Internal Revenue Bulletin 1998-3 (PDF rendition): IRS Revenue Procedures

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

EMPLOYEE PLANS
Notice 98–1, page 42.
Nondiscrimination testing; section 401(k) and section
401(m). This notice describes nondiscrimination testing with
respect to cash or deferred arrangements under section
401(k) as well as employer matching and employee contribu-
tions under section 401(m) of the Code.
EXCISE TAX
T.D. 8740, page 4.
REG–102894–97, page 59.
Temporary and proposed regulations under section 6302 of
the Code relate to the availability of the safe harbor deposit
rule based on look-back quarter liability and affect persons
required to make deposits of excise taxes.
T.D. 8741, page 6.
REG–109704–97, page 60.
Temporary and proposed regulations under section 9812 of
the Code relate to mental health parity requirements im-
posed on group health plans.
ADMINISTRATIVE
Rev. Proc. 98–9, page 56.
This procedure sets forth the maximum face amount of
Qualified Zone Academy Bonds that may be issued for each
state in 1998. For this purpose, “state” includes the District of
Columbia and the possessions of the United States.
Notice 98–3, page 48.
Elections under section 7704(g). This notice provides the
requirements for making and revoking an election under sec-
tion 7704(g) of the Code. This election allows grandfathered
publicly traded partnerships to avoid being treated as corpora-
tions for federal tax purposes.
Notice 98–5, page 49.
Foreign tax credit abuse. Treasury and the Service expect to
issue regulations that will disallow foreign tax credits for foreign
taxes paid or accrued in connection with certain abusive trans-
actions.
Notice 98–6, page 52.
Notice on section 685. Guidance is provided on Qualified
Funeral Trust (QFT) eligibility requirements, election procedures,
and simplified reporting requirements.
Notice 98–7, page 54.
Information reporting; interest on education loans. Pay-
ees of interest that may be deductible by the payor as qualified
education loan interest are informed of their information report-
ing requirements for 1998 under section 6050S of the Code,
as added by the Taxpayer Relief Act of 1997.
Internal Revenue
bbuulllleettiinn
Bulletin No. 1998–3
January 20, 1998
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
Department of the Treasury
Internal Revenue Service
Finding Lists begin on page 63.

Mission of the Service
The purpose of the Internal Revenue Service is to collect
the proper amount of tax revenue at the least cost; serve
the public by continually improving the quality of our prod-
ucts and services; and perform in a manner warranting
the highest degree of public confidence in our integrity, effi-
ciency, and fairness.
2
Statement of Principles
of Internal Revenue
Tax Administration
The function of the Internal Revenue Service is to adminis-
ter the Internal Revenue Code. Tax policy for raising revenue
is determined by Congress.
With this in mind, it is the duty of the Service to carry out that
policy by correctly applying the laws enacted by Congress;
to determine the reasonable meaning of various Code provi-
sions in light of the Congressional purpose in enacting them;
and to perform this work in a fair and impartial manner, with
neither a government nor a taxpayer point of view.
At the heart of administration is interpretation of the Code. It
is the responsibility of each person in the Service, charged
with the duty of interpreting the law, to try to find the true
meaning of the statutory provision and not to adopt a
strained construction in the belief that he or she is “protect-
ing the revenue.” The revenue is properly protected only
when we ascertain and apply the true meaning of the statute.
The Service also has the responsibility of applying and
administering the law in a reasonable, practical manner.
Issues should only be raised by examining officers when
they have merit, never arbitrarily or for trading purposes.
At the same time, the examining officer should never hesi-
tate to raise a meritorious issue. It is also important that
care be exercised not to raise an issue or to ask a court to
adopt a position inconsistent with an established Service
position.
Administration should be both reasonable and vigorous. It
should be conducted with as little delay as possible and
with great courtesy and considerateness. It should never
try to overreach, and should be reasonable within the
bounds of law and sound administration. It should, howev-
er, be vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax devices and
fraud.

The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing offi-
cial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents of a permanent nature are consoli-
dated semiannually into Cumulative Bulletins, which are sold
on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of in-
ternal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Service
personnel in the disposition of other cases. In applying pub-
lished rulings and procedures, the effect of subsequent leg-
islation, regulations, court decisions, rulings, and proce-
dures must be considered, and Service personnel and oth-
ers concerned are cautioned against reaching the same con-
clusions in other cases unless the facts and circumstances
are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Sub-
parts. Also included in this part are Bank Secrecy Act Admin-
istrative Rulings. Bank Secrecy Act Administrative Rulings
are issued by the Department of the Treasury’s Office of the
Assistant Secretary (Enforcement).
Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemaking
and the disbarment and suspension list included in this part,
none of these announcements are consolidated in the Cumu-
lative Bulletins.
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 quarterly and
semiannual basis, and are published in the first Bulletin of the
succeeding quarterly and semiannual period, respectively.
3
Introduction
The contents of this publication are not copyrighted and may be reprinted freely. Acitation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

Section 901.—Taxes of Foreign
Countries and of Possessions of
United States
Guidance is provided as to whether a foreign tax
credit is allowed with respect to foreign taxes paid
or accrued in connection with certain abusive trans-
actions. See Notice 98–5, page 49.
Section 1397E.—Credit to
Holders of Qualified Zone
Academy Bonds
What is the 1998 qualified zone academy bond
national limitation for each State, the District of Co-
lumbia, and the possessions of the United States?
See Rev. Proc. 98–9, page 56.
Section 6011.—General
Requirement of Return,
Statement, or List
26 CFR 301.6011–2T: Required use of magnetic
media (temporary).
What information reporting requirements apply
to payees of education loan interest for 1998 under
§ 6050S of the Code, as added by the Taxpayer Re-
lief Act of 1997. See Notice 98–7, page 54.
Section 6050H.—Returns
Relating to Mortgage Interest
Received in Trade or Business
From Individuals
26 CFR 1.6050H–1: Information reporting of
mortgage interest received in a trade or business
from an individual.
What information reporting requirements apply
to payees of education loan interest for 1998 (in-
cluding those secured by real property) under
§ 6050S of the Code, as added by the Taxpayer Re-
lief Act of 1997. See Notice 98–7, page 54.
Section 6302.—Mode or Time
of Collection
26 CFR 40.6302(c)–1T: Use of government
depositaries (temporary).
T.D. 8740
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 40
Deposits of Excise Taxes
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Temporary regulations.
SUMMARY: This document contains
temporary regulations relating to the
availability of the safe harbor deposit rule
based on look-back quarter liability and
affects persons required to make deposits
of excise taxes. This document also con-
tains temporary regulations relating to
floor stocks taxes and affects persons li-
able for those taxes. The regulations im-
plement certain changes made by the
Small Business Job Protection Act of
1996 (the 1996 Act) and the Airport and
Airway Trust Fund Tax Reinstatement
Act of 1997 (the 1997 Act). The text of
these regulations also serves as the text of
REG–102894–97, page 59.
DATES: These regulations are effective
December 29, 1997. For dates of applica-
bility, see §§40.6302(c)–1Tand
40.6302(c)–2T.
FOR FURTHER INFORMATION CON-
TACT: Ruth Hoffman (202) 622-3130
(not a toll-free call).
SUPPLEMENTARYINFORMATION:
Background
This document contains amendments to
the Excise Tax Procedural Regulations
(26 CFR part 40) that implement certain
changes made by the 1996 Act and the
1997 Act.
The aviation excise taxes that expired
on December 31, 1995, were reinstated by
the 1996 Act for the period from August
27 through December 31, 1996, by the
1997 Act for the period from March 7
through September 30, 1997, and were
extended, with modifications, for the pe-
riod from October 1, 1997, through Sep-
tember 30, 2007.
Deposit Safe Harbor Rules
Sections 40.6302(c)–1(c)(2) and
40.6302(c)–2(b)(2) (relating to deposit
safe harbors) currently provide, generally,
that a person can satisfy excise tax deposit
obligations for a calendar quarter by de-
positing an amount equal to the person’s
excise tax liability reported on the return
for the second preceding quarter (the
look-back quarter). For this purpose, the
tax liability for the look-back quarter
must be modified to take into account any
increase in rates in the current quarter, but
the safe harbor does not specifically ad-
dress the effect of the enactment of a new
tax or the reinstatement of an expired tax.
Notice 97–15, 1997–8 I.R.B. 23, and sec-
tion 2(f) of the 1997 Act provide that the
look-back safe harbor shall not apply with
respect to any tax unless the tax was im-
posed throughout the look-back period.
The temporary regulations modify the
look-back safe harbor rules to reflect this
change. Under the temporary regulations,
the general look-back safe harbor of
§40.6302(c)–1(c)(2) is modified for a
class of tax that includes a tax that was
not in effect at all times during the look-
back quarter (or, in the case of an alterna-
tive method tax, that was not in effect at
all times during the look-back quarter and
the month preceding the look-back quar-
ter). The safe harbor does not apply to
that class of tax unless, for each semi-
monthly period, the deposit is not less
than the greater of (1) 1/6 of the net tax li-
ability reported for the class of tax for the
look-back quarter, or (2) the sum of (i) 95
percent of the net tax liability incurred
with respect to new or reinstated taxes
during the semimonthly period, and (ii)
1/6 of the net tax liability reported for all
other taxes in the class for the look-back
quarter. Also, the section 4681 tax
(ozone-depleting chemicals) look-back
safe harbor provided under §40.6302(c)–
2(b)(2) is modified in a similar manner if
the tax liability for the quarter includes li-
ability for any chemical that was not sub-
ject to tax at all times during the look-
back quarter.
The new rules apply to liabilities for
new or reinstated taxes incurred after Feb-
ruary 28, 1997.
Fuel Floor Stocks Taxes
Section 1609(h) of the 1996 Act im-
poses a floor stocks tax on aviation fuel
(other than gasoline) on which tax was im-
posed by section 4091 before August 27,
1996, and that is held on the first moment
January 20, 199841998–3 I.R.B.
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

of that date by any person. Section 2(d) of
the 1997 Act imposes a floor stocks tax on
aviation gasoline and aviation fuel (other
than gasoline) on which tax was imposed
by section 4081 or 4091 before March 7,
1997, and that is held on the first moment
of that date by any person.
The temporary regulations provide that
the rules set forth in 26 CFR part 40 (re-
lating to administrative provisions for cer-
tain excise taxes, including the excise
taxes on aviation fuels) also apply to re-
lated floor stocks taxes. Thus, persons li-
able for floor stocks taxes on aviation
fuels must file returns reporting those
taxes in accordance with the provisions of
26 CFR part 40.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regulatory
action as defined in EO 12866. 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
these regulations and, because these regu-
lations do not impose on small entities a
collection of information requirement, the
Regulatory Flexibility Act (5 U.S.C. chap-
ter 6) does not apply. Therefore, a Regula-
tory Flexibility Analysis is not required.
Pursuant to section 7805(f) of the Internal
Revenue Code, these temporary regula-
tions will be submitted to the Chief Coun-
sel for Advocacy of the Small Business
Administration for comment on their im-
pact on small business.
Drafting Information
The principal author of these regula-
tions is Ruth Hoffman, Office of Assistant
Chief Counsel (Passthroughs and Special
Industries). However, other personnel
from the IRS and Treasury Department
participated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 40 is
amended as follows:
PART40—EXCISE TAX
PROCEDURALREGULATIONS
Paragraph 1. The authority citation for
part 40 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 40.0–1Tis added to
read as follows:
§40.0–1TIntroduction (temporary).
(a) through (f). [Reserved]
(g) Applicability to floor stocks taxes.
The regulations in this part 40 also apply
with respect to floor stocks taxes imposed
on articles subject to a tax described in
§40.0–1(a), beginning April 1, 1991.
Par. 3. Section 40.6011(a)–1Tis added
to read as follows:
§40.6011(a)–1TReturns (temporary).
(a)(1) through (a)(2)(ii). [Reserved]
(a)(2)(iii) Floor stocks tax return.Are-
turn reporting liability for a floor stocks
tax described in §40.0–1T(g) is a return
for the calendar quarter in which the tax
payment is due and not for the calendar
quarter in which the liability for tax is in-
curred, beginning April 1, 1991.
Par. 4. Section 40.6302(c)–1Tis added
to read as follows:
§40.6302(c)–1TUse of Government
depositaries (temporary).
(a) through (c)(2)(iii). [Reserved]
(c)(2)(iv) Modification for new or rein-
stated taxes—(A) Applicability.The safe
harbor rule of §40.6302(c)–1(c)(2)(i) is
modified for any calendar quarter in
which a person’s liability for a class of tax
includes liability for any new or reinstated
tax. For this purpose, a new or reinstated
tax is—
(1) Any tax (including an alternative
method tax) that was not in effect at all
times during the look-back quarter; and
(2) Any alternative method tax that was
not in effect at all times during the month
preceding the look-back quarter.
(B) Modification. The safe harbor rule
of §40.6302(c)–1(c)(2)(i) does not apply
to a class of tax unless the deposit of taxes
in that class for each semimonthly period
in the calendar quarter is not less than the
greater of—
(1) 1/6 of the net tax liability reported
for the class of tax for the look-back quar-
ter; or
(2) The sum of—
(i) 95 percent of the net tax liability in-
curred with respect to new or reinstated
taxes during the semimonthly period; and
(ii) 1/6 of the net tax liability reported
for all other taxes in the class for the look-
back quarter.
(C) Effective date.This paragraph
(c)(2)(iv) applies to tax liabilities for new
or reinstated taxes incurred after February
28, 1997, except that paragraph (c)(2)(iv)-
(A)(2) of this section applies only for cal-
endar quarters beginning after December
31, 1997.
(c)(3) through (f)(4). [Reserved]
(f)(5) Taxes excluded; floor stocks
taxes.No deposit is required in the case
of any floor stocks tax described in
§40.0–1T(g), beginning April 1, 1991.
Par. 5. Section 40.6302(c)-2Tis added
to read as follows:
§40.6302(c)–2TSpecial rule for use of
Government depositaries under section
4681 (temporary).
(a) through (b)(2)(ii). [Reserved]
(b)(2)(iii) Modification for new chemi-
cals—(A) Applicability.The safe harbor
rule of §40.6302(c)–2(b)(2)(i) is modified
for any calendar quarter in which a per-
son’s liability for section 4681 tax includes
liability with respect to any new chemical.
For this purpose, a new chemical is any
chemical that was not subject to tax at all
times during the look-back quarter.
(B) Modification.The safe harbor rule
of §40.6302(c)–2(b)(2)(i) does not apply
unless the deposit of section 4681 taxes for
each semimonthly period in the calendar
quarter is not less than the greater of—
(1) 1/6 of the net tax liability reported
under section 4681 for the look-back
quarter; or
(2) The sum of—
(i) 95 percent of the net tax liability in-
curred under section 4681 with respect to
the new chemical during the semimonthly
period; and
(ii) 1/6 of the net tax liability reported
under section 4681 with respect to all
other chemicals for the look-back quarter.
(C) Effective date.This paragraph
(b)(2)(iii) applies to tax liabilities for new
chemicals incurred after February 28,
1997.
Michael P. Dolan,
Acting Commissioner of
Internal Revenue.
Approved November 6, 1997.
Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.
1998–3 I.R.B5January 20, 1998

January 20, 199861998–3 I.R.B.
(Filed by the Office of the Federal Register on De-
cember 24, 1997, 8:45 a.m., and published in the
issue of the Federal Register for December 29, 1997,
62 F.R. 67568)
Section 6721.—Failure to File
Correct Information Returns
26 CFR 301.6721–1: Failure to file correct
information returns.
What information reporting requirements apply
to payees of education loan interest for 1998 under
§ 6050S of the Code, as added by the Taxpayer Re-
lief Act in 1997. See Notice 98–7, page 54.
Section 6722.—Failure to
Furnish Correct Payee
Statements
26 CFR 301.6722–1: Failure to furnish correct
payee statements.
What information reporting requirements apply
to payees of education loan interest for 1998 under
§ 6050S of the Code, as added by the Taxpayer Re-
lief Act of 1997. See Notice 98–7, page 54.
Section 9812.—Parity in
Application of Certain Limits to
Mental Health Benefits
26 CFR 54.9812–1T: Parity in the application of
certain limits to mental health benefits (temporary).
T.D. 8741
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 54
DEPARTMENT OF LABOR
Pension and Welfare Benefits
Administration
29 CFR Part 2590
DEPARTMENT OF HEALTH AND
HUMAN SERVICES
Health Care Financing
Administration
45 CFR Part 146
Interim Rules for Mental Health
Parity
AGENCIES:Internal Revenue Service,
Department of the Treasury; Pension and
Welfare Benefits Administration, Depart-
ment of Labor; Health Care Financing
Administration, Department of Health
and Human Services.
ACTION:Interim rules with request for
comments.
SUMMARY:This document contains
interim rules governing parity between
medical/surgical benefits and mental
health benefits in group health plans and
health insurance coverage offered by
issuers in connection with a group health
plan. The rules contained in this docu-
ment implement changes made to certain
provisions of the Internal Revenue Code
of 1986 (Code), the Employee Retirement
Income Security Act of 1974 (ERISAor
Act), and the Public Health Service Act
(PHS Act) enacted as part of the Mental
Health Parity Act of 1996 (MHPA) and
the Taxpayer Relief Act of 1997.
Interested persons are invited to submit
comments on the interim rules for consid-
eration by the Department of the Treasury,
the Department of Labor, and the Depart-
ment of Health and Human Services
(Departments) in developing final rules.
The rules contained in this document are
being adopted on an interim basis to
ensure that sponsors and administrators of
group health plans, participants and bene-
ficiaries, States, and issuers of group
health insurance coverage have timely
guidance concerning compliance with the
requirements of MHPA.
DATES: Effective date.The interim
rules are effective January 1,1998.
Applicability dates. The requirements
of MHPAand the interim rules apply to
group health plans and health insurance
issuers offering health insurance cover-
age in connection with a group health
plan for plan years beginning on or after
January 1, 1998. MHPAincludes a sun-
set provision under which the MHPAre-
quirements do not apply to benefits for
services furnished on or after September
30, 2001.
Information collection.Affected parties
are not required to comply with the infor-
mation collection requirements in these
interim rules until the Departments pub-
lish in the Federal Register the control
numbers assigned to these information
collection requirements by the Office of
Management and Budget (OMB). Publi-
cation of the control numbers notifies the
public that OMB has approved these in-
formation collection requirements under
the Paperwork Reduction Act of 1995.
The Departments have submitted a copy
of this rule to OMB for its review of the
information collections. Interested per-
sons are invited to send comments regard-
ing these burdens or any other aspect of
these collections of information on or be-
fore February 23, 1998.
Comments. Written comments on these
interim rules are invited and must be re-
ceived by the Departments on or before
March 23, 1998.
ADDRESSES:Comments on the infor-
mation collection requirements should be
sent directly to:
Office of Information and Regulatory
Affairs
Office of Management and Budget
Room 10235
New Executive Office Building
Washington, DC 20503
Attention: HCFADesk Officer
Health Care Financing Administration
Office of Financial and Human
Resources
Management Planning and Analysis Staff
Room C2-26-17
7500 Security Boulevard
Baltimore, MD 21244-1850
Attention: John Burke
Written comments on other aspects of
the interim rules should be submitted with
a signed original and three copies (except
for electronic submissions sent to the In-
ternal Revenue Service (IRS)) to any of
the addresses specified below. For conve-
nience, comments may be addressed to
any of the Departments. Comments ad-
dressed to any Department will be shared
with the other Departments.
Comments to the IRS can be addressed
to:
CC:DOM:CORP:R (REG–109704–97)
Room 5228
Internal Revenue Service
POB 7604, Ben Franklin Station
Washington, DC 20044.
In the alternative, comments may be
hand-delivered between the hours of 8
a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG–109704–97)
Courier’s Desk
Internal Revenue Service

1998–3 I.R.B7January 20, 1998
1111 Constitution Avenue, NW
Washington DC 20224
Alternatively, taxpayers may transmit
comments electronically via the IRS In-
ternet site at: http://www.irs.ustreas.gov/
prod/tax_regs/comments.html
Comments to the Department of Labor
can be addressed to:
U.S. Department of Labor
Pension and Welfare Benefits
Administration
200 Constitution Avenue, NW
Room N-5669
Washington, DC 20210
Attention:MHPAComments
Alternatively, comments may be hand-de-
livered between the hours of 9 a.m. and 5
p.m. to the same address.
Comments to the Department of Health
and Human Services can be addressed to:
Health Care Financing Administration
Department of Health and Human
Services
Attention: HCFA-2891-IFC
P.O. Box 26688
Baltimore, MD 21207
In the alternative, comments may be
hand-delivered between the hours of 8:30
a.m. and 5:00 p.m. to either:
Room 309-G
Hubert Humphrey Building
200 Independence Avenue, SW
Washington, DC 20201
or
Room C5-09-26
7500 Security Boulevard
Baltimore, MD 21244-1850
All submissions to the Internal Rev-
enue Service will be open to public in-
spection and copying in Room 1621, 1111
Constitution Avenue, NW, Washington,
DC from 9:00 a.m. to 4:00 p.m.
All submissions to the Department of
Labor will be open to public inspection
and copying in the Public Documents
Room, Pension and Welfare Benefits Ad-
ministration, U.S. Department of Labor,
Room N-5638, 200 Constitution Avenue,
NW, Washington, DC from 8:30 a.m. to
5:30 p.m.
All submissions to the Department of
Health and Human Services will be open
to public inspection and copying in Room
309-G of the Department of Health and
Human Services offices at 200 Indepen-
dence Avenue, SW, Washington, DC from
8:30 a.m. to 5:00 p.m.
FOR FURTHER INFORMATION
CONTACT:Terese Klitenic, Health Care
Financing Administration, Department of
Health and Human Services, at (410) 786-
1565; Mark Connor, Pension and Welfare
Benefits Administration, Department of
Labor, at (202) 219-4377; or Russ Wein-
heimer, Internal Revenue Service, Depart-
ment of the Treasury, at (202) 622-4695.
Customer service information.Individ-
uals interested in obtaining a copy of the
Department of Labor’s booklet entitled
“Questions and Answers: Recent Changes
in Health Care Law,” which includes in-
formation on MHPA, may call the follow-
ing toll-free number: 1-800-998-7542.
SUPPLEMENTARY
INFORMATION:
A. Background
The Mental Health Parity Act of 1996
(MHPA) was enacted on September 26,
1996 (Pub. L. 104–204, 110 Stat. 2944).
MHPAamended the Employee Retire-
ment Income Security Act of 1974
(ERISA) and the Public Health Service
Act (PHS Act) to provide for parity in the
application of certain dollar limits on
mental health benefits with dollar limits
on medical/surgical benefits. Provisions
implementing MHPAwere later added to
the Internal Revenue Code of 1986
(Code) under the Taxpayer Relief Act of
1997 (Pub. L. 105–34).
1. Regulatory Responsibility
The provisions of MHPAare set forth
in Chapter 100 of Subtitle K of the Code,
Part 7 of Subtitle B of Title I of ERISA,
and Title XXVII of the PHS Act.
1
The
Secretaries of the Treasury, Labor, and
Health and Human Services share juris-
diction over the MHPAprovisions. These
provisions are substantially similar, ex-
cept as follows:
•The MHPAprovisions in the Code gener-
ally apply to all group health plans other
than governmental plans, but they do not
apply to health insurance issuers. Atax-
payer that fails to comply with these pro-
visions may be subject to an excise tax
under section 4980D of the Code.
•The MHPAprovisions in ERISAgener-
ally apply to all group health plans
other than governmental plans, church
plans, and certain other plans. These
provisions also apply to health insur-
ance issuers that offer health insurance
coverage in connection with such
group health plans. Generally, the Sec-
retary of Labor enforces the MHPA
provisions in ERISA, except that no
enforcement action may be taken by
the Secretary against issuers. How-
ever, individuals may generally pursue
actions against issuers under ERISA
and, in some circumstances, under
State law.
•The MHPAprovisions in the PHS Act
generally apply to health insurance is-
suers that offer health insurance cover-
age in connection with group health
plans and to certain State and local
governmental plans. States, in the first
instance, enforce the PHS Act with re-
spect to issuers. Only if a State does
not substantially enforce any provi-
sions under its insurance laws will the
Department of Health and Human Ser-
vices enforce the provisions, through
the imposition of civil money penalties.
Moreover, no enforcement action may
be taken by the Secretary of Health and
Human Services against any group
health plan except certain State and
local governmental plans.
The interim rules being issued today by
the Secretaries of the Treasury, Labor, and
Health and Human Services have been
developed on a coordinated basis by the
Departments. In addition, these interim
rules take into account comments re-
ceived by the Departments in response to
the request for public comments on
MHPApublished in the Federal Register
on June 26, 1997 (62 FR 34604). Except
to the extent needed to reflect the statu-
tory differences described above, the in-
terim rules of each Department are sub-
stantively identical. However, there are
certain non-substantive differences. The
interim rules reflect certain stylistic dif-
ferences in language and structure to con-
form to conventions used by a particular
Department. These differences have been
minimized and any differences in word-
1
Chapter 100 of Subtitle K of the Code, Part 7 of
Subtitle B of Title I of ERISA, and Title XXVII of
the PHS Act were added by the Health Insurance
Portability and Accountability Act of 1996 (HIPAA),
Pub. L. 104–191.

January 20, 199881998–3 I.R.B.
ing are not intended to create any substan-
tive difference.
2. Preemption of State Laws
The McCarran-Ferguson Act of 1945
(Pub. L. 79–15) exempts the business of
insurance from federal antitrust regulation
to the extent that it is regulated by the
States and indicates that no federal law
should be interpreted as overriding State
insurance regulation unless it does so ex-
plicitly. Section 514(a) of ERISApre-
empts State laws relating to employee
benefit plans (including group health
plans). Section 731 of ERISAand sec-
tion 2723 of the PHS Act provide that Part
7 of Subtitle B of Title I of ERISAand
Part Aof Title XXVII of the PHS Act (in-
cluding the MHPAprovisions) do not in
any way affect or modify section 514 of
ERISAwith respect to group health plans.
Section 514(b)(2) of ERISAsaves from
preemption any State law that regulates
insurance. However, section 731(a) of
ERISAand section 2723(a) of the PHS
Act preempt State insurance laws relating
to health insurance issuers in connection
with group health insurance coverage to
the extent such laws “prevent the applica-
tion of” Part 7 of Subtitle B of Title I of
ERISAor Part Aof Title XXVII of the
PHS Act, including the MHPAprovisions.
(There is no corresponding provision in
the Code.) In this regard, the conference
report to HIPAAstates that the conferees
generally intended the narrowest preemp-
tion of State laws with regard to health in-
surance issuers (not group health plans)
with respect to the provisions of Part 7 of
Subtitle B of Title I of ERISAand Part A
of Title XXVII of the PHS Act.
2
Conse-
quently, the conference report to HIPAA
states that State laws with regard to health
insurance issuers that are broader than
federal requirements in certain areas
would not “prevent the application of”
the provisions of Part 7 of Subtitle B of
Title I of ERISAor Part Aof Title XXVII
of the PHS Act. Further, the conference
report to MHPAstates that the application
of these preemption provisions should
permit the operation of any State law or
provision that requires more favorable
treatment of mental health benefits under
health insurance coverage than that re-
quired under the MHPAprovisions.
Thus, generally, a State law that re-
quires more favorable treatment of mental
health benefits under health insurance
coverage offered by issuers would not be
preempted by the provisions of MHPA
and the interim rules.
B. Overview of MHPAand the Interim
Rules
The MHPAprovisions are set forth in
section 9812 of the Code, section 712 of
ERISA, and section 2705 of the PHS Act.
MHPAand the interim rules apply to a
group health plan (or health insurance
coverage offered by issuers in connection
with a group health plan) that provides
both medical/surgical benefits and mental
health benefits.
The MHPAprovisions provide for par-
ity in the application of aggregate lifetime
dollar limits, and annual dollar limits, be-
tween mental health benefits and med-
ical/surgical benefits. If a group health
plan offers two or more benefit packages
under the plan, the requirements of
MHPAand the interim rules apply sepa-
rately to each package. The interim rules
make clear that the MHPArequirements
apply regardless of whether the mental
health benefits are administered sepa-
rately under the plan. In addition, the in-
terim rules make clear that the MHPAre-
quirements in ERISAand the PHS Act
apply both to group health plans and to
health insurance issuers offering coverage
in connection with a group health plan.
MHPAand the interim rules do not re-
quire a group health plan (or health insur-
ance coverage offered in connection with
a group health plan) to provide mental
health benefits. In addition, MHPAand
the interim rules do not affect the terms
and conditions (including cost sharing,
limits on the number of visits or days of
coverage, requirements relating to med-
ical necessity, requirements that patients
or providers obtain prior authorization for
treatment, and requirements relating to
primary care physicians’referrals for
treatment) relating to the amount, dura-
tion, or scope of mental health benefits
under a plan (or coverage) except as
specifically provided in regard to parity of
aggregate lifetime dollar limits and an-
nual dollar limits.
3
1.Aggregate Lifetime Limits and Annual
Limits
Under MHPAand the interim rules, a
group health plan (or health insurance
coverage offered in connection with a
group health plan) providing both med-
ical/surgical benefits and mental health
benefits may comply with the MHPApar-
ity requirements in any of the following
general ways:
•The plan (or coverage) may comply by
not including any aggregate lifetime
dollar limit or annual dollar limit on
mental health benefits.
•The plan (or coverage) may comply by
imposing a single aggregate lifetime or
annual dollar limit on both medical/sur-
gical benefits and mental health bene-
fits in a way that does not distinguish
between the two.
•The plan (or coverage) may comply by
imposing an aggregate lifetime dollar
limit or annual dollar limit on mental
health benefits that is not less than the
aggregate lifetime dollar limit or annual
dollar limit on medical/surgical benefits.
•In the case of a plan (or coverage) under
which aggregate lifetime dollar limits
or annual dollar limits differ for cate-
gories of medical/surgical benefits, the
plan (or coverage) may comply by cal-
culating a weighted average aggregate
lifetime dollar limit or weighted aver-
age annual dollar limit for mental health
benefits. The weighted average must
be based on a formula in the interim
rules that takes into account the limits
on different categories of medical/sur-
gical benefits.
In addition, under MHPAand the interim
rules, benefits for treatment of substance
abuse or chemical dependency may not be
2
However, the preemption is broader for the statuto-
ry requirements of section 701 of ERISAand section
2701 of the PHS Act that limit the application of pre-
existing condition exclusions. Under these broader
provisions, State laws cannot “differ” from the pre-
existing condition exclusion requirements of section
701 of ERISAor section 2701 of the PHS Act except
as specifically permitted by section 721(b)(2) of
ERISAand section 2723(b)(2) of the PHS Act.
These provisions permit a State to impose on health
insurance issuers certain stricter limitations relating
to preexisting condition exclusions.
3
In response to the Departments’request for public
comments on MHPApublished in the Federal
Register(62 FR 34604), the Equal Employment
Opportunity Commission (EEOC) noted that the
Americans with Disabilities Act (ADA) prohibits
disability-based distinctions (including such distinc-
tions relating to the provision of mental health bene-
fits) in employer-provided health insurance plans
unless the plan otherwise falls within the protections
of sectin 501(c) of the ADA. The aDAis within the
regulatory jurisdiction of the EEOC.

1998–3 I.R.B9January 20, 1998
counted in applying an aggregate lifetime
or annual dollar limit that applies sepa-
rately to mental health benefits.
2.Exemptions from the Requirements of
MHPA
(a) Small Employer Exemption
The parity requirements under MHPA
and the interim rules do not apply to any
group health plan (or health insurance
coverage offered in connection with a
group health plan) for any plan year of a
small employer. The term “small em-
ployer” is defined as an employer who
employed an average of at least 2 but not
more than 50 employees on business days
during the preceding calendar year and
who employs at least 2 employees on the
first day of the plan year.
4
For purposes of the small employer ex-
emption, all persons treated as a single
employer under subsections (b), (c), (m),
and (o) of section 414 of the Code (26
U.S.C. 414) are treated as one employer.
In addition, if an employer was not in ex-
istence throughout the preceding calendar
year, whether the employer is a small em-
ployer is determined on the average num-
ber of employees the employer reason-
ably expects to employ on business days
during the current calendar year. Finally,
any reference to an employer in the small
employer exemption includes a reference
to a predecessor of the employer.
(b) Increased Cost Exemption
The second exemption from the MHPA
requirements applies to group health
plans (or health insurance coverage of-
fered in connection with a group health
plan) if the application of the MHPApar-
ity requirements described in paragraph
(b)(1)(i)
5
results in an increase in the cost
under the plan (or coverage) of at least
one percent. This exemption is available
only if the requirements of paragraph (f)
are met. If a plan offers more than one
benefit package, the exemption is applied
separately to each benefit package. Ex-
cept as provided in the transition period
described in paragraph (h), a plan must
implement the parity requirements for the
first plan year beginning on or after Janu-
ary 1, 1998, and must continue to comply
with the parity requirements until Sep-
tember 30, 2001 (the sunset date in para-
graph (i)) unless the plan satisfies the ex-
emption described in paragraph (f).
However, the exemption is not effective
until 30 days after the notice requirements
in paragraph (f)(3) are satisfied.
The interim rules, in paragraph (f)(2),
describe the ratio of two terms used to de-
termine if a plan (or coverage) has experi-
enced a cost increase of one percent or
more. The first term is the total cost in-
curred under parity (including both men-
tal health costs and medical/surgical
costs). The second term is the total cost
incurred under parity reduced by the costs
required solely to comply with parity.
Costs required solely to comply with par-
ity include mental health claims that
would have been denied absent amend-
ments required to comply with parity, the
administrative costs related to those
claims, and other administrative costs at-
tributable to complying with the parity re-
quirements. Premium payments are not
considered in this calculation. The ratio
is expressed by the following formula:
IE
≥1.01000
IE – (CE + AE)
IE represents the incurred expenditures
during the base period. CErepresents the
claims incurred during the base period
that would have been denied under the
terms of the plan absent plan amendments
required to comply with the parity re-
quirements of paragraph (b)(1)(i). AE
represents administrative costs related to
claims in CEand other administrative
costs attributable to complying with the
parity requirements of paragraph
(b)(1)(i).
Examples illustrate how the rule is ap-
plied in the case of a self-funded plan, a
fully insured plan, and a partially insured
plan. Moreover, in the case of a partially
insured plan in which the partially insured
portion is pooled for rating purposes, the
costs of the pool should be allocated pro-
portionally among the pool members by
reasonable methods, including propor-
tional enrollment. Additional provisions
in paragraph (f) describe the baseline for
determining those costs that are attribut-
able solely to compliance with the parity
requirements, the base period used to cal-
culate whether a plan may claim the ex-
emption, and how long the exemption ap-
plies once it is claimed. The base period
must begin on the first day in any plan
year that the plan complies with the re-
quirements of paragraph (b)(1)(i) of this
section and must extend for a period of at
least six consecutive calendar months.
However, in no event may the base period
begin prior to September 26, 1996 (the
date of enactment of the Mental Health
Parity Act (Pub. L. 104–204, 110 Stat.
2944)).
Before a group health plan may claim
the one-percent increased cost exemption,
it must furnish participants and
beneficiaries with a notice of the plan’s
exemption from the parity requirements
that includes the information described in
paragraph (f)(3)(i). Aplan may satisfy
this requirement by providing participants
and beneficiaries with a summary of mate-
rial reductions in covered services or ben-
efits, under 29 CFR 2520.104b–3(d), if it
includes all the information required by
paragraph (f)(3)(i). However, this exemp-
tion under MHPAis not effective until at
least 30 days after the notice is sent to the
participants and beneficiaries and the ap-
propriate federal agency even if the notice
is incorporated into a summary of material
reductions in covered services or benefits.
Agroup health plan that is not subject
to Part 7 of Subtitle B of Title I of ERISA,
and a plan subject to Part 7 of Subtitle B
of Title I of ERISAthat chooses not to in-
corporate the information in paragraph
(f)(3)(i) into a summary of material re-
ductions in covered services or benefits
(which must be furnished to participants
and beneficiaries and the appropriate fed-
eral agency), may use the following
model to satisfy the notice requirement
under paragraph (f)(3) of the interim
rules:
4
Section 9831(a) of the Code, section 732(a) of
ERISA, and section 2721(a) of the PHS Act provide
an exception that applies under the MHPAprovi-
sions as well as under provisions added by HIPAA
and the Newborns’and Mothers’Health Protection
Act of 1996. The exception applies to any group
health plan (and health insurance coverage offered in
connection with a group health plan) for any plan
year if, on the first day of the plan year, the plan has
fewer than 2 participants who are current employees.
5
Any reference to a particular paragraph in this pre-
amble to the interim rules is a reference to the corre-
sponding paragraphs in each of the Departments’
interim rules.

