us-irs-revenue-rulings-irb-2000-7-pdf•Internal Revenue Bulletin 2000-7 (PDF rendition): IRS Revenue Rulings
Internal Revenue Bulletin 2000-7 (PDF rendition): IRS Revenue Rulings
us-irs-revenue-rulings-irb-2000-7-pdfInternal Revenue Bulletin 2000-7 (PDF rendition): IRS Revenue RulingsGuidance
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INCOME TAX T.D. 8864, page 614. Final and temporary regulations under section 274 of the Code relate to the substantiation of certain business expenses. T.D. 8865, page 589. Final regulations under sections 167(f) and 197 of the Code provide guidance concerning the amortization of goodwill and certain other intangible property. T.D. 8867, page 620. Final regulations under section 1296 of the Code relate to the new mark-to-market election for stock of a passive for- eign investment company (PFIC) and define the term “mar- ketable stock.” EMPLOYEE PLANS Rev. Rul. 2000–8, page 617. Cash or deferred arrangements; elective deferrals. This ruling specifies the criteria to be met in order to auto- matically reduce an employee’s compensation by a certain amount and have that amount contributed as an elective de- ferral to an employer’s section 401(k) plan. Rev. Rul. 98–30 amplified and superseded. REG–113572–99, page 624. Proposed regulations under section 132(f) of the Code pro- vide guidance on qualified transportation fringe benefits pro- vided by employers to employees. A public hearing is sched- uled for June 1, 2000. ADMINISTRATIVE REG–100163–00, PAGE 633. Proposed regulations under section 197 of the Code pro- vide guidance on how the anti-churning rules of section 197(f) apply to partnership transactions involving sections 732(b) and 734(b). A public hearing is scheduled for May 24, 2000. Internal Revenue bbuulllleettiinn Bulletin No. 2000–7 February 14, 2000 HIGHLIGHTS OF THIS ISSUE These synopses are intended only as aids to the reader in identifying the subject matter covered. They may not be relied upon as authoritative interpretations. Department of the Treasury Internal Revenue Service Actions Relating to Court Decisions is on the page following the Introduction. Finding Lists begin on page ii. February 14, 20002000–7 I.R.B. The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for announcing offi- cial rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation, court decisions, and other items of general interest. It is published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin contents are consolidated semiannually into Cumulative Bulletins, which are sold on a single-copy basis. It is the policy of the Service to publish in the Bulletin all sub- stantive rulings necessary to promote a uniform application of the tax laws, including all rulings that supersede, revoke, modify, or amend any of those previously published in the Bulletin. All published rulings apply retroactively unless other- wise indicated. Procedures relating solely to matters of in- ternal management are not published; however, statements of internal practices and procedures that affect the rights and duties of taxpayers are published. Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts stated in the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices, identifying details and information of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory requirements. Rulings and procedures reported in the Bulletin do not have the force and effect of Treasury Department Regulations, but they may be used as precedents. Unpublished rulings will not be relied on, used, or cited as precedents by Service personnel in the disposition of other cases. In applying pub- lished rulings and procedures, the effect of subsequent leg- islation, regulations, court decisions, rulings, and proce- dures must be considered, and Service personnel and oth- ers concerned are cautioned against reaching the same con- clusions in other cases unless the facts and circumstances are substantially the same. The Bulletin is divided into four parts as follows: Part I.—1986 Code. This part includes rulings and decisions based on provisions of the Internal Revenue Code of 1986. Part II.—Treaties and Tax Legislation. This part is divided into two subparts as follows: Subpart A, Tax Conventions, and Subpart B, Legislation and Related Committee Reports. Part III.—Administrative, Procedural, and Miscellaneous. To the extent practicable, pertinent cross references to these subjects are contained in the other Parts and Sub- parts. Also included in this part are Bank Secrecy Act Admin- istrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the Treasury’s Office of the Assistant Secretary (Enforcement). Part IV.—Items of General Interest. This part includes notices of proposed rulemakings, disbar- ment and suspension lists, and announcements. The first Bulletin for each month includes a cumulative index for the matters published during the preceding months. These monthly indexes are cumulated on a semiannual basis, and are published in the first Bulletin of the succeeding semi- annual period, respectively. The IRS Mission Provide America’s taxpayers top quality service by help- ing them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all. Introduction The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate. For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402. 2000–7 I.R.B.February 14, 2000 It is the policy of the Internal Revenue Service to announce at an early date whether it will follow the holdings in cer- tain cases. An Action on Decision is the document making such an announcement. An Action on Decision will be issued at the discretion of the Service only on un- appealed issues decided adverse to the government. Generally, an Action on De- cision is issued where its guidance would be helpful to Service personnel working with the same or similar issues. Unlike a Treasury Regulation or a Revenue Ruling, an Action on Decision is not an affirma- tive statement of Service position. It is not intended to serve as public guidance and may not be cited as precedent. Actions on Decisions shall be relied upon within the Service only as conclu- sions applying the law to the facts in the particular case at the time the Action on Decision was issued. Caution should be exercised in extending the recommenda- tion of the Action on Decision to similar cases where the facts are different. More- over, the recommendation in the Action on Decision may be superseded by new legislation, regulations, rulings, cases, or Actions on Decisions. Prior to 1991, the Service published ac- quiescence or nonacquiescence only in certain regular Tax Court opinions. The Service has expanded its acquiescence program to include other civil tax cases where guidance is determined to be help- ful. Accordingly, the Service now may ac- quiesce or nonacquiesce in the holdings of memorandum Tax Court opinions, as well as those of the United States District Courts, Claims Court, and Circuit Courts of Appeal. Regardless of the court decid- ing the case, the recommendation of any Action on Decision will be published in the Internal Revenue Bulletin. The recommendation in every Action on Decision will be summarized as ac- quiescence, acquiescence in result only, or nonacquiescence. Both “acquies- cence” and “acquiescence in result only” mean that the Service accepts the holding of the court in a case and that the Service will follow it in disposing of cases with the same controlling facts. However, “ac- quiescence” indicates neither approval nor disapproval of the reasons assigned by the court for its conclusions; whereas, “acquiescence in result only” indicates disagreement or concern with some or all of those reasons. “Nonacquiescence” sig- nifies that, although no further review was sought, the Service does not agree with the holding of the court and, gener- ally, will not follow the decision in dis- posing of cases involving other taxpay- ers. In reference to an opinion of a circuit court of appeals, a “nonacquiescence” in- dicates that the Service will not follow the holding on a nationwide basis. How- ever, the Service will recognize the precedential impact of the opinion on cases arising within the venue of the de- ciding circuit. The Actions on Decisions published in the weekly Internal Revenue Bulletin are consolidated semiannually and appear in the first Bulletin for July and the Cumu- lative Bulletin for the first half of the year. A semiannual consolidation also ap- pears in the first Bulletin for the follow- ing January and in the Cumulative Bul- letin for the last half of the year. The Commissioner ACQUIESCES in result only in the following decision: Ahadpour v. Commissioner, 1 T.C. Memo. 1999–9 T.C. Dkt. No. 4843–96 Actions Relating to Court Decisions 1 Acquiescence in result only relating to whether certain payments received by petitioners, pursuant to a sales agreement for real property, should be included in gross income in the year received. 2000–7 I.R.B.589February 14, 2000 Section 197.—Amortization of Goodwill and Certain Other Intangibles 26 CFR 1.197–2: Amortization of goodwill and certain other intangibles. T.D. 8865 DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1 and 602 Amortization of Intangible Property AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final regulations. SUMMARY: This document contains final regulations relating to the amortiza- tion of certain intangible property. The final regulations reflect changes to the law made by the Omnibus Budget Recon- ciliation Act of 1993 (OBRA ’93) and af- fect taxpayers who acquired intangible property after August 10, 1993, or made a retroactive election to apply OBRA ’93 to intangibles acquired after July 25, 1991. DATES: Effective Date: January 25, 2000. Applicability Dates: These regulations apply to property acquired after January 25, 2000]. Regulations to implement sec- tion 197(e)(4)(D) are applicable August 11, 1993, for property acquired after Au- gust 10, 1993 (or July 26, 1991, for prop- erty acquired after July 25, 1991, if a valid retroactive election has been made under §1.197–1T). FOR FURTHER INFORMATION CON- TACT: John Huffman at (202) 622-3110 (not a toll-free number). SUPPLEMENTARY INFORMATION: Paperwork Reduction Act The collection of information con- tained in these final regulations has been reviewed and, pending receipt and evalu- ation of public comments, approved by the Office of Management and Budget (OMB) under 44 U.S.C. 3507 and as- signed control number 1545-1671. The collection of information in this regulation is in §1.197–2(h)(9). This in- formation is required in order to provide guidance on the time and manner of mak- ing the election under section 197(f)(9)(B). Under this election, the seller of a section 197 intangible may pay a tax on the sale in order to avoid the ap- plication of the anti-churning rules of sec- tion 197(f)(9) to the purchaser. This in- formation will be used to confirm the parties to the transaction, calculate any additional tax due, and notify the pur- chaser of the seller’s election. The likely respondents are business or other for- profit institutions. 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, OP:FS:FP, Wash- ington, DC 20224. Comments on the col- lection of information should be received by March 27, 2000. Comments are specifi- cally requested concerning: Whether the collection of information is necessary for the proper performance of the functions of the Internal Revenue Ser- vice, including whether the information will have practical utility; The accuracy of the estimated burden as- sociated with the collection of informa- tion (see below); How the quality, utility, and clarity of the information to be collected may be en- hanced; How the burden of complying with the col- lection of information may be minimized, including through the application of auto- mated 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. Estimated total annual reporting burden: 1500 hours. Estimated average annual burden hours per respondent varies from 2 to 4 hours, depending on individual circumstances, with an estimated average of 3 hours. Estimated number of respondents: 500 per year. Estimated annual frequency of responses: 1 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. Books or records relating to this collec- tion of information must be retained as long as their contents may become mater- ial in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. Background On January 16, 1997, the IRS published proposed regulations REG–209709–94, 1997–1 C.B. 731, in the Federal Register (62 F.R. 2336) inviting comments under sections 167(f) and 197. A public hearing was held May 15, 1997. Numerous com- ments have been received. After considera- tion of all the comments, the proposed reg- ulations are adopted as revised by this Treasury decision. Explanation of Provisions Section 162(k) Application Example 4of the proposed regulation §1.197–2(k) provided that amounts paid for a covenant not to compete entered into in connection with a redemption was nondeductible under section 162(k) and thus not subject to section 197. Commen- tators suggested that guidance on the ap- plication of section 162(k) to transactions involving section 197 intangibles should be addressed in regulations under section 162(k). No reference to section 162(k) is made in the final regulations. Purchase of a Trade or Business Certain intangibles are excepted from the application of section 197 if they are not acquired as part of a purchase of a trade or business. The proposed regula- tions provide that, for purposes of section 197, a group of assets constitutes a trade or business if their use would constitute a trade or business under section 1060 (that is, if goodwill or going concern value could, under any circumstances, attach to the assets). In addition, the proposed reg- ulations treat a group of assets as a trade Part I. Rulings and Decisions Under the Internal Revenue Code of 1986 February 14, 20005902000–7 I.R.B. or business if they include any customer- based intangibles or, with certain excep- tions, any franchise, trademark, or trade name (the per se rules). The preamble of the proposed regulations state that the IRS intends to provide additional guidance on the circumstances in which a group of as- sets is treated as a trade or business in reg- ulations under section 1060. Although a number of comments re- quested that the final regulations under section 197 provide such additional guid- ance, the final regulations generally re- tain, without amplification, the rules in the proposed regulations. The IRS and Treasury Department will, however, con- tinue to consider this issue during the de- velopment of final regulations under sec- tion 1060. Commentators also requested modifi- cations to the per se rules. In response to these comments, the final regulations limit the applicability of these rules to the cases specifically described in the legisla- tive history of section 197 (that is, the ac- quisition of a franchise, trademark, or trade name). The final regulations retain the proposed exceptions under which cer- tain franchises, trademarks, and trade names are disregarded in applying the per se rules. In addition, the regulations clar- ify that a license of a trademark or trade name is also disregarded in applying the per se rules. Computer Software The final regulations contain rules that supersede certain of the procedures set forth in Revenue Procedure 69–21 (1969–2 C.B. 303), which provides guidelines relating to costs incurred to de- velop, purchase, or lease computer soft- ware. Specifically, the final regulations provide that purchased computer software is amortizable over 15 years if section 197 applies and over 36 months if the soft- ware is not a section 197 intangible. In addition, the regulations clarify that sec- tion 197 (rather than §1.162–11) applies to certain costs incurred with respect to leased software (that is, costs to acquire a section 197 intangible that is a limited in- terest in software). Computer software costs included, without being separately stated, in the cost of the computer hard- ware (bundled software) continue to be capitalized and depreciated as part of the computer hardware. In addition, the final regulations treat software costs as cur- rently deductible (and not subject to sec- tion 197) if they are not chargeable to capital account under the rules applicable to licensing transactions (discussed below) and are otherwise currently de- ductible. The final regulations clarify that, for this purpose, an amount de- scribed in §1.162–11 is not currently de- ductible if, without regard to §1.162–11, such amount is properly chargeable to capital account. A proper and consistent practice of taking software costs into ac- count under §1.162–11 may, however, be continued if the costs are not subject to section 197. A revenue procedure superseding Rev. Proc. 69–21 and providing procedures consistent with the rules in the final regu- lations will be issued in the near future. In the meantime, taxpayers may not rely on the procedures in Rev. Proc. 69–21 to the extent they are inconsistent with sec- tion 167(f), section 197, or the final regu- lations. Mortgage Servicing Rights The proposed regulations treat mort- gage servicing rights relating to a pool of mortgages as a single asset under section 167(f) (relating to mortgage servicing rights not acquired as part of a purchase of a trade or business). Thus, if some but not all mortgages in a pool prepay, no loss is recognized. Commentators assert that each right in the pool is a discrete asset, and thus, taxpayers should be able to rec- ognize a loss upon the prepayment of an individual mortgage within the pool. The Service and the Treasury Department be- lieve this is generally inappropriate in cases where depreciation is based on the average useful life of the assets. See §1.167(a)–8. Thus, the regulations retain the rule that no loss is recognized if some but not all mortgages in a pool prepay or are sold or exchanged. The final regula- tions provide, however, that if a taxpayer establishes multiple accounts within a pool at the time of its acquisition, gain or loss is recognized on the sale or exchange of all mortgage servicing rights within any such account. When Section 197 Amortization Begins The proposed regulations provide that amortization begins the later of the first day of the month in which the property is acquired, or the first month in which the active conduct of a trade or business be- gins. Commentators suggest that the lit- eral language of section 197(a) allows amortization beginning with the month the intangible is acquired. Under section 197(c)(1), however, a section 197 intangi- ble is amortizable only if it is held in con- nection with the conduct of a trade or business or an activity described in sec- tion 212. Moreover, there is no sugges- tion in the legislative history that Con- gress intended to apply a rule differing from those applicable under section 167 and former section 1253(d). Former section 1253(d)(2) provided, in language similar to that in section 197(a), that the amortization of certain amounts begins in the taxable year in which the amounts are paid. Although section 1253(d)(2) did not contain any reference to section 162 or to use in a trade or business, it was nevertheless well established at the time of the enactment of section 197 that the provision embodied a trade or business requirement and that amounts were not de- ductible thereunder unless the taxpayer was operating or conducting a trade or business after the amounts were paid. Commentators suggest that it is signifi- cant that section 167 refers to “property used in the trade or business” while prop- erty can qualify for amortization under sec- tion 197 if it is “held in connection with the conduct of a trade or business.” Further, commentators assert that the language used in section 197 is closer to the “held in connection with his trade or business” lan- guage used in section 174, which does not require the current conduct of a trade or business, than to the language of section 167. The different language used in these provisions can be explained, however, without departing from previous practice under sections 167 and 1253(d) regarding the time at which amortization com- mences. Broader language under section 197 is necessary because it applies to as- sets, such as goodwill, that although held in connection with the conduct of a trade or business are not commonly viewed as being used in the trade or business. Fur- ther, modifying the language used in sec- tion 174 by adding the words “conduct of” indicates that Congress did not intend to change the longstanding trade or business requirement for purposes of determining when amortization commences. 2000–7 I.R.B.591February 14, 2000 Consequently, the final regulations re- tain the rule in the proposed regulations that amortization begins no earlier than the first day of the month in which the ac- tive trade or business or the activity de- scribed in section 212 begins. Transactions Involving Partnerships The final regulations relating to part- nership transactions have been changed from the proposed regulations in several respects to reflect the recommendations of commentators. Example 17of the pro- posed regulation § 1.197-2(k) provided that a partner may amortize a § 743 ad- justment with respect to a section 197 in- tangible only if the formation of the part- nership and the sale of the partnership interest are “unrelated transactions.” Commentators suggested that an unre- lated transaction standard would create significant confusion for taxpayers. Ac- cording to the commentators, taxpayers would have greater certainty with respect to their transactions, and the government still would be adequately protected, if these transactions were analyzed under general tax principles, including the step transaction doctrine. The final regulations remove the unrelated transaction require- ment. However, if the transaction is structured so that, under general princi- ples of tax law, the transaction is not properly characterized as a sale of a part- nership interest, then section 197 will apply to the transaction as recast to reflect its true economic substance. Certain commentators also requested that Example 16of proposed regulation § 1.197–2(k) be modified to allow a part- nership to amortize an intangible con- tributed to the partnership under the transferred basis rules under section 197(f)(2), even if a partner related to the partnership under section 197(f)(9)(C) had owned the intangible during the tran- sition period and, as part of an integrated transaction, had sold the intangible to an unrelated party before forming the part- nership. The commentators suggested that because section 197(f)(9)(E) gener- ally permits amortization for the stepped- up basis in a partnership transaction under section 743 where a section 754 election was in effect, amortization also should be allowed in a sale of an intangi- ble followed by a contribution of the in- tangible to a partnership, an economi- cally similar transaction. This recom- mendation was not adopted. In general, a partnership is treated as an entity separate from its partners in characterizing related party transfers. See, e.g., Section 707(b)(1) (specifically referenced in sec- tion 197(f)(9)(C)(i)(I)). Section 197(f)(9)(E) does provide a special anti- churning rule for certain partnership transactions. However, this special rule is not applicable in situations where a partnership has a transferred basis in the intangible under section 723. With re- spect to the analogy under section 743, where a transferee is allowed to amortize a section 743 basis step-up, it is only the increase in basis that may be amortized, and the amortization attributable to the basis increase is segregated for use only by the transferee partner. Neither of these results necessarily follow from a sale of property followed by a contribu- tion of the property to the partnership. The proposed regulations did not allow partners to deduct, for federal income tax purposes, curative or remedial amortiza- tion allocations from the partnership in situations where the asset was a section 197(f)(9) intangible (and thus nonamorti- zable) in the hands of the contributing partner. Commentators have suggested allowing curative and remedial alloca- tions under section 704(c). The final reg- ulations generally permit a partnership to make curative or remedial allocations to its noncontributing partners of amortiza- tion relating to an asset that was amortiz- able (or a zero-basis intangible that other- wise would have been amortizable) in the hands of the contributor. For assets that were section 197(f)(9) intangibles (and thus nonamortizable) in the hands of the contributor, however, the partnership may make deductible amortization allocations to the noncontributing partners under the remedial method only. The final regula- tions permit remedial allocations because, under section 704(c), remedial allocations treat the amortizable portion of con- tributed property like newly purchased property, with a new holding period and determinable allocation of tax items. This result, which is similar to the result ob- tained for basis increases under section 743, does not follow under the curative method because curative allocations are not determined as if the applicable prop- erty were newly purchased property. The decision to allow amortization for reme- dial allocations in these regulations also is consistent with the decisions regarding fungibility of partnership interests that are inherent in the recently finalized regula- tions under sections 743 and 755. Finally, the rules governing section 704(c) alloca- tions of amortization from section 197 in- tangibles contributed to a partnership in a nonrecognition transaction are still sub- ject to the anti-churning provisions. Ac- cordingly, remedial allocations of de- ductible amortization expenses may not be made to a partner who is related to a partner that contributes an intangible sub- ject to the anti-churning rules. Certain problems may arise in maintaining capital accounts where a partnership elects to make remedial allocations, and the anti- churning rules apply with respect to one or more partners. These problems also arise in the context of section 734(b) ad- justments and are discussed in the pream- ble to the proposed regulations relating to the application of the anti-churning rules to basis adjustments under sections 732(b) and 734(b), which are being issued at the same date as these final regulations. Commentators requested that the final regulations provide additional guidance on how the special anti-churning rule of section 197(f)(9)(E) applies to increases in the basis of property under sections 732, 734, and 743. In accordance with these comments, the final regulations pro- vide rules for determining the amount of a basis adjustment under sections 732(d) and 743 that will be subject to the anti- churning rules. The Treasury Department and the IRS also are issuing, at the same time as these final regulations, proposed regulations addressing how to determine the amount of a basis adjustment under sections 732(b) and 734(b) that will be subject to the anti-churning rules. Finally, the final regulations provide that where, for purposes of the anti-churn- ing rules, a partner is treated as holding its proportionate share of partnership prop- erty under section 197(f)(9)(E), the con- tinued or subsequent use (by license or otherwise) of an intangible by a partner could cause the anti-churning rules to apply with respect to that partner’s share of the intangible in situations where a basis step-up under section 732(d) or 743(b) otherwise would be amortizable. February 14, 20005922000–7 I.R.B. This rule is necessary in order to prevent the circumvention of section 197(f)(9)(A) through the use of a partnership. The pro- posed regulations being issued in conjunc- tion with these final regulations expand the application of this rule to basis adjust- ments under sections 732(b) and 734(b). Contracts for the Use of a Section 197 Intangible The proposed regulations provide that a right to use a section 197 intangible pursuant to a license, contract, or other arrangement is, itself, a section 197 in- tangible. The proposed regulations fur- ther provide that amounts paid for such a right are chargeable to capital account, whether or not the payments would have been deductible (for example, as a roy- alty) if the right were not a section 197 intangible. Under the proposed regula- tions, the amount chargeable to capital account is generally determined without regard to sections 483 and 1274 (that is, no part of the amount paid is recharacter- ized as unstated interest or original issue discount). Finally, the proposed regula- tions treat the acquisition of a franchise, trademark, or trade name as the acquisi- tion of a trade or business, thereby pre- venting other intangibles acquired in the same transaction or series of related transactions from qualifying for any of the exceptions applicable to separately acquired property. Commentators suggested that these rules have negative consequences for common cross-border and affiliate li- censes, which frequently include, in addi- tion to rights that would not be subject to section 197 if not acquired as part of a purchase of a trade or business, rights to use a trademark or trade name. Under prior law, amounts paid for these licenses were generally currently deductible. The proposed regulations, however, require amortization over 15 years. In addition, cost recovery over the 15-year period is significantly backloaded because the li- censes generally involve contingent pay- ments that are not includible in basis until the year in which they are paid or in- curred and, in addition, the proposed reg- ulations provide that sections 483 and 1274 are generally inapplicable. After further consideration of this issue in light of the concerns raised by the commentators, the IRS and Treasury Department have concluded that, particu- larly in the case of common licensing transactions involving technology and similar intangible property, a different approach is appropriate. The clearest in- dication of Congressional intent on this issue is the statement in the legislative history to the effect that, with certain ex- ceptions, section 197 generally does not apply to amounts that were otherwise currently deductible before the enactment of section 197. Nevertheless, the IRS and Treasury Department are also mind- ful that Congress directed the issuance of such regulations as may be appropriate to prevent avoidance of the purposes of sec- tion 197. The final regulations generally provide that royalty payments under a contract for the use of section 197 intangibles uncon- nected with the purchase of a trade or business are not required to be capital- ized. Licensing transactions will, how- ever, be closely scrutinized under the principles of section 1235 for purposes of determining whether the payments are, in fact, deductible royalties or, instead, rep- resent purchase price that should be charged to capital account. The final regulations also modify the rule that treats the acquisition of a fran- chise, trademark, or trade name as the ac- quisition of a trade or business. Under the final regulations, the acquisition of an in- terest in a trademark or trade name is dis- regarded in determining whether acquired property is a trade or business if, under the principles of section 1253, the grant of the interest is not a transfer of all substan- tial rights in the trademark or trade name. Thus, the acquisition of such an interest in a trademark or trade name will not subject other intangibles acquired in the same transaction or series of related transac- tions to the generally less favorable rules applicable to intangibles acquired as part of a purchase of a trade or business. To prevent abuses, the final regulations provide that if the right to use a section 197 intangible is provided under a license entered into as part of a purchase of a trade or business, amounts paid for the right are, as under the proposed regula- tions, chargeable to capital account. An exception, not contained in the proposed regulations, is provided for licenses of technology, know-how, and other similar items (including most types of informa- tion base). Royalties paid under these li- censes are not required to be capitalized if the taxpayer establishes that the payments are, in fact, deductible royalties under general tax principles and represent an arm’s-length consideration for the trans- ferred rights. Finally, any amount otherwise charge- able to capital account with respect to a section 197 intangible and payable after the acquisition of the intangible to which it relates is treated, in determining the tax treatment of the purchaser, as an amount payable under a debt instrument. Thus, the extent to which such amounts are treated as payments of principal and the time at which the amount treated as prin- cipal is included in basis is determined under generally applicable rules relating to imputed interest and original issue dis- count. If, under these rules, a basis in- crease occurs after the beginning of the 15-year amortization period, the increase is amortized over the remainder of the 15- year period (or, in the case of an increase occurring after the end of the amortization period, is immediately deductible). Anti-churning Rules The anti-churning rules of section 197 prevent taxpayers from converting good- will, going concern value, and similar as- sets held or used at any time during the transition period into amortizable section 197 intangibles through transactions such as transfers to related parties. The pro- posed regulations provide guidance on a number of specific issues arising under the anti-churning rules. The final regula- tions retain this guidance with certain modifications and, in addition, set forth the purpose of the anti-churning rules (generally, to prevent the amortization of certain intangibles that are not acquired after the applicable effective date in a transaction giving rise to a significant change in ownership or use). The final regulations further provide that the anti- churning rules are to be applied in a man- ner that carries out their purpose. The final regulations include a rule providing that a transaction will be presumed to have a principal purpose of avoiding the anti-churning rules if it does not effect a significant change in ownership or use. The final regulations also provide addi- 2000–7 I.R.B.593February 14, 2000 tional guidance concerning the circum- stances in which persons are treated as re- lated for purposes of the anti-churning rules. Section 197 provides that a rela- tionship is tested for purposes of the anti- churning rules both immediately before and immediately after the acquisition. The proposed regulations further provide that, in the case of intangibles acquired in a series of related transactions, testing be- gins immediately before the first acquisi- tion and continues until immediately after the last acquisition. Comments suggested that momentary relationships created in the course of the acquisition should be dis- regarded for purposes of the anti-churning rules. Such relationships can arise, for ex- ample, in the course of a stock acquisition followed by a liquidation or when assets are contributed to a newly created sub- sidiary and, pursuant to a binding commit- ment, all stock of the subsidiary is sold to an unrelated person or persons immedi- ately after the contribution. To address these and similar situations, the final regulations provide that in the case of a series of related transactions (or a series of transactions that together com- prise a qualified stock purchase within the meaning of section 338(d)(3)) a person is treated as related to another person if the relationship exists immediately before the earliest such transaction or immediately after the last such transaction. In addi- tion, any relationship created as part of a series of related transactions in which a person acquires stock of a corporation fol- lowed by a liquidation of the acquired corporation under section 331 generally is disregarded. Further, as with all other provisions of the regulations relating to the anti-churning rules, these provisions are to be applied in a manner that carries out the purpose of the anti-churning rules. The final regulations also provide guid- ance on the exemption from the anti- churning rules if the person from whom the taxpayer acquires an intangible elects to recognize gain and agrees to pay a specified amount of tax. In general, these rules are the same as those contained in the proposed regulations, except that the proposed regulations do not prescribe procedures for making the election. The final regulations provide guidance on the manner of making the election, including procedures that apply to persons not oth- erwise subject to Federal income tax. Effective Dates The regulations under sections 167(f) and 197 were proposed to apply on the date on which the final regulations are published in the Federal Register(Janu- ary 25, 2000). Regulations to implement section 197(e)(4)(D) (separately acquired contracts of fixed duration or amount) were proposed to apply August 11, 1993, for property acquired after August 10, 1993 (or July 26, 1991, if a valid retroac- tive election has been made under §1.197–1T). Comments suggested that the applicability date should be modified to clarify that the regulations (other than the implementation of section 197(e)(4)(D)) apply only to property ac- quired on or after the date final regula- tions are published. This suggestion has been adopted. Accordingly, the final reg- ulations generally apply only to intangible property acquired after January 25, 2000. The applicability date of the rules im- plementing section 197(e)(4)(D) is simi- larly clarified. Thus, the final regulations provide that these rules apply to property acquired after August 10, 1993 (or July 25, 1991, if a valid retroactive election has been made under §1.197–1T). The regulations also provide consent for changes in method of accounting to com- ply with the rules and automatic proce- dures for making the change. In addition, the final regulations permit taxpayers to apply the rules in the final regulations to property acquired before the applicability date of the final regula- tions (or to rely on the proposed regula- tions for such property) and provide simi- lar consent and automatic change procedures for taxpayers that choose to apply the final regulations to pre-effective date acquisitions. Special Analyses It has been determined that this Trea- sury decision is not a significant regula- tory action as defined in Executive Order 12866. Therefore, a regulatory assess- ment is not required. It is hereby certified that these regulations do not have a signif- icant impact on a substantial number of small entities. This certification is based on the fact that the time required to pre- pare and file the election statement and notify acquirers is minimal and will not have a significant impact on those few small entities that choose to make the elec- tion. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking was sub- mitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. Drafting Information The principal author of these regula- tions is John Huffman, Office of Assistant Chief Counsel (Passthroughs and Special Industries), IRS. However, other person- nel from the IRS and Treasury Depart- ment participated in their development. * * * * * Amendments to the Regulations Accordingly, 26 CFR parts 1 and 602 are amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read as follows: Authority: 26 U.S.C. 7805 * * * Section 1.197–2 also issued under 26 U.S.C. 197(g). * * * Par. 2. Section 1.162–11 is amended by adding a sentence at the end of para- graph (a) to read as follows: §1.162–11 Rentals. (a) * * * See §1.197–2 for rules gov- erning the amortization of costs to acquire limited interests in section 197 intangi- bles. * * * * * Par. 3. Section 1.167(a)–3 is amended by adding a sentence at the end to read as follows: §1.167(a)–3 Intangibles. * * * See sections 197 and 167(f) and, to the extent applicable, §§1.197–2 and 1.167(a)–14 for amortization of goodwill and certain other intangibles acquired after August 10, 1993, or after July 25, 1991, if a valid retroactive election under §1.197–1T has been made. Par. 4. Section 1.167(a)–6 is amended by adding two sentences at the end of paragraph (a) to read as follows: February 14, 20005942000–7 I.R.B. §1.167(a)–6 Depreciation in special cases. (a) * * * See §1.167(a)–14(c)(4) for de- preciation of a separately acquired inter- est in a patent or copyright described in section 167(f)(2) acquired after January 25, 2000. See §1.197–2 for amortization of interests in patents and copyrights that constitute amortizable section 197 intan- gibles. * * * * * Par. 5. Section 1.167(a)–14 is added to read as follows: §1.167(a)–14 Treatment of certain intan- gible property excluded from section 197. (a) Overview. This section provides rules for the amortization of certain intan- gibles that are excluded from section 197 (relating to the amortization of goodwill and certain other intangibles). These ex- cluded intangibles are specifically de- scribed in §1.197–2(c)(4), (6), (7), (11), and (13) and include certain computer software and certain other separately ac- quired rights, such as rights to receive tangible property or services, patents and copyrights, certain mortgage servicing rights, and rights of fixed duration or amount. Intangibles for which an amorti- zation amount is determined under sec- tion 167(f) and intangibles otherwise ex- cluded from section 197 are amortizable only if they qualify as property subject to the allowance for depreciation under sec- tion 167(a). (b) Computer software—(1) In general. The amount of the deduction for com- puter software described in section 167(f)(1) and §1.197–2(c)(4) is deter- mined by amortizing the cost or other basis of the computer software using the straight line method described in §1.167(b)–1 (except that its salvage value is treated as zero) and an amortization pe- riod of 36 months beginning on the first day of the month that the computer soft- ware is placed in service. If costs for de- veloping computer software that the tax- payer properly elects to defer under section 174(b) result in the development of property subject to the allowance for depreciation under section 167, the rules of this paragraph (b) will apply to the un- recovered costs. In addition, this para- graph (b) applies to the cost of separately acquired computer software where these costs are separately stated and the costs are required to be capitalized under sec- tion 263(a). (2) Exceptions.Paragraph (b)(1) of this section does not apply to the cost of computer software properly and consis- tently taken into account under §1.162–11. The cost of acquiring an in- terest in computer software that is in- cluded, without being separately stated, in the cost of the hardware or other tangible property is treated as part of the cost of the hardware or other tangible property that is capitalized and depreciated under other applicable sections of the Internal Revenue Code. (3) Additional rules. Rules similar to those in §1.197–2(f)(1)(iii), (f)(1)(iv), and (f)(2) (relating to the computation of amortization deductions and the treatment of contingent amounts) apply for pur- poses of this paragraph (b). (c) Certain interests or rights not ac- quired as part of a purchase of a trade or business—(1) Certain rights to receive tangible property or services. The amount of the deduction for a right (other than a right acquired as part of a purchase of a trade or business) to receive tangible property or services under a contract or from a governmental unit (as specified in section 167(f)(2) and §1.197–2(c)(6)) is determined as follows: (i) Amortization of fixed amounts. The basis of a right to receive a fixed amount of tangible property or services is amor- tized for each taxable year by multiplying the basis of the right by a fraction, the nu- merator of which is the amount of tangi- ble property or services received during the taxable year and the denominator of which is the total amount of tangible property or services received or to be re- ceived under the terms of the contract or governmental grant. For example, if a taxpayer acquires a favorable contract right to receive a fixed amount of raw ma- terials during an unspecified period, the taxpayer must amortize the cost of acquir- ing the contract right by multiplying the total cost by a fraction, the numerator of which is the amount of raw materials re- ceived under the contract during the tax- able year and the denominator of which is the total amount of raw materials received or to be received under the contract. (ii) Amortization of unspecified amount over fixed period. The cost or other basis of a right to receive an unspecified amount of tangible property or services over a fixed period is amortized ratably over the period of the right. (See para- graph (c)(3) of this section regarding re- newals). (iii) Amortization in other cases. [Re- served] (2) Rights of fixed duration or amount. The amount of the deduction for a right (other than a right acquired as part of a purchase of a trade or business) of fixed duration or amount received under a con- tract or granted by a governmental unit (specified in section 167(f)(2) and §1.197–2(c)(13)) and not covered by paragraph (c)(1) of this section is deter- mined as follows: (i) Rights to a fixed amount.The basis of a right to a fixed amount is amortized for each taxable year by multiplying the basis by a fraction, the numerator of which is the amount received during the taxable year and the denominator of which is the total amount received or to be received under the terms of the con- tract or governmental grant. (ii) Rights to an unspecified amount over fixed duration of less than 15 years. The basis of a right to an unspecified amount over a fixed duration of less than 15 years is amortized ratably over the pe- riod of the right. (3) Application of renewals.