[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 1998 Edition]
[From the U.S. Government Publishing Office]
[[Page i]]
26
Internal Revenue
PARTS 2 TO 29
Revised as of April 1, 1998
CONTAINING
A CODIFICATION OF DOCUMENTS
OF GENERAL APPLICABILITY
AND FUTURE EFFECT
AS OF APRIL 1, 1998
With Ancillaries
Published by
the Office of the Federal Register
National Archives and Records
Administration
as a Special Edition of
the Federal Register
[[Page ii]]
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1998
For sale by U.S. Government Printing Office
Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328
[[Page iii]]
Table of Contents
Page
Explanation................................................. v
Title 26:
Chapter I--Internal Revenue Service, Department of the
Treasury (Continued).................................. 3
Finding Aids:
Table of CFR Titles and Chapters.......................... 753
Alphabetical List of Agencies Appearing in the CFR........ 769
Table of OMB Control Numbers.............................. 779
List of CFR Sections Affected............................. 795
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Cite this Code: CFR
To cite the regulations in this volume use title, part and
section number. Thus, 26 CFR 2.1 refers to title 26, part
2, section 1.
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EXPLANATION
The Code of Federal Regulations is a codification of the general and
permanent rules published in the Federal Register by the Executive
departments and agencies of the Federal Government. The Code is divided
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name of the issuing agency. Each chapter is further subdivided into
parts covering specific regulatory areas.
Each volume of the Code is revised at least once each calendar year
and issued on a quarterly basis approximately as follows:
Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1
The appropriate revision date is printed on the cover of each
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OMB CONTROL NUMBERS
The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires
Federal agencies to display an OMB control number with their information
collection request.
[[Page vi]]
Many agencies have begun publishing numerous OMB control numbers as
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OBSOLETE PROVISIONS
Provisions that become obsolete before the revision date stated on
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[[Page vii]]
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Raymond A. Mosley,
Director,
Office of the Federal Register.
April 1, 1998.
[[Page ix]]
THIS TITLE
Title 26--Internal Revenue is composed of nineteen volumes. The
contents of these volumes represent all current regulations issued by
the Internal Revenue Service, Department of the Treasury, as of April 1,
1998. The first twelve volumes comprise part 1 (Subchapter A--Income
Tax) and are arranged by sections as follows: Secs. 1.0-1-1.60;
Secs. 1.61-1.169; Secs. 1.170-1.300; Secs. 1.301-1.400; Secs. 1.401-
1.440; Secs. 1.441-1.500; Secs. 1.501-1.640; Secs. 1.641-1.850;
Secs. 1.851-1.907; Secs. 1.908-1.1000; Secs. 1.1001-1.1400 and
Sec. 1.1401 to end. The thirteenth volume containing parts 2-29,
includes the remainder of subchapter A and all of Subchapter B--Estate
and Gift Taxes. The last six volumes contain parts 30-39 (Subchapter C--
Employment Taxes and Collection of Income Tax at Source); parts 40-49;
parts 50-299 (Subchapter D--Miscellaneous Excise Taxes); parts 300-499
(Subchapter F--Procedure and Administration); parts 500-599 (Subchapter
G--Regulations under Tax Conventions); and part 600 to end (Subchapter
H--Internal Revenue Practice).
The OMB control numbers for Title 26 appear in Sec. 602.101 of this
chapter. For the convenience of the user, Sec. 602.101 appears in the
Finding Aids section of the volumes containing parts 1 to 599.
For this volume, Cheryl E. Sirofchuck was Chief Editor. The Code of
Federal Regulations publication program is under the direction of
Frances D. McDonald, assisted by Alomha S. Morris.
[[Page x]]
[[Page 1]]
TITLE 26--INTERNAL REVENUE
(This book contains parts 2 to 29)
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Part
Chapter i--Internal Revenue Service, Department of the
Treasury (Continued)...................................... 2
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CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (Continued)
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SUBCHAPTER A--INCOME TAX (CONTINUED)
Part Page
2 Maritime construction reserve fund.......... 5
3 Capital construction fund................... 21
4 Temporary income tax regulations under
section 954 of the Internal Revenue Code 41
5 Temporary income tax regulations under the
Revenue Act of 1978..................... 74
5c Temporary income tax regulations under the
Economic Recovery Tax Act of 1981....... 79
5e Temporary income tax regulations, travel
expenses of Members of Congress......... 99
5f Temporary income tax regulations under the
Tax Equity and Fiscal Responsibility Act
of 1982................................. 102
6a Temporary regulations under Title II of the
Omnibus Reconciliation Act of 1980...... 120
7 Temporary income tax regulations under the
Tax Reform Act of 1976.................. 145
8 Temporary income tax regulations under
section 3 of the Act of October 26, 1974
(Pub. L. 93-483)........................ 191
9 Temporary income tax regulations under the
Tax Reduction Act of 1975............... 192
11 Temporary income tax regulations under the
Employee Retirement Income Security Act
of 1974................................. 194
12 Temporary income tax regulations under the
Revenue Act of 1971..................... 214
13 Temporary income tax regulations under the
Tax Reform Act of 1969.................. 224
14a Temporary income tax regulations relating to
incentive stock options................. 230
15 Temporary income tax regulations relating to
exploration expenditures in the case of
mining.................................. 236
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15a Temporary income tax regulations under the
Installment Sales Revision Act.......... 241
16 Temporary regulations under the Revenue Act
of 1962................................. 260
16A Temporary income tax regulations relating to
the partial exclusion for certain
conservation cost-sharing payments...... 262
17 Temporary income tax regulations under 26
U.S.C. 103(c)........................... 269
18 Temporary income tax regulations under the
Subchapter S Revision Act of 1982....... 270
19 Temporary regulations under the Revenue Act
of 1964................................. 273
SUBCHAPTER B--ESTATE AND GIFT TAXES
20 Estate tax; estates of decedents dying after
August 16, 1954......................... 276
22 Temporary estate tax regulations under the
Economic Recovery Tax Act of 1981....... 539
25 Gift tax; gifts made after December 31, 1954 540
26 Generation-skipping transfer tax regulations
under the Tax Reform Act of 1986........ 711
28--29
[Reserved]
Supplementary Publications: Internal Revenue Service Looseleaf
Regulations System.
Additional supplementary publications are issued covering individual
parts of the Alcohol, Tobacco and Firearms Regulations, and Regulations
Under Tax Convention.
[[Page 5]]
SUBCHAPTER A--INCOME TAX (Continued)
PART 2--MARITIME CONSTRUCTION RESERVE FUND--Table of Contents
Sec.
2.1 Statutory provisions; sections 511 and 905, Merchant Marine Act,
1936, and related statutes.
2.1-1 Definitions.
2.1-2 Scope of section 511 of the Act and the regulations in this part.
2.1-3 Requirements as to vessel operations.
2.1-4 Application to establish fund.
2.1-5 Tentative authorization to establish fund.
2.1-6 Establishment of fund.
2.1-7 Circumstances permitting reimbursement from a construction
reserve fund.
2.1-8 Investment of funds in securities.
2.1-9 Valuation of securities in fund.
2.1-10 Withdrawals from fund.
2.1-11 Time deposits.
2.1-12 Election as to nonrecognition of gain.
2.1-13 Deposit of proceeds of sales or indemnities.
2.1-14 Deposit of earnings and receipts.
2.1-15 Time for making deposits.
2.1-16 Tax liability as to earnings deposited.
2.1-17 Basis of new vessel.
2.1-18 Allocation of gain for tax purposes.
2.1-19 Requirements as to new vessels.
2.1-20 Obligation of deposits.
2.1-21 Period for construction of certain vessels.
2.1-22 Time extensions for expenditure or obligation.
2.1-23 Noncompliance with requirements.
2.1-24 Extent of tax liability.
2.1-25 Assessment and collection of deficiencies.
2.1-26 Reports by taxpayers.
2.1-27 Controlled corporation.
2.1-28 Administrative jurisdiction.
Authority: Sec. 511(b), 49 Stat. 1985, as amended, sec. 7805, 68A
Stat. 917; 26 U.S.C. 7805, 46 U.S.C. 1161(b).
Source: T.D. 6820, 30 FR 6030, Apr. 29, 1965, unless otherwise
noted.
Editorial Note: The regulations contained in this part have been
recodified in 46 CFR part 287.
Sec. 2.1 Statutory provisions; sections 511 and 905, Merchant Marine Act, 1936, and related statutes.
Sec. 511. [Merchant Marine Act, 1936] (a) When used in this section
the term new vessel means any vessel (1) documented or agreed with the
Commission to be documented under the laws of the United States; (2)
constructed in the United States after December 31, 1939, or the
construction of which has been financed under titles V or VII of this
Act, as amended, or the construction of which has been aided by a
mortgage insured under title XI of this Act as amended; and (3) either
(A) of such type, size, and speed as the Commission shall determine to
be suitable for use on the high seas or Great Lakes in carrying out the
purposes of this Act, but not of less than 2,000 gross tons or of less
speed than twelve knots, unless the Commission shall determine and
certify in each case that a vessel of a specified lesser tonnage or
speed is desirable for use by the United States in case of war or
national emergency, or (B) constructed to replace a vessel or vessels
requisitioned or purchased by the United States.
(b) For the purpose of promoting the construction, reconstruction,
reconditioning, or acquisition of vessels, or for other purposes
authorized in this section, necessary to carrying out the policy set
forth in title I of this Act, any citizen of the United States who is
operating a vessel or vessels in the foreign or domestic commerce of the
United States or in the fisheries or owns in whole or in part a vessel
or vessels being so operated, or who, at the time of purchase or
requisition of the vessel by the Government, was operating a vessel or
vessels so engaged or owned in whole or in part a vessel or vessels
being so operated or had acquired or was having constructed a vessel or
vessels for the purpose of operation in such commerce or in the
fisheries, may establish a construction reserve fund, for the
construction, reconstruction, reconditioning, or acquisition of new
vessels, or for other purposes authorized in this section, to be
composed of deposits of proceeds from sales of vessels, indemnities on
account of losses of vessels, earnings from the operation of vessels
documented under the laws of the United States and from services
incident thereto, and receipts, in the form of interest or otherwise,
with respect to amounts previously deposited. Such construction reserve
fund shall be established, maintained, expended, and used in accordance
with the provisions of this section and rules or regulations to be
prescribed jointly by the Commission and the Secretary of the Treasury.
(c) In the case of the sale or actual or constructive total loss of
a vessel, if the taxpayer deposits an amount equal to the net proceeds
of the sale or to the net indemnity with respect to the loss in a
construction reserve fund established under subsection (b), then--
(1) If the taxpayer so elects in his income-tax return for the
taxable year in which the gain was realized, or
[[Page 6]]
(2) In case a vessel is purchased or requisitioned by the United
States, or is lost, in any taxable year beginning after December 31,
1939, and the taxpayer receives payment for the vessel so purchased or
requisitioned, or receives from the United States indemnity on account
of such loss, subsequent to the end of such taxable year, if the
taxpayer so elects prior to the expiration of sixty days after the
receipt of the payment or indemnity, and in accordance with a form of
election to be prescribed by the Commissioner of Internal Revenue with
the approval of the Secretary of the Treasury,
no gain shall be recognized to the taxpayer in respect of such sale or
indemnification in the computation of net income for the purposes of
Federal income or excess-profits taxes. If an election is made under
subdivision (2) and if computation or recomputation in accordance with
this subsection is otherwise allowable but is prevented, on the date of
making such election or within six months thereafter, by any statute of
limitation, such computation or recomputation nevertheless shall be made
notwithstanding such statute if a claim therefor is filed within six
months after the date of making such election.
For the purposes of this subsection no amount shall be considered as
deposited in a construction reserve fund unless it is deposited within
sixty days after it is received by the taxpayer.
As used in this subsection the term net proceeds and the term net
indemnity mean the sum of (1) the adjusted basis of the vessel and (2)
the amount of gain which would be recognized to the taxpayer without
regard to this subsection.
(d) The basis for determining gain or loss and for depreciation, for
the purposes of Federal income or excess profits taxes, of any new
vessel constructed, reconstructed, reconditioned, or acquired by the
taxpayer, or with respect to which purchase-money indebtedness is
liquidated as provided in subsection (g), in whole or in part out of the
construction reserve fund shall be reduced by that portion of the
deposits in the fund expended in the construction, reconstruction,
reconditioning, acquisition, or liquidation of purchase-money
indebtedness of the new vessel which represents gain not recognized for
tax purposes under subsection (c).
(e) For the purposes of this section, (1) if the net proceeds of a
sale or the net indemnity in respect of a loss are deposited in more
than one deposit, the amount consisting of the gain shall be considered
as first deposited; (2) amounts expended, obligated, or otherwise
withdrawn shall be applied against the amounts deposited in the fund in
the order of deposit; and (3) if any deposit consists in part of gain
not recognized under subsection (c), any expenditure, obligation, or
withdrawal applied against such deposit shall be considered to consist
of gain in the proportion that the part of the deposit consisting of
gain bears to the total amount of the deposit.
(f) With respect to any taxable year, amounts on deposit on the last
day of such year in a construction reserve fund in accordance with this
section and with respect to which all the requirements of subsection (g)
have been satisfied, to the extent that such requirements are applicable
as of the last day of said taxable year, shall not constitute an
accumulation of earnings or profits within the meaning of section 102 of
the Internal Revenue Code [Part I (section 531 and following),
Subchapter A, Chapter 1 of the Internal Revenue Code of 1954].
(g) The provisions of subsections (c) and (f) shall apply to any
deposit in the construction reserve fund only to the extent that such
deposit is expended or obligated for expenditure, in accordance with
rules and regulations to be prescribed jointly by the Commission and the
Secretary of the Treasury--
(1) Under a contract for the construction or acquisition of a new
vessel or vessels (or in the discretion of the Commission, for a part
interest therein), or, with the approval of the Commission, for the
reconstruction or reconditioning of a new vessel or vessels, entered
into within (i) two years from the date of deposit or the date of any
extension thereof which may be granted by the Commission pursuant to the
provisions of section 511(h), in the case of deposits made prior to the
date [July 17, 1952] on which these amendatory provisions become
effective, or (ii) three years from the date of such deposit in the case
of a deposit made after such effective date, only if under such rules
and regulations--
(A) Within such period not less than 12\1/2\ per centum of the
construction or contract price of the vessel or vessels is paid or
irrevocably committed on account thereof and the plans and
specifications therefor are approved by the Commission to the extent by
it deemed necessary; and
(B) In case of a vessel or vessels not constructed under the
provisions of this title or not purchased from the Commission, (i) said
construction is completed, within six months from the date of the
construction contract, to the extent of not less than 5 per centum
thereof (or in case the contract covers more than one vessel, the
construction of the first vessel so contracted for is so completed to
the extent of not less than 5 per centum) as estimated by the Commission
and certified by it to the Secretary of the Treasury, and (ii) all
construction under such contract is completed with reasonable dispatch
thereafter;
(2) For the liquidation of existing or subsequently incurred
purchase-money indebtedness to persons other than a parent company of,
or a company affiliated or associated
[[Page 7]]
with, the mortgagor on a new vessel or vessels within (i) two years from
the date of deposit or the date of any extension thereof which may be
granted by the Commission pursuant to the provisions of section 511(h),
in the case of deposits made prior to the date [July 17, 1952] on which
these amendatory provisions become effective, or (ii) three years from
the date of such deposit in the case of a deposit made after such
effective date.
(h) The Commission is authorized under rules and regulations to be
prescribed jointly by the Secretary of the Treasury and the Commission
to grant extensions of the period within which the deposits shall be
expended or obligated or within which construction shall have progressed
to the extent of 5 per centum of completion as provided herein, but such
extension shall not be for an aggregate additional period in excess of
two years with respect to the expenditure or obligation of such deposits
or more than one year with respect to the progress of such construction:
Provided, That until January 1, 1965, in addition to the extensions
hereinbefore permitted, further extensions may be granted ending not
later than December 31, 1965.
(i) Any such deposited gain or portion thereof which is not so
expended or obligated within the period provided, or which is otherwise
withdrawn before the expiration of such period, or with respect to which
the construction has not progressed to the extent of 5 per centum of
completion within the period provided, or with respect to which the
Commission finds and certifies to the Secretary of the Treasury that,
for causes within the control of the taxpayer, the entire construction
is not completed with reasonable dispatch, if otherwise taxable income
under the law applicable to the taxable year in which such gain was
realized, shall be included in the gross income for such taxable year,
except for the purpose of the declared value excess-profits tax and the
capital stock tax. If any such deposited gain or portion thereof with
respect to a deposit made in any taxable year ending on or before June
30, 1945, is so included in gross income for such taxable year, there
shall (in addition to any other deficiency) be assessed, collected, and
paid in the same manner as if it were a deficiency, an amount equal to
1.1 per centum of the amount of gain so included, such amount being in
lieu of any adjustment with respect to the declared value excess-profits
tax for such taxable year.
(j) Notwithstanding any other provision of law, any deficiency in
tax for any taxable year resulting from the inclusion of any amount in
gross income as provided by subsection (i), and the amount to be treated
as a deficiency under such subsection in lieu of any adjustment with
respect to the declared value excess-profits tax, may be assessed or a
proceeding in court for the collection thereof may be begun without
assessment, at any time: Provided, however, That interest on any such
deficiency or amount to be treated as a deficiency shall not begin until
the date the deposited gain or portion thereof in question is required
under subsection (i) to be included in gross income.
(k) This section shall be applicable to a taxpayer only in respect
of sales or indemnifications for losses occurring within a taxable year
beginning after December 31, 1939, and only in respect of earnings
derived during a taxable year beginning after December 31, 1939.
(l) For the purposes of this section a vessel shall be considered as
constructed or acquired by the taxpayer if constructed or acquired by a
corporation at a time when the taxpayer owns at least 95 per centum of
the total number of shares of each class of stock of the corporation.
(m) The terms used in this section shall have the same meaning as in
chapter 1 of the Internal Revenue Code.
(n) The terms contract for the construction and construction
contract, as used in this section, shall include, in the case of a
taxpayer who constructs a new vessel in a shipyard owned by such
taxpayer, an agreement between such taxpayer and the Commission with
respect to such construction and containing provisions deemed necessary
or advisable by the Commission to carry out the purposes and policy of
this section.
(o) The terms reconstruction and reconditioning, as used in this
section, shall include the reconstruction, reconditioning, or
modernization of a vessel for exclusive use on the Great Lakes,
including the St. Lawrence River and Gulf, if the Commission determines
that the objectives of this Act will be promoted by such reconstruction,
reconditioning, or modernization, and, notwithstanding any other
provisions of law, such vessel shall be deemed to be a ``new vessel''
within the meaning of this section for such reconstruction,
reconditioning, or modernization.
[Sec. 511 as added by Act of October 10, 1940 (Pub. L. 840, 76th Cong.,
54 Stat. 1106), as amended by Act of June 17, 1943 (Pub. L. 78, 78th
Cong., 57 Stat. 157); Act of Dec. 23, 1944 (Pub. L. 552, 78th Cong., 58
Stat. 920); secs. 9-14, Act of July 17, 1952 (Pub. L. 586, 82d Cong., 66
Stat. 762); Act of Sept. 12, 1964 (Pub. L. 88-595, 78 Stat. 943)]
Sec. 905. [Merchant Marine Act, 1936.] When used in this Act--
(a) The words foreign commerce or foreign trade mean commerce or
trade between the United States, its Territories or possessions,
[[Page 8]]
or the District of Columbia, and a foreign country.
* * * * *
(c) The words citizen of the United States include a corporation,
partnership, or association only if it is a citizen of the United States
within the meaning of section 2 of the Shipping Act, 1916, as amended
(U.S.C., title 46, sec. 802), and with respect to a corporation under
title VI of this Act, all directors of the corporation are citizens of
the United States, and, in the case of a corporation, partnership, or
association operating a vessel on the Great Lakes, or on bays, sounds,
rivers, harbors, or inland lakes of the United States the amount of
interest required to be owned by a citizen of the United States shall be
not less than 75 per centum.
* * * * *
(e) The terms United States Maritime Commission and Commission shall
mean the Secretary of Commerce, the Maritime Administrator, or the * * *
[Maritime Subsidy Board] as the context may require * * *.
[Sec. 905 (a), (c), and (e) (49 Stat. 2016), amended by sec. 39 (a) and
(b), Act of June 23, 1938 (Pub. L. 705, 75th Cong., 52 Stat. 964); Act
of July 17, 1952 (Pub. L. 586, 82d Cong., 66 Stat. 765); sec. 4, Act of
Sept. 21, 1959 (Pub. L. 86-327, 73 Stat. 597)]
Sec. 2. [Shipping Act, 1916.] (a) That within the meaning of this
Act no corporation, partnership, or association shall be deemed a
citizen of the United States unless the controlling interest therein is
owned by citizens of the United States, and, in the case of a
corporation, unless its president or other chief executive officer and
the chairman of its board of directors are citizens of the United States
and unless no more of its directors than a minority of the number
necessary to constitute a quorum are noncitizens and the corporation
itself is organized under the laws of the United States or of a State,
Territory, District, or possession thereof, but in the case of a
corporation, association, or partnership operating any vessel in the
coastwise trade the amount of interest required to be owned by citizens
of the United States shall be 75 per centum.
(b) The controlling interest in a corporation shall not be deemed to
be owned by citizens of the United States (a) if the title to a majority
of the stock thereof is not vested in such citizens free from any trust
or fiduciary obligation in favor of any person not a citizen of the
United States; or (b) if the majority of the voting power in such
corporation is not vested in citizens of the United States; or (c) if
through any contract or understanding it is so arranged that the
majority of the voting power may be exercised, directly or indirectly,
in behalf of any person who is not a citizen of the United States; or
(d) if by any other means whatsoever control of the corporation is
conferred upon or permitted to be exercised by any person who is not a
citizen of the United States.
(c) Seventy-five per centum of the interest in a corporation shall
not be deemed to be owned by citizens of the United States (a) if the
title to 75 per centum of its stock is not vested in such citizens free
from any trust or fiduciary obligation in favor of any person not a
citizen of the United States; or (b) if 75 per centum of the voting
power in such corporation is not vested in citizens of the United
States; or (c) if, through any contract or understanding it is so
arranged that more than 25 per centum of the voting power in such
corporation may be exercised, directly or indirectly, in behalf of any
person who is not a citizen of the United States; or (d) if by any other
means whatsoever control of any interest in the corporation in excess of
25 per centum is conferred upon or permitted to be exercised by any
person who is not a citizen of the United States.
(d) The provisions of this Act shall apply to receivers and trustees
of all persons to whom the Act applies, and to the successors or
assignees of such persons.
[Sec. 2 (39 Stat. 729) as amended by Act of July 15, 1918 (Pub. L. 198,
65th Cong., 40 Stat. 900); sec. 38, Merchant Marine Act, 1920 (41 Stat.
1008); sec. 3, Act of Sept. 21, 1959 (Pub. L. 86-327, 73 Stat. 597)]
Sec. 2.1-1 Definitions.
(a) As used in the regulations in this part, except as otherwise
expressly provided--
(1) Act means the Merchant Marine Act, 1936, as amended (46 U.S.C.
27).
(2) Section means one of the sections of the regulations in this
part.
(3) Administration means the Maritime Administration of the
Department of Commerce as created by Reorganization Plan No. 21 of 1950
(46 U.S.C. 1111 note).
(4) Citizen means a person who, if an individual, was born or
naturalized as a citizen of the United States or, if other than an
individual, meets the requirements of section 905(c) of the Act and
section 2 of the Shipping Act, 1916, as amended (46 U.S.C. 802).
(5) Taxpayer means a citizen who has established or seeks to
establish a construction reserve fund under the provisions of section
511 of the Act and the regulations in this part, and may include a
partnership.
[[Page 9]]
(6) Corporation includes associations, joint-stock companies and
insurance companies.
(7) Stock includes the shares in an association, joint-stock
company, or insurance company.
(8) Affiliate or associate means a person directly or indirectly
controlling, controlled by, or under common control with, another
person.
(9) Control, as used in subparagraph (8) of this paragraph, means
the possession of the power to direct in any manner the management and
policies of a person, and the terms ``controlling'' and ``controlled''
shall have the meanings correlative to the foregoing.
(10) Person means an individual, a corporation, a partnership, an
association, an estate, a trust, or a company.
(11) Partnership includes a syndicate, group, pool, joint venture,
or other unincorporated organization.
(12) Construction, if so determined by the Administration, shall
include reconstruction and reconditioning.
(13) Reconstruction and reconditioning shall include the
reconstruction, reconditioning, or modernization of a vessel for
exclusive use on the Great Lakes, including the Saint Lawrence River and
Gulf, if the Administration determines that the objectives of the Act
will be promoted by such reconstruction, reconditioning, or
modernization, and, notwithstanding any other provisions of law, such
vessel shall be deemed to be a ``new vessel'' within the meaning of
section 511 of the Act for such reconstruction, reconditioning, or
modernization.
(14) Purchase-money indebtedness means any indebtedness, or evidence
thereof, created as the result of the purchase of a vessel by the
taxpayer.
(15) Contract, contract for the construction, and construction
contract shall include, if so determined by the Administration, a
contract for reconstruction or reconditioning and shall include, in the
case of a taxpayer who constructs a new vessel in a shipyard owned by
such taxpayer, an agreement, between such taxpayer and the
Administration with respect to such construction, and containing
provisions deemed necessary or advisable by the Administration to carry
out the purposes and policy of section 511 of the Act.
(b) Insofar as the computation and collection of taxes are
concerned, other terms used in the regulations in this part, except as
otherwise provided, have the same meaning as in the Internal Revenue
Code and the regulations thereunder.
Sec. 2.1-2 Scope of section 511 of the Act and the regulations in this part.
(a) Applicability of regulations. (1) The regulations prescribed in
this part--
(i) Apply to gain realized from the sale or loss of vessels,
earnings from the operation of vessels, and interest (or otherwise) with
respect to amounts previously deposited in the construction reserve
fund, for a taxable year beginning after December 31, 1964, and
(ii) Apply to the expenditure, obligation, or withdrawal, during a
taxable year beginning after December 31, 1964, of any deposits of gain,
earnings, and interest (or otherwise) of the character referred to in
subdivision (i) of this subparagraph without regard to the taxable year
in which the deposits were made.
(2) As to gain, earnings, or interest (or otherwise) described in
subparagraph (1)(i) of this paragraph and as to an expenditure,
obligation, or withdrawal described in subparagraph (1)(ii) of this
paragraph, the regulations in this part supersede Treasury Decision
5330, as amended (26 CFR (1939) Part 32).
(b) Nonrecognition and accumulation. Section 511 of the Act
provides, under conditions specified, for the nonrecognition, for income
and excess-profits tax purposes, of the gain realized from the sale or
indemnification for loss of certain vessels including certain vessels in
the course of construction, or shares therein. It also permits the
accumulation of the proceeds of such sales or indemnification and of
certain earnings without liability under Part I (section 531 and
following), Subchapter G, Chapter I of the Internal Revenue Code of
1954, and the regulations thereunder (Secs. 1.531-1 through 1.537-3 of
this chapter (Income Tax Regulations)).
(c) Availability of benefits. The benefits of section 511 of the Act
are available to any citizen as defined in paragraph (a)(4) of Sec. 2.1-
1, who, during any
[[Page 10]]
taxable year owns, in whole or in part, a vessel or vessels within the
scope of Sec. 2.1-3. A citizen operating such a vessel or vessels owned
by any other person or persons can derive no benefit from the provisions
relating to the nonrecognition of gain from the sale or loss of such
vessel or vessels so owned, but may establish a construction reserve
fund in which he may deposit earnings from the operation of such vessel
or vessels.
(d) Applicability of section 511. Section 511 of the Act applies
only with respect to sales or losses of vessels within the scope of
Sec. 2.1-3 or in respect of earnings derived from the operation of such
vessels. A loss to be within section 511 of the Act must be an actual or
constructive total loss. Whether there is a total loss, actual or
constructive, will be determined by the Administration.
Sec. 2.1-3 Requirements as to vessel operations.
Section 511 of the Act applies with respect to vessels operated in
the foreign or domestic commerce of the United States or in the
fisheries of the United States and vessels acquired or being constructed
for the purpose of such operation. The foreign commerce of the United
States includes commerce or trade between the United States (including
the District of Columbia), the territories and possessions which are
embraced within the coastwise laws, and a foreign country or other
territories and possessions of the United States. The domestic commerce
of the United States includes commerce or trade between ports of the
United States and its territories and possessions, embraced within the
coastwise laws and on inland rivers. The fisheries include the fisheries
of the United States and its territories and possessions. Section 511 of
the Act does not apply to vessels operated in the foreign commerce or
fisheries of any country other than the United States.
Sec. 2.1-4 Application to establish fund.
Any person claiming to be entitled to the benefits of section 511 of
the Act may make application, in writing, to the Administration for
permission to establish a construction reserve fund. The application
shall be in such form and substance as the Administration may prescribe
and shall designate, among other things, the depository or depositories
with which the taxpayer proposes to establish the said fund. The
original application shall be executed and verified by the taxpayer, or
if the taxpayer is a corporation, by one of its principal officers, in
triplicate, and shall be accompanied by eight conformed copies when
filed with the Administration.
Sec. 2.1-5 Tentative authorization to establish fund.
Where the time between the receipt by the Administration of the
application for permission to establish a construction reserve fund and
the date prior to which an amount received from the sale or loss of a
vessel must be deposited to come within the scope of section 511 of the
Act is insufficient to permit a determination of the eligibility of the
applicant, the Administration may tentatively authorize the
establishment of a construction reserve fund and the deposit of such
amount therein. Such tentative authorization shall be subject to
rescission by the Administration if subsequently it is determined that
the applicant is not entitled to the benefits of section 511 of the Act,
or has not complied with the statutory requirements. For example, a
tentative authorization will be rescinded if the Administration
ascertains that the applicant is not a citizen. Upon such determination,
the fund shall be closed and all amounts on deposit therein shall be
withdrawn.
Sec. 2.1-6 Establishment of fund.
(a) Authorization by the Administration. If the application is
approved by the Administration, the Administration will adopt Orders
authorizing the establishment of a construction reserve fund with the
depository or depositories designated by the taxpayer and approved by
the Administration. The Orders will provide for joint control by the
Administration and the taxpayer over such fund, will set forth the
conditions governing the establishment and maintenance of the fund and
the making of deposits therein and withdrawals
[[Page 11]]
therefrom, and will designate the representatives authorized to execute
instruments of withdrawal on behalf of the Administration.
(b) Resolution or agreement of the taxpayer. A certified copy of the
Orders of the Administration will be furnished the taxpayer. If the
taxpayer is a corporation, it shall promptly adopt, through its board of
directors, a resolution satisfactory in form and substance to the
Administration, authorizing the establishment and maintenance of the
fund in conformity with the action of the Administration. If the
taxpayer is not a corporation, it shall promptly execute an agreement
with the depository satisfactory in form and substance to the
Administration to conform to the action of the Administration as set
forth in the Orders. Certified copies of the Orders of the
Administration and of the resolution of the taxpayer (if it is a
corporation) will be furnished to the depository by the Administration
and the taxpayer, respectively, for its guidance in maintaining the fund
and honoring instruments of withdrawal. The taxpayer, if a corporation,
shall also furnish the Administration with a certified copy of its
resolution, or if not a corporation, a duplicate original of its
agreement with the depository.
(c) Constructive action not recognized. Constructive deposits,
substitutions or withdrawals will not be recognized by the
Administration in the establishment and maintenance of the fund.
(d) Failure to make deposits as basis for termination of fund. In
the event no deposit is made into the fund for more than five years, any
amounts remaining in the fund shall be removed from the fund at the
discretion of the Administration and, if so removed, the fund shall be
terminated. In the event of such termination, see Sec. 2.1-23 for
recognition of gain.
Sec. 2.1-7 Circumstances permitting reimbursement from a construction reserve fund.
(a) Payments prior to establishment of fund. If, prior to the
establishment of a construction reserve fund under the regulations in
this part, a taxpayer has made necessary payments under a contract which
satisfies the provisions of the regulations in this part and section 511
of the Act for the construction or acquisition of a new vessel, such
taxpayer may, if subsequently authorized to establish a construction
reserve fund under the regulations in this part, draw against such fund
as reimbursement for the amount, if any, of other funds which, with the
approval or ratification of the Administration, the taxpayer used for
making such necessary payments prior to the establishment of the fund.
(b) Payments subsequent to establishment of fund. If, subsequent to
the establishment of a construction reserve fund under the regulations
in this part, the taxpayer has made necessary payments under a contract
which satisfies the provisions of the regulations in this part and
section 511 of the Act for the construction or acquisition of a new
vessel, such taxpayer may draw against such fund as reimbursement for
the amount, if any, of other funds which, with the approval or
ratification of the Administration, the taxpayer had used for the
purpose of making such necessary payments.
Sec. 2.1-8 Investment of funds in securities.
(a) Obligations of or guaranteed by the United States. Interest-
bearing direct obligations of the United States, or obligations fully
guaranteed as to principal and interest by the United States, may be
deposited in the construction reserve fund in lieu of cash, may be
purchased with cash on deposit in the fund, or may be substituted for
securities or commitment to finance in the fund, subject to the
provisions of paragraph (b) of this section.
(b) Other securities. In cases where the taxpayer desires to deposit
any securities in the fund in lieu of cash other than those of or
guarantees by the United States or to purchase such other securities
with cash on deposit in the fund, or to substitute such other securities
for securities or commitment to finance in the fund, the taxpayer shall
make written application to the Administration and shall not consummate
the transaction until the written consent of the Administration shall
have been received. The application shall describe the securities fully.
Every approval by the Administration
[[Page 12]]
of such application shall be conditioned upon agreement by the taxpayer
forthwith to dispose of such securities upon subsequent request by the
Administration. Immediately upon the purchase of any securities for
deposit in the fund, the taxpayer shall advise the Administration,
giving the date of purchase, a description of the securities, and the
price paid therefor (net, brokerage and other charges, and gross).
Ordinarily, the Administration will not approve the deposit in the fund
in lieu of cash, or the purchase with cash on deposit in the fund or the
substitution for securities in the fund of securities not actively
traded in on exchanges registered under the Securities Exchange Act of
1934 (15 U.S.C. ch. 2B), or securities which are not legal for
investment of trust funds. Whenever the Administration approves the
substitution of other securities for securities in the fund, such
substitution shall be effected only upon or after the deposit of the
substituted securities into the fund.
(c) Cash. Cash may be substituted for amounts which are on deposit
in the fund in any other form.
(d) Devalued securities. In the event the Administration determines
that the market value at any date of any securities in the fund has
decreased to a figure which is less than 90 percent of the market value
at the time of deposit into the fund, then within 60 days after the
taxpayer receives notice of such determination the taxpayer shall
(except as otherwise provided in this paragraph) deposit into the fund
cash or securities in an amount equal to the difference between the
current market value of the devalued securities and the market value of
such securities at the time of their original deposit. However if any
securities in the fund are valued at the time of their deposit at less
than the market value of such securities at the time of their deposit
the taxpayer shall be required to deposit only an amount equal to that
portion of the difference between the current market value of the
devalued securities and the market value of such securities at the time
of their original deposit which bears the same ratio to such total
difference as the amount at which the securities were valued at the time
of their deposit bears to the market value at the time of such deposit.
Sec. 2.1-9 Valuation of securities in fund.
(a) Equivalent values. In cases where securities are deposited in
the fund in lieu of cash, or are purchased with cash on deposit in the
fund, or are substituted for securities in the fund, the value of such
securities must not be less than the amount of cash in lieu of which
they are so deposited or with which they are so purchased, or the value
at the time of deposit of the securities for which they were so
substituted. If the securities on deposit in the fund are replaced by
cash from the general funds of the taxpayer, the amount of cash to be
deposited in the fund in lieu thereof shall be not less than the amount
at which such securities were valued at the time of their deposit in the
fund.
(b) Determination of value. (1) For the purpose of determining the
amount in the fund, the value of securities shall be their ``market
value'' (which shall be the basis for determining value, unless
otherwise agreed to by the administration) and shall be determined in
the following manner:
(i) In instances where no actual purchase is involved, such as the
initial deposit of securities in the fund in lieu of cash, the last
sales price thereof on the principal exchange on the day the deposit was
made shall be deemed to be the ``market value'' thereof, or, if no such
sales were made, the ``market value'' thereof will be determined by the
Administration on such basis as it may deem to be fair and reasonable in
each case.
(ii) In instances where the purchase of securities with cash on
deposit in the fund is involved, ``market value'' shall be the gross
price paid (adjusted for accrued interest): Provided, That if such
securities are purchased otherwise than upon a registered exchange the
price shall be within the range of transactions on the exchange on the
date of such purchase, or, if there were no such transactions, then the
``market value'' thereof will be determined by the Administration on
such basis as it may deem to be fair and reasonable in each case.
[[Page 13]]
(2) Purchase-money obligations secured by mortgages on vessels sold
or irrevocable commitments to finance the construction or acquisition of
new vessels which are deposited in the construction reserve fund as
provided in Sec. 2.1-13 ordinarily will be considered as equivalent to
their face value.
Sec. 2.1-10 Withdrawals from fund.
(a) Withdrawals for obligations or liquidation. (1) Checks, drafts,
or other instruments of withdrawal to meet obligations under a contract
for the construction or acquisition of a new vessel or vessels or for
the liquidation of existing or subsequently incurred purchase-money
indebtedness, after having been executed by the taxpayer, shall be
forwarded to the Administration in Washington, DC, with appropriate
explanation of the purpose of the proposed withdrawal, including
properly certified invoices or other supporting papers. Such instruments
of withdrawal, if payable to the Administration, will be deposited by
the Administration for collection, and the proceeds thereof, upon
collection, will be credited to the appropriate contract with the
Administration; but if drawn to the order of payees other than the
Administration, after countersignature on behalf of the Administration,
will ordinarily be forwarded to the payees.
(2) An amount obligated under a contract for the construction or
acquisition of a new vessel or vessels or for the liquidation of
existing or subsequently incurred purchase-money indebtedness, whether
the obligor has the entire or a partial interest therein within the
scope of section 511 of the Act, may not, so long as the contract or
indebtedness continues in full force and effect, be withdrawn except to
meet payments due or to become due under such contract or for such
liquidation.
(b) Other withdrawals. Checks, drafts, or other instruments of
withdrawal executed by the taxpayer for purposes other than to meet
obligations under a contract for the construction or acquisition of a
new vessel or vessels or for the liquidation of existing or subsequently
incurred purchase-money indebtedness, whether the taxpayer has the
entire or a partial interest therein, shall be drawn by the taxpayer to
its own order and forwarded to the Administration in Washington, DC,
with appropriate explanation of the purpose of the proposed withdrawal.
Such withdrawals may occur by reason of a determination by the
Administration that the taxpayer is not entitled to the benefits of
section 511 of the Act (see Sec. 2.1-5), or that a particular deposit
has been improperly made (see Sec. 2.1-13), or by reason of the election
of the taxpayer to make such withdrawals. Upon receipt of such checks,
drafts, or other instruments of withdrawal, the Administration will give
notice thereof to the Commissioner of Internal Revenue. The Commissioner
will advise the Administration of the receipt of the notice and the date
it was received. The Administration shall not countersign such checks,
drafts, or other instruments of withdrawal or transmit them to the
taxpayer until the expiration of 30 days from the date of receipt of the
notice by the Commissioner, unless the Commissioner or such official of
the Internal Revenue Service as he may designate for the purpose
consents in writing to earlier countersignature by the Administration
and transmittal to the taxpayer. Upon the expiration of such 30-day
period, or prior thereto if the aforesaid consent of the Commissioner
has been obtained, the Administration will countersign the check, draft,
or other instrument of withdrawal and forward it to the taxpayer.
(c) Inapplicability to certain transactions. The provisions of this
section shall not be applicable to transactions deemed to be withdrawals
by reason of the sale of securities held in the fund for an amount less
than the market value thereof at the time of their deposit (see
Sec. 2.1-23), nor to the cancellation of an irrevocable commitment
deposited in the fund, upon proof satisfactory to the Administration
that the terms of such commitment have been fully satisfied.
Sec. 2.1-11 Time deposits.
Deposits in the construction reserve fund not invested in securities
may be placed in time deposits when, in the judgment of the taxpayer, it
is desirable and feasible so to do. The taxpayer
[[Page 14]]
shall promptly advise the Administration of any time deposit
arrangements made with the depository. The Administration reserves the
right at any time to require the termination or modification of any such
arrangements. With prior approval of the Administration a time deposit
may be made in a depository other than the one with which the
construction reserve fund is established.
Sec. 2.1-12 Election as to nonrecognition of gain.
(a) Election requirements. As a prerequisite to the nonrecognition
of gain on the sale or loss of a vessel (or of a part interest therein)
for Federal income tax purposes, the taxpayer, after establishing a
construction reserve fund, must make an election with respect to such
vessel or interest in the manner set forth in this paragraph.
(1) In general. Except as provided in subparagraph (2) of this
paragraph, the election must be made in the taxpayer's Federal income
tax return (or, in the case of a partnership, in the partnership return
of income) for the taxable year in which the gain with respect to the
sale or loss of the vessel is realized. The election as to the
nonrecognition of gain shall be shown by a statement to that effect,
submitted as a part of, and attached to, the return. The statement,
which need not be on any prescribed form, shall set forth a computation
of the amount of the realized gain, the identity of the vessel, the
nature and extent of the taxpayer's interest therein, whether such
vessel was sold or lost and the date of sale or loss, the full sale
price or full amount of indemnity, and the amount and date of each
payment thereof, the basis for tax purposes and any other data affecting
the determination of the realized gain.
(2) Certain Government payments. In case a vessel is purchased or
requisitioned by the United States, or is lost, in any taxable year and
the taxpayer receives payment for the vessel so purchased or
requisitioned, or receives from the United States indemnity on account
of such loss, subsequent to the end of such taxable year, the taxpayer
shall make his election by filing notice thereof with the Commissioner
of Internal Revenue, Washington, DC, 20224, prior to the expiration of
60 days after receipt of the payment or indemnity. The taxpayer shall
file a copy of the notice with the Secretary, Federal Maritime Board,
Washington, DC, 20573. The form of the notice of election shall be
prepared by the taxpayer and shall be substantially as follows:
Election Relative to Nonrecognition of Gain Under Section 511(c)(2),
Merchant Marine Act, 1936
Pursuant to the provisions of section 511(c)(2) of the Merchant
Marine Act, 1936, as amended, notice is hereby given that the
undersigned taxpayer elects that gain in respect of the sale to the
United States, or indemnification received from the United States on
account of the loss, of the vessel named below or share therein shall
not be recognized. The circumstances involved in the computation of such
gain are as follows:
Name and other identification of vessel________________________________
Nature and extent of the taxpayer's interest in the vessel_____________
Nature of disposition, i.e., sale or loss______________________________
Date of disposition____________________________________________________
Full sale price or full amount of indemnity received by taxpayer_______
Amount and date of each payment of sale price or indemnity received by
taxpayer________________________________________________________________
Amount and date of each previous deposit of such payments in
construction reserve fund_______________________________________________
_______________________________________________________________________
Identification of each check or other instrument by which payment made
to taxpayer_____________________________________________________________
_______________________________________________________________________
Tax basis of taxpayer's interest in vessel______________________________
Any other data affecting the determination of the realized gain________
Amount of gain (submit computation)____________________________________
_______________________________________________________________________
(Name of taxpayer)
By_____________________________________________________________________
_______________________________________________________________________
(Date of execution)
Sec. 2.1-13 Deposit of proceeds of sales or indemnities.
(a) Manner of deposit. The deposit required by section 511 of the
Act must be made in a construction reserve fund established with a
depository or depositories approved by the Administration and subject to
the joint control of the Administration and the taxpayer. It is not
necessary to establish a separate fund with respect to each vessel or
share in a vessel sold or lost.
(b) Amount of deposit. With respect to any vessel sold or lost, or a
share
[[Page 15]]
therein, the deposit must be in an amount equal to the ``net proceeds''
of the sale, or the ``net indemnity'' for the loss. By ``net proceeds''
and ``net indemnity'' is meant (1) the depositor's interest in the
adjusted basis of the vessel plus (2) the amount of gain which would be
recognized for tax purposes in the absence of section 511 of the Act. In
determining ``net proceeds'', the amount necessarily paid or incurred
for brokers' commissions is to be deducted from the gross amount of the
sales price. In the event the taxpayer is an affiliate or associate of
the buyer, the amount of the sales price shall not exceed the fair
market value of the vessel or vessels sold as determined by the
Administration. In such case the taxpayer shall furnish evidence
sufficient, in the opinion of the Administration, to establish that the
sales price is not in excess of the fair market value. In determining
``net indemnity'', the amount necessarily paid or incurred purely for
collection, or rate of exchange discounts on the payment, of the
indemnity is to be deducted from the gross amount of collectible
indemnity. In case of the sale or loss of several vessels or share
therein, a deposit of the ``net proceeds'' or ``net indemnity'' with
respect to one or more of the vessels or shares is permissible. Where
several vessels or shares are sold for a lump sum, the ``net proceeds''
allocated to each vessel or share shall be determined in accordance with
any reasonable rule satisfactory to the Commissioner of Internal
Revenue. The taxpayer must deposit the full amount of each payment
(including cash, notes, or other evidences of indebtedness) as a single
deposit in the construction reserve fund. A payment divided between two
or more depositories will be regarded as a single deposit. Amounts
received by the taxpayer prior to the date of consummation of the sale
of the vessel shall be considered as having been received by the
taxpayer at the time the sale is consummated.
(c) Purchase-money obligations. Where the proceeds from the sale of
a vessel include purchase-money obligations, such obligations together
with the entire collateral therefor, or, in the case of deposit of the
proceeds of a share in the vessel, a proportionate part of the
obligations and collateral as determined by the Administration, shall be
deposited, with the remainder of the proceeds, in the construction
reserve fund as a part of the ``net proceeds''. The depository shall
receive payment of all amounts due on such purchase-money obligations
and such amounts shall be placed in the fund in substitution for the
portion of the obligations paid. All installments of purchase-money
obligations shall be paid directly into the fund by the obligor. In the
event any such installment is not so deposited, the Administration, at
any time after the due date, may require the taxpayer to deposit an
amount equal to such installment. If the taxpayer so desires, he may
deposit in the construction reserve fund cash or approved securities in
an amount equal to the face value of any purchase-money obligations in
lieu of depositing such obligations.
(d) Vessel subject to mortgage at time of sale or loss. Where a
vessel is subject to a mortgage or other encumbrance at the time of its
sale or loss and the taxpayer actually receives only an amount
representing the equity therein or a share in such equity corresponding
to his share in the vessel, he shall deposit in the construction reserve
fund such amount and concurrently therewith other funds in an amount
equal to the difference between the amount received and the ``net
proceeds'' or ``net indemnity''. Such other funds may be in the form of
cash, or, subject to the approval of the Administration, (1) interest-
bearing securities, or (2) an irrevocable and unconditional commitment
to finance the construction or acquisition of a new vessel in whole or
in part by an obligor approved by the Administration in an amount equal
to the amount by which the ``net proceeds'' exceed the cash or
securities deposited in the fund.
(e) Unauthorized deposits. A deposit which is not provided for by
section 511 of the Act shall, without unreasonable delay, be withdrawn
from the fund and tax liability will be determined as though such
deposit had not been made. (See Secs. 2.1-10 and 2.1-24.)
[[Page 16]]
Sec. 2.1-14 Deposit of earnings and receipts.
(a) Earnings. A citizen may deposit all or any part of earnings
derived from the operation, within the scope of Sec. 2.1-3, of a vessel
or vessels owned either by himself or any other person, if such earnings
are intended for construction or acquisition of new vessels. Such
earnings may include payments received by an owner, as compensation for
use of his vessel, from other persons by whom it is so operated.
Earnings from other sources may not be deposited. The earnings from
operation of vessels which are eligible for deposit are the net earnings
determined without regard to any deduction for depreciation,
obsolescence, or amortization with respect to such vessels.
(b) Receipts. Receipts from deposited funds, in the form of interest
or otherwise, may be deposited.
Sec. 2.1-15 Time for making deposits.
(a) Proceeds of sale or indemnification. Deposits of amounts
representing proceeds of the sale or indemnification for loss of a
vessel or share therein must be made within 60 days after receipt by the
taxpayer.
(b) Earnings and receipts. Earnings and receipts for the taxable
year may be deposited at any time. (See Sec. 2.1-14.)
Sec. 2.1-16 Tax liability as to earnings deposited.
Deposit in the construction reserve fund of earnings from the
operation of a vessel or vessels, or receipts, in the form of interest
or otherwise, with respect to amounts previously deposited does not
exempt the taxpayer from tax liability with respect thereto nor postpone
the time such earnings or receipts are includible in gross income.
Earnings and receipts deposited in a construction reserve fund
established in accordance with the provisions of section 511 of the Act
and the regulations in this part will be deemed to have been accumulated
for the reasonable needs of the business within the meaning of Part 1
(section 531 and following), Subchapter G, Chapter I of the Internal
Revenue Code of 1954, so long as the requirements of section 511 of the
Act and the regulations in this part are satisfied relative to the use
of the fund in the construction, reconstruction, reconditioning, or
acquisition of new vessels, or for the liquidation of purchase-money
indebtedness on such vessels. For incurrence of tax liability due to
noncompliance with the requirements of section 511 of the Act and the
regulations in this part with respect to deposits in the construction
reserve fund, see the provisions of Sec. 2.1-23.
Sec. 2.1-17 Basis of new vessel.
The basis for determining gain or loss and for depreciation for the
purpose of the Federal income tax with respect to a new vessel
constructed, reconstructed, reconditioned, or acquired by the taxpayer,
or with respect to which purchase-money indebtedness is liquidated as
provided in section 511(g) of the Act, with funds deposited in the
construction reserve fund, is reduced by the amount of the unrecognized
gain represented in the funds allocated under the provisions of the
regulations in this part to the cost of such vessel. (See Sec. 2.1-18.)
Sec. 2.1-18 Allocation of gain for tax purposes.
(a) General rules of allocation. As provided in Sec. 2.1-17, if
amounts on deposit in a construction reserve fund are expended,
obligated, or withdrawn for construction, reconstruction,
reconditioning, or acquisition of new vessels, or for the liquidation of
purchase-money indebtedness of such vessels, the portion thereof which
represents gain shall be applied in reduction of the basis of such new
vessels. The rules set forth below in this paragraph shall apply in
allocating the unrecognized gain to the amounts so expended, obligated,
or withdrawn:
(1) If the ``net proceeds'' of a sale or ``net indemnity'' in
respect of a loss are deposited in more than one deposit, the portion
thereof representing unrecognized gain shall be considered as having
been deposited first.
(2) Amounts expended, obligated, or withdrawn from the construction
reserve fund shall be applied against amounts deposited in the order of
deposit.
(3) If any deposit consists in part of gain not recognized under
section 511(c)
[[Page 17]]
of the Act, then any expenditure, obligation, or withdrawal applied
against such deposit shall be considered to consist of gain in the same
proportion that the part of the deposit which constitutes gain bears to
the total amount of the deposit.
(b) Date of obligation. The date funds are obligated under a
contract for the construction, reconstruction, reconditioning, or
acquisition of new vessels, or for the liquidation of purchase-money
indebtedness on such vessels, rather than the date of payment from the
fund, will determine the order of application against the deposits in
the fund. When a contract for the construction, reconstruction,
reconditioning, or acquisition of new vessels, or for the liquidation of
purchase-money indebtedness on such vessels is entered into, amounts on
deposit in the construction reserve fund will be deemed to be obligated
to the extent of the amount of the taxpayer's liability under the
contract. Deposits will be deemed to be so obligated in the order of
deposit, each new contract obligating the earliest deposit not
previously expended, obligated, or withdrawn. If the liability under the
contract exceeds the amount in the construction reserve fund, the
contract will be deemed to obligate, to the extent of that part of such
excess not otherwise satisfied, the earliest deposit or deposits
thereafter made.
(c) Illustration. The foregoing rules are illustrated in the
following example:
Example. (1) A taxpayer who makes his returns on the calendar year
basis sells a vessel in 1963 for $1,000,000, realizing a gain of
$400,000. Payment of $100,000 is received in March 1963 when the
contract is signed, and the balance of $900,000 is received in June 1963
on delivery of the vessel. The $1,000,000 is deposited in a construction
reserve fund in July 1963. In December 1963, the taxpayer also deposits
$150,000, representing earnings of that year. In 1964, he sells another
vessel for $1,000,000, realizing a gain of $250,000. The sale price of
$1,000,000 is received on delivery of the vessel in February 1964, and
deposited in the construction reserve fund in March 1964. In September
1964, the taxpayer purchases for cash out of the construction reserve
fund a new vessel for $1,750,000. To the cost of this vessel must be
allocated the 1963 deposits of $1,150,000 and $600,000 of the March 1964
deposit. This leaves in the fund $400,000 of the March 1964 deposit. The
amount of the unrecognized gain to be applied against the basis of the
new vessel is $550,000, computed as follows: Gain of $400,000
represented in the 1963 deposits, plus the same proportion of the
$250,000 gain represented in the March 1964 deposit ($1,000,000) which
the amount ($600,000) allocated to the vessel is of the amount of the
deposit, i.e., $400,000 plus 600,000/1,000,000 of $250,000 or $150,000,
a total of $550,000. This reduces the basis of the new vessel to
$1,200,000 ($l,750,000 less $550,000).
(2) In 1965, the taxpayer sells a third vessel for $3,000,000,
realizing a gain of $900,000. The $3,000,000 is received and deposited
in the construction reserve fund in June 1965, making a total in the
fund of $3,400,000. In December 1965, the taxpayer contracts for the
construction of a second new vessel to cost a maximum of $3,200,000,
thereby obligating that amount of the fund, and in June 1966, receives
permission to withdraw the unobligated balance amounting to $200,000. To
the cost of the second new vessel must be allocated the $400,000 balance
of the March 1964 deposit and $2,800,000 of the June 1965 deposit. The
unrecognized gain to be applied against the basis of such new vessel is
that proportion of the gain represented in each deposit which the
portion of the deposit allocated to the vessel bears to the amount of
such deposit, i.e., 400,000/1,000,000 of $250,000, or $100,000 plus
2,800,000/3,000,000 of $900,000, or $840,000 making a total of $940,000.
The $200,000 withdrawal is applied against the June 1965 deposit and the
portion thereof which represents gain will be recognized as income for
1965, the year in which realized. The computation of the recognized gain
is as follows: 200,000/3,000,000 of $900,000, or $60,000.
Sec. 2.1-19 Requirements as to new vessels.
(a) Requirements. For the purposes of section 511 of the Act and the
regulations in this part, the new vessel must be--
(1) Documented under the laws of the United States when it is
acquired by the taxpayer, or the taxpayer must agree that when acquired
it will be documented under the laws of the United States;
(2)(i) Constructed in the United States after December 31, 1939, or
(ii) its construction has been financed under Title V or Title VII of
the Act, or (iii) its construction has been aided by a mortgage insured
under Title XI of the Act; and
(3) Either (i) of such type, size, and speed as the Administration
determines to be suitable for use on the high seas or Great Lakes in
carrying out the
[[Page 18]]
purposes of the Act, but of not less than 2,000 gross tons or of less
speed than 12 knots, except that a particular vessel may be of lesser
tonnage or speed if the Administration determines and certifies that the
particular vessel is desirable for use by the United States in case of
war or national emergency, or (ii) constructed to replace a vessel or
vessels requisitioned or purchased by the United States, in which event
it must be of such type, size, and speed as to constitute a suitable
replacement for the vessel requisitioned or purchased, but if a vessel
already built is acquired to replace a vessel or vessels requisitioned
or purchased by the United States, such vessel must meet the
requirements set forth in subdivision (i) of this subparagraph.
Ordinarily, under subdivision (i) of this subparagraph, a vessel
constructed more than five years before the date on which deposits in a
construction reserve fund are to be expended or obligated for
acquisition of such vessel will not be considered suitable for use in
carrying out the purpose of the Act, except that the five-year age
limitation provided above in this sentence shall not apply to a vessel
to be reconstructed before being placed in operation by the taxpayer.
(b) Time of construction. A vessel will be deemed to be constructed
after December 31, 1939, only if construction was commenced after that
date. Subject to the provisions of this section, a new vessel may be
newly built for the taxpayer, or may be acquired after it is built.
(c) Replacement of vessels. It is not necessary that vessels shall
be replaced vessel for vessel. The new vessels may be more or less in
number than the replaced vessels, provided the other requirements of
this section are met.
Sec. 2.1-20 Obligation of deposits.
(a) Time for obligation. Within three years from the date of any
deposit in a construction reserve fund, unless extension is granted as
provided in Sec. 2.1-22, such deposit must be obligated under a contract
for the construction or acquisition of a new vessel or vessels (or in
the discretion of the Administration for a share therein), with not less
than 12\1/2\ percent of the construction or contract price of the entire
vessel or vessels actually paid or irrevocably committed on account
thereof or must be expended or obligated for the liquidation of existing
or subsequently incurred purchase-money indebtedness to persons other
than a parent company of, or a company affiliated or associated with,
the mortgagor on a new vessel or vessels. Amounts on deposit in a
construction reserve fund will be deemed to be obligated for expenditure
when a binding contract of construction or acquisition has been entered
into or when purchase-money indebtedness has been incurred and, if
obligated under a contract of construction or acquisition, will be
deemed to be irrevocably committed when due and payable in accordance
with the terms of the contract of construction or acquisition.
(b) Requirements for obligations. Unless otherwise authorized by the
Administration, contracts for the construction of new vessels must be
for a fixed price, or provide for a base price that may be adjusted for
changes in labor and material costs not exceeding 15 percent of the base
price. The fixed or base price, as the case may be, shall be fair and
reasonable as determined by the Maritime Administration. Any financial
or other interests between the taxpayer and the contractor shall be
disclosed to the Administration by the taxpayer. Plans and
specifications for the new vessel or vessels must be approved by the
Administration to the extent it deems necessary. A deposit in a
construction reserve fund may be expended or obligated for expenditure
for procurement under an acquisition or construction contract of a part
interest in a new vessel or vessels only after obtaining the written
consent of the Administration. The granting of such consent shall be
entirely in the discretion of the Administration and it may impose such
conditions with respect thereto as it may deem necessary or advisable
for the purpose of carrying out the provisions of section 511 of the
Act. Applications for such consent shall be executed in triplicate, and,
together with eight conformed copies thereof, filed with the
Administration.
[[Page 19]]
Sec. 2.1-21 Period for construction of certain vessels.
A new vessel constructed otherwise than under the provisions of
Title V of the Act, and not purchased from the Administration must,
within six months from the date of the construction contract, or within
the period of any extension, be completed to the extent of not less than
5 percent as estimated by the Administration and certified by it to the
Secretary of the Treasury. In case of a contract covering more than one
vessel it will be sufficient if one of the vessels is 5 percent
completed within the six months' period from the date of the contract or
within the period of any extension, and so certified. All construction
must be completed with reasonable dispatch as determined by the
Administration. If, for causes within the control of the taxpayer, the
entire construction is not completed with reasonable dispatch, the
Administration will so certify to the Secretary of the Treasury. For the
effect of such certification, see Sec. 2.1-23.
Sec. 2.1-22 Time extensions for expenditure or obligation.
(a) Extensions. The Administration, upon application and a showing
of proper circumstances, (1) may allow an extension of time within which
deposits shall be expended or obligated, not to exceed one year, and
upon a second application received before the expiration of the first
extension, may allow an additional extension not to exceed one year, and
(2) may allow an extension or extensions of time within which five
percent of the construction shall have been completed as provided in
Sec. 2.1-21 not to exceed one year in the aggregate, and (3) may allow
any other extensions that may be provided by amendment to the Act.
(b) Application required. A taxpayer seeking an extension of time
shall make application therefor, and transmit it with an appropriate
statement of the circumstances, including the reasons justifying the
requested extension or extensions, and appropriate documents in
substantiation of the statement, to the Administration. The
Administration will notify the Commissioner of Internal Revenue of any
extension granted. In case an application for extension is denied, the
taxpayer will be liable for delay as though no application had been
made.
Sec. 2.1-23 Noncompliance with requirements.
(a) Noncompliance. The amount of the gain which is that portion of
the construction reserve fund otherwise constituting taxable income
under the law applicable to the taxable year in which such gain was
realized shall be included in the taxpayer's gross income for such
taxable year for income or excess-profits tax purposes, if--
(1) A portion of such fund is withdrawn for purposes other than--
(i) The construction, reconstruction, reconditioning, or acquisition
of a new vessel; or
(ii) The liquidation of existing or subsequently incurred purchase-
money indebtedness to persons other than a parent company of, or a
company affiliated or associated with, the mortgagor on a new vessel or
vessels; or
(2) The taxpayer fails to comply with the requirements of section
511 of the Act or the regulations in this part relating to the
utilization of construction reserve funds in the construction,
reconstruction, reconditioning, or acquisition of a new vessel, or the
liquidation of purchase-money indebtedness on such a vessel.
If securities on deposit in a construction reserve fund are sold and the
amount placed in the fund in lieu thereof is less than the value of the
securities at the time of their deposit, the difference between such
value and the amount placed in the fund in lieu of the securities will
be deemed to have been withdrawn. With respect to the substitution of
new financing in the case of an irrevocable commitment, see paragraph
(d) of Sec. 2.1-13.
(b) Amount recognized. In the event of noncompliance with the
prescribed conditions relative to any contract for construction,
reconstruction, reconditioning, or acquisition of new vessels, or for
the liquidation of purchase-money indebtedness on such vessels,
recognition will extend to the entire amount of the gain represented in
that portion of the construction reserve fund obligated under such
contract.
[[Page 20]]
Thus, if the Administration determines and certifies to the Secretary of
the Treasury that for causes within the control of the taxpayer
construction under a contract is not completed with reasonable dispatch,
the entire amount of the gain represented in the portion of the
construction reserve fund obligated under the contract will be
recognized even though all other conditions have been satisfied. In case
of noncompliance with the requirements of section 511 of the Act or the
regulations in this part, see the provisions of Sec. 2.1-18 as to the
allocation of gain.
(c) Unreasonable accumulation. Noncompliance with the provisions of
section 511 of the Act or the regulations in this part relative to the
utilization of the deposited amounts may also, inasmuch as the provision
of section 511(f) of the Act is then inapplicable, warrant an
examination to ascertain whether such amounts constitute an unreasonable
accumulation of earnings and profits within the meaning of Part I
(section 531 and following), Subchapter G, Chapter I of the Internal
Revenue Code of 1954, or corresponding provisions of prior law. If
amounts are deposited and the fund maintained in good faith for the
purpose of construction, reconstruction, reconditioning, and acquisition
of new vessels, or for the liquidation of purchase-money indebtedness on
such vessels, such amounts will be deemed to have been accumulated for
the reasonable needs of the business.
Sec. 2.1-24 Extent of tax liability.
(a) Declared value excess-profits tax. Gain which is includible in
gross income under Sec. 2.1-23 shall be included in gross income for all
income and excess-profits tax purposes, but not for the purposes of the
declared value excess-profits tax and the capital stock tax as provided
in section 511(i) of the Act. In lieu of any adjustment with respect to
such declared value excess-profits tax, there is imposed for any taxable
year ending on or before June 30, 1945, in which the gain is realized an
additional tax of 1.1 percent of the amount of the gain. No additional
capital stock tax liability is incurred.
(b) Improper deposits. In the case of deposits in the construction
reserve fund of amounts derived from sources other than those specified
in section 511 of the Act, or in the case of failure to deposit an
amount equal to the ``net proceeds'' or ``net indemnity'' within the
period prescribed in section 511(c) of the Act and Sec. 2.1-15, the
taxpayer obtains no suspension or postponement of any tax liability and
the tax is collectible without regard to the provisions of section
511(c) of the Act.
(c) Time for filing claim subsequent to election under section
511(c)(2). If an election is made under section 511(c)(2) of the Act and
paragraph (a)(2) of Sec. 2.1-12, and if computation or recomputation in
accordance therewith is otherwise allowable but is prevented, on the
date of filing of notice of such election, or within six months
thereafter, by any statute of limitation; such computation or
recomputation nevertheless shall be made notwithstanding such statute if
a claim therefor is filed within six months after the date of making
such election. If as the result of such computation or recomputation an
overpayment is disclosed a claim for refund should be made in accordance
with Sec. 301.6402-3 within such six months' period. For other rules
applicable to the filing of claims for credit or refund of an
overpayment of tax, see Sec. 301.6402-2 of this chapter (Regulations on
Procedure and Administration), relating to claims for credit or refund.
[T.D. 6820, 30 FR 6030, Apr. 29, 1965, as amended by T.D. 7410, 41 FR
11020, Mar. 16, 1976]
Sec. 2.1-25 Assessment and collection of deficiencies.
Any additional tax, including the 1.1 percent amount imposed by
section 511(i) of the Act, due on account of withdrawal from a
construction reserve fund, or failure to comply with section 511 of the
Act or the regulations in this part, is collectible as a deficiency.
Interest upon such deficiency will run from the date the withdrawal or
noncompliance occurs. The amount of any deficiency, including interest
and additions to the tax, determined as a result of such withdrawal or
noncompliance, may be assessed, or a proceeding in court for the
collection thereof may be begun without assessment, at any time and
without regard to any period of limitations or any other provisions of
[[Page 21]]
law or rule of law, including the doctrine of res judicata.
Sec. 2.1-26 Reports by taxpayers.
(a) Information required. With each income tax return filed for a
taxable year during any part of which a construction reserve fund is in
existence the taxpayer shall submit a statement setting forth a detailed
analysis of such fund. The statement, which need not be on any
prescribed form, shall include the following information with respect to
the construction reserve fund:
(1) The actual balance in the fund at the beginning and end of the
taxable year;
(2) The date, amount, and source of each deposit during the taxable
year;
(3) If any deposit referred to in subparagraph (2) of this paragraph
consists of proceeds from the sale, or indemnification of loss, of a
vessel or share thereof, the amounts of the unrecognized gain;
(4) The date, amount, and purpose of each expenditure or withdrawal
from the fund; and
(5) The date and amount of each contract, under which deposited
funds are deemed to be obligated during the taxable year, for the
construction, reconstruction, reconditioning, or acquisition of new
vessels, or for the liquidation of purchase-money indebtedness on such
vessels, and the identification of such vessels.
(b) Records required. Taxpayers shall keep such records and make
such additional reports as the Commissioner of Internal Revenue or the
Administration may require.
Sec. 2.1-27 Controlled corporation.
For the purpose of section 511 of the Act and the regulations in
this part a new vessel is considered as constructed, reconstructed,
reconditioned, or acquired by the taxpayer if constructed,
reconstructed, reconditioned, or acquired by a corporation at a time
when the taxpayer owns not less than 95 percent of the total number of
shares of each class of stock of the corporation.
Sec. 2.1-28 Administrative jurisdiction.
Sections 2.1-3 to 2.1-11, inclusive, Secs. 2.1-13 to 2.1-15,
inclusive, and Secs. 2.1-19 to 2.1-22, inclusive, deal primarily with
matters under the jurisdiction of the Administration. Sections 2.1-12,
2.1-16 to 2.1-18, inclusive, and Secs. 2.1-23 to 2.1-27, inclusive, deal
primarily with matters under the jurisdiction of the Commissioner of
Internal Revenue. Generally, matters relating to the establishment,
maintenance, expenditure, and use of construction reserve funds and the
construction, reconstruction, reconditioning, or acquisition of new
vessels are under the jurisdiction of the Administration; and matters
relating to the determination, assessment, and collection of taxes are
under the jurisdiction of the Commissioner of Internal Revenue.
Correspondence should be addressed to the particular authority having
jurisdiction in the matter.
PART 3--CAPITAL CONSTRUCTION FUND--Table of Contents
Sec.
3.0 Statutory provisions; section 607, Merchant Marine Act, 1936, as
amended.
3.1 Scope of section 607 of the Act and the regulations in this part.
3.2 Ceiling on deposits.
3.3 Nontaxability of deposits.
3.4 Establishment of accounts.
3.5 Qualified withdrawals.
3.6 Tax treatment of qualified withdrawals.
3.7 Tax treatment of nonqualified withdrawals.
3.8 Certain corporate reorganizations and changes in partnerships, and
certain transfers on death. [Reserved]
3.9 Consolidated returns. [Reserved]
3.10 Transitional rules for existing funds.
3.11 Definitions.
Authority: Sec. 21(a) of the Merchant Marine Act of 1970 (84 Stat.
1026); sec. 7805 of the Internal Revenue Code of 1954 (68A Stat. 917; 26
U.S.C. 7805).
Source: T.D. 7398, 41 FR 5812, Feb. 10, 1976, unless otherwise
noted.
Sec. 3.0 Statutory provisions; section 607, Merchant Marine Act, 1936, as amended.
Sec. 607 (a) Agreement Rules.
Any citizen of the United States owning or leasing one or more
eligible vessels (as defined in subsection (k)(1)) may enter into an
agreement with the Secretary of Commerce under, and as provided in, this
section to establish a capital construction fund (hereinafter in this
section referred to as the ``fund'') with respect to any or all of such
[[Page 22]]
vessels. Any agreement entered into under this section shall be for the
purpose of providing replacement vessels, additional vessels, or
reconstructed vessels, built in the United States and documented under
the laws of the United States for operation in the United States,
foreign, Great Lakes, or noncontiguous domestic trade or in the
fisheries of the United States and shall provide for the deposit in the
fund of the amounts agreed upon as necessary or appropriate to provide
for qualified withdrawals under subsection (f). The deposits in the
fund, and all withdrawals from the fund, whether qualified or
nonqualified, shall be subject to such conditions and requirements as
the Secretary of Commerce may by regulations prescribe or are set forth
in such agreement; except that the Secretary of Commerce may not require
any person to deposit in the fund for any taxable year more than 50
percent of that portion of such person's taxable income for such year
(computed in the manner provided in subsection (b)(1)(A)) which is
attributable to the operation of the agreement vessels.
(b) Ceiling on Deposits.
(1) The amount deposited under subsection (a) in the fund for any
taxable year shall not exceed the sum of:
(A) That portion of the taxable income of the owner or lessee for
such year (computed as provided in chapter 1 of the Internal Revenue
Code of 1954 but without regard to the carryback of any net operating
loss or net capital loss and without regard to this section) which is
attributable to the operation of the agreement vessels in the foreign or
domestic commerce of the United States or in the fisheries of the United
States,
(B) The amount allowable as a deduction under section 167 of the
Internal Revenue Code of 1954 for such year with respect to the
agreement vessels,
(C) If the transaction is not taken into account for purposes of
subparagraph (A), the net proceeds (as defined in joint regulations)
from (i) the sale or other disposition of any agreement vessel, or (ii)
insurance or indemnity attributable to any agreement vessel, and
(D) The receipts from the investment or reinvestment of amounts held
in such fund.
(2) In the case of a lessee, the maximum amount which may be
deposited with respect to an agreement vessel by reason of paragraph
(1)(B) for any period shall be reduced by any amount which, under an
agreement entered into under this section, the owner is required or
permitted to deposit for such period with respect to such vessel by
reason of paragraph (1)(B).
(3) For purposes of paragraph (1), the term ``agreement vessel''
includes barges and containers which are part of the complement of such
vessel and which are provided for in the agreement.
(c) Requirements as to Investments.
Amounts in any fund established under this section shall be kept in
the depository or depositories specified in the agreement and shall be
subject to such trustee and other fiduciary requirements as may be
specified by the Secretary of Commerce. They may be invested only in
interest-bearing securities approved by the Secretary of Commerce;
except that, if the Secretary of Commerce consents thereto, an agreed
percentage (not in excess of 60 percent) of the assets of the fund may
be invested in the stock of domestic corporations. Such stock must be
currently fully listed and registered on an exchange registered with the
Securities and Exchange Commission as a national securities exchange,
and must be stock which would be acquired by prudent men of discretion
and intelligence in such matters who are seeking a reasonable income and
the preservation of their capital. If at any time the fair market value
of the stock in the fund is more than the agreed percentage of the
assets in the fund, any subsequent investment of amounts deposited in
the fund, and any subsequent withdrawal from the fund, shall be made in
such a way as to tend to restore the fund to a situation in which the
fair market value of the stock does not exceed such agreed percentage.
For purposes of this subsection, if the common stock of a corporation
meets the requirements of this subsection and if the preferred stock of
such corporation would meet such requirements but for the fact that it
cannot be listed and registered as required because it is nonvoting
stock, such preferred stock shall be treated as meeting the requirements
of this subsection.
(d) Nontaxability for Deposits.
(1) For purposes of the Internal Revenue Code of 1954--
(A) Taxable income (determined without regard to this section) for
the taxable year shall be reduced by an amount equal to the amount
deposited for the taxable year out of amounts referred to in subsection
(b)(1)(A),
(B) Gain from a transaction referred to in subsection (b)(1)(C)
shall not be taken into account if an amount equal to the net proceeds
(as defined in joint regulations) from such transaction is deposited in
the fund,
(C) The earnings (including gains and losses) from the investment
and reinvestment of amounts held in the fund shall not be taken into
account,
(D) The earnings and profits of any corporation (within the meaning
of section 316 of such Code) shall be determined without regard to this
section, and
(E) In applying the tax imposed by section 531 of such Code
(relating to the accumulated earnings tax), amounts while held in the
fund shall not be taken into account.
(2) Paragraph (1) shall apply with respect to any amount only if
such amount is deposited in the fund pursuant to the agreement
[[Page 23]]
and not later than the time provided in joint regulations.
(e) Establishment of Accounts.
For purposes of this section--
(1) Within the fund established pursuant to this section three
accounts shall be maintained:
(A) The capital account,
(B) The capital gain account, and
(C) The ordinary income account.
(2) The capital account shall consist of--
(A) Amounts referred to in subsection (b)(1)(B),
(B) Amounts referred to in subsection (b)(1)(C) other than that
portion thereof which represents gain not taken into account by reason
of subsection (d)(1)(B),
(C) 85 percent of any dividend received by the fund with respect to
which the person maintaining the fund would (but for subsection
(d)(1)(C)) be allowed a deduction under section 243 of the Internal
Revenue Code of 1954, and
(D) Interest income exempt from taxation under section 103 of such
Code.
(3) The capital gain account shall consist of--
(A) Amounts representing capital gains on assets held for more than
6 months and referred to in subsection (b)(1)(C) or (b)(1)(D), reduced
by--
(B) Amounts representing capital losses on assets held in the fund
for more than 6 months.
(4) The ordinary income account shall consist of--
(A) Amounts referred to in subsection (b)(1)(A),
(B)(i) Amounts representing capital gains on assets held for 6
months or less and referred to in subsection (b)(1)(C) or (b)(1)(D),
reduced by--
(ii) Amounts representing capital losses on assets held in the fund
for 6 months or less,
(C) Interest (not including any tax-exempt interest referred to in
paragraph (2)(D)) and other ordinary income (not including any dividend
referred to in subparagraph (E)) received on assets held in the fund,
(D) Ordinary income from a transaction described in subsection
(b)(1)(C), and
(E) 15 percent of any dividend referred to in paragraph (2)(C).
(5) Except on termination of a fund, capital losses referred to in
paragraph (3)(B) or in paragraph (4)(B)(ii) shall be allowed only as an
offset to gains referred to in paragraph (3)(A) or (4)(B)(i),
respectively.
(f) Purposes of Qualified Withdrawals.
(1) A qualified withdrawal from the fund is one made in accordance
with the terms of the agreement but only if it is for:
(A) The acquisition, construction, or reconstruction of a qualified
vessel,
(B) The acquisition, construction, or reconstruction of barges and
containers which are part of the complement of a qualified vessel, or
(C) The payment of the principal on indebtedness incurred in
connection with the acquisition, construction, or reconstruction of a
qualified vessel or a barge or container which is part of the complement
of a qualified vessel.
Except to the extent provided in regulations prescribed by the Secretary
of Commerce, subparagraph (B), and so much of subparagraph (C) as
relates only to barges and containers, shall apply only with respect to
barges and containers constructed in the United States.
(2) Under joint regulations, if the Secretary of Commerce determines
that any substantial obligation under any agreement is not being
fulfilled, he may, after notice and opportunity for hearing to the
person maintaining the fund, treat the entire fund or any portion
thereof as an amount withdrawn from the fund in a nonqualified
withdrawal.
(g) Tax Treatment of Qualified Withdrawals.
(1) Any qualified withdrawal from a fund shall be treated--
(A) First as made out of the capital account,
(B) Second as made out of the capital gain account, and
(C) Third as made out of the ordinary income account.
(2) If any portion of a qualified withdrawal for a vessel, barge, or
container is made out of the ordinary income account, the basis of such
vessel, barge, or container shall be reduced by an amount equal to such
portion.
(3) If any portion of a qualified withdrawal for a vessel, barge, or
container is made out of the capital gain account, the basis of such
vessel, barge, or container shall be reduced by an amount equal to--
(A) Five-eighths of such portion, in the case of a corporation
(other than an electing small business corporation, as defined in
section 1371 of the Internal Revenue Code of 1954), or
(B) One-half of such portion, in the case of any other person.
(4) If any portion of a qualified withdrawal to pay the principal on
any indebtedness is made out of the ordinary income account or the
capital gain account, then an amount equal to the aggregate reduction
which would be required by paragraphs (2) and (3) if this were a
qualified withdrawal for a purpose described in such paragraphs shall be
applied, in the order provided in joint regulations, to reduce the basis
of vessels, barges, and containers owned by the person maintaining the
fund. Any amount of a withdrawal remaining after the application of the
preceding sentence shall be treated as a nonqualified withdrawal.
[[Page 24]]
(5) If any property the basis of which was reduced under paragraph
(2), (3), or (4) is disposed of, any gain realized on such disposition,
to the extent it does not exceed the aggregate reduction in the basis of
such property under such paragraphs, shall be treated as an amount
referred to in subsection (h)(3)(A) which was withdrawn on the date of
such disposition. Subject to such conditions and requirements as may be
provided in joint regulations, the preceding sentence shall not apply to
a disposition where there is a redeposit in an amount determined under
joint regulations which will, insofar as practicable, restore the fund
to the position it was in before the withdrawal.
(h) Tax Treatment of Nonqualified Withdrawals.
(1) Except as provided in subsection (i), any withdrawal from a fund
which is not a qualified withdrawal shall be treated as a nonqualified
withdrawal.
(2) Any nonqualified withdrawal from a fund shall be treated--
(A) First as made out of the ordinary income account,
(B) Second as made out of the capital gain account, and
(C) Third as made out of the capital account.
For purposes of this section, items withdrawn from any account shall be
treated as withdrawn on a first-in-first-out basis; except that (i) any
nonqualified withdrawal for research, development, and design expenses
incident to new and advanced ship design, machinery and equipment, and
(ii) any amount treated as a nonqualified withdrawal under the second
sentence of subsection (g)(4), shall be treated as withdrawn on a last-
in-first-out basis.
(3) For purposes of the Internal Revenue Code of 1954--
(A) Any amount referred to in paragraph (2)(A) shall be included in
income as an item of ordinary income for the taxable year in which the
withdrawal is made.
(B) Any amount referred to in paragraph (2)(B) shall be included in
income for the taxable year in which the withdrawal is made as an item
of gain realized during such year from the disposition of an asset held
for more than 6 months, and
(C) For the period on or before the last date prescribed for payment
of tax for the taxable year in which this withdrawal is made--
(i) No interest shall be payable under section 6601 of such Code and
no addition to the tax shall be payable under section 6651 of such Code,
(ii) Interest on the amount of the additional tax attributable to
any item referred to in subparagraph (A) or (B) shall be paid at the
applicable rate (as defined in paragraph (4)) from the last date
prescribed for payment of the tax for the taxable year for which such
item was deposited in the fund, and
(iii) No interest shall be payable on amounts referred to in clauses
(i) and (ii) of paragraph (2) or in the case of any nonqualified
withdrawal arising from the application of the recapture provision of
section 606(5) of the Merchant Marine Act of 1936 as in effect on
December 31, 1969.
(4) For purposes of paragraph (3)(C)(ii), the applicable rate of
interest for any nonqualified withdrawal--
(A) Made in a taxable year beginning in 1970 or 1971 is 8 percent,
or
(B) Made in a taxable year beginning after 1971, shall be determined
and published jointly by the Secretary of the Treasury and the Secretary
of Commerce and shall bear a relationship to 8 percent which the
Secretaries determine under joint regulations to be comparable to the
relationship which the money rates and investment yields for the
calendar year immediately preceding the beginning of the taxable year
bear to the money rates and investment yields for the calendar year
1970.
(i) Certain Corporate Reorganizations and Changes in Partnerships.
Under joint regulations--
(1) A transfer of a fund from one person to another person in a
transaction to which section 381 of the Internal Revenue Code of 1954
applies may be treated as if such transaction did not constitute a
nonqualified withdrawal, and
(2) A similar rule shall be applied in the case of a continuation of
a partnership (within the meaning of subchapter K of such Code).
(j) Treatment of Existing Funds.
(1) Any person who was maintaining a fund or funds (hereinafter in
this subsection referred to as ``old fund'') under this section (as in
effect before the enactment of this subsection) may elect to continue
such old fund but--
(A) May not hold moneys in the old fund beyond the expiration date
provided in the agreement under which such old fund is maintained
(determined without regard to any extension or renewal entered into
after April 14, 1970),
(B) May not simultaneously maintain such old fund and a new fund
established under this section, and
(C) If he enters into an agreement under this section to establish a
new fund, may agree to the extension of such agreement to some or all of
the amounts in the old fund.
(2) In the case of any extension of an agreement pursuant to
paragraph (1)(C), each item in the old fund to be transferred shall be
transferred in a nontaxable transaction to the appropriate account in
the new fund established under this section. For purposes of subsection
(h)(3)(C), the date of the deposit of any item so transferred shall be
July 1,
[[Page 25]]
1971, or the date of the deposit in the old fund, whichever is the
later.
(k) Definitions.
For purposes of this section--
(1) The term ``eligible vessel'' means any vessel--
(A) Constructed in the United States and, if reconstructed,
reconstructed in the United States,
(B) Documented under the laws of the United States, and
(C) Operated in the foreign or domestic commerce of the United
States or in the fisheries of the United States.
Any vessel which (i) was constructed outside of the United States but
documented under the laws of the United States on April 15, 1970, or
(ii) constructed outside the United States for use in the United States
foreign trade pursuant to a contract entered into before April 15, 1970,
shall be treated as satisfying the requirements of subparagraph (A) of
this paragraph and the requirements of subparagraph (A) of paragraph
(2).
(2) The term ``qualified vessel'' means any vessel--
(A) Constructed in the United States and, if reconstructed,
reconstructed in the United States,
(B) Documented under the laws of the United States, and
(C) Which the person maintaining the fund agrees with the Secretary
of Commerce will be operated in the United States foreign, Great Lakes,
or noncontiguous domestic trade or in the fisheries of the United
States.
(3) The term ``agreement vessel'' means any eligible vessel or
qualified vessel which is subject to an agreement entered into under
this section.
(4) The term ``United States,'' when used in a geographical sense,
means the continental United States including Alaska, Hawaii, and Puerto
Rico.
(5) The term ``United States foreign trade'' includes (but is not
limited to) those areas in domestic trade in which a vessel built with
construction-differential subsidy is permitted to operate under the
first sentence of section 506 of this Act.
(6) The term ``joint regulations'' means regulations prescribed
under subsection (1).
(7) The term ``vessel'' includes cargo handling equipment which the
Secretary of Commerce determines is intended for use primarily on the
vessel. The term ``vessel'' also includes an ocean-going towing vessel
or an ocean-going barge or comparable towing vessel or barge operated on
the Great Lakes.
(8) The term ``noncontiguous trade'' means (i) trade between the
contiguous forty-eight States on the one hand and Alaska, Hawaii, Puerto
Rico, and the insular territories and possessions of the United States
on the other hand, and (ii) trade from any point in Alaska, Hawaii,
Puerto Rico, and such territories and possessions to any other point in
Alaska, Hawaii, Puerto Rico, and such territories and possessions.
(l) Records; Reports; Changes in Regulations.
Each person maintaining a fund under this section shall keep such
records and shall make such reports as the Secretary of Commerce or the
Secretary of the Treasury shall require. The Secretary of the Treasury
and the Secretary of Commerce shall jointly prescribe all rules and
regulations, not inconsistent with the foregoing provisions of this
section, as may be necessary or appropriate to the determination of tax
liability under this section. If, after an agreement has been entered
into under this section, a change is made either in the joint
regulations or in the regulations prescribed by the Secretary of
Commerce under this section which could have a substantial effect on the
rights or obligations of any person maintaining a fund under this
section, such person may terminate such agreement.
Sec. 3.1 Scope of section 607 of the Act and the regulations in this part.
(a) In general. The regulations prescribed in this part provide
rules for determining the income tax liability of any person a party to
an agreement with the Secretary of Commerce establishing a capital
construction fund (for purposes of this part referred to as the
``fund'') authorized by section 607 of the Merchant Marine Act, 1936, as
amended (for purposes of this part referred to as the ``Act''). With
respect to such parties, section 607 of the Act in general provides for
the nontaxability of certain deposits of money or other property into
the fund out of earnings or gains realized from the operation of vessels
covered in an agreement, gains realized from the sale or other
disposition of agreement vessels or proceeds from insurance for
indemnification for loss of agreement vessels, earnings from the
investment or reinvestment of amounts held in a fund, and gains with
respect to amounts or deposits in the fund. Transitional rules are also
provided for the treatment of ``old funds'' existing on or before the
effective date of the Merchant Marine Act of 1970 (see Sec. 3.10).
(b) Cross references. For rules relating to eligibility for a fund,
deposits, and withdrawals and other aspects, see the regulations
prescribed by the Secretary of Commerce in titles 46 (Merchant Marine)
and 50 (Fisheries) of the Code of Federal Regulations.
[[Page 26]]
(c) Code. For purposes of this part, the term ``Code'' means the
Internal Revenue Code of 1954, as amended.
Sec. 3.2 Ceiling on deposits.
(a) In general--(1) Total ceiling. Section 607(b) of the Act
provides a ceiling on the amount which may be deposited by a party for a
taxable year pursuant to an agreement. The amount which a party may
deposit into a fund may not exceed the sum of the following subceilings:
(i) The lower of (a) the taxable income (if any) of the party for
such year (computed as provided in Chapter I of the Code but without
regard to the carryback of any net operating loss or net capital loss
and without regard to section 607 of the Act) or (b) taxable income (if
any) of such party for such year attributable under paragraph (b) of
this section to the operation of agreement vessels (as defined in
paragraph (f) of this section) in the foreign or domestic commerce of
the United States or in the fisheries of the United States (see section
607(b)(1)(A) of the Act).
(ii) Amounts allowable as a deduction under section 167 of the Code
for such year with respect to the agreement vessels (see section
607(b)(1)(B) of the Act),
(iii) The net proceeds (if not included in subdivision (i) of this
paragraph) from (a) the sale or other disposition of any agreement
vessels or (b) insurance or indemnity attributable to any agreement
vessels (see section 607(b)(1)(C) of the Act and paragraph (c) of this
section), and
(iv) Earnings and gains from the investment or reinvestment of
amounts held in such fund (see section 607(b)(1)(D) of the Act and
paragraphs (d) and (g) of this section).
(2) Overdeposits. (i) If for any taxable year an amount is deposited
into the fund under a subceiling computed under subparagraph (1) of this
paragraph which is in excess of the amount of such subceiling for such
year, then at the party's option such excess (or any portion thereof)
may--
(a) Be treated as a deposit into the fund for that taxable year
under another available subceiling, or
(b) Be treated as not having been deposited for the taxable year and
thus, at the party's option, may be disposed of either by it being--
(1) Treated as a deposit into the fund under any subceiling
available in the first subsequent taxable year in which a subceiling is
available, in which case such amount shall be deemed to have been
deposited on the first day of such subsequent taxable year, or
(2) Repaid to the party from the fund.
(ii)(a) When a correction is made for an overdeposit, proper
adjustment shall be made with respect to all items for all taxable years
affected by the overdeposit, such as, for example, amounts in each
account described in Sec. 3.4, treatment of nonqualified withdrawals,
the consequences of qualified withdrawals and the treatment of losses
realized or treated as realized by the fund. Thus, for example, if the
party chooses to have the fund repay to him the amount of an
overdeposit, amounts in each account, basis of assets, and any affected
item will be determined as though no deposit and repayment had been
made. Accordingly, in such a case, if there are insufficient amounts in
an account to cover a repayment of an overdeposit (as determined before
correcting the overdeposit), and the party had applied the proceeds of a
qualified withdrawal from such account towards the purchase of a
qualified vessel (within the meaning of Sec. 3.11(a)(2)), then such
account and the basis of the vessel shall be adjusted as of the time
such withdrawal was made and proceeds were applied, and repayment shall
be made from such account as adjusted. If a party chooses to treat the
amount of an overdeposit as a deposit under a subceiling for a
subsequent year, similar adjustments to affected items shall be made. If
the amount of a withdrawal would have exceeded the amount in the fund
(determined after adjusting all affected amounts by reason of correcting
the overdeposit), the withdrawal to the extent of such excess shall be
treated as a repayment made at the time the withdrawal was made.
(b) If the accounts (as defined in Sec. 3.4) that were increased by
reason of excessive deposits contain sufficient amounts at the time the
overdeposit is
[[Page 27]]
discovered to repay the party, the party may, at his option, demand
repayment of such excessive deposits from such accounts in lieu of
making the adjustments required by (a) of this subdivision (ii).
(iii) During the period beginning with the day after the date an
overdeposit was actually made and ending with the date it was disposed
of in accordance with subdivision (i)(b) of this subparagraph, there
shall be included in the party's gross income for each taxable year the
earnings attributed to any amount of overdeposit on hand during such a
year. The earnings attributable to any amount of overdeposit on hand
during a taxable year shall be an amount equal to the product of--
(a) The average daily earnings for each one dollar in the fund (as
determined in subdivision (iv) of this subparagraph),
(b) The amount of overdeposit (as determined in subdivision (vi) of
this subparagraph), and
(c) The number of days during the taxable year the overdeposit
existed.
(iv) For purposes of subdivision (iii) (a) of this subparagraph, the
average daily earnings for each dollar in the fund shall be determined
by dividing the total earnings of the fund for the taxable year by the
sum of the products of--
(a) Any amount on hand during the taxable year (determined under
subdivision (v) of this subparagraph), and
(b) The number of days during the taxable year such amount was on
hand in the fund.
(v) For purposes of this subparagraph--
(a) An amount on hand in the fund or an overdeposit shall not be
treated as on hand on the day deposited but shall be treated as on hand
on the day withdrawn, and
(b) The fair market value of such amounts on hand for purposes of
this subparagraph shall be determined as provided in Sec. 20.2031-2 of
the Estate Tax Regulations of this chapter but without applying the
blockage and other special rules contained in paragraph (e) thereof.
(vi) For purposes of subdivision (iii) (b) of this subparagraph, the
amount of overdeposit on hand at any time is an amount equal to--
(a) The amount deposited into the fund under a subceiling computed
under subparagraph (1) of this paragraph which is in excess of the
amount of such subceiling, less
(b) The sum of--
(1) Amounts described in (a) of this subdivision (vi) treated as a
deposit under another subceiling for the taxable year pursuant to
subdivision (i) of this subparagraph,
(2) Amounts described in (a) of this subdivision (vi) disposed of
(or treated as disposed of) in accordance with subdivision (i) or (ii)
of this subparagraph prior to such time.
(vii) To the extent earnings attributed under subdivision (iii) of
this subparagraph represent a deposit for any taxable year in excess of
the subceiling described in subparagraph (1)(iv) of this paragraph for
receipts from the investment or reinvestment of amounts held in the
fund, such attributed earnings shall be subject to the rules of this
subparagraph for overdeposits.
(3) Underdeposit caused by audit adjustment. [Reserved]
(4) Requirements for deficiency deposits. [Reserved]
(b) Taxable income attributable to the operation of an agreement
vessel--(1) In general. For purposes of this section, taxable income
attributable to the operation of an agreement vessel means the amount,
if any, by which the gross income of a party for the taxable year from
the operation of an agreement vessel (as defined in paragraph (f) of
this section) exceeds the allowable deductions allocable to such
operation (as determined under subparagraph (3) of this paragraph). The
term ``taxable income attributable to the operation of the agreement
vessels'' means the sum of the amounts described in the preceding
sentence separately computed with respect to each agreement vessel (or
share therein) or, at the party's option, computed in the aggregate.
(2) Gross income. (i) Gross income from the operation of agreement
vessels means the sum of the revenues which are derived during the
taxable year from the following:
(a) Revenues derived from the transportation of passengers, freight,
or
[[Page 28]]
mail in such vessels, including amounts from contracts for the charter
of such vessels to others, from operating differential subsidies, from
collections in accordance with pooling agreements and from insurance or
indemnity net proceeds relating to the loss of income attributable to
such agreement vessels.
(b) Revenues derived from the operation of agreement vessels
relating to commercial fishing activities, including the transportation
of fish, support activities for fishing vessels, charters for commercial
fishing, and insurance or indemnity net proceeds relating to the loss of
income attributable to such agreement vessels.
(c) Revenues from the rental, lease, or use by others of terminal
facilities, revenues from cargo handling operations and tug and lighter
operations, and revenues from other services or operations which are
incidental and directly related to the operation of an agreement vessel.
Thus, for example, agency fees, commissions, and brokerage fees derived
by the party at his place of business for effecting transactions for
services incidental and directly related to shipping for the accounts of
other persons are includible in gross income from the operation of
agreement vessels where the transaction is of a kind customarily
consummated by the party for his own account at such place of business.
(d) Dividends, interest, and gains derived from assets set aside and
reasonably retained to meet regularly occurring obligations relating to
the shipping or fishing business directly connected with the agreement
vessel which obligations cannot at all times be met from the current
revenues of the business because of layups or repairs, special surveys,
fluctuations in the business, and reasonably foreseeable strikes
(whether or not a strike actually occurs), and security amounts retained
by reason of participation in conferences, pooling agreements, or
similar agreements.
(ii) The items of gross income described in subdivision (i) (c) and
(d) of this subparagraph shall be considered to be derived from the
operations of a particular agreement vessel in the same proportion that
the sum of the items of gross income described in subdivision (i) (a)
and (b) of this subparagraph which are derived from the operations of
such agreement vessel bears to the party's total gross income for the
taxable year from operations described in subdivision (i) (a) and (b) of
this subparagraph.
(iii) In the case of a party who uses his own or leased agreement
vessels to transport his own products, the gross income attributable to
such vessel operations is an amount determined to be an arm's length
charge for such transportation. The arm's length charge shall be
determined by applying the principles of section 482 of the Code and the
regulations thereunder as if the party transporting the product and the
owner of the product were not the same person but were controlled
taxpayers within the meaning of Sec. 1.482-1(a)(4) of the Income Tax
Regulations of this chapter. Gross income attributable to the operation
of agreement vessels does not include amounts for which the party is
allowed a deduction for percentage depletion under sections 611 and 613
of the Code.
(3) Deductions. From the gross income attributable to the operation
of an agreement vessel or vessels as determined under subparagraph (2)
of this paragraph, there shall be deducted, in accordance with the
principles of Sec. 1.861-8 of the Income Tax Regulations of this
chapter, the expenses, losses, and other deductions definitely related
and therefore allocated and apportioned thereto and a ratable part of
any expenses, losses, or other deductions which are not definitely
related to any gross income of the party. Thus, for example, if a party
has gross income attributable to the operation of an agreement vessel
and other gross income and has a particular deduction definitely related
to both types of gross income, such deduction must be apportioned
between the two types of gross income on a reasonable basis in
determining the taxable income attributable to the operation of the
agreement vessel.
(4) Net operating and capital loss deductions. The taxable income of
a party attributable to the operation of agreement vessels shall be
computed without regard to the carryback of any net
[[Page 29]]
operating loss deduction allowed by section 172 of the Code, the
carryback of any net capital loss deduction allowed by sections 165(f)
of the Code, or any reduction in taxable income allowed by section 607
of the Act.
(5) Method of accounting. Taxable income must be computed under the
method of accounting which the party uses for Federal income tax
purposes. Such method may include a method of reporting whereby items of
revenue and expense properly allocable to voyages in progress at the end
of any accounting period are eliminated from the computation of taxable
income for such accounting period and taken into account in the
accounting period in which the voyage is completed.
(c) Net proceeds from transactions with respect to agreement
vessels. [Reserved]
(d) Earnings and gains from the investment or reinvestment of
amounts held in a fund--(1) In general. (i) Earnings and gains received
or accrued by a party from the investment or reinvestment of assets in a
fund is the total amount of any interest or dividends received or
accrued, and gains realized, by the party with respect to assets
deposited in, or purchased with amounts deposited in, such fund. Such
earnings and gains are therefore required to be included in the gross
income of the party unless such amount, or a portion thereof, is not
taken into account under section 607(d)(1)(C) of the Act and
Sec. 3.3(b)(2)(ii) by reason of a deposit or deemed deposit into the
fund. For rules relating to receipts from the sale or other disposition
of nonmoney deposits into the fund, see paragraph (g) of this section.
(ii) Earnings received or accrued by a party from investment or
reinvestment of assets in a fund include the ratable monthly portion of
original issue discount included in gross income pursuant to section
1232(a)(3) of the Code. Such ratable monthly portion shall be deemed to
be deposited into the ordinary income account of the fund, but an actual
deposit representing such ratable monthly portion shall not be made.
For basis of a bond or other evidence of indebtedness issued at a
discount, see Sec. 3.3(b)(2)(ii)(b).
(2) Gain realized. (i) The gain realized with respect to assets in
the fund is the excess of the amount realized (as defined in section
1001(b) of the Code and the regulations thereunder) by the fund on the
sale or other disposition of a fund asset over its adjusted basis (as
defined in section 1011 of the Code) to the fund. For the adjusted basis
of nonmoney deposits, see paragraph (g) of this section.
(ii) Property purchased by the fund (including property considered
under paragraph (g)(1)(iii) of this section as purchased by the fund)
which is withdrawn from the fund in a qualified withdrawal (as defined
in Sec. 3.5) is treated as a disposition to which subdivision (i) of
this subparagraph applies. For purposes of determining the amount by
which the balance within a particular account will be reduced in the
manner provided in Sec. 3.6(b) (relating to order of application of
qualified withdrawals against accounts) and for purposes of determining
the reduction in basis of a vessel, barge, or container (or share
therein) pursuant to Sec. 3.6(c), the value of the property is its fair
market value on the day of the qualified withdrawal.
(3) Holding period. Except as provided in paragraph (g) of this
section, the holding period of fund assets shall be determined under
section 1223 of the Code.
(e) Leased vessels. In the case of a party who is a lessee of an
agreement vessel, the maximum amount which such lessee may deposit with
respect to any agreement vessel by reason of section 607(b)(1)(B) of the
Act and paragraph (a)(1)(ii) of this section (relating to depreciation
allowable) for any period shall be reduced by the amount (if any) which,
under an agreement entered into under section 607 of the Act, the owner
is required or permitted to deposit for such period with respect to such
vessel by reason of section 607(b)(1)(B) of the Act and paragraph
(a)(1)(ii) of this section. The amount of depreciation depositable by
the lessee under this paragraph is the amount of depreciation deductible
by the lessor on its income tax return, reduced by the amount described
in the preceding sentence or the amount set forth in the agreement,
whichever is lower.
(f) Definition of agreement vessel. For purposes of this section,
the term ``agreement vessel'' (as defined in
[[Page 30]]
Sec. 3.11(a)(3) and 46 CFR 390.6) includes barges and containers which
are the complement of an agreement vessel and which are provided for in
the agreement, agreement vessels which have been contracted for or are
in the process of construction, and any shares in an agreement vessel.
Solely for purposes of this section, a party is considered to have a
``share'' in an agreement vessel if he has a right to use the vessel to
generate income from its use whether or not the party would be
considered as having a proprietary interest in the vessel for purposes
of State or Federal law. Thus, a partner may enter into an agreement
with respect to his share of the vessel owned by the partnership and he
may make deposits of his distributive share of the sum of the four
subceilings described in paragraph (a)(1) of this section.
Notwithstanding the provisions of subchapter K of the Code (relating to
the taxation of partners and partnerships), the Internal Revenue Service
will recognize, solely for the purposes of applying this part, an
agreement by an owner of a share in an agreement vessel even though the
``share'' arrangement is a partnership for purposes of the Code.
(g) Special rules for nonmoney deposits and withdrawals--(1) In
general. (i) Deposits may be made in the form of money or property of
the type permitted to be deposited under the agreement. (For rules
relating to the types of property which may be deposited into the fund,
see 46 CFR Sec. 390.7(d), and 50 CFR part 259.) For purposes of this
paragraph, the term ``property'' does not include money.
(ii) Whether or not the election provided for in subparagraph (2) of
this paragraph is made--
(a) The amount of any property deposit, and the fund's basis for
property deposited in the fund, is the fair market value of the property
at the time deposited, and
(b) The fund's holding period for the property begins on the day
after the deposit is made.
(iii) Unless such an election is made, deposits of property into a
fund are considered to be a sale at fair market value of the property, a
deposit of cash equal to such fair market value, and a purchase by the
fund of such property for cash. Thus, in the absence of the election,
the difference between the fair market value of such property deposited
and its adjusted basis shall be taken into account as gain or loss for
purposes of computing the party's income tax liability for the year of
deposit.
(iv) For fund's basis and holding period of assets purchased by the
fund, see paragraph (d) (2) and (3) of this section.
(2) Election not to treat deposits of property other than money as a
sale or exchange at the time of deposit. A party may elect to treat a
deposit of property as if no sale or other taxable event had occurred on
the date of deposit. If such election is made, in the taxable year the
fund disposes of the property, the party shall recognize as gain or loss
the amount he would have recognized on the day the property was
deposited into the fund had the election not been made. The party's
holding period with respect to such property shall not include the
period of time such property was held by the fund. The election shall be
made by a statement to that effect, attached to the party's Federal
income tax return for the taxable year to which the deposit relates, or,
if such return is filed before such deposit is made, attached to the
party's return for the taxable year during which the deposit is actually
made.
(3) Effect of qualified withdrawal of property deposited pursuant to
election. If property deposited into a fund, with respect to which an
election under subparagraph (2) of this paragraph is made, is withdrawn
from the fund in a qualified withdrawal (as defined in Sec. 3.5) such
withdrawal is treated as a disposition of such property resulting in
recognition by the party of gain or loss (if any) as provided in
subparagraph (2) of this paragraph with respect to nonfund property. In
addition, such withdrawal is treated as a disposition of such property
by the fund resulting in recognition of gain or loss by the party with
respect to fund property to the extent the fair market value of the
property on the date of withdrawal is greater or less (as the case may
be) than the adjusted basis of the property to the fund on such date.
For purposes of determining the amount by which
[[Page 31]]
the balance within a particular account will be reduced in the manner
provided in Sec. 3.6(b) (relating to order of application of qualified
withdrawals against accounts) and for purposes of determining the
reduction in basis of a vessel, barge, or container (or share therein)
pursuant to Sec. 3.6(c), the value of the property is its fair market
value on the day of the qualified withdrawal. For rules relating to the
effect of a qualified withdrawal of property purchased by the fund
(including deposited property considered under subparagraph (1)(iii) of
this paragraph as purchased by the fund), see paragraph (d)(2)(ii) of
this section.
(4) Effect of nonqualified withdrawal of property deposited pursuant
to election. If property deposited into a fund with respect to which an
election under subparagraph (2) of this paragraph is made, is withdrawn
from the fund in a nonqualified withdrawal (as defined in Sec. 3.7(b)),
no gain or loss is to be recognized by the party with respect to fund
property or nonfund property but an amount equal to the adjusted basis
of the property to the fund is to be treated as a nonqualified
withdrawal. Thus, such amount is to be applied against the various
accounts in the manner provided in Sec. 3.7(c), such amount is to be
taken into account in computing the party's taxable income as provided
in Sec. 3.7(d), and such amount is to be subject to interest to the
extent provided for in Sec. 3.7(e). In the case of withdrawals to which
this subparagraph applies, the adjusted basis of the property in the
hands of the party is the adjusted basis on the date of deposit,
increased or decreased by the adjustments made to such property while
held in the fund, and in determining the period for which the party has
held the property there shall be included, in addition to the period the
fund held the property, the period for which the party held the property
before the date of deposit of the property into the fund. For rules
relating to the basis and holding period of property purchased by the
fund (including deposited property considered under subparagraph (1)(ii)
of this paragraph as purchased by the fund) and withdrawn in a
nonqualified withdrawal see Sec. 3.7(f).
(5) Examples. The provisions of this paragraph are illustrated by
the following examples:
Example (1). X Corporation, which uses the calendar year as its
taxable year, maintains a fund described in Sec. 3.1. X's taxable income
(determined without regard to section 607 of the Act) is $100,000, of
which $80,000 is taxable income attributable to the operation of
agreement vessels (as determined under paragraph (b)(1) of this
section). Under the agreement, X is required to deposit into the fund
all earnings and gains received from the investment or reinvestment of
amounts held in the fund, an amount equal to the net proceeds from
transactions referred to in Sec. 3.2(c), and an amount equal to 50
percent of its earnings attributable to the operation of agreement
vessels provided that such 50 percent does not exceed X's taxable income
from all sources for the year of deposit. The agreement permits X to
make voluntary deposits of amounts equal to 100 percent of its earnings
attributable to the operation of agreement vessels, subject to the
limitation with respect to taxable income from all sources. The
agreement also provides that deposits attributable to such earnings may
be in the form of cash or other property. On March 15, 1973, X deposits,
with respect to its 1972 earnings attributable to the operation of
agreement vessels, stock with a fair market value at the time of deposit
of $80,000 and an adjusted basis to X of $10,000. Such deposit
represents agreement vessel income of $80,000. At the time of deposit,
such stock had been held by X for a period exceeding 6 months. X does
not elect under subparagraph (2) of this paragraph to defer recognition
of the gain. Accordingly, under subparagraph (1)(iii) of this paragraph,
the deposit is treated as a deposit of $80,000 and X realizes a long-
term capital gain of $70,000 on March 15, 1973.
Example (2). The facts are the same as in example (1), except that X
elects in accordance with subparagraph (2) of this paragraph not to
treat the deposit as a sale or exchange. On July 1, 1974, the fund sells
the stock for $85,000. The basis to the fund of the stock is $80,000
(see subparagraph (1)(ii) (a) of this paragraph). With respect to
nonfund property, X recognizes $70,000 of long-term capital gain on the
sale includible in its gross income for 1974. With respect to fund
property, X realizes $5,000 of long-term capital gain (the difference
between the amount received by the fund on the sale of the stock,
$85,000, and the basis to the fund of the stock, $80,000), an amount
equal to which is required to be deposited into the fund with respect to
1974, as a gain from the investment or reinvestment of amounts held in
the
[[Page 32]]
fund. Since the fund held the stock for a period exceeding 6 months, the
$5,000 is allocated to the fund's capital gain account under
Sec. 3.4(c).
Example (3). The facts are the same as in example (2), except that
the fund sells the stock on July 1, 1974, for $75,000. As the basis to
the fund of the stock is $80,000, with respect to fund property, X
realizes a long-term capital loss on the sale (the difference between
the amount received by the fund on the sale of the stock, $75,000, and
the basis to the fund of the stock, $80,000), of $5,000, an amount equal
to which is required to be charged against the fund's capital gain
account under Sec. 3.4(e). Under subparagraph (2) of this paragraph, X
recognizes $70,000 of long-term capital gain with respect to nonfund
property on the sale which is includible in its gross income for 1974.
Example (4). The facts are the same as in example (2), except that
on July 1, 1974, X makes a qualified withdrawal (as defined in
Sec. 3.5(a)) of the stock and uses it to pay indebtedness pursuant to
Sec. 3.5(b). On the disposition by X considered to occur under
subparagraph (3) of this paragraph on the qualified withdrawal, X
recognizes $70,000 of long-term capital gain with respect to nonfund
property, which is includible in its gross income for 1974, and a long-
term capital gain of $5,000 with respect to fund property, an amount
equal to which is allocated to the fund's capital gain account under
Sec. 3.4(c). The fund is treated as having a qualified withdrawal of an
amount equal to the fair market value of the stock on the day of
withdrawal, $85,000 (see subparagraph (3) of this paragraph). In
addition, $85,000 is applied against the various accounts in the order
provided in Sec. 3.6(b). The basis of the vessel with respect to which
the indebtedness was incurred is to be reduced as provided in
Sec. 3.6(c).
Example (5). The facts are the same as in example (2), except that X
withdraws the stock from the fund in a nonqualified withdrawal (as
defined in Sec. 3.7(b)). Under subparagraph (4) of this paragraph, X
recognizes no gain or loss with respect to fund or nonfund property on
such withdrawal. An amount equal to the basis of the stock to the fund
($80,000) is applied against the various accounts in the order provided
in Sec. 3.7(c), and is taken into account in computing X's taxable
income for 1974 as provided in Sec. 3.7(d). In addition, X must pay
interest on the withdrawal as provided in Sec. 3.7(e). The basis to X of
the stock is $10,000 notwithstanding the fact that the fair market value
of such stock was $85,000 on the day of withdrawal (see subparagraph (4)
of this paragraph).
Sec. 3.3 Nontaxability of deposits.
(a) In general. Section 607(d) of the Act sets forth the rules
concerning the income tax effects of deposits made with respect to
ceilings described in section 607(b) and Sec. 3.2. The specific
treatment of deposits with respect to each of the subceilings is set
forth in paragraph (b) of this section.
(b) Treatment of deposits--(1) Earnings of agreement vessels.
Section 607(d)(1)(A) of the Act provides that taxable income of the
party (determined without regard to section 607 of the Act) shall be
reduced by an amount equal to the amount deposited for the taxable year
out of amounts referred to in section 607(b)(1)(A) of the Act and
Sec. 3.2(a)(1)(i). For computation of the foreign tax credit, see
paragraph (i) of this section.
(2) Net proceeds from agreement vessels and fund earnings. (i)(a)
Section 607(d)(1)(B) provides that gain from a transaction referred
to in section 607(b)(1)(C) of the Act and Sec. 3.2(a)(1)(iii) (relating
to ceilings on deposits of net proceeds from the sale or other
disposition of agreement vessels) is not to be taken into account for
purposes of the Code if an amount equal to the net proceeds from
transactions referred to in such sections is deposited in the fund. Such
gain is to be excluded from gross income of the party for the taxable
year to which such deposit relates. Thus, the gain will not be taken
into account in applying section 1231 of the Code for the year to which
the deposit relates.
(b) [Reserved]
(ii)(a) Section 607(d)(1)(C) of the Act provides that the earnings
(including gains and losses) from the investment and reinvestment of
amounts held in the fund and referred to in section 607(b)(1)(D) of the
Act and Sec. 3.2(a)(1)(iv) shall not be taken into account for purposes
of the Code if an amount equal to such earnings is deposited into the
fund. Such earnings are to be excluded from the gross income of the
party for the taxable year to which such deposit relates.
(b) However, for purposes of the basis adjustment under section
1232(a)(3)(E) of the Code, the ratable monthly portion of original issue
discount included in gross income shall be determined without regard to
section 607(d)(1)(C) of the Act.
(iii) In determining the tax liability of a party to whom
subparagraph (1) of
[[Page 33]]
this paragraph applies, taxable income, determined after application of
subparagraph (1) of this paragraph, is in effect reduced by the portion
of deposits which represent gain or earnings respectively referred to in
subdivision (i) or (ii) of this subparagraph. The excess, if any, of
such portion over taxable income determined after application of
subparagraph (1) of this paragraph is taken into account in computing
the net operating loss (under section 172 of the Code) for the taxable
year to which such deposits relate.
(3) Time for making deposits. (i) This section applies with respect
to an amount only if such amount is deposited in the fund pursuant to
the agreement and not later than the time provided in subdivision (ii),
(iii), or (iv) of this subparagraph for the making of such deposit or
the date the Secretary of Commerce provides, whichever is earlier.
(ii) Except as provided in subdivision (iii) or (iv) of this
subparagraph, a deposit may be made not later than the last day
prescribed by law (including extensions thereof) for filing the party's
Federal income tax return for the taxable year to which such deposit
relates.
(iii) If the party is a subsidized operator under an operating-
differential subsidy contract, and does not receive on or before the
59th day preceding such last day, payment of all or part of the accrued
operating-differential subsidy payable for the taxable year, the party
may deposit an amount equivalent to the unpaid accrued operating-
differential subsidy on or before the 60th day after receipt of payment
of the accrued operating-differential subsidy.
(iv) A deposit pursuant to Sec. 3.2(a)(3)(i) (relating to
underdeposits caused by audit adjustments) must be made on or before the
date prescribed for such a deposit in Sec. 3.2(a)(4).
(4) Date of deposits. (i) Except as otherwise provided in
subdivisions (ii) and (iii) of this subparagraph (with respect to
taxable years beginning after December 31, 1969, and prior to January 1,
1972), in Sec. 3.2(a)(2)(i), or in Sec. 3.10(b), deposits made in a fund
within the time specified in subparagraph (3) of this paragraph are
deemed to have been made on the date of actual deposit.
(ii)(a) For taxable years beginning after December 31, 1969, and
prior to January 1, 1971, where an application for a fund is filed by a
taxpayer prior to January 1, 1972, and an agreement is executed and
entered into by the taxpayer prior to March l, 1972,
(b) For taxable years beginning after December 31, 1970, and prior
to January 1, 1972, where an application for a fund is filed by a
taxpayer prior to January 1, 1973, and an agreement is executed and
entered into by the taxpayer prior to March l, 1973, and
(c) For taxable years beginning after December 31, 1971, and prior
to January 1, 1975, where an agreement is executed and entered into by
the taxpayer on or prior to the due date, with extensions, for the
filing of his Federal income tax return for such taxable year,
deposits in a fund which are made within 60 days after the date of
execution of the agreement, or on or before the due date, with
extensions thereof, for the filing of his Federal income tax return for
such taxable year or years, whichever date shall be later, shall be
deemed to have been made on the date of the actual deposit or as of the
close of business of the last regular business day of each such taxable
year or years to which such deposits relate, whichever day is earlier.
(iii) Notwithstanding subdivision (ii) of this subparagraph, for
taxable years beginning after December 31, 1970, and ending prior to
January 1, 1972, deposits made later than the last date permitted under
subdivision (ii) but on or before January 9, 1973, in a fund pursuant to
an agreement with the Secretary of Commerce, acting by and through the
Administrator of the National Oceanic and Atmospheric Administration,
shall be deemed to have been made on the date of the actual deposit or
as of the close of business of the last regular business day of such
taxable year, whichever is earlier.
(c) Determination of earnings and profits. [Reserved]
(d) Accumulated earnings tax. As provided in section 607(d)(1)(E) of
the Act amounts, while held in the fund, are not to be taken into
account in computing the ``accumulated taxable income'' of the party
within the meaning of section 531 of the Code. Amounts
[[Page 34]]
while held in the fund are considered held for the purpose of acquiring,
constructing, or reconstructing a qualified vessel or barges and
containers which are part of the complement of a qualified vessel or the
payment of the principal on indebtedness incurred in connection with any
such acquisition, construction, or reconstruction. Thus, for example, if
the reasonable needs of the business (within the meaning of section 537
of the Code) justify a greater amount of accumulation for providing
replacement vessels than can be satisfied out of the fund, such greater
amount accumulated outside of the fund shall be considered to be
accumulated for the reasonable needs of the business. For a further
example, although amounts in the fund are not taken into account in
applying the tax imposed by section 531 of the Code, to the extent there
are amounts in a fund to provide for replacing a vessel, amounts
accumulated outside of the fund to replace the same vessel are not
considered to be accumulated for the reasonable needs of the business.
(e) Nonapplicability of section 1231. If an amount equivalent to
gain from a transaction referred to in section 607(b)(1)(C) of the Act
and Sec. 3.2(c) (1) and (5) is deposited into the fund and, therefore,
such gain is not taken into account in computing gross income under the
provisions of paragraph (b)(2) of this section, then such gain will not
be taken into account for purposes of the computations under section
1231 of the Code.
(f) Deposits of capital gains. In respect of capital gains which are
not included in the gross income of the party by virtue of a deposit to
which section 607(d) of the Act and this section apply, the following
provisions of the Code do not apply: the minimum tax for tax preferences
imposed by section 56 of the Code; the alternative tax imposed by
section 1201 of the Code on the excess of the party's net long-term
capital gain over his net short-term capital loss; and, in the case of a
taxpayer other than a corporation, the deduction provided by section
1202 of the Code of 50% of the amount of such excess. However, section
56 may apply upon a nonqualified withdrawal with respect to amounts
treated under Sec. 3.7(d)(2) as being made out of the capital gain
account.
(g) Deposits of dividends. The deductions provided by section 243 of
the Code (relating to the deductions for dividends from a domestic
corporation received by a corporation) shall not apply in respect of
dividends (earned on assets held in the fund) which are deposited into a
fund, and which, by virtue of such deposits and the provisions of
section 607(d) of the Act and this section, are not included in the
gross income of the party.
(h) Presumption of validity of deposit. All amounts deposited in the
fund shall be presumed to have been deposited pursuant to an agreement
unless, after an examination of the facts upon the request of the
Commissioner of Internal Revenue or his delegate, the Secretary of
Commerce determines otherwise. The Commissioner or his delegate will
request such a determination where there is a substantial question as to
whether a deposit is made in accordance with an agreement.
(i) Special rules for application of the foreign tax credit--(1) In
general. For purposes of computing the limitation under section 904 of
the Code on the amount of the credit provided by section 901 of the Code
(relating to the foreign tax credit), the party's taxable income from
any source without the United States and the party's entire taxable
income are to be determined after application of section 607(d) of the
Act. Thus, amounts deposited for the taxable year with respect to
amounts referred to in section 607(b)(1)(A) of the Act and
Sec. 3.2(a)(1)(i) (relating to taxable income attributable to the
operation of agreement vessels) shall be treated as a deduction in
arriving at the party's taxable income from sources without the United
States (subject to the apportionment rules and subparagraph (2) of this
paragraph) and the party's entire taxable income for the taxable year.
Amounts deposited with respect to gain described in section 607(d)(1)(B)
of the Act and Sec. 3.2(c) (relating to net proceeds from the sale or
other disposition of an agreement vessel and net proceeds from insurance
or indemnity) and amounts deposited with respect to earnings described
in section
[[Page 35]]
607(d)(1)(C) of the Act and paragraph (b)(2)(ii) (relating to earnings
from the investment and reinvestment of amounts held in a fund) of this
section are not taken into account for purposes of the Code and hence
are not included in the party's taxable income from sources without the
United States or in the party's entire taxable income for purposes of
this paragraph.
(2) Apportionment of taxable income attributable to agreement
vessels. For purposes of computing the overall limitation under section
904(a)(2) of the Code the amount of the deposit made with respect to
taxable income attributable to agreement vessels pursuant to
Sec. 3.2(a)(1)(i) which is allocable to sources without the United
States is the total amount of such deposit multiplied by a fraction the
numerator of which is the gross income from sources without the United
States from the operation of agreement vessels and the denominator of
which is the total gross income from the operation of agreement vessels
computed as provided in Sec. 3.2(b)(2). For purposes of this paragraph,
gross income from sources without the United States attributable to the
operation of agreement vessels is to be determined under sections 861
through 863 of the Code and under the taxpayer's usual method of
accounting provided such method is reasonable and in keeping with sound
accounting practice. Any computation under the per-country limitation of
section 904(a)(1) shall be made in the manner consistent with the
provisions of the preceding sentences of this subparagraph.
Sec. 3.4 Establishment of accounts.
(a) In general. Section 607(e)(1) of the Act requires that three
bookkeeping or memorandum accounts are to be established and maintained
within the fund: the capital account, the capital gain account, and the
ordinary income account. Deposits of the amounts under the subceilings
in section 607(b) of the Act and Sec. 3.2 are allocated among the
accounts under section 607(e) of the Act and this section.
(b) Capital account. The capital account shall consist of:
(1) Amounts referred to in section 607(b)(1)(B) of the Act and
Sec. 3.2(a)(1)(ii) (relating to deposits for depreciation),
(2) Amounts referred to in section 607(b)(1)(C) of the Act and
Sec. 3.2(a)(1)(iii) (relating to deposits of net proceeds from the sale
or other disposition of agreement vessels) other than that portion
thereof which represents gain not taken into account for purposes of
computing gross income by reason of section 607(d)(1)(B) of the Act and
Sec. 3.3(b)(2) (relating to nontaxability of gain from the sale or other
disposition of an agreement vessel),
(3) Amounts representing 85 percent of any dividend received by the
fund with respect to which the party would, but for section 607(d)(1)(C)
of the Act and Sec. 3.3(b)(2)(ii) (relating to nontaxability of deposits
of earnings from investment and reinvestment of amounts held in a fund),
be allowed a deduction under section 243 of the Code, and
(4) Amounts received by the fund representing interest income which
is exempt from taxation under section 103 of the Code.
(c) Capital gain account. The capital gain account shall consist of
amounts which represent the excess of (1) deposits of long-term capital
gains on property referred to in section 607(b)(1) (C) and (D) of the
Act and Sec. 3.2(a)(1) (iii) and (iv) (relating respectively to certain
agreement vessels and fund assets), over (2) amounts representing losses
from the sale or exchange of assets held in the fund for more than 6
months (for purposes of this section referred to as ``long-term capital
losses''). For purposes of this paragraph and paragraph (d)(2) of this
section, an agreement vessel disposed of at a gain shall be treated as a
capital asset to the extent that gain thereon is not treated as ordinary
income, including gain which is ordinary income under section 607(g)(5)
of the Act (relating to treatment of gain on disposition of a vessel
with a reduced basis) and Sec. 3.6(e) or under section 1245 of the Code
(relating to gain from disposition of certain depreciable property). For
provisions relating to the treatment of short-term capital gains on
certain transactions involving agreement vessels or realized by the
fund, see paragraph (d) of this section. For rules relating to the
treatment of capital losses on assets held in the fund, see paragraph
(e) of this section.
[[Page 36]]
(d) Ordinary income account. The ordinary income account shall
consist of:
(1) Amounts referred to in section 607(b)(1)(A) of the Act and
Sec. 3.2(a)(1)(i) (relating to taxable income attributable to the
operation of an agreement vessel),
(2) Amounts representing (i) deposits of gains from the sale or
exchange of capital assets held for 6 months or less (for purposes of
this section referred to as ``short-term capital gains'') referred to in
section 607(b)(1) (C) or (D) of the Act and Sec. 3.2(a)(1) (iii) and
(iv) (relating respectively to certain agreement vessels and fund
assets), reduced by (ii) amounts representing losses from the sale or
exchange of capital assets held in the fund for 6 months or less (for
purposes of this section referred to as ``short-term capital losses'').
For rules relating to the treatment of certain agreement vessels as
capital assets, see paragraph (c) of this section,
(3) Amounts representing interest (not including any tax-exempt
interest referred to in section 607(e)(2)(D) of the Act and paragraph
(b)(4) of this section) and other ordinary income received on assets
held in the fund (not including any dividend referred to in section
607(e)(2)(C) of the Act and subparagraph (5) of this paragraph),
(4) Amounts representing ordinary income from a transaction
(involving certain net proceeds with respect to an agreement vessel)
described in section 607(b)(1)(C) of the Act and Sec. 3.2(a)(1)(iii),
including gain which is ordinary income under section 607(g)(5) of the
Act and Sec. 3.6(e) (relating to treatment of gain on the disposition of
a vessel with a reduced basis) or under section 1245 of the Code
(relating to gain from disposition of certain depreciable property), and
(5) Fifteen percent of any dividend referred to in section
607(e)(2)(C) of the Act and paragraph (b)(3) of this section received on
any assets held in the fund.
(e) Limitation on deduction for capital losses on assets held in a
fund. Except on termination of a fund, long-term (and short-term)
capital losses on assets held in the fund shall be allowed only as an
offset to long-term (and short-term) capital gains on assets held in the
fund, but only if such gains are deposited into the fund, and shall not
be allowed as an offset to any capital gains on assets not held in the
fund. The net long-term capital loss of the fund for the taxable year
shall reduce the earliest long-term capital gains in the capital gain
account at the beginning of the taxable year and the net short-term
capital loss for the taxable year shall reduce the earliest short-term
capital gains remaining in the ordinary income account at the beginning
of the taxable year. Any such losses that are in excess of the capital
gains in the respective accounts shall reduce capital gains deposited
into the respective accounts in subsequent years (without regard to
section 1212, relating to capital loss carrybacks and carryovers). On
termination of a fund, any net long-term capital loss in the capital
gain account and any net short-term capital loss remaining in the
ordinary income account is to be taken into account for purposes of
computing the party's taxable income for the year of termination as a
long-term or short-term (as the case may be) capital loss recognized in
the year the fund is terminated. With respect to the determination of
the basis to a fund of assets held in such fund, see Sec. 3.2(g).
[T.D. 7398, 41 FR 5812, Feb. 10, 1976, as amended by T.D. 7831, 47 FR
39675, Sept. 9, 1982]
Sec. 3.5 Qualified withdrawals.
(a) In general. (1) A qualified withdrawal is one made from the fund
during the taxable year which is in accordance with section 607(f)(1) of
the Act, the agreement, and with regulations prescribed by the Secretary
of Commerce and which is for the acquisition, construction, or
reconstruction of a qualified vessel (as defined in Sec. 3.11(a)(2)) or
barges and containers which are part of the complement of a qualified
vessel (or shares in such vessels, barges, and containers), or for the
payment of the principal of indebtedness incurred in connection with the
acquisition, construction, or reconstruction of such qualified vessel
(or a barge or container which is part of the complement of a qualified
vessel).
(2) For purposes of this section the term share is used to reflect
an interest in a vessel and means a proprietary interest in a vessel
such as, for example,
[[Page 37]]
that which results from joint ownership. Accordingly, a share within the
meaning of Sec. 3.2(f) (relating to the definition of ``agreement
vessel'' for the purpose of making deposits) will not necessarily be
sufficient to be treated as a share within the meaning of this section.
(3) For purposes of this section, the term acquisition means any of
the following:
(i) Any acquisition, but only to the extent the basis of the
property acquired in the hands of the transferee is its cost. Thus, for
example, if a party transfers a vessel and $1 million in an exchange for
another vessel which qualifies for nonrecognition of gain or loss under
section 1031 (a) of the Code (relating to like-kind exchange), there is
an acquisition to the extent of $1 million.
(ii) With respect to a lessee's interest in a vessel, expenditures
which result in increasing the amounts with respect to which a deduction
for depreciation (or amortization in lieu thereof) is allowable.
(b) Payments on indebtedness. Payments on indebtedness may
constitute qualified withdrawals only if the party shows to the
satisfaction of the Secretary of Commerce a direct connection between
incurring the indebtedness and the acquisition, construction, or
reconstruction of a qualified vessel or its complement of barges and
containers whether or not the indebtedness is secured by the vessel or
its complement of barges and containers. The fact that an indebtedness
is secured by an interest in a qualified vessel, barge, or container is
insufficient by itself to demonstrate the necessary connection.
(c) Payments to related persons. Notwithstanding paragraph (a) of
this section, payments from a fund to a person owned or controlled
directly or indirectly by the same interests as the party within the
meaning of section 482 of the Code and the regulations thereunder are
not to be treated as qualified withdrawals unless the party demonstrates
to the satisfaction of the Secretary of Commerce that no part of such
payment constitutes a dividend, a return of capital, or a contribution
to capital under the Code.
(d) Treatment of fund upon failure to fulfill obligations. Section
607(f)(2) of the Act provides that if the Secretary of Commerce
determines that any substantial obligation under the agreement is not
being fulfilled, he may, after notice and opportunity for hearing to the
party, treat the entire fund, or any portion thereof, as having been
withdrawn as a nonqualified withdrawal. In determining whether a party
has breached a substantial obligation under the agreement, the Secretary
will consider among other things, (1) the effect of the party's action
or omission upon his ability to carry out the purposes of the fund and
for which qualified withdrawals are permitted under section 607(f)(1) of
the Act, and (2) whether the party has made material misrepresentations
in connection with the agreement or has failed to disclose material
information. For the income tax treatment of nonqualified withdrawals,
see Sec. 3.7.
Sec. 3.6 Tax treatment of qualified withdrawals.
(a) In general. Section 607(g) of the Act and this section provide
rules for the income tax treatment of qualified withdrawals including
the income tax treatment on the disposition of assets acquired with fund
amounts.
(b) Order of application of qualified withdrawals against accounts.
A qualified withdrawal from a fund shall be treated as being made:
First, out of the capital account; second, out of the capital gain
account; and third, out of the ordinary income account. Such withdrawals
will reduce the balance within a particular account on a first-in-first-
out basis, the earliest qualified withdrawals reducing the items within
an account in the order in which they were actually deposited or deemed
deposited in accordance with this part. The date funds are actually
withdrawn from the fund determines the time at which withdrawals are
considered to be made.
(c) Reduction of basis. (1) If any portion of a qualified withdrawal
for the acquisition, construction, or reconstruction of a vessel, barge,
or container (or share therein) is made out of the ordinary income
account, the basis of such vessel, barge, or container (or
[[Page 38]]
share therein) shall be reduced by an amount equal to such portion.
(2) If any portion of a qualified withdrawal for the acquisition,
construction, or reconstruction of a vessel, barge, or container (or
share therein) is made out of the capital gain account, the basis of
such vessel, barge, or container (or share therein) shall be reduced by
an amount equal to--
(i) Five-eighths of such portion, in the case of a corporation
(other than an electing small business corporation, as defined in
section 1371 of the Code), or
(ii) One-half of such portion, in the case of any other person.
(3) If any portion of a qualified withdrawal to pay the principal of
an indebtedness is made out of the ordinary income account or the
capital gain account, then the basis of the vessel, barge, or container
(or share therein) with respect to which such indebtedness was incurred
is reduced in the manner provided by subparagraphs (1) and (2) of this
paragraph. If the aggregate amount of such withdrawal from the ordinary
income account and capital gain account would cause a basis reduction in
excess of the party's basis in such vessel, barge, or container (or
share therein), the excess is applied against the basis of other
vessels, barges, or containers (or shares therein) owned by the party at
the time of withdrawal in the following order: (i) vessels, barges, or
containers (or shares therein) which were the subject of qualified
withdrawals in the order in which they were acquired, constructed, or
reconstructed; (ii) agreement vessels (as defined in section 607(k)(3)
of the Act and Sec. 3.11(a)(3)) and barges and containers which are part
of the complement of an agreement vessel (or shares therein) which were
not the subject of qualified withdrawals, in the order in which such
vessels, barges, or containers (or shares therein) were acquired by the
party; and (iii) other vessels, barges, and containers (or shares
therein), in the order in which they were acquired by the party. Any
amount of a withdrawal remaining after the application of this
subparagraph is to be treated as a nonqualified withdrawal. If the
indebtedness was incurred to acquire two or more vessels, barges, or
containers (or shares therein), then the basis reduction in such
vessels, barges, or containers (or shares therein) is to be made pro
rata in proportion to the adjusted basis of such vessels, barges, or
containers (or shares therein) computed, however, without regard to this
section and adjustments under section 1016(a) (2) and (3) of the Code
for depreciation or amortization.
(d) Basis for depreciation. For purposes of determining the
allowance for depreciation under section 167 of the Code in respect of
any property which has been acquired, constructed, or reconstructed from
qualified withdrawals, the adjusted basis for determining gain on such
property is determined after applying paragraph (c) of this section. In
the case of reductions in the basis of any property resulting from the
application of paragraph (c)(3) of this section, the party may adopt a
method of accounting whereby (1) payments shall reduce the basis of the
property on the day such payments are actually made, or (2) payments
made at any time during the first half of the party's taxable year shall
reduce the basis of the property on the first day of the taxable year,
and payments made at any time during the second half of the party's
taxable year shall reduce the basis of the property on the first day of
the succeeding taxable year. For requirements respecting the change of
methods of accounting, see Sec. 1.446-1(e)(3) of the Income Tax
Regulations of this chapter.
(e) Ordinary income treatment of gain from disposition of property
acquired with qualified withdrawals. [Reserved]
Sec. 3.7 Tax treatment of nonqualified withdrawals.
(a) In general. Section 607(h) of the Act provides rules for the tax
treatment of nonqualified withdrawals, including rules for adjustments
to the various accounts of the fund, the inclusion of amounts in income,
and the payment of interest with respect to such amounts.
(b) Nonqualified withdrawals defined. Except as provided in section
607 of the Act and Sec. 3.8 (relating to certain corporate
reorganizations, changes in partnerships, and transfers by reason of
death), any withdrawal from a fund
[[Page 39]]
which is not a qualified withdrawal shall be treated as a nonqualified
withdrawal which is subject to tax in accordance with section 607(h) of
the Act and the provisions of this section. Examples of nonqualified
withdrawals are amounts remaining in a fund upon termination of the
fund, and withdrawals which are treated as nonqualified withdrawals
under section 607(f)(2) of the Act and Sec. 3.5(d) (relating to failure
by a party to fulfill substantial obligation under agreement) or under
the second sentence of section 607(g)(4) of the Act and Sec. 3.6(c)(3)
(relating to payments against indebtedness in excess of basis).
(c) Order of application of nonqualified withdrawals against
deposits. A nonqualified withdrawal from a fund shall be treated as
being made: first, out of the ordinary income account; second, out of
the capital gain account; and third, out of the capital account. Such
withdrawals will reduce the balance within a particular account on a
first-in-first-out basis, the earliest nonqualified withdrawals reducing
the items within an account in the order in which they were actually
deposited or deemed deposited in accordance with this part. Nonqualified
withdrawals for research, development, and design expenses incident to
new and advanced ship design, machinery, and equipment, and any amount
treated as a nonqualified withdrawal under the second sentence of
section 607(g)(4) of the Act and Sec. 3.6(c)(3), shall be applied
against the deposits within a particular account on a last-in-first-out
basis. The date funds are actually withdrawn from the fund determines
the time at which withdrawals are considered to be made. For special
rules concerning the withdrawal of contingent deposits of net proceeds
from the installment sale of an agreement vessel, see Sec. 3.2(c)(6).
(d) Inclusion in income. (1) Any portion of a nonqualified
withdrawal which, under paragraph (c) of this section, is treated as
being made out of the ordinary income account is to be included in gross
income as an item of ordinary income for the taxable year in which the
withdrawal is made.
(2) Any portion of a nonqualified withdrawal which, under paragraph
(c) of this section, is treated as being made out of the capital gain
account is to be included in income as an item of long-term capital gain
recognized during the taxable year in which the withdrawal is made.
(3) For effect upon a party's taxable income of capital losses
remaining in a fund upon the termination of a fund (which, under
paragraph (b) of this section, is treated as a nonqualified withdrawal
of amounts remaining in the fund), see Sec. 3.4(e).
(e) Interest. (1) For the period on or before the last date
prescribed by law, including extensions thereof, for filing the party's
Federal income tax return for the taxable year during which a
nonqualified withdrawal is made, no interest shall be payable under
section 6601 of the Code in respect of the tax on any item which is
included in gross income under paragraph (d) of this section, and no
addition to such tax for such period shall be payable under section 6651
of the Code. In lieu of the interest and additions to tax under such
sections, simple interest on the amount of the tax attributable to any
item included in gross income under paragraph (d) of this section is to
be paid at the rate of interest determined for the year of withdrawal
under subparagraph (2) of this paragraph. Such interest is to be charged
for the period from the last date prescribed for payment of tax for the
taxable year for which such item was deposited in the fund to the last
date for payment of tax for the taxable year in which the withdrawal is
made. Both dates are to be determined without regard to any extensions
of time for payment. Interest determined under this paragraph which is
paid within the taxable year shall be allowed as a deduction for such
year under section 163 of the Code. However, such interest is to be
treated as part of the party's tax for the year of withdrawal for
purposes of collection and in determining any interest or additions to
tax for the year of withdrawal under section 6601 or 6651, respectively,
of the Code.
(2) For purposes of section 607(h)(3)(C)(ii) of the Act, and for
purposes of certain dispositions of vessels constructed, reconstructed,
or acquired with qualified withdrawals described in
[[Page 40]]
Sec. 3.6(e), the applicable rate of interest for any nonqualified
withdrawal--
(i) Made in a taxable year beginning in 1970 and 1971 is 8 percent.
(ii) Made in a taxable year beginning after 1971, the rate for such
year as determined and published jointly by the Secretary of the
Treasury or his delegate and the Secretary of Commerce. Such rate shall
bear a relationship to 8 percent which the Secretaries determine to be
comparable to the relationship which the money rates and investment
yields for the calendar year immediately preceding the beginning of the
taxable year bear to the money rates and investment yields for the
calendar year 1970. The determination of the applicable rate for any
such taxable year will be computed by multiplying 8 percent by the ratio
which (a) the average yield on 5-year Treasury securities for the
calendar year immediately preceding the beginning of such taxable year,
bears to (b) the average yield on 5-year Treasury securities for the
calendar year 1970. The applicable rate so determined shall be computed
to the nearest one-hundredth of 1 percent. If such a determination and
publication is made, the latest published percentage shall apply for any
taxable year beginning in the calendar year with respect to which
publication is made.
