The taxpay-
er’s equity in the house is sufficient to permit
payment of the liability he owes. However, because
of his disability and limited earning potential, the
taxpayer is unable to obtain a mortgage or otherwise
borrow against this equity. In addition, because the
taxpayer’s home has been specially equipped to
accommodate his disability, forced sale of the tax-
payer’s residence would create severe adverse con-
sequences for the taxpayer. The taxpayer’s overall
compliance history does not weigh against compro-
mise.
(iv) The following examples illustrate
the types of cases that may be compro-
mised by the Secretary, at the Secretary’s
discretion, under the public policy and
equity provisions of paragraph (b)(3)(ii)
of this section:
Example 1. In October of 1986, the taxpayer
developed a serious illness that resulted in almost
continuous hospitalizations for a number of years.
The taxpayer’s medical condition was such that
during this period the taxpayer was unable to manage
any of his financial affairs. The taxpayer has not filed
tax returns since that time. The taxpayer’s health has
now improved and he has promptly begun to attend
to his tax affairs. He discovers that the IRS prepared
a substitute for return for the 1986 tax year on the
basis of information returns it had received and had
assessed a tax deficiency. When the taxpayer discov-
ered the liability, with penalties and interest, the tax
bill is more than three times the original tax liability.
The taxpayer’s overall compliance history does not
weigh against compromise.
Example 2. The taxpayer is a salaried sales
manager at a department store who has been able to
place $2,000 in a tax-deductible IRA account for
each of the last two years. The taxpayer learns that he
can earn a higher rate of interest on his IRA savings
by moving those savings from a money management
account to a certificate of deposit at a different
financial institution. Prior to transferring his savings,
the taxpayer submits an e-mail inquiry to the IRS at
its Web Page, requesting information about the steps
he must take to preserve the tax benefits he has
enjoyed and to avoid penalties. The IRS responds in
an answering e-mail that the taxpayer may withdraw
his IRA savings from his neighborhood bank, but he
must redeposit those savings in a new IRA account
within 90 days. The taxpayer withdraws the funds
and redeposits them in a new IRA account 63 days
later. Upon audit, the taxpayer learns that he has been
misinformed about the required rollover period and
that he is liable for additional taxes, penalties and
additions to tax for not having redeposited the
amount within 60 days. Had it not been for the
erroneous advice that is reflected in the taxpayer’s
retained copy of the IRS e-mail response to his
inquiry, the taxpayer would have redeposited the
amount within the required 60-day period. The
taxpayer’s overall compliance history does not weigh
against compromise.
(d)Procedures for submission and con-
sideration of offers—(1)In general.An
offer to compromise a tax liability pursu-
ant to section 7122 must be submitted
according to the procedures, and in the
form and manner, prescribed by the Sec-
retary. An offer to compromise a tax
liability must be made in writing, must be
signed by the taxpayer under penalty of
perjury, and must contain all of the infor-
mation prescribed or requested by the
Secretary. However, taxpayers submitting
offers to compromise liabilities solely on
the basis of doubt as to liability will not be
required to provide financial statements.
(2)When offers become pending and
return of offers. An offer to compromise
becomes pending when it is accepted for
processing. The IRS may not accept for
processing any offer to compromise a
liability following reference of a case
involving such liability to the Department
of Justice for prosecution or defense. If an
offer accepted for processing does not
contain sufficient information to permit
the IRS to evaluate whether the offer
should be accepted, the IRS will request
that the taxpayer provide the needed addi-
tional information. If the taxpayer does
not submit the additional information that
the IRS has requested within a reasonable
time period after such a request, the IRS
may return the offer to the taxpayer. The
IRS may also return an offer to compro-
mise a tax liability if it determines that the
offer was submitted solely to delay collec-
tion or was otherwise nonprocessable. An
offer returned following acceptance for
processing is deemed pending only for the
period between the date the offer is ac-
cepted for processing and the date the IRS
returns the offer to the taxpayer. See
paragraphs (f)(5)(ii) and (g)(4) of this
section for rules regarding the effect of
such returns of offers.
(3)Withdrawal. An offer to compro-
mise a tax liability may be withdrawn by
the taxpayer or the taxpayer’s representa-
tive at any time prior to the IRS’accep-
tance of the offer to compromise. An offer
will be considered withdrawn upon the
IRS’receipt of written notification of the
withdrawal of the offer either by personal
delivery or certified mail, or upon issu-
ance of a letter by the IRS confirming the
taxpayer’s intent to withdraw the offer.
(e)Acceptance of an offer to compro-
mise a tax liability. (1) An offer to com-
promise has not been accepted until the
IRS issues a written notification of accep-
tance to the taxpayer or the taxpayer’s
representative.
(2) As additional consideration for the
acceptance of an offer to compromise, the
IRS may request that taxpayer enter into
any collateral agreement or post any secu-
rity which is deemed necessary for the
protection of the interests of the United
States.
(3) Offers may be accepted when they
provide for payment of compromised
amounts in one or more equal or unequal
installments.
(4) If the final payment on an accepted
offer to compromise is contingent upon
the immediate and simultaneous release of
a tax lien in whole or in part, such pay-
ment must be made in accordance with the
forms, instructions, or procedures pre-
scribed by the Secretary.
(5) Acceptance of an offer to compro-
mise will conclusively settle the liability
of the taxpayer specified in the offer.
Compromise with one taxpayer does not
extinguish the liability of, nor prevent the
IRS from taking action to collect from,
any person not named in the offer who is
also liable for the tax to which the com-
promise relates. Neither the taxpayer nor
the Government will, following accep-
tance of an offer to compromise, be per-
mitted to reopen the case except in
instances where—
August 19, 20023542002–33 I.R.B.

(i) False information or documents
are supplied in conjunction with the offer;
(ii) The ability to pay or the assets of
the taxpayer are concealed; or
(iii) A mutual mistake of material fact
sufficient to cause the offer agreement to
be reformed or set aside is discovered.
(6)Opinion of Chief Counsel. Except
as otherwise provided in this paragraph
(e)(6), if an offer to compromise is ac-
cepted, there will be placed on file the
opinion of the Chief Counsel for the IRS
with respect to such compromise, along
with the reasons therefor. However, no
such opinion will be required with respect
to the compromise of any civil case in
which the unpaid amount of tax assessed
(including any interest, additional amount,
addition to the tax, or assessable penalty)
is less than $50,000. Also placed on file
will be a statement of—
(i) The amount of tax assessed;
(ii) The amount of interest, additional
amount, addition to the tax, or assessable
penalty, imposed by law on the person
against whom the tax is assessed; and
(iii) The amount actually paid in accor-
dance with the terms of the compromise.
(f)Rejection of an offer to compromise.
(1) An offer to compromise has not
been rejected until the IRS issues a written
notice to the taxpayer or his representa-
tive, advising of the rejection, the rea-
son(s) for rejection, and the right to an
appeal.
(2) The IRS may not notify a taxpayer
or taxpayer’s representative of the rejec-
tion of an offer to compromise until an
independent administrative review of the
proposed rejection is completed.
(3) No offer to compromise may be
rejected solely on the basis of the amount
of the offer without evaluating that offer
under the provisions of this section and
the Secretary’s policies and procedures
regarding the compromise of cases.
(4)Offers based upon doubt as to
liability. Offers submitted on the basis of
doubt as to liability cannot be rejected
solely because the IRS is unable to locate
the taxpayer’s return or return information
for verification of the liability.
(5)Appeal of rejection of an offer to
compromise—(i)In general. The taxpayer
may administratively appeal a rejection of
an offer to compromise to the IRS Office
of Appeals (Appeals) if, within the 30-day
period commencing the day after the date
on the letter of rejection, the taxpayer
requests such an administrative review in
the manner provided by the Secretary.
(ii)Offer to compromise returned fol-
lowing a determination that the offer was
nonprocessable, a failure by the taxpayer
to provide requested information, or a
determination that the offer was submitted
for purposes of delay. Where a determina-
tion is made to return offer documents
because the offer to compromise was non-
processable, because the taxpayer failed to
provide requested information, or because
the IRS determined that the offer to com-
promise was submitted solely for purposes
of delay under paragraph (d)(2) of this
section, the return of the offer does not
constitute a rejection of the offer for
purposes of this provision and does not
entitle the taxpayer to appeal the matter to
Appeals under the provisions of this para-
graph (f)(5). However, if the offer is
returned because the taxpayer failed to
provide requested financial information,
the offer will not be returned until a
managerial review of the proposed return
is completed.
(g)Effect of offer to compromise on
collection activity—(1)In general.The
IRS will not levy against the property or
rights to property of a taxpayer who sub-
mits an offer to compromise, to collect the
liability that is the subject of the offer,
during the period the offer is pending, for
30 days immediately following the rejec-
tion of the offer, and for any period when
a timely filed appeal from the rejection is
being considered by Appeals.
(2)Revised offers submitted following
rejection. If, following the rejection of an
offer to compromise, the taxpayer makes a
good faith revision of that offer and sub-
mits the revised offer within 30 days after
the date of rejection, the IRS will not levy
to collect from the taxpayer the liability
that is the subject of the revised offer to
compromise while that revised offer is
pending.
(3)Jeopardy. The IRS may levy to
collect the liability that is the subject of an
offer to compromise during the period the
IRS is evaluating whether that offer will
be accepted if it determines that collection
of the liability is in jeopardy.
(4)Offers to compromise determined
by IRS to be nonprocessable or submitted
solely for purposes of delay. If the IRS
determines, under paragraph (d)(2) of this
section, that a pending offer did not con-
tain sufficient information to permit evalu-
ation of whether the offer should be
accepted, that the offer was submitted
solely to delay collection, or that the offer
was otherwise nonprocessable, then the
IRS may levy to collect the liability that is
the subject of that offer at any time after it
returns the offer to the taxpayer.
(5)Offsets under section 6402. Not-
withstanding the evaluation and process-
ing of an offer to compromise, the IRS
may, in accordance with section 6402,
credit any overpayments made by the
taxpayer against a liability that is the
subject of an offer to compromise and may
offset such overpayments against other
liabilities owed by the taxpayer to the
extent authorized by section 6402.
(6)Proceedings in court. Except as
otherwise provided in this paragraph
(g)(6), the IRS will not refer a case to the
Department of Justice for the commence-
ment of a proceeding in court, against a
person named in a pending offer to com-
promise, if levy to collect the liability is
prohibited by paragraph (g)(1) of this
section. Without regard to whether a per-
son is named in a pending offer to com-
promise, however, the IRS may authorize
the Department of Justice to file a coun-
terclaim or third-party complaint in a re-
fund action or to join that person in any
other proceeding in which liability for the
tax that is the subject of the pending offer
to compromise may be established or
disputed, including a suit against the
United States under 28 U.S.C. 2410. In
addition, the United States may file a
claim in any bankruptcy proceeding or
insolvency action brought by or against
such person.
(h)Deposits. Sums submitted with an
offer to compromise a liability or during
the pendency of an offer to compromise
are considered deposits and will not be
applied to the liability until the offer is
accepted unless the taxpayer provides
written authorization for application of the
payments. If an offer to compromise is
withdrawn, is determined to be nonproc-
essable, or is submitted solely for pur-
poses of delay and returned to the
taxpayer, any amount tendered with the
offer, including all installments paid on
the offer, will be refunded without inter-
est. If an offer is rejected, any amount
tendered with the offer, including all in-
2002–33 I.R.B.355August 19, 2002

stallments paid on the offer, will be re-
funded,withoutinterest,afterthe
conclusion of any review sought by the
taxpayer with Appeals. Refund will not be
required if the taxpayer has agreed in
writing that amounts tendered pursuant to
the offer may be applied to the liability for
which the offer was submitted.
(i)Statute of limitations—(1)Suspen-
sion of the statute of limitations on collec-
tion. The statute of limitations on
collection will be suspended while levy is
prohibited under paragraph (g)(1) of this
section.
(2)Extension of the statute of limita-
tions on assessment. For any offer to
compromise, the IRS may require, where
appropriate, the extension of the statute of
limitations on assessment. However, in
any case where waiver of the running of
the statutory period of limitations on as-
sessment is sought, the taxpayer must be
notified of the right to refuse to extend the
period of limitations or to limit the exten-
sion to particular issues or particular peri-
ods of time.
(j)Inspection with respect to accepted
offers to compromise. For provisions re-
lating to the inspection of returns and
accepted offers to compromise, see sec-
tion 6103(k)(1).
(k)Effective date. This section applies
to offers to compromise pending on or
submitted on or after July 18, 2002.
§§301.7122–0T and 301.7122–1T
[Removed]
Par. 3. Sections 301.7122–0T and
301.7122–1T are removed.
Charles O. Rossotti,
Commissioner of Internal Revenue.
Approved July 15, 2002.
Pamela F. Olson,
Acting Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on July
18, 2002, 12:32 p.m., and published in the issue of
the Federal Register for July 23, 2002, 67 F.R.
48025)
31 CFR 10.0: Scope of part.
T.D. 9011
DEPARTMENT OF THE
TREASURY
Office of the Secretary
31 CFR Part 10
Regulations Governing
Practice Before the Internal
Revenue Service
AGENCY: Office of the Secretary,
Treasury.
ACTION: Final regulations.
SUMMARY: This document contains fi-
nal regulations governing practice before
the Internal Revenue Service (Circular
230). These regulations affect individuals
who are eligible to practice before the
Internal Revenue Service. These regula-
tions modify the general standards of
practice before the Internal Revenue Ser-
vice.
DATES:Effective date:These regulations
are effective July 26, 2002.
Applicability date:For dates of appli-
cability, see§10.91.
FOR FURTHER INFORMATION CON-
TACT: Brinton Warren at (202) 622–4940
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in these final regulations has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control
number 1545–1726. The collection of in-
formation in these final regulations is in
§§10.6, 10.29, and 10.30.
Section 10.6 requires an enrolled agent
to maintain records and educational mate-
rials regarding his or her satisfaction of
the qualifying continuing professional
education credit. Section 10.6 also re-
quires sponsors of qualifying continuing
professional education programs to main-
tain records and educational material con-
cerning these programs and those who
attended them. The collection of this ma-
terial helps to ensure that individuals en-
rolled to practice before the Internal
Revenue Service are informed of the new-
est developments in Federal tax practice.
Section 10.29 requires a practitioner to
obtain and retain for a reasonable period
written consents to representation when-
ever such representation conflicts with the
interests of the practitioner or the interests
of another client of the practitioner. The
consents are to be obtained after full
disclosure of the conflict is provided to
each party. Section 10.30 requires a prac-
titioner to retain for a reasonable period
any communication and the list of persons
to whom that communication was pro-
vided with respect to public dissemination
of fee information. The collection of con-
sents to representation and communica-
tions concerning practitioner fees protects
the practitioner against claims of impro-
priety and ensures the integrity of the tax
administration system.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number.
Books or records relating to a collec-
tion of information must be retained as
long as their contents might become ma-
terial in the administration of any internal
revenue law. Generally, tax returns and tax
return information are confidential, as re-
quired by 26 U.S.C. 6103.
Background
Section 330 of title 31 of the United
States Code authorizes the Secretary of
the Treasury to regulate the practice of
representatives before the Treasury De-
partment. The Secretary of the Treasury is
authorized, after notice and an opportunity
for a proceeding, to suspend or disbar
from practice before the Department those
representatives who are,inter alia, incom-
petent, disreputable, or who violate regu-
lations prescribed under section 330 of
title 31. Pursuant to section 330 of title 31,
the Secretary has published the regula-
tions in Circular 230 (31 CFR part 10).
These regulations authorize the Director
of Practice to act upon applications for
enrollment to practice before the Internal
Revenue Service, to make inquiries with
respect to matters under the Director of
Practice’s jurisdiction, to institute pro-
ceedings for suspension or disbarment
from practice before the Internal Revenue
August 19, 20023562002–33 I.R.B.

Service, and to perform such other duties
as are necessary to carry out these func-
tions.
The regulations have been amended
from time to time to address various
specific issues in need of resolution. For
example, on February 23, 1984, the regu-
lations were amended to provide standards
for providing opinions used in tax shelter
offerings (49 FR 6719). On October 17,
1985, the regulations were amended to
conform to legislative changes requiring
the disqualification of an appraiser who is
assessed a penalty under section 6701 of
the Internal Revenue Code for aiding and
abetting the understatement of a tax liabil-
ity (50 FR 42014). The regulations were
most recently amended on June 20, 1994
(T.D. 8545, 1994–2 C.B. 415 [59 FR
31523]), to provide standards for tax re-
turn preparation, to limit the use of con-
tingent fees in tax return or refund claim
preparation, to provide expedited rules for
suspension, and to clarify or amend cer-
tain other items.
On June 15, 1999, an advance notice of
proposed rulemaking was published (64
FR 31994) requesting comments on
amendments to the regulations that would
take into account legal developments, pro-
fessional integrity and fairness to practi-
tioners, taxpayer service, and sound tax
administration. On May 5, 2000, an ad-
vance notice of proposed rulemaking was
published (65 FR 30375) requesting com-
ments on amendments to the regulations
relating to standards of practice governing
tax shelters and other general matters. On
January 12, 2001, a notice of proposed
rulemaking (REG–111835–99, 2001–1
C.B. 834 [66 FR 3276]) was published
that proposed amendments to the regula-
tions, requested comments on the pro-
posed amendments, and announced a
public hearing on the subject of the pro-
posed amendments. The January 12, 2001,
notice of proposed rulemaking addressed
both general matters pertaining to practice
before the Internal Revenue Service and
also matters pertaining specifically to tax
shelter opinions. A public hearing was
held on these proposals on May 2, 2001.
The final regulations in this document
encompass only those proposals address-
ing non-tax shelter related matters pertain-
ing to practice before the Internal Revenue
Service. Accordingly, this document does
not contain final regulations governing
standards for tax shelter opinions. The
standards that currently govern tax shelter
opinions remain in effect. The Department
of Treasury and Internal Revenue Service
intend to issue a second notice of pro-
posed rulemaking that re-proposes amend-
ments for such standards. The Department
of Treasury and Internal Revenue Service
also intend to issue an additional advance
notice of proposed rulemaking that will
cover additional non-tax shelter matters
pertaining to practice before the Internal
Revenue Service. Many of the matters
covered by the advance notice of proposed
rulemaking will be distinct from those that
have been the focus of the non-tax shelter
revisions of Circular 230 to this point,
e.g., matters concerning unenrolled prac-
tice and whether the use of contingent fee
arrangements should be further restricted.
Summary of Comments
Fifty-one written comments were re-
ceived concerning revisions to Circular
230. All comments were considered and
are available for public inspection upon
request. These comments addressed both
the tax shelter and non-tax shelter related
proposed amendments. Many commenta-
tors expressed general support for amend-
ingCircular230.Thefollowing
paragraphs provide a summary of signifi-
cant comments concerning the non-tax
shelter proposals.
One commentator recommended spe-
cific language for proposed§10.6 with
respect to determining credits for continu-
ing professional education through dis-
tance learning programs, and another
recommended that the standards for con-
tinuing professional education classes be
modified to include more diverse subjects
beyond those strictly related to taxation,
such as in the fields of financial services
and practice management.
With regard to unenrolled practice un-
der proposed§10.7(c)(1)(viii), one com-
mentator argued that a restriction on the
right of non-practitioners to practice ham-
pers the ability of taxpayers to obtain a
speedy and inexpensive resolution of mat-
ters before the Internal Revenue Service.
In contrast, some commentators recom-
mended that unenrolled practice as per-
mitted by§10.7(c)(1)(viii) be further
restricted or eliminated outright. One of
these commentators suggested that it is
not appropriate to allow a tax return pre-
parer who may not have demonstrated
knowledge of tax law or tax procedure to
represent a taxpayer during an examina-
tion merely because the preparer has
signed the return under examination.
A number of commentators expressed
concern regarding the information to be
furnished to the Internal Revenue Service
under proposed§10.20. Commentators
were concerned that the proposal is overly
burdensome, puts an improper affirmative
obligation on a practitioner, fails to re-
spect privileged communications, and im-
pairs a represented taxpayer’s right to
challenge an unlawful request for infor-
mation by the Internal Revenue Service.
Particular concern was expressed as to the
removal of the phrase“of doubtful legal-
ity,”appearing in the current section gov-
erning the topic.
Commentators both supported and
criticized the proposed amendment to
§10.21 regarding a practitioner’s duties
when discovering a client’s error or omis-
sion on a return, claim for refund, or other
document. Two commentators suggested
that the proposal to mandate that a practi-
tioner advise a client regarding the conse-
quences of not taking corrective action
was a good one, but should be expanded to
include advice regarding the conse-
quences of taking corrective action. Some
commentators criticized the proposal on
the ground that it would require some
practitioners to offer advice beyond their
competence.
Commentators suggested that the Inter-
nal Revenue Service’s interpretation of
§10.26 is too strict and thus imposes
obligations on the firms of former govern-
ment employees that are more burden-
some than the related criminal statute.
With regard to the proposed clarifica-
tion of the prohibition on contingent fees
in§10.27, one commentator was support-
ive of the clarification, but recommended
further amendments to address ambigu-
ities, uncertainties, and opportunities for
abuse with regard to the section’s applica-
tion. Another commentator urged that the
section be amended so that contingent fees
can be charged for advice regarding return
positions on original returns when the
practitioner reasonably anticipates that the
return position will be substantively re-
viewed by the Internal Revenue Service
prior to the filing of the return.
2002–33 I.R.B.357August 19, 2002