(i) For purposes of paragraphs (c)(1) and (2) of this section, the duration of a right under a contract (or granted by a governmental unit) includes any renewal period if, based on all of the facts and circum- stances in existence at any time during the taxable year in which the right is ac- quired, the facts clearly indicate a reason- able expectancy of renewal. (ii) The mere fact that a taxpayer will have the opportunity to renew a contract right or other right on the same terms as are available to others, in a competitive auction or similar process that is designed to reflect fair market value and in which the taxpayer is not contractually advan- taged, will generally not be taken into ac- count in determining the duration of such right provided that the bidding produces a fair market value price comparable to the price that would be obtained if the rights were purchased immediately after re- newal from a person (other than the per- son granting the renewal) in an arm’s- length transaction. (iii) The cost of a renewal not included 2000–7 I.R.B.595February 14, 2000 in the terms of the contract or governmen- tal grant is treated as the acquisition of a separate intangible asset. (4) Patents and copyrights.If the pur- chase price of a interest (other than an in- terest acquired as part of a purchase of a trade or business) in a patent or copyright described in section 167(f)(2) and §1.197–2(c)(7) is payable on at least an annual basis as either a fixed amount per use or a fixed percentage of the revenue derived from the use of the patent or copyright, the depreciation deduction for a taxable year is equal to the amount of the purchase price paid or incurred during the year. Otherwise, the basis of such patent or copyright (or an interest therein) is depreciated either ratably over its re- maining useful life or under section 167(g) (income forecast method). If a patent or copyright becomes valueless in any year before its legal expiration, the adjusted basis may be deducted in that year. (5) Additional rules. The period of amortization under paragraphs (c)(1) through (4) of this section begins when the intangible is placed in service, and rules similar to those in §1.197–2(f)(2) apply for purposes of this paragraph (c). (d) Mortgage servicing rights—(1) In general.The amount of the deduction for mortgage servicing rights described in section 167(f)(3) and §1.197–2(c)(11) is determined by using the straight line method described in §1.167(b)–1 (except that the salvage value is treated as zero) and an amortization period of 108 months beginning on the first day of the month that the rights are placed in service. Mortgage servicing rights are not depre- ciable to the extent the rights are stripped coupons under section 1286. (2) Treatment of rights acquired as a pool—(i) In general.Except as provided in paragraph (d)(2)(ii) of this section, all mortgage servicing rights acquired in the same transaction or in a series of related transactions are treated as a single asset (the pool) for purposes of determining the depreciation deduction under this para- graph (d) and any gain or loss from the sale, exchange, or other disposition of the rights. Thus, if some (but not all) of the rights in a pool become worthless as a re- sult of prepayments, no loss is recognized by reason of the prepayment and the ad- justed basis of the pool is not affected by the unrecognized loss. Similarly, any amount realized from the sale or ex- change of some (but not all) of the mort- gage servicing rights is included in in- come and the adjusted basis of the pool is not affected by the realization. (ii) Multiple accounts. If the taxpayer establishes multiple accounts within a pool at the time of its acquisition, gain or loss is recognized on the sale or exchange of all mortgage servicing rights within any such account. (3) Additional rules. Rules similar to those in §1.197–2(f)(1)(iii), (f)(1)(iv), and (f)(2) (relating to the computation of amortization deductions and the treatment of contingent amounts) apply for pur- poses of this paragraph (d). (e) Effective date— (1) In general. This section applies to property acquired after January 25, 2000, except that §1.167(a)–14(c)(2) (depreciation of the cost of certain separately acquired rights) and so much of §1.167(a)–14(c)(3) as re- lates to §1.167(a)–14(c)(2) apply to prop- erty acquired after August 10, 1993 (or July 25, 1991, if a valid retroactive elec- tion has been made under §1.197–1T). (2) Change in method of accounting. See §1.197–2(l)(4) for rules relating to changes in method of accounting for property to which §1.167(a)–14 applies. Par. 6. Section 1.197–0 is added to read as follows: §1.197–0 Table of contents. This section lists the headings that ap- pear in §1.197–2. §1.197–2 Amortization of goodwill and certain other intangibles. (a) Overview. (1) In general. (2) Section 167(f) property. (3) Amounts otherwise deductible. (b) Section 197 intangibles; in general. (1) Goodwill. (2) Going concern value. (3) Workforce in place. (4) Information base. (5) Know-how, etc. (6) Customer-based intangibles. (7) Supplier-based intangibles. (8) Licenses, permits, and other rights granted by governmental units. (9) Covenants not to compete and other similar arrangements. (10) Franchises, trademarks, and trade names. (11) Contracts for the use of, and term in- terests in, other section 197 intangibles. (12) Other similar items. (c) Section 197 intangibles; exceptions. (1) Interests in a corporation, partnership, trust, or estate. (2) Interests under certain financial con- tracts. (3) Interests in land. (4) Certain computer software. (i) Publicly available. (ii) Not acquired as part of trade or busi- ness. (iii) Other exceptions. (iv) Computer software defined. (5) Certain interests in films, sound recordings, video tapes, books, or other similar property. (6) Certain rights to receive tangible prop- erty or services. (7) Certain interests in patents or copy- rights. (8) Interests under leases of tangible prop- erty. (i) Interest as a lessor. (ii) Interest as a lessee. (9) Interests under indebtedness. (i) In general. (ii) Exceptions. (10) Professional sports franchises. (11) Mortgage servicing rights. (12) Certain transaction costs. (13) Rights of fixed duration or amount. (d) Amortizable section 197 intangibles. (1) Definition. (2) Exception for self-created intangibles. (i) In general. (ii) Created by the taxpayer. (A) Defined. (B) Contracts for the use of intangibles. (C) Improvements and modifications. (iii) Exceptions. (3) Exception for property subject to anti- churning rules. (e) Purchase of a trade or business. (1) Goodwill or going concern value. (2) Franchise, trademark, or trade name. (i) In general. (ii) Exceptions. (3) Acquisitions to be included. (4) Substantial portion. (5) Deemed asset purchases under section 338. (6) Mortgage servicing rights. (7) Computer software acquired for inter- nal use. (f) Computation of amortization deduc- tion. (1) In general. February 14, 20005962000–7 I.R.B. (2) Treatment of contingent amounts. (i) Amounts added to basis during 15-year period. (ii) Amounts becoming fixed after expira- tion of 15-year period. (iii) Rules for including amounts in basis. (3) Basis determinations for certain as- sets. (i) Covenants not to compete. (ii) Contracts for the use of section 197 intangibles; acquired as part of a trade or business. (A) In general. (B) Know-how and certain information base. (iii) Contracts for the use of section 197 intangibles; not acquired as part of a trade or business. (iv) Applicable rules. (A) Franchises, trademarks, and trade names. (B) Certain amounts treated as payable under a debt instrument. (1) In general. (2) Rights granted by governmental units. (3) Treatment of other parties to transac- tion. (4) Basis determinations in certain trans- actions. (i ) Certain renewal transactions. (ii) Transactions subject to section 338 or 1060. (iii) Certain reinsurance transactions. (g) Special rules. (1) Treatment of certain dispositions. (i) Loss disallowance rules. (A) In general. (B) Abandonment or worthlessness. (C) Certain nonrecognition transfers. (ii) Separately acquired property. (iii) Disposition of a covenant not to com- pete. (iv) Taxpayers under common control. (A) In general. (B) Treatment of disallowed loss. (2) Treatment of certain nonrecognition and exchange transactions. (i) Relationship to anti-churning rules. (ii) Treatment of nonrecognition and ex- change transactions generally. (A) Transfer disregarded. (B) Application of general rule. (C) Transactions covered. (iii) Certain exchanged-basis property. (iv) Transfers under section 708(b)(1). (A) In general. (B) Termination by sale or exchange of interest. (C) Other terminations. (3) Increase in the basis of partnership property under section 732(b), 734(b), 743(b), or 732(d). (4) Section 704(c) allocations. (i) Allocations where the intangible is amortizable by the contributor. (ii) Allocations where the intangible is not amortizable by the contributor. (5) Treatment of certain reinsurance trans- actions. (i) In general. (ii) Determination of adjusted basis. (A) Acquisitions (other than under section 338) of specified insurance contracts. (B) Insolvent ceding company (C) Other acquisitions. [Reserved] (6) Amounts paid or incurred for a fran- chise, trademark, or trade name. (7) Amounts properly taken into account in determining the cost of property that is not a section 197 intangible. (8) Treatment of amortizable section 197 intangibles as depreciable property. (h) Anti-churning rules. (1) Scope and purpose. (i) Scope. (ii) Purpose. (2) Treatment of section 197(f)(9) intangi- bles. (3) Amounts deductible under section 1253(d) or §1.162–11. (4) Transition period. (5) Exceptions. (6) Related person. (i) In general. (ii) Time for testing relationships. (iii) Certain relationships disregarded. (iv) De minimis rule. (A) In general. (B) Determination of beneficial owner- ship interest. (7) Special rules for entities that owned or used property at any time during the tran- sition period and that are no longer in ex- istence. (8) Special rules for section 338 deemed acquisitions. (9) Gain-recognition exception. (i) Applicability. (ii) Effect of exception. (iii) Time and manner of election. (iv) Special rules for certain entities. (v) Effect of nonconforming elections. (vi) Notification requirements. (vii) Revocation. (viii) Election Statement. (ix) Determination of highest marginal rate of tax and amount of other Federal in- come tax on gain. (A) Marginal rate. (1) Noncorporate taxpayers. (2) Corporations and tax-exempt entities. (B) Other Federal income tax on gain. (x) Coordination with other provisions. (A) In general. (B) Section 1374. (C) Procedural and administrative provi- sions. (D) Installment method. (xi) Special rules for persons not other- wise subject to Federal income tax. (10) Transactions subject to both anti- churning and nonrecognition rules. (11) Avoidance purpose. (12) Additional partnership anti-churning rules (i) In general. (ii) Section 732(b) adjustments. [Re- served] (iii) Section 732(d) adjustments. (iv) Section 734(b) adjustments. [Re- served] (v) Section 743(b) adjustments. (vi) Partner is or becomes a user of part- nership intangible. (A) General rule. (B) Anti-churning partner. (C) Effect of retroactive elections. (vii) Section 704(c) elections. (A) Allocations where the intangible is amortizable by the contributor. (B) Allocations where the intangible is not amortizable by the contributor. (viii) Operating rule for transfers upon death. (i) Reserved (j) General anti-abuse rule. (k) Examples. (l) Effective dates. (1) In general. (2) Application to pre-effective date ac- quisitions. (3) Application of regulation project REG–209709–94 to pre-effective date ac- quisitions. (4) Change in method of accounting. (i) In general. (ii) Application to pre-effective date transactions. (iii) Automatic change procedures. Par. 7. Section 1.197–2 is added to read as follows: §1.197–2 Amortization of goodwill and certain other intangibles. (a) Overview—(1) In general. Section 197 allows an amortization deduction for the capitalized costs of an amortizable section 197 intangible and prohibits any other depreciation or amortization with respect to that property. Paragraphs (b), (c), and (e) of this section provide rules and definitions for determining whether property is a section 197 intangible, and paragraphs (d) and (e) of this section pro- vide rules and definitions for determining whether a section 197 intangible is an amortizable section 197 intangible. The amortization deduction under section 197 is determined by amortizing basis ratably over a 15-year period under the rules of paragraph (f) of this section. Section 197 also includes various special rules per- taining to the disposition of amortizable section 197 intangibles, nonrecognition transactions, anti-churning rules, and anti- abuse rules. Rules relating to these provi- sions are contained in paragraphs (g), (h), and (j) of this section. Examples demon- strating the application of these provi- sions are contained in paragraph (k) of this section. The effective date of the rules in this section is contained in para- graph (l) of this section. (2) Section 167(f) property.Section 167(f) prescribes rules for computing the depreciation deduction for certain property to which section 197 does not apply. See §1.167(a)–14 for rules under section 167(f) and paragraphs (c)(4), (6), (7), (11), and (13) of this section for a description of the property subject to section 167(f). (3) Amounts otherwise deductible. Section 197 does not apply to amounts that are not chargeable to capital account under paragraph (f)(3) (relating to basis determinations for covenants not to com- pete and certain contracts for the use of section 197 intangibles) of this section and are otherwise currently deductible. For this purpose, an amount described in §1.162–11 is not currently deductible if, without regard to §1.162–11, such amount is properly chargeable to capital account. (b) Section 197 intangibles; in general. Except as otherwise provided in para- graph (c) of this section, the term section 197 intangiblemeans any property de- scribed in section 197(d)(1). The follow- ing rules and definitions provide guidance concerning property that is a section 197 intangible unless an exception applies: (1) Goodwill. Section 197 intangibles include goodwill. Goodwill is the value of a trade or business attributable to the expectancy of continued customer patron- age. This expectancy may be due to the name or reputation of a trade or business or any other factor. (2) Going concern value. Section 197 intangibles include going concern value. Going concern value is the additional value that attaches to property by reason of its existence as an integral part of an ongoing business activity. Going concern value includes the value attributable to the ability of a trade or business (or a part of a trade or business) to continue functioning or generating income without interruption notwithstanding a change in ownership, but does not include any of the intangibles described in any other provision of this paragraph (b). It also includes the value that is attributable to the immediate use or availability of an acquired trade or busi- ness, such as, for example, the use of the revenues or net earnings that otherwise would not be received during any period if the acquired trade or business were not available or operational. (3) Workforce in place. Section 197 in- tangibles include workforce in place. Workforce in place (sometimes referred to as agency force or assembled work- force) includes the composition of a workforce (for example, the experience, education, or training of a workforce), the terms and conditions of employment whether contractual or otherwise, and any other value placed on employees or any of their attributes. Thus, the amount paid or incurred for workforce in place includes, for example, any portion of the purchase price of an acquired trade or business at- tributable to the existence of a highly- skilled workforce, an existing employ- ment contract (or contracts), or a relationship with employees or consul- tants (including, but not limited to, any key employee contract or relationship). Workforce in place does not include any covenant not to compete or other similar arrangement described in paragraph (b)(9) of this section. (4) Information base. Section 197 in- tangibles include any information base, including a customer-related information base. For this purpose, an information base includes business books and records, operating systems, and any other informa- tion base (regardless of the method of recording the information) and a cus- tomer-related information base is any in- formation base that includes lists or other information with respect to current or prospective customers. Thus, the amount paid or incurred for information base in- cludes, for example, any portion of the purchase price of an acquired trade or business attributable to the intangible value of technical manuals, training man- uals or programs, data files, and account- ing or inventory control systems. Other examples include the cost of acquiring customer lists, subscription lists, insur- ance expirations, patient or client files, or lists of newspaper, magazine, radio, or television advertisers. (5) Know-how, etc. Section 197 intan- gibles include any patent, copyright, for- mula, process, design, pattern, know-how, format, package design, computer soft- ware (as defined in paragraph (c)(4)(iv) of this section), or interest in a film, sound recording, video tape, book, or other simi- lar property. (See, however, the excep- tions in paragraph (c) of this section.) (6) Customer-based intangibles. Sec- tion 197 intangibles include any cus- tomer- based intangible. A customer- based intangible is any composition of market, market share, or other value re- sulting from the future provision of goods or services pursuant to contractual or other relationships in the ordinary course of business with customers. Thus, the amount paid or incurred for customer- based intangibles includes, for example, any portion of the purchase price of an ac- quired trade or business attributable to the existence of a customer base, a circulation base, an undeveloped market or market growth, insurance in force, the existence of a qualification to supply goods or ser- vices to a particular customer, a mortgage servicing contract (as defined in para- graph (c)(11) of this section), an invest- ment management contract, or other rela- tionship with customers involving the future provision of goods or services. (See, however, the exceptions in para- graph (c) of this section.) In addition, customer-based intangibles include the deposit base and any similar asset of a fi- nancial institution. Thus, the amount paid or incurred for customer-based intangi- bles also includes any portion of the pur- chase price of an acquired financial insti- tution attributable to the value represented 2000–7 I.R.B.597February 14, 2000 by existing checking accounts, savings accounts, escrow accounts, and other sim- ilar items of the financial institution. However, any portion of the purchase price of an acquired trade or business at- tributable to accounts receivable or other similar rights to income for goods or ser- vices provided to customers prior to the acquisition of a trade or business is not an amount paid or incurred for a customer- based intangible. (7) Supplier-based intangibles. Section 197 intangibles include any supplier- based intangible. A supplier-based intan- gible is the value resulting from the future acquisition, pursuant to contractual or other relationships with suppliers in the ordinary course of business, of goods or services that will be sold or used by the taxpayer. Thus, the amount paid or in- curred for supplier-based intangibles in- cludes, for example, any portion of the purchase price of an acquired trade or business attributable to the existence of a favorable relationship with persons pro- viding distribution services (such as fa- vorable shelf or display space at a retail outlet), the existence of a favorable credit rating, or the existence of favorable sup- ply contracts. The amount paid or in- curred for supplier-based intangibles does not include any amount required to be paid for the goods or services themselves pursuant to the terms of the agreement or other relationship. In addition, see the ex- ceptions in paragraph (c) of this section, including the exception in paragraph (c)(6) of this section for certain rights to receive tangible property or services from another person. (8) Licenses, permits, and other rights granted by governmental units. Section 197 intangibles include any license, per- mit, or other right granted by a govern- mental unit (including, for purposes of section 197, an agency or instrumentality thereof) even if the right is granted for an indefinite period or is reasonably ex- pected to be renewed for an indefinite pe- riod. These rights include, for example, a liquor license, a taxi-cab medallion (or li- cense), an airport landing or takeoff right (sometimes referred to as a slot), a regu- lated airline route, or a television or radio broadcasting license. The issuance or re- newal of a license, permit, or other right granted by a governmental unit is consid- ered an acquisition of the license, permit, or other right. (See, however, the excep- tions in paragraph (c) of this section, in- cluding the exceptions in paragraph (c)(3) of this section for an interest in land, para- graph (c)(6) of this section for certain rights to receive tangible property or ser- vices, paragraph (c)(8) of this section for an interest under a lease of tangible prop- erty, and paragraph (c)(13) of this section for certain rights granted by a governmen- tal unit. See paragraph (b)(10) of this sec- tion for the treatment of franchises.) (9) Covenants not to compete and other similar arrangements.Section 197 intan- gibles include any covenant not to com- pete, or agreement having substantially the same effect, entered into in connection with the direct or indirect acquisition of an interest in a trade or business or a sub- stantial portion thereof. For purposes of this paragraph (b)(9), an acquisition may be made in the form of an asset acquisi- tion (including a qualified stock purchase that is treated as a purchase of assets under section 338), a stock acquisition or redemption, and the acquisition or re- demption of a partnership interest. An agreement requiring the performance of services for the acquiring taxpayer or the provision of property or its use to the ac- quiring taxpayer does not have substan- tially the same effect as a covenant not to compete to the extent that the amount paid under the agreement represents rea- sonable compensation for the services ac- tually rendered or for the property or use of the property actually provided. (10) Franchises, trademarks, and trade names. (i) Section 197 intangibles in- clude any franchise, trademark, or trade name. The term franchisehas the mean- ing given in section 1253(b)(1) and in- cludes any agreement that provides one of the parties to the agreement with the right to distribute, sell, or provide goods, ser- vices, or facilities, within a specified area. The term trademarkincludes any word, name, symbol, or device, or any combina- tion thereof, adopted and used to identify goods or services and distinguish them from those provided by others. The term trade name includes any name used to identify or designate a particular trade or business or the name or title used by a person or organization engaged in a trade or business. A license, permit, or other right granted by a governmental unit is a franchise if it otherwise meets the defini- tion of a franchise. A trademark or trade name includes any trademark or trade name arising under statute or applicable common law, and any similar right granted by contract. The renewal of a franchise, trademark, or trade name is treated as an acquisition of the franchise, trademark, or trade name. (ii) Notwithstanding the definitions provided in paragraph (b)(10)(i) of this section, any amount that is paid or in- curred on account of a transfer, sale, or other disposition of a franchise, trade- mark, or trade name and that is subject to section 1253(d)(1) is not included in the basis of a section 197 intangible. (See paragraph (g)(6) of this section.) (11) Contracts for the use of, and term interests in, section 197 intangibles. Sec- tion 197 intangibles include any right under a license, contract, or other arrange- ment providing for the use of property that would be a section 197 intangible under any provision of this paragraph (b) (including this paragraph (b)(11)) after giving effect to all of the exceptions pro- vided in paragraph (c) of this section. Section 197 intangibles also include any term interest (whether outright or in trust) in such property. (12) Other similar items. Section 197 intangibles include any other intangible property that is similar in all material re- spects to the property specifically de- scribed in section 197(d)(1)(C)(i) through (v) and paragraphs (b)(3) through (7) of this section. (See paragraph (g)(5) of this section for special rules regarding certain reinsurance transactions.) (c) Section 197 intangibles; exceptions. The term section 197 intangibledoes not include property described in section 197(e). The following rules and defini- tions provide guidance concerning prop- erty to which the exceptions apply: (1) Interests in a corporation, partner- ship, trust, or estate. Section 197 intangi- bles do not include an interest in a corpo- ration, partnership, trust, or estate. Thus, for example, amortization under section 197 is not available for the cost of acquir- ing stock, partnership interests, or inter- ests in a trust or estate, whether or not the interests are regularly traded on an estab- lished market. (See paragraph (g)(3) of this section for special rules applicable to property of a partnership when a section 754 election is in effect for the partner- February 14, 20005982000–7 I.R.B. 2000–7 I.R.B.599February 14, 2000 ship.) (2) Interests under certain financial contracts. Section 197 intangibles do not include an interest under an existing fu- tures contract, foreign currency contract, notional principal contract, interest rate swap, or other similar financial contract, whether or not the interest is regularly traded on an established market. How- ever, this exception does not apply to an interest under a mortgage servicing con- tract, credit card servicing contract, or other contract to service another person’s indebtedness, or an interest under an as- sumption reinsurance contract. (See para- graph (g)(5) of this section for the treat- ment of assumption reinsurance contracts. See paragraph (c)(11) of this section and §1.167(a)–14(d) for the treatment of mortgage servicing rights.) (3) Interests in land. Section 197 intan- gibles do not include any interest in land. For this purpose, an interest in land in- cludes a fee interest, life estate, remain- der, easement, mineral right, timber right, grazing right, riparian right, air right, zon- ing variance, and any other similar right, such as a farm allotment, quota for farm commodities, or crop acreage base. An interest in land does not include an airport landing or takeoff right, a regulated air- line route, or a franchise to provide cable television service. The cost of acquiring a license, permit, or other land improve- ment right, such as a building construc- tion or use permit, is taken into account in the same manner as the underlying im- provement. (4) Certain computer software—(i) Publicly available. Section 197 intangi- bles do not include any interest in com- puter software that is (or has been) readily available to the general public on similar terms, is subject to a nonexclusive li- cense, and has not been substantially modified. Computer software will be treated as readily available to the general public if the software may be obtained on substantially the same terms by a signifi- cant number of persons that would rea- sonably be expected to use the software. This requirement can be met even though the software is not available through a system of retail distribution. Computer software will not be considered to have been substantially modified if the cost of all modifications to the version of the software that is readily available to the general public does not exceed the greater of 25 percent of the price at which the un- modified version of the software is read- ily available to the general public or $2,000. For the purpose of determining whether computer software has been sub- stantially modified— (A) Integrated programs acquired in a package from a single source are treated as a single computer program; and (B) Any cost incurred to install the computer software on a system is not treated as a cost of the software. How- ever, the costs for customization, such as tailoring to a user’s specifications (other than embedded programming options) are costs of modifying the software. (ii) Not acquired as part of trade or business. Section 197 intangibles do not include an interest in computer software that is not acquired as part of a purchase of a trade or business. (iii) Other exceptions. For other excep- tions applicable to computer software, see paragraph (a)(3) of this section (relating to otherwise deductible amounts) and paragraph (g)(7) of this section (relating to amounts properly taken into account in determining the cost of property that is not a section 197 intangible). (iv) Computer software defined. For purposes of this section, computer soft- ware is any program or routine (that is, any sequence of machine-readable code) that is designed to cause a computer to perform a desired function or set of func- tions, and the documentation required to describe and maintain that program or routine. It includes all forms and media in which the software is contained, whether written, magnetic, or otherwise. Computer programs of all classes, for ex- ample, operating systems, executive sys- tems, monitors, compilers and translators, assembly routines, and utility programs as well as application programs, are in- cluded. Computer software also includes any incidental and ancillary rights that are necessary to effect the acquisition of the title to, the ownership of, or the right to use the computer software, and that are used only in connection with that specific computer software. Such incidental and ancillary rights are not included in the de- finition of trademark or trade name under paragraph (b)(10)(i) of this section. For example, a trademark or trade name that is ancillary to the ownership or use of a specific computer software program in the taxpayer’s trade or business and is not acquired for the purpose of marketing the computer software is included in the defi- nition of computer software and is not in- cluded in the definition of trademark or trade name. Computer software does not include any data or information base de- scribed in paragraph (b)(4) of this section unless the data base or item is in the pub- lic domain and is incidental to a computer program. For this purpose, a copyrighted or proprietary data or information base is treated as in the public domain if its avail- ability through the computer program does not contribute significantly to the cost of the program. For example, if a word-processing program includes a dic- tionary feature used to spell-check a doc- ument or any portion thereof, the entire program (including the dictionary feature) is computer software regardless of the form in which the feature is maintained or stored. (5) Certain interests in films, sound recordings, video tapes, books, or other similar property. Section 197 intangibles do not include any interest (including an interest as a licensee) in a film, sound recording, video tape, book, or other simi- lar property (such as the right to broadcast or transmit a live event) if the interest is not acquired as part of a purchase of a trade or business. A film, sound record- ing, video tape, book, or other similar property includes any incidental and an- cillary rights (such as a trademark or trade name) that are necessary to effect the ac- quisition of title to, the ownership of, or the right to use the property and are used only in connection with that property. Such incidental and ancillary rights are not included in the definition of trade- mark or trade name under paragraph (b)(10)(i) of this section. For purposes of this paragraph (c)(5), computer software (as defined in paragraph (c)(4)(iv) of this section) is not treated as other property similar to a film, sound recording, video tape, or book. (See section 167 for amor- tization of excluded intangible property or interests.) (6) Certain rights to receive tangible property or services. Section 197 intangibles do not include any right to receive tangible property or services under a contract or from a gov- ernmental unit if the right is not acquired February 14, 20006002000–7 I.R.B. as part of a purchase of a trade or busi- ness. Any right that is described in the preceding sentence is not treated as a sec- tion 197 intangible even though the right is also described in section 197(d)(1)(D) and paragraph (b)(8) of this section (relat- ing to certain governmental licenses, per- mits, and other rights) and even though the right fails to meet one or more of the requirements of paragraph (c)(13) of this section (relating to certain rights of fixed duration or amount). (See §1.167(a)–14(c)(1) and (3) for applicable rules.) (7) Certain interests in patents or copy- rights. Section 197 intangibles do not in- clude any interest (including an interest as a licensee) in a patent, patent application, or copyright that is not acquired as part of a purchase of a trade or business. A patent or copyright includes any inciden- tal and ancillary rights (such as a trade- mark or trade name) that are necessary to effect the acquisition of title to, the own- ership of, or the right to use the property and are used only in connection with that property. Such incidental and ancillary rights are not included in the definition of trademark or trade name under paragraph (b)(10)(i) of this section. (See §1.167(a)–14(c)(4) for applicable rules.) (8) Interests under leases of tangible property—(i) Interest as a lessor.Section 197 intangibles do not include any inter- est as a lessor under an existing lease or sublease of tangible real or personal prop- erty. In addition, the cost of acquiring an interest as a lessor in connection with the acquisition of tangible property is taken into account as part of the cost of the tan- gible property. For example, if a taxpayer acquires a shopping center that is leased to tenants operating retail stores, any por- tion of the purchase price attributable to favorable lease terms is taken into ac- count as part of the basis of the shopping center and in determining the depreciation deduction allowed with respect to the shopping center. (See section 167(c)(2).) (ii) Interest as a lessee. Section 197 in- tangibles do not include any interest as a lessee under an existing lease of tangible real or personal property. For this pur- pose, an airline lease of an airport passen- ger or cargo gate is a lease of tangible property. The cost of acquiring such an interest is taken into account under sec- tion 178 and §1.162–11(a). If an interest as a lessee under a lease of tangible prop- erty is acquired in a transaction with any other intangible property, a portion of the total purchase price may be allocable to the interest as a lessee based on all of the relevant facts and circumstances. (9) Interests under indebtedness—(i) In general. Section 197 intangibles do not include any interest (whether as a creditor or debtor) under an indebtedness in exis- tence when the interest was acquired. Thus, for example, the value attributable to the assumption of an indebtedness with a below-market interest rate is not amorti- zable under section 197. In addition, the premium paid for acquiring a debt instru- ment with an above-market interest rate is not amortizable under section 197. See section 171 for rules concerning the treat- ment of amortizable bond premium. (ii) Exceptions. For purposes of this paragraph (c)(9), an interest under an ex- isting indebtedness does not include the deposit base (and other similar items) of a financial institution. An interest under an existing indebtedness includes mortgage servicing rights, however, to the extent the rights are stripped coupons under sec- tion 1286. (10) Professional sports franchises. Section 197 intangibles do not include any franchise to engage in professional baseball, basketball, football, or any other professional sport, and any item (even though otherwise qualifying as a section 197 intangible) acquired in connection with such a franchise. (11) Mortgage servicing rights.Sec- tion 197 intangibles do not include any right described in section 197(e)(7) (con- cerning rights to service indebtedness se- cured by residential real property that are not acquired as part of a purchase of a trade or business). (See §1.167(a)–14(d) for applicable rules.) (12) Certain transaction costs. Section 197 intangibles do not include any fees for professional services and any transac- tion costs incurred by parties to a transac- tion in which all or any portion of the gain or loss is not recognized under part III of subchapter C of the Internal Revenue Code. (13) Rights of fixed duration or amount. (i) Section 197 intangibles do not include any right under a contract or any license, permit, or other right granted by a governmental unit if the right— (A) Is acquired in the ordinary course of a trade or business (or an activity de- scribed in section 212) and not as part of a purchase of a trade or business; (B) Is not described in section 197(d)(1)(A), (B), (E), or (F); (C) Is not a customer-based intangible, a customer-related information base, or any other similar item; and (D) Either— (1) Has a fixed duration of less than 15 years; or (2) Is fixed as to amount and the ad- justed basis thereof is properly recover- able (without regard to this section) under a method similar to the unit-of-production method. (ii) See §1.167(a)–14(c)(2) and (3) for applicable rules. (d) Amortizable section 197 intangi- bles—(1) Definition. Except as otherwise provided in this paragraph (d), the term amortizable section 197 intangiblemeans any section 197 intangible acquired after August 10, 1993 (or after July 25, 1991, if a valid retroactive election under §1.197–1T has been made), and held in connection with the conduct of a trade or business or an activity described in sec- tion 212. (2) Exception for self-created intangi- bles—(i) In general. Except as provided in paragraph (d)(2)(iii) of this section, amortizable section 197 intangibles do not include any section 197 intangible created by the taxpayer (a self-created in- tangible). (ii) Created by the taxpayer—(A) De- fined. A section 197 intangible is created by the taxpayer to the extent the taxpayer makes payments or otherwise incurs costs for its creation, production, development, or improvement, whether the actual work is performed by the taxpayer or by an- other person under a contract with the tax- payer entered into before the contracted creation, production, development, or im- provement occurs. For example, a tech- nological process developed specifically for a taxpayer under an arrangement with another person pursuant to which the tax- payer retains all rights to the process is created by the taxpayer. (B)Contracts for the use of intangibles. A section 197 intangible is not a self- created intangible to the extent that it results from the entry into (or re- newal of) a contract for the use of an ex- isting section 197 intangible. Thus, for example, the exception for self-created intangibles does not apply to capitalized costs, such as legal and other professional fees, incurred by a licensee in connection with the entry into (or renewal of) a con- tract for the use of know-how or similar property. (C) Improvements and modifications. If an existing section 197 intangible is im- proved or otherwise modified by the tax- payer or by another person under a con- tract with the taxpayer, the existing intangible and the capitalized costs (if any) of the improvements or other modifi- cations are each treated as a separate sec- tion 197 intangible for purposes of this paragraph (d). (iii) Exceptions. (A) The exception for self-created intangibles does not apply to any section 197 intangible described in section 197(d)(1)(D) (relating to licenses, permits or other rights granted by a gov- ernmental unit), 197(d)(1)(E) (relating to covenants not to compete), or 197(d)(1)(F) (relating to franchises, trade- marks, and trade names). Thus, for exam- ple, capitalized costs incurred in the de- velopment, registration, or defense of a trademark or trade name do not qualify for the exception and are amortized over 15 years under section 197. (B) The exception for self-created in- tangibles does not apply to any section 197 intangible created in connection with the purchase of a trade or business (as de- fined in paragraph (e) of this section). (C) If a taxpayer disposes of a self-cre- ated intangible and subsequently reac- quires the intangible in an acquisition de- scribed in paragraph (h)(5)(ii) of this section, the exception for self-created in- tangibles does not apply to the reacquired intangible. (3) Exception for property subject to anti-churning rules. Amortizable section 197 intangibles do not include any prop- erty to which the anti-churning rules of section 197(f)(9) and paragraph (h) of this section apply. (e) Purchase of a trade or business. Several of the exceptions in section 197 apply only to property that is not acquired in (or created in connection with) a trans- action or series of related transactions in- volving the acquisition of assets constitut- ing a trade or business or a substantial portion thereof. Property acquired in (or created in connection with) such a trans- action or series of related transactions is referred to in this section as property ac- quired as part of (or created in connection with) a purchase of a trade or business. For purposes of section 197 and this sec- tion, the applicability of the limitation is determined under the following rules: (1) Goodwill or going concern value. An asset or group of assets constitutes a trade or business or a substantial portion thereof if their use would constitute a trade or business under section 1060 (that is, if goodwill or going concern value could under any circumstances attach to the assets). See §1.1060–1T(b)(2). For this purpose, all the facts and circum- stances, including any employee relation- ships that continue (or covenants not to compete that are entered into) as part of the transfer of the assets, are taken into account in determining whether goodwill or going concern value could attach to the assets. (2) Franchise, trademark, or trade name—(i) In