[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2011 Edition]
[From the U.S. Government Printing Office]
[[Page 1]]
Title 26
Internal Revenue
________________________
Parts 50 to 299
Revised as of April 1, 2011
Containing a codification of documents of general
applicability and future effect
As of April 1, 2011
Published by the Office of the Federal Register
National Archives and Records Administration as a
Special Edition of the Federal Register
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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........................ 567
Alphabetical List of Agencies Appearing in the CFR...... 587
Table of OMB Control Numbers............................ 597
List of CFR Sections Affected........................... 615
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Cite this Code: CFR
To cite the regulations in
this volume use title,
part and section number.
Thus, 26 CFR 50.1 refers
to title 26, part 50,
section 1.
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[[Page v]]
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
into 50 titles which represent broad areas subject to Federal
regulation. Each title is divided into chapters which usually bear the
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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LEGAL STATUS
The contents of the Federal Register are required to be judicially
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HOW TO USE THE CODE OF FEDERAL REGULATIONS
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To determine whether a Code volume has been amended since its
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Each volume of the Code contains amendments published in the Federal
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OMB CONTROL NUMBERS
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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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(c) The incorporating document is drafted and submitted for
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that volume.
[[Page vii]]
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Raymond A. Mosley,
Director,
Office of the Federal Register.
April 1, 2011.
[[Page ix]]
THIS TITLE
Title 26--Internal Revenue is composed of twenty volumes. The
contents of these volumes represent all current regulations issued by
the Internal Revenue Service, Department of the Treasury, as of April 1,
2011. The first thirteen volumes comprise part 1 (Subchapter A--Income
Tax) and are arranged by sections as follows: Sec. Sec. 1.0-1.60;
Sec. Sec. 1.61-1.169; Sec. Sec. 1.170-1.300; Sec. Sec. 1.301-1.400;
Sec. Sec. 1.401-1.440; Sec. Sec. 1.441-1.500; Sec. Sec. 1.501-1.640;
Sec. Sec. 1.641-1.850; Sec. Sec. 1.851-1.907; Sec. Sec. 1.908-1.1000;
Sec. Sec. 1.1001-1.1400; Sec. Sec. 1.1401-1.1550; and Sec. 1.1551 to
end of part 1. The fourteenth 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
Michael L. White, assisted by Ann Worley.
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TITLE 26--INTERNAL REVENUE
(This book contains parts 50 to 299)
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Part
chapter i--Internal Revenue Service, Department of the
Treasury (Continued)...................................... 50
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CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
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Editorial Note: IRS published a document at 45 FR 6088, Jan. 25, 1980,
deleting statutory sections from their regulations. In Chapter I cross
references to the deleted material have been changed to the
corresponding sections of the IRS Code of 1954 or to the appropriate
regulations sections. When either such change produced a redundancy, the
cross reference has been deleted. For further explanation, see 45 FR
20795, March 31, 1980.
SUBCHAPTER D--MISCELLANEOUS EXCISE TAXES (CONTINUED)
Part Page
50 Regulations relating to the tax imposed with
respect to certain hydraulic mining..... 5
52 Environmental taxes......................... 7
53 Foundation and similar excise taxes......... 41
54 Pension excise taxes........................ 258
55 Excise tax on real estate investment trusts
and regulated investment companies...... 492
56 Public charity excise taxes................. 498
141 Temporary excise tax regulations under the
Employee Retirement Income Security Act
of 1974................................. 538
143 Temporary excise tax regulations under the
Tax Reform Act of 1969.................. 538
145 Temporary excise tax regulations under the
Highway Revenue Act of 1982 (Pub. L. 97-
424).................................... 540
148 Certain excise tax matters under the Excise
Tax Technical Changes Act of 1958....... 550
151-155
[Reserved]
156 Excise tax on greenmail..................... 552
157 Excise tax on structured settlement
factoring transactions.................. 558
158-169
[Reserved]
SUBCHAPTER E [RESERVED]
170-299
[Reserved]
Supplementary Publications: Internal Revenue Service Looseleaf
Regulations System.
Additional supplementary publications are issued covering Alcohol,
Tobacco and Firearms Regulations, and Regulations Under Tax Conventions.
[[Page 5]]
SUBCHAPTER D_MISCELLANEOUS EXCISE TAXES (CONTINUED)
PART 50_REGULATIONS RELATING TO THE TAX IMPOSED WITH RESPECT TO CERTAIN HYDRAULIC MINING--Table of Contents
Sec.
50.1 Introduction.
50.2 Scope of regulations.
50.3 General definitions and use of terms.
50.4 Rates of tax.
50.5 Liability for the tax.
50.6 Ascertainment of quantity mined.
50.7 Returns.
50.8 Due date and place for filing returns and paying tax.
Authority: Sec. 23, 27, Stat. 510, as amended; 33 U.S.C. 683.
Source: T.D. 6419, 24 FR 8546, Oct. 22, 1959, unless otherwise
noted.
Sec. 50.1 Introduction.
The Act entitled ``An Act to create the California Debris Commission
and regulate hydraulic mining in the State of California'', approved
March 1, 1893, as amended, 27 Stat. 507; 34 Stat. 1001; 48 Stat. 1118;
52 Stat. 1040; 61 Stat. 501; 33 U.S.C. 661-687, provides in part as
follows:
That a commission is hereby created, to be known as the California
Debris Commission, consisting of three members. * * *
Sec. 3. That the jurisdiction of said commission, insofar as the
same affects mining carried on by the hydraulic process, shall extend to
all such mining in the territory drained by the Sacramento and San
Joaquin river systems in the State of California. * * *
Sec. 8. That for the purposes of this act ``hydraulic mining'' and
``mining by the hydraulic process,'' are hereby declared to have the
meaning and application given to said terms in said State.
Sec. 9. That the individual proprietor or proprietors, or in the
case of a corporation its manager or agent appointed for that purpose,
owning mining ground in the territory in the State of California
mentioned in section three hereof, which it is desired to work by the
hydraulic process, must file with said commission a verified petition,
setting forth such facts as will comply with law and the rules
prescribed by said commission.
* * * * *
Sec. 13. That in case a majority of the members of said Commission,
within thirty days after the time so fixed, concur in the decision in
favor of the petitioner or petitioners, the said Commission shall
thereupon make an order directing the methods and specifying in detail
the manner in which operations shall proceed in such mine or mines; * *
*
Sec. 23. Upon the construction by the said commission of dams or
other works for the detention of debris from hydraulic mines and the
issuing of the order provided for by this Act to any individual,
company, or corporation to work any mine or mines by hydraulic process,
the individual, company, or corporation operating thereunder working any
mine or mines by hydraulic process, the debris from which flows into or
is in whole or in part restrained by such dams or other works erected by
said commission, shall pay for each cubic yard mined from the natural
bank a tax equal to the total capital cost of the dam, reservoir, and
rights of way divided by the total capacity of the reservoir for the
restraint of debris, as determined in each case by the California Debris
Commission, which tax shall be paid annually on a date fixed by said
commission and in accordance with regulations to be adopted by the
Secretary of the Treasury, and the Treasurer of the United States is
hereby authorized to receive the same. * * * The Secretary of the Army
is authorized to enter into contracts to supply storage for water and
use of outlet facilities from debris storage reservoirs, for domestic
and irrigation purposes and power development upon such conditions of
delivery, use, and payment as he may approve: Provided, That the moneys
received from such contracts shall be deposited to the credit of the
reservoir project from which the water is supplied, and the total
capital cost of said reservoir, which is to be repaid by tax on mining
operations as herein provided, shall be reduced in the amount so
received.
Sec. 50.2 Scope of regulations.
(a) In general. The regulations in this part relate to the tax
imposed with respect to hydraulic mining, the debris from which flows
into or is in whole or in part restrained by dams or other works erected
for the detention of debris by the California Debris Commission in the
area drained by the Sacramento and San Joaquin river systems in the
State of California. The regulations have application to taxable years
beginning after August 31, 1959.
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For definition of the term taxable year, see Sec. 50.3(g).
(b) Extent to which the regulations in this part supersede prior
regulations. The regulations in this part, with respect to the subject
matter within the scope thereof, supersede Treasury Decision 4952 (26
CFR (1939) part 317).
Sec. 50.3 General definitions and use of terms.
As used in the regulations in this part:
(a) The term Act means ``An Act to create the California Debris
Commission and regulate hydraulic mining in the State of California''
approved March 1, 1893, as amended, 27 Stat. 507; 34 Stat. 1001; 48
Stat. 1118; 52 Stat. 1040; 61 Stat. 501; 33 U.S.C. 661-687.
(b) The term person means an individual, a trust, estate,
partnership, company, or corporation.
(c) The term Secretary means the Secretary of the Treasury.
(d) The term Commissioner means the Commissioner of Internal
Revenue.
(e) The term district director means the district director of
internal revenue.
(f) The terms hydraulic mining and mining by the hydraulic process
shall have the meaning and application given said terms in the State of
California.
(g) The term taxable year means the twelve-month period ending on
August 31 of each year for which the tax imposed by the Act is payable.
Sec. 50.4 Rates of tax.
(a) Determination of rate. Under the Act the California Debris
Commission will determine and prescribe with respect to each debris dam
or other works the rate of tax payable in the area served by the
particular debris dam or works. The Secretary of the Army will notify
the Secretary of the Treasury of the rate of tax fixed with respect to
each debris dam or works as such rate becomes known.
(b) Measure of tax. The tax is payable annually on the basis of the
number of cubic yards mined from the natural bank by the hydraulic
process during the taxable year.
Sec. 50.5 Liability for the tax.
Liability for tax attaches to any person engaged at any time during
the taxable year in hydraulic mining in the area identified in paragraph
(a) of Sec. 50.2, if the debris from such mining operations is in whole
or in part restrained by any of the debris dams or works constructed by
the California Debris Commission.
Sec. 50.6 Ascertainment of quantity mined.
Each person engaged in hydraulic mining operations within the scope
of the tax shall make or cause to be made appropriate surveys of the
premises on which such hydraulic mining operations are conducted for the
purpose of determining the cubic yardage mined from the natural bank.
Such surveys shall be made at the beginning and end of hydraulic mining
operations in each taxable year by a licensed engineer or other
qualified agency having prior approval of the California Debris
Commission, and shall conform to requirements prescribed by the
California Debris Commission.
Sec. 50.7 Returns.
(a) Form of return. Every person liable for tax for any taxable year
shall prepare for such year a return on Form 1 (California Debris) in
accordance with the instructions thereon and in accordance with the
regulations in this part.
(b) Content of return. The return shall show:
(1) The identity of the particular dam or other works restraining
debris from the mine;
(2) The name and location of the mine;
(3) The name and address of the person to whom the California Debris
Commission has issued a license to operate the mine;
(4) The number and date of the license;
(5) The name and address of the owner of the mine;
(6) The dates on which hydraulic mining operations began and ended
during the taxable year for which the return is made;
(7) The number of cubic yards mined by the hydraulic process at the
mine during the taxable year;
[[Page 7]]
(8) The rate of tax per cubic yard determined by the California
Debris Commission applicable to the particular mine; and
(9) The amount of tax due and payable (cubic yards mined multiplied
by the rate of tax per cubic yard).
(c) Supporting statement. With each return there must be submitted a
supporting statement of the person who made the surveys at the mine for
the mining season covered by the return (see Sec. 50.6), stating that
such surveys were made in accordance with requirements prescribed by the
California Debris Commission.
(d) Verification of return and supporting statement. The return and
the supporting statement shall be verified by written declarations that
they are made under the penalties of perjury.
Sec. 50.8 Due date and place for filing returns and paying tax.
The return for a taxable year shall be filed with, and the tax shall
be paid to, the district director at San Francisco, California, on or
before September 30 of the calendar year in which the taxable year ends.
The tax is due and payable on such date without assessment by, or notice
from, the district director.
PART 52_ENVIRONMENTAL TAXES--Table of Contents
Sec.
52.0-1 Introduction.
52.4681-1 Taxes imposed with respect to ozone-depleting chemicals.
52.4682-1 Ozone-depleting chemicals.
52.4682-2 Qualifying sales.
52.4682-3 Imported taxable products.
52.4682-4 Floor stocks tax.
52.4682-5 Exports.
Authority: 26 U.S.C. 7805.
Section 52.4682-3 also issued under 26 U.S.C. 4682(c)(2);
Section 52.4682-5 also issued under 26 U.S.C. 4662(e)(4).
Sec. 52.0-1 Introduction.
The regulations in this part 52 are designated ``Environmental Tax
Regulations.'' The regulations relate to the environmental taxes imposed
by chapter 38 of the Internal Revenue Code. See part 40 of this chapter
for regulations relating to returns, payments, and deposits of taxes
imposed by chapter 38.
[T.D. 8442, 57 FR 48186, Oct. 22, 1992]
Sec. 52.4681-1 Taxes imposed with respect to ozone-depleting chemicals.
(a) Taxes imposed. Sections 4681 and 4682 impose the following taxes
with respect to ozone-depleting chemicals (ODCs):
(1) Tax on ODCs. Section 4681(a)(1) imposes a tax on ODCs that are
sold or used by the manufacturer or importer thereof. Except as
otherwise provided in Sec. 52.4682-1 (relating to the tax on ODCs), the
amount of the tax is equal to the product of--
(i) The weight (in pounds) of the ODC;
(ii) The base tax amount (determined under section 4681(b)(1) (B) or
(C)) for the calendar year in which the sale or use occurs; and
(iii) The ozone-depletion factor (determined under section 4682(b))
for the ODC.
(2) Tax on imported taxable products. Section 4681(a)(2) imposes a
tax on imported taxable products that are sold or used by the importer
thereof. Except as otherwise provided in Sec. 52.4682-3 (relating to
the tax on imported taxable products), the tax is computed by reference
to the weight of the ODCs used as materials in the manufacture of the
product. The amount of tax is equal to the tax that would have been
imposed on the ODCs under section 4681(a)(1) if the ODCs had been sold
in the United States on the date of the sale or use of the imported
product. The weight of such ODCs is determined under Sec. 52.4682-3.
(3) Floor stocks tax--(i) Imposition of tax. Section 4682(h) imposes
a floor stocks tax on ODCs that--
(A) Are held by any person other than the manufacturer or importer
of the ODC on a date specified in paragraph (a)(3)(ii) of this section;
and
(B) Are held on such date for sale or for use in further
manufacture.
(ii) Dates on which tax imposed. The floor stocks tax is imposed on
January 1 of each calendar year after 1989.
(iii) Amount of tax. Except as otherwise provided in Sec. 52.4682-4
(relating to the floor stocks tax), the amount of the
[[Page 8]]
floor stocks tax is equal to the excess of--
(A) The tax that would be imposed on the ODC under section
4681(a)(1) if a sale or use of the ODC by its manufacturer or importer
occurred on the date the floor stocks tax is imposed (the tentative tax
amount), over
(B) The sum of the taxes previously imposed (if any) on the ODC
under sections 4681 and 4682.
(b) Cross-references--(1) Tax on ODCs. Additional rules relating to
the tax on ODCs are contained in Sec. Sec. 52.4682-1 and 52.4682-2.
(2) Tax on imported taxable products. Additional rules relating to
the tax on imported taxable products are contained in Sec. 52.4682-3.
(3) Floor stocks tax. Additional rules relating to the floor stocks
tax are contained in Sec. 52.4682-4.
(4) Returns, payments, and deposits of tax. Rules requiring returns
reporting the taxes imposed by sections 4681 and 4682 are contained in
part 40 of this chapter. Part 40 of this chapter also provides rules
relating to the use of Government depositaries and to the time for
filing returns and making payments of tax.
(c) Definitions of general application. The following definitions
set forth the meaning of certain terms for purposes of the regulations
under sections 4681 and 4682:
(1) Ozone-depleting chemical. The term ``ozone-depleting chemical''
(ODC) means any chemical listed in section 4682(a)(2).
(2) United States. The term ``United States'' has the meaning given
such term by section 4612(a)(4). Under section 4612(a)(4)--
(i) The term ``United States'' means the 50 States, the District of
Columbia, the Commonwealth of Puerto Rico, any possession of the United
States, the Commonwealth of the Northern Mariana Islands, and the Trust
Territory of the Pacific Islands; and
(ii) The term includes--
(A) Submarine seabed and subsoil that would be treated as part of
the United States (as defined in paragraph (c)(2)(i) of this section)
under the principles of section 638 relating to continental shelf areas;
and
(B) Foreign trade zones of the United States.
(3) Manufacture; manufacturer. The term ``manufacture'' when used
with respect to any ODC or imported product includes its production, and
the term ``manufacturer'' includes a producer.
(4) Entry into United States for consumption, use, or warehousing--
(i) In general. Except as otherwise provided in this paragraph (c)(4),
the term ``entered into the United States for consumption, use, or
warehousing'' when used with respect to any goods means--
(A) Brought into the customs territory of the United States (the
customs territory) if applicable customs law requires that the goods be
entered into the customs territory for consumption, use, or warehousing;
(B) Admitted into a foreign trade zone for any purpose if like goods
brought into the customs territory for such purpose would be entered
into the customs territory for consumption, use, or warehousing; or
(C) Imported into any other part of the United States (as defined in
paragraph (c)(2) of this section) for any purpose if like goods brought
into the customs territory for such purpose would be entered into the
customs territory for consumption, use, or warehousing.
(ii) Entry for transportation and exportation. Goods entered into
the customs territory for transportation and exportation are not goods
entered for consumption, use, or warehousing.
(iii) Entries described in two or more provisions. In the case of
any goods with respect to which entries are described in two or more
provisions of paragraph (c)(4)(i) of this section, only the first such
entry is taken into account. Thus, if the admission of goods into a
foreign trade zone is an entry into the United States for consumption,
use, or warehousing, the subsequent entry of such goods into the customs
territory will not be treated as an entry into the United States for
consumption, use, or warehousing.
(iv) Certain imported products not entered for consumption, use, or
warehousing. Imported products that are entered into the United States
for consumption, use, or warehousing do
[[Page 9]]
not include any imported products that--
(A) Are entered into the customs territory under Harmonized Tariff
Schedule (HTS) heading 9801, 9802, 9803, or 9813;
(B) Would, if entered into the customs territory, be entered under
any such heading; or
(C) Are brought into the United States by an individual if the
product is brought in for use by the individual and is not expected to
be used in a trade or business other than a trade or business of
performing services as an employee.
(5) Importer. The term ``importer'' means the person that first
sells or uses goods after their entry into the United States for
consumption, use, or warehousing (within the meaning of paragraph (c)(4)
of this section).
(6) Sale. The term ``sale'' means the transfer of title or of
substantial incidents of ownership (whether or not delivery to, or
payment by, the buyer has been made) for consideration which may include
money, services, or property. The determination as to the time a sale
occurs shall be made under applicable local law.
(7) Use--(i) In general. Except as otherwise provided in regulations
under sections 4681 and 4682, ODCs and imported taxable products are
used when they are--
(A) Used as a material in the manufacture of an article, whether by
incorporation into such article, chemical transformation, release into
the atmosphere, or otherwise; or
(B) Put into service in a trade or business or for production of
income.
(ii) Loss, destruction, packaging, warehousing, and repair. The
loss, destruction, packaging (including repackaging), warehousing, or
repair of ODCs and imported taxable products is not a use of the ODC or
product lost, destroyed, packaged, warehoused, or repaired.
(iii) Cross-references to exceptions. For exceptions to the rule
contained in paragraph (c)(7)(i) of this section, see--
(A) Section 52.4682-1(b)(2)(iii) (relating to mixture elections),
Sec. 52.4682-1(b)(2)(iv) (relating to mixtures for export), and Sec.
52.4682-1(b)(2)(v) (relating to mixtures for use as a feedstock);
(B) Section 52.4682-3(c)(2) (relating to the election to treat entry
of an imported taxable product as use); and
(C) Section 52.4682-3(c)(3) (relating to treating sale of an article
incorporating an imported taxable product as the first sale or use of
the product).
(8) Pound. The term ``pound'' means a unit of weight that is equal
to 16 avoirdupois ounces.
(9) Post-1990 ODC; post-1989 ODC. The term ``post-1990 ODC'' means
any ODC that is listed below Halon-2402 in the table contained in
section 4682(a)(2). The term ``post-1989 ODC'' means any ODC other than
a post-1990 ODC.
(d) Effective date. Sections 52.4681-0, 52.4681-1, 52.4682-1,
52.4682-2, 52.4682-3, and 52.4682-4 are effective as of January 1, 1990,
and apply to--
(1) Post-1989 ODCs that the manufacturer or importer thereof first
sells or uses after December 31, 1989, and post-1990 ODCs that the
manufacturer or importer thereof first sells or uses after December 31,
1990;
(2) Imported taxable products that the importer thereof first sells
or uses after December 31, 1989 (but, in the case of products first sold
or used before January 1, 1991, by taking into account only the post-
1989 ODCs used as materials in their manufacture); and
(3) Post-1989 ODCs held for sale or for use in further manufacture
by any person other than the manufacturer or importer thereof on January
1, 1990, and post-1989 and post-1990 ODCs that are so held on January 1
of each calendar year after 1990.
[T.D. 8370, 56 FR 56305, Nov. 4, 1991, as amended by T.D. 8442, 57 FR
48186, Oct. 22, 1992; T.D. 8622, 60 FR 52849, Oct. 11, 1995]
Sec. 52.4682-1 Ozone-depleting chemicals.
(a) Overview. This section provides rules relating to the tax
imposed on ozone-depleting chemicals (ODCs) under section 4681,
including rules for identifying taxable ODCs and determining when the
tax is imposed, and rules prescribing special treatment for certain
ODCs. See Sec. 52.4681-1(a)(1) and (c) for general rules and
definitions relating to the tax on ODCs.
(b) Taxable ODCs; taxable event--(1) Taxable ODCs--(i) In general.
Except as provided in paragraphs (c) through (g) of this section, an ODC
is taxable if--
[[Page 10]]
(A) It is listed in section 4682(a)(2) on the date it is sold or
used by its manufacturer or importer; and
(B) It is manufactured in the United States or entered into the
United States for consumption, use, or warehousing.
(ii) Storage containers. An ODC described in paragraph (b)(1)(i) of
this section is taxable without regard to the type or size of storage
container in which the ODC is held.
(iii) Example. The application of this paragraph (b)(1) may be
illustrated by the following example:
Example. A brings CFC-12, an ODC listed in section 4682(a)(2), into
the customs territory and enters the CFC-12 for transportation and
exportation. The ODC is not taxable because it is not entered for
consumption, use, or warehousing. The ODC also would not be taxable if
it were admitted to a foreign trade zone (rather than brought into the
customs territory) for transportation and exportation.
(2) Taxable event--(i) In general--(A) General rule. The tax on an
ODC is imposed when the ODC is first sold or used (as defined in Sec.
52.4681-1(c)(6) and (7)) by its manufacturer or importer.
(B) Example. The application of this paragraph (b)(2)(i) may be
illustrated by the following example:
Example. A enters CFC-113, an ODC listed in section 4682(a)(2), into
the United States for consumption, use, or warehousing. A warehouses the
CFC-113 and then decides to ship the ODC to its factory outside the
United States (as defined in Sec. 52.4681-1 (c)(2)). The CFC-113 is a
taxable ODC because the requirements of paragraph (b)(1)(i) of this
section have been met. However, tax is not imposed on the ODC because
there is no taxable event. A did not sell the ODC and, under Sec.
52.4681-1(c)(7), warehousing is not a use.
(ii) Mixtures. Except as provided in paragraphs (b)(2)(iii), (iv),
and (v) of this section, the creation of a mixture containing two or
more ingredients is treated as a taxable use of the ODCs contained in
the mixture. For this purpose, a mixture cannot be represented by a
chemical formula, and an ODC is contained in a mixture only if the
chemical identity of the ODC is not changed. Thus, except as provided in
paragraphs (b)(2)(iii), (iv), and (v) of this section--
(A) The tax on the post-1989 ODCs (as defined in Sec. 52.4681-
1(c)(9)) contained in mixtures created after December 31, 1989, or on
the post-1990 ODCs (as defined in Sec. 52.4681-1(c)(9)) contained in
mixtures created after December 31, 1990, is imposed when the mixture is
created and not on any subsequent sale or use of the mixture; and
(B) No tax is imposed under section 4681 on the post-1989 ODCs
contained in mixtures created before January 1, 1990, or on the post-
1990 ODCs contained in mixtures created before January 1, 1991.
(iii) Mixture elections--(A) Permitted elections. The only elections
permitted under this paragraph (b)(2)(iii) are--
(1) An election for the first calendar quarter beginning after
December 31, 1989, and all subsequent periods (the 1990 election); and
(2) An election for the first calendar quarter beginning after
December 31, 1990, and all subsequent periods (the 1991 election).
(B) In general. A manufacturer or importer may elect to treat the
sale or use of mixtures containing ODCs as the first sale or use of the
ODCs contained in the mixtures. If a 1990 election is made under this
paragraph (b)(2)(iii), the tax on post-1989 ODCs contained in a mixture
sold or used after December 31, 1989 (including any such mixture created
before January 1, 1990) is imposed on the date of such sale or use.
Similarly, if a 1991 election is made under this paragraph (b)(2)(iii),
the tax on post-1990 ODCs contained in a mixture sold or used after
December 31, 1990 (including any such mixture created before January 1,
1991) is imposed on the date of such sale or use.
(C) Applicability of elections. An election under this paragraph
(b)(2)(iii) applies--
(1) In the case of a 1990 election, to all post-1989 ODCs contained
in mixtures sold or used by the manufacturer or importer after December
31, 1989 (including any such mixture created before January 1, 1990);
and
(2) In the case of a 1991 election, to all post-1990 ODCs contained
in mixtures sold or used by the manufacturer or importer after December
31, 1990 (including any such mixture created before January 1, 1991).
(D) Making the election; revocation. An election under this
paragraph (b)(2)(iii)
[[Page 11]]
shall be made in accordance with the instructions for the return on
which the manufacturer or importer reports liability for tax under
section 4681. After October 9, 1990, the election may be revoked only
with the consent of the Commissioner.
(iv) Special rule for exports. The creation of a mixture for export
is not a taxable use of the ODCs contained in the mixture. If a
manufacturer or importer sells a mixture for export, Sec. 52.4682-5
applies to the ODCs contained in the mixture. See Sec. 52.4682-5(e) for
rules relating to liability of a purchaser for tax if the mixture is not
exported.
(v) Special rule for use as a feedstock. The creation of a mixture
for use as a feedstock (within the meaning of paragraph (c) of this
section) is not a taxable use of the ODCs contained in the mixture.
(c) ODCs used as a feedstock--(1) Exemption from tax. No tax is
imposed on an ODC if the manufacturer or importer of the ODC--
(i) Uses the ODC as a feedstock in the manufacture of another
chemical; or
(ii) Sells the ODC in a qualifying sale (within the meaning of
paragraph (c)(4) of this section) for use as a feedstock.
(2) Excess payments--(i) In general. Under section 4682(d)(2)(B), a
credit or refund is allowed to a person if--
(A) The person uses an ODC as a feedstock; and
(B) The amount of any tax paid with respect to the ODC under section
4681 or 4682 was not determined under section 4682(d)(2)(A).
(ii) Procedural rules. See section 6402 and the regulations
thereunder for rules relating to claiming a credit or refund of tax paid
with respect to ODCs that are used as a feedstock. A credit against the
income tax is not allowed for the amount determined under section
4682(d)(2)(B).
(3) Definition. An ODC is used as a feedstock only if the ODC is
entirely consumed (except for trace amounts) in the manufacture of
another chemical. Thus, the transformation of an ODC into one or more
new compounds (such as the transformation of CFC-113 into
chlorotrifluoroethylene (CTFE or 1113), of CFC-113 into CFC-115 and CFC-
116, or of carbon tetrachloride into hydrochloric acid during petroleum
refining or incineration) is treated as use as a feedstock. On the other
hand, the ODCs used in a mixture (including an azeotrope such as R-500
or R-502) are not used as a feedstock.
(4) Qualifying sale. A sale of ODCs for use as a feedstock is a
qualifying sale if the requirements of Sec. 52.4682-2(b)(1) are
satisfied with respect to such sale.
(d) ODCs used in the manufacture of rigid foam insulation--(1)
Phase-in of tax--(i) In general. The amount of tax imposed on an ODC is
determined under section 4682(g) if the manufacturer or importer of the
ODC--
(A) Uses the ODC during 1990, 1991, 1992, or 1993 in the manufacture
of rigid foam insulation; or
(B) Sells the ODC in a qualifying sale (within the meaning of
paragraph (d)(5) of this section) during 1990, 1991, 1992, or 1993.
(ii) Amount of tax. Under section 4682(g), ODCs described in
paragraph (d)(1)(i) of this section are not taxed if sold or used during
1990 and are taxed at a reduced rate if sold or used during 1991, 1992,
or 1993.
(2) Excess payments--(i) In general. Under section 4682(g)(3), a
credit against income tax or a refund is allowed to a person if--
(A) The person uses an ODC during 1990, 1991, 1992, or 1993 in the
manufacture of rigid foam insulation; and
(B) The amount of any tax paid with respect to the ODC under section
4681 or 4682 was not determined under section 4682(g).
(ii) Procedural rules--(A) The amount determined under section
4682(g)(3) shall be treated as a credit described in section 34(a)
(relating to credits for gasoline and special fuels) unless a claim for
refund has been filed.
(B) See section 6402 and the regulations thereunder for rules
relating to claiming a credit or refund of the tax paid with respect to
ODCs that are used in the manufacture of rigid foam insulation.
(3) Definition--(i) Rigid foam insulation. The term ``rigid foam
insulation'' means any rigid foam that is designed for use as thermal
insulation in buildings, equipment, appliances, tanks, railcars, trucks,
or vessels, or on pipes, including any such rigid foam actually
[[Page 12]]
used for purposes other than insulation. Information such as test
reports on R-values and advertising material reflecting R-value claims
for a particular rigid foam may be used to show that such rigid foam is
designed for use as thermal insulation.
(ii) Rigid foam--(A) In general. The term ``rigid foam'' means any
closed cell polymeric foam (whether or not rigid) in which
chlorofluorocarbons are used to fill voids within the polymer.
(B) Examples of rigid foam products. Rigid foam includes extruded
polystyrene foam, polyisocyanurate foam, spray and pour-in-place
polyurethane foam, polyethylene foam, phenolic foam, and any other
product that the Commissioner identifies as rigid foam in a
pronouncement of general applicability. The form of a product identified
under this paragraph (d)(3)(ii)(B) does not affect its character as
rigid foam. Thus, such products are rigid foam whether in the form of a
board, sheet, backer rod, or wrapping, or in a form applied by spraying,
pouring, or frothing.
(4) Use in manufacture. An ODC is used in the manufacture of rigid
foam insulation if it is incorporated into such product or is expended
as a propellant or otherwise in the manufacture or application of such
product.
(5) Qualifying sale. A sale of an ODC for use in the manufacture of
rigid foam insulation is a qualifying sale if the requirements of Sec.
52.4682-2(b)(2) are satisfied with respect to such sale.
(e) Halons; phase-in of tax. The amount of tax imposed on Halon-
1211, Halon-1301, or Halon-2402 (Halons) is determined under section
4682(g) if the manufacturer or importer of Halons sells or uses Halons
during 1990, 1991, 1992, or 1993. Under section 4682(g), Halons are not
taxed if sold or used during 1990 and are taxed at a reduced rate if
sold or used during 1991, 1992, or 1993.
(f) Methyl chloroform; reduced rate of tax in 1993. The amount of
tax imposed on methyl chloroform is determined under section 4682(g)(5)
if the manufacturer or importer of the methyl chloroform sells or uses
it during 1993.
(g) ODCs used as medical sterilants--(1) Phase-in of tax. The amount
of tax imposed on an ODC is determined under section 4682(g)(4) if the
manufacturer or importer of the ODC--
(i) Uses the ODC during 1993 as a medical sterilant; or
(ii) Sells the ODC in a qualifying sale (within the meaning of
paragraph (g)(4) of this section) during 1993.
(2) Excess payments--(i) In general. Under section 4682(g)(4)(B), a
credit against income tax (without interest) or a refund of tax (without
interest) is allowed to a person if--
(A) The person uses an ODC during 1993 as a medical sterilant; and
(B) The amount of any tax paid with respect to the ODC under section
4681 or 4682 exceeds the amount that would have been determined under
section 4682(g)(4).
(ii) Amount of credit or refund. The amount of credit or refund of
tax is equal to the excess of--
(A) The tax that was paid with respect to the ODCs under sections
4681 and 4682; over
(B) The tax that would have been imposed under section 4682(g)(4).
(iii) Procedural rules. (A) The amount determined under section
4682(g)(4)(B) and paragraph (g)(2)(ii) of this section is treated as a
credit described in section 34(a) (relating to credits for gasoline and
special fuels) unless a claim for refund has been filed.
(B) See section 6402 and the regulations under that section for
procedural rules relating to claiming a credit or refund of tax.
(3) Definition of use as a medical sterilant. An ODC is used as a
medical sterilant if it is used in the manufacture of sterilant gas.
(4) Qualifying sale. A sale of an ODC for use as a medical sterilant
is a qualifying sale if the requirements of Sec. 52.4682-2(b)(3) are
satisfied with respect to the sale.
(h) ODCs used as propellants in metered-dose inhalers--(1) Reduced
rate of tax. The amount of tax imposed on an ODC is determined under
section 4682(g)(4) if the manufacturer or importer of the ODC--
(i) Uses the ODC after 1992 as a propellant in a metered-dose
inhaler; or
(ii) Sells the ODC in a qualifying sale (within the meaning of
paragraph (h)(4) of this section) after 1992.
[[Page 13]]
(2) Excess payments--(i) In general. Under section 4682(g)(4)(B), a
credit against income tax (without interest) or a refund of tax (without
interest) is allowed to a person if--
(A) The person uses an ODC after 1992 as a propellant in a metered-
dose inhaler; and
(B) The amount of any tax paid with respect to the ODC under section
4681 or 4682 exceeds the amount that would have been determined under
section 4682(g)(4).
(ii) Amount of credit or refund. The amount of credit or refund of
tax is equal to the excess of--
(A) The tax that was paid with respect to the ODCs under sections
4681 and 4682; over
(B) The tax that would have been imposed under section 4682(g)(4).
(iii) Procedural rules--(A) The amount determined under section
4682(g)(4)(B) and paragraph (h)(2)(ii) of this section is treated as a
credit described in section 34(a) (relating to credits for gasoline and
special fuels) unless a claim for refund has been filed.
(B) See section 6402 and the regulations under that section for
procedural rules relating to claiming a credit or refund of tax.
(3) Definition of metered-dose inhaler. A metered-dose inhaler is an
aerosol device that delivers a precisely-measured dose of a therapeutic
drug.
(4) Qualifying sale. A sale of an ODC for use as a propellant for a
metered-dose inhaler is a qualifying sale if the requirements of Sec.
52.4682-2(b)(4) are satisfied with respect to the sale.
(i) [Reserved]
(j) Exports; cross-reference. For the treatment of exports of ODCs,
see Sec. 52.4682-5.
(k) Recycling. [Reserved]
[T.D. 8370, 56 FR 56307, Nov. 4, 1991, as amended by T.D. 8622, 60 FR
52849, Oct. 11, 1995]
Sec. 52.4682-2 Qualifying sales.
(a) In general--(1) Special rules applicable to certain sales.
Special rules apply to sales of ODCs in the following cases:
(i) Under section 4682(d)(2), Sec. 52.4682-1(c), and Sec. 52.4682-
4(b)(2)(v) (relating to ODCs used as a feedstock), ODCs sold in
qualifying sales are not taxed.
(ii) Under section 4682(g), Sec. 52.4682-1(d), and Sec. 52.4682-
4(d)(2) (relating to ODCs used in the manufacture of rigid foam
insulation), ODCs sold in qualifying sales are not taxed in 1990 and are
taxed at a reduced rate in 1991, 1992, and 1993.
(iii) Under section 4682(g)(4) and Sec. 52.4682-1(g) (relating to
ODCs used as medical sterilants), ODCs sold in qualifying sales are
taxed at a reduced rate in 1993.
(iv) Under section 4682(g)(4) and Sec. 52.4682-1(h) (relating to
ODCs used as propellants in metered-dose inhalers), ODCs sold in
qualifying sales are taxed at a reduced rate in years after 1992.
(2) Qualifying sales. A sale of ODCs is not a qualifying sale unless
the requirements of this section are satisfied. Although registration
with the Internal Revenue Service is not required to establish that a
sale of ODCs is a qualifying sale, the certificates required by this
section shall be made available for inspection by internal revenue
agents and officers.
(b) Requirements for qualification--(1) Use as a feedstock. A sale
of ODCs is a qualifying sale for purposes of Sec. Sec. 52.4682-1(c) and
52.4682-4(b)(2)(v) if the manufacturer or importer of the ODCs--
(i) Obtains a certificate in substantially the form set forth in
paragraph (d)(2) of this section from the purchaser of the ODCs; and
(ii) Relies on the certificate in good faith.
(2) Use in the manufacture of rigid foam insulation. A sale of ODCs
is a qualifying sale for purposes of Sec. Sec. 52.4682-1(d) and
52.4682-4(d)(2) if the manufacturer or importer of the ODCs--
(i) Obtains a certificate in substantially the form set forth in
paragraph (d)(3) of this section from the purchaser of the ODCs; and
(ii) Relies on the certificate in good faith.
(3) Use as medical sterilants. A sale of ODCs is a qualifying sale
for purposes of Sec. 52.4682-1(g) if the manufacturer or importer of
the ODCs--
(i) Obtains a certificate in substantially the form set forth in
paragraph (d)(4) of this section from the purchaser of the ODCs; and
(ii) Relies on the certificate in good faith.
[[Page 14]]
(4) Use as propellants in metered-dose inhalers. A sale of ODCs is a
qualifying sale for purposes of Sec. Sec. 52.4682-1(h) and 52.4682-
4(b)(2)(vii) if the manufacturer or importer of the ODCs--
(i) Obtains a certificate in substantially the form set forth in
paragraph (d)(5) of this section from the purchaser of the ODCs; and
(ii) Relies on the certificate in good faith.
(c) Good faith reliance--(1) In general. The requirements of
paragraph (b) of this section are not satisfied with respect to a sale
of ODCs and the sale is not a qualifying sale if at the time of the
sale--
(i) The manufacturer or importer has reason to believe that the
purchaser will use the ODCs other than for the purpose set forth in the
certificate; or
(ii) The Internal Revenue Service has notified the manufacturer or
importer that the purchaser's right to provide a certificate has been
withdrawn.
(2) Withdrawal of right to provide a certificate. The Internal
Revenue Service may withdraw the right of a purchaser to provide a
certificate to its supplier if such purchaser uses the ODCs to which its
certificate applies other than for the purpose set forth in such
certificate, or otherwise fails to comply with the terms of the
certificate. The Internal Revenue Service may notify the supplier to
whom the purchaser provided the certificate that the purchaser's right
to provide a certificate has been withdrawn.
(d) Certificate--(1) In general--(i) Rules relating to all
certificates. This paragraph (d) sets forth certificates that satisfy
the requirements of paragraphs (b)(1) through (4) of this section. The
certificate shall consist of a statement executed and signed under
penalties of perjury by a person with authority to bind the purchaser. A
certificate provided under paragraph (d)(2) or (5) of this section may
apply to a single purchase or to multiple purchases and need not specify
an expiration date. A certificate provided under paragraph (d)(3) or (4)
of this section may apply to a single purchase or multiple purchases,
and will expire as of December 31, 1993, unless an earlier expiration
date is specified in the certificate. A new certificate must be given to
the supplier if any information on the current certificate changes. The
certificate may be included as part of any business records normally
used to document a sale.
(ii) Special rule relating to certificates executed before January
1, 1992. Certificates provided under this paragraph (d)(2) and executed
before January 1, 1992, satisfy the requirements of paragraph (b) of
this section if they are in substantially the same form as certificates
set forth in Sec. 52.4682-2T.
(2) Certificate relating to ODCs used as a feedstock--(i) ODCs that
will be resold for use by the second purchaser as a feedstock. If the
purchaser will resell the ODCs to a second purchaser for use by such
second purchaser as a feedstock, the certificate provided by the
purchaser must be in substantially the following form:
Certificate of Purchaser of Chemicals That Will Be Resold for Use by the
Second Purchaser as a Feedstock
(To support tax-free sales under section 4682(d)(2) of the Internal
Revenue Code.)
Date____________________________________________________________________
The undersigned purchaser (``Purchaser'') hereby certifies the
following under penalties of perjury:
The following percentage of ozone-depleting chemicals purchased from
________________________________________________________________________
(name and address of seller)
will be resold by Purchaser to persons (Second Purchasers) that certify
to Purchaser that they are purchasing the ozone-depleting chemicals for
use as a feedstock (as defined in Sec. 52.4682-1(c)(3) of the
Environmental Tax Regulations).
------------------------------------------------------------------------
Product Percentage
------------------------------------------------------------------------
CFC-11.....................................
CFC-12.....................................
CFC-113....................................
CFC-114....................................
CFC-115....................................
Carbon tetrachloride.......................
Methyl chloroform..........................
Other (specify)............................
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account
number(s):
[[Page 15]]
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Purchaser will not claim a credit or refund under section
4682(d)(2)(B) of the Internal Revenue Code for any ozone-depleting
chemicals covered by this certificate.
Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the
purpose set forth in this certificate may result in the withdrawal by
the Internal Revenue Service of Purchaser's right to provide a
certificate.
Purchaser will retain the business records needed to document the
sales covered by this certificate and will make such records available
for inspection by Government officers. Purchaser also will retain and
make available for inspection by Government officers the certificates of
its Second Purchasers.
Purchaser has not been notified by the Internal Revenue Service that
its right to provide a certificate has been withdrawn. In addition, the
Internal Revenue Service has not notified Purchaser that the right to
provide a certificate has been withdrawn from any Second Purchaser who
will purchase ozone-depleting chemicals to which this certificate
applies.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment, or both, together with the costs
of prosecution.
________________________________________________________________________
Signature
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Title of person signing
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number
(ii) ODCs that will be used by the purchaser as a feedstock. If the
purchaser will use the ODCs as a feedstock, the certificate provided by
the purchaser must be in substantially the following form:
Certificate of Purchaser of Chemicals That Will Be Used by the Purchaser
as a Feedstock
(To support tax-free sales under section 4682(d)(2) of the Internal
Revenue Code.)
Date____________________________________________________________________
The undersigned purchaser (``Purchaser'') hereby certifies the
following under penalties of perjury:
The following percentage of ozone-depleting chemicals purchased from
________________________________________________________________________
(name and address of seller)
will be used by Purchaser as a feedstock (as defined in Sec. 52.4682-
1(c)(3) of the Environmental Tax Regulations).
------------------------------------------------------------------------
Kilograms to be
Product Percentage transformed
------------------------------------------------------------------------
CFC-11...........................
CFC-12...........................
CFC-113..........................
CFC-114..........................
CFC-115..........................
Carbon tetrachloride.............
Methyl chloroform................
Other (specify)..................
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account
number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Purchaser will not claim a credit or refund under section
4682(d)(2)(B) of the Internal Revenue Code for any ozone-depleting
chemicals covered by this certificate.
Purchaser understands that any use of the ozone-depleting chemicals
to which this certificate applies other than as a feedstock may result
in the withdrawal by the Internal
[[Page 16]]
Revenue Service of Purchaser's right to provide a certificate.
Purchaser will retain the business records needed to document the
use as a feedstock of the ozone-depleting chemicals to which this
certificate applies and will make such records available for inspection
by Government officers.
Purchaser has not been notified by the Internal Revenue Service that
its right to provide a certificate has been withdrawn.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment, or both, together with the costs
of prosecution.
________________________________________________________________________
Signature
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Title of person signing
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number
(3) Certificate relating to ODCs used in the manufacture of rigid
foam insulation--(i) ODCs that will be resold to a second purchaser for
use by the second purchaser in the manufacture of rigid foam insulation.
If the purchaser will resell the ODCs to a second purchaser for use by
such second purchaser in the manufacture of rigid foam insulation, the
certificate provided by the purchaser must be in substantially the
following form:
Certificate of Purchaser of Chemicals That Will Be Resold for Use by the
Second Purchaser in the Manufacture of Rigid Foam Insulation
(To support tax-free or tax-reduced sales under section 4682(g) of the
Internal Revenue Code.)
Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not after 12/31/93)
The undersigned purchaser (``Purchaser'') hereby certifies the
following under penalties of perjury:
The following percentage of ozone-depleting chemicals purchased from
________________________________________________________________________
(name and address of seller)
will be resold by Purchaser to persons (Second Purchasers) that certify
to Purchaser that they are purchasing the ozone-depleting chemicals for
use in the manufacture of rigid foam insulation (as defined in Sec.
52.4682-1(d)(3) and (4) of the Environmental Tax Regulations).
------------------------------------------------------------------------
Product Percentage
------------------------------------------------------------------------
CFC-11.....................................
CFC-12.....................................
CFC-113....................................
CFC-114....................................
CFC-115....................................
Carbon tetrachloride.......................
Methyl chloroform..........................
Other (specify)............................
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account
number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Purchaser will not claim a credit or refund under section 4682(g)(3)
of the Internal Revenue Code for any ozone-depleting chemicals covered
by this certificate.
Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the
purpose set forth in this certificate may result in the withdrawal by
the Internal Revenue Service of Purchaser's right to provide a
certificate.
Purchaser will retain the business records needed to document the
sales covered by this certificate and will make such records available
for inspection by Government officers. Purchaser also will retain and
make available for inspection by Government officers the certificates of
its Second Purchasers.
Purchaser has not been notified by the Internal Revenue Service that
its right to provide a certificate has been withdrawn. In addition, the
Internal Revenue Service has not notified Purchaser that the right to
provide a certificate has been withdrawn from any Second Purchaser who
will purchase ozone-
[[Page 17]]
depleting chemicals to which this certificate applies.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment, or both, together with the costs
of prosecution.
________________________________________________________________________
Signature
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Title of person signing
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number
(ii) ODCs that will be used by the purchaser in the manufacture of
rigid foam insulation. If the purchaser will use the ODCs in the
manufacture of rigid foam insulation, the certificate provided by the
purchaser must be in substantially the following form:
Certificate of Purchaser of Chemicals That Will Be Used by the Purchaser
in the Manufacture of Rigid Foam Insulation
(To support tax-free or tax-reduced sales under section 4682(g) of the
Internal Revenue Code.)
Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not after 12/31/93)
The undersigned purchaser (``Purchaser'') hereby certifies the
following under penalties of perjury:
The following percentage of ozone-depleting chemicals purchased from
________________________________________________________________________
(name and address of seller)
will be used by Purchaser in the manufacture of rigid foam insulation
(as defined in Sec. 52.4682-1(d) (3) and (4) of the Environmental Tax
Regulations).
------------------------------------------------------------------------
Product Percentage
------------------------------------------------------------------------
CFC-11.....................................
CFC-12.....................................
CFC-113....................................
CFC-114....................................
CFC-115....................................
Carbon tetrachloride.......................
Methyl chloroform..........................
Other (specify)............................
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account
number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Purchaser will not claim a credit or refund under section 4682(g)(3)
of the Internal Revenue Code for any ozone-depleting chemicals covered
by this certificate.
Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than in the
manufacture of rigid foam insulation may result in the withdrawal by the
Internal Revenue Service of Purchaser's right to provide a certificate.
Purchaser will retain the business records needed to document the
use in the manufacture of rigid foam insulation of the ozone-depleting
chemicals to which this certificate applies and will make such records
available for inspection by Government officers.
Purchaser has not been notified by the Internal Revenue Service that
its right to provide a certificate has been withdrawn.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment, or both, together with the costs
of prosecution.
________________________________________________________________________
Signature
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Title of person signing
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number
(4) Certificate relating to ODCs used as medical sterilants--(i)
ODCs that will be
[[Page 18]]
resold for use by the second purchaser as medical sterilants. If the
purchaser will resell the ODCs to a second purchaser for use by such
second purchaser as medical sterilants, the certificate provided by the
purchaser must be in substantially the following form:
CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE RESOLD FOR USE BY THE
SECOND PURCHASER AS MEDICAL STERILANTS
(To support tax-reduced sales under section 4682(g)(4) of the Internal
Revenue Code.)
Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not after 12/31/93)
The undersigned purchaser (Purchaser) certifies the following under
penalties of perjury:
The following percentage of ozone-depleting chemicals purchased
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
will be resold by Purchaser to persons (Second Purchasers) that certify
to Purchaser that they are purchasing the ozone-depleting chemicals for
use as medical sterilants (as defined in Sec. 52.4682-1(g)(3) of the
Environmental Tax Regulations).
------------------------------------------------------------------------
Product Percentage
------------------------------------------------------------------------
CFC-12..................................................... ----------
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account
number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Purchaser will not claim a credit or refund under section 4682(g)(4)
of the Internal Revenue Code for any ozone-depleting chemicals covered
by this certificate.
Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the
purpose set forth in this certificate may result in the withdrawal by
the Internal Revenue Service of Purchaser's right to provide a
certificate.
Purchaser will retain the business records needed to document the
sales covered by this certificate and will make such records available
for inspection by Government officers. Purchaser also will retain and
make available for inspection by Government officers the certificates of
its Second Purchasers.
Purchaser has not been notified by the Internal Revenue Service that
its right to provide a certificate has been withdrawn. In addition, the
Internal Revenue Service has not notified Purchaser that the right to
provide a certificate has been withdrawn from any Second Purchaser who
will purchase ozone-depleting chemicals to which this certificate
applies.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment, or both, together with the costs
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature
(ii) ODCs that will be used by the purchaser as medical sterilants.
If the purchaser will use the ODCs as medical sterilants, the
certificate provided by the purchaser must be in substantially the
following form:
CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE USED BY THE PURCHASER
AS MEDICAL STERILANTS
(To support tax-reduced sales under section 4682(g)(4) of the Internal
Revenue Code.)
Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not after 12/31/93)
The undersigned purchaser (Purchaser) certifies the following under
penalties of perjury:
The following percentage of ozone-depleting chemicals purchased
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
[[Page 19]]
will be used by Purchaser as medical sterilants (as defined in Sec.
52.4682-1(g)(3) of the Environmental Tax Regulations).
------------------------------------------------------------------------
Product Percentage
------------------------------------------------------------------------
CFC-12..................................................... ----------
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account
number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Purchaser will not claim a credit or refund under section 4682(g)(4)
of the Internal Revenue Code for any ozone-depleting chemicals covered
by this certificate.
Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than as
medical sterilants may result in the withdrawal by the Internal Revenue
Service of Purchaser's right to provide a certificate.
Purchaser will retain the business records needed to document the
use as medical sterilants of the ozone-depleting chemicals to which this
certificate applies and will make such records available for inspection
by Government officers.
Purchaser has not been notified by the Internal Revenue Service that
its right to provide a certificate has been withdrawn.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment, or both, together with the costs
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature
(5) Certificate relating to ODCs used as propellants in metered-dose
inhalers--(i) ODCs that will be resold for use by the second purchaser
as propellants in metered-dose inhalers. If the purchaser will resell
the ODCs to a second purchaser for use by such second purchaser as
propellants in metered-dose inhalers, the certificate provided by the
purchaser must be in substantially the following form:
CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE RESOLD FOR USE BY THE
SECOND PURCHASER AS PROPELLANTS IN METERED-DOSE INHALERS
(To support tax-reduced sales under section 4682(g)(4) of the Internal
Revenue Code.)
Date____________________________________________________________________
The undersigned purchaser (Purchaser) certifies the following under
penalties of perjury:
The following percentage of ozone-depleting chemicals purchased
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
will be resold by Purchaser to persons (Second Purchasers) that certify
to Purchaser that they are purchasing the ozone-depleting chemicals for
use as propellants in metered-dose inhalers (as defined in Sec.
52.4682-1(h)(3) of the Environmental Tax Regulations).
------------------------------------------------------------------------
Product Percentage
------------------------------------------------------------------------
CFC-11..................................................... --------
CFC-12..................................................... --------
CFC-114.................................................... --------
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
-------- All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following Purchaser
account number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following purchase
order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- One or more shipments to Purchaser identified as follows:
________________________________________________________________________
[[Page 20]]
________________________________________________________________________
________________________________________________________________________
Purchaser will not claim a credit or refund under section 4682(g)(4)
of the Internal Revenue Code for any ozone-depleting chemicals covered
by this certificate.
Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the
purpose set forth in this certificate may result in the withdrawal by
the Internal Revenue Service of Purchaser's right to provide a
certificate.
Purchaser will retain the business records needed to document the
sales covered by this certificate and will make such records available
for inspection by Government officers. Purchaser also will retain and
make available for inspection by Government officers the certificates of
its Second Purchasers.
Purchaser has not been notified by the Internal Revenue Service that
its right to provide a certificate has been withdrawn. In addition, the
Internal Revenue Service has not notified Purchaser that the right to
provide a certificate has been withdrawn from any Second Purchaser who
will purchase ozone-depleting chemicals to which this certificate
applies.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment, or both, together with the costs
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature
(ii) ODCs that will be used by the purchaser as propellants in
metered-dose inhalers. If the purchaser will use the ODCs as propellants
in metered-dose inhalers, the certificate provided by the purchaser must
be in substantially the following form:
CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE USED BY THE PURCHASER
AS PROPELLANTS IN METERED-DOSE INHALERS
(To support tax-reduced sales under section 4682(g)(4) of the Internal
Revenue Code.)
Date____________________________________________________________________
The undersigned purchaser (Purchaser) certifies the following under
penalties of perjury:
The following percentage of ozone-depleting chemicals purchased
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
will be used by Purchaser as propellants in metered-dose inhalers (as
defined in Sec. 52.4682-1(h)(3) of the Environmental Tax Regulations).
------------------------------------------------------------------------
Product Percentage
------------------------------------------------------------------------
CFC-11..................................................... --------
CFC-12..................................................... --------
CFC-114.................................................... --------
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
-------- All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following Purchaser
account number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following purchase
order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Purchaser will not claim a credit or refund under section 4682(g)(4)
of the Internal Revenue Code for any ozone-depleting chemicals covered
by this certificate.
Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than as
propellants in metered-dose inhalers may result in the withdrawal by the
Internal Revenue Service of Purchaser's right to provide a certificate.
Purchaser will retain the business records needed to document the
use as propellants in metered-dose inhalers of the ozone-depleting
chemicals to which this certificate applies and will make such records
available for inspection by Government officers.
Purchaser has not been notified by the Internal Revenue Service that
its right to provide a certificate has been withdrawn.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment,
[[Page 21]]
or both, together with the costs of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature
[T.D. 8370, 56 FR 56308, Nov. 4, 1991, as amended by T.D. 8622, 60 FR
52850, Oct. 11, 1995]
Sec. 52.4682-3 Imported taxable products.
(a) Overview; references to Tables; special rule for 1990--(1)
Overview. This section provides rules relating to the tax imposed on
imported taxable products under section 4681, including rules for
identifying imported taxable products, determining the weight of the
ozone-depleting chemicals (ODCs) used as materials in the manufacture of
such products, and computing the amount of tax on such products. See
Sec. 52.4681-1(a)(2) and (c) for general rules and definitions relating
to the tax on imported taxable products.
(2) References to Tables. When used in this section--
(i) The term Imported Products Table (Table) refers to the Table set
forth in paragraph (f)(6) of this section; and
(ii) The term current Imported Products Table (current Table) used
with respect to a product refers to the Table in effect on the date such
product is first sold or used by the importer thereof.
(3) Special rule for 1990. In the case of products first sold or
used before January 1, 1991, post-1990 ODCs (as defined in Sec.
52.4681-1(c)(9)) shall not be taken into account in applying the rules
of this section.
(b) Imported taxable products--(1) In general--(i) Rule. Except as
provided in paragraph (b)(2) of this section, the term ``imported
taxable product'' means any product that--
(A) Is entered into the United States for consumption, use, or
warehousing; and
(B) Is listed in the current Table.
(ii) Example. The application of this paragraph (b)(1) may be
illustrated by the following example:
Example. A brings a light truck with a Harmonized Tariff Schedule
classification of 8704 into the customs territory and enters the truck
for transportation and exportation. Although the truck is listed in the
current Table, it is not an imported taxable product because it is not
entered for consumption, use, or warehousing. The truck also would not
be an imported taxable product if it were admitted to a foreign trade
zone (rather than brought into the customs territory) for transportation
and exportation.
(2) Exceptions--(i) In general. A product is not treated as an
imported taxable product if--
(A) The product is listed in Part I of the current Table and the
adjusted tax with respect to the product is de minimis (within the
meaning of paragraph (b)(2)(ii) of this section); or
(B) The product is listed in Part II of the current Table, the
adjusted tax with respect to the product is de minimis (within the
meaning of paragraph (b)(2)(ii) of this section), and the ODCs (other
than methyl chloroform) used as materials in the manufacture of the
product were not used for purposes of refrigeration or air conditioning,
creating an aerosol or foam, or manufacturing electronic components.
(ii) De minimis adjusted tax. The adjusted tax with respect to a
product is de minimis if such tax is less than one/tenth of one percent
of the importer's cost of acquiring such product. The term adjusted tax
means the tax that would be imposed under section 468l on the ODCs used
as materials in the manufacture of such product if such ODCs were sold
in the United States and the base tax amount were $1.00.
(c) Taxable event--(1) In general. Except as otherwise provided in
paragraphs (c) (2) and (3) of this section, the tax on an imported
taxable product is imposed when the product is first sold or used (as
defined in Sec. 52.4681-1(c) (6) and (7)) by its importer. Thus, for
example, imported taxable products that are warehoused or repackaged
after entry and then exported without being sold or used in the United
States are not subject to tax.
(2) Election to treat importation as use--(i) In general. An
importer may elect to treat the entry of products
[[Page 22]]
into the United States as the use of such products. In the case of
imported taxable products to which an election under this paragraph
(c)(2) applies--
(A) Tax is imposed on the products on the date of entry (as
determined under paragraph (c)(2)(ii) of this section) if the products
are entered into the United States after the election becomes effective;
(B) Tax is imposed on the products on the date the election becomes
effective if the products were entered into the United States after
December 3l, 1989, and before the election becomes effective; and
(C) No tax is imposed if the products were entered into the United
States before January 1, 1990.
(ii) Date of entry. The date of entry is determined by reference to
customs law. If the actual date is unknown, the importer may use any
reasonable and consistent method to determine the date of entry,
provided that such date is within 10 business days of arrival of
products in the United States.
(iii) Applicability of election. An election under this paragraph
(c)(2) applies to all imported taxable products that are owned (and have
not been used) by the importer at the time the election becomes
effective and all imported taxable products that are entered into the
United States by the importer after the election becomes effective. An
election under this paragraph (c)(2) becomes effective at the beginning
of the first calendar quarter to which the election applies. After
October 9, 1990, the election may be revoked only with the consent of
the Commissioner.
(iv) Making the election. An election under this paragraph (c)(2)
shall be made in accordance with the instructions for the return on
which the importer is required to report liability for tax under section
4681.
(3) Treating the sale of an article incorporating an imported
taxable product as the first sale or use of such product--(i) In
general. In the case of articles to be sold, an importer may treat the
sale of an article manufactured or assembled in the United States as the
first sale or use of an imported taxable product incorporated in such
article, but only if the importer--
(A) Has consistently treated the sale of similar articles as the
first sale or use of similar imported taxable products; and
(B) Has not made an election under paragraph (c)(2) of this section.
(ii) Similar articles and imported taxable products. An importer may
establish any reasonable criteria for determining whether articles or
imported taxable products are similar for purposes of this paragraph
(c)(3).
(iii) Establishment of consistent treatment. An importer has
consistently treated the sale of similar articles as the first sale or
use of similar imported taxable products only if such treatment is
reflected in the computation of tax on the importer's returns for all
prior calendar quarters in which such treatment would affect tax
liability.
(iv) Example. The application of this paragraph (c)(3) may be
illustrated by the following example:
Example. (a) An importer of printed circuits and other electronic
components uses those products in assembling television receivers in the
United States and also uses the printed circuits in assembling VCRs in
the United States. Under the importer's criteria for determining
similarity, printed circuits are similar to other printed circuits, but
not to the other electronic components. In addition, television
receivers are similar to other television receivers, but not to VCRs.
The importer has not made an election under paragraph (c)(2) of this
section.
(b) Under this paragraph (c)(3), the importer may treat the sale of
the television receivers as the first sale or use of the imported
printed circuits incorporated into the television receivers. In that
case, the tax on the printed circuits would be imposed when the
television receivers are sold rather than when the printed circuits are
used in assembling the television receivers.
(c) The importer may treat the sale of the television receivers as
the first sale or use of the printed circuits incorporated into the
television receivers even if the sale of the television receivers is not
treated as the first sale or use of the other electronic components
incorporated into the television receivers and even if the sale of VCRs
is not treated as the first sale or use of the printed circuits
incorporated into the VCRs. Under paragraph (c)(3)(i)(A) of this
section, however, the importer must have consistently treated the sale
of television receivers as the first sale or use of printed circuits
incorporated into the receivers. Thus, in the case of television
receivers that were assembled
[[Page 23]]
before January 1, 1990, and sold after December 31, 1989, the importer
must have treated the sale of the television receivers as the first sale
or use of the printed circuits incorporated into the television
receivers when reporting tax under section 4681 with respect to such
printed circuits.
(d) ODCs used as materials in the manufacture of imported taxable
products--(1) ODC weight. The tax imposed on an imported taxable product
under section 4681 is computed by reference to the weight of the ODCs
used as materials in the manufacture of the product (ODC weight). The
ODC weight of a product includes the weight of ODCs used as materials in
the manufacture of any components of the product.
(2) ODCs used as materials in the manufacture of a product. Except
as provided in paragraph (d)(3) of this section, an ODC is used as a
material in the manufacture of a product if the ODC is--
(i) Incorporated into the product;
(ii) Released into the atmosphere in the process of manufacturing
the product; or
(iii) Otherwise used in the manufacture of the product (but only to
the extent the cost of the ODC is properly allocable to the product).
(3) Protective packaging. ODCs used in the manufacture of the
protective material in which a product is packaged are not treated as
ODCs used as materials in the manufacture of such product.
(4) Examples. The provisions of this paragraph (d) may be
illustrated by the following examples:
Example 1. A, a manufacturer located outside the United States, uses
ODCs as a solvent to clean the printed circuits it manufactures and as a
coolant in the air-conditioning system of the factory in which the
printed circuits are manufactured. The ODCs used as a solvent are
released into the atmosphere, and, under paragraph (d)(2)(ii) of this
section, are used as materials in the manufacture of the printed
circuits. The ODCs used as a coolant in the air-conditioning system are
also used in the manufacture of the printed circuits. Under paragraph
(d)(2)(iii) of this section, these ODCs are used as materials in the
manufacture of the printed circuits only to the extent the cost of the
ODCs is properly allocable to the printed circuits.
Example 2. B manufactures television receivers outside the United
States and wraps them for shipping in a protective packing material
manufactured with ODCs. Under paragraph (d)(3) of this section, the ODCs
used in the manufacture of the protective packing material are not
treated as ODCs used as a material in the manufacture of the television
receivers.
(e) Methods of determining ODC weight; computation of tax--(1) In
general. This paragraph (e) sets forth the methods to be used for
determining the ODC weight of an imported taxable product and a method
to be used in computing the tax when the ODC weight cannot be
determined. The amount of tax is computed separately for each imported
taxable product and the method to be used in determining the ODC weight
or otherwise computing the tax is separately determined for each such
product. Thus, an importer may use one method in computing the tax on
some imported taxable products and different methods in computing the
tax on other products. For example, an importer of telephone sets may
compute the tax using the exact method described in paragraph (e)(2) of
this section for determining the ODC weight of telephone sets supplied
by one manufacturer and using the Table method described in paragraph
(e)(3) of this section for telephone sets supplied by other
manufacturers that have not provided sufficient information to allow the
importer to use the exact method.
(2) Exact method. If the importer determines the weight of each ODC
used as a material in the manufacture of an imported taxable product and
supports that determination with sufficient and reliable information,
the ODC weight of the product is the weight so determined. Under this
method, the ODC weight of a mixture is equal to the weight of the ODCs
contained in the mixture. Representations by the manufacturer of the
product to the importer as to the weight of the ODCs used as materials
in the manufacture of the product may be sufficient and reliable
information for this purpose. Thus, a letter to the importer signed by
the manufacturer may constitute sufficient and reliable information if
the letter adequately identifies the product and states the weight of
each ODC used as a material in the product's manufacture.
[[Page 24]]
(3) Table method--(i) In general. If the ODC weight of an imported
taxable product is not determined using the exact method described in
paragraph (e)(2) of this section and the current Table specifies an ODC
weight for the product, the ODC weight of the product is the Table ODC
weight, regardless of what ODCs were used in the manufacture of the
product. In computing the amount of tax, the Table ODC weight shall not
be rounded.
(ii) Special rules--(A) Articles assembled in the United States. An
importer that assembles finished articles in the United States may
compute the amount of tax imposed on the imported taxable products
incorporated into the finished article by using the Table ODC weight
specified for the article instead of the Table ODC weights specified for
the components. In order to compute the tax under this special rule, the
importer must determine the actual number of articles manufactured. For
example, if an importer manufactures 100 camcorders using imported
subassemblies, the importer may compute the amount of tax on the
subassemblies by using the Table ODC weight specified for camcorders.
Thus, the tax imposed on the subassemblies is equal to the tax that
would be imposed on 100 camcorders.
(B) Combination method. This paragraph (e)(3)(ii)(B) applies to an
imported taxable product if the current Table specifies weights for two
or more ODCs with respect to the product and the importer of the product
can determine the weight of any such ODC (and of any ODC used as a
substitute for such ODC) and can support such determination with
sufficient and reliable information. In determining the ODC weight of
any such product, the importer may replace the weight specified in the
Table for such ODC with the weight (as determined by the importer) of
such ODC and its substitutes. For example, if an importer has sufficient
and reliable information to determine the amount of CFC-12 included in a
product as a coolant (and to determine that no ODCs have been used as
substitutes for CFC-12) but cannot determine the amount of CFC-113 used
in manufacturing the product's electronic components, the importer may
use the weight specified in the Table for CFC-113 and the actual weight
determined by the importer for CFC-12 in determining the ODC weight of
the product.
(C) ODCs used in the manufacture of rigid foam insulation. In
computing the tax using the method described in this paragraph (e)(3),
any ODC for which the Table specifies a weight followed by an asterisk
(*) shall be treated as an ODC used in the manufacture of rigid foam
insulation (as defined in Sec. 52.4682-1(d) (3) and (4)).
(4) Value method--(i) General rule. If the importer cannot determine
the ODC weight of an imported taxable product under the exact method
described in paragraph (e)(2) of this section and the Table ODC weight
of the product is not specified, the tax imposed on the product under
section 4681 is one percent of the entry value of the product.
(ii) Special rule for mixtures. If, in the case of an imported
taxable product that is a mixture, the tax was determined under the
method described in this paragraph (e)(4), the Commissioner may
redetermine the tax based on the ODC weight of the mixture.
(5) Adjustment for prior taxes--(i) In general. If any manufacture
with respect to an imported taxable product occurred in the United
States or the product incorporates a taxed component or a taxed chemical
was used in its manufacture, the product's ODC weight (or value)
attributable to manufacture within the United States or to taxed
components or taxed chemicals shall be disregarded in computing the tax
on such product using a method described in paragraph (e) (2), (3), or
(4) of this section.
(ii) Taxed component. The term ``taxed component'' means any
component that previously was subject to tax as an imported taxable
product or that would have been so taxed if section 4681 had been in
effect for periods before January 1, 1990.
(iii) Taxed chemical. The term ``taxed chemical'' means any ODC that
previously was subject to tax.
(6) Examples. The application of this paragraph (e) may be
illustrated by the following examples:
[[Page 25]]
Example 1. A is an importer (as defined in Sec. 52.4681-1(c)(5)) of
VCRs. The HTS classification for the VCRs is 8528.10.40. VCRs classified
under HTS heading 8528.10.40 are imported taxable products because they
are listed in the Table (contained in paragraph (f)(6) of this section)
by name and HTS heading (as described in paragraph (f)(3)(i) of this
section). Each VCR is wrapped in protective packing material
manufactured with ODCs. A imports and sells 100 VCRs during the first
calendar quarter of 1991. A may determine the ODC weight for the VCRs by
reference to the Table. The Table ODC weight specified for VCRs
classified under HTS heading 8528.10.40 is 0.0586 pound of CFC-113. This
weight does not take protective packaging into account. The amount of
tax for the first quarter of 1991 is $6.42 (0.0586 (the ODC weight) x
100 (the number of VCRs sold in the quarter) x $1.37 (the base tax
amount for CFC-113 in 1991) x 0.8 (the ozone-depletion factor for CFC-
113)). If A uses the exact method (as described in paragraph (e)(2) of
this section) to determine the ODC weight for the VCRs, A does not take
into account the ODCs used in the manufacture of the protective
packaging. (Imported protective packaging containing foams made with
ODCs other than foams defined in Sec. 52.4682-1(d)(3) is subject to
tax, however, if the packaging is sold as packaging or first used as
packaging in the United States.)
Example 2. The facts are the same as in Example 1, except that A's
VCRs are manufactured using methyl chloroform as the solvent instead of
CFC-113. If A does not use the exact method to determine the weight of
the methyl chloroform used in the manufacture of the VCRs, A must, under
paragraphs (e)(3)(i) and (e)(4)(i) of this section, determine the ODC
weight by reference to the Table. If A uses the Table ODC weight, the
computation of tax is the same as in Example 1, using the base tax
amount and ozone-depletion factor for CFC-113. A does not substitute the
base tax amount and ozone-depletion factor of methyl chloroform for
those of CFC-113.
Example 3. B imports and sells mixtures of ethylene oxide and CFC-
12. The mixture is 88 percent CFC-12 by weight. B also imports and sells
R-502. The R-502 is 51 percent CFC-115 by weight. In the first calendar
quarter of 1991 B sells 100 pounds of imported ethylene oxide/CFC-12
mixture and 10,000 pounds of imported R-502. The ethylene/CFC-12 mixture
and the R-502 are imported taxable products because they are listed in
Part I of the Table (contained in paragraph (f)(6) of this section).
Under the exact method described in paragraph (e)(2) of this section, B
computes the tax based on 88 pounds of CFC-12, the amount of ODCs
contained in the imported ethylene oxide mixture, and based on 5100
pounds of CFC-115, the amount of ODCs in the imported R-502.
(f) Imported Products Table--(1) In general. This paragraph (f)
contains rules relating to the Imported Products Table (Table) and sets
forth the Table. The Table lists all the products that are subject to
the tax on imported taxable products and specifies the Table ODC weight
of each product for which such a weight has been determined.
(2) Applicability of Table--(i) In general. Except as provided in
paragraph (f)(2)(ii) of this section, the Table contained in paragraph
(f)(6) of this section is effective on January 1, 1990.
(ii) Treatment of certain products--(A) Products included in a
listing that is preceded by a double asterisk (**) in the Table shall
not be treated as imported taxable products until October 1, 1990.
(B) Products included in a listing that is preceded by a triple
asterisk (***) in the Table shall not be treated as imported taxable
products until January l, 1992.
(3) Identification of products--(i) In general. Each listing in the
Table identifies a product by name and includes only products that are
described by that name. Most listings (other than listings for mixtures)
identify a product by both name and HTS heading. In such cases, a
product is included in that listing only if the product is described by
that name and the rate of duty on the product is determined by reference
to that HTS heading. However, the product is included in that listing
even if it is manufactured with or contains a different ODC than the ODC
specified in the Table.
(ii) Electronic items not listed by specific name--(A) In general.
Part II of the Table contains listings for electronic items that are not
included within any other listing in the Table. An imported product is
included in these listings only if such imported product--
(1) Is an electronic component listed in chapters 84, 85, or 90 of
the Harmonized Tariff Schedule; or
(2) Contains components described in paragraph (f)(3)(ii)(A)(1) of
this section and more than 15 percent of the cost of the imported
product is attributable to such components.
(B) Electronic component. For purposes of this paragraph (f)(3)(ii),
an electronic component is a component
[[Page 26]]
whose operation involves the use of nonmechanical amplification or
switching devices such as tubes, transistors, and integrated circuits.
Such components do not include passive electrical devices such as
resistors and capacitors.
(C) Certain items not included. Items such as screws, nuts, bolts,
plastic parts, and similar specially fabricated parts that may be used
to construct an electronic item are not themselves included in the
listing for electronic items not otherwise listed in the Table.
(iii) Examples. The application of this paragraph (f)(3) may be
illustrated by the following examples:
Example 1. The Table lists ``electronic integrated circuits and
microassemblies; HTS heading 8542.'' A bipolar transistor under HTS
heading 8542.11.00.05 is included in this listing because a bipolar
transistor is a type of electronic integrated circuit and HTS heading
8542.11.00.05 is included within HTS heading 8542.
Example 2. The Table lists ``radios; HTS heading 8527.19,'' ``radio
combinations; HTS heading 8527.11'' and ``radio combinations; HTS
heading 8527.31.'' A radio classified under HTS heading 8527.19 is not
included within either listing for radio combinations. However, a radio
classified under HTS heading 8527.19.00.20 is included within the
listing for radios; HTS heading 8527.19. A radio combination classified
under HTS heading 8527.11.20 is included within the listing for radio
combinations; HTS heading 8527.11 but not the listing for radio
combinations; HTS heading 8527.31. Any radio or radio combination not
classified under the HTS heading for any other listing is included in
the listing for electronic items not otherwise listed.
(4) Rules for listing products. Products are listed in the Table in
accordance with the following rules:
(i) Listing in part I. A product is listed in part I of the Table if
it is a mixture containing ODCs. In addition, a product other than a
mixture containing ODCs will be listed in part I of a revised Table if
the Commissioner has determined that--
(A) The ODC weight of the product is not de minimis when the product
is produced using the predominant method of manufacturing the product;
and
(B) None of the ODCs used as materials in the manufacture of the
product under the predominant method are used for purposes of
refrigeration or air conditioning, creating an aerosol or foam, or
manufacturing electronic components.
(ii) Listing in part II. A product is listed in part II of the Table
if the Commissioner has determined that the ODCs used as materials in
the manufacture of the product under the predominant method are used for
purposes of refrigeration or air conditioning, creating an aerosol or
foam, or manufacturing electronic components.
(iii) Listing in part III. A product is listed in part III of the
Table if the Commissioner has determined that the product is not an
imported taxable product and the product would otherwise be included
within a listing in part II of the Table. For example, floppy disk drive
units are listed in part III because they are not imported taxable
products and they would, but for their listing in part III, be included
within the part II listing for electronic items not specifically
identified.
(5) Table ODC weight. The Table ODC weight of a product is the
weight, determined by the Commissioner, of the ODCs that are used as
materials in the manufacture of the product under the predominant method
of manufacturing. The Table ODC weight is given in pounds per single
unit of product unless otherwise specified.
(6) Table. The Table is set forth below:
Imported Products Table
----------------------------------------------------------------------------------------------------------------
Harmonized
tariff
Product name schedule ODC ODC weight
heading
----------------------------------------------------------------------------------------------------------------
Part I--Products that are mixtures containing ODCs:
Mixtures containing ODCs, including but not limited to:
--anti-static sprays........................................
--automotive products such as ``carburetor cleaner,'' ``stop
leak,'' and ``oil charge''.................................
--cleaning solvents.........................................
--contact cleaners..........................................
--degreasers................................................
[[Page 27]]
--dusting sprays............................................
--electronic circuit board coolants.........................
--electronic solvents.......................................
--ethylene oxide/CFC-12.....................................
--fire extinguisher preparations and charges................
--flux removers for electronics.............................
--insect and wasp sprays....................................
--mixtures of ODCs..........................................
--propellants...............................................
--refrigerants.............................................. .............. .............. ..............
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Harmonized
tariff
Product name schedule ODC ODC weight
heading
----------------------------------------------------------------------------------------------------------------
Part II--Products in which ODCs are
used for purposes of refrigeration or
air conditioning, creating an aerosol
or form or manufacturing electronic
components:
Rigid foam insulation defined in .............. ......................... ............................
Sec. 52.4682-1(d)(3).
Foams made with ODCs, other than .............. ......................... ............................
foams defined in Sec. 52.4682-
1(d)(3).
Scrap flexible foams made with ODCs .............. ......................... ............................
Medical products containing ODCs:
Surgical staplers.............. .............. ......................... ............................
Cryogenic medical instruments.. .............. ......................... ............................
Drug delivery systems.......... .............. ......................... ............................
Inhalants...................... .............. ......................... ............................
Dehumidifiers, household........... 8415.82.00.50 CFC-12................... 0.344
Chillers:.......................... 8415.82.00.65 ......................... ............................
Charged with CFC-12............ .............. CFC-12................... 1600.
Charged with CFC-114........... .............. CFC-114.................. 1250.
Charged with R-500............. .............. CFC-12................... 1920.
Refrigerator-freezers, household:
Not 184 liters..... 8418.10.00.10 CFC-11................... \1\1.08
CFC-12................... 0.13
184 liters but not 8418.10.00.20 CFC-11................... \1\1.32
269 liters. CFC-12................... 0.26
269 liters but not 8418.10.00.30 CFC-11................... \1\1.54
382 liters. CFC-12................... 0.35
382 liters......... 8418.10.00.40 CFC-11................... \1\1.87
CFC-12................... 0.35
Refrigerators, household:
Not 184 liters..... 8418.21.00.10 CFC-11................... \1\1.08
CFC-12................... 0.13
184 liters but not 8418.21.00.20 CFC-11................... \1\1.32
269 liters. CFC-12................... 0.26
269 liters but not 8418.21.00.30 CFC-11................... \1\1.54
382 liters. CFC-12................... 0.35
382 liters......... 8418.21.00.90 CFC-11................... \1\1.87
CFC-12................... 0.35
Freezers, household................ 8418.30 CFC-11................... \1\ 2.0
CFC-12................... 0.4
Freezers, household................ 8418.40 CFC-11................... \1\2.0
CFC-12................... 0.4
Refrigerating display counters not 8418.50 CFC-11................... \1\ 50.0
227 kg. CFC-12................... 260.0
Icemaking machines................. 8418.69 ......................... ............................
Charged with CFC-12............ .............. CFC-12................... 1.4
Charged with R-502............. .............. CFC-115.................. 3.39
Drinking water coolers............. 8418.69 ......................... ............................
Charged with CFC-12............ .............. CFC-12................... 0.21
Charged with R-500............. .............. CFC-12................... 0.22
Centrifugal chillers, hermetic..... 8418.69 ......................... ............................
Charged with CFC-12............ .............. CFC-12................... 1600.
Charged with CFC-114........... .............. CFC-114.................. 1250.
Charged with R-500............. .............. CFC-12................... 1920.
Reciprocating chillers............. 8418.69 ......................... ............................
Charged with CFC-12............ .............. CFC-12................... 200.
Mobile refrigeration systems....... 8418.99 ......................... ............................
Containers..................... .............. CFC-12................... 15.
[[Page 28]]
Trucks......................... .............. CFC-12................... 11.
Trailers....................... .............. CFC-12................... 20.
Refrigeration condensing units:
not 746W........... 8418.99.00.05 CFC-12................... 0.3
746W but not 2.2KW.
2.2KW but not 7.5KW.
7.5KW but not 22.3KW.
22.3 KW............ 8418.99.00.25 CFC-12................... 17.0
Fire extinguishers, charged w/ODCs. 8424 ......................... ............................
Electronic typewriters and word 8469 CFC-113.................. 0.2049
processors.
Electronic calculators............. 8470.10 CFC-113.................. 0.0035
Electronic calculators w/printing 8470.21 CFC-113.................. 0.0057
device.
Electronic calculators............. 8470.29 CFC-113.................. 0.0035
Account machines................... 8470.40 CFC-113.................. 0.1913
Cash registers..................... 8470.50 CFC-113.................. 0.1913
Digital automatic data processing 8471.20 CFC-113.................. 0.3663
machines w/cathode ray tube, not
included in subheading
8471.20.00.90.
Laptops, notebooks, and pocket 8471.20.00.90 CFC-113.................. 0.03567
computers.
Digital processing units w/entry
value:
Not $100K.......... 8471.91 CFC-113.................. 0.4980
$100K.............. 8471.91 CFC-113.................. 27.6667
Combined input/output units 8471.92 CFC-113.................. 0.3600
(terminals).
Keyboards.......................... 8471.92 CFC-113.................. 0.0742
Display units...................... 8471.92 CFC-113.................. 0.0386
Printer units...................... 8471.92 CFC-113.................. 0.1558
lnput or output units.............. 8471.92 CFC-113.................. 0.1370
Hard magnetic disk drive units not
included in subheading 8471.93.10
for a disk of a diameter:
Not 9 cm (3\1/2\ 8471.93 CFC-113.................. 0.2829
inches).
9 cm (3\1/2\ 8471.93 CFC-113.................. 1.1671
inches) but not 21
cm (8\1/4\ inches).
Nonmagnetic storage units w/ entry 8471.93 CFC-113.................. 2.7758
value $1,000.