To claim the one-percent increased cost
exemption, a group health plan that is a
church plan (as defined in section 414(e)
of the Code) also must furnish to the De-
partment of the Treasury a copy of the no-
tice sent to participants and beneficiaries
that satisfies the requirements of para-
graph (f)(3)(i). To claim the one percent
increased cost exemption, a group health
plan subject to Part 7 of Subtitle B of Title
I of ERISAalso must furnish to the De-
partment of Labor a copy of the notice
sent to participants and beneficiaries that
satisfies the requirements of paragraph
(f)(3)(i). To claim the one percent in-
creased cost exemption, a group health
plan that is a nonfederal governmental
plan also must furnish to the Department
of Health and Human Services a copy of
the notice sent to participants and benefi-
ciaries that satisfies the requirements of
paragraph (f)(3)(i). In all cases, the ex-
emption is not effective until 30 days after
notice has been sent both to participants
and beneficiaries and to the appropriate
federal agency. Any notice submitted to
the Department of Labor or Health and
Human Services will be available for pub-
lic inspection.
The Secretaries have designated the
following addresses for delivery of these
notices:
For notices to the Department of the Trea-
sury, church plans should mail the notice
to:
Office of the Assistant Commissioner,
Examination
Examination Programs CP:EX:E
1111 Constitution Avenue, NW
Washington, DC 20224
Attention: MHPAone-percent cost
exemption notice
For notices to the Department of Labor,
plans should mail the notice to:
Public Documents Room
Pension and Welfare Benefits
Administration
January 20, 1998101998–3 I.R.B.
NOTICE OF GROUP HEALTH PLAN’S EXEMPTION FROM THE MENTAL HEALTH PARITYACT
* DESCRIPTION OFTHE ONE PERCENTINCREASED COSTEXEMPTION — This notice is required to be pro-
vided to you underthe requirements of the Mental Health Parity Act of 1996 (MHPA) because the group health plan
identified in Line 1 below is claiming the one percent increased cost exemption from the requirements of MHPA. Under
MHPA, a group health plan offering both medical/surgical and mental health benefits generally can no longerset annual
oraggregate lifetime dollarlimits on mental health benefits that are lowerthan any such dollarlimits formedical/surgi-
cal benefits. In addition, a plan that does not impose an annual oraggregate lifetime dollarlimit on medical/surgical ben-
efits generally may not impose such a limit on mental health benefits. However, a group health plan can claim an ex-
emption from these requirements if the plan’s costs increase one percent ormore due to the application of MHPA’s
requirements.
This notice is to inform you that the group health plan identified in Line 1 below is claiming the exemption from the re-
quirements of MHPA. The exemption is effective as of the date identified in Line 4 below. Since benefits underyour
group health plan may change as of the date identified in Line 4 it is important that you contact yourplan administrator
orthe plan representative identified in Line 5 below to see how yourbenefits may be affected as a result of yourgroup
health plan’s election of this exemption from the requirements of MHPA.
Upon submission of this notice by you (oryourrepresentative) to the plan administratororthe person identified in Line
5 below, the plan will provide you oryourrepresentative, free of charge, a summary of the information upon which the
plan’s exemption is based.
1. Name of the group health plan and the plan number (PN): ______________________________________
2. Name, address, and telephone number of plan administrator responsible for providing this notice:
______________________________________________
______________________________________________
______________________________________________
3. For single-employer plans, the name, address, telephone number, (if different from Line 2) and employer identification num-
ber (EIN) of the employer sponsoring the group health plan:
______________________________________________
______________________________________________
______________________________________________
4. Effective date of the exemption (at least 30 days after the notices are sent): __________________________________
5. For further information, call: __________________________________

1998–3 I.R.B11January 20, 1998
U.S. Department of Labor
Room N-5638
200 Constitution Avenue, NW
Washington, DC 20210
Attention: MHPAone-percent cost
exemption notice
For notices to the Department of Health
and Human Services, plans should mail
the notice to:
Health Care Financing Administration
7500 Security Boulevard
Baltimore, MD 21244-1850
Attention: Insurance Standards:
Exemptions
Finally, to claim the one percent in-
creased cost exemption, a plan (or issuer)
must make available to participants and
beneficiaries (or their representatives), on
request and at no charge, a summary of
the information described in paragraph
(f)(4). An individual who is not a partici-
pant or beneficiary and who presents a
notice described in paragraph (f)(3)(i) is
considered to be a representative. For this
purpose, individually identifiable infor-
mation in the notice may be redacted.
The summary of information must in-
clude the incurred expenditures, the base
period, the dollar amount of claims in-
curred during the base period that would
have been denied under the terms of the
plan absent amendments required to com-
ply with parity, and the administrative ex-
penses attributable to complying with the
parity requirements. In no event should a
summary of information include individu-
ally identifiable information.
Civil money penalties as described in
regulations at 45 CFR 146.184(d) apply
to an issuer or nonfederal governmental
plan that fails to satisfy the requirements
of paragraph (f).
3. MHPA’s Effective Date and Sunset
Provision
The MHPAprovisions are generally
effective for group health plans (and
health insurance issuers offering health
insurance coverage in connection with a
group health plan) for plan years begin-
ning on or after January 1, 1998. MHPA
includes a sunset provision under which
the MHPArequirements do not apply to
benefits for services furnished on or after
September 30, 2001.
However, for requirements of this sec-
tion other than the one-percent increased
cost exemption, the interim rules provide
a limitation on enforcement actions in
paragraph (h)(2). Under that paragraph,
no enforcement action can be taken by
any of the Secretaries against a group
health plan (or issuer) that has sought to
comply in good faith with the require-
ments of section 9812 of the Code, sec-
tion 712 of ERISA, and section 2705 of
the PHS Act with respect to a violation
that occurs before the earlier of the first
day of the first plan year beginning on or
after April 1, 1998, or January 1, 1999.
Compliance with the requirements of the
interim rules is deemed to be good faith
compliance with the requirements of sec-
tion 9812 of the Code, section 712 of
ERISA, and section 2705 of the PHS Act.
With respect to the increased cost ex-
emption, the interim rules provide in
paragraph (h)(3) a transition period for
compliance with the requirements of
paragraph (f). Under paragraph (h)(3), no
enforcement action will be taken against a
group health plan (or issuer) that is sub-
ject to the MHPArequirements prior to
April 1, 1998 solely because the plan has
claimed the increased cost exemption
under section 9812(c)(2) of the Code, sec-
tion 712(c)(2) of ERISA, or section
2705(c)(2) of the PHS Act based on as-
sumptions inconsistent with the rules
under paragraph (f) of the interim rules,
provided that the plan is amended to com-
ply with the parity requirements no later
than March 31, 1998 and the plan com-
plies with the notice requirements in para-
graph (h)(3)(ii).
Agroup health plan satisfies this transi-
tion period notice requirement only if the
plan provides notice to the applicable fed-
eral agency and posts such notice at the
location(s) where documents must be
made available for examination under
section 104(b)(2) of ERISAand the regu-
lations thereunder (§2520.104b–1(b)(3)).
The notice must indicate the plan’s intent
to use the transition period by 30 days
after the first day of the plan year begin-
ning on or after January 1, 1998, but in no
event later than March 31, 1998. For a
group health plan that is a church plan,
the applicable federal agency is the De-
partment of the Treasury. For a group
health plan that is subject to Part 7 of Sub-
title B of Title I of ERISA, the applicable
federal agency is the Department of
Labor. For a group health plan that is a
nonfederal governmental plan, the applic-
able federal agency is the Department of
Health and Human Services. In all cases,
the notice must include the date; the name
of the plan and the plan number; the
name, address, and telephone number of
the plan sponsor or plan administrator; the
employer identification number (in the
case of single-employer plans only); the
individual to contact for further informa-
tion; the signature of the plan administra-
tor; and the date signed. In addition, the
notice must be provided at no charge to
participants and beneficiaries (or their
representatives) within 15 days after re-
ceipt of a written or oral request for such
notification, but in no event does the no-
tice have to be provided before it has been
sent to the applicable federal agency. For
this purpose, plans may use the following
model:

The Secretaries have designated the
following addresses for delivery of the
notices:
For notices to the Department of the Trea-
sury, plans should mail the notice to:
Office of the Assistant Commissioner,
Examination
Examination Programs CP:EX:E
1111 Constitution Avenue, NW
Washington, DC 20224
Attention: MHPAtransition period
notice
For notices to the Department of the
Labor, plans should mail the notice to:
Public Documents Room
Pension and Welfare Benefits
Administration
U.S. Department of Labor
Room N-5638
200 Constitution Avenue, NW
Washington, DC 20210
Attention: MHPAtransition period notice
For notices to the Department of Health
and Human Services, plans should mail
the notice to:
Health Care Financing Administration
7500 Security Boulevard
Baltimore, MD 21244-1850
Attention: Insurance Standards:
Exemptions
C. Interim Rules and Request for
Comments
Section 9833 of the Code (formerly
section 9806), section 734 of ERISA(for-
merly section 707), and section 2792 of
the PHS Act provide, in part, that the Sec-
retaries of the Treasury, Labor, and Health
and Human Services may promulgate any
interim final rules as they determine are
appropriate to carry out the provisions of
Chapter 100 of Subtitle K of the Code,
Part 7 of Subtitle B of Title I of ERISA,
and Part Aof Title XXVII of the PHS Act,
including the MHPAprovisions.
Under Section 553(b) of the Adminis-
trative Procedure Act (5 U.S.C. 551 et
seq.) a general notice of proposed rule-
making is not required when an agency,
for good cause, finds that notice and pub-
lic comment thereon are impracticable,
unnecessary, or contrary to the public in-
terest.
These rules are being adopted on an in-
terim final basis because the Secretaries
have determined that without prompt
guidance some members of the regulated
community may not know what steps to
take to comply with the MHPArequire-
ments, which may result in an adverse im-
pact on participants and beneficiaries with
regard to their mental health benefits
under group health plans and the protec-
tions provided under MHPA. Moreover,
January 20, 1998121998–3 I.R.B.
NOTICE OF GROUP HEALTH PLAN’S USE OF TRANSITION PERIOD
* IMPORTANT— This notice is required to be provided if a group health plan uses the transition period underthe re-
quirements of the Mental Health Parity Act (MHPA). UnderMHPA, a group health plan offering both medical/surgical
and mental health benefits generally can no longerset annual oraggregate lifetime dollarlimits on mental health benefits
that are lowerthan any such dollarlimits formedical/surgical benefits. In addition, a plan that does not impose an annual
oraggregate lifetime dollarlimit on medical/surgical benefits generally may not impose such a limit on mental health ben-
efits. However, a group health plan can claim an exemption from these requirements if the plan’s costs increase one per-
cent ormore due to the application of MHPA’s requirements. UnderMHPA, a plan that claimed the one percent in-
creased cost exemption priorto the issuance of the MHPAinterim regulations based on assumptions inconsistent with the
MHPAinterim regulations may delay compliance with the parity requirements of MHPAuntil a date no laterthan March
31, 1998.
This notice is to inform you that the plan is utilizing the MHPAtransition period and that the plan is delaying compliance
with the parity requirements of MHPAuntil a time no laterthan March 31, 1998.
1. Name of the group health plan and the plan number (PN): ______________________________________
2. Name, address, and telephone number of plan administrator responsible for providing this notice:
______________________________________________
______________________________________________
______________________________________________
3. For single-employer plans, the name, address, telephone number, (if different from Line 2), and employer identification num-
ber (EIN) of the employer sponsoring the group health plan:
______________________________________________
______________________________________________
______________________________________________
4. For further information, call: ______________________________________________
5. Signature of plan administrator: _____________________________________ Date: _____________

1998–3 I.R.B13January 20, 1998
MHPA’s requirements will affect the reg-
ulated community in the immediate fu-
ture.
MHPA’s requirements are effective for
all group health plans and for health in-
surance issuers offering coverage in con-
nection with such plans for plan years be-
ginning on or after January 1, 1998. Plan
administrators and sponsors, issuers, and
participants and beneficiaries, will need
guidance on the new statutory provisions
before MHPA’s effective date. As noted
earlier, these interim rules take into ac-
count comments received by the Depart-
ments in response to the request for public
comments on MHPApublished in the
Federal Registeron June 26, 1997 (62
FR 34604). For the foregoing reasons,
the Departments find that the publication
of a proposed regulation, for the purpose
of notice and public comment thereon,
would be impracticable, unnecessary, and
contrary to the public interest.
D. Regulatory Flexibility Act
The Regulatory Flexibility Act (5
U.S.C. 601 et. seq.)(RFA) requires an
agency to publish a regulatory flexibility
analysis describing the impact of a pro-
posed rule which the agency determines
would have a significant impact on a sub-
stantial number of small entities. The
RFArequires that the agency present an
initial regulatory flexibility analysis and
seek public comment on its analysis when
the agency publishes a general notice of
proposed rulemaking (NPRM) under sec-
tion 553 of the Administrative Procedures
Act (5 U.S.C. 553 et seq.) (APA). Under
the RFA, small entities include small
businesses, non-profit organizations and
governmental agencies. For our pur-
poses, under the RFA, States and individ-
uals are not considered small entities.
However, small employers and small
group health plans are considered small
entities.
Since these rules are issued as interim
final rules, and not as an NPRM, a formal
regulatory flexibility analysis has not
been prepared. Nonetheless, in the dis-
cussion below on the rule’s impact on the
regulated community, the Departments
present an analysis addressing many of
the same issues otherwise required by the
RFA, including the likely impact of the
interim rule on small entities, and a dis-
cussion of regulatory alternatives consid-
ered in crafting the rule. The Depart-
ments invite interested persons to submit
comments for consideration in the devel-
opment of the final rules implementing
the MHPA. Consistent with the RFA, the
Departments encourage the public to sub-
mit comments that accomplish the stated
purpose of the MHPAand minimize the
impact on small entities. Specifically, we
welcome comments addressing the im-
pact of the MHPA’s 1 percent cost exemp-
tion for plans and issuers that can demon-
strate that implementation of the parity
rules would raise their expenditures by
more than one percent. We also welcome
comments addressing the operation of the
MHPAprovision requiring that plans
using differential aggregate lifetime or
annual limits for various categories of
benefits use a weighted average of such
differential limits to calculate the overall
aggregate lifetime and annual limits for
the plan.
E. Executive Order12866 —
Departments of Laborand Health and
Human Services
The Office of Management and Budget
has determined this rule to be a major
rule, as well as an economically signifi-
cant regulatory action under Section 3(f)
of Executive Order 12866. The following
analysis fulfils the requirement under the
Executive Order to assess the economic
impact of major and economically signifi-
cant regulatory actions.
Executive Order 12866 requires agen-
cies to assess the costs and benefits of
available regulatory alternatives, and
when regulation is necessary, to select
regulatory approaches that maximize net
benefits (including potential economic,
environmental, public health and safety
effects; distributive impacts; and equity).
Section 3(f) of the Executive Order 12866
requires agencies to prepare a regulatory
impact analysis for any rule which is
deemed a “significant regulatory action”
according to specified criteria, including
whether the rule may have an annual ef-
fect on the economy of $100 million or
more or certain other specified effects; or
whether the rules raise novel legal or pol-
icy issues arising out of the President’s
priorities.
This analysis was conducted by the De-
partments of Labor and Health and
Human Services. It discusses the eco-
nomic impact of the MHPA, which this
rule implements, with special emphasis
on the one percent cost exemption. It
quantifies the number of plans and indi-
viduals who might be affected by the ex-
emption rule, illustrating the exemption’s
effect in the context of other statutory
MHPAprovisions. It separately considers
the impact of regulatory discretion exer-
cised by the Departments in connection
with this rule.
a.Overall Impact of the MHPA
In general, the MHPAmay have both
direct and indirect effects on group health
plans, plan sponsors, and plan partici-
pants. Direct effects may include broader
coverage of mental health treatments and
associated increases in mental health ben-
efit payments. Indirect effects may in-
clude the steps employers who sponsor
plans may take to reduce or offset their
expenditures attributable to compliance
with the MHPA, such as amending, cur-
tailing or dropping mental health benefits
or other components of compensation, as
well as participants’responses to any ex-
penditure increases that are passed to
them.
Direct Effects
The most direct effect of the MHPAis
broader health insurance coverage for
mental health treatment. In many health
plans, mental health coverage is more re-
strictive than medical/surgical coverage
due to lower annual and/or lifetime dollar
limits, more restrictive limits on visits and
stays, and other plan provisions. For ex-
ample, a recent survey of employee bene-
fit plans by Hay/Huggins illustrates the
differences in plan terms and lower dollar
limits of mental health services and med-
ical/surgical services. The survey re-
ported that indemnity plans typically im-
pose a lifetime limit of $50,000 for
mental health benefits. On the other
hand, medical/surgical benefits of a typi-
cal indemnity plan provide a lifetime limit
of $1,000,000.
Requiring fuller coverage of mental
health treatment will increase mental
health benefit payments and associated
plan expenditures. Some of this increase
will be paid by plan sponsors, and some
will be paid by participants in the form of
increased premiums and/or reductions in

January 20, 1998141998–3 I.R.B.
other compensation. Aside from any in-
creased administrative costs involved,
these plan expenditure increases generally
represent one side of transfer payments
rather than erosion in overall social wel-
fare. In other words, additional plan ex-
penditures arising from the MHPAare
balanced by additional benefits paid for
mental health services. One result will be
that some money that would have been
spent on other goods or services will be
spent instead on mental health services.
The direct effects of the MHPAwill in
turn cause other effects due to subsequent
responses by affected employers (in their
capacity as plans sponsors) and partici-
pants.
Indirect Effects of the MHPA
There are numerous ways in which
plan sponsors affected by the MHPA
might react. Some might take no action
other than to remove or increase dollar
limits on mental health benefits. Others
might make other changes to their mental
health benefits in order to reduce or offset
expenditure increases from compliance
with MHPA. The statute explicitly pre-
serves plan sponsors’right to provide no
mental health benefits, or to set the “terms
and conditions (including cost sharing,
limits on numbers of visits or days of cov-
erage, and requirements relating to med-
ical necessity) relating to the amount, du-
ration, or scope of mental health
benefits,” except with respect to annual or
lifetime dollar limits. Some plan design
options would be associated with lower
plan expenditure increases from compli-
ance with the MHPA. The statute also
provides an “increased cost exemption”
under which the statute “shall not apply”
if its application “results in an increase in
the cost . . . of at least 1 percent” (ERISA
Section 712(c)(2)). Plan sponsors’re-
sponses to the MHPAmay lessen their ex-
penditures associated with compliance;
that is, their responses may reduce the
amount of transfers arising from the
MHPA.
For example, many mental health plans
currently have non-dollar limits. Accord-
ing to the U.S. Bureau of Labor Statistics,
among full-time participants at private es-
tablishments with 100 or more employees
in 1993, 55 percent were subject to sepa-
rate day limits for inpatient mental health
treatment, and 43 percent were subject to
separate visit limits for outpatient mental
health treatment (U.S. Bureau of Labor
Statistics, Employee Benefits in Medium
and Large Private Establishments, 1993).
Plans that impose non-dollar limits on
mental health benefits may face smaller
expenditures increases from the MHPA.
Many plans currently subject mental
health benefits to separate cost sharing
provisions. Among full-time participants
in medium and large private establish-
ments in 1993, 15 percent were subject to
separate coinsurance rates and 4 percent
were subject to separate copayment rates
for inpatient mental health care, while 53
percent and 18 percent were respectively
subject to separate coinsurance and co-
payment rates for outpatient mental health
care. Cost sharing generally affects plan
expenditures in two ways. First, by shift-
ing some payments for services to partici-
pants, cost sharing directly reduces the
expenditures borne by plans. Second, by
increasing the price of services faced by
participants, cost sharing reduces the
quantity of services that participants de-
mand. Because of both of these mecha-
nisms, plans that have more cost sharing
for mental health benefits will not be im-
pacted as much by the MHPAas plans
that have parity in cost sharing.
Many plans use HMO-style manage-
ment techniques to control mental health
benefit expenditures. Plans that have
HMO-style mental health “carve-outs”
but no mental health limits are likely to
pay less for mental health benefits than
fee-for-service plans with low dollar lim-
its that are impermissible under the
MHPA. For example, a FFS plan with
utilization review and an annual mental
health limit of $10,000 averages $6.51 per
member per month, while an unlimited
“carve out” plan pays $6.12, according to
a Price Waterhouse LLPactuarial model
developed for the Departments based on
the same data as above.
There are a number of reasons why the
permissible plan designs outlined here
should have little negative effect on exist-
ing mental health coverage. First, the
modest expenditure increases necessitated
by the MHPAwould be unlikely to
prompt many major design changes. As
noted below, approximately 10 percent of
affected plans will face increased expen-
ditures under the MHPAof at least one
percent, according to the Price Water-
house, LLPanalysis conducted for the
Departments. Only 4 percent of affected
plans are expected to be faced with in-
creases from the MHPAof 1.5 percent or
more, according to the same analysis.
Second, the largest expenditure increases
and therefore the most aggressive re-
sponses will be associated with plans that
have the tightest dollar caps today—that
is, with plans that would have provided
the most restrictive coverage anyway.
Other effects resulting from the MHPA
may include plan sponsors dropping men-
tal health coverage altogether, or drop-
ping or curtailing other health benefits or
components of compensation. Such cur-
tailments could include shifting some of
the cost of benefits to employees, for ex-
ample in the form of increased participant
premium contributions for health bene-
fits. Participants, in turn, might respond
to premium increases by dropping their
health benefits or electing less expensive
plans. As with plan sponsor amendments
to mental health benefits, such responses
by plan sponsors and participants are ex-
pected to be modest and/or rare, given the
generally small direct effects of the
MHPAon plan expenditures.
b.Review of Quantitative Estimates
The Congressional Budget Office
(CBO) estimated that the MHPA’s direct
effect would be to increase health plan ex-
penditures by 0.4 percent on aggregate.
(See Congressional Budget Office,
“CBOs Estimates of the Mental Health
Parity Amendments to the VA/HUD Ap-
propriation Bill, as Passed in the Senate,”
September 10, 1996.) This assumes that
plan sponsors make no changes to their
plans other than to raise or eliminate dol-
lar limits on mental health benefits con-
sistent with the MHPA’s parity require-
ments. However, some plan sponsors
may make other changes to their plans in
order to reduce or offset the impact of the
MHPAon their expenditures. For exam-
ple, some plan sponsors might amend,
curtail, or drop mental health benefits or
health benefits in general. Taking into ac-
count the likely incidence of such plan
sponsor responses to the MHPA, CBO es-
timated that the true aggregate increase in
health plan expenditures attributable to
the MHPAwould only be 0.16 percent.
Combining these figures with those
from an earlier CBO analysis, the Depart-

1998–3 I.R.B15January 20, 1998
ments calculate that, in dollar terms, the
total annual direct impact of the MHPA
would be to increase aggregate health
plan expenditures by $1.16 billion, not ac-
counting for plan sponsor responses to re-
duce that impact. Accounting for those
responses, the actual increase in annual
aggregate health plan expenditures would
be $464 million. It should be noted that
these figures do not account for the
MHPA’s increased cost exemption, its ex-
emption of firms with 50 or fewer em-
ployees, the incidence of managed care
plans whose added cost under the MHPA
would be smaller than those of managed
fee for service plans, or for plans that are
separately subject to state requirements
equal or greater than the MHPA’s. The
Departments’estimates, reported below,
incorporate these adjustments.
CBO also reports the Joint Committee
on Taxation’s estimate that the MHPA
will reduce federal revenues by $560 mil-
lion over six years. CBO explains that
most of the 0.16 percent increase in plan
expenditures would be shifted back to
employees as lower pay, thus eroding the
income and payroll tax bases. On an an-
nual basis, the MHPAwould increase ex-
penditures for federal annuitants’health
benefits by $30 million, CBO reports. Fi-
nally, the MHPA’s impact on nonfederal
governmental entities would amount to
$50 million, while its impact on the pri-
vate sector would probably exceed $100
million, according to CBO.
The CBO estimates were based on a
typical fee-for-service indemnity plan
with customary management techniques
to control expenditures, and not on plans
with other types of delivery systems,
such as Health Maintenance Organiza-
tions (HMOs), Preferred Provider Orga-
nizations (PPOs), or Point-of-Service
(POS) plans. In fact, plans using differ-
ent delivery systems will face different
expenditure increases under the MHPA.
For example, HMOs, which typically
contract with health care providers at dis-
counted rates and tightly manage utiliza-
tion, will face smaller increases under the
MHPA.
Coopers & Lybrand (C&L) also esti-
mated the impact of the MHPA(Ronald
E. Bachman, “An Actuarial Analysis of
S. 2031, The Mental Health Parity Act of
1996,” prepared for the American Psy-
chological Association. Coopers & Ly-
brand LLP, September 1996). C&Lesti-
mated that the MHPAwould increase plan
expenditures by 0.12 percent per plan on
average before taking into account any re-
sponses by plan sponsors. Taking plans
sponsors’responses into account and
using the same response assumption as
CBO, C&Lestimated that plan expendi-
tures would increase by less than 0.05
percent. In dollar terms, these increases
would amount to $348 million and $139
million respectively.
Unlike CBO, C&Lconsidered four dif-
ferent delivery systems: fee-for-service
with standard utilization review on typical
medical services, fee-for-service with
specialized mental health utilization re-
view, PPO and POS plans with special-
ized mental health utilization review, and
HMO and carve-out mental health plans.
Under each delivery system, C&Lalso
considered a variety of annual dollar lim-
its ranging from $10,000 to unlimited
amounts, rather than assuming that all
plans in the delivery system provided the
same level of benefits.
The Departments performed additional
quantitative analysis, generally analogous
to CBO’s, in the course of assessing the
impact of the regulatory discretion re-
flected in this rule. The additional analy-
sis suggests that the direct impact of the
MHPA, not accounting for plan sponsors’
responses, would be to increase annual
aggregate health plans expenditures by
0.29 percent or $653 million. Under
CBO’s assumption regarding plan spon-
sor responses to reduce the added expen-
diture, actual added expenditures would
amount to $261 million. The Depart-
ments did not attempt to independently
quantify such responses. However, the
Departments estimate that if all plans eli-
gible for the one percent cost exemption
exercise it, the increase in plan expendi-
tures would be reduced from 0.29 percent
to 0.14 percent or $310 million. The De-
partments’analysis is detailed below.
c.Exercise of Regulatory Discretion
One Percent Cost Exemption
The main area in which the agencies
exercised regulatory discretion is in con-
nection with the one percent cost increase
exemption. Alternative regulatory inter-
pretations can impact the outcome of the
number of plans, firms, policyholders,
and covered lives that would be exempted
from the MHPA.
The Departments considered options
concerning the interpretation of the one-
percent cost exemption and how it should
be implemented. In general, they consid-
ered (1) whether the eligibility for the ex-
emption should be determined retrospec-
tively or prospectively, and what, if any,
rules should be established with respect to
how eligibility should be determined, (2)
whether eligibility should be contingent
on affirmative approval from an enforce-
ment agency or simply subject to possible
review by such an agency, and (3)
whether plan sponsors electing exemp-
tions should be required to notify partici-
pants and/or enforcement agencies of this
action and/or to disclose to these parties
evidence documenting eligibility for the
exemption. They also considered the ad-
ministrability of each option, seeking to
balance the costs and benefits to plans and
participants, as well as the benefits and
burdens of the regulatory scheme on the
federal government.
Retro/prospective Determination
The options considered ranged from a
purely retrospective interpretation to a
purely prospective one, and included in-
termediate interpretations that blend these
two approaches.
Under a purely retrospective interpreta-
tion, the one percent increased cost ex-
emption would be based on actually in-
curred expenditures increases, measured
retrospectively after implementation of
the statute. In other words, all plans must
comply and provide parity of annual
and/or lifetime dollar limits of mental
health and medical services for the first
year beginning with the start of a plan
year on or after January 1, 1998. If during
the first year, a plan experiences increases
in expenditures equal to one percent or
more as a result of complying with the
statute, that plan would then be eligible to
exercise an exemption from the MHPA
for subsequent plan years.
The calculation for determining the
percent increase would be based on the
ratio of the increase in plan expenditures
to the total plan expenditures, that is, both
medical and mental health expenditures.
For self-insured plans, the numerator
would be the actual value of mental health
claims paid in excess of the previous plan

January 20, 1998161998–3 I.R.B.
limits. For example, if the annual mental
health limit were $10,000 and the med-
ical/surgical were $1,000,000, then the
sum of all mental health claims paid in
excess of $10,000 would be included in
the numerator of the ratio used for that
plan in calculations related to the one per-
cent exemption. The denominator for
self-insured plans would be the total value
of medical and mental health claims ex-
cluding mental health claims in excess of
$10,000. If the result is an increase of one
or more percent, the plan would be ex-
empt from complying with the statute in
any other year until the statute sunsets in
2001. Because there is a lag between the
time that claims are incurred and the time
they are reported, complete data needed
for the calculation might not be available
until three or six months after the end of
the first plan year under the MHPA. With
respect to fully insured plans, the calcula-
tion would be slightly different. To the
extent that different plans’experiences
are pooled for purposes of setting premi-
ums, their eligibility for the exemption
would depend on their pooled experience
under MHPA, rather than on each plan’s
individual experience.
The purely retrospective interpretation
would minimize the availability of the ex-
emption, and therefore might result in
both the greatest incidence of parity in
lifetime and annual dollar limits and the
greatest incidence of other plan actions to
reduce or offset the increase in expendi-
tures arising from the MHPA. It would
also assure that all plan elections to exer-
cise the one percent increased cost ex-
emption are based on actual experience
under the MHPA’s parity requirements
and not on projections or estimates of
such experience.
Under a purely prospective interpreta-
tion, the a plan would be eligible for the
exemption prospectively if its expected
additional expenditures from the MHPA
act equaled or exceeded one percent of its
expected total expenditures absent the
MHPA. Aself-insured plan would project
these figures, relying on available data
and actuarial projection methods. Afully
insured plan would compare legitimate
premium quotes with and without the ex-
emption to determine if the difference
equals or exceeds one percent. The
purely prospective interpretation would
maximize the availability of the exemp-
tion, and therefore might result in both the
least incidence of parity in lifetime and
annual dollar limits and the least inci-
dence of other plan actions to reduce or
offset expenditure increases arising from
the MHPA.
Other interpretations were also consid-
ered, some closer to a purely retrospective
interpretation and others closer to a purely
prospective one. For example, one inter-
pretation might allow plans to prospec-
tively determine their eligibility and exer-
cise the exemption, but only based upon a
narrowly constrained analysis of their
own prior experience, taking into account
only the potential added expenditure from
the MHPAassociated with participants
whose past mental health claims reached
or nearly reached MHPA-prohibited dol-
lar limits. Interpretations closer to the
purely retrospective view would lessen
the availability of the exemption, and
therefore might result in both greater inci-
dence of parity in lifetime and annual dol-
lar limits and lesser incidence of other
plan actions to reduce or offset expendi-
ture increases arising from the MHPA;
those closer to the purely prospective
view would do the opposite.
The approach adopted under this rule,
referenced above, can be characterized as
modified retrospective approach, based
on a relatively brief base period. It is in-
tended to assure the accurate measure-
ment of increased costs while minimizing
the burden on plan sponsors who wish to
exercise the exemption as soon as accu-
rate measurements can be made. It also
assures that all plan elections to exercise
the one percent increased cost exemption
are based on actual experience under the
MHPA’s parity requirements and not on
projections or estimates of such experi-
ence. The rule eases compliance burdens
by providing a transition period under
which certain plans whose plan years
begin during the first quarter of 1998 can
exercise the exemption until April 1,
1998.
Exemption Authority
This rule provides that plans may deter-
mine their own eligibility for the exemp-
tion and, if eligible, exercise the exemp-
tion, without affirmative approval from
any enforcement agency.
Notification and Disclosure
The Departments also exercised discre-
tion in requiring notice and disclosure in
connection with the one percent increased
cost exemption. The rule requires plans
exercising the one percent increased cost
exemption during all or part of the first
quarter of 1998 under the rule’s transition
provisions to notify the federal govern-
ment, and to post a copy of this notice at
the workplace. It further requires plans
otherwise exercising the exemption to no-
tify participants and the federal govern-
ment, and to disclose on request to these
parties summary documentation of the
plans’eligibility for the exemption.
Notifications and disclosures will be of
benefit to participants. They will help as-
sure plans’compliance with the MHPA,
and will promote participants’under-
standing of their and their plans’status
under the MHPA. Moreover, by promot-
ing participants’understanding, notifica-
tions and disclosures will inform partici-
pants’choices among plans and their
feedback to plan sponsors, thereby foster-
ing more vigorous competition among
plan sponsors and issuers to provide bene-
fits attractive to participants at competi-
tive prices. The cost of these notifications
and disclosures is outlined below.
Weighted Average Limits
The Departments also exercised discre-
tion in developing rules that specify when
plans may impose separate dollar limits on
mental health benefits equal to the
weighted average of limits imposed on
other benefit categories, and in how this
weighted average may be calculated. In
general, the rules provide that such mental
health limits may be imposed if the benefit
categories to which separate limits apply
account for at least one-third of total plan
expenditures and are comparable in scope
to mental health benefits. The average is
calculated by weighting each applicable
limit to reflect its share of total plan expen-
ditures. Any unlimited categories are fig-
ured into the average by using in place of a
limit a reasonable estimate of the maxi-
mum plan expenditure that could possibly
be incurred in connection with all such cat-
egories, and weighting this estimate to re-
flect the proportion of total plan expendi-
tures attributable to all such categories.

Alternative rules might have permitted
more, fewer, or different plans to impose
such limits on mental health benefits,
and/or resulted in calculated averages that
were higher or lower. For example, if un-
limited categories were treated as having
infinite limits, then the weighted average
of category limits would equal infinity
and the option of imposing a weighted av-
erage limit on mental health benefits ef-
fectively would be foreclosed. In con-
trast, if limits applicable to benefit
categories narrower in scope than mental
health benefits could be averaged to ar-
rive at the permissible mental health limit,
plans might be able to impose very low
limits on very narrow benefit categories,
with little effect on coverage of these cat-
egories but with the result of a lower per-
missible mental health benefit limit.
d. Impact of Regulatory Discretion
Because the Departments exercised
regulatory discretion in connection with
the one percent cost exemption, it is nec-
essary to quantify the number of plans eli-
gible for the exemption. This requires
both estimates of the affected universe
and estimates of the distribution of im-
pacts within that universe. CBO reported
universe estimates but did not estimate
the distribution of impacts. C&Lpro-
vided a distribution but not universe esti-
mates. Thus, neither source provides the
necessary basis for estimating the reach of
the one percent cost exemption. To ad-
dress this gap, the Departments, assisted
by Price Waterhouse LLP, combined the
CBO and C&Lanalyses with other data to
produce relevant national estimates, as
follows.
First, the Departments estimated the
relevant universe at 3.0 million plans
sponsored by 2.8 million employers cov-
ering 145 million individuals. To derive
these estimates, we tallied the number of
group health plan policyholders and de-
pendents by firm size from the Census
Bureau’s March 1996 Current Population
Survey. Census enterprise data provided
average firm sizes in each size category,
allowing us to estimate the number of em-
ployers covering these individuals.
KPMG Peat Marwick’s 1997 survey pro-
vided the average number of plans per
firm in each size group, supporting esti-
mates of the number of plans. Data from
the Bureau of Labor Statistics’Employee
Benefits Survey and the Health and Re-
tirement Study provided a proportionate
breakdown of plans and individuals in
each firm size group across plan types
(HMO, PPO, and fee for service). Like-
wise, data from KPMG and Foster Hig-
gins surveys were used to divide insured
from self-insured plans.
Second, the Departments narrowed the
focus to plans affected by the MHPA.
Approximately 296,000 plans, sponsored
by 136,000 employers and covering 113
million individuals, would be directly af-
fected by the MHPA. This excludes firms
with fewer than 50 employees (which are
exempt under ERISASection 712 (c)(1)),
plans already covered by state mandates
to provide parity in annual and lifetime
dollar limits (based on C&Land Hay
Huggins reports of the incidence of differ-
ential limits—roughly 29,000 plans were
excluded here), and insured plans in 13
states that, independent of the MHPA, as
of January 1, 1998 will require parity
equivalent to or surpassing that required
by the MHPA. (Those 13 states are: Indi-
ana, Maryland, Minnesota, Montana,
Arkansas, Colorado, Connecticut, Maine,
Missouri, New Hampshire, North Car-
olina, Rhode Island, and Texas.). Some
of the plans identified here as affected
may not be affected. The MHPApermits
self-insured nonfederal governmental
plans to opt out of compliance. This in-
cludes roughly 22,000 plans covering
about 18 million individuals. It also ex-
empts plans whose costs increase by one
percent or more, as enumerated below.
Third, the Departments estimated the
overall impact of the MHPAas follows:
affected plans’potential increases in men-
tal health expenditures under the MHPA
equal $653 million, or 0.29 percent of af-
fected plans’$226 billion in total expen-
ditures. (The 0.29 percent figure is
benchmarked to CBO’s estimate that the
average cost increase for indemnity plans
would be 0.4 percent, but it is adjusted to
reflect C&L’s assessment of the relative
magnitude of cost increases for different
plan types. The $226 billion figure is
benchmarked to CBO’s $290 billion uni-
verse, but reduced proportionately to re-
flect the Department’s estimate of the pro-
portion of the total universe that is
affected by the MHPA.) Under CBO’s as-
sumption regarding plan sponsor actions
to reduce the added expenditure, actual
added expenditures would amount to
$261 million. Expenditures could be
smaller still as a result of self-insured
nonfederal governmental plans’right to
opt out of compliance and the MHPA’s
one percent increased cost exemption,
which are not accounted for in the forego-
ing estimates. Recall also that these ex-
penditures represent transfer payments
and not social costs.
One Percent Cost Exemption
The effect of this rule will be to pro-
hibit all covered plans from imposing an-
nual or lifetime dollar limits on mental
health benefits that are lower than limits
imposed on medical and surgical benefits
during at least seven months of the first
plan year beginning on or after January 1,
1998. Specifically, after six months, the
rule permits plans to exercise an exemp-
tion as soon as they document a cost in-
crease of one percent or more and provide
30 days notice to participants and the fed-
eral government.
Exactly when a given plan will become
eligible to elect the one percent increased
cost exemption will depend on the timing
of its increased costs and its documenta-
tion of those costs. In many cases, plans’
increased costs under the MHPAwill not
equal or exceed one percent until more
than the initial six months have elapsed.
For example, added costs from the
MHPA’s provision restricting the use of
annual dollar limits on mental health ben-
efits would likely be concentrated late in
the plans year, when some participants
would otherwise have reached these lim-
its. In addition, plans that utilize this rule’
transition period may not be affected by
the MHPA’s provisions until after the first
three months of the plan year have
elapsed. Therefore, these may be less
likely to incur added costs of one percent
or more until later in the plan year, or
until a subsequent plan year (in which
they would be affected by the MHPAbe-
ginning on the first day of the plan year).
Whether eligible plans wishing to re-
duce the direct impact of the MHPAwill
opt to pursue the exemption or opt for al-
ternative responses will depend on each
plan’s particular circumstances and priori-
ties.
The Departments estimated the number
of affected plans with potential increases
of at least one percent. Roughly 30,000
1998–3 I.R.B17January 20, 1998

plans, or about 10 percent of a plans af-
fected by MHPA, potentially would be el-
igible for the one-percent increased cost
exemption. That is, all else being equal,
complying with the MHPAwould in-
crease 30,000 plans’expenditures by at
least one percent. These plans cover
about 5 million policyholders and 11 mil-
lion individuals. This is the universe po-
tentially affected by the provisions of this
rule that address the one percent increased
cost exemption.
In assessing the impact of this rule, the
Departments considered the economic
consequences of its provisions imple-
menting the one percent cost exemption.
Several factors are likely to affect the
magnitude of those consequences.
First, under any interpretation, only 10
percent of MHPA-affected plans (or
30,000 plans) could become eligible for
the exemption, and only some of those
would elect to exercise it. The estimated
30,000 plans that would could become el-
igible for the one-percent cost exemption
represents the upper limit of the number
of plans that would actually exercise the
exemption. Many of the potentially eligi-
ble plans are likely to forego the exemp-
tion in favor of other permitted actions. A
survey of 300 large firms conducted by
William M. Mercer, Inc., found that fewer
than 2 percent intended to pursue the one
percent increased cost exemption. Ex-
trapolated to the Departments’estimated
plan universe, this suggests that 6,000
plans, or 22 percent of the 30,000 that are
potentially eligible, would pursue the ex-
emption.
Second, expenditure increases from the
MHPAwill generally be modest, even for
plans potentially eligible for the one per-
cent cost exemption. Their potential ex-
penditure increase would be $332 million
on a base of $23 billion in total expendi-
tures, or 1.47 percent overall.
Third, as noted above, plans can be de-
signed in ways that lessen these expendi-
ture increases.
Fourth, the 2,215 self-insured nonfed-
eral governmental plans that might be-
come eligible for the one percent cost ex-
emption are separately permitted to opt
out of the MHPAentirely, thereby exer-
cising an alternative exemption with
equivalent effect. These plans cover 1.8
million individuals, or 16 percent of indi-
viduals in potentially eligible plans.
Fifth, the estimates presented in this
analysis are conservative; actual expendi-
tures arising from compliance with the
MHPAare likely to be less than reported
here. In particular, the estimates may un-
derstate the reach and cost-effectiveness
of managed mental health programs that
will exist during the years that the MHPA
is in effect (See Roland Sturm, “How Ex-
pensive is Unlimited Mental Health Care
Coverage Under Managed Care?” JAMA,
Nov. 12, 1997—Vol. 278 No. 18).
Sixth, because plan expenditure in-
creases under the MHPA(aside from in-
creases in administrative expenses) are
transfers, the availability and use of the
exemption does not change aggregate so-
cial welfare. However, the availability
and use of the exemption does affect the
size and incidence of transfers across af-
fected parties.
Finally, this rule preserves the availabil-
ity of most of this savings under the one
percent exemption—certain eligible plans
are permitted to exercise the exemption
after seven months, thereby operating
under the exemption for up to 38 of the 45
months during which the MHPAis in ef-
fect.
This rule also requires certain notices
and disclosures by plans exercising the
one percent increased cost exemption.
The Departments undertook to estimate
the paperwork burdens associated with
these provisions, as well as the burden as-
sociated with determining whether a plan
is eligible for the exemption. These esti-
mates are summarized below.
The estimates reported immediately
below are for all plans affected by the no-
tice and disclosure provisions of this rule.
The Paperwork Reduction Act (PRA)
analysis that follows is presented sepa-
rately for affected private-sector plans
and for plans sponsored by nonfederal
governmental employers, which are under
the jurisdictions of the Departments of
Labor and of Health and Human Services,
respectively.
With respect to the notice to partici-
pants and beneficiaries and to the federal
government by plans exercising the one
percent cost exemption, the maximum
possible number of such notices is ap-
proximately 5.0 million (reflecting all
plans potentially eligible to elect the ex-
emption), while a more likely figure is 1.1
million (reflecting the Mercer survey
cited above). Assuming each notice re-
quires 2 minutes of labor at $11 per hour,
plus $0.50 for postage and materials, total
costs would amount to up to $4.3 million
or more probably $931,000. (These as-
sumptions reflect plans’ability to satisfy
this notice requirement through the provi-
sions of a separately required summary of
material modifications, as well as avail-
ability of a model notice to the govern-
ment, which together essentially elimi-
nate separate preparation burdens under
this requirement and help minimize ongo-
ing burdens.)
With respect to requirement for group
health plans to notify the federal govern-
ment of use of the transition period, and
to post these notices in the workplace,
only those plans whose plan years begin
during the first three months on 1998 and
who are potentially eligible for the one
percent cost exemption are potentially af-
fected by this provision. These notices
would be filed and posted within 30 days
or less of the beginning of the plan year,
so all would be filed in 1998. Based on
annual reports filed with the Department
of Labor, the Departments estimate that 60
percent of all eligible plans, accounting
for 72 percent of participants in such
plans, begin their plan years during these
months. This amounts to 18,000 plans,
representing the maximum number of no-
tices that would be filed. Extrapolating
from the Mercer survey cited above, about
4,000 of these plans might intend to pur-
sue the exemption, representing a more
probable number of notices to be filed.
Applying the same per unit cost assump-
tions as above to the filing and posting of
these notices, the cost of these notices
would be no more than $8,000 and more
likely $2,000. These assumptions reflect
the availability of a model notice, the use
of which eliminates preparation costs and
helps minimize ongoing burdens.
With respect to the requirement for
plans to disclose on request summary in-
formation documenting the plan’s eligibil-
ity for the one percent increased cost ex-
emption, the number of such disclosures
will depend on the volume of requests.
One might expect requests to arise most
commonly when participants are at or near
plans’dollar limits. Hay Huggins esti-
mates for the Congressional Research Ser-
vice (See Roland Sturm, “How Expensive
is Unlimited Mental Health Care Coverage
January 20, 1998181998–3 I.R.B.