(3) No interest shall be payable in respect of taxes on amounts
referred to in section 607(h)(2) (i) and (ii) of the Act (relating to
withdrawals for research and development and payments against
indebtedness in excess of basis) or in the case of any nonqualified
withdrawal arising from the application of the recapture provision of
section 606(5) of the Merchant Marine Act, 1936, as in effect on
December 31, 1969.
(f) Basis and holding period in the case of property purchased by
the fund or considered purchased by the fund. In the case of a
nonqualified withdrawal of property other than money which was purchased
by the fund (including deposited property considered under
Sec. 3.2(g)(1)(ii) as purchased by the fund), the adjusted basis of the
property in the hands of the party is its adjusted basis to the fund on
the day of the withdrawal. In determining the period for which the
taxpayer has held the property withdrawn in a nonqualified withdrawal,
there shall be included only the period beginning with the date on which
the withdrawal occurred. For basis and holding period in the case of
nonqualified withdrawals of property other than money deposited into the
fund, see Sec. 3.2(g)(4).
Sec. 3.8 Certain corporate reorganizations and changes in partnerships, and certain transfers on death. [Reserved]
Sec. 3.9 Consolidated returns. [Reserved]
Sec. 3.10 Transitional rules for existing funds.
(a) In general. Section 607(j) of the Act provides that any person
who was maintaining a fund or funds under section 607 of the Merchant
Marine Act, 1936, prior to its amendment by the Merchant Marine Act of
1970 (for purposes of this part referred to as ``old fund'') may
continue to maintain such old fund in the same manner as under prior law
subject to the limitations contained in section 607(j) of the Act. Thus,
a party may not simultaneously maintain such old fund and a new fund
established under the Act.
(b) Extension of agreement to new fund. If a person enters into an
agreement under the Act to establish a new fund, he may agree to the
extension of such agreement to some or all of the amounts in the old
fund and transfer the amounts in the old fund to which the agreement is
to apply from the old fund to the new fund. If an agreement to establish
a new fund is extended to amounts from an old fund, each item in the old
fund to which such agreement applies shall be considered to be
transferred to the appropriate account in the manner provided for in
Sec. 3.8(d) in the new fund in a nontaxable transaction which is in
accordance with the provisions of the agreement under which such old
fund was maintained. For purposes of determining the amount of interest
under section 607(h)(3)(C) of the Act and Sec. 3.7(e), the date of
deposit of any item so transferred shall be deemed to be July 1, 1971,
or the date of the deposit in the old fund, whichever is the later.
[[Page 41]]
Sec. 3.11 Definitions.
(a) As used in the regulations in this part and as defined in
section 607(k) of the Act--
(1) The term eligible vessel means any vessel--
(i) Constructed in the United States, and if reconstructed,
reconstructed in the United States,
(ii) Documented under the laws of the United States, and
(iii) Operated in the foreign or domestic commerce of the United
States or in the fisheries of the United States. Any vessel which was
constructed outside of the United States but documented under the laws
of the United States on April 15, 1970, or constructed outside the
United States for use in the U.S. foreign trade pursuant to a contract
entered into before April 15, 1970, shall be treated as satisfying the
requirements of subdivision (i) of this subparagraph and the
requirements of subparagraph (2)(i) of this section.
(2) The term qualified vessel means any vessel--
(i) Constructed in the United States and, if reconstructed,
reconstructed in the United States,
(ii) Documented under the laws of the United States, and
(iii) Which the person maintaining the fund agrees with the
Secretary of Commerce will be operated in the U.S. foreign, Great
Lakes, or noncontiguous domestic trade or in the fisheries of the United
States.
(3) The term agreement vessel means any eligible vessel or qualified
vessel which is subject to an agreement entered into under section 607
of the Act.
(4) The term vessel includes cargo handling equipment which the
Secretary of Commerce determines is intended for use primarily on the
vessel. The term ``vessel'' also includes an ocean-going towing vessel
or an ocean-going barge or comparable towing vessel or barge operated in
the Great Lakes.
(b) Insofar as the computation and collection of taxes are
concerned, other terms used in the regulations in this part, except as
otherwise provided in the Act or this part, have the same meaning as in
the Code and the regulations thereunder.
PART 4--TEMPORARY INCOME TAX REGULATIONS UNDER SECTION 954 OF THE INTERNAL REVENUE CODE--Table of Contents
Sec.
4.954-0 Introduction.
4.954-1 Foreign base company income; taxable years beginning after
December 31, 1986.
4.954-2 Foreign personal holding company income; taxable years
beginning after December 31, 1986.
Authority: 26 U.S.C. 7805.
Section 4.954-0 also issued under 26 U.S.C. 954 (b) and (c).
Section 4.954-1 also issued under 26 U.S.C. 954 (b) and (c).
Section 4.954-2 also issued under 26 U.S.C. 954 (b) and (c).
Sec. 4.954-0 Introduction.
(a) Effective date. (1) The provisions of Secs. 4.954-1 and 4.954-2
apply to taxable years of a controlled foreign corporation beginning
after December 31, 1986. Consequently, any gain or loss (including
foreign currency gain or loss as defined in section 988(b)) recognized
during such taxable years of a controlled foreign corporation is subject
to these provisions. For further guidance, see Sec. 1.954-0(a) of this
chapter.
(2) The provisions of Secs. 1.954A-1 and 1.954A-2 apply to taxable
years of a controlled foreign corporation beginning before January 1,
1987. All references therein to sections of the Code are to the Internal
Revenue Code of 1954 prior to the amendments made by the Tax Reform Act
of 1986.
(b) Outline of regulation provisions for sections 954(b)(3),
954(b)(4), 954(b)(5) and 954(c) for taxable years of a controlled
foreign corporation beginning after December 31, 1986.
(I) Sec. 4.954-0 Introduction.
(a) Effective dates.
(b) Outline.
(II) Sec. 4.954-1 Foreign base company income.
(a) In general.
(1) Purpose and scope.
(2) Definition of gross foreign base company income.
(3) Definition of adjusted gross foreign base company income.
(4) Definition of net foreign base company income.
(5) Definition of adjusted net foreign base company income.
(6) Insurance income definitions.
[[Page 42]]
(7) Additional items of adjusted net foreign base company income or
adjusted net insurance income by reason of section 952(c).
(8) Illustration.
(b) Computation of adjusted gross foreign base company income and
adjusted gross insurance income.
(1) De minimus rule and full inclusion rule.
(i) In general.
(ii) Five percent de minimus test.
(iii) Seventy percent full inclusion test.
(2) Character of items of adjusted gross foreign base company
income.
(3) Coordination with section 952(c).
(4) Anti-abuse rule.
(i) In general.
(ii) Presumption.
(iii) Definition of related person.
(iv) Illustration.
(5) Illustration.
(c) Computation of net foreign base company income.
(d) Computation of adjusted net foreign base company income or
adjusted net insurance income.
(1) Application of high tax exception.
(2) Effective rate at which taxes are imposed.
(3) Taxes paid or accrued with respect to an item of income.
(i) Income other than foreign personal holding company income.
(ii) Foreign personal holding company income.
(4) Definition of an item of income.
(i) Income other than foreign personal holding company income.
(ii) Foreign personal holding company income.
(A) In general.
(B) Consistency rule.
(5) Procedure.
(6) Illustrations.
(e) Character of an item of income.
(1) Substance of the transaction.
(2) Separable character.
(3) Predominant character.
(4) Coordination of categories of gross foreign base company income
or gross insurance income.
(III) Sec. 4.954-2 Foreign Personal Holding Company Income.
(a) Computation of foreign personal holding company income.
(1) In general.
(2) Coordination of overlapping definitions.
(3) Changes in use or purpose with which property is held.
(i) In general.
(ii) Illustrations.
(4) Definitions.
(i) Interest.
(ii) Inventory and similar property.
(iii) Regular dealer.
(iv) Dealer property.
(v) Debt instrument.
(b) Dividends, etc.
(1) In general.
(2) Exclusion of certain export financing.
(i) In general.
(ii) Conduct of a banking business.
(iii) Illustration.
(3) Exclusion of dividends and interest from related persons.
(i) Excluded dividends and interest.
(ii) Interest paid out of adjusted foreign base company income or
insurance income.
(iii) Dividends paid out of prior years' earnings.
(iv) Fifty percent substantial assets test.
(v) Value of assets.
(vi) Location of tangible property used in a trade or business.
(A) In general.
(B) Exception.
(vii) Location of intangible property used in a trade or business.
(A) In general.
(B) Property located in part in the payor's country of incorporation
and in part in other countries.
(viii) Location of property held for sale to customers.
(A) In general.
(B) Inventory located in part in the payor's country of
incorporation and in part in other countries.
(ix) Location of debt instruments.
(x) Treatment of certain stock interests.
(xi) Determination of period during which property is used in a
trade or business.
(xii) Treatment of banks and insurance companies [Reserved]
(4) Exclusion of rents and royalties derived from related persons.
(i) In general.
(ii) Rents or royalties paid out of adjusted foreign base company
income or insurance income.
(5) Exclusion of rents and royalties derived in the active conduct
of a trade or business.
(6) Treatment of tax exempt interest.
(c) Excluded rents.
(1) Trade or business cases.
(2) Special rules.
(i) Adding substantial value.
(ii) Substantiality of foreign organization.
(iii) Definition of active leasing expense.
(iv) Adjusted leasing profits.
(3) Illustrations.
(d) Excluded royalties.
(1) Trade or business cases.
(2) Special rules.
(i) Adding substantial value.
(ii) Substantiality of foreign organization.
(iii) Definition of active licensing expense.
(iv) Definition of adjusted licensing profit.
(3) Illustrations.
(e) Certain property transactions.
(1) In general.
(i) Inclusion of FPHC income.
(ii) Dual character property.
(2) Property that gives rise to certain income.
[[Page 43]]
(i) In general.
(ii) Exception.
(3) Property that does not give rise to income.
(4) Classification of gain or loss from the disposition of a debt
instrument or on a deferred payment sale.
(i) Gain.
(ii) Loss.
(5) Classification of options and other rights to acquire or
transfer property.
(6) Classification of certain interests in pass-through entities.
[Reserved]
(f) Commodities transactions.
(1) In general.
(2) Definitions.
(i) Commodity.
(ii) Commodities transaction.
(3) Definition of the term ``qualified active sales''.
(i) In general.
(ii) Sale of commodities.
(iii) Active conduct of a commodities business.
(iv) Definition of the term ``substantially all.''
(4) Definition of the term ``qualified hedging transaction''.
(g) Foreign currency gain.
(1) In general.
(2) Exceptions.
(i) Qualified business units using the dollar approximate separate
transactions method.
(ii) Tracing to exclude foreign currency gain or loss from qualified
business and hedging transactions.
(iii) Election out of tracing.
(3) Definition of the term ``qualified business transaction''.
(i) In general.
(ii) Specific section 988 transactions attributable to the sale of
goods or services.
(A) Acquisition of debt instruments.
(B) Becoming the obligor under debt instruments.
(C) Accrual of any item of gross income.
(D) Accrual of any item of expense.
(E) Entering into forward contracts, futures contracts, options, and
similar instruments.
(F) Disposition of nonfunctional currency.
(4) Definition of the term ``qualified hedging transaction''.
(i) In general.
(ii) Change in purpose of hedging transaction.
(5) Election out of tracing.
(i) In general.
(ii) Exception.
(iii) Procedure.
(A) In general.
(B) Time and manner.
(C) Termination.
(h) Income equivalent to interest.
(1) In general.
(2) Illustrations.
(3) Income equivalent to interest from factoring.
(i) General rule.
(ii) Exceptions.
(iii) Factored receivable.
(iv) Illustrations.
(4) Determination of sales income.
(5) Receivables arising from performance of services.
[T.D. 8216, 53 FR 27491, July 21, 1988. Redesignated and amended by T.D.
8618, 60 FR 46530, Sept. 7, 1995]
Sec. 4.954-1 Foreign base company income; taxable years beginning after December 31, 1986.
(a) In general--(1) Purpose and scope. Section 954 (b) through (g)
and Secs. 1.954-1T and 1.954-2T provide rules for computing the foreign
base company income of a controlled foreign corporation. Foreign base
company income is included in the subpart F income of a controlled
foreign corporation under the rules of section 952 and the regulations
thereunder. Subpart F income is included in the gross income of a United
States shareholder of a controlled foreign corporation under the rules
of section 951 and the regulations thereunder, and thus is subject to
current taxation under section 1 or 11 of the Code. The determination of
whether a foreign corporation is a controlled foreign corporation, the
subpart F income of which is included currently in the gross income of
its United States shareholders, is made under the rules of section 957
and the regulations thereunder.
(2) Gross foreign base company income. For taxable years of a
controlled foreign corporation beginning after December 31, 1986, the
gross foreign base company income of a controlled foreign corporation
consists of the following categories of gross income:
(i) Its foreign personal holding company income, as defined in
section 954(c) and Sec. 1.954-2T,
(ii) Its foreign base company sales income, as defined in section
954(d) and the regulations thereunder,
(iii) Its foreign base company services income, as defined in
section 954(e) and the regulations thereunder,
(iv) Its foreign base company shipping income, as defined in section
954(f) and the regulations thereunder, and
[[Page 44]]
(v) Its foreign base company oil related income, as defined in
section 954(g) and the regulations thereunder.
(3) Adjusted gross foreign base company income. The term ``adjusted
gross foreign base company income'' means the gross foreign base company
income of a controlled foreign corporation as adjusted by the de minimis
and full inclusion rules of paragraph (b) of this section.
(4) Net foreign base company income. The term ``net foreign base
company income'' means the adjusted gross foreign base company income of
a controlled foreign corporation reduced so as to take account of
deductions properly allocable to such income under the rules of section
954(b)(5) and paragraph (c) of this section. In computing net foreign
base company income, foreign personal holding company income is reduced
(but not below zero) by related person interest expense before
allocating and apportioning other expenses in accordance with the rules
of paragraph (c) of this section and Sec. 1.904(d)-5(c)(2).
(5) Adjusted net foreign base company income. The term ``adjusted
net foreign base company income'' means the net foreign base company
income of a controlled foreign corporation reduced by any items of net
foreign base company income for which the high tax exception of
paragraph (d) of this section is elected. The term ``foreign base
company income'' as used in the Code and elsewhere in the regulations
generally means adjusted net foreign base company income.
(6) Insurance income definitions. The term ``gross insurance
income'' includes any item of gross income taken into account in
determining insurance income under section 953 and the regulations
thereunder. The term ``adjusted gross insurance income'' means gross
insurance income as adjusted by the de minimis and full inclusion rules
of paragraph (b) of this section. The term ``net insurance income''
means adjusted gross insurance income reduced under section 953 and the
regulations thereunder so as to take into account deductions properly
allocable or apportionable to such income. The term ``adjusted net
insurance income'' means net insurance income reduced by any items of
net insurance income for which the high tax exception of paragraph (d)
of this section is elected.
(7) Additional items of adjusted net foreign base company income or
adjusted net insurance income by reason of section 952(c). Earnings and
profits of the controlled foreign corporation that are recharacterized
as foreign base company income or insurance income under section 952(c)
are items of adjusted net foreign base company income or adjusted net
insurance income. Thus, they are not included in the gross foreign base
company income or gross insurance income of the controlled foreign
corporation in computing adjusted gross foreign base company income or
adjusted gross insurance income (for purposes of applying the de minimis
and full inclusion tests of paragraph (b) of this section).
(8) Illustration. The order of computation is illustrated by the
following example. Computations in this paragraph (a)(8) and in
paragraph (b)(5) of this section involving the operation of section
952(c) are included for purposes of illustration only and do not provide
substantive rules concerning the operation of that section.
Example. (i) Gross income. CFC, a controlled foreign corporation,
has gross income of $1000 for the current taxable year. Of that $1000 of
income, $100 is interest income that is included in the definition of
foreign personal holding company income under section 954(c)(1)(A) and
Sec. 1.954-2T(b)(1)(ii), is not income from a trade or service
receivable described in section 864(d)(1) or (6), and is not excluded
from foreign personal holding company income under any provision of
section 954(c) and Sec. 1.954-2T. Another $50 is foreign base company
sales income under section 954(d) and the regulations thereunder. The
remaining $850 of gross income is not included in the definition of
foreign base company income or insurance income under sections 954(c),
(d), (e), (f), (g), or 953 and the regulations thereunder, and is
foreign source general limitation income described in section
904(d)(1)(I) and the regulations thereunder.
(ii) Expenses. CFC has expenses for the current taxable year of
$500. Of that $500, $8 is from interest paid to a related person and is
allocable to foreign personal holding company income along with $2 of
other expense. Another $20 of expense is allocable to foreign base
company sales. The remaining $470 of expense is allocable to income
other than foreign base company income or insurance income.
[[Page 45]]
(iii) Earnings and deficits. CFC has earnings and profits for the
current taxable year of $500. In the prior taxable year, CFC had losses
with respect to income other than gross foreign base company income or
gross insurance income. By reason of the limitation provided under
section 952(c)(1)(A) and the regulations thereunder, those losses
reduced the subpart F income (consisting entirely of foreign source
general limitation income) of CFC by $600 for the prior taxable year.
(iv) Taxes. Foreign tax of $30 is considered imposed on the interest
income under the rules of section 954(b)(4) and paragraph (d) of this
section. Foreign tax of $14 is considered imposed on the foreign base
company sales income under the rules of section 954(b)(4) and paragraph
(d) of this section. Foreign tax of $177 is considered imposed on the
remaining foreign source general limitation income under the rules of
section 954(b)(4) and paragraph (d) of this section. For the taxable
year of the foreign corporation, the maximum U.S. rate of taxation under
section 11 is 34 percent.
(v) Conclusion. Based on these facts, if CFC elects to exclude all
items of income subject to a high foreign tax under section 954(b)(4)
and paragraph (d), it will have $500 of subpart F income as defined in
section 952(a) (consisting entirely of foreign source general limitation
income) determined as follows. The following steps do not illustrate the
computation of the subpart F income of a controlled foreign corporation
that has income from a trade or service receivable treated as interest
under section 864(d)(1) or interest described in section 864(d)(6).
Step 1--Determine gross income:
(1) Gross income...................................................$1000
Step 2--Determine gross foreign base company income and gross insurance
income:
(2) Interest income included in foreign personal holding company income
under section 954 (c)................................................100
(3) Foreign base company sales income under section 954(d)............50
(4) Total gross foreign base company income gross insurance income as
defined in sections 954(c), (d), (e), (f) and (g) and 953 and the
regulations thereunder (line (3) plus line (4))......................150
Step 3--Determine adjusted gross foreign base company income and
adjusted gross insurance income:
(5) Five percent of gross income (.05 x line (1))...................50
(6) Seventy percent of gross income (.70 x line (1))...............700
(7) Adjusted gross foreign base company income and adjusted gross
insurance income after the application of the de minimis test of
paragraph (b) (line (4), or zero if line (4) is less than the lesser of
line (5) or $1,000,000)..............................................150
(8) Adjusted gross foreign base company income and adjusted gross
insurance income after the application of the full inclusion test of
paragraph (b) (line (4), or line (1) if line (4) is greater than line
(6)).................................................................150
Step 4--Compute net foreign base company income:
(9) Related person interest expense and other expense allocable and
apportionable to foreign personal holding company income..............10
(10) Deductions allocable and apportionable to foreign base company
sales income..........................................................20
(11) Foreign personal holding company income after allocating deductions
under section 954(b)(5) and paragraph (c) of this section (the lesser of
line (2) or line (7), reduced (but not below zero) by line (9)).......90
(12) Foreign base company sales income after allocating deductions under
section 954(b)(5) and paragraph (c) of this section (the lesser of line
(3) or line (7), reduced (but not below zero) by line (10))...........30
(13) Total net foreign base company income after allocating deductions
under section 954(b)(5) and paragraph (c) (line (11) plus line (12))
120
Step 5--Compute net insurance income:
(14) Net insurance income under section 953 and the regulations
thereunder.............................................................0
Step 6--Compute adjusted net foreign base company income:
(15) Foreign tax imposed on foreign personal holding company income (as
determined under paragraph (d)).......................................30
(16) Foreign tax imposed on foreign base company sales income (as
determined under paragraph (d)).......................................14
(17) Ninety percent of the maximum U.S. corporate tax rate..........30.6
(18) Effective rate of foreign tax imposed on foreign personal holding
company income (interest) under section 954(b)(4) and paragraph (d)
(line (15) divided by line (11))......................................33
(19) Effective rate of foreign tax imposed on $40 of foreign base
company sales income under section 954(b)(4) and paragraph (d) (line
(16) divided by line (12))............................................47
(20) Foreign personal holding company
[[Page 46]]
income subject to a high foreign tax under section 954(b)(4) and
paragraph (d) (zero, or line (11) if line (18) is greater than line
(17)).................................................................90
(21) Foreign base company sales income subject to a high foreign tax
under section 954(b)(4) and paragraph (d) (zero, or line (12) if line
(19) is greater than line (17)).......................................30
(22) Adjusted net foreign base company income after applying section
954(b)(4) and paragraph (d) (line (13), reduced by the sum of line (20)
and line (21)).........................................................0
Step 7--Compute adjusted net insurance income:
(23) Adjusted net insurance income.....................................0
Step 8--Additions to or reduction of adjusted net foreign base company
income by reason of section 952(c):
(24) Earnings and profits for the current year.......................500
(25) The excess in earnings and profits over subpart F income subject to
being recharacterized as adjusted net foreign base company income under
section 952(c)(2) (excess of line (24) over the sum of lines (22) and
(23); if there is a deficit, then the limitation of section 952(c)(1)
may apply for the current year)......................................500
(26) Amount of reduction in subpart F income for prior taxable years by
reason of the limitation of section 952(c)(1) and the regulations
thereunder...........................................................600
(27) Subpart F income as defined in section 952(a), assuming section
952(a) (3), (4), or (5) does not apply (the sum of line (22), line (23),
and the lesser of line (25) or line (26))............................500
(b) Computation of adjusted gross foreign base company income and
adjusted gross insurance income--(1) De minimis rule, etc.--(i) In
general. If the de minimis rule of paragraph (b)(1)(ii) of this section
applies, then adjusted gross foreign base company income and adjusted
gross insurance income are each equal to zero. If the full inclusion
rule of paragraph (b)(1)(iii) of this section applies, then adjusted
gross foreign base company income consists of all items of gross income
of the controlled foreign corporation other than gross insurance income,
and adjusted gross insurance income consists of all items of gross
insurance income. Otherwise, the adjusted gross foreign base company
income of a controlled foreign corporation consists of the gross foreign
base company income of the controlled foreign corporation, and the
adjusted gross insurance income of a controlled foreign corporation
consists of the gross insurance income of the controlled foreign
corporation.
(ii) Five percent de minimis test--(A) In general. The de minimis
rule of this paragraph (b)(1)(ii) applies if the sum of the gross
foreign base company income and the gross insurance income of a
controlled foreign corporation is less than the lesser of--
(1) 5 percent of gross income, or
(2) $1,000,000.
Controlled foreign corporations having a functional currency other than
the U.S. dollar shall translate the $1,000,000 threshold using the
exchange rate provided under section 989(b)(3) and the regulations
thereunder for amounts included in income under section 951(a).
(B) Coordination with section 864(d). Gross foreign base company
income or gross insurance income of a controlled foreign corporation
always includes items of income from trade or service receivables
described in section 864(d)(1) or (6), even if the de minimis rule of
this paragraph (b)(1)(ii) is otherwise applicable. In that case,
adjusted gross foreign base company income consists only of the items of
income from trade or service receivables described in section 864(d)(1)
or (6) that are included in gross foreign base company income, and
adjusted gross insurance income consists only of the items of income
from trade or service receivables described in section 864(d)(1) or (6)
that are included in gross insurance income.
(iii) Seventy percent full inclusion test. The full inclusion rule
of this paragraph (b)(1)(iii) applies if the sum of the foreign base
company income and the gross insurance income for the taxable year
exceeds 70 percent of gross income.
(2) Character of items of gross income included in adjusted gross
foreign base company income. The items of gross income included in the
adjusted gross foreign base company income of a controlled foreign
corporation retain their character as foreign personal holding
[[Page 47]]
company income, foreign base company sales income, foreign base company
services income, foreign base company shipping income, or foreign base
company oil related income. Items of gross income included in adjusted
gross income because the full inclusion test of paragraph (b)(1)(iii) of
this section is met are termed ``full inclusion foreign base company
income,'' and constitute a separate category of adjusted gross foreign
base company income for purposes of allocating and apportioning
deductions under paragraph (c) of this section.
(3) Coordination with section 952(c). Items of gross foreign base
company income or gross insurance income that are excluded from adjusted
foreign base company income or adjusted gross insurance income because
the de minimis test of paragraph (b)(1)(ii) of this section is met are
potentially subject to recharacterization as adjusted net foreign base
company income or adjusted net insurance income (or other categories of
income included in the computation of subpart F income under section 952
and the regulations thereunder) for the taxable year under the rules of
section 952(c). Items of full inclusion foreign base company income that
are included in adjusted gross foreign base company income because the
full inclusion test of paragraph (b)(1)(iii) of this section is met, and
are included in subpart F income under section 952 and the regulations
thereunder, do not reduce amounts that, under section 952(c), are
subject to recharacterization in later years on account of deficits in
prior years.
(4) Anti-abuse rule--(i) In general. For purposes of applying the de
minimis and full inclusion tests of paragraph (b)(1) of this section,
the income of two or more controlled foreign corporations shall be
aggregated and treated as the income of a single corporation if one
principal purpose for separately organizing, acquiring, or maintaining
such multiple corporations is to avoid the application of the de minimis
or full inclusion requirements of paragraph (b)(1) of this section. For
purposes of this paragraph (b), a principal purpose need not be the
purpose of first importance.
(ii) Presumption. Two or more controlled foreign corporations are
presumed to have been organized, acquired or maintained to avoid the
effect of the de minimis and full inclusion requirements of paragraph
(b)(1) of this section if the corporations are related persons as
defined in subdivision (iii) of this paragraph (b)(4) and the
corporations are described in subdivision (A), (B), or (C). This
presumption may be rebutted by proof to the contrary.
(A) The activities now carried on by the controlled foreign
corporations, or the assets used in those activities, are substantially
the same activities that were carried on, or assets that were previously
held by a single controlled foreign corporation, and the United States
shareholders of the controlled foreign corporations or related persons
(as determined under subdivision (iii) of this paragraph (b)(4)) are
substantially the same as the United States shareholders of the one
controlled foreign corporation in that prior taxable year. A presumption
made in connection with the requirements of this subdivision (A) of
paragraph (b)(4)(ii) may be rebutted by proof that the activities
carried on by each controlled foreign corporation would constitute a
separate branch under the principles of Sec. 1.367(a)-6T(g) if carried
on directly by a United States person.
(B) The controlled foreign corporations carry on a business,
financial operation, or venture as partners directly or indirectly in a
partnership (as defined in section 7701(a)(2) and Sec. 301.7701-3) that
is a related person (as defined in subdivision (iii) of this paragraph
(b)(4)) with respect to each such controlled foreign corporation.
(C) The activities carried on by the controlled foreign corporations
would constitute a single branch operation under Sec. 1.367(a)-6T(g)(2)
if carried on directly by the United States person.
(iii) Related persons. For purposes of this paragraph (b), two or
more persons are related persons if they are in a relationship described
in section 267(b). In determining for purposes of this paragraph (b)
whether two or more corporations are members of the same controlled
group under section 267(b)(3), a person is considered to own stock owned
directly by such person,
[[Page 48]]
stock owned with the application of section 1563(e)(1), and stock owned
with the application of section 267(c). In determining for purposes of
this paragraph (b) whether a corporation is related to a partnership
under section 267(b)(10), a person is considered to own the partnership
interest owned directly by such person and the partnership interest
owned with the application of section 267(e)(3).
(iv) Illustration. The following example illustrates the application
of this paragraph (b)(4).
Example. USP is the sole United States shareholder of three
controlled foreign corporations: CFC1, CFC2 and CFC3. The three
controlled foreign corporations all have the same taxable year. The
three controlled foreign corporations are partners in FP, a foreign
entity classified as a partnership under section 7701(a)(2) and
Sec. 301.7701-3 of the regulations. For their current taxable years,
each of the controlled foreign corporations derives all of its income
other than foreign base company income from activities conducted through
FP, and its foreign base company income from activities conducted both
jointly through FP and separately without FP. Based on the facts in the
table below, for their current taxable years, the foreign base company
income derived by each controlled foreign corporation, including income
derived from FP, is less than five percent of the gross income of each
controlled foreign corporation and is less than $1,000,000:
------------------------------------------------------------------------
CFC1 CFC2 CFC3
------------------------------------------------------------------------
Gross income....................... $4,000,000 $8,000,000 $12,000,000
Five percent of gross income....... 200,000 400,000 600,000
Foreign base company income........ 199,000 398,000 597,000
------------------------------------------------------------------------
Thus, without the application of the anti-abuse rule of this
subparagraph (5), each controlled foreign corporation would be treated
as having no foreign base company income after the application of the de
minimis rule of section 954(b)(3)(A) and Sec. 1.954-1T(b)(1).
However, under these facts the requirements of subdivision (i) of
this paragraph (b)(4) are presumed to be met. The sum of the foreign
base company income of the controlled foreign corporations is
$1,194,000. Thus, the amount of adjusted gross foreign base company
income will not be less than the amount of gross foreign base company
income by reason of the de minimis rule of section 954(b)(3)(A) and this
paragraph (b).
(5) Illustration. The following example illustrates computations
required by sections 952 and 954 and this Sec. 1.954-1T if the full
inclusion test of paragraph (b)(1)(iii) is met (see paragraph (a)(8) for
an example illustrating computations required if the de minimis test of
paragraph (b)(1)(ii) is met):
Example. (i) Gross Income. CFC, a controlled foreign corporation,
has gross income of $1,000 for the current taxable year. Of that $1,000
of income, $720 is interest income that is included in the definition of
foreign personal holding company income under section 954(c)(1)(A) and
Sec. 1.954-2T(b)(ii), is not income from trade or service receivables
described in section 864(d) (1) or (6), and is not excluded from foreign
personal holding company income under any provisions of section 954(c)
and Sec. 1.954-2T. The remaining $280 is services income that is not
included in the definition of foreign base company income or insurance
income under sections 954(c), (d), (e), (f), (g) or 953 and the
regulations thereunder, and is foreign source general limitation income
for purposes of section 904(d)(1)(I).
(ii) Expenses. CFC has expenses for the current taxable year of
$650. Of that $650, $350 is from interest paid to related persons that
is allocable to foreign personal holding company income along with $50
of other expense. The remaining $250 of expense is allocable to services
income other than foreign base company income or insurance income.
(iii) Earnings and deficits. CFC has earnings and profits for the
current taxable year of $350. In the prior taxable year, CFC had losses
with respect to income other than foreign base company income or
insurance income. By reason of the limitation provided under section
952(c)(1)(A) and the regulations thereunder, those losses reduced the
subpart F income of CFC (consisting entirely of foreign source general
limitation income) by $600 for the prior taxable year.
(iv) Taxes. A foreign tax of $120 is considered imposed on the $720
of interest income under the rules of section 954(b)(4) and paragraph
(d) of this section, and a foreign tax of $2 is considered imposed on
the services income under the rules of section 954(b)(4) and paragraph
(d) of this section. For the taxable year of the foreign corporation,
the maximum U.S. rate of taxation under section 11 is 34 percent.
(v) Conclusion. Based on these facts, if CFC elects to exclude all
items of income subject to a high foreign tax under section 954(b)(4)
and paragraph (d), it will have $350 of subpart F income as defined in
section 952(a) determined as follows:
Step 1--Determine gross income:
(1) Gross income...................................................$1000
Step 2--Compute gross foreign base company income and gross insurance
income:
(2) Gross foreign base company income
[[Page 49]]
and insurance income as defined in sections 954(c), (d), (e), (f), (g)
and 953 and the regulations thereunder (interest income).............720
Step 3--Compute adjusted gross foreign base company income:
(3) Seventy percent of gross income (.70 x line (1))...............700
(4) Adjusted gross foreign base company income or insurance income after
the application of the full inclusion rule of this paragraph (b)(1)
(line (2), or line (1) if line (2) is greater than line (3))........1000
(5) Full inclusion foreign base company income under paragraph
(a)(2)(vi) (line (4) minus line (2)).................................280
Step 4--Compute net foreign base company income:
(6) Related person interest expense and other deductions allocable and
apportionable to foreign personal holding company income under section
954(b)(5) and paragraph (c)..........................................400
(7) Deductions allocable and apportionable to full inclusion foreign
base company income under section 954(b)(5) and paragraph (c)........250
(8) Foreign personal holding company income after allocating deductions
under section 954(b)(5) and paragraph (c) of this section (line (2)
reduced (but not below zero) by line (6))............................320
(9) Full inclusion foreign base company income after allocating
deductions under section 954(b)(5) paragraph (c) of this section (line
(5) reduced (but not below zero) by line (7)).........................30
(10) Total gross foreign base company income after allocating deductions
under section 954(b)(5) and paragraph (c) (line (8) plus line (9))...350
Step 5--Compute net insurance income:
(11) Net insurance income under section 953 and the regulations
thereunder.............................................................0
Step 6--Compute adjusted net foreign base company income:
(12) Foreign tax imposed on foreign personal holding company income
(interest)...........................................................120
(13) Foreign tax imposed on full inclusion foreign base company income
2
(14) Ninety percent of the maximum U.S. corporate tax rate..........30.6
(15) Effective rate of foreign tax imposed on $320 of foreign personal
holding company income under section 954(b)(4) and paragraph (d) (line
(12) divided by line (8)).............................................38
(16) Effective rate of foreign tax imposed of $30 of full inclusion
foreign base company income under section 954(b)(4) and paragraph (d)
(line (13) divided by line (9))........................................7
(17) Foreign personal holding company income subject to a high foreign
tax under section 954(b)(4) and paragraph (d) (zero, or line (8) if line
(15) is greater than line (14))......................................320
(18) Full inclusion foreign base company income subject to a high
foreign tax under section 954(b)(4) and paragraph (d) (zero, or line (9)
if line (16) is greater than line (14))................................0
(19) Adjusted net foreign base company income after applying section
954(b)(4) and paragraph (d) (line (10), reduced by the sum of line (17)
and line (18))........................................................30
Step 7--Compute adjusted net insurance income:
(20) Adjusted net insurance income.....................................0
Step 8--Additions to or reduction of adjusted net foreign base company
income by reason of section 952(c):
(21) Earnings and profits for the current year.......................350
(22) The excess in earnings and profits over subpart F income, which is
subject to being recharacterized as adjusted net foreign base company
income under section 952(c)(2) (excess of line (21) over the sum of line
(19) and line (20)); if there is a deficit, then the limitation of
952(c)(1) may apply for the current year.............................320
(23) Amount of reduction in subpart F income for prior taxable years by
reason of the limitation of section 952(c)(1) and the regulations
thereunder...........................................................600
(24) Subpart F income as defined in section 952(a), assuming section
952(a) (3), (4), or (5) does not apply (the sum of line (19) and line
(20) plus the lesser of line (22) or line (23))......................350
(25) Amount of prior years' deficit remaining to be recharacterized as
subpart F income in later years under section 952(c) (excess of line
(23) over line (22)).................................................280
(c) Computation of net foreign base company income--The net foreign
base company income of a controlled foreign corporation is computed by
reducing (but not below zero) the amount of
[[Page 50]]
gross income in each of the categories of adjusted gross foreign base
company income described in paragraph (b)(2) of this section, so as to
take into account deductions allocable and apportionable to such income.
For purposes of section 954 and this section, expenses must be allocated
and apportioned consistent with the allocation and apportionment of
expenses for purposes of section 904(d). For purposes of this
Sec. 1.954-1T, an item of net foreign base company income must be
categorized according to the category of adjusted gross foreign base
company income from which it is derived. Thus, an item of net foreign
base company income must be categorized as a net item of--
(1) Foreign personal holding company income,
(2) Foreign base company sales income,
(3) Foreign base company services income,
(4) Foreign base company shipping income,
(5) Foreign base company oil related income, or
(6) Full inclusion foreign base company income.
(d) Computation of adjusted net foreign base company income or
adjusted net insurance income--(1) Application of high tax exception.
Adjusted net foreign base company income (or adjusted net insurance
income) equals the net foreign base company income (or net insurance
income) of a controlled foreign corporation, reduced by any item of such
income (other than foreign base company oil related income as defined in
section 954(g)) subject to the high tax exception provided by section
954(b)(4) and this paragraph (d). An item of income is subject to the
high tax exception only if--
(i) It is established that the income was subject to creditable
income taxes imposed by a foreign country or countries at an effective
rate that is greater than 90 percent of the maximum rate of tax
specified in section 11 or 15 for the taxable year of the controlled
foreign corporation; and
(ii) An election is made under section 954(b)(4) and paragraph
(d)(5) of this section to exclude the income from the computation of
subpart F income.
See paragraph (d)(4) of this section for the definition of the term
``item of income.'' For rules concerning the treatment for foreign tax
credit purposes of amounts excluded from subpart F under section
954(b)(4), see Sec. 904-1.4(c)(1).
(2) Effective rate at which taxes are imposed. For purposes of this
paragraph (d), the effective rate at which taxes are imposed on an item
of income is--
(i) The amount of income taxes paid or accrued (or deemed paid or
accrued) with respect to the item of income, determined under paragraph
(d)(3) of this section, divided by
(ii) The item of net foreign base company income or net insurance
income, determined under paragraph (d)(4) of this section (including the
appropriate amount of income taxes referred to in subdivision (i) of
this paragraph (d)(2), immediately above).
(3) Taxes paid or accrued with respect to an item of income--(i)
Income other than passive foreign personal holding company income. The
amount of income taxes paid or accrued with respect to an item of income
(other than an item of foreign personal holding company income that is
passive income) for purposes of section 954(b)(4) and this paragraph (d)
is the amount of foreign income taxes that would be deemed paid under
section 960 with respect to that item if that item were included in the
gross income of a U.S. shareholder under section 951(a)(1)(A). For this
purpose, the amounts that would be deemed paid under section 960 shall
be determined separately with respect to each controlled foreign
corporation and without regard to the limitation applicable under
section 904(a).
(ii) Passive foreign personal holding company income. The amount of
income taxes paid or accrued with respect to an item of foreign personal
holding company income that is passive income for purposes of section
954(b)(4) and this paragraph (d) is the amount of foreign income taxes
paid or accrued or deemed paid by the foreign corporation that would be
taken into account for purposes of applying the provisions of
Sec. 1.904-4(c) with respect to that item of income.
(4) Item of income--(i) Income other than passive foreign personal
holding
[[Page 51]]
company income. The high tax exception applies (when elected) to all
income that constitutes a single item under this paragraph (d)(4). A
single item of net foreign base company income or net insurance income
is an amount of net foreign base company income (other than foreign
personal holding company income that is passive income) or net insurance
income that:
(A) Falls within a single category of net foreign base company
income, as defined in paragraph (c) of this section, or net insurance
income, and
(B) Also falls within a single separate limitation category for
purposes of sections 904(d) and 960 and the regulations thereunder.
(ii) Passive foreign personal holding company income--(A) In
general. For purposes of this paragraph (d) a single item of net foreign
personal holding company income that is passive income is an amount of
such income that falls within a single group of passive income under the
grouping rules of Sec. 1.904-4(c) (3), (4), and (5).
(B) Consistency rule. An election to exclude income from subpart F
must be consistently made with respect to all items of passive foreign
personal holding company income eligible to be excluded. Thus, high-
taxed passive foreign personal holding company income of a controlled
foreign corporation must be excluded in its entirety, or remain subject
to subpart F.
(5) Procedure. The election provided by this paragraph (d) must be
made--
(i) By controlling United States shareholders, as defined in
Sec. 1.964-1(c)(5), by attaching a statement to such effect with their
original or amended income tax returns, and including any additional
information required by subsequent administrative pronouncements, or
(ii) In such other manner as may be prescribed in subsequent
administrative pronouncements.
An election made under the procedure provided by this paragraph (d)(5)
is binding on all United States shareholders of the controlled foreign
corporation.
(6) Illustrations. The rules of this paragraph (d) are illustrated
by the following examples.
Example 1. (i) Items of income. During its 1987 taxable year,
controlled foreign corporation CFC receives from outside its country of
operation portfolio dividend income of $100 and interest income of $100
(consisting of a gross payment of $150 reduced by a third-country
withholding tax of $50). For purposes of illustration, assume that the
CFC incurs no expenses. None of the income is taxed in CFC's country of
operation. The dividend income was not subject to their-country
withholding taxes. The interest income was subject to withholding taxes
equal to $50, and is therefore high withholding tax interest for
purposes of section 960 (pursuant to the operation of section 904). The
dividend income is passive income for purposes of section 960.
Accordingly, pursuant to paragraph (d)(4) of this section, CFC has two
items of income: (1) $100 of FPHC/passive income (the dividends) and (2)
$100 of FPHC/high withholding tax income (the interest). The election
under paragraph (d)(5) of this section to exclude high-taxed income from
the operation of subpart F is potentially applicable to each such item
in its entirety.
(ii) Effective rates of tax. No foreign tax would be deemed paid
under section 960 with respect to item (1). Therefore, the effective
rate of foreign tax is 0, and the item may not be excluded from subpart
F under the rules of this paragraph (d). Foreign tax of $50 would be
deemed paid under section 960 with respect to item (2). Therefore, the
effective rate of foreign tax is 33 percent ($50 of creditable taxes
paid, divided by $150, consisting of the item of net foreign base
company income ($100) plus creditable taxes paid thereon ($50). The
highest rate of tax specified in section 11 for the 1987 taxable year is
34 percent. Accordingly, item (2) may be excluded from subpart F
pursuant to an election under paragraph (d)(5) of this section, since it
is subject to foreign tax at an effective rate that is greater than 30.6
percent (90 percent of 34 percent). However, it remains high withholding
tax interest when included.
Example 2. The facts are the same as in Example 1, except that CFC's
country of operation imposes a tax of $50 with respect to CFC's dividend
income. The interest income is still high withholding tax interest. The
dividend income is still passive income (without regard to the possible
applicability of the high tax exception of section 904(d)(2)).
Accordingly, CFC has two items of income for purposes of this paragraph
(d): (1) $100 of FPHC/high withholding tax interest income, and (2) $50
of FPHC/passive income (net of the $50 foreign tax). Both items are
taxed at an effective rate greater than 31.6 percent. Item 1: Foreign
tax ($50) divided by sum ($150) of income item ($100) plus creditable
tax thereon ($50) equals 33 percent. Item 2: Foreign tax ($50) divided
by sum ($100) of income item ($50) plus creditable tax thereon
[[Page 52]]
($50) equals 50 percent. Accordingly, an election may be made under
paragraph (d)(5) of this section to exclude either, both, or neither of
items 1 and 2 from subpart F.
Example 3. The facts are the same as in Example 1, except that the
$100 of portfolio dividend income is subject to a third-country
withholding tax of $50, and the $150 of interest income is from sources
within CFC's country of operation, is subject to a $10 income tax
therein, and is not subject to a withholding tax. Although the interest
income and the dividend income are both passive income, under paragraph
(d)(4)(ii)(A) of this section they constitute separate items of income
pursuant to the application of the grouping rules of Sec. 1.904-4(c).
Accordingly, CFC has two items of income for purposes of this paragraph
(d): (1) $50 (net of tax) of FPHC/non-country of operation/greater than
15 percent withholding tax income; and (2) $140 (net of $10 tax) of
FPHC/country of operation income. Item 1 is taxed at an effective rate
greater than 30.6 percent, but Item 2 is not. Item 1: Foreign tax ($50)
divided by sum ($100) of income item ($50) plus creditable tax thereon
($50) equals 50 percent. Item 2: Foreign tax ($10) divided by sum ($150)
of income item ($140) plus creditable tax thereon ($10) equals 6.67
percent. Therefore, an election may be made under paragraph (d)(5) of
this section to exclude Item 1 but not Item 2 from subpart F.
Example 4. The facts are the same as in Example 3, except that the
$150 of interest income is subject to an income tax of $50 in CFC's
country of operation. Accordingly, CFC has two items of income, as in
Example 4, but both items are taxed at an effective rate greater than
30.6 percent. Item 1: Foreign tax ($50) divided by sum ($100) of income
item ($50) plus creditable tax thereon ($50) equals 50 percent. Item 2:
Foreign tax ($50) divided by sum ($150) if income item ($100) plus
creditable tax thereon ($50) equals 33 percent. Pursuant to the
consistency rule of paragraph (d)(4)(ii)(B) of this section, CFC's
shareholders must consistently elect or not elect to exclude from
subpart F all items of FPHC income that are eligible to be excluded.
Therefore, an election may be made to exclude both Item 1 and Item 2
from subpart F, or neither may be excluded.
(e) Character of an item of income--(1) Substance of the
transaction. For purposes of section 954 and the regulations thereunder,
items of income shall be characterized in accordance with the substance
of the transaction, and not in accordance with the designation applied
by the parties to the transaction. For example, an amount received as
``rent'' which actually constitutes income from the sale of property,
royalties, or income from services shall not be characterized as
``rent'' but shall be characterized as income from the sale of property,
royalties or income from services, respectively. Local law shall not be
controlling in characterizing an item of income.
(2) Separable character. To the extent one of the definitional
provisions of section 953 or 954 describes a portion of the income or
gain derived from a transaction, that portion of income or gain is so
characterized. Thus, a single transaction may give rise to income in
more than one category of foreign base company income described in
paragraph (a)(2) of this section. For example, if a controlled foreign
corporation, in its business of purchasing and selling personal
property, receives interest (including imputed interest and market
discount) on an account receivable arising from a sale, a portion of the
income derived from the transaction by the controlled foreign
corporation will be interest, and another portion will be gain (or loss)
from the sale of personal property. If the sale is denominated in a
currency other than a functional currency as defined in section 985 and
the regulations thereunder, the controlled foreign corporation may have
additional income in the form of foreign currency gain as defined in
section 988.
(3) Predominant character. The portion of income derived from a
transaction that meets the definition of foreign personal holding
company income is always separately determinable, and thus must always
be segregated from other income and separately classified under
paragraph (2) of this paragraph (e). However, the portion of income
derived from a transaction that would meet a particular definitional
provision under section 954 or 953 and the regulations thereunder (other
than the definition of foreign personal holding company income) in
unusual circumstances may be indeterminable. If such portion is
indeterminable, it must be classified in accordance with the predominant
character of the transaction. For example, if a controlled foreign
corporation engineers, fabricates, and installs a fixed offshore
drilling platform as part of an integrated transaction, and the portion
of income that relates to services is not
[[Page 53]]
accounted for separately from the portion that relates to sales, and is
otherwise indeterminable, then the classification of income from the
transaction shall be made in accordance with the predominant character
of the particular integrated arrangement.
(4) Coordination of categories of gross foreign base company income
or gross insurance income. The definitions of gross foreign base company
income and gross insurance income are limited by the following rules (to
be applied in numerical order):
(i) If an item of income is included in subpart F income under
section 952(a)(1) and the regulations thereunder as insurance income, it
is by definition excluded from any other category of subpart F income.
(ii) If an item of income is included in the foreign base company
oil related income of a controlled foreign corporation, it is by
definition excluded from any other category of foreign base company
income, other than as provided in subdivision (i) of this paragraph
(e)(4).
(iii) If an item of income is included in the foreign base company
shipping income of a controlled foreign corporation, it is by definition
excluded from any other category of foreign base company income, other
than as provided in subdivisions (i) and (ii) of this paragraph (e)(4).
(iv) If an item of income is included in foreign personal holding
company income of a controlled foreign corporation, it is by definition
not included in any other category of foreign base company income, other
than as provided in subdivisions (i), (ii), and (iii) of this paragraph
(e)(4).
An item of income shall not be excluded from the definition of a
category of gross foreign base company income or gross insurance income
under this paragraph (e)(4) by reason of being included in the general
definition of another category of gross foreign base company income or
gross insurance income, if the item of income is excluded from that
other category by a more specific provision of section 953 or 954 and
the regulations thereunder. For example, income derived from a commodity
transaction that is excluded from foreign personal holding company
income under Sec. 1.954-2T(f) as income from qualified active sales may
be included in gross foreign base company income if it also meets the
definition of foreign base company sales income. See Sec. 1.954-2T(a)(2)
for the coordination of overlapping categories within the definition of
foreign personal holding company income.
[T.D. 8216, 53 FR 27492, July 21, 1988. Redesignated and amended by T.D.
8618, 60 FR 46530, Sept. 7, 1995]
Sec. 4.954-2 Foreign personal holding company income; taxable years beginning after December 31, 1986.
(a) Computation of foreign personal holding company income--(1) In
general. Foreign personal holding company income consists of the
following categories of income:
(i) Dividends, interest, rents, royalties, and annuities as defined
in paragraph (b) of this section;
(ii) Gain from certain property transactions as defined in paragraph
(e) of this section;
(iii) Gain from commodities transactions as defined in paragraph (f)
of this section;
(iv) Foreign currency gain as defined in paragraph (g) of this
section; and
(v) Income equivalent to interest as defined in paragraph (h) of
this section.
Paragraph (a)(3) of this section provides rules for determining the use
or purpose for which property is held, if a change in use or purpose
would affect the computation of foreign personal holding company income
under paragraphs (e), (f), and (g) of this section. Paragraphs (c) and
(d) of this section provide rules for determining certain rents and
royalties that are excluded from foreign personal holding company income
under paragraph (b) of this section.
(2) Coordination of overlapping definitions. If a particular portion
of income from a transaction in substance falls within more than one of
the definitional rules of section 954(c) and this section, its character
is determined under the rules of subdivision (i) through (iii) of this
paragraph (a)(2). The character of loss from a transaction must be
similarly determined under the rules of this paragraph (a)(2).
[[Page 54]]
(i) If a portion of the income from a transaction falls within the
definition of income equivalent to interest under paragraph (h) of this
section and the definition of gain from certain property transactions
under paragraph (e) of this section, gain from a commodities transaction
under paragraph (f) of this section (whether or not derived from a
qualified hedging transaction or qualified active sales), or foreign
currency gain under paragraph (g) of this section (whether or not
derived from a qualified business transaction or a qualified hedging
transaction), that portion of income is treated as income equivalent to
interest for purposes of section 954(c) and this section.
(ii) If a portion of the income from a transaction falls within the
definition of foreign currency gain under paragraph (g) of this section
(whether or not derived from a qualified business transaction or a
qualified hedging transaction) and the definition of gain from certain
property transactions under paragraph (e) of this section, or gain from
a commodities transaction under paragraph (f) of this section (whether
or not derived from a qualified hedging transaction or qualified active
sales), that portion of income is treated as foreign currency gain for
purposes of section 954(c) and this section.
(iii) If a portion of the income from a transaction falls within the
definition of gain from a commodities transaction under paragraph (f) of
this section (whether or not derived from a qualified hedging
transaction or qualified active sales) and the definition of gain from
certain property transactions under paragraph (e) of this section, that
portion of income is treated as gain from a commodities transaction for
purposes of section 954(c) and this section.
(3) Changes in the use or purpose with which property is held--(i)
In general. Under paragraphs (e), (f), and (g) of this section,
transactions in certain property give rise to gain or loss included in
the computation of foreign personal holding company income if the
controlled foreign corporation holds that property for a particular use
or purpose. For purposes of this section, in determining the purpose or
use for which property is held, the period shortly before disposition is
the most significant period. However, if a controlled foreign
corporation held property with a purpose that would have caused its
disposition to give rise to gain or loss included in the computation of
foreign personal holding company income under this section, and prior to
disposition the controlled foreign corporation changed the purpose or
use for which it held the property to one that would cause its
disposition to give rise to gain or loss excluded from the computation
of foreign personal holding company income, then the later purpose or
use shall be ignored unless it was continuously present for a
predominant portion of the period during which the controlled foreign
corporation held the property. Under paragraph (g)(4)(iii) of this
section, a currency hedging transaction may be treated as two or more
separate hedging transactions, such that each portion is separately
considered in applying this paragraph (a)(3).
(ii) Illustrations. The following examples illustrate the
application of this paragraph (a)(3).
Example 1. At the beginning of taxable year 1, CFC, a controlled
foreign corporation, purchases a building for investment. During taxable
years 1 and 2, CFC derives rents from this building that are included in
the computation of foreign personal holding company income under
paragraph (b)(1)(iii) of this section. At the beginning of taxable year
3, CFC changes the use of the building by terminating all leases, and
using it in an active trade or business. At the beginning of taxable
year 4, CFC sells the building at a gain. For purposes of paragraph (e)
of this section (gains from the sale or exchange of certain property)
the building is considered to be property that gives rise to rents, as
described in paragraph (e)(2). Because there was a change of use at the
beginning of year 3 that would cause the disposition of the building to
give rise to gain or loss excluded from the computation of foreign
personal holding company income, the characterization of the gain
derived at the beginning of year 4 is determined according to the
property's use during the predominant portion of the period from
purchase to date of sale. Therefore, gain from the sale of that building
is included in the computation of foreign personal holding company
income under paragraph (e) of this section.
[[Page 55]]
Example 2. For taxable years 1, 2, and 3, CFC, a controlled foreign
corporation, is engaged in the active conduct of a commodity business as
a handler of gold, as defined in paragraph (f)(3)(iii), and
substantially all of its business is as an active handler of gold, as
defined in paragraph (f)(3)(iv). At the beginning of taxable year 1, CFC
purchases 1000 ounces of gold for investment. At the beginning of
taxable year 3, CFC begins holding that gold in physical form for sale
to customers. During taxable year 3, CFC sells the entire 1000 ounces of
gold in transactions described in paragraph (f)(3)(ii) at a gain. For
purposes of paragraph (f), CFC is considered to hold the gold for
investment, and not in its capacity as an active handler of gold. Thus,
under paragraph (f)(3)(i), the gold is not considered to be sold in the
active trade or business of the CFC as a handler of gold, and gain from
the sale is included in the computation of foreign personal holding
company income under paragraph (f) of this section.
Example 3. CFC, a controlled foreign corporation, is a regular
dealer in unimproved land. The functional currency (as defined in
section 985 and the regulations thereunder) of CFC is country X
currency. On day 1 of its current taxable year, CFC enters into an
agreement with A to pay $100 for certain real property to be held by CFC
for investment. On day 10, under its method of accounting, CFC accrues
the value of $100 in country X currency, but payment will not be made
until the first day of the next taxable year (day 366). On day 190, CFC
determines to hold the property for sale to customers in a transaction
that would be a qualified business transaction under paragraph (g)(3) of
this section. For purposes of this section, the land is considered to be
held for investment, and the foreign currency gain attributable to that
transaction is included in the computation of foreign personal holding
company income under paragraph (g) of this section.
Example 4. CFC, a controlled foreign corporation, is a regular
dealer in widgets. The functional currency (as defined in section 985
and the regulations thereunder) of CFC is country X currency. On day 1
of its current taxable year, CFC sells widgets held in inventory to A
for delivery on day 60. The sales price is denominated in U.S. dollars,
and payment is to be made by A on the same day the widgets are to be
delivered to A. The remaining facts and circumstances are such that this
sale would meet the definition of a qualified business transaction under
paragraph (g)(4), the foreign currency gain from which would be excluded
from the computation of foreign personal holding company income under
paragraph (g). On day 1, CFC sells U.S. dollars forward for delivery in
60 days in a transaction that would be a qualified hedging transaction
under paragraph (g)(5). On day 25 the sale of widgets to A is cancelled
in a transaction that does not result in CFC realizing any foreign
currency gain or loss with respect to the sale of widgets. However, CFC
holds the dollar forward contract to maturity. Because the forward
contract does not hedge a qualified business transaction during the
period shortly before its maturity, it is not to be considered a
qualified hedging transaction under paragraph (g), and any foreign
currency gain or loss recognized therefrom is included in the
computation of foreign personal holding company income under paragraph
(g). However, if CFC identifies the portion of the foreign currency gain
or loss derived from the forward contract that is attributable to days 1
through 25, and the portion that is attributable to days 25 through 60,
the forward contract may be considered two separate transactions in
accordance with the rules provided by paragraph (g)(4)(ii) of this
section. Thus, the forward sale may be separately considered a qualified
hedging transaction for day 1 through day 25, and the foreign currency
gain or loss attributable to day 1 through day 25 may be excluded from
the computation of foreign personal holding company income under
paragraph (g) of this section.
Example 5. CFC, a controlled foreign corporation, has country X
currency as its functional currency under section 985 and the
regulations thereunder. On day 1 of the current taxable year, CFC,
speculating on exchange rates, sells dollars forward for delivery in 120
days. On day 65, CFC sells widgets held in inventory at a price
denominated in dollars to be paid on day 120 in a transaction that is a
qualified business transaction. CFC had not made any other dollar sales
between day 1 and day 65 and does not anticipate making any other dollar
sales during the taxable year. On day 65, CFC accrues the value of $100
in country X currency. On day 120, CFC receives $100 payment for the
widgets and recognizes foreign currency loss pursuant to that
transaction. On day 120 CFC also delivers dollars in connection with the
forward sale, and recognizes foreign currency gain pursuant to the
delivery. Under this paragraph (a)(3) the currency transaction is
considered to have been entered into for speculation, and any currency
gain recognized by CFC on the forward sale of dollars must be included
in the computation of foreign personal holding company income under
paragraph (g). However, if CFC identifies the portion of the forward
sale, and the foreign currency gain or therefrom, that is attributable
to day 1 through day 64, and the portion that is attributable to day 65
through day 120, the forward sale may be considered two separate
transactions in accordance with the rules provided by paragraph
(g)(4)(ii) of this section. Thus, the transaction for day 65 through day
120 may be considered a separate transaction that is a
[[Page 56]]
qualified hedging transaction, and the foreign currency gain
attributable to day 65 through day 120 may be excluded from the
computation of foreign personal holding company income under this
paragraph (g) if all the other requirements for treatment as a qualified
hedging transaction under paragraph (g) are met.
(4) Definitions. The following definitions apply for purposes of
computing foreign personal holding company income under this section.
(i) Interest. The term ``interest'' includes amounts that are
treated as ordinary income, original issue discount or interest income
(including original issue discount and interest on a tax-exempt
obligation) by reason of sections 482, 483, 864(d), 1273, 1274, 1276,
1281, 1286, 1288, 7872 and the regulations thereunder, or as interest or
original issue discount income by reason of any other provision of law.
For special rules concerning interest exempt from U.S. tax pursuant to
section 103, see paragraph (b)(6) of this section.
(ii) Inventory and similar property. The term ``inventory and
similar property'' (or ``inventory or similar property'') means property
that is stock in trade of the controlled foreign corporation or other
property of a kind which would properly be included in the inventory of
the controlled corporation if on hand at the close of the taxable year
(were the controlled foreign corporation a domestic corporation), or
property held by the controlled foreign corporation primarily for sale
to customers in the ordinary course of its trade or business. Rights to
property held in bona fide hedging transactions that reduce the risk of
price changes in the cost of ``inventory and similar property'' are
included in the definition of that term if they are an integral part of
the system by which a controlled foreign corporation purchases such
property, and they are so identified by the close of the fifth day after
the day on which the hedging transaction is entered into.
(iii) Regular dealer. The term ``regular dealer'' means a merchant
with an established place of business that--
(A) Regularly and actively engages as a merchant in purchasing
property and selling it to customers in the ordinary course of business
with a view to the gains and profits that may be derived therefrom, or
(B) Makes a market in derivative financial products of property
(such as forward contracts to buy or sell property, option contracts to
buy or sell property, interest rate and currency swap contracts or other
national principal contracts) by regularly and actively offering to
enter into positions in such products to the public in the ordinary
course of business.
Purchasing and selling property through a regulated exchange or
established off-exchange market (for example, engaging in futures
transactions) is not actively engaging as a merchant for purposes of
this section.
(iv) Dealer property. Property held by a controlled foreign
corporation is ``dealer property'' if--
(A) The controlled foreign corporation is a regular dealer in
property of such kind, and
(B) The property is held by the controlled foreign corporation in
its capacity as a dealer.
Property which is held by the controlled foreign corporation for
investment or speculation is not such property.
(v) Debt instrument. The term ``debt instrument'' includes bonds,
debentures, notes, certificates, accounts receivable, and other
evidences of indebtedness.
(b) Dividends, etc.--(1) In general. Foreign personal holding
company includes:
(i) Dividends, except certain dividends from related persons as
described in paragraph (b)(3) of this section and distributions of
previously taxed income under section 959(b) and the regulations
thereunder;
(ii) Interest, except export financing interest as defined in
paragraph (b)(2) of this section and certain interest received from
related persons as described in paragraph (b)(3) of this section;
(iii) Rents and royalties, except certain rents and royalties
received from related persons as described in (b)(4) of this section and
rents and royalties derived in the active conduct of a trade or business
as defined in paragraph (b)(5); and
(iv) Annuities.
(2) Exclusion of certain export financing--(i) In general. Pursuant
to section
[[Page 57]]
954(c)(2)(B), foreign personal holding company income computed under
section 954(c)(1)(A) and this paragraph (b) does not include interest
that is export financing interest. For purposes of section 954(c)(2)(B)
and this section, the term ``export financing interest'' means interest
that is derived in the conduct of a banking business and is export
financing interest as defined in section 904(d)(2)(G) and the
regulations thereunder. Pursuant to section 864(d)(5)(A)(iii), it does
not include income from related party factoring that is treated as
interest under section 864(d)(1) or interest described in section
864(d)(6).
(ii) Conduct of a banking business. For purposes of this section,
export financing interest as defined in section 904(d)(2)(G) and the
regulations thereunder is considered derived in the conduct of a banking
business if, in connection with the financing from which the interest is
derived, the corporation, through its own officers or staff of
employees, engages in all the activities in which banks customarily
engage in issuing and servicing a loan.
(iii) Illustration. The following example illustrates the
application of this provision:
Example. DS, a domestic corporation, manufactures property in the
United States. In addition to selling inventory (property described in
section 1221(1)), DS occasionally sells depreciable equipment it
manufactures for use in its trade or business, which is property
described in section 1221(2). Less than 50 percent of the fair market
value, determined in accordance with section 904(d)(2)(G) and the
regulations thereunder, of each item of inventory or equipment sold by
DS is attributable to products imported into the United States. CFC, a
controlled foreign corporation related (as defined in section 954(d)) to
DS, provides loans for the purchase of property from DS, if the property
is purchased exclusively for use of consumption outside the United
States.
If, in issuing and servicing loans made with respect to purchases
from DS of depreciable equipment used in its trade or business, which is
property described in section 1221(2) in the hands of DS, CFC engages in
all the activities in which banks customarily engage in issuing and
servicing loans, the interest accrued from these loans would be export
financing interest meeting the requirements of paragraph (b)(2) of this
section, which would not be included in foreign personal holding company
income under section 954(c) and paragraph (b)(1)(ii) of this section.
However, interest from the loans made with respect to purchases from DS
of property which is inventory in the hands of DS cannot be export
financing interest because it is treated as income from a trade or
service receivable under section 864(d)(6) and the regulations
thereunder, and thus is included in foreign personal holding company
income under paragraph (b)(1)(ii) of this section. See Sec. 1.864-8T(d)
for rules concerning certain income from trade and service receivables
qualifying under the same country exception of section 864(d)(7).
(3) Exclusion of dividends and interest from related persons--(i)
Excluded dividends and interest. Foreign personal holding company income
does not include dividends and interest if--
(A) The payor is a corporation that is a related person as defined
in section 954(a)(3),
(B) The payor is created or organized (``incorporated'') under the
laws of the same foreign country as the controlled foreign corporation,
and
(C) A substantial part of the payor's assets are used in a trade or
business in the payor's country of incorporation as determined under
subdivision (iv) of this paragraph (b)(3).
Except as otherwise provided under this paragraph (b)(3), the principles
of section 367(a) and regulations thereunder shall apply in determining
whether the payor has a trade or business in its country of
incorporation, and whether its assets are used in that trade or
business.
(ii) Interest paid out of adjusted foreign base company income or
insurance income. Interest may not be excluded from the foreign personal
holding company income of the recipient under this paragraph (b)(3) to
the extent that the deduction for the interest is allocated under
Sec. 1.954-1T(c) to the payor's adjusted gross foreign base company
income (as defined in Sec. 1.954-1T(a)(3)), adjusted gross insurance
income (as defined in Sec. 1.954-1T(a)(6)), or other categories of
income included in the computation of subpart F income under section
952(a), for purposes of computing the payor's net foreign base company
income (as defined in Sec. 1.954-1T(a)(4), net insurance income (as
defined in Sec. 1.954-1T(a)(6)), or income described in sections 952(a)
(3), (4), and (5).
[[Page 58]]
(iii) Dividends paid out of prior years' earnings. Dividends are
excluded from foreign personal holding company income under this
paragraph (b)(3) only to the extent they are paid out of earnings and
profits which were earned or accumulated during a period in which the
requirements of subdivision (i) of this paragraph (b)(3) were satisfied
or, to the extent earned or accumulated during a taxable year of the
related foreign corporation ending on or before December 31, 1962,
during a period in which the payor was a related corporation as to be
controlled foreign corporation and the other requirements of subdivision
(i) of this paragraph (b)(3) are substantially satisfied.
(iv) Fifty percent substantial assets test. A substantial part of
the assets of the payor will be considered used in a trade or business
located in its country of incorporation only if, for each quarter during
such taxable year, the average value (as of the beginning and end of the
quarter) of its assets which are used in the trade or business and are
located in such country constitutes over 50 percent of the average value
(as of the beginning and end of the quarter) of all the assets of the
payor (including assets not used in a trade or business). For such
purposes the value of assets shall be determined under subdivision (v)
of this paragraph (b)(3), and the location of assets used in a trade or
business of the payor shall be determined under subdivisions (vi)
through (xi) of this paragraph (b)(3).
(v) Value of assets. For purposes of determining whether a
substantial part of the assets of the payor are used in a trade or
business in its country of incorporation, the value of assets shall be
their actual value (not reduced by liabilities), which, in the absence
of affirmative evidence to the contrary, shall be deemed to be their
adjusted basis.
(vi) Location of tangible property used in a trade or business--(A)
In general. Tangible property (other than inventory and similar
property) used in a trade or business is considered located in the
country in which it is physically located.
(B) Exception. If tangible personal property used in a trade or
business is intended for use in the payor's country of incorporation,
but is temporarily located elsewhere, it will be considered located
within payor's country of incorporation if the reason for its location
elsewhere is for inspection or repair, and it is not currently in
service in a country other than the payor's country of incorporation and
is not to be placed in service in a country other than the payor's
country of incorporation following the inspection or repair.
(vii) Location of intangible property used in a trade or business--
(A) In general. The location of intangible property (other than
inventory or similar property and debt instruments) used in a trade or
business is determined based on the site of the activities conducted by
the payor during the current year in connection with using or exploiting
that property. An item of intangible property is located in the payor's
country of incorporation during each quarter of the current taxable year
if the activities connected with its use or exploitation are conducted
during the entire current taxable year by the payor in its country of
incorporation. For this purpose, the determination of the country in
which services are performed shall be made under the principles of
section 954(e) and Sec. 1.954-4(c).
(B) Property located in part in the payor's country of incorporation
and in part in other countries. If the activities connected with the use
or exploitation of an item of intangible property are conducted during
the current taxable year by the payor in the payor's country of
incorporation and in other countries, then a percentage of the
intangible (measured by the average value of the item as of the
beginning and end of the quarter) is considered located in the payor's
country of incorporation during each quarter. That percentage equals the
ratio that the expenses of the payor incurred during the entire taxable
year by reason of such activities that are conducted in the payor's
country of incorporation bear to the expenses of the payor incurred
during the entire taxable year by reason of all such activities
worldwide. Expenses incurred in connection with the use or exploitation
of an item of intangible property are included in the computation
provided by this paragraph (b)(3) if they are deductible under section
162 or
[[Page 59]]
includible in inventory costs or the costs of goods sold (were the payor
a domestic corporation).
(viii) Location of property held for sale to customers--(A) In
general. Inventory or similar property is considered located in the
payor's country of incorporation during each quarter of the taxable year
if the activities of the payor in connection with the production and
sale, or purchase and release, of such property and conducted in the
payor's country of incorporation during the entire taxable year. If the
payor conducts such activities through an independent contractor, then
the location of such activities shall be the place in which they are
conducted by the independent contractor.
(B) Inventory located in part in the payor's country of
incorporation and in part in other countries. If the activities
connected with the production and sales, or purchase and resale, of
inventory or similar property are conducted by the payor in the payor's
country of incorporation and other countries, then a percentage of the
inventory or similar property (measured by the average value of the item
as of the beginning and end of the quarter) is considered located in the
payor's country of incorporation each quarter. That percentage equals
the ratio that the costs of the payor incurred during the entire taxable
year by reason of such activities that are conducted in the payor's
country of incorporation bear to all such costs incurred by reason of
such activities worldwide. A cost incurred in connection with the
production and sale or purchase and resale of inventory or similar
property is included in this computation if it--
(1) Must be included in inventory costs or otherwise capitalized
with respect to inventory or similar property under section 61, 263A,
471, or 472 and the regulations thereunder (whichever would be
applicable were the payor a domestic corporation), or
(2) Would be deductible under section 162 (were the payor a domestic
corporation) and is definitely related to gross income derived from such
property (but not to all classes of gross income derived by the payor)
under the principles of Sec. 1.861-8.
(ix) Location of debt instruments. For purposes of this paragraph
(b)(3), debt instruments are considered to be used in a trade or
business only if they arise from the sale of inventory or similar
property by the payor or from the rendition of services by the payor in
the ordinary course of a trade or business of the payor, but only until
such time as interest is required to be charged under section 482 and
the regulations thereunder. Debt instruments that arise from the sale of
inventory or similar property are treated as having the same location,
proportionately, as inventory or similar property that is held during
the same calendar quarter. Debt instruments arising from the rendition
of services in the ordinary course of a trade or business are considered
located on a proportionate basis in the countries in which the services
to which they relate are performed.
(x) Treatment of certain stock interests. For the purpose of
determining the value of assets used in a trade or business in the
country of incorporation, stock directly or indirectly owned by the
payor within the meaning of section 958(a) in a controlled foreign
corporation (``lower-tier corporation''), which is incorporated in the
same country as the payor, shall be considered located in the country of
incorporation and used in a trade or business of the payor in proportion
to the value of the assets of the lower-tier corporation that are used
in a trade or business in the country of incorporation. The location of
assets used in a trade or business of the lower-tier corporation shall
be determined under the rules of this paragraph (b)(3).
(xi) Determination of period during which property is used in a
trade or business. Property purchased or produced for use in a trade or
business shall not be considered used in a trade or business until it is
placed in service, and shall cease to be considered used in a trade or
business when it is retired from service. The dates during which
depreciable property is determined to be in use must be consistent with
the determination of depreciation under sections 167 and 168 and the
regulations thereunder.
[[Page 60]]
(xii) Treatment of banks and insurance companies. [Reserved.]
(4) Exclusion of rents and royalties derived from related persons--
(i) In general. Foreign personal holding company income does not include
rents or royalties if--
(A) The payor is a corporation that is a related person as defined
in section 954(d)(3), and
(B) The rents or royalties are for the use of, or the privilege of
using, property within the country under the laws of which the recipient
of the payments is created or organized.
If the property is used both within and without the country under the
laws of which the controlled foreign corporation is created or
organized, the part of the rent or royalty attributable to the use of,
or the privilege of using, the property outside such country of
incorporation is, unless otherwise provided, foreign personal holding
company income under this paragraph (b).
(ii) Rents or royalties paid out of adjusted foreign base company
income or insurance income. Rents or royalties may not be excluded from
the foreign personal holding company income of the recipient under this
paragraph (b)(4) to the extent that deductions for the payments are
allocated under section 954(b)(5) and Sec. 1.954-1T(a)(4) to the payor's
adjusted gross foreign base company income (as defined in Sec. 1.954-
1T(a)(3)), adjusted gross insurance income (as defined in Sec. 1.954-
1T(a)(6), or other categories of income included in the computation of
subpart F income under section 952(a), for purposes of computing the
payor's net foreign base company income (as defined in Sec. 1.954-
1T(a)(4)), net insurance income (as defined in Sec. 1.954-1T(a)(6)), or
income described in section 952(a) (3), (4), or (5).
(5) Exclusion of rents and royalties derived in the active conduct
of a trade or business. Foreign personal holding company income shall
not include rents or royalties which are derived in the active conduct
of a trade or business and which are received from a person other than a
related person within the meaning of section 954(d)(3). Whether or not
rents or royalties are derived in the active conduct of a trade or
business is to be determined from the facts and circumstances of each
case; but see paragraph (c) or (d) of this section for specific cases in
which rents or royalties will be considered for purposes of this
paragraph to be derived in the active conduct of a trade or business.
The frequency with which a foreign corporation enters into transactions
from which rents or royalties are derived will not of itself establish
the fact that such rents or royalties are derived in the active conduct
of a trade or business.
(6) Treatment of tax exempt interest. Foreign personal holding
company income includes all interest income, including interest that is
exempt from U.S. tax pursuant to section 103 (``tax-exempt interest'').
However, that net foreign base company income of a controlled foreign
corporation that is attributable to such tax-exempt interest shall be
treated as tax-exempt interest in the hands of the U.S. shareholders of
the foreign corporation. Accordingly, any net foreign base company
income that is included in the subpart F income of a U.S. shareholder
and that is attributable to such tax-exempt interest shall remain exempt
from the regular income tax, but potentially subject to the alternative
minimum tax, in the hands of the U.S. shareholder.
(c) Excluded rents--(1) Trade or business cases. Rents will be
considered for purposes of paragraph (b)(5) of this section to be
derived in the active conduct of a trade or business if such rents are
derived by the controlled foreign corporation (``lessor'') from
leasing--
(i) Property which the lessor has manufactured or produced, or has
acquired and added substantial value to, but only if the lessor is
regularly engaged in the manufacture or production of, or in the
acquisition and addition of substantial value to, property of such kind,
(ii) Real property with respect to which the lessor, through its own
officers or staff of employees, regularly performs active and
substantial management and operational functions while the property is
leased,
(iii) Personal property ordinarily used by the lessor in the active
conduct of a trade or business, leased during a temporary period when
the property would, but for such leasing, be idle, or
[[Page 61]]
(iv) Property which is leased as a result of the performance of
marketing functions by such lessor if the lessor, through its own
officers or staff of employees located in a foreign country, maintains
and operates an organization in such country which is regularly engaged
in the business of marketing, or of marketing and servicing, the leased
property and which is substantial in relation to the amount of rents
derived from the leasing of such property.
(2) Special rules--(i) Adding substantial value. For purposes of
paragraph (c)(1)(i) of this section, the performance of marketing
functions will not be considered to add substantial value to property.
(ii) Substantiality of foreign organization. An organization in a
foreign country will be considered substantial in relation to the amount
of rents, for purposes of paragraph (c)(1)(iv) of this section, if
active leasing expenses, as defined in paragraph (c)(2)(iii), equal or
exceed 25 percent of the adjusted leasing profit, as defined in
paragraph (c)(2)(iv) of this section.
(iii) Active leasing expenses The term ``active leasing expenses''
means the deductions incurred by an organization of the lessor in a
foreign country which are properly allocable to rental income and which
would be allowable under section 162 to the lessor (were the lessor a
domestic corporation) other than--
(A) Deductions for compensation for personal services rendered by
shareholders of, or related persons with respect to, the lessor,
(B) Deductions for rents paid or accrued,
(C) Deductions which, although generally allowable under section
162, would be specifically allowable to the lessor (were the lessor a
domestic corporation) under sections other than section 162 (such as
sections 167 and 168), and
(D) Deductions for payments made to independent contractors with
respect to the leased property.
(iv) Adjusted leasing profit. The term ``adjusted leasing profit''
means the gross income of the lessor from rents, reduced by the sum of--
(A) The rents paid or incurred by the controlled foreign corporation
with respect to such gross rental income,
(B) The amounts which would be allowable to such lessor (were the
lessor a domestic corporation) as deductions under section 167 or 168
with respect to such rental income, and
(C) The amounts paid to independent contractors with respect to such
rental income.
(3) Illustrations. The application of this paragraph (c) is
illustrated by the following examples.
Example 1. Controlled foreign corporation A is regularly engaged in
the production of office machines which it sells or leases to others and
services. Under paragraph (c)(1)(i) of this section, the rental income
of A Corporation from the leases is derived in the active conduct of a
trade or business for purposes of section 954(c)(2)(A).
Example 2. Controlled foreign corporation D purchases motor vehicles
which it leases to others. In the conduct of its short-term leasing of
such vehicles in foreign country X, Corporation D owns a large number of
motor vehicles in country X which it services and repairs, leases motor
vehicles to customers on an hourly, daily, or weekly basis, maintains
offices and service facilities in country X from which to lease and
service such vehicles, and maintains therein a sizable staff of its own
administrative, sales, and service personnel. Corporation D also leases
in country X on a long-term basis, generally for a term of one year,
motor vehicles which it owns. Under the terms of the long-term leases,
Corporation D is required to repair and service, during the term of the
lease, the leased motor vehicles without cost to the lessee. By the
maintenance in country X of office, sales, and service facilities and
its complete staff of administrative, sales, and service personnel,
Corporation D maintains and operates an organization therein which is
regularly engaged in the business of marketing and servicing the motor
vehicles which are leased. The deductions incurred by such organization
satisfy the 25-percent test of paragraph (c)(2)(ii) of this section;
thus, such organization is substantial in relation to the rents
Corporation D receives from leasing the motor vehicles. Therefore, under
paragraph (c)(1)(iv) of this section, such rents are derived in the
active conduct of a trade or business for purposes of section
954(c)(2)(A).
Example 4. Controlled foreign corporation E owns a complex of
apartment buildings which it has acquired by purchase. Corporation E
engages a real estate management firm to lease the apartments, manage
the buildings and pay over the net rents to the
[[Page 62]]
owner. The rental income of E Corporation from such leases is not
derived in the active conduct of a trade or business for purposes of
section 954(c)(2)(A).
Example 5. Controlled foreign corporation F acquired by purchase a
twenty-story office building in a foreign country, three floors of which
it occupies and the rest of which it leases. Corporation F acts as
rental agent for the leasing of offices in the building and employs a
substantial staff to perform other management and maintenance functions.
Under paragraph (c)(1)(ii) of this section, the rents received by
Corporation F from such leasing operations are derived in the active
conduct of a trade or business for purposes of section 954(c)(2)(A).
Example 6. Controlled foreign corporation G owns equipment which it
ordinarily uses to perform contracts in foreign countries to drill oil
wells. For occasional brief and irregular periods it is unable to obtain
contracts requiring immediate performance sufficient to employ all such
equipment. During such a period it sometimes leases such idle equipment
temporarily. After the expiration of such temporary leasing of the
property, Corporation G continues the use of such equipment in the
performance of its own drilling contracts. Under paragraph (c)(1)(iii)
of this section, rents G receives from such leasing of idle equipment
are derived in the active conduct of a trade or business for purposes of
section 954(c)(2)(A).
(d) Excluded royalties--(1) Trade or business cases. Royalties will
be considered for purposes of paragarph (b)(5) of this section to be
derived in the active conduct of a trade or business if such royalties
are derived by the controlled foreign corporation (``licensor'') from
licensing--
(i) Property which the licensor has developed, created, or produced,
or has acquired and added substantial value to, but only so long as the
licensor is regularly engaged in the development, creation, or
production of, or in the acquisition of and addition of substantial
value to, property of such kind, or
(ii) Property which is licensed as a result of the performance of
marketing functions by such licensor and the licensor, through its own
staff of employees located in a foreign country, maintains and operates
an organization in such country which is regularly engaged in the
business of marketing, or of marketing and servicing, the licensed
property and which is substantial in relation to the amount of royalties
derived from the licensing of such property.
(2) Special rules--(i) Adding substantial value. For purposes of
paragraph (d)(1)(i), the performance of marketing functions will not be
considered to add substantial value to property.
(ii) Substantiality of foreign organization. An organization in a
foreign country will be considered substantial in relation to the amount
of royalties, for purposes of paragraph (d)(1)(ii) of this section, if
the active licensing expenses, as defined in paragraph (d)(2)(iii) of
this section, equal or exceed 25 percent of the adjusted licensing
profit, as defined in paragraph (d)(2)(iv) of this section.
(iii) Active licensing expenses. The term ``active licensing
expenses'' means the deductions incurred by an organization of the
licensor which are properly allocable to royalty income and which would
be allowable under section 162 to the licensor (were the licensor a
domestic corporation) other than--
(A) Deductions for compensation for personal services rendered by
shareholders of, or related persons with respect to, the licensor,
(B) Deductions for royalties paid or incurred,
(C) Deductions which, although generally allowable under section
162, would be specifically allowable to the licensor (were the
controlled foreign corporation a domestic corporation) under sections
other than section 162 (such as section 167), and
(D) Deductions for payments made to independent contractors with
respect to the licensed property.
(iv) Adjusted licensing profit. The term ``adjusted licensing
profit'' means the gross income of the licensor from royalties, reduced
by the sum of--
(A) The royalties paid or incurred by the controlled foreign
corporation with respect to such gross royalty income,
(B) The amounts which would be allowable to such licensor as
deductions under section 167 (were the licensor a domestic corporation)
with respect to such royalty income, and
(C) The amounts paid to independent contractors with respect to such
royalty income.
(3) Illustrations. The application of this paragraph (d) is
illustrated by the following examples.
[[Page 63]]
Example 1. Controlled foreign corporation A, through its own staff
of employees, owns and operates a research facility in foreign country
X. At the research facility employees of Corporation A who are full time
scientists, engineers, and technicians regularly perform experiments,
tests, and other technical activities, which ultimately result in the
issuance of patents that it sells or licenses. Under paragraph (d)(1)(i)
of this section, royalties received by Corporation A for the privilege
of using patented rights which it develops as a result of such research
activity are derived in the active conduct of a trade or business for
purposes of section 954(c)(2)(A).
Example 2. Assume that Corporation A in example 1, in addition to
receiving royalties for the use of patents which it develops, receives
royalties for the use of patents which it acquires by purchase and
licenses to others without adding any value thereto. Corporation A
generally consummates royalty agreements on such purchased patents as
the result of inquiries received by it from prospective licensees when
the fact becomes known in the business community, as a result of the
filing of a patent, advertisements in trade journals, announcements, and
contacts by employees of Corporation A, that Corporation A has acquired
rights under a patent and is interested in licensing its rights.
Corporation A does not, however, maintain and operate an organization in
a foreign country which is regularly engaged in the business of
marketing the purchased patents. The royalties received by Corporation A
for the use of the purchased patents are not derived in the active
conduct of a trade or business for purposes of section 954(c)(2)(A).
Example 3. Controlled foreign corporation B receives royalties for
the use of patents which it acquires by purchase. The primary business
of Corporation B, operated on a regular basis, consists of licensing
patents which it has purchased ``raw'' from inventors and, through the
efforts of a substantial staff of employees consisting of scientists,
engineers, and technicians, made susceptible to commercial application.
For example, Corporation B, after purchasing patent rights covering a
chemical process, designs specialized production equipment required for
the commercial adaptation of the process and, by so doing, substantially
increases the value of the patent. Under paragraph (d)(1)(i) of this
section, royalties received by Corporation B from the use of such patent
are derived in the active conduct of a trade or business for purposes of
section 954(c)(2)(A).
Example 4. Controlled foreign corporation D finances independent
persons in the development of patented items in return for an ownership
interest in such items from which it derives a percentage of royalty
income, if any, subsequently derived from the use by others of the
protected right. Corporation D also attempts to increase its royalty
income from such patents by contacting prospective licensees and
rendering to licensees advice which is intended to promote the use of
the patented property. Corporation D does not, however, maintain and
operate an organization in a foreign country which is regularly engaged
in the business of marketing the patents. Royalties received by
Corporation D for the use of such patents are not derived in the active
conduct of a trade or business for purposes of section 954(c)(2)(A).
(e) Certain property transactions--(1) In general--(i) Inclusion in
FPHC income. Foreign personal holding company income includes the excess
of gains over losses from the sale or exchange of--
(A) Property which gives rise to dividends, interest, rents,
royalties or annuities as described in paragraph (e)(2) of this section,
and
(B) Property which does not give rise to income, as described in
paragraph (e)(3) of this section.
If losses from the sale or exchange of such property exceed gains, the
net loss is not within the definition of foreign personal holding
company income under this paragraph (e), and may not be allocated to, or
otherwise reduce, other foreign personal holding company income under
section 954(b)(5) and Sec. 1.954-1T(c). Gain or loss from a transaction
that is treated as capital gain or loss under section 988(a)(1)(B) is
not foreign currency gain or loss as defined in paragraph (g), but is
gain or loss from the sale or exchange of property which is included in
the computation of foreign personal holding company income under this
paragraph (e)(1). Paragraphs (e) (4) and (5) of this section provide
specific rules for determining whether gain or loss from dispositions of
debt instruments and dispositions of options or similar property must be
included in the computation of foreign personal holding company income
under this paragraph (e)(1). A loss that is deferred or that otherwise
may not be taken into account under any provision of the Code may not be
taken into account for purposes of determining foreign personal holding
company income under any provision of this paragraph (e).
(ii) Dual character property. Property may only in part constitute
property
[[Page 64]]
that gives rise to certain income as described in paragraph (e)(2) of
this section or property that does not give rise to any income as
described in paragraph (e)(3) of this section. In such cases, the
property must be treated as two separate properties for purposes of this
paragraph (e). Accordingly, the sale or exchange of such dual character
property will give rise to gain or loss that in part must be included in
the computation of foreign personal holding company income under this
paragraph (e), and in part is excluded from such computation. Gain or
loss from the disposition of dual character property must be bifurcated
for purposes of this paragraph (e)(1)(i) pursuant to the method that
most reasonably reflects the relative uses of the property. Reasonable
methods may include comparisons in terms of gross income generated or
the physical division of the property. In the case of real property, the
physical division of the property will in most cases be the most
reasonable method available. For example, if a controlled foreign
corporation owns an office building, uses 60 percent of the building in
its business, and rents out the other 40 percent, then 40 percent of the
gain recognized on the disposition of the property would reasonably be
treated as gain which is included in the computation of foreign personal
holding company income under this paragraph (e)(1). This paragraph
(e)(1)(ii) addresses the contemporaneous use of property for dual
purposes; for rules concerning changes in the use of property affecting
its classification for purposes of this paragraph (e), see paragraph
(a)(3) of this section.
(2) Property that gives rise to certain income--(i) In general.
Property the sale or exchange of which gives rise to foreign personal
holding company income under this paragraph (e)(2) includes property
that gives rise to dividends, interest, rents, royalties and annuities
described in paragraph (b) of this section, except for rents and
royalties derived from unrelated persons in the active conduct of a
trade or business under paragraph (b)(5) of this section. The property
described by this paragraph (e)(2) includes property which gives rise to
export financing interest described in paragraph (b)(2) of this section
and property which gives rise to income from related persons described
in paragraphs (b)(3) and (b)(4) of this section.
(ii) Exception. Property described in this paragraph (e)(2) does not
include--
(A) Dealer property (as defined in paragraph (a)(4)(iv) of this
section), and
(B) Inventory and similar property (as defined in paragraph
(a)(4)(ii) of this section) other than securities.
(3) Property that does not give rise to income. The term ``property
that does not give rise to income'' for purposes of this section
includes all rights and interests in property (whether or not a capital
asset) except--
(i) Property that gives rise to dividends, interest, rents,
royalties and annuities described in paragraph (e)(2) of this section
and property that gives rise to rents and royalties derived in the
active conduct of a trade or business under paragraph (b)(5) of this
section;
(ii) Dealer property (as defined in paragraph (a)(4)(iv) of this
section);
(iii) Inventory and similar property (as defined in paragraph
(a)(4)(ii)) other than securities;
(iv) Property (other than real property) used in the controlled
foreign corporation's trade or business that is of a character which
would be subject to the allowance for depreciation under section 167 or
168 and the regulations thereunder (including tangible property
described in Sec. 1.167(a)-2 and intangibles described in Sec. 1.167(a)-
3);
(v) Real property that does not give rise to rental or similar
income, to the extent used in the controlled foreign corporation's trade
or business; and
(vi) Intangible property as defined in section 936(h)(3)(B) and
goodwill that is not subject to the allowance for depreciation under
section 167 and the regulations thereunder to the extent used in the
controlled foreign corporation's trade or business and disposed of in
connection with the sale of a trade or business of the controlled
foreign corporation.
(4) Classification of gain or loss from the disposition of a debt
instrument or on a deferred payment sale--(i) Gain. Gain from the sale,
exchange, or retirement of a debt instrument is included in the
[[Page 65]]
computation of foreign personal holding company income under this
paragraph (e) unless--
(A) It is treated as interest income (as defined in paragraph
(a)(4)(i) of this section); or
(B) It is treated as income equivalent to interest under paragraph
(h) of this section.
(ii) Loss. Loss from the sale, exchange, or retirement of a debt
instrument is included in the computation of foreign personal holding
company income under this paragraph (e) unless--
(A) It is directly allocated to interest income (as defined in
paragraph (a)(4)(i) of this section) or income equivalent to interest
(as defined in paragraph (h) of this section) under any provision of the
Code or regulations thereunder;
(B) It is required to be apportioned in the same manner as interest
expense under section 864(e) or any other provision of the Code or
regulations thereunder; or
(C) The debt instrument was taken in consideration for the sale or
exchange of property (or the provision of services) by the controlled
foreign corporation and gain or loss from that sale or exchange (or
income from the provision of services) is not includible in foreign base
company income under this section.
(5) Classification of options and other rights to acquire or
transfer property. Subject to the exceptions provided in paragraphs
(e)(3) (ii) and (iii) of this section (relating to certain dealer
property and inventory property), rights to acquire or transfer
property, including property that gives rise to income, are classified
as property that does not give rise to income under paragraph (e)(3) of
this section. These rights include options, warrants, futures contracts,
options on a futures contract, forward contracts, and options on an
index relating to stocks, securities or interest rates.
(6) Classification of certain interests in pass through entities.
[Reserved.]
(f) Commodities transactions--(1) In general. Except as otherwise
provided in this paragraph (f), foreign personal holding company income
includes the excess of gains over losses from commodities transactions.
If losses from commodities transactions exceed gains, the net loss is
not within the definition of foreign personal holding company income
under this paragraph (f), and may not be allocated to, or otherwise
reduce, foreign personal holding company income under section 954(b)(5)
and Sec. 1.954-1T(a)(4). The terms ``commodity'' and ``commodities
transactions'' are defined in paragraph (f)(2) of this section. Gains
and losses from qualified active sales and qualified hedging
transactions are excluded from the computation of foreign personal
holding company income under this paragraph (f). The term ``qualified
active sales'' is defined in paragraph (f)(3). The term ``qualified
hedging transaction'' is defined in paragraph (f)(4) of this section. An
election is provided under paragraph (g)(5) of this section to include
all gains and losses from section 1256 foreign currency transactions,
which would otherwise be commodities transactions, in the computation of
foreign personal holding company income under paragraph (g) instead of
this paragraph (f). A loss that is deferred or that otherwise may not be
taken into account under any provision of the Code may not be taken into
account for purposes of determining foreign personal holding company
income under any provision of this paragraph (f).
(2) Definitions--(i) Commodity. For purposes of this section, the
term ``commodity'' means:
(A) Tangible personal property of a kind which is actively traded or
with respect to which contractual interests are actively traded, and
(B) Nonfunctional currency (as defined under section 988 and the
regulations thereunder).
(ii) Commodities transaction. A commodities transaction means the
purchase or sale of a commodity for immediate (spot) delivery, or
deferred (forward) delivery, or the right to purchase, sell, receive, or
transfer a commodity, or any other right or obligation with respect to a
commodity, accomplished through a cash or off-exchange market, an
interbank market, an organized exchange or board of trade, an over-the-
counter market, or in a transaction effected between private parties
outside of any market.
[[Page 66]]
Commodities transactions include, but are not limited to:
(A) A futures or forward contract in a commodity,
(B) A leverage contract in a commodity purchased from leverage
transaction merchants,
(C) An exchange of futures for physical transaction,
(D) A transaction in which the income or loss to the parties is
measured by reference to the price of a commodity, a pool of
commodities, or an index of commodities,
(E) The purchase or sale of an option or other right to acquire or
transfer a commodity, a futures contract in a commodity, or an index of
commodities, and
(F) The delivery of one commodity in exchange for the delivery of
another commodity, the same commodity at another time, cash, or
nonfunctional currency.
(3) Definition of the term ``qualified active sales''--(i) In
general. The term ``qualified active sales'' means the sale of
commodities in the active conduct of a commodity business as a producer,
processor, merchant, or handler of commodities if substantially all of
the controlled foreign corporation's business is as an active producer,
processor, merchant, or handler of commodities of like kind. The sale of
commodities held by a controlled foreign corporation other than in its
capacity as an active producer, processor, merchant or handler of
commodities of like kind is not a qualified active sale.
(ii) Sale of commodities. The term ``sale of commodities'' means any
transaction in which the controlled foreign corporation intends to
deliver to a purchaser a commodity held by the controlled foreign
corporation in physical form.
(iii) Active conduct of a commodities business. For purposes of this
paragraph, a controlled foreign corporation is engaged in the active
conduct of a commodities business as a producer, processor, merchant, or
handler of commodities only if--
(A) It holds commodities as inventory or similar property (as
defined in paragraph (a)(4)(ii)); and
(B) It incurs substantial expenses in the ordinary course of a
commodities business from engaging in one of the following activities
directly, and not through an independent contractor:
(1) Substantial activities in the production of commodities,
including planting, tending or harvesting crops, raising or slaughtering
livestock, or extracting minerals.
(2) Substantial processing activities prior to the sale of
commodities including concentrating, refining, mixing, crushing,
aerating, or milling; or
(3) Significant activities relating to the physical movement,
handling and storage of commodities including preparation of contracts
and invoices; arranging freight, insurance and credit; arranging for
receipt, transfer or negotiation of shipping documents; arranging
storage or warehousing, and dealing with quality claims; owning and
operating facilities for storage or warehousing or owning or chartering
vessels or vehicles for the transportation of commodities.
For purposes of this paragraph (f), a corporation is not engaged in a
commodities business as a producer, processor, merchant, or handler of
commodities if its business is primarily financial. In general, the
business of a controlled foreign corporation is financial if it
primarily engages in commodities transactions for investment or
speculation, or if it primarily provides products or services to
customers for investment or speculation.
(iv) Substantially all. Substantially all of the controlled foreign
corporation's business is as an active producer, processor, merchant, or
handler of commodities if the activities described in paragraph
(f)(3)(iii) give rise to 85 percent of the taxable income of the
controlled foreign corporation (computed as though the corporation were
a domestic corporation). For this purpose, gains or losses from
qualified hedging transactions, as defined in paragraph (f)(4), are
considered derived from the qualified active sales to which they relate
or are expected to relate.
(4) Definition of the term ``qualified hedging transaction.'' The
term ``qualified hedging transaction'' means a bona fide hedging
transaction that:
[[Page 67]]
(i) Is reasonably necessary to the conduct of business as a
producer, processor, merchant or handler of a commodity in the manner in
which such business is customarily and usually conducted by others;
(ii) Is entered into primarily to reduce the risk of price change
(but not the risk of currency fluctuations) with respect to commodities
sold or to be sold in qualified active sales described in paragraph
(f)(3) of this paragraph; and
(iii) Is clearly identified on the controlled foreign corporation's
records before the close of the fifth day after the day during which the
hedging transaction is entered into and at a time when there is a
reasonable risk of loss; however, if the controlled foreign corporation
does not at such time specifically and properly identify the qualified
active sales (or category of such sales) to which a hedging transaction
relates, the district director in his sole discretion may determine
which hedging transactions (if any) are related to qualified active
sales.
(g) Foreign currency gain--(1) In general. Except as provided in
paragraph (g)(2), foreign personal holding company income includes the
excess of foreign currency gains over losses (as defined in section
988(b)) attributable to any section 988 transactions. If foreign
currency losses exceed gains, the net loss is not within the definition
of foreign personal holding company income under this paragraph (g), and
may not be allocated to, or otherwise reduce, foreign personal holding
company income under section 954(b)(5) and Sec. 1.954-1T(a)(4). To the
extent the gain or loss from a transaction is treated as interest income
or expense under sections 988(a)(2) or 988(d) and the regulations
thereunder, it is not included in the computation of foreign personal
holding company income under this paragraph (g). (For other rules
concerning income described in more than one category of foreign
personal holding company income, see Sec. 1.954-2(a)(2).) A loss that is
deferred or that otherwise may not be taken into account under any
provision of the Code may not be taken into account for purposes of
determining foreign personal holding company income under any provision
of this paragraph (g).
(2) Exceptions--(i) Qualified business units using the dollar
approximate separate transactions method. Any DASTM gain or loss
computed under Sec. 1.985-3(d) must be allocated under the rules of
Sec. 1.985-3 (e)(2)(iv) or (e)(3).
(ii) Tracing to exclude foreign currency gain or loss from qualified
business and hedging transactions. A foreign currency gain or loss is
excluded from the computation of foreign personal holding company income
under this paragraph (g) if it is clearly identified on the records of
the controlled foreign corporation as being derived from a qualified
business transaction or a qualified hedging transaction. The term
``qualified business transaction'' is defined in paragraph (g)(3) of
this section. The term ``qualified hedging transaction'' is defined
paragraph (g)(4) of this section. However, currency gain or loss of a
qualified business unit included in the computation of currency gain or
loss under subdivision (i) of this paragraph (g)(2) may not be excluded
from foreign personal holding company income under the tracing rule of
this paragraph (g)(2)(ii). Furthermore, the tracing rule of this
paragraph (g)(2)(ii) will not apply if a controlled foreign corporation
makes the election provided by paragraph (g)(2)(iii) of this section.
(iii) Election out of tracing. A controlled foreign corporation may
elect a method of accounting under which all foreign currency gains or
losses attributable to section 988 transactions are included in foreign
personal holding company income. The scope and requirements for this
election are provided in paragraph (g)(5) of this section. This election
does not apply to foreign currency gains or losses of a qualified
business unit included in the computation of gain or loss under
paragraph (g)(2)(i) of this section.
(3) Definition of the term ``qualified business transaction''--(i)
In general. The term ``qualified business transaction'' means a
transaction (other than a ``qualified hedging transaction'' as described
in paragraph (g)(4) of this section) that:
(A) Does not have investment or speculation as a significant
purpose;
[[Page 68]]
(B) Is not attributable to property or an activity of the kind that
gives rise to subpart F income (other than foreign currency gain under
this paragraph (g)), or could reasonably be expected to give rise to
subpart F income (including upon disposition); for example, the
transaction may not be attributable to stock or debt of another
corporation (including related corporations organized and operating in
the same country), or property likely to give rise to foreign base
company sales or services income; and
(C) Is attributable to business transactions described in
subdivision (ii) of this paragraph (g)(3).
A qualified business transaction includes the disposition of a debt
instrument that constitutes inventory property under paragraph
(a)(4)(ii) or dealer property under paragraph (a)(4)(iv) of this
section. The provisions of this paragraph (g)(3) do not apply to the
foreign currency gain or loss of a qualified business unit (as
determined under Sec. 1.985-3T(d)(2)) included in the computation of
gain or loss under paragraph (g)(2)(i) of this section. The provisions
of this paragraph (g)(3) do, however, apply to other currency
transactions of a qualified business unit that elects (or is deemed to
elect) the U.S. dollar as its functional currency under section
985(b)(3) and Sec. 1.985-2T. Qualified business transactions and the
amount of foreign currency gain or loss derived therefrom must be
clearly identified on its records by the controlled foreign corporation.
If the controlled foreign corporation is unable to specifically identify
the qualified business transactions and the foreign currency gain or
loss derived therefrom, the district director in his sole discretion may
determine which transactions of the corporation giving rise to the
foreign currency gains or losses are attributable to qualified business
transactions.
(ii) Specific business transactions. A transaction of a controlled
foreign corporation must meet the requirements of any of subdivisions
(A) through (F) of this paragraph (g)(3)(ii) to be a qualified business
transaction under this paragraph (g)(3).
(A) Acquisition of debt instruments. If the transaction is the
acquisition of a debt instrument described in section 988(c)(1)(B)(i)
and the regulations thereunder, the debt must be derived from--
(1) The sale of inventory and similar property to customers by the
controlled foreign corporation in the ordinary course of regular
business operations, or
(2) The rendition of services by the corporation in the ordinary
course of regular business operations.
For purposes of this paragraph (g)(3)(ii)(A), a debt instrument will not
be considered derived in the ordinary course of regular business
operations unless the instrument matures, and is reasonably expected to
be satisfied, within the period for which interest need not be charged
under section 482 and the regulations thereunder.
(B) Becoming the obligor under debt instruments. If the transaction
is becoming the obligor under a debt instrument described in section
988(c)(1)(B)(i) and the regulations thereunder, the debt must be
incurred for:
(1) Payment of expenses that are includible by the controlled
foreign corporation in the cost of goods sold under Sec. 1.61-3 for
property held primarily for sale to customers in the ordinary course of
regular business operations, are inventoriable costs under section 471
and the regulations thereunder, or are allocable or apportionable under
the rules of Sec. 1.861-8 to gross income derived from inventory and
similar property,
(2) Payment of expenses that are allocable or apportionable under
the rules of Sec. 1.861-8 to gross income derived from services provided
by the controlled foreign corporation in the ordinary course of regular
business operations,
(3) Acquisition of an asset that does not give rise to subpart F
income during the current taxable year (other than by application of
section 952(c)) and is not reasonably expected to give rise to subpart F
income in subsequent taxable years, or
(4) Acquisition of dealer property as defined in paragraph
(a)(4)(iv) of this section.
The identification requirements of subdivision (i) of this paragraph
(g)(3) will not be met with respect to a borrowing
[[Page 69]]
if the controlled foreign corporation fails to clearly identify the debt
and the expenses (or categories of expenses) to which it relates before
the close of the fifth day after the day on which the expenses are
incurred.
(C) Accrual of any item of gross income. If the transaction is the
accrual (or otherwise taking into account) of any item of gross income
or receipts as described in section 988(c)(1)(B)(ii) and the regulations
thereunder, the item of gross income or receipts must be derived from:
(1) The sale of inventory and similar property in the ordinary
course of regular business operations, or
(2) The provision of services by the controlled foreign corporation
to customers in the ordinary course of regular business operations.
(D) Accrual of any item of expense. If the transaction is the
accrual (or otherwise taking into account) of any item of expense as
described in section 988(c)(1)(B)(ii) and the regulations thereunder,
the item of expense must be:
(1) An expense that is includible by the controlled foreign
corporation in the cost of goods sold under Sec. 1.61-3 for property
held primarily for sale to customers in the ordinary course of regular
business operations, is an inventoriable cost under section 471 and the
regulations thereunder, or is allocable or apportionable under the rules
of Sec. 1.861-8 to gross income derived from inventory and similar
property, or
(2) An expense that is allocable or apportionable under the rules of
Sec. 1.861-8 to gross income derived from services provided by the
controlled foreign corporation in the ordinary course of regular
business operations.
(E) Entering into forward contracts, futures contracts, options and
similar instruments. If the transaction is entering into any forward
contract, futures contract, option or similar financial instrument and
if such contract or instrument is not marked to market at the close of
the taxable year under section 1256, as described in section
988(c)(1)(B)(iii) and the regulations thereunder, then the contract or
instrument must be property held as dealer property as defined in
paragraph (a)(4)(ii) of this section.
(F) Disposition of nonfunctional currency. If the transaction is the
disposition of nonfunctional currency, as described in section
988(c)(1)(C) and the regulations thereunder, then the transaction must
be for a purpose described in paragraph (g)(3)(ii)(B), for the payment
of taxes not attributable to subpart F income, or must be the
disposition of property held as dealer property as defined in paragraph
(a)(4)(iv) of this section.
(G) Transactions in business assets. The acquisition or disposition
of an asset that is used or held for use in the active conduct of a
trade or business.
(4) Definition of the term ``qualified hedging transaction''--(i) In
general. The term ``qualified hedging transaction'' means a bona fide
hedging transaction meeting all the requirements of subdivisions (A)
through (D) of this paragraph (g)(4)(i):
(A) The transaction must be reasonably necessary to the conduct of
regular business operations in the manner in which such business
operations are customarily and usually conducted by others.
(B) The transaction must be entered into primarily to reduce the
risk of currency fluctuations with respect to property or services sold
or to be sold or expenses incurred or to be incurred in transactions
that are qualified business transactions under paragraph (g)(3) of this
section.
(C) The hedging transaction and the property or expense (or category
of property or expense) to which it relates must be clearly identified
on the records of the controlled foreign corporation before the close of
the fifth day after the day during which the hedging transaction is
entered into and at a time during which there is a reasonable risk of
currency loss.
(D) The amount of foreign currency gain or loss that is attributable
to a specific hedging transaction must be clearly identifiable on the
records of the controlled foreign corporation or its controlling
shareholder (as defined in Sec. 1.964-1(c)(5)).
[[Page 70]]
The provisions of this paragraph (g)(4) do not apply to transactions of
a qualified business unit included in the computation of gain or loss
under paragraph (g)(2)(i). The provisions of this paragraph (g)(4) do
apply, however, to other currency transactions of a qualified business
unit that elects (or is deemed to elect) the U.S. dollar as its
functional currency under section 985(b)(3) and Sec. 1.985-3T. If the
controlled foreign corporation does not specifically identify the
qualified business transactions (or category of qualified business
transactions) to which a hedging transaction relates or is unable to
specifically identify the amount of foreign currency gain or loss
derived from the hedging transactions, the district director in his sole
discretion may make the identifications required of the controlled
foreign corporation and determine which hedging transactions (if any)
are related to qualified business transactions, and the amount of
foreign currency gain or loss attributable to the qualified hedging
transactions.
(ii) Change in purpose of hedging transaction. If a hedging
transaction is entered into for one purpose, and the purpose for that
transaction subsequently changes, the transaction may be treated as two
separate hedging transactions for purposes of this paragraph (g)(4). In
such a case, the portion of the transaction that relates to a qualified
business transaction is considered a qualified hedging transaction if it
separately meets all the other requirements of this paragraph (g)(4) for
treatment as a qualified hedging transaction. For purposes of paragraph
(g)(4)(i)(C), the foreign corporation must identify on its records the
portion of the transaction that relates to a qualified business
transaction by the close of the fifth day after the day on which the
hedge becomes so related (i.e., either the day on which the hedge is
first entered into or on the day on which it first relates to a
qualified business transaction due to a change in its purpose). The
foreign corporation must identify on its records the portion of the
transaction that does not relate to a qualified business transaction by
the close of the fifth day after the day on which the purpose for the
hedging transaction changes.
(5) Election out of tracing--(i) In general. A controlled foreign
corporation may elect to account for currency gains and losses under
section 988 and gains and losses from section 1256 currency contracts by
including in the computation of foreign personal holding company income
under this paragraph (g) all foreign currency gains or losses
attributable to section 988 transactions, and all gains or losses from
section 1256 foreign currency contracts. Separate elections for section
1256 foreign currency contracts and section 988 transactions are not
permitted. If a controlled foreign corporation makes the election
described in this paragraph (g)(5)(i), the election is effective for all
related persons as defined in section 954(d)(3) and the regulations
thereunder.
(ii) Exception. The election provided by this paragraph (g)(5) does
not apply to foreign currency gain or loss of a qualified business unit
determined under Sec. 1.985-3T(d)(2). It does, however, apply to other
foreign currency gains or losses of a qualified business unit that
elects (or is deemed to elect) the U.S. dollar as its functional
currency.
(iii) Procedure--(A) In general. The election provided by this
paragraph (g)(5) shall be made in the manner prescribed in this
paragraph and in subsequent administrative pronouncements.
(B) Time and manner. The controlled foreign corporation may make the
election by filing a statement with its original or amended information
return for the taxable year for which the election is made. The
controlling United States shareholders, as defined in Sec. 1.964-
1(c)(5), may make the election on behalf of the controlled foreign
corporation and related corporations by filing a statement to such
effect with their original or amended income tax returns for the taxable
year during which the taxable year of the controlled foreign corporation
for which the election is made ends. The election is effective for the
taxable year of the controlled foreign corporation for which the
election is made, for the taxable years of all related controlled
foreign corporations ending within such taxable year, and for all
subsequent
[[Page 71]]
years of such corporations. The statement shall include the following
information:
(1) The name, address, taxpayer identification number, and taxable
year of each United States shareholder;
(2) The name, address, and taxable year of each controlled foreign
corporation for which the election is effective; and
(3) Any additional information to be required by the Secretary by
administrative pronouncement.
Each United States shareholder or controlled foreign corporation filing
the election must provide copies of the election to all controlled
foreign corporations for which the election is effective, and all United
States shareholders of such corporations. However, failure to provide
such copies will not void (or cause to be voidable) an election under
this paragraph (g)(5).
(C) Termination. The election provided by this paragraph (g)(5) may
be terminated only with the consent of the Commissioner: Attn.: CC:INTL.
(h) Income equivalent to interest--(1) In general. Foreign personal
holding company income includes income that is equivalent to interest.
Income equivalent to interest includes, but is not limited to, income
derived from the following categories of transactions:
(i) An investment, or series of integrated transactions which
include an investment, in which the payments, net payments, cash flows,
or return predominantly reflect the time value of money, and
(ii) Transactions in which the payments or a predominant portion
thereof are in substance for the use or forebearance of money, but are
not generally treated as interest.
However, amounts treated as interest under section 954(c)(1)(A) and
paragraph (b) of this section are not income equivalent to interest
under this paragraph (h). Income from the sale of property will not be
treated as income equivalent to interest for purposes of this paragraph
(h), subject to the rule of paragraph (h)(4) of this section, unless the
sale is part of an integrated transaction that gives rise to interest or
income equivalent to interest. See sections 482, 483 and 1274 for the
extent to which such income may be characterized as interest income
subject to paragraph (b) of this section. Income equivalent to interest
for purposes of this paragraph (h) includes all income attributable to a
transfer of securities subject to section 1058. Income equivalent to
interest also includes a portion of certain deferred payments received
for the purpose of services, in accordance with the provisions of
paragraph (h)(5) of this section. Income equivalent to interest does not
include income attributable to notional principal contracts such as
interest rate swaps, currency swaps, interest rate floor agreements, or
similar contracts except to the extent that such contracts are part of
an integrated transaction that gives rise to income equivalent to
interest. Income derived from notional contracts by a person acting in
its capacity as a regular dealer in such contracts will be presumed not
to be integrated with an investment.
(2) Illustrations. The following examples illustrate the application
of this paragraph (h):
Example 1. CFC, a controlled foreign corporation, promises that A,
an unrelated person, may borrow up to $500 in principal for one year
beginning at any time during the next three months at an interest rate
of 10 percent. In exchange, A pays CFC a commitment fee of $2.00.
Pursuant to this loan commitment, CFC lends $80 to A. As a result, the
entire $2.00 fee is included in the computation of foreign personal
holding company income under this paragraph (h)(1)(ii).
Example 2. (i) At the beginning of its current taxable year, CFC, a
controlled foreign corporation, purchases at face value a one-year debt
instrument issued by A having a $100 principal amount and bearing a
floating rate of interest set at the London Interbank Offered Rate
(``LIBOR'') plus one percentage point. Contemporaneously, CFC borrows
$100 from B for one year at a fixed interest rate of 10 percent, using
the debt instrument as security.
(ii) During its current taxable year, CFC accrues $11 of interest
from A on the bond. That interest is foreign personal holding company
income under section 954(c)(1) and Sec. 1.954-2T(b), and thus is not
income equivalent to interest. During its current taxable year, CFC
incurs $10 of interest expense with respect to the borrowing from B.
That expense is allocated and apportioned to, and reduces, foreign base
company income or insurance income to the extent provided in sections
954(b)(5), 863(e), and 864(e) and the regulations thereunder.
[[Page 72]]
Example 3. (i) At the beginning of its 1988 taxable year, CFC, a
controlled foreign corporation, purchases at face value a one-year debt
instrument issued by A having a $100 principal amount and bearing a
floating rate of interest set at the London Interbank Offered Rate
(``LIBOR'') plus one percentage point payable on the last day of CFC's
current taxable year. CFC subsequently determines that it would prefer
receiving interest at a fixed rate, and, on January 1, 1989, enters into
an agreement with B, an unrelated person, whereby B promises to pay CFC
on the last day of CFC's 1989 taxable year an amount equal to 10 percent
on a notional principal amount of $100. In exchange, CFC promises to pay
B on the last day of CFC's 1989 taxable year an amount equal to LIBOR
plus one percentage point on the notional principal amount.
(ii) CFC receives a total of $10 from B, and pays $9 to B. CFC also
receives $9 from A. The $9 paid to B is directly allocated to, or is
otherwise an adjustment to, the $10 received from B. The transactions
are considered an intergrated transaction giving rise to $9 of interest
income (paid by A) and, under paragraph (h)(1)(i), $1 of income
equivalent to interest (paid by B).
Example 4. The facts are the same as in Example 3, except that CFC
does not hold any debt obligations. Since the transaction with B is not
integrated with an investment giving rise to interest or income
equivalent to interest, the net $1 of income realized by CFC does not
constitute income equivalent to interest.
Example 5. (i) CFC, a controlled foreign corporation, enters into an
agreement with A whereby CFC purchases commodity X from A at a price of
$100, and A contemporaneously repurchases commodity X from CFC for
payment and delivery in 3 months at a price of $104 set by the forward
market.
(ii) The transaction is in substance a loan from CFC to A secured by
commodity X. Thus, CFC accrues $4 of gross income which is included in
foreign personal holding company income as interest under section
954(c)(1)(A) and paragraph (b) of this section.
Example 6. (i) CFC purchases commodity Y on the spot market for $100
and contemporaneously, sells commodity Y forward for delivery and
payment in 3 months at a price of $104 set by the forward market.
(ii) The $100 paid on the spot purchase of commodity Y offsets any
market risk on the forward sale so that the $4 of income to be derived
predominantly reflects time value of money. Thus, under paragraph
(h)(1)(i), the spot purchase of commodity Y and the offsetting forward
sale will be treated as an integrated transaction giving rise to $4 of
income equivalent to interest.
(3) Income equivalent to interest from factoring--(i) General rule.
Income equivalent to interest includes factoring income. Except as
provided in paragraph (h)(3)(ii) of this section, the term ``factoring
income'' includes any income (including any discount income or service
fee, but excluding any stated interest) derived from the acquisition and
collection or disposition of a factored receivable. The rules of this
paragraph (h)(3) apply only with respect to the tax treatment of
factoring income derived from the acquisition and collection or
disposition of a factored receivable and shall not affect the
characterization of an expense or loss of either the person whose goods
or services gave rise to a factored receivable or the obligor under a
receivable. The amount of income equivalent to interest realized with
respect to a factored receivable is the difference (if a positive
number) between the amount paid for the receivable by the foreign
corporation and the amount that it collects on the receivable (or
realizes upon its sale of the receivable).
(ii) Exceptions. Factoring income shall not include--
(A) Income treated as interest under section 864(d)(1) or (6) and
the regulations thereunder (relating to income derived from trade or
service receivables of related persons), even if such income is not
treated as described in section 864(d)(1) by reason of the same-country
exception of section 864(d)(7);
(B) Income derived from a factored receivable if payment for the
acquisition of the receivable is made on or after the date on which
stated interest begins to accrue, but only if the rate of stated
interest equals or exceeds 120 percent of the Federal short term rate
(as defined under section 1274) (or the equivalent rate for a currency
other than the dollar) as of the date on which the receivable is
acquired by the foreign corporation; or
(C) Income derived from a factored receivable if payment for the
acquisition of the receivable by the foreign corporation is made only on
or after the anticipated date of payment of all principal by the obligor
(or the anticipated weighted average date of payment of a pool of
purchased receivables).
(iii) Factored receivable. For purposes of this paragraph (h)(3),
the term
[[Page 73]]
``factored receivable'' includes any account receivable or other
evidence of indebtedness, whether or not issued at a discount and
whether or not bearing stated interest, arising out of the disposition
of property or the performance of services by any person, if such
account receivable or evidence of indebtedness is acquired by a person
other than the person who disposed of the property or provided the
services that gave rise to the account receivable or evidence of
indebtedness. For purposes of this paragraph (h)(3), it is immaterial
whether the person providing the property or services agrees to transfer
the receivable at the time of sale (as by accepting a third-party charge
or credit card) or at a later time.
(iv) Illustrations. The following examples illustrate the
application of this paragraph (h)(3).
Example 1. DP, a domestic corporation, owns all of the outstanding
stock of FS, a controlled foreign corporation. FS acquires accounts
receivable arising from the sale of property by unrelated corporation X.
The receivables have a face amount of $100, and after 30 days bear
stated interest equal to at least 120 percent of the applicable short
term Federal rate (determined as of the date the receivable is
acquired). FS purchases the receivables from X for $95 on Day 1 and
collects $100 from the obligor under the receivable on Day 40. Income
(other than stated interest) derived by FS from the factored receivables
is factoring income within the meaning or paragraph (h)(3)(i) of this
section and, therefore, is income equivalent to interest.
Example 2. The facts are the same as in example 1, except that FS
does not pay X for the receivables until Day 30. Income derived by FS
from the factored receivables is not factoring income by reason of
paragraph (h)(3)(ii)(B) of this section.
Example 3. The facts are the same as in example 2, except that it is
anticipated that all principal will be paid by the obligor of the
receivables by Day 30. Income derived by FS from this ``maturity
factoring'' of the receivables is not factoring income by reason of
paragraph (h)(3)(ii)(C) of this section, and therefore does not give
rise to income equivalent to interest.
Example 4. The facts are the same as in example 1, except that,
rather than collecting $100 from the obligor under the factored
receivable on Day 40, FS sells the receivable to controlled foreign
corporation Y on Day 15 for $97. Both the income derived by FS on the
factored receivable and the income derived by Y (other than stated
interest) on the receivable are factoring income within the meaning of
paragraph (h)(3)(i) of this section, and therefore, constitute income
equivalent to interest.
Example 5. The facts are the same as in example 4, except that FS
sells the factored receivable to Y for $99 on Day 45, at which time
interest is accruing on the unpaid balance of $100. FS has $4 of net
factoring income that is income equivalent to interest. Because interest
was accruing at the time Y acquired the receivable at a rate equal to at
least 120 percent of the applicable short term Federal rate, income
derived by Y from the factored receivable is not factoring income by
reason of pargraph (h)(3)(ii)(B).
Example 6. DP, a domestic corporation engaged in an integrated
credit card business, owns all of the outstanding stock of FS, a
controlled foreign corporation. On Day 1 individual A uses a credit card
issued by DP to purchase shoes priced at $100 from X, a foreign
corporation unrelated to DP, FS, or A. By prearrangement with DP, on Day
7, X transfers the receivable arising from A's purchase to FS in
exchange for $95. FS collects $100 from A on Day 45. Income derived by
FS on the factored receivable is factoring income within the meaning of
paragraph (h)(3)(i) of this section and, therefore, is income equivalent
to interest.
(4) Determination of sales income. Income equivalent to interest for
purposes of this paragraph (h) does not include income from the sale of
property unless the sale is part of an integrated transaction that gives
rise to interest or income equivalent to interest. Income derived by a
controlled foreign corporation will be treated as arising from the sale
of property only if the corporation in substance carries out sales
activities. Accordingly, an arrangement that is designed to lend the
form of a sales transaction to a transaction that in substance
constitutes and advance of funds will be disregarded. For example, if a
controlled foreign corporation acquires property on 30-day payment terms
from one person and sells that property to another person on 90 day
payment terms and at prearranged prices and terms such that the foreign
corporation bears no substantial economic risk with respect to the
purchase and sale other than the risk of non-payment, the foreign
corporation has not in substance derived income from the sale of
property.
[[Page 74]]
(5) Receivables arising from performance of services. If payment for
services performed by a controlled foreign corporation is not made until
more than 120 days after the date on which such services are performed,
then the income derived by the foreign corporation constitutes income
equivalent to interest to the extent that interest income would be
imputed under the principles of section 483 or the original issue
discount provisions (section 1271 et seq.), if--
(A) Such provisions applied to contracts for the performance of
services,
(B) The time period referred to in sections 483(c)(1) and
1274(c)(1)(B) were 120 days rather than six months, and
(C) The time period referred to in section 483(c)(1)(A) were 120
days rather than one year.
[T.D. 8216, 53 FR 27498, July 21, 1988; 53 FR 29801, Aug. 8, 1988, as
amended by T.D. 8556, 59 FR 37672, July 25, 1994. Redesignated and
amended by T.D. 8618, 60 FR 46530, Sept. 7, 1995]
PART 5--TEMPORARY INCOME TAX REGULATIONS UNDER THE REVENUE ACT OF 1978--Table of Contents
Sec.
5.856-1 Extensions of the grace period for foreclosure property by a
real estate investment trust.
5.1502-45 Limitation on losses to amount at risk.
5.1561-1 Taxable years of component members of controlled group of
corporations that include December 31, 1978.
5.6411-1 Tentative refund under claim of right adjustment.
Authority: 26 U.S.C. 7805.
Sec. 5.856-1 Extensions of the grace period for foreclosure property by a real estate investment trust.
(a) In general. Under section 856(e), a real estate investment trust
(``REIT'') may elect to treat as foreclosure property certain real
property (including interests in real property), and any personal
property incident to such real property, that the REIT acquires after
December 31, 1973. In general, the REIT must acquire the property as the
result of having bid in the property at foreclosure, or having otherwise
reduced the property to ownership or possession by agreement or process
of law, after there was default (or default was imminent) on a lease of
such property (where the REIT was the lessor) or on an indebtedness owed
to the REIT which such property secured. Property that a REIT elects to
treat as foreclosure property ceases to be foreclosure property with
respect to such REIT at the end of a grace period. The grace period ends
on the date which is 2 years after the date on which the REIT acquired
the property, unless the REIT has been granted an extension or
extensions of the grace period. If the grace period is extended, the
property ceases to be foreclosure property on the day immediately
following the last day of the grace period, as extended.
(b) Rules for extensions of the grace period. In general,
Sec. 1.856-6(g) prescribes rules regarding extensions of the grace
period. However, in order to reflect the amendment of section 856(e)(3)
of the Code by section 363(c) of the Revenue Act of 1978, the following
rules also apply:
(1) In the case of extensions granted after November 6, 1978, with
respect to extension periods beginning after December 31, 1977, the
district director may grant one or more extensions of the grace period
for the property, subject to the limitation that no extension shall
extend the grace period beyond the date which is 6 years after the date
the REIT acquired the property. In any other case, an extension shall be
for a period of not more than 1 year, and not more than two extensions
can be granted with respect to the property.
(2) In the case of an extension period beginning after December 31,
1977, a request for an extension filed on or before March 28, 1980, will
be considered to be timely if the limitation on the number and length of
extensions in section 856(e)(3), as in effect before the amendment made
by section 363(c) of the Revenue Act of 1978, would have barred the
extension.
[T.D. 7767, 46 FR 11284, Feb. 6, 1981]
Sec. 5.1502-45 Limitation on losses to amount at risk.
(a) In general--(1) Scope. This section applies to a loss of any
subsidiary if the common parent's stock meets the stock ownership
requirement described in section 465(a)(1)(C).
[[Page 75]]
(2) Limitation on use of losses. Except as provided in paragraph
(a)(4) of this section, a loss from an activity of a subsidiary during a
consolidated return year is includible in the computation of
consolidated taxable income (or consolidated net operating loss) and
consolidated capital gain net income (or consolidated net capital loss)
only to the extent the loss does not exceed the amount that the parent
is at risk in the activity at the close of that subsidiary's taxable
year. In addition, the sum of a subsidiary's losses from all its
activities is includible only to the extent that the parent is at risk
in the subsidiary at the close of that year. Any excess may not be taken
into account for the consolidated return year but will be treated as a
deduction allocable to that activity of the subsidiary in the first
succeeding taxable year.
(3) Amount parent is at risk in subsidiary's activity. The amount
the parent is at risk in an activity of a subsidiary is the lesser of
(i) the amount the parent is at risk in the subsidiary or (ii) the
amount the subsidiary is at risk in the activity. These amounts are
determined under paragraph (b) of this section and the principles of
section 465. See section 465 and the regulations thereunder and the
examples in paragraph (e) of this section.
(4) Excluded activities. The limitation on the use of losses in
paragraph (a)(2) of this section does not apply to a loss attributable
to an activity described in section 465(c)(3)(D).
(5) Substance over form. Any transaction or arrangement between
members (or between a member and a person that is not a member) which
does not cause the parent to be economically at risk in an activity of a
subsidiary will be treated in accordance with the substance of the
transaction or arrangement notwithstanding any other provision of this
section.
(b) Rules for determining amount at risk--(1) Excluded amounts. The
amount a parent is at risk in an activity of a subsidiary at the close
of the subsidiary's taxable year does not include any amount which would
not be taken into account under section 465 were the subsidiary not a
separate corporation. Thus, for example, if the amount a parent is at
risk in the activity of a subsidiary is attributable to nonrecourse
financing, the amount at risk is not more than the fair market value of
the property (other than the subsidiary's stock or debt or assets)
pledged as security.
(2) Guarantees. If a parent guarantees a loan by a person other than
a member to a subsidiary, the loan increases the amount the parent is at
risk in the activity of the subsidiary.
(c) Application of section 465. This section applies in a manner
consistent with the provisions of section 465. Thus, for example, the
recapture of losses provided in section 465(e) applies if the amount the
parent is at risk in the activity of a subsidiary is reduced below zero.
(d) Other consolidated return provisions unaffected. This section
limits only the extent to which losses of a subsidiary may be used in a
consolidated return year. This section does not apply for other
purposes, such as Secs. 1.1502-32 and 1.1502-19, relating to investment
in stock of a subsidiary and excess loss accounts, repectively. Thus, a
loss which reduces a subsidiary's earnings and profits in a consolidated
return year, but is disallowed as a deduction for the year by reason of
this section, may nonetheless result in a negative adjustment to the
basis of an owning member's stock in the subsidiary or create (or
increase) an excess loss account.
(e) Examples. The provisions of this section may be illustrated by
the examples in this paragraph (e). In each example, the stock ownership
requirement of section 465(a)(1)(C) is met for the stock of the parent
(P), and each affiliated group files a consolidated return on a calendar
year basis and comprises only the members described.
Example (1). In 1979, P forms S with a contribution of $200 in
exchange for all of S's stock. During the year, S borrows $400 from a
commercial lender and P guarantees $100 of the loan. S uses $500 of its
funds to acquire a motion picture film. S incurs a loss of $120 for the
year with respect to the film. At the close of 1979, the amount P is at
risk in S's activity is $300. If S has no gain or loss in 1980, and
there are no contributions from or distributions to P, at the close of
1980 P's amount at risk in S's activity will be $180.
[[Page 76]]
Example. (2). P forms S-1 with a capital contribution of $1 on
January 1, 1980. On February 1, 1980. S-1 borrows $100 with full
recourse and contributes all $101 to its newly formed subsidiary S-2. S-
2 uses the proceeds to explore for natural oil and gas resources. S-2
incurs neither gain nor loss from its explorations during the taxable
year. As of December 31, 1980, P is at risk in the exploration activity
of S-2 only to the extent of $1.
(f) Effective date. This section applies to consolidated return
years ending on or after December 31, 1979.
[T.D. 7685, 45 FR 16484, Mar. 14, 1980]
Sec. 5.1561-1 Taxable years of component members of controlled group of corporations that include December 31, 1978.
(a) In general. This section prescribes a regulation for applying
sections 301 (a) and (b) (19), and 106, of the Revenue Act of 1978 (the
Act) in the case of certain taxable years of component members of a
controlled group of corporations (as defined in section 1563 of the
Internal Revenue Code). The section applies only to taxable years that
include December 31, 1978, and only if the taxable year of at least one
component member ends in 1979.
(b) Background. Section 301(a) of the Act amends section 11 of the
Code (relating to tax imposed on corporations) to provide for taxable
income brackets that are subject to tax at rates less than the maximum
rate of 46 percent. Section 301(b)(19) of the Act amends section 1561(a)
of the Code (relating to limitations on certain multiple tax benefits in
the case of certain controlled corporations) to limit the component
members of a controlled group to an aggregate amount in each bracket
which does not exceed the maximum amount in such bracket to which a
corporation which is not a component member of a controlled group is
entitled. Section 106 of the Act amends section 21 of the Code (relating
to effect of changes in rate of tax) to provide that the amendments made
by section 301 of the Act shall be treated as a change in a rate of tax.
Since the amendments made by section 301 of the Act are effective for
taxable years beginning after December 31, 1978, under the amendment to
section 21 the effective date of the change in rate of tax is January 1,
1979.
(c) No apportionment plan in effect. If no apportionment plan (see
Sec. 1.1561-3 of the Income Tax Regulations) is in effect with respect
to December 31, 1978, the single $50,000 surtax exemption available
before January 1, 1979, and the single bracket amounts available after
December 31, 1978, shall be equally divided among the component members
of the controlled group on December 31, 1978. In the case of a
controlled group which includes component members that join in the
filing of a consolidated return and other component members that do not
join in the filing of such a return, each component member of the group
(including each component member that joins in filing the consolidated
return) shall be treated as a separate corporation for purposes of
equally apportioning the $50,000 surtax exemption in effect before
January 1, 1979, and the bracket amounts in effect after December 31,
1978. In such a case, the surtax exemption and bracket amounts of the
corporations filing the consolidated return shall be the sum of the
amount apportioned to each component member that joins in filing the
consolidated return.
(d) Apportionment plan. (1) If one or more component members of the
controlled group have a calendar taxable year and if an apportionment
plan is adopted under Sec. 1.1561-3 apportioning the entire $50,000
surtax exemption available for 1978 to such calendar-year members, then
the amount in each taxable income bracket available for fiscal-year
members is zero. If only a part of the $50,000 surtax exemption is
apportioned to calendar-year members, then a proportionate part of the
$25,000 amount in each taxable income bracket is available for the
fiscal-year members. For example, if $30,000 (\3/5\ of $50,000) is
apportioned to calendar-year members, \2/5\ of the $25,000 amount in
each bracket, or $10,000, as well as the remaining \2/5\ of the 1978
surtax exemption, is available to the fiscal-year members.
(2) The amount in each taxable income bracket available to fiscal-
year members may be apportioned among such members in any manner the
controlled group may select. For example,
[[Page 77]]
the available amount in the first bracket (subject to a 17-percent rate)
may be allocated to one member, the amount in the second bracket
(subject to a 20-percent rate) may be allocated to another member, and
so on. Moreover, the available amount in each bracket may be divided
among the members in any manner the group may select.
(3) In computing 1978 tentative taxes under section 21, the total
surtax exemption available to fiscal-year members for 1978 must be
divided among such members in the same proportion as the sum of the
available amount in each bracket is divided among them. Thus, if the sum
of the available bracket amounts is $100,000 (i.e., $25,000 in each
bracket), and if corporation X is apportioned 30 percent, or $30,000, of
this amount (regardless of which brackets corporation X may select),
then 30 percent of the surtax exemption available to the fiscal-year
members for 1978 (i.e., 30 percent of $50,000, or $15,000) must be
apportioned to corporation X.
(e) Corporations affected. The provisions of section 1561 may reduce
the surtax exemption or bracket amounts of any corporation which is a
component member of a controlled group of corporations and which is
subject to the tax imposed by section 11, or by any other provision of
subtitle A of the Code if the tax under such other provisions is
computed by reference to the tax imposed by section 11. Such other
provisions include, for example, sections 511(a)(1), 594, 802, 831, 852,
857, 882, 1201, and 1378.
(f) Example. This section may be illustrated by the following
example:
Example. Corporations X, Y, and Z are component members of a
controlled group of corporations on December 31, 1978. X has taxable
income of $10,000 for the taxable year ending December 31, 1978. Y has
taxable income of $60,000 for the taxable year ending June 30, 1979. Z
has taxable income of $90,000 for the taxable year ending September 30,
1979. The group files an apportionment plan under Sec. 1.1561-3
apportioning $10,000 (i.e., \1/5\ of $50,000) to X, the calendar-year
member. Therefore, \4/5\ of the amount in each bracket, or $20,000, is
available to Y and Z, the fiscal-year members. Under the plan, Y is
apportioned the entire amount in the first bracket and $10,000 of the
amount in the second bracket. Z is apportioned $10,000 of the amount in
the second bracket and the entire amount in the third and fourth
brackets. Therefore, Y is apportioned $30,000, or \3/8\ of the total
available amount in the four brackets, and Z is apportioned $50,000, or
\5/8\ of the total available amount. The tax liabilities of Y and Z for
their taxable years ending in 1979 are computed as follows: (Computation
of X's tax liability for 1978, using a surtax exemption of $10,000, is
not shown.)
1979 TENTATIVE TAX
Y
----------
Taxable income............................................... $60,000
==========
Tax on amount in first bracket: 17 percent of $20,000........ 3,400
Tax on amount in second bracket: 20 percent of $10,000....... 2,000
Tax on remaining income: 46 percent of $30,000............... 13,800
----------
1979 tentative tax........................................... 19,200
==========
Z
----------
Taxable income............................................... 90,000
==========
Tax on amount in second bracket: 20 percent of $10,000....... 2,000
Tax on amount in third bracket: 30 percent of $20,000........ 6,000
Tax on amount in fourth bracket: 40 percent of $20,000....... 8,000
Tax on remaining income: 46 percent of $40,000............... 18,400
----------
1979 tentative tax........................................... 34,400
==========
1978 TENTATIVE TAX
Y
------------
Taxable income............... 60,000
============
Normal tax:
20 percent of $7,500 (\3/8\ 1,500
of $20,000).
[[Page 78]]
22 percent of $52,500...... 11,550
------------
13,050
Surtax:
Taxable income......... $60,000
Surtax exemption....... 15,000 (\3/8\ of $40,000)
-----------
$45,000 x 26 percent...... 11,700
----------
1978 tentative tax........................................... 24,750
============
Z
------------
Taxable income............... 90,000
============
Normal tax:
20 percent of $12,500 (\5/ 2,500
8\ of $20,000).
22 percent of $77,500...... 17,050
------------
19,500
Surtax:
Taxable income......... $90,000
Surtax exemption....... 25,000 (\5/8\ of $40,000)
-----------
$65,000 x 26 percent..... 16,900
----------
1978 tentative tax........................................... 36,450
============
The 1978 and 1979 tentative
taxes are apportioned as
follows:
Corporation Y:
1978--184/365 of 12,477
$24,750.
1979--181/365 of 9,521
$19,200.
------------
Total tax for taxable 21,998
year.
============
Corporation Z:
1978--92/365 of $36,450.... 9,187
1979--273/365 of $34,400... 25,729
Total tax for taxable 34,916
year.
============
[T.D. 7583, 44 FR 872, Jan. 4, 1979]
Sec. 5.6411-1 Tentative refund under claim of right adjustment.
(a) Effective date. This section applies to applications for
tentative refunds filed after November 5, 1978, under section 6411(d).
(b) In general. Section 6411(d) allows taxpayers to apply for a
tentative refund of amounts treated under section 1341(b)(1) as an
overpayment of tax under a claim of right adjustment. This section
contains rules for filing an application for this tentative refund. The
computation of amounts treated as an overpayment must be made in
accordance with section 1341 and the regulations under that section.
(c) Method of applying for tentative refund--(1) In general. For a
corporation, the application is made by filing Form 1139. For taxpayers
other than corporations, the application is made by filing Form 1045.
The application must be made by filing those forms even if the taxpayer
is not applying for a tentative carryback adjustment under section
6411(a). If the taxpayer files the form to apply for the section 6411(d)
tentative refund only, it may disregard those lines on the form used to
compute the section 6411(a) carryback adjustment. If the taxpayer has a
carryback of a net operating loss, credit, or capital loss for the
taxable year (determined without the deduction described in section
1341(a)(2)) and applies for both the section 6411(a) tenative carryback
adjustment and the section 6411(d) tentative refund, an ordering rule
applies. The taxpayer must take into account any adjustments made in
applying for the tentative carryback adjustment under section 6411(a)
before determining the amount of the overpayment for which an
application under section 6411(d) is being made. The taxpayer must
attach to the form a separate
[[Page 79]]
schedule containing the information required under paragraph (d) of this
section.
(2) Applications made before February 7, 1980. Applications made
before February 7, 1980 that are made under penalties of perjury will be
considered meeting the requirements of this section if made by filing a
separate statement whether or not it is attached to Form 1139 or 1045.
This application, however, must contain the information required under
paragraph (d) of this section (other than paragraph (d)(2)).
(d) Information required--(1) In general. The application must
contain (i) the taxpayer's name, address, and identification number and
(ii) the information set forth in paragraph (d) (2) and (3) of this
section, determined in accordance with section 1341 and the regulations
under that section. For example, the decrease in tax under paragraph
(d)(3)(iii) of this section is determined under Sec. 1.1341-1(d)(4).