general.The acquisition of a franchise, trademark, or trade name con- stitutes the acquisition of a trade or busi- ness or a substantial portion thereof. (ii) Exceptions. For purposes of this paragraph (e)(2)— (A) A trademark or trade name is disre- garded if it is included in computer soft- ware under paragraph (c)(4) of this sec- tion or in an interest in a film, sound recording, video tape, book, or other simi- lar property under paragraph (c)(5) of this section; (B) A franchise, trademark, or trade name is disregarded if its value is nominal or the taxpayer irrevocably disposes of it immediately after its acquisition; and (C) The acquisition of a right or interest in a trademark or trade name is disre- garded if the grant of the right or interest is not, under the principles of section 1253, a transfer of all substantial rights to such property or of an undivided interest in all substantial rights to such property. (3) Acquisitions to be included. The assets acquired in a transaction (or series of related transactions) include only as- sets (including a beneficial or other indi- rect interest in assets where the interest is of a type described in paragraph (c)(1) of this section) acquired by the taxpayer and persons related to the taxpayer from an- other person and persons related to that other person. For purposes of this para- graph (e)(3), persons are related only if their relationship is described in section 267(b) or 707(b) or they are engaged in trades or businesses under common con- trol within the meaning of section 41(f)(1). (4) Substantial portion.The determi- nation of whether acquired assets consti- tute a substantial portion of a trade or business is to be based on all of the facts and circumstances, including the nature and the amount of the assets acquired as well as the nature and amount of the as- sets retained by the transferor. The value of the assets acquired relative to the value of the assets retained by the transferor is not determinative of whether the acquired assets constitute a substantial portion of a trade or business. (5) Deemed asset purchases under sec- tion 338.A qualified stock purchase that is treated as a purchase of assets under section 338 is treated as a transaction in- volving the acquisition of assets constitut- ing a trade or business only if the direct acquisition of the assets of the corporation would have been treated as the acquisition of assets constituting a trade or business or a substantial portion thereof. (6) Mortgage servicing rights. Mort- gage servicing rights acquired in a trans- action or series of related transactions are disregarded in determining for purposes of paragraph (c)(11) of this section whether the assets acquired in the transac- tion or transactions constitute a trade or business or substantial portion thereof. (7) Computer software acquired for in- ternal use.Computer software acquired in a transaction or series of related trans- actions solely for internal use in an exist- ing trade or business is disregarded in de- termining for purposes of paragraph (c)(4) of this section whether the assets acquired in the transaction or series of re- lated transactions constitute a trade or business or substantial portion thereof. (f) Computation of amortization deduc- tion—(1) In general. Except as provided in paragraph (f)(2) of this section, the amortization deduction allowable under section 197(a) is computed as follows: (i) The basis of an amortizable section 197 intangible is amortized ratably over the 15-year period beginning on the later of— (A) The first day of the month in which 2000–7 I.R.B.601February 14, 2000 the property is acquired; or (B) In the case of property held in con- nection with the conduct of a trade or business or in an activity described in sec- tion 212, the first day of the month in which the conduct of the trade or business or the activity begins. (ii) Except as otherwise provided in this section, basis is determined under section 1011 and salvage value is disre- garded. (iii) Property is not eligible for amorti- zation in the month of disposition. (iv) The amortization deduction for a short taxable year is based on the number of months in the short taxable year. (2) Treatment of contingent amounts— (i) Amounts added to basis during 15- year period. Any amount that is properly included in the basis of an amortizable section 197 intangible after the first month of the 15-year period described in paragraph (f)(1)(i) of this section and be- fore the expiration of that period is amor- tized ratably over the remainder of the 15- year period. For this purpose, the remainder of the 15-year period begins on the first day of the month in which the basis increase occurs. (ii) Amounts becoming fixed after expi- ration of 15-year period.Any amount that is not properly included in the basis of an amortizable section 197 intangible until after the expiration of the 15-year period described in paragraph (f)(1)(i) of this section is amortized in full immedi- ately upon the inclusion of the amount in the basis of the intangible. (iii) Rules for including amounts in basis.See §§1.1275–4(c)(4) and 1.483–4(a) for rules governing the extent to which contingent amounts payable under a debt instrument given in consider- ation for the sale or exchange of an amor- tizable section 197 intangible are treated as payments of principal and the time at which the amount treated as principal is included in basis. See §1.461–1(a)(1) and (2) for rules governing the time at which other contingent amounts are taken into account in determining the basis of an amortizable section 197 intangible. (3) Basis determinations for certain as- sets—(i) Covenants not to compete. In the case of a covenant not to compete or other similar arrangement described in paragraph (b)(9) of this section (a covenant), the amount chargeable to capi- tal account includes, except as provided in this paragraph (f)(3), all amounts that are required to be paid pursuant to the covenant, whether or not any such amount would be deductible under sec- tion 162 if the covenant were not a section 197 intangible. (ii) Contracts for the use of section 197 intangibles; acquired as part of a trade or business—(A) In general. Except as pro- vided in this paragraph (f)(3), any amount paid or incurred by the transferee on ac- count of the transfer of a right or term in- terest described in paragraph (b)(11) of this section (relating to contracts for the use of, and term interests in, section 197 intangibles) by the owner of the property to which such right or interest relates and as part of a purchase of a trade or business is chargeable to capital account, whether or not such amount would be deductible under section 162 if the property were not a section 197 intangible. (B) Know-how and certain information base. The amount chargeable to capital account with respect to a right or term in- terest described in paragraph (b)(11) of this section is determined without regard to the rule in paragraph (f)(3)(ii)(A) of this section if the right or interest relates to property (other than a customer-related information base) described in paragraph (b)(4) or (5) of this section and the acquir- ing taxpayer establishes that— (1) The transfer of the right or interest is not, under the principles of section 1235, a transfer of all substantial rights to such property or of an undivided interest in all substantial rights to such property; and (2) The right or interest was transferred for an arm’s-length consideration. (iii) Contracts for the use of section 197 intangibles; not acquired as part of a trade or business. The transfer of a right or term interest described in paragraph (b)(11) of this section by the owner of the property to which such right or interest re- lates but not as part of a purchase of a trade or business will be closely scruti- nized under the principles of section 1235 for purposes of determining whether the transfer is a sale or exchange and, accord- ingly, whether amounts paid on account of the transfer are chargeable to capital account. If under the principles of section 1235 the transaction is not a sale or ex- change, amounts paid on account of the transfer are not chargeable to capital ac- count under this paragraph (f)(3). (iv) Applicable rules—(A) Franchises, trademarks, and trade names. For pur- poses of this paragraph (f)(3), section 197 intangibles described in paragraph (b)(11) of this section do not include any property that is also described in paragraph (b)(10) of this section (relating to franchises, trademarks, and trade names). (B) Certain amounts treated as payable under a debt instrument—(1) In general. For purposes of applying any provision of the Internal Revenue Code to a person making payments of amounts that are oth- erwise chargeable to capital account under this paragraph (f)(3) and are payable after the acquisition of the section 197 intangible to which they relate, such amounts are treated as payable under a debt instrument given in consideration for the sale or exchange of the section 197 in- tangible. (2) Rights granted by governmental units. For purposes of applying any pro- vision of the Internal Revenue Code to any amounts that are otherwise charge- able to capital account with respect to a li- cense, permit, or other right described in paragraph (b)(8) of this section (relating to rights granted by a governmental unit or agency or instrumentality thereof) and are payable after the acquisition of the section 197 intangible to which they re- late, such amounts are treated, except as provided in paragraph (f)(4)(i) of this sec- tion (relating to renewal transactions), as payable under a debt instrument given in consideration for the sale or exchange of the section 197 intangible. (3) Treatment of other parties to trans- action. No person shall be treated as hav- ing sold, exchanged, or otherwise dis- posed of property in a transaction for purposes of any provision of the Internal Revenue Code solely by reason of the ap- plication of this paragraph (f)(3) to any other party to the transaction. (4) Basis determinations in certain transactions—(i ) Certain renewal trans- actions. The costs paid or incurred for the renewal of a franchise, trademark, or trade name or any license, permit, or other right granted by a governmental unit or an agency or instrumentality thereof are amortized over the 15-year period that be- gins with the month of renewal. Any costs paid or incurred for the issuance, or February 14, 20006022000–7 I.R.B. earlier renewal, continue to be taken into account over the remaining portion of the amortization period that began at the time of the issuance, or earlier renewal. Any amount paid or incurred for the protec- tion, expansion, or defense of a trademark or trade name and chargeable to capital account is treated as an amount paid or in- curred for a renewal. (ii) Transactions subject to section 338 or 1060. In the case of a section 197 in- tangible deemed to have been acquired as the result of a qualified stock purchase within the meaning of section 338(d)(3), the basis shall be determined pursuant to section 338(b)(5) and the regulations thereunder. In the case of a section 197 intangible acquired in an applicable asset acquisition within the meaning of section 1060(c), the basis shall be determined pursuant to section 1060(a) and the regu- lations thereunder. (iii) Certain reinsurance transactions. See paragraph (g)(5)(ii) of this section for special rules regarding the adjusted basis of an insurance contract acquired through an assumption reinsurance transaction. (g) Special rules—(1) Treatment of certain dispositions—(i) Loss disal- lowance rules—(A) In general. No loss is recognized on the disposition of an amortizable section 197 intangible if the taxpayer has any retained intangibles. The retained intangibles with respect to the disposition of any amortizable section 197 intangible (the transferred intangible) are all amortizable section 197 intangi- bles, or rights to use or interests (includ- ing beneficial or other indirect interests) in amortizable section 197 intangibles (in- cluding the transferred intangible) that were acquired in the same transaction or series of related transactions as the trans- ferred intangible and are retained after its disposition. Except as otherwise pro- vided in paragraph (g)(1)(iv)(B) of this section, the adjusted basis of each of the retained intangibles is increased by the product of— (1) The loss that is not recognized solely by reason of this rule; and (2) A fraction, the numerator of which is the adjusted basis of the retained intan- gible on the date of the disposition and the denominator of which is the total adjusted bases of all the retained intangibles on that date. (B) Abandonment or worthlessness. The abandonment of an amortizable sec- tion 197 intangible, or any other event rendering an amortizable section 197 in- tangible worthless, is treated as a disposi- tion of the intangible for purposes of this paragraph (g)(1), and the abandoned or worthless intangible is disregarded (that is, it is not treated as a retained intangible) for purposes of applying this paragraph (g)(1) to the subsequent disposition of any other amortizable section 197 intangible. (C) Certain nonrecognition transfers. The loss disallowance rule in paragraph (g)(1)(i)(A) of this section also applies when a taxpayer transfers an amortizable section 197 intangible from an acquired trade or business in a transaction in which the intangible is transferred basis property and, after the transfer, retains other amor- tizable section 197 intangibles from the trade or business. Thus, for example, the transfer of an amortizable section 197 in- tangible to a corporation in exchange for stock in the corporation in a transaction described in section 351, or to a partner- ship in exchange for an interest in the partnership in a transaction described in section 721, when other amortizable sec- tion 197 intangibles acquired in the same transaction are retained, followed by a sale of the stock or partnership interest re- ceived, will not avoid the application of the loss disallowance provision to the ex- tent the adjusted basis of the transferred intangible at the time of the sale exceeds its fair market value at that time. (ii) Separately acquired property. Paragraph (g)(1)(i) of this section does not apply to an amortizable section 197 intangible that is not acquired in a trans- action or series of related transactions in which the taxpayer acquires other amorti- zable section 197 intangibles (a separately acquired intangible). Consequently, a loss may be recognized upon the disposi- tion of a separately acquired amortizable section 197 intangible. However, the ter- mination or worthlessness of only a por- tion of an amortizable section 197 intan- gible is not the disposition of a separately acquired intangible. For example, neither the loss of several customers from an ac- quired customer list nor the worthlessness of only some information from an ac- quired data base constitutes the disposi- tion of a separately acquired intangible. (iii) Disposition of a covenant not to compete. If a covenant not to compete or any other arrangement having substan- tially the same effect is entered into in connection with the direct or indirect ac- quisition of an interest in one or more trades or businesses, the disposition or worthlessness of the covenant or other arrangement will not be considered to occur until the disposition or worthless- ness of all interests in those trades or busi- nesses. For example, a covenant not to compete entered into in connection with the purchase of stock continues to be amortized ratably over the 15-year recov- ery period (even after the covenant ex- pires or becomes worthless) unless all the trades or businesses in which an interest was acquired through the stock purchase (or all the purchaser’s interests in those trades or businesses) also are disposed of or become worthless. (iv) Taxpayers under common control—(A) In general.Except as pro- vided in paragraph (g)(1)(iv)(B) of this section, all persons that would be treated as a single taxpayer under section 41(f)(1) are treated as a single taxpayer under this paragraph (g)(1). Thus, for example, a loss is not recognized on the disposition of an amortizable section 197 intangible by a member of a controlled group of cor- porations (as defined in section 41(f)(5)) if, after the disposition, another member retains other amortizable section 197 in- tangibles acquired in the same transaction as the amortizable section 197 intangible that has been disposed of. (B) Treatment of disallowed loss. If re- tained intangibles are held by a person other than the person incurring the disal- lowed loss, only the adjusted basis of in- tangibles retained by the person incurring the disallowed loss is increased, and only the adjusted basis of those intangibles is included in the denominator of the frac- tion described in paragraph (g)(1)(i)(A) of this section. If none of the retained intan- gibles are held by the person incurring the disallowed loss, the loss is allowed rat- ably, as a deduction under section 197, over the remainder of the period during which the intangible giving rise to the loss would have been amortizable, except that any remaining disallowed loss is allowed in full on the first date on which all other retained intangibles have been disposed of or become worthless. (2) Treatment of certain nonrecognition and exchange transactions—(i) Relation- 2000–7 I.R.B.603February 14, 2000 ship to anti-churning rules. This para- graph (g)(2) provides rules relating to the treatment of section 197 intangibles ac- quired in certain transactions. If these rules apply to a section 197(f)(9) intangi- ble (within the meaning of paragraph (h)(1)(i) of this section), the intangible is, notwithstanding its treatment under this paragraph (g)(2), treated as an amortiz- able section 197 intangible only to the ex- tent permitted under paragraph (h) of this section. (ii) Treatment of nonrecognition and exchange transactions generally—(A) Transfer disregarded. If a section 197 in- tangible is transferred in a transaction de- scribed in paragraph (g)(2)(ii)(C) of this section, the transfer is disregarded in de- termining— (1) Whether, with respect to so much of the intangible’s basis in the hands of the transferee as does not exceed its basis in the hands of the transferor, the intangible is an amortizable section 197 intangible; and (2) The amount of the deduction under section 197 with respect to such basis. (B) Application of general rule. If the intangible described in paragraph (g)(2)(ii)(A) of this section was an amor- tizable section 197 intangible in the hands of the transferor, the transferee will con- tinue to amortize its adjusted basis, to the extent it does not exceed the transferor’s adjusted basis, ratably over the remainder of the transferor’s 15-year amortization period. If the intangible was not an amor- tizable section 197 intangible in the hands of the transferor, the transferee’s adjusted basis, to the extent it does not exceed the transferor’s adjusted basis, cannot be amortized under section 197. In either event, the intangible is treated, with re- spect to so much of its adjusted basis in the hands of the transferee as exceeds its adjusted basis in the hands of the trans- feror, in the same manner for purposes of section 197 as an intangible acquired from the transferor in a transaction that is not described in paragraph (g)(2)(ii)(C) of this section. The rules of this paragraph (g)(2)(ii) also apply to any subsequent transfers of the intangible in a transaction described in paragraph (g)(2)(ii)(C) of this section. (C) Transactions covered. The transac- tions described in this paragraph (g)(2)(ii)(C) are— (1) Any transaction described in section 332, 351, 361, 721, or 731; and (2) Any transaction between corpora- tions that are members of the same con- solidated group immediately after the transaction. (iii) Certain exchanged-basis property. This paragraph (g)(2)(iii) applies to prop- erty that is acquired in a transaction sub- ject to section 1031 or 1033 and is permit- ted to be acquired without recognition of gain (replacement property). Replace- ment property is treated as if it were the property by reference to which its basis is determined (the predecessor property) in determining whether, with respect to so much of its basis as does not exceed the basis of the predecessor property, the re- placement property is an amortizable sec- tion 197 intangible and the amortization period under section 197 with respect to such basis. Thus, if the predecessor prop- erty was an amortizable section 197 intan- gible, the taxpayer will amortize the ad- justed basis of the replacement property, to the extent it does not exceed the ad- justed basis of the predecessor property, ratably over the remainder of the 15-year amortization period for the predecessor property. If the predecessor property was not an amortizable section 197 intangible, the adjusted basis of the replacement property, to the extent it does not exceed the adjusted basis of the predecessor property, may not be amortized under sec- tion 197. In either event, the replacement property is treated, with respect to so much of its adjusted basis as exceeds the adjusted basis of the predecessor prop- erty, in the same manner for purposes of section 197 as property acquired from the transferor in a transaction that is not sub- ject to section 1031 or 1033. (iv) Transfers under section 708(b)(1)—(A) In general. Paragraph (g)(2)(ii) of this section applies to trans- fers of section 197 intangibles that occur or are deemed to occur by reason of the termination of a partnership under section 708(b)(1). (B) Termination by sale or exchange of interest. In applying paragraph (g)(2)(ii) of this section to a partnership that is ter- minated pursuant to section 708(b)(1)(B) (relating to deemed terminations from the sale or exchange of an interest), the termi- nated partnership is treated as the trans- feror and the new partnership is treated as the transferee with respect to any section 197 intangible held by the terminated partnership immediately preceding the termination. (See paragraph (g)(3) of this section for the treatment of increases in the bases of property of the terminated partnership under section 743(b).) (C) Other terminations. In applying paragraph (g)(2)(ii) of this section to a partnership that is terminated pursuant to section 708(b)(1)(A) (relating to cessation of activities by a partnership), the termi- nated partnership is treated as the trans- feror and the distributee partner is treated as the transferee with respect to any sec- tion 197 intangible held by the terminated partnership immediately preceding the termination. (3)Increase in the basis of partnership property under section 732(b), 734(b), 743(b), or 732(d). Any increase in the ad- justed basis of a section 197 intangible under sections 732(b) or 732(d) (relating to a partner’s basis in property distributed by a partnership), section 734(b) (relating to the optional adjustment to the basis of undistributed partnership property after a distribution of property to a partner), or section 743(b) (relating to the optional ad- justment to the basis of partnership prop- erty after transfer of a partnership inter- est) is treated as a separate section 197 intangible. For purposes of determining the amortization period under section 197 with respect to the basis increase, the in- tangible is treated as having been ac- quired at the time of the transaction that causes the basis increase. The provisions of paragraph (f)(2) of this section apply to the extent that the amount of the basis in- crease is determined by reference to con- tingent payments. For purposes of the ef- fective date and anti-churning provisions (paragraphs (l)(1) and (h) of this section) for a basis increase under section 732(d), the intangible is treated as having been acquired by the transferee partner at the time of the transfer of the partnership in- terest described in section 732(d). (4) Section 704(c) allocations—(i) Al- locations where the intangible is amortiz- able by the contributor. To the extent that the intangible was an amortizable section 197 intangible in the hands of the con- tributing partner, a partnership may make allocations of amortization deductions with respect to the intangible to all of its partners under either the curative or reme- February 14, 20006042000–7 I.R.B. dial allocation methods described in the regulations under section 704(c). See §1.704–3(c) and (d). (ii) Allocations where the intangible is not amortizable by the contributor.To the extent that the intangible was not an amortizable section 197 intangible in the hands of the contributing partner, the in- tangible is not amortizable by the partner- ship. However, if a partner contributes a section 197 intangible to a partnership and the partnership adopts the remedial allocation method for making section 704(c) allocations of amortization deduc- tions, the partnership generally may make remedial allocations of amortization de- ductions with respect to the contributed section 197 intangible in accordance with § 1.704–3(d). See paragraph (h)(12) of this section to determine the application of the anti-churning rules in the context of remedial allocations. (5) Treatment of certain reinsurance transactions—(i) In general.Section 197 applies to any insurance contract acquired from another person through an assump- tion reinsurance transaction. For pur- poses of section 197, an assumption rein- surance transaction is— (A) Any arrangement in which one in- surance company (the reinsurer) becomes solely liable to policyholders on contracts transferred by another insurance company (the ceding company); and (B) Any acquisition of an insurance contract that is treated as occurring by reason of an election under section 338. (ii) Determination of adjusted basis— (A) Acquisitions (other than under sec- tion 338) of specified insurance contracts. The amount taken into account for pur- poses of section 197 as the adjusted basis of specified insurance contracts (as de- fined in section 848(e)(1)) acquired in an assumption reinsurance transaction that is not described in paragraph (g)(5)(i)(B) of this section is equal to the excess of— (1) The amount paid or incurred (or treated as having been paid or incurred) by the reinsurer for the purchase of the contracts (as determined under §1.817–4(d)(2)); over (2) The amount of the specified policy acquisition expenses that are attributable to the reinsurer’s net positive considera- tion for the reinsurance agreement (as de- termined under §1.848–2(f)(3)). (B) Insolvent ceding company.The re- duction of the amount of specified policy acquisition expenses by the reinsurer with respect to an assumption reinsurance transaction with an insolvent ceding com- pany where the ceding company and rein- surer have made a valid joint election under section 1.848–2(i)(4) is disregarded in determining the amount of specified policy acquisition expenses for purposes of this paragraph (g)(5)(ii). (C) Other acquisitions. [Reserved] (6) Amounts paid or incurred for a franchise, trademark, or trade name. If an amount to which section 1253(d) (re- lating to the transfer, sale, or other dispo- sition of a franchise, trademark, or trade name) applies is described in section 1253(d)(1)(B) (relating to contingent ser- ial payments deductible under section 162), the amount is not included in the ad- justed basis of the intangible for purposes of section 197. Any other amount, whether fixed or contingent, to which sec- tion 1253(d) applies is chargeable to capi- tal account under section 1253(d)(2) and is amortizable only under section 197. (7) Amounts properly taken into ac- count in determining the cost of property that is not a section 197 intangible. Sec- tion 197 does not apply to an amount that is properly taken into account in deter- mining the cost of property that is not a section 197 intangible. The entire cost of acquiring the other property is included in its basis and recovered under other applic- able Internal Revenue Code provisions. Thus, for example, section 197 does not apply to the cost of an interest in com- puter software to the extent such cost is included, without being separately stated, in the cost of the hardware or other tangi- ble property and is consistently treated as part of the cost of the hardware or other tangible property. (8) Treatment of amortizable section 197 intangibles as depreciable property. An amortizable section 197 intangible is treated as property of a character subject to the allowance for depreciation under section 167. Thus, for example, an amor- tizable section 197 intangible is not a cap- ital asset for purposes of section 1221, but if used in a trade or business and held for more than one year, gain or loss on its dis- position generally qualifies as section 1231 gain or loss. Also, an amortizable section 197 intangible is section 1245 property and section 1239 applies to any gain recognized upon its sale or exchange between related persons (as defined in section 1239(b)). (h) Anti-churning rules—(1) Scope and purpose—(i) Scope. This paragraph (h) applies to section 197(f)(9) intangibles. For this purpose, section 197(f)(9) intan- gibles are goodwill and going concern value that was held or used at any time during the transition period and any other section 197 intangible that was held or used at any time during the transition pe- riod and was not depreciable or amortiz- able under prior law. (ii) Purpose. To qualify as an amortiz- able section 197 intangible, a section 197 intangible must be acquired after the ap- plicable date (July 25, 1991, if the acquir- ing taxpayer has made a valid retroactive election pursuant to §1.197–1T; August 10, 1993, in all other cases). The purpose of the anti-churning rules of section 197(f)(9) and this paragraph (h) is to pre- vent the amortization of section 197(f)(9) intangibles unless they are transferred after the applicable effective date in a transaction giving rise to a significant change in ownership or use. (Special rules apply for purposes of determining whether transactions involving partner- ships give rise to a significant change in ownership or use. See paragraph (h)(12) of this section.) The anti-churning rules are to be applied in a manner that carries out their purpose. (2) Treatment of section 197(f)(9) in- tangibles.Except as otherwise provided in this paragraph (h), a section 197(f)(9) intangible acquired by a taxpayer after the applicable effective date does not qualify for amortization under section 197 if— (i) The taxpayer or a related person held or used the intangible or an interest therein at any time during the transition period; (ii) The taxpayer acquired the intangi- ble from a person that held the intangible at any time during the transition period and, as part of the transaction, the user of the intangible does not change; or (iii) The taxpayer grants the right to use the intangible to a person that held or used the intangible at any time during the tran- sition period (or to a person related to that person), but only if the transaction in which the taxpayer grants the right and the transaction in which the taxpayer ac- quired the intangible are part of a series of 2000–7 I.R.B.605February 14, 2000 related transactions. (3) Amounts deductible under section 1253(d) or §1.162–11. For purposes of this paragraph (h), deductions allowable under section 1253(d)(2) or pursuant to an election under section 1253(d)(3) (in ei- ther case as in effect prior to the enact- ment of section 197) and deductions al- lowable under §1.162–11 are treated as deductions allowable for amortization under prior law. (4) Transition period. For purposes of this paragraph (h), the transition period is July 25, 1991, if the acquiring taxpayer has made a valid retroactive election pur- suant to §1.197–1T and the period begin- ning on July 25, 1991, and ending on Au- gust 10, 1993, in all other cases. (5) Exceptions. The anti-churning rules of this paragraph (h) do not apply to— (i) The acquisition of a section 197(f)(9) intangible if the acquiring tax- payer’s basis in the intangible is deter- mined under section 1014(a); or (ii) The acquisition of a section 197(f)(9) intangible that was an amortiz- able section 197 intangible in the hands of the seller (or transferor), but only if the acquisition transaction and the transaction in which the seller (or transferor) acquired the intangible or interest therein are not part of a series of related transactions. (6) Related person—(i) In general. Except as otherwise provided in para- graph (h)(6)(ii) of this section, a person is related to another person for purposes of this paragraph (h) if— (A) The person bears a relationship to that person that would be specified in sec- tion 267(b) (determined without regard to section 267(e)) and, by substitution, sec- tion 267(f)(1), if those sections were amended by substituting 20 percent for 50 percent; or (B) The person bears a relationship to that person that would be specified in sec- tion 707(b)(1) if that section were amended by substituting 20 percent for 50 percent; or (C) The persons are engaged in trades or businesses under common control (within the meaning of section 41(f)(1)(A) and (B)). (ii) Time for testing relationships. Ex- cept as provided in paragraph (h)(6)(iii) of this section, a person is treated as re- lated to another person for purposes of this paragraph (h) if the relationship ex- ists— (A) In the case of a single transaction, immediately before or immediately after the transaction in which the intangible is acquired; and (B) In the case of a series of related transactions (or a series of transactions that together comprise a qualified stock purchase within the meaning of section 338(d)(3)), immediately before the earli- est such transaction or immediately after the last such transaction. (iii) Certain relationships disregarded. In applying the rules in paragraph (h)(7) of this section, if a person acquires an in- tangible in a series of related transactions in which the person acquires stock (meet- ing the requirements of section 1504(a)(2)) of a corporation in a fully tax- able transaction followed by a liquidation of the acquired corporation under section 331, any relationship created as part of such series of transactions is disregarded in determining whether any person is re- lated to such acquired corporation imme- diately after the last transaction. (iv) De minimis rule—(A) In general. Two corporations are not treated as re- lated persons for purposes of this para- graph (h) if— (1) The corporations would (but for the application of this paragraph (h)(6)(iv)) be treated as related persons solely by rea- son of substituting “more than 20 per- cent” for “more than 50 percent” in sec- tion 267(f)(1)(A); and (2) The beneficial ownership interest of each corporation in the stock of the other corporation represents less than 10 percent of the total combined voting power of all classes of stock entitled to vote and less than 10 percent of the total value of the shares of all classes of stock outstanding. (B)Determination of beneficial owner- ship interest. For purposes of this para- graph (h)(6)(iv), the beneficial ownership interest of one corporation in the stock of another corporation is determined under the principles of section 318(a), except that— (1) In applying section 318(a)(2)(C), the 50-percent limitation contained therein is not applied; and (2) Section 318(a)(3)(C) is applied by substituting “20 percent” for “50 per- cent”. (7) Special rules for entities that owned or used property at any time during the transition period and that are no longer in existence.A corporation, partnership, or trust that owned or used a section 197 intangible at any time during the transi- tion period and that is no longer in exis- tence is deemed, for purposes of deter- mining whether a taxpayer acquiring the intangible is related to such entity, to be in existence at the time of the acquisition. (8) Special rules for section 338 deemed acquisitions. In the case of a qualified stock purchase that is treated as a deemed sale and purchase of assets pur- suant to section 338, the corporation treated as purchasing assets as a result of an election thereunder (new target) is not considered the person that held or used the assets during any period in which the assets were held or used by the corpora- tion treated as selling the assets (old tar- get). Thus, for example, if a corporation (the purchasing corporation) makes a qualified stock purchase of the stock of another corporation after the transition period, new target will not be treated as the owner during the transition period of assets owned by old target during that pe- riod even if old target and new target are treated as the same corporation for certain other purposes of the Internal Revenue Code or old target and new target are the same corporation under the laws of the State or other jurisdiction of its organiza- tion. However, the anti-churning rules of this paragraph (h) may nevertheless apply to a deemed asset purchase resulting from a section 338 election if new target is re- lated (within the meaning of paragraph (h)(6) of this section) to old target. (9) Gain-recognition exception—(i) Applicability.A section 197(f)(9) intangi- ble qualifies for the gain-recognition ex- ception if— (A) The taxpayer acquires the intangi- ble from a person that would not be re- lated to the taxpayer but for the substitu- tion of 20 percent for 50 percent under paragraph (h)(6)(i)(A) of this section; and (B) That person (whether or not other- wise subject to Federal income tax) elects to recognize gain on the disposition of the intangible and agrees, notwithstanding any other provision of law or treaty, to pay for the taxable year in which the dis- position occurs an amount of tax on the gain that, when added to any other Fed- eral income tax on such gain, equals the gain on the disposition multiplied by the February 14, 20006062000–7 I.R.B. highest marginal rate of tax for that tax- able year. (ii) Effect of exception. The anti-churn- ing rules of this paragraph (h) apply to a section 197(f)(9) intangible that qualifies for the gain-recognition exception only to the extent the acquiring taxpayer’s basis in the intangible exceeds the gain recog- nized by the transferor. (iii) Time and manner of election.The election described in this paragraph (h)(9) must be made by the due date (including extensions of time) of the electing tax- payer’s Federal income tax return for the taxable year in which the disposition oc- curs. The election is made by attaching an election statement satisfying the re- quirements of paragraph (h)(9)(viii) of this section to the electing taxpayer’s original or amended income tax return for that taxable year (or by filing the state- ment as a return for the taxable year under paragraph (h)(9)(xi) of this section). In addition, the taxpayer must satisfy the no- tification requirements of paragraph (h)(9)(vi) of this section. The election is binding on the taxpayer and all parties whose Federal tax liability is affected by the election. (iv) Special rules for certain entities. In the case of a partnership, S corporation, estate or trust, the election under this paragraph (h)(9) is made by the entity rather than by its owners or beneficiaries. If a partnership or S corporation makes an election under this paragraph (h)(9) with respect to the disposition of a section 197(f)(9) intangible, each of its partners or shareholders is required to pay a tax determined in the manner described in paragraph (h)(9)(i)(B) of this section on the amount of gain that is properly alloca- ble to such partner or shareholder with re- spect to the disposition. (v) Effect of nonconforming elections. An attempted election that does not sub- stantially comply with each of the re- quirements of this paragraph (h)(9) is dis- regarded in determining whether a section 197(f)(9) intangible qualifies for the gain- recognition exception. (vi) Notification requirements. A tax- payer making an election under this para- graph (h)(9) with respect to the disposi- tion of a section 197(f)(9) intangible must provide written notification of the elec- tion on or before the due date of the return on which the election is made to the per- son acquiring the section 197 intangible. In addition, a partnership or S corporation making an election under this paragraph (h)(9) must attach to the Schedule K-1 furnished to each partner or shareholder a written statement containing all informa- tion necessary to determine the recipient’s additional tax liability under this para- graph (h)(9). (vii) Revocation. An election under this paragraph (h)(9) may be revoked only with the consent of the Commissioner. (viii) Election Statement.An election statement satisfies the requirements of this paragraph (h)(9)(viii) if it is in writ- ing and contains the information listed below. The required information should be arranged and identified in accordance with the following order and numbering system: (A) The name and address of the elect- ing taxpayer. (B) Except in the case of a taxpayer that is not otherwise subject to Federal in- come tax, the taxpayer identification number (TIN) of the electing taxpayer. (C) A statement that the taxpayer is making the election under section 197(f)(9)(B). (D) Identification of the transaction and each person that is a party to the transac- tion or whose tax return is affected by the election (including, except in the case of persons not otherwise subject to Federal income tax, the TIN of each such person). (E) The calculation of the gain realized, the applicable rate of tax, and the amount of the taxpayer’s additional tax liability under this paragraph (h)(9). (F) The signature of the taxpayer or an individual authorized to sign the tax- payer’s Federal income tax return. (ix) Determination of highest marginal rate of tax and amount of other Federal income tax on gain—(A) Marginal rate. The following rules apply for purposes of determining the highest marginal rate of tax applicable to an electing taxpayer: (1) Noncorporate taxpayers. In the case of an individual, estate, or trust, the highest marginal rate of tax is the highest marginal rate of tax in effect under sec- tion 1, determined without regard to sec- tion 1(h). (2) Corporations and tax-exempt enti- ties. In the case of a corporation or an en- tity that is exempt from tax under section 501(a), the highest marginal rate of tax is the highest marginal rate of tax in effect under section 11, determined without re- gard to any rate that is added to the other- wise applicable rate in order to offset the effect of the graduated rate schedule. (B) Other Federal income tax on gain. The amount of Federal income tax (other than the tax determined under this para- graph (h)(9)) imposed on any gain is the lesser of— (1) The amount by which the tax- payer’s Federal income tax liability (de- termined without regard to this paragraph (h)(9)) would be reduced if the amount of such gain were not taken into account; or (2) The amount of the gain multiplied by the highest marginal rate of tax for the taxable year. (x) Coordination with other provisions—(A) In general. The amount of gain subject to the tax determined under this paragraph (h)(9) is not reduced by any net operating loss deduction under section 172(a), any capital loss under sec- tion 1212, or any other similar loss or de- duction. In addition, the amount of tax determined under this paragraph (h)(9) is not reduced by any credit of the taxpayer. In computing the amount of any net oper- ating loss, capital loss, or other similar loss or deduction, or any credit that may be carried to any taxable year, any gain subject to the tax determined under this paragraph (h)(9) and any tax paid under this paragraph (h)(9) is not taken into ac- count. (B) Section 1374. No provision of paragraph (h)(9)(iv) of this section pre- cludes the application of section 1374 (re- lating to a tax on certain built-in gains of S corporations) to any gain with respect to which an election under this paragraph (h)(9) is made. In addition, neither para- graph (h)(9)(iv) nor paragraph (h)(9)(x)(A) of this section precludes a taxpayer from applying the provisions of section 1366(f)(2) (relating to treatment of the tax imposed by section 1374 as a loss sustained by the S corporation) in de- termining the amount of tax payable under paragraph (h)(9) of this section. (C) Procedural and administrative pro- visions. For purposes of subtitle F, the amount determined under this paragraph (h)(9) is treated