Under Managed Care?” JAMA, Nov. 12,
1997—Vol. 278 No. 18) suggest that 0.73
percent of participants on average incur
mental health claims of more than
$10,000—a typical annual limit—in a
given year. The Departments adjusted this
figure to reflect the estimated relationship
between increased expenditures under the
MHPAfor plans eligible for the one per-
cent increased cost exemption and in-
creased expenditures under the MHPAfor
all affected plans, concluding that 3.74
percent of participants in plans eligible for
the one percent increased cost exemption
incur claims of more than $10,000 in a
given year. Assuming that this proportion
of participants in plans electing the ex-
emption request disclosures, the maxi-
mum number of such disclosure requests
would be 186,000, while a more probable
figure would be 40,000. Given the same
per unit cost assumptions as above, the as-
sociated costs would be $161,000 and
$35,000, respectively.
Finally, with respect to plan determina-
tions of eligibility for the one percent in-
creased cost exemption, the Departments
expect that plans wishing to exercise the
one percent increased cost exemption or
their service providers will revise their
automated claim record systems to facili-
tate calculation of the plans’increased
costs attributable to the MHPA. The
number of plans performing such func-
tions in-house that might wish to exercise
the exemption is estimated to be no than
5,346 and more probably 1,142. The
number of service providers (including
health insurance issuers and third party
administrators) that will perform this
function for plans that wish to exercise
the exemption is estimated to be 1,770
(including 400 third party administrators,
650 health insurers, 645 HMOs, and 75
Blue Cross Blue Shield organizations).
Assuming a start up cost of $5,000 per af-
fected entity, the total start-up cost associ-
ated with determining plans’eligibility to
exercise the exemption amounts to $14.6
million to $35.6 million, to be amortized
over 10 years beginning in 1998.
The estimates of the numbers and costs
of notices, disclosures and calculations
reported above, and below in connection
with the Paperwork Reduction Act, may
be high with respect to nonfederal gov-
ernmental plans. An estimated 2,215 self-
insured nonfederal governmental plans
might become eligible for the one percent
cost exemption. These plans are sepa-
rately permitted to opt out of the MHPA
entirely, thereby exercising an alternative
exemption with equivalent effect, and
without becoming subject to the calcula-
tion, notice, and disclosure requirements.
These plans cover 1.8 million individuals,
or 16 percent of individuals in potentially
eligible plans.
Weighted Average
The economic impact of the Depart-
ments’exercise of discretion in the
weighted average rule is also expected to
be modest.
First, separate limits for benefit cate-
gories other than mental health are not
very common. For example, among full-
time employees at establishments with
100 or more employees participating in
non-HMO group health plans in 1993,
only a fraction were subject to separate
limits for many major benefit categories.
For example, just 14 percent were subject
to separate limits for inpatient surgery,
just 13 percent were subject to such limits
for outpatient surgery, and only about one
in four were subject to separate limits for
both inpatient and office physician visits
(U.S. Bureau of Labor Statistics, Em-
ployee Benefits in Medium and Large Pri-
vate Establishments, 1993). “Separate
limits” in this context include not only
dollar limits, but also non-dollar limits,
such as inpatient day or outpatient visit
limits, as well as differential coinsurance
rates, copayments, or deductibles. There-
fore, the proportion with separate dollar
limits that would permit imposition of a
weighted average limit on mental health
benefits would be even smaller. In addi-
tion, such separate limits are even less
common in HMOs.
Second, discretion exercised in the
weighted average rule affects plans’abil-
ity to impose weighted average limits on
mental health benefits only at the margin.
In other words, compared with the ap-
proach set forth in the rule, alternative ap-
proaches would have increased or de-
creased the proportion of plans that are
able to impose weighted average limits
and the dollar level of calculated averages
by only a small amount.
Third, not all plans that are permitted to
impose weighted average limits on mental
health benefits will elect to do so.
Fourth, some plans that under the rule
are not permitted to impose weighted av-
erage limits on mental health benefits,
under an alternative approach, might have
been permitted to impose only a relatively
high limit. As such, their expenditure in-
creases from the MHPAmight have been
nearly the same with a weighted average
limit on mental health benefits as with no
separate limit on such benefits. Consider
a plan with a $500,000 annual cap on all
inpatient care and a $250,000 annual cap
on all outpatient care, and a $25,000 an-
nual cap on mental health benefits. Under
the interim rules, such a plan could not
impose a weighted average limit on men-
tal health benefits. Any separate limit on
mental health care would have to be at
least $750,000, or at least $500,000 for
inpatient care and at least $250,000 for
outpatient care. Had the plan been per-
mitted to impose a weighted average cap,
however, it still would have been required
to increase its mental health cap from
$25,000 to some amount between
$250,000 and $500,000, depending on the
weights.
Finally, as with the one percent cost ex-
emption and with the MHPAgenerally,
the impact of regulatory discretion in the
weighted average rule will be reduced be-
cause self-insured nonfederal governmen-
tal plans can opt out, the MHPA’s added
expenditure is modest, plans can be de-
signed in ways that lessen the MHPA’s
added expenditure, and the estimates pre-
sented here are conservative.
F. Unfunded Mandates Reform Act of
1995
The Unfunded Mandates Reform Act
of 1995 (P.L. 104–4) requires agencies to
prepare several analytic statements before
proposing any rules that may result in an-
nual expenditures of $100 million by
state, local and tribal governments or the
private sector. These rules are not subject
to the Unfunded Mandates Reform Act
because they are interim final rules.
However, consistent with the policy em-
bodied in the Unfunded Mandates Reform
Act, the regulation has been designed to
be the least burdensome alternative for
1998–3 I.R.B19January 20, 1998

January 20, 1998201998–3 I.R.B.
state, local and tribal governments, and
the private sector, while achieving the ob-
jectives of the MHPA.
G. Small Business Regulatory
Enforcement and Fairness Act of 1995.
The Administrator of the Office of In-
formation and Regulatory Affairs of the
Office of Management and Budget has
determined that this is a major rule for
purposes of the Small Business Regula-
tory Enforcement Fairness Act of 1996 (5
U.S.C. Section 801 et. seq.)(SBREFA).
The Secretaries have determined that the
effective date of these interim final rules is
January 1, 1998. Pursuant to Section
808(2) of SBREFA, the Secretaries find,
for good cause, that notice and public pro-
cedure thereon are impracticable, unneces-
sary and contrary to the public interest.
These rules are adopted on an interim
final basis because the Secretaries have
determined that without prompt guidance
some members of the regulated commu-
nity may have difficulty complying with
the MHPArequirements, which may re-
sult in an adverse impact on participants
and beneficiaries with regard to their
mental health benefits under group health
plans and the protections provided under
MHPA. Moreover, MHPA’s requirements
will affect the regulated community in the
immediate future.
MHPA’s requirements are effective for
all group health plans, and for health in-
surance issuers offering coverage in con-
nection with such plans for plan years be-
ginning on or after January 1, 1998. Plan
administrators and sponsors, issuers and
participants and beneficiaries will need
guidance on the new statutory provisions
before MHPA’s effective date. As noted
earlier, these interim rules take into ac-
count comments received by the Depart-
ments, in response to the request for pub-
lic comments on MHPApublished in the
Federal Registeron June 26, 1997 (62
FR 34604). For the foregoing reasons, the
Departments find that notice and public
comment would be impracticable, unnec-
essary and contrary to the public interest.
H. Paperwork Reduction Act—The
Department of Laborand the
Department of the Treasury
The Department of Labor and the De-
partment of the Treasury have submitted
this emergency processing public infor-
mation collection request (ICR), consist-
ing of three distinct ICRs to the Office of
Management and Budget (OMB) for re-
view and clearance under the Paperwork
Reduction Act of 1995 (Pub. L. 104–13,
44 U.S.C. Chapter 35). The Departments
have asked for OMB clearance as soon as
possible, and OMB approval is antici-
pated by the applicable effective date.
These regulations contain three dis-
tinct ICRs. The first ICR is a notice to
participants and beneficiaries and to the
federal government of the plan’s election
of the exemption from the MHPA’s provi-
sions due to an increase in cost under the
plan of at least one percent attributable to
compliance with these provisions. Aplan
may satisfy this requirement by provid-
ing participants and beneficiaries with a
notice of material reductions in covered
service or benefits, under the Department
of Labor’s regulations at 29 CFR section
2520.104b– 3(d), that includes the infor-
mation in paragraph (f)(3)(i) of this in-
terim final rule regarding issuing a notice
to participants and beneficiaries of the
plan’s exemption from these parity re-
quirements. Before the one percent in-
creased cost exemption is effective, the
plan must also notify the federal govern-
ment. For this purpose, the group health
plan may either send the Department of
Labor a copy of the summary of material
reductions in covered services or benefits
sent to participants and beneficiaries,
containing the plan number and the plan
sponsor’s employer identification num-
ber, or the plan (or coverage) may use the
Departments’model notice in this interim
final rule which has been developed for
this purpose.
The second ICR is a summary of the in-
formation used to calculate the plan’s in-
creased costs under the MHPAfor pur-
poses of electing the one percent
increased cost exemption, which the plan
must make available to participants and
beneficiaries, on request at no charge.
The third ICR is a notice of a group
health plan’s use of the transition period.
The rule requires plans exercising the one
percent increased cost exemption during
all or part of the first quarter of 1998
under the rule’s transition provisions to
notify the federal government, and to post
a copy of this notice at the workplace.
1.Notice to Participants and
Beneficiaries and the Federal
Government of Electing One Percent
Increased Cost Exemption
i.Department of Labor
The Department of Labor, as part of its
continuing effort to reduce paperwork and
respondent burden, conducts a preclear-
ance consultation program to provide the
general public and Federal agencies with
an opportunity to comment on proposed
and/or continuing collections of informa-
tion in accordance with the Paperwork
Reduction Act of 1995 (Pub. L. 104–13,
44 U.S.C. Chapter 35) and 5 CFR
1320.11. This program helps to ensure
that requested data can be provided in the
desired format, reporting burden (time
and financial resources) is minimized,
collection instruments are clearly under-
stood, and the impact of collection re-
quirements on respondents can be prop-
erly assessed. Currently, the Pension and
Welfare Benefits Administration is solic-
iting comments concerning the proposed
collection of information, Notice to Par-
ticipants and Beneficiaries and the Fed-
eral Government of Electing One Percent
Increased Cost Exemption. Acopy of the
proposed ICR can be obtained by contact-
ing the employee listed below in the con-
tact section of the notice.
Information collection: affected parties
are not required to comply with the ICRs
in these rules until the Department of
Labor publishes in the Federal Register
the control numbers assigned to these
ICRs by OMB. The publication of the
control numbers notifies the public that
OMB has approved these ICRs under the
Paperwork Reduction Act of 1995. The
Department has asked for OMB clearance
as soon as possible, and OMB approval is
anticipated by the applicable effective
date.
Dates:Written comments must be sub-
mitted to the office listed in the addressee
section below on or before February 20,
1998. The Department of Labor is partic-
ularly interested in comments which:
•evaluate whether the proposed collec-
tion of information is necessary for the
proper performance of the functions of
the agency, including whether the infor-
mation will have practical utility;

1998–3 I.R.B21January 20, 1998
•evaluate the accuracy of the agency’s
estimate of the burden of the proposed
collection of information, including the
validity of the methodology and as-
sumptions used;
•enhance the quality, utility, and clarity
of the information to be collected; and
•minimize the burden of the collection of
information on those who are to re-
spond, including through the use of ap-
propriate automated, electronic, me-
chanical, or other technological
collection techniques or other forms of
information technology, e.g., permitting
electronic submissions of responses.
Addressee: Gerald B. Lindrew, Office
of Policy and Research, U.S. Department
of Labor, Pension and Welfare Benefits
Administration, 200 Constitution Av-
enue, Room N-5647, Washington, DC
20210. Telephone: 202-219-4782 (this is
not a toll-free number). Fax: 202-219-
4745.
ii.Department of the Treasury
The collection of information is in
54.9812–1T. This information is required
by the interim final rules so that partici-
pants will be informed about their rights
under MHPA, and so that participants and
beneficiaries, and the federal government,
will receive notice of a plan’s election of
the one percent increased cost exemption.
The likely respondents are business or
other for-profit institutions, non-profit insti-
tutions, small businesses or organizations,
and Taft-Hartley trusts. Responses to this
collection of information are required to
obtain the benefit of the exemption.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Comments on the collection of infor-
mation should be sent to the Office of
Management and Budget, Attn: Desk Of-
ficer for the Department of the Treasury,
Office of Information and Regulatory Af-
fairs, Washington, DC 20503, with copies
to the Internal Revenue Service, Attn: IRS
Reports Clearance Officer, T:FP, Wash-
ington, DC 20224. Comments on the col-
lection of information should be received
on or before February 20, 1998. In light
of the request for OMB clearance by the
effective date of the MHPA, submission
of comments within the first 30 days is
encouraged to ensure their consideration.
Comments are specifically requested con-
cerning:
Whether the proposed collection of in-
formation is necessary for the proper per-
formance of the functions of the Internal
Revenue Service, including whether the
information will have practical utility;
The accuracy of the estimated burden
associated with the proposed collection of
information;
How to enhance the quality, utility, and
clarity of the information to be collected;
How to minimize the burden of com-
plying with the proposed collection of in-
formation, including 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 pur-
chase of services to provide information.
I.Background:MHPAgenerally re-
quires that group health plans provide par-
ity in the application of dollar limits to
mental health and medical/surgical bene-
fits. The statute exempts plans from this
requirement if its application results in an
increase in the cost under the plan or cov-
erage of at least one percent. This regula-
tion requires a plan electing this exemption
to notify participants and beneficiaries and
the federal government of the plan’s elec-
tion of the exemption. This ICR covers this
notification requirement.
II.Current Actions: Under 29 CFR
2590.712 (f)(3)(i) and (ii), and 26 CFR
54.9812–1Ta group health plan electing
the one percent exemption is obligated to
provide a written notice of that election to
participants and beneficiaries and to the
federal government of the plan’s election
of the exemption. Aplan may satisfy this
requirement by providing participants and
beneficiaries with a notice of material re-
ductions in covered service or benefits,
under the Department of Labor’s regula-
tions at 29 CFR section 2520.104b–3(d),
that includes the information in paragraph
(f)(3)(i) of this interim final rule regard-
ing issuing a notice to participants and
beneficiaries of the plan’s exemption
from these parity requirements. To satisfy
the requirement to notify the federal gov-
ernment, a group health plan may either
send the Department a copy of the sum-
mary of material reductions in covered
services or benefits sent to participants
and beneficiaries, containing the plan
number and the plan sponsor’s employer
identification number, or the plan may use
the Department’s model notice in this in-
terim final rule which has been developed
for this purpose. Based on past experi-
ence, the staff believes that most of the
materials required to be issued under this
notice procedure will be prepared by con-
tract service providers such as insurance
companies and third-party administrators.
Type of Review: New.
Agencies: U.S. Department of Labor,
Pension and Welfare Benefits Administra-
tion; U.S. Department of the Treasury, In-
ternal Revenue Service.
Title: Notice to Participants and Bene-
ficiaries and the Federal Government of
Electing One Percent Increased Cost Ex-
emption
OMB Number: XXXXXXX
Affected Public: Individuals or house-
holds; Business or other for-profit; Not-
for-profit institutions; Group health plans.
Frequency: On occasion
Burden:
YearTotal Total ResponsesAverage TimeBurden HoursCost
Respondents (range)per Response(range)(range)
(range)(range)
1998–––––
19995,612 to 25,446813,505 to 3.8MM2 minutes6,324 to 29,605$705,037
to $3.3MM
2000 –––––
TOTALS5,612 to 25,446813,505 to 3.8MM2 minutes6,324 to 29,605$705,037
to $3.3MM

Comments submitted in response to this
notice will be summarized and/or in-
cluded in the request for OMB approval
of the ICRs; they will also become a mat-
ter of public record.
2.Calculation and Disclosure of
Documentation of Eligibility for
Exemption
i.Department of Labor
The Department of Labor, as part of its
continuing effort to reduce paperwork and
respondent burden, conducts a preclear-
ance consultation program to provide the
general public and Federal agencies with
an opportunity to comment on proposed
and/or continuing collections of informa-
tion in accordance with the Paperwork
Reduction Act of 1995 (Pub. L. 104–13,
44 U.S.C. Chapter 35) and 5 CFR
1320.11. This program helps to ensure
that requested data can be provided in the
desired format, reporting burden (time
and financial resources) is minimized,
collection instruments are clearly under-
stood, and the impact of collection re-
quirements on respondents can be prop-
erly assessed. Currently, the Pension and
Welfare Benefits Administration is solic-
iting comments concerning the proposed
collection of information, Disclosure of
Documentation of Eligibility for Exemp-
tion. Acopy of the proposed ICR can be
obtained by contacting the employee
listed below in the contact section of the
notice.
Information collection: affected parties
are not required to comply with the ICRs
in these rules until the Department of
Labor publishes in the Federal Register
the control numbers assigned to these
ICRs by OMB. The publication of the
control numbers notifies the public that
OMB has approved these ICRs under the
Paperwork Reduction Act of 1995. The
Department has asked for OMB clearance
as soon as possible, and OMB approval is
anticipated by the applicable effective
date.
Dates:Written comments must be sub-
mitted to the office listed in the addressee
section below on or before February 20,
1998. The Department of Labor is partic-
ularly interested in comments which:
•evaluate whether the proposed collec-
tion of information is necessary for the
proper performance of the functions of
the agency, including whether the infor-
mation will have practical utility;
•evaluate the accuracy of the agency’s
estimate of the burden of the proposed
collection of information, including the
validity of the methodology and as-
sumptions used;
•enhance the quality, utility, and clarity
of the information to be collected; and
•minimize the burden of the collection of
information on those who are to re-
spond, including through the use of ap-
propriate automated, electronic, me-
chanical, or other technological
collection techniques or other forms of
information technology, e.g., permitting
electronic submissions of responses.
Addressee: Gerald B. Lindrew, Office
of Policy and Research, U.S. Department
of Labor, Pension and Welfare Benefits
Administration, 200 Constitution Avenue,
Room N-5647, Washington, DC 20210.
Telephone: 202-219-4782 (this is not a
toll-free number). Fax: 202-219-4745.
ii.Department of the Treasury
The collection of information is in Sec-
tion 54.9812–1T. This information is re-
quired by the interim final rules so that
participants will be informed about their
rights under MHPA, and so that partici-
pants and beneficiaries may receive a
summary of the information upon which
the plan based it election of the one per-
cent increased cost exemption. The likely
respondents are business or other for-
profit institutions, non-profit institutions,
small businesses or organizations, and
Taft-Hartley trusts. Responses to this col-
lection of information are required to ob-
tain the benefit of the exemption.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Comments on the collection of infor-
mation should be sent to the Office of
Management and Budget, Attn: Desk Of-
ficer for the Department of the Treasury,
Office of Information and Regulatory Af-
fairs, Washington, DC 20503, with copies
to the Internal Revenue Service, Attn: IRS
Reports Clearance Officer, T:FP, Wash-
ington, DC 20224. Comments on the col-
lection of information should be received
on or before February 20, 1998. In light
of the request for OMB clearance by the
effective date of the MHPA, submission
of comments within the first 30 days is
encouraged to ensure their consideration.
Comments are specifically requested con-
cerning:
Whether the proposed collection of in-
formation is necessary for the proper per-
formance of the functions of the Internal
Revenue Service, including whether the
information will have practical utility;
The accuracy of the estimated burden
associated with the proposed collection of
information;
How to enhance the quality, utility, and
clarity of the information to be collected;
How to minimize the burden of com-
plying with the proposed collection of in-
formation, including 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 pur-
chase of services to provide information.
I.Background:MHPAgenerally re-
quires that group health plans provide
parity in the application of dollar limits to
mental health and medical/surgical bene-
fits. The statute exempts plans from this
requirement if its application results in an
increase in the cost under the plan or cov-
erage of at least one percent. This regula-
tion requires plans wishing to elect this
exemption to calculate their increased
costs according to certain rules. It further
requires plans electing this exemption to
disclose to participants and beneficiaries
(or their representatives), on request, and
at no charge, a summary of the informa-
tion upon which the exemption was
based. This ICR covers this disclosure re-
quirement.
II.Current Actions: Under 29 CFR
2590.712(f)(2) and 26 CFR 54.9812–1T,
a group health plan wishing to elect the
one percent exemption must calculate
their increased costs according to certain
rules. Under 29 CFR 2590.712(f)(4) and
26 CFR 54.9812–1T, a group health plan
electing the one percent exemption is ob-
ligated to disclose to participants and ben-
eficiaries (or their representatives), on re-
quest and at no charge, a summary of the
information on which the exemption was
based.
January 20, 1998221998–3 I.R.B.

Type of Review: New.
Agencies: U.S. Department of Labor,
Pension and Welfare Benefits Administra-
tion; U.S. Department of the Treasury, In-
ternal Revenue Service.
Title: Calculation and Disclosure of
Documentation of Eligibility for Exemp-
tion
OMB Number: XXXXXXX
Affected Public: Individuals or house-
holds; Business or other for-profit; Not-
for-profit institutions; Group Health
Plans.
Frequency: On occasion
Calculation burden: It is expected that
plans wishing to exercise the one percent
increased cost exemption or their service
providers will revise their automated
claim record systems to facilitate calcula-
tion of the plans’increased costs attribut-
able to the MHPA. The number of plans
performing such functions in-house that
might wish to exercise the exemption is
estimated to be no than 4,489 and more
probably 958. The number of service
providers (including health insurance is-
suers and third party administrators) that
will perform this function for plans using
service providers that wish to exercise the
exemption is estimated to be 1,770. As-
suming a cost of $5,000 per affected en-
tity, the total cost associated with deter-
mining plans’eligibility to exercise the
exemption amounts to $12.5 million to
$30.1 million, to be amortized over 10
years beginning in 1998.
Disclosure burden: In addition to the
calculation burden, plans wishing to elect
the one percent increased cost exemption
will incur a burden in connection with
disclosure requests from participants, as
detailed below.
1998–3 I.R.B23January 20, 1998
YearTotal Total ResponsesAverage Burden HoursCost
Respondents(range)Time per(range)(range)
(range)Response
1998–––––
19995,612 to 25,46630,188 to 140,4122 minutes235 to 1,101$26,163 to $121,690
2000 5,612 to 25,46630,188 to 140,4122 minutes235 to 1,101$26,163 to $121,690
TOTALS5,612 to 25,46660,377 to 280,8242 minutes470 to 2,201$52,326 to $243,381
Comments submitted in response to
this notice will be summarized and/or in-
cluded in the request for OMB approval
of the ICRs; they will also become a mat-
ter of public record.
3.Notice of Group Health Plan’s Use of
Transition Period, and Posting
Thereof
i.Department of Labor
The Department of Labor, as part of its
continuing effort to reduce paperwork and
respondent burden, conducts a preclear-
ance consultation program to provide the
general public and Federal agencies with
an opportunity to comment on proposed
and/or continuing collections of informa-
tion in accordance with the Paperwork
Reduction Act of 1995 (Pub. L. 104–13,
44 U.S.C. Chapter 35) and 5 CFR
1320.11. This program helps to ensure
that requested data can be provided in the
desired format, reporting burden (time
and financial resources) is minimized,
collection instruments are clearly under-
stood, and the impact of collection re-
quirements on respondents can be prop-
erly assessed. Currently, the Pension and
Welfare Benefits Administration is solic-
iting comments concerning the proposed
collection of information, Notice of
Group Health Plan’s Use of Transition Pe-
riod. Acopy of the proposed ICR can be
obtained by contacting the employee
listed below in the contact section of the
notice.
Information collection: affected parties
are not required to comply with the ICRs
in these rules until the Department of
Labor publishes in the Federal Register
the control numbers assigned to these
ICRs by OMB. The publication of the
control numbers notifies the public that
OMB has approved these ICRs under the
Paperwork Reduction Act of 1995. The
Department has asked for OMB clearance
as soon as possible, and OMB approval is
anticipated by the applicable effective
date.
Dates:Written comments must be sub-
mitted to the office listed in the addressee
section below on or before February 20,
1998. The Department of Labor is partic-
ularly interested in comments which:
•evaluate whether the proposed collec-
tion of information is necessary for the
proper performance of the functions of
the agency, including whether the infor-
mation will have practical utility;
•evaluate the accuracy of the agency’s
estimate of the burden of the proposed
collection of information, including the
validity of the methodology and as-
sumptions used;
•enhance the quality, utility, and clarity
of the information to be collected; and
•minimize the burden of the collection of
information on those who are to re-
spond, including through the use of ap-
propriate automated, electronic, me-
chanical, or other technological
collection techniques or other forms of
information technology, e.g., permitting
electronic submissions of responses.
Addressee: Gerald B. Lindrew, Office
of Policy and Research, U.S. Department
of Labor, Pension and Welfare Benefits
Administration, 200 Constitution Av-
enue, Room N-5647, Washington, DC
20210. Telephone: 202-219-4782 (this is
not a toll-free number). Fax: 202-219-
4745.
ii.Department of the Treasury
The collection of information is in Sec-
tion 54.9812–1T. This information is re-
quired by the interim final rules so that
participants will be informed about their
rights under MHPA, and so that plans
electing the one percent increased cost ex-
emption during all or part of the first quar-
ter of 1998 under the rules’transition pro-

visions will notify the federal government
and post the notice in the workplace. The
likely respondents are business or other
for-profit institutions, non-profit institu-
tions, small businesses or organizations,
and Taft-Hartley trusts. Responses to this
collection of information are required to
obtain the benefit of the exemption.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Comments on the collection of informa-
tion should be sent to the Office of Man-
agement and Budget, Attn: Desk Officer
for the Department of the Treasury, Office
of Information and Regulatory Affairs,
Washington, DC 20503, with copies to the
Internal Revenue Service, Attn: IRS Re-
ports Clearance Officer, T:FP, Washing-
ton, DC 20224. Comments on the collec-
tion of information should be received on
or before February 20, 1998. In light of
the request for OMB clearance by the ef-
fective date of the MHPA, submission of
comments within the first 30 days is en-
couraged to ensure their consideration.
Comments are specifically requested con-
cerning:
Whether the proposed collection of in-
formation is necessary for the proper per-
formance of the functions of the Internal
Revenue Service, including whether the
information will have practical utility;
The accuracy of the estimated burden
associated with the proposed collection of
information;
How to enhance the quality, utility, and
clarity of the information to be collected;
How to minimize the burden of com-
plying with the proposed collection of in-
formation, including 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 services to provide informa-
tion.
I.Background:MHPAgenerally re-
quires that group health plans provide
parity in the application of dollar limits to
mental health and medical/surgical bene-
fits. The statute exempts plans from this
requirement if its application results in an
increase in the cost under the plan or cov-
erage of at least one percent. This regula-
tion requires a notice of group health
plan’s use of transition period, under
which plans electing the one percent in-
creased cost exemption during all or part
of the first quarter of 1998 under the
rule’s transition provisions must notify
the federal government and to post a copy
of the notice in the workplace. This ICR
covers this notification requirement.
II.Current Actions: Under 29 CFR
2590.712(h)(3)(ii) and 26 CFR 54.9812–
1T, group health plans electing the one
percent increased cost exemption during
all or part of the first quarter of 1998
under the rule’s transition provisions must
notify the federal government. Based on
past experience, the staff believes that
most of the materials required to be issued
under this notice procedure will be pre-
pared by contract service providers such
as insurance companies and third-party
administrators.
Type of Review: New.
Agencies : U.S. Department of Labor,
Pension and Welfare Benefits Administra-
tion; U.S. Department of the Treasury, In-
ternal Revenue Service.
Title: Notice of Group Health Plan’s
Use of Transition Period
OMB Number: XXXXXXX
Affected Public: Individuals or house-
holds; Business or other for-profit; Not-
for-profit institutions; Group Health
Plans.
Frequency: On occasion
Burden:
January 20, 1998241998–3 I.R.B.
YearTotal Total ResponsesAverageBurden HoursCost
Respondents(range)Time per(range)(range)
(range)Response
19983,348 to 15,1933,348 to 15,1932 minutes19 to 89$1,514 to $6,910
1999–––––
2000 –––––
TOTALS3,348 to 15,1933,348 to 15,1932 minutes19 to 89$1,514 to $6,910
Comments submitted in response to
this notice will be summarized and/or in-
cluded in the request for OMB approval
of the ICRs; they will also become a mat-
ter of public record.
I. Paperwork Reduction Act—
Department of Health and Human
Services
Under the Paperwork Reduction Act of
1995 (PRA), agencies are required to pro-
vide a 60-day notice in the Federal Reg-
isterand solicit public comment before a
collection of information requirement is
submitted to the Office of Management
and Budget (OMB) for review and ap-
proval. In order to fairly evaluate
whether an information collection should
be approved by OMB, section
3506(c)(2)(A) of the PRArequires that
we solicit comment on the following is-
sues:
•Whether the information collection is
necessary and useful to carry out the
proper functions of the agency;
•The accuracy of the agency’s esti-
mate of the information collection
burden;
•The quality, utility, and clarity of the
information to be collected; and
•Recommendations to minimize the
information collection burden on the
affected public, including automated
collection techniques.
Therefore, we are soliciting public com-
ment on each of these issues for the infor-
mation collection requirements discussed
below.
Section 146.136 of this document con-
tains three distinct information collection
requirements, as summarized below:
Type of Information Request:New collec-
tion.
Title of Information Collection:Mental
Health Parity Act of 1996; Information

Collection Requirements Contained in 45
CFR 146.136; HCFA-2891-IFC.
Form Number:HCFA-R-223 (OMB ap-
proval #: 0938-XXXX)
Use:The information collection require-
ments contained in this interim final rule
will help ensure that sponsors and admin-
istrators of group health plans notify the
required individuals/entities of a plan’s
exemption from the MHPAparity require-
ments and make the data used to calculate
the exemption available to affected indi-
viduals and entities.
Frequency:On occasion.
Affected Public:States, businesses or
other for profit, not-for-profit institutions,
Federal Government, individuals or
households.
Notification Requirements:Nonfederal
governmental plans, not exempt from the
parity requirements by reason of an opt
out under regulations at 45 CFR 146.180,
must furnish participants and beneficia-
ries with a notice of the plan’s exemption
from the parity requirements based on in-
creased costs. Aplan may satisfy this re-
quirement by providing participants and
beneficiaries with a notice of material re-
ductions in covered services or benefits,
under 29 CFR 2520.104b–3(d), that in-
cludes the information in paragraph
(f)(3)(i). Even though a plan generally is
not required to furnish a material reduc-
tion in covered services or benefits for 60
days, in no case will the exemption be ef-
fective until 30 days after the notice is
sent to participants and beneficiaries. For
this purpose, a plan that does not furnish
the summary of material reductions in
covered services or benefits may satisfy
its notice requirements by using the
model exemption notice described above
in this preamble.
In addition, the nonfederal governmen-
tal plan (or issuer providing coverage to
such a plan) must also furnish to the De-
partment of Health and Human Services a
notice similar to the notice sent to partici-
pants and beneficiaries before the exemp-
tion is effective. For this purpose, the
plan may either send the Department the
summary of material reductions in cov-
ered services or benefits sent to partici-
pants and beneficiaries, or the plan (or is-
suer) may use the model described above.
In all cases, the exemption is not effective
until 30 days after notice has been sent.
Burden:
1998–3 I.R.B25January 20, 1998
YearTotalTotalAverageBurdenCost
RespondentsResponsesTime perHours(range)
(range)(range)Response(range)
(range)
1998–––––
1999890 to 4,092261,000 to 1.2 MM2 minutes2,133 to 9,975$226,000
to $1.1 MM
2000–––––
TOTALS890 to 4,092261,000 to 1.2 MM2 minutes2,133 to 9,975$226,000
to $1.1 MM
Availability of documentation:Nonfed-
eral governmental plans that take the ex-
emption, or issuers that provide coverage
for such plans, must make available to
participants and beneficiaries, on request
and at no charge, a summary of the data
used to calculate the exemption of this
section. The summary of data must in-
clude the incurred expenditures (includ-
ing identification of the portion of the
total representing claims and the portion
of the total representing administrative
expenses), the base period, the claims in-
curred during the base period that would
have been denied under the terms of the
plan absent amendments required to com-
ply with parity, and the administrative ex-
penses attributable to complying with the
parity requirements.
Burden:
YearTotalTotalAverageBurdenCost
RespondentsResponsesTime perHours(range)
(range)(range)Response(range)
(range)
1998–––––
1999890 to 4,0929,700 to 45,3002 minutes79 to 372$8,400 to
$39,300
2000890 to 4,0929,700 to 45,3002 minutes79 to 372$8,400 to
$39,300
TOTALS890 to 4,09219,400 to 90,6002 minutes158 to 744$16,800
to $78,600