(2) Computation under section 1341(a)(4). The application must
contain the following information related to the computation under
section 1341(a)(4):
(i) The amount of income restored by the taxpayer to another during
the taxable year and the amount of the corresponding deduction described
in section 1341(a)(2);
(ii) The tax for the taxable year computed with the deduction
described in section 1341(a)(2); and
(iii) The tax for each prior taxable year (determined before
adjustment under section 1341) to which any net operating loss described
in section 1341(b)(4)(A) may be carried and the decrease in tax for each
of those years that results from the carryback of that loss.
(3) Computation under section 1341(a)(5). The application must
contain the following information related to the computation under
section 1341(a)(5):
(i) The tax for the taxable year without the deduction described in
section 1341(a)(2);
(ii) The tax for each prior taxable year (determined before
adjustment under section 1341) for which a decrease in tax is computed
under section 1341(a)(5)(B);
(iii) The decrease in tax for each prior taxable year computed under
section 1341(a)(5)(B), including any decrease resulting from a net
operating loss or capital loss described in section 1341(b)(4)(B); and
(iv) The amount treated as an overpayment of tax under section
1341(b)(1).
(e) Time and place for filing. The application must be filed no
earlier than the date of filing the return for the taxable year of
restoration and no later than the date 12 months from the last day of
that taxable year. The application must be filed with the Internal
Revenue Service Center (or other office) where the taxpayer filed its
return for the taxable year of restoration.
(f) Not a claim for credit or refund. An application for tentative
refund under section 6411(d) is not a claim for credit or refund. The
principles of paragraph (b)(2) of Sec. 1.6411-1 apply in determining the
effect of an application for a tentative refund. For example, the filing
of an application for tentative refund under section 6411(d) is not a
claim for credit or refund in determining whether a claim for credit or
refund was timely filed.
[T.D. 7672, 45 FR 8295, Feb. 7, 1980; 45 FR 17138, Mar. 18, 1980]
PART 5c--TEMPORARY INCOME TAX REGULATIONS UNDER THE ECONOMIC RECOVERY TAX ACT OF 1981--Table of Contents
Sec.
5c.44F-1 Leases and qualified research expenses.
5c.103-1 Leases and capital expenditures.
5c.103-2 Leases and industrial development bonds.
5c.103-3 Leases and arbitrage.
5c.168(f)(8)-1 Special rules for leases.
5c.168(f)(8)-2 Election to characterize transaction as a section
168(f)(8) lease.
5c.168(f)(8)-3 Requirements for lessor.
5c.168(f)(8)-4 Minimum investment of lessor.
5c.168(f)(8)-5 Term of lease.
5c.168(f)(8)-6 Qualified leased property.
5c.168(f)(8)-7 Reporting of income, deductions and investment tax
credit; at risk rules.
5c.168(f)(8)-8 Loss of section 168(f)(8) protection; recapture.
5c.168(f)(8)-9 Pass-through leases--transfer of only the investment tax
credit to a party other than the ultimate user of the
property. [Reserved]
[[Page 80]]
5c.168(f)(8)-10 Leases between related parties. [Reserved]
5c.168(f)(8)-11 Consolidated returns. [Reserved]
5c.442-1 Temporary regulations relating to change of annual accounting
period.
5c.1305-1 Special income averaging rules for taxpayers otherwise
required to compute tax in accordance with Sec. 5c.1256-3.
Authority: 26 U.S.C. 168(f)(8)(G) and 7805.
Source: T.D. 7791, 46 FR 51907, Oct. 23, 1981, unless otherwise
noted.
Sec. 5c.44F-1 Leases and qualified research expenses.
For purposes of section 44F(b)(2)(A)(iii), the determination of
whether any amount is paid or incurred to another person for the right
to use personal property in the conduct of qualified research shall be
made without regard to the characterization of the transaction as a
lease under section 168(f)(8). See Sec. 5c.168(f)(8)-1(b).
Sec. 5c.103-1 Leases and capital expenditures.
For purposes of section 103(b)(6)(D) and Sec. 1.103-10(b)(2)(iv)(b),
the determination of whether property is leased and whether property is
of a type that is ordinarily subject to a lease shall be made without
regard to the characterization of the transaction as a lease under
section 168(f)(8).
Sec. 5c.103-2 Leases and industrial development bonds.
For purposes of section 103(b)(2), the determination of whether an
obligation constitutes an industrial development bond shall be made
without regard to the characterization of the transaction as a lease
under section 168(f)(8).
[T.D. 7800, 46 FR 63257, Dec. 31, 1981]
Sec. 5c.103-3 Leases and arbitrage.
In the case of a sale and leaseback transaction qualifying under
section 168(f)(8), where the lessee's rental payments are substantially
equal in timing and amount to the principal and interest payments on the
lessor's note, the arbitrage provisions of section 103(c) and
Secs. 1.103-13, 1.103-14, and 1.103-15 shall apply to any obligations of
the lessee (or party related to the lessee) without regard to the
section 168(f)(8) lease transaction.
[T.D. 7800, 46 FR 63257, Dec. 31, 1981]
Sec. 5c.168(f)(8)-1 Special rules for leases.
(a) In general. Section 168(f)(8) of the Internal Revenue Code of
1954 provides special rules for characterizing certain agreements as
leases and characterizing the parties to the agreement as lessors and
lessees for Federal tax law purposes. These rules apply only with
respect to qualified leased property. If all the requirements of section
168(f)(8) and Secs. 5c.168(f)(8)-2 through 5c.168(f)(8)-11 are met, then
the agreement shall be treated as a lease, and the party characterized
as the lessor shall be treated as the owner of the property. In such
case, the lessor shall be deemed to have entered into the lease in the
course of carrying on a trade or business and shall be allowed
accelerated cost recovery system (ACRS) deductions under section 168 and
the investment tax credit under section 38 with respect to the leased
property.
(b) Exception for qualified research expenditures. For purposes of
section 44F(b)(2)(A)(iii), the determination of whether any amount is
paid or incurred to another person for the right to use personal
property in the conduct of qualified research shall be made without
regard to the characterization of the transaction as a lease under
section 168(f)(8). Thus, if a lessee would be considered the owner of
the property without regard to section 168(f)(8), any amounts paid by
the lessee under the lease shall not be considered amounts paid or
incurred for the right to use the property.
(c) Other factors disregarded. If an agreement meets the
requirements of section 168(f)(8) and Secs. 5c.168(f)(8)-2 through
5c.168(f)(8)-11, the following factors will not be taken into account in
determining whether the transaction is a lease:
(1) Whether the lessor or lessee must take the tax benefits into
account in order to determine that a profit is made from the
transaction;
(2) The fact that the lessee is the nominal owner of the property
for State or local law purposes (e.g., has legal title to the property)
and retains the burdens, benefits, and incidents of
[[Page 81]]
ownership (such as payment of taxes and maintenance charges with respect
to the property);
(3) Whether or not a person other than the lessee may be able to use
the property after the lease term;
(4) The fact that the property may (or must) be bought or sold at
the end of the lease term at a fixed or determinable price that is more
or less than its fair market value at that time;
(5) The fact that the lessee or related party has provided financing
or has guaranteed financing for the transaction (other than for the
lessor's minimum 10 percent investment); and
(6) The fact that the obligation of any person is subject to any
contingency or offset agreement. See, for example, the rent and debt
service offset in Example (2) of paragraph (e).
An agreement that meets the requirements of section 168(f)(8) and
Secs. 5c.168(f)(8)-2 through 5c.168(f)(8)-11 may be treated by the
parties as a lease for Federal Tax law purposes only. Similarly, a sale
by the lessee of the leased property to the lessor in a transaction
where the property is leased back under an agreement that meets the
requirements of section 168(f)(8) may be treated by the parties as a
sale for Federal tax law purposes only. The agreements need not comply
with State law requirements concerning transfer of title, recording,
etc.
(d) Ownership in one of the parties. Notwithstanding any other
section, if neither the lessor nor the lessee would be the owner of the
property without regard to section 168(f)(8), or, if any party with an
economic interest in the property (other than the lessor or lessee or
any subsequent transferee of their interests) claims ACRS deductions or
any investment tax credit with respect to the leased property, an
election under section 168(f)(8) with respect to such property shall be
void as of the date of the execution of the lease agreement.
(e) Examples. The application of section 168(f)(8) and
Secs. 5c.168(f)(8)-2 through 5c.168(f)(8)-11 may be illustrated by the
following examples:
Example (1). X Corp. wishes to acquire a $1 million piece of
equipment which is ``qualified leased property'' as defined in section
168(f)(8)(D). The equipment has a 10-year economic life and falls within
the 5-year ACRS class. Y Corp. is a person meeting the qualifications
set forth in section 168(f)(8)(B)(i) and Sec. 5c.168(f)(8)-3 and wishes
to be the owner of the property for Federal tax law purposes. Y
therefore purchases the equipment from the manufacturer for $1 million,
paying $200,000 in cash and borrowing $800,000 from a bank (payable over
9 years and requiring nine equal annual payments of principal and
interest of $168,000). Y then leases the equipment to X under an
agreement providing for nine annual rental payments of $168,000, and the
parties elect in accordance with the provisions of Sec. 5c.168(f)(8)-2
to have the provisions of section 168(f)(8) apply. The timing and amount
of the rental payments required to be made by X (the ``lessee-user'')
under the lease will be exactly equal to the timing and amount of the
principal and interest payments that Y (the ``lessor'') will be required
to make to the bank under its purchase money note. Under these
circumstances, Y is treated as the owner and lessor of the property for
Federal tax law purposes; it therefore is entitled to the investment tax
credit and the ACRS deductions with respect to the property. Y's basis
in the property is $1 million. Y must report the rent as income and will
be entitled to deduct the interest on the purchase money note. The
aggregate payments required to be made by X under the lease are treated
as rent in accordance with Sec. 5c.168(f)(8)-7 and are deductible as
such.
Example (2). The facts are the same as in example (1) except that X
purchases the equipment for $1 million and wishes to transfer ownership
of the property for Federal tax law purposes to Y under a sale and
leaseback arrangement. Accordingly, X sells the property to Y for
$200,000 in cash (which represents the agreed upon compensation for the
tax benefits to be enjoyed by Y as lessor) plus a 9-year, $800,000 note
calling for nine $168,000 annual payments of principal and interest. Y
then leases the property back to X under an agreement providing for nine
annual rental payments of $168,000. The parties elect in accordance with
the provisions of Sec. 5c.168(f)(8)-2 to have the provisions of section
168(f)(8) apply. The timing and amount of the rental payments required
to be made by X (as the lessee-user) under the lease will be exactly
equal to the timing and amount of the principal and interest payments
that Y will be required to make to X under Y's purchase money note, so
that the only cash transferred between X and Y is the $200,000 down
payment. Y's obligation to make debt service payments on the note is
contingent on X's obligation to make rental payments under the lease.
Under these circumstances, Y is treated as the owner and lessor of the
property for Federal tax law purposes; it therefore is entitled to the
investment tax credit and ACRS deductions with respect to
[[Page 82]]
the property. Y's basis in the property is $1 million. Y must report the
rent as income and will be entitled to deduct the interest on the
purchase money note. No gain or loss will be recognized by X on the sale
of the property since the sale price equals X's basis in the property. X
must report as income the interest paid by Y on the note and will be
entitled to a deduction for the rental payments it makes under the lease
in accordance with Sec. 5c.168(f)(8)-7.
Example (3). Assume that in both examples (1) and (2) X has an
option to purchase the equipment at the end of the lease term for $1.00.
The fact that the property may (or must) be bought or sold at the end of
the lease term at a fixed or determinable price that is more or less
than its fair market value is not taken into account in determining the
status of the transactions as leases under section 168(f)(8).
[T.D. 7791, 46 FR 51907, Oct. 23, 1981, as amended by T.D. 7795, 46 FR
56148, Nov. 13, 1981]
Sec. 5c.168(f)(8)-2 Election to characterize transaction as a section 168(f)(8) lease.
(a) Election--(1) In general. The election to characterize a
transaction as a lease qualifying under section 168(f)(8) shall be made
within the time and manner as set forth in this section without regard
to section 168(f)(4).
(2) Lease agreement. For an agreement to be treated as a lease under
section 168(f)(8) and this section, the lease agreement must be executed
not later than 3 months after the property was first placed in service,
as defined in Sec. 5c.168(f)(8)-6(b)(2)(i) (or prior to November 14,
1981, if the property was first placed in service by the lessee after
December 31, 1980, and before August 14, 1981). The agreement must be in
writing and must state that all of the parties to the agreement agree to
characterize it as a lease for purposes of Federal tax law and elect to
have the provisions of section 168(f)(8) apply to the transaction. The
agreement must also name the party who will be treated as the lessor and
the party who will be treated as the lessee.
(3) Information return concerning the election. (i) Except as
provided in subdivision (ii), for each lease agreement, the lessor and
lessee must jointly file Form 6793, Safe Harbor Lease Information
Return, concerning their election under section 168(f)(8). The
information return must be signed by both the lessor and the lessee and
filed not later than the 30th day after the agreement is executed with
the Commissioner of Internal Revenue, 1111 Constitution Avenue, N.W.,
Washington, D.C. 20224 (Attn: Form 6793). Unless the failure to file
timely is shown to be due to reasonable cause, the failure to file the
information return timely shall void the section 168(f)(8) election as
of the date of the execution of the lease agreement. The information
return shall include the following items:
(A) The name, address, and taxpayer identifying number of the lessor
and the lessee (and the common parent company if a consolidated return
is filed);
(B) The service center with which the income tax returns of the
lessor and lessee are filed;
(C) A description of each property with respect to which the
election is made;
(D) The date on which the lessee places the property in service
(determined as defined in Sec. 5c.168(f)(8)-6(b)(2)(i)), the date on
which the lease begins, and the term of the lease;
(E) The recovery property class of the leased property under section
168(c)(2) (for example, 5 years) and the ADR midpoint life of the leased
property;
(F) The terms of the payments between the parties to the lease
transaction;
(G) Whether the ACRS deductions and the investment tax credit are
allowable to the same taxpayer;
(H) The aggregate amount paid to outside parties to arrange or carry
out the transaction, such as, for example, legal and investment banking
fees;
(I) For the lessor only: The unadjusted basis of the property as
defined in section 168(d)(1);
(J) For the lessor only: If the lessor is a partnership or a grantor
trust, the name, address, and taxpayer identifying number of the
partners or the beneficiaries, and the Service Center with which the
income tax return of each partner or beneficiary is filed; and
(K) Such other information as may be required by the return or its
instructions.
The aggregate amount paid to outside parties which is described in
paragraph
[[Page 83]]
(a)(3)(i)(H) of this section need not be disclosed unless it is
reasonable to estimate that either the lessor or the lessee will lease
property under section 168(f)(8) for the calendar year which has an
aggregate adjusted basis to such person of more than $1,000,000. If
either the lessor or the lessee reasonably expects to lease property
with an aggregate basis of more than $1,000,000, then both parties must
disclose their transaction costs.
(ii) In the case of an agreement executed before January 1, 1982,
only the lessor is required to file the information return described in
paragraph (a)(3)(i) of this section and the return must be postmarked
not later than January 31, 1982. Unless the failure to file timely is
shown to be due to reasonable cause, or unless the lessee files the
information return postmarked by January 31, 1982, the lessor's failure
to file the information return timely shall be a disqualifying event as
of February 1, 1982, which shall cause an agreement to cease to be
treated as a lease under section 168(f)(8). For the Federal income tax
consequences of a disqualifying event, see Sec. 5c.168(f)(8)-8.
(iii) A copy of the information return described in paragraph (a)(3)
(i) and (ii) shall be filed by each party with its timely filed Federal
income tax return for its taxable year during which the lease term
begins. However, for taxable years ending in 1981 with respect to lease
agreements executed during calendar year 1981, such statement shall be
filed by the later of (A) the due date (taking extensions into account)
of the party's 1981 Federal income tax return, or (B) where the filing
of an amended return is required, with the amended return within 3
months following the execution of the lease agreement. For the
requirement to file an amended return within 3 months and the
consequences of the failure to so file, see Sec. 5c.168(f)(8)-
6(b)(2)(ii). A taxpayer that is required to file the information return
with its Federal income tax return before an information return form is
available shall file, in lieu of the required information return, a
statement which contains the information set forth in subparagraphs (A)
through (J) of pargraph (a)(3)(i). The failure by the lessor to file the
information return (or, if applicable, the statement referred to in the
preceding sentence) with its timely filed Federal income tax return
shall be a disqualifying event which shall cause an agreement to cease
to be treated as a lease under section 168(f)(8). For the Federal income
tax consequences of a disqualifying event, see Sec. 5c.168(f)(8)-8.
(4) Election is irrevocable. An agreement made pursuant to paragraph
(a)(2) of this section shall be irrevocable as of the later of the date
such agreement was executed or November 23, 1981.
(5) Disposition by lessee. Except in the case of transactions
described in subparagraph (6), of this paragraph, if the lessee (or any
transferee of the lessee's interest) sells or assigns its interest in
the lease or in the property, the agreement will cease to be
characterized as a lease under section 168(f)(8) as of the time of the
sale or assignment unless the transferee furnishes to the lessor within
60 days following the transfer the transferee's written consent to take
the property subject to the lease, and the transferee and lessor file a
statement with their timely filed Federal income tax returns for the
taxable year in which the transfer occurs containing the following
information:
(i) The name, address, and taxpayer identifying number of the lessor
and the transferee;
(ii) The district director's office with which the income tax
returns of the lessor and transferee are filed;
(iii) A description of the property; and
(iv) Confirmation of the transferee's consent.
See Sec. 5c.168(f)(8)-8 for the Federal income tax consequence where an
agreement ceases to be characterized as a lease under section 168(f)(8).
(6) Disposition of lessee's interest in bankruptcy, etc., or similar
proceeding. In the case of an agreement executed after May 31, 1982,
where the lessee's interest in the lease or in the property is sold or
assigned in a bankruptcy, liquidation, receivership, a court-supervised
foreclosure, or in any similar proceeding for the relief or protection
of insolvent debtors in Federal or State court, the agreement will
continue to
[[Page 84]]
be characterized as a lease under section 168(f)(8) and the purchaser or
assignee shall take the property subject to the lease if--
(i) Prior to the consummation of the sale or assignment, the lessor
gives written notice of its Federal income tax ownership to the judicial
or administrative body having jurisdiction over the proceeding and to
the debtor in possession of the interest or, if at such time a trustee,
receiver or similar person has been appointed by the court, to the
person appointed. The notice must contain a request that the court and
the debtor or the person appointed provide a copy of the notice to the
purchaser or assignee prior to the consummation of the sale or
assignment. Within 60 days following the sale or assignment, the lessor
must provide notice of its Federal income tax ownership and copies of
the lease agreement, and, in the case of a sale and leaseback
transaction, the lessor's purchase money obligation, to the purchaser or
assignee;
(ii) The lessor files a statement with its timely filed Federal
income tax return for the taxable year in which the sale or assignment
occurs containing the following information:
(A) The name, address, and taxpayer identifying number of the lessor
and the purchaser or assignee;
(B) The district director's office with which the Federal income tax
returns of the lessor and purchaser or assignee are filed;
(C) A description of the property; and
(iii) Prior to the consummation of the sale or assignment, all
secured lenders of the lessee with interests in the property, which
interests arose not later than the time the lessee first used the
property under the lease (and which were perfected in accordance with
applicable local law), specifically either exclude or release in writing
the Federal income tax ownership of the property from their interests.
The purchaser or assignee of the interest with respect to which this
paragraph applies shall file a statement with its timely filed Federal
income tax return for the taxable year in which the sale or assignment
occurs containing the information described in subdivision (ii) of this
subparagraph. If the interest is subsequently transferred (other than in
a bankruptcy, liquidation, receivership, court-supervised foreclosure,
or similar proceeding) during the term of the lease, the agreement will
continue to be characterized as a lease under section 168(f)(8) and the
transferee will take the property subject to the lease if either (A) the
lessor gives the transferee, prior to the transfer, a copy of the lease,
written notice of its Federal income tax ownership, and, in the case of
a sale and leaseback transaction, a copy of the lessor's purchase money
obligation, and the lessor files a statement with its timely filed
Federal income tax return as described in subdivision (ii) of this
subparagraph, or (B) within 60 days following the transfer, the
transferee agrees in writing to take the property subject to the lease
and the lessor and transferee file a statement with their timely filed
Federal income tax returns within the time and in the manner described
in paragraph (a)(5) of this section. However, an agreement will not
continue to be characterized as a lease under this subparagraph if,
under another applicable provision, it would cease to be characterized
as a lease. See Sec. 5c.168(f)(8)-8 for the Federal income tax
consequences where an agreement ceased to be characterized as a lease
under section 168(f)(8).
(7) Consequences of taking the property subject to the lease
agreement. For purposes of Secs. 5c.168(f)(8)-1 through 5c168(f)(8)-11,
in a situation where a transferee of a lessee's interest acquires the
property subject to the lease, the transferee shall be deemed to have
acquired a leasehold interest in the property equal to the remaining
lease term, any unpaid obligation of the lessor arising in connection
with the sale of the property by the original lessee in a sale and
leaseback transaction, and any option of the lessee to purchase the
property. Any consideration paid by the transferee for the property
shall be allocated to the lessor's obligation to the extent of the
unpaid balance of the obligation. Any excess over the unpaid balance
shall be allocated between the leasehold interest and the purchase
option in proportion to their relative fair market values. As the new
lessee, the transferee
[[Page 85]]
shall not be entitled to claim any ACRS deduction with respect to the
property while the lease remains in effect and shall not be entitled to
any investment tax credit with respect to the property. The transferee
shall report interest income on the lessor's obligation, and shall be
entitled to deduct the rent paid under the lease, in accordance with
Sec. 5c.168(f)(8)-7. In addition, the transferee shall be entitled to
amortize the portion of its cost allocable to the leasehold interest.
Coversely, as long as the lease remains in effect, the lessor will
continue to be recognized as the owner of the property for Federal
income tax purposes, shall be required to report rents due under the
lease, and shall be entitled to deduct interest on its obligation.
(8) Election to treat certain leases under subparagraph (6) rules.
The lessor under a section 168(f)(8) lease executed on or before May 31,
1982, may elect to have the provisions of paragraph (a)(6) of this
section apply in the case of a sale or assignment of the lessee's
interest in the lease or in the property in a bankruptcy, receivership,
liquidation, court-supervised foreclosure, or similar proceeding. The
election of the lessor with respect to any leased property may be made
at any time prior to the consummation of any sale or assignment of such
property in a bankruptcy, etc., or similar proceeding, by complying with
the provisions of subparagraph (6) of this paragraph.
(b) Examples. The application of the provisions of this section may
be illustrated by the following examples:
Example (1). X Corp. maintains its books and records for Federal tax
law purposes on a calendar year basis. On February 1, 1981, X acquires
certain equipment for use in its business, and the equipment is deemed
to be placed in service on that date within the meaning of
Sec. 5c.163(f)(8)-6(b)(2)(i). On November 1, 1981, X sells the equipment
to Y and leases it back under a lease in which the parties elect to have
the provisions of section 168(f)(8) apply. The election is considered
timely for purposes of making Y the owner of the property under section
168(f)(8) since the lease agreement was executed before November 14,
1981.
Example (2). The facts are the same as in example (1) except that X
Corp.'s taxable year ends on February 28, 1981. X claimed the investment
tax credit and depreciation deductions with respect to the property in
its return filed April 1, 1981. The lease will qualify for safe harbor
treatment under section 168(f)(8) provided X, within 3 months after the
lease agreement was executed, files an amended return pursuant to
Sec. 5c.168(f)(8)-6(b)(2)(ii) for its taxable year ending February 28,
1981, in which X foregoes its right to claim any investment tax credit
or ACRS deductions with respect to the property subject to the lease.
Example (3). X Corp. (as lessee) sells certain new equipment to Y
Corp. (as lessor) and leases it back under a section 168(f)(8) lease.
During the term of the lease X sells its interest in the property to T
Corp. (other than in a bankruptcy or similar proceeding), and T does not
give Y a written consent to take the property subject to the leased. The
agreement ceases to be treated as a lease under section 168(f)(8) as of
the date of the sale.
Example (4). The facts are the same as in example (3) except that
the sale of the property takes place while X is under the jurisdiction
of a court in a bankruptcy proceeding. All lenders of X having perfected
interests in the property that arose by the time the property was first
used under the lease have specifically either excluded or released the
ownership of the property for Federal income tax purposes from their
interests. Within the required time periods, Y gives appropriate
notification to the court, the bankruptcy trustee, and T that the
property is subject to the lease and files the required statement with
its Federal income tax return for the taxable year in which the sale
occurs. The agreement continues to be treated as a lease under section
168(f)(8). T will take the property subject to the lease. T must
allocate the purchase price among the lessor's note, the leasehold
interest, and the option (if any) to purchase the property.
Example (5). The facts are the same as in example (4), except that
one lender of X having a perfected and timely interest in the property
does not specifically exclude or release the Federal income tax
ownership of the property from its interest. The agreement will cease to
be treated as a lease under section 168(f)(8) as of the date of the
transfer to T. The result would be the same if Y failed to furnish any
of the notices required by subdivision (i) of paragraph (a) and (6) or
failed to file a statement as required by subdivision (ii) of paragraph
(a)(6).
Example (6). The facts are the same as in example (4). In addition,
during the term of the lease T transfers the property to U Corp. and Y
fails to furnish U with written notice that the property is subject to
the lease prior to the sale and U refuses to agree to consent to the
lease agreement. The agreement will cease to be treated as a lease under
section 168(f)(8) as of the date of the transfer to U. The result would
be the same if Y furnished U with timely written notice
[[Page 86]]
of its tax ownership but failed to file the required statement with its
tax return for its taxable year in which the sale occurred.
[T.D. 7791, 46 FR 51907, Oct. 23, 1981, as amended by T.D. 7795, 46 FR
56148, Nov. 13, 1981; T.D. 7800, 46 FR 63257, Dec. 31, 1981]
Sec. 5c.168(f)(8)-3 Requirements for lessor.
(a) Qualified lessor. In order for an agreement to be treated as a
lease under section 168(f)(8), the party characterized in the agreement
as the lessor must be a qualified lessor. The term ``qualified lessor''
means--
(1) A corporation which is neither an electing small business
corporation under section 1371(b) nor a personal holding company under
section 542(a), or
(2) A partnership all of whose partners are corporations described
in subparagraph (1), or
(3) A grantor trust whose grantor and beneficiaries are all
corporations described in paragraph (a)(1) or partnerships described in
paragraph (a)(2).
(b) Effect of disqualification of lessor. If at any time during the
term of the agreement the lessor ceases to be a qualified lessor, the
agreement will lose its characterization as a lease under section
168(f)(8) as of the date of the event causing such disqualification. If
any partner of a partnership described in paragraph (a)(2) ceases to be
a corporation described in paragraph (a)(1), the partnership entity
shall cease to be a qualified lessor. Similarly, if any beneficiary of a
trust described in paragraph (a)(3) ceases to be a corporation described
in paragraph (a)(1), the trust shall cease to be a qualified lessor. See
Sec. 5c.168(f)(8)-8 for the Federal income tax consequences of such a
disqualification.
(c) One tax owner per property. Only one person may be a qualified
lessor under section 168(f)(8) with respect to leased property. Thus,
property that is subject to a lease under section 168(f)(8) may not be
subleased under a lease for which a section 168(f)(8) election is made.
In addition, if a lessor sells or assigns in a taxable transaction its
interest in a section 168(f)(8) lease or in the underlying property, the
lease shall cease to qualify under section 168(f)(8) and no other lease
may be executed under section 168(f)(8) with respect to the property.
The preceding sentence applies to a sale or assignment of its interest
by a partner of a lessor that is a partnership described in paragraph
(a)(2) of this section or by a beneficiary of a lessor that is a trust
described in paragraph (a)(3) of this section. See Sec. 5c.168(f)(8)-8
for the Federal income tax consequences where a lease ceases to qualify
under section 168(f)(8). However, lease brokers, agents, etc., may, for
example, prepare executory contracts with the lessee whereby the
broker's assignee may execute a lease as lessor, and, if the
requirements of section 168(f)(8) and Secs. 5c.168(f)(8)-1 through
5c.168(f)(8)-11 are met, the lease will qualify under section 168(f)(8).
(d) Examples. The application of paragraph (c) may be illustrated by
the following examples:
Example (1). X Corp. (as lessee) sells certain new equipment to Y
Corp. (as lessor) and leases it back under a section 168(f)(8) lease.
Within 3 months after the property was placed in service, Y assigns its
interest in the lease to Z. Upon the transfer to Z, the lease will no
longer qualify for treatment under section 168(f)(8). The property may
not thereafter be the subject of a section 168(f)(8) lease.
Example (2). X Corp., which wishes to acquire certain equipment for
use in its business and to transfer ownership of the property for
Federal income tax law purposes, purchases the equipment and enters into
an executory contract with LB, a lease broker, under which X agrees to
execute a section 168(f)(8) lease as lessee with a third party lessor.
At a later date (but within the prescribed 3-month period), LB arranges
for X and T Corp. (which wishes to secure Federal income tax law
ownership) to execute a lease agreement in accordance with
Sec. 5c.168(f)(8)-2. The lease will qualify for treatment under section
168(f)(8).
[T.D. 7791, 46 FR 51907, Oct. 23, 1981, as amended by T.D. 7795, 46 FR
56149, Nov. 13, 1981]
Sec. 5c.168(f)(8)-4 Minimum investment of lessor.
(a) Minimum investment. Under section 168(f)(8)(B)(ii), an agreement
will not be characterized as a lease for purposes of section 168(f)(8)
unless the qualified lessor has a minimum at risk investment which, at
the time the property is placed in service under the
[[Page 87]]
lease and at all times during the term of the lease, is not less than 10
percent of the adjusted basis of the leased property. As the adjusted
basis of the leased property is reduced by capital cost recovery
deductions, the minimum investment required will also be reduced to 10
percent of the revised adjusted basis, until the adjusted basis has been
completely recovered, at which time no minimum investment will be
required. Financing provided by the lessee or a party related to the
lessee, such as a recourse note given by the lessor to the lessee, will
not be taken into account in determining the lessor's minimum
investment.
(b) At risk amount. The minimum investment which the lessor has at
risk with respect to the leased property for purposes of paragraph (a)
of this section includes only consideration paid and recourse
indebtedness incurred by the lessor to purchase the property. The lessor
must have sufficient net worth (without regard to the value of any
leases which qualify under section 168(f)(8)) to satisfy any personal
liability incurred. Any tax benefits which the lessor derives from the
leased property shall not be taken into account to reduce the amount the
lessor has at risk. An agreement between the lessor and the lessee
requiring either or both parties to purchase or sell the qualified
leased property at some price (whether or not fixed in the agreement) at
the end of the lease term shall not affect the amount the lessor has at
risk with respect to the property. However, an option held by the lessor
to sell the property that is exercisable before the end of the period
prescribed under section 168(c)(2) for the recovery property class of
the leased property (taking into account any election by the lessor or
lessee under section 168(b)(3)) shall reduce the amount the lessor is
considered to have at risk by the amount of the option price at the time
the option becomes exercisable.
Sec. 5c.168(f)(8)-5 Term of lease.
(a) Term of lease--Basic rules. To qualify as a lease under section
168(f)(8) and Sec. 5c.168 (f)(8)-1 (a), the lease agreement must provide
for a term that does not exceed the maximum term described in paragraph
(b) of this section; such term must also at least equal the minimum term
described in paragraph (c).
(b) Maximum term. For purposes of section 168(f)(8)(B)(iii) and this
section, the term of the lease may not exceed the greater of--
(1) 90 percent of the useful life of the property under section 167,
or
(2) 150 percent of the asset depreciation range (ADR) present class
life (``midpoint'') of such property, applicable as of January 1, 1981
(without regard to section 167(m)(4)), published in Rev. Proc. 77-10,
1977-1 C. B. 548, and revisions thereto.
Solely for purposes of this paragraph (b), ``useful life'' means the
period when the leased asset can reasonably be expected to be
eonomically useful in anyone's trade or business; such term does not
mean the period during which the lessor expects to lease the property.
Any option to extend the term of the lease, whether or not at fair
market value rent, must be included in the term of the lease for
purposes of this paragraph. If several different pieces of property are
the subject of a single lease, the maximum allowable term for such lease
will be measured with respect to the property with the shortest life. In
no case, however, will the lease term qualify under this section if such
term with respect to any piece of property is less than the minimum term
described in paragraph (c).
(c) Minimum term. For purposes of this section, the term of the
lease must at least equal the period prescribed under section 168(c)(2)
for the recovery property class of the leased property. For example, if
a piece of leased equipment is in the 5-year recovery property class,
the lease agreement must have a minimum term of 5 years. In general, the
determination of whether property is 3-year recovery property, 5-year
recovery property, etc., in the hands of the lessor will be based on the
characterization of the property in the hands of the owner as determined
without regard to the section 168(f)(8) lease. Thus, for example,
property which is public utility property or RRB replacement property
absent the section 168(f)(8) lease will be characterized as such in the
hands of the lessor for purposes of section 168(f)(8). However, with
respect to RRB replacement property, the
[[Page 88]]
transitional rule of section 168(f)(3) shall be inapplicable to the
lessor. In addition, any election under section 168(b)(3) by the lessor
with respect to the class of recovery property to which the qualified
leased property is assigned shall apply to the leased property in
determining the term of the lease. A lease term that does not exceed the
term required to satisfy the minimum lease term of this paragraph will
be deemed to comply with the maximum lease term described in paragraph
(b) if such minimum lease term exceeds such maximum lease term.
(d) Examples. The application of this section may be illustrated by
the following examples:
Example (1). X Corp. (as lessee) and Y Corp. (as lessor) enter into
a lease which they elect to be treated under section 168(f)(8) with
respect to a chemical manufacturing facility that will also generate
steam for use in the production of electricity. The assets comprising
the chemical plant are described in ADR guideline class 28.0 (midpoint
life of 9.5 years), and the assets comprising the steam plant are
described in ADR class 00.4 (midpoint life of 22 years). To satisfy the
maximum lease term requirement of section 168(f)(8)(B)(iii)(II) and
Sec. 5c.168 (f)(8)-5(b), the lease term may not exceed 14.25 years (150
percent of the 9.5 year midpoint life of the chemical plant).
Example (2). The facts are the same as in example (1) except that
the chemical plant and the steam plant are the subject of separate
leases. For purposes of section 168(f)(8)(B)(iii)(II) and
Sec. 5c.168(f)(8)-5 (b), the maximum term of the lease with respect to
the chemical plant is 14.25 years (150 percent of 9.5 years) and the
maximum term of the lease with respect to the steam plant is 33 years
(150 percent of 22 years).
[T.D. 7791, 46 FR 51907, Oct. 23, 1981; 50 FR 13020, Apr. 2, 1985]
Sec. 5c.168(f)(8)-6 Qualified leased property.
(a) Basic rules--(1) In general. An agreement shall be treated as a
section 168(f)(8) lease only if the property which is leased is
qualified leased property. Qualified leased property is recovery
property as defined in section 168(c) and is either--
(i) Except as provided in subparagraph (2), new section 38 property
of the lessor which is leased no later than 3 months after the date the
property was placed in service (or prior to November 14, 1981, if the
property was placed in service after December 31, 1980, and before
August 14, 1981) and which, if acquired by the lessee, would have been
new section 38 property of the lessee, or
(ii) Property which is a qualified mass commuting vehicle (as
defined in section 103(b)(9)) and which is financed in whole or in part
by proceeds from an issue of obligations the interest on which is
excludable from income under section 103(a).
(2) Sale and leaseback arrangement. (i) Where the leased property is
purchased, directly or indirectly, by the lessor from the lessee (or a
party related to the lessee), the property will not be qualified leased
property unless the property was (or would have been) new section 38
property of the lessee and was purchased and leased no later than 3
months after the date the property was placed in service by the lessee
(or prior to November 14, 1981, if the property was placed in service by
the lessee after December 31, 1980 and before August 14, 1981) and with
respect to which the lessor's adjusted basis does not exceed the
adjusted basis of the lessee (or a party related to the lessee) at the
time of the lease. If the lessor's adjusted basis in the property
exceeds the seller's adjusted basis with respect to the property at the
beginning of the lease, the property will not be qualified leased
property.
(ii) For purposes of this paragraph (a)(2) and paragraph (b)(3)(ii)
of this section, transactional costs with respect to a sale and
leaseback arrangement that are not currently deductible shall be
allocated to the lease agreement (and not included in the lessor's
adjusted basis with respect to the property) and amortized over the term
of the lease. These costs include legal and investment banking fees and
printing costs.
(iii) The application of this paragraph (a)(2) may be illustrated by
the following examples:
Example (1). X, an airline, contracts to have an airplane
constructed for a fixed price of $10 million. Prior to completion of
construction of the airplane, the value of the airplane increases to $11
million. X buys the airplane at the contract price of $10 million and,
before it is placed in service, sells the
[[Page 89]]
airplane at its fair market value of $11 million to Y and then leases it
back. The lease will not qualify for safe harbor protection under
section 168(f)(8) because the lessor's adjusted basis in the airplane
exceeds the lessee's adjusted basis. This result obtains even though the
airplane qualifies as new section 38 property of X airline.
Example (2). Assume the same facts as in example (1) except that,
prior to completion of the construction of the airplane, X assigns its
contract to Y for $1 million, and Y thereafter buys the airplane at the
contract price of $10 million. The acquisition by Y is treated as an
indirect purchase from the lessee. Because Y's adjusted basis in the
airplane would exceed the lessee's adjusted basis, the lease will not
qualify under section 168(f)(8).
(b) Special rules--(1) New section 38 property. (i) New section 38
property is section 38 property described in subsection (b) of section
48 and the regulations thereunder other than a qualified rehabilitated
building (within the meaning of section 48(g)(1)). Qualified leased
property must be new section 38 property at the beginning of the lease
and must continue to be section 38 property in the hands of the lessor
and the lessee throughout the lease term. The fact that the lessee used
the property within the 3-month period prior to the lease will not
disqualify the property as new section 38 property of the lessee.
(ii) The application of this paragraph (b)(1) may be illustrated by
the following examples:
Example (1). N is a hospital exempt from Federal income tax and
wishes to purchase certain equipment for use in furtherance of its
exempt functions (i.e., other than for use in an unrelated trade or
business). O, a qualified lessor as defined in Sec. 5c.168(f)(8)-3(a),
acquires the property and leases it to N. Since the equipment would not
be new section 38 property of N if N had acquired it by virtue of
section 48(a)(4) (relating to exception from definition of section 38
property for certain property used by certain tax-exempt organizations),
the equipment is not qualified leased property and the lease does not
qualify under section 168(f)(8). Whether O is considered the owner of
the property for Federal tax law purposes will be determined without
regard to the provisions of section 168(f)(8).
Example (2). P Corp. is constructing progress expenditure property
as defined in section 46(d)(2) for R Corp. Progress expenditure property
is property which it is reasonable to believe will be section 38
property in the hands of the taxpayer when it is placed in service.
Before the date that the property is placed in service (as defined in
Sec. 5c.168(f)(8)-6(b)(2)(i)), the property is not new section 38
property. Accordingly, progress expenditure property cannot be qualified
leased property.
Example (3). R Corp., a foreign railroad, acquires new rolling stock
and enters into a sale and leaseback transaction with B Corp., a
domestic corporation. R uses the rolling stock within and without the
United States, but predominantly outside the United States within the
meaning of section 48(a)(2)(A). Section 48(a)(2)(B)(ii) is inapplicable
to R because R is neither a domestic railroad corporation nor a United
States person; therefore, the rolling stock cannot be section 38
property to R. The property is not qualified leased property.
(2) Placed in service. (i) Property shall be considered as placed in
service at the time the property is placed in a condition or state of
readiness and availability for a specifically assigned function. If an
entire facility is leased under one lease, property which is part of the
facility will not be considered placed in service under this rule until
the entire facility is placed in service. If the lessee claims any
investment tax credit or ACRS deductions with respect to any component
which is part of an entire facility that is subsequently leased, the
lessee must file an amended return within the time prescribed in
paragraph (b)(2)(ii) of this section in which it foregoes its claim to
the investment tax credit and ACRS deductions. If such amended return
may not be filed because the time for filing a claim for refund with
respect to any component under section 6511 has expired, each component
of the facility will be considered as placed in service at the time the
individual component is placed in a condition or state of readiness and
availability for a specifically assigned function and not when the
entire facility is placed in service.
(ii) For purposes other than determining whether property is
qualified leased property, property subject to a lease under section
168(f)(8) will be deemed to have been placed in service not earlier than
the date such property is used under the lease. If the lessee claims any
investment tax credit or ACRS deductions with respect to property placed
in service under a lease, the lessee must file an amended return within
3 months following the execution of the lease agreement in which
[[Page 90]]
the lessee foregoes its claim to the investment tax credit and ACRS
deductions with respect to the leased property or the election under
section 168(f)(8) will be void.
(iii) The application of this paragraph (b)(2) may be illustrated by
the following examples:
Example (1). X Corp. acquires equipment on December 31, 1982, and
places the equipment in service. X's taxable year ends December 31. On
March 20, 1983, X sells the equipment to Y Corp. and leases it back in a
transaction that qualifies under section 168(f)(8). The property is
considered to be new section 38 property to X under paragraph (b)(1). X
is not allowed any investment tax credit or ACRS deductions with respect
to the property in 1982 because the property is not considered to have
been placed in service for purposes other than determining whether it is
qualified leased property until it is used under the lease under
subdivision (ii) of this subparagraph (2). If X has claimed credits or
deductions on its 1982 return, it must file an amended return for 1982
within 3 months following the execution of the lease agreement or the
election will be void.
Example (2). In March 1985, K Corp. completes reconditioning of a
machine, which it constructed and placed in service in 1982 and which
has an adjusted basis in 1985 of $10,000. The cost of reconditioning
amounts to an additional $20,000. K would be entitled to a basis of
$20,000 in computing its qualified investment in new section 38 property
for 1985. In May 1985, K enters into a sale and leaseback transaction
with L Corp. with respect to the reconditioned parts of the machine that
are new section 38 property to K. K and L elect to have section
168(f)(8) apply. Assuming that the adjusted basis of the leased property
is the same to L as it is to K, the property qualifies as qualified
leased property under section 168(f)(8)(D)(ii) and L is considered the
tax owner of the property. Since, for purposes other than determining
whether property is qualified leased property, the property is deemed
originally placed in service not earlier than the date the property is
used under the lease, the property is new section 38 property to L and L
may claim the investment tax credit (and ACRS deductions) with respect
to the leased property.
(3) Qualified mass commuting vehicle. (i) A qualified mass commuting
vehicle as defined in section 103(b)(9) will constitute qualified leased
property for purposes of section 168(f)(8)(D)(iii) and this section
provided all of the following requirements are met:
(A) At least part (as, for example, 5 percent) of the financing for
the purchase of such vehicle must be derived from proceeds of
obligations the interest on which is excludable from income under
section 103(a)(1) (whether or not such obligations are described in
section 103(b)(4)(I));
(B) The vehicle must be recovery property (i.e., it must have been
first placed in service by the lessee after December 31, 1980); and
(C) The vehicle must not have been previously leased under a section
168(f)(8) lease by the lessee.
A qualified mass commuting vehicle that is qualified leased property may
be leased under section 168(f)(8) at any time after December 31, 1980.
The requirement of paragraph (b)(3)(i)(A) of this section may be
satisfied where the vehicles leased under a section 168(f)(8) lease are
refinanced with proceeds of an obligation the interest on which is
excludable from income under section 103(a)(1).
(ii) Where the leased property is purchased, directly or indirectly,
by the lessor from the lessee (or a party related to the lessee), the
property will not qualify under this subsection unless the lessor's
adjusted basis in the property does not exceed the adjusted basis of the
lessee (or related party) at the time of the execution of the lease. The
adjusted basis of property to a lessee (or related party) shall be
determined under Part II of Subchapter O of Chapter I of the Code for
purposes of determining gain, except that the adjustment described in
section 1016(a)(3) and Sec. 1.1016-4 need not be made for property
acquired during calendar year 1981 and leased no later than March 1,
1982.
(iii) In a transaction characterized as a lease under section
168(f)(8), the lessor's adjusted basis may not include that portion, if
any, of the cost of the vehicle to the lessee (or related party) that is
financed, directly or indirectly, with an Urban Mass Transportation
Administration (UMTA) grant (excluding a grant under the interstate
transfer provision of the Federal-Aid Highway Act (FAHA)), a FAHA grant,
or any other Federal grant. Where a vehicle is included as part of an
UMTA-funded project, 80 percent of the vehicle's cost will be deemed to
be financed
[[Page 91]]
with an UMTA grant and 20 percent will be deemed to be financed from
non-Federal sources without regard to whether the UMTA funds or the non-
Federal funds are traceable to any particular vehicle included within
the project. For purposes of this subparagraph and paragraph (b)(3)(ii)
of this section, amounts originating from non-Federal sources which are
paid or incurred with respect to leased property by a State or political
subdivision of the State (or political subdivision created by the joint
authorization of two or more States) shall be taken into account in
computing the lessee's adjusted basis in the leased property as if the
lessee had paid or incurred such amounts.
(iv) If a vehicle is purchased pending approval of an UMTA grant,
the lessor's unadjusted basis in the vehicle may equal the lessee's
unadjusted basis unreduced by any subsequently approved UMTA grant;
however, if an UMTA grant is later approved and the vehicle is included
as part of an UMTA-funded project, except as provided hereinafter in
this subparagraph, the lease shall terminate with respect to an
undivided 80 percent interest in the vehicle. For the Federal income tax
consequences of the termination of a lease, see Sec. 5c.168(f)(8)-8. If
such a subsequently approved UMTA grant is used to purchase additional
qualified mass commuting vehicles, the portion of each vehicle deemed to
be allocable to non-UMTA financing (i.e., 20 percent) may be leased
under section 168(f)(8). If a vehicle is purchased pending approval of
an UMTA grant and leased under section 168(f)(8), the lease will not be
deemed to have terminated with respect to 80 percent of the vehicle when
the UMTA grant is later approved if the total interest leased before the
grant is approved did not exceed 20 percent of the lessee's adjusted
basis in the vehicle (unadjusted basis prior to March 1, 1982) unreduced
by any subsequently approved UMTA grant. For purposes of this
subparagraph and paragraph (b)(3)(iii) of this section, the allocation
principles applicable to UMTA grants shall apply in the case of FAHA
grants except that 85 percent and 15 percent shall be substituted for 80
percent and 20 percent, respectively. Similar allocation rules shall
also apply to other Federal grants used to finance the acquisition of
qualified mass commuting vehicles.
(v)(A) Notwithstanding the provisions of Sec. 5c.168(f)(8)-
2(a)(3)(iii), the lessee in a transaction to which this paragraph (b)(3)
applies is not required to file an information return or a statement
concerning its election under section 168(f)(8).
(B) Notwithstanding the provisions of Sec. 5c.168(f)(8)-2(a)(5), if
the transfer of a qualified mass commuting vehicle is not otherwise a
disqualifying event, the transferee is not required to file the
statement mentioned therein.
(C) The fact that a qualified mass commuting vehicle is not section
38 property because it is used by an exempt entity will not disqualify
the lease under Sec. 5c.168(f)(8)-8(b)(4); however, a disqualifying
event will occur, and the agreement will cease to be characterized as a
lease under section 168(f)(8), with respect to a vehicle which (1)
ceases to be a qualified mass commuting vehicle or (2) would cease to be
section 38 property if used by a taxable entity as, for example, a
vehicle used predominantly outside the United States. For the Federal
income tax consequences of a disqualifying event, see Sec. 5c.168(f)(8)-
8.
(vi) The lessor of a qualified vehicle will not be allowed an
investment tax credit with respect to it under section 38.
(vii) The application of this paragraph (b)(3) may be illustrated by
the following examples:
Example (1). On July 1, 1981, a unit of city X, X Transit Authority
(XTA), purchases 100 buses after receiving an UMTA grant for 80 percent
of their purchase price. Fifteen percent of the purchase price is
financed with a combination of State and local governmental grants and 5
percent is financed with proceeds from an issue of tax-exempt
obligations described in section 103(b)(4)(I). Because UMTA financed an
80 percent interest in the 100 buses, XTA may lease under section
168(f)(8) only a 20 percent interest in each bus. If XTA were to lease
100 percent of 20 buses, only 20 percent of such buses would be deemed
to be leased under a safe harbor lease.
Example (2). The facts are the same as in example (1) except that
UMTA has not yet approved XTA's application in 1981. Pending the UMTA
approval, XTA purchases and
[[Page 92]]
places in service 20 buses in July 1981. The 20 buses are financed with
tax-exempt obligations described in section 103(b)(4)(I). On December
15, 1981, XTA sells a 100 percent interest in these 20 buses to
Corporation M and leases them back under a lease in which the parties
elect to have the provisions of section 168(f)(8) apply. M is a
calendar-year taxpayer and claims an ACRS deduction with respect to the
buses on its return for taxable year 1981. On July 1, 1982, UMTA
approves XTA's grant application, thus enabling XTA to purchase an
additional 80 buses. Because 80 percent of the original 20 buses are
deemed to have been financed by UMTA beginning on July 1, 1982, the safe
harbor lease terminates with respect to an undivided 80 percent interest
in the 20 buses. If XTA would be considered the owner of the buses
without regard to section 168(f)(8), the termination will result in a
deemed sale of an undivided 80 percent interest in the 20 buses by M to
XTA. The amount realized by M on the sale will include a proportionate
part of the outstanding amount of M's debt plus the sum of any other
consideration received by M. M will realize gain or loss, depending upon
its basis, with applicable section 1245 recapture. However, XTA may
lease the 20 percent interest in the 80 new buses it purchased in 1982
which is deemed to have been financed with non-Federal funds.
Example (3). The facts are the same as in example (2) except that
the grant approved by UMTA is used to purchase and renovate a bus garage
facility. Eighty percent of the original 20 buses are deemed to have
been financed by UMTA beginning on July 1, 1982. The lease would still
terminate with respect to an undivided 80 percent interest in the
vehicles. XTA cannot lease the garage facility under 168(f)(8) because
it does not constitute a qualified mass commuting vehicle.
Example (4). The facts are the same as in example (2) except that on
December 15, 1981, XTA sells and leases back only a 20 percent interest
in the 20 buses acquired in July 1981. When the UMTA grant is later
approved, the lease will not terminate with respect to any portion of
the 20 buses. In addition, XTA may lease the 20 percent interest in the
80 new buses purchased in 1982 and deemed to have been financed with
non-Federal funds.
Example (5). On August 1, 1982, UMTA approves a grant for a major 5-
year capital expenditure program to improve city Y's rapid rail transit
system. None of the funds relating to this UMTA-funded project, provided
either by UMTA or by city Y, will be used to purchase qualified mass
commuting vehicles. Instead, a number of rapid rail cars and buses will
be purchased entirely with funds provided with a combination of grants
by the State and city governments and of proceeds from an issue of tax-
exempt obligations described in section 103(a). Because none of the
rapid rail cars and buses are included as part of the UMTA-funded
project, no part of them is deemed to be financed by UMTA. If at least 5
percent of the cost of the qualified mass commuting vehicles is provided
by tax exempt obligations under section 103(a), the vehicles will be
qualified leased property in their entirety.
Example (6). City Z has a mass transit agency (ZTA) which purchases
on July 1, 1982, 10 buses for which it pays $1,000,000, 95 percent of
which is derived from grants from city Z and 5 percent from tax exempt
obligations described in section 103(a). The buses have a useful life
within the meaning of Sec. 1.167(a)-1(b) of 10 years and their salvage
value is zero. On July 1, 1983, ZTA sells these buses to corporation P
and leases them back in a transaction which the parties elect to have
treated as a lease under section 168(f)(8). At the time of the sale and
leaseback, ZTA's adjusted basis in the 10 buses under section 1016(a)(3)
and Sec. 1.1016-4 is $900,000 ($1,000,000 cost less $100,000 of
depreciation sustained, computed on a stright-line basis). Before the
transaction will qualify under section 168(f)(8) and Sec. 5c.168(f)(8)-
6(b)(3)(ii), P's adjusted basis in the vehicles may not exceed ZTA's
basis, or $900,000.
Assuming that the transaction qualifies under section 168(f)(8) and that
corporation P is a calendar year taxpayer, P may claim ACRS deductions
for 1982 of $135,000 (15 percent of $900,000).
Example (7). The facts are the same as in example (6) except that
the sale and leaseback transaction is closed on December 31, 1982. P's
adjusted basis in the vehicles may not exceed ZTA's basis, or $950,000
($1,000,000 cost less $50,000 of depreciation sustained, computed on a
straight-line basis).
Example (8). The facts are the same as in example (6) except that
ZTA purchases the buses on June 1, 1981, and enters into the sale and
leaseback transaction with corporation P on December 31, 1981. Under
Sec. 5c.168(f)(8)-6(b)(3)(ii), no adjustment is made to ZTA's basis in
the buses for depreciation sustained. Therefore, P's basis in the buses
may equal ZTA's cost of $1,000,000.
Example (9). On July 1, 1981, a unit of city W, W Transit Authority
(WTA), purchases 100 buses with local grants derived entirely from a
city W sales tax. The buses do not constitute qualified leased property
under Sec. 5c.168(f)(8)-6(b)(3) because no part of the financing for
their purchase was derived from the proceeds of tax exempt obligations.
Example (10). The facts are the same as in example (9) except that
on November 1, 1981, WTA borrows 5 percent of the cost of the buses and
pledges them as security. The interest on WTA's obligation is excludable
from income under section 103(a)(1). On December 31, 1981, WTA sells to
T Corp. all 100 buses and leases them back. Under Sec. 5c.168(f)(8)-
6(b)(3)(i), each bus is deemed to
[[Page 93]]
be financed with the proceeds of tax exempt obligations. Therefore, if
the vehicles otherwise meet the definition of qualified leased property,
all the vehicles will be qualified leased property under this section.
(4) Foreign lessees. In addition to the other provisions of this
section, property which is leased under a section 168(f)(8) lease to a
foreign person shall not be qualified leased property unless the gross
income attributable to the property from all sources (determined without
regard to section 872(a) or 882(b)) is effectively connected with a
trade or business within the United States, and the taxable income, if
any, attributable to the property is subject to tax under section
871(b)(1) or 882(a)(1). For this purpose, if income attributable to the
property is not included in gross income of a foreign lessee, and is
exempt from taxation, under sections 872 or 833, or if the income is
otherwise exempt from taxation under any income tax convention to which
the United States is a party, then the property shall not be qualified
leased property.
(5) Other rules. (i) Qualified leased property may include undivided
interests in property or property regardless of whether or not it is
considered separate property under State or local law. If property
subject to a section 168(f)(8) lease is later determined not to be
qualified leased property, disqualification of the lease under section
168(f)(8) will apply only as to that property.
(ii) The application of this paragraph (b)(5) may be illustrated by
the following examples:
Example (1). On July 1, 1981, X Corp. contracts to have a
manufacturing facility constructed for use in its business. Construction
of the facility is completed on July 1, 1982, and the facility is deemed
to be placed in service as of that date under Sec. 5c.168(f)(8)-
6(b)(2)(i). The facility is comprised of a mixture of new section 38
property and buildings that do not qualify as section 38 property. On
August 1, 1982, X sells the new section 38 property in the facility to Y
and leases it back under an agreement in which the parties elect to be
treated as a lease described in section 168(f)(8). Assuming that the
other requirements of this paragraph are met, the new section 38
property contained in the facility will be qualified leased property. If
it is later determined that property subject to the section 168(f)(8)
lease is not new section 38 property (and thus not qualified leased
property), the safe harbor protection will be lost only as to that
property.
Example (2). X Corp. acquires a certain piece of equipment (which is
new section 38 property) for use in its business. Within 3 months, X
sells a 70 percent undivided interest in the property to lessor A and a
10 percent undivided interest in the property to lessor B and leases
both portions back under separate section 168(f)(8) leases. The
investment tax credit and ACRS deductions associated with the property
will be divided among X, lessor A, and lessor B, on a basis of 20
percent, 70 percent, and 10 percent, respectively.
[T.D. 7791, 46 FR 51907, Oct. 23, 1981, as amended by T.D. 7795, 46 FR
56150, Nov. 13, 1981; T.D. 7800, 46 FR 63258, Dec. 31, 1981]
Sec. 5c.168(f)(8)-7 Reporting of income, deductions and investment tax credit; at risk rules.
(a) In general. The fact that the lessor's payments of interest and
principal and the lessee's rental payments under the lease are not equal
in amount will not prevent the lease from qualifying under section
168(f)(8). However, see paragraph (b) for special requirements in sale
and leaseback transactions. In determining the parties' income,
deductions, and investment tax credit under the lease, the rules in
paragraphs (c) through (g) of this section shall apply regardless of the
overall method of accounting otherwise used by the parties.
(b) Requirements for sale and leaseback transaction. If the property
leased is financed by the lessee (or a related party of the leasee) in a
sale and leaseback transaction, the lease will not qualify under section
168(f)(8) unless--
(1) The term of the lessor's purchase money obligation is
coterminous with the term of the lease, and
(2) The lessor's obligation bears a reasonable rate of interest. For
this purpose, a rate of interest shall be presumed to be reasonable if,
on the date the agreement is executed, it is within 3 percentage points
of (i) the rate in effect under section 6621, the prime rate in effect
at any local commercial bank, or the most recent applicable rate
determined by the Secretary under Sec. 1.385-6 (e)(2)(i), or (ii) an
arm's-length rate as defined in Sec. 1.482-2, or (iii) any rate between
any two of the rates described by subdivisions (i) and (ii) of this
paragraph(b)(2).
[[Page 94]]
(c) Interest deductions and income--(1) Deductibility from income.
In determining the amount of interest that a lessor may deduct in a
taxable year with respect to its purchase money obligation given to the
lessee or to a third party creditor, the lessor may not claim a
deduction that would be--
(i) Greater than a deduction that would be allowed to an accrual
basis taxpayer under a level-payment mortgage, amortized over a period
equal to the term of the lessor's obligation, or
(ii) Less than a deduction that would be allowed to an accrual basis
taxpayer under a straight line amortization of the principal over the
term of the lessor's obligation.
In cases in which the property is not financed by the lessee or a party
related to the lessee, the computation of the interest deduction may
take into account fluctuations in the interest rate which are dependent
on adjustments in the prime rate or events outside the control of the
lessor and the third party creditor.
(2) Includibility in income. The lessee shall include interest on
the lessor's purchase money obligation in income at the same time and in
the same amount as the lessor's interest deductions, as determined under
paragraph (c)(1).
(d) Rental income and deductions--(1) Deductibility from income. The
amount of the lessee's rent deduction under a section 168(f)(8) lease
with respect to any taxable year shall be a pro rata portion of the
aggregate amount required to be paid by the lessee to the lessor under
the terms of the lease agreement. If the lessee is required to purchase
the leased property at the end of the lease term, of if the lessor has
an option to sell the property to the lessee, rent shall not include the
lesser of--
(i) The amount of the lessee's purchase obligation, whether fixed by
the terms of the lease agreement or conditioned on the exercise of the
lessor's option to sell the property to the lessee, or
(ii) The fair market value of the property at the end of the lease
term determined at the beginning of the lease term.
For this purpose, fair market value shall be determined without taking
into account any increase or decrease for inflation or deflation during
the lease term. Rent deductions may be adjusted pursuant to the terms of
the lease agreement to account for fluctuations which are dependent on
events outside the control of the lessor and lessee, such as a change in
the interest rate charged by a third party creditor of the lessor on the
debt incurred to finance the purchase of the leased property.
(2) Includibility in income. The lessor shall include rent in income
as follows:
(i) In the case of prepayments of rent, the earlier of when such
rent is paid by the lessee or accrued under the lease, and
(ii) In the case of other rent, at the same time and in the same
amount as the lessee's rent deductions, as determined under paragraph
(d)(1).
(e) ACRS deductions. The deductions that the lessor is allowed under
section 168(a) with respect to property subject to a section 168(f)(8)
lease shall be determined without regard to the limitation in section
168(f)(10)(B)(iii). The recovery class of qualified leased property in
the hands of the lessor shall be determined by the character of the
property in the hands of the owner of the property without regard to
section 168(f)(8). Any elections under section 168(b)(3) by the lessor
with respect to the class of recovery property to which the qualified
leased property is assigned shall apply to the leased property. However,
with respect to RRB replacement property, the transitional rule of
section 168(f)(3) shall be inapplicable to the lessor.
(f) At risk requirements. The amount of the investment credit and
ACRS deductions that a lessor shall be allowed with respect to the
leased property shall be limited to the extent the at risk rules under
the investment tax credit provisions and section 465 apply to the lessee
or to the lessor. In determining the amount the lessee would be at risk,
the at risk rules will be applied as if the lessee had not elected to
have section 168(f)(8) apply. Thus, for example, if, without regard to
section 168(f)(8), an individual lessee would be
[[Page 95]]
treated as the owner of the leased property for Federal tax law
purposes, the lessor under a section 168(f)(8) lease would be allowed
ACRS deductions or investment tax credits with respect to the property
only to the extent that the lessee may have claimed them had the parties
not elected treatment under section 168(f)(8). In addition, the ACRS
deductions and investment tax credits that a lessor is allowed with
respect to the property are further limited to the extent that the at
risk rules apply to the lessor as owner of the property under the
section 168(f)(8) lease. If the lessor and the lessee are subject to the
at risk rules, the lessor is allowed only the lesser of the ACRS
deductions and investment tax credits allowable to the lessor and the
lessee.
(g) Limitation on section 48(d) amount. If in a sale and leaseback
transaction the lessor elects pursuant to section 48(d) to treat the
lessee (which is the user of the property) as having acquired the
property for purposes of claiming the investment tax credit, the lessee
shall be treated as acquiring the property for an amount equal to the
basis of the property to the lessor (and not for an amount equal to its
fair market value). The investment tax credit allowable to the lessee is
further limited to the extent the at risk rules apply to either the
lessor or to the lessee. See paragraph (f) of this section.
(h) Examples. The application of the provisions of this section may
be illustrated by the following examples.
Example (1). Y, a qualified lessor, acquires a piece of equipment
which is qualified leased property for $1 million and leases it to X
under a lease which the parties properly elect to have characterized as
a lease described in section 168(f)(8). The equipment has a 10-year
economic life and falls within the 5-year ACRS class. Under the terms of
the lease, X, the lessee-user, is obligated to pay Y nine annual
payments of $10,000 and, at the end of the lease term, Y has the option
to sell the property to X for $2,160,000. Under Sec. 5c.168(f)(8)-7(d),
the aggregate payments required to be made by X under the lease are
$2,250,000 ($90,000 rent plus $2,160,000 option price) and are treated
as rent to Y (less a reasonable estimate for the residual value of the
property) and taxable as such. Assuming a reasonable estimate of the
residual value is zero, the full $2,250,000 will be treated as rent, and
under Sec. 5c.168(f)(8)-7(d), such amount is deductible by X and
includible in Y's income ratably over the term of the lease, i.e., at a
rate of $250,000 per year ($2,250,000 divided by 9).
Example (2). The facts are the same as in example (1) except that
under the terms of the lease X is obligated to make rental payments of
$100,000 for each of the first 5 years of the lease and $300,000 for
each of the 4 remaining years under the lease. Further, X has an option
to purchase the equipment for $1.00 at the end of the lease term.
Pursuant to Sec. 5c.168(f)(8)-7(d), X's aggregate rental payments are
deductible by X and are includible in Y's income ratably over the term
of the lease. Thus, the annual rental payments are deemed to be $188,000
per year ($1,700,000 divided by 9).
[T.D. 7791, 46 FR 51907, Oct. 23, 1981, as amended by T.D. 7795, 46 FR
56150, Nov. 13, 1981]
Sec. 5c.168(f)(8)-8 Loss of section 168(f)(8) protection; recapture.
(a) In general. Upon the occurrence of an event that causes an
agreement to cease to be characterized as a lease under section
168(f)(8), the characterization of the lessor and lessee shall be
determined without regard to section 168(f)(8).
(b) Events which cause an agreement to cease to be characterized as
a lease. A disqualifying event shall cause an agreement to cease to be
treated as a lease under section 168(f)(8) as of the date of the
disqualifying event. A disqualifying event shall include the following:
(1) The lessor sells or assigns its interest in the lease or in the
qualified leased property in a taxable transaction.
(2) The failure by the lessor to file a copy of the information
return (or applicable statement) with its income tax return as required
in Sec. 5c.168(f) (8)-2 (a)(3)(iii).
(3) The lessee (or any transferee of the lessee's interest) sells or
assigns its interest in the lease or in the qualified leased property in
a transaction not described in Sec. 5c.168(f)(8)-2(a)(6) and the
transferee fails to execute, within the prescribed time, the consent
described in Sec. 5c.168(f)(8)-2(a)(5), or either the lessor or the
transferee fail to file statements with their income tax returns as
required by that paragraph.
(4) The property ceases to be section 38 property as defined in
Sec. 1.48-1 in the hands of the lessor or lessee, for example, due to
its conversion to personal
[[Page 96]]
use or to use predominantly outside the United States, or to use by a
lessee exempt from Federal income taxation.
(5) The lessor ceases to be a qualified lessor by becoming an
electing small business corporation or a personal holding company
(within the meaning of section 542(a)).
(6) The minimum investment of the lessor becomes less than 10
percent of the adjusted basis of the qualified leased property as
described in section 168(f)(8)(B)(ii) and Sec. 5c.168(f)(8)-4.
(7) The lease terminates.
(8) The property becomes subject to more than one lease for which an
election is made under section 168(f)(8).
(9) Retirements and casualties. [Reserved]
(10) The property is transferred in a bankruptcy or similar
proceeding and the lessor fails either to furnish the appropriate
notification or to file a statement with its income tax return as
required by Sec. 5c.168(f)(8)-2(a)(6).
(11) The property is transferred in a bankruptcy or similar
proceeding and not all lenders with perfected and timely interests in
the property specifically exclude or release the Federal income tax
ownership of the property as required under Sec. 5c.168(f)(8)-
2(a)(6)(iii.)
(12) The property is transferred subsequent to a bankruptcy or
similar proceeding and the lessor fails to furnish notice to the
transferee prior to the transfer or fails to file a statement with its
income tax return, and either the lessor fails to secure the
transferee's consent or the lessor or the transferee fail to file
statements with their returns.
(13) The property is leased under the provisions of section
168(f)(8)(D)(iii) and Sec. 5c.168(f)(8)-6(b)(3) and ceases to be a
qualified mass commuting vehicle.
(14) The failure by the lessor to file the required information
return described in Sec. 5c.168(f)(8)-2 (a)(3)(ii) by January 31, 1982,
unless the lessee files such return by January 31, 1982.
(c) Recapture. The required amount of recapture of the investment
tax credit and of accelerated cost recovery deductions after a
disqualifying event shall be determined under sections 47 and 1245,
respectively.
(d) Consequences of loss of safe harbor protection. The tax
consequences of a disqualifying event depend upon the characterization
of the parties without regard to section 168(f)(8). If the lessee would
be the owner of the property without regard to section 168(f)(8), the
disqualifying event will be deemed to be a sale of the qualified leased
property by the lessor to the lessee. The amount realized by the lessor
on the sale will include the outstanding amount (if any) of the lessor's
debt on the property plus the sum of any other consideration received by
the lessor. A disposition that results from a disqualifying event shall
not be treated as an installment sale under section 453.
(e) Examples. The application of the provisions of this section may
be illustrated by the following examples:
Example (1). M Corp. and N Corp. enter into a sale and leaseback
transaction in which the leaseback agreement is characterized as a lease
under section 168(f)(8) and M is treated as the lessor. In the second
year of the lease, M becomes an electing small business corporation
under subchapter S. The agreement ceases to be treated as a lease under
section 168(f)(8) as of the date of the subchapter S election. Without
respect to section 168(f)(8), N would be considered the owner of the
property. The disqualification of M will be treated as a sale of the
qualified leased property from M to N for the amount of the purchase
money debt on the property then outstanding. M will realize gain or
loss, depending upon its basis, with applicable investment tax credit
and section 1245 recapture. N will acquire the property with a basis
equal to the amount of the outstanding obligation. The property will not
be used section 38 property to N under Sec. 1.48-3(a)(2).
Example (2). Q Corp. (as lessor) and P Corp. (as lessee) enter into
a lease that is characterized as a lease under section 168(f)(8). The
lease has a 6-year term. P has no option to renew the lease or to
purchase the property. At the end of 6 years, if P would be considered
the owner of the property without regard to section 168(f)(8), upon the
termination of the lease the property will be deemed to be sold by Q to
P for the amount of the purchase money debt outstanding with respect to
the property.
[T.D. 7791, 46 FR 51907, Oct. 23, 1981, as amended by T.D. 7795, 46 FR
56150, Nov. 13, 1981; T.D. 7800, 46 FR 63259, Dec. 31, 1981]
[[Page 97]]
Sec. 5c.168(f)(8)-9 Pass-through leases--transfer of only the investment tax credit to a party other than the ultimate user of the property. [Reserved]
Sec. 5c.168(f)(8)-10 Leases between related parties. [Reserved]
Sec. 5c.168(f)(8)-11 Consolidated returns. [Reserved]
Sec. 5c.442-1 Temporary regulations relating to change of annual accounting period.
(a) Applicability. The rules of paragraph (b) of this section apply
to a request for a change of annual accounting period if--
(1) The taxpayer requesting the change of annual accounting period
is an individual;
(2) The purpose for the change of annual accounting period is to
benefit as of the first day of a calendar year from changes in the
individual income tax rates that do not apply until the first day of the
taxpayer's taxable year because of section 21(d) (relating to
inapplicability of section 21 to changes made by the Economic Recovery
Tax Act of 1981);
(3) The requested change of annual accounting period is from a
fiscal year to a calendar year;
(4) In the case of a principal partner in a partnership formed after
April 1, 1954, whose principal partners all change to a calendar year,
the partnership changes to a calendar year;
(5) In the case of a shareholder in an electing small business
corporation whose shareholders all change to a calendar year, the small
business corporation changes to a calendar year; and
(6) The short period involved in the change ends on December 31,
1981 or December 31, 1982.
(b) Special rules. In the case of a request for a change of annual
accounting period described in paragraph (a) of this section, the
following special rules apply:
(1) The substantial business purpose requirement contained in
Sec. 1.442-1(b) (relating to change of annual accounting period) does
not apply.
(2) If the short period involved in the change ends on December 31,
1981, the application for change of annual accounting period may be
filed at any time on or before June 15, 1982.
(3) The taxpayer may obtain approval of a change of annual
accounting period in the manner set forth in Rev. Proc. 82-25, 1982-15
I.R.B.
(4) The taxpayer shall disclose on the application for change of
accounting period any partnership formed after April 1, 1954 in which
the taxpayer is a principal partner and any electing small business
corporation in which the taxpayer is a shareholder.
(5) Approval of the change of annual accounting period will be
granted without regard to the number of years that have elapsed since
the taxpayer's previous change of annual accounting period.
(6) No subsequent change of annual accounting period will be
approved if the short period involved in the subsequent change would end
fewer than 5 calendar years after the last day of the short period
involved in the change of accounting period described in paragraph (a)
of this section. If the short period involved in the subsequent change
would end more than 5 calendar years after the last day of the short
period involved in the change of accounting period described in
paragraph (a) of this section, the Commissioner will determine whether
to approve such change--
(i) Without regard to the change of annual accounting period
described in paragraph (a) of this section; and
(ii) In the case of a change to the fiscal year used by the taxpayer
before the change of annual accounting period described in paragraph (a)
of this section, without regard to the number of years that have elapsed
since the taxpayer previously adopted such fiscal year.
(Sec. 7805, Internal Revenue Code of 1954 (68A Stat. 917 (26 U.S.C.
7805)))
[T.D. 7816, 47 FR 15331, Apr. 9, 1982]
Sec. 5c.1305-1 Special income averaging rules for taxpayers otherwise required to compute tax in accordance with Sec. 5c.1256-3.
(a) In general. If an eligible individual (as defined in section
1303 and the regulations thereunder) is described in the first sentence
of Sec. 5c.1256-3(a), chooses
[[Page 98]]
the benefits of income averaging and otherwise complies with the special
rules under section 1304 and the regulations thereunder, and has
averagable income (as defined in section 1302 and the regulations
thereunder) in excess of $3,000, then the individual shall compute the
tax under section 1301 as provided in this section. The computation
under this section shall be in lieu of the computation under
Sec. 5c.1256-3.
(b) Computation of tax. The individual shall compute the tax under
section 1301 as follows:
Step (1). Compute tax under section 1301 and the regulations thereunder
on all taxable income, including gains or losses on regulated futures
contracts subject to section 1256(a) and the regulations thereunder,
using rates applicable to the taxpayer for the taxable year which
includes June 23, 1981.
Step (2). Compute tax under section 1301 and the regulations thereunder
on all taxable income, including gains or losses on regulated futures
contracts subject to section 1256(a) and the regulations thereunder,
using rates applicable to the taxpayer for taxable years beginning in
1982.
Step (3). Compute the percentage of adjusted gross income attributable
to all sources except regulated futures contracts subject to section
1256(a) and the regulations thereunder.
Step (4). Compute the percentage of adjusted gross income attributable
to regulated futures contracts subject to section 1256(a) and the
regulations thereunder. Both the percentage in Step (3) and the
percentage in Step (4) are to be rounded to the nearest percent. The sum
of both percentages must equal 100 percent.
Step (5). Multiply the result of Step (1) with the result of Step (3).
Step (6). Multiply the result of Step (2) with the result of Step (4).
Step (7). Add the result of Step (5) and the result of Step (6). This is
the tax for the individual under section 1301 for the taxable year which
includes June 23, 1981.
(c) Option to defer tax. If an individual computes the tax under
section 1301 as provided in paragraph (a) of this section, the
individual may also opt to pay part or all of the deferrrable tax under
income averaging (as defined in paragraph (d) of this section) for the
taxable year which includes June 23, 1981, in 2 or more, but not more
than 5, equal installments in accordance with this section. Such
individual may not opt to pay part or all of the deferrable tax in
installments under Sec. 5c.1256-3. An individual opting to defer payment
must attach a statement to Form 6781 indicating the computation of
deferrable tax under income averaging, the number of installments in
which the individual opts to pay the deferrable tax under income
averaging, and the amount of each such payment.
(d) Deferrable tax under income averaging. The deferrable tax under
income averaging is the excess of--
(1) The tax for the taxable year which includes June 23, 1981,
computed pursuant to paragraph (b) of this section, over
(2) The tax for the taxable year which includes June 23, 1981,
computed pursuant to paragraph (b) of this section, except that pre-
transitional year gain or loss (as described in Sec. 5c.1256-2(g)) is
omitted for purposes of recomputing the percentage in Step (4). As
computed under this subparagraph (2), the sum of the percentage in Step
(3) and Step (4) will not equal 100 percent.
(e) Rules of application. The provisions of Sec. 5c.1256-3 (c), (f),
(g), (h), (i), and (j) shall apply in computing the tax and in
determining the deferrable tax under income averaging under this
section.
(f) Examples. The application of this section may be illustrated by
the following examples:
Example (1). Individual A is a single, calendar year taxpayer with
no dependents. A reported the following amounts for the following years
on line 34 of Form 1040:
1977--$80,000
1978--$90,000
1979--$100,000
1980--$110,000
A reports the following amounts for the following lines on Form 1040 for
1981:
line 7--$120,000
line 12--$600,000
line 32b--$19,000
line 33--$1,000
The amount on line 12 is computed as follows: $937,500 of gain is
attributable to regulated futures contracts subject to section 1256(a).
Of that total, 40 percent is short term capital gain ($375,000) and 60
percent is long term capital gain ($562,500). Of the long term capital
gain, 40 percent is taxable ($225,000). Therefore, A reports $600,000 on
line 12 ($375,000+$225,000).
The result of Step (1) is $464,013.41. The result of Step (2) is
$337,051.52. The result of Step (3) is 17 percent. The result of Step
(4)
[[Page 99]]
is 83 percent. The result of Step (5) is $78,882.28. The result of Step
(6) is $279,752.76. The result of Step (7) is $358,635.04. This is A's
tax for 1981 under section 1301.
Example (2). The facts are the same as in Example (1), except that
$703,125 of the $937,500 gain attributable to regulated futures
contracts is pre-transitional year gain or loss (as described in
Sec. 5c.1256-2(g)). A's tax for 1981 under section 1301 is $358,635.04.
A may opt to pay in installments a maximum of $221,004.68 of the tax due
in 1981. If A opts to defer the maximum amount and pay in 5 equal
installments, A must pay for 1981 a tax of $181,831.30. Each of the 4
succeeding installments is $44,200.94 plus interest computed in
accordance with Sec. 5c.1256-3(g)(3).
(Secs. 1305 and 7805 of the Internal Revenue Code of 1954 (78 Stat. 110,
26 U.S.C. 1305; 68A Stat. 917, 26 U.S.C. 7805); secs. 508(c) and 509 of
the Economic Recovery Tax Act of 1981 (95 Stat. 333-335))
[T.D. 7826, 47 FR 38692, Sept. 2, 1982]
PART 5e--TEMPORARY INCOME TAX REGULATIONS, TRAVEL EXPENSES OF MEMBERS OF CONGRESS--Table of Contents
Authority: Secs. 280A(f)(4)(B) and 7805 of the Internal Revenue Code
of 1954 (95 Stat. 1641, 26 U.S.C. 7805; 68A Stat. 917, 26 U.S.C. 7805).
Sec. 5e.274-8 Travel expenses of Members of Congress.
(a) In general. Members of Congress (including any Delegate and
Resident Commissioner) who are away from home within the meaning of
section 162 (a), in the Washington, DC area, may elect in accordance
with paragraph (f) of this section to deduct an amount described in
paragraph (c) of this section as living expenses, without
substantiation. A Member who elects under this section may not deduct
any amount for the living expenses described in paragraph (b). A Member
who does not make an election under this section must substantiate his
expenses for living in Washington, DC in accordance with section 274 and
Sec. 1.274-5.
(b) Living expenses covered. The amount allowed to be deducted
without substantiation, pursuant to this section, for costs incurred for
living in the Washington, DC area represents amounts expended for meals,
lodging, and other incidental expenses. Meals include the actual cost of
the food and expenses incident to the preparation and serving thereof.
Lodging includes amounts paid for rent, care of premises, utilities,
insurance and depreciation of household furnishings owned by the Member.
In the case of a Member who lives in a residence owned by him in the
Washington, DC area, the cost of lodging also includes depreciation on
such residence. Other incidental expenses include laundry, cleaning, and
local transportation. Local transportation includes travel within a 50
mile radius of Washington, DC, whether by private automobile, taxicab or
other transportation for hire. Interest and taxes on personal property
will not be considered expenses to be included within this paragraph.
(c)(1) Amounts allowed without substantiation. The amount that may
be deducted pursuant to section 162 and these regulations is an amount
equal to the product of the number of Congressional days in the taxable
year, multiplied by the designated amount. The designated amount is--
(i) In the case of a Member who deducts interest and taxes
attributable to the ownership of a personal residence in the Washington,
DC area, two-thirds of the maximum amount of actual subsistence for
Washington, DC payable pursuant to 5 U.S.C. 5702(c), or
(ii) In the case of a Member not described in paragraph (c)(1)(i),
the maximum amount of actual subsistence for Washington, DC payable
pursuant to 5 U.S.C. 5702(c).
A Member who incurs interest and taxes on his residence in the
Washington, DC area may forego the deduction of such amounts and use the
designated amount prescribed by paragraph (c)(1)(ii).
(2) If a Member, who lives in a residence owned by him in the
Washington, DC area, chooses to deduct amounts prescribed in paragraph
(c)(1) of this section, the Member must treat as an adjustment to the
basis of such residence an amount equal to 20 percent of the maximum
amount of actual subsistence multiplied by the number of Congressional
days. Such adjustments will be considered a proper adjustment
[[Page 100]]
for exhaustion, wear, and tear under this subtitle.
(d) Congressional days. The number of Congressional days with
respect to a Member is the number of days in the taxable year less the
number of days in periods in which the Member's Congressional chamber
was not in session for 5 consecutive days or more (including Saturday
and Sunday). The number of days with respect to a Member is determined
without regard to whether or not the Member was in the Washington, DC
area on such days.
[[Page 101]]
[GRAPHIC] [TIFF OMITTED] TC16OC91.000
(e) Other deductible amounts. This section does not preclude the
deduction of otherwise allowable expenses for travel fares (other than
local travel in the Washington, DC), long distance telephone and
telegraph, and travel expenses incurred other than in the Washington, DC
area. However, such
[[Page 102]]
expenses are subject to the substantiation requirements of section 274.
(f) Election. To elect to deduct the amounts prescribed by this
section, a Member must attach to his return for the taxable year a
statement indicating, (1) that the deduction for travel expenses while
living in the Washington, DC area are computed pursuant to Sec. 5e.274-
8, and (2) whether a separate deduction is being taken for interest and
taxes paid or incurred with respect to the personal residence of the
Member if in the Washington, DC area.
(g) Effective date. This section is effective for taxable year
beginning after December 31, 1980.
(h) Examples. The following examples are based on a calendar from a
Final Edition of the Calendar of the United States, House of
Representatives and History of Legislation. The marked days indicate
days the House of Representatives was in session.
Example 1--In determining the number of Congressional days for 198X
for which the designated amount may be computed, the number of days in
such year is reduced by 125 days determined as follows:
------------------------------------------------------------------------
Days
------------------------------------------------------------------------
Feb. 14-18..................................................... 5
Apr. 3-14...................................................... 12
May 23-27...................................................... 5
July 3-20...................................................... 18
Aug. 2-17...................................................... 16
Aug. 29-Sept. 2................................................ 5
Oct. 3-Nov. 11................................................. 40
Nov. 22-Nov. 30................................................ 9
Dec. 17-Dec. 31................................................ 15
--------
Total...................................................... 125
------------------------------------------------------------------------
Thus for 198X (a leap year) a typical Member of the House of
Representatives will have 241 (366-125) Congressional days.
Example 2--On August 1, Z a calendar year taxpayer is elected to the
Congress to fill the unexpired term of Member Y. In determining the
number of Congressional days, Z may only consider the number of days
during the year for which he was a Member of Congress. For Z the number
of Congressional days is 68.
Example 3--Member X, a calendar year taxpayer, owns his own home in
Washington, DC, where he lives with his family. While in Washington, DC,
Member X is away from home within the meaning of section 162(a). X
maintains no records attributable to his expenses in Washington, DC X
has been a Member of Congress for the entire year. The maximum amount of
subsistence for Washington, DC for 198X is $75. X may deduct for 198X
$18,075 (241 days x $75) attributable to expenses while away from home
in Washington, DC. Even if X maintained records as to living expenses in
Washington, DC, X may choose to deduct $18,075 as the total amount
attributable to living expenses in Washington, DC. If X deducts $18,075
X may not deduct any interest and taxes under section 163 or 164
attributable to the residence in Washington, DC.
Example 4--Member C, a calendar year taxpayer owns his own home in
Washington, DC, where he lives with his family. While in Washington, DC.
Member C is away from home within the meaning of section 162(a). C can
establish that he paid $12,000 as interest on a mortgage and $3,000 in
local real estate taxes. C has been a Member of Congress for the entire
year. C may choose to deduct $12,050 (241 days x [\2/3\ x $75])
attributable to expenses in Washington, DC. Further, C may deduct under
sections 163 and 164 $12,000 of interest and $3,000 of taxes
respectively.
Example 5--Assume the same facts as in Example (4). In addition, on
March 15, 16, and 17, Member C travels to New York City to deliver a
speech for which he receives an honorarium which he includes in income.
C receives no additional amounts for travel reimbursement. While in New
York City C incurs $350 for 3 nights lodging at a hotel and $150 for
meals. In addition to the amounts deductible pursuant to this section, C
may deduct the $500 as a travel expenses. Such deduction is subject to
the substantiation rules of section 274.
Example 6--Assume the same facts as example (5). Member C receives,
in addition to the honorarium, $600 reimbursement for travel expenses. C
must include the $600 in income and may deduct the travel expenses he
incurred.
[T.D. 7802, 47 FR 2987, Jan. 21, 1982; 47 FR 4680, Feb. 2, 1982]
PART 5f--TEMPORARY INCOME TAX REGULATIONS UNDER THE TAX EQUITY AND FISCAL RESPONSIBILITY ACT OF 1982--Table of Contents
Sec.
5f.103-1 Obligations issued after December 31, 1982, required to be in
registered form.
5f.103-2 Public approval of industrial development bonds.
5f.103-3 Information reporting requirements for certain bonds.
5f.163-1 Denial of interest deduction on certain obligations issued
after December 31, 1982, unless issued in registered form.
5f.168(f)(8)-1 Questions and answers concerning transitional rules and
related matters regarding certain safe harbor leases.
5f.442-1 Temporary regulations relating to change of annual accounting
period.
[[Page 103]]
5f.6045-1 Returns of information of brokers and barter exchanges.
Authority: 26 U.S.C. 7805. Secs. 5f.103-1 and 5f.163-1 also issued
under 26 U.S.C. 103(j), 26 U.S.C. 163(f), and 96 Stat. 595. Sec.
5f.6045-1 also issued under 26 U.S.C. 6045.
Sec. 5f.103-1 Obligations issued after December 31, 1982, required to be in registered form.
(a) Registration; general rule. Interest on a registration-required
obligation (as defined in paragraph (b) of this section) shall not be
exempt from tax notwithstanding section 103 (a) or any other provision
of law, exclusive of any treaty obligation of the United States, unless
the obligation is issued in registered form (as defined in paragraph (c)
of this section).
(b) Registration-required obligation. For purposes of this section,
the term ``registration-required obligation'' means any obligation
except any one of the following:
(1) An obligation not of a type offered to the public. The
determination as to whether an obligation is not of a type offered to
the public shall be based on whether similar obligations are in fact
publicly offered or traded.
(2) An obligation that has a maturity at the date of issue of not
more than 1 year.
(3) An obligation issued before January 1, 1983. An obligation first
issued before January 1, 1983, shall not be considered to have been
issued on or after that date merely as a result of the existence of a
right on the part of the holder of such obligation to convert the
obligation from registered form into bearer form, or as a result of the
exercise of such a right.
(4) An obligation described in Sec. 5f.163-1 (c) (relating to
certain obligations issued to foreign persons).
(c) Registered form--(1) General rule. An obligation issued after
January 20, 1987, pursuant to a binding contract entered into after
January 20, 1987, is in registered form if--
(i) The obligation is registered as to both principal and any stated
interest with the issuer (or its agent) and transfer of the obligation
may be effected only by surrender of the old instrument and either the
reissuance by the issuer of the old instrument to the new holder or the
issuance by the issuer of a new instrument to the new holder,
(ii) The right to the principal of, and stated interest on, the
obligation may be transferred only through a book entry system
maintained by the issuer (or its agent) (as described in paragraph
(c)(2) of this section), or
(iii) The obligation is registered as to both principal and any
stated interest with the issuer (or its agent) and may be transferred
through both of the methods described in subdivisions (i) and (ii).
(2) Special rule for registration of a book entry obligation. An
obligation shall be considered transferable through a book entry system
if the ownership of an interest in the obligation is required to be
reflected in a book entry, whether or not physical securities are
issued. A book entry is a record of ownership that identifies the owner
of an interest in the obligation.
(d) Effective date. The provisions of this section shall apply to
obligations issued after December 31, 1982, unless issued on an exercise
of a warrant for the conversion of a convertible obligation if such
warrant or obligation was offered or sold outside the United States
without registration under the Securities Act of 1933 and was issued
before August 10, 1982.
(e) Special rules. The following special rules apply to obligations
issued after January 20, 1987, pursuant to a binding contract entered
into after January 20, 1987.
(1) An obligation that is not in registered form under paragraph (c)
of this section is considered to be in bearer form.
(2) An obligation is not considered to be in registered form as of a
particular time if it can be transferred at that time or at any time
until its maturity by any means not described in paragraph (c) of this
section.
(3) An obligation that as of a particular time is not considered to
be in registered form by virtue of subparagraph (2) of this paragraph
(e) and that, during a period beginning with a later time and ending
with the maturity of the obligation, can be transferred only by a means
described in paragraph (c) of this section, is considered to be in
[[Page 104]]
registered form at all times during such period.
(f) Examples. The application of this section may be illustrated by
the following examples:
Example (1). Municipality X publicly offers its general debt
obligations to United States persons. The obligations have a maturity at
issue exceeding 1 year. The obligations are registration-required
obligations under Sec. 5f.103-1(b). When individual A buys an
obligation, X issues an obligation in A's name evidencing A's ownership
of the principal and interest under the obligation. A can transfer the
obligation only by surrendering the obligation to X and by X issuing a
new instrument to the new holder. The obligation is issued in registered
form.
Example (2). Municipality Y issues a single obligation on January 4,
1983 to Bank M provided that (i) Bank M will not at any time transfer
any interest in the obligation to any person unless the transfer is
recorded on Municipality Y's records (except by means of a transfer
permitted in (ii) of this example) and (ii) interests in the obligation
that are sold by Bank M (and any persons who acquire interests from M)
will be reflected in book entries. C, an individual, buys an interest in
Y's obligation from Bank M. Bank M receives the interest or principal
payments with respect to C's interest in the obligation as agent for C.
Bank M records interests in the Municipality Y obligation as agent of
Municipality Y. Any transfer of C's interest must be reflected in a book
entry in accordance with Bank M's agreement with Municipality Y. Since
C's interest can only be transferred through a book entry system
maintained by the issuer (or its agent), the obligation is considered
issued in registered form. Interest received by C is excludable from
gross income under section 103(a).
Example (3). Municipality Z wishes to sell its debt obligations
having a maturity in excess of 1 year. The obligations are sold to Banks
N, O, and P, all of which are located in Municipality Z. By their terms
the obligations are freely transferable, although each of the banks has
stated that it acquired the obligations for purposes of investment and
not for resale. Obligations similar to the obligations sold by
Municipality Z are traded in the market for municipal securities. The
obligations issued by Municipality Z are of a type offered to the public
and are therefore registration-required under Sec. 5f.103-1 (b).
Example (4). Corporation A issues an obligation that is registered
with the corporation as to both principal and any stated interest.
Transfer may be effected by the surrender of the old instrument and
either the reissuance by the issuer of the old instrument to the new
holder or the issuance by the issuer of a new instrument to the new
holder. The obligation can be converted into a form in which the right
to the principal of, or stated interest on, the obligation may be
effected by physical transfer of the obligation. Under Sec. 5f.103-1 (c)
and (e), the obligation is not considered to be in registered form and
is considered to be in bearer form.
Example (5). Corporation B issues its obligations in a public
offering in bearer definitive form. Beginning at X months after the
issuance of the obligations, a purchaser (either the original purchaser
or a purchaser in the secondary market) may deliver the definitive bond
in bearer form to the issuer in exchange for a registration receipt
evidencing a book entry record of the ownership of the obligation. The
issuer maintains the book entry system. The purchaser identified in the
book entry as the owner of record has the right to receive a definitive
bearer obligation at any time. Under Sec. 5f.103-1 (c) and (e), the
obligation is not considered to be issued in registered form and is
considered to be issued in bearer form. All purchasers of the obligation
are considered to hold an obligation in bearer form.
Example (6). Corporation C issues obligations in bearer form. A
foreign person purchases a definitive bearer obligation and then sells
it to a United States person. At the time of the sale, the United States
person delivers the bearer obligation to Corporation C and receives an
obligation that is identical except that the obligation is registered as
to both principal and any stated interest with the issuer or its agent
and may be transferred at all times until its maturity only through a
means described in Sec. 5f.103-1(c). Under Sec. 5f.103-1(e), the
obligation is considered to be in registered form from the time it is
delivered to Corporation C until its maturity.
(g) Cross-references. See section 103A(j)(1) for the registration
requirement of certain mortgage subsidy bonds issued after December 31,
1981, and Sec. 6a.103A-1(a)(5) for the definition of registered form for
such obligations issued after December 31, 1981, and on or before
December 31, 1982. See also section 103(h) (requiring registration of
certain energy bonds issued on or after October 18, 1979).
[T.D. 7852, 47 FR 51361, Nov. 15, 1982, as amended by T.D. 8111, 51 FR
15463, Dec. 19, 1986]
Sec. 5f.103-2 Public approval of industrial development bonds.
(a) General rule. An industrial development bond (within the meaning
of Sec. 1.103-7(b)(1) issued after December 31, 1982, shall be treated
as an obligation not described in section 103(a) unless it
[[Page 105]]
is issued as part of an issue which satisfies the public approval
requirement of section 103(k) and paragraph (c) of this section or is
described in the exceptions set forth in paragraph (b) of this section.
(b) Exceptions--(1) No extension of maturity. Paragraph (a) of this
section does not apply to a refunding obligation if--
(i) It refunds an obligation which was approved under section 103(k)
and this section (or which is treated as approved pursuant to paragraph
(f) of this section), and
(ii) It has a maturity date which is not later than the maturity
date of the obligation to be refunded.
(2) Refunding of pre-July 1, 1982, obligation. Paragraph (a) of this
section does not apply to an obligation issued solely to refund an
obligation which--
(i) Was issued before July 1, 1982, and
(ii) Has a term which does not exceed 3 years.
The term of an obligation is determined without regard to whether it is
a refunding obligation. With respect to the refunding of an issue also
containing obligations with terms which exceed 3 years, paragraph (b)(2)
applies only if the refunding issue proceeds are used solely to refund
obligations with terms not exceeding 3 years and to pay reasonable
incidental costs of the refunding (e.g., legal and accounting fees,
printing costs, and rating fees) attributable thereto. Paragraph (b)(2)
applies only to issues issued after December 31, 1982, the proceeds of
which are used to refund issues issued prior to July 1, 1982. Thus,
subsequent refundings of such refunding issues must satisfy the public
approval requirement of section 103(k) and paragraph (c) of this
section.
(c) Public approval requirement--(1) In general. An issue is
publicly approved if prior to the date of issue the governmental unit(s)
described in subparagraphs (2) and (3) this paragraph (c) approve the
issue, in the manner described in paragraph (d) of this section. See
paragraph (f) for rules pertaining to determining the scope of an
approval and paragraph (g)(1) for the definition of ``governmental
unit''.
(2) Issuer approval. The governmental unit (i) which will issue the
obligations or (ii) on behalf of which the issue is to be issued must
approve the issue (``issuer approval''). If the issuer is not a
governmental unit, the governmental unit on behalf of which the issuer
acts shall be determined in a manner consistent with determinations
under Sec. 1.103-1, and such unit must approve the issue. However, in
the case of an issuer which issues obligations on behalf of more than
one governmental unit (e.g., an authority which acts for two counties),
any one of such units may give the issuer approval required by this
paragraph (c)(2).
(3) Host approval. Each governmental unit the geographic
jurisdiction (as defined in paragraph (g)(4)) of which contains the site
of a facility to be financed by the issue must approve the issue (``host
approval''). However, if the entire site of a facility to be financed by
the issue is within the geographic jurisdiction of more than one
governmental unit within a State (counting the State as a governmental
unit within such State), then any one of such units may provide host
approval for the issue with respect to that facility. For purposes of
this paragraph (c)(3), if property to be financed by the issue is
located within two or more governmental units but not entirely within
either of such units, each portion of the property which is located
entirely within the smallest respective governmental units may be
treated as a separate facility. The issuer approval (as described in
paragraph (c)(2)) may be treated as a host approval if the governmental
unit giving the issuer approval is also a governmental unit described in
this paragraph (c)(3). See paragraph (e)(2) with respect to host
approval by a governmental unit with no applicable elected
representative.
(d) Method of public approval. For purposes of this section, an
issue is approved by a governmental unit only if--
(1) An applicable elected representative (as defined in paragraph
(e)) of such unit approves the issue following a public hearing (as
defined in paragraph (g)(2)) held in a location which, under the facts
and circumstances, is convenient for residents of the unit, and for
which there was reasonable public notice (as defined in paragraph
(g)(3)), or
[[Page 106]]
(2) A referendum of the voters of the unit (as defined in paragraph
(g)(5)) approves the issue.
An approval may satisfy the requirements of this section without regard
to the authority under State or local law for the acts constituting such
approval. The location of hearing will be presumed convenient for
residents of the unit if it is located in the approving governmental
unit's capital or seat of government. If more than one governmental unit
is required to provide a public hearing, such hearings may be combined
as long as the combined hearing is a joint undertaking that provides all
of the residents of the participating governmental units (i.e., those
relying on such hearing as an element of public approval) a reasonable
opportunity to be heard. The location of any combined hearing is
presumed to provide a reasonable opportunity to be heard provided it is
no farther than 100 miles from the seat of government of each
participating governmental unit beyond whose geographic jurisdiction the
hearing is conducted.
(e) Applicable elected representative--(1) In general. The
applicable elected representative of a governmental unit means--
(i) Its elected legislative body,
(ii) Its chief elected executive officer,
(iii) In the case of a State, the chief elected legal officer of the
State's executive branch of government, or
(iv) Any official elected by the voters of the unit and designated
for purposes of this section by the unit's chief elected executive
officer or by State or local law to approve issues for the unit.
For purposes of subdivisions (ii), (iii), and (iv) of this paragraph
(e)(1), an official shall be considered elected by the voters of the
unit only if he is popularly elected at-large by the voters of the
governmental unit. If an official popularly elected at-large by the
voters of a governmental unit is appointed or selected pursuant to State
or local law to be the chief executive officer of the unit, such
official is deemed to be an elected chief executive officer for purposes
of this section but for no longer than his tenure as an official elected
at-large. In the case of a bicameral legislature which is popularly
elected, both chambers together constitute an applicable elected
representative, but neither chamber does independently, unless so
designated under paragraph (e)(1)(iv). If multiple elected legislative
bodies of a governmental unit have independent legislative authority,
however, the body with the more specific authority relating to the issue
is the only legislative body described in paragraph (e)(1)(i) of this
section. See paragraph (h), Example (7) of this section.
(2) Governmental unit with no applicable elected representative. (i)
The applicable elected representatives of a governmental unit with no
representative (but for this paragraph (e)(2) and section
103(k)(2)(E)(ii)) are deemed to be those of the next higher governmental
unit (with an applicable elected representative) from which the
governmental unit derives its authority. For purposes of this
subparagraph (2), a governmental unit derives its authority from another
unit which--
(A) Enacts a specific law (e.g., a provision in a State
constitution, charter or statute) by or under which the governmental
unit is created,
(B) Otherwise empowers or approves the creation of the governmental
unit, or
(C) Appoints members to the governing body of the governmental unit.
In the case of a governmental unit with no applicable elected
representative (but for this paragraph (e)(2)), any unit described in
subdivision (A), (B), or (C) or this paragraph (e)(2)(i) may be treated
as the next higher unit, without regard to the relative status of all of
such units under State law.
(ii) In the case of a host approval (as required under paragraph
(c)(3) of this section), a unit may be treated as the next higher unit,
only if--
(A) The facility is located within its geographic jurisdiction, and
(B) Eligible individuals, if any, residing at the site of the
facility are entitled to vote for the applicable elected representative
of that unit (as determined under this paragraph (e)).
(3) On behalf of issuers. In the case of an issuer which is not a
governmental unit but which issues bonds on behalf of a governmental
unit, the applicable elected representative is any applicable elected
representative of the unit on behalf of which the bonds are issued. If
[[Page 107]]
the unit on behalf of which the bonds are issued has no applicable
elected representative (but for paragraph (e)(2) of this section), the
applicable elected representative of the governmental unit is determined
in the manner described in paragraph (e)(2).
(f) Scope of approval--(1) In general. Public approval is required
by section 103(k) and this section for issues of industrial development
bonds, except as otherwise provided in paragraphs (a) and (b) of this
section. An issue is treated as approved if the governmental units
(described in paragraph (c) of this section in relation to the issue)
have approved either--
(i) The issue (by approving each facility to be financed), not more
than one year before the date of issue, or
(ii) A plan of financing for each facility financed by the issue
pursuant to which the issue in question is timely issued (as required in
paragraph (f)(3) of this section).
In either case, the scope of the approval is determined by the
information, as specified in paragraph (f)(2), contained in the notice
of hearing (when required) and the approval.
(2) Information required. A facility is within the scope of an
approval if the notice of hearing (when required) and the approval
contain--
(i) A general, functional description of the type and use of the
facility to be financed (e.g., ``a 10,000 square foot machine shop and
hardware manufacturing plant'', ``400-room airport hotel building'',
``dock facility for supertankers'', ``convention center auditorium and
sports arena with 25,000 seating capacity'', ``air and water pollution
control facilities for oil refinery''),
(ii) The maximum aggregate face amount of obligations to be issued
with respect to the facility,
(iii) The initial owner, operator, or manager of the facility,
(iv) The prospective location of the facility by its street address
or, if none, by a general description designed to inform readers of its
specific location.
An approval is valid for purposes of this section with respect to any
issue used to provide publicly approved facilities, notwithstanding
insubstantial deviations with respect to the maximum aggregate face
amount of the bonds issued under the approval for the facility, the name
of its initial owner, manager, or operator, or the type or location of
the facility from that described in the approval. An approval or notice
of public hearing will not be considered to be adequate if any of the
items in subdivisions (i) through (iv) of this subparagraph (2), with
respect to the facility to be financed, are unknown on the date of the
approval or the date of the public notice.
(3) Timely issuance pursuant to a plan of financing. An issue is
timely issued pursuant to a plan of financing for a facility if--
(i) The issue is issued no later than 3 years after the first issue
pursuant to the plan, and
(ii) The first such issue in whole or in part issued pursuant to the
plan was issued no later than 1 year after the date of approval.
(4) Facility--definition. For purposes of this paragraph (f), the
term ``facility'' includes a tract or adjoining tracts of land, the
improvements thereon and any personal property used in connection with
such real property. Separate tracts of land (including improvements and
connected personal property) may be treated as one facility only if they
are used in an integrated operation.
(g) Definitions. For purposes of this section--(1) Governmental
unit. Governmental unit has the same meaning as in Sec. 1.103-1. Thus, a
governmental unit is a State, territory, a possession of the United
States, the District of Columbia, or any political subdivision thereof.
The term ``political subdivision'' denotes any division of any State or
local governmental unit which is a municipal corporation or which has
been delegated the right to exercise part of the sovereign power of the
unit.
(2) Public hearing. Public hearing means a forum providing a
reasonable opportunity for interested individuals to express their
views, both orally and in writing, on the proposed issue of bonds and
the location and nature of a proposed facility to be financed. In
general, a governmental unit may select its own procedure for the
hearing, provided that interested individuals
[[Page 108]]
have a reasonable opportunity to express their views. Thus, it may
impose reasonable requirements on persons who wish to participate in the
hearing, such as a requirement that persons desiring to speak at the
hearing so request in writing at least 24 hours before the hearing or
that they limit their oral remarks to 10 minutes. For purposes of this
public hearing requirement, it is not necessary, for example, that the
applicable elected representative who will approve the bonds be present
at the hearing, that a report on the hearing be submitted to that
official, or that State administrative procedural requirements for
public hearings in general be observed. However, compliance with such
State procedural requirements (except those at variance with a specific
requirement set forth in this section) will generally assure that the
hearing satisfies the requirements of this section. The hearing may be
conducted by any individual appointed or employed to perform such
function by the governmental unit or its agencies, or by the issuer (if
on behalf of issuer). Thus, for example, for bonds to be issued by an
authority that acts on behalf of a county, the hearing may be conducted
by the authority, the county, or an appointee or employee of either.
(3) Reasonable public notice. Reasonable public notice means
published notice which is reasonably designed to inform residents of the
affected governmental units, including residents of the issuing unit and
the governmental unit where a facility is to be located, of the proposed
issue. The notice must state the time and place for the hearing and
contain the information contained in paragraph (f)(2) of this section.
Notice is presumed reasonable if published no fewer than 14 days before
the hearing. Except in the locality of the facility, publication is
presumed to be reasonably designed to inform residents of the approving
governmental unit if given in the same manner and same locations as
required of the approving governmental unit for any other purposes for
which applicable State or local law specifies a notice of public hearing
requirement (including laws relating to notice of public meetings of the
governmental unit). Notice is presumed reasonably designed to inform
affected residents in the locality of the facility only if published in
one or more newspapers of general circulation available to residents of
that locality or if announced by radio or television broadcast to those
residents.
(4) Geographic jurisdiction. Geographic jurisdiction is the area
encompassed by the boundaries prescribed by State or local law for a
governmental unit or, if there are no such boundaries, the area in which
a unit may exercise such sovereign powers that make that unit a
governmental unit for purposes of Sec. 1.103-1 and this section.
(5) Voter referendum. A voter referendum is a vote by the voters of
the affected governmental unit conducted in the manner and at such a
time as voter referenda on matters relating to governmental spending or
bond issuances by the governmental unit under applicable State and local
law.
(h) Examples. The provisions of this section may be illustrated by
the following examples:
Example (1). State X proposes to issue an industrial development
bond, the proceeds of which are to finance a facility located entirely
within the geographic jurisdiction of City Y (which is located in State
X). Under the provisions of paragraph (c), only State X must approve the
issue because State X is the issuer and the facility is to be located
entirely within the State's geographic jurisdiction. Its applicable
elected representative must approve the issue after the public notice
and public hearing requirements are satisfied.
Example (2). (i) Industrial Development Authority X proposes to
issue an industrial development bond, the proceeds of which are to
finance a facility located entirely within the geographic jurisdiction
of City Y (which is located in State Z). Authority X acts on behalf of
State Z. Under the provisions of paragraph (c), only State Z must
approve the issue because State Z is the governmental unit on behalf of
which Authority X, the issuer, is acting and the facility is to be
located entirely within its geographic jurisdiction.
(ii) State Z has a governor, an elected bicameral legislature and an
appointed attorney general who is the chief legal officer of State Z.
Under the laws of State Z, the attorney general must approve any issue
of industrial development bonds. The approval by the attorney general is
not a sufficient approval under this section, since the attorney
[[Page 109]]
general is not an applicable elected representative within the meaning
of this section. Under the provisions of paragraphs (d) and (e), either
the governor, both chambers of the legislature or any popularly elected
official of the State who is designated for this purpose by the governor
or by State law must approve the issue after the public notice and
public hearing requirements are satisfied.
Example (3). (i) County Y, a county in State X, proposes to issue an
industrial development bond, the proceeds of which are to finance a
facility located entirely within its jurisdiction. Under the provisions
of paragraph (c), only County Y must approve the issue because County Y
is the issuer and the facility is to be located entirely within the
geographic jurisdiction of County Y.
(ii) County Y has no elected officials or legislature. County Y
derives its authority from State X which is the next higher governmental
unit with an applicable elected representative. The laws of State X
designate the attorney general, who is an official of State X elected
at-large, as the official who must approve any issue of industrial
development bonds for the State. Under this section, State X's attorney
general is an applicable elected representative who may approve the
issue after the public notice and public hearing requirements are
satisfied.
Example (4). (i) City X, a city located in County Y and State Z,
proposes to issue an industrial development bond, the proceeds of which
are to finance a facility located entirely within the geographic
jurisdiction of City X. Under the provisions of paragraph (c), only City
X must approve the issue because it is the issuer and the facility is to
be located entirely within the geographic jurisdiction of City X.
(ii) Mayor A, the chief elected executive officer of City X, has
designated, for purposes of this section, Deputy Mayor B, an official of
City X elected at-large, to approve industrial development bond issues
for the city. Under the provisions of paragraph (e), Deputy Mayor B may
approve the issue, since he is an applicable elected representative,
after the public notice and public hearing requirements are satisfied.
Example (5). (i) County M proposes to issue an industrial
development bond to finance a project located partly within the
geographic jurisdiction of County M and partly within the geographic
jurisdiction of County N. Both counties are located in State X. The part
of the project in County N is also located partly within the geographic
jurisdiction of City O and partly within the geographic jurisdiction of
City P. Under the provisions of paragraph (c)(2), County M must give
issuer approval. Additionally, under the provisions of paragraph (c)(3),
either State X, County N, or both Cities O and P, must give host
approval.
(ii) Counties M and N will approve the issue, but neither has any
officials who are elected at-large by the voters of the respective
governmental units. Both governmental units derive their authority from
State X which is the next higher governmental unit with an applicable
elected representative. Under the provisions of paragraph (e), an
applicable elected representative of State X must approve the issue for
Counties M and N after the public notice and public hearing requirements
are satisfied.
Example (6). (i) County M proposes to issue an industrial
development bond to finance two facilities. One facility is located
entirely within the geographic jurisdiction of County M and the second
facility is located partly within the geographic jurisdiction of County
M and partly within the geographic jurisdiction of County N. The second
facility is also located within the geographic jurisdictions of Cities O
and P, which cities are located within the geographic jurisdiction of
County N. Under the provisions of paragraph (c)(2), County M must give
issuer approval. Additionally, under the provisions of paragraph (c)(3),
either State X, County N, or both Cities O and P, must give host
approval.
(ii) Counties M and N will approve the issue. Each has a chief
elected executive officer. Under the provisions of paragraphs (d) and
(e), the chief elected executive officer of each county may approve the
issue, after the public notice and public hearing requirements are
satisfied.
Example (7). (i) State X proposes to issue an industrial development
bond to finance a facility located partly within the geographic
jurisdiction of State X and partly within the geographic jurisdiction of
State Y. That portion of the facility located in State Y is located
entirely within the geographic jurisdiction of City Z. State X must give
issuer approval. Additionally, either State Y or City Z must give host
approval as that part of the facility to be located outside State X will
be entirely within the geographic jurisdiction of each unit.
(ii) Under the provisions of paragraphs (d) and (e), the governor of
State X may approve the issue, after the public notice and public
hearing requirements are satisfied. City Z (assuming that it give host
approval for the bond) has a city council and a school board, both of
which are elected legislative bodies with independent jurisdiction. The
authority of the school board is limited under State law to matters
directly concerning the provision of public education. Under paragraph
(e), the school board is not an applicable elected representative of
City Z but the city council is an applicable elected representative of
City Z. The city council may approve the issue after the public hearing
and public notice requirements are satisfied.
Example (8). (i) Public Housing Authority M, a governmental unit,
proposes to issue an
[[Page 110]]
industrial development bond to finance several housing projects with
known sites located entirely within its geographic jurisdiction. M's
geographic jurisdiction is coextensive with the combined geographic
jurisdictions of Counties N and O. The projects are separately owned and
managed. They are not adjacent to each other. The projects also are
located in County N. Under the provisions of paragraph (c), M must give
issuer approval.
(ii) M, which has no elected officials or legislature, was created
by both Counties N and O pursuant to a special statute of State Q
permitting such a joint undertaking. Both Counties N and O have an
applicable elected representative. Under the provisions of paragraph
(e)(2), either County N, County O, or State Q is deemed to be the next
higher governmental unit with an applicable elected representative, and
an applicable elected representative from any of these units may give
the issuer approval for Authority M. Therefore, either the applicable
representative of County N, County O, or State Q can give the issuer
approval for Authority M.
(iii) For purposes of the host approval, the issuer approval by M
will satisfy the host approval requirement only if the applicable
elected representative of County N or State Q gives issuer approval for
M. Under the provisions of paragraph (e)(2), the host approval
requirement is satisfied only if qualified persons residing at the site
of the facility are entitled to vote for the applicable elected
representative who gave the approval (i.e., the representative of State
Q or County N). However, if the applicable elected representative of O
gave issuer approval for Authority M, a separate host approval would be
required because the residents of the sites where the projects are
located (i.e., County N) could not note for the applicable elected
representative of County O.
(iv) Public Housing Authority M conducts a public hearing concerning
prospective housing projects following notice thereof published in a
newspaper of general circulation in County N. Additionally, M provides
notice to the residents of O (which are also within M's jurisdiction) in
the manner required for notice of public hearing for other purposes
under State Q law. Following the public hearing, the chief elected
executive officer of County N approves for Authority M prospective
issues for the project. M issues two $7 million issues, one for each
project. One issue is issued six months after the date of approval; the
second issue is issued thirteen months thereafter. On these facts, only
the first issue satisfied the public approval requirement of this
section.
[T.D. 7892, 48 FR 21117, May 11, 1983]
Sec. 5f.103-3 Information reporting requirements for certain bonds.
(a) General rule. Under section 103(l), any private purpose bond
issued after December 31, 1982 (including any obligation issued
thereafter to refund private purpose bonds issued before December 31,
1982) shall be treated as an obligation not described in section 103(a)
unless the information reporting requirement (as described in paragraph
(c) of this section) is substantially satisfied with respect to the
issue of which the bond is a part. For rules concerning bonds issued
after December 31, 1986, see Sec. 1.149(e)-1 of this chapter.
(b) Private purpose bonds. For purposes of this section, the term
``private purpose bond'' means--
(1) Any industrial development bond (as defined in section 103(b)(2)
and Sec. 1.103-7(b)(1)), or
(2) Any obligation which is issued as part of an issue all or a
major portion of the proceeds of which are to be used directly or
indirectly--
(i) To finance loans to individuals for educational or related
expenses (hereinafter referred to as a ``student loan bond''), or
(ii) By an organization described in section 501(c)(3) which is
exempt from taxation by reason of section 501(a) (hereinafter referred
to as ``private exempt entity bond'').
The meaning of the terms ``major portion'' and ``directly or
indirectly'' shall be the same as under Sec. 1.103-7. Student loan bonds
include, but are not limited to, qualified scholarship funding bonds (as
defined in section 103(e)).
(c) Information required. An obligation satisfies the requirements
of section 103(l) and this section only if it is issued as part of an
issue with respect to which the issuer, based on information and
reasonable expectations determined as of the date of issue, submits on
Form 8038 the information required therein, including--
(1) The name, address, and employer identification number of the
issuer,
(2) The date of issue (as defined in paragraph (g)(1)),
(3) The face amount of the issue,
(4) The total purchase price of the issue,
[[Page 111]]
(5) The amount allocated to a reasonably required reserve or
replacement fund,
(6) The amount of lendable proceeds (as defined in paragraph (g)(4)
of this section),
(7) The stated interest rate of each maturity (as defined in
paragraph (g)(2) of this section) or, if the interest rate is variable,
a description of the method under which the interest rate is computed,
(8) The term (as defined in paragraph (g)(3)) of each maturity,
(9) A general description of the property to be financed by the
issue (including property financed by an obligation that will be
refunded with the issue proceeds) which includes--
(i) The type of bond issued, that is, a student loan bond, a private
exempt entity bond, or an industrial development bond and in the case of
an industrial development bond described in section 103(b)(4), the
subparagraph of section 103(b)(4) that describes the property, e.g., for
a football stadium, that the property is described in section
103(b)(4)(B),
(ii) The recovery classes (as defined in section 168(c)(2)), if
applicable, of the various items of financed property and the
approximate amount of lendable proceeds attributable thereto,
(iii) The approximate amount of lendable proceeds attributable to
land or other property not described in subdivision (ii),
(iv) In the case of obligations described in section 103(b)(6) or
private exempt entity bonds, the four-digit Standard Industrial
Classification Code of the facilities financed,
(10) If section 103(k) (relating to public approval requirement for
industrial development bonds) applies to such issue, the name(s) of the
approving governmental unit(s) and of the applicable elected
representative(s) (as defined in section 103(k)(2)(E) and Sec. 5f.103-
2(e)) or a description of the voter referendum that approved the issue
for such unit(s), and
(11) The name, address, and employer identification number of--
(i) Each initial principal user (as defined in paragraph (g)(5) of
this section) of any facilities provided with the proceeds of the issue,
(ii) The common parent, if any, of any affiliated group of
corporations (as defined in section 1504(a) but determined without
regard to the exceptions of section 1504(b)) of which such initial
principal user is a member, and
(iii) Any person (not included under paragraph (c)(11)(i)) that is
treated as a principal user under section 103(b)(6)(L), but only if the
issue is treated as a separate issue under section 103(b)(6)(K).
The information to be supplied must be determined based on information
and reasonable expectations as of the date of issue. Therefore, such
statement need not be amended to report information learned subsequent
to the date of issue. However, if the statement is filed after the date
of issue it may reflect such information and the reasonable expectations
of the issuer as of that date.
(d) Additional information. An issuer may supply the following
information--
(1) The average maturity of the issue (as defined in section
103(b)(14)), and
(2) The average reasonably expected economic life (as defined in
section 103(b)(14)) of the facility which is financed with the issue.
(e) Time for filing. The statement required by section 103(l) and
this section shall be filed not later than the 15th day of the 2nd
calendar month after the close of the calendar quarter in which the
obligation is issued. It may be filed at any time before such date but
must be complete based on facts and reasonable expectations as of the
date of issue. The Secretary may grant an extension of time for filing
the statement required under section 103(l) and this section if there is
reasonable cause for the failure to file such statement in a timely
fashion.
(f) Place for filing. Form 8038 is to be mailed to the Internal
Revenue Service Center, Philadelphia, Pennsylvania 19255.
(g) Definitions. For purposes of this section--
(1) The term date of issue means the date on which the issuer
physically exchanges the first of the obligations which are part of the
issue for the underwriter's (or other purchaser's) funds. In the event
that amounts are
[[Page 112]]
periodically advanced with respect to an issue, the date of issue is
when the first of such obligations under the issue is created and the
funds are advanced.
(2) The term maturity means those obligations of the issue having
both the same maturity date and the same stated interest rate.
(3) The term term of an issue means the duration of the period
beginning on the date of issue and ending on the latest maturity date of
any obligation of the issue without regard to optional redemption dates.
(4) The term lendable proceeds means the amount of the original
proceeds, net of amounts allocated to a reasonably required reserve or
replacement fund. See generally Sec. 1.103-13(b) and Sec. 1.103-14(d)
for further definitions.
(5) The term initial principal user means each person who as of the
date of issue is obligated to use the facility to such an extent that
under section 103(b)(6) such person would be treated as a principal
user. With respect to organizations described in section 501(c)(3),
however, such determination is made without regard to whether such
organization is treated as an exempt organization under section
103(b)(3) and Sec. 1.103-7(b)(2).
[T.D. 7892, 48 FR 21120, May 11, 1983, as amended by T.D. 8129, 52 FR
7411, Mar. 11, 1987; T.D. 8425, 57 FR 36003, Aug. 12, 1992]
Sec. 5f.163-1 Denial of interest deduction on certain obligations issued after December 31, 1982, unless issued in registered form.
(a) Denial of deduction generally. Interest paid or accrued on a
registration-required obligation (as defined in paragraph (b) of this
section) shall not be allowed as a deduction under section 163 or any
other provision of law unless such obligation is issued in registered
form (as defined in Sec. 5f.103-1(c)).
(b) Registration-required obligation. For purposes of this section,
the term ``registration-required obligation'' means any obligation
except any one of the following:
(1) An obligation issued by a natural person.
(2) An obligation not of a type offered to the public. The
determination as to whether an obligation is not of a type offered to
the public shall be based on whether similar obligations are in fact
publicly offered or traded.
(3) An obligation that has a maturity at the date of issue of not
more than 1 year.
(4) An obligation issued before January 1, 1983. An obligation first
issued before January 1, 1983, shall not be considered to have been
issued on or after such date merely as a result of the existence of a
right on the part of the holder of such obligation to convert such
obligation from registered form into bearer form, or as a result of the
exercise of such a right.
(5) An obligation described in subparagraph (1) of paragraph (c)
(relating to certain obligations issued to foreign persons).
(c) [Reserved]
(d) Effective date. The provisions of this section shall apply to
obligations issued after December 31, 1982, unless issued on an exercise
of a warrant for the conversion of a convertible obligation if such
warrant or obligation was offered or sold outside the United States
without registration under the Securities Act of 1933 and was issued
before August 10, 1982.
(e) Obligations first issued after December 31, 1982, where the
right exists for the holder to convert such obligation from registered
form into bearer form. [Reserved]
(f) Examples. The application of this section may be illustrated by
the following examples:
Example (1). All of the shares of Corporation X are owned by two
individuals, A and B. X desires to sell all of its assets to Corporation
Y, all of the shares of which are owned by individual C. Following the
sale, Corporation X will be completely liquidated. As partial
consideration for the Corporation X assets, Corporation Y delivers a
promissory note to X, secured by a security interest and mortgage on the
acquired assets. The note given by Y to X is not of a type offered to
the public.
Example (2). Corporation Z has a credit agreement with Bank M
pursuant to which Corporation Z may borrow amounts not exceeding $10X
upon delivery of Z's note to Bank M. The note Z delivers to M is not of
a type offered to the public.
Example (3). Individuals D and E operate a retail business through
partnership DE. D wishes to loan partnership DE $5X. DE's note
evidencing the loan from D is not of a type offered to the public.
[[Page 113]]
Example (4). Individual F owns one-third of the shares of
Corporation W. F makes a cash advance to W. W's note evidencing F's cash
advance is not of a type offered to the public.
Example (5). Closely-held Corporation R places its convertible
debentures with 30 individuals who are United States persons. The
offering is not required to be registered under the Securities Act of
1933. Similar debentures are publicly offfered and traded. The
obligations are not considered of a type not offered to the public.
Example (6). In 1980, Corporation V issued its bonds due in 1986
through an offering registered with the Securities and Exchange
Commission. Although the bonds were initially issued in registered form,
the terms of the bonds permit a holder, at his option, to convert a bond
into bearer form at any time prior to maturity. Similarly, a person who
holds a bond in bearer form may, at any time, have the bond converted
into registered form.
(i) Assume G bought one of Corporation V's bonds upon the original
issuance in 1980. In 1983, G requests that V convert the bond into
bearer form. Except for the change from registered to bearer form, the
terms of the bond are unchanged. The bond held by G is not considered
issued after December 31, 1982, under Sec. 5f.163-1(b)(4).
(ii) Assume H buys one of Corporation V's bonds in the secondary
market in 1983. The bond H receives is in registered form, but H
requests that V convert the obligation into bearer form. There is no
other change in the terms of the instrument. The bond held by H is not
considered issued after December 31, 1982, under Sec. 5f.163-1(b)(4).
(iii) Assume the same facts as in (ii) except that in 1984 I
purchases H's V Corporation bond, which is in bearer form. I requests V
to convert the bond into registered form. There is no other change in
the terms of the instrument. In 1985, I requests V to convert the bond
back into bearer form. Again, there is no other change in the terms of
the instrument. The bond purchased by I is not considered issued after
December 31, 1982, under Sec. 5f.163-1(b)(4).
Example (7). Corporation U wishes to make a public offering of its
debentures to United States persons. U issues a master note to Bank N.
The terms of the note require that any person who acquires an interest
in the note must have such interest reflected in a book entry. Bank N
offers for sale interests in the Corporation U note. Ownership interests
in the note are reflected on the books of Bank N. Corporation U's
debenture is considered issued in registered form.
Example (8). Issuer S wishes to make a public offering of its debt
obligations to United States persons. The obligations will have a
maturity in excess of one year. On November 1, 1982, the closing on the
debt offering occurs. At the closing, the net cash proceeds of the
offering are delivered to S, and S delivers a master note to the
underwriter of the offering. On January 2, 1983, S delivers the debt
obligations to the purchasers in definitive form and the master note is
cancelled. The obligations are not registration-required because they
are considered issued before January 1, 1983.
Example (9). In July 1983, Corporation T sells an issue of debt
obligations maturing in 1985 to the public in the United States. Three
of the obligations of the issue are issued to J in bearer form. The
balance of the obligations of the issue are issued in registered form.
The terms of the registered and bearer obligations are identical. The
obligations issued to J are of a type offered to the public and are
registration-required obligations. Since the three obligations are
issued in bearer form, T is subject to the tax imposed under section
4701 with respect to the three bearer obligations. In addition, interest
paid or accrued on the three bearer obligations is not deductible by T.
Moreover, since the issuance of the three bearer obligations is subject
to tax under section 4701, J is not prohibited from deducting losses on
the obligations under section 165(j) or from treating gain on the
obligations as capital gain under section 1232(d). The balance of the
obligations in the issue do not give rise to liability for the tax under
section 4701, and the deductibility of interest on such obligations is
not affected by section 163(f).
Example (10). Broker K acquires a bond issued in 1980 by the United
States Treasury through the Bureau of Public Debt. Broker K sells
interests in the bond to the public after December 31, 1982. A purchaser
may acquire an interest in any interest payment falling due under the
bond or an interest in the principal of the bond. The bond is held by
Custodian L for the benefit of the persons acquiring these interests. On
receipt of interest and principal payments under the bond, Custodian L
transfers the amount received to the person whose ownership interest
corresponds to the bond component giving rise to the payment. Under
section 1232B, each bond component is treated as an obligation issued
with original issue discount equal to the excess of the stated
redemption price at maturity over the purchase price of the bond
component. The interests sold by K are obligations of a type offered to
the public. Further, the interests are, in accordance with section
1232B, considered issued after December 31, 1982. Accordingly, the
interests are registration-required obligations under Sec. 5f.163-1(b).
[T.D. 7852, 47 FR 51362, Nov. 15, 1982, as amended by T.D. 7965, 49 FR
33235, Aug. 22, 1984]
[[Page 114]]
Sec. 5f.168(f)(8)-1 Questions and answers concerning transitional rules and related matters regarding certain safe harbor leases.
The following questions and answers concern the transitional rules
and related matters regarding certain safe harbor leases under section
208(d) of the Tax Equity and Fiscal Responsibility Act of 1982 (Pub. L.
97-248) (``TEFRA''):
Q-1: If a lessee, prior to the period beginning after December 31,
1980, and ending before July 2, 1982 (the ``window period''), enters
into a binding contract to acquire property and the property is
delivered to the lessee during the window period, is the property
eligible for the transitional rule provided in section 208(d)(3) of
TEFRA which applies the safe harbor leasing rules of section 168(f)(8)
of the Internal Revenue Code of 1954 as in effect before the enactment
of TEFRA?
A-1: Yes, assuming all other requirements of the TEFRA transitional
rules are met. Section 208(d)(3)(A) (i) and (ii) of TEFRA provide
alternative tests under which an item of property may constitute
``transitional safe harbor lease property'' for purposes of the
transitional rules under the modifications to the safe harbor lease
provisions of section 168(f)(8). The tests are:
(i) The lease entered into a binding contract to acquire the
property;
(ii) The lessee entered into a binding contract to construct the
property;
(iii) The property was acquired by the lessee; or
(iv) Construction of the property was commenced by or for the
lessee.
These tests are stated in the alternative, and, accordingly, property
may be eligible for pre-TEFRA safe harbor leasing if any one of the
tests is satisfied. Thus, if a lessee acquired property during the
window period, the property may be eligible for pre-TEFRA safe harbor
leasing even though a binding contract to acquire the property was
executed before the window period. Similarly, if construction of
property commences during the window period, the property may be
eligible for pre-TEFRA safe harbor leasing even though a binding
contract to construct the property was executed before the window
period.
Q-2: How do the transitional rules apply to components of an
integrated manufacturing, production, or extraction process, none of
which would be considered ``placed in service'' until all of the
components are placed in service?
A-2: (i) The transitional rules regarding acquisition, binding
contracts, and commencement of construction are applied to each separate
item of property which is part of a manufacturing, production, or
extraction process. What constitutes a separate item will be determined
on a case-by-case basis, taking into account all relevant factors. In
general, a discrete component capable of performing a function which is
separate from or in addition to the function of other components to
which it may be related is a separate item of property; but an item that
is integrated into a component which performs a function separate from
other components to which it is related is not itself a separate item of
property. For example, a bolt or a nut that is used to construct a
machine does not constitute a separate item of property. On the other
hand, the transitional rules will not be applied to an entire facility
as a whole, as was the case under the investment tax credit transition
rule of section 50 in Hawaiian Independent Refinery, Inc. v. United
States, 49 AFTR 2d 675 (Ct. Cl. Tr. Judge 1982), where the taxpayer was
held to have constructed a property which consisted of an entire
refinery complex. Thus, for example, for purposes of these transitional
rules, an oil or gas well, storage tanks, and pipeline located on a
lease would not be considered a single item of property. Although each
item is related to the production of oil or gas, each is discrete and
each is capable of performing a separate function from the other. In
addition, in the case of an integrated manufacturing, production, or
extraction process, commencement of construction of one item of property
within the process would not be considered construction of any other
item of property that is part of the process.
(ii) If property qualifies as transitional safe harbor lease
property, all direct and indirect costs allocable to the property
(except for those described in Sec. 5c.168(f)(8)-6(a)(2)(ii)) and
required to be capitalized for Federal income tax purposes will also
qualify as transitional safe harbor lease property to the extent such
costs are incurred on or before the date on which the property is leased
under section 168(f)(8).
(iii) The adjusted basis to the lessor of property leased on or
prior to December 1, 1982, under a transitional safe harbor lease shall
be deemed to include all direct and indirect costs (including
installation costs) described in subdivision (ii) allocable to such
property that were incurred before it was leased despite the fact that
such costs were not included in the lessor's adjusted basis of such
property under the terms of the lease agreement, provided that the
parties to such agreement reasonably believed that they had leased the
whole of such property. Such costs will be treated as having been
included in the lessor's adjusted basis of such safe harbor lease
property on the date the lease agreement was executed without regard to
any provisions in the lease agreement that limits the dollar amount of
the permissible adjustment of the lessor's adjusted basis to such
property. To qualify for inclusion of
[[Page 115]]
such direct and indirect costs within the basis of such property, the
parties to such agreement must file an amended Form 6793, the Safe
Harbor Lease Information Return, no later than April 21, 1983, which
reflects the parties' intent to include installation and other such
costs within the basis of such property. For purposes of this
subdivision, a transitional safe harbor lease is a lease either which
was executed after July 1, 1982, and on or prior to December 1, 1982, or
which includes some transitional safe harbor lease property, as defined
in TEFRA section 208(d)(3), that was placed in service after July 1,
1982, and on or prior to December 1, 1982.
Q-3: What test will be applied in determining whether an item of
property is constructed or acquired by the lessee?
A-3: Except as expressly provided in section 208(d)(3) (D) or (E) of
TEFRA, the determination of whether and when any such events occurred
with respect to an item of property will generally be made in accordance
with the principles and precedents prior to TEFRA under the investment
tax credit and depreciation allowance transitional provisions. See
Secs. 1.48-2(b)(6) and 1.167(c)-1(a)(2), which provide definitions of
the term ``acquired'', and Secs. 1.48-2(b)(1) and 1.167(c)-1(a)(1),
which provide definitions of the term ``constructed by''. Also see Rev.
Rul. 80-312, 1980-2 C.B. 21, which discusses the factors to be
considered in determining when a taxpayer has control over a project
being constructed.
In general, for purposes of TEFRA section 208(d)(3), construction of
an item of property is considered to have commenced when physical work
of a significant nature has begun with respect to the property. Thus,
construction does not begin when parts or components which enter into
construction are acquired. If property is assembled from purchased parts
or components, the commencement of construction occurs when actual
assembly of the property begins. If a taxpayer manufactures a major part
or component of an item of property for itself, construction will be
considered to have begun when the manufacturing of that part or
component commences. However, construction of an item of property will
not be considered as begun if physical work by the taxpayer relates to
minor parts or components. Clearing and grading of land will be
considered in determining when construction begins on an item of
property only if they are directly associated with the construction of
the property.
Q-4: Under section 168(f)(8)(J), the at-risk rules are liberalized
for closely held lessors that engage in safe harbor leasing. These rules
apply ``in the case of property placed in service after the date of
enactment of this subparagraph,'' namely, after September 3, 1982.
Do the liberalized at-risk rules apply in the case where otherwise
qualified property is placed in service by a lessee in August of 1982
but is leased by a corporate lessor subject to the at-risk rules after
September 3, 1982?
A-4: The liberalized at-risk rule in section 168 (f)(8)(J) is
applicable in this case because, in determining whether property is
placed in service before or after the date of enactment of section
168(f)(8)(J), the relevant date is the date the property is placed in
service by the lessor. Additionally, a closely held corporate lessor,
which is not a personal service corporation, may lease transitional safe
harbor lease property placed in service after September 3, 1982, under
the liberalized at-risk rule.
Q-5: Is it necessary for property placed in service by a lessee in
December of 1982 to be leased before January 1, 1983, in order to
qualify under the general transitional rule of section 208(d)(3)(A) of
TEFRA, which requires that the property be placed in service before
January 1, 1983?
A-5: The legislative intent of this transitional rule was to provide
a 3-month period after property is placed in service by a lessee in
which a safe harbor lease could be entered into. Cf. section 209(c) of
TEFRA (3-month window applies to true leases entered into after 1983).
The legislative intent further was to permit property to qualify as
transitional safe harbor lease property if it was placed in service by
the end of 1982 by a lessee. Accordingly, transitional safe harbor lease
property placed in service in 1982 by a lessee may be leased in a safe
harbor lease transaction within 3 months after it is placed in service
by the lessee without losing its status as transitional safe harbor
lease property.
However, for all other purposes of the Code other than section
168(f)(8)(D)(i), section 168(f)(8)(D)(viii)(II) will apply and the
property will be treated as originally placed in service not earlier
than the date that the property is used under the lease. Thus, for
example, if transitional safe harbor lease property is placed in service
in December of 1982 and leased under section 168(f)(8) in January of
1983, the property will not lose its status as transitional safe harbor
lease property, but the basis adjustment rules of section 48(g) will
apply with respect to the property.
Q-6: Will a contract to acquire property be considered ``binding''
for purposes of section 208(d)(3)(A)(i) of TEFRA if the contract
contains no liquidated damages clause?
A-6: Generally, an irrevocable contract which contains no provision
for liquidated damages in the event of breach or cancellation would be
considered binding. Morover, in determining the amount of the lessee's
potential liability, the fair market value of the property will not be
taken into account. For example, if a lessee entered into an irrevocable
contract to purchase an asset for $100
[[Page 116]]
and the contract contained no provision for liquidated damages, the
contract would be considered binding notwithstanding the fact that the
property at all times after July 1, 1982, had a value of $99 and under
local law the seller could only recover the difference in the event the
lessee failed to perform. On the other hand, if the contract by its
terms provided for liquidated damages of less than 5 percent of the
purchase price which is in lieu of any damages allowable by law, in the
event of breach or cancellation, the contract would not be considered
binding.
Q-7: How does the 50-percent limitation on lessors in section
168(i)(1) and the 45-percent limitation on lessees in section
168(f)(8)(D)(ii) apply to corporations which are part of an affiliated
group filing consolidated returns?
A-7: Both the 50-percent limitation on lessors and the 45-percent
limitation on lessees will be applied on a consolidated basis for
corporations filing consolidated returns.
Q-8: Section 168(f)(8)(J) liberalized the at-risk rules for safe
harbor leasing and provides that in cases where the safe harbor lessee
would be considered the owner of the property without regard to the safe
harbor lease, the lessor is considered to be at risk with respect to the
property in an amount equal to the amount the lessee is considered at
risk with respect to such property as determined under section 465.
Will a corporate lessor that would ordinarily be subject to the at-
risk rules under section 465 be exempt from such rules under section
168(f)(8)(J) in a situation where acquisition of the leased property is
financed with nonrecourse debt by a lessee that is not subject to the
at-risk rules?
A-8: Yes. The liberalized at-risk rules of section 168(f)(8)(J) will
apply in cases where the lessee's ACRS deductions and investment tax
credit with respect to the property would not have been limited under
the at-risk rules had the parties not elected treatment under section
168(f)(8).
Q-9: Section 168(f)(8)(J)(ii) excepts certain service corporations
from the liberalized at-risk rules of section 168(f)(8)(J)(i). Does the
exception in subdivision (ii) also extend to subsidiaries of such
service corporations that file consolidated returns?
A-9: Yes. The liberalized at-risk rules of section 168(f)(8)(J)(i)
will not apply to any subsidiary filing a consolidated return with a
service organization described in section 168(f)(8)(J)(ii).
Q-10: Will property lose its status as transitional safe harbor
lease property under section 208(d)(3) of TEFRA solely by reason of the
fact that the person who is a party to a binding contract to acquire the
property assigns his rights in the contract to another person?
A-10: When a person who is a party to a binding contract transfers
his rights in the contract (or the property covered by the contract) to
another person and the transferor (or a corporation which is a member of
the same affiliated group as the transferor) will use the property under
a lease for a period not less than 50 percent of the appropriate
recovery period for the leased property under section 168(c), then to
the extent of the transferred rights, this other person will succeed to
the position of the transferor with respect to the binding contract and
the property. Accordingly, under these circumstances, property will not
lose its status as transitional safe harbor lease property.
In addition, property will not be disqualified as transitional safe
harbor lease property solely by reason of a transfer by a person of his
rights in a contract (or the property covered by the contract) in a
transaction in which the basis of the property in the hands of the
transferee is determined by reference to its basis in the hands of the
transferor (e.g., transfers governed by sections 332, 351, 361, 721, and
731). Thus, for example, if a corporation entered into a binding
contract for the construction or acquisition of property prior to July
1, 1982, and after such date assigned the contract to a corporation
within the same affiliated group which files consolidated returns, the
assignee will be entitled to treat the property acquired pursuant to the
contract as transitional safe harbor lease property, assuming the
property would have so qualified in the hands of the transferor.
Similarly, if a joint venture or partnership between two corporations
entered into a binding contract or commenced construction of property
before July 2, 1982, but dissolved and distributed its assets to the
partners or joint venturers after July 2, 1982, the joint venturers or
partners may treat the assets as transitional safe harbor lease
property, assuming the property would have so qualified had the joint
venture or partnership remained in existence.