Magnetic disk drive units for a 8471.93.10 CFC-113.................. 4.0067
disk of a diameter over 21 cm (8\1/
4\ inches).
Power supplies..................... 8471.99.30 CFC-113.................. 0.0655
Electronic office machines......... 8472 CFC-113.................. 0.001
Populated cards for digital
processing units in subheading
8471.91 w/value:
Not $100K.......... 8473.30 CFC-113.................. 0.1408
$100K.............. 8473.30 CFC-113.................. 4.82
Automatic goods-vending machines 8476.11 CFC-12................... 0.45
with refrigerating device.
Microwave ovens with electronic 8516.50 ......................... ............................
controls, with capacity of.
0.99 cu. ft. or less........... .............. CFC-113.................. 0.0300
1.0 through 1.3 cu. ft......... .............. CFC-113.................. 0.0441
1.31 cu. ft. or greater........ .............. CFC-113.................. 0.0485
Microwave oven combinations with 8516.60.40.60 CFC-113.................. 0.0595
electronic controls.
Telephone sets w/entry value:
Not $11.00......... 8517.10 CFC-113.................. 0.0225
$11.00............. 8517.10 CFC-113.................. 0.1
Teleprinters and teletypewriters... 8517.20 CFC-113.................. 0.1
Switching equipment not included in 8517.30 CFC-113.................. 0.1267
subheading 8517.30.20.
Private branch exchange switching 8517.30.20 CFC-113.................. 0.0753
equipment.
Modems............................. 8517.40 CFC-113.................. 0.0225
Intercoms.......................... 8517.81 CFC-113.................. 0.0225
Facsimile machines................. 85l7.82 CFC-113.................. 0.0225
Loudspeakers, microphones, 8518 CFC-113.................. 0.0022
headphones, and electric sound
amplifier sets, not included in
subheading 8518.30.10.
Telephone handsets................. 8518.30.10 CFC-113.................. 0.042
Turntables, record players, 8519 CFC-113.................. 0.0022
cassette players, and other sound
reproducing apparatus.
Magnetic tape recorders and other 8520 CFC-113.................. 0.0022
sound recording apparatus, not
included in subheading 8520.20.
Telephone answering machines....... 8520.20 CFC-113.................. 0.1
Color video recording/reproducing 8521.10.00.20 CFC-113.................. 0.0586
apparatus.
Videodisc players.................. 8521.90 CFC-113.................. 0.0106
Cordless handset telephones........ 8525.20.50 CFC-113.................. 0.1
Cellular communication equipment... 8525.20.60 CFC-113.................. 0.4446
TV cameras......................... 8525.30 CFC-113.................. 1.423
Camcorders......................... 8525.30 CFC-113.................. 0.0586
Radio combinations................. 8527.11 CFC-113.................. 0.0022
Radios............................. 8527.19 CFC-113.................. 0.0014
Motor Vehicle radios with or w/o 8527.21 CFC-113.................. 0.0021
tape player.
Radio combinations................. 8527.31 CFC-113.................. 0.0022
[[Page 29]]
Radios............................. 8527.32 CFC-113.................. 0.0014
Tuners w/o speaker................. 8527.39.00.20 CFC-113.................. 0.0022
Television receivers............... 8528 CFC-113.................. 0.0386
VCRs............................... 8528.10.40 CFC-113.................. 0.0586
Home satellite earth stations...... 8528.10.80.55 CFC-113.................. 0.0106
Electronic assemblies for HTS 8529.90 CFC-113.................. 0.0816
headings 8525, 8527, & 8528.
Indicator panels incorporating 8531.20 CFC-113.................. 0.0146
liquid crystal devices or light
emitting diodes.
Printed circuits................... 8534 CFC-113.................. 0.001
Computerized numerical controls.... 8537.10.00.30 CFC-113.................. 0.1306
Diodes, crystals, transistors and 8541 CFC-113.................. 0.0001
other similar discrete
semiconductor devices.
Electronic integrated circuits and 8542 CFC-113.................. 0.0002
microassemblies.
Signal generators.................. 8543.20 CFC-113.................. 0.6518
Avionics........................... 8543.90.40 CFC-113.................. 0.915
Signal generators subassemblies.... 8543.90.80 CFC-113.................. 0.1265
Insulated or refrigerated railway 8606 CFC-11................... \1\100.
freight cars.
Passenger automobiles.............. 8703 ......................... ............................
Foams (interior)............... .............. CFC-11................... 0.8
Foams (exterior)............... .............. CFC-11................... 0.7
With charged a/c............... .............. CFC-12................... 2.0
Without charged a/c............ .............. CFC-12................... 0.2
Electronics.................... .............. CFC-113.................. 0.5
Light trucks....................... 8704 ......................... ............................
Foams (interior)............... .............. CFC-11................... 0.6
Foams (exterior)............... .............. CFC-11................... 0.1
With charged a/c............... .............. CFC-12................... 2.0
Without charged a/c............ .............. CFC-12................... 0.2
Electronics.................... .............. CFC-113.................. 0.4
Heavy trucks and tractors, GVW 8704 ......................... ............................
33,001 lbs or more: \2\.
Foams (interior)............... .............. CFC-11................... 0.6
Foams (exterior)............... .............. CFC-11................... 0.1
With charged a/c............... .............. CFC-12................... 3.0
Without charged a/c............ .............. CFC-12................... 0.2
Electronics.................... .............. CFC-113.................. 0.4
Motorcycles with seat foamed with 8711 CFC-11................... 0.04
ODCs.
Bicycles with seat foamed with ODCs 8712 CFC-11................... 0.04
Seats foamed with ODCs............. 8714.95 CFC-11................... 0.04
Aircraft........................... 8802 CFC-12................... 0.25 lb/1000 lbs Operating
Empty Weight (OEW).
.............. CFC-113.................. 30.0 lbs./1000 lbs.OEW
Optical fibers..................... 9001 CFC-12................... 0.005 lb/thousand feet.
Electronic cameras................. 9006 CFC-113.................. 0.01
Photocopiers....................... 9009 CFC-113.................. 0.0426
Avionics........................... 9014.20 CFC-113.................. 0.915
Electronic drafting machines....... 9017 CFC-113.................. 0.12
Complete patient monitoring systems 9018.19.80 CFC-12................... 0.94
CFC-113.................. 3.4163
Complete patient monitoring 9018.19.80.60 CFC-113.................. 1.9320
systems; subassemblies thereof.
Physical or chemical analysis 9027 CFC-12................... 0.0003
instruments. CFC-113.................. 0.0271
Oscilloscopes...................... 9030 CFC-11................... 0.49
CFC-12................... 0.5943
CFC-113.................. 0.2613
Foam chairs........................ 9401 CFC-11................... 0.30
Foam sofas......................... 9401 CFC-11................... 0.75
Foam mattresses.................... 9404.21 CFC-11................... 1.60
Electronic games and electronic 9504 CFC-113.................. ............................
components thereof.
Electronic items not otherwise listed
in the Table:
Included in HTS chapters 84, 85, 90 .............. CFC-113.................. 0.0004 pound/$1.00 of entry
value.
Not included in HTS chapters 84, .............. CFC-113.................. 0.0004 pound/$1.00 of entry
85, 90 \3\. value.
PART III--Products that are not
Imported Taxable Products:
Room air conditioners.............. 8415.10.00.60 ......................... ............................
Dishwashers........................ 8422.11 ......................... ............................
Clothes washers.................... 8450.11 ......................... ............................
Clothes dryers..................... 8451.21 ......................... ............................
Floppy disk drive units............ 8471.93 ......................... ............................
[[Page 30]]
Transformers and inductors......... 8504 ......................... ............................
Toasters........................... 8516.72 ......................... ............................
Unrecorded media................... 8523 ......................... ............................
Recorded media..................... 8524 ......................... ............................
Capacitors......................... 8532 ......................... ............................
Resistors.......................... 8533 ......................... ............................
Switching apparatus................ 8536 ......................... ............................
Cathode tubes...................... 8540 ......................... ............................
----------------------------------------------------------------------------------------------------------------
\1\ See paragraph (e)(3)(ii)(C) of this section. Denotes an ODC used in the manufacture of rigid foam
insulation.
\2\ See paragraph (f)(2)(ii)(A) of this section. Denotes product for which the effective date is October 1,
1990.
\3\ See paragraph (f)(2)(ii)(B) of this section. Denotes products for which the effective date is January 1,
1992.
(g) Requests for modification of Table--(1) In general. Any
manufacturer or importer of a product may request that the Secretary
modify the Table in any of the following respects:
(i) Adding a product to the Table and specifying its Table ODC
weight.
(ii) Removing a product from the Table.
(iii) Changing or specifying the Table ODC weight of a product.
(2) Form of request. The Secretary will consider a request for
modification that includes the following:
(i) The name, address, taxpayer identifying number, and principal
place of business of the requester.
(ii) For each product with respect to which a modification is
requested:
(A) The name of the product;
(B) The HTS heading or subheading;
(C) The type of modification requested;
(D) The Table ODC weight that should be specified for the product if
the request relates to adding a product or changing or specifying its
Table ODC weight; and
(E) The data supporting the request.
(3) Address. The address for submission of requests under this
paragraph (g) is: Internal Revenue Service, P.O. Box 7604, Ben Franklin
Station, Attn: CC:CORP:T:R (Imported Products Table), room 5228,
Washington, DC 20044.
(4) Public inspection and copying. Requests submitted under this
paragraph (g) will be available in the Internal Revenue Service Freedom
of Information Reading Room for public inspection and copying.
[T.D. 8370, 56 FR 56311, Nov. 4, 1991, as amended by T.D. 8370, 58 FR
14518, Mar. 18, 1993]
Sec. 52.4682-4 Floor stocks tax.
(a) Overview. This section provides rules for identifying ozone-
depleting chemicals (ODCs) that are subject to the floor stocks tax
imposed by section 4682(h)(1), determining the person that is liable for
the tax, and computing the amount of the tax. See Sec. 52.4681-1(a)(3)
and (c) for general rules and definitions relating to the floor stocks
tax.
(b) Identifying rules--(1) ODCs subject to floor stocks tax; ODCs
held for sale or for use in further manufacture--(i) In general. The
floor stocks tax is imposed only on an ODC that is held for sale or for
use in further manufacture on the date the tax is imposed. This
paragraph (b)(1) provides rules for identifying ODCs held for sale or
for use in further manufacture.
(ii) Held for sale--(A) In general. For purposes of determining
whether an ODC is held for sale, the term sale shall have the meaning
set forth in Sec. 52.4681-1(c)(6). ODCs held for sale include ODCs that
will be sold in connection with the provision of services or in
connection with the sale of a manufactured article and, in such cases,
include ODCs that will be sold without the statement of a separate
charge for those ODCs.
(B) ODCs held by a government. An ODC that is held by a government
for its own use is not held for sale even if the ODC will be transferred
between agencies or other subdivisions that have or are required to have
different employer identification numbers.
(iii) Held for use in further manufacture. Except as otherwise
provided in paragraph (b)(2)(v) of this section, an ODC is held for use
in further manufacture if--
(A) The ODC will be used as a material (within the meaning of
paragraph
[[Page 31]]
(b)(1)(iv) of this section) in the manufacture of an article; and
(B) Such article will be held for sale.
(iv) Use as material--(A) In general. Except as provided in
paragraph (b)(1)(iv)(B) of this section, an ODC will be used as a
material in the manufacture of an article if the ODC will be--
(1) Incorporated into the article; or
(2) Released into the atmosphere in the process of manufacturing the
article.
(B) ODCs used in equipment. For purposes of the floor stocks tax, an
ODC is not used as a material in the manufacture of an article if the
ODC is (or will be) contained in equipment used in such manufacture and
the ODC will be used for its intended purpose without being released
from such equipment. Thus, ODCs that are (or will be) used as coolants
in a factory's air-conditioning system are not used as materials in the
manufacture of articles produced in the factory.
(v) Storage containers. The floor stocks tax is imposed on an ODC
without regard to the type or size of the storage container in which the
ODC is held. Thus, the tax may apply to an ODC whether it is in a 14-
ounce can or a 30-pound tank.
(vi) Examples. The provisions of this paragraph (b)(1) may be
illustrated by the following examples:
Example 1. A, a manufacturer of air conditioners, holds an ODC for
use in air conditioners that it will manufacture and sell. A holds the
ODC for use in further manufacture.
Example 2. B, a manufacturer of electronic components, holds an ODC
for use as a solvent to clean printed circuits that it will sell to
computer manufacturers. B holds the ODC for use in further manufacture.
Example 3. C, an automobile dealer, holds an ODC for use in charging
air conditioners installed in automobiles that it sells to retail
customers. C does not hold the ODC for use in further manufacture. C
does, however, hold the ODC for sale, even if the customers are not
separately charged for ODCs used in the automobile air conditioners.
Example 4. D operates an air-conditioning repair service and holds
an ODC for use in repairing air conditioners for its customers. D holds
the ODC for sale even if the customers are not separately charged for
ODCs used in the repairs.
Example 5. E, a grocery-store chain, holds an ODC for use in its
refrigeration units. E does not hold the ODC for sale or for use in
further manufacture.
Example 6. F, a bank, holds an ODC for use in its fire extinguishers
to protect the computer system. F does not hold the ODC for sale or for
use in further manufacture.
Example 7. G, a government agency, holds an ODC for use in the
refrigeration equipment of its various units. The units have separate
employer identification numbers. The ODC is stored in a central
warehouse until needed by a unit and then transferred to the unit upon
request. G does not hold the ODC for sale or for use in further
manufacture.
(2)(i) Mixtures--(A) Tax imposed on January 1, 1990. In the case of
the floor stocks tax imposed on January l, 1990, the tax is not imposed
on an ODC that has been mixed with any other ingredients.
(B) Taxes imposed after 1990--(1) In general. In the case of the
floor stocks tax imposed on January 1 of a calendar year after 1990, the
tax is not imposed on an ODC that has been mixed with any other
ingredients, but only if it is established that such ingredients
contribute to the accomplishment of the purpose for which the mixture
will be used. A mixture is not exempt from tax under this paragraph
(b)(2)(i)(B), however, if it contains only an ODC and an inert
ingredient that does not contribute to the accomplishment of the purpose
for which the mixture will be used.
(2) Exception. In the case of a floor stocks tax imposed on or after
January 1, 1992, a mixture is not exempt from floor stocks tax under
this paragraph (b)(2)(i)(B) if it contains only ODCs and one or more
stabilizers. For this purpose, the term stabilizer means an ingredient
needed to maintain the chemical integrity of the ODC.
(C) Examples. The provisions of this paragraph (b)(2)(i) may be
illustrated by the following examples:
Example 1. The floor stocks tax is not imposed on the ODCs contained
in refrigerants such as R-500 and R-502 because such products are
mixtures of ODCs and other chemicals that contribute to the
accomplishment of the purpose for which the mixture will be used.
Example 2. The floor stocks tax is not imposed on the ODCs contained
in automotive products used for checking for leaks because such products
are a mixture of ODCs and
[[Page 32]]
small amounts of dyes and oils that contribute to the accomplishment of
the purpose for which the mixture will be used.
Example 3. The floor stocks tax is not imposed on Halon 1301
pressurized with nitrogen. Although nitrogen is an inert ingredient, it
contributes to the accomplishment of the purpose for which the mixture
will be used.
Example 4. On January 1, 1993, the floor stocks tax is imposed on
methyl chloroform that is stabilized to prevent hydrolization or
chemical reaction during transportation or use, unless the stabilized
methyl chloroform has also been mixed with other ingredients that
contribute to the accomplishment of the purpose for which the mixture
will be used.
(ii) Manufactured articles. The floor stocks tax is not imposed on
an ODC that is contained in a manufactured article in which the ODC will
be used for its intended purpose without being released from such
article. For example, the tax is not imposed on the ODCs contained in
the cooling coils of a refrigerator even if the refrigerator is held for
sale. However, the tax is imposed on a can of ODC used to recharge an
air conditioning unit because the ODC must be expelled from the can in
order to be used. Similarly, beginning in 1991, the tax is imposed on
Halons contained in a fire extinguisher held for sale because such ODCs
must be expelled from the fire extinguisher in order to be used.
(iii) Recycled ODCs. The floor stocks tax is not imposed on ODCs
that have been reclaimed or recycled. For example, the tax is not
imposed on an ODC that is held for use in further manufacture after
being used as a solvent and recycled.
(iv) ODCs held by the manufacturer or importer. The floor stocks tax
is not imposed on ODCs held by their manufacturer or importer.
(v) ODCs used as a feedstock--(A) In general. The floor stocks tax
is not imposed on any ODC that was sold in a qualifying sale for use as
a feedstock (as defined in Sec. 52.4682-1(c)).
(B) Post-1989 ODCs sold before January 1, 1990; post-1990 ODCs sold
before January 1, 1991. A post-1989 ODC that was sold by its
manufacturer or importer before January 1, 1990, or a post-1990 ODC that
was sold by its manufacturer or importer before January 1, 1991, shall
be treated, for purposes of this paragraph (b)(2)(v), as an ODC that was
sold in a qualifying sale for purposes of Sec. 52.4682-1(c) if the ODC
will be used as a feedstock (within the meaning of Sec. 52.4682-
2(c)(3)).
(vi) ODCs to be exported--(A) In general. The floor stocks tax is
not imposed on any ODC that was sold in a qualifying sale for export (as
defined in Sec. 52.4682-5(d)(1)).
(B) ODCs sold before January 1, 1993. An ODC that was sold by its
manufacturer or importer before January 1, 1993, is treated, for
purposes of this paragraph (b)(2)(vi), as an ODC that was sold in a
qualifying sale for export for purposes of Sec. 52.4682-5(d)(1) if the
ODC will be exported.
(vii) ODCs used as propellants in metered-dose inhalers; years after
1992--(A) In general. The floor stocks tax is not imposed on January 1
of calendar years after 1992 on any ODC that was sold in a qualifying
sale for use as a propellant in a metered-dose inhaler (as defined in
Sec. 52.4682-1(h)).
(B) ODCs sold before January 1, 1993. An ODC that was sold by its
manufacturer or importer before January 1, 1993, is treated, for
purposes of this paragraph (b)(2)(vii), as an ODC that was sold in a
qualifying sale for purposes of Sec. 52.4682-1(h) if the ODC will be
used as a propellant in a metered-dose inhaler (within the meaning of
Sec. 52.4682-1(h)).
(viii) ODCs used as medical sterilants; 1993. The floor stocks tax
is not imposed in 1993 on any ODC held for use as a medical sterilant
(as defined in Sec. 52.4682-1(g)).
(c) Person liable for tax--(1) In general. The person liable for the
floor stocks tax on an ODC is the person that holds the ODC on a date on
which the tax is imposed. The person who holds the ODC is the person who
has title to the ODC (whether or not delivery to such person has been
made) as of the first moment of such date. The person who has title at
such time is determined under applicable local law.
(2) Special rule. Each business unit that has, or is required to
have, its own employer identification number is treated as a separate
person for purposes of the floor stocks tax. For example, a chain of
automotive parts stores that has one employer identification
[[Page 33]]
number is one person for purposes of the floor stocks tax, and a parent
corporation and subsidiary corporation that each have a different
employer identification number are two persons for purposes of the floor
stocks tax.
(d) Computation of tax; tentative tax amount--(1) In general--(i)
Generally applicable rules. This paragraph (d) provides rules for
determining the tentative tax amount and the amount of the floor stocks
tax. Section 52.4681-1(a)(3) provides that the amount of the floor
stocks tax on an ODC is determined by reference to a tentative tax
amount. The tentative tax amount is the amount of tax that would be
imposed on the ODC under section 4681(a)(1) if a sale of the ODC by the
manufacturer or importer had occurred on the date the floor stocks tax
is imposed. The amount of the floor stocks tax imposed on the ODCs
contained in a nonexempt mixture is computed on the basis of the weight
of the ODCs in that mixture.
(ii) Floor stocks tax imposed on post-1989 ODCs on January 1, 1990.
The floor stocks tax imposed on post-1989 ODCs (as defined in Sec.
52.4681-1(c)(9)) on January 1, 1990, is equal to the tentative tax
amount. See paragraph (d)(2) of this section for rules relating to the
floor stocks tax imposed on ODCs used in the manufacture of rigid foam
insulation. See paragraph (d)(3) of this section for rules relating to
the floor stocks tax imposed on Halons.
(iii) Floor stocks tax imposed on post-1990 ODCs on January 1, 1991.
The floor stocks tax imposed on post-1990 ODCs (as defined in Sec.
52.4681-1(c)(9)) on January 1, 1991, is equal to the tentative tax
amount.
(iv) Other floor stocks taxes--(A) In general. The following rules
apply for floor stocks taxes imposed on post-1989 ODCs after January 1,
1990, and on post-1990 ODCs after January 1, 1991:
(1) The tentative tax amount is determined, except as provided in
paragraph (d)(2), (3), or (4) of this section, by reference to the rate
of tax prescribed in section 4681(b)(1)(B) and the ozone-depletion
factors prescribed in section 4682(b).
(2) The amount of the floor stocks tax on an ODC is equal to the
amount by which the tentative tax amount exceeds the amount of taxes
previously imposed on the ODC.
(B) Example. The application of this paragraph (d)(1)(iv) may be
illustrated by the following example:
Example. The floor stocks tax imposed on one pound of CFC-12 held
for sale on January 1, 1992, is $0.30 (the amount by which $1.67, the
tentative tax, exceeds $1.37, the tax previously imposed on CFC-12).
(2) ODCs used in the manufacture of rigid foam insulation; 1990,
1991, 1992, and 1993--(i) In general. In the case of an ODC that was
sold in a qualifying sale for purposes of Sec. 52.4682-1(d) (relating
to use in the manufacture of rigid foam insulation) the tentative tax
amount is determined under section 4682(g) for purposes of computing the
floor stocks tax imposed on the ODC on January 1, 1990, 1991, 1992 or
1993. For purposes of computing the floor stocks tax imposed on the ODC
on January 1, 1990, the tentative tax amount is zero. The floor stocks
tax is not imposed on ODCs for use in the manufacture of rigid foam
insulation in 1992 and 1993.
(ii) Post-1989 ODCs sold before January 1, 1990; post-1990 ODCs sold
before January 1, 1991. A post-1989 ODC that was sold by its
manufacturer or importer before January 1, 1990, or a post-1990 ODC that
was sold by its manufacturer or importer before January 1, 1991, shall
be treated, for purposes of paragraphs (d)(2) and (e) of this section,
as an ODC that was sold in a qualifying sale for purposes of Sec.
52.4682-1(d) if the ODC wi11 be used in the manufacture of rigid foam
insulation (within the meaning of Sec. Sec. 52.4682-1(d) (3) and (4)).
(3) Halons; 1990, 1991, 1992, and 1993. In the case of Halon-1211,
Halon-1301, or Halon-2402 (Halons), the tentative tax amount is
determined under section 4682(g) for purposes of computing the floor
stocks tax imposed on Halons on January 1, 1990, 1991, 1992, or 1993.
For purposes of computing the floor stocks tax imposed on Halons on
January 1, 1990, the tentative tax amount is zero. The floor stocks tax
is not imposed on Halons in 1992 and 1993.
(4) Methyl chloroform; 1993. In the case of methyl chloroform, the
tentative tax amount is determined under section 4682(g)(5) for purposes
of computing the floor stocks tax imposed on January 1, 1993.
[[Page 34]]
(e) De minimis exception--(1) 1990 and 1992. In the case of the
floor stocks tax imposed on January 1, 1990 or 1992, a person is liable
for the tax only if, on the date the tax is imposed, the person holds at
least 400 pounds of post-1989 ODCs that are not described in paragraph
(d) (2) or (3) of this section and are otherwise subject to tax.
(2) 1991. In the case of the floor stocks tax imposed on January 1,
1991, a person is liable for the tax only if, on such date, the person
holds at least 400 pounds of ODCs subject to the 1991 floor stocks tax.
For this purpose, ODCs subject to the 1991 floor stocks tax are--
(i) Post-1990 ODCs that are subject to tax; and
(ii) Post-1989 ODCs that are described in paragraph (d) (2) or (3)
of this section and are otherwise subject to tax.
(3) 1993. In the case of the floor stocks tax imposed on January 1,
1993, a person is liable for the tax only if, on such date, the person
holds at least 400 pounds of ODCs that are not described in paragraph
(d) (2) or (3) of this section and are otherwise subject to tax.
(4) 1994. In the case of the floor stocks tax imposed on January 1,
1994, a person is liable for the tax only if, on such date, the person
holds--
(i) At least 400 pounds of ODCs that are not described in paragraph
(d)(2) or (d)(3) of this section and are otherwise subject to tax;
(ii) At least 200 pounds of ODCs that are described in paragraph
(d)(2) of this section and are otherwise subject to tax; or
(iii) At least 20 pounds of ODCs that are described in paragraph
(d)(3) of this section and are otherwise subject to tax.
(5) Calendar years after 1994. In the case of the floor stocks tax
imposed on January 1 of 1995 and each following calendar year, a person
is liable for the tax only if, on such date, the person holds--
(i) At least 400 pounds of ODCs that are not described in paragraph
(d)(3) or (d)(4) of this section and are otherwise subject to tax;
(ii) At least 50 pounds of ODCs that are described in paragraph
(d)(3) of this section and are otherwise subject to tax; or
(iii) At least 1000 pounds of ODCs that are described in paragraph
(d)(4) of this section and are otherwise subject to tax.
(6) Examples. The rules of this paragraph (e) may be illustrated by
the following examples:
Example 1. On January 1, 1990, A holds for sale 300 pounds of CFC-12
(a post-1989 ODC not described in paragraph (d)(2) or (d)(3) of this
section)) and 500 pounds of R-500 (a mixture). A does not hold at least
400 pounds of ODCs that are taken into account under paragraph (e)(1) of
this section and, under paragraph (b)(2)(i) of this section, mixtures
are not subject to the floor stocks tax. Thus, A is not liable for the
floor stocks tax imposed on January 1, 1990.
Example 2. On January 1, 1990, B holds for sale 250 pounds of CFC-12
and 250 pounds of CFC-113 (post-1989 ODCs not described in paragraph (d)
(2) or (3) of this section). B holds 500 pounds of ODCs that are taken
into account under paragraph (e)(1) of this section. Thus, B is liable
for the floor stocks tax imposed on January 1, 1990, because B holds at
least 400 pounds of ODCs for sale.
Example 3. On January 1, 1990, C holds 200 pounds of post-1990 ODCs
and 500 pounds of post-1989 ODCs for use in further manufacture. C will
use 300 pounds of the post-1989 ODCs in the manufacture of rigid foam
insulation (as defined in Sec. 52.4682-1(d) (3) and (4)). The remainder
of the ODCs are not described in paragraph (d) (2) or (3) of this
section. Under paragraph (e)(1) of this section, post-1990 ODCs and ODCs
that will be used in the manufacture of rigid foam insulation are
disregarded in determining whether the de minimis exception is
applicable in 1990. Thus, C holds only 200 pounds of ODCs that are taken
into account under paragraph (e)(1) of this section and is not liable
for the floor stocks tax imposed on January 1, 1990.
Example 4. (a) The facts are the same as in Example 3, except that
the ODCs are held on January 1, 1991. Under paragraph (e)(2) of this
section, the 200 pounds of post-1990 ODCs and the 300 pounds of post-
1989 ODCs that will be used in the manufacture of rigid foam insulation
are taken into account in determining whether the de minimis exception
is applicable in 1991. Under paragraph (b)(2) of this section, the
remaining 200 pounds of post-1989 ODCs are not taken into account
because the base tax amount applicable to post-1989 ODCs does not
increase in 1991. Thus, C holds 500 pounds of ODCs that are taken into
account under paragraph (e)(2) of this section and is liable for the
floor stocks tax imposed on January 1, 1991.
(b) The amount of the floor stocks tax imposed on the 200 pounds of
post-1990 ODCs and the 300 pounds of post-1989 ODCs that will be used in
the manufacture of rigid foam
[[Page 35]]
insulation is equal to the tentative tax amount because those ODCs were
not previously subject to tax.
Example 5. (a) On January 1, 1994, D holds for sale 300 pounds of
CFC-113 (an ODC not described in paragraph (d)(2) or (d)(3) of this
section) and 25 pounds of Halon-1301 (an ODC described in paragraph
(d)(3) of this section). D is liable for the floor stocks tax imposed on
January 1, 1994, because 25 pounds of Halon-1301 exceeds the de minimis
amount specified in paragraph (e)(4)(iii) of this section. The 300
pounds of CFC-113 is less than the amount specified in paragraph
(e)(4)(i) of this section. Nevertheless, tax is imposed on both the 25
pounds of Halon-1301 and the 300 pounds of CFC-113.
(b) The amount of the floor stocks tax is determined separately for
the 300 pounds of CFC-113 and the 25 pounds of Halon-1301 and is equal
to the difference between the tentative tax amount and the amount of tax
previously imposed on those ODCs. For Halon-1301, for example, the tax
is determined as follows. The tentative tax amount is $1,087.50 ($4.35
(the base tax amount in 1994) x 10 (the ozone-depletion factor for
Halon-1301) x 25 (the number of pounds held)). The tax previously
imposed on the Halon-1301 is $6.28 ($3.35 (the base tax amount in 1993)
x 10 (the ozone-depletion factor for Halon-1301) x 0.75 percent (the
applicable percentage determined under section 4682(g)(2)(A)) x 25 (the
number of pounds held)). Thus, the floor stocks tax imposed on the 25
pounds of Halon-1301 in 1994 is $1,081.22, the difference between
$1,087.50 (the tentative tax amount) and $6.28 (the tax previously
imposed).
(f) Inventory--(1) In general. If, on the date on which the floor
stocks tax is imposed, a person holds ODCs for sale or for use in
further manufacture and the ODCs were not manufactured or imported by
such person, the following rules apply:
(i) The person shall prepare an inventory of all such ODCs that the
person holds on the date on which the tax is imposed.
(ii) The inventory shall be taken as of the first moment of the date
on which the tax is imposed, but work-back or work-forward inventories
will be acceptable if supported by adequate commercial records of
receipt, use, and disposition of ODCs held for sale or for use in
further manufacture.
(iii) The person must maintain records of the inventory and make
such records available for inspection and copying by internal revenue
agents and officers. Records of the inventory are not to be filed with
the Internal Revenue Service.
(2) Circumstances in which an inventory is not required. The
inventory requirement of paragraph (f)(1) of this section does not apply
to any person holding, on a date on which floor stocks tax is imposed,
only ODCs that are not subject to tax by reason of a statutory exemption
(e.g., use as a feedstock) or regulatory exclusion other than the de
minimis exception provided by paragraph (e) of this section (e.g.,
mixtures). In addition, any person that holds ODCs subject to the floor
stocks tax and also holds ODCs that are nontaxable under the provisions
of paragraph (b)(2) of this section, is not required to inventory the
nontaxable ODCs. However, any person that holds any ODCs that either are
subject to the floor stocks tax or would be subject to the floor stocks
tax but for the de minimis exception must inventory those ODCs.
(3) Examples. The rules of this paragraph (f) may be illustrated by
the following examples:
Example 1. On January 1, 1990, A holds for sale 300 pounds of CFC-12
(a post-1989 ODC not described in paragraph (d)(2) or (d)(3) of this
section) and 500 pounds of R-500 (a mixture). As required by paragraph
(f)(1) of this section, A must prepare an inventory of the CFC-12 A
holds for sale on that date even though, under paragraph (e)(1) of this
section, the 300 pounds of CFC-12 is not taken into account because it
is de minimis. However, as provided in paragraph (f)(2) of this section,
A is not required to inventory the R-500 because, under paragraph (b)(2)
of this section, mixtures are not subject to the floor stocks tax.
Example 2. On January 1, 1991, B holds for sale 1,000 pounds of CFC-
12 (a post-1989 ODC not described in paragraph (d)(2) or (d)(3) of this
section). As provided under paragraph (f)(2) of this section, B is not
required to prepare an inventory because CFC-12 is not subject to the
floor stocks tax in 1991.
(g) Time for paying tax. The floor stocks tax imposed under section
4682(h) shall be paid without assessment or notice. In the case of the
floor stocks tax imposed on January 1, 1990, the tax shall be paid by
April 1, 1990. In the case of floor stocks taxes imposed after January
1, 1990, the tax shall be
[[Page 36]]
paid by June 30 of the year in which the tax is imposed.
[T.D. 8370, 56 FR 56317, Nov. 4, 1991, as amended by T.D. 8622, 60 FR
52852, Oct. 11, 1995]
Sec. 52.4682-5 Exports.
(a) Overview. This section provides rules relating to the tax
imposed under section 4681 on ozone-depleting chemicals (ODCs) that are
exported. In general, tax is not imposed on ODCs that a manufacturer or
importer sells for export, or for resale by the purchaser to a second
purchaser for export, if the procedural requirements set forth in
paragraph (d) of this section are met. The tax benefit of this exemption
is limited, however, to the manufacturer's or importer's exemption
amount. Thus, if the tax that would otherwise be imposed under section
4681 on ODCs that a manufacturer or importer sells for export exceeds
this exemption amount, a tax equal to the excess is imposed on the ODCs.
The exemption amount, which is determined separately for post-1989 ODCs
and post-1990 ODCs, is calculated for each calendar year in accordance
with the rules of paragraph (c) of this section. This section also
provides rules under which a tax imposed under section 4681 on exported
ODCs may be credited or refunded, subject to the same limit on tax
benefits, if the procedural requirements set forth in paragraph (f) of
this section are met. See Sec. 52.4681-1(c) for definitions relating to
the tax on ODCs.
(b) Exemption or partial exemption from tax--(1) In general. Except
as provided in paragraph (b)(2) of this section, no tax is imposed on an
ODC if the manufacturer or importer of the ODC sells the ODC in a
qualifying sale for export (within the meaning of paragraph (d)(1) of
this section).
(2) Tax imposed if exemption amount exceeded--(i) Post-1989 ODCs.
The tax imposed on post-1989 ODCs that a manufacturer or importer sells
in qualifying sales for export during a calendar year is equal to the
excess (if any) of--
(A) The tax that would be imposed on the ODCs but for section
4682(d)(3) and this section; over
(B) The post-1989 ODC exemption amount for the calendar year
determined under paragraph (c)(1) of this section.
(ii) Post-1990 ODCs. The tax imposed on post-1990 ODCs that a
manufacturer or importer sells in qualifying sales for export during a
calendar year is equal to the excess (if any) of--
(A) The tax that would be imposed on the ODCs but for section
4682(d)(3) and this section; over
(B) The post-1990 ODC exemption amount for the calendar year
determined under paragraph (c)(2) of this section.
(iii) Allocation of tax--(A) Post-1989 ODCs. The tax (if any)
determined under paragraph (b)(2)(i) of this section may be allocated
among the post-1989 ODCs on which it is imposed in any manner, provided
that the amount allocated to any post-1989 ODC does not exceed the tax
that would be imposed on such ODC but for section 4682(d)(3) and this
section.
(B) Post-1990 ODCs. The tax (if any) determined under paragraph
(b)(2)(ii) of this section may be allocated among the post-1990 ODCs on
which it is imposed in any manner, provided that the amount allocated to
any post-1990 ODC does not exceed the tax that would be imposed on such
ODC but for section 4682(d)(3) and this section.
(c) Exemption amount--(1) Post-1989 ODC exemption amount. A
manufacturer's or importer's post-1989 ODC exemption amount for a
calendar year is the sum of the following amounts:
(i) The 1986 export percentage of the aggregate tax that would (but
for section 4682(d), section 4682(g), and this section) be imposed under
section 4681 on the maximum quantity, determined without regard to
additional production allowances, of post-1989 ODCs that the person is
permitted to manufacture during the calendar year under rules prescribed
by the Environmental Protection Agency (40 CFR part 82).
(ii) The aggregate tax that would (but for section 4682(d), section
4682(g), and this section) be imposed under section 4681 on post-1989
ODCs that the person manufactures during the calendar year under any
additional production allowance granted by the Environmental Protection
Agency.
(iii) The aggregate tax that would (but for section 4682(d), section
4682(g),
[[Page 37]]
and this section) be imposed under section 4681 on post-1989 ODCs
imported by the person during the calendar year.
(2) Post-1990 ODC exemption amount. A manufacturer's or importer's
post-1990 ODC exemption amount for a calendar year is the sum of the
following amounts:
(i) The 1989 export percentage of the aggregate tax that would (but
for section 4682(d), section 4682(g), and this section) be imposed under
section 4681 on the maximum quantity, determined without regard to
additional production allowances, of post-1990 ODCs the person is
permitted to manufacture during the calendar year under rules prescribed
by the Environmental Protection Agency.
(ii) The aggregate tax that would (but for section 4682(d), section
4682(g), and this section) be imposed under section 4681 on post-1990
ODCs that the person manufactures during the calendar year under any
additional production allowance granted by the Environmental Protection
Agency.
(iii) The aggregate tax that would (but for section 4682(d), section
4682(g), and this section) be imposed under section 4681 on post-1990
ODCs imported by the person during the calendar year.
(3) Definitions--(i) 1986 export percentage. See section
4682(d)(3)(B)(ii) for the meaning of the term 1986 export percentage.
(ii) 1989 export percentage. See section 4682(d)(3)(C) for the
meaning of the term 1989 export percentage.
(d) Procedural requirements relating to tax-free sales for export--
(1) Qualifying sales--(i) In general. A sale of ODCs is a qualifying
sale for export if--
(A) The seller is the manufacturer or importer of the ODCs and the
purchaser is a purchaser for export or for resale to a second purchaser
for export;
(B) At the time of the sale, the seller and the purchaser are
registered with the Internal Revenue Service; and
(C) At the time of the sale, the seller--
(1) Has an unexpired certificate in substantially the form set forth
in paragraph (d)(3)(ii) of this section from the purchaser; and
(2) Relies on the certificate in good faith.
(ii) Qualifying resale. A sale of ODCs is a qualifying resale for
export if--
(A) The seller acquired the ODCs in a qualifying sale for export and
the purchaser is a second purchaser for export;
(B) At the time of the sale, the seller and the purchaser are
registered with the Internal Revenue Service; and
(C) At the time of the sale, the seller--
(1) Has an unexpired certificate in substantially the form set forth
in paragraph (d)(3)(ii)(A) of this section from the purchaser of the
ODCs; and
(2) Relies on the certificate in good faith.
(iii) Special rule relating to sales made before July 1, 1993. If a
sale for export made before July 1, 1993, satisfies all the requirements
of paragraph (d)(1)(i) or (ii) of this section other than those relating
to registration, the sale will be treated as a qualifying sale (or
resale) for export. Thus, a sale made before July 1, 1993, may be a
qualifying sale (or resale) even if the parties to the sale are not
registered and the required certificate does not contain statements
regarding registration.
(iv) Registration. Application for registration is made on Form 637
(or any other form designated for the same use by the Commissioner)
according to the instructions applicable to the form. A person is
registered only if the district director has issued that person a letter
of registration and it has not been revoked or suspended. The effective
date of the registration must be no earlier than the date on which the
district director signs the letter of registration. Each business unit
that has, or is required to have, a separate employer identification
number is treated as a separate person.
(2) Good faith reliance. The requirements of paragraph (d)(1) of
this section are not satisfied with respect to a sale of ODCs and the
sale is not a qualifying sale (or resale) if, at the time of the sale--
(i) The seller has reason to believe that the ODCs are not purchased
for export; or
(ii) The Internal Revenue Service has notified the seller that the
purchaser's registration has been revoked or suspended.
[[Page 38]]
(3) Certificate--(i) In general. The certificate required under
paragraph (d)(1) of this section consists of a statement executed and
signed under penalties of perjury by a person with authority to bind the
purchaser, in substantially the same form as model certificates provided
in paragraph (d)(3)(ii) of this section, and containing all information
necessary to complete such model certificate. A new certificate must be
given if any information in the current certificate changes. The
certificate may be included as part of any business records normally
used to document a sale. The certificate expires on the earliest of the
following dates--
(A) The date one year after the effective date of the certificate;
(B) The date the purchaser provides a new certificate to the seller;
or
(C) The date the seller is notified by the Internal Revenue Service
or the purchaser that the purchaser's registration has been revoked or
suspended.
(ii) Model certificates--(A) ODCs sold for export by the purchaser.
If the purchaser will export the ODCs, the certificate must be in
substantially the following form:
CERTIFICATE OF PURCHASER OF CHEMICALS FOR EXPORT BY THE PURCHASER
(To support tax-free sales under section 4682(d)(3) of the Internal
Revenue Code.)
Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not more than one year
after effective date)
The undersigned purchaser (Purchaser) certifies the following under
penalties of perjury:
Purchaser is registered with the Internal Revenue Service as a
purchaser of ozone-depleting chemicals for export under registration
number ----------. Purchaser's registration has not been suspended or
revoked by the Internal Revenue Service.
The following percentage of ozone-depleting chemicals purchased
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
________________________________________________________________________
(Taxpayer identifying number of seller)
are purchased for export by Purchaser.
------------------------------------------------------------------------
Product Percentage
------------------------------------------------------------------------
CFC-11..................................................... ----------
CFC-12..................................................... ----------
CFC-113.................................................... ----------
CFC-114.................................................... ----------
CFC-115.................................................... ----------
Halon-1211................................................. ----------
Halon-1301................................................. ----------
Halon-2402................................................. ----------
Carbon tetrachloride....................................... ----------
Methyl chloroform.......................................... ----------
Other (specify)
--------------............................................ ----------
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account
number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Purchaser understands that Purchaser will be liable for tax imposed
under section 4681 if Purchaser does not export the ODCs to which this
certificate applies.
Purchaser understands that any use of the ODCs to which this
certificate applies other than for export may result in the revocation
of Purchaser's registration.
Purchaser will retain the business records needed to document the
export of the ozone-depleting chemicals to which this certificate
applies and will make such records available for inspection by
Government officers.
Purchaser has not been notified by the Internal Revenue Service that
its registration has been revoked or suspended.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment, or both, together with the costs
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
[[Page 39]]
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature
(B) ODCs sold by the purchaser for resale for export by the second
purchaser. If the purchaser will resell the ODCs to a second purchaser
for export by the second purchaser, the certificate must be in
substantially the following form:
CERTIFICATE OF PURCHASER OF CHEMICALS FOR RESALE FOR EXPORT BY THE
SECOND PURCHASER
(To support tax-free sales under section 4682(d)(3) of the Internal
Revenue Code.)
Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not more than one year
after effective date)
The undersigned purchaser (Purchaser) certifies the following under
penalties of perjury:
Purchaser is registered with the Internal Revenue Service as a
purchaser of ozone-depleting chemicals for export under registration
number ----------. Purchaser's registration has not been suspended or
revoked by the Internal Revenue Service.
The following percentage of ozone-depleting chemicals purchased
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
________________________________________________________________________
(Taxpayer identifying number of seller)
will be resold by Purchaser to persons (Second Purchasers) that certify
to Purchaser that they are (1) registered with the Internal Revenue
Service as purchasers of ozone-depleting chemicals for export and (2)
purchasing the ozone-depleting chemicals for export.
------------------------------------------------------------------------
Product Percentage
------------------------------------------------------------------------
CFC-11..................................................... ----------
CFC-12..................................................... ----------
CFC-113.................................................... ----------
CFC-114.................................................... ----------
CFC-115.................................................... ----------
Halon-1211................................................. ----------
Halon-1301................................................. ----------
Halon-2402................................................. ----------
Carbon tetrachloride....................................... ----------
Methyl chloroform.......................................... ----------
Other (specify)
--------------............................................. ----------
------------------------------------------------------------------------
This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account
number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Purchaser understands that Purchaser will be liable for tax imposed
under section 4681 if Purchaser does not resell the ODCs to which this
certificate applies to a Second Purchaser for export or export those
ODCs.
Purchaser understands that any use of the ODCs to which this
certificate applies other than for resale to Second Purchasers for
export may result in the revocation of Purchaser's registration.
Purchaser will retain the business records needed to document the
sales to Second Purchasers for export covered by this certificate and
will make such records available for inspection by Government officers.
Purchaser also will retain and make available for inspection by
Government officers the certificates of its Second Purchasers.
Purchaser has not been notified by the Internal Revenue Service that
its registration has been revoked or suspended. In addition, the
Internal Revenue Service has not notified Purchaser of the revocation or
suspension of the registration of any Second Purchaser who will purchase
ozone-depleting chemicals to which this certificate applies.
Purchaser understands that the fraudulent use of this certificate
may subject Purchaser and all parties making such fraudulent use of this
certificate to a fine or imprisonment, or both, together with the costs
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature
[[Page 40]]
(4) Documentation of export--(i) After December 31, 1992. After
December 31, 1992, to document the exportation of any ODCs, a person
must have the evidence required by the Environmental Protection Agency
as proof that the ODCs were exported.
(ii) Before January 1, 1993. Before January 1, 1993, to document the
exportation of any ODCs, a person must have evidence substantially
similar to that required by the Environmental Protection Agency as proof
that the ODCs were exported.
(e) Purchaser liable for tax--(1) Purchaser in qualifying sale. The
purchaser of ODCs in a qualifying sale for export is treated as the
manufacturer of the ODC and is liable for any tax imposed under section
4681 (determined without regard to exemptions for qualifying sales under
this section or Sec. 52.4682-1) when it sells or uses the ODCs if that
purchaser does not-
(i) Export the ODCs and document the exportation of the ODCs in
accordance with paragraph (d)(4) of this section; or
(ii) Sell the ODCs in a qualifying resale for export.
(2) Purchaser in qualifying resale. The purchaser of ODCs in a
qualifying resale for export is treated as the manufacturer of the ODC
and is liable for any tax imposed under section 4681 (determined without
regard to exemptions for qualifying sales under this section or Sec.
52.4682-1) when it sells or uses the ODCs if that purchaser does not
export the ODCs and document the exportation of the ODCs in accordance
with paragraph (d)(4) of this section.
(f) Credit or refund--(1) In general. Except as provided in
paragraph (f)(2) of this section, a manufacturer or importer that meets
the conditions of paragraph (f)(3) of this section is allowed a credit
or refund (without interest) of the tax it paid to the government under
section 4681 on ODCs that are exported. Persons other than manufacturers
and importers of ODCs cannot file claims for credit or refund of tax
imposed under section 4681 on ODCs that are exported.
(2) Limitation. The amount of credits or refunds of tax under this
paragraph (f) is limited--
(i) In the case of tax paid on post-1989 ODCs sold during a calendar
year, to the amount (if any) by which the post-1989 exemption amount for
the year exceeds the tax benefit provided to such post-1989 ODCs under
paragraph (b) of this section; and
(ii) In the case of tax paid on post-1990 ODCs sold during a
calendar year, to the amount (if any) by which the post-1990 exemption
amount for the year exceeds the tax benefit provided to such post-1990
ODCs under paragraph (b) of this section.
(3) Conditions to allowance of credit or refund. The conditions of
this paragraph (f)(3) are met if the manufacturer or importer--
(i) Documents the exportation of the ODCs in accordance with
paragraph (d)(4) of this section; and
(ii) Establishes that it has--
(A) Repaid or agreed to repay the amount of the tax to the person
that exported the ODC; or
(B) Obtained the written consent of the exporter to the allowance of
the credit or the making of the refund.
(4) Procedural rules. See section 6402 and the regulations under
that section for procedural rules relating to filing a claim for credit
or refund of tax.
(g) Examples. The following examples illustrate the provisions of
this section. In each example, the sales are qualifying sales for export
(within the meaning of paragraph (d)(1) of this section), all
registration, certification, and documentation requirements of this
section are met, and the ODCs sold for export are exported:
Example 1. (i) Facts. D, a corporation, manufactures CFC-11, a post-
1989 ODC, and does not manufacture or import any other ODCs. In 1993, D
manufactures 100,000 pounds of CFC-11, the maximum quantity D is allowed
to manufacture in 1993 under EPA regulations. D has no additional
production allowance from EPA for 1993. In 1993, the tax on CFC-11 is
$3.35 per pound. D's 1986 export percentage for post-1989 ODCs is 50%.
In 1993, D sells 80,000 pounds of CFC-11 in qualifying sales for export.
The remainder of D's production is not exported.
(ii) Components of limit on tax benefit. Under paragraph (c)(1) of
this section, D's exemption amount for 1993 is equal to the sum of--
(A) D's 1986 export percentage multiplied by the aggregate tax that
would (but for section 4682(d), section 4682(g), and Sec. 52.4682-5) be
imposed under section 4681 on the maximum
[[Page 41]]
quantity of post-1989 ODCs D is permitted to manufacture during 1993;
(B) The aggregate tax that would (but for section 4682(d), section
4682(g), and Sec. 52.4682-5) be imposed under section 4681 on post-1989
ODCs that D manufactures during 1993 under an additional production
allowance; and
(C) The aggregate tax that would (but for section 4682(d), section
4682(g), and Sec. 52.4682-5) be imposed under section 4681 on post-1989
ODCs imported by D during 1993.
(iii) Limit on tax benefit. The amounts described in paragraphs
(ii)(B) and (C) of this Example 1 are equal to zero. Thus, D's 1993
exemption amount is $167,500 (50% of $335,000 (the tax that would
otherwise be imposed on 100,000 pounds of CFC-11 in 1993)).
(iv) Application of limit on tax benefit. Under paragraph (b)(2) of
this section, the tax imposed on the CFC-11 D sells for export is equal
to the excess of the tax that would have been imposed on those ODCs but
for section 4682(d) and Sec. 52.4682-5, over D's 1993 exemption amount.
But for Sec. 52.4682-5, $268,000 ($3.35 x 80,000) of tax would have
been imposed on the CFC-11 sold for export. Thus, $100,500 ($268,000 -
$167,500) of tax is imposed on the CFC-11 sold for export.
Example 2. (i) Facts. E, a corporation, manufactures CFC-11, a post-
1989 ODC, and does not manufacture or import any other ODCs. In 1993, E
manufactures 100,000 pounds of CFC-11, the maximum quantity E is allowed
to manufacture in 1993 under EPA regulations. E has no additional
production allowance from EPA for 1993. In 1993, the tax on CFC-11 is
$3.35 per pound. E's 1986 export percentage for post-1989 ODCs is 50%.
In 1993, E sells 45,000 pounds of CFC-11 tax free in qualifying sales
for export and pays tax under section 4681 on an additional 35,000
pounds of exported CFC-11. The remainder of E's production is not
exported.
(ii) Limit on tax benefit. E's 1993 exemption amount is $167,500,
(50% of $335,000 (the tax that would otherwise be imposed on 100,000
pounds of CFC-11 in 1993)). The credit or refund allowed to E under
paragraph (f) of this section is limited under paragraph (f)(2) of this
section to the amount by which E's 1993 exemption amount exceeds E's
1993 tax benefit under paragraph (b) of this section.
(iii) Application of limit on tax benefit. Because E sold 45,000
pounds of CFC-11 tax free in qualifying sales for export in 1993, E's
1993 tax benefit under paragraph (b) of this section is $150,750 ($3.35
x 45,000). Thus, the credit or refund allowed to E under paragraph (f)
of this section is limited to $16,750 ($167,500-$150,750).
Example 3. (i) Facts. F, a corporation, manufactures CFC-11, a post-
1989 ODC, and does not manufacture any other ODCs. F also imports CFC-
11. In 1993, F manufactures 60,000 pounds of CFC-11 (100,000 pounds is
the maximum quantity F is allowed to manufacture in 1993 under EPA
regulations) and imports 40,000 pounds. F has no additional production
allowance from EPA for 1993. In 1993, the tax on CFC-11 is $3.35 per
pound. F's 1986 export percentage for post-1989 ODCs is 50%. In 1993, F
sells 45,000 pounds of CFC-11 tax free in qualifying sales for export
and pays tax under section 4681 on an additional 35,000 pounds of
exported CFC-11. The remainder of F's production is not exported.
(ii) Limit on tax benefit. F's 1993 exemption amount is $301,500,
($167,500 (50% of $335,000 (the tax that would otherwise be imposed on
100,000 pounds of CFC-11 in 1993) plus $134,000 (the tax that would
otherwise be imposed on the 40,000 pounds imported)). The credit or
refund allowed to F under paragraph (f) of this section is limited under
paragraph (f)(2) of this section to the amount by which F's 1993
exemption amount exceeds F's 1993 tax benefit under paragraph (b) of
this section.
(iii) Application of limit on tax benefit. Because F sold 45,000
pounds of CFC-11 tax free in qualifying sales for export in 1993, F's
1993 tax benefit under paragraph (b) of this section is $150,750 ($3.35
x 45,000). Thus, the credit or refund allowed to F under paragraph (f)
of this section is limited to $150,750 ($301,500-$150,750). The
limitation does not affect F's credit or refund because the tax F paid
on exported ODCs is only $117,250 ($3.35 x 35,000).
(h) Effective date. This section is effective January 1, 1993.
[T.D. 8622, 60 FR 52853, Oct. 11, 1995]
PART 53_FOUNDATION AND SIMILAR EXCISE TAXES--Table of Contents
Subpart A_Taxes on Investment Income
Sec.
53.4940-1 Excise tax on net investment income.
Subpart B_Taxes on Self-Dealing
53.4941(a)-1 Imposition of initial taxes.
53.4941(b)-1 Imposition of additional taxes.
53.4941(c)-1 Special rules.
53.4941(d)-1 Definition of self-dealing.
53.4941(d)-2 Specific acts of self-dealing.
53.4941(d)-3 Exceptions to self-dealing.
53.4941(d)-4 Transitional rules.
53.4941(e)-1 Definitions.
53.4941(f)-1 Effective dates.
Subpart C_Taxes on Failure To Distribute Income
53.4942(a)-1 Taxes for failure to distribute income.
53.4942(a)-2 Computation of undistributed income.
[[Page 42]]
53.4942(a)-3 Qualifying distributions defined.
53.4942(b)-1 Operating foundations.
53.4942(b)-2 Alternative tests.
53.4942(b)-3 Determination of compliance with operating foundation
tests.
Subpart D_Taxes on Excess Business Holdings
53.4943-1 General rule; purpose.
53.4943-2 Imposition of tax on excess business holdings of private
foundations.
53.4943-3 Determination of excess business holdings.
53.4943-4 Present holdings.
53.4943-5 Present holdings acquired by trust or a will.
53.4943-6 Five-year period to dispose of gifts, bequests, etc.
53.4943-7 Special rules for readjustments involving grandfathered
holdings.
53.4943-8 Business holdings; constructive ownership.
53.4943-9 Business holdings; certain periods.
53.4943-10 Business enterprise; definition.
53.4943-11 Effective date.
Subpart E_Taxes on Investments Which Jeopardize Charitable Purpose
53.4944-1 Initial taxes.
53.4944-2 Additional taxes.
53.4944-3 Exception for program-related investments.
53.4944-4 Special rules.
53.4944-5 Definitions.
53.4944-6 Special rules for investments made prior to January 1, 1970.
Subpart F_Taxes on Taxable Expenditures
53.4945-1 Taxes on taxable expenditures.
53.4945-2 Propaganda influencing legislation.
53.4945-3 Influencing elections and carrying on voter registration
drives.
53.4945-4 Grants to individuals.
53.4945-5 Grants to organizations.
53.4945-6 Expenditures for noncharitable purposes.
Subpart G_Definitions and Special Rules
53.4946-1 Definitions and special rules.
Subpart H_Application to Certain Nonexempt Trusts
53.4947-1 Application of tax.
53.4947-2 Special rules.
Subpart I_Tax on Investment Income of and Denial of Exemption to Certain
Foreign Organizations
53.4948-1 Application of taxes and denial of exemption with respect to
certain foreign organizations.
Subpart J_Black Lung Benefit Trust Excise Taxes
53.4951-1 Black lung trusts--taxes on self-dealing.
53.4952-1 Black lung trusts--taxes on taxable expenditures.
Subpart K_Second Tier Excise Taxes
53.4955-1 Tax on political expenditures.
53.4958-0 Table of contents.
53.4958-1 Taxes on excess benefit transactions.
53.4958-2 Definition of applicable tax-exempt organization.
53.4958-3 Definition of disqualified person.
53.4958-4 Excess benefit transaction.
53.4958-5 Transaction in which the amount of the economic benefit is
determined in whole or in part by the revenues of one or more
activities of the organization. [Reserved]
53.4958-6 Rebuttable presumption that a transaction is not an excess
benefit transaction.
53.4958-7 Correction.
53.4958-8 Special rules.
53.4961-1 Abatement of second tier taxes for correction within
correction period.
53.4961-2 Court proceedings to determine liability for second tier tax.
53.4963-1 Definitions.
53.4965-1 Overview.
53.4965-2 Covered tax-exempt entities.
53.4965-3 Prohibited tax shelter transactions.
53.4965-4 Definition of tax-exempt party to a prohibited tax shelter
transaction.
53.4965-5 Entity managers and related definitions.
53.4965-6 Meaning of ``knows or has reason to know''.
53.4965-7 Taxes on prohibited tax shelter transactions.
53.4965-8 Definition of net income and proceeds and standard for
allocating net income or proceeds to various periods.
53.4965-9 Effective/applicability dates.
Subpart L_Procedure and Administration
53.6001-1 Notice or regulations requiring records, statements, and
special returns.
53.6011-1 General requirement of return, statement or list.
[[Page 43]]
53.6011-4 Requirement of statement disclosing participation in certain
transactions by taxpayers.
53.6060-1 Reporting requirements for tax return preparers.
53.6061-1 Signing of returns and other documents.
53.6065-1 Verification of returns.
53.6071-1 Time for filing returns.
53.6071-1T Time for filing returns (temporary).
53.6081-1 Automatic extension of time for filing the return to report
taxes due under section 4951 for self-dealing with a nuclear
decommissioning fund.
53.6091-1 Place for filing chapter 42 tax returns.
53.6091-2 Exceptional cases.
53.6107-1 Tax return preparer must furnish copy of return or claim for
refund to taxpayer and must retain a copy or record.
53.6109-1 Tax return preparers furnishing identifying numbers for
returns or claims for refund filed.
53.6151-1 Time and place for paying tax shown on returns.
53.6161-1 Extension of time for paying tax or deficiency.
53.6165-1 Bonds where time to pay tax or deficiency has been extended.
53.6601-1 Interest on underpayment, nonpayment, or extensions of time
for payment, of tax.
53.6651-1 Failure to file tax return or to pay tax.
53.6694-1 Section 6694 penalties applicable to tax return preparer.
53.6694-2 Penalties for understatement due to an unreasonable position.
53.6694-3 Penalty for understatement due to willful, reckless, or
intentional conduct.
53.6694-4 Extension of period of collection when tax return preparer
pays 15 percent of a penalty for understatement of taxpayer's
liability and certain other procedural matters.
53.6695-1 Other assessable penalties with respect to the preparation of
tax returns or claims for refund for other persons.
53.6696-1 Claims for credit or refund by tax return preparers.
53.7101-1 Form of bonds.
53.7701-1 Tax return preparer.
Authority: 26 U.S.C. 7805.
Section 53.6060-1 also issued under 26 U.S.C. 6060(a);
Section 53.6081-1 also issued under 26 U.S.C. 6081(a);
Section 53.6109-1 also issued under 26 U.S.C. 6109(a);
Section 53.6109-2 also issued under 26 U.S.C. 6109(a);
Section 53.6695-1 also issued under 26 U.S.C. 6695(b).
Subpart A_Taxes on Investment Income
Sec. 53.4940-1 Excise tax on net investment income.
(a) In general. For taxable years beginning after September 30,
1977, section 4940 imposes an excise tax of 2 percent of the net
investment income (as defined in section 4940(c) and paragraph (c) of
this section) of a tax-exempt private foundation (as defined in section
509). For taxable years beginning after December 31, 1969, and before
October 1, 1977, the tax imposed by section 4940 is 4 percent of the net
investment income. This tax will be reported on the form the foundation
is required to file under section 6033 for the taxable year and will be
paid annually at the time prescribed for filing such annual return
(determined without regard to any extension of time for filing). In
addition, an excise tax is imposed in the manner prescribed in paragraph
(b) of this section on certain non-exempt private foundations (including
certain non-exempt charitable trusts). Except as provided in the
succeeding sentence, this tax is to be reported by means of a schedule
attached to the organization's income tax return. For taxable years
ending on or after December 31, 1975, the tax imposed by section 4940(b)
and paragraph (b) of this section on a trust described in section
4947(a)(1) which is a private foundation shall be reported on Form 5227.
The tax imposed by section 4940(b) and this section is to be paid
annually at the time the organization is required to pay its income
taxes imposed under subtitle A. Except as otherwise provided herein, no
exclusions or deductions from gross investment income or credits against
tax are allowable under this section.
(b) Taxable foundations. (1) The excise tax imposed under section
4940 on private foundations which are not exempt from taxation under
section 501(a) is equal to:
(i) The amount (if any) by which the sum of
(A) The tax on net investment income imposed under section 4940(a),
computed as if such private foundation were exempt from taxation under
section 501(a) and described in section 501(c)(3) for the taxable year,
plus
[[Page 44]]
(B) The amount of the tax which would have been imposed under
section 511 for such taxable year if such private foundation had been
exempt from taxation under section 501(a), exceeds.
(ii) The tax imposed under subtitle A on such private foundation for
the taxable year.
(2) The provisions of this paragraph may be illustrated by the
following examples:
Example 1. Assume that the tax liability under subtitle A for
private foundation X, which is not exempt from taxation under section
501(a) for 1970, is $10,000. Had X been exempt under section 501(a) for
1970, the tax imposed under section 4940(a) would have been $4,000 and
the tax imposed under section 511 would have been $7,000. The excess of
the sum of the taxes which would have been imposed under sections
4940(a) and 511 ($11,000) over the tax that was imposed under subtitle A
($10,000) is $1,000, the amount of the tax imposed on such organization
under section 4940(b).
Example 2. Assume the facts stated in Example (1), except that the
tax liability under subtitle A is $15,000 rather than $10,000. Because
the sum of the taxes which would have been imposed under sections
4940(a) and 511 ($11,000) does not exceed the tax that was imposed under
subtitle A ($15,000), there is no tax imposed under section 4940(b) with
respect to such foundation.
(c) Net investment income defined--(1) In general. For purposes of
section 4940(a), net investment income of a private foundation is the
amount by which:
(i) The sum of the gross investment income (as defined in section
4940(c)(2) and paragraph (d) of this section) and the capital gain net
income (net capital gain for taxable years beginning before January 1,
1977) (within the meaning of section 4940(c)(4) and paragraph (f) of
this section) exceeds
(ii) The deductions allowed by section 4940(c)(3) and paragraph (e)
of this section.
Except to the extent inconsistent with the provisions of this section,
net investment income shall be determined under the principles of
Subtitle A.
(2) Tax-exempt income. For purposes of computing net investment
income under section 4940, the provisions of section 103 (relating to
interest on certain governmental obligations) and section 265 (relating
to expenses and interest relating to tax-exempt income) and the
regulations thereunder shall apply.
(d) Gross investment income--(1) In general. For purposes of
paragraph (c) of this section, ``gross investment income'' means the
gross amounts of income from interest, dividends, rents, and royalties
(including overriding royalties) received by a private foundation from
all sources, but does not include such income to the extent included in
computing the tax imposed by section 511. Under this definition,
interest, dividends, rents, and royalties derived from assets devoted to
charitable activities are includible in gross investment income.
Therefore, for example, interest received on a student loan would be
includible in the gross investment income of a private foundation making
such loan. For purposes of paragraph (c) of this section, gross
investment income also includes the items of investment income described
in Sec. 1.512(b)-1(a).
(2) Certain estate and trust disbursements. In the case of a
distribution from an estate or a trust described in section 4947(a) (1)
or (2), such distribution shall not retain its character in the hands of
the distributee for purposes of computing the tax under section 4940;
except that, in the case of a distribution from a trust described in
section 4947(a)(2), the income of such trust attributable to transfers
in trust after May 26, 1969, shall retain its character in the hands of
a distributee private foundation for purposes of section 4940 (unless
such income is taken into account because of the application of section
671).
(3) Treatment of certain distributions in redemption of stock. For
purposes of applying section 302(b)(1), any distribution made to a
private foundation by a disqualified person (as defined in section
4946(a)), in redemption of stock held by such private foundation in a
business enterprise shall be treated as not essentially equivalent to a
dividend if all of the following conditions are satisfied: (i) Such
redemption is of stock which was owned by a private foundation on May
26, 1969 (or which is acquired by a private foundation under the terms
of a trust which was irrevocable on May 26, 1969, or under the terms of
a will executed on or before
[[Page 45]]
such date, which is in effect on such date and at all times thereafter,
or would have passed under such a will but before that time actually
passes under a trust which would have met the test of this subdivision
but for the fact that the trust was revocable (but was not in fact
revoked)); (ii) such foundation is required to dispose of such property
in order not to be liable for tax under section 4943 (relating to taxes
on excess business holdings); and (iii) such foundation receives in
return an amount which equals or exceeds the fair market value of such
property at the time of such disposition or at the time a contract for
such disposition was previously executed in a transaction which would
not constitute a prohibited transaction (within the meaning of section
503(b) or the corresponding provisions of prior law). In the case of a
disposition before January 1, 1975, section 4943 shall be applied
without taking section 4943(c) (4) into account. A distribution which
otherwise qualifies under section 302 as a distribution in part or full
payment in exchange for stock shall not be treated as essentially
equivalent to a dividend because it does not meet the requirements of
this subparagraph.
(e) Deductions--(1) In general. (i) For purposes of computing net
investment income, there shall be allowed as a deduction from gross
investment income all the ordinary and necessary expenses paid or
incurred for the production or collection of gross investment income or
for the management, conservation, or maintenance of property held for
the production of such income, determined with the modifications set
forth in subparagraph (2) of this paragraph. Such expenses include that
portion of a private foundation's operating expenses which is paid or
incurred for the production or collection of gross investment income.
Taxes paid or incurred under this section are not paid or incurred for
the production or collection of gross investment income. A private
foundation's operating expenses include compensation of officers, other
salaries and wages of employees, outside professional fees, interest,
and rent and taxes upon property used in the foundation's operations.
Where a private foundation's officers or employees engage in activities
on behalf of the foundation for both investment purposes and for exempt
purposes, compensation and salaries paid to such officers or employees
must be allocated between the investment activities and the exempt
activities. To the extent a private foundation's expenses are taken into
account in computing the tax imposed by section 511, they shall not be
deductible for purposes of computing the tax imposed by section 4940.
(ii) Where only a portion of property produces, or is held for the
production of, income subject to the section 4940 excise tax, and the
remainder of the property is used for exempt purposes, the deductions
allowed by section 4940(c)(3) shall be apportioned between the exempt
and non-exempt uses.
(iii) No amount is allowable as a deduction under this section to
the extent it is paid or incurred for purposes other than those
described in subdivision (i) of this subparagraph. Thus, for example,
the deductions prescribed by the following sections are not allowable:
(1) The charitable deduction prescribed under section 170 and 642(c);
(2) the net operating loss deduction prescribed under section 172; and
(3) the special deductions prescribed under Part VIII, Subchapter B,
Chapter 1.
(2) Deduction modifications. The following modifications shall be
made in determining deductions otherwise allowable under this paragraph:
(i) The depreciation deduction shall be allowed, but only on the
basis of the straight line method provided in section 167(b)(1).
(ii) The depletion deduction shall be allowed, but such deduction
shall be determined without regard to section 613, relating to
percentage depletion.
(iii) The basis to be used for purposes of the deduction allowed for
depreciation or depletion shall be the basis determined under the rules
of Part II of Subchapter O of Chapter 1, subject to the provisions of
section 4940(c)(3)(B), and without regard to section 4940(c)(4)(B),
relating to the basis for determining gain, or section 362(c). Thus, a
private foundation must reduce the cost or other substituted or
transferred basis by an amount equal to the straight line depreciation
or cost depletion, without regard to whether the
[[Page 46]]
foundation deducted such depreciation or depletion during the period
prior to its first taxable year beginning after December 31, 1969.
However, where a private foundation has previously taken depreciation or
depletion deductions in excess of the amount which would have been taken
had the straight line or cost method been employed, such excess
depreciation or depletion also shall be taken into account to reduce
basis. If the facts necessary to determine the basis of property in the
hands of the donor or the last preceding owner by whom it was not
acquired by gift are unknown to a donee private foundation, then the
original basis to such foundation of such property shall be determined
under the rules of Sec. 1.1015-1(a)(3).
(iv) The deduction for expenses paid or incurred in any taxable year
for the production of gross investment income earned as an incident to a
charitable function shall be no greater than the income earned from such
function which is includible as gross investment income for such year.
For example, where rental income is incidentally realized in 1971 from
historic buildings held open to the public, deductions for amounts paid
or incurred in 1971 for the production of such income shall be limited
to the amount of rental income includible as gross investment income for
1971.
(f) Capital gain and losses--(1) General rule. In determining
capital gain net income (net capital gain for taxable years beginning
before January 1, 1977) for purposes of the tax imposed by section 4940,
there shall be taken into account only capital gains and losses from the
sale or other disposition of property held by a private foundation for
investment purposes (other than program-related investments, as defined
in section 4944(c)), and property used for the production of income
included in computing the tax imposed by section 511 except to the
extent gain or loss from the sale or other disposition of such property
is taken into account for purposes of such tax. For taxable years
beginning after December 31, 1972, property shall be treated as held for
investment purposes even though such property is disposed of by the
foundation immediately upon its receipt, if it is property of a type
which generally produces interest, dividends, rents, royalties, or
capital gains through appreciation (for example, rental real estate,
stock, bonds, mineral interests, mortgages, and securities). Under this
subparagraph, gains and losses from the sale or other disposition of
property used for the exempt purposes of the private foundation are
excluded. For example, gain or loss on the sale of the buildings used
for the exempt activities of a private foundation would not be subject
to the section 4940 tax. Where the foundation uses property for its
exempt purposes, but also incidentally derives income from such property
which is subject to the tax imposed by section 4940(a), any gain or loss
resulting from the sale or other disposition of such property is not
subject to the tax imposed by section 4940(a). For example, if a tax-
exempt private foundation maintains buildings of a historical nature and
keeps them open for public inspection, but requires a number of its
employees to live in these buildings and charges the employees rent, the
rent would be subject to the tax imposed by section 4940(a), but any
gain or loss resulting from the sale of such property would not be
subject to such tax. However, where the foundation uses property for
both exempt purposes and (other than incidentally) for investment
purposes (for example, a building in which the foundation's charitable
and investment activities are carried on), that portion of any gain or
loss from the sale or other disposition of such property which is
allocable to the investment use of such property must be taken into
account in computing capital gain net income (net capital gain for
taxable years beginning before January 1, 1977) for such taxable year.
For purposes of this paragraph, a distribution of property for purposes
described in section 170(c) (1) or (2)(B) which is a qualifying
distribution under section 4942 shall not be treated as a sale or other
disposition of property.
(2) Basis. (i) The basis for purposes of determining gain from the
sale or other disposition of property shall be the greater of:
(A) Fair market value on December 31, 1969, plus or minus all
adjustments
[[Page 47]]
after December 31, 1969, and before the date of disposition under the
rules of Part II of Subchapter O of Chapter 1, provided that the
property was held by the private foundation on December 31, 1969, and
continuously thereafter to the date of disposition, or
(B) Basis as determined under the rules of Part II of Subchapter O
of Chapter 1,
subject to the provisions of section 4940(c)(3)(B) (and without regard
to section 362(c)).
(ii) For purposes of determining loss from the sale or other
disposition of property, basis as determined in subdivision (i)(B) of
this subparagraph shall apply.
(3) Losses. Where the sale or other disposition of property referred
to in section 4940(c)(4)(A) results in a capital loss, such loss may be
subtracted from capital gains from the sale or other disposition of
other such property during the same taxable year, but only to the extent
of such gains. Should losses from the sale or other disposition of such
property exceed gains from the sale or other disposition of such
property during the same taxable year, such excess may not be deducted
from gross investment income under section 4940(c)(3) in any taxable
year, nor may such excess by used to reduce gains in either prior or
future taxable years, regardless of whether the foundation is a
corporation or a trust.
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. A private foundation holds certain depreciable real
property on December 31, 1969, having a basis of $102,000. The fair
market value of such property on that date was $100,000. For its taxable
year 1970 the foundation was allowed depreciation for such property of
$5,100 on the straight line method, the allowable amount computed on the
$102,000 basis. The property was sold on January 1, 1971, for $100,000.
Because fair market value on December 31, 1969, less straight line
depreciation of $5,100 ($94,900) is less than basis as determined by
Part II of Subchapter O of Chapter 1, $96,900 ($102,000 less $5,100), a
gain of $3,100 is recognized (i.e., sales price of $100,000 less the
greater of the two possible bases).
Example 2. Assume the same facts in example 1, except that the sale
price was $95,000. Because the sale price was $1,900 less than the basis
for loss ($96,900 as determined by the application of subparagraph
(2)(ii) of this paragraph), there is a capital loss of $1,900 which may
be deducted against capital gains for 1971 (if any) in determining net
capital gain (capital gain net income for taxable years beginning after
December 31, 1976).
Example 3. A private foundation holds certain depreciable real
property on December 31, 1969, having a basis of $102,000. The fair
market value of such property on that date was $110,000. For its taxable
year 1970 the foundation was allowed depreciation for such property of
$5,100 on the straight line method, the allowable amount computed on the
$102,000 basis. The property was sold on January 1, 1971, for $100,000.
Fair market value on December 31, 1969, less straight line depreciation
of $5,100 ($104,900) exceeds basis as determined by Part II of
Subchapter O of Chapter 1, $96,900 ($102,000 less $5,100), and will be
used for purposes of determining gain. Because basis for purposes of
determining gain exceeds sale price, there is no gain. There is no loss
because basis for purposes of determining loss ($96,900) is less than
sale price.
[T.D. 7250, 38 FR 868, Jan. 5, 1973; 38 FR 7549, Mar. 23, 1973, as
amended by T.D. 7407, 41 FR 9321, Mar. 4, 1976; T.D. 7606, 44 FR 18971,
Mar. 30, 1979; T.D. 7728, 45 FR 72651, Nov. 3, 1980; T.D. 8423, 57 FR
33444, July 29, 1992]
Subpart B_Taxes on Self-Dealing
Source: T.D. 7270, 38 FR 9493, Apr. 17, 1973, unless otherwise
noted.
Sec. 53.4941(a)-1 Imposition of initial taxes.
(a) Tax on self-dealer--(1) In general. Section 4941(a)(1) of the
code imposes an excise tax on each act of self-dealing between a
disqualified person (as defined in section 4946(a)) and a private
foundation. Except as provided in subparagraph (2) of this paragraph,
this tax shall be imposed on a disqualified person even though he had no
knowledge at the time of the act that such act constituted self-dealing.
Notwithstanding the preceding two sentences, however, a transaction
between a disqualified person and a private foundation will not
constitute an act of self-dealing if:
(i) The transaction is a purchase or sale of securities by a private
foundation through a stockbroker where normal trading procedures on a
stock exchange or recognized over-the-counter market are followed;
(ii) Neither the buyer nor the seller of the securities nor the
agent of either
[[Page 48]]
knows the identity of the other party involved; and
(iii) The sale is made in the ordinary course of business, and does
not involve a block of securities larger than the average daily trading
volume of that stock over the previous 4 weeks.
However, the preceding sentence shall not apply to a transaction
involving a dealer who is a disqualified person acting as a principal or
to a transaction which is an act of self-dealing pursuant to section
4941(d)(1)(B) and Sec. 53.4941(d)-2 (c)(1). The tax imposed by section
4941(a)(1) is at the rate of 5 percent of the amount involved (as
defined in section 4941(e)(2) and Sec. 53.4941(e)-1(b)) with respect to
the act of self-dealing for each year or partial year in the taxable
period (as defined in section 4941(e)(1)) and shall be paid by any
disqualified person (other than a foundation manager acting only in the
capacity of a foundation manager) who participates in the act of self-
dealing. However, if a foundation manager is also acting as a self-
dealer, he may be liable for both the tax imposed by section 4941(a)(1)
and the tax imposed by section 4941(a)(2).
(2) Government officials. In the case of a government official (as
defined in sec. 4946(a)), the tax shall be imposed upon such government
official who participates in an act of self-dealing, only if he knows
that such act is an act of self-dealing. See paragraph (b)(3) of this
section for a definition of knowing.
(3) Participation. For purposes of this paragraph, a disqualified
person shall be treated as participating in an act of self-dealing in
any case in which he engages or takes part in the transaction by himself
or with others, or directs any person to do so.
(b) Tax on foundation manager--(1) In general. Section 4941(a)(2) of
the code imposes an excise tax on the participation of any foundation
manager in an act of self-dealing between a disqualified person and a
private foundation. This tax is imposed only in cases in which the
following circumstances are present:
(i) A tax is imposed by section 4941(a)(1),
(ii) Such participating foundation manager knows that the act is an
act of self-dealing, and
(iii) The participation by the foundation manager is willful and is
not due to reasonable cause.
The tax imposed by section 4941(a)(2) is at the rate of 2\1/2\ percent
of the amount involved with respect to the act of self-dealing for each
year or partial year in the taxable period and shall be paid by any
foundation manager described in subdivisions (ii) and (iii) of this
subparagraph.
(2) Participation. The term ``participation'' shall include silence
or inaction on the part of a foundation manager where he is under a duty
to speak or act, as well as any affirmative action by such manager.
However, a foundation manager will not be considered to have
participated in an act of self-dealing where he has opposed such act in
a manner consistent with the fulfillment of his responsibilities to the
private foundation.
(3) Knowing. For purposes of section 4941, a person shall be
considered to have participated in a transaction ``knowing'' that it is
an act of self-dealing only if:
(i) He has actual knowledge of sufficient facts so that, based
solely upon such facts, such transaction would be an act of self-
dealing,
(ii) He is aware that such an act under these circumstances may
violate the provisions of Federal tax law governing self-dealing, and
(iii) He negligently fails to make reasonable attempts to ascertain
whether the transaction is an act of self-dealing, or he is in fact
aware that it is such an act.
For purposes of this part and Chapter 42, the term ``knowing'' does not
mean ``having reason to know''. However, evidence tending to show that a
person has reason to know of a particular fact or particular rule is
relevant in determining whether he had actual knowledge of such fact or
rule. Thus, for example, evidence tending to show that a person has
reason to know of sufficient facts so that, based solely upon such
facts, a transaction would be an act of self-dealing is relevant in
determining whether he has actual knowledge of such facts.
(4) Willful. Participation by a foundation manager shall be deemed
willful if
[[Page 49]]
it is voluntary, conscious, and intentional. No motive to avoid the
restrictions of the law or the incurrence of any tax is necessary to
make the participation willful. However, participation by a foundation
manager is not willful if he does not know that the transaction in which
he is participating is an act of self-dealing.
(5) Due to reasonable cause. A foundation manager's participation is
due to reasonable cause if he has exercised his responsibility on behalf
of the foundation with ordinary business care and prudence.
(6) Advice of counsel. If a person, after full disclosure of the
factual situation to legal counsel (including house counsel), relies on
the advice of such counsel expressed in a reasoned written legal opinion
that an act is not an act of self-dealing under section 4941, although
such act is subsequently held to be an act of self-dealing, the person's
participation in such act will ordinarily not be considered ``knowing''
or ``willful'' and will ordinarily be considered ``due to reasonable
cause'' within the meaning of section 4941(a)(2). For purposes of this
subparagraph, a written legal opinion will be considered ``reasoned''
even if it reaches a conclusion which is subsequently determined to be
incorrect so long as such opinion addresses itself to the facts and
applicable law. However, a written legal opinion will not be considered
``reasoned'' if it does nothing more than recite the facts and express a
conclusion. However, the absence of advice of counsel with respect to an
act shall not, by itself, give rise to any inference that a person
participated in such act knowingly, willfully, or without reasonable
cause.
(c) Burden of proof. For provisions relating to the burden of proof
in cases involving the issue whether a foundation manager or a
government official has knowingly participated in an act of self-
dealing, see section 7454(b).
[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7299, 38 FR
35304, Dec. 27, 1973]
Sec. 53.4941(b)-1 Imposition of additional taxes.
(a) Tax on self-dealer. Section 4941(b)(1) of the Code imposes an
excise tax in any case in which an initial tax is imposed by section
4941(a)(1) on an act of self-dealing by a disqualified person with a
private foundation and the act is not corrected within the taxable
period (as defined in Sec. 53.4941(e)-1(a)). The tax imposed by section
4941(b)(1) is at the rate of 200 percent of the amount involved and
shall be paid by any disqualified person (other than a foundation
manager action only in the capacity of a foundation manager) who
participated in the act of self-dealing.
(b) Tax on foundation manager. Section 4941(b)(2) of the Code
imposes an excise tax to be paid by a foundation manager in any case in
which a tax is imposed by section 4941(b)(1) and the foundation manager
refused to agree to part or all of the correction of the self-dealing
act. The tax imposed by section 4941(b)(2) is at the rate of 50 percent
of the amount involved and shall be paid by any foundation manager who
refused to agree to part or all of the correction of the self-dealing
act. For the limitations on liability of a foundation manager, see Sec.
53.4941(c)-1(b).
[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 8084, 51 FR
16301, May 2, 1986]
Sec. 53.4941(c)-1 Special rules.