A number of commentators expressed
concern regarding the proposed amend-
ment in§10.28 that would require a
practitioner to return a client’s records
upon a client’s request regardless of a
dispute over fees. One commentator rec-
ommended that the section distinguish
between records pertaining to tax and
non-tax matters because Circular 230
should not attempt to regulate a practitio-
ner’s conduct with respect to non-tax mat-
ters. A number of commentators urged that
the section be revised to distinguish more
completely the records of the client from
the practitioner’s work product, so that a
client may not take advantage of a practi-
tioner by obtaining the practitioner’s work
product without paying for it. A number of
commentators objected to the section on
the grounds that it conflicts with state laws
governing attorneys’liens.
With regard to the proposal regarding
representation of conflicting interests in
§10.29, many commentators expressed
concern with the use of the word“poten-
tial”to modify“conflicting interests,”ar-
guing that the use of the word made the
section’s application too ambiguous. A
number of commentators objected to the
proposal that consents from taxpayers be
in writing, some arguing that the require-
ment could create disharmony among cli-
ents. Some commentators observed that
the section incongruously failed to require
written consents when the conflict arises
with the practitioner’s own interest.
Some commentators objected to the
proposal in§10.30 to prohibit enrolled
agents from using the termlicensedin
describing their professional designation.
These commentators argued that the term
“licensed”is not misleading to the public
and does accurately describe the profes-
sional status of enrolled agents.
With regard to the proposal to add
censure as a sanction available under Cir-
cular 230, as proposed in§10.50, some
commentators questioned the statutory au-
thority for the censure sanction. One com-
mentator expressed concern that the
censure sanction as proposed did not ful-
fill the role of an intermediate sanction
because the remedial conditions proposed
for censured practitioners appear to be of
indefinite duration.
With regard to proposed§10.53, gov-
erning the receipt of information by the
Director of Practice concerning practitio-
ners, some commentators recommended
that the section provide for the destruction
of information determined to be frivolous
and also establish a timetable for the
Director of Practice’s destruction of
records in general.
With regard to the proposed amend-
ments in Subpart D, governing the con-
duct of disciplinary proceedings under
Circular 230, one commentator praised the
proposal to merge the provisions govern-
ing proceedings for appraisers into the
same subpart. One commentator urged
that the standard of proof in a Circular 230
hearing be specified, and that such stan-
dard should be one of clear and convinc-
ing evidence. This commentator also
recommended that Subpart D be amended
to provide for additional discovery proce-
dures.
Explanation of Provisions
The final regulations adopted in this
document concern only the non-tax shelter
related provisions as proposed in the Janu-
ary 12, 2001, notice of proposed rulemak-
ing. The Department of Treasury and
Internal Revenue Service intend to issue a
second notice of proposed rulemaking that
re-proposes amendments for the standards
governing tax shelter opinions.
Who May Practice
Paragraph (d)(2) of§10.3 of the regu-
lations adopts the proposed changes that
expanded the list of issues with respect to
which an enrolled actuary is authorized to
represent a taxpayer in limited practice
before the Internal Revenue Service. The
list is expanded to include issues involv-
ing 26 U.S.C. 419 (treatment of funded
welfare benefits), 419A (qualified asset
accounts), 420 (transfers of excess pen-
sion assets to retiree health accounts),
4972 (tax on nondeductible contributions
to qualified employer plans), 4976 (taxes
with respect to funded welfare benefit
plans), and 4980 (tax on reversion of
qualified plan assets to employer).
Enrollment
Section 10.6 sets forth the conditions
and process for renewal of enrollment to
practice before the Internal Revenue Ser-
vice. One condition for renewal of enroll-
ment is that the enrolled agent complete a
minimum number of hours of continuing
professional education in programs com-
prised of current subject matter in Federal
taxation or Federal tax related matters.
The final regulations do not adopt the
commentator’s suggestion to expand the
subjects of qualifying tax programs to
non-tax related matters, nor do they adopt
the suggested language for determining
distance learning credits.
Section 10.6 as adopted differs from
the proposed section in that it incorporates
a system of rolling renewals for enroll-
ment. The year in which enrolled agents
will be required to apply for renewal of
enrollment will vary based on the last digit
of the enrolled agent’s social security
number. This change is ministerial only
and is made in order to balance the work-
flow involved in processing renewals.
The final regulations adopt new para-
graph 10.6(a) that clarifies that enrollment
and the renewal of enrollment of actuaries
is also governed by the regulations of the
Joint Board for the Enrollment of Actuar-
ies at 20 CFR 901.1et seq.
Unenrolled Practice
The final regulations adopt the provi-
sions governing unenrolled practice as
proposed in paragraph 10.7(c)(viii). This
amendment preserves the scope of unen-
rolled practice as it has existed and only
makes non-substantive changes in nomen-
clature that are necessitated by the orga-
nizational restructuring of the Internal
Revenue Service.
Information to be Furnished
Section 10.20 of the regulations adopts
the proposed changes in modified form.
Paragraph (a) of§10.20 requires a prac-
titioner to respond promptly to a proper
and lawful request for records and infor-
mation, unless the practitioner believes in
good faith and on reasonable grounds that
the records or information are privileged.
The right and ability of practitioners to
resist efforts that the practitioner believes
to be of doubtful legality is preserved. The
phrase“of doubtful legality”was excised
from§10.20 merely to eliminate the
redundancy in the section’s text, which
requires requests from the Internal Rev-
enue Service to be“proper and lawful,”
not to effectuate a substantive change with
regard to a practitioner’s ability to resist
efforts by the government to obtain docu-
August 19, 20023582002–33 I.R.B.

ments or information that are irrelevant to
an inquiry, confidential, privileged, or oth-
erwise immune from compulsion.
The final regulations adopt, with
amendment and clarification, the proposed
amendment to require a practitioner to
provide information regarding the identity
of persons the practitioner reasonably be-
lieves may have possession or control of
requested documents. The requirement, in
paragraph (a)(2) of§10.20, applies only
when requested records or information are
not in the possession or control of the
practitioner or the practitioner’s client.
The paragraph is modified from its pro-
posed form to clarify that the practitio-
ner’s duty is limited only to making
reasonable inquiry of the practitioner’s
client and that there exists no obligation
on the practitioner to make inquiry of any
other person or to independently verify
information provided by a client.
The right and ability of a practitioner to
resist a request by the Director of Practice
regarding an alleged violation of Circular
230 that the practitioner believes to be of
doubtful legality is similarly unchanged in
paragraph (b), which requires practitioners
to provide information to the Director of
Practice regarding the alleged violations
of Circular 230 by any person. An alleged
violation under paragraph (b) is not lim-
ited to a violation that is the subject of a
proceeding under subpart D, for the nec-
essary reason that the Director of Practice
should be able to obtain evidence regard-
ingallegedviolationstodetermine
whether they merit formal charges.
Knowledge of client’s omission
Section 10.21 of Circular 230 has his-
torically required a practitioner to advise a
client promptly of any noncompliance,
error, or omission. The proposed rules
expanded the practitioner’s duty under
§10.21 to include providing advice to the
client regarding the manner in which the
error or omission might be corrected and
the possible consequences of a failure to
take such corrective action. Rather than
adopting§10.21 as proposed, the final
regulations modify the preexisting duty by
simply requiring that, in addition to noti-
fying the client of the fact of the noncom-
pliance, error, or omission, the practitioner
advise the client of the consequences as
provided under the Code and regulations
of the noncompliance, error, or omission.
This change requires practitioners to pro-
vide information that taxpayers who con-
sult tax professionals typically expect to
receive.
Diligence as to Accuracy
The final regulations adopt the pro-
posed clarification in§10.22 that a prac-
titioner is presumed to have exercised due
diligence if the practitioner relies on the
work product of another person and the
practitioner uses reasonable care in engag-
ing, supervising, training, and evaluating
such person, taking proper account of the
relationship between the practitioner and
the person. It is expected that practitioners
will use common sense and experience in
guiding their conduct under this section.
The section applies both in the context of
a firm and in circumstances involving a
practitioner’s engagement of an outside
practitioner. For example, in circum-
stances in which a practitioner must hire
another practitioner for a specialized or
complicated matter, such practitioner’s
duty under the section will be more fo-
cused on the reasonable care taken in the
engagement of the specialist. Supervising
and training are not part of a practitioner’s
engagement of a specialist. Conversely, in
the context of a firm, the section’s appli-
cation will focus more on supervising and
training, if there is an issue with regard to
a supervisory practitioner’s reliance on a
subordinate. Finally, the presumption of
due diligence provided by this section
does not apply for purposes of§10.33 and
§10.34, governing tax shelter opinions
and standards for advising with respect to
tax return positions, respectively, which
have their own rules concerning due dili-
gence.
Practice by Former Government
Employees, Their Partners and Their
Associates
The final regulations adopt without
change the proposed amendments found
in§10.25 (former§10.26) governing the
restrictions on the practice of former Gov-
ernment employees, their partners, and
their associates with respect to matters
that the former Government employees
participated in during the course of their
Government employment. This section re-
flects changes to the Federal statutes gov-
erningpost-employmentrestrictions
applicable to former Government employ-
ees. The former§10.25, governing the
practice of partners of former Government
employees, is removed, as was proposed,
because the statutory prohibition imple-
mented by the provision was repealed.
Contingent Fees
The final regulations adopt the pro-
posed clarification governing the prohibi-
tion on contingent fees in connection with
advice rendered in connection with a po-
sition taken or to be taken on an original
tax return. The Department of the Trea-
sury and the Internal Revenue Service
remain concerned regarding the use of
contingent fees and will request further
public comments regarding contingent
fees in the upcoming advance notice of
proposed rulemaking.
Return of Client’s Records
The final regulations adopt, with sub-
stantial changes, the proposed amendment
to§10.28 that requires a practitioner to
return a client’s records upon the client’s
request, regardless of a fee dispute. As
recommended by one commentator, the
section’s application is restricted by para-
graph (a) to the client’s records that are
necessary for the client to comply with his
or her Federal tax obligations.
Further, as recommended by a number
of commentators, the termrecords of the
clientis defined to exclude items such as
returns or other documents prepared by
the practitioner that the practitioner is
withholding pending the client’s payment
of fees for those documents. These
changes are incorporated to protect prac-
titioners from being disadvantaged or
compromised by clients seeking to obtain
an unfair advantage under this section. In
consideration of various state laws that
may permit liens on a client’s records in
favor of practitioners during the course of
fee disputes, the regulations provide that a
practitioner must only return those records
that must be attached to the client’s return
if a fee dispute has triggered an applicable
state lien provision. The practitioner, how-
ever, must provide the client access to
review and copy any of the client’s
records retained by the practitioner under
state law that are necessary for the client
to comply with his Federal tax obligations.
2002–33 I.R.B.359August 19, 2002

Conflicting Interests
The final regulations adopt the amend-
ments as proposed in§10.29, with modi-
fication. The modifierpotentialhas been
removed in the identification of conflicts
of interest. The final regulations have been
modified from the proposed regulations to
conform more closely with the approach
of the recently revised Model Rule 1.7 of
the American Bar Association Rules of
Professional Conduct. Section 10.29 re-
quires a client to give informed consent,
confirmed in writing, to representation by
a practitioner when the representation of
one client will be directly adverse to
another client or there is a significant risk
that the representation of one or more
clients will be materially limited by the
practitioner’s responsibilities to another
client, a former client or a third person or
by a personal interest of the practitioner.
The adoption of this requirement results in
parallel application to conflicts with an-
other client and conflicts with the practi-
tioner’s own interest. The section requires
a practitioner to retain the written consent
for at least 36 months after the conclusion
of the representation and to provide the
written consents to the Internal Revenue
Service, if requested to do so.
Solicitation
The final regulations adopt some but
not all of the changes to the solicitation
standards from the proposed regulations.
Under the final regulations, a practitioner
is prohibited from making written and oral
solicitations of employment in matters
related to the Internal Revenue Service if
such solicitations would violate Federal or
State statutes or other rules applicable to
the practitioner regarding the uninvited
solicitation of prospective clients. For ex-
ample, if an attorney is prohibited under
that attorney’s governing State bar rules
from making a certain type of uninvited
solicitation, the attorney’s uninvited so-
licitation with respect to a matter related
to the Internal Revenue Service will con-
stitute a violation of§10.30. Conversely,
if such a solicitation is permissible under
the relevant State bar rule, the making of
the solicitation with respect to a matter
related to the Internal Revenue Service is
permissible under§10.30.
Section 10.30 also expands the prohi-
bition of deceptive and other improper
solicitation practices to cover private, as
well as public, solicitations. The final
regulations provide that a practitioner may
not, in matters related to the Internal
Revenue Service, assist, or accept assis-
tance from, any person or entity who, to
the knowledge of the practitioner, obtains
clients, or otherwise practices in a manner
forbidden under this section.
In consideration of the comments re-
ceived, the final regulations do not adopt
the change that would have prohibited
enrolled agents from using the termli-
censedin describing their professional
designation. The Department of Treasury
and the Internal Revenue Service recog-
nize the valuable services provided by the
over thirty-thousand enrolled agents in the
United States, but want to ensure that the
respective roles of enrolled agents, attor-
neys and certified public accountants are
understood by taxpayers. The Treasury
Department and Internal Revenue Service
will solicit comments in an advance notice
ofproposedrulemakingregarding
whether an additional designation may be
employed to describe the professional ser-
vices of enrolled agents.
Sanctions
The final regulations adopt the addi-
tional sanction of censure, which is de-
fined as a public reprimand, as proposed
in the amendments to§10.50. The sanc-
tion of censure is not listed with disbar-
ment or suspension in 31 U.S.C. 330(b),
but the authority of the Secretary to regu-
late practice before the Internal Revenue
Service is not limited to those specific
sanctions. A censure sanction is authorized
by the general grant of authority to“regu-
late the practice of representatives of per-
sons before the Department of the
Treasury”as provided in 31 U.S.C.
330(a). Additionally, the final regulations
are modified in§10.79 to clarify that
suspended representatives may be subject
to conditions and the conditions placed
upon suspended or censured practitioners
may only be imposed for a period that is
reasonable in light of the gravity of a
practitioner’s violations.
Disreputable Conduct
Section 10.51 defines disreputable con-
duct for which a practitioner may be
censured, suspended, or disbarred. Such
disreputable conduct includes the filing of
a complaint against Internal Revenue Ser-
vice personnel under section 1203 of the
Internal Revenue Service Restructuring
and Reform Act of 1998, if the practitioner
knows the complaint is false. Similarly,
disreputable conduct also includes know-
ingly advancing frivolous arguments in
collection due process hearings, or in con-
nection with offers in compromise, install-
ment agreements, or the appeals process.
Additionally, the definition of disreputable
conduct is amended, as proposed, to in-
clude conviction of any felony involving
conduct that renders the practitioner unfit
to practice before the Internal Revenue
Service.
Receipt of Information Concerning
Practitioner
The final regulations incorporate pro-
visions for the destruction of documents
by the Director of Practice. Section 10.53
of the final regulations requires the Direc-
tor of Practice to destroy reports as soon
as permissible under the applicable record
control schedules approved by the Na-
tional Archives and Records Administra-
tion and designated in the Internal
Revenue Manual.
Evidence that alleges practitioner mis-
conduct, but which is on its face without
merit, should not be maintained in a man-
ner that falsely conveys a willingness of
the Director of Practice to use such evi-
dence at an indefinite time in the future.
This same principle applies to evidence
that merits investigation, but is eventually
determined to be insufficient to justify the
initiation of disciplinary proceedings. If
the currently applicable records control
schedule proves to be unsuitable in assur-
ing fairness to practitioners, or if it proves
to be unworkable given the demands
placed upon the Director of Practice, the
Internal Revenue Service will initiate the
public process required to request a
change of the records control schedule
throughtheNational Archivesand
Records Administration.
August 19, 20023602002–33 I.R.B.

Consolidation of Appraiser
Disqualification Rules
The final regulations adopt without
change the consolidation of the virtually
identical rules applicable to disciplinary
proceedings against practitioners and ap-
praisers that heretofore have been sepa-
rately set out in separate subparts. The
final regulations consolidate the rules re-
garding sanctions of practitioners and ap-
praisers under subpart D.
Various Aspects of Disciplinary
Proceedings
The final regulations adopt the pro-
posed rules of subpart D regarding the
conductofdisciplinaryproceedings
largely without change. In response to the
request of a commentator,§10.76 has
been modified to specifically provide that
the standard of proof in Circular 230
proceedings is that of a preponderance of
the evidence, if the sanction sought by the
Director of Practice is censure or a sus-
pension of less than six month’s duration.
If the Director of Practice seeks a sanction
of disbarment or a suspension of six
months or longer or the disqualification of
an appraiser, the standard of proof is clear
and convincing evidence. The Treasury
Department and Internal Revenue Service
conclude that the preponderance of evi-
dence standard is justified in the case of
the less severe sanctions of censure and
suspension of a short duration. When the
Director of Practice seeks a more signifi-
cant sanction, the clear and convincing
evidence standard is adopted to protect the
interests of the practitioner.
Effective Date
These regulations are effective on July
26, 2002.
Special Analyses
It has been determined that these regu-
lations are not a significant regulatory
action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It is hereby certified that
these regulations will not have a signifi-
cant economic impact on a substantial
number of small entities because the gen-
eral requirements, including the collection
of information requirements, of these
regulations are substantially the same as
the requirements of the regulations that
these regulations replace. Persons autho-
rized to practice have long been required
to comply with certain standards of con-
duct when practicing before the Internal
Revenue Service. These regulations do not
alter the basic nature of the obligations
and responsibilities of these practitioners.
These regulations clarify those obligations
in response to public comments and judi-
cial decisions, and make other modifica-
tions to reflect the development of
electronic media. Therefore, a regulatory
flexibility analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not
required. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice of
proposed rulemaking was submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small businesses.
Drafting Information
The principal authors of these regula-
tions are Richard S. Goldstein and Brinton
T. Warren, of the Office of Associate Chief
counsel (Procedure and Administration),
Administrative Provisions and Judicial
Practice Division.
*****
Adoption of Amendments to the
Regulations
Accordingly, 31 CFR part 10 is
amended as follows:
Paragraph 1. The table of contents
reads as follows:
PA RT 1 0—PRACTICE BEFORE THE
INTERNAL REVENUE SERVICE
Sec.
10.0Scope of part.
Subpart A—Rules Governing
Authority to Practice
10.1Director of Practice.
10.2Definitions.
10.3Who may practice.
10.4Eligibility for enrollment.
10.5Application for enrollment.
10.6Enrollment.
10.7Representing oneself; participating
in rulemaking; limited practice;
special appearances; and return
preparation.
10.8Customhouse brokers.
Subpart B—Duties and
Restrictions Relating to Practice
Before the Internal Revenue
Service
10.20Information to be furnished.
10.21Knowledge of client’s omission.
10.22Diligence as to accuracy.
10.23Prompt disposition of pending
matters.
10.24Assistance from or to disbarred or
suspended persons and former
Internal Revenue Service
employees.
10.25Practice by former Government
employees, their partners and their
associates.
10.26Notaries.
10.27Fees.
10.28Return of client’s records.
10.29Conflicting interests.
10.30Solicitation.
10.31Negotiation of taxpayer checks.
10.32Practice of law.
10.33Tax shelter opinions.
10.34Standards for advising with respect
to tax return positions and for
preparing or signing returns.
Subpart C—Sanctions for
Violation of the Regulations
10.50Sanctions.
10.51Incompetence and disreputable
conduct.
10.52Violation of regulations.
10.53Receipt of information concerning
practitioner.
Subpart D—Rules Applicable to
Disciplinary Proceedings
10.60Institution of proceeding.
10.61Conferences.
10.62Contents of complaint.
10.63Service of complaint; service and
filing of other papers.
10.64Answer; default.
10.65Supplemental charges.
10.66Reply to answer.
10.67Proof; variance; amendment of
pleadings.
10.68Motions and requests.
10.69Representation;ex parte
communication.
10.70Administrative Law Judge.
10.71Hearings.
10.72Evidence.
10.73
Depositions.
10.74Transcript.
10.75Proposed findings and conclusions.
2002–33 I.R.B.361August 19, 2002

10.76Decision of Administrative Law
Judge.
10.77Appeal of decision of Administra-
tive Law Judge.
10.78Decision on appeal.
10.79Effect of disbarment, suspension,
or censure.
10.80Notice of disbarment, suspension,
censure, or disqualification.
10.81Petition for reinstatement.
10.82Expedited suspension upon crimi-
nal conviction or loss of license for
cause.
Subpart E—General Provisions
10.90Records.
10.91Saving clause.
10.92Special orders.
10.93Effective date.
Authority: Sec. 3, 23 Stat. 258, secs.
2–12, 60 Stat. 237et. seq.; 5 U.S.C. 301,
500, 551–559; 31 U.S.C. 321; 31 U.S.C.
330;
§10.0 Scope of part.
This part contains rules governing the
recognition of attorneys, certified public
accountants, enrolled agents, and other
persons representing taxpayers before the
Internal Revenue Service. Subpart A of
this part sets forth rules relating to the
authority to practice before the Internal
Revenue Service; subpart B of this part
prescribes the duties and restrictions relat-
ing to such practice; subpart C of this part
prescribes the sanctions for violating the
regulations; subpart D of this part contains
the rules applicable to disciplinary pro-
ceedings; and subpart E of this part con-
tainsgeneralprovisionsincluding
provisions relating to the availability of
official records.
Par. 2. In part 10, subpart A is revised
to read as follows:
Subpart A—Rules Governing
Authority to Practice
§10.1 Director of Practice.
(a)Establishment of office.The Of-
fice of Director of Practice is established
in the Office of the Secretary of the
Treasury. The Director of Practice is ap-
pointed by the Secretary of the Treasury,
or his or her designate.
(b)Duties.The Director of Practice
acts on applications for enrollment to
practice before the Internal Revenue Ser-
vice; makes inquiries with respect to mat-
ters under his or her jurisdiction; institutes
and provides for the conduct of disciplin-
ary proceedings relating to attorneys, cer-
tified public accountants, enrolled agents,
enrolled actuaries and appraisers; and per-
forms other duties as are necessary or
appropriate to carry out his or her func-
tions under this part or as are prescribed
by the Secretary of the Treasury, or his or
her delegate.
(c)Acting Director of Practice.The
Secretary of the Treasury, or his or her
delegate, will designate an officer or em-
ployee of the Treasury Department to act
as Director of Practice in the absence of
the Director or a vacancy in that office.
§10.2 Definitions.
As used in this part, except where the
text clearly provides otherwise:
(a)Attorneymeans any person who is
a member in good standing of the bar of
the highest court of any State, territory, or
possession of the United States, including
a Commonwealth, or the District of Co-
lumbia.
(b)Certified public accountantmeans
any person who is duly qualified to prac-
tice as a certified public accountant in any
State, territory, or possession of the United
States, including a Commonwealth, or the
District of Columbia.
(c)Commissionerrefers to the Com-
missioner of Internal Revenue.
(d)Practice before the Internal Rev-
enue Servicecomprehends all matters
connected with a presentation to the Inter-
nal Revenue Service or any of its officers
or employees relating to a taxpayer’s
rights, privileges, or liabilities under laws
or regulations administered by the Internal
Revenue Service. Such presentations in-
clude, but are not limited to, preparing and
filing documents, corresponding and com-
municating with the Internal Revenue Ser-
vice,andrepresentingaclientat
conferences, hearings, and meetings.
(e)Practitionermeans any individual
described in paragraphs (a), (b), (c), or (d)
of§10.3.
(f) Atax returnincludes an amended
tax return and a claim for refund.
(g)Servicemeans the Internal Rev-
enue Service.
§10.3 Who may practice.
(a)Attorneys.Any attorney who is not
currently under suspension or disbarment
from practice before the Internal Revenue
Service may practice before the Internal
Revenue Service by filing with the Inter-
nal Revenue Service a written declaration
that he or she is currently qualified as an
attorney and is authorized to represent the
party or parties on whose behalf he or she
acts.
(b)Certified public accountants.Any
certified public accountant who is not
currently under suspension or disbarment
from practice before the Internal Revenue
Service may practice before the Internal
Revenue Service by filing with the Inter-
nal Revenue Service a written declaration
that he or she is currently qualified as a
certified public accountant and is autho-
rized to represent the party or parties on
whose behalf he or she acts.
(c)Enrolled agents. Any individual
enrolled as an agent pursuant to this part
who is not currently under suspension or
disbarment from practice before the Inter-
nal Revenue Service may practice before
the Internal Revenue Service.
(d)Enrolled actuaries.(1) Any indi-
vidual who is enrolled as an actuary by the
Joint Board for the Enrollment of Actuar-
ies pursuant to 29 U.S.C. 1242 who is not
currently under suspension or disbarment
from practice before the Internal Revenue
Service may practice before the Internal
Revenue Service by filing with the Inter-
nal Revenue Service a written declaration
stating that he or she is currently qualified
as an enrolled actuary and is authorized to
represent the party or parties on whose
behalf he or she acts.
(2) Practice as an enrolled actuary is
limited to representation with respect to
issues involving the following statutory
provisions in title 26 of the United States
Code: sections 401 (relating to qualifica-
tion of employee plans), 403(a) (relating
to whether an annuity plan meets the
requirements of section 404(a)(2)), 404
(relating to deductibility of employer con-
tributions), 405 (relating to qualification
of bond purchase plans), 412 (relating to
funding requirements for certain em-
ployee plans), 413 (relating to application
of qualification requirements to collec-
tively bargained plans and to plans main-
tained by more than one employer), 414
(relating to definitions and special rules
with respect to the employee plan area),
419 (relating to treatment of funded wel-
August 19, 20023622002–33 I.R.B.