Q-11: During 1982, Corporation Y placed in service section 38
property with a total cost of $100X. On August 15, 1982, Corporation Y
placed in service the last component of an entire facility within the
meaning of Sec. 5c.168(f)(8)-6(b)(2). The facility had a total cost
basis of $40X, of which $30X was transitional safe harbor lease property
within the meaning of section 208(d)(3) of TEFRA and $10X was not
transitional safe harbor lease property. On November 1, 1982,
Corporation Y sold and leased back under a section 168(f)(8) lease the
$30X of transitional safe harbor lease property in the facility.
Will the entire facility rule in Sec. 5c.168(f)(8)-6(b)(2) apply in
this situation where the taxpayer has not leased all of the section 38
property in the facility?
A-11: No. The placed in service date, for purposes of the rule
requiring that property be leased within 3 months after such property
was placed in service by the lessee, would be determined under the
entire facility rule in Sec. 5c.168(f)(8)-6(b)(2) only if Corporation Y
had leased all the qualified leased
[[Page 117]]
property in the facility. Since Corporation Y leased only the $30X of
transitional section 38 property, of the facility and did not lease the
$10X of nontransitional property, Corporation Y may not rely on the
entire facility rule of Sec. 5c.168(f)(8)-6(b)(2) for purposes of
determining the placed in service date for the property under the
section 168(f)(8) lease.
Q-12: Assume the same facts as in Q-11, except that Corporation Y
had also placed in service by August 15, 1982, $30X of miscellaneous
machinery and equipment all of which was transitional safe harbor lease
property within the meaning of section 208(d)(3) of TEFRA. On November
1, 1982, in addition to the $30X of transitional property in the
facility, Corporation Y also sold and leased back under a separate
section 168(f)(8) lease the $30X of miscellaneous machinery and
equipment.
Will the entire facility rule in Sec. 5c.168(f)(8)-6(b)(2) apply in
this situation to the $30X of transitional property in the facility?
A-12: Yes. Since Corporation Y leased $30X of transitional machinery
and equipment and the $30X of the facility which consisted of
transitional property, Corporation Y can lease none of the
nontransitional property in the facility because, by reason of the 45-
percent cap on lessees contained in section 168(f)(8)(D) (ii) and (iii)
and (I), it is not qualified leased property for purposes of section
168(f)(8). Thus, on the facts, Corporation Y has leased all the
qualified leased property in the facility.
Q-13: Corporation X constructed a manufacturing complex consisting
of three integrated operational components, each with a different ADR
present class life midpoint, which together constitute an ``entire
facility'' within the meaning of Sec. 5c.168(f)(8)-6(b)(2). The last
components of the facility were placed in service on August 15, 1982. On
October 1, 1982, Corporation X sold to Corporation Z and leased back
under section 168(f)(8) all the qualified leased property of the
facility.
For purposes of the rule requiring that property be leased within 3
months after such property was placed in service by the lessee, will the
leased components of the entire facility be considered placed in service
by the lessee on August 15, 1982, the date the last components were
placed in service, if the components are leased at one time pursuant to
documents consisting of three section 168(f)(8) leases with different
terms to reflect the different ADR midpoint lives of the qualified
leased property in the facility?
A-13: Yes. If the entire facility rule in Sec. 5c.168(f)(8)-6(b)(2)
applies, the facility components which were placed in service prior to
August 15, 1982, will be treated as placed in service by the lessee on
August 15, 1982, for purposes of the 3-month rule. This rule will apply
if all the qualified leased property of the facility is leased at one
time. The documentation may be in the form of multiple, simultaneously
executed agreements or maybe in the form of an agreement comprised of
one or more parts or schedules. Each of the multiple agreements, or each
of the parts or schedules of an agreement, may have different lease
terms for property with different ADR midpoint lives, so long as each
such agreement or part of schedule individually would be treated as a
lease under section 168(f)(8), taking into account the entire facility
rule, with lease terms commencing on the same date. A single transaction
effected by multiple agreements or by an agreement with one or more
parts or schedules will meet the maximum lease term requirement of
Sec. 5c.168(f)(8)-5(b) so long as each agreement or each part or
schedule of an agreement meets the maximum lease term requirement.
Q-14: Under Sec. 5c.168(f)(8)-6(b)(2), the special rule for
facilities applies only if the entire facility is leased under a section
168(f)(8) lease.
Will a transaction not qualify under section 168(f)(8) if the
parties, acting in good faith, omit an insubstantial portion of the
qualified lease property from the lease?
A-14: No. The facility rule of Sec. 5c.168(f)(8)-6(b)(2) will apply
if the parties, acting in good faith, substantially comply with its
terms.
Q-15: When will construction of an aircraft be considered to have
been begun after June 25, 1981, and before February 20, 1982, for
purposes of TEFRA section 208(d)(3)(D)?
A-15: Construction of an aircraft will be considered to have been
begun after June 25, 1981, and before February 20, 1982, if during such
period any of the following events occurred:
(i) Construction or reconstruction of a subassembly designated for
the aircraft was commenced;
(ii) Construction of a lot increment of subassemblies (one or more
of which was designated for the aircraft) was commenced; or
(iii) The stub wing join occurred.
Q-16: Does the definition of assets used in the manufacture or
production of steel for purposes of TEFRA section 208(d)(2)(F) include
all assets used in this function (such as electrical and steam
generators and distribution equipment, coke oven by-product equipment)
although not necessarily includible in the former ADR guideline class
for primary steel mill products?
A-16: Yes, all assets that are used, in their primary function, as
an integral part of the steel manufacturing or production process are
included. Cf. Sec. 1.48-1(d)(4). However, the steel manufacturing or
production process does not include processing beyond the production of
primary ferrous metals (as defined by the ADR Class for Manufacture of
Primary Ferrous Metals).
Q-17: Where a qualified mass commuting vehicle meets the
requirements for both the TEFRA section 208(d)(2) transitional rule and
the TEFRA section 208(d)(5) special rule for mass commuting vehicles,
which provision will control?
[[Page 118]]
A-17: The general transitional rule of TEFRA section 208(d)(2) will
apply. Thus, pursuant to TEFRA section 208(d)(2)(B), the provisions of
section 168(f)(8)(J), but not the provisions of section 168(i)(1), will
apply only to such property. If the general transitional rule does not
apply to a specific mass commuting vehicle, the provision of section
168(i)(1) applies to the lessor who leases such vehicle.
Q-18: Does the definition of a qualified mass commuting vehicle
include component parts of a qualified mass commuting vehicle--such as
an undercarriage of a subway car or the costs of rehabilitation or
reconstruction of a mass commuting vehicle (or component part thereof)?
A-18: Yes.
[T.D. 7850, 47 FR 50853, Nov. 10, 1982, as amended by T.D. 7879, 48 FR
11942, Mar. 22, 1983]
Sec. 5f.442-1 Temporary regulations relating to change of annual accounting period.
(a) In general. Notwithstanding paragraph (c) (1) and (2) of
Sec. 1.442-1 of the Income Tax Regulations, a corporation which--
(1) Is described in section 934(b) and is an inhabitant of the
Virgin Islands (within the meaning of section 28(a) of the Revised
Organic Act of the Virgin Islands (48 U.S.C. 1642)), or
(2) Has in effect an election under section 936 may change its
taxable year only if it secures the prior approval of the Commissioner
in accordance with paragraph (b)(1) of Sec. 1.442-1.
(b) Effective date. This section shall apply only if the statement
described in paragraph (c)(1) of Sec. 1.442-1 is filed after September
3, 1982.
[T.D. 7864, 47 FR 57921, Dec. 29, 1982; 48 FR 3367, Jan. 25, 1983]
Sec. 5f.6045-1 Returns of information of brokers and barter exchanges.
(a)-(b) [Reserved]
(c) Reporting by brokers.
(1)-(2) [Reserved]
(3) Exceptions--(i) Sales effected for exempt recipients--(A) In
general. No return of information is required with respect to a sale
effected for a customer that is an exempt recipient as defined in
paragraph (c)(3)(i)(B) of this section.
(B) Exempt recipient defined. The term ``exempt recipient'' means--
(1) A corporation as defined in section 7701(a)(3), whether domestic
or foreign;
(2) An organization exempt from taxation under section 501(a) or an
individual retirement plan;
(3) The United States or a State, the District of Columbia, a
possession of the United States, a political subdivision of any of the
foregoing, a wholly-owned agency or instrumentality of any one or more
of the foregoing or a pool or partnership composed exclusively of any of
the foregoing;
(4) A foreign government, a political subdivision thereof, an
international organization or any wholly-owned agency or instrumentality
of the foregoing;
(5) A foreign central bank of issue (as defined in Sec. 1.895-
1(b)(1) as a bank which is by law or government sanction the principal
authority, other than the government itself, issuing instruments
intended to circulate as currency);
(6) A dealer in securities or commodities registered as such under
the laws of the United States or a State;
(7) A futures commission merchant registered as such with the
Commodity Futures Trading Commission;
(8) A real estate investment trust (as defined in section 856);
(9) An entity registered at all times during the taxable year under
the Investment Company Act of 1940;
(10) A common trust fund (as defined in section 584(a));
(11) A financial institution such as a bank, mutual savings bank,
savings and loan association, building and loan association, cooperative
bank, homestead association, credit union, industrial loan association
or bank, or other similar organization; or
(12) A person registered under the Investment Advisers Act of 1940
who regularly acts as a broker within the meaning of paragraph (a)(1) of
Sec. 1.6045-1.
The terms used in this paragraph (c)(3)(i)(B) shall have the same
meaning as those contained in 26 CFR 31.3452(c)-1 (revised as of April
1, 1983). A broker may treat any person described in paragraph
(c)(3)(i)(B) (1) through (11) of this section as an exempt recipient
without requiring such person to file an exemption certificate if the
conditions of 26 CFR 31.3452(c)-1
[[Page 119]]
(revised as of April 1, 1983) are satisfied. A broker may treat any
person described in paragraph (c)(3)(i)(B)(12) of this section as an
exempt recipient without requiring such person to file an exemption
certificate if the person's status as a registered investment adviser
who regularly acts as a broker within the meaning of paragraph (a)(1) of
Sec. 1.6045-1 is known generally in the investment community.
Alternatively, a broker can require any exempt recipient to file an
exemption certificate and may treat an exempt recipient who fails to
file such certificate as a recipient which is not exempt.
(ii) Multiple brokers. In the case of a sale in which a broker is
instructed to initiate the sale by a person that is an exempt recipient
described in paragraph (c)(3)(i)(B) (6), (7), (11), or (12), of this
section, no return of information is required with respect to the sale
by the broker so instructed. In the case of a redemption of stock or
retirement of securities, only the broker responsible for paying the
holder redeemed or retired, or crediting the gross proceeds on the sale
to such holder's account, is required to report the sale.
(iii) Cash on delivery transactions. In the case of a sale of
securities through a ``cash on delivery'' account, a ``delivery versus
payment'' account, or other similar account or transaction, only the
broker which receives the gross proceeds from the sale against delivery
of the securities sold is required to report the sale. If, however, such
broker's customer is another broker (``second-party broker'') which is
an exempt recipient, then only the second-party broker is required to
report the sale.
(iv) Custodians, trustees and partnerships. No return of information
is required with respect to a sale effected by a custodian or trustee in
its capacity as such or a redemption of a partnership interest by a
partnership provided the sale is otherwise reported by the custodian or
trustee on a properly filed From 1041 or the redemption is otherwise
reported by the partnership on a properly filed Form 1065, and all
Schedule K-1 reporting requirements are satisfied.
(v) Sales at issue price. No return of information is required with
respect to a sale of an interest in a regulated investment company
(within the meaning of section 851) that computes its current price per
share for purposes of distributions, redemptions, and purchases so as to
stabilize the price per share at a constant amount that approximates its
issue price or the price at which it was originally sold to the public.
(vi) Obligor payments on certain obligations. No return of
information is required with respect to payments representing obligor
payments on--
(A) Nontransferable obligations (including savings bonds, savings
accounts, checking accounts, and NOW accounts);
(B) Obligations as to which the entire gross proceeds are reported
by the broker on Form 1099 under provisions of the Internal Revenue Code
other than section 6045 (including stripped coupons issued prior to July
1, 1982); or
(C) Retirement of short-term obligations (i.e., obligations with a
fixed maturity date not exceeding one year from the date of issue) that
have original issue discount, as defined in section 1232(b)(1).
(vii) Callable obligations. No return of information is required
with respect to payments representing obligor payments on demand
obligations that also are callable by the obligor and that have no
premium or discount.
(viii) Foreign currency. No return of information is required with
respect to a sale of foreign currency other than a sale pursuant to a
forward contract or regulated futures contract that requires delivery of
foreign currency.
(ix) Fractional share. No return of information is required with
respect to a sale of a fractional share of stock if the gross proceeds
on the sale of the fractional share are less than $20.
(x) Certain retirements. No return of information is required from
an issuer or its agent with respect to the retirement of book entry or
registered form obligations as to which the relevant books and records
indicate that no interim transfers have occurred.
(4) Examples. The following examples illustrate the application of
the reporting requirements:
Example (1). A, an individual who is not an exempt recipient, places
an order with B, a person generally known in the investment
[[Page 120]]
community to be a federally registered broker/dealer, to sell A's stock
in a publicly traded corporation. B, in turn, places an order to sell
the stock with C, a second broker, which will execute the sale. B
discloses to C the identity of the customer placing the order. C is not
required to make a return of information with respect to the sale
because C was instructed by B, an exempt recipient as defined in
paragraph (c)(3)(i)(B)(6) of this section, to initiate the sale. B is
required to make a return of information with respect to the sale.
Example (2). The facts are the same as in Example (1) except that B
has an omnibus account with C so that B does not disclose to C whether
the transaction is for a customer of B or for B's own account. C is not
required to make a return of information with respect to the sale
because C was instructed by B, an exempt recipient as defined in
paragraph (c)(3)(i)(B)(6) of this section, to initiate the sale. B is
required to make a return of information with respect to the sale.
Example (3). D, an individual who is not an exempt recipient, enters
into a ``cash on delivery'' (``COD'') stock transaction by instructing
K, a federally registered broker/dealer, to sell stock owned by D, and
to deliver the proceeds to L, a custodian bank. In addition,
concurrently with the above instructions, D instructs L to deliver D's
stock to K (or K's designee) against delivery of such proceeds from K.
The records of both K and L with respect to this transaction show an
account in the name of D. Pursuant to paragraph (h)(1) of Sec. 1.6045-1,
D is considered the customer of K and L. Under paragraph (c)(3)(iii) of
this section, K is not required to make a return of information with
respect to the sale because K will pay the gross proceeds to L against
delivery of the securities sold. L is required to make a return of
information with respect to the sale.
Example (4). The facts are the same as in Example (3) except that E,
a federally registered investment adviser who regularly acts as a broker
within the meaning of paragraph (a)(1) of Sec. 1.6045-1, instructs K to
sell stock owned by D and to deliver the proceeds to L. In addition,
concurrently with the above instructions, E instructs L to delivery D's
stock to K (or K's designee) against delivery of such proceeds from K.
The records of both K and L with respect to this transaction show an
account in the name of E. Pursuant to paragraph (h)(1) of Sec. 1.6045-1,
E is considered the customer of K and L. Under paragraph (c)(3)(iii) of
this section, K is not required to make a return of information with
respect to the sale because K will pay the gross proceeds to L against
delivery of the securities sold. In addition, L is not required to make
a return of information with respect to the sale because L's customer,
E, is another broker which is an exempt recipient. E is required to make
a return of information with respect to the sale. The result would be
the same even if the records of K and L with respect to this transaction
show an account in the name of D.
Example (5). F, an individual who is not an exempt recipient, owns
bonds that are held by G, a federally registered broker/dealer, in an
account for F with G designated as nomineee for F. Upon the retirement
of the bonds, the gross proceeds are automatically credited to the
account of F. G is required to make a return of information with respect
to the retirement because G is the broker responsible for making payment
of the gross proceeds to F.
[T.D. 7960, 49 FR 22282, May 29, 1984]
PART 6a--TEMPORARY REGULATIONS UNDER TITLE II OF THE OMNIBUS RECONCILIATION ACT OF 1980--Table of Contents
Sec.
6a.103A-1 Interest on mortgage subsidy bonds.
6a.103A-2 Qualified mortgage bond.
6a.103A-3 Qualified veterans' mortgage bonds.
6a.6652(g)-1 Failure to make return or furnish statement required under
section 6039C.
Authority: 26 U.S.C. 7805.
Sections 6a.103A-2(k), (l), and (m) also issued under 26 U.S.C.
103A(j) (3), (4), and (5).
Sec. 6a.103A-1 Interest on mortgage subsidy bonds.
(a) In general--(1) Mortgage subsidy bond. A mortgage subsidy bond
shall be treated as an obligation not described in section 103 (a)(1) or
(a)(2). Thus, the interest on a mortgage subsidy bond is includable in
gross income and subject to Federal income taxation.
(2) Exceptions. Any qualified mortgage bond and any qualified
veterans' mortgage bond shall not be treated as a mortgage subsidy bond.
See Sec. 6a.103A-2 with respect to requirements of qualified mortgage
bonds and Sec. 6a.103A-3 with respect to requirements of qualified
veterans' mortgage bonds.
(3) Additional requirement. In addition to the requirements of
Sec. 6a.103A-2, Sec. 6a.103A-3, and this section, qualified mortgage
bonds and qualified veterans' mortgage bonds shall be subject to the
requirements of section 103(c) and the regulations thereunder.
[[Page 121]]
(4) Advance refunding. On or after December 5, 1980, no tax-exempt
obligation may be issued for the advance refunding of a mortgage subsidy
bond (determined without regard to section 103A(b)(2) or Sec. 6a.103A-
1(a)(2)). An obligation issued for the refunding of a mortgage subsidy
bond will be considered to be an advance refunding obligation if it is
issued more than 180 days before the prior issue is discharged.
(5) Registration. Any obligation that is part of a qualified
mortgage bond issue or qualified veterans' mortgage bond issue and which
is issued after December 31, 1981, must be in registered form. The term
``in registered form'' has the same meaning as in Sec. 1.6049-2(d).
Thus, in general, an obligation is issued in registered form if it is
registered as to both principal and interest and if its transfer must be
effected by the surrender of the old instrument to the issuer and by
either the reissuance of the old instrument to a new holder or the
issuance of a new instrument to a new holder.
(b) Definitions. For purposes of Secs. 6a.103A-2, 6a.103A-3, and
this section the following definitions apply:
(1) Mortgage subsidy bond. (i) The term ``mortgage subsidy bond''
means any obligation which is issued as part of an issue a significant
portion of the proceeds of which is to be used directly or indirectly to
provide mortgages on owner-occupied residences.
(ii) For purposes of subdivision (i), a significant portion of the
proceeds of an issue is used to provide mortgages if 5 percent or more
of the proceeds are so used.
(2) Mortgage. The term ``mortgage'' includes deeds of trust,
conditional sales contracts, pledges, agreements to hold title in
escrow, and any other form of owner financing.
(3) Bond. The term ``bond'' means any obligation. The term
``obligation'' means any evidence of indebtedness.
(4) State. (i) The term ``State'' includes a possession of the
United States and the District of Columbia.
(ii) For purposes of subdivision (i), obligations issued by or on
behalf of any State or local governmental unit by constituted
authorities impowered to issue such obligations are the obligations of
such governmental unit. See Sec. 1.103-1(b).
(5) Proceeds. The term ``proceeds'' includes original proceeds and
investment proceeds. The terms ``original proceeds'' and ``investment
proceeds'' shall have the same meaning as in Sec. 1.103-13(b)(2). Unless
otherwise provided in Sec. 6a.103A-2 or this section, however, amounts
earned from the investment of proceeds which are derived from qualified
mortgage bonds in nonmortgage investments may not be commingled for the
purposes of accounting for expenditures with other non-bond amounts, and
such proceeds are investment proceeds even though not treated as
investment proceeds for purposes of section 103(c). Repayments of
principal on mortgages shall be treated as proceeds of an issue. Amounts
(such as State appropriations or surplus funds) which are provided by
the issuer or a private lender in conjunction with a qualified mortgage
bond or a qualified veterans' mortgage bond shall not be treated as
proceeds of a mortgage subsidy bond under this section. However, fees
which are paid by a participating financial institution pursuant to an
agreement with the issuer whereby such institution receives the right to
originate or service mortgages and which are retained by an issuer are
treated as original proceeds of the issue. Amounts provided by the
issuer or a private lender may be treated as proceeds of an issue for
purposes of section 103(c).
(6) Single-family and owner-occupied residences. Except for purposes
of Sec. 6a.103A-2 (g) and (h)(2)(ii), the terms ``single-family'' and
``owner-occupied,'' when used with respect to residences, include two-,
three-, and four-family residences--
(i) One unit of which is occupied by the owner of the units, and
(ii) Which were first occupied as a residence at least 5 years
before the mortgage is executed.
[T.D. 7780, 46 FR 34314, July 1, 1981; 46 FR 37890, July 23, 1981, as
amended by T.D. 7794, 46 FR 55514, Nov. 10, 1981]
Sec. 6a.103A-2 Qualified mortgage bond.
(a) In general--(1) Qualified mortgage bond. A qualified mortgage
bond shall not be treated as a mortgage subsidy
[[Page 122]]
bond, and the interest on a qualified mortgage bond will be exempt from
Federal income taxation.
(2) Termination date. No obligation issued after December 31, 1987,
shall be treated as part of a qualified mortgage bond issue.
(b) Definitions and special rules. For purposes of this section and
Sec. 6a.103A-1, the following definitions apply:
(1) Qualified mortgage bond. The term ``qualified mortgage bond''
means one or more obligations issued by a State or any political
subdivision thereof (hereinafter referred to as ``governmental unit'')
as part of an issue--
(i) All of the original proceeds of which, net of the costs of
issuing the obligations and proceeds invested in a reasonably required
reserve fund (such net amount hereinafter in this section referred to as
``lendable proceeds''), are to be used to finance owner-occupied
residences, and
(ii) Which meets each of the requirements of Sec. 6a.103A-1 and this
section.
A qualified mortgage bond does not include any bond that is an
industrial development bond under section 103(b).
(2) Constitutional home rule city. The term ``constitutional home
rule city'' means, with respect to any calendar year, any political
subdivision of a State which, under a State constitution which was
adopted in 1970 and effective on July 1, 1971, had home rule powers on
the 1st day of the calendar year.
(3) Targeted area residence. The term ``targeted area residence''
means a residence in an area which is either--
(i) A qualified census tract, or
(ii) An area of chronic economic distress.
(4) Qualified census tract. (i) The term ``qualified census tract''
means a census tract in which 70 percent or more of the families have an
income which is 80 percent or less of the State-wide median family
income.
(ii) The determination under subdivision (i) shall be made on the
basis of the most recent decennial census for which data are available.
With respect to any particular bond issue, such determination may be
based upon the decennial census data available 3 months prior to the
date of issuance and shall not be affected by official changes to such
data during or after such 3-month period.
(iii) The term ``census tract'' means a census tract as defined by
the Secretary of Commerce.
(5) Areas of chronic economic distress. (i) The term ``area of
chronic economic distress'' means an area designated by a State as
meeting the standards established by that State for purposes of this
subparagraph and approved by the Secretary and by the Secretary of
Housing and Urban Development in accordance with the criteria set forth
in (iii) of this subparagraph. A State may withdraw such designation at
any time, with reasonable cause. Such withdrawal shall be effective upon
notification by the State to the Assistant Secretary for Housing/Federal
Housing Commissioner of the Department of Housing and Urban Development.
Such withdrawal shall not affect the tax-exempt status of any
outstanding issue of obligations.
(ii) For purposes of making a designation under this subparagraph,
withdrawing a designation, or making any other submission, ``State''
means the governor of a State, or a State official commissioned by the
governor or by State statute for such purposes.
(iii) The following criteria will be used in evaluating a proposed
designation of an area of chronic economic distress:
(A) The condition of the housing stock, including the age of the
housing and the number of abandoned and substandard residential units.
Data pertinent to this criterion include the number and percentage of
housing units that were constructed prior to 1940, the average age of
the housing stock, the number and percentage of abandoned housing units,
and the number and percentage of substandard residential units.
(B) The need of area residents for owner financing under a qualified
mortgage bond issue as indicated by low per capita income, a high
percentage of families in poverty, a high number of welfare recipients,
and high unemployment rates. Data pertinent to this criterion include
the per capita income of the population in the area, the number and
percentage of families eligible to receive food stamps from a
[[Page 123]]
program pursuant to 7 U.S.C. 2011, the number and percentage of families
eligible to receive payments under the Aid to Families with Dependent
Children program, and the unemployment rate.
(C) The potential for use of owner financing under a qualified
mortgage bond issue to improve housing conditions in the area. Data
pertinent to this criterion include the number and percentage of owner-
occupied homes that are substandard, the number and percentage of
families that are low- or moderate-income renters, and the number and
percentage of substandard units in the area that will be improved
through the use of owner financing provided by the proceeds of a
qualified mortgage bond issue.
(D) The existence of a housing assistance plan which provides a
displacement program and a public improvements and services program
(similar to the Housing Assistance Plan (HAP) required by the Department
of Housing and Urban Development under the Community Development Block
Grant program (42 U.S.C. 5301 et seq.)).
This determination shall be based upon the most recent data availabe.
The certification described in subdivision (iv)(C) shall satisfy the
criteria set forth in subdivisions (C) and (D). A certification
described in (iv)(D) shall satisfy the criteria set forth in
subdivisions (A) and (B): Provided, That the majority of the households
in the proposed area have incomes less than 80 percent of the median
income for the standard metropolitan statistical area (SMSA) in which
the proposed area is located or, if the proposed area is not within a
SMSA, less than 80 percent of the median income for the State.
(iv) A proposal by the State that an area be approved as an area of
chronic economic distress shall contain the following information:
(A) A description of the proposed area by its geographical limits.
(B) Maps of the State and of areas within the State that are
qualified census tracts and existing or proposed areas of chronic
economic distress.
(C) Where applicable, a certification of the local Area Manager of
the Department of Housing and Urban Development in which the proposed
area is located that the proposed area is a Neighborhood Strategy Area
(NSA) under 24 CFR 570.301(c) promulgated pursuant to the Community
Development Block Grant program or an area comparable to a NSA which has
been reviewed and approved by the Area Manager as meeting the standards
for an NSA.
(D) Where applicable, a certification from the HUD Area Manager with
jurisdiction over the proposed area that the proposed area is within a
geographic area which has been declared eligible for grants under the
Urban Development Action Grant Program, Pursuant to 24 CFR 570.452, by
the Secretary of Housing and Urban Development.
(E) Statistical and descriptive information pertinent to the
criteria enumerated in subdivision (iii) of this subparagraph, and a
succinct statement of how the information furnished satisfies those
criteria. Such statistical information shall be based upon the most
recent data available.
(F) If the State so desires, a written request for a conference
prior to any adverse decision on the proposed designation.
(G) A certification by the Governor or designated official that the
proposed designation conforms to these regulations.
(v) The proposed designation and the information furnished with it
as required by subdivision (iv) of this subparagraph shall be submitted
in triplicate to the Assistant Secretary for Housing/Federal Housing
Commissioner of the Department of Housing and Urban Development
(Attention: Office of State Agency and Bond Financed Programs, Rm. 6138,
451 7th Street, SW., Washington, D.C. 20410).
(vi) Only those areas of chronic economic distress that have been
previously designated by the State and approved in accordance with this
subparagraph at least 3 months prior to the date of issuance need to be
taken into account for any particular bond issue. Residences located in
areas designated as areas of chronic economic distress approved in
accordance with this subparagraph within such 3-month period or after
the date of issue, however, may be treated as targeted area
[[Page 124]]
residences. However, for purposes of paragraph (h)(2), relating to the
specified portion of proceeds to be placed in targeted areas, and
paragraph (i)(3)(ii)(A), relating to the 1\1/2\ year temporary period,
only areas approved as areas of chronic economic distress in accordance
with this subparagraph at the time of issue may be taken into
consideration.
(6) Standard metropolitan statistical area. A standard metropolitan
statistical area (``SMSA'') is an area in and around a city of 50,000
inhabitants or more (or equivalent area) and defined by the Secretary of
Commerce as an SMSA.
(7) Statistical area. The term ``statistical area'' means--
(i) An SMSA,
(ii) Any county (or portion thereof) which is not within an SMSA, or
(iii) If there is insufficient recent statistical information with
respect to a county (or portion thereof) described in subdivision (ii)
of this subparagraph, such other area as may be designated by the
Commissioner, upon proper application, as a substitute for such county
(or portion thereof).
For purposes of subdivisions (ii) and (iii) of this subparagraph, in
Alaska, the entire State, and in Louisiana, a parish, shall be treated
in a manner similar to a county.
(8) Acquisition cost. (i) The term ``acquisition cost'' means the
cost of acquiring a residence from the seller as a completed residential
unit. Acquisition cost includes the following:
(A) All amounts paid, either in cash or in kind, by the purchaser
(or a related party or for the benefit of the purchaser) to the seller
(or a related party or for the benefit of the seller) as consideration
for the residence.
(B) If a residence is incomplete, the reasonable cost of completing
the residence whether or not the cost of completing construction is to
be financed with bond proceeds. For example, where a mortgagor purchases
a building which is so incomplete that occupancy of the building is not
permitted under local law, the acquisition cost includes the cost of
completing the building so that occupancy of the building is permitted.
(C) Where a residence is purchased subject to a ground rent, the
capitalized value of the ground rent. Such value shall be calculated
using a discount rate equal to the yield on the issue (as defined in
Sec. 6a.103A-2(i)(2)(vi)).
(ii) The term ``acquisition cost'' does not include the following:
(A) The usual and reasonable settlement or financing costs.
Settlement costs include titling and transfer costs, title insurance,
survey fees, or other similar costs. Financing costs include credit
reference fees, legal fees, appraisal expenses, ``points'' which are
paid by the buyer (but not the seller, even though borne by the
mortgagor through a higher purchase price) or other costs of financing
the residence. However, such amounts will be excluded in determining
acquisition cost only to the extent that the amounts do not exceed the
usual and reasonable costs which would be paid by the buyer where
financing is not provided through a qualified mortgage bond issue. For
example, if the purchaser agrees to pay to the seller more than a pro
rata share of property taxes, such excess shall be treated as part of
the acquisition cost of a residence.
(B) The value of services performed by the mortgagor or members of
the mortgagor's family in completing the residence. For purposes of the
preceding sentence, the family of an individual shall include only the
individual's brothers and sisters (whether by the whole or half blood),
spouse, ancestors, and lineal descendants. For example, where the
mortgagor builds a home alone or with the help of family members, the
acquisition cost includes the cost of materials provided and work
performed by subcontractors (whether or not related to the mortgagor)
but does not include the imputed cost of any labor actually performed by
the mortgagor or a member of the mortgagor's family in constructing the
residence. Similarly, where the mortgagor purchases an incomplete
residence the acquisition cost includes the cost of material and labor
paid by the mortgagor to complete the residence but does not include the
imputed value of the mortgagor's labor or the labor of the mortgagor's
family in completing the residence.
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(C) The cost of land which has been owned by the mortgagor for at
least 2 years prior to the date on which construction of the residence
begins.
(iii) The following examples illustrate the provisions of
subparagraph (8):
Example (1). A contracts with B, a builder of single-family
residences, for the purchase of a residence. Under the terms of the
contract, B will deliver a residential unit to A that contains an
uncompleted recreation room and an unfinished third floor and which
lacks a garage. Normally, a completed recreation room, a finished third
floor and a garage are provided as part of the residence built by B. The
contract price for the residence is $58,000. At the same time, A
contracts with C, an affiliate of B, to complete the recreation room and
third floor and to construct the garage for a contract price of $10,000.
C will perform this work after A receives title to the unit from B.
Under Sec. 6a.103A-2(b)(8)(i)(A), the acquisition cost of A's completed
residential unit is $68,000, which represents the contract price of the
residence plus the cost of completion of the recreation room and third
floor and construction of the garage.
Example (2). E owns a single-family residence which E has listed for
sale. D contracts to purchase E's residence, and the contract provides
for a selling price of $30,000. D also agrees to pay an unsecured debt
in the amount of $5,000, which E owes to X, a local bank. D further
agrees to purchase from E the refrigerator, stove, washer, and dryer
located in E's residence for $500. Such amount is equal to the fair
market value of such personalty. D also agrees to purchase the light
fixtures, curtain rods, and wall-to-wall carpeting for a fair market
value price of $700. Under Sec. 6a.103A-2(b)(8)(i)(A), the acquisition
cost of D's completed residential unit is $35,700. Such amount includes
the $5,000 unsecured debt paid off by D. The $500 paid for the
refrigerator, stove, washer, and dryer are not included because such
items are not included within the definition of a residence under
Sec. 6a.103A-2(d)(4). Such definition does include, however, the light
fixtures, curtain rods, and wall-to-wall carpeting purchased by D.
Example (3). F contracts with G to purchase G's home for $40,000.
After purchasing the residence, F pays a party unrelated to G $3,000 for
painting, minor repairs, and refinishing the floors. Under Sec. 6a.103A-
2(b)(8)(i)(A), the acquisition cost of the residence is $40,000. Such
fix-up expenses are not treated as part of the acquisition costs. If G
had incurred such fix-up expenses, however, F may not reduce his
acquisition cost of the residence by such amounts.
(9) Qualified home improvement loan. (i) The term ``qualified home
improvement loan'' means the financing (whether or not secured by a
mortgage), in an amount which does not exceed $15,000 with respect to
any residence, of alterations, repairs, and improvements on, or in
connection with, an existing single-family, owner-occupied residence by
the owner thereof, but only if such items substantially protect or
improve the basic livability or energy efficiency of the residence.
(ii) Alterations, repairs, or improvements that satisfy the
requirement of subdivision (i) of this subparagraph include the
renovation of plumbing or electric systems, the installation of improved
heating or air conditioning systems, the addition of living space, or
the renovation of a kitchen area. Items that will not be considered to
substantially protect or improve the basic livability of the residence
include swimming pools, tennis courts, saunas, or other recreational or
entertainment facilities.
(iii) If--(A) Two or more qualified home improvement loans are
provided for the same residence, whether or not by the same lender, and
(B) Any person who had a present ownership interest in such
residence at the time the previous qualified home improvement loan or
loans were made has a present ownership interest in the residence at the
time the subsequent qualified home improvement loan is made,
Then the allowable amount of the subsequent qualified home improvement
loan shall be reduced by the amount, at origination, of any previous
qualified home improvement loan, so that the sum of such loans does not
exceed $15,000.
(iv) The following example illustrates the provisions of
subparagraph (9):
Example. A and B jointly own a residence located in Town M. They
obtain a qualified home improvement loan for $10,000 from Town M. A
acquires B's interest in the residence. A applies to State X for a
qualified home improvement loan. The maximum amount of a qualified home
improvement loan which may be made by State X is $5,000, the amount that
when added to the $10,000 previous loan from Town M does not exceed
$15,000.
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(10) Qualified rehabilitation loans. (i) The term ``qualified
rehabilitation loan'' means any owner financing provided in connection
with--
(A) A qualified rehabilitation, or
(B) The acquisition of a residence with respect to which there has
been a qualified rehabilitation,
But only if the mortgagor to whom such financing is provided is the
first resident of the residence after completion of the rehabilitation.
Where there are two or more mortgagors of a rehabilitation loan, the
first residency requirement is met if any of the mortgagors meets the
first residency requirement.
(ii) The term ``qualified rehabilitation'' means any rehabilitation
of a residence if--
(A) There is a period of at least 20 years between the date on which
the building was first used and the date on which physical work on such
rehabilitation begins,
(B) 75 percent or more of the existing external walls of such
building are retained in place as external walls in the rehabilitation
process, and
(C) The expenditures for such rehabilitation are 25 percent or more
of the mortgagor's adjusted basis in the residence (including the land
on which the residence is located).
(iii) For purposes of (A) and (B), the rules applicable to the
investment tax credit for qualified rehabilitated buildings under
section 48(g)(1) (A)(iii) and (B) shall apply. However, unlike section
48(g)(1)(B), once a building meets the 20-year test, more than one
rehabilitation of that building within a 20-year period may qualify as a
qualified rehabilitation.
(iv) The adjusted basis to the mortgagor is the mortgagor's adjusted
basis for purposes of determining gain or loss on the sale or exchange
of a capital asset (as defined in section 1221). The mortgagor's
adjusted basis shall be determined as of the date of completion of the
rehabilitation, or, if later, the date the mortgagor acquires the
residence, i.e., the date on which the mortgagor includes in basis any
amounts expended for rehabilitation that are expended for capital
assets.
(v) The amounts expended by the mortgagor for rehabilitation include
all amounts expended for rehabilitation regardless of whether the
amounts expended were financed from the proceeds of the loan or from
other sources, and regardless of whether the expenditure is a capital
expenditure, so long as the expenditure is made during the
rehabilitation of the residence and is reasonably related to the
rehabilitation of the residence. The value of services performed by the
mortgagor or members of the mortgagor's family (as used in Sec. 6a.103A-
2(b)(8)(ii)(B)) in rehabilitating the residence will not be included in
determining the rehabilitation expenditures for purposes of the 25-
percent test.
(vi) Where a mortgagor purchases a residence that has been
substantially rehabilitated, the 25-percent test is determined by
comparing the total expenditures made by the seller for the
rehabilitation of the residence with the acquisition cost of the
residence to the mortgagor. The total expenditures made by the seller
for rehabilitation do not include the cost of acquiring the building or
land but do include all amounts directly expended by the seller in
rehabilitating the building (excluding overhead and other indirect
charges).
(c) Good faith compliance efforts--(1) Mortgage eligibility
requirements. An issue of qualified mortgage bonds which fails to meet
one or more of the requirements of paragraphs (d), (e), (f), and (j) of
this section shall be treated as meeting such requirements if each of
the following provisions is met.
(i) The issuer in good faith attempted to meet all such requirements
before the mortgages were executed. Good faith requires that the trust
indenture, participation agreements with loan originators, and other
relevant instruments contain restrictions that permit the financing of
mortgages only in accordance with such requirements. In addition, the
issuer must establish reasonable procedures to ensure compliance with
such requirements. Such procedures include reasonable investigations by
the issuer or its agent to determine that the mortgages satisfy such
requirements.
(ii) Ninety-five percent or more of the lendable proceeds (as
defined in Sec. 6a.103A-2(b)(1)) that were devoted to
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owner financing were devoted to residences with respect to which, at the
time the mortgages were executed or assumed, all such requirements were
met. In determining whether the proceeds are devoted to owner financing
which meets such requirements, the issuer may rely on an affidavit of
the mortgagor that the property is located within the issuer's
jurisdiction and an affidavit of the mortgagor and the seller that the
requirements of Sec. 6a.103A-2(f) are met. The issuer may also rely on
his own or his agent's examination of copies of income tax returns which
were filed with the Internal Revenue Service and which are provided by
the mortgagor or obtained by the issuer or loan originator in accordance
with the procedures set forth in Sec. 301.6103(c)-1 which indicate that,
during the preceding 3 years, the mortgagor did not claim deductions for
taxes or interest on indebtness with respect to real property
constituting his principal residence, in addition to an affidavit of the
mortgagor that the requirements of Sec. 6a.103A-2(e) are met. The
mortgagor may also provide the issuer or his agent with an affidavit
that the mortgagor was not required to file such return in accordance
with section 6012 during one or all of the preceding 3 years. Where a
particular mortgage fails to meet more than one of these requirements,
the amount of the mortgage will be taken into account only once in
determining whether the 95-percent requirement is met. However, all of
the defects in the mortgage must be corrected pursuant to paragraph
(c)(1)(iii) of this section.
(iii) Any failure to meet such requirements is corrected within a
reasonable period after such failure is discovered. For example, where a
mortgage fails to meet one or more of such requirements those failures
can be corrected by calling the nonqualifying mortgage or by replacing
the nonqualifying mortgage with a qualifying mortgage.
(iv) Examples. The following examples illustrate the application of
paragraph (c)(1) of this section:
Example (1). State X issues obligations to be used to provide
mortgages for owner-occupied residences. X contracts with bank M to
originate and service the mortgages. The trust indenture and
participation agreement require that the mortgages meet the mortgage
eligibility requirements referred to in paragraph (c)(1). In addition,
pursuant to procedures established by X, M obtains a signed affidavit
from each applicant that the applicant intends to occupy the property as
his or her principal residence within 60 days after the final closing
and thereafter to maintain the property as his or her principal
residence. Further, M obtains from each applicant copies certified by
the Internal Revenue Service of the applicant's Federal tax returns for
the preceding 3 years and examines each statement to determine whether
the applicant has claimed a deduction for taxes on real property which
was the applicant's principal residence pursuant to section 164(a)(1) or
a deduction pursuant to section 163 for interest paid on a mortgage
secured by real property which was the applicant's principal residence.
Also in accordance with X's procedures, M obtains from each applicant a
signed affidavit as to facts that are sufficient for M to determine
whether the residence is located within X's jurisdiction and affidavits
from the seller and the buyer that the purchase price and the new
mortgage requirements have been met, and neither M nor X knows or has
reason to believe that such affidavits are false. The mortgage
instrument provides that the mortgage may not be assumed by another
person unless X determines that the principal residence, 3-year, and
purchase price requirements are met at the time of the assumption. These
facts are sufficient evidence of the good faith of the issuer and meet
the requirements of paragraph (c)(1)(i). Further, if 95 percent of the
lendable proceeds are devoted to owner financing which according to
these procedures meet the requirements of paragraphs (d), (e), (f), and
(i), then the issue meets the requirements of paragraph (c)(1)(ii).
Example (2). State Y issues obligations to be used to provide
mortgages for owner-occupied residences. Y contracts with bank N to
originate and service the mortgages. The trust indenture and
participation agreement require that the mortgagor certify compliance
with the requirements referred to in paragraph (c)(1). By itself, this
certification is not sufficient evidence of the good faith of the issuer
to meet the requirements referred to in paragraph (c)(1).
Example (3). The facts are the same as in Example 1, except that M
discovers through a verification procedure required by X that, at the
time of closing, A fraudulently executed the residencey affidavit.
Instead of occupying the property as a principal residence, A leased the
property to B for one year. A did not use the property as his residence
during the lease term. Thus, at the time that A's mortgage was executed
the residence failed to meet the requirements of paragraph (d) of this
section.
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More than 95 percent of the lendable proceeds of the issue were devoted
to residences which met all the requirements referred to in paragraph
(c)(1) at the time the mortgages were executed. Furthermore, pursuant to
a provision in the mortgage instrument M called the loan. Any failures
with respect to other mortgages are corrected by M. Based on these
facts, the issue meets the requirements of subparagraph (c)(1).
Example (4). The facts are the same as in Example (1), except that
the issuer requires copies of the applicant's signed tax returns that
were filed with the Internal Revenue Service for the preceding 3 years
but does not require that such returns be certified. If 95 percent of
the lendable proceeds are devoted to owner financing which according to
these procedures meet the requirements of paragraphs (d), (e), (f), and
(i), then the issue meets the requirements of paragraph (c)(1)(ii).
(2) Nonmortgage eligibility requirements. An issue of qualified
mortgage bonds which fails to meet one or more of the requirements of
paragraphs (g), (h), and (i) of this section and Sec. 6a.103A-1(a)(5)
shall be treated as meeting such requirements if each of the following
provisions is met.
(i) The issuer in good faith attempted to meet all such
requirements. This good faith requirement will be met if all reasonable
steps are taken by the issuer to ensure that the issue complies with
these requirements.
(ii) Any failure to meet such requirements is due to inadvertent
error, e.g., mathematical error, after taking reasonable steps to comply
with such requirements.
(iii) The following examples illustrate the application of this
subparagraph (2):
Example (1). City X issues obligations to finance owner-occupied
residences. However, despite taking all reasonable steps to determine
accurately the size of the market share limitation, as provided in
paragraph (g)(3), the limit is exceeded because the amount of the
mortgages originated in the area during the past 3 years is incorrectly
computed as a result of mathematical error. Such facts are sufficient
evidence of the good faith of the issuer to meet the requirements of
paragraph (c)(2).
Example (2). City Y issues $25 million of bonds to finance single-
family, owner-occupied homes. Attorney A gives an opinion that the bonds
satisfy the arbitrage requirements of Sec. 6a.103A-2(i) and
Sec. 6a.103A-1(a)(3). In fact, however, the legal conclusion reached by
A is erroneous, and the bonds do not meet the requirements of
Sec. 6a.103A-2(i). The issue does not meet the requirements of
subparagraph (c)(2) because the erroneous opinion does not constitute
inadvertent error.
(d) Residence requirements--(1) In general. An issue meets the
requirements of this paragraph only if all of the residences for which
owner financing is provided under the issue meet the requirements of
this paragraph. A residence meets the requirements of this paragraph
only if--
(i) It is a single-family residence (as defined in Sec. 6a.103A-
1(b)(6)) which, at the time the mortgage is executed or assumed, can
reasonably be expected by the issuer to become the principal residence
of the mortgagor within a reasonable time after the financing is
provided; and
(ii) It is located within the jurisdiction of the authority issuing
the obligation.
(2) Affidavit. The requirements of subparagraph (1)(i) of this
paragraph may normally be met if the mortgagor executes an affidavit of
his intent to use the residence as his principal residence within a
reasonable time (e.g., 60 days) after the financing is provided.
(3) Principal residence. Whether a residence is used as a principal
residence depends upon all the facts and circumstances of each case,
including the good faith of the mortgagor. A residence which is
primarily intended to be used in a trade or business shall not satisfy
the requirements of this paragraph. For purposes of the preceding
sentence, any use of a residence which does not qualify for a deduction
allowable for certain expenses incurred in connection with the business
use of a home under section 280A shall not be considered as a use in a
trade or business. Except for certain owner-occupied residences
described in paragraph (b)(6) of Sec. 6a.103A-1, a residence more than
15 percent of the total area of which is reasonably expected to be used
primarily in a trade or business does not satisfy the requirements of
this subparagraph. Further, a residence used as an investment property
or a recreational home does not satisfy the requirements of this
subparagraph.
(4) Residence. (i) The term ``residence'' includes stock held by a
tenant-stockholder in a cooperative housing
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corporation (as those terms are defined in section 216(b) (1) and (2)).
It does not include property such as an appliance, a piece of furniture,
a radio, etc., which, under applicable local law, is not a fixture. The
term also includes factory-made housing which is permanently fixed to
real property. The determination of whether factory-made housing is
permanently fixed to real property shall be made on the basis of the
facts and circumstances of each particular case.
(ii) Land. Land appurtenant to a residence shall be considered as
part of the residence only if such land reasonably maintains the basic
livability of the residence and does not provide, other than
incidentally, a source of income to the mortgagor.
(5) Examples. The following examples illustrate the application of
this paragraph (d):
Example (1). A contracts to purchase a new residence from B. Since B
is unable to move from the residence until 1 month after the scheduled
closing date, A agrees to lease the residence to B for 1 month at a rent
equal to the fair rental value. A applies for a mortgage to be provided
from the proceeds of a qualified mortgage bond. In light of all the
facts and circumstances in the case, the fact that A temporarily leases
the residence to B does not prevent the residence from being considered
as property that can reasonably be expected to be used as A's principal
residence within a reasonable period of time after financing is
provided.
Example (2). C contracts to purchase a new residence located on 2
acres of land in city X. City X has a zoning regulation which prevents
the subdividing of any lot in that part of the city for use as a private
residence into parcels of less than 2 acres. In light of all the facts
and circumstances in the case, the fact that the residence is located on
2 acres of land appurtenant to the residence does not prevent the entire
property from being considered as property to be used by C as a
residence.
Example (3). D contracts to purchase a new residence located on 40
acres of land that D intends to farm. Any financing provided for the
purchase of that portion of the property intended to be farmed will not
be considered as financing provided for an owner-occupied residence.
(e) 3-year requirement--(1) In general. An issue meets the
requirements of this paragraph only if each of the mortgagors to whom
owner financing is provided under the issue meets the requirements of
this paragraph. A mortgagor meets the requirements of this paragraph
only if the mortgagor had no present ownership interest in a principal
residence at any time during the 3-year period prior to the date on
which the mortgage is executed. For purposes of the preceding sentence,
the mortgagor's interest in the residence with respect to which the
financing is being provided shall not be taken into account.
(2) Exceptions. Subparagraph (1) shall not apply with respect to--
(i) Any financing provided with respect to a targeted area residence
(as defined in Sec. 6a.103A-2(b)(3)),
(ii) Any qualified home improvement loan (as defined in Sec. 6a103A-
2(b)(9)), and
(iii) Any qualified rehabilitation loan (as defined in Sec. 6a.103A-
2(b)(10)).
(3) Multiple mortgagors. In the event that there is more than one
mortgagor with respect to a particular residence, each of such
mortgagors must meet the 3-year requirement. A person who is liable
under a note secured by the mortgage but who does not have a present
ownership interest in a residence subject to the mortgage need not meet
the 3-year requirement. For example, where a parent of a home purchaser
cosigns the note for a child but the parent takes no interest in the
residence, it is not necessary that the parent meet the 3-year
requirement since the parent is not a mortgagor of the residence.
(4) Included interests. Examples of interests which constitute
present ownership interests are the following:
(i) A fee simple interest;
(ii) A joint tenancy, a tenancy in common, or tenancy by the
entirety;
(iii) The interest of a tenant-shareholder in a cooperative;
(iv) A life estate;
(v) A land contract (i.e., a contract pursuant to which possession
and the benefits and burdens of ownership are transferred although legal
title is not transferred until some later time); and
(vi) An interest held in trust for the mortgagor (whether or not
created by the mortgagor) that would constitute a present ownership
interest if held directly by the mortgagor.
[[Page 130]]
(5) Excluded interests. Examples of interests which do not
constitute present ownership interests are the following:
(i) A remainder interest;
(ii) A lease with or without an option to purchase;
(iii) A mere expectancy to inherit an interest in a principal
residence;
(iv) The interest that a purchaser of a residence acquires on the
execution of a purchase contract; and
(v) An interest in other than a principal residence during the
previous 3 years.
(f) Purchase price requirements--(1) In general. An issue meets the
requirements of this paragraph only if the acquisition cost (as defined
in Sec. 6a.103A-2(b)(8)) of each residence, other than a targeted area
residence, for which owner financing is provided does not exceed 90
percent of the average area purchase price applicable to such residence.
In the case of a targeted area residence (as defined in Sec. 6a.103A-
2(b)(3)), the acquistion cost may not exceed 110 percent of the average
area purchase price applicable to such residence.
(2) Exception. Paragraph (1) shall not apply with respect to any
qualified home improvement loan (as defined in Sec. 6a.103A-2(b)(9)).
(3) Average area purchase price. The term ``average area purchase
price'' means, with respect to any residence, the average purchase price
of all single-family residences in the statistical area (as defined in
Sec. 6a.103A-2(b)(7)) in which the residence being financed is located
for the most recent 12-month period for which sufficient statistical
information is available. The determination whether a particular
residence meets the purchase price requirement shall be made as of the
date on which the commitment to provide the financing is made or, if
earlier, the date of purchase of the residence.
(4) Special rules. (i) In the case of a qualified rehabilitation
loan, the requirements of this paragraph are met if the mortgagor's
adjusted basis in the property as of the completion of the
rehabilitation (including the cost of the rehabilitation) meets the
requirements of paragraph (f)(1). For this purpose, a rehabilitated
residence is to be treated as a residence which has been previously
occupied.
(ii) The determination of average area purchase price shall be made
separately with respect to--
(A) Residences which have not been previously occupied;
(B) Residences which have been previously occupied; and
(C) One-family, two-family, three-family, and four-family
residences.
(5) Safe harbor limitation. (i) For purposes of meeting the
requirements of this paragraph, an issuer may rely upon average area
purchase price limitations published by the Treasury Department for the
statistical area in which a residence is located. These safe harbor
limitations will be effective for the period stated at the time of
publication. An issuer may use a limitation different from such safe
harbor limitation for any statistical area (as defined in Sec. 6a.103A-
2(b)(7)) for which the issuer has more accurate and comprehensive data.
(ii) The following example illustrates the application of
subparagraph (5)(i):
Example. The average area purchase price safe harbor limitation for
new single-family residences published by the Treasury Department for
the second half of 1981 for the jurisdiction of governmental unit X is
$41,500. However, on July 1, 1981, X determines that its average area
purchase price for new single-family residences is actually $43,000.
Such determination is based on a comprehensive survey of residential
housing sales in the jurisdiction over the previous calendar year. The
data accumulated are based on records maintained by the county clerk's
office in X's jurisdiction, which enables X to compute average area
purchase prices separately for new and used residences and for one-,
two-, three-, and four-family residences. X cannot reasonably update
such data more often than once a year. X may use average area purchase
prices computed from these data for mortgages made from July 1, 1981,
through June 30, 1982, rather than the safe harbor published by the
Treasury Department.
(g) Limitation on aggregate amount of qualified mortgage bonds
issued during any calendar year--(1) In general. An issue meets the
requirements of this section only if the aggregate amount of bonds
issued pursuant thereto, when added to the sum of (i) the aggregate
amount of qualified mortgage bonds
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previously issued by the issuing authority during the calendar year and
(ii) the amount of qualified mortgage bonds which the issuing authority
previously elected not to issue under section 25(c)(2)(A)(ii) and the
regulations thereunder during the calendar year, does not exceed the
applicable limit (``market limitation'') for such authority for such
calendar year.
(2) State housing finance agency. Except as provided in paragraph
(g)(4) of this section, the market limitation for any State housing
finance agency for any calendar year shall be 50 percent of the State
ceiling for such year. For purposes of the preceding sentence, if any
State has more than one housing finance agency all such agencies shall
be treated as a single agency.
(3) Other issuers. Except as provided in paragraph (g)(4), the
market limitation for any issuing authority (other than a State housing
finance agency) for any calendar year is an amount equal to that
authority's proportionate share of 50 percent of the State ceiling
amount for such calendar year. The proportionate share is an amount
which bears the same ratio to 50 percent of the State ceiling for such
year as--
(i) The average annual aggregate principal amount of mortgages
executed during the immediately preceding 3 calendar years for single-
family, owner-occupied residences located within the jurisdiction of
such issuing authority, bears to
(ii) An average determined in the same way for the entire State.
(4) Constitutional home rule city. (i) In determining the market
limitation for any constitutional home rule city (as defined in
paragraph (b)(2) of this section), subparagraph (3) shall be applied by
substituting ``100 percent'' for ``50 percent.''
(ii) In a State with one or more constitutional home rule cities, in
computing the market limitation for issuers other than constitutional
home rule cities, the State ceiling amount for any calendar year shall
be reduced by the aggregate market limitation for such year for all
constitutional home rule cities in the State.
(5) Overlapping jurisdictions. (i) For purposes of subparagraph (3)
of this paragraph, if an area is within the jurisdiction of two or more
governmental units, such area shall be treated as only within the
jurisdiction of the unit having jurisdiction over the smallest
geographical area. However, the governmental unit with jurisdiction over
the smallest geographical area may enter into a written agreement to
allocate all or a designated portion of such overlapping area to the
governmental unit having jurisdiction over the next smallest
geographical area.
(ii) Where two governmental units have authority to issue mortgage
subsidy bonds and both governmental units have jurisdiction over the
identical geographical area, the aggregate principal amount of mortgages
on residences located within that area shall be allocated to the
governmental unit having broader sovereign powers.
(6) State ceiling. (i) Except as provided in paragraph (g)(6)(v),
the State ceiling applicable to any State for any calendar year shall be
the greater of--
(A) 9 percent of the average annual aggregate principal amount of
mortgages executed during the immediately preceding 3 calendar years for
single-family, owner-occupied residences located within the jurisdiction
of such State, or
(B) $200,000,000.
Only single-family owner-occupied residences (without regard to the
definition of such term under Sec. 6a.103A-1(b)(6)) may be used in
determining the market limitation regardless of whether or not
residences with up to four family units are to be financed by the
program. First and second mortgages or mortgages used to refinance an
existing mortgage shall be used in making such determination. Liens,
special assessments, and similar encumbrances may not be taken into
consideration.
(ii) For mortgages on residences with more than one family unit, the
full amount of the mortgage shall be applied toward the market
limitation and not merely that portion allocable to the owner-occupied
unit.
(iii) For purposes of determining the State ceiling amount
applicable to any State for any calendar year an issuer may rely upon
the State ceiling amount published by the Treasury Department for such
calendar year. An
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issuer may rely on a different State ceiling amount than such safe-
harbor limitation where the issuer has made a more accurate and
comprehensive determination of such amount.
(iv) The following example illustrates the application of
subparagraphs (3) and (6) of this paragraph (g):
Example. Pursuant to the allocation rule provided in subparagraph
(3), City Y determines that its maximum market limitation in 1981 is
$15,000,000. This determination is based on records maintained by the
county clerk's office from which data for the preceding 3 years have
been accumulated by City Y as to the number of sales of single-family
homes in City Y's jurisdiction, the purchase price in each such sales
transaction, the number of such sales that were financed by mortgages
and the volume of second mortgages and refinancing on previously
purchased owner-occupied single-family residences. This information,
combined with estimates made by City Y of the average mortgage-loan-to-
purchase-price ratio and the ratio of sales of single-family, owner-
occupied residences to all sales of single-family residences from a
representative sample of sales transactions, enables Y to estimate the
preceding 3 years' annual aggregate mortgage volume by using the
following formula:
[GRAPHIC] [TIFF OMITTED] TC16OC91.001
where
v=The preceding 3 years' average annual aggregate volume of mortgages on
single-family, owner-occupied residences in City Y,
ui=Number of sales of single-family residences,
wi=Average purchase price of all sales,
xi=Percent of all sales transactions that were financed with
mortgages,
yi=Estimated average mortgage-loan-to-purchase-price ratio,
zi=Estimated percent of sales that were owner-occupied
residences,
ai=Total volume of second mortgages and refinancing on
previously purchased owner-occupied, single-family residences,
i=The annual period of calculation, and
t=The current year.
City Y determines its applicable limit for 1981 based on the following
formula:
L=0.5 (v/s) r, where
L=Market limitation for City Y for the current year,
s=The preceding 3 years' average annual aggregate volume of mortgages on
single-family, owner-occupied residences in State X, and
r=Ceiling for State X (i.e., r=the greater of .09s or $200,000,000).
City Y may use the Treasury estimate of s which will be published with
the mortgage volume safe harbor limitation. City Y may rely on its
determination of its market limitation for obligations issued during
1981.
(v) Reduction in State ceiling. If for any calendar year an issuer
of mortgage credit certificates, as defined in section 25 and the
regulations thereunder, fails to meet the requirements of section 25
(d)(2) and the regulations thereunder, relating to the limit on the
aggregate amount of mortgage credit certificates that may be issued, the
applicable State ceiling under paragraph (g)(6)(i) of this section for
the State in which the program operates will be reduced by 1.25 times
the correction amount (as defined in section 25 (f)(2) and the
regulations thereunder) with respect to that failure for the calendar
year following the calendar year in which the Commissioner determines
the correction amount with respect to that failure.
(7) Excess obligations. Where an issue of obligations when added to
the aggregate amount of bonds issued by the same issuing authority in
the same calendar year exceeds the market limitation determined in
accordance with this paragraph (g), no portion of the issue will be
treated as a qualified mortgage bond issue, and interest on such
obligations shall be subject to Federal income taxation. However,
previously issued qualified mortgage bond issues which met the market
limitation at the time of their issuance will not cease to be qualified
mortgage bond issues even though a subsequent issue causes the aggregate
amount of obligations to exceed such limitation for a calendar year.
(8) Transitional rule obligations. In applying this paragraph (g) to
any calendar year, there shall not be taken into account any bond which,
by reason of section 1104 of the Mortgage Subsidy Bond Tax Act of 1980
(94 Stat. 2670) (relating to transitional rules), receives the same tax
treatment as bonds issued on or before April 24, 1979.
(9) Procedure for providing a different allocation. (i) A State may,
by law enacted after December 5, 1980, provide a different formula for
allocating the
[[Page 133]]
State ceiling amount among the governmental units in such State (other
than constitutional home rule jurisdictions) having authority to issue
qualified mortgage bonds.
(ii) The governor of any State may proclaim a different formula than
provided in subparagraphs (g)(2) and (g)(3) for allocating the State
ceiling amount among the governmental units in such State having
authority to issue qualified mortgage bonds. The authority of the
governor to proclaim a different formula shall not apply after the
earlier of--
(A) The 1st day of the 1st calendar year beginning after the 1st
calendar year after 1980 during which the legislature of the State met
in regular session, or
(B) The effective date of any State legislation dealing with such
ceiling enacted after December 5, 1980.
If, on or before either date, the governor of any State exercises the
authority to provide a different allocation, such allocation shall be
effective until the date specified in (B).
(iii) Unless otherwise provided in a State constitutional amendment
or by law changing the home rule provisions adopted in the manner
provided by the State constitution, the allocation of that portion of
the State ceiling which is allocated to any constitutional home rule
city may not be changed by the governor or State legislature unless such
city agrees to such different allocation.
(iv) Where a State elects to make a different allocation in
accordance with subdivision (i) or (ii) of this subparagraph, the
determination as to whether a particular bond issue meets the
requirements of paragraph (g) of this section will be based upon the
allocation in effect at the time such bonds were issued. Moreover, the
authority to provide for a different allocation may not be used directly
or indirectly to increase the State ceiling amount.
(v) An issuing authority located in a State with one or more
constitutional home rule cities may use an alternative method to those
provided in subparagraphs (2), (3), and (4) for determining such issuing
authority's market limitation if, prior to issuing any obligations for
the calendar year, it demonstrates to the satisfaction of the
Commissioner that--
(A) The use of the methods provided in subparagraph (2), (3), or (4)
would impose an unreasonable hardship on the issuing authority, and
(B) Such alternative method is reasonable.
(h) Portion of loans required to be placed in targeted areas--(1) In
general. An issue meets the requirements of this paragraph only if--
(i) The portion of the lendable proceeds (as defined in
Sec. 6a.103A-2(b)(1)) of the issue specified in subparagraph (2) is made
available for owner financing of targeted area residences (as defined in
Sec. 6a.103A-2(b)(3)) for at least 1 year after the date on which owner
financing is first made available with respect to targeted area
residences, and
(ii) The issuer attempts with reasonable diligence to place such
proceeds in qualified mortgages.
Proceeds are considered first made available with respect to targeted
area residences on the date on which any financing of mortgages with the
lendable proceeds of an issue first becomes available. Reasonable
diligence requires that the issuer and the loan originators use
reasonable efforts in trying to place mortgages in targeted areas, such
as by advertising that mortgage funds are available for targeted areas.
Reasonable diligence is not shown by merely providing in the governing
instruments that the required amount be set aside for targeted areas.
(2) Specified portion. The specified portion of lendable proceeds of
an issue required to be made available in targeted areas is the lesser
of--
(i) 20 percent of the lendable proceeds, or
(ii) 40 percent of the average annual aggregate principal amount of
mortgages executed during the immediately preceding 3 calendar years for
single-family, owner-occupied residences in targeted areas within the
jurisdiction of the issuing authority.
(3) Safe harbor. For purposes of computing the required portion of
proceeds specified in subparagraph (2)(ii) of this paragraph, where such
provision is applicable, an issuer may rely upon the
[[Page 134]]
amount produced by the following formula:
[GRAPHIC] [TIFF OMITTED] TC16OC91.002
where
P=Required portion to be made available in targeted areas,
X=Average annual aggregate principal amount of mortgages executed during
the immediately preceding 3 calendar years for single-family, owner-
occupied residences within the State in which the issuing jurisdiction
is located,
Y=The total population within the State, based on the most recent
decennial census for which data are available, and
Z=The total population in the targeted areas located within the issuer's
jurisdiction, based on the most recent decennial census for which data
are available.
The issuing jurisdiction may use the Treasury Department estimate of X
which will be published with the mortgage volume safe harbor limitation.
(4) Minimum amount. (i) The specified portion required to be made
available in targeted areas is a minimum amount. More than the minimum
amount may be (but need not be) made available in targeted areas.
(ii) With respect to any proceeds not required to be made available
in targeted areas, the requirements of this paragraph do not abrogate
the requirement of the arbitrage rules that due diligence be used in
placing lendable proceeds into mortgages.
(i) Arbitrage and investment gain--(1) In general. An issue meets
the requirements of this paragraph only if such issue meets the
requirements of subparagraphs (2), (3), and (4) of this paragraph. For
purposes of these requirements, all determinations of yield, effective
interest rates, and amounts required to be paid or credited to
mortgagors under paragraph (i)(4)(i) of this section shall be made on an
actuarial basis taking into account the present value of money. The
requirements of section 103A(i) and this paragraph are applicable in
addition to the requirements of section 103(c) and Secs. 1.103-13,
1.103-14, and 1.103-15.
(2) Effective rate of mortgage interest not to exceed bond yield by
more than 1 percentage point--(i) Maximum yield. An issue of qualified
mortgage bonds shall be treated as meeting the requirements of this
subparagraph only if the excess of--
(A) The effective rate of interest on the mortgages financed by the
issue, over
(B) The yield on the issue,
is not greater over the term of the issue than 1 percentage point.
(ii) Effective rate of interest. (A) In determining the effective
rate of interest on any mortgage for purposes of this subparagraph,
there shall be taken into account all fees, charges, and other amounts
borne by the mortgagor which are attributable to the mortgage or to the
bond issue. Such amounts include points, commitment fees, origination
fees, servicing fees, and prepayment penalties paid by the mortgagor.
(B) Items that shall be treated as borne by the mortgagor and shall
be taken into account in calculating the effective rate of interest also
include--
(1) All points, commitment fees, origination fees, or similar
charges borne by the seller of the property;
(2) The excess of any amounts received from any person other than
the mortgagor by any person in connection with the acquisition of the
mortgagor's interest in the property over the usual and reasonable costs
incurred by a person acquiring like property where owner financing is
not provided through the use of qualified mortgage bonds.
(C) The following items shall not be treated as borne by the
mortgagor and shall not be taken into account in calculating the
effective rate of interest:
(1) Any expected rebate of arbitrage profit (as required by
Sec. 6a.103A-2(i)(4)).
(2) Any application fee, survey fee, credit report fee, insurance
fee or similar settlement or financing cost to the extent such amount
does not exceed amounts charged in such area in cases where owner
financing is not provided through the use of qualified mortgage bonds.
For example, amounts paid for FHA, VA, or similar private mortgage
insurance on an individual's mortgage need not be taken into account so
long as such amounts do not exceed the amounts charged in the area with
respect to a similar mortgage that is not financial with qualified
mortgage bonds. Premiums charged for pool mortgage insurance will be
considered
[[Page 135]]
amounts in excess of the usual and reasonable amounts charged for
insurance in cases where owner financing is not provided through the use
of qualified mortgage bonds.
(D)(1) Where amounts other than those derived from the proceeds of a
mortgage subsidy bond are used to finance single-family residences such
amounts will not be treated as the proceeds of a qualified mortgage bond
issue and will not be subject to the limitations set forth in
subparagraphs (2), (3), and (4) of this paragraph (i). Such amounts may,
however, be treated as proceeds for purposes of the requirements of
section 103(c) and the regulations thereunder. Thus, the portion of the
mortgage pool financed by the proceeds of a qualified mortgage bond
issue will be subject to the limitations of subparagraphs (2), (3), and
(4) of this paragraph (i), while the portion not provided with bond
proceeds will not be subject to such limitations. The interest rate,
points, origination fees, servicing fees, and other amounts charged with
respect to that portion of a mortgage loan financed with non-bond
amounts may not exceed the reasonable and customary amount which would
be charged where financing is not provided through a qualified mortgage
bond issue. Where the charge does exceed such reasonable and customary
amount, any excess will be taken into account in computing the effective
interest rate on the portion of the loan provided with the proceeds of
the qualified mortgage bond issue. Furthermore, where such fees and
other charges are less than the reasonable and customary charges, the
issuer may not allocate that portion of the charges on the loan amounts
made with bond proceeds which is equal to such differential to loan
amounts made with non-bond proceeds.
(2) If any mortgage is allocated to two or more sources of funds,
the receipt of amounts which are described in paragraph (i)(2)(ii) (A)
and (B) of this section, repayments of principal, or payments of
interest on such mortgage must be allocated to each source of funds.
(E) The effective rate of interest on any mortgage shall be
determined in a manner consistent with actuarial methods and shall take
into account the discounted value of all amounts from the time received
to an amount equal to the ``purchase price'' of the mortgage. Such
discount rate is the effective rate of interest on the mortgages. The
``purchase price'' of a mortgage means the net amount loaned to the
mortgagor. For example, if a mortgage loan is in the amount of $30,000
and the mortgagor is charged one point ($300) as an origination fee
which amount is deducted from loan proceeds available to the mortgagor,
the purchase price is $29,700. If interest on an issue is paid
semiannually, all regular monthly mortgage payments and prepayments of
principal may be treated as being received at the end of each semiannual
debt service period.
(1) If interest on an issue is paid semiannually, all regular
monthly mortgage payments may be treated as being received at the end of
each semiannual debt service period.
(2) Prepayments of principal shall be treated as being received on
the last day of the month in which the issuer reasonably expects to
receive such prepayments.
(F) The rate shall be determined on a composite basis for all
mortgages financed by the issue.
(iii) Example. The following example illustrate the provisions of
subparagraph (2)(ii) of this paragraph:
Example. Purchaser A contracts with seller B, who is represented by
real estate agent C, for the purchase of B's residence for $65,000. A
applies to County X for a mortgage provided by the proceeds of a
qualified mortgage bond. County X requires that agent C provide it with
a principal residence affidavit as well as verify the purchase price of
the residence and the location of the purchasers previous residences.
Due to the increased administrative burden imposed on agent C by County
X, C charges B a real estate commission of 8 percent ($5,200), rather
than 6 percent ($3,900). The normal real estate commission is 6 percent.
Since the 8 percent commission charged by C and paid by B is in excess
of the usual and reasonable real estate commission where owner financing
is not provided through the use of qualified mortgage bonds, 2 percent
($1,300) shall be treated as borne by A and taken into account in
calculating the effective rate of interest on the mortgage.
(iv) Prepayment assumption In determining the affective rate of
interest on
[[Page 136]]
mortgages, it shall be assumed that the mortagage prepayment rate for
mortgages made out of both original proceeds and mortgages that the
issuer expects with reasonable certainty to be made out of prepayments
of principal will be equal to 100 percent of the rate set forth in the
most recent mortgage maturity experience table for mortgages having the
same term insured under section 203 of the National Housing Act and
published by the Federal Housing Administration in ``Survivorship and
Decrement Tables for HUD/FHA Home MORTGAGE Insurance Program'' for the
region, or, if available, the State in which the residence is located.
For purposes of applying these tables, either the original balance
method or the declining balance method of calculating mortgage loan
prepayments may be used. For proceeds used to finance qualified home
improvement loans or shorter term qualified rehabilitation loans for
which there are no comparable FHA mortgage maturity experience tables,
the assumption used by the issuer as to the rate of prepayment shall be
based upon the reasonable expectations of the issuer, as reflected,
where applicable, by the issuer's prior experience with such loans.
(v) Net losses. The projected net losses on the mortgage pool (after
foreclosure and payment of insurance proceeds), based on the most recent
default experience for the area in which the residences are located,
shall be taken into consideration in calculating the effective rate of
interest on the mortgages. However, where mortgages provided under an
issue are insured with FHA, VA, or private mortgage insurance, in
conjunction with pool mortgage insurance, the expected net losses will
be presumed to be zero. In the event that the actual losses on the
mortgage pool exceed the projected net losses which were taken into
consideration in calculating the effective rate of interest on the
mortgages, investment proceeds earned from nonmortgage assets may be
used to recover the excess losses and need not be paid or credited to
the mortgagors under Sec. 6a.103A-2(i)(4).
(vi) Yield on the issue. (A) The yield on an issue of qualified
mortgage bonds shall be calculated on the basis of--
(1) The issue price, and
(2) An expected maturity for the bonds which is consistent with the
prepayment assumption required under subparagraph (2)(iv) of this
paragraph.
The expected maturity will be considered consistent with such prepayment
assumption if all prepayments are assumed to be used to call bonds
proportionately (i.e., a ``strip'' call). The preceding sentence shall
not apply to prepayments of mortgages provided from original proceeds to
the extent such prepayments are used to provide mortgages.
(B) For purposes of (1) of this subdivision (vi), the term ``issue
price'' shall have the same meaning as in section 1232(b)(2). Thus, in
general, such term means the initial offering price to the public, not
including bond houses and brokers, or similar persons or organizations
acting in the capacity of underwriters or wholesalers, at which price a
substantial amount of such obligations were sold or, if privately
placed, the price paid by the first buyer of such obligations or the
acquisition cost of the first buyer.
(3) Nonmortgage investments--(i) Maximum investment. Except as
provided in subdivision (ii) of this subparagraph, an issue meets the
requirements of this subparagraph only if--
(A) At no time during any bond year does the aggregate amount
invested in nonmortgage investments, e.g., reasonably required reserve
funds, with a yield materially higher than the yield on the issue exceed
150 percent of the debt service on the issue for the current bond year,
and
(B) Such aggregate amount invested in nonmortgage assets with a
yield materially higher than the yield on the issue is promptly and
appropriately reduced as mortgages are repaid.
The amount subject to the maximum investment rule in subdivision (i)(A)
of this subparagraph includes the original bond proceeds, investment
proceeds and repayments of principal on the mortgages. For purposes of
subdivision (B), the amount described in subdivision (A) shall be
considered promptly and appropriately reduced if beginning in the first
bond year after the expiration of the temporary period for original
proceeds described in subdivision
[[Page 137]]
(ii)(A) of this subparagraph, such amount is reduced within 30 days of
the beginning of each bond year by an amount equal to the difference
between the average scheduled monthly mortgage receipts for the bond
year (excluding any receipts that were scheduled with respect to
mortgages that were discharged in the preceding bond year) and the
average scheduled monthly mortgage receipts for the preceding bond year.
(ii) Temporary periods. Subparagraph (3)(i) of this paragraph shall
not apply to--
(A) Proceeds (including prepayments of principal designated to be
used to acquire additional mortgages) of the issue invested for an
initial temporary period not to exceed 1 year (1\1/2\ years for proceeds
required to be set aside for placing mortgages in targeted areas) until
such proceeds are needed for mortgages, and
(B) Repayments of principal and interest on mortgages that are
contributed to a bona fide debt service fund (as defined in Sec. 1.103-
13(b)(12)) and invested for a 13-month temporary period as provided in
Sec. 1.103-14(b)(10).
(iii) Debt service defined. For purposes of subparagraph (3)(i)(A)
of this paragraph, the debt service on the issue for any bond year is
the scheduled amount of interest and amortization of principal payable
for such year with respect to such issue. There shall not be taken into
account amounts scheduled with respect to any bond which has been
retired before the beginning of the bond year.
(iv) Nonmortgage investments. A nonmortgage investment is any
investment other than an investment in a qualified mortgage. For
example, a mortgage-secured certificate or obligation is a nonmortgage
investment. Investment earnings from participation fees (described in
Sec. 6a.103A-1(b)(5)) are treated as investment proceeds on nonmortgage
investments unless such fees are used to pay debt service or to finance
owner occupied residences.
(v) Bonds issued after June 30, 1993. Section 1.148-2(f)(2)(iv)
applies to bonds issued after June 30, 1993, in lieu of this paragraph
(i)(3).
(4) Arbitrage and investment gains to be used to reduce costs of
owner financing--(i) Rebate requirement. An issue shall be treated as
meeting the requirements of this subparagraph only if an amount equal to
the sum of:
(A) The excess of--
(1) The net amount earned on all nonmortgage investments pursuant to
subparagraph (3)(i) and (ii) of this paragraph (other than investments
attributable to an excess described in this subdivision (A)) over
(2) The amount which would have been earned if the investments were
invested at a rate equal to the yield on the issue, plus
(B) Any income attributable to the excess described in subdivision
(A),--
shall be paid or credited to the mortgagors as rapidly as practicable.
Such amount may be disproportionately distributed to the mortgagors if
the larger portion of such amount is distributed to lower income
mortgagors. The determination of the excess described in subdivision (A)
shall take into account any reinvestment of nonmortgage investment
receipts and any gain or loss realized on the disposition of nonmortgage
investments. In addition, where nonmortgage investments are retained by
the issuer after retirement of an issue, any unrealized gains or losses
as of the date of retirement of such issue must be taken into account,
in calculating the amount to be rebated to the mortgagors. The amount
described in subdivision (A)(2) is the amount that would have been
earned if the investments in nonmortgage obligations were invested at a
rate equal to the yield on the issue calculated in the same manner as
provided in Sec. 6a.103A-2(i)(2)(vi) and by using the same compounding
method. For purposes of subdivision (B), any income attributable to the
excess described in subdivision (A) shall be taken into account whether
or not such income exceeds the yield on the bonds.
(ii) Computation period. Whether earnings are amounts described in
subdivision (i) (A) or (B) of this subparagraph shall be determined by
making computations on an annual basis. For example, if at the end of
the first year the earnings on nonmortgage investments exceed the amount
that could have been earned if such investments were invested at the
bond yield, the
[[Page 138]]
amount of earnings equal to such difference constitutes an excess
described in subdivision (i)(A) of this subparagraph. In the following
year, investment proceeds earned on such excess must be taken into
account, whether or not such earnings exceed the yield on the bonds, and
may not be treated as ``negative arbitrage''.
(iii) Paid or credited. For purposes of subdivision (i) of this
subparagraph, amounts are paid or credited to mortgagors as rapidly as
practicable if such amounts are paid or credited to such mortgagors at
the time the mortgagor discharges the mortgage, for example, through
prepayment of the entire principal amount or through making the last
regular payment on the mortgage. The amount paid or credited to the
mortgagors must have a present value at least equal to the present value
of the amount described in subdivision (i) of this subparagraph, using
the yield on the bonds as the discount rate. In the case of prepayments,
the cumulative amount required to be rebated under subparagraph (4)(i)
of this paragraph may be determined as of a date before the actual
prepayment but not more than 1 year earlier than the date of prepayment.
Except as provided in subparagraph (2)(v) or subparagraph (4)(iv) of
this paragraph, such amount may not be subject to the claim of any
party, e.g., a bondholder, and may not be paid over to any party other
than the mortgagor or the United States.
(iv) Reduction where issuer does not use full 1 percentage point.
(A) The amount required to be paid or credited to mortgagors under
subparagraph (4)(i) of this paragraph shall be reduced by the amount
which (if it were treated as an interest payment made by mortgagors)
would result in the excess referred to in subparagraph (2)(i) of this
paragraph being equal to 1 percentage point. Such amount shall be fixed
and determined as of the yield determination date. This fixed dollar
amount may be received by the issuer at any time but may not be adjusted
for the time of payment. Such fixed dollar amount shall be equal to the
difference between the purchase price of mortgages financed by the
proceeds of the issue and the present value of expected payments of
principal and interest on such mortgages, using a discount rate equal to
the bond yield plus 1 percentage point.
(B) The following example illustrates the provisions of subparagraph
(4)(iv)(A) of this paragraph:
Example. In 1981, County X issues obligations to provide mortgages
for owner-occupied residences. The yield paid on the obligations is 10
percent, and the effective rate of interest on the mortgages provided by
the proceeds of such obligations is 9.75 percent. X maintains a
reasonably required reserve fund which is invested at 15 percent and
intends to recover that additional amount computed in the manner
described in subparagraph (4)(iv) which could have been earned from
investment of the proceeds in mortgages with an effective interest rate
of 11 percent from the arbitrage earned from the reserve fund
nonmortgage assets. X plans to recover such amount from the arbitrage
over a period of 3 years; thus, X will not recover such amount until
1984. X may not adjust the amount to be received to account for the time
when such amount will be received.
(v) Election to pay United States. Subparagraph (4)(i) of this
paragraph shall be satisfied with respect to any issue if the issuer
elects in writing before issuing the obligations to pay over to the
United States--
(A) Not less frequently than once each 5 years after the date of
issue, an amount equal to 90 percent of the aggregate amount described
in subdivision (i) earned during such period (and not theretofore paid
to the United States), and
(B) Not later than 30 days after the redemption of the last
obligation, 100 percent of such aggregate amount not theretofore paid to
the United States.
(j) New mortgages--(1) In general. An issue meets the requirements
of this paragraph only if no part of the proceeds of such issue is to be
used to acquire or replace an existing mortgage. All of the lendable
proceeds must be used to provide mortgage loans to persons who did not
have a mortgage (whether or not paid off) on the residence securing the
mortgage note at any time prior to the execution of the mortgage.
(2) Exceptions. For purposes of this paragraph, the replacement of--
(i) Construction period loans,
(ii) Bridge loans or similar temporary initial financing, and
(iii) In the case of a qualified rehabilitation, an existing
mortgage,
[[Page 139]]
shall not be treated as the acquisition or replacement of an existing
mortgage. Generally, temporary initial financing is any financing which
has a term of 24 months or less.
(3) Assumptions. An issue meets the requirement of this paragraph
only if a mortgage with respect to which owner financing has been
provided under such issue may be assumed only if the requirements of
paragraphs (d), (e), and (f) of this section are met with respect to
such assumption. The determination of whether these requirements are met
is based upon the facts as they exist at the time of the assumption as
if the loan were being made for the first time. For example, the
purchase price requirement is to be determined by reference to the
average area purchase price at the time of the assumption and not when
the mortgage was originally placed. If the bond documents and relevant
mortgage instruments provide that a mortgage may be assumed only if the
issuer has determined that the conditions stated in this subparagraph
are satisfied, the good faith and 95-percent requirements of paragraph
(c)(1) (i) and (ii) of this section will be considered satisfied with
respect to the requirements of this subparagraph at the time the
mortgages were executed. However, any failure to meet the requirements
of this subparagraph at the time a mortgage is assumed is subject to the
remedy requirement in paragraph (c)(1)(iii) of this section.
(4) Examples. The following examples illustrate the application of
this paragraph (j):
Example (1). In June 1981 mortgagor A obtained a mortgage from a
private lending institution in order to construct a house on land which
A purchased without a mortgage in May 1981. In January 1982 A applies to
obtain permanent financing on the residence from a program sponsored by
State housing finance agency Y. Such program is funded with the proceeds
of qualified mortgage bonds. If A meets the other requirements of this
section, A qualifies for such permanent financing since the replacing of
construction financing is not treated as the acquisition or replacement
of an existing mortgage.
Example (2). In June 1981 mortgagor B purchased a new residence in a
targeted area but was unable to sell his former residence. Therefore, B
obtained temporary financing for his new residence until his former
residence was sold. In October 1981 B applies to County Z to obtain
financing from a program funded with proceeds of qualified mortgage
bonds. Such financing is needed by B to replace the temporary financing
for his new residence. If B meets the other requirements of this
section, the mortgage qualifies for such permanent financing since the
permanent financing replaces temporary initial financing.
Example (3). In 1979 mortgagor C purchased a residence but was
unable to obtain financing from a program sponsored by County W because
such program prohibited loans from the program which were in excess of
80 percent of the fair market value of the property. Therefore, in 1979
C obtained financing from a private lending institution with the
intention of refinancing when he accumulated sufficient equity in the
property. In 1981 C has accumulated sufficient equity in the property so
as to comply with the requirements of the program. C applies to County W
to refinance under the program, which is funded with the proceeds of
qualified mortgage bonds. Even if C met the other requirements of this
section, the mortgage would fail to meet the requirement of paragraph
(j) since such a mortgage would replace an existing mortgage.
Example (4). In 1969 mortgagor D purchased a residence and obtained
financing from a private lending institution. In 1981 D applies to
County U for a loan for the rehabilitation of the property and for the
refinancing of the existing mortgage. The program is funded with
qualified mortgage bonds. If D meets the other requirements of this
section the mortgage qualifies for such permanent financing since the
replacement of the mortgage is not treated as the replacement or
acquisition of an existing mortgage.
Example (5). In 1950 mortgagor E purchased a residence, obtaining a
mortgage from a private lending institution to finance the purchase
price. In 1980 E completed repaying the mortgage. In 1981 E applies for
a loan from a program sponsored by State housing finance agency X and
funded with the proceeds of qualified mortgage bonds. The mortgage does
not meet the requirements of paragraph (j) since E had a previous
mortgage on his residence, even though such mortgage was previously
released.
(k) Information reporting requirement. See Sec. 1.103A-2(k) for
rules relating to section 103A(j)(3).
(l) Policy statement. See Sec. 1.103A-2(l) for rules relating to
section 103A(j)(5).
[[Page 140]]
(m) State certification. See Sec. 1.103A-2(m) for rules relating to
section 103A(j)(4).
(98 Stat. 901 (26 U.S.C. 103A(j) (3) and (4)); 68A Stat. 917 (26 U.S.C.
7805))
[T.D. 7780, 46 FR 34314, July 1, 1981, as amended by T.D. 7794, 46 FR
55514, Nov. 10, 1981; T.D. 7817, 47 FR 22361, May 24, 1982; T.D. 7819,
47 FR 24701, June 8, 1982; T.D. 7821, 47 FR 28094, June 29, 1982; T.D.
7995, 49 FR 48293, Dec. 12, 1984; T.D. 8023, 50 FR 19355, May 8, 1985;
T.D. 8049, 50 FR 35547, Sept. 3, 1985; T.D. 8476, 58 FR 33553, June 18,
1993]
Sec. 6a.103A-3 Qualified veterans' mortgage bonds.
(a) In general. A qualified veterans' mortgage bond shall not be
treated as a mortgage subsidy bond, and the interest shall be exempt
from Federal income taxation.
(b) Qualified veterans' mortgage bond. (1) With respect to
obligations issued prior to July 19, 1984, the term ``qualified
veterans' mortgage bond'' means any issue of obligations--
(i) Which meets the requirements of Sec. 6a.103A-1, Sec. 6a.103A-
2(j) (1) and (2), and this section;
(ii) Substantially all of the proceeds of which are to be used to
provide financing for single-family, owner-occupied residences (which
meet the requirements of Sec. 6a.103A-1(b)(6) and Sec. 6a.103A-2(d)) for
veterans; and
(iii) Payment of the principal and interest on which is secured by a
pledge of the full faith and credit of the issuing State.
A qualified veterans' mortgage bond does not include any bond that is an
industrial development bond under section 103(b).
(2) With respect to obligations issued after July 18, 1984, the term
``qualified veterans' mortgage bond'' means any issue of obligations--
(i) Which meets the requirements of Sec. 6.103A-1, Sec. 6a.103A-2(d)
(relating to residence requirements), (j) (1) and (2) (relating to new
mortgage requirement), and (k) (relating to information reporting
requirement), and this section;
(ii) Substantially all of the proceeds of which are to be used to
provide financing for qualified veterans; and
(iii) Payment of the principal and interest on which is secured by a
pledge of the full faith and credit of the issuing State.
A qualified veterans' mortgage bond does not include any bond that is an
industrial development bond under section 103(b).
(c) Qualified veteran. (1) An issue meets the requirements of this
paragraph only if each of the mortgagors to whom owner financing is
provided is a qualified veteran.
(2) With respect to obligations issued prior to July 19, 1984, the
term ``qualified veteran'' means any veteran.
(3) With respect to obligations issued after July 18, 1984, the term
``qualified veteran'' means any veteran who--
(i) Served on active duty at some time before January 1, 1977, and
(ii) Applied for financing before the later of--
(A) The date 30 years after the date on which such veteran left
active service, or
(B) January 1, 1985.
(4) The term ``veteran'' shall have the same meaning as in 38 U.S.C.
101(2), that is, a person who served in the active military, naval, or
air service, and who was discharged or released therefrom under
conditions other than dishonorable.
(d) Husband and wife. For purposes of this section, if a residence
is to be owned by a husband and wife as joint tenants, as tenants by the
entirety, or as community property, and if one spouse is a veteran, then
both spouses shall be treated as satisfying the requirements of
paragraph (c) of this section.
(e) Substantially all. For purposes of this section, the term
``substantially all'' shall have the same meaning as in Sec. 1.103-8.
(f) Qualified home improvement loan. The term ``qualified home
improvement loan'' means the financing (whether or not secured by a
mortgage) of alterations, repairs, and improvements on, or in connection
with, an existing single-family, owner-occupied residence by a veteran
who is the owner thereof. The alterations, repairs, and improvements,
however, must substantially protect or improve the basic livability or
energy efficiency of the property, such as the renovation of
[[Page 141]]
plumbing or electric systems, the installation of improved heating or
air conditioning systems, the addition of living space, or the
renovation of a kitchen area. Items that will not be considered to
substantially protect or improve the basic livability of the property
include swimming pools, tennis courts, saunas, or other recreational or
entertainment facilities.
(g) Volume limitation--(1) In general. In the case of obligations
issued after June 22, 1984, an issue meets the requirements of this
paragraph only if the aggregate amount of obligations issued pursuant
thereto, when added to the aggregate amount of qualified veterans'
mortgage bonds previously issued by the State during the calendar year,
does not exceed the State veterans limit for such calendar year. In
determining the aggregate amount of qualified veterans' mortgage bonds
issued in calendar year 1984, obligations issued prior to June 23, 1984,
shall not be taken into account.
(2) State veterans limit. (i) The State veterans limit for any State
is the amount equal to--
(A) The aggregate amount of qualified veterans' mortgage bonds
issued by the State during the period beginning on January 1, 1979, and
ending on June 22, 1984 (not including the amount of any qualified
veterans' mortgage bonds actually issued during the calendar year, or
the applicable portion of 1984, in such period for which the amount of
such bonds was the lowest), divided by
(B) The number (not to exceed 5) of calendar years after 1978 and
before 1985 during which the State issued qualified veterans' mortgage
bonds.
In determining the number of calendar years after 1978 and before 1985
during which the State issued qualified veterans' mortgage bonds, any
qualified veterans' mortgage bonds issued after June 22, 1984, shall not
be taken into account. A State that did not issue qualified veterans'
mortgage bonds during the period beginning on January 1, 1979, and
ending on June 22, 1984, may not issue qualified veterans' mortgage
bonds after June 22, 1984.
(ii) In the case of any obligation which has a term of 1 year or
less and which was issued to provide financing for property taxes, the
amount taken into account under this paragraph with respect to such
obligation shall be \1/15\ of its principal amount.
(3) Examples. The following examples illustrate the provisions of
this paragraph:
Example (1). State R issued the following issues of qualified
veterans' mortgage bonds: a $200 million issue on March 31, 1979, a $150
million issue on May 1, 1980, a $75 million issue on September 1, 1981,
a $200 million issue on June 5, 1982, a $125 million issue on March 1,
1983, a $60 million issue on April 1, 1984, and a $100 million issue on
September 1, 1984. R issued no other issues of qualified veterans'
mortgage bonds during the period beginning January 1, 1979, and ending
on December 31, 1984. The aggregate amount of qualified veterans'
mortgage bonds issued during the period January 1, 1984, through June
22, 1984 ($60 million), is not taken into account in determining R's
State veterans limit because that is the lowest aggregate amount of
qualified veterans' mortgage bonds issued during the calendar year or
the applicable portion of 1984, in the period beginning on January 1,
1979, and ending on June 22, 1984. Thus, R's State veterans limit is
$150 million ($750 million (which is the sum of $200 million, $150
million, $75 million, $200 million, and $125 million) divided by 5). The
September 1, 1984, issue is not included in determinig the State
veterans limit because that issue was issued after June 22, 1984. The
September 1, 1984, issue of qualified veterans' mortgage bonds meets the
requirements of Sec. 6a. 103A-3 (g) since the aggregate amount of
qualified veterans' mortgage bonds issued in calendar year 1984 (not
including obligations issued prior to June 23, 1984), does not exceed
the State veterans limit.
Example (2). State S issued a $100 million issue of qualified
veterans' mortgage bonds on March 31, 1984. S issued no other issues of
qualified veterans' mortgage bonds during the period beginning on
January 1, 1979, and ending on June 22, 1984. The aggregate amount of
qualified veterans' mortgage bonds issued in the calendar year, or the
applicable portion of 1984, in the period January 1, 1979, through June
22, 1984, for which the amount of bonds was the lowest is zero. Thus,
the State veterans limit for S is $100 million (($100 million minus $0)
divided by 1).
(h) Good faith compliance efforts--(1) Mortgage eligibility
requirements. An issue of qualified veterans' mortgage bonds issued
after July 18, 1984, which fails to meet the requirements of section
103A(o)(1), Sec. 6a.103A-2(d) relating to residence requirements), and
Sec. 6a.103A-2(j) (1) and (2) (relating to new
[[Page 142]]
mortgage requirements) shall be treated as meeting such requirements if
each of the following provisions is complied with:
(i) The issuer in good faith attempted to meet all such requirements
before the mortgages were executed. Good faith requires that the trust
indenture, participation agreements with loan originators, and other
relevant instruments contain restrictions that permit the financing of
residences only in accordance with such requirements. In addition, the
issuer must establish reasonable procedures to ensure compliance with
such requirements. Such procedures include reasonable investigations by
the issuer to satisfy such requirements.
(ii) Ninety-five percent or more of the lendable proceeds (as
defined in Sec. 6a.103A-2(b)(1)) that were devoted to owner-financing
were devoted to residences with respect to which, at the time the
mortgages were executed, all such requirements were met. In determining
whether a person is a qualified veteran the issuer may rely on copies of
the mortgagor's certificate of discharge indicating that the mortgagor
served on active duty at some time before January 1, 1977, and stating
the date on which the mortgagor left active service provided that
neither the issuer nor its agent knows or has reason to believe that
such affidavit is false. Where a particular mortgage fails to meet more
than one of these requirements, the amount of the mortgage will be taken
into account only once in determining whether the 95-percent requirement
is met. However, all of the defects in the mortgage must be corrected
pursuant to subdivision (iii).
(iii) Any failure to meet such requirements is corrected within a
reasonable period after such failure is discovered. For example,
failures can be corrected by calling the nonqualifying mortgage or by
replacing the nonqualifying mortgage with a qualifying mortgage.
(2) Nonmortgage eligibility requirements. An issue of qualified
veterans' mortgage bonds issued after July 18, 1984, which fails to meet
the requirements of paragraph (g) of this section shall be treated as
meeting such requirements if each of the requirements of Sec. 6a.103A-
2(c)(2) (i) and (ii) is met.
(98 Stat. 901(26 U.S.C. 103A(j) (3) and (4)); 68A Stat. 917 ( 26 U.S.C.
7805))
[T.D. 7780, 46 FR 34314, July 1, 1981; 46 FR 37890, July 23, 1981, as
amended by T.D. 7995, 49 FR 48297, Dec. 12, 1984]
Sec. 6a.6652(g)-1 Failure to make return or furnish statement required under section 6039C.
(a) Amount imposed. In the case of each failure to meet the
requirements of--
(1) Section 6039C, relating to information returns with respect to
United States real property interests, or
(2) Section 6039C(b)(3), relating to statements to be provided to
substantial investors in United States real property interests,
on or before the date prescribed therefor (determined with regard to any
extension of time for filing), the person failing to meet such
requirement shall pay $25 for each day during which such failure
continues.
(b) Limitation--(1) Domestic corporations and nominees. The maximum
penalty which may be imposed under paragraph (a) of this section on a
domestic corporation or nominee for failure to meet the requirements of
section 6039C(a) for any calendar year is $25,000.
(2) Partnerships, trusts, estates and foreign corporations. The
maximum penalty which may be imposed on a partnership, trust, estate or
foreign corporation for failure to meet the requirements of section
6039C(b) for any calendar year is $25,000.
(3) Foreign persons holding U.S. real property interests and
nominees. The maximum penalty which may be imposed on a foreign person
holding a U.S. real property interest or on a nominee holding a U.S.
real property interest for a foreign person for failure to meet the
requirements of section 6039C(c) for any calendar year is the lesser of
$25,000 or 5 percent of the aggregate of the fair market value of the
U.S. real property interests owned by such person at any time during
such calendar year.
(c) Definitions--(1) Fair market value. The term ``fair market
value'' as used
[[Page 143]]
in this section is defined in Sec. 6a.897-1 (in the Federal Register 47
FR 41541, Sept. 21, 1982).
(2) Failure. The term ``failure to meet the requirements of section
6039C'' includes the failure to file a return for any calendar year on
the date prescribed therefor (determined with regard to any extension of
time for such filing), or the omission on a return of one or more items
of information required by section 6039C and the regulations thereunder
to be provided on the return. It also includes the failure to furnish a
statement required by section 6039C(b)(3). The failure to furnish a
return required under section 6039C(b)(1) and the failure to furnish a
statement to a substantial investor as required by section 6039C(b)(3),
are separate failures for purposes of paragraph (a) of this section.
Also, each failure to provide a statement to each substantial investor
is a separate failure for purposes of paragraph (a). Thus, if an entity
has 100 substantial investors as defined in section 6039C and fails to
furnish any of the required statements to substantial investors, there
are 100 separate failures to furnish the required statement.
(3) Aggregate of the fair market value of the United States real
property interests. The ``aggregate of the fair market value of the U.S.
real property interests'' is the total of the fair market values of each
U.S. real property interest owned at any time during the calendar year.
Fair market value is determined as of December 31 of such year for
property held at the end of the year and on the date of disposition for
property disposed of during the year.
(d) Attribution of ownership. For purposes of calculating the
penalty limitation under Sec. 6a.6652(g)-1(b)(3) with respect to failure
to meet the requirements of section 6039C(c), U.S. real property
interests held by a partnership, trust, or estate shall be treated as
owned proportionately by its partners or beneficiaries.
(e) Exceptions--(1) Provision of security. If a person otherwise
required by section 6039C to file a return for a calendar year or
furnish a statement to a substantial investor complies with the
requirements of Sec. 6a.6039C-5 relating to furnishing security in lieu
of filing such return, or is exempt, by virtue of Sec. 6a.6039C-5(f),
from filing a return for such year with respect to its U.S. real
property interests held, no penalty will be imposed under paragraph (a)
of this section for failure to file such return or furnish such
statement.
(2) Showing of reasonable cause. No amount shall be imposed under
paragraph (a) of this section for a failure described in such paragraph
if it is established to the satisfaction of the Director of the Internal
Revenue Service Center, 11601 Roosevelt Boulevard, Philadelphia,
Pennsylvania 19155 or in the case of returns concerning the Virgin
Islands, the Commissioner of the Bureau of Internal Revenue, Tax
Division, Charlotte Amalie, St. Thomas, V.I. 00801, that such failure is
due to reasonable cause and not to willful neglect. An affirmative
showing of reasonable cause must be made in the form of a written
statement, made under the penalties of perjury, containing a declaration
by the person failing to make a return or furnish a statement under
section 6039C setting forth all the facts alleged as reasonable cause.
Whether reasonable cause is shown may depend upon the subsection of
section 6039C under which the failure occurs. However, the fact that
stock of a foreign corporation, or any other interest in any entity to
which this section applies, is registered in bearer form does not
constitute reasonable cause under this paragraph (e)(2) of this section
for failure to comply with the requirements of section 6039C(b). Also,
the fact that disclosure of ownership would contravene a secrecy law of
any country does not constitute reasonable cause for failure to comply
with the requirements of section 6039C(b). Where a return has been filed
and there is an omission of one or more items of information required by
section 6039C and the regulations thereunder, one of the facts to be
considered in determining whether such failure is due to reasonable
cause is the materiality of the item omitted.
(3) Spouse or parent already filed with respect to same property. If
an individual files a return with respect to all U.S. real property
interests held by such individual in accordance with Sec. 6a.6039C-4(b),
no penalty shall be imposed under
[[Page 144]]
this section on such individual's spouse or minor child for failure to
file a return under Sec. 6a.6039C-4 with respect to the same property.
(f) Manner of payment. The amount imposed under paragraph (a) of
this section on any person shall be paid in the same manner as tax upon
the issuance of a notice and demand therefor.
(g) Examples. The provisions of this section may be illustrated by
the following examples:
Example (1). Domestic corporation X is required under section 6039C
(a) to make a return for calendar year 1982. X does not file such return
on or before May 15, 1983 as required under Sec. 6a.6039C-1(c). The
failure to file the return for calendar year 1982 continues throughout
calendar years 1983, 1984, 1985, and 1986. The failure to file is not
due to reasonable cause and no security has been furnished in lieu of
filing. The maximum penalty which can be imposed on X for failure to
file the 1982 return is $25,000, determined as follows:
------------------------------------------------------------------------
Cumulative
Penalty penalty for
incurred failure to
in given file 1982
year return
------------------------------------------------------------------------
Total penalty incurred in 1983 ($25 per day x
230 days)...................................... $5,750 $5,750
Total penalty incurred in 1984 (a leap year):
($25 per day x 366 days)..................... 9,150 14,900
Total penalty incurred in 1985 ($25 per day x
365 days)...................................... 9,125 24,025
Total penalty incurred in 1986 (lesser of $25
per day x 365 days or $975 (remaining penalty
which may be imposed))......................... 975 25,000
------------------------------------------------------------------------
Example (2). The facts are the same as in example (1) except that X
also fails to file a return under section 6039C (a) for calendar year
1983. The failure to file its return for calendar year 1983 continues
throughout calendar years 1984, 1985, 1986 and 1987. The total penalty
which may be imposed on X for failure to file its return for calendar
year 1983 is $25,000. The amount of penalty which can be imposed on X in
calendar years 1984, 1985, 1986 and 1987 is determined as follows:
------------------------------------------------------------------------
Total
Penalty Penalty penalty
for 1982 for 1983 for
failure failure given
year
------------------------------------------------------------------------
Penalty incurred in 1984 (a leap year):
For failure to file 1982 return ($25 per
day x 366 days)...................... $9,150 ........ ........
For failure to file 1983 return ($25 per
day x 230 days)...................... ........ $5,750 ........
---------
Total................................. ........ ........ $14,900
=========
Penalty incurred in 1985:
For failure to file 1982 return ($25 per
day x 365 days)...................... 9,125 ........ ........
For failure to file 1983 return ($25 per
day x 365 days)...................... ........ 9,125 ........
---------
Total................................. ........ ........ 18,250
=========
Penalty incurred in 1986:
For failure to file 1982 return (lesser
of $25 per day x 365 days or $975
(remaining penalty which may be
imposed)).............................. 975 ........ ........
For failure to file 1983 return ($25 per
day x 365 days)...................... ........ 9,125 ........
---------
Total................................. ........ ........ 10,100
=========
Penalty incurred in 1987: For failure to
file 1983 return (lesser of $25 per day
x 365 days or $1,000 (remaining penalty
which may be imposed))................... 1,000 ........
---------
Total................................. ........ ........ 1,000
------------------------------------------------------------------------
Example (3). Foreign corporation Y is required under section
6039C(b)(1) to make a return for calendar year 1982. In addition, Y is
required under section 6039C(b)(3) to furnish statements to each
substantial investor in U.S. real property interests. Y has 10 such
substantial investors. Y does not file such return on or before May 15,
1983 as required under Sec. 6a.6039C-1(c), nor does it furnish the
required statements on or before January 31, 1983 as required under
Sec. 6a.6039C-3(h). The failure to file the return for calendar year
1982 and to furnish the required statements for 1982 continues
throughout calendar years 1984 and 1985. The failure to meet the
requirements of section 6039C(b) are not due to reasonable cause and no
security has been furnished in lieu of filing. The total penalty which
can be imposed on Y for failure to file the return and statements
required under section 6039C(b) for calendar year 1982 is $25,000. The
amount of penalty incurred by Y in calendar year 1983 for failure to
file the return and statements for calendar year 1982 is $25,000,
determined as follows:
Penalty incurred in 1982:
For failure to file return ($25 per day x 230 days)......... $5,750
[[Page 145]]
For each failure to furnish a statement required by section
6039C(b)(3) ($25 per day x 10 statements x the 334 days
from February 1, 1983 to December 31, 1983 ($83,500) but
not more than $19,250 (which when added to $5,750 would
total $25,000))............................................ 19,250
---------
Total..................................................... 25,000
Since Y has incurred the maximum penalty for failure to file its return
and statements required for 1982 by the end of calendar year 1983, no
further penalty for these failures is imposed.
Example (4). Under section 6039C(c) foreign person Y is required to
make a return for calendar year 1982. Y does not file such return on May
15, 1983 and the failure is not due to reasonable cause. No security has
been furnished in lieu of filing. All properties owned by Y in 1982 are
U.S. real property interests. Y purchased property M in January 1982
when its fair market value was $10,000. In March, Y purchased property N
when its fair market value was $15,000. In November, Y sold property M
for $20,000. The fair market value of property N on December 31, 1982,
was $20,000. The total of the fair market values of M and N (M as of the
date of its sale and N as of December 31, 1982) is $40,000. The maximum
penalty which may be imposed on Y for failure to meet the requirements
of section 6093C(c) for any calendar year is the lesser of $25,000 or 5
percent of the aggregate of the fair market values of the U.S. real
property interests owned by Y at any time during such calendar year.
Since $2,000 (5 percent of $40,000) is less than $5,750 ($25 times 230
days, the number of days in calendar year 1983 for which the failure
continues), the maximum penalty which may be imposed on Y in 1983 is
$2,000. Since the maximum penalty for the failure to file the 1982
return is incurred in 1983, no amount may be imposed for Y's continuing
failure to file the return for calendar year 1982 during calendar years
after 1983.
(h) Effective date. This section shall apply to 1980 and subsequent
calendar years. The calendar year 1980 shall be treated as beginning on
June 19, 1980 and ending on December 31, 1980.
[T.D. 7866, 48 FR 648, Jan. 6, 1983]
PART 7--TEMPORARY INCOME TAX REGULATIONS UNDER THE TAX REFORM ACT OF 1976--Table of Contents
Sec.
7.48-1 Election to have investment credit for movie and television
films determined in accordance with previous litigation.
7.48-2 Election of forty-percent method of determining investment
credit for movie and television films placed in service in a
taxable year beginning before January 1, 1975.
7.48-3 Election to apply the amendments made by sections 804 (a) and
(b) of the Tax Reform Act of 1976 to property described in
section 50(a) of the Code.
7.57(d)-1 Election with respect to straight line recovery of
intangibles.
7.105-1 Questions and answers relating to exclusions of certain
disability income payments.
7.105-2 Substantial gainful activity.
7.367(b)-1 Other transfers.
7.367(b)-2 Definitions.
7.367(b)-3 Special rules.
7.367(b)-4 Certain exchanges described in more than one Code provision.
7.367(b)-5 Complete liquidation of foreign subsidiary.
7.367(b)-6 Exchange of stock in a foreign investment company.
7.367(b)-7 Exchange of stock described in section 354.
7.367(b)-8 Transfer of assets by a foreign corporation in an exchange
described in section 351.
7.367(b)-9 Attribution of earnings and profits on an exchange described
in section 351, 354, or 356.
7.367(b)-10 Distribution of stock described in section 355.
7.367(b)-11 Deficit in earnings and profits.
7.367(b)-12 Subsequent treatment of amounts attributed or included in
income.
7.367(b)-13 Examples.
7.367(c)-1 Section 355 distribution treated as an exchange.
7.367(c)-2 Contribution of capital to controlled corporations.
7.465-1 Amounts at risk with respect to activities begun prior to
effective date; in general.
7.465-2 Determination of amount at risk.
7.465-3 Allocation of loss for different taxable years.
7.465-4 Insufficient records.
7.465-5 Examples.
7.704-1 Partner's distributive share.
7.936-1 Qualified possession source investment income.
7.999-1 Computation of the international boycott factor.
7.6039A-1 Information regarding carryover basis property acquired from
a decedent.
7.6041-1 Return of information as to payments of winnings from bingo,
keno, and slot machines.
Authority: 26 U.S.C. 7805, unless otherwise stated.
Section 7.367 (b)-1 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-2 also issued under 26 U.S.C. 367 (b).
[[Page 146]]
Section 7.367 (b)-3 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-4 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-5 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-6 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-7 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-8 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-9 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-10 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-11 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-12 also issued under 26 U.S.C. 367 (b).
Section 7.367 (b)-13 also issued under 26 U.S.C. 367 (b).
Sec. 7.48-1 Election to have investment credit for movie and television films determined in accordance with previous litigation.
(a) Generally. Under section 804(c)(3) of the Tax Reform Act of 1976
(Pub. L. 94-455, 90 Stat. 1595), any taxpayer who filed an action in any
court of competent jurisdiction before January 1, 1976, for a
determination of such taxpayer's rights to investment credit under
section 38 of the Internal Revenue Code of 1954 with respect to any film
placed in service in any taxable year beginning before January 1, 1975,
may elect to have investment credit on all films placed in service in
taxable years beginning before January 1, 1975, (except those subject to
an election under section 804(e)(2) of the Act), determined as though
section 804 of the Act (except section 804(c)(3) of the Act) had not
been enacted.
(b) Manner of making the election. The election allowed by section
804(c)(3) of the Act may be made by a notification in the form of a
letter signed by the taxpayer or an authorized representative of the
taxpayer stating:
(1) The taxpayer's name, address, and identification number;
(2) The taxable years in which the films were placed in service with
respect to which the election shall apply; and
(3) The court in which the litigation was commenced and information
adequate to identify the particular litigation, for example, the names
of the litigants, the date the suit was commenced, and the court case or
docket number of the litigation.
The letter should be sent to the Deputy Commissioner of Internal
Revenue, Attention: CC:RL:Br2, Room 4617, 1111 Constitution Avenue,
N.W., Washington, DC 20224.
(c) Time for making the election. The election under section
804(c)(3) of the Act must be made not later than January 3, 1977. If
mailed, the cover containing the notification of such election must be
postmarked not later than January 3, 1977.
(d) Revocation of election. An election under section 804(c)(3) of
the Act, once made, shall be irrevocable.
[T.D. 7449, 41 FR 56629, Dec. 29, 1976]
Sec. 7.48-2 Election of forty-percent method of determining investment credit for movie and television films placed in service in a taxable year beginning
before January 1, 1975.
(a) General rule. Under section 804(c)(2) of the Tax Reform Act of
1976 (90 Stat. 1595), taxpayers who placed movie or television films
(here- inafter referred to as films and tapes) in service during taxable
years beginning before January 1, 1975, may elect to have their
investment credit on all such films and tapes determined under section
46(c) of the Code using an amount equal to 40 percent of aggregate
production costs in lieu of the basis of such property. If the election
is made, 100 percent is the applicable percentage used in determining
qualified investment under section 46(c) of the Code regardless of
actual useful life. The election can be made only with respect to
qualified films and tapes that are new section 38 property and the
investment credit is allowed only to the extent that a taxpayer has an
ownership interest in the film or tape. No investment credit is allowed
under section 804(c)(2) of the Act on any film or tape that is not
section 38 property or that was produced and shown exclusively outside
of the United States. Thus, no election may be made under this section
with respect to a film or tape which is suspension period property to
which section 48(h) applies or to a film or tape which is termination
period property
[[Page 147]]
to which section 49(a) applies. Any investment credit taken on any film
or tape subject to the election is not subject to recapture because of
an early disposition or because a film or tape otherwise ceases to be
section 38 property under section 47(a) of the Code. Thus, there will be
no recapture because a film or tape is used outside the United States
under section 48(a)(2) of the Code or section 804(c)(1)(C) of the Act,
or because of any disposition under section 47(a)(7)(B) of the Code.
(b) Time and manner of making an election--(1) Time for making the
election. The election under section 804(c)(2) of the Act must be made
not later than April 25, 1977.
(2) Manner of making the election. An election under this section
must be made by filing amended income tax returns for each taxable year
beginning before January 1, 1975, in which films and tapes subject to
the election were placed in service, together with a statement signed by
the taxpayer containing the information described below. The amended
returns and the statement must be filed with the district director
having audit jurisdiction over the last return filed to which the
election relates. Each amended return shall contain a schedule listing
by name all films and tapes placed in service during the year to which
the amended return relates and setting forth all computations necessary
to determine the aggregate production costs of each such film or tape
listed and the ownership interest of the taxpayer in each film or tape
listed. In the case of a taxpayer which is a partner, shareholder of an
electing small business corporation, or beneficiary of a trust or
estate, such computations must be adequate to determine the ownership
interest of the partnership, electing small business corporation, or
trust or estate in each such film or tape, (a taxpayer which is a
partner, shareholder, or beneficiary may satisfy the requirements of the
preceding sentence by attaching to his amended return a copy of an
amended return, if one is filed, of the partnership, electing small
business corporation, or trust or estate which sets forth computations
necessary to determine the ownership interest of the entity in each such
film or tape.) No amended return need be filed for a taxable year if
application of the election to films and tapes placed in service during
that year would not affect tax liability for any taxable year.
The statement shall contain the following information:
(i) The taxpayer's name and taxpayer identification number (under
section 6109 of the Code).
(ii) A statement that the taxpayer is making the election under
section 804(c)(2) of the Act.
(iii) A statement that the taxpayer agrees that the period for
assessment and collection under section 6501 of the Code will remain
open until December 31, 1978, solely with respect to adjustments of tax
liability attributable to investment credit allowed on films and tapes
placed in service in each year covered by the election. Unless the
district director notifies the taxpayer within 7 days of receipt of the
statement that such extension is denied, it will be presumed that the
district director consents to such extension. Of course, the period
covered by this statement may be extended beyond December 31, 1978 by
mutual agreement. This statement does not shorten the regular statutory
period for any year or take precedence over a previous or subsequent
agreement with the Internal Revenue Service extending the statutory
period for any year.
(iv) A list of the addresses used by the taxpayer on each return
filed during each taxable year subject to the election.
(v) A statement that the taxpayer consents to join in judicial
proceedings to determine the investment credit allowable and entitlement
to investment credit on any film or tape subject to the election, which
meets all of the requirements set forth in paragraph (b)(3) of this
section.
(vi) A statement as to whether an election has been made by the
taxpayer under section 804(e)(2) of the Act for films and tapes which
are property described in section 50(a) of the Code which were placed in
service in taxable years beginning before January 1, 1975.
(vii) A list by name of all films or tapes placed in service during
the years to which the election relates.
[[Page 148]]
(viii) With respect to each film or tape listed in paragraph
(b)(2)(vii) of this section, a list of all producers, distributors, and
persons with a participation interest (with addresses where available).
(ix) In the case of an election made by a partner, shareholder of an
electing small business corporation (as defined in section 1371(b) of
the Code), or beneficiary, a statement indicating the name, taxpayer
identification number, and address for tax return purposes of the
respective partnership, electing small business corporation, or trust or
estate.
(3) Consent to join in judicial proceedings. No election may be made
by any taxpayer unless the statement made under paragraph (b)(2)(v) of
this section provides that the taxpayer shall:
(i) Treat the determination of the investment credit allowable on
each film or tape subject to an election as a separate cause of action;
(ii) Make all reasonable efforts necessary to join in or intervene
in any judicial proceeding in any court for determining the person
entitled to, and the amount of, the investment credit allowable with
respect to any film or tape covered by the election after receiving
notice from the Commissioner of Internal Revenue or his delegate
indicating that a conflicting claim to the investment credit for such
film or tape is being asserted in such court by another person; and
(iii) Consent to revocation of the election by the Commissioner of
Internal Revenue or his delegate with respect to all films and tapes
placed in service in taxable years for which the election applies, if
the taxpayer fails to make all reasonable efforts necessary to join in
or intervene in any judicial proceeding under paragraph (b)(3)(ii) of
this section.
(4) Who makes the election. The election must be made separately by
each person who has an ownership interest. However, where a film or tape
is owned by a partnership, electing small business corporation (as
defined in section 1371(b) of the Code), or trust or estate, the
election must be made separately by each partner, shareholder or
beneficiary. The election is not to be made by a partnership or electing
small business corporation, and is to be made by a trust or estate only
if the trust or estate in determining its tax liability would be allowed
investment credit on a film or tape subject to the election. The
election of any partner, shareholder, beneficiary or trust or estate
shall be effective regardless of whether any related partner,
shareholder, beneficiary, or trust or estate makes the election.
(5) Additional time to perfect election. A taxpayer that by April
25, 1977, files a statement containing the information described in
paragraph (b)(2) (i) through (v) of this section shall be deemed to have
made a timely election under paragraph (b)(2) of this section if by July
5, 1977, the taxpayer has complied with all of the requirements of
paragraph (b)(2) of this section. If a taxpayer demonstrates to the
satisfaction of the district director that it is unable to meet the July
5, 1977, date even though it has made a good faith effort to do so, the
district director may at his discretion extend that date to no later
than October 4, 1977, for that taxpayer. Requests for extensions of the
July 5, 1977, date should be addressed to the district director with
whom the statement was filed.
(c) Revocation of election--(1) Revocation by taxpayer. (i) Except
as provided in paragraph (c)(1)(ii) of this section, an election made
under section 804(c)(2) of the Act may not be revoked by a taxpayer
unless consent to revoke the election is obtained from the Commissioner
of Internal Revenue or his delegate. Application for consent to revoke
the election will be accepted only if permanent regulations are issued
which contain rules which may not reasonably have been anticipated by
taxpayers at the time the election was made. Any permanent regulations
will provide a reasonable period of time within which taxpayers will be
permitted to apply for consent to revoke the election and will allow
revocation (where revocation is not barred by the limitations on credit
or refund inspection 6511 of the Code) in the event of a determination
by the Commissioner of Internal Revenue or his delegate that such
permanent regulations contain provisions that may not reasonably
[[Page 149]]
have been anticipated by taxpayers at the time of making such election.
(ii) An election properly made under section 804(e)(2) of the Act,
to have sections 48(k) and 47 (a)(7) of the Code apply to films and
tapes which are property described in section 50(a) of the Code and
which were placed in service in taxable years beginning before January
1, 1975, shall automatically revoke any election under section 804(c)(2)
of the Act with respect to such films and tapes. Such revocation does
not require the consent of the Commissioner of Internal Revenue or his
delegate.
(2) Revocation by Commissioner. The Commissioner of Internal Revenue
or his delegate shall revoke an election made under section 804(c)(2) of
the Act if a taxpayer fails to make all reasonable efforts necessary to
join in or intervene, in a judicial proceeding for determination of the
person entitled to, and the amount of, the investment credit allowable
with respect to any film or tape covered by the election after receiving
notice from the Commissioner or his delegate which indicates that a
conflicting claim to the investment credit for such film or tape is
being asserted in court by another person.
(d) Furnishing of supplementary information required. If these
regulations are revised to require the furnishing of information in
addition to that which was furnished with the amended returns and
statement of election filed pursuant to paragraph (b) (2) and (3) of
this section, the taxpayer must furnish such additional information in a
statement addressed to the district director with whom the amended
return and statement of election were filed.
((68A Stat. 917; 26 U.S.C. 7804); sec. 804(c)(2) (C) and (D) of the Tax
Reform Act of 1976 (90 Stat. 1595))
[T.D. 7474, 42 FR 17123, Mar. 31, 1977; T.D. 7480, 42 FR 19479, Apr. 14,
1977]
Sec. 7.48-3 Election to apply the amendments made by sections 804 (a) and (b) of the Tax Reform Act of 1976 to property described in section 50(a) of the Code.
(a) General rule. Under section 804(e)(2) of the Tax Reform Act of
1976 (90 Stat. 1596), taxpayers may elect to apply the amendments made
by section 804 (a) and (b) of the Act to movie and television films that
are property described in section 50(a) of the Code and that were placed
in service in taxable years beginning before January 1, 1975.
(b) Time for and manner of making election--(1) Time for making
election. The election under section 804(e)(2) the Act must be made not
later than October 4, 1977.
(2) Manner of making election. The election under section 804(e)(2)
shall be made by applying the same rules applicable under section
804(c)(2) as described in Sec. 7.48-2(b) (2), (3), and (4) except that
Sec. 7.48-2(b)(2)(ii) shall be read to require a statement that the
taxpayer is making an election under section 804(e)(2) of the Act, and
Sec. 7.48-2(b)(2)(vi) shall not apply. An election properly made under
section 804(e)(2) of the Act may not be revoked after October 4, 1977.
(Sec. 804(e)(2), Tax Reform Act of 1976 (90 Stat. 1596))
[T.D. 7509, 42 FR 47828, Sept. 22, 1977]
Sec. 7.57(d)-1 Election with respect to straight line recovery of intangibles.
(a) Purpose. This section prescribes rules for making the election
permitted under section 57(d)(2), as added by the Tax Reform Act of
1976. Under this election taxpayers may use cost depletion to compute
straight line recovery of intangibles.
(b) Election. The election under section 57(d) is subject to the
following rules:
(1) The election is made within the time prescribed by law
(including extensions thereof) for filing the return for the taxable
year in which the intangible drilling costs are paid or incurred or, if
later, by July 25, 1978.
(2) The election is made separately for each well. Thus, a taxpayer
may make the election for only some of his or her wells.
(3) The election is made by using, for the well or wells to which
the election applies, cost depletion to compute straight line recovery
of intangibles for purposes of determining the amount of the preference
under section 57(a)(11).
[[Page 150]]
(4) The election may be made whether or not the taxpayer uses cost
depletion in computing taxable income.
(5) The election is made by a partnership rather than by each
partner.
(c) Computation of cost depletion. For purposes of computing
straight line recovery of intangibles through cost depletion, both
depletable and depreciable intangible drilling and development costs for
the taxable year are taken into account. They are treated as if
capitalized, added to basis, and recovered under Sec. 1.611-2(a). Costs
paid or incurred in other taxable years are not taken into account.
(Secs. 57(d) and 7805 of the Internal Revenue Code of 1954 (90 Stat.
1551; 68A Stat. 917; 26 U.S.C. 57(d), 7805))
[T.D. 7541, 43 FR 17816, Apr. 26, 1978; 43 FR 18993, May 3, 1978]
Sec. 7.105-1 Questions and answers relating to exclusions of certain disability income payments.
The following questions and answers relate to the exclusion of
certain disability income payments under section 105(d) of the Internal
Revenue Code of 1954, as amended by sections 505 (a) and (c) of the Tax
Reform Act of 1976 (90 Stat. 1566):
Q-1: What effect on the sick pay exclusion does the new law have?
A-1: The ``sick pay'' provisions of prior law (which allowed a
limited exclusion from gross income of sick pay received before
mandatory retirement age by active employees temporarily absent from
work because of sickness or injury, as well as by disability retirees)
have been replaced by provisions of the new law (which provide for a
limited exclusion of disability payments but restrict its application to
individuals retired on disability who meet certain requirements as to
permanent and total disability, age, etc.) (Q-4). As a result of the
more restrictive provisions of the new law, many taxpayers who qualified
for the exclusion in previous taxable years will not be eligible to
claim the disability payments exclusion beginning with the effective
date of the new law.
Q-2: What is the effective date of the new law relating to
disability exclusion?
A-2: The disability income exclusion and related annuity provisions
of the Tax Reform Act of 1976 are effective for taxable years beginning
on or after January 1, 1977. In addition, the Tax Reduction and
Simplification Act of 1977 allows certain taxpayers to begin excluding
pension or annuity costs in taxable years beginning in 1976. In the case
of a retiree who uses the cash receipts and disbursements method of
accounting, the new law applies to payments received on or after the
effective date even if the payment is for a period before the effective
date. Thus, a payment for December 1976 that is received in January 1977
by a calendar-year, cash-basis taxpayer is controlled by the new law.
Q-3: What are disability payments?
A-3: In general, disability payments are amounts constituting wages
or payments in lieu of wages made under provisions of a plan providing
for the payment of such amounts to an employee for a period during which
the employee is absent from work on account of permanent and total
disability. Amounts paid to such an employee after mandatory retirement
age is attained are not wages or payments in lieu of wages for purposes
of the disability income exclusion.
Q-4: Who is eligible to exclude disability payments?
A-4: A taxpayer who receives disability payments in lieu of wages
under a plan providing for the payment of such amounts may qualify for
the exclusion provided all of the following requirements are met:
(1) The taxpayer has not reached age 65 (see Q-9) before the end of
the taxable year;
(2) The taxpayer has not reached mandatory retirement age (see Q-8)
before the beginning of the taxable year;
(3) The taxpayer retired on disability (see Q-10) (or if retired
prior to January 1, 1977 and did not retire on disability, would have
been eligible to retire on disability at the time of such retirement);
(4) The taxpayer was permanently and totally disabled (see Q-11)
when the taxpayer retired (or if the taxpayer retired before January 1,
1977, was permanently and totally disabled on January 1, 1976, or
January 1, 1977); and
(5) The taxpayer has not made an irrevocable election not to claim
the disability income exclusion (see Q-17 through Q-19).
Q-5: What limitations are placed on the amounts excludable?
A-5: The amount of disability income that is excludable:
(a) Cannot exceed the amount of the disability income payments
received for any pay period;
(b) Cannot exceed a maximum weekly rate of $100 per taxpayer. Thus,
the maximum disability income exclusion allowable on a joint return (see
Q-7) in the usual case where one spouse receives disability payments,
generally, would be $5,200, and if both spouses received disability
payments the maximum exclusion, generally, would be $10,400 ($5,200 for
each spouse);
(c) Cannot exceed, in the case of a disability income payment for a
period of less than a week, a prorated portion of the amount
[[Page 151]]
otherwise excludable for that week (see Q-6); and
(d) Cannot exceed, for the entire taxable year, the total amount
otherwise excludable for such taxable year reduced, dollar for dollar,
by the amount by which the taxpayer's adjusted gross income (determined
without regard to the disability income exclusion) exceeds $15,000.
Where a disability income exclusion is claimed by either or both spouses
on a joint return, the taxpayer's adjusted gross income means the total
adjusted gross income of both spouses combined (determined without
regard to the disability income exclusion) (see also Q-7).
Q-6: On what occasion is a taxpayer likely to receive part-week
disability payments? How do you prorate such payments?
A-6: Such part-week payments may be received when one of the
following events occurs after the first day of the taxpayer's normal
workweek: (a) the disability retirement commences: (b) the taxpayer
reaches mandatory retirement age in a taxable year prior to the taxable
year in which such taxpayer attains age 65; or (c) the taxpayer dies. To
prorate a part-week disability income payment for purposes of the
exclusion, the taxpayer must:
(1) Determine the ``daily exclusion,'' which is the lesser of--
(a) The taxpayer's daily rate of disability pay, or
(b) $100 divided by the number of days in the taxpayer's normal
workweek.
(2) Multiply the daily exclusion by the number of days for which the
part-week payment was made.
Thus, for a taxpayer whose normal workweek was Monday through Friday and
whose retirement on permanent and total disability began on Wednesday,
the first disability income payment would include a payment for a part-
week consisting of three days. Assuming that the daily exclusion
determined in (1), above, is $20, the taxpayer's exclusion for the first
week would be $60 ($20 x 3).
Q-7: What filing restrictions apply to a married taxpayer who claims
a disability income exclusion?
A-7: A taxpayer married at the close of the taxable year who lived
with his or her spouse at any time during such taxable year must file a
joint return in order to claim the disability income exclusion. However,
a taxpayer married at the close of the taxable year who lived apart from
his or her spouse for the entire taxable year may claim the exclusion on
either a joint or separate return.
Q-8: What is ``mandatory retirement age''?
A-8: Generally, mandatory retirement age is the age at which the
taxpayer would have been required to retire under the employer's
retirement program, had the taxpayer not become disabled.
Q-9: Does a taxpayer reach age 65 on the day before his or her 65th
birthday for purposes of the disability income exclusion, as is the case
for purposes of the exemption for age and the credit for the elderly?
A-9: No. For purposes of the disability income exclusion, a taxpayer
reaches age 65 on the day of his or her 65th birthday anniversary. Thus,
a taxpayer whose 65th birthday occurs on January 1, 1978, is not
considered to reach age 65 during 1977, for purposes of the disability
income exclusion.
Q-10: What does ``retired on disability'' mean?
A-10: Generally, it means that an employee has ceased active
employment in all respects because of a disability and has retired under
a disability provision of a plan for employees. However, an employee who
has actually ceased active employment in all respects because of a
disability may be treated as ``retired on disability'' even though the
employee has not yet gone through formal ``retirement'' procedures, as
for example, where an employer carries the disabled employee in a non-
retired status under the disability provisions of the plan solely for
the purpose of continuing such employee's eligibility for certain
employer-provided fringe benefits. In addition, such an employee may be
treated as ``retired on disability'' even though the initial period
immediately following his or her ceasing of employment on account of a
disability must first be used against accumulated ``sick leave'' or
``annual leave'' prior to the employee being formally placed in
disability retirement status.
Q-11: What is permanent and total disability?
A-11: It is the inability to engage in any substantial gainful
activity by reason of any medically determinable physical or mental
impairment that:
(a) Can be expected to result in death;
(b) Has lasted for a continuous period of not less than 12 months;
or
(c) Can be expected to last for a continuous period of not less than
12 months. The substantial gainful activity referred to is not limited
to the activity, or a comparable activity, in which the individual
customarily engaged prior to such individual's retirement on disability.
See Sec. 7.105-2 for additional information relating to substantial
gainful activity.
Q-12: If a taxpayer retired on disability but it is not clear until
the following taxable year that the disability as of the date of such
retirement was permanent and total (so that the employee did not exclude
any amount as disability income in the earlier taxable year), may the
taxpayer file an amended return to claim the disability income exclusion
for the taxable year in which such taxpayer retired on disability which
was permanent and total?
A-12: Yes.
Q-13: What proof must a taxpayer furnish to establish the existence
of permanent and total disability?
[[Page 152]]
A-13: If retired on disability before January 1, 1977: A certificate
from a qualified physician attesting that--
(a) The taxpayer was permanently and totally disabled on January 1,
1976 or January 1, 1977; or
(b) The records of the Veterans Administration show that the
taxpayer was permanently and totally disabled as defined in 38 CFR 3.340
or 3.342 on January 1, 1976 or January 1, 1977.
If retired on disability during 1977 or thereafter: A certificate
from a qualified physician attesting that--
(a) The taxpayer was permanently and totally disabled on the date he
or she retired; or
(b) The records of the Veterans Administration show that the
taxpayer was permanently and totally disabled as defined in 38 CFR 3.340
or 3.342 on the date he or she retired.
In either case, the taxpayer must attach the certificate or a copy
of the certificate to his or her income tax return. The certificate
shall give the physician's name and address. No certificate from any
employer is required with regard to the determination of permanent and
total disability.
Q-14: For what period does a taxpayer eligible (see Q-4) for the
disability income exclusion (without regard to the $15,000 income
phaseout explained in Q-5) continue to be eligible for such exclusion?
A-14: Unless the taxpayer earlier makes the irrevocable election not
to claim the disability income exclusion described in Q-17 through Q-19,
such taxpayer continues to be eligible until the earlier of:
(a) The beginning of the taxable year in which the taxpayer reaches
age 65; and
(b) The day on which the taxpayer reaches mandatory retirement age.
Q-15: May a taxpayer while eligible (see Q-4) for the disability
income exclusion under the new law, exclude any applicable pension or
annuity costs?
A-15: No. This is true even though while eligible for the disability
income exclusion, such taxpayer is unable to exclude any amount of the
disability income payments because of the $15,000 income phaseout (see
Q-5).
Q-16: When will a taxpayer who is eligible (see Q-4) to exclude
disability income payments (without regard to the $15,000 phaseout
explained in Q-5) under the new law be able to exclude any applicable
pension or annuity costs?
A-16: In general, such a taxpayer will begin to exclude any of his
or her pension or annuity costs under applicable rules of the Code
beginning on the first day of the taxable year in which he or she
attains age 65 or, if mandatory retirement age is attained in an earlier
taxable year, beginning on the day the taxpayer attains mandatory
retirement age.
Q-17: May a taxpayer who is eligible (see Q-4) to exclude disability
income payments (without regard to the $15,000 phaseout explained in Q-
5) under the new law begin to exclude applicable pension or annuity
costs in an earlier taxable year?
A-17: Yes, but such a taxpayer must make the election described in
Q-18 and Q-19 in which case the taxpayer would no longer be eligible for
the disability income exclusion.
Q-18: What is an election not to claim the disability income
exclusion?
A-18: It is an irrevocable election for the taxable year for which
the election is made, and each taxable year thereafter. If such an
election is made the taxpayer will begin to recover tax-free, out of the
payments, his or her annuity costs as provided under the applicable
provision of the Code.
Q-19: How does a taxpayer who is eligible to exclude disability
income payments (without regard to the $15,000 phaseout explained in Q-
5) under the new law make this election?
A-19: The election is made by means of a statement attached to the
taxpayer's income tax return (or amended return) for the taxable year in
which the taxpayer wishes to have the applicable annuity rule apply. The
statement shall set forth the taxpayers qualifications to make the
election (i.e., that the taxpayer is eligible (see Q-4) to exclude
disability income payments (without regard to the $15,000 income
phaseout explained in Q-5)) and that such taxpayer irrevocably elects
not to claim the benefit of excluding disability income payments under
section 105(d), as amended, for such taxable year and each taxable year
thereafter. The election cannot be made for any taxable year beginning
before January 1, 1976.
Q-20: Did the changes made by the Tax Reduction and Simplification
Act provide any relief to taxpayers eligible for the sick pay exclusion
in taxable years beginning in 1976?
A-20: Yes. As originally enacted, the more restrictive provisions of
the disability income exclusion applied to taxable years beginning in
1976. The Tax Reduction and Simplification Act postponed the effective
date of these provisions for 1 year. Thus, taxpayers may claim the sick
pay exclusion in taxable years beginning in 1976.
(Secs. 105(d) and 7805 of the Internal Revenue Code of 1954 (90 Stat.
1566; 68A Stat. 917; 26 U.S.C. 105(d); 7805))
[T.D. 7450, 41 FR 56630, Dec. 29, 1976, as amended at 42 FR 2954, Jan.
14, 1977; T.D. 7544, 43 FR 19655, May 8, 1978]
Sec. 7.105-2 Substantial gainful activity.
(a) Purpose. This section defines substantial gainful activity for
purposes of section 105(d) and Sec. 7.105-1, prescribes
[[Page 153]]
rules for determining whether a taxpayer has the ability to engage in
substantial gainful activity, and provides examples of the application
of the definition and rules in specific factual situations.
(b) Definition. Substantial gainful activity is the performance of
significant duties over a reasonable period of time in work for
remuneration or profit (or in work of a type generally performed for
remuneration or profit).
(c) General rules. (1) Full-time work under competitive
circumstances generally indicates ability to engage in substantial
gainful activity.
(2) Work performed in self-care or the taxpayer's own household
tasks, and nonremunerative work performed in connection with hobbies,
institutional therapy or training, school attendance, clubs, social
programs, and similar activities is not substantial gainful activity.
However, the nature of the work performed may be evidence of ability to
engage in substantial gainful activity.
(3) The fact that a taxpayer is unemployed for any length of time is
not, of itself, conclusive evidence of inability to engage in
substantial gainful activity.
(4) Regular performance of duties by a taxpayer in a full-time,
competitive work situation at a rate of pay at or above the minimum wage
will conclusively establish the taxpayer's ability to engage in
substantial gainful activity. For purposes of paragraphs (c)(4) and
(c)(5) of this section, the minimum wage is the minimum wage prescribed
by section 6(a)(1) of the Fair Labor Standards Act of 1938, as amended,
29 U.S.C. 206(a)(1).
(5) Regular performance of duties by a taxpayer in a part-time,
competitive work situation at a rate of pay at or above the minimum wage
will conclusively establish the taxpayer's ability to engage in
substantial gainful activity, if the duties are performed at the
employer's convenience.
(6) In situations other than those described in paragraphs (c)(4)
and (c)(5) of this section, other factors, such as the nature of the
duties performed, may establish a taxpayer's ability to engage in
substantial gainful activity.
(d) Examples. The following examples illustrate the application of
the definition in paragraph (b) of this section and the rules in
paragraph (c) of this section in specific factual situations. In
examples 1 through 5, the facts establish that the taxpayers are able to
engage in substantial gainful activity and, therefore, are not entitled
to claim the disability income exclusion of section 105(d). In examples
6 through 9, the facts do not, of themselves, establish the taxpayers'
ability or inability to engage in substantial gainful activity. In these
situations, all the facts and circumstances must be examined to
determine whether the taxpayers are able to engage in substantial
gainful activity.
Example (1). Before retirement on disability, taxpayer worked for a
hotel as night desk clerk. After retirement, the taxpayer is hired by
another hotel as night desk clerk at a rate of pay exceeding the minimum
wage. Since the taxpayer regularly performs duties in a full-time
competitive work situation at a rate of pay at or above the minimum
wage, he or she is able to engage in substantial gainful activity.
Example (2). A taxpayer who retired on disability from employment as
a sales clerk is employed as a full-time babysitter at a rate of pay
equal to the minimum wage. Since the taxpayer regularly performs duties
in a full-time, competitive work situation at a rate of pay at or above
the minimum wage, he or she is able to engage in substantial gainful
activity.
Example (3). A taxpayer retired on disability from employment as a
teacher because of terminal cancer. The taxpayer's physician recommended
continuing employment for therapeutic reasons and taxpayer accepted
employment as a part-time teacher at a rate of pay in excess of the
minimum wage. The part-time teaching work is done at the employer's
convenience. Even though the taxpayer's illness is terminal, the
employment was recommended for therapeutic reasons, and the work is
part-time, the fact that the work is done at the employer's convenience
demonstrates that the taxpayer is able to engage in substantial gainful
activity.
Example (4). A taxpayer who retired on disability, is employed full-
time in a competitive work situation that is less demanding than his or
her former position. The rate of pay exceeds the minimum wage but is
about half of the taxpayer's rate of pay in the former position. It is
immaterial that the new work activity is less demanding or less gainful
than the work in which the taxpayer was engaged before his or her
retirement on
[[Page 154]]
disability. Since the taxpayer regularly performs duties in a full-time,
competitive work situation at a rate of pay at or above the minimum
wage, he or she is able to engage in substantial gainful activity.
Example (5). A taxpayer who retired on disability from employment as
a bookkeeper drives trucks for a charitable organization at the
taxpayer's convenience. The taxpayer receives no compensation, but
duties of this nature generally are performed for remuneration or
profit. Some weeks the taxpayer works 10 hours, some weeks 40 hours, and
over the year the taxpayer works an average of 20 hours per week. Even
though the taxpayer receives no compensation, works part-time, and at
his or her convenience, the nature of the duties performed and the
average number of hours worked per week conclusively establish the
taxpayer's ability to engage in substantial gainful activity.
Example (6). A taxpayer who retired on disability was instructed by
a doctor that uninterrupted bedrest was vital to the treatment of his or
her disability. However, because of financial need, the taxpayer secured
new employment in a sedentary job. After attempting the new employment
for approximately two months, the taxpayer was physically unable to
continue the employment. The fact that the taxpayer attempted to work
and did, in fact, work for two months, does not, of itself, conclusively
establish the taxpayer's ability to engage in substantial gainful
activity.
Example (7). A taxpayer who retired on disability accepted
employment with a former employer on a trial basis. The purpose of the
employment was to determine whether the taxpayer was employable. The
trial period continued for an extended period of time and the taxpayer
was paid at a rate equal to the minimum wage. However, because of the
taxpayer's disability only light duties of a nonproductive make-work
nature were assigned. Unless the activity is both substantial and
gainful, the taxpayer is not engaged in substantial gainful activity.
The activity was gainful because the taxpayer was paid at a rate at or
above the minimum wage. However, the activity was not substantial
because the duties were of a nonproductive, make-work nature.
Accordingly, these facts do not, of themselves, establish the taxpayer's
ability to engage in substantial gainful activity.
Example (8). A taxpayer who retired on disability from employment as
a bookkeeper lives with a relative who manages several motel units. The
taxpayer assisted the relative for one or two hours a day by performing
duties such as washing dishes, answering phones, registering guests, and
bookkeeping. The taxpayer can select the times during the day when he or
she feels most fit to perform the tasks undertaken. Work of this nature,
performed off and on during the day at the taxpayer's convenience, is
not activity of a ``substantial and gainful'' nature even if the
individual is paid for the work. The performance of these duties does
not, of itself, show that the taxpayer is able to engage in substantial
gainful activity.
Example (9). A taxpayer who retired on disability because of a
physical or mental impairment accepts sheltered employment in a
protected environment under an institutional program. Sheltered
employment is offered in sheltered workshops, hospitals and similar
institutions, homebound programs, and Veterans Administration
domiciliaries. Typically, earnings are lower in sheltered employment
than in commercial employment. Consequently, impaired workers normally
do not seek sheltered employment if other employment is available. The
acceptance of sheltered employment by an impaired taxpayer does not
necessarily establish his or her ability to engage in substantial
gainful activity.
(Secs. 105(d) and 7805 of the Internal Revenue Code of 1954 (90 Stat.
1566; 68A Stat. 917; 26 U.S.C. 105(d); 7805))
[T.D. 7544, 43 FR 19656, May 8, 1978]
Sec. 7.367(b)-1 Other transfers.
(a) Scope. This section and Secs. 7.367(b)-2 through 7.367(b)-12
apply to exchanges to which section 367(b), as amended by section
1042(a) of the Tax Reform Act of 1976, applies. This section sets forth
certain general rules regarding the extent to which a foreign
corporation shall be considered to be a corporation in connection with
an exchange to which section 367(b) applies. An exchange to which
section 367(b) applies is an exchange described in section 367(b) and in
section 332, 351, 354, 355, 356, or 361 with respect to which the status
of a foreign corporation as a corporation is relevant for determining
the extent to which gain shall be recognized and in connection with
which there is no transfer described in section 367(a). An election by a
domestic corporation under section 1504(d) to treat a corporation
organized under the laws of a contiguous foreign country as a domestic
corporation shall be considered to be a transfer of property made
pursuant to an exchange to which section 367(b) applies.
(b) General rule. If section 367(b) applies to an exchange, a
foreign corporation shall be considered to be a corporation in respect
of that exchange except to the extent otherwise provided
[[Page 155]]
in this section and in Secs. 7.367(b)-4 through 7.367(b)-12. Unless
otherwise provided, if a taxpayer fails to comply with Secs. 7.367(b)-1
through 7.367(b)-12, the Commissioner shall make a determination whether
a foreign corporation will be considered to be a corporation based on
all the facts and circumstances surrounding failure to comply. In making
this determination the Commissioner may conclude that:
(1) A foreign corporation will be considered to be a corporation
despite the failure to comply;
(2) A foreign corporation will be considered to be a corporation
provided that the conditions imposed under Secs. 7.367(b)-4 through
7.367(b)-12 are fulfilled; or
(3) A foreign corporation will not be considered to be a corporation
only for purposes of determining the extent to which gain shall be
recognized on such exchange but that any gain recognized by reason of
the Commissioner's determination to disregard the corporate status of a
foreign corporation will be taken into account for purposes of applying
the provisions of section 334, 358 or 362.
See, Secs. 7.367(b)-5(b), 7.367(b)-6(c), 7.367(b)-7(c)(2), and 7.367(b)-
10(j) for specific provisions which override the provisions of paragraph
(b)(3) of this section.
(c) Notice required--(1) In general. If any person referred to in
section 6012 (relating to the requirement to make returns of income)
realized gain or other income (whether or not recognized) on account of
any exchange to which section 367(b) applies, such person must file a
notice of such exchange on or before the last date for filing a Federal
income tax return (taking into account any extensions of time therefor)
for the person's taxable year in which gain or other income is realized.
This notice must be filed with the district director with whom the
person would be required to file a Federal income tax return for the
taxable year in which the exchange occurs.
(2) Information required. The notice shall contain:
(i) A statement that the exchange is one to which section 367(b)
applies;
(ii) A complete description of the exchange;
(iii) A description of any stock or securities received in the
exchange;
(iv) A statement which describes any amount required, under
Secs. 7.367(b)-4 through 7.367(b)-12 to be included in gross income or
added to the earnings and profits or deficit of an exchanging foreign
corporation for the person's taxable year in which the exchange occurs;
(v) A statement which describes any amount of earnings and profits
attributed by reason of the exchange under Secs. 7.367(b)-4 through
7.367(b)-12, to stock owned by any United States person;
(vi) Any information which is or would be required to be furnished
with a Federal income tax return pursuant to regulations under sections
332, 351, 354, 355, 356, 361, or 368 (whether or not a Federal income
tax return is required to be filed) if such information has not
otherwise been provided;
(vii) Any information required to be furnished under section 6038 or
6046 if such information has not otherwise been provided; and
(viii) If applicable, a statement that the taxpayer is making the
election permitted under paragraph (d) of Sec. 7.367(b)-3 relating to
earnings and profits of a less developed country corporation.
(ix) If applicable, a statement that all relevant shareholders are
making the election provided in paragraph (c)(1)(iii) of Sec. 7.367(b)-
7, in paragraph (f) of Sec. 7.367(b)-9, in paragraph (i)(3)(ii)(C) of
Sec. 7.367(b)-10, or in paragraph (f) of Sec. 7.367(b)-10 in order to
obtain the increase in basis of stock provided in paragraph (c)(1)(iii)
of Sec. 7.367(b)-7, paragraph (i)(3)(ii)(C) of Sec. 7.367(b)-10,
paragraph (e)(1) of Sec. 7.367(b)-9, or paragraph (e) of Sec. 7.367(b)-
10.
(3) Failure to provide notice. If a person required to give notice
under pagraph (c)(1) of this section fails to provide, in a timely
manner, information sufficent to apprise the Commissioner of the
occurrence and nature of an exchange to which section 367(b) applies,
the taxpayer will be considered to have failed to comply with the
provisions of Secs. 7.367(b)-1 through 7.367(b)-12 only if the taxpayer
fails to establish reasonable cause for the failure.
(d) Records to be kept--(1) Adjustments to earnings and profits. Any
corporation
[[Page 156]]
whose earnings and profits are required to be adjusted under
Secs. 7.367(b)-4 through 7.367(b)-12 must keep records adequate to
establish the adjustment.
(2) Amounts attributed to stock. If, under Secs. 7.367(b)-4 through
7.367(b)-12, an amount is attributable to stock in a foreign corporation
which is owned by a United States person, that person must keep records
to establish the amount so attributed. If the person fails to maintain
such records, and an inclusion in gross income of such amount is
required by reason of section 1248 or Secs. 7.367(b)-4 through 7.367(b)-
12, the district director shall make a reasonable determination of the
amount attributed.
(e) Close of taxable year in certain section 368(a)(1)(F)
reorganizations. If a foreign corporation is the transferor corporation
in a reorganization described in section 368(a)(1)(F) after March 30,
1987, in which the acquiring corporation is a domestic corporation, then
the taxable year of the transferor corporation shall end with the close
of the date of the transfer and the taxable year of the acquiring
corporation shall end with the close of the date on which the
transferor's taxable year would have ended but for the occurrence of the
transfer. If a foreign corporation, with effectively connected earnings
and profits or non-previously taxed accumulated effectively connected
earnings and profits (as defined in the regulations under section 884),
is the transferor corporation in a reorganization described in section
368(a)(1)(F) in a taxable year beginning after February 15, 1990 (or in
a taxable year beginning after December 31, 1986, and on or before
February 15, 1990 to which the transferor corporation chooses to apply
this rule), in which the acquiring corporation is a foreign corporation,
then the taxable year of the transferor corporation shall end with the
close of the date of the transfer and the taxable year of the acquiring
corporation shall end with the close of the date on which the
transferor's taxable year would have ended but for the occurrence of the
transfer. With regard to the consequences of the closing of the taxable
year, see section 381 and the regulations thereunder.
(f) Exchanges under sections 354(a) and 361(a) in certain section
368(a)(1)(F) reorganizations. In every reorganization under section
368(a)(1)(F), where the transferor corporation is a foreign corporation,
there is considered to exist--
(1) A transfer of assets by the transferor corporation to the
acquiring corporation under section 361(a) in exchange for stock of the
acquiring corporation and the assumption by the acquiring corporation of
the transferor corporation's liabilities;
(2) A distribution of the stock (or stock and securities) of the
acquiring corporation by the transferor corporation to the shareholders
(or shareholders and security holders) of the transferor corporation;
and
(3) An exchange by the transferor corporation's shareholders (or
shareholders and security holders) of the stock (or stock and
securities) of the transferor corporation for stock (or stock and
securities) of the acquiring corporation under section 354(a).
For this purpose, it shall be immaterial that the applicable foreign or
domestic law treats the acquiring corporation as a continuance of the
transferor corporation.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634; 26 U.S.C.
367))
[T.D. 7530, 42 FR 65157, Dec. 30, 1977, as amended by T.D. 8087, 51 FR
17960, May 16, 1986; T.D. 8280, 55 FR 1417, Jan. 16, 1990]
Sec. 7.367(b)-2 Definitions.
(a) Controlled foreign corporation. The term ``controlled foreign
corporation'' means a controlled foreign corporations as defined in
section 957 and the regulations thereunder.
(b) United States shareholder. The term ``United States
shareholder'' means any United States person who satisfies the ownership
requirements of section 1248(a)(2) or of section 1248(c)(2) with respect
to a foreign corporation.
(c) Section 1246 amount. In the case of an exchange of stock in a
foreign investment company (as defined in section 1246(b)) to which
section 367(b) applies, the term ``section 1246 amount'', means the
earning and profits, if any, of the foreign investment company, which
would have been attributable under section 1246 and the regulations
[[Page 157]]
thereunder to the stock exchanged if the stock had been sold in a
transaction to which section 1246 applied.
(d) Section 1248 amount. See Sec. 1.367 (b)-2 (d) of this chapter.
(e) Section 1248(c)(2) amount. In the case of an exchange of stock
in a lower-tier foreign corporation to which section 367(b) applies and
which is made by another foreign corporation, the term ``section
1248(c)(2) amount'' means the earnings and profits or deficit in
earnings and profits which would have been attributable under section
1248(c)(2) and the regulations thereunder to the stock of the foreign
corporation exchanged (including stock in other lower-tier corporations
owned by reason of ownership of the stock exchanged). The determination
shall be made as if stock in any first-tier corporation by reason of the
ownership of which the United States shareholder owns the stock
exchanged had been sold in a transaction to which section 1248(a)
applied.
(f) All earnings and profits amount. See Sec. 1.367e(b)-2(f) of this
chapter.
(g) Additional earnings and profits amount. The term ``additional
earnings and profits amount'' means the earnings and profits or deficit
in earnings and profits for taxable years beginning before Janurary 1,
1963, which are attributable under the principles of section 1248 and
the regulations thereunder to the stock of the foreign corporation
exchanged. The determination shall be made by applying section 1248 as
modified by Secs. 7.367(b)-2 through 7.367(b)-12 as if there were no
distinction in those sections between earnings and profits accumulated
before of after December 31, 1962.
(h) All earnings and profits amount or additional earnings and
profits amount. In computing an ``all earnings and profits amount'' or
``additional earnings and profits amount'' under the principles of
section 1248, if the stock exchanged is:
(1) Stock in a first-tier corporation, then section 1248(c)(2)
(inclusion of earnings and profits of subsidiaries) does not apply.
(2) Stock in a lower-tier corporation, then section 1248(c)(2) shall
be applied to determine the earnings and profits of that lower-tier
corporation which are attributable to the stock exchanged but that
section shall not be applied with respect to any other lower-tier
corporations.
(i) Inclusion of earnings and profits described in section 1248(d).
For purposes of computing any of the amounts defined in paragraphs (d)
through (g) of this section, the exclusions from earnings and profits
provided for under section 1248(d) shall not apply. See, however,
paragraph (c) of Sec. 7.367(b)-3 (relating to amounts retaining
character as exclusions under section 1248(d)).
(j) Corporations organized under laws of Puerto Rico or United
States possessions corporations. For purposes of computing the amounts
defined in paragraphs (f) and (g) of this section, if, for a taxable
year, a corporation organized in or under the laws of the Commonwealth
of Puerto Rico or a possessions of the United States meets the
requirements of section 957(c) (or would have met such requirement if
the Revenue Act of 1962 had been in effect) then:
(1) Earnings and profits accumulated by the corporations during such
a taxable year which begins before January 1, 1978, are not required to
be taken into account, and
(2) Earnings and profits accumulated by the corporation during such
a taxable year which begins after December 31, 1977, are required to be
taken into account only to the extent such earnings would not qualify
for the credit of section 936(a) had the corporation been a domestic
corporation which met the requirements of section 936(a)(1) and which
had elected the credit under that section.
A corporation which, during its first taxable year beginning after
December 31, 1962, meets the requirements of section 957(c) will be
considered to have met such requirements during taxable years beginning
prior to January 1, 1963.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65158, Dec. 30, 1977, as amended by T.D. 8243, 54 FR
9201, Mar. 6, 1989, T.D. 8397, 57 FR 6556, Feb. 26, 1992]
[[Page 158]]
Sec. 7.367(b)-3 Special rules.
(a) Character of section 1246 amount. If, under Sec. 7.367(b)-6, an
amount attributable to stock in a foreign investment company (as defined
in section 1246(b)) is required to be taken into gross income of its
shareholders, such earnings and profits will be included in income as--
(1) Gain from the sale of an asset which is not a capital asset to
the extent attributable to earnings and profits accumulated in taxable
years beginning after December 31, 1962; and
(2) A dividend deemed paid in money to the extent attrubutable to
earnings and profits accumulated in taxable years beginning before
January 1, 1963, and required to be included as part of the ``all
earnings and profits amount''.
(b) Character of amounts computed under the principles of section
1248. If, under Sec. 7.367(b)-5 or Secs. 7.367(b)-7 through 7.367(b)-12,
any amount is required to be included in the gross income of a United
States person, that amount shall be considered to have been distributed
as a dividend paid in money immediately prior to the exchange and
taxable under section 301 as a dividend formally declared in the same
amount.
(c) Amounts retaining character as exclusions under section 1248(d).
(1) Amounts described in paragraphs (d) through (g) of Sec. 7.367(b)-2
which must be included in gross income of a United States person shall
be reduced--
(i) In all cases, by earnings and profits retaining their character
as exclusions under section 1248(d) (1), (2), (4), and (5), and
(ii) If the inclusion in gross income is required by a provision
other than paragraph (b) of Sec. 7.367(b)-5, paragraph (c)(2) of
Sec. 7.367(b)-7, or paragraph (j) of Sec. 7.367(b)-10, by earnings and
profits retaining their character as exclusions under section
1248(d)(3). See, however, paragraph (d) of this section.
(2) Amounts described in paragraph (e) or (g) of Sec. 7.367(b)-2
which must be added to the earnings and profits or deficit of an
exchanging foreign corporation shall not be reduced by earnings and
profits retaining their character as exclusions under section 1248(d).
(d) Less developed country corporation election. This paragraph
applies to all earnings and profits of a character described in section
1248(d)(3). Any such earnings and profits which are required to be
included in gross income of a domestic corporate shareholder as part of
an all earnings and profits amount may, at the election of such
taxpayer, be taxed as gain from the sale of a capital asset. Such
election shall be made in the notice required under paragraph (c) of
Sec. 7.367(b)-1. A corporation which during its first taxable year
beginning after December 31, 1962, meets the requirements of section
902(d), as in effect before the enactment of the Tax Reduction Act of
1975, will be considered to have met such requirements during taxable
years beginning prior to January 1, 1963.
(e) Character of certain earnings and profits. Earnings and profits
or a deficit in earnings and profits to which a corporation succeeds
under section 381(a)(1) or amounts which are attributed to stock under
Secs. 7.367(b)-9, 7.367(b)-10, and 7.367(b)-12 shall retain their
character. Earnings and profits or deficits shall be considered as if
accumulated or incurred by the corporation which succeeds to such
earnings and profits or deficits.
This paragraph applies for all purposes, including but not limited to
sections 901 to 908, 959, 960, 1248, and Secs. 7.367(b)-1 through
7.367(b)-12.
(f) Foreign tax credit. If an amount of earnings and profits of a
foreign corporation which is considered to have been distributed as a
dividend is included in gross income of a United States person, the
foreign tax credit provisions (sections 78, and 901 through 908) shall
apply as if such earnings and profits were actually distributed by a
foreign corporation as a dividend.
(g) Treatment of section 1248 amounts and section 1248(c)(2) amounts
where attribution is not made. (1) The portion of the section 1248
amount included in gross income of a United States person which is
attributable to each particular foreign corporation shall be determined
as follows. First, the total gross earnings and profits (determined
without regared to any deficit) attributable to each particular
corporation shall be determined as if it were the only corporation
included in the section 1248 amount. In situations to which
[[Page 159]]
Sec. 7.367(b)-10 applies, the determination shall be made without regard
to the allocation under paragraph (d) of that section. Next, that amount
shall be multiplied by the amount included in gross income. Finally, the
product shall be divided by the section 1248 amount. The result will be
the amount of earnings and profits from that particular corporation
which are included in gross income.
(2) The section 1248 amount included in gross income by a United
States person which is attributable to the earnings and profits of a
foreign corporation shall be considered as if distributed directly to
the United States person by the foreign corporation. A section
1248(c)(2) amount which is added to the earnings and profits or deficit
of an exchanging foreign corporation shall be considered as if
accumulated or incurred directly by the exchanging foreign corporation.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65158, Dec. 30, 1977]
Sec. 7.367(b)-4 Certain exchanges described in more than one Code provision.
(a) Scope. This section provides special rules for purposes of
applying section 367 to certain exchanges which are described in more
than one section of subchapter C of chapter 1 of subtitle A of the Code.
(b) Treatment of certain exchanges described in both section 354 and
in either section 351 or 361--(1) In general. If an exchange of stock in
a foreign corporation (whether or not a controlled foreign corporation)
by a United States person (whether or not a United States shareholder
within the meaning of Sec. 7.367(b)-2(b)) pursuant to a reorganization
described in section 368(a)(1)(B) involving a foreign corporation
transferee is described in section 351 or section 361 as well as in
section 354, such exchange is not an exchange described in section
367(a)(1) and--
(i) If the exchanging shareholder is a United States shareholder
(within the meaning of Sec. 7.367(b)-2(b)) of the corporation whose
stock is exchanged--
(A) The exchange shall be subject to the rules of Sec. 7.367(b)-7,
and
(B) The excess of the gain realized (i.e., the fair market value of
the stock received over the adjusted basis of the stock exchanged) over
the section 1248 amount taken into account under Sec. 7.367(b)-7 shall
be included in the gross income of the exchanging shareholder as gain
recognized from the sale or exchange of the stock exchanged; or
(ii) If the exchanging shareholder is not a United States
shareholder (within the meaning of Sec. 7.367(b)-2(b)) of the
corporation whose stock is exchanged, the entire amount of gain realized
(i.e., the fair market value of the stock received over the adjusted
basis of the stock exchanged) shall be included in the gross income of
the exchanging shareholder as gain recognized from the sale or exchange
of the stock exchanged.
(2) Exceptions. This subparagraph (2) applies only to the gain
treated as gain recognized on the sale or exchange of the stock
exchanged and does not apply to any amount subject to the rules of
Sec. 7.367(b)-7, as provided in paragraph (b)(1)(i)(A) of this section.
(i) Specified treatment. If an exchange of stock in a foreign
corporation by a U.S. person is an exchange to which the rules under
section 367(a) apply, then the gain required to be included in gross
income under paragraph (b)(1)(i)(B) or paragraph (b)(1)(ii) of this
section shall not be required to be immediately recognized under this
paragraph (b), and instead the transaction shall be treated in
accordance with the regulations under section 367(a). See Sec. 1.367(a)-
3T.
(ii) Controlled foreign corporations. If--
(A) The transferee corporation is a controlled foreign corporation
after the transfer, and
(B) The exchanging shareholder is a United States shareholder
(within the meaning of Sec. 7.367(b)-2(b)) of the corporation whose
stock is exchanged both before and after the transfer and of the
transferee corporation after the transfer, then paragraph (b)(1)(i)(B)
of this section shall not apply.
(3) Effective date. The rules of this paragraph (b) apply to
exchanges that begin after January 26, 1983. For the rules applicable to
exchanges that began before that date, see 26 CFR 7.367(b)-4(b) as it
appeared in the Code
[[Page 160]]
of Federal Regulations revised as of April 1, 1982. However, the rules
contained in paragraph (b) (1) and (2) of this section for the treatment
of certain exchanges described in that paragraph may, at the option of
the taxpayer, apply also to any exchange beginning after December 31,
1977, and during a taxable year with respect to which action by the
Internal Revenue Service is not barred by any statute of limitations.
(c) Precedence of section 1036 over section 354. If an exchange of
stock in a foreign corporation pursuant to a reorganization is described
both in sections 354 and 1036, the exchange will be considered to be
described in section 1036, unless the stock surrendered is stock to
which an amount h as been attributed under Secs. 7.367(b)-5 through
7.367(b)-12. In that event, the provisions of these regulations shall
apply to the attributed amounts as if section 1036 did not apply to the
subsequent exchange.
(d) Special definition of reorganization described in section
368(a)(1)(F). For purposes of section 367(b) and Secs. 7.367(b)-1
through 7.367(b)-12, a reorganization will be considered to be described
in section 368(a)(1)(F) only if it involves a mere change in identity,
form, or place of organization, however effected, of a single corporate
entity.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65159, Dec. 30, 1977, as amended by T.D. 7863, 47 FR
57490, Dec. 27, 1982; T.D. 8087, 51 FR 17961, May 16, 1986]
Sec. 7.367(b)-5 Complete liquidation of foreign subsidiary.
(a) Scope. This section applies to an exchange described in section
332 which involves receipt of a distribution in complete liquidation of
a foreign corporation.
(b) Receipt of distribution by a domestic corporation. If a domestic
corporation which receives a distribution in complete liquidation of a
foreign corporation includes in its gross income the all earnings and
profits amount attributable to its stock in the distributor foreign
corporation, the foreign corporation will be considered to be a
corporation for purposes of applying Subchapter C of Chapter I of
Subtitle A of the Code. The domestic corporation must include the all
earnings and profits amount in gross income for the taxable year in
which occurs the date of distribution (within the meaning of section
381(b)(2) and the regulations thereunder). If the domestic corporation
does not include this amount in gross income, for the purpose of
determining the extent to which gain is recognized on the exchange, the
foreign corporation will not be considered to be a corporation. However,
the provisions of the Code other than section 332 shall apply as if the
foreign corporation were considered a corporation. For example, sections
334(b)(1) and 381(a)(1) shall apply where applicable.
(c) Receipt of distribution by a foreign corporation. If a foreign
corporation receives a distribution in complete liquidation of another
foreign corporation, a foreign corporation will be treated as a
corporation for purposes of section 332 and other applicable sections
such as section 381.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65159, Dec. 30, 1977]
Sec. 7.367(b)-6 Exchange of stock in a foreign investment company.
(a) Scope. This section applies to an exchange of stock in a foreign
investment company (as defined in section 1246(b)) if:
(1) The exchange is described in section 354 or 356 pursuant to any
reorganization described in subparagraph (B), (C), (D), or (F) of
section 368(a)(1) and in section 368(a)(2)(F) (if applicable), and
(2) Stock in a domestic corporation is received pursuant to the
exchange. In the case of an exchange to which stock in a foreign
corporation is received see section 1246(c).
(b) General rule. Except as provided in paragraph (c) of this
section, a taxpayer who makes an exchange to which this section applies
shall include in gross income for its taxable year in which the exchange
occurs the section 1246 amount attributable to the stock in the foreign
investment company which was exchanged to the extent of the excess of
the fair market value of such stock over its adjusted bases.
[[Page 161]]
(c) Exchange pursuant to certain asset acquisitions. (1) If the
exchange to which this section applies is made pursuant to a
reorganization described in section 368(a)(1) (C), (D), or (F) involving
the acquisition of assets of a foreign investment company (the
``acquired corporation'') by a domestic corporation, and the exchanging
taxpayer is a domestic corporation, such taxpayer shall include in gross
income for its taxable year in which the exhange occurs the all earnings
and profits amount with respect to that stock computed in accordance
with the principles of section 1246.
(2) If the domestic corporation does not include the amount referred
to in paragraph (c)(1) of this section in gross income, for the purpose
of determining the extent to which gain is recognized on the exchange,
the foreign corporation will not be considered to be a corporation.
However, the provisions of the Code other than section 354 or 356 shall
apply as if the foreign corporation were considered a corporation. For
example, sections 358, 362, and 381 (if applicable) shall apply as if no
gain had been recognized.
(d) Adjustment to basis. Any amount included in gross income under
paragraph (b) or (c)(1) of this section which is characterized as gain
from the sale of an asset which is not a capital asset shall be treated
as gain recognized for purposes of applying sections 358 and 362.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65159, Dec. 30, 1977]
Sec. 7.367(b)-7 Exchange of stock described in section 354.
(a) Scope. This section applies to an exchange of stock in a foreign
corporation (other than a foreign investment company as defined in
section 1246(b)) if:
(1) The exchange is described in section 354 or 356 and is made
pursuant to a reorganization described in section 368(a)(1) (B) through
(F); and
(2) The exchanging person is either a United States shareholder or a
foreign corporation having a United States shareholder who is also a
United States shareholder of the corporation whose stock is exchanged.
(b) Receipt of stock in a controlled foreign corporation. If an
exchanging shareholder receives stock of a controlled foreign
corporation in an exchange to which this section applies (other than in
an exchange pursuant to a reorganization described in section 368(a)(1)
(E) or (F)), Sec. 7.367(b)-9 applies if, with respect to such
corporation, immediately after the exchange--
(1) The exchanging shareholder is a United States shareholder of
that controlled foreign corporation, or
(2) All United States shareholders of the exchanging foreign
corporate shareholder are United States shareholders of that controlled
foreign corporation.
(c) Receipt of other stock--(1) General rule. Except as provided in
paragraph (c)(2) of this section, if an exchanging shareholder receives
stock of a domestic corporation, or stock of a foreign corporation which
is not a controlled foreign corporation, or stock of a controlled
foreign corporation as to which the exchanging United States shareholder
or any United States shareholder of the exchanging foreign corporation
is not a United States shareholder, then--
(i) An exchanging United States shareholder shall include in gross
income the section 1248 amount attributable to the stock exchanged, to
the extent that the fair market value of the stock exchanged exceeds its
adjusted basis, or
(ii) See Sec. 1.367 (b)-7 (c)(1)(ii) of this chapter.
(iii) See Sec. 1.367 (b)-7 (c)(1)(iii) of this chapter.
(iv) In situations to which paragraph (c)(1)(ii) of this section
applies, the basis of the stock received by the exchanging shareholder
shall be increased by the earnings and profits added to the earnings and
profits of the exchanging foreign corporation under paragraph (c)(1)(ii)
of this section. Correspondingly, the basis of such exchanging
shareholder shall be decreased by any deficits added to deficits of the
exchanging foreign corporation under paragraph (c)(1)(ii) of this
section. Any increase in basis attributable to earnings and profits
included
[[Page 162]]
in the section 1248(c)(2) amount referred to in paragraph (c)(1)(ii) of
this section shall be made only if all United States shareholders of the
exchanging corporation consent to treat amounts added to the earnings
and profits of the exchanging foreign corporation as a dividend. Such
consent shall be given in the notice required by paragraph (c) of
Sec. 7.367(b)-1. See paragraph (f)(1) of Sec. 7.367(b)-9 for the effect
of such election. The adjustment to basis in respect of earnings and
profits or deficit accumulated or incurred in taxable years beginning
before January 1, 1963, shall be taken into account only for purposes of
computing an all earnings and profits amount and additional earnings and
profits amount, where such amounts must be computed after an exchange of
stock the basis of which has been adjusted under this paragraph
(c)(1)(iii).
(2) Exchange of stock by certain domestic corporations. (i) A United
States person shall include in gross income the all earnings and profits
amount if:
(A) Pursuant to a reorganization described in section 368(a)(1) (C),
(D), or (F), assets of a foreign corporation are acquired by a domestic
corporation;
(B) The exchanging United States person is a domestic corporation;
and
(C) Such United States person receives stock of a domestic
corporation in exchange for its stock in the acquired corporation.
(ii) If the domestic corporation does not include this amount in
gross income, for the purpose of determining the extent to which gain is
recognized on the exchange, the foreign corporation will not be
considered to be a corporation. However, the applicable provisions of
the Code other than section 354 or 356 shall apply as if the foreign
corporation were considered a corporation. For example, sections 358,
362, and 381, if applicable, shall apply as if no gain had been
recognized.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65160, Dec. 30, 1977, as amended by T.D. 8243, 54 FR
9202, Mar. 6, 1989, T.D. 8397, 57 FR 6556, Feb. 26, 1992]
Sec. 7.367(b)-8 Transfer of assets by a foreign corporation in an exchange described in section 351.
(a) Scope. This section applies to a transfer of property pursuant
to an exchange described in section 351, regardless of whether the
transfer is also described in section 361, if:
(1) The transferor of property is a foreign corporation; and
(2) In the case of a transfer also described in section 361, the
transferor remains in existence immediately after the transaction.
(b) Section 381 inapplicable. If this section applies to a transfer
described in section 361, section 381(a)(2) shall not apply with respect
to items described in section 381(c)(2).
(c) Transfer of stock in controlled foreign corporation. If the
transferor corporation transfers stock in a foreign corporation of which
there is a United States shareholder immediately before the exchange,
and the transferor receives stock--
(1) Of a controlled foreign corporation as to which all United
States shareholders of the transferor corporation remain United States
shareholders, Sec. 7.367(b)-9 shall apply.
(2) See Sec. 1.367(b)-8(c)(2) of this chapter.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65160, Dec. 30, 1977, as amended by T.D. 8397, 57 FR
6556, Feb. 26, 1992]
Sec. 7.367(b)-9 Attribution of earnings and profits on an exchange described in section 351, 354, or 356.
(a) Scope. This section applies to a transaction involving an
exchange of stock in a foreign corporation to which paragraph (b) of
Sec. 7.367(b)-7 or paragraph (c)(1) of Sec. 7.367(b)-8 applies.
(b) General rule. Upon an exchange of stock to which this section
applies:
(1) The section 1248 amount, the section 1248(c)(2) amount, the all
earnings and profits amount and the additional earnings and profits
amount shall be computed with respect to each United States shareholder
and to each foreign corporation as to which there is a United States
shareholder who exchanges stock in the transaction. The
[[Page 163]]
amounts so computed shall be attributed to the stock received by each
exchanging shareholder in the exchange in accordance with the principles
of Secs. 1.1248-2 and 1.1248-3. For the effect of attribution, see
Sec. 7.367(b)-12.
(2) Earnings and profits or deficit of the corporation whose stock
is received in the exchange shall be increased as provided in paragraph
(c) of this section.
(3) Earnings and profits or deficit of the corporation whose stock
is exchanged and of any lower-tier corporations whose earnings and
profits would be taken into account under section 1248(c)(2) shall be
reduced as provided in paragraph (d) of this section.
(4) See Sec. 1.367(b)-9(b)(4) of this chapter.
(c) Earnings and profits or deficits of the corporation whose stock
is received. (1) Earnings and profits or deficit of the corporation
whose stock is received in the exchange shall be increased by the
earnings and profits or deficit to which it would succeed if:
(i) That corporation were the acquiring corporation, within the
meaning of paragraph (b)(2) of Sec. 1.381(a)-1, in a transaction to
which section 381 applies (whether or not section 381 applies or that
corporation would be considered the acquiring corporation); and
(ii) The corporation whose stock is exchanged, and each lower-tier
corporation whose earnings and profits would be taken into account in
calculating a section 1248 or section 1248(c)(2) amount, were a
transferor corporation for purposes of section 381(a)(2).
A corporation which actually is the acquiring corporation in a
transaction to which section 381(a)(2) applies shall not succeed to an
item of the transferor described in section 381(c)(2) by reason of
section 381(a)(2). However, that corporation shall succeed to all other
items described in section 381(c).
(2) To the extent that the corporation whose stock is received does
not acquire, either directly or through other entities, all the stock of
the corporation whose stock is exchanged or of any lower-tier
corporation whose earnings and profits would be taken into account in
calculating a section 1248(c)(2) amount, paragraph (c)(1) of this
section shall apply only to the proportion of earnings and profits or
deficits attributable to the stock acquired. Such proportion shall be
determined as if the earnings and profits or deficits were section 1248
or section 1248(c)(2) amounts. The earnings and profits or deficit to
which the corporation whose stock is received does not succeed by reason
of this paragraph shall be considered entirely attributable to the stock
not acquired by the corporation whode stock is received.
(d) Earnings and profits of corporation whose stock is exchanged and
of lower-tier corporation. The earnings and profits or deficit of the
corporation whose stock is exchanged and of any lower-tier corporation
whose earnings and profits or deficit would be taken into account under
section 1248 shall be reduced to the extent that the adjustment required
under paragraph (c) of this section is attributable to earnings and
profits or deficit of that corporation.
(e) Adjustment to basis. (1) This paragraph (e)(1) applies to
increases and decreases to basis of stock in corporations which as to
the corporation whose stock is exchanged are lower-tier corporations. To
the extent that earnings and profits of corporations (other than the
corporations whose stock is exchanged) are reduced under paragraph (d)
of this section, the basis in stock of each corporation whose earnings
and profits are so reduced shall, in the hands of its immediate
shareholder, be increased. The increase shall equal the total reduction
in earnings and profits in respect of all corporations which as to such
immediate shareholder are lower-tier corporations. Correspondingly, the
basis to such immediate shareholder of stock in a corporation (other
than the corporation whose stock is exhanged) whose deficit is reduced
shall be decreased by the total reduction in deficits in respect of the
corporations which as to that shareholder are lower-tier corporations.
(2) This paragraph (e)(2) applies to increases and decreases to
basis of stock in corporations which are not lower-tier corporations as
to the corporation whose stock is exchanged but are
[[Page 164]]
lower-tier corporations of the corporation whose stock is received. In
the case of a reorganization described in section 368(a)(1)(B) or of a
reorganization in which the acquiring corporation, within the meaning of
Sec. 1.381(a)-1(b)(2), is a lower-tier corporation as to the corporation
whose stock is received, the basis of stock shall be adjusted as
provided in this paragraph (e)(2). To the extent that earnings and
profits of the corporation whose stock is exchanged and of its lower-
tier corporations are reduced under paragraph (d) of this section, the
basis to the immediate corporate shareholder:
(i) Of stock in the corporation whose stock is exchanged, or
(ii) Of stock in a corporation (other than the corporation whose
stock is received) which is the acquiring corporation of the corporation
whose stock is exchanged,
shall be increased by the total reduction in earnings and profits under
paragraph (d) of this section, except to the extent that the basis of
such stock is determined by reference to the basis of the assets of the
corporation whose stock is exchanged. The basis in such stock to each
immediate corporate shareholder shall be similarly increased, and such
increase shall in turn be made at each successive tier. The basis of the
stock of the corporation whose stock is received, however, shall not be
increased. Correspondingly, the basis of such stock to each immediate
corporate shareholder, and at each successive higher tier, shall be
decreased by the total reduction in deficits under paragraph (d) of this
section, except to the extent that the basis of such stock is determined
by reference to the basis of the assets of the corporation whose stock
is exchanged.
(3) Any adjustment to basis in respect of earnings and profits or
deficit accumulated or incurred in taxable years beginning before
January 1, 1963, shall be taken into account only for purposes of
computing all the earnings and profits and additional earnings and
profits amounts.
(f) Election as condition of increase in basis with respect to post-
1962 earnings and profits. (1) An increase in basis under paragraph
(e)(1) of this section attributable to earnings and profits for taxable
years beginning after December 31, 1962, shall be made only if all
United States shareholders of the corporation whose corporation whose
stock is exchanged make a consent dividend election in the notice
required by paragraph (c) of Sec. 7.367(b)-1. If such consent is made,
the portion of such earnings and profits attributable to each particular
corporation shall be treated as if, immediately prior to the
reorganization, it had been distributed as a dividend through any
intervening corporations to the corporation whose stock is exchanged.
(2) An increase in basis under paragraph (e)(2) of this section
attributable to earnings and profits for taxable years beginning after
December 31, 1962, shall be made only if:
(i) An election has been made under paragraph (f)(1) of this
section, and
(ii) All United States shareholders of the corporation whose stock
is received make a consent dividend election as provided in section 565
for the taxable year in which the reorganization occurs.
If such consent is made, such earnings and profits attributable to the
corporation whose stock is exchanged and of its lower-tier corporations
whose earnings and profits were reduced under paragraph (d) of this
section shall be treated as if immediately after the reorganization, it
had been distributed as a dividend through any intervening corporations
to the corporation whose stock is received.
(3) See sections 553, 951 and 959 as to the possible effect of an
election under this section.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65160, Dec. 30, 1977, as amended by T.D. 8243, 53 FR
9202, Mar. 6, 1989, T.D. 8397, 57 FR 6556, Feb. 26, 1992]
Sec. 7.367(b)-10 Distribution of stock described in section 355.
(a) Scope. This section provides rules relating to a distribution
described in section 355 to which section 367(b) applies. For purposes
of this section, the terms ``distributing corporation'' and ``controlled
corporation'' have the meaning of those terms as used in section 355.
[[Page 165]]
(b) Distribution by a domestic corporation. If a domestic
corporation distributes stock in a controlled corporation which is a
controlled foreign corporation as to which the distributing corporation
is a United States shareholder, section 1248(f) applies to such
distribution. After earnings and profits attributable to the stock have
been determined under section 1248(f), paragraphs (d) through (f) of
this section apply. With respect to subsequent transactions involving
the distributing group, the allocation described in paragraph (d) of
this section shall not increase or decrease the amounts described in
paragraphs (d) through (g) of Sec. 7.367(b)-2.
(c) Distribution of stock by a foreign corporation. If a foreign
corporation having a United States shareholder distributes stock in
another corporation, paragraphs (d) through (j) of this section apply.
(d) Allocation of earnings and profits. Earnings and profits or
deficit accumulated or incurred by the distributing corporation, the
controlled corporation (or corporations), and by corporations which
directly or indirectly are controlled by either, shall be allocated
among those corporations immediately after the distribution. For
purposes of making this allocation:
(1) Section 1.312-10 shall not apply.
(2) The sum of the earnings and profits accumulated prior to the
distribution by each corporation shall be determined.
(3) The sum of the deficits in earnings and profits incurred prior
to the distribution by each corporation shall be determined.
(4) The total gross earnings and profits and deficits shall be
allocated between the distributing corporation and any corporations
controlled by it after the distribution (the ``distributing group'') and
the controlled corporation (or corporations) and any corporations
controlled by them after the distribution (the ``controlled group'').
Such allocation shall be made in accordance with the net fair market
value of the assets of each group. In determining the fair market value
of the assets of a group, the fair market value of stock in a
corporation controlled by another corporation in a group shall not be
taken into account.
(5) For purposes of allocating earnings and profit or deficits to
either the distributing group or the controlled group:
(i) Earnings and profits or deficit of only the distributing
corporation or of the controlled corporation shall be increased;
(ii) No allocation shall be made from one member to another member
of the same group;
(iii) The earnings and profits allocated from a particular
corporation shall be the proportion of total earnings and profits
allocated from its group to the other group which earnings and profits
of that particular corporation prior to the allocation bears to the
total gross earnings and profits of all corporations in that group
having earnings and profits prior to the allocation; and
(iv) The deficit in earnings and profits allocated from a particular
corporation shall be the proportion of the total deficits allocated from
its group to the other group which the deficit of that particular
corporation prior to the allocation bears to the total gross deficit of
all corporations in that group having deficits prior to the allocation.
(6) To the extent that there is not distributed all the stock of the
controlled corporation, or of any lower-tier corporation of the
controlled corporation whose earnings and profits would be taken into
acccount in calculating a section 1248(c)(2) amount, paragraph (d) (1)
through (5) of this section shall apply only to the proportion of the
earnings and profits or deficits attributable to the stock distributed.
Such proportion shall be determined as if the earnings and profits were
section 1248 or section 1248(c)(2) amounts. The earnings and profits or
deficits not allocated by reason of this paragraph shall be considered
entirely attributable to the stock not distributed.
(e) Adjustment to basis. (1) Except as provided in paragraph (f) of
this section, to the extent earnings and profits are allocated from a
corporation other than the distributing or controlled corporations, the
basis of the stock of that corporation in the hands of its immediate
shareholder shall be increased by
[[Page 166]]
the amount of earnings and profits allocated from it and from members of
the group which as to that corporation are lower-tier corporations.
Correspondingly, to the extent deficits are allocated from a corporation
other than the distributing or controlled corporation, the basis of the
stock of that corporation in the hands of its immediate shareholder
shall be decreased by the amount of deficit allocated from it and from
members of the group which as to that corporation are lower-tier
corporations.
(2) Any adjustment to basis in respect of earnings and profits or
deficit accumulated or incurred in taxable years beginning before
January 1, 1963, shall be taken into account only for purposes of
computing the all earnings and profits and additional earnings and
profits amounts.
(f) Election as condition of increase in basis. An increase in basis
attributable to allocation of earnings and profits for taxable years
beginning after December 31, 1962, of a corporation to the other group
shall be made only if all United States shareholders of the group from
which the allocation is made (determined after the distribution) make a
consent dividend election in the notice required by paragraph (c) of
Sec. 7.367(b)-1. If such consent is made, such earnings and profits,
allocated from each particular corporation shall be treated as if,
immediately after the distribution, they had been distributed as a
dividend through any intervening corporations to the distributing
corporation or controlled corporation as the case may be. See sections
553, 951, and 959 for the possible effect of an election under this
section.
(g) Computation of certain amounts. Upon a distribution described in
paragraph (c) of this section, the section 1248 or section 1248(c)(2)
amount, the all earnings and profits amount, and the additional earnings
and profits amount shall be computed with respect to each United States
shareholder and to each foreign corporation as to which there is a
United States shareholder. The computation shall be made with reference
to stock owned by the shareholder in the distributing corporation prior
to the distribution and shall be made regardless of whether the
shareholder is an exchanging shareholder.
(h) Attribution to stock owned after the distribution. (1) The
amounts described in paragraph (g) of this section shall be attributed
to all stock owned after the distribution except stock owned after the
distribution except stock received in the distribution and to which
paragraph (i) or (j) or this section applies.
(2) Attribution of an amount shall be made to stock of a corporation
in the proportion that the value of such stock bears to all stock owned
after the distribution, including for this purpose stock to which
paragraph (i) or (j) of this section applies and to which no attribution
is made.
(3) If after the distribution the distributing foreign corporation
is no longer controlled foreign corporation as to a United States
shareholder, see section 1248(a)(2) with respect to stock disposed of
within five years after a change in status.
(i) Receipt of other stock. Except as provided in paragraph (j) of
this section, if an exchanging shareholder receives--
(1) Stock of a domestic corporation,
(2) Stock of a foreign corporation which is not a controlled foreign
corporation, or
(3) Stock of a controlled foreign corporation as to which the
exchanging United States shareholder or any United States shareholder of
the exchanging foreign corporation is not a United States shareholder,
then--
(i) An exchanging United States shareholder shall include in gross
income the excess of--
(A) The section 1248 amount computed under paragraph (g) of this
section, over
(B) The section 1248 amount attributed to stock under paragraph (h)
of this section,
to the extent that the fair market value of stock in the distributing
corporation owned by the shareholder prior to the distribution exceeds
its adjusted basis; or
(ii) There shall be added to the earnings and profits or deficit of
an exchanging foreign corporation the excess of;
[[Page 167]]
(A) The section 1248(c)(2) amount computed under paragraph (g) of
this section, over
(B) The section 1248(c)(2) amount attributed to stock under
paragraph (h) of this section. The amount added shall not be considered
a dividend.
(C) In situations to which subdivision (B) of this subparagraph
applies, the basis adjustment and election rules of Sec. 7.367(b)-
7(c)(1)(iii) shall apply.
(j) Receipt of stock by certain domestic corporations. A United
States person shall include in its gross income the excess of the all
earnings and profits amount computed under paragraph (g) of this section
over the all earnings and profits amount attributed under paragraph (h)
of this section if--
(1) The distribution is made pursuant to a reorganization described
in section 368(a)(1)(D) and involving the acquisition of assets of the
foreign distributing corporation by a domestic corporation; and
(2) The United States person is a domestic corporation.
If the domestic corporation does not include this amount in gross
income, for purposes of determining the extent to which gain is
recognized on the exchange, the foreign corporation will not be
considered to be a corporation. However, the applicable provisions of
the Code other than section 35, 356, or 361 shall apply as if the
foreign corporation were considered a corporation. For example, sections
358 and 362, if applicable, shall apply as if no gain had been
recognized.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65161, Dec. 30, 1977]
Sec. 7.367(b)-11 Deficit in earnings and profits.
(a) Scope. This section provides rules relating to the manner in
which a deficit in earnings and profits of a corporation may be used
after certain exchanges to which section 367(b) applies.
(b) Limitation on deficits allocated to a corporation. Any deficit
in earnings and profits incurred prior to the distribution which are
allocated to a corporation under paragraph (c) of Sec. 7.367(b)-9 or
allocated under paragraph (d) of Sec. 7.367(b)-10 shall be used only in
the manner prescribed under section 381(c)(2)(B) and the regulations
thereunder.
(c) Deficit in earnings and profits. If section 382 would apply to a
net operating loss of a corporation in respect of a transaction to which
section 367(b) applies, the percentage reduction provided in section 382
with respect to net operating losses shall reduce a deficit in earnings
and profits allocated to that corporation.
(d) Computation of allocated amounts. If paragraph (c) of this
section applies, a deficit attributed to stock under Secs. 7.367(b)-5
through 7.367(b)-11 shall be adjusted in accordance with the rule of
paragraph (b).
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65162, Dec. 30, 1977]
Sec. 7.367(b)-12 Subsequent treatment of amounts attributed or included in income.
(a) Application. This section applies to distributions with respect
to, or a disposition of, stock--
(1) To which an amount has been attributed pursuant to
Sec. 7.367(b)-9, or Sec. 7.367(b)-10; or
(2) In respect of which an amount has been included in income or
added to earnings and profits pursuant to Sec. 7.367(b)-7 or
Sec. 7.367(b)-10.
(b) Successor in interest. A subsequent United States shareholder of
stock to which this section applies--
(1) Whose holding period is considered to include the period during
which such stock was held by the prior United States shareholder, and
(2) Who acquired the stock other than by means of a transfer to
which Secs. 7.367(b)-1 through 7.367(b)-12 apply,
shall be considered to be the ``successor in interest'' to the prior
United States shareholder. The successor in interest will succeed to the
earnings and profits or deficit which the regulations under section
367(b) attribute to the stock in the hands of the prior United States
shareholder.
(c) Distributions after attribution. Distributions with respect to
stock made after an amount has been attributed to the stock under
Sec. 7.367(b)-9 or Sec. 7.367(b)-
[[Page 168]]
10 shall be considered to be made in accordance with the following
rules:
(1) Distributions shall be considered to be made first out of
earnings and profits accumulated since the attribution.
(2) To the extent that as of the close of a taxable year
distributions have exceeded earnings and profits accumulated since the
attribution, excess distributions during that years shall be considered
to be made out of earnings and profits previously attributed to the
stock (but will not increase a deficit attributed to the stock). Solely
for this purpose, amounts which would have been attributed to stock
under Sec. 7.367(b)-9 or Sec. 7.367(b)-10 had such stock been owned by a
United States shareholder or by an exchanging foreign corporation as to
which there is a United States shareholder shall be attributed to such
stock.
(3) Distributed earnings and profits considered under paragraph
(c)(2) of this section to be made out of attributed amounts shall be
considered as if distributed from each of the corporations from which
amounts have been attributed, in the proportion that amounts attributed
from that corporation bear to amounts attributed from all corporations
from which amounts have been attributed. Such amounts shall retain their
character for all purposes, including sections 901 through 908 and 959.
(4) When all earnings and profits attributed have been distributed,
the distributions shall be considered to have been made from earnings
and profits accumulated by the distributing corporation, whether before
or after the attribution.
(d) Distributions after an inclusion in income or addition to
earnings and profits. Amounts included in gross income of a United
States person pursuant to Sec. 7.367(b)-7 or Sec. 7.367(b)-10 shall be
treated for purposes of this section in the same manner as amounts
previously included in income under section 951. Thus--
(1) Subsequent distributions of amounts which would but for this
section be treated as dividends shall be considered first to consist of
amounts previously included in income and shall be excluded in the same
manner as under section 959.
(2) In the case of an inclusion under Sec. 7.367(b)-10, this
paragraph shall apply only with respect to distributions from the
corporations described in paragraph (i) or (j) of that section.
(3) Amounts of which an election applies under Sec. 7.367(b)-
7(c)(1)(iii) or Sec. 7.367(b)-10(i)(3)(ii)(C) shall be treated in the
same manner as amounts described in paragraph (d)(1) of this section but
only to the extent distributed to the exchanging foreign shareholder.
(e) Disposition after an attribution or inclusion in income. Upon a
disposition of stock to which section 1248 or Sec. 7.367(b)-1 through
Sec. 7.367(b)-12 apply, amounts described in Sec. 7.367(b)-2 (d) through
(g) shall be determined in the following manner:
(1) In the case of amounts to which a corporation succeeds under
section 381(a)(1), the rules of section 1248 will apply.
(2) In the case of amounts attributed under Secs. 7.367(b)-9 and
7.367(b)-10:
(i) There shall first be determined earnings and profits or deficits
attributed to the stock disposed of,
(ii) The earnings and profits described in paragraph (e)(2)(i) of
this section shall be reduced (but deficits shall not be increased) by
distributions referred to in paragraph (c)(2) of this section.
(iii) To the amount determined after applying paragraph (e)(2)(ii)
of this section there shall be added amounts attributable to the stock
without regard to the attribution; however, earnings and profits or
deficits accumulated or incurred prior to the attribution shall not be
taken into account.
Moreover, deficits incurred after the attribution shall not be taken
into account to the extent they would occur by reason of distributions
of previously attributed earnings and profits. For example,
distributions described in paragraph (c)(2) of this section shall not be
taken into account in computing a deficit under Sec. 1.1248-3(b)(3); and
no part of any deficit attributable to distributions described in
paragraph (c)(2) of this section shall be allocated to stock until after
the earnings and profits previously attributed have been distributed.
[[Page 169]]
(iv) Amounts to which paragraph (d)(1) or (d)(3) of this section
apply shall increase the basis of stock in the same manner as under
section 961, and distributions attributable to those amounts shall
correspondingly decrease the basis of stock.
(v) Earnings and profits distributed out of accumulated amounts
shall be considered as if distributed from each of the corporations from
which earnings and profits have been attributed, in the ratio that
earnings and profits attributed from that corporation bear to earnings
and profits attributed from the corporations from which earnings and
profits have been attributed. Such distributions shall reduce the
amounts previously attributed and shall retain their character for all
purposes, including sections 901 through 908 and section 959.
(vi) When all attributed amounts have been distributed, the
distributions shall be considered to have been made from earnings and
profits accumulated by the distributing corporation, whether before or
after the distribution.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65163, Dec. 30, 1977]
Sec. 7.367(b)-13 Examples.
The following examples illustrate the application of Secs. 7.367(b)-
1 through 7.367(b)-12, inclusive. Unless otherwise indicated, no foreign
corporation in any of these examples is a person referred to in section
6012.
Example (1). F, F1, and F2 are foreign corporations that were
organized on January 1, 1960. At all times since this date, A, a
domestic corporation, has owned 100 percent of the outstanding stock in
F, F has owned 100 percent of the outstanding stock in F1, and F1 has
owned 100 percent of the outstanding stock in F2. A, F, F1, and F2 each
uses the calendar year as its taxable year. For each taxable year since
their date of organization, F, F1, and F2 each has earnings and profits
of $1,000. None of these earnings and profits is of a character
described in section 1248(d). On January 1, 1980, F1 is liquidated into
F in an exchange to which section 332 would apply if the status of F and
F1 as corporations is recognized. A complies with the reporting
requirements of Sec. 7.367(b)-1(c) (with respect to the foreign personal
holding company income realized by F on the liquidation).
Under Sec. 7.367(b)-5(c), F and F1 are considered to be corporations
for purposes of section 332 and other applicable sections. Under section
381(a)(1), F succeeds to F1's $20,000 of earnings and profits. These
earnings and profits are considered to have been accumulated by F and
retain their character as provided in Sec. 7.367(b)-3(e) (e.g., $3,000
retains its character as pre-1963 earnings and profits). F's basis in
the stock in F2 received in the liquidating distribution is determined
under section 334(b)(1).
Example (2). After the completion of the transaction in example (1),
F has earnings and profits of $2,000 for its taxable year 1980, which,
when added to the $20,000 of earnings and profits previously accumulated
by F and the $20,000 of earnings and profits accumulated by F1 to which
F succeeded under section 381(a)(1), gives a total of $42,000. F2 has
earnings and profits of $1,000 for its taxable year 1980, giving F2 a
total of $21,000 of earnings and profits. A's basis in its stock in F is
$25,000.
(a) On January 1, 1981, A sells all its stock in F to an unrelated
person for $100,000 in a transaction to which section 1248(a) applies. A
recognizes gain of $75,000 ($100,000-$25,000) on this sale.
As provided in Sec. 7.367(b)-12(e)(1), the rules of section 1248
apply in determining the portion of gain recognized by A that must be
treated as a dividend. Under section 1248 and the regulations
thereunder, the gain recognized by A must be treated as a dividend to
the extent of the earnings and profits of F and F2 attributable to A's
stock in F which were accumulated in taxable years beginning after
December 31, 1962. The earnings and profits of F1 to which F succeeded
under section 381(a)(1) by reason of the transaction in example (1) are
considered to have been accumulated by F under Sec. 7.367(b)-3(e). The
earnings and profits of F1 accumulated in taxable years beginning before
January 1, 1963, retain their character as pre-1963 earnings in the
hands of F. Thus, the earnings and profits attributable to A's stock in
F (the ``section 1248 amount'') total $54,000. This total consists of
$19,000 actually accumulated during taxable years of F ($22,000-$3,000
of pre-1963 earnings and profits), $18,000 actually accumulated during
taxable years of F2 ($21,000-$3,000 of pre-1963 earnings and profits)
and $17,000 of the earnings and profits of F1 to which F succeeded under
section 381(a)(1) by reason of the transaction in example (1)
($20,000-$3,000 of pre-1963 earnings and profits). For its taxable year
1981, A must include in its gross income $54,000 as a dividend and
$21,000 ($75,000 gain-$54,000) as capital gain.
(b) On January 1, 1981, instead of A selling the stock of F as in
example (2)(a), F is liquidated into A in an exchange to which section
332 would apply if the status of F as a
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corporation is recognized. F's basis in its assets is $20,000.
The all earnings and profits amount of A with respect to F is
$42,000. This amount includes $20,000 of the earnings and profits of F1
to which F succeeded under section 381(a)(1) by reason of the
transaction in example (1) since, under Sec. 7.367(b)-3(e), the $20,000
is considered as if accumulated by F. It also includes the $22,000
actually accumulated during taxable years of F. As provided in
Sec. 7.367(b)-2(f) and (h)(1), however, it does not include the $21,000
of earnings and profits of F2. A complies with the reporting
requirements of Sec. 7.367(b)-1 (c).
(i) A includes in gross income for its taxable year 1981 the all
earnings and profits amount of $42,000.
The $42,000 included in income is considered to be a dividend as
provided in Sec. 7.367(b)-3(b). This amount increases the earnings and
profits of A and decreases the earnings and profits of F to zero. Under
Sec. 7.367(b)-5(b), F is considered to be a corporation. A's basis in
F's assets, determined under section 334(b)(1), is $20,000.
(ii) A does not include the all earnings and profits amount in gross
income for its taxable year 1981.
Under Sec. 7.367(b)-5(b), solely for the purpose of determining the
extent to which gain is recognized on the exchange, F is not considered
to be a corporation, and A must include in gross income $75,000
($100,000 fair market value of assets received-$25,000 basis in the
stock in F). For all other purposes, F is a corporation. Thus, section
1248 applies to A's exchange of its stock in F and $54,000 is included
in A's gross income as a dividend and $21,000 is included as capital
gain. See example (2)(a). A succeeds to F's earnings and profits under
section 381(a)(1). Pursuant to Sec. 7.367(b)-5(b), A's basis in F's
assets is $20,000 under section 334(b)(1).
(iii) A makes a computational error in determining the all earnings
and profits amount to include in gross income for its taxable year 1981.
If A demonstrates that the error was made in good faith and agrees to
correct the error, the Commissioner shall conclude under Sec. 7.367(b)-
1(b)(2) that F will be considered to be a corporation for purposes of
applying section 332.
(c) The facts are the same as in example (2)(b) except that F is a
corporation organized under the laws of Puerto Rico, which in all
relevant years has met the requirements of section 957(c) or would have
met such requirements if the Revenue Act of 1962 had been in effect.
Neither F1 nor F2 meets or has ever met the requirements of section
957(c). Of the $4,000 in earnings accumulated by F after December 31,
1977, $450 would not have qualified for the credit of section 936(a) had
F been a domestic corporation which met the requirements of section
936(a)(1) and which had elected the credit under that section.
The all earnings and profits amount of A with respect to F is
$20,450. This amount includes the $20,000 of earnings and profits to
which F succeeded under section 381(a)(1) upon the liquidation of F1.
See example (2)(b). This $20,000 retains its character as earnings and
profits which do not meet the requirements of section 957(c). Under
Sec. 7.367(b)-2(j), the all earnings and profits amount also includes
the $450 of earnings and profits accumulated by F, after December 31,
1977, which would not have qualified for the credit of section 936(a).
(i) A includes in gross income for its taxable year 1981, the all
earnings and profits amount of $20,450 pursuant to the liquidation of F
on January 1, 1981.
The $20,450 included in income is considered to be a dividend as
provided in Sec. 7.367(b)-3(b). This amount increases the earnings and
profits of A and decreases the earnings and profits of F. A succeeds
under section 381(a)(1) to the remaining $21,550
($22,000+$20,000-$20,450) of F's earnings and profits. A's basis in F's
assets, determined under section 334(b)(1), is $20,000.
(ii) A does not include the all earnings and profits amount in gross
income for its taxable year 1981.
Under Sec. 7.367(b)-5(b), solely for the purpose of determining the
extent to which gain is recognized on the exchange pursuant to the
liquidation of F on January 1, 1981, F is not considered to be a
corporation. Thus, A must include in its gross income $75,000 ($100,000
fair market of assets received-$25,000 basis in the stock in F). Section
1248(a) does not apply because F never has been a controlled foreign
corporation. See section 957(c). Thus, the entire $75,000 is capital
gain. The other consequences of A's election not to include the all
earnings and profits amount in gross income are the same as those
illustrated in example (2)(b)(ii).
(d) The facts are the same as in example (2)(b) except that, of the
$22,000 of earnings and profits actually accumulated during taxable
years of F, the $16,000 accumulated in taxable years beginning before
January 1, 1976, is of a character described in section 1248(d)(3).
As explained in example (2)(b), the all earnings and profits amount
of A with respect to F is $42,000. This amount is not reduced by the
$16,000 of earnings and profits of F which are of a character described
in section 1248(d)(3). See Sec. 7.367(b)-3(c)(1)(ii). Pursuant to the
liquidation of F on January 1, 1981, A includes $42,000 in gross income
as provided in Sec. 7.367(b)-5(b). In the notice required under
Sec. 7.367(b)-1(c), A elects to treat the $16,000 of earnings and
profits of a character described in section 1248(d)(3) as capital gain.
See Sec. 7.367(b)-3(d). Thus, of the $42,000, $26,000 is considered to
be a dividend
[[Page 171]]
under Sec. 7.367(b)-3(b), and the remaining $16,000 is considered to be
capital gain.
Example (3). On July 1, 1980, A, a domestic corporation, purchased
all the outstanding stock of F, a foreign corporation, from B, an
unrelated person, for $5,000. At all times since this date, A has owned
all of the outstanding stock in F. A and F each uses the calendar year
as its taxable year. On January 1, 1982, F is liquidated into A pursuant
to a plan of liquidation adopted on July 15, 1980, in an exchange to
which section 332 would apply if the status of F as a corporation is
recognized. A complies with the reporting requirements of Sec. 7.367(b)-
1(c). On the date of the liquidation, F's assets have an aggregate fair
market value of $6,000. No distributions were made with respect to A's
stock in F during the period from July 1, 1980, to and including January
1, 1982. A's all earnings and profits amount under Sec. 7.367(b)-2(f)
with respect to F is $150, the earnings and profits accumulated by F
during this period. None of the these earnings and profits is of a
character described in section 1248(d).
(a) A includes in gross income for its taxable year 1982 the all
earnings and profits amount of $150.
The $150 included in income is considered to be a dividend as
provided in Sec. 7.367(b)-3(b). This amount increases the earnings and
profits of A and decreases the earnings and profits of F. Under
Sec. 7.367(b)-5(b), F is considered to be a corporation. A's basis in
F's assets is determined under section 334(b)(2) and Sec. 1.334-1(c).
Thus, A's basis in F's assets is determined by allocating $5,150 (A's
basis of $5,000 in the F stock increased, as provided in Sec. 1.334-
1(c)(4)(v)(a)(2), by F's earnings and profits of $150 for the period
between July 1, 1980 and January 1, 1982) among the assets distributed
as provided in Sec. 1.334-1(c).
(b) A does not include the all earnings and profits amount in gross
income for its taxable year 1982.
Under Sec. 7.367(b)-5(b), solely for the purpose of determining the
extent to which gain is recognized on the exchange, F is not considered
to be a corporation, and A must include in gross income $1,000 ($6,000
fair market value of assets received-$5,000 basis in the stock in F).
For all other purposes, F is a corporation. Thus, section 1248 applies
to A's exchange of its stock in F and $150 (the earnings and profits
attributable to A's stock in F) is included in A's gross income as a
dividend, and $850 ($1,000-$150) is included as capital gain. Pursuant
to Sec. 7.367(b)-5(b), A's basis in F's assets is determined under
section 334(b)(2) and Sec. 1.334-1(c). Thus, the basis of these assets
will be determined by allocating $5,150 among these assets in the manner
described in example (3)(a).
Example (4). F is a foreign investment company (as defined in
section 1246(b)) that was organized on January 1, 1960, and uses the
calendar year as its taxable year. A, a domestic corporation, has owned
all the outstanding stock of F since F's organization. For each of its
taxable years, F has $100 of earnings and profits. A's basis in its
stock in F is $200. F's basis in its assets is $250.
(a) On January 1, 1980, foreign corporation X, which is not an
``investment company'' within the meaning of section 368(a)(2)(F)(iii),
acquires all of A's stock in F. In exchange for this stock, A receives
10 percent of the voting stock in X having a fair market value of
$5,000. Section 354 would apply to the exchange of stock by A, and the
transaction would qualify as a reorganization described in section
368(a)(1)(B), if the status of F and X as corporations is recognized. A
complies with the reporting requirements of Sec. 7.367(b)-1 (c).
Section 7.367(b)-6 does not apply to the exchange because X is a
foreign corporation. Section 7.367(b)-7 does not apply because F is a
foreign investment company. F and X are considered to be corporations
and A does not recognize the gain of $4,800 ($5,000 fair market value of
X stock received-$200 basis in F stock exchanged) realized on the
exchange. A's stock in X is treated as stock of a foreign investment
company held by A throughout the period that A held stock in F. See
section 1246(c). A's basis in the stock in X and X's basis in the stock
in F are each $200 under sections 358 and 362, respectively.
(b) The facts are the same as in example (4)(a), except that X is a
domestic corporation.
A's section 1246 amount with respect to F is $1,700. As provided in
section 1246 and Sec. 7.367(b)-2(c), this amount takes into account only
the earnings and profits of F accumulated in its 17 taxable years
beginning after December 31, 1962. Pursuant to the exchange on January
1, 1980, of A's stock in F for stock in X, A, as provided in
Sec. 7.367(b)-6(b), includes the Section 1246 amount of $1,700 in gross
income for its taxable year 1980 as gain from the sale of an asset which
is not a capital asset under Sec. 7.367(b)-3(a)(1). This amount
increases the earnings and profits of A but does not decrease the
earnings and profits of F. F is considered to be a corporation. As
provided in Sec. 7.367(b)-6(d), the $1,700 is treated as gain recognized
for purposes of applying sections 358 and 362. Thus, A's basis in the
stock in X received in the exchange, as determined under section 358, is
$1,900 (A's basis of $200 in the stock in F increased by its $1,700
gain). X's basis in the stock in F acquired in the exchange, as
determined under section 362, is $1,900 (the $200 basis of the stock in
F in the hands of A increased by A's $1,700 gain).
(c) The facts are the same as in example (4) (b), except that on
January 1, 1980, A receives the stock in X (a domestic corporation)
pursuant to the acquisition by X of all of F's assets and the
liquidation of F, rather than pursuant to the acquisition by X of all of
A's
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stock in F. Section 354 would apply to the exchange of stock in F by A
pursuant to the liquidation of F, and the transaction would qualify as a
reorganization described in section 368(a)(1)(C), if the status of F as
a corporation is recognized. A's all earnings and profits amount with
respect to its stock in F, determined under Sec. 7.367(b)-2(f), is
$2,000 ($100 x 20 years beginning with January 1, 1960, the date of
organization of F).
(i) Pursuant to Sec. 7.367(b)-6(c)(1), A includes the all earnings
and profits amount of $2,000 in gross income for its taxable year 1980.
As provided in Sec. 7.367(b)-3(a), the $1,700 of earnings and
profits accumulated in taxable years beginning after December 31, 1962,
is included in income as gain from the sale of an asset which is not a
capital asset, and the $300 of earnings and profits accumulated in
taxable years beginning before January 1, 1963, is included in income as
a dividend. These amounts increase the earnings and profits of A but do
not decrease the earnings and profits of F. F is considered to be a
corporation. A's basis in the stock in X received in the exchange,
determined under section 358, is $2,200 (A's basis of $200 in the F
stock increased by the $1,700 gain, under Sec. 7.367(b)-6(d), and by the
$300 included in income as a dividend, under section 358(a)(1), X's
basis in the assets of F acquired in the exchange, determined under
section 362, is $250 (F's basis in those assets), since no gain was
recognized to F, the transferor. X succeeds to F's earnings and profits
under section 381(a)(2).
(ii) A does not include the all earnings and profits amount in gross
income as required by Sec. 7.367(b)-6(c)(1).
Under Sec. 7.367(b)-6(c)(2), solely for the purpose of determining
the extent to which gain is recognized on the exchange, F is not
considered to be a corporation and A must recognize gain of $4,800
($5,000 fair market value of X stock received-$200 basis in F stock
exchanged). For all other purposes, F is a corporation. Thus, section
1246 applies to A's exchange of its stock in F and $1,700 (the section
1246 amount) is included in A's gross income as ordinary income and
$3,100 is included as capital gain. As provided in Sec. 7.367(b)-
6(c)(2), A's basis in the stock in X received is $200, determined under
section 358. X's basis in the assets of F which were acquired is $250,
determined under section 362. X succeeds to F's earnings and profits
under section 381(a)(2).
Example. (5). F, F1, and F2 are foreign corporations that were
organized on January 1, 1960. At all times since this date, A, a
domestic corporation, has owned 60 percent of the outstanding stock of
F, and X, a foreign corporation which is unrelated to A and not subject
to tax under subtitle A of the Code, has owned 40 percent of the
outstanding stock of F. At all times since this date, F has owned 100
percent of the outstanding stock in F1, and F1 has owned 100 percent of
the outstanding stock in F2. A, F, F1, and F2 each uses the calendar
year as its taxable year.
(a) For each taxable year since their date of organization, F, F1,
and F2 each has earnings and profits of $100. For each taxable year
beginning with 1963, F has $40 of subpart F income. For each such
taxable year, A includes in its income $24 ($40 x 60 percent of the
stock in F) by reason of section 951(a)(1)(A). For each of these years,
$24 of F's earnings and profits are attributable to amounts thus
included in income by A and therefore are of a character described in
section 1248(d)(1). None of the earnings and profits of F1 or F2 is of a
character described in section 1248(d). A's basis in its stock in F was
$324 on January 1, 1960. As of January 1, 1980, A has included $408 ($24
x 17 years beginning with 1963) in gross income as subpart F income.
Thus, under section 961(a), A's basis in its stock in F is $732 ($324 +
$408) on that date. F's basis in its assets is $250.
On January 1, 1980, foreign corporation Y acquires all the assets of
F in return for Y's voting stock. A and X exchange all their stock in F
for stock in Y, and F is liquidated. The Y stock received by A has a
fair market value of $6,000 so that A realizes gain of $5,268 ($6,000-
$732 basis in the F stock exchanged). Section 354 would apply to the
exchange of the stock in F by A, and the transaction would qualify as a
reorganization described in section 368(a)(1)(C), if the status of F and
Y as corporations is recognized.
(i) In the exchange on January 1, 1980, by A of its stock in F, A
receives 20 percent of the voting stock in Y. After the exchange Y is a
controlled foreign corporation. Since A is a United States shareholder
of Y under Sec. 7.367(b)-2(b), the attribution rules of Sec. 7.367(b)-9
apply, as provided in Sec. 7.367(b)-7(b). A's section 1248 amount with
respect to F is $3,060. This amount, determined as provided in
Sec. 7.367(b)-2 (d) and (i), consists of $1,020 ($100 x 17 years
beginning with 1963 x 60 percent of the F stock) of earnings and
profits of F, F1, and F2, respectively. Of the $1,020 of earnings and
profits of F, $408 ($24 x 17 years beginning with 1963) is of a
character described in section 1248(d)(1). A's all earnings and profits
amount with respect to F, determined as provided in Sec. 7.367(b)-2(f)
and (h)(1), is $1,200 ($100 x 20 years beginning with 1960 x 60
percent of the F stock). A's additional earnings and profits amount with
respect to F is $180 ($100 x 3 years ending with 1962 x 60 percent
of the F stock).
Under Sec. 7.367(b)-9(b)(1), A's section 1248 amount, A's all
earnings and profits amount, and A's additional earnings and profits
amount are attributed to the stock in Y which A receives in the
exchange. Under Sec. 7.367(b)-9(b)(2) and Sec. 7.367(b)-9(c), the
earnings and profits of Y are increased by $6,000 ($2,000 of earnings
and profits of F, F1, and F2, respectively). Under Sec. 7.367(b)-9(b)(3)
and
[[Page 173]]
(d), the earnings and profits of F, F1, and F2, respectively, are
reduced by $2,000. A complies with the reporting requirements of
Sec. 7.367(b)-1(c), and Y, F, F1, and F2 comply with the recordkeeping
requirements of Sec. 7.367(b)-1(d). F and Y are considered to be
corporations and section 354 applies to the exchange of the stock in F
by A.
In the notice required under Sec. 7.367(b)-1(c), A makes the consent
dividend election provided for in Sec. 7.367(b)-9(f)(1). Thus, the
$1,700 of post-1962 earnings and profits of F2 is treated as if,
immediately prior to the reorganization, it had been distributed as a
dividend through F1 to F. The $1,700 of post-1962 earnings and profits
of F1 is treated as if, immediately prior to the reorganization, it had
been distributed as a dividend to F. These earnings and profits treated
as if distributed must be included in A's gross income to the extent, if
any, required under section 551 or 951. If A includes under section 951
its full pro-rata share of the amount treated as distributed, the amount
attributed to A's stock in Y which is of a character described in
section 1248(d)(1) will be $2,448 ($3,400 x 60 percent of the F stock
+ $408 of F's earnings and profits which otherwise are of a character
described in section 1248(d)(1)).
A's basis in its stock in F immediately prior to the reorganization
is increased under section 961(a) by $2,040 from $732 to $2,772. Thus,
A's basis in the Y stock received, determined under section 358, is
$2,772. In addition, under Sec. 7.367(b)-9(e)(1), the basis of Y's stock
in F1 is increased by $4,000 ($600 of pre-1963 earnings and profits +
3,400 of post-1962 earnings and profits), and the basis of F1's stock in
F2 is increased by $2,000 ($300 of pre-1963 earnings and profits +$1,700
of post-1962 earnings and profits). However, the increases in respect of
pre-1963 earnings and profits are made only for purposes of computing
the all earnings and profits amount and the additional earnings and
profits amount with respect to subsequent transactions. See
Sec. 7.367(b)-9(e)(3).
(ii) In the exchange on January 1, 1980, by A of its stock in F, A
receives 5 percent of the voting stock in Y (rather than 20 percent as
in example (5)(a)(i)).
Since A is not a United States shareholder of Y as defined in
Sec. 7.367(b)-2(b) immediately after the exchange, Sec. 7.367(b)-
7(c)(1)(i) applies. A complies with the reporting requirements of
Sec. 7.367(b)-1(c). As required by Sec. 7.367(b)-7(c)(1)(i), A includes
in gross income for its taxable year 1980 $2,652, which is the section
1248 amount of $3,060 (computed as in example (5)(a)(i)) reduced, as
provided in Sec. 7.367(b)-3(c)(1), by the $408 of earnings and profits
of F retaining their character as earnings and profits described in
section 1248(d)(1). F and Y are considered to be corporations for
purposes of applying section 354 to the exchange of the stock in F by A.
Accordingly, no gain is recognized by A. Y succeeds to the $2,000 of
earnings and profits of F under section 381(a)(2). In addition, A's
basis in the stock in Y received in the exchange, determined under
section 358, is $3,384 ($732 basis in F stock exchanged + $2,652
included in gross income in the manner provided in section 961). See
Sec. 7.367(b)-12(d). Y's basis in the assets of F, determined under
section 362, is $250 (F's basis in those assets), since no gain was
recognized to F.
Under Sec. 7.367(b)-3 (b) and (f), the foreign tax credit provisions
(sections 78 and 901 through 908) apply as if the $2,652 included in
gross income by A were actually distributed to A as a dividend
immediately before the exchange. A will be deemed to have paid the
proportion of the foreign taxes paid or deemed paid by F, F1, and F2,
determined as provided in section 902 and the regulations thereunder.
For this purpose, the portions of the section 1248 amount included in
gross income by A which are attributable, respectively, to F, F1, and F2
are determined as provided in Sec. 7.367(b)-3(g)(1). Thus, $612 ($612
x $2,652/$2,652) is attributable to F and $1,020 ($1,020 x $2,652/
$2,652) is attributable to F1 and F2, respectively. (The first factor in
the numerator is the section 1248 amount determined as if the
corporation in question were the only corporation, and reduced under
Sec. 7.367(b)-3(c)(1)(i) by the amount of earnings and profits retaining
its character as earnings and profits described in section 1248(d)(1).
The second factor in the numerator is the amount included in A's gross
income as a dividend. The denominator is the section 1248 amount reduced
under Sec. 7.367(b)-3(c)(1)(i) by the amount of earnings and profits
retaining its character as earnings and profits described in section
1248(d)(1).) As provided in Sec. 7.367(b)-3(g)(2), the amounts thus
determined to be attributable to F1 and F2 are treated as if distributed
directly to A by F1 and F2, respectively, for purposes of applying
section 902. These amounts increase the earnings and profits of A but do
not decrease the earnings and profits of F, F1, or F2.
(b) The facts are the same as in example (5)(a)(ii) except that A's
basis in its F stock was $3,824 on January 1, 1960 (rather than $324)
and, by reason of section 961(a), is $4,232 ($3,824+$408 earnings and
profits of F previously included in A's gross income under section
951(a)(1)(A)) on January 1, 1980. On the exchange on January 1, 1980 of
its stock in F for 5 percent of the voting stock in Y, A realizes a gain
of $1,768 ($6,000 fair market value of the Y stock received -$4,232
basis in the F stock exchanged).
As required by Secs. 7.367(b)-3(c)(1)(i) and 7.367(b)-7(c)(1)(i), A
includes in gross income as a dividend the realized gain of $1,768 since
that amount is less than $2,652 ($3,060 section 1248 amount-$408 of
earnings and profits of F retaining their character as earnings and
profits described in section 1248(d)(1)). For the purpose of determining
the proportion of
[[Page 174]]
the foreign taxes paid or deemed paid by F, F1, and F2 which A will be
deemed to have paid under section 902 and the regulations thereunder,
the portions of the amount included in gross income by A which are
attributable, respectively, to F, F1, and F2 are determined as provided
in Sec. 7.367(b)-3(g)(1). Thus, $408 ($612 x $1,768/$2,652) is
attributable to F and $680 ($1,020 x $1,768/$2,652) is attributable to
F1 and F2, respectively.
(c) The facts are the same as in example (5)(b), except that, since
January 1, 1963, F1 has earnings and profits of $100 for each of five
taxable years and deficits of ($100) for each of the other twelve
taxable years, and F2 has deficits of ($100) for each of four taxable
years and earnings and profits of $100 for each of the other thirteen
taxable years (rather than F1 and F2 having earnings and profits of $100
for each taxable year). On the exchange, on January 1, 1980, of its
stock in F for 5 percent of the voting stock in Y, A realizes a gain of
$1,768 ($6,000-$4,232) as in example (5)(b). A's section 1248 amount
with respect to F is $1,140. This amount, determined as provided in
Sec. 7.367(b)-2(d) and (i), consists of $1,020 of earnings and profits
of F ($100 x 17 years beginning with 1963 x 60 percent of the F
stock), ($420) of deficit of F1 ($100 x 5 profitable years x 60
percent x 100 percent of the F1 stock-($100) x 12 deficit years x
60 percent x 100 percent), and $540 of earnings and profits of F2
($100 x 13 profitable years x 60 percent x 100 percent x 100
percent of the F2 stock--($100) X 4 deficit years X 60 percent X 100
percent X 100 percent).
As required by Secs. 7.367(b)-3(c)(1)(i) and 7.367(b)-7(c)(1)(i), A
includes in gross income as a dividend, $732 ($1,140 section 1248
amount-$408 of earnings and profits retaining its character as earnings
and profits described in section 1248(d)(1)). For the purpose of
determining the proportion of the foreign taxes paid or deemed paid by
F, F1, and F2 which A will be deemed to have paid under section 902 and
the regulations thereunder, the portions of the amount included in gross
income by A which are attributable respectively to F, F1, and F2 are
determined as provided in Sec. 7.367(b)-3(g)(1). (Deficits are
disregarded in computing the first factor in the numerator of each
fraction. They are not, however, disregarded for any other purpose.)
Thus, $612 ($612 x $732/$732) is attributable to F, $500 ($500 x
$732/$732) is attributable to F1, and $1,300 ($1,300 x $732/$732) is
attributable to F2.
Example (6). On January 1, 1981, one year after the transaction
described in example (5)(a)(ii), Y makes a pro-rata distribution of
$10,000 with respect to its stock. As of January 1, 1981, Y has $10,000
of earnings and profits, including the $2,000 of F's earnings and
profits to which Y succeeded under section 381(a)(2) pursuant to the
earlier transaction. None of the $8,000 of earnings and profits actually
accumulated by Y is of a character described in section 1248(d). A,
which owns the 5 percent of the Y voting stock received in the earlier
transaction, receives $500 as its pro-rata share of the distribution
from Y.
As provided in Sec. 7.367(b)-12(d), the $2,652 that was included in
gross income by A under Sec. 7.367(b)-7 pursuant to the earlier
transaction is treated in the same manner as amounts previously included
in A's gross income under section 951. By virtue of succeeding to F's
earnings and profits, Y has $1,020 of earnings and profits which have
previously been included in A's gross income. This amount consists of
the $408 of F's subpart F income and the $612 of the section 1248 amount
attributable to F which was included in A's gross income pursuant to the
earlier transaction. Under Sec. 7.367(b)-12(d)(1), the $500 distributed
by Y to A shall be excluded from A's gross income in the same manner as
under section 959. A's basis in its stock in Y shall be decreased by
$500 in the manner provided in section 961 (b) from $3,384 to $2,884.
After the distribution, Y has $520 ($1,020-$500) of earnings and profits
which have previously been included in A's gross income. (F1 and F2 each
has $1,020 of such earnings and profits.)
Example (7). On January 1, 1981, one year after the transaction
described in example (5)(a)(i), Y makes a pro-rata distribution of
$10,000 with respect to its stock. As of January 1, 1981, Y has $10,000
of earnings and profits. This amount consists of the $6,000 of earnings
and profits of F, F1, and F2 by which the earnings and profits of Y were
increased under Sec. 7.367(b)-9 (b)(2) and (c) pursuant to the earlier
transaction, $1,000 actually accumulated by Y after the earlier
transaction (in its taxable year 1980), and $3,000 actually accumulated
by Y before the earlier transaction. None of the $4,000 of earnings and
profits actually accumulated by Y is of a character described in section
1248(d). Pursuant to the earlier transaction, A's section 1248 amount of
$3,060, A's all earnings and profits amount of $1,200, and A's
additional earnings and profits amount of $180 have been attributed to
A's stock in Y under Sec. 7.367(b)-9(b)(1). Of the $3,060 section 1248
amount so attributed, $408 of the earnings and profits from F (A's pro-
rata share of the subpart F income actually derived by F), and $1,020 of
the earnings and profits from F1 and F2, respectively (pursuant to the
Sec. 7.367(b)-9(f)(1) consent dividend election), are of a character
described in section 1248(d)(1).
Since the amount of the distribution does not exceed Y's earnings
and profits (including the earnings and profits of F, F1, and F2 by
which the earnings and profits of Y were increased), the entire
distribution is a dividend except to the extent provided in
Sec. 7.367(b)-12. A, which owns 20 percent of the Y voting stock
received in the earlier transaction, receives $2,000 as its pro-rata
share of the distribution from Y. Under Sec. 7.367(b)-
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12(c), this distribution is considered to be made first out of $200 of
the $1,000 of earnings and profits accumulated by Y since the
attribution pursuant to the earlier transaction and is a dividend to A.
The remaining $1,800 is considered to be made out of the earnings and
profits attributed to A's stock in Y. Under Sec. 7.367(b)-12(c)(3), $600
of this $1,800 is considered as if distributed from the earnings and
profits of F, F1, and F2, respectively ($1,800 x $1,020 of section
1248 amount attributed from each corporation/$3,060 section 1248 amount
attributed to A's stock in Y). These amounts retain their character as
amounts described in section 1248(d)(1). Since $408 of the earnings and
profits attributed from F, and all $1,020 of the earnings and profits
attributed from F1 and F2, respectively, are of such a character, only
$192 [($600-$408) + ($600-$600) + ($600-$600)] of the $1,800 distributed
out of attributed earnings and profits is considered to be a dividend.
the $1,608 ($408 + $600 + $600) distribution of earnings and profits of
a character described in section 1248(d)(1), which otherwise would be
treated as a dividend, is excluded from gross income under section 959.
Thus, $392 of the $2,000 distributed to A is considered to be a
dividend, of which $200 is from earnings and profits of Y for its
taxable year 1980 and $192 is from earnings and profits accumulated by F
prior to its acquisition by Y.
A's basis in its stock in Y is reduced, under section 961(b), by the
$1,608 excluded from gross income under section 959(a) from $2,772 to
$1,164. A's section 1248 amount attributed to its stock in Y is reduced,
under Sec. 7.367(b)-12(c)(2), by $1,800 from $3,060 to $1,260, of which
$840 [($1,020-$600) + ($1,020-$600)] is of a character described in
section 1248(d)(1). A's all earnings and profits amount is reduced from
$1,200 to $600, none of which is of a character described in section
1248(d)(1). A's additional earnings and profits amount is not affected
by the distribution. See section 316.
Example (8). On January 1, 1982, 2 years after the transaction
described in example (5)(a)(i), and 1 year after the distribution
described in example (7), A sells all its stock in Y for $7,000
realizing a gain of $5,836 ($7,000-$1,164). During 1981, Y had $1,000 of
earnings and profits. Under Sec. 7.367(b)-12(e), the section 1248 amount
attributable to A's stock in Y is $1,460. This amount consists of $200
of the $1,000 of Y's earnings and profits for 1981 (A owns 20 percent of
the stock in Y), plus the $3,060 section 1248 amount attributed to A's
stock in Y, reduced as provided in Sec. 7.367(b)-12(e)(2)(ii) by the
$1,800 considered distributed in example (7) out of the section 1248
amount so attributed. (See Sec. 7.367(b)-12(c)(2).) Of this section 1248
amount of $1,460, the $840 [($1,020-$600) + ($1,020-$600)] of the
earnings and profits attributed from F1 and F2 that remain after the
distribution described in example (7) are of a character described in
section 1248(d)(1). Thus, $620 ($1,460 Section 1248 amount -$840 section
1248(d)(1) earnings and profits) of the gain on the sale of the Y stock
is treated as a dividend under section 1248(a) and the remaining $5,216
($5,836-$620) is recognized as capital gain.
Example (9). F, F1, F2, and F3 are foreign corporations that were
organized on January 1, 1975. At all times since this date, A, a
domestic corporation, has owned 60 percent of the outstanding stock in
F, and X, a foreign corporation unrelated to A and not subject to tax
under subtitle A of the Code, has owned 40 percent of the outstanding
stock in F. At all times since this date, F has owned 100 percent of the
outstanding stock in F1, F1 has owned 100 percent of the outstanding
stock in F2, and F2 has owned 100 percent of the outstanding stock in
F3. A, F, F1, F2, and F3 each uses the calendar year as its taxable
year. For each taxable year since their date of organization, F, F1, and
F3 each has earnings and profits of $100. For each taxable year since
its date of organization, F2 has a deficit of ($100). None of the
earnings and profits of F, F1, or F3 is of a character described in
section 1248(d). A's basis in its stock in F is $620.
On January 1, 1980, A and X exchange all of their stock in F. As
sole consideration for the stock exchanged, A receives 20 percent of the
voting stock in foreign corporation Y, and X receives 13.3 percent of
the voting stock in Y. The Y stock received by A has a fair market value
of $4,000. Section 354 would apply to the exchange of stock in F by A,
and the transaction would qualify as a reorganization described in
section 368(a)(1)(B), if the status of F and Y as corporations is
recognized. After the transaction, Y is a controlled foreign corporation
but is not a foreign personal holding company.
A realizes gain of $3,380 ($4,000 fair market value of the Y stock
received--$620 basis in the F stock exchanged). Since A owns 20 percent
of the voting stock in Y immediately after the exchange, A is a United
States shareholder of Y as defined in Sec. 7.367(b)-2(b). Accordingly,
the attribution rules of Sec. 7.367(b)-9 apply, as provided in
Sec. 7.367(b)-7(b)(1). Under Sec. 7.367(b)-9(b)(1), A's section 1248
amount of $600 is attributed to the stock in Y which A received in the
exchange. This amount consists of $300 of earnings and profits of F, F1,
and F3, respectively ($100 x 5 years x 60 percent of the stock in F),
and ($300) of deficit of F2 (($100) x 5 years x 60 percent). Under
Sec. 7.367(b)-9(b)(2) and Sec. 7.367(b)-9(c), the earnings and profits
of Y are increased by $1,500 ($500 of earnings and profits of F, F1 and
F3, respectively). Any deficit of Y is increased by the ($500) deficit
of F2, subject to Sec. 7.367(b)-11, relating to the manner in which such
deficit may be used. These earnings and profits and deficit retain their
character as
[[Page 176]]
provided in Sec. 7.367(b)-3(e). Under Sec. 7.367(b)-9(b)(3) and
Sec. 7.367(b)-9(d), the earnings and profits of F, F1, and F3, and the
deficit of F2 are each correspondingly reduced by $500. A complies with
the reporting requirements of Sec. 7.367(b)-1(c), and Y, F, F1, F2, and
F3 comply with the recordkeeping requirement of Sec. 7.367(b)-1(d). F
and Y are considered to be corporations and section 354 applies to the
exchange of stock by A. A's basis in the stock in Y determined under
section 358 is $620.
(a) In the notice required under Sec. 7.367 (b)-1(c), A does not
make the consent dividend election provided for Sec. 7.367 (b)-9(f)(1).
Under Sec. 7.367-9(e)(1), F1's basis in its stock in F2 and F's
basis in its stock in F1 are each reduced by $500. These reductions are
made on account of the $500 reduction in F2's deficit. Since A did not
make the election under Sec. 7.367(b)-9(f)(1), no basis adjustment on
account of F1 and F3's earnings and profits is permitted under
Sec. 7.367(b)-9(e)(1). Under Sec. 7.367(b)-9(e)(2), Y's basis in its
stock in F is reduced by $500 on account of the $500 reduction F2's
deficit. Since A did not make the election under Sec. 7.367(b)-9(f)(1),
no adjustment to Y's basis in F is permitted on account of earnings and
profits accumulated in taxable years beginning after December 31, 1962,
even if the election provided for in Sec. 7.367(b)-9(f)(2)(ii) is made.
See Sec. 7.367(b)-9(f)(2). Thus, Y's basis in its F stock, determined
under section 362 and Sec. 7.367(b)-9(e), is $120 ($620-$500).
(b) The facts are the same as in example (9)(a), except that in the
notice required under Sec. 7.367(b)-1(c), A makes the consent dividend
election provided for in Sec. 7.367(b)-9(f)(1). In addition, all the
United States shareholders of Y make a consent dividend election as
provided in section 565 for 1980 (the taxable year in which the
reorganization occurred). See Sec. 7.367(b)-9(f)(2)(ii).
Under Sec. 7.367(b)-9(f)(1), the $500 of earnings and profits of F3
is treated as if, immediately prior to the reorganization, it had been
distributed as a dividend through F2 and F1 (unreduced by the deficit of
F2) to F. The $500 of earnings and profits of F1 is treated as if,
immediately prior to the reorganization, it had been distributed as a
dividend to F. Accordingly, under Sec. 7.367(b)-9(e)(1), F2's basis in
the F3 stock is increased by $500; F1's basis in the F2 stock is
decreased by the ($500) deficit from F2 (see example (9)(a)) and
increased by the $500 of earnings and profits from F3 for a net
adjustment of zero; and F's basis in the F1 stock is decreased by the
($500) deficit from F2 (see example (9)(a)) and increased by the $1,000
of earnings and profits from F3 and F1 for a net increase of $500. For
the consequences to A of making the consent dividend election provided
for in Sec. 7.367(b)-9(f)(1), see example (5)(a).
Under Sec. 7.367(b)-9(f)(2), the $500 of earnings and profits of F3
is treated as if, immediately after the reorganization, it had been
distributed as a dividend through F2, F1 and F (unreduced by the deficit
of F2) to Y. The $500 of earnings and profits of F1 is treated as if,
immediately after the reorganization, it had been distributed as a
dividend through F to Y. The $500 of earnings and profits of F is
treated as if, immediately after the reorganization, it had been
distributed as a dividend to Y. Accordingly, under Sec. 7.367(b)-
9(e)(2), Y's basis in the F stock is increased by the $1,500 total of
the earnings and profits treated as if distributed to Y and is decreased
by the ($500) deficit of F2 (see example (9)(a)). Thus, the net increase
in Y's basis in the F stock is $1,000 and this basis, determined under
section 362 and Sec. 7.367(b)-9(e), is $1,620 ($620 + $1,000). For the
consequences to the United States shareholders of Y of the consent
dividend to Y, see sections 951 and 959.
Example (10). F, F1, and F2 are foreign corporations that were
organized on January 1, 1975. At all times since this date, A, a
domestic corporation, has owned 100 percent of the outstanding stock in
F, F has owned 90 percent of the outstanding stock in F1, X, a foreign
corporation unrelated to A and not subject to tax under subtitle A of
the Code, has owned 10 percent of the outstanding stock in F1, and F1
has owned 100 percent of the outstanding stock in F2. F, F1, and F2 each
uses the calendar year as its taxable year. For each taxable year since
their date of organization, F, F1, and F2 each has earnings and profits
of $100. None of the earnings and profits of F, F1, or F2 is of a
character described in section 1248(d). F's basis in its stock in F1 is
$620.
On January 1, 1980, F exchanges all of its stock in F1. X retains
its stock in F1. As sole consideration for the stock exchanged, F
receives 20 percent of the voting stock in foreign corporation Y. The Y
stock received by F has a fair market value of $4,000. Section 354 would
apply to the exchange of the stock in F1 by F, and the transaction would
qualify as a reorganization described in section 368(a)(1)(B), if the
status of F1 and Y as corporations is recognized. After the transaction
Y is a controlled foreign corporation. Y uses the calendar year as its
taxable year.
F realizes gain of $3,380 ($4,000 fair market value of the Y stock
received--$620 basis in the F1 stock exchanged). Since A is a United
States shareholder of Y after the exchange, the attribution rules of
Sec. 7.367(b)-9 apply, as provided in Sec. 7.367(b)-7(b). Under
Sec. 7.367(b)-9(b)(1), A's section 1248(c)(2) amount of $900 is
attributed to the stock in Y which F receives in the exchange. This
amount consists of $450 ($100 x 5 years x 90 percent of the stock in
F1) of the earnings and profits of F1 and F2, respectively. The earnings
and profits of Y are increased by the $450 of earnings and profits
[[Page 177]]
of F1 and the $450 of earnings and profits of F2, in accordance with
Secs. 7.367(b)-9(b)(2) and 7.367(b)-9(c). The earnings and profits of F1
and F2, respectively, are correspondingly reduced by $450 under
Secs. 7.367(b)-9(b)(3) and 7.367(b)-9(d). In addition, under
Sec. 7.367(b)-9(c)(2), the $50 of earnings and profits of F1 and F2,
respectively, which do not increase the earnings and profits of Y, is
considered to be entirely attributable to the stock not acquired by Y
(i.e., the stock owned by X). A complies with the reporting requirements
of Sec. 7.367(b)-1(c), and Y, F, F1, and F2 comply with the
recordkeeping requirements of Sec. 7.367(b)-1(d). F1 and Y are
considered to be corporations and section 354 applies to the exchange of
F1 stock by F.
In the notice required in Sec. 7.367(b)-1(c), A does not make the
consent dividend election provided for in Sec. 7.367(b)-9(f)(1).
Accordingly, no adjustment to basis is made under Sec. 7.367(b)-9(e).
Example (11). On January 1, 1981, after the transaction described in
example (10), A sells all its stock in F. In taxable year 1980, Y, F,
F1, and F2 each has $100 of earnings and profits. Upon A's sale of its
stock in F, A's section 1248 amount is $1,556. This amount consists of
$600 of earnings and profits of F ($100 x 6 years beginning with 1975
x 100 percent of the stock in F) under section 1248(a), and, under
Sec. 7.367(b)-12(e)(2), the section 1248(c)(2) amount of $900 attributed
to the stock in Y received by F pursuant to the earlier transaction, $20
of earnings and profits accumulated by Y in 1980 ($100 x 100 percent
x 20 percent of the stock in Y), and $18 of earnings and profits
accumulated by F1 and F2, respectively, in 1980 ($100 x 100 percent
x 20 percent x 90 percent of the stock in F1).
Example (12). On December 31, 1980, after the transaction described
in example (10), F1 makes a pro-rata distribution of $180, no part of
which is subpart F income, to Y and X. Without regard to this
distribution Y, F, F1, and F2 each has $100 of earnings and profits in
1980. On December 31, 1980, F1 has $100 of current earnings and profits
and $50 of accumulated earnings and profits ($500 accumulated between
1975 and 1979--$450 by which the earnings and profits of F1 were reduced
pursuant to the transaction in example (10)). Thus, $135 ($150 x 90
percent of the stock in F1) of the distribution to Y is a dividend. Y's
basis in the stock in F1 is reduced under section 301(c)(2) by $27.
On January 1, 1981, A sells all its stock in F. Upon this sale, A's
section 1248 amount is $1,565. This amount consists of $600 of earnings
and profits of F ($100 x 6 years beginning with 1975 x 100 percent
of the stock in F), the section 1248(c)(2) amount of $900 attributed to
the stock in Y received by F pursuant to the earlier transaction, $47 of
the $235 of earnings and profits accumulated by Y in 1980 ($100 plus the
$135 dividend from F1) and $18 of the $100 of earnings and profits
accumulated by F2 in 1980. (After the $180 distribution, F1 has no
earnings and profits attributable to the stock in F sold by A. See
Secs. 1.1248-2(d)(1) and 1.1248-3(b)(3).)
Example (13). On December 31, 1980, after the transaction described
in example (10), Y sells all its stock in F1 and recognizes gain of
$1,200. Without regard to this sale, Y, F, F1, and F2 each has $100 of
earnings and profits in 1980. On January 1, 1981, A sells all its stock
in F. Upon this sale, A's section 1248 amount is $1,760. This amount
consists of $600 of earnings and profits of F, the section 1248(c)(2)
amount of $900 attributed to the stock in Y received by F pursuant to
the earlier transaction, and $260 of the $1,300 of earnings and profits
accumulated by Y in 1980 ($100 plus the $1,200 gain on the sale of the
stock in F1). (The earnings and profits accumulated by F1 and F2 in 1980
have been otherwise taken into account under section 1248, within the
meaning of section 1248(c)(2)(C), by virtue of the inclusion in Y's
earnings and profits of Y's gain on the sale of the stock in F1.)
Example (14). (a) F is a foreign corporation that was organized in
country C on January 1, 1978. At all times since that date, A, a
domestic corporation, has owned 100 percent of the outstanding stock of
F. All of F's assets are used in a manufacturing business. The F stock
does not comprise substantially all of A's assets. On January 1, 1983, A
exchanges all of its stock of F for 80 percent of the outstanding voting
stock of Y, an unrelated foreign corporation organized in country C. At
the time of the exchange, A's Y stock received in the exchange has a
fair market value of $600, A's adjusted basis in its F stock is $300,
and A's section 1248 amount attributable to its F stock is $200. The
exchange of stock of F by A would be described in section 351 if the
status of Y as a corporation is recognized. This exchange would also be
described in section 354 (a reorganization described in section
368(a)(1)(B)) if the status of F and Y as corporations is recognized.
Under Sec. 7.367(b)-4(b)(1)(i)(A), the exchange is considered to be one
to which Sec. 7.367(b)-7 applies. Under Sec. 7.367(b)-7(b), the exchange
is treated as one to which Sec. 7.367(b)-9 applies, and under that
latter section the section 1248 amount of $200 must be attributed to the
Y stock received in the exchange. If Sec. 7.367(b)-4(b)(2)(i) or (ii)
did not apply, then under Sec. 7.367(b)-4(b)(1)(i)(B), A would have to
include $100 in gross income as gain from the exchange of the F stock.
This amount is equal to the excess of the gain realized, or $300 ($600
minus $300), over the section 1248 amount taken into account under
Sec. 7.367(b)-4(b)(1)(i)(A), or $200. However, since Y is a controlled
foreign corporation after the transfer and since A is a United States
shareholder (within the meaning of Sec. 7.367(b)-2(b)) of F both before
and after the transfer and of Y after the transfer, by reason of
[[Page 178]]
Sec. 7.367(b)-4(b)(2)(ii) no gain is recognized on the transfer under
Sec. 7.367(b)-4(b)(1)(i)(B), but the section 1248 amount of $200 must be
attributed to the Y stock received in the exchange under Sec. 7.367(b)-
4(b)(1)(i)(A).
(b) The facts are the same as in paragraph (a) of this example,
except that A receives only 30 percent of the Y stock, unrelated foreign
persons receive an additional 50 percent of the Y stock in exchange for
their contribution of property to Y, and Y is not a controlled foreign
corporation after the exchange. Under Sec. 7.367(b)-7(c)(1)(i), A must
include in gross income the $200 section 1248 amount attributable to the
F stock exchanged. Unless Sec. 7.367(b)-4(b)(2)(i) applies, under
Sec. 7.367(b)-4(b)(1)(i)(B) of this section, A must also include $100 in
gross income as gain from the exchange of the F stock.
(c) The facts are the same as in paragraph (b) of this example,
except that under Sec. 7.367(b)-4(b)(2)(i)(A), A receives a favorable
ruling that the exchange is not considered to be in pursuance of a plan
having as one of its principal purposes the avoidance of Federal income
taxes. As a result, A is only required to include in gross income the
$200 section 1248 amount determined pursuant to Sec. 7.367(b)-
4(b)(1)(i)(A) and is not required to include in gross income the $100
determined pursuant to Sec. 7.367(b)-4(b)(1)(i)(B).
(d) The facts are the same as in paragraph (a) of this example,
except that A owns only five percent of the outstanding F stock, B (an
unrelated domestic corporation) owns 75 percent of the outstanding F
stock, and both A and B exchange their F stock for 5 and 75 percent,
respectively, of the outstanding stock in Y. Although A is a United
States person at the time of the exchange, A is not and has never been a
United States shareholder (within the meaning of Sec. 7.367(b)-2(b)) of
F. Therefore, A's section 1248 amount with respect to its F stock is
zero. Unless Sec. 7.367(b)-4(b)(2)(i) applies, under Sec. 7.367(b)-
4(b)(1)(ii) A must include $300 in gross income as gain from the
exchange of its F stock.
(e) The facts are the same as in paragraph (a) of this example,
except that the F stock does comprise substantially all of A's assets, A
transfers all of its stock in F to Y in exchange for 70 percent of Y's
outstanding stock, and A remains in existence and does not distribute
the Y stock received in the exchange to its shareholders. The exchange
of stock of F by A would be described in section 361 (a reorganization
described in section 368(a)(1)(C)) if the status of Y as a corporation
is recognized. This exchange would also be described in section 354 (a
reorganization described in section 368(a)(1) (B)) if the status of F
and Y as corporations is recognized. Under Sec. 7.367(b)-4(b), the
exchange is considered to be one to which section 367(b) applies. The
remaining tax consequences of this exchange are the same as the
consequences illustrated in paragraph (a) of this example.
(f) The facts are the same as in paragraph (a) of this example,
except that on January 1, 1982, A sells 60 percent of the voting stock
of F to a foreign corporation at a gain and reports such gain as
required under the Code. At the time of the January 1, 1983 exchange of
F stock by A for Y stock, A's adjusted basis in the retained stock of F
is $300 and A's section 1248 amount attributable to the retained stock
of F is $200. While F is no longer a controlled foreign corporation, A
is treated as a United States shareholder of F for five years following
the sale of F stock under Sec. 7.367(b)-2(b). Therefore, Sec. 7.367(b)-
4(b)(1)(i)(A) and the exception of Sec. 7.367(b)-4(b)(2)(ii) apply to
the January 1, 1983 exchange of F stock by A for Y stock, and the tax
consequences of that exchange are the same as the consequences
illustrated in paragraph (a) of this example.
Example (15). F is a foreign corporation that was organized on
January 1, 1979. At all times since this date, A, a domestic
corporation, has owned all of the outstanding stock in F. On December
31, 1981, foreign corporation Y acquires all the assets of F in return
for voting stock in Y. A exchanges all of its stock in F for the stock
in Y and F is liquidated. After the transaction, A is a United States
shareholder of Y, and Y is a controlled foreign corporation. Section 354
would apply to the exchange of the stock in F by A, and the transaction
would qualify as a reorganization described in section 368(a)(1)(C), if
the status of F and Y as corporations is recognized. As of December 31,
1981, F has a deficit in earnings and profits of ($300). A's section
1248 amount with respect to F is also ($300). Assume F had a net
operating loss carryover that section 382(b)(2) required to be reduced
by 20 percent.
Since A is a United States shareholder of controlled foreign
corporation Y, Sec. 7.367(b)-9 applies to the exchange as provided in
Sec. 7.367(b)-7(b). Thus, A's section 1248 amount is attributed to the
stock in Y received by A. Pursuant to Sec. 7.367(b)-11(c), the amount of
the deficit in earnings and profits of F by which the deficit in
earnings and profits of Y is increased under Sec. 7.367-9(b)(2) and (c),
is reduced by 20 percent from ($300) to ($240). As provided in
Sec. 7.367(b)-11 (b) and (d), this deficit and the section 1248 amount
attributed to the stock in Y received by A shall be used only in the
manner prescribed in section 381(c)(2)(B) and the regulations
thereunder.
Example (16). F and G are foreign corporations engaged in the same
business activity that were organized on January 1, 1975. At all times
since this date, A and B, domestic corporations, have each owned 50
percent of the outstanding stock in F and G, respectively. On January 1,
1980, G acquires all the assets of F in return for G's voting stock. A
and B exchange all their stock in F for stock
[[Page 179]]
in G, and F is liquidated. After the transaction, G continues the
business activity of F and G unchanged. Section 354 would apply to the
exchange of the stock in F by A and B, and the transaction would qualify
as a reorganization described in section 368(a)(1)(D), if the status of
F and G as foreign corporations is recognized. Under Sec. 7.367(b)-4(d),
the transaction is not considered to be a reorganization described in
section 368(a)(1)(F) for purposes of section 367 and Secs. 7.367(b)-1
through 7.367(b)-12, even though it might be considered to be a
reorganization described in section 368(a)(1)(F) for other purposes.
Thus, the attribution rules of Sec. 7.367(b)-9 apply by reason of
Sec. 7.367(b)-7(b).
Example (17). F and F1 are foreign corporations that were organized
on January 1, 1960. X is a domestic corporation that was organized on
the same date. At all times since this date, X has owned 100 percent of
the outstanding stock in F, and F has owned 100 percent of the
outstanding stock in F1. D is a domestic corporation that was organized
on January 1, 1976. At all times since this date, X has owned 100
percent of the outstanding stock in D. From January 1, 1960 until
January 1, 1974, A, a domestic corporation, owned 100 percent of the
outstanding stock in X. On January 1, 1974, B, a domestic corporation,
purchased stock in X from A in a taxable sale, and, at all times since
this date, A and B each has owned 50 percent of the outstanding stock in
X. F, F1, X, D, A, and B each uses the calendar year as its taxable
year. As of January 1, 1978, X, F, F1, and D have earnings and profits
or deficits as follows:
----------------------------------------------------------------------------------------------------------------
X F F1 D
-----------------------------------------------------------------------
E&P Deficit E&P Deficit E&P Deficit E&P Deficit
----------------------------------------------------------------------------------------------------------------
1960.................................... ....... (200) ....... (100) ....... (200) ....... .......
1961.................................... ....... (200) ....... (100) ....... (200) ....... .......
1962.................................... ....... (200) ....... (100) ....... (200) ....... .......
1963.................................... ....... (200) 100 ....... ....... (200) ....... .......
1964.................................... ....... (200) 100 ....... ....... (200) ....... .......
1965.................................... 100 ....... 100 ....... 100 ....... ....... .......
1966.................................... 100 ....... 100 ....... 100 ....... ....... .......
1967.................................... 100 ....... 100 ....... 100 ....... ....... .......
1968.................................... 100 ....... 100 ....... 100 ....... ....... .......
1969.................................... 100 ....... 100 ....... 100 ....... ....... .......
1970.................................... 100 ....... 100 ....... 100 ....... ....... .......
1971.................................... 100 ....... 100 ....... 100 ....... ....... .......
1972.................................... 100 ....... 100 ....... 100 ....... ....... .......
1973.................................... 100 ....... 100 ....... 100 ....... ....... .......
1974.................................... 100 ....... 100 ....... 100 ....... ....... .......
1975.................................... 100 ....... 100 ....... 100 ....... ....... .......
1976.................................... 100 ....... 100 ....... 100 ....... ....... (100)
1977.................................... 100 ....... 100 ....... 100 ....... ....... (100)
-----------------------------------------------------------------------
Total............................... 1,300 (1,000) 1,500 (300) 1,300 (1,000) ....... (200)
----------------------------------------------------------------------------------------------------------------
On January 1, 1978, X distributes all of its stock in F to A in
exchange for half of A's stock in X. A's basis in the stock in X that A
exchanged is $1,000, and the fair market value of the stock in F that A
receives is $2,000. After the distribution, A owns 33 percent and B owns
67 percent of the stock in X.
(a) Section 1248(f) applies to the distribution by X of its stock in
F since X is a domestic corporation. See Sec. 7.367(b)-10(b). Thus, X
must include the amount computed under section 1248(f)(1) in its gross
income as a dividend for 1978. After the distribution, the net fair
market value of the assets of the distributing group, X and D, exclusive
of the stock in D, equals the net fair market value of the assets of the
controlled group, F and F1, exclusive of the stock in F1. Section 355
would apply to the distribution (assuming the conditions of section
355(a)(1) (B) and (C) are met) if the status of F as a corporation is
recognized. A and X comply with the reporting requirements of
Sec. 7.367(b)-1(c), and X, F, and F1 comply with the recordkeeping
requirement of Sec. 7.367(b)-1(d).
The provisions of Sec. 7.367(b)-10(d) through (f) apply to the
distribution of the stock in F by reason of Sec. 7.367(b)-10(b). In
accordance with Sec. 7.367(b)-10(d), the earnings and profits and
deficits of X, F, F1, and D are allocated so that, after the
distribution, the distributing group and the controlled group each has
total gross earnings and profits of $2,050 ($4,100 total gross earnings
and profits of X, F, F1, F1,and D/2), and a total deficit of ($1,250)
(($2,500) total gross deficit of X, F, and D/2), as follows:
------------------------------------------------------------------------
E&P Deficit
------------------------------------------------------------------------
Distributing Group:
X.................................................. $2,050 ($1,050)
D.................................................. ....... (200)
------------------
Total............................................ 2,050 (1,250)
==================
Controlled Group:
F.................................................. 1,098 (288)
[[Page 180]]
F1................................................. 952 (962)
------------------
Total............................................ 2,050 (1,250)
------------------------------------------------------------------------
X's earnings and profits consist of $1,300 actually accumulated by X,
$402 allocated from F ($750 allocated from the controlled group X $1,500
earnings and profits of F/$2,800 gross earnings and profits of the
controlled group), and $348 allocated from F1 ($750 X $1,300/$2,800).
X's deficit consists of ($1,000) acutally incurred by X, ($12) allocated
from F (($50) X ($300)/($1,300)), and ($38) allocated from F1 (($50) X
($1,000)/($1,300)). The ($50) deficit allocated to X from F and F1 may
be used only as provided in Sec. 7.637(b)-11(b).
A, the only United States shareholder (determined after the
distribution) of the controlled group (the group from which in this case
the allocation of earnings and profits was made), makes a consent
dividend election, described in Sec. 7.367(b)-10(f), in the notice
required by Sec. 7.367(b)-1(c). Thus, the $348 of earnings and profits
allocated from F1 to X is treated as if, immediately after the
distribution of the stock in F, it had been distributed as a dividend to
F. (See sections 551 and 951 for possible consequences to A of the
consent dividend election.) Since the election under Sec. 7.367(b)-10(f)
is made, the basis of F in the stock in F1 is increased by $348 under
Sec. 7.367(b)-10(e)(1). In addition, whether or not this election is
made, the basis of F in the stock in F1 is decreased under
Sec. 7.367(b)-10(e)(1) by the ($38) deficit allocated from F1 to X. Of
this decrease, $23 (($38) x ($600) pre-1963 gross deficit of F1/($1,000)
gross deficit of F) is in respect of pre-1963 deficits and so shall be
taken into account, as provided in Sec. 7.367(b)-10(e)(2), only for
purposes of computing the all earnings and profits and additional
earnings and profits amounts with respect to subsequent transactions.
F is considered to be a corporation and section 355 applies to the
distribution by X of the stock in F.
(b) The facts are the same as in example 17(a) except that X is a
foreign corporation instead of a domestic corporation. After the
distribution by X to A of the stock in F in exchange for half of A's
stock in X, the fair market value of the stock in F owned by A equals
the fair market value of the stock in X owned by A. Section 355 would
apply to the distribution (assuming the conditions of section 355(a)(1)
(B) and (C) are met) if the status of F and X as corporations is
recognized. A complies with the reporting requirements of Sec. 7.367(b)-
1(c), and X, F, and F1 comply with the recordkeeping requirements of
Sec. 7.367(b)-1(d).
The application of Sec. 7.367(b)-10 (d) through (f) results in the
same allocation of earnings and profits and deficits and adjustments to
basis as in example 17(a). In addition, under Sec. 7.367(b)-10 (g), the
following amounts are computed with reference to A's and B's stock in X
prior to the distribution.
------------------------------------------------------------------------
A B
------------------------------------------------------------------------
Section 1248 amount................................... $1,650 $600
All earnings and profits amount....................... 150 200
Additional earnings and profits amount................ (300) 0
------------------------------------------------------------------------
Under Sec. 7.367(b)-10(h), half of each of these amounts of A is
attributed to the stock in X and F, respectively, owned by A after the
distribution. All of each of these amounts of B is attributed to the
stock in X owned by B after the distribution.
X and F are considered to be corporations and section 355 applies to
the distribution by X of the stock in F.
(c) The facts are the same as in example (17)(b) except that X
distributes its stock in D (rather than its stock in F) to A in exchange
for half of A's stock in X. Section 355 would apply to the distribution
(assuming the conditions of section 355(a)(1) (B) and (C) are met) if
the status of X as a corporation is recognized. A's basis in the stock
in X which A exchanges is $1,000 and the fair market value of the stock
in D that A receives is $2,000. After the distribution, the net fair
market value of the assets of the distributing group, X, F, and F1,
exclusive of the stock in F and F1, equals the net fair market value of
the assets of the controlled group, D. The value of the stock in D owned
by A equals the value of the stock in X owned by A. A complies with the
reporting requirements of Sec. 7.367(b)-1(c), and X, F, F1, and D comply
with the recordkeeping requirements of Sec. 7.367(b)-1(d).
After the allocation required by Sec. 7.367(b)-10(d), the earnings
and profits and deficits of the groups are as follows:
------------------------------------------------------------------------
E & P Deficit
------------------------------------------------------------------------
Distributing Group:
X................................................ $650 ($543.50)
F................................................ 750 (163.00)
F1............................................... 650 (543.50)
--------------------
Total.......................................... 2,050 (1,250.00)
Controlled Group:
D................................................ 2,050 (1,250)
------------------------------------------------------------------------
D's earnings and profits consist of $650 allocated from X ($2,050
allocated from distributing group X $1,300 gross earnings and profits of
X/$4,100 gross earnings and profits of distributing group), $750
allocated from F ($2,050 X $1,500/$4,100), and $650 allocated from F1
($2,050 X $1,300/$4,100). D's deficit consists of ($200) actually
incurred by D, ($137) allocated from F (($1,050) allocated from
Distributing group X ($300) gross deficit of F/($2,300) gross deficit of
distributing group), and ($456.50) allocated from X and F1, respectively
(($1,050) X ($1,000)/($2,300)).
[[Page 181]]
A and B, the United States shareholders (determined after the
distribution) of the distributing group (the group from which in this
case the allocation of earnings and profits was made), make a consent
dividend election, described in Sec. 7.367(b)-10(f), in the notice
required by Sec. 7.367(b)-1(c). Thus, the $650 of earnings and profits
of F1 allocated to D is treated as if, immediately after the
distribution of the stock in D, it had been distributed as a dividend
through F to X. The $750 of earnings and profits of F allocated to D is
treated as if, immediately after the distribution, it had been
distributed as a dividend to X. See sections 551 and 951 for possible
consequences to A and B of the consent dividend election. Since this
election is made, the basis of F in the stock in F1 is increased by
$650, and the basis of X in the stock in F is increased by $1,400 ($650
+ $750) under Sec. 7.367(b)-10(e)(1). In addition, whether or not this
election is made, the basis of F in the stock in F1 is decreased by the
($456.50) deficit allocated from F1 to D. Of this decrease, $273.90
(($456.50 X ($600) pre-1963 gross deficit of F1/($1,000) gross deficit
of F1) is in respect of a pre-1963 deficit and so shall be taken into
account only for purposes of computing the all earnings and profits and
additional earnings and profits amounts with respect to subsequent
transactions. The basis of X in the stock in F is decreased by $593.50
(($456.50) + ($137) deficit allocated from F to D). Of this decrease,
$410.90 (($273.90) + ($137)) is in respect of a pre-1963 deficit and so
shall be taken into account only for purposes of computing the all
earnings and profits and additional earnings and profits amounts with
respect to subsequent transactions.
Under Sec. 7.367(b)-10(h), half of A's section 1248 amount of
$1,650, all earnings and profits amount of $150, and additional earnings
and profits amount of ($300) is attributed to the stock in X owned by A
after the distribution of the stock in D. No amounts are attributed to
the stock in D owned by A after the distribution. See Sec. 7.367-
10(i)(1). All of B's section 1248 amount of $600, all earnings and
profits amount of $200, and additional earnings and profits amount of $0
is attributed to the stock in X owned by B after the distribution.
Section 7.367(b)-10(i) applies since A received stock in D, a domestic
corporation. Accordingly, A includes in gross income as a dividend $825
($1,650 section 1248 amount--$825 attributed to stock in X owned by A
after the distribution). This amount increases the earnings and profits
of A but does not decrease the earnings and profits of X, F, F1, or D.
X is considered to be a corporation and section 355 applies to the
distribution by X of the stock in D.
(Secs. 367(b) and 7805 of the Internal Revenue Code of 1954 (90 Stat.
1634 and 68A Stat. 917; 26 U.S.C. 367(b) and 7805))
[44 FR 57390, Oct. 5, 1979, as amended by T.D. 7863, 47 FR 57491, Dec.
27, 1982; 48 FR 1710, Jan. 14, 1983]
Sec. 7.367(c)-1 Section 355 distribution treated as an exchange.
(a) General rule. For purposes of section 367 as in effect both
before and after October 4, 1976, any distribution which is described in
section 355 (or so much of section 356 as relates to section 355) shall
be treated as an exchange whether or not it is in exchange.
(b) Ruling required. In the case of any distribution to which this
section applies which begins (within the meaning of Sec. 7.367(a)-
1(b)(2)) before January 1, 1978, a foreign corporation shall not be
considered to be a corporation for purposes of determining the extent to
which gain shall be recognized on such distribution unless, pursuant to
a ruling request timely filed in accordance with the provisions of
Sec. 7.367(a)-1(d), it is established to the satisfaction of the
Commissioner at the applicable time that such distribution is not in
pursuance of a plan having as one of its principal purposes the
avoidance of Federal income taxes.
(c) Application of section 367(b) regulations. In the case of any
distribution to which this section applies which begins on or after
January 1, 1978, and in connection with which there is no transfer
described in section 367(a)(1) (as defined in Sec. 7.367(a)-1(b)(3)),
the provisions of section 367(b), as amended by the Tax Reform Act of
1976, apply. Accordingly, a foreign corporation shall be considered to
be a corporation on such distribution to the extent provided in
Secs. 7.367(b)-1 through 7.367(b)-12.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634, 26 U.S.C.
367))
[T.D. 7530, 42 FR 65163, Dec. 30, 1977]
[[Page 182]]
Sec. 7.367(c)-2 Contribution of capital to controlled corporations.
(a) General rule. For purposes of Chapter I of Subtitle A of the
Internal Revenue Code of 1954, any transfer of property to a foreign
corporation as a contribution to the capital of such corporation which
is made after December 31, 1970, by one or more persons who immediately
after the transfer, own (within the meaning of section 318) stock
possessing at least 80 percent of the total combined voting power of all
classes of stock of such corporation entitled to vote shall, except as
provided in paragraph (b) of this section, be treated as an exchange of
such property for stock of such foreign corporation equal in value to
the fair market value of the property transferred.
(b) Treatment as contribution to capital. In the case of a transfer
of property referred to in paragraph (a) of this section which begins
before October 10, 1975, such transfer shall not be treated as an
exchange if, prior to the transfer, it is established that such transfer
is not in pursuance of a plan having as one of its principal purposes
the avoidance of Federal income taxes.
(c) Ruling required. In the case of a transfer of property which
begins after October 9, 1975, and which is treated as an exchange under
paragraph (a) of this section, a ruling is required if section 367(a)(1)
applies. For example, if after October 9, 1975 and before January 1,
1978, a foreign corporation transfers property to its wholly owned
foreign subsidiary as a contribution to capital, the exchange which is
considered to occur is described in section 351 and section 367(a)(1)
applies to such transfer.
(d) Application of section 367(b) regulations. In the case of a
transfer of property which (i) begins after December 31, 1977, (ii) is
treated as an exchange as provided in paragraph (a) of this section, and
(iii) is not a transfer described in section 367(a)(1), if such a
transfer is an exchange described in section 367(b) or made in
connection with an exchange described in that section, a foreign
corporation shall be considered to be a corporation on such transfer to
the extent and upon fulfillment of any applicable conditions specified
in Secs. 7.367(b)-1 through 7.367(b)-12.
(Sec. 367 of the Internal Revenue Code of 1954 (90 Stat. 1634; 26 U.S.C.
367))
[T.D. 7530, 42 FR 65163, Dec. 30, 1977]
Sec. 7.465-1 Amounts at risk with respect to activities begun prior to effective date; in general.
Section 465 provides that a taxpayer (other than a corporation which
is not a subchapter S corporation or a personal holding company) engaged
in certain activities may not deduct losses from such activity to the
extent the losses exceed the amount the taxpayer is at risk with respect
to the activity. For the types of activities to which section 465
applies and for determining what constitutes a separate activity, see
section 465(c). Section 465 generally applies to losses attributable to
amounts paid or incurred in taxable years beginning after December 31,
1975. For the purposes of applying the at risk limitation to activities
begun before the effective date of the provision (and which were not
excepted from application of the provision), it is necessary to
determine the amount at risk as of the first day of the first taxable
year beginning after December 31, 1975. The amount at risk in an
activity as of the first day of the first taxable year of the taxpayer
beginning after December 31, 1975, (for the purposes of Sec. 7.465-1
through 7.465-5 such first day shall be referred to as the effective
date) shall be determined according to the rules provided in
Secs. 7.465-2 through 7.465-5.
[T.D. 7504, 42 FR 42197, Aug. 22, 1977]
Sec. 7.465-2 Determination of amount at risk.
(a) Initial amount. The amount a taxpayer is at risk on the
effective date with respect to an activity to which section 465 applies
shall be determined in accordance with this section. The initial amount
the taxpayer is at risk in the activity shall be the taxpayer's initial
basis in the activity as modified by disregarding amounts described in
section 465(b) (3) or (4) (relating generally to amounts protected
against loss or borrowed from related persons).
(b) Succeeding adjustments. For each taxable year ending before the
effective
[[Page 183]]
date, the initial amount at risk shall be increased and decreased by the
items which increased and decreased the taxpayer's basis in the activity
in that year as modified by disregarding the amounts described in
section 465(b) (3) or (4).
(c) Application of losses and withdrawals. (1) Losses described in
section 465(d) which are incurred in taxable years beginning prior to
January 1, 1976 and deducted in such taxable years, will be treated as
reducing first that portion of the taxpayer's basis which is
attributable to amounts not at risk. On the other hand, withdrawals made
in taxable years beginning before January 1, 1976, will be treated as
reducing the amount which the taxpayer is at risk.
(2) Therefore, if in a taxable year beginning prior to January 1,
1976 there is a loss described in section 465(d), it shall reduce the
amount at risk only to the extent it exceeds the amount of the
taxpayer's basis which is not at risk. For the purposes of this
paragraph the taxpayer's basis which is not at risk is that portion of
the taxpayer's basis in the activity (as of the close of the taxable
year and prior to reduction for the loss) which is attributable to
amounts described in section 465(b) (3) or (4).
(d) Amount at risk shall not be less than zero. If, after
determining the amount described in paragraph (a), (b), and (c) of this
section, the amount at risk (but for this paragraph) would be less than
zero, the amount at risk on the effective date shall be zero.
[T.D. 7504, 42 FR 42197, Aug. 22, 1977]
Sec. 7.465-3 Allocation of loss for different taxable years.
If the taxable year of the entity conducting the activity differs
from that of the taxpayer, the loss attributable to the activity for the
first taxable year of the entity ending after the beginning of the first
taxable year of the taxpayer beginning after December 31, 1975, shall be
allocated in the following manner. That portion of the loss from the
activity for such taxable year of the entity which bears the same ratio
as the number of days in such taxable year before January 1, 1976,
divided by the total number of days in the taxable year, shall be
attributable to taxable years of the taxpayer beginning before January
1, 1976. Consequently, that portion shall be treated in accordance with
Sec. 7.465-2.
[T.D. 7504, 42 FR 42198, Aug. 22, 1977]
Sec. 7.465-4 Insufficient records.
If sufficient records do not exist to accurately determine under
Sec. 7.465-2 the amount which a taxpayer is at risk on the effective
date, the amount at risk shall be the taxpayer's basis in the activity
reduced (but not below zero) by the taxpayer's share of amounts
described in section 465(b) (3) or (4) with respect to the activity on
the day before the effective date.
[T.D. 7504, 42 FR 42198, Aug. 22, 1977]
Sec. 7.465-5 Examples.
The provisions of Sec. 7.465-1 and Sec. 7.465-2 may be illustrated
by the following examples:
Example (1). J and K, as equal partners, form partnership JK on
January 1, 1975. Partnership JK is engaged solely in an activity
described in section 465(c)(1). On January 1, 1975, each partner
contributes $10,000 in cash from personal assets to JK. On July 1, 1975,
JK borrows $40,000 (of which J's share is $20,000) from a bank under a
nonrecourse financing arrangement secured only by the new equipment (for
use in the activity) purchased with the $40,000. On September 1, 1975,
JK reduces the amount due on the loan to $36,000 (of which J's share is
$18,000). On October 1, 1975, JK distributes $3,000 to each partner. For
taxable year 1975, JK has no income or loss. Although J's basis in the
activity is $25,000 ($10,000+$18,000--$3,000) J's amount at risk on the
effective date is $7,000 determined as follows:
Initial amount at risk........................................ $10,000
Plus: Items which increased basis other than amounts described
in sec. 465(b) (3) or (4).................................... 0
---------
Total..................................................... 10,000
Less: Distribution............................................ 3,000
=========
J's amount at risk on effective date.......................... 7,000
Example (2). Assume the same facts as in Example (1) except that JK
has a loss (as described in section 465(d) for 1975 of which J's share
is $12,000. Although J's basis in the activity is $13,000
($10,000+$18,000--($3,000+$12,000)) J's amount at risk on the effective
date is $7,000 determined as follows:
Initial amount at risk........................................ $10,000
Plus: Items which increased basis other than amounts described
in sec. 465(b) (3) or (4).................................... 0
---------
Total..................................................... 10,000
=========
[[Page 184]]
Less: Distribution............................................ 3,000
Portion of loss ($12,000) in excess of portion of basis not at
risk ($18,000)............................................... 0
---------
Total..................................................... 3,000
=========
J's amount at risk on effective date.......................... 7,000
Example (3). Assume the same facts as in Example (1) except that JK
has a loss (as described in section 465(d) for 1975, and J's share is
$23,000. J's basis in the activity is $2,000 ($10,000+$18,000--
($3,000+$23,000)). The amount at risk on the effective date is
determined as follows:
Initial amount at risk........................................ $10,000
Plus: Items which increased basis other than amounts described
in sec. 465(b) (3) or (4).................................... 0
---------
Total..................................................... 10,000
=========
Less: Distribution............................................ 3,000
Portion of loss ($23,000) in excess of portion of basis not at
risk ($18,000)............................................... 5,000
---------
Total..................................................... 8,000
=========
J's amount at risk on the effective date...................... 2,000
[T.D. 7504, 42 FR 42198, Aug. 22, 1977]
Sec. 7.704-1 Partner's distributive share.
(a)-(c) [Reserved]
(d) Limitation on allowance of losses.
(1)-(2) [Reserved]
(3)(i) Section 213(e) of the Tax Reform Act of 1976 amended section
704(d) of the Internal Revenue Code relating to the deductions by
partners of losses incurred by a partnership. A partner is entitled to
deduct the share of partnership loss to the extent of the adjusted basis
of the partner's interest in the partnership. As amended, section 704(d)
provides, in general, that the adjusted basis of a partner's interest in
the partnership for the purpose of deducting partnership losses shall
not include any portion of a partnership liability for which the partner
has no personal liability. This restriction, however, does not apply to
any activity to the extent that section 465 of the Code applies nor to
any partnership whose principal activity is investing in real property,
other than mineral property. Section 465 does not apply to corporations
other than a subchapter S corporation or a personal holding company.
(ii) The restrictions in the amendment to section 704(d) will not
apply to any corporate partner with respect to liabilities incurred in
an activity described in section 465(c)(1). In all other respects the
restrictions in the amendment will apply to all corporate partners
unless the partnership's principal activity is investment in real
property, other than mineral property.
[T.D. 7445, 41 FR 55344, Dec. 20, 1976]
Sec. 7.936-1 Qualified possession source investment income.
For purposes of this section, interest earned after September 30,
1976 (less applicable deductions), by a domestic corporation, engaged in
the active conduct of a trade or business in Puerto Rico, which elects
the application of section 936 with respect to deposits with certain
Puerto Rican financial institutions will be treated as qualified
possession source investment income within the meaning of section
936(d)(2) if (1) the interest qualifies for exemption from Puerto Rican
income tax under regulations issued by the Secretary of the Treasury of
Puerto Rico, as in effect on September 28, 1976, under the authority of
section 2(j) of the Puerto Rico Industrial Incentive Act of 1963, as
amended, (2) the interest is from sources within Puerto Rico (within the
meaning of section 936(d)(2)(A)), and (3) the funds with respect to
which the interest is earned are derived from the active conduct of a
trade or business in Puerto Rico or from investment of funds so derived.
[T.D. 7452, 41 FR 56794, Dec. 30, 1976]
Sec. 7.999-1 Computation of the international boycott factor.
(a) In general. Sections 908(a), 952(a)(3), and 995(b)(1)(F) provide
that certain benefits of the foreign tax credit, deferral of earnings of
foreign corporations, and DISC are denied if a person or a member of a
controlled group (within the meaning of section 993(a)(3)) that includes
that person participates in or cooperates with an international boycott
(within the meaning of section 999(b)(3)). The loss of tax benefits may
be determined by multiplying the otherwise allowable tax benefits by the
``international boycott factor.'' Section 999(c)(1) provides that the
international boycott factor is to be determined under regulations
[[Page 185]]
prescribed by the Secretary. The method of computing the international
boycott factor is set forth in paragraph (c) of this section. A special
rule for computing the international boycott factor of a person that is
a member of two or more controlled groups is set forth in paragraph (d).
Transitional rules for making adjustments to the international boycott
factor for years affected by the effective dates are set forth in
paragraph (e). The definitions of the terms used in this section are set
forth in paragraph (b).
(b) Definitions. For purposes of this section:
(1) Boycotting country. In respect of a particular international
boycott, the term ``boycotting country'' means any country described in
section 999(a)(1) (A) or (B) that requires participation in or
cooperation with that particular international boycott.
(2) Participation in or cooperation with an international boycott.
For the definition of the term ``participation in or cooperation with an
international boycott'', see section 999(b)(3) and Parts H through M of
the Treasury Department's International Boycott Guidelines.
(3) Operations in or related to a boycotting country. For the
definitions of the terms ``operations'', ``operations in a boycotting
country'', ``operations related to a boycotting country'', and
``operations with the government, a company, or a national of a
boycotting country'', see Part B of the Treasury Department's
International Boycott Guidelines.
(4) Clearly demonstrating clearly separate and identifiable
operations. For the rules for ``clearly demonstrating clearly separate
and identifiable operations'', see Part D of the Treasury Department's
International Boycott Guidelines.
(5) Purchase made from a country. The terms ``purchase made from a
boycotting country'' and ``purchases made from any country other than
the United States'' mean, in respect of any particular country, the
gross amount paid in connection with the purchase of, the use of, or the
right to use:
(i) Tangible personal property (including money) from a stock of
goods located in that country,
(ii) Intangible property (other than securities) in that country,
(iii) Securities by a dealer to a beneficial owner that is a
resident of that country (but only if the dealer knows or has reason to
know the country of residence of the beneficial owner),
(iv) Real property located in that country, or
(v) Services performed in, and the end product of services performed
in, that country (other than payroll paid to a person that is an officer
or employee of the payor).
(6) Sales made to a country. The terms ``sales made to a boycotting
country'' and ``sales made to any country other than the United States''
mean, in respect of any particular country, the gross receipts from the
sale, exchange, other disposition, or use of:
(i) Tangible personal property (including money) for direct use,
consumption, or disposition in that country,
(ii) Services performed in that country,
(iii) The end product of services (wherever performed) for direct
use, consumption, or disposition in that country,
(iv) Intangible property (other than securities) in that country,
(v) Securities by a dealer to a beneficial owner that is a resident
of that country (but only if the dealer knows or has reason to know the
country of residence of the beneficial owner), or
(vi) Real property located in that country.
To determine the country of direct use, consumption, or disposition of
tangible personal property and the end product of services, see
paragraph (b)(10) of this section.
(7) Sales made from a country. The terms ``sales made from a
boycotting country'' and ``sales made from any country other than the
United States'' mean, in respect of a particular country, the gross
receipts from the sale, exchange, other disposition, or use of:
(i) Tangible personal property (including money) from a stock of
goods located in that country,
(ii) Intangible property (other than securities) in that country, or
[[Page 186]]
(iii) Services performed in, and the end product of services
performed in, that country.
However, gross receipts from any such sale, exchange, other disposition,
or use by a person that are included in the numerator of that person's
international boycott factor by reason of paragraph (b)(6) of this
section shall not again be included in the numerator by reason of this
subparagraph.
(8) Payroll paid or accrued for services performed in a country. The
terms ``payroll paid or accrued for services performed in a boycotting
country'' and ``payroll paid or accrued for services performed in any
country other than the United States'' mean, in respect of a particular
country, the total amount paid or accrued as compensation to officers
and employees, including wages, salaries, commissions, and bonuses, for
services performed in that country.
(9) Services performed partly within and partly without a country--
(i) In general. Except as provided in paragraph (b)(9)(ii) of this
section, for purposes of allocating to a particular country:
(A) The gross amount paid in connection with the purchase or use of,
(B) The gross receipts from the sale, exchange, other disposition or
use of, and
(C) The payroll paid or accrued for services performed, or the end
product of services performed, partly within and partly without that
country, the amount paid, received, or accrued to be allocated to that
country, unless the facts and circumstances of a particular case warrant
a different amount, will be that amount that bears the same relation to
the total amount paid, received, or accrued as the number of days of
performance of the services within that country bears to the total
number of days of performance of services for which the total amount is
paid, received, or accrued.
(ii) Transportation, telegraph, and cable services. Transportation,
telegraph, and cable services performed partly within one country and
partly within another country are allocated between the two countries as
follows:
(A) In the case of a purchase of such services performed from
Country A to Country B, fifty percent of the gross amount paid is deemed
to be a purchase made from Country A and the remaining fifty percent is
deemed to be a purchase made from Country B.
(B) In the case of a sale of such services performed from Country A
to Country B, fifty percent of the gross receipts is deemed to be a sale
made from Country R and the remaining fifty percent is deemed to be a
sale made to Country B.