as a tax imposed by sec- tion 1 or 11, as appropriate. (D) Installment method. The gain sub- ject to the tax determined under paragraph 2000–7 I.R.B.607February 14, 2000 (h)(9)(i) of this section may not be re- ported under the method described in sec- tion 453(a). Any such gain that would, but for the application of this paragraph (h)(9)(x)(D), be taken into account under section 453(a) shall be taken into account in the same manner as if an election under section 453(d) (relating to the election not to apply section 453(a)) had been made. (xi) Special rules for persons not other- wise subject to Federal income tax. If the person making the election under this para- graph (h)(9) with respect to a disposition is not otherwise subject to Federal income tax, the election statement satisfying the re- quirements of paragraph (h)(9)(viii) of this section must be filed with the Philadelphia Service Center. For purposes of this para- graph (h)(9) and subtitle F, the statement is treated as an income tax return for the cal- endar year in which the disposition occurs and as a return due on or before March 15 of the following year. (10) Transactions subject to both anti- churning and nonrecognition rules. If a person acquires a section 197(f)(9) intan- gible in a transaction described in para- graph (g)(2) of this section from a person in whose hands the intangible was an amortizable section 197 intangible, and immediately after the transaction (or se- ries of transactions described in paragraph (h)(6)(ii)(B) of this section) in which such intangible is acquired, the person acquir- ing the section 197(f)(9) intangible is re- lated to any person described in paragraph (h)(2) of this section, the intangible is, notwithstanding its treatment under para- graph (g)(2) of this section, treated as an amortizable section 197 intangible only to the extent permitted under this paragraph (h). (See, for example, paragraph (h)(5)(ii) of this section.) (11) Avoidance purpose. A section 197(f)(9) intangible acquired by a tax- payer after the applicable effective date does not qualify for amortization under section 197 if one of the principal pur- poses of the transaction in which it is ac- quired is to avoid the operation of the anti-churning rules of section 197(f)(9) and this paragraph (h). A transaction will be presumed to have a principal purpose of avoidance if it does not effect a signifi- cant change in the ownership or use of the intangible. Thus, for example, if section 197(f)(9) intangibles are acquired in a transaction (or series of related transac- tions) in which an option to acquire stock is issued to a party to the transaction, but the option is not treated as having been exercised for purposes of paragraph (h)(6) of this section, this paragraph (h)(11) may apply to the transaction. (12) Additional partnership anti-churn- ing rules—(i) In general. In determining whether the anti-churning rules of this paragraph (h) apply to any increase in the basis of a section 197(f)(9) intangible under section 732(b), 732(d), 734(b), or 743(b), the determinations are made at the partner level and each partner is treated as having owned and used the partner’s pro- portionate share of partnership property. In determining whether the anti-churning rules of this paragraph (h) apply to any transaction under another section of the Internal Revenue Code, the determina- tions are made at the partnership level, unless under §1.701–2(e) the Commis- sioner determines that the partner level is more appropriate. (ii) Section 732(b) adjustments—Re- served. (iii) Section 732(d) adjustments. The anti-churning rules of this paragraph (h) do not apply to an increase in the basis of partnership property under section 732(d) if the distributee partner was not related (at the time of the transfer of the partner- ship interest) to the person who trans- ferred the partnership interest with respect to which the distribution is being made. (iv) Section 734(b) adjustments— Re- served. (v) Section 743(b) adjustments. The anti-churning rules of this paragraph (h) do not apply to an increase in the basis of partnership property under section 743(b) if the person acquiring the partnership in- terest is not related to the person transfer- ring the partnership interest. (vi) Partner is or becomes a user of partnership intangible—(A) General rule. If, as part of a series of related trans- actions that includes a transaction de- scribed in paragraph (h)(12) (iii) or (v) of this section, an anti-churning partner or a person related to an anti-churning partner becomes (or remains) a user of an intangi- ble that is treated as transferred in the transaction (as a result of the partners being treated as having owned their pro- portionate share of partnership assets), the anti-churning rules of this paragraph (h) apply to the proportionate share of such intangible that is treated as transferred by the anti-churning partner, notwithstanding the application of paragraph (h)(12) (iii) or (v) of this section. (B) Anti-churning partner. For pur- poses of this paragraph (h)(12)(vi), anti- churning partner means - - (1) With respect to all intangibles held by a partnership on or before August 10, 1993, any partner, but only to the extent that (i) The partner’s interest in the partner- ship was acquired on or before August 10, 1993, or (ii) The interest was acquired from a person related to the partner on or after August 10, 1993, and such interest was not held by any person other than persons related to such partner at any time after August 10, 1993 (disregarding, for this purpose, a person’s holding of an interest if the acquisition of such interest was part of a transaction or series of related trans- actions in which the partner or persons re- lated to the partner subsequently acquired such interest), (2) With respect to any section 197(f)(9) intangible acquired by a part- nership after August 10, 1993, that is not amortizable with respect to the partner- ship, any partner, but only to the extent that (i) The partner’s interest in the partner- ship was acquired on or before the date the partnership acquired the section 197(f)(9) intangible, or (ii) The interest was acquired from a person related to the partner on or after the date the partnership acquired the sec- tion 197(f)(9) intangible, and such inter- est was not held by any person other than persons related to such partner at any time after the date the partnership acquired the section 197(f)(9) intangible (disregarding, for this purpose, a person’s holding of an interest if the acquisition of such interest was part of a transaction or series of re- lated transactions in which the partner or persons related to the partner subse- quently acquired such interest), and (3) With respect to any intangible, a partner who received an interest in the partnership in exchange for such intangi- ble (or a portion thereof) or a related per- son who received such interest in the part- nership from such a partner, but only to the extent that the intangible (or portion thereof) transferred by such partner is not an amortizable section 197 intangible February 14, 20006082000–7 I.R.B. with respect to the partnership. (C) Effect of retroactive elections. For purposes of paragraph (h)(12)(vi)(B) of this section, references to August 10, 1993, are treated as references to July 25, 1991, if the relevant party made a valid retroactive election under §1.197–1T. (vii) Section 704(c) allocations—(A) Allocations where the intangible is amortiz- able by the contributor. The anti-churning rules of this paragraph (h) do not apply to the curative or remedial allocations of amortization with respect to a section 197(f)(9) intangible if the intangible was an amortizable section 197 intangible in the hands of the contributing partner (unless paragraph (h)(10) of this section applies so as to cause the intangible to cease to be an amortizable section 197 intangible in the hands of the partnership). (B) Allocations where the intangible is not amortizable by the contributor. Notwithstanding paragraph (g)(3)(ii) of this section, where the section 197(f)(9) intan- gible was not an amortizable section 197 intangible in the hands of the contributing partner, a partner may not receive remedial allocations of amortization under section 704(c) that are deductible for Federal in- come tax purposes if that partner is related to the partner that contributed the intangi- ble. Taxpayers may use any reasonable method to determine amortization of the asset for book purposes, provided that the method used does not contravene the pur- poses of the anti-churning rules under sec- tion 197 and this paragraph (h). A method will be considered to contravene the pur- poses of the anti-churning rules if the effect of the book adjustments resulting from the method is such that any portion of the tax deduction for amortization attributable to section 704(c) is allocated, directly or indi- rectly, to a partner who is subject to the anti-churning rules with respect to such ad- justment. (viii) Operating rule for transfers upon death. For purposes of this paragraph (h)(12), if the basis of a partner’s interest in a partnership is determined under sec- tion 1014(a), such partner is treated as ac- quiring such interest from a person who is not related to such partner, and such inter- est is treated as having previously been held by a person who is not related to such partner. (i) [Reserved] (j) General anti-abuse rule. The Com- missioner will interpret and apply the rules in this section as necessary and ap- propriate to prevent avoidance of the pur- poses of section 197. If one of the princi- pal purposes of a transaction is to achieve a tax result that is inconsistent with the purposes of section 197, the Commis- sioner will recast the transaction for Fed- eral tax purposes as appropriate to achieve tax results that are consistent with the purposes of section 197, in light of the applicable statutory and regulatory provi- sions and the pertinent facts and circum- stances. (k) Examples. The following examples illustrate the application of this section: Example 1. Advertising costs.(i) Q manufactures and sells consumer products through a series of whole- salers and distributors. In order to increase sales of its products by encouraging consumer loyalty to its prod- ucts and to enhance the value of the goodwill, trade- marks, and trade names of the business, Q advertises its products to the consuming public. It regularly in- curs costs to develop radio, television, and print adver- tisements. These costs generally consist of employee costs and amounts paid to independent advertising agencies. Q also incurs costs to run these advertise- ments in the various media for which they were devel- oped. (ii) The advertising costs are not chargeable to cap- ital account under paragraph (f)(3) of this section (re- lating to costs incurred for covenants not to compete, rights granted by governmental units, and contracts for the use of section 197 intangibles) and are currently deductible as ordinary and necessary expenses under section 162. Accordingly, under paragraph (a)(3) of this section, section 197 does not apply to these costs. Example 2. Computer software.(i) X purchases all of the assets of an existing trade or business from Y. One of the assets acquired is all of Y’s rights in certain computer software previously used by Y under the terms of a nonexclusive license from the software de- veloper. The software was developed for use by man- ufacturers to maintain a comprehensive accounting system, including general and subsidiary ledgers, pay- roll, accounts receivable and payable, cash receipts and disbursements, fixed asset accounting, and inven- tory cost accounting and controls. The developer modified the software for use by Y at a cost of $1,000 and Y made additional modifications at a cost of $500. The developer does not maintain wholesale or retail outlets but markets the software directly to ultimate users. Y’s license of the software is limited to an en- tity that is actively engaged in business as a manufac- turer. (ii) Notwithstanding these limitations, the software is considered to be readily available to the general public for purposes of paragraph (c)(4)(i) of this sec- tion. In addition, the software is not substantially modified because the cost of the modifications by the developer and Y to the version of the software that is readily available to the general public does not exceed $2,000. Accordingly, the software is not a section 197 intangible. Example 3. Acquisition of software for internal use. (i) B, the owner and operator of a worldwide package-delivery service, purchases from S all rights to software developed by S. The software will be used by B for the sole purpose of improving its package- tracking operations. B does not purchase any other as- sets in the transaction or any related transaction. (ii) Because B acquired the software solely for in- ternal use, it is disregarded in determining for pur- poses of paragraph (c)(4)(ii) of this section whether the assets acquired in the transaction or series of re- lated transactions constitute a trade or business or sub- stantial portion thereof. Since no other assets were acquired, the software is not acquired as part of a pur- chase of a trade or business and under paragraph (c)(4)(ii) of this section is not a section 197 intangible. Example 4. Governmental rights of fixed duration. (i) City M operates a municipal water system. In order to induce X to locate a new manufacturing business in the city, M grants X the right to purchase water for 16 years at a specified price. (ii) The right granted by M is a right to receive tan- gible property or services described in section 197(e)(4)(B) and paragraph (c)(6) of this section and, thus, is not a section 197 intangible. This exclusion applies even though the right does not qualify for ex- clusion as a right of fixed duration or amount under section 197(e)(4)(D) and paragraph (c)(13) of this sec- tion because the duration exceeds 15 years and the right is not fixed as to amount. It is also immaterial that the right would not qualify for exclusion as a self- created intangible under section 197(c)(2) and para- graph (d)(2) of this section because it is granted by a governmental unit. Example 5. Separate acquisition of franchise. (i) S is a franchiser of retail outlets for specialty coffees. G enters into a franchise agreement (within the meaning of section 1253(b)(1)) with S pursuant to which G is permitted to acquire and operate a store using the S trademark and trade name at the location specified in the agreement. G agrees to pay S $100,000 upon exe- cution of the agreement and also agrees to pay, throughout the term of the franchise, additional amounts that are deductible under section 1253(d)(1). The agreement contains detailed specifications for the construction and operation of the business, but G is not required to purchase from S any of the materials necessary to construct the improvements at the loca- tion specified in the franchise agreement. (ii) The franchise is a section 197 intangible within the meaning of paragraph (b)(10) of this section. The franchise does not qualify for the exclusion relating to self-created intangibles described in section 197(c)(2) and paragraph (d)(2) of this section because the fran- chise is described in section 197(d)(1)(F). In addition, because the acquisition of the franchise constitutes the acquisition of an interest in a trade or business or a substantial portion thereof, the franchise may not be excluded under section 197(e)(4). Thus, the franchise is an amortizable section 197 intangible, the basis of which must be recovered over a 15-year period. How- ever, the amounts that are deductible under section 1253(d)(1)are not subject to the provisions of section 197 by reason of section 197(f)(4)(C) and paragraph (b)(10)(ii) of this section. Example 6. Acquisition and amortization of covenant not to compete. (i) As part of the acquisition of a trade or business from C, B and C enter into an agreement containing a covenant not to compete. Under this agreement, C agrees that it will not com- pete with the business acquired by B within a pre- scribed geographical territory for a period of three years after the date on which the business is sold to B. 2000–7 I.R.B.609February 14, 2000 In exchange for this agreement, B agrees to pay C $90,000 per year for each year in the term of the agree- ment. The agreement further provides that, in the event of a breach by C of his obligations under the agreement, B may terminate the agreement, cease making any of the payments due thereafter, and pursue any other legal or equitable remedies available under applicable law. The amounts payable to C under the agreement are not contingent payments for purposes of §1.1275–4. The present fair market value of B’s rights under the agreement is $225,000. The aggre- gate consideration paid for all assets acquired in the transaction (including the covenant not to compete) exceeds the sum of the amount of Class I assets and the aggregate fair market value of all Class II, Class III, Class IV, Class V, and Class VI assets by $50,000. See §1.338–6T(b) for rules for determining the assets in each class. (ii) Because the covenant is acquired in an applica- ble asset acquisition (within the meaning of section 1060(c)), paragraph (f)(4)(ii) of this section applies and the basis of B in the covenant is determined pur- suant to section 1060(a) and the regulations thereun- der. Under §§1.1060–1T(c)(2) and 1.338–6T(c)(1), B’s basis in the covenant cannot exceed its fair market value. Thus, B’s basis in the covenant immediately after the acquisition is $225,000. This basis is amor- tized ratably over the 15-year period beginning on the first day of the month in which the agreement is en- tered into. Although the payments under the agree- ment ($270,000) exceed the amount allocated to the covenant by $45,000, all of the remaining considera- tion ($50,000) is allocated to Class VII assets (good- will and going concern value). See §§1.1060–1T(c)(2) and 1.338–6T(b). Example 7. Stand-alone license of technology.(i) X is a manufacturer of consumer goods that does busi- ness throughout the world through subsidiary corpora- tions organized under the laws of each country in which business is conducted. X licenses to Y, its sub- sidiary organized and conducting business in Country K, all of the patents, formulas, designs, and know-how necessary for Y to manufacture the same products that X manufactures in the United States. Assume that the license is not considered a sale or exchange under the principles of section 1235. The license is for a term of 18 years, and there are no facts to indicate that the li- cense does not have a fixed duration. Y agrees to pay X a royalty equal to a specified, fixed percentage of the revenues obtained from selling products manufac- tured using the licensed technology. Assume that the royalty is reasonable and is not subject to adjustment under section 482. The license is not entered into in connection with any other transaction. Y incurs capi- talized costs in connection with entering into the li- cense. (ii) The license is a contract for the use of a section 197 intangible within the meaning of paragraph (b)(11) of this section. It does not qualify for the ex- ception in section 197(e)(4)(D) and paragraph (c)(13) of this section (relating to rights of fixed duration or amount) because it does not have a term of less than 15 years, and the other exceptions in section 197(e) and paragraph (c) of this section are also inapplicable. Accordingly, the license is a section 197 intangible. (iii) The license is not acquired as part of a pur- chase of a trade or business. Thus, under paragraph (f)(3)(iii) of this section, the license will be closely scrutinized under the principles of section 1235 for purposes of determining whether the transfer is a sale or exchange and, accordingly, whether the payments under the license are chargeable to capital account. Because the license is not a sale or exchange under the principles of section 1235, the royalty payments are not chargeable to capital account for purposes section 197. The capitalized costs of entering into the license are not within the exception under paragraph (d)(2) of this section for self-created intangibles, and thus are amortized under section 197. Example 8. License of technology and trademarks . (i) The facts are the same as in Example 7, except that the license also includes the use of the trademarks and trade names that X uses to manufacture and dis- tribute its products in the United States. Assume that under the principles of section 1253 the transfer is not a sale or exchange of the trademarks and trade names or an undivided interest therein and that the royalty payments are described in section 1253(d)(1)(B). (ii) As in Example 7, the license is a section 197 in- tangible. Although the license conveys an interest in X’s trademarks and trade names to Y, the transfer of the interest is disregarded for purposes of paragraph (e)(2) of this section unless the transfer is considered a sale or exchange of the trademarks and trade names or an undivided interest therein. Accordingly, the licens- ing of the technology and the trademarks and trade names is not treated as part of a purchase of a trade or business under paragraph (e)(2) of this section. (iii) Because the technology license is not part of the purchase of a trade or business, it is treated in the manner described in Example 7.The royalty pay- ments for the use of the trademarks and trade names are deductible under section 1253(d)(1) and, under section 197(f)(4)(C) and paragraph (b)(10)(ii) of this section, are not chargeable to capital account for pur- poses of section 197. The capitalized costs of entering into the license are treated in the same manner as in example 7. Example 9. Disguised sale. (i) The facts are the same as in Example 7, except that Y agrees to pay X, in addition to the contingent royalty, a fixed minimum royalty immediately upon entering into the agreement and there are sufficient facts present to characterize the transaction, for federal tax purposes, as a transfer of ownership of the intellectual property from X to Y. (ii) The purported license of technology is, in fact, an acquisition of an intangible described in section 197(d)(1)(C)(iii) and paragraph (b)(5) of this section (relating to know-how, etc.). As in Example 7, the ex- ceptions in section 197(e) and paragraph (c) of this section do not apply to the transfer. Accordingly, the transferred property is a section 197 intangible. Y’s basis in the transferred intangible includes the capital- ized costs of entering into the agreement and the fixed minimum royalty payment payable at the time of the transfer. In addition, except to the extent that a portion of any payment will be treated as interest or original issue discount under applicable provisions of the Inter- nal Revenue Code, all of the contingent payments under the purported license are properly chargeable to capital account for purposes of section 197 and this section. The extent to which such payments are treated as payments of principal and the time at which any amount treated as a payment of principal is taken into account in determining basis are determined under the rules of §1.1275–4(c)(4) or 1.483–4(a), whichever is applicable. Any contingent amount that is included in basis after the month in which the acqui- sition occurs is amortized under the rules of paragraph (f)(2)(i) or (ii) of this section. Example 10. License of technology and customer list as part of sale of a trade or business. (i) X is a computer manufacturer that produces, in separate op- erating divisions, personal computers, servers, and pe- ripheral equipment. In a transaction that is the pur- chase of a trade or business for purposes of section 197, Y (who is unrelated to X) purchases from X all assets of the operating division producing personal computers, except for certain patents that are also used in the division manufacturing servers and customer lists that are also used in the division manufacturing peripheral equipment. As part of the transaction, X transfers to Y the right to use the retained patents and customer lists solely in connection with the manufac- ture and sale of personal computers. The transfer agreement requires annual royalty payments contin- gent on the use of the patents and also requires a pay- ment for each use of the customer list. In addition, Y incurs capitalized costs in connection with entering into the licenses. (ii) The rights to use the retained patents and cus- tomer lists are contracts for the use of section 197 in- tangibles within the meaning of paragraph (b)(11) of this section. The rights do not qualify for the excep- tion in 197(e)(4)(D) and paragraph (c)(13) of this sec- tion (relating to rights of fixed duration or amount) be- cause they are transferred as part of a purchase of a trade or business and the other exceptions in section 197(e) and paragraph (c) of this section are also inap- plicable. Accordingly, the licenses are section 197 in- tangibles. (iii) Because the right to use the retained patents is described in paragraph (b)(11) of this section and the right is transferred as part of a purchase of a trade or business, the treatment of the royalty payments is de- termined under paragraph (f)(3)(ii) of this section. In addition, however, the retained patents are described in paragraph (b)(5) of this section. Thus, the annual royalty payments are chargeable to capital account under the general rule of paragraph (f)(3)(ii)(A) of this section unless Y establishes that the license is not a sale or exchange under the principles of section 1235 and the royalty payments are an arm’s length consider- ation for the rights transferred. If these facts are estab- lished, the exception in paragraph (f)(3)(ii)(B) of this section applies and the royalty payments are not chargeable to capital account for purposes of section 197. The capitalized costs of entering into the license are treated in the same manner as in Example 7. (iv) The right to use the retained customer list is also described in paragraph (b)(11) of this section and is transferred as part of a purchase of a trade or busi- ness. Thus, the treatment of the payments for use of the customer list is also determined under paragraph (f)(3)(ii) of this section. The customer list, although described in paragraph (b)(6) of this section, is a cus- tomer-related information base. Thus, the exception in paragraph (f)(3)(ii)(B) of this section does not apply. Accordingly, payments for use of the list are charge- able to capital account under the general rule of para- graph (f)(3)(ii)(A) of this section and are amortized under section 197. In addition, the capitalized costs of entering into the contract for use of the customer list are treated in the same manner as in Example 7. Example 11. Loss disallowance rules involving re- lated persons. (i) Assume that X and Y are treated as a single taxpayer for purposes of paragraph (g)(1) of this section. In a single transaction, X and Y acquired from Z all of the assets used by Z in a trade or busi- ness. Z had operated this business at two locations, February 14, 20006102000–7 I.R.B. and X and Y each acquired the assets used by Z at one of the locations. Three years after the acquisition, X sold all of the assets it acquired, including amortizable section 197 intangibles, to an unrelated purchaser. The amortizable section intangibles are sold at a loss of $120,000. (ii) Because X and Y are treated as a single tax- payer for purposes of the loss disallowance rules of section 197(f)(1) and paragraph (g)(1) of this section, X’s loss on the sale of the amortizable section 197 in- tangibles is not recognized. Under paragraph (g)(1)(iv)(B) of this section, X’s disallowed loss is al- lowed ratably, as a deduction under section 197, over the remainder of the 15-year period during which the intangibles would have been amortized, and Y may not increase the basis of the amortizable section 197 intangibles that it acquired from Z by the amount of X’s disallowed loss. Example 12. Disposition of retained intangibles by related person. (i) The facts are the same as in Exam- ple 11, except that 10 years after the acquisition of the assets by X and Y and 7 years after the sale of the as- sets by X, Y sells all of the assets acquired from Z, in- cluding amortizable section 197 intangibles, to an un- related purchaser. (ii) Under paragraph (g)(1)(iv)(B) of this section, X may recognize, on the date of the sale by Y, any loss that has not been allowed as a deduction under section 197. Accordingly, X recognizes a loss of $50,000, the amount obtained by reducing the loss on the sale of the assets at the end of the third year ($120,000) by the amount allowed as a deduction under paragraph (g)(1)(iv)(B) of this section during the 7 years follow- ing the sale by X ($70,000). Example 13. Acquisition of an interest in partner- ship with no section 754 election. (i) A, B, and C each contribute $1,500 for equal shares in general partner- ship P. On January 1, 1998, P acquires as its sole asset an amortizable section 197 intangible for $4,500. P still holds the intangible on January 1, 2003, at which time the intangible has an adjusted basis to P of $3,000, and A, B, and C each have an adjusted basis of $1,000 in their partnership interests. D (who is not re- lated to A) acquires A’s interest in P for $1,600. No section 754 election is in effect for 2003. (ii) Because there is no change in the basis of the intangible under section 743(b), D merely steps into the shoes of A with respect to the intangible. D’s pro- portionate share of P’s adjusted basis in the intangible is $1,000, which continues to be amortized over the 10 years remaining in the original 15-year amortization period for the intangible. Example 14. Acquisition of an interest in partner- ship with a section 754 election. (i) The facts are the same as in Example 13, except that a section 754 elec- tion is in effect for 2003. (ii) Pursuant to paragraph (g)(3) of this section, for purposes of section 197, D is treated as if P owns two assets. D’s proportionate share of P’s adjusted basis in one asset is $1,000, which continues to be amortized over the 10 years remaining in the original 15-year amortization period. For the other asset, D’s propor- tionate share of P’s adjusted basis is $600 (the amount of the basis increase under section 743 as a result of the section 754 election), which is amortized over a new 15-year period beginning January 2003. With re- spect to B and C, P’s remaining $2,000 adjusted basis in the intangible continues to be amortized over the 10 years remaining in the original 15-year amortization period. Example 15. Payment to a retiring partner by partnership with a section 754 election.(i) The facts are the same as in Example 13, except that a section 754 election is in effect for 2003 and, instead of D ac- quiring A’s interest in P, A retires from P. A, B, and C are not related to each other within the meaning of paragraph (h)(6) of this section. P borrows $1,600, and A receives a payment under section 736 from P of such amount, all of which is in exchange for A’s inter- est in the intangible asset owned by P. (Assume, for purposes of this example, that the borrowing by P and payment of such funds to A does not give rise to a dis- guised sale of A’s partnership interest under section 707(a)(2)(B).) P makes a positive basis adjustment of $600 with respect to the section 197 intangible under section 734(b). (ii) Pursuant to paragraph (g)(3) of this section, be- cause of the section 734 adjustment, P is treated as having two amortizable section 197 intangibles, one with a basis of $3,000 and a remaining amortization period of 10 years and the other with a basis of $600 and a new amortization period of 15 years. Example 16. Termination of partnership under section 708(b)(1)(B). (i) A and B are partners with equal shares in the capital and profits of general part- nership P. P’s only asset is an amortizable section 197 intangible, which P had acquired on January 1, 1995. On January 1, 2000, the asset had a fair market value of $100 and a basis to P of $50. On that date, A sells his entire partnership interest in P to C, who is unre- lated to A, for $50. At the time of the sale, the basis of each of A and B in their respective partnership inter- ests is $25. (ii) The sale causes a termination of P under section 708(b)(1)(B). Under section 708, the transaction is treated as if P transfers its sole asset to a new partner- ship in exchange for the assumption of its liabilities and the receipt of all of the interests in the new part- nership. Immediately thereafter, P is treated as if it is liquidated, with B and C each receiving their propor- tionate share of the interests in the new partnership. The contribution by P of its asset to the new partner- ship is governed by section 721, and the liquidating distributions by P of the interests in the new partner- ship are governed by section 731. C does not realize a basis adjustment under section 743 with respect to the amortizable section 197 intangible unless P had a sec- tion 754 election in effect for its taxable year in which the transfer of the partnership interest to C occurred or the taxable year in which the deemed liquidation of P occurred. (iii) Under section 197, if P had a section 754 elec- tion in effect, C is treated as if the new partnership had acquired two assets from P immediately preceding its termination. Even though the adjusted basis of the new partnership in the two assets is determined solely under section 723, because the transfer of assets is a transaction described in section 721, the application of sections 743(b) and 754 to P immediately before its termination causes P to be treated as if it held two as- sets for purposes of section 197. See paragraph (g)(3) of this section. B’s and C’s proportionate share of the new partnership’s adjusted basis is $25 each in one asset, which continues to be amortized over the 10 years remaining in the original 15-year amortization period. For the other asset, C’s proportionate share of the new partnership’s adjusted basis is $25 (the amount of the basis increase resulting from the appli- cation of section 743 to the sale or exchange by A of the interest in P), which is amortized over a new 15- year period beginning in January 2000. (iv) If P did not have a section 754 election in effect for its taxable year in which the sale of the partnership interest by A to C occurred or the taxable year in which the deemed liquidation of P occurred, the ad- justed basis of the new partnership in the amortizable section 197 intangible is determined solely under sec- tion 723, because the transfer is a transaction de- scribed in section 721, and P does not have a basis in- crease in the intangible. Under section 197(f)(2) and paragraph (g)(2)(ii) of this section, the new partner- ship continues to amortize the intangible over the 10 years remaining in the original 15-year amortization period. No additional amortization is allowable with respect to this asset. Example 17. Disguised sale to partnership. (i) E and F are individuals who are unrelated to each other within the meaning of paragraph (h)(6) of this section. E has been engaged in the active conduct of a trade or business as a sole proprietor since 1990. E and F form EF Partnership. E transfers all of the assets of the business, having a fair market value of $100, to EF, and F transfers $40 of cash to EF. E receives a 60 per- cent interest in EF and the $40 of cash contributed by F, and F receives a 40 percent interest in EF, under cir- cumstances in which the transfer by E is partially treated as a sale of property to EF under §1.707–3(b). (ii) Under §1.707–3(a)(1), the transaction is treated as if E had sold to EF a 40 percent interest in each asset for $40 and contributed the remaining 60 percent interest in each asset to EF in exchange solely for an interest in EF. Because E and EF are related persons within the meaning of paragraph (h)(6) of this section, no portion of any transferred section 197(f)(9) intangi- ble that E held during the transition period (as defined in paragraph (h)(4) of this section) is an amortizable section 197 intangible pursuant to paragraph (h)(2) of this section. Section 197(f)(9)(E) and paragraph (g)(3) of this section do not apply to any portion of the sec- tion 197 intangible in the hands of EF because the basis of EF in these assets was not increased under any of sections 732, 734, or 743. Example 18. Acquisition by related person in non- recognition transaction.(i) A owns a nonamortizable intangible that A acquired in 1990. In 2000, A sells a one-half interest in the intangible to B for cash. Imme- diately after the sale, A and B, who are unrelated to each other, form partnership P as equal partners. A and B each contribute their one-half interest in the in- tangible to P. (ii) P has a transferred basis in the intangible from A and B under section 723. The nonrecognition trans- fer rule under paragraph (g)(2)(ii) of this section ap- plies to A’s transfer of its one-half interest in the intan- gible to P, and consequently P steps into A’s shoes with respect to A’s nonamortizable transferred basis. The anti-churning rules of paragraph (h) of this section apply to B’s transfer of its one-half interest in the in- tangible to P, because A, who is related to P under paragraph (h)(6) of this section immediately after the series of transactions in which the intangible was ac- quired by P, held B’s one-half interest in the intangible during the transition period. Pursuant to paragraph (h)(10) of this section, these rules apply to B’s transfer of its one-half interest to P even though the nonrecog- nition transfer rule under paragraph (g)(2)(ii) of this section would have permitted P to step into B’s shoes with respect to B’s otherwise amortizable basis. Therefore, P’s entire basis in the intangible is non- amortizable. However, if A (not B) elects to recognize 2000–7 I.R.B.611February 14, 2000 gain under paragraph (h)(9) of this section on the transfer of each of the one-half interests in the intangi- ble to B and P, then the intangible would be amortiz- able by P to the extent provided in section 197(f)(9)(B) and paragraph (h)(9) of this section. Example 19. Acquisition of partnership interest following formation of partnership.(i) The facts are the same as in Example 18except that, in 2000, A formed P with an affiliate, S, and contributed the in- tangible to the partnership and except that in a subse- quent year, in a transaction that is properly character- ized as a sale of a partnership interest for Federal tax purposes, B purchases a 50 percent interest in P from A. P has a section 754 election in effect and holds no assets other than the intangible and cash. (ii) For the reasons set forth in Example 16(iii), B is treated as if P owns two assets. B’s proportionate share of P’s adjusted basis in one asset is the same as A’s proportionate share of P’s adjusted basis in that asset, which is not amortizable under section 197. For the other asset, B’s proportionate share of the remain- ing adjusted basis of P is amortized over a new 15- year period. Example 20. Acquisition by related corporation in nonrecognition transaction. (i) The facts are the same as Example 18, except that A and B form corporation P as equal owners. (ii) P has a transferred basis in the intangible from A and B under section 362. Pursuant to paragraph (h)(10) of this section, the application of the nonrecog- nition transfer rule under paragraph (g)(2)(ii) of this section and the anti-churning rules of paragraph (h) of this section to the facts of this Example 18is the same as in Example 16. Thus, P’s entire basis in the intangi- ble is nonamortizable. Example 21. Acquisition from corporation related to purchaser through remote indirect interest. (i) X, Y, and Z are each corporations that have only one class of issued and outstanding stock. X owns 25 percent of the stock of Y and Y owns 25 percent of the outstand- ing stock of Z. No other shareholder of any of these corporations is related to any other shareholder or to any of the corporations. On June 30, 2000, X pur- chases from Z section 197(f)(9) intangibles that Z owned during the transition period (as defined in para- graph (h)(4) of this section). (ii) Pursuant to paragraph (h)(6)(iv)(B) of this sec- tion, the beneficial ownership interest of X in Z is 6.25 percent, determined by treating X as if it owned a pro- portionate (25 percent) interest in the stock of Z that is actually owned by Y. Thus, even though X is related to Y and Y is related to Z, X and Z are not considered to be related for purposes of the anti-churning rules of section 197. Example 22. Gain recognition election.