fare benefits), 419A (relating to qualified
asset accounts), 420 (relating to transfers
of excess pension assets to retiree health
accounts), 4971 (relating to excise taxes
payable as a result of an accumulated
funding deficiency under section 412),
4972 (relating to tax on nondeductible
contributions to qualified employer plans),
4976 (relating to taxes with respect to
funded welfare benefit plans), 4980 (relat-
ing to tax on reversion of qualified plan
assets to employer), 6057 (relating to an-
nual registration of plans), 6058 (relating
to information required in connection with
certain plans of deferred compensation),
6059 (relating to periodic report of actu-
ary), 6652(e) (relating to the failure to file
annual registration and other notifications
by pension plan), 6652(f) (relating to the
failure to file information required in con-
nection with certain plans of deferred
compensation), 6692 (relating to the fail-
ure to file actuarial report), 7805(b) (relat-
ing to the extent to which an Internal
Revenue Service ruling or determination
letter coming under the statutory provi-
sions listed here will be applied without
retroactive effect); and 29 U.S.C. 1083
(relating to the waiver of funding for
nonqualified plans).
(3) An individual who practices before
the Internal Revenue Service pursuant to
paragraph (d)(1) of this section is subject
to the provisions of this part in the same
manner as attorneys, certified public ac-
countants and enrolled agents.
(e)Others. Any individual qualifying
under paragraph (d) of§10.5 or§10.7 is
eligible to practice before the Internal
Revenue Service to the extent provided in
those sections.
(f)Government officers and employees,
and others.An individual, who is an
officer or employee of the executive, leg-
islative, or judicial branch of the United
States Government; an officer or em-
ployee of the District of Columbia; a
Member of Congress; or a Resident Com-
missioner may not practice before the
Internal Revenue Service if such practice
violates 18 U.S.C. 203 or 205.
(g)State officers and employees.No
officer or employee of any State, or sub-
division of any State, whose duties require
him or her to pass upon, investigate, or
deal with tax matters for such State or
subdivision, may practice before the Inter-
nal Revenue Service, if such employment
may disclose facts or information appli-
cable to Federal tax matters.
§10.4 Eligibility for enrollment.
(a)Enrollment upon examination.The
Director of Practice may grant enrollment
to an applicant who demonstrates special
competence in tax matters by written ex-
amination administered by, or adminis-
tered under the oversight of, the Director
of Practice and who has not engaged in
any conduct that would justify the cen-
sure, suspension, or disbarment of any
practitioner under the provisions of this
part.
(b)Enrollment of former Internal
Revenue Service employees.The Director
of Practice may grant enrollment to an
applicant who, by virtue of his or her past
service and technical experience in the
Internal Revenue Service, has qualified
for such enrollment and who has not
engaged in any conduct that would justify
the censure, suspension, or disbarment of
any practitioner under the provisions of
thispart,underthefollowing
circumstances—
(1) The former employee applies for
enrollment to the Director of Practice on a
form supplied by the Director of Practice
and supplies the information requested on
the form and such other information re-
garding the experience and training of the
applicant as may be relevant.
(2) An appropriate office of the Inter-
nal Revenue Service, at the request of the
Director of Practice, will provide the Di-
rector of Practice with a detailed report of
the nature and rating of the applicant’s
work while employed by the Internal Rev-
enue Service and a recommendation
whether such employment qualifies the
applicant technically or otherwise for the
desired authorization.
(3) Enrollment based on an appli-
cant’s former employment with the Inter-
nal Revenue Service may be of unlimited
scope or it may be limited to permit the
presentation of matters only of the particu-
lar class or only before the particular unit
or division of the Internal Revenue Ser-
vice for which the applicant’s former em-
ployment has qualified the applicant.
(4) Application for enrollment based
on an applicant’s former employment with
the Internal Revenue Service must be
made within 3 years from the date of
separation from such employment.
(5) An applicant for enrollment who
is requesting such enrollment based on his
or her former employment with the Inter-
nal Revenue Service must have had a
minimum of 5 years continuous employ-
ment with the Internal Revenue Service
during which he or she must have been
regularly engaged in applying and inter-
preting the provisions of the Internal Rev-
enue Code and the regulations thereunder
relating to income, estate, gift, employ-
ment, or excise taxes.
(6) For the purposes of paragraph
(b)(5) of this section, an aggregate of 10 or
more years of employment in positions
involving the application and interpreta-
tion of the provisions of the Internal Rev-
enue Code, at least 3 of which occurred
within the 5 years preceding the date of
application, is the equivalent of 5 years
continuous employment.
(c)Natural persons.Enrollment to
practice may be granted only to natural
persons.
§10.5 Application for enrollment.
(a)Form; address.An applicant for
enrollment must file an application on
Form 23,“Application for Enrollment to
Practice Before the Internal Revenue Ser-
vice,”properly executed under oath or
affirmation, with the Director of Practice.
The address of the applicant entered on
Form 23 will be the address under which a
successful applicant is enrolled and is the
address to which the Director of Practice
will send correspondence concerning en-
rollment. An enrolled agent must send
notification of any change to his or her
enrollment address to the Director of Prac-
tice, Internal Revenue Service,1111Con-
stitution Avenue, NW, Washington, DC
20224, or at such other address specified
by the Director of Practice. This notifica-
tion must include the enrolled agent’s
name, old address, new address, social
security number or tax identification num-
ber, signature, and the date.
(b)Fee.The application for enroll-
ment must be accompanied by a check or
money order in the amount set forth on
Form 23, payable to the Internal Revenue
Service, which amount constitutes a fee
charged to each applicant for enrollment.
This fee will be retained by the United
States whether or not the applicant is
granted enrollment.
(c)Additional information; examina-
2002–33 I.R.B.363August 19, 2002

tion.The Director of Practice, as a condi-
tion to consideration of an application for
enrollment, may require the applicant to
file additional information and to submit
to any written or oral examination under
oath or otherwise. The Director of Practice
will, on written request filed by an appli-
cant, afford such applicant the opportunity
to be heard with respect to his or her
application for enrollment.
(d)Temporary recognition.On receipt
of a properly executed application, the
Director of Practice may grant the appli-
cant temporary recognition to practice
pending a determination as to whether
enrollment to practice should be granted.
Temporary recognition will be granted
only in unusual circumstances and it will
not be granted, in any circumstance, if the
application is not regular on its face, if the
information stated in the application, if
true, is not sufficient to warrant enroll-
ment to practice, or if there is any infor-
mation before the Director of Practice
indicating that the statements in the appli-
cation are untrue or that the applicant
would not otherwise qualify for enroll-
ment. Issuance of temporary recognition
does not constitute enrollment to practice
or a finding of eligibility for enrollment,
and the temporary recognition may be
withdrawn at any time by the Director of
Practice.
(e)Appeal from denial of application.
The Director of Practice must inform the
applicant as to the reason(s) for any denial
of an application for enrollment. The ap-
plicant may, within 30 days after receipt of
the notice of denial of enrollment, file a
written appeal of the denial of enrollment
with the Secretary of the Treasury or his or
her delegate. A decision on the appeal will
be rendered by the Secretary of the Trea-
sury, or his or her delegate, as soon as
practicable.
§10.6 Enrollment.
(a)Roster.The Director of Practice
will maintain rosters of all individuals—
(1) Who have been granted active en-
rollment to practice before the Internal
Revenue Service;
(2) Whoseenrollmenthasbeen
placed in inactive status for failure to meet
the requirements for renewal of enroll-
ment;
(3) Whoseenrollmenthasbeen
placed in inactive retirement status;
(4) Who have been censured, sus-
pended, or disbarred from practice before
the Internal Revenue Service;
(5) Whose offer of consent to resign
from enrollment to practice before the
Internal Revenue Service has been ac-
cepted by the Director of Practice under
§10.61; and
(6) Whose application for enrollment
has been denied.
(b)Enrollment card.The Director of
Practice will issue an enrollment card to
each individual whose application for en-
rollment to practice before the Internal
Revenue Service is approved after July 26,
2002. Each enrollment card will be valid
for the period stated on the enrollment
card. An individual is not eligible to prac-
tice before the Internal Revenue Service if
his or her enrollment card is not valid.
(c)Term of enrollment.Each indi-
vidual enrolled to practice before the In-
ternal Revenue Service will be accorded
active enrollment status subject to his or
her renewal of enrollment as provided in
this part.
(d)Renewal of enrollment.To main-
tain active enrollment to practice before
the Internal Revenue Service, each indi-
vidual enrolled is required to have his or
her enrollment renewed. Failure by an
individual to receive notification from the
Director of Practice of the renewal re-
quirement will not be justification for the
failure to satisfy this requirement.
(1) All individuals licensed to prac-
tice before the Internal Revenue Service
who have a social security number or tax
identification number that ends with the
numbers 0, 1, 2, or 3, except for those
individuals who received their initial en-
rollment after November 1, 2003, must
apply for renewal between November 1,
2003, and January 31, 2004. The renewal
will be effective April 1, 2004.
(2) All individuals licensed to prac-
tice before the Internal Revenue Service
who have a social security number or tax
identification number that ends with the
numbers 4, 5, or 6, except for those
individuals who received their initial en-
rollment after November 1, 2004, must
apply for renewal between November 1,
2004, and January 31, 2005. The renewal
will be effective April 1, 2005.
(3) All individuals licensed to prac-
tice before the Internal Revenue Service
who have a social security number or tax
identification number that ends with the
numbers 7, 8, or 9, except for those
individuals who received their initial en-
rollment after November 1, 2005, must
apply for renewal between November 1,
2005, and January 31, 2006. The renewal
will be effective April 1, 2006.
(4) Thereafter, applications for re-
newal will be required between November
1 and January 31 of every subsequent
third year as specified in paragraphs
(d)(1), (2) or (3) of this section according
to the last number of the individual’s
social security number or tax identifica-
tion number. Those individuals who re-
ceive initial enrollment after November 1
and before April 2 of the applicable re-
newal period will not be required to renew
their enrollment before the first full re-
newal period following the receipt of their
initial enrollment.
(5) The Director of Practice will no-
tify the individual of his or her renewal of
enrollment and will issue the individual a
card evidencing enrollment.
(6) A reasonable nonrefundable fee
may be charged for each application for
renewal of enrollment filed with the Di-
rector of Practice.
(7) Forms required for renewal may
be obtained from the Director of Practice,
Internal Revenue Service,1111Constitu-
tion Avenue, NW, Washington, DC 20224.
(e)Condition for renewal: Continuing
professional education.In order to qualify
for renewal of enrollment, an individual
enrolled to practice before the Internal
Revenue Service must certify, on the ap-
plication for renewal form prescribed by
the Director of Practice, that he or she has
satisfied the following continuing profes-
sional education requirements.
(1)For renewed enrollment effective
after March 31, 2004.(i) A minimum of
16 hours of continuing education credit
must be completed during each calendar
year in the enrollment term.
(2)For renewed enrollment effective
after April 1, 2007.(i) A minimum of 72
hours of continuing education credit must
be completed during each three year pe-
riod described in paragraph (d)(4) of this
section. Each such three year period is
known as an enrollment cycle.
(ii) A minimum of 16 hours of continu-
ing education credit, including 2 hours of
August 19, 20023642002–33 I.R.B.

ethics or professional conduct, must be
completed in each year of an enrollment
cycle.
(iii) An individual who receives initial
enrollment during an enrollment cycle
must complete two (2) hours of qualifying
continuing education credit for each
month enrolled during the enrollment
cycle. Enrollment for any part of a month
is considered enrollment for the entire
month.
(f)Qualifying continuing education—
(1)General.To qualify for continuing
education credit, a course of learning
must—
(i) Be a qualifying program designed to
enhance professional knowledge in Fed-
eral taxation or Federal tax related mat-
ters,i.e., programs comprised of current
subject matter in Federal taxation or Fed-
eral tax related matters, including account-
ing, tax preparation software and taxation
or ethics; and
(ii) Be conducted by a qualifying spon-
sor.
(2)Qualifying programs—(i)Formal
programs.A formal program qualifies as
continuing education programs if it—
(A) Requires attendance. Additionally,
the program sponsor must provide each
attendee with a certificate of attendance;
and
(B) Requires that the program be con-
ducted by a qualified instructor, discus-
sion leader, or speaker,i.e., a person
whose background, training, education
and experience is appropriate for instruct-
ing or leading a discussion on the subject
matter of the particular program; and
(C) Provides or requires a written out-
line, textbook, or suitable electronic edu-
cational materials.
(ii)Correspondence or individual study
programs (including taped programs).
Qualifying continuing education programs
include correspondence or individual
study programs that are conducted by
qualifying sponsors and completed on an
individual basis by the enrolled individual.
The allowable credit hours for such pro-
grams will be measured on a basis com-
parable to the measurement of a seminar
or course for credit in an accredited edu-
cational institution. Such programs qualify
as continuing education programs if
they—
(A) Require registration of the partici-
pants by the sponsor;
(B) Provide a means for measuring
completion by the participants (e.g.,a
written examination), including the issu-
ance of a certificate of completion by the
sponsor; and
(C) Provide a written outline, textbook,
or suitable electronic educational materi-
als.
(iii)Serving as an instructor, discus-
sion leader or speaker.(A) One hour of
continuingeducationcreditwillbe
awarded for each contact hour completed
as an instructor, discussion leader, or
speaker at an educational program that
meets the continuing education require-
ments of paragraph (f) of this section.
(B) Two hours of continuing education
credit will be awarded for actual subject
preparation time for each contact hour
completed as an instructor, discussion
leader, or speaker at such programs. It is
the responsibility of the individual claim-
ing such credit to maintain records to
verify preparation time.
(C) The maximum credit for instruction
and preparation may not exceed 50 per-
cent of the continuing education require-
ment for an enrollment cycle.
(D) An instructor, discussion leader, or
speaker who makes more than one presen-
tation on the same subject matter during
an enrollment cycle, will receive continu-
ing education credit for only one such
presentation for the enrollment cycle.
(iv)Credit for published articles,
books, etc.(A) Continuing education
credit will be awarded for publications on
Federal taxation or Federal tax related
matters, including accounting, financial
management, tax preparation software,
and taxation, provided the content of such
publications is current and designed for
the enhancement of the professional
knowledge of an individual enrolled to
practice before the Internal Revenue Ser-
vice.
(B) The credit allowed will be on the
basis of one hour credit for each hour of
preparation time for the material. It is the
responsibility of the person claiming the
credit to maintain records to verify prepa-
ration time.
(C) The maximum credit for publica-
tions may not exceed 25 percent of the
continuing education requirement of any
enrollment cycle.
(3)Periodic examination.(i) Individu-
als may establish eligibility for renewal of
enrollment for any enrollment cycle by—
(A) Achieving a passing score on each
part of the Special Enrollment Examina-
tion administered under this part during
the three year period prior to renewal; and
(B) Completing a minimum of 16 hours
of qualifying continuing education during
the last year of an enrollment cycle.
(ii) Courses designed to help an appli-
cant prepare for the examination specified
in paragraph (a) of§10.4 are considered
basic in nature and are not qualifying
continuing education.
(g)Sponsors.(1) Sponsors are those
responsible for presenting programs.
(2) To qualify as a sponsor, a program
presenter must—
(i) Be an accredited educational insti-
tution;
(ii) Be recognized for continuing edu-
cation purposes by the licensing body of
any State, territory, or possession of the
United States, including a Common-
wealth, or the District of Columbia.
(iii) Be recognized by the Director of
Practice as a professional organization or
society whose programs include offering
continuing professional education oppor-
tunities in subject matters within the scope
of paragraph (f)(1)(i) of this section; or
(iv) File a sponsor agreement with the
Director of Practice and obtain approval
of the program as a qualified continuing
education program.
(3) A qualifying sponsor must ensure
the program complies with the following
requirements—
(i) Programs must be developed by
individual(s) qualified in the subject mat-
ter;
(ii) Program subject matter must be
current;
(iii) Instructors, discussion leaders,
and speakers must be qualified with re-
spect to program content;
(iv) Programs must include some
means for evaluation of technical content
and presentation;
(v) Certificates of completion must be
provided to the participants who success-
fully complete the program; and
(vi) Records must be maintained by
the sponsor to verify the participants who
attended and completed the program for a
period of three years following comple-
tion of the program. In the case of con-
tinuous conferences, conventions, and the
like, records must be maintained to verify
2002–33 I.R.B.365August 19, 2002

completion of the program and attendance
by each participant at each segment of the
program.
(4) Professional organizations or soci-
eties wishing to be considered as qualified
sponsors must request this status from the
Director of Practice and furnish informa-
tion in support of the request together with
any further information deemed necessary
by the Director of Practice.
(5) A professional organization or soci-
ety recognized as a qualified sponsor by
the Director of Practice will retain its
status for one enrollment cycle. The Di-
rector of Practice will publish the names
of such sponsors on a periodic basis.
(h)Measurement of continuing educa-
tion coursework.(1) All continuing edu-
cation programs will be measured in terms
of contact hours. The shortest recognized
program will be one contact hour.
(2) A contact hour is 50 minutes of
continuous participation in a program.
Credit is granted only for a full contact
hour,i.e., 50 minutes or multiples thereof.
For example, a program lasting more than
50 minutes but less than 100 minutes will
count as one contact hour.
(3) Individual segments at continuous
conferences, conventions and the like will
be considered one total program. For ex-
ample, two 90-minute segments (180 min-
utes) at a continuous conference will
count as three contact hours.
(4) For university or college courses,
each semester hour credit will equal 15
contact hours and a quarter hour credit
will equal 10 contact hours.
(i)Recordkeeping requirements.(1)
Each individual applying for renewal must
retain for a period of three years following
the date of renewal of enrollment the
information required with regard to quali-
fying continuing professional education
credit hours. Such information includes—
(i) The name of the sponsoring orga-
nization;
(ii) The location of the program;
(iii) The title of the program and de-
scription of its content;
(iv) Written outlines, course syllibi,
textbook, and/or electronic materials pro-
vided or required for the course;
(v) The dates attended;
(vi) The credit hours claimed;
(vii) The name(s) of the instructor(s),
discussion leader(s), or speaker(s), if ap-
propriate; and
(viii) The certificate of completion
and/or signed statement of the hours of
attendance obtained from the sponsor.
(2) To receive continuing education
credit for service completed as an instruc-
tor, discussion leader, or speaker, the fol-
lowing information must be maintained
for a period of three years following the
date of renewal of enrollment—
(i) The name of the sponsoring orga-
nization;
(ii) The location of the program;
(iii) The title of the program and de-
scription of its content;
(iv) The dates of the program; and
(v) The credit hours claimed.
(3) To receive continuing education
credit for publications, the following in-
formation must be maintained for a period
of three years following the date of re-
newal of enrollment—
(i) The publisher;
(ii) The title of the publication;
(iii) A copy of the publication;
(iv) The date of publication; and
(v) Recordsthatsubstantiatethe
hours worked on the publication.
(j)Waivers.(1) Waiver from the con-
tinuing education requirements for a given
period may be granted by the Director of
Practice for the following reasons—
(i) Health, which prevented compli-
ance with the continuing education re-
quirements;
(ii) Extended active military duty;
(iii) Absence from the United States
for an extended period of time due to
employment or other reasons, provided
the individual does not practice before the
Internal Revenue Service during such ab-
sence; and
(iv) Other compelling reasons, which
will be considered on a case-by-case basis.
(2) A request for waiver must be ac-
companied by appropriate documentation.
The individual is required to furnish any
additional documentation or explanation
deemed necessary by the Director of Prac-
tice. Examples of appropriate documenta-
tion could be a medical certificate or
military orders.
(3) A request for waiver must be filed
no later than the last day of the renewal
application period.
(4) If a request for waiver is not
approved, the individual will be placed in
inactive status, so notified by the Director
of Practice, and placed on a roster of
inactive enrolled individuals.
(5) If a request for waiver is approved,
the individual will be notified and issued a
card evidencing renewal.
(6) Those who are granted waivers are
required to file timely applications for
renewal of enrollment.
(k)Failure to comply.(1) Compliance
by an individual with the requirements of
this part is determined by the Director of
Practice. An individual who fails to meet
the requirements of eligibility for renewal
of enrollment will be notified by the
Director of Practice at his or her enroll-
ment address by first class mail. The
notice will state the basis for the determi-
nation of noncompliance and will provide
the individual an opportunity to furnish
information in writing relating to the mat-
ter within 60 days of the date of the notice.
Such information will be considered by
the Director of Practice in making a final
determination as to eligibility for renewal
of enrollment.
(2) The Director of Practice may re-
quire any individual, by notice sent by
first class mail to his or her enrollment
address, to provide copies of any records
required to be maintained under this part.
The Director of Practice may disallow any
continuing professional education hours
claimed if the individual fails to comply
with this requirement.
(3) An individual who has not filed a
timely application for renewal of enroll-
ment, who has not made a timely response
to the notice of noncompliance with the
renewal requirements, or who has not
satisfied the requirements of eligibility for
renewal will be placed on a roster of
inactive enrolled individuals. During this
time, the individual will be ineligible to
practice before the Internal Revenue Ser-
vice.
(4) Individuals placed in inactive en-
rollment status and individuals ineligible
to practice before the Internal Revenue
Service may not state or imply that they
are enrolled to practice before the Internal
Revenue Service, or use the termenrolled
agent, the designation“E. A.,”or other
form of reference to eligibility to practice
before the Internal Revenue Service.
(5) An individual placed in an inactive
status may be reinstated to an active en-
rollment status by filing an application for
renewal of enrollment and providing evi-
August 19, 20023662002–33 I.R.B.