(10) Country of use, consumption, or disposition. As a general rule,
the country of use, consumption, or disposition of tangible personal
property (including money) and the end product of services (wherever
performed) is deemed to be the country of destination of the tangible
personal property or the end product of the services. (Thus, if legal
services are performed in one country and an opinion is given for use by
a client in a second country, the end product of the legal services is
used, consumed, or disposed of in the second country.) The occurrence in
a country of a temporary interruption in the shipment of the tangible
personal property or the delivery of the end product of services shall
not constitute such country the country of destination. However, if at
the time of the transaction the person providing the tangible personal
property or the end product of services knew, or should have known from
the facts and circumstances surrounding the transaction, that the
tangible personal property or the end product of services probably would
not be used, consumed, or disposed of in the country of destination,
that person must determine the country of ultimate use, consumption or
disposition of the tangible personal property or the end product of
services. Notwithstanding the preceding provisions of this subparagraph,
a person that sells, exchanges, otherwise disposes of, or makes
available for use, tangible personal property to any person all of whose
business except for an insubstantial part consists of selling from
inventory to retail customers at retail outlets all within one country
may assume at the time of such sale to such person that the tangible
personal property will be used, consumed, or disposed of within such
country.
(11) Controlled group taxable year. The term ``controlled group
taxable year''
[[Page 187]]
means the taxable year of the controlled group's common parent
corporation. In the event that no common parent corporation exists, the
members of the group shall elect the taxable year of one of the members
of the controlled group to serve as the controlled group taxable year.
The taxable year election is a binding election to be changed only with
the approval of the Secretary of his delegate. The election is to be
made in accordance with the procedures set forth in the instructions to
Form 5713, the International Boycott Report.
(c) Computation of international boycott factor--(1) In general. The
method of computing the international boycott factor of a person that is
not a member of a controlled group is set forth in paragraph (c)(2) of
this section. The method of computing the international boycott factor
of a person that is a member of a controlled group is set forth in
paragraph (c)(3) of this section. For purposes of paragraphs (c) (2) and
(3), purchases and sales made by, and payroll paid or accrued by, a
partnership are deemed to be made or paid or accrued by a partner in
that proportion that the partner's distributive share bears to the
purchases and sales made by, and the payroll paid or accrued by, the
partnership. Also for purposes of paragraphs (c) (2) and (3), purchases
and sales made by, and payroll paid or accrued by, a trust referred to
in section 671 are deemed to be made both by the trust (for purposes of
determining the trust's international boycott factor), and by a person
treated under section 671 as the owner of the trust (but only in that
proportion that the portion of the trust that such person is considered
as owning under sections 671 through 679 bears to the purchases and
sales made by, and the payroll paid and accrued by, the trust).
(2) International boycott factor of a person that is not a member of
a controlled group. The international boycott factor to be applied by a
person that is not a member of a controlled group (within the meaning of
section 993(a)(3)) is a fraction.
(i) The numerator of the fraction is the sum of the--
(A) Purchases made from all boycotting countries associated in
carrying out a particular international boycott.
(B) Sales made to or from all boycotting countries associated in
carrying out a particular international boycott, and
(C) Payroll paid or accrued for services performed in all boycotting
countries associated in carrying out a particular international boycott
by that person during that person's taxable year, minus the amount of
such purchases, sales, and payroll that is clearly demonstrated to be
attributable to clearly separate and identifiable operations in
connection with which there was no participation in or cooperation with
that international boycott.
(ii) The denominator of the fraction is the sum of the--
(A) Purchases made from any country other than the United States,
(B) Sales made to or from any country other than the United States,
and
(C) Payroll paid or accrued for services performed in any country
other than the United States by that person during that person's taxable
year.
(3) International boycott factor of a person that is a member of a
controlled group. The international boycott factor to be applied by a
person that is a member of a controlled group (within the meaning of
section 993(a)(3)) shall be computed in the manner described in
paragraph (c)(2) of this section, except that there shall be taken into
account the purchases and sales made by, and the payroll paid or accrued
by, each member of the controlled group during each member's own taxable
year that ends with or within the controlled group taxable year that
ends with or within that person's taxable year.
(d) Computation of the international boycott factor of a person that
is a member of two or more controlled groups. The international boycott
factor to be applied under sections 908(a), 952(a)(3), and 995(b)(1)(F)
by a person that is a member of two or more controlled groups shall be
determined in the manner described in paragraph (c)(3), except that the
purchases, sales, and payroll included in the number and denominator
shall include the purchases, sales, and payroll of that person and of
all other members of the two or more
[[Page 188]]
controlled groups of which that person is a member.
(e) Transitional rules--(1) Pre-November 3, 1976 boycotting
operations. The international boycott factor to be applied under
sections 908(a), 952(a)(3), and 995(b)(1)(F) by a person that is not a
member of a controlled group, for that person's taxable year that
includes November 3, 1976, or a person that is a member of a controlled
group, for the controlled group taxable year that includes November 3,
1976, shall be computed in the manner described in paragraphs (c)(2) and
(c)(3), respectively, of this section. However, that the following
adjustments shall be made:
(i) There shall be excluded from the numerators described in
paragraphs (c)(2)(i) and (c)(3)(i) of this section purchases, sales, and
payroll clearly demonstrated to be attributable to clearly separate and
identifiable operations--
(A) That were completed on or before November 3, 1976, or
(B) In respect of which it is demonstrated that the agreements
constituting participation in or cooperation with the international
boycott were renounced, the renunciations were communicated on or before
November 3, 1976, to the governments or persons with which the
agreements were made and the agreements have not been reaffirmed after
November 3, 1976, and
(ii) The international boycott factor resulting after the numerator
has been modified in accordance with paragraph (e)(1)(i) of this section
shall be further modified by multiplying it by a fraction. The numerator
of that fraction shall be the number of days in that person's taxable
year (or, if applicable, in that person's controlled group taxable year)
remaining after November 3, 1976, and the denominator shall be 366.
The principles of this subparagraph are illustrated in the following
example:
Example. Corporation A, a calendar year taxpayer, is not a member of
a controlled group. During the 1976 calendar year, Corporation DA had
three operations in a boycotting country under three separate contracts,
each of which contained agreements constituting participation in or
cooperation with an international boycott. Each contract was entered
into on or after September 2, 1976. Operation (1) was completed on
November 1, 1976. The sales made to a boycotting country in connection
with Operation (1) amounted to $10. Operation (2) was not completed
during the taxable year, but on November 1, 1976, Corporation A
communicated a renunciation of the boycott agreement covering that
operation to the government of the boycotting country. The sales made to
a boycotting country in connection with Operation (2) amounted to $40.
Operation (3) was not completed during the taxable year, nor was any
renunciation of the boycott agreement made. The sales made to a
boycotting country in connection with Operation (3) amounted to $25.
Corporation A had no purchases made from, sales made from, or payroll
paid or accrued for services performed in, a boycotting country.
Corporation A had $500 of purchases made from, sales made from, sales
made to, and payroll paid or accrued for services performed in,
countries other than the United States. Company A's boycott factor for
1976, computed under paragraph (c)(2) of this section (before the
application of this subparagraph) would be:
[GRAPHIC] [TIFF OMITTED] TC16OC91.003
However, the $10 is eliminated from the numerator by reason of
paragraph (e)(1)(i)(A) of this section, and the $40 is eliminated from
the numerator by reason of paragraph (e)(1)(i)(B) of this section. Thus,
before the application of paragraph (e)(1)(ii) of this section,
Corporation A's international boycott factor is $25/$500. After the
application of paragraph (e)(1)(ii), Corporation A's international
boycott factor is:
[GRAPHIC] [TIFF OMITTED] TC16OC91.004
(2) Pre-December 31, 1977 boycotting operations. The international
boycott factor to be applied under sections 908(a), 952(a)(3), and
995(b)(1)(F) by a person that is not a member of a controlled group, for
that person's taxable year that includes December 31, 1977, or by a
person that is a member of a controlled group, for the controlled group
taxable year that includes December 31, 1977, shall be computed in the
manner described in paragraphs (c)(2) and (c)(3), respectively, of this
section. However, the following adjustments shall be made:
(i) There shall be excluded from the numerators described in
paragraphs (c)(2)(i) and (c)(3)(i) of this section purchases, sales, and
payroll clearly demonstrated to be attributable to clearly separate and
identifiable operations that were carried out in accordance
[[Page 189]]
with the terms of binding contracts entered into before September 2,
1976, and--
(A) That were completed on or before December 31, 1977, or
(B) In respect of which it is demonstrated that the agreements
constituting participation in or cooperation with the international
boycott were renounced, the renunciations were communicated on or before
December 31, 1977, to the governments or persons with which the
agreements were made, and the agreements were not reaffirmed after
December 31, 1977, and
(ii) In the case of clearly separate and identifiable operations
that are carried out in accordance with the terms of binding contracts
entered into before September 2, 1976, but that do not meet the
requirements of paragraph (e)(2)(i) of this section, the numerators
described in paragraphs (c)(2)(i) and (c)(3)(i) of this section shall be
adjusted by multiplying the purchases, sales, and payroll clearly
demonstrated to be attributable to those operations by a fraction, the
numerator of which is the number of days in such person's taxable year
(or, if applicable, in such person's controlled group taxable year)
remaining after December 31, 1977, and the denominator of which is 365.
The principles of this subparagraph are illustrated in the following
example:
Example. Corporation A is not a member of a controlled group and
reports on the basis of a July 1-June 30 fiscal year. During the 1977-
1978 fiscal year, Corporation A had 2 operations carried out pursuant to
the terms of separate contracts, each of which had a clause that
constituted participation in or cooperation with an international
boycott. Neither operation was completed during the fiscal year, nor
were either of the boycotting clauses renounced. Operation (1) was
carried out in accordance with the terms of a contract entered into on
November 15, 1976. Operation (2) was carried out in accordance with the
terms of a binding contract entered into before September 2, 1976.
Corporation A had sales made to a boycotting country in connection with
Operation (1) in the amount of $50, and in connection with Operation (2)
in the amount of $100. Corporation A had sales made to countries other
than the United States in the amount of $500. Corporation A had no
purchases made from, sales made from, or payroll paid or accrued for
services performed in, any country other than the United States. In the
absence of this subparagraph, Corporation A's international boycott
factor would be
[GRAPHIC] [TIFF OMITTED] TC16OC91.005
However, by reason of the application of this subparagraph, Corporation
A's international boycott factor is reduced to
[GRAPHIC] [TIFF OMITTED] TC16OC91.006
(3) Incomplete controlled group taxable year. If, at the end of the
taxable year of a person that is a member of a controlled group, the
controlled group taxable year that includes November 3, 1976 has not
ended, or the taxable year of one or more members of the controlled
group that includes November 3, 1976 has not ended, then the
international boycott factor to be applied under sections 908(a),
952(a)(3) and 995(b)(1)(F) by such person for the taxable year shall be
computed in the manner described in paragraph (c)(3) of this section.
However, the numerator and the denominator in that paragraph shall
include only the purchases, sales, and payroll of those members of the
controlled group whose taxable years ending after November 3, 1976 have
ended as the end of the taxable year of such person.
(f) Effective date. This section applies to participation in or
cooperation with
[[Page 190]]
an international boycott after November 3, 1976. In the case of
operations which constitute participation in or cooperation with an
international boycott and which are carried out in accordance with the
terms of a binding contract entered into before September 2, 1976, this
section applies to such participation or cooperation after December 31,
1977.
[T.D. 7467, 42 FR 11833, Mar. 1, 1977]
Sec. 7.6039A-1 Information regarding carryover basis property acquired from a decedent.
(a) Information for Internal Revenue Service. In the case of a
decedent who dies after December 31, 1976, the executor (as defined in
section 2203) shall furnish to the Internal Revenue Service the
following information, as applicable--
(1) If an estate tax return is required to be filed under section
6018 of the Internal Revenue Code of 1954, as amended, and if the return
form contains questions relating to carryover basis property, the
executor must answer those questions.
(2) If no estate tax return is required to be filed under section
6018 of the Internal Revenue Code of 1954, as amended, or if a return is
required to be filed but the return form used does not contain questions
relating to carryover basis property, the executor must file the form
prescribed by the Commissioner. This form may be attached to the estate
tax return or the decedent's final individual income tax return. If this
form is not attached to the estate tax return or the decedent's final
individual income tax return, it must be filed with the Internal Revenue
Service office where the decedent's final income tax return would be
filed if one were required within 9 months after the date of the
decedent's death or by December 31, 1978, whichever is later.
(b) Information to be furnished to beneficiaries. Any executor
required under paragraph (a) of this section to furnish information to
the Internal Revenue Service relating to carryover basis property must
furnish in writing to the distributee of each piece of carryover basis
property--
(1) A description of the property,
(2) The adjusted basis of the property as computed under section
1023 (a), (c), and (d),
(3) The amount of the increase in the basis of the property
determined under section 1023(h),
(4) The value of the property for Federal estate tax purposes, and
(5) A notice that the beneficiary should keep this information as
part of permanent records.
(c) Time for furnishing information to beneficiaries. The
information which an executor is required to furnish to the
beneficiaries under this paragraph must be furnished on or before the
latest of--
(1) The date the property is distributed to the beneficiary,
(2)(i) In the case of an executor who is required to file an estate
tax return, 6 months after the due date (including extensions) of such
return,
(ii) In the case of an executor who is not required to file an
estate tax return, 15 months from the date of death of the decedent, or
(3) December 31, 1978.
(d) Subsequent adjustments to carryover basis. In the event
subsequent adjustments are made which relate to the carryover basis of
any piece of property included in a decedent's gross estate, whether by
reason of an adjustment resulting from an examination of the estate tax
return or otherwise, any executor required under paragraph (a) of this
section to furnish information to the Internal Revenue Service shall,
within 3 months of a determination, as defined in section 1313 (a), of
such adjustments, provide to the recipient of each item of carryover
basis property the information set forth in paragraph (b) of this
section recomputed as required by such adjustments.
(e) Effective date. This section is effective in respect of
decedents dying after December 31, 1976.
(Secs. 7805 and 6039A of the Internal Revenue Code of 1954 (68A Stat.
917, 90 Stat. 1878; 26 U.S.C. 7805, 6039A))
[T.D. 7540, 43 FR 16735, Apr. 20, 1978, as amended by T.D. 7559, 43 FR
36244, Aug. 16, 1978]
[[Page 191]]
Sec. 7.6041-1 Return of information as to payments of winnings from bingo, keno, and slot machines.
(a) In general. On or after May 1, 1977, every person engaged in a
trade or business and making a payment in the course of such trade or
business of winnings (including winnings which are exempt from
withholding under section 3402(q)(5)) of $1,200 or more from a bingo
game or slot machine play or of $1,500 or more from a keno game shall
make an information return with respect to such payment.
(b) Special rules. For purposes of paragraph (a) of this section, in
determining whether such winnings equal or exceed the $1,200 or $1,500
amount--
(1) In the case of a bingo game or slot machine play, the amount of
winnings shall not be reduced by the amount wagered;
(2) In the case of a keno game, the amount of winnings from one game
shall be reduced by the amount wagered in that one game;
(3) Winnings shall include the fair market value of a payment in any
medium other than cash;
(4) All winnings by the winner from one bingo or keno game shall be
aggregated; and
(5) Winnings and losses from any other wagering transaction by the
winner shall not be taken into account.
(c) Prescribed form. The return required by paragraph (a) of this
section shall be made on Form W-2G and shall be filed with the Internal
Revenue Service Center serving the district in which is located the
principal place of business of the person making the return on or before
February 28 of the calendar year following the calendar year in which
the payment of winnings is made. Each Form W-2G shall contain the
following:
(1) Name, address, and employer identification number of the person
making the payment;
(2) Name, address, and social security number of the winner;
(3) General description of two types of identification (e.g.,
``driver's license'', ``social security card'', or ``voter registration
card'') furnished to the maker of the payment for verification of the
winner's name, address, and social security number;
(4) Date and amount of the payment; and
(5) Type of wagering transaction.
In addition, in the case of a bingo or keno game, Form W-2G shall show
any number, color, or other designation assigned to the game with
respect to which the payment is made. In the case of a slot machine
play, Form W-2G shall show the identification number of the slot
machine.
[T.D. 7457, 42 FR 1471, Jan. 7, 1977, as amended by T.D. 7492, 42 FR
33286, June 30, 1977]
PART 8--TEMPORARY INCOME TAX REGULATIONS UNDER SECTION 3 OF THE ACT OF OCTOBER 26, 1974 (PUB. L. 93-483)--Table of Contents
Authority: Secs. 2055(e)(3) and 7805 of the Internal Revenue Code of
1954 (68A Stat. 917; 26 U.S.C. 7805).
Sec. 8.1 Charitable remainder trusts.
(a) Certain wills and trusts in existence on September 21, 1974. In
the case of a will executed before September 21, 1974, or a trust
created (within the meaning of applicable local law) after July 31,
1969, and before September 21, 1974, which is amended pursuant to
section 2055(e)(3) and Sec. 24.1 of this chapter (Temporary Estate Tax
Regulations), a charitable remainder trust resulting from such amendment
will be treated as a charitable remainder trust from the date it would
be deemed created under Sec. 1.664-1(a) (4) and (5) of this chapter
(Income Tax Regulations), whether or not such date is after September
20, 1974.
(b) Certain transfers to trusts created before August 1, 1969.
Property transferred to a trust created (within the meaning of
applicable local law) before August 1, 1969, whose governing instrument
provides that an organization described in section 170(c) receives an
irrevocable remainder interest in such trust shall be deemed transferred
to a trust created on the date of such transfer, provided that the
transfer occurs after July 31, 1969 and prior to October 18, 1971, and
pursuant to an amendment provided in Sec. 24.1 of this chapter
(Temporary Estate Tax Regulations), the transferred property and any
undistributed income therefrom is severed and
[[Page 192]]
placed in a separate trust as of the date of the amendment.
[T.D. 7393, 40 FR 58853, Dec. 19, 1975]
PART 9--TEMPORARY INCOME TAX REGULATIONS UNDER THE TAX REDUCTION ACT OF 1975--Table of Contents
Sec.
9.1 Investment credit--public utility property elections.
9.2 [Reserved]
9.3 Temporary TRASOP requirements for 1-percent additional investment
credit.
Sec. 9.1 Investment credit--public utility property elections.
(a) Applicability of prior election under section 46(f)--(1) In
general. Except as provided in paragraph (a)(2) of this section, an
election made before March 10, 1972 (hereinafter referred to as a 1972
election) under section 46(f) (redesignated from section 46(e) by the
Tax Reduction Act of 1975) applies to the credit allowable for a taxable
year with respect to public utility property described in section
46(f)(5) by reason of sections 301 and 302 of the Tax Reduction Act of
1975.
(2) 1972 immediate flow-through election. A 1972 election under
section 46(f)(3) (hereinafter referred to as an election for immediate
flow-through) does not apply to the additional credit allowed under
section 38 with respect to limited property (public utility property
described in section 46(c)(3)(B) to which section 167(1)(2)(C) applies,
other than nonregulated communication property of the type described in
the last sentence of section 46(c)(3)(B) by reason of the Tax Reduction
Act of 1975. However, a 1972 election for immediate flow-through does
apply to the additional credit allowed for a taxable year with respect
to property described in section 46(f)(5)(B). See paragraph (b) of this
section for a new election under section 46(f)(3) with regard to the
additional credit with respect to limited property allowed by reason of
the Tax Reduction Act of 1975. See paragraph (a)(3) of this section for
determination of additional credit. For purposes of this section the
phrase ``determined as if the Tax Reduction Act had not been enacted''
means the following amendments shall be disregarded in determining
credit allowable or allowed:
(i) The increase in the amount of credit from 7 percent to 10 or 11
percent under section 46(a)(1) (A), (B), and (D),
(ii) The increase in the amount of qualified investment from 4/7 to
7/7 under section 46(a)(1)(C) and (c)(3)(A),
(iii) The increase in the dollar limitation from $50,000 to $100,000
on used property under section 48(c)(2), and
(iv) The increase in the limitation based on tax under section
46(a)(6) for certain public utilities.
In determining the amount of credit attributable to limited property
possible disallowance under section 46(f) shall be disregarded.
(3) Additional credit allowed--(i) Credit earned in taxable year.
The amount of additional credit allowed for credit earned for limited
property for taxable year is an amount equal to the excess of--
(A) The credit allowed by section 38 for the taxable year
(determined without regard to section 46(b)) multiplied by a fraction,
the numerator of which is the amount of credit earned for limited
property for the taxable year and the denominator of which is the amount
of credit earned for all section 38 property for the taxable year, over
(B) The amount of normal credit allowed for limited property for the
taxable year (determined without regard to section 46(b)). The amount of
normal credit allowed for limited property is the amount of credit that
would be allowed for the taxable year determined as if the Tax Reduction
Act had not been enacted multiplied by a fraction, the numerator of
which is the amount of credit earned for limited property for the
taxable year determined as if the Tax Reduction Act had not been enacted
and the denominator of which is the credit earned for all section 38
property for the taxable year determined as if the Tax Reduction Act had
not been enacted.
(ii) Carryover or carryback to taxable year. The amount of
additional credit allowed for limited property attributable to a
carryover or a carryback of any unused credit to any taxable year in an
amount equal to the excess of--
[[Page 193]]
(A) The amount of credit allowed by section 38 for the taxable year
by reason of section 46(b) multiplied by the fraction contained in
paragraph (a)(3)(i)(A) of this section for the unused credit year, over
(B) The amount of unused normal credit allowed for limited property
for the taxable year. The amount of unused normal credit allowed for
limited property is the amount of unused credit that would be allowed
for the taxable year under section 38 by reason of section 46(b), taking
into account the amount of unused credit that would be allowed for any
preceding year, determined as if the Tax Reduction Act had not been
enacted, multiplied by the fraction contained in paragraph (a)(3)(i)(B)
of this section for the unused credit year.
(b) New election--(1) In general. A taxpayer who made a 1972
election for immedite flow-through under section 46(f)(3) with respect
to limited property may elect to apply section 46(f)(3) to the
additional credit allowed by the Tax Reduction Act of 1975 with respect
to such property, or, if eligible, may make the election in paragraph
(b)(2) of this section to apply section 46(f)(2) to such additional
credit. The election to apply section 46(f) (2) or (3) must be made
before June 28, 1975, in the manner provided in paragraph (c) of this
section. If the taxpayer does not make a new election, section 46(f)(1)
shall apply to additional credit for limited property. However, if the
taxpayer made a 1972 election under section 46(f)(2) with respect to
property to which section 46(f)(3) does not apply, then section 46(f)(2)
shall apply to such additional credit notwithstanding any prohibition in
section 46(f)(3) to the contrary.
(2) Special section 46(f)(2) election. A taxpayer who:
(i) Made a 1972 election under section 46(f)(3),
(ii) Did not make an election to apply section 46(f)(2) with respect
to property to which section 46(f)(3) does not apply, and
(iii) Did not acquire property to which section 46(f)(1) applied in
any taxable year ending before January 1, 1975, may elect to apply
section 46(f)(2) to the additional credit allowed by the Tax Reduction
Act of 1975 with respect to limited property notwithstanding any
prohibition in section 46(f)(3) to the contrary.
(c) Method of making election. A taxpayer may make an election
described in paragraph (b) of this section by filing a statement before
June 28, 1975, with the district director or director of the internal
revenue service center with whom the taxpayer ordinarily files its
income tax return. For rules with respect to taxpayers filing
consolidated returns, see Sec. 1.1502-77(a) of part 1 of this chapter.
The statement shall contain the following information: (1) The name,
address, and taxpayer identification number of the taxpayer, and (2) the
election which the taxpayer is making under paragraph (b) of this
section. If a taxpayer is electing flow-through under section 46(f)(3),
the statement shall also contain a written recitation that the election
is made at the taxpayer's own option and without regard to any
requirement imposed by an agency described in section 46(c)(3)(B) having
jurisdiction over the taxpayer. The recitation shall be verified by a
written declaration that it is made under the penalties of perjury.
(Secs. 46(f) and 7805 of the Internal Revenue Code of 1954 (85 Stat.
503, 68A Stat. 917; 26 U.S.C. 46, 7805))
[T.D. 7360, 40 FR 25472, June 16, 1975]
Sec. 9.2 [Reserved]
Sec. 9.3 Temporary TRASOP requirements for 1-percent additional investment credit.
The provisions listed in Sec. 1.46-8 (a)(4) (i)--(ix) (Income Tax
Regulations) are deemed effective only as temporary regulations under
this section.
(Sec. 301(d)(2)(C) and (10) of the Tax Reduction Act of 1975 and sec.
7805 of the Internal Revenue Code of 1954 (89 Stat. 38, 68A Stat. 917
(26 U.S.C. 7805)))
[T.D. 7589, 44 FR 4145, Jan. 16, 1979; 44 FR 6715, Feb. 2, 1979]
[[Page 194]]
PART 11--TEMPORARY INCOME TAX REGULATIONS UNDER THE EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974--Table of Contents
Sec.
11.401(a)-11 Qualified joint and survivor annuities.
11.401(a)-19 Nonforfeitability in case of certain withdrawals.
11.401(b)-1 Certain retroactive changes in plan.
11.401(d)(1)-1 Nonbank trustees of trusts benefiting owner-employees.
11.402(e)(4)(A)-1 Lump sum distributions in the case of an employee who
has separated from service.
11.402(e)(4)(B)-1 Election to treat an amount as a lump sum
distribution.
11.404(a)(6)-1 Time when contributions to ``H.R. 10'' plans considered
made.
11.408(a)(2)-1 Trustee of individual retirement accounts.
11.410-1 Election by church to have participation, vesting, funding,
etc., provisions apply.
11.410(b)-1 Minimum coverage requirements.
11.412(c)-7 Election to treat certain retroactive plan amendments as
made on the first day of the plan year.
11.412(c)-11 Election with respect to bonds.
11.412(c)-12 Extension of time to make contributions to satisfy
requirements of section 412.
11.415(c)(4)-1 Special elections for section 403(b) annuity contracts
purchased by educational institutions, hospitals and home
health service agencies.
Authority: Sec. 7805 of the Internal Revenue Code of 1954 (68A Stat.
917; 26 U.S.C. 7805), unless otherwise noted.
Sec. 11.401(a)-11 Qualified joint and survivor annuities.
(a) In general--(1) General rule. A trust, which is a part of a plan
providing for the payment of benefits in any form of a life annuity
(i.e., an annuity requiring survival of the participant or his spouse as
a condition for payment), shall not constitute a qualified trust under
section 401(a)(11) and this section unless such plan provides that these
benefits must be paid in a form having the effect of a qualified joint
and survivor annuity. Therefore, any benefits which may be paid in any
form of a life annuity must be paid in a form having the effect of a
qualified joint and survivor annuity unless the participant makes the
election, described in paragraph (c) of this section, not to receive
benefits in this form. A plan will not fail to meet the requirements of
section 401(a)(11) and this section merely because it provides that the
spouse of a deceased participant may elect to have benefits paid in a
form other than a qualified joint and survivor annuity. Section
401(a)(11) and this section shall apply only in the case of a plan to
which section 411 (relating to minimum vesting standards) applies
without regard to section 411(e)(2). Without regard to the election
provided under paragraph (d)(3) of this section, unless an election has
been made under paragraph (c) of this section, a plan to which this
section applies must provide that a survivor annuity shall be payable on
the death of an active participant after normal retirement age.
(2) Illustration. The provisions of this paragraph may be
illustrated by the following example:
Example. The X Corporation Defined Contribution Plan was established
in 1960. As in effect on January 1, 1974, the plan provided that, upon
his retirement, a participant could elect to receive the balance of his
individual account in the form of (1) a lump-sum cash payment, (2) a
lump-sum distribution consisting of X Corporation stock, (3) five equal
annual cash payments, (4) a life annuity, or (5) a combination of
options (1) through (4). The plan also provided that, if a participant
did not elect another form of distribution, the balance of his
individual account would be distributed to him in the form of a lump-sum
cash payment upon his retirement. Assume that section 401(a)(11) and
this section first become applicable to the plan as of its plan year
beginning January 1, 1976, with respect to persons who were active
participants in the plan on such date (see paragraph (h) of this
section). Unless the X Corporation Defined Contribution Plan either
discontinues the life annuity payment option or is amended to provide
that the balance of a participant's individual account will be paid to
him in a form having the effect of a qualified joint and survivor
annuity unless the participant elects another form of benefit payment,
the trust established under the plan will fail to qualify under section
401(a).
(b) Definitions. As used in this section--
(1) Qualified joint and survivor annuity. The term ``qualified joint
and survivor annuity'' means an annuity for the life of the participant
with a survivor annuity for the life of his spouse
[[Page 195]]
which is neither (i) less than one-half of, nor (ii) greater than, the
amount of the annuity payable during the joint lives of the participant
and his spouse. A qualified joint and survivor annuity must be at least
the actuarial equivalent of the normal form of annuity or any optional
form of benefit offered under the plan. Equivalence may be determined,
on the basis of consistently applied reasonable actuarial factors, for
each participant or for all participants or reasonable groupings of
participants, if such determination does not result in discrimination in
favor of employees who are officers, shareholders, or highly
compensated. An annuity is not a qualified joint and survivor annuity if
payments to the spouse of a deceased participant are terminated because
of such spouse's remarriage.
(2) Annuity starting date. The term ``annuity starting date'' means
the first day of the first period with respect to which an amount is
received as an annuity, whether by reason of retirement or by reason of
disability.
(3) Earliest retirement age. The term ``earliest retirement age''
means the earliest date on which, under the plan, the participant could
elect to receive retirement benefits, including any benefit the
participant is entitled to receive on account of disability.
(c) Election not to take joint and survivor annuity form--(1) In
general. A plan shall not be treated as satisfying the requirements of
this section unless each participant has the right to elect in writing
not to take a joint and survivor annuity during a reasonable period
before the annuity starting date. However, if a plan provides that a
qualified joint and survivor annuity is the only form of benefit payable
under the plan, no election need be provided.
(2) Information to be provided to the participant. (i) The plan
administrator must furnish to the participant a written notification, in
nontechnical terms, of the availability of the election provided by this
paragraph, within a reasonable amount of time after the first day of the
election period. This notification shall also inform the participant of
the availability of the information specified in subdivision (ii) of
this subparagraph.
(ii) The plan administrator must furnish to the participant a
written explanation in nontechnical language of the terms and conditions
of the joint and survivor annuity and the financial effect upon the
participant's annuity (in terms of dollars per annuity payment) of
making an election under this paragraph. This explanation must be
provided to the participant within a reasonable amount of time from the
date of the participant's request during the election period.
(3) Form of election. The election shall be in writing and clearly
indicate that the participant is electing to receive his benefits under
the plan in a form other than that of a joint and survivor annuity.
(4) Election is revocable. This election may be revoked in writing
during the election period. After an election is revoked another
election under this paragraph may be made during the election period.
(d) Plans providing for early retirement--(1) Period during which
qualified joint and survivor annuity not required. Notwithstanding the
provisions of paragraph (a) of this section, in the case of a plan which
provides for the payment of benefits before the normal retirement age
(as defined in section 411(a)(8)), the plan is not required to provide
for the payment of annuity benefits in a form having the effect of a
qualified joint and survivor annuity during the period beginning on the
date on which the employee enters into the plan as a participant and
ending on the later of--
(i) The date the employee reaches the earliest retirement age under
the plan (as defined in paragraph (b)(3) of this section), or
(ii) The first day of the 120th month beginning before the date on
which the employee reaches normal retirement age.
(2) Period during which qualified joint and survivor annuity
required. (i) If a participant terminates employment and begins to
receive retirement benefits during the period described in subparagraph
(1) of this paragraph, he and his spouse must receive, after the
termination of such period (or after the date such period would have
terminated if the participant had survived),
[[Page 196]]
benefits having the effect of a qualified joint and survivor annuity,
unless the participant has made an election under paragraph (c) of this
section.
(ii) If a participant terminates employment and begins to receive
retirement benefits after the period described in subparagraph (1) of
this paragraph, he and his spouse must receive benefits having the
effect of a qualified joint and survivor annuity, unless the participant
has made an election under paragraph (c) of this section.
(iii) The provisions of this subparagraph may be illustrated by the
following example:
Example. A plan which provides a benefit in the form of a life
annuity also provides that a participant may retire before the normal
retirement age of 65 and receive a benefit, if he has completed 30 years
of service. A, an employee, became a participant at the age of 18. A
retires and begins to receive retirement benefits at the age of 48.
Unless A otherwise elects, the plan must provide a qualified joint and
survivor annuity to A and his spouse after A reaches age 55 (the later
of the earliest retirement age (age 48) or 10 years before normal
retirement age (age 55)) or after the date A would have reached age 55,
if he had survived. The survivor annuity paid to the spouse must satisfy
the requirements of paragraph (b)(1) of this section. The plan may, but
is not required to, provide the survivor annuity before age 55 if the
participant dies between age 48 and age 55.
(3) Election of survivor annuity--(i) In general. (A) A plan
described in subparagraph (1) of this paragraph does not meet the
requirements of paragraph (a) of this section unless, under the plan, a
participant may elect, during a reasonable period, a survivor annuity to
be payable on his death during the period beginning on the date on which
the period described in subparagraph (1) of this paragraph ends and
ending on the date on which he reaches normal retirement age if he
continues his employment during that period. Breaks in service during
that period will neither invalidate a previous election or revocation
nor prevent an election from being made or revoked during the election
period.
(B) If a plan provides that a survivor annuity is the only form of
benefit payable under the plan, no election need be provided.
(ii) Example. The provisions of subdivision (i) of this subparagraph
may be illustrated by the following example:
Example. A plan which provides a life annuity also provides that a
participant may retire before the normal retirement age of 65 and
receive a benefit, if he has completed 30 years of service. Under this
plan, an employee who became a participant at the age of 18 will be
eligible to receive retirement benefits at the age of 48. This plan must
allow a participant who continues his employment to elect a survivor
annuity, described in subdivision (v) of this subparagraph, to be
payable on the death of the participant if death occurs after age 55
(the later of the date the participant reaches the earliest retirement
age (age 48) or 10 years before normal retirement age (age 55)) but
before the date the participant reaches normal retirement age (age 65).
(iii) Information to be provided by plan administrator. (A) The plan
administrator must furnish to the participant a written notification in
nontechnical terms of the availability of the election provided by this
subparagraph, within a reasonable amount of time after the first day of
the election period. This notification shall also inform the participant
of the availability of the information specified in subdivision (iii)(B)
of this subparagraph.
(B) During the election period, the plan administrator must furnish
to the participant, within a reasonable amount of time from the date of
his request, a written explanation in nontechnical language of the terms
and conditions of the survivor annuity and the financial effect upon the
participant's annuity (in terms of dollars per annuity payment) of an
election or of a revocation of an election under this subparagraph.
(iv) Payments under the survivor annuity. In order to meet the
requirements of this subparagraph, if an election is made, the payments
under the survivor annuity must not be less than the payments which
would have been made under the joint and survivor annuity to which the
surviving spouse would have been entitled if the participant had made
the election described in this subparagraph immediately prior to his
retirement and if his retirement had occurred on the day before his
death and within the period during which an
[[Page 197]]
election can be made. For example, if a participant is entitled to a
single life annuity of $100 per month or a reduced amount under a
qualified joint and survivor annuity of $80 per month, regardless of
when he makes a valid election under subparagraph (2) of this paragraph,
his spouse is entitled to a payment of at least $40, but not more than
$80 per month, under the survivor annuity.
(v) Form of election. The election shall be in writing and clearly
indicate that the participant is electing the joint and survivor annuity
form.
(vi) Election is revocable. An election under this subparagraph may
be revoked in writing during the election period. After an election has
been revoked, another election under this subparagraph may be made
during the election period. See paragraph (c) of this section, relating
to the right to elect not to take the joint and survivor annuity form.
(e) Marriage requirements. (1) A plan shall be treated as satisfying
the requirements of this section even though it requires the participant
and his spouse to have been married to each other on the annuity
starting date.
(2) A plan shall be treated as satisfying the requirements of this
section even though it provides that the spouse of the participant is
not entitled to receive a survivor annuity (whether or not the election
described in paragraph (d)(3) of this section has been made) unless the
participant and his spouse have been married to each other throughout
the 1-year period ending on the date of such participant's death.
(f) Effect of participant's death on an election or revocation of an
election under paragraph (c) or (d)(3). A plan shall not be treated as
not satisfying the requirements of this section merely because the plan
contains a provision that any election made under paragraph (c) or
(d)(3) of this section and any revocation of any such election does not
become effective or ceases to be effective if the participant dies
within a period, not in excess of 2 years, beginning on the date of such
election or revocation. A plan containing a provision described in the
preceding sentence shall not satisfy the requirements of this section
unless it also provides that any such election and any revocation of any
such election will be given effect in any case in which--
(1) The participant dies from accidental causes,
(2) A failure to give effect to the election or revocation would
deprive the participant's survivor of a survivor annuity, and
(3) Such election or revocation is made before such accident
occurred.
(g) Costs of providing joint and survivor annuity form. A plan may
take into account in any equitable manner consistent with generally
accepted actuarial principles applied on a consistent basis any
increased costs resulting from providing joint and survivor annuity
benefits.
(h) Application and effective date. (1) Section 401(a)(11) and this
section shall apply to a plan only with respect to plan years to which
section 411 (relating to minimum vesting standards) is applicable to the
plan.
(2) Section 401(a)(11) and this section shall apply if--
(i) The participant's annuity starting date falls within a plan year
beginning after December 31, 1975, and
(ii) The participant was an active participant in the plan on or
after the first day of the first plan year beginning after December 31,
1975.
For purposes of this paragraph, the term ``active participant'' means a
participant for whom benefits are being accrued under the plan on his
behalf, the employer is obligated to contribute to or under the plan on
his behalf, or the employer would have been obligated to contribute to
or under the plan on his behalf if any contributions were made to or
under the plan.
(Sec. 401(a)(11) of the Internal Revenue Code of 1954, 88 Stat. 935 (26
U.S.C. 401(a)(11)))
[T.D. 7379, 40 FR 45810, Oct. 3, 1975; 40 FR 49326, Oct. 22, 1975]
Sec. 11.401(a)-19 Nonforfeitability in case of certain withdrawals.
(a) Application of section. Section 401(a)(19) and this section
apply to a plan to which section 411(a) applies. (See section 411(e) and
Sec. 11.411(a)-2 for applicability of section 411.)
[[Page 198]]
(b) Prohibited forfeitures--(1) General rule. A plan to which this
section applies is not a qualified plan (and a trust forming a part of
such plan is not a qualified trust) if, under such plan, any part of a
participant's accrued benefit derived from employer contributions is
forfeitable solely because a benefit derived from the participant's
contributions under the plan is voluntarily withdrawn by him after he
has become a 50 percent vested participant.
(2) 50 percent vested participant. For purposes of paragraph (b)(1)
of this section, a participant is a 50 percent vested participant when
he has a nonforfeitable right (within the meaning of section 411 and the
regulations thereunder) to at least 50 percent of his accrued benefit
derived from employer contributions.
(3) Certain forfeitures. Paragraph (b)(1) of this section does not
apply in the case of a forfeiture permitted by section 411(a)(3)(D)(iii)
and Sec. 11.411(a)-4(b)(5)(i) (relating to forfeitures of certain
benefits accrued before September 2, 1974).
[T.D. 7387, 40 FR 51421, Nov. 5, 1975]
Sec. 11.401(b)-1 Certain retroactive changes in plan.
(a) General rule. (1) Under section 401(b), a stock bonus, pension,
profit-sharing or annuity plan or bond purchase plan which does not
satisfy the requirements of section 401(a) on any day solely as a result
of a disqualifying provision (as defined in paragraph (b) of this
section) shall be considered to have satisfied such requirements on such
day if there is adopted during the remedial amendment period (as
determined under paragraphs (c) and (d) of this section) with respect to
such disqualifying provision an amendment which causes the plan to
satisfy all such requirements of section 401(a), 403(a) or 405(a) for
the whole of the remedial amendment period (including extension
thereof).
(2) This section shall not apply to any disqualifying provision if
the remedial amendment period (as determined under paragraphs (c) and
(d)(1) of this section determined without regard to paragraph (d)(2) of
this section) with respect to such disqualifying provision ends prior to
September 2, 1974.
(b) Disqualifying provisions. For purposes of this section, with
respect to a plan described in paragraph (a) of this section the term
``disqualifying provision'' means any provision of--
(1) A plan as adopted,
(2) A plan amendment, or
(3) The Employee Income Security Act of 1974 (Pub. L. 93-406, 88
Stat. 829),
which causes such plan to fail to satisfy the requirements of section
401(a), 403(a), or 405(a).
(c) Remedial amendment period. (1) The remedial amendment period
with respect to a disqualifying provision begins on the effective date
of the disqualifying provision. For purposes of this section, the
effective date of a disqualifying provision is--
(i) In the case of a disqualifying provision in a plan as adopted,
the date the plan is put into effect,
(ii) In the case of a plan amendment, the date the plan amendment is
adopted or put into effect (whichever is earlier), or
(iii) In the case of a statutory provision described in paragraph
(b)(3) of this section, the effective date of such provision.
(2) Unless extended as provided by paragraph (d) of this section,
the remedial amendment period ends with the time prescribed by law
(including extensions) for filing the return of the employer for the
employer's taxable year in which falls--
(i) With respect to a disqualifying provision in a plan as adopted,
or a plan amendment, the later of the date on which such provision was
adopted or put into effect.
(ii) With respect to a statutory provision described in paragraph
(b)(3) of this section, the effective date of such provision.
(d) Extension for determination letters--(1) In general. If, before
the end of the remedial amendment period (determined without regard to
this paragraph) with respect to a disqualifying provision, the employer
or plan administrator files a request pursuant to Sec. 601.210(o) of
this chapter (Statement of Procedural Rules) for a determination letter
with respect to the initial qualifications of the plan or the effect of
such disqualifying provision on the qualified status of the plan (or a
trust
[[Page 199]]
which is part of a plan) under section 401(a), 403(a), or 405(a), then
except as provided in subparagraph (3) of this paragraph, such remedial
amendment period may be extended for a period not to exceed 150 days,
beginning on the day after the last day of the employers taxable year in
which falls the dates described in subdivisions (i) and (ii) of
paragraph (c)(2) of this section. The 150-day period does not include
any day on which there is pending before the Internal Revenue Service a
request for a determination letter described in this subparagraph. For
this purpose, such a request is considered to be pending before the
Internal Revenue Service from the date it is filed with the Internal
Revenue Service to the date on which notice of the final determination
with respect to the request is issued by the Internal Revenue Service,
the request is withdrawn, or the request is otherwise finally disposed
of by the Internal Revenue Service.
(2) Special rules. Except as provided in subparagraph (3) of this
paragraph, the period provided by subparagraph (1) of this paragraph
shall not end prior to the later of December 31, 1975, or the expiration
of 30 days after--
(i) The date on which a notice of final determination with respect
to a request described in that subparagraph is issued by the Internal
Revenue Service, or, where applicable,
(ii) The date on which a judgment pursuant to section 7476 (relating
to declaratory judgments) by the United States Tax Court in a case or
controversy involving such determination becomes final.
(3) Overall limitation. The period provided by subparagraph (1) of
this paragraph shall not expire later than the last day (determined
under section 6501) for assessment of any tax imposed by the Internal
Revenue Code with respect to the taxable year of the employer
immediately preceding the first day of such period.
(Sec. 401(b), Internal Revenue Code of 1954, 88 Stat. 943 (26 U.S.C.
401(b)))
[T.D. 7377, 40 FR 44544, Sept. 29, 1975]
Sec. 11.401(d)(1)-1 Nonbank trustees of trusts benefiting owner-employees.
(a) Effective dates--(1) General rule. For a plan not in existence
on January 1, 1974, this section shall apply to the first plan year
commencing after September 2, 1974, and all subsequent plan years.
(2) Existing plans. For a plan in existence on January 1, 1974, this
section shall apply to the first plan year commencing after December 31,
1975, and all subsequent plan years.
(b) In general. For plan years to which this section applies, the
trustee of a trust described in Sec. 1.401-12(c)(1)(i) may
(notwithstanding Sec. 1.401-12(c)) be a person other than a bank (within
the meaning of section 401(d)(1)) if he demonstrates to the satisfaction
of the Commissioner that the manner in which he will administer trusts
will be consistent with the requirements of section 401. Such
demonstration must be made by a written application to the Commissioner
of Internal Revenue, Attention: E:EP, Internal Revenue Service,
Washington, DC 20224. Such application must meet the requirements set
forth in paragraphs (c) to (g) of this section.
(c) Fiduciary ability. The applicant must demonstrate in detail his
ability to act within the accepted rules of fiduciary conduct. Such
demonstration must include the following elements of proof:
(1) Continuity. (i) The applicant must assure the uninterrupted
performance of its fiduciary duties notwithstanding the death or change
of its owners. Thus, for example, there must be sufficient diversity in
the ownership of the applicant to ensure that the death or change of its
owners will not interrupt the conduct of its business. Therefore, the
applicant cannot be an individual.
(ii) Sufficient diversity in the ownership of an incorporated
applicant means that individuals each of whom owns more than 20 percent
of the voting stock in the applicant own, in the aggregate, no more than
50 percent of such stock.
(iii) Sufficient diversity in the ownership of an applicant which is
a partnership means that--
[[Page 200]]
(A) Individuals each of whom owns more than 20 percent of the
profits interest in the partnership own, in the aggregate, no more than
50 percent of such profits interest, and
(B) Individuals each of whom owns more than 20 percent of the
capital interest in the partnership own, in the aggregate, no more than
50 percent of such capital interest.
(iv) For purposes of this subparagraph, the ownership of stock and
of capital and profits interests shall be determined in accordance with
the rules for constructive ownership of stock provided in section
1563(e) and (f)(2). For this purpose, the rules for constructive
ownership of stock provided in section 1563(e) and (f)(2). For this
purpose, the rules for constructive ownership of stock provided in
section 1563(e) and (f)(2) shall apply to a capital or profits interest
in a partnership as if it were a stock interest.
(2) Established location. The applicant must have an established
place of business in the United States where he is accessible during
every business day.
(3) Fiduciary experience. The applicant must have fiduciary
experience or expertise sufficient to ensure that he will be able to
perform his fiduciary duties. Evidence of fiduciary experience must
include proof that a significant part of the business of the applicant
consists of exercising fiduciary powers similar to those he will
exercise if his application is approved. Evidence of fiduciary expertise
must include proof that the applicant employs personnel experienced in
the administration of fiduciary powers similar to those he will exercise
if his application is approved.
(4) Fiduciary responsibility. The applicant must assure compliance
with the rules of fiduciary conduct set out in paragraph (f) of this
section.
(5) Financial responsibility. The applicant must exhibit a high
degree of solvency commensurate with the obligations imposed by this
section. Among the factors to be taken into account are the applicant's
net worth, his liquidity, and his ability to pay his debts as they come
due.
(d) Capacity to account. The applicant must demonstrate in detail
his experience and competence with respect to accounting for the
interests of a large number of individuals (including calculating and
allocating income earned and paying out distributions to payees).
Examples of accounting for the interests of a large number of
individuals include accounting for the interests of a large number of
shareholders in a regulated investment company and accounting for the
interests of a large number of variable annuity contract holders.
(e) Fitness to handle funds--(1) In general. The applicant must
demonstrate in detail his experience and competence with respect to
other activities normally associated with the handling of retirement
funds.
(2) Examples. Examples of activities normally associated with the
handling of retirement funds include:
(i) To receive, issue receipts for, and safely keep securities;
(ii) To collect income;
(iii) To execute such ownership certificates, to keep such records,
make such returns, and render such statements as are required for
Federal tax purposes;
(iv) To give proper notification regarding all collections;
(v) To collect matured or called principal and properly report all
such collections;
(vi) To exchange temporary for definitive securities;
(vii) To give proper notification of calls, subscription rights,
defaults in principal or interest, and the formation of protective
committees;
(viii) To buy, sell, receive, or deliver securities on specific
directions.
(f) Rules of fiduciary conduct--(1) Administration of fiduciary
powers. The applicant must demonstrate that under applicable regulatory
requirements, corporate or other governing instruments, or its
established operating procedures:
(i)(A) The owners or directors of the applicant will be responsible
for the proper exercise of fiduciary powers by the applicant. Thus, all
matters pertinent thereto, including the determination of policies, the
investment and disposition of property held in a fiduciary capacity, and
the direction and review of the actions of all employees utilized by the
applicant in the exercise of his fiduciary powers, will be the
[[Page 201]]
responsibility of the owners or directors. In discharging this
responsibility, the owners or directors may assign to designated
employees, by action duly recorded, the administration of such of the
applicant's fiduciary powers as may be proper to assign.
(B) A written record will be made of the acceptance and of the
relinquishment or closing out of all fiduciary accounts, and of the
assets held for each account.
(C) At least once during each period of 12 months all the assets
held in or for each fiduciary account where the applicant has investment
responsibilities will be reviewed to determine the advisability of
retaining or disposing of such assets.
(ii) All employees taking part in the performance of the applicant's
fiduciary duties will be adequately bonded. Nothing in this subdivision
shall require any person to be bonded in contravention of section 412(d)
of the Employee Retirement Income Security Act of 1974 (29 U.S.C.
1112(d)).
(iii) The applicant will designate, employ, or retain legal counsel
who will be readily available to pass upon fiduciary matters and to
advise the applicant.
(iv) In order to segregate the performance of his fiduciary duties
from other business activities, the applicant will maintain a separate
trust division under the immediate supervision of an individual
designated for that purpose. The trust division may utilize the
personnel and facilities of other divisions of the applicant, and other
divisions of the applicant may utilize the personnel and facilities of
the trust division, as long as the separate identity of the trust
division is preserved.
(2) Adequacy of net worth. (i) Not less frequently than once during
each calendar year the applicant will determine the value of the assets
held by him in trust. Such assets will be valued at their current value,
except that the assets of an employee benefit plan to which section
103(b)(3)(A) of the Employee Retirement Income Security Act of 1974 (29
U.S.C. 1023(b)(3)(A)) applies will be considered to have the value
stated in the most recent annual report of the plan.
(ii) No fiduciary account will be accepted by the applicant unless
his net worth (determined as of the end of the most recent taxable year)
exceeds the greater of--
(A) $100,000, or
(B) Four percent of the value of all of the assets held by the
applicant in trust (determined as of the most recent valuation date).
(iii) The applicant will take whatever lawful steps are necessary
(including the relinquishment of fiduciary accounts) to ensure that his
net worth (determined as of the close of each taxable year) exceeds the
greater of--
(A) $50,000, or
(B) Two percent of the value of all of the assets held by the
applicant in trust (determined as of the most recent valuation date).
(3) Audits. (i) The applicant will at least once during each period
of 12 months cause detailed audits of the fiduciary books and records to
be made by an independent qualified public accountant, and at such time
will ascertain whether the fiduciary accounts have been administered in
accordance with law, this section, and sound fiduciary principles. Such
audits shall be conducted in accordance with generally accepted auditing
standards, and shall involve such tests of the fiduciary books and
records of the applicant as are considered necessary by the independent
qualified public accountant.
(ii) In the case of an applicant who is regulated, supervised, and
subject to periodic examination by a State or Federal agency, such
applicant may adopt an adequate continuous audit system in lieu of the
periodic audits required by paragraph (f)(3)(i) of this section.
(iii) A report of the audits and examinations required under this
subparagraph, together with the action taken thereon, will be noted in
the fiduciary records of the applicant.
(4) Funds awaiting investment or distribution. Funds held in a
fiduciary capacity by the applicant awaiting investment or distribution
will not be held uninvested or undistributed any longer than is
reasonable for the proper management of the account.
(5) Custody of investments. (i) Except for investments pooled in a
common
[[Page 202]]
investment fund in accordance with the provisions of paragraph (f)(6) of
this section, the investments of each account will not be commingled
with any other property.
(ii) Fiduciary assets requiring safekeeping will be deposited in an
adequate vault. A permanent record will be kept of fiduciary assets
deposited in or withdrawn from the vault.
(6) Common investment funds. Where not in contravention of local law
the assets of an account may be pooled in a common investment fund (as
defined in paragraph (f)(8)(iii) of this section) which must be
administered as follows:
(i) Each common investment fund must be established and maintained
in accordance with a written agreement, containing appropriate
provisions as to the manner in which the fund is to be operated,
including provisions relating to the investment powers and a general
statement of the investment policy of the applicant with respect to the
fund; the allocation of income, profits and losses; the terms and
conditions governing the admission or withdrawal of participations in
the fund; the auditing of accounts of the applicant with respect to the
fund; the basis and method of valuing assets in the fund, setting forth
specific criteria for each type of asset; the minimum frequency for
valuation of assets of the fund; the period following each such
valuation date during which the valuation may be made (which period in
usual circumstances may not exceed 10 business days); the basis upon
which the fund may be terminated; and such other matters as may be
necessary to define clearly the rights of participants in the fund. A
copy of the agreement must be available at the principal office of the
applicant for inspection during all business hours, and upon request a
copy of the agreement must be furnished to any interested person.
(ii) All participations in the common investment fund must be on the
basis of a proportionate interest in all of the assets.
(iii) Not less frequently than once during each period of 3 months
applicant must determine the value of the assets in the fund as of the
date set for the valuation of assets. No participation may be admitted
to or withdrawn from the fund except (A) on the basis of such valuation
and (B) as of such valuation date. No participation may be admitted to
or withdrawn from the fund unless a written request for or notice of
intention of taking such action has been entered on or before the
valuation date in the fiduciary records of the applicant. No request or
notice may be canceled or countermanded after the valuation date.
(iv)(A) The applicant must at least once during each period of 12
months cause an adequate audit to be made of the common investment fund
by a qualified public accountant.
(B) The applicant must at least once during each period of 12 months
prepare a financial report of the fund which, based upon the above
audit, must contain a list of investments in the fund showing the cost
and current market value of each investment; a statement for the period
since the previous report showing purchases, with cost; sales, with
profit or loss and any other investment changes; income and
disbursements; and an appropriate notation as to any investments in
default.
(C) The applicant must transmit and certify the accuracy of the
financial report to the administrator of each plan participating in the
common investment fund within 120 days after the end of the plan year.
(v) When participations are withdrawn from a common investment fund,
distributions may be made in cash or ratably in kind, or partly in cash
and partly in kind, provided that all distributions as of any one
valuation date must be made on the same basis.
(vi) If for any reason an investment is withdrawn in kind from a
common investment fund for the benefit of all participants in the fund
at the time of such withdrawal and such investment is not distributed
ratably in kind, it must be segregated and administered or realized upon
for the benefit ratably of all participants in the common investment
fund at the time of withdrawal.
(7) Books and records. (i) The applicant must keep his fiduciary
records separate and distinct from other records. All fiduciary records
must be
[[Page 203]]
so kept and retained for as long as the contents thereof may become
material in the administration of any internal revenue law. The
fiduciary records must contain full information relative to each
account.
(ii) The applicant must keep an adequate record of all pending
litigation to which he is a party in connection with the exercise of
fiduciary powers.
(8) Definitions. For purposes of this paragraph and paragraph (c)(5)
of this section--
(i) The term ``account'' or ``fiduciary account'' means a trust
described in section 401(a) (including a custodial account described in
section 401(f)), a custodial account described in section 403(b)(7), or
an individual retirement account described in section 408(a) (including
a custodial account described in section 408(h)).
(ii) The term ``administrator'' means an administrator as defined in
section 3(16)(A) of the Employee Retirement Income Security Act of 1974,
29 U.S.C. 1002(16)(A).
(iii) The term ``common investment fund'' means a trust which
satisfied the following requirements:
(A) The trust consists of all or part of the assets of several
accounts which have been established with the applicant, and
(B) The trust is described in section 401(a) and exempt from tax
under section 501(a), or is a common investment fund described in
Sec. 1.408-2(b)(5) (as published with notice of proposed rulemaking in
the Federal Register on February 21, 1975, at 40 FR 7661), or both.
(iv) The term ``employee benefit plan'' means an employee benefit
plan as defined in section 3(2) of the Employee Retirement Income
Security Act of 1974, 29 U.S.C. 1002(2).
(v) The term ``fiduciary records'' means all matters which are
written, transcribed, recorded, received or otherwise come into the
possession of the applicant and are necessary to preserve information
concerning the acts and events relevant to the fiduciary activities of
the applicant.
(vi) The term ``qualified public accountant'' means a qualified
public accountant as defined in section 103(a)(3)(D) of the Employee
Retirement Income Security Act of 1974, 29 U.S.C. 1023(a)(3)(D).
(vii) The term ``net worth'' means the amount of the applicant's
assets less the amount of his liabilities, as determined in accordance
with generally accepted accounting principles.
(g) Special rules--(1) Passive trustee. (i) An applicant who
undertakes to act only as a passive trustee may be relieved of one or
more of the requirements of this section upon clear and convincing proof
that such requirements are not germane, under all the facts and
circumstances, to the manner in which he will administer any trust. A
trustee is a passive trustee only if under the written trust instrument
he has no discretion to direct the investment of the trust funds or any
other aspect of the business administration of the trust, but is merely
authorized to acquire and hold particular investments specified by the
trust instrument. Thus, for example, in the case of an applicant who
undertakes merely to acquire and hold the stock of a single regulated
investment company, the requirements of paragraphs (f)(1)(i)(C),
(1)(iv), and (6) of this section shall not apply and no negative
inference shall be drawn from the applicant's failure to demonstrate his
experience or competence with respect to the activities described in
paragraph (e)(2)(v) to (viii) of this section.
(ii) The determination letter issued to an applicant who is approved
by reason of this subparagraph shall state that the applicant is
authorized to act only as a passive trustee.
(2) Federal or State regulation. Evidence that an applicant is
subject to Federal or State regulation with respect to one or more
relevant factors shall be given weight in proportion to the extent that
such regulatory standards are consonant with the requirements of section
401.
(3) Savings account. (i) An applicant will be approved to act as
trustee under this subparagraph if the following requirements are
satisfied:
(A) The applicant is a credit union, industrial loan company,
savings and loan association, or other financial institution designated
by the Commissioner;
[[Page 204]]
(B) The investment of the trust assets will be solely in deposits in
the applicant;
(C) Deposits in the applicant are insured (up to the dollar limit
prescribed by applicable law) by an agency or instrumentality of the
United States or a State.
(ii) Any applicant who satisfies the requirements of this
subparagraph is hereby approved, and (notwithstanding paragraph (b) of
this section) is not required to submit a written application. This
approval takes effect on the first day after December 22, 1976, on which
the applicant satisfies the requirements of this subparagraph, and
continues in effect for so long as the applicant continues to satisfy
those requirements.
(4) Notification of Commissioner. The applicant must notify the
Commissioner in writing of any change which affects the continuing
accuracy of any representation made in the application required by this
section, whether the change occurs before or after the applicant
receives a determination letter. Such notification must be addressed to
Commissioner of Internal Revenue, Attention: E:EP, Internal Revenue
Service, Washington, DC 20224.
(5) Substitution of trustee. No applicant shall be approved unless
he undertakes to act as trustee only under trust instruments which
contain a provision to the effect that the employer is to substitute
another trustee upon notification by the Commissioner that such
substitution is required because the applicant has failed to comply with
the requirements of this section or is not keeping such records, or
making such returns, or rendering such statements as are required by
forms or regulations.
(6) Revocation. Approval of the application required by this section
may be revoked for any good and sufficient reason.
(Sec. 401(d)(1) and Internal Revenue Code of 1954 (88 Stat. 939 26
U.S.C. 401))
[T.D. 7383, 40 FR 48509, Oct. 16, 1975 as amended by T.D. 7448, 41 FR
55510, Dec. 21, 1976]
Sec. 11.402(e)(4)(A)-1 Lump sum distributions in the case of an employee who has separated from service.
(a) Balance to the credit of an employee. Section 402(e)(4)(A)
provides that in order for a distribution or payment from a qualified
plan to be a lump sum distribution, the distribution or payment must
represent the employee's balance under the plan. The employee's balance
does not include any amount which is forfeited under the plan (even
though the amount may be reinstated) as of the close of the taxable year
of the recipient within which the distribution is made. In addition, in
the case of an employee who has separated from service, the employee's
balance does not include an amount which is subject to forfeiture not
later than the close of the plan year within which the employee incurs a
one-year break in service (within the meaning of section 411) if--
(1) By reason of the break in service, the amount is actually
forfeited at or prior to the close of that plan year, and
(2) The break in service occurs within 25 months after the
employee's separation from service. In the case of a plan which uses the
elapsed time method of crediting service, the break in service may occur
within 25 months of the employee's severance from service. See
Department of Labor regulations relating to the elapsed time method for
the date an employee severs from service.
An employee may assume that an amount subject to forfeiture will be
treated as forfeited by the date prescribed in paragraphs (a) (1) and
(2) of this section if, under the plan, forfeiture will occur not later
than that date. Therefore, he may assume that a distribution is a lump
sum distribution at the time it is made, if the other requirements for
lump sum distributions are satisfied. However, if the amount is not
forfeited by that date, the amount will be taken into account in
determining the balance to the credit of the employee. Accordingly, the
distribution will not be a lump sum distribution because it did not
include the employee's entire balance under the plan.
[[Page 205]]
(b) Rollover contribution. As described in paragraph (a) of this
section, an employee may assume that a distribution is a lump sum
distribution even though part of the balance of his account has not been
forfeited at the time the distribution is made. He may then roll the
distribution over as a contribution to an individual retirement
arrangement pursuant to section 402(a)(5) or 403(a)(4). It may be
subsequently determined that the distribution was not a lump sum
distribution because an amount subject to forfeiture was not in fact
forfeited within the time required in paragraph (a) of this section. In
that case, the contribution will be an excess contribution to the
individual retirement arrangement, deemed made in the first taxable year
of the employee in which it can be determined that an amount subject to
forfeiture will not be forfeited.
(c) Effective date. This section is effective for distributions made
in taxable years of recipients beginning after December 31, 1973.
[T.D. 7488, 42 FR 27882, June 1, 1977]
Sec. 11.402(e)(4)(B)-1 Election to treat an amount as a lump sum distribution.
(a) In general. For purposes of sections 402, 403, and this section,
an amount which is described in section 402(e)(4)(A) and which is not an
annuity contract may be treated as a lump sum distribution under section
402(e)(4)(A) only if the taxpayer elects for the taxable year to have
all such amounts received during such year so treated. Not more than one
election may be made under this section with respect to an employee
after such employee has attained age 59\1/2\.
(b) Taxpayers eligible to make the election. Individuals, estates,
and trusts are the only taxpayers eligible to make the election provided
by this section. In the case of a lump sum distribution made with
respect to an employee to 2 or more trusts, the election provided by
this section shall be made by the employee or by the personal
representative of a deceased employee.
(c) Procedure for making election--(1) Time and scope of election.
An election under this section shall be made for each taxable year to
which such election is to apply. The election shall be made before the
expiration of the period (including extension thereof) prescribed in
section 6511 for making a claim for credit or refund of the assessed tax
imposed by Chapter I of Subtitle A of the Code for such taxable year.
(2) Manner of making election. An election by the taxpayer with
respect to a taxable year shall be made by filing Form 4972 as a part of
the taxpayer's income tax return or amended return for the taxable year.
(3) Revocation of election. An election made pursuant to this
section may be revoked within the time prescribed in subparagraph (1) of
this paragraph for making an election, only if there is filed, within
such time, an amended income tax return for such taxable year, which
includes a statement revoking the election and is accompanied by payment
of any tax attributable to the revocation. If an election for a taxable
year is revoked, another election may be made for that taxable year
under subparagraphs (1) and (2) of this paragraph.
(Sec. 402(e)(4)(B) of the Internal Revenue Code of 1954 (88 Stat. 989,
26 U.S.C. 402(e)(4)(B)))
[T.D. 7339, 40 FR 1016, Jan. 6, 1975]
Sec. 11.404(a)(6)-1 Time when contributions to ``H.R. 10'' plans considered made.
(a) In general. Section 404(a)(6), as amended by section 1013(c)(2)
of the Employee Retirement Income Security Act of 1974, provides that
for purposes of paragraphs (1), (2), and (3) of section 404(a), a
taxpayer shall be deemed to have made a payment on the last day of the
preceding taxable year if the payment is on account of such taxable year
and is made not later than the time prescribed by law for filing the
return for such taxable year (including extensions thereof). Under
section 1017(b) of the Employee Retirement Income Security Act of 1974
(prior to its amendment by the Tax Reduction Act of 1975), in the case
of a plan which was in existence on January 1, 1974, the foregoing
provision generally applies for contributions on account of taxable
years of an employer ending with or within plan years beginning after
December 31, 1975. In the case of a plan
[[Page 206]]
not in existence on January 1, 1974, the foregoing provision generally
applies for contributions on account of taxable years of an employer
ending with or within plan years beginning after September 2, 1974. See
Sec. 11.410(a)-2(c) for time a plan is considered in existence. See also
Sec. 11.410(a)-2(d), which provides that a plan in existence on January
1, 1974 may elect to have certain provisions, including the amendment to
section 404(a)(6) contained in section 1013 of the Employee Retirement
Income Security Act of 1974, apply to a plan year beginning after
September 2, 1974, and before the otherwise applicable effective date
contained in that section.
(b) ``H.R. 10'' plans may elect new provision. Under section 402 of
the Tax Reduction Act of 1975 (89 Stat. 47), in the case of a plan which
was in existence on January 1, 1974, and which provides contributions or
benefits for employees some or all of whom are employees within the
meaning of section 401(c)(1) of the Code and Sec. 1.401-10(b), the
provision described in paragraph (a) of this section shall apply for
taxable years of an employer ending with or within plan years beginning
after December 31, 1974, but only if the employer (within the meaning of
section 401(c)(4) of the Code and Sec. 1.401-10(e)) elects to have such
provisions apply as provided in paragraph (c) of this section.
(c) Manner of election. The election described in paragraph (b) of
this section shall be considered to be made if the employer (as
described in paragraph (b) of this section)--
(1) Makes a contribution which relates to his preceding taxable year
within the time prescribed in paragraph (a) of this section to a plan
described in paragraph (b) of this section, and
(2) Claims a deduction for such contribution on his tax return for
such year (or, in the case of a contribution by a partnership on behalf
of a partner, the contribution is shown on Schedule K of the partnership
tax return for such year); no formal statement is necessary. In the case
of an employer whose income tax return for the year on account of which
the payment is made is required to be filed (determined without regard
to extensions of time) on or before April 15, 1976, and who made a
payment within the time prescribed in paragraph (a) of this section, the
election also may be made by filing an amended return or claim for
refund with respect to such year on or before September 30, 1976.
(d) Election is irrevocable. Any election made under paragraph (c)
of this section, once made, shall be irrevocable.
(e) Examples. The rules of this section are illustrated by the
following examples.
Example (1). On October 15, 1976, the ABC Partnership made a
contribution to the ABC Profit Sharing Plan and Trust on behalf of
partners and common-law employees with respect to the plan year ending
December 31, 1975. The ABC Profit Sharing Trust was exempt under section
501 (a) throughout 1975. The contribution for both partners and
employees was reflected on the partnership return for the calendar year
1975 which was filed on October 10, 1976; proper extensions of the due
date of the partnership return had been received, extending the due date
to October 15, 1976. The election is valid since all requirements of
this section have been met.
Example (2). The XYZ Partnership made a plan contribution on April
10, 1976, with respect to the plan year ending December 31, 1975, but
the amount contributed for 1975 was not reflected in the partnership
return filed for the calendar year 1975 on April 15, 1976. However, the
XYZ Partnership filed an amended partnership return for the year 1975 on
September 30, 1976, claiming a deduction for the employee-related
contribution and setting forth on Schedule K the contribution relating
to partners. The election is valid, since the contribution on account of
1975 was made within the time required, and was shown on the amended tax
return of the employer for 1975 filed within the time prescribed in
paragraph (c)(2) of this section.
Example (3). Mr. Smith, a sole proprietor whose taxable year is the
calendar year, made a contribution to the Smith Profit Sharing Plan and
Trust on April 15, 1976, for the plan year which began December 1, 1974,
and ended November 30, 1975. The plan was in existence on January 1,
1974. Since the contribution was made within the time prescribed by this
section and was on account of a taxable year of the employer ending
within a plan year which began after December 31, 1974, the contribution
may be deducted on Mr. Smith's return for 1975, even though the
contribution was for a plan year beginning before December 31, 1974.
Example (4). The DEF Partnership, reporting its income on the basis
of a fiscal year ending June 30, made a contribution to its ``H.R. 10''
plan which was in existence on January 1, 1974, and whose plan year was
the calendar year. The contribution was made on
[[Page 207]]
September 30, 1975, and was on account of the taxable year of the
partnership ending June 30, 1975. The contribution was properly
reflected in the partnership return for the fiscal year ending June 30,
1975. The partnership's election to have section 404(a)(6), as amended,
apply to its fiscal year ending June 30, 1975, is valid since that year
ended with or within a plan year beginning after December 31, 1974.
[T.D. 7402, 41 FR 5633, Feb. 9, 1976]
Sec. 11.408(a)(2)-1 Trustee of individual retirement accounts.
A person may demonstrate to the satisfaction of the Commissioner
that the manner in which he will administer the trust will be consistent
with the requirements of section 408 only upon the filing of a written
application to the Commissioner of Internal Revenue, Attention: E:EP,
Internal Revenue Service, Washington, D.C. 20224. Such application must
meet the applicable requirements of the regulations under section
401(d)(1) relating to nonbank trustees of pension and profit-sharing
trusts benefiting owner-employees.
(Sec. 408(a)(2) of the Internal Revenue Code of 1954 (88 Stat. 959, 26
U.S.C. 408(a)(2)))
[T.D. 7390, 40 FR 53580, Nov. 19, 1975]
Sec. 11.410-1 Election by church to have participation, vesting, funding, etc., provisions apply.
(a) In general. If a church or convention or association of churches
which maintains any church plan, as defined in section 414(e), makes an
election under this section, certain provisions of the Code and Title I
of the Employee Retirement Income Security Act of 1974 (the ``Act'')
shall apply to such church plan as if such plan were not a church plan.
The provisions of the Code referred to are section 410 (relating to
minimum participation standards), section 411 (relating to minimum
vesting standards), section 412 (relating to minimum funding standards),
section 4975 (relating to prohibited transactions), and paragraphs (11),
(12), (13), (14), (15), and (19) of section 401(a) (relating to joint
and survivor annuities, mergers and consolidations, assignment or
alienation of benefits, time of benefit commencement, certain social
security increases, and withdrawals of employee contributions,
respectively).
(b) Election is irrevocable. An election under this section with
respect to any church plan shall be binding with respect to such plan
and, once made, shall be irrevocable.
(c) Procedure for making election--(1) Time of election. An election
under this section may be made for plan years for which the provisions
of section 410(d) of the Code apply to the church plan. By reason of
section 1017(b) of the Act section 410(d) does not apply to a plan in
existence on January 1, 1974, for plan years beginning before December
31, 1975. Section 1017(d) of the Act permits a plan administrator to
elect to have certain provisions of the Code (including section 410(d))
apply to a plan before the otherwise applicable effective dates of such
provisions. See Sec. 420.0-1 of the regulations in this chapter
(Temporary Regulations on Procedure and Administration under the
Employee Retirement Income Security Act of 1974). Therefore, an election
under section 410(d) of the Code may be made for a plan year beginning
before December 31, 1975, only if an election has been made under
section 1017(d) of the Act with respect to that plan year.
(2) By whom election is to be made. The election provided by this
section may be made only by the plan administrator of the church plan.
(3) Manner of making election. The plan administrator may elect to
have the provisions of the Code described in paragraph (a) of this
section apply to the church plan as if it were not a church plan by
attaching the statement described in subparagraph (5) of this paragraph
to either (i) the annual return required under section 6058(a) (or an
amended return) with respect to the plan which is filed for the first
plan year for which the election is effective or (ii) a written request
for a determination letter relating to the qualification of the plan
under section 401(a), 403(a), or 405(a) of the Code and, if trusteed,
the exempt status under section 501(a) of the Code of a trust
constituting a part of the plan.
(4) Conditional election. If an election is made with a written
request for a determination letter, the election may be
[[Page 208]]
conditioned upon issuance of a favorable determination letter and will
become irrevocable upon issuance of such letter.
(5) Statement. The statement described in subparagraph (3) of this
paragraph shall indicate (i) that the election is made under section
410(d) of the Code and (ii) the first plan year for which it is
effective.
(Sec. 410(d), Internal Revenue Code, 1954 (88 Stat. 901; 26 U.S.C.
410(d)))
[T.D. 7363, 40 FR 27217, June 27, 1975]
Sec. 11.410(b)-1 Minimum coverage requirements.
(a)-(c) [Reserved]
(d) Special rules. (1) [Reserved]
(2) Discrimination. The determination as to whether a plan
discriminates in favor of employees who are officers, shareholders, or
highly compensated, is made on the basis of the facts and circumstances
of each case, allowing a reasonable difference between the percentage of
such employees benefited by the plan to all employees benefited by the
plan and the percentage of all such employees of the employer to all
employees of the employer. A showing that a specified percentage of
employees covered by a plan are not officers, shareholders, or highly
compensated, without a showing that the difference (if any) between such
percentage and the percentage of all employees who are not officers,
shareholders, or highly compensated is reasonable, is not sufficient to
establish that the plan does not discriminate in favor of employees who
are officers, shareholders, or highly compensated.
(Sec. 410, Internal Revenue Code of 1954 (88 Stat. 898; 26 U.S.C. 410))
[T.D. 7380, 40 FR 45816, Oct. 3, 1975, as amended by T.D. 7508, 42 FR
47197, Sept. 20, 1977]
Sec. 11.412(c)-7 Election to treat certain retroactive plan amendments as made on the first day of the plan year.
(a) General rule. Under section 412(c)(8), a plan administrator may
elect to have any amendment which is adopted after the close of the plan
year to which it applies deemed to have been made on the first day of
such plan year if the amendment--
(1) Is adopted no later than 2 and one-half months after the close
of such plan year (or, in the case of a multiemployer plan, no later
than 2 years after the close of such plan year),
(2) Does not reduce the accrued benefit of any participant
determined as of the beginning of such plan year, and
(3) Does not reduce the accrued benefit of any participant
determined as of the time of adoption of the amendment, or, if it does
so reduce such accrued benefit, it is shown that the plan administrator
filed a notice with the Secretary of Labor notifying him of the
amendment, and--
(i) The Secretary of Labor approved the amendment, or
(ii) The Secretary of Labor failed to disapprove the amendment
within 90 days after the date on which the notice was filed.
(b) Time and manner of making election. (1) The election under
section 412(c)(8) shall be made by the plan administrator by a statement
of election described in subparagraph (3) of this paragraph, attached to
the annual return relating to minimum funding standards required to be
filed under section 6058 with respect to the plan year to which the
election relates.
(2) In the event that an amendment to which paragraph (a) of this
section applies is adopted after the filing of the annual return
required under section 6058, the plan administrator may make the
election under section 412(c)(8) by attaching a statement of election,
described in paragraph (b)(3) of this section, to a copy of such annual
return, and filing such copy no later than the time allowed for the
filing of such returns under section 6058. (In the case of multiemployer
plans, such copy may be filed within a 24 month period beginning with
the date prescribed for the filing of such returns.)
(3) The statement of election filed by or on behalf of the plan
administrator shall--
(i) State the date of the close of the first plan year to which the
amendment applies and the date on which the amendment was adopted;
[[Page 209]]
(ii) Contain a statement that the amendment does not reduce the
accrued benefit of any participant determined as of the beginning of the
plan year preceding the plan year in which the amendment is adopted; and
(iii) Contain either--
(A) A statement that the amendment does not reduce the accrued
benefit of any participant determined as of the time of adoption of such
amendment, or
(B) A copy of the notice filed with the Secretary of Labor under
section 412(c)(8) and a statement that either the Secretary of Labor has
approved the amendment or he has failed to act within 90 days after
notification of the amendment.
[T.D. 7338, 39 FR 44751, Dec. 27, 1974]
Sec. 11.412(c)-11 Election with respect to bonds.
(a) In general. Section 412(c)(2)(B) provides that, at the election
of the administrator of a plan which includes a trust qualified under
section 401(a) or of a plan which satisfies the requirements of section
403(a) or section 405(a), the value of a bond or other evidence of
indebtedness which is held by the plan and which is not in default as to
principal or interest may be determined on an amortized basis running
from initial cost at purchase to the amount payable at maturity (or, in
the case of a bond which is callable prior to maturity, the earliest
call date). So long as this election is in effect, the value of any such
evidence of indebtedness shall, for purposes of section 412, be
determined on such an amortized basis rather than on a method taking
into account fair market value as described in section 412(c)(2)(A).
(b) Manner of making election. The election to value evidences of
indebtedness in accordance with paragraph (a) of this section shall be
made by a statement to that effect attached to and filed as a part of
the annual return of the plan required under section 6058 of the Code.
(c) Effect of election. The election provided by section
412(c)(2)(B), once made, will affect the valuation of all evidences of
indebtedness, not in default as to principal or interest, which are held
by the plan for the plan year for which the election is made and any
evidences of indebtedness which are subsequently acquired by the plan.
The value of any evidence of indebtedness which is in default as of the
valuation date for the plan year must be determined on the basis of any
reasonable actuarial method of valuation which takes into account fair
market value in accordance with section 412(c)(2)(A) and must continue
to be so valued until the indebtedness is no longer in default.
(d) Consent to revoke required--(1) In general. An election made in
accordance with paragraph (a) of this section may be revoked only if
consent to revoke the election is obtained from the Secretary or his
delegate.
(2) Manner of obtaining permission for revocation. [Reserved]
(Secs. 302(c)(2)(B), 412(c)(2)(B) of the Internal Revenue Code of 1954
(88 Stat. 871, 914))
[T.D. 7335, 39 FR 44009, Dec. 20, 1974]
Sec. 11.412(c)-12 Extension of time to make contributions to satisfy requirements of section 412.
(a) In general. Section 412(c)(10) of the Internal Revenue Code of
1954 provides that for purposes of section 412 a contribution for a plan
year made after the end of such plan year but not later than two and
one-half months after the last day of such plan year shall be deemed to
have been made on such last day. Section 412(c) (10) further provides
that the two and one-half month period may be extended for not more than
six months under regulations.
(b) Six month extension of two and one-half month period. (1) For
purposes of section 412 a contribution for a plan year to which section
412 applies that is made not more than eight and one-half months after
the end of such plan year shall be deemed to have been made on the last
day of such year.
(2) The rules of this section relating to the time a contribution to
a plan is deemed made for purposes of the minimum funding standard under
section 412 are independent from the rules contained in section 404(a)
(6) relating to the time a contribution to a plan is deemed made for
purposes of claiming
[[Page 210]]
a deduction for such contribution under section 404.
(Sec. 412(c)(10), Internal Revenue Code of 1954 (88 Stat. 917; 26 U.S.C.
412(c)(10)))
[T.D. 7439, 41 FR 46597, Oct. 22, 1976]
Sec. 11.415(c)(4)-1 Special elections for section 403(b) annuity contracts purchased by educational institutions, hospitals and home health service agencies.
(a) Limitations applicable to contributions for section 403(b)
annuity contracts--(1) In general. An annuity contract described in
section 403(b) which is treated as a defined contribution plan (as
defined in section 414(i)) is subject to the rules regarding the amount
of annual additions (as defined in section 415(c)(2)) that may be made
to a participant's account in a defined contribution plan for any
limitation year (as defined in subparagraph (2) of this paragraph) under
section 415(c)(1) and Revenue Ruling 75-481, 1975-2 C.B. 188. An annual
addition to the account of an individual under a section 403(b) annuity
contract in excess of such limitation for a limitation year is
includible in the gross income of the individual for the taxable year
with or within which such limitation year ends and reduces the exclusion
allowance under section 403(b)(2) for such taxable year to the extent of
the excess. Such annuity contracts are, of course, also subject to the
limitation imposed by section 403(b)(2) with respect to the amount that
may be contributed by the employer for the purchase of an annuity
contract described in section 403(b) and be excluded from the gross
income of the employee on whose behalf such annuity contract is
purchased. In general, the excludable contribution for such an annuity
contract for a particular taxable year is the lesser of the exclusion
allowance computed under section 403(b)(2) for such taxable year or the
limitation imposed by section 415(c)(1) for the limitation year ending
with or within such taxable year. For purposes of the limitation imposed
by section 415(c)(1), the amount contributed toward the purchase of an
annuity contract described in section 403(b) is treated as allocated to
the employee's account as of the last day of the limitation year ending
with or within the taxable year during which such contribution is made.
(2) Limitation year. For purposes of this section--
(i) Except as provided in subdivision (ii) of this subparagraph, the
limitation year applicable to an individual on whose behalf an annuity
contract described in section 403(b) has been purchased by an employer
shall be the calendar year unless such individual elects to change the
limitation year to another 12-month period and attaches a statement to
his income tax return filed for the taxable year in which such change is
made.
(ii) The limitation year applicable to an individual described in
subdivision (i) of this subparagraph who is in control (within the
meaning of section 414 (b) or (c) as modified by section 415(h)) of any
employer shall be the same as the limitation year of such employer.
(3) Special elections. Under section 415(c)(4), special elections
are permitted with respect to section 403(b) annuity contracts
(including custodial accounts treated as section 403(b) annuity
contracts under section 403(b)(7)) purchased by educational institutions
(as defined in section 151(e)(4) and the regulations thereunder), home
health service agencies (as defined in subparagraph (4) of this
paragraph) and hospitals. In lieu of the limitation described in section
415(c)(1)(B) otherwise applicable to the annual addition (as defined in
section 415(c)(2)) that may be made to the account of a participant in a
qualified defined contribution plan for a particular limitation year, an
individual for whom an annuity contract described in this subparagraph
is purchased may elect, in accordance with the provisions of paragraph
(b) of this section, to have substituted for such limitation the amounts
described in subparagraph (5)(i) or (5)(ii) of this paragraph. In lieu
of the exclusion allowance determined under section 403(b)(2) and the
regulations thereunder otherwise applicable for the taxable year with or
within which the limitation year ends to an individual on whose behalf
an annuity contract described in this subparagraph is purchased, such an
individual may elect, in accordance with the provisions of
[[Page 211]]
paragraph (b) of this section, to have substituted for such exclusion
allowance the amount described in subparagraph (5)(iii) of this
paragraph.
(4) Definition. For purposes of this section, a home health service
agency is an organization described in section 501(c)(3) which is exempt
from taxation under section 501(a) and which has been determined by the
Secretary of Health, Education, and Welfare to be a home health agency
under section 1395(x)(o) of Title 42 of the United States Code.
(5) Elections. (i) For the limitation year that ends with or within
the taxable year in which an individual separates from the service of
his employer (and only for such limitation year), the ``(A) election
limitation'' shall be the exclusion allowance computed under section
403(b)(2)(A) and the regulations thereunder (without regard to section
415) for the taxable year in which such separation occurs taking into
account such individual's years of service (as defined in section
403(b)(4) and the regulations thereunder) for the employer and
contributions described in section 403(b)(2)(A)(ii) and the regulations
thereunder during the period of years (not exceeding 10) ending on the
date of separation. For purposes of the preceding sentence, all service
for the employer performed within such period must be taken into
account. However, the ``(A) election limitation'' shall not exceed the
amount described in section 415(c)(1)(A) (as adjusted under section
415(d)(1)(B)) applicable to such individual for such limitation year.
(ii) For any limitation year, the ``(B) election limitation'' shall
be equal to the least of the following amounts--
(A) $4,000, plus 25 percent of the individual's includable
compensation (as defined in section 403(b)(3) and the regulations
thereunder) for the taxable year with or within which the limitation
year ends,
(B) The amount of the exclusion allowance determined under section
403(b)(2)(A) and the regulations thereunder for the taxable year with or
within which such limitation year ends, or
(C) $15,000.
(iii) For any taxable year, the ``(C) election limitation'' shall
equal the lesser of the amount described in section 415(c)(1)(A) (as
adjusted under section 415(d)(1)(B)) or the amount described in section
415(c)(1)(B) applicable to the individual for the limitation year ending
with or within such taxable year. For purposes of the preceding
sentence, compensation described in section 415(c)(1)(B) taken into
account for a particular limitation year does not include amounts
contributed toward the purchase of an annuity contract described in
section 403(b) during such limitation year (whether or not includable in
the gross income of the individual on whose behalf such contribution is
made).
(b) Special rules for elections and salary reduction agreements for
years before final regulations are published--(1) Election. (i) For a
limitation year which ends before or with or within the taxable year in
which applicable final regulations under section 415 are first published
in the Federal Register, an individual may wish to take advantage of the
alternative limitations described in section 415(c)(4). One way of doing
this is to attach a statement of intention to his individual tax return
for the taxable year. The statement should provide that the individual
intends to elect one of those alternative limitations. It should also
specify which alternative he intends to elect. No form is prescribed for
the statement of intention, but it must include the individual's name,
address and Social Security number. If the individual is not required to
file an income tax return for the taxable year to which the statement of
intention is to apply, the statement of intention may still be filed at
the Internal Revenue Service Center where that individual would file the
return if he were required to file. It should be filed by the time he
would have filed his return. The Internal Revenue Service will treat the
statement of intention as an actual election for all taxable years
through the taxable year in which applicable final regulations under
section 415 are first published in the Federal Register for all
purposes, except that it will not be irrevocable. If, pursuant to this
subdivision, an individual takes advantage of an alternative limitation
for a taxable
[[Page 212]]
year, then, except as provided in paragraph (b)(1)(iii) of this section,
the individual may not take advantage of any other alternative
limitation pursuant to this subdivision for any taxable year. If an
individual does not file a statement of intention, he will still be able
to take advantage of the alternative limitations for these taxable
years. He will be able to do this if he determines his income tax
liability for the taxable year in a way which is consistent with one of
the alternative limitations.
(ii) The actual election for all taxable years through the taxable
year in which applicable final regulations under section 415 are first
published in the Federal Register will be made by filing the election
with the Internal Revenue Service at the time and in the manner to be
described by final regulations under section 415.
(iii) When an individual makes the actual election for any taxable
year through the taxable year in which applicable final regulations
under section 415 are published in the Federal Register, he may choose
any of the alternative limitations, even if his choice is inconsistent
with the alternative limitation which he used in determining his income
tax liability for that taxable year. He may also choose not to elect any
of the alternative limitations, even if he used one of them in
determining his income tax liability for that taxable year. However, if
his choice is different from the choice which he used in determining his
income tax liability for the taxable year, there may be an adjustment in
his tax for that year. For purposes of section 6654 (relating to failure
of an individual to pay estimated tax), a difference in tax for such a
year resulting from a difference in these choices will not be treated as
an underpayment. This rule applies to the extent the difference in tax
is due to the actual election of one of the alternative limitations or
to a final decision not to use one of the alternative limitations for
the taxable year.
(2) Salary reduction agreements for 1976 and 1977. (i) An individual
who is employed by an organization described in paragraph (a)(3) may
make a salary reduction agreement for his taxable year beginning in 1976
or 1977 at any time before the end of the 1976 or 1977 taxable year,
respectively, without the agreement's being considered a new agreement
within the meaning of Sec. 1.403(b)-1(b)(3)(i). The agreement for 1976
may be made on or before June 15, 1977, if that date is later than the
end of the individual's 1976 taxable year. The agreement for 1977 may be
made on or before April 17, 1978, if that date is later than the end of
the individual's 1977 taxable year.
(ii) This subparagraph applies only if the individual actually
elects one of the alternative limitations under section 415(c)(4) for
1976 or 1977 (as the case may be).
(iii) The salary reduction agreement for 1976 may be made effective
with respect to any amount earned during the taxpayer's most recent one-
year period of service (as described in Sec. 1.403(b)-1(f)) ending not
later than the end of the 1976 taxable year, notwithstanding
Sec. 1.403(b)-1(b)(3)(i). Similarly, the salary reduction agreement for
1977 may be made effective with respect to such period of service ending
not later than the end of the 1977 taxable year.
(iv) If the salary reduction agreement for 1976 is entered into at
any time after December 31, 1976, or if the salary reduction agreement
for 1977 is entered into at any time after December 31, 1977, an amended
Form W-2 must be filed on behalf of the individual.
(3) Election is irrevocable. The election described in paragraph
(a)(3) of this section, once made in accordance with the provisions of
subparagraph (1) of this paragraph, shall be irrevocable with respect to
the limitation years or taxable years to which such election relates.
(4) Limitations. With respect to any limitation or taxable year, an
election by an individual pursuant to subparagraph (1) of this paragraph
to have any subdivision of paragraph (a)(5) of this section apply to
contributions made on his behalf by his employer with respect to any
section 403(b) annuity contract will preclude an election to have any
other subdivision of paragraph (a)(5) apply for any future limitation or
taxable year with respect to any section 403(b) annuity contract
contributions
[[Page 213]]
made by any employer of such individual. With respect to any limitation
year, an election by an individual to have paragraph (a)(5)(i) of this
section apply to contributions made on his behalf by his employer with
respect to any section 403(b) annuity contract will preclude an election
to have any subdivision of paragraph (a)(5) apply for any future
limitation or taxable year with respect to any section 403(b) annuity
contract contributions made by any employer of such individual.
(5) Aggregation rules--(i) Annuity contracts described in section
403(b). For purposes of applying the limitations of this section for a
particular limitation or taxable year, all contributions toward the
purchase of annuity contracts described in section 403(b) made on behalf
of an individual by his employer and any related employer (as defined in
subdivision (ii) of this subparagraph) must be aggregated without regard
to:
(A) Whether such individual makes any election pursuant to
subparagraph (1) of this paragraph for such year; and
(B) Whether such individual files a statement of intention pursuant
to subparagraph (1) of this paragraph, for such year. In addition, any
other aggregation required by Revenue Ruling 75-481, 1975-2 C.B. 188,
must be made to the extent applicable.
(ii) Definition. For purposes of this section, with respect to a
particular employer, a related employer is any other employer which is a
member of a controlled group of corporations (as defined in section
414(b), and the regulations thereunder and as modified by section
415(h)) or a group of trades or business (whether or not incorporated)
under common control (as defined in section 414(c) and the regulations
thereunder and as modified by section 415(h)) in which such particular
employer is a member.
(c) Examples. The provisions of this section may be illustrated by
the following examples:
Example (1). Doctor M is an employee of H Hospital (an organization
described in section 501(c)(3) and exempt from taxation under section
501(a)) for the entire 1976 calendar year. M is not in control of H
within the meaning of section 414 (b) or (c), as modified by section
415(h). M uses the calendar year as the taxable year and M uses the
calendar year as the limitation year. M has includible compensation (as
defined in section 403(b)(3) and the regulations thereunder) and
compensation (as defined in section 415(c)(3)) for taxable year 1976 of
$30,000, and M has 4 years of service (as defined in Sec. 1.403(b)-1(f))
with H as of December 31, 1976. During M's prior service with H, H had
contributed a total of $12,000 on M's behalf for annuity contracts
described in section 403(b), which amount was excludable from M's gross
income for such prior years. Thus, for the limitation year ending with
or within taxable year 1976, M's exclusion allowance determined under
section 403(b)(2)(A) is $12,000 ((.20 x $30,000 x 4) -$12,000). The
limitation imposed by section 415(c)(1) that is applicable to M for
limitation year 1976 is the lesser of $26,825 (the amount described in
section 415(c)(1)(A) adjusted under section 415(d)(1)(B) for limitation
year 1976) or $7,500 (the amount described in section 415(c)(1)(B)).
Absent the special elections provided in section 415(c)(4), $7,500 would
be the maximum contribution H could make for annuity contracts described
in section 403(b) on M's behalf for limitation year 1976 without
increasing M's gross income for taxable year 1976. However, because H is
an organization described in section 415(c)(4), M may make a special
election with respect to amounts contributed by H on M's behalf for
section 403(b) annuity contracts for 1976. Assume that M does not
separate from the service of H during 1976 and that, therefore, the
``(A) election limitation'' described in section 415(c)(4)(A) is not
available to M. If M elects the ``(B) election limitation'' for 1976, H
could contribute $11,500 on M's behalf for annuity contracts described
in section 403(b) for that year (the least of $11,500 (the amount
described in section 415(c)(4) (B)(i)); $12,000 (the amount described in
section 415(c)(4)(B)(ii)), and $15,000 (the amount described in section
415(c)(4)(B)(iii))). If M elects the ``(C) election limitation'' for
1976, H could only contribute up to $7,500 (the lower of the amounts
described in section 415(c)(1) (A) or (B)) for section 403(b) annuity
contracts on M's behalf for 1976 without increasing M's gross income for
that year.
Example (2). Assume the same facts as in example (1) except that H
had contributed a total of $18,000 on M's behalf for annuity contracts
in prior years, which amount was excludable from M's gross income for
such prior years. Accordingly, for 1976, M's exclusion allowance
determined under section 403(b)(2)(A) is $6,000 ((.20 x $30,000 x 4)
-$18,000). The limitation imposed by section 415(c)(1) applicable to M
for 1976 is $7,500 (the lesser of the amount described in section
415(c)(1) (A) or (B)). Absent the special elections provided in section
415(c)(4), $6,000 would be the maximum amount H could contribute for
annuity contracts described in section 403(b) on M's behalf for 1976
without increasing M's gross income for that year. However, if M elects
[[Page 214]]
the ``(C) election limitation'' for 1976, H may contribute up to $7,500
without increasing M's gross income for that year.
Example (3). G, a teacher, is an employee of E, an educational
institution described in section 151(e)(4). G uses the calendar year as
the taxable year and G uses the 12-month consecutive period beginning
July 1 as the limitation year. G has includible compensation (as defined
in section 403(b)(3) and the regulations thereunder) for taxable year
1976 of $12,000 and G has compensation (as defined in section 415(c)(3))
for the limitation year ending with or within taxable year 1976 of
$12,000. G has 20 years of service (as defined in Sec. 1.403(b)-1(f)) as
of May 30, 1976, the date G separates from the service of E. During G's
service with E before taxable year 1976, E had contributed $34,000
toward the purchase of a section 403(b) annuity contract on G's behalf,
which amount was excludable from G's gross income for such prior years.
Of this amount, $19,000 was so contributed and excluded during the 10
year period ending on May 30, 1976. For the taxable year 1976, G's
exclusion allowance determined under section 403(b)(2)(A) is $14,000
((.20 x $12,000 x 20) -$34,000). Absent the special elections described
in section 415(c)(4), $3,000 (the lesser of G's exclusion allowance for
taxable year 1976 or the section 415(c)(1) limitation applicable to G
for the limitation year ending with or within such taxable year) would
be the maximum excludable contribution E could make for section 403(b)
annuity contracts on G's behalf for the limitation year ending with or
within taxable year 1976. However, because E is an organization
described in section 415(c)(4), G may make a special election with
respect to amounts contributed on G's behalf by E for section 403(b)
annuity contracts for the limitation year ending with or within taxable
year 1976. Because G has separated from the service of E during such
taxable year, G may elect the ``(A) election limitation'' as well as the
``(B) election limitation'' or the ``(C) election limitation''. If G
elects the ``(A) election limitation'' for the limitation year ending
with or within taxable year 1976, E could contribute up to $5,000
((.20 x $12,000 x 10) -$19,000) on G's behalf for section 403(b) annuity
contracts for such limitation year without increasing G's gross income
for the taxable year with or within which such limitation year ends. If
G elects the ``(B) election limitation'' for such limitation year, E
could contribute $7,000 (the least of $7,000 (the amount described in
section 415(c)(4)(B)(i)); $14,000 (the amount described in section
415(c)(4)(B)(ii)); and $15,000 (the amount described in section
415(c)(4)(B)(iii))). If G elects the ``(C) election limitation'' for
taxable year 1976, E could contribute $3,000 (the lesser of the amounts
described in section 415(c)(1) (A) or (B)).
(d) Plan year. For purposes of section 415 and this section, an
annuity contract described in section 403(b) shall be deemed to have a
plan year coinciding with the taxable year of the individual on whose
behalf the contract has been purchased unless that individual
demonstrates that a different 12-month period should be considered to be
the plan year.
(e) Effective date. The provisions of this section are applicable
for taxable years beginning in and for limitation years ending with or
within taxable years beginning in 1976.
(Sec. 415(c)(4)(D) of the Internal Revenue Code of 1954 (88 Stat. 983;
26 U.S.C. 415(c)(4)(D)))
[T.D. 7442, 41 FR 52296, Nov. 29, 1976, as amended by T.D. 7531, 43 FR
1065, Jan. 6, 1978]
PART 12--TEMPORARY INCOME TAX REGULATIONS UNDER THE REVENUE ACT OF 1971--Table of Contents
Sec.
12.3 Investment credit, public utility property elections.
12.4 Election of Class Life Asset Depreciation Range System (ADR).
12.7 Election to be treated as a DISC.
12.8 Elections with respect to net leases of real property.
12.9 Election to postpone determination with respect to the presumption
described in section 183(d).
Authority: 26 U.S.C. 167, 263, and 7805.
Sec. 12.3 Investment credit, public utility property elections.
(a) Elections--(1) In general. Under section 46(e), three elections
may be made on or before March 9, 1972, with respect to section 46(e)
property (as defined in subparagraph (3) of this paragraph). An election
made under the provisions of section 46(e) shall be irrevocable.
(2) Applicability of elections. (i) Any election under section 46(e)
shall be made with respect to all of the taxpayer's property eligible
for the election whether or not the taxpayer is regulated by more than
one regulatory body.
(ii)(a) Paragraph (1) of section 46(e) shall apply to all of the
taxpayer's section 46(e) property in the absence of an election under
paragraph (2) or (3) of
[[Page 215]]
section 46(e). If an election is made under paragraph (2) of section
46(e), paragraph (1) of such section shall not apply to any of the
taxpayer's section 46(e) property.
(b) An election made under the last sentence of section 46(e)(1)
shall apply to that portion of the taxpayer's section 46(e) property to
which paragraph (1) of section 46(e) applies and which is short supply
property within the meaning of Sec. 1.46-5(b)(2) of this chapter (Income
Tax Regulations) as set forth in a notice of proposed rule making
published in 37 FR 3526 on February 17, 1971.
(iii) If a taxpayer makes an election under paragraph (2) of section
46(e), and makes no election under paragraph (3) of such section, the
election under paragraph (2) of section 46(e) shall apply to all of its
section 46(e) property.
(iv) If a taxpayer makes an election under paragraph (3) of section
46(e), such election shall apply to all of the taxpayer's section 46(e)
property to which section 167(l)(2)(C) applies. Paragraph (1) or (2) of
section 46(e) (as the case may be) shall apply to that portion of the
taxpayer's section 46(e) property which is not property to which section
167(l)(2)(C) applies. Thus, for example, if a taxpayer makes an election
under paragraph (2) of section 46(e), and also makes an election under
paragraph (3) of section 46(e), paragraph (3) shall apply to all of the
taxpayer's section 46(e) property to which section 167(l)(2)(C) applies
and paragraph (2) shall apply to the remainder of the taxpayer's section
46(e) property.
(3) Section 46(e) property. ``Section 46(e) property'' is section 38
property which is both property described in section 50 and is--
(i) Public utility property within the meaning of section
46(c)(3)(B) (other than nonregulated communication property of the type
described in the last sentence of section 46(c)(3)(B)), or
(ii) Property used predominantly in the trade or business of the
furnishing or sale of (a) steam through a local distribution system or
(b) the transportation of gas or steam by pipeline, if the rates for
such furnishing or sale are established or approved by a governmental
unit, agency, instrumentality, or commission described in section
46(c)(3)(B).
(b) Method of making elections. A taxpayer may make the elections
described in section 46(e) by filing a statement, on or before March 9,
1972, with the district director or director of the internal revenue
service center with whom the taxpayer ordinarily files its income tax
return. For rules in the case of taxpayers filing consolidated returns,
see Sec. 1.1502-77(a) of this chapter (Income Tax Regulations). Such
statement shall contain the following information:
(1) The name, address, and taxpayer identification number of the
taxpayer,
(2) The paragraph (or paragraphs) of section 46(e) under which the
taxpayer is making the election,
(3) If an election is made under the last sentence of section
46(e)(1), the name and address of all regulatory bodies which have
jurisdiction over the taxpayer with respect to the section 46(e)
property covered by such election and a statement setting forth the type
of the public utility activity described in section 46(e)(5)(B) in which
the taxpayer engages, and
(4) If an election is made under paragraph (3) of section 46(e), a
statement indicating whether an election has been made by the taxpayer
under section 167(l)(4)(A).
[T.D. 7161, 37 FR 3511, Feb. 17, 1972]
Sec. 12.4 Election of Class Life Asset Depreciation Range System (ADR).
(a) Elections filed before February 1, 1972. No election or tax
return shall be filed which does not conform to section 109 of the
Revenue Act of 1971 (Pub. L. 92-178, 85 Stat. 508). If a taxpayer has
before February 1, 1972 filed an election and a tax return in accordance
with Sec. 1.167(a)-11 of this chapter (relating to depreciation
allowances using the Asset Depreciation Range System published in the
Federal Register for June 23, 1971), such election will be treated as an
election under the Class Life Asset Depreciation Range System (ADR) as
contained in section 109 of the Revenue Act of 1971 and the proposed
amendments to Sec. 1.167(a)-11 of this chapter published in the Federal
Register for January 27, 1972, provided that the election conforms with
the
[[Page 216]]
provisions of the Class Life Asset Depreciation Range System (ADR)
contained in section 109 of the Revenue Act of 1971 and the amendments
to the regulations as finally adopted. Such an election and the
determination of tax liability on the tax return are subject to the
terms and conditions of section 109 of the Revenue Act of 1971 and the
final regulations prescribing the Class Life Asset Depreciation Range
System (ADR). (For revocation of an election, see paragraph (c) of this
section.) An election and tax return filed before February 1, 1972,
which does not conform with the final regulations prescribing the Class
Life Asset Depreciation Range System (ADR) is an invalid election unless
corrected by an amended tax return and election filed no later than the
time permitted by paragraph (c) of this section. If a valid election
under Sec. 1.167(a)-11 of this chapter is not filed for a taxable year,
the taxpayer is required to file or amend his tax return and determine
tax liability for the taxable year without regard to Sec. 1.167(a)-11 of
this chapter.
(b) Elections filed after January 31, 1972. No election or tax
return shall be filed which does not conform with section 109 of the
Revenue Act of 1971. An election and tax return filed under
Sec. 1.167(a)-11 of this chapter after January 31, 1972, and before the
final amendments to the regulations are published in the Federal
Register, should be filed in accordance with section 109 of the Revenue
Act of 1971 and the proposed amendments to Sec. 1.167(a)-11 of this
chapter relating to the Class Life Asset Depreciation Range System
(ADR). Such election and the determination of tax liability on the tax
return are subject to the terms and conditions of section 109 of the
Revenue Act of 1971 and the final regulations prescribing the Class Life
Asset Depreciation Range System (ADR). An election and tax return filed
after January 31, 1972, which does not conform with the final
regulations prescribing the Class Life Asset Depreciation Range System
(ADR), is not a valid election unless corrected by an amended tax return
and election filed no later than the time permitted by paragraph (c) of
this section. (For revocation of election, see paragraph (c) of this
section.) If a valid election under Sec. 1.167(a)-11 of this chapter is
not filed for a taxable year the taxpayer is required to file or amend
his tax return and determine tax liability for the taxable year without
regard to Sec. 1.167(a)-11 of this chapter.
(c) Special rule for election and revocation. Notwithstanding the
rules of Sec. 1.167(a)-11 of this chapter, a taxpayer is permitted to
make, amend or revoke an election under Sec. 1.167(a)-11 of this chapter
at any time before the latest of (1) the time the taxpayer files his
first return for the taxable year of election, (2) 120 days after the
final regulations prescribing the Class Life Asset Depreciation Range
System (ADR) are published in the Federal Register, or (3) the time
prescribed by law (including extensions thereof) for filing the return
for the taxable year of election. The notification of amendment or
revocation of an election shall be made by filing an amended tax return
with the Internal Revenue Service Center with which the election was
filed. The election should be filed in the manner specified in the Class
Life Asset Depreciation Range System (ADR) regulations as finally
prescribed.
(d) Examples. The principles of this section may be illustrated by
the following examples:
Example (1). Taxpayer A filed an election under Sec. 1.167(a)-11
before February 1, 1972. A elected to use the modified half-year
convention by treating all assets as placed in service on the first day
of the second quarter of the taxable year, excluded section 1250
property (as defined in section 1250(c)) and property used predominantly
outside the United States from the election, and included ``subsidiary
assets'' (as defined in Sec. 1.167(a)-11(b)(5)(vii) of the proposed
amendments to the regulations) in the election. A's election does not
conform with the regulations under Sec. 1.167(a)-11 as proposed to be
amended. A should file an amended return and election within 120 days
after the publication of the final Class Life Asset Depreciation Range
System (ADR) regulations under Sec. 1.167(a)-11. Such amended return and
election must conform to the final amendments to the regulations. In the
amended election, A must adopt one of the conventions permitted by the
final amendments. Assuming the proposed amendments are finally adopted,
A may exclude his subsidiary assets from the election provided the
conditions of paragraph (b)(5)(vii) of Sec. 1.167(a)-11 of the
regulations, as proposed to be amended, are met, and A must include
[[Page 217]]
property used predominantly outside the United States in the election
unless paragraph (b)(5)(iii), (v), or (vi) of Sec. 1.167(a)-11, as
proposed to be amended, permit the exclusion of the property. Generally,
A must include section 1250 property in the election unless paragraph
(b)(5)(vi) of Sec. 1.167(a)-11, as proposed to be amended, permits the
exclusion of the property.
Example (2). Taxpayer B filed an election to compute depreciation
under Sec. 1.167(a)-11 before February 1, 1972. B elected to use the
half-year convention and has no assets used predominantly outside the
United States. B excluded section 1250 property from the election and
included his subsidiary assets in the election. Assume that the
provisions of paragraph (b)(5)(vi) of Sec. 1.167(a)-11, as proposed to
be amended, apply and permit the exclusion of section 1250 property and
that B does not elect to exclude subsidiary assets pursuant to paragraph
(b)(5)(vii), as proposed to be amended. B has no assets which were
excluded from the election under paragraph (b)(5)(v) of Sec. 1.167(a)-
11, as proposed to be amended. The election which was filed before
February 1, 1972, will be treated as a valid election under the Class
Life Asset Depreciation Range System (ADR) as contained in the final
amendments to the regulations, if it conforms with those amendments. B
need not file an amended election provided his election conforms to the
final regulations under Sec. 1.167(a)-11. However, B may file an amended
election within 120 days after the final regulations under
Sec. 1.167(a)-11 are published in the Federal Register in order to
include section 1250 property, or to exclude subsidiary assets, or to
make other changes, or to revoke the election.
[T.D. 7159, 37 FR 1469, Jan. 29, 1972]
Sec. 12.7 Election to be treated as a DISC.
(a) Manner and time of election--(1) Manner--(i) In general. A
corporation can elect to be treated as a DISC under section 992(b) for a
taxable year beginning after December 31, 1971. Except as provided in
subdivision (ii) of this subparagraph, the election is made by the
corporation filing Form 4876 with the service center with which it would
file its income tax return if it were subject for such taxable year to
all the taxes imposed by subtitle A of the Internal Revenue Code of
1954, and a copy of the completed Form 4876 with the Commissioner of
Internal Revenue (attention: ACTS:A:AO), Washington, D.C. 20224. The
form shall be signed by any person authorized to sign a corporation
return under section 6062, and shall contain the information required by
such form. Except as provided in paragraphs (b)(3) and (c) of this
section, such election to be treated as a DISC shall be valid only if
the consent of every person who is a shareholder of the corporation as
of the beginning of the first taxable year for which such election is
effective is on or attached to such Form 4876 when filed with the
service center.
(ii) Transitional rule for corporations electing during 1972. If the
first taxable year for which an election by a corporation to be treated
as a DISC is a taxable year beginning after December 31, 1971, and on or
before December 31, 1972, such election may be made either in the manner
prescribed in subdivision (i) of this subparagraph or by filing, at the
place prescribed in subdivision (i) of this subparagraph, a statement
captioned ``Election to be Treated as a DISC''. Such statement of
election shall be valid only if the consent of each shareholder is filed
with the service center in the form, and at the time, prescribed in
paragraph (b) of this section. Such statement shall be signed by any
person authorized to sign a corporation return under section 6062 and
shall include the name, address, and employer identification number (if
known) of the corporation, the beginning date of the first taxable year
for which the election is effective, the number of shares of stock of
the corporation issued and outstanding as of the earlier of the
beginning of the first taxable year for which the election is effective
or the time the statement is filed, the number of shares held by each
shareholder as of the earlier of such dates, and the date and place of
incorporation. As a condition of the election being effective, a
corporation which elects to become a DISC by filing a statement in
accordance with this subdivision must furnish (to the service center
with which the statement was filed) such additional information as is
required by Form 4876 by March 31, 1973.
(2) Time of making election--(i) In general. In the case of a
corporation making an election to be treated as a DISC for its first
taxable year, such election shall be made within 90 days after the
beginning of such taxable year. In the case of a corporation which makes
an election to be treated as a DISC for any
[[Page 218]]
taxable year beginning after March 31, 1972 (other than the first
taxable year of such corporation), the election shall be made during the
90-day period immediately preceding the first day of such taxable year.
(ii) Transitional rules for certain corporations electing during
1972. In the case of a corporation which makes an election to be treated
as a DISC for a taxable year beginning after December 31, 1971, and on
or before March 31, 1972 (other than its first taxable year), the
election shall be made within 90 days after the beginning of such
taxable year.
(b) Consent by shareholders--(1) In general--(i) Time and manner of
consent. Under paragraph (a)(1)(i) of this section, subject to certain
exceptions, the election to be treated as a DISC is not valid unless
each person who is a shareholder as of the beginning of the first
taxable year for which the election is effective signs either the
statement of consent on Form 4876 or a separate statement of consent
attached to such form. A shareholder's consent is binding on such
shareholder and all transferees of his shares and may not be withdrawn
after a valid election is made by the corporation. In the case of a
corporation which files an election to become a DISC for a taxable year
beginning after December 31, 1972, if a person who is a shareholder as
of the beginning of the first taxable year for which the election is
effective does not consent by signing the statement of consent set forth
on Form 4876, such election shall be valid (except in the case of an
extension of the time for filing granted under the provisions of
subparagraph (3) of this paragraph or paragraph (c) of this section)
only if the consent of such shareholder is attached to the Form 4876
upon which such election is made.
(ii) Form of consent. A consent other than the statement of consent
set forth on Form 4876 shall be in the form of a statement which is
signed by the shareholder and which sets forth (a) the name and address
of the corporation and of the shareholder and (b) the number of shares
held by each such shareholder as of the time the consent is made and (if
the consent is made after the beginning of the corporation's taxable
year for which the election is effective) as of the beginning of such
year. If the consent is made by a recipient of transferred shares
pursuant to paragraph (c) of this section, the statement of consent
shall also set forth the name and address of the person who held such
shares as of the beginning of such taxable year and the number of such
shares. Consent shall be made in the following form: ``I (insert name of
shareholder), a shareholder of (insert name of corporation seeking to
make the election) consent to the election of (insert name of
corporation seeking to make the election) to be treated as a DISC under
section 992(b) of the Internal Revenue Code. The consent so made by me
is irrevocable and is binding upon all transferees of my shares in
(insert name of corporation seeking to make the election).'' The
consents of all shareholders may be incorporated in one statement.
(iii) Who may consent. Where stock of the corporation is owned by a
husband and wife as community property (or the income from such stock is
community property), or is owned by tenants in common, joint tenants, or
tenants by the entirety, each person having a community interest in such
stock or the income therefrom and each tenant in common, joint tenant,
and tenant by the entirety must consent to the election. The consent of
a minor shall be made by his legal guardian or by his natural guardian
if no legal guardian has been appointed. The consent of an estate shall
be made by the executor or administrator thereof. The consent of a trust
shall be made by the trustee thereof. The consent of an estate or trust
having more than one executor, administrator, or trustee may be made by
any executor, administrator, or trustee authorized to make a return of
such estate or trust pursuant to section 6012(b)(5). The consent of a
corporation or partnership shall be made by an officer or partner
authorized pursuant to section 6062 or 6063, as the case may be, to sign
the return of such corporation or partnership. In the case of a foreign
person, the consent may be signed by any individual (whether or not a
U.S. person) who would be authorized under sections 6061 through
[[Page 219]]
6063 to sign the return of such foreign person if he were a U.S. person.
(2) Transitional rule for corporations electing during 1972. In the
case of a corporation which files an election to be treated as a DISC
for a taxable year beginning after December 31, 1971, and on or before
December 31, 1972, such election shall be valid only if the consent of
each person who is a shareholder as of the beginning of the first
taxable year for which such election is effective is filed with the
service center with which the election was filed within 90 days after
the first day of such taxable year or within the time granted for an
extension of time for filing such consent. The form of such consent
shall be the same as that prescribed in subparagraph (1) of this
paragraph. Such consent shall be attached to the statement of election
or shall be filed separately (with such service center) with a copy of
the statement of election. An extension of time for filing a consent may
be granted in the manner, and subject to the conditions, described in
subparagraph (3) of this paragraph.
(3) Extension of time to consent. An election which is timely filed
and would be valid except for the failure to attach the consent of any
shareholder to the Form 4876 upon which the election was made or to
comply with the 90-day requirement in subparagraph (2) of this paragraph
or paragraph (c)(1) of this section, as the case may be, will not be
invalid for such reason if it is shown to the satisfaction of the
service center that there was a reasonable cause for the failure to file
such consent, and if such shareholder files a proper consent to the
election within such extended period of time as may be granted by the
Internal Revenue Service. In the case of a late filing of a consent, a
copy of the Form 4876 or statement of election shall be attached to such
consent and shall be filed with the same service center as the election.
The form of such consent shall be the same as that set forth in
paragraph (b)(1)(ii) of this section. In no event can any consent be
made pursuant to this paragraph on or after the last day of the first
taxable year for which a corporation elects to be treated as a DISC.
(c) Consent by holder of transferred shares--(1) In general. If a
shareholder of a corporation transfers--
(i) Prior to the first day of the first taxable year for which such
corporation elects to be treated as a DISC, some or all of the shares
held by him without having consented to such election, or
(ii) On or before the 90th day after the first day of the first
taxable year for which such corporation elects to be treated as a DISC,
some or all of the shares held by him as of the first day of such year
(or if later, held by him as of the time such shares are issued),
without having consented to such election, then consent may be made by
any recipient of such shares on or before the 90th day after the first
day of such first taxable year. If such recipient fails to file his
consent on or before such 90th day, an extension of time for filing such
consent may be granted in the manner, and subject to the conditions,
described in paragraph (b)(3) of this section. In addition, if the
transfer occurs more than 90 days after the first day of such taxable
year, an extension of time for filing such consent may be granted to
such recipient only if it is determined under paragraph (b)(3) of this
section that an extension of time would have been granted the transferor
for the filing of such consent if the transfer had not occurred. A
consent which is not attached to the original Form 4876 or statement of
election (as the case may be) shall be filed with the same service
center as the original Form 4876 or statement of election and shall have
attached a copy of such original form or statement of election. The form
of such consent shall be the same as that set forth in paragraph
(b)(1)(ii) of this section. For the purposes of this paragraph, a
transfer of shares includes any sale, exchange, or other disposition,
including a transfer by gift or at death.
(2) Requirement for the filing of an amended form 4876 or statement
of election. In any case in which a consent to a corporation's election
to be treated as a DISC is made pursuant to subparagraph (1) of this
paragraph, such corporation must file an amended form 4876 or statement
of election (as the case may be) reflecting all changes in
[[Page 220]]
ownership of shares. Such form must be filed with the same service
center with which the original form 4876 or statement of election was
filed by such corporation.
(d) Effect of election--(1) Effect on corporation. A valid election
to be treated as a DISC remains in effect (without regard to whether the
electing corporation qualifies as a DISC for a particular year) until
terminated by any of the methods provided in paragraph (e) of this
section. While such election is in effect, the electing corporation is
subject to sections 991 through 997 and other provisions of the code
applicable to DISC's for any taxable year for which it qualifies as a
DISC (or is treated as qualifying as a DISC pursuant to section
992(a)(2)). Such corporation is also subject to such provisions for any
taxable year for which it is treated as a former DISC as a result of
qualifying or being treated as a DISC for any taxable year for which
such election was in effect.
(2) Effect on shareholders. A valid election by a corporation to be
treated as a DISC subjects the shareholders of such corporation to the
provisions of section 995 (relating to the taxation of the shareholders
of a DISC or former DISC) and to all other provisions of the code
relating to the shareholders of a DISC or former DISC. Such provisions
of the code apply to any person who is a shareholder of a DISC or former
DISC whether or not such person was a shareholder at the time the
corporation elected to become a DISC.
(e) Termination of election--(1) In general. An election to be
treated as a DISC is terminated only as provided in subparagraph (2) or
(3) of this paragraph.
(2) Revocation of election--(i) Manner of revocation. An election by
a corporation to be treated as a DISC may be revoked by the corporation
for any taxable year of the corporation after the first taxable year for
which the election is effective. Such revocation shall be made by the
corporation filing a statement that the corporation revokes its election
under section 992(b) to be treated as a DISC. Such statement shall
indicate the corporation's name, address, employer identification
number, and the first taxable year of the corporation for which the
revocation is to be effective. The statement shall be signed by any
person authorized to sign a corporation return under section 6062. Such
revocation shall be filed with the service center with which the
corporation filed its election, except that, if it filed an annual
information return under section 6011(e)(2), the revocation shall be
filed with the service center with which it filed its last such return.
(ii) Years for which revocation is effective. If a corporation files
a statement revoking its election to be treated as a DISC during the
first 90 days of a taxable year (other than the first taxable year for
which such election is effective), such revocation will be effective for
such taxable year and all taxable years thereafter. If the corporation
files a statement revoking its election to be treated as a DISC after
the first 90 days of a taxable year, the revocation will be effective
for all taxable years following such taxable year.
(3) Continued failure to be a DISC. If a corporation which has
elected to be treated as a DISC does not qualify as a DISC (and is not
treated as a DISC pursuant to section 992(a)(2)) for each of any 5
consecutive taxable years, such election terminates and will not be
effective for any taxable year after such 5th taxable year. Such
termination will be effective automatically, without notice to such
corporation or to the Internal Revenue Service. If, during any 5-year
period for which an election is effective, the corporation should
qualify as a DISC (or be treated as a DISC pursuant to section
992(a)(2)) for a taxable year, a new 5-year period shall automatically
start at the beginning of the following taxable year.
(4) Election after termination. If a corporation has made a valid
election to be treated as a DISC and such election terminates in either
manner described in subparagraph (2) or (3) of this paragraph, such
corporation is eligible to reelect to be treated as a DISC at any time
by following the procedures described in paragraphs (a) through (c) of
this section. If a corporation terminates its election and subsequently
reelects to be treated as a DISC, the corporation and its shareholders
continue to be subject to sections 995 and 996
[[Page 221]]
with respect to the period during which its first election was in
effect. Thus, for example, distributions upon disqualification
includible in the gross incomes of shareholders of a corporation
pursuant to section 995(b)(2) continue to be so includible for taxable
years for which a second election of such corporation is in effect
without regard to the second election.
[T.D. 7237, 37 FR 28626, Dec. 28, 1972]
Sec. 12.8 Elections with respect to net leases of real property.
(a) In general. The elections described in this section are
available for determining whether real property held by the taxpayer is
subject to a net lease for purposes of section 57 (relating to items of
tax preference for purposes of the minimum tax for tax preferences) or
163(d) (relating to limitation on interest on investment indebtedness).
Under sections 57(c)(1)(A) and 163(d)(4)(A)(i), property will be
considered to be subject to a net lease for a taxable year where the sum
of the deductions of the lessor with respect to the property for the
taxable year allowable solely by reason of section 162 (other than rents
and reimbursed amounts with respect to the property) is less than 15
percent of the gross income from rents produced by the property
(hereinafter referred to as the ``expense test''). Under sections
57(c)(2) and 163(d)(7)(A), where a parcel of real property of the
taxpayer is leased under two or more leases, the taxpayer may elect to
apply the expense test set forth in sections 57(c)(1)(A) and
163(d)(4)(A)(i) by treating all leased portions of such property as
subject to a single lease. Under sections 57(c)(3) and 163(d)(7)(B), at
the election of the taxpayer, the expense test set forth in sections
57(c)(1)(A) and 163(d)(4)(A)(i) shall not apply with respect to real
property of the taxpayer which has been in use for more than 5 years.
(b) Election with respect to multiple leases of single parcel of
real property. If a parcel of real property of the taxpayer is leased
under two or more leases, the expense test referred to in paragraph (a)
of this section shall, at the election of the taxpayer, be applied by
treating all leased portions of such property as subject to a single
lease. For purposes of this paragraph, the term ``parcel of real
property'' includes adjacent properties each of which is subject to
lease.
(c) Election with respect to real property in use for more than 5
years. At the election of the taxpayer, the expense test referred to in
paragraph (a) of this section shall not apply with respect to real
property of the taxpayer which has been in use for more than 5 years.
For this purpose, real property is in use only during the period that
such property is both owned and used for commercial purposes by the
taxpayer. If an improvement to the property was made during the time
such property was owned by the taxpayer, and if, as a result of such
improvement, the adjusted basis of such property was increased by 50
percent or more, use of such property for commercial purposes shall be
deemed to have commenced for purposes of this paragraph as of the date
such improvement was completed. An election under this paragraph shall
apply to all real property of the taxpayer which has been in use for
more than 5 years.
(d) Procedure for making election--(1) Time and scope of election.
An election under paragraph (b) or (c) of this section shall be made for
each taxable year to which such election is to apply. The election must
be made before the later of (i) the time prescribed by law for filing
the taxpayer's return for the taxable year for which the election is
made (determined with regard to any extension of time) or (ii) August
31, 1973, but the election may not be made after the expiration of the
time prescribed by law for the filing of a claim for credit or refund of
tax with respect to the taxable year for which the election is to apply.
(2) Manner of making election. Except as provided in the following
sentence, an election by the taxpayer with respect to a taxable year
shall be made by a statement containing the information described in
paragraph (d)(3) of this section which is--
(i) Attached to the taxpayer's return or amended return for such
taxable year,
(ii) Attached to a timely filed claim by the taxpayer for credit or
refund of tax for such taxable year, or
[[Page 222]]
(iii) Filed by the taxpayer with the director of the Internal
Revenue Service Center where the return for such taxable year was filed.
In the case of a taxable year ending before July 1, 1973, no formal
statement of election is necessary if the taxpayer's return took into
account an election under paragraph (b) or (c) of this section; the
taxpayer will be considered to have made an election in accordance with
the manner in which leases with respect to parcels of real property
described in paragraph (b) of this section, or leases of property which
has been in use for more than 5 years as described in paragraph (c) of
this section, are treated in the return.
(3) Statement. The statement described in paragraph (d)(2) of this
section shall contain the following information:
(i) The name, address, and taxpayer identification number of the
taxpayer;
(ii) The taxable year to which the election is to apply if the
statement is not attached to the return or a claim for credit or refund;
(iii) A description of any leases which are to be treated as a
single lease; and
(iv) A description of any real property in use for more than 5 years
to which the expense test is not to apply.
(4) Revocation of election. An election made pursuant to this
paragraph may be revoked within the time prescribed in paragraph (d)(1)
of this section for making an election and may not be revoked
thereafter. Any such revocation shall be made in the manner prescribed
by paragraph (d)(2) of this section for the making of an election.
(e) Election by members of partnership. Under section 703(b) (as
amended by section 304(c) of the Revenue Act of 1971), any election
under section 57(c) or 163(d)(7) with respect to property held by a
partnership shall be made by each partner separately, rather than by the
partnership. If an election made by a taxpayer under paragraph (b) of
this section applies in whole or in part to property held by a
partnership, the taxpayer shall, in applying the expense test referred
to in paragraph (a) of this section, take into account his distributive
share of the deductions of the partnership with respect to the property
for the taxable year allowable solely by reason of section 162 (other
than rents and reimbursed amounts with respect to the property) and also
his distributive share of the partnership's rental income from such
property for the taxable year.
[T.D. 7271, 38 FR 9296, Apr. 13, 1973]
Sec. 12.9 Election to postpone determination with respect to the presumption described in section 183(d).
(a) In general. An individual, electing small business corporation,
trust or estate may elect in accordance with the rules set forth in this
section to postpone a determination whether the presumption described in
section 183(d) applies with respect to any activity in which the
taxpayer engages until after the close of the fourth taxable year (sixth
taxable year, in the case of an activity described in Sec. 1.183-
1(c)(3)) following the taxable year in which the taxpayer first engages
in such activity. The election must be made in accordance with the
applicable requirements of paragraphs (b), (c) and (d) of this section.
Except as otherwise provided in paragraphs (c) and (e) of this section,
an election made pursuant to this section shall be binding for the first
taxable year in which the taxpayer first engages in the activity and for
all subsequent taxable years in the five (or seven) year period referred
to in the first sentence of this paragraph. For purposes of this
section, a taxpayer shall be treated as not having engaged in an
activity during any taxable year beginning before January 1, 1970.
(b) Period to which an election applies. An individual, trust,
estate, or small business corporation may make the election. The five
year presumption period (seven year presumption period in the case of an
activity described in Sec. 1.183-1(c)(3)) to which the election shall
apply shall be the five (or seven) consecutive taxable years of such
taxpayer beginning with the taxable year in which such taxpayer first
engages in the activity. For purposes of this section, a taxpayer who
engages in an activity as a partner, engages in it in each of his
taxable years with or within which ends a partnership year during which
the activity was carried on by the partnership.
[[Page 223]]
(c) Time for making an election. A taxpayer who is an individual,
trust, estate or small business corporation may make the election
provided in Sec. 183(e) by filing the statement and consents required by
paragraph (d) of this section within--
(1) 3 years after the due date of such taxpayer's return (determined
without extensions) for the taxable year in which such taxpayer first
engages in the activity, but not later than
(2) 60 days after such taxpayer receives a written notice (if any)
from a district director that the district director proposes to disallow
deductions attributable to an activity not engaged in for profit under
section 183.
The provisions of paragraph (c)(2) of this section shall in no event be
construed to extend the period described in (c)(1) of this section for
making such election. Notwithstanding the time periods prescribed in
paragraph (c) (1) and (2) of this section, if no election has been made
before a suit or proceeding described in section 7422(a) is maintained
or a petition is filed in the Tax Court for a redetermination of a
deficiency for any taxable year within the presumption period to which
the election would apply, no election may be made except with the
consent of the Commissioner which will not be given unless no
appreciable delay in the suit or proceeding will be caused.
(d) Manner of making election. (1) The election shall be made by the
individual, trust, estate, or electing small business corporation, as
the case may be, engaged in the activity, by filing a statement which
sets forth the following information--
(i) The name, address, and taxpayer identification number of such
taxpayer, and, if applicable, of the partnership in which he engages in
the activity,
(ii) A declaration stating that the taxpayer elects to postpone a
determination as to whether the presumption described in section 183(d)
applies until after the close of the taxpayer's fourth taxable year
(sixth taxable year, in the case of an activity described in Sec. 1.183-
1(c)(3)) following the taxable year in which the taxpayer first engaged
in such activity and identifying that first such taxable year, and,
(iii) A description of each activity (as defined in Sec. 1.183-
1(d)(1)) with respect to which the election is being made.
(2) For an election to be effective, there must be attached to the
statement properly executed consents, in the form prescribed by the
Commissioner, extending the period prescribed by section 6501 for the
assessment of any tax to a date which is not earlier than 18 months
after the due date of the return (determined without extensions) for the
final year in the presumption period to which the election applies, as
follows:
(i) Consents for each of the taxpayer's taxable years in the
presumption period to which the election applies,
(ii) If the election is made by an electing small business
corporation, a consent of each person who is a shareholder during any
taxable year to which the election applies, for each of such
shareholder's taxable years with or within which end each of the
corporation's taxable years in the presumption period,
(iii) If a taxpayer referred to in paragraph (d)(2)(i) of this
section or shareholder referred to in paragraph (d)(2)(ii) of this
section is married at the time of the election, in the case of his
present spouse, a consent for each of such spouse's taxable years which
correspond to the taxable years (other than prior years of the
shareholder during no part of which he was a shareholder) for which
consents are required by paragraph (d)(2) (i) or (ii) of this section as
the case may be.
Such consents shall not be construed to shorten the period described in
section 6501 for any taxable year within the presumption period to which
the election applies.
(3) The statement, with the required consents attached, shall be
filed--
(i) With the service center at which the taxpayer making the
election is required to file his return, or
(ii) If the taxpayer is notified by a district director that,
pursuant to section 183 he is proposing to disallow deductions with
respect to an activity not engaged in for profit, with such district
director.
(e) Subsequent invalidations. If, after a timely election has been
made, but
[[Page 224]]
still within the presumption period, a suit or proceeding (as described
in section 7422(a)) is maintained by the electing taxpayer, a
shareholder referred to in paragraph (d)(2)(ii) of this section, or
spouse referred to in paragraph (d)(2)(iii) of this section for any
taxable year for which a consent is required by this section and the
taxpayer, shareholder, or spouse has not been issued a notice of
deficiency (as described in section 6212(a)) with respect to such
taxable year, such election shall not be effective to postpone the
determination whether the presumption applies, for such taxable year,
but the consents extending the statute of limitations filed with the
election shall not thereby be invalidated. The immediately preceding
sentence shall not apply to a suit or proceeding maintained by the
spouse of an electing taxpayer for a taxable year for which such spouse
has filed a separate return, or a suit or proceeding maintained by a
shareholder for a taxable year in which he was not such a shareholder.
An election by an individual taxpayer or electing small business
corporation, shall be subsequently invalidated for all years in the
presumption period to which it had applied if--
(1) The electing taxpayer or shareholder taxpayer files a joint
return for one of the first three (five, in the case of an activity
described in Sec. 1.183-1(c) (3)) taxable years in such presumption
period, and
(2) The spouse with whom he files such joint return has not
previously executed a consent described in paragraph (d)(2)(iii) of this
section, and
(3) Within one year after the filing of such joint return (or, if
later, 90 days after March 14, 1974), such spouse has not filed a
consent described in paragraph (d)(2) of this section.
An election by an electing small business corporation shall be
invalidated for all years in the presumption period to which it applies
if a person who was not a shareholder on the date of election becomes a
shareholder during the first three (or five) years of the presumption
period to which the election applies and does not, within 90 days after
the date on which he becomes a shareholder (or, if later, 90 days after
March 14, 1974), file a consent required by paragraph (d)(2) of this
section. Invalidation of the election by operation of this paragraph
will in no case affect the validity of the consents filed with such
election.
(f) Extension of time for filing election in hardship cases. The
Commissioner may upon application by a taxpayer, consent to an extension
of time prescribed in this section for making an election if he finds
that such an extension would be justified by hardship incurred by reason
of the time at which this section is published. The burden will be on
the taxpayer to establish that under the relevant facts the Commissioner
should so consent.
[T.D. 7308, 39 FR 9947, Mar. 15, 1974]
PART 13--TEMPORARY INCOME TAX REGULATIONS UNDER THE TAX REFORM ACT OF 1969--Table of Contents
Sec.
13.0--13.3 [Reserved]
13.4 Arbitrage bonds; temporary rules.
13.5--13.9 [Reserved]
13.10 Distribution of money in lieu of fractional shares.
13.11 Revocation of election to report income on the installment basis.
Authority: 26 U.S.C. 7805.
Secs. 13.0--13.3 [Reserved]
Sec. 13.4 Arbitrage bonds; temporary rules.
(a) In general--(1) Arbitrage bonds. Section 103(d)(1) provides that
any arbitrage bond (as such term is defined in section 103(d)(2)) shall
be treated as an obligation not described in section 103(a)(1). Thus,
the interest on an obligation which would have been excluded from gross
income pursuant to the provisions of section 103(a)(1) will be included
in gross income and subject to Federal income taxation if such
obligation is an arbitrage bond. Under section 103(d)(2), an obligation
is an arbitrage bond if it is issued by a governmental unit as part of
an issue of obligations (for purposes of this section referred to as
``governmental obligations'') all or a major portion of the proceeds of
which are (i) reasonably expected to be used directly or indirectly
[[Page 225]]
to acquire certain obligations or securities (for purposes of this
section referred to as ``acquired obligations'') which may reasonably be
expected, at the time of issuance of such governmental obligations, to
produce a yield over the term of the issue of such governmental
obligations which is materially higher (taking into account any discount
or premium) than the yield on such issue, or (ii) reasonably expected to
be used to replace funds which were used directly or indirectly to
acquire such acquired obligations. For rules as to industrial
development bonds, see section 103(c).
(2) Definitions. (i) For purposes of this section, the term
``governmental unit'' means a State, the District of Columbia, a
Territory, or a possession of the United States, or any political
subdivision of any of the foregoing.
(ii) For purposes of this section, the term ``securities'' has the
same meaning as in section 165(g)(2) (A) and (B).
(3) Materially higher. For purposes of this section, the yield
produced by acquired obligations is not ``materially higher'' than the
yield produced by an issue of governmental obligations if it is
reasonably expected, at the time of issue of such governmental
obligations, that the adjusted yield (computed in accordance with
subparagraphs (4) and (5) of this paragraph) to be produced by the
acquired obligations will not exceed the adjusted yield (computed in
accordance with subparagraphs (4) and (5) of this paragraph) to be
produced by the issue of governmental obligations by more than one-
eighth of 1 percentage point. In the case of an issue of governmental
obligations issued on or before July 1, 1972, the percentage specified
in the preceding sentence shall be one-half of 1 percentage point.
(4) Yield. (i) For purposes of this section, ``yield'' shall be
computed using the ``interest cost per annum'' method in accordance with
subdivision (ii) or (iii) of this subparagraph (as the case may be) or
any other method satisfactory to the Commissioner which is consistent
with generally accepted principles of computing yield. In the case of
acquired obligations, the yield to be produced by such obligations shall
be computed as if all acquired obligations comprised a single issue of
obligations. Thus, for example, if the governmental unit acquires two
blocks of Federal obligations, with different interest rates and
maturity periods for each block, the yield on such acquired obligations
shall be computed as if one issue of obligations with different interest
rates and maturity periods had been acquired. The maturity period of
each acquired obligation shall be the period that the governmental unit
reasonably expects to hold such obligation.
(ii) If all the governmental or acquired obligations of an issue
have a single interest rate (expressed in dollars per $1,000 of face
amount of bonds), yield shall be computed using the following 4 steps:
(a) Step (1). Compute the total number of bond years for the issue
by multiplying the number of bonds (treating each $1,000 of face value
as one bond for purposes of this computation) of each maturity by the
length of the maturity period (expressed in years and fractions thereof)
and then adding together the amounts determined for each maturity
period.
(b) Step (2). Compute the total interest payable on the issue by
multiplying the total number of bond years (as computed in step (1)) by
the amount payable, expressed in dollars, as interest on each $1,000 of
bonds for 1 year.
(c) Step (3). Compute the net interest in dollars for the issue by
adding the amount, in dollars, of any discount to, or by subtracting the
amount, in dollars, of any premium from, the total interest payable on
the issue.
(d) Step (4). Compute yield by dividing the net interest by the
product obtained by multiplying the total number of bond years for the
issue by 10.
(iii) If governmental or acquired obligations of an issue have
different interest rates (expressed in dollars per $1,000 of face amount
of bonds), yield shall be computed using the following 4 steps:
(a) Step (1). Compute the total number of bond years for each group
of bonds bearing the same interest rate (treating each $1,000 of face
value as one bond for purposes of this computation) in the manner
described in step 1 of subdivision (ii) of this subparagraph.
(b) Step (2). Compute the total interest payable on the issue by
multiplying the total number of bond years for each
[[Page 226]]
group of bonds bearing the same interest rate (as computed in step (1))
by the amount payable, expressed in dollars, as interest on each $1,000
of bonds for 1 year, and then adding together the amounts determined for
each group.
(c) Step (3). Compute net interest in the manner described in step
(3) of subdivision (ii) of this subparagraph.
(d) Step (4). Compute the yield produced by the issue in the manner
described in step (4) of subdivision (ii) of this subparagraph.
(iv) For purposes of this section, the same method of computing
yield shall be used to compute the yield to be produced by an issue of
governmental obligations and to compute the yield to be produced by
acquired obligations acquired with the proceeds of such issue of
governmental obligations.
(v) The following example illustrates the provisions of this
subparagraph:
Example. Assume an issue of $200,000 ($1,000 per bond) with a stated
interest (expressed in dollars per bond) of $50 on bonds maturing in 1,
2, or 3 years, a stated interest of $60 on bonds maturing in 4, 5, 6, or
7 years and a stated interest of $70 on bonds maturing in 8, 9, or 10
years. Assume also that a price of $101 has been bid for the issue. The
yield on the issue is determined in accordance with the table below:
----------------------------------------------------------------------------------------------------------------
Total
bond
Amount Rate Years to Bond years at x Interest = Interest
maturity years interest rate cost
rate
----------------------------------------------------------------------------------------------------------------
$10,000 $50 1
5,000 50 2
25,000 50 3
--------
95 $4,750
10,000 60 4 40
10,000 60 5 50
30,000 60 6 180
50,000 60 7 350
--------
620 37,200
20,000 70 8 160
25,000 70 9 225
15,000 70 10 150
------------------------------------
535 70 37,450
----------- ----------
Totals............................ 200,000 1,250 79,400
---------- =========== ==========
Less premium......................................................................................... 2,000
-----------
Net interest cost................. 77,400
Divide by: Product of total bond
years (1,250), multiplied by 10.. 12,500
-----------
Yield (Percent)................... 6,192
----------------------------------------------------------------------------------------------------------------
(5) Adjusted yield. (i) For purposes of this section, ``adjusted
yield'' shall be computed in accordance with subparagraph (4) of this
paragraph, except that in the case of--
(a) Acquired obligations, an amount equal to the sum of the
administrative costs reasonably expected to be incurred in purchasing,
carrying, and selling or redeeming such obligations shall be treated as
a premium on the purchase price of such acquired obligations.
(b) An issue of governmental obligations, an amount equal to the sum
of the reasonably expected administrative costs of issuing, carrying,
and repaying such issue of obligations shall be treated as a discount on
the selling price of such issue of governmental obligations.
(ii) The provisions of subdivision (i) of this subparagraph may be
illustrated by the following examples:
Example (1). State Z issues $15 million of obligations all of which
will mature in 10 years. The obligations are sold at $1,000 each (par)
to yield 6 percent interest. The adjusted yield produced by such issue
of obligations will be determined as follows, assuming the following
administrative expenses of issuing, carrying, and repaying such issue of
obligations are reasonably expected:
[[Page 227]]
Issuing costs:
Printing...................................... $12,500
Financial advisors............................ 25,000
Counsel fees.................................. 12,500
Total................................................... $50,000
Carrying costs, paying agent and trustees fees.. 10,000
Repaying costs, paying agent.................... 3,000
-------------
Total administrative costs.................. 63,000
-------------
Bond years (15,000 x 10 years).................. 150,000
Interest cost per $1,000 bond per year.......... 60
-------------
Total interest cost......................... 9,000,000
Discount or premium........................... 0
Plus adjustments.............................. 63,000
-------------
Net interest cost............................. 9,063,000
Divide by product of bond years (150,000)
multiplied by 10............................. 1,500,000
-------------
Adjusted yield................................ 6.042%
Example (2). State Z uses the net proceeds of the issue of
obligations described in Example (1) to acquire $14,922,000 of student's
notes at par of $1,000 each under a student loan program. The students'
notes will all mature in 10 years, and all have a stated interest of
7\1/2\ percent. Expenses of the program including printing of forms
($5,000), financial advisors' fees ($11,000), counsel fees ($12,000),
trustees' fees ($5,000), fees for the collecting agents and various
banks which administer the loans ($100,000), advertising expenses
($10,000), credit reference checks ($20,000), and general office
overhead ($5,000). Of the expenses listed in the preceding sentence,
only those indicated on the following table constitute adjustments to
yield in order to determine the adjusted yield to be produced by the
students' notes:
Purchasing costs:
Printing forms............................... $5,000
Financial advisors........................... 11,000
Counsel fees................................. 12,000
-------------
Total................................................... $28,000
Carrying costs, trustees fees.................. 5,000
--------------
Total administrative costs................. 33,000
--------------
Bond years (14,922 x 10 years)................. 149,220
Interest receivable per $1,000 note per year... 75
--------------
Total interest receivable.................. 11,191,500
Discount or premium.......................... 0
Minus adjustments............................ 33,000
--------------
Net interest receivable...................... 11,158,500
Divide by product of bond years (149,220)
multiplied by 10............................ 1,492,200
--------------
Adjusted yield............................... 7.478%
(b) Rule with respect to certain governmental programs--(1) General
rule. Subject to the limitations of subparagraph (3) of this paragraph,
any obligations which are part of an issue of governmental obligations
the proceeds of which are reasonably expected to be used to finance
certain governmental programs (described in subparagraph (2) of this
paragraph) are not arbitrage obligations.
(2) Governmental programs. A governmental program is described in
this subparagraph if--
(i) The program involves the acquisition of acquired purpose
obligations to carry out the purposes of such program (which
obligations, for purposes of this paragraph, are referred to as
``acquired program obligations'');
(ii) At least 90 percent of all such acquired program obligations,
by amount of cost outstanding, are evidences of loans to a substantial
number of persons representing the general public, loans to exempt
persons within the meaning of section 103(c)(3), or loans to provide
housing and related facilities, or any combination of the foregoing;
(iii) At least 90 percent of all of the amounts received by the
governmental unit with respect to acquired program obligations shall be
used for one or more of the following purposes: To pay the principal or
interest or otherwise to service the debt on governmental obligations
relating to the governmental program; to reimburse the governmental
unit, or to pay, for administrative costs of issuing such governmental
obligations; to reimburse the governmental unit, or to pay, for
administrative and other costs and anticipated future losses directly
related to the program financed by such governmental obligations; to
make additional loans for the same general purposes specified in such
programs; or to redeem and retire governmental obligations at the next
earliest possible date of redemption; and
(iv) Requires that any person (or any related person, as defined in
section 103(c)(6)(C)) from whom the governmental unit may, under the
program, acquire acquired program obligations shall not, pursuant to an
arrangement, formal or informal, purchase the governmental obligations
in an acquired program obligations to be acquired from such person by
the governmental unit.
(3) Limitation. The provisions of subparagraph (1) of this paragraph
shall apply only if it is reasonably expected that--
[[Page 228]]
(i) A major portion of the proceeds of such issue of governmental
obligations, including proceeds represented by repayments of principal
and interest received by the governmental unit with respect to acquired
program obligations, shall not be invested for more than a temporary
period (within the meaning of section 103(d)(4)(A)), in acquired
obligations (other than acquired program obligations) which produce a
materially higher yield than the yield produced over the term of the
issue by such governmental obligations, and
(ii)(a) The adjusted yield (computed in accordance with paragraphs
(a) (4) and (5) of this section) to be produced by acquired program
obligations shall not exceed the adjusted yield (computed in accordance
with paragraphs (a) (4) and (5) of this section) to be produced by such
issue of governmental obligations by more than 1\1/2\ percentage points,
or
(b) Where the difference in the adjusted yields described in
subdivision (ii)(a) of this subparagraph is expected to exceed 1\1/2\
percentage points, the amounts to be obtained as a result of the
difference in such adjusted yields shall not exceed the amount necessary
to pay expenses (including losses resulting from bad debts) reasonably
expected to be incurred as a direct result of administering the program
to be financed with the proceeds of such issue of governmental
obligations, to the extent that such amounts are not payable with funds
appropriated from other sources.
(4) Examples. The following examples illustrate governmental
programs described in subparagraph (2) of this paragraph:
Example (1). State A issues obligations the proceeds of which are to
be used to purchase certain home mortgage notes from commercial banks.
The purpose of the governmental program is to encourage the construction
of low income residential housing by creating a secondary market for
mortgage notes and thereby increasing the availability of mortgage money
for low income housing. The legislation provides that the adjusted yield
produced by the mortgage notes to be acquired will not exceed the
adjusted yield produced by such issue of obligations by more than 1\1/2\
percentage points. Amounts received as interest and principal payments
on the mortgage notes are to be used for one or more of the following
purposes: (1) To service the debt on the governmental obligations, (2)
to retire such obligations at their earliest possible date of
redemption, (3) to purchase additional mortgage notes. The governmental
program is one which is described in subparagraph (2) of this paragraph
and the governmental obligations are not arbitrage bonds.
Example (2). State B issues obligations the proceeds of which are to
be used to make loans directly to students and to purchase from
commercial banks promissory notes made by students as the result of
loans made to them by such banks. The legislation authorizing the
student loan program provides that the purpose of the program is to
enable financially disadvantaged students to continue their studies. The
legislation also provides that purchases will be made from banks only
where such banks agree that an amount at least equal to the purchase
price will be devoted to new or additional student loans. It is
reasonably expected that the difference in adjusted yields between the
issue of governmental obligations by State B and the students' notes
will be 1\3/4\ percentage points. It is also reasonably expected that
the amount necessary to pay the expenses (other than expenses taken into
account in computing adjusted yield) enumerated in subparagraph
(3)(ii)(b) of this paragraph, directly incurred as a result of
administering State B's student loan program, such as, for example,
losses resulting from bad debts, insurance costs, bookkeeping expenses,
advertising expenses, credit reference checks, appraisals, title
searches, general office overhead, service fees for collecting agents
and various banks which administer the loans, and salaries of employees
not paid from other sources, will not require a difference in adjusted
yields in excess of 1\1/2\ percentage points. The governmental program
is one which is described in subparagraph (2) of this paragraph. Since,
however, the difference in adjusted yields produced by the students'
notes and the issue of State B obligations is reasonably expected to
exceed 1\1/2\ percentage points, and since State B cannot show that 1\3/
4\ percentage points is necessary to cover such expenses, the provisions
of subparagraph (1) of this paragraph shall not apply to the issue of
State B obligations. If, however, State B reasonably expected that 1\3/
4\ percentage points would be necessary to cover such expenses, the
provisions of subparagraph (1) of this paragraph would apply and the
governmental obligations would not be arbitrage bonds.
Example (3). Authority C issues obligations the proceeds of which
are to be used to purchase land to be sold to veterans. The governmental
unit will receive purchase-money mortgage notes secured by mortgages on
the land from the veterans in return for such land. The purpose of the
program is to enable veterans to acquire land at reduced cost. The
[[Page 229]]
adjusted yield produced by the mortgage notes is not reasonably expected
to exceed the adjusted yield produced by the issue of obligations issued
by Authority C by more than 1\1/2\ percentage points. Amounts received
as interest and principal payments on the mortgage notes are to be used
for one or more of the following purposes: (1) To pay the administrative
costs directly related to the program, (2) to service the debt on the
governmental obligations, (3) to retire such governmental obligations at
their earliest possible call date, (4) to purchase additional land to be
sold to veterans. The governmental program is one which is described in
subparagraph (2) of this paragraph and the governmental obligations are
not arbitrage bonds.
(c) Effective date. The provisions of this section will apply with
respect to obligations issued after October 9, 1969, and before final
regulations are promulgated.
[T.D. 7072, 35 FR 17406, Nov. 13, 1970; 35 FR 18524, Dec. 5, 1970, as
amended by T.D. 7174, 37 FR 10932, June 1, 1972; T.D. 7273, 38 FR 10927,
May 3, 1973]
Secs. 13.5--13.9 [Reserved]
Sec. 13.10 Distribution of money in lieu of fractional shares.
(a) In general. (1) Under the general rule of section 305, as
amended by section 421(a) of the Tax Reform Act of 1969, gross income
does not include the amount of any distribution of the stock (or rights
to acquire the stock) of a corporation made by such corporation to its
shareholders with respect to its stock. Under an exception to the
general rule, a distribution by a corporation of its stock or rights to
acquire its stock is treated as a distribution of property to which
section 301 applies if the distribution (or a series of distributions of
which such distribution is one) has the result of (i) the receipt of
money or other property by some shareholders, and (ii) an increase in
the proportionate interests of other shareholders in the assets or
earnings and profits of the corporation. Also, the Secretary or his
delegate is directed to prescribe regulations under which a redemption
which is treated as a distribution to which section 301 applies, or any
other transaction having a similar effect on the interest of any
shareholder, shall be treated as a distribution with respect to any
shareholder whose proportionate interest in the assets or earnings and
profits of the corporation is increased by such redemption or
transaction.
(2) The general rule, and not the exception, applies in the case
where cash is distributed in lieu of fractional shares to which the
shareholders would otherwise be entitled, provided the purpose in
distributing the cash is to save the distributing corporation the
trouble, expense, and inconvenience of issuing and transferring
fractional shares (or scrip representing fractional shares), or issuing
full shares representing the sum of fractional shares, and not to give
any particular group of shareholders an increased interest in the assets
or earnings and profits of the corporation.
(b) Illustration. The application of paragraph (a) of this section
may be illustrated by the following example:
Example. Corporation X is a large corporation whose stock is widely
held by the public, no one shareholder owning more than 10 percent of
the outstanding stock. The stock is listed on a recognized exchange and
is currently selling at less than $75 per share. During the year the
corporation pays a 3-percent stock dividend. Cash is paid to each
shareholder in lieu of a fractional share to which he would otherwise be
entitled. The distribution of cash in lieu of fractional shares is not
intended to give any particular group of shareholders an increased
interest in the assets or earnings and profits of the corporation, but
is intended to save the corporation the trouble, expense, and
inconvenience of issuing and transferring scrip representing fractional
shares. The general rule, and not the exception, applies in this
situation.
(Sec. 305(c), 83 Stat. 614; 26 U.S.C. 305(c))
[T.D. 7039, 35 FR 7012, May 2, 1970]
Sec. 13.11 Revocation of election to report income on the installment basis.
(a) In general. Under section 453(c)(4) taxpayers who are dealers in
personal property and who elected installment-basis income reporting,
subject to the provisions of section 453(c)(1) (relating to change from
accrual to installment basis), may revoke their previously made
election.
(b) Time and manner of revoking election. The revocation by a
taxpayer may be made by filing an amended return on an appropriate form
or forms, such
[[Page 230]]
as Form 1040X for an individual taxpayer, for the year of change (the
first year for which income was computed using the installment basis)
and for each subsequent year for which a return was filed using the
installment basis. The taxpayer should indicate on such amended returns
that he is revoking an election to report income on the installment
basis. Such revocation must be made within 3 years from the last date
prescribed for the filing of the return for the year of change including
any extension of time granted the taxpayer. In reporting income on the
amended returns described in this section, the taxpayer shall use the
accrual method of accounting.
[T.D. 7044, 35 FR 8823, June 6, 1970]
PART 14a--TEMPORARY INCOME TAX REGULATIONS RELATING TO INCENTIVE STOCK OPTIONS--Table of Contents
Authority: 26 U.S.C. 7805.
Sec. 14a.422A-1 Questions and answers relating to incentive stock option transitional rules.
The following questions and answers relate to the application of
incentive stock option (ISO) treatment to certain previously granted
stock options, pursuant to section 422A of the Internal Revenue Code of
1954, as added by section 251 of the Economic Recovery Tax Act of 1981
(95 Stat. 172) (ERTA):
General Description of Section 422A and Its Transitional Rules
Q-1: What is the significance of new section 422A of the Code
entitled ``Incentive Stock Options?''
A-1: Prior to the enactment of section 422a, the tax treatment of
employee stock options generally was governed by section 83 of the Code
and the regulations thereunder. Under those rules, the value of a stock
option constituted ordinary income to the employee when granted only if
the option itself had a readily ascertainable fair market value at that
time. If the option did not have a readily ascertainable value when
granted, it did not constitute ordinary income at that time. Instead,
when the option was exercised, the difference between the value of the
stock at exercise and the option price constituted ordinary income to
the employee. An employer who granted a stock option generally was
allowed a business expense deduction equal to the amount includible in
the employee's income in its corresponding taxable year.
Section 422A provides for incentive stock options (ISO's). Under this
new provision there will be no tax consequences when an ISO is either
granted or exercised, and the employee generally will be taxed at
capital gains rates when and if the stock received on exercise of the
option is sold. Similarly, no business expense deduction will be allowed
to the employer with respect to an ISO.
Q-2: What requirements must be met for ISO treatment under section
422A?
A-2: (a) Section 422A provides that the employee, in order to
receive ISO treatment, must not dispose of the stock within two years
after the option is granted, and must hold the stock itself for at least
one year. If all requirements other than these holding period rules are
met, tax is deferred until disposition of the stock, but gain (in an
amount equal to the lesser of (1) the fair market value of the stock on
the date of exercise minus the option price or (2) the amount realized
on disposition minus the option price) is treated as ordinary income and
the employer is allowed a deduction at that time.
(b) In addition, for the entire time from the date of granting the
option until three months before the date of exercise (expanded to 12
months if employment ceased due to permanent and total disability), the
option holder must be an employee either of the company granting the
option, a parent or subsidiary of that corporation, or a corporation (or
parent or subsidiary of that corporation) which has assumed the option
of another corporation as a result of a corporate reorganization,
liquidation, etc. This requirement and the holding period requirement
are waived in the case of the death of the employee.
(c) For an option to qualify as an ISO, the following conditions
must be met:
(1) The option must be granted under a plan specifying the aggregate
number of shares of stock which may be issued and the employees or class
of employees eligible to receive the options. This plan must be approved
by the stockholders of the granting corporation within 12 months before
or after the plan is adopted.
(2) The option must be granted within ten years from the date the
plan is adopted or the date the plan is approved by the stockholders,
whichever is earlier.
(3) The option must by its terms be exercisable only within ten
years of the date it is granted.
(4) The option price must equal or exceed the fair market value of
the stock at the time the option is granted. This requirement will be
deemed satisfied if there has been a
[[Page 231]]
good faith attempt to value the stock accurately, even if the option
price is less than the stock value.
(5) The option by its terms must be nontransferable other than at
death and must be exercisable during the employee's lifetime only by the
employee.
(6) The employee must not, at the time the option is granted, own
stock representing more than ten percent of the voting power of all
classes of stock of the employer corporation or its parent or
subsidiary. However, the stock ownership limitation will not apply if
the option price is at least 110 percent of the fair market value (at
the time the option is granted) of the stock subject to the option and
the option by its terms is not exercisable more than five years from the
date it is granted.
(7) The option by its terms is not exercisable while there is
outstanding any ISO which was granted to the employee at an earlier
time. For this purpose, an option which has not been exercised in full
is outstanding until the expiration of the period which under its
initial terms it could have been exercised. Thus, the cancellation of an
earlier option will not enable a subsequent option to be exercised any
sooner.
(8) In the case of options granted after 1980 the terms of the plan
must limit the amount of aggregate fair market value of the stock
(determined at the time of the grant of the option) for which any
employee may be granted ISO's in any calendar year to not more than
$100,000 plus a carryover amount. The carryover amount for an employee
from any year after 1980 is one-half of the amount by which $100,000
exceeds the value at time of grant of the stock for which ISO's were
granted in such prior year. Amounts may be carried over three years.
Options granted in any year use up the $100,000 current year limitation
first and then the carryover from the earliest year.
(d) Section 422A also provides that:
(1) Stock acquired on exercise of an ISO may be paid for with stock
of the corporation granting the option.
(2) The difference between the option price and the fair market
value of the stock at the exercise of an ISO is not an item of tax
preference.
(3) The employee may have the right to receive additional
compensation (in cash or property) at the time of exercise of the ISO so
long as the additional amount is subject to inclusion in income under
the provisions of sections 61 and 83 of the Code.
(4) An ISO will not be disqualified because of the inclusion of any
condition not inconsistent with the qualification requirements.
Q-3: What are the transitional rules relating to ISO treatment under
section 422A?
A-3: ERTA Sec. 251(c) provides the transitional rules relating to
ISO treatment. That section initially limits the applicability of
section 422A to options originally granted on or after January 1, 1976.
In the case of an option granted during the years 1976 through 1980,
section 422A will apply only if (1) the option was exercised on or after
January 1, 1981, or was outstanding on that date, and (2) the employer
elects (in such manner as the Treasury Department provides) to have the
option treated as an ISO (see A-4). (See A-12 for necessary section 422A
qualification requirements.) The aggregate fair market value (determined
at time of grant) of stock for which an employee may be granted ISO's
prior to 1981 may not exceed $50,000 per calendar year and $200,000 in
the aggregate for the five-year period 1976-1980.
In the case of an option granted on or after January 1, 1976, and
outstanding on August 13, 1981, paragraph (1) of section 425(h) of the
Code shall not apply to either any change in the option terms (or the
terms of the plan under which the option was granted) or the obtaining
of shareholder approval, to permit such option to qualify as an ISO,
provided such change and/or shareholder approval occurs on or before
August 13, 1982. (Section 425(h) of the Code requires that if an option
is changed, so that it is modified, extended, or renewed, the option
shall be treated as newly granted as of the date of such change.)
Election Procedure and Selection of Options
Q-4: What is the procedure for electing ISO treatment for options
granted during the years 1976 through 1980 and outstanding on January 1,
1981?
A-4: Note: The following procedure preempts the election procedure
set forth in Temporary Regulation Sec. 301.9100-4T(d) of this chapter
(TD 7793, 46 FR 54538 (November 3, 1981)). If, prior to December 21,
1981, a corporation has filed an election statement that conforms to the
requirements of Sec. 301.9100-4T(d) of this chapter, such an election
statement will be considered to have been properly filed. An election
statement filed prior to December 21, 1981, that does not meet the
requirements of either Sec. 301.9100-4T(d) of this chapter or this A-4,
will not be considered to have been properly filed. In any event, a
corporation may re-file the election statement, conforming it to the
requirements of this A-4, and such re-filing will then constitute the
only election (see A-9, regarding timely rescissions, for a possible
reason a corporation may want to re-file).
A corporation may file only one election statement and that statement
must include all options that are to receive ISO treatment. Thus a
corporation that makes an election with respect to certain options
granted before 1981 may not make any subsequent election with respect to
other options granted before 1981. An election shall be
[[Page 232]]
made by attaching a statement to the employer's income tax return (or
amended return) for the first taxable year during which either an option
subject to the election or an option qualifying under the rules of
section 422A is exercised. An election shall be made no later than the
due date (including extensions) of the income tax return for such year,
except that if the due date occurs before August 14, 1982, the employer
will be permitted to make the election at any time prior to August 14,
1982, on a statement attached to an amended return. In any event, no
election will be permitted after the due date (taking extensions into
account) of the income tax return for the taxable year including
December 31, 1982.
The statement must--
(a) Contain the name, address, and taxpayer identification number of
the corporation.
(b) Identify the election as an election under section 251(c)(1)(B)
of the Economic Recovery Tax Act of 1981.
(c) Specify, by employee, the options to which the election applies.
For each option so elected, the filing must state the option's date of
original grant (and, if applicable, date of most recent modification)
and total exercise price (i.e., the total number of shares subject to
the option multiplied by the price per share).
All options that are subject to the election must meet the section 422A
qualification requirements (see A-2(c)) at the time the election
statement is filed. The only exception to this rule is the requirement,
when necessary, of securing shareholder approval (see A-32 and A-34).
Q-5: In electing ISO treatment for options granted during the years
1976 through 1980 and outstanding on January 1, 1981, may a corporation
select only those options that it wants to receive ISO treatment?
A-5: Yes. However the original grant dates--or later grant dates for
options with section 425(h) amendments (see A-9)--of the options
selected for ISO treatment will determine the new sequencing order for
purposes of the ISO sequential exercise restriction (see A-2(c)(7)). For
example consider the case of options granted in 1977, 1978, and 1979,
and assume that in 1980 the 1978 option was modified to add a term
beneficial to the employee (a modification which under 425(h) would be
treated as the granting of a new option). If the 1977, 1978 (as
modified), and 1979 options are now elected as ISO's, the sequencing
order is as follows: the 1977 option must be exercised first, the 1979
option second, and the 1978 option (as modified) third. See also A-9 and
A-38.
Q-6: In electing ISO treatment for options granted during the years
1976 through 1980 and outstanding on January 1, 1981, may a corporation
select options on an option-by-option basis and/or an employee-by-
employee basis?
A-6: Yes. Subject to the $50,000 per year and $200,000 aggregate
limits (see A-3), a corporation may select for ISO treatment any or all
options granted to any or all employees, subject only to plan
requirements as to who must be benefited under a plan, as among
different classes of employees.
Q-7: In electing ISO treatment for options granted during the years
1976 through 1980 and outstanding on January 1, 1981, may a corporation
select only a portion of the elected option to receive such treatment?
A-7: Yes. Subject to the $50,000 per year and $200,000 aggregate
limits (see A-3), a corporation may select for ISO treatment any portion
of any option. If the option is not exercised prior to January 21, 1982,
the option must be amended so that the ISO portion is clearly
identified. When such a ``split'' option is exercised, separate stock
certificates must be issued (or reissued)--one for the ISO stock and one
for the non-ISO stock. See also A-15 and A-18.
Eligibility Requirements and Issues Involving Pre-enactment
Modifications, Dollar Limitations, and Dual Plans
Q-8: Is an option originally granted prior to January 1, 1976, and
amended on or after January 1, 1976, eligible for ISO treatment?
A-8: No. For purposes of ISO eligibility, the controlling date is
the date of original grant. A modification, extension, or renewal on or
after January 1, 1976, of any option originally granted before that
date, will not make such option eligible for ISO treatment, regardless
of whether or not the option, as so modified, extended, or renewed,
would be treated as newly granted within the meaning of section 425(h).
Q-9: If an option granted on or after January 1, 1976, was amended
between its date of grant and August 13, 1981, will such an amendment
affect the option's eligibility for ISO treatment?
A-9: An amendment to an otherwise eligible option (or plan) prior to
August 13, 1981, will be subject to the rules of section 425(h). If,
pursuant to section 425(h), the amendment is a modification, extension,
or renewal of the option, such amendment shall be considered as the
granting of a new option. In order for such an option to be eligible for
ISO treatment, the option (and plan) must comply with the section 422A
qualification requirements (see A-2(c)). The option will be deemed to
have been granted on the date it was amended. Thus, the option price
cannot be less than the fair market value of the stock on that date. If
the corporation wishes to retain the original grant price (and grant
date) of the option, the corporation may do so by rescinding the
amendment that was either a modification, extension, or renewal pursuant
to section 425(h), so long as such rescission occurs prior to the
earliest of the exercise of the option, the election of ISO
[[Page 233]]
treatment, and August 14, 1982. To be effective, such rescission must
apply to the entire option. For example, in the case of a $100,000
option granted in 1978 and amended in 1980, the corporation could not
rescind the modification as to only half of the option, and then elect
for ISO treatment both $50,000 of the option granted in 1978 and $50,000
of the option as amended in 1980.
Q-10: An option granted during 1978 was amended during 1980 to add
the following features: An alternative stock appreciation right, the
right to exercise the option with previously-acquired corporate stock,
and the right to receive a cash bonus upon the exercise of the option.
At the same time, the exercise period of the option was extended from
five to ten years and the post-employment exercise period was extended
from 3 to 18 months. If the option is to be elected as an ISO, which of
the above amendments is either a modification, extension, or renewal
within the meaning of section 425(h) so that the option will be treated
as newly granted on the date it was amended?
A-10: Any one of the above amendments will cause the option,
pursuant to section 425(h), to be treated as newly granted on the date
it was amended.
Q-11: An option granted during 1978 was amended during 1980 to add
the right to exercise the option with previously acquired corporate
stock. During 1981, the corporation properly elected ISO treatment for
the amended option and, pursuant to section 425(h), adjusted the option
price upward so that it equaled the fair market value of the stock
subject to the option as of the date of the 1980 amendment. During 1982,
the employee intends to exercise the option and will pay cash. Under
these circumstances, is the employee entitled to exercise the option at
the 1978 option price?
A-11: No. The option price, as amended in 1980, is the option price.
The application of section 425(h) to option amendments is not affected
by whether or not the employee actually benefits from such amendments
(but see A-9 regarding timely rescissions).
Q-12: Is an option granted on or after January 1, 1976, and
exercised on or after January 1, 1981, eligible for ISO treatment, if,
at the time of exercise, the option (or plan) did not meet all of the
qualification requirements of section 422A and the transitional rules
(see A-2(c) and A-3, respectively)?
A-12: No. Except in cases described in A-13 through A-15, and A-34,
in order for an option to be eligible for ISO treatment it must, at the
time of exercise, conform to all of the qualification requirements of
section 422A and the transition rules. It is not possible to amend an
exercised option retroactively, in order to correct non-conforming or
missing terms, or to rescind an improper exercise.
Q-13: Is an option granted on or after January 1, 1976, and
exercised on or after January 1, 1981, eligible for ISO treatment if, at
the time of exercise, the terms of the option did not contain the ISO
sequential exercise restriction (see A-2(c)(7))?
A-13: If the option was exercised prior to January 21, 1982, without
containing the ISO sequential exercise restriction, such option may
still be eligible for ISO treatment. The absence of the restriction will
not disqualify an option if the employee in fact had no prior
outstanding ISO's at the time the option in question was exercised. If
the option was exercised on or after January 21, 1982, the absence of
the ISO sequential exercise restriction will not disqualify an option if
the employee in fact had no prior outstanding ISO's at the time the
option in question was granted. In order to identify prior outstanding
ISO's, it will be necessary to take into account all options either
elected or qualifying for ISO treatment (see A-5, A-9, and A-38).
Q-14: Is an option granted and exercised during 1981 eligible for
ISO treatment if, at the time of exercise, the terms of the plan
pursuant to which the option was granted did not contain the $100,000
per year limit on ISO grants (see A-2(c)(8))?
A-14: If the option was exercised prior to January 21, 1982, the
absence from the plan of the $100,000 per year limit will not disqualify
the option. ISO treatment will only be available, however, for exercised
amounts that do not exceed the $100,000 limit. Those amounts in excess
of the limit will be treated as non-ISO's. If it is necessary to
``split'' an exercised option because the $100,000 limit has been
exceeded, separate stock certificates must be issued (or reissued) no
later than January 21, 1982, one for the ISO stock and one for the non-
ISO stock. If the option was not exercised prior to January 21, 1982,
the rules of A-18 will apply.
Q-15: Is an option granted during the years 1976 through 1980, and
exercised during 1981, eligible for ISO treatment if, at the time of
exercise, the option, either alone or in conjunction with similarly
granted options, exceeded the $50,000 per year limit (or the $200,000
aggregate limit) on ISO grants (see A-3)?
A-15: If the option was exercised prior to January 21, 1982, the
fact that the aggregate fair market value of the stock exceeded the
$50,000 per year limit (or the $200,000 aggregate limit) will not
prevent the election of up to $50,000 of the option as an ISO (subject
to the $200,000 aggregate limit). Those amounts in excess of the
applicable dollar limits cannot be elected as ISO's. If it is necessary
to ``split'' an exercised option because the applicable dollar limits
have been exceeded, separate stock certificates must be issued (or
reissued) no later than January 21, 1982, one for the ISO stock and one
for the non-ISO stock (see also A-7). If the option was not exercised
prior to January 21, 1982, the rules of A-18 will apply.
[[Page 234]]
Q-16: Do the $100,000 per year limit (see A-2(c)(8)), and the
$50,000 per year and $200,000 aggregate limits (see A-3) apply to all
options granted to an employee or only to elected and qualifying ISO's?
A-16: All three limits apply only to elected and qualifying ISO's.
Q-17: Do the $100,000 per year limit (see A-2(c)(8)), and the
$50,000 per year and $200,000 aggregate limits (see A-3) apply to the
fair market value of the stock granted, or to the option price of the
options granted?
A-17: The dollar limits apply to the fair market value of the stock
granted. Thus, an employee who is also a 10 percent shareholder would be
permitted to receive an ISO grant to purchase $100,000 worth of stock at
an option price of $110,000 (see A-2(c)(6)).
Q-18: How do the $100,000 per year limit (see A-2(c)(8)), and the
$50,000 per year and $200,000 aggregate limits (see A-3) apply to an
option granted on or after January 1, 1976, and not exercised prior to
January 21, 1982?
A-18: Such an option will not qualify for ISO treatment if, at the
time it is exercised, the option amount is in excess of the applicable
dollar limit. In order for such an option to qualify for ISO treatment,
it must be ``split'' into an ISO and a non-ISO portion so that the ISO
portion of the option does not exceed the applicable dollar limit. This
option ``split'' must be accomplished prior to the exercise of the
original option and the ISO portion of the option must be clearly
identified. Any ``split'' option that was required, by its original
terms, to be exercised in full, will still be required to be exercised
in full after it is ``split.'' Upon the exercise of a ``split'' option,
separate stock certificates must be issued--one for the ISO stock and
one for the non-ISO stock. Additionally, if the option was granted on or
after January 1, 1981, the terms of the plan pursuant to which the
option was granted must be amended to add the $100,000 per year limit--
before the option is exercised.
Q-19: How does the $50,000 per year limit (see A-3) apply to the
case of an employee who was granted $100,000 of options in 1979, and who
proposes to exercise these options $50,000 in 1982 and $50,000 in 1983?
A-19: Only $50,000 (valued as of the date of grant) of the stock for
which options were granted in 1979 will be eligible for ISO treatment.
The $50,000 per year limit relates only to the year of grant, not to the
year of vesting (as in the case of installment options) or exercise.
Additionally, no carryover provision applies to the $50,000 per year
limit. Thus, even if the employee had not been granted any options in
prior years, the result described above would not change.
Q-20: Is it permissible for a corporation to grant ISO's and non-
ISO's under the same plan, or must such options be granted pursuant to
separate plans?
A-20: Both ISO's and non-ISO's may be granted pursuant to one plan
so long as such plan, by its terms, meets all of the ISO qualification
requirements (see A-2 (c)). Additionally, each option granted pursuant
to such a ``dual'' plan must be clearly identified as to its status,
i.e., ISO or non-ISO.
Q-21: May a single option agreement, issued pursuant to a plan,
grant both ISO's and non-ISO's, or must such option agreements grant
either only ISO's or only non-ISO's?
A-21: Both ISO's and non-ISO's may be granted pursuant to a single
option agreement, so long as each option is clearly identified as to its
status, i.e., ISO or non-ISO, and none of the options are subject to a
``tandem'' exercise arrangement (see A-39).
Q-22: When either amending an existing plan or creating a new plan
that is to grant ISO's, is it necessary under the ISO qualification
requirements (see A-2(c)) to specify only the aggregate number of total
shares issuable under the plan, or must the aggregate numbers of ISO's
and non-ISO's be specified?
A-22: Only the aggregate number of total shares issuable under the
plan must be specified.
Q-23: Must either an option, or the plan pursuant to which the
option is granted, contain a specific provision restricting the exercise
of any ISO to within 3 months of termination of the employee's
employment (see A-2(b))?
A-23: No. An otherwise eligible option will receive ISO treatment if
it is, in fact, exercised within 3 months of termination of the
employee's employment (except in cases of disability or death).
Moreover, an option term that permits exercise beyond 3 months after
termination of employment, will not disqualify an option from receiving
ISO treatment.
Q-24: In order for an option to be eligible for ISO treatment, the
option price must equal or exceed the fair market value of the stock
subject to the option when the option is granted. This requirement will
be deemed to have been satisfied if, at the time of grant, there was a
good faith attempt to accurately value the stock--even if such valuation
should subsequently prove to be in error (see A-2(c)(4)). Do similar
good faith rules apply to the $100,000 per year and 50 percent carryover
limits (see A-2(c)(8)), and the $50,000 per year and $200,000 aggregate
limits (see A-3) relating to the value of ISO options granted per
employee?
A-24: Yes.
Required Option and Plan Amendments
Q-25: What types of amendments, under the transitional rule
governing changes in the terms of options and plans (see A-3), will not
invoke the application of section 425(h)?
A-25: The transitional rule waives the applicability of section
425(h) only with respect to amendments which are necessary in order to
permit an option or plan to meet the minimum qualification requirements
of section
[[Page 235]]
422A (see A-2(c)). Amendments to add or delete permissible terms (such
as the right to use previously acquired corporate stock to exercise the
option) do not fall within the waiver of section 425(h).
Q-26: Is an option granted after August 13, 1981, under a plan (or
option terms) which fails to meet the qualification requirements of
section 422A (see A-2(c)), eligible for ISO treatment?
A-26: No. However, prior to being exercised, such an option (or its
plan) may be amended to meet the qualification requirements of section
422A and thus become eligible for ISO treatment. All such amendments,
where an option is granted after August 13, 1981, will be subject to the
rules of section 425(h) (see A-3). Thus, for example, if an option is
granted on September 1, 1981, it may qualify as an ISO only if it is
amended, and the option price is at least equal to the fair market value
of the stock as of the amendment date.
Q-27: May the terms of an outstanding option that was granted on or
after January 1, 1981, and that automatically qualified for ISO
treatment, be selectively amended so as to disqualify the option from
receiving ISO treatment? May the option be cancelled?
A-27: Yes. However, despite either the cancellation of the option or
any disqualifying amendment to the option (or the plan pursuant to which
the option was granted), the original option will, for purposes of the
ISO sequential exercise restriction, be treated as an outstanding ISO
until such option, by its original terms, expires by reason of lapse of
time (see A-2(c)(7)).
Q-28: May a non-ISO plan be amended so as to qualify only
prospectively granted options for ISO treatment?
A-28: Yes. Amendments to a non-ISO plan, so as to meet the section
422A qualification requirements (see A-2(c)), will only apply to
previously granted and outstanding options when such amendments, by
their terms, are clearly intended to have retroactive effect.
Q-29: If a corporation grants new ISO's in exchange for the
cancellation of outstanding non-ISO's, will such an exchange violate
either the 422A qualification requirements (see A-2(c)) or the
transition rules (see A-3)?
A-29: No, so long as such an exchange does not constitute a
``tandem'' exercise arrangement (see A-39).
Shareholder Approval Issues
Q-30: If a plan received shareholder approval within 12 months
before or after the date such plan was originally adopted and it is
being amended to conform to the qualification requirements of section
422A (see A-2(c)), will new shareholder approval be required?
A-30: For purposes of the section 422A qualification requirements,
new shareholder approval will be required only if the original plan did
not specify the aggregate number of issuable shares or identify the
eligible employees (or class of employees).
Q-31: Does the amendment of a plan to add the $100,000 per year and
50 percent carryover limits (see A-2(c)(8)), relating to options granted
on or after January 1, 1981, require new shareholder approval?
A-31: No.
Q-32: If a plan never received shareholder approval, or did not
receive such approval within 12 months before or after the plan was
adopted, will such plan conform to the qualification requirements of
section 422A (see A-2(c)) if shareholder approval is obtained prior to
August 14, 1982?
A-32: Yes, but only if an option granted pursuant to the plan was
outstanding on August 13, 1981 (see A-3). If no option granted pursuant
to the plan was outstanding on August 13, 1981, such plan must be re-
adopted by the granting corporation and, if necessary, amended to meet
the section 422A qualification requirements. Shareholder approval must
be obtained within 12 months before or after the date the plan is re-
adopted. Consequently, any option granted after August 13, 1981, and
before the date the plan is re-adopted, will be treated as newly granted
on the date of re-adoption of the plan.
Q-33: If an option was granted pursuant to no plan at all and the
option was outstanding on August 13, 1981, may a plan now be instituted
and shareholder approval obtained, as part of the amendments permitted
under the transitional rules (see A-3)?
A-33: Yes.
Q-34: Assuming that shareholder approval is required with respect to
certain amendments made to conform an option outstanding on August 13,
1981 (or its plan), to the qualification requirements of section 422A
(see A-2(c)), may such option be exercised prior to securing shareholder
approval and still be eligible for ISO treatment?
A-34: Yes, so long as shareholder approval is secured within the
one-year period specified by the transitional rules (see A-3).
Sequential Exercise Issues
Q-35: Will the existence (or exercise) of prior stock options which
are neither elected nor qualified to receive ISO treatment, ever prevent
the exercise of an ISO under the 422A sequential exercise restriction
(see A-2)?
A-35: No. However, if an option that is either elected or qualified
to receive ISO treatment, contains sequencing restrictions that refer to
options other than ISO's, the option will continue to be burdened by
such restrictions. The deletion of such non-ISO sequencing restrictions
from the option is not an amendment necessary in order to qualify an
option for ISO treatment as permitted by the transitional rules (see A-
3). Consequently, section 425(h) would be applicable to such an
amendment.
[[Page 236]]
Q-36: Under the sequencing rules applicable to section 422 qualified
stock options, an option was permitted to be exercised out of sequence
so long as it was issued at a higher price than prior outstanding
options (section 422(c)(6)). Will a similar exception to the sequencing
restriction be applicable to ISO's?
A-36: No. Section 422A does not contain such an exception to the
sequencing restriction.
Q-37: How does the section 422A sequential exercise restriction (see
A-2(c)(7)) apply to an ISO granted in one year that, by its terms, can
only be exercised in installments over a period of years?
A-37: Such an installment ISO is the grant of a single option. The
section 422A sequential exercise restriction would restrict the exercise
of any later-granted ISO until either the exercise or expiration of all
installments of this earlier-granted ISO.
Q-38: Assume that an option granted and exercised during January of
1982 automatically qualifies, by its terms, for ISO treatment. During
February of 1982, the same employee exercised a second option, one that
had been granted during 1978. Prior to the exercise of the 1978 option,
it was amended under the transitional rules (see A-3) so that it would
conform to the section 422A qualification requirements (see A-2(c)). If
the 1978 option is properly elected to receive ISO treatment (see A-4),
will such an election adversely affect the 1982 option's status as an
ISO?
A-38: Yes. The election of the 1978 option to receive ISO treatment
will automatically disqualify the 1982 option. If the 1982 option is to
qualify as an ISO, it cannot be exercised prior to the exercise or
expiration of all ISO's previously granted and outstanding on the 1982
option's date of grant (see A-2(c)(7)). When the 1982 option was granted
during January of 1982, the 1978 option was already granted and
outstanding for purposes of the section 422A sequential exercise
restriction.
Receipt of Property or Cash Upon Exercise of an ISO
Q-39: Section 422A provides that ISO treatment will be available
even though the employee has the right to receive cash or other property
at the time of the exercise of the option, so long as such property is
subject to inclusion in income under section 83 (see A-2(d)(3)). To what
extent does section 422A permit the use of tandem options and stock
appreciation rights (SARs) in connection with ISO's?
A-39: A tandem stock option, wherein two options are issued together
and the exercise of one affects the right to exercise the other, is not
permitted because such a tandem option arrangement may be used to evade
the section 422A qualification requirements (see A-2(c)).
A tandem ISO-SAR, wherein an ISO and an SAR are granted together and the
exercise of one affects the right to exercise the other, is permitted so
long as the SAR, by its terms, meets the following requirements:
(a) The SAR will expire no later than the expiration of the
underlying ISO.
(b) The SAR may be for no more than 100% of the spread, i.e., the
difference between the exercise price of the underlying option and the
market price of the stock subject to the underlying option at the time
the SAR is exercised.
(c) The SAR is transferable only when the underlying ISO is
transferable, and under the same conditions.
(d) The SAR may be exercised only when the underlying ISO is
eligible to be exercised.
(e) The SAR may be exercised only when there is a positive spread,
i.e., when the market price of the stock subject to the option exceeds
the exercise price of the option.
If all of the above requirements are met, for purposes of the 422A
sequential exercise restriction (see A-2(c)(7)), a tandem ISO-SAR will
be considered exercised in full when either the underlying ISO or the
SAR is exercised. Additionally, SAR's may be paid in either cash or
property, or a combination thereof, so long as the section 83 income
inclusion rule applies to any property so transferred.
[T.D. 7799, 46 FR 61840, Dec. 21, 1981, as amended by T.D. 8435, 57 FR
43896, Sept. 23, 1992]
PART 15--TEMPORARY INCOME TAX REGULATIONS RELATING TO EXPLORATION EXPENDITURES IN THE CASE OF MINING--Table of Contents
Sec.
15.0-1 Scope of regulations in this part.
15.1-1 Elections to deduct.
15.1-2 Revocation of election to deduct.
15.1-3 Elections as to method of recapture.
15.1-4 Special rules.
Authority: Sec. 7805, 68A Stat. 917; 26 U.S.C. 7805.
Source: T.D. 6907, 31 FR 16776, Dec. 31, 1966, unless otherwise
noted.
Sec. 15.0-1 Scope of regulations in this part.
The regulations in this part relate to expenditures of the type
described in section 615(a) or in section 617(a)(1) paid or incurred
after September 12, 1966. The regulations in this part do not apply to
the income tax treatment of mining exploration expenditures paid or
incurred before September 13, 1966, and no election made pursuant to the
provisions of the regulations in
[[Page 237]]
this part shall have any effect on the income tax treatment of
exploration expenditures paid or incurred before such date. See
Sec. 15.1-4 for rules relating to treatment of exploration expenditures
paid or incurred during taxable years beginning before September 13,
1966, and ending after September 12, 1966.
Sec. 15.1-1 Elections to deduct.
(a) Manner of making election--(1) Election to deduct under section
617(a). The election to deduct exploration expenditures as expenses
under section 617(a) may be made by deducting such expenditures in the
taxpayer's income tax return for the first taxable year ending after
September 12, 1966, for which the taxpayer desires to deduct exploration
expenditures which are paid or incurred by him during such taxable year
and after September 12, 1966. This election may be exercised by
deducting such expenditures either in the taxpayer's return for such
taxable year or in an amended return filed before the expiration of the
period for filing a claim for credit or refund of income tax for such
taxable year. Where the election is made in an amended return for a
taxable year prior to the most recent year for which the taxpayer has
filed a return, the taxpayer shall file amended income tax returns,
reflecting any increase or decrease in tax attributable to the election,
for all taxable years affected by the election. See section 617(a)(2)(C)
for provisions relating to the tolling of the statute of limitations for
the assessment of any deficiency for any taxable year, to the extent the
deficiency is attributable to an election under section 617(a). In
applying the election to the years affected there shall be taken into
account the effect that any adjustments resulting from the election
shall have on other items affected thereby, such as the deduction for
charitable contributions, the foreign tax credit, net operating loss and
other deductions or credits the amount of which is limited by the
taxpayer's taxable income, and the effect that adjustments of any such
items have on other taxable years. Amended returns filed for taxable
years subsequent to the taxable year for which the election under
section 617(a) is made by amended return shall apply the recapture
provisions of subsections (b)(1)(B), (c), and (d) of section 617.
(2) Election to deduct under section 615--(i) General rule. The
election to deduct exploration expenditures under section 615 shall be
made in a statement filed with the district director, or director of the
regional service center, with whom the taxpayer's income tax return is
required to be filed. If the election is made within the time period
prescribed for filing an income tax return (including extensions
thereof) for the first taxable year ending after September 12, 1966,
during which the taxpayer pays or incurs expenditures which are within
the scope of section 615 and which are paid or incurred by him after
September 12, 1966, this statement shall be attached to the taxpayer's
income tax return for such taxable year. If the election is made after
the time prescribed for filing such return but before the expiration of
the period (described in paragraph (d)(1) of this section) for making
the election under section 615(e), the statement must be signed by the
taxpayer or his authorized representative. The statement shall be filed
even though the taxpayer charges to capital account all such
expenditures paid or incurred by him during such taxable year after such
date. The statement shall clearly indicate that the taxpayer elects to
have section 615 apply to all amounts deducted by him with respect to
mining exploration expenditures paid or incurred after September 12,
1966. If the taxpayer desires, he may file this statement by attaching
it to his return for a taxable year prior to the first taxable year
ending after September 12, 1966, in which he pays or incurs mining
exploration expenditures. Except as provided, in subdivision (ii) of
this subparagraph, if the taxpayer does not file such a statement within
the period prescribed by section 615(e) and paragraph (d)(1) of this
section, any amounts deducted by him with respect to exploration
expenditures paid or incurred by him after September 12, 1966, will be
deemed to have been deducted pursuant to an election under section
617(a).
(ii) Exception. The last sentence of subdivision (i) of this
subparagraph
[[Page 238]]
shall not apply if all mining exploration expenditures which are paid or
incurred by the taxpayer after September 12, 1966, and which are
deducted by him in his income tax return for the first taxable year
ending after September 12, 1966, during which he pays or incurs such
expenditures are outside the scope of section 617(a). For example,
assume that, in his return for his first taxable year ending after
September 12, 1966, a taxpayer deducts mining exploration expenditures
paid or incurred after September 12, 1966, and does not attach to his
return the statement described in subdivision (i) of this subparagraph.
However, all of the exploration expenditures paid or incurred by the
taxpayer after September 12, 1966, and before the end of the taxable
year were paid or incurred with respect to minerals located neither in
the United States nor on the Outer Continental Shelf. The taxpayer will
be deemed to have made an election under section 615(e) by deducting all
or part of those expenditures as expenses in his income tax return.
(b) Information to be furnished. A taxpayer who makes or has made an
election under either section 615(e) or section 617(a) to deduct
expenditures paid or incurred after September 12, 1966, shall indicate
clearly on his income tax return for each taxable year for which he
deducts any such expenditures the amount of the deduction claimed under
section 615 (a) or (b) or section 617(a) with respect to each property
or area of interest. Such property or area of interest shall be
identified by a description sufficiently adequate to permit application
of the recapture rules of section 617 (b), (c), and (d) and the rules of
section 615(g) (relating to effect of transfer of mineral property).
(c) Effect of election. A taxpayer who has made an election under
section 615(e) may never make an election under section 617(a) unless,
within the period set forth in section 615(e) and paragraph (b)(1) of
Sec. 15.1-2, he revokes his election under section 615(e). A taxpayer
who has made an election under section 617(a) may never make an election
under section 615(e) unless, within the period set forth in section
615(e) and paragraph (b)(1) of Sec. 15.1-2, he revokes his election
under section 617(a). A taxpayer who has made, and has not revoked, an
election under section 617(a) may not, in his return for the taxable
year for which the election is made or for any subsequent taxable year,
charge to capital account any expenditures which are within the scope of
section 617(a), and he must deduct all such expenditures as expenses.
Except as provided in paragraph (a)(2) of Sec. 1.615-2 of this chapter
(Income Tax Regulations), a taxpayer who makes an election under 615(e)
may not change his treatment of exploration expenditures deducted,
deferred, or capitalized pursuant to such election unless he revokes the
election made under section 615(e).
(d) Time for making election--(1) Election under section 615(e). A
taxpayer may not make an election under section 615(e) after the
expiration of the 3-year period beginning with the date prescribed by
section 6072 or other provision of law for filing the taxpayer's income
tax return for the first taxable year ending after September 12, 1966,
in which the taxpayer pays or incurs expenditures to which section
615(a) would apply if an election were made under section 615(e). This
3-year period shall be determined without regard to any extension of
time for filing the taxpayer's income tax return. An election under
section 615(e) may not be made after the expiration of the 3-year period
even though the taxpayer charged to capital account, or erroneously
deducted as development expenditures under section 616, all mine
exploration expenditures paid or incurred by him after September 12,
1966, and before the end of his first taxable year ending after
September 12, 1966, in which he paid or incurred such expenditures.
(2) Election under section 617(a). The election under section 617(a)
may be made at any time before the expiration of the period prescribed
for filing a claim for credit or refund of the tax imposed by chapter 1
for the first taxable year for which the taxpayer desires to deduct
exploration expenditures under section 617.
(3) Timely mailing treated as timely filing. Section 7502 (relating
to timely mailing treated as timely filing) shall apply in determining
the date when an
[[Page 239]]
election under either section 615(e) or section 617(a) is made.
Sec. 15.1-2 Revocation of election to deduct.
(a) Manner of revoking election. A taxpayer may revoke an election
made by him under section 615(e) or section 617(a) by filing with the
internal revenue officer with whom the taxpayer's income tax return is
required to be filed, within the periods set forth in paragraph (b) of
this section, a statement, signed by the taxpayer or his authorized
representative, which sets forth that the taxpayer is revoking the
election previously made by him with respect to the deduction of mining
exploration expenditures paid or incurred after September 12, 1966, and
states with whom the document making the election was filed. A taxpayer
revoking such an election shall file amended income tax returns,
reflecting any increase or decrease in tax attributable to the
revocation of election, for all taxable years affected by the revocation
of election. See section 617(a)(2)(C) for provisions relating to the
tolling of the statute of limitations for the assessment of any
deficiency for any taxable year, to the extent the deficiency is
attributable to an election or revocation of election under section
617(a). In applying the revocation of an election to the years affected
there shall be taken into account the effect that any adjustments
resulting from the revocation of election shall have on other items
affected thereby, such as the deduction for charitable contributions,
the foreign tax credit, net operating loss, and other deductions or
credits the amount of which is limited by the taxpayer's taxable income,
and the effect that adjustments of any such items have on other taxable
years.
(b) Time for revoking election--(1) Election under section 615(e).
An election under section 615(e) may be revoked at any time before the
expiration of the 3-year period described in paragraph (d)(1) of
Sec. 15.1-1. Such an election may not be revoked after the expiration of
the 3-year period.
(2) Election under section 617(a). An election under section 617(a)
may be revoked before the expiration of the last day of the third month
following the month in which the final regulations issued under the
authority of section 617 are published in the Federal Register. After
the expiration of this period, a taxpayer who has made an election under
section 617(a) may not revoke that election unless he obtains the
consent of the Secretary or his delegate in the manner to be set forth
in the final regulations under section 617.
(c) Additional information to be furnished by a transferor of
mineral property. If, before revoking his election, the taxpayer has
transferred any mineral property with respect to which he deducted
exploration expenditures paid or incurred after September 12, 1966, to
another person in a transaction as a result of which the basis of such
property in the hands of the transferee is determined by reference to
the basis in the hands of the transferor, the statement submitted
pursuant to paragraph (a) of this section shall state that such property
has been so transferred and shall identify the transferee, the property
transferred, and the date of the transfer.
Sec. 15.1-3 Elections as to method of recapture.
(a) In general. If the taxpayer so elects with respect to all mines
with respect to which deductions have been allowed under section 617(a)
and which reach the producing stage during a taxable year, he shall
include in gross income for the taxable year an amount equal to the
adjusted exploration expenditures with respect to such mines (determined
under section 617(f)(1)). The amount so included in income shall be
treated for purposes of Subtitle A of the Internal Revenue Code as
expenditures which are paid or incurred on the respective dates on which
the mines reach the producing stage and which are properly chargeable to
capital account. If the taxpayer does not make this election for a
taxable year during which any mine with respect to which deductions have
been allowed under section 617(a) reaches the producing stage, the
deduction for depletion under section 611 with respect to the property
(whether determined under Sec. 1.611-2 of this chapter (Income Tax
Regulations) or under section 613) shall be disallowed until the amount
of
[[Page 240]]
depletion which would be allowable but for section 617(b)(1)(B) equals
the amount of the adjusted exploration expenditures with respect to the
mine. The fact that a taxpayer does not make the election described in
the first sentence of this paragraph for a taxable year during which
mines with respect to which deductions have been allowed under section
617(a) reach the producing stage shall not preclude the taxpayer from
making the election with respect to other mines which reach the
producing stage during a subsequent taxable year. However, an election
may not be made for any taxable year with respect to any mines which
reached the producing stage during a preceding taxable year.
(b) Manner of making elections. A taxpayer will be considered to
have made an election in accordance with the manner in which the
adjusted exploration expenditures with respect to the mines reaching the
producing stage during a taxable year are treated in his return for such
taxable year.
(c) Time for making election. The election described in paragraph
(a) of this section may be made, or changed by filing an amended return,
not later than the time prescribed by law for filing the return
(including extensions thereof) for the taxable year.
Sec. 15.1-4 Special rules.
(a) Taxable years beginning before September 13, 1966, and ending
after September 12, 1966--(1) General rule. An election made under
section 615(e) or section 617(a) applies only to expenditures paid or
incurred after September 12, 1966. The income tax treatment of
exploration expenditures paid or incurred before September 13, 1966,
will be determined in accordance with the provisions of section 615
prior to its amendment by the Act of September 12, 1966 (Pub. L. 89-570,
80 Stat. 759). If a taxpayer makes an election under section 615(e) in
his income tax return for a taxable year beginning before September 13,
1966, and ending after September 12, 1966, amounts deducted under
section 615 with respect to expenditures paid or incurred during such
taxable year but before September 13, 1966, will be taken into account
in determining whether the $100,000 limitation set forth in section
615(a) is reached during 1966. Similarly, a taxpayer making an election
under section 615(e) shall take into account expenditures deducted under
section 615 for periods prior to September 13, 1966, in determining when
the $400,000 overall limitation set forth in section 615(c) is reached.
The fact that a taxpayer deducts under section 615 expenditures paid or
incurred prior to September 13, 1966, shall not affect his right to make
an election under section 617(a) to deduct under section 617
expenditures paid or incurred after September 12, 1966.
(2) Allocation in case of inadequate records. If a taxpayer pays or
incurs exploration expenditures during a taxable year beginning before
September 13, 1966, and ending after September 12, 1966, but his records
as to any mine or property are inadequate to permit a determination of
the amount paid or incurred during the portion of the year ending after
September 12, 1966, and the amount paid or incurred on or before such
date, the exploration expenditures as to which the records are
inadequate paid or incurred with respect to the mine or property during
the taxable year shall be allocated to each part year (that is, the part
occurring before September 13, 1966, and the part occurring after
September 12, 1966) in the ratio which the number of days in such part
year bears the number of days in the entire taxable year. For example,
if the records of a calendar year taxpayer for 1966 are inadequate to
permit a determination of the amount of exploration expenditures paid or
incurred with respect to a certain mine or property after September 12,
1966, and the amount paid or incurred before September 13, 1966, \255/
365\ of the total exploration expenditures paid or incurred by the
taxpayer with respect to the mine or property during 1966 shall be
allocated to the period beginning January 1, 1966, and ending September
12, 1966, and \110/365\ of the total exploration expenditures paid or
incurred with respect to the mine or property during 1966 shall be
allocated to the period beginning September 13, 1966, and ending
December 31, 1966.
[[Page 241]]
(3) Partnership elections. With respect to exploration expenditures
paid or incurred by a partnership before September 13, 1966, the option
to deduct under section 615(a) and the election to defer under section
615(b) shall be made by the partnership, rather than by the individual
partners. All elections under sections 615(e), 617(a), or 617(b) as to
the tax treatment of a partner's distributive share of exploration
expenditures paid or incurred by any partnership of which he is a member
shall be made by the individual partner, rather than by the partnership.
(b) Effect of transfer of mineral property. The binding effect of a
taxpayer's election under section 615(e) shall not be affected by his
receiving property with respect to which deductions have been allowed
under section 617(a). The binding effect of a taxpayer's election under
section 617(a) shall not be affected by his receiving property with
respect to which deductions have been allowed under section 615 pursuant
to an election made under section 615(e). However, see section 615(g)(2)
for rules under which amounts deducted under section 615 by a transferor
may be subject to recapture in the hands of a transferee who has made an
election under section 617(a).
PART 15a--TEMPORARY INCOME TAX REGULATIONS UNDER THE INSTALLMENT SALES REVISION ACT--Table of Contents
Sec.
15a.453-0 Taxable years affected.
15a.453-1 Installment method reporting for sales of real property and
casual sales of personal property.
15a.453-2 Installment obligations received as liquidating distribution.
[Reserved]
Authority: 26 U.S.C. 453(i) and 7805.
Sec. 15a.453-0 Taxable years affected.
(a) In general. Except as otherwise provided, the provisions of
Sec. 15a.453-1 (a) through (e) generally apply to installment method
reporting for sales of real property and casual sales of personal
property occurring after October 19, 1980. See 26 CFR Sec. 1.453-1 (rev.
as of April 1, 1980) for the provisions relating to installment method
reporting for sales of real property and casual sales before October 20,
1980 (except as provided in paragraph (b) of this section) and for
provisions relating to installment sales by dealers in personal property
occurring before October 20, 1980.
(b) Certain limitations. The provisions of prior law (section 453(b)
of the Internal Revenue Code of 1954, in effect as of October 18, 1980)
which required that the buyer receive no more than 30 percent of the
selling price in the taxable year of the installment sale and that at
least two payments be received shall not apply to reporting for casual
installment sales of personal property and installment sales of real
property occurring in a taxable year ending after October 19, 1980.
[T.D. 7768, 46 FR 10709, Feb. 4, 1981; 46 FR 43036, Aug. 26, 1981]
Sec. 15a.453-1 Installment method reporting for sales of real property and casual sales of personal property.
(a) In general. Unless the taxpayer otherwise elects in the manner
prescribed in paragraph (d)(3) of this section, income from a sale of
real property or a casual sale of personal property, where any payment
is to be received in a taxable year after the year of sale, is to be
reported on the installment method.
(b) Installment sale defined--(1) In general. The term ``installment
sale'' means a disposition of property (except as provided in paragraph
(b)(4) of this section) where at least one payment is to be received
after the close of the taxable year in which the disposition occurs. The
term ``installment sale'' includes dispositions from which payment is to
be received in a lump sum in a taxable year subsequent to the year of
sale. For purposes of this paragraph, the taxable year in which payments
are to be received is to be determined without regard to section 453(e)
(relating to related party sales), section (f)(3) (relating to the
definition of a ``payment'') and section (g) (relating to sales of
depreciable property to a spouse or 80-percent-owned entity).
(2) Installment method defined--(i) In general. Under the
installment method, the amount of any payment which is income to the
taxpayer is that portion of the installment payment received in
[[Page 242]]
that year which the gross profit realized or to be realized bears to the
total contract price (the ``gross profit ratio''). See paragraph (c) of
this section for rules describing installment method reporting of
contingent payment sales.
(ii) Selling price defined. The term ``selling price'' means the
gross selling price without reduction to reflect any existing mortgage
or other encumbrance on the property (whether assumed or taken subject
to by the buyer) and, for installment sales in taxable years ending
after October 19, 1980, without reduction to reflect any selling
expenses. Neither interest, whether stated or unstated, nor original
issue discount is considered to be a part of the selling price. See
paragraph (c) of this section for rules describing installment method
reporting of contingent payment sales.
(iii) Contract price defined. The term ``contract price'' means the
total contract price equal to selling price reduced by that portion of
any qualifying indebtedness (as defined in paragraph (b)(2)(iv) of this
section), assumed or taken subject to by the buyer, which does not
exceed the seller's basis in the property (adjusted, for installment
sales in taxable years ending after October 19, 1980, to reflect
commissions and other selling expenses as provided in paragraph
(b)(2)(v) of this section). See paragraph (c) of this section for rules
describing installment method reporting of contingent payment sales.
(iv) Qualifying indebtedness. The term ``qualifying indebtedness''
means a mortgage or other indebtedness encumbering the property and
indebtedness, not secured by the property but incurred or assumed by the
purchaser incident to the purchaser's acquisition, holding, or operation
in the ordinary course of business or investment, of the property. The
term ``qualifying indebtedness'' does not include an obligation of the
taxpayer incurred incident to the disposition of the property (e.g.,
legal fees relating to the taxpayer's sale of the property) or an
obligation functionally unrelated to the acquisition, holding, or
operating of the property (e.g., the taxpayer's medical bill). Any
obligation created subsequent to the taxpayer's acquisition of the
property and incurred or assumed by the taxpayer or placed as an
encumbrance on the property in contemplation of disposition of the
property is not qualifying indebtedness if the arrangement results in
accelerating recovery of the taxpayer's basis in the installment sale.
(v) Gross profit defined. The term ``gross profit'' means the
selling price less the adjusted basis as defined in section 1011 and the
regulations thereunder. For sales in taxable years ending after October
19, 1980, in the case of sales of real property by a person other than a
dealer and casual sales of personal property, commissions and other
selling expenses shall be added to basis for purposes of determining the
proportion of payments which is gross profit attributable to the
disposition. Such additions to basis will not be deemed to affect the
taxpayer's holding period in the transferred property.
(3) Payment--(i) In general. Except as provided in paragraph (e) of
this section (relating to purchaser evidences of indebtedness payable on
demand or readily tradable), the term ``payment'' does not include the
receipt of evidences of indebtedness of the person acquiring the
property (``installment obligation''), whether or not payment of such
indebtedness is guaranteed by a third party (including a government
agency). For special rules regarding the receipt of an evidence of
indebtedness of a transferee of a qualified intermediary, see
Secs. 1.1031(b)-2(b) and 1.1031(k)-1(j)(2)(iii) of this chapter. A
standby letter of credit (as defined in paragraph (b)(3)(iii) of this
section) shall be treated as a third party guarantee. Payments include
amounts actually or constructively received in the taxable year under an
installment obligation. For a special rule regarding a transfer of
property to a qualified intermediary followed by the sale of such
property by the qualified intermediary, see Sec. 1.1031(k)-1(j)(2)(ii)
of this chapter. Receipt of an evidence of indebtedness which is secured
directly or indirectly by cash or a cash equivalent, such as a bank
certificate of deposit or a treasury note, will be treated as the
receipt of payment. For a special rule
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regarding a transfer of property in exchange for an obligation that is
secured by cash or a cash equivalent held in a qualified escrow account
or a qualified trust, see Sec. 1.1031(k)-1(j)(2)(i) of this chapter.
Payment may be received in cash or other property, including foreign
currency, marketable securities, and evidences or indebtedness which are
payable on demand or readily tradable. However, for special rules
relating to the receipt of certain property with respect to which gain
is not recognized, see paragraph (f) of this section (relating to
transactions described in sections 351, 356(a) and 1031). Except as
provided in Sec. 15a.453-2 of these regulations (relating to
distributions of installment obligations in corporate liquidations
described in section 337), payment includes receipt of an evidence of
indebtedness of a person other than the person acquiring the property
from the taxpayer. For purposes of determining the amount of payment
received in the taxable year, the amount of qualifying indebtedness (as
defined in paragraph (b)(2)(iv) of this section) assumed or taken
subject to by the person acquiring the property shall be included only
to the extent that it exceeds the basis of the property (determined
after adjustment to reflect selling expenses). For purposes of the
preceding sentence, an arrangement under which the taxpayer's liability
on qualifying indebtedness is eliminated incident to the disposition
(e.g., a novation) shall be treated as an assumption of the qualifying
indebtedness. If the taxpayer sells property to a creditor of the
taxpayer and indebtedness of the taxpayer is cancelled in consideration
of the sale, such cancellation shall be treated as payment. To the
extent that cancellation is not in consideration of the sale, see
Secs. 1.61-12(b)(1) and 1.1001-2(a)(2) relating to discharges of
indebtedness. If the taxpayer sells property which is encumbered by a
mortgage or other indebtedness on which the taxpayer is not personally
liable, and the person acquiring the property is the obligee, the
taxpayer shall be treated as having received payment in the amount of
such indebtedness.
(ii) Wrap-around mortgage. This paragraph (b)(3)(ii) shall apply
generally to any installment sale after March 4, 1981 unless the
installment sale was completed before June 1, 1981 pursuant to a written
obligation binding on the seller that was executed on or before March 4,
1981. A ``wrap-around mortgage'' means an agreement in which the buyer
initially does not assume and purportedly does not take subject to part
or all of the mortgage or other indebtedness encumbering the property
(``wrapped indebtedness'') and, instead, the buyer issues to the seller
an installment obligation the principal amount of which reflects such
wrapped indebtedness. Ordinarily, the seller will use payments received
on the installment obligation to service the wrapped indebtedness. The
wrapped indebtedness shall be deemed to have been taken subject to even
though title to the property has not passed in the year of sale and even
though the seller remains liable for payments on the wrapped
indebtedness. In the hands of the seller, the wrap-around installment
obligation shall have a basis equal to the seller's basis in the
property which was the subject of the installment sale, increased by the
amount of gain recognized in the year of sale, and decreased by the
amount of cash and the fair market value of other nonqualifying property
received in the year of sale. For purposes of this paragraph (b)(3)(ii),
the amount of any indebtedness assumed or taken subject to by the buyer
(other than wrapped indebtedness) is to be treated as cash received by
the seller in the year of sale. Therefore, except as otherwise required
by section 483 or 1232, the gross profit ratio with respect to the wrap-
around installment obligation is a fraction, the numerator of which is
the face value of the obligation less the taxpayer's basis in the
obligation and the denominator of which is the face value of the
obligation.
(iii) Standby letter of credit. The term ``standby letter of
credit'' means a non-negotiable, non-transferable (except together with
the evidence of indebtedness which it secures) letter of credit, issued
by a bank or other financial institution, which serves as a guarantee of
the evidence of indebtedness which is secured by the letter of credit.
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Whether or not the letter of credit explicitly states it is non-
negotiable and nontransferable, it will be treated as non-negotiable and
nontransferable if applicable local law so provides. The mere right of
the secured party (under applicable local law) to transfer the proceeds
of a letter of credit shall be disregarded in determining whether the
instrument qualifies as a standby letter of credit. A letter of credit
is not a standby letter of credit if it may be drawn upon in the absence
of default in payment of the underlying evidence of indebtedness.
(4) Exceptions. The term ``installment sale'' does not include, and
the provisions of section 453 do not apply to, dispositions of personal
property on the installment plan by a person who regularly sells or
otherwise disposes of personal property on the installment plan, or to
dispositions of personal property of a kind which is required to be
included in the inventory of the taxpayer if on hand at the close of the
taxable year. See section 453A and the regulations thereunder for rules
relating to installment sales by dealers in personal property. A dealer
in real property or a farmer who is not required under his method of
accounting to maintain inventories may report the gain on the
installment method under section 453.
(5) Examples. The following examples illustrate installment method
reporting under this section:
Example (1). In 1980, A, a calendar year taxpayer, sells Blackacre,
an unencumbered capital asset in A's hands, to B for $100,000: $10,000
down and the remainder payable in equal annual installments over the
next 9 years, together with adequate stated interest. A's basis in
Blackacre, exclusive of selling expenses, is $38,000. Selling expenses
paid by A are $2,000. Therefore, the gross profit is $60,000 ($100,000
selling price-$40,000 basis inclusive of selling expenses). The gross
profit ratio is \3/5\ (gross profit of $60,000 divided by $100,000
contract price). Accordingly, $6,000 \3/5\ of $10,000) of each $10,000
payment received is gain attributable to the sale and $4,000
($10,000-$6,000) is recovery of basis. The interest received in addition
to principal is ordinary income to A.
Example (2). C sells Whiteacre to D for a selling price of $160,000.
Whiteacre is encumbered by a longstanding mortgage in the principal
amount of $60,000. D will assume or take subject to the $60,000 mortgage
and pay the remaining $100,000 in 10 equal annual installments together
with adequate stated interest. C's basis in Whiteacre is $90,000. There
are no selling expenses. The contract price is $100,000, the $160,000
selling price reduced by the mortgage of $60,000 assumed or taken
subject to. Gross profit is $70,000 ($160,000 selling price less C's
basis of $90,000). C's gross profit ratio is \7/10\ (gross profit of
$70,000 divided by $100,000 contract price). Thus, $7,000 (\7/10\ of
$10,000) of each $10,000 annual payment is gain attributable to the
sale, and $3,000 ($10,000-$7,000) is recovery of basis.
Example (3). The facts are the same as in example (2), except that
C's basis in the land is $40,000. In the year of the sale C is deemed to
have received payment of $20,000 ($60,000-$40,000, the amount by which
the mortgage D assumed or took subject to exceeds C's basis). Since
basis is fully recovered in the year of sale, the gross profit ratio is
1 ($120,000/$120,000) and C will report 100% of the $20,000 deemed
payment in the year of sale and each $10,000 annual payment as gain
attributable to the sale.
Example (4). E sells Blackacre, an unencumbered capital gain
property in E's hands, to F on January 2, 1981. F makes a cash down
payment of $500,000 and issues a note to E obliging F to pay an
additional $500,000 on the fifth anniversary date. The note does not
require a payment of interest. In determining selling price, section 483
will apply to recharacterize as interest a portion of the $500,000
future payment. Assume that under section 483 and the applicable
regulations $193,045 is treated as total unstated interest, and the
selling price is $806,955 ($1 million less unstated interest). Assuming
E's basis (including selling expenses) in Blackacre is $200,000) gross
profit is $606,955 ($806,955-$200,000) and the gross profit ratio is
75.21547%. Accordingly, of the $500,000 cash down payment received by E
in 1981, $376,077 (75.21547% of $500,000) is gain attributable to the
sale and $123,923 is recovery of basis ($500,000-$376,077).
Example (5). In 1982, G sells to H Blackacre, which is encumbered by
a first mortgage with a principal amount of $500,000 and a second
mortgage with a principal amount of $400,000, for a selling price of $2
million. G's basis in Blackacre is $700,000. Under the agreement between
G and H, passage of title is deferred and H does not assume and
purportedly does not take subject to either mortgage in the year of
sale. H pays G $200,000 in cash and issues a wrap-around mortgage note
with a principal amount of $1,800,000 bearing adequate stated interest.
H is deemed to have acquired Blackacre subject to the first and second
mortgages (wrapped indebtedness) totalling $900,000. The contract price
is $1,300,000 (selling price of $2 million less $700,000 mortgages
within the seller's basis assumed or taken subject to). Gross profit is
also $1,300,000 (selling
[[Page 245]]
price of $2 million less $700,000 basis). Accordingly in the year of
sale, the gross profit ratio is 1 ($1,300,000/$1,300,000). Payment in
the year of sale is $400,000 ($200,000 cash received plus $200,000
mortgage in excess of basis ($900,000-$700,000)). Therefore, G
recognizes $400,000 gain in the year of sale ($400,000 x 1). In the
hands of G the wrap-around installment obligation has a basis of
$900,000, equal to G's basis in Blackacre ($700,000) increased by the
gain recognized by G in the year of sale ($400,000) reduced by the cash
received by G in the year of sale ($200,000). G's gross profit with
respect to the note is $900,000 ($1,800,000 face amount less $900,000
basis in the note) and G's contract price with respect to the note is
its face amount of $1,800,000. Therefore, the gross profit ratio with
respect to the note is \1/2\ ($900,000/$1,800,000).
Example (6). The facts are the same as example (5) except that under
the terms of the agreement H assumes the $500,000 first mortgage on
Blackacre. H does not assume and purportedly does not take subject to
the $400,000 second mortgage on Blackacre. The wrap-around installment
obligation issued by H to G has a face amount of $1,300,000. The tax
results in the year of sale to G are the same as example (5) ($400,000
payment received and gain recognized). In the hands of G, basis in the
wrap-around installment obligation is $400,000 ($700,000 basis in
Blackacre plus $400,000 gain recognized in the year of sale minus
$700,000 ($200,000 cash received and $500,000 treated as cash received
as a result of H's assumption of the first mortgage)). G's gross profit
with respect to the note is $900,000 ($1,300,000 face amount of the
wrap-around installment obligation less $400,000 basis in that note) and
G's contract price with respect to the note is its face value of
$1,300,000. Therefore, the gross profit ratio with respect to the note
is \9/13\ ($900,000/$1,300,000).
Example (7). A sells the stock of X corporation to B for a $1
million installment obligation payable in equal annual installments over
the next 10 years with adequate stated interest. The installment
obligation is secured by a standby letter of credit (within the meaning
of paragraph (b)(3)(iii) of this section) issued by M bank. Under the
agreement between B and M bank, B is required to maintain a compensating
balance in an account B maintains with M bank and is required by the M
bank to post additional collateral, which may include cash or a cash
equivalent, with M bank. Under neither the standby letter of credit nor
any other agreement or arrangement is A granted a direct lien upon or
other security interest in such cash or cash equivalent collateral.
Receipt of B's installment obligation secured by the standby letter of
credit will not be treated as the receipt of payment by A.
Example (8). The facts are the same as in example (7) except that
the standby letter of credit is in the drawable sum of $600,000. To
secure fully its $1 million note issued to A, B deposits in escrow
$400,000 in cash and Treasury bills. Under the escrow agreement, upon
default in payment of the note A may look directly to the escrowed
collateral. Receipt of B's installment obligation will be treated as the
receipt payment by A in the sum of $400,000.
(c) Contingent payment sales--(1) In general. Unless the taxpayer
otherwise elects in the manner prescribed in paragraph (d)(3) of this
section, contingent payment sales are to be reported on the installment
method. As used in this section, the term ``contingent payment sale''
means a sale or other disposition of property in which the aggregate
selling price cannot be determined by the close of the taxable year in
which such sale or other disposition occurs.
The term ``contingent payment sale'' does not include transactions with
respect to which the installment obligation represents, under applicable
principles of tax law, a retained interest in the property which is the
subject of the transaction, an interest in a joint venture or a
partnership, an equity interest in a corporation or similar
transactions, regardless of the existence of a stated maximum selling
price or a fixed payment term. See paragraph (c)(8) of this section,
describing the extent to which the regulations under section 385 apply
to the determination of whether an installment obligation represents an
equity interest in a corporation.
This paragraph prescribes the rules to be applied in allocating the
taxpayer's basis (including selling expenses except for selling expenses
of dealers in real estate) to payments received and to be received in a
contingent payment sale. The rules are designed appropriately to
distinguish contingent payment sales for which a maximum selling price
is determinable, sales for which a maximum selling price is not
determinable but the time over which payments will be received is
determinable, and sales for which neither a maximum selling price nor a
definite payment term is determinable. In addition, rules are prescribed
under which, in appropriate circumstances, the taxpayer will be
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permitted to recover basis under an income forecast computation.
(2) Stated maximum selling price--(i) In general. (A) contingent
payment sale will be treated as having a stated maximum selling price
if, under the terms of the agreement, the maximum amount of sale
proceeds that may be received by the taxpayer can be determined as of
the end of the taxable year in which the sale or other disposition
occurs. The stated maximum selling price shall be determined by assuming
that all of the contingencies contemplated by the agreement are met or
otherwise resolved in a manner that will maximize the selling price and
accelerate payments to the earliest date or dates permitted under the
agreement. Except as provided in paragraph (c)(2)(ii) and (7) of this
section (relating to certain payment recomputations), the taxpayer's
basis shall be allocated to payments received and to be received under a
stated maximum selling price agreement by treating the stated maximum
selling price as the selling price for purposes of paragraph (b) of this
section. The stated maximum selling price, as initially determined,
shall thereafter be treated as the selling price unless and until that
maximum amount is reduced, whether pursuant to the terms of the original
agreement, by subsequent amendment, by application of the payment
recharacterization rule (discribed in paragraph (c)(2)(ii) of this
section), or by a subsequent supervening event such as bankruptcy of the
obligor. When the maximum amount is subsequently reduced, the gross
profit ratio will be recomputed with respect to payments received in or
after the taxable year in which an event requiring reduction occurs. If,
however, application of the foregoing rules in a particular case would
substantially and inappropriately accelerate or defer recovery of the
taxpayer's basis, a special rule will apply. See paragraph (c)(7) of
this section.
(B) The following examples illustrate the provisions of paragraph
(e)(2)(i) of this section. In each example, it is assumed that
application of the rules illustrated will not substantially and
inappropriately defer or accelerate recovery of the taxpayer's basis.
Example (1). A sells all of the stock of X corporation to B for
$100,000 payable at closing plus an amount equal to 5% of the net
profits of X for each of the next nine years, the contingent payments to
be made annually together with adequate stated interest. The agreement
provides that the maximum amount A may receive, inclusive of the
$100,000 down payment but exclusive of interest, shall be $2,000,000.
A's basis in the stock of X inclusive of selling expenses, is $200,000.
Selling price and contract price are considered to be $2,000,000. Gross
profit is $1,800,000, and the gross profit ratio is 9/10 ($1,800,000/
$2,000,000). Accordingly, of the $100,000 received by A in the year of
sale, $90,000 is reportable as gain attributable to the sale and $10,000
is recovery of basis.
Example (2). C owns Blackacre which is encumbered by a long-standing
mortgage of $100,000. On January 15, 1981, C sells Blackacre to D under
the following payment arrangement: $100,000 in cash on closing; nine
equal annual installment payments of $100,000 commencing January 15,
1982; and nine annual payments (the first to be made on March 30, 1982)
equal to 5% of the gross annual rental receipts from Blackacre generated
during the preceding calendar year. The agreement provides that each
deferred payment shall be accompanied by a payment of interest
calculated at the rate of 12% per annum and that the maximum amount
payable to C under the agreement (exclusive of interest) shall be
$2,100,000. The agreement also specifies that D will assume the long-
standing mortgage. C's basis (inclusive of selling expenses) in
Blackacre is $300,000. Accordingly, selling price is $2,100,000 and
contract price is $2,000,000 (selling price of $2,100,000 less the
$100,000 mortgage). The gross profit ratio is 9/10 (gross profit of
$1,800,000 divided by $2,000,000 contract price). Of the $100,000 cash
payment received by C in 1981, $90,000 is gain attributable to the sale
of Blackacre and $10,000 is recovery of basis.
(ii) Certain interest recomputations. When interest is stated in the
contingent price sale agreement at a rate equal to or greater than the
applicable prescribed test rate referred to in Sec. 1.483-1(d)(1)(ii)
and such stated interest is payable in addition to the amounts otherwise
payable under the agreement, such stated interest is not considered a
part of the selling price. In other circumstances (i.e., section 483 is
applicable because no interest is stated or interest is stated below the
applicable test rate, or interest is stated under a payment
recharacterization provision of the sale agreement), the special rule
set forth in this (ii) shall be applied in the initial computation
[[Page 247]]
and subsequent recomputations of selling price, contract price, and
gross profit ratio. The special rule is referred to in this section as
the ``price-interest recomputation rule.'' As used in this section, the
term ``payment recharacterization'' refers to a contractual arrangement
under which a computed amount otherwise payable as part of the selling
price is denominated an interest payment. The amount of unstated
interest determined under section 483 or (if section 483 is inapplicable
in the particular case) the amount of interest determined under a
payment recharacterization arrangement is collectively referred to in
this section as ``internal interest'' amounts. The price-interest
recomputation rule is applicable to any stated maximum selling price
agreement which contemplates receipt of internal interest by the
taxpayer. Under the rule, stated maximum selling price will be
determined as of the end of the taxpayer's taxable year in which the
sale or other disposition occurs, taking into account all events which
have occurred and are subject to prompt subsequent calculation and
verification and assuming that all amounts that may become payable under
the agreement will be paid on the earliest date or dates permitted under
the agreement. With respect to the year of sale, the amount (if any) of
internal interest then shall be determined taking account of the
respective components of that calculation. The maximum amount initially
calculated, minus the internal interest so determined, is the initial
stated maximum selling price under the price-interest recomputation
rule. For each subsequent taxable year, stated maximum selling price
(and thus selling price, contract price, and gross profit ratio) shall
be recomputed, taking into account all events which have occurred and
are subject to prompt subsequent calculation and verification and
assuming that all amounts that may become payable under the agreement
will be paid on the earliest date or dates permitted under the
agreement. The redetermined gross profit ratio, adjusted to reflect
payments received and gain recognized in prior taxable years, shall be
applied to payments received in that taxable year.
(iii) Examples. The following examples illustrate installment method
reporting of a contingent payment sale under which there is a stated
maximum selling price. In each example, it is assumed that application
of the rules described will not substantially and inappropriately defer
or accelerate recovery of the taxpayer's basis.
Example (1). A owns all of the stock of X corporation with a basis
to A of $20 million. On July 1, 1981, A sells the stock of X to B under
an agreement calling for fifteen annual payments respectively equal to
5% of the net profits of X earned in the immediately preceding fiscal
year beginning with the fiscal year ending March 31, 1982. Each payment
is to be made on the following June 15th, commencing June 15, 1982,
together with adequate stated interest. The agreement specifies that the
maximum amount (exclusive of interest) payable to A shall not exceed $60
million. Since stated interest is payable as an addition to the selling
price and the specified rate is not below the section 483 test rate,
there is no internal interest under the agreement. The stated maximum
selling price is $60 million. The gross profit ratio is \2/3\ (gross
profit of $40 million divided by $60 million contract price). Thus, if
on June 15, 1982, A receives a payment of $3 million (exclusive of
interest) under the agreement, in that year A will report $2 million ($3
million x \2/3\) as gain attributable to the sale, and $1 million as
recovery of basis.
Example (2). (i) The facts are the same as in example (1) except
that the agreement does not call for the payment of any stated interest
but does provide for an initial cash payment of $3 million on July 1,
1981. The maximum amount payable, including the $3 million initial
payment, remains $60 million. Since section 483 will apply to each
payment received by A more than one year following the date of sale
(section 483 is inapplicable to the contingent payment that will be
received on June 15, 1982 since that date is within one year following
the July 1, 1981 sale date), the agreement contemplates internal
interest and the price-interest recomputation rule is applicable. Under
the rule, an initial determination must be made for A's taxable year
1981. On December 31, 1981, the last day of the taxable year, no events
with regard to the first fiscal year have occurred which are subject to
prompt subsequent calculation and verification because that fiscal year
will end March 31, 1982. Under the price-interest recomputation rule, on
December 31, 1981 A is required to assume that the maximum amount
subsequently payable under the agreement ($57 million, equal to $60
million less the $3 million initial cash payment received by A in 1981)
will be paid on the earliest date permissible under the agreement,
[[Page 248]]
i.e., on June 15, 1982. Since no part of a payment received on that date
would be treated as interest under section 483, the initial stated
maximum selling price, applicable to A's 1981 tax calculations, is
deemed to be $60 million. Thus, the 1981 gross profit ratio is \2/3\ and
for the taxable year 1981 A will report $2 million as gain attributable
to the sale.
(ii) The net profits of X for its fiscal year ending March 31, 1982
are $120 million. On June 15, 1982 A receives a payment from B equal to
5% of that amount, or $6 million. On December 31, 1982, A knows that the
maximum amount he may subsequently receive under the agreement is $51
million, and A is required to assume that this amount will be paid to
him on the earliest permissible date, June 15, 1983. Section 483 does
not treat as interest any part of the $6 million received by A on June
15, 1982, but section 483 will treat as unstated interest a computed
part of the $51 million it is assumed A will receive on June 15, 1983.
Assuming that under the tables in the regulations under section 483, it
is determined that the principal component of a payment received more
than 21 months but less than 27 months after the date of sale is
considered to be .82270, $41,957,700 of the presumed $51 million payment
will be treated as principal. The balance of $9,042,300 is interest.
Accordingly, in A's 1982 tax calculations stated maximum selling price
will be $50,957,700, which amount is equal to the stated maximum selling
price that was determined in the 1981 tax calculations ($60 million)
reduced by the section 483 interest component of the $6 million payment
received by A in 1982 ($0) and further reduced by the section 483
interest component of the $51 million presumed payment to be received by
A on June 15, 1983 ($9,042,300). Similarly, in determining gross profit
for 1982 tax calculations, the gross profit of $40 million determined in
the 1981 tax calculations must be reduced by the same section 483
interest amounts, yielding a recomputed gross profit of $30,957,700
($40,000,000-$9,042,300). Further, since prior to 1982 A received
payment under the agreement (1981 payment of $3 million of which $2
million was profit), the appropriate amounts must be subtracted in the
1982 tax calculation. The total previously received selling price
payment of $3 million is subtracted from the recomputed maximum selling
price of $50,957,700, yielding an adjusted selling price of $47,957,700.
The total previously recognized gain of $2 million is subtracted from
the recomputed maximum gross profit of $30,957,700, yielding an adjusted
gross profit of $28,957,700. The gross profit percentage applicable to
1982 tax calculations thus is determined to be 60.38175%, equal to the
quotient of dividing the adjusted gross profit of $28,957,700 by the
adjusted selling price of $47,957,700. Accordingly, of the $6 million
received by A in 1982, no part of which is unstated interest under
section 483, A will report $3,622,905 (60.38175% of $6 million) as gain
attributable to the sale and $2,377,095 ($6,000,000-$3,622,905) as
recovery of basis.
(iii) The net profits of X for its fiscal year ending March 31, 1983
are $200 million. On June 15, 1983 A receives a payment from B equal to
$10 million. On December 31, 1983, A knows that the maximum amount he
may subsequently receive under the agreement is $41 million, and A is
required to assume that this amount will be paid to him on the earliest
permissible date, June 15, 1984. Assuming that under the tables in the
regulations under section 483 it is determined that the principal
component of a payment received more than 33 months but less than 39
months after the date of sale is .74622, $30,595,020 of the presumed $41
million ($51 million-$10 million) payment will be treated as principal
and $10,404,980 is interest. Based upon the assumed factor for 21 months
but less than 27 months (.82270) $8,227,000 of the $10 million payment
is principal and $1,773,000 is interest. Accordingly, in A's 1983 tax
calculations stated maximum selling price will be $47,822,020, which
amount is equal to the stated maximum selling price determined in the
1981 calculation ($60 million) reduced by the section 483 interest
component of the $6 million 1982 payment ($0), the section 483 interest
component of the 1983 payment ($1,773,000) and by the section 483
interest component of the presumed $41 million payment to be received in
1984 ($10,404,980). The recomputed gross profit is $27,822,020 ($40
million-$10,404,980-$1,773,000). The previously reported payments must
be deducted for the 1983 calculation. Selling price is reduced to
$38,822,020 by subtracting the $3 million 1981 payment and the $6
million 1982 payment ($47,822,020-$9 million) and gross profit is
reduced to $22,199,115 by subtracting the 1981 profit of $2 million and
the 1982 profit of $3,622,905 ($27,822,020-$5,622,905), yielding a gross
profit percentage of 57.18176% ($22,199,115/$38,822,020). Accordingly,
of the $10 million received in 1983, A will report $1,773,000 as
interest under section 483, and of the remaining principal component of
$8,227,000, $4,704,343 as gain attributable to the sale
($8,227,000 x 57.18176%) and $3,522,657 ($8,227,000-$4,704,343) as
recovery of basis.
Example (3). The facts are the same as in example (2) except that X
is a collapsible corporation as defined in section 341(b)(1) and no
limitation or exception under section 341 (d), (e), or (f) is
applicable. Under section 341(a), all of A's gain on the sale will be
ordinary income. Accordingly, section 483 will not apply to treat as
interest any part of the payments to be received by A under his
agreement with B. See section 483(f)(3). Therefore, the price-interest
recomputation rule is inapplicable and the tax results to A in each year
in which payment is received
[[Page 249]]
will be determined in a manner consistent with example (1).
Example (4). The facts are the same as in example (2) (maximum
amount payable under the agreement $60 million) except that the
agreement between A and B contains the following ``payment
recharacterization'' provision:
``Any payment made more than one year after the (July 1, 1981) date
of sale shall be composed of an interest element and a principal
element, the interest element being computed on the principal element at
an interest rate of 9% per annum computed from the date of sale to the
date of payment.''
The results reached in example (2), with respect to the $3 million
initial cash payment received by A in 1981 remain the same because,
under the payment recharacterization formula, no amount received or
assumed to be received prior to July 1, 1982 is treated as interest. The
1982 tax computation method described in example (2) is equally
applicable to the $6 million payment received in 1982. However, the
adjusted gross profit ratio determined in this example (4) will differ
from the ratio determined in example (2). The difference is attributable
to the difference between a 9% stated interest rate calculation (in this
example (4)) and the compound rate of unstated interest required under
section 483 and used in calculating the results in example (2).
Example (5). The facts are the same as in example (1). In 1992 X is
adjudged a bankrupt and it is determined that, in and after 1992, B will
not be required to make any further payments under the agreement, i.e.,
B's contingent payment obligation held by A now has become worthless.
Assume that A previously received aggregate payments (exclusive of
interest) of $45 million and out of those payments recovered $15 million
of A's total $20 million basis. For 1992 A will report a loss of $5
million attributable to the sale, taken at the time determined to be
appropriate under the rules generally applicable to worthless debts.
Example (6). (i) C owns all of the stock of Z corporation, a
calendar year taxpayer. On July 1, 1981, C sells the stock of Z to D
under an agreement calling for payment, each year for the next ten
years, of an amount equal to 10% of the net profits of Z earned in the
immediately preceding calendar year beginning with the year ending
December 31, 1981. Each payment is to be made on the following April
1st, commencing April 1, 1982. In addition, C is to receive a payment of
$5 million on closing. The agreement specifies that the maximum amount
payable to C, including the $5 million cash payment at closing, is $24
million. The agreement does not call for the payment of any stated
interest. Since section 483 will apply to each payment received by C
more than one year following the date of sale (section 483 is
inapplicable to the payment that will be received on April 1, 1982,
since that date is within one year following the July 1, 1981 sale
date), the agreement contemplates internal interest and the price
interest recomputation rule is applicable. Under that rule, C must make
an initial determination for his taxable year 1981.
(ii) On December 31, 1981, the exact amount of Z's 1981 net profit
is not known, since it normally takes a number of weeks to compile the
relevant information. However, the events which will determine the
amount of the payment C will receive on April 1, 1982 have already
occurred, and the information (Z's 1981 financial statement) will be
promptly calculated and verified and will be available prior to the time
C's 1981 tax return is timely filed. On March 15, 1982, Z reports net
income of $14 million, and on April 1, 1982 D pays C $1.4 million.
(iii) Under the price-interest recomputation rule, C is required to
determine the gross profit ratio for the 1981 $5 million payment on the
basis of the events which occurred by the close of that taxable year and
which are verifiable before the due date of the 1981 return. Because at
the end of C's 1981 taxable year all events which will determine the
amount of the April 1, 1982 payment have occurred and because the actual
facts are known prior to the due date of C's return, C will take those
facts into account when calculating the gross profit ratio. Thus,
because C knows that the 1982 payment is $1.4 million, C knows that the
remaining amount to be recovered under the contract is $17.6 million
($24 million - ($5 million + $1.4 million)). For purposes of this
paragraph C must assume that the entire $17.6 million will be paid on
the earliest possible date, April 1, 1983. Because section 483 will
apply to that payment, and assuming that under the tables in the
regulations under section 483 the principal component of a payment
received 21 months after the date of sale is considered to be .86384,
$15,203,584 of the $17.6 million would be principal and $2,396,416
($17,600,000 - $15,203,584) would be interest. Therefore, C must assume,
for purposes of reporting the $5 million payment received in 1981, that
the selling price is $21,603,584 calculated as follows:
Total selling price..................................... $24,000,000
Interest component of the $17,600,000 payment which C
must assume will be made April 1, 1983................. -2,396,416
---------------
Adjusted selling price to be used when reporting the
1981 payment......................................... 21,603,584
(iv) Assume that on March 15, 1982, Z reports net income of $15
million for 1982 and that on April 1, 1983 D pays C $1.5 million.
Because section 483 will apply to that payment, and assuming that under
the tables in
[[Page 250]]
the regulations under section 483 the principal component of a payment
received 21 months after the date of sale is considered to be .86384,
$1,295,760 of the $1,500,000 payment will be principal and $204,240
($1,500,000 - $1,295,760) will be interest. Because C knows the amount
of the 1983 payment when filing the 1982 tax return, C must assume that
the remaining amount to be received under the contract, $16.1 million
($24 million - ($5 million + $1.4 million + $1.5 million)), will be
received as a lump sum on April 1, 1984. Because section 483 will again
apply, and assuming that the principal component of a payment made 34
months after the date of the sale is .74622, $12,014,142 of the $16.1
million would be principal, and $4,085,858 ($16,100,000 - $12,014,142)
would be interest. Therefore, C must assume, for purpose of reporting
the $1.4 million payment made April 1, 1982, that the adjusted selling
price (within the meaning of example (2)) is $14,709,902, calculated as
follows:
Total selling price..................................... $24,000,000
Interest component of the $1,500,000 payment made April
1, 1983................................................ -204,240
Interest component of the $16,100,000 payment which C
must assume will be made April 1, 1984................. -4,085,858
Payment made in 1981.................................... -5,000,000
---------------
Adjusted selling price for calculations for reporting
the 1982 payment..................................... 14,709,902
(3) Fixed period--(i) In general. When a stated maximum selling
price cannot be determined as of the close of the taxable year in which
the sale or other disposition occurs, but the maximum period over which
payments may be received under the contingent sale price agreement is
fixed, the taxpayer's basis (inclusive of selling expenses) shall be
allocated to the taxable years in which payment may be received under
the agreement in equal annual increments. In making the allocation it is
not relevant whether the buyer is required to pay adequate stated
interest. However, if the terms of the agreement incorporate an
arithmetic component that is not identical for all taxable years, basis
shall be allocated among the taxable years to accord with that component
unless, taking into account all of the payment terms of the agreement,
it is inappropriate to presume that payments under the contract are
likely to accord with the variable component. If in any taxable year no
payment is received or the amount of payment received (exclusive of
interest) is less than the basis allocated to that taxable year, no loss
shall be allowed unless the taxable year is the final payment year under
the agreement or unless it is otherwise determined in accordance with
the rules generally applicable to worthless debts that the future
payment obligation under the agreement has become worthless. When no
loss is allowed, the unrecovered portion of basis allocated to the
taxable year shall be carried forward to the next succeeding taxable
year. If application of the foregoing rules to a particular case would
substantially and inappropriately defer or accelerate recovery of the
taxpayer's basis, a special rule will apply. See paragraph (c)(7) of
this section.
(ii) Examples. The following examples illustrate the rules for
recovery of basis in a contingent payment sale in which stated maximum
selling price cannot be determined but the period over which payments
are to be received under the agreement is fixed. In each case, it is
assumed that application of the described rules will not substantially
and inappropriately defer or accelerate recovery of the taxpayer's
basis.
Example (1). A sells Blackacre to B for 10 percent of Blackacre's
gross yield for each of the next 5 years. A's basis in Blackacre is $5
million. Since the sales price is indefinite and the maximum selling
price is not ascertainable from the terms of the contract, basis is
recovered ratably over the period during which payment may be received
under the contract. Thus, assuming A receives the payments (exclusive of
interest) listed in the following table, A will report the following:
----------------------------------------------------------------------------------------------------------------
Gain
Year Payment Basis attributable
recovered to the sale
----------------------------------------------------------------------------------------------------------------
1............................................................... $1,300,000 $1,000,000 $300,000
2............................................................... 1,500,000 1,000,000 500,000
3............................................................... 1,400,000 1,000,000 400,000
4............................................................... 1,800,000 1,000,000 800,000
5............................................................... 2,100,000 1,000,000 1,100,000
----------------------------------------------------------------------------------------------------------------
Example (2). The facts are the same as in example (1), except that
the payment in year 1 is only $900,000. Since the installment payment is
less than the amount of basis allocated to that year, the unrecovered
basis, $100,000, is carried forward to year 2.
----------------------------------------------------------------------------------------------------------------
Gain
Year Payment Basis attributable
recovered to the sale
----------------------------------------------------------------------------------------------------------------
1............................................................... $900,000 $900,000 ..............
[[Page 251]]
2............................................................... 1,500,000 1,100,000 $400,000
3............................................................... 1,400,000 1,000,000 400,000
4............................................................... 1,800,000 1,000,000 800,000
5............................................................... 2,100,000 1,000,000 1,100,000
----------------------------------------------------------------------------------------------------------------
Example (3). C owns all of the stock of X corporation with a basis
of $100,000 (inclusive of selling expenses). D purchases the X stock
from C and agrees to make four payments computed in accordance with the
following formula: 40% of the net profits of X in year 1, 30% in year 2,
20% in year 3, and 10% in year 4. Accordingly, C's basis is allocated as
follows: $40,000 to year 1, $30,000 to year 2, $20,000 to year 3, and
$10,000 to year 4.
Example (4). The facts are the same as in example (3), but the
agreement also requires that D make fixed installment payments in
accordance with the following schedule: no payment in year 1, $100,000
in year 2, $200,000 in year 3, $300,000 in year 4, and $400,000 in year
5. Thus, while it is reasonable to project that the contingent component
of the payments will decrease each year, the fixed component of the
payments will increase each year. Accordingly, C is required to allocate
$20,000 of basis to each of the taxable years 1 through 5.
(4) Neither stated maximum selling price nor fixed period. If the
agreement neither specifies a maximum selling price nor limits payments
to a fixed period, a question arises whether a sale realistically has
occurred or whether, in economic effect, payments received under the
agreement are in the nature of rent or royalty income. Arrangements of
this sort will be closely scrutinized. If, taking into account all of
the pertinent facts, including the nature of the property, the
arrangement is determined to qualify as a sale, the taxpayer's basis
(including selling expenses) shall be recovered in equal annual
increments over a period of 15 years commencing with the date of sale.
However, if in any taxable year no payment is received or the amount of
payment received (exclusive of interest) is less than basis allocated to
the year, no loss shall be allowed unless it is otherwise determined in
accordance with the timing rules generally applicable to worthless debts
that the future payment obligation under the agreement has become
worthless; instead the excess basis shall be reallocated in level
amounts over the balance of the 15 year term. Any basis not recovered at
the end of the 15th year shall be carried forward to the next succeeding
year, and to the extent unrecovered thereafter shall be carried forward
from year to year until all basis has been recovered or the future
payment obligation is determined to be worthless. The general rule
requiring initial level allocation of basis over 15 years shall not
apply if the taxpayer can establish to the satisfaction of the Internal
Revenue Service that application of the general rule would substantially
and inappropriately defer recovery of the taxpayer's basis. See
paragraph (c)(7) of this section. If the Service determines that
initially allocating basis in level amounts over the first 15 years will
substantially and inappropriately accelerate recovery of the taxpayer's
basis in early years of that 15-year term, the Service may require that
basis be reallocated within the 15-year term but the Service will not
require that basis initially be allocated over more than 15 years. See
paragraph (c)(7) of this section.
(5) Foreign currency and other fungible payment units--(i) In
general. An installment sale may call for payment in foreign currency.
For federal income tax purposes, foreign currency is property. Because
the value of foreign currency will vary over time in relation to the
United States dollar, an installment sale requiring payment in foreign
currency is a contingent payment sale. However, when the consideration
payable under an installment sale agreement is specified in foreign
currency, the taxpayer's basis (including selling expenses) shall be
recovered in the same manner as basis would have been recovered had the
agreement called for payment in United States dollars. This rule is
equally applicable to any installment sale in which the agreement
specifies that payment shall be made in identified, fungible units of
property the value of which will or may vary over time in relation to
the dollar (e.g., bushels of wheat or ounces of gold).
(ii) Example. The following example illustrates the provisions of
this subparagraph:
Example. A sells Blackacre to B for 4 million Swiss francs payable 1
million in year 2 and 3 million in year 3, together with adequate stated
interest. A's basis (including
[[Page 252]]
selling expenses) in Blackacre is $100,000. Twenty five thousand dollars
of A's basis (\1/4\ of total basis) is allocable to the year 2 payment
of 1 million Swiss francs and $75,000 of A's basis is allocable to the
year 3 payment of 3 million Swiss francs.
(6) Income forecast method for basis recovery--(i) In general. The
rules for ratable recovery of basis set forth in paragraph (c) (2)
through (4) of this section focus on the payment terms of the contingent
selling price agreement. Except to the extent contemplated by
paragraph(c)(7) of this section (relating to a special rule to prevent
substantial distortion of basis recovery), the nature and productivity
of the property sold is not independently relevant to the basis to be
recovered in any payment year. The special rule for an income forecast
method of basis recovery set forth in paragraph (c)(6) of this section
recognizes that there are cases in which failure to take account of the
nature or productivity of the property sold may be expected to result in
distortion of the taxpayer's income over time. Specifically, when the
property sold is depreciable property of a type normally eligible for
depreciation on the income forecast method, or is depletable property of
a type normally eligible for cost depletion in which total future
production must be estimated, and payments under the contingent selling
price agreement are based upon receipts or units produced by or from the
property, the taxpayer's basis may appropriately be recovered by using
an income forecast method.
(ii) Availability of method. In lieu of applying the rules set forth
in paragraph (c) (2) through (4) of this section, in an appropriate case
the taxpayer may elect (on its tax return timely filed for the first
year under the contingent payment agreement in which a payment is
received) to recover basis using the income forecast method of basis
recovery. No special form of election is prescribed. An appropriate case
is one meeting the criteria set forth in paragraph (c)(6)(i) of this
section in which the property sold is a mineral property, a motion
picture film, a television film, or a taped television show. The
Internal Revenue Service may from time to time specify other properties
of a similar character which, in appropriate circumstances, will be
eligible for recovery of basis on the income forecast method. In
addition, a taxpayer may seek a ruling from the Service as to whether a
specific property qualifies as property of a similar character eligible,
in appropriate circumstances, for income forecast recovery of basis.
(iii) Required calculations. The income forecast method requires
application of a fraction, the numerator of which is the payment
(exclusive of interest) received in the taxable year under a contingent
payment agreement, and the denominator of which is the forecast or
estimated total payments (exclusive of interest) to be received under
the agreement. This fraction is multiplied by the taxpayer's basis in
the property sold to determine the basis recovered with respect to the
payment received in the taxable year. If in a subsequent year it is
found that the income forecast was substantially overestimated or
underestimated by reason of circumstances occurring in such subsequent
year, an adjustment of the income forecast of such subsequent year shall
be made. In such case, the formula for computing recovery of basis would
be as follows: payment received in the taxable year (exclusive of
interest) divided by the revised estimated total payments (exclusive of
interest) then and thereafter to be made under the agreement (the
current year's payment and total estimated future payments), multiplied
by the taxpayer's unrecovered basis remaining as of the beginning of the
taxable year. If the agreement contemplates internal interest (as
defined in paragraph (c)(2)(ii) of this section), in making the initial
income forecast computation and in making any required subsequent
recomputation the amount of internal interest (which shall not be
treated as payment under the agreement) shall be calculated by assuming
that each future contingent selling price payment will be made in the
amount and at the time forecast. The total forecast of estimated
payments to be received under the agreement shall be based on the
conditions known to exist at the end of the taxable year for which the
return is
[[Page 253]]
filed. If a subsequent upward or downward revision of this estimate is
required, the revision shall be made at the end of the subsequent
taxable year based on additional information which became available
after the last prior estimate. No loss shall be allowed unless the
taxable year is the final payment year under the agreement or unless it
is otherwise determined in accordance with the rules generally
applicable to the time a debt becomes worthless that the future payment
obligation under the agreement has become worthless.
(iv) Examples. The following examples illustrate the income forecast
method of basis recovery:
Example (1). A sells a television film to B for 5% of annual gross
receipts from the exploitation of the film. The film is an ordinary
income asset in the hands of A. A reasonably forecasts that total
payments to be received under the contingent selling price agreement
will be $1,200,000, and that A will be paid $600,000 in year 1, $150,000
in year 2, $300,000 in year 3, $100,000 in year 4, and $50,000 in year
5. A reasonably anticipates no or only insignificant receipts
thereafter. A's basis in the film is $100,000. Under the income forecast
method, A's basis initially is allocated to the five taxable years of
forecasted payment as follows:
------------------------------------------------------------------------
Year Percentage Basis
------------------------------------------------------------------------
1....................................... 50.00 $50,000
2....................................... 12.50 12,500
3....................................... 25.00 25,000
4....................................... 8.33 8,333
5....................................... 4.17 4,167
------------------------------------------------------------------------
Payments are received and A reports the sale under the installment
method as follows:
----------------------------------------------------------------------------------------------------------------
Payment Basis
Year received recovered Gain on sale
----------------------------------------------------------------------------------------------------------------
1............................................................... $600,000 $50,000 $550,000
2............................................................... 150,000 12,500 137,500
3............................................................... 300,000 25,000 275,000
4............................................................... 100,000 8,333 91,667
5............................................................... 50,000 4,167 45,833
----------------------------------------------------------------------------------------------------------------
Example (2). The facts are the same as in example (1), except that
in year 2 A receives no payment. In year 3 A receives a payment of
$300,000 and reasonably estimates that in subsequent years he will
receive total additional payments of only $100,000. In year 2 A will be
allowed no loss. At the beginning of year 3 A's unrecovered basis is
$50,000. In year 3 A must recompute the applicable basis recovery
fraction based upon facts known and forecast as at the end of year 3:
year 3 payment of $300,000 divided by estimated current and future
payments of $400,000, equaling 75%. Thus, in year 3 A recovers $37,500
(75% of $50,000) of A's previously unrecovered basis.
(7) Special rule to avoid substantial distortion--(i) In general.
The normal basis recovery rules set forth in paragraph (c) (2) through
(4) of this section may, with respect to a particular contingent payment
sale, substantially and inappropriately defer or accelerate recovery of
the taxpayer's basis.
(ii) Substantial and inappropriate deferral. The taxpayer may use an
alternative method of basis recovery if the taxpayer is able to
demonstrate prior to the due date of the return including extensions for
the taxable year in which the first payment is received, that
application of the normal basis recovery rule will substantially and
inappropriately defer recovery of basis. To demonstrate that application
of the normal basis recovery rule will substantially and inappropriately
defer recovery of basis, the taxpayer must show (A) that the alternative
method is a reasonable method of ratably recovering basis and, (B) that,
under that method, it is reasonable to conclude that over time the
taxpayer likely will recover basis at a rate twice as fast as the rate
at which basis would have been recovered under the otherwise applicable
normal basis recovery rule. The taxpayer must receive a ruling from the
Internal Revenue Service before using an alternative method of basis
recovery described in paragraph (c)(7)(ii) of this section.
The request for a ruling shall be made in accordance with all applicable
procedural rules set forth in the Statement of Procedural Rules (26 CFR
part 601) and any applicable revenue procedures relating to submission
of ruling requests. The request shall be submitted to the Commissioner
of Internal Revenue, Attention: Assistant Commissioner (Technical),
Washington, DC 20224. The taxpayer must file a request for a ruling
prior to the due date for the return including extensions. In
demonstrating that application of the normal basis recovery rule would
substantially and inappropriately defer recovery of the taxpayer's
basis, the taxpayer in appropriate circumstances
[[Page 254]]
may rely upon contemporaneous or immediate past relevant sales, profit,
or other factual data that are subject to verification. The taxpayer
ordinarily is not permitted to rely upon projections of future
productivity, receipts, profits, or the like. However, in special
circumstances a reasonable projection may be acceptable if the
projection is based upon a specific event that already has occurred
(e.g., corporate stock has been sold for future payments contingent on
profits and an inadequately insured major plant facility of the
corporation has been destroyed).
(iii) Substantial and inappropriate acceleration. Notwithstanding
the other provisions of this paragraph, the Internal Revenue Service may
find that the normal basis recovery rule will substantially and
inappropriately accelerate recovery of basis. In such a case, the
Service may require an alternate method of basis recovery, unless the
taxpayer is able to demonstrate either (A) that the method of basis
recovery required by the Service is not a reasonable method of ratable
recovery, or (B) that it is not reasonable to conclude that the taxpayer
over time is likely to recover basis at a rate twice as fast under the
normally applicable basis recovery rule as the rate at which basis would
be recovered under the method proposed by the Service. In making such
demonstrations the taxpayer may rely in appropriate circumstances upon
contemporaneous or immediate past relevant sales, profit, or other
factual data subject to verification. In special circumstances a
reasonable projection may be acceptable, but only with the consent of
the Service, if the projection is based upon a specific event that has
already occurred.
(iv) Subsequent recomputation. A contingent payment sale may
initially and properly have been reported under the normally applicable
basis recovery rule and, during the term of the agreement, circumstances
may show that continued reporting on the original method will
substantially and inappropriately defer or accelerate recovery of the
unrecovered balance of the taxpayer's basis. In this event, the special
rule provided in this paragraph is applicable.
(v) Examples. The following examples illustrate the application of
the special rule of this paragraph. In examples (1) and (2) it is
assumed that rulings consistent with paragraph (c)(7)(ii) of this
section have been requested.
Example (1). A owns all of the stock of X corporation with a basis
of $100,000. A sells the stock of X to B for a cash down payment of
$1,800,000 and B's agreement to pay A an amount equal to 1% of the net
profits of X in each of the next 10 years (together with adequate stated
interest). The agreement further specifies that the maximum amount that
may be paid to A (exclusive of interest) shall not exceed $10 million. A
is able to demonstrate that current and recent profits of X have
approximated $2 million annually, and that there is no reason to
anticipate a major increase in the annual profits of X during the next
10 years. One percent of $2 million annual profits is $20,000, a total
of $200,000 over 10 years. Under the basis recovery rule normally
applicable to a maximum contingent selling price agreement, in the year
of sale A would recover $18,000 of A's total $100,000 basis, and would
not recover more than a minor part of the balance until the final year
under the agreement. On a $2 million selling price ($200,000 plus
$1,800,000 down payment), A would recover $90,000 of A's total $100,000
basis in the year of sale and 5% of each payment ($100,000/$2,000,000)
received up to a maximum of $10,000 over the next ten years. Since the
rate of basis recovery under the demonstrated method is more than twice
the rate under the normal rule, A will be permitted to recover $90,000
basis in the year of sale.
Example (2). The facts are the same as in example (1) except that no
maximum contingent selling price is stated in the agreement. Under the
basis recovery rule normally applicable when no maximum amount is stated
but the payment term is fixed, in the year of sale and in each
subsequent year A would recover approximately $9,100 (1/11 of $100,000)
of A's total basis. A will be permitted to recover $90,000 of A's total
basis in the year of sale.
Example (3). The facts are the same as in example (1) except that A
sells the X stock to B on the following terms: 1% of the annual net
profits of X in each of the next 10 years and a cash payment of
$1,800,000 in the eleventh year, all payments to be made together with
adequate stated interest. No maximum contingent selling price is stated.
Under the normally applicable basis recovery rule, A would recover 1/11
of A's total $100,000 basis in each of the 11 payment years
[[Page 255]]
under the agreement. On the facts (see example (1)), A cannot
demonstrate that application of the normal rule would not substantially
and inappropriately accelerate recovery of A's basis. Accordingly, A
will be allowed to recover only $1,000 of A's total basis in each of the
10 contingent payment years under the agreement, and will recover the
$90,000 balance of A's basis in the final year in which the large fixed
cash payment will be made.
(8) Coordination with regulations under section 385. (i) In general.
The regulations under section 385 do not apply to an instrument (as
defined in Sec. 1.385-3(c)) providing for a contingent payment of
principal (with or without stated interest) issued in connection with a
sale or other disposition of property to a corporation if Sec. 1.385-6
(relating to proportionality) does not apply to such instrument (or to a
class of instruments which includes such instrument). Thus, such
instrument will be treated as stock or indebtedness under applicable
principles of law without reference to the regulations under section
385.
(ii) Examples. The following examples illustrate the application of
this paragraph:
Example (1). On January 1, 1982, corporation X buys a factory from
Y, an independent creditor (within the meaning of Sec. 1.385-6(b)). In
exchange for the factory, Y receives $200,000 in cash on January 1,
1982. In addition, on January 1, 1984, Y will receive a payment in the
range of $100,000 to $300,000, plus adequate stated interest, depending
on the factory's output. Based on these facts, Sec. 1.385-6 does not
apply to X's obligation to Y (see Sec. 1.385-6(a)(3)(ii)) and the
regulations under section 385 doe not apply to X's obligation to Y.
Example (2). The facts are the same as in example (1), except that
the contingent payment due on January 1, 1984 will be in the range of
$50,000 to $250,000. In addition, on January 1, 1982, Y receives a
$50,000 noninterest-bearing note due absolutely and unconditionally on
January 1, 1984. Based on these facts, the $50,000 note is treated as
stock or indebtedness under the regulations under section 385.
(d) Election not to report an installment sale on the installment
method--(1) In general. An installment sale is to be reported on the
installment method unless the taxpayer elects otherwise in accordance
with the rules set forth in paragraph (d)(3) of this section.
(2) Treatment of an installment sale when a taxpayer elects not to
report on the installment method--(i) In general. A taxpayer who elects
not to report an installment sale on the installment method must
recognize gain on the sale in accordance with the taxpayer's method of
accounting. The fair market value of an installment obligation shall be
determined in accordance with paragraph (d)(2) (ii) and (iii) of this
section. In making such determination, any provision of contract or
local law restricting the transferability of the installment obligation
shall be disregarded. Receipt of an installment obligation shall be
treated as a receipt of property, in an amount equal to the fair market
value of the installment obligation, whether or not such obligation is
the equivalent of cash. An installment obligation is considered to be
property and is subject to valuation, as provided in paragraph (d)(2)
(ii) and (iii) of this section, without regard to whether the obligation
is embodied in a note, an executory contract, or any other instrument,
or is an oral promise enforceable under local law.
(ii) Fixed amount obligations. (A) A fixed amount obligation means
an installment obligation the amount payable under which is fixed.
Solely for the purpose of determining whether the amount payable under
an installment obligation is fixed, the provisions of section 483 and
any ``payment recharacterization'' arrangement (as defined in paragraph
(c)(2)(ii) of this section) shall be disregarded. If the fixed amount
payable is stated in identified, fungible units of property the value of
which will or may vary over time in relation to the United States dollar
(e.g., foreign currency, ounces of gold, or bushels of wheat), such
units shall be converted to United States dollars at the rate of
exchange or dollar value on the date the installment sale is made. A
taxpayer using the cash receipts and disbursements methods of accounting
shall treat as an amount realized in the year of sale the fair market
value of the installment obligation. In no event will the fair market
value of the installment obligation be considered to be less than the
fair market value of the property sold (minus any other consideration
received by the taxpayer on the sale). A taxpayer using the accrual
method of accounting shall treat
[[Page 256]]
as an amount realized in the year of sale the total amount payable under
the installment obligation. For this purpose, neither interest (whether
stated or unstated) nor original issue discount is considered to be part
of the amount payable. If the amount payable is otherwise fixed, but
because the time over which payments may be made is contingent, a
portion of the fixed amount will or may be treated as internal interest
(as defined in paragraph (c)(2)(ii) of this section), the amount payable
shall be determined by applying the price interest recomputation rule
(described in paragraph (c)(2)(ii) of this section). Under no
circumstances will an installment sale for a fixed amount obligation be
considered an ``open'' transaction. For purposes of this (ii), remote or
incidential contingencies are not to be taken into account.
(B) The following examples illustrate the provisions of paragraph
(d)(2) of this section.
Example (1). A, an accrual method taxpayer, owns all of the stock of
X corporation with a basis of $20 million. On July 1, 1981, A sells the
stock of X corporation to B for $60 million payable on June 15, 1992.
The agreement also provides that against this fixed amount, B shall make
annual prepayments (on June 15) equal to 5% of the net profits of X
earned in the immediately preceding fiscal year beginning with the
fiscal year ending March 31, 1982. Thus the first prepayment will be
made on June 15, 1982. No stated interest is payable under the agreement
and thus the unstated interest provisions of section 483 are applicable.
Under section 483, no part of any payment made on June 15, 1982 (which
is within one year following the July 1, 1981 sale date), will be
treated as unstated interest. Under the price interest recomputation
rule, it is presumed that the entire $60 million fixed amount will be
paid on June 15, 1982. Accordingly, if A elects not to report the
transaction on the installment method, in 1981 A must report $60 million
as the amount realized on the sale and must report $40 million as gain
on the sale in that year.
Example (2). The facts are the same as in example (1) except that A
uses the cash receipts and disbursements method of accounting. In 1981 A
must report as an amount realized on the sale the fair market value of
the installment obligation and must report as gain on the sale in 1981
the excess of that amount realized over A's basis of $20 million. In no
event will the fair market value of the installment obligation be
considered to be less than the fair market value of the stock of X. In
determining the fair market value of the installment obligation, any
contractual or legal restrictions on the transferability of the
installment obligation, and any remote or incidental contingencies
otherwise affecting the amount payable or time of payments under the
installment obligation, shall be disregarded.
(iii) Contingent payment obligations. Any installment obligation
which is not a fixed amount obligation (as defined in paragraph
(d)(2)(ii) of this section) is a contingent payment obligation. If an
installment obligation contains both a fixed amount component and a
contingent payment component, the fixed amount component shall be
treated under the rules of paragraph (d)(2)(ii) of this section and the
contingent amount component shall be treated under the rules of this
(iii). The fair market value of a contingent payment obligation shall be
determined by disregarding any restrictions on transfer imposed by
agreement or under local law. The fair market value of a contingent
payment obligation may be ascertained from, and in no event shall be
considered to be less than, the fair market value of the property sold
(less the amount of any other consideration received in the sale). Only
in those rare and extraordinary cases involving sales for a contingent
payment obligation in which the fair market value of the obligation
(determinable under the preceding sentences) cannot reasonably be
ascertained will the taxpayer be entitled to assert that the transaction
is ``open.'' Any such transaction will be carefully scrutinized to
determine whether a sale in fact has taken place. A taxpayer using the
cash receipts and disbursements method of accounting must report as an
amount realized in the year of sale the fair market value of the
contingent payment obligation. A taxpayer using the accrual method of
accounting must report an amount realized in the year of sale determined
in accordance with that method of accounting, but in no event less than
the fair market value of the contingent payment obligation.
(3) Time and manner for making election--(i) In general. An election
under paragraph (d)(1) of this section must be made on or before the due
date prescribed by law (including extensions) for filing the taxpayer's
return for the
[[Page 257]]
taxable year in which the installment sale occurs. The election must be
made in the manner prescribed by the appropriate forms for the
taxpayer's return for the taxable year of the sale. A taxpayer who
reports an amount realized equal to the selling price including the full
face amount of any installment obligation on the tax return filed for
the taxable year in which the installment sale occurs will be considered
to have made an effective election under paragraph (d)(1) of this
section. A cash method taxpayer receiving an obligation the fair market
value of which is less than the face value must make the election in the
manner prescribed by appropriate instructions for the return filed for
the taxable year of the sale.
(ii) Election made after the due date. Elections after the time
specified in paragraph (d)(3)(i) of this section will be permitted only
in those rare circumstances when the Internal Revenue Service concludes
that the taxpayer had good cause for failing to make a timely election.
A recharacterization of a transaction as a sale in a taxable year
subsequent to the taxable year in which the transaction occurred (e.g.,
a transaction initially reported as a lease later is determined to have
been an installment sale) will not justify a late election. No
conditional elections will be permitted. For a special transitional rule
relating to certain taxable years for which a return is filed prior to
February 19, 1981, see paragraph (d)(5) of this section.
(4) Revoking an election. Generally, an election made under
paragraph (d)(1) is irrevocable. An election may be revoked only with
the consent of the Internal Revenue Service. A revocation is
retroactive. A revocation will not be permitted when one of its purposes
is the avoidance of Federal income taxes, or when the taxable year in
which any payment was received has closed. For a special transitional
rule relating to certain taxable years for which a return is filed prior
to February 19, 1981, see paragraph (d)(5) of this section.
(5) Transitional rules. The following transitional rules shall apply
with respect to any contingent payment sale made after October 19, 1980
in a taxable year, ending after that date, for which the taxpayer has
filed a federal income tax return prior to February 19, 1981. If in such
tax return the taxpayer has treated the contingent payment sale under
the installment method, consent of the Internal Revenue Service to a
late election by the taxpayer not to report the transaction on the
installment method will generally be granted if the request for election
out of installment method treatment is filed by May 5, 1981. If in such
tax return the taxpayer has elected not to report the contingent payment
sale under the installment method, consent of the Service to revocation
of the election by the taxpayer will generally be granted if the request
for revocation is filed by May 5, 1981.
(e) Purchaser evidences of indebtedness payable on demand or readily
tradable--(1) Treatment as payment--(i) In general. A bond or other
evidence of indebtedness (hereinafter in this section referred to as an
obligation) issued by any person and payable on demand shall be treated
as a payment in the year received, not as installment obligations
payable in future years. In addition, an obligation issued by a
corporation or a government or political subdivision thereof--
(A) With interest coupons attached (whether or not the obligation is
readily tradable in an established securities market),
(B) In registered form (other than an obligation issued in
registered form which the taxpayer establishes will not be readily
tradable in an established securities market), or
(C) In any other form designed to render such obligation readily
tradable in an established securities market,
shall be treated as a payment in the year received, not as an
installment obligation payable in future years. For purposes of this
paragraph, an obligation is to be considered in registered form if it is
registered as to principal, interest, or both and if its transfer must
be effected by the surrender of the old instrument and either the
reissuance by the corporation of the old instrument to the new holder or
the issuance by the corporation of a new instrument to the new holder.
(ii) Examples. The rules stated in this paragraph may be illustrated
by the following examples:
[[Page 258]]
Example (1). On July 1, 1981, A, an individual on the cash method of
accounting reporting on a calendar year basis, transferred all of his
stock in corporation X (traded on an established securities market and
having a fair market value of $1,000,000) to corporation Y in exchange
for 250 of Y's registered bonds (which are traded in an over-the-
counter-market) each with a principal amount and fair market value of
$1,000 (with interest payable at the rate of 12 percent per year), and
Y's unsecured promissory note with a principal amount of $750,000. At
the time of such exchange A's basis in the X stock is $900,000. The
promissory note is payable at the rate of $75,000 annually, due on July
1 of each year following 1981 until the principal balance is paid. The
note provides for the payment of interest at the rate of 12 percent per
year also payable on July 1 of each year. Under the rule stated in
paragraph (e)(1)(i) of this section, the 250 registered bonds of Y are
treated as a payment in 1981 in the amount of the value of the bonds,
$250,000.
Example (2). Assume the same facts as in example (1). Assume further
that on July 1, 1982, Y makes its first installment payment to A under
the terms of the unsecured promissory note with 75 more of its $1,000
registered bonds. A must include $7,500 (i.e., 10 percent gross profit
percentage times $75,000) A's gross income for calendar year 1982. In
addition, A includes the interest payment made by Y on July 1 in A's
gross income for 1982.
(2) Amounts treated as payment. If under paragraph (e)(1) of this
section an obligation is treated as a payment in the year received, the
amount realized by reason of such payment shall be determined in
accordance with the taxpayer's method of accounting. If the taxpayer
uses the cash receipts and disbursements method of accounting, the
amount realized on such payment is the fair market value of the
obligation. If the taxpayer uses the accrual method of accounting, the
amount realized on receipt of an obligation payable on demand is the
face amount of the obligation, and the amount realized on receipt of an
obligation with coupons attached or a readily tradable obligation is the
stated redemption price at maturity less any original issue discount (as
defined in section 1232(b)(1)) or, if there is no original issue
discount, the amount realized is the stated redemption price at maturity
appropriately discounted to reflect total unstated interest (as defined
in section 483(b)), if any.
(3) Payable on demand. An obligation shall be treated as payable on
demand only if the obligation is treated as payable on demand under
applicable state or local law.
(4) Designed to be readily tradable in an established securities
market--(i) In general. Obligations issued by a corporation or
government or political subdivision thereof will be deemed to be in a
form designed to render such obligations readily tradable in an
established securities market if--
(A) Steps necessary to create a market for them are taken at the
time of issuance (or later, if taken pursuant to an expressed or implied
agreement or understanding which existed at the time of issuance),
(B) If they are treated as readily tradable in an established
securities market under paragraph (e)(4)(ii) of this section, or
(C) If they are convertible obligations to which paragraph (e)(5) of
this section applies.
(ii) Readily tradable in an established securities market. An
obligation will be treated as readily tradable in an established
securities market if--
(A) The obligation is part of an issue or series of issues which are
readily tradable in an established securities market, or
(B) The corporation issuing the obligation has other obligations of
a comparable character which are described in paragraph (e)(4)(ii)(A) of
this section. For purposes of paragraph (e)(4)(ii)(B) of this section,
the determination as to whether there exist obligations of a comparable
character depends upon the particular facts and circumstances. Factors
to be considered in making such determination include, but are not
limited to, substantial similarity with respect to the presence and
nature of security for the obligation, the number of obligations issued
(or to be issued), the number of holders of such obligation, the
principal amount of the obligation, and other relevant factors.
(iii) Readily tradable. For purposes of paragraph (e)(4)(ii)(A) of
this section, an obligation shall be treated as readily tradable if it
is regularly quoted by brokers or dealers making a market in such
obligation or is part of an issue a
[[Page 259]]
portion of which is in fact traded in an established securities market.
(iv) Established securities market. For purposes of this paragraph,
the term ``established securities market'' includes (A) a national
securities exchange which is registered under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f), (B) an exchange which
is exempted from registration under section 5 of the Securities Exchange
Act of 1934 (15 U.S.C. 78e) because of the limited volume of
transactions, and (c) any over-the-counter market. For purposes of this
(iv), an over-the-counter market is reflected by the existence of an
interdealer quotation system. An interdealer quotation system is any
system of general circulation to brokers and dealers which regularly
disseminates quotations of obligations by identified brokers or dealers,
other than a quotation sheet prepared and distributed by a broker or
dealer in the regular course of business and containing only quotations
of such broker or dealer.
(v) Examples. The rules stated in this paragraph may be illustrated
by the following examples:
Example (1). On June 1, 1982, 25 individuals owning equal interests
in a tract of land with a fair market value of $1 million sell the land
to corporation Y. The $1 million sales price is represented by 25 bonds
issued by Y, each having a face value of $40,000. The bonds are not in
registered form and do not have interest coupons attached, and, in
addition, are payable in 120 equal installments, each due on the first
business day of each month. In addition, the bonds are negotiable and
may be assigned by the holder to any other person. However, the bonds
are not quoted by any brokers or dealers who deal in corporate bonds,
and, furthermore, there are no comparable obligations of Y (determined
with reference to the characteristics set forth in paragraph (e)(2) of
this section) which are so quoted. Therefore, the bonds are not treated
as readily tradable in an established securities market. In addition,
under the particular facts and circumstances stated, the bonds will not
be considered to be in a form designed to render them readily tradable
in an established securities market. The receipt of such bonds by the
holder is not treated as a payment for purposes of section 453(f)(4),
notwithstanding that they are freely assignable.
Example (2). On April 1, 1981, corporation M purchases in a casual
sale of personal property a fleet of trucks from corporation N in
exchange for M's negotiable notes, not in registered form and without
coupons attached. The M notes are comparable to earlier notes issued by
M, which notes are quoted in the Eastern Bond section of the National
Daily Quotation Sheet, which is an interdealer quotation system. Both
issues of notes are unsecured, held by more than 100 holders, have a
maturity date of more than 5 years, and were issued for a comparable
principal amount. On the basis of these similar characteristics it
appears that the latest notes will also be readily tradable. Since an
interdealer system reflects an over-the-counter market, the earlier
notes are treated as readily tradable in an established securities
market. Since the later notes are obligations comparable to the earlier
ones, which are treated as readily tradable in an established securities
market, the later notes are also treated as readily tradable in an
established securities market (whether or not such notes are actually
traded).
(5) Special rule for convertible securities--(i) General rule. If an
obligation contains a right whereby the holder of such obligation may
convert it directly or indirectly into another obligation which would be
treated as a payment under paragraph (e)(1) of this section or may
convert it directly or indirectly into stock which would be treated as
readily tradable or designed to be readily tradable in an established
securities market under paragraph (e)(4) of this section, the
convertible obligation shall be considered to be in a form designed to
render such obligation readily tradable in an established securities
market unless such obligation is convertible only at a substantial
discount. In determining whether the stock or obligation into which an
obligation is convertible is readily tradable or designed to be readily
tradable in an established securities market, the rules stated in
paragraph (e)(4) of this section shall apply, and for purposes of such
paragraph (e)(4) if such obligation is convertible into stock then the
term ``stock'' shall be substituted for the term ``obligation'' wherever
it appears in such paragraph (e)(4).
(ii) Substantial discount rule. Whether an obligation is convertible
at a substantial discount depends upon the particular facts and
circumstances. A substantial discount shall be considered to exist if at
the time the convertible obligation is issued, the fair market
[[Page 260]]
value of the stock or obligation into which the obligation is
convertible is less than 80 percent of the fair market value of the
obligation (determined by taking into account all relevant factors,
including proper discount to reflect the fact that the convertible
obligation is not readily tradable in an established securities market
and any additional consideration required to be paid by the taxpayer).
Also, if a privilege to convert an obligation into stock or an
obligation which is readily tradable in an established securities market
may not be exercised within a period of one year from the date the
obligation is issued, a substantial discount shall be considered to
exist.
(6) Effective date. The provisions of this paragraph (e) shall apply
to sales or other dispositions occurring after May 27, 1969, which are
not made pursuant to a binding written contract entered into on or
before such date. No inference shall be drawn from this section as to
any questions of law concerning the application of section 453 to sales
or other dispositions occurring on or before May 27, 1969.
[T.D. 7768, 46 FR 10709, Feb. 4, 1981; 46 FR 13688, Feb. 24, 1981; 46 FR
43036, Aug. 26, 1981, as amended by T.D. 7788, 46 FR 48920, Oct. 5,
1981; T.D. 8535, 59 FR 18751, Apr. 20, 1994]
Sec. 15a.453-2 Installment obligations received as liquidating distribution. [Reserved]
PART 16--TEMPORARY REGULATIONS UNDER THE REVENUE ACT OF 1962--Table of Contents
Authority: Sec. 7805, 68 Stat. 917; 26 U.S.C. 7805.
Sec. 16.3-1 Returns as to the creation of or transfers to certain foreign trusts.
(a) Requirement of return. Every United States person who, on or
after October 16, 1962, either creates a foreign trust or transfers
money or property to a foreign trust, directly or indirectly, shall file
an information return on Form 3520, except as provided in subparagraph
(4) of paragraph (d) of this section. The return must be filed by the
grantor or the transferor, or the fiduciary of the estate in the case of
a testamentary trust. The return must be filed whether or not any
beneficiary is a United States person and whether or not the grantor or
any other person may be treated as the substantial owner of any portion
of the trust under sections 671-678.
(b) Meaning of terms. For purposes of this section the following
terms shall have the meaning assigned to them in this paragraph:
(1) Foreign trust. See section 7701(a)(31) of the Code for the
definition of foreign trust.
(2) United States person. See section 7701(a)(30) of the Code for
the definition of United States person.
(3) Grantor. The term ``grantor'' refers to any United States person
who by an inter vivos declaration or agreement creates a foreign trust.
(4) Transferor. The term ``transferor'' refers to any United States
person, other than a person who is the grantor or the fiduciary (as
defined in subparagraph (5) of this paragraph), who transfers money or
property to or for the benefit of a foreign trust. It does not refer to
a person who transfers money or property to a foreign trust pursuant to
a sale or an exchange which is made for full and adequate consideration.
(5) Fiduciary of an estate. In the case of a testamentary trust
expressed in the will of a decedent the term ``fiduciary of an estate''
refers to the executor or administrator who is responsible for
establishing a foreign trust on behalf of the decedent.
(c) Information required. The return required by section 6048 and
this section shall be made on Form 3520 and shall set forth the
following information:
(1) The name, address, and identifying number of the person (or
persons) filing the return, a statement identifying each person named as
either a grantor, fiduciary of an estate, or transferor, and the date of
the transaction for which the return is being filed;
(2) In the case of a fiduciary of an estate, the name and
identifying number of the decedent;
(3) The name of the trust and the name of the country under whose
laws the foreign trust was created;
[[Page 261]]
(4) The date the foreign trust was created and the name and address
of the person (or persons) who created it;
(5) The date on which the trust is to terminate or a statement
describing the conditions which will cause the trust to terminate;
(6) The name and business address of the foreign trustee (or
trustees);
(7) A statement either that the trustee is required to distribute
all of the trust's income currently (in which case the information
required in subparagraph (c)(9) of this paragraph need not be furnished)
or a statement that the trust may accumulate some or all of its income;
(8) The name, address, and identifying number, if any, of each
beneficiary who is either named in the instrument or whose identity is
definitely ascertainable at the time the return required by this section
is filed, and the date of birth for each beneficiary who is a United
States person and whose rights under the trust are determined, in whole
or in part, by reference to the beneficiary's age;
(9) Except as provided in subparagraph (c)(7) of this paragraph, a
statement with respect to each beneficiary setting forth his right to
receive income or corpus, or both, from the trust, his proportionate
interest, if any, in the income or corpus, or both, of the trust, and
any condition governing the time when a distribution to him may be made,
such as a specific date or age (or in lieu of such statement a copy of
the trust instrument which must be attached to the return);
(10) A detailed list of the property transferred to the foreign
trust in the transaction for which the return is being filed, containing
a complete description of each item transferred, its adjusted basis and
its fair market value on the date transferred, and the consideration, if
any, paid by the foreign trust for such transfer; and
(11) The name and address of the person (or persons) having custody
of the books of account and records of the foreign trust, and the
location of such books and records if different from such address.
(d) Special provisions--(1) Separate return for each foreign trust
and each transfer. If a United States person creates more than one
foreign trust or transfers money or property to more than one foreign
trust, then separate returns must be filed with respect to each foreign
trust where returns are required under section 6048 and this section. If
a United States person transfers money or property to the same foreign
trust at different times, then separate returns must be filed with
respect to each transfer where returns are required under section 6048
and this section. However, where more than one transfer to the same
foreign trust is made by a United States person during any 90-day
period, such person may, at his election, file a single return, so long
as the return includes the information required with respect to each
transfer and is filed on or before the 90th day after the earliest
transfer in any such period.
(2) Joint returns. Where returns are required under section 6048 and
this section by two or more persons who either jointly create a foreign
trust or jointly transfer money or property to a foreign trust, they may
jointly execute and file one return in lieu of filing several returns.
(3) Actual ownership of money or property transferred. If any person
referred to in this section is not the real party in interest as to the
money or property transferred but is merely acting for a United States
person, the information required under this section shall be furnished
in the name of and by the actual owner of such money or property, except
that a fiduciary of an estate shall file information relating to the
decedent.
(4) Payments to an employees' trust, etc. In the case of
contributions made to a foreign trust under a plan which provides
pension, profit-sharing, stock bonus, sickness, accident, unemployment,
welfare, or similar benefits or a combination of such benefits for
employees, neither employers nor employees shall be required to file a
return as set forth in this section.
(e) Time and place for filing return--(1) Time for filing. Any
return required by section 6048 and this section shall be filed on or
before the 90th day after either the creation of any foreign trust
[[Page 262]]
by a United States person or the transfer of any money or property to a
foreign trust by a United States person. The Director of International
Operations is authorized to grant reasonable extensions of time to file
returns under section 6048 and this section in accordance with the
applicable provisions of section 6081(a) and Sec. 1.6081-1.
(2) Place for filing. Returns required by section 6048 and this
section shall be filed with the Director of International Operations,
Internal Revenue Service, Washington D.C. 20225.
(f) Penalties--(1) Criminal. For criminal penalties for failure to
file a return see section 7203. For criminal penalties for filing a
false or fraudulent return, see sections 7206 and 7207.
(2) Civil. For civil penalty for failure to file a return or failure
to show the information required on a return under this section, see
section 6677.
[T.D. 6632, 28 FR 277, Jan. 10, 1963]
PART 16A--TEMPORARY INCOME TAX REGULATIONS RELATING TO THE PARTIAL EXCLUSION FOR CERTAIN CONSERVATION COST-SHARING PAYMENTS--Table of Contents
Sec.
16A.126-0 Effective dates.
16A.126-1 Certain cost-sharing payments--in general.
16A.126-2 Section 126 elections.
16A.1255-1 General rule for treatment of gain from disposition of
section 126 property.
16A.1255-2 Special rules.
Authority: Secs. 126 and 7805 of the Internal Revenue Code of 1954
(92 Stat. 2888, 26 U.S.C. 126; 68A Stat. 917, 26 U.S.C. 7805).
Source: T.D. 7778, 46 FR 27637, May 21, 1981, unless otherwise
noted.
Sec. 16A.126-0 Effective dates.
These temporary regulations shall apply to any payments received
under a contract signed by the taxpayer and the appropriate agency after
September 30, 1979.
Sec. 16A.126-1 Certain cost-sharing payments--in general.
(a) Introduction. In general, section 126 provides that recipients
of payments made after September 30, 1979 under certain conservation,
reclamation and restoration programs may exclude all or a portion of
those payments from income if the payments do not substantially increase
the annual income derived by the taxpayer from the affected property.
For purposes of this section, the term ``payment'' as used in section
126 means payment of the economic benefit, if any, conferred upon the
taxpayer upon receipt of the improvement. An increase in annual income
is substantial if it exceeds the greater of 10 percent of the average
annual income derived from the affected property prior to receipt of the
improvement or an amount equal to $2.50 times the number of affected
acres. The amount of gross income which a taxpayer realizes upon the
receipt of a section 126 payment is the value of the section 126
improvement, reduced by the sum of the excludable portion and the
taxpayer's share of the cost of the improvement (if any).
(b) Definitions. For purposes of this section, the term:
(1) ``Cost of the improvement'' means the sum of amounts paid by a
government and the taxpayer, whether or not with borrowed funds, for the
improvement.
(2) ``Section 126 cost'' means the cost of the improvement less the
sum of
(i) Any government payments under a program which is not listed in
section 126(a),
(ii) Any portion of a government payment under a program which is
listed in section 126(a) which the Secretary of Agriculture has not
certified is primarily for purposes of conservation,
(iii) Any government payment to the taxpayer which is in the nature
of rent or compensation for services.
(3) ``Value of the section 126 improvement'' means the fair market
value of the improvement multiplied by a fraction, the numerator of
which is the section 126 cost and the denominator of which is the cost
of the improvement.
(4) ``Affected acreage'' means the acres affected by the
improvement.
(5) ``Excludable portion'' means the present fair market value of
the right to receive annual income from the affected acreage of the
greater of 10 percent of the prior average annual income from the
affected acreage or $2.50 times the number of affected acres.
[[Page 263]]
(6) ``Prior average annual income'' means the average of the gross
receipts from the affected acreage for the last three taxable years
preceding the taxable year in which installation of the improvement is
commenced.
(7) ``Section 126 improvement'' means the portion of the improvement
equal to the percentage which government payments made to the taxpayer,
which the Secretary of Agriculture has certified were made primarily for
the purpose of conservation, bear to the cost of the improvement.
(c) Income realized upon receipt of a section 126 improvement--(1)
Section 126 exclusion applied. Unless a taxpayer elects not to have
section 126 apply, the amount of gross income realized on receipt of the
section 126 improvement is the value of the section 126 improvement less
the sum of the taxpayer's share of the cost of the improvement and the
excludable portion.
(2) Section 126 exclusion not applied. If a taxpayer elects under
section 126(c) not to have section 126 apply in whole or in part, the
amount realized on the receipt of the section 126 improvement is the
value of the section 126 improvement less the sum of the taxpayer's
share of the cost of the improvement and the excludable portion that
applies, if any.
(d) Payments under watershed programs--(1) Programs within section
126(a)(9). Section 126(a)(9) covers certain programs affecting small
watersheds.
These programs must be administered by the Secretary of Agriculture and
be determined by the Commissioner to be substantially similar to the
type of program described in section 126(a) (1) through (8). The
Commissioner has determined that section 126 improvements made in
connection with small watersheds are within the scope of section
126(a)(9) if they are made under one of the following programs:
(A) The Watershed Protection and Flood Prevention Act, Pub. L. 566,
68 Stat. 666, as amended (16 U.S.C. 1001, et seq.), as funded by the Act
of November 9, 1979, Pub. L. 96-108, 93 Stat. 834.
(B) Flood Prevention Projects, Pub. L. 86-468, sec. 1, 74 Stat. 131,
as amended (16 U.S.C. 1006a); Pub. L. 78-534, sec. 2, 58 Stat. 889 (33
U.S.C. 701a-1); Pub. L. 78-534, sec. 13, 58 Stat. 905;
(C) Emergency Watershed Protection, Pub. L. 81-516, sec. 216, 64
Stat. 184 (33 U.S.C. 701b-1), and
(D) Colorado River Basin Salinity Control Act, Pub. L. 93-320, 88
Stat. 266:
(1) Title 1--Programs downstream from Imperial Dam, and
(2) Title 2--Measures upstream from Imperial Dam.
(2) Other programs. The Commissioner may announce further
determinations under section 126(a)(9) from time to time in the Internal
Revenue Bulletin.
(3) Small watershed defined. A watershed is a ``small watershed''
under this paragraph and section 126(a)(9) if the watershed or
subwatershed does not exceed 250,000 acres and does not include any
single structure providing more than 12,500 acre-feet of floodwater
detention capacity, nor more than 25,000 acre-feet of total capacity.
(e) Basis of property not increased by reason of excludable amounts.
Notwithstanding any provision of section 1016 (relating to adjustments
to basis) to the contrary, basis of any property does not include any
amount which is excludable from gross income under section 126.
(f) Cross reference. For rules relating to the recapture as ordinary
income of the gain from the disposition (within 20 years of the date of
receipt) of property for which an exclusion is claimed for a section 126
improvement, see section 1255 and the regulations thereunder.
(g) Examples. The provisions of this section are illustrated by the
following examples:
Example (1). In 1981, 100 acres of the taxpayer's land is reclaimed
under a Rural Abandoned Mine Program contract with the Soil Conservation
Service of the U.S. Department of Agriculture. The total cost of the
improvement is $700,000. USDA pays $690,000, the taxpayer $10,000. The
Secretary of Agriculture certifies that 95% of the $690,000 USDA payment
was primarily for the purpose of conservation. Therefore, $34,500
($690,000 x .05) is a nonsection 126 payment. $150,000 of USDA's payment
is compensation for the taxpayer's service in the reclamation project
and is includable in gross income as compensation for services. The
taxpayer has $20,000 of allowable deductions in 1981, $15,500 of which
are properly attributable to the USDA payment. Based on all the facts
and circumstances, the value of the improvement
[[Page 264]]
is $21,000. The taxpayer elects not to have section 126 apply. The
taxpayer computes the amount which is included in gross income as a
result of receipt of the improvement as follows:
(1)
Cost of improvement......................................... $700,000
Nonsection 126 payment.................................... (34,500)
Compensation for services................................. (150,000)
Current deductions........................................ (15,500)
===========
Section 126 cost........................................ 500,000
===========
(2)
Value of improvement........................................ 21,000
Multiplied by section 126 cost............................ x 500,000
-----------
Cost of improvement....................................... 700,000
===========
Value of section 126 improvement........................ 15,000
===========
(3)
Value of section 126 improvement............................ 15,000
(Taxpayer's contribution)................................... 10,000
===========
Amount included in gross income......................... 5,000
Example (2). The facts are the same as example (1) except that
section 126 applies. Based on all the facts and circumstances, the
present fair market value of the right to receive annual income from the
property of 10 percent of the prior average annual income of the
affected acreage prior to the receipt of the improvement is $1,380 and
the present fair market value of the right to receive $250 ($2.50 x 100
acres) is $1,550. The excludable portion is, therefore, $1,550. The
taxpayer computes the amount included in gross income as follows:
Value of section 126 improvement............................ $15,000
(Taxpayer's contribution)................................... (10,000)
(Excludable portion)........................................ (1,550)
-----------
Amount included in income............................... 3,450
Example (3). The facts are the same as example (2) except that the
present value of 10 percent of the prior average annual income is
$5,600. The taxpayer realizes no income as a result of receipt of the
section 126 project.
(1)
Value of section 126 improvement............................ $15,000
(Taxpayer's contribution)................................... (10,000)
(Excludable portion)........................................ (5,600)
-----------
Amount included in income............................... 0
Example (4). In 1983, the taxpayer signs a contract under the water
bank program under which he will maintain 20 acres of undisturbed
wetlands as a wildfowl preserve. In return he will receive $90 an acre
as rent from the government. Although the payment is made under a
program listed in section 126(a) and the Secretary of Agriculture has
certified that the entire amount of payment was made primarily for the
purpose of conservation, there is no income eligible for section 126
exclusion because the full payment is rent. The rent is included in full
in gross income.
Example (5). In 1980, the taxpayer reforests 200 acres of
nonindustrial private forest land by planting tree seedlings. The
taxpayer pays the full cost of the reforestation, $15,000. Under the
cost-sharing provisions of the forestry incentives program, the taxpayer
receives a reimbursement from USDA of $12,000. The Secretary of
Agriculture certifies that 100% of the USDA payment is primarily for the
purpose of conservation. Assume that the excludable portion is $3,500
and that based on all the facts and circumstances, the value of the
improvement is $15,000. The amount which is includable in income is the
value of the section 126 improvement, reduced by the excludable portion
and the taxpayer's share of the cost of the improvement. Therefore the
taxpayer includes $8,500 in gross income as a result of the USDA
payment, computed as follows:
Value of the section 126 improvement.................... $15,000
(Excludable portion).................................... (3,500)
(Taxpayer's contribution)............................... (3,000)
---------------
Amount included in gross income..................... 8,500
[T.D. 7748, 46 FR 27637, May 21, 1981; 46 FR 41043, Aug. 14, 1981]
Sec. 16A.126-2 Section 126 elections.
(a) Election for section 126 not to apply in whole or in part. A
taxpayer may elect under section 126(c) not to have section 126 apply to
all or any part of an improvement described in section 126.
(b) Application of the section 126 exclusion. To the extent the
section 126 exclusion applies, the taxpayer should so indicate on an
attachment to the tax return (or amended return) for the taxable year in
which the taxpayer received the last payment made by a government for
the improvement. The attachment should state the dollar amount of the
section 126 cost funded by a government payment, the value of the
section 126 improvement, and the amount that the taxpayer is excluding
under section 126.
Sec. 16A.1255-1 General rule for treatment of gain from disposition of section 126 property.
(a) Ordinary income--(1) General rule. Except as otherwise provided
in this section and Sec. 16A.1255-2, if section 126 property is disposed
of after September 30, 1979, then under section 1255(a)(1)
[[Page 265]]
there shall be recognized as ordinary income the lesser of--
(i) The ``excludable portion'' under section 126, or
(ii)(A) The excess of the amount realized (in the case of a sale,
exchange, or involuntary conversion), or the fair market value of the
section 126 property (in the case of any other disposi-tion), over the
adjusted basis of the property, less
(B) The amount recognized as ordinary income under the other
provisions of Chapter I, Subchapter P, Part IV of the Code.
(2) Application of section. Any gain treated as ordinary income
under section 1255(a)(1) shall be recognized as ordinary income
notwithstanding any other provision of subtitle A of the Code except
that section 1255 does not apply to the extent the gain is recognized as
ordinary income under the other provisions of Subchapter P, Part IV of
the Code. For special rules with respect to the application of section
1255, see Sec. 16A.1255-2. For the relation of section 1255 to other
provisions, see paragraph (c) of this section.
(3) Meaning of terms. For purposes of section 1255 and these
regulations--
(i) The term ``section 126 property'' means any property acquired,
improved, or otherwise modified as a result of a payment listed in
section 126(a) which has been certified by the Secretary of Agriculture
as primarily for the purpose of conservation;
(ii) The term ``excludable portion'' is defined in Sec. 16A.126-
1(b)(5);
(iii) The term ``disposition'' has the same meaning as in
Sec. 1.1245-1(a)(3);
(iv) The term ``date of receipt of the section 126 payment'' means
the last date the government made a payment for the improvements.
(4) Applicable percentage. If section 126 property is disposed of
less than 10 years after the date of receipt of the last payment which
has been certified by the Secretary of Agriculture as primarily for the
purpose of conservation, the ``applicable percentage'' is 100 percent;
if section 126 property is disposed of more than 10 years after that
date, the applicable percentage is 100 percent reduced (but not below
zero) by 10 percent for each year or part thereof in excess of 10 years
such property was held after the date of the section 126 payment.
(5) Portion of parcel. The amount of gain to be recognized as
ordinary income under section 1255(a)(1) shall be determined separately
for each parcel of section 126 property in a manner consistent with the
principles of Sec. 1245-1(a) (4) and (5) relating to gain from
disposition of certain depreciable property. If (i) only a portion of a
parcel of section 126 property is disposed of in a transaction, or if
two or more portions of a single parcel are disposed of in one
transaction, and (ii) the aggregate of ``excludable portions'' with
respect to any such portion cannot be established to the satisfaction of
the Commissioner, then the aggregate of the ``excludable portions'' in
respect of the entire parcel shall be allocated to each portion in
proportion to the fair market value of each at the time of the
disposition.
(b) Instances of nonapplication--(1) In general. Section 1255 does
not apply if a taxpayer disposes of section 126 property more than 20
years after receipt of the last section 126 payment with respect to the
property.
(2) Losses. Section 1255(a)(1) does not apply to losses. Thus,
section 1255(a)(1) does not apply if a loss is realized upon a sale,
exchange, or involuntary conversion of property, all of which is section
126 property, nor does the section apply to a disposition of the
property other than by way of sale, exchange, or involuntary conversion
if at the time of the disposition the fair market value of the property
is not greater than its adjusted basis.
(c) Relation of section 1255 to other provisions--(1) General. The
provisions of section 1255 apply notwithstanding any other provisions of
Subtitle A of the Code except that they do not apply to the extent gain
is recognized as ordinary income under the other provisions of
Subchapter P, Part IV of the Code. Thus, unless an exception or
limitation under Sec. 16A.1255-2 applies, gain under section 1255(a)(1)
is recognized notwithstanding any contrary nonrecognition provision or
income characterizing provision. For example, since section 1255
overrides section 1231 (relating to property used in the trade or
business), the gain recognized under section 1255 upon
[[Page 266]]
a disposition of section 126 property will be treated as ordinary income
and only the remaining gain, if any, from the disposition may be
considered as gain from the sale or exchange of property to which
section 1231 applies. See example (1) of paragraph (d) of this section.
(2) Nonrecognition sections overridden. The nonrecognition of gain
provisions of Subtitle A of the Code which section 1255 overrides
include, but are not limited to, sections 267(d), 311(a), 336, 337, and
512(b)(5). See Sec. 16A.1255-2 for the extent to which section
1255(a)(1) overrides sections 332, 351, 361, 371(a), 374(a), 721, 731,
1031, and 1033.
(3) Installment method. Gain from a disposition to which section
1255(a)(1) applies may be reported under the installment method if such
method is otherwise available under section 453 of the Code. In such a
case, the portion of the installment payment that is gain is treated as
follows: first as ordinary gain under other sections of Chapter I
Subchapter P, Part IV of the Code until all that gain has been reported;
next as ordinary gain to which section 1255 applies until all that gain
is reported; and finally as gain under other sections of Chapter I,
Subchapter D, Part IV of the Code. For treatment of amounts as interest
on certain deferred payments, see section 483.
(4) Exempt income. With regard to exempt income, the principles of
Sec. 1.1245-6(e) shall be applicable.
(5) Treatment of gain not recognized under section 1255(a)(1). For
treatment of gain not recognized under this section, the principles of
Sec. 1.1245-6(f) shall be applicable.
(d) Example. The provisions of this section may be illustrated by
the following example:
Example (1). Individual A uses the calendar year as his taxable
year. On April 10, 1995, A sells for $75,000 section 126 property with
an adjusted basis of $52,500 for a realized gain of $22,500. The
excludable portion under section 126 was $18,000. A received the section
126 payment on January 5, 1990. No gain is recognized as ordinary gain
under sections 1231 through 1254. Because the applicable percentage, 100
percent, of the aggregate of the section 126 improvements ($18,000),
$18,000, is lower than the gain realized, $22,500, the amount of gain
recognized as ordinary income under section 1255(a)(1) is $18,000. The
remaining $4,500 of the gain may be treated as gain from the sale or
exchange of property described in section 1231.
Sec. 16A.1255-2 Special rules.
(a) Exception for gifts--(1) General rule. In general, no gain shall
be recognized under section 1255(a)(1) upon a disposition of section 126
property by gift. For purposes of section 1255 and this paragraph, the
term ``gift'' shall have the same meaning as in Sec. 1.1245-4(a) and,
with respect to the application of this paragraph, principles
illustrated by the examples of Sec. 1.1245-4(a)(2) shall apply.
(2) Disposition in part a sale or exchange and in part a gift. Where
a disposition of section 126 property is in part a sale or exchange and
in part a gift, the amount of gain which shall be recognized as ordinary
income under section 1255(a)(1) shall be computed under Sec. 16A.1255-
1(a)(1), applied by treating the gain realized (for purposes of
Sec. 16A.1255-1(a)(1)(ii)), as the excess of the amount realized over
the adjusted basis of the section 126 property.
(3) Treatment of section 126 property in hands of transferee. See
paragraph (d) of this section for treatment of the transferee in the
case of a disposition to which this paragraph applies.
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example (1). On March 2, 1986, A makes a gift to B of a parcel of
land having an adjusted basis of $40,000 and fair market value of
$65,000. On the date of that gift, the aggregate of excludable portions
under section 126 was $24,000. The section 126 payments were all
received on January 15, 1981. Upon making the gift, A recognizes no gain
under section 1255(a)(1). See paragraph (a)(1) of this section. For
treatment of the property in the hands of B, see example (1) of
paragraph (d)(3) of this section.
Example (2). (i) Assume the same facts as in example (1), except
that A transfers the land to B for $50,000. Assume further that no gain
is recognized as ordinary income under any other provision of Chapter I,
Subchapter P, Part IV of the Code. Thus, the gain realized is $10,000
(amount realized, $50,000, minus adjusted basis, $40,000), and A has
made a gift of $15,000 (fair market value, $65,000, minus amount
realized, $50,000).
(ii) Upon the transfer of the land to B, A recognizes $10,000 as
ordinary income under section 1255(a)(1), computed under paragraph
(a)(2) of this section as follows:
[[Page 267]]
(1) Aggregate of excludable portions under section 126..... $24,000
(2) Multiply: Applicable percentage for land disposed if
within sixth year after section 126 payments were received 100
(3) Amount in Sec. 16A.1255-1(a)(1)(i).................... $24,000
============
(4) Gain realized (see (i) of this example)................ 10,000
(5) Amount in Sec. 16A.1255-1(a)(1)(ii) applied in
accordance with paragraph (a)(2) of this section.......... 10,000
============
(6) Lower of line (3) or line (5).......................... 10,000
Thus, the entire gain realized on the transfer, $10,000, is
recognized as ordinary income.
For treatment of the farm land in the hands of B, see example (2) of
paragraph (d)(3) of this section.
(b) Exception for transfer at death--(1) In general. Except as
provided in section 691 (relating to income in respect of a decedent),
no gain shall be recognized under section 1255(a)(1) upon a transfer at
death. For purposes of section 1255 and this paragraph, the term
``transfer at death'' shall have the same meaning as in Sec. 1.1245-4(b)
and, with respect to the application of this paragraph, principles
illustrated by the examples of Sec. 1.1245-4(b)(2) shall apply.
(2) Treatment of section 126 property in hands of transferee. If, as
of the date a person acquires section 126 property from a decedent, the
person's basis is determined by reason of the application of section
1014(a), solely by reference to the fair market value of the property on
the date of the decedent's death, or on the applicable date provided in
section 2032 (relating to alternative valuation date), then on that date
the aggregate of excludable portions under section 126 in the hands of
such transferee is zero.
(c) Limitation for certain tax-free transactions--(1) Limitation on
amount of gain. Upon a transfer of section 126 property described in
paragraph (c)(2) of this section, the amount of gain recognized as
ordinary income under section 1255(a)(1) shall not exceed an amount
equal to the excess (if any) of (i) the amount of gain recognized to the
transferor on the transfer (determined without regard to section 1255)
over (ii) the amount (if any) of gain recognized as ordinary income
under the other provisions of Chapter I, Subchapter P, Part IV of the
Code. For purposes of paragraph (c)(1) of this section, the principles
of Sec. 1.1245-4(c)(1) shall apply. Thus, in the case of a transfer of
section 126 property and other property in one transaction, the amount
realized from the disposition of the section 126 property (as determined
in a manner consistent with the principles of Sec. 1.1245-1(a)(5)) shall
consist of that portion of the fair market value of each property
acquired which bears the same ratio to the fair market value of the
acquired property as the amount realized from the disposition of the
section 126 property bears to the total amount realized. The preceding
sentence shall be applied solely for purposes of computing the portion
of the total gain (determined without regard to section 1255) which is
eligible to be recognized as ordinary income under section 1255(a)(1).
The provisions of this paragraph do not apply to a disposition of
property to an organization (other than a cooperative described in
section 521) which is exempt from the tax imposed by Chapter I of the
Code.
(2) Transfers covered. The transfers referred to in paragraph (c)(1)
of this section are transfers of section 126 property in which the basis
of the property in the hands of the transferee is determined by
reference to its basis in the hands of the transferor by reason of the
application of any of the following provisions:
(i) Section 332 (relating to distributions in complete liquidation
of an 80-percent-or-more controlled subsidiary corporation). For
application of paragraph (c)(1) of this section to such a complete
liquidation, the principles of Sec. 1.1245-4(c)(3) shall apply. Thus,
for example, the provisions of paragraph (c)(1) of this section do not
apply to a liquidating distribution of section 126 property by an 80-
percent-or-more controlled subsidiary to its parent if the parent's
basis for the property is determined, under section 334(b)(2), by
reference to its basis for the stock of the subsidiary.
(ii) Section 351 (relating to transfer to a corporation controlled
by the transferor).
(iii) Section 361 (relating to exchanges pursuant to certain
corporate reorganizations).
(iv) Section 371(a) (relating to exchanges pursuant to certain
receivership and bankruptcy proceedings).
[[Page 268]]
(v) Section 374(a) (relating to exchanges pursuant to certain
railroad reorganizations).
(vi) Section 721 (relating to transfers to a partnership in exchange
for a partnership interest). See paragraph (e) of this section.
(vii) Section 731 (relating to distributions by a partnership to a
partner). For special carryover of basis rule, see paragraph (e) of this
section.
(viii) Section 1031 (relating to like kind exchanges).
(ix) Section 1034 (relating to rollover of gain on the sale of a
principal residence).
(3) Treatment of section 126 property in the hands of transferee.
See paragraph (d) of this section for treatment of the transferee in the
case of a disposition to which this paragraph applies.
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example (1). On January 4, 1986, A holds a parcel of property that
is section 126 property having an adjusted basis of $15,000 and a fair
market value of $40,000. On that date he transfers the parcel to
corporation M in exchange for stock in the corporation worth $40,000 in
a transaction qualifying under section 351. On the date of the transfer,
the aggregate of excludable portions under section 126 with respect to
the transferred property is $18,000 and all of such amount was received
on March 25, 1981. With regard to section 1255, A would recognize no
gain under section 351 upon the transfer and M's basis for the land
would be determined under section 362(a) by reference to its basis in
the hands of A. Thus, as a result of the disposition, no gain is
recognized as ordinary income under section 1255 by A since the amount
of gain recognized under that section is limited to the amount of gain
which is recognized under section 351 (determined without regard to
section 1255). See paragraph (c)(1) of this section. For treatment of
the section 126 property in the hands of B, see paragraph (d)(1) of this
section.
Example (2). Assume the same facts in example (1), except that A
transferred the property to M for stock in the corporation worth $32,000
and $8,000 cash. The gain realized is $25,000 (amount realized, $40,000,
minus adjusted basis, $15,000). Without regard to section 1255, A would
recognize $8,000 of gain under section 351(b). Assume further that no
gain is recognized as ordinary income under the other provisions of
Chapter I, Subchapter P, Part IV of the Code. Therefore, since the
applicable percentage, 100 percent of the aggregate excludable portions
under section 126, $18,000, is lower than the gain realized, $25,000,
the amount of gain to be recognized as ordinary income under section
1255(a)(1) would be $18,000 if the provisions of paragraph (c)(1) of
this section do not apply. Since under section 351(b) gain in the amount
of $8,000 would be recognized to the transferor without regard to
section 1255, the limitation provided in paragraph (c)(1) of this
section limits the gain taken into account by A under section 1255(a)(1)
to $8,000.
Example (3). Assume the same facts as in example (2), except that
$5,000 of gain is recognized as ordinary income under section
1251(c)(1). The amount of gain recognized as ordinary income under
section 1255(a)(1) is $3,000 computed as follows:
(1) Amount of gain under section 1255(a)(1) (determined
without regard to paragraph (c)(1) of this section):
(a) Aggregate of excludable portions under section 126..... $18,000
(b) Multiply: Applicable percentage for property disposed
of within the fifth year after section 126 payments were
received (percent)........................................ 100
(c) Amount in Sec. 16A.1255-1(a)(1)(i).................... $18,000
==========
(d) Gain realized (amount realized $40,000 less adjusted
basis, $15,000)........................................... $25,000
(e) Lower of line (c) or line (d).......................... $18,000
==========
(2) Limitation in paragraph (c)(1) of this section:
(a) Gain recognized (determined without regard to section
1255)..................................................... $8,000
(b) Minus: Gain recognized as ordinary income under section
1251(c)(1)................................................ $5,000
----------
(c) Difference............................................. $3,000
(3) Lower of line (1)(e) or line (2)(c)...................... $3,000
Thus, the entire gain recognized under section 351(b) (determined
without regard to sections 1251 and 1255), $8,000, is recognized as
ordinary income since that amount is equal to the sum of the gain
recognized as ordinary income under section 1251(c)(1), $5,000, and
under section 1255(a)(1), $3,000.
(d) Treatment of section 126 property received by a transferee in a
disposition by gift and certain tax-free transactions--(1) General rule.
If section 126 property is disposed of in a transaction which is either
a gift to which paragraph (a)(1) of this section applies, or a
completely tax-free transfer to which paragraph (c)(1) of this section
applies, then for purposes of section 1255--
(i) The aggregate of the excludable portions under section 126 in
respect of the land in the hands of the transferee immediately after the
disposition shall be an amount equal to the amount of such aggregate in
the hands of the transferor immediately before the disposition, and
[[Page 269]]
(ii) For purposes of applying section 1255 upon a subsequent
disposition by the transferee (including a computation of the applicable
percentage), the dates of receipt of section 126 payments shall not be
affected by the dispositions.
(2) Certain partially tax-free transfers. If section 126 property is
disposed of in a transaction which either is in part a sale or exchange
and in part a gift to which paragraph (a)(2) of this section applies, or
is a partially tax-free transfer to which paragraph (c)(1) of this
section applies, then for purposes of section 1255 the amount determined
under paragraph (d)(1) of this section shall be reduced by the amount of
gain taken into account under section 1255 by the transferor upon the
disposition. Upon a subsequent disposition by the transferee, the dates
of receipt of section 126 payments remain the same in the hands of the
transferee as they were in the hands of the transferor. With respect to
the 175 and 182 deductions taken by the transferee, the holding period
shall not include the holding period of the transferor.
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example (1). Assume the same facts as in example (1) of paragraph
(a)(4) of this section. Therefore, on the date B receives the land in
the gift transaction, under paragraph (d)(1) of this section the
aggregate of excludable portions under section 126 in respect of the
land in the hands of B is the amount in the hands of A, $24,000, and for
purposes of applying section 1255 upon a subsequent disposition by B
(including a computation of the applicable percentage) the date the
section 126 payments were received is the same as it was when the
property was in A's hands (January 15, 1981).
Example (2). Assume the same facts as in example (2) of paragraph
(a)(4) of this section. Under paragraph (d)(2) of this section, the
aggregate of excludable portions under section 126 which pass over to B
for purposes of section 1255 is $14,000 ($24,000 excluded under section
126 minus $10,000 gain recognized under section 1255(d)(1) in accordance
with example (2) of paragraph (a)(4) of this section). The date the
section 126 payments were received is the same as when the property was
in B's hands (January 15, 1981).
(e) Disposition of section 126 property not specifically covered. If
section 126 property is disposed of in a transaction not specifically
covered under Sec. 16A.1255-1, and this section, then the principles of
section 1245 shall apply.
PART 17--TEMPORARY INCOME TAX REGULATIONS UNDER 26 U.S.C. 103(c)--Table of Contents
Authority: Sec. 7805 of the Internal Revenue Code of 1954; 68A Stat.
917 (26 U.S.C. 7805).
Sec. 17.1 Industrial development bonds used to provide solid waste disposal facilities; temporary rules.
(a) In general. Section 103(c)(4)(E) provides that section 103(c)(1)
shall not apply to obligations issued by a State or local governmental
unit which are part of an issue substantially all the proceeds of which
are used to provide solid waste disposal facilities. Section 1.103-8(f)
of this chapter provides general rules with respect to such facilities
and defines such facilities. In the case of property which has both a
solid waste disposal function and a function other than the disposal of
solid waste, only the portion of the cost of the property allocable to
the function of solid waste disposal (as determined under paragraph (b)
of this section) is taken into account as an expenditure to provide
solid waste disposal facilities. A facility which otherwise qualifies as
a solid waste disposal facility will not be treated as having a function
other than solid waste disposal merely because material or heat which
has utility or value is recovered or results from the disposal process.
Where materials or heat are recovered, the waste disposal function
includes the processing of such materials or heat which occurs in order
to put them into the form in which the materials or heat are in fact
sold or used, but does not include further processing which converts the
materials or heat into other products.
(b) Allocation. The portion of the cost of property allocable to
solid waste disposal is determined by allocating the cost of such
property between the property's solid waste disposal function and any
other functions by any method which, with reference to all the facts and
circumstances with respect to such
[[Page 270]]
property, reasonably reflects a separation of costs for each function of
the property.
(c) Example. The principles of this paragraph may be illustrated by
the following example:
Example. Company A intends to construct a new facility to process
solid waste which City X will deliver to the facility. City X will pay a
disposal fee for each ton of solid waste that City X dumps at the
facility. The waste will be processed by A in a manner which separates
metals, glass, and similar materials. As separated, some of such items
are commercially saleable; but A does not intend to sell the metals and
glass until the metals are further separated, sorted, sized, and cleaned
and the glass is pulverized. The metals and pulverized glass will then
be sold to commercial users. The waste disposal function includes such
processing of the metals and glass, but no further processing is
included.
The remaining waste will be burned in an incinerator. Gases
generated by the incinerator will be cleaned by use of an electrostatic
precipitator. To reduce the size and cost of the electrostatic
precipitator, the incinerator exhaust gases will be cooled and reduced
in volume by means of a heat exchange process using boilers. The
precipitator is functionally related and subordinate to disposal of the
waste residue and is therefore property used in solid waste disposal.
The heat can be used by A to produce steam. Company B operates an
adjacent electric generating facility and B can use steam to power its
turbine-generator. B needs steam with certain physical characteristics
and as a result A's boilers, heat exchanger and related equipment are
somewhat more costly than might be required to produce steam for some
other uses. The disposal function includes the equipment actually used
to put the heat into the form in which it is sold.
Company A intends to construct pipes to carry the steam from A's
boiler to B's facility. When converted to such steam the heat is in the
form in which sold, and therefore the disposal function does not include
subsequent transporting of the steam by pipes. Similarly, if A installed
generating equipment and used the steam to generate electricity, the
disposal function would not include the generating equipment, since such
equipment transforms the commercially saleable steam into another form
of energy.
[T.D. 7362, 40 FR 26028, June 20, 1975]
PART 18--TEMPORARY INCOME TAX REGULATIONS UNDER THE SUBCHAPTER S REVISION ACT OF 1982--Table of Contents
Sec.
18.0 Effective date of temporary regulations under the Subchapter S
Revision Act of 1982.
18.1371-1 Election to treat distributions as dividends during certain
post-termination transition periods.
18.1378-1 Taxable year of S corporation.
18.1379-1 Transitional rules on enactment.
18.1379-2 Special rules for all elections, consents, and refusals.
Authority: 26 U.S.C. 7805.
Source: T.D. 7872, 48 FR 3590, Jan. 26, 1983, unless otherwise
noted.
Sec. 18.0 Effective date of temporary regulations under the Subchapter S Revision Act of 1982.
The temporary regulations provided under Sec. 18.1377-1, 18.1379-1,
and 18.1379-2 are effective with respect to taxable years beginning
after 1982, and the temporary regulations provided under Sec. 18.1378-1
are effective with respect to elections made after October 19, 1982.
[T.D. 8600, 60 FR 37588, July 21, 1995]
Sec. 18.1371-1 Election to treat distributions as dividends during certain post-termination transition periods.
A corporation may make an election under section 1371(e) (as amended
by section 721(o) of the Act) to treat all distributions of money made
during the post-termination transition period described in section
1377(b)(1)(A) as coming out of the corporation's earnings and profits
(after earnings and profits have been eliminated, the distributions are
applied against and reduce the adjusted basis of the stock). The
election may be made only with the consent of each shareholder to whom
the corporation makes a distribution (whether or not it is a cash
distribution) during such post-termination transition period. Any such
election shall be made by the corporation by attaching to its income tax
return for the C year in which such post-
[[Page 271]]
termination transition period ends a statement which clearly indicates
that the corporation elects to have section 1371(e)(1) not apply to all
distributions made during such post-termination transition period. The
election shall not be effective unless such statement is signed by a
person authorized to sign the return required to be filed under section
6012 and by each shareholder required to consent to the election.
[T.D. 7976, 49 FR 35493, Sept. 10, 1984]
Sec. 18.1378-1 Taxable year of S corporation.
(a) In general. No corporation may make an election be an S
corporation for any taxable year unless the taxable year is a permitted
year. In addition, an S corporation shall not change its taxable year to
any taxable year other than a permitted year. A permitted year is a
taxable year ending on December 31 or is any other taxable year for
which the corporation establishes a business purpose (within the meaning
of Sec. 1.442-1(b)(1)) to the satisfaction of the Commissioner.
(b) Corporations qualifying for automatic change of taxable year to
a taxable year ending December 31 and corporations adopting a taxable
year ending December 31--(1) Qualification for automatic change.
Notwithstanding section 442 (relating to change of taxable year) and the
regulations thereunder, a corporation may automatically change its
taxable year to a taxable year ending on December 31 to comply with the
permitted year requirement if all of its principal shareholders have
taxable years ending on December 31, or if all of its principal
shareholders concurrently change to such taxable year. A shareholder may
not change his or her taxable year without securing prior approval from
the Commissioner. See section 442 and the regulations thereunder. For
purposes of this paragraph, a principal shareholder is a shareholder
having 5% or more of the issued and outstanding stock of the
corporation. See paragraph (d) of this section in the case where a
corporation does not qualify under this subparagraph for an automatic
change of its taxable year to a taxable year ending on December 31.
(2) Effect of filing an election--(i) General rule. The filing of an
election to be an S corporation by a corporation that has, prior to
making the election, adopted a taxable year ending other than on
December 31, and that qualifies under paragraph (b)(1) of this section
for an automatic change of its taxable year to a taxable year ending on
December 31, shall constitute such automatic change for the first
taxable year for which the election is effective. The filing of an
election to be an S corporation by a corporation that has not, prior to
making the election, adopted a taxable year shall constitute the
adoption of a taxable year (or, if the corporation qualifies under
paragraph (b)(1) of this section for the automatic change, the change to
a taxable year) ending on December 31 for the first taxable year for
which the election is effective. Where the taxable year has been changed
pursuant to this subdivision and paragraph (b)(1) of this section, the
first taxable year for which the election shall be effective shall
commence on the first day of the first taxable year for which the
election would have been effective if the taxable year had not been
changed and shall end on December 31 of that taxable year. See
Sec. 1.1362-6(b)(2)(ii) of this chapter for the time within which to
make an election to be an S corporation.
(ii) Request to retain (or adopt) a taxable year ending other than
December 31. A request to retain (or adopt) a taxable year ending other
than on December 31 by a corporation subject to paragraph (b)(2)(i) of
this section shall (except as provided in paragraph (b)(3)(ii) of this
paragraph and in paragraph (c) of this section) be made on Form 2553
when the election to be an S corporation is filed. See Sec. 1.1362-
6(b)(2)(i) of this chapter for the manner of making an election to be an
S corporation. If such corporation receives permission to retain (or
adopt) a taxable year ending other than on December 31, the election
shall be effective and the provisions of paragraph (b)(2)(i) of this
section shall be inapplicable. Denial of the request shall render the
election ineffective unless--
(A) The request is accompanied by another request in which the
corporation states that, in the event the request to retain (or adopt) a
taxable year ending other than on December 31
[[Page 272]]
is denied, it chooses to be governed by the provisions of paragraph
(b)(2)(i) of this section, or
(B) The Commissioner waives the requirement to file the additional
request described in paragraph (b)(2)(ii)(A) of this section and permits
the corporation to be governed by the provisions of paragraph (b)(2)(i)
of this section.
(c) [Reserved]
(d) Elections by corporations not qualifying for automatic change.
An election to be an S corporation made after October 19, 1982, by a
corporation that has a taxable year ending other than on December 31,
and that does not qualify under paragraph (b)(1) of this section for an
automatic change of its taxable year to a taxable year ending on
December 31, shall be ineffective unless the corporation has first
secured a permitted year. At the request of a corporation wishing to
secure a permitted year, the Commissioner shall make a determination
that--
(1) The corporation's taxable year is a permitted year, or
(2) The corporation may, under Sec. 1.442-1(b)(1), change its
taxable year to a taxable year ending on December 31, or
(3) The corporation may, under Sec. 1.442-1(b)(1), change its
taxable year to a taxable year ending other than on December 31, which
taxable year shall be a permitted year.
[T.D. 7872, 48 FR 3590, Jan. 26, 1983; 48 FR 33481, July 22, 1983, as
amended by T.D. 8123, 52 FR 3623, Feb. 5, 1987; T.D. 8600, 60 FR 37589,
July 21, 1995]
Sec. 18.1379-2 Transitional rules on enactment.
(a) Prior elections. Any election that was made under section
1372(a) (as in effect before the enactment of the Subchapter S Revision
Act of 1982), and that is still in effect as of the first day of a
taxable year beginning in 1983, shall be treated as being an election
made under section 1362(a). In addition, any election that was made
under section 1371(g)(2) (as in effect before the enactment of that
Act), and that is still in effect as of the first day of a taxable year
beginning in 1983, shall be treated as being an election made under
section 1362(d)(2).
(b) Prior terminations. For purposes of section 1362(g), any
termination under section 1372(e) (as in effect before the enactment of
the Subchapter S Revision Act of 1982) shall not be taken into account.
(c) Time and manner of making an election under section 6(c)(3)(B)
of the Subchapter S Revision Act of 1982. In the case of a qualified oil
corporation (as defined in section 6(c)(3)(B) of the Subchapter S
Revision Act of 1982), the corporation may elect under that section of
the Act to have the amendments made by the Act not apply and to have
Subchapter S (as in effect on July 1, 1982), Chapter I of the Internal
Revenue Code of 1954 apply. The election shall be made by the
corporation by filing a statement that--
(1) Contains the name, address, and taxpayer identification number
of the corporation and of each shareholder,
(2) Identifies the election as an election under section 6(c)(3)(B)
of the Subchapter S Revision Act of 1982, and
(3) Provides all information necessary in the judgment of the
district director to show that the corporation meets the requirements
(other than the requirement of making this election) of a qualified oil
corporation.
The statement shall be signed by any person authorized to sign the
return required to be filed under section 6037 and by each person who is
or was a shareholder in the corporation at any time during the taxable
year beginning in 1983 and shall be filed with the return for that
taxable year.
Sec. 18.1379-2 Special rules for all elections, consents, and refusals.
(a) Additional information required. If later regulations issued
under the section of the Code or of the Subchapter S Revision Act of
1982 under which the election, consent, or refusal was made require the
furnishing of information in addition to that which was furnished with
the statement of election, consent, or refusal as provided by part 18 of
this title, and if an office of the Internal Revenue Service requests
the taxpayer to provide the additional information, the taxpayer shall
furnish the additional information in a statement filed with that office
of the Internal Revenue Service within 60 days
[[Page 273]]
after the date on which the request is made. This statement shall also--
(1) Contain the name, address, and taxpayer identification number of
each party identified in connection with the election, consent, or
refusal,
(2) Identify the election, consent, or refusal by reference to the
section of the Code or Act under which the election, consent, or refusal
was made, and
(3) Specify the scope of the election, consent, or refusal.
If the additional information is not provided within 60 days after the
date on which the request is made, the election, consent, or refusal
may, at the discretion of the Commissioner, be held invalid.
(b) State law incorporator. For purposes of any election, consent,
or refusal provided in part 18 of this title, any person who is
considered to be a shareholder for state law purposes solely by virtue
of his or her status as an incorporator shall not be treated as a
shareholder.
PART 19--TEMPORARY REGULATIONS UNDER THE REVENUE ACT OF 1964--Table of Contents
Authority: 26 U.S.C. 7805.
Sec. 19.3-1 Interest on certain deferred payments; interest rate for use in determining whether there is total unstated interest under a contract.
(a) In general. Section 224(a) of the Revenue Act of 1964 adds a new
section 483 to the Internal Revenue Code of 1954. Section 483(a)
provides, generally, that in the case of any contract for the sale or
exchange of property (which is a capital asset or section 1231 property)
there shall be treated as interest that part of a payment to which
section 483 applies which bears the same ratio to the amount of such
payment as the total unstated interest under such contract bears to the
total of the payments to which such section applies which are due under
the contract. Section 483(b) defines the term ``total unstated
interest'', with respect to a contract for the sale or exchange of
property, as an amount equal to the excess of--
(1) The sum of the payments to which section 483 applies which are
due under the contract, over
(2) The sum of the present values of such payments and the present
values of any interest payments due under the contract.
Section 483(b) further provides that, for purposes of section 483(b)(2),
the present value of a payment shall be determined, as of the date of
the sale or exchange, by discounting such payment at the rate, and in
the manner, provided in regulations prescribed by the Secretary or his
delegate, and that such regulations shall provide for discounting on the
basis of 6-month brackets and shall provide that the present value of
any interest payment due not more than 6 months after the date of the
sale or exchange is an amount equal to 100 percent of such payment.
Section 483(c) provides that, except as provided in section 483(f)
(relating to exceptions and limitations), section 483 shall apply to any
payment on account of the sale or exchange of property which constitutes
part or all of the sales price and which is due more than 6 months after
the date of such sale or exchange under a contract under which some or
all of the payments are due more than one year after the date of such
sale or exchange, and under which, using a rate provided by regulations
(for purposes of section 483(c)(1)(B)), there is total unstated
interest. Section 483(c) further provides that any rate prescribed for
determining whether there is total unstated interest for purposes of
section 483(c)(1)(B) shall be at least one percentage point lower than
the rate prescribed for purposes of section 483(b)(2).
(b) Rate of interest and table of present values for purposes of
section 483(c)(1)(B). For purposes of determining under section
483(c)(1)(B) whether there is total unstated interest under a contract
(other than a contract of sale or exchange under which the purchaser is
the United States, a State, or any other purchaser described in section
103) which provides for the payment of some interest, a rate of 4
percent per annum simple interest shall be used. As an illustration of
the meaning of simple interest, if a contract provides
[[Page 274]]
for payments of $6,000 in 3 equal installments of $2,000 plus 4 percent
per annum simple interest, such installments of principal and interest
being due 1, 2, and 3 years, respectively, from the date of the sale,
the amount of interest due with the first installment is $80
($2,000 x 0.04 x 1), the amount of interest due with the second
installment is $160 ($2,000 x 0.04 x 2), and the amount of interest due
with the third installment is $240 ($2,000 x 0.04 x 3). Section 483
shall not apply if the interest payments specified in a contract are at
a rate of at least 4 percent per annum, whether simple or compounded. In
all other cases, for purposes of determining, under section
483(c)(1)(B), whether there is total unstated interest, under a contract
(not involving a purchaser described in section 103), the following
table, which provides for discounting payments at a 4 percent per annum
simple interest rate, shall be used for computing the present value of a
payment to which section 483 applies which is due under the contract,
and the present value of any interest payment due under the contract:
Present Value of Deferred Payment (4 Percent Per Annum Simple Interest)
------------------------------------------------------------------------
Number of months deferred
--------------------------------------------- Present value of $1 at 4%
At least But less than simple interest
------------------------------------------------------------------------
0.................... 6 1.00000
6.................... 9 .98039
9.................... 15 .96154
15................... 21 .94340
21................... 27 .92593
27................... 33 .90909
33................... 39 .89286
39................... 45 .87719
45................... 51 .86207
51................... 57 .84746
57................... 63 .83333
63................... 69 .81967
69................... 75 .80645
75................... 81 .79365
81................... 87 .78125
87................... 93 .76923
93................... 99 .75758
99................... 105 .74627
105.................. 111 .73529
111.................. 117 .72464
117.................. 123 .71429
123.................. 129 .70423
129.................. 135 .69444
135.................. 141 .68493
141.................. 147 .67568
147.................. 153 .66667
153.................. 159 .65789
159.................. 165 .64935
165.................. 171 .64103
171.................. 177 .63291
177.................. 183 .62500
183.................. 189 .61728
189.................. 195 .60976
195.................. 201 .60241
201.................. 207 .59524
207.................. 213 .58824
213.................. 219 .58140
219.................. 225 .57471
225.................. 231 .56818
231.................. 237 .56180
237.................. 243 .55556
243.................. 249 .54945
249.................. 255 .54348
255.................. 261 .53763
261.................. 267 .53191
267.................. 273 .52632
273.................. 279 .52083
279.................. 285 .51546
285.................. 291 .51020
291.................. 297 .50505
297.................. 303 .50000
303.................. 309 .49505
309.................. 315 .49020
315.................. 321 .48544
321.................. 327 .48077
327.................. 333 .47619
333.................. 339 .47170
339.................. 345 .46729
345.................. 351 .46296
351.................. 357 .45872
357.................. 363 .45455
363.................. 369 .45045
369.................. 375 .44643
375.................. 381 .44248
381.................. 387 .43860
387.................. 393 .43478
393.................. 399 .43103
399.................. 405 .42735
405.................. 411 .42373
411.................. 417 .42017
417.................. 423 .41667
423.................. 429 .41322
429.................. 435 .40984
435.................. 441 .40650
441.................. 447 .40323
447.................. 453 .40000
453.................. 459 .39683
459.................. 465 .39370
465.................. 471 .39063
471.................. 477 .38760
477.................. 483 .38462
483.................. 489 .38168
489.................. 495 .37879
495.................. 501 .37594
501.................. 507 .37313
[[Page 275]]
507.................. 513 .37037
513.................. 519 .36765
519.................. 525 .36496
525.................. 531 .36232
531.................. 537 .35971
537.................. 543 .35714
543.................. 549 .35461
549.................. 555 .35211
555.................. 561 .34965
561.................. 567 .34722
567.................. 573 .34483
573.................. 579 .34247
579.................. 585 .34014
585.................. 591 .33784
591.................. 597 .33557
597.................. 603 .33333
603.................. 609 .33113
609.................. 615 .32895
615.................. 621 .32680
621.................. 627 .32468
627.................. 633 .32258
633.................. 639 .32051
639.................. 645 .31847
645.................. 651 .31646
651.................. 657 .31447
657.................. 663 .31250
663.................. 669 .31056
669.................. 675 .30864
675.................. 681 .30675
681.................. 687 .30488
687.................. 693 .30303
693.................. 699 .30120
699.................. 705 .29940
705.................. 711 .29762
711.................. 717 .29586
717.................. 723 .29412
------------------------------------------------------------------------
To compute the present value of a payment, multiply the amount of the
payment by the factor contained in the present value column for the
appropriate number of months the payment is deferred. For example, the
present value of an installment payment of $5,000 due 2 years (24
months) from the date of the sale would be $4,629.65 ($5,000 x 0.92593).
(c) Effective date. The provisions of section 483 and these
temporary regulations shall apply to payments made after December 31,
1963, on account of sales or exchanges of property occurring after June
30, 1963, other than any sale or exchange made pursuant to a binding
written contract (including an irrevocable written option) entered into
before July 1, 1963.
[T.D. 6720, 29 FR 4882, Apr. 7, 1964]
[[Page 276]]
SUBCHAPTER B--ESTATE AND GIFT TAXES
PART 20--ESTATE TAX; ESTATES OF DECEDENTS DYING AFTER AUGUST 16, 1954--Table of Contents
Introduction
Sec.
20.0-1 Introduction.
20.0-2 General description of tax.
Estates of Citizens or Residents
Tax Imposed
20.2001-1 Rate of tax.
20.2002-1 Liability for payment of tax.
Credits Against Tax
20.2011-1 Credit for State death taxes.
20.2011-2 Limitation on credit if a deduction for State death taxes is
allowed under section 2053(d).
20.2012-1 Credit for gift tax.
20.2013-1 Credit for tax on prior transfers.
20.2013-2 ``First limitation''.
20.2013-3 ``Second limitation''.
20.2013-4 Valuation of property transferred.
20.2013-5 ``Property'' and ``transfer'' defined.
20.2013-6 Examples.
20.2014-1 Credit for foreign death taxes.
20.2014-2 ``First limitation''.
20.2014-3 ``Second limitation''.
20.2014-4 Application of credit in cases involving a death tax
convention.
20.2014-5 Proof of credit.
20.2014-6 Period of limitations on credit.
20.2014-7 Limitation on credit if a deduction for foreign death taxes
is allowed under section 2053(d).
20.2015-1 Credit for death taxes on remainders.
20.2016-1 Recovery of death taxes claimed as credit.
Gross Estate
20.2031-0 Table of contents.
20.2031-1 Definition of gross estate; valuation of property.
20.2031-2 Valuation of stocks and bonds.
20.2031-3 Valuation of interests in businesses.
20.2031-4 Valuation of notes.
20.2031-5 Valuation of cash on hand or on deposit.
20.2031-6 Valuation of household and personal effects.
20.2031-7 Valuation of annuities, interests for life or term of years,
and remainder or reversionary interests for estates of
decedents for which the valuation date of the gross estate is
after April 30, 1989.
20.2031-8 Valuation of certain life insurance and annuity contracts;
valuation of shares in an open-end investment company.
20.2031-9 Valuation of other property.
20.2032-1 Alternate valuation.
20.2032A-3 Material participation requirements for valuation of certain
farm and closely-held business real property.
20.2032A-4 Method of valuing farm real property.
20.2032A-8 Election and agreement to have certain property valued under
section 2032A for estate tax purposes.
20.2033-1 Property in which the decedent had an interest.
20.2034-1 Dower or curtesy interests.
20.2036-1 Transfers with retained life estate.
20.2037-1 Transfers taking effect at death.
20.2038-1 Revocable transfers.
20.2039-1 Annuities.
20.2039-1T Limitations and repeal of estate tax exclusion for qualified
plans and individual retirement plans (IRAs) (temporary).
20.2039-2 Annuities under ``qualified plans'' and section 403(b)
annuity contracts.
20.2039-3 Lump sum distributions under ``qualified plans;'' decedents
dying after December 31, 1976, and before January 1, 1979.
20.2039-4 Lump sum distributions from ``qualified plans;'' decedents
dying after December 31, 1978.
20.2039-5 Annuities under individual retirement plans.
20.2040-1 Joint interests.
20.2041-1 Powers of appointment; in general.
20.2041-2 Powers of appointment created on or before October 21, 1942.
20.2041-3 Powers of appointment created after October 21, 1942.
20.2042-1 Proceeds of life insurance.
20.2043-1 Transfers for insufficient consideration.
20.2044-1 Certain property for which marital deduction was previously
allowed.
20.2044-1T Certain property for which marital deduction was
previously allowed (temporary).
20.2044-2 Effective dates.
20.2045-1 Applicability to pre-existing transfers or interests.
20.2046-1 Disclaimed property.
Actuarial Tables Applicable Before May 1, 1989
20.2031-7A Valuation of annuities, interests for life or term of years,
and remainder or reversionary interests for estates of
decedents for which the valuation date of the gross estate is
before May 1, 1989.
Taxable Estate
20.2051-1 Definition of taxable estate.
[[Page 277]]
20.2052-1 Exemption.
20.2053-1 Deductions for expenses, indebtedness, and taxes; in general.
20.2053-2 Deduction for funeral expenses.
20.2053-3 Deduction for expenses of administering estate.
20.2053-4 Deduction for claims against the estate; in general.
20.2053-5 Deductions for charitable, etc., pledges or subscriptions.
20.2053-6 Deduction for taxes.
20.2053-7 Deduction for unpaid mortgages.
20.2053-8 Deduction for expenses in administering property not subject
to claims.
20.2053-9 Deduction for certain State death taxes.
20.2053-10 Deduction for certain foreign death taxes.
20.2054-1 Deduction for losses from casualties or theft.
20.2055-1 Deduction for transfers for public, charitable, and religious
uses; in general.
20.2055-2 Transfers not exclusively for charitable purposes.
20.2055-3 Death taxes payable out of charitable transfers.
20.2055-4 Disallowance of charitable, etc., deductions because of
``prohibited transactions'' in the case of decedents dying
before January 1, 1970.
20.2055-5 Disallowance of charitable, etc., deductions in the case of
decedents dying after December 31, 1969.
20.2055-6 Disallowance of double deduction in the case of qualified
terminable interest property.
20.2056-0 Table of contents.
20.2056(a)-1 Marital deduction; in general.
20.2056(a)-2 Marital deduction; ``deductible interests'' and
``nondeductible interests''.
20.2056(b)-1 Marital deduction; limitation in case of life estate or
other ``terminable interest''.
20.2056(b)-2 Marital deduction; interest in unidentified assets.
20.2056(b)-3 Marital deduction; interest of spouse conditioned on
survival for limited period.
20.2056(b)-4 Marital deduction; valuation of interest passing to
surviving spouse.
20.2056(b)-5 Marital deduction; life estate with power of appointment
in surviving spouse.
20.2056(b)-6 Marital deduction; life insurance or annuity payments with
power of appointment in surviving spouse.
20.2056(b)-7 Election with respect to life estate for surviving spouse.
20.2056(b)-7T Election with respect to life estate for surviving spouse
(temporary).
20.2056(b)-8 Special rule for charitable remainder trusts.
20.2056(b)-9 Denial of double deduction.
20.2056(b)-10 Effective dates.
20.2056(b)-10T Effective dates (temporary).
20.2056(c)-1 Marital deduction; definition of passed from the decedent.
20.2056(c)-2 Marital deduction; definition of passed from the decedent
to his surviving spouse.
20.2056(c)-3 Marital deduction; definition of ``passed from the
decedent to a person other than his surviving spouse''.
20.2056(d)-1 Marital deduction; special rules for marital deduction if
surviving spouse is not a United States citizen.
20.2056(d)-2 Marital deduction; effect of disclaimers of post-December
31, 1976 transfers.
20.2056(d)-3 Marital deduction; effect of disclaimers of pre-January 1,
1977 transfers.
20.2056A-0 Table of contents.
20.2056A-1 Restrictions on allowance of marital deduction if surviving
spouse is not a United States citizen.
20.2056A-2 Requirements for qualified domestic trust.
20.2056A-3 QDOT election.
20.2056A-4 Procedures for conforming marital trusts and nontrust
marital transfers to the requirements of a qualified domestic
trust.
20.2056A-5 Imposition of section 2056A estate tax.
20.2056A-6 Amount of tax.
20.2056A-7 Allowance of prior transfer credit under section 2013.
20.2056A-8 Special rules for joint property.
20.2056A-9 Designated Filer.
20.2056A-10 Surviving spouse becomes citizen after QDOT established.
20.2056A-11 Filing requirements and payment of the section 2056A estate
tax.
20.2056A-12 Increased basis for section 2056A estate tax paid with
respect to distribution from a QDOT.
20.2056A-13 Effective date.
Estates of Nonresidents Not Citizens
20.2101-1 Estates of nonresidents not citizens; tax imposed.
20.2102-1 Estates of nonresidents not citizens; credits against tax.
20.2103-1 Estates of nonresidents not citizens; ``entire gross
estate''.
20.2104-1 Estates of nonresidents not citizens; property within the
United States.
20.2105-1 Estates of nonresidents not citizens; property without the
United States.
20.2106-1 Estates of nonresidents not citizens; taxable estate;
deductions in general.
20.2106-2 Estates of nonresidents not citizens; deductions for
expenses, losses, etc.
20.2107-1 Expatriation to avoid tax.
Miscellaneous
20.2201-1 Members of the Armed Forces dying during an induction period.
20.2202-1 Missionaries in foreign service.
20.2203-1 Definition of executor.
20.2204-1 Discharge of executor from personal liability.
[[Page 278]]
20.2204-2 Discharge of fiduciary other than executor from personal
liability.
20.2204-3 Special rules for estates of decedents dying after December
31, 1976; special lien under section 6324A.
20.2205-1 Reimbursement out of estate.
20.2206-1 Liability of life insurance beneficiaries.
20.2207-1 Liability of recipient of property over which decedent had
power of appointment.
20.2207A-1 Right of recovery of estate taxes in the case of certain
marital deduction property.
20.2207A-2 Effective date.
20.2208-1 Certain residents of possessions considered citizens of the
United States.
20.2209-1 Certain residents of possessions considered nonresidents not
citizens of the United States.
Procedure and Administration
20.6001-1 Persons required to keep records, and render statements.
20.6011-1 General requirement of return, statement, or list.
20.6018-1 Returns.
20.6018-2 Returns; person required to file return.
20.6018-3 Returns; contents of returns.
20.6018-4 Returns; documents to accompany the return.
20.6036-1 Notice of qualification as executor of estate of decedent
dying before 1971.
20.6036-2 Notice of qualification as executor of estate of decedent
dying after 1970.
20.6061-1 Signing of returns and other documents.
20.6065-1 Verification of returns.
20.6071-1 Time for filing preliminary notice required by Sec. 20.6036-
1.
20.6075-1 Returns; time for filing estate tax return.
20.6081-1 Extension of time for filing the return.
20.6091-1 Place for filing returns or other documents.
20.6091-2 Exceptional cases.
20.6151-1 Time and place for paying tax shown on the return.
20.6161-1 Extension of time for paying tax shown on the return.
20.6161-2 Extension of time for paying deficiency in tax.
20.6163-1 Extension of time for payment of estate tax on value of
reversionary or remainder interest in property.
20.6165-1 Bonds where time to pay tax or deficiency has been extended.
20.6166-1 Election of alternate extension of time for payment of estate
tax where estate consists largely of interest in closely held
business.
20.6166A-1 Extension of time for payment of estate tax where estate
consists largely of interest in closely held business.
20.6166A-2 Definition of an interest in a closely held business.
20.6166A-3 Acceleration of payment.
20.6166A-4 Special rules applicable where due date of return was before
September 3, 1958.
20.6314-1 Duplicate receipts for payment of estate taxes.
20.6321 Statutory provisions; lien for taxes.
20.6321-1 Lien for taxes.
20.6323-1 Validity and priority against certain persons.
20.6324-1 Special lien for estate tax.
20.6324A-1 Special lien for estate tax deferred under section 6166 or
6166A.
20.6324B-1 Special lien for additional estate tax attributable to farm,
etc., valuation.
20.6325-1 Release of lien or partial discharge of property; transfer
certificates in nonresident estates.
20.6601-1 Interest on underpayment, nonpayment, or extensions of time
for payment, of tax.
20.6905-1 Discharge of executor from personal liability for decedent's
income and gift taxes.
20.7101-1 Form of bonds.
General Actuarial Valuations
20.7520-1 Valuation of annuities, unitrust interests, interests for
life or term of years, and remainder or reversionary
interests.
20.7520-2 Valuation of charitable interests.
20.7520-3 Limitation on the application of section 7520.
20.7520-4 Transitional rules.
Authority: 26 U.S.C. 7805.
Section 20.2031-7 also issued under 26 U.S.C. 7520(c)(2).
Section 20.2031-7A also issued under 26 U.S.C. 7520(c)(2).
Section 20.7520-1 also issued under 26 U.S.C. 7520(c)(2).
Section 20.7520-2 also issued under 26 U.S.C. 7520(c)(2).
Section 20.7520-3 also issued under 26 U.S.C. 7520(c)(2).
Section 20.7520-4 also issued under 26 U.S.C. 7520(c)(2).
Source: T.D. 6296, 23 FR 4529, June 24, 1958; 25 FR 14021, Dec. 31,
1960, unless otherwise noted.
Introduction
Sec. 20.0-1 Introduction.
(a) In general. (1) The regulations in this part (part 20,
subchapter B, chapter I, title 26, Code of Federal Regulations) are
designated ``Estate Tax Regulations.'' These regulations pertain to (i)
the Federal estate tax imposed by chapter 11 of subtitle B of the
Internal
[[Page 279]]
Revenue Code on the transfer of estates of decedents dying after August
16, 1954, and (ii) certain related administrative provisions of subtitle
F of the Code. It should be noted that the application of many of the
provisions of these regulations may be affected by the provisions of an
applicable death tax convention with a foreign country. Unless otherwise
indicated, references in the regulations to the ``Internal Revenue
Code'' or the ``Code'' are references to the Internal Revenue Code of
1954, as amended, and references to a section or other provision of law
are references to a section or other provision of the Internal Revenue
Code of 1954, as amended. Unless otherwise provided, the Estate Tax
Regulations are applicable to the estates of decedents dying after
August 16, 1954, and supersede the regulations contained in part 81,
subchapter B, chapter I, title 26, Code of Federal Regulations (1939)
(Regulations 105, Estate Tax), as prescribed and made applicable to the
Internal Revenue Code of 1954 by Treasury Decision 6091, signed August
16, 1954 (19 FR 5167, Aug. 17, 1954). The regulations in this part do
not reflect the amendments made by the Foreign Investors Tax Act of 1966
(80 Stat. 1539).
(2) Section 2208 makes the provisions of chapter 11 of the Code
apply to the transfer of the estates of certain decedents dying after
September 2, 1958, who were citizens of the United States and residents
of a possession thereof at the time of death. Section 2209 makes the
provisions of chapter 11 apply to the transfer of the estates of certain
other decedents dying after September 14, 1960, who were citizens of the
United States and residents of a possession thereof at the time of
death. See Secs. 20.2208-1 and 20.2209-1. Except as otherwise provided
in Secs. 20.2208-1 and 20.2209-1, the provisions of these regulations do
not apply to the estates of such decedents.
(b) Scope of regulations--(1) Estates of citizens or residents.
Subchapter A of Chapter 11 of the Code pertains to the taxation of the
estate of a person who was a citizen or a resident of the United States
at the time of his death. A ``resident'' decedent is a decedent who, at
the time of his death, had his domicile in the United States. The term
``United States'', as used in the estate tax regulations, includes only
the States and the District of Columbia. The term also includes the
Territories of Alaska and Hawaii prior to their admission as States. See
section 7701(a)(9). A person acquires a domicile in a place by living
there, for even a brief period of time, with no definite present
intention of later removing therefrom. Residence without the requisite
intention to remain indefinitely will not suffice to constitute
domicile, nor will intention to change domicile effect such a change
unless accompanied by actual removal. For the meaning of the term
``citizen of the United States'' as applied in a case where the decedent
was a resident of a possession of the United States, see Sec. 20.2208-1.
The regulations pursuant to subchapter A are set forth in Secs. 20.2001-
1 to 20.2056(d)-1.
(2) Estates of nonresidents not citizens. Subchapter B of Chapter 11
of the Code pertains to the taxation of the estate of a person who was a
nonresident not a citizen of the United States at the time of his death.
A ``nonresident'' decedent is a decedent who, at the time of his death,
had his domicile outside the United States under the principles set
forth in subparagraph (1) of this paragraph. (See, however, section 2202
with respect to missionaries in foreign service.) The regulations
pursuant to subchapter B are set forth in Secs. 20.2101-1 to 20.2107-1.
(3) Miscellaneous substantive provisions. Subchapter C of Chapter 11
of the Code contains a number of miscellaneous substantive provisions.
The regulations pursuant to subchapter C are set forth in Secs. 20.2201-
1 to 20.2209-1.
(4) Procedure and administration provisions. Subtitle F of the
Internal Revenue Code contains some sections which are applicable to the
Federal estate tax. The regulations pursuant to those sections are set
forth in Secs. 20.6001-1 to 20.7101-1. Such regulations do not purport
to be all the regulations on procedure and administration which are
pertinent to estate tax matters. For the remainder of the regulations on
procedure and administration which are pertinent to estate tax matters,
see part 301 (Regulations on Procedure and Administration) of this
chapter.
[[Page 280]]
(c) Arrangement and numbering. Each section of the regulations in
this part (other than this section and Sec. 20.0-2) is designated by a
number composed of the part number followed by a decimal point (20.);
the section of the Internal Revenue Code which it interprets; a hyphen
(-); and a number identifying the section. By use of these designations
one can ascertain the sections of the regulations relating to a
provision of the Code. For example, the regulations pertaining to
section 2012 of the Code are designated Sec. 20.2012-1.
[T.D. 6296, 23 FR 4529, June 24, 1958, as amended by T.D. 6526, 26 FR
414, Jan. 19, 1961; T.D. 7238, 37 FR 28717, Dec. 29, 1972; T.D. 7296, 38
FR 34191, Dec. 12, 1973; T.D. 7665, 45 FR 6089, Jan. 25, 1980; T.D.
8522, 59 FR 9646, Mar. 1, 1994]
Sec. 20.0-2 General description of tax.
(a) Nature of tax. The Federal estate tax is neither a property tax
nor an inheritance tax. It is a tax imposed upon the transfer of the
entire taxable estate and not upon any particular legacy, devise, or
distributive share. Escheat of a decedent's property to the State for
lack of heirs is a transfer which causes the property to be included in
the decedent's gross estate.
(b) Method of determining tax; estate of citizen or resident--(1) In
general. Subparagraphs (2) to (5) of this paragraph contain a general
description of the method to be used in determining the Federal estate
tax imposed upon the transfer of the estate of a decedent who was a
citizen or resident of the United States at the time of his death.
(2) Gross estate. The first step in determining the tax is to
ascertain the total value of the decedent's gross estate. The value of
the gross estate includes the value of all property to the extent of the
interest therein of the decedent at the time of his death. (For certain
exceptions in the case of real property situated outside the United
States, see paragraphs (a) and (c) of Sec. 20.2031-1.) In addition, the
gross estate may include property in which the decedent did not have an
interest at the time of his death. A decedent's gross estate for Federal
estate tax purposes may therefore be very different from the same
decedent's estate for local probate purposes. Examples of items which
may be included in a decedent's gross estate and not in his probate
estate are the following: certain property transferred by the decedent
during his lifetime without adequate consideration; property held
jointly by the decedent and others; property over which the decedent had
a general power of appointment; proceeds of certain policies of
insurance on the decedent's life; annuities; and dower or curtesy of a
surviving spouse or a statutory estate in lieu thereof. For a detailed
explanation of the method of ascertaining the value of the gross estate,
see sections 2031 through 2044, and the regulations thereunder.
(3) Taxable estate. The second step in determining the tax is to
ascertain the value of the decedent's taxable estate. The value of the
taxable estate is determined by subtracting from the value of the gross
estate the authorized exemption and deductions. Under various conditions
and limitations, deductions are allowable for expenses, indebtedness,
taxes, losses, charitable transfers, and transfers to a surviving
spouse. For a detailed explanation of the method of ascertaining the
value of the taxable estate, see sections 2051 through 2056, and the
regulations thereunder.
(4) Gross estate tax. The third step is the determination of the
gross estate tax. This is accomplished by the application of certain
rates to the value of the decedent's taxable estate. In this connection,
see section 2001 and the regulations thereunder.
(5) Net estate tax payable. The final step is the determination of
the net estate tax payable. This is done by subtracting from the gross
estate tax the authorized credits against tax. Under certain conditions
and limitations, credits are allowable for the following (computed in
the order stated below):
(i) State death taxes paid in connection with the decedent's estate
(section 2011);
(ii) Gift taxes paid on inter-vivos transfers by the decedent of
property included in his gross estate (section 2012);
(iii) Foreign death taxes paid in connection with the decedent's
estate (section 2014); and
[[Page 281]]
(iv) Federal estate taxes paid on transfers of property to the
decedent (section 2013).
Sections 25.2701-5 and 25.2702-6 of this chapter contain rules that
provide additional adjustments to mitigate double taxation in cases
where the amount of the decedent's gift was previously determined under
the special valuation provisions of sections 2701 and 2702. For a
detailed explanation of the credits against tax, see sections 201l
through 2016 and the regulations thereunder.
(c) Method of determining tax; estate of nonresident not a citizen.
In general, the method to be used in determining the Federal estate tax
imposed upon the transfer of an estate of a decedent who was a
nonresident not a citizen of the United States is similar to that
described in paragraph (b) of this section with respect to the estate of
a citizen or resident. Briefly stated, the steps are as follows: First,
ascertain the sum of the value of that part of the decedent's ``entire
gross estate'' which at the time of his death was situated in the United
States (see Secs. 20.2103-1 and 20.2014-1) and, in the case of an estate
of an expatriate to which section 2107 applies, any amounts includible
in his gross estate under section 2107(b) (see paragraph (b) of
Sec. 20.2107-1); second, determine the value of the taxable estate by
subtracting from the amount determined under the first step the amount
of the allowable deductions (see Sec. 20.2106-1); third, compute the
gross estate tax on the taxable estate (see Sec. 20.2106-1); and fourth,
subtract from the gross estate tax the total amount of any allowable
credits in order to arrive at the net estate tax payable (see
Sec. 20.2102-1 and paragraph (c) of Sec. 20.2107-1).
[T.D. 6296, 23 FR 4529, June 24, 1958, as amended by T.D. 6684, 28 FR
11408, Oct. 24, 1963; T.D. 7296, 38 FR 34191, Dec. 12, 1973; T.D. 8395,
57 FR 4254, Feb. 4, 1992]
Estates of Citizens or Residents
Tax Imposed--Table of Contents
Sec. 20.2001-1 Rate of tax.
(a) The gross estate tax is computed by the application of
progressively graduated rates to the value of the decedent's taxable
estate in accordance with the following table:
Table for Computation of Gross Estate Tax
------------------------------------------------------------------------
(D)--Rate of
(A)--Taxable (C)--Tax on tax on excess
estate equal to or (B)--Taxable amount in over amount in
more than-- estate less than-- column (A) column (A)
(percent)
------------------------------------------------------------------------
$5,000 ............... 3
$5,000............ 10,000 $150 7
10,000............ 20,000 500 11
20,000............ 30,000 1,600 14
30,000............ 40,000 3,000 18
40,000............ 50,000 4,800 22
50,000............ 60,000 7,000 25
60,000............ 100,000 9,500 28
100,000........... 250,000 20,700 30
250,000........... 500,000 65,700 32
500,000........... 750,000 145,700 35
750,000........... 1,000,000 233,200 37
1,000,000......... 1,250,000 325,700 39
1,250,000......... 1,500,000 423,200 42
1,500,000......... 2,000,000 528,200 45
2,000,000......... 2,500,000 753,200 49
2,500,000......... 3,000,000 998,200 53
3,000,000......... 3,500,000 1,263,200 56
3,500,000......... 4,000,000 1,543,200 59
4,000,000......... 5,000,000 1,838,200 63
5,000,000......... 6,000,000 2,468,200 67
6,000,000......... 7,000,000 3,138,200 70
7,000,000......... 8,000,000 3,838,200 73
8,000,000......... 10,000,000 4,568,200 76
10,000,000........ .................. 6,088,200 77
------------------------------------------------------------------------
(b) The application of the table may be illustrated by the following
example:
Example. The decedent died January 1, 1955, having a gross estate of
$600,000. The exemption and authorized deductions amount to $75,000,
thus leaving a taxable estate of $525,000. Reference to the table
discloses that the specified amount in column (A) nearest to and less
than the value of the decedent's taxable estate is $500,000. The tax
upon this amount as indicated in column (C), is $145,700. The amount by
which the taxable estate exceeds the same specified amount is $25,000.
The tax upon this amount, computed at the rate of 35 percent indicated
in column (D), is $8,750. Thus the total gross estate tax upon a taxable
estate of $525,000 is $154,450. From this amount, the credits authorized
by sections 2011 through 2014 are subtracted in order to determine the
net estate tax payable.
Sec. 20.2002-1 Liability for payment of tax.
The Federal estate tax imposed both with respect to the estates of
citizens or residents and with respect to estates of nonresidents not
citizens is payable by the executor or administrator of the
[[Page 282]]
decedent's estate. This duty applies to the entire tax, regardless of
the fact that the gross estate consists in part of property which does
not come within the possession of the executor or administrator. If
there is no executor or administrator appointed, qualified and acting in
the United States, any person in actual or constructive possession of
any property of the decedent is required to pay the entire tax to the
extent of the value of the property in his possession. See section 2203,
defining the term ``executor''. The personal liability of the executor
or such other person is described in section 3467 of the Revised
Statutes (31 U.S.C. 192) as follows:
Every executor, administrator, or assignee, or other person, who
pays, in whole or in part, any debt due by the person or estate for whom
or for which he acts before he satisfies and pays the debts due to the
United States from such person or estate, shall become answerable in his
own person and estate to the extent of such payments for the debts so
due to the United States, or for so much thereof as may remain due and
unpaid.
As used in said section, the word ``debt'' includes a beneficiary's
distributive share of an estate. Thus, if the executor pays a debt due
by the decedent's estate or distributes any portion of the estate before
all the estate tax is paid, he is personally liable, to the extent of
the payment or distribution, for so much of the estate tax as remains
due and unpaid. In addition, section 6324(a)(2) provides that if the
estate tax is not paid when due, then the spouse, transferee, trustee
(except the trustee of an employee's trust which meets the requirements
of section 401(a)), surviving tenant, person in possession of the
property by reason of the exercise, nonexercise, or release of a power
of appointment, or beneficiary, who receives, or has on the date of the
decedent's death, property included in the gross estate under section
2034 through 2042, is personally liable for the tax to the extent of the
value, at the time of the decedent's death, of such property. See also
the following related sections of the Internal Revenue Code: Section
2204, discharge of executor from personal liability; section 2205,
reimbursement out of estate; sections 2206 and 2207, liability of life
insurance beneficiaries and recipients of property over which decedent
had power of appointment; sections 6321 through 6325, concerning liens
for taxes; and section 6901(a)(1), concerning the liabilities of
transferees and fiduciaries.
Credits Against Tax
Sec. 20.2011-1 Credit for State death taxes.
(a) In general. A credit is allowed under section 2011 against the
Federal estate tax for estate, inheritance, legacy or succession taxes
actually paid to any State, Territory, or the District of Columbia, or,
in the case of decedents dying before September 3, 1958, any possession
of the United States (hereinafter referred to as ``State death taxes'').
The credit, however, is allowed only for State death taxes paid (1) with
respect to property included in the decedent's gross estate, and (2)
with respect to the decedent's estate. The amount of the credit is
subject to the limitation described in paragraph (b) of this section. It
is subject to further limitations described in Sec. 20.2011-2 if a
deduction is allowed under section 2053(d) for State death taxes paid
with respect to a charitable gift. See paragraph (a) of Sec. 20.2014-1
as to the allowance of a credit for death taxes paid to a possession of
the United States in a case where the decedent died after September 2,
1958.
(b) Amount of credit. (1) If the decedent's taxable estate does not
exceed $40,000, the credit for State death taxes is zero. If the
decedent's taxable estate does exceed $40,000, the credit for State
death taxes is limited to an amount computed in accordance with the
following table:
Table for Computation of Maximum Credit for State Death Taxes
------------------------------------------------------------------------
(D)--Rates of
credit on
(A)--Taxable (B)--Taxable (C)--Credit on excess over
estate equal to or estate less than-- amount in column amount in
more than-- (A) column (A)
(percent)
------------------------------------------------------------------------
$40,000........... $90,000 ................ 0.8
90,000............ 140,000 $400 1.6
140,000........... 240,000 1,200 2.4
240,000........... 440,000 3,600 3.2
440,000........... 640,000 10,000 4.0
640,000........... 840,000 18,000 4.8
840,000........... 1,040,000 27,600 5.6
[[Page 283]]
1,040,000......... 1,540,000 38,800 6.4
1,540,000......... 2,040,000 70,800 7.2
2,040,000......... 2,540,000 106,800 8.0
2,540,000......... 3,040,000 146,800 8.8
3,040,000......... 3,540,000 190,800 9.6
3,540,000......... 4,040,000 238,800 10.4
4,040,000......... 5,040,000 290,800 11.2
5,040,000......... 6,040,000 402,800 12.0
6,040,000......... 7,040,000 522,800 12.8
7,040,000......... 8,040,000 650,800 13.6
8,040,000......... 9,040,000 786,800 14.4
9,040,000......... 10,040,000 930,800 15.2
10,040,000........ ................. 1,082,800 16.0
------------------------------------------------------------------------
(2) Subparagraph (1) of this paragraph may be illustrated by the
following example:
Example. (i) The decedent died January 1, 1955, leaving a taxable
estate of $150,000. On January 1, 1956, inheritance taxes totaling
$2,500 were actually paid to a State with respect to property included
in the decedent's gross estate. Reference to the table discloses that
the specified amount in column (A) nearest to but less than the value of
the decedent's taxable estate is $140,000. The maximum credit in respect
of this amount, as indicated in column (C), is $1,200. The amount by
which the taxable estate exceeds the same specified amount is $10,000.
The maximum credit in respect of this amount, computed at the rate of
2.4 percent indicated in column (D), is $240. Thus, the maximum credit
in respect of the decedent's taxable estate of $150,000 is $1,440, even
though $2,500 in inheritance taxes was actually paid to the State.
(ii) If, in subdivision (i) of this example, the amount actually
paid to the State was $950, the credit for State death taxes would be
limited to $950. If, in subdivision (i) of this example, the decedent's
taxable estate was $35,000, no credit for State death taxes would be
allowed.
(c) Miscellaneous limitations and conditions to credit--(1) Period
of limitations. The credit for State death taxes is limited under
section 2011(c) to those taxes which were actually paid and for which a
credit was claimed within four years after the filing of the estate tax
return for the decedent's estate. If, however, a petition has been filed
with the Tax Court of the United States for the redetermination of a
deficiency within the time prescribed in section 6213(a), the credit is
limited to those taxes which were actually paid and for which a credit
was claimed within four years after the filing of the return or within
60 days after the decision of the Tax Court becomes final, whichever
period is the last to expire. Similarly, if an extension of time has
been granted under section 6161 for payment of the tax shown on the
return, or of a deficiency, the credit is limited to those taxes which
were actually paid and for which a credit was claimed within four years
after the filing of the return, or before the date of the expiration of
the period of the extension, whichever period is last to expire. If a
claim for refund or credit of an overpayment of the Federal estate tax
is filed within the time prescribed in section 6511, the credit for
State death taxes is limited to such taxes as were actually paid and
credit therefor claimed within four years after the filing of the return
or before the expiration of 60 days from the date of mailing by
certified or registered mail by the district director to the taxpayer of
a notice of disallowance of any part of the claim, or before the
expiration of 60 days after a decision by any court of competent
jurisdiction becomes final with respect to a timely suit instituted upon
the claim, whichever period is the last to expire. See section 2015 for
the applicable period of limitations for credit for State death taxes on
reversionary or remainder interests if an election is made under section
6163(a) to postpone payment of the estate tax attributable to
reversionary or remainder interests. If a claim for refund based on the
credit for State death taxes is filed within the applicable period
described in this subparagraph, a refund may be made despite the general
limitation provisions of sections 6511 and 6512. Any refund based on the
credit described in this section shall be made without interest.
(2) Submission of evidence. Before the credit for State death taxes
is allowed, evidence that such taxes have been paid must be submitted to
the district director. The district director may require the submission
of a certificate from the proper officer of the taxing State, Territory,
or possession of the United States, or the District of Columbia,
showing: (i) The total amount of tax imposed (before adding interest
[[Page 284]]
and penalties and before allowing discount); (ii) the amount of any
discount allowed; (iii) the amount of any penalties and interest imposed
or charged; (iv) the total amount actually paid in cash; and (v) the
date or dates of payment. If the amount of these taxes has been
redetermined, the amount finally determined should be stated. The
required evidence should be filed with the return, but if that is not
convenient or possible, then it should be submitted as soon thereafter
as practicable. The district director may require the submission of such
additional proof as is deemed necessary to establish the right to the
credit. For example, he may require the submission of a certificate of
the proper officer of the taxing jurisdiction showing (vi) whether a
claim for refund of any part of the State death tax is pending and (vii)
whether a refund of any part thereof has been authorized, and if a
refund has been made, its date and amount, and a description of the
property or interest in respect of which the refund was made. The
district director may also require an itemized list of the property in
respect of which State death taxes were imposed certified by the officer
having custody of the records pertaining to those taxes. In addition, he
may require the executor to submit a written statement (containing a
declaration that it is made under penalties of perjury) stating whether,
to his knowledge, any person has instituted litigation or taken an
appeal (or contemplates doing so), the final determination of which may
affect the amount of those taxes. See section 2016 concerning the
redetermination of the estate tax if State death taxes claimed as credit
are refunded.
(d) Definition of ``basic estate tax''. Section 2011(d) provides
definitions of the terms ``basic estate tax'' and ``additional estate
tax'', used in the Internal Revenue Code of 1939, and ``estate tax
imposed by the Revenue Act of 1926'', for the purpose of supplying a
means of computing State death taxes under local statutes using those
terms, and for use in determining the exemption provided for in section
2201 for estates of certain members of the Armed Forces. See section
2011(e)(3) for a modification of these definitions if a deduction is
allowed under section 2053(d) for State death taxes paid with respect to
a charitable gift.
[T.D. 6296, 23 FR 4529, June 24, 1958, as amended by T.D. 6526, 26 FR
414, Jan. 19, 1961]
Sec. 20.2011-2 Limitation on credit if a deduction for State death taxes is allowed under section 2053(d).
If a deduction is allowed under section 2053(d) for State death
taxes paid with respect to a charitable gift, the credit for State death
taxes is subject to special limitations. Under these limitations, the
credit cannot exceed the least of the following:
(a) The amount of State death taxes paid other than those for which
a deduction is allowed under section 2053(d);
(b) The amount indicated in section 2011(b) to be the maximum credit
allowable with respect to the decedent's taxable estate; or
(c) An amount, A, which bears the same ratio to B (the amount which
would be the maximum credit allowable under section 2011(b) if the
deduction under section 2053(d) for State death taxes were not allowed
in computing the decedent's taxable estate) as C (the amount of State
death taxes paid other than those for which a deduction is allowed under
section 2053(d)) bears to D (the total amount of State death taxes
paid). For the purpose of this computation, in determining what the
decedent's taxable estate would be if the deduction for State death
taxes under section 2053(d) were not allowed, adjustment must be made
for the decrease in the deduction for charitable gifts under section
2055 or 2106(a)(2) (for estates of nonresidents not citizens) by reason
of any increase in Federal estate tax which would be charged against the
charitable gifts.
The application of this section may be illustrated by the following
example:
Example. The decedent died January 1, 1955, leaving a gross estate
of $925,000. Expenses, indebtedness, etc., amounted to $25,000. The
decedent bequeathed $400,000 to his son with the direction that the son
bear the State death taxes on the bequest. The residuary estate was left
to a charitable organization. Except as noted above, all Federal and
State death taxes were payable out of the residuary estate. The State
imposed death taxes of $60,000 on the son's bequest and death taxes
[[Page 285]]
of $75,000 on the bequest to charity. No death taxes were imposed by a
foreign country with respect to any property in the gross estate. The
decedent's taxable estate (determined without regard to the limitation
imposed by section 2011(e)(2)(B) is computed as follows:
Gross estate................................................ ........... ........... ........... $925,000.00
Expenses, indebtedness, etc................................. ........... ........... $25,000.00
Exemption................................................... ........... ........... 60,000.00
Deduction under section 2053(d)............................. ........... ........... 75,000.00
Charitable deduction:
Gross estate.............................................. ........... $925,000.00
Expenses, etc............................................. $25,000.00
Bequest to son............................................ 400,000.00
State death tax paid from residue......................... 75,000.00
Federal estate tax paid from residue...................... 122,916.67 622,916.67 302,083.33 462,083.33
---------------------------------------------------
Taxable estate.............................................. ........... ........... ........... 462,916.67
============
Gross estate................................................ ........... ........... ........... $925,000.00
Expenses, indebtedness, etc................................. ........... ........... $25,000.00
Exemption................................................... ........... ........... 60,000.00
Charitable deduction:
Gross estate.............................................. ........... $925,000.00
Expenses, etc............................................. $25,000.00
Bequest to son............................................ 400,000.00
State death tax paid from residue......................... 75,000.00
Federal estate tax paid from residue...................... 155,000.00 655,000.00 270,000.00 355,000.00
---------------------------------------------------
Taxable estate.............................................. ........... ........... ........... 570,000.00
============
(1) Amount of State death taxes paid other than those for
which a deduction is allowed under section 2053(d)
($135,000-$75,000)........................................ $60,000.00
(2) Amount indicated in section 2011(b) to be the maximum
credit allowable with respect to the decedent's taxable
estate of $462,916.67..................................... 10,916.67
(3) Amount determined by use of the ratio described in
paragraph (c) above [($60,000 $135,000) x
$15,200].................................................. 6,755.56
(4) Credit for State death taxes (least of subparagraphs
(1) through (3) above).................................... 6,755.56
[T.D. 6296, 23 FR 4529, June 24, 1958, as amended by T.D. 6600, 27 FR
4983, May 29, 1962]
Sec. 20.2012-1 Credit for gift tax.
(a) In general. With respect to gifts made before 1977, a credit is
allowed under section 2012 against the Federal estate tax for gift tax
paid under chapter 12 of the Internal Revenue Code, or corresponding
provisions of prior law, on a gift by the decedent of property
subsequently included in the decedent's gross estate. The credit is
allowable even though the gift tax is paid after the decedent's death
and the amount of the gift tax is deductible from the gross estate as a
debt of the decedent.
(b) Limitations on credit. The credit for gift tax is limited to the
smaller of the following amounts:
(1) The amount of gift tax paid on the gift computed as set forth in
paragraph (c) of this section, or
(2) The amount of the estate tax attributable to the inclusion of
the gift in the gross estate, computed as set forth in paragraph (d) of
this section.
When more than one gift is included in the gross estate, a separate
computation of the two limitations on the credit is to be made for each
gift.
(c) ``First limitation''. The amount of the gift tax paid on the
gift is the ``first limitation''. Thus, if only one gift was made during
a certain calendar quarter, or calendar year if the gift was made before
January 1, 1971, and the gift is wholly included in the decedent's gross
estate for the purpose
[[Page 286]]
of the estate tax, the credit with respect to the gift is limited to the
amount of the gift tax paid for that calendar quarter or calendar year.
On the other hand, if more than one gift was made during a certain
calendar quarter or calendar year, the credit with respect to any such
gift which is included in the decedent's gross estate is limited under
section 2012(d) to an amount, A, which bears the same ratio to B (the
total gift tax paid for that calendar quarter or calendar year) as C
(the ``amount of the gift,'' computed as described below) bears to D
(the total taxable gifts for the calendar quarter or the calendar year,
computed without deduction of the gift tax specific exemption). Stated
algebraically, the ``first limitation'' (A) equals:
``Amount of the gift'' (C) Total taxable gifts, plus specific
exemption allowed (D) x Total gift tax paid (B).
For purposes of the ratio stated above, the ``amount of the gift''
referred to as factor ``C'' is the value of the gift reduced by any
portion excluded or deducted under sections 2503(b) (annual exclusion),
2522 (charitable deduction), or 2523 (marital deduction) of the Internal
Revenue Code or corresponding provisions of prior law. In making the
computations described in this paragraph, the values to be used are
those finally determined for the purpose of the gift tax, irrespective
of the values determined for the purpose of the estate tax. A similar
computation is made in case only a portion of any gift is included in
the decedent's gross estate. The application of this paragraph may be
illustrated by the following example:
Example. The donor made gifts during the calendar year 1955 on which
a gift tax was determined as shown below:
Gift of property to son on February 1......................... $13,000
Gift of property to wife on May 1................... 86,000
Gift of property to charitable organization on May
15................................................. 10,000
-----------
Total gifts....................................... 109,000
Less exclusions ($3,000 for each gift).............. 9,000
-----------
Total included amount of gifts.................... 100,000
Marital deduction (for gift to wife)................ $43,000
Charitable deduction................................ 7,000
Specific exemption ($30,000 less $20,000 used in
prior years)....................................... 10,000
----------
Total deductions............................................ 60,000
-----------
Taxable gifts..................................... 40,000
Total gift tax paid for calendar year 1955.......... 3,600
The donor's gift to his wife was made in contemplation of death and was
thereafter included in his gross estate. Under the ``first limitation'',
the credit with respect to that gift cannot exceed:
[$86,000 - $3,000 - $43,000 (gift to wife, less annual exclusion and
marital deduction)] [$40,000 + $10,000 (taxable
gifts, plus specific exemption allowed)] x $3,600 (total
gift tax paid) = $2,880.
(d) ``Second limitation''. (1) The amount of the estate tax
attributable to the inclusion of the gift in the gross estate is the
``second limitation''. Thus, the credit with respect to any gift of
property included in the gross estate is limited to an amount, E, which
bears the same ratio to F (the gross estate tax, reduced by any credit
for State death taxes under section 2011) as G (the ``value of the
gift'', computed as described in subparagraph (2) of this paragraph)
bears to H (the value of entire gross estate, reduced by the total
deductions allowed under sections 2055 or 2106(a)(2) (charitable
deduction) and 2056 (marital deduction)). Stated algebraically, the
``second limitation'' (E) equals:
``Value of the gift'' (G) Value of gross estate, less marital
and charitable deductions (H) x Gross estate tax, less credit for
State death taxes (F).
(2) For purposes of the ratio stated in subparagraph (1) of this
paragraph, the ``value of the gift'' referred to as factor ``G'' is the
value of the property transferred by gift and included in the gross
estate, as determined for the purpose of the gift tax or for the purpose
of the estate tax, whichever is lower, and adjusted as follows:
(i) The appropriate value is reduced by all or a portion of any
annual exclusion allowed for gift tax purposes under section 2503(b) of
the Internal Revenue Code or corresponding provisions of prior law. If
the gift tax value is lower than the estate tax value, it is reduced by
the entire amount of the exclusion. If the estate tax value is lower
than the gift tax value, it is reduced by an amount which bears the same
ratio to the estate tax value as the annual exclusion bears to the total
value of the
[[Page 287]]
property as determined for gift tax purposes. To illustrate: In 1955, a
donor, in contemplation of death, transferred certain property to his
five children which was valued at $300,000, for the purpose of the gift
tax. Thereafter, the same property was included in his gross estate at a
value of $270,000. In computing his gift tax, the donor was allowed
annual exclusions totalling $15,000. The reduction provided for in this
subdivision is:
$15,000 (annual exclusions allowed) $300,000 (value of
transferred property for the purpose of the gift tax) x $270,000
(value of transferred property for the purpose of the estate tax) =
$13,500.
(ii) The appropriate value is further reduced if any portion of the
value of the property is allowed as a marital deduction under section
2056 or as a charitable deduction under section 2055 or section
2106(a)(2) (for estates of nonresidents not citizens). The amount of the
reduction is an amount which bears the same ratio to the value
determined under subdivision (i) of this subparagraph as the portion of
the property allowed as a marital deduction or as a charitable deduction
bears to the total value of the property as determined for the purpose
of the estate tax. Thus, if a gift is made solely to the decedent's
surviving spouse and is subsequently included in the decedent's gross
estate as having been made in contemplation of death, but a marital
deduction is allowed under section 2056 for the full value of the gift,
no credit for gift tax on the gift will be allowed since the reduction
under this subdivision together with the reduction under subdivision (i)
of this subparagraph will have the effect of reducing the factor ``G''
of the ratio in subparagraph (1) of this paragraph to zero.
(e) Credit for ``split gifts''. If a decedent made a gift of
property which is thereafter included in his gross estate, and, under
the provisions of section 2513 of the Internal Revenue Code of 1954 or
section 1000(f) of the Internal Revenue Code of 1939, the gift was
considered as made one-half by the decedent and one-half by his spouse,
credit against the estate tax is allowed for the gift tax paid with
respect to both halves of the gift. The ``first limitation'' is to be
separately computed with respect to each half of the gift in accordance
with the principles stated in paragraph (c) of this section. The
``second limitation'' is to be computed with respect to the entire gift
in accordance with the principles stated in paragraph (d) of this
section. To illustrate: A donor, in contemplation of death, transferred
property valued at $106,000 to his son on January 1, 1955, and he and
his wife consented that the gift should be considered as made one-half
by him and one-half by her. The property was thereafter included in the
donor's gross estate. Under the ``first limitation'', the amount of the
gift tax of the donor paid with respect to the one-half of the gift
considered as made by him is determined to be $11,250, and the amount of
the gift tax of his wife paid with respect to the one-half of the gift
considered as made by her is determined to be $1,200. Under the ``second
limitation'', the amount of the estate tax attributable to the property
is determined to be $28,914. Therefore, the credit for gift tax allowed
is $12,450 ($11,250 plus $1,200).
[T.D. 6296, 23 FR 4529, June 24, 1958, as amended by T.D. 7238, 37 FR
28718, Dec. 29, 1972; T.D. 8522, 59 FR 9646, Mar. 1, 1994]
Sec. 20.2013-1 Credit for tax on prior transfers.
(a) In general. A credit is allowed under section 2013 against the
Federal estate tax imposed on the present decedent's estate for Federal
estate tax paid on the transfer of property to the present decedent from
a transferor who died within ten years before, or within two years
after, the present decedent's death. See Sec. 20.2013-5 for definition
of the terms ``property'' and ``transfer''. There is no requirement that
the transferred property be identified in the estate of the present
decedent or that the property be in existence at the time of the
decedent's death. It is sufficient that the transfer of the property was
subjected to Federal estate tax in the estate of the transferor and that
the transferor died within the prescribed period of time. The executor
must submit such proof as may be requested by the district director in
order to establish the right of the estate to the credit.
[[Page 288]]
(b) Limitations on credit. The credit for tax on prior transfers is
limited to the smaller of the following amounts:
(1) The amount of the Federal estate tax attributable to the
transferred property in the transferor's estate, computed as set forth
in Sec. 20.2013-2; or
(2) The amount of the Federal estate tax attributable to the
transferred property in the decedent's estate, computed as set forth in
Sec. 20.2013-3.
Rules for valuing property for purposes of the credit are contained in
Sec. 20.2013-4.
(c) Percentage reduction. If the transferor died within the two
years before, or within the two years after, the present decedent's
death, the credit is the smaller of the two limitations described in
paragraph (b) of this section. If the transferor predeceased the present
decedent by more than two years, the credit is a certain percentage of
the smaller of the two limitations described in paragraph (b) of this
section, determined as follows:
(1) 80 percent, if the transferor died within the third or fourth
years preceding the present decedent's death;
(2) 40 percent, if the transferor died within the fifth or sixth
years preceding the present decedent's death;
(3) 40 percent, if the transferor died within the seventh or eighth
years preceding the present decedent's death; and
(4) 20 percent, if the transferor died within the ninth or tenth
years preceding the present decedent's death.
The word ``within'' as used in this paragraph means ``during''.
Therefore, if a death occurs on the second anniversary of another death,
the first death is considered to have occurred within the two years
before the second death. If the credit for tax on prior transfers
relates to property received from two or more transferors, the
provisions of this paragraph are to be applied separately with respect
to the property received from each transferor. See paragraph (d) of
example (2) in Sec. 20.2013-6.
(d) Examples. For illustrations of the application of this section,
see examples (1) and (2) set forth in Sec. 20.2013-6.
Sec. 20.2013-2 ``First limitation''.
(a) The amount of the Federal estate tax attributable to the
transferred property in the transferor's estate is the ``first
limitation.'' Thus, the credit is limited to an amount, A, which bears
the same ratio to B (the ``transferor's adjusted Federal estate tax'',
computed as described in paragraph (b) of this section) as C (the value
of the property transferred (see Sec. 20.2013-4)) bears to D (the
``transferor's adjusted taxable estate'', computed as described in
paragraph (c) of this section). Stated algebraically, the ``first
limitation'' (A) equals:
Value of transferred property (C) ``Transferor's adjusted
taxable estate'' (D) x ``Transferor's adjusted Federal estate tax''
(B).
(b) For purposes of the ratio stated in paragraph (a) of this
section, the ``transferor's adjusted Federal estate tax'' referred to as
factor ``B'' is the amount of the Federal estate tax paid with respect
to the transferor's estate plus:
(1) Any credit allowed the transferor's estate for gift tax under
section 2012, or the corresponding provisions of prior law; and
(2) Any credit allowed the transferor's estate, under section 2013,
for tax on prior transfers, but only if the transferor acquired property
from a person who died within 10 years before the death of the present
decedent.
(c)(1) For purposes of the ratio stated in paragraph (a) of this
section, the ``transferor's adjusted taxable estate'' referred to as
factor ``D'' is the amount of the transferor's taxable estate (or net
estate) decreased by the amount of any ``death taxes'' paid with respect
to his gross estate and increased by the amount of the exemption allowed
in computing his taxable estate (or net estate). The amount of the
transferor's taxable estate (or net estate) is determined in accordance
with the provisions of Sec. 20.2051-1 in the case of a citizen or
resident of the United States or of Sec. 20.2106-1 in the case of a
nonresident not a citizen of the United States (or the corresponding
provisions of prior regulations). The term ``death taxes'' means the
Federal estate tax plus all other estate, inheritance, legacy,
succession, or similar death taxes imposed by, and paid to, any taxing
authority, whether within or without the United States. However, only
the net
[[Page 289]]
amount of such taxes paid is taken into consideration.
(2) The amount of the exemption depends upon the citizenship and
residence of the transferor at the time of his death. Except in the case
of a decedent described in section 2209 (relating to certain residents
of possessions of the United States who are considered nonresidents not
citizens), if the decedent was a citizen or resident of the United
States, the exemption is the $60,000 authorized by section 2052 (or the
corresponding provisions of prior law). If the decedent was a
nonresident not a citizen of the United States, or is considered under
section 2209 to have been such a nonresident, the exemption is the
$30,000 or $2,000, as the case may be, authorized by section 2106(a)(3)
(or the corresponding provisions of prior law), or such larger amount as
is authorized by section 2106(a)(3)(B) or may have been allowed as an
exemption pursuant to the prorated exemption provisions of an applicable
death tax convention. See Sec. 20.2052-1 and paragraph (a)(3) of
Sec. 20.2106-1.
(d) If the credit for tax on prior transfers relates to property
received from two or more transferors, the provisions of this section
are to be applied separately with respect to the property received from
each transferor. See paragraph (b) of example (2) in Sec. 20.2013-6.
(e) For illustrations of the application of this section, see
examples (1) and (2) set forth in Sec. 20.2013-6.
M019*[T.D. 6296, 23 FR 4529, June 24, 1958; 25 FR 14021, Dec. 31, 1960,
as amended by T.D. 7296, 38 FR 34191, Dec. 12, 1973]
Sec. 20.2013-3 ``Second limitation''.
(a) The amount of the Federal estate tax attributable to the
transferred property in the present decedent's estate is the ``second
limitation''. Thus, the credit is limited to the difference between--
(1) The net estate tax payable (see paragraph (b)(5) or (c), as the
case may be, of Sec. 20.0-2) with respect to the present decedent's
estate, determined without regard to any credit for tax on prior
transfers under section 2013 or any credit for foreign death taxes
claimed under the provisions of a death tax convention, and
(2) The net estate tax determined as provided in subparagraph (1) of
this paragraph but computed by subtracting from the present decedent's
gross estate the value of the property transferred (see Sec. 20.2013-4),
and by making only the adjustment indicated in paragraph (b) of this
section if a charitable deduction is allowable to the estate of the
present decedent.
(b) If a charitable deduction is allowable to the estate of the
present decedent under the provisions of section 2055 or section 2106
(a)(2) (for estates of nonresidents not citizens), for purposes of
determining the tax described in paragraph (a)(2) of this section, the
charitable deduction otherwise allowable is reduced by an amount, E,
which bears the same ratio to F (the charitable deduction otherwise
allowable) as G (the value of the transferred property (see
Sec. 20.2013-4)) bears to H (the value of the present decedent's gross
estate reduced by the amount of the deductions for expenses,
indebtedness, taxes, losses, etc., allowed under the provisions of
sections 2053 and 2054 or section 2106(a)(1) (for estates of
nonresidents not citizens)). See paragraph (c)(2) of example (1) and
paragraph (c)(2) of example (2) in Sec. 20.2013-6.
(c) If the credit for tax on prior transfers relates to property
received from two or more transferors, the property received from all
transferors is aggregated in determining the limitation on credit under
this section (the ``second limitation''). However, the limitation so
determined is apportioned to the property received from each transferor
in the ratio that the property received from each transferor bears to
the total property received from all transferors. See paragraph (c) of
example (2) in Sec. 20.2013-6.
(d) For illustrations of the application of this section, see
examples (1) and (2) set forth in Sec. 20.2013-6.
[T.D. 6296, 23 FR 4529, June 24, 1958; 25 FR 14021, Dec. 31, 1960, as
amended by T.D. 7296, 38 FR 34191, Dec. 12, 1973]
Sec. 20.2013-4 Valuation of property transferred.
(a) For purposes of section 2013 and Secs. 20.2013-1 to 20.2013-6,
the value of the property transferred to the decedent is
[[Page 290]]
the value at which the property was included in the transferor's gross
estate for the purpose of the Federal estate tax (see sections 2031,
2032, 2103, and 2107, and the regulations thereunder) reduced as
indicated in paragraph (b) of this section. If the decedent received a
life estate or a remainder or other limited interest in property that
was included in a transferor decedent's gross estate, the value of the
interest is determined as of the date of the transferor's death on the
basis of recognized valuation principles (see Secs. 20.2031-7 (or, for
certain prior periods, Sec. 20.2031-7A) and 20.7520-1 through 20.7520-
4). The application of this paragraph may be illustrated by the
following examples:
Example (1). A died on January 1, 1953, leaving Blackacre to B. The
property was included in A's gross estate at a value of $100,000. On
January 1, 1955, B sold Blackacre to C for $150,000. B died on February
1, 1955. For purposes of computing the credit against the tax imposed on
B's estate, the value of the property transferred to B is $100,000.
Example (2). A died on January 1, 1953, leaving Blackacre to B for
life and, upon B's death, remainder to C. At the time of A's death, B
was 56 years of age. The property was included in A's gross estate at a
value of $100,000. The part of that value attributable to the life
estate is $44,688 and the part of that value attributable to the
remainder is $55,312 (see Sec. 20.2031-7A(b)). B died on January 1,
1955, and C died on January 1, 1956. For purposes of computing the
credit against the tax imposed on B's estate, the value of the property
transferred to B is $44,688. For purposes of computing the credit
against the tax imposed on C's estate, the value of the property
transferred to C is $55,312.
(b) In arriving at the value of the property transferred to the
decedent, the value at which the property was included in the
transferor's gross estate (see paragraph (a) of this section) is reduced
as follows:
(1) By the amount of the Federal estate tax and any other estate,
inheritance, legacy, or succession taxes which were payable out of the
property transferred to the decedent or which were payable by the
decedent in connection with the property transferred to him. For
example, if under the transferor's will or local law all death taxes are
to be paid out of other property with the result that the decedent
receives a bequest free and clear of all death taxes, no reduction is to
be made under this subparagraph;
(2) By the amount of any marital deduction allowed the transferor's
estate under section 2056 (or under section 812(e) of the Internal
Revenue Code of 1939) if the decedent was the spouse of the transferor
at the time of the transferor's death; and
(3)(i) By the amount of any encumbrance on the property or by the
amount of any obligation imposed by the transferor and incurred by the
decedent with respect to the property, to the extent such charges would
be taken into account if the amount of a gift to the decedent of such
property were being determined.
(ii) For purposes of this subparagraph, an obligation imposed by the
transferor and incurred by the decedent with respect to the property
includes a bequest, etc., in lieu of the interest of the surviving
spouse under community property laws, unless the interest was,
immediately prior to the transferor's death, a mere expectancy. However,
an obligation imposed by the transferor and incurred by the decedent
with respect to the property does not include a bequest, devise, or
other transfer in lieu of dower, curtesy, or of a statutory estate
created in lieu of dower or curtesy, or of other marital rights in the
transferor's property or estate.
(iii) The application of this subparagraph may be illustrated by the
following examples:
Example (1). The transferor devised to the decedent real estate
subject to a mortgage. The value of the property transferred to the
decedent does not include the amount of the mortgage. If, however, the
transferor by his will directs the executor to pay off the mortgage,
such payment constitutes an additional amount transferred to the
decedent.
Example (2). The transferor bequeathed certain property to the
decedent with a direction that the decedent pay $1,000 to X. The value
of the property transferred to the decedent is the value of the property
reduced by $1,000.
Example (3). The transferor bequeathed certain property to his wife,
the decedent, in lieu of her interest in property held by them as
community property under the law of the State of their residence. The
wife elected to relinquish her community property interest and to take
the bequest. The value of the property transferred to the decedent is
the
[[Page 291]]
value of the property reduced by the value of the community property
interest relinquished by the wife.
Example (4). The transferor bequeathed to the decedent his entire
residuary estate, out of which certain claims were to be satisfied. The
entire distributable income of the transferor's estate (during the
period of its administration) was applied toward the satisfaction of
these claims and the remaining portion of the claims was satisfied by
the decedent out of his own funds. Thus, the decedent received a larger
sum upon settlement of the transferor's estate than he was actually
bequeathed. The value of the property transferred to the decedent is the
value at which such property was included in the transferor's gross
estate, reduced by the amount of the estate income and the decedent's
own funds paid out in satisfaction of the claims.
[T.D. 6296, 23 FR 4529, June 24, 1958, as amended by T.D. 7077, 35 FR
18461, Dec. 4, 1970; T.D. 7296, 38 FR 34191, Dec. 12, 1973; T.D. 8522,
59 FR 9646, Mar. 1, 1994; T.D. 8540, 59 FR 30151, June 10, 1994]
Sec. 20.2013-5 ``Property'' and ``transfer'' defined.
(a) For purposes of section 2013 and Secs. 20.2013-1 to 20.2013-6,
the term ``property'' means any beneficial interest in property,
including a general power of appointment (as defined in section 2041)
over property. Thus, the term does not include an interest in property
consisting merely of a bare legal title, such as that of a trustee. Nor
does the term include a power of appointment over property which is not
a general power of appointment (as defined in section 2041). Examples of
property, as described in this paragraph, are annuities, life estates,
estates for terms of years, vested or contingent remainders and other
future interests.
(b) In order to obtain the credit for tax on prior transfers, there
must be a transfer of property described in paragraph (a) of this
section by or from the transferor to the decedent. The term ``transfer''
of property by or from a transferor means any passing of property or an
interest in property under circumstances which were such that the
property or interest was included in the gross estate of the transferor.
In this connection, if the decedent receives property as a result of the
exercise or nonexercise of a power of appointment, the donee of the
power (and not the creator) is deemed to be the transferor of the
property if the property subject to the power is includible in the
donee's gross estate under section 2041 (relating to powers of
appointment). Thus, notwithstanding the designation by local law of the
capacity in which the decedent takes, property received from the
transferor includes interests in property held by or devolving upon the
decedent: (1) As spouse under dower or curtesy laws or laws creating an
estate in lieu of dower or curtesy; (2) as surviving tenant of a tenancy
by the entirety or joint tenancy with survivorship rights; (3) as
beneficiary of the proceeds of life insurance; (4) as survivor under an
annuity contract; (5) as donee (possessor) of a general power of
appointment (as defined in section 2041); (6) as appointee under the
exercise of a general power of appointment (as defined in section 2041);
or (7) as remainderman under the release or nonexercise of a power of
appointment by reason of which the property is included in the gross
estate of the donee of the power under section 2041.
(c) The application of this section may be illustrated by the
following example:
Example: A devises Blackacre to B, as trustee, with directions to
pay the income therefore to C, his son, for life. Upon C's death.
Blackacre is to be sold. C is given a general testamentary power, to
appoint one-third of the proceeds, and a testamentary power, which is
not a general power, to appoint the remaining two-thirds of the
proceeds, to such of the issue of his sister D as he should choose. D
has a daughter, E, and a son, F. Upon his death, C exercised his general
power by appointing one-third of the proceeds to D and his special power
by appointing two-thirds of the proceeds to E. Since B's interest in
Blackacre as a trustee is not a beneficial interest, no part of it is
``property'' for purpose of the credit in B's estate. On the other hand,
C's life estate and his testamentary power over the one-third interest
in the remainder constitute ``property'' received from A for purpose of
the credit in C's estate. Likewise, D's one-third interest in the
remainder received through the exercise of C's general power of
appointment is ``property'' received from C for purpose of the credit in
D's estate. No credit is allowed E's estate for the property which
passed to her from C since the property was not included in C's gross
estate. On the other hand, no credit is allowed in E's estate for
property passing to her from A since her interest was not susceptible of
valuation at the time of A's death (see Sec. 20.2013-4).
[[Page 292]]
Sec. 20.2013-6 Examples.
The application of Secs. 20.2013-1 to 20.2013-5 may be further
illustrated by the following examples:
Example (1). (a) A died December 1, 1953, leaving a gross estate of
$1,000,000. Expenses, indebtedness, etc., amounted to $90,000. A
bequeathed $200,000 to B, his wife, $100,000 of which qualified for the
marital deduction. B died November 1, 1954, leaving a gross estate of
$500,000. Expenses, indebtedness, etc., amounted to $40,000. B
bequeathed $150,000 to charity. A and B were both citizens of the United
States. The estates of A and B both paid State death taxes equal to the
maximum credit allowable for State death taxes. Death taxes were not a
charge on the bequest to B.
(b) ``First limitation'' on credit for B's estate (Sec. 20.2013-2):
A's gross estate....................................... $1,000,000.00
Expenses, indebtedness, etc........... 90,000.00
------------------
A's adjusted gross estate......... 910,000.00
Marital deduction..................... $100,000.00
Exemption............................. 60,000.00
-----------------
160,000.00
------------------
A's taxable estate................................. 750,000.00
==================
A's gross estate tax.............. 233,200.00
Credit for State death taxes.......... 23,280.00
------------------
A's net estate tax payable........ 209,920.00
================
``First limitation'' = $209,920.00
(Sec. 20.2013-2(b)) x
[($200,000.00 - $100,000.00) (Sec.
20.2013-4) ($750,000.00 -
$209,920.00 - $23,280.00 +
$60,000.00) (Sec. 20.2013-2(c))].... ............... $36,393.90
(c) ``Second limitation'' on credit for B's estate (Sec. 20.2013-3):
(1) B's net estate tax payable as described in Sec. 20.2013-3(a)(1)
(previously taxed transfer included):
B's gross estate.............................. $500,000.00
Expenses, indebtedness, etc................... $40,000.00
Charitable deduction.......................... 150,000.00
Exemption..................................... 60,000.00
-------------
250,000.00
------------
B's taxable estate........................ 250,000.00
============
B's gross estate tax....................................... $65,700.00
Credit for State death taxes.................. 3,920.00
--------------
B's net estate tax payable................ 61,780.00
(2) B's net estate tax payable as described in Sec. 20.2013-3(a)(2)
(previously taxed transfer excluded):
B's gross estate.............................. ........... $400,000.00
Expenses, indebtedness, etc................... $40,000.00
Charitable deduction (Sec. 20.2013-3(b)) =
$150,000.00 - [$150,000.00 x ($200,000.00 -
$100,000.00 $500,000.00 -
$40,000.00)]................................. 117,391.30
Exemption..................................... 60,000.00
-------------
217,391.30
------------
B's taxable estate......................................... 182,608.70
==============
B's gross estate tax.......................... 45,482.61
Credit for State death taxes.................. 2,221.61
--------------
B's net estate tax payable................ 43,260.00
============
(3) ``Second limitation'':
Subparagraph (1).............................. $61,780.00
Less: Subparagraph (2)........................ 43,260.00
-------------
$18,520.00
(d) Credit of B's estate for tax on prior transfers (Sec. 20.2013-
1(c)):
Credit for tax on prior transfers=$18,520.00 (lower of
paragraphs (b) and (c)) x 100 percent (percentage to be
taken into account under Sec. 20.2013-1(c))............... $18,520.00
Example (2). (a) The facts are the same as those contained in
example (1) of this paragraph with the following additions. C died
December 1, 1950, leaving a gross estate of $250,000. Expenses,
indebtedness, etc., amounted to $50,000. C bequeathed $50,000 to B. C
was a citizen of the United States. His estate paid State death taxes
equal to the maximum credit allowable for State death taxes. Death taxes
were not a charge on the bequest to B.
(b) ``First limitation'' on credit for B's estate (Sec. 20.2013-
2(d))-
(1) With respect to the property received from A:
``First limitation''=$36,393.90 (this computation is identical with
the one contained in paragraph (b) of example (1) of this section).
(2) With respect to the property received from C:
C's gross estate.............................. $250,000.00
Expenses, indebtedness, etc................... $50,000.00
Exemption..................................... $60,000.00
-------------
$110,000.00
------------
C's taxable estate........................ 140,000.00
============
C's gross estate tax.......................... ........... 32,700.00
Credit for State death taxes.................. 1,200.00
------------
C's net estate tax payable................ 31,500.00
============
``First limitation'' = $31,500.00 (Sec. 20.2013-2(b)) x
[$50,000.00 (Sec. 20.2013-4) ($140,000.00 -
$31,500.00 - $1,200.00 + $60,000.00) (Sec. 20.2013-2(c))] $9,414.23
[[Page 293]]
(c) ``Second limitation'' on credit for B's estate (Sec. 20.2013-
3(c)):
(1) B's net estate tax payable as described in Sec. 20.2013-3(a)(1)
(previously taxed transfers included)=$61,780.00 (this computation is
identical with the one contained in paragraph (c)(1) of example (1) of
this section).
(2) B's net estate tax payable as described in Sec. 20.2013-3(a)(2)
(previously taxed transfers excluded):
B's gross estate........................................... $350,000.00
Expenses, indebtedness, etc................... $40,000.00
Charitable deduction (Sec. 20.2013-3(b)) =
$150,000.00 - [$150,000.00 x ($200,000.00 -
$100,000.00 + $50,000.00)
($500,000.00 - $40,000.00)].................. 101,086.96
Exemption..................................... 60,000.00
-------------
201,086.96
------------
B's taxable estate........................ ........... 148,913.04
------------
B's gross estate tax.......................... ........... 35,373.91
Credit for State death taxes.................. ........... 1,413.91
------------
B's net estate tax payable................ ........... 33,960.00
============
(3) ``Second limitation'':
Subparagraph (1).............................. $61,780.00
Less: Subparagraph (2)........................ 33,960.00
-------------
$27,820.00
(4) Apportionment of ``second limitation'' on credit:
Transfer from A (Sec. 20.2013-4).......................... $100,000.00
Transfer from C (Sec. 20.2013-4).......................... 50,000.00
------------
Total.................................................. 150,000.00
Portion of ``second limitation'' attributable to transfer
from A (100/150 of $27,820.00)............................ 18,546.67
Portion of ``second limitation'' attributable to transfer
from C (50/150 of $27,820.00)............................. 9,273.33
(d) Credit of B's estate for tax on prior transfers (Sec. 20.2013-
1(c)):
Credit for tax on transfer from A=
$18,546.67 (lower of ``first limitation'' computed in
paragraph (b)(1) and ``second limitation'' apportioned to
A's transfer in paragraph (c)(4)) x 100 percent
(percentage to be taken into account under Sec. 20.2013-
1(c)).................................................... $18,546.67
Credit for tax on transfer from C=
$9,273.33 (lower of ``first limitation'' computed in
paragraph (b)(2) and ``second limitation'' apportioned to
B's transfer in paragraph (c)(4)) x 80 percent
(percentage to be taken into account under Sec. 20.2013-
1(c)).................................................... 7,418.66
-----------
Total credit for tax on prior transfers................... 25,965.33
Sec. 20.2014-1 Credit for foreign death taxes.
(a) In general. (1) A credit is allowed under section 2014 against
the Federal estate tax for any estate, inheritance, legacy, or
succession taxes actually paid to any foreign country (hereinafter
referred to as ``foreign death taxes''). The credit is allowed only for
foreign death taxes paid (i) with respect to property situated within
the country to which the tax is paid, (ii) with respect to property
included in the decedent's gross estate, and (iii) with respect to the
decedent's estate. The credit is allowable to the estate of a decedent
who was a citizen of the United States at the time of his death. The
credit is also allowable, as provided in paragraph (c) of this section,
to the estate of a decedent who was a resident but not a citizen of the
United States at the time of his death. The credit is not allowable to
the estate of a decedent who was neither a citizen nor a resident of the
United States at the time of his death. See paragraph (b)(1) of
Sec. 20.0-1 for the meaning of the term ``resident'' as applied to a
decedent. The credit is allowable not only for death taxes paid to
foreign countries which are states in the international sense, but also
for death taxes paid to possessions or political subdivisions of foreign
states. With respect to the estate of a decedent dying after September
2, 1958, the term ``foreign country'', as used in this section and
Secs. 20.2014-2 to 20.2014-6, includes a possession of the United
States. See Secs. 20.2011-1 and 20.2011-2 for the allowance of a credit
for death taxes paid to a possession of the United States in the case of
a decedent dying before September 3, 1958. No credit is allowable for
interest or penalties paid in connection with foreign death taxes.
(2) In addition to the credit for foreign death taxes under section
2014, similar credits are allowed under death tax conventions with
certain foreign countries. If credits against the Federal estate tax are
allowable under section 2014, or under section 2014 and one or more
death tax conventions, for death taxes paid to more than one country,
the credits are combined and the aggregate amount is credited against
the Federal estate tax, subject to the limitation provided for in
paragraph (c) of Sec. 20.2014-4. For application of the credit in cases
involving a death tax convention, see Sec. 20.2014-4.
[[Page 294]]
(3) No credit is allowable under section 2014 in connection with
property situated outside of the foreign country imposing the tax for
which credit is claimed. However, such a credit may be allowable under
certain death tax conventions. In the case of a tax imposed by a
political subdivision of a foreign country, credit for the tax shall be
allowed with respect to property having a situs in that foreign country,
even though, under the principles described in this subparagraph, the
property has a situs in a political subdivision different from the one
imposing the tax. Whether or not particular property of a decedent is
situated in the foreign country imposing the tax is determined in
accordance with the same principles that would be applied in determining
whether or not similar property of a nonresident decedent not a citizen
of the United States is situated within the United States for Federal
estate tax purposes. See Secs. 20.2104-1 and 20.2105-1. For example,
under Sec. 20.2104-1 shares of stock are deemed to be situated in the
United States only if issued by a domestic corporation. Thus, a share of
corporate stock is regarded as situated in the foreign country imposing
the tax only if the issuing corporation is incorporated in that country.
Further, under Sec. 20.2105-1 amounts receivable as insurance on the
life of a nonresident not a citizen of the United States at the time of
his death are not deemed situated in the United States. Therefore, in
determining the credit under section 2014 in the case of a decedent who
was a citizen or resident of the United States, amounts receivable as
insurance on the life of the decedent and payable under a policy issued
by a corporation incorporated in a foreign country are not deemed
situated in such foreign country. In addition, under Sec. 20.2105-1 in
the case of an estate of a nonresident not a citizen of the United
States who died on or after November 14, 1966, a debt obligation of a
domestic corporation is not considered to be situated in the United
States if any interest thereon would be treated under section 862(a)(1)
as income from sources without the United States by reason of section
861(a)(1)(B) (relating to interest received from a domestic corporation
less than 20 percent of whose gross income for a 3-year period was
derived from sources within the United States). Accordingly, a debt
obligation the primary obligor on which is a corporation incorporated in
the foreign country imposing the tax is not considered to be situated in
that country if, under circumstances corresponding to those described in
Sec. 20.2105-1 less than 20 percent of the gross income of the
corporation for the 3-year period was derived from sources within that
country. Further, under Sec. 20.2104-1 in the case of an estate of a
nonresident not a citizen of the United States who died before November
14, 1966, a bond for the payment of money is not situated within the
United States unless it is physically located in the United States.
Accordingly, in the case of the estate of a decedent dying before
November 14, 1966, a bond is deemed situated in the foreign country
imposing the tax only if it is physically located in that country.
Finally, under Sec. 20.2105-1 moneys deposited in the United States with
any person carrying on the banking business by or for a nonresident not
a citizen of the United States who died before November 14, 1966, and
who was not engaged in business in the United States at the time of
death are not deemed situated in the United States. Therefore, an
account with a foreign bank in the foreign country imposing the tax is
not considered to be situated in that country under corresponding
circumstances.
(4) Where a deduction is allowed under section 2053(d) for foreign
death taxes paid with respect to a charitable gift, the credit for
foreign death taxes is subject to further limitations as explained in
Sec. 20.2014-7.
(b) Limitations on credit. The credit for foreign death taxes is
limited to the smaller of the following amounts:
(1) The amount of a particular foreign death tax attributable to
property situated in the country imposing the tax and included in the
decedent's gross estate for Federal estate tax purposes, computed as set
forth in Sec. 20.2014-2; or
(2) The amount of the Federal estate tax attributable to particular
property situated in a foreign country, subjected to foreign death tax
in that country,
[[Page 295]]
and included in the decedent's gross estate for Federal estate tax
purposes, computed as set forth in Sec. 20.2014-3.
(c) Credit allowable to estate of resident not a citizen. (1) In the
case of an estate of a decedent dying before November 14, 1966, who was
a resident but not a citizen of the United States, a credit is allowed
to the estate under section 2014 only if the foreign country of which
the decedent was a citizen or subject, in imposing foreign death taxes,
allows a similar credit to the estates of citizens of the United States
who were resident in that foreign country at the time of death.
(2) In the case of an estate of a decedent dying on or after
November 14, 1966, who was a resident but not a citizen of the United
States, a credit is allowed to the estate under section 2014 without
regard to the similar credit requirement of subparagraph (1) of this
paragraph unless the decedent was a citizen or subject of a foreign
country with respect to which there is in effect at the time of the
decedent's death a Presidential proclamation, as authorized by section
2014(h), reinstating the similar credit requirement. In the case of an
estate of a decedent who was a resident of the United States and a
citizen or subject of a foreign country with respect to which such a
proclamation has been made, and who dies while the proclamation is in
effect, a credit is allowed under section 2014 only if that foreign
country, in imposing foreign death taxes, allows a similar credit to the
estates of citizens of the United States who were resident in that
foreign country at the time of death. The proclamation authorized by
section 2014(h) for the reinstatement of the similar credit requirement
with respect to the estates of citizens or subjects of a specific
foreign country may be made by the President whenever he finds that--
(i) The foreign country, in imposing foreign death taxes, does not
allow a similar credit to the estates of citizens of the United States
who were resident in the foreign country at the time of death,
(ii) The foreign country, after having been requested to do so, has
not acted to provide a similar credit to the estates of such citizens,
and
(iii) It is in the public interest to allow the credit under section
2014 to the estates of citizens or subjects of the foreign country only
if the foreign country allows a similar credit to the estates of
citizens of the United States who were resident in the foreign country
at the time of death.
The proclamation for the reinstatement of the similar credit requirement
with respect to the estates of citizens or subjects of a specific
foreign country may be revoked by the President. In that case, a credit
is allowed under section 2014, to the estate of a decedent who was a
citizen or subject of that foreign country and a resident of the United
States at the time of death, without regard to the similar credit
requirement if the decedent dies after the proclamation reinstating the
similar credit requirement has been revoked.
[T.D. 6296, 23 FR 4529, June 24, 1958, as amended by T.D. 6526, 26 FR
415, Jan. 19, 1961; T.D. 6600, 27 FR 4983, May 29, 1962; T.D. 7296, 38
FR 34192, Dec. 12, 1973]
Sec. 20.2014-2 ``First limitation''.
(a) The amount of a particular foreign death tax attributable to
property situated in the country imposing the tax and included in the
decedent's gross estate for Federal estate tax purposes is the ``first
limitation.'' Thus, the credit for any foreign death tax is limited to
an amount, A, which bears the same ratio to B (the amount of the foreign
death tax without allowance of credit, if any, for Federal estate tax),
as C (the value of the property situated in the country imposing the
foreign death tax, subjected to the foreign death tax, included in the
gross estate and for which a deduction is not allowed under section
2053(d)) bears to D (the value of all property subjected to the foreign
death tax). Stated algebraically, the ``first limitation'' (A) equals--
Value of property in foreign country subjected to foreign death tax,
included in gross estate and for which a deduction is not allowed under
section 2053(d)(C) Value of all property subjected to foreign
death tax (D) x Amount of foreign death tax (B)
[[Page 296]]
The values used in this proportion are the values determined for the
purpose of the foreign death tax. The amount of the foreign death tax
for which credit is allowable must be converted into United States
money. The application of this paragraph may be illustrated by the
following example:
Example. At the time of his death on June 1, 1966, the decedent, a
citizen of the United States, owned stock in X Corporation (a
corporation organized under the laws of Country Y) valued at $80,000. In
addition, he owned bonds issued by Country Y valued at $80,000. The
stock and bond certificates were in the United States. Decedent left by
will $20,000 of the stock and $50,000 of the Country Y bonds to his
surviving spouse. He left the rest of the stock and bonds to his son.
Under the situs rules referred to in paragraph (a)(3) of Sec. 20.2014-1
the stock is deemed situated in Country Y while the bonds are deemed to
have their situs in the United States. (The bonds would be deemed to
have their situs in Country Y if the decedent had died on or after
November 14, 1966.) There is not death tax convention in existence
between the United States and Country Y. The laws of Country Y provide
for inheritance taxes computed as follows:
Inheritance tax of surviving spouse:
Value of stock.............................................. $20,000
Value of bonds.............................................. 50,000
---------
Total value................................................. 70,000
---------
Tax (16 percent rate)....................................... 11,200
=========
Inheritance tax of son:
Value of stock.............................................. 60,000
Value of bonds................................................ $30,000
---------
Total value............................................... 90,000
---------
Tax (16 percent rate)......................................... 14,400
=========
The ``first limitation'' on the credit for foreign death taxes is:
$20,000 + $60,000 (factor C of the ratio stated at Sec. 20.2014-2(a))
$70,000+ $90,000 (factor D of the ratio stated at
Sec. 20.2014-2(a)) x ($11,200+$14,400) (factor B of the
ratio stated at Sec. 20.2014-2(a)) = $12,800
(b) If a foreign country imposes more than one kind of death tax or
imposes taxes at different rates upon the several shares of an estate,
or if a foreign country and a political subdivision or possession
thereof each imposes a death tax, a ``first limitation'' is to be
computed separately for each tax or rate and the results added in order
to determine the total ``first limitation.'' The application of this
paragraph may be illustrated by the following example:
Example. The facts are the same as those contained in the example
set forth in paragraph (a) of this section, except that the tax of the
surviving spouse was computed at a 10 percent rate and amounted to
$7,000, and the tax of the son was computed at a 20 percent rate and
amounted to $18,000. In this case, the ``first limitation'' on the
credit for foreign death taxes is computed as follows:
``First limitation'' with respect to inheritance tax of
surviving spouse:
[$20,000 (factor C of the ratio stated at Sec. 20.2014-
2(a)) $70,000 (factor D of the ratio stated at
Sec. 20.2014-2(a))] x $7,000 (factor B of the ratio
stated at Sec. 20.2014-2(a))=............................. $2,000.
``First limitation'' with respect to inheritance tax of son:
[$60,000 (factor C of the ratio stated at Sec. 20.2014-
2(a)) $90,000 (factor D of the ratio stated at
Sec. 20.2014-2(a))] x $18,000 (factor B of the ratio
stated at Sec. 20.2014-2(a))=............................. 12,000.
---------
Total ``first limitation'' on the credit for foreign death
taxes...................................................... 14,000
[T.D. 6296, 23 FR 4529, June 24, 1958, as amended by T.D. 6600, 27 FR
4984, May 29, 1962; T.D. 6684, 28 FR 11408, Oct. 24, 1963; T.D. 7296, 38
FR 34193, Dec. 12, 1973; 39 FR 2090, Jan. 17, 1974]
Sec. 20.2014-3 ``Second limitation''.
(a) The amount of the Federal estate tax attributable to particular
property situated in a foreign country, subjected to foreign death tax
in that country, and included in the decedent's gross estate for Federal
estate tax purposes is the ``second limitation.'' Thus, the credit is
limited to an amount, E, which bears the same ratio to F (the gross
Federal estate tax, reduced by any credit for State death taxes under
section 2011 and by any credit for gift tax under section 2012) as G
(the ``adjusted value of the property situated in the foreign country,
subjected to foreign death tax, and included in the gross estate'',
computed as described in paragraph (b) of this section) bears to H (the
value of the entire gross estate, reduced by the total amount of the
deductions allowed under sections 2055 (charitable deduction) and 2056
(marital deduction)). Stated algebraically, the ``second limitation''
(E) equals:
``Adjusted value of the property situated in the foreign country,
subjected to foreign
[[Page 297]]
death taxes, and included in the gross estate'' (G) Value of
entire gross estate, less charitable and marital deductions (H) x
Gross Federal estate tax, less credits for State death taxes and gift
tax (F)
The values used in this proportion are the values determined for the
purpose of the Federal estate tax.
(b) Adjustment is required to factor ``G'' of the ratio stated in
paragraph (a) of this section if a deduction for foreign death taxes
under section 2053(d), a charitable deduction under section 2055, or a
marital deduction under section 2056 is allowed with respect to the
foreign property. If a deduction for foreign death taxes is allowed, the
value of the property situated in the foreign country, subjected to
foreign death tax, and included in the gross estate does not include the
value of any property in respect of which the deduction for foreign
death taxes is allowed. See Sec. 20.2014-7. If a charitable deduction or
a marital deduction is allowed, the value of such foreign property
(after exclusion of the value of any property in respect of which the
deduction for foreign death taxes is allowed) is reduced as follows:
(1) If a charitable deduction or a marital deduction is allowed to a
decedent's estate with respect to any part of the foreign property,
except foreign property in respect of which a deduction for foreign
death taxes is allowed, specifically bequeathed, devised, or otherwise
specifically passing to a charitable organization or to the decedent's
spouse, the value of the foreign property is reduced by the amount of
the charitable deduction or marital deduction allowed with respect to
such specific transfer. See example (1) of paragraph (c) of this
section.
(2) If a charitable deduction or a marital deduction is allowed to a
decedent's estate with respect to a bequest, devise or other transfer of
an interest in a group of assets including both the foreign property and
other property, the value of the foreign property is reduced by an
amount, I, which bears the same ratio to J (the amount of the charitable
deduction or marital deduction allowed with respect to such transfer of
an interest in a group of assets) as K (the value of the foreign
property, except foreign property in respect of which a deduction for
foreign death taxes is allowed, included in the group of assets) bears
to L (the value of the entire group of assets). As used in this
subparagraph, the term ``group of assets'' has reference to those assets
which, under applicable law, are chargeable with the charitable or
marital transfer. See example (2) of paragraph (c) of this section.
Any reduction described in paragraph (b)(1) or (b)(2) of this section on
account of the marital deduction must proportionately take into account,
if applicable, the limitation on the aggregate amount of the marital
deduction contained in Sec. 20.2056(a)-1(c). See Sec. 20.2014-3(c),
Example 3.
(c) The application of paragraphs (a) and (b) of this section may be
illustrated by the following examples. In each case, the computations
relate to the amount of credit under section 2014 without regard to the
amount of credit which may be allowable under an applicable death tax
convention.
Example (1). (i) Decedent, a citizen and resident of the United
States at the time of his death on February 1, 1967, left a gross estate
of $1,000,000 which includes the following: shares of stock issued by a
domestic corporation, valued at $750,000; bonds issued in 1960 by the
United States and physically located in foreign Country X, valued at
$50,000; and shares of stock issued by a Country X corporation, valued
at $200,000, with respect to which death taxes were paid to Country X.
Expenses, indebtedness, etc., amounted to $60,000. Decedent specifically
bequeathed $40,000 of the stock issued by the Country X corporation to a
U.S. charity and left the residue of his estate, in equal shares, to his
son and daughter. The gross Federal estate tax is $266,500, and the
credit for State death taxes is $27,600. Under the situs rules referred
to in paragraph (a)(3) of Sec. 20.2014-1, the shares of stock issued by
the Country X corporation comprise the only property deemed to be
situated in Country X. (The bonds also would be deemed to have their
situs in Country X if the decedent had died before November 14, 1966.)
(ii) The ``second limitation'' on the credit for foreign death taxes
is:
[($200,000 - $40,000 (factor G of the ratio stated at Sec. 20.2014-3(a);
see also Sec. 20.2014-3(b)(1))) ($1,000,000 - $40,000
(factor H of the ratio stated at Sec. 20.2014-3(a)))] x
($266,500 - $27,600) (factor F of the ratio stated at
Sec. 20.2014-3(a)) = $39,816.67.
The lesser of this amount and the amount of the ``first limitation''
(computed under
[[Page 298]]
Sec. 20.2014-2) is the credit for foreign death taxes.
Example (2). (i) Decedent, a citizen and resident of the United
States at the time of his death, left a gross estate of $1,000,000 which
includes: shares of stock issued by a United States corporation, valued
at $650,000; shares of stock issued by a Country X corporation, valued
at $200,000; and life insurance, in the amount of $150,000, payable to a
son. Expenses, indebtedness, etc., amounted to $40,000. The decedent
made a specific bequest of $25,000 of the Country X corporation stock to
Charity A and a general bequest of $100,000 to Charity B. The residue of
his estate was left to his daughter. The gross Federal estate tax is
$242,450 and the credit for State death taxes is $24,480. Under these
facts and applicable law, neither the stock of the Country X corporation
specifically bequeathed to Charity A nor the insurance payable to the
son could be charged with satisfying the bequest to Charity B.
Therefore, the ``group of assets'' which could be so charged is limited
to stock of the Country X corporation valued at $175,000 and stock of
the United States corporation valued at $650,000.
(ii) Factor ``G'' of the ratio which is used in determining the
``second limitation'' is computed as follows:
Value of property situated in Country X................. $200,000.00
Less:
Reduction described in Sec. 20.2014-
3(b)(1).............................. $25,000.00
Reduction described in Sec. 20.2014-
3(b)(2) = [$175,000 (factor K of the
ratio stated at Sec. 20.2014-3
(b)(2)) ($175,000 + $650,000
(factor L of the ratio stated at Sec.
20.2014-3 (b)(2)))] x $100,000
(factor J of the ratio stated at Sec.
20.2014-3(b)(2)) =.................. 21,212.12
----------------
46,212.12
---------------
Factor ``G'' of the ratio........... .............. 153,787.88
(iii) In this case, the ``second limitation'' on the credit for
foreign death taxes is:
[$153,787.88 (factor G of the ratio stated at Sec. 20.2014-3(a); see
also subdivision (ii) above) ($1,000,000 - $125,000
(factor H of the ratio stated at Sec. 20.2014-3(a)))] x
($242,450 - $24,480) (factor F of the ratio stated at
Sec. 20.2014-3(a)) = $38,309.88.
Example (3). (i) Decedent, a citizen and resident of the United
States at the time of his death, left a gross estate of $850,000 which
includes: shares of stock issued by United States corporations, valued
at $440,000; real estate located in the United States, valued at
$110,000; and shares of stock issued by Country X corporations, valued
at $300,000. Expenses, indebtedness, etc., amounted to $50,000. Decedent
devised $40,000 in real estate to a United States charity. In addition,
he bequeathed to his wife $200,000 in United States stocks and $300,000
in Country X stocks. The residue of his estate passed to his children.
The gross Federal estate tax is $81,700 and the credit for State death
taxes is $5,520.
(ii) Decedent's adjusted gross estate is $800,000 (i.e., the
$850,000, gross estate less $50,000, expenses, indebtedness, etc.).
Assume that the limitation imposed by section 2056(c), as in effect
before 1982, is applicable so that the aggregate allowable marital
deduction is limited to one-half the adjusted gross estate, or $400,000
(which is 50 percent of $800,000). Factor ``G'' of the ratio which is
used in determining the ``second limitation'' is computed as follows:
Value of property situated in Country X.................... $300,000
Less: Reduction described in Sec. 20.2014-3
(b)(1) determined as follows (see also end of
Sec. 20.2014-3(b))--
Total amount of bequests which qualify for
the marital deduction:
Specific bequest of Country X stock....... $300,000
Specific bequest of United States stock... 200,000
-------------
500,000
Limitation on aggregate marital deduction
under section 2056(c)........................ 400,000
Part of specific bequest of Country X stock with respect to
which the marital deduction is allowed--($400,000