(a) Joint and several liability. (1) In any case where more than one
person is liable for the tax imposed by any paragraph of section 4941
(a) or (b), all such persons shall be jointly and severally liable for
the taxes imposed under such paragraph with respect to such act of self-
dealing.
(2) The provisions of this paragraph may be illustrated by the
following example:
Example. A and B, who are managers of private foundation X, lend one
of the foundation's paintings to G, a disqualified person, for display
in G's office, in a transaction which gives rise to liability for tax
under section 4941(a)(2) (relating to tax on foundation managers). An
initial tax is imposed on both A and B with respect to the act of
lending the foundation's painting to G. A and B are jointly and
severally liable for the tax.
(b) Limits on liability for management. (1) The maximum aggregate
amount of tax collectible under section 4941(a)(2) from all foundation
managers with respect to any one act of self-dealing shall be $10,000,
and the maximum aggregate amount of tax collectible
[[Page 50]]
under section 4941(b)(2) from all foundation managers with respect to
any one act of self-dealing shall be $10,000.
(2) The provisions of this paragraph may be illustrated by the
following example:
Example. A, a disqualified person with respect to private foundation
Y, sells certain real estate having a fair market value of $500,000 to Y
for $500,000 in cash. B, C, and D, all the managers of foundation Y,
authorized the purchase on Y's behalf knowing that such purchase was an
act of self-dealing. The actions of B, C, and D in approving the
purchase were willful and not due to reasonable cause. Initial taxes are
imposed upon the foundation managers under subsections (a)(2) and (c)(2)
of section 4941. The tax to be paid by the foundation managers is
$10,000 (the lesser of $10,000 or 2\1/2\ percent of the amount
involved). The managers are jointly and severally liable for this
$10,000, and this sum may be collected by the Internal Revenue Service
from any one of them.
Sec. 53.4941(d)-1 Definition of self-dealing.
(a) In general. For purposes of section 4941, the term self-dealing
means any direct or indirect transaction described in Sec. 53.4941(d)-
2. For purposes of this section, it is immaterial whether the
transaction results in a benefit or a detriment to the private
foundation. The term ``self-dealing'' does not, however, include a
transaction between a private foundation and a disqualified person where
the disqualified person status arises only as a result of such
transaction. For example, the bargain sale of property to a private
foundation is not a direct act of self-dealing if the seller becomes a
disqualified person only by reason of his becoming a substantial
contributor as a result of the bargain element of the sale. For the
effect of sections 4942, 4943, 4944, and 4945 upon an act of self-
dealing which also results in the imposition of tax under one or more of
such sections, see the regulations under those sections.
(b) Indirect self-dealing--(1) Certain business transactions. The
term ``indirect self-dealing'' shall not include any transaction
described in Sec. 53.4941(d)-2 between a disqualified person and an
organization controlled by a private foundation (within the meaning of
paragraph (6)(5) of this section) if:
(i) The transaction results from a business relationship which was
established before such transaction constituted an act of self-dealing
(without regard to this paragraph),
(ii) The transaction was at least as favorable to the organization
controlled by the foundation as an arm's-length transaction with an
unrelated person, and
(iii) Either:
(a) The organization controlled by the foundation could have engaged
in the transaction with someone other than a disqualified person only at
a severe economic hardship to such organization, or
(b) Because of the unique nature of the product or services provided
by the organization controlled by the foundation, the disqualified
person could not have engaged in the transaction with anyone else, or
could have done so only by incurring severe economic hardship. See
example (2) of subparagraph (8) of this paragraph.
(2) Grants to intermediaries. The term ``indirect self-dealing''
shall not include a transaction engaged in with a government official by
an intermediary organization which is a recipient of a grant from a
private foundation and which is not controlled by such foundation
(within the meaning of paragraph (6) (5) of this section) if the private
foundation does not earmark the use of the grant for any named
government official and there does not exist an agreement, oral or
written, whereby the grantor foundation may cause the selection of the
government official by the intermediary organization. A grant by a
private foundation is earmarked if such grant is made pursuant to an
agreement, either oral or written, that the grant will be used by any
named individual. Thus, a grant by a private foundation shall not
constitute an indirect act of self-dealing even though such foundation
had reason to believe that certain government officials would derive
benefits from such grant so long as the intermediary organization
exercises control, in fact, over the selection process and actually
makes the selection completely independently of the private foundation.
See example (3) of subparagraph (8) of this paragraph.
(3) Transactions during the administration of an estate or revocable
trust. The
[[Page 51]]
term ``indirect self-dealing'' shall not include a transaction with
respect to a private foundation's interest or expectancy in property
(whether or not encumbered) held by an estate (or revocable trust,
including a trust which has become irrevocable on a grantor's death),
regardless of when title to the property vests under local law, if:
(i) The administrator or executor of an estate or trustee of a
revocable trust either:
(a) Possesses a power of sale with respect to the property,
(b) Has the power to reallocate the property to another beneficiary,
or
(c) Is required to sell the property under the terms of any option
subject to which the property was acquired by the estate (or revocable
trust);
(ii) Such transaction is approved by the probate court having
jurisdiction over the estate (or by another court having jurisdiction
over the estate (or trust) or over the private foundation);
(iii) Such transaction occurs before the estate is considered
terminated for Federal income tax purposes pursuant to paragraph (a) of
Sec. 1.641(b)-3 of this chapter (or in the case of a revocable trust,
before it is considered subject to sec. 4947);
(iv) The estate (or trust) receives an amount which equals or
exceeds the fair market value of the foundation's interest or expectancy
in such property at the time of the transaction, taking into account the
terms of any option subject to which the property was acquired by the
estate (or trust); and
(v) With respect to transactions occurring after April 16, 1973, the
transaction either:
(a) Results in the foundation receiving an interest or expectancy at
least as liquid as the one it gave up,
(b) Results in the foundation receiving an asset related to the
active carrying out of its exempt purposes, or
(c) Is required under the terms of any option which is binding on
the estate (or trust).
(4) Transactions with certain organizations. A transaction between a
private foundation and an organization which is not controlled by the
foundation (within the meaning of subparagraph (5) of this paragraph),
and which is not described in section 4946(a)(1) (E), (F), or (G)
because persons described in section 4946(a)(1) (A), (B), (C), or (D)
own no more than 35 percent of the total combined voting power or
profits or beneficial interest of such organization, shall not be
treated as an indirect act of self-dealing between the foundation and
such disqualified persons solely because of the ownership interest of
such persons in such organization.
(5) Control. For purposes of this paragraph, an organization is
controlled by a private foundation if the foundation or one or more of
its foundation managers (acting only in such capacity) may, only by
aggregating their votes or positions of authority, require the
organization to engage in a transaction which if engaged in with the
private foundation would constitute self-dealing. Similarly, for
purposes of this paragraph, an organization is controlled by a private
foundation in the case of such a transaction between the organization
and a disqualified person, if such disqualified person, together with
one or more persons who are disqualified persons by reason of such a
person's relationship (within the meaning of section 4946(a)(1) (C)
through (G)) to such disqualified person, may, only by aggregating their
votes or positions of authority with that of the foundation, require the
organization to engage in such a transaction. The ``controlled''
organization need not be a private foundation; for example, it may be
any type of exempt or nonexempt organization including a school,
hospital, operating foundation, or social welfare organization. For
purposes of this paragraph, an organization will be considered to be
controlled by a private foundation or by a private foundation and
disqualified persons referred to in the second sentence of this
subparagraph if such persons are able, in fact, to control the
organization (even if their aggregate voting power is less than 50
percent of the total voting power of the organization's governing body)
or if one or more of such persons has the right to exercise veto power
over the actions of such organization relevant to any potential acts of
self-dealing. A private foundation shall not be regarded as having
control over an organization merely because it exercises expenditure
responsibility (as defined
[[Page 52]]
in section 4945 (d)(4) and (h)) with respect to contributions to such
organization. See example (6) of subparagraph (8) of this paragraph.
(6) Certain transactions involving limited amounts. The term
``indirect self-dealing'' shall not include any transaction between a
disqualified person and an organization controlled by a private
foundation (within the meaning of subparagraph (5) of this paragraph) or
between two disqualified persons where the foundation's assets may be
affected by the transaction if:
(i) The transaction arises in the normal and customary course of a
retail business engaged in with the general public,
(ii) In the case of a transaction between a disqualified person and
an organization controlled by a private foundation, the transaction is
at least as favorable to the organization controlled by the foundation
as an arm's-length transaction with an unrelated person, and
(iii) The total of the amounts involved in such transactions with
respect to any one such disqualified person in any one taxable year does
not exceed $5,000.
See example (7) of subparagraph (8) of this paragraph.
(7) Applicability of statutory exceptions to indirect self-dealing.
The term ``indirect self-dealing'' shall not include a transaction
involving one or more disqualified persons to which a private foundation
is not a party, in any case in which the private foundation, by reason
of section 4941(d)(2), could itself engage in such a transaction. Thus,
for example, even if a private foundation has control (within the
meaning of subparagraph (5) of this paragraph) of a corporation, the
corporation may pay to a disqualified person, except a government
official, reasonable compensation for personal services.
(8) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. Private foundation P owns the controlling interest of the
voting stock of corporation X, and as a result of such interest, elects
a majority of the board of directors of X. Two of the foundation
managers, A and B, who are also directors of corporation X, form
corporation Y for the purpose of building and managing a country club. A
and B receive a total of 40 percent of Y's stock, making Y a
disqualified person with respect to P under section 4946(a)(1)(E). In
order to finance the construction and operation of the country club, Y
requested and received a loan in the amount of $4 million from X. The
making of the loan by X to Y shall constitute an indirect act of self-
dealing between P and Y.
Example 2. Private foundation W owns the controlling interest of the
voting stock of corporation X, a manufacturer of certain electronic
computers. Corporation Y, a disqualified person with respect to W, owns
the patent for, and manufactures, one of the essential component parts
used in the computers. X has been making regular purchases of the
patented component from Y since 1965, subject to the same terms as all
other purchasers of such component parts. X could not buy similar
components from another source. Consequently, X would suffer severe
economic hardship if it could not continue to purchase these components
from Y, since it would then be forced to develop a computer which could
be constructed with other components. Under these circumstances, the
continued purchase by X from Y of these components shall not be an
indirect act of self-dealing between W and Y.
Example 3. Private foundation Y made a grant to M University, an
organization described in section 170(b)(1)(A)(ii), for the purpose of
conducting a seminar to study methods for improving the administration
of the judicial system. M is not controlled by Y within the meaning of
subparagraph (5) of this paragraph. In conducting the seminar, M made
payments to certain government officials. By the nature of the grant, Y
had reason to believe that government officials would be compensated for
participation in the seminar. M, however, had completely independent
control over the selection of such participants. Thus, such grant by Y
shall not constitute an indirect act of self-dealing with respect to the
government officials.
Example 4. A, a substantial contributor to P, a private foundation,
bequeathed one-half of his estate to his spouse and one-half of his
estate to P. Included in A's estate is a one-third interest in AB, a
partnership. The other two-thirds interest in AB is owned by B, a
disqualified person with respect to P. The one-third interest in AB was
subject to an option agreement when it was acquired by the estate. The
executor of A's estate sells the one-third interest in AB to B pursuant
to such option agreement at the price fixed in such option agreement in
a sale which meets the requirements of subparagraph (3) of this
paragraph. Under these circumstances, the sale does not constitute an
indirect act of self-dealing between B and P.
[[Page 53]]
Example 5. A bequeathed $100,000 to his wife and a piece of
unimproved real estate of equivalent value to private foundation Z, of
which A was the creator and a foundation manager. Under the laws of
State Y, to which the estate is subject, title to the real estate vests
in the foundation upon A's death. However, the executor has the power
under State law to reallocate the property to another beneficiary.
During a reasonable period for administration of the estate, the
executor exercises this power and distributes the $100,000 cash to the
foundation and the real estate to A's wife. The probate court having
jurisdiction over the estate approves the executor's action. Under these
circumstances, the executor's action does not constitute an indirect act
of self-dealing between the foundation and A's wife.
Example 6. Private foundation P owns 20 percent of the voting stock
of corporation W. A, a substantial contributor with respect to P, owns
16 percent of the voting stock of corporation W. B, A's son, owns 15
percent of the voting stock of corporation W. The terms of the voting
stock are such that P, A, and B could vote their stock in a block to
elect a majority of the board of directors of W. W is treated as
controlled by P (within the meaning of subparagraph (5) of this
paragraph) for purposes of this example A and B also own 50 percent of
the stock of corporation Y, making Y a disqualified person with respect
to P under section 4946(a)(1)(E). W makes a loan to Y of $1 million. The
making of this loan by W to Y shall constitute an indirect act of self-
dealing between P and Y.
Example 7. A, a disqualified person with respect to private
foundation P, enters into a contract with corporation M, which is also a
disqualified person with respect to P. P owns 20 percent of M's stock,
and controls M within the meaning of subparagraph (5) of this paragraph.
M is in the retail department store business. Purchases by A of goods
sold by M in the normal and customary course of business at retail or
higher prices are not indirect acts of self-dealing so long as the total
of the amounts involved in all of such purchases by A in any one year
does not exceed $5,000.
[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended at 38 FR 12604, May
14, 1973]
Sec. 53.4941(d)-2 Specific acts of self-dealing.
Except as provided in Sec. 53.4941(d)-3 or Sec. 53.4941(d)-4:
(a) Sale or exchange of property--(1) In general. The sale or
exchange of property between a private foundation and a disqualified
person shall constitute an act of self-dealing. For example, the sale of
incidental supplies by a disqualified person to a private foundation
shall be an act of self-dealing regardless of the amount paid to the
disqualified person for the incidental supplies. Similarly, the sale of
stock or other securities by a disqualified person to a private
foundation in a ``bargain sale'' shall be an act of self-dealing
regardless of the amount paid for such stock or other securities. An
installment sale may be subject to the provisions of both section
4941(d)(1)(A) and section 4941(d)(1)(B).
(2) Mortgaged property. For purposes of subparagraph (1) of this
paragraph, the transfer of real or personal property by a disqualified
person to a private foundation shall be treated as a sale or exchange if
the foundation assumes a mortgage or similar lien which was placed on
the property prior to the transfer, or takes subject to a mortgage or
similar lien which a disqualified person placed on the property within
the 10-year period ending on the date of transfer. For purposes of this
subparagraph, the term ``similar lien'' shall include, but is not
limited to, deeds of trust and vendors' liens, but shall not include any
other lien if such lien is insignificant in relation to the fair market
value of the property transferred.
(b) Leases--(1) In general. Except as provided in subparagraphs (2)
and (3) of this paragraph, the leasing of property between a
disqualified person and a private foundation shall constitute an act of
self-dealing.
(2) Certain leases without charge. The leasing of property by a
disqualified person to a private foundation shall not be an act of self-
dealing if the lease is without charge. For purposes of this
subparagraph, a lease shall be considered to be without charge even
though the private foundation pays for janitorial services, utilities,
or other maintenance costs it incurs for the use of the property, so
long as the payment is not made directly or indirectly to a disqualified
person.
(3) Certain leases of office space. For taxable years beginning
after December 31, 1979, the leasing of office space by a disqualified
person to a private foundation shall not be an act of self-dealing if:
[[Page 54]]
(i) The leased space is in a building in which there are other
tenants who are not disqualified persons,
(ii) The lease is pursuant to a binding lease which was in effect on
October 9, 1969, or pursuant to renewals of such a lease,
(iii) The execution of the lease was not a prohibited transaction
(within the meaning of section 503(b) or the corresponding provisions of
prior law) at the time of such execution, and
(iv) The terms of the lease (or any renewal) reflect an arm's length
transaction.
A lease or renewal of such lease is described in this subparagraph (3)
only if it satisfies the requirements of Sec. 53.4941(d)-4(c) (1) and
(2), applied without regard to the December 31, 1979 deadline described
therein.
(c) Loans--(1) In general. Except as provided in subparagraphs (2),
(3), and (4) of this paragraph, the lending of money or other extension
of credit between a private foundation and a disqualified person shall
constitute an act of self-dealing. Thus, for example, an act of self-
dealing occurs where a third party purchases property and assumes a
mortgage, the mortgagee of which is a private foundation, and
subsequently the third party transfers the property to a disqualified
person who either assumes liability under the mortgage or takes the
property subject to the mortgage. Similarly, except in the case of the
receipt and holding of a note pursuant to a transaction described in
Sec. 53.4941(d)-1(b)(3), an act of self-dealing occurs where a note,
the obligor of which is a disqualified person, is transferred by a third
party to a private foundation which becomes the creditor under the note.
(2) Loans without interest. Subparagraph (1) of this paragraph shall
not apply to the lending of money or other extension of credit by a
disqualified person to a private foundation if the loan or other
extension of credit is without interest or other charge.
(3) Certain evidences of future gifts. The making of a promise,
pledge, or similar arrangement to a private foundation by a disqualified
person, whether evidenced by an oral or written agreement, a promissory
note, or other instrument of indebtedness, to the extent motivated by
charitable intent and unsupported by consideration, is not an extension
of credit (within the meaning of this paragraph) before the date of
maturity.
(4) General banking functions. Under section 4941(d)(2)(E) the
performance by a bank or trust company which is a disqualified person of
trust functions and certain general banking services for a private
foundation is not an act of self-dealing, where the banking services are
reasonable and necessary to carrying out the exempt purposes of the
private foundation, if the compensation paid to the bank or trust
company, taking into account the fair interest rate for the use of the
funds by the bank or trust company, for such services is not excessive.
The general banking services allowed by this subparagraph are:
(i) Checking accounts, as long as the bank does not charge interest
on any overwithdrawals,
(ii) Savings accounts, as long as the foundation may withdraw its
funds on no more than 30-days notice without subjecting itself to a loss
of interest on its money for the time during which the money was on
deposit, and
(iii) Safekeeping activities.
See example (3) Sec. 53.4941(d)-3(c)(2).
(d) Furnishing goods, services, or facilities--(1) In general.
Except as provided in subparagraph (2) or (3) of this paragraph (or
Sec. 53.4941(d)-3(b)), the furnishing of goods, services, or facilities
between a private foundation and a disqualified person shall constitute
an act of self-dealing. This subparagraph shall apply, for example, to
the furnishing of goods, services, or facilities such as office space,
automobiles, auditoriums, secretarial help, meals, libraries,
publications, laboratories, or parking lots. Thus, for example, if a
foundation furnishes personal living quarters to a disqualified person
(other than a foundation manager or employee) without charge, such
furnishing shall be an act of self-dealing.
(2) Furnishing of goods, services, or facilities to foundation
managers and employees. The furnishing of goods, services, or facilities
such as those described in subparagraph (1) of this paragraph to a
foundation manager in
[[Page 55]]
recognition of his services as a foundation manager, or to another
employee (including an individual who would be an employee but for the
fact that he receives no compensation for his services) in recognition
of his services in such capacity, is not an act of self-dealing if the
value of such furnishing (whether or not includible as compensation in
his gross income) is reasonable and necessary to the performance of his
tasks in carrying out the exempt purposes of the foundation and, taken
in conjunction with any other payment of compensation or payment or
reimbursement of expenses to him by the foundation, is not excessive.
For example, if a foundation furnishes meals and lodging which are
reasonable and necessary (but not excessive) to a foundation manager by
reason of his being a foundation manager, then, without regard to
whether such meals and lodging are excludable from gross income under
section 119 as furnished for the convenience of the employer, such
furnishing is not an act of self-dealing. For the effect of section
4945(d)(5) upon an expenditure for unreasonable administrative expenses,
see Sec. 53.4945-6(b)(2).
(3) Furnishing of goods, services, or facilities by a disqualified
person without charge. The furnishing of goods, services, or facilities
by a disqualified person to a private foundation shall not be an act of
self-dealing if they are furnished without charge. Thus, for example,
the furnishing of goods such as pencils, stationery, or other incidental
supplies, or the furnishing of facilities such as a building, by a
disqualified person to a foundation shall be allowed if such supplies or
facilities are furnished without charge. Similarly, the furnishing of
services (even though such services are not personal in nature) shall be
permitted if such furnishing is without charge. For purposes of this
subparagraph, a furnishing of goods shall be considered without charge
even though the private foundation pays for transportation, insurance,
or maintenance costs it incurs in obtaining or using the property, so
long as the payment is not made directly or indirectly to the
disqualified person.
(e) Payment of compensation. The payment of compensation (or payment
or reimbursement of expenses) by a private foundation to a disqualified
person shall constitute an act of self-dealing. See, however, Sec.
53.4941(d)-3(c) for the exception for the payment of compensation by a
foundation to a disqualified person for personal services which are
reasonable and necessary to carry out the exempt purposes of the
foundation.
(f) Transfer or use of the income or assets of a private
foundation--(1) In general. The transfer to, or use by or for the
benefit of, a disqualified person of the income or assets of a private
foundation shall constitute an act of self-dealing. For purposes of the
preceding sentence, the purchase or sale of stock or other securities by
a private foundation shall be an act of self-dealing if such purchase or
sale is made in an attempt to manipulate the price of the stock or other
securities to the advantage of a disqualified person. Similarly, the
indemnification (of a lender) or guarantee (of repayment) by a private
foundation with respect to a loan to a disqualified person shall be
treated as a use for the benefit of a disqualified person of the income
or assets of the foundation (within the meaning of this subparagraph).
In addition, if a private foundation makes a grant or other payment
which satisfies the legal obligation of a disqualified person, such
grant or payment shall ordinarily constitute an act of self-dealing to
which this subparagraph applies. However, if a private foundation makes
a grant or payment which satisfies a pledge, enforceable under local
law, to an organization described in section 501(c)(3), which pledge is
made on or before April 16, 1973, such grant or payment shall not
constitute an act of self-dealing to which this subparagraph applies so
long as the disqualified person obtains no substantial benefit, other
than the satisfaction of his obligation, from such grant or payment.
(2) Certain incidental benefits. The fact that a disqualified person
receives an incidental or tenuous benefit from the use by a foundation
of its income or assets will not, by itself, make such use an act of
self-dealing. Thus, the public
[[Page 56]]
recognition a person may receive, arising from the charitable activities
of a private foundation to which such person is a substantial
contributor, does not in itself result in an act of self-dealing since
generally the benefit is incidental and tenuous. For example, a grant by
a private foundation to a section 509(a) (1), (2), or (3) organization
will not be an act of self-dealing merely because such organization is
located in the same area as a corporation which is a substantial
contributor to the foundation, or merely because one of the section
509(a) (1), (2), or (3) organization's officers, directors, or trustees
is also a manager of or a substantial contributor to the foundation.
Similarly, a scholarship or a fellowship grant to a person other than a
disqualified person, which is paid or incurred by a private foundation
in accordance with a program which is consistent with:
(i) The requirements of the foundation's exempt status under section
501(c)(3),
(ii) The requirements for the allowance of deductions under section
170 for contributions made to the foundation, and
(iii) The requirements of section 4945(g)(1),
will not be an act of self-dealing under section 4941(d)(1) merely
because a disqualified person indirectly receives an incidental benefit
from such grant. Thus, a scholarship or a fellowship grant made by a
private foundation in accordance with a program to award scholarships or
fellowship grants to the children of employees of a substantial
contributor shall not constitute an act of self-dealing if the
requirements of the preceding sentence are satisfied. For an example of
the kind of scholarship program with an employment nexus that meets the
above requirements, see Sec. 53.4945-4(b)(5) (example 1).
(3) Non-compensatory indemnification of foundation managers against
liability for defense in civil proceedings. (i) Except as provided in
Sec. 53.4941(d)-3(c), section 4941(d)(1) shall not apply to the
indemnification by a private foundation of a foundation manager, with
respect to the manager's defense in any civil judicial or civil
administrative proceeding arising out of the manager's performance of
services (or failure to perform services) on behalf of the foundation,
against all expenses (other than taxes, including taxes imposed by
chapter 42, penalties, or expenses of correction) including attorneys'
fees, judgments and settlement expenditures if--
(A) Such expenses are reasonably incurred by the manager in
connection with such proceeding; and
(B) The manager has not acted willfully and without reasonable cause
with respect to the act or failure to act which led to such proceeding
or to liability for tax under chapter 42.
(ii) Similarly, except as provided in Sec. 53.4941(d)-3(c), section
4941(d)(1) shall not apply to premiums for insurance to make or to
reimburse a foundation for an indemnification payment allowed pursuant
to this paragraph (f)(3). Neither shall an indemnification or payment of
insurance allowed pursuant to this paragraph (f)(3) be treated as part
of the compensation paid to such manager for purposes of determining
whether the compensation is reasonable under chapter 42.
(4) Compensatory indemnification of foundation managers against
liability for defense in civil proceedings. (i) The indemnification by a
private foundation of a foundation manager for compensatory expenses
shall be an act of self-dealing under this paragraph unless when such
payment is added to other compensation paid to such manager the total
compensation is reasonable under chapter 42. A compensatory expense for
purposes of this paragraph (f) is--
(A) Any penalty, tax (including a tax imposed by chapter 42), or
expense of correction that is owed by the foundation manager;
(B) Any expense not reasonably incurred by the manager in connection
with a civil judicial or civil administrative proceeding arising out of
the manager's performance of services on behalf of the foundation; or
(C) Any expense resulting from an act or failure to act with respect
to which the manager has acted willfully and without reasonable cause.
(ii) Similarly, the payment by a private foundation of the premiums
for an insurance policy providing liability insurance to a foundation
manager for
[[Page 57]]
expenses described in this paragraph (f)(4) shall be an act of self-
dealing under this paragraph (f) unless when such premiums are added to
other compensation paid to such manager the total compensation is
reasonable under chapter 42.
(5) Insurance allocation. A private foundation shall not be engaged
in an act of self-dealing if the foundation purchases a single insurance
policy to provide its managers both the noncompensatory and the
compensatory coverage discussed in this paragraph (f), provided that the
total insurance premium is allocated and that each manager's portion of
the premium attributable to the compensatory coverage is included in
that manager's compensation for purposes of determining reasonable
compensation under chapter 42.
(6) Indemnification. For purposes of this paragraph (f), the term
indemnification shall include not only reimbursement by the foundation
for expenses that the foundation manager has already incurred or
anticipates incurring but also direct payment by the foundation of such
expenses as the expenses arise.
(7) Taxable income. The determination of whether any amount of
indemnification or insurance premium discussed in this paragraph (f) is
included in the manager's gross income for individual income tax
purposes is made on the basis of the provisions of chapter 1 and without
regard to the treatment of such amount for purposes of determining
whether the manager's compensation is reasonable under chapter 42.
(8) De minimis items. Any property or service that is excluded from
income under section 132(a)(4) may be disregarded for purposes of
determining whether the recipient's compensation is reasonable under
chapter 42.
(9) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. M, a private foundation, makes a grant of $50,000 to the
governing body of N City for the purpose of alleviating the slum
conditions which exist in a particular neighborhood of N. Corporation P,
a substantial contributor to M, is located in the same area in which the
grant is to be used. Although the general improvement of the area may
constitute an incidental and tenuous benefit to P, such benefit by
itself will not constitute an act of self-dealing.
Example 2. Private foundation X established a program to award
scholarship grants to the children of employees of corporation M, a
substantial contributor to X. After disclosure of the method of carrying
out such program, X received a determination letter from the Internal
Revenue Service stating that X is exempt from taxation under section
501(c)(3), that contributions to X are deductible under section 170, and
that X's scholarship program qualifies under section 4945(g)(1). A
scholarship grant to a person not a disqualified person with respect to
X paid or incurred by X in accordance with such program shall not be an
indirect act of self-dealing between X and M.
Example 3. Private foundation Y owns voting stock in corporation Z,
the management of which includes certain disqualified persons with
respect to Y. Prior to Z's annual stockholder meeting, the management
solicits and receives the foundation's proxies. The transfer of such
proxies in and of itself shall not be an act of self-dealing.
Example 4. A, a disqualified person with respect to private
foundation S, contributes certain real estate to S for the purpose of
building a neighborhood recreation center in a particular
underprivileged area. As a condition of the gift, S agrees to name the
recreation center after A. Since the benefit to A is only incidental and
tenuous, the naming of the recreation center, by itself, will not be an
act of self-dealing.
(g) Payment to a government official. Except as provided in section
4941(d)(2)(G) or Sec. 53.4941(d)-3(e), the agreement by a private
foundation to make any payment of money or other property to a
government official, as defined in section 4946(c), shall constitute an
act of self-dealing. For purposes of this paragraph, an individual who
is otherwise described in section 4946(c) shall be treated as a
government official while on leave of absence from the government
without pay.
[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7938, 49 FR
3848, Jan. 31, 1984; T.D. 8639, 60 FR 65568, Dec. 20, 1995]
Sec. 53.4941(d)-3 Exceptions to self-dealing.
(a) General rule. In general, a transaction described in section
4941(d)(2) (B), (C), (D), (E), (F), (G), or (H) is not an act of self-
dealing. Section 4941(d)(2) (B), (C), and (H) provide limited exceptions
to certain specific transactions, as described in paragraphs (b)(2),
(b)(3),
[[Page 58]]
(c)(2), and (d)(3) of Sec. 53.4941(d)-2. Section 4941(d)(2) (D), (E),
(F), and (G) and paragraphs (b) through (e) of this section described
certain transactions which are not acts of self-dealing.
(b) Furnishing of goods, services, or facilities to a disqualified
person--(1) In general. Under section 4941(d)(2)(D), the furnishing of
goods, services, or facilities by a private foundation to a disqualified
person shall not be an act of self-dealing if such goods, services, or
facilities are made available to the general public on at least as
favorable a basis as they are made available to the disqualified person.
This subparagraph shall not apply, however, in the case of goods,
services, or facilities furnished later than May 16, 1973, unless such
goods, services, or facilities are functionally related, within the
meaning of section 4942(j)(5), to the exercise or performance by a
private foundation of its charitable, educational, or other purpose or
function constituting the basis for its exemption under section
501(c)(3).
(2) General public. For purposes of this paragraph, the term
``general public'' shall include those persons who, because of the
particular nature of the activities of the private foundation, would be
reasonably expected to utilize such goods, services, or facilities. This
paragraph shall not apply, however, unless there is a substantial number
of persons other than disqualified persons who are actually utilizing
such goods, services, or facilities. Thus, a private foundation which
furnishes recreational or park facilities to the general public may
furnish such facilities to a disqualified person provided they are
furnished to him on a basis which is not more favorable than that on
which they are furnished to the general public. Similarly, the sale of a
book or magazine by a private foundation to disqualified persons shall
not be an act of self-dealing if the publication of such book or
magazine is functionally related to a charitable or educational activity
of the foundation and the book or magazine is made available to the
disqualified persons and the general public at the same price. In
addition, if the terms of the sale require, for example, payment within
60 days from the date of delivery of the book or magazine, such terms
are consistent with normal commercial practices, and payment is made
within the 60-day period, the transaction shall not be treated as a loan
or other extension of credit under Sec. 53.4941(d)-2(c)(1).
(c) Payment of compensation for certain personal services--(1) In
general. Under section 4941(d)(2)(E), except in the case of a Government
official (as defined in section 4946(c)), the payment of compensation
(and the payment or reimbursement of expenses, including reasonable
advances for expenses anticipated in the immediate future) by a private
foundation to a disqualified person for the performance of personal
services which are reasonable and necessary to carry out the exempt
purpose of the private foundation shall not be an act of self-dealing if
such compensation (or payment or reimbursement) is not excessive. For
purposes of this subparagraph the term ``personal services'' includes
the services of a broker serving as agent for the private foundation,
but not the services of a dealer who buys from the private foundation as
principal and resells to third parties. For the determination whether
compensation is excessive, see Sec. 1.162-7 of this chapter (Income Tax
Regulations). This paragraph applies without regard to whether the
person who receives the compensation (or payment or reimbursement) is an
individual. The portion of any payment which represents payment for
property shall not be treated as payment of compensation (or payment or
reimbursement of expenses) for the performance of personal services for
purposes of this paragraph. For rules with respect to the performance of
general banking services, see Sec. 53.4941(d)-2(c)(4). Further, the
making of a cash advance to a foundation manager or employee for
expenses on behalf of the foundation is not an act of self-dealing, so
long as the amount of the advance is reasonable in relation to the
duties and expense requirements of the foundation manager. Except where
reasonably allowable pursuant to subdivision (iii) of this subparagraph,
such advances shall not ordinarily exceed $500. For example, if a
foundation makes an advance to a foundation manager to cover anticipated
out-of-
[[Page 59]]
pocket current expenses for a reasonable period (such as a month) and
the manager accounts to the foundation under a periodic reimbursement
program for actual expenses incurred, the foundation will not be
regarded as having engaged in an act of self-dealing:
(i) When it makes the advance,
(ii) When it replenishes the funds upon receipt of supporting
vouchers from the foundation manager, or
(iii) If it temporarily adds to the advance to cover extraordinary
expenses anticipated to be incurred in fulfillment of a special
assignment (such as long distance travel).
(2) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. M, a partnership, is a firm of 10 lawyers engaged in the
practice of law. A and B, partners in M, serve as trustees to private
foundation W and, therefore, are disqualified persons. In addition, A
and B own more than 35 percent of the profits interest in M, thereby
making M a disqualified person. M performs various legal services for W
from time to time as such services are requested. The payment of
compensation by W to M shall not constitute an act of self-dealing if
the services performed are reasonable and necessary for the carrying out
of W's exempt purposes and the amount paid by W for such services is not
excessive.
Example 2. C, a manager of private foundation X, owns an investment
counseling business. Acting in his capacity as an investment counselor,
C manages X's investment portfolio for which he receives an amount which
is determined to be not excessive. The payment of such compensation to C
shall not constitute an act of self-dealing.
Example 3. M, a commercial bank, serves as a trustee for private
foundation Y. In addition to M's duties as trustee, M maintains Y's
checking and savings accounts and rents a safety deposit box to Y. The
use of the funds by M and the payment of compensation by Y to M for such
general banking services shall be treated as the payment of compensation
for the performance of personal services which are reasonable and
necessary to carry out the exempt purposes of Y if such compensation is
not excessive.
Example 4. D, a substantial contributor to private foundation Z,
owns a factory which manufactures microscopes. D contracts with Z to
manufacture 100 microscopes for Z. Any payment to D under the contract
shall constitute an act of self-dealing, since such payment does not
constitute the payment of compensation for the performance of personal
services.
(d) Certain transactions between a foundation and a corporation--(1)
In general. Under section 4941(d)(2)(F), any transaction between a
private foundation and a corporation which is a disqualified person will
not be an act of self-dealing if such transaction is engaged in pursuant
to a liquidation, merger, redemption, recapitalization, or other
corporate adjustment, organization, or reorganization, so long as all
the securities of the same class as that held (prior to such
transaction) by the foundation are subject to the same terms and such
terms provide for receipt by the foundation of no less than fair market
value. For purposes of this paragraph, all of the securities are not
``subject to the same terms unless, pursuant to such transaction,'' The
corporation makes a bona fide offer on a uniform basis to the foundation
and every other person who holds such securities. The fact that a
private foundation receives property, such as debentures, while all
other persons holding securities of the same class receive cash for
their interests, will be evidence that such offer was not made on a
uniform basis. This paragraph may apply even if no other person holds
any securities of the class held by the foundation. In such event,
however, the consideration received by holders of other classes of
securities, or the interests retained by holders of such other classes,
when considered in relation to the consideration received by the
foundation, must indicate that the foundation received at least as
favorable treatment in relation to its interests as the holders of any
other class of securities. In addition, the foundation must receive no
less than the fair market value of its interests.
(2) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. Private foundation X owns 50 percent of the class A
preferred stock of corporation M, which is a disqualified person with
respect to X. The terms of such securities provide that the stock may be
called for redemption at any time by M at 105 percent of the face amount
of the stock. M exercises this right and calls all the class A preferred
stock by paying 105 percent of the face amount in cash. At the time of
the redemption of the class A preferred stock, it is determined that the
fair market value of the
[[Page 60]]
preferred stock is equal to its face amount. In such case, the
redemption by M of the preferred stock of X is not an act of self-
dealing.
Example 2. Private foundation Y, which is on a calendar year basis,
acquires 60 percent of the class A preferred stock of corporation N by
will on January 10, 1970. N, which is also on a calendar year basis, is
a disqualified person with respect to Y. In 1971, N offers to redeem all
of the class A preferred stock for a consideration equal to 100 percent
of the face amount of such stock by the issuance of debentures. The
offer expires January 2, 1972. Both Y and all other holders of the class
A preferred stock accept the offer and enter into the transaction on
January 2, 1972, at which time it is determined that the fair market
value of the debentures is no less than the fair market value of the
preferred stock. The transaction on January 2, 1972, shall not be
treated as an act of self-dealing for 1972. However, because under Sec.
53.4941 (e)-1 (e)(1)(i) an act of self dealing occurs on the first day
of each taxable year or portion of a taxable year that an extension of
credit from a foundation to a disqualified person goes uncorrected, if
such debentures are held by Y after December 31, 1972, except as
provided in Sec. 53.4941(d)-4(c)(4), such extension of credit shall not
be excepted from the definition of an act of self dealing by reason of
the January 2, 1972, transaction. See Sec. 53.4941(d)-4(c)(4) for rules
indicating that under certain circumstances such debentures could be
held by Y until December 31, 1979.
(e) Certain payments to government officials. Under section
4941(d)(2)(G), in the case of a government official, in addition to the
exceptions provided in section 4941(d)(2) (B), (C), and (D), section
4941(d)(1) shall not apply to:
(1) A prize or award which is not includible in gross income under
section 74(b), if the government official receiving such prize or award
is selected from the general public;
(2) A scholarship or a fellowship grant which is excludable from
gross income under section 117(a) and which is to be utilized for study
at an educational institution described in section 151(e)(4);
(3) Any annuity or other payment (forming part of a stock-bonus,
pension, or profit sharing plan) by a trust which constitutes a
qualified trust under section 401;
(4) Any annuity or other payment under a plan which meets the
requirements of section 404(a)(2);
(5) Any contribution or gift (other than a contribution or gift of
money) to, or services or facilities made available to, any government
official, if the aggregate value of such contributions, gifts, services,
and facilities does not exceed $25 during any calendar year;
(6) Any payment made under 5 U.S.C. Chapter 41 (relating to
government employees' training programs);
(7) Any payment or reimbursement of traveling expenses (including
amounts expended for meals and lodging, regardless of whether the
government official is away from home within the meaning of section
162(a)(2), and including reasonable advances for such expenses
anticipated in the immediate future) for travel solely from one point in
the United States to another in connection with one or more purposes
described in section 170(c) (1) or (2)(B), but only if such payment or
reimbursement does not exceed the actual cost of the transportation
involved plus an amount for all other traveling expenses not in excess
of 125 percent of the maximum amount payable under 5 U.S.C. 5702(a) for
like travel by employees of the United States;
(8) Any agreement to employ or make a grant to a government official
for any period after the termination of his government service if such
agreement is entered into within 90 days prior to such termination;
(9) If a government official attends or participates in a conference
sponsored by a private foundation, the allocable portion of the cost of
such conference and other nonmonetary benefits (for example, benefits of
a professional, intellectual, or psychological nature, or benefits
resulting from the publication or the distribution to participants of a
record of the conference), as well as the payment or reimbursement of
expenses (including reasonable advances for expenses anticipated in
connection with such a conference in the near future), received by such
government official as a result of such attendance or participation
shall not be subject to section 4941(d)(1), so long as the conference is
in furtherance of the exempt purposes of the foundation; or
(10) In the case of any government official who was on leave of
absence without pay on December 31, 1969, pursuant to a commitment
entered into on or before such date for the purpose of
[[Page 61]]
engaging in certain activities for which such individual was to be paid
by one or more private foundations, any payment of compensation (or
payment or reimbursement of expenses, including reasonable advances for
expenses anticipated in the immediate future) by such private
foundations to such individual for any continuous period after December
31, 1969, and prior to January 1, 1971, during which such individual
remains on leave of absence to engage in such activities. A commitment
is considered entered into on or before December 31, 1969, if on or
before such date, the amount and nature of the payments to be made and
the name of the individual receiving such payments were entered on the
records of the payor, or were otherwise adequately evidenced, or the
notice of the payment to be received was communicated to the payee
orally or in writing.
[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7938, 49 FR
3848, Jan. 31, 1984]
Sec. 53.4941(d)-4 Transitional rules.
(a) Certain transactions involving securities acquired by a
foundation before May 27, 1969--(1) In general. Under section
101(l)(2)(A) of the Tax Reform Act of 1969 (83 Stat. 533), any
transaction between a private foundation and a corporation which is a
disqualified person shall not be an act of self-dealing if such
transaction is pursuant to the terms of securities of such corporation,
if such terms were in existence at the time such securities were
acquired by the foundation, and if such securities were acquired by the
foundation before May 27, 1969.
(2) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. Private foundation X purchased preferred stock of
corporation M, a disqualified person with respect to X, on March 15,
1969. The terms of such securities on such date provided that the stock
could be called by M at any time if M paid the outstanding shareholders
cash equal to 105 percent of the face amount of the stock. If M
exercises this right and calls the stock owned by X on February 15,
1970, such call shall not constitute an act of self-dealing even if such
price is not equivalent to fair market value on such date and even if
not all of the securities of that class are called.
(b) Disposition of certain business holdings--(1) In general. Under
section 101(l)(2)(B) of the Tax Reform Act of 1969 (83 Stat. 533), the
sale, exchange, or other disposition of property which is owned by a
private foundation on May 26, 1969, to a disqualified person shall not
be an act of self-dealing if the foundation is required to dispose of
such property in order not to be liable for tax under section 4943
(determined without regard to section 4943(c)(2)(C) and as if every
disposition by the foundation were made to disqualified persons) and if
such disposition satisfies the requirements of subparagraph (2) of this
paragraph. For purposes of applying this paragraph in the case of a
disposition completed before January 1, 1975, or after October 4, 1976,
and before January 1, 1977, the amount of excess business holdings is
determined under section 4943(c) without taking subsection (c)(4) into
account.
(2) Terms of the disposition. Subparagraph (1) of this paragraph
shall not apply unless:
(i) The private foundation receives an amount which equals or
exceeds the fair market value of the business holdings at the time of
disposition or at the time a contract for such disposition was
previously executed; and
(ii) At the time with respect to which subdivision (i) of this
subparagraph is applied, the transaction would not have constituted a
prohibited transaction within the meaning of section 503(b) or the
corresponding provisions of prior law if such provisions had been
applied at such time.
(3) Property received under a trust or will. For purposes of this
paragraph, property shall be considered as owned by a private foundation
on May 26, 1969, if such property is acquired by such foundation under
the terms of a will executed on or before such date, under the terms of
a trust which was irrevocable on such date, or under the terms of a
revocable trust executed on or before such date if the property would
have passed under a will which would have met the requirements of this
subparagraph but for the fact that a grantor dies without having revoked
the trust. An amendment or republication of a will which was executed on
or before May 26, 1969, does not prevent any
[[Page 62]]
interest in a business enterprise which was to pass under the terms of
such will (which terms were in effect on May 26, 1969, and at all times
thereafter) from being treated as owned by a private foundation on or
before May 26, 1969, solely because:
(i) There is a reduction in the interest in the business enterprise
which the foundation was to receive under the terms of the will (for
example, if the foundation is to receive the residuary estate and one
class of stock is disposed of by the decedent during his lifetime or by
a subsequent codicil),
(ii) Such amendment or republication is necessary in order to comply
with section 508(e) and the regulations thereunder,
(iii) There is a change in the executor of the will, or
(iv) There is any other change which does not otherwise change the
rights of the foundation with respect to such interest in the business
enterprise.
However, if under such amendment or republication there is an increase
of the interest in the business enterprise which the foundation was to
receive under the terms of the will in effect on May 26, 1969, such
increase shall not be treated as owned by the private foundation on or
before May 26, 1969, but under such circumstances the interest which
would have been acquired before such increase shall be treated as owned
by the private foundation on or before May 26, 1969.
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. On May 26, 1969, private foundation X owns 10 percent of
corporation Y's voting stock, which is traded on the New York Stock
Exchange. Disqualified persons with respect to X own an additional 40
percent of such voting stock. X is on a calendar year basis. Prior to
January 1, 1975, X privately sold its entire 10 percent for cash to B, a
disqualified person, at the price quoted on the stock exchange at the
close of the day less commissions. Since the 10 percent owned by X would
constitute excess business holdings without the application of section
4943(c) (2)(C) or (4), the disposition will not constitute an act of
self-dealing.
Example 2. Assume the facts as stated in example (1), except that
the only stock of corporation Y which X owns is 1.5 percent of Y's
voting stock. Since the 1.5 percent owned by X would constitute excess
business holdings without the application of section 4943(c) (2)(C) or
(4), the disposition of the stock to B for cash will not constitute an
act of self-dealing.
Example 3. Assume the facts as stated in example (1), except that B,
instead of paying cash as consideration for the stock, issued a 10-year
secured promissory note as consideration for the stock. The issuance of
such promissory note will not be treated as an act of self-dealing until
taxable years beginning after December 31, 1979, unless such issuance
would have been a prohibited transaction under section 503(b), or unless
the transaction does not remain throughout its life at least as
favorable as an arm's-length contract negotiated currently. See
paragraph (c) of this section.
(c) Existing leases and loans--(1) In general. Under section
101(1)(2)(C) of the Tax Reform Act of 1969 (83 Stat. 533), the leasing
of property or the lending of money (or other extension of credit)
between a disqualified person and a private foundation pursuant to a
binding contract which was in effect on October 9, 1969 (or pursuant to
a renewal or modification of such a contract, as described in
subparagraph (2) of this paragraph), shall not be an act of self-dealing
until taxable years beginning after December 31, 1979, if:
(i) At the time the contract was executed, such contract was not a
prohibited transaction (within the meaning of section 503(b) or the
corresponding provisions of prior law), and
(ii) The leasing or lending of money (or other extension of credit)
remains throughout the term of the lease or extension of credit at least
as favorable as a current arm's-length transaction with an unrelated
person.
(2) Renewal or modification of existing contracts. A renewal or a
modification of an existing contract is referred to in subparagraph (1)
of this paragraph only if any modifications of the terms of such
contract are not substantial and the relative advantages of the modified
contract compared with contracts entered into at arm's-length with an
unrelated person at the time of the renewal or modification are at least
as favorable to the private foundation as the relative advantages of the
original contract compared with contracts entered into at arm's-length
with an unrelated person at the time of execution of the original
contract. Such renewal or modification need not be provided
[[Page 63]]
for in the original contract; it may take place before or after the
expiration of the original contract and at any time before the first day
of the first taxable year of the private foundation beginning after
December 31, 1979. Where, in a normal commercial setting, an unrelated
party in the position of a private foundation could be expected to
insist upon a renegotiation or termination of a binding contract, the
private foundation must so act. Thus, for example, if a disqualified
person leases office space from a private foundation on a month-to-month
basis, and a party in the position of the private foundation could be
expected to renegotiate the rent required in such contract because of a
rise in the fair market value of such office space, the private
foundation must so act in order to avoid participation in an act of
self-dealing. Where the private foundation has no right to insist upon
renegotiation, an act of self-dealing shall occur if the terms of the
contract become less favorable to the foundation than an arm's-length
contract negotiated currently, unless:
(i) The variation from current fair market value is de minimis, or
(ii) The contract is renegotiated by the foundation and the
disqualified person so that the foundation will receive no less than
fair market value. For purposes of subdivision (i) of this subparagraph
de minimis ordinarily shall be no more than one-half of 1 percent in the
rate of return in the case of a loan, or 10 percent of the rent in the
case of a lease.
(3) Example. The provisions of subparagraphs (1) and (2) of this
paragraph may be illustrated by the following example.
Example. Under a binding contract entered into on January 1, 1964,
X, a private foundation, leases a building for 10 years from Z, a
disqualified person. At the time the contract was executed, the lease
was not a ``prohibited transaction'' within the meaning of section
503(b), since the rent charged X was only 50 percent of the rent which
would have been charged in an arm's-length transaction with an unrelated
person. On January 1, 1974, X renewed the lease for 5 additional years.
The terms of the renewal agreement provided for a 20 percent increase in
the amount of rent charged X. However, at the time of such renewal, the
rent which would have been charged in an arm's-length transaction had
also increased by 20 percent from that of 1964. The renewal agreement
shall not be treated as an act of self-dealing.
(4) Certain exchanges of stock or securities for bonds, debentures
or other indebtedness. (i) In the case of a transaction described in
paragraph (a) or (b) of this section or paragraph (d) of Sec.
53.4941(d)-3, where a bond, debenture, or other indebtedness of a
disqualified person is acquired by a private foundation in exchange for
stock or securities which it held on October 9, 1969, and at all times
thereafter, such indebtedness shall be treated as an extension of credit
pursuant to a binding contract in effect on October 9, 1969, to which
this paragraph applies. Thus, so long as the extension of credit remains
at least as favorable as an arm's-length transaction with an unrelated
person and neither the acquisition of the securities which were
exchanged for the indebtedness nor the exchange of such securities for
the indebtedness was a prohibited transaction within the meaning of
section 503(b) (or the corresponding provisions of prior law) at the
time of such acquisition, such extension of credit shall not be an act
of self-dealing until taxable years beginning after December 31, 1979.
(ii) The provisions of this subparagraph may be illustrated by the
following examples:
Example 1. Assume the facts as stated in example (2) of Sec.
53.4941 (d)-3 (d)(2), except that the preferred stock was held by Y on
October 9, 1969, and at all times thereafter until the redemption
occurred on January 2, 1972. In addition, assume that the acquisition of
the preferred stock was not a prohibited transaction within the meaning
of section 503(b) at the time of such acquisition and the exchange of
the preferred stock for the debentures would not have been a prohibited
transaction within the meaning of section 503(b). For 1973 through 1979,
the extension of credit arising from the holding of the debentures is
not an act of self-dealing so long as the extension of credit remains at
least as favorable as an arm's-length transaction with an unrelated
person. See, however, example (3) of Sec. 53.4941 (e)-1 (e)(1)(ii).
Example 2. Assume the same facts as stated in example (1) of Sec.
53.4941 (d)-4 (b)(4), except that private foundation X sold its entire
10 percent of corporation Y's voting stock in exchange for Y's secured
notes which mature on December 31, 1985. For taxable years beginning
before January 1, 1980, the extension
[[Page 64]]
of credit arising from the holding of such notes by X is not an act of
self-dealing so long as the extension of credit remains at least as
favorable as an arm's-length transaction with an unrelated person and
neither the acquisition of the securities which were exchanged for the
indebtedness nor the exchange of such securities for the indebtedness
was a prohibited transaction within the meaning of section 503(b) (or
the corresponding provisions of prior law). Under Sec. 53.4941(e)-1, a
new extension of credit occurs on the first day of each taxable year in
which an indebtedness is outstanding; therefore, if the secured notes
are held by X after December 31, 1979, a new extension of credit not
excepted from the definition of an act of self-dealing will occur on the
first day of the first taxable year beginning after December 31, 1979,
and on the first day of each succeeding taxable year in which X holds
such secured notes.
(d) Sharing of goods, services, or facilities before January 1,
1980. (1) Under section 101(1)(2)(D) of the Tax Reform Act of 1969 (83
Stat. 533), the use (other than leasing) of goods, services, or
facilities which are shared by a private foundation and a disqualified
person shall not be an act of self-dealing until taxable years beginning
after December 31, 1979, if:
(i) The use is pursuant to an arrangement in effect before October
9, 1969, and at all times thereafter;
(ii) The arrangement was not a prohibited transaction (within the
meaning of sec. 503(b) or the corresponding provisions of prior law) at
the time it was made; and
(iii) The arrangement would not be a prohibited transaction if
section 503(b) continued to apply.
For purposes of this paragraph, such arrangement need not be a binding
contract.
(2) The provisions of this paragraph may be illustrated by the
following example:
Example. In 1964 X, a private foundation, and B, a disqualified
person, arranged for the sharing of computer time in B's son's company
for a 10-year period commencing January 1, 1965. B's son has the
unilateral right to terminate the arrangement at any time. X uses the
computer facilities in connection with an analysis of its grant-making
activities, while B's use is related to his business affairs. Both X and
B make reasonable fixed payments to the computer company based on the
number of hours of computer use and comparable to fees charged in arm's-
length transactions with unrelated parties. The company imposes a
maximum limit per month on the sum of the number of hours for which X
and B use the computer facilities. Under these circumstances, the
sharing of computer time is not an act of self-dealing.
(e) Use of certain property acquired before October 9, 1969. (1)
Under section 101(1)(2)(E) of the Tax Reform Act of 1969 (83 Stat. 533),
the use of property in which a private foundation and a disqualified
person have a joint or common interest will not be an act of self-
dealing if the interests of both in such property were acquired before
October 9, 1969.
(2) The provisions of this paragraph may be illustrated by the
following example:
Example. Prior to October 9, 1969, C, a disqualified person, gave
beachfront property to private foundation X for use as a recreational
facility for underprivileged, inner-city children during the summer
months. However, C retained the right to use such property for his life.
The use of such property by C or X is not an act of self-dealing.
(f) Disposition of leased property--(1) In general. Under section
101(l)(2)(F) of the Tax Reform Act of 1969, as amended by the Tax Reform
Act of 1976 (90 Stat. 1713), the sale, exchange or other disposition
(other than by lease) to a disqualified person of property being leased
to the disqualified person by a private foundation is not an act of
self-dealing if:
(i) The private foundation is leasing substantially all of the
property to the disqualified person under a lease to which paragraph (c)
of this section applies;
(ii) The disposition occurs after October 4, 1976, and before
January 1, 1978; and
(iii) The disposition satisfies the requirements of paragraph (f)(2)
of this section.
(2) Terms of disposition. Paragraph (f)(1) of this section applies
only if:
(i) The private foundation receives an amount that equals or exceeds
the fair market value of the property either at the time of the
disposition or at the time (after June 30, 1976) the contract for such
disposition was executed;
(ii) In computing the fair market value of the property, no
diminution of that value results from the fact that
[[Page 65]]
the property is subject to any lease to disqualified persons; and
(iii) At the time with respect to which paragraph (f)(2)(i) of this
section is applied, the transaction would not have constituted a
prohibited transaction within the meaning of section 503(b) or the
corresponding provisions of prior law if those provisions had been
applied at the time of the transaction.
[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7678, 45 FR
12416, Feb. 26, 1980]
Sec. 53.4941(e)-1 Definitions.
(a) Taxable period--(1) In general. For purposes of any act of self-
dealing, the term ``taxable period'' means the period beginning with the
date on which the act of self-dealing occurs and ending on the earliest
of:
(i) The date of mailing of a notice of deficiency under section 6212
with respect to the tax imposed by section 4941(a)(1),
(ii) The date on which correction of the act of self-dealing is
completed, or
(iii) The date on which the tax imposed by section 4941(a)(1) is
assessed.
(2) Date of occurrence. An act of self-dealing occurs on the date on
which all the terms and conditions of the transaction and the
liabilities of the parties have been fixed. Thus, for example, if a
private foundation gives a disqualified person a binding option on June
15, 1971, to purchase property owned by the foundation at any time
before June 15, 1972, the act of self-dealing has occurred on June 15,
1971. Similarly, in the case of a conditional sales contract, the act of
self-dealing shall be considered as occurring on the date the property
is transferred subject only to the condition that the buyer make payment
for receipt of such property.
(3) Special rule. Where a notice of deficiency referred to in
subparagraph (1)(i) of this paragraph is not mailed because a waiver of
the restrictions on assessment and collection of a deficiency has been
accepted, or because the deficiency is paid, the date of filing of the
waiver or the date of such payment, respectively, shall be treated as
the end of the taxable period.
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. On July 16, 1970, F, a manager of private foundation X
acting on behalf of the foundation, knowing his act to be one of self-
dealing, willfully and without reasonable cause engaged in an act of
self-dealing by selling certain real estate to A, a disqualified person.
On March 25, 1973, the Internal Revenue Service mailed a notice of
deficiency to A with respect to the tax imposed on the sale under
section 4941(a)(1). The taxable period with respect to the act of self-
dealing for both A and F is July 16, 1970, through March 25, 1973.
Example 2. Assume the facts as stated in example (1), except that
the act of self-dealing is corrected by A on March 17, 1971. The taxable
period with respect to the act of self-dealing for both A and F is July
16, 1970, through March 17, 1971.
Example 3. Assume the facts as stated in example (1), except that on
August 20, 1972, A files a waiver of the restrictions on assessment and
collection of the tax imposed on the sale under section 4941(a)(1) which
is accepted. The taxable period with respect to the act of self-dealing
for both A and F is July 16, 1970, through August 20, 1972.
(b) Amount involved--(1) In general. Except as provided in
subparagraph (2) of this paragraph, for purposes of any act of self-
dealing, the term ``amount involved'' means the greater of the amount of
money and the fair market value of the other property given or the
amount of money and the fair market value of the other property
received.
(2) Exceptions. (i) In the case of the payment of compensation for
personal services to persons other than Government officials, the amount
involved shall be only the excess compensation paid by the private
foundation.
(ii) Where the use of money or other property is involved, the
amount involved shall be the greater of the amount paid for such use or
the fair market value of such use for the period for which the money or
other property is used. Thus, for example, in the case of a lease of a
building by a private foundation to a disqualified person, the amount
involved is the greater of the amount of rent received by the private
foundation from the disqualified person or the fair rental value of the
building for the period such building is used by the disqualified
person.
(iii) In cases in which a transaction would not have been an act of
self-dealing had the private foundation received fair market value, the
amount involved
[[Page 66]]
is the excess of the fair market value of the property transferred by
the private foundation over the amount which the private foundation
receives, but only if the parties have made a good faith effort to
determine fair market value. For purposes of this subdivision a good
faith effort to determine fair market value shall ordinarily have been
made where:
(a) The person making the valuation is not a disqualified person
with respect to the foundation and is both competent to make the
valuation and not in a position, whether by stock ownership or
otherwise, to derive an economic benefit from the value utilized, and
(b) The method utilized in making the valuation is a generally
accepted method for valuing comparable property, stock, or securities
for purposes of arm's-length business transactions where valuation is a
significant factor.
See section 4941(d)(2)(F) and Sec. Sec. 53.4941(d)-1(b)(3), 53.4941(d)-
3 (d)(1) and 53.4941(d)-4(b). Thus, for example, if a corporation which
is a disqualified person with respect to a private foundation
recapitalizes in a transaction which would be described in section
4941(d)(2)(F) but for the fact that the private foundation receives new
stock worth only $95,000 in exchange for the stock which it previously
held in the corporation and which has a fair market value of $100,000 at
the time of the recapitalization, the amount involved would be $5,000
($100,000--$95,000) if there had been a good faith attempt to value the
stock. Similarly, if an estate enters into a transaction with a
disqualified person with respect to a foundation and such transaction
would be described in Sec. 53.4941(d)-1(b)(3) but for the fact that the
estate receives less than fair market value for the property exchanged,
the amount involved is the excess of the fair market value of the
property the estate transfers to the disqualified person over the money
and the fair market value of the property received by the estate.
(3) Time for determining fair market value. The fair market value of
the property or the use thereof, as the case may be, shall be determined
as of the date on which the act of self-dealing occurred in the case of
the initial taxes imposed by section 4941(a) and shall be the highest
fair market value during the taxable period in the case of the
additional taxes imposed by section 4941(b).
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. A, a disqualified person with respect to private
foundation M, uses an airplane owned by M on June 15 and June 16, 1970,
for a 2-day trip to New York City on personal business and pays M $500
for the use of such airplane. The fair rental value for the use of the
airplane for those 2 days is $3,000. For purposes of section 4941(a),
the amount involved with respect to the act of self-dealing is $3,000.
Example 2. On April 10, 1970, B, a manager of private foundation P,
borrows $100,000 from P at 6 percent interest per annum. Both principal
and interest are to be paid 1 year from the date of the loan. The fair
market value of the use of the money on April 10, 1970, is 10 percent
per annum. Six months later, B and P terminate the loan, and B repays
the $100,000 principal plus $3,000 ($100,000x6 percent for one-half
year) interest. For purposes of section 4941(a), the amount involved
with respect to the act of self-dealing is $5,000 ($100,000x10 percent
for one-half year) for each year or partial year in the taxable period.
Example 3. C, a substantial contributor to private foundation S,
leases office space in a building owned by S for $3,600 for 1 year
beginning on January 1, 1971. The fair rental value of the building for
a 1-year lease on January 1, 1971, is $5,600. On December 31, 1971, the
lease is terminated. For purposes of section 4941(a), the amount
involved with respect to the act of self-dealing is $5,600 for each year
or partial year in the taxable period.
Example 4. D, a disqualified person with respect to private
foundation T, purchases 100 shares of stock from T for $5,000 on June
15, 1982. The fair market value of the 100 shares of stock on that date
is $4,800. D sells the 100 shares of stock on December 20, 1983, for
$6,000. On December 27, 1983, a notice of deficiency with respect to the
taxes imposed under subsections (a) and (b) of section 4941 is mailed to
D and the taxable period ends. D fails to correct during the taxable
period. Between June 15, 1982, and the end of the taxable period, the
stock was quoted on the New York Stock Exchange at a high of $67 per
share. The amount involved with respect to the tax imposed under
subsection (a) is $5,000, and the amount involved with respect to the
tax imposed under subsection (b) for failure to correct is $6,700 (100
shares at $67 per share), the highest fair market value during the
taxable period.
[[Page 67]]
Example 5. Corporation M, a disqualified person with respect to
private foundation V, redeems all of its Class B common stock, some of
which is held by V. The redemption of V's stock would be described in
section 4941(d)(2)(F) but for the fact that V receives only $95,000 in
exchange for stock which has a fair market value of $100,000 at the time
of the transaction. The $95,000 value of V's stock, which is not
publicly traded, was determined by investment bankers in accordance with
accepted methods of valuation that would be utilized if the M stock held
by V were to be offered for sale to the public. Therefore, the amount
involved with respect to the transaction will ordinarily be limited to
$5,000 ($100,000--$95,000).
(c) Correction--(1) In general. Correction shall be accomplished by
undoing the transaction which constituted the act of self-dealing to the
extent possible, but in no case shall the resulting financial position
of the private foundation be worse than that which it would be if the
disqualified person were dealing under the highest fiduciary standards.
For example, where a disqualified person sells property to a private
foundation for cash, correction may be accomplished by recasting the
transaction in the form of a gift by returning the cash to the
foundation. Subparagraphs (2) through (6) of this paragraph illustrate
the minimum standards of correction in the case of certain specific acts
of self-dealing. Principles similar to the principles contained in such
subparagraphs shall be applied with respect to other acts of self-
dealing. Any correction pursuant to this paragraph and section 4941
shall not be an act of self-dealing.
(2) Sales by foundation. (i) In the case of a sale of property by a
private foundation to a disqualified person for cash, undoing the
transaction includes, but is not limited to, requiring recission of the
sale where possible. However, in order to avoid placing the foundation
in a position worse than that in which it would be if rescission were
not required, the amount returned to the disqualified person pursuant to
the rescission shall not exceed the lesser of the cash received by the
private foundation or the fair market value of the property received by
the disqualified person. For purposes of the preceding sentence, fair
market value shall be the lesser of the fair market value at the time of
the act of self-dealing or the fair market value at the time of
rescission. In addition to rescission, the disqualified person is
required to pay over to the private foundation any net profits he
realized after the original sale with respect to the property he
received from the sale. Thus, for example, the disqualified person must
pay over to the foundation any income derived by him from the property
he received from the original sale to the extent such income during the
correction period exceeds the income derived by the foundation during
the correction period from the cash which the disqualified person
originally paid to the foundation.
(ii) If, prior to the end of the correction period, the disqualified
person resells the property in an arm's-length transaction to a bona
fide purchaser who is not the foundation or another disqualified person,
no rescission is required. In such case, the disqualified person must
pay over to the foundation the excess (if any) of the greater of the
fair market value of such property on the date on which correction of
the act of self-dealing occurs or the amount realized by the
disqualified person from such arm's length resale over the amount which
would have been returned to the disqualified person pursuant to
subdivision (i) of this subparagraph if rescission had been required. In
addition, the disqualified person is required to pay over to the
foundation any net profits he realized, as described in subdivision (i)
of this subparagraph.
(iii) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. On July 1, 1970, private foundation M sold a painting to
A, a disqualified person, for $5,000, in a transaction not within any of
the exceptions to self-dealing. The fair market value of the painting on
such date was $6,000. On March 25, 1971, the painting is still owned by
A and has a fair market value of $7,200. A did not derive any income as
a result of purchasing the painting. In order to correct the act of
self-dealing under this subparagraph on March 25, 1971, the sale must be
rescinded by the return of the painting to M. However, pursuant to such
rescission, M must not pay A more than $5,000, the original
consideration received by M.
Example 2. Assume the facts as stated in Example (1), except that A
sold the painting on December 15, 1970, in an arm's-length transaction
to C, a bona fide purchaser who
[[Page 68]]
is not a disqualified person, for $6,100. In addition, assume that the
fair market value of the painting on March 25, 1971, is $7,600. In order
to correct the act of self-dealing under this subparagraph on March 25,
1971, A must pay M $2,600 ($7,600, the fair market value at the time of
correction, less $5,000, the amount which would have been returned to A
if rescission had been required). Since the painting was sold to C in an
arm's-length transaction prior to correction, no rescission is required.
(3) Sales to foundation. (i) In the case of a sale of property to a
private foundation by a disqualified person for cash, undoing the
transaction includes, but is not limited to, requiring rescission of the
sale where possible. However, in order to avoid placing the foundation
in a position worse than that in which it would be if rescission were
not required, the amount received from the disqualified person pursuant
to the rescission shall be the greatest of the cash paid to the
disqualified person, the fair market value of the property at the time
of the original sale, or the fair market value of the property at the
time of rescission. In addition to rescission, the disqualified person
is required to pay over to the private foundation any net profits he
realized after the original sale with respect to the consideration he
received from the sale. Thus, for example, the disqualified person must
pay over to the foundation any income derived by him from the cash he
received from the original sale to the extent such income during the
correction period exceeds the income derived by the foundation during
the correction period from the property which the disqualified person
originally transferred to the foundation.
(ii) If, prior to the end of the correction period, the foundation
resells the property in an arm's-length transaction to a bona fide
purchaser who is not a disqualified person, no rescission is required.
In such case, the disqualified person must pay over to the foundation
the excess (if any) of the amount which would have been received from
the disqualified person pursuant to subdivision (i) of this
subparagraph, if recission had been required over the amount realized by
the foundation upon resale of the property. In addition, the
disqualified person is required to pay over to the foundation any net
profits he realized, as described in subdivision (i) of this
subparagraph.
(iii) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. On February 10, 1972, D, a disqualified person with
respect to private foundation P, sells 100 shares of X stock to P for
$2,500 in a transaction which does not fall within any of the exceptions
to selfdealing. The fair market value of the 100 shares of X stock on
February 10, 1972, is $3,200. On June 1, 1973, the 100 shares of X stock
have a fair market value of $2,900. From February 10, 1972, through June
1, 1973, P has received dividends of $90 from the stock, and D has
received interest of $300 from the $2,500 which D received as
consideration for the stock. In order to correct the act of self-dealing
under this subparagraph on June 1, 1973, the sale must be rescinded by
the return of the stock to D. However, pursuant to such rescission, D
must pay P $3,200, the fair market value of the stock on the date of
sale. In addition, D must pay P $210, the amount of income derived by D
during the correction period from the $2,500 received from P ($300)
minus the income derived by P during the correction period from the
stock sold to P ($90).
Example 2. Assume the facts as stated in Example (1), except that on
September 1, 1972, P sells the 100 shares of X stock to E, a bona fide
purchaser who is not a disqualified person, in an arm's-length
transaction for $2,750. Assume further that P has not received any
dividends from the stock prior to the sale to E, but that P receives
interest of $260 from the $2,750 received as consideration for the stock
for the period from September 1, 1972, to June 1, 1973. In order to
correct the act of self-dealing under this subparagraph on June 1, 1973,
D must pay P $450 ($3,200, the amount which would have been received
from D if rescission had been required, less $2,750, the amount realized
by P from the sale to E). In addition, D must pay P $40, the amount of
income derived by D during the correction period from the $2,500
received from P ($300) minus the income derived by P during the
correction period from the stock sold to P ($260 from the $2,750
received as consideration for the stock). Since the stock was sold to E
in an arm's-length transaction prior to correction, no rescission is
required.
(4) Use of property by a disqualified person. (i) In the case of the
use by a disqualified person of property owned by a private foundation,
undoing the transaction includes, but is not limited to, terminating the
use of such property. In addition to termination, the disqualified
person must pay the foundation:
[[Page 69]]
(a) The excess (if any) of the fair market value of the use of the
property over the amount paid by the disqualified person for such use
until such termination, and
(b) The excess (if any) of the amount which would have been paid by
the disqualified person for the use of the property on or after the date
of such termination, for the period such disqualified person would have
used the property (without regard to any further extensions or renewals
of such period) if such termination had not occurred, over the fair
market value of such use for such period.
In applying (a) of this subdivision the fair market value of the use of
property shall be the higher of the rate (that is, fair rental value per
period in the case of use of property other than money or fair interest
rate in the case of use of money) at the time of the act of self-dealing
(within the meaning of paragraph (e)(1) of this section) or such rate at
the time of correction of such act of self-dealing. In applying (b) of
this subdivision the fair market value of the use of property shall be
the rate at the time of correction.
(ii) The provisions of this subparagraph may be illustrated by the
following examples:
Example 1. On January 1, 1972, private foundation S rented the third
story of its office building to A, a disqualified person, for 1 year at
an annual rent of $10,000, in a transaction not within any of the
exceptions to self-dealing. Both S and A are on the calendar year basis.
The fair rental value of such office space for a 1-year period on
January 1, 1972, is $12,000. On June 30, 1972, the fair rental value of
such office space for a 1-year period is $13,000. In order to correct
the act of self-dealing under this subparagraph on June 30, 1972, A must
terminate his use of the property. In addition, A must pay S $1,500, the
excess of $6,500 (the fair rental value for 6 months as of June 30,
1972) over $5,000 (the amount paid to S from Jan. 1, 1972, to June 30,
1972).
Example 2. On January 1, 1972, private foundation R rented the
fourth story of its office building to B, a disqualified person, for 1
year at an annual rent of $10,000, in a transaction not included in any
of the exceptions to self-dealing. Both R and B are on the calendar year
basis. On January 1, 1973, B continues to rent the office space as a
periodic tenant paying his rent monthly at an annual rate of $10,000.
The fair rental value of such office space for a 1-year period on
January 1, 1972, is $12,000, and as of January 1, 1973, is $1,250 per
month. As of December 31, 1973, the fair rental value of such office
space is $14,000 for a 1-year period and $1,200 on a monthly basis. In
order to correct his acts of self-dealing (within the meaning of
paragraph (e)(1) of this section) under this subparagraph on December
31, 1973, B must terminate his use of the property. In addition, B must
pay R $9,000, $4,000 for his use of the property for 1972 (the excess of
$14,000, the fair rental value for 1 year as of Dec. 31, 1973, over
$10,000, the amount B paid R for his use of the property for 1972) and
$5,000 for his use of the property for 1973 (the excess of $15,000, the
fair rental value for 12 months as of Jan. 1, 1973, over $10,000, the
amount B paid R for his use of the property for 1973).
Example 3. B, a substantial contributor to private foundation T,
leases office space in a building owned by T for $5,000 for 1 year
beginning on November 10, 1972, in a transaction not included in any of
the exceptions to self-dealing. The fair rental value of the building
for a 1-year period on November 10, 1972, is $4,000. On May 10, 1973,
the fair rental value of the building for the remaining period of the
lease is $2,200. In order to correct the acts of self-dealing under this
subparagraph on May 10, 1973, B and T must terminate the lease. In
addition, B must pay T $300 (the excess of $2,500, the amount which
would have been paid by B for the remaining period of the lease if it
had not been terminated, over $2,200, the fair rental value at the time
of correction for the remaining period of the lease).
(5) Use of property by a private foundation. (i) In the case of the
use by a private foundation of property owned by a disqualified person,
undoing the transaction includes, but is not limited to, terminating the
use of such property. In addition to termination, the disqualified
person must pay the foundation:
(a) The excess (if any) of the amount paid to the disqualified
person for such use until such termination over the fair market value of
the use of the property, and
(b) The excess (if any) of the fair market value of the use of the
property, for the period the foundation would have used the property
(without regard to any further extensions or renewals of such period) if
such termination had not occurred, over the amount which would have been
paid to the disqualified person on or after the date of such termination
for such use for such period.
[[Page 70]]
In applying (a) of this subdivision the fair market value of the use of
property shall be the lesser of the rate (that is, fair rental value per
period in the case of use of property other than money or fair interest
rate in the case of use of money) at the time of the act of self-dealing
(within the meaning of paragraph (e)(1) of this section) or such rate at
the time of correction of such act of self-dealing. In applying (b) of
this subdivision the fair market value of the use of property shall be
the rate at the time of correction.
(ii) The provisions of this subparagraph may be illustrated by the
following examples:
Example 1. On July 1, 1972, private foundation X leases office space
in a building owned by C, a disqualified person, for 1 year at an annual
rent of $6,000. Both X and C are on the calendar year basis. The fair
rental value of such office space for a 1-year period as of July 1,
1972, is $4,200. As of January 1, 1973, the fair rental value of such
office space for a 1-year period is $5,400, and as of June 30, 1973, the
fair rental value of such office space for a 1-year period is $4,800. In
order to correct his acts of self-dealing (within the meaning of
paragraph (e)(1) of this section) under this subparagraph on June 30,
1973, C must terminate X's use of the property. In addition, C must pay
X $1,500, $900 (the excess of $3,000, the amount paid to C from July 1,
1972, through December 31, 1972, over $2,100, the fair rental value for
6 months as of July 1, 1972) plus $600 (the excess of $3,000, the amount
paid to C from January 1, 1973, through June 30, 1973, over $2,400, the
fair rental value for 6 months as of June 30, 1973).
Example 2. On April 1, 1973, D, a disqualified person with respect
to private foundation Y, loans $100,000 to Y at 6 percent interest per
annum. Both principal and interest are to be paid on April 1, 1978. The
fair market value of the use of the money on April 1, 1973, is 9 percent
per annum. On April 1, 1974, D and Y terminate the loan. On such date,
the fair market value of the use of $100,000 is 10 percent per annum. In
order to correct the act of self-dealing on April 1, 1974, in addition
to the termination of the loan from D to Y, D must pay Y $16,000, the
excess of $40,000 ($100,000x10 percent, the fair market value of the use
determined at the time of correction, from April 1, 1974, to April 1,
1978) over $24,000 (the amount of interest Y would have paid to D from
April 1, 1974, to April 1, 1978, if the loan from D to Y had not been
terminated).
(6) Payment of compensation to a disqualified person. In the case of
the payment of compensation by a private foundation to a disqualified
person for the performance of personal services which are reasonable and
necessary to carry out the exempt purpose of such foundation, undoing
the transaction requires that the disqualified person pay to the
foundation any amount which is excessive. However, termination of the
employment or independent contractor relationship is not required.
(7) Special rule for correction of valuation errors. (i) In the case
of a transaction described in paragraph (b)(2)(iii) of this section, a
``correction'' of the act of self-dealing shall ordinarily be deemed to
occur if the foundation is paid an amount of money equal to the amount
involved (as defined in paragraph (b)(2)(iii) of this section) plus such
additional amounts as are necessary to compensate it for the loss of the
use of the money or other property during the period commencing on the
date of the act of self-dealing and ending on the date the transaction
is corrected pursuant to this subparagraph.
(ii) The provisions of this subparagraph may be illustrated by the
following example:
Example. Assume the same facts as in example (5) of paragraph (b)(4)
of this section. Such transaction shall be considered as corrected by a
payment of $5,000 by M to V, together with an additional payment to V of
an amount equal to the interest which V could have obtained on $5,000
for the period commencing on the date of the redemption and ending on
the date the act is corrected.
(d) Cross reference. For rules relating to taxable events that are
corrected within the correction period, defined in section 4963 (e), see
section 4961 (a), and the regulations thereunder.
(e) Act of self-dealing--(1) Number of acts; use of money or
property--(i) In general. If a transaction between a private foundation
and a disqualified person is determined to be self-dealing (as defined
in section 4941(d)), for purposes of section 4941 there is generally one
act of self-dealing. For the date on which such act is treated as
occurring, see paragraph (a)(2) of this section. If, however, such
transaction relates to the leasing of property, the lending of money or
other extension of credit, other use of money or property, or payment of
compensation, the transaction will generally be treated (for purposes
[[Page 71]]
of section 4941 but not section 507 or section 6684) as giving rise to
an act of self-dealing on the day the transaction occurs plus an act of
self-dealing on the first day of each taxable year or portion of a
taxable year which is within the taxable period and which begins after
the taxable year in which the transaction occurs.
(ii) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. On August 31, 1970, X, a private foundation, sells a
building to A, a disqualified person with respect to X. A is on the
calendar year basis. Under these circumstances, the transaction between
A and X is one act of self-dealing which is treated for purposes of
section 4941 as occurring on August 31, 1970.
Example 2. Assume the facts as stated in example (1), except that,
instead of selling the building to A, X leases the building to A for a
term of 4 years beginning July 31, 1970, at an annual rental of $12,000.
The fair rental value of the building is also $12,000 per annum as of
July 31, 1970, and throughout the next 4 years. This transaction is
corrected on September 30, 1973, in accordance with paragraph (c)(4) of
this section. Under these circumstances, the transaction between A and X
constitutes four separate acts of self-dealing, which are treated for
purposes of section 4941 as occurring on July 31, 1970, January 1, 1971,
January 1, 1972, and January 1, 1973. Consequently, there are four
taxable periods. The first taxable period is from July 31, 1970, to
September 30, 1973; the second is from January 1, 1971, to September 30,
1973; the third is from January 1, 1972, to September 30, 1973; and the
fourth is from January 1, 1973, to September 30, 1973. For purposes of
the initial taxes in section 4941(a), the amount involved is $5,000 for
the first taxable period, $12,000 for the second, $12,000 for the third,
and $9,000 for the fourth. The initial taxes to be paid by A are thus
$1,000 ($5,000x5%x4 taxable years or partial taxable years in the
taxable period) for the first act; $1,800 ($12,000x5%x3) for the second
act; $1,200 ($12,000x5%x2) for the third act; and $450 ($9,000x5%x1) for
the fourth act.
Example 3. Assume the facts as stated in example (1) of Sec.
53.4941(d)-4(c)(4)(ii). If the debentures are held by Y after December
31, 1979, the extension of credit will not be excepted from the
definition of an act of self-dealing, because an act of self-dealing
will be treated (for purposes of section 4941) as occurring on January
1, 1980.
(2) Number of acts; joint participation by disqualified persons--(i)
In general. If joint participation in a transaction by two or more
disqualified persons constitutes self-dealing (such as a joint sale of
property to a private foundation or joint use of its money or property),
such transaction shall generally be treated as a separate act of self-
dealing with respect to each disqualified person for purposes of section
4941. For purposes of section 507 and, in the case of a foundation
manager, section 6684, however, such transaction shall be treated as
only one act of self-dealing. For purposes of this subparagraph, an
individual and one or more members of his family (within the meaning of
section 4946(d)) shall be treated as one person, regardless of whether a
member of the family is a disqualified person not only by reason of
section 4946(a)(1)(D) but also by reason of another subparagraph of
section 4946(a)(1). However, the liability imposed on a disqualified
person and one or more members of his family for joint participation in
an act of self-dealing shall be joint and several in accordance with
section 4941(c)(1) and Sec. 53.4941(c)-1(a).
(ii) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. Private foundation X permits A, a substantial contributor
to X, and her spouse, H, to use an automobile owned by X and normally
used in its foundation activities to travel from State Z to State Y for
a vacation on December 1, 1971. The automobile is then returned to X
until December 21, 1971, when X again permits them to use the automobile
to return to their home in State Z. Under these circumstances, there is
one act of self-dealing on December 1, 1971, and a second act of self-
dealing on December 21, 1971.
Example 2. Assume the facts as stated in example (1), except that B
joined A and H on their vacation and traveled with them both to and from
State Y. B is a disqualified person with respect to X, but he is not
related by blood or marriage to A or H. Assume also that X is not paid
for the use of its automobile, but that the fair rental value during the
taxable period is $300 (or $100 per person) for a one-way trip between
State Y and State Z. Under these circumstances, there are four acts of
self-dealing, two with respect to A and H and two with respect to B. The
amount involved with respect to A and H is $200 for each act, and the
amount involved with respect to B is $100 for each act.
(f) Fair market value. For purposes of Sec. Sec. 53.4941(a)-1
through 53.4941 (f)-1, fair
[[Page 72]]
market value shall be determined pursuant to the provisions of Sec.
53.4942(a)-2 (c)(4).
[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 8084, 51 FR
16301, May 2, 1986]
Sec. 53.4941(f)-1 Effective dates.
(a) In general. Except as provided in paragraph (b) of this section,
Sec. Sec. 53.4941(a)-1 through 53.4941(e)-1 shall apply to all acts of
self-dealing engaged in after December 31, 1969.