dence of the completion of all required
continuing professional education hours
for the enrollment cycle. Continuing edu-
cation credit under this paragraph (k)(5)
may not be used to satisfy the require-
ments of the enrollment cycle in which the
individual has been placed back on the
active roster.
(6) An individual placed in an inactive
status must file an application for renewal
of enrollment and satisfy the requirements
for renewal as set forth in this section
within three years of being placed in an
inactive status. The name of such indi-
vidual otherwise will be removed from the
inactive enrollment roster and his or her
enrollment will terminate. Eligibility for
enrollment must then be reestablished by
the individual as provided in this section.
(7) Inactive enrollment status is not
available to an individual who is the
subject of a disciplinary matter in the
Office of Director of Practice.
(l)Inactive retirement status.An indi-
vidual who no longer practices before the
Internal Revenue Service may request be-
ing placed in an inactive status at any time
and such individual will be placed in an
inactive retirement status. The individual
will be ineligible to practice before the
Internal Revenue Service. Such individual
must file a timely application for renewal
of enrollment at each applicable renewal
or enrollment period as provided in this
section. An individual who is placed in an
inactive retirement status may be rein-
stated to an active enrollment status by
filing an application for renewal of enroll-
ment and providing evidence of the
completion of the required continuing pro-
fessional education hours for the enroll-
ment cycle. Inactive retirement status is
not available to an individual who is
subject of a disciplinary matter in the
Office of Director of Practice.
(m)Renewal while under suspension
or disbarment.An individual who is ineli-
gible to practice before the Internal Rev-
enue Service by virtue of disciplinary
action is required to be in conformance
with the requirements for renewal of en-
rollment before his or her eligibility is
restored.
(n)Verification.The Director of Prac-
tice may review the continuing education
records of an enrolled individual and/or
qualified sponsor in a manner deemed
appropriate to determine compliance with
the requirements and standards for re-
newal of enrollment as provided in para-
graph (f) of this section.
(o)Enrolled Actuaries.The enrollment
and the renewal of enrollment of actuaries
authorized to practice under paragraph (d)
of§10.3 are governed by the regulations
of the Joint Board for the Enrollment of
Actuaries at 20 CFR 901.1 through
901.71. (Approved by the Office of Man-
agement and Budget under Control No.
1545–0946 and 1545–1726)
§10.7 Representing oneself;
participating in rulemaking; limited
practice; special appearances; and
return preparation.
(a) Representing oneself.Individuals
may appear on their own behalf before the
Internal Revenue Service provided they
present satisfactory identification.
(b)Participating in rulemaking.Indi-
viduals may participate in rulemaking as
provided by the Administrative Procedure
Act. See 5 U.S.C. 553.
(c)Limited practice—(1)In general.
Subject to the limitations in paragraph
(c)(2) of this section, an individual who is
not a practitioner may represent a taxpayer
before the Internal Revenue Service in the
circumstances described in this paragraph
(c)(1), even if the taxpayer is not present,
provided the individual presents satisfac-
tory identification and proof of his or her
authority to represent the taxpayer. The
circumstances described in this paragraph
(c)(1) are as follows:
(i) An individual may represent a
member of his or her immediate family.
(ii) A regular full-time employee of an
individual employer may represent the
employer.
(iii) A general partner or a regular
full-time employee of a partnership may
represent the partnership.
(iv) Abona fideofficer or a regular
full-time employee of a corporation (in-
cluding a parent, subsidiary, or other af-
filiatedcorporation),association,or
organized group may represent the corpo-
ration, association, or organized group.
(v) A regular full-time employee of a
trust, receivership, guardianship, or estate
may represent the trust, receivership,
guardianship, or estate.
(vi) An officer or a regular employee
of a governmental unit, agency, or author-
ity may represent the governmental unit,
agency, or authority in the course of his or
her official duties.
(vii) An individual may represent any
individual or entity, who is outside the
United States, before personnel of the
Internal Revenue Service when such rep-
resentation takes place outside the United
States.
(viii) An individual who prepares and
signs a taxpayer’s tax return as the pre-
parer, or who prepares a tax return but is
not required (by the instructions to the tax
return or regulations) to sign the tax re-
turn, may represent the taxpayer before
revenue agents, customer service repre-
sentatives or similar officers and employ-
ees of the Internal Revenue Service during
an examination of the taxable year or
period covered by that tax return, but,
unless otherwise prescribed by regulation
or notice, this right does not permit such
individual to represent the taxpayer, re-
gardless of the circumstances requiring
representation, before appeals officers,
revenue officers, Counsel or similar offic-
ers or employees of the Internal Revenue
Service or the Department of Treasury.
(2)Limitations.(i) An individual who
is under suspension or disbarment from
practice before the Internal Revenue Ser-
vice may not engage in limited practice
before the Internal Revenue Service under
paragraph (c)(1) of this section.
(ii) The Director, after notice and op-
portunity for a conference, may deny eli-
gibility to engage in limited practice
before the Internal Revenue Service under
paragraph (c)(1) of this section to any
individual who has engaged in conduct
that would justify censuring, suspending,
or disbarring a practitioner from practice
before the Internal Revenue Service.
(iii) An individual who represents a
taxpayer under the authority of paragraph
(c)(1) of this section is subject, to the
extent of his or her authority, to such rules
of general applicability regarding stan-
dards of conduct and other matters as the
Director of Practice prescribes.
(d)Special appearances.The Director
of Practice may, subject to such conditions
as he or she deems appropriate, authorize
an individual who is not otherwise eligible
to practice before the Internal Revenue
Service to represent another person in a
particular matter.
(e)Preparing tax returns and furnish-
2002–33 I.R.B.367August 19, 2002

ing information.Any individual may pre-
pare a tax return, appear as a witness for
the taxpayer before the Internal Revenue
Service, or furnish information at the re-
quest of the Internal Revenue Service or
any of its officers or employees.
(f)Fiduciaries.For purposes of this
part, a fiduciary (i.e., a trustee, receiver,
guardian, personal representative, admin-
istrator, or executor) is considered to be
the taxpayer and not a representative of
the taxpayer.
§10.8 Customhouse brokers.
Nothing contained in the regulations
in this part will affect or limit the right of
a customhouse broker, licensed as such by
the Commissioner of Customs in accor-
dance with the regulations prescribed
therefor, in any customs district in which
he or she is so licensed, at a relevant local
office of the Internal Revenue Service or
before the National Office of the Internal
Revenue Service, to act as a representative
in respect to any matters relating specifi-
cally to the importation or exportation of
merchandise under the customs or internal
revenue laws, for any person for whom he
or she has acted as a customhouse broker.
Par. 3. In part 10, subpart B is
amended by revising§§10.20 through
10.32 and revising§10.34.
Subpart B—Duties and
Restrictions Relating to Practice
Before the Internal Revenue Service
§10.20 Information to be furnished.
(a)To the Internal Revenue Service.
(1) A practitioner must, on a proper and
lawful request by a duly authorized officer
or employee of the Internal Revenue Ser-
vice, promptly submit records or informa-
tion in any matter before the Internal
Revenue Service unless the practitioner
believes in good faith and on reasonable
grounds that the records or information
are privileged.
(2) Where the requested records or
information are not in the possession of, or
subject to the control of, the practitioner or
the practitioner’s client, the practitioner
must promptly notify the requesting Inter-
nal Revenue Service officer or employee
and the practitioner must provide any
information that the practitioner has re-
garding the identity of any person who the
practitioner believes may have possession
or control of the requested records or
information. The practitioner must make
reasonable inquiry of his or her client
regarding the identity of any person who
may have possession or control of the
requested records or information, but the
practitioner is not required to make in-
quiry of any other person or independently
verify any information provided by the
practitioner’s client regarding the identity
of such persons.
(b)To the Director of Practice.When
a proper and lawful request is made by the
Director of Practice, a practitioner must
provide the Director of Practice with any
information the practitioner has concern-
ing an inquiry by the Director of Practice
into an alleged violation of the regulations
in this part by any person, and to testify
regarding this information in any proceed-
ing instituted under this part, unless the
practitioner believes in good faith and on
reasonable grounds that the information is
privileged.
(c)Interference with a proper and
lawful request for records or information.
A practitioner may not interfere, or at-
tempt to interfere, with any proper and
lawful effort by the Internal Revenue Ser-
vice, its officers or employees, or the
Director of Practice, or his or her employ-
ees, to obtain any record or information
unless the practitioner believes in good
faith and on reasonable grounds that the
record or information is privileged.
§10.21 Knowledge of client’s omission.
A practitioner who, having been re-
tained by a client with respect to a matter
administered by the Internal Revenue Ser-
vice, knows that the client has not com-
plied with the revenue laws of the United
States or has made an error in or omission
from any return, document, affidavit, or
other paper which the client submitted or
executed under the revenue laws of the
United States, must advise the client
promptly of the fact of such noncompli-
ance, error, or omission. The practitioner
must advise the client of the consequences
as provided under the Code and regula-
tions of such noncompliance, error, or
omission.
§10.22 Diligence as to accuracy.
(a)In general.A practitioner must
exercise due diligence—
(1) In preparing or assisting in the
preparation of, approving, and filing tax
returns, documents, affidavits, and other
papers relating to Internal Revenue Ser-
vice matters;
(2) In determining the correctness of
oral or written representations made by
the practitioner to the Department of the
Treasury; and
(3) In determining the correctness of
oral or written representations made by
the practitioner to clients with reference to
any matter administered by the Internal
Revenue Service.
(b) Reliance on others.Except as pro-
vided in§§10.33 and 10.34, a practitioner
will be presumed to have exercised due
diligence for purposes of this section if the
practitioner relies on the work product of
another person and the practitioner used
reasonable care in engaging, supervising,
training, and evaluating the person, taking
proper account of the nature of the rela-
tionship between the practitioner and the
person.
§10.23 Prompt disposition of pending
matters.
A practitioner may not unreasonably
delay the prompt disposition of any matter
before the Internal Revenue Service.
§10.24 Assistance from or to disbarred
or suspended persons and former
Internal Revenue Service employees.
A practitioner may not, knowingly and
directly or indirectly:
(a) Accept assistance from or assist
any person who is under disbarment or
suspension from practice before the Inter-
nal Revenue Service if the assistance re-
lates to a matter or matters constituting
practice before the Internal Revenue Ser-
vice.
(b) Accept assistance from any former
government employee where the provi-
sions of§10.25 or any Federal law would
be violated.
§10.25 Practice by former Government
employees, their partners and their
associates.
(a)Definitions.For purposes of this
section—
(1)Assistmeans to act in such a way
as to advise, furnish information to, or
August 19, 20023682002–33 I.R.B.

otherwise aid another person, directly or
indirectly.
(2)Government employeeis an officer
or employee of the United States or any
agency of the United States, including a
special government employeeas defined
in 18 U.S.C. 202(a), or of the District of
Columbia, or of any State, or a member of
Congress or of any State legislature.
(3)Member of a firmis a sole practi-
tioner or an employee or associate thereof,
or a partner, stockholder, associate, affili-
ate or employee of a partnership, joint
venture, corporation, professional associa-
tion or other affiliation of two or more
practitioners who represent nongovern-
mental parties.
(4)Practitionerincludes any indi-
vidual described in paragraph (f) of
§10.2.
(5)Official responsibilitymeans the
direct administrative or operating author-
ity, whether intermediate or final, and
either exercisable alone or with others,
and either personally or through subordi-
nates, to approve, disapprove, or other-
wise direct Government action, with or
without knowledge of the action.
(6)Participate or participationmeans
substantial involvement as a Government
employee by making decisions, or prepar-
ing or reviewing documents with or with-
out the right to exercise a judgment of
approval or disapproval, or participating
in conferences or investigations, or ren-
dering advice of a substantial nature.
(7)Ruleincludes Treasury Regula-
tions, whether issued or under preparation
for issuance as Notices of Proposed Rule
Making or as Treasury Decisions; revenue
rulings; and revenue procedures published
in the Internal Revenue Bulletin.Rule
does not include atransactionas defined
in paragraph (a)(8) of this section.
(8)Transactionmeans any decision,
determination, finding, letter ruling, tech-
nical advice, Chief Counsel advice, or
contract or the approval or disapproval
thereof, relating to a particular factual
situation or situations involving a specific
party or parties whose rights, privileges,
or liabilities under laws or regulations
administered by the Internal Revenue Ser-
vice, or other legal rights, are determined
or immediately affected therein and to
which the United States is a party or in
which it has a direct and substantial inter-
est, whether or not the same taxable peri-
ods are involved.Transactiondoes not
includeruleas defined in paragraph (a)(7)
of this section.
(b)General rules.(1) No former Gov-
ernment employee may, subsequent to his
or her Government employment, represent
anyone in any matter administered by the
Internal Revenue Service if the represen-
tation would violate 18 U.S.C. 207 or any
other laws of the United States.
(2) No former Government employee
who participated in a transaction may,
subsequent to his or her Government em-
ployment, represent or knowingly assist,
in that transaction, any person who is or
was a specific party to that transaction.
(3) A former Government employee
who within a period of one year prior to
the termination of Government employ-
ment had official responsibility for a trans-
action may not, within two years after his
or her Government employment is ended,
represent or knowingly assist in that trans-
action any person who is or was a specific
party to that transaction.
(4) No former Government employee
may, within one year after his or her
Government employment is ended, appear
before any employee of the Treasury De-
partment in connection with the publica-
tion,withdrawal,amendment,
modification, or interpretation of a rule in
the development of which the former
Government employee participated or for
which, within a period of one year prior to
the termination of his or her Government
employment, he or she had official re-
sponsibility. This paragraph (b)(4) does
not, however, preclude such former em-
ployee from appearing on his or her own
behalf or from representing a taxpayer
before the Internal Revenue Service in
connection with a transaction involving
the application or interpretation of such a
rule with respect to that transaction, pro-
vided that such former employee does not
utilize or disclose any confidential infor-
mation acquired by the former employee
in the development of the rule.
(c)Firm representation.(1) No mem-
ber of a firm of which a former Govern-
ment employee is a member may
represent or knowingly assist a person
who was or is a specific party in any
transaction with respect to which the re-
strictions of paragraph (b)(2) or (3) of this
section apply to the former Government
employee, in that transaction, unless the
firm isolates the former Government em-
ployee in such a way to ensure that the
former Government employee cannot as-
sist in the representation.
(2) When isolation of a former Gov-
ernment employee is required under para-
graph (c)(1) of this section, a statement
affirming the fact of such isolation must
be executed under oath by the former
Government employee and by another
member of the firm acting on behalf of the
firm. The statement must clearly identify
the firm, the former Government em-
ployee, and the transaction(s) requiring
isolation and it must be filed with the
Director of Practice (and at such other
place(s) directed by the Director of Prac-
tice) and in such other place and in the
manner prescribed by rule or regulation.
(d)Pending representation.Practice
by former Government employees, their
partners and associates with respect to
representation in specific matters where
actual representation commenced before
July 26, 2002, is governed by the regula-
tions set forth at 31 CFR Part 10 revised as
of July 1, 2002. The burden of showing
that representation commenced before
July 26, 2002, lies with the former Gov-
ernment employees, and their partners and
associates.
§10.26 Notaries.
A practitioner may not take acknowl-
edgments, administer oaths, certify pa-
pers, or perform any official act as a
notary public with respect to any matter
administered by the Internal Revenue Ser-
vice and for which he or she is employed
as counsel, attorney, or agent, or in which
he or she may be in any way interested.
§10.27 Fees.
(a)Generally.A practitioner may not
charge an unconscionable fee for repre-
senting a client in a matter before the
Internal Revenue Service.
(b)Contingent fees.(1) For purposes
of this section, a contingent fee is any fee
that is based, in whole or in part, on
whether or not a position taken on a tax
return or other filing avoids challenge by
the Internal Revenue Service or is sus-
tained either by the Internal Revenue Ser-
vice or in litigation. A contingent fee
includes any fee arrangement in which the
practitioner will reimburse the client for
2002–33 I.R.B.369August 19, 2002

all or a portion of the client’s fee in the
event that a position taken on a tax return
or other filing is challenged by the Internal
Revenue Service or is not sustained,
whether pursuant to an indemnity agree-
ment, a guarantee, rescission rights, or any
other arrangement with a similar effect.
(2) A practitioner may not charge a
contingent fee for preparing an original
tax return or for any advice rendered in
connection with a position taken or to be
taken on an original tax return.
(3) A contingent fee may be charged
for preparation of or advice in connection
with an amended tax return or a claim for
refund (other than a claim for refund made
on an original tax return), but only if the
practitioner reasonably anticipates at the
time the fee arrangement is entered into
that the amended tax return or refund
claim will receive substantive review by
the Internal Revenue Service.
§10.28 Return of client’s records.
(a) In general, a practitioner must, at
the request of a client, promptly return any
and all records of the client that are
necessary for the client to comply with his
or her Federal tax obligations. The practi-
tioner may retain copies of the records
returned to a client. The existence of a
dispute over fees generally does not re-
lieve the practitioner of his or her respon-
sibility under this section. Nevertheless, if
applicable state law allows or permits the
retention of a client’s records by a practi-
tioner in the case of a dispute over fees for
services rendered, the practitioner need
only return those records that must be
attached to the taxpayer’s return. The
practitioner, however, must provide the
client with reasonable access to review
and copy any additional records of the
client retained by the practitioner under
state law that are necessary for the client
to comply with his or her Federal tax
obligations.
(b)Forpurposesofthis
section—Records of the clientinclude all
documents or written or electronic mate-
rials provided to the practitioner, or ob-
tained by the practitioner in the course of
the practitioner’s representation of the cli-
ent, that preexisted the retention of the
practitioner by the client. The term also
includes materials that were prepared by
the client or a third party (not including an
employee or agent of the practitioner) at
any time and provided to the practitioner
with respect to the subject matter of the
representation. The term also includes any
return, claim for refund, schedule, affida-
vit, appraisal or any other document pre-
pared by the practitioner, or his or her
employee or agent, that was presented to
the client with respect to a prior represen-
tation if such document is necessary for
the taxpayer to comply with his or her
current Federal tax obligations. The term
does not include any return, claim for
refund, schedule, affidavit, appraisal or
any other document prepared by the prac-
titioner or the practitioner’s firm, employ-
ees or agents if the practitioner is
withholding such document pending the
client’s performance of its contractual ob-
ligation to pay fees with respect to such
document.
§10.29 Conflicting interests.
(a) Except as provided by paragraph
(b) of this section, a practitioner shall not
represent a client in his or her practice
before the Internal Revenue Service if the
representation involves a conflict of inter-
est. A conflict of interest exists if:
(1) The representation of one client
will be directly adverse to another client;
or
(2) There is a significant risk that the
representation of one or more clients will
be materially limited by the practitioner’s
responsibilities to another client, a former
client or a third person or by a personal
interest of the practitioner.
(b) Notwithstanding the existence of a
conflict of interest under paragraph (a) of
this section, the practitioner may represent
a client if:
(1) The practitioner reasonably be-
lieves that the practitioner will be able to
provide competent and diligent represen-
tation to each affected client;
(2) The representation is not prohib-
ited by law;
(3) Each affected client gives informed
consent, confirmed in writing.
(c) Copies of the written consents
must be retained by the practitioner for at
least 36 months from the date of the
conclusion of the representation of the
affected clients and the written consents
must be provided to any officer or em-
ployee of the Internal Revenue Service on
request.
(Approved by the Office of Manage-
ment and Budget under Control No. 1545–
1726)
§10.30 Solicitation.
(a)Advertising and solicitation re-
strictions. (1) A practitioner may not, with
respect to any Internal Revenue Service
matter, in any way use or participate in the
use of any form of public communication
or private solicitation containing a false,
fraudulent, or coercive statement or claim;
or a misleading or deceptive statement or
claim. Enrolled agents, in describing their
professional designation, may not utilize
the term of art“certified”or imply an
employer/employee relationship with the
Internal Revenue Service. Examples of
acceptable descriptions are“enrolled to
represent taxpayers before the Internal
Revenue Service,”“enrolled to practice
before the Internal Revenue Service,”and
“admitted to practice before the Internal
Revenue Service.”
(2) A practitioner may not make, di-
rectly or indirectly, an uninvited written or
oral solicitation of employment in matters
related to the Internal Revenue Service if
the solicitation violates Federal or State
law or other applicable rule,e.g., attorneys
are precluded from making a solicitation
that is prohibited by conduct rules appli-
cable to all attorneys in their State(s) of
licensure. Any lawful solicitation made by
or on behalf of a practitioner eligible to
practice before the Internal Revenue Ser-
vice must, nevertheless, clearly identify
the solicitation as such and, if applicable,
identify the source of the information used
in choosing the recipient.
(b)Fee information. (1)(i) A practitio-
ner may publish the availability of a writ-
ten schedule of fees and disseminate the
following fee information—
(A) Fixed fees for specific routine
services.
(B) Hourly rates.
(C) Range of fees for particular ser-
vices.
(D) Fee charged for an initial consul-
tation.
(ii) Any statement of fee information
concerning matters in which costs may be
incurred must include a statement disclos-
ing whether clients will be responsible for
such costs.
(2) A practitioner may charge no more
than the rate(s) published under paragraph
August 19, 20023702002–33 I.R.B.