(i) B owns 25 percent of the stock of S, a corporation that uses the calendar year as its taxable year. No other shareholder of B or S is related to each other. S is not a member of a controlled group of corporations within the meaning of section 1563(a). S has section 197(f)(9) intangibles that it owned during the transition period. S has a basis of $25,000 in the intangibles. In 2001, S sells these intangibles to B for $75,000. S recognizes a gain of $50,000 on the sale and has no other items of in- come, deduction, gain, or loss for the year, except that S also has a net operating loss of $20,000 from prior years that it would otherwise be entitled to use in 2001 pursuant to section 172(b). S makes a valid gain recognition election pursuant to section 197(f)(9)(B) and paragraph (h)(9) of this section. In 2001, the high- est marginal tax rate applicable to S is 35 percent. But for the election, all of S’s taxable income would be taxed at a rate of 15 percent. (ii) If the gain recognition election had not been made, S would have taxable income of $30,000 for 2001 and a tax liability of $4,500. If the gain were not taken into account, S would have no tax liability for the taxable year. Thus, the amount of tax (other than the tax imposed under paragraph (h)(9) of this section) imposed on the gain is also $4,500. The gain on the disposition multiplied by the highest marginal tax rate is $17,500 ($50,000 x .35). Accordingly, S’s tax liabil- ity for the year is $4,500 plus an additional tax under paragraph (h)(9) of this section of $13,000 ($17,500 - $4,500). (iii) Pursuant to paragraph (h)(9)(x)(A) of this sec- tion, S determines the amount of its net operating loss deduction in subsequent years without regard to the gain recognized on the sale of the section 197 intangi- ble to B. Accordingly, the entire $20,000 net operating loss deduction that would have been available in 2001 but for the gain recognition election may be used in 2002, subject to the limitations of section 172. (iv) B has a basis of $75,000 in the section 197(f)(9) intangibles acquired from S. As the result of the gain recognition election by S, B may amortize $50,000 of its basis under section 197. Under para- graph (h)(9)(ii) of this section, the remaining basis does not qualify for the gain-recognition exception and may not be amortized by B. Example 23. Section 338 election. (i) Corporation P makes a qualified stock purchase of the stock of T corporation from two shareholders in July 2000, and a section 338 election is made by P. No shareholder of either T or P owns stock in both of these corporations, and no other shareholder is related to any other share- holder of either corporation. (ii) Pursuant to paragraph (h)(8) of this section, in the case of a qualified stock purchase that is treated as a deemed sale and purchase of assets pursuant to sec- tion 338, the corporation treated as purchasing assets as a result of an election thereunder (new target) is not considered the person that held or used the assets dur- ing any period in which the assets were held or used by the corporation treated as selling the assets (old tar- get). Because there are no relationships described in paragraph (h)(6) of this section among the parties to the transaction, any nonamortizable section 197(f)(9) intangible held by old target is an amortizable section 197 intangible in the hands of new target. (iii) Assume the same facts as set forth in para- graph (i) of this Example 23, except that one of the selling shareholders is an individual who owns 25 per- cent of the total value of the stock of each of the T and P corporation. (iv) Old target and new target (as these terms are defined in §1.338–1(c)(13)) are members of a con- trolled group of corporations under section 267(b)(3), as modified by section 197(f)(9)(C)(i), and any non- amortizable section 197(f)(9) intangible held by old target is not an amortizable section 197 intangible in the hands of new target. However, a gain recognition election under paragraph (h)(9) of this section may be made with respect to this transaction. Example 24. Relationship created as part of public offering. (i) On January 1, 2001, Corporation X en- gages in a series of related transactions to discontinue its involvement in one line of business. X forms a new corporation, Y, with a nominal amount of cash. Shortly thereafter, X transfers all the stock of its sub- sidiary conducting the unwanted business (Target) to Y in exchange for 100 shares of Y common stock and a Y promissory note. Target owns a nonamortizable section 197(f)(9) intangible. Prior to January 1, 2001, X and an underwriter (U) had entered into a binding agreement pursuant to which U would purchase 85 shares of Y common stock from X and then sell those shares in a public offering. On January 6, 2001, the public offering closes. X and Y make a section 338(h)(10) election for Target. (ii) Pursuant to paragraph (h)(8) of this section, in the case of a qualified stock purchase that is treated as a deemed sale and purchase of assets pursuant to sec- tion 338, the corporation treated as purchasing assets as a result of an election thereunder (new target) is not considered the person that held or used the assets dur- ing any period in which the assets were held or used by the corporation treated as selling the assets (old tar- get). Further, for purposes of determining whether the nonamortizable section 197(f)(9) intangible is ac- quired by new target from a related person, because the transactions are a series of related transactions, the relationship between old target and new target must be tested immediately before the first transaction in the series (the formation of Y) and immediately after the last transaction in the series (the sale to U and the pub- lic offering). See paragraph (h)(6)(ii)(B) of this sec- tion. Because there was no relationship between old target and new target immediately before the forma- tion of Y (because the section 338 election had not been made) and only a 15% relationship between old target and new target immediately after, old target is not related to new target for purposes of applying the anti-churning rules of paragraph (h) of this section. Accordingly, Target may amortize the section 197 in- tangible. Example 25. Other transfers to controlled corpo- rations. (i) In 2001, Corporation A transfers a section 197(f)(9) intangible that it held during the transition period to X, a newly formed corporation, in exchange for 15% of X’s stock. As part of the same transaction, B transfers property to X in exchange for the remain- ing 85% of X stock. (ii) Because the acquisition of the intangible by X is part of a qualifying section 351 exchange, under section 197(f)(2) and paragraph (g)(2)(ii) of this sec- tion, X is treated in the same manner as the transferor of the asset. Accordingly, X may not amortize the in- tangible. If, however, at the time of the exchange, B has a binding commitment to sell 25 percent of the X stock to C, an unrelated third party, the exchange, in- cluding A’s transfer of the section 197(f)(9) intangi- ble, would fail to qualify as a section 351 exchange. Because the formation of X, the transfers of property to X, and the sale of X stock by B are part of a series of related transactions, the relationship between A and X must be tested immediately before the first transac- tion in the series (the transfer of property to X) and im- mediately after the last transaction in the series (the sale of X stock to C). See paragraph (h)(6)(ii)(B) of this section. Because there was no relationship be- tween A and X immediately before and only a 15% re- lationship immediately after, A is not related to X for purposes of applying the anti-churning rules of para- graph (h) of this section. Accordingly, X may amor- tize the section 197 intangible. Example 26. Relationship created as part of stock acquisition followed by liquidation.(i) In 2001, Part- nership P purchases 100 percent of the stock of Corpo- ration X. P and X were not related prior to the acquisi- February 14, 20006122000–7 I.R.B. tion. Immediately after acquiring the X stock, and as part of a series of related transactions, P liquidates X under section 331. In the liquidating distribution, P re- ceives a section 197(f)(9) intangible that was held by X during the transition period. (ii) Because the relationship between P and X was created pursuant to a series of related transactions where P acquires stock (meeting the requirements of section 1504(a)(2)) in a fully taxable transaction fol- lowed by a liquidation under section 331, the relation- ship immediately after the last transaction in the series (the liquidation) is disregarded. See paragraph (h)(6)(iii) of this section. Accordingly, P is entitled to amortize the section 197(f)(9) intangible. Example 27. Section 743(b) adjustment with no change in user. (i) On January 1, 2001, A forms a partnership (PRS) with B in which A owns a 60-per- cent, and B owns a 40-percent, interest in profits and capital. A contributes a nonamortizable section 197(f)(9) intangible with a value of $80 and an ad- justed basis of $0 to PRS in exchange for its PRS in- terest and B contributes $120 cash. At the time of the contribution, PRS licenses the section 197(f)(9) intan- gible to A. On February 1, 2001, A sells its entire in- terest in PRS to C, an unrelated person, for $80. PRS has a section 754 election in effect. (ii) The section 197(f)(9) intangible contributed to PRS by A is not amortizable in the hands of PRS. Pur- suant to section (g)(2)(ii) of this section, PRS steps into the shoes of A with respect to A’s nonamortizable transferred basis in the intangible. (iii) When A sells the PRS interest to C, C will have a basis adjustment in the PRS assets under section 743(b) equal to $80. The entire basis adjustment will be allocated to the intangible because the only other asset held by PRS is cash. Ordinarily, under paragraph (h)(12)(v) of this section, the anti-churning rules will not apply to an increase in the basis of partnership property under section 743(b) if the person acquiring the partnership interest is not related to the person transferring the partnership interest. However, A is an anti-churning partner under paragraph (h)(12)(vi)(B)(3) of this section. Because A remains a user of the section 197(f)(9) intangible after the trans- fer to C, paragraph (h)(12)(vi)(A) of this section will cause the anti-churning rules to apply to the entire basis adjustment under section 743(b). (l) Effective dates—(1) In general. This section applies to property acquired after January 25, 2000, except that paragraph (c)(13) of this section (exception from sec- tion 197 for separately acquired rights of fixed duration or amount) applies to prop- erty acquired after August 10, 1993 (or July 25, 1991, if a valid retroactive election has been made under §1.197–1T). (2) Application to pre-effective date ac- quisitions. A taxpayer may choose, on a transaction-by-transaction basis, to apply the provisions of this section and §1.167(a)–14 to property acquired after August 10, 1993 (or July 25, 1991, if a valid retroactive election has been made under §1.197–1T) and on or before Janu- ary 25, 2000. (3) Application of regulation project REG–209709–94 to pre-effective date ac- quisitions. A taxpayer may rely on the provisions of regulation project REG–209709– 94 (1997–1 C.B. 731) for property acquired after August 10, 1993 (or July 25, 1991, if a valid retroactive election has been made under §1.197–1T) and on or before January 25, 2000. (4) Change in method of accounting— (i)In general. For the first taxable year ending after January 25, 2000, a taxpayer that has acquired property to which the exception in §1.197–2(c)(13) applies is granted consent of the Commissioner to change its method of accounting for such property to comply with the provisions of this section and §1.167(a)–14 unless the proper treatment of such property is an issue under consideration (within the meaning of Rev. Proc. 97–27 (1997–21 IRB 10)(see §601.601(d)(2) of this chap- ter)) in an examination, before an Appeals office, or before a Federal court. (ii) Application to pre-effective date acquisitions. For the first taxable year ending after January 25, 2000, a taxpayer is granted consent of the Commissioner to change its method of accounting for all property acquired in transactions de- scribed in paragraph (l)(2) of this section to comply with the provisions of this sec- tion and §1.167(a)–14 unless the proper treatment of any such property is an issue under consideration (within the meaning of Rev. Proc. 97–27 (1997–21 IRB 10)(see §601.601(d)(2) of this chapter)) in an examination, before an Appeals of- fice, or before a Federal court. (iii) Automatic change procedures. A taxpayer changing its method of account- ing in accordance with this paragraph (l)(4) must follow the automatic change in accounting method provisions of Rev. Proc. 99–49 (1999–52 IRB 725)(see §601.601(d)(2) of this chapter) except, for purposes of this paragraph (l)(4), the scope limitations in section 4.02 of Rev. Proc. 99–49 (1999–52 IRB 725) are not applicable. However, if the taxpayer is under examination, before an appeals of- fice, or before a federal court, the tax- payer must provide a copy of the applica- tion to the examining agent(s), appeals officer, or counsel for the government, as appropriate, at the same time that it files the copy of the application with the Na- tional Office. The application must con- tain the name(s) and telephone number(s) of the examining agent(s), appeals officer, or counsel for the government, as appro- priate. Part 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT Par. 8. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 9. In §602.101, paragraph (b) is amended by adding an entry to the table in numerical order to read as follows. §602.101 OMB Control numbers. * * * * * (b) * * * David Mader, Acting Deputy Commissioner of Internal Revenue. Approved January 14, 2000. Jonathan Talisman, Acting Assistant Secretary of the Treasury. (Filed by the Office of the Federal Register on Janu- ary 20, 2000, 1:19 p.m., and published in the issue of the Federal Register for January 25, 2000, 65 F.R. 3820) 2000–7 I.R.B.613February 14, 2000 CFR part or section whereCurrent OMB identified and describedcontrol No. * * * * * 1.197–2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1671 * * * * * Section 274.—Disallowance of Certain Entertainment, Etc., Expenses 26 CFR 1.274–5: Substantiation requirements. T.D. 8864 DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1 and 602 Substantiation of Business Expenses AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final and temporary regula- tions. SUMMARY: This document contains final and temporary Income Tax Regula- tions that provide rules for the substantia- tion of certain business expenses under sections 62 and 274 of the Internal Rev- enue Code (Code). Individuals and other taxpayers who claim or reimburse certain business expenses will be affected by these regulations. DATES: Effective date. These regula- tions are effective January 26, 2000. Date of Applicability. For date of applic- ability, see §§1.62–2(m) and 1.274–5(m). FOR FURTHER INFORMATION CON- TACT: Edwin B. Cleverdon, (202) 622- 4920 (not a toll-free number). SUPPLEMENTARY INFORMATION: Paperwork Reduction Act The collection of information con- tained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507) under control number 1545-0771. Responses to this collection of information are required in order to deduct certain business expenses or exclude from income certain reim- bursed business expenses of employees. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the col- lection of information displays a valid control number. The estimated annual burden per re- spondent or recordkeeper varies from 10 minutes to 20 hours, depending on indi- vidual circumstances, with an estimated average of 1.3 hours. Comments concerning the accuracy of this burden estimate and suggestions or reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Trea- sury, Office of Information and Regula- tory Affairs, Washington, DC 20503. Books or records relating to this collec- tion of information must be retained as long as their contents may become mater- ial in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. Background On November 6, 1985, the IRS pub- lished in the Federal Register(50 F.R. 46006) temporary regulations (TD 8061, 1985–2 C.B. 93) adding §1.274–5T re- garding substantiation of expenses with documentary evidence under section 274(d) of the Code. A notice of proposed rulemaking (LR–145–84, 1985–2 C.B. 809) cross-referencing the temporary reg- ulations was published in the Federal Register(50 F.R. 46087) for the same day. The notice of proposed rulemaking invited comments on only those portions of the temporary regulations under §1.274–5T that amended §1.274–5 (now designated §1.274–5A) to reflect contem- poraneous legislation. On March 25, 1997, the IRS published in the Federal Register(62 F.R. 13988) temporary regulations (T.D. 8715, 1997–1 C.B. 79) amending paragraphs (c)(2)(iii)(B) and (f)(4) of §1.274–5T. The amendments raised the receipt threshold from $25 to $75 and authorized the Commissioner to prescribe rules mod- ifying the substantiation requirements for an adequate accounting by an employee to an employer. Under the amendment, the Commissioner could publish rules defining the circumstances (including the use of specified internal controls) under which an employee may make an ade- quate accounting to his employer by sub- mitting an expense account alone, without the necessity of submitting documentary evidence (such as receipts). A notice of proposed rulemaking (REG–209785–95, 1997–1 C.B. 753) cross-referencing the temporary regulations was published in the Federal Register(62 F.R. 14051) for the same day. On October 1, 1998, the IRS published a notice of proposed rulemaking (REG–122488–97, 1998–42 I.R.B. 19) in the Federal Register(63 F.R. 52660), proposing amendments to the Income Tax Regulations (26 CFR part 1) under sec- tions 62(c) and 274(d) of the Code regard- ing substantiation of expenses using mileage and per diem rates. Specifically, the amendments removed the limitation in §1.274(d)–1(a)(3) that provides that mileage allowances prescribed in rules by the Commissioner are available only to the owner of a vehicle. On that date the IRS also published temporary Income Tax Regulations (T.D. 8784, 1998–42 I.R.B. 4) under section 62(c) and 274(d) of the Code in the Federal Register(63 F.R. 52600), relating to the substantiation of expenses under a reimbursement or other expense allowance arrangement. Comments were received in response to the 1985 proposed regulations, and a public hearing was held on March 3, 1986. Few of the written comments, and none of the comments at the hearing, re- late to the provisions in this Treasury De- cision. Written comments were also re- ceived with respect to the 1997 proposed regulations, but no public hearing was re- quested or held. No comments were re- ceived, and no hearings were requested or held, with respect to the 1998 proposed regulations. Summary and Discussion of Comments This Treasury Decision incorporates the suggestions made in the written comments with some exceptions. With respect to the 1985 regulations, one commentator sug- gested that the definition of an adequate ac- counting in §1.274–5T(f)(4), in the case of automobile expense reimbursements, should be satisfied by a reimbursement based on data on the type of automobile and local operating and fixed costs. Al- though this suggestion has not been specifi- cally adopted in the final regulations, the standard mileage rate revenue procedure provides for this type of substantiation. See, e.g., section 8 of Rev. Proc. 98–63, February 14, 20006142000–7 I.R.B. 1998–52 I.R.B. 25. Another commentator suggested, inter alia, (1) adding exceptions to the docu- mentary evidence requirements under §1.274–5T(c)(2)(iii) and (2) providing that the Commissioner, in establishing a meal allowance under §1.274–5T(j), may allow a specific dollar allowance per meal. These suggestions are not adopted because the intent of the regulations is to give the Commissioner the discretion to make these practical decisions. Similarly, with respect to the 1997 reg- ulations, commentators made suggestions regarding the specific content of the guid- ance to be issued under the proposed reg- ulations at §1.274–5(f)(4). We did not in- corporate these suggestions because the regulations are designed to describe ap- propriate published guidance of general applicability, not the specific provisions of such guidance. However, all of the comments will be taken into considera- tion by the Commissioner in issuing pub- lished guidance. Explanation of Provisions This Treasury Decision adopts the revi- sion to §1.62–2(e)(2) proposed in REG–122488–97, with minor changes. This Treasury Decision also adopts §§1.274–5(c)(2)(iii), (f)(4), (g), (j), and (m) as proposed by LR–216–84, modified by REG–209785–95, 1997–1 C.B. 753, and REG–122488–97, 1998–42 I.R.B. 19, and removes and reserves the corresponding pro- visions in §1.274–5T. Finally, this Treasury Decision adopts the proposal in REG–122488–97 to remove §§1.62–2T, 1.274(d)–1, and 1.274(d)–1T. Special Analyses It has been determined that this Trea- sury decision is not a significant regula- tory 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 Pro- cedure Act (5 U.S.C. chapter 5) does not apply to these regulations. Sections 1.274–5(c)(2)(iii) and (f) were originally proposed by a notice of proposed rule- making (LR–145–84) that was issued on November 6, 1985. Therefore, the Regu- latory Flexibility Act (5 U.S.C. chapter 6) does not apply with respect to those col- lections of information. With respect to the collection of information in §1.274–5(c)(iii)(B) as proposed by REG–209785–95 on March 25, 1997, it is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that, by increasing the receipt threshold from $25 to $75, these regulations reduce the existing recordkeeping requirements of taxpayers, including small entities. The regulations do not otherwise significantly alter the reporting or recordkeeping duties of small entities. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the IRS sub- mitted the notices of proposed rulemaking preceding these regulations to the Chief Counsel for Advocacy of the Small Busi- ness Administration for comment on its impact on small business. Drafting Information The principal author of these final and temporary regulations is Edwin B. Cleverdon, Office of the Assistant Chief Counsel (Income Tax and Accounting). However, personnel from other offices of the IRS and Treasury Department partici- pated in their development. * * * * * Adoption of Amendments to the Regulations Accordingly, 26 CFR parts 1 and 602 are amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 is amended by adding an entry to read in part as follows: Authority: 26 U.S.C. 7805 * * * Section 1.274–5 also issued under 26 U.S.C. 274(d). * * * Par. 2. Section 1.62–2 is amended by: 1. Revising paragraph (e)(2). 2. Removing the last two sentences of paragraph (m). 3. Adding a sentence to the end of paragraph (m). The revision and addition read as fol- lows: §1.62–2 Reimbursement and other ex- pense allowance arrangements. * * * * * (e) * * * (2) Expenses governed by section 274(d). An arrangement that reimburses travel, entertainment, use of a passenger automobile or other listed property, or other business expenses governed by sec- tion 274(d) meets the requirements of this paragraph (e)(2) if information suffi- cient to satisfy the substantiation require- ments of section 274(d) and the regula- tions thereunder is submitted to the payor. See §1.274–5. Under section 274(d), information sufficient to substan- tiate the requisite elements of each ex- penditure or use must be submitted to the payor. For example, with respect to travel away from home, §1.274–5(b)(2) requires that information sufficient to substantiate the amount, time, place, and business purpose of the expense must be submitted to the payor. Similarly, with respect to use of a passenger automobile or other listed property, §1.274–5(b)(6) requires that information sufficient to substantiate the amount, time, use, and business purpose of the expense must be submitted to the payor. See §1.274–5(g), however, which grants the Commissioner authority to prescribe rules permitting the amount of certain expenses to be deemed substantiated to the payor (in lieu of sub- stantiating the actual amount of such ex- penses) by means of per diem or mileage rates for travel away from home or trans- portation expenses. See also §1.274–5(j)(1), which grants the Com- missioner the authority to establish a method under which a taxpayer may use a specified amount for meals while trav- eling away from home in lieu of substan- tiating the actual cost of meals, and §1.274–5(j)(2), which grants the Com- missioner the authority to establish a method under which a taxpayer may use mileage rates to determine the amount of the ordinary and necessary expenses of using a vehicle for local transportation and transportation to, from, and at the destination while traveling away from home in lieu of substantiating the actual costs. Substantiation of the amount of a business expense in accordance with rules prescribed pursuant to the authority granted by §1.274–5(g) or (j) will be treated as substantiation of the amount of such expense for purposes of this section. * * * * * (m) * * * Paragraph (e)(2) of this sec- tion applies to payments made under re- 2000–7 I.R.B.615February 14, 2000 imbursement or other expense allowance arrangements received by an employee with respect to expenses paid or incurred after December 31, 1997. §1.62–2T [REMOVED] Par. 3. Section 1.62–2T is removed. Par. 4. Section 1.274–5 is added to read as follows: §1.274–5 Substantiation requirements. (a) and (b) [Reserved]. For further guidance, see §1.274–5T(a) and (b). (c) Rules of substantiation—(1) [Re- served]. For further guidance, see §1.274–5T(c)(1). (2) Substantiation by adequate records—(i) and (ii) [Reserved]. For fur- ther guidance, see §1.274–5T(c)(2)(i) and (ii). (iii) Documentary evidence—(A) Ex- cept as provided in paragraph (c)(2)(iii)(B), documentary evidence, such as receipts, paid bills, or similar evi- dence sufficient to support an expendi- ture, is required for– (1) Any expenditure for lodging while traveling away from home, and (2) Any other expenditure of $75 or more except, for transportation charges, documentary evidence will not be re- quired if not readily available. (B) The Commissioner, in his or her discretion, may prescribe rules waiving the documentary evidence requirements in circumstances where it is impracticable for such documentary evidence to be re- quired. Ordinarily, documentary evi- dence will be considered adequate to sup- port an expenditure if it includes sufficient information to establish the amount, date, place, and the essential character of the expenditure. For exam- ple, a hotel receipt is sufficient to support expenditures for business travel if it con- tains the following: name, location, date, and separate amounts for charges such as for lodging, meals, and telephone. Simi- larly, a restaurant receipt is sufficient to support an expenditure for a business meal if it contains the following: name and location of the restaurant, the date and amount of the expenditure, the num- ber of people served, and, if a charge is made for an item other than meals and beverages, an indication that such is the case. A document may be indicative of only one (or part of one) element of an ex- penditure. Thus, a cancelled check, to- gether with a bill from the payee, ordinar- ily would establish the element of cost. In contrast, a cancelled check drawn payable to a named payee would not by itself sup- port a business expenditure without other evidence showing that the check was used for a certain business purpose. (iv) and (v) [Reserved]. For further guidance, see §1.274–5T(c)(2)(iv) and (v). (d) and (e) [Reserved]. For further guidance, see §1.274–5T(d) and (e). (f) Reporting and substantiation of ex- penses of certain employees for travel, entertainment, gifts, and with respect to listed property—(1) through (3) [Re- served]. For further guidance, see §1.274–5T(f)(1) through (3). (4) Definition of an adequate account- ing to the employer–(i) In general. For purposes of this paragraph (f) an adequate accountingmeans the submission to the employer of an account book, diary, log, statement of expense, trip sheet, or similar record maintained by the employee in which the information as to each element of an expenditure or use (described in paragraph (b) of this section) is recorded at or near the time of the expenditure or use, together with supporting documen- tary evidence, in a manner that conforms to all the adequate records requirements of paragraph (c)(2) of this section. An ad- equate accounting requires that the em- ployee account for all amounts received from the employer during the taxable year as advances, reimbursements, or al- lowances (including those charged di- rectly or indirectly to the employer through credit cards or otherwise) for travel, entertainment, gifts, and the use of listed property. The methods of substanti- ation allowed under paragraph (c)(4) or (c)(5) of this section also will be consid- ered to be an adequate accounting if the employer accepts an employee’s substan- tiation and establishes that such substanti- ation meets the requirements of paragraph (c)(4) or (c)(5). For purposes of an ade- quate accounting, the method of substan- tiation allowed under paragraph (c)(3) of this section will not be permitted. (ii) Procedures for adequate account- ing without documentary evidence.The Commissioner may, in his or her discre- tion, prescribe rules under which an em- ployee may make an adequate accounting to an employer by submitting an account book, log, diary, etc., alone, without sub- mitting documentary evidence. (iii) Employer. For purposes of this section, the term employerincludes an agent of the employer or a third party payor who pays amounts to an employee under a reimbursement or other expense allowance arrangement. (5) [Reserved]. For further guidance, see §1.274–5T(f)(5). (g) Substantiation by reimbursement arrangements or per diem, mileage, and other traveling allowances—(1) In gen- eral. The Commissioner may, in his or her discretion, prescribe rules in pro- nouncements of general applicability under which allowances for expenses de- scribed in paragraph (g)(2) of this section will, if in accordance with reasonable business practice, be regarded as equiva- lent to substantiation by adequate records or other sufficient evidence, for purposes of paragraph (c) of this section, of the amount of the expenses and as satisfying, with respect to the amount of the ex- penses, the requirements of an adequate accounting to the employer for purposes of paragraph (f)(4) of this section. If the total allowance received exceeds the de- ductible expenses paid or incurred by the employee, such excess must be reported as income on the employee’s return. See paragraph (j)(1) of this section relating to the substantiation of meal expenses while traveling away from home, and paragraph (j)(2) of this section relating to the sub- stantiation of expenses for the business use of a vehicle. (2) Allowances for expenses described. An allowance for expenses is described in this paragraph (g)(2) if it is a— (i) Reimbursement arrangement cover- ing ordinary and necessary expenses of traveling away from home (exclusive of transportation expenses to and from desti- nation); (ii) Per diem allowance providing for ordinary and necessary expenses of trav- eling away from home (exclusive of transportation costs to and from destina- tion); or (iii) Mileage allowance providing for ordinary and necessary expenses of local transportation and transportation to, from, and at the destination while traveling away from home. (h) [Reserved]. For further guidance, see §1.274–5T(h). February 14, 20006162000–7 I.R.B. (i) [Reserved]. (j) Authority for optional methods of computing certain expenses—(1) Meal expenses while traveling away from home. The Commissioner may establish a method under which a taxpayer may use a specified amount or amounts for meals while traveling away from home in lieu of substantiating the actual cost of meals. The taxpayer will not be relieved of the requirement to substantiate the actual cost of other travel expenses as well as the time, place, and business purpose of the travel. See paragraphs(b)(2) and (c) of this section. (2) Use of mileage rates for vehicle ex- penses. The Commissioner may establish a method under which a taxpayer may use mileage rates to determine the amount of the ordinary and necessary expenses of using a vehicle for local transportation and transportation to, from, and at the destination while traveling away from home in lieu of substantiating the actual costs. The method may include appropri- ate limitations and conditions in order to reflect more accurately vehicle expenses over the entire period of usage. The tax- payer will not be relieved of the require- ment to substantiate the amount of each business use (i.e., the business mileage), or the time and business purpose of each use. See paragraphs (b)(2) and (c) of this section. (k) and (l) [Reserved]. For further guidance, see §1.274–5T(k) and (l). (m) Effective date. This section applies to expenses paid or incurred after Decem- ber 31, 1997. Par. 5. Section 1.274–5T is amended by: 1. Revising paragraphs (c)(2)(iii), (f)(4), (g) and (j). 2. Adding a sentence at the end of paragraph (m). The revision and addition read as fol- lows: §1.274–5T Substantiation requirements. * * * * * (c) * * * (2) * * * (iii) [Reserved]. For further guidance, see §1.274–5(c)(2)(iii). * * * * * (f)* * * (4) [Reserved]. For further guidance, see §1.274–5(f)(4). * * * * * (g) [Reserved]. For further guidance, see §1.274–5(g). * * * * * (j) [Reserved]. For further guidance, see §1.274–5(j). * * * * * (m) Effective date. * * * Paragraphs (c)(2)(iii), (f)(4), (g), and (j) of this sec- tion apply to expenses paid or incurred after December 31, 1997. §1.274(d)–1 [REMOVED] Par. 6. Section 1.274(d)–1 is removed. §1.274(d)–1T [REMOVED] Par. 7. Section 1.274(d)–1T is re- moved. PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT Par. 8. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 9. In §602.101, paragraph (b) is amended by adding the following entry to the table: §602.101 OMB Control numbers * * * * * (b) * * * Robert E. Wenzel, Deputy Commissioner of Internal Revenue. Approved December 28, 1999. Jonathan Talisman, Acting Assistant Secretary of the Treasury. (Filed by the Office of the Federal Register on Janu- ary 21, 2000, 3:09 p.m., and published in the issue of the Federal Register for January 26, 2000, 65 F.R. 4121) 2000–7 I.R.B.617February 14, 2000 CFR part or section whereCurrent OMB identified and describedcontrol No. * * * * * §1.274–5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-0771 * * * * * Section 401.—Qualified Pension, Profit-Sharing, Stock Bonus Plans, etc. 26 CFR 1.401(k)–1: Certain cash or deferred arrangements. Cash or deferred arrangements; elective deferrals. This ruling specifies the criteria to be met in order to automati- cally reduce an employee’s compensation by a certain amount and have that amount contributed as an elective deferral to an employer’s section 401(k) plan. Rev. Rul. 2000–8 ISSUE Will employer contributions to a profit- sharing plan fail to be considered elective contributions, within the meaning of § 1.401(k)–1(g)(3) of the Income Tax Regulations, made under a qualified cash or deferred arrangement, within the meaning of § 401(k) of the Internal Rev- enue Code, merely because they are made pursuant to an arrangement under which a fixed percentage of an employee’s com- pensation is contributed to the plan unless the employee affirmatively elects to re- ceive the amount in cash? FACTS Situation 1 Employer X maintains Plan A, a profit- sharing plan intended to satisfy the re- quirements of § 401(a), including §§ 401(k) and 401(m), and maintained on a calendar-year basis. Under Plan A, any employee of Employer X, including a newly hired employee, may elect to have Employer X make contributions on the employee’s behalf to Plan A in lieu of re- ceiving that amount as cash compensation that would otherwise be payable to the employee. The employee may designate the amount of these compensation reduc- tion contributions as a percentage of the employee’s compensation, subject to cer- tain limitations set forth in the plan. Under Plan A, if a newly hired em- ployee does not affirmatively elect to re- ceive cash or have a specified amount contributed to Plan A, his or her compen- sation is automatically reduced by 3 per- cent and this amount is contributed to Plan A. An election by any employee not to make compensation reduction contri- butions or to contribute a different per- centage of compensation can be made at any time. The election is effective for the first pay period and subsequent pay peri- ods (until superseded by a subsequent election) if filed when the employee is hired or if filed within a reasonable period thereafter ending before the compensation for the first pay period is currently avail- able. Thus, if an employee files an elec- tion to receive cash in lieu of compensa- tion reduction contributions and the election is filed when the employee is hired or within a reasonable period there- after ending before the compensation is currently available, then no compensation reduction contributions for the first pay period or subsequent pay periods are made on the employee’s behalf to Plan A until the employee makes a subsequent affirmative election to reduce his or her compensation. Elections filed at a later date are effective for payroll periods be- ginning in the month next following the date the election is filed. At the time an employee is hired, the employee receives a notice that explains the automatic compensation reduction election and the employee’s right to elect to have no such compensation reduction contributions made to the plan or to alter the amount of those contributions, includ- ing the procedure for exercising that right and the timing for implementation of any such election. Each participant in Plan A is notified annually of his or her compen- sation reduction percentage and the par- ticipant’s right to change the percentage, including the procedure for exercising that right and the timing for implementa- tion of any such election. Plan A provides that compensation re- duction contributions are immediately nonforfeitable and, if the employee has not attained age 59 1/2, cannot be distrib- uted prior to the employee’s retirement, death, or separation from service, except in the case of hardship (as defined in the plan). Plan A also provides that, for each employee who has at least 1 year of ser- vice, Employer X will make matching contributions to Plan A on account of the employee’s compensation reduction con- tributions up to a specified percentage of the employee’s compensation. Plan A does not permit after-tax employee contri- butions. Plan A provides that both matching contributions and compensation reduc- tion contributions will be invested in ac- cordance with the participant’s election among a broad range of investment funds held by the trustee or, if no invest- ment election is made by the participant, in the trust’s balanced fund which in- cludes both diversified equity and fixed income investments. 1 Situation 2 The facts are the same as in Situation 1, except Plan A is amended, effective the next January 1, to apply the same rule to both current and newly hired em- ployees. Thus, under Plan A as amended, if an employee hired before January 1 who has not elected compen- sation reduction contributions of at least 3 percent of compensation does not affir- matively elect during a specified reason- able period ending on the January 1 ef- fective date to receive cash or have a specified amount contributed to Plan A, his or her compensation is automatically reduced by 3 percent and this amount is contributed to Plan A beginning the first pay period that begins after the January 1 effective date. Under the terms of Plan A as amended, if a current employee files an election to receive cash in lieu of com- pensation reduction contributions and the election is filed during the reason- able period ending on the January 1 ef- fective date, then no compensation re- duction contributions for the first pay period beginning on or after the January 1 effective date or for subsequent pay periods are made on the employee’s be- half to Plan A until the employee makes a subsequent affirmative election to re- duce his or her compensation. In the case of a current employee who has a compensation reduction contribution election in effect for less than 3 percent, who does not make a new compensation reduction contribution election during the reasonable period ending on the Jan- uary 1 effective date, and whose com- pensation is therefore automatically re- duced by 3 percent beginning on that January 1, if that employee thereafter makes an affirmative election to reduce his or her compensation by another amount (or no amount), then that affir- mative election will continue in effect until the employee makes a subsequent affirmative election for a different amount. At the beginning of the reasonable pe- riod ending on the January 1 effective date, each current employee receives a notice that explains the new automatic compensation reduction election and the employee’s right to elect to have no such compensation reduction contributions made to the plan or to alter the amount of those contributions, including the proce- dure for exercising that right and the tim- ing for implementation of any such elec- tion. Thereafter, each employee receives the annual notice described above in Sit- uation 1. LAW AND ANALYSIS Section 401(k) provides that a profit- sharing or stock bonus plan, a pre- ERISA money purchase plan, or a rural cooperative plan can meet the require- ments of § 401(a) even if it includes a qualified cash or deferred arrangement. Section 401(k) also sets forth the re- quirements that a cash or deferred arrangement must satisfy in order to be a qualified cash or deferred arrangement. Section 1.401(k)–1(a)(2)(i) defines a February 14, 20006182000–7 I.R.B. 1 The Department of Labor has advised Treasury and the Service that, under Title I of the Employee Retirement Income Security Act of 1974 (ERISA), fiduciaries of a plan must ensure that the plan is administered prudently and solely in the interest of plan participants and beneficiaries. While ERISA § 404(c) may serve to relieve certain fiduciaries from liability when participants or beneficiaries exercise control over the assets in their individual accounts, the Department of Labor has taken the position that a participant or beneficiary will not be considered to have exercised control when the par- ticipant or beneficiary is merely apprised of invest- ments that will be made on his or her behalf in the absence of instructions to the contrary. See 29 CFR § 2550.404c-1 and 57 F.R. 46924. cash or deferred arrangement as an arrangement under which an eligible em- ployee may make a cash or deferred election with respect to contributions to, or accruals or other benefits under, a plan that is intended to satisfy the re- quirements of § 401(a). Section 1.401(k)–1(a)(2)(ii) provides that a cash or deferred arrangement does not include an arrangement under which amounts contributed under a plan at an em- ployee’s election are designated or treated at the time of contribution as after-tax employee contributions. Section 1.401(k)–1(a)(3)(i) defines a cash or deferred election as any election (or modification of an earlier election) by an employee to have the employer either provide an amount to the employee in the form of cash (or some other taxable bene- fit) that is not currently available or con- tribute an amount to a trust (or provide an accrual or other benefit) under a plan de- ferring the receipt of compensation. Sec- tion 1.401(k)1(a)(3)(iv) provides that a cash or deferred election does not include a one-time irrevocable election, made at the time an employee commences em- ployment with the employer or upon the employee’s first becoming eligible under any plan of the employer, to have contri- butions made by the employer on the em- ployee’s behalf to the plan (or to any other plan of the employer) equal to a specified amount or percentage of the employee’s compensation. Section 1.401(k)–1(e)(2) provides generally that a qualified cash or de- ferred arrangement must provide that the amount that each eligible employee may defer as an elective contribution is avail- able to the employee in cash. Section 1.401(k)–1(g)(3) defines elec- tive contributions as employer contribu- tions made to a plan that were subject to a cash or deferred election under a cash or deferred arrangement. Such contribu- tions are elective contributions without regard to whether the cash or deferred arrangement is a qualified cash or de- ferred arrangement. The definition of a cash or deferred election in § 1.401(k)–1(a)(3)(i) re- quires that the employee have an elec- tion between the employer paying cash (or some other taxable benefit) to the employee or making a contribution to a trust on behalf of the employee. The regulation does not require that the em- ployee receive an amount in cash in any case in which the employee does not make an affirmative election to have that amount contributed to the trust. Thus, a cash or deferred election will not fail to be made under a qualified cash or deferred arrangement merely be- cause, when an employee fails to make an affirmative election with respect to an amount of compensation, that amount is contributed on the employee’s behalf to a trust, provided that the employee had an effective opportunity to elect to receive that amount in cash. The em- ployee has an effective opportunity to elect to receive an amount in cash as re- quired under § 1.401(k)–1(a)(3)(i) if the employee receives notice of the avail- ability of the election and the employee has a reasonable period before the cash is currently available to make the elec- tion. If Plan A were to permit after-tax em- ployee contributions, then the amounts contributed to the plan would have to be designated or treated, at the time of the contribution, as pre-tax compensation re- duction contributions or after-tax em- ployee contributions. In Situation 1, compensation reduction contributions made by Employer X to Plan A, including those made on behalf of a newly hired employee who has not filed an election to the contrary, are amounts contributed pursuant to a procedure under which the employee receives a notice ex- plaining his or her rights to have no com- pensation reduction contributions made and, after receiving the notice, the em- ployee has a reasonable period before the cash is currently available to elect to re- ceive the cash in lieu of having it con- tributed to the plan. Similarly, in Situa- tion 2, compensation reduction contributions made by Employer X to Plan A, including those made on behalf of a newly hired employee who has not filed an election to the contrary and those made on behalf of a current employee who has elected less than 3 percent compensation reduction contributions, are amounts con- tributed pursuant to a procedure under which the employee receives a notice ex- plaining his or her rights to have no com- pensation reduction contributions made and, after receiving the notice, the em- ployee has a reasonable period before the cash is currently available to elect to re- ceive the cash in lieu of having it con- tributed to the plan. Thus, in Situation 1 andSituation 2, an eligible employee has an effective opportunity to elect to receive cash or have a contribution made to the plan on the employee’s behalf. In addi- tion, compensation reduction contribu- tions made under the plan are not contri- butions made pursuant to a one-time irrevocable election because the em- ployee can change the election in the fu- ture. Consequently, the compensation re- duction contributions described in Situation 1 andSituation 2are made pur- suant to cash or deferred elections and satisfy the requirement in § 1.401(k)–1(a)(3)(i) that the amount that each eligible employee may defer as an elective contribution be available to the employee in cash. The result would be the same if the plan required a period of service (permitted under § 401(k)(2)(D)) before an employee became eligible for elective contributions. HOLDING Where, as in Situation 1 andSituation 2, a newly hired or a current employee has an effective opportunity to elect to receive an amount in cash or have that amount contributed by the employer to a profit-sharing plan, those employer con- tributions made on the employee’s behalf to the plan in lieu of receipt of cash com- pensation will not fail to be considered elective contributions within the mean- ing of § 1.401(k)–1(g)(3) made under a qualified cash or deferred arrangement within the meaning of § 401(k) merely because they are made pursuant to an arrangement under which, in any case in which an employee does not affirma- tively elect to receive cash, the em- ployee’s compensation is reduced by a fixed percentage and that amount is con- tributed on the employee’s behalf to the plan. EFFECT ON OTHER DOCUMENTS Rev. Rul. 98–30, 1998–25 I.R.B. 8, is amplified and superseded. PAPERWORK REDUCTION ACT The collection of information con- tained in this revenue ruling has been re- viewed and approved by the Office of 2000–7 I.R.B.619February 14, 2000 February 14, 20006202000–7 I.R.B. Management and Budget (OMB) in ac- cordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control num- ber 1545-1605. An agency may not conduct or spon- sor, and a person is not required to re- spond to, a collection of information un- less the collection of information displays a valid OMB control number. The collections of information in this revenue ruling are in the third, sixth, and last paragraphs in the section headed “FACTS” and in the sixth paragraph in the section headed “LAW AND ANALY- SIS.” The collections of information are required to enable personnel in the Tax Exempt and Government Entities Divi- sion of the Internal Revenue Service to determine if an employer’s retirement plan satisfies the requirements to obtain favorable tax treatment and to enable certain employee elections to meet the requirements of § 401(k). The collec- tions of information are required to ob- tain a benefit. The likely respondents are businesses or other for-profit institu- tions, and not-for-profit institutions. The estimated total annual reporting burden is 1,750 hours. The estimated av- erage annual burden per respondent is 1 hour and 10 minutes. The estimated number of respondents is 1,500. The es- timated annual frequency of responses is on occasion. Books or records relating to a collec- tion of information must be retained as long as their contents may become mate- rial in the administration of any Internal Revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. DRAFTING INFORMATION The principal author of this revenue ruling is Roger Kuehnle of the Tax Ex- empt and Government Entities Division. For further information regarding this revenue ruling, call the Employee Plans’ taxpayer assistance telephone service at (202) 622-6074/6075 (not toll-free num- bers) between 1:30 and 3:30 p.m. East- ern Time, Monday through Thursday. Section 1296.