Plans that take the exemption will incur
start up costs for preparing to issue the in-
formation they must disclose. We esti-
mate the start up costs for nonfederal gov-
ernmental plans that take this exemption
to range from $2.1 million to $5.5 million.
Notice of Use of Transition Period:
With respect to the increased cost exemp-
tion, the interim rules provide in para-
graph (g)(3) a transition period for com-
pliance with the requirements of
paragraph (f). Under paragraph (g)(3), no
enforcement action shall be taken against
a nonfederal governmental plan that is
subject to the MHPArequirements prior
to April 1, 1998 solely because the plan
claims the increased cost exemption
under section 2705(c)(2) of the PHS Act
based on assumptions inconsistent with
the rules under paragraph (f), provided
that the plan is amended to comply with
the parity requirements no later than
March 31, 1998 and the plan complies
with the certain notice requirements. A
nonfederal governmental plan satisfies
the notice requirements only if such plan
provides notice to the Department of
Health and Human Services of the plan’s
intent to use the transition period by 30
days after the first day of the plan year be-
ginning on or after January 1, 1998, but in
no event can the notice be provided later
than March 31, 1998. Such notice shall
include the name of the plan; the name,
address, and telephone number of the plan
sponsor or plan administrator; the em-
ployer identification number; and the plan
number. In addition, such notice must be
provided at no charge to participants
within 30 days after receipt of a written
request for such notification.
Burden:
January 20, 1998261998–3 I.R.B.
YearTotalTotalAverageBurdenCost
RespondentsResponsesTime perHours(range)
(range)(range)Response(range)
(range)
1998531 to 2,441531 to 2,4412 minutes4 to17$250 to
$1,151
1999–––––
2000–––––
TOTALS531 to 2,441531 to 2,4412 minutes4 to17$250 to
$1,151
We have submitted a copy of this pro-
posed rule to OMB for its review of the
information collection requirements in
§146.136. These requirements are not ef-
fective until they have been approved by
OMB.
If you comment on any of these infor-
mation collection and recordkeeping re-
quirements, please mail copies directly to
the following:
Health Care Financing Administration,
Office of Information Services,
Information Technology Investment
Management Group,
Division of HCFAEnterprise
Standards,
Room C2-26-17, 7500 Security
Boulevard,
Baltimore, MD 21244-1850.
ATTN: John Burke HCFA-2891-IFC
We have submitted a copy of this rule
to OMB for its review of these informa-
tion collections. Anotice will be pub-
lished in the Federal Registerwhen ap-
proval is obtained. Interested persons are
invited to send comments regarding this
burden or any other aspect of these collec-
tions of information. If you comment on
these information collection and record-
keeping requirements, please mail copies
directly to the following addresses:
Office of Information and Regulatory
Affairs
Office of Management and Budget
Room 10235
New Executive Office Building
Washington, DC 20530, Attn: Allison
Herron Eydt, HCFADesk Officer.
DATED:
Gerald B. Lindrew
Deputy Director, Pension and Welfare
Benefits Administration,
Office of Policy and Research
Statutory Authority
The Department of the Treasury tempo-
rary rule is adopted pursuant to the author-
ity contained in sections 7805 and 9833 of
the Code (26 U.S.C. 7805, 9833), as
amended by HIPAA(Pub. L. 104–191, 110
Stat. 1936) and the Taxpayer Relief Act of
1997 (Pub. L. 105–34, 111 Stat. 788).
The Department of Labor interim final
rule is adopted pursuant to the authority
contained in sections 107, 209, 505, 701–
703, 711, 712, and 731–734 of ERISA(29
U.S.C. 1027, 1059, 1135, 1171–1173,
1181, 1182, and 1191-1194), as amended
by HIPAA(Pub. L. 104–191, 110 Stat.
1936) and MHPA(Pub. L. 104–204, 110
Stat. 2944), and Secretary of Labor’s Order
No. 1–87, 52 FR 13139, April 21, 1987.
The Department of Health and Human
Services interim final rule is adopted pur-
suant to the authority contained in sec-
tions 2701, 2702, 2705, 2711, 2712, 2713,
2721, 2722, 2723, and 2792 of the PHS
Act (42 U.S.C. 300gg, 300gg–1,
300gg–5, 300gg–11, 300gg–12, 300gg-
13, 300gg–21, 300gg–22, 300gg–23, and
300gg-92), as established by HIPAA
(Pub. L. 104–191, 110 Stat. 1936) and
MHPA(Pub. L. 104–204, 110 Stat. 2944).
* * * * *
Adoption of Amendments to the
Regulations
Internal Revenue Service
26 CFR Chapter I
Accordingly, 26 CFR Part 54 is
amended as follows:
PART54—PENSION EXCISE TAXES
Paragraph 1. The authority citation for
part 54 is amended by revising the entries

for §§54.9801–1Tthrough 54.9801–6T
and 54.9802–1T, by removing the entries
for §§54.9804–1Tand 54.9806–1T, and
by adding entries for §§54.9812–1T,
54.9831–1T, and 54.9833–1Tto read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 54.9801–1Talso issued under
26 U.S.C. 9833.
Section 54.9801–2Talso issued under
26 U.S.C. 9833.
Section 54.9801–3Talso issued under
26 U.S.C. 9833.
Section 54.9801–4Talso issued under
26 U.S.C. 9833.
Section 54.9801–5Talso issued under
26 U.S.C. 9801(c)(4), 9801(e)(3), and
9833.
Section 54.9801–6Talso issued under
26 U.S.C. 9833.
Section 54.9802–1Talso issued under
26 U.S.C. 9833.
Section 54.9812–1Talso issued under
26 U.S.C. 9833.
Section 54.9831–1Talso issued under
26 U.S.C. 9833.
Section 54.9833–1Talso issued under
26 U.S.C. 9833.
Par. 2. In §54.9801–1T, paragraph (a)
is revised to read as follows:
§54.9801–1TBasis and scope
(temporary).
(a) Statutory basis.Sections 54.9801–
1Tthrough 54.9801-6T, 54.9802–1T,
54.9812–1T, 54.9831–1Tand 54.9833–
1T(portability sections) implement Chap-
ter 100 of Subtitle K of the Internal Rev-
enue Code of 1986.
* * * * *
Par. 3. Section 54.9801-2Tis amended
by:
1. Revising the introductory text.
2. Revising the definition of excepted
benefits.
3. Revising the definition of health in-
surance coverage.
The revisions read as follows:
§54.9801–2TDefinitions (temporary).
Unless otherwise provided, the defini-
tions in this section govern in applying
the provisions of §§54.9801–1Tthrough
54.9801–6T, 54.9802–1T, 54.9812–1T,
54.9831–1T, and 54.9833–1T.
* * * * *
Excepted benefitsmeans the benefits
described as excepted in §54.9831–1T(b).
* * * * *
Health insurance coveragemeans ben-
efits consisting of medical care (provided
directly, through insurance or reimburse-
ment, or otherwise) under any hospital or
medical service policy or certificate, hos-
pital or medical service plan contract, or
HMO contract offered by a health insur-
ance issuer. However, benefits described
in §54.9831–1T(b)(2) are not treated as
benefits consisting of medical care.
* * * * *
Par. 4. In §54.9801–4T, paragraph
(a)(2) is revised to read as follows:
§54.9801–4TRules relating to
creditable coverage (temporary).
(a) * * *
(2) Excluded coverage.Creditable
coverage does not include coverage con-
sisting solely of coverage of excepted
benefits (described in §54.9831–1T).
* * * * *
Par. 5. In §54.9801–5T, the first sen-
tence of paragraph (a)(3)(vi) is revised to
read as follows:
§54.9801–5TCertification and
disclosure of previous coverage
(temporary).
(a) * * *
(3) * * *
(vi) Excepted benefits; categories of
benefits. No certificate is required to be
furnished with respect to excepted bene-
fits described in §54.9831–1T. * * *
* * * * *
§54.9804–1T[Redesignated as
§54.9831–1T]
Par. 6. Section 54.9804–1Tis redesig-
nated as §54.9831–1Tand revised in
paragraph (b)(1) to read as follows:
§54.9831–1TSpecial rules relating to
group health plans (temporary).
* * * * *
(b) Excepted benefits—(1) In general.
The requirements of §§54.9801–1T
through 54.9801–6T, 54.9802–1T, and
54.9812–1Tdo not apply to any group
health plan in relation to its provision of
the benefits described in paragraph (b)(2),
(3), (4), or (5) of this section (or any com-
bination of these benefits).
* * * * *
§54.9806–1T[Redesignated as
§54.9833–1T]
Par. 7. Section 54.9806–1Tis redesig-
nated as §54.9833–1Tand amended by:
1. Revising redesignated paragraph
(a)(1).
2. Revising the first sentence of redes-
ignated paragraph (a)(2).
The revisions read as follows:
§54.9833–1TEffective dates (temporary).
(a) General effective dates—(1) Non-
collectively-bargained plans.Except as
otherwise provided in this section, Chap-
ter 100 of Subtitle K and §§54.9801–1T
through 54.9806–1T, 54.9802–1T, and
54.9831–1Tapply with respect to group
health plans for plan years beginning after
June 30, 1997.
(2) Collectively bargained plans.Ex-
cept as otherwise provided in this section
(other than paragraph (a)(1) of this sec-
tion), in the case of a group health plan
maintained pursuant to one or more col-
lective bargaining agreements between
employee representatives and one or more
employers ratified before August 21,
1996, Chapter 100 of Subtitle K and
§§54.9801–1Tthrough 54. 9801–6T,
54.9802–1T, and 54.9831–1Tdo not
apply to plan years beginning before the
later of July 1, 1997, or the date on which
the last of the collective bargaining agree-
ments relating to the plan terminates (de-
termined without regard to any extension
thereof agreed to after August 21, 1996).
* * *
* * * * *
Par. 8. Section 54.9812–1Tis added to
read as follows:
§54.9812–1TParity in the application of
certain limits to mental health benefits
(temporary).
(a) Definitions.For purposes of this
section, except where the context clearly
indicates otherwise, the following defini-
tions apply:
Aggregate lifetime limitmeans a dollar
limitation on the total amount of specified
benefits that may be paid under a group
1998–3 I.R.B27January 20, 1998

health plan for an individual (or for a
group of individuals considered a single
unit in applying this dollar limitation,
such as a family or an employee plus
spouse).
Annual limitmeans a dollar limitation
on the total amount of specified benefits
that may be paid in a 12-month period
under a plan for an individual (or for a
group of individuals considered a single
unit in applying this dollar limitation, such
as a family or an employee plus spouse).
Medical/surgical benefitsmeans bene-
fits for medical or surgical services, as de-
fined under the terms of the plan, but does
not include mental health benefits.
Mental health benefitsmeans benefits
for mental health services, as defined
under the terms of the plan, but does not
include benefits for treatment of sub-
stance abuse or chemical dependency.
(b) Requirements regarding limits on
benefits—(1) In general—(i) General
parity requirement.Agroup health plan
that provides both medical/surgical bene-
fits and mental health benefits must com-
ply with paragraph (b)(2), (3), or (6) of
this section.
(ii) Exception.The rule in paragraph
(b)(1)(i) of this section does not apply if a
plan satisfies the requirements of para-
graph (e) or (f) of this section.
(2) Plan with no limit or limits on less
than one-third of all medical/surgical
benefits.If a plan does not include an ag-
gregate lifetime or annual limit on any
medical/surgical benefits or includes ag-
gregate lifetime or annual limits that
apply to less than one-third of all med-
ical/surgical benefits, it may not impose
an aggregate lifetime or annual limit, re-
spectively, on mental health benefits.
(3) Plan with a limit on at least two-
thirds of all medical/surgical benefits.If
a plan includes an aggregate lifetime or
annual limit on at least two-thirds of all
medical/surgical benefits, it must either—
(i) Apply the aggregate lifetime or an-
nual limit both to the medical/surgical
benefits to which the limit would other-
wise apply and to mental health benefits
in a manner that does not distinguish be-
tween the medical/surgical and mental
health benefits; or
(ii) Not include an aggregate lifetime
or annual limit on mental health benefits
that is less than the aggregate lifetime or
annual limit, respectively, on the med-
ical/surgical benefits.
(4) Examples.The rules of paragraphs
(b)(2) and (3) of this section are illus-
trated by the following examples:
Example 1.(i) Prior to the effective date of the
mental health parity provisions, a group health plan
had no annual limit on medical/surgical benefits and
had a $10,000 annual limit on mental health bene-
fits. To comply with the parity requirements of this
paragraph (b), the plan sponsor is considering each
of the following options:
(A) Eliminating the plan’s annual limit on mental
health benefits;
(B) Replacing the plan’s previous annual limit on
mental health benefits with a $500,000 annual limit
on all benefits (including medical/surgical and men-
tal health benefits); and
(C) Replacing the plan’s previous annual limit on
mental health benefits with a $250,000 annual limit
on medical/surgical benefits and a $250,000 annual
limit on mental health benefits.
(ii) In this Example 1,each of the three options
being considered by the plan sponsor would comply
with the requirements of this section because they
offer parity in the dollar limits placed on
medical/surgical and mental health benefits.
Example 2. (i) Prior to the effective date of the
mental health parity provisions, a group health plan
had a $100,000 annual limit on medical/surgical in-
patient benefits, a $50,000 annual limit on
medical/surgical outpatient benefits, and a $100,000
annual limit on all mental health benefits. To com-
ply with the parity requirements of this paragraph
(b), the plan sponsor is considering each of the fol-
lowing options:
(A) Replacing the plan’s previous annual limit on
mental health benefits with a $150,000 annual limit
on mental health benefits; and
(B) Replacing the plan’s previous annual limit on
mental health benefits with a $100,000 annual limit
on mental health inpatient benefits and a $50,000
annual limit on mental health outpatient benefits.
(ii) In this Example 2, each option under consid-
eration by the plan sponsor would comply with the
requirements of this section because they offer par-
ity in the dollar limits placed on medical/surgical
and mental health benefits.
Example 3.(i) Agroup health plan that is sub-
ject to the requirements of this section has no aggre-
gate lifetime or annual limit for either medical/surgi-
cal benefits or mental health benefits. While the
plan provides medical/surgical benefits with respect
to both network and out-of-network providers, it
does not provide mental health benefits with respect
to out-of-network providers.
(ii) In this Example 3,the plan complies with the
requirements of this section because they offer par-
ity in the dollar limits placed on medical/surgical
and mental health benefits.
Example 4.(i) Prior to the effective date of the
mental health parity provisions, a group health plan
had an annual limit on medical/surgical benefits and
a separate but identical annual limit on mental health
benefits. The plan included benefits for treatment of
substance abuse and chemical dependency in its def-
inition of mental health benefits. Accordingly,
claims paid for treatment of substance abuse and
chemical dependency were counted in applying the
annual limit on mental health benefits. To comply
with the parity requirements of this paragraph (b),
the plan sponsor is considering each of the following
options:
(A) Making no change in the plan so that claims
paid for treatment of substance abuse and chemical
dependency continue to count in applying the annual
limit on mental health benefits;
(B) amending the plan to count claims paid for
treatment of substance abuse and chemical depen-
dency in applying the annual limit on medical/surgi-
cal benefits (rather than counting those claims in ap-
plying the annual limit on mental health benefits);
(C) amending the plan to provide a new category
of benefits for treatment of chemical dependency
and substance abuse that is subject to a separate,
lower limit and under which claims paid for treat-
ment of substance abuse and chemical dependency
are counted only in applying the annual limit on this
separate category; and
(D) amending the plan to eliminate distinctions
between medical/surgical benefits and mental health
benefits and establishing an overall limit on benefits
offered under the plan under which claims paid for
treatment of substance abuse and chemical depen-
dency are counted with medical/surgical benefits and
mental health benefits in applying the overall limit.
(ii) In this Example 4,the group health plan is
described in paragraph (b)(3) of this section. Be-
cause mental health benefits are defined in para-
graph (a) of this section as excluding benefits for
treatment of substance abuse and chemical depen-
dency, the inclusion of benefits for treatment of sub-
stance abuse and chemical dependency in applying
an aggregate lifetime limit or annual limit on mental
health benefits under option (A) of this Example 4
would not comply with the requirements of para-
graph (b)(3) of this section. However, options (B),
(C), and (D) of this Example 4 would comply with
the requirements of paragraph (b)(3) of this section
because they offer parity in the dollar limits placed
on medical/surgical and mental health benefits.
(5) Determining one-third and two-
thirds of all medical/surgical benefits.
For purposes of this paragraph (b), the de-
termination of whether the portion of
medical/surgical benefits subject to a
limit represents one-third or two-thirds of
all medical/surgical benefits is based on
the dollar amount of all plan payments for
medical/surgical benefits expected to be
paid under the plan for the plan year (or
for the portion of the plan year after a
change in plan benefits that affects the ap-
plicability of the aggregate lifetime or an-
nual limits). Any reasonable method may
be used to determine whether the dollar
amounts expected to be paid under the
plan will constitute one-third or two-
thirds of the dollar amount of all plan pay-
ments for medical/surgical benefits.
(6)Plan not described in paragraph
(b)(2) or (3) of this section—(i) In gen-
eral.Agroup health plan that is not de-
scribed in paragraph (b)(2) or (3) of this
section, must either—
January 20, 1998281998–3 I.R.B.

(A) Impose no aggregate lifetime or an-
nual limit, as appropriate, on mental
health benefits; or
(B) Impose an aggregate lifetime or an-
nual limit on mental health benefits that is
no less than an average limit for med-
ical/surgical benefits calculated in the fol-
lowing manner. The average limit is cal-
culated by taking into account the
weighted average of the aggregate life-
time or annual limits, as appropriate, that
are applicable to the categories of med-
ical/surgical benefits. Limits based on de-
livery systems, such as inpatient/outpa-
tient treatment or normal treatment of
common, low-cost conditions (such as
treatment of normal births), do not consti-
tute categories for purposes of this para-
graph (b)(6)(i)(B). In addition, for pur-
poses of determining weighted averages,
any benefits that are not within a category
that is subject to a separately-designated
limit under the plan are taken into account
as a single separate category by using an
estimate of the upper limit on the dollar
amount that a plan may reasonably be ex-
pected to incur with respect to such bene-
fits, taking into account any other applica-
ble restrictions under the plan.
(ii) Weighting.For purposes of this
paragraph (b)(6), the weighting applica-
ble to any category of medical/surgical
benefits is determined in the manner set
forth in paragraph (b)(5) of this section
for determining one-third or two-thirds of
all medical/surgical benefits.
(iii) Example.The rules of this para-
graph (b)(6) are illustrated by the follow-
ing example:
Example.(i) Agroup health plan that is subject
to the requirements of this section includes a
$100,000 annual limit on medical/surgical benefits
related to cardio-pulmonary diseases. The plan does
not include an annual limit on any other category of
medical/surgical benefits. The plan determines that
40% of the dollar amount of plan payments for med-
ical/surgical benefits are related to cardio-pul-
monary diseases. The plan determines that
$1,000,000 is a reasonable estimate of the upper
limit on the dollar amount that the plan may incur
with respect to the other 60% of payments for med-
ical/surgical benefits.
(ii) In this Example,the plan is not described in
paragraph (b)(3) of this section because there is not
one annual limit that applies to at least two-thirds of
all medical/surgical benefits. Further, the plan is not
described in paragraph (b)(2) of this section because
more than one-third of all medical/surgical benefits
are subject to an annual limit. Under this paragraph
(b)(6), the plan sponsor can choose either to include
no annual limit on mental health benefits, or to in-
clude an annual limit on mental health benefits that
is not less than the weighted average of the annual
limits applicable to each category of medical/surgi-
cal benefits. In this example, the minimum
weighted average annual limit that can be applied to
mental health benefits is $640,000 (40%
3
$100,000 + 60% x $1,000,000 = $640,000).
(c) Rule in the case of separate benefit
packages. If a group health plan offers
two or more benefit packages, the re-
quirements of this section, including the
exemption provisions in paragraph (f) of
this section, apply separately to each ben-
efit package. Examples of a group health
plan that offers two or more benefit pack-
ages include a group health plan that of-
fers employees a choice between indem-
nity coverage or HMO coverage, and a
group health plan that provides one bene-
fit package for retirees and a different
benefit package for current employees.
(d) Applicability—(1) Group health
plans.The requirements of this section
apply to a group health plan offering both
medical/surgical benefits and mental
health benefits regardless of whether the
mental health benefits are administered
separately under the plan.
(2) Health insurance issuers.See 29
CFR 2590.712(d)(2) and 45 CFR
146.136(d)(2), which provide that health
insurance issuers offering health insur-
ance coverage for both medical/surgical
benefits and mental health benefits in
connection with a group health plan are
subject to rules similar to those applicable
to group health plans under this section.
(3) Scope.This section does not—
(i) Require a group health plan to pro-
vide any mental health benefits; or
(ii) Affect the terms and conditions (in-
cluding cost sharing, limits on the number
of visits or days of coverage, require-
ments relating to medical necessity, re-
quiring prior authorization for treatment,
or requiring primary care physicians’re-
ferrals for treatment) relating to the
amount, duration, or scope of the mental
health benefits under the plan except as
specifically provided in paragraph (b) of
this section.
(e) Small employer exemption—(1) In
general.The requirements of this section
do not apply to a group health plan for a
plan year of a small employer. For pur-
poses of this paragraph (e), the term small
employermeans, in connection with a
group health plan with respect to a calen-
dar year and a plan year, an employer who
employed an average of at least two but
not more than 50 employees on business
days during the preceding calendar year
and who employs at least two employees
on the first day of the plan year. See sec-
tion 9831(a) and §54.9831–1T(a), which
provide that this section (and certain other
sections) does not apply to any group
health plan for any plan year if, on the
first day of the plan year, the plan has
fewer than two participants who are cur-
rent employees.
(2) Rules in determining employer size.
For purposes of paragraph (e)(1) of this
section—
(i) All persons treated as a single em-
ployer under subsections (b), (c), (m), and
(o) of section 414 are treated as one em-
ployer;
(ii) If an employer was not in existence
throughout the preceding calendar year,
whether it is a small employer is deter-
mined based on the average number of
employees the employer reasonably ex-
pects to employ on business days during
the current calendar year; and
(iii) Any reference to an employer for
purposes of the small employer exemp-
tion includes a reference to a predecessor
of the employer.
(f) Increased cost exemption—(1) In
general.Agroup health plan is not sub-
ject to the requirements of this section if
the requirements of this paragraph (f) are
satisfied. If a plan offers more than one
benefit package, this paragraph (f) applies
separately to each benefit package. Ex-
cept as provided in paragraph (h) of this
section, a plan must comply with the re-
quirements of paragraph (b)(1)(i) of this
section for the first plan year beginning
on or after January 1, 1998, and must con-
tinue to comply with the requirements of
paragraph (b)(1)(i) of this section until the
plan satisfies the requirements in this
paragraph (f). In no event is the exemp-
tion of this paragraph (f) effective until 30
days after the notice requirements in para-
graph (f)(3) of this section are satisfied.
If the requirements of this paragraph (f)
are satisfied with respect to a plan, the ex-
emption continues in effect (at the plan’s
discretion) until September 30, 2001,
even if the plan subsequently purchases a
different policy from the same or a differ-
ent issuer and regardless of any other
changes to the plan’s benefit structure.
1998–3 I.R.B29January 20, 1998

(2) Calculation of the one-percent in-
crease—(i) Ratio.Agroup health plan
satisfies the requirements of this para-
graph (f)(2) if the application of para-
graph (b)(1)(i) of this section to the plan
results in an increase in the cost under the
plan of at least one percent. The applica-
tion of paragraph (b)(1)(i) of this section
results in an increased cost of at least one
percent under a group health plan only if
the ratio below equals or exceeds
1.01000. The ratio is determined as fol-
lows:
(A) The incurred expenditures during
the base period, divided by,
(B) The incurred expenditures during
the base period, reduced by—-
(1) The claims incurred during the
base period that would have been denied
under the terms of the plan absent plan
amendments required to comply with this
section; and
(2) Administrative expenses attribut-
able to complying with the requirements
of this section.
(ii) Formula.The ratio of paragraph
(f)(2)(i) of this section is expressed math-
ematically as follows:
IE
≥1.01000
IE – (CE + AE)
(A) IEmeans the incurred expendi-
tures during the base period.
(B) CEmeans the claims incurred dur-
ing the base period that would have been
denied under the terms of the plan absent
plan amendments required to comply with
this section
(C) AEmeans administrative costs re-
lated to claims in CEand other adminis-
trative costs attributable to complying
with the requirements of this section.
(iii) Incurred expenditures. Incurred
expenditures meansactual claims in-
curred during the base period and re-
ported within two months following the
base period, and administrative costs for
all benefits under the group health plan,
including mental health benefits and med-
ical/surgical benefits, during the base pe-
riod. Incurred expenditures do not in-
clude premiums.
(iv) Base period. Base period means
the period used to calculate whether the
plan may claim the one-percent increased
cost exemption in this paragraph (f). The
base period must begin on the first day in
any plan year that the plan complies with
the requirements of paragraph (b)(1)(i) of
this section and must extend for a period
of at least six consecutive calendar
months. However, in no event may the
base period begin prior to September 26,
1996 (the date of enactment of the Mental
Health Parity Act (Pub. L. 104-204, 110
Stat. 2944)).
(v) Rating pools.For plans that are
combined in a pool for rating purposes,
the calculation under this paragraph (f)(2)
for each plan in the pool for the base pe-
riod is based on the incurred expenditures
of the pool, whether or not all the plans in
the pool have participated in the pool for
the entire base period. (However, only
the plans that have complied with para-
graph (b)(1)(i) of this section for at least
six months as a member of the pool sat-
isfy the requirements of this paragraph
(f)(2).) Otherwise, the calculation under
this paragraph (f)(2) for each plan is cal-
culated by the plan administrator based on
the incurred expenditures of the plan.
(vi) Examples.The rules of this para-
graph (f)(2) are illustrated by the follow-
ing examples:
Example 1.(i) Agroup health plan has a plan
year that is the calendar year. The plan satisfies the
requirements of paragraph (b)(1)(i) of this section as
of January 1, 1998. On September 15, 1998, the
plan determines that $1,000,000 in claims have been
incurred during the period between January 1, 1998
and June 30, 1998 and reported by August 30, 1998.
The plan also determines that $100,000 in adminis-
trative costs have been incurred for all benefits
under the group health plan, including mental health
benefits. Thus, the plan determines that its incurred
expenditures for the base period are $1,100,000.
The plan also determines that the claims incurred
during the base period that would have been denied
under the terms of the plan absent plan amendments
required to comply with this section are $40,000 and
that administrative expenses attributable to comply-
ing with the requirements of this section are
$10,000. Thus, the total amount of expenditures for
the base period had the plan not been amended to
comply with the requirements of paragraph (b)(1)(i)
of this section are $1,050,000 ($1,100,000 –
($40,000 + $10,000) = $1,050,000).
(ii) In this Example 1,the plan satisfies the re-
quirements of this paragraph (f)(2) because the ap-
plication of this section results in an increased cost
of at least one percent under the terms of the plan
($1,100,000/$1,050,000 = 1.04762).
Example 2.(i) Ahealth insurance issuer sells a
group health insurance policy that is rated on a
pooled basis and is sold to 30 group health plans.
One of the group health plans inquires whether it
qualifies for the one-percent increased cost exemp-
tion. The issuer performs the calculation for the
pool as a whole and determines that the application
of this section results in an increased cost of 0.500
percent (for a ratio under this paragraph (f)(2) of
1.00500) for the pool. The issuer informs the re-
questing plan and the other plans in the pool of the
calculation.
(ii) In this Example 2,none of the plans satisfy
the requirements of this paragraph (f)(2) and a plan
that purchases a policy not complying with the re-
quirements of paragraph (b)(1)(i) of this section vio-
lates the requirements of this section.
Example 3.(i) Apartially insured plan is collect-
ing the information to determine whether it qualifies
for the exemption. The plan administrator deter-
mines the incurred expenses for the base period for
the self-funded portion of the plan to be $2,000,000
and the administrative expenses for the base period
for the self-funded portion to be $200,000. For the
insured portion of the plan, the plan administrator
requests data from the insurer. For the insured por-
tion of the plan, the plan’s own incurred expenses
for the base period are $1,000,000 and the adminis-
trative expenses for the base period are $100,000.
The plan administrator determines that under the
self-funded portion of the plan, the claims incurred
for the base period that would have been denied
under the terms of the plan absent the amendment
are $0 because the self-funded portion does not
cover mental health benefits and the plan’s adminis-
trative costs attributable to complying with the re-
quirements of this section are $1,000. The issuer de-
termines that under the insured portion of the plan,
the claims incurred for the base period that would
have been denied under the terms of the plan absent
the amendment are $25,000 and the administrative
costs attributable to complying with the require-
ments of this section are $1,000. Thus, the total in-
curred expenditures for the plan for the base period
are $3,300,000 ($2,000,000 + $200,000 +
$1,000,000 + $100,000 = $3,300,000) and the total
amount of expenditures for the base period had the
plan not been amended to comply with the require-
ments of paragraph (b)(1)(i) of this section are
$3,273,000 ($3,300,000 – ($0 + $1,000 + $25,000 +
$1,000) = $3,273,000).
(ii) In this Example 3,the plan does not satisfy
the requirements of this paragraph (f)(2) because the
application of this section does not result in an in-
creased cost of at least one percent under the terms
of the plan ($3,300,000/$3,273,000 = 1.00825).
(3) Notice of exemption—(i) Partici-
pants and beneficiaries—(A) In general.
Agroup health plan must notify partici-
pants and beneficiaries of the plan’s deci-
sion to claim the one-percent increased
cost exemption. The notice must include
the following information:
(1) Astatement that the plan is exempt
from the requirements of this section and
a description of the basis for the exemp-
tion;
(2) The name and telephone number of
the individual to contact for further infor-
mation;
(3) The plan name and plan number
(PN);
(4) The plan administrator’s name, ad-
dress, and telephone number;
January 20, 1998301998–3 I.R.B.

(5) For single-employer plans, the plan
sponsor’s name, address, and telephone
number (if different from paragraph
(f)(3)(i)(A)(3) of this section) and the
plan sponsor’s employer identification
number (EIN);
(6) The effective date of the exemption;
(7) The ability of participants and bene-
ficiaries to contact the plan administrator
to see how benefits may be affected as a
result of the plan’s claim of the exemp-
tion; and
(8) The availability, upon request and
free of charge, of a summary of the infor-
mation required under paragraph (f)(4) of
this section.
(B) Use of summary of material reduc-
tions in covered services or benefits.A
plan may satisfy the requirements of para-
graph (f)(3)(i)(A) of this section by pro-
viding participants and beneficiaries (in
accordance with paragraph (f)(3)(i)(C) of
this section) with a summary of material
reductions in covered services or benefits
required under 29 CFR 2520.104b-3(d)
that also includes the information of this
paragraph (f)(3)(i). However, in all cases,
the exemption is not effective until 30
days after notice has been sent.
(C) Delivery.The notice described in
this paragraph (f)(3)(i) is required to be
provided to all participants and beneficia-
ries. The notice may be furnished by any
method of delivery that satisfies the re-
quirements of section 104(b)(1) of the
Employee Retirement Income Security
Act of 1974 (29 U.S.C. 1024(b)(1)) (e.g.,
first-class mail). If the notice is provided
to the participant at the participant’s last
known address, then the requirements of
this paragraph (f)(3)(i) are satisfied with
respect to the participant and all benefi-
ciaries residing at that address. If a bene-
ficiary’s last known address is different
from the participant’s last known address,
a separate notice is required to be pro-
vided to the beneficiary at the benefi-
ciary’s last known address.
(D) Example.The rules of this para-
graph (f)(3)(i) are illustrated by the fol-
lowing example:
E
xample.(i) Agroup health plan has a plan year
that is the calendar year and has an open enrollment
period every November 1 through November 30.
The plan determines on September 15 that it satis-
fies the requirements of paragraph (f)(2) of this sec-
tion. As part of its open enrollment materials, the
plan mails, on October 15, to all participants and
beneficiaries a notice satisfying the requirements of
this paragraph (f)(3)(i).
(ii) In this Example,the plan has sent the notice
in a manner that complies with this paragraph
(f)(3)(i).
(ii) Federal agencies.Agroup health
plan that is a church plan (as defined in
section 414(e)) claiming the exemption of
this paragraph (f) for any benefit package
must provide notice in accordance with the
requirement of this paragraph (f)(3)(ii).
This requirement is satisfied if the plan
sends a copy, to the address designated by
the Secretary in generally applicable guid-
ance, of the notice described in paragraph
(f)(3)(i) of this section identifying the ben-
efit package to which the exemption ap-
plies. For any other group health plan, see
29 CFR 2590.712(f)(3)(ii)(B).
(4) Availability of documentation.The
plan must make available to participants
and beneficiaries (or their representa-
tives), on request and at no charge, a sum-
mary of the information on which the ex-
emption was based. An individual who is
not a participant or beneficiary and who
presents a notice described in paragraph
(f)(3)(i) of this section is considered to be
a representative. Arepresentative may
request the summary of information by
providing the plan a copy of the notice
provided to the participant under para-
graph (f)(3)(i) of this section with any in-
dividually identifiable information
redacted. The summary of information
must include the incurred expenditures,
the base period, the dollar amount of
claims incurred during the base period
that would have been denied under the
terms of the plan absent amendments re-
quired to comply with paragraph (b)(1)(i)
of this section, the administrative costs re-
lated to those claims, and other adminis-
trative costs attributable to complying
with the requirements of this section. In
no event should the summary of informa-
tion include any individually identifiable
information.
(g) Special rules for group health in-
surance coverage—(1) Sale of nonparity
policies.See 29 CFR 2590.712(g)(1) and
45 CFR 146.136(g)(1) for rules limiting
the right of an issuer to sell a policy with-
out parity (as described in 29 CFR
2590.712(b) and 45 CFR 146.136(b)) to a
plan that meets the requirements of 29
CFR 2590.712(e) or (f) and 45 CFR
146.136(e) or (f)).
(2) Duration of exemption.After a plan
meets the requirements of paragraph (f) of
this section, the plan may change issuers
without having to meet the requirements
of paragraph (f) of this section again be-
fore September 30, 2001.
(h) Effective dates—(1) In general.
The requirements of this section are ap-
plicable for plan years beginning on or
after January 1, 1998.
(2) Limitation on actions(i) Except as
provided in paragraph (h)(3) of this sec-
tion, no enforcement action is to be taken
by the Secretary against a group health
plan that has sought to comply in good
faith with the requirements of section
9812, with respect to a violation that oc-
curs before the earlier of—
(A) The first day of the first plan year
beginning on or after April 1, 1998; or
(B) January 1, 1999.
(ii) Compliance with the requirements
of this section is deemed to be good faith
compliance with the requirements of sec-
tion 9812.
(iii) The rules of this paragraph (h)(2)
are illustrated by the following examples:
Example 1.(i) Agroup health plan has a plan
year that is the calendar year. The plan complies
with section 9812 in good faith using assumptions
inconsistent with paragraph (b)(6) of this section re-
lating to weighted averages for categories of bene-
fits.
(ii) In this Example 1, no enforcement action
may be taken against the plan with respect to a vio-
lation resulting solely from those assumptions and
occurring before January 1, 1999.
Example 2. (i) Agroup health plan has a plan
year that is the calendar year. For the entire 1998
plan year, the plan applies a $1,000,000 annual limit
on medical/surgical benefits and a $100,000 annual
limit on mental health benefits.
(ii) In this Example 2, the plan has not sought to
comply with the requirements of section 9812 in
good faith, and this paragraph (h)(2) does not apply.
(3) Transition period for increased cost
exemption—(i) In general.No enforce-
ment action will be taken against a group
health plan that is subject to the require-
ments of this section based on a violation
of this section that occurs before April 1,
1998 solely because the plan claims the
increased cost exemption under section
9812(c)(2) based on assumptions incon-
sistent with the rules under paragraph (f)
of this section, provided that a plan
amendment that complies with the re-
quirements of paragraph (b)(1)(i) of this
section is adopted and effective no later
than March 31, 1998 and the plan com-
plies with the notice requirements in para-
graph (h)(3)(ii) of this section.
1998–3 I.R.B31January 20, 1998

(ii) Notice of plan’s use of transition
period.(A) Agroup health plan satisfies
the requirements of this paragraph
(h)(3)(ii) only if the plan provides notice
to the applicable federal agency and posts
the notice at the location(s) where docu-
ments must be made available for exami-
nation by participants and beneficiaries
under section 104(b)(2) of the Employee
Retirement Income Security Act of 1974,
and the regulations thereunder (29 CFR
2520.104b-1(b)(3)). The notice must in-
dicate the plan’s decision to use the transi-
tion period in paragraph (h)(3)(i) of this
section by 30 days after the first day of
the plan year beginning on or after Janu-
ary 1, 1998, but in no event later than
March 31, 1998. For a group health plan
that is a church plan (as defined in section
414(e)), the applicable federal agency is
the Department of the Treasury. For a
group health plan that is not a church
plan, see 29 CFR 2590.712(h)(3)(ii). The
notice must include—
(1) The name of the plan and the plan
number (PN);
(2) The name, address, and telephone
number of the plan administrator;
(3) For single-employer plans, the
name, address, and telephone number of
the plan sponsor (if different from the
plan administrator) and the plan sponsor’s
employer identification number (EIN);
(4) The name and telephone number of
the individual to contact for further infor-
mation; and
(5) The signature of the plan adminis-
trator and the date of the signature.
(B) The notice must be provided at no
charge to participants or their representa-
tive within 15 days after receipt of a writ-
ten or oral request for such notification,
but in no event before the notice has been
sent to the applicable federal agency.
(i) Sunset.This section does not apply
to benefits for services furnished on or
after September 30, 2001.
Deputy Commissioner of
Internal Revenue.
Acting Assistant Secretary of
the Treasury.
Pension and Welfare Benefits
Administration
29 CFR Chapter XXV
29 CFR Part 2590 is amended as fol-
lows:
PART2590—RULES AND
REGULATIONS FOR HEALTH
INSURANCE PORTABILITYAND
RENEWABILITYFOR GROUP
HEALTH PLANS
1. The authority citation for Part 2590
is revised to read as follows:
Authority:Secs. 107, 209, 505, 701-
703, 711, 712, and 731-734 of ERISA(29
U.S.C. 1027, 1059, 1135, 1171-1173,
1181, 1182, and 1191-1194), as amended
by Pub. L. 104-191, 110 Stat. 1936) and
Pub. L. 104-204, 110 Stat. 2944; and Sec-
retary of Labor’s Order No. 1-87, 52 FR
13139, April 21, 1987.
Subpart B—OtherRequirements
2. Section 2590.712 is revised to read
as follows:
§ 2590.712 Parity in the application of
certain limits to mental health benefits.
(a) Definitions. For purposes of this
section, except where the context clearly
indicates otherwise, the following defini-
tions apply:
Aggregate lifetime limitmeans a dollar
limitation on the total amount of specified
benefits that may be paid under a group
health plan (or group health insurance
coverage offered in connection with such
a plan) for an individual (or for a group of
individuals considered a single unit in ap-
plying this dollar limitation, such as a
family or an employee plus spouse).
Annual limitmeans a dollar limitation
on the total amount of specified benefits
that may be paid in a 12-month period
under a plan (or group health insurance
coverage offered in connection with such
a plan) for an individual (or for a group of
individuals considered a single unit in ap-
plying this dollar limitation, such as a
family or an employee plus spouse).
Medical/surgical benefitsmeans bene-
fits for medical or surgical services, as de-
fined under the terms of the plan or group
health insurance coverage, but does not
include mental health benefits.
Mental health benefitsmeans benefits
for mental health services, as defined
under the terms of the plan or group
health insurance coverage, but does not
include benefits for treatment of sub-
stance abuse or chemical dependency.
(b) Requirements regarding limits on
benefits—(1) In general—(i) General
parity requirement.Agroup health plan
(or health insurance coverage offered by
an issuer in connection with a group
health plan) that provides both
medical/surgical benefits and mental
health benefits must comply with para-
graph (b)(2), (3), or (6) of this section.
(ii) Exception. The rule in paragraph
(b)(1)(i) of this section does not apply if a
plan, or coverage, satisfies the require-
ments of paragraph (e) or (f) of this sec-
tion.
(2) Plan with no limit or limits on less
than one-third of all medical/surgical
benefits.If a plan (or group health insur-
ance coverage) does not include an aggre-
gate lifetime or annual limit on any med-
ical/surgical benefits or includes
aggregate lifetime or annual limits that
apply to less than one-third of all med-
ical/surgical benefits, it may not impose
an aggregate lifetime or annual limit, re-
spectively, on mental health benefits.
(3) Plan with a limit on at least two-
thirds of all medical/surgical benefits.If
a plan (or group health insurance cover-
age) includes an aggregate lifetime or an-
nual limit on at least two-thirds of all
medical/surgical benefits, it must either—
(i) Apply the aggregate lifetime or an-
nual limit both to the medical/surgical
benefits to which the limit would other-
wise apply and to mental health benefits
in a manner that does not distinguish be-
tween the medical/surgical and mental
health benefits; or
(ii) Not include an aggregate lifetime
or annual limit on mental health
benefits that is less than the aggregate
lifetime or annual limit, respectively, on
the medical/surgical benefits.
(4) Examples.The rules of paragraphs
(b)(2) and (3) of this section are illus-
trated by the following examples:
January 20, 1998321998–3 I.R.B.