(b) Transitional rules--(1) Commitments made prior to January 1,
1970, between private foundations and government officials. Section 4941
shall not apply to a payment for one or more purposes described in
section 170(c) (1) or (2)(B) made on or after January 1, 1970, by a
private foundation to a government official, if such payment is made
pursuant to a commitment entered into prior to such date, but only if
such commitment was made in accordance with the foundation's usual
practices and is reasonable in amount in light of the purposes of the
payment. For purposes of this subparagraph, a commitment will be
considered entered into prior to January 1, 1970, if prior to such date,
the amount and nature of the payments to be made and the name of the
payee were entered on the records of the payor, or were otherwise
adequately evidenced, or the notice of the payment to be received was
communicated to the payee in writing.
(2) Special transitional rule. In the case of an act of self-dealing
engaged in prior to July 5, 1971, section 4941(a) (1) shall not apply
if:
(i) The participation (as defined in Sec. 53.4941(a)-1(a)(3)) by
the disqualified person in such act is not willful and is due to
reasonable cause (as defined in Sec. 53.4941(a)-1(b) (4) and (5)),
(ii) The transaction would not be a prohibited transaction if
section 503(b) applied, and
(iii) The act is corrected (within the meaning of Sec. 53.4941(e)-
1(c)) within a period ending [insert 90 days after date on which final
regulations under section 4941 are filed by the Federal Register],
extended (prior to the expiration of the original period) by any period
which the Commissioner determines is reasonable and necessary (within
the meaning of Sec. 53.4941(e)-1(d)) to bring about correction of the
act of self-dealing.
Subpart C_Taxes on Failure To Distribute Income
Source: T.D. 7249, 38 FR 768, Jan. 4, 1973, unless otherwise noted.
Sec. 53.4942(a)-1 Taxes for failure to distribute income.
(a) Imposition of tax--(1) Initial tax. Except as provided in
paragraph (b) of this section, section 4942(a) imposes an excise tax of
15 percent on the undistributed income (as defined in paragraph (a) of
Sec. 53.4942(a)-2) of a private foundation for any taxable year which
has not been distributed before the first day of the second (or any
succeeding) taxable year following such taxable year (if such first day
falls within the taxable period as defined in paragraph (c)(1) of this
section). For purposes of section 4942 and this section, the term
distributed means distributed as qualifying distributions under section
4942(g). See paragraph (d)(2) of Sec. 53.4942(a)-3 with respect to
correction of deficient distributions for prior taxable years.
(2) Additional tax. In any case in which an initial excise tax is
imposed by section 4942(a) on the undistributed income of a private
foundation for any taxable year, section 4942(b) imposes an additional
excise tax on any portion of such income remaining undistributed at the
close of the correction period (as defined in paragraph (c)(1) of this
section). The tax imposed by section 4942(b) is equal to 100 percent of
the amount remaining undistributed at the close of the taxable period.
(3) Payment of tax. Payment of the excise taxes imposed by section
4942 (a) or (b) is in addition to, and not in lieu of, making the
distribution of such undistributed income as required by section 4942.
See section 507(a)(2) and the regulations thereunder.
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. M, a private foundation which uses the calendar year as
its taxable year, has at the end of 1981, $50,000 of undistributed
income (as defined in paragraph (a) of Sec. 53.4942 (a)-2) for 1981. As
of January 1, 1983,
[[Page 73]]
$40,000 is still undistributed. On August 15, 1983, a notice of
deficiency with respect to the excise taxes imposed by section 4942 (a)
and (b) is mailed to M under section 6212 (a) and the taxable period
ends. Thus, under these facts, an initial excise tax of $6,000 (15
percent of $40,000) is imposed upon M. An additional excise tax of
$40,000 (100 percent of $40,000) is imposed by section 4942(b). Under
section 4961(a), however, if the undistributed income is reduced to zero
during the correction period, this latter tax will not be assessed, and
if assessed, it will be abated, and if collected, it will be credited or
refunded as an overpayment.
Example 2. Assume the facts as stated in example (1), except that
the notice of deficiency is mailed to M on September 7, 1984, and as of
January 1, 1984, only $10,000 of the $50,000 of undistributed income
with respect to 1981 is undistributed. Therefore, initial excise taxes
of $6,000 (15 percent of $40,000, M's undistributed income from 1981, as
of January 1, 1983) and $1,500 (15 percent of $10,000, M's undistributed
income from 1981 as of January 1, 1984) are imposed by section 4942(a).
If the $10,000 remains undistributed as of September 7, 1984, the end of
the taxable period, an additional excise tax of $10,000 (100 percent of
$10,000, M's undistributed income from 1981, as of September 7, 1984) is
imposed by section 4942(b).
(b) Exceptions--(1) In general. The initial excise tax imposed by
section 4942(a) shall not apply to the undistributed income of a private
foundation:
(i) For any taxable year for which it is an operating foundation (as
defined in section 4942(j)(3) and the regulations thereunder), or
(ii) To the extent that the foundation failed to distribute any
amount solely because of incorrect valuation of assets under paragraph
(c)(4) of Sec. 53.4942(a)-2, if:
(a) The failure to value the assets properly was not willful and was
due to reasonable cause,
(b) Such amount is distributed as qualifying distributions (within
the meaning of paragraph (a) of Sec. 53.4942 (a)-3) by the foundation
during the allowable distribution period (as defined in paragraph (c)(2)
of this section),
(c) The foundation notifies the Commissioner that such amount has
been distributed (within the meaning of subdivision (ii)(b) of this
subparagraph) to correct such failure, and
(d) Such distribution is treated under paragraph (d)(2) of Sec.
53.4942(a)-3 as made out of the undistributed income for the taxable
year for which a tax would (except for this subdivision) have been
imposed by section 4942(a).
(2) Improper valuation. For purposes of subparagraph (1)(ii) of this
paragraph, failure to value an asset properly shall be regarded as ``not
willful'' and ``due to reasonable cause'' whenever, under all the facts
and circumstances, the foundation can show that it has made all
reasonable efforts in good faith to value such an asset in accordance
with the provisions of paragraph (c)(4) of Sec. 53.4942(a)-2. If a
foundation, after full disclosure of the factual situation, obtains a
bona fide appraisal of the fair market value of an asset by a person
qualified to make such an appraisal (whether or not such a person is a
disqualified person with respect to the foundation), and such foundation
relies upon such appraisal, then failure to value the asset properly
shall ordinarily be regarded as ``not willful'' and ``due to reasonable
cause''. Notwithstanding the preceding sentence, the failure to obtain
such a bona fide appraisal shall not, by itself, give rise to any
inference that a foundation's failure to value an asset properly was
willful or not due to reasonable cause.
(3) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. In 1976 M, a private foundation which was established in
1975 and which uses the calendar year as the taxable year, incorrectly
values its assets under paragraph (c)(4) of Sec. 53.4942(a)-2 in a
manner which is not willful and is due to reasonable cause. As a result
of the incorrect valuation of assets, $20,000 which should be
distributed with respect to 1976 is not distributed, and as of January
1, 1978, such amount is still undistributed. On March 29, 1978, a notice
of deficiency with respect to the excise taxes imposed by section 4942
(a) and (b) is mailed to M under section 6212(a). On May 5, 1978 (within
the allowable distribution period), M makes a qualifying distribution of
$20,000 which is treated under paragraph (d)(2) of Sec. 53.4942(a)-3 as
made out of M's undistributed income for 1976. M notifies the
Commissioner of its action. Under the stated facts, an initial excise
tax of $3,000 (15 percent of $20,000) would (except for the exception
contained in subparagraph (1)(ii) of this paragraph) have been imposed
by section 4942(a), but since all of the requirements of such
subparagraph are satisfied no tax is imposed by section 4942(a).
[[Page 74]]
(c) Certain periods. For purposes of this section--
(1) Taxable period. (i) The term ``taxable period'' means, with
respect to the undistributed income of a private foundation for any
taxable year, the period beginning with the first day of the taxable
year and ending on the earlier of:
(A) The date of mailing of a notice of deficiency under section
6212(a) with respect to the initial excise tax imposed under section
4942(a), or
(B) The date on which the initial excise tax imposed under section
4942(a) is assessed.
For example, assume M, a private foundation which uses the calendar year
as the taxable year, has $15,000 of undistributed income for 1981. A
notice of deficiency is mailed to M under section 6212(a) on June 1,
1983. With respect to the undistributed income of M for 1981, the
taxable period began on January 1, 1981, and ended on June 1, 1983.
(ii) Where a notice of deficiency referred to in subdivision (i) of
this subparagraph is not mailed because there is a waiver of the
restrictions on assessment and collection of a deficiency, or because
the deficiency is paid, the date of filing of the waiver or the date of
such payment, respectively, shall be treated as the end of the taxable
period.
(2) Allowable distribution period. (i) The term ``allowable
distribution period'' means the period beginning with the first day of
the first taxable year following the taxable year in which the incorrect
valuation of foundation assets (described in paragraph (b)(1)(ii) of
this section) occurred and ending 90 days after the date of mailing of a
notice of deficiency under section 6212(a) with respect to the initial
excise tax imposed by section 4942(a). This period shall be extended by
any period in which a deficiency cannot be assessed under section
6213(a), and any other period which the Commissioner determines is
reasonable and necessary to permit a distribution of undistributed
income under section 4942.
(ii) Where a notice of deficiency referred to in subdivision (i) of
this subparagraph is not mailed because there is a waiver of the
restrictions on assessment and collection of a deficiency, or because
the deficiency is paid, the date of filing of the waiver or the date of
such payment, respectively, shall be treated as the end of the allowable
distribution period.
(3) Cross reference. For rules relating to taxable events that are
corrected within the correction period, defined in section 4963(e), see
section 4961 (a) and the regulations thereunder.
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. In 1975 M, a private foundation which uses the calendar
year as the taxable year, made an error in valuing its assets which was
not willful and was due to reasonable cause. The error caused M not to
distribute $25,000 that should have been distributed with respect to
1975. On March 1, 1978, a notice of deficiency with respect to the
excise taxes imposed by section 4942 (a) and (b) was mailed to M under
section 6212(a). With respect to the undistributed income for 1975, the
taxable period is the period from January 1, 1975, through March 1,
1978, and the allowable distribution period is the period from January
1, 1976, through May 30, 1978 (90 days after the mailing of the notice
of deficiency).
Example 2. Assume the facts as stated in example (1), except that
the Commissioner determines that it is reasonable and necessary to
extend the period for distribution through June 15, 1978. Thus, the
allowable distribution period is from January 1, 1976, through June 15,
1978.
(d) Effective date. Except as otherwise specifically provided,
section 4942 and the regulations thereunder shall only apply with
respect to taxable years beginning after December 31, 1969.
[T.D. 7256, 38 FR 3317, Feb. 7, 1973, as amended by T.D. 8084, 51 FR
16302, May 2, 1986]
Sec. 53.4942(a)-2 Computation of undistributed income.
(a) Undistributed income. For purposes of section 4942, the term
``undistributed income'' means, with respect to any private foundation
for any taxable year as of any time, the amount by which:
(1) The distributable amount (as defined in paragraph (b) of this
section) for such taxable year, exceeds
(2) The qualifying distributions (as defined in Sec. 53.4942(a)-3)
made before such time out of such distributable amount.
(b) Distributable amount--(1) In general. For purposes of paragraph
(a) of this section, the term ``distributable amount'' means:
[[Page 75]]
(i) For taxable years beginning before January 1, 1982, an amount
equal to the greater of the minimum investment return (as defined in
paragraph (c) of this section) or the adjusted net income (as defined in
paragraph (d) of this section); and
(ii) For taxable years beginning after December 31, 1981, an amount
equal to the minimum investment return (as defined in paragraph (c) of
this section), reduced by the sum of the taxes imposed on such private
foundation for such taxable year under subtitle A of the Code and
section 4940, and increased by the amounts received from trusts
described in subparagraph (2) of this paragraph.
(2) Certain trust amounts--(i) In general. The distributable amount
shall be increased by the income portion (as defined in subdivision (ii)
of this subparagraph) of distributions from trusts described in section
4947(a)(2) with respect to amounts placed in trust after May 26, 1969.
If such distributions are made with respect to amounts placed in trust
both on or before and after May 26, 1969, such distributions shall be
allocated between such amounts to determine the extent to which such
distributions shall be included in the foundation's distributable
amount. For rules relating to the segregation of amounts placed in trust
on or before May 26, 1969, from amounts placed in trust after such date
and to the allocation of income derived from such amounts, see paragraph
(c) (5) of Sec. 53.4947-1.
(ii) Income portion of distributions to private foundations. For
purposes of subdivision (i) of this subparagraph, the income portion of
a distribution from a section 4947(a)(2) trust to a private foundation
in a particular taxable year of such foundation shall be the greater of:
(a) The amount of such distribution which is treated as income
(within the meaning of section 643(b)) of the trust, or
(b) The guaranteed annuity, or fixed percentage of the fair market
value of the trust property (determined annually), which the private
foundation is entitled to receive for such year, regardless of whether
such amount is actually received in such year or in any prior or
subsequent year.
(iii) Limitation. Notwithstanding subdivisions (i) and (ii) of this
subparagraph, a private foundation shall not be required to distribute a
greater amount for any taxable year than would have been required
(without regard to this subparagraph) for such year had the corpus of
the section 4947(a) (2) trust to which the distribution described in
subdivision (ii) of this subparagraph is attributable been taken into
account by such foundation as an asset described in paragraph (c) (1)
(i) of this section.
(c) Minimum investment return--(1) In general. For purposes of
paragraph (b) of this section, the ``minimum investment return'' for any
private foundation for any taxable year is the amount determined by
multiplying:
(i) The excess of the aggregate fair market value of all assets of
the foundation, other than those described in subparagraph (2) or (3) of
this paragraph, over the amount of the acquisition indebtedness with
respect to such assets (determined under section 514(c)(1), but without
regard to the taxable year in which the indebtedness was incurred), by
(ii) The applicable percentage (as defined in subparagraph (5) of
this paragraph) for such year.
For purposes of subdivision (i) of this subparagraph, the aggregate fair
market value of all assets of the foundation shall include the average
of the fair market values on a monthly basis of securities for which
market quotations are readily available (within the meaning of
subparagraph (4)(i)(a) of this paragraph), the average of the
foundation's cash balances on a monthly basis (less the cash balances
excluded from the computation of the minimum investment return by
operation of subparagraph (3)(iv) of this paragraph), and the fair
market value of all other assets (except those assets described in
subparagraph (2) or (3) of this paragraph) for the period of time during
the taxable year for which such assets are held by the foundation. Any
determination of the fair market value of an asset required pursuant to
the provisions of this subparagraph shall
[[Page 76]]
be made in accordance with the rules of subparagraph (4) of this
paragraph.
(2) Certain assets excluded. For purposes of this paragraph, the
assets taken into account in determining minimum investment return shall
not include the following:
(i) Any future interest (such as a vested or contingent remainder,
whether legal or equitable) of a foundation in the income or corpus of
any real or personal property, other than a future interest created by
the private foundation after December 31, 1969, until all intervening
interests in, and rights to the actual possession or enjoyment of, such
property have expired, or, although not actually reduced to the
foundation's possession, until such future interest has been
constructively received by the foundation, as where it has been credited
to the foundation's account, set apart for the foundation, or otherwise
made available so that the foundation may acquire it at any time or
could have acquired it if notice of intention to acquire had been given;
(ii) The assets of an estate until such time as such assets are
distributed to the foundation or, due to a prolonged period of
administration, such estate is considered terminated for Federal income
tax purposes by operation of paragraph (a) of Sec. 1.641(b)-3 of this
chapter (Income Tax Regulations);
(iii) Any present interest of a foundation in any trust created and
funded by another person (see, however, paragraph (b) (2) of this
section with respect to amounts received from certain trusts described
in section 4947(a) (2));
(iv) Any pledge to the foundation of money or property (whether or
not the pledge may be legally enforced); and
(v) Any assets used (or held for use) directly in carrying out the
foundation's exempt purpose.
(3) Assets used (or held for use) in carrying out the exempt
purpose--(i) In general. For purposes of subparagraph (2)(v) of this
paragraph, an asset is ``used (or held for use) directly in carrying out
the foundation's exempt purpose'' only if the asset is actually used by
the foundation in the carrying out of the charitable, educational, or
other similar purpose which gives rise to the exempt status of the
foundation, or if the foundation owns the asset and establishes to the
satisfaction of the Commissioner that its immediate use for such exempt
purpose is not practical (based on the facts and circumstances of the
particular case) and that definite plans exist to commence such use
within a reasonable period of time. Consequently, assets which are held
for the production of income or for investment (for example, stocks,
bonds, interest-bearing notes, endowment funds, or, generally, leased
real estate) are not being used (or held for use) directly in carrying
out the foundation's exempt purpose, even though the income from such
assets is used to carry out such exempt purpose. Whether an asset is
held for the production of income or for investment rather than used (or
held for use) directly by the foundation to carry out its exempt purpose
is a question of fact. For example, an office building used for the
purpose of providing offices for employees engaged in the management of
endowment funds of the foundation is not being used (or held for use)
directly by the foundation to carry out its charitable, educational, or
other similar exempt purpose. However, where property is used both for
charitable, educational, or other similar exempt purposes and for other
purposes, if such exempt use represents 95 percent or more of the total
use, such property shall be considered to be used exclusively for a
charitable, educational, or other similar exempt purpose. If such exempt
use of such property represents less than 95 percent of the total use,
reasonable allocation between such exempt and nonexempt use must be made
for purposes of this paragraph. Property acquired by the foundation to
be used in carrying out its charitable, educational, or other similar
exempt purpose may be considered as used (or held for use) directly to
carry out such exempt purpose even though the property, in whole or in
part, is leased for a limited period of time during which arrangements
are made for its conversion to the use for which it was acquired,
provided such income-producing use of the property does not exceed a
reasonable period of time. Generally, 1 year shall be deemed to be a
reasonable period of time for purposes of the immediately preceding
sentence.
[[Page 77]]
For treatment of the income derived from such income-producing use, see
paragraph (d)(2)(viii) of this section. Where the income-producing use
continues beyond a reasonable period of time, the property shall not be
deemed to be used by the foundation to carry out its charitable,
educational, or other similar exempt purpose, but, instead, as of the
time the income-producing use becomes unreasonable, such property shall
be treated as disposed of within the meaning of paragraph (d)(2)(iii)(b)
of this section to the extent that the acquisition of the property was
taken into account as a qualifying distribution (within the meaning of
paragraph (a)(2) of Sec. 53.4942(a-3) for any taxable year. If,
subsequently, the property is used by the foundation directly in
carrying out its charitable, educational, or other similar exempt
purpose, a qualifying distribution in the amount of its then fair market
value, determined in accordance with the rules contained in subparagraph
(4) of this paragraph, shall be deemed to have been made as of the time
such exempt use begins.
(ii) Illustrations. Examples of assets which are ``used (or held for
use) directly in carrying out the foundation's exempt purpose'' include,
but are not limited to, the following:
(a) Administrative assets, such as office equipment and supplies
which are used by employees or consultants of the foundation, to the
extent such assets are devoted to and used directly in the
administration of the foundation's charitable, educational or other
similar exempt activities;
(b) Real estate or the portion of a building used by the foundation
directly in its charitable, educational, or other similar exempt
activities;
(c) Physical facilities used in such activities, such as paintings
or other works of art owned by the foundation which are on public
display, fixtures and equipment in classrooms, research facilities and
related equipment which under the facts and circumstances serve a useful
purpose in the conduct of such activities;
(d) Any interest in a functionally related business (as defined in
subdivision (iii) of this subparagraph) or in a program-related
investment (as defined in section 4944(c));
(e) The reasonable cash balances (as described in subdivision (iv)
of this subparagraph) necessary to cover current administrative expenses
and other normal and current disbursements directly connected with the
foundation's charitable, educational, or other similar exempt
activities; and
(f) Any property leased by a foundation in carrying out its
charitable, educational, or other similar exempt purpose at no cost (or
at a nominal rent) to the lessee or for a program-related purpose
(within the meaning of section 4944(c)), such as the leasing of
renovated apartments to low-income tenants at a low rental as part of
the lessor foundation's program for rehabilitating a blighted portion of
a community. For treatment of the income derived from such use, see
paragraph (d) (2) (viii) of this section.
(iii) Functionally related business--(a) In general. The term
``functionally related business'' means:
(1) A trade or business which is not an unrelated trade or business
(as defined in section 513), or
(2) An activity which is carried on within a larger aggregate of
similar activities or within a larger complex of other endeavors which
is related (aside from the need of the organization for income or funds
or the use it makes of the profits derived) to the charitable,
educational, or other similar exempt purpose of the organization.
(b) Examples. The provisions of this subdivision may be illustrated
by the following examples:
Example 1. X, a private foundation, maintains a community of
historic value which is open to the general public. For the convenience
of the public, X, through a wholly owned, separately incorporated,
taxable entity, maintains a restaurant and hotel in such community. Such
facilities are within the larger aggregate of activities which makes
available for public enjoyment the various buildings of historic
interest and which is related to X's exempt purpose. Thus, the operation
of the restaurant and hotel under such circumstances constitutes a
functionally related business.
Example 2. Y, a private foundation, as part of its medical research
program under section 501(c) (3), publishes a medical journal in
carrying out its exempt purpose. Space in
[[Page 78]]
the journal is sold for commercial advertising. Notwithstanding the fact
that the advertising activity may be subject to the tax imposed by
section 511, such activity is within a larger complex of endeavors which
makes available to the scientific community and the general public
developments with respect to medical research and is therefore a
functionally related business.
(iv) Cash held for charitable, etc. activities. For purposes of
subdivision (ii)(e) of this subparagraph, the reasonable cash balances
which a private foundation needs to have on hand to cover expenses and
disbursements described in such subdivision will generally be deemed to
be an amount, computed on an annual basis, equal to one and one-half
percent of the fair market value of all assets described in subparagraph
(1)(i) of this paragraph, without regard to subdivision (ii)(e) of this
subparagraph. However, if the Commissioner is satisfied that under the
facts and circumstances an amount in addition to such one and one-half
percent is necessary for payment of such expenses and disbursements,
then such additional amount may also be excluded from the amount of
assets described in subparagraph (1)(i) of this paragraph. All remaining
cash balances, including amounts necessary to pay any tax imposed by
section 511 or any section of chapter 42 of the Code except section
4940, are to be included in the assets described in subparagraph (1)(i)
of this paragraph.
(4) Valuation of assets--(i) Certain securities. (a) For purposes of
subparagraph (1)(i) of this paragraph, a private foundation may use any
reasonable method to determine the fair market value on a monthly basis
of securities for which market quotations are readily available, as long
as such method is consistently used. For purposes of this subparagraph,
market quotations are readily available if a security is:
(1) Listed on the New York Stock Exchange, the American Stock
Exchange, or any city or regional exchange in which quotations appear on
a daily basis, including foreign securities listed on a recognized
foreign national or regional exchange;
(2) Regularly traded in the national or regional over-the-counter
market, for which published quotations are available; or
(3) Locally traded, for which quotations can readily be obtained
from established brokerage firms.
(b) For purposes of this subdivision, commonly accepted methods of
valuation must be used in making an appraisal. Valuations made in
accordance with the principles stated in the regulations under section
2031 constitute acceptable methods of valuation. This paragraph
(c)(4)(i)(b) applies only for taxable years beginning before January 1,
1976. See section 4942(e)(2)(B) and paragraph (c)(4)(i)(c) of this
section for special valuation rules that apply for subsequent taxable
years.
(c) For purposes of this subdivision (i) and with respect to taxable
years beginning after December 31, 1975, if the private foundation can
show that the value of securities determined on the basis of market
quotations as provided by subdivision (i)(a) does not reflect the fair
market value thereof because:
(1) The securities constitute a block of securities so large in
relation to the volume of actual sales on the existing market that it
could not be liquidated in a reasonable time without depressing the
market.
(2) The securities are securities in a closely held corporation and
sales are few or of a sporadic nature, and, or
(3) The sale of the securities would result in a forced or distress
sale because the securities could not be offered to the public for sale
without first being registered under the Securities Act of 1933 or
because of other factors,
then the price at which the securities could be sold as such outside the
usual market, as through an underwriter, may be a more accurate
indication of value than market quotations. On the other hand, if the
securities to be valued represents a controlling interest, either actual
or effective, in a going business, the price at which other lots change
hands may have little relation to the true value of the securities. No
decrease in the fair market value of any given class of securities
determined on the basis of market quotations as provided by subdivision
(i)(a) shall be allowed except as authorized by this subdivision, and no
such decrease shall in the aggregate exceed 10 percent of the fair
market value of
[[Page 79]]
such class of securities so determined on the basis of market quotations
and without regard to this subdivision.
(d) In the case of securities described in subdivision (i)(a) of
this subparagraph, which are held in trust for, or on behalf of, a
foundation by a bank or other financial institution which values such
securities periodically by use of a computer, a foundation may determine
the correct value of such securities by use of such computer pricing
system, provided the Commissioner has accepted such computer pricing
system as a valid method for valuing securities for Federal estate tax
purposes.
(e) This subdivision may be illustrated by the following examples:
Example 1. U, a private foundation, owns 1,000 shares of the stock
of M Corporation. M stock is regularly traded on the New York Stock
Exchange. U consistently follows a practice of valuing its 1,000 shares
of M stock on the last trading day of each month based upon the quoted
closing price for M stock. U's method of valuing its M Corporation stock
is permissible under the rules contained in subdivision (i)(a) of this
subparagraph.
Example 2. Assume the facts as stated in example (1), except that U
consistently follows a practice of valuing its 1,000 shares of M stock
by taking the mean of the closing prices for M stock on the first and
last trading days of each month and the trading day nearest the 15th day
of each month. U's method of valuing its M stock is permissible under
the rules contained in subdivision (i)(a) of this subparagraph.
Example 3. Assume the facts as stated in example (1), except that U
consistently follows a practice of valuing its M stock by taking the
mean of the highest and lowest quoted prices for the stock on the last
trading day of each month. U's method of valuing its M stock is
permissible under the rules contained in subdivision (1)(a) of this
subparagraph.
Example 4. V, a private foundation, owns 1,000 shares of the stock
of N Corporation. N stock is regularly traded in the national over-the-
counter market and published quotations of the bid and asked prices for
the stock are available. V consistently follows a practice of valuing
its 1,000 shares of N stock on the first trading day of each month by
taking the mean of the bid and asked prices on that day. V's method of
valuing its N Corporation stock is permissible under the rules contained
in subdivision (i)(a) of this subparagraph.
Example 5. W, a private foundation, owns 1,000 shares of the stock
of O Corporation. O stock is locally traded and quotations can readily
be obtained from established brokerage firms. W consistently follows a
practice of valuing its O stock on the 15th day of each month by
obtaining a bona fide quotation of bid and asked prices for the stock
from an established brokerage firm and taking the mean of such prices on
that day. If a quotation is unavailable on the regular valuation date, W
values its O stock based upon a bona fide quotation on the first day
thereafter on which such a quotation is available. W's method of valuing
its O Corporation stock is permissible under the rules contained in
subdivision (i)(a) of this subparagraph.
(ii) Cash. In order to determine the amount of a foundation's cash
balances, the foundation shall value its cash on a monthly basis by
averaging the amount of cash on hand as of the first day of each month
and as of the last day of each month.
(iii) Common trust funds. If a private foundation owns a
participating interest in a common trust fund (as defined in section
584) established and administered under a plan providing for the
periodic valuation of participating interests during the fund's taxable
year and the reporting of such valuations to participants, the value of
the foundation's interest in the common trust fund based upon the
average of the valuations reported to the foundation during its taxable
year will ordinarily constitute an acceptable method of valuation.
(iv) Other assets. (a) Except as otherwise provided in subdivision
(iv)(b) of this subparagraph, the fair market value of assets other than
those described in subdivisions (i) through (iii) of this subparagraph
shall be determined annually. Thus, the fair market value of securities
other than those described in subdivision (i) of this subparagraph shall
be determined in accordance with this subdivision (a). If, however, a
private foundation owns voting stock of an issuer of unlisted securities
and has, or together with disqualified persons or another private
foundation has, effective control of the issuer (within the meaning of
Sec. 53.4943-3(b)(3)(ii), then to the extent that the issuer's assets
consist of shares of listed securities issues, such assets shall be
valued monthly on the basis of market quotations or in accordance with
section 4942(e)(2)(B), if applicable.
[[Page 80]]
Thus, for example, if a private foundation and a disqualified person
together own all of the unlisted voting stock of a holding company which
in turn holds a portfolio of securities of issues which are listed on
the New York Stock Exchange, in determining the net worth of the holding
company, the underlying portfolio securities are to be valued monthly by
reference to market quotations for their issues unless a decrease in
such value is authorized in accordance with section 4942(e)(2)(b). Such
determination may be made by employees of the private foundation or by
any other person, without regard to whether such person is a
disqualified person with respect to the foundation. A valuation made
pursuant to the provisions of this subdivision, if accepted by the
Commissioner, shall be valid only for the taxable year for which it is
made. A new valuation made in accordance with these provisions is
required for the succeeding taxable year.
(b) If the requirements of this subdivision are met, the fair market
value of any interest in real property, including any improvements
thereon, may be determined on a 5-year basis. Such value must be
determined by means of a certified, independent appraisal made in
writing by a qualified person who is neither a disqualified person with
respect to, nor an employee of, the private foundation. The appraisal is
certified only if it contains a statement at the end thereof to the
effect that, in the opinion of the appraiser, the values placed on the
assets appraised were determined in accordance with valuation principles
regularly employed in making appraisals of such property using all
reasonable valuation methods. The foundation shall retain a copy of the
independent appraisal for its records. If a valuation made pursuant to
the provisions of this subdivision in fact falls within the range of
reasonable values for the appraised property, such valuation may be used
by the foundation for the taxable year for which the valuation is made
and for each of the succeeding 4 taxable years. Any valuation made
pursuant to the provisions of this subdivision may be replaced during
the 5-year period by a subsequent 5-year valuation made in accordance
with the rules set forth in this subdivision, or with an annual
valuation made in accordance with subdivision (iv)(a) of this
subparagraph, and the most recent such valuation of such assets shall be
used in computing the foundation's minimum investment return. In the
case of a foundation organized before May 27, 1969, a valuation made in
accordance with this subdivision applicable to the foundation's first
taxable year beginning after December 31, 1972, and the 4 succeeding
taxable years must be made no later than the last day of such first
taxable year. In the case of a foundation organized after May 26, 1969,
a valuation made in accordance with this subdivision applicable to the
foundation's first taxable year beginning after February 5, 1973 and the
succeeding 4 taxable years must be made no later than the last day of
such first taxable year. Any subsequent valuation made in accordance
with this subdivision must be made no later than the last day of the
first taxable year for which such new valuation is applicable. A
valuation, if properly made in accordance with the rules set forth in
this subdivision, will not be disturbed by the Commissioner during the
5-year period for which it applies even if the actual fair market value
of such property changes during such period.
(c) For purposes of this subdivision, commonly accepted methods of
valuation must be used in making an appraisal. Valuations made in
accordance with the principles stated in the regulations under section
2031 constitute acceptable methods of valuation. The term appraisal, as
used in this subdivision, means a determination of fair market value and
is not to be construed in a technical sense peculiar to particular
property or interests therein, such as, for example, mineral interests
in real property.
(v) Definition of ``securities''. For purposes of this subparagraph,
the term ``securities'' includes, but is not limited to, common and
preferred stocks, bonds, and mutual fund shares.
(vi) Valuation date. (a) In the case of an asset which is required
to be valued on an annual basis as provided in subdivision (iv)(a) of
this subparagraph, such asset may be valued as of any day in the private
foundation's taxable
[[Page 81]]
year to which such valuation applies, provided the foundation follows a
consistent practice of valuing such asset as of such date in all taxable
years.
(b) A valuation described in subdivision (iv)(b) of this
subparagraph may be made as of any day in the first taxable year of the
private foundation to which such valuation is to be applied.
(vii) Assets held for less than a taxable year. For purposes of this
paragraph, any asset described in subparagraph (1)(i) of this paragraph
which is held by a foundation for only part of a taxable year shall be
taken into account for purposes of determining the foundation's minimum
investment return for such taxable year by multiplying the fair market
value of such asset (as determined pursuant to this subparagraph) by a
fraction, the numerator of which is the number of days in such taxable
year that the foundation held such asset and the denominator of which is
the number of days in such taxable year.
(5) Applicable percentage--(i) In general. For purposes of paragraph
(c)(1)(ii) of this section, except as provided in paragraph (c)(5)(ii)
or (iii) of this section, the applicable percentage is:
(a) Six percent for a taxable year beginning in 1970 or 1971;
(b) Five and a half percent for a taxable year beginning in 1972;
(c) Five and one-quarter percent for a taxable year beginning in
1973;
(d) Six percent for a taxable year beginning in 1974 or 1975; and
(e) Five percent for taxable years beginning after Dec. 31, 1975.
(ii) Transitional rule. In the case of organizations organized
before May 27, 1969 (including organizations deemed to be so organized
by virtue of the provisions of paragraph (e)(2) of this section),
section 4942 shall, for all purposes other than the determination of the
minimum investment return under section 4942(j)(3)(B)(ii), for taxable
years:
(a) Beginning before January 1, 1972, apply without regard to
section 4942(e).
(b) Beginning in 1972, apply with an applicable percentage of 4\1/8\
percent,
(c) Beginning in 1973, apply with an applicable percentage of 4\3/8\
percent and
(d) Beginning in 1974, apply with an applicable percentage of 5\1/2\
percent.
(iii) Short taxable periods. In any case in which a taxable year
referred to in this subparagraph is a period less than 12 months, the
applicable percentage to be applied to the amount determined under the
provisions of subparagraph (1) of this paragraph shall be equal to the
applicable percentage for the calendar year in which the short taxable
period began multiplied by a fraction, the numerator of which is the
number of days in such short taxable period and the denominator of which
is 365.
(d) Adjusted net income--(1) Definition. For purposes of paragraph
(b) of this section, the term ``adjusted net income'' means the excess
(if any) of:
(i) The gross income for the taxable year (including gross income
from any unrelated trade or business) determined with the income
modifications provided by subparagraph (2) of this paragraph, over
(ii) The sum of the deductions (including deductions directly
connected with the carrying on of any unrelated trade or business),
determined with the deduction modifications provided by subparagraph (4)
of this paragraph, which would be allowed to a corporation subject to
the tax imposed by section 11 for the taxable year.
In computing the income includible under this paragraph as gross income
and the deductions allowable under this paragraph from such income, the
principles of subtitle A of the Code shall apply except to the extent
such principles conflict with section 4942 and the regulations
thereunder (without regard to this sentence). Except as otherwise
provided in this paragraph, no exclusions or deductions from gross
income or credits against tax are allowable under this paragraph. For
purposes of subdivision (i) of this subparagraph, the term ``gross
income'' does not include gifts, grants, or contributions received by
the private foundation but does include income from a functionally
related business (as defined in paragraph (c)(3)(iii) of this section).
(2) Income modifications. The income modifications referred to in
subparagraph (1)(i) of this paragraph are as follows:
[[Page 82]]
(i) Section 103 (relating to interest on certain governmental
obligations) shall not apply. Hence, interest which would have been
excluded from gross income by section 103 shall be included in gross
income.
(ii) Capital gains and losses from the sale or other disposition of
property shall be taken into account only in an amount equal to any net
short-term capital gain (as defined in section 1222(5)) for the taxable
year. Long-term capital gain or loss is not included in the computation
of adjusted net income. Similarly, net section 1231 gains shall be
excluded from the computation of adjusted net income. However, net
section 1231 losses shall be included in the computation of adjusted net
income, if such losses are otherwise described in subparagraph (1)(ii)
of this paragraph. Any net short-term capital loss for a given taxable
year shall not be taken into account in computing adjusted net income
for such year or in computing net short-term capital gain for purposes
of determining adjusted net income for prior or future taxable years
regardless of whether the foundation is a corporation or a trust.
(iii) The following amounts shall be included in gross income for
the taxable year:
(a) Amounts received or accrued as repayments of amounts which were
taken into account as a qualifying distribution within the meaning of
paragraph (a)(2)(i) of Sec. 53.4942(a)-3 for any taxable year;
(b) Notwithstanding subdivision (ii) of this subparagraph, gross
amounts received or accrued from the sale or other disposition of
property to the extent that the acquisition of such property was taken
into account as a qualifying distribution (within the meaning of
paragraph (a)(2)(ii) of Sec. 53.4942(a)-3) for any taxable year; and
(c) Any amount set aside under paragraph (b) of Sec. 53.4942(a)-3
to the extent it is determined that such amount is not necessary for the
purposes for which it was set aside.
(iv) Any distribution received by a private foundation from a
disqualified person in redemption of stock held by such private
foundation in a business enterprise shall be treated as not essentially
equivalent to a dividend under section 302(b)(1) if all of the following
conditions are satisfied:
(a) Such redemption is of stock which was owned by a private
foundation on May 26, 1969 (or which is acquired by a private foundation
under the terms of a trust which was irrevocable on May 26, 1969, or
under the terms of a will executed on or before such date which are in
effect on such date and at all times thereafter);
(b) Such foundation is required to dispose of such property in order
not to be liable for tax under section 4943 (relating to taxes on excess
business holdings) applied, in the case of a disposition before January
1, 1975, without taking section 4943(c)(4) into account; and
(c) Such foundation receives in return an amount which equals or
exceeds the fair market value of such property at the time of such
disposition or at the time a contract for such disposition was
previously executed in a transaction which would not constitute a
prohibited transaction (within the meaning of section 503(b) or the
corresponding provisions of prior law).
(v) If, as of the date of distribution of property for purposes
described in section 170(c) (1) or (2)(B), the fair market value of such
property exceeds its adjusted basis, such excess shall not be deemed an
amount includible in gross income.
(vi) The income received by a private foundation from an estate
during the period of administration of such estate shall not be included
in such foundation's gross income, unless, due to a prolonged period of
administration, such estate is considered terminated for Federal income
tax purposes by operation of paragraph (a) of Sec. 1.641(b)-3 of this
chapter (Income Tax Regulations).
(vii) Distributions received by a private foundation from a trust
created and funded by another person shall not be included in the
foundation's gross income. However, with respect to distributions from
certain trusts described in section 4947(a)(2), see paragraph (b)(2) of
this section.
(viii) Gross income shall include all amounts derived from, or in
connection with, property held by the foundation, even though the fair
market value of such property may not be included in
[[Page 83]]
such foundation's assets for purposes of determining minimum investment
return by operation of paragraph (c)(3) of this section.
(ix) Gross income shall include amounts treated in a preceding
taxable year as a ``qualifying distribution'' by operation of paragraph
(c) of Sec. 53.4942(a)-3 where such amounts are not redistributed by
the close of the donee organization's succeeding taxable year in
accordance with the rules prescribed in such paragraph (c). In such
cases, such amounts shall be included in the donor foundation's gross
income for such foundation's first taxable year beginning after the
close of the donee organization's first taxable year following the donee
organization's taxable year of receipt.
(x) For taxable years ending after October 4, 1976, section
4942(f)(2)(D) states that section 483 (relating to imputed interest on
deferred payments) does not apply to payments made pursuant to a binding
contract entered into in a taxable year beginning before January 1,
1970. Amounts that are not treated as imputed interest because of
section 4942(f)(2)(D) and this subdivision will represent gain or loss
from the sale of property. If the gain or loss is long term capital gain
or loss, section 4942(f)(2)(B) excludes the gain or loss from the
computation of the foundation's gross income. If, in a taxable year
beginning after December 31, 1969, there is a substantial change in the
terms of a contract entered into in a taxable year beginning before
January 1, 1970, then any payment made pursuant to the changed contract
is not considered a payment made pursuant to a contract entered into in
a taxable year beginning before January 1, 1970. Whether or not a change
in the terms of a contract (for example, a change relating to time of
payment, sales price, or obligations under the contract) is a
substantial change is determined by applying the rules under section 483
and Sec. 1.483-1(b)(4). As used in this subdivision, a binding contract
includes an irrevocable written option.
(3) Adjusted basis--(i) In general. For purposes of subparagraph
(2)(ii) of this paragraph, the adjusted basis for purposes of
determining gain from the sale or other disposition of property shall be
determined in accordance with the rules set forth in subdivision (ii) of
this subparagraph and the adjusted basis for purposes of determining
loss from such disposition shall be determined in accordance with the
rules set forth in subdivision (iii) of this subparagraph. Further, the
provisions of this subparagraph do not apply for any purpose other than
for purposes of subparagraph (2)(ii) of this paragraph. For example, the
determination of gain pursuant to the provisions of section 341 is
determined without regard to this subparagraph.
(ii) Gain from sale or other disposition. The adjusted basis for
purposes of determining gain from the sale or other disposition of
property shall be the greater of:
(a) The fair market value of such property on December 31, 1969,
plus or minus all adjustments after December 31, 1969, and before the
date of sale or other disposition under the rules of Part II, Subchapter
O, Chapter 1 of the Code, provided that the property was held by the
private foundation on December 31, 1969, and continuously thereafter to
such date of sale or other disposition; or
(b) The adjusted basis as determined under the rules of Part II,
Subchapter O, Chapter 1 of the Code, subject to the provisions of
section 4940(c)(3)(B) and the regulations thereunder (and without regard
to section 362(c)). With respect to assets acquired prior to December
31, 1969, which were subject to depreciation or depletion, for purposes
of determining the adjustments to be made to basis between the date of
acquisition and December 31, 1969, and amount equal to straight-line
depreciation or cost depletion shall be taken into account. In addition,
in determining such adjustments to basis, if any other adjustments would
have been made during such period (such as a change in useful life based
upon additional data or a change in facts), such adjustments shall also
be taken into account.
(iii) Loss from sale or other disposition. For purposes of
determining loss from the sale or other disposition of property,
adjusted basis as determined in subdivision (ii)(b) of this subparagraph
shall apply.
[[Page 84]]
(iv) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. A private foundation, which uses the cash receipts and
disbursements method of accounting, purchased certain depreciable real
property on December 1, 1969. On December 31, 1969, the fair market
value of such property was $100,000 and its adjusted basis (determined
under the provisions of this subparagraph) was $102,000. The property
was sold on January 2, 1970, for $105,000. Because fair market value on
December 31, 1969, $100,000, is less than the adjusted basis as
determined by Part II, Subchapter O, Chapter 1 of the Code, $102,000, a
short-term gain of $3,000 is recognized (i.e., sale price of $105,000
less the greater of the two possible bases) for purposes of subparagraph
(2)(ii) of this paragraph.
Example 2. Assume the facts as stated in example (1), except that
the sale price was $95,000. Because the sale price was $7,000 less than
the adjusted basis for loss ($102,000 as determined by the application
of subdivision (iii) of this subparagraph), there is a capital loss of
$7,000 which may be deducted against short-term capital gains for 1970
(if any) in determining net short-term capital gain.
Example 3. A private foundation, which uses the cash receipts and
disbursements method of accounting, purchased unimproved land on
December 1, 1969. On December 31, 1969, the fair market value of such
property was $110,000 and its adjusted basis (determined under the
provisions of this subparagraph) was $102,000. The property was sold on
January 2, 1970, for $105,000. Since the fair market value on December
31, 1969, $110,000, exceeds the adjusted basis as determined by Part II,
Subchapter O, Chapter 1 of the Code, $102,000, such fair market value
will be used for purposes of determining gain. However, because the
adjusted basis for purposes of determining gain exceeds the sale price,
there is no gain. Furthermore, because the adjusted basis for purposes
of determining loss, $102,000, is less than sale price, there is no
loss.
(4) Deduction modifications--(i) In general. For purposes of
computing adjusted net income under subparagraph (1) of this paragraph,
no deduction shall be allowed other than all the ordinary and necessary
expenses paid or incurred for the production or collection of gross
income or for the management, conservation, or maintenance of property
held for the production of such income, except as provided in
subdivision (ii) of this subparagraph. Such expenses include that
portion of a private foundation's operating expenses which is paid or
incurred for the production or collection of gross income. Operating
expenses include compensation of officers, other salaries and wages of
employees, interest, rent, and taxes. Where only a portion of the
property produces (or is held for the production of) income subject to
the provisions of section 4942, and the remainder of the property is
used for charitable, educational, or other similar exempt purposes, the
deductions allowed by this subparagraph shall be apportioned between the
exempt and nonexempt uses. Similarly, where the deductions with respect
to property used for a charitable, educational, or other similar exempt
purpose exceed the income derived from such property, such excess shall
not be allowed as a deduction, but may be treated as a qualifying
distribution described in paragraph (a)(2)(ii) of Sec. 53.4942(a)-3.
Furthermore, this subdivision does not allow deductions which are not
paid or incurred for the purposes herein prescribed. Thus, for example,
the deductions prescribed by the following sections are not allowable:
(a) The charitable contributions deduction prescribed under sections 170
and 642(c); (b) the net operating loss deduction prescribed under
section 172; and (c) the special deductions prescribed under Part VIII,
Subchapter B, Chapter 1 of the Code.
(ii) Special rules. For purposes of computing adjusted net income
under subparagraph (1) of this paragraph: (a) The allowances for
depreciation and depletion as determined under section 4940(c)(3)(B) and
the regulations thereunder shall be taken into account, and (b) section
265 (relating to expenses and interest relating to tax-exempt interest)
shall not apply.
(e) Certain transitional rules--(1) In general. In the case of
organizations organized before May 27, 1969, section 4942 shall:
(i) Not apply to an organization to the extent its income is
required to be accumulated pursuant to the mandatory terms (as in effect
on May 26, 1969, and at all times thereafter) of an instrument executed
before May 27, 1969, with respect to the transfer of income producing
property to such organization, except that section 4942 shall
[[Page 85]]
apply to such organization if the organization would have been denied
exemption had section 504(a) not been repealed, or would have had its
deductions under section 642(c) limited had section 681(c) not been
repealed. In applying the preceding sentence, in addition to the
limitations contained in section 504(a) or 681(c) before its repeal,
section 504(a)(1) or 681(c)(1) shall be treated as not applying to an
organization to the extent its income is required to be accumulated
pursuant to the mandatory terms (as in effect on January 1, 1951, and at
all times thereafter) of an instrument executed before January 1, 1951,
with respect to the transfer of income producing property to such
organization before such date, if such transfer was irrevocable on such
date; and
(ii) Not apply to an organization which is prohibited by its
governing instrument or other instrument from distributing capital or
corpus to the extent the requirements of section 4942 are inconsistent
with such prohibitions.
(2) Certain existing organizations. For purposes of this section, an
organization will be deemed to be organized prior to May 26, 1969, if it
is either a testamentary trust created under the will of an individual
who died prior to such date or an inter visos trust which was in
existence and irrevocable prior to such date, even though it is not
funded until after May 26, 1969. Similarly, a split-interest trust, as
described in section 4947(a)(2) (without regard to section
4947(a)(2)(C)), which became irrevocable prior to May 27, 1969, and
which is treated as a private foundation under section 4947(a)(1)
subsequent to such date, likewise shall be treated as an organization
organized prior to such date. See section 507(b)(2) and the regulations
thereunder with respect to the applicability of transitional rules where
there has been a merger of two or more private foundations or a
reorganization of a private foundation.
(3) Limitation. With respect to taxable years beginning after
December 31, 1971, subparagraph (1) (i) and (ii) of this paragraph shall
apply only for taxable years during which there is pending any judicial
proceeding by the private foundation which is necessary to reform, or to
excuse such foundation from compliance with, its governing instrument or
any other instrument (as in effect on May 26, 1969) in order to comply
with the provisions of section 4942, and in the case of subparagraph
(1)(i) of this paragraph for all taxable years following the taxable
year in which such judicial proceeding is terminated during which the
governing instrument or any other instrument does not permit compliance
with such provisions. Thus, the exception described in subparagraph
(1)(ii) of this paragraph applies after 1971 only for taxable years
during which such judicial proceeding is pending. Accordingly, beginning
with the first taxable year following the taxable year in which such
judicial proceeding is terminated, such foundation will be required to
meet the requirements of section 4942 and the regulations thereunder
(and be subject to the taxes provided upon failure to do so) except to
the extent such foundation is required to accumulate income as described
in subparagraph (1)(i) of this paragraph, even if the governing
instrument continues to prohibit invasion of capital or corpus. In any
case where a foundation's governing instrument or any other instrument
requires accumulation of income as described in subparagraph (1)(i) of
this paragraph beginning with the first taxable year following the
taxable year in which such judicial proceeding is terminated, the
distributable amount (as defined in paragraph (b) of this section) for
such foundation shall be reduced by the amount of the income required to
be accumulated. Therefore, if the foundation's adjusted net income for
any taxable year equals or exceeds its minimum investment return for
such year, the accumulation provisions will be given full effect.
However, if the minimum investment return exceeds the adjusted net
income for any taxable year, the foundation will be required to
distribute such excess for such year. For purposes of this paragraph, a
judicial proceeding will be treated as pending only if the foundation is
diligently pursuing its judicial remedies and there is no unreasonable
delay in such proceeding for which the private foundation is
responsible.
[[Page 86]]
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. X, a private foundation organized in 1930, is required by
the mandatory terms of its governing instrument to accumulated 25
percent of its adjusted net income and to add such accumulations to
corpus. The instrument also prohibits distribution of corpus for any
purpose. On July 13, 1971, X instituted an action in the appropriate
State court to reform the instrument by deleting the accumulation and
corpus provisions described above. If the court's final order reforms
the accumulation provisions to allow distributions of income sufficient
to avoid the imposition of a tax under section 4942, then section 4942
applies to X, regardless of the court's action with respect to the
corpus provisions. However, if the court rules that the accumulation
provision may not be reformed, section 4942 applies to X only to the
extent provided for in subparagraph (3) of this paragraph, regardless of
the court's action with respect to the corpus provision.
Example 2. Private foundation Y was created by the will of A who
died in 1940. Y's governing instrument requires that 40 percent of Y's
adjusted net income be added to corpus each year. In an action commenced
prior to December 31, 1971, a court of competent jurisdiction rules that
this accumulation provisions must be complied with. In Y's succeeding
taxable year its adjusted net income is $120,000, and its minimum
investment return is $140,000. Thus, Y is required to accumulated
$48,000 (40 percent of $120,000) and shall be allowed to do so.
Therefore, Y's distributable amount for such taxable year shall be the
greater of its adjusted net income ($120,000) or its minimum investment
return ($140,000), reduced by the amount of the income required to be
accumulated ($48,000) and the taxes imposed by Subtitle A of the Code
and section 4940 and increased by any trust distributions described in
paragraph (b)(2) of this section. Accordingly, Y's distributable amount
for such taxable year is $92,000 ($140,000 reduced by $48,000), before
other adjustments. If Y's minimum investment return had been $120,000
instead of $140,000, its distributable amount for such taxable year
would have been $72,000 ($120,000 reduced by $48,000), before other
adjustments. Similarly, if Y's minimum investment return had been
$100,000 instead of $140,000, its distributable amount for such taxable
year would also have been $72,000, before other adjustments.
[T.D. 7256, 38 FR 3317, Feb. 5, 1973; 38 FR 4577, Feb. 16, 1973, as
amended by T.D. 7486, 42 FR 24265, May 13, 1977; TD 7594, 44 FR 7138,
Feb. 6, 1979; T.D. 7610, 44 FR 21644, Apr. 11, 1979; T.D. 7715, 45 FR
56803, Aug. 26, 1980; T.D. 7849, 47 FR 50857, Nov. 10, 1982; T.D. 7878,
48 FR 11943, Mar. 22, 1983]
Sec. 53.4942(a)-3 Qualifying distributions defined.
(a) In general--(1) Distributions generally. For purposes of section
4942 and the regulations thereunder, the amount of a qualifying
distribution of property (as defined in subparagraph (2) of this
paragraph) is the fair market value of such property as of the date such
qualifying distribution is made. The amount of an organization's
qualifying distributions will be determined solely on the cash receipts
and disbursements method of accounting described in section 446(c)(1).
(2) Definition. The term qualifying distribution means:
(i) Any amount (including program-related investments, as defined in
section 4944(c), and reasonable and necessary administrative expenses)
paid to accomplish one or more purposes described in section 170(c) (1)
or (2)(B), other than any contribution to:
(a) A private foundation which is not an operating foundation (as
defined in section 4942(j)(3)), except as provided in paragraph (c) of
this section, or
(b) An organization controlled (directly or indirectly) by the
contributing private foundation or one or more disqualified persons with
respect to such foundation, except as provided in paragraph (c) of this
section;
(ii) Any amount paid to acquire an asset used (or held for use)
directly in carrying out one or more purposes described in section
170(c) (1) or (2)(B). See paragraph (c)(3) of Sec. 53.4942(a)-2 for the
definition of used (or held for use); or
(iii) Any amount set aside within the meaning of paragraph (b) of
this section.
(3) Control. For purposes of subparagraph (2)(i)(b) of this
paragraph, an organization is ``controlled'' by a foundation or one or
more disqualified persons with respect to the foundation if
[[Page 87]]
any of such persons may, by aggregating their votes or positions of
authority, require the donee organization to make an expenditure, or
prevent the donee organization from making an expenditure, regardless of
the method by which the control is exercised or exercisable. ``Control''
of a donee organization is determined without regard to any conditions
imposed upon the donee as part of the distribution or any other
restrictions accompanying the distribution as to the manner in which the
distribution is to be used, unless such conditions or restrictions are
described in paragraph (a)(8) of Sec. 1.507-2 of this chapter (Income
Tax Regulations). In general, it is the donee, not the distribution,
which must be ``controlled'' by the distributing private foundation for
the provisions of subparagraph (2)(i)(b) of this paragraph to apply.
Thus, the furnishing of support to an organization and the consequent
imposition of budgetary procedures upon that organization with respect
to such support shall not in itself be treated as subjecting that
organization to the distributing foundation's control within the meaning
of this subparagraph. Such ``budgetary procedures'' include expenditure
responsibility requirements under section 4945(d)(4). The ``controlled''
organization need not be a private foundation; it may be any type of
exempt or nonexempt organization including a school, hospital, operating
foundation, or social welfare organization.
(4) Borrowed funds--(i) In general. For purposes of this paragraph,
if a private foundation borrows money in a particular taxable year to
make expenditures for a specific charitable educational, or other
similar purpose, a qualifying distribution out of such borrowed funds
will, except as otherwise provided in subdivision (ii) of this
subparagraph, be deemed to have been made only at the time that such
borrowed funds are actually distributed for such exempt purpose.
(ii) Funds borrowed before 1970. (a) If a private foundation has
borrowed money in a taxable year beginning before January 1, 1970, or
subsequently borrows money pursuant to a written commitment which was
binding as of the last day of such taxable year, to make expenditures
for a specific charitable, educational, or other similar exempt purpose,
if such borrowed funds are in fact expended for such purpose in any
taxable year, and if such loan is thereafter repaid, in whole or in
part, in a taxable year beginning after December 31, 1969, then, at the
election of the foundation as provided in subdivision (ii)(b) of this
subparagraph, a qualifying distribution will be deemed to have been made
at such time or times that such loan principal is so repaid rather than
at the earlier time that the borrowed funds were actually distributed
for such exempt purpose.
(b) The election described in subdivision (ii)(a) of this
subparagraph is to be made by attaching a statement to the form the
private foundation is required to file under section 6033 for the first
taxable year beginning after December 31, 1969, in which a repayment of
loan principal is made. Such statement shall be made a part of such form
and shall be attached to such form in each succeeding taxable year in
which any repayment of loan principal is made. The statement shall set
forth the name and address of the lender, the amount borrowed, the
specific use made of such borrowed funds, and the private foundation's
election to treat repayments of loan principal as qualifying
distributions.
(iii) Interest. Any payment of interest with respect to a loan
described in subdivision (i) or (ii) of this subparagraph shall be
treated as a deduction under paragraph (d)(1)(ii) of Sec. 53.4942(a)-2
in the taxable year in which it is made.
(5) Changes in use of an asset. If an asset not used (or held for
use) directly in carrying out one or more purposes described in section
170(c) (1) or (2)(B) is subsequently converted to such a use, the
foundation may treat such conversion as a qualifying distribution. The
amount of such qualifying distribution shall be the fair market value of
the converted asset as of the date of its conversion. For purposes of
the preceding sentence, fair market value shall be determined by making
a valuation of the converted asset as of the date of its conversion in
accordance with the rules set forth in paragraph (c)(4) of Sec.
53.4942(a)-2.
[[Page 88]]
(6) Certain foreign organizations--(i) In general. Distributions for
purposes described in section 170(c)(2)(B) to a foreign organization,
which has not received a ruling or determination letter that it is an
organization described in section 509(a) (1), (2), or (3) or 4942(j)(3),
will be treated as a distribution made to an organization described in
section 509(a) (1), (2), or (3) or 4942(j)(3) if the distributing
foundation has made a good faith determination that the donee
organization is an organization described in section 509(a) (1), (2), or
(3) or 4942(j)(3). Such a ``good faith determination'' ordinarily will
be considered as made where the determination is based on an affidavit
of the donee organization or an opinion of counsel (of the distributing
foundation or the donee organization) that the donee is an organization
described in section 509(a) (1), (2), or (3) or 4942(j)(3). Such an
affidavit or opinion must set forth sufficient facts concerning the
operations and support of the donee organization for the Internal
Revenue Service to determine that the donee organization would be likely
to qualify as an organization described in section 509(a) (1), (2), or
(3) or 4942(j)(3).
(ii) Definition. For purposes of this subparagraph, the term foreign
organization means any organization which is not described in section
170(c)(2)(A).
(7) Payment of tax. The payment of any tax imposed under chapter 42
of the Code shall not be treated as a qualifying distribution.
(8) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. M, a private foundation which uses the calendar year as
the taxable year, makes the following payments in 1970: (i) a payment of
$44,000 to five employees for conducting a foundation program of
educational grants for research and study; (ii) $20,000 for various
items of overhead, 10 percent of which is attributable to the activities
of the employees mentioned in payment (i) of this example and the other
90 percent of which is attributable to administrative expenses which
were not paid to accomplish any section 170(c) (1) or (2)(B) purpose;
and (iii) a $100,000 general purpose grant paid to an educational
institution described in section 170(b)(1)(A)(ii) which is not
controlled by M or any disqualified persons with respect to M. Payments
(i) and (ii) of this example are qualifying distributions to the extent
of $46,000 ($44,000 of salaries and 10 percent of the overhead, both of
which are reasonable administrative expenses paid to accomplish section
170(c) (1) or (2)(B) purposes). Payment (iii) of this example is also a
qualifying distribution, since it is a contribution for section
170(c)(2)(B) purposes to an organization which is not described in
subparagraph (2)(i) (a) or (b) of this paragraph. The other 90 percent
of payment (ii) of this example may constitute items of deduction under
paragraph (d)(1)(ii) of Sec. 53.4942(a)-2 if such items otherwise
qualify under such paragraph.
Example 2. On February 21, 1972, N, a private foundation which uses
the calendar year as the taxable year, pays $500,000 for real property
on which it plans to build hospital facilities to be used for medical
care and education. The real property produces no income and the
hospital facilities will not be constructed until 1974 according to the
setaside plan submitted to and approved by the Commissioner pursuant to
paragraph (b) of this section. The purchase of the land is a qualifying
distribution under subparagraph (2)(ii) of this paragraph. If, however,
the property used were to produce rental income for more than a
reasonable period of time before construction of the hospital is begun,
then as of the time such rental use becomes unreasonable (i) such
purchase would no longer constitute a qualifying distribution under
subparagraph (2)(ii) of this paragraph, and (ii) the amount of the
qualifying distribution would be included in N's gross income. See
paragraphs (c)(3)(i) and (d)(2)(iii)(b) of Sec. 53.4942(a)-2.
Example 3. In 1971, X, a private foundation engaged in holding
paintings and exhibiting them to the public, purchases an additional
building to be used to exhibit the paintings. Such expenditure is a
qualifying distribution under subparagraph (2)(ii) of this paragraph. In
1975, X sells the building. Under paragraph (d)(2)(iii)(b) of Sec.
53.4942(a)-2, all of the proceeds of the sale (less direct costs of the
sale) are included in X's adjusted net income for 1975.
Example 4. In January 1969, M, a private foundation which uses the
calendar year as the taxable year, borrows $10 million to give to N, a
private college, for the construction of a science center. M borrowed
the money from X, a commercial bank. M is to repay X at the rate of $1.1
million per year ($1 million principal and $0.1 million interest) for 10
years, beginning in January, 1973. M distributed $5 million of the
borrowed funds to N in February 1969 and the other $5 million in March
1970. M files a statement with the form it is required to file under
section 6033 for 1973 which contains the information required by
subparagraph (4)(ii)(b) of this paragraph. Pursuant to M's election,
each repayment of loan principal constitutes a qualifying distribution
in the year of repayment. Accordingly, the distribution of $5 million to
[[Page 89]]
N in March 1970 will not be treated as a qualifying distribution. Each
payment of interest ($0.1 million annually) with respect to M's loan
from X is treated as a deduction under paragraph (d)(1)(ii) of Sec.
53.4942(a)-2 in the taxable year in which it is made.
Example 5. Private foundation Y engages in providing care for the
aged. Y makes a distribution of cash to H, a hospital described in
section 170(b)(1)(A)(iii) which is not controlled by Y or any
disqualified person with respect to Y. The distribution is made subject
to the conditions that H will invest the money as a separate fund which
will bear a name commemorating the creator of Y and will use the income
from such fund only for H's exempt hospital purposes which relate to
care for the aged. Under these circumstances, the distribution from Y to
H is a qualifying distribution pursuant to subparagraph (2)(i) of this
paragraph.
(b) Certain set-asides--(1) In general. An amount set aside for a
specific project that is for one or more of the purposes described in
section 170(c) (1) or (2)(B) may be treated as a qualifying distribution
in the year in which set aside (but not in the year in which actually
paid), if the requirements of section 4942(g)(2) and this paragraph (b)
are satisfied. The requirements of this paragraph (b) are satisfied if
the private foundation establishes to the satisfaction of the
Commissioner that the amount set aside will be paid for the specific
project within 60 months after it is set aside, and
(i) The set-aside satisfies the suitability test described in
subparagraph (2) of this paragraph, or
(ii) With respect to a set-aside made in a taxable year beginning
after December 31, 1974, the private foundation satisfies the cash
distribution test described in subparagraph (3) of this paragraph.
If the suitability test or cash distribution test is otherwise
satisfied, the 60 month period for paying the amount set aside may, for
good cause shown, be extended by the Commissioner.
(2) Suitability test. The suitability test is satisfied if the
private foundation establishes to the satisfaction of the Commissioner
that the specific project for which the amount is set aside is one that
can be better accomplished by the set-aside than by the immediate
payment of funds. Specific projects that can be better accomplished by
the use of a set-aside include, but are not limited to, projects in
which relatively long-term grants or expenditures must be made in order
to assure the continuity of particular charitable projects or program-
related investments (as defined in section 4944(c)) or where grants are
made as part of a matching-grant program. Such projects include, for
example, a plan to erect a building to house the direct charitable,
educational, or other similar exempt activity of the private foundation
(such as a museum building in which paintings are to be hung), even
though the exact location and architectural plans have not been
finalized; a plan to purchase an additional group of paintings offered
for sale only as a unit that requires an expenditure of more than one
year's income; or a plan to fund a specific research program that is of
such magnitude as to require an accumulation of funds before beginning
the research, even though not all of the details of the program have
been finalized.
(3) Cash distribution test; in general. The cash distribution test
is satisfied if:
(i) The specific project for which the amount is set aside will not
be completed before the end of the taxable year in which the set-aside
is made,
(ii) The private foundation actually distributes, in cash or its
equivalent and for one or more of the purposes described in section
170(c) (1) or (2)(B), the ``start-up period minimum amount'' described
in subparagraph (4) of this paragraph during the private foundation's
start-up period, and
(iii) The private foundation actually distributes, in cash or its
equivalent and for one or more of the purposes described in section
170(c) (1) or (2)(B), the ``full-payment period minimum amount''
described in subparagraph (5) of this paragraph in each taxable year of
the private foundation's full-payment period.
For purposes of the cash distribution test, an amount set aside will be
treated as distributed in the year in which actually paid and not in the
year in which set aside.
(4) Minimum distribution required during start-up period--(i) Start-
up period. For private foundations created before January 1, 1972, the
start-up period is
[[Page 90]]
the four taxable years immediately preceding the taxable year beginning
in calendar year 1976. For private foundations created after December
31, 1971 (or for organizations that first become private foundations
after that date), the start-up period is the four taxable years
following the taxable year in which the private foundation was created
(or otherwise became a private foundation). For purposes of this
subparagraph (4), a private foundation will be considered ``created'' in
the taxable year in which the private foundation's distributable amount
(as determined under section 4942(d)) first exceeds $500.
(ii) Start-up period minimum amount. The amount that a private
foundation must actually distribute in cash or its equivalent during the
private foundation's start-up period is not less than the sum of:
(a) Twenty percent of the private foundation's distributable amount
(as determined under section 4942(d)) for the first taxable year of the
start-up period,
(b) Forty percent of the private foundation's distributable amount
for the second taxable year of the start-up period,
(c) Sixty percent of the private foundation's distributable amount
for the third taxable year of the start-up period, and
(d) Eighty percent of the private foundation's distributable amount
for the fourth taxable year of the start-up period.
(iii) Timing of distributions. The requirement that a private
foundation distribute the start-up period minimum amount during the
start-up period is a requirement that such amount be distributed before
the end of the start-up period, and is not a requirement that any
portion of such amount be distributed in any one taxable year of the
start-up period.
(iv) Distribution actually made during start-up period. In general,
only a distribution actually made during the start-up period is taken
into account in determining whether a private foundation has distributed
the start-up period minimum amount. However, in the case of a private
foundation created after December 31, 1971 (or an organization that
first became a private foundation after that date), a distribution
actually made during the taxable year in which the foundation was
created (the year immediately preceding the first taxable year of the
private foundation's start-up period) may be treated as a distribution
actually made during the start-up period. In addition, a distribution
actually made by a private foundation within 5\1/2\ months after the end
of the start-up period will be treated as a distribution actually made
during the start-up period if:
(a) The private foundation was unable to determine the distributable
amount for the fourth taxable year of the start-up period until after
the end of such period, and
(b) The private foundation actually made distributions prior to the
end of the start-up period based upon a reasonable estimate of the
private foundation's distributable amount for the fourth taxable year of
the start-up period.
(v) Examples. The provisions of this subparagraph (4) may be
illustrated by the following examples:
Example 1. F, a private foundation created on January 1, 1975, uses
the calendar year as its taxable year. The start-up period for F is
January 1, 1976 through December 31, 1979. F has distributable amounts
under section 4942(d) for taxable years 1976 through 1979 in the
following amounts: 1976, $100,000; 1977, $120,000; 1978, $150,000; 1979,
$200,000. F's start-up period minimum amount is the sum of the following
amounts: 20% of $100,000 ($20,000); 40% of $120,000 ($48,000); 60% of
$150,000 ($90,000); and 80% of $200,000 ($160,000); which equals
$318,000. Thus F is required to actually distribute at least $318,000 in
cash or its equivalent during the start-up period.
Example 2. F, a private foundation created in 1969, uses the
calendar year as its taxable year. F's start-up period is the calendar
years 1972 through 1975. F makes two cash distributions in 1972. The
first distribution is made on account of a set-aside made in 1969. Under
section 4942(g), that distribution is treated as a qualifying
distribution made in 1969. The second distribution is treated under
section 4942(h) has made out of F's undistributed income for 1971. In
addition, F makes a cash distribution in 1976 that is treated under
section 4942(h) as made out of F's undistributed income for 1975. In
determining whether F has distributed its start-up period minimum amount
within the start-up period, the 1972 distributions are both taken into
account because they were actually made during F's start-up period. The
1976 distribution is not taken into account, however, because
[[Page 91]]
that distribution was not actually made during F's start-up period.
(5) Minimum distribution required during full-payment period--(i)
Full-payment period. A private foundation's full-payment period includes
each taxable year that begins after the end of the private foundation's
start-up period.
(ii) Full-payment period minimum amount. The amount that a private
foundation must actually distribute in cash or its equivalent in a
taxable year of the private foundation's full-payment period is not less
than 100 percent of the private foundation's distributable amount
determined under section 4942(d) (without regard to section 4942(i))
with respect to the taxable year.
(iii) Carryover of distributions in excess of full-payment period
minimum amount. If, in a taxable year beginning after December 31, 1975,
a private foundation distributes an amount in excess of the full-payment
period minimum amount for the taxable year, the excess shall be used to
reduce the full-payment period minimum amount in the taxable years in
the adjustment period. The amount of the excess distribution used to
reduce the full-payment period minimum amount in each successive taxable
year of the adjustment period shall be equal to the amount of such
excess less the sum of the full-payment period minimum amounts for all
prior taxable years in the adjustment period to which the excess was
previously applied. The taxable years in the adjustment period are the
five taxable years immediately following the taxable year in which the
excess distribution is made. Any distribution in excess of the full-
payment period minimum amount made during a taxable year of the
adjustment period shall not be taken into account under this
subparagraph (iii) until any earlier excess has been completely applied
against full-payment period minimum amounts during its adjustment
period.
(iv) Distributions actually made during a taxable year. Except as
described in subdivision (ii) of subparagraph (6), only a distribution
actually made during a taxable year of the full-payment period is taken
into account in determining whether a private foundation has distributed
the full-payment period minimum amount for such year.
(v) Examples. The provisions of this subparagraph (5) may be
illustrated by the following examples:
Example 1. F, a private foundation created on January 1, 1973, uses
the calendar year as its taxable year. F has a start-up period of
January 1, 1974, through December 31, 1977, and a full-payment period
that includes every taxable year beginning after December 31, 1977. F's
distributable amount (as determined under section 4942(d)) for 1978 is
$500,000. Thus, F's full-payment period minimum amount for 1978 is
$500,000. During 1978 F distributes $100,000 in cash to Charity X and
$400,000 in cash to Charity Y on account of a set-aside made in 1973. F
has distributed its full-payment period minimum amount for 1978 because
it has made actual cash distributions during that year which total
$500,000. However, F has made qualifying distributions (as determined
under section 4942(g)) with respect to 1978 of only $100,000. In order
to avoid liability for the tax on undistributed income under section
4942(a), F must distribute or set aside an additional $400,000 before
January 1, 1980.
Example 2. Assume the facts as stated in Example (1) except that in
1978 F makes cash distributions totaling $600,000. Since the total cash
distributions made in 1978 ($600,000) exceed the full-payment period
minimum amount for 1978 ($500,000), there exists a $100,000 excess which
must be used by F to reduce its full-payment period minimum amounts for
the years 1979-1983 (the taxable years in the adjustment period with
respect to the 1978 excess). Therefore, if F's distributable amount (as
determined under section 4942(d)) for 1979 is $500,000, F's full-payment
period minimum amount for 1979 is $400,000 ($500,000-$100,000).
(6) Failure to distribute minimum amounts--(i) In general. If a
private foundation fails to actually distribute the start-up period
minimum amount during the start-up period or, except as described in
subdivision (ii) of this subparagraph (6), if a private foundation fails
to actually distribute the full-payment period minimum amount during a
taxable year of the full-payment period, then any set-aside made by the
private foundation during the start-up period (if the failure relates to
the start-up period) or during the taxable year (if the failure relates
to the full-payment period) that was not approved by the Commissioner
under the suitability test described in subparagraph (2) of this
paragraph will not be treated
[[Page 92]]
as a qualifying distribution. Further, any set-aside made after the year
of such a failure to so distribute a minimum amount will be treated as a
qualifying distribution only if the Commissioner approves the set-aside
under the suitability test. In any case in which a set-aside ceases to
be treated as a qualifying distribution as a result of a failure to
distribute the full-payment period minimum amount, a private foundation
may be assessed a deficiency under section 4942(a) within the period
described in section 6501(n)(3).
(ii) Correction of certain failures to distribute. If a private
foundation's failure to distribute the full-payment period minimum
amount during a taxable year of the full-payment period was not willful
and was due to reasonable cause, the private foundation may correct the
failure to so distribute. Correction will be achieved if the private
foundation distributes within the correction period cash or its
equivalent in an amount not less than the difference between the full-
payment period minimum amount for the taxable year and the amount
actually distributed during the taxable year. The correction period is
the correction period as defined in section 4962(e), determined with
respect to the earliest occurring taxable event (as defined in section
4962(e)(2)(A)) that would result if the failure to distribute a full-
payment period minimum amount were not corrected. The additional
distribution will be treated for purposes of subparagraph (5) of this
paragraph as made during the taxable year with respect to which the
failure occurred. If a private foundation fails to distribute the full-
payment period minimum amount during a taxable year of the full-payment
period because such amount can be determined only after the end of the
taxable year, no ``willful failure to distribute'' the full-payment
period minimum amount will occur if the private foundation makes an
additional distribution within 5\1/2\ months after the end of the
taxable year.
(7) Approval and information requirements--(i) Suitability test. If
an amount is set aside under the suitability test of section
4942(g)(2)(B)(i) and subparagraph (2) of this paragraph, the private
foundation must apply for the Commissioner's approval of the set-aside
before the end of the taxable year in which the amount is set aside. The
Commissioner will either approve or disapprove the set-aside in writing.
An otherwise proper set-aside will not be treated as a qualifying
distribution under this paragraph (b) with respect to a taxable year if
the Commissioner's approval is not sought before the end of the taxable
year in which the amount is actually set aside. To obtain approval by
the Commissioner for a set-aside under the suitability test, the private
foundation must write to Commissioner of Internal Revenue, Attention:
OP:E:EO:T, 1111 Constitution Avenue, NW., Washington, DC 20224, and
include:
(a) A statement describing the nature and purposes of the specific
project and the amount of the set-aside for which approval is requested;
(b) A statement describing the amounts and approximate dates of any
planned additions to the set-aside after its initial establishment;
(c) A statement of the reasons why the project can be better
accomplished by a set-aside than by the immediate payment of funds;
(d) A detailed description of the project, including estimated
costs, sources of any future funds expected to be used for completion of
the project, and the location or locations (general or specific) of any
physical facilities to be acquired or constructed as part of the
project; and
(e) A statement by an appropriate foundation manager (as defined in
section 4946(b)) that the amounts to be set aside will actually be paid
for the specific project within a specified period of time that ends not
more than 60 months after the date of the first set-aside, or a
statement showing good cause why the period for paying the amount set
aside should be extended (including a showing that the proposed project
could not be divided into two or more projects covering periods of no
more than 60 months each) and setting forth the extension of time
required.
(ii) Cash distribution test. If an amount is set aside under the
cash distribution test of section 4942(g)(2)(B)(ii) and subparagraphs
(3), (4), and (5) of this paragraph, then for taxable years
[[Page 93]]
ending after April 2, 1984, the private foundation must submit an
attachment with the return required by section 6033 for the taxable year
in which the amount is set aside and for certain subsequent taxable
years. For the taxable year in which the amount is set aside the
attachment must include:
(a) A statement describing the nature and purposes of the specific
project for which amounts are to be set aside;
(b) A statement that the amounts set aside for the specific project
will actually be paid for the specific project within a specified period
of time that ends not more than 60 months after the date of the set-
aside;
(c) A statement that the project will not be completed before the
end of the taxable year of the private foundation in which the set-aside
is made;
(d) A statement showing the distributable amounts determined under
section 4942(d) for any past taxable years in the private foundation's
start-up and full-payment periods; and
(e) A statement showing the aggregate amount of actual payments made
in cash or its equivalent, for purposes described in section 170(c) (1)
or (2)(B), during each taxable year in the private foundation's start-up
and full-payment periods. This statement should include a detailed
description of any payments that are to be treated, pursuant to the
rules of subparagraphs (4)(iv) and (6)(ii) of this paragraph (b), as
distributed during a taxable year prior to the taxable year in which
such payments were actually made and, in addition, should explain the
circumstances that justify the application of those rules.
For the five taxable years following the taxable year in which the
amount is set aside (or, if longer, for each taxable year in the
extended period for paying the amount set aside), the attachment must
include the statements required by (d) and (e) of this subdivision (ii).
The submission of the statement required by (b) of this subdivision (ii)
will satisfy the requirement of section 4942(g)(2)(B) and subparagraph
(1) of this paragraph (b) that the private foundation establish to the
satisfaction of the Commissioner that the amount set aside will be paid
for the specific project within 60 months after it is set aside.
(8) Evidence of set-aside. A set-aside that is approved by the
Commissioner or which satisfies the cash distribution test shall be
evidenced by the entry of a dollar amount on the books and records of a
private foundation as a pledge or obligation to be paid at a future date
or dates. Any amount which is set aside shall be taken into account for
purposes of determining the private foundation's minimum investment
return under Sec. 53.4942(a)-2 (c)(1), and any income attributable to
such set-aside shall be taken into account in computing adjusted net
income under Sec. 53.4942(a)-2(d).
(9) Contingent set-aside. In the event a private foundation is
involved in litigation and may not distribute assets or income because
of a court order, the private foundation may (except as provided in
Sec. 53.4942(a)-2 (e)(1)(i) or (ii)) seek and obtain a set-aside for a
purpose described in Sec. 53.4942(a)-3 (a)(2). The amount to be set
aside shall be equal to that portion of the private foundation's
distributable amount which is attributable to the assets or income that
are held pursuant to court order and which, but for the court order
precluding the distribution of such assets or income, would have been
distributed. In the event that the litigation encompasses more than one
taxable year, the private foundation may seek additional contingent set-
asides. Such amounts must actually be distributed by the last day of the
taxable year following the taxable year in which the litigation is
terminated. Amounts not distributed by the close of the appropriate
taxable year shall be treated as described in Sec. 53.4942(a)-2
(d)(2)(iii)(c) for the succeeding taxable year.
(c) Certain contributions to section 501(c)(3) organizations--(1) In
general. For purposes of this section, the term ``qualifying
distribution'' includes (in the year in which it is paid) a contribution
to an exempt organization described in section 501(c)(3) and described
in paragraph (a)(2)(i) (a) or (b) of this section if:
(i) Not later than the close of the first taxable year after the
donee organization's taxable year in which such contribution is
received, such donee organization makes a distribution equal
[[Page 94]]
to the full amount of such contribution and such distribution is a
qualifying distribution (within the meaning of paragraph (a) of this
section, without regard to this paragraph) which is treated under
paragraph (d) of this section as a distribution out of corpus (or would
be so treated if such section 501(c)(3) organization were a private
foundation which is not an operating foundation); and
(ii) The private foundation making the contribution obtains adequate
records or other sufficient evidence from such donee organization (such
as a statement by an appropriate officer, director, or trustee of such
donee organization) showing (except as otherwise provided in this
subparagraph) (a) that the qualifying distribution described in
subdivision (i) of this subparagraph has been made by such organization,
(b) the names and addresses of the recipients of such distribution and
the amount received by each, and (c) that the distribution is treated as
a distribution out of corpus under paragraph (d) of this section (or
would be so treated if the donee organization were a private foundation
which is not an operating foundation). Where a distribution is for an
administrative expense which is part of a section 170(c) (1) or (2)(B)
expenditure or is part of another section 170(c) (1) or (2)(B)
expenditure that cannot reasonably be separately accounted for, the
provisions of subdivision (ii) of this subparagraph may be satisfied by
the submission by the donee organization of a statement setting forth
the general purpose for which such expenditure was made and that the
amount was distributed as a qualifying distribution described in
subdivision (ii)(c) of this subparagraph.
(2) Distribution requirements. (i) In order for a donee organization
to meet the distribution requirements of subparagraph (1)(i) of this
paragraph, it must, not later than the close of the first taxable year
after its taxable year in which any contributions are received,
distribute (within the meaning of this subparagraph) an amount equal in
value to the contributions received in such prior taxable year and have
no remaining undistributed income for such prior taxable year. In the
event that a donee organization redistributes less than an amount equal
to the total contributions from donor organizations which are required
to be redistributed by such donee organization by the close of the first
taxable year following the taxable year in which such contributions were
received, amounts treated as redistributions of such contributions shall
be deemed to have been made pro rata out of all such contributions
regardless of any earmarking or identification made by such donee
organization with respect to the source of such distributions. See
paragraph (d)(2)(ix) of Sec. 53.4942(a)-2 for the treatment of amounts
deemed not to have been so redistributed. For purposes of this
paragraph, the term contributions means all contributions, whether of
cash or property, and the fair market value of contributed property
determined as of the date of the contribution must be used in
determining whether an amount equal in value to the contributions
received has been redistributed.
(ii) For purposes of this paragraph, the characterization of
qualifying distributions made during the taxable year (i.e., whether out
of the prior year's undistributed income, the current year's
undistributed income, or corpus) is to be made as of the close of the
taxable year in question, except to the extent that a different
characterization is effected by means of the election provided for by
paragraph (d)(2) of this section or by subdivision (iv) of this
subparagraph. Once it is determined that a qualifying distribution is
attributable to corpus, such distribution will first be charged to
distributions which are required to be redistributed under this
paragraph.
(iii) All amounts contributed to a specific exempt organization
described in section 501(c)(3) and in paragraph (a)(2)(i) (a) or (b) of
this section within any one taxable year of such organization shall be
treated (with respect to the contributing private foundation) as one
``contribution''. If subparagraph (1) (i) or (ii) of this paragraph is
not completely satisfied with respect to such contribution within the
meaning of such subparagraph, only that portion
[[Page 95]]
of such contribution which was redistributed (within the meaning of
subparagraph (1) (i) and (ii) of this paragraph) shall be treated as a
qualifying distribution.