—Election of Mark to Market For Marketable Stock 26 CFR 1.1296(e)–1: Definition of marketable stock. T.D. 8867 DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 Passive Foreign Investment Companies; Definition of Marketable Stock AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final Regulations. SUMMARY: This document contains final regulations under section 1296 relat- ing to the new mark-to-market election for stock of a passive foreign investment company (PFIC). The final regulations interpret changes made by the Taxpayer Relief Act of 1997. The final regulations affect persons holding PFIC stock that is regularly traded on certain U.S. or foreign exchanges or markets or holding stock in certain PFICs comparable to U.S. regu- lated investment companies (RICs). DATES: Effective Date: January 25, 2000. Applicability Dates: For dates of ap- plicability see section 1.1296(e)–1(g) of these regulations. FOR FURTHER INFORMATION CON- TACT: Robert Laudeman, (202) 622- 3840 (not a toll-free number). SUPPLEMENTARY INFORMATION: Background On February 2, 1999, the IRS pub- lished in the Federal Registerproposed regulations (REG-113744-98, 1999–10 I.R.B. 59, [64 F.R. 5014]) regarding the taxation of U.S. holders of PFIC stock. Three written comments regarding the proposed regulations were received. Be- cause no one requested to speak at a pub- lic hearing, no hearing was held. After consideration of all of the comments re- ceived, the proposed regulations under section 1296 are adopted as final regula- tions with some changes. The changes are discussed below. The preamble to the proposed regula- tions (64 F.R. 5014) provides a detailed discussion of the mark-to-market election for shareholders of PFIC stock and the proposed regulations. Summary of Public Comments and Changes Exchange or Other Market The proposed regulations require that a foreign exchange or market be regulated or supervised by a governmental authority of the country in which the market is lo- cated. The proposed regulations also list additional characteristics that the foreign exchange or market must have for stock that is regularly traded on the exchange or market to be marketable stock for pur- poses of section 1296. Specifically, the proposed regulations require that the ex- change have trading volume, listing, fi- nancial disclosure and other requirements designed to prevent fraud, perfect the mechanism of a free and open market, and protect investors. The final regulations add a surveillance requirement and add the concept of perfect- ing a fair and orderly market to the require- ments for exchanges. These changes are intended to clarify the characteristics that an exchange or other market must have in order to be a qualified exchange or market for purposes of section 1296 and to more closely represent common characteristics of foreign markets. See International Fed- eration of Stock Exchanges (FIBV), 1998 Market Principles, available by request from secretariat@fibv.com, and Interna- tional Organization of Securities Commis- sions (IOSCO), Supervisory Framework for Markets, Report by the Technical Com- mittee, May 1999 (visited Oct. 5, 1999) <http://www.iosco.org/iosco.html>. Stock in Certain PFICs The proposed regulations provide that stock in certain PFICs is marketable stock if the PFIC both is a corporation de- scribed in section 1296(e)(1)(B) (foreign corporations comparable to RICs) and of- fers for sale or has outstanding stock of which it is the issuer and which is re- deemable at its net asset value. The pro- posed regulations further provide that a PFIC is a corporation described in section 1296(e)(1)(B) only if the PFIC satisfies eight conditions listed in the proposed regulations with respect to the class of shares held by the electing taxpayer. The conditions are intended to describe PFICs that are comparable to RICs in relevant respects and to implement the intent of the statute by ensuring that the net asset valuations of such companies represent legitimate and sound fair market values for the companies’ stock. Two commentators asserted that the statute and legislative history indicate that Congress was only concerned that PFICs redeem stock at net asset values and that such values represent sound and legiti- mate fair market values and, therefore, it is not necessary that the PFIC resemble a RIC. The commentators suggest that the regulations be modified to include PFICs that redeem their stock at its net asset value but do not otherwise resemble RICs. Because the plain language of the statute clearly requires that the stock in any foreign corporation be comparable to a RIC, the final regulations retain the ap- proach of requiring PFICs to be compara- ble to RICs in order for their stock to be marketable stock for purposes of section 1296(e)(1)(B). The proposed regulations provide that a foreign corporation must have one hun- dred or more unrelated shareholders. One commentator recommended that the number be reduced to ten unrelated shareholders, arguing that a corporation with ten unrelated shareholders as op- posed to one hundred unrelated share- holders has the same susceptibility to legal liabilities if valuations are inaccu- rate. Requiring that a PFIC have one hundred or more unrelated shareholders is comparable to the requirement im- posed on RICs by section 851(a). In ad- dition, the IRS and the Treasury Depart- ment believe that there will be less likelihood of share price manipulation with corporations that have one hundred or more unrelated shareholders. Conse- quently, the above described rule in the proposed regulations is not changed ex- cept that “one hundred or more” is cor- rected to read “more than one hundred” unrelated shareholders. The proposed regulations require that the class of shares of the foreign corpo- ration be readily available for purchase by the general public at its net asset value by new investors in initial amounts not greater than $10,000 (U.S.). One commentator recommended that this condition not be included in the final regulations because an investment ceil- ing will not make the valuation easier or less likely to be manipulated. The condition in the proposed regula- tions regarding initial investments is not an investment ceiling. Rather, the condi- tion specifies that the foreign corporation not require a minimum initial investment of greater than $10,000 (U.S.) and that shares of the foreign corporation be read- ily available for purchase by the general public at net asset values. For example, a foreign corporation that requires new in- vestors to purchase shares for a minimum initial investment of $5,000 (U.S.) satis- fies the condition. However, a foreign corporation that requires new investors to purchase shares for a minimum initial in- vestment of $20,000 (U.S.) does not sat- isfy the condition. There is not any limit, however, on the total amount that a share- holder can invest. The final regulations clarify that this condition is not an invest- ment ceiling. Two additional requirements in the proposed regulations are that shares be available for purchase by the general public and that, no less frequently than annually, financial statements prepared by independent auditors be available to the public. One commentator asserted that availability to the general public of the shares of the foreign corporation and of the financial statements is not neces- sary and should not be required because it will not necessarily ensure a legitimate and sound fair market value for the for- eign corporation’s stock. Availability of shares for purchase by the general public is comparable to the requirement of availability of shares of RICs for purchase by the general public. In addition, availability of shares for purchase by the the general public for net asset value (in addition to current in- vestors being able to redeem shares for the same net asset value), will ensure that the net asset values are legitimate and sound. However, shares will not be considered available for purchase by the general public if the shares are only available to individuals with high annual incomes or high net worth. For example, limiting investors to individuals with an- nual incomes in excess of $200,000 or net worth in excess of $1 million will not be considered available for purchase by the general public. Similarly, availability to the general public of audited financial statements is comparable to conditions imposed on RICs and will help to ensure that the for- eign corporation’s financial information is readily available to potential and cur- rent investors, which, in turn, will help ensure that the net asset values are legiti- mate and sound. Availability of financial statements to the general public requires no more than that the statements be available upon request to potential and current investors. The proposed regulations require that quotations for the shares of the foreign corporation be determined and published on a daily basis in a widely-available medium, such as a newspaper of general circulation. One commentator asserted that the condition is not necessary be- cause the mark-to-market election is made on an annual basis at the close of the taxpayer’s taxable year. The com- mentator recommended that the condi- tion be changed to require that values be communicated to shareholders, on at least an annual basis, in written form that serves as support for such valuation. The final regulations do not adopt the commentator’s recommendation. The publication of quotations for the shares is not intended to serve solely as a means for a current shareholder of the PFIC to determine the value of the PFIC on the mark date. The publication of quotations for the shares is comparable to the prac- tice of RICs and helps to ensure that asset valuations are legitimate and sound by allowing potential investors as well as current shareholders to have ready ac- cess to price information. Because quotations for the shares of some PFICs may not be published on a daily basis, the daily publication require- ment in the proposed regulations is changed to require that quotations for the shares of the foreign corporation be de- termined and published no less fre- quently than weekly. In addition, the publication requirement is changed to clarify that the quotations must be pub- lished in a permanent medium not con- trolled by the issuer of the shares, such as an independent trade publication. The requirement that the medium be per- manent does not require the medium to be saved in a printed form; archived electronic data not susceptible to subse- quent alteration are permanent. This change is intended to assist shareholders and the IRS in verifying valuations. 2000–7 I.R.B.621February 14, 2000 The proposed regulations require that the foreign corporation be supervised or regulated as an investment company by a foreign government or instrumentality thereof. One commentator suggested that the condition be clarified with re- spect to the meaning of governmental su- pervision. In particular, the commenta- tor asks whether a foreign jurisdiction that requires a local corporation to file information upon incorporation with the local government or agency would qual- ify as supervision or regulation. The condition in the proposed regula- tions is intended to require that the PFIC be supervised or regulated as an invest- ment company in a manner comparable, but not identical, to RICs. Consequently, the final regulations clarify the type of supervision or regulation required. The final regulations provide that sufficient supervision or regulation requires that the government or agency have broad in- spection and enforcement authority and effective oversight over investment com- panies to ensure that such companies provide complete and accurate disclo- sure of relevant financial information to shareholders and potential investors and to provide adequate sanctions for false or inadequate disclosure. The mere filing of information upon incorporation does not qualify as supervision or regulation. Finally, the proposed regulations re- quire that the foreign corporation have no senior securities authorized or out- standing, including any debt other than de minimis amounts. In addition, the proposed regulations require that the for- eign corporation meet the PFIC income and asset tests in sections 1297(a)(1) and (2) with the requisite percentages in- creased from 75 percent to 90 percent and from 50 percent to 90 percent re- spectively. One commentator asserted that these conditions not be included in the final regulations because there is no basis for requiring a PFIC to have the same borrowing restrictions, asset com- position, and characteristics of RICs in order for the PFIC’s stock to be mar- ketable stock under section 1296. Conditions regarding debt and asset composition are essential characteristics of RICs. The IRS and the Treasury Depart- ment believe that Congress intended to pro- vide mark-to-market treatment to shares of PFICs that are, in fact, comparable to RICs. Special Rules for RICs The proposed regulations provide that if shares in a PFIC are owned directly or indirectly by a RIC, that is offering for sale, or has outstanding any stock of which it is the issuer, and which is re- deemable at net asset value, the PFIC shares shall be treated as marketable stock for purposes of section 1296. Section 1296(e)(2) further provides that except as provided in regulations, similar treatment as marketable stock shall apply in the case of any other RIC which publishes net asset valuations at least annually. The IRS and Treasury Department invited comments regarding situations where PFIC stock held by other RICs that pub- lish asset valuations at least annually should not be treated as marketable stock for purposes of section 1296. One commentator explained why PFIC stock held by any closed-end RIC that publishes net asset values at least annu- ally should be treated as marketable stock. In particular, that commentator pointed out that closed-end RICs are sub- ject to many of the same regulatory re- quirements as open-end RICs. In addi- tion, that commentator explained that an industry practice has developed under which closed-end RICs typically deter- mine and publish current share prices, to- gether with net asset values, on a weekly basis in print and other media. At this time, the IRS and Treasury De- partment know of no reason not to treat PFIC stock held by closed-end funds that publish net asset values at least annually as marketable stock. Consequently, as provided by section 1296(e)(2), PFIC stock held by any closed-end RIC that publishes net asset values at least annu- ally shall be treated as marketable stock. The final regulations, however, continue to reserve this issue in the event that it is determined that situations exist where PFIC stock held by closed-end RICs that publish net asset valuations at least annu- ally should not be treated as marketable stock for purposes of section 1296. If such a situation is found to exist, the reservation will be replaced at that time by a new regulatory exception. Special Analyses It has been determined that these regula- tions are not significant regulatory actions as defined in EO 12866. Therefore, a regu- latory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regula- tions, and, because the regulations do not impose a requirement for the collection of information on small entities, the Regula- tory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceeding these reg- ulations was submitted to the Chief Coun- sel for Advocacy of the Small Business Ad- ministration for comment on its impact on small business. Drafting Information The principal author of these regula- tions is Robert Laudeman of the Office of the Associate Chief Counsel (Interna- tional). However, other personnel from the IRS and Treasury Department partici- pated in their development. * * * * * Adoption of Amendments to the Regulations Accordingly, 26 CFR part 1 is amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read as follows: Authority: 26 U.S.C. 7805 * * * Section 1.1296(e)–1 also issued under 26 U.S.C. 1296(e). * * * Par. 2. Section 1.1296(e)–1 is added to read as follows: §1.1296(e)–1 Definition of marketable stock. (a) General rule. For purposes of sec- tion 1296, the term marketable stock means— (1) Passive foreign investment com- pany (PFIC) stock that is regularly traded, as defined in paragraph (b) of this section, on a qualified exchange or other market, as defined in paragraph (c) of this section; (2) Stock in certain PFICs, as described in paragraph (d) of this section; and (3) Options on stock that is described in paragraph (a)(1) or (2) of this section, to the extent provided in paragraph (e) of this section. (b) Regularly traded—(1) General rule. For purposes of paragraph (a)(1) of this section, a class of stock that is traded February 14, 20006222000–7 I.R.B. on one or more qualified exchanges or other markets, as defined in paragraph (c) of this section, is regularly traded on such exchanges or markets for any calendar year during which such class of stock is traded, other than in de minimis quanti- ties, on at least 15 days during each calen- dar quarter. (2) Anti-abuse rule. Trades that have as one of their principal purposes the meeting of the trading requirement of paragraph (b)(1) of this section shall be disregarded. Further, a class of stock shall not be treated as meeting the trading requirement of paragraph (b)(1) of this section if there is a pattern of trades con- ducted to meet the requirement of para- graph (b)(1) of this section. (c) Qualified exchange or other market—(1) General rule. For purposes of paragraph (a)(1) of this section, the term qualified exchange or other market means, for any calendar year— (i) A national securities exchange that is registered with the Securities and Ex- change Commission or the national mar- ket system established pursuant to section 11A of the Securities Exchange Act of 1934 (15 U.S.C. 78f); or (ii) A foreign securities exchange that is regulated or supervised by a governmen- tal authority of the country in which the market is located and which has the fol- lowing characteristics— (A) The exchange has trading volume, listing, financial disclosure, surveillance, and other requirements designed to pre- vent fraudulent and manipulative acts and practices, to remove impediments to and perfect the mechanism of a free and open, fair and orderly, market, and to protect in- vestors; and the laws of the country in which the exchange is located and the rules of the exchange ensure that such re- quirements are actually enforced; and (B) The rules of the exchange effectively promote active trading of listed stocks. (2) Exchange with multiple tiers. If an exchange in a foreign country has more than one tier or market level on which stock may be separately listed or traded, each such tier shall be treated as a sepa- rate exchange. (d) Stock in certain PFICs—(1) Gen- eral rule. Except as provided in para- graph (d)(2) of this section, a foreign cor- poration is a corporation described in section 1296(e)(1)(B), and paragraph (a)(2) of this section, if the foreign corpo- ration offers for sale or has outstanding stock of which it is the issuer and which is redeemable at its net asset value and if the foreign corporation satisfies the following conditions with respect to the class of shares held by the electing taxpayer— (i) At all times during the calendar year, the foreign corporation has more than one hundred shareholders with respect to the class, other than shareholders who are re- lated under section 267(b); (ii) At all times during the calendar year, the class of shares of the foreign cor- poration is readily available for purchase by the general public at its net asset value and the foreign corporation does not re- quire a minimum initial investment of greater than $10,000 (U.S.); (iii) At all times during the calendar year, quotations for the class of shares of the foreign corporation are determined and published no less frequently than on a weekly basis in a widely-available perma- nent medium not controlled by the issuer of the shares, such as a newspaper of gen- eral circulation or a trade publication; (iv) No less frequently than annually, in- dependent auditors prepare financial state- ments of the foreign corporation that in- clude balance sheets (statements of assets, liabilities, and net assets) and statements of income and expenses, and those statements are made available to the public; (v) The foreign corporation is super- vised or regulated as an investment com- pany by a foreign government or an agency or instrumentality thereof that has broad inspection and enforcement author- ity and effective oversight over invest- ment companies; (vi) At all times during the calendar year, the foreign corporation has no senior securities authorized or outstanding, in- cluding any debt other than in de minimis amounts; (vii) Ninety percent or more of the gross income of the foreign corporation for its taxable year is passive income, as defined in section 1297(a)(1) and the reg- ulations thereunder; and (viii) The av- erage percentage of assets held by the for- eign corporation during its taxable year which produce passive income or which are held for the production of passive in- come, as defined in section 1297(a)(2) and the regulations thereunder, is at least 90 percent. (2) Anti-abuse rule. If a foreign corpo- ration undertakes any actions that have as one of their principal purposes the ma- nipulation of the net asset value of a class of its shares, for the calendar year in which the manipulation occurs, the shares are not marketable stock for purposes of paragraph (d)(1) of this section. (e) [Reserved] (f) Special rules for regulated invest- ment companies (RICs) —(1) General rule. In the case of any RIC that is offering for sale, or has out- standing, any stock of which it is the is- suer and which is redeemable at net asset value, if the RIC owns directly or indi- rectly, as defined in sections 958(a)(1) and (2), stock in any passive foreign in- vestment company, that stock will be treated as marketable stock owned by that RIC for purposes of section 1296. Except as provided in paragraph (f)(2) of this sec- tion, in the case of any other RIC that publishes net asset valuations at least an- nually, if the RIC owns directly or indi- rectly, as defined in sections 958(a)(1) and (2), stock in any passive foreign in- vestment company, that stock will be treated as marketable stock owned by that RIC for purposes of section 1296. (2) [Reserved] (g) Effective date. This section applies to shareholders whose taxable year ends on or after January 25, 2000 for stock in a foreign corporation whose taxable year ends with or within the shareholder’s tax- able year. In addition, shareholdersmay elect to apply these regulations to any tax- able year beginning after December 31, 1997, for stock in a foreign corporation whose taxable year ends with or within the shareholder’s taxable year. Robert E. Wenzel, Deputy Commissioner of Internal Revenue. Approved January 12, 2000. Jonathan Talisman, Acting Assistant Secretary of the Treasury. (Filed by the Office of the Federal Register on Janu- ary 21, 2000, 8:45 a.m., and published in the issue of the Federal Register for January 25, 2000, 65 F.R. 3817) 2000–7 I.R.B.623February 14, 2000 February 14, 20006242000–7 I.R.B. Notice of Proposed Rulemaking and Notice of Public Hearing Qualified Transportation Fringe Benefits REG–113572–99 AGENCY: Internal Revenue Service ACTION: Notice of proposed rulemaking and notice of public hearing. SUMMARY: This document contains proposed regulations relating to qualified transportation fringe benefits. These pro- posed regulations reflect changes to the law made by the Energy Policy Act of 1992, the Taxpayer Relief Act of 1997, and the Transportation Equity Act for the 21 st Century. These proposed regulations affect employers that offer qualified transportation fringes and employees who receive these benefits. This document also provides notice of a public hearing on these proposed regulations. DATES: Written and electronic comments must be received by April 26, 2000. Out- lines of topics to be discussed at the public hearing scheduled for June 1, 2000 at 10 a.m. must be received by May 10, 2000. ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–113572–99), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand de- livered Monday through Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG–113572–99), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washing- ton, DC. Alternatively, taxpayers may sub- mit comments electronically via the Inter- net 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/tax_regs/reglist. html. The public hearing will be held in room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW., Washing- ton, DC. FOR FURTHER INFORMATION CON- TACT: Concerning the proposed regula- tions, John Richards of the Office of As- sociate Chief Counsel (Employee Benefits and Exempt Organizations), (202) 622-6040; concerning submissions of comments, the hearing and/or to be placed on the building access list to attend the hearing, LaNita Van Dyke, (202) 622- 7190 (not toll-free numbers). SUPPLEMENTARY INFORMATION: Paperwork Reduction Act The collections of information con- tained in this notice of proposed rulemak- ing have been submitted to the Office of Management and Budget for review in ac- cordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Com- ments on the collections of information should be sent to the Office of Manage- ment and Budget, Attn: Desk Officer for the Department of Treasury, Office of In- formation and Regulatory Affairs, Wash- ington, DC 20503, with copies to the In- ternal Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224. Comments on the collection of information should be re- ceived by March 27, 2000. Comments are specifically requested concerning: Whether the proposed collections of in- formation are necessary for the proper performance of the functions of the Inter- nal Revenue Service, including whether the information will have practical utility; The accuracy of the estimated burden as- sociated with the proposed collections of information (see below); How the quality, utility, and clarity of the information to be collected may be en- hanced; How the burden of complying with the proposed collections of informa- tion may be minimized, including through the application of automated collection techniques or other forms of information technology; and Estimates of capital or start-up costs and costs of operation, maintenance, and pur- chase of service to provide information. The collections of information in this proposed regulation are in 26 CFR 1.132–9(b). This information is required by the Internal Revenue Service to imple- ment section 132(f). This information will be used to verify compliance with section 132(f). Section 132(f)(3) provides that qualified transportation fringes can include cash reimbursement for qualified trans- portation fringes. The proposed regulations require that employers keep records of sub- stantiation provided by employees in order to receive cash reimbursement for qualified transportation fringes. Section 132(f)(4) provides that an employee may choose be- tween cash compensation and any qualified transportation fringe. The proposed regu- lations require that employers keep records, in a verifiable form, such as written or elec- tronic, of employee elections to reduce compensation. The value of qualified transportation fringes provided for a month exceeding the applicable statutory monthly limit must be reported on the employee’s Form W-2. The burden for this require- ment is reflected in the burden for Form W- 2. The likely recordkeepers are employers. The likely respondents are employees. Estimated total annual recordkeeping burden: 7,020,000 hours. Estimated average annual recordkeep- ing burden per recordkeeper : The av- erage annual recordkeeping burden will vary depending on the size of the em- ployer. The estimated average annual recordkeeping burden per recordkeeper is 26.5 hours. Estimated number of recordkeepers: 265,343 Estimated total annual reporting bur- den: 5,948,728 hours Estimated average annual reporting burden per respondent: .8 hours. Estimated number of respondents: 7,264,970 Estimated annual frequency of re- sponses: Monthly. 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. Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. Background This document contains a proposed amendment to the Income Tax Regula- tions (26 CFR part 1) under section Part IV. Items of General Interest 2000–7 I.R.B.625February 14, 2000 132(f). Congress amended section 132 as part of the Energy Policy Act of 1992, Public Law No. 102-486, section 1911 (106 Stat. 3012), effective after December 31, 1992. This provision ex- cludes from gross income the value of any qualified transportation fringe pro- vided by an employer to an employee to the extent it does not exceed the applica- ble statutory monthly limit. This 1992 amendment to section 132 resulted in three changes to the tax treat- ment of employer-provided transporta- tion benefits. First, Congress added an exclusion for transportation provided by an employer to an employee in a com- muter highway vehicle. Second, mass transit passes provided by an employer to an employee became excludable as a qualified transportation fringe and not as a de minimis fringe. The exclusions for transportation provided by an employer to an employee in a commuter highway vehicle and mass transit passes were made subject to an aggregate $60 per month limit (adjusted for cost of living). Third, Congress eliminated the working condition fringe for commuter parking, imposed a $150 per month limit (ad- justed for cost of living) for the exclu- sion for qualified parking, and provided that employer-provided parking is ex- cludable from gross income only as a qualified transportation fringe. The 1992 amendment provided that qualified transportation fringes could not be pro- vided in lieu of salary. Section 1072 of the Taxpayer Relief Act of 1997 (TRA ‘97), Pub. L. No. 105-34 (111 Stat. 948), amended section 132(f), ef- fective for tax years beginning after De- cember 31, 1997, to permit qualified park- ing to be provided to employees in lieu of salary. Section 9010 of the Transportation Equity Act for the 21 st Century (TEA 21), Pub. L. No. 105-178 (112 Stat. 507), amended section 132(f) to increase the monthly dollar limits to $65 for transporta- tion in a commuter highway vehicle and mass transit passes 1 and $175 for qualified parking and to provide that, effective after December 31, 1997, any qualified trans- portation fringe may be provided to em- ployees in lieu of salary. Explanation of Provisions This document contains proposed regu- lations under section 132. The proposed regulations provide guidance, in question and answer form, to employers that pro- vide qualified transportation fringes to employees. Qualified transportation fringes consist of transportation in a com- muter highway vehicle, any transit pass, and qualified parking provided by an em- ployer to an employee. Notice 94–3, 1994–1 C.B. 327, pro- vided guidance on qualified transporta- tion fringes in the form of questions and answers. The proposed regulations re- flect statutory changes in section 132(f) since 1994, including the revised monthly dollar limits and the use of bona fide salary reduction arrangements, as permit- ted under TRA ’97 and TEA 21, and gen- erally conform with the guidance in No- tice 94–3. In response to public comments, the proposed regulations also provided additional guidance concerning the standards for determining when the section 132(f) exclusion applies to cash reimbursement of transit pass expenses. Section 132(f) limits the value of quali- fied transportation fringes that may be ex- cluded from an employee’s gross income. The proposed regulations explain that there are two categories of qualified transportation fringes for purposes of de- termining the amount that is excludable from gross income. The first category is transportation in a commuter highway ve- hicle and transit passes. The second cate- gory is qualified parking. There is a statutory monthly limit on the value of the benefits from each category that is ex- cludable from gross income. For 1999 and 2000, the statutory monthly limit is $65 for transportation in a commuter highway vehicle and mass transit passes and $175 for qualified parking. An em- ployee may receive benefits from each category provided the applicable statutory monthly limit for that category is not ex- ceeded. The amount by which the value of qualified transportation fringes pro- vided by an employer to an employee ex- ceeds the applicable statutory monthly limit is included in the employee’s wages for income and employment tax purposes. The proposed regulations provide that, for purposes of valuing qualified parking, the valuation rules under section 1.61–21(b) generally apply. With respect to employer-provided van pool benefits, the regulations provide that an employer may use the special valuation rules pro- vided under section 1.61–21(c), (d), (e), and (f) in valuing these benefits. An exam- ple in the proposed regulations illustrates that in determining the value of a transit pass sold at a discount for purposes of sec- tion 132(f), the purchase price rather than the face amount of the transit pass controls. The proposed regulations reflect that qualified transportation fringes include cash reimbursement by an employer to an employee for expenses incurred by the em- ployee for transportation in a commuter highway vehicle and qualified parking. Section 132(f)(3) provides that qualified transportation fringes include cash reim- bursement for a transit pass only if a voucher or similar item that is exchange- able for a transit pass is not readily avail- able for direct distribution by the employer to the employee. In defining “readily available,” the regulations reflect the gen- eral standards set forth in Notice 94–3, under which an amount is readily available if an employer can obtain it on terms no less favorable than those available to an in- dividual employee and without incurring a significant administrative cost. In addition, the proposed regulations clarify the meaning of “significant adminis- trative costs.” The proposed regulations provide that the determination of whether obtaining a voucher would result in a sig- nificant administrative cost is made with respect to each transit system voucher. A transit system voucher is a voucher that is accepted by one or more mass transit oper- ators (e.g., train, subway, and bus) in an area as fare media (or in exchange for fare media). The proposed regulations provide a safe harbor under which administrative costs are treated as significant if the aver- age monthly administrative costs incurred by the employer for a voucher (disregard- ing delivery charges imposed by the fare media provider to the extent not in excess of $15 per order) are more than 1 percent of the average monthly value of the vouchers for a system. These standards are intended to provide clear guidance so that employers can determine when qualified transporta- tion fringes include cash reimbursement for transit passes. The proposed regulations provide that 1 The dollar limit for transportation in a commuter highway vehicle and transit passes was further increased to $100 effective January 1, 2002. February 14, 20006262000–7 I.R.B. reimbursements may be made only pur- suant to a bona fide reimbursement arrangement. Thus, an employee must provide substantiation that an expense has been incurred for qualified transportation fringes in order to receive a reimburse- ment. The regulations recognize that the substantiation requirements vary depend- ing upon the payment method used to pur- chase transportation in a commuter high- way vehicle, mass transit passes, and qualified parking. The regulations pro- vide examples of what constitutes reason- able reimbursement procedures in certain circumstances. For example, if an em- ployee uses metered parking, the substan- tiation requirement may be satisfied if the employee certifies that the expense was incurred and the employer has no reason to believe the employee did not actually incur the expense. The proposed regulations provide that there are no substantiation requirements with respect to mass transit passes pro- vided directly by an employer to its em- ployees. Of course, an employer may im- pose its own substantiation requirements in addition to those required under the regulations. The proposed regulations follow the approach taken in Notice 94–3 with re- spect to taxing the value of employer-pro- vided parking benefits provided to mem- bers of car and van pools. The regulations provide that the “prime mem- ber” bears the tax consequences with re- spect to the parking space. 2 The prime member is the employee to whom the parking space is assigned. The proposed regulations reflect that qualified transportation fringes may be provided under a compensation reduction arrangement which permits an employee to make a compensation reduction election. A compensation reduction election is an election in which the employee chooses between a fixed amount of compensation to be received at a specified future date and a fixed amount of qualified transportation fringes to be provided with respect to a specified future period (such as a calendar month). The proposed regulations provide that the compensation reduction election for any month in a year may not exceed the aggregate statutory monthly maximum for that year (e.g., $240 for 1999 and 2000 ($65 plus $175)). The election must be made before the employee is able currently to receive the taxable compensation. Under the proposed regulations, the deter- mination of whether the employee is able currently to receive the taxable compensa- tion does not depend on whether the com- pensation has been constructively received for purposes of section 451. The proposed regulations require that an election be irrevocable after the beginning of the period for which the qualified trans- portation fringes will be provided. How- ever, unused amounts can be carried over to any subsequent months, including months in subsequent years, but cannot be used for any purpose other than qualified transporta- tion fringes under section 132(f). The proposed regulations provide that the exclusion for qualified transportation fringes applies only to employees. Part- ners, 2-percent S-corporation sharehold- ers, and independent contractors are not considered to be employees for purposes of qualified transportation fringes. How- ever, amounts may be excludable pur- suant to the working condition fringe rules and the de minimis fringe rules that apply to partners, 2-percent S- corpora- tion shareholders, and independent con- tractors under section 132(d) and (e). The proposed regulations provide that qualified transportation fringes not ex- ceeding the applicable statutory monthly limit are not subject to employment taxes. However, qualified transportation fringes exceeding the applicable statutory monthly limit are includible in the em- ployee’s wages for income and employ- ment tax purposes. If the value of non- cash qualified transportation fringes provided to an employee exceeds the ap- plicable statutory monthly limit, the em- ployer may follow the reporting and with- holding guidelines provided in Announcement 85–113, 1985–31 I.R.B. 31. Announcement 85–113 provides that employers may elect, for purposes of the FICA, the FUTA, and federal income tax withholding, to treat noncash fringe bene- fits as paid on a pay period, quarterly, semi-annual, annual, or other basis, pro- vided that the benefits are treated as paid no less frequently than annually. An- nouncement 85–113 also provides a spe- cial accounting rule for noncash fringes provided during the last two months of a calendar year. Special Analyses It has been determined that this notice of proposed rulemaking is not a signifi- cant regulatory action as defined in Exec- utive Order 12866. Therefore, a regula- tory assessment is not required. An Initial Regulatory Flexibility Analysis has been prepared as required for the collection of information in this notice of proposed rulemaking under 5 U.S.C. § 603. The analysis follows: Initial Regulatory Flexibility Analysis This proposed rule may have an impact on small organizations that provide quali- fied transportation fringes in the form of cash reimbursement or that offer qualified transportation fringes in lieu of salary. Section 132(f)(3) provides that qualified transportation fringes may be provided in the form of cash reimbursement. The leg- islative history indicates that cash reim- bursements must be made pursuant to a bona fide reimbursement arrangement. Thus, this proposed rule provides that em- ployers must receive substantiation from employees as a condition to providing cash reimbursement for qualified trans- portation fringes. Section 132(f)(4) pro- vides that an employee may choose be- tween cash compensation and qualified transportation fringes. This proposed rule provides that employers must keep records with respect to employee com- pensation reduction elections. Thus, the requirements under this proposed rule create a collection of information require- ment for employers. The objectives of this proposed rule with respect to employee substantiation of qualified transportation fringes is to carry out the legislative intent that cash reim- bursement be provided by an employer only under a bona fide reimbursement arrangement. The objective of the record- keeping requirement with respect to em- ployee compensation reduction elections is to ensure against recharacterization of taxable compensation after it has been paid to an employee. The legal basis for this proposed rule is section 132(f)(3) and (4). All classes of employers will likely 2 Other pool members may chose to reimburse the costs of the prime member, in which event, under Rev. Rul. 55-555, 1955-2 C.B. 20, the reimburse- ments will not be includible in the prime member’s gross income. See also Rev. Rul. 80-99, 1980-1 C.B. 10. 