Example 1. (i) Prior to the effective date of the
mental health parity provisions, a group health plan
had no annual limit on medical/surgical benefits and
had a $10,000 annual limit on mental health bene-
fits. To comply with the parity requirements of this
paragraph (b), the plan sponsor is considering each
of the following options:
(A) Eliminating the plan’s annual limit on mental
health benefits;
(B) Replacing the plan’s previous annual limit on
mental health benefits with a $500,000 annual limit
on all benefits (including medical/surgical and men-
tal health benefits); and
(C) Replacing the plan’s previous annual limit on
mental health benefits with a $250,000 annual limit
on medical/surgical benefits and a $250,000 annual
limit on mental health benefits.
(ii) In this Example 1,each of the three options
being considered by the plan sponsor would comply
with the requirements of this section because they
offer parity in the dollar limits placed on
medical/surgical and mental health benefits.
Example 2.(i) Prior to the effective date of the
mental health parity provisions, a group health plan
had a $100,000 annual limit on medical/surgical in-
patient benefits, a $50,000 annual limit on
medical/surgical outpatient benefits, and a $100,000
annual limit on all mental health benefits. To com-
ply with the parity requirements of this paragraph
(b), the plan sponsor is considering each of the fol-
lowing options:
(A) Replacing the plan’s previous annual limit on
mental health benefits with a $150,000 annual limit
on mental health benefits; and
(B) Replacing the plan’s previous annual limit on
mental health benefits with a $100,000 annual limit
on mental health inpatient benefits and a $50,000
annual limit on mental health outpatient benefits.
(ii) In this Example 2,each option under consid-
eration by the plan sponsor would comply with the
requirements of this section because they offer par-
ity in the dollar limits placed on medical/surgical
and mental health benefits.
Example 3.(i) Agroup health plan that is sub-
ject to the requirements of this section has no aggre-
gate lifetime or annual limit for either medical/surgi-
cal benefits or mental health benefits. While the
plan provides medical/surgical benefits with respect
to both network and out-of-network providers, it
does not provide mental health benefits with respect
to out-of-network providers.
(ii) In thisExample 3,the plan complies with the
requirements of this section because they offer par-
ity in the dollar limits placed on medical/surgical
and mental health benefits.
Example 4.(i) Prior to the effective date of the
mental health parity provisions, a group health plan
had an annual limit on medical/surgical benefits and
a separate but identical annual limit on mental health
benefits. The plan included benefits for treatment of
substance abuse and chemical dependency in its def-
inition of mental health benefits. Accordingly,
claims paid for treatment of substance abuse and
chemical dependency were counted in applying the
annual limit on mental health benefits. To comply
with the parity requirements of this paragraph (b),
the plan sponsor is considering each of the following
options:
(A) Making no change in the plan so that claims
paid for treatment of substance abuse and chemical
dependency continue to count in applying the annual
limit on mental health benefits;
(B) amending the plan to count claims paid for
treatment of substance abuse and chemical depen-
dency in applying the annual limit on medical/surgi-
cal benefits (rather than counting those claims in ap-
plying the annual limit on mental health benefits);
(C) amending the plan to provide a new category
of benefits for treatment of chemical dependency
and substance abuse that is subject to a separate,
lower limit and under which claims paid for treat-
ment of substance abuse and chemical dependency
are counted only in applying the annual limit on this
separate category; and
(D) amending the plan to eliminate distinctions
between medical/surgical benefits and mental health
benefits and establishing an overall limit on benefits
offered under the plan under which claims paid for
treatment of substance abuse and chemical depen-
dency are counted with medical/surgical benefits and
mental health benefits in applying the overall limit.
(ii) In this Example 4,the group health plan is
described in paragraph (b)(3) of this section. Be-
cause mental health benefits are defined in para-
graph (a) of this section as excluding benefits for
treatment of substance abuse and chemical depen-
dency, the inclusion of benefits for treatment of sub-
stance abuse and chemical dependency in applying
an aggregate lifetime limit or annual limit on mental
health benefits under option (A) of this Example 4
would not comply with the requirements of para-
graph (b)(3) of this section. However, options (B),
(C), and (D) of this Example 4would comply with
the requirements of paragraph (b)(3) of this section
because they offer parity in the dollar limits placed
on medical/surgical and mental health benefits.
(5) Determining one-third and two-
thirds of all medical/surgical benefits.
For purposes of this paragraph (b), the de-
termination of whether the portion of
medical/surgical benefits subject to a
limit represents one-third or two-thirds of
all medical/surgical benefits is based on
the dollar amount of all plan payments for
medical/surgical benefits expected to be
paid under the plan for the plan year (or
for the portion of the plan year after a
change in plan benefits that affects the ap-
plicability of the aggregate lifetime or an-
nual limits). Any reasonable method may
be used to determine whether the dollar
amounts expected to be paid under the
plan will constitute one-third or two-
thirds of the dollar amount of all plan pay-
ments for medical/surgical benefits.
(6) Plan not described in paragraph
(b)(2) or (3) of this section—(i) In gen-
eral. Agroup health plan (or group health
insurance coverage) that is not described
in paragraph (b)(2) or (3) of this section,
must either—
(A) Impose no aggregate lifetime or an-
nual limit, as appropriate, on mental
health benefits; or
(B) Impose an aggregate lifetime or an-
nual limit on mental health benefits that is
no less than an average limit calculated
for medical/surgical benefits in the fol-
lowing manner. The average limit is cal-
culated by taking into account the
weighted average of the aggregate life-
time or annual limits, as appropriate, that
are applicable to the categories of med-
ical/surgical benefits. Limits based on de-
livery systems, such as inpatient/outpa-
tient treatment or normal treatment of
common, low-cost conditions (such as
treatment of normal births), do not consti-
tute categories for purposes of this para-
graph (b)(6)(i)(B). In addition, for pur-
poses of determining weighted averages,
any benefits that are not within a category
that is subject to a separately-designated
limit under the plan are taken into account
as a single separate category by using an
estimate of the upper limit on the dollar
amount that a plan may reasonably be ex-
pected to incur with respect to such bene-
fits, taking into account any other applica-
ble restrictions under the plan.
(ii) Weighting.For purposes of this
paragraph (b)(6), the weighting applica-
ble to any category of medical/surgical
benefits is determined in the manner set
forth in paragraph (b)(5) of this section
for determining one-third or two-thirds of
all medical/surgical benefits.
(iii) Example.The rules of this para-
graph (b)(6) are illustrated by the follow-
ing example:
Example. (i) Agroup health plan that is subject
to the requirements of this section includes a
$100,000 annual limit on medical/surgical benefits
related to cardio- pulmonary diseases. The plan
does not include an annual limit on any other cate-
gory of medical/surgical benefits. The plan deter-
mines that 40% of the dollar amount of plan pay-
ments for medical/surgical benefits are related to
cardio-pulmonary diseases. The plan determines
that $1,000,000 is a reasonable estimate of the upper
limit on the dollar amount that the plan may incur
with respect to the other 60% of payments for med-
ical/surgical benefits.
(ii) In thisExample,the plan is not described in
paragraph (b)(3) of this section because there is not
one annual limit that applies to at least two-thirds of
all medical/surgical benefits. Further, the plan is not
described in paragraph (b)(2) of this section because
more than one-third of all medical/surgical benefits
are subject to an annual limit. Under this paragraph
(b)(6), the plan sponsor can choose either to include
no annual limit on mental health benefits, or to in-
clude an annual limit on mental health benefits that
is not less than the weighted average of the annual
limits applicable to each category of medical/surgi-
cal benefits. In this example, the minimum
1998–3 I.R.B33January 20, 1998

weighted average annual limit that can be applied to
mental health benefits is $640,000 (40% x $100,000
+ 60% 3$1,000,000 = $640,000).
(c) Rule in the case of separate benefit
packages.If a group health plan offers
two or more benefit packages, the re-
quirements of this section, including the
exemption provisions in paragraph (f) of
this section, apply separately to each ben-
efit package. Examples of a group health
plan that offers two or more benefit pack-
ages include a group health plan that of-
fers employees a choice between indem-
nity coverage or HMO coverage, and a
group health plan that provides one bene-
fit package for retirees and a different
benefit package for current employees.
(d) Applicability—(1) Group health
plans. The requirements of this section
apply to a group health plan offering both
medical/surgical benefits and mental
health benefits regardless of whether the
mental health benefits are administered
separately under the plan.
(2) Health insurance issuers.The re-
quirements of this section apply to a
health insurance issuer offering health in-
surance coverage for both medical/surgi-
cal benefits and mental health benefits in
connection with a group health plan.
(3) Scope.This section does not—
(i) Require a group health plan (or
health insurance issuer offering coverage
in connection with a group health plan) to
provide any mental health benefits; or
(ii) Affect the terms and conditions (in-
cluding cost sharing, limits on the number
of visits or days of coverage, require-
ments relating to medical necessity, re-
quiring prior authorization for treatment,
or requiring primary care physicians’re-
ferrals for treatment) relating to the
amount, duration, or scope of the mental
health benefits under the plan (or cover-
age) except as specifically provided in
paragraph (b) of this section.
(e) Small employer exemption—(1) In
general.The requirements of this section
do not apply to a group health plan (or
health insurance issuer offering coverage
in connection with a group health plan)
for a plan year of a small employer. For
purposes of this paragraph (e), the term
small employermeans, in connection with
a group health plan with respect to a cal-
endar year and a plan year, an employer
who employed an average of at least two
but not more than 50 employees on busi-
ness days during the preceding calendar
year and who employs at least two em-
ployees on the first day of the plan year.
See section 732(a) of the Act and
§2590.732(a), which provide that this sec-
tion (and certain other sections) does not
apply to any group health plan (and health
insurance issuer offering coverage in con-
nection with a group health plan) for any
plan year if, on the first day of the plan
year, the plan has fewer than two partici-
pants who are current employees.
(2) Rules in determining employer size.
For purposes of paragraph (e)(1) of this
section—
(i) All persons treated as a single em-
ployer under subsections (b), (c), (m), and
(o) of section 414 of the Internal Revenue
Code of 1986 (26 U.S.C. 414) are treated
as one employer;
(ii) If an employer was not in existence
throughout the preceding calendar year,
whether it is a small employer is deter-
mined based on the average number of
employees the employer reasonably ex-
pects to employ on business days during
the current calendar year; and
(iii) Any reference to an employer for
purposes of the small employer exemp-
tion includes a reference to a predecessor
of the employer.
(f) Increased cost exemption—(1) In
general.Agroup health plan (or health
insurance coverage offered in connection
with a group health plan) is not subject to
the requirements of this section if the re-
quirements of this paragraph (f) are satis-
fied. If a plan offers more than one bene-
fit package, this paragraph (f) applies
separately to each benefit package. Ex-
cept as provided in paragraph (h) of this
section, a plan must comply with the re-
quirements of paragraph (b)(1)(i) of this
section for the first plan year beginning
on or after January 1, 1998, and must con-
tinue to comply with the requirements of
paragraph (b)(1)(i) of this section until the
plan satisfies the requirements in this
paragraph (f). In no event is the exemp-
tion of this paragraph (f) effective until 30
days after the notice requirements in para-
graph (f)(3) of this section are satisfied.
If the requirements of this paragraph (f)
are satisfied with respect to a plan, the ex-
emption continues in effect (at the plan’s
discretion) until September 30, 2001,
even if the plan subsequently purchases a
different policy from the same or a differ-
ent issuer and regardless of any other
changes to the plan’s benefit structure.
(2) Calculation of the one-percent in-
crease—(i) Ratio.Agroup health plan
(or group health insurance coverage) sat-
isfies the requirements of this paragraph
(f)(2) if the application of paragraph
(b)(1)(i) of this section to the plan (or to
such coverage) results in an increase in
the cost under the plan (or for such cover-
age) of at least one percent. The applica-
tion of paragraph (b)(1)(i) of this section
results in an increased cost of at least one
percent under a group health plan (or for
such coverage) only if the ratio below
equals or exceeds 1.01000. The ratio is
determined as follows:
(A) The incurred expenditures during
the base period, divided by,
(B) The incurred expenditures during
the base period, reduced by —
(1) The claims incurred during the
base period that would have been denied
under the terms of the plan absent plan
amendments required to comply with this
section; and
(2) Administrative expenses attribut-
able to complying with the requirements
of this section.
(ii) Formula.The ratio of paragraph
(f)(2)(i) of this section is expressed math-
ematically as follows:
IE
≥1.01000
IE – (CE + AE)
(A) IEmeans the incurred expendi-
tures during the base period.
(B) CEmeans the claims incurred dur-
ing the base period that would have been
denied under the terms of the plan absent
plan amendments required to comply with
this section
(C) AEmeans administrative costs re-
lated to claims in CE and other adminis-
trative costs attributable to complying
with the requirements of this section.
(iii) Incurred expenditures. Incurred
expendituresmeans actual claims in-
curred during the base period and re-
ported within two months following the
base period, and administrative costs for
all benefits under the group health plan,
including mental health benefits and med-
ical/surgical benefits, during the base pe-
riod. Incurred expenditures do not in-
clude premiums.
(iv) Base period. Base period means
the period used to calculate whether the
January 20, 1998341998–3 I.R.B.

plan may claim the one-percent increased
cost exemption in this paragraph (f). The
base period must begin on the first day in
any plan year that the plan complies with
the requirements of paragraph (b)(1)(i) of
this section and must extend for a period
of at least six consecutive calendar
months. However, in no event may the
base period begin prior to September 26,
1996 (the date of enactment of the Mental
Health Parity Act (Pub. L. 104–204, 110
Stat. 2944)).
(v) Rating pools. For plans that are
combined in a pool for rating purposes,
the calculation under this paragraph (f)(2)
for each plan in the pool for the base pe-
riod is based on the incurred expenditures
of the pool, whether or not all the plans in
the pool have participated in the pool for
the entire base period. (However, only
the plans that have complied with para-
graph (b)(1)(i) of this section for at least
six months as a member of the pool sat-
isfy the requirements of this paragraph
(f)(2).) Otherwise, the calculation under
this paragraph (f)(2) for each plan is cal-
culated by the plan administrator (or is-
suer) based on the incurred expenditures
of the plan.
(vi) Examples.The rules of this para-
graph (f)(2) are illustrated by the follow-
ing examples:
Example 1.(i) Agroup health plan has a plan
year that is the calendar year. The plan satisfies the
requirements of paragraph (b)(1)(i) of this section as
of January 1, 1998. On September 15, 1998, the
plan determines that $1,000,000 in claims have been
incurred during the period between January 1, 1998
and June 30, 1998 and reported by August 30, 1998.
The plan also determines that $100,000 in adminis-
trative costs have been incurred for all benefits
under the group health plan, including mental health
benefits. Thus, the plan determines that its incurred
expenditures for the base period are $1,100,000.
The plan also determines that the claims incurred
during the base period that would have been denied
under the terms of the plan absent plan amendments
required to comply with this section are $40,000 and
that administrative expenses attributable to comply-
ing with the requirements of this section are
$10,000. Thus, the total amount of expenditures for
the base period had the plan not been amended to
comply with the requirements of paragraph (b)(1)(i)
of this section are $1,050,000 ($1,100,000 -
($40,000 + $10,000) = $1,050,000).
(ii) In this Example 1,the plan satisfies the re-
quirements of this paragraph (f)(2) because the ap-
plication of this section results in an increased cost
of at least one percent under the terms of the plan
($1,100,000/$1,050,000 = 1.04762).
Example 2. (i) Ahealth insurance issuer sells a
group health insurance policy that is rated on a
pooled basis and is sold to 30 group health plans.
One of the group health plans inquires whether it
qualifies for the one-percent increased cost exemp-
tion. The issuer performs the calculation for the
pool as a whole and determines that the application
of this section results in an increased cost of 0.500
percent (for a ratio under this paragraph (f)(2) of
1.00500) for the pool. The issuer informs the re-
questing plan and the other plans in the pool of the
calculation.
(ii) In this Example 2,none of the plans satisfy
the requirements of this paragraph (f)(2) and a plan
that purchases a policy not complying with the re-
quirements of paragraph (b)(1)(i) of this section vio-
lates the requirements of this section. In addition, an
issuer that issues to any of the plans in the pool a
policy not complying with the requirements of para-
graph (b)(1)(i) of this section violates the require-
ments of this section.
Example 3.(i) Apartially insured plan is collect-
ing the information to determine whether it qualifies
for the exemption. The plan administrator deter-
mines the incurred expenses for the base period for
the self-funded portion of the plan to be $2,000,000
and the administrative expenses for the base period
for the self-funded portion to be $200,000. For the
insured portion of the plan, the plan administrator
requests data from the insurer. For the insured por-
tion of the plan, the plan’s own incurred expenses
for the base period are $1,000,000 and the adminis-
trative expenses for the base period are $100,000.
The plan administrator determines that under the
self-funded portion of the plan, the claims incurred
for the base period that would have been denied
under the terms of the plan absent the amendment
are $0 because the self-funded portion does not
cover mental health benefits and the plan’s adminis-
trative costs attributable to complying with the re-
quirements of this section are $1,000. The issuer de-
termines that under the insured portion of the plan,
the claims incurred for the base period that would
have been denied under the terms of the plan absent
the amendment are $25,000 and the administrative
costs attributable to complying with the require-
ments of this section are $1,000. Thus, the total in-
curred expenditures for the plan for the base period
are $3,300,000 ($2,000,000 + $200,000 +
$1,000,000 + $100,000 = $3,300,000) and the total
amount of expenditures for the base period had the
plan not been amended to comply with the require-
ments of paragraph (b)(1)(i) of this section are
$3,273,000 ($3,300,000 - ($0 + $1,000 + $25,000 +
$1,000) = $3,273,000).
(ii) In thisExample 3, the plan does not satisfy
the requirements of this paragraph (f)(2) because the
application of this section does not result in an in-
creased cost of at least one percent under the terms
of the plan ($3,300,000/$3,273,000 = 1.00825).
(3) Notice of exemption—(i) Partici-
pants and beneficiaries—(A) In general.
Agroup health plan must notify partici-
pants and beneficiaries of the plan’s deci-
sion to claim the one- percent increased
cost exemption. The notice must include
the following information:
(1) Astatement that the plan is exempt
from the requirements of this section and a
description of the basis for the exemption;
(2) The name and telephone number of
the individual to contact for further infor-
mation;
(3) The plan name and plan number
(PN);
(4) The plan administrator’s name, ad-
dress, and telephone number;
(5) For single-employer plans, the plan
sponsor’s name, address, and telephone
number (if different from paragraph
(f)(3)(i)(A)(3) of this section) and the
plan sponsor’s employer identification
number (EIN);
(6) The effective date of the exemption;
(7) The ability of participants and bene-
ficiaries to contact the plan administrator
to see how benefits may be affected as a
result of the plan’s claim of the exemp-
tion; and
(8) The availability, upon request and
free of charge, of a summary of the infor-
mation required under paragraph (f)(4) of
this section.
(B) Use of summary of material reduc-
tions in covered services or benefits.A
plan may satisfy the requirements of para-
graph (f)(3)(i)(A) of this section by pro-
viding participants and beneficiaries (in
accordance with paragraph (f)(3)(i)(C) of
this section) with a summary of material
reductions in covered services or benefits
required under §2520.104b-3(d) that also
includes the information of this paragraph
(f)(3)(i). However, in all cases, the ex-
emption is not effective until 30 days after
notice has been sent.
(C) Delivery.The notice described in
this paragraph (f)(3)(i) is required to be
provided to all participants and beneficia-
ries. The notice may be furnished by any
method of delivery that satisfies the re-
quirements of section 104(b)(1) of ERISA
(e.g., first-class mail). If the notice is pro-
vided to the participant at the participant’s
last known address, then the requirements
of this paragraph (f)(3)(i) are satisfied
with respect to the participant and all ben-
eficiaries residing at that address. If a
beneficiary’s last known address is differ-
ent from the participant’s last known ad-
dress, a separate notice is required to be
provided to the beneficiary at the benefi-
ciary’s last known address.
(D) Example. The rules of this para-
graph (f)(3)(i) are illustrated by the fol-
lowing example:
Example.(i) Agroup health plan has a plan year
that is the calendar year and has an open enrollment
1998–3 I.R.B35January 20, 1998

period every November 1 through November 30.
The plan determines on September 15 that it satis-
fies the requirements of paragraph (f)(2) of this sec-
tion. As part of its open enrollment materials, the
plan mails, on October 15, to all participants and
beneficiaries a notice satisfying the requirements of
this paragraph (f)(3)(i).
(ii) In thisExample,the plan has sent the notice
in a manner that complies with this paragraph
(f)(3)(i).
(ii) Federal agencies—(A) Church
plans.Achurch plan (as defined in sec-
tion 414(e) of the Internal Revenue Code)
claiming the exemption of this paragraph
(f) for any benefit package must provide
notice to the Department of the Treasury.
This requirement is satisfied if the plan
sends a copy, to the address designated by
the Secretary in generally applicable
guidance, of the notice described in para-
graph (f)(3)(i) of this section identifying
the benefit package to which the exemp-
tion applies.
(B) Group health plans subject to Part
7 of Subtitle B of Title I of ERISA.Agroup
health plan subject to Part 7 of Subtitle B
of Title I of ERISA, and claiming the ex-
emption of this paragraph (f) for any ben-
efit package, must provide notice to the
Department of Labor. This requirement is
satisfied if the plan sends a copy, to the
address designated by the Secretary in
generally applicable guidance, of the no-
tice described in paragraph (f)(3)(i) of this
section identifying the benefit package to
which the exemption applies.
(C) Nonfederal governmental plans. A
group health plan that is a nonfederal gov-
ernmental plan claiming the exemption of
this paragraph (f) for any benefit package
must provide notice to the Department of
Health and Human Services (HHS). This
requirement is satisfied if the plan sends a
copy, to the address designated by the
Secretary in generally applicable guid-
ance, of the notice described in paragraph
(f)(3)(i) of this section identifying the
benefit package to which the exemption
applies.
(4) Availability of documentation. The
plan (or issuer) must make available to
participants and beneficiaries (or their
representatives), on request and at no
charge, a summary of the information on
which the exemption was based. An indi-
vidual who is not a participant or benefi-
ciary and who presents a notice described
in paragraph (f)(3)(i) of this section is
considered to be a representative. Arep-
resentative may request the summary of
information by providing the plan a copy
of the notice provided to the participant
under paragraph (f)(3)(i) of this section
with any individually identifiable infor-
mation redacted. The summary of infor-
mation must include the incurred expen-
ditures, the base period, the dollar amount
of claims incurred during the base period
that would have been denied under the
terms of the plan absent amendments re-
quired to comply with paragraph (b)(1)(i)
of this section, the administrative costs re-
lated to those claims, and other adminis-
trative costs attributable to complying
with the requirements of this section. In
no event should the summary of informa-
tion include any individually identifiable
information.
(g) Special rules for group health in-
surance coverage— (1) Sale of nonparity
policies.An issuer may sell a policy
without parity (as described in paragraph
(b) of this section) only to a plan that
meets the requirements of paragraphs (e)
or (f) of this section.
(2) Duration of exemption.After a plan
meets the requirements of paragraph (f) of
this section, the plan may change issuers
without having to meet the requirements
of paragraph (f) of this section again be-
fore September 30, 2001.
(h) Effective dates—(1) In general.
The requirements of this section are ap-
plicable for plan years beginning on or
after January 1, 1998.
(2) Limitation on actions. (i) Except as
provided in paragraph (h)(3) of this sec-
tion, no enforcement action is to be taken
by the Secretary against a group health
plan that has sought to comply in good
faith with the requirements section 712 of
the Act, with respect to a violation that
occurs before the earlier of—
(A) The first day of the first plan year
beginning on or after April 1, 1998; or
(B) January 1, 1999.
(ii) Compliance with the requirements
of this section is deemed to be good faith
compliance with the requirements of sec-
tion 712 of Part 7 of Subtitle B of Title I
of ERISA.
(iii) The rules of this paragraph (h)(2)
are illustrated by the following examples:
Example 1. (i) Agroup health plan has a plan
year that is the calendar year. The plan complies
with section 712 of Part 7 of Subtitle B of Title I of
ERISAin good faith using assumptions inconsistent
with paragraph (b)(6) of this section relating to
weighted averages for categories of benefits.
(ii) In this Example 1,no enforcement action
may be taken against the plan with respect to a vio-
lation resulting solely from those assumptions and
occurring before January 1, 1999.
Example 2.(i) Agroup health plan has a plan
year that is the calendar year. For the entire 1998
plan year, the plan applies a $1,000,000 annual limit
on medical/surgical benefits and a $100,000 annual
limit on mental health benefits.
(ii) In this Example 2,the plan has not sought to
comply with the requirements of section 712 of the
Act in good faith and this paragraph (h)(2) does not
apply.
(3) Transition period for increased cost
exemption—(i) In general.No enforce-
ment action will be taken against a group
health plan that is subject to the require-
ments of this section based on a violation
of this section that occurs before April 1,
1998 solely because the plan claims the
increased cost exemption under section
712(c)(2) of Part 7 of Subtitle B of Title I
of ERISAbased on assumptions inconsis-
tent with the rules under paragraph (f) of
this section, provided that a plan amend-
ment that complies with the requirements
of paragraph (b)(1)(i) of this section is
adopted and effective no later than March
31, 1998 and the plan complies with the
notice requirements in paragraph
(h)(3)(ii) of this section.
(ii) Notice of plan’s use of transition
period. (A) Agroup health plan satisfies
the requirements of this paragraph
(h)(3)(ii) only if the plan provides notice
to the applicable federal agency and posts
such notice at the location(s) where docu-
ments must be made available for exami-
nation by participants and beneficiaries
under section 104(b)(2) of ERISAand the
regulations thereunder (29 CFR
2520.104b–1(b)(3)). The notice must in-
dicate the plan’s decision to use the transi-
tion period in paragraph (h)(3)(i) of this
section by 30 days after the first day of
the plan year beginning on or after Janu-
ary 1, 1998, but in no event later than
March 31, 1998. For a group health plan
that is a church plan, the applicable fed-
eral agency is the Department of the Trea-
sury. For a group health plan that is sub-
ject to Part 7 of Subtitle B of Title I of
ERISA, the applicable federal agency is
the Department of Labor. For a group
health plan that is a nonfederal govern-
mental plan, the applicable federal agency
is the Department of Health and Human
Services. The notice must include —
January 20, 1998361998–3 I.R.B.

(1) The name of the plan and the plan
number (PN);
(2) The name, address, and telephone
number of the plan administrator;
(3) For single-employer plans, the
name, address, and telephone number of
the plan sponsor (if different from the
plan administrator) and the plan sponsor’s
employer identification number (EIN);
(4) The name and telephone number of
the individual to contact for further infor-
mation; and
(5) The signature of the plan adminis-
trator and the date of the signature.
(B) The notice must be provided at no
charge to participants or their representa-
tive within 15 days after receipt of a writ-
ten or oral request for such notification,
but in no event before the notice has been
sent to the applicable federal agency.
(i) Sunset.This section does not apply
to benefits for services furnished on or
after September 30, 2001.
Signed at Washington, DC, this day of
December, 1997.
Olena Berg,
Assistant Secretary,
Pension Welfare Benefits Administration,
U.S. Department of Labor.
Health Care Financing
Administration
45 CFR Subtitle A, Subchapter B
45 CFR Part 146 is amended as fol-
lows:
PART146—REQUIREMENTS FOR
THE GROUPHEALTH INSURANCE
MARKET
1. The authority citation for Part 146 is
revised to read as follows:
Authority:Secs. 2701 through 2763,
2791, and 2792 of the PHS Act (42 U.S.C.
300gg through 300gg–63, 300gg–91, and
300gg–92).
2. Anew Subpart C is added to Part
146 to read as follows:
Subpart C—Requirements Related to
Benefits
§ 146.136 Parity in the application of
certain limits to mental health benefits.
(a) Definitions.For purposes of this
section, except where the context clearly
indicates otherwise, the following defini-
tions apply:
Aggregate lifetime limitmeans a dollar
limitation on the total amount of specified
benefits that may be paid under a group
health plan (or group health insurance
coverage offered in connection with such
plan) for an individual (or for a group of
individuals considered a single unit in ap-
plying this dollar limitation, such as a
family or an employee plus spouse).
Annual limitmeans a dollar limitation
on the total amount of specified benefits
that may be paid in a 12-month period
under a plan (or group health insurance
coverage offered in connection with such
plan) for an individual (or for a group of
individuals considered a single unit in ap-
plying this dollar limitation, such as a
family or an employee plus spouse).
Medical/surgical benefits means bene-
fits for medical or surgical services, as de-
fined under the terms of the plan or group
health insurance coverage, but does not
include mental health benefits.
Mental health benefitsmeans benefits
for mental health services, as defined
under the terms of the plan or group
health insurance coverage, but does not
include benefits for treatment of sub-
stance abuse or chemical dependency.
(b) Requirements regarding limits on
benefits—(1) In general—(i) General
parity requirement.Agroup health plan
(or health insurance coverage offered by
an issuer in connection with a group
health plan) that provides both medical/
surgical benefits and mental health bene-
fits must comply with paragraph (b)(2),
paragraph (b)(3), or paragraph (b)(6) of
this section.
(ii) Exception.The rule in paragraph
(b)(1)(i) of this section does not apply if a
plan, or coverage, satisfies the require-
ments of paragraph (e) or paragraph (f) of
this section.
(2) Plan with no limit or limits on less
than one-third of all medical/surgical
benefits.If a plan (or group health insur-
ance coverage) does not include an aggre-
gate lifetime or annual limit on any med-
ical/surgical benefits or includes
aggregate lifetime or annual limits that
apply to less than one-third of all med-
ical/surgical benefits, it may not impose
an aggregate lifetime or annual limit, re-
spectively, on mental health benefits.
(3) Plan with a limit on at least two-
thirds of all medical/surgical benefits. If
a plan (or group health insurance cover-
age) includes an aggregate lifetime or an-
nual limit on at least two-thirds of all
medical/surgical benefits, it must either—
(i) Apply the aggregate lifetime or an-
nual limit both to the medical/surgical
benefits to which the limit would other-
wise apply and to mental health benefits
in a manner that does not distinguish be-
tween the medical/surgical and mental
health benefits; or
(ii) Not include an aggregate lifetime
or annual limit on mental health benefits
that is less than the aggregate lifetime or
annual limit, respectively, on the med-
ical/surgical benefits.
(4) Examples.The rules of paragraphs
(b)(2) and (3) of this section are illus-
trated by the following examples:
Example 1. (i) Prior to the effective date of the
mental health parity provisions, a group health plan
had no annual limit on medical/surgical benefits and
had a $10,000 annual limit on mental health bene-
fits. To comply with the parity requirements of this
paragraph (b), the plan sponsor is considering each
of the following options:
(A) Eliminating the plan’s annual limit on mental
health benefits;
(B) Replacing the plan’s previous annual limit on
mental health benefits with a $500,000 annual limit
on all benefits (including medical/surgical and men-
tal health benefits); and
(C) Replacing the plan’s previous annual limit on
mental health benefits with a $250,000 annual limit
on medical/surgical benefits and a $250,000 annual
limit on mental health benefits.
(ii) In this Example 1,each of the three options
being considered by the plan sponsor would comply
with the requirements of this section because they
offer parity in the dollar limits placed on
medical/surgical and mental health benefits.
Example 2.(i) Prior to the effective date of the
mental health parity provisions, a group health plan
had a $100,000 annual limit on medical/surgical in-
patient benefits, a $50,000 annual limit on
medical/surgical outpatient benefits, and a $100,000
annual limit on all mental health benefits. To com-
ply with the parity requirements of this paragraph
(b), the plan sponsor is considering each of the fol-
lowing options:
(A) Replacing the plan’s previous annual limit on
mental health benefits with a $150,000 annual limit
on mental health benefits; and
(B) Replacing the plan’s previous annual limit on
mental health benefits with a $100,000 annual limit
on mental health inpatient benefits and a $50,000
annual limit on mental health outpatient benefits.
(ii) In this Example 2,each option under consid-
eration by the plan sponsor would comply with the
requirements of this section because they offer par-
ity in the dollar limits placed on medical/surgical
and mental health benefits.
Example 3.(i) Agroup health plan that is sub-
ject to the requirements of this section has no aggre-
gate lifetime or annual limit for either medical/surgi-
1998–3 I.R.B37January 20, 1998

cal benefits or mental health benefits. While the
plan provides medical/surgical benefits with respect
to both network and out-of-network providers, it
does not provide mental health benefits with respect
to out-of-network providers.
(ii) In thisExample 3,the plan complies with the
requirements of this section because they offer par-
ity in the dollar limits placed on medical/surgical
and mental health benefits.
Example 4.(i) Prior to the effective date of the
mental health parity provisions, a group health plan
had an annual limit on medical/surgical benefits and
a separate but identical annual limit on mental health
benefits. The plan included benefits for treatment of
substance abuse and chemical dependency in its def-
inition of mental health benefits. Accordingly,
claims paid for treatment of substance abuse and
chemical dependency were counted in applying the
annual limit on mental health benefits. To comply
with the parity requirements of this paragraph (b),
the plan sponsor is considering each of the following
options:
(A) Making no change in the plan so that claims
paid for treatment of substance abuse and chemical
dependency continue to count in applying the annual
limit on mental health benefits;
(B) Amending the plan to count claims paid for
treatment of substance abuse and chemical depen-
dency in applying the annual limit on medical/surgi-
cal benefits (rather than counting those claims in ap-
plying the annual limit on mental health benefits);
(C) Amending the plan to provide a new category
of benefits for treatment of chemical dependency
and substance abuse that is subject to a separate,
lower limit and under which claims paid for treat-
ment of substance abuse and chemical dependency
are counted only in applying the annual limit on this
separate category; and
(D) Amending the plan to eliminate distinctions
between medical/surgical benefits and mental health
benefits and establishing an overall limit on benefits
offered under the plan under which claims paid for
treatment of substance abuse and chemical depen-
dency are counted with medical/surgical benefits
and mental health benefits in applying the overall
limit.
(ii) In this Example 4,the group health plan is
described in paragraph (b)(3) of this section. Be-
cause mental health benefits are defined in para-
graph (a) of this section as excluding benefits for
treatment of substance abuse and chemical depen-
dency, the inclusion of benefits for treatment of sub-
stance abuse and chemical dependency in applying
an aggregate lifetime limit or annual limit on mental
health benefits under option (A) of this Example 4
would not comply with the requirements of para-
graph (b)(3) of this section. However, options (B),
(C), and (D) of this Example 4would comply with
the requirements of paragraph (b)(3) of this section
because they offer parity in the dollar limits placed
on medical/surgical and mental health benefits.
(5) Determining one-third and two-
thirds of all medical/surgical benefits.
For purposes of this paragraph (b), the de-
termination of whether the portion of
medical/surgical benefits subject to a
limit represents one-third or two-thirds of
all medical/surgical benefits is based on
the dollar amount of all plan payments for
medical/surgical benefits expected to be
paid under the plan for the plan year (or
for the portion of the plan year after a
change in plan benefits that affects the ap-
plicability of the aggregate lifetime or an-
nual limits). Any reasonable method may
be used to determine whether the dollar
amounts expected to be paid under the
plan will constitute one-third or two-
thirds of the dollar amount of all plan pay-
ments for medical/surgical benefits.
(6) Plan not described in paragraph
(b)(2) or paragraph (b)(3) of this
section— (i) In general.Agroup health
plan (or group health insurance coverage)
that is not described in paragraph (b)(2) or
paragraph (b)(3) of this section, must ei-
ther impose—
(A) No aggregate lifetime or annual
limit, as appropriate, on mental health
benefits; or
(B) An aggregate lifetime or annual
limit on mental health benefits that is no
less than an average limit for medical/sur-
gical benefits calculated in the following
manner. The average limit is calculated
by taking into account the weighted aver-
age of the aggregate lifetime or annual
limits, as appropriate, that are applicable
to the categories of medical/surgical ben-
efits. Limits based on delivery systems,
such as inpatient/outpatient treatment, or
normal treatment of common, low-cost
conditions (such as treatment of normal
births), do not constitute categories for
purposes of this paragraph (b)(6)(i)(B).
In addition, for purposes of determining
weighted averages, any benefits that are
not within a category that is subject to a
separately-designated limit under the plan
are taken into account as a single separate
category by using an estimate of the upper
limit on the dollar amount that a plan may
reasonably be expected to incur with re-
spect to such benefits, taking into account
any other applicable restrictions under the
plan.
(ii) Weighting.For purposes of this
paragraph (b)(6), the weighting applica-
ble to any category of medical/surgical
benefits is determined in the manner set
forth in paragraph (b)(5) of this section
for determining one-third or two-thirds of
all medical/surgical benefits.
(iii) Examples.The rules of this para-
graph (b)(6) are illustrated by the follow-
ing example:
Example.(i) Agroup health plan that is subject
to the requirements of this section includes a
$100,000 annual limit on medical/surgical benefits
related to cardio-pulmonary diseases. The plan does
not include an annual limit on any other category of
medical/surgical benefits. The plan determines that
40% of the dollar amount of plan payments for med-
ical/surgical benefits are related to cardio-pul-
monary diseases. The plan determines that
$1,000,000 is a reasonable estimate of the upper
limit on the dollar amount that the plan may incur
with respect to the other 60% of payments for med-
ical/surgical benefits.
(ii) In this Example, the plan is not described in
paragraph (b)(3) of this section because there is not
one annual limit that applies to at least two-thirds of
all medical/surgical benefits. Further, the plan is not
described in paragraph (b)(2) of this section because
more than one-third of all medical/surgical benefits
are subject to an annual limit. Under this paragraph
(b)(6), the plan sponsor can choose either to include
no annual limit on mental health benefits, or to in-
clude an annual limit on mental health benefits that
is not less than the weighted average of the annual
limits applicable to each category of medical/surgi-
cal benefits. In this example, the minimum
weighted average annual limit that can be applied to
mental health benefits is $640,000 (40% 3
$100,000 + 60% 3$1,000,000 = $640,000).
(c) Rule in the case of separate benefit
packages. If a group health plan offers
two or more benefit packages, the re-
quirements of this section, including the
exemption provisions in paragraph (f) of
this section, apply separately to each ben-
efit package. Examples of a group health
plan that offers two or more benefit pack-
ages include a group health plan that of-
fers employees a choice between indem-
nity coverage or HMO coverage, and a
group health plan that provides one bene-
fit package for retirees and a different
benefit package for current employees.
(d) Applicability—(1) Group health
plans.The requirements of this section
apply to a group health plan offering both
medical/surgical benefits and mental
health benefits regardless of whether the
mental health benefits are administered
separately under the plan.
(2) Health insurance issuers.The re-
quirements of this section apply to a
health insurance issuer offering health in-
surance coverage for both medical/surgi-
cal benefits and mental health benefits in
connection with a group health plan.
(3) Scope.This section does not—
(i) Require a group health plan (or
health insurance issuer offering coverage
in connection with a group health plan) to
provide any mental health benefits; or
(ii) Affect the terms and conditions (in-
cluding cost sharing, limits on the number
January 20, 1998381998–3 I.R.B.