(iv) In order to satisfy distribution requirements under section
170(b) (1)(E)(ii) or this paragraph, a donee organization may elect to
treat as a current distribution out of corpus any amount distributed in
a prior taxable year which was treated as a distribution out of corpus
under paragraph (d)(1)(iii) of this section provided that (a) such
amount has not been availed of for any other purpose, such as a
carryover under paragraph (e) of this section or a redistribution under
this paragraph for a prior year, (b) such corpus distribution occurred
within the preceding 5 years, and (c) such amount is not later availed
of for any other purpose. Such election must be made by attaching a
statement to the return the foundation is required to file under section
6033 with respect to the taxable year for which such election is to
apply. Such statement must contain a declaration by an appropriate
foundation manager (within the meaning of section 4946(b)(1)) that the
foundation is making an election under this paragraph and it must
specify that the distribution was treated under paragraph (d)(1)(iii) of
this section as a distribution out of corpus in a designated prior
taxable year (or years).
(3) Examples. The provisions of subparagraphs (1) and (2) of this
paragraph may be illustrated by the following examples. It is assumed in
these examples that all private foundations described use the calendar
as the taxable year.
Example 1. In 1972 M, a private foundation, makes a contribution out
of 1971 income to X, another private foundation which is not an
operating foundation. The contribution is the only one received by X in
1972. In 1973 X makes a qualifying distribution to an art museum
maintained by an operating foundation in an amount equal to the amount
of the contribution received from M. X also distributes all of its
undistributed income for 1972 and 1973 for other purposes described in
section 170(c)(2)(B). Under the provisions of paragraph (d) of this
section, such distribution to the museum is treated as a distribution
out of corpus. Thus, M's contribution to X is a qualifying distribution
out of M's 1971 income provided M obtains adequate records or other
sufficient evidence from X showing the nature and amount of the
distribution made by X, the identity of the recipient, and the fact that
the distribution is treated as made out of corpus. If X's qualifying
distributions during 1973 had been equal only to M's contribution to X
and X's undistributed income for 1972, X could have made an election
under paragraph (d)(2) of this section to treat the amount distributed
in excess of its 1972 undistributed income as a distribution out of
corpus and in that manner satisfied the requirements of this paragraph.
Example 2. Assume the facts stated in example (1), except that X is
a private college described in section 170(b)(1)(A)(ii) which is
controlled by disqualified persons with respect to M and that the
records which X furnishes to M show that the distribution would have
been treated as made out of corpus if X were a private nonoperating
foundation. Under these circumstances, result is the same as in example
(1).
Example 3. Assume the facts stated in example (1), except that X
makes a distribution to the museum equal only to one-half of the
contribution from M, that the remainder of such contribution is added to
X's funds and used to pay charitable administrative expenses, and that
the records obtained by M from X are not sufficient to show the amounts
distributed or the identities of the recipients of the distributions.
The contribution by M to X will be a qualifying distribution only to the
extent that M can obtain (i) other sufficient evidence (such as
statements from officers or employees of X or from the museum) showing
the facts required by subparagraph (1)(ii) (a), (b), and (c) of this
paragraph and (ii) a statement from X setting forth that the remainder
of the contribution was used for charitable administrative expenses
which constituted qualifying distributions described in paragraph
(a)(2)(i) of this section.
Example 4. X and Y are private nonoperating foundations. A is an
exempt organization which is not described in section 501(c)(3) but
which supervises and conducts a program described in section
170(c)(2)(B). Y, but not X, controls A within the meaning of paragraph
(a)(3) of this section. In 1972, X and Y each makes a grant to A of
$100, specifically designated for use in the operation of A's section
170(c)(2)(B) program. X has made a qualifying distribution to A because
the distribution is one described in paragraph (a)(2)(i) of this
section. However, because A is controlled by Y, Y's grant of $100 to A
does not constitute a qualifying distribution within the meaning of such
paragraph (a)(2)(i). Furthermore, because A is not an exempt
organization described in section 501(c)(3), Y's grant to A does not
constitute a qualifying distribution by operation of the provisions of
this paragraph.
[[Page 96]]
Example 5. N, a private nonoperating foundation, had distributable
amounts of $100 in 1970 and $125 in 1971. In 1970 N received total
contributions of $540: $150 from Y, a public charity; $70 from Z, a
private foundation; $140 from Q, a private foundation, subject to the
requirement that N earmark the amount and distribute it before
distributing Z's contribution; and, $180 from R, also a private
foundation. However, R specifically instructed N that such contribution
did not have to be redistributed because R already had made enough
qualifying distributions to avoid all section 4942 taxes. N is not
controlled by Y, Z, Q, or R, and N made no qualifying distributions in
1970. By the close of 1971, N had made qualifying distributions of $420,
earmarking $140 as having been a distribution of Q's contribution, but
had made no election under paragraph (d)(2) of this section to have any
amount distributed which was in excess of N's 1970 undistributed income
treated as distributed out of corpus. Therefore, the first $225 of
qualifying distributions made in 1971 (the sum of $100 and $125, N's
distributable amounts for 1970 and 1971, respectively) are treated as
amounts described in paragraph (d)(1) (i) and (ii) of this section.
Since Y's contribution is a contribution from a public charity and does
not have to be ``redistributed'' and since R specifically instructed N
that its contribution need not be ``redistributed'', the remaining $195
of qualifying distributions will be treated as distributed pro rata from
Z's and Q's contributions, regardless of N's earmarking. Accordingly, of
Z's original qualifying distribution of $70 only $65 ($195 multiplied by
$70, Z's contribution, over $210, the total ($70 plus $140) of Z's and
Q's contributions) will be treated as redistributed by N. Similarly, of
Q's original qualifying distribution of $140 only $130 ($195 multiplied
by $140 over $210) will be treated as redistributed by N. Thus, Z's
gross income for 1972 will be increased by $5 ($70 less the $65 actually
redistributed), and Q's gross income for 1972 will be increased by $10
($140 less the $130 actually redistributed).
(4) Limitation. A contribution by a private foundation to a donee
organization which the donee uses to make payments to another
organization (the secondary donee) shall not be regarded as a
contribution by the private foundation to the secondary donee if the
distributing foundation does not earmark the use of the contribution for
any named secondary donee and does not retain power to cause the
selection of the secondary donee by the organization to which such
foundation has made the contribution. For purposes of this subparagraph,
a contribution described herein shall not be regarded as a contribution
by the foundation to the secondary donee even though such foundation has
reason to believe that certain organizations would derive benefits from
such contribution so long as the original donee organization exercises
control, in fact, over the selection process and actually makes the
selection completely independently of such foundation.
(5) Transitional rule. (i) For purposes of this paragraph, a
contribution to a private foundation which is not an operating
foundation and which is not controlled (directly or indirectly) by the
distributing foundation or one or more disqualified persons with respect
to the distributing foundation will be treated as a contribution to an
operating foundation if:
(a) Such contribution is made pursuant to a written commitment which
was binding on May 26, 1969, and at all times thereafter.
(b) Such contribution is made for one or more of the purposes
described in section 170(c) (1) or (2)(B), and
(c) Such contribution is to be paid out to the donee private
foundation on or before December 31, 1974.
(ii) For purposes of this subparagraph, a written commitment will be
considered to have been binding prior to May 27, 1969, only if the
amount and nature of the contribution and the name of the donee
foundation were entered in the records of the distributing foundation,
or were otherwise adequately evidenced, prior to May 27, 1969, or notice
of the contribution was communicated in writing to such donee prior to
May 27, 1969.
(d) Treatment of qualifying distributions--(1) In general. Except as
provided in subparagraph (2) of this paragraph, any qualifying
distribution made during a taxable year shall be treated as made:
(i) First out of the undistributed income (as defined in paragraph
(a) of Sec. 53.4942(a)-2) of the immediately preceding taxable year (if
the private foundation was subject to the initial excise tax imposed by
section 4942(a) for such preceding taxable year) to the extent thereof;
[[Page 97]]
(ii) Second out of the undistributed income for the taxable year to
the extent thereof; and
(iii) Then out of corpus.
(2) Election. In the case of any qualifying distribution which
(under subparagraph (1) of this paragraph) is not treated as made out of
the undistributed income of the immediately preceding taxable year, the
foundation may elect to treat any portion of such distribution as made
out of the undistributed income of a designated prior taxable year or
out of corpus. Such election must be made by filing a statement with the
Commissioner during the taxable year in which such qualifying
distribution is made or by attaching a statement to the return the
foundation is required to file under section 6033 with respect to the
taxable year in which such qualifying distribution was made. Such
statement must contain a declaration by an appropriate foundation
manager (within the meaning of section 4946(b)(1)) that the foundation
is making an election under this subparagraph, and it must specify
whether the distribution is made out of the undistributed income of a
designated prior taxable year (or years) or is made out of corpus. In
any case where the election described in this subparagraph is made
during the taxable year in which the qualifying distribution is made,
such election may be revoked in whole or in part by filing a statement
with the Commissioner during such taxable year revoking such election in
whole or in part or by attaching a statement to the return the
foundation is required to file under section 6033 with respect to the
taxable year in which the qualifying distribution was made revoking such
election in whole or in part. Such statement must contain a declaration
by an appropriate foundation manager (within the meaning of section
4946(b)(1)) that the foundation is revoking an election under this
subparagraph in whole or in part, and it must specify the election or
part thereof being revoked.
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. M, a private foundation which was created in 1968 and
which uses the calendar year as the taxable year, has distributable
amounts and qualifying distributions for 1970 through 1976 as follows:
------------------------------------------------------------------------
1970 1971 1972 1973
------------------------------------------------------------------------
Distributable amount.................... $100 $100 $100 $100
Qualifying distribution................. 0 100 250 100
-------------------------------
1974 1975 1976 ......
-------------------------------
Distributable amount.................... $100 $100 $100 ......
Qualifying distribution................. 100 100 100 ......
------------------------------------------------------------------------
In 1971 the qualifying distribution of $100 is treated under
subparagraph (1)(i) of this paragraph as made out of the $100 of
undistributed income for 1970. The qualifying distribution of $250 in
1972 is treated as made: (i) $100 out of the undistributed income for
1971 under subparagraph (1)(i) of this paragraph; (ii) $100 out of the
undistributed income for 1972 under subparagraph (1)(ii) of this
paragraph; and (iii) $50 out of corpus in 1972 under subparagraph
(1)(iii) of this paragraph. The qualifying distribution of $100 in each
of the years 1973 through 1976 is treated as made out of the
undistributed income for each of those respective years under
subparagraph (1)(ii) of this paragraph. See paragraph (e) of this
section for rules relating to the carryover of qualifying distributions
out of corpus.
Example 2. M, a private foundation which uses the calendar year as
the taxable year, has undistributed income of $300 for 1981, $200 for
1982, and $400 for 1983. On January 14, 1983, M makes its first
qualifying distribution in 1983 when it sets aside (within the meaning
of paragraph (b) of this section) $700 for construction of a hospital.
On February 24, 1983 a notice of deficiency with respect to the excise
taxes imposed by section 4942 (a) and (b) in regard to M 's
undistributed income for 1981 is mailed to M under section 6212(a). M
notifies the Commissioner in writing on March 24, 1983, that it is
making an election under subparagraph (2) of this paragraph to have its
distribution of January 14th applied first against its undistributed
income for 1982, next against its undistributed income for 1981, and
last against its undistributed income for 1983. Thus, $200 of the $700
qualifying distribution is treated as made out of the undistributed
income for 1982; $300, out of undistributed income for 1981; and $200
($700 less the sum of $200 and $300), out of the undistributed income
for 1983. Thus, an initial excise tax of $45 (15 percent of $300) is
imposed under section 4942(a). Since M made the election described
above, the $300 (treated as distributed out of undistributed income for
1981) corrects (within the meaning of section 4963(d)(2)) the taxable
act because the undistributed income for 1981 is reduced to zero.
Furthermore, correction is effected within the correction period (as
defined in section 4963(e)(1) and Sec. 53.4963-1(e)). Therefore, under
the provisions of section
[[Page 98]]
4961(a), the additional tax imposed by section 4942(b) will not be
assessed.
(e) Carryover of excess qualifying distributions--(1) In general. If
in any taxable year for which an organization is subject to the initial
excise tax imposed by section 4942(a) there is created an excess of
qualifying distributions (as determined under subparagraph (2) of this
paragraph), such excess may be used to reduce distributable amounts in
any taxable year of the adjustment period (as defined subparagraph (3)
of this paragraph). For purposes of section 4942, including paragraph
(d) of this section, the distributable amount for a taxable year in the
adjustment period shall be reduced to the extent of the lesser of (i)
the excess of qualifying distributions made in prior taxable years to
which such adjustment period applies or (ii) the remaining undistributed
income at the close of such taxable year after applying any qualifying
distributions made in such taxable year to the distributable amount for
such taxable year (determined without regard to this paragraph). If
during any taxable year of the adjustment period there is created
another excess of qualifying distributions, such excess shall not be
taken into account until any earlier excess of qualifying distributions
has been completely applied against distributable amounts during its
adjustment period.
(2) Excess qualifying distributions. An excess of qualifying
distributions is created for any taxable year beginning after December
31, 1969, if:
(i) The total qualifying distributions treated (under paragraph (d)
of this section) as made out of the undistributed income for such
taxable year or as made out of corpus with respect to such taxable year
(other than amounts distributed by an organization in satisfaction of
section 170(b)(1)(E)(ii) or paragraph (c) of this section, or applied to
a prior taxable year by operation of the elections contained in
paragraphs (c)(2)(iv) and (d)(2) of this section), exceeds
(ii) The distributable amount for such taxable year (determined
without regard to this paragraph).
(3) Adjustment period. For purposes of this paragraph, the taxable
years in the adjustment period are the 5 taxable years immediately
following the taxable year in which the excess of qualifying
distributions is created. Thus, an excess (within the meaning of
subparagraph (2) of this paragraph) for any 1 taxable year cannot be
carried over beyond the succeeding 5 taxable years. However, if during
any taxable year in the adjustment period an organization ceases to be
subject to the initial excise tax imposed by section 4942(a), any
portion of the excess of qualifying distributions, which prior to such
taxable year has not been applied against distributable amounts, may not
be carried over to such taxable year or subsequent taxable years in the
adjustment period, even if during any of such taxable years the
organization again becomes subject to the initial excise tax imposed by
section 4942(a).
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. (i) F, a private foundation which was created in 1967 and
which uses the calendar year as the taxable year, has distributable
amounts and qualifying distributions for 1970 through 1976 as follows:
------------------------------------------------------------------------
Year 1970 1971 1972 1973
------------------------------------------------------------------------
Distributable amount.................... $100 $100 $100 $100
Qualifying distribution................. 0 $250 $70 $140
------------------------------------------------------------------------
------------------------------------------------------------------------
Year 1974 1975 1976
------------------------------------------------------------------------
Distributable amount.................... $100 $100 $100 ......
Qualifying distribution................. $60 $75 $105 ......
------------------------------------------------------------------------
(ii) The qualifying distributions made in 1971 will be treated under
paragraph (d) of this section as $100 made out of the undistributed
income for 1970, then as $100 made out of the undistributed income for
1971, and finally as $50 out of corpus in 1971. Since the total
qualifying distributions for 1971 ($150) exceed the distributable amount
for 1971 ($100), there exists a $50 excess of qualifying distributions
which F may use to reduce its distributable amounts for the years 1972
through 1976 (the taxable years in the adjustment period with respect to
the 1971 excess). Therefore, the $100 distributable amount for 1972 is
reduced by $30 (the lesser of the 1971 excess ($50) and the remaining
undistributed income at the close of 1972 ($30), after the qualifying
distributions of $70 for 1972 were applied to the original distributable
amount for 1972 of $100). Since the distributable amount for 1972 was
reduced to $70, there is no remaining undistributed income for 1972.
Accordingly, the qualifying distributions made in 1973 will be treated
as $100 made out
[[Page 99]]
of the undistributed income for 1973 and as $40 out of corpus in 1973.
Since this amount ($140) exceeds the distributable amount for 1973
($100), there exists a $40 excess which F may use to reduce its
distributable amounts for the years 1974 through 1978 (the taxable years
in the adjustment period with respect to the 1973 excess). However, in
accordance with subparagraph (1) of this paragraph such excess may not
be used to reduce F's distributable amounts for the years 1974 through
1976 until the excess created in 1971 has been completely applied
against distributable amounts during such years. The distributable
amount for 1974 is reduced by $40 (the lesser of the unused portion of
the 1971 excess ($20) plus the 1973 excess ($40) and the remaining
undistributed income at the close of 1974 ($40), after the qualifying
distributions of $60 for 1974 were applied to the original distributable
amount for 1974 of $100). The distributable amount for 1975 is reduced
by $20 (the lesser of the unused portion of the 1973 excess of
qualifying distributions ($20) and the remaining undistributed income at
the close of 1975 ($25), after the qualifying distributions of $75 for
1975 were applied to the original distributable amount for 1975 of
$100). Consequently, qualifying distributions made in 1976 will be
treated as made first out of the $5 of remaining undistributed income
for 1975 and then as $100 made out of the undistributed income for 1976.
Example 2. Assume the facts as stated in example (1), except that in
1974 F receives a contribution of $300 from G, a private foundation
which controls F (within the meaning of paragraph (a)(3) of this
section), and F distributes such contribution in 1975 in satisfaction of
paragraph (c) of this section. Under these circumstances, there would be
no excess of qualifying distributions for 1975 with respect to such
distribution, since such distribution is excluded from the computation
of an excess of qualifying distributions by operation of subparagraph
(2)(i) of this paragraph.
Example 3. Assume the facts as stated in example (1), except that in
1972 F is treated as an operating foundation (as such term is defined in
section 4942(j)(3)). In accordance with subparagraph (3) of this
paragraph since F is not subject to the initial excise tax imposed by
section 4942(a) for 1972, the 1971 excess cannot be carried forward to
1972 or any subsequent year in the adjustment period with respect to the
1971 excess, even if F is subsequently treated as a private nonoperating
foundation for any year during the period 1973 through 1976.
[T.D. 7256, 38 FR 3323, Feb. 5, 1973, as amended by T.D. 7486, 42 FR
24265, May 13, 1977; T.D. 7849, 47 FR 50857, Nov. 10, 1982; T.D. 7938,
49 FR 3848, Jan. 31, 1984; T.D. 8084, 51 FR 16302, May 2, 1986]
Sec. 53.4942(b)-1 Operating foundations.
(a) Operating foundation defined--(1) In general. For purposes of
section 4942 and the regulations thereunder, the term ``operating
foundation'' means any private foundation which, in addition to
satisfying the assets test, the endowment test or the support test set
forth in Sec. 53.4942(b)-2 (a), (b) and (c), makes qualifying
distributions (within the meaning of Sec. 53.4942(a)-3(a)(2)) directly
for the active conduct of activities constituting its charitable,
educational, or other similar exempt purpose equal in value to:
(i) For taxable years beginning before January 1, 1982,
substantially all of the foundation's adjusted net income (as defined in
Sec. 53.4942(a)-2(d)); and
(ii) For taxable years beginning after December 31, 1981,
substantially all of the lesser of the foundation's adjusted net income
(as defined in Sec. 53.4942(a)-2(d)) or minimum investment return (as
defined in Sec. 53.4942(a)-2(c)). If the foundation's qualifying
distributions exceed its minimum investment return (but are less than
the foundation's adjusted net income) substantially all of such
qualifying distributions must be made directly for the active conduct of
activities constituting its charitable, educational or other similar
exempt purpose. However, if the foundation's minimum investment return
is less than its adjusted net income and the foundation's qualifying
distributions equal or exceed such adjusted net income, only that
portion of the qualifying distributions equal to substantially all of
the foundation's adjusted net income must be made directly for the
active conduct of activities constituting its charitable, educational or
other similar exempt purpose.
(2) Certain elderly care facilities described in section
4942(j)(6)--(i) In general. For purposes of the distribution
requirements of section 4942 (but no other provision of the Internal
Revenue Code) and for taxable years beginning after December 31, 1969,
the term ``operating foundation'' includes a private foundation which:
(A) On or before May 26, 1969, and continuously thereafter to the
close of the taxable year, operates and maintains, as its principal
functional purpose, residential facilities for the long-
[[Page 100]]
term care, comfort, maintenance, or education of permanently and totally
disabled persons, elderly persons, needy widows, or children, and
(B) Satisfies the endowment test set forth in Sec. 53.4942(b)-2
(b).
(ii) Principal functional purpose. For purposes of section
4942(j)(6) and this subparagraph (2), an organization's ``principal
functional purpose'' is operating and maintaining residential facilities
for the long-term care, comfort, maintenance, or education of
permanently and totally disabled persons, elderly persons, needy widows,
or children, if it is organized for the principal purpose of operating
and maintaining such residential facilities and is primarily engaged
directly in the operation and maintenance of those facilities. An
organization will be treated as being primarily engaged directly in the
operation and maintenance of the described residential facilities if at
least 50% of the qualifying distributions (as defined in Sec.
53.4942(a)-3(a)(2)) normally made by the organization are expended for
the operation and maintenance of the facilities.
(b) Active conduct of activities constituting the exempt purpose--
(1) In general. For purposes of this section, except as provided in
subparagraph (2) or (3) of this paragraph, qualifying distributions are
not made by a foundation ``directly for the active conduct of activities
constituting its charitable, educational, or other similar exempt
purpose'' unless such qualifying distributions are used by the
foundation itself, rather than by or through one or more grantee
organizations which receive such qualifying distributions directly or
indirectly from such foundation. Thus, grants made to other
organizations to assist them in conducting activities which help to
accomplish their charitable, educational, or other similar exempt
purpose are considered an indirect, rather than direct, means of
carrying out activities constituting the charitable, educational, or
other similar exempt purpose of the grantor foundation, regardless of
the fact that the exempt activities of the grantee organization may
assist the grantor foundation in carrying out its own exempt activities.
However, amounts paid to acquire or maintain assets which are used
directly in the conduct of the foundation's exempt activities, such as
the operating assets of a museum, public park, or historic site, are
considered direct expenditures for the active conduct of the
foundation's exempt activities. Likewise, administrative expenses (such
as staff salaries and traveling expenses) and other operating costs
necessary to conduct the foundation's exempt activities (regardless of
whether they are ``directly for the active conduct'' of such exempt
activities) shall be treated as qualifying distributions expended
directly for the active conduct of such exempt activities if such
expenses and costs are reasonable in amount. Conversely, administrative
expenses and operating costs which are not attributable to exempt
activities, such as expenses in connection with the production of
investment income, are not treated as such qualifying distributions.
Expenses attributable to both exempt and nonexempt activities shall be
allocated to each such activity on a reasonable and consistently applied
basis. Any amount set aside by a foundation for a specific project, such
as the acquisition and restoration, or construction, of additional
buildings or facilities which are to be used by the foundation directly
for the active conduct of the foundation's exempt activities, shall be
deemed to be qualifying distributions expended directly for the active
conduct of the foundation's exempt activities if the initial setting
aside of the funds constitutes a set-aside within the meaning of
paragraph (b) of Sec. 53.4942(a)-3.
(2) Payments to individual beneficiaries--(i) In general. If a
foundation makes or awards grants, scholarships, or other payments to
individual beneficiaries (including program related investments within
the meaning of section 4944(c) made to individuals or corporate
enterprises) to support active programs conducted to carry out the
foundation's charitable, educational, or other similar exempt purpose,
such grants, scholarships, or other payments will be treated as
qualifying distributions made directly for the active conduct of exempt
activities for purposes of paragraph (a) of this section only if the
foundation, apart from the
[[Page 101]]
making or awarding of the grants, scholarships, or other payments,
otherwise maintains some significant involvement (as defined in
subdivision (ii) of this subparagraph) in the active programs in support
of which such grants, scholarships, or other payments were made or
awarded. Whether the making or awarding of grants, scholarships, or
other payments constitutes qualifying distributions made directly for
the active conduct of the foundation's exempt activities is to be
determined on the basis of the facts and circumstances of each
particular case. The test applied is a qualitative, rather than a
strictly quantitative, one. Therefore, if the foundation maintains a
significant involvement (as defined in subdivision (ii) of this
subparagraph) it will not fail to meet the general rule of subparagraph
(1) of this paragraph solely because more of its funds are devoted to
the making or awarding of grants, scholarships, or other payments than
to the active programs which such grants, scholarships, or other
payments support. However, if a foundation does no more than select,
screen, and investigate applicants for grants or scholarships, pursuant
to which the recipients perform their work or studies alone or
exclusively under the direction of some other organization, such grants
or scholarships will not be treated as qualifying distributions made
directly for the active conduct of the foundation's exempt activities.
The administrative expenses of such screening and investigation (as
opposed to the grants or scholarships themselves) may be treated as
qualifying distributions made directly for the active conduct of the
foundation's exempt activities.
(ii) Definition. For purposes of this subparagraph, a foundation
will be considered as maintaining a ``significant involvement'' in a
charitable, educational, or other similar exempt activity in connection
with which grants, scholarships, or other payments are made or awarded
if:
(A) An exempt purpose of the foundation is the relief of poverty or
human distress, and its exempt activities are designed to ameliorate
conditions among a poor or distressed class of persons or in an area
subject to poverty or national disaster (such as providing food or
clothing to indigents or residents of a disaster area), the making or
awarding of the grants or other payments to accomplish such exempt
purpose is direct and without the assistance of an intervening
organization or agency, and the foundation maintains a salaried or
voluntary staff of administrators, researchers, or other personnel who
supervise and direct the activities described in this subdivision (A) on
a continuing basis; or
(B) The foundation has developed some specialized skills, expertise,
or involvement in a particular discipline or substantive area (such as
scientific or medical research, social work, education, or the social
sciences), it maintains a salaried staff of administrators, researchers,
or other personnel who supervise or conduct programs or activities which
support and advance the foundation's work in its particular area of
interest, and, as a part of such programs or activities, the foundation
makes or awards grants, scholarships, or other payments to individuals
to encourage and further their involvement in the foundation's
particular area of interest and in some segment of the programs or
activities carried on by the foundation (such as grants under which the
recipients, in addition to independent study, attend classes, seminars,
or conferences sponsored or conducted by the foundation, or grants to
engage in social work or scientific research projects which are under
the general direction and supervision of the foundation).
(3) Payment of section 4940 tax. For purposes of section 4942(j)(3)
(A) and (B)(ii), payment of the tax imposed upon a foundation under
section 4940 shall be considered a qualifying distribution which is made
directly for the active conduct of activities constituting the
foundation's charitable, educational, or other similar exempt purpose.
(c) Substantially all. For purposes of this section, the term
``substantially all'' shall mean 85 percent or more. Thus, if a
foundation makes qualifying distributions directly for the active
conduct of activities constituting its charitable, educational, or other
similar exempt purpose in an amount equal
[[Page 102]]
to at least 85 percent of its adjusted net income, it will be considered
as satisfying the income test described in this section even if it makes
grants to organizations or engages in other activities with the
remainder of its adjusted net income and with other funds. In
determining whether the amount of qualifying distributions made directly
for the active conduct of such exempt activities equals at least 85
percent of a foundation's adjusted net income, a foundation is not
required to trace the source of such expenditures to determine whether
they were derived from income or from contributions.
(d) Examples. The provisions of this section may be illustrated by
the following examples. It is assumed that none of the organizations
described in these examples is described in section 509(a) (1), (2), or
(3).
Example 1. N, an exempt museum described in section 501(c)(3), was
founded by the gift of an endowment from a single contributor. N uses 90
percent of its adjusted net income to operate the museum. If N satisfies
one of the tests set forth in Sec. 53.4942(b)-2 it may be classified as
an operating foundation since substantially all of the qualifying
distributions made by N are used directly for the active conduct of N's
exempt activities within the meaning of paragraph (b)(1) of this
section.
Example 2. M, an exempt organization described in section 501(c)(3),
was created to improve conditions in a particular urban ghetto. M
receives its funds primarily from a limited number of wealthy
contributors interested in helping carry out its exempt purpose. M's
program consists of making a survey of the problems of the ghetto to
determine the areas in which its funds may be applied most effectively.
Approximately 10 percent of M's adjusted net income is used to conduct
this survey. The balance of its income is used to make grants to other
nonprofit organizations doing work in the ghetto in those areas
determined to have the greatest likelihood of resulting in improved
conditions. Under these circumstances, since only 10 percent of M's
adjusted net income may be considered as constituting qualifying
distributions made directly for the active conduct of M's exempt
activities, M cannot qualify as an operating foundation.
Example 3. Assume the facts as stated in example (2), except that M
uses the remaining 90 percent of its adjusted net income for the
following purposes: (1) M maintains a salaried staff of social workers
and researchers who analyze its surveys and make recommendations as to
methods for improving ghetto conditions; (2) M makes grants to
independent social scientists who assist in these analyses and
recommendations; (3) M publishes periodic reports indicating the results
of its surveys and recommendations; (4) M makes grants to social workers
and others who act as advisers to nonprofit organizations, as well as
small business enterprises, functioning in the community (these advisers
acting under the general direction of M attempt to implement M's
recommendations through their advice and assistance to the nonprofit
organizations and small business enterprises); and (5) M makes grants to
other social scientists who study and report on the success of the
various enterprises which attempt to implement M's recommendations.
Under these circumstances, M satisfies the requirements of paragraph (b)
(2) of this section, and the various grants it makes constitute
qualifying distributions made directly for the active conduct of its
exempt activities. Thus, if M satisfies one of the tests set forth in
Sec. 53.4942(b)-2 it may be classified as an operating foundation.
Example 4. P, an exempt educational organization described in
section 501(c)(3), was created for the purpose of training teachers for
institutions of higher education. Each year P awards a substantial
number of fellowships to students for graduate study leading toward
their M.A. or Ph. D. degrees. The applicants for these fellowships are
carefully screened by P's staff, and only those applicants who indicate
a strong interest in teaching in colleges or universities are chosen. P
publishes and circulates various pamphlets encouraging a development of
interest in college teaching and describing its fellowships. P also
conducts annual summer seminars which are attended by its fellowship
recipients, its staff, consultants, and other interested parties. The
purpose of these seminars is to foster and encourage the development of
college teaching. P publishes a report of the seminar proceedings along
with related studies written by those who attended. Despite the fact
that a substantial portion of P's adjusted net income is devoted to
granting fellowships, its commitment to encouraging individuals to
become teachers at institutions of higher learning, its maintenance of a
staff and programs designed to further this purpose, and the granting of
fellowships to encourage involvement both in its own seminars and in its
exempt purpose indicate a significant involvement by P beyond the mere
granting of fellowships. Thus, the fellowship grants made by P
constitute qualifying distributions made directly for the active conduct
of P's exempt activities within the meaning of paragraph (b) (2) of this
section.
Example 5. Q, an exempt organization described in section 501(c)
(3), is composed of professional organizations interested in different
branches of one academic discipline. Q
[[Page 103]]
trains its own professional staff, conducts its own program of research,
selects research topics, screens and investigates grant recipients,
makes grants to those selected, and sets up and conducts conferences and
seminars for the grantees. Q has particular knowledge and skill in the
given discipline, carries on activities to advance its study of that
discipline, and makes grants to individuals to enable them to
participate in activities which it conducts in carrying out its exempt
purpose. Under these circumstances, Q's grants constitute qualifying
distributions made directly for the active conduct of Q's exempt
activities within the meaning of paragraph (b) (2) of this section.
Example 6. R, an exempt medical research organization described in
section 501 (c) (3), was created to study and perform research
concerning heart disease. R has its own research center in which it
carries on a broad number of research projects in the field of heart
disease with its own professional staff. Physicians and scientists who
are interested in special projects in this area present the plans for
their projects to R. The directors of R study these plans and decide if
the project is feasible and will further the work being done by R. If it
is, R makes a grant to the individual to enable him to carry out his
project, either at R's facilities or elsewhere. Reports of the progress
of the project are made periodically to R, and R exercises a certain
amount of supervision over the project. The resulting findings of these
projects are usually published by R. Under these circumstances, the
grants made by R constitute qualifying distributions made directly for
the active conduct of R's exempt activities within the meaning of
paragraph (b) (2) of this section.
Example 7. S, an exempt organization described in section 501(c)
(3), maintains a large library of manuscripts and other historical
reference material relating to the history and development of the region
in which the collection is located. S makes a limited number of annual
grants to enable post-doctoral scholars and doctoral candidates to use
its library. Sometimes S obtains the right to publish the scholar's
work, although this is not a prerequisite to the receipt of a grant. The
primary criterion for selection of grant recipients is the usefulness of
the library's resources to the applicant's field of study. Under these
circumstances, the grants made by S constitute qualifying distributions
made directly for the active conduct of S's exempt activities within the
meaning of paragraph (b) (2) of this section.
Example 8. T, an exempt charitable organization described in section
501(c)(3), was created by the members of one family for the purpose of
relieving poverty and human suffering. T has a large salaried staff of
employees who operate offices in various areas throughout the country.
Its employees make gifts of food and clothing to poor persons in the
area serviced by each office. On occasion, T also provides temporary
relief in the form of food and clothing to persons in areas stricken by
natural disasters. If conditions improve in one poverty area, T
transfers the resources of the office in that area to another poverty
area. Under these circumstances, the gifts of food and clothing made by
T constitute qualifying distributions made directly for the active
conduct of T's exempt activities within the meaning of paragraph (b) (2)
of this section.
Example 9. U, an exempt scientific organization described in section
501(c) (3), was created for the principal purpose of studying the
effects of early childhood brain damage. U conducts an active and
continuous research program in this area through a salaried staff of
scientists and physicians. As part of its research program, U awards
scholarships to young people suffering mild brain damage to enable them
to attend special schools equipped to handle such problems. The
recipients are periodically tested to determine the effect of such
schooling upon them. Under these circumstances, the scholarships awarded
by U constitute qualifying distributions made directly for the active
conduct of U's exempt activities within the meaning of paragraph (b) (2)
of this section.
Example 10. O, an exempt charitable organization described in
section 501(c) (3), was created for the purpose of giving scholarships
to children of the employees of X Corporation who meet the standards set
by O. O not only screens and investigates each applicant to make sure
that he complies with the academic and financial requirements set for
scholarship recipients, but also administers an examination which each
applicant must take--90 percent of O's adjusted net income is used in
awarding these scholarships to the chosen applicants. O does not conduct
any activities of an educational nature on its own. Under these
circumstances, O is not using substantially all of its adjusted net
income directly for the active conduct of its exempt activities within
the meaning of paragraph (b) of this section. Thus, O is not an
operating foundation because it fails to satisfy the income test set
forth in paragraph (a) of this section.
[T.D. 7249, 38 FR 768, Jan. 4, 1973, as amended by T.D. 7718, 45 FR
58520, Sept. 4, 1980; 46 FR 11254, Feb. 6, 1981; T.D. 7878, 48 FR 11943,
Mar. 22, 1983]
Sec. 53.4942(b)-2 Alternative tests.
(a) Assets test--(1) In general. A private foundation will satisfy
the assets test under the provisions of this paragraph if substantially
more than half of the foundation's assets:
[[Page 104]]
(i) Are devoted directly (A) to the active conduct of activities
constituting the foundation's charitable, educational, or other similar
exempt purpose, (B) to functionally related businesses (as defined in
paragraph (c)(3)(iii) of Sec. 53.4942(a)-2), or (C) to any combination
thereof;
(ii) Are stock of a corporation which is controlled by the
foundation (within the meaning of section 368(c)) and substantially all
the assets of which (within the meaning of paragraph (c) of Sec.
53.4942(b)-1) are so devoted; or
(iii) Are in part assets which are described in subdivision (i) of
this subparagraph and in part stock which is described in subdivision
(ii) of this subparagraph.
(2) Qualifying assets--(i) In general. For purposes of subparagraph
(1) of this paragraph, an asset is ``devoted directly to the active
conduct of activities constituting the foundation's charitable,
educational, or other similar exempt purpose'' only if the asset is
actually used by the foundation directly for the active conduct of
activities constituting its charitable, educational, or other similar
exempt purpose. Thus, such assets as real estate, physical facilities or
objects (such as museum assets, classroom fixtures and equipment, and
research facilities), and intangible assets (such as patents,
copyrights, and trademarks) will be considered qualifying assets for
purposes of this paragraph to the extent they are used directly for the
active conduct of the foundation's exempt activities. However, assets
which are held for the production of income, for investment, or for some
other similar use (for example, stocks, bonds, interest-bearing notes,
endowment funds, or, generally, leased real estate) are not devoted
directly to the active conduct of the foundation's exempt activities,
even though the income derived from such assets is used to carry out
such exempt activities. Whether an asset is held for the production of
income, for investment, or for some other similar use rather than being
used for the active conduct of the foundation's exempt activities is a
question of fact. For example, an office building used for the purpose
of providing offices for employees engaged in the management of
endowment funds of the foundation is not devoted to the active conduct
of the foundation's exempt activities. However, where property is used
both for exempt purposes and for other purposes, if such exempt use
represents 95 percent or more of the total use, such property shall be
considered to be used exclusively for an exempt purpose. Property
acquired by a foundation to be used in carrying out the foundation's
exempt purpose may be considered as devoted directly to the active
conduct of such purpose even though the property, in whole or in part,
is leased for a limited period of time during which arrangements are
made for its conversion to the use for which it was acquired, provided
such income-producing use of the property does not exceed a reasonable
period of time. Generally, 1 year shall be deemed to be a reasonable
period of time for purposes of the immediately preceding sentence.
Similarly, where property is leased by a foundation in carrying out its
exempt purpose and where the rental income derived from such property by
the foundation is less than the amount which would be required to be
charged in order to recover the cost of purchase and maintenance of such
property (taking into account the deductions permitted by paragraph
(d)(4) of Sec. 53.4942(a)-2), such property shall be considered devoted
directly to the active conduct of the foundation's exempt activities.
(ii) Limitations. (A) Assets which are held for the purpose of
extending credit or making funds available to members of a charitable
class (including any interest in a program related-investment, except as
provided in paragraph (b)(2) of Sec. 53.4942(b)-1) are not considered
assets devoted directly to the active conduct of activities constituting
the foundation's charitable, educational, or other similar exempt
purpose. For example, assets which are set aside in special reserve
accounts to guarantee student loans made by lending institutions will
not be considered assets devoted directly to the active conduct of the
foundation's exempt activities.
(B) Any amount set aside by a foundation within the meaning of
paragraph (b) (1) of Sec. 53.4942(b)-1 shall not be treated as an asset
devoted directly to
[[Page 105]]
the active conduct of the foundation's exempt activities.
(3) Assets held for less than a taxable year. For purposes of this
paragraph, any asset which is held by a foundation for part of a taxable
year shall be taken into account for such taxable year by multiplying
the fair market value of such asset (as determined pursuant to
subparagraph (4) of this paragraph) by a fraction, the numerator of
which is the number of days in such taxable year that the foundation
held such asset and the denominator of which is the number of days in
such taxable year.
(4) Valuation. For purposes of this paragraph, all assets shall be
valued at their fair market value. Fair market value shall be determined
in accordance with the rules set forth in paragraph (c)(4) of Sec.
53.4942(a)-2, except in the case of assets which are devoted directly to
the active conduct of the foundation's exempt activities and for which
neither a ready market nor standard valuation methods exist (such as
historical objects or buildings, certain works of art, and botanical
gardens). In such cases, the historical cost (unadjusted for
depreciation) shall be considered equal to fair market value unless the
foundation demonstrates that fair market value is other than cost. In
any case in which the foundation so demonstrates that the fair market
value of an asset is other than historical cost, such substituted
valuation may be used for the taxable year for which such new valuation
is demonstrated and for each of the succeeding 4 taxable years if the
valuation methods and procedures prescribed by paragraph (c)(4)(iv)(B)
of Sec. 53.4942 (a)-2 are followed.
(5) Substantially more than half. For purposes of this paragraph,
the term substantially more than half shall mean 65 percent or more.
(6) Examples. The provisions of this paragraph may be illustrated by
the following examples. It is assumed that none of the organizations
described in these examples is described in section 509(a) (1), (2), or
(3).
Example 1. W, an exempt organization described in section 501(c)(3),
is devoted to the maintenance and operation of a historic area for the
benefit of the general public. W has acquired and erected facilities for
lodging and other visitor accommodations in such area, which W operates
through a wholly owned, separately incorporated, taxable entity. These
facilities comprise substantially all of the subsidiary's assets. The
operation of such accommodations constitutes a functionally related
business within the meaning of paragraph (c)(3)(iii) of Sec.
53.4942(a)-2. Under these circumstances, the stock of the subsidiary
will be considered as part of W's assets which may be taken into account
by W in determining whether it satisfies the assets test described in
this paragraph.
Example 2. M, an exempt conservation organization described in
section 501(c)(3), is devoted to acquiring, preserving, and otherwise
making available for public use geographically diversified areas of
natural beauty. M has acquired and erected facilities for lodging and
other visitor accommodations in national park areas. The operation of
such accommodations constitutes a functionally related business within
the meaning of paragraph (c)(3)(iii) of Sec. 53.4942(a)-2. Therefore,
M's assets which are directly devoted to such visitor accommodations may
be taken into account by M in determining whether it satisfies the
assets test described in this paragraph.
Example 3. P, an exempt organization described in section 501(c)(3),
is devoted to acquiring and restoring historic houses. To insure that
the restored houses will be kept in the restored condition, and to make
the houses more readily available for public display, P rents the houses
rather than sells them once they have been restored. The rental income
derived by P is substantially less than the amount which would be
required to be charged in order to recover the cost of purchase,
restoration, and maintenance of such houses. Therefore, such houses may
be taken into account by P in determining whether it satisfies the
assets test described in this paragraph.
Example 4. Z, an exempt organization described in section 501(c)(3),
is devoted to improving the public's understanding of Renaissance art.
Z's principal assets are a number of paintings of this period which it
circulates on an active and continuing basis to museums and schools for
public display. These paintings constitute 80 percent of Z's assets.
Under these circumstances, although Z does not have a building in which
it displays these paintings, such paintings are devoted directly to the
active conduct of activities constituting Z's exempt purpose. Therefore,
Z has satisfied the assets test described in this paragraph.
(b) Endowment test--(1) In general. A foundation will satisfy the
endowment test under the provisions of this paragraph if it normally
makes qualifying distributions (within the meaning of
[[Page 106]]
paragraph (a)(2) of Sec. 53.4942(a)-3) directly for the active conduct
of activities constituting its charitable, educational, or other similar
exempt purpose in an amount not less than two-thirds of its minimum
investment return (as defined in paragraph (c) of Sec. 53.4942(a)-2).
In determining whether the amount of such qualifying distributions is
not less than an amount equal to two-thirds of the foundation's minimum
investment return, the foundation is not required to trace the source of
such expenditures to determine whether they were derived from investment
income or from contributions.
(2) Definitions. For purposes of this paragraph, the phrase directly
for the active conduct of activities constituting the foundation's
charitable, educational, or other similar exempt purpose shall have the
same meaning as in paragraph (b) of Sec. 53.4942(b)-1.
(3) Example. This paragraph may be illustrated by the following
example:
Example. X, an exempt organization described in section 501(c)(3)
and not described in section 509(a) (1), (2), or (3), was created on
July 15, 1970. X uses the cash receipts and disbursements method of
accounting. For 1971, the fair market value of X's assets not described
in paragraph (c) (2) or (3) of Sec. 53.4942(a)-2 is $400,000. X makes
qualifying distributions for 1971 directly for the active conduct of its
exempt activities of $17,000. For 1971 two-thirds of X's minimum
investment return is $16,000 (6 percent x $400,000 = $24,000; \2/3\ x
$24,000 = $16,000). Under these circumstances, X has satisfied the
endowment test described in this paragraph for 1971. However, if X's
qualifying distributions for 1971 directly for the active conduct of its
exempt activities were only $15,000, X would not satisfy the endowment
test for 1971, unless the fair market value of its assets not described
in paragraph (c) (2) or (3) of Sec. 53.4942(a)-2 were no greater than
$375,000 (6 percent x $375,000 = $22,500; \2/3\ x $22,500 = $15,000).
(c) Support test--(1) In general. A foundation will satisfy the
support test under the provisions of this paragraph if:
(i) Substantially all of its support (other than gross investment
income as defined in section 509(e)) is normally received from the
general public and from five or more exempt organizations which are not
described in section 4946(a)(1)(H) with respect to each other or the
recipient foundation;
(ii) Not more than 25 percent of its support (other than gross
investment income) is normally received from any one such exempt
organization; and
(iii) Not more than half of its support is normally received from
gross investment income.
(2) Definitions and special rules. For purposes of this paragraph:
(i) Support. The term support shall have the same meaning as in
section 509(d).
(ii) Substantially all. The term substantially all shall have the
same meaning as in paragraph (c) of Sec. 53.4942(b)-1.
(iii) Support from exempt organizations. The support received from
any one exempt organization may be counted towards satisfaction of the
support test described in this paragraph only if the foundation receives
support from no fewer than five exempt organizations. For example, a
foundation which normally receives 20 percent of its support (other than
gross investment income) from each of five exempt organizations may
qualify under this paragraph even though it receives no support from the
general public. However, if a foundation normally received 10 percent of
its support from each of three exempt organizations and the balance of
its support from sources other than exempt organizations, such support
could not be taken into account in determining whether the foundation
had satisfied the support test set forth in this paragraph.
(iv) Support from the general public. ``Support'' received from an
individual, or from a trust or corporation (other than an exempt
organization), shall be taken into account as support from the general
public only to the extent that the total amount of the support received
from any such individual, trust, or corporation during the period for
determining the normal sources of the foundation's support (as set forth
in Sec. 53.4942 (b)-3) does not exceed 1 percent of the foundation's
total support (other than gross investment income) for such period. In
applying this 1-percent limitation, all support received by the
foundation from any person and from any other person or persons standing
in a relationship to such person which is described in section
4946(a)(1) (C)
[[Page 107]]
through (G) and the regulations thereunder shall be treated as received
from one person. For purposes of this paragraph, support received from a
governmental unit described in section 170(c)(1) shall be treated as
support received from the general public, but shall not be subject to
the 1-percent limitation.
Sec. 53.4942(b)-3 Determination of compliance with operating foundation tests.
(a) In general. A foundation may satisfy the income test and either
the assets, endowment, or support test by satisfying such tests for any
3 taxable years during a 4-year period consisting of the taxable year in
question and the three immediately preceding taxable years or on the
basis of an aggregation of all pertinent amounts of income or assets
held, received, or distributed during such 4-year period. A foundation
may not use one method for satisfying the income test described in
paragraph (a) of Sec. 53.4942(b)-1 and another for satisfying either
the assets, endowment, or support test described in Sec. 53.4942(b)-2.
Thus, if a foundation satisfies the income test on the 3-out-of-4-year
basis for a particular taxable year, it may not use the aggregation
method for satisfying either the assets, endowment, or support test for
such particular taxable year. However, the fact that a foundation has
chosen one method for satisfying the tests under Sec. Sec. 53.4942(b)-1
and 53.4942(b)-2 for 1 taxable year will not preclude it from satisfying
such tests for a subsequent taxable year by the alternate method. If a
foundation fails to satisfy the income test and either the assets,
endowment, or support test for a particular taxable year under either
the 3-out-of-4-year method or the aggregation method, it shall be
treated as a nonoperating foundation for such taxable year and for all
subsequent taxable years until it satisfies the tests set forth in
Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 for a taxable year occurring
after the taxable year in which it was treated as a nonoperating
foundation.
(b) New organizations--(1) In general. Except as provided in
subparagraph (2) of this paragraph, an organization organized after
December 31, 1969, will be treated as an operating foundation only if it
has satisfied the tests set forth in Sec. Sec. 53.4942(b)-1 and
53.4942(b)-2 for its first taxable year of existence. If an organization
satisfies such tests for its 1st taxable year, it will be treated as an
operating foundation from the beginning of such taxable year. If such is
the case, the organization will be treated as an operating foundation
for its 2d and 3d taxable years of existence only if it satisfies the
tests set forth in Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 by the
aggregation method for all such taxable years that it has been in
existence.
(2) Special rule. An organization organized after December 31, 1969,
will be treated as an operating foundation prior to the end of its 1st
taxable year if such organization has made a good faith determination
that it is likely to satisfy the income test set forth in paragraph (a)
of Sec. 53.4942(b)-1 and one of the tests set forth in Sec.
53.4942(b)-2 for such 1st taxable year pursuant to subparagraph (1) of
this paragraph. Such a ``good faith determination'' ordinarily will be
considered as made where the determination is based on an affidavit or
opinion of counsel of such organization that such requirements will be
satisfied. Such an affidavit or opinion must set forth sufficient facts
concerning the operations and support of such organization for the
Commissioner to be able to determine that such organization is likely to
satisfy such requirements. An organization which, pursuant to this
subparagraph, has been treated as an operating foundation for its 1st
taxable year, but actually fails to qualify as an operating foundation
under subparagraph (1) of this paragraph for such taxable year, will be
treated as a private foundation which is not an operating foundation as
of the 1st day of its 2d taxable year for purposes of making any
determination under the internal revenue laws with respect to such
organization. The preceding sentence shall not apply if such
organization establishes to the satisfaction of the Commissioner that it
is likely to qualify as an operating foundation on the basis of its 2d,
3d, and 4th taxable years. Thus, if such an organization fails to
qualify as an operating foundation in its 2d, 3d, or 4th taxable year
after having failed in its
[[Page 108]]
1st taxable year, it will be treated as a private foundation which is
not an operating foundation as of the 1st day of such 2d, 3d, or 4th
taxable year in which it fails to qualify as an operating foundation,
except as otherwise provided by paragraph (d) of this section. Such
status as a private foundation which is not an operating foundation will
continue until such time as the organization is able to satisfy the
tests set forth in Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 by either
the 3-out-of-4-year method or the aggregation method. For the status of
grants or contributions made to such an organization with respect to
sections 170 and 4942, see paragraph (d) of this section.
(c) Transitional rule for existing organizations. An organization
organized before December 31, 1969 (including organizations deemed to be
so organized by virtue of the principles of paragraph (e)(2) of Sec.
53.4942(a)-2), but which is unable to satisfy the tests under Sec. Sec.
53.4942(b)-1 and 53.4942(b)-2 for its first taxable year beginning after
December 31, 1969 on the basis of its operations for taxable years prior
to such taxable year by either the 3-out-of-4-year method or the
aggregation method, will be treated as a new organization for purposes
of paragraph (b) of this section only if:
(1) The organization changes its methods of operation prior to its
first taxable year beginning after December 31, 1972 to conform to the
requirements of Sec. Sec. 53.4942(b)-1 and 53.4942 (b)-2;
(2) The organization has made a good faith determination (within the
meaning of paragraph (b) (2) of the section) that it is likely to
satisfy the tests set forth in Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2
prior to its first taxable year beginning after December 31, 1972 on the
basis of its income or assets held, received, or distributed during its
taxable years beginning in 1970 through 1972; and
(3) Such good faith determination is attached to the return the
organization is required to file under section 6033 for its taxable year
beginning in 1972.
(d) Treatment of contributions--(1) In general. The status of grants
or contributions made to an operating foundation with respect to
sections 170 and 4942 will not be affected until notice of change of
status of such organization is made to the public (such as by
publication in the Internal Revenue Bulletin), unless the grant or
contribution was made after:
(i) The act or failure to act that resulted in the organization's
inability to satisfy the requirements of Sec. Sec. 53.4942 (b)-1 and
53.4942(b)-2, and the grantor or contributor was responsible for, or was
aware of, such act or failure to act, or
(ii) The grantor or contributor acquired knowledge that the
Commissioner has given notice to such organization that it would be
deleted from classification as an operating foundation.
(2) Exception. For purposes of subparagraph (1) (i) of this
paragraph, a grantor or contributor will not be considered to be
responsible for, or aware of, the act or failure to act that resulted in
the grantee organization's inability to satisfy the requirements of
Sec. Sec. 53.4942 (b)-1 and 53.4942(b)-2 if such grantor or contributor
has made his grant or contribution in reliance upon a written statement
by the grantee organization that such grant or contribution would not
result in the inability of such grantee organization to qualify as an
operating foundation. Such a statement must be signed by a foundation
manager (as defined in section 4946(b)) of the grantee organization and
must set forth sufficient facts concerning the operations and support of
such grantee organization to assure a reasonably prudent man that his
grant or contribution will not result in the grantee organization's
inability to qualify as an operating foundation.
Subpart D_Taxes on Excess Business Holdings
Authority: Secs. 4943 and 7805, Internal Revenue Code of 1954, 68A
Stat. 917, 83 Stat. 507; 26 U.S.C. 4943, 7805.
Source: T.D. 7496, 42 FR 46285, Sept. 15, 1977, unless otherwise
noted.
Sec. 53.4943-1 General rule; purpose.
Generally, under section 4943, the combined holdings of a private
foundation and all disqualified persons (as defined in section 4946(a))
in any corporation conducting a business which is not substantially
related (aside from the
[[Page 109]]
need of the foundation for income or funds or the use it makes of the
profits derived) to the exempt purposes of the foundation are limited to
20 percent of the voting stock in such corporation. In addition, the
combined holdings of a private foundation and all disqualified persons
in any unincorporated business (other than a sole proprietorship) which
is not substantially related (aside from the need of the foundation for
income or funds or the use it makes of the profits derived) to the
exempt purposes of such foundation are limited to 20 percent of the
beneficial or profits interest in such business. In the case of a sole
proprietorship which is not substantially related (within the meaning of
the preceding sentence), section 4943 provides that a private foundation
shall have no permitted holdings. These general provisions are subject
to a number of exceptions and special provisions which will be described
in following sections.
Sec. 53.4943-2 Imposition of tax on excess business holdings of private foundations.
(a) Imposition of initial tax--(1) In general--(i) Initial tax.
Section 4943(a)(1) imposes an initial excise tax (the ``initial tax'')
on the excess business holdings of a private foundation for each taxable
year of the foundation which ends during the taxable period defined in
section 4943(d)(2). The amount of such tax is equal to 5 percent of the
total value of all the private foundation's excess business holdings in
each of its business enterprises. In determining the value of the excess
business holdings of the foundation subject to tax under section 4943,
the rules set forth in Sec. Sec. 20.2031-1 through 20.2031-3 of this
chapter (Estate Tax Regulations) shall apply.
(ii) Disposition of certain excess business holdings within ninety
days. In any case in which a private foundation acquires excess business
holdings, other than as a result of a purchase by the foundation, the
foundation shall not be subject to the taxes imposed by section 4943,
but only if it disposes of an amount of its holdings so that it no
longer has such excess business holdings within 90 days from the date on
which it knows, or has reason to know, of the event which caused it to
have such excess business holdings. Similarly, a private foundation
shall not be subject to the taxes imposed by section 4943 because of its
purchase of holdings where it did not know, or have reason to know of
prior acquisitions by disqualified persons, but only if the foundation
disposes of its excess holdings within the 90-day period described
previously, and its purchase would not have created excess business
holding but for such prior acquisitions by disqualified persons. In
determining whether for purposes of this (ii) the foundation has
disposed of such excess business holdings during such 90-day period, any
disposition of holdings, by a disqualified person during such period
shall be disregarded.
(iii) Extension of ninety day period. The period described in
paragraph (a)(1)(ii) of this section, during which no tax shall be
imposed under section 4943, shall be extended to include the period
during which a foundation is prevented by federal or state securities
laws from disposing of such excess business holdings.
(iv) Effect of disposition subject to material restrictions. If a
private foundation disposes of an interest in a business enterprise but
imposes any material restrictions or conditions that prevent the
transferee from freely and effectively using or disposing of the
transferred interest, then the transferor foundation will be treated as
owning such interest until all such restrictions or conditions are
eliminated (regardless of whether the transferee is treated for other
purposes of the Code as owning such interest from the date of the
transfer). However, a restriction or condition imposed in compliance
with federal or state securities laws, or in accordance with the terms
or conditions of the gift or bequest through which such interest was
acquired by the foundation, shall not be considered a material
restriction or condition imposed by a private foundation.
(v) Foundation knowledge of acquisitions made by disqualified
persons. (A) For purposes of paragraph (a)(1)(ii) of this section,
whether a private foundation will be treated as knowing, or having
reason to know, of the acquisition of holdings by a disqualified person
[[Page 110]]
will depend on the facts and circumstances of each case. Factors which
will be considered relevant to a determination that a private foundation
did not know or had no reason to know of an acquisition are: the fact
that it did not discover acquisitions made by disqualified persons
through the use of procedures reasonably calculated to discover such
holdings; the diversity of foundation holdings; and the existence of
large numbers of disqualified persons who have little or no contact with
the foundation or its managers.
(B) The provisions of paragraph (a)(1)(v)(A) of this section may be
illustrated by the following example:
Example. By the fifteenth day of the fifth month after the close of
each taxable year, the F Foundation sends to each foundation manager,
substantial contributor, person holding more than a 20% interest (as
described in section 4946(a)(1)(C) in a substantial contributor, and
foundation described in section 4946(a)(1)(H), a questionnaire asking
such persons to list all holdings, actual or constructive, in each
business enterprise in which F had holdings during the taxable year in
excess of those permitted by the 2 percent de minimis rule of section
4943(c)(2)(C). In preparing the list of such enterprises, F takes into
account its constructive holdings only if, during the taxable year, F
(along with all related foundations described in section 4946(a)(1)(H))
owned over 2% of the voting stock, profits interest or beneficial
interest in the entity actually owning the holdings constructively held
by F. The questionnaire asks each such person to list the holdings in
such enterprises of any persons who, because of their relationship to
such disqualified person, were themselves disqualified persons (i.e.,
members of the family (as defined in section 4946(d)), and any
corporations, partnerships, trusts and estates described in section
4946(a)(1) (E) through (G) in which such person, or members of his
family, had an interest). The questionnaire asks that constructive
holdings be listed only if, during the taxable year, the disqualified
person owned over 2% of the voting stock, profits interest or beneficial
interest in the entity actually owning the holdings constructively held
by such person. (Thus a disqualified person owning less than 2% of a
mutual fund is not required to list his attributed share of all the
securities in the portfolio of the fund.) If no response to the
questionnaire is received, the foundation seeks the information
requested by the questionnaire by mailing a second (but not a third)
questionnaire. If a questionnaire which is returned to the foundation
indicates that certain information was unavailable to the person
completing the questionnaire, the foundation seeks that information
directly. For example, if a disqualified person indicates that he could
not find out whether a corporation described in section 4946(a)(1)(E)
had holdings in the enterprise listed in the questionnaire, the
foundation seeks to obtain this information directly from the
corporation by mailing it a questionnaire. In such a case F may be found
not to have reason to know of the acquisition of holdings by a
disqualified person.
(vi) Holdings acquired other than by purchases. See section
4943(c)(6) and Sec. 53.4943-6 for rules relating to the acquisition of
certain holdings other than by purchase by the foundation or a
disqualified person.
(2) Special rules. In applying subparagraph (1) of this paragraph,
the tax imposed by section 4943(a)(1):
(i) Shall be imposed on the last day of the private foundation's
taxable year, but
(ii) The amount of such tax and the value of the excess business
holdings subject to such tax shall be determined with respect to the
foundation's holdings (based upon voting power, profits or beneficial
interest, or value, whichever is applicable) in any business enterprise
as of that day during the foundation's taxable year when the
foundation's excess holdings in such enterprise were the greatest.
In applying subdivision (ii) of this subparagraph, if a foundation's
excess business holdings in a business enterprise which constitute such
foundation's greatest excess holdings in such enterprise for any taxable
year are maintained for 2 or more days during such taxable year, the
value of such excess holdings which is subject to tax under section
4943(a)(1) shall be the greatest value of such excess holdings in such
enterprise as of any day on which such greatest excess holdings are
maintained during such taxable year.
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. Y is a private foundation reporting on a calendar year
basis. On January 1, 1973, Y has 20 shares of common stock in
corporation N, of which five shares constitute excess business holdings.
On June 1, 1973, Y
[[Page 111]]
disposes of such five shares; however, because of additional
acquisitions of N common stock on such date by disqualified persons with
respect to Y, the remaining 15 shares of N common stock held by Y now
constitute excess business holdings. There are no further acquisitions
or dispositions of N common stock during 1973 by Y or its disqualified
persons. Although Y's greatest holdings in N during 1973 are held
between January 1, 1973, and May 31, 1973, Y's greatest excess holdings
in N during 1973 are held between June 1, 1973, and December 31, 1973.
Therefore, the tax specified in section 4943(a)(1) shall be computed on
the basis of the greatest value of such greatest excess holdings as of
any day between June 1 and December 31, 1973.
Example 2. X is a private foundation reporting on a calendar year
basis. On January 1, 1972, X has 100 shares of common stock in M
corporation which are excess business holdings. On such date each share
of M common stock has a fair market value of $100. On February 28, 1972,
in an effort to dispose of such excess business holdings, X sells 70
shares of M common stock for $120 per share (the fair market value of
each share on such date) to A, an individual who is not a disqualified
person within the meaning of section 4946(a). The value of $120 per
share is the highest fair market value between January 1 and February
28, 1972. X disposes of no more stock in M for the reminder of calendar
year 1972. On December 31, 1972, the fair market value of each share of
M common stock is $80. X calculates its tax on its excess business
holdings in M for 1972 as follows:
100 shares of M common stock times $120 fair market value $12,000
per share as of Feb. 28, 1972..............................
$12,000 multiplied by rate of tax (percent)................. 5
Amount of tax on X foundation's excess business holdings for $600
1972.......................................................
Example 3. Assume the same facts as in Example (2) except that the
sale of X to A occurs on January 7, 1973, when the fair market value of
each share of M corporation common stock equals $70. A value of $100 per
share is the highest fair market value of the M common stock between
January 1 and January 7, 1973. On may 9, 1973, X for the first time has
excess business holdings in N corporation in the form of 200 shares of N
common stock. The value per share of N common stock on May 9, 1973,
equals $200. X makes no disposition of the N common stock during 1973,
and the value of each share of N common stock as of December 31, 1973
equals $250 (the highest value of N common stock during 1973). X
calculates its tax on its excess business holdings in both M and N for
1973 as follows:
100 shares of M common stock times $100 fair market value $10,000
per share..................................................
$250 fair market value per share.......................... $50,000
Total................................................... $60,000
-----------
Total................................................... $60,000
$60,000 multiplied by rate of tax (percent)................. 5
Amount of tax on X foundation's excess business holdings for $3,000
1973.......................................................
(b) Additional tax. In any case in which the initial tax is imposed
under section 4943(a) with respect to the holdings of a private
foundation in any business enterprise, if, at the close of the taxable
period (as defined in section 4943(d)(2) and Sec. 53.4943-9) with
respect to such holdings the foundation still has excess business
holdings in such enterprise, there is imposed a tax under section
4943(b) equal to 200 percent of the value of such excess holdings as of
the last day of the taxable period.
[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 8084, 51 FR
16302, May 2, 1986]
Sec. 53.4943-3 Determination of excess business holdings.
(a) Excess business holdings--(1) In general. For purposes of
section 4943, the term ``excess business holdings'' means, with respect
to the holdings of any private foundation in any business enterprise (as
described in section 4943(d)(4)), the amount of stock or other interest
in the enterprise which, except as provided in Sec. 53.4943-2(a)(1),
the foundation, or a disqualified person, would have to dispose of, or
cause the disposition of, to a person other than a disqualified person
(as defined in section 4946(a)) in order for the remaining holdings of
the foundation in such enterprise to be permitted holdings (as defined
in paragraphs (b) and (c) of this section). If a private foundation is
required by section 4943 and the regulations thereunder to dispose of
certain shares of a class of stock in a particular period of time and
other shares of the same class of stock in a shorter period of time, any
stock disposed of shall be charged first against those dispositions
which must be made in such shorter period.
(2) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. Corporation X has outstanding 100 shares of voting stock,
with each share entitling the holder thereof to one vote. F, a private
foundation, possesses 20 shares of X voting stock representing 20
percent of the voting power in X. Assume that the permitted
[[Page 112]]
holdings of F in X under paragraph (b)(1) of this section are 11 percent
of the voting stock in X. F, therefore, possesses voting stock in X
representing a percentage of voting stock in excess of the percentage
permitted by such paragraph. Such excess percentage is 9 percent of the
voting stock in X, determined by subtracting the percentage of voting
stock representing the permitted holdings of F in X (i.e., 11 percent)
from the percentage of voting stock held by F in X (I.E., 20 percent).
(20%-11%=9%). The excess business holdings of F in X are an amount of
voting stock representing such excess percentage, or 9 shares of X
voting stock (9 percent of 100).
(b) Permitted holdings in an incorporated business enterprise--(1)
In general--(i) Permitted holdings defined. Except as otherwise provided
in section 4943(c) (2) and (4), the permitted holdings of any private
foundation in an incorporated business enterprise (including a real
estate investment trust, as defined in section 856) are:
(A) 20 percent of the voting stock in such enterprise reduced (but
not below zero) by
(B) The percentage of voting stock in such enterprise actually or
constructively owned by all disqualified persons.
(ii) Voting stock. For purposes of this section, the percentage of
voting stock held by any person in a corporation is normally determined
by reference to the power of stock to vote for the election of
directors, with treasury stock and stock which is authorized but
unissued being disregarded. Thus, for example, if a private foundation
holds 20 percent of the shares of one class of stock in a corporation,
which class is entitled to elect three directors, and such foundation
holds no stock in the other class of stock, which is entitled to elect
five directors, such foundation shall be treated as holding 7.5 percent
of the voting stock because the class of stock it holds has 37.5 percent
of such voting power, by reason of being able to elect three of the
eight directors, and the foundation holds one-fifth of the shares of
such class (20 percent of 37.5 percent is 7.5 percent). The fact that
extraordinary corporate action (e.g., charter or by-law amendments) by a
corporation may require the favorable vote of more than a majority of
the directors, or of the outstanding voting stock, of such corporation
shall not alter the determination of voting power of stock in such
corporation in accordance with the two preceding sentences.
(2) Nonvoting stock as permitted holdings--(i) In general. In
addition to those holdings permitted by paragraph (b)(1) of this
section, the permitted holdings of a private foundation in an
incorporated business enterprise shall include any share of nonvoting
stock in such enterprise held by the foundation in any case in which all
disqualified persons hold, actually or constructively, no more than 20
percent (35 percent where third persons have effective control as
defined in paragraph (b)(3)(ii) of this section) of the voting stock in
such enterprise. All equity interests which do not have voting power
attributable to them shall, for purposes of section 4943, the classified
as nonvoting stock. For this purpose, evidences of indebtedness
(including convertible indebtedness), and warrants and other options or
rights to acquire stock shall not be considered equity interests.
(ii) Stock with contingent voting rights and convertible nonvoting
stock. Stock carrying voting rights which will vest only when
conditions, the occurrence of which are indeterminate, have been met,
such as preferred stock which gains such voting rights only if no
dividends are paid thereon, will be treated as nonvoting stock until the
conditions have occurred which cause the voting rights to vest. When
such rights vest, the stock will be treated as voting stock that was
acquired other than by purchase, but only if the private foundation or
disqualified persons had no control over whether the conditions would
occur. Similarly, nonvoting stock which may be converted into voting
stock will not be treated as voting stock until such conversion occurs.
For special rules where stock is acquired other than by purchase, see
section 4943(c)(6) and the regulations thereunder.
(iii) Example. The provisions of this pararaph (2) may be
illustrated by the following example:
Example. Assume that F, a private foundation, holds 10 percent of
the single class of voting stock of corporation X, and owns 20
[[Page 113]]
shares of nonvoting stock in X. Assume further that A and B, the only
disqualified persons with respect to F, hold 10 percent of the voting
stock of X. Under the provisions of paragraph (b)(1) of this section the
10 percent of X voting stock held by F will be classified as permitted
holdings of F in X since 20 percent less the percentage of voting stock
held by A and B in X is 10 percent. In addition, under the provisions of
this (2), the 20 shares of X nonvoting stock will qualify as permitted
holdings of F in X since the percentage of voting stock held by A and B
in X is no greater than 20 percent.
(3) Thirty-five-percent rule where third person has effective
control of enterprise--(i) In general. Except as provided in section
4943(c)(4), paragraph (b)(1) of this section shall be applied by
substituting 35 percent for 20 percent if:
(A) The private foundation and all disqualified persons together do
not hold, actually or constructively, more than 35 percent of the voting
stock in the business enterprise, and
(B) The foundation establishes to the satisfaction of the
Commissioner that effective control (as defined in paragraph (b)(3)(ii)
of this section) of the business enterprise is in one or more persons
(other than the foundation itself) who are not disqualfied persons.
(ii) ``Effective control'' defined. For purposes of this
subparagraph, the term ``effective control'' means the possession,
directly or indirectly, of the power to direct or cause the direction of
the management and policies of a business enterprise, whether through
the ownership of voting stock, the use of voting trusts, or contractual
arrangements, or otherwise. It is the reality of control which is
decisive and not its form or the means by which it is exercisable. Thus,
where a minority interest held by individuals who are not disqualified
persons has historically elected the majority of a corporation's
directors, effective control is in the hands of those individuals.
(4) Two percent de minimis rule--(i) In general. Under section
4943(c)(2)(C), a private foundation is not treated as having excess
business holdings in any incorporated business enterprise in which it
(together with all other private foundations (including trusts described
in section 4947(a)(2)) which are described in section 4946(a)(1)(H))
actually or constructively owns not more than 2 percent of the voting
stock and not more than 2 percent in value of all outstanding shares of
all classes of stock. If, however, the private foundation, together with
all other private foundations which are described in section
4946(a)(1)(H), actually or constructively owns more than 2 percent of
either the voting stock or the value of the outstanding shares of all
classes of stock in any incorporated business enterprise, all the stock
in such business enterprise classified as excess business holding under
section 4943 is treated as excess business holdings. For purposes of
this paragraph, any stock owned by a private foundation which is treated
as held by a disqualified person under section 4943(c)(4)(B), (5), or
(6) shall be treated as actually owned by the private foundation. See
paragraph (b)(1) of Sec. 53.4941(d)-4 for the determination of excess
business holdings without regard to section 4943(c)(2)(C) for purposes
of applying section 101(C)(2)(B) of the Tax Reform Act of 1969 (83 Stat.
533).
(ii) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. F, a private foundation, owns 1 percent of the single
class of voting stock and 1 percent in value of all the outstanding
shares of all classes of stock in X corporation. No other private
foundation described in section 4946(a)(1)(H) owns any stock in X. All
of the stock owned by F in X would be excess business holdings under
section 4943 (c)(1) if section 4943(c)(2)(C) were inapplicable. F owns
no no other shares of stock in X. Since F owns more than 2 percent of
the voting stock and no more than 2 percent in value of all outstanding
shares of all classes of stock in X, under section 4943(c)(2)(C) none of
the stock in X owned by F is treated as excess business holdings.
Example 2. Assume the facts as stated in Example (1), except that F
and T, a controlled private foundation under section 4946 (a)(1)(H),
together own 1 percent of all the voting stock and 1 percent in value of
all the outstanding shares of all classes of stock in X. All of the
stock in X owned by F and T would be excess business holdings under
section 4943(c)(1) if section 4943(c)(2)(C) were inapplicable. Since F
and T together owned no more than 2 percent of the voting stock and no
more than 2 percent in value of all outstanding shares of all classes of
stock in X, under section 4943(c)(2)(C) none of the stock in X owned by
either F or T is treated as excess business holdings.
[[Page 114]]
Example 3. Assume the facts as stated in Example (1), except that F
owns 3 percent of the voting stock in X, 2 percent of which is treated
as held by P, a disqualified person of F, under section 4943(c)(4)(B).
Under subdivision (i) of this subparagraph, the 2 percent of the stock
in X owned by F which is treated as held by P under section
4943(c)(4)(B) is treated as actually owned by F for purposes of section
4943(c)(2)(C). Consequently, all of the X stock owned by F is treated as
excess business holdings under section 4943(c)(2)(C). However, only 1
percent of the stock in X is subject to tax under section 4943(a), since
the other 2 percent is treated as owned by a disqualified person under
section 4943(c)(4)(B) for purposes of determining the tax upon F under
section 4943(a).
(c) Permitted holdings in an unincorporated business enterprise--(1)
In general. The permitted holdings of a private foundation in any
business enterprise which is not incorporated shall, subject to the
provisions of subparagraphs (2), (3), and (4) of this paragraph, be
determined under the principles of paragraph (b) of this section.
(2) Partnership or joint venture. In the case of a partnership
(including a limited partnership) or joint venture. the terms ``profits
interest'' and ``capital interest'' shall be substituted for ``voting
stock'' and ``nonvoting stock,'' respectively, wherever those terms
appear in paragraph (b) of this section. The interest in profits of such
foundation (or such disqualified person) shall be determined in the same
manner as its distributive share of partnership taxable income. See
section 704(b) (relating to the determination of the distributive share
by the income or loss ratio) and the regulations thereunder. In the
absence of a provision in the partnership agreement, the capital
interest of such foundation (or such disqualified person) in a
partnership shall be determined on the basis of its interest in the
assets of the partnership which would be distributable to such
foundation (or such disqualified person) upon its withdrawal from the
partnership, or upon liquidation of the partnership, whichever is the
greater.
(3) Sole proprietorship. For purposes of section 4943, a private
foundation shall have no permitted holdings in a sole proprietorship. In
the case of a transfer by a private foundation of a portion of a sole
proprietorship, see paragraph (c)(2) of this section (relating to
permitted holdings in partnerships). For the treatment of a private
foundation's ownership of a sole proprietorship prior to May 26, 1969,
see Sec. 53.4943-4.
(4) Trusts and other unincorporated business enterprises--(i) In
general. In the case of any unincorporated business enterprise which is
not described in paragraph (c) (2) or (3) of this section, the term
``beneficial interest'' shall be substitued for ``voting stock''
wherever the term appears in paragraph (b) of this section. Any and all
references to nonvoting stock in paragraph (b) of this section shall be
inapplicable with respect to any unincorporated business enterprise
described in this subparagraph.
(ii) Trusts. For purposes of section 4943, the beneficial interest
of a private foundation or any disqualified person in a trust shall be
the beneficial remainder interest of such foundation or person
determined as provided in paragraph (b) of Sec. 53.4943-8.
(iii) Other unincorporated business enterprises. For purposes of
section 4943, the beneficial interest of a private foundation or any
disqualified person in an unincorporated business enterprise (other than
a trust or an enterprise described in paragraph (c) (2) or (3) of this
section) includes any right to receive a portion of distributions of
profits of such enterprise, and, if the portion of distributions is not
fixed by an agreement among the participants, any right to receive a
portion of the assets (if any) upon liquidation of the enterprise,
except as a creditor or employee. For purposes of this subparagraph, a
right to receive distributions of profits includes a right to receive
any amount from such profits (other than as a creditor or employee),
whether as a sum certain or as a portion of profits realized by the
enterprise. Where there is no agreement fixing the rights of the
participants in such enterprise, the interest of such foundation (or
such disqualified person) in such enterprise shall be determined by
dividing the amount of all equity investments or contributions to the
capital of the enterprise made or obligated to be made by such
foundation (or such disqualified person) by the amount of all equity
investments or contributions to capital made or obligated to be
[[Page 115]]
made by all participants in the enterprise.
(d) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. Corporation X has outstanding 100 shares of voting stock,
with each share entitling the holder thereof to one vote. Assume that F,
a private foundation, possesses 30 shares of X voting stock, and that A
and B, the only disqualified persons with respect to F, together own 10
shares of X voting stock. The excess business holdings of F in X are 20
shares of X voting stock, determined as follows:
(i) Determination of voting stock percentages
(a) Total number of outstanding votes in X.............. 100
(b) Total number of votes in X held by F................ 30
(c) Total number of votes in X held by A and B.......... 10
(d) Percentage of voting stock in X held by F (item (b) 30
divided by item (a)) (percent).........................
(e) Percentage of voting stock in X held by A and B 10
(item (c) divided by item (a)) (percent)...............
(ii) Determination of permitted holdings of voting stock
(a) Percentage of voting stock in X held by A and B 10
(percent)..............................................
(b) Permitted holdings of voting stock by F in X (20 pct 10
less item (a)) (percent)...............................
(iii) Determination of excess business holdings
(a) Percentage of voting stock in X held by F (percent). 30
(b) Permitted holdings of voting stock by F in X 10
(percent)..............................................
(c) Item (a) less item (b) (percent).................... 20
(d) Excess business holdings of F in X (i.e., an amount 20
of X voting stock representing a percentage of voting
stock equivalent to that in item (c)) (shares).........
* * * * * * *
------------------------------------------------------------------------
Example 2. F, a private foundation, is a partner in P partnership.
In addition, A and B, the only disqualified persons with respect to F,
are partners in P. The partnership agreement of P contains no provisions
regarding the sharing of profits by, and the respective capital
interests of, the partners.
(i) assume that, under section 704(b), F's distributive share of P
taxable income is determined to be 20 percent. In addition, assume that
under such section, A and B are determined to have a 4-percent
distributive share each of P taxable income. Accordingly, F holds a 20-
percent profits interest in P, and A and B hold an 8-percent profits
interest in P. Assuming that the provisions of section 4943(c)(2)(B) do
not apply, the permitted holdings of F in P are 12 percent of the
profits interest in P, determined by subtracting the percentage of the
profits interest held by A and B in P (i.e., 8 percent) from 20 percent.
(20 percent-8 percent=12 percent.) F, therefore, holds a percentage of
the profits interest in P in excess of the percentage permitted by Sec.
53.4943-3(b)(1). The excess business holdings of F in P are a percentage
of the profits interest in P equivalent to such excess percentage, or 8
percent of the profits interest in P, determined by subtracting the
permitted holdings of F in P (i.e., 12 percent) from the percentage of
the profit interest held by F in P (i.e., 20 percent) (20 percent-12
percent=8 percent.)
(ii) Assume that, under the partnership agreement, F would be
entitled to a distribution of 20 percent of P's assets upon F's
withdrawal from P and to a distribution of 30 percent of P's assets upon
the liquidation profits interest held by F in P (i.e., 20 percent) (20
percent-12 percent=8 percent), of P. F, therefore, holds a 30-percent
capital percentage of the assets of P distributable to F upon F's
withdrawal from P, or the percentage of such assets distributable to F
upon the liquidation of P. Since the percentage of the profits interest
held by A and B in P is less than 20 percent, such 30-percent capital
interest will be included in the permitted holdings of F in P.
Sec. 53.4943-4 Present holdings.
(a) Introduction--(1) Section 4943 (c)(4) in general. (i) Paragraph
(4) of section 4943(c) prescribes transition rules for a private
foundation which, but for such paragraph, would have excess business
holdings on May 26, 1969. Section 4943(c)(4) provides such a foundation
with protection from the initial tax on excess business holdings in two
ways. First, the entire interest of such a foundation in any business
enterprise in which such a foundation, but for section 4943(c)(4), would
have had excess business holdings on May 26, 1969, is treated under
section 4943(c)(4)(B) as held by disqualified persons for a certain
period of time (the ``first phase''). The effect of such treatment is to
prevent a private foundation from being subject to the initial tax with
respect to its May 26, 1969, interest during the first phase holding
period and also to prevent the foundation from purchasing any additional
business holdings in such business enterprise during
[[Page 116]]
such period (unless the combined holdings of the foundation and all
disqualified persons fall below the 20 percent (or 35 percent, if
applicable) figure prescribed by section 4943(c)(2)). Second, section
4943(c)(4)(A)(i) initially increases the percentage of permitted
holdings of such a foundation to a percentage equal to the difference
between:
(A) The percentage of combined holdings of the foundation and all
disqualified persons in such business enterprise on May 26, 1969
(subject to a 50 percent maximum), and
(B) The percentage of holdings of all disqualified persons.
The percentage referred to in paragraph (a)(1)(i)(A) of this section is
referred to in this section as the ``substituted level''. This
``substituted level'' is then reduced by the ``downward ratchet rule''
prescribed by section 4943(c)(4)(A)(ii) and paragraph (d)(3) of this
section for certain dispositions by such foundation or by disqualified
persons. The primary purpose of the substituted level is to indicate
what the permitted holdings in such business enterprise will be
immediately after the expiration of the first phase holding period.
Thereafter, the permitted holdings of a private foundation itself are
further limited to a maximum 25 percent interest in such business
enterprise by section 4943(c)(4)(D) as soon as the combined holdings of
all disqualified persons in such business enterprise exceed 2 percent
(of the voting stock). If the combined holdings of all disqualified
persons at no time exceed 2 percent (of the voting stock) during the 15
years following the first phase (the ``second phase''), then the
substituted level is reduced to a 35 percent maximum after the second
phase.