(b)(1) of this section for at least 30 calen-
dar days after the last date on which the
schedule of fees was published.
(c)Communication of fee information.
Fee information may be communicated in
professional lists, telephone directories,
print media, mailings, electronic mail, fac-
simile, hand delivered flyers, radio, tele-
vision, and any other method. The method
chosen, however, must not cause the com-
munication to become untruthful, decep-
tive, or otherwise in violation of this part.
A practitioner may not persist in attempt-
ing to contact a prospective client if the
prospective client has made it known to
the practitioner that he or she does not
desire to be solicited. In the case of radio
and television broadcasting, the broadcast
must be recorded and the practitioner must
retain a recording of the actual transmis-
sion. In the case of direct mail and
e-commerce communications, the practi-
tioner must retain a copy of the actual
communication, along with a list or other
description of persons to whom the com-
munication was mailed or otherwise dis-
tributed. The copy must be retained by the
practitioner for a period of at least 36
months from the date of the last transmis-
sion or use.
(d)Improper associations.A practitio-
ner may not, in matters related to the
Internal Revenue Service, assist, or accept
assistance from, any person or entity who,
to the knowledge of the practitioner, ob-
tains clients or otherwise practices in a
manner forbidden under this section.
(Approved by the Office of Manage-
ment and Budget under Control No. 1545–
1726)
§10.31 Negotiation of taxpayer checks.
A practitioner who prepares tax re-
turns may not endorse or otherwise nego-
tiate any check issued to a client by the
government in respect of a Federal tax
liability.
§10.32 Practice of law.
Nothing in the regulations in this part
may be construed as authorizing persons
not members of the bar to practice law.
*****
§10.34 Standards for advising with
respect to tax return positions and for
preparing or signing returns.
(a)Realistic possibility standard.A
practitioner may not sign a tax return as a
preparer if the practitioner determines that
the tax return contains a position that does
not have a realistic possibility of being
sustained on its merits (the realistic possi-
bility standard) unless the position is not
frivolous and is adequately disclosed to
the Internal Revenue Service. A practitio-
ner may not advise a client to take a
position on a tax return, or prepare the
portion of a tax return on which a position
is taken, unless—
(1) The practitioner determines that
the position satisfies the realistic possibil-
ity standard; or
(2) The position is not frivolous and
the practitioner advises the client of any
opportunity to avoid the accuracy-related
penalty in section 6662 of the Internal
Revenue Code by adequately disclosing
the position and of the requirements for
adequate disclosure.
(b)Advising clients on potential pen-
alties.A practitioner advising a client to
take a position on a tax return, or prepar-
ing or signing a tax return as a preparer,
must inform the client of the penalties
reasonably likely to apply to the client
with respect to the position advised, pre-
pared, or reported. The practitioner also
must inform the client of any opportunity
to avoid any such penalty by disclosure, if
relevant, and of the requirements for ad-
equate disclosure. This paragraph (b) ap-
plies even if the practitioner is not subject
to a penalty with respect to the position.
(c)Relying on information furnished
by clients.A practitioner advising a client
to take a position on a tax return, or
preparing or signing a tax return as a
preparer, generally may rely in good faith
without verification upon information fur-
nished by the client. The practitioner may
not, however, ignore the implications of
information furnished to, or actually
known by, the practitioner, and must make
reasonable inquiries if the information as
furnished appears to be incorrect, incon-
sistent with an important fact or another
factual assumption, or incomplete.
(d)Definitions.For purposes of this
section—
(1)Realistic possibility.A position is
considered to have a realistic possibility of
being sustained on its merits if a reason-
able and well informed analysis of the law
and the facts by a person knowledgeable
in the tax law would lead such a person to
conclude that the position has approxi-
mately a one in three, or greater, likeli-
hood of being sustained on its merits. The
authorities described in 26 CFR 1.6662–
4(d)(3)(iii), or any successor provision, of
the substantial understatement penalty
regulations may be taken into account for
purposes of this analysis. The possibility
that a tax return will not be audited, that an
issue will not be raised on audit, or that an
issue will be settled may not be taken into
account.
(2)Frivolous.A position is frivolous if
it is patently improper.
Par. 4. In part 10, subparts C, D, and E
are revised to read as follows:
Subpart C—Sanctions for
Violation of the Regulations
§10.50 Sanctions.
(a)Authority to censure, suspend, or
disbar.The Secretary of the Treasury, or
his or her delegate, after notice and an
opportunity for a proceeding, may cen-
sure, suspend or disbar any practitioner
from practice before the Internal Revenue
Service if the practitioner is shown to be
incompetent or disreputable, fails to com-
ply with any regulation in this part, or with
intent to defraud, willfully and knowingly
misleads or threatens a client or prospec-
tive client. Censure is a public reprimand.
(b)Authority to disqualify.The Secre-
tary of the Treasury, or his or her delegate,
after due notice and opportunity for hear-
ing, may disqualify any appraiser with
respect to whom a penalty has been as-
sessed under section 6701(a) of the Inter-
nal Revenue Code.
(1) If any appraiser is disqualified
pursuant to this subpart C, such appraiser
is barred from presenting evidence or
testimony in any administrative proceed-
ing before the Department of Treasury or
the Internal Revenue Service, unless and
until authorized to do so by the Director of
Practice pursuant to§10.81, regardless of
whether such evidence or testimony
would pertain to an appraisal made prior
to or after such date.
(2) Any appraisal made by a disquali-
fied appraiser after the effective date of
disqualification will not have any proba-
2002–33 I.R.B.371August 19, 2002

tive effect in any administrative proceed-
ing before the Department of the Treasury
or the Internal Revenue Service. An ap-
praisal otherwise barred from admission
into evidence pursuant to this section may
be admitted into evidence solely for the
purpose of determining the taxpayer’s re-
liance in good faith on such appraisal.
§10.51 Incompetence and disreputable
conduct.
Incompetence and disreputable con-
duct for which a practitioner may be
censured, suspended or disbarred from
practice before the Internal Revenue Ser-
vice includes, but is not limited to—
(a) Conviction of any criminal offense
under the revenue laws of the United
States;
(b) Conviction of any criminal offense
involving dishonesty or breach of trust;
(c) Conviction of any felony under
Federal or State law for which the conduct
involved renders the practitioner unfit to
practice before the Internal Revenue Ser-
vice;
(d) Giving false or misleading infor-
mation, or participating in any way in the
giving of false or misleading information
to the Department of the Treasury or any
officer or employee thereof, or to any
tribunal authorized to pass upon Federal
tax matters, in connection with any matter
pending or likely to be pending before
them, knowing such information to be
false or misleading. Facts or other matters
contained in testimony, Federal tax re-
turns, financial statements, applications
for enrollment, affidavits, declarations, or
any other document or statement, written
or oral, are included in the terminforma-
tion.
(e) Solicitation of employment as pro-
hibited under§10.30, the use of false or
misleading representations with intent to
deceive a client or prospective client in
order to procure employment, or intimat-
ing that the practitioner is able improperly
to obtain special consideration or action
from the Internal Revenue Service or of-
ficer or employee thereof.
(f) Willfully failing to make a Federal
tax return in violation of the revenue laws
of the United States, willfully evading,
attempting to evade, or participating in
any way in evading or attempting to evade
any assessment or payment of any Federal
tax, or knowingly counseling or suggest-
ing to a client or prospective client an
illegal plan to evade Federal taxes or
payment thereof.
(g) Misappropriation of, or failure
properly and promptly to remit funds re-
ceived from a client for the purpose of
payment of taxes or other obligations due
the United States.
(h) Directly or indirectly attempting to
influence, or offering or agreeing to at-
tempt to influence, the official action of
any officer or employee of the Internal
Revenue Service by the use of threats,
false accusations, duress or coercion, by
the offer of any special inducement or
promise of advantage or by the bestowing
of any gift, favor or thing of value.
(i) Disbarment or suspension from
practice as an attorney, certified public
accountant, public accountant, or actuary
by any duly constituted authority of any
State, territory, possession of the United
States, including a Commonwealth, or the
District of Columbia, any Federal court of
record or any Federal agency, body or
board.
(j) Knowingly aiding and abetting an-
other person to practice before the Internal
Revenue Service during a period of sus-
pension, disbarment, or ineligibility of
such other person.
(k) Contemptuous conduct in connec-
tion with practice before the Internal Rev-
enue Service, including the use of abusive
language, making false accusations and
statements, knowing them to be false, or
circulating or publishing malicious or li-
belous matter.
(l) Giving a false opinion, knowingly,
recklessly, or through gross incompetence,
including an opinion which is intention-
ally or recklessly misleading, or engaging
in a pattern of providing incompetent
opinions on questions arising under the
Federal tax laws. False opinions described
in this paragraph (l) include those which
reflect or result from a knowing misstate-
ment of fact or law, from an assertion of a
position known to be unwarranted under
existing law, from counseling or assisting
in conduct known to be illegal or fraudu-
lent, from concealing matters required by
law to be revealed, or from consciously
disregarding information indicating that
material facts expressed in the tax opinion
or offering material are false or mislead-
ing. For purposes of this paragraph (l),
reckless conduct is a highly unreasonable
omission or misrepresentation involving
an extreme departure from the standards
of ordinary care that a practitioner should
observe under the circumstances. A pat-
tern of conduct is a factor that will be
taken into account in determining whether
a practitioner acted knowingly, recklessly,
or through gross incompetence. Gross in-
competence includes conduct that reflects
gross indifference, preparation which is
grossly inadequate under the circum-
stances, and a consistent failure to perform
obligations to the client.
§10.52 Violation of regulations.
A practitioner may be censured, sus-
pended or disbarred from practice before
the Internal Revenue Service for any of
the following:
(a) Willfully violating any of the regu-
lations contained in this part.
(b) Recklessly or through gross in-
competence (within the meaning of
§10.51(l)) violating§10.33 or 10.34.
§10.53 Receipt of information
concerning practitioner.
(a)Officer or employee of the Internal
Revenue Service.If an officer or employee
of the Internal Revenue Service has reason
to believe that a practitioner has violated
any provision of this part, the officer or
employee will promptly make a written
report to the Director of Practice of the
suspected violation. The report will ex-
plain the facts and reasons upon which the
officer’s or employee’s belief rests.
(b)Other persons.Any person other
than an officer or employee of the Internal
Revenue Service having information of a
violation of any provision of this part may
make an oral or written report of the
alleged violation to the Director of Prac-
tice or any officer or employee of the
Internal Revenue Service. If the report is
made to an officer or employee of the
Internal Revenue Service, the officer or
employee will make a written report of the
suspected violation to the Director of
Practice.
(c)Destruction of report.No report
made under paragraph (a) or (b) of this
section shall be maintained by the Direc-
tor of Practice unless retention of such
record is permissible under the applicable
records control schedule as approved by
the National Archives and Records Ad-
August 19, 20023722002–33 I.R.B.

ministration and designated in the Internal
Revenue Manual. The Director of Practice
must destroy such reports as soon as
permissible under the applicable records
control schedule.
(d)Effect on proceedings under sub-
part D.The destruction of any report will
not bar any proceeding under subpart D of
this part, but precludes the Director of
Practice’s use of a copy of such report in a
proceeding under subpart D of this part.
Subpart D—Rules Applicable to
Disciplinary Proceedings
§10.60 Institution of proceeding.
(a) Whenever the Director of Practice
determines that a practitioner violated any
provision of the laws or regulations in this
part, the Director of Practice may repri-
mand the practitioner or, in accordance
with§10.62, institute a proceeding for
censure, suspension, or disbarment of the
practitioner. A proceeding for censure,
suspension, or disbarment of a practitioner
is instituted by the filing of a complaint,
the contents of which are more fully
described in§10.62.
(b) Whenever the Director of Practice
is advised or becomes aware that a penalty
has been assessed against an appraiser
under section 6701(a) of the Internal Rev-
enue Code, the Director of Practice may
reprimand the appraiser or, in accordance
with§10.62, institute a proceeding for
disqualification of the appraiser. A pro-
ceeding for disqualification of an ap-
praiser is instituted by the filing of a
complaint, the contents of which are more
fully described in§10.62.
(c) Except as provided in§10.82, a
proceeding will not be instituted under
this section unless the proposed respon-
dent previously has been advised in writ-
ing of the law, facts and conduct
warranting such action and has been ac-
corded an opportunity to dispute facts,
assert additional facts, and make argu-
ments (including an explanation or de-
scription of mitigating circumstances).
§10.61 Conferences.
(a)In general.The Director of Prac-
tice may confer with a practitioner or an
appraiser concerning allegations of mis-
conduct irrespective of whether a proceed-
ing for censure, suspension, disbarment,
or disqualification has been instituted
against the practitioner or appraiser. If the
conference results in a stipulation in con-
nection with an ongoing proceeding in
which the practitioner or appraiser is the
respondent, the stipulation may be entered
in the record by either party to the pro-
ceeding.
(b)Resignation or voluntary censure,
suspension or disbarment.In lieu of a
proceeding being instituted or continued
under paragraph (a) of§10.60, a practi-
tioner may offer his or her consent to the
issuance of a censure, suspension or dis-
barment, or, if the practitioner is an en-
rolled agent, may offer to resign. The
Director of Practice may, in his or her
discretion, accept or decline the offered
censure, suspension, disbarment, or offer
of resignation by an enrolled agent, in
accordance with the consent offered. In
any declination, the Director of Practice
may state that he or she would accept an
offer of censure, suspension, or disbar-
ment, or, if the practitioner is an enrolled
agent, offer of resignation, containing dif-
ferent terms; the Director of Practice may,
in his or her discretion, accept or reject a
revised offer of censure, suspension, dis-
barment, or offer of resignation by an
enrolled agent, submitted in response to
the declination or may counteroffer and
act upon any accepted counteroffer.
(c)Voluntary disqualification.In lieu
of a proceeding being instituted or contin-
ued under paragraph (b) of§10.60, an
appraiser may offer his or her consent to
disqualification. The Director of Practice
may, in his or her discretion, accept or
decline the offered disqualification, in ac-
cordance with the consent offered. In any
declination, the Director of Practice may
state that he or she would accept an offer
of disqualification containing different
terms; the Director of Practice may, in his
or her discretion, accept or reject a revised
offer of censure, suspension or disbarment
submitted in response to the declination or
may counteroffer and act upon any ac-
cepted counteroffer.
§10.62 Contents of complaint.
(a)Charges.A complaint must name
the respondent, provide a clear and con-
cise description of the facts and law that
constitute the basis for the proceeding, and
be signed by the Director of Practice or a
person representing the Director of Prac-
tice under§10.69(a)(1). A complaint is
sufficient if it fairly informs the respon-
dent of the charges brought so that he or
she is able to prepare a defense. In the case
of a complaint filed against an appraiser,
the complaint is sufficient if it refers to a
penalty imposed previously on the respon-
dent under section 6701(a) of the Internal
Revenue Code.
(b)Specification of sanction.The
complaint must specify the sanction
sought by the Director of Practice against
the practitioner or appraiser. If the sanc-
tion sought is a suspension, the duration of
the suspension sought must be specified.
(c)Demand for answer.The Director
of Practice must, in the complaint or in a
separate paper attached to the complaint,
notify the respondent of the time for
answering the complaint, the time for
which may not be less than15 days from
the date of service of the complaint, the
name and address of the Administrative
Law Judge with whom the answer must be
filed, the name and address of the person
representing the Director of Practice to
whom a copy of the answer must be
served, and that a decision by default may
be rendered against the respondent in the
event an answer is not filed as required.
§10.63 Service of complaint; service
and filing of other papers.
(a)Service of complaint.
(1)In general.The complaint or a
copy of the complaint must be served on
the respondent by any manner described
in paragraphs (a)(2) or (3) of this section.
(2)Service by certified or first class
mail.(i) Service of the complaint may be
made on the respondent by mailing the
complaint by certified mail to the last
known address (as determined under sec-
tion 6212 of the Internal Revenue Code
and the regulations thereunder) of the
respondent. Where service is by certified
mail, the returned post office receipt duly
signed by the respondent will be proof of
service.
(ii) If the certified mail is not claimed
or accepted by the respondent, or is re-
turned undelivered, service may be made
on the respondent, by mailing the com-
plaint to the respondent by first class mail.
Service by this method will be considered
complete upon mailing, provided the com-
plaint is addressed to the respondent at the
respondent’s last known address as deter-
2002–33 I.R.B.373August 19, 2002

mined under section 6212 of the Internal
Revenue Code and the regulations there-
under.
(3)Service by other than certified or
first class mail.(i) Service of the com-
plaint may be made on the respondent by
delivery by a private delivery service des-
ignated pursuant to section 7502(f) of the
Internal Revenue Code to the last known
address (as determined under section 6212
of the Internal Revenue Code and the
regulations thereunder) of the respondent.
Service by this method will be considered
complete, provided the complaint is ad-
dressed to the respondent at the respon-
dent’s last known address as determined
under section 6212 of the Internal Rev-
enue Code and the regulations thereunder.
(ii) Service of the complaint may be
made in person on, or by leaving the
complaint at the office or place of business
of, the respondent. Service by this method
will be considered complete and proof of
service will be a written statement, sworn
or affirmed by the person who served the
complaint, identifying the manner of ser-
vice, including the recipient, relationship
of recipient to respondent, place, date and
time of service.
(iii) Service may be made by any other
means agreed to by the respondent. Proof
of service will be a written statement,
sworn or affirmed by the person who
served the complaint, identifying the man-
ner of service, including the recipient,
relationship of recipient to respondent,
place, date and time of service.
(4) For purposes of this paragraph (a),
“respondent”means the practitioner or
appraiser named in the complaint or any
other person having the authority to accept
mail on behalf of the practitioner or ap-
praiser.
(b)Service of papers other than com-
plaint.Any paper other than the complaint
may be served on the respondent, or his or
herauthorizedrepresentativeunder
§10.69(a)(2) by:
(1) mailing the paper by first class
mail to the last known address (as deter-
mined under section 6212 of the Internal
Revenue Code and the regulations there-
under) of the respondent or the respon-
dent’s authorized representative,
(2) delivery by a private delivery ser-
vice designated pursuant to section
7502(f) of the Internal Revenue Code to
the last known address (as determined
under section 6212 of the Internal Rev-
enue Code and the regulations thereunder)
of the respondent or the respondent’s au-
thorized representative, or
(3) as provided in paragraphs (a)(3)(ii)
and (a)(3)(iii) of this section.
(c)Service of papers on the Director
of Practice.Whenever a paper is required
or permitted to be served on the Director
of Practice in connection with a proceed-
ing under this part, the paper will be
served on the Director of Practice’s autho-
rized representative under§10.69(a)(1) at
the address designated in the complaint, or
at an address provided in a notice of
appearance. If no address is designated in
the complaint or provided in a notice of
appearance, service will be made on the
Director of Practice, Internal Revenue
Service,1111Constitution Avenue, NW,
Washington, DC 20224.
(d)Filing of papers. Whenever the
filing of a paper is required or permitted in
connection with a proceeding under this
part, the original paper, plus one addi-
tional copy, must be filed with the Admin-
istrative Law Judge at the address
specified in the complaint or at an address
otherwise specified by the Administrative
Law Judge. All papers filed in connection
with a proceeding under this part must be
served on the other party, unless the Ad-
ministrative Law Judge directs otherwise.
A certificate evidencing such must be
attached to the original paper filed with
the Administrative Law Judge.
§10.64 Answer; default.
(a)Filing.The respondent’s answer
must be filed with the Administrative Law
Judge, and served on the Director of
Practice, within the time specified in the
complaint unless, on request or applica-
tion of the respondent, the time is ex-
tended by the Administrative Law Judge.
(b) Contents.The answer must be
written and contain a statement of facts
that constitute the respondent’s grounds of
defense. General denials are not permit-
ted. The respondent must specifically ad-
mit or deny each allegation set forth in the
complaint, except that the respondent may
state that the respondent is without suffi-
cient information to admit or deny
a specific allegation. The respondent, nev-
ertheless, may not deny a material allega-
tion in the complaint that the respondent
knows to be true, or state that the respon-
dent is without sufficient information to
form a belief, when the respondent pos-
sesses the required information. The re-
spondent also must state affirmatively any
special matters of defense on which he or
she relies.
(c)Failure to deny or answer allega-
tions in the complaint.Every allegation in
the complaint that is not denied in the
answer is deemed admitted and will be
considered proved; no further evidence in
respect of such allegation need be adduced
at a hearing.
(d)Default.Failure to file an answer
within the time prescribed (or within the
time for answer as extended by the Ad-
ministrative Law Judge), constitutes an
admission of the allegations of the com-
plaint and a waiver of hearing, and the
Administrative Law Judge may make the
decision by default without a hearing or
further procedure. A decision by default
constitutes a decision under§10.76.
(e)Signature.The answer must be
signed by the respondent or the respon-
dent’s authorized representative under
§10.69(a)(2) and must include a statement
directly above the signature acknowledg-
ing that the statements made in the answer
are true and correct and that knowing and
willful false statements may be punishable
under 18 U.S.C. 1001.
§10.65 Supplemental charges.
If it appears that the respondent, in his
or her answer, falsely and in bad faith,
denies a material allegation of fact in the
complaint or states that the respondent has
insufficient knowledge to form a belief,
when the respondent in fact possesses
such information, or if it appears that the
respondent has knowingly introduced
false testimony during proceedings for his
or her censure, suspension, disbarment, or
disqualification, the Director of Practice
may file supplemental charges against the
respondent. The supplemental charges
may be heard with other charges in the
case, provided the respondent is given due
notice of the charges and is afforded an
opportunity to prepare a defense to such
charges.
§10.66 Reply to answer.
The Director of Practice may file a
reply to the respondent’s answer, but un-
less otherwise ordered by the Administra-
August 19, 20023742002–33 I.R.B.