of visits or days of coverage, require-
ments relating to medical necessity, re-
quiring prior authorization for treatment,
or requiring primary care physicians’re-
ferrals for treatment) relating to the
amount, duration, or scope of the mental
health benefits under the plan (or cover-
age) except as specifically provided in
paragraph (b) of this section.
(e) Small employer exemption—(1) In
general.The requirements of this section
do not apply to a group health plan (or
health insurance issuer offering coverage
in connection with a group health plan)
for a plan year of a small employer. For
purposes of this paragraph (e), the term
small employermeans, in connection with
a group health plan with respect to a cal-
endar year and a plan year, an employer
who employed an average of at least two
but not more than 50 employees on busi-
ness days during the preceding calendar
year and who employs at least two em-
ployees on the first day of the plan year.
See regulations at § 146.145(a), which
provide that this section (and certain other
sections) does not apply to any group
health plan (and health insurance issuer
offering coverage in connection with a
group health plan) for any plan year if, on
the first day of the plan year, the plan has
fewer than two participants who are cur-
rent employees.
(2) Rules in determining employer size.
For purposes of paragraph (e)(1) of this
section—
(i) All persons treated as a single em-
ployer under subsections (b), (c), (m), and
(o) of section 414 of the Internal Revenue
Code of 1986 (26 U.S.C. 414) are treated
as one employer;
(ii) If an employer was not in existence
throughout the preceding calendar year,
whether it is a small employer is deter-
mined based on the average number of
employees the employer reasonably ex-
pects to employ on business days during
the current calendar year; and
(iii) Any reference to an employer for
purposes of the small employer exemp-
tion includes a reference to a predecessor
of the employer.
(f) Increased cost exemption—(1) In
general.Agroup health plan (or health
insurance coverage offered in connection
with a group health plan) is not subject to
the requirements of this section if the re-
quirements of this paragraph (f) are satis-
fied. If a plan offers more than one bene-
fit package, this paragraph (f) applies sep-
arately to each benefit package. Except
as provided in paragraph (h) of this sec-
tion, a plan must comply with the require-
ments of paragraph (b)(1)(i) of this sec-
tion for the first plan year beginning on or
after January 1, 1998, and must continue
to comply with the requirements of para-
graph (b)(1)(i) of this section until the
plan satisfies the requirements in this
paragraph (f). In no event is the exemp-
tion of this paragraph (f) effective until 30
days after the notice requirements in para-
graph (f)(3) of this section are satisfied.
If the requirements of this paragraph (f)
are satisfied with respect to a plan, the ex-
emption continues in effect (at the plan’s
discretion) until September 30, 2001,
even if the plan subsequently purchases a
different policy from the same or a differ-
ent issuer and regardless of any other
changes to the plan’s benefit structure.
(2) Calculation of the one-percent in-
crease—(i) Ratio.Agroup health plan
(or group health insurance coverage) sat-
isfies the requirements of this paragraph
(f)(2) if the application of paragraph
(b)(1)(i) of this section to the plan (or to
such coverage) results in an increase in
the cost under the plan (or for such cover-
age) of at least one percent. The applica-
tion of paragraph (b)(1)(i) of this section
results in an increased cost of at least one
percent under a group health plan (or for
such coverage) only if the ratio below
equals or exceeds 1.01000. The ratio is
determined as follows:
(A) The incurred expenditures during
the base period, divided by,
(B) The incurred expenditures during
the base period, reduced by —
(1) The claims incurred during the
base period that would have been denied
under the terms of the plan absent plan
amendments required to comply with this
section, and
(2) Administrative expenses attribut-
able to complying with the requirements
of this section.
(ii) Formula. The ratio of paragraph
(f)(2)(i) is expressed mathematically as
follows:
IE
≥1.01000
IE – (CE + AE)
(A) IEmeans the incurred expendi-
tures during the base period.
(B) CEmeans the claims incurred dur-
ing the base period that would have been
denied under the terms of the plan absent
plan amendments required to comply with
this section.
(C) AEmeans administrative costs re-
lated to claims in CEand other adminis-
trative costs attributable to complying
with the requirements of this section.
(iii) Incurred expenditures.Incurred
expendituresmeans actual claims in-
curred during the base period and re-
ported within two months following the
base period, and administrative costs for
all benefits under the group health plan,
including mental health benefits and med-
ical/surgical benefits, during the base pe-
riod. Incurred expenditures do not in-
clude premiums.
(iv) Base period.Base period means
the period used to calculate whether the
plan may claim the one-percent increased
cost exemption in this paragraph (f). The
base period must begin on the first day in
any plan year that the plan complies with
the requirements of paragraph (b)(1)(i) of
this section and must extend for a period
of at least six consecutive calendar
months. However, in no event may the
base period begin prior to September 26,
1996 (the date of enactment of the Mental
Health Parity Act (Pub. L. 104–204, 110
Stat. 2944)).
(v) Rating pools.For plans that are
combined in a pool for rating purposes,
the calculation under this paragraph (f)(2)
for each plan in the pool for the base pe-
riod is based on the incurred expenditures
of the pool, whether or not all the plans in
the pool have participated in the pool for
the entire base period. (However, only
the plans that have complied with para-
graph (b)(1)(i) of this section for at least
six months as a member of the pool sat-
isfy the requirements of this paragraph
(f)(2).) Otherwise, the calculation under
this paragraph (f)(2) for each plan is cal-
culated by the plan administrator (or is-
suer) based on the incurred expenditures
of the plan.
(vi) Examples.The rules of this para-
graph (f)(2) are illustrated by the follow-
ing examples:
Example 1.(i) Agroup health plan has a plan
year that is the calendar year. The plan satisfies the
requirements of paragraph (b)(1)(i) of this section as
of January 1, 1998. On September 15, 1998, the
plan determines that $1,000,000 in claims have been
1998–3 I.R.B39January 20, 1998

incurred during the period between January 1, 1998
and June 30, 1998 and reported by August 30, 1998.
The plan also determines that $100,000 in adminis-
trative costs have been incurred for all benefits
under the group health plan, including mental health
benefits. Thus, the plan determines that its incurred
expenditures for the base period are $1,100,000.
The plan also determines that the claims incurred
during the base period that would have been denied
under the terms of the plan absent plan amendments
required to comply with this section are $40,000 and
that administrative expenses attributable to comply-
ing with the requirements of this section are
$10,000. Thus, the total amount of expenditures for
the base period had the plan not been amended to
comply with the requirements of paragraph (b)(1)(i)
of this section are $1,050,000 ($1,100,000 –
($40,000 + $10,000) = $1,050,000).
(ii) In this Example 1,the plan satisfies the re-
quirements of this paragraph (f)(2) because the ap-
plication of this section results in an increased cost
of at least one percent under the terms of the plan
($1,100,000/$1,050,000 = 1.04762).
Example 2.(i) Ahealth insurance issuer sells a
group health insurance policy that is rated on a
pooled-basis and is sold to 30 group health plans.
One of the group health plans inquires whether it
qualifies for the one percent increased cost exemp-
tion. The issuer performs the calculation for the
pool as a whole and determines that the application
of this section results in an increased cost of 0.500
percent (for a ratio under this paragraph (f)(2) of
1.00500) for the pool. The issuer informs the re-
questing plan and the other plans in the pool of the
calculation.
(ii) In thisExample 2, none of the plans satisfy
the requirements of this paragraph (f)(2) and a plan
that purchases a policy not complying with the re-
quirements of paragraph (b)(1)(i) of this section vio-
lates the requirements of this section. In addition, an
issuer that issues to any of the plans in the pool a
policy not complying with the requirements of para-
graph (b)(1)(i) of this section violates the require-
ments of this section.
Example 3.(i) Apartially-insured plan is col-
lecting the information to determine whether it qual-
ifies for the exemption. The plan administrator de-
termines the incurred expenses for the base period
for the self-funded portion of the plan to be
$2,000,000 and the administrative expenses for the
base period for the self-funded portion to be
$200,000. For the insured portion of the plan, the
plan administrator requests data from the insurer.
For the insured portion of the plan, the plan’s own
incurred expenses for the base period are $1,000,000
and the administrative expenses for the base period
are $100,000. The plan administrator determines
that under the self-funded portion of the plan, the
claims incurred for the base period that would have
been denied under the terms of the plan absent the
amendment are $0 because the self-funded portion
does not cover mental health benefits and the plan’s
administrative costs attributable to complying with
the requirements of this section are $1,000. The is-
suer determines that under the insured portion of the
plan, the claims incurred for the base period that
would have been denied under the terms of the plan
absent the amendment are $25,000 and the adminis-
trative costs attributable to complying with the re-
quirements of this section are $1,000. Thus, the
total incurred expenditures for the plan for the base
period are $3,300,000 ($2,000,000 + $200,000 +
$1,000,000 + $100,000 = $3,300,000) and the total
amount of expenditures for the base period had the
plan not been amended to comply with the require-
ments of paragraph (b)(1)(i) of this section are
$3,273,000 ($3,300,000 - ($0 + $1,000 + $25,000 +
$1,000) = $3,273,000).
(ii) In this Example 3,the plan does not satisfy
the requirements of this paragraph (f)(2) because the
application of this section does not result in an in-
creased cost of at least one percent under the terms
of the plan ($3,300,000/$3,273,000 = 1.00825).
(3) Notice of exemption—(i) Partici-
pants and beneficiaries—(A) In general.
Agroup health plan must notify partici-
pants and beneficiaries of the plan’s deci-
sion to claim the one percent increased
cost exemption. The notice must include
the following information:
(1) Astatement that the plan is exempt
from the requirements of this section and
a description of the basis for the exemp-
tion.
(2) The name and telephone number of
the individual to contact for further infor-
mation.
(3)The plan name and plan number
(PN).
(4) The plan administrator’s name, ad-
dress, and telephone number.
(5) For single-employer plans, the plan
sponsor’s name, address, and telephone
number (if different from paragraph
(f)(3)(i)(A)(3) of this section) and the
plan sponsor’s employer identification
number (EIN).
(6) The effective date of such exemp-
tion.
(7) The ability of participants and bene-
ficiaries to contact the plan administrator
to see how benefits may be affected as a
result of the plan’s election of the exemp-
tion.
(8) The availability, upon request and
free of charge, of a summary of the infor-
mation required under paragraph (f)(4) of
this section.
(B) Use of summary of material reduc-
tions in covered services or benefits. A
plan may satisfy the requirements of para-
graph (f)(3)(i)(A) by providing partici-
pants and beneficiaries (in accordance
with paragraph (f)(3)(i)(C)) with a sum-
mary of material reductions in covered
services or benefits consistent with De-
partment of Labor regulations at 29 CFR
2520.104b–3(d) that also includes the in-
formation of this paragraph (f)(3)(i).
However, in all cases, the exemption is
not effective until 30 days after notice has
been sent.
(C) Delivery. The notice described in
this paragraph (f)(3)(i) is required to be
provided to all participants and beneficia-
ries. The notice may be furnished by any
method of delivery that satisfies the re-
quirements of section 104(b)(1) of ERISA
(29 U.S.C. 1024(b)(1)) (e.g., first-class
mail). If the notice is provided to the par-
ticipant at the participant’s last known ad-
dress, then the requirements of this para-
graph (f)(3)(i) are satisfied with respect to
the participant and all beneficiaries resid-
ing at that address. If a beneficiary’s last
known address is different from the par-
ticipant’s last known address, a separate
notice is required to be provided to the
beneficiary at the beneficiary’s last
known address.
(D) Example.The rules of this para-
graph (f)(3)(i) are illustrated by the fol-
lowing example:
Example.(i) Agroup health plan has a plan year
that is the calendar year and has an open enrollment
period every November 1 through November 30.
The plan determines on September 15 that it satis-
fies the requirements of paragraph (f)(2) of this sec-
tion. As part of its open enrollment materials, the
plan mails, on October 15, to all participants and
beneficiaries a notice satisfying the requirements of
this paragraph (f)(3)(i).
(ii) In this Example,the plan has sent the notice
in a manner that complies with this paragraph
(f)(3)(i).
(ii) Federal agencies—(A) Church
plans.Achurch plan (as defined in sec-
tion 414(e) of the Internal Revenue Code)
claiming the exemption of this paragraph
(f) for any benefit package must provide
notice to the Department of the Treasury.
This requirement is satisfied if the plan
sends a copy, to the address designated by
the Secretary in generally applicable
guidance, of the notice described in para-
graph (f)(3)(i) of this section identifying
the benefit package to which the exemp-
tion applies.
(B) Group health plans subject to Part
7 of Subtitle B of Title I of ERISA.Agroup
health plan subject to Part 7 of Subtitle B
of Title I of ERISA, and claiming the ex-
emption of this paragraph (f) for any ben-
efit package, must provide notice to the
Department of Labor. This requirement is
satisfied if the plan sends a copy, to the
address designated by the Secretary in
generally applicable guidance, of the no-
tice described in paragraph (f)(3)(i) of this
January 20, 1998401998–3 I.R.B.

section identifying the benefit package to
which the exemption applies.
(C) Non-Federal governmental plans.
Agroup health plan that is a non-Federal
governmental plan claiming the exemp-
tion of this paragraph (f) for any benefit
package must provide notice to the De-
partment of Health and Human Services
(HHS). This requirement is satisfied if
the plan sends a copy, to the address des-
ignated by the Secretary in generally ap-
plicable guidance, of the notice described
in paragraph (f)(3)(i) of this section iden-
tifying the benefit package to which the
exemption applies.
(4)Availability of documentation.The
plan (or issuer) must make available to
participants and beneficiaries (or their
representatives), on request and at no
charge, a summary of the information on
which the exemption was based. An indi-
vidual who is not a participant or benefi-
ciary and who presents a notice described
in paragraph (f)(3)(i) of this section is
considered to be a representative. Arep-
resentative may request the summary of
information by providing the plan a copy
of the notice provided to the participant
under paragraph (f)(3)(i) of this section
with any individually identifiable infor-
mation redacted. The summary of infor-
mation must include the incurred expen-
ditures, the base period, the dollar amount
of claims incurred during the base period
that would have been denied under the
terms of the plan absent amendments re-
quired to comply with paragraph (b)(1)(i)
of this section, the administrative costs re-
lated to those claims, and other adminis-
trative costs attributable to complying
with the requirements for the exemption.
In no event should the summary of infor-
mation include any individually identifi-
able information.
(g) Special rules for group health in-
surance coverage—(1) Sale of nonparity
policies.An issuer may sell a policy
without parity (as described in paragraph
(b) of this section) only to a plan that
meets the requirements of paragraph (e)
or paragraph (f) of this section.
(2) Duration of exemption.After a plan
meets the requirements of paragraph (f) of
this section, the plan may change issuers
without having to meet the requirements
of paragraph (f) of this section again be-
fore September 30, 2001.
(h) Effective dates—(1) In general.
The requirements of this section are ap-
plicable for plan years beginning on or
after January 1, 1998.
(2) Limitation on actions.(i) Except as
provided in paragraph (h)(3) of this sec-
tion, no enforcement action is to be taken
by the Secretary against a group health
plan that has sought to comply in good
faith with the requirements of section
2705 of the PHS Act, with respect to a vi-
olation that occurs before the earlier of —
(A) The first day of the first plan year
beginning on or after April 1, 1998; or
(B) January 1, 1999.
(ii) Compliance with the requirements
of this section is deemed to be good faith
compliance with the requirements of sec-
tion 2705 of the PHS Act.
(iii) The rules of this paragraph (h)(2)
are illustrated by the following examples:
Example 1. (i) Agroup health plan has a plan
year that is the calendar year. The plan complies
with section 2705 of the PHS Act in good faith using
assumptions inconsistent with paragraph (b)(6) of
this section relating to weighted averages for cate-
gories of benefits.
(ii) In this Example 1,no enforcement action
may be taken against the plan with respect to a vio-
lation resulting solely from those assumptions and
occurring before January 1, 1999.
Example 2. (i) Agroup health plan has a plan
year that is the calendar year. For the entire 1998
plan year, the plan applies a $1,000,000 annual limit
on medical/surgical benefits and a $100,000 annual
limit on mental health benefits.
(ii) In this Example 2,the plan has not sought to
comply with the requirements of section 2705 of the
PHS Act in good faith and this paragraph (h)(2) does
not apply.
(3) Transition period for increased cost
exemption—(i) In general.No enforce-
ment action will be taken against a group
health plan that is subject to the require-
ments of this section based on a violation of
this section that occurs before April 1, 1998
solely because the plan claims the in-
creased cost exemption under section
2705(c)(2) of the PHS Act based on as-
sumptions inconsistent with the rules under
paragraph (f) of this section, provided that a
plan amendment that complies with the re-
quirements of paragraph (b)(1)(i) of this
section is adopted and effective no later
than March 31, 1998 and the plan complies
with the notice requirements in paragraph
(h)(3)(ii) of this section.
(ii) Notice of plan’s use of transition
period.(A) Agroup health plan satisfies
the requirements of this paragraph
(h)(3)(ii) only if the plan provides notice
to the applicable federal agency and posts
the notice at the location(s) where docu-
ments must be made available for exami-
nation by participants and beneficiaries
under section 104(b)(2) of ERISAand the
regulations thereunder (29 CFR
2520.104b–1(b)(3)). The notice must in-
dicate the plan’s decision to use the transi-
tion period in paragraph (h)(3)(i) of this
section by 30 days after the first day of
the plan year beginning on or after Janu-
ary 1, 1998, but in no event later than
March 31, 1998. For a group health plan
that is a church plan, the applicable fed-
eral agency is the Department of the Trea-
sury. For a group health plan that is sub-
ject to Part 7 of Subtitle B of Title I of
ERISA, the applicable federal agency is
the Department of Labor. For a group
health plan that is a nonfederal govern-
mental plan, the applicable federal agency
is the Department of Health and Human
Services. The notice must include —
(1) The name of the plan and the plan
number (PN);
(2) The name, address, and telephone
number of the plan administrator;
(3) For single-employer plans, the
name, address, and telephone number of
the plan sponsor (if different from the
plan administrator) and the plan sponsor’s
employer identification number (EIN);
(4) The name and telephone number of
the individual to contact for further infor-
mation; and
(5) The signature of the plan adminis-
trator and the date of the signature.
(B) The notice must be provided at no
charge to participants or their representa-
tive within 15 days after receipt of a writ-
ten or oral request for such notification,
but in no event before the notice has been
sent to the applicable federal agency.
(i) Sunset.This section does not apply
to benefits for services furnished on or
after September 30, 2001.
Authority:Secs. 2741 through 2763,
2791, and 2792 of the PHS Act, 42 U.S.C.
300gg–41 through 300gg–63, 300gg–91,
and 300gg–92.
Nancy-Ann Min DeParle,
Administrator, Health Care Financing
Administration.
Donna E. Shalala,
Secretary.
(Filed by the Office of the Federal Register on De-
cember 19, 1997, 8:45 a.m., and published in the
issue of the Federal Register for December 22, 1997,
62 F.R. 66932)
1998–3 I.R.B41January 20, 1998

January 20, 1998421998–3 I.R.B.
Cash or Deferred
Arrangements;
Nondiscrimination
Notice 98–1
I. PURPOSE
This notice provides guidance and tran-
sition relief relating to recent statutory
amendments to the nondiscrimination
rules under §401(k) and §401(m) of the
Internal Revenue Code. The rules applic-
able to qualified cash or deferred arrange-
ments under §401(k) and matching and
employee contributions under §401(m)
were amended by the Small Business Job
Protection Act of 1996 (SBJPA), Pub. L.
104–188.
Specifically, this notice provides guid-
ance on
•The election to use the current year
testing method.
•The use of qualified nonelective con-
tributions (QNCs) and qualified
matching contributions (QMACs)
under the prior year testing method.
•The application of the first plan year
rule under the prior year testing
method.
•The impact of certain plan population
changes under the prior year testing
method.
•Achange from the current year test-
ing method to the prior year testing
method, including related transition
relief.
•Plan amendments needed to reflect
the testing method of a plan, includ-
ing the application of the remedial
amendment period under §401(b).
II. BACKGROUND
A. SBJPAAmendments to §401(k)
and §401(m)
Under §401(k) and §401(m), the ac-
tual deferral percentage (ADP) and the
actual contribution percentage (ACP) of
highly compensated employees (HCEs)
are compared with those of nonhighly
compensated employees (NHCEs). Sec-
tion 1433(c) of SBJPAamended
§401(k)(3)(A) and §401(m)(2)(A), ef-
fective for plan years beginning after De-
cember 31, 1996, to provide for the use of
prior year data in determining the ADP
and ACPfor NHCEs, while continuing to
provide for the use of current year data for
HCEs. Alternatively, an employer may
elect to use current year data for deter-
mining the ADPand ACPfor both HCEs
and NHCEs, but the statute provides that
this election may be changed only as pro-
vided by the Secretary. Section 1433(d)
of SBJPAamended §401(k)(3) and
§401(m)(3) to provide a special rule for
determining the ADPand ACPfor
NHCEs for the first plan year of a plan
(other than a successor plan) where the
prior year testing method is used.
B. Guidance on the SBJPA
Amendments
Notice 97–2, 1997–2 I.R.B. 22, pro-
vides guidance on determining the indi-
viduals who are taken into account in
computing the ADPor ACPfor NHCEs
for the prior year under the prior year test-
ing method. The guidance provides tran-
sition relief to allow plans using the cur-
rent year testing method for the 1997
testing year to change to the prior year
testing method for the 1998 testing year
without obtaining approval from the In-
ternal Revenue Service. The notice also
provides rules for distributions of excess
contributions and excess aggregate contri-
butions.
Notice 97–2 states that Treasury and
the Service will issue guidance regarding
the conditions under which employers
that elect to use current year data for the
1998 or a later plan year may change that
election and use prior year testing for sub-
sequent plan years. Notice 97–2 also re-
quested comments concerning (i) the use
of QNCs and QMACs in computing the
prior year’s ADPfor NHCEs, including
methods of preventing inappropriate dou-
ble counting; and (ii) the appropriate de-
termination of the prior year’s ADPfor
NHCEs when the group of employees
tested is significantly different in the cur-
rent year than in the prior year. After con-
sideration of the comments received, this
notice provides guidance on these issues.
Rev. Proc. 97–41, 1997–33 I.R.B. 51,
provides guidance to sponsors of plans
that are qualified under §401(a) with re-
spect to the date by which they must
adopt amendments to comply with
changes in the law, including a remedial
amendment period for amendments to re-
flect changes to the qualification require-
ments made by SBJPA.
C. Definitions
If a term that is used in this notice is de-
fined in the regulations under §401(k) or
§401(m), then the definition under these
regulations applies for purposes of this
notice. For example, “plan” as used in
this notice means plan as defined in
§1.401(k)–1(g)(11) of the Income Tax
Regulations.
In addition, for purposes of this notice,
the “testing year” is the plan year for
which the ADPor ACPfor HCEs is being
tested; the “prior year” is the plan year
immediately preceding the testing year. If
the plan uses data from the testing year in
determining the ADPor ACPfor NHCEs,
it is using the “current year testing
method;” if the plan uses data from the
prior year in determining the ADPor ACP
for NHCEs, it is using the “prior year test-
ing method.”
Sections Vand VI of this notice pro-
vide additional definitions used in apply-
ing the first plan year rule and definitions
used in the rules relating to changes in the
group of eligible employees when a plan
uses the prior year testing method.
D. Effect of Statutory Changes on
Regulations
Because of the amendments made to
§401(k) and §401(m), certain portions of
§1.401(k)–1 and §§1.401(m)–1 and
1.401(m)–2 no longer reflect current law.
This notice provides guidance on a limited
number of issues relating to the use of the
prior year testing method and relating to a
change in testing method. The regulations
shall continue in force to the extent that
they are not inconsistent with the Code, as
amended, and subsequent guidance, in-
cluding Notice 97–2 and this notice.
III. USE OFCURRENTYEAR
TESTING METHOD
As provided under §401(k)(3)(A) and
§401(m)(2)(A), an employer may elect to
Part III. Administrative, Procedural, and Miscellaneous

1998–3 I.R.B43January 20, 1998
use the current year testing method for a
plan in lieu of the prior year testing
method. Aplan using the prior year test-
ing method may adopt the current year
testing method for any subsequent testing
year. Notification to or filing with the
Service of an election to use the current
year testing method is not required in
order for the election to be valid. How-
ever, as provided in section IX of this no-
tice, the plan document governing the
plan must reflect whether the plan uses
the current year testing method or the
prior year testing method for a testing
year.
Aplan that uses the current year testing
method for a testing year may not be per-
missively aggregated under §1.410(b)–
7(d) with a plan that uses the prior year
testing method for that testing year.
IV. USE OFQNCs AND QMACs
UNDER PRIOR YEAR TESTING
METHOD
Section 401(k)(3)(D) and §401(m)(3)
provide that an employer may take into
account QNCs and QMACs in calculating
the ADP, and QNCs in calculating the
ACP, as provided by the Secretary. Aplan
may continue to take QNCs and QMACs
into account under the prior year testing
method, subject to the limitations set forth
in section VII.B. of this notice.
A. Timing of Contribution of QNCs
and QMACs
In order to be taken into account in the
calculation of the ADPor ACPfor a year
under the prior year testing method, a
QNC or QMAC must be allocated as of a
date within the year and must actually be
paid to the trust no later than the end of
the 12-month period following the end of
the year to which the contribution relates.
See §§1.401(k)–1(b)(4)(i)(A) and
(b)(5)(v) and §§1.401(m)–1(b)(4)(ii) and
(b)(5)(iv). Consequently, under the prior
year testing method, in order to be taken
into account in calculating the ADPor
ACPfor NHCEs for the prior year, a QNC
or QMAC must be contributed by the end
of the testing year. Thus, for example, if
the prior year testing method is used for
the 1998 testing year, QNCs that are allo-
cated to the accounts of NHCEs for the
1997 plan year (i.e., the prior year) must
be contributed to the plan by the end of
the 1998 plan year in order to be treated
as elective contributions for purposes of
the ADPtest for the 1998 testing year. By
contrast, in order to be taken into account
in calculating the ADPor ACPfor HCEs
for the 1998 testing year, a QNC or
QMAC must be contributed by the end of
the 1999 plan year.
It should be noted that §1.415–6(b)-
(7)(ii) provides that, for purposes of satis-
fying §415, employer contributions shall
not be deemed credited to a participant’s
account for a particular limitation year
unless the contributions are actually made
to the plan no later than 30 days after the
end of the period described in §404(a)(6)
applicable to the taxable year with or
within which the particular limitation year
ends. Thus, contributions made after the
date described in §1.415–6(b)(7)(ii) are
treated as annual additions for the next
§415 limitation year. Accordingly, under
either the prior year testing method or the
current year testing method, a violation of
§415(c) might occur if QNCs or QMACs
are contributed after the date described in
§1.415–6(b)(7)(ii).
B. Nondiscrimination Testing of
QNCs under the Prior Year Testing
Method
Section 1.401(k)-1(b)(5) provides that
(i) the amount of nonelective contribu-
tions, including those QNCs treated as
elective contributions for purposes of the
ADPtest, and (ii) the amount of nonelec-
tive contributions, excluding those QNCs
treated as elective contributions for pur-
poses of the ADPtest, must each satisfy
the requirements of §401(a)(4). Under
§1.401(m)-1(b)(5), a similar rule applies
to QNCs treated as matching contribu-
tions for purposes of the ACPtest.
These nondiscrimination requirements
continue to apply to plans that use the
prior year testing method. This is true
even though the QNCs allocated to the
HCEs and NHCEs in a single plan year
are taken into account for ADPand ACP
testing in different testing years. Accord-
ingly, QNCs allocated to the accounts of
NHCEs and HCEs for the same plan year
will be subject to the requirements of
§401(a)(4) for that plan year; however,
QNCs allocated to the accounts of HCEs
will be taken into account for ADPor
ACPtesting in the plan year for which
they are allocated, while QNCs allocated
to the accounts of NHCEs will not be
taken into account in determining the per-
mitted ADPor ACPfor HCEs until the
following plan year.
V. FIRSTPLAN YEAR RULE
UNDER PRIOR YEAR TESTING
METHOD
Section 401(k)(3)(E) provides that, for
the first plan year of any plan (other than a
successor plan) that uses the prior year
testing method, the ADPfor NHCEs for
the prior year is 3%, or, if the employer
elects, is the ADPfor NHCEs for that first
plan year. For this purpose, the “first plan
year” of any plan is the first year in which
the plan, within the meaning of §414(l), is
or includes a section401(k) plan (i.e., the
first year a plan provides for elective con-
tributions described in §1.401(k)–1(g)-
(3)). However, a plan does not have a first
plan year if for such plan year the plan is
aggregated under §1.401(k)–1(g)11) with
any other plan that was or that included a
section401(k) plan in the prior year.
Section 401(m)(3) provides that rules
similar to the rules of §401(k)(3)(E) shall
apply for purposes of the ACPtest. For
purposes of the ACPtest, the “first plan
year” of any plan is the first year in which
a plan, within the meaning of §414(l), is
or includes a section 401(m) plan (i.e., the
first year a plan provides for employee
contributions described in §1.401(m)–
1(f)(6) or matching contributions de-
scribed in §1.401(m)–1(f)(12), or both).
However, a plan does not have a first plan
year if for such plan year the plan is ag-
gregated for purposes of §1.401(m)–
1(g)(14) with any other plan that was or
that included a section401(m) plan in the
prior year.
For purposes of this notice, a plan is a
“successor plan” if 50% or more of the el-
igible employees for the first plan year
were eligible employees under another
section 401(k) plan (or section 401(m)
plan, as applicable) maintained by the
employer in the prior year. For example,
in 1998, Employer H sponsors Plan T, a
section 401(k) plan. In 1999, Employer H
establishes Plan U, also a section401(k)
plan, which had 200 eligible employees,
including 100 employees who were eligi-
ble employees under Plan Tin 1998. Plan
U is a successor plan.

January 20, 1998441998–3 I.R.B.
If a plan (other than a successor plan)
uses the prior year testing method and for
its first plan year the plan determines the
ADPor ACPfor NHCEs for the prior plan
year using the ADPor ACPfor NHCEs
for that first plan year (in lieu of 3%),
then the use of the prior year testing
method in the next testing year is not
treated as a change in testing method.
Such a plan would not be subject to the
limitations on double counting described
in section VII.B. for that next testing year.
If a successor plan uses the prior year test-
ing method for its first plan year, the ADP
and ACPfor NHCEs for the prior year are
determined under the rules in section Vof
this notice.
VI. CHANGES IN THE GROUPOF
ELIGIBLE NHCEs WHERE
PLAN USES PRIOR YEAR
TESTING METHOD
A. General Rule: Disregard Changes
in the Group of NHCEs
Except as provided in section VI.B. and
C., below, under the prior year testing
method, the ADPor ACPfor NHCEs for
the prior year under a plan is determined
without regard to changes in the group of
NHCEs who are eligible employees under
the plan in the testing year. Thus, under
the prior year testing method, the prior
year ADPor ACPfor NHCEs is used even
though some NHCEs may have first be-
come eligible employees under the plan in
the testing year because they meet exist-
ing plan eligibility requirements, and
even though individuals who were eligi-
ble employees under the plan and NHCEs
in the prior year are no longer employed
by the employer or have become HCEs in
the testing year.
B. Exception for Plan Coverage
Changes
If a plan results from, or is otherwise
affected by, a plan coverage change that
becomes effective during the testing year,
then the ADPand ACPfor NHCEs for the
prior year under the plan is the weighted
average of the ADPs for the prior year
subgroups and the weighted average of
the ACPs for the prior year subgroups, re-
spectively.
C. Optional Rule for Minor Plan
Coverage Changes
If a plan results from, or is otherwise
affected by, a plan coverage change, and
90% or more of the total number of
NHCEs from all prior year subgroups are
from a single prior year subgroup, then in
determining the ADPor ACPfor NHCEs
for the prior year under the plan, an em-
ployer may elect to use the ADPand ACP
for NHCEs for the prior year of the plan
under which that single prior year sub-
group was eligible, in lieu of using the
weighted averages described in section
VI.B., above.
D. Definitions
For purposes of this notice:
1.“Plan coverage change” means a
change in the group or groups of eligible
employees under a plan on account of (a)
the establishment or amendment of a
plan, (b) a plan merger, consolidation, or
spinoff under §414(l), (c) a change in the
way plans within the meaning of §414(l)
are combined or separated for purposes of
§1.401(k)–1(g)(11) (e.g., permissively
aggregating plans not previously aggre-
gated under §1.410(b)–7(d), or ceasing to
permissively aggregate plans under
§1.410(b)–7(d)), or (d) a combination of
any of the foregoing.
2.“Prior year subgroup” means all
NHCEs for the prior year who, in the
prior year, were eligible employees under
a specific section 401(k) plan (or, in the
case of the ACPtest, a specific section
401(m) plan) maintained by the employer
and who would have been eligible em-
ployees in the prior year under the plan
being tested if the plan coverage change
had first been effective as of the first day
of the prior year instead of first being ef-
fective during the testing year.
3.“Weighted average of the ADPs for
the prior year subgroups” and “weighted
average of the ACPs for the prior year
subgroups” mean the sum, for all prior
year subgroups, of the adjusted ADPs and
adjusted ACPs, respectively.
4.“Adjusted ADP” and “adjusted
ACP” with respect to a prior year sub-
group mean the respective ADPand ACP
for NHCEs for the prior year of the spe-
cific plan under which the members of the
prior year subgroup were eligible employ-
ees, multiplied by a fraction, the numera-
tor of which is the number of NHCEs in
the prior year subgroup and the denomi-
nator of which is the total number of
NHCEs in all prior year subgroups.
E. Examples
The requirements of this section VI are
illustrated by the following examples:
Example 1:
(i) Employer B maintains two plans,
Plan N and Plan P, each of which includes
a section401(k) plan. The plans were not
permissively aggregated under
§1.410(b)–7(d) for the 1998 testing year.
Both plans use the prior year testing
method. Plan N had 300 eligible employ-
ees who were NHCEs for 1998, and their
ADPfor that year was 6%. Plan Phad
100 eligible employees who were NHCEs
for 1998, and the ADPfor those NHCEs
for that plan was 4%. Plan N and Plan P
are permissively aggregated under
§1.410(b)–7(d) for the 1999 plan year.
(ii) The permissive aggregation of Plan
N and Plan Pfor the 1999 testing year
under §1.410(b)–7(d) is a plan coverage
change that results in treating the plans as
one plan (Plan NP) for purposes of
§1.401(k)–1(g)(11). Therefore, the prior
year ADPfor NHCEs under Plan NPfor
the 1999 testing year is the weighted aver-
age of the ADPs for the prior year sub-
groups.
(iii) The first step in determining the
weighted average of the ADPs for the
prior year subgroups is to identify the
prior year subgroups. With respect to the
1999 testing year, an employee is a mem-
ber of a prior year subgroup if the em-
ployee (A) was an NHCE of Employer B
for the 1998 plan year, (B) was an eligible
employee for the 1998 plan year under
any section 401(k) plan maintained by
Employer B, and (C) would have been an
eligible employee in the 1998 plan year
under Plan NPif Plan N and Plan Phad
been permissively aggregated under
§1.410(b)–7(d) for that plan year. The
NHCEs who were eligible employees
under separate section401(k) plans for
the 1998 plan year comprise separate

1998–3 I.R.B45January 20, 1998
prior year subgroups. Thus, there are two
prior year subgroups under Plan NPfor
the 1999 testing year: the 300 NHCEs
who were eligible employees under Plan
N for the 1998 plan year and the 100
NHCEs who were eligible employees
under Plan Pfor the 1998 plan year.
(iv) The weighted average of the ADPs
for the prior year subgroups is the sum of:
(A) the adjusted ADPwith respect to the
prior year subgroup that consists of the
NHCEs who were eligible employees
under Plan N, and (B) the adjusted ADP
with respect to the prior year subgroup
that consists of the NHCEs who were eli-
gible employees under Plan P. The ad-
justed ADPfor the prior year subgroup
that consists of the NHCEs who were eli-
gible employees under Plan N is 4.5%,
calculated as follows: 6% (the ADPfor
the NHCEs under Plan N for the prior
year) x 300/400 (the number of NHCEs in
that prior year subgroup divided by the
total number of NHCEs in all prior year
subgroups), which equals 4.5%. The ad-
justed ADPfor the prior year subgroup
that consists of the NHCEs who were eli-
gible employees under Plan Pis 1%, cal-
culated as follows: 4% (the ADPfor the
NHCEs under Plan Pfor the prior year)
3
100/400 (the number of NHCEs in that
prior year subgroup divided by the total
number of NHCEs in all prior year sub-
groups), which equals 1%. Thus, the
prior year ADPfor NHCEs under Plan NP
for the 1999 testing year is 5.5% (the sum
of adjusted ADPs for the prior year sub-
groups, 4.5% plus 1%).
Example 2:
(i) Employer C maintains a plan, Plan
Q, which includes a section 401(k) plan
and which uses the prior year testing
method. Plan Q covers employees of Di-
vision Aand Division B. In 1998, Plan Q
had 500 eligible employees who were
NHCEs, and the ADPfor those NHCEs
for 1998 was 5%. Effective January 1,
1999, Employer C spins off a portion of
Plan Q under §414(l), creating a new
Plan R which includes a section 401(k)
plan in which the 100 employees of Divi-
sion B are eligible employees.
(ii) The spin-off of Plan R is a plan
coverage change that affects Plan Q. Ac-
cordingly, for purposes of the 1999 test-
ing year under Plan Q, the prior year ADP
for NHCEs under Plan Q is the weighted
average of the ADPs for the prior year
subgroups. Plan Q has only one prior
year subgroup (because the only NHCEs
who would have been eligible employees
under Plan Q for the 1998 plan year if the
spin-off had occurred as of the first day of
that plan year were eligible employees
under Plan Q). Therefore, for purposes of
the 1999 testing year under Plan Q, the
ADPfor NHCEs for the prior year is the
weighted average of the ADPs for the
prior year subgroups, or 5%, the same as
if the plan spin-off had not occurred.
Example 3:
(i) The facts are the same as in Exam-
ple 2, except that instead of spinning off
Plan R from Plan Q, Employer C amends
the eligibility provisions under Plan Q to
exclude employees of Division B effec-
tive January 1, 1999. In addition, effec-
tive on that same date, Employer C estab-
lishes a new plan, Plan R, which includes
a section 401(k) plan that uses the prior
year testing method. The only eligible
employees under Plan R are the 100 em-
ployees of Division B who were eligible
employees under Plan Q.
(ii) Plan R is a successor plan, within
the meaning of section Vof this notice
(because all of the employees were eligi-
ble employees under Plan Q in the prior
year), and, therefore, the first plan year
rule of that section does not apply.
(iii) The amendment to the eligibility
provisions of Plan Q and the establish-
ment of Plan R are plan coverage changes
that affect Plan Q and result in Plan R.
Accordingly, the prior year ADPfor
NHCEs under Plan Q is the weighted av-
erage of the ADPs for the prior year sub-
groups. Plan Q has only one prior year
subgroup (because the only NHCEs who
would have been eligible employees
under Plan Q for the 1998 plan year if the
amendment to the Plan Q eligibility pro-
visions had occurred as of the first day of
that plan year were eligible employees
under Plan Q). Therefore, for purposes of
the 1999 testing year under Plan Q, the
ADPfor NHCEs for the prior year is the
weighted average of the ADPs for the
prior year subgroups, or 5%, the same as
if the plan amendment had not occurred.
(iv) Similarly, Plan R has only one
prior year subgroup (because the only
NHCEs who would have been eligible
employees under Plan R for the 1998 plan
year if the plan were established as of the
first day of that plan year were eligible
employees under Plan Q). Therefore, for
purposes of the 1999 testing year under
Plan R, the ADPfor NHCEs for the prior
year is the weighted average of the ADPs
for the prior year subgroups, or 5%, the
same as that of Plan Q.
Example 4:
(i) The facts are the same as in Exam-
ple 3, except that the provisions of Plan R
extend eligibility to 50 hourly employees
who previously were not eligible employ-
ees under any section 401(k) plan main-
tained by Employer C.
(ii) Plan R is a successor plan, within
the meaning of section Vof this notice
(because 100 of Plan R’s 150 eligible em-
ployees were eligible employees under
another section 401(k) plan maintained by
Employer C in the prior year), and, there-
fore, the first plan year rule of that section
does not apply.
(iii) The establishment of Plan R is a
plan coverage change that affects Plan R.
Because the 50 hourly employees were
not eligible employees under any section
401(k) plan of Employer C for the prior
year, they do not comprise a prior year
subgroup. Accordingly, Plan R still has
only one prior year subgroup. Therefore,
for purposes of the 1999 testing year
under Plan R, the ADPfor NHCEs for the
prior year is the weighted average of the
ADPs for the prior year subgroups, or 5%,
the same as that of Plan Q.
VII. CHANGE FROM CURRENT
YEAR TO PRIOR YEAR
TESTING METHOD
A. General Rule
Section 401(k)(3)(A) provides that if an
employer elects to use the current year test-
ing method for purposes of the ADPtest,
that method may not be changed except as
provided by the Secretary. Asimilar rule
applies under §401(m)(2)(A) in the case
of the ACPtest. Thus, the statute indicates
that once an employer elects to use the cur-
rent year testing method, the ability to
change that election will be limited.
In general, it is expected that plans will
select a testing method and retain it.