2000–7 I.R.B.627February 14, 2000 offer qualified transportation fringes and therefore will be affected by this proposed rule. Approximately 265,000 small enti- ties may be affected by this proposed rule. There are no professional skills necessary for the recordkeeping required under this proposed rule. The IRS is not aware of any other rele- vant federal rules which may duplicate, overlap, or conflict with this proposed rule. A less burdensome alternative for small organizations would be to exempt those entities from the recordkeeping require- ments under this proposed rule. However, it would be inconsistent with the statutory provisions and the legislative history to ex- empt those entities from the recordkeeping requirements imposed under this rule. This proposed rule provides several op- tions which avoid more burdensome recordkeeping requirements for small enti- ties. This proposed rule provides that (1) there are no substantiation requirements if the employer distributes transit passes in kind; (2) a compensation reduction elec- tion can be made electronically; (3) an election to reduce compensation can be au- tomatically renewed; and (4) an employer can provide for deemed compensation re- duction elections under its qualified trans- portation fringe benefit plan. Pursuant to section 7805(f) of the Inter- nal Revenue Code, this notice of pro- posed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. Comments and Public Hearing Before these proposed regulations are adopted as final regulations, considera- tion will be given to any written com- ments (a signed original and eight (8) copies) and electronic comments that are submitted timely to the IRS. The IRS and Treasury Department specifically request comments on the clarity of the proposed regulations and how they can be made easier to understand, and on the adminis- trability of the rules in the proposed regu- lations. All comments will be available for public inspection and copying. A public hearing has been scheduled for June 1, 2000, beginning at 10 a.m. in room 2615 of the Internal Revenue Building, 1111 Constitution Avenue, NW., Wash- ington, DC. Due to building security pro- cedures, visitors must enter at the 10 th Street entrance, located between Constitu- tion and Pennsylvania Avenues, NW. In addition, all visitors must present photo identification to enter the building. Be- cause of access restrictions, visitors will not be admitted beyond the immediate en- trance area more than 15 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CON- TACT” section of this preamble. The rules of 26 CFR 601.601 (a) (3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written comments and an outline of the topics to be discussed and the time to be devoted to each topic (signed origi- nal and eight (8) copies) by May 10, 2000. A period of 10 minutes will be al- lotted to each person for making com- ments. An agenda showing the schedul- ing of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing. Drafting Information The principal author of these proposed regulations is John Richards, Office of the Associate Chief Counsel (Employee Ben- efits and Exempt Organizations). How- ever, other personnel from the IRS and Treasury Department participated in their development. * * * * * Proposed Amendments to the Regulations Accordingly, 26 CFR part 1 is pro- posed to be amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read to read in part as follows: Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.132–0 is amended by adding entries for §1.132–9 to read as fol- lows: §1.132–0 Outline of regulations under section 132. * * * * * §1.132–9(a) Table of Contents. §1.132–9(b) Questions and Answers. * * * * * Par. 3 Section 1.132–9 is added to read as follows: §1.132–9 Qualified Transportation Fringes. (a) Table of Contents. This section contains a list of the questions and an- swers in §1.132–9. Q-1. What is a qualified transportation fringe? Q-2. What is transportation in a com- muter highway vehicle? Q-3. What are transit passes? Q-4. What is qualified parking? Q-5. To which workers may qualified transportation fringes be provided? Q-6. Must a qualified transportation fringe benefit plan be in writing? Q-7. Is there a limit on the value of quali- fied transportation fringes that may be ex- cluded from an employee’s gross income? Q-8. What amount is includible in an em- ployee’s wages for income and employ- ment tax purposes if the value of the qual- ified transportation fringe exceeds the applicable statutory monthly limit? Q-9. Are excludable qualified transporta- tion fringes calculated on a monthly basis? Q-10. May an employee receive qualified transportation fringes from more than one employer? Q-11. May qualified transportation fringes be provided to employees pur- suant to a compensation reduction agree- ment? Q-12. What is a compensation reduction election for purposes of section 132(f)? Q–13. Is there a limit to the amount of the compensation reduction? Q–14. When must the employee have made a compensation reduction election and under what circumstances can the amount be paid in cash to the employee? Q–15. May an employee whose qualified transportation fringe costs are less than the employee’s compensation reduction carry over this excess amount to subse- quent periods? Q–16. How does section 132(f) apply to expense reimbursements? Q-17. May an employer provide nontax- able cash reimbursement under section 132(f) for periods longer than one month? Q-18. What are the substantiation re- quirements if an employer distributes transit passes? Q-19. May an employer choose to im- pose substantiation requirements in addi- tion to those described in this regulation? February 14, 20006282000–7 I.R.B. Q-20. How is the value of parking deter- mined? Q-21. How do the qualified transporta- tion fringe rules apply to van pools? Q-22. What are the reporting and em- ployment tax requirements for qualified transportation fringes? Q-23. How does section 132(f) interact with other fringe benefit rules? Q-24. May qualified transportation fringes be provided to individuals who are partners, 2-percent shareholders of S-cor- porations, or independent contractors? (b) Questions and Answers. Q-1. What is a qualified transporta- tion fringe? A-1. (a) The following benefits are “qualified transportation fringe” benefits: (1) Transportation in a commuter high- way vehicle. (2) Transit passes. (3) Qualified parking. (b) An employer may simultaneously provide an employee with any one or more of these three benefits. Q-2. What is transportation in a commuter highway vehicle? A-2. Transportation in a commuter highway vehicle is transportation pro- vided by an employer to an employee in connection with travel between the em- ployee’s residence and place of employ- ment. A “commuter highway vehicle” is a highway vehicle with a seating capacity of at least 6 adults (excluding the driver) and with respect to which at least 80 per- cent of the vehicle’s mileage is reasonably expected to be– (a) For transporting employees in con- nection with travel between their resi- dences and their place of employment; and (b) On trips during which the number of employees transported for commuting is at least one-half of the adult seating ca- pacity of the vehicle (excluding the dri- ver). Q-3. What are transit passes? A-3. A “transit pass” is any pass, token, farecard, voucher, or similar item (including an item exchangeable for fare media) that entitles a person to transporta- tion— (a) On mass transit facilities (whether or not publicly owned); or (b) Provided by any person in the busi- ness of transporting persons for compen- sation or hire in a highway vehicle with a seating capacity of at least six adults (ex- cluding the driver). Q-4. What is qualified parking? A-4. (a) “Qualified parking” is parking provided to an employee by an employer— (1) On or near the employer’s business premises; or (2) At a location from which the em- ployee commutes to work by carpool, commuter highway vehicle, mass transit facilities, transportation provided by any person in the business of transporting per- sons for compensation or hire or by any other means. (b) However, parking on or near prop- erty used by the employee for residential purposes is not qualified parking. (c) Parking is provided by an employer if— (1) The employer pays for the parking; (2) The employer reimburses the em- ployee for parking expenses; or (3) The parking is on property that the employer owns or leases. See Q/A-16 of this section for rules relating to cash reim- bursements. Q-5. To which workers may quali- fied transportation fringes be provided? A-5. Qualified transportation fringes may be provided only by employ- ers to employees. The term “employee” for purposes of qualified transportation fringes is defined in §1.132–1(b)(2)(i). This term includes only common law em- ployees and other statutory employees, such as officers of corporations. See Q/A-24 of this section for rules regarding partners, 2-percent shareholders, and in- dependent contractors. Q-6. Must a qualified transportation fringe benefit plan be in writing? A-6. No. Section 132(f) does not re- quire that a qualified transportation fringe benefit plan be in writing. Q-7. Is there a limit on the value of qualified transportation fringes that may be excluded from an employee’s gross in- come? A-7. (a) Transportation in a com- muter highway vehicle and transit passes. Before January 1, 2002, up to $65 is ex- cludable from the gross income of an em- ployee for transportation in a commuter highway vehicle and transit passes pro- vided by an employer for a month. On January 1, 2002, this amount is increased to $100 per month. (b) Parking. Up to $175 is exclud- able from the gross income of an em- ployee for qualified parking in a month. (c) Combination. An employer may provide qualified parking benefits in addi- tion to transportation in a commuter high- way vehicle and transit passes. (d) Cost-of-living adjustments. The amounts in paragraphs (a) and (b) of this Q/A–7 are adjusted annually, beginning with 2000, to reflect cost-of-living. The adjusted figures are announced by the Service before the beginning of the year. Q-8. What amount is includible in an employee’s wages for income and em- ployment tax purposes if the value of the qualified transportation fringe exceeds the applicable statutory monthly limit? A-8. Generally, an employee must include in gross income the amount by which the fair market value of the benefit exceeds the sum of the amount, if any, paid by the employee and any amount ex- cluded from gross income under section 132(a)(5). Thus, assuming no other statu- tory exclusion applies, if an employer provides an employee with a qualified transportation fringe that exceeds the ap- plicable statutory monthly limit and the employee does not make any payment, the value of the benefits provided in ex- cess of the applicable statutory monthly limit is included in the employee’s wages for income and employment tax purposes. See § 1.61–21(b)(1). The following ex- amples illustrate the principles of this Q/A-8: Example 1. (i) For each month in 2000, Em- ployer M provides a transit pass valued at $75 to Employee D, who does not pay any amount to Em- ployer M for the transit pass. (ii) In this example, because the value of the monthly transit pass exceeds the statutory monthly limit by $10, $120 ($75 - $65, times 12 months) must be included in D’s wages for income and em- ployment tax purposes for 2000 with respect to the transit passes. Example 2. (i) For each month in 2000, Em- ployer M provides qualified parking valued at $195 to Employee E, who does not pay any amount to M for the parking. (ii) In this example, because the fair market value of the qualified parking exceeds the statutory monthly limit by $20, $240 ($195 - $175, times 12 months) must be included in Employee E’s wages for income and employment tax purposes for 2000 with respect to the qualified parking. Example 3. (i) For each month in 2000, Em- ployer P provides qualified parking with a fair mar- ket value of $220 per month to its employees, but charges each employee $45 per month. (ii) In this example, because the sum of the amount paid by an employee ($45) plus the amount 2000–7 I.R.B.629February 14, 2000 excludable for qualified parking ($175) is not less than the fair market value of the monthly benefit, no amount is includible in the employee’s wages for in- come and employment tax purposes with respect to the qualified parking. Q-9. Are excludable qualified trans- portation fringes calculated on a monthly basis? A-9. Yes. The value of transporta- tion in a commuter highway vehicle, tran- sit passes, and qualified parking is calcu- lated on a monthly basis to determine whether the value of the benefit has ex- ceeded the applicable statutory monthly limit on qualified transportation fringes. Except in the case of a transit pass, the ap- plicable statutory monthly limit applies to qualified transportation fringes used by the employee in a month. In the case of a transit pass, the applicable statutory monthly limit applies to the transit passes provided by the employer to the employee in a month for that month or for any pre- vious month in the calendar year. Monthly exclusion amounts are not com- bined to provide a qualified transportation fringe in any month exceeding the statu- tory limit. A “month” is a calendar month or a substantially equivalent period ap- plied consistently. The following exam- ples illustrate the principles of this Q/A-9: Example 1.(i) Employee E incurs $150 for qual- ified parking used during the month of June, 2000, for which E is reimbursed $150 by Employer R. E incurs $180 in expenses for qualified parking used during the month of July, 2000, for which E is reim- bursed $180 by R. (ii) In this example, because monthly exclusion amounts may not be combined to provide a benefit in any month greater than the applicable statutory limit, the amount by which the amount reimbursed for July exceeds the applicable statutory monthly limit ($180 minus $175 equals $5) is includible in E’s wages for income and employment tax purposes. Example 2. (i). Employee F receives transit passes from Employer G with a value of $195 in the month of March (when the applicable statutory monthly limit is $65). F was hired during January and has not received any transit passes from G. (ii). In this example, the value of the transit passes (three months times $65 equals $195) is ex- cludable from F’s wages for income and employ- ment tax purposes. However, if F was not hired until March, only $65 would be excludable from F’s wages for income and employment tax purposes. Example 3. (i). Each month during 2000, Em- ployer R distributes transit passes with a face amount of $70 to each of its employees. Transit passes with a face amount of $70 can be purchased from the transit system by any individual for $65. (ii). In this example, because the value of the transit passes distributed by R does not exceed the applicable statutory monthly limit ($65), no portion of the transit passes is included as wages for income and employment tax purposes. Q-10. May an employee receive qualified transportation fringes from more than one employer? A-10. Yes. The statutory monthly limits described in Q/A-7 of this section apply to benefits provided by an employer to its employees. For this purpose, all employees treated as employed by a sin- gle employer under section 414(b), (c), (m), or (o) are treated as employed by a single employer. See § 1.132–1(c). Thus, qualified transportation fringes paid by entities under common control under sec- tion 414(b), (c), (m), or (o) are combined for purposes of applying the applicable statutory limit. In addition, an individual who is treated as an employee of the em- ployer under section 414(n) is treated as an employee of the employer for purposes of section 132. See § 414(t). The follow- ing examples illustrate the principles of this Q/A-10: Example 1. (i) During 2000, Employee E works for Employers M and N, who are unrelated and not treated as a single employer under section 414(b), (c), (m), or (o). Each month, M and N each provide qualified parking benefits to E with a value of $100. (ii) In this example, because M and N are unre- lated employers, and the value of the monthly park- ing benefit provided by each is not more than the ap- plicable statutory monthly limit, the parking benefits provided by each employer are excludable as quali- fied transportation fringes assuming that the other requirements of this section are satisfied. Example 2. (i) Same facts as in Example 1, ex- cept that M and N are treated as a single employer under section 414(b). (ii) In this example, because M and N are treated as a single employer, the value of the monthly park- ing benefit provided by M and N must be combined for purposes of determining whether the applicable statutory monthly limit has been exceeded. Thus, the amount by which the value of the parking benefit exceeds the monthly limit ($200 minus $175 equals $25) for each month in 2000 is includible in E’s wages for income and employment tax purposes. Q-11. May qualified transportation fringes be provided to employees pur- suant to a compensation reduction agree- ment? A-11. Yes. An employer may offer employees a choice between cash com- pensation and any qualified transportation fringe. An employee who is offered this choice and who elects qualified trans- portation fringes is not required to include the cash compensation in income if— (a) The election is pursuant to an arrangement described in Q/A-12 of this section; (b) The amount of the reduction in cash compensation does not exceed the limitation in Q/A-13 of this section; (c) The arrangement satisfies the tim- ing and reimbursement rules in Q/A-14 and 16 of this section; and (d) The related fringe benefit arrange- ment otherwise satisfies the requirements set forth elsewhere in this section. Q-12. What is a compensation re- duction election for purposes of section 132(f)? A-12. (a) Election requirements generally.A compensation reduction arrangement is an arrangement under which the employer provides the em- ployee with the right to elect whether the employee will receive either a fixed amount of cash compensation at a speci- fied future date or a fixed amount of qual- ified transportation fringes to be provided for a specified future period (such as qual- ified parking to be used during a future calendar month). The employee’s elec- tion must be in writing or another form, such as electronic, that includes, in a per- manent and verifiable form, the informa- tion required to be in the election. The election must contain the date of the elec- tion, the amount of the compensation to be reduced, and the period for which the benefit will be provided. The election must relate to a fixed dollar amount or fixed percentage of compensation reduc- tion. An election to reduce compensation for a period by a set amount for such pe- riod may be automatically renewed for subsequent periods. (b) Negative election permitted. An employer may provide under its qualified transportation fringe benefit plan that a compensation reduction election will be deemed to have been made if the em- ployee does not elect to receive cash com- pensation in lieu of the qualified trans- portation fringe provided that the employee receives adequate notice that a compensation reduction will be made and is given adequate opportunity to choose to receive the cash compensation instead of the qualified transportation fringe. Q–13. Is there a limit to the amount of the compensation reduction? A–13. Yes. Each month, the amount of the compensation reduction may not exceed the combined applicable statutory monthly limits for transportation in a commuter highway vehicle, transit passes, and qualified parking. For exam- ple, for 2000, an employee could elect to reduce compensation for any month by no February 14, 20006302000–7 I.R.B. more than $240 ($65 for transportation in a commuter highway vehicle and transit passes, plus $175 for qualified parking) with respect to qualified transportation fringes. If an employee were to elect to reduce compensation by $250 for a month, the excess $10 ($250 minus $240) would be includible in the employee’s wages for income and employment tax purposes. Q–14. When must the employee have made a compensation reduction election and under what circumstances can the amount be paid in cash to the em- ployee? A–14. The compensation reduction election must satisfy the following re- quirements. (a) Timing of election. The compen- sation reduction election must be made before the employee is able currently to receive the cash or other taxable amount at the employee’s discretion. The deter- mination of whether the employee is able currently to receive the cash does not de- pend on whether it has been construc- tively received for purposes of section 451. The election must specify that the period (such as a calendar month) for which the qualified transportation fringe will be provided must not begin before the election is made. For this purpose, the date a qualified transportation fringe is provided is— (1) The date the employee receives a voucher or similar item; or (2) In any other case, the date the em- ployee uses the qualified transportation fringe. (b) Thus, a compensation reduction election must relate to qualified trans- portation fringes to be provided after the election. (c) Revocability of elections. The employee may not revoke a compensation reduction election after the employee is able currently to receive the cash or other taxable amount at the employee’s discre- tion. In addition, the election may not be revoked after the beginning of the period for which the qualified transportation fringe will be provided. (d) Compensation reduction amounts not refundable. Unless an elec- tion is revoked in a manner consistent with paragraph (c) of this Q/A-14, an em- ployee may not subsequently receive the compensation (in cash or any form other than by payment of a qualified transporta- tion fringe under the employer’s plan). Thus, an employer’s qualified transporta- tion fringe benefit plan may not provide that an employee who ceases to partici- pate in the employer’s qualified trans- portation fringe benefit plan is entitled to receive a refund of the amounts by which the employee’s compensation reduction exceeds the actual qualified transportation fringes provided to the employee by the employer. (e) Examples.The following examples illustrate the principles of this Q/A-14: Example 1. (i) Employer P maintains a qualified transportation fringe benefit arrangement. Employ- ees of P are paid twice per month, with the payroll dates being the first and the fifteenth day of the month. Under P’s arrangement, an employee is per- mitted to elect at any time before the first day of a month to reduce his or her compensation payable during that month in an amount up to the applicable statutory monthly limit (i.e., for 2000, $65 if the em- ployee elects coverage for transportation in a com- muter highway vehicle or a mass transit pass, or $175 if the employee chooses qualified parking) in return for the right to receive qualified transporta- tion fringes up to the amount of the election. If such an election is made, P will provide a mass transit pass for that month with a value not exceeding the compensation reduction amount elected by the em- ployee or will reimburse the cost of other qualified transportation fringes used by the employee on or after the first day of that month up to the compensa- tion reduction amount elected by the employee. Any compensation reduction amount elected by the em- ployee for the month that is not used for qualified transportation fringes is not refunded to the em- ployee at any future date. (ii) In this example, the arrangement satisfies the requirements of this Q/A-14 because the election is made before the employee is able currently to re- ceive the cash and the election specifies the future period for which the qualified transportation fringes will be provided. The arrangement would also sat- isfy the requirements of this Q/A-14 and Q/A-13 of this section if employees were allowed to elect to re- duce compensation up to $240 (for 2000) per month. (iii) The arrangement would also satisfy the re- quirements of this Q/A-14 (and Q/A-13 of this sec- tion) if employees were allowed to make an election at any time before the first or the fifteenth day of the month to reduce their compensation payable on that payroll date by an amount not in excess of one-half of the applicable statutory monthly limit (depending on the type of qualified transportation fringe elected by the employee) and P provides a mass transit pass on or after the applicable payroll date for the com- pensation reduction amount elected by the employee for the payroll date or reimburses the cost of other qualified transportation fringes used by the em- ployee on or after the payroll date up to the compen- sation reduction amount elected by the employee for that payroll date. Example 2. (i) Employee Q elects to reduce his compensation payable on March 1 of a year (when the statutory monthly limit for transportation in a commuter highway vehicle and transit passes is $65) by $195 in exchange for a mass transit voucher to be provided in March. The election is made on the pre- ceding February 27. Employee Q was hired in Janu- ary of the year. On March 10 of the year, the em- ployer of Employee Q delivers to Employee Q a mass transit voucher worth $195. (ii) In this example, $130 is included in Em- ployee Q’s wages for income and employment tax purposes because the compensation reduction elec- tion fails to satisfy the requirement in this Q/A-14 and Q/A-12 of this section that the election relate to qualified transportation fringes to be provided for a future period to the extent the election relates to $65 worth of transit passes for each of January and Feb- ruary of the year. No amount would be included in Employee Q’s wages as a result of the election if $195 worth of mass transit passes were instead de- livered to Employee Q in May of the year (because the compensation reduction would relate solely to fringes to be provided for a future period and the amount provided does not exceed the aggregate limit for the period, i.e., the sum of $65 for each of March, April, and May) Q–15. May an employee whose qualified transportation fringe costs are less than the employee’s compensation re- duction carry over this excess amount to subsequent periods? A–15. Yes. An employee may carry over unused compensation reduction amounts to subsequent periods under the plan of the employee’s employer. The following example illustrates the princi- ples of this Q/A-15: Example. (i) By an election made before No- vember 1, 1999, Employee E elects to reduce com- pensation in the amount of $65 for the month of No- vember, 1999. E incurs $50 in employee-operated commuter highway vehicle expenses during No- vember for which E is reimbursed $50 by Employer R. By an election made before December 1, 1999, E elects to reduce compensation by $65 for the month of December. E incurs $65 in employee-operated commuter highway vehicle expenses during Decem- ber for which E is reimbursed $65 by R. Before Jan- uary 1, 2000, E elects to reduce compensation by $50 for the month of January. E incurs $65 in em- ployee-operated commuter highway vehicle ex- penses during January for which E is reimbursed $65 by R because R allows E to carry over to Janu- ary, 2000, the $15 amount by which the compensa- tion reductions for November and December ex- ceeded the employee-operated commuter highway vehicle expenses incurred during those months. (ii) In this example, because E is reimbursed in an amount not exceeding the applicable statutory monthly limit, and the reimbursement does not ex- ceed the amount of employee-operated commuter highway vehicle expenses incurred during the month of January, the amount reimbursed ($65) is excludable from E’s wages for income and employ- ment tax purposes. Q–16. How does section 132(f) apply to expense reimbursements? A-16. (a) In general. The term “qualified transportation fringe” includes 2000–7 I.R.B.631February 14, 2000 cash reimbursement by an employer to an employee for expenses incurred or paid by an employee for transportation in a commuter highway vehicle or qualified parking. The reimbursement must be made under a bona fide reimbursement arrangement which meets the rules of paragraph (d) of this Q/A-16. The term “cash reimbursement” does not include cash advances. (b) Special rule for transit passes. The term “qualified transportation fringe” includes cash reimbursement for transit passes made under a bona fide reimburse- ment arrangement, but, in accordance with section 132(f)(3), only if no voucher or similar item that may be exchanged only for a transit pass is readily available for direct distribution by the employer to employees. For this purpose, a voucher or similar item is “readily available” if an employer can obtain it— (1) On terms no less favorable than those available to an individual employee; and (2) Without incurring a significant ad- ministrative cost. (c) Significant administrative cost. Administrative costs relate only to fees paid to fare media providers. The deter- mination of whether obtaining a voucher would result in a significant administra- tive cost is made with respect to each transit system voucher. A transit system voucher is a voucher that is accepted by one or more mass transit operators (e.g., train, subway, and bus) in an area as fare media (or in exchange for fare media). Administrative costs are treated as signifi- cant if the average monthly administrative costs incurred by the employer for a voucher (disregarding delivery charges imposed by the fare media provider to the extent not in excess of $15 per order) are more than 1 percent of the average monthly value of the vouchers for a sys- tem. Thus, whether a voucher is readily available without incurring a significant administrative cost is determined with re- spect to the transit system in each area for which the voucher may be used. The fol- lowing example illustrates the principles of this Q/A-16: Example. (i) Company C in City X sells mass transit vouchers to employers in the metropolitan area of X worth $65 each. Several different bus, rail, van pool, and ferry operators service X, and a number of the operators accept the vouchers either as fare media or in exchange for fare media. Em- ployers can readily obtain vouchers for distribution to their employees. To cover its operating expenses, C imposes on each voucher a 50 cents charge, plus a $15 charge for delivery. Employer M disburses vouchers purchased from C to its employees who use operators that accept the vouchers. (ii) In this example, because the cost of a voucher disbursed to M’s employees is not more than 1 per- cent of the value of the voucher (50 cents divided by $65 equals 0.77 percent) and the delivery charges are disregarded because they are not more than $15, vouchers for X are readily available. Thus, the vouchers disbursed to M’s employees are qualified transportation fringes and any reimbursement of mass transportation costs in X would not be a quali- fied transportation fringe. (d) Substantiation requirements. Employers that make cash reimburse- ments must establish a bona fide reim- bursement arrangement to establish that their employees have, in fact, incurred ex- penses for transportation in a commuter highway vehicle, transit passes, or quali- fied parking. For purposes of section 132(f), what constitutes a bona fide reim- bursement arrangement may vary depend- ing on the facts and circumstances, in- cluding the method or methods of payment utilized within the mass transit system. The employer must implement reasonable procedures to ensure that an amount equal to the reimbursement was incurred for transportation in a commuter highway vehicle, transit passes, or quali- fied parking. The following are examples of reasonable reimbursement procedures for purposes of this Q/A-16: (1) An employee presents to the em- ployer a parking expense receipt for park- ing on or near the employer’s business premises and certifies that the parking was used by the employee and the em- ployer has no reason to doubt the em- ployee’s certification. (2) An employee submits a used transit pass to the employer at the end of the month and certifies both that he or she purchased it, and that he or she used it during the month, or presents a transit pass to the employer at the beginning of the month and certifies that it will be used it during the month. In both cases, the employer has no reason to doubt the em- ployee’s certification. (3) If a receipt is not provided in the ordinary course of business (e.g., if the em- ployee uses metered parking or if used transit passes cannot be returned to the user), the employee certifies to the em- ployer the type and the amount of expenses incurred and the employer has no reason to doubt the employee’s certification. Q-17. May an employer provide nontaxable cash reimbursement under section 132(f) for periods longer than one month? A-17. Yes. Qualified transportation fringes include reimbursement to employ- ees for costs incurred for transportation in more than one month, provided the reim- bursement for each month is calculated separately and does not exceed the applic- able statutory monthly limit for any month. See Q/A-8 and 9 of this section if the limit for a month is exceeded. The following example illustrates the princi- ples of this Q/A-17: Example. (i) Employee R pays $100 per month for qualified parking used during the period from April 1, 2000 through June 30, 2000. After receiv- ing adequate substantiation from R, R’s employer reimburses R $300 in cash on June 30, 2000. (ii) In this example, because the value of the re- imbursed expenses for each month did not exceed the applicable statutory monthly limit, the $300 re- imbursement is excludable from R’s wages for in- come and employment tax purposes as a qualified transportation fringe. Q-18. What are the substantiation requirements if an employer distributes transit passes? A-18. There are no substantiation requirements if the employer distributes transit passes. Thus, an employer may distribute a transit pass for each month with a value not more than the statutory monthly limit without requiring any certi- fication from the employee regarding the use of the transit pass. Q-19. May an employer choose to impose substantiation requirements in ad- dition to those described in this regula- tion? A-19. Yes. Q-20. How is the value of parking determined? A-20. Section 1.61–21(b)(2) applies for purposes of determining the value of parking. Q-21. How do the qualified trans- portation fringe rules apply to van pools? A-21. (a) Van pools generally. Em- ployer- and employee-operated van pools, as well as private or public transit-oper- ated van pools, may qualify as qualified transportation fringes. The value of van pool benefits which are qualified trans- portation fringes may be excluded up to the applicable statutory monthly limit for transportation in a commuter highway ve- hicle and transit passes, less the value of February 14, 20006322000–7 I.R.B. any transit passes provided by the em- ployer for the month. (b) Employer-operated van pools. The value of van pool transportation pro- vided by or for an employer to its employ- ees is excludable as a qualified transporta- tion fringe, provided the van qualifies as a “commuter highway vehicle” as defined in section 132(f)(5)(B) and Q/A–2 of this section. A van pool is operated by or for the employer if the employer purchases or leases vans to enable employees to com- mute together or the employer contracts with and pays a third party to provide the vans and some or all of the costs of operat- ing the vans, including maintenance, liabil- ity insurance and other operating expenses. (c) Employee-operated van pools. Cash reimbursement by an employer to employees for expenses incurred for transportation in a van pool operated by employees independent of their employer are excludable as qualified transportation fringes provided that the van qualifies as a “commuter highway vehicle” as defined in section 132(f)(5)(B) and Q/A-2 of this section. See Q/A-16 of this section for the rules governing cash reimbursements. (d) Private or public transit-oper- ated van pool transit passes. The quali- fied transportation fringe exclusion for transit passes is available for travel in van pools owned and operated either by pub- lic transit authorities or by any person in the business of transporting persons for compensation or hire. In accordance with paragraph (b) of Q/A-3 of this section, the van must seat at least six adults (exclud- ing the driver). See Q/A-16(b) and (c) of this section for a special rule for cash re- imbursement for transit passes. (e) Value of van pool transportation benefits. Section 1.61–21(b)(2) provides that the fair market value of a fringe benefit is based on all the facts and circumstances. Alternatively, transportation in an em- ployer-provided commuter highway vehi- cle may be valued under the automobile lease valuation rule in § 1.61–21(d), the ve- hicle cents-per-mile rule in § 1.61–21(e), or the commuting valuation rule in § 1.61–21(f). If one of these special valua- tion rules is used, the employer must use the same valuation rule to value the use of the commuter highway vehicle by each em- ployee who share the use. See § 1.61–21(c). (f) Qualified parking prime member. If an employee obtains a qualified parking space as a result of membership in a car or van pool, the applicable statutory monthly limit for qualified parking applies to the individual to whom the parking space is assigned. This individual is the “prime member.” In determining the tax conse- quences to the prime member, the statu- tory monthly limit amounts of each car pool member may not be combined. If the employer provides access to the space and the space is not assigned to a particu- lar individual, then the employer must designate one of its employees as the prime member who will bear the tax con- sequences. The employer may not desig- nate more than one prime member for a car or van pool during a month. The em- ployer of the prime member is responsible for including the value of the qualified parking in excess of the statutory monthly limit in the prime member’s wages for in- come and employment tax purposes. Q-22. What are the reporting and employment tax requirements for quali- fied transportation fringes? A-22. (a) Employment tax treatment generally. Qualified transportation fringes not exceeding the applicable statu- tory monthly limit described in Q/A-7 of this section are not wages for purposes of the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and federal income tax with- holding. Any amount by which an em- ployee elects to reduce compensation as provided in Q/A-11 of this section is not subject to the FICA, the FUTA, and fed- eral income tax withholding. Qualified transportation fringes exceeding the ap- plicable statutory monthly limit described in Q/A-7 of this section are wages for pur- poses of the FICA, the FUTA, and federal income tax withholding and are reported on the employee’s Form W-2, Wage and Tax Statement. (b) Employment tax treatment of cash reimbursement exceeding monthly limits. Cash reimbursement to employees (for example, cash reimbursement for qualified parking) in excess of the applic- able statutory monthly limit under section 132(f) are treated as paid for employment tax purposes when actually or construc- tively paid. See §§ 31.3121(a)–2(a), 31.3301–4, 31.3402(a)–1(b) of this chap- ter. Employers must report and deposit the amounts withheld in addition to re- porting and depositing other employment taxes. See Q/A-16 of this section for rules governing cash reimbursements. (c) Noncash fringe benefits exceed- ing monthly limits. If the value of non- cash qualified transportation fringes ex- ceeds the applicable statutory monthly limit, the employer may elect, for pur- poses of the FICA, the FUTA, and federal income tax withholding, to treat the non- cash taxable fringe benefits as paid on a pay period, quarterly, semi-annual, an- nual, or other basis, provided that the benefits are treated as paid no less fre- quently than annually. Q–23. How does section 132(f) in- teract with other fringe benefit rules? A-23. For purposes of section 132, the terms “working condition fringe” and “de minimis fringe” do not include any qualified transportation fringe under sec- tion 132(f). If, however, an employer pro- vides local transportation other than transit passes, the value of the benefit may be ex- cludable, either totally or partially, under fringe benefit rules other than the qualified transportation fringe rules under section 132(f). See §§ 1.132–6(d)(2)(i) (occa- sional local transportation fare), 1.132–6(d)(2)(iii) (transportation provided under unusual circumstances), and 1.61–21(k) (valuation of local transporta- tion provided to qualified employees). Q-24. May qualified transportation fringes be provided to individuals who are partners, 2-percent shareholders of S- corporations, or independent contractors? A-24. (a) General rule. Section 132(f)(5)(E) states that self-employed in- dividuals who are employees within the meaning of section 401(c)(1) are not em- ployees for purposes of section 132(f). Therefore, individuals who are partners, sole proprietors, or other independent contractors are not employees for pur- poses of section 132(f). In addition, under section 1372(a), 2-percent share- holders of S corporations are treated as partners for fringe benefit purposes. Thus, an individual who is both a 2-per- cent shareholder of an S corporation and a common law employee of that S corpo- ration is not considered an employee for purposes of section 132(f). However, while section 132(f) does not apply to in- dividuals who are partners, 2-percent shareholders of S corporations, or inde- pendent contractors, other exclusions for 2000–7 I.R.B.633February 14, 2000 working condition and de minimis fringes may be available as described in paragraphs (b) and (c) of this Q/A-24. See §§ 1.132–1(b)(2) and 1.132–1(b)(4). (b) Transit passes. The working condition and de minimis fringe exclu- sions under section 132(a)(3) and (4) are available for transit passes provided to in- dividuals who are partners, 2-percent shareholders, and independent contrac- tors. For example, tokens or farecards provided by a partnership to an individual who is a partner that enable the partner to commute on a public transit system (not including privately-operated van pools) are excludable from the partner’s gross income if the value of the tokens and fare- cards in any month does not exceed the dollar amount specified in § 1.132–6(d)(1). However, if the value of a pass provided in a month exceeds the dol- lar amount specified in § 1.132–6(d)(1), the full value of the benefit provided (not merely the amount in excess of the dollar amount specified in § 1.132–6(d)(1)) is includible in gross income. (c) Parking. The working condition fringe rules under section 132(d) do not apply to commuter parking. See § 1.132–5(a)(1). However, the de minimis fringe rules under section 132(e) are available for parking provided to individ- uals who are partners, 2-percent share- holders, or independent contractors that qualifies under the de minimis rules. See § 1.132–6(a) and (b). The following ex- ample illustrates the principles of this Q/A-24: Example.