(ii) Paragraph (a)(1)(i) of this section may be illustrated by the
following example:
Example. On May 26, 1969, private foundation P held a 5 percent
interest in corporation X (voting stock and value). On such date
disqualified persons held a 16 percent interest in X (voting stock and
value). Assume that except for section 4943(c)(4), P would have had a 1
percent interest in X which would have consitituted excess business
holdings. Therefore, section 4943(c)(4)(B) applies and P's 5 percent
interest in X is treated as held by a disqualified person during the 10-
year period beginning May 26, 1969. Since the entire 21 percent held by
P and disqualified persons is now treated as held by disqualified
persons, P's substituted level is 21 percent and its permitted holdings
are zero (21%-21%). However, P has no excess business holdings in X,
because during the 10-year period P is not treated as holding such
interest. The only change in the interest in X occurs on January 2,
1972, when P disposes of 2 percent of its interest in X to A, an
unrelated person. Since the interest held by P and all disqualified
persons (21%-2%=19%) has decreased below 20 percent, P's substituted
level is reduced to 20 percent and its permitted holdings are 1 percent
(20%-19%) on such date. Therefore, if the other interests in X do not
change, P will not have excess business holdings if P purchases no more
than an additional 1 percent interest in X.
(2) Interaction of provisions of section 4943(c) (4), (5), and (6).
During the first phase, a private foundation may acquire additional
interests in a business enterprise, other than by purchase, which are
entitled to be treated as held by disqualified persons for varying
holding periods under section 4943(c) (5) or (6) (relating respectively
to certain holdings aquired pursuant to the terms of a trust or will in
effect on May 26, 1969, and to the 5-year period to dispose of certain
gifts, bequests, etc.). In any case holdings which the private
foundation disposes of shall be charged first against those holdings
which it must dispose of in the shortest period in order to avoid the
initial tax thereon. Further, acquisions of a private foundation under a
pre-May 27, 1969, will or trust described in section 4943(3)(5) are
treated in a manner similar to the treatment of interests actually held
by a private foundation on May 26, 1969. See Sec. Sec. 53.4943-5 and
53.4943-6.
(b) Present holdings in general. (1) Section 4943(c)(4)(B) provides
that any interest in a business enterprise held by a private foundation
on May 26, 1969, if the foundation on such date has excess business
holdings (determined without regard to section 4943(c)(4)), shall (while
held by the foundation) be treated as held by a disqualified person
during a first phase. Therefore, no interest of a private foundation
shall be treated as held by a disqualified person under section
4943(c)(4)(B) and this section unless:
[[Page 117]]
(i) The private foundation was an entity (not including a revocable
trust) in existence on May 26, 1969, even though it was not then treated
as a private foundation under section 509 or section 4947;
(ii) Such interest was actually or constructively owned by such
entity on such date; and
(iii) Without regard to section 4943(c)(4) such entitly had on such
date an interest (considered in connection with the interests actually
or constructively owned by all disqualified persons with respect to such
entity on that date in the same business enterprise, determined as if
the entity were then a private foundation) which exceeded the permitted
holdings prescribed by section 4943(c) (2) or (3).
(See, however, section 4943(c)(5) and Sec. 53.4943-5 for similar
treatment for certain interests acquired by a private foundation under
the terms of a trust or a will which were in effect on May 26, 1969.) If
a private foundation owns an interest described by section
4943(c)(4)(B), then the length of the first phase for such an interest
is prescribed by paragraph (c) of this section and shall not be affected
by any interest acquired by the private foundation or any disqualified
person in such business enterprise after May 26, 1969. In addition, the
amount of permitted holdings in such business enterprise is prescribed
by paragraph (d) of this section. An interest constructively held by a
private foundation (or a disqualified person) on May 26, 1969, shall not
cease to be an interest to which section 4943(c)(4) applies merely
because it is later distributed to such foundation (or to such
disqualified person). Nor shall an interest directly held by a private
foundation (or to such disqualified person) on May 26, 1969, cease to be
treated as an interest to which section 4943(c)(4) applies to the extent
it remains actually or constructively held by such foundation (or such
disqualified person) upon transfer of such interest, such as upon the
incorporation of a sole proprietorship.
(2) The provision of this paragraph may be illustrated by the
following example:
Example. A, a nonprofit research organization described in section
501(c)(3), was organized in 1966. On May 26, 1969, A held 50 percent of
the stock of corporation B. For its taxable years 1970, 1971, and 1972,
A is classified as an organization described in section 509(a)(2).
However, for 1973 and subsequent years, A fails to satisfy the gross
investment income limitation of section 509(a)(2)(B), and is thus
classified as a private foundation. In such a case, section 4943(c)(4)
applies, and a disqualified person shall be treated as holding A's stock
in B during a first phase that begins on May 26, 1969.
(c) First Phase holding periods--(1) In general. If, on May 26,
1969, a private foundation has excess business holdings in any business
enterprise (determined with regard to the 20 or 35 percent permitted
holdings of section 4943(c)(2)), then all interest which such foundation
holds, actually or constructively, in such enterprise on May 26, 1969,
shall (while held by such foundation) be deemed held by a disqualified
person during the following periods:
(i) The 20-year period beginning on May 26, 1969, if the private
foundation holds, actually or constructively, more than 95 percent of
the voting stock (or more than a 95 percent profits or beneficial
interest in the case of an unincorporated enterprise) in such enterprise
on such date;
(ii) Except as provided in paragraph (c)(1)(i) of this section, the
15-year period beginning on May 26, 1969, if the private foundation and
all disqualified persons hold, actually or constructively on such date
more than 75 percent of the voting stock (or more than a 75 percent
profits or beneficial interest in the case of any unincorporated
enterprise) or 75 percent of the value of all outstanding shares of all
classes of stock in such enterprise (or more than a 75 percent profits
and capital interest in the case of a partnership or joint venture); or
(iii) The 10-year period beginning on May 26, 1969, in any case not
described in paragraph (c)(1) (i) or (ii) of this section.
The 20-year, 15-year, or 10-year period described in this subdivision
(whichever applies) shall, for purposes of section 4943 and this
section, be known as the ``first phase.''
(2) Sole proprietorships. The 20-year period described in paragraph
(c)(1) of this section shall apply with respect to
[[Page 118]]
any interest which a private foundation holds in a sole proprietorship
on May 26, 1969. See paragraph (b) of this section for the effect of
converting such an enterprise to a corporate, partnership, or other
form.
(3) Suspension of first-phase periods. The 20-year, 15-year, or 10-
year period described in paragraph (c)(1) of this section shall be
suspended during the dependency of any judicial proceeding which is
brought and diligently litigated by the private foundation and which is
necessary to reform, or to excuse the foundation from compliance with,
its governing instrument or any other instrument (as in effect on May
26, 1969) in order to allow disposition of any excess business holdings
held by the foundation on May 26, 1969.
(4) Election to shorten the period during which certain holdings of
private foundations are treated as held by disqualified persons. If, on
May 26, 1969, the combined holdings of a private foundation and all
disqualified persons in any one business enterprise are such as to make
applicable the 15-year period referred to in paragraph (c)(1)(ii) of
this section, and if, on such date, the foundation's holdings do not
exceed 95 percent of the voting stock in such enterprise, then such 15-
year period is shortened to the 10-year period referred to in paragraph
(c)(1)(iii), if at any time before January 1, 1971, one or more
individuals:
(i) Who are substantial contributors (as described in section
507(d)(2)), or members of the family within the meaning of section
4946(d) of one or more substantial contributors, to such private
foundation, and
(ii) Who on May 26, 1969, held in the aggregate more than 15 percent
of the voting stock in the enterprise, made an election in the manner
described in 26 CFR 143.6 (rev. as of Apr. 1, 1974).
(5) Examples. The provisions of this paragraph (c) may be
illustrated by the following examples:
Example 1. Assume that F, a private foundation, owns, on May 26,
1969, 50 shares of voting stock in corporation X respresenting 50
percent of the voting power in X and 25 percent of the value of all
outstanding shares of all classes of stock in X. Assume further that A
and B, the only disqualified persons with respect to F, own five shares
each of voting stock in X on such date. The 10 shares of voting stock in
X owned by A and B together represent 10 percent of the voting power in
X and 5 percent of the value of all outstanding shares of all classes of
stock in X. Under the provisions of Sec. 53.4943-3, the excess business
holdings of F, in X (determined without regard to section 4943(c)(4)) as
of such date are, therefore, 40 percent of X voting stock. Accordingly,
since the combined holdings of F, A, and B in X are, on such date, less
than 75 percent of the voting stock in X and less than 75 percent of the
value of all outstanding shares of all classes of stock in X, under the
provisions of section 4943(c)(4)(B)(iii), all holdings of F in X (i.e.,
50 percent of X voting stock) will be treated as held by a disqualified
person through May 25, 1979.
Example 2. Assume the facts as stated in Example (1), except that F,
on December 15, 1969, purchases an additional 10 shares of voting stock
in X representing 10 percent of X voting power. Assume, further, that
there were no other transactions in the stock in X during 1969. While
the 50 percent of X voting stock held by F on May 26, 1969, will be
deemed held by a disqualified person through May 25, 1979, the
additional 10 shares of X voting stock acquired by purchase by F on
December 15, 1969, will no be deemed to be so held. Accordingly, since,
under the provisions of Sec. 53.4943-3, such 10 shares represent excess
business holding of F in X, such 10 shares will be subject to the
imposition of tax under the provisions of section 4943(a).
Example 3. Assume the facts as stated in Example (1), except that F,
on December 15, 1971 acquires an additional 10 shares of voting stock in
X (representing 10 percent of X voting power) under the terms of a will
which was executed before May 26, 1969, to which section 4943(c)(5)
applies. While the 50 percent of X voting stock held by F on May 26,
1969, will be deemed held by a disqualified person through May 25, 1979,
the additional 10 percent of X voting stock acquired by F on December
15, 1971, will, under the provisions of section 4943(c)(5), be deemed
held by a disqualified person through December 14, 1981. See Sec.
53.4943-5.
Example 4. Assume that F, a private foundation, owns on May 26,
1969, 50 shares of voting stock in corporation Y representing 50 percent
of the voting power in Y. Assume further that C and D, the only
disqualified persons with respect to F, own on such date 15 shares each
of Y voting stock and that the 30 shares of Y voting stock owned by C
and D together represent 30 percent of the voting power in Y. Under the
provisions of Sec. 53.4943-3 the excess business holdings of F in Y
(determined without regard to section 4943(c)(4)) as of such date are,
therefore, 50 percent of Y voting stock. Accordingly, since the combined
holdings of F, C, and D in Y represent, on such date, more than 75
percent of the voting stock in Y, under the provisions of section
4943(c)(4)(B)(ii), all holdings of F in Y
[[Page 119]]
(i.e., 50 percent of Y voting stock will be treated as held by a
disqualified person through May 25, 1984.
Example 5. M, a private foundation, owns on May 26, 1969, sole
proprietorship S. Since, under the provisions of Sec. 53.5954-3, M's
ownership of S constitutes excess business holdings (determined without
regard to section 4943(c)(4) as of May 26, 1969, and since M's interest
in S is greater than 95 percent on such date, under the provisions of
this paragraph a disqualified person will be treated as the owner of S
for the 20-year period beginning on such date. If S is later
incorporated, that percentage of the interest in S retained by M, even
though less than a 95-percent interest, shall continue to be treated as
held by a disqualified person through May 25, 1989.
Example 6. A and B, individuals, together own on May 26, 1969, 40
shares of voting stock in corporation X representng 40 percent of the
voting power in X and 20 percent of the value of all outstanding shares
of all classes of stock in X. A and B are both disqualified persons with
respect to F, a private foundation, which owns no stock in X on May 26,
1969. On January 1, 1973, A and B donate the 40 shares of X voting stock
held by them to F. Since F had no excess business holdings on May 26,
1969, section 4943(c)(4) does not apply. See however, section 4943(c)(6)
and Sec. 53.4943-6.
Example 7. Assume the facts as stated in Example (6), except that F,
on May 26, 1969, owns 50 shares of voting stock in X, representing 50
percent of the voting power in X and 25 percent of the value of all
outstanding shares of all classes of stock in X. Under the provisions of
this paragraph, the 50 shares of X voting stock held by F on May 26,
1969 shall be treated in accordance with the provisions of section
4943(c)(4), while the 40 shares of X voting stock acquired by F on
January 1, 1973 shall be treated in accordance with the provisions of
section 4943(c)(6). See Sec. 53.4943-6.
(d) Permitted holdings under section 4943(c)(4)--(1) In general. The
permitted holdings of a private foundation to which section 4943 (c)(4)
applies in a business enterprise shall be as follows:
(i) The excess of the substituted combined voting level over the
disqualified person voting level, and separately,
(ii) The excess of the substituted combined value level over the
disqualified person value level.
(2) Definitions. For purposes of paragraph (d) of this section:
(i) The term disqualified person voting level on any given date
means the percentage of voting stock held by all disqualified persons
together on such date (including stock deemed held by such a person by
reason of section 4943(c)(4), (5), or (6)).
(ii) The term disqualified person value level on any given date
means the percentage of the total value of all outstanding shares of all
classes of stock in a business enterprise held by all disqualified
persons together on such date (including stock deemed held by such a
person by reason of section 4943(c)(4), (5), or (6)).
(iii) The term foundation voting level prior to the second phase is
equal to zero. After the first phase, such term on any given date means
the lowest percentage of voting stock held by a private foundation
(without regard to section 4943(c)(4)(B)) in a business enterprise on
May 26, 1969, and at all times thereafter up to such date. See section
4943(c)(5) and Sec. 53.4943-5 for the effect of the interests acquired
pursuant to the terms of certain wills or trusts in effect on May 26,
1969.
(iv) The term foundation value level prior to the second phase is
equal to zero. After the first phase, such term on any given date means
the lowest percentage of the total value of all outstanding shares of
all classes of stock held by a private foundation (without regard to
section 4943(c)(4)(B)) in a business enterprise on May 26, 1969, and at
all times thereafter up to such date. See section 4943(c)(5) and Sec.
53.4943-5 for the effect of interests acquired pursuant to the terms of
certain wills or trusts in effect on May 26, 1969.
(v) The term substituted combined voting level means the lowest
percentage to which the sum of the foundation voting level plus the
disqualified person voting level has been reduced since May 26, 1969, by
paragraph (d)(4) of this section to the following modifications (the
``downward ratchet rule''), subject;
(A) In no event shall such substituted level exceed 50 percent; and
(B) Such substituted level shall be increased (but not above 50
percent) in accordance with section 4943(c)(5) and Sec. 53.4943-5 for
certain interests acquired by such foundation pursuant to the terms of a
will or trust in effect on May 26, 1969.
(vi) The term substituted combined value level means the lowest
percentage to which the sum of the foundation value level plus the
disqualified person
[[Page 120]]
value level has been reduced since May 26, 1969, by paragraph (d)(4) of
this section (the ``downward ratchet rule''), subject to the following
modifications:
(A) In no event shall such substituted level exceed 50 percent; and
(B) Such substituted level shall be increased (but not above 50
percent) in accordance with section 4943(c)(5) and Sec. 53.4943-5 for
certain interests acquired by such foundation pursuant to the terms of a
will or trust in effect on May 26, 1969.
(vii) In the case of an interest in a partnership or joint venture,
definitions (i) through (iv) of this subparagraph shall be applied by
substituting ``profit interests'' for ``voting stock'' and ``all
partnership interests'' for ``all outstanding shares of all classes of
stock.''
(viii) In the case of an interest in a business enterprise other
than a corporation, partnership or joint venture, definitions (i)
through (iv) of this subparagraph shall be applied by substituting
``beneficial remainder interests'' for ``voting stock'' and ``all
beneficial remainder interests'' and ``all outstanding shares of all
classes of stock.''
(ix) Each level defined in paragaph (d)(2)(iii), (iv) and (v) and
(vi) as of any date shall be carried over to the subsequent date subject
to any adjustments prescribed for such level.
(3) Permitted holdings--First phase. Since during the first phase
the substituted combined voting level generally does not exceed the
disqualified person voting level, and the substituted combined value
level generally does not exceed the disqualified person value level, the
permitted holdings during the first phase are generally equal to zero.
The permitted holdings during the first phase exceed zero only where the
20 percent (or 35 percent) limitation on the downward ratchet rule
contained in paragraph (d)(4)(ii)(B) of this section applies.
(4) Downward ratchet rule--(i) In general. Except as provided in
paragraph (d)(4)(ii) of this section and section 4943(c)(5):
(A) Scope of rule. In general, when the percentage of the holdings
in a business enterprise held by a private foundation and all
disqualified persons together to which section 4943(c)(4) applies
decreases, or when the percentage of the holdings of the private
foundation alone in such business enterprise decreases, such holdings
may not be increased (except as provided under section 4943(c) (5) or
(6)). This so-called ``downward ratchet rule'' is designed to prevent
the private foundation from purchasing additional holdings in the
business enterprise until the substituted combined voting level reduced
to the 20-percent (or 35 percent) figure prescribed by section
4943(c)(2).
(B) Levels affected. Under the downward ratchet rule any decrease
after May 26, 1969, in the percentage of holdings comprising either the
substituted combined voting level, the substituted combined value level,
the foundation voting level or the foundation value level shall cause
the respective level to be decreased to such decreased percentage for
purposes of determining the foundation's permitted holdings.
(C) Implementation of reductions. Thus, if at any time the sum of
the foundation voting level and the disqualified peson voting level is
less than the immediately preceding substituted combined voting level,
the substituted level shall be decreased so that it equals such sum. For
example, if on May 26, 1969, a foundation and all disqualified persons
together have holdings in a business enterprise equal to 50 percent, on
such date the substituted combined voting level and the disqualified
person voting level equal 50 percent (since such holdings of the
foundation are treated as held by a disqualified person). If the private
foundation or a disqualified person on May 27, 1969, sold 2 percent of
such holdings to a nondisqualified person, the disqualified person
voting level would be decreased to 48 percent (50%-2%), causing the
substituted combined voting level to be decreased to 48 percent. As a
further example, assume that on May 26, 1969, a foundation and all
disqualified persons together have holdings in a business enterprise
equal to 50 percent, and when the first phase expires on May 26, 1979,
the substituted combined voting level is still 50 percent, the
foundation voting level is 10 percent, and the disqualified person
voting level is 40 percent. If a disqualified person there-
[[Page 121]]
after sells 2 percent to a nondisqualified person so that the sum of the
disqualified person voting level (40%-2%=38%) and the foundation voting
level (10%) equals 48 percent (38%+10%), then the substituted combined
voting level is decreased to 48 percent. Similarly, if at any time the
sum of the foundation value level and the disqualified person value
level is less than the immediately preceding substituted combined value
level, the substituted combined value level shall be decreased so that
it equals such sum.
(D) Restrictions on increases in levels. In addition, none of the
four levels referred to in paragraph (d)(4)(i)(B) of this section may be
adjusted upward to reflect any increase in the holdings comprising such
level, except as provided in section 4943(c)(5) and Sec. 53.4943-5. As
a result, any transfer of May 26, 1969, holdings from a disqualified
person to a private foundation shall not increase the foundation voting
level or the foundation value level (unless the transfer qualifies under
section 4943(c)(5)), and thus may reduce the substituted combined value
level (and where appropriate, the substituted combined voting level).
Thus, in the last preceding example, if the disqualified person, instead
of selling the 2 percent interest to a nondisqualified person, had sold
such interest to the foundation, the substituted combined voting level
would still be reduced to 48 percent, since the disqualified person
voting level would be reduced by 2 percent (to 38%) but the foundation
voting level would not be increased by 2 percent (remaining at 10%).
However, any transfer of May 26, 1969, holdings from a private
foundation to a disqualified person under section 101(1)(2)(B) of the
Tax Reform Act of 1969, shall reduce the foundation value level (and,
where appropriate, the foundation voting level), but will not reduce the
substituted combined value level or the subsituted combined voting
level. The disqualified person voting level and disqualified person
value level are correspondingly increased, not being limited to interest
held since May 26, 1969. In addition, a transfer of May 26, 1969,
holdings from one disqualified person to another, for example, by
bequest, shall not reduce the substituted combined voting level nor the
substituted combined value level.
(ii) Exceptions--(A) One percent de minimus rule. If after May 26,
1969, there are one or more decreases in the holdings comprising any of
the four levels referred to in paragraph (d)(4)(i)(B) of this section
during any taxable year of a private foundation, and if such decreases
are attributable to issuances of stock (or such issuances coupled with
redemptions), then, unless the aggregate of such decreases equals or
exceeds 1 percent, the determination of whether there is a decrease in
such level for purposes of this paragraph (d)(4) shall be made only at
the close of such taxable year. If, however, the aggregate of such
decreases equals or exceeds 1 percent, such level shall be decreased at
that time as if the previous sentence has never applied.
(B) Twenty percent (or 35 percent) floor. In no event shall the
downward rachet rule contained in paragraph (d)(4)(i) of this section
decrease the substituted combined voting level or the substituted
combined value level below 20 percent, or, for purposes of section
4943(c)(2)(B), below 35 percent.
(iii) Special rules--(A) Change of foundation managers. In the case
of a foundation manager (as defined in section 4946(b)) who on May 26,
1969, owns holdings in a business enterprise and who is replaced by
another foundation manager, the decrease in the substituted combined
voting or value levels shall be limited to the excess, if any, of the
departing foundation manager's holdings over his successor's holdings.
(B) Termination of private foundation status under section 507. If
an organization gives the notification described in section
507(b)(1)(B)(ii) of the commencement of a 60-month termination period
and fails to meet the requirements of section 509(a)(1), (2) or (3) for
the entire period, then such organization will be treated as a private
foundation during the entire 60-month period for purposes of this
paragraph (d)(4) and section 4946(a)(1)(H). For example, X, a private
foundation gives notification of the commencement of a 60-month
termination commencing on
[[Page 122]]
January 1, 1972. X and Y, another private foundation, are effectively
controlled by the same persons within the meaning of section
4946(a)(1)(H). X and Y hold 25 percent each of the voting stock of Z
corporation on May 26, 1969, so that the substituted combined voting
level for X or Y is 50 percent on such date. If X meets the requirements
of section 509(a) (1), (2), or (3) for the entire 60-month period,
section 4946(a)(1)(H) is inapplicable to X, and, under the downward
ratchet rule, the substituted combined voting level for Y is decreased
by 25 percent. On the other hand, if X meets the requirements of section
509(a)(2) for its taxable years 1972 and 1973, but fails to meet the
requirements of section 509(a) (1), (2), or (3) in 1974, 1975, and 1976,
then solely for purposes of section 4943(c)(4)(A)(ii) and this paragraph
(d)(4), X will be treated as a disqualified person with respect to Y,
and Y will be treated as a disqualified person with respect to X, for
taxable years 1972 through 1976 pursuant to section 4946(a)(1)(H). Thus,
for purposes of section 4943(c)(4)(A)(ii) the substituted combined
voting level for X or Y will not be decreased by reason of the fact that
X was attempting to terminate under section 507(b)(1)(B), and assuming
no other transportations, such level; will remain at 50 percent.
(iv) Examples. The provisions of this paragraph (d)(4) may be
illustrated by the following examples:
Example 1. F, a private foundation, owns on May 26, 1969, 50 shares
of voting stock in corporation X representing to 50 percent of the
voting stock in X and 25 percent of the value of all outstanding shares
of all classes of stock in X. A and B, the only disqualified persons
with respect to F, together own, on such date, 2 shares of voting stock
in X representing 2 percent of the voting shock in X and 1 percent of
the value of all outstanding shares of all classes of stock in X. In
addition, on such date, F owns 30 shares of nonvoting stock in X,
representing 30 percent of the value of all outstanding shares of all
classes of stock in X, and A and B together own 15 shares of nonvoting
stock in X representing 15 percent of the value of all outstanding
shares of classes of stock in X. The provisions of section
4943(c)(4)(B)(iii) apply and during the 10-year period beginning on May
26, 1969, a disqualified person is deemed to hold all interests of F in
X. Assume that on February 1, 1972, F sells to C, unrelated in
individual, 12 shares of voting stock in X representing 12 percent of
the voting stock in X and 6 percent of the value of all outstanding
shares of all classes of stock in X.
(i) Beginning on May 26, 1969, the disqualified person voting level
is 52 percent, the foundation voting level is zero, and the substituted
combined voting level is 50 percent; the disqualified person value level
is 71 percent, the foundation value level is zero, and the substituted
combined value level is 50 percent.
(ii) Beginning on February 1, 1972, the disqualified person voting
level is 40 percent (52%-12%), the foundation voting level is zero, and
the substituted combined voting level is 40 percent; the disqualified
person value level is 65 percent (71%-6%), the foundation value level is
zero and the substituted combined value level is 50 percent.
Example 2. F, a private foundation on the calendar year basis,
holds, on May 26, 1969, 30 percent of the voting stock in corporation Y.
C and D, the only disqualified persons with respect to F, together hold,
on such date, 10 percent of the voting stock in Y. The provisions of
section 4943(c)(4)(B)(iii) apply with respect to F, and disqualified
persons are deemed to hold all interests of F in Y for the 10-year
period beginning on May 26, 1969, so that the substituted combined
voting level as of such date is 40 percent. On February 1, 1973, a stock
issuance by Y causes the combined holdings of voting power by F, C, and
D in Y to decrease by 0.3 percent. on June 1, 1973, another such
issuance causes such combined holdings to decrease by 0.5 percent. In
September 1, 1973, an unrelated stock redemption by Y causes such
combined holdings to increase by 0.4 percent. Under this paragraph the
determination whether there is a decrease in the substituted combined
voting level for purposes of the downward ratchet rule shall not be made
before January 1, 1974, since the aggregate of the decreases occurring
on February 1 and June 1 of 1973 is less than 1 percent (0.3%+0.5%).
Therefore, the substituted combined voting level as of January 1, 1974,
is 39.6 percent (40%-[(0.3%+0.5%)-0.4%].)
Example 3. Assume the facts as stated in Example (2), except that,
on October 1, 1973, a stock issuance by Y causes the combined holdings
of voting power by F, C, and D in Y to decrease by 0.3 percent. Since
the aggregate of the decreases occurring on February 1, June 1, and
October 1 of 1973 exceeds 1 percent, the determination whether there is
a decrease in the substituted combined voting level shall be made as of
October 1, 1973. At that time the substituted combined voting level
shall be reduced to 39.2 percent (40%-0.3%-0.5%), the lowest actual
combined holdings during the period that the de minimis rule was in
effect.
(5) Permitted holdings--Second phase--(i) In general. For purposes
of section
[[Page 123]]
4943 and this section, the term ``second phase'' means the 15-year
period immediately following the first phase. Upon the expiration of the
first phase with respect to an interest to which section 4943(c)(4)
applies, such interest shall no longer be treated as held by a
disqualified person under section 4943(c)(4)(B). During the second
phase, the manner of determining the permitted holdings of a private
foundation to which section 4943(c)(4) applies shall be the same as
applicable to the first phase, except that a 25 percent maximum shall
apply under certain conditions specified in paragraph (d)(5)(ii) of this
section. For these purposes the substituted combined voting level and
the substituted combined value level in effect for the foundation at the
end of the first phase shall be carried over to the second phase. The
substituted levels are carried over because although there is a decrease
in the disqualified person levels (since holdings are no longer treated
as held by disqualified persons under section 4943(c)(4)(B)), a
corresponding increase in the foundation levels occurs. For example, if
a private foundation on May 26, 1969, held 10 percent of the voting
stock in a corporation and disqualified persons held 40 percent of the
voting stock, both the disqualified person voting level and the
substituted combined voting level equal 50 percent (10%+40%). Assuming
no transactions during the first phase, on May 26, 1979, the
disqualified person voting level would be decreased to 40 percent (50%-
10%), but the foundation voting level would be increased to 10 percent
so that the substituted combined voting level would remain at 50
percent. In addition, the downward ratchet rule of paragraph (d)(4) of
this section shall continue to apply, to prevent the foundation and
disqualified persons from purchasing any additional interest in the same
enterprise until the substituted combined voting level decreases below
20 percent.
(ii) 25 percent maximum on foundation holdings. If, or as soon as,
the disqualified person voting level exceeds 2 percent after the
expiration of the first phase, the permitted holdings shall not
thereafter exceed 25 percent of the voting stock or 25 percent of the
value of all outstanding shares of all classes of stock, even though the
holdings of the foundation and all disqualified persons combined do not
exceed the substituted level. Solely for purposes of determining whether
the 25 percent limitation of this subdivision (ii) applies, the
disqualified person voting level shall not be treated as exceeding 2
percent solely as a result of the holdings of a private foundation which
are treated as held by a disqualified person by reason of section
4943(c) (5) or (6). For example, where under the constructive ownership
rules for trusts in Sec. 53.4943-8(b), a private foundation is deemed
to own more than 2 percent of the voting stock of a business enterprise
but such stock is treated as held by a disqualified person under section
4943(c)(5), the determination of the substituted percentage for
permitted holdings in the second phase will be as if the foundation
owned the stock held by the trust. Similarly, where a private foundation
is the only remainder beneficiary of a trust that is a disqualified
person under section 4946(a)(1)(H), the disqualified person voting level
shall not be treated as exceeding 2 percent solely as a result of the
holdings of such a trust.
(6) Permitted holdings--Third phase. For purposes of section 4943
and this section, the term ``third phase'' means the entire period
following the second phase. During the third phase the manner of
determining the permitted holdings of a private foundation to which
section 4943(c)(4) applies shall be the same as applicable to the second
phase under paragraph (d)(5) of this section (including the carryover of
levels from the earlier phase). However, if the 25 percent limit of
paragraph (d)(5)(ii) of this section never applied during the second
phase, the substituted combined voting level and the substituted
combined value level each shall not exceed 35 percent during the third
phase.
(7) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. F, a private foundation, owns on May 26, 1969, 30 shares
of voting stock in corporation Z representing 30 percent of the voting
power in Z and 15 percent of the value of all outstanding shares of all
classes of stock in Z, and owns, on such date, 10 shares of nonvoting
stock in Z representing 10 percent of the value of all outstanding
shares of
[[Page 124]]
all classes of stock in Z. E and G, the only disqualified persons with
respect to F, own, on such date, 5 shares each of nonvoting stock in Z.
The 10 shares of nonvoting stock in Z owned by E and G together
represent 10 percent of the value of all outstanding shares of all
classes of stock in Z. Assume further that F cannot meet the
requirements for the 35 percent test of section 4943(c)(2)(B). For
purposes of applying section 4943(c)(4)(B) and this paragraph, F has
excess business holdings in Z (determined without regard to section
4943(c)(4)), because under section 4943(c)(2)(A) F's permitted holdings
are 20 percent (20%-0%) of the voting stock since disqualified persons
have no holdings of voting stock. Therefore, section 4943(c)(4)(B) and
this paragraph apply, and a disqualified person is treated as holding
F's shares of both voting and nonvoting stock in Z for the 10-year
period through May 25, 1979. Thus, since all holdings by F in Z are
treated as held by a disqualified person during the first phase, F
cannot be subject to tax under section 4943(a) on its May 26, 1969,
holdings prior to the termination of the first phase, regardless of
whether or not disqualified persons purchase additional shares of Z
during the first phase.
Example 2. Assume the same facts as in Example (1), and further
assume that there were no transactions in the stock of Z during the
first phase (May 26, 1969 through May 25, 1979). During the first phase
the permitted holdings by F in Z for both the voting stock and the value
is zero. The disqualified person voting level and the substituted
combined voting level are each 30 percent, and the disqualified person
value level and the substituted combined value level are each 35 percent
(15%+10%+10%). The substituted levels are carried over into the second
phase. The disqualified person voting level on May 26, 1979, the
beginning of the second phase, is zero, because the voting shares held
by F are no longer treated as held by a disqualified person. Therefore,
F's permitted holdings on such date are 30 percent of the voting stock,
because such percentage is equal to the excess of the substituted
combined voting level (30%) over the disqualified person voting level
(0%). The disqualified person value level on May 26, 1979, is 10
percent, because the voting and nonvoting shares held by F are no longer
treated as held by a disqualified person. Therefore, F's permitted
holdings on such date are 25 percent of the value of Z stock, because
such percentage is equal to the excess of the substituted combined value
level (35%) over the disqualified person value level (10%) as of such
date.
Example 3. Assume the facts as stated in Example (2), except that E
and G acquire, on February 1, 1970, 10 shares of Z voting stock
representing 10 percent of the voting power in Z and 5 percent of the
value of all outstanding shares of all classes of stock in Z. During the
first phase such permitted holdings remain zero, and prior to May 25,
1979, the substituted combined voting level and substituted combined
value level remain 30 and 35 percent, respectively, because such levels
may not be increased by acquisitions by disqualified persons. However,
the disqualified person voting level and the disqualified person value
level are each increased to 40 percent (30%+10%) and 40 percent (35%+5%)
respectively. During the first phase the excess of the disqualified
person voting level over the substituted combined voting level (40%-30%)
and the excess of the disqualified person value level over the
substituted combined value level (40%-35%) indicate how much stock F
must dispose of during the first phase to avoid the initial tax when it
expires. On May 25, 1979, the last day of the first phase, F disposes of
12 shares of Z voting stock, representing 12 percent of the voting power
in Z and 6 percent of the value of all such outstanding shares. The
disposition by F reduces the interest F owns to 18 percent (30%-12%) of
the voting power, and 19 percent (25%-6%) of the value of all
outstanding shares of all classes of stock, in Z. Since the disqualified
person voting level decreases to 28 percent (40%-12%), the substituted
combined voting level as of May 25, 1979, accordingly is decreased to 28
percent under the downward ratchet rule. Similarly, the substituted
combined value level is decreased to 34 percent, as the disqualified
person value level as of such date is 34 percent (40%-6%). On May 26,
1979, the disqualified person voting level is 10 percent (28%-18%), and
the disqualified person value level is 15 percent (34%-19%), since the
shares owned by F are no longer treated as held by a disqualified person
as of such date. Accordingly, on May 26, 1979, the permitted holdings by
F and Z are 18 percent of the voting power in Z, because such percentage
is equal to the excess of the substituted combined voting level (28%)
over the disqualified person voting level (10%) as of such date.
Similarly, the permitted holdings of F in Z by value are 19 percent
(34%-15%). If F had not disposed of the 12 shares, then on May 26, 1979,
F's permitted holdings in voting power and value would be 20 percent
(30%-10%) and 20 percent (35%-15%), respectively.
Example 4. F, a private foundation, owns on May 26, 1969, 35 shares
of voting stock in corporation Y representing 35 percent of the voting
stock in Y and 17.5 percent of the value of all classes of stock in Y,
and owns on such date 45 shares of nonvoting stock representing 22.5
percent of the value of all outstanding shares of all classes of stock
in Y. No disqualified person with respect to F owns, on such date, any
stock in Y. Assume further that Y cannot meet the requirements of the 35
percent test of section 4943(c)(2)(B). For purposes of applying section
4943(c)(4)(B) and this paragraph, F has excess business
[[Page 125]]
holdings in Y (determined without regard to section 4943(c)(4)), because
under section 4943(c)(2)(A) F's permitted holdings are 20 percent (20%-
0%) of the voting stock since disqualified persons have no holdings of
voting stock. Therefore, section 4943(c)(4)(B) and this paragraph apply,
and a disqualified person is treated as holding F's shares of both
voting and nonvoting stock in Y for the 10-year period through May 25,
1979. During the first phase the permitted holdings by F in Y of both
the voting stock and of value are zero. The disqualified person voting
level and the substituted combined voting level are each 35 percent, and
the disqualified person value level and the substituted combined value
level are each 40 percent (17.5%+22.5%). The substituted levels are
carried over into the second phase. The disqualified person voting level
and value level on May 26, 1979, are both zero, because the shares held
by F are no longer treated as held by a disqualified person. Therefore,
F's permitted holdings on such date are 35 percent of the voting power
(35%-0%) and 40 percent of the value (40%-0%). Assume that on February
1, 1981, A, a disqualified person, acquires 6 percent of the voting
stock in Y representing 3 percent of the value of all outstanding shares
of all classes of stock in Y. The permitted holdings by F in Z on
February 1, 1981, are thus reduced to 25 percent of the voting stock
(the lesser of the separate 25% second phase limitation or 29% (35%
substituted combined voting level minus 6% disqualified person voting
level)) and 25 percent of the value (the lesser of the separate 25%
second phase limitation or 37% (40% substituted combined value level
minus 3% disqualified person value level)). But see paragraph (d)(8) of
this section for limitations on restrictions with respect to nonvoting
stock.
Example 5. Assume the same facts as in Example (4) except that A
does not acquire the 6 shares of voting stock until February 1, 1996 (in
the third phase), rather than on February 1, 1981. Thus, F's permitted
holdings in Y would remain at 35 percent of the voting stock and 40
percent of the value during the second phase, which expired on May 25,
1994. Assume that on May 25, 1994, the last day of the second phase, F
disposes of 10 shares of nonvoting stock representing 5 percent of the
value of all outstanding shares in Y to meet the 35 percent third phase
limit. In accordance with the downward ratchet rule, the substituted
combined value level and F's permitted holdings in Y would be reduced to
35 percent of value. On February 1, 1996, F's permitted holdings in Y
would be reduced to 25 percent of the voting stock (the lesser of the
separate 25% third phase limitation or 29% (35% substituted combined
voting level minus 6% disqualified person level)) and 25 percent of the
value (the lesser of the separate 25% third phase limitation or 32% (35%
substituted combined value level minus 3% disqualified person value
level)). But see paragraph (d)(8) of this section for limitations on
restrictions with respect to nonvoting stock.
(8) Special rule where all holdings are permitted under section
4943(c)(2). (i) Since section 4943(c)(4) and this paragraph provide
transitional rules for foundations which would otherwise have had excess
business holdings on May 26, 1969, no holdings shall cease to be
permitted holdings under this paragraph where such holdings would be
permitted holdings under section 4943(c)(2) and Sec. 53.4943-3. Thus,
for example, where the substituted combined voting level had been
reduced to 20 percent, the provisions of Sec. 53.4943-3(b)(2)
concerning nonvoting stock as permitted holdings generally apply.
(ii) The provisions of this paragraph (d)(8) may be illustrated by
the following example:
Example. (A) F, a private foundation, owns, on May 26, 1969, 40
shares of voting stock in corporation X representing 40 percent of the
voting stock in X and 20 percent of the value of all outstanding shares
of all classes of stock in X, and owns, on such date, 60 shares of
nonvoting stock in X, representing 30 percent of the value of all
outstanding shares of all classes of stock in X. A, the only
disqualified person with respect to F, owns, on such date, 10 shares of
voting stock in X, representing 10 percent of the voting stock in X and
5 percent of the value of all outstanding shares of all classes of stock
in X. Under section 4943(c)(4)(B)(iii), a disqualified person is deemed
the owner of all holdings by F in X for the 10-year period beginning on
May 26, 1969.
(B) Assume that the only transaction in X stock during the first
phase is the disposition of 30 shares of voting stock by F on May 1,
1975. The voting stock held by F is permitted holdings under Sec.
53.4943-3 and under such section since all disqualified persons together
do not own more than 20 percent of the voting stock in X, all nonvoting
stock held by F shall also be treated as permitted holdings. Therefore,
all the stock held by F is permitted holdings.
(C) Assume that on May 1, 1975, F had disposed of only 15 shares of
voting stock and also had disposed of 35 shares of nonvoting stock. On
May 26, 1979, at the beginning of the second phase, this paragraph
(d)(8) would not apply since F would have excess business holdings under
Sec. 53.4943-3. Under the provisions of this section, the permitted
holdings by F in X on such date are 25 percent of the
[[Page 126]]
voting stock (35% substituted combined voting level minus 10%
disqualified person voting level) and 25 percent of the value (30%
substituted combined value level minus 5% disqualified person value
level).
(9) Special rule for certain private foundations. In the case of a
private foundation:
(i) Which was incorporated before January 1, 1951.
(ii) Substantially all of the assets of which on May 26, 1969,
consisted of more than 90 percent of the stock of an incorporated
business enterprise which is licensed and regulated, the sales or
contracts of which are regulated, and the professional representatives
of which are licensed, by State regulatory agencies in at least 10
States;
(iii) Which acquired such stock solely by gift, devise, or bequest;
(iv) Which does not purchase any stock or other interest in such
enterprise after May 26, 1969, and does not acquire any stock or other
interest in any other business enterprise which constitutes excess
business holdings under Sec. 53.4943-3; and
(v) Which, in the last 5 taxable years ending on or before December
31, 1970, expended substantially all of its adjusted net income (as
defined in section 4942(f)) for the purpose or function for which it is
organized and operated;
paragraph (d) (1) through (5) of this section (permitted holdings during
the first and second phase) shall be applied with respect to the
holdings of such foundation in such incorporated business enterprise by
substituting ``51 percent'' for ``50 percent,'' and section
4943(c)(4)(D) (third phase) shall not apply with respect to such
holdings. For purposes of the preceding sentence, stock of such
enterprise in a trust created before May 27, 1969, of which the
foundation is the remainder beneficiary shall be deemed to be held by
such foundation on May 26, 1969, if such foundation held (without regard
to such trust) more than 20 percent of the stock of such enterprise on
May 26, 1969.
(10) Special rule for changes in the relative values of stock of
different classes. (i) In the case of a corporation that has more than
one class of stock outstanding, if the percentage of value held by the
private foundation, its disqualified persons, or both, increases over a
period of time solely as a result of changes in the relative values of
the stock of different classes, then the foundation value level, the
disqualified person value level, and the substituted combined value
level, as defined in paragraph (d)(2) of this section, shall be adjusted
to reflect such increase. An increase in the percentage of value held
shall not be considered to have occurred solely as a result of changes
in the relative values of the stock of different classes if:
(A) There has been any increase during the period in the percentage
of any class of stock held by the private foundation, its disqualified
persons, or both, or
(B) There has been any issuance, redemption, or purchase by the
issuing corporation of any stock during the period.
See Sec. 53.4943-6(d) for rules relating to increases caused by
readjustments.
(ii) Example. The provisions of this paragraph (b)(10) may be
illustrated by the following example:
Example. (i) At all times since May 26, 1969, F, a private
foundation, has held 25% (500,000 shares) of the outstanding class of
voting stock of X corporation. No disqualified person with respect to F
holds any voting stock of X. In addition X has had outstanding since May
26, 1969, a class of non-voting preferred stock, none of which is held
by F or a disqualified person. X is an active business corporation and
third parties do not have effective control of X. On May 26, 1969, the
voting stock (2 million shares outstanding) was trading for $5 a share
on the New York Stock Exchange. The non-voting preferred stock, not
publicly traded, was valued at $1 million. The total value of all
outstanding stock was $11 million ($10 million voting stock plus $1
million non-voting preferred). On May 26, 1969, F held 22.73% of the
value of X's outstanding stock ($2.5 million/$11 million).
(ii) On October 31, 1982, X's voting stock is trading for $20 a
share and the nonvoting stock is valued at $3 million. At all times
during the period May 26, 1969, through October 31, 1982, F has held 25
percent of the voting stock and none of the nonvoting stock of X. No
stock of X is owned by disqualified persons. No stock of X has been
issued, redeemed or purchased by X during this period. On October 13,
1982, the total value of X's outstanding stock (is $43 million ($40
million voting stock and $3 million nonvoting stock) and F holds 23.26
percent of the value of X's outstanding stock ($10 million/$43 million).
[[Page 127]]
F's foundation value level and the substituted combined value level are
increased from 22.73 percent to 23.26 percent to reflect this change.
(iii) On November 1, 1982, X corporation distributes the stock of Y
corporation, a wholly-owned subsidiary, to X's shareholders. Y is a
business enterprise. Under this paragraph (d)(10), all of F's stock in X
is permitted holdings under section 4943 (c)(4) even though the
percentage of value held by F has increased from 22.73 percent on May
26, 1969, to 23.26 percent on November 1, 1982. F's permitted holdings
in Y will be determined by reference to F's permitted holdings in X
under Sec. 53.4943-7. Therefore, assuming no prohibited transaction
occurs, F's permitted holdings in Y stock equal 25 percent of Y's voting
stock and, separately, 23.26 percent of the value of all of Y's
outstanding stock.
[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR
6478, Feb. 22, 1984]
Sec. 53.4943-5 Present holdings acquired by trust or a will.
(a) Interests to which section 4943(c)(5) applies--(1) In general.
Section 4943(c)(5) provides that section 4943(c)(4) (other than the 20-
year first phase holding period) applies to an interest in a business
enterprise acquired after May 26, 1969 by a private foundation under the
terms of a trust which was irrevocable on May 26, 1969, or under the
terms of a will executed on or before May 26, 1969, which were in effect
on May 26, 1969, and at all times thereafter, as if such interest were
held on May 26, 1969. However the first phase holding period prescribed
by Sec. 53.4943-4(c)(1) (ii) or (iii) shall commence for such an
interest on the date of distribution to the foundation. Unlike section
4943(c)(4) and Sec. 53.4943-4, section 4943(c)(5) and this section
treat only the interest so acquired (and not the entire interest held by
the foundation in such enterprise on the date of distribution) as held
by a disqualified person during a first phase holding period. (See,
however, section 4943(c)(6) and paragraph (b)(2) of Sec. 53.4943-6 for
the treatment of other holdings of the foundation in the same enterprise
if an interest to which section 4943(c)(5) applies is acquired from a
person who was not a disqualified person prior to the acquisition.) In
addition, section 4943(c)(5) and this section shall not apply if after
the acquisition of such an interest the foundation would not have excess
business holdings (determined without regard to section 4943(c) (4),
(5), or (6)).
(2) After-acquired interests. Section 4943(c)(5) and this section
shall not apply to any interest acquired after May 26, 1969, by an
estate or trust, other than by reason of the death of the decedent. For
example, where a foundation is a residuary beneficiary under the terms
of a will executed before May 26, 1969, and the residue of the estate
consists of cash, then stock subsequently purchased with cash for
distribution to the foundation will not be treated as an interest
acquired under the terms of a will executed on or before May 26, 1969.
(3) Certain revocable trusts. If an interest in a business
enterprise actually passes to a private foundation under a trust which
would have met the tests referred to in paragraph (a)(1) of this section
but for the fact that the trust was revocable (even though it was not in
fact revoked) and such interest would have passed to such foundation
under a will that meets those tests but for the fact that the grantor
died without having revoked the trust, then for purposes of section
4943(c)(5) and this section, such an interest shall be treated as having
been acquired by the foundation under the will.
(4) Modification of will--(i) In general. For purposes of section
4943(c)(5) and this section, an amendment or republication of a will
which was executed on or before May 26, 1969, does not prevent any
interest in a business enterprise which was to pass under the terms
(which were in effect on May 26, 1969, and at all times there- after) of
such will from being treated as a present holding under section 4943(c)
(4) or (5):
(A) Solely because there is a reduction in the interest in the
business enterprise which the foundation was to receive under the terms
of the will (for example, if the foundation is to receive the residuary
estate, and if one class of stock is disposed of by the decedent during
his lifetime or by a subsequent codicil);
(B) Solely because such amendment or republication is necessary in
order to comply with section 508(e) and the regulations thereunder;
[[Page 128]]
(C) Solely because there is a change in the executor of the will; or
(D) Solely because of any other change which does not otherwise
change the rights of the foundation with respect to such interest in the
business enterprise.
However, if under such amendment or republication there is an increase
in the interest in the business enterprise which the foundation was to
receive under the terms of the will in effect on May 26, 1969, such
increase shall not be treated as present holdings under section 4943(c)
(4) or (5). Under such circumstances the interest which would have been
acquired before such increase shall remain present holdings. See section
4943(c)(6) and Sec. 53.4943-6 with respect to the treatment of such
increase in holdings of a private foundation.
(ii) Examples. The provisions of this paragraph (a)(4) may be
illustrated by the following examples:
Example 1. On May 9, 1985, A modifies by codicil his will which was
in effect on May 26, 1969, and was unchanged until such modification.
The purpose of the codicil was, in the event of A's death, to increase
the number of shares in X Corporation that would pass to the W
foundation from 70 percent of all the voting power and value to 80
percent. Under these facts, if A dies without further modifying the
terms of the will which apply to W's interest in X, section 4943(c)(5)
will apply to 70 percent of the X voting power and value and section
4943(c)(6) will apply to 10 percent of the X voting power and value,
since 10 percent of the X voting power and value would not pass under a
provision of the will which was in effect on May 26, 1969, and at all
times thereafter. Accordingly, if the stock is distributed to W on July
6, 1988, then, assuming that on May 26, 1969, W and all disqualified
persons owned less than 75% of the voting stock in X, an amount of such
stock representing 70 percent of X voting power and value shall be
treated as held by a disqualified person through July 5, 1998, and an
amount of such stock representing 10 percent of X voting power and value
shall be treated as held by a disqualified person through July 5, 1993.
Example 2. Assume the facts as stated in Example (1), except that
the sole purpose of the codicil was to change the executor of the will.
Under paragraph (a)(4)(i) of this section, such codicil will not prevent
the X voting stock which was bequeathed to W from being treated as held
by a disqualified person through July 5, 1998.
(b) Holding periods--(1) In general. An interest to which section
4943(c)(5) applies shall be entitled to a 15-year holding period
starting on the date of distribution only if the interests actually or
constructively owned by a private foundation and all disqualified
persons on May 26, 1969, in a business enterprise exceed 75 percent of
the voting stock (or of the profits or beneficial interest) or 75
percent of the value of all outstanding shares of all classes of stock
(or of the profits and capital interest) in such enterprise. For
purposes of the preceding sentence, interests held by the foundation on
May 26, 1969, shall be deemed to include an interest to which section
4943(c)(5) applies and which has been acquired (on or before the date of
distribution for the interest in question) from a person who was not a
disqualified person on May 26, 1969. Therefore, if under the terms of a
will in effect on May 26, 1969, and at all times thereafter, a private
foundation is created on July 1, 1975, and receives 76 percent of the
voting stock of a business enterprise on that date, such stock shall be
treated as held by a disqualified person until June 30, 1990. Any
interest to which section 4943(c)(5) applies but which is not entitled
to a 15-year holding period shall be entitled to a 10-year holding
period starting on the date of distribution. For purposes of this
paragraph the date of distribution shall be deemed to occur no later
than the date on which the trust or estate is considered to be
terminated under Sec. 1.641(b)-(3) of this chapter (Income Tax
Regulations).
(2) Constructive ownership prior to date of distribution. To the
extent that an interest to which section 4943(c)(5) applies is
constructively held by a private foundation under section 4943(d)(1) and
Sec. 53.4943-8 prior to the date of distribution, it shall be treated
as held by a disqualified person prior to such date by reason of section
4943(c)(5). In addition, in the case of a foundation's interest in a
trust which was irrevocable on May 26, 1969, and to which both sections
4943 (c)(4) and (c)(5) apply, the first phase holding period for such
interest shall end with whichever such period under section 4943(c) (4)
or (5) ends later. For example, if under the terms of such a trust, 96
percent of the
[[Page 129]]
voting stock in a business enterprise was constructively held by a
private foundation on May 26, 1969, and was distributed to such
foundation on June 30, 1970, such interest is entitled to a 20-year
holding period beginning on May 26, 1969.
(c) Permitted holdings--(1) In general. The permitted holdings of a
private foundation which has an interest in a business enterprise to
which section 4943(c)(5) applies shall be determined in accordance with
the rules of paragraph (d) of Sec. 53.4943-4. The levels referred to in
such paragraph shall be adjusted to take into account the acquisition of
such an interest as if it were treated as held by a disqualified person
from May 26, 1969, until the date of acquisition. See also Sec.
53.4943-6(b)(2) for the special rule for interests held by a private
foundation at the time it acquires a section 4943(c)(5) interest from a
nondisqualified person. Thus, for example, if on June 30, 1975, the
disqualified person voting level and the substituted combined voting
level in corporation X with respect to foundation F are 45 percent, and
a nondisqualified person's 10 percent voting interest in X is acquired
by F on July 1, 1975, in a transaction to which section 4943(c)(5)
applies, the above-mentioned levels shall be increased to 55 and 50
percent respectively, on July 1, 1975. However, if such interest had
been acquired from a person who was a disqualified person on May 26,
1969, rather than from a nondisqualified person, no adjustments in such
levels would have taken place on July 1, 1975. In such a case, though,
at the beginning of the second phase on July 1, 1985, the foundation
voting level would be increased by 10 percent, and the disqualified
person voting level decreased by 10 percent (assuming that none of the
acquired stock had been disposed of prior to such date).
(2) Separate phases. The phases for each interest to which section
4943(c)(5) applies start independently from those for any other interest
of the foundation in the same enterprise to which section 4943(c) (4) or
(5) applies. Therefore, until an interest enters its own second phase,
the 25 percent limit described in paragraph (d)(5) of Sec. 53.4943-4
shall not apply to such interest since such interest (and any
subsequently acquired section 4943(c)(5) interest in the first phase) is
still treated as held by a disqualified person for purposes of that 25
percent limit. In addition, if such an interest enters its second phase
and at such time all disqualified persons together do not have holdings
in excess of 2 percent of the voting stock in the same business
enterprise, then the 25 percent limit of section 4943(c)(4)(D)(i) shall
not then apply to such interest, even though such limit may have been
applicable to an interest with an earlier second phase. Moreover, the 35
percent limit of section 4943(c)(4)(D)(ii) shall cause only interests
which have entered the third phase to become excess business holdings,
taking into account, however, interests in prior phases in determining
the holdings subject to such limit.
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples: (After each example is a chart setting forth the
chronological changes in the various levels referred to in paragraph (d)
of Sec. 53.4943-4.)
Example 1. On May 26, 1969, F, a private foundation, owns no stock
in M Corporation, and A, a disqualified person owns 40 percent of the
voting stock (voting power and value) in M. A dies on May 1, 1971,
leaving 30 percent of the voting stock in M to F and leaving the other
10 percent to a disqualified person. Distribution is made on June 1,
1972, and assume that section 4943(c)(5) applies. No transactions in the
stock of M, other than those described in this example, occur. On May
26, 1969, the substituted combined voting level is 40 percent, the
disqualified person voting level is deemed to be 40 percent, and the
permitted holdings by F in M is deemed to be 0 percent (40%-40%). On May
1, 1971 (the date that F acquired the M stock by reason of its
constructive ownership of A's estate), the various levels remain
unchanged. On May 1, 1971, the 30 percent interest is treated as held by
a disqualified person for a period extending through May 31, 1982. On
June 1, 1981, F disposes of 6 percent of the voting stock to a
nondisqualified person. The substituted combined voting level and the
disqualified person voting level thereby are reduced to 34 percent (40%-
6%) each. On June 1, 1982, at the beginning of the second phase, the
foundation voting level increases to 24 percent (30%-6%) and the
disqualified person voting level is reduced to 10 percent (34%-10%). The
substituted combined voting level as of June 1, 1982, remains at 34
percent. The permitted holdings as of such date are 24 percent (34%-
10%). If F had not disposed of any holdings prior to June 1, 1982,
[[Page 130]]
F's permitted holdings would have been 25 percent, the lesser of 25
percent (the limitation of section 4943(c)(4)(D)(i)), or 30 percent
(40%-10%). Since on such date the 30 percent interest would no longer
have been treated as held by a disqualified person, F would have had
excess business holdings of 5 percent (30%-25%).
--------------------------------------------------------------------------------------------------------------------------------------------------------
Interest
treated as Foundation Substituted Disqualified
F owns held by Disqualified voting combined person Permitted
Date (percent) disqualified persons own level voting voting level holdings Comments
person (percent) (percent) level (percent) (percent)
(percent) (percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969......................... 0 0 40 0 40 40 0
May 1, 1971.......................... +30 +30 -30 .......... ........... ............ ......... A dies.
Do.................................. 30 30 10 0 40 40 0
June 1, 1972......................... 30 30 10 0 40 40 0 Distribution.
June 1, 1981......................... -6 -6 ............ .......... -6 -6 ......... F sells 6 pct.
Do.................................. 24 24 10 0 34 34 0
June 1, 1982......................... ......... -24 ............ +24 ........... -24 +24 2d phase begins.
Do.................................. 24 0 10 24 34 10 24
--------------------------------------------------------------------------------------------------------------------------------------------------------
Example 2. (i) On May 26, 1969, F, a private foundation, owns 30
percent of the voting stock of N Corporation (voting power and value)
and disqualified persons own 20 percent of the voting stock of N
Corporation. On May 1, 1971, B, a disqualified person, dies leaving 15
percent of the voting stock to F. Assume the distribution was made on
June 1, 1972, and that section 4943(c)(5) applies. On May 26, 1969, the
substituted combined voting level and the disqualified person voting
levels are each 50 percent and the permitted holdings are 0 percent
(50%-50%). On May 1, 1971, and June 1, 1972, these levels remain
unchanged. On May 1, 1971, the 15 percent interest is treated as held by
a disqualified person for a period extending through May 31, 1982.
(ii) On July 1, 1978, F sells 6 percent of the F stock to a
nondisqualified person, thereby reducing the disqualified person voting
level and the substituted combined voting level to 44 percent (50%-6%).
On May 26, 1979, at the beginning of the second phase for F's 1969
holdings, the foundation voting level is 24 percent (30%-6%), the
substituted combined voting level is still 44 percent, and the
disqualified person voting level is 20 percent (44%-24%). The permitted
holdings are 24 percent (44%-20%). In addition F's 24 percent holdings
do not exceed the 25 percent limitation of section 4943(c)(4)(D)(i) and
paragraph (d)(5)(ii) of Sec. 53.4943-4.
(iii) On August 1, 1981, F sells 16 percent of the N stock to a
nondisqualified person, thereby reducing the foundation voting level to
8 percent (24%-16%), and reducing the substituted combined voting level
to 28 percent (44%-16%). The disqualified person voting level remains at
20 percent. On June 1, 1982, at the beginning of the second phase for
F's holdings acquired by will, the substituted combined voting level is
still 28 percent, the foundation voting level is 23 percent (8%+15%),
the disqualified person voting level is 5 percent (20%-15%), and the
permitted holdings are 23 percent (28%-5%).
(iv) If F had not disposed of the 6 percent on July 1, 1978, then on
May 26, 1979, at the beginning of the second phase for F's 1969
holdings, F's permitted holdings would have been 25 percent, the lesser
of 25 percent (the limitation of section 4943(c)(4)(D)(i), or 30 percent
(50%-20%). Since F's 30 percent interest would no longer have been
treated as held by a disqualified person on May 26, 1979, F would have
had excess business holdings of 5 percent (30%-25%). Similarly, if F had
not disposed of the 16 percent interest on August 1, 1981 (but had
disposed of the 6 percent interest), on July 1, 1982, at the beginning
of the second phase for F's holdings acquired by will, F's permitted
holdings would have been 25 percent, the lesser of 25 percent (under
section 4943(c)(4)(D)(i)), or 39 percent (44%-5%). Since as of such date
F's entire holdings of 39 percent would no longer have been treated as
held by a disqualified person, F would have had excess business holdings
of 14 percent (39%-25%).
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Interest
F's F's treated as Foundation Substituted Disqualified
F owns interest interest held by Disqualified voting combined person Permitted
Date (percent) 1969 1971 disqualified persons own level voting voting level holdings Comments
(percent) (percent) person (percent) (percent) level (percent) (percent)
(percent) (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969.................................. 30 30 ......... 30 20 0 50 50 0
[[Page 131]]
May 1, 1971................................... +15 ......... +15 +15 -15 .......... ........... ............ ......... B dies.
Do........................................... 45 30 15 45 5 0 50 50 0
June 1, 1972.................................. 45 30 15 45 5 0 50 50 0 Distribution.
July 1, 1978.................................. -6 -6 ......... -6 ............ .......... -6 -6 ......... F sells 6 pct.
Do........................................... 39 24 15 39 5 0 44 44 0
May 16, 1979.................................. ......... ......... ......... -24 ............ +24 ........... -24 +24 2d phase for 24 pct.
Do........................................... 39 24 15 15 5 24 44 20 24
Aug. 1, 1981.................................. -16 -16 ......... ............ ............ -16 -16 ............ -16 F sells 16 pct.
D0........................................... 23 8 15 15 5 8 28 20 8
July 1, 1982.................................. ......... ......... ......... -15 ............ +15 ........... -15 +15 All in 2d phase.
Do........................................... 23 8 15 0 5 23 28 5 23
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Example. (3). (i) On May 26, 1969, F, a private foundation owns 5
percent of the voting stock of O Corporation (voting power and value),
and disqualified persons own 45 percent of the voting stock. C, a
disqualified person, dies on May 1, 1971, and leaves 41 percent of the
voting stock of O to F. Assume that distribution is made on June 1,
1972, and that section 4943(c)(5) applies. On May 26, 1969, the
substituted combined voting level and the disqualified person voting
level are 50 percent and the permitted holdings are 0 percent (50%-50%).
On May 1, 1971, and June 1, 1972, the various levels remain unchanged.
On May 1, 1971, the 41 percent interest is treated as held by a
disqualified person for a period extending through May 31, 1982. On May
26, 1979, at the beginning of the second phase for F's 1969 holdings of
5 percent, the 5 percent is no longer treated as held by a disqualified
person, the foundation voting level is 5 percent, the disqualified
person voting level is reduced to 45 percent (50%-5%), and the
substituted combined voting level remains at 50 percent. On such date
F's permitted holdings are 5 percent (50%-45%). Since the 41 percent
interest is treated as held by a disqualified person, the interest
treated as held by F (5%) does not exceed the 25 percent limitation of
section 4943(c)(4)(D)(i).
(ii) On August 1, 1981, F sells 22 percent of the O stock to a
nondisqualified person, thereby reducing the foundation voting level to
0 percent. Since the reductions are first applied to the 1969 holdings
of 5 percent, 17 percent (22%-5%) applies to the 41 percent interest,
reducing such interest to 24 percent (41%-17%), and reducing the
disqualified person voting level to 28 percent (45%-17%). The
substituted combined voting level is reduced to 28 percent (0%+28%). On
June 1, 1982, at the beginning of the second phase for F's holdings
acquired by will, the substituted combined voting level remains at 28
percent, the foundation voting level is 24 percent, the disqualified
person voting level is reduced to 4 percent (28%-4%).
(iii) If F had not disposed of the 22 percent interest prior to June
1, 1982, F's permitted holdings would have been 25 percent, the lesser
of 25 percent, (under section 4943(c)(4)(D)(i)), or 46 percent (50%-4%).
Since as of such date, F's entire holdings of 46 percent would no longer
have been treated as held by a disqualified person, F would have had
excess business holdings of 21 percent (46%-25%).
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Interest
F's F's treated as Foundation Substituted Disqualified
F owns interest interest held by Disqualified voting combined person Permitted
Date (percent) 1969 1971 disqualified persons own level voting voting level holdings Comments
(percent) (percent) person (percent) (percent) level (percent) (percent)
(percent) (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969.................................. 5 5 ......... 5 45 0 50 50 0 .................................
May 1, 1971................................... +41 ......... +41 +41 -41 .......... ........... ............ ......... C dies.
Do........................................... 46 5 41 46 4 0 50 50 0
June 1, 1972.................................. 46 5 41 46 4 0 50 50 0 Distribution.
[[Page 132]]
May 26, 1979.................................. ......... ......... ......... -5 ............ +5 ........... -5 +5 2d phase for 5 pct.
Do........................................... 46 5 41 41 4 5 50 45 5
Aug. 1, 1981.................................. -22 -5 -17 -17 ............ -5 -22 -17 -5 F sells 22 pct.
Do........................................... 24 0 24 24 4 0 28 28 0
June 1, 1982.................................. ......... ......... ......... -24 ............ +24 ........... -24 +24 2d phase for 24 pct.
Do........................................... 24 0 24 0 4 24 28 4 24
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Example 4. (i) On May 26, 1969, F, a private foundation, owns 30
percent of the voting stock in P Corporation (voting power and value),
and disqualified persons own 20 percent. On May 1, 1971, D, a
disqualified person, dies leaving 18 percent of the voting stock to F.
Assume that distribution was made on June 1, 1972, and that section 4943
(c)(5) applies. On May 26, 1969, the substituted combined voting level
and the disqualified person voting level are each 50 percent and the
permitted holdings are 0 percent (50%-50%). On May 1, 1971, and June 1,
1972, these levels remain unchanged. On May 1, 1971, the 18 percent
interest is treated as held by a disqualified person for a period
extending through May 31, 1982. On May 26, 1979, the foundation voting
level increases to 30 percent, the disqualified person voting level
decreases to 20 percent (50%-30%), and the permitted holdings are 30
percent (50%-20%). On June 1, 1982, the foundation voting level
increases to 48 percent, the disqualified person voting level decreases
to 2 percent and the permitted holdings are 48 percent (50%-2%). Since
at no time during the second phase for F's 1969 holdings did all
disqualified persons together have holdings in excess of 2 percent of
the voting stock of P, the 25 percent limitation of section
4943(c)(4)(D)(i) did not apply to F's 1969 holdings.
(ii) On July 1, 1993, F disposes of 16 percent of the stock in P,
thereby reducing the substituted combined voting level to 34 percent
(50%-16%), and reducing the permitted holdings to 32 percent (34%-2%).
If F had not disposed of the 16 percent of the stock of P prior to May
26, 1994, on such date, under section 4943(c)(4)(D)(ii), F's substituted
combined voting level for its 1969 holdings would have been 35 percent,
and the permitted holdings would have been 33 percent (35%-2%). Since
none of F's holdings of 48 percent would have been treated as held by a
disqualified person on such date (the beginning of the third phase for
F's 1969 holdings), F would have had excess business holdings of 15
percent, the lesser of 30 percent (F's 1969 holdings in the third
phase), of 15 percent (the excess of F's 48 percent holdings over the
permitted holdings of 33 percent).
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Interest
F's F's treated as Foundation Substituted Disqualified
F owns interest interest held by Disqualified voting combined person Permitted
Date (percent) 1969 1971 disqualified persons own level voting voting level holdings Comments
(percent) (percent) person (percent) (percent) level (percent) (percent)
(percent) (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969.................................. 30 30 ......... 30 20 0 50 50 0
May 1, 1971................................... +18 ......... +18 +18 -18 .......... ........... ............ ......... D dies.
Do........................................... 48 30 18 48 2 0 50 50 0
June 1, 1972.................................. 48 30 18 48 2 0 50 50 0 Distribution.
May 26, 1979.................................. ......... ......... ......... -30 ............ +30 ........... -30 +30 2d phase for 30 pct.
Do........................................... 48 30 18 18 2 30 50 20 30
June 1, 1982.................................. ......... ......... ......... -18 ............ +18 ........... -18 +18 2d phase for 18 pct.
Do........................................... 48 30 18 0 2 48 50 2 48
July 1, 1993.................................. -16 -16 ......... ............ ............ -16 -16 ............ -16 F disposes of 16 pct.
Do........................................... 32 14 18 0 2 32 34 2 32
[[Page 133]]
May 26, 1994.................................. 32 14 18 0 2 32 34 2 32 3d phase for 14 pct.
June 1, 1997.................................. 32 14 18 0 2 32 34 2 32 3d phase for 18 pct.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Example 5. (i) On May 26, 1969, F, a private foundation, owns 5
percent of the voting stock in Q Corporation (voting power and value),
and disqualified persons own 45 percent. On May 1, 1971, E, a
disqualified person, dies leaving 43 percent of the voting stock to F.
Assume that distribution was made on June 2, 1972, and that section
4943(c)(5) applies. On May 26, 1969, the substituted combined voting
level and the disqualified person voting level are each 50 percent and
the permitted holdings are 0 percent (50%-50%). On May 1, 1971, and June
1, 1972, these levels remain unchanged. On May 1, 1971, the 43 percent
interest is treated as held by a disqualified person for a period
extending through May 31, 1982. On May 26, 1979, the foundation voting
level increases to 5 percent, the disqualified person voting level
decreases to 45 percent, and the permitted holdings are 5 percent (50%-
45%). On June 1, 1982, the foundation voting level increases to 48
percent, the disqualified person voting level decreases to 2 percent,
and the permitted holdings are 48 percent (50%-2%). At no time during
the second phase for F's 1969 holdings did all disqualified persons
together have holdings in excess of 2 percent of the voting stock of Q.
Therefore, the 25 percent limitation of section 4943(c)(4)(D)(i) did not
apply.
(ii) On July 1, 1993, F sells 6 percent of the stock in Q to a
nondisqualified person. This reduces the substituted combined voting
level to 44 percent and reduces the permitted holdings to 42 percent
(44%-2%). If F had not disposed of the 6 percent of the stock in 1993,
on May 26, 1994, at the beginning of the third phase for F's 1969
holdings, F would have had 5 percent excess business holdings. The
excess business holdings are 5 percent because although the excess
business holdings computed for the third phase are 15 percent (the
excess of F's actual holdings (48%) over the permitted holdings of 33
percent (35%-2%)), only 5 percent of the holdings are in this phase and
subject to the 35 percent combined holdings limitation.
(iii) On July 1, 1995, F sells 10 percent of the stock in Q, thereby
reducing the substituted combined voting level to 34 percent and
reducing the permitted holdings to 32 percent (34%-2%). If F had not
disposed of the 10 percent of the stock, on June 1, 1997, at the
beginning of the third phase for F's acquired holdings, F would have had
9 percent excess business holdings (the excess of F's total holdings in
the third phase (42%) over the permitted holdings of 33 percent (35%-
2%)).
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Interest
F's F's treated as Foundation Substituted Disqualified
F's owns interest interest held by Disqualified voting combined person Permitted
Date (percent) 1969 1971 disqualified persons own level voting voting level holdings Comments
(percent) (percent) person (percent) (percent) level (percent) (percent)
(percent) (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969.................................. 5 5 ......... 5 45 0 50 50 0
May 1, 1971................................... +43 ......... +43 +43 -43 .......... ........... ............ ......... E dies.
Do........................................... 48 5 43 48 2 0 50 50 0
June 1, 1972.................................. 48 5 43 48 2 0 50 50 0 Distribution.
May 26, 1979.................................. ......... ......... ......... -5 ............ +5 ........... -5 +5 2d phase for 5 pct
Do........................................... 48 5 43 43 2 5 50 45 5
June 1, 1982.................................. ......... ......... ......... -43 ............ +43 ........... -43 +43 2d phase for 43 pct.
Do........................................... 48 5 43 0 2 48 50 2 43
July 1, 1993.................................. -6 -5 -1 ............ ............ -6 -6 ............ -6 F sells 6 pct.
Do........................................... 42 0 42 0 2 42 44 2 42
July 1, 1995.................................. -10 ......... -10 ............ ............ -10 -10 ............ -10 F sells 10 pct.
[[Page 134]]
Do........................................... 32 0 32 0 2 32 34 2 32
June 1, 1997.................................. 32 0 32 0 2 32 34 2 32 3d phase for 32 pct.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Example 6. (i) On May 26, 1969, F, a private foundation, owns 30
percent of the voting stock in R Corporation (voting power and value),
and disqualified persons own 20 percent. On August 1, 1978, F disposes
of 6 percent of the stock to a nondisqualified person. On May 1, 1981,
G, a disqualified person, dies leaving 15 percent of the voting stock to
F. Assume that distribution was made on June 1, 1982, and that section
4943(c)(5) applies. On May 26, 1969, the substituted combined voting
level and the disqualified person voting level are each 50 percent, and
the permitted holdings are 0 percent (50%-50%). On August 1, 1978, these
levels decrease to 44 percent (50%-6%). On May 26, 1979, the foundation
voting level increases to 24 percent (30%-6%), the disqualified person
voting level decreases to 20 percent (44%-24%), and the permitted
holdings are 24 percent (44%-20%). If F had not disposed of the 6
percent of the stock prior to May 26, 1979, on May 26, 1979, the
beginning of the second phase for F's 1969 holdings, F's permitted
holdings would have been 25 percent, the lesser of 25 percent (under
section 4943(c)(4)(D)(i)) or 30 percent (50%-20%). Since the 30 percent
interest would no longer have been treated as held by a disqualified
person on such date, F would have had excess business holdings of 5
percent (30%-25%).
(ii) On May 1, 1981, and June 1, 1982 (assuming F had disposed of
the 6 percent holdings), the foundation voting level, the disqualified
person voting level, the substituted combined voting level and permitted
holdings remain respectively 24 percent, 20 percent, 44 percent and 24
percent. On May 1, 1981, the 15 percent interest is treated as held by a
disqualified person for a period extending through May 31, 1992. On July
1, 1991, F sells 16 percent of the voting stock in R to a
nondisqualified person, thereby reducing the substituted combined voting
level to 28 percent (44%-16%), and reducing the foundation voting level
to 8 percent (24%-16%). The disqualified person voting level remains at
20 percent. On June 1, 1992, at the beginning of the second phase for
F's holdings acquired by will, the substituted combined voting level
remains at 28 percent, the foundation voting level increases to 23
percent (8%+15%) and the disqualified person voting level decreases to 5
percent (20%-15%). The permitted holdings on such date are 23 percent
(28%-5%). If F had not disposed of the 16 percent interest prior to June
1, 1992, F's permitted holdings would have been 25 percent, the lesser
of 25 percent (under section 4943 (c)(4)(D)(i)) or 39 percent (44%-5%).
Since as of such date, F's entire holdings of 39 percent would no longer
have been treated as held by a disqualified person, F would have had
excess business holdings of 14 percent (39%-25%).
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Interest
F's F's treated as Foundation Substituted Disqualified
F's owns interest interest held by Disqualified voting combined person Permitted
Date (percent) 1969 1981 disqualified persons own level voting voting level holdings Comments
(percent) (percent) person (percent) (percent) level (percent) (percent)
(percent) (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969.................................. 30 30 ......... 30 20 0 50 50 0
Aug. 1, 1978.................................. -6 -6 ......... -6 ............ .......... -6 -6 ......... F disposes of 6 pct.
Do........................................... 24 24 ......... 24 20 0 44 44 0
May 26, 1979.................................. ......... ......... ......... -24 ............ +24 ........... -24 +24 2d phase for 24 pct.
Do........................................... 24 24 ......... 0 20 24 44 20 24
May 1, 1981................................... +15 ......... +15 +15 -15 .......... ........... ............ ......... G dies.
Do........................................... 39 24 15 15 5 24 44 20 24
June 1, 1982.................................. 39 24 15 15 5 24 44 20 24 Distribution.
July 1, 1991.................................. -16 -16 ......... ............ ............ -16 -16 ............ -16 F disposes of 16 pct.
Do........................................... 23 8 15 15 5 8 28 20 8
[[Page 135]]
June 1, 1992.................................. ......... ......... ......... -15 ............ +15 ........... -15 +15 2d phase for 15 pct.
Do........................................... 23 8 15 0 5 23 28 5 23
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Example 7. (i) On May 26, 1969, F, a private foundation, owns 5
percent of the voting stock in S Corporation (voting power and value),
and disqualified persons own 45 percent. On May 1, 1980, H, a
disqualified person, dies leaving 41 percent of the voting stock to F.
Assume that distribution is made on June 1, 1981, and that section
4943(c)(5) applies. On May 26, 1969, the substituted combined voting
level and disqualified person voting levels are each 50 percent. On May
26, 1979, the disqualified person voting level decreases to 45 percent,
the foundation voting level increases to 5 percent, and the permitted
holdings are 5 percent (50%-45%). On May 1, 1980, and June 1, 1981, the
levels remain the same. Since the 41 percent holdings are treated as
held by a disqualified person for the period beginning on May 1, 1980,
and extending through May 31, 1991, F's remaining holdings of 5 percent
do not exceed the 25 percent limitation of section 4943(c)(4)(D)(i).
(ii) On August 1, 1990, F sells 22 percent of the voting stock of S
to a nondisqualified person, reducing the 5 percent foundation voting
level to zero, leaving 17 percent (22%-5%) to reduce the disqualified
person voting level to 28 percent (45%-17%) so that the substituted
combined voting level equals 28 percent (50%-22%). On June 1, 1991, the
beginning of the second phase for the remaining 24 percent (41%-17%) of
F's holdings acquired by will, the foundation voting level increases
from zero to 24 percent, the disqualified person voting level decreases
to 4 percent (28%-24%), the substituted combined voting level remains at
28 percent, and the permitted holdings equal 24 percent (28%-4%).
(iii) If F had not disposed of the 22 percent holdings prior to June
1, 1991, F's permitted holdings would have been 25 percent, the lesser
of 25 percent (under section 4943(c)(4)(D)(i)) or 46 percent (50%-4%).
Since as of such date, F's entire holdings of 46 percent would no longer
have been treated as held by a disqualified person, F would have had
excess business holdings of 21 percent (46%-25%).
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Interest
F's F's treated as Foundation Substituted Disqualified
F owns interest interest held by Disqualified voting combined person Permitted
Date (percent) 1969 1980 disqualified persons own level voting voting level holdings Comments
(percent) (percent) person (percent) (percent) level (percent) (percent
(percent) (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969.................................. 5 5 ......... 5 45 0 50 50 0
Do........................................... ......... ......... ......... -5 ............ +5 ........... -5 +5 2d phase for 5 pct.
May 26, 1969.................................. 5 5 ......... 0 45 5 50 45 5
May 1, 1980................................... +41 ......... +41 +41 -41 .......... ........... ............ ......... H dies.
Do........................................... 46 5 41 41 4 5 50 45 5
June 1, 1981.................................. 46 5 41 41 4 5 50 45 5 Distribution.
Aug. 1, 1990.................................. -22 -5 -17 -17 ............ -5 -22 -17 -5 F disposes of 22 pct.
Do........................................... 24 0 24 24 4 0 28 28 0
June 1, 1991.................................. ......... ......... ......... -24 ............ +24 ........... -24 +24 2d phase for 24 pct.
Do........................................... 24 0 24 0 4 24 28 4 24
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[[Page 136]]
Sec. 53.4943-6 Five-year period to dispose of gifts, bequests, etc.
(a) In general--(1) Application. (i) Paragraph (6) of section
4943(c) prescribes transition rules for a private foundation, which, but
for such paragraph, would have excess business holdings as a result of a
change in the holdings in a business enterprise after May 26, 1969
(other than by purchase by such private foundation or by a disqualified
person) to the extent that section 4943(c)(5) (relating to certain
holdings acquired under a pre-May 27, 1969, will on trust) does not
apply.
(ii) Subparagraph (A) of section 4943(c)(6) applies where,
immediately prior to a change in holdings described in paragraph
(a)(1)(i) of this section, the foundation has no excess business
holdings in such enterprise (determined without regard to section
4943(c) (4), (5), or (6)). In such a case, the entire interest of the
foundation in such enterprise (immediately after such change) shall
(while held by the foundation) be treated as held by a disqualified
person (rather than by the foundation) during the five-year period
beginning on the date of such change.
(iii) Subparagraph (B) of section 4943(c)(6) applies where the
foundation has excess business holdings in such enterprise (determined
without regard to section 4943(c) (4), (5), or (6)) immediately prior to
a change in holdings described in paragraph (a)(1)(i) of this section.
In such a case, the interest of the foundation in such enterprise
(immediately after such change) shall (while held by the foundation) be
treated as held by a disqualified person (rather than the foundation)
during the five-year period beginning on the date of such change, except
that if and as soon as any holdings in such enterprise become excess
business holdings during such period (determined without regard to such
change (and the resulting application of section 4943(c)(6) to the
foundation's interest in such enterprise)), such holdings shall no
longer be treated as held by a disqualified person under this section,
but shall constitute excess business holdings subject to the initial
tax. In applying the preceding sentence, if holdings of the foundation
which (but for such change in holdings (and the resulting application of
section 4943(c)(6) to the foundation's interest in such enterprise))
would be subject to the 25 percent limit prescribed by section
4943(c)(4)(D) after the expiration of the first phase, such holdings
shall be treated as subject to such percentage limitation for purposes
of determining excess business holdings. For example, if a private
foundation in 1978 has present holdings of 28 percent in a busines
enterprise to which section 4943(c)(4) applies, and such holdings would
exceed the 25 percent limit of section 4943(c)(4)(D)(i) on May 26, 1979,
a gift of 5 percent to the foundation in 1978 of an interest in such
enterprise shall not prevent the 3 percent (28%-25%) excess over the 25
percent limit from constituting excess business holdings on May 26,
1979, if on such date disqualified persons hold more than a 2 percent
interest in such enterprise (and no other transaction has taken place).
(2) Acquisitions that are not purchases. Section 4943(c)(6) does not
apply if a change in holdings in a business enterprise is the result of
a purchase by the private foundation or a disqualified person. For
purposes of subparagraph (a) of this paragraph, the term ``purchase''
shall not include any acquisition by gift, devise, bequest, legacy, or
interstate succession. Paragraph (d) of this section provides rules for
the treatment of increases in holdings received in a readjustment (as
defined in Sec. 53.4943-7(d)(1)).
(3) Examples. The provisions of paragraph (a) of this section may be
illustrated by the following examples:
Example 1. On January 4, 1985, A, an individual, makes a
contribution to F, a private foundation, of 200 shares of X Corporation
common stock. Assume that F had no X stock before January 4, 1985, and
under section 4943(c)(1) the receipt of the X stock by F would cause
some or all of the 200 shares of the X stock to be classified as excess
business holdings. Under the provisions of section 4943(c)(6)(A) and
this paragraph (a), since the contribution of the X stock to F is a gift
and not a purchase, the X stock in F's hands is treated as held by
disqualified persons and not by F through January 3, 1990.
Example 2. Assume the facts as stated in Example (1) except that F
receives the X stock as a bequest pursuant to the terms of A's will
executed on April 1, 1980. A dies on June 3, 1984, and the stock is
distributed to F on February 16, 1985. As in Example (1), the
[[Page 137]]
bequest of X to F is not a purchase under this paragraph (a).