January 20, 1998461998–3 I.R.B.
Treasury and the Service recognize, how-
ever, that there may be legitimate reasons
for occasionally reevaluating and chang-
ing the testing method under a plan. In
addition, certain business transactions
may result in a diversity of testing meth-
ods among plans of an employer, and the
employer may wish to use consistent test-
ing methods. Finally, Treasury and the
Service believe that employers with exist-
ing plans should be given a period of time
to decide whether to change from the cur-
rent year testing method (which was the
required testing method prior to the
SBJPAchanges) to the prior year testing
method.
Accordingly, a plan is permitted to
change from the current year testing
method to the prior year testing method in
any of the following situations:
1.The plan is not the result of the ag-
gregation of two or more plans, and the
current year testing method was used
under the plan for each of the 5 plan years
preceding the plan year of the change (or
if lesser, the number of plan years the plan
has been in existence, including years in
which the plan was a portion of another
plan).
2.The plan is the result of the aggrega-
tion of two or more plans, and for each of
the plans that are being aggregated (the
aggregating plans), the current year test-
ing method was used for each of the 5
plan years preceding the plan year of the
change (or if lesser, the number of plan
years since that aggregating plan has been
in existence, including years in which the
aggregating plan was a portion of another
plan).
3.Atransaction occurs that is described
in §410(b)(6)(C)(i) and §1.410(b)–2(f);
as a result of the transaction, the employer
maintains both a plan using the prior year
testing method and a plan using the cur-
rent year testing method; and the change
from the current year testing method to
the prior year testing year method occurs
within the transition period described in
§410(b)(6)(C)(ii).
4.The change occurs during the plan’s
remedial amendment period for the
SBJPAchanges (see Rev. Proc. 97–41).
Notification to or filing with the Service
of a change from the current year to the
prior year testing method is not required
in order for the change to be valid. How-
ever, as provided in section IX of this no-
tice, the plan document governing the
plan must reflect such a change.
B.Limitations on Double Counting
of Certain Contributions
If a plan changes from the current year
testing method to the prior year testing
method, then, for purposes of the first
testing year for which the change is effec-
tive, the ADPand ACPfor NHCEs for the
prior year is determined in the following
manner:
1.The ADPfor NHCEs for the prior
year is determined taking into account
only (a) elective contributions for those
NHCEs that were taken into account for
purposes of the ADPtest (and not the
ACPtest) under the current year testing
method for the prior year and (b) QNCs
that were allocated to the accounts of
those NHCEs for the prior year but that
were not used to satisfy the ADPtest or
the ACPtest under the current year testing
method for the prior year.
2.The ACPfor NHCEs for the prior
year is determined taking into account
only (a) employee contributions for those
NHCEs for the prior year, (b) matching
contributions for those NHCEs that were
taken into account for purposes of the
ACPtest (and not the ADPtest) under the
current year testing method for the prior
year, and (c) QNCs that were allocated to
the accounts of those NHCEs for the prior
year but that were not used to satisfy the
ACPtest or the ADPtest under the current
year testing method for the prior year.
Thus, in determining the ADPfor NHCEs
for the prior year, the following contribu-
tions made for the prior testing year are
disregarded: QNCs used to satisfy either
the ADPor ACPtest under the current
year testing method for the prior testing
year, elective contributions taken into ac-
count for purposes of the ACPtest, and all
QMACs. Similarly, in determining the
ACPfor NHCEs for the prior year, the
following contributions made for the prior
testing year are disregarded: QNCs used
to satisfy either the ADPor ACPtest
under the current year testing method for
the prior testing year, QMACs taken into
account for purposes of the ADPtest, and
all elective contributions.
The limitations on double counting
under this section VII.B. do not apply for
testing years beginning before January 1,
1999. Accordingly, in the case of a plan
that changes from the current year to the
prior year testing method for the first time
for either the 1997 or 1998 testing year,
the ADPand ACPfor NHCEs used for
that testing year are the same as the ADP
and ACP, respectively, for NHCEs used
for the prior testing year.
3.Examples
The limitations on double counting are
illustrated by the following examples:
Example 1:
(i) Employer Aestablished Plan M, a
calendar year section 401(k) plan, in 1993
and, through the 2000 testing year, has al-
ways used the current year testing method
under Plan M. The ADPfor the HCEs
under Plan M is 7% for the 2000 testing
year. Based solely on elective contribu-
tions by NHCEs under Plan M for the
2000 testing year, the ADPfor NHCEs for
the 2000 testing year is 4%. In order to
satisfy the ADPtest, Employer Aprovides
a QNC to each NHCE for the 2000 testing
year equal to 1% of compensation. No
other contributions under Plan M are
taken into account in determining the
ADPfor NHCEs. Thus, the ADPfor
NHCEs for the 2000 testing year is 5%.
Plan M is amended to use the prior year
testing method instead of the current year
testing method for purposes of the ADP
test for the 2001 testing year.
(ii) In determining the ADPfor
NHCEs under Plan M for the 2001 testing
year in accordance with the prior year
testing method, the elective contributions
made by NHCEs under Plan M for the
2000 plan year are taken into account.
However, the QNCs equal to 1% of com-
pensation made under Plan M on behalf
of NHCEs for the 2000 plan year are dis-
regarded because they were used to sat-
isfy the ADPtest for the 2000 testing year.
Thus, for purposes of the 2001 testing
year, the ADPfor NHCEs for the prior
year is 4% (unless additional QNCs for
NHCEs are timely contributed and allo-
cated for the 2000 plan year).
Example 2:
(i) The facts are the same as in Exam-
ple 1, except that the testing years are
1997 and 1998, instead of 2000 and 2001.
(ii) For purposes of the 1998 testing
year, the ADPfor NHCEs for the prior

1998–3 I.R.B47January 20, 1998
year is 5%. The QNCs equal to 1% of
compensation made under Plan M on be-
half of NHCEs that were used to satisfy
the ADPtest for the 1997 testing year are
not disregarded because the limitation on
double counting applies only for testing
years beginning on or after January 1,
1999.
VIII. ANTI-ABUSE PROVISION
This guidance is designed to provide
simple, practical rules that accommodate
legitimate plan changes. At the same
time, the rules are intended to be applied
by employers in a manner that does not
make use of changes in plan testing pro-
cedures or other plan provisions to inflate
inappropriately the prior year ADPand
ACPfor NHCEs (which are used as
benchmarks for testing the ADPand ACP
for HCEs). Further, the ADPand ACP
tests are part of the overall requirement
that benefits or contributions not discrimi-
nate in favor of HCEs. Therefore, a plan
will not be treated as satisfying the ADP
or ACPtest if there are repeated changes
in plan testing procedures or plan provi-
sions that have the effect of distorting the
ADPor ACPtest so as to increase signifi-
cantly the permitted ADPor ACPfor
HCEs and if a principal purpose of the
changes was to achieve such a result.
IX. PLAN PROVISIONS
REGARDING TESTING
METHOD
Sections 1.401(k)–1(b)(2)(iii) and
1.401(m)–1(b)(2) require that a plan to
which §401(k) or §401(m) applies must
provide that the ADPor ACPtest will be
met. Because a plan may now use either
the current year testing method or the
prior year testing method, a plan must
specify which of these two testing meth-
ods it is using. If the employer changes
the testing method under a plan, the plan
must be amended to reflect the change.
Further, if the first plan year rule de-
scribed in §401(k)(3)(E) and §401(m)(3)
and section Vof this notice applies, a plan
that incorporates these provisions by ref-
erence must specify whether the ADPand
ACPfor NHCEs for the prior plan year is
3% or the current year’s ADPand ACP
for the NHCEs.
The regulations under §401(k) and
§401(m) permit a plan to incorporate by
reference §401(k)(3) and §401(m)(2)
(and, if applicable, §401(m)(9)) and the
specific underlying regulations. Aplan
that incorporates these provisions by ref-
erence must continue to refer to the ap-
plicable Code sections and the specific
underlying regulations, must specify
which of the two testing methods (prior
year or current year) it is using, and must
now provide that it is incorporating by
reference subsequent Internal Revenue
Service guidance issued under the applic-
able Code provisions. Further, for pur-
poses of the first plan year rule described
in §401(k)(3)(E) and §401(m)(3) and
section Vof this notice, a plan that incor-
porates these provisions by reference
must specify whether the ADPand ACP
for NHCEs for the prior plan year is 3%
or the current year’s ADPand ACPfor the
NHCEs.
Rev. Proc. 97–41 provides that quali-
fied retirement plans have a remedial
amendment period under §401(b) so that
certain plan amendments for SBJPAgen-
erally are not required to be adopted be-
fore the last day of the first plan year be-
ginning on or after January 1, 1999.
Pursuant to Rev. Proc. 97–41, a plan pro-
vision reflecting the ADPor ACPtesting
method is a disqualifying provision, and
thus any plan amendments to reflect a
choice in testing method are not required
to be adopted until the end of this reme-
dial amendment period. However, plans
must be operated in accordance with the
SBJPAchanges to §401(k)(3)(A) and
§401(m)(2)(A) as of the statutory effec-
tive date. In addition, under Rev. Proc.
97–41, any retroactive amendments must
reflect the choices made in the operation
of the plan for each testing year, including
the choice of testing method (and any
changes to that election), and must reflect
the date on which the plan began to oper-
ate in accordance with those choices (and
any such changes).
X. PAPERWORK REDUCTION ACT
The collection of information con-
tained in this notice has been reviewed
and approved by the Office of Manage-
ment and Budget (OMB) in accordance
with the Paperwork Reduction Act (44
U.S.C. 3507) under control number
1545–1579.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
OMB control number.
The collection of information in this
notice is in section IX. This requirement
to amend plan documents is necessary to
reflect the new nondiscrimination test
under §401(k)(3) and §401(m)(2) as
amended by SBJPA. The pre-SBJPA
method of nondiscrimination testing is
still available under these Code sections
and a plan amendment may not be re-
quired to reflect the choice of the pre-
SBJPAtesting method. The information
will be used to determine whether the
ADPand ACPof HCEs exceeds the ADP
and ACPof NHCEs by more than the
statutory limits. The collection of infor-
mation is required to obtain a benefit.
The likely respondents are businesses or
other for-profit institutions, and nonprofit
institutions.
The estimated total annual recordkeep-
ing burden is 49,000 hours. The esti-
mated annual burden per recordkeeper is
20 minutes. The estimate number of
recordkeepers is 147,000.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any Internal
Revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
XI. COMMENTS
Treasury and the Service invite com-
ments regarding the matters discussed in
this notice. Comments may be submitted
to the Service at CC:DOM:CORP:R (No-
tice 98–1), Room 5226, Internal Revenue
Service, P.O. Box 7604, Ben Franklin Sta-
tion, Washington, DC 20044. Alterna-
tively, taxpayers may hand-deliver com-
ments between the hours of 8 a.m. and 5
p.m. to CC:DOM:CORP:R (Notice 97–
XX), Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW,
Washington, DC, or may submit com-
ments electronically via the Service’s In-
ternet site at http://www.irs.ustreas.
gov/prod/tax_regs/comments.html.
Drafting Information
The principal authors of this notice are
Susan Lennon of the Office of the Associ-
ate Chief Counsel (Employee Benefits
and Exempt Organizations) and Roger
Kuehnle of the Employee Plans Division.

January 20, 1998481998–3 I.R.B.
For further information regarding this no-
tice, contact the Employee Plans Divi-
sion’s telephone assistance service be-
tween 1:30 and 4:00 p.m., Eastern Time,
Monday through Thursday at (202) 622-
6074/75. (These telephone numbers are
not toll-free.)
Publicly Traded Partnerships
Notice 98–3
This notice provides the method for
grandfathered publicly traded partner-
ships to elect to remain exempt from §
7704 of the Internal Revenue Code pur-
suant to § 7704(g). This notice also pro-
vides the procedures for revoking the
election. In addition, this notice informs
grandfathered publicly traded partner-
ships that do not elect the application of
§ 7704(g) that the rules contained in pro-
posed regulation § 1.743–2 regarding spe-
cial § 743(b) basis accounts may be fol-
lowed for purposes of a conversion from a
partnership to a corporation. The refer-
ences in this notice to § 7704(g) reflect
the amendments made by the Taxpayer
Relief Act of 1997 (1997 TRA), Pub. L.
No. 105–34, 111 Stat. 788 (1997).
BACKGROUND
Section 7704(a) provides that a pub-
licly traded partnership is treated as a cor-
poration.
Section 7704(b) defines a partnership
as a “publicly traded partnership” if inter-
ests in the partnership are traded on an es-
tablished securities market or are readily
tradable on a secondary market (or the
substantial equivalent thereof).
Section 7704(c) provides that a pub-
licly traded partnership will not be treated
as a corporation if, for the current taxable
year and each preceding taxable year be-
ginning after December 31, 1987 during
which the partnership (or any predeces-
sor) was in existence, (1) at least 90 per-
cent of the gross income of the partner-
ship consisted of certain “qualifying
income” (as defined in § 7704(d)), and (2)
the partnership would not be described in
§ 851(a) if the partnership were a domes-
tic corporation.
Section 7704 applies to taxable years
beginning after December 31, 1987.
However, for any existing partnership (as
defined in § 10211(c)(2) of the Revenue
Reconciliation Act of 1987 (1987 Act),
1987-3 C.B. 125), § 7704 applies to tax-
able years beginning after December 31,
1997. The term “existing partnership”
means any partnership that was a publicly
traded partnership on December 17, 1987.
If a substantial new line of business is
added with respect to an existing partner-
ship anytime after December 17, 1987,
the grandfather status of the partnership
terminates.
Section 7704(g) was enacted as part of
the 1997 TRA. Under § 7704(g), an ex-
isting 1987 partnership may elect to re-
main exempt from § 7704(a) by agreeing
to pay each taxable year a 3.5 percent tax
on gross income from the active conduct
of all trades and businesses of the partner-
ship. Apublicly traded partnership may
make the election under § 7704(g) if: (1)
the partnership is an existing partnership
(as defined in § 10211(c)(2) of the 1987
Act), (2) § 7704(a) has not applied (and
without regard to § 7704(c)(1) would not
have applied) to the partnership for all
taxable years beginning after December
31, 1987, and before January 1, 1998, and
(3) the partnership elects the application
of § 7704(g) for its first taxable year be-
ginning after December 31, 1997, and
consents to the application of the 3.5 per-
cent tax imposed for each taxable year on
gross income from the active conduct of
all trades or businesses of the partnership.
PROCEDURALREQUIREMENTS
To make an election under § 7704(g), a
partnership must file with the Memphis
Service Center a statement that provides
the following: (1) a notification at the top
of the statement that an election is being
made (that is, “ELECTION UNDER
SECTION 7704(g) FILED PURSUANT
TO NOTICE 98-3”); (2) the name of the
partnership; (3) the federal tax identifica-
tion number of the partnership; (4) the
mailing address of the partnership; (5) the
taxable year of the partnership; and (6) a
declaration that, pursuant to § 7704(g),
the partnership consents to the imposition
of a 3.5 percent tax on gross income from
the active conduct of all trades and busi-
nesses by the partnership.
The statement must be signed by the
tax matters partner of the partnership (as
defined under § 6231(a)(7)) and must be
filed at any time on or before the 75th day
of the first taxable year of the partnership
beginning after December 31, 1997. The
mailing address for the Memphis Service
Center is Internal Revenue Service, Stop
1, 5333 Getwell Road, Memphis, TN
38118.
TAX ON GROSS INCOME
An electing partnership must pay each
taxable year a tax of 3.5 percent of the
gross income from all active trades and
businesses conducted by the partnership.
The tax is not deductible by the partner-
ship. Pursuant to § 705(a)(2)(B), a part-
ner of an electing partnership must reduce
the adjusted basis of the partner’s partner-
ship interest by a proportionate share of
the 3.5 percent tax paid by the partner-
ship.
TERMINATION OF ELECTION
If a partnership that elects special treat-
ment under § 7704(g) adds a substantial
new line of business after December 31,
1997, the election under § 7704(g) will
terminate. The rules concerning a new
line of business and the timing of a result-
ing termination that are set forth in §
1.7704–2 of the regulations will be ap-
plied to electing partnerships.
In addition, a partnership may volun-
tarily terminate its election at any time by
filing a notice of revocation. The revoca-
tion will be effective as of the date desig-
nated in the notice, but not earlier than the
date that the notice is filed with the Inter-
nal Revenue Service. Once a partnership
revokes or otherwise terminates its elec-
tion under § 7704(g), the election may not
be reinstated. If the partnership remains a
publicly traded partnership on the date of
the termination and does not meet the ex-
ception for partnerships with passive-type
income contained in § 7704(c), then ab-
sent an actual transaction that eliminates
the partnership, the conversion from a
partnership to a corporation will be deter-
mined under § 7704(f).
PROCEDURALREQUIREMENTS FOR
REVOCATION
To make a revocation under § 7704(g),
a partnership must file with the Memphis
Service Center a statement that provides
the following: (1) a notification at the top
of the statement that a revocation is being
made (that is, “REVOCATION UNDER

1998–3 I.R.B49January 20, 1998
SECTION 7704(g) FILED PURSUANT
TO NOTICE 98–3”; (2) the name of the
partnership; (3) the federal tax identifica-
tion number of the partnership; (4) the
mailing address of the partnership; (5) the
taxable year of the partnership; (6) a dec-
laration that, pursuant to § 7704(g), the
partnership revokes its election to pay a
3.5 percent tax on gross income from the
active conduct of all trades and businesses
by the partnership; and (7) the effective
date of the revocation. The statement
must be signed by the tax matters partner
of the partnership (as defined under §
6231(a)(7)).
PARTNERSHIPS THATDO NOT
ELECT
If an existing partnership does not elect
the special treatment of § 7704(g), then
the partnership will become taxable as a
corporation if it (1) remains a publicly
traded partnership on the first day of its
first taxable year beginning after Decem-
ber 31, 1997, and (2) does not meet the
exception for partnerships with passive-
type income contained in § 7704(c). Ab-
sent an actual transaction that eliminates
the partnership, the conversion from a
partnership to a corporation will be
treated under § 7704(f) as an asset trans-
fer from the partnership to the corporation
followed by a liquidation of the partner-
ship.
On October 28, 1997, proposed regula-
tions under § 743 were issued that provide
that upon the contribution of assets by a
partnership to a corporation, the special
§ 743 basis accounts are reflected in the
basis of the assets in the hands of the cor-
poration. 62 Fed. Reg. 55768, 1997–48
I.R.B. 13. Although these rules are in
proposed form, the Service will not chal-
lenge a taxpayer’s § 7704(f) conversion,
or any actual transaction applying the
conversion method of § 7704(f) that fol-
lows the rules in proposed regulation
§ 1.743–2, so long as the conversion or
transaction occurs prior to the issuance of
further guidance on this issue.
DRAFTING INFORMATION
The principal author of this notice is
Christopher Kelley of the Office of the
Assistant Chief Counsel (Passthroughs
and Special Industries). For further infor-
mation regarding this notice, contact
Christopher Kelley at (202) 622-3080
(not a toll-free number).
Foreign Tax Credit Abuse
Notice 98–5
Treasury and the Internal Revenue Ser-
vice understand that certain U.S. taxpay-
ers (primarily multinational corporations)
have entered into or may be considering a
variety of abusive tax-motivated transac-
tions with a purpose of acquiring or gen-
erating foreign tax credits that can be used
to shelter low-taxed foreign-source in-
come from residual U.S. tax. These trans-
actions generally are structured to yield
little or no economic profit relative to the
expected U.S. tax benefits, and typically
involve either: (1) the acquisition of an
asset that generates an income stream
subject to foreign withholding tax, or (2)
effective duplication of tax benefits
through the use of certain structures de-
signed to exploit inconsistencies between
U.S. and foreign tax laws. This notice an-
nounces that Treasury and the Service
will address these transactions through
the issuance of regulations as well as by
application of other principles of existing
law, and requests public comment with
respect to these and related foreign tax
credit issues.
I. BACKGROUND
United States persons are subject to
U.S. income tax on foreign-source as well
as U.S.-source income. Subject to applic-
able limitations, U.S. persons with for-
eign-source income may credit income
taxes imposed by foreign jurisdictions
against their U.S. income tax liability on
foreign-source income.
Worldwide taxation of U.S. persons
coupled with the allowance of a foreign
tax credit establishes general tax neutral-
ity between foreign and domestic invest-
ment by U.S. taxpayers. Atax system that
simply exempts foreign-source income
from taxation creates an incentive for citi-
zens and residents to invest overseas in
low-taxed jurisdictions. On the other
hand, worldwide taxation without a for-
eign tax credit creates double taxation that
distorts investment decisions by inhibit-
ing foreign investment or business activi-
ties. The foreign tax credit provisions of
the Code, principally sections 901
through 907 and 960, effectuate Con-
gress’s intent to provide relief from dou-
ble taxation and alleviate these distor-
tions. American Chicle Co. v. United
States, 316 U.S. 450 (1942); Burnet v.
Chicago Portrait Co.,285 U.S. 1 (1932).
In contrast to certain tax credits that are
intended to create an incentive for taxpay-
ers to invest in certain activities, such as
the research credit under section 41 or the
low-income housing credit under section
42, the foreign tax credit is designed to re-
duce the disincentive for taxpayers to in-
vest abroad that would be caused by dou-
ble taxation. In other words, the foreign
tax credit is intended to preserve neutral-
ity between U.S. and foreign investment
and to minimize the effect of tax conse-
quences on taxpayers’decisions about
where to invest and conduct business.
Relief from double taxation generally is
not calculated separately with respect to
each dollar of foreign-source income and
tax. The foreign tax credit limitation or
“basket” regime of section 904(d) permits,
to a limited extent, a credit for foreign tax
imposed with respect to income taxed at a
rate in excess of the applicable U.S. rate to
shelter from U.S. tax income from other,
similar investments and activities that are
subject to a relatively low rate of tax (the
“cross-crediting regime”). Accordingly,
the foreign tax credit provisions do not
limit credits on an item-by-item basis.
Rather, subject to certain restrictions, the
provisions permit cross-crediting of for-
eign taxes imposed with respect to speci-
fied groups or types of income as consis-
tent with the interrelated quality of
multinational operations of U.S. persons.
Multinational corporations that are sub-
ject to relatively low rates of tax on their
foreign-source income may be in an ex-
cess limitation position. Generally, such
taxpayers may properly use credits for
foreign taxes imposed on high-taxed for-
eign income to offset residual U.S. tax on
their low-taxed foreign income. Treasury
and the Service are concerned, however,
that such taxpayers may enter into foreign
tax credit-generating schemes designed to
abuse the cross-crediting regime and ef-
fectively transform the U.S. worldwide
system of taxation into a system exempt-
ing foreign-source income from residual
U.S. tax.

January 20, 1998501998–3 I.R.B.
This result is clearly incompatible with
the existence of the detailed foreign tax
credit provisions and cross-crediting limi-
tations enacted by Congress. No statutory
purpose is served by permitting credits for
taxes generated in abusive transactions
designed to reduce residual U.S. tax on
low-taxed foreign-source income. The
foreign tax credit benefits derived from
such transactions represent subsidies from
the U.S. Treasury to taxpayers that oper-
ate and earn income in low-tax or zero-tax
jurisdictions. The effect is economically
equivalent to the tax sparing benefits for
U.S. taxpayers that Congress and the
Treasury have consistently opposed in the
tax treaty context because such benefits
are inconsistent with U.S. tax principles
and sound tax policy.
II. ABUSIVE ARRANGEMENTS
Treasury and the Service have identi-
fied two classes of transactions that create
potential for foreign tax credit abuse. The
first class consists of transactions involv-
ing transfers of tax liability through the ac-
quisition of an asset that generates an in-
come stream subject to foreign gross basis
taxes such as withholding taxes. Transac-
tions described in this class may include
acquisitions of income streams through
securities loans and similar arrangements
and acquisitions in combination with total
return swaps. In abusive arrangements in-
volving such transactions, foreign tax
credits are effectively purchased by a U.S.
taxpayer in an arrangement where the ex-
pected economic profit from the arrange-
ment is insubstantial compared to the for-
eign tax credits generated.
The second class of transactions con-
sists of cross-border tax arbitrage transac-
tions that permit effective duplication of
tax benefits. Duplicate benefits result
when the U.S. grants benefits and, in ad-
dition, a foreign country grants benefits
(including benefits from a full or partial
imputation or exemption system, or a
preferential rate for certain income) to
separate persons with respect to the same
taxes or income. These duplicate benefits
generally can result where the U.S. and a
foreign country treat all or part of a trans-
action or amount differently under their
respective tax systems. In abusive
arrangements involving such transactions,
the U.S. taxpayer exploits these inconsis-
tencies where the expected economic
profit is insubstantial compared to the for-
eign tax credits generated.
The following are examples of abusive
arrangements within the scope of this no-
tice.
Example 1
On June 29, 1998, US, a domestic corporation,
purchases all rights to a copyright for $75.00. The
copyright will expire shortly and the only income
expected to be received with respect to the copyright
is a royalty payable June 30, 1998. The gross
amount of the royalty is expected to be $100.00.
The royalty payment is subject to a 30-percent
Country X withholding tax. On June 30, 1998, US
receives the $100.00 royalty payment, less the
$30.00 withholding tax. USreasonably expects to
incur a $5.00 economic loss (having paid $75.00 for
the right to receive a $70.00 net royalty payment),
but expects to acquire a $30.00 foreign tax liability.
In this example, US has effectively purchased for-
eign tax credits in a transaction that was reasonably
expected to result in an economic loss.
Example 2
On June 29, 1998, US, a domestic corporation,
purchases a foreign bond for $1096.00 (including
accrued interest). The foreign bond provides for an-
nual interest payments of $100.00 payable June 30
of each year. The interest payments are subject to a
4.9-percent Country X withholding tax. On June 30,
1998, USreceives a $95.10 interest payment on the
bond (net of a $4.90 Country X withholding tax).
On July 4, 1998, USsells the bond for $1001.05.
Because the value of the bond is not reasonably ex-
pected to appreciate due to market factors, USrea-
sonably can expect only a $0.15 economic profit
(the $1001.05 sales price and the $95.10 net interest
coupon, less the $1096.00 purchase price) and ex-
pects to acquire a $4.90 foreign tax liability. In this
example, UShas effectively purchased foreign tax
credits in a transaction with respect to which the rea-
sonably expected economic profit is insubstantial in
relation to expected U.S. foreign tax credits. No im-
plication is intended as to whether the interest de-
scribed in this example will constitute high with-
holding tax interest under section 904(d)(2)(B).
Example 3
F, an entity that does not receive a tax benefit
from foreign tax credits, wishes to acquire a foreign
bond with a value of $1000.00 that provides for an-
nual interest payments of $100.00. The interest pay-
ments are subject to a 4.9-percent Country X with-
holding tax. Instead of purchasing the bond, F
invests its $1000.00 elsewhere and enters into a
three-year notional principal contract (NPC) with
US, an unrelated domestic corporation. Under the
terms of the NPC, USagrees to make an annual pay-
ment to Fequal to $96.00 and Fagrees to make an
annual payment to USequal to the product of
$1000.00 and a rate calculated based on LIBOR. In
addition, the parties agree that, upon termination of
the NPC, USwill make a payment to Fbased on the
appreciation, if any, in the value of the foreign bond,
and Fwill make a payment to USbased on the de-
preciation, if any, in the value of the foreign bond.
In order to hedge its obligations under the NPC, US
purchases the bond for $1000.00. Assume that, in
connection with the purchase of the foreign bond,
USincurs or maintains an additional $1000.00 of
borrowing at an interest rate equal to the LIBOR-
based rate provided for in the NPC.
At the time USenters into this arrangement, US
reasonably expects to incur an annual $0.90 eco-
nomic loss each year under the arrangement (the
$95.10 net interest payment on the bond plus the
LIBOR-based amount received from Funder the
NPC, less the sum of the $96.00 payment to Funder
the NPC and the LIBOR-based amount associated
with the $1000.00 borrowing incurred or maintained
in order to acquire the foreign bond). In this exam-
ple, UShas effectively purchased foreign tax credits
in a transaction that was reasonably expected to re-
sult in an economic loss.
Example 4
US, a domestic corporation, forms N, a Country
X corporation, by contributing $10.00 to the capital
of Nin exchange for the only share of Ncommon
stock. Nborrows $90.00 from F, a Country X indi-
vidual unrelated to US, at an annual interest rate of
7.5 percent, and Npurchases preferred stock of an
unrelated party with a par value of $100.00 or a
bond with a face amount of $100.00. USreasonably
expects the preferred stock or bond to pay dividends
or interest at an annual rate of 10 percent. Alterna-
tively, rather than purchasing preferred stock or the
bond, Nlends $100.00 to USat an annual interest
rate of 10 percent.
Country X treats the Floan as an equity invest-
ment and does not allow a deduction for N’s interest
expense. Country X imposes an individual income
tax and a corporate income tax of 30 percent. Coun-
try X thus is expected to impose a $3.00 corporate
income tax each year on N. Country X has an impu-
tation system, under which dividends from Country
X corporations are excluded from the gross income
of Country X individuals. (Asimilar result could be
achieved if the dividends are wholly or partially ex-
empt from Country X tax due to a consolidated re-
turn or group relief regime, a dividend-received de-
duction, or an imputation credit.)
At the time USenters into this arrangement, US
reasonably expects that Nwill have annual earnings
and profits of $0.25 ($10.00 dividend or interest in-
come from the preferred stock or bond (or $10.00 in-
terest income from the loan to US), less $6.75 inter-
est expense and $3.00 foreign tax liability). US
expects that each year Nwill pay a $0.25 dividend to
USand USwill claim a $3.00 foreign tax credit for
taxes deemed paid under section 902. In this exam-
ple, UShas entered into an arrangement to exploit
the inconsistency between U.S. and Country X tax
laws in order to generate foreign tax credits in a
transaction with respect to which the reasonably ex-
pected economic profit is insubstantial in relation to
expected U.S. foreign tax credits.
Example 5
US, a domestic corporation, forms N, a Country
X entity. UScontributes $100.00 to the capital of N
in exchange for a 100-percent ownership interest. N
borrows $900.00 from F, an unrelated Country X
corporation, at an annual interest rate of 8 percent,
and Npurchases preferred stock of an unrelated

1998–3 I.R.B51January 20, 1998
party with a par value of $1000.00 that USreason-
ably expects to pay dividends at an annual rate of 10
percent. The dividends are subject to a Country Y
25-percent withholding tax.
Country X treats the Floan as an equity invest-
ment in Nand treats Nas a partnership. Conse-
quently, Fclaims a foreign tax credit in Country X
for 90 percent of the withholding tax paid by N.
Under U.S. law, the Floan is respected as debt, and
Nis disregarded as a separate entity (a partnership
with only one partner). SeeReg. § 301.7701-3(a)
and § 301.7701-3(b)(2)(C). Thus, USclaims a U.S.
foreign tax credit for the taxes paid by Nand the tax
benefit of the foreign taxes paid by Nare effectively
duplicated.
At the time USenters into this arrangement, US
reasonably expects an annual profit of $3.00
($100.00 dividend income, less $72.00 interest ex-
pense and $25.00 foreign tax liability) and an annual
foreign tax credit of $25. In this example, UShas
entered into an arrangement to exploit the inconsis-
tency between U.S. and Country X tax laws in order
to generate foreign tax credits in a transaction with
respect to which the reasonably expected economic
profit is insubstantial in relation to expected U.S.
foreign tax credits.
III. REGULATIONS TO BE ISSUED
PURSUANTTO THIS NOTICE
Regulations will be issued to disallow
foreign tax credits for taxes generated in
abusive arrangements such as those de-
scribed in Part II above. These regula-
tions will be issued under the authority of
some or all of the following sections of
the Internal Revenue Code of 1986: sec-
tion 901, section 901(k)(4), section 904,
section 864(e)(7), section 7701(l), and
section 7805(a).
In general, these regulations will disal-
low foreign tax credits in an arrangement
such as those described in Part II above
from which the reasonably expected eco-
nomic profit is insubstantial compared to
the value of the foreign tax credits ex-
pected to be obtained as a result of the
arrangement. The regulations will em-
phasize an objective approach to calculat-
ing expected economic profit and credits,
and will require that the determination of
expected economic profit reflect the like-
lihood of realizing both potential gain and
potential loss (including loss in excess of
the taxpayer’s investment). Thus, under
the regulations, expected economic profit
will be determined without regard to ex-
ecutory financial contracts (e.g.,a no-
tional principal contract, forward con-
tract, or similar instrument) that do not
represent a real economic investment or
potential for profit or that are not properly
treated as part of the arrangement. Fur-
ther, the regulations will require that ex-
pected economic profit be determined
over the term of the arrangement, prop-
erly discounted to present value.
It is expected that the regulations in
general and any test relying on a compari-
son of economic profit and credits in par-
ticular would be applied to discrete
arrangements. The utility of a test com-
paring profits and credits depends upon
the proper delineation of the arrangement
to be tested. If necessary to effectuate the
purposes of the regulations, a series of re-
lated transactions or investments may be
treated as a single arrangement or por-
tions of a single transaction or investment
may be treated as separate arrangements.
The proper grouping of transactions and
investments into arrangements will de-
pend on all relevant facts and circum-
stances.
For example, a series of transactions
involving a purchase and resale might be
treated as a single arrangement. Simi-
larly, an investment together with related
hedging and financing transactions,e.g.,a
borrowing, an investment, and an asset
swap designed to limit the taxpayer’s eco-
nomic exposure with respect to the invest-
ment, might be treated as a single
arrangement. In addition, if a controlled
foreign corporation, as part of its busi-
ness, enters into a buy-sell transaction in-
volving a debt instrument, that buy-sell
transaction could be treated as a separate
arrangement.
In general, reasonably expected eco-
nomic profit will be determined by taking
into account foreign tax consequences
(but not U.S. tax consequences). How-
ever, it is inappropriate in the context of
the U.S. foreign tax credit system to allow
foreign tax credits with respect to abusive
arrangements simply because the arrange-
ments generate substantial foreign tax
savings. Accordingly, the regulations will
provide that the calculation of expected
economic profit will not include expected
foreign tax savings attributable to a tax
credit or similar benefit allowed by a for-
eign country with respect to a tax paid to
another foreign country.
In general, expected economic profit
will be determined by taking into account
expenses associated with an arrangement,
without regard to whether such expenses
are deductible in determining taxable in-
come. For example, in determining eco-
nomic profit, foreign taxes will be treated
as an expense. In addition, interest ex-
pense (and similar amounts, including
borrowing fees, “in lieu of” payments,
forward contract payments, and notional
principal contract payments) generally
will be taken into account in determining
expected economic profit only to the ex-
tent that the indebtedness or contract giv-
ing rise to the expense is part of the
arrangement.
In addition, the regulations will provide
special rules that will operate to deny
credits for foreign taxes generated in abu-
sive arrangements involving asset swaps
or other hedging devices (including rules
that allocate interest expense to an
arrangement in certain cases other than
pursuant to a tracing approach). For ex-
ample, an arrangement involving a pur-
chase of a foreign security coupled with
an asset swap that is designed to hedge
substantially all of the taxpayer’s risk of
loss with respect to the security for the
duration of the arrangement generally will
constitute an abusive foreign tax credit
arrangement even if the taxpayer has not
incurred indebtedness for the specific pur-
pose of acquiring the asset. However, the
regulations will not treat arrangements in-
volving debt instruments as abusive
solely because the taxpayer diminishes its
risk of interest rate or currency fluctua-
tions, unless the taxpayer also diminishes
its risk of loss with respect to other risks
(e.g.,creditor risk) for a significant por-
tion of the taxpayer’s holding period. See
Part VI of this notice for additional rules
for portfolio hedging strategies and partial
hedges.
Under the foregoing principles, the reg-
ulations will not disallow foreign tax
credits merely because income from the
arrangement is subject to a high foreign
tax rate. Treasury and the Service antici-
pate that credits for taxes paid to a high-
tax jurisdiction will not be subject to dis-
allowance under the regulations absent
other indicia of abuse.
The regulations generally will not dis-
allow a credit for withholding taxes on
dividends if the holding period require-
ment of section 901(k) is satisfied. How-
ever, the regulations will operate to deter-
mine whether foreign tax credits with
respect to cross-border tax arbitrage
arrangements (as described in Part II,
above) will be disallowed, even if such

January 20, 1998521998–3 I.R.B.
credits arise with respect to withholding
taxes on dividends and the section 901(k)
holding period is satisfied. In addition,
the regulations generally will apply to de-
termine whether credits should be disal-
lowed with respect to qualified taxes (as
defined in section 901(k)(4)(B)) that are
not subject to the general section 901(k)
holding period rule. For example, the
regulations may disallow credits with re-
spect to gross basis taxes paid or accrued
with respect to certain arrangements in-
volving equity swaps and equity buy-sell
transactions entered into by securities
dealers even if such credits would not
have been disallowed under section
901(k) pursuant to section 901(k)(4). See
section 901(k)(4)(C).
IV. EFFECTIVE DATE OF
REGULATIONS ISSUED
PURSUANTTO THIS NOTICE
The regulations to be issued with re-
spect to arrangements of the kind de-
scribed in Part II above generally will be
effective with respect to taxes paid or ac-
crued on or after December 23, 1997, the
date this notice was issued to the public.
The effective date of the regulations is-
sued pursuant to this notice, however, will
not limit the application of other princi-
ples of existing law to determine the
proper tax consequences of the structures
or transactions addressed in the regula-
tions.
V. IRS COORDINATION
PROCEDURES
The Service intends to carefully exam-
ine foreign tax credits claimed in arrange-
ments of the type described in Part II to
determine whether such credits should be
disallowed under existing law even with-
out application of the regulations to be is-
sued pursuant to this notice. The Service
plans to establish early coordination pro-
cedures utilizing foreign tax credit experts
in the National Office and the Interna-
tional Field Assistance Specialization
Program to assist examining agents in an-
alyzing these transactions. These coordi-
nation procedures will continue in effect
following issuance of the regulations to
ensure uniform and appropriate applica-
tion of the regulations by examining
agents.
VI. OTHER FOREIGN TAX CREDIT
GUIDANCE
Treasury and the Service are consider-
ing issuing other guidance to ensure that
foreign tax credits are allowed to U.S.
taxpayers in a manner consistent with the
overall structure of the Code and the in-
tent of Congress in enacting the credit.
For example, Treasury and the Service are
considering issuing additional regulations
under section 904(d)(2)(B)(iii) to address
abusive transactions involving high with-
holding taxes. Treasury and the Service
are also considering whether additional
approaches may be necessary to identify
abuses in the case of foreign gross basis
taxes generally.
In addition, Treasury and the Service
are considering various approaches to ad-
dress structures (including hybrid entity
structures) and transactions intended to
create a significant mismatch between the
time foreign taxes are paid or accrued and
the time the foreign-source income giving
rise to the relevant foreign tax liability is
recognized for U.S. tax purposes. For
such structures and transactions, Treasury
and the Service are considering either de-
ferring the tax credits until the taxpayer
recognizes the income, or accelerating the
income recognition to the time at which
the credits are allowed (e.g.,by allocating
the credits or the income under section
482).
Finally, Treasury and the Service are
concerned about credits claimed in trans-
actions described in Part II above, with
respect to assets or income streams that
are hedged pursuant to portfolio hedging
strategies and with respect to hedges en-
tered into with respect to assets or income
streams that the taxpayer holds without
diminished risk of loss for a significant
period of time.
In general, regulations addressing these
other foreign tax credit issues will be ef-
fective no earlier than the date on which
proposed regulations (or other guidance
such as a notice) describing the tax conse-
quences of the arrangements are issued to
the public. The effective date of any such
regulations will not, however, affect the
application of other principles of existing
law to determine the proper tax conse-
quences of the structures or transactions
addressed in the regulations.
VII. COMMENTS
Comments are requested on the matters
discussed in this notice. Written comments
may be submitted to the Internal Revenue
Service, P.O. Box 7604, Ben Franklin Sta-
tion, Attention: CC:DOM:CORP:R (No-
tice 98–5), Room 5226, Washington DC
20044. Submissions may be hand deliv-
ered between the hours of 8 a.m. and 5
p.m. to CC:DOM:CORP:R (Notice 98–5),
Courier’s Desk, Internal Revenue Service,
1111 Constitution Avenue NW, Washing-
ton DC. Alternatively, taxpayers may sub-
mit comments directly to the IRS Internet
site at http://www.irs.ustreas.gov/prod/tax_
regs/comments.html. Comments will be
available for public inspection and copy-
ing.
For further information regarding this
notice, contact Seth Goldstein or Rebecca
Rosenberg of the Office of Associate
Chief Counsel (International) at 202-622-
3850 (not a toll-free call).
Qualified Funeral Trusts
Notice 98–6
PURPOSE
Section 1309 of the Taxpayer Relief
Act of 1997, Pub. L. No. 105-34, 111 Stat.
788 (the Act) added § 685 of the Internal
Revenue Code to permit certain trusts to
elect Qualified Funeral Trust (QFT) sta-
tus. This notice provides guidance on
QFTeligibility requirements, election
procedures, and simplified reporting re-
quirements.
BACKGROUND
Apre-need funeral trust arises from an
arrangement where funeral merchandise
or services are purchased from a seller to
benefit a specified beneficiary before the
beneficiary’s death. Apre-need cemetery
merchandise trust arises from an arrange-
ment where cemetery merchandise or ser-
vices are purchased from a seller to bene-
fit a specified beneficiary before the
beneficiary’s death. The purchaser enters
into a contract with the seller of the fu-
neral or cemetery merchandise or services
whereby the purchaser selects the mer-
chandise and services to be provided upon
the death of the beneficiary, and agrees to