tiveLawJudge,noreplytothe
respondent’s answer is required. If a reply
is not filed, new matter in the answer is
deemed denied.
§10.67 Proof; variance; amendment of
pleadings.
In the case of a variance between the
allegations in pleadings and the evidence
adduced in support of the pleadings, the
Administrative Law Judge, at any time
before decision, may order or authorize
amendment of the pleadings to conform to
the evidence. The party who would other-
wise be prejudiced by the amendment
must be given a reasonable opportunity to
address the allegations of the pleadings as
amended and the Administrative Law
Judge must make findings on any issue
presented by the pleadings as amended.
§10.68 Motions and requests.
(a)Motions.At any time after the
filing of the complaint, any party may file
a motion with the Administrative Law
Judge. Unless otherwise ordered by the
Administrative Law Judge, motions must
be in writing and must be served on the
opposing party as provided in§10.63(b).
A motion must concisely specify its
grounds and the relief sought, and, if
appropriate, must contain a memorandum
of facts and law in support. Before mov-
ing, a party must make a good faith effort
to resolve with the other party any dispute
that gives rise to, or is a concern of, the
motion. The movant must certify such an
attempt was made and state, if it is known,
whether the opposing party opposes the
motion.
(b)Response.Unless otherwise or-
dered by the Administrative Law Judge,
the nonmoving party is not required to file
a response to a motion. If the Administra-
tive Law Judge does not order the non-
moving party to file a response, the
nonmoving party is deemed to oppose the
motion.
(c)Oral motions and arguments.The
Administrative Law Judge may, for good
cause and with notice to the parties, permit
oral motions and oral opposition to mo-
tions. The Administrative Law Judge may,
within his or her discretion, permit oral
argument on any motion.
§10.69 Representation; ex parte
communication.
(a)Representation.(1) The Director of
Practice may be represented in proceed-
ings under this part by an attorney or other
employee of the Internal Revenue Service.
An attorney or an employee of the Internal
Revenue Service representing the Director
of Practice in a proceeding under this part
may sign the complaint or any document
required to be filed in the proceeding on
behalf of the Director of Practice.
(2) A respondent may appear in per-
son, be represented by a practitioner, or be
represented by an attorney who has not
filed a declaration with the Internal Rev-
enue Service pursuant to§10.3. A practi-
tioner or an attorney representing a
respondent or proposed respondent may
sign the answer or any document required
to be filed in the proceeding on behalf of
the respondent.
(b)Ex parte communication.The Di-
rector of Practice, the respondent, and any
representatives of either party, may not
attempt to initiate or participate inex parte
discussions concerning a proceeding or
potential proceeding with the Administra-
tive Law Judge (or any person who is
likely to advise the Administrative Law
Judge on a ruling or decision) in the
proceeding before or during the pendency
of the proceeding. Any memorandum, let-
ter or other communication concerning the
merits of the proceeding, addressed to the
Administrative Law Judge, by or on be-
half of any party shall be regarded as an
argument in the proceeding and shall be
served on the other party.
§10.70 Administrative Law Judge.
(a)Appointment.Proceedings on com-
plaints for the censure, suspension or dis-
barmentofapractitionerorthe
disqualification of an appraiser will be
conducted by an Administrative Law
Judge appointed as provided by 5 U.S.C.
3105.
(b)Powers of the Administrative Law
Judge.The Administrative Law Judge,
among other powers, has the authority, in
connection with any proceeding under
§10.60 assigned or referred to him or her,
to do the following:
(1) Administer oaths and affirmations;
(2) Make rulings on motions and re-
quests, which rulings may not be appealed
prior to the close of a hearing except in
extraordinary circumstances and at the
discretion of the Administrative Law
Judge;
(3) Determine the time and place of
hearing and regulate its course and con-
duct;
(4) Adopt rules of procedure and
modify the same from time to time as
needed for the orderly disposition of pro-
ceedings;
(5) Rule on offers of proof, receive
relevant evidence, and examine witnesses;
(6) Take or authorize the taking of
depositions;
(7) Receive and consider oral or writ-
ten argument on facts or law;
(8) Hold or provide for the holding of
conferences for the settlement or simplifi-
cation of the issues with the consent of the
parties;
(9) Perform such acts and take such
measures as are necessary or appropriate
to the efficient conduct of any proceeding;
and
(10) Make decisions.
§10.71 Hearings.
(a)In general.An Administrative Law
Judge will preside at the hearing on a
complaint filed under paragraph (c) of
§10.60 for the censure, suspension, or
disbarment of a practitioner or disqualifi-
cation of an appraiser. Hearings will be
stenographically recorded and transcribed
and the testimony of witnesses will be
taken under oath or affirmation. Hearings
will be conducted pursuant to 5 U.S.C.
556. A hearing in a proceeding requested
under paragraph (g) of§10.82 will be
conductedde novo. An evidentiary hear-
ing must be held in all proceedings prior
to the issuance of a decision by the Ad-
ministrative Law Judge unless: the Direc-
tor of Practice withdraws the complaint;
the practitioner consents to a sanction
pursuant to§10.61(b); a decision is issued
by default pursuant to§10.64(d), a deci-
sion is issued under§10.82(e); the re-
spondent requests a decision on the record
without a hearing; or the Administrative
Law Judge issues a decision on a motion
that disposes of the case prior to the
hearing.
(b)Publicity of Proceedings.A request
by a practitioner or appraiser that a hear-
ing in a disciplinary proceeding concern-
ing him or her be public, and that the
2002–33 I.R.B.375August 19, 2002

record of such disciplinary proceeding be
made available for inspection by inter-
ested persons may be granted by the
Administrative Law Judge where the par-
ties stipulate in advance to protect from
disclosure confidential tax information in
accordance with all applicable statutes and
regulations.
(c)Location.The location of the hear-
ing will be determined by the agreement
of the parties with the approval of the
Administrative Law Judge, but, in the
absence of such agreement and approval,
the hearing will be held in Washington,
D.C.
(d)Failure to appear.If either party to
the proceeding fails to appear at the hear-
ing, after notice of the proceeding has
been sent to him or her, the party will be
deemed to have waived the right to a
hearing and the Administrative Law Judge
may make his or her decision against the
absent party by default.
§10.72 Evidence.
(a)In general.The rules of evidence
prevailing in courts of law and equity are
not controlling in hearings or proceedings
conducted under this part. The Adminis-
trative Law Judge may, however, exclude
evidence that is irrelevant, immaterial, or
unduly repetitious,
(b)Depositions.The deposition of any
witness taken pursuant to§10.73 may be
admitted into evidence in any proceeding
instituted under§10.60.
(c)Proof of documents.Official docu-
ments, records, and papers of the Internal
Revenue Service and the Office of Direc-
tor of Practice are admissible in evidence
without the production of an officer or
employee to authenticate them. Any such
documents, records, and papers may be
evidenced by a copy attested or identified
by an officer or employee of the Internal
Revenue Service or the Treasury Depart-
ment, as the case may be.
(d)Withdrawal of exhibits.If any
document, record, or other paper is intro-
duced in evidence as an exhibit, the Ad-
ministrative Law Judge may authorize the
withdrawal of the exhibit subject to any
conditions that he or she deems proper.
(e)Objections.Objections to evidence
are to be made in short form, stating the
grounds for the objection. Except as or-
dered by the Administrative Law Judge,
argument on objections will not be re-
corded or transcribed. Rulings on objec-
tions are to be a part of the record, but no
exception to a ruling is necessary to pre-
serve the rights of the parties.
§10.73 Depositions.
(a) Depositions for use at a hearing
may be taken, with the written approval of
the Administrative Law Judge, by either
the Director of Practice or the respondent
or their duly authorized representatives.
Depositions may be taken before any of-
ficer duly authorized to administer an oath
for general purposes or before an officer
or employee of the Internal Revenue Ser-
vice who is authorized to administer an
oath in internal revenue matters.
(b) The party taking the deposition
must provide the deponent and the other
party with 10 days written notice of the
deposition, unless the deponent and the
parties agree otherwise. The notice must
specify the name of the deponent, the time
and place where the deposition is to be
taken, and whether the deposition will be
taken by oral or written interrogatories.
When a deposition is taken by written
interrogatories,anycross-examination
also will be by written interrogatories.
Copies of the written interrogatories must
be served on the other party with the
notice of deposition, and copies of any
written cross-interrogation must be mailed
or delivered to the opposing party at least
5 days before the date that the deposition
will be taken, unless the parties mutually
agree otherwise. A party on whose behalf
a deposition is taken must file the re-
sponses to the written interrogatories or a
transcript of the oral deposition with the
Administrative Law Judge and serve cop-
ies on the opposing party and the depo-
nent. Expenses in the reporting of
depositions will be borne by the party that
requested the deposition.
§10.74 Transcript.
In cases where the hearing is steno-
graphically reported by a Government
contract reporter, copies of the transcript
may be obtained from the reporter at rates
not to exceed the maximum rates fixed by
contract between the Government and the
reporter. Where the hearing is steno-
graphically reported by a regular em-
ployee of the Internal Revenue Service, a
copy will be supplied to the respondent
either without charge or upon the payment
of a reasonable fee. Copies of exhibits
introduced at the hearing or at the taking
of depositions will be supplied to the
parties upon the payment of a reasonable
fee (Sec. 501, Public Law 82–137) (65
Stat. 290) (31 U.S.C. 483a).
§10.75 Proposed findings and
conclusions.
Except in cases where the respondent
has failed to answer the complaint or
where a party has failed to appear at the
hearing, the parties must be afforded a
reasonable opportunity to submit pro-
posed findings and conclusions and their
supporting reasons to the Administrative
Law Judge.
§10.76 Decision of Administrative Law
Judge.
(a) As soon as practicable after the
conclusion of a hearing and the receipt of
any proposed findings and conclusions
timely submitted by the parties, the Ad-
ministrative Law Judge will enter a deci-
sion in the case. The decision must include
a statement of findings and conclusions, as
well as the reasons or basis for making
such findings and conclusions, and an
order of censure, suspension, disbarment,
disqualification, or dismissal of the com-
plaint. If the sanction is censure or a
suspension of less than six month’s dura-
tion, the Administrative Law Judge, in
rendering findings and conclusions, will
consider an allegation of fact to be proven
if it is established by the party who is
alleging the fact by a preponderance of
evidence in the record. In the event that
the sanction is disbarment or a suspension
of a duration of six months or longer, an
allegation of fact that is necessary for a
finding against the practitioner must be
proven by clear and convincing evidence
in the record. An allegation of fact that is
necessary for a finding of disqualification
against an appraiser must be proven by
clear and convincing evidence in the
record. The Administrative Law Judge
will provide the decision to the Director of
Practice and a copy of the decision to the
respondent or the respondent’s authorized
representative.
(b) In the absence of an appeal to the
Secretary of the Treasury or his or her
designee, or review of the decision on
August 19, 20023762002–33 I.R.B.

motion of the Secretary or his or her
designee, the decision of the Administra-
tive Law Judge will, without further pro-
ceedings, become the decision of the
agency 30 days after the date of the
Administrative Law Judge’s decision.
§10.77 Appeal of decision of
Administrative Law Judge.
Within 30 days from the date of the
Administrative Law Judge’s decision, ei-
ther party may appeal to the Secretary of
the Treasury, or his or her delegate. The
respondent must file his or her appeal with
the Director of Practice in duplicate and a
notice of appeal must include exceptions
to the decision of the Administrative Law
Judge and supporting reasons for such
exceptions. If the Director of Practice files
an appeal, he or she must provide a copy
to the respondent. Within 30 days after
receipt of an appeal or copy thereof, the
other party may file a reply brief in
duplicate with the Director of Practice. If
the reply brief is filed by the Director of
Practice, he or she must provide a copy of
it to the respondent. The Director of Prac-
tice must provide the entire record to the
Secretary of the Treasury, or his or her
delegate, after the appeal and any reply
brief has been filed.
§10.78 Decision on appeal.
On appeal from or review of the deci-
sion of the Administrative Law Judge, the
Secretary of the Treasury, or his or her
delegate, will make the agency decision.
The Secretary of the Treasury, or his or
delegate, will provide a copy of the
agency decision to the Director of Practice
and the respondent or the respondent’s
authorized representative. The decision of
the Administrative Law Judge will not be
reversed unless the appellant establishes
that the decision is clearly erroneous in
light of the evidence in the record and
applicable law. Issues that are exclusively
matters of law will be reviewedde novo.
In the event that the Secretary of the
Treasury, or his or her delegate, deter-
mines that there are unresolved issues
raised by the record, the case may be
remanded to the Administrative Law
Judge to elicit additional testimony or
evidence. A copy of the agency decision or
that of his or her delegate will be provided
to the Director of Practice and the respon-
dent contemporaneously.
§10.79 Effect of disbarment, suspension,
or censure.
(a)Disbarment.When the final deci-
sion in a case is against the respondent (or
the respondent has offered his or her
consent and such consent has been ac-
cepted by the Director of Practice) and
such decision is for disbarment, the re-
spondent will not be permitted to practice
before the Internal Revenue Service un-
less and until authorized to do so by the
Director of Practice pursuant to§10.81.
(b)Suspension.When the final deci-
sion in a case is against the respondent (or
the respondent has offered his or her
consent and such consent has been ac-
cepted by the Director of Practice) and
such decision is for suspension, the re-
spondent will not be permitted to practice
before the Internal Revenue Service dur-
ing the period of suspension. For periods
after the suspension, the practitioner’s fu-
ture representations may be subject to
conditions as authorized by paragraph (d)
of this section.
(c)Censure.When the final decision
in the case is against the respondent (or
the respondent has offered his or her
consent and such consent has been ac-
cepted by the Director of Practice) and
such decision is for censure, the respon-
dent will be permitted to practice before
the Internal Revenue Service, but the re-
spondent’s future representations may be
subject to conditions as authorized by
paragraph (d) of this section.
(d)Conditions.After being subject to
the sanction of either suspension or cen-
sure, the future representations of a prac-
titioner so sanctioned shall be subject to
conditions prescribed by the Director of
Practice designed to promote high stan-
dards of conduct. These conditions can be
imposed for a reasonable period in light of
the gravity of the practitioner’s violations.
For example, where a practitioner is cen-
sured because he or she failed to advise
his or her clients about a potential conflict
of interest or failed to obtain the clients’
written consents, the Director of Practice
may require the practitioner to provide the
Director of Practice or another Internal
Revenue Service official with a copy of all
consents obtained by the practitioner for
an appropriate period following censure,
whether or not such consents are specifi-
cally requested.
§10.80 Notice of disbarment,
suspension, censure, or disqualification.
On the issuance of a final order cen-
suring, suspending, or disbarring a practi-
tioner or a final order disqualifying an
appraiser, the Director of Practice may
give notice of the censure, suspension,
disbarment, or disqualification to appro-
priate officers and employees of the Inter-
nal Revenue Service and to interested
departments and agencies of the Federal
government. The Director of Practice may
determine the manner of giving notice to
the proper authorities of the State by
which the censured, suspended, or dis-
barred person was licensed to practice.
§10.81 Petition for reinstatement.
The Director of Practice may entertain
a petition for reinstatement from any per-
son disbarred from practice before the
Internal Revenue Service or any disquali-
fied appraiser after the expiration of 5
years following such disbarment or dis-
qualification. Reinstatement may not be
granted unless the Director of Practice is
satisfied that the petitioner, thereafter, is
not likely to conduct himself contrary to
the regulations in this part, and that grant-
ing such reinstatement would not be con-
trary to the public interest.
§10.82 Expedited suspension upon
criminal conviction or loss of license for
cause.
(a)When applicable.Whenever the
Director of Practice determines that a
practitioner is described in paragraph (b)
of this section, the Director of Practice
may institute a proceeding under this sec-
tion to suspend the practitioner from prac-
tice before the Internal Revenue Service.
(b)To whom applicable.This section
applies to any practitioner who, within 5
years of the date a complaint instituting a
proceeding under this section is served:
(1) Has had his or her license to
practice as an attorney, certified public
accountant, or actuary suspended or re-
voked for cause (not including a failure to
pay a professional licensing fee) by any
authority or court, agency, body, or board
described in§10.51(i); or
2002–33 I.R.B.377August 19, 2002

(2) Has, irrespective of whether an
appeal has been taken, been convicted of
any crime under title 26 of the United
States Code, any crime involving dishon-
esty or breach of trust, or any felony for
which the conduct involved renders the
practitioner unfit to practice before the
Internal Revenue Service.
(3) Has violated conditions designed
to promote high standards of conduct
established pursuant to§10.79(d).
(c)Instituting a proceeding.A pro-
ceeding under this section will be insti-
tuted by a complaint that names the
respondent, is signed by the Director of
Practice or a person representing the Di-
rector of Practice under§10.69(a)(1), is
filed in the Director of Practice’s office,
and is served according to the rules set
forth in paragraph (a) of§10.63. The
complaint must give a plain and concise
description of the allegations that consti-
tute the basis for the proceeding. The
complaint must notify the respondent—
(1) Of the place and due date for filing
an answer;
(2) That a decision by default may be
rendered if the respondent fails to file an
answer as required;
(3) That the respondent may request a
conference with the Director of Practice to
address the merits of the complaint and
that any such request must be made in the
answer; and
(4) That the respondent may be sus-
pended either immediately following the
expiration of the period within which an
answer must be filed or, if a conference is
requested, immediately following the con-
ference.
(d)Answer.The answer to a complaint
described in this section must be filed no
later than 30 calendar days following the
date the complaint is served, unless the
Director of Practice extends the time for
filing. The answer must be filed in accor-
dance with the rules set forth in§10.64,
except as otherwise provided in this sec-
tion. A respondent is entitled to a confer-
ence with the Director of Practice only if
the conference is requested in a timely
filed answer. If a request for a conference
is not made in the answer or the answer is
not timely filed, the respondent will be
deemed to have waived his or her right to
a conference and the Director of Practice
may suspend such respondent at any time
following the date on which the answer
was due.
(e)Conference.The Director of Prac-
tice or his or her designee will preside at a
conference described in this section. The
conference will be held at a place and time
selected by the Director of Practice, but no
sooner than 14 calendar days after the date
by which the answer must be filed with
the Director of Practice, unless the respon-
dent agrees to an earlier date. An autho-
rized representative may represent the
respondent at the conference. Following
the conference, upon a finding that the
respondent is described in paragraph (b)
of this section, or upon the respondent’s
failure to appear at the conference either
personally or through an authorized repre-
sentative, the Director of Practice may
immediately suspend the respondent from
practice before the Internal Revenue Ser-
vice.
(f)Duration of suspension.A suspen-
sion under this section will commence on
the date that written notice of the suspen-
sion is issued. A practitioner’s suspension
will remain effective until the earlier of
the following—
(1) The Director of Practice lifts the
suspension after determining that the prac-
titioner is no longer described in para-
graph (b) of this section or for any other
reason; or
(2) The suspension is lifted by an
Administrative Law Judge or the Secre-
tary of the Treasury in a proceeding re-
ferred to in paragraph (g) of this section
and instituted under§10.60.
(g)Proceedinginstitutedunder
§10.60. If the Director of Practice sus-
pends a practitioner under this section, the
practitioner may ask the Director of Prac-
tice to issue a complaint under§10.60.
The request must be made in writing
within 2 years from the date on which the
practitioner’s suspension commences. The
Director of Practice must issue a com-
plaint requested under this paragraph
within 30 calendar days of receiving the
request.
Subpart E—General Provisions
§10.90 Records.
Availability.The Director of Practice
will make available for public inspection
at the Office of Director of Practice the
roster of all persons enrolled to practice,
the roster of all persons censured, sus-
pended, or disbarred from practice before
the Internal Revenue Service, and the
roster of all disqualified appraisers. Other
records of the Director of Practice may be
disclosed upon specific request, in accor-
dance with the applicable disclosure rules
of the Internal Revenue Service and the
Treasury Department.
§10.91 Saving clause.
Any proceeding instituted under regu-
lations in effect prior to July 26, 2002, that
is not final prior to July 26, 2002, will not
be affected by this part and will apply the
rules set forth at 31 CFR part 10 revised as
of July 1, 2002. Any proceeding under this
part based on conduct engaged in prior to
July 26, 2002, which is instituted after that
date, shall apply Subpart D and E of this
part, but the conduct engaged in prior to
July 26, 2002, shall be judged by the
regulations in effect at the time the con-
duct occurred.
§10.92 Special orders.
The Secretary of the Treasury reserves
the power to issue such special orders as
he or she deems proper in any cases within
the purview of this part.
§10.93 Effective date.
Subject to§10.91, this part is appli-
cable on July 26, 2002.
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
Approved July 17, 2002.
David Aufhauser,
General Counsel,
Office of the Secretary.
(Filed by the Office of the Federal Register on July
25, 2002, 8:45 a.m., and published in the issue of the
Federal Register for July 26, 2002, 67 F.R. 48760)
August 19, 20023782002–33 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous
Weighted Average Interest
Rate Update
Notice 2002–57
Sections 412(b)(5)(B) and 412(l)(7)
(C)(i) of the Internal Revenue Code pro-
vide that the interest rates used to calcu-
late current liability for purposes of
determining the full funding limitation
under§412(c)(7) and the required contri-
bution under§412(l) must be within a
permissible range around the weighted
average of the rates of interest on 30-year
Treasury securities during the four-year
period ending on the last day before the
beginning of the plan year.
Notice 88–73, 1988–2 C.B. 383, pro-
vides guidelines for determining the
weighted average interest rate and the
resulting permissible range of interest
rates used to calculate current liability for
the purpose of the full funding limitation
of§412(c)(7) of the Code.
Section 417(e)(3)(A)(ii)(II) of the
Code defines the applicable interest rate,
which must be used for purposes of deter-
mining 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 regu-
lations prescribe. Section 1.417(e)–1(d)(3)
of the Income Tax Regulations provides
that the applicable interest rate for a
month is the annual interest rate on
30-year Treasury securities as specified by
the Commissioner for that month in rev-
enue rulings, notices or other guidance
published in the Internal Revenue Bulle-
tin.
The rate of interest on 30-year Trea-
sury Securities for July 2002 is 5.39 per-
cent.PursuanttoNotice2002–26,
2002–15 I.R.B. 743, the Service has de-
termined this rate as the monthly average
of the daily determination of yield on the
30-year Treasury bond maturing in Febru-
ary 2031.
Section 405 of the Job Creation and
Worker Assistance Act of 2002 amended
§412(l)(7)(C) of the Code to provide that
for plan years beginning in 2002 and 2003
the permissible range is extended to 120
percent.
The following rates were determined
for the plan years beginning in the month
shown below.
MonthYear
Weighted
Average
90% to 110%
Permissible
Range
90% to 120%
Permissible
Range
August20025.655.09 to 6.225.09 to 6.78
Drafting Information
The principal author of this notice is
Todd Newman of the Employee Plans, Tax
Exempt and Government Entities Divi-
sion. For further information regarding
this notice, please contact the Employee
Plans’taxpayer assistance telephone ser-
vice at 1–877–829–5500 (a toll-free num-
ber), between the hours of 8:00 a.m. and
6:30 p.m. Eastern time, Monday through
Friday. Mr. Newman may be reached at
1–202–283–9888 (not a toll-free number).
2002–33 I.R.B.379August 19, 2002

Part IV. Items of General Interest
Notice of Proposed
Rulemaking and Notice of
Public Hearing
Definition of Guaranteed
Annuity and Lead Unitrust
Interests
REG–115781–01
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed
rulemaking and notice of public hearing.
SUMMARY: This document contains pro-
posed regulations conforming the income,
gift, and estate tax regulations to the Tax
Court’s decision inEstate of Boeshore v.
Commissioner, 78 T.C. 523 (1982),acq. in
result,1987–2 C.B. 1, holding portions of
§20.2055–2(e)(2)(vi)(e) of the Estate Tax
Regulations invalid.
DATES: Written or electronic comments
and requests to speak at the public hearing
scheduled for October 16, must be re-
ceived by September 25, 2002.
ADDRESSES:Sendsubmissionsto:
CC:ITA:RU(REG–115781–01),room
5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submission of comments may
be hand delivered Monday through Friday
between the hours of 8 a.m. and 5 p.m. to:
CC:ITA:RU (REG–115781–01), Courier’s
Desk, Internal Revenue Service,1111
Constitution Avenue NW, Washington,
DC. Alternatively, taxpayers may submit
comments electronically via the Internet
directly to the IRS Internet site at
www.irs.gov/regs. The public hearing will
be held in Room 4718, Internal Revenue
Service,1111Constitution Avenue, NW,
Washington, DC.
FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions, Susan Hurwitz (202) 622–3090;
concerning submissions of comments,
Sonya Cruse (202) 622–7180.
SUPPLEMENTARY INFORMATION
Background
In general, if interests in the same
property are transferred for both charitable
and noncharitable purposes, the charitable
interest will qualify for the charitable
deduction for federal income, gift, and
estate tax purposes only if the interest is in
one of certain prescribed forms. If the
charitable interest is not a remainder inter-
est, sections 170(f), 2522(c)(2), and
2055(e)(2) of the Internal Revenue Code
(Code) require that the charitable interest
be in the form of either a guaranteed
annuity or a fixed percentage of the annual
net fair market value of the property
(unitrust interest).
A guaranteed annuity is defined in the
regulations under sections 170, 2522, and
2055 as an arrangement pursuant to which
a specified sum is paid not less often than
annually, for a specified term of years or
for the life or lives of certain named
individuals. A unitrust interest is defined
as a right to receive not less often than
annually a fixed percentage of the net fair
market value, determined annually, of the
property funding the unitrust interest, pay-
able for a specified term of years or for the
life of certain named individuals. The
income, estate, and gift tax regulations
also provide that if guaranteed annuity or
unitrust interests are payable for private
and charitable purposes from a trust and
the private interest is payable before the
expiration of the charitable interest, then
in order for the charitable guaranteed an-
nuity interest or unitrust interest to be
deductible, among other requirements, the
charitable interest must begin either be-
fore, or at the same time as, the
privateinterest.See,forexample,
§20.2055–2(e)(2)(vii)(e) regarding the es-
tate tax provision applicable to unitrust
interests. See also, Rev. Rul. 76–225,
1976–1 C.B. 281.
InEstate of Boeshore v. Commis-
sioner, the decedent devised the residue of
her estate to a charitable remainder uni-
trust described in section 664 of the Code.
Under the terms of the trust, a 6 percent
unitrust amount was to be paid annually
from the trust. During the life of the
decedent’s surviving spouse, 70 percent of
the distribution was to be paid to the
surviving spouse and the remaining 30
percent to the decedent’s daughter and two
grandchildren.Uponthesurviving
spouse’s death, 58 percent of the unitrust
amount was to be paid to the decedent’s
daughter and two grandchildren for their
lives, and the remaining 42 percent was to
be paid to a qualifying charity. Upon the
death of the last to die of the four indi-
vidual beneficiaries, the remainder interest
was to be paid to charity. The decedent’s
estate claimed an estate tax charitable
deduction for the present values of the
charitable remainder interest and the
charitable unitrust interest that was to
begin upon the spouse’s death.
Under the authority of§20.2055–2
(e)(2)(vi)(e) (currently§20.2055–2(e)(2)
(vii)(e)), the IRS disallowed the deduction
for the present value of the charitable
unitrust interest, because it was preceded
by a noncharitable unitrust interest.
The court noted that the rules con-
tained in section 2055(e)(2) ensure that
the value of the charitable interest is not
subject to manipulation through trustee
investment practices and that the actual
benefit charity receives bears a reasonable
relationship to the deduction allowed for
the value of the charitable interest. Since
all the nonremainder interests in theBoe-
shoretrust, both charitable and nonchari-
table, were in the form of unitrust
interests, any incentives to manipulate the
income interest were removed.Estate of
Boeshore v. Commissioner, 78 T.C. at 529.
Under these circumstances, the court was
unable to find any congressional intent to
preclude a charitable deduction for an
otherwise qualified charitable unitrust in-
terest.Accordingly,thecourtheld
§20.2055–2(e)(2)(vi)(e) invalid insofar as
the regulation disallowed a deduction for
the charitable unitrust interest under the
facts presented.
Explanation of Provisions
The proposed regulations amend the
existing regulations under sections 170,
2055, and 2522 governing charitable guar-
anteed annuity interests and unitrust inter-
ests to eliminate the requirement that the
charitable interest can not be preceded in
point of time by a noncharitable interest
that is in the form of a guaranteed annuity
or unitrust interest. The regulations will
August 19, 20023802002–33 I.R.B.

continue to require that any amounts pay-
able for a private purpose before the
expiration of the charitable annuity or
unitrust interest either must be in the form
of a guaranteed annuity or unitrust interest
or must be payable from a separate group
of assets devoted exclusively to private
purposes.
Effective Date
The regulations are applicable as of
the date these regulations are published in
theFederal Registeras final regulations.
Effect on Other Document
The following publication is revoked
as of the date these regulations are pub-
lished in theFederal Registeras final
regulations.
Rev. Rul. 76–225, 1976–1 C.B. 281
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Ex-
ecutiveOrder12866.Therefore,a
regulatory assessment is not required. It
has also been determined that section
553(b) of the Administrative Procedures
Act (5 U.S.C. chapter 5) does not apply to
these regulations, and because the regula-
tion does not impose a collection of infor-
mation requirement on small entities, the
Regulatory Flexibility Act (5 U.S.C. chap-
ter 5) does not apply. Pursuant to section
7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administration
for comment on its impact on small busi-
ness.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written (a signed
original and eight (8) copies, if written) or
electronic comments that are submitted
timely (in the manner described in the
ADDRESSES portion of this preamble) to
the IRS. All comments will be available
for public inspection and copying.
A public hearing has been scheduled
for October 16, 2002, at 10:00 a.m., Room
4718, Internal Revenue Building,1111
Constitution Avenue, NW, Washington,
DC. Due to building security procedures,
visitors must enter at the Constitution
Avenue entrance. In addition, all visitors
must present photo identification to enter
the building. Because of access restric-
tions, visitors will not be admitted beyond
the immediate entrance area more than 30
minutes before the hearing starts. For
information about having your name
placed on the building access list to attend
the hearing, see“FOR FURTHER IN-
FORMATION CONTACT”section of this
preamble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons who wish to
present oral comments at the hearing must
submit comments and an outline of the
topics to be discussed and the time to be
devoted to each topic (preferably a signed
original and eight (8) copies) by Septem-
ber 25, 2002.
A period of 10 minutes will be allotted
to each person for making comments. An
agenda showing the scheduling of the
speakers will be prepared after the dead-
line for receiving outlines has passed.
Copies of the agenda will be available free
of charge at the hearing.
Drafting Information
The principal author of these proposed
regulations is Susan Hurwitz of the Office
oftheAssociateChiefCounsel
(Passthroughs and Special Industries).
However, personnel from other offices of
the IRS and the Treasury Department
participated in their development.
*****
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PA RT 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805***
Par. 2. Section 1.170A–6 is amended
as follows:
1. Paragraph (c)(2)(i)(E) is revised and
the example following paragraph (c)(2)
(i)(E) is removed.
2. Paragraph (c)(2)(ii)(D) is revised.
The revision reads as follows:
§1.170A-6 Charitable contributions in
trust.
*****
(c)***
(2)***
(i)***
(E) Where a charitable interest in the
form of a guaranteed annuity interest is
transferred after May 21, 1972, the chari-
table interest generally is not a guaranteed
annuity interest if any amount may be paid
by the trust for a private purpose before
the expiration of all the charitable annuity
interests. There are two exceptions to this
general rule. First, the charitable interest is
a guaranteed annuity interest if the amount
payable for a private purpose is in the
form of a guaranteed annuity interest and
the trust’s governing instrument does not
provide for any preference or priority in
the payment of the private annuity as
opposed to the charitable annuity. Second,
the charitable interest is a guaranteed an-
nuity interest if under the trust’s governing
instrument the amount that may be paid
for a private purpose is payable only from
a group of assets that are devoted exclu-
sively to private purposes and to which
section 4947(a)(2) is inapplicable by rea-
son of section 4947(a)(2)(B). For purposes
of this paragraph (c)(2)(i)(E), an amount is
not paid for a private purpose if it is paid
for an adequate and full consideration in
money or money’s worth. See§53.
4947–1(c) of this chapter (Foundation and
Similar Excise Tax Regulations) for rules
relating to the inapplicability of section
4947(a)(2) to segregated amounts in a
split-interest trust.***
*****
(ii)***
(D) Where a charitable interest is in
the form of a unitrust interest, the chari-
table interest generally is not a unitrust
interest if any amount may be paid by the
trust for a private purpose before the
expiration of all the charitable unitrust
interests. There are two exceptions to this
general rule. First, the charitable interest is
a unitrust interest if the amount payable
for a private purpose is in the form of a
unitrust interest and the trust’s governing
instrument does not provide for any pref-
erence or priority in the payment of the
private unitrust interest as opposed to the
charitable unitrust interest. Second, the
2002–33 I.R.B.381August 19, 2002

charitable interest is a unitrust interest if
under the trust’s governing instrument the
amount that may be paid for a private
purpose is payable only from a group of
assets that are devoted exclusively to pri-
vate purposes and to which section
4947(a)(2) is inapplicable by reason of
section 4947(a)(2)(B). For purposes of
this paragraph (c)(2)(ii)(D), an amount is
not paid for a private purpose if it is paid
for an adequate and full consideration in
money or money’s worth. See§53.
4947–1(c) of this chapter (Foundation and
Similar Excise Tax Regulations) for rules
relating to the inapplicability of section
4947(a)(2) to segregated amounts in a
split-interest trust.
*****
PA RT 2 0—ESTATE TAX; ESTATES OF
DECEDENTS DYING AFTER
AUGUST 16, 1954
Par. 3. The authority citation for part
20 continues to read in part as follows:
Authority: 26 U.S.C. 7805****
Par. 4. Section 20.2055–2 is amended
as follows:
1. Paragraph (e)(2)(vi)(f) is revised.
2. Paragraph (e)(2)(vii)(e) is revised.
3. In paragraph (f)(2)(iv)Example (4)
is removed.
The revisions read as follows:
§20.2055–2 Transfers not exclusively
for charitable purposes.
*****
(e)***
(2)***
(vi)***
(f) Where a charitable interest in the
form of a guaranteed annuity interest is in
trust, the charitable interest generally is
not a guaranteed annuity interest if any
amount may be paid by the trust for a
private purpose before the expiration of all
the charitable annuity interests. There are
two exceptions to this general rule. First,
the charitable interest is a guaranteed an-
nuity interest if the amount payable for a
private purpose is in the form of a guar-
anteed annuity interest and the trust’s
governing instrument does not provide for
any preference or priority in the payment
of the private annuity as opposed to the
charitable annuity. Second, the charitable
interest is a guaranteed annuity interest if
under the trust’s governing instrument the
amount that may be paid for a private
purpose is payable only from a group of
assets that are devoted exclusively to pri-
vate purposes and to which section
4947(a)(2) is inapplicable by reason of
section 4947(a)(2)(B). For purposes of
this paragraph (e)(2)(vi)(f), an amount is
not paid for a private purpose if it is paid
for an adequate and full consideration in
money or money’s worth. See§53.
4947–1(c) of this chapter (Foundation and
Similar Excise Tax Regulations) for rules
relating to the inapplicability of section
4947(a)(2) to segregated amounts in a
split-interest trust.
*****
(vii)***
(e) Where a charitable interest in the
form of a unitrust interest is in trust, the
charitable interest generally is not a uni-
trust interest if any amount may be paid by
the trust for a private purpose before the
expiration of all the charitable unitrust
interests. There are two exceptions to this
general rule. First, the charitable interest is
a unitrust interest if the amount payable
for a private purpose is in the form of a
unitrust interest and the trust’s governing
instrument does not provide for any pref-
erence or priority in the payment of the
private unitrust interest as opposed to the
charitable unitrust interest. Second, the
charitable interest is a unitrust interest if
under the trust’s governing instrument the
amount that may be paid for a private
purpose is payable only from a group of
assets that are devoted exclusively to pri-
vate purposes and to which section
4947(a)(2) is inapplicable by reason of
section 4947(a)(2)(B). For purposes of
this paragraph (e)(2)(vii)(e), an amount is
not paid for a private purpose if it is paid
for an adequate and full consideration in
money or money’s worth. See§53.
4947–1(c) of this chapter (Foundation and
Similar Excise Tax Regulations) for rules
relating to the inapplicability of section
4947(a)(2) to segregated amounts in a
split-interest trust.
*****
PA RT 2 5—GIFT TAX; GIFTS MADE
AFTER DECEMBER 31, 1954
Par. 5. The authority for part 25 con-
tinues to read in part as follows:
Authority: 26 U.S.C. 7805***
Par.6.Section25.2522(c)–3is
amended as follows:
1. Paragraph (c)(2)(vi)(f) is revised.
2. Paragraph (c)(2)(vii)(e) is revised.
3. In paragraph (d)(2)(iv),Example 4,
is removed.
The revisions read as follows:
§25.2522(c)–3 Transfers not exclusively
for charitable, etc., purposes in the case
of gifts made after July 31, 1969.
*****
(c)***
(2)***
(vi)***
(f) Where a charitable interest in the
form of a guaranteed annuity interest is in
trust, and the gift of such interest is made
after May 21, 1972, the charitable interest
generally is not a guaranteed annuity in-
terest if any amount may be paid by the
trust for a private purpose before the
expiration of all the charitable annuity
interests. There are two exceptions to this
general rule. First, the charitable interest is
a guaranteed annuity interest if the amount
payable for a private purpose is in the
form of a guaranteed annuity interest and
the trust’s governing instrument does not
provide for any preference or priority in
the payment of the private annuity as
opposed to the charitable annuity. Second,
the charitable interest is a guaranteed an-
nuity interest if under the trust’s governing
instrument the amount that may be paid
for a private purpose is payable only from
a group of assets that are devoted exclu-
sively to private purposes and to which
section 4947(a)(2) is inapplicable by rea-
son of section 4947(a)(2)(B). For purposes
of this paragraph (c)(2)(vi)(f), an amount
is not paid for a private purpose if it is
paid for an adequate and full consideration
in money or money’s worth. See§53.
4947–1(c) of this chapter (Foundation and
Similar Excise Tax Regulations) for rules
relating to the inapplicability of section
4947(a)(2) to segregated amounts in a
split-interest trust.
*****
(vii)***
(e) Where a charitable interest in the
form of a unitrust interest is in trust, the
charitable interest generally is not a uni-
trust interest if any amount may be paid by
the trust for a private purpose before the
expiration of all the charitable unitrust
August 19, 20023822002–33 I.R.B.

interests. There are two exceptions to this
general rule. First, the charitable interest is
a unitrust interest if the amount payable
for a private purpose is in the form of a
unitrust interest and the trust’s governing
instrument does not provide for any pref-
erence or priority in the payment of the
private unitrust interest as opposed to the
charitable unitrust interest. Second, the
charitable interest is a unitrust interest if
under the trust’s governing instrument the
amount that may be paid for a private
purpose is payable only from a group of
assets that are devoted exclusively to pri-
vate purposes and to which section
4947(a)(2) is inapplicable by reason of
section 4947(a)(2)(B). For purposes of
this paragraph (c)(2)(vii)(e), an amount is
not paid for a private purpose if it is paid
for an adequate and full consideration in
money or money’s worth. See§53.
4947–1(c) of this chapter (Foundation and
Similar Excise Tax Regulations) for rules
relating to the inapplicability of section
4947(a)(2) to segregated amounts in a
split-interest trust.
*****
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on July
22, 2002, 8:45 a.m., and published in the issue of the
Federal Register for July 23, 2002, 67 F.R. 48070)
Notice of Proposed
Rulemaking
Earnings Calculation for
Returned or Recharacterized
IRA Contributions
REG–124256–02
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed
rulemaking.
SUMMARY: These proposed regulations
provide a new method to be used for
calculating the net income attributable to
IRA contributions that are distributed as a
returned contribution pursuant to section
408(d)(4) of the Internal Revenue Code or
recharacterizedpursuanttosection
408A(d)(6). The regulations will affect
IRA owners and IRA trustees, custodians
and issuers.
DATES: Written or electronic comments
must be received by October 21, 2002.
ADDRESSES:Sendsubmissionsto:
CC:ITA:RU(REG–124256–02),room
5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand
delivered Monday through Friday be-
tween the hours of 8 a.m. and 5 p.m. to:
CC:ITA:RU (REG–124256–02), Couri-
er’s Desk Internal Revenue Service,1111
Constitution Avenue, NW, Washington,
DC. Alternatively, taxpayers may submit
comments electronically directly to the
IRS Internet site atwww.irs.gov/regs.
FOR FURTHER INFORMATION CON-
TACT: Cathy Vohs at (202) 622–6090.
SUPPLEMENTARY INFORMATION
Background
Section 408(d)(4) provides that an
IRA contribution will not be included in
the IRA owner’s gross income when dis-
tributed as a returned contribution if: (1) it
is received by the IRA owner on or before
the day prescribed by law (including ex-
tensions) for filing the owner’s Federal
income tax return for the year of the
contribution; (2) no deduction is allowed
with respect to the contribution; and (3)
the distribution is accompanied by the
amount of net income attributable to the
contribution.
Section 408A governs Roth IRAs and
was added by section 302 of the Taxpayer
Relief Act of 1997, Public Law 105–34
(111 Stat. 788). Section 408A(d)(6) pro-
vides that a contribution made to one type
of IRA may be recharacterized as having
been made to another type of IRA if: (1)
the recharacterization transfer occurs on
or before the date prescribed by law (in-
cluding extensions) for filing the IRA
owner’s Federal income tax return for the
year for which the contribution was made;
(2) no deduction is allowed with respect to
the contribution to the transferor IRA; and
(3) the transfer is accompanied by any net
income allocable to the contribution.
Section 1.408–4(c)(2)(ii) of the In-
come Tax Regulations prescribes the
method (the old method) for calculating
the amount of net income attributable to a
contribution distributed pursuant to sec-
tion 408(d)(4). The old method bases the
calculation of the amount of net income
attributable to a contribution on the in-
come earned by the IRA during the period
beginning on the first day of the taxable
year in which the contribution is made and
ending on the date of the distribution from
the account. Under the old method, net
income cannot be negative.
Section 1.408A–5, A-2(c), provides
that if a contribution being recharacterized
is in an IRA that at any time contained
other contributions, the net income attrib-
utable to the contribution being recharac-
terized is calculated in the manner
prescribed by§1.408–4(c)(2)(ii) (the old
method), except that net income can be
negative. Section 1.408A–5, A–2(b), pro-
vides that if an IRA is established with a
contribution and no other contributions or
distributions are made, then the subse-
quent recharacterization transfer of the
entire account balance of the IRA will
satisfy the requirement that the transfer be
accompanied by any net income allocable
to the contribution.
In connection with issuing the regula-
tions under section 408A governing Roth
IRAs, it became apparent that the old
method produced anomalous results for
contributions made late in the year. This is
because, under the old method, account
activity in the part of the year that pre-
cedes the date the contribution is made is
taken into account in the calculation of the
net income attributable to the contribution.
In response to this concern, the IRS
issued Notice 2000–39, 2000–2 C.B. 132,
which provided a new method for calcu-
lating net income that generally bases the
calculation of the amount of net income
attributable to a contribution on the actual
earnings and losses of the IRA during the
time it held the contribution. Under this
new method, net income can be negative.
Notice 2000–39 provided that until further
guidance is issued, either the old method
or the new method may be used to calcu-
late net income. Notice 2000–39 also re-
quested comments regarding the new
method.
The Service received comments on the
new method which were generally favor-
able. However, commentators provided a
number of suggestions for improving the
method, including: (1) allowing a single
2002–33 I.R.B.383August 19, 2002

computation period to be used in the case
of multiple IRA contributions; (2) clarify-
ing how transfers in or out of IRAs are
treated under the new method; and (3)
allowing net income to be determined on
the basis of tracing specific assets, rather
than dollar amounts. This last suggestion
was focused primarily on the calculation
of net income in the case of a recharacter-
ization back to a traditional IRA following
a conversion of an amount in a traditional
IRA to a Roth IRA.
Explanation of Provisions
New Method for Net Income Calcula-
tion Under Section 408(d)(4)
These proposed regulations would in-
corporate, with certain modifications, the
new method provided in Notice 2000–39.
Under the proposed regulations, for pur-
poses of returned contributions under sec-
tion 408(d)(4), the net income attributable
to a contribution is determined by allocat-
ing to the contribution apro-rataportion
of the net income on the assets in the IRA
(whether positive or negative) during the
period the IRA held the contribution. This
new method is represented by the follow-
ing formula:
Net Income = Contribution x (Adjusted Closing Balance - Adjusted Opening Balance)
Adjusted Opening Balance
Under this formula, the opening bal-
ance is the fair market value of the IRA
immediately before the contribution being
returned is made to the account and the
closing balance is the fair market value of
the account immediately before the con-
tribution is removed. The opening balance
then is adjusted to include the amount of
any contributions or transfers made to the
IRA during the computation period. In
addition, the closing balance is adjusted to
include the amount of any distributions or
transfers made from the IRA during the
computation period. In the case of an IRA
that has received more than one regular
contribution for a particular taxable year,
the last regular contribution made to the
IRA for the year is deemed to be the
contribution that is distributed as a re-
turnedcontributionundersection
408(d)(4), up to the amount of the contri-
bution identified by the IRA owner as the
amount distributed as a returned contribu-
tion.
In response to comments received, the
proposed regulations would clarify that a
transfer made in or out of an IRA during
the computation period is treated in the
same manner as a contribution or distribu-
tion made to or from the IRA. The pro-
posed regulations also provide that a
single computation period is used if more
than one contribution was made to the
IRA as a regular contribution.
New Method for Net Income Calculation
Under Section 408A(d)(6)
The proposed regulations would pro-
vide rules for calculating net income
allocable to a contribution being recharac-
terized under section 408A(d)(6) that are
substantially similar to the rules appli-
cable to contributions being returned un-
der section 408(d)(4). However, if more
than one contribution is being recharacter-
ized, different rules apply. In the case of
multiple contributions for a particular year
that are eligible for recharacterization, the
IRA owner chooses (by date and dollar
amount, not by specific assets acquired
with those dollars) which contribution is
to be recharacterized. In addition, if a
series of regular contributions was made,
and consecutive contributions in that se-
ries are being recharacterized, the compu-
tation period is determined using a single
computation period, based on the first
contribution in the series.
The proposed regulations would retain
the rule that net income calculations must
be based on the overall value of an IRA
and the dollar amounts contributed, dis-
tributed or recharacterized to or from the
IRA. Even in a recharacterization of an
amount converted to a Roth IRA, the
proposed regulations would not permit net
income to be calculated on the basis of the
return on specific assets. The dollars con-
tributed to an IRA are invested in assets
that generate gains and losses. Once con-
tributions are commingled in an account,
those dollars are no longer associated with
particular assets. In the absence of main-
taining separate accounts, tying particular
assets to a particular contribution would
create administrative problems for taxpay-
ers, IRA providers and the IRS.
Proposed Effective Date
The regulations are proposed to be
applicable for calculating income allo-
cable to IRA contributions made on or
after January 1, 2004. For purposes of
determining net income applicable to IRA
contributions made during 2002 and 2003,
taxpayers may continue to apply the rules
set forth in Notice 2000–39 or may rely on
these proposed regulations. If, and to the
extent, future guidance is more restrictive
than these proposed regulations, the future
guidance will be issued without retroac-
tive effect.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Ex-
ecutiveOrder12866.Therefore,a
regulatory 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
theseregulations.Becauseproposed
§1.408–11 and revised A–2(c) of
§1.408A–5 impose no new collection of
information on small entities, a Regula-
tory Flexibility Analysis under the Regu-
latory Flexibility Act (5 U.S.C. chapter 6)
is not required. Pursuant to section 7805(f)
of the Internal Revenue Code, this notice
of proposed rulemaking will be submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on its impact on small business.
Comments and Request for a Public
Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written comments (a
signed original and eight (8) copies) that
August 19, 20023842002–33 I.R.B.

are submitted timely to the IRS. All com-
ments will be available for public inspec-
tion and copying.
A public hearing may be scheduled if
requested in writing by a person that
timely submits written comments. If a
public hearing is scheduled, notice of the
date, time and place for the hearing will be
published in theFederal Register.
Drafting Information
The principal author of these regula-
tions is Cathy A. Vohs of the Office of the
Division Counsel/Associate Chief Coun-
sel (Tax Exempt and Government Enti-
ties). However, other personnel from the
IRS and Treasury participated in their
development.
*****
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PA RT 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding entries in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805***
§1.408–4 also issued under 26 U.S.C.
408.
§1.408–11 also issued under 26 U.S.C.
408.***
Par. 2. Section 1.408–4 is amended by
adding the following text before the first
sentence of (c)(1):
§1.408–4 Treatment of distributions
from individual retirement arrangements.
*****
(c)***(1)***
The rules in this paragraph (c) apply
for purposes of determining net income
attributable to IRA contributions made
before January 1, 2004, and returned pur-
suant to section 408(d)(4). The rules in
§1.408–11 apply for purposes of deter-
mining net income attributable to IRA
contributions made on or after January 1,
2004, and returned pursuant to section
408(d)(4).
*****
Par. 3. Section 1.408–11 is added to
read as follows:
§1.408–11 Net income calculation for
returned or recharacterized IRA
contributions.
(a)Net income calculation for re-
turned IRA contributions—(1)General
rule.For purposes of returned contribu-
tions under section 408(d)(4), the net in-
come attributable to a contribution made
to an IRA is determined by allocating to
the contribution apro-rataportion of the
earnings on the assets in the IRA during
the period the IRA held the contribution.
This attributable net income is calculated
by using the following formula:
Net Income = Contribution x (Adjusted Closing Balance - Adjusted Opening Balance
Adjusted Opening Balance
(2)Special rule. If an IRA is estab-
lished with a contribution and no other
contributions, distributions or transfers are
made to or from that IRA, then the subse-
quent distribution of the entire account
balance of the IRA pursuant to section
408(d)(4) will satisfy the requirement of
that Code section that the return of a
contribution be accompanied by the
amount of net income attributable to the
contribution.
(b)Definitions.For purposes of this
section the following definitions apply—
(1)Adjusted opening balance.The
term adjusted opening balance means the
fair market value of the IRA at the begin-
ning of the computation period plus the
amount of any contributions or transfers
(including the contribution that is distrib-
uted as a returned contribution pursuant to
section 408(d)(4) and recharacterizations
of contributions pursuant to section
408A(d)(6)) made to the IRA during the
computation period.
(2)Adjusted closing balance.The term
adjusted closing balance means the fair
market value of the IRA at the end of the
computation period plus the amount of
any distributions or transfers (including
recharacterizations of contributions pursu-
ant to section 408A(d)(6)) made from the
IRA during the computation period.
(3)Computation period.The term
computation period means the period be-
ginning immediately prior to the time that
the contribution being returned was made
to the IRA and ending immediately prior
to the removal of the contribution. If more
than one contribution was made as a
regular contribution and is being returned
from the IRA, the computation period
begins immediately prior to the time the
first contribution being returned was con-
tributed.
(4)Regular contribution.The term
regular contribution means an IRA contri-
bution made by the IRA owner that is
neither a trustee-to-trustee transfer from
another IRA nor a rollover from another
IRA or retirement plan.
(c)Additional rules—(1) When an
IRA asset is not normally valued on a
daily basis, the fair market value of the
asset at the beginning of the computation
period is deemed to be the most recent,
regularly determined, fair market value of
the asset, determined as of a date that
coincides with or precedes the first day of
the computation period. In addition, solely
for purposes of this section, notwithstand-
ing A–3of§1.408A–5, recharacterized
contributions are taken into account for
the period they are actually held in a
particular IRA.
(2) In the case of an IRA that has
received more than one regular contribu-
tion for a particular taxable year, the last
regular contribution made to the IRA for
the year is deemed to be the contribution
that is distributed as a returned contribu-
tion under section 408(d)(4), up to the
amount of the contribution identified by
the IRA owner as the amount distributed
as a returned contribution.
(3) In the case of an individual who
owns multiple IRAs, the net income cal-
culation is performed only on the IRA
containing the contribution being re-
turned, and that IRA is the IRA that must
distribute the contribution.
(d)Examples.The following examples
illustrate the net income calculation under
section 408(d)(4) and this section:
Example 1.(i) On May 1, 2004, when her IRA
is worth $4,800, Taxpayer A makes a $1,600 regular
contribution to her IRA. Taxpayer A requests that
$400 of the May 1, 2004, contribution be returned to
her pursuant to section 408(d)(4). Pursuant to this
request, on February 1, 2005, when the IRA is worth
$7,600, the IRA trustee distributes to Taxpayer A the
2002–33 I.R.B.385August 19, 2002

$400 plus attributable net income. During this time,
no other contributions have been made to the IRA
and no distributions have been made.
(ii) The adjusted opening balance is $6,400
[$4,800 + $1,600] and the adjusted closing balance is
$7,600. Thus, the net income attributable to the $400
May 1, 2004, contribution is $75 [$400 x ($7,600 -
$6,400)÷$6,400]. Therefore, the total to be distrib-
uted on February 1, 2005, pursuant to§408(d)(4) is
$475.
Example 2.(i) Beginning in January 2004,
Taxpayer B contributes $300 on the 15th of each
month to an IRA for 2004, resulting in an excess
regular contribution of $600 for that year. Taxpayer
B requests that the $600 excess regular contribution
be returned to her pursuant to section 408(d)(4).
Pursuant to this request, on March 1, 2005, when the
IRA is worth $16,000, the IRA trustee distributes to
Taxpayer B the $600 plus attributable net income.
The excess regular contributions to be returned are
deemed to be the last two made in 2004: the $300
December 15 contribution and the $300 November
15 contribution. On November 15 the IRA was worth
$11,000 immediately prior to the contribution. No
distributions or transfers have been made from the
IRA and no contributions or transfers, other than the
monthly contributions (including $300 in January
and February 2005), have been made.
(ii) As of the beginning of the computation
period (November 15), the adjusted opening balance
is $12,200 [$11,000 + $300 + $300 + $300 + $300]
and the adjusted closing balance is $16,000. Thus,
the net income attributable to the excess regular
contributions is $187 [$600 x ($16,000 - $12,200)÷
12,200]. Therefore, the total to be distributed as
returned contributions on March 1, 2005, to correct
the excess regular contribution is $787 [$600 +
$187].
Par.4.In§1.408A–5, A–2(c) is re-
vised to read as follows:
§1.408A–5 Recharacterized
contributions.
*****
A-2.***
(c) (1) If paragraph (b) of this A–2
does not apply, then, for purposes of
determining net income attributable to
IRA contributions, the net income attrib-
utable to the amount of a contribution is
determined by allocating to the contribu-
tion apro-rataportion of the earnings on
the assets in the IRA during the period the
IRA held the contribution. This attribut-
able net income is calculated by using the
following formula:
Net Income = Contribution x (Adjusted Closing Balance - Adjusted Opening Balance)
Adjusted Opening Balance
(2) For purposes of this paragraph (c),
the following definitions apply—
(i) The term adjusted opening balance
means the fair market value of the IRA at
the beginning of the computation period
plus the amount of any contributions or
transfers (including the contribution that is
being recharacterized pursuant to section
408A(d)(6) and any other recharacteriza-
tions) made to the IRA during the compu-
tation period.
(ii) The term adjusted closing balance
means the fair market value of the IRA at
the end of the computation period plus the
amount of any distributions or transfers
(including contributions returned pursuant
to section 408(d)(4) and recharacteriza-
tions of contributions pursuant to section
408A(d)(6)) made from the IRA during
the computation period.
(iii) The term computation period
means the period beginning immediately
prior to the time the particular contribu-
tion being recharacterized is made to the
IRA and ending immediately prior to the
recharacterizing transfer of the contribu-
tion. If a series of regular contributions
was made to the IRA, and consecutive
contributions in that series are being re-
characterized, the computation period be-
gins immediately prior to the time the first
of the regular contributions being rechar-
acterized was made.
(3) When an IRA asset is not normally
valued on a daily basis, the fair market
value of the asset at the beginning of the
computation period is deemed to be the
most recent, regularly determined, fair
market value of the asset, determined as of
a date that coincides with or precedes the
first day of the computation period. In
addition, solely for purposes of this para-
graph (c), notwithstanding A–3 of this
section, recharacterized contributions are
taken into account for the period they are
actually held in a particular IRA.
(4) In the case of an individual with
multiple IRAs, the net income calculation
is performed only on the IRA containing
the particular contribution to be recharac-
terized, and that IRA is the IRA from
which the recharacterizing transfer must
be made.
(5) In the case of multiple contribu-
tions made to an IRA for a particular year
that are eligible for recharacterization, the
IRA owner can choose (by date and by
dollar amount, not by specific assets ac-
quired with those dollars) which contribu-
tion, or portion thereof, is to be
recharacterized.
(6) The following examples illustrate
the net income calculation under section
408A(d)(6) and this paragraph:
Example 1. (i) On March 1, 2004, when her
Roth IRA is worth $80,000, Taxpayer A makes a
$160,000 conversion contribution to the Roth IRA.
Subsequently, Taxpayer A discovers that she was
ineligible to make a Roth conversion contribution in
2004 and so she requests that the $160,000 be
recharacterized to a traditional IRA pursuant to
section 408A(d)(6). Pursuant to this request, on
March 1, 2005, when the IRA is worth $225,000, the
Roth IRA trustee transfers to a traditional IRA the
$160,000 plus allocable net income. No other con-
tributions have been made to the Roth IRA and no
distributions have been made.
(ii) The adjusted opening balance is $240,000
[$80,000 + $160,000] and the adjusted closing bal-
ance is $225,000. Thus the net income allocable to
the $160,000 is -$10,000 [$160,000 x ($225,000 -
$240,000)÷$240,000]. Therefore, in order to rechar-
acterize the March 1, 2004, $160,000 conversion
contribution on March 1, 2005, the Roth IRA trustee
must transfer from Taxpayer A’s Roth IRA to her
traditional IRA $150,000 [$160,000 - $10,000].
Example 2.(i) On April 1, 2004, when her
traditional IRA is worth $100,000, Taxpayer B con-
verts the entire amount, consisting of 100 shares of
stock in ABC Corp. and 100 shares of stock in XYZ
Corp., by transferring the shares to a Roth IRA. At
the time of the conversion, the 100 shares of stock in
ABC Corp. are worth $50,000 and the 100 shares of
stock in XYZ Corp. are also worth $50,000. Tax-
payer B decides that she would like to recharacterize
the ABC Corp. shares back to a traditional IRA.
However, B may choose only by dollar amount the
contribution or portion thereof that is to be rechar-
acterized. On the date of transfer, November 1, 2004,
the 100 shares of stock in ABC Corp. are worth
$40,000 and the 100 shares of stock in XYZ Corp.
are worth $70,000. No other contributions have been
made to the Roth IRA and no distributions have been
made.
(ii) If B requests that $50,000 (which was the
value of the ABC Corp. shares at the time of
conversion) be recharacterized, the net income allo-
cable to the $50,000 is $5,000 [$50,000 x ($110,000
- $100,000)÷$100,000]. Therefore, in order to
recharacterize $50,000 of the April 1, 2004, conver-
sion contribution on November 1, 2004, the Roth
August 19, 20023862002–33 I.R.B.

IRA trustee must transfer from Taxpayer B’s Roth
IRA to a traditional IRA assets with a value of
$55,000 [$50,000 + $5,000].
(iii) If, on the other hand, B requests that
$40,000 (which was the value of the ABC Corp.
shares on November 1) be recharacterized, the net
income allocable to the $40,000 is $4,000 [$40,000 x
($110,000 - $100,000)÷$100,000]. Therefore, in
order to recharacterize $40,000 of the April 1, 2004,
conversion contribution on November 1, 2004, the
Roth IRA trustee must transfer from Taxpayer B’s
Roth IRA to a traditional IRA assets with a value of
$44,000 [$40,000 + $4,000].
(iv) Regardless of the amount of the contribu-
tion recharacterized, the determination of that
amount (or of the net income allocable thereto) is not
affected by whether the recharacterization is accom-
plished by the transfer of shares of ABC Corp. or of
shares of XYZ Corp.
(7) This paragraph (c) applies for pur-
poses of determining net income attribut-
able to IRA contributions, made on or
after January 1, 2004. For purposes of
determining net income attributable to
IRA contributions made before January 1,
2004, see paragraph (c) of this A–2of
§1.408A–5 (as it appeared in the April 1,
2003, edition of 26 CFR part 1).
*****
David A. Mader,
Acting Deputy Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on July
22, 2002, 8:45 a.m., and published in the issue of the
Federal Register for July 23, 2002, 67 F.R. 48067)
Supplement to Publication
590,Individual Retirement
Arrangements (IRAs)
Announcement 2002–73
A supplement to Publication 590 is
available from the Internal Revenue Ser-
vice. This supplement contains new life
expectancy and uniform lifetime tables.
These tables are used in figuring required
minimum distributions.
You can get a copy of this supplement
by calling 1–800–TA X–FORM (1–800–
829–3676). You can also write the IRS
Distribution Center nearest you. Check
your income tax package for the address.
The publication is also available on the
IRS Internet web site atwww.irs.gov
New Revision of Publication
971,Innocent Spouse Relief
(And Separation of Liability
and Equitable Relief)
Announcement 2002–74
Publication 971, revised June 2002, is
now available from the Internal Revenue
Service. It replaces the April 2000 revi-
sion.
This publication discusses the inno-
cent spouse relief initiatives that protect
taxpayers whose spouses violate the tax
laws without their knowledge.
You can get a copy of this publication
by calling 1–800–TAX-FORM (1–800–
829–3676). You can also write the IRS
Forms Distribution Center nearest you.
Check your income tax package for the
address. The publication is also available
on the IRS web site atwww.irs.gov.
2002–33 I.R.B.387August 19, 2002

Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as“rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplifieddescribes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus, if
an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
withmodified, below).
Clarifiedis used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
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 pub-
lished position. (Compare withamplified
andclarified, 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
rulings that are obsoleted because of
changes in law or regulations. A ruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.
Revokeddescribes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.
Supersededdescribes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a
period of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example,modified
andsupersededdescribes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case,
the previously published ruling is first
modified and then, as modified, is super-
seded.
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
ruling has been supplemented several
times, a new ruling may be published that
includes the list in the original ruling and
the additions, and supersedes all prior rul-
ings in the series.
Suspendedis used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current
use and formerly used will appear in
material published in the Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
August 19, 2002i2002–33 I.R.B.

Numerical Finding List
1
Bulletin 2002–26 through 2002–32
Announcements:
2002–59, 2002–26 I.R.B.28
2002–60, 2002–26 I.R.B.28
2002–61, 2002–27 I.R.B.72
2002–62, 2002–27 I.R.B.72
2002–63, 2002–27 I.R.B.72
2002–64, 2002–27 I.R.B.72
2002–65, 2002–29 I.R.B.182
2002–66, 2002–29 I.R.B.183
2002–67, 2002–30 I.R.B.237
2002–68, 2002–31 I.R.B.283
2002–69, 2002–31 I.R.B.283
2002–70, 2002–31 I.R.B.284
2002–71, 2002–32 I.R.B.323
2002–72, 2002–32 I.R.B.323
Notices:
2002–42, 2002–27 I.R.B.36
2002–43, 2002–27 I.R.B.38
2002–44, 2002–27 I.R.B.39
2002–45, 2002–28, I.R.B.93
2002–46, 2002–28 I.R.B.96
2002–47, 2002–28 I.R.B.97
2002–48, 2002–29 I.R.B.130
2002–49, 2002–29 I.R.B.130
2002–50, 2002–28 I.R.B.98
2002–51, 2002–29 I.R.B.131
2002–52, 2002–30 I.R.B.187
2002–53, 2002–30 I.R.B.187
2002–54, 2002–30 I.R.B.189
2002–56, 2002–32 I.R.B.319
Proposed Regulations:
REG–248110–96, 2002–26 I.R.B.19
REG–110311–98, 2002–28 I.R.B.109
REG–103823–99, 2002–27 I.R.B.44
REG–103829–99, 2002–27 I.R.B.59
REG–103735–00, 2002–28 I.R.B.109
REG–106457–00, 2002–26 I.R.B.23
REG–106871–00, 2002–30 I.R.B.190
REG–107524–00, 2002–28 I.R.B.110
REG–115285–01, 2002–27 I.R.B.62
REG–116644–01, 2002–31 I.R.B.268
REG–123345–01, 2002–32 I.R.B.321
REG–126024–01, 2002–27 I.R.B.64
REG–164754–01, 2002–30 I.R.B.212
REG–165868–01, 2002–31 I.R.B.270
REG–122564–02, 2002–26 I.R.B.25
REG–123305–02, 2002–26 I.R.B.26
Revenue Procedures:
2002–43, 2002–28 I.R.B.99
2002–44, 2002–26 I.R.B.10
2002–45, 2002–27 I.R.B.40
2002–46, 2002–28 I.R.B.105
2002–47, 2002–29 I.R.B.133
2002–49, 2002–29 I.R.B.172
2002–50, 2002–29 I.R.B.173
Revenue Procedures.—Continued
2002–51, 2002–29 I.R.B.175
2002–52, 2002–31 I.R.B.242
2002–53, 2002–31 I.R.B.253
Revenue Rulings:
2002–38, 2002–26 I.R.B.4
2002–39, 2002–27 I.R.B.33
2002–40, 2002–27 I.R.B.30
2002–41, 2002–28 I.R.B.75
2002–42, 2002–28 I.R.B.76
2002–43, 2002–28 I.R.B.85
2002–44, 2002–28 I.R.B.84
2002–45, 2002–29 I.R.B.116
2002–46, 2002–29 I.R.B.117
2002–47, 2002–29 I.R.B.119
2002–48, 2002–31 I.R.B.239
2002–49, 2002–32 I.R.B.288
2002–50, 2002–32 I.R.B.292
Treasury Decisions:
8997, 2002–26 I.R.B.6
8998, 2002–26 I.R.B.1
8999, 2002–28 I.R.B.78
9000, 2002–28 I.R.B.87
9001, 2002–29 I.R.B.128
9002, 2002–29 I.R.B.120
9003, 2002–32 I.R.B.294
9005, 2002–32 I.R.B.290
9006, 2002–32 I.R.B.315
1
A cumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 2002–1 through 2002–25 is
in Internal Revenue Bulletin 2002–26, dated July 1, 2002.
2002–33 I.R.B.iiAugust 19, 2002

Finding List of Current Actions
on Previously Published Items
1
Bulletin 2002–26 through 2002–32
Announcements:
98–99
Superseded by
Rev. Proc. 2002–44, 2002–26 I.R.B.10
2000–4
Modified by
Ann. 2002–60, 2002–26 I.R.B.28
2001–9
Superseded by
Rev. Proc. 2002–44, 2002–26 I.R.B.10
Proposed Regulations:
REG–209114–90
Corrected by
Ann. 2002–65, 2002–29 I.R.B.182
REG–209813–96
Withdrawn by
REG–106871–00, 2002–30 I.R.B.190
REG–103823–99
Corrected by
Ann. 2002–67, 2002–30 I.R.B.237
REG–105885–99
Corrected by
Ann. 2002–67, 2002–30 I.R.B.237
REG–105369–00
Clarified by
Notice 2002–52, 2002–30 I.R.B.187
Corrected by
Ann. 2002–67, 2002–30 I.R.B.237
REG–118861–00
Corrected by
Ann. 2002–67, 2002–30 I.R.B.237
REG–136193–01
Corrected by
Ann. 2002–67, 2002–30 I.R.B.237
REG–161424–01
Corrected by
Ann. 2002–67, 2002–30 I.R.B.237
REG–165706–01
Corrected by
Ann. 2002–67, 2002–30 I.R.B.237
REG–102740–02
Corrected by
Ann. 2002–67, 2002–30 I.R.B.237
REG–123305–02
Corrected by
Ann. 2002–69, 2002–31 I.R.B.283
Revenue Procedures:
91–23
Modified and superseded by
Rev. Proc. 2002–52, 2002–31 I.R.B.242
91–26
Modified and superseded by
Rev. Proc. 2002–52, 2002–31 I.R.B.242
95–18
Superseded by
Rev. Proc. 2002–51, 2002–29 I.R.B.175
96–13
Modified and superseded by
Rev. Proc. 2002–52, 2002–31 I.R.B.242
96–14
Modified and superseded by
Rev. Proc. 2002–52, 2002–31 I.R.B.242
96–53
Amplified by
Rev. Proc. 2002–52, 2002–31 I.R.B.242
2001–17
Modified and superseded by
Rev. Proc. 2002–47, 2002–29 I.R.B.133
2001–26
Superseded by
Rev. Proc. 2002–53, 2002–31 I.R.B.253
2002–9
Modified and amplified by
Rev. Proc. 2002–46, 2002–28 I.R.B.105
2002–13
Modified by
Rev. Proc. 2002–45, 2002–27 I.R.B.40
Revenue Rulings:
69–259
Modified and superseded by
Rev. Rul. 2002–50, 2002–32 I.R.B.292
92–17
Amplified by
Rev. Rul. 2002–49, 2002–32 I.R.B.288
92–75
Clarified by
Rev. Proc. 2002–52, 2002–31 I.R.B.242
94–76
Amplified by
Rev. Rul. 2002–42, 2002–28 I.R.B.76
Treasury Decisions:
8997
Corrected by
Ann. 2002–68, 2002–31 I.R.B.283
8999
Corrected by
Ann. 2002–71, 2002–32 I.R.B.323
1
A cumulative list of current actions on previously published
items in Internal Revenue Bulletins 2002–1 through 2002–25 is
in Internal Revenue Bulletin 2002–26, dated July 1, 2002.
August 19, 2002iii2002–33 I.R.B.

This page is reserved for Adriana Rojas.
2002–33 I.R.B.August 19, 2002

This page is reserved for Zachary Rodriguez.
August 19, 20022002–33 I.R.B.