Consequently, the X stock in F's hands is treated as held by
disqualified persons and not by F through February 15, 1990.
Example 3. On February 1, 1980, F, a private foundation, owns 15
percent of the voting stock of X Corporation, and disqualified persons
own 4 percent of the voting stock of X Corporation. On February 2, 1980,
B, a nondisqualified person, contributes 8 percent of the voting stock
of X to F in a transaction to which section 4943(c)(5) does not apply.
Assuming that the 35 percent limit of section 4943(c)(2)(B) does not
apply, under the provisions of section 4943(c)(6)(A) and paragraph (a)
of this section the 23 percent voting stock owned by F on such date is
treated as held by a disqualified person through February 1, 1985, since
F would have had excess business holdings of 7 percent as a result of
the contribution (23% actual holdings less 16% (20%-4%) permitted
holdings). On March 1, 1984, C, another nondisqualified person,
contributes 6 percent of the voting stock of X Corporation to F. But for
this second contribution and the resulting application of section
4943(c)(6) to F's interest in X, F would have excess business holdings
of 7 percent (23%-16%) within the five-year period beginning on the date
of such contribution. Accordingly, under section 4943(c)(6)(B) and
paragraph (a) of this section, all 29 percent (6%+23%) of the stock held
by F on March 1, 1984, will be treated as held by a disqualified person
until March 1, 1989, except that 7 percent will cease to be so treated
on February 2, 1985. If prior to February 2, 1985, no further
transactions occurred in the stock of X, F would have excess business
holdings of 7 percent subject to the initial tax, since the amount still
treated as held by disqualified persons (29%-7%) plus the amount
actually held by disqualified persons (4%) already exceed 20 percent.
(b) Special rules for acquisitions by will or trust--(1) In general.
In the case of an acquisition of holdings in a business enterprise by a
private foundation pursuant to the terms of a will or trust, the five-
year period described in section 4943(c)(6) and in this section shall
not commence until the date on which the distribution of such holdings
from the estate or trust to the foundation occurs. See Sec. 53.4943-
5(b)(1) for rules relating to the determination of the date of
distribution under the terms of a will or trust. For purposes of this
subparagraph, holdings in a business enterprise will not be treated as
acquired by a private foundation pursuant to the terms of a will where
the holdings in the business enterprise were not held by the decedent.
Thus, in the case of after-acquired property, this subparagraph shall
not apply, the five-year period described in section 4943(c)(6) and this
section shall commence on the date of acquisition of such holdings by
the estate, and such five-year period may expire prior to the date of
distribution of such holdings from the estate. To the extent that an
interest to which section 4943(c)(6) and this paragraph (b)(1) apply is
constructively held by a private foundation under section 4943(d)(1) and
Sec. 53.4943-8 prior to the date of distribution, it shall be treated
as held by a disqualified person prior to such date by reason of section
4943(c)(6). See Sec. 53.4943-8 for rules relating to constructive
holdings held in an estate or trust for the benefit of the foundation.
(2) Special rule for section 4943(c)(5) interests acquired from a
nondisqualified person. (i) In the case of holdings of a private
foundation in a business enterprise to which section 4943(c)(5)
(relating to certain holdings acquired under a pre-May 27, 1969, will or
trust) applies which are acquired from a nondisqualified person, the
interest of the foundation in such enterprise (immediately after such
acquisition) shall (while held by the foundation) be treated as held by
a disqualified person (rather than the foundation) under section
4943(c)(6)(B) and paragraph (a)(1)(iii) of this section from the date of
acquisition until the end of the fifth year following the date of
distribution of such holdings. Thereafter, only the holdings to which
section 4943(c)(5) and Sec. 53.4943-5(a)(1) apply shall continue to be
treated as held by a disqualified person until the end of the first
phase with respect thereto.
(ii) The provisions of paragraph (b)(2)(i) of this section may be
illustrated by the following examples:
Example 1. On May 26, 1969, F, a private foundation, owns 5 percent
of the voting stock of Corporation X and no disqualified persons own any
stock in X. On June 30, 1977, a nondisqualified person bequeaths to F 33
percent of the voting stock in X to which section 4943(c)(5) applies.
This 33 percent interest is distributed to F on August 17, 1978. Under
section 4943(c)(6)(A) the entire 38 percent (5%+33%) of the X voting
stock shall be treated as held by a disqualified person from June 30,
1977 (the date the 33 percent interest
[[Page 138]]
is contructively acquired by F) until August 17, 1983 (five years after
the date of distribution of the 33 percent interest to F). However,
assuming that the 35 percent limit of section 4943(c)(2)(B) does not
apply, the substituted combined voting level on June 30, 1977 is only 33
percent because there was no interest to which section 4943(c) (4) or
(5) applied immediately before that date and thus there was no
substituted combined voting level at that time. In that case, since the
3-phase holding period is only available for the interest acquired by
will (33%) under section 4943(c)(5), the substituted combined voting
level on June 30, 1977 is only 33 percent, not 38 percent. Assuming that
the substituted combined voting level remains 33 percent at all relevant
times, and prior to August 17, 1983, no further transactions occur in
the stock of X, F on that date would have excess business holdings of 5
percent subject to the initial tax. The amount treated as held by
disqualified persons at that time (33%) would equal the substituted
combined voting level at that time (33%), and thus permitted holdings
would be zero. Under section 4943(c)(5) the 33 percent interest will
continue to be treated as held by a disqualified person until August 17,
1988 (10 years after the date of distribution).
Example 2. On May 26, 1969, F, a private foundation, owns 29 percent
of the stock (voting power and value) of Corporation X, and on June 30,
1977, a nondisqualified person bequeaths to F 23 percent of the stock
(voting power and value) in X to which section 4943(c)(5) does apply.
This 23 percent interest is distributed to F on August 17, 1978.
Disqualified persons hold no stock of X. Although the substituted
combined voting and value levels cannot exceed 50 percent on May 26,
1979 (at the start of the second phase with respect to the 29 percent
interest), under section 4943(c)(6)(B) the entire 52 percent (29%+23%)
of the X voting stock shall be treated as held by a disqualified person
from June 30, 1977 (the date the 23% interest is constructively acquired
by F) until August 17, 1983 (five years after the date of distribution
of the 23% interest to F). On June 1, 1980, during such second phase, D,
a disqualified person, purchases 3 percent of the X stock (voting power
and value). On such date, but for the acquisition by F of the 23 percent
interest, F would have had excess business holdings of 4 percent. The
purchase by D of more than 2 percent of the voting stock of X causes the
25 percent limit of section 4943(c)(4)(D)(i) to apply to the 29 percent
interest (29%-25%=4%). Thus, on June 1, 1980, 4 percent of the X voting
stock held by F since May 27, 1969, shall cease to be treated as held by
a disqualified person under section 4943(c)(6)(B) and become excess
business holdings subject to the initial tax. See Sec. 53.4943-
2(a)(1)(ii) for the 90-day period in which to dispose of these excess
business holdings resulting from the purchase by the disqualified
person.
(c) Exceptions. (1) Section 4943(c)(6) and this section shall not
apply to any transfer of holdings in a business enterprise by one
private foundation to another private foundation which is related to the
first foundation within the meaning of section 4946(a)(1)(H).
(2) Section 4943(c)(6) and this section shall not apply to an
increase in the holdings of a private foundation in a business
enterprise that is part of a plan whereby disqualified persons will
purchase additional holdings in the same enterprise during the five-year
period beginning on the date of such change, e.g., to maintain control
of such enterprise, since such increase shall be treated as caused in
part by the purchase of such additional holdings.
(3) The purchase of holdings by an entity whose holdings are treated
as constructively owned by a foundation, its disqualified persons, or
both, under section 4943(d)(1) shall be treated as a purchase by a
disqualified person if the foundation, its disqualified persons or both
have effective control of the entity or otherwise can control the
purchase. For example, if a foundation is the beneficiary of a specific
bequest of $20,000 and its consent is required for the estate to make a
purchase using such cash, then a purchase by the estate using such cash
would be treated as a purchase by a disqualified person. Similarly, if
an executor of an estate is a disqualified person with respect to a
private foundation, any purchase by the estate would be treated as a
purchase by a disqualified person.
(4) If a private foundation, its disqualified persons, or both, hold
an interest in specific property under the terms of a will or trust, and
if the private foundation, its disqualified persons, or both, consent or
otherwise agree to the substitution of holdings in a business enterprise
for such specific property, such holdings shall be treated as acquired
by purchase by a disqualified person. For example, if a private
foundation is the beneficiary of a specific bequest of $20,000 and the
private foundation agrees to accept certain of the estate's holdings in
a business enterprise in satisfaction of such
[[Page 139]]
specific bequest, such holdings will be treated as acquired by purchase
by a disqualified person even if such holdings were held by the
decedent.
(d) Readjustments and distributions--(1) General rule. Except as
otherwise provided in subparagraph (2) of this paragraph, any increase
in holdings in a business enterprise that is the result of a
readjustment (as defined in Sec. 53.4943-7(d)(1)) shall be treated as
acquired other than by purchase. However, holdings that are attributable
to holdings owned by the private foundation that would have been excess
business holdings except for the fact that such holdings were treated as
held by a disqualified person prior to the readjustment shall in no
event be treated as held by a disqualified person after the date on
which the holdings to which the change is attributable would have ceased
to be treated as held by a disqualified person.
(2) Exceptions. Any increase in holdings in a business enterprise
that is the result of a readjustment (as defined in Sec. 53.4943-
7(d)(1)), including any change resulting from application of the rule in
Sec. 53.4943-8(c)(3), shall be treated as occurring by purchase by a
disqualified person:
(i) To the extent the increase is attributable to holdings that were
excess business holdings prior to the readjustment, and separately
(ii) To the full extent of the increase if the readjustment includes
a prohibited transaction, unless the foundation establishes to the
satisfaction of the Commissoner that effective control of all parties to
the transaction was, at the time of the transaction, in one or more
persons (other than the foundation) who are not disqualified persons
with respect to the foundation. See Sec. 53.4943-7(d)(2) for the
definition of prohibited transaction.
(3) Section 4943(c)(6) holdings. If, immediately prior to a
readjustment (as defined in Sec. 53.4943-7(d)(1)), a private foundation
has holdings in a business enterprise that are treated under section
4943(c)(6) as held by a disqualified person, then any holdings in a
business enterprise that are received in the readjustment in exchange
for such section 4943(c)(6) holdings shall be treated as the holdings
surrendered in the exchange to the same extent as provided in Sec.
53.4943-7 with respect to exchanges involving holdings to which section
4943(c) (4) or (5) applies. Rules similar to those in Sec. 53.4943-
7(a)(2) shall be applied to determine when holdings are treated as
surrendered or received in a readjustment for purposes of this
paragraph.
(4) Redemption by a corporation that is a disqualified person. If a
foundation holds an interest in a corporation that is a disqualified
person, an increase in the holdings of the private foundation, its
disqualified person, or both, as a result of a redemption or a purchase
of stock of the disqualified person corporation by such corporation
shall not be treated as acquired by purchase by a disqualified person
based solely on the status of the corporation as a disqualified person.
(5) One percent rule for redemptions. If the holdings of a
foundation, its disqualified persons, or both, in a business enterprise
are increased as a result of one or more redemptions during any taxable
year then, unless the aggregate of such increases equals or exceeds one
percent of the outstanding voting stock or one percent of the value of
all outstanding shares of all classes of stock, the determination of
whether such increases cause the foundation to have excess business
holdings shall be made only at the close of the private foundation's
taxable year. The five-year period described in section 4943(c)(6) or
the 90-day period described in Sec. 53.4943-2(a)(1)(ii), whichever is
applicable, shall begin on the last day of such taxable year. If,
however, the aggregate of such increases equals or exceeds one percent
of the outstanding voting stock or one percent of the value of all
outstanding shares of all classes of stock, the determination of whether
such increases cause the foundation to have excess business holdings
shall be made, and the applicable five-year or 90-day period shall
begin, as of the date the increases, in the aggregate, equal or exceed
one percent.
(6) Examples. The provisions of this paragraph are illustrated in
Sec. 53.4943-7(f) and by the following examples:
Example 1. (i) F, a private foundation, holds 20% of the voting
stock of X corporation, an active business enterprise. No disqualified
[[Page 140]]
person with respect to F holds any X stock. In 1980, X redeems 10% of
its outstanding shares, increasing F's holdings to 22% of the X stock.
Assume the redemption by X is not a prohibited transaction.
(ii) All of F's holdings before the redemption are permitted
holdings under section 4943(c)(2). There is no effective control of X by
third parties so the 35% permitted holdings rule is inapplicable. F's
holdings after the redemption exceed the permitted holdings under
section 4943 (c)(2) (20%). Because the increase is attributable to stock
that was permitted holdings prior to the readjustment, and the
readjustment does not involve a prohibited transaction, the 2% increase
in F's holdings of X stock is treated as acquired other than by
purchase. Therefore, under section 4943(c)(6) and this section, F will
have 5 years from the date of the redemption to dispose of the 2%
excess.
Example 2. (i) Assume the same facts as in Example (1) except that
the 20% of X stock held by F was donated by X corporation, was worth
more than $5,000 and represented 20% of the contributions received by
the foundation through the end of the taxable year in which the gift of
stock was made.
(ii) X corporation is a disqualified person with respect to F under
section 4946(a)(1)(A). Under subparagraph (4), the redemption of X stock
is not treated as a purchase by a disqualified person merely because X
is a disqualified person with respect to F. Therefore the rules of this
paragraph apply as if the redemption were made by a corporation which is
not a disqualified person. The analysis and result are the same as in
Example (1).
Example 3. (i) On May 1, 1990, F, a private foundation, received a
donation of 40% of the stock of X corporation, a business enterprise.
Neither F nor any disqualified person with respect to F holds any other
interest in X. On June 1, 1992, the X corporation redeemed F's 40%
interest in exchange for 100% of the stock of Y corporation, a wholly-
owned subsidiary of X. Assume the redemption by X is not a prohibited
transaction.
(ii) Under section 4943(c)(6), the X stock acquired by gift is
treated as held by disqualified persons through April 30, 1995. Under
subparagraph (3) of this paragraph (d), 40% of the 100% interest in Y
received in exchange for F's 40% interest in X is treated as F's 40%
interest in X and is therefore treated as held by disqualified persons
through April 30, 1995. In addition, under subparagraph (1) of this
paragraph (d), the 60% interest in Y that represents an increase in
holdings above the 40% held before the readjustment will be treated as
acquired other than by purchase. However, F's 20% interest in X in
excess of 20% permitted holdings under 4943(c)(2) would have been excess
business holdings if such interest had not been treated as held by as
disqualified person on June 1, 1992. Therefore, to the extent of a 30%
interest in Y, (i.e., the portion of the increased holdings in Y
attributable to F's 20% holdings in X) the increased holdings will be
treated as held by disqualified person only through April 30, 1995,
since this is the latest date on which F's original 40% interest in X
would have been treated as held by disqualified persons. The remaining
30% interest in Y will be treated as held by disqualified persons for
five years from the date of the exchange (through May 31, 1997).
(e) Constructive holdings. Any change in holdings in a business
enterprise that occurs because a corporation ceases to be actively
engaged in a trade or business, thus causing its holdings to be
constructively owned by its shareholders, shall be treated as acquired
other than by purchase.
(f) Certain transactions treated as purchases; cross references. For
the application of section 4943(c)(6) to holdings that were not an
interest in a business enterprise when acquired but that subsequently
become holdings in a business enterprise, see Sec. 53.4943-10(d)(2).
[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR
6479, Feb. 22, 1984]
Sec. 53.4943-7 Special rules for readjustments involving grandfathered holdings.
(a) General rules--(1) Readjustments. Except to the extent provided
in paragraph (b) of this section, if a private foundation, its
disqualified persons, or both together have holdings in a corporation to
which section 4943(c) (4) or (5) applies, stock of a corporation
received by the foundation, its disqualified persons, or both together
in a readjustment (as defined in paragraph (d)(1) of this section) in
exchange for such holdings to which section 4943 (c) (4) or (5) applies
shall be treated, for purposes of section 4943 (c) (4) or (5), as the
stock surrendered in the exchange.
(2) No exchange necessary. Paragraph (a)(1) of this section shall
apply to all readjustments even if no exchange occurs. For purposes of
this section, all stock held (directly or indirectly) before a
readjustment in any corporation involved in the readjustment shall be
treated as stock surrendered in the readjustment and all stock held
(directly or indirectly) after the readjustment in
[[Page 141]]
any corporation involved in the readjustment shall be treated as stock
received in the readjustment in exchange for the stock treated as
surrendered.
(b) Exceptions and limitations--(1) Limitation on increases in
percentage of voting stock. (i) If the percentage of voting stock in a
business enterprise owned (directly or indirectly) by a private
foundation by reason of its ownership of stock received in an exchange
described in paragraph (a) of this section exceeds the greatest
percentage of voting stock in any business enterprise owned (directly or
indirectly) by the private foundation prior to such exchange by reason
of its ownership of the stock surrendered by it in the exchange, then:
(A) That portion of the stock received by the private foundation in
the exchange which represents such excess is to be treated as an
increase in the holdings of the private foundation in accordance with
Sec. 53.4943-6 (d), and
(B) Only the remaining portion of the stock received by the private
foundation in the exchange shall be treated as the stock surrendered by
the private foundation in the exchange.
(ii) If the sum of the percentage of voting stock in a business
enterprise owned (directly or indirectly) by disqualified persons by
reason of their ownership of stock received in an exchange described in
paragraph (a) of this section plus the percentage of voting stock in the
business enterprise owned (directly or indirectly) by the private
foundation by reason of its ownership of stock received in the exchange
and treated as the stock surrendered under paragraph (b) (1) (i) of this
section exceeds the greatest percentage of voting stock in any business
enterprise owned (directly or indirectly) by the private foundation and
its disqualified person in combination by reason of their ownership of
the stock surrendered by them in the exchange, then:
(A) That portion of the stock received by the disqualified persons
in the exchange which represents such excess is to be treated as an
increase in the holdings of the disqualified persons in accordance with
Sec. 53.4943-6(d), and
(B) Only the remaining portion of the stock received by the
disqualified persons in the exchange is to be treated as the stock
surrendered by the disqualified persons in the exchange.
(2) Limitation on increase in percentage of value. (i) If the
percentage of value of all outstanding shares of all classes of stock in
a business enterprise owned (directly or indirectly) by a private
foundation by reason of its ownership of stock received in an exhange
described in paragraph (a) of this section exceeds the greatest
percentage of such value in any business enterprise owned (directly or
indirectly) by the private foundation prior to such exchange by reason
of its ownership of the stock surrendered by it in the exchange, then:
(A) That portion of the stock received by the private foundation in
the exchange which represents such excess is to be treated as an
increase in the holdings of the private foundation in accordance with
Sec. 53.4943-6(d), and
(B) Only the remaining portion of the stock received by the private
foundation in the exchange shall be treated as the stock surrendered by
the private foundation in the exchange.
(ii) If the sum of the percentage of value of all outstanding shares
of all classes of stock in a business enterprise owned (directly or
indirectly) by disqualified persons by reason of their ownership of
stock received in an exchange described in paragraph (a) of this section
plus the percentage of such value in the business enterprise owned
(directly or indirectly) by the private foundation by reason of its
ownership of stock received in the exchange and treated as the stock
surrendered under paragraph (b)(2)(i) of this section exceeds the
greatest percentage of such value in any business enterprise owned
(directly or indirectly) by the private foundation and its disqualified
persons in combination prior to the exchange by reason of their
ownership of the stock surrendered by them in the exchange, then:
(A) That portion of the stock received by the disqualified persons
in the exchange which represents such excess is to be treated as an
increase in the holdings of the disqualified persons in accordance with
Sec. 53.4943-6(d), and
(B) Only the remaining portion of the stock received by the
disqualified persons in the exchange is to be treated as
[[Page 142]]
the stock surrendered by the disqualified persons in the exchange.
(3) Increases in percentage of both voting stock and value. (i) If,
as the result of an exchange described in paragraph (a) of this section,
a private foundation has excesses determined under both paragraphs
(b)(1)(i) and (b)(2)(i) of this section, then:
(A) That portion of the stock received by the private foundation in
the exchange that represents the larger excess is to be treated as an
increase in the holdings of the private foundation in accordance with
Sec. 53.4943-6(d), and
(B) Only the remaining portion of the stock received by the private
foundation in the exchange is to be treated as the stock surrendered by
the private foundation in the exchange.
(ii) If as the result of an exchange described in paragraph (a) of
this section, disqualified persons have excesses determined under both
paragraphs (b)(1)(ii) and (b)(2)(ii) of this section, then:
(A) That portion of the stock received by the disqualified persons
in the exchange that represents the larger excess is to be treated as an
increase in the holdings of the disqualified persons in accordance with
Sec. 53.4943-6(d), and
(B) Only the remaining portion of the stock received by disqualified
persons in the exchange is to be treated as the stock surrendered by
disqualified persons in the exchange.
(4) Exception for prohibited transactions. If a readjustment
includes a prohibited transaction, as defined in paragraph (d)(2) of
this section, then this paragraph shall be applied substituting, for
purposes of paragraph (b)(1) and (b)(2), the lowest percentage of voting
power or value owned prior to the exchange in any business enterprise
involved in the readjustment to which the exchange relates for the
greatest percentage of voting power or value in any business enterprise
owned by reason of ownership of the stock surrendered in the exchange.
(5) Voting and value levels. After an exchange described in
paragraph (a) of this section, the private foundation voting and value
levels, and the substituted combined voting and value levels (as defined
in Sec. 53.4943-4(d)(2)) shall be the lesser of each respective level
immediately prior to the exchange with respect to the stock surrendered
in the exchange and each such respective level determined immediately
after the exchange by taking into account only the stock received in the
exchange that is treated under this paragraph as the stock surrendered
in the exchange. If the stock of more than one corporation is
surrendered in exchange for stock of one corporation, the highest of
each voting or value level determined immediately prior to the exchange
with respect to the stock of the corporations surrendered in the
exchange shall be treated as such level immediately prior to the
exchange.
(6) Determination of phases--(i) In general. Stock received in an
exchange described in paragraph (a) of this section that is treated as
stock surrendered in the exchange under this paragraph shall be treated
as subject to the same first, second, and third phases that were
applicable to the stock surrendered for it. For purposes of determining
the applicable phases, stock received in an exchange shall be treated as
received in exchange for particular holdings of stock surrendered based
on the terms of the exchange. Where only a portion of the stock received
is treated as the stock surrendered, such portion of the stock received
shall be treated as exchanged for particular holdings of stock
surrendered in the same proportions as the total stock received was
exchanged for particular holdings of stock surrendered. For example, if
20 shares of X stock owned by a private foundation, subject to a first
phase beginning on January 1, 1978 and ending on December 31, 1987, are
exchanged for 20 shares of Y stock, and 40 shares of X stock owned by
the private foundation, subject to a first phase beginning on June 1,
1980 and ending on May 31, 1990, are exchanged for 40 shares of Y stock,
then \1/3\ of the Y stock received by the private foundation is treated
as received in exchanged for X stock having the January 1, 1978-December
31, 1987 first phase and \2/3\ of the Y stock received by the private
foundation is treated as received in exchange for the X stock having the
June 1, 1980-May 31, 1990 first phase. If only 30 shares of the Y stock
received by the private foundation are treated as the
[[Page 143]]
stock surrendered, then \1/3\ (10 Y shares) will be subject to the
January 1, 1978-December 31, 1987 first phase and \2/3\ (20 Y shares)
will be subject to the June 1, 1980-May 31, 1990 first phase.
(ii) Transitional rule. In any case in which holdings subject to
section 4943(c)(4) or 4943(c)(5) have been consolidated prior to May 22,
1984, then the longest first phase applicable to any of the holdings
surrendered in the consolidation shall be applied to the holdings
received by the foundation in the consolidation that are treated as the
holdings surrendered in the consolidation. For purposes of this clause,
a consolidation is any readjustment that results in a reduction in the
number of entities in which the foundation has direct holdings.
(c) Plan to dispose of excess business holdings. (1) Notwithstanding
Sec. 53.4943-4(d)(i)(4)(D) (relating to restrictions on increases in
levels) and paragraphs (a) and (b) of this section, if a readjustment
occurs under an approved plan to dispose of stock to which section
4943(c) (4) or (5) applies, in order to meet the requirements of section
4943(c)(4) (i.e., to meet the reduced limits that will be applicable
after the first phase holding period described in Sec. 53.4943-4(c)) or
to meet the requirements of section 4943(c)(2), all of the stock
received in the readjustment shall be treated as held by disqualified
persons through the end of the longest first phase holding period
applicable to stock surrendered in the readjustment. The foundation and
substituted combined voting and value levels shall not be increased on
account of the readjustment.
(2) For purposes of this paragraph, a plan is an approved plan only
if it is approved by the Commissioner and may be subject to such
conditions as the Commissioner determines. A plan must be approved prior
to any exchange or distribution pursuant to the plan except for a
showing of good cause such as a business emergency.
(d) Definitions--(1) Readjustments. For purposes of this section,
the term ``readjustment'' includes, but is not limited to:
(i) A merger or consolidation;
(ii) A recapitalization;
(iii) An acquisition of stock or assets;
(iv) A transfer of assets;
(v) A change in identity, form, or place of organization, however
effected;
(vi) A redemption;
(vii) A distribution of assets or of stock, including a distribution
to which section 301, 302, 331, or 355 applies or a distribution of
stock of the distributing corporation.
(2) Prohibited transaction. A prohibited transaction is any
transaction involving a private foundation that has holdings in a
business enterprise which:
(i) Acquires stock (or similar interest in the case of an
unincorporated entity) or assets of a business enterprise or redeems its
own stock (or similar interest in the case of an unincorporated entity)
using cash or other property transferred to the acquiring business
enterprise (e.g., as a contribution to capital) by the private
foundation, its disqualified persons, or both;
(ii) Acquires stock (or similar interest in the case of an
unincorporated entity) or assets of a business enterprise or redeems its
own stock (or similar interest in the case of an unincorporated entity)
using the proceeds of a loan made to, or guaranteed by, the private
foundation, its disqualified persons, or both;
(iii) Acquires 40 percent or more of the voting stock (or similar
interest in the case of an unincorporated entity), 40 percent or more of
the value of all outstanding shares of all classes of stock (or similar
interest in the case of an unincorporated entity), or 40 percent or more
of the assets of a business enterprise if the acquiring business
enterprise's net assets used in its trade or business prior to such
acquisition are insubstantial when compared to the net assets acquired
or when compared to the net assets of the business enterprise, the stock
(or similar interest in the case of an unincorporated entity) of which
was acquired. For this purpose, an insubstantial ratio means a ratio
that is 15% or less; or
(iv) Is used as a device to acquire or expand excess business
holdings. The determination of whether a business enterprise is used as
a device to acquire or expand excess business holdings shall be
determined based on all the
[[Page 144]]
facts and circumstances. A business enterprise shall be presumed to have
been used as a device to acquire or expand excess business holdings if
it acquires 40 percent or more of the voting stock (or similar interest
in the case of an unincorporated entity), 40 percent or more of the
value of all outstanding shares of all classes of stock (or similar
interest in the case of an unincorporated entity), or 40 percent or more
of the assets of a business enterprise if the consideration for the
acquisition consists primarily of nonvoting stock (or similar interest
in the case of an unincorporated entity) of the acquiring business
enterprise.
(3) Corporation involved in a readjustment. A corporation shall be
treated as involved in a readjustment if, as part of the readjustment,
any stock of the corporation is issued or redeemed, or any stock or
assets of the corporation are distributed, exchanged, purchased, sold,
acquired, or otherwise transferred.
(e) Application to unincorporated business enterprise. The rules of
this section shall apply equally to partnerships and other
unincorporated business enterprises, applying the rules and
substitutions provided in Sec. 53.4943-3(c)(2), (3), and (4).
(f) Examples. The provisions of this section and Sec. 53.4943-6(d)
are illustrated by the following examples, which assume no prohibited
transactions are involved unless otherwise stated:
Example 1. (i) F, a private foundation, has owned 80% of the one
outstanding class of stock of X corporation since 1965. The X is subject
to section 4943(c)(4) with a first phase ending on May 25, 1984. On
January 1, 1982, X merges with Y corporation to form Z corporation. X,
Y, and Z are active business corporations. F owns no Y stock. No
disqualified person with respect to F owns any stock in Y.Y, or Z. After
the merger, F owns 25% of the one outstanding class of Z stock. Third
parties do not control Z so that the 35% permitted holdings rule under
section 4943(c)(2) is inapplicable
(ii) F's percentage of voting power and value in Z after the merger
(25%) are less than F's percentages of voting power and value in X
before the merger (80%). Therefore, under paragraph (a)(1) of this
section, all of F's holdings in Z are treated as the X stock
surrendered. Therefore, the Z stock is treated as subject to section
4943(c)(4) with a first phase ending on May 25, 1984. Under downward
ratchet of paragraph (a)(5) of this section, the foundation voting and
value levels and the substituted combined voting and value levels are
reduced to 25%.
Example 2. (i) F, a private foundation, owns 100% of the one
outstanding class of stock in X corporation and 30% of the one
outstanding class of stock in Y corporation. F has held this stock
continuously since 1960, and no disqualified person has even owned any
stock in X or Y. Under section 4943(c)(4), F's holdings in X are treated
as held by disqualified persons through the end of the first phase on
May 25, 1989, and F's holdings in Y are permitted holdings during the
second phase, which began on May 25, 1989, and F's holdings in Y are
permitted holdings during the second phase, which began on May 26, 1979.
On January 1, 1985, X and Y consolidate, forming a new corporation Z. In
the consolidation, F acquires 50% of the one class of outstanding stock
of Z, 40% in exchange for F's 100% interest in X and 10% in exchange for
F's 30% interest in Y. Unrelated parties hold the remaining 50% of Z.
(ii) F's percentage of voting power and value in Z after the merger
(50%) are less than F's percentages of voting power and value in X
before the merger (100%). Thus, under paragraph (a)(1) of this section,
the 50% interest in Z held by F is treated as the stock surrendered in
the exchange for purposes of section 4943(c)(4). Under paragraph (b)(6)
of this section, the 10% interest in Z received for the Y stock is
subject to the same second phase period as the surrendered Y stock. The
40% interest first phase period as the surrendered X stock.
Example 3. (i) F, a private foundation, owns 50% of the one class of
outstanding stock in X corporation which F has held continuously since
1935. No disqualified person with respect to F owns any stock in X.
Neither F nor any disqualified person with respect to F owns any stock
in Y corporation. On July 1, 1982, X and Y enter into an agreement to
consolidate their businesses in a reorganization to which section
368(a)(1)(A) will apply. As a result of the contemplated consolidation,
F will own 60% of the voting stock in Z, the resulting corporation. In
addition, parties unrelated to F will own the remaining 40% of the Z
voting stock and 100% of a new issue of nonvoting preferred stock in Z.
Assume for purposes of this example, that the 60% of the voting stock to
be held by F in Z will represent 50% of the fair market value of the
outstanding Z stock.
(ii) Under the provisions of paragraph (b)(1) of this section, that
portion of the Z stock held by F which represents a percentage of voting
power equivalent to that held by F in X immediately prior to the
consolidation (i.e., 50%) will be treated as the X stock held by F on
May 26, 1969, for purposes of section 4943(c)(4). Therefore, 50% of the
Y stock will
[[Page 145]]
be treated as subject to a second phase ending on May 25, 1994. The
remaining portion of the Z voting stock held by F (10%) is subject to
the provisions of Sec. 53.4943-6(d)(1). F will have five years from the
date of the merger in which to dispose of 10% of the Z stock without
incurring the tax on excess business holdings.
Example 4. (i) F, a private foundation, owns 80% of the one class of
outstanding stock in X corporation, an active business corporation. F
has held this stock continuously since 1960 and no disqualified person
with respect to F owns any stock in X. X has two operating divisions,
one which manufacturers shoes and the other which manufactures
refrigerators. On January 1, 1978, in a section 351(a) exchange, X
transferred all of the assets of its shoe manufacturing division to Y, a
corporation which X has formed for this purpose, and receives 100% of
the stock of Y so that Y is a wholly-owned subsidiary of X. X then
transfers all of the Y stock to F in exchange for all of F's holdings of
X stock in a distribution to which section 355 applies.
(ii) Under paragraph (b)(1) of this section, 80% of the Y stock is
treated as the X stock surrendered in the exchange for purposes of
section 4943(c)(4). The 80% is treated under Sec. 53.4943-4(c) as held
by disqualified persons through May 25, 1984, which constitutes the 15-
year first phase holding period applicable to the 80% holding in X. The
80% of the Y stock must be reduced to the permitted holdings allowed
during the second and third phase as provided by section 4943(c)(4)(D)
in the same manner as F's holdings of X stock would have had to have
been reduced.
(iii) Under Sec. 53.4943-6(d)(1), the remaining 20% of Y stock is
treated as held by a disqualified person for five years from the date of
the exchange. F will have five years from the date of the exchange in
which to dispose of 20% of the Y stock without incurring the tax on
excess business holdings.
Example 5. (i) X corporation, an active business corporation, has
outstanding 1,000 shares of one class of stock, of which 600 shares have
been held by F1, a private foundation; 100 shares have been held by F2,
another private foundation; and 100 shares have been held by D, a
disqualified person with respect to both F1 and F2. Unrelated parties
hold the remaining 200 shares. F1 and F2 are disqualified persons with
respect to each other under section 4946(a)(1)(H). Thus, F1 holds 60% of
the X stock (600/1000); F2 and D each hold 10% (100/1000); and the
foundation group (F1, F2 and D) holds 80% of X (800/1000). The holdings
of F1 and F2 were acquired on January 1, 1980 pursuant to a pre-1969
will and are subject to section 4943(c)(5). There have been no changes
in holdings since January 1, 1980.
(ii) On January 1, 1985, pursuant to a plan to dispose of excess
business holdings approved by the Commissioner under paragraph (c) of
this section, X redeems for cash the 600 shares held by F1. After the
redemption, D and F2 each hold 25% of X (100/400). F1 no longer holds
any X stocks. The foundation group's holdings (F1, F2 and D) have
decreased from 80% to 50% while holdings of unrelated parties have
increased from 20% to 50%. At the same time F2's and D's holdings each
have increased from 10% to 25%.
(iii) Notwithstanding the increase in F2's and D's holdings, under
paragraph (c) of this section, all of the X stock held by F2 will be
treated as held by a disqualified person through the end of the first
phase (December 31, 1994). However, the foundation voting and value
levels do not increase. Therefore, after the end of the first phase,
F2's holdings in X may not exceed 10 percent (if the combined holdings
of F1, F2 and D exceed the permitted holdings under section 4943(c)(2)).
Example 6. (i) X corporation, an active business corporation, has
outstanding 1,000 shares of its one class of stock. Since 1960, 100
shares (10%) have been held by F, a private foundation and 350 shares
(35%) have been held by D, a disqualified person with respect to F. All
of the stock held by F is permitted holdings under section 4943(c)(4)
and the substituted combined voting and value levels are 45% (10% +
35%). Because of disagreements concerning management of X between D and
A, an unrelated party who holds 300 shares (30%) of the X stock, X
redeems all of A's shares on December 1, 1981.
(ii) After the redemption, F holds 14.3% (100/700) of the X stock
and D holds 50% (350/700), for combined holdings of 64.3%. Because the
combined holdings exceed the substituted combined voting level (45%) by
more than F's entire holdings, all of the F stock is excess business
holdings. However, all of F's stock will be treated as acquired other
than by purchase under Sec. 53.4943-6(d)(1) and therefore will be
treated under section 4943(c)(6) and this section, as held by a
disqualified person for five years from the date of the redemption
(through November 30, 1986). If the combined holdings of F and its
disqualified person are reduced to 45 percent by the end of the five
year period, F may retain a portion of its holdings in X (limited to no
more than the foundation voting and value level of 10 percent).
Example 7. Assume the same facts as in Example (6), except that D
loaned the money to X that was used to redeem A's shares. Under these
facts, the increased holdings result from a prohibited transaction
described in paragraph (d)(2) of this section. Therefore, all of F's
stock will be treated as acquired by purchase by a disqualified person
under Sec. 53.4943-6(d)(2). F will have 90 days after the redemption in
which to dispose of its holdings or to reduce its holdings and the
combined holdings to the levels held prior to the redemption as
discussed in Example (6).
[[Page 146]]
Example 8. (i) F, a private foundation, has held 100% of the
outstanding stock of X corporation since 1960. F also holds 15% of the
voting stock of Y corporation. Both X and Y are active business
corporations. X has $1 million in net assets used in its trade or
business and Y has $6.7 million used in its trade or business. On June
1, 1985, Y is merged into X. After the merger F holds 25% of the voting
stock of X. No person other than F controls X after the merger.
(ii) Because more than 40% of Y was acquired and the net assets of
X, the acquiring corporation, used in its trade or business prior to the
merger represent less than 15% of the net assets of Y used in its trade
or business, the merger is a prohibited transaction described in
paragraph (d)(2)(iii). Therefore, only 15% of the stock X is treated,
pursuant to paragraph (b), as the stock held by F prior to the
redemption. F's holding of 5% (the excess of F's 25% holdings over the
20% permitted holdings in X (determined under section 4943(c)(2)) are
treated as purchased by a disqualified person pursuant to Sec. 53.4943-
6(d)(2). F will have 90 days after June 1, 1985, in which to dispose of
the 5% excess holdings.
[T.D. 7944, 49 FR 6480, Feb. 22, 1984]
Sec. 53.4943-8 Business holdings; constructive ownership.
(a) Constructive ownership--(1) In general. For purposes of section
4943, in computing the holdings in a business enterprise of a private
foundation, or a disqualified person (as defined in section 4946), any
stock or other interest owned, directly or indirectly, by or for a
corporation, partnership, estate or trust shall be considered as being
owned proportionately by or for its shareholders, partners, or
beneficiaries except as otherwise provied paragraphs (b), (c) and (d) of
this section. Any interest in a business enterprise actually or
constructively owned by a shareholder of a corporation, a partner of a
partnership, or beneficiary of an estate or trust shall not be
considered as constructively held by the corporation, partnership, trust
or estate. Further, if any corporation, partnership, estate or trust has
a warrant or other option to acquire an interest in a business
enterprise, such interest is not deemed to be constructively owned by
such entity until the option is exercised. (See paragraph (b)(2) of
Sec. 53.4943-3 for rules that options are not stock for purposes of
determining excess business holdings.)
(2) Powers of appointment. Any interest in business enterprise over
which a foundation or a disqualified person has a power of appointment
exercisable in favor of the foundation or a disqualified person shall be
considered owned by the foundation or disqualified person holding such
power of appointment.
(3) Determination of extent of constructive ownership. If an
interest in a business enterprise owned by a corporation is
constructively owned by a shareholder, each shareholder's proportion of
ownership is generally computed on the basis of the voting stock each
shareholder has in the corporation. In determining holdings permitted
under section 4943(c) (4) and (5), each shareholder's proportion of
ownership in the business enterprise shall also be computed on the basis
of value, taking into account both voting and nonvoting stock held by
the shareholder.
(4) Nonvoting stock. If a private foundation, its disqualified
persons, or both, own (directly or constructively) nonvoting stock of a
parent corporation, the holdings of which are treated as constructively
owned by its shareholders by reason of section 4943(d)(1) and this
section, such nonvoting stock shall be treated as nonvoting stock of any
corporation in which the parent corporation holds an interest for
purposes of the limitation on the holding of nonvoting stock under
section 4943(c)(2)(A) and Sec. 53.4943-3(b)(2).
(5) Interests held by certain disqualified persons. In the case of
an entity that is a disqualified person (other than an entity described
in section 4946(a)(1)(H)), the holdings of which are treated as
constructively owned by its shareholders, partners, or beneficiaries,
for purposes of determining the total holdings of disqualified persons
the holdings of the entity shall be considered held by a disqualified
person only to the extent such holdings are treated as constructively
owned by disqualified persons who are shareholders, partners, or
beneficiaries of the entity. In the case of an entity described in
section 4946(a)(1)(H) or an entity, the holdings of which are not
treated as constructively owned by its shareholders, partners, or
beneficiaries, all holdings of such entity shall be treated as held by
[[Page 147]]
a disqualified person if and only if the entity itself is a disqualified
person.
(b) Estates and trusts--(1) In general. Any interest actually or
constructively owned by an estate or trust is deemed constructively
owned, in the case of an estate, by its beneficiaries or, in the case of
a trust, by its remainder beneficiaries except as provided in paragraphs
(b) (2), (3) and (4) of this section (relating to certain split-interest
trusts described in section 4947(a)(2), to trusts of qualified pension,
profit-sharing, and stock bonus plans described in section 401(a) and to
revocable trusts). Thus, if a trust owns 100 percent of the stock of a
corporation A, and if, on an actuarial basis, W's life interest in the
trust is 15 percent, Y's life interest is 25 percent, and Z's remainder
interest is 60 percent, under this paragraph (b), Z will be considered
to be the owner of 100 percent of the stock of corporation A. See Sec.
53.4943-4, Sec. 53.4943-5 and Sec. 53.4943-6 for rules relating to
certain actual or constructive holdings of a foundation being treated as
held by a disqualified person. For the treatment of certain property
acquired by an estate or trust after May 26, 1969, see paragraph (a)(2)
of Sec. 53.4943-5.
(2) Split-interest trusts--(i) Amounts transferred in trust after
May 26, 1969. In the case of an interest in a business enterprise which
was transferred to a trust described in section 4947(a)(2) after May 26,
1969, for the benefit of a private foundation, no portion of such
interest shall be considered as owned by the private foundation:
(A) If the foundation holds only an income interest in the trust, or
(B) If the foundation holds only a remainder interest in the trust
(unless the foundation can exercise primary investment discretion with
respect to such interest)
until such trust ceases to be so described. See section 4947(a)(2) and
(b)(3) and the regulations thereunder for rules relating to such trusts.
See also sections 4946(a)(1) (G) and (H) and the regulations thereunder
for rules relating to when a trust described in this paragraph (b)(2) is
itself a disqualified person.
(ii) Amounts transferred in trust on or before May 26, 1969. In the
case of an interest in a business enterprise which was transferred to a
trust described in section 4947(a)(2) (without regard to section
4947(a)(2)(C)) on or before May 26, 1969, for the benefit of a private
foundation, no portion of such interest shall be considered as owned by
the foundation until it is actually distributed to the foundation or
until the trust ceases to be so described. See section 4943(c)(5) and
Sec. 53.4943-5 for rules relating to certain trusts which were
irrevocable on May 26, 1969.
(3) Employee benefit trusts. An interest in a business enterprise
owned by a trust described in section 401(a) (pension and profit-sharing
plans) shall not be considered as owned by its beneficiaries, unless
disqualified persons (within the meaning of section 4946) control the
investment of the trust assets.
(4) Revocable trusts. An interest in a business enterprise owned by
a revocable trust shall be treated as owned by the grantor of such
trust.
(5) Estates. For purposes of applying section 4943(d)(1) to estates,
the term ``beneficiary'' includes any person (including a private
foundation) entitled to receive property of a decedent pursuant to a
will or pursuant to laws of descent and distribution. However, a person
shall no longer be considered a beneficiary of an estate when all the
property to which he is entitled has been received by him, when he no
longer has a claim against the estate and when there is only a remote
possibility that it will be necessary for the estate to seek the return
of property or to seek payment from him by contribution or otherwise to
satisfy claims against the estate or expenses of administration. When
pursuant to the preceding sentence, a person (including a private
foundation) ceases to be a beneficiary, stock or another interest in a
business enterprise owned by the estate shall not thereafter be
considered owned by such person. If any person is the constructive owner
of an interest in a business enterprise actually held by an estate, the
date of death of the testator or decedent intestate shall be the first
day on which such person shall be considered a constructive owner of
such interest. See Sec. 53.4943-5 for rules relating to wills executed
on or before May 26, 1969.
[[Page 148]]
(c) Corporation actively engaged in a trade or business--(1) In
general. Except as provided in paragraphs (c)(2) and (3) of this
section, any interest (whether or not in a separate entity) owned by a
corporation which is actively engaged in a trade or business shall not
be deemed to be constructively owned by such corporation's shareholders.
(2) Actively engaged in a trade or business. For purposes of
paragraph (c)(1) of this section:
(i) A corporation shall not be considerd to be actively engaged in a
trade or business if the corporation is not a business enterprise by
reason of section 4943(d)(3) (A) or (B) and Sec. 53.4943-10 (b) or (c);
(ii) In the case of a corporation which owns passive holdings and is
actively engaged in a trade or business, such corporation shall not be
considered to be actively engaged in a trade or business if the net
assets used in such trade or business are insubstantial when compared to
passive holdings.
(3) Exceptions. If a corporation has been involved in a prohibited
transaction, any interest in a business enterprise owned by such
corporation shall be treated as constructively owned by its
shareholders, whether or not such corporation is actively engaged in a
trade or business. For a definition of prohibited transaction, see Sec.
53.4943-7 (d)(2).
(4) Affiliated group. In applying this paragraph to the common
parent in an affiliated group (as defined in Sec. 53.4943-10
(c)(3)(ii)), the assets and activities of the affiliated group shall be
treated as the assets and activities of the common parent.
(d) Partnerships. Any interest in a business enterprise which is
owned by a partnership shall be deemed to be constructively owned by the
partners in such partnerships.
(e) Examples. The provisions of this section are illustrated by the
following examples.
Example 1. F, a private foundation, directly owns voting stock of X,
a holding company described in section 4943(d)(3)(B). That stock
represents 40% of the voting power in X and 20% of the value of all
outstanding shares of all classes of stock in X. F also owns nonvoting
stock in X that represents 10% of the value of all outstanding shares of
all classes of stock in X. D, a disqualified person, owns voting stock
of X that represents 40% of the voting power in X and 20% of the value.
D does not own any nonvoting stock in X. X corporation's only holding is
stock of Y corporation. The Y voting stock held by X represents 50% of
the voting power in Y and 25% of the value of all outstanding shares of
all classes of stock in Y. X also owns nonvoting stock in Y that
represents 25% of the value of all outstanding shares of all classes of
stock in Y. Under paragraph (a)(3) of this section, F and D each
constructively owns 20% of the voting power in Y through their voting
interest in X (40% of X's 50% of Y). F also constructively owns 15% of
the value of all outstanding shares of all classes of stock in Y through
F's interest in X (F's 30% of the value of X multiplied by X's 50% of
the value of Y), while D constructively owns 10% of the value of Y (D's
20% of the value of X multiplied by X's 50% of the value of Y).
Example 2. (i) F, a private foundation, owns 50% of the one class of
nonvoting stock of X corporation, a corporation described in section
4943(d)(3)(B) and paragraph (c)(2)(i) above. D, a disqualified person
with respect to F as described in section 4946(a)(1)(A), owns 40% of the
one class of voting stock of X. X corporation is a disqualified person
with respect to F because D owns more than 35% of the voting of X. (See
section 4946(a)(1)(E)). On January 1, 1980, X purchases for cash 40% of
the only class of stock of Y corporation, a retail clothing store, from
unrelated third parties.
(ii) Under paragraph (a)(4) of this section, F is treated as owning
nonvoting stock of Y. Although X is a disqualified person, its holdings
are not treated as held by disqualified persons except as constructive
holdings. Therefore, the ``deemed'' nonvoting stock in Y is a permitted
holding because D, a disqualified person with respect to F,
constructively owns only 16% of the voting stock of Y (less than 20%
permitted under section 4943(c)(2)).
Example 3. (i) The facts are the same as in Example (2), except that
X purchases 100% of this stock of Y corporation. Under paragraph (a)(4)
of this section, F is treated as owning nonvoting stock of Y. The
``deemed'' nonvoting stock in Y is not a permitted holdings because D, a
disqualified person with respect to F, constructively owns 40% of the
voting stock of Y.
Example 4. (i) D, a disqualified person with respect to F, owns 40%
of the one class of stock in X corporation, an active business. X is a
disqualified person with respect to F. X acquires 40% of the voting
stock in Y corporation. Under paragraph (a)(5) of this section, the
holdings of X in Y are treated as
[[Page 149]]
held by a disqualified person. F cannot hold any Y stock, voting or
nonvoting.
[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR
6484, Feb. 22, 1984]
Sec. 53.4943-9 Business holdings; certain periods.
(a) Taxable period--(1) In general. For purposes of section 4943,
the term ``taxable period'' means, with respect to any excess business
holdings of a private foundation in a business enterprise, the period
beginning with the first day on which there are such excess business
holdings and ending on the earliest of:
(i) The date of mailing of a notice of deficiency under section 6212
with respect to the tax imposed on the holdings by the section 4943(a);
(ii) The date on which the excess is eliminated; or
(iii) The date on which the tax imposed by section 4943(a) is
assessed.
For example, M, a private foundation, first has excess business holdings
in X, a corporation, on February 5, 1972. A notice of deficiency is
mailed under section 6212 to M on June 1, 1974. With respect to M 's
excess business holdings in X, the taxable period begins on February 5,
1972, and ends on June 1, 1974.
(2) Special rule. Where a notice of deficiency referred to in
subparagraph (1)(i) of this paragraph is not mailed because there is a
waiver of the restrictions on assessment and collection of a deficiency,
or because the deficiency is paid, the date of filing of the waiver or
the date of such payment, respectively, shall be treated as the end of
the taxable period.
(3) Suspension of taxable period for 90 days. In any case in which a
private foundation has excess business holdings solely because of the
acquisition of an interest in a business enterprise to which paragraph
(a)(1) (ii) or (iii) of Sec. 53.4943-2 applies, the taxable period
described in paragraph (a) of this section shall be suspended for the
90-day period (as extended) starting with the date on which the
foundation knows or has reason to know of the acquisition, provided that
at the end of such period the foundation has disposed of such excess
holdings.
(b) Cross reference. For rules relating to taxable events that are
corrected within the correction period, defined in section 4863(e), see
section 4861(a) and the regulations thereunder.
(c) Correction. For purposes of section 4943, correction shall be
considered as made when no interest in the enterprise held by the
foundation is classified as an excess business holdings under section
4943(c)(1). In any case where the private foundation has excess business
holdings which are constructively held for it under section 4943(c)(1),
correction shall be considered made when either a corporation,
partnership, estate, or trust in which holdings in such enterprise are
constructively held for the foundation or a disqualified person; the
foundation itself; or a disqualified person disposes of a sufficient
interest in the enterprise so that no interest in the enterprise held by
the foundation is classified as excess business holdings under section
4943(c)(1).
[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 8084, 51 FR
16302, May 2, 1986]
Sec. 53.4943-10 Business enterprise; definition.
(a) In general. (1) Except as provided in paragraph (b) or (c) of
this section under section 4943(d)(4) the term ``business enterprise''
includes the active conduct of a trade or business, including any
activity which is regularly carried on for the production of income from
the sale of goods or the performance of services and which constitutes
an unrelated trade or business under section 513. For purposes of the
preceding sentence, where an activity carried on for profit constitutes
an unrelated trade or business, no part of such trade or business shall
be excluded from the classification of a business enterprise merely
because it does not result in a profit.
(2) Notwithstanding paragraph (a)(1) of this section, a bond or
other evidence of indebtedness does not constitute a holding in a
business enterprise unless such bond or evidence of indebtedness is
otherwise determined to be an equitable interest in such enterprise.
Similarly, a lease-hold interest in real property does not constitute
[[Page 150]]
an interest in a business enterprise, even though rent payable under
such lease is dependent, in whole or in part, upon the income or profits
derived by another from such property, unless such leasehold interest
constitutes an interest in the income or profits of an unrelated trade
or business under section 513.
(b) Certain program-related activities. For purposes of section
4943(d)(4) the term ``business enterprise'' does not include a
functionally related business as defined in section 4942(j)(5). See
Sec. 53.4942(a)-2(c)(3)(iii). In addition, business holdings do not
include program-related investments (such as investments in small
businesses in central cities or in corporations to assist in
neighborhood renovation) as defined in section 4944(c) and the
regulations thereunder.
(c) Income derived from passive sources--(1) In general. For
purposes of section 4943(d)(4), the term ``business enterprise'' does
not include a trade or business at least 95 percent of the gross income
of which is derived from passive sources; except that if in the taxable
year in question less than 95 percent of the income of a trade or
business is from passive sources, the foundation may, in applying this
95 percent test, substitute for the passive source gross income in such
taxable year the average gross income from passive sources for the 10
taxable years immediately preceding the taxable year in question (or for
such shorter period as the entity has been in existence). Thus, stock in
a passive holding company is not to be considered a holding in a
business enterprise even if the company is controlled by the foundation.
Instead, the foundation is treated as owning its proportionate share of
any interests in a business enterprise held by such company under
section 4943(d)(1).
(2) Gross income from passive sources. Gross income from passive
sources, for purposes of this paragraph, includes the items excluded by
section 512(b)(1) (relating to dividends, interest, and annuities),
512(b)(2) (relating to royalties), 512(b)(3) (relating to rent) and
512(b)(5) (relating to gains or losses from the disposition of certain
property). Any income classified as passive under this paragraph does
not lose its character merely because section 512(b)(4) or 514 (relating
to unrelated debt-financed income) applies to such income. In addition,
income from passive sources includes income from the sale of goods
(including charges or costs passed on at cost to purchasers of such
goods or income received in settlement of a dispute concerning or in
lieu of the exercise of the right to sell such goods) if the seller does
not manufacture, produce, physically receive or deliver, negotiate sales
of, or maintain inventories in such goods. Thus, for example, where a
corporation purchases a product under a contract with the manufacturer,
resells it under contract at a uniform markup in price, and does not
physically handle the product, the income derived from that markup meets
the definition of passive income for purposes of this paragraph. On the
other hand, income from individually negotiated sales, such as those
made by a broker, would not meet such definition even if the broker did
not physically handle the goods.
(3) Affiliated group. (i) For a common parent corporation in an
affiliated group, substitute ``consolidated gross income'' in
subparagraph (1) of this paragraph.
(ii) For purposes of this section, the term affiliated group shall
have the same meaning as in section 1504(a), without regard to section
1504 (b) through (e).
(iii) Section 53.4943-11(d) provides a transitional rule for certain
parent corporations.
(d) Application of section 4943(c)(6)--(1) Program related
activities. If a private foundation holds an interest which is not an
interest in a business enterprise because of paragraph (b) of this
section (relating to program related activities), and such interest
later becomes an interest in a business enterprise solely by reason of
failing to meet the requirements of such paragraph (b), such interest
will then be subject to section (regardless of when it was originally
acquired) and will be treated as having been acquired other than by
purchase for purposes of section 4943(c)(6).
(2) Passive holdings, etc. (i) Except as provided in subdivision
(ii), if a private
[[Page 151]]
foundation holds an interest that is not an interest in a business
enterprise, and the interest later becomes an interest in a business
enterprise (other than by reason of a readjustment as defined in Sec.
53.4943-7(d)(1)), the interest will be treated as having been acquired
by purchase by a disqualified person at the time the interest becomes an
interest in a business enterprise. The treatment of an interest that
becomes an interest in a business enterprise by reason of a readjustment
shall be determined under Sec. 53.4943-6 and Sec. 53.4943-7.
(ii) If a private foundation establishes that the events which
caused an interest not originally a business enterprise to become a
business enterprise were not effectively controlled by the private
foundation, then such interest shall be treated as acquired other than
by purchase from the time of the change for purposes of section
4943(c)(6).
(iii) See Sec. 53.4943-3(b)(3)(ii) for the definition of effective
control.
(e) Sole proprietorship. For purposes of section 4943 and the
regulations thereunder, the term ``sole proprietorship'' means any
business enterprise (as defined in paragraphs (a), (b), and (c) of this
section:
(1) Which is actually and directly owned by a private foundation,
(2) In which the foundation has a 100 percent equity interest, and
(3) Which is not held by a corporation, trust, or other business
entity for such foundation.
A foundation may be considered to own a sole proprietorship even though
the foundation is itself a corporation or a trust. However, a sole
proprietorship which is owned by a foundation shall cease to be treated
as a sole proprietorship when the foundation no longer has a 100-percent
interest in the equity of the business enterprise. Thus, if and when a
foundation sells a 10-percent interest in a sole proprietorship, such
business enterprise shall be treated as a partnership under section 4943
and the regulations thereunder.
[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR
6484, Feb. 22, 1984]
Sec. 53.4943-11 Effective date.
(a) In general. Section 4943 and Sec. Sec. 53.4943-1 through
53.4943-11 shall take effect for taxable years beginning after December
31, 1969, except as otherwise provided by such sections.
(b) Special transitional rule. In the case of any acquisition of
excess holdings prior to February 2, 1973, section 4943(a)(1) shall not
apply if correction occurs (within the meaning of paragraph (c) of Sec.
53.4943-9) within a period ending 90 days after July 5, 1977 extended
(prior to the expiration of the original period) by any period which the
Commissioner determines is reasonable and necessary (within the meaning
of paragraph (b) of Sec. 53.4943-9) to bring about such correction.
(c) Special transitional rule for acquisition by will, etc. (1) The
rule in Sec. 53.4943-6(b)(1) whereby holdings not held by a decedent
are not treated as acquired under a will shall not apply to acquisitions
of after-acquired property of a decedent's estate occurring on or before
May 22, 1984.
(2) The rule in Sec. 53.4943-6(b)(1) treating a purchase by an
estate as a purchase by a disqualified person where the executor is a
disqualified person shall not apply to purchases occurring on or before
May 22, 1984.
(d) Special transitional rule for affiliated groups. If on or before
May 22, 1984 a foundation holds an interest in a common parent
corporation in an affiliated group, as defined in Sec. 53.4943-
10(c)(3)(ii), the foundation may elect to have both Sec. 53.4943-
8(c)(4) and Sec. 53.4943-10(c)(3) not apply to such common parent
corporation. No election may be made to have only one section not apply.
Such election shall be made by the governing body of the private
foundation at any time prior to February 22, 1985.
(e) Special transitional rule for changes to a business enterprise.
Any interest that is not an interest in a business enterprise which
becomes an interest in a business enterprise under Sec. 53.4943-
10(d)(2) prior to May 22, 1984 will be treated as having been acquired
other than by purchase for purposes of section 4943(c)(6).
[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR
6485, Feb. 22, 1984]
[[Page 152]]
Subpart E_Taxes on Investments Which Jeopardize Charitable Purpose
Source: T.D. 7240, 37 FR 28747, Dec. 27, 1972, unless otherwise
noted.
Sec. 53.4944-1 Initial taxes.
(a) On the private foundation--(1) In general. If a private
foundation (as defined in section 509) invests any amount in such a
manner as to jeopardize the carrying out of any of its exempt purposes,
section 4944(a) (1) of the Code imposes an excise tax on the making of
such investment. This tax is to be paid by the private foundation and is
at the rate of 5 percent of the amount so invested for each taxable year
(or part thereof) in the taxable period (as defined in section 4944(e)
(1)). The tax imposed by section 4944(a)(1) and this paragraph shall
apply to investments of either income or principal.
(2) Jeopardizing investments. (i) Except as provided in section
4944(c), Sec. 53.4944-3, Sec. 53.4944-6(a), and subdivision (ii) of
this subparagraph, an investment shall be considered to jeopardize the
carrying out of the exempt purposes of a private foundation if it is
determined that the foundation managers, in making such investment, have
failed to exercise ordinary business care and prudence, under the facts
and circumstances prevailing at the time of making the investment, in
providing for the long- and short-term financial needs of the foundation
to carry out its exempt purposes. In the exercise of the requisite
standard of care and prudence the foundation managers may take into
account the expected return (including both income and appreciation of
capital), the risks of rising and falling price levels, and the need for
diversification within the investment portfolio (for example, with
respect to type of security, type of industry, maturity of company,
degree of risk and potential for return). The determination whether the
investment of a particular amount jeopardizes the carrying out of the
exempt purposes of a foundation shall be made on an investment by
investment basis, in each case taking into account the foundation's
portfolio as a whole. No category of investments shall be treated as a
per se violation of section 4944. However, the following are examples of
types or methods of investment which will be closely scrutinized to
determine whether the foundation managers have met the requisite
standard of care and prudence: Trading in securities on margin, trading
in commodity futures, investments in working interests in oil and gas
wells, the purchase of ``puts,'' ``calls,'' and ``straddles,'' the
purchase of warrants, and selling short. The determination whether the
investment of any amount jeopardizes the carrying out of a foundation's
exempt purposes is to be made as of the time that the foundation makes
the investment and not subsequently on the basis of hindsight.
Therefore, once it has been ascertained that an investment does not
jeopardize the carrying out of a foundation's exempt purposes, the
investment shall never be considered to jeopardize the carrying out of
such purposes, even though, as a result of such investment, the
foundation subsequently realizes a loss. The provisions of section 4944
and the regulations thereunder shall not exempt or relieve any person
from compliance with any Federal or State law imposing any obligation,
duty, responsibility, or other standard of conduct with respect to the
operation or administration of an organization or trust to which section
4944 applies. Nor shall any State law exempt or relieve any person from
any obligation, duty, responsibility, or other standard of conduct
provided in section 4944 and the regulations thereunder.
(ii)(a) Section 4944 shall not apply to an investment made by any
person which is later gratuitously transferred to a private foundation.
If such foundation furnishes any consideration to such person upon the
transfer, the foundation will be treated as having made an investment
(within the meaning of section 4944(a)(1)) in the amount of such
consideration.
(b) Section 4944 shall not apply to an investment which is acquired
by a private foundation solely as a result of a corporate reorganization
within the meaning of section 368(a).
(iii) For purposes of section 4944, a private foundation which,
after December 31, 1969, changes the form or terms
[[Page 153]]
of an investment (regardless of whether subdivision (ii) of this
subparagraph applies to such investment), will be considered to have
entered into a new investment on the date of such change, except as
provided in subdivision (ii)(b) of this subparagraph. Accordingly, a
determination, under subdivision (i) of this subparagraph, whether such
change in the investment jeopardizes the carrying out of the
foundation's exempt purposes shall be made at such time.
(iv) It is not intended that the taxes imposed under Chapter 42 be
exclusive. For example, if a foundation purchases a sole proprietorship
in a business enterprise within the meaning of section 4943(d)(4), in
addition to tax under section 4943, the foundation may be liable for tax
under section 4944 if the investment jeopardizes the carrying out of any
of its exempt purposes.
(b) On the management--(1) In general. In any case in which a tax is
imposed by section 4944(a)(1) and paragraph (a) of this section, section
4944 (a)(2) of the Code imposes on the participation of any foundation
manager in the making of the investment, knowing that it is jeopardizing
the carrying out of any of the foundation's exempt purposes, a tax equal
to 5 percent of the amount so invested for each taxable year of the
foundation (or part thereof) in the taxable period (as defined in
section 4944(e)(1)), subject to the provisions of section 4944(d) and
Sec. 53.4944-4, unless such participation is not willful and is due to
reasonable cause. The tax imposed under section 4944(a)(2) shall be paid
by the foundation manager.
(2) Definitions and special rules--(i) Knowing. For purposes of
section 4944, a foundation manager shall be considered to have
participated in the making of an investment ``knowing'' that it is
jeopardizing the carrying out of any of the foundation's exempt purposes
only if:
(a) He has actual knowledge of sufficient facts so that, based
solely upon such facts, such investment would be a jeopardizing
investment under paragraph (a)(2) of this section,
(b) He is aware that such an investment under these circumstances
may violate the provisions of federal tax law governing jeopardizing
investments, and
(c) He negligently fails to make reasonable attempts to ascertain
whether the investment is a jeopardizing investment, or he is in fact
aware that it is such an investment.
For purposes of this part and Chapter 42, the term knowing does not mean
``having reason to know''. However, evidence tending to show that a
foundation manager has reason to know of a particular fact or particular
rule is relevant in determining whether he had actual knowledge of such
fact or rule. Thus, for example, evidence tending to show that a
foundation manager has reason to know of sufficient facts so that, based
solely upon such facts, an investment would be a jeopardizing investment
is relevant in determining whether he has actual knowledge of such
facts.
(ii) Willful. A foundation manager's participation in a jeopardizing
investment is willful if it is voluntary, conscious, and intentional. No
motive to avoid the restrictions of the law or the incurrence of any tax
is necessary to make such participation willfull. However, a foundation
manager's participation in a jeopardizing investment is not willful if
he does not know that it is a jeopardizing investment under paragraph
(a)(2) of this section.
(iii) Due to reasonable cause. A foundation manager's actions are
due to reasonable cause if he has exercised his responsibility on behalf
of the foundation with ordinary business care and prudence.
(iv) Participation. The participation of any foundation manager in
the making of an investment shall consist of any manifestation of
approval of the investment.
(v) Advice of counsel. If a foundation manager, after full
disclosure of the factual situation to legal counsel (including house
counsel), relies on the advice of such counsel expressed in a reasoned
written legal opinion that a particular investment would not jeopardize
the carrying out of any of the foundation's exempt purposes (because, as
a matter of law, the investment is excepted from such classification,
for
[[Page 154]]
example, as a program-related investment under section 4944(c)), then
although such investment is subsequently held to be a jeopardizing
investment under paragraph (a)(2) of this section, the foundation
manager's participation in such investment will ordinarily not be
considered ``knowing'' or ``willfull'' and will ordinarily be considered
``due to reasonable cause'' within the meaning of section 4944(a) (2).
In addition, if a foundation manager, after full disclosure of the
factual situation to qualified investment counsel, relies on the advice
of such counsel, such advice being derived in a manner consistent with
generally accepted practices of persons who are such a qualified
investment counsel and being expressed in writing that a particular
investment will provide for the long and short term financial needs of
the foundation under paragraph (a)(2) of this section, then although
such investment is subsequently held not to provide for such long and
short term financial needs, the foundation manager's participation in
failing to provide for such long and short term financial needs will
ordinarily not be considered ``knowing'' or ``willful'' and will
ordinarily be considered ``due to reasonable cause'' within the meaning
of section 4944(a)(2). For purposes of this subdivision, a written legal
opinion will be considered ``reasoned'' even if it reaches a conclusion
which is subsequently determined to be incorrect so long as such opinion
addresses itself to the facts and applicable law. However, a written
legal opinion will not be considered ``reasoned'' if it does nothing
more than recite the facts and express a conclusion. However, the
absence of advice of legal counsel or qualified investment counsel with
respect to the investment shall not, by itself, give rise to any
inference that a foundation manager participated in such investment
knowingly, willfully, or without reasonable cause.
(vi) Cross reference. For provisions relating to the burden of proof
in cases involving the issue whether a foundation manager has knowingly
participated in the making of a jeopardizing investment, see section
7454(b).
(c) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. A is a foundation manager of B, a private foundation with
assets of $100,000. A approves the following three investments by B
after taking into account with respect to each of them B's portfolio as
a whole: (1) An investment of $5,000 in the common stock of corporation
X; (2) an investment of $10,000 in the common stock of corporation Y;
and (3) an investment of $8,000 in the common stock of corporation Z.
Corporation X has been in business a considerable time, its record of
earnings is good and there is no reason to anticipate a diminution of
its earnings. Corporation Y has a promising product, has had earnings in
some years and substantial losses in others, has never paid a dividend,
and is widely reported in investment advisory services as seriously
undercapitalized. Corporation Z has been in business a short period of
time and manufactures a product that is new, is not sold by others, and
must compete with a well-established alternative product that serves the
same purpose. Z's stock is classified as a high-risk investment by most
investment advisory services with the possibility of substantial long-
term appreciation but with little prospect of a current return. A has
studied the records of the three corporations and knows the foregoing
facts. In each case the price per share of common stock purchased by B
is favorable to B. Under the standards of paragraph (a)(2)(i) of this
section, the investment of $10,000 in the common stock of Y and the
investment of $8,000 in the common stock of Z may be classified as
jeopardizing investments, while the investment of $5,000 in the common
stock of X will not be so classified. B would then be liable for an
initial tax of $500 (i.e., 5 percent of $10,000) for each year (or part
thereof) in the taxable period for the investment in Y, and an initial
tax of $400 (i.e., 5 percent of $8,000) for each year (or part thereof)
in the taxable period for the investment in Z. Further, since A had
actual knowledge that the investments in the common stock of Y and Z
were jeopardizing investments, A would then be liable for the same
amount of initial taxes as B.
Example 2. Assume the facts as stated in Example (1), except that:
(1) In the case of corporation Y, B's investment will be made for new
stock to be issued by Y and there is reason to anticipate that B's
investment, together with investments required by B to be made
concurrently with its own, will satisfy the capital needs of corporation
Y and will thereby overcome the difficulties that have resulted in Y's
uneven earnings record; and (2) in the case of corporation Z, the
management has a demonstrated capacity for getting new businesses
started successfully and Z has received substantial orders for its new
[[Page 155]]
product. Under the standards of paragraph (a) (2) (i) of this section,
neither the investment in Y nor the investment in Z will be classified
as a jeopardizing investment and neither A nor B will be liable for an
initial tax on either of such investments.
Example 3. D is a foundation manager of E, a private foundation with
assets of $200,000. D was hired by E to manage E's investments after a
careful review of D's training, experience and record in the field of
investment management and advice indicated to E that D was well
qualified to provide professional investment advice in the management of
E's investment assets. D, after careful research into how best to
diversify E's investments, provide for E's long-term financial needs,
and protect against the effects of long-term inflation, decides to
allocate a portion of E's investment assets to unimproved real estate in
selected areas of the country where population patterns and economic
factors strongly indicate continuing growth at a rapid rate. D
determines that the short-term financial needs of E can be met through
E's other investments. Under the standards of paragraph (a)(2)(i) of
this section, the investment of a portion of E's investment assets in
unimproved real estate will not be classified as a jeopardizing
investment and neither D nor E will be liable for an initial tax on such
investment.
[T.D. 7240, 37 FR 28747, Dec. 29, 1972, as amended by T.D. 7299, 38 FR
35304, Dec. 27, 1973]
Sec. 53.4944-2 Additional taxes.
(a) On the private foundation. Section 4944(b)(1) of the Code
imposes an excise tax in any case in which an initial tax is imposed by
section 4944(a)(1) and Sec. 53.4944-1(a) on the making of a
jeopardizing investment by a private foundation and such investment is
not removed from jeopardy within the taxable period (as defined in
section 4944(e)(1)). The tax imposed under section 4944(b)(1) is to be
paid by the private foundation and is at the rate of 25 percent of the
amount of the investment. This tax shall be imposed upon the portion of
the investment which has not been removed from jeopardy within the
taxable period.
(b) On the management. Section 4944(b)(2) of the Code imposes an
excise tax in any case in which an additional tax is imposed by section
4944 (b)(1) and paragraph (a) of this section and a foundation manager
has refused to agree to part or all of the removal of the investment
from jeopardy. The tax imposed under section 4944(b)(2) is at the rate
of 5 percent of the amount of the investment, subject to the provisions
of section 4944(d) and Sec. 53.4944-4. This tax is to be paid by any
foundation manager who has refused to agree to the removal of part or
all of the investment from jeopardy, and shall be imposed upon the
portion of the investment which has not been removed from jeopardy
within the taxable period.
(c) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. X is a foundation manager of Y, a private foundation. On
the advice of X, Y invests $5,000 in the common stock of corporation M.
Assume that both X and Y are liable for the taxes imposed by section
4944(a) on the making of the investment. Assume further that no part of
the investment is removed from jeopardy within the taxable period and
that X refused to agree to such removal. Y will be liable for an
additional tax of $1,250 (i.e., $5,000x25%). X will be liable for an
additional tax of $250 (i.e., $5,000x5%).
Example 2. Assume the facts as stated in Example (1), except that X
is not liable for the tax imposed by section 4944(a)(2) for his
participation in the making of the investment, because such
participation was not willful and was due to reasonable cause. X will
nonetheless be liable for the tax of $250 imposed by section 4944(b)(2)
since an additional tax has been imposed upon Y and since X refused to
agree to the removal of the investment from jeopardy.
Example 3. Assume the facts as stated in Example (1), except that Y
removes $2,000 of the investment from jeopardy within the taxable
period, with X refusing to agree to the removal from jeopardy of the
remaining $3,000 of such investment. Y will be liable for an additional
tax of $750, imposed upon the portion of the investment which has not
been removed from jeopardy within the taxable period (i.e., $3,000x25%).
Further X will be liable for an additional tax of $150, also imposed
upon the same portion of the investment (i.e., $3,000x5%).
[T.D. 7240, 37 FR 28747, Dec. 27, 1972, as amended by T.D. 8084, 51 FR
16302, May 2, 1986]
Sec. 53.4944-3 Exception for program-related investments.
(a) In general. (1) For purposes of section 4944 and Sec. Sec.
53.4944-1 through 53.4944-6, a ``program-related investment'' shall not
be classified as an investment which jeopardizes the carrying out of the
exempt purposes of a private foundation. A program-related
[[Page 156]]
investment is an investment which possesses the following
characteristics:
(i) The primary purpose of the investment is to accomplish one or
more of the purposes described in section 170(c)(2)(B);
(ii) No significant purpose of the investment is the production of
income or the appreciation of property; and
(iii) No purpose of the investment is to accomplish one or more of
the purposes described in section 170(c)(2)(D).
(2)(i) An investment shall be considered as made primarily to
accomplish one or more of the purposes described in section 170(c)(2)(B)
if it significantly furthers the accomplishment of the private
foundation's exempt activities and if the investment would not have been
made but for such relationship between the investment and the
accomplishment of the foundation's exempt activities. For purposes of
section 4944 and Sec. Sec. 53.4944-1 through 53.4944-6, the term
purposes described in section 170(c)(2)(B) shall be treated as including
purposes described in section 170(c)(2)(B) whether or not carried out by
organizations described in section 170(c).
(ii) An investment in an activity described in section 4942(j)(5)(B)
and the regulations thereunder shall be considered, for purposes of this
paragraph, as made primarily to accomplish one or more of the purposes
described in section 170(c)(2)(B).
(iii) In determining whether a significant purpose of an investment
is the production of income or the appreciation of property, it shall be
relevant whether investors solely engaged in the investment for profit
would be likely to make the investment on the same terms as the private
foundation. However, the fact that an investment produces significant
income or capital appreciation shall not, in the absence of other
factors, be conclusive evidence of a significant purpose involving the
production of income or the appreciation of property.
(iv) An investment shall not be considered as made to accomplish one
or more of the purposes described in section 170(c)(2)(D) if the
recipient of the investment appears before, or communicates to, any
legislative body with respect to legislation or proposed legislation of
direct interest to such recipient, provided that the expense of engaging
in such activities would qualify as a deduction under section 162.
(3)(i) Once it has been determined that an investment is ``program-
related'' it shall not cease to qualify as a ``program-related
investment'' provided that changes, if any, in the form or terms of the
investment are made primarily for exempt purposes and not for any
significant purpose involving the production of income or the
appreciation of property. A change made in the form or terms of a
program-related investment for the prudent protection of the
foundation's investment shall not ordinarily cause the investment to
cease to qualify as program-related. Under certain conditions, a
program-related investment may cease to be program-related because of a
critical change in circumstances, as, for example, where it is serving
an illegal purpose or the private purpose of the foundation or its
managers. For purposes of the preceding sentence, an investment which
ceases to be program-related because of a critical change in
circumstances shall in no event subject the foundation making the
investment to the tax imposed by section 4944(a)(1) before the 30th day
after the date on which such foundation (or any of its managers) has
actual knowledge of such critical change in circumstances.
(ii) If a private foundation changes the form or terms of an
investment, and if, as a result of the application of subdivision (i) of
this subparagraph, such investment no longer qualifies as program-
related, the determination whether the investment jeopardizes the
carrying out of exempt purposes shall be made pursuant to the provisions
of Sec. 53.4944-1(a)(2).
(b) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. X is a small business enterprise located in a
deteriorated urban area and owned by members of an economically
disadvantaged minority group. Conventional sources of funds are
unwilling or unable to provide funds to X on terms it considers
economically feasible. Y, a private foundation, makes a loan to X
bearing interest below the market rate for commercial loans of
comparable risk. Y's primary purpose for making
[[Page 157]]
the loan is to encourage the economic development of such minority
groups. The loan has no significant purpose involving the production of
income or the appreciation of property. The loan significantly furthers
the accomplishment of Y's exempt activities and would not have been made
but for such relationship between the loan and Y's exempt activities.
Accordingly, the loan is a program-related investment even though Y may
earn income from the investment in an amount comparable to or higher
than earnings from conventional portfolio investments.
Example 2. Assume the facts as stated in Example (1), except that
after the date of execution of the loan Y extends the due date of the
loan. The extension is granted in order to permit X to achieve greater
financial stability before it is required to repay the loan. Since the
change in the terms of the loan is made primarily for exempt purposes
and not for any significant purpose involving the production of income
or the appreciation of property, the loan shall continue to qualify as a
program-related investment.
Example 3. X is a small business enterprise located in a
deteriorated urban area and owned by members of an economically
disadvantaged minority group. Conventional sources of funds are
unwilling to provide funds to X at reasonable interest rates unless it
increases the amount of its equity capital. Consequently, Y, a private
foundation, purchases shares of X's common stock. Y's primary purpose in
purchasing the stock is to encourage the economic development of such
minority group, and no significant purpose involves the production of
income or the appreciation of property. The investment significantly
furthers the accomplishment of Y's exempt activities and would not have
been made but for such relationship between the investment and Y's
exempt activities. Accordingly, the purchase of the common stock is a
program-related investment, even though Y may realize a profit if X is
successful and the common stock appreciates in value.
Example 4. X is a business enterprise which is not owned by low-
income persons or minority group members, but the continued operation of
X is important to the economic well-being of a deteriorated urban area
because X employes a substantial number of low-income persons from such
area. Conventional sources of funds are unwilling or unable to provide
funds to X at reasonable interest rates. Y, a private foundation, makes
a loan to X at an interest rate below the market rate for commercial
loans of comparable risk. The loan is made pursuant to a program run by
Y to assist low-income persons by providing increased economic
opportunities and to prevent community deterioration. No significant
purpose of the loan involves the production of income or the
appreciation of property. The investment significantly furthers the
accomplishment of Y's exempt activities and would not have been made but
for such relationship between the loan and Y's exempt activities.
Accordingly, the loan is a program-related investment.
Example 5. X is a business enterprise which is financially secure
and the stock of which is listed and traded on a national exchange. Y, a
private foundation, makes a loan to X at an interest rate below the
market rate in order to induce X to establish a new plant in a
deteriorated urban area which, because of the high risks involved, X
would be unwilling to establish absent such inducement. The loan is made
pursuant to a program run by Y to enhance the economic development of
the area by, for example, providing employment opportunities for low-
income persons at the new plant, and no significant purpose involves the
production of income or the appreciation of property. The loan
significantly furthers the accomplishment of Y's exempt activities and
would not have been made but for such relationship between the loan and
Y's exempt activities. Accordingly, even though X is large and
established, the investment is program-related.
Example 6. X is a business enterprise which is owned by a nonprofit
community development corporation. When fully operational, X will market
agricultural products, thereby providing a marketing outlet for low-
income farmers in a depressed rural area. Y, a private foundation, makes
a loan to X bearing interest at a rate less than the rate charged by
financial institutions which have agreed to lend funds to X if Y makes
the loan. The loan is made pursuant to a program run by Y to encourage
economic redevelopment of depressed areas, and no significant purpose
involves the production of income or the appreciation of property. The
loan significantly furthers the accomplishment of Y's exempt activities
and would not have been made but for such relationship between the loan
and Y's exempt activities. Accordingly, the loan is a program-related
investment.
Example 7. X, a private foundation, invests $100,000 in the common
stock of corporation M. The dividends received from such investment are
later applied by X in furtherance of its exempt purposes. Although there
is a relationship between the return on the investment and the
accomplishment of X's exempt activities, there is no relationship
between the investment per se and such accomplishment. Therefore, the
investment cannot be considered as made primarily to accomplish one or
more of the purposes described in section 170(c)(2)(B) and cannot
qualify as program-related.
Example 8. S, a private foundation, makes an investment in T, a
business corporation, which qualifies as a program-related investment
under section 4944(c) at the time that it is made. All of T's voting
stock is owned
[[Page 158]]
by S. T experiences financial and management problems which, in the
judgment of the foundation, require changes in management, in financial
structure or in the form of the investment. The following three methods
of resolving the problems appear feasible to S, but each of the three
methods would result in reduction of the exempt purposes for which the
program-related investment was initially made:
(a) Sale of stock or assets. The foundation sells its stock to an
unrelated person. Payment is made in part at the time of sale; the
balance is payable over an extended term of years with interest on the
amount outstanding. The foundation receives a purchase-money mortgage.
(b) Lease. The corporation leases its assets for a term of years to
an unrelated person, with an option in the lessee to buy the assets. If
the option is exercised, the terms of payment are to be similar to those
described in (a) of this example.
(c) Management contract. The corporation enters into a management
contract which gives broad operating authority to one or more unrelated
persons for a term of years. The foundation and the unrelated persons
are obligated to contribute toward working capital requirements. The
unrelated persons will be compensated by a fixed fee or a share of
profits, and they will receive an option to buy the stock held by S or
the assets of the corporation. If the option is exercised, the terms of
payment are to be similar to those described in (a) of this example.