1998–3 I.R.B53January 20, 1998
pay for them before the beneficiary’s
death. Under state law, such amounts (or
a portion thereof) are required to be held
in trust during the beneficiary’s lifetime
and are paid to the seller upon the benefi-
ciary’s death.
Rev. Rul. 87–127, 1987–2 C.B. 156,
addresses the taxation of pre-need funeral
trusts. The ruling provides four situations
under which funeral trusts are formed and
concludes that in all four situations the
trust is a grantor trust and the purchaser is
treated for federal tax purposes as the
owner of the trust. Any amount that a
seller receives from the trust (as payment
for services or merchandise) is includible
in the gross income of the seller.
Section 685 permits the trustees of cer-
tain pre-need trusts to elect QFTstatus on
behalf of the trusts. If the election is
made, a trust is not treated as a grantor
trust and the purchaser would not be sub-
ject to tax on trust income. The trustee is
liable for the tax on the taxable income of
the trust as determined in accordance with
the income tax rate schedule generally ap-
plicable to estates and trusts. However,
the personal exemption deduction under §
642(b) is unavailable.
QFTELIGIBILITYREQUIREMENTS
Section 685(b) defines a QFTas any
trust (other than a foreign trust) if—(1)
the trust arises as a result of a contract
with a person engaged in the trade or
business of providing funeral or burial
services or property necessary to provide
such services, (2) the sole purpose of the
trust is to hold, invest and reinvest funds
in the trust and to use the funds solely to
make payments for those services or
property for the benefit of the beneficia-
ries of the trust, (3) the only beneficiaries
of the trust are individuals with respect to
whom those services or property are to be
provided at their death under contracts de-
scribed in item (1), (4) the only contribu-
tions to the trust are contributions by or
for the benefit of those beneficiaries, (5)
the trustee elects the application of this
subsection, and (6) the trust would, but
for this election, be treated as owned
under subpart E (the grantor trust provi-
sions) by the purchasers of the contracts.
Pre-need cemetery merchandise trusts
are substantially similar to pre-need fu-
neral trusts and therefore the analysis in
Rev. Rul. 87–127 applies to them. Pre-
need funeral trusts and pre-need cemetery
merchandise trusts that meet one of the
situations under Rev. Rul. 87–127 are
grantor trusts and the purchasers of the
contracts giving rise to the trusts are the
owners of the trusts. Accordingly, these
trusts may elect to be treated as QFTs if
they meet the other QFTrequirements
under § 685.
AQFTcannot accept aggregate contri-
butions by or for the benefit of an individ-
ual in excess of $7,000 (contribution limit).
Section 685(c)(1). Section 685(c)(2) pro-
vides that for purposes of § 685(c)(1), all
trusts having trustees that are related per-
sons shall be treated as 1 trust. Persons are
related if (A) the relationship between the
persons is described in §§ 267 or 707(b),
(B) the persons are treated as a single em-
ployer under subsection (a) or (b) of § 52,
or (C) the Secretary determines that treat-
ing the persons as related is necessary to
prevent avoidance of the purposes of this
section. The $7,000 contribution limit is
adjusted annually for inflation for any con-
tracts entered into after calendar year 1998.
Section 685(c)(3).
Atrust is deemed to exceed the contri-
bution limit under § 685(c) if the trust is
determined, over the anticipated life of
the trust, to receive projected contribu-
tions (based upon existing contributions,
the applicable state law trust contribution
requirements, and any expected contribu-
tions in excess of the state law require-
ments) that exceed the contribution limit.
The determination is made at the incep-
tion of the trust and is made again when
the amount of the projected contributions
used in the previous determination
changes. For example, a trust that is de-
termined at its inception to exceed the
contribution limit during the life of the
trust will be deemed to exceed the contri-
bution limit at inception. However, a
trust that is determined at its inception not
to exceed the contribution limit but ex-
ceeds the contribution limit in a future
year, due to a change in projected contri-
butions, will be deemed to exceed the
contribution limit at the time of the
change in projected contributions. Atrust
loses its QFTstatus at the time that it is
deemed to exceed the contribution limit.
If a QFThas multiple beneficiaries, the
contribution limit will apply separately to
each beneficiary. AQFTthat has multiple
beneficiaries will be taxed as if each ben-
eficiary’s interest in the QFTis a separate
trust. Each beneficiary’s share of the total
contributions to a trust and share of the
trust’s income is determined in accor-
dance with the beneficiary’s interest in the
trust; a beneficiary’s interest in a trust
may be determined under any reasonable
method.
QFTELECTION PROCEDURES
Atrustee may elect QFTstatus for
trusts that meet the requirements of QFTs
under § 685 for taxable years ending after
August 5, 1997. Therefore, trusts existing
prior to August 5, 1997, and trusts created
after August 4, 1997, may elect QFTsta-
tus. The filing of Form 1041–QFTis
treated as the election. The election must
be filed no later than the due date, with
extensions, for filing the trust income tax
return for the year of election. The elec-
tion applies to each trust reported in the
QFTreturn.
Atrustee need not elect QFTstatus for
the trust’s first eligible year; even if no
election is made for the first eligible year,
a QFTelection may be made for subse-
quent tax years. AQFTelection, once
made, cannot be revoked without the con-
sent of the Commissioner.
Under both § 685 and Rev. Rul. 87–
127, amounts received by the seller from
a trust are treated as payments for services
and merchandise and are includible in the
gross income of the seller in the taxable
year received or properly accrued under
the seller’s method of accounting. In the
case where a seller was not reporting in-
come in accordance with Rev. Rul. 87–
127, for example, where a seller improp-
erly reported investment income in the
taxable year it was earned by the trust
rather than the purchaser reporting such
income, a duplication of income may re-
sult from an election under § 685. The
Service is continuing to study this issue.
SIMPLIFIED QFTREPORTING
REQUIREMENTS
Atrustee of a QFTis required to file a
trust return on behalf of the QFT. The
proper form to file is Form 1041–QFT. A
trustee may file one aggregate Form
1041–QFTfor all of its QFTs and should
follow the instructions associated with
that form.

January 20, 1998541998–3 I.R.B.
REQUESTS FOR COMMENTS
The Treasury and the Service invite
comments from the public on issues that
may arise in implementing § 685. Send
written comments to the following address:
Internal Revenue Service
CC:DOM:CORP(NT98-6;
CC:DOM:P&SI:1)
P.O. Box 7604, Ben Franklin Station
Washington, DC 20044
Alternatively, send written comments
electronically via the Internet to the IRS
Internet site at http://www.irs.ustreas.gov/
prod/tax_regs/comments.htm1. Please
identify the comments as relating to this
Notice.
DRAFTING INFORMATION
The principal author of this notice is
Daniel J. Coburn of the Office of Assis-
tant Chief Counsel (Passthroughs and
Special Industries). For further informa-
tion regarding this notice contact Mr.
Coburn at (202) 622-3050 (not a toll-free
call).
Returns Relating to Interest on
Education Loans
Notice 98–7
PURPOSE
This notice describes the information
reporting requirements for 1998 under
§ 6050S of the Internal Revenue Code (as
enacted by the Taxpayer Relief Act of
1997, Pub. L. No. 105–34, § 202(c), 111
Stat. 804 (the Act)) that apply to certain
persons who receive payments of interest
that may be deductible as qualified educa-
tion loan (“student loan”) interest. The
Treasury Department intends to issue reg-
ulations on the information reporting re-
quired under § 6050S. Pending the is-
suance of those regulations, this notice
describes who must report information
with respect to payments of student loan
interest, and the nature of the information
that will be required under § 6050S for
1998.
For 1998, payees are required to report
interest received only with respect to stu-
dent loans that have a “covered period”
(described below) ending during or after
1998. Comments are requested regarding
the student loan interest reporting require-
ments that should apply for future years.
The Internal Revenue Service will issue
additional guidance on the student loan
interest that a taxpayer may deduct, in-
cluding further guidance for determining
whether a taxpayer has made a payment
of interest on a student loan during the
first 60 months in which interest pay-
ments are required.
BACKGROUND
A. The Student Loan Interest
Deduction.
Section 202(a) of the Act added § 221
to the Code. Section 221 allows certain
taxpayers who pay interest on qualified
education loans to claim a federal income
tax deduction for their interest payments,
regardless of whether they itemize other
deductions.
Aqualified education loan is a loan
used to pay the costs of attendance at an
eligible educational institution for a stu-
dent enrolled at least half-time in a pro-
gram leading to a degree, certificate, or
other recognized educational credential.
The student must be the taxpayer, the tax-
payer’s spouse, or the taxpayer’s depen-
dent at the time the loan was taken. A
loan made by an individual who is related
to the borrower, within the meaning of
§ 267(b) or § 707(b)(1), is not a qualified
education loan.
An eligible educational institution is
any college, university, vocational school,
or other postsecondary educational insti-
tution that is described in § 481 of the
Higher Education Act of 1965 (20 U.S.C.
1088) and, therefore, is eligible to partici-
pate in the student aid programs adminis-
tered by the Department of Education.
This category includes virtually all ac-
credited public, nonprofit, and proprietary
postsecondary institutions. For purposes
of the student loan interest deduction, eli-
gible educational institutions also include
institutions that conduct an internship or
residency program leading to a degree or
certificate awarded by an institution of
higher education, a hospital, or a health
care facility that offers postgraduate train-
ing.
Costs of attendance are generally the
same as those described in § 472 of the
Higher Education Act for purposes of cal-
culating a student’s financial need (e.g.,
tuition, fees, room, board, books, equip-
ment, and other necessary expenses, such
as transportation). However, for purposes
of the student loan interest deduction,
costs of attendance are reduced by educa-
tional assistance that the student receives
and excludes from gross income under
§ 127, 135, 530, or as a scholarship.
The student loan interest deduction is
available only for interest payments made
during the first 60 months, whether or not
consecutive, in which interest payments
are required on the loan. Notice 97-60,
1997-46 I.R.B. 8, provides additional in-
formation about the student loan interest
deduction.
B. Information Reporting Relating to
Student Loan Interest.
Section 6050S(a) requires information
reporting by any person engaged in a
trade or business who, in the course of
that trade or business, receives from any
individual interest aggregating $600 or
more for any calendar year on 1 or more
qualified education loans.
Section 6050S(b) provides that the re-
turn of information must be in the form
prescribed by the Secretary and contain:
(1) the name, address, and taxpayer
identification number (TIN) of the indi-
vidual with respect to whom interest was
received,
(2) the name, address, and TIN of any
individual certified by the individual
named in the first item as the taxpayer
who will claim that individual as a depen-
dent for purposes of the deduction under §
151 for any taxable year ending with or
within the year for which the information
return is filed,
(3) the aggregate amount of interest re-
ceived for the calendar year with respect
to the individual named in the first item,
and
(4) such other information as the Secre-
tary may prescribe.
Section 6050S(c) states that informa-
tion reporting is required by governmental
units or any agency or instrumentality
thereof. The return required by the gov-
ernmental entity must be made by the offi-
cer or employee appropriately designated
for the purpose of making the return.
Section 6050S(d) provides that every
person required to make an information
return under § 6050S(a) must also furnish
to each individual whose name is required

to be included in the return a written state-
ment showing the name, address, and
phone number of the reporting person’s
information contact, and the aggregate
amounts required to be included in the re-
turn.
Section 6050S(f) provides that, in the
case of any amount received on behalf of
another person, only the person first re-
ceiving the amount is required to make
the return under § 6050S. Thus, where
more than one person has a connection
with a qualified education loan, the per-
son first receiving the payment of interest,
such as a loan servicer or collection agent
receiving payments on behalf of the
lender, is required to file an information
return regarding the interest received on
the loan.
DISCUSSION
A. Definitions.
The following definitions apply to
these terms for purposes of this notice:
(1) Payee. Apayee is the person first
receiving one or more interest payments
on a student loan.
(2)Payor.Apayor is the individual
with respect to whom interest payments
are received on a particular student loan.
(3) Consolidated Loan.Aconsolidated
loan is a single loan refinancing more
than one student loan.
(4) Collapsed Loan.Acollapsed loan
is a set of loans of a single payor treated
as a single loan for loan servicing pur-
poses.
(5) Defaulted Loan.Adefaulted loan is
a loan with respect to which required pay-
ments of interest and principal have not
been made when due over a period of
time such that the holder has declared the
loan in default based on its terms and con-
ditions, and, if applicable, sought re-
course against the ultimate guarantor of
the loan.
(6) Covered Period.For loans other
than consolidated loans, collapsed loans,
and defaulted loans, the covered period
begins on:
(a) the date on which the loan went into
repayment status if the payee knows or
has reason to know that date; or
(b) January 1, 1998, if the payee does
not know and does not have reason to
know that date.
For consolidated loans and collapsed
loans, the covered period begins on:
(a) the most recent date on which any
of the loans subject to consolidation or
collapse went into repayment status, if the
payee knows or has reason to know that
date; or
(b) January 1, 1998, if the payee does
not know and does not have reason to
know that date.
For defaulted loans, the covered period
begins on:
(a) the date the loan went into repay-
ment status if the payee knows or has rea-
son to know that date;
(b) the date the loan went into default,
if the payee knows or has reason to know
that date and does not know or have rea-
son to know the date the loan went into
repayment status; or
(c) January 1, 1998, if the payee does
not know and does not have reason to
know the dates the loan went into repay-
ment status or default.
The covered period ends on the date that
is 60 months after the date on which the
period starts or, if later, the last day of the
month in which that 60-month date oc-
curs. However, if the payee knows or has
reason to know of any periods of grace,
deferment, or forbearance during the cov-
ered period, the covered period is ex-
tended by the number of months the loan
was subject to grace, deferment, or for-
bearance.
(7) Covered Student Loan.Acovered
student loan is a loan with a covered pe-
riod ending during or after 1998 that is ei-
ther:
(a) subsidized, guaranteed, financed, or
otherwise treated as a student loan under a
program of the federal, state, or local gov-
ernment or an institution of postsecondary
education, or
(b) certified by the payor as a student
loan.
B. Who Must File for 1998.
Payees who receive interest aggregat-
ing $600 or more during 1998 with re-
spect to a single payor on one or more
covered student loans must file an infor-
mation return with respect to that interest.
C. Information Required for 1998.
Payees required under this notice to file
information returns for 1998 must prop-
erly complete Form 1098–E, Student
Loan Interest Statement, for all student
loan accounts that contain one or more
covered student loans (“student loan ac-
count”). Apayee may file a separate
Form 1098-E for each student loan ac-
count of the payor, or a single Form 1098-
E for all student loan accounts of the
payor.
For 1998, a properly completed Form
1098-E filed with the Service must in-
clude:
(1) the name, address, and TIN of the
payee;
(2) the name, address, and TIN of the
payor; and
(3) the aggregate amount of interest re-
ceived during 1998 with respect to the
student loans in the account or accounts
included on the return.
D. Mixed Use Loans and Revolving
Accounts.
Payments of interest made on or after
January 1, 1998, on mixed use loans or re-
volving accounts, such as credit card ac-
counts, are treated as interest paid with re-
spect to a student loan (and must be
reported as such) only if the mixed use
loan or revolving account is certified to
be, in part, a student loan, and the payee
has a reasonable method for allocating the
interest payments to the part of loan that
is certified to be a student loan.
E. Coordination with Reporting on
Payments of Mortgage Interest.
If, for a year before 1998, a payee
treated a loan as a mortgage within the de-
finition of § 6050H(e) for purposes of the
information reporting required under §
6050H, the payee must continue to treat
the loan as a mortgage for information re-
porting purposes, even if all or part of the
loan is used to pay costs of attendance.
For loans made on or after January 1,
1998, the payee must treat loans secured
by real property and not made exclusively
to acquire or improve real property as ei-
ther mortgages or student loans in accor-
dance with the certification provided by
the payor. Thus, if a payor certifies all of
a loan secured by real property and made
on or after January 1, 1998, as a student
loan, the payee must treat the entire loan
as a student loan and not as a mortgage
for purposes of information reporting. If
the payor certifies part of a loan as a stu-
dent loan, only the certified portion of the
loan may be treated as a student loan for
purposes of information reporting. For
1998–3 I.R.B55January 20, 1998

loans made on or after January 1, 1998,
the payee must treat a loan secured by real
property and made exclusively to acquire
or improve real property as a mortgage
and provide information returns as re-
quired by § 6050H. The regulations
under § 6050H will be amended to be
consistent with this rule.
F. When To File.
The information returns required under
§ 6050S for 1998 must be sent to the Ser-
vice by March 1, 1999.
G. Manner of Filing.
The regulations under § 6011 will be
amended to require any person required to
file 250 or more Forms 1098–E for 1998
to file those returns by magnetic media or
electronically. Additional guidance will
be provided on how to file by magnetic
media or electronically.
H. Statements To Be Provided to
Payors.
The payee must provide each payor a
statement containing the same informa-
tion that is provided to the Service on the
information return required by § 6050S.
In addition, the statement provided to the
payor must contain a phone number for
the individual serving as information con-
tact of the payee. The statement must
also notify the payor that the amount of
interest reported as paid may differ from
the amount of interest that the payor may
be able to claim as a deduction. The
statement must be provided to the payor
by February 1, 1999. The statement may
be a copy of Form 1098–E (or an accept-
able substitute statement).
I. Collecting Information.
The Service is developing an optional
Form W-9S for use in collecting informa-
tion for the purpose of complying with §
6050S. The payee will be able to use the
form to collect the information necessary
to meet the information reporting require-
ments of § 6050S. The information can
be collected on paper or on an electronic
version of Form W–9S (or an acceptable
substitute). The payee also may collect
the necessary information by using its
own forms and procedures.
J. Waiver of Penalties.
The Treasury Department intends to
issue regulations under § 6050S, and
modify the regulations under § 6050H, to
provide guidance on how payees are to
comply with the requirements of the
statute. Until the regulations are adopted,
no penalties will be imposed under §§
6721 and 6722 for failure to file correct
information returns with the Service or to
furnish correct statements to the payors
with respect to whom information report-
ing is required under § 6050S (or § 6050H
for those loans secured by real property
the proceeds from which are used to pay
the costs of postsecondary education).
Furthermore, even after the regulations
are adopted, no penalties will be imposed
under §§ 6721 and 6722 for failure to file
correct information returns or furnish cor-
rect statements for 1998 as required by §
6050S or § 6050H if the payee made a
good faith effort to file information re-
turns and furnish statements in accor-
dance with this notice.
K. Request for Comments.
The Conference Report accompanying
the Act states the following, “The confer-
ees expect that the Secretary of Treasury
will issue regulations setting forth report-
ing procedures that will facilitate the ad-
ministration of this provision. Specifi-
cally, such regulations should require
lenders separately to report to borrowers
the amount of interest that constitutes de-
ductible student loan interest (i.e.,interest
on a student loan during the first 60
months in which interest payments are re-
quired). In this regard, the regulations
should include a method for borrower cer-
tification to a lender that the loan pro-
ceeds are being used to pay for qualified
higher education expenses.” H.R. Conf.
Rep. No. 220, 105 Cong., 1st Sess. at 368
(1997). Treasury and the Service invite
taxpayers to submit comments on how
regulations could be drafted in accor-
dance with the legislative history. In par-
ticular, comments are requested on how
parties receiving interest are to determine
whether a payment of interest on a student
loan has been made during the first 60
months in which interest payments are re-
quired and on how much of a payment
should be treated as interest, especially
where interest has been capitalized.
Comments are requested by April 30,
1998. An original and eight copies of
written comments should be sent to:
Internal Revenue Service
Attn: CC:DOM:CORP:R
Room 5228 (IT&A:Br1)
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044,
or hand delivered between the hours of
8:00 a.m. and 5:00 p.m. to:
Courier’s Desk
Internal Revenue Service
Attn: CC:DOM:CORP:R
Room 5228 (IT&A:Br1)
1111 Constitution Ave., NW
Washington, DC
Alternatively, taxpayers may submit com-
ments electronically via the Internet by
selecting the “Tax Regs” option on the
IRS Home Page, or by submitting com-
ments directly to http://www.irs.ustreas.
gov/prod/tax_regs/comments.html (the
IRS Internet site). All comments will be
available for public inspection and copy-
ing in their entirety.
DRAFTING INFORMATION
The principal author of this notice is
John McGreevy of the Office of the As-
sistant Chief Counsel (Income Tax and
Accounting). For further information re-
garding information reporting, contact
Mr. McGreevy on (202) 622-4910 (not a
toll-free call) or, regarding the deduction,
call John Moriarty on (202) 622-4950
(not a toll-free call).
26 CFR 601.601: Rules and regulations.
(Also Part I, § 1397E)
Rev. Proc. 98–9
SECTION 1. PURPOSE
This revenue procedure sets forth the
maximum face amount of Qualified Zone
Academy Bonds (“Bond” or “Bonds”)
that may be issued for each State during
1998. For this purpose “State” includes
the District of Columbia and the posses-
sions of the United States.
SECTION 2. BACKGROUND
Section 226 of the Tax Relief Act of
1997, Pub. L. 105–34, 111 Stat. 788
January 20, 1998561998–3 I.R.B.

(1997), added § 1397E to the Internal Rev-
enue Code to provide a credit to holders of
Bonds under certain circumstances so that
the Bonds generally can be issued without
discount or interest. Ninety-five percent of
Bond proceeds are to be used for qualified
purposes, as defined by § 1397E(d)(5),
with respect to a qualified zone academy,
as defined by § 1397E(d)(4).
The aggregate amount of Bonds that
may be issued for the States is limited to
$400 million for 1998 and $400 million
for 1999 (the “national limitation”). This
amount is to be allocated among the
States by the Secretary on the basis of
their respective populations below the
poverty level (as defined by the Office of
Management and Budget). This amount
is further allocated by the State to quali-
fied zone academies within the State or
possession. AState may carry forward to
the next calendar year any amount of an
allocation of the national limitation for a
calendar year that is in excess of the
amount of Bonds issued during that cal-
endar year that are designated with re-
spect to qualified academies within the
State.
SECTION 3. SCOPE
This revenue procedure applies to
Bonds issued under § 1397E during 1998.
SECTION 4. NATIONAL
QUALIFIED ZONE ACADEMY
BOND LIMITATION FOR 1998
The total face amount of Bonds that
may be issued in 1998 is $400 million.
This amount is allocated among the States
as follows:
1998–3 I.R.B57January 20, 1998
MAXIMUM FACE AMOUNTOF
BONDS THATMAYBE
ISSUED DURING 1998
STATE(thousands of dollars)
ALABAMA$6,128
ALASKA556
ARIZONA10,094
ARKANSAS4,625
CALIFORNIA56,360
COLORADO4,243
CONNECTICUT4,037
DELAWARE649
DISTRICTOF COLUMBIA1,339
FLORIDA20,981
GEORGIA11,299
HAWAII1,463
IDAHO1,442
ILLINOIS14,718
INDIANA4,408
IOWA2,874
KANSAS2,956
KENTUCKY6,777
LOUISIANA8,992
MAINE1,390
MARYLAND5,376
MASSACHUSETTS6,406
MICHIGAN11,000
MINNESOTA4,717
MISSISSIPPI5,922
MISSOURI 5,150
MONTANA1,596
NEBRASKA1,741

MAXIMUM FACE AMOUNTOF
BONDS THATMAYBE
ISSUED DURING 1998
STATE(thousands of dollars)
NEVADA1,370
NEWHAMPSHIRE752
NEWJERSEY7,478
NEWMEXICO4,861
NEWYORK31,497
NORTH CAROLINA9,115
NORTH DAKOTA711
OHIO14,667
OKLAHOMA5,727
OREGON3,934
PENNSYLVANIA14,152
RHODE ISLAND1,071
SOUTH CAROLINA4,964
SOUTH DAKOTA845
TENNESSEE9,043
TEXAS32,753
UTAH1,576
VERMONT762
VIRGINIA8,188
WASHINGTON6,860
WESTVIRGINIA3,327
WISCONSIN4,738
WYOMING597
AMERICAN SAMOA350
GUAM227
NORTHERN MARIANAS268
PUERTO RICO22,659
VIRGIN ISLANDS268
January 20, 1998581998–3 I.R.B.
SECTION 6. EFFECTIVE DATE
This revenue procedure applies to
Bonds issued after December 31, 1997.
DRAFTING INFORMATION
The principal author of this revenue
procedure is Timothy L. Jones of the Of-
fice of Assistant Chief Counsel (Financial
Institutions & Products). For further in-
formation regarding this revenue proce-
dure contact Mr. Jones on (202) 622-3980
(not a toll free call).

1998–3 I.R.B59January 20, 1998
Notice of Proposed Rulemaking
Deposits of Excise Taxes
REG–102894–97
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing by cross-reference to temporary regu-
lations.
SUMMARY: In T.D. 8740, page 4, the
IRS is issuing temporary regulations re-
lating to deposits of excise taxes. The
temporary regulations contain rules relat-
ing to the availability of the safe harbor
deposit rule based on look-back quarter li-
ability and to floor stocks taxes. The text
of those temporary regulations also serves
as the text of these proposed regulations.
DATES: Written comments and requests
for a public hearing must be received by
March 30, 1998.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG–102894–97),
room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. Submissions may be
hand delivered between the hours of 8
a.m. and 5 p.m. to: CC:DOM:CORP:R
(REG–102894–97), Courier’s Desk, In-
ternal Revenue Service, 1111 Constitution
Avenue NW, Washington, DC. Alterna-
tively, taxpayers may submit comments
electronically via the Internet by selecting
the “Tax Regs” option on the IRS Home
Page, or by submitting comments directly
to the IRS Internet site at http://www.irs.
ustreas.gov/prod/tax_regs/comments.html.
FOR FURTHER INFORMATION CON-
TACT: Concerning submissions, the
Regulations Unit, (202) 622-7180; con-
cerning the regulations, Ruth Hoffman,
(202) 622-3130 (not toll-free numbers).
SUPPLEMENTARYINFORMATION:
Background
T.D. 8740 amends the Excise Tax Pro-
cedural Regulations (26 CFR part 40).
The temporary regulations contain rules
relating to the availability of the safe har-
bor deposit rule based on look-back quar-
ter liability and to floor stocks taxes.
The text of those temporary regulations
also serves as the text of these proposed
regulations. The preamble to the tempo-
rary regulations explains the temporary
regulations.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It also has been de-
termined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions and, because these regulations do
not impose on small entities a collection
of information requirement, the Regula-
tory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Therefore, a Regulatory
Flexibility Analysis is not required. Pur-
suant 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 Busi-
ness Administration for comment on its
impact on small business.
Comments and Requests for a Public
Hearing
Before these proposed regulations are
adopted as final regulations, considera-
tion will be given to any written com-
ments (a signed original and eight (8)
copies) that are submitted timely to the
IRS. All comments will be available for
public inspection and copying. Apublic
hearing may be scheduled if requested in
writing by any 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
the Federal Register.
Drafting Information
The principal author of these regula-
tions is Ruth Hoffman, Office of Assistant
Chief Counsel (Passthroughs and Special
Industries). However, other personnel
from the IRS and Treasury Department
participated in their development.
*****
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 40 is pro-
posed to be amended as follows:
PART40—EXCISE TAX
PROCEDURALREGULATIONS
Paragraph 1. The authority citation for
part 40 continues to read in part as fol-
lows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In §40.0–1, paragraph (a) is
amended by revising the second sentence
to read as follows:
§40.0–1 Introduction.
(a) * * * The regulations set forth ad-
ministrative provisions relating to the ex-
cise taxes imposed by chapters 31, 32, 33,
34, 36, 38, and 39 (except for the chapter
32 tax imposed by section 4181 (firearms
tax) and the chapter 36 taxes imposed by
sections 4461 (harbor maintenance tax)
and 4481 (heavy vehicle use tax)), and to
floor stocks taxes imposed on articles
subject to any of these taxes. * * *
*****
Par. 3. In §40.6011(a)–1, add para-
graph (a)(2)(iii) to read as follows:
§40.6011(a)–1 Returns.
(a) * * *
(2) * * *
(iii) Floor stocks tax return.
[The text of this proposed paragraph is
the same as the text of §40.6011(a)–
1T(a)(2)(iii) published in T.D. 8740].
Par. 4. Section 40.6302(c)–1 is
amended as follows:
1. Paragraph (c)(2)(iv) is added.
2. Paragraph (f)(1) is amended by
adding a sentence to the end of the para-
graph.
The additions read as follows:
§40.6302(c)–1 Use of Government
depositaries.
*****
(c) * * *
(2) * * *
(iv) Modification for new or reinstated
taxes.
[The text of this proposed paragraph is
the same as the text of §40.6302(c)–
1T(c)(2)(iv) published in T.D. 8740.]
Part IV. Items of General Interest

*****
(f) * * * (1) * * * Also, no deposit is re-
quired in the case of any floor stocks tax
described in §40.0–1(a).
*****
Par. 5. In §40.6302(c)–2, add para-
graph (b)(2)(iii) to read as follows:
§40.6302(c)–2 Special rules for use of
Government depositaries under section
4681.
*****
(b) * * *
(2) * * *
(iii) Modification for new chemicals.
[The text of this proposed paragraph is
the same as the text of §40.6302(c)–
2T(b)(2)(iii) published in T.D. 8740.]
*****
Michael P. Dolan,
Acting Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on De-
cember 24, 1997, 8:45 a.m., and published in the
issue of the Federal Register for December 29, 1997,
62 F.R. 67589)
Notice of Proposed Rulemaking
HIPAA Mental Health Parity Act
REG–109704–97
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing by cross-reference to temporary regu-
lations.
SUMMARY: In T.D. 8741, page 6, the
IRS is issuing temporary regulations re-
lating to mental health parity require-
ments imposed on group health plans.
These requirements were added to the In-
ternal Revenue Code by section 1532 of
the Taxpayer Relief Act of 1997. The IRS
is issuing the temporary regulations at the
same time that the Pension and Welfare
Benefits Administration of the U.S. De-
partment of Labor and the Health Care Fi-
nancing Administration of the U.S. De-
partment of Health and Human Services
are issuing substantially similar interim
final regulations relating to mental health
parity requirements added by the Mental
Health Parity Act of 1996 to the Em-
ployee Retirement Income Security Act of
1974 and the Public Health Service Act.
The temporary regulations provide guid-
ance to employers and group health plans
relating to the new mental health parity
requirements. The text of those tempo-
rary regulations also serves as the text of
these proposed regulations.
DATES: Written comments and requests
for a public hearing must be received by
March 23, 1998.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG–109704–97),
room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. Submissions may be
hand-delivered between the hours of 8
a.m. and 5 p.m. to: CC:DOM:CORP:R
(REG–109704–97), Courier’s Desk, In-
ternal Revenue Service, 1111 Constitution
Avenue, NW, Washington, DC.
Alternatively, taxpayers may submit
comments electronically via the Internet
by selecting the “Tax Regs” option on the
IRS Home Page, or by submitting com-
ments directly to the IRS Internet site at:
http://www.irs.ustreas.gov/prod/tax_regs/
comments.html
FOR FURTHER INFORMATION CON-
TACT: Concerning the regulations, Russ
Weinheimer, (202) 622-4695; concerning
submissions or to request a hearing, Mike
Slaughter, 202-622-7180. These are not
toll-free numbers.
SUPPLEMENTARYINFORMATION:
Paperwork Reduction Act
The collection of information refer-
enced in this notice of proposed rulemak-
ing has been submitted to the Office of
Management and Budget for review in ac-
cordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)).
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 collection of information is in
§54.9812–1T(see T.D. 8741). The col-
lection of information is required if a plan
wishes to avail itself of an exemption pro-
vided under the statute. The likely re-
spondents are business or other for-profit
institutions, nonprofit institutions, small
businesses or organizations, and Taft-
Hartley trusts. Responses to this collec-
tion of information are required in order
to obtain the benefit of being exempt from
the mental health parity requirement.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Comments on the collection of infor-
mation should be sent to the Office 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 the Internal Revenue Service,
Attn: IRS Reports Clearance Officer,
T:FP, Washington, DC 20224. Comments
on the collection of information should be
received by February 20, 1998. Com-
ments are specifically requested concern-
ing:
— Whether the proposed collection of
information is necessary for the proper
performance of the functions of the Inter-
nal Revenue Service, including whether
the information will have practical utility;
— The accuracy of the estimated burden
associated with the proposed collection of
information (see the preamble to the tem-
porary regulations published in T.D. 8741);
— How to enhance the quality, utility,
and clarity of the information to be col-
lected;
— How to minimize the burden of com-
plying with the proposed collection of in-
formation, including the application of au-
tomated collection techniques or other
forms of information technology; and
— Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of services to provide informa-
tion.
Background
The temporary regulations published in
T.D. 8741 add §54.9812-1Tto the Miscel-
laneous Excise Tax Regulations. These
regulations are being published as part of
a joint rulemaking with the Department of
Labor and the Department of Health and
January 20, 1998601998–3 I.R.B.

Human Services (the joint rulemaking).
The text of those temporary regulations
also serves as the text of these proposed
regulations. The preamble to the tempo-
rary regulations explains the temporary
regulations.
Special Analyses
Pursuant to sections 603(a) and 605(b)
of the Regulatory Flexibility Act, it is
hereby certified that the collection of in-
formation referenced in this notice of pro-
posed rulemaking (see §54.9812–1Tof
the temporary regulations published in
T.D. 8741) will not have a significant eco-
nomic impact on a substantial number of
small entities. Employers with 50 or
fewer employees are not subject to the
law. Moreover, even for employers that
are subject to the mental health parity re-
quirements, no collection of information
is required unless they qualify for and
claim the 1% increased cost exemption.
Even for employers subject to the law
who claim the exemption, the estimated
time for each response is 2 minutes.
Thus, for example, an employer with 100
employees in its group health plan that
claimed the 1% increased cost exemption,
that took advantage of the three-month
transitional period provided in the tempo-
rary regulations and that received 10 re-
quests to examine the assumptions used in
claiming the exemption would incur a
total one-time burden of less than 4 hours.
At an estimated cost of $11 per hour, this
would result in a one-time cost of less
than $44. This is not a significant eco-
nomic impact.
This regulation is not subject to the Un-
funded Mandates Reform Act of 1995 be-
cause the regulation is an interpretive reg-
ulation. For further information and for
analyses relating to the joint rulemaking,
see the preamble to the joint rulemaking.
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 Busi-
ness Administration for comment on its
impact on small business.
Comments and Requests for a Public
Hearing
Before these proposed regulations are
adopted as final regulations, considera-
tion will be given to any written com-
ments (a signed original and eight (8)
copies) that are submitted timely to the
IRS. All comments will be available for
public inspection and copying. Apublic
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
the Federal Register.
Drafting Information
The principal author of these proposed
regulations is Russ Weinheimer, Office of
the Chief Counsel, Employee Benefits
and Exempt Organizations. However,
other personnel from the IRS and Trea-
sury Department participated in their de-
velopment. The proposed regulations, as
well as the temporary regulations, have
been developed in coordination with per-
sonnel from the U.S. Department of
Labor and U.S. Department of Health and
Human Services.
*****
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 54 is pro-
posed to be amended as follows:
PART54—PENSION EXCISE TAXES
Paragraph 1. The authority citation for
part 54 is amended by adding an entry in
numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 54.9812–1 is also issued under
26 U.S.C. 9833. * * *
Par. 2. Section 54.9812–1 is added to
read as follows:
§54.9812–1 Parity in the application of
certain limits to mental health benefits.
[The text of this proposed section is the
same as the text of §54.9812 1Tpublished
in T.D. 8741.]
Deputy Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on De-
cember 19, 1997, 8:45 a.m., and published in the
issue of the Federal Register for December 22, 1997,
62 F.R. 66967)
1998–3 I.R.B61January 20, 1998

January 20, 1998621998–3 I.R.B.
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”)
that have an effect on previous rulings
use the following defined terms to de-
scribe the effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus,
if an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to Abut not
to B, and the new ruling holds that it ap-
plies to both Aand B, the prior ruling is
modified because it corrects a published
position. (Compare with amplified and
clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. Aruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.
Revoked describes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example, modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is super-
seded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be pub-
lished that includes the list in the original
ruling and the additions, and supersedes
all prior rulings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current use and for-
merly used will appear in material published in the
Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C.—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Proc..—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedral Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
Definition of Terms

1998–3 I.R.B63January 20, 1998
1
Acumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 1997–27 through
1997–52 will be found in Internal Revenue Bulletin
1998–1, dated January 5, 1998.
Numerical Finding List
1
Bulletins 1998–1 and 1998–2
Announcements:
98–1, 1998–2 I.R.B. 38
98–2, 1998–2 I.R.B.38
98–3, 1998–2 I.R.B.38
Notices:
98–2, 1998–2 I.R.B. 22
98–4, 1998–2 I.R.B. 25
Revenue Procedures:
98–1, 1998–1 I.R.B. 7
98–2, 1998–1 I.R.B. 74
98–3, 1998–1 I.R.B. 100
98–4, 1998–1 I.R.B. 113
98–5, 1998–1 I.R.B. 155
98–6, 1998–1 I.R.B. 183
98–7, 1998–1 I.R.B. 222
98–8, 1998–1 I.R.B. 225
98–10, 1998–2 I.R.B. 35
Revenue Rulings:
98–1, 1998–2 I.R.B. 5
98–2, 1998–2 I.R.B. 15
98–3, 1998–2 I.R.B. 4
98–4, 1998–2 I.R.B. 18
98–5, 1998–2 I.R.B. 20

January 20, 1998641998–3 I.R.B.
Finding List of Current Action on
Previously Published Items
1
Bulletins 1998–1 and 1998–2
Revenue Procedures:
97–1
Superseded by
98–1, 1998–1 I.R.B. 7
97–2
Superseded by
98–2, 1998–1 I.R.B. 74
97–3
Superseded by
98–3, 1998–1 I.R.B. 100
97–4
Superseded by
98–4, 1998–1 I.R.B. 113
97–5
Superseded by
98–5, 1998–1 I.R.B. 155
97–6
Superseded by
98–6, 1998–1 I.R.B. 183
97–7
Superseded by
98–7, 1998–1 I.R.B. 222
97–8
Superseded by
98–8, 1998–1 I.R.B. 225
97–21
Superseded by
98–2, 1998–1 I.R.B. 74
97–53
Superseded by
98–3, 1998–1 I.R.B. 100
Revenue Rulings:
75–17
Supplemented and superseded by
98–5, 1998–2 I.R.B. 20
92–19
Supplemented in part by
98–2, 1998–2 I.R.B. 15
1
Acumulative finding list for previously published
items mentioned in Internal Revenue Bulletins
1997–27 through 1997–52 will be found in Internal
Revenue Bulletin 1998–1, dated January 5, 1998.

January 20, 1998651998–3 I.R.B.
Notes

Notes
January 20, 1998661998–3 I.R.B.

INTERNAL REVENUE BULLETIN
The Introduction on page 3 describes the purpose and content of this publication. The weekly Internal Revenue Bulletin is sold
on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by the Superintendent of
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The contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are
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ly Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of print
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WE WELCOME COMMENTS ABOUT THE
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would be pleased to hear from you. You can e-mail us your suggestions or comments through the IRS Internet Home Page
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