(i) Individual G is a partner in partner- ship P. Individual G commutes to and from G’s of- fice every day and parks free of charge in P’s lot. (ii) In this example, the value of the parking is not excluded under section 132(f), but may be ex- cluded under section 132(e) if the parking is a de minimis fringe under § 1.132–6. Robert E. Wenzel, Deputy Commissioner of Internal Revenue. (Filed by the Office of the Federal Register on Janu- ary 24, 2000, 1:36 p.m., and published in the issue of the Federal Register for January 27, 2000, 65 F.R. 4388) Notice of Proposed Rulemaking and Notice of Public Hearing Applying Section 197 to Partnerships REG–100163–00 AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Notice of proposed rulemaking and notice of public hearing. SUMMARY: This document contains proposed regulations relating to the amor- tization of certain intangible property to partnership transactions involving sec- tions 732(b) and 734(b). The proposed regulations interpret the provisions of sec- tion 197(f)(9), reflecting changes to the law made by the Omnibus Budget Recon- ciliation Act of 1993 (OBRA ’93) and af- fect taxpayers who acquired intangible property after August 10, 1993, or made a retroactive election to apply OBRA ’93 to intangibles acquired after July 25, 1991. This document also provides a notice of public hearing on these proposed regula- tions. DATES: Written comments must be re- ceived by April 24, 2000. Outlines of top- ics to be discussed at the public hearing scheduled for May 24, 2000, at 10 a.m. must be received by May 3, 2000. ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–100163–00), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand de- livered Monday through Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG–100163–00), Courier’s desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washing- ton, DC. Alternatively, taxpayers may sub- mit comments electronically via the Inter- net 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/re gslist.html. The public hearing will be held in Room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW., Washing- ton, DC. FOR FURTHER INFORMATION CON- TACT: Concerning the proposed regula- tions, Robert G. Honigman, (202) 622- 3050; concerning submissions of comments, the hearing, and/or to be placed on the building access list to attend the hearing Guy Traynor, (202) 622-7180 (not toll-free numbers). SUPPLEMENTARY INFORMATION: This document proposes to amend sec- tion 197 of the Income Tax Regulations (26 CFR Part 1) to provide additional rules regarding the application of section 197(f)(9) to partnership transactions under sections 732(b) and 734(b). Background On January 16, 1997, the IRS published proposed regulations REG–209709–94, 1997–1 C.B. 731, in the Federal Register (62 F.R. 2336) inviting comments under sections 167(f) and 197, including the anti- churning rules in section 197(f)(9). Com- mentators requested that the final regula- tions provide additional guidance on how the special anti-churning rule of section 197(f)(9)(E) applies to increases in the basis of partnership property under sections 732, 734, and 743. In accordance with these comments, these proposed regula- tions provide rules for determining the amount of a basis adjustment under sec- tions 732(b) and 734(b) that will be subject to the anti-churning rules. Final regulations being issued in T.D. 8865 at the same time as these proposed regulations provide rules for determining the amount of a basis ad- justment under sections 732(d) and 743(b) that will be subject to the anti-churning rules. Explanation of Provisions A. In General Section 197(f)(9)(E) provides that, in applying the anti-churning rules for basis adjustments under sections 732, 734, and 743, determinations are made at the part- ner level, and each partner is treated as having owned and used such partner’s proportionate share of the partnership’s assets. With respect to basis adjustments under sections 732(b) and 734(b), this rule requires taxpayers and the IRS to an- alyze transactions that actually involve a distribution of property from the partner- ship to a partner as deemed transactions involving transfers of property directly among the partners. B. Two-Step Analysis The proposed regulations embody a two-step analysis in determining whether the anti-churning rules apply to the deemed transfer of intangibles in transac- February 14, 20006342000–7 I.R.B. tions giving rise to basis adjustments under sections 732(b) and 734(b). First, it is necessary to determine whether the por- tion of an intangible that a partner is deemed to transfer is treated, immediately prior to the deemed transfer, as being sub- ject to the anti-churning rules for pur- poses of applying these provisions. Sec- ond, if the partner’s share of the intangible is treated, immediately prior to the deemed transfer, as being subject to the anti-churning rules for purposes of ap- plying these provisions, it is necessary to determine whether the deemed transferor and transferee are related so that the anti- churning rules will continue to apply to the intangible after the deemed transfer. For purposes of applying the first prong of the analysis, when a partner acquires an interest in a partnership, the proposed regulations treat the partner as acquiring an undivided interest in all section 197(f)(9) intangibles held by a partner- ship at the time that the partner acquires an interest in the partnership. If a partner acquires an interest in a partnership from an unrelated person after August 10, 1993 (or, in certain cases, after July 25, 1991), the partner’s share of any intangible held by the partnership as of August 10, 1993 (or, in certain cases, after July 25, 1991) is treated as no longer subject to the anti- churning rules for purposes of analyzing subsequent deemed transfers of intangi- bles in transactions that give rise to the basis adjustments under sections 732(b) and 734(b). With respect to intangibles acquired by the partnership after August 10, 1993, that are subject to the anti- churning rules in the hands of the partner- ship, a partner’s share of the intangible is treated as not subject to the anti-churning rules for purposes of analyzing these basis adjustments if the partner acquired the in- terest in the partnership from an unrelated person after the partnership acquired the tainted intangible. Once a partner’s share of an intangible is treated as no longer subject to the anti-churning rules for pur- poses of analyzing subsequent deemed transfers, that share of the intangible will remain untainted even if the partner trans- fers the interest to the original transferor or a person who is related to the original transferor, so long as the transfers are not part of the same transaction or series of related transactions. Special rules are provided where a partner acquires a part- nership interest in exchange for property contributed to a partnership. For purposes of applying the anti-churn- ing rules to basis adjustments under section 732(b), the distributee partner is deemed to acquire the distributed intangible directly from the continuing partners of the distrib- uting partnership. The proposed regula- tions contain a favorable stacking rule that treats the distributee partner as acquiring the intangible first from the continuing partners for whom transfers would not be subject to the anti-churning rules (either be- cause the continuing partner’s share of the intangible is treated, for purposes of this rule, as not being subject to the anti-churn- ing rules or the distributee partner is not re- lated to the continuing partner) to the extent of such partners’ share of appreciation in the intangible. The proposed regulations contain a special rule to ensure that, in analyzing subsequent transfers, a partner cannot treat the entire intangible as no longer subject to the anti-churning rules simply because the full basis of the intangible (which may be significantly less than the intangible’s fair market value) becomes amortizable as a result of the favorable stacking rule that applies to section 732(b) basis adjustments. For purposes of applying the anti-churn- ing rules to basis adjustments under section 734(b), the continuing partners are deemed to acquire interests in the intangible that re- mains in the partnership from the partner who received a distribution (giving rise to the section 734(b) basis adjustment) of property other than the intangible. To the extent that the distributee partner could transfer the intangible directly to a continu- ing partner (who may be the distributee partner) and the transfer would not be sub- ject to the anti-churning rules (either be- cause the distributee partner’s share of the intangible is treated (for purposes of this rule) as not being subject to the anti-churn- ing rules or the continuing partner is not re- lated to the distributee (except in certain circumstances)), the basis adjustment will be amortizable with respect to the continu- ing partner. The proposed regulations contain a special rule which provides that if a distri- bution that gives rise to an increase in the basis under section 734(b) of a section 197(f)(9) intangible held by the partner- ship is undertaken as part of a series of re- lated transactions that include a contribu- tion of the intangible to the partnership by a continuing partner, the continuing part- ner is treated as related to the distributee partner to the extent that the continuing partner’s partnership interest was re- ceived in exchange for the intangible. In addition to issues relating to deter- mining the amount of a basis adjustment that is subject to the anti-churning rules, the Treasury Department and the IRS also recognize that certain problems may arise in maintaining capital accounts where a portion of a section 734(b) adjustment is allocated to an intangible that is subject to the anti-churning rules with respect to one or more partners. In some situations, the failure to allocate deductions for amortiza- tion to any partner whose allocable share of a section 734(b) adjustment is subject to the anti-churning rules will distort the partners’ economic agreement. For exam- ple, where partners agree to share depreci- ation and amortization deductions equally, if one partner’s share of a section 734(b) adjustment allocable to an intangible asset is subject to the anti-churning rules, the capital accounts of the partners will not re- flect an equivalent sharing of the eco- nomic amortization from the asset absent special adjustments to account for the dis- parity between the allocation of tax amor- tization and the intended allocation of eco- nomic amortization. Furthermore, divergence of book and tax accounts with respect to an intangible that may result from such special adjustments can cause problems in allocating the correct amount of taxable gain or loss to the appropriate parties upon disposition of the intangible. Similar problems may arise as a result of allowing remedial allocations for intangi- bles that otherwise are subject to the anti- churning rules and are addressed in §1.197–2(h)(12)(vii)(B). These regula- tions are not intended to create such dis- tortions. Nevertheless, a general rule that resolves these distortions in all situations (including different allocations of gain and depreciation or amortization) would be extremely complicated and, perhaps, un- duly narrow. Therefore, the proposed reg- ulations provide that taxpayers may use any reasonable method to determine amortization for book purposes in these situations, provided that the method used does not contravene the purposes of the anti-churning rules under section 197 (i.e., 2000–7 I.R.B.635February 14, 2000 the effect of the book adjustments will not be such that a partner who is subject to the anti-churning rules will receive, directly or indirectly, deductions for amortization, for Federal income tax purposes, attribut- able to the section 734(b) adjustment). The Treasury Department and IRS may consider providing guidance with respect to this issue in the future and request com- ments relating thereto. C. Effective Date These regulations are proposed to apply to distributions occurring on or after the date final regulations are pub- lished in the Federal Register. Special Analyses It has been determined that this notice of proposed rulemaking is not a signifi- cant regulatory action as defined in EO 12866. It also has been determined that section 533(b) of the Administrative Pro- cedures Act (5 U.S.C. chapter 5) does not apply to these regulations, and because these regulations do not impose a collec- tion of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Admin- istration for comment on its impact on small business. Comments and Public Hearing Before these proposed regulations are adopted as final regulations, considera- tion will be given to any written com- ments (a signed original and eight (8) copies) that are submitted timely to the IRS. All comments will be available for public inspection and copying. The Trea- sury Department and IRS specifically re- quest comments on the clarity of the pro- posed regulations and how they may be made easier to understand. A public hearing has been scheduled for May 24, 2000, at 10 a.m. in Room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW., Washington, DC. Due to building security procedures, visitors must enter at the 10 th Street en- trance, located between Constitution and Pennsylvania Avenues, NW. In addition, all visitors must present photo identifica- tion to enter the building. Because of ac- cess restrictions, visitors will not be ad- mitted beyond the immediate entrance area more than 15 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble. The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons that wish to present oral com- ments at the hearing must submit written comments and an outline of the topics to be discussed and the time devoted to each topic (signed original and eight (8) copies) by April 24, 2000. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing. Drafting Information The principal author of these proposed regulations is Robert G. Honigman, Of- fice of the Assistant Chief Counsel (Passthroughs & Special Industries). However, other personnel from the Trea- sury Department and IRS participated in their development. * * * * * Proposed Amendments to the Regulations Accordingly, 26 CFR part 1 is pro- posed to be amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read in part as follows: Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.197–2 is amended by: 1. Revising paragraphs (h)(12)(ii), (h)(12)(iv), and (h)(12)(vi). 2. Adding Examples 28, 29, and 30to paragraph (k). 3. Adding a sentence at the end of paragraph (l)(1). The additions and revisions read as fol- lows: §1.197–2 Amortization of goodwill and other intangibles. * * * * * (h) * * * (12) * * * (ii) Section 732(b) adjustments— (A) In general. The anti-churning rules of this paragraph (h) apply to any increase in the adjusted basis of a section 197(f)(9) intangible under section 732(b) to the ex- tent that the basis increase exceeds the total unrealized appreciation from the in- tangible allocable to – (1) Partners other than the distributee partner or persons related to the distribu- tee partner; (2) If the distributed intangible is a sec- tion 197(f)(9) intangible acquired by the partnership on or before August 10, 1993, the distributee partner and persons related to the distributee partner to the extent that – (i) They acquired an interest or inter- ests in the partnership after August 10, 1993; and (ii) Such interest or interests were held after August 10, 1993, by a person or per- sons other than the distributee partner or persons who were related to the distribu- tee partner, and the acquisition of such in- terest or interests by such person or per- sons was not part of a transaction or series of related transactions in which the dis- tributee partner or persons related to the distributee partner subsequently acquired such interest or interests; and (3) If the distributed intangible is a sec- tion 197(f)(9) intangible that is acquired by the partnership after August 10, 1993, and that is not amortizable with respect to the partnership, the distributee partner and persons related to the distributee part- ner to the extent that – (i) They acquired an interest or interests in the partnership after the partnership ac- quired the distributed intangible; and (ii) Such interest or interests were held after the partnership acquired the distrib- uted intangible, by a person or persons other than the distributee partner or per- sons who were related to the distributee partner, and the acquisition of such inter- est or interests by such person or persons was not part of a transaction or series of related transactions in which the distribu- tee partner or persons related to the dis- tributee partner subsequently acquired such interest or interests. (B) Effect of retroactive elections. For purposes of paragraph (h)(12)(ii)(A) of this section, references to August 10, 1993, are treated as references to July 25, February 14, 20006362000–7 I.R.B. 1991, if the relevant party made a valid retroactive election under §1.197–1T. (C) Intangible still subject to anti- churning rules. Notwithstanding para- graph (h)(12)(ii) of this section, in apply- ing the provisions of this paragraph (h) with respect to subsequent transfers, the distributed intangible remains subject to the provisions of this paragraph (h) in a percentage (determined at the time of the distribution) equal to – (1) The sum of – (i) The amount of the distributed intangi- ble’s basis that is nonamortizable under paragraph (g)(2)(ii)(B) of this section; and (ii) The total unrealized appreciation inherent in the intangible reduced by the amount of the increase in the adjusted basis of the distributed intangible under section 732(b) to which the anti-churning rules do not apply; over – (2) The fair market value of such intan- gible. (D) Partner’s allocable share of unre- alized appreciation from the intangible. The amount of unrealized appreciation from an intangible that is allocable to a partner is the amount of taxable gain that would have been allocated to that partner if the partnership had sold the intangible immediately before the distribution for its fair market value in a fully taxable transaction. (E) Acquisition of partnership interest by contribution. Solely for purposes of paragraphs (h)(12)(ii)(A)(2) and (3) of this section, a partner who acquires an in- terest in a partnership in exchange for a contribution of property to the partnership is deemed to acquire a pro rata portion of that interest in the partnership from each person who is a partner in the partnership at the time of the contribution based on each such partner’s proportionate interest in the partnership. However, if the part- ner contributed the distributed section 197(f)(9) intangible to the partnership, the interest acquired by such partner in ex- change for the intangible is treated as not being described in paragraphs (h)(12)(ii)(A)(2) or (3) of this section. * * * * * (iv) Section 734(b) adjustments— (A) In general. The anti-churning rules of this paragraph (h) do not apply to a con- tinuing partner’s share of an increase in the basis of a section 197(f)(9) intangible held by a partnership under section 734(b) to the extent that the continuing partner is an eligible partner. (B) Eligible partner. For purposes of this paragraph (h)(12)(iv), eligible partner means – (1) A continuing partner that is not the distributee partner or a person related to the distributee partner; (2) With respect to any section 197(f)(9) intangible acquired by the part- nership on or before August 10, 1993, a continuing partner that is the distributee partner or a person related to the distribu- tee partner to the extent that – (i) The distributee partner’s interest in the partnership was acquired after August 10, 1993; and (ii) Such interest was held after August 10, 1993 by a person or persons who were not related to the distributee partner, and the acquisition of such interest by such person or persons was not part of a trans- action or series of related transactions in which the distributee partner or persons related to the distributee partner subse- quently acquired such interest; or (3) With respect to any section 197(f)(9) intangible acquired by the part- nership after August 10, 1993, that is not amortizable with respect to the partner- ship, a continuing partner that is the dis- tributee partner or a person related to the distributee partner to the extent that – (i) The distributee partner’s interest in the partnership was acquired after the partnership acquired the relevant intangi- ble; and (ii) Such interest was held after the partnership acquired the relevant intangi- ble by a person or persons who were not related to the distributee partner, and the acquisition of such interest by such per- son or persons was not part of a transac- tion or series of related transactions in which the distributee partner or persons related to the distributee partner subse- quently acquired such interest. (C) Effect of retroactive elections. For purposes of paragraph (h)(12)(iv)(A) of this section, references to August 10, 1993, are treated as references to July 25, 1991, if the distributee partner made a valid retroactive election under §1.197–1T. (D) Partner’s share of basis increase. For purposes of this paragraph (h)(12)(iv), a continuing partner’s share of a basis increase is equal to – (1) The total basis increase allocable to the intangible; multiplied by (2) A fraction equal to – (i) The unrealized appreciation from the intangible that would have been allo- cated to the continuing partner if the part- nership had sold the intangible immedi- ately before the distribution for its fair market value in a fully taxable transac- tion; over (ii) The total unrealized appreciation from the intangible that would have been realized by the partnership if the partner- ship had sold the intangible immediately before the distribution for its fair market value in a fully taxable transaction. (E) Interests acquired by contribu tion— (1) Application of paragraphs (h)(12)(iv)(B)(2) and (3) of this section. Solely for purposes of paragraphs (h)(12)(iv)(B)(2) and (3) of this section, a partner who acquires an interest in a part- nership in exchange for a contribution of property to the partnership is deemed to acquire a pro rata portion of that interest in the partnership from each person who is a partner in the partnership at the time of the contribution based on each such partner’s proportionate interest in the partnership. However, if the partner con- tributed the distributed section 197(f)(9) intangible to the partnership, the interest acquired by such partner in exchange for the intangible is treated as not being de- scribed in paragraphs (h)(12)(iv)(B)(2) or (3) of this section. (2) Special rule with respect to para- graph (h)(12)(iv)(B)(1) of this section. Solely for purposes of paragraph (h)(12)(iv)(B)(1) of this section, if a dis- tribution that gives rise to an increase in the basis under section 734(b) of a section 197(f)(9) intangible held by the partner- ship is undertaken as part of a series of re- lated transactions that include a contribu- tion of the intangible to the partnership by a continuing partner, the continuing part- ner is treated as related to the distributee partner to the extent that the continuing partner’s partnership interest was re- ceived in exchange for the intangible. (F) Effect of section 734(b) adjustment on partners’ capital accounts. If one or more partners are subject to the anti- churning rules under this paragraph (h) with respect to a section 734(b) adjust- ment allocable to an intangible asset, tax- payers may use any reasonable method to determine amortization of the asset for book purposes, provided that the method used does not contravene the purposes of the anti-churning rules under section 197 and this paragraph (h). A method will be considered to contravene the purposes of the anti-churning rules if the effect of the book adjustments resulting from the method is such that any portion of the tax deduction for amortization attributable to the section 734 adjustment is allocated, directly or indirectly, to a partner who is subject to the anti-churning rules with re- spect to such adjustment. * * * * * (vi) Partner is or becomes a user of partnership intangible— (A) General rule.If, as part of a series of related trans- actions that includes a transaction de- scribed in paragraph (h)(12)(ii), (iii), (iv), or (v) of this section, an anti-churning partner becomes (or remains) a user of an intangible that is treated as transferred in the transaction (as a result of the partners being treated as having owned their pro- portionate share of partnership assets), the anti-churning rules shall apply to the pro- portionate share of such intangible that is treated as transferred by the anti-churning partner, notwithstanding the application of paragraph (h)(12)(ii), (iii), (iv), or (v) of this section. * * * * * (k) * * * Example 28. Distribution of section 197(f)(9) in- tangible to partner who acquired partnership inter- est prior to the effective date. (i) In 1990, A, B, and C each contribute $150 cash to form general partner- ship ABC for the purpose of engaging in a consult- ing business and a software manufacturing business. The partners agree to share partnership profits and losses equally. In 2000, the partnership distributes the consulting business to A in liquidation of A’s en- tire interest in ABC. The only asset of the consult- ing business is a nonamortizable intangible, which has a fair market value of $180 and a basis of $0. At the time of the distribution, the adjusted basis of A’s interest in ABC is $150. A is not related to B or C. (ii) Under section 732(b), A’s adjusted basis in the intangible distributed by ABC is $150, a $150 increase over the basis of the intangible in ABC’s hands. In de- termining whether the anti-churning rules apply to any portion of the basis increase, A is treated as having owned and used A’s proportionate share of partnership property. Thus, A is treated as holding an interest in the intangible during the transition period. Because the intangible was not amortizable prior to the enact- ment of section 197, the section 732(b) increase in the basis of the intangible may be subject to the anti- churning provisions. Paragraph (h)(12)(ii) of this sec- tion provides that the anti-churning provisions apply to the extent that the section 732(b) adjustment ex- ceeds the total unrealized appreciation from the intan- gible allocable to partners other than A or persons re- lated to A, as well as certain other partners whose pur- chase of their interests meet certain criteria. Because B and C are not related to A, and A’s acquisition of its partnership interest does not satisfy the necessary cri- teria, the section 732(b) basis increase is subject to the anti-churning provisions to the extent that it exceeds B and C’s proportionate share of the unrealized apprecia- tion from the intangible. B and C’s proportionate shares of the unrealized appreciation from the intangi- ble is $120 (2/3 of $180). This is the amount of gain that would be allocated to B and C if the partnership sold the intangible immediately before the distribution for its fair market value of $180. Therefore, $120 of the section 732(b) basis increase is not subject to the anti-churning rules. The remaining $30 of the section 732(b) basis increase is subject to the anti-churning rules. Accordingly, A is treated as having two intangi- bles, an amortizable section 197 intangible with an ad- justed basis of $120 and a new amortization period of 15 years and a nonamortizable intangible with an ad- justed basis of $30. (iii) In applying the anti-churning rules to future transfers of the distributed intangible, under para- graph (h)(12)(ii)(C) of this section, one-third of the intangible will continue to be subject to the anti- churning rules, determined as follows: The sum of the amount of the distributed intangible’s basis that is nonamortizable under paragraph (g)(2)(ii)(B) of this section ($0) and the total unrealized apprecia- tion inherent in the intangible reduced by the amount of the increase in the adjusted basis of the distributed intangible under section 732(b) to which the anti-churning rules do not apply ($180 - $120 = $60), over the fair market value of the distributed in- tangible ($180). Example 29. Distribution of section 197(f)(9) in- tangible to partner who acquired partnership inter- est after the effective date. (i) The facts are the same as in example 28, except that B and C form ABC in 1990. A does not acquire an interest in ABC until 1995. In 1995, A contributes $150 to ABC in ex- change for a one-third interest in ABC. At the time of the distribution, the adjusted basis of A’s interest in ABC is $150. (ii) As in Example 28, the anti-churning rules do not apply to the increase in the basis of the intangi- ble distributed to A under section 732(b) to the ex- tent that it does not exceed the unrealized apprecia- tion from the intangible allocable to B and C. Under paragraph (h)(12)(ii) of this section, the anti-churn- ing provisions also do not apply to the section 732(b) basis increase to the extent of A’s allocable share of the unrealized appreciation from the intan- gible because A acquired the ABC interest from an unrelated person after August 10, 1993, and the in- tangible was acquired by the partnership before A acquired the ABC interest. Under paragraph (h)(12)(ii)(E) of this section, A is deemed to acquire the ABC partnership interest from an unrelated per- son because A acquired the ABC partnership interest in exchange for a contribution to the partnership of property other than the distributed intangible and, at the time of the contribution, no partner in the part- nership was related to A. Consequently, the increase in the basis of the intangible under section 732(b) is not subject to the anti-churning rules to the extent of the total unrealized appreciation from the intangible allocable to A, B, and C. The total unrealized appre- ciation from the intangible allocable to A, B, and C is $180 (the gain the partnership would have recog- nized if it had sold the intangible for its fair market value immediately before the distribution). Because this amount exceeds the section 732(b) basis in- crease of $150, the entire section 732(b) basis in- crease is amortizable. (iii) In applying the anti-churning rules to future transfers of the distributed intangible, under para- graph (h)(12)(ii)(C) of this section, one-sixth of the intangible will continue to be subject to the anti- churning rules, determined as follows: The sum of the amount of the distributed intangible’s basis that is nonamortizable under paragraph (g)(2)(ii)(B) of this section ($0) and the total unrealized apprecia- tion inherent in the intangible reduced by the amount of the increase in the adjusted basis of the distributed intangible under section 732(b) to which the anti-churning rules do not apply ($180 - $150 = $30), over the fair market value of the distributed in- tangible ($180). Example 30. Distribution of section 197(f)(9) in- tangible contributed to the partnership by a partner. (i) The facts are the same as in Example 29, except that C purchased the intangible used in the consult- ing business in 1988 for $60 and contributed the in- tangible to ABC in 1990. At that time, the intangible had a fair market value of $150 and an adjusted tax basis of $60. When ABC distributes the intangible to A in 2000, the intangible has a fair market value of $180 and a basis of $60. (ii) As in Examples 28and 29, the adjusted basis of the intangible in A’s hands is $150 under section 732(b). However, the increase in the adjusted basis of the intangible under section 732(b) is only $90 ($150 adjusted basis after the distribution compared to $60 basis before the distribution). Pursuant to paragraph (g)(2)(ii)(B) of this section, A steps into the shoes of ABC with respect to the $60 of A’s adjusted basis in the intangible that corresponds to ABC’s basis in the intangible and this portion of the basis is nonamortiz- able. B and C are not related to A, A acquired the ABC interest from an unrelated person after August 10, 1993, and the intangible was acquired by ABC be- fore A acquired the ABC interest. Therefore, under paragraph (h)(12)(ii) of this section, the section 732(b) basis increase is amortizable to the extent of A, B, and C’s allocable share of the unrealized apprecia- tion from the intangible. The total unrealized appreci- ation from the intangible that is allocable to A, B, and C is $120. If ABC had sold the intangible immedi- ately before the distribution to A for its fair market value of $180, it would have recognized gain of $120, which would have been allocated $10 to A, $10 to B, and $100 to C under section 704(c). Because A, B, and C’s allocable share of the unrealized appreciation from the intangible exceeds the section 732(b) basis increase in the intangible, the entire $90 of basis in- crease is amortizable by A. Accordingly, after the dis- tribution, A will be treated as having two intangibles, an amortizable section 197 intangible with an ad- justed basis of $90 and a new amortization period of 15 years and a nonamortizable intangible with an ad- justed basis of $60. (iii) In applying the anti-churning rules to future transfers of the distributed intangible, under paragraph (h)(12)(ii)(C) of this section, one-half of the intangible will continue to be subject to the anti-churning rules, determined as follows: The sum of the amount of the distributed intangible’s basis that is nonamortizable under paragraph (g)(2)(ii)(B) of this section ($60) and 2000–7 I.R.B.637February 14, 2000 the total unrealized appreciation inherent in the intan- gible reduced by the amount of the increase in the ad- justed basis of the distributed intangible under section 732(b) to which the anti-churning rules do not apply ($120 - $90 = $30), over the fair market value of the distributed intangible ($180). * * * * * (l) * * * (1) In general. * * * Paragraphs (h)(12)(ii), (iv), and (vi) of this section apply to partnership distributions occur- ring on or after the date final regulations are published in the Federal Register. * * * * * David Mader, Acting Deputy Commissioner of Internal Revenue. (Filed by the Office of the Federal Register on Janu- ary 20, 2000, 1:19 p.m., and published in the issue of the Federal Register for January 25, 2000, 65 F.R. 3903) February 14, 20006382000–7 I.R.B. 2000–7 I.R.B.iFebruary 14, 2000 Revenue rulings and revenue procedures (hereinafter referred to as “rulings”) that have an effect on previous rulings use the following defined terms to describe the effect: Amplified describes a situation where no change is being made in a prior pub- lished position, but the prior position is being extended to apply to a variation of the fact situation set forth therein. Thus, if an earlier ruling held that a principle applied to A, and the new ruling holds that the same principle also applies to B, the earlier ruling is amplified. (Compare with modified, below). Clarified is used in those instances where the language in a prior ruling is being made clear because the language has caused, or may cause, some confu- sion. It is not used where a position in a prior ruling is being changed. Distinguisheddescribes a situation where a ruling mentions a previously published ruling and points out an essen- tial difference between them. Modified is used where the substance of a previously published position is being changed. Thus, if a prior ruling held that a principle applied to A but not to B, and the new ruling holds that it ap- plies to both A and B, the prior ruling is modified because it corrects a published position. (Compare with amplified and clarified, above). Obsoleted describes a previously pub- lished ruling that is not considered deter- minative with respect to future transac- tions. This term is most commonly used in a ruling that lists previously published rulings that are obsoleted because of changes in law or regulations. A ruling may also be obsoleted because the sub- stance has been included in regulations subsequently adopted. Revoked describes situations where the position in the previously published rul- ing is not correct and the correct position is being stated in the new ruling. Superseded describes a situation where the new ruling does nothing more than restate the substance and situation of a previously published ruling (or rulings). Thus, the term is used to republish under the 1986 Code and regulations the same position published under the 1939 Code and regulations. The term is also used when it is desired to republish in a single ruling a series of situations, names, etc., that were previously published over a pe- riod of time in separate rulings. If the new ruling does more than restate the substance of a prior ruling, a combination of terms is used. For example, modified and superseded describes a situation where the substance of a previously pub- lished ruling is being changed in part and is continued without change in part and it is desired to restate the valid portion of the previously published ruling in a new ruling that is self contained. In this case the previously published ruling is first modified and then, as modified, is super- seded. Supplemented is used in situations in which a list, such as a list of the names of countries, is published in a ruling and that list is expanded by adding further names in subsequent rulings. After the original ruling has been supplemented several times, a new ruling may be pub- lished that includes the list in the original ruling and the additions, and supersedes all prior rulings in the series. Suspended is used in rare situations to show that the previous published rulings will not be applied pending some future action such as the issuance of new or amended regulations, the outcome of cases in litigation, or the outcome of a Service study. Abbreviations The following abbreviations in current use and for- merly used will appear in material published in the Bulletin. A—Individual. Acq.—Acquiescence. B—Individual. BE—Beneficiary. BK—Bank. B.T.A.—Board of Tax Appeals. C.—Individual. C.B.—Cumulative Bulletin. CFR—Code of Federal Regulations. CI—City. COOP—Cooperative. Ct.D.—Court Decision. CY—County. D—Decedent. DC—Dummy Corporation. DE—Donee. Del. Order—Delegation Order. DISC—Domestic International Sales Corporation. DR—Donor. E—Estate. EE—Employee. E.O.—Executive Order. ER—Employer. ERISA—Employee Retirement Income Security Act. EX—Executor. F—Fiduciary. FC—Foreign Country. FICA—Federal Insurance Contribution Act. FISC—Foreign International Sales Company. FPH—Foreign Personal Holding Company. F.R.—Federal Register. FUTA—Federal Unemployment Tax Act. FX—Foreign Corporation. G.C.M.—Chief Counsel’s Memorandum. GE—Grantee. GP—General Partner. GR—Grantor. IC—Insurance Company. I.R.B.—Internal Revenue Bulletin. LE—Lessee. LP—Limited Partner. LR—Lessor. M—Minor. Nonacq.—Nonacquiescence. O—Organization. P—Parent Corporation. PHC—Personal Holding Company. PO—Possession of the U.S. PR—Partner. PRS—Partnership. PTE—Prohibited Transaction Exemption. Pub. L.—Public Law. REIT—Real Estate Investment Trust. Rev. Proc.—Revenue Procedure. Rev. Rul.—Revenue Ruling. S—Subsidiary. S.P.R.—Statements of Procedral Rules. Stat.—Statutes at Large. T—Target Corporation. T.C.—Tax Court. T.D.—Treasury Decision. TFE—Transferee. TFR—Transferor. T.I.R.—Technical Information Release. TP—Taxpayer. TR—Trust. TT—Trustee. U.S.C.—United States Code. X—Corporation. Y—Corporation. Z—Corporation. Definition of Terms February 14, 2000ii2000–7 I.R.B. Numerical Finding List 1 Bulletins 2000–1 through 2000–6 Announcements: 2000–1, 2000–2 I.R.B. 294 2000–2, 2000–2 I.R.B. 295 2000–3, 2000–2 I.R.B. 296 2000–4, 2000–3 I.R.B. 317 2000–5, 2000–4 I.R.B. 427 2000–6, 2000–4 I.R.B. 428 2000–7, 2000–6 I.R.B. 586 2000–8, 2000–6 I.R.B. 586 Notices: 2000–1, 2000–2 I.R.B. 288 2000–3, 2000–4 I.R.B. 413 2000–4, 2000–3 I.R.B. 313 2000–5, 2000–3 I.R.B. 314 2000–6, 2000–3 I.R.B. 315 2000–7, 2000–4 I.R.B. 419 2000–8, 2000–4 I.R.B. 420 2000–9, 2000–5 I.R.B. 449 2000–10, 2000–5 I.R.B. 451 2000–11, 2000–6 I.R.B. 572 Proposed Regulations: REG–208254–90, 2000–6 I.R.B. 577 REG–101492–98, 2000–3 I.R.B. 326 REG–106012–98, 2000–2 I.R.B. 290 REG–103831–99, 2000–5 I.R.B. 452 REG–105089–99, 2000–6 I.R.B. 580 REG–105606–99, 2000–4 I.R.B. 421 REG–111119–99, 2000–5 I.R.B. 455 REG–116048–99, 2000–6 I.R.B. 584 REG–116567–99, 2000–5 I.R.B. 463 REG–116704–99, 2000–3 I.R.B. 325 Revenue Procedures: 2000–1, 2000–1 I.R.B. 4 2000–2, 2000–1 I.R.B. 73 2000–3, 2000–1 I.R.B. 103 2000–4, 2000–1 I.R.B. 115 2000–5, 2000–1 I.R.B. 158 2000–6, 2000–1 I.R.B. 187 2000–7, 2000–1 I.R.B. 227 2000–8, 2000–1 I.R.B. 230 2000–9, 2000–2 I.R.B. 280 2000–10, 2000–2 I.R.B. 287 2000–11, 2000–3 I.R.B. 309 2000–12, 2000–4 I.R.B. 387 2000–13, 2000–6 I.R.B. 515 2000–15, 2000–5 I.R.B. 447 2000–16, 2000–6 I.R.B. 518 2000–20, 2000–6 I.R.B. 553 Revenue Rulings: 2000–1, 2000–2 I.R.B. 250 2000–2, 2000–3 I.R.B. 305 2000–3, 2000–3 I.R.B. 297 2000–4, 2000–4 I.R.B. 331 2000–5, 2000–5 I.R.B. 436 2000–6, 2000–6 I.R.B. 512 2000–9, 2000–6 I.R.B. 497 Treasury Decisions: 8849, 2000–2 I.R.B. 245 8850, 2000–2 I.R.B. 265 Treasury Decisions—Continued 8851, 2000–2 I.R.B. 275 8852, 2000–2 I.R.B.253 8853, 2000–4 I.R.B.377 8854, 2000–3 I.R.B.306 8855, 2000–4 I.R.B.374 8856, 2000–3 I.R.B.298 8857, 2000–4 I.R.B.365 8858, 2000–4 I.R.B.332 8859, 2000–5 I.R.B.429 8860, 2000–5 I.R.B.437 8861, 2000–5 I.R.B.441 8862, 2000–6 I.R.B.466 8863, 2000–6 I.R.B.488 8866, 2000–6 I.R.B.495 8868, 2000–6 I.R.B.491 8869, 2000–6 I.R.B.498 1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 1999–27 through 1999–52 is in Internal Revenue Bulletin 2000–1, dated January 3, 2000. 2000–7 I.R.B.iiiFebruary 14, 2000 Finding List of Current Actions on Previously Published Items 1 Bulletins 2000–1 through 2000–6 Announcements: 99–50 Modified by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 Notices: 92–48 Obsoleted by Notice 2000–11, 2000–6 I.R.B. 572 97–19 Modified by Rev. Proc. 2000–1, 2000–1 I.R.B. 4 98–52 Modified by Notice 2000–3, 2000–4 I.R.B. 413 98–61 Modified and superseded by Rev. Proc. 2000–15, 2000–5 I.R.B. 447 99–8 Obsoleted by Rev. Proc. 2000–12, 2000–4 I.R.B. 387 Revenue Procedures: 80–18 Modified by Rev. Proc. 2000–13, 2000–6 I.R.B. 515 89–9 Superseded by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 89–13 Superseded by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 90–21 Superseded by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 91–66 Superseded by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 92–13 Modified, amplified, and superseded by Rev. Proc. 2000–11, 2000–3 I.R.B. 309 92–13A Modified, amplified, and superseded by Rev. Proc. 2000–11, 2000–3 I.R.B. 309 92–41 Superseded by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 93–9 Superseded by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 93–10 Superseded by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 94–12 Modified, amplified, and superseded by Rev. Proc. 2000–11, 2000–3 I.R.B. 309 Revenue Procedures—Continued 95–42 Superseded by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 96–13 Modified by Rev. Proc. 2000–1, 2000–1 I.R.B. 4 98–22 Modified and superseded by Rev. Proc. 2000–16, 2000–6 I.R.B. 518 98–27 Superseded by Rev. Proc. 2000–12, 2000–4 I.R.B. 387 98–64 Superseded by Rev. Proc. 2000–9, 2000–2 I.R.B. 280 99–1 Superseded by Rev. Proc. 2000–1, 2000–1 I.R.B. 4 99–2 Superseded by Rev. Proc. 2000–2, 2000–1 I.R.B. 73 99–3 Superseded by Rev. Proc. 2000–3, 2000–1 I.R.B. 103 99–4 Superseded by Rev. Proc. 2000–4, 2000–1 I.R.B. 115 99–5 Superseded by Rev. Proc. 2000–5, 2000–1 I.R.B. 158 99–6 Superseded by Rev. Proc. 2000–6, 2000–1 I.R.B. 187 99–7 Superseded by Rev. Proc. 2000–7, 2000–1 I.R.B. 227 99–8 Superseded by Rev. Proc. 2000–8, 2000–1 I.R.B. 230 99–13 Modified and superseded by Rev. Proc. 2000–16, 2000–6 I.R.B. 518 99–31 Modified and superseded by Rev. Proc. 2000–16, 2000–6 I.R.B. 518 99–49 Modified and amplified by both Rev. Rul. 2000–4, 2000–4 I.R.B. 331 and Notice 2000–4, 2000–3 I.R.B. 313 99–51 Superseded by Rev. Proc. 2000–3, 2000–1 I.R.B. 103 2000–6 Modified by Rev. Proc. 2000–20, 2000–6 I.R.B. 553 2000–8 Modified by both Rev. Proc. 2000–16, 2000–6 I.R.B. 518 and Rev. Proc. 2000–20, 2000–6 I.R.B. 553 Revenue Rulings: 88–36 Modified by Rev. Rul. 2000–6, 2000–6 I.R.B. 512 Treasury Decisions: 8734 Modified by T.D. 8856, 2000–3, I.R.B. 298 8804 Modified by T.D. 8856, 2000–3, I.R.B. 298 1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 1999–27 through 1999–52 is in Internal Revenue Bulletin 2000–1, dated January 3, 2000. INTERNAL REVENUE BULLETIN The Introduction at the beginning of this issue 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. 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