Each of the three methods involves a change in the form or terms of a
program-related investment for the prudent protection of the
foundation's investment. Thus, under Sec. 53.4944-3(a)(3)(i), none of
the three transactions (nor any debt instruments or other obligations
held by S as a result of engaging in one of these transactions) would
cause the investment to cease to qualify as program-related.
Example 9. X is a socially and economically disadvantaged
individual. Y, a private foundation, makes an interest-free loan to X
for the primary purpose of enabling X to attend college. The loan has no
significant purpose involving the production of income or the
appreciation of property. The loan significantly furthers the
accomplishment of Y's exempt activities and would not have been made but
for such relationship between the loan and Y's exempt activities.
Accordingly, the loan is a program-related investment.
Example 10. Y, a private foundation, makes a high-risk investment in
low-income housing, the indebtedness with respect to which is insured by
the Federal Housing Administration. Y's primary purpose in making the
investment is to finance the purchase, rehabilitation, and construction
of housing for low-income persons. The investment has no significant
purpose involving the production of income or the appreciation of
property. The investment significantly furthers the accomplishment of
Y's exempt activities and would not have been made but for such
relationship between the investment and Y's exempt activities.
Accordingly, the investment is program-related.
Sec. 53.4944-4 Special rules.
(a) Joint and several liability. In any case where more than one
foundation manager is liable for the tax imposed under section 4944
(a)(2) or (b)(2) with respect to any one jeopardizing investment, all
such foundation managers shall be jointly and severally liable for the
tax imposed under each such paragraph with respect to such investment.
(b) Limits on liability for management. With respect to anyone
jeopardizing investment, the maximum aggregate amount of tax collectible
under section 4944(a)(2) from all foundation managers shall not exceed
$5,000, and the maximum aggregate amount of tax collectible under
section 4944(b)(2) from all foundation managers shall not exceed
$10,000.
(c) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. A, B, and C are foundation managers of X, a private
foundation. Assume that A, B, and C are liable for both initial and
additional taxes under sections 4944(a)(2) and 4944(b)(2), respectively,
for the following investments by X: an investment of $5,000 in the
common stock of corporation M, and an investment of $10,000 in the
common stock of corporation N. A, B, and C will be jointly and severally
liable for the following initial taxes under section 4944(a)(2): a tax
of $250 (i.e., 5 percent of $5,000) for each year (or part thereof) in
the taxable period (as defined in section 4944(e)(1)) for the investment
in M, and a tax of $500 (i.e., 5 percent of $10,000) for each year (or
part thereof) in the taxable period for the investment in N. Further, A,
B, and C will be jointly and severally liable for the following
additional taxes under section 4944(b)(2): a tax of $250 (i.e., 5
percent of $5,000) for the investment in M, and a tax of $500 (i.e., 5
percent of $10,000) for the investment in N.
Example 2. Assume the facts as stated in Example (1), except that X
has invested $500,000 in the common stock of M, and $1 million in the
common stock of N. A, B, and C will be jointly and severally liable for
the following initial taxes under section 4944(a)(2): a tax of $5,000
for the investment in M, and a tax of $5,000 for the investment
[[Page 159]]
in N. Further, A, B, and C will be jointly and severally liable for the
following additional taxes under section 4944(b) (2): a tax of $10,000
for the investment in M, and a tax of $10,000 for the investment in N.
Sec. 53.4944-5 Definitions.
(a) Taxable period--(1) In general. For purposes of section 4944,
the term ``taxable period'' means, with respect to any investment which
jeopardizes the carrying out of a private foundation's exempt purposes,
the period beginning with the date on which the amount is invested and
ending on the earliest of:
(i) The date of mailing of a notice of deficiency under section 6212
with respect to the tax imposed on the making of the investment by
section 4944(a)(1);
(ii) The date on which the amount invested is removed from jeopardy;
or
(iii) The date on which the tax imposed by section 4944(a)(1) is
assessed.
(2) Special rule. Where a notice of deficiency referred to in
subparagraph (1) (i) of this paragraph is not mailed because there is a
waiver of the restrictions on assessment and collection of a deficiency,
or because the deficiency is paid, the date of filing of the waiver or
the date of such payment, respectively, shall be treated as the end of
the taxable period.
(b) Removal from jeopardy. An investment which jeopardizes the
carrying out of a private foundation's exempt purposes shall be
considered to be removed from jeopardy when:
(1) The foundation sells or otherwise disposes of the investment,
and
(2) The proceeds of such sale or other disposition are not
themselves investments which jeopardize the carrying out of such
foundation's exempt purposes.
A change by a private foundation in the form or terms of a jeopardizing
investment shall result in the removal of the investment from jeopardy
if, after such change, the investment no longer jeopardizes the carrying
out of such foundation's exempt purposes. For purposes of section 4944,
the making by a private foundation of one jeopardizing investment and a
subsequent exchange by the foundation of such investment for another
jeopardizing investment will be treated as only one jeopardizing
investment, except as provided in Sec. 53.4944-6 (b) and (c). For the
treatment of a jeopardizing investment which is removed from jeopardy or
otherwise transferred by a private foundation by the making of a grant
or by bargain-sale, see sections 4941 and 4945 and the regulations
thereunder. A jeopardizing investment cannot be removed from jeopardy by
a transfer from a private foundation to another private foundation which
is related to the transferor foundation within the meaning of section
4946(a) (1)(H) (i) or (ii), unless the investment is a program-related
investment in the hands of the transferee foundation.
(c) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. X, a private foundation on the calendar year basis, makes
a $1,000 jeopardizing investment on January 1, 1970. X thereafter sells
the investment for $1,000 on January 3, 1971. The taxable period is from
January 1, 1970, to January 3, 1971. X will be liable for an initial tax
of $100, that is, a tax of 5 percent of the amount of the investment for
each year (or part thereof) in the taxable period.
Example 2. Assume that both C and D are investments which jeopardize
exempt purposes. X, a private foundation, purchases C in 1971 and later
exchanges C for D. Such exchange does not constitute a removal of C from
jeopardy. In addition, no new taxable period will arise with respect to
D, since, for purposes of section 4944, only one jeopardizing investment
has been made.
Example 3. Assume the facts as stated in Example (2), except that X
sells C for cash and later reinvests such cash in D. Two separate
investments jeopardizing exempt purposes have resulted. Since the cash
received in the interim is not of a jeopardizing nature, the amount
invested in C has been removed from jeopardy and, thus, the taxable
period with respect to C has been terminated. The subsequent
reinvestment of such cash in D gives rise to a new taxable period with
respect to D.
(d) Cross reference. For rules relating to taxable events that are
corrected within the correction period, defined in section 4963(e), see
section 4961(a) and the regulations thereunder.
[T.D. 7240, 37 FR 28747, Dec. 27, 1972, as amended by T.D. 8084, 51 FR
16303, May 2, 1986]
[[Page 160]]
Sec. 53.4944-6 Special rules for investments made prior to January 1, 1970.
(a) Except as provided in paragraph (b) or (c) of this section, an
investment made by a private foundation prior to January 1, 1970, shall
not be subject to the provisions of section 4944.
(b) If the form or terms of an investment made by a private
foundation prior to January 1, 1970, are changed (other than as
described in paragraph (c) of this section) on or after such date, the
provisions of Sec. 53.4944-1(a)(2)(iii) shall apply with respect to
such investment.
(c) In the case of an investment made by a private foundation prior
to January 1, 1970, which is exchanged on or after such date for another
investment, for purposes of section 4944 the foundation will be
considered to have made a new investment on the date of such exchange,
unless the post-1969 investment is described in Sec. 53.4944-
1(a)(2)(ii)(b). Accordingly, a determination, under Sec. 53.4944-1(a)
(2)(i), whether the investment jeopardizes the carrying out of the
foundation's exempt purposes shall be made at such time.
Subpart F_Taxes on Taxable Expenditures
Source: T.D. 7215, 37 FR 23161, Oct. 31, 1972, unless otherwise
noted.
Sec. 53.4945-1 Taxes on taxable expenditures.
(a) Imposition of initial taxes--(1) Tax on private foundation.
Section 4945(a)(1) of the Code imposes an excise tax on each taxable
expenditure (as defined in section 4945(d)) of a private foundation.
This tax is to be paid by the private foundation and is at the rate of
10 percent of the amount of each taxable expenditure.
(2) Tax on foundation manager--(i) In general. Section 4945(a)(2) of
the Code imposes, under certain circumstances, an excise tax on the
agreement of any foundation manager to the making of a taxable
expenditure by a private foundation. This tax is imposed only in cases
in which the following circumstances are present:
(a) A tax is imposed by section 4945(a)(1);
(b) Such foundation manager knows that the expenditure to which he
agrees is a taxable expenditure, and
(c) Such agreement is willfull and is not due to reasonable cause.
However, the tax with respect to any particular expenditure applies only
to the agreement of those foundation managers who are authorized to
approve, or to exercise discretion in recommending approval of, the
making of the expenditure by the foundation and to those foundation
managers who are members of a group (such as the foundation's board of
directors or trustees) which is so authorized. For the definition of the
term foundation manager, see section 4946(b) and the regulations
thereunder.
(ii) Agreement. The agreement of any foundation manager to the
making of a taxable expenditure shall consist of any manifestation of
approval of the expenditure which is sufficient to constitute an
exercise of the foundation manager's authority to approve, or to
exercise discretion in recommending approval of, the making of the
expenditure by the foundation, whether or not such manifestation of
approval is the final or decisive approval on behalf of the foundation.
(iii) Knowing. For purposes of section 4945, a foundation mangager
shall be considered to have agreed to an expenditure ``knowing'' that it
is a taxable expenditure only if:
(a) He has actual knowledge of sufficient facts so that, based
solely upon such facts, such expenditure would be a taxable expenditure,
(b) He is aware that such an expenditure under these circumstances
may violate the provisions of federal tax law governing taxable
expenditures, and
(c) He negligently fails to make reasonable attempts to ascertain
whether the expenditure is a taxable expenditure, or he is in fact aware
that it is such an expenditure.
For purposes of this part and Chapter 42, the term knowing does not mean
``having reason to know''. However, evidence tending to show that a
foundation manager has reason to know of a particular fact or particular
rule is relevant in determining whether he
[[Page 161]]
had actual knowledge of such fact or rule. Thus, for example, evidence
tending to show that a foundation manager has reason to know of
sufficient facts so that, based solely upon such facts, an expenditure
would be a taxable expenditure is relevant in determining whether he has
actual knowledge of such facts.
(iv) Willful. A foundation manager's agreement to a taxable
expenditure is willful if it is voluntary, conscious, and intentional.
No motive to avoid the restrictions of the law or the incurrence of any
tax is necessary to make an agreement willful. However, a foundation
manager's agreement to a taxable expenditure is not willful if he does
not know that it is a taxable expenditure.
(v) Due to reasonable cause. A foundation manager's actions are due
to reasonable cause if he has exercised his responsibility on behalf of
the foundation with ordinary business care and prudence.
(vi) Advice of counsel. If a foundation manager, after full
disclosure of the factual situation to legal counsel (including house
counsel), relies on the advice of such counsel expressed in a reasoned
written legal opinion that an expenditure is not a taxable expenditure
under section 4945 (or that expenditures conforming to certain
guidelines are not taxable expenditures), although such expenditure is
subsequently held to be a taxable expenditure (or that certain proposed
reporting procedures with respect to an expenditure will satisfy the
tests of section 4945(h), although such procedures are subsequently held
not to satisfy such section), the foundation manager's agreement to such
expenditure (or to grants made with provision for such reporting
procedures which are taxable solely because of such inadequate reporting
procedures) will ordinarily not be considered ``knowing'' or ``willful''
and will ordinarily be considered ``due to reasonable cause'' within the
meaning of section 4945(a)(2). For purposes of the subdivision, a
written legal opinion will be considered ``reasoned'' even if it reaches
a conclusion which is subsequently determined to be incorrect so long as
such opinion addresses itself to the facts and applicable law. However,
a written legal opinion will not be considered ``reasoned'' if it does
nothing more than recite the facts and express a conclusion. However,
the absence of advice of counsel with respect to an expenditure shall
not, by itself, give rise to any inference that a foundation manager
agreed to the making of the expenditure knowingly, willfully, or without
reasonable cause.
(vii) Rate and incidence of tax. The tax imposed under section
4945(a)(2) is at the rate of 2\1/2\ percent of the amount of each
taxable expenditure to which the foundation manager has agreed. This tax
shall be paid by the foundation manager.
(viii) Cross reference. For provisions relating to the burden of
proof in cases involving the issue whether a foundation manager has
knowingly agreed to the making of a taxable expenditure, see section
7454(b).
(b) Imposition of additional taxes--(1) Tax on private foundation.
Section 4945(b)(1) of the Code imposes an excise tax in any case in
which an initial tax is imposed under section 4945(a)(1) on a taxable
expenditure of a private foundation and the expenditure is not corrected
within the taxable period (as defined in section 4945(i)(2)). The tax
imposed under section 4945(b)(1) is to be paid by the private foundation
and is at the rate of 100 percent of the amount of each taxable
expenditure.
(2) Tax on foundation manager. Section 4945(b)(2) of the Code
imposes an excise tax in any case in which a tax is imposed under
section 4945(b)(1) and a foundation manager has refused to agree to part
or all of the correction of the taxable expenditure. The tax imposed
under section 4945(b)(2) is at the rate of 50 percent of the amount of
the taxable expenditure. This tax is to be paid by any foundation
manager who has refused to agree to part or all of the correction of the
taxable expenditure.
(c) Special rules--(1) Joint and several liability. In any case
where more than one foundation manager is liable for tax imposed under
section 4945 (a) (2) or (b)(2) with respect to the making of a taxable
expenditure, all such foundation managers shall be jointly and severally
liable for the tax imposed under such paragraph with respect to such
taxable expenditure.
[[Page 162]]
(2) Limits on liability for management. The maximum aggregate amount
of tax collectible under section 4945(a)(2) from all foundation managers
with respect to any one taxable expenditure shall be $5,000, and the
maximum aggregate amount of tax collectible under section 4945(b) (2)
from all foundation managers with respect to any one taxable expenditure
shall be $10,000.
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. A, B, and C comprise the board of directors of Foundation
M. They vote unanimously in favor of a grant of $100,000 to D, a
business associate of each of the directors. The grant is to be used by
D for travel and educational purposes and is not made in accordance with
the requirements of section 4945(g). Each director knows that D was
selected as the recipient of the grant solely because of his friendship
with the directors and is aware that some grants made for travel, study,
or other similar purposes may be taxable expenditures. Also, none of the
directors makes any attempt to consult counsel, or to otherwise
determine, whether this grant is a taxable expenditure. Initial taxes
are imposed under paragraphs (1) and (2) of section 4945(a). The tax to
be paid by the foundation is $10,000 (10 percent of $100,000). The tax
to be paid by the board of directors is $2,500 (2\1/2\ percent of
$100,000). A, B, and C are jointly and severally liable for this $2,500
and this sum may be collected by the Service from any one of them.
Example 2. Assume the same facts as in example (1). Further assume
that within the taxable period A makes a motion to correct the taxable
expenditure at a meeting of the board of directors. The motion is
defeated by a two-to-one vote, A voting for the motion and B and C
voting against it. In these circumstances an additional tax is imposed
on the private foundation in the amount of $100,000 (100 percent of
$100,000). The additional tax imposed on B and C is $10,000 (50 percent
of $100,000 subject to a maximum of $10,000). B and C are jointly and
severally liable for the $10,000, and this sum may be collected by the
Service from either of them.
(d) Correction--(1) In general. Except as provided in paragraph (d)
(2) or (3) of this paragraph, correction of a taxable expenditure shall
be accomplished by recovering part or all of the expenditure to the
extent recovery is possible, and, where full recovery cannot be
accomplished, by any additional corrective action which the Commissioner
may prescribe. Such additional corrective action is to be determined by
the circumstances of each particular case and may include the following:
(i) Requiring that any unpaid funds due the grantee be withheld;
(ii) Requiring that no further grants be made to the particular
grantee;
(iii) In addition to other reports that are required, requiring
periodic (e.g., quarterly) reports from the foundation with respect to
all expenditures of the foundation (such reports shall be equivalent in
detail to the reports required by section 4945(h)(3) and Sec. 53.4945-
5(d));
(iv) Requiring improved methods of exercising expenditure
responsibility;
(v) Requiring improved methods of selecting recipients of individual
grants; and
(vi) Requiring such other measures as the Commissioner may prescribe
in a particular case.
The foundation making the expenditure shall not be under any obligation
to attempt to recover the expenditure by legal action if such action
would in all probability not result in the satisfaction of execution on
a judgment.
(2) Correction for inadequate reporting. If the expenditure is
taxable only because of a failure to obtain a full and complete report
as required by section 4945(h)(2) or because of a failure to make a full
and detailed report as required by section 4945(h)(3), correction may be
accomplished by obtaining or making the report in question. In addition,
if the expenditure is taxable only because of a failure to obtain a full
and complete report as required by section 4945(h)(2) and an
investigation indicates that no grant funds have been diverted to any
use not in furtherance of a purpose specified in the grant, correction
may be accomplished by exerting all reasonable efforts to obtain the
report in question and reporting the failure to the Internal Revenue
Service, even though the report is not finally obtained.
(3) Correction for failure to obtain advance approval. Where an
expenditure is taxable under section 4945(d)(3) only because of a
failure to obtain advance approval of procedures with respect to grants
as required by section 4945(g), correction may be accomplished by
obtaining approval of the grant making procedures and establishing to
the satisfaction of the Commissioner that:
[[Page 163]]
(i) No grant funds have been diverted to any use not in furtherance
of a purpose specified in the grant;
(ii) The grant making procedures instituted would have been approved
if advance approval of such procedures had been properly requested; and
(iii) Where advance approval of grant making procedures is
subsequently required, such approval will be properly requested.
(e) Certain periods--(1) Taxable period. For purposes of section
4945, the term ``taxable period'' means, with respect to any taxable
expenditure, the period beginning with the date on which the taxable
expenditure occurs and ending on the earlier of:
(i) The date of mailing of a notice of deficiency under section 6212
with respect to the tax imposed on taxable expenditures by section
4945(a)(1); or
(ii) The date on which the tax imposed by section 4945(a)(1) is
assessed.
(2) Cross reference. For rules relating to taxable events that are
corrected within the correction period, defined in section 4963(e), see
section 4961(a) and the regulations thereunder.
[T.D. 7215, 37 FR 23161, Oct. 31, 1972, as amended by T.D. 7299, 38 FR
35305, Dec. 27, 1973; T.D. 7527, 42 FR 64625, Dec. 27, 1977; T.D. 8084,
51 FR 16303, May 2, 1986]
Sec. 53.4945-2 Propaganda influencing legislation.
(a) Propaganda influencing legislation, etc.--(1) In general. Under
section 4945(d)(1) the term ``taxable expenditure'' includes any amount
paid or incurred by a private foundation to carry on propaganda, or
otherwise to attempt, to influence legislation. An expenditure is an
attempt to influence legislation if it is for a direct or grass roots
lobbying communication, as defined in Sec. 56.4911-2 (without reference
to Sec. Sec. 56.4911-2(b)(3) and 56.4911-2(c)) and Sec. 56.4911-3.
See, however, paragraph (d) of this section for exceptions to the
general rule of this paragraph (a)(1).
(2) Expenditures for membership communications. Section 56.4911-5,
which provides special rules for electing public charities'
communications with their members, does not apply to private
foundations. Thus, whether a private foundation's communications with
its members (assuming it has any) are lobbying communications is
determined solely under Sec. 56.4911-2 and without reference to Sec.
56.4911-5. However, where a private foundation makes a grant to an
electing public charity, Sec. 56.4911-5 applies to the electing public
charity's communications with its own members. Therefore, in the limited
context of determining whether a private foundation's grant to an
electing public charity is a taxable expenditure under section 4945, the
Sec. 56.4911-5 membership rules apply. For example, if the grant is
specifically earmarked for a communication from the electing public
charity to its members and the communication is, because of Sec.
56.4911-5, a nonlobbying communication, the grant is not a taxable
expenditure under section 4945.
(3) Jointly funded projects. A private foundation will not be
treated as having paid or incurred any amount to attempt to influence
legislation merely because it makes a grant to another organization upon
the condition that the recipient obtain a matching support appropriation
from a governmental body. In addition, a private foundation will not be
treated as having made taxable expenditures of amounts paid or incurred
in carrying on discussions with officials of governmental bodies
provided that:
(i) The subject of such discussions is a program which is jointly
funded by the foundation and the Government or is a new program which
may be jointly funded by the foundation and the Government,
(ii) The discussions are undertaken for the purpose of exchanging
data and information on the subject matter of the programs, and
(iii) Such discussions are not undertaken by foundation managers in
order to make any direct attempt to persuade governmental officials or
employees to take particular positions on specific legislative issues
other than such program.
(4) Certain expenditures by recipients of program-related
investments. Any amount paid or incurred by a recipient of a program-
related investment (as defined in Sec. 53.4944-3) in connection with
[[Page 164]]
an appearance before, or communication with, any legislative body with
respect to legislation or proposed legislation of direct interest to
such recipient shall not be attributed to the investing foundation, if:
(i) The foundation does not earmark its funds to be used for any
activities described in section 4945(d) (1) and
(ii) A deduction under section 162 is allowable to the recipient for
such amount.
(5) Grants to public organizations--(i) In general. A grant by a
private foundation to an organization described in section 509(a) (1),
(2) or (3) does not constitute a taxable expenditure by the foundation
under section 4945(d), other than under section 4945(d)(1), if the grant
by the private foundation is not earmarked to be used for any activity
described in section 4945(d) (2) or (5), is not earmarked to be used in
a manner which would violate section 4945(d) (3) or (4), and there does
not exist an agreement, oral or written, whereby the grantor foundation
may cause the grantee to engage in any such prohibited activity or to
select the recipient to which the grant is to be devoted. For purposes
of this paragraph (a)(5)(i), a grant by a private foundation is
earmarked if the grant is given pursuant to an agreement, oral or
written, that the grant will be used for specific purposes. For the
expenditure responsibility requirements with respect to organizations
other than those described in section 509(a) (1), (2), or (3), see Sec.
53.4945-5. For rules for determining whether grants to public charities
are taxable expenditures under section 4945(d)(1), see paragraphs
(a)(2), (a)(6) and (a)(7) of this section.
(ii) Certain ``public'' organizations. For purposes of this section,
an organization shall be considered a section 509(a)(1) organization if
it is treated as such under subparagraph (4) of Sec. 53.4945-5(a).
(6) Grants to public organizations that attempt to influence
legislation--(i) General support grant. A general support grant by a
private foundation to the organization described in section 509(a) (1),
(2), or (3) (a ``public charity'' for purposes of paragraphs (a) (6) and
(7) of this section) does not constitute a taxable expenditure under
section 4945(d)(1) to the extent that the grant is not earmarked, within
the meaning of Sec. 53.4945-2(a)(5)(i), to be used in an attempt to
influence legislation. The preceding sentence applies without regard to
whether the public charity has made the election under section 501(h).
(ii) Specific project grant. A grant, by a private foundation to
fund a specific project of a public charity is not a taxable expenditure
by the foundation under section 4945(d)(1) to the extent that--
(A) The grant is not earmarked, within the meaning of Sec. 53.4945-
2(a)(5)(i), to be used in an attempt to influence legislation, and
(B) The amount of the grant, together with other grants by the same
private foundation for the same project for the same year, does not
exceed the amount budgeted, for the year of the grant, by the grantee
organization for activities of the project that are not attempts to
influence legislation. If the grant is for more than one year, the
preceding sentence applies to each year of the grant with the amount of
the grant measured by the amount actually disbursed by the private
foundation in each year or divided equally between years, at the option
of the private foundation. The same method of measuring the annual
amount must be used in all years of a grant. This paragraph (a)(6)(ii)
applies without regard to whether the public charity has made the
election under section 501(h).
(iii) Reliance upon grantee's budget. For purposes of determining
the amount budgeted by a prospective grantee for specific project
activities that are not attempts to influence legislation under
paragraph (a)(6)(ii) of this section, a private foundation may rely on
budget documents or other sufficient evidence supplied by the grantee
organization (such as a signed statement by an authorized officer,
director or trustee of such grantee organization) showing the proposed
budget of the specific project, unless the private foundation doubts or,
in light of all the facts and circumstances, reasonably should doubt the
accuracy or reliability of the documents.
(7) Grants to organizations that cease to be described in
501(c)(3)--(i) Not taxable expenditure; conditions. A grant to a
[[Page 165]]
public charity (as defined in paragraph (a)(6)(i) of this section) that
thereafter ceases to be an organization described in section 501(c)(3)
by reason of its attempts to influence legislation is not a taxable
expenditure if--
(A) The grant meets the requirements of paragraph (a)(6) of this
section,
(B) The recipient organization had received a ruling or
determination letter, or an advance ruling or determination letter, that
it is described in sections 501(c)(3) and 509(a),
(C) Notice of a change in the recipient organization's status has
not been made to the public (such as by publication in the Internal
Revenue Bulletin), and the private foundation has not acquired knowledge
that the Internal Revenue Service has given notice to the recipient
organization that it will be deleted from such status; and
(D) The recipient organization is not controlled directly or
indirectly by the private foundation. A recipient organization is
controlled by a private foundation for this purpose if the private
foundation and disqualified persons (defined in section 4946(a)(1) (A)
through (H) with reference to the private foundation, by aggregating
their votes or positions of authority, can cause or prevent action on
legislative issues by the recipient.
(ii) Examples. The provisions of paragraphs (a)(6) and (a)(7) of
this section are illustrated by the following examples:
Example 1. W, a private foundation, makes a general support grant to
Z, a public charity described in section 509(a)(1). Z informs W that, as
an insubstantial portion of its activities, Z attempts to influence the
State legislature with regard to changes in the mental health laws. The
use of the grant is not earmarked by W to be used in a manner that would
violate section 4945(d)(1). Even if the grant is subsequently devoted by
Z to its legislative activities, the grant by W is not a taxable
expenditure under section 4945(d).
Example 2. X, a private foundation, makes a specific project grant
to Y University for the purpose of conducting research on the potential
environmental effects of certain pesticides. X does not earmark the
grant for any purpose that would violate section 4945(d)(1) and there is
no oral or written agreement or understanding whereby X may cause Y to
engage in any activity described in section 4945(d) (1), (2), or (5), or
to select any recipient to which the grant may be devoted. Further, X
determines, based on budget information supplied by Y, that Y's budget
for the project does not contain any amount for attempts to influence
legislation. X has no reason to doubt the accuracy or reliability of the
budget information. Y uses most of the funds for the research project;
however, Y expends a portion of the grant funds to send a representative
to testify at Congressional hearings on a specific bill proposing
certain pesticide control measures. The portion of the grant funds
expended with respect to the Congressional hearings is not treated as a
taxable expenditure by X under section 4945(d)(1).
Example 3. M, a private foundation, makes a specific project grant
of $150,000 to P, a public charity described in section 509(a)(1). In
requesting the grant from M, P stated that the total budgeted cost of
the project is $200,000, and that of this amount $20,000 is allocated to
attempts to influence legislation related to the project. M relies on
the budget figures provided by P in determining the amount P will spend
on influencing legislation and M has no reason to doubt the accuracy or
reliability of P's budget figures. In making the grant, M did not
earmark any of the funds from the grant to be used for attempts to
influence legislation. M's grant of $150,000 to P will not constitute a
taxable expenditure under section 4945(d)(1) because M did not earmark
any of the funds for attempts to influence legislation and because the
amount of its grant ($150,000) does not exceed the amount allocated to
specific project activities that are not attempts to influence
legislation ($200,000-$20,000=$180,000).
Example 4. Assume the same facts as in example (3), except that M's
grant letter to P provides that M has the right to renegotiate the terms
of the grant if there is a substantial deviation from those terms. This
additional fact does not make M's grant a taxable expenditure under
section 4945(d)(1).
Example 5. Assume the same facts as in example (3), except that M
made a specific project grant of $200,000 to P. Part of M's grant of
$200,000 will constitute a taxable expenditure under section 4945(d)(1).
The amount of the grant ($200,000) exceeds by $20,000 the amount P
allocated to specific project activities that are not attempts to
influence legislation ($180,000). M has made a taxable expenditure of
$20,000.
Example 6. Assume the same facts as example (3), except that M made
a specific project grant of $180,000, and received from P an enforceable
commitment that grant funds would not be used in connection with
attempts to influence legislation. M's grant is not a taxable
expenditure under section 4945(d)(1).
Example 7. Assume the same facts as in example (3) except that M
directed P to hire A, an individual, to expend $20,000 from the
[[Page 166]]
grant to engage in direct lobbying (within the meaning of Sec. 56.4911-
2(b)) and grass roots lobbying (within the meaning of Sec. 56.4911-
2(c)). P does not expend any other grant funds for lobbying activities.
The $20,000 that is earmarked for direct lobbying and grass roots
lobbying is a taxable expenditure under section 4945(d)(1).
Example 8. R, a public charity described in section 509(a)(1),
requested N, a private foundation, to make a general purpose grant to it
to aid R in carrying out its exempt purpose. In making this request, R
notified N that it had elected the expenditure test under section 501(h)
and that it expected to attempt to influence legislation in areas
related to its exempt purpose. Since its formation, R generally has had
exempt purpose expenditures (as defined in Sec. 56.4911-4) in excess of
$7,000,000 in each of its taxable years, and has budgeted in excess of
$7,000,000 of exempt purpose expenditures for the year of the grant. N
made a grant of $200,000 to R. N did not earmark the funds for R's
attempt to influence legislation. The general purpose grant by N does
not constitute a taxable expenditure under section 4945(d)(1).
Example 9. Assume the same facts as in example (8), except that N
learns that R has had excess lobbying expenditures (within the meaning
of Sec. 56.4911-1(b)) in some prior years. N also learns that in no
year has R's lobbying or grass roots expenditures (within the meaning of
Sec. 56.4911-2 (a) and (c)) exceeded the corresponding ceiling amount
(within the meaning of Sec. 1.501(h)-3(c) (3) and (6)). N then makes
the grant to R. After receiving the grant, R spends a large portion of
its funds on influencing legislation and, as a consequence, is denied
exemption from tax, as an organization described in section 501(c)(3),
under section 501(h) and Sec. 1.501(h)-3. No disqualified person with
respect to N controlled, in whole or in part, R's attempts to influence
legislation. The general purpose grant will not constitute a taxable
expenditure under section 4945(d)(1).
Example 10. X, a private foundation, makes a specific project grant
to Y, a public charity described in section 509(a). In requesting the
grant, Y stated that it planned to use the funds to purchase a computer
for purpose of computerizing its research files and that the grant will
not be used to influence legislation. Two years after X makes the grant,
X discovers that Y has also used the computer for purposes of
maintaining and updating the mailing list for Y's lobbying newsletter.
Because X did not earmark any of the grant funds to be used for attempts
to influence legislation and because X had no reason to doubt the
accuracy or reliability of Y's documents representing that the grant
would not be used to influence legislation, X's grant is not treated as
a taxable expenditure.
Example 11. G, a private foundation, makes a specific project grant
of $300,000 to L, a public charity described in section 509(a)(1) for a
three-year specific project studying child care problems. L provides
budget material indicating that the specific project will expend
$200,000 in each of three years. L's budget materials indicate that
attempts to influence legislation will amount to $10,000 in the first
year, $20,000 in the second year and $100,000 in the third year. G
intends to pay its $300,000 grant over three years as follows: $200,000
in the first year, $50,000 in the second year and $50,000 in the third
year. The amount of the grant actually disbursed by G in the first year
of the grant exceeds the nonlobbying expenditures of L in that year.
However, because the amount of the grant in each of the three years,
when divided equally among the three years ($100,000 for each year), is
not more than the nonlobbying expenditures of L on the specific project
for any of the three years, none of the grant is treated as a taxable
expenditure under section 4945(d)(1).
Example 12. P, a private foundation, makes a $120,000 specific
project grant to C, a public charity described in section 509(a) for a
three-year project. P intends to pay its grant to C in three equal
annual installments of $40,000. C provides budget material indicating
that the specific project will expend $100,000 in each of three years.
C's budget materials, which P reasonably does not doubt, indicate that
the project's attempts to influence legislation will amount to $50,000
in each of the three years. After P pays the first annual installment to
C, but before P pays the second installment to C, reliable information
comes to P's attention that C has spent $90,000 of the project's
$100,000 first-year budget on attempts to influence legislation. This
information causes P to doubt the accuracy and reliability of C's budget
materials. Because of the information, P does not pay the second-year
installment to C. P's payment of the first installment of $40,000 is not
a taxable expenditure under section 4945(d)(1) because the grant in the
first year is not more than the nonlobbying expenditures C projected in
its budget materials that P reasonably did not doubt.
Example 13. Assume the same facts as in Example (12), except that P
pays the second-year installment of $40,000 to C. In the project's
second year, C once again spends $90,000 of the project's $100,000
annual budget in attempts to influence legislation. Because P doubts or
reasonably should doubt the accuracy or reliability of C's budget
materials when P makes the second-year grant payment, P may not rely
upon C's budget documents at that time. Accordingly, although none of
the $40,000 paid in the first installment is a taxable expenditure, only
$10,000 ($100,000 minus $90,000) of the second-year grant payment is not
a taxable expenditure.
[[Page 167]]
The remaining $30,000 of the second installment is a taxable expenditure
within the meaning of section 4945(d)(1).
Example 14. B, a private foundation, makes a specific project grant
to C, a public charity described in section 509(a), of $40,000 for the
purpose of conducting a study on the effectiveness of seat belts in
preventing traffic deaths. B did not earmark any of the grant for
attempts to influence legislation. In requesting the grant from B, C
submitted a budget of $100,000 for the project. The budget contained
expenses for postage and mailing, computer time, advertising, consulting
services, salaries, printing, advertising, and similar categories of
expenses. C also submitted to B a statement, signed by an officer of C,
that 30% of the budgeted funds would be devoted to attempts to influence
legislation within the meaning of section 4945. B has no reason to doubt
the accuracy of the budget figures or the statement. B may rely on the
budget figures and signed statement provided by C in determining the
amount C will spend on influencing legislation. B's grant to C will not
constitute a taxable expenditure under section 4945(d)(1), because the
amount of the grant does not exceed the amount allocated to specific
project activities that are not attempts to influence legislation.
(b)-(c) [Reserved]
(d) Exceptions--(1) Nonpartisan analysis, study, or research--(i) In
general. A communication is not a lobbying communication, for purposes
of Sec. 53.4945-2(a)(1), if the communication constitutes engaging in
nonpartisan analysis, study or research and making available to the
general public or a segment or members thereof or to governmental
bodies, officials, or employees the results of such work. Accordingly,
an expenditure for such a communication does not constitute a taxable
expenditure under section 4945(d)(1) and Sec. 53.4945-2(a)(1).
(ii) Nonpartisan analysis, study, or research. For purposes of
section 4945(e), ``nonpartisan analysis, study, or research'' means an
independent and objective exposition of a particular subject matter,
including any activity that is ``educational'' within the meaning of
Sec. 1.501(c)(3)-1(d)(3). Thus, ``nonpartisan analysis, study, or
research'' may advocate a particular position or viewpoint so long as
there is a sufficiently full and fair exposition of the pertinent facts
to enable the public or an individual to form an independent opinion or
conclusion. On the other hand, the mere presentation of unsupported
opinion does not qualify as ``nonpartisan analysis, study, or
research''.
(iii) Presentation as part of a series. Normally, whether a
publication or broadcast qualifies as ``nonpartisan analysis, study, or
research'' will be determined on a presentation-by-presentation basis.
However, if a publication or broadcast is one of a series prepared or
supported by a private foundation and the series as a whole meets the
standards of subdivision (ii) of this subparagraph, then any individual
publication or broadcast within the series will not result in a taxable
expenditure even though such individual broadcast or publication does
not, by itself, meet the standards of subdivision (ii) of this
subparagraph. Whether a broadcast or publication is considered part of a
series will ordinarily depend on all the facts and circumstances of each
particular situation. However, with respect to broadcast activities, all
broadcasts within any period of 6 consecutive months will ordinarily be
eligible to be considered as part of a series. If a private foundation
times or channels a part of a series which is described in this
subdivision in a manner designed to influence the general public or the
action of a legislative body with respect to a specific legislative
proposal in violation of section 4945(d)(1), the expenses of preparing
and distributing such part of the analysis, study, or research will be a
taxable expenditure under this section.
(iv) Making available results of analysis, study, or research. A
private foundation may choose any suitable means, including oral or
written presentations, to distribute the results of its nonpartisan
analysis, study, or research, with or without charge. Such means include
distribution of reprints of speeches, articles, and reports (including
the report required under section 6056); presentation of information
through conferences, meetings, and discussions; and dissemination to the
news media, including radio, television, and newspapers, and to other
public forums. For purposes of this
[[Page 168]]
paragraph (d)(1)(iv), such communications may not be limited to, or be
directed toward, persons who are interested solely in one side of a
particular issue.
(v) Subsequent lobbying use of certain analysis, study, or
research--(A) In general. Even though certain analysis, study or
research is initially within the exception for nonpartisan analysis,
study, or research, subsequent use of that analysis, study or research
for grass roots lobbying may cause that analysis, study or research to
be treated as a grass roots lobbying communication that is not within
the exception for nonpartisan analysis, study, or research. This
paragraph (d)(1)(v) of this section does not cause any analysis, study,
or research to be considered a direct lobbying communication. For rules
regarding when analysis, study, or research is treated as a grass roots
lobbying communication that is not within the scope of the exception for
nonpartisan analysis, study, or research, see Sec. 56.4911-2(b)(2)(v).
(B) Special rule for grants to public charities. This paragraph
(d)(1)(v)(B) of this section applies where a public charity uses a
private foundation grant to finance, in whole or in part, a nonlobbying
communication that is subsequently used in lobbying, causing the public
charity's expenditures for the communication to be treated as lobbying
expenditures under the subsequent use. In such a case, the private
foundation's grant will ordinarily not be characterized as a lobbying
expenditure by virtue of the subsequent use rule. The only situations
where the private foundation's grant will be treated as a lobbying
expenditure under the subsequent use rule are where the private
foundation's primary purpose in making the grant to the public charity
was for lobbying or where, at the time of making the grant, the private
foundation knows (or in light of all the facts and circumstances
reasonably should know) that the public charity's primary purpose in
preparing the communication to be funded by the grant is for use in
lobbying.
(vi) Directly encouraging action by recipients of a communication. A
communication that reflects a view on specific legislation is not within
the nonpartisan analysis, study, or research exception of this Sec.
53.4945-2(d)(1) if the communication directly encourages the recipient
to take action with respect to such legislation. For purposes of this
section, a communication directly encourages the recipient to take
action with respect to legislation if the communication is described in
one or more of Sec. 56.4911-2(b)(2)(iii)(A) through (C). As described
in Sec. 56.4911-2(b)(2)(iv), a communication would encourage the
recipient to take action with respect to legislation, but not directly
encourage such action, if the communication does no more than
specifically identify one or more legislators who will vote on the
legislation as: opposing the communication's view with respect to the
legislation; being undecided with respect to the legislation; being the
recipient's representative in the legislature; or being a member of the
legislative committee or subcommittee that will consider the
legislation.
(vii) Examples. The provisions of this paragraph may be illustrated
by the following examples:
Example 1. M, a private foundation, establishes a research project
to collect information for the purpose of showing the dangers of the use
of pesticides in raising crops. The information collected includes data
with respect to proposed legislation, pending before several State
legislatures, which would ban the use of pesticides. The project takes
favorable positions on such legislation without producing a sufficiently
full and fair exposition of the pertinent facts to enable the public or
an individual to form an independent opinion or conclusion on the pros
and cons of the use of pesticides. This project is not within the
exception for nonpartisan analysis, study, or research because it is
designed to present information merely on one side of the legislative
controversy.
Example 2. N, a private foundation, establishes a research project
to collect information concerning the dangers of the use of pesticides
in raising crops for the ostensible purpose of examining and reporting
information as to the pros and cons of the use of pesticides in raising
crops. The information is collected and distributed in the form of a
published report which analyzes the effects and costs of the use and
nonuse of various pesticides under various conditions on humans,
animals, and crops. The report also presents the advantages,
disadvantages, and economic cost of allowing the continued use of
pesticides unabated, of controlling the use of pesticides, and of
developing alternatives to pesticides. Even if the report sets forth
[[Page 169]]
conclusions that the disadvantages as a result of using pesticides are
greater than the advantages of using pesticides and that prompt
legislative regulation of the use of pesticides is needed, the project
is within the exception for nonpartisan analysis, study or research
since it is designed to present information on both sides of the
legislative controversy and presents a sufficiently full and fair
exposition of the pertinent facts to enable the public or an individual
to form an independent opinion or conclusion.
Example 3. O, a private foundation, establishes a research project
to collect information on the presence or absence of disease in humans
from eating food grown with pesticides and the presence or absence of
disease in humans from eating food not grown with pesticides. As part of
the research project, O hires a consultant who prepares a ``fact sheet''
which calls for the curtailment of the use of pesticides and which
addresses itself to the merits of several specific legislative proposals
to curtail the use of pesticides in raising crops which are currently
pending before State legislatures. The ``fact sheet'' presents reports
of experimental evidence tending to support its conclusions but omits
any reference to reports of experimental evidence tending to dispute its
conclusions. O distributes 10,000 copies to citizens' groups.
Expenditures by O in connection with this work of the consultant are not
within the exception for nonpartisan analysis, study, or research.
Example 4. P publishes a bi-monthly newsletter to collect and report
all published materials, ongoing research, and new developments with
regard to the use of pesticides in raising crops. The newsletter also
includes notices of proposed pesticide legislation with impartial
summaries of the provisions and debates on such legislation. The
newsletter does not encourage recipients to take action with respect to
such legislation, but is designed to present information on both sides
of the legislative controversy and does present information fully and
fairly. It is within the exception for nonpartisan analysis, study, or
research.
Example 5. X is satisfied that A, a member of the faculty of Y
University, is exceptionally well qualified to undertake a project
involving a comprehensive study of the effects of pesticides on crop
yields. Consequently, X makes a grant to A to underwrite the cost of the
study and of the preparation of a book on the effect of pesticides on
crop yields. X does not take any position on the issues or control the
content of A's output. A produces a book which concludes that the use of
pesticides often has a favorable effect on crop yields, and on that
basis argues against pending bills which would ban the use of
pesticides. A's book contains a sufficiently full and fair exposition of
the pertinent facts, including known or potential disadvantages of the
use of pesticides, to enable the public or an individual to form an
independent opinion or conclusion as to whether pesticides should be
banned as provided in the pending bills. The book does not directly
encourage readers to take action with respect to the pending bills.
Consequently, the book is within the exception for nonpartisan analysis,
study, or research.
Example 6. Assume the same facts as Example (2), except that,
instead of issuing a report, X presents within a period of 6 consecutive
months a two-program television series relating to the pesticide issue.
The first program contains information, arguments, and conclusions
favoring legislation to restrict the use of pesticides. The second
program contains information, arguments, and conclusions opposing
legislation to restrict the use of pesticides. The programs are
broadcast within 6 months of each other during commensurate periods of
prime time. X's programs are within the exception for nonpartisan
analysis, study, or research. Although neither program individually
could be regarded as nonpartisan, the series of two programs constitutes
a balanced presentation.
Example 7. Assume the same facts as Example (6), except that X
arranged for televising the program favoring legislation to restrict the
use of pesticides at 8 p.m. on a Thursday evening and for televising the
program opposing such legislation at 7 a.m. on a Sunday morning. X's
presentation is not within the exception for nonpartisan analysis,
study, or research, since X disseminated its information in a manner
prejudicial to one side of the legislative controversy.
Example 8. Organization Z researches, writes, prints and distributes
a study on the use and effects of pesticide X. A bill is pending in the
U.S. Senate to ban the use of pesticide X. Z's study leads to the
conclusion that pesticide X is extremely harmful and that the bill
pending in the U.S. Senate is an appropriate and much needed remedy to
solve the problems caused by pesticide X. The study contains a
sufficiently full and fair exposition of the pertinent facts, including
known or potential advantages of the use of pesticide X, to enable the
public or an individual to form an independent opinion or conclusion as
to whether pesticides should be banned as provided in the pending bills.
In its analysis of the pending bill, the study names certain undecided
Senators on the Senate committee considering the bill. Although the
study meets the three part test for determining whether a communication
is a grass roots lobbying communication, the study is within the
exception for nonpartisan analysis, study or research, because it does
not directly encourage recipients of the communication to urge a
legislator to oppose the bill.
Example 9. Assume the same facts as in Example (8), except that,
after stating support
[[Page 170]]
for the pending bill, the study concludes: ``You should write to the
undecided committee members to support this crucial bill.'' The study is
not within the exception for nonpartisan analysis, study or research
because it directly encourages the recipients to urge a legislator to
support a specific piece of legislation.
Example 10. Organization X plans to conduct a lobbying campaign with
respect to illegal drug use in the United States. It incurs $5,000 in
expenses to conduct research and prepare an extensive report primarily
for use in the lobbying campaign. Although the detailed report discusses
specific pending legislation and reaches the conclusion that the
legislation would reduce illegal drug use, the report contains a
sufficiently full and fair exposition of the pertinent facts to enable
the public or an individual to form an independent conclusion regarding
the effect of the legislation. The report does not encourage readers to
contact legislators regarding the legislation. Accordingly, the report
does not, in and of itself, constitute a lobbying communication.
Copies of the report are available to the public at X's office, but
X does not actively distribute the report or otherwise seek to make the
contents of the report available to the general public. Whether or not
X's distribution is sufficient to meet the requirement in Sec. 53.4945-
2(d)(1)(iv) that a nonpartisan communication be made available, X's
distribution is not substantial (for purposes of Sec. Sec. 53.4945-
2(D)(1)(v) and 56.4911-2(b)(2)(v)) in light of all of the facts and
circumstances, including the normal distribution pattern of similar
nonpartisan reports. X then mails copies of the report, along with a
letter, to 10,000 individuals on X's mailing list. In the letter, X
requests that individuals contact legislators urging passage of the
legislation discussed in the report. Because X's research and report
were primarily undertaken by X for lobbying purposes and X did not make
a substantial distribution of the report (without an accompanying
lobbying message) prior to or contemporaneously with the use of the
report in lobbying, the report is a grass roots lobbying communication
that is not within the exception for nonpartisan analysis, study or
research. Thus, the expenditures for preparing and mailing both the
report and the letter are taxable expenditures under section 4945.
Example 11. Assume the same facts as in Example (10), except that
before using the report in the lobbying campaign, X sends the research
and report (without an accompanying lobbying message) to universities
and newspapers. At the same time, X also advertises the availability of
the report in its newsletter. This distribution is similar in scope to
the normal distribution pattern of similar nonpartisan reports. In light
of all of the facts and circumstances, X's distribution of the report is
substantial. Because of X's substantial distribution of the report, X's
primary purpose will be considered to be other than for use in lobbying
and the report will not be considered a grass roots lobbying
communication. Accordingly, only the expenditures for copying and
mailing the report to the 10,000 individuals on X's mailing list, as
well as for preparing and mailing the letter, are expenditures for grass
roots lobbying communications, and are thus taxable expenditures under
section 4945.
Example 12. Organization M pays for a bumper sticker that reads:
``STOP ABORTION: Vote NO on Prop. X!'' M also pays for a 30-second
television advertisement and a billboard that similarly advocate
opposition to Prop. X. In light of the limited scope of the
communications, none of the communications is within the exception for
nonpartisan analysis, study or research. First, none of the
communications rises to the level of analysis, study or research.
Second, none of the communications is nonpartisan because none contains
a sufficiently full and fair exposition of the pertinent facts to enable
the public or an individual to form an independent opinion or
conclusion. Thus, each communication is a lobbying communication.
(2) Technical advice or assistance--(i) In general. Amounts paid or
incurred in connection with providing technical advice or assistance to
a governmental body, a governmental committee, or a subdivision of
either of the foregoing, in response to a written request by such body,
committee, or subdivision do not constitute taxable expenditures for
purposes of this section. Under this exception, the request for
assistance or advice must be made in the name of the requesting
governmental body, committee or subdivision rather than an individual
member thereof. Similarly, the response to such request must be
available to every member of the requesting body, committee or
subdivision. For example, in the case of a written response to a request
for technical advice or assistance from a congressional committee, the
response will be considered available to every member of the requesting
committee if the response is submitted to the person making such request
in the name of the committee and it is made clear that the response is
for the use of all the members of the committee.
(ii) Nature of technical advice or assistance. ``Technical advice or
assistance'' may be given as a result of knowledge
[[Page 171]]
or skill in a given area. Because such assistance or advice may be given
only at the express request of a governmental body, committee or
subdivision, the oral or written presentation of such assistance or
advice need not qualify as nonpartisan analysis, study or research. The
offering of opinions or recommendations will ordinarily qualify under
this exception only if such opinions or recommendations are specifically
requested by the governmental body, committee or subdivision or are
directly related to the materials so requested.
(iii) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. A congressional committee is studying the feasibility of
legislation to provide funds for scholarships to U.S. students attending
schools abroad. X, a private foundation which has engaged in a private
scholarship program of this type, is asked, in writing, by the committee
to describe the manner in which it selects candidates for its program.
X's response disclosing its methods of selection constitutes technical
advice or assistance.
Example 2. Assume the same facts as Example (1), except that X's
response not only includes a description of its own grant-making
procedures, but also its views regarding the wisdom of adopting such a
program. Since such views are directly related to the subject matter of
the request for technical advice or assistance, expenditures paid or
incurred with respect to the presentation of such views would not
constitute taxable expenditures. However, expenditures paid or incurred
with respect to a response which is not directly related to the subject
matter of the request for technical advice or assistance would
constitute taxable expenditures unless the presentation can qualify as
the making available of nonpartisan analysis, study or research.
Example 3. Assume the same facts as Example (1), except that X is
requested, in addition, to give any views it considers relevant. A
response to this request giving opinions which are relevant to the
committee's consideration of the scholarship program but which are not
necessarily directly related to X's scholarship program, such as
discussions of alternative scholarships programs and their relative
merits, would qualify as ``technical advice or assistance'', and
expenditures paid or incurred with respect to such response would not
constitute taxable expenditures.
Example 4. A, an official of the State Department, makes a written
request in his official capacity for information from foundation Y
relating to the economic development of country M and for the opinions
of Y as to the proper position of the United States in pending
negotiations with M concerning a proposed treaty involving a program of
economic and technical aid to M. Y's furnishing of such information and
opinions constitutes technical advice or assistance.
Example 5. In response to a telephone inquiry from Senator X's
staff, organization B sends Senator X a report concluding that the
Senate should not advise and consent to the nomination of Z to serve as
a Supreme Court Justice. Because the request was not in writing, and
also because the request was not from the Senate itself or from a
committee or subcommittee, B's report is not within the scope of the
exception for responses to requests for technical advice. Accordingly,
B's report is a lobbying communication unless the report is within the
scope of the exception for nonpartisan analysis, study or research.
Example 6. Assume the same facts as in Example (5), except that B's
report is sent in response to a written request that Senator X sends to
B. The request from Senator X is a request from the Senator as an
individual member of the Senate rather than from the Senate itself or
from a committee or subcommittee. Accordingly, B's report is not within
the scope of the exception for responses to requests for technical
advice and is a lobbying conmmunication unless the report is within the
scope of the exception for nonpartisan analysis, study or research.
Example 7. Assume the same facts as in Example (6), except that B's
report is sent in response to a written request from the Senate
committee that is considering the nomination for an evaluation of the
nominee's legal writings and a recommendation as to whether the
candidate is or is not qualified to serve on the Supreme Court. The
report is within the scope of the exception for responses to requests
for technical advice and is not a lobbying communication.
(3) Decisions affecting the powers, duties, etc., of a private
foundation--(i) In general. Paragraph (c) of this section does not apply
to any amount paid or incurred in connection with an appearance before,
or communication with, any legislative body with respect to a possible
decision of such body which might affect the existence of the private
foundation, its powers and duties, its tax-exempt status, or the
deductibility of contributions to such foundation. Under this exception,
a foundation may communicate with the entire legislative body,
committees or subcommittees of such legislative body, individual
congressmen or legislators,
[[Page 172]]
members of their staffs, or representatives of the executive branch, who
are involved in the legislative process, if such communication is
limited to the prescribed subjects. Similarly, the foundation may make
expenditures in order to initiate legislation if such legislation
concerns only matters which might affect the existence of the private
foundation, its powers and duties, its tax-exempt status, or the
deductibility of contributions to such foundation.
(ii) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. A bill is being considered by Congress which would, if
enacted, restrict the power of a private foundation to engage in
transactions with certain related persons. Under the proposed bill a
private foundation would lose its exemption from taxation if it engages
in such transactions. W, a private foundation, writes to the
congressional committee considering the bill, arguing that the enactment
of such a bill would not be advisable, and subsequently appears before
such committee to make its arguments. In addition, W requests that the
congressional committee consider modification of the 2 percent de
minimis rule of section 4943(c) (2) (C). Expenditures paid or incurred
with respect to such submissions do not constitute taxable expenditures
since they are made with respect to a possible decision of Congress
which might affect the existence of the private foundation, its powers
and duties, its tax-exempt status, or the deduction of contributions to
such foundation.
Example 2. A bill being considered in a State legislature is
designed to implement the requirements of section 508(e) of the Internal
Revenue Code of 1954. Under such section, a private foundation is
required to make certain amendments to its governing instrument. X, a
private foundation, makes a submission to the legislature which proposes
alternative measures which might be taken in lieu of the proposed bill.
X also arranges to have its president contact certain State legislators
with regard to this bill. Expenditures paid or incurred in making such
submission and in contacting the State legislators do not constitute
taxable expenditures since they are made with respect to a possible
decision of such State legislature which might affect the existence of
the private foundation, its powers and duties, its tax-exempt status, or
the deduction of contributions to such foundation.
Example 3. A bill is being considered by a State legislature under
which the State would assume certain responsibilities for nursing care
of the aged. Y, a private foundation which hitherto has engaged in such
activities, appears before the State legislature and contends that such
activities can be better performed by privately supported organizations.
Expenditures paid or incurred with respect to such appearance are not
made with respect to possible decisions of the State legislature which
might affect the existence of the private foundation, its powers and
duties, its tax-exempt status, or the deduction of contributions to such
foundation, but rather merely affect the scope of the private
foundation's future activities.
Example 4. A State legislature is considering the annual
appropriations bill. Z, a private foundation which had hitherto
performed contract research for the State, appears before the
appropriations committee in order to attempt to persuade the committee
of the advisability of continuing the program. Expenditures paid or
incurred with respect to such appearance are not made with respect to
possible decisions of the State legislature which might affect the
existence of the private foundation, its powers and duties, its tax-
exempt status, or the deduction of contributions to such foundation, but
rather merely affect the scope of the private foundation's future
activities.
(4) Examination and discussions of broad social, economic, and
similar problems. Examinations and discussions of broad social,
economic, and similar problems are neither direct lobbying
communications under Sec. 56.4911-2(b)(1) nor grass roots lobbying
communications under Sec. 56.4911-2(b)(2) even if the problems are of
the type with which government would be expected to deal ultimately.
Thus, under Sec. Sec. 56.4911-2(b) (1) and (2), lobbying communications
do not include public discussion, or communications with members of
legislative bodies or governmental employees, the general subject of
which is also the subject of legislation before a legislative body, so
long as such discussion does not address itself to the merits of a
specific legislative proposal and so long as such discussion does not
directly encourage recipients to take action with respect to
legislation. For example, this paragraph (d)(4) excludes from grass
roots lobbying under Sec. 56.4911(b)(2) an organization's discussions
of problems such as environmental pollution or population growth that
are being considered by Congress and various State legislatures, but
only where the discussions are not directly addressed to specific
legislation being considered, and only where the
[[Page 173]]
discussions do not directly encourage recipients of the communication to
contact a legislator, an employee of a legislative body, or a government
official or employee who may participate in the formulation of
legislation.
[T.D. 7215, 37 FR 23161, Oct. 31, 1972; 37 FR 23918, Nov. 11, 1972, as
amended by T.D. 8308, 55 FR 35594, Aug. 31, 1990]
Sec. 53.4945-3 Influencing elections and carrying on voter registration drives.
(a) Expenditures to influence elections or carry on voter
registration drives--(1) In general. Under section 4945(d) (2), the term
``taxable expenditure'' includes any amount paid or incurred by a
private foundation to influence the outcome of any specific public
election or to carry on, directly or indirectly, any voter registration
drive, unless such amount is paid or incurred by an organization
described in section 4945(f). However, for treatment of nonearmarked
grants to public organizations, see Sec. 53.4945-2(a) (5) and for
treatment of certain earmarked grants to organizations described in
section 4945(f), see paragraph (b) (2) of this section.
(2) Influencing the outcome of a specific public election. For
purposes of this section, an organization shall be considered to be
influencing the outcome of any specific public election if it
participates or intervenes, directly or indirectly, in any political
campaign on behalf of or in opposition to any candidate for public
office. The term candidate for public office means an individual who
offers himself, or is proposed by others, as a contestant for an
elective public office, whether such office be national, State or local.
Activities which constitute participation or intervention in a political
campaign on behalf of or in opposition to a candidate include, but are
not limited to:
(i) Publishing or distributing written or printed statements or
making oral statements on behalf of or in opposition to such a
candidate;
(ii) Paying salaries or expenses of campaign workers; and
(iii) Conducting or paying the expenses of conducting a voter-
registration drive limited to the geographic area covered by the
campaign.
(b) Nonpartisan activities carried on by certain organizations--(1)
In general. If an organization meets the requirements described in
section 4945(f), an amount paid or incurred by such organization shall
not be considered a taxable expenditure even though the use of such
amount is otherwise described in section 4945(d) (2). Such requirements
are:
(i) The organization is described in section 501(c) (3) and exempt
from taxation under section 501(a);
(ii) The activities of the organization are nonpartisan, are not
confined to one specific election period, and are carried on in five or
more States;
(iii) The organization expends at least 85 percent of its income
directly for the active conduct (within the meaning of section 4942(j)
(3) and the regulations thereunder) of the activities constituting the
purpose or function for which it is organized and operated;
(iv) The organization receives at least 85 percent of its support
(other than gross investment income as defined in section 509(e)) from
exempt organizations, the general public, governmental units described
in section 170(c) (1), or any combination of the foregoing; the
organization does not receive more than 25 percent of its support (other
than gross investment income) from any one exempt organization (for this
purpose treating private foundations which are described in section
4946(a) (1) (H) with respect to each other as one exempt organization);
and not more than half of the support of the organization is received
from gross investment income; and
(v) Contributions to the organization for voter registration drives
are not subject to conditions that they may be used only in specified
States, possessions of the United States, or political subdivisions or
other areas of any of the foregoing, or the District of Columbia, or
that they may be used in only one specific election period.
(2) Grants to section 4945(f) organizations. If a private foundation
makes a grant to an organization described in section 4945(f) (whether
or not such grantee is a private foundation as defined in section
509(a)), such grant will not be treated as a taxable expenditure
[[Page 174]]
under section 4945(d) (2) or (4). Even if a grant to such an
organization is earmarked for voter registration purposes generally,
such a grant will not be treated as a taxable expenditure under section
4945(d) (2) or (4) as long as such earmarking does not violate section
4945(f) (5).
(3) Period for determining support--(i) In general. The
determination whether an organization meets the support test in section
4945(f) (4) for any taxable year is to be made by aggregating all
amounts of support received by the organization during the taxable year
and the immediately preceding four taxable years. However, the support
received in any taxable year which begins before January 1, 1970, shall
be excluded.
(ii) New organizations and organizations with no preceding taxable
years beginning after December 31, 1969. Except as provided in
subparagraph (4) of this paragraph, in the case of a new organization or
an organization with no taxable years that begin after December 31,
1969, and immediately precede the taxable year in question, the
requirements of the support test in section 4945(f)(4) will be
considered as met for the taxable year if such requirements are met by
the end of the taxable year.
(iii) Organization with three or fewer preceding taxable years. In
the case of an organization which has been in existence for at least 1
but fewer than 4 preceding taxable years beginning after December 31,
1969, the determination whether such organization meets the requirements
of the support test in section 4945(f)(4) for the taxable year is to be
made by taking into account all the support received by such
organization during the taxable year and during each preceding taxable
year beginning after December 31, 1969.
(4) Advance rulings. An organization will be given an advance ruling
that it is an organization described in section 4945(f) for its first
taxable year of operation beginning after October 30, 1972, or for its
first taxable year of operation beginning after December 31, 1969, if it
submits evidence establishing that it can reasonably be expected to meet
the tests under section 4945(f) for such taxable year. An organization
which, pursuant to this subparagraph, has been treated as an
organization described in section 4945(f) for a taxable year (without
withdrawal of such treatment by notification from the Internal Revenue
Service during such year), but which actually fails to meet the
requirements of section 4945(f) for such taxable year, will not be
treated as an organization described in section 4945(f) as of the first
day of its next taxable year (for purposes of making any determination
under the internal revenue laws with respect to such organization) and
until such time as the organization does meet the requirements of
section 4945(f). For purposes of section 4945, the status of grants or
contributions with respect to grantors or contributors to such
organization will not be affected until notice of change of status of
such organization is made to the public (such as by publication in the
Internal Revenue Bulletin). The preceding sentence shall not apply,
however, if the grantor or contributor was responsible for, or was aware
of, the fact that the organization did not satisfy section 4945(f) at
the end of the taxable year with respect to which the organization had
obtained an advance ruling or a determination letter that it was a
section 4945(f) organization, or acquired knowledge that the Internal
Revenue Service had given notice to such organization that it would be
deleted from classification as a section 4945(f) organization.
[T.D. 7215, 37 FR 23161, Oct. 31, 1972; 37 FR 23918, Nov. 11, 1972]
Sec. 53.4945-4 Grants to individuals.
(a) Grants to individuals--(1) In general. Under section 4945(d) (3)
the term ``taxable expenditure'' includes any amount paid or incurred by
a private foundation as a grant to an individual for travel, study, or
other similar purposes by such individual unless the grant satisfies the
requirements of section 4945(g). Grants to individuals which are not
taxable expenditures because made in accordance with the requirements of
section 4945(g) may result in the imposition of excise taxes under other
provisions of chapter 42.
(2) ``Grants'' defined. For purposes of section 4945, the term
``grants'' shall include, but is not limited to, such expenditures as
scholarships, fellowships, internships, prizes, and awards. Grants
[[Page 175]]
shall also include loans for purposes described in section 170(c) (2)
(B) and ``program related investments'' (such as investments in small
businesses in central cities or in businesses which assist in
neighborhood renovation). Similarly, ``grants'' include such
expenditures as payments to exempt organizations to be used in
furtherance of such recipient organizations' exempt purposes whether or
not such payments are solicited by such recipient organizations.
Conversely, ``grants'' do not ordinarily include salaries or other
compensation to employees. For example, ``grants'' do not ordinarily
include educational payments to employees which are includible in the
employees' incomes pursuant to section 61. In addition, ``grants'' do
not ordinarily include payments (including salaries, consultants' fees
and reimbursement for travel expenses such as transportation, board, and
lodging) to persons (regardless of whether such persons are individuals)
for personal services in assisting a foundation in planning, evaluating
or developing projects or areas of program activity by consulting,
advising, or participating in conferences organized by the foundation.
(3) Requirements for individual grants--(i) Grants for other than
section 4945(d)(3) purposes. A grant to an individual for purposes other
than those described in section 4945(d) (3) is not a taxable expenditure
within the meaning of section 4945(d) (3). For example, if a foundation
makes grants to indigent individuals to enable them to purchase
furniture, such grants are not taxable expenditures within the meaning
of section 4945(d) (3) even if the requirements of section 4945(g) are
not met.
(ii) Grants for section 4945(d) (3) purposes. Under section 4945(g),
a grant to an individual for travel, study, or other similar purposes is
not a ``taxable expenditure'' only if:
(a) The grant is awarded on an objective and nondiscriminatory basis
(within the meaning of paragraph (b) of this section);
(b) The grant is made pursuant to a procedure approved in advance by
the Commissioner; and
(c) It is demonstrated to the satisfaction of the Commissioner that:
(1) The grant constitutes a scholarship or fellowship grant which is
excluded from gross income under section 117(a) and is to be utilized
for study at an educational institution described in section 151(e) (4);
(2) The grant constitutes a prize or award which is excluded from
gross income under section 74(b), and the recipient of such prize or
award is selected from the general public (within the meaning of section
4941(d) (2) (G) (i) and the regulations thereunder); or
(3) The purpose of the grant is to achieve a specific objective,
produce a report or other similar product, or improve or enhance a
literary, artistic, musical, scientific, teaching, or other similar
capacity, skill, or talent of the grantee.
If a grant is made to an individual for a purpose described in section
4945(g) (3) and such grant otherwise meets the requirements of section
4945(g), such grant shall not be treated as a taxable expenditure even
if it is a scholarship or a fellowship grant which is not excludable
from income under section 117 or if it is a prize or award which is
includible in income under section 74.
(iii) Renewals. A renewal of a grant which satisfied the
requirements of subdivision (ii) of this subparagraph shall not be
treated as a grant to an individual which is subject to the requirements
of this section, if:
(a) The grantor has no information indicating that the original
grant is being used for any purpose other than that for which it was
made,
(b) Any reports due at the time of the renewal decision pursuant to
the terms of the original grant have been furnished, and
(c) Any additional criteria and procedures for renewal are objective
and nondiscriminatory.
For purposes of this section, an extension of the period over which a
grant is to be paid shall not itself be regarded as a grant or a renewal
of a grant.
(4) Certain designated grants--(i) In general. A grant by a private
foundation to another organization, which the grantee organization uses
to make payments to an individual for purposes described in section
4945(d)(3), shall not be regarded as a grant by the private
[[Page 176]]
foundation to the individual grantee if the foundation does not earmark
the use of the grant for any named individual and there does not exist
an agreement, oral or written, whereby such grantor foundation may cause
the selection of the individual grantee by the grantee organization. For
purposes of this subparagraph, a grant described herein shall not be
regarded as a grant by the foundation to an individual grantee even
though such foundation has reason to believe that certain individuals
would derive benefits from such grant so long as the grantee
organization exercises control, in fact, over the selection process and
actually makes the selection completely independently of the private
foundation.
(ii) Certain grants to ``public charities''. A grant by a private
foundation to an organization described in section 509(a) (1), (2), or
(3), which the grantee organization uses to make payments to an
individual for purposes described in section 4945(d)(3), shall not be
regarded as a grant by the private foundation to the individual grantee
(regardless of the application of subdivision (i) of this subparagraph)
if the grant is made for a project which is to be undertaken under the
supervision of the section 509(a) (1), (2), or (3) organization and such
grantee organization controls the selection of the individual grantee.
This subdivision shall apply regardless of whether the name of the
individual grantee was first proposed by the private foundation, but
only if there is an objective manifestation of the section 509(a), (1),
(2), or (3) organization's control over the selection process, although
the selection need not be made completely independently of the private
foundation. For purposes of this subdivision, an organization shall be
considered a section 509(a)(1) organization if it is treated as such
under subparagraph (4) of Sec. 53.4945-5(a).
(iii) Grants to governmental agencies. If a private foundation makes
a grant to an organization described in section 170(c)(1) (regardless of
whether it is described in section 501(c)(3)) and such grant is
earmarked for use by an individual for purposes described in section
4945(d)(3), such grant is not subject to the requirements of section
4945(d)(3) and (g) and this section (regardless of the application of
subdivision (i) of this subparagraph) if the section 170(c)(1)
organization satisfies the Commissioner in advance that its grant-making
program:
(a) Is in furtherance of a purpose described in section
170(c)(2)(B),
(b) Requires that the individual grantee submit reports to it which
would satisfy paragraph (c)(3) of this section, and
(c) Requires that the organization investigate jeopardized grants in
a manner substantially similar to that described in paragraph (c)(4) of
this section.
(iv) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. M, a university described in section 170(b)(1)(A)(ii),
requests that P, a private foundation, grant it $100,000 to enable M to
obtain the services of a particular scientist for a research project in
a special field of biochemistry in which he has exceptional
qualifications and competence. P, after determining that the project
deserves support, makes the grant to M to enable it to obtain the
services of this scientist. M is authorized to keep the funds even if it
is unsuccessful in attempting to employ the scientist. Under these
circumstances P will not be treated as having made a grant to the
individual scientist for purposes of section 4945(d)(3) and (g), since
the requirements of subdivision (i) of this subparagraph have been
satisfied. Even if M were not authorized to keep the funds if it is
unsuccessful in attempting to employ the scientist, P would not be
treated as having made a grant to the individual scientist for purposes
of section 4945(d)(3) and (g), since it is clear from the facts and
circumstances that the selection of the particular scientist was made by
M and thus the requirements of subdivision (ii) of this subparagraph
would have been satisfied.
Example 2. Assume the same facts as Example (1), except that there
are a number of scientists who are qualified to administer the research
project, P suggests the name of the particular scientist to be employed
by M, and M is not authorized to keep the funds if it is unsuccessful in
attempting to employ the particular scientist. For purposes of section
4945(d)(3) and (g), P will be treated as having made a grant to the
individual scientist whose name it suggested, since it is clear from the
facts and circumstances that selection of the particular scientist was
made by P.
Example 3. X, a private foundation, is aware of the exceptional
research facilities at Y University, an organization described in
[[Page 177]]
section 170(b)(1)(A)(ii). Officials of X approach officials of Y with an
offer to give Y a grant of $100,000 if Y will engage an adequately
qualified physicist to conduct a specific research project. Y's
officials accept this proposal, and it is agreed that Y will administer
the funds. After examining the qualifications of several research
physicists, the officials of Y agree that A, whose name was first
suggested by officials of X and who first suggested the specific
research project to X, is uniquely qualified to conduct the project. X's
grant letter provides that X has the right to renegotiate the terms of
the grant if there is a substantial deviation from such terms, such as
breakdown of Y's research facilities or termination of the conduct of
the project by an adequately qualified physicist. Under these
circumstances, X will not be treated as having made a grant to A for
purposes of section 4945(d)(3) and (g), since the requirements of
subdivision (ii) of this subparagraph have been satisfied.
Example 4. Professor A, a scholar employed by University Y, an
organization described in section 170(b)(1)(A)(ii), approaches
Foundation X to determine the availability of grant funds for a
particular research project supervised or conducted by Professor A
relevant to the program interests of Foundation X. After learning that
Foundation X would be willing to consider the project if University Y
were to submit the project to X, Professor A submits his proposal to the
appropriate administrator of University Y. After making a determination
that it should assume responsibility for the project, that Professor A
is qualified to conduct the project, and that his participation would be
consistent with his other faculty duties, University Y formally adopts
the grant proposal and submits it to Foundation X. The grant is made to
University Y which, under the terms of the grant, is responsible for the
expenditure of the grant funds and the grant project. In such a case,
and even if Foundation X retains the right to renegotiate the terms of
the grant if the project ceases to be conducted by Professor A, the
grant shall not be regarded as a grant by Foundation X to Professor A
since University Y has retained control over the selection process
within the meaning of subdivision (ii) of this subparagraph.
(5) Earmarked grants to individuals. A grant by a private foundation
to an individual, which meets the requirements of section 4945(d)(3) and
(g), is a taxable expenditure by such foundation under section 4945(d)
only if:
(i) The grant is earmarked to be used for any activity described in
section 4945(d) (1), (2), or (5), or is earmarked to be used in a manner
which would violate section 4945(d) (3) or (4),
(ii) There is an agreement, oral or written, whereby such grantor
foundation may cause the grantee to engage in any such prohibited
activity and such grant is in fact used in a manner which violates
section 4945(d), or
(iii) The grant is made for a purpose other than a purpose described
in section 170(c)(2)(B).
For purposes of this subparagraph, a grant by a private foundation is
earmarked if such grant is given pursuant to an agreement, oral or
written, that the grant will be used for specific purposes.
(b) Selection of grantees on ``an objective and nondiscriminatory
basis''--(1) In general. For purposes of this section, in order for a
foundation to establish that its grants to individuals are made on an
objective and nondiscriminatory basis, the grants must be awarded in
accordance with a program which, if it were a substantial part of the
foundation's activities, would be consistent with:
(i) The existence of the foundation's exempt status under section
501(c)(3);
(ii) The allowance of deductions to individuals under section 170
for contributions to the granting foundation; and
(iii) The requirements of subparagraphs (2), (3), and (4) of this
paragraph.
(2) Candidates for grants. Ordinarily, selection of grantees on an
objective and nondiscriminatory basis requires that the group from which
grantees are selected be chosen on the basis of criteria reasonably
related to the purposes of the grant. Furthermore, the group must be
sufficiently broad so that the giving of grants to members of such group
would be considered to fulfill a purpose described in section
170(c)(2)(B). Thus, ordinarily the group must be sufficiently large to
constitute a charitable class. However, selection from a group is not
necessary where taking into account the purposes of the grant, one or
several persons are selected because they are exceptionally qualified to
carry out these purposes or it is otherwise evident that the selection
is particularly calculated to effectuate the charitable purpose of the
grant rather than to benefit particular persons or a particular class of
persons.
[[Page 178]]
Therefore, consistent with the requirements of this subparagraph, the
foundation may impose reasonable restrictions on the group of potential
grantees. For example, selection of a qualified research scientist to
work on a particular project does not violate the requirements of
section 4945(d)(3) merely because the foundation selects him from a
group of three scientists who are experts in that field.
(3) Selection from within group of potential grantees. The criteria
used in selecting grant recipients from the potential grantees should be
related to the purpose of the grant. Thus, for example, proper criteria
for selecting scholarship recipients might include (but are not limited
to) the following: Prior academic performance; performance on tests
designed to measure ability and aptitude for college work;
recommendations from instructors; financial need; and the conclusions
which the selection committee might draw from a personal interview as to
the individual's motivation, character, ability, and potential.
(4) Persons making selections. The person or group of persons who
select recipients of grants should not be in a position to derive a
private benefit, directly or indirectly, if certain potential grantees
are selected over others.
(5) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. X company employs 100,000 people of whom 1,000 are
classified by the company as executives. The company has organized the X
company foundation which, as its sole activity, provides 100 4-year
college scholarships per year for children of the company's employees.
Children of all employees (other than disqualified persons with respect
to the foundation) who have worked for the X company for at least 2
years are eligible to apply for these scholarships. In previous years,
the number of children eligible to apply for such scholarships has
averaged 2,000 per year. Selection of scholarship recipients from among
the applicants is made by three prominent educators, who have no
connection (other than as members of the selection committee) with the
company, the foundation or any of the employees of the company. The
selections are made on the basis of the applicants' prior academic
performance, performance on certain tests designed to measure ability
and aptitude for college work, and financial need. No disproportionate
number of scholarships has been granted to relatives of executives of X
company. Under these circumstances, the operation of the scholarship
program by the X company foundation: (1) Is consistent with the
existence of the foundation's exempt status under section 501(c) (3) and
with the allowance of deductions under section 170 for contributions to
the foundation; (2) utilizes objective and nondiscriminatory criteria in
selecting scholarship recipients from among the applicants; and (3)
utilizes a selection committee which appears likely to make objective
and nondiscriminatory selections of grant recipients.
Example 2. Assume the same facts as Example (1), except that the
foundation establishes a program to provide 20 college scholarships per
year for members of a certain ethnic minority. All members of this
minority group (other than disqualified persons with respect to the
foundation) living in State Z are eligible to apply for these
scholarships. It is estimated that at least 400 persons will be eligible
to apply for these scholarships each year. Under these circumstances,
the operation of this scholarship program by the foundation: (1) Is
consistent with the existence of the foundation's exempt status under
section 501(c)(3) and with the allowance of deductions under section 170
for contributions to the foundation; (2) utilizes objective and
nondiscriminatory criteria in selecting scholarship recipients from
among the applicants; and (3) utilizes a selection committee which
appears likely to make objective and nondiscriminatory selections of
grant recipients.
(c) Requirements of a proper procedure--(1) In general. Section
4945(g) requires that grants to individuals must be made pursuant to a
procedure approved in advance. To secure such approval, a private
foundation must demonstrate to the satisfaction of the Commissioner
that:
(i) Its grant procedure includes an objective and nondiscriminatory
selection process (as described in paragraph (b) of this section);
(ii) Such procedure is reasonably calculated to result in
performance by grantees of the activities that the grants are intended
to finance; and
(iii) The foundation plans to obtain reports to determine whether
the grantees have performed the activities that the grants are intended
to finance.
No single procedure or set of procedures is required. Procedures may
vary depending upon such factors as the size
[[Page 179]]
of the foundation, the amount and purpose of the grants and whether one
or more recipients are involved.
(2) Supervision of scholarship and fellowship grants. Except as
provided in subparagraph (5) of this paragraph, with respect to any
scholarship or fellowship grants, a private foundation must make
arrangements to receive a report of the grantee's courses taken (if any)
and grades received (if any) in each academic period. Such a report must
be verified by the educational institution attended by the grantee and
must be obtained at least once a year. In cases of grantees whose study
at an educational institution does not involve the taking of courses but
only the preparation of research papers or projects, such as the writing
of a doctoral thesis, the foundation must receive a brief report on the
progress of the paper or project at least once a year. Such a report
must be approved by the faculty member supervising the grantee or by
another appropriate university official. Upon completion of a grantee's
study at an educational institution, a final report must also be
obtained.
(3) Grants described in section 4945(g)(3). With respect to a grant
made under section 4945(g)(3), the private foundation shall require
reports on the use of the funds and the progress made by the grantee
toward achieving the purposes for which the grant was made. Such reports
must be made at least once a year. Upon completion of the undertaking
for which the grant was made, a final report must be made describing the
grantee's accomplishments with respect to the grant and accounting for
the funds received under such grant.
(4) Investigation of jeopardized grants. (i) Where the reports
submitted under this paragraph or other information (including the
failure to submit such reports) indicates that all or any part of a
grant is not being used in furtherance of the purposes of such grant,
the foundation is under a duty to investigate. While conducting its
investigation, the foundation must withhold further payments to the
extent possible until any delinquent reports required by this paragraph
have been submitted and where required by subdivision (ii) or (iii) of
this subparagraph.
(ii) In cases in which the grantor foundation determines that any
part of a grant has been used for improper purposes and the grantee has
not previously diverted grant funds to any use not in furtherance of a
purpose specified in the grant, the foundation will not be treated as
having made a taxable expenditure solely because of the diversion so
long as the foundation:
(a) Is taking all reasonable and appropriate steps either to recover
the grant funds or to insure the restoration of the diverted funds and
the dedication (consistent with the requirements of (b) (1) and (2) of
this subdivision) of other grant funds held by the grantee to the
purposes being financed by the grant, and
(b) Withholds any further payments to the grantee after the grantor
becomes aware that a diversion may have taken place (hereinafter
referred to as ``further payments'') until it has:
(1) Received the grantee's assurances that future diversions will
not occur, and
(2) Required the grantee to take extraordinary precaution to prevent
future diversions from occurring.
If a foundation is treated as having made a taxable expenditure under
this subparagraph in a case to which this subdivision applies, then
unless the foundation meets the requirements of (a) of this subdivision
the amount of the taxable expenditure shall be the amount of the
diversion plus the amount of any further payments to the same grantee.
However, if the foundation complies with the requirements of (a) of this
subdivision but not the requirements of (b) of this subdivision, the
amount of the taxable expenditure shall be the amount of such further
payments.
(iii) In cases where a grantee has previously diverted funds
received from a grantor foundation, and the grantor foundation
determines that any part of a grant has again been used for improper
purposes, the foundation will not be treated as having made a taxable
expenditure solely by reason of such diversion so long as the
foundation:
[[Page 180]]
(a) Is taking all reasonable and appropriate steps to recover the
grant funds or to insure the restoration of the funds and the dedication
(consistent with the requirements of (b) (2) and (3) of this
subdivision) of other grant funds held by the grantee to the purposes
being financed by the grant, and
(b) Withholds further payments until:
(1) Such funds are in fact so recovered or restored,
(2) It has received the grantee's assurances that future diversions
will not occur, and
(3) It requires the grantee to take extraordinary precautions to
prevent future diversions from occurring.
If a foundation is treated as having made a taxable expenditure under
this subparagraph in a case to which this subdivision applies, then
unless the foundation meets the requirements of (a) of this subdivision,
the amount of the taxable expenditure shall be the amount of the
diversion plus the amount of any further payments to the same grantee.
However, if the foundation complies with the requirements of (a) of this
subdivision, but fails to withhold further payments until the
requirements of (b) of this subdivision are met, the amount of the
taxable expenditure shall be the amount of such further payments.
(iv) The phrase ``all reasonable and appropriate steps'' in
subdivisions (ii) and (iii) of this subparagraph includes legal action
where appropriate but need not include legal action if such action would
in all probability not result in the satisfaction of execution on a
judgment.
(5) Supervision of certain scholarship and fellowship grants.
Subparagraphs (2) and (4) of this paragraph shall be considered
satisfied with respect to scholarship or fellowship grants under the
following circumstances:
(i) The scholarship or fellowship grants are described in section
4945(g) (1);
(ii) The grantor foundation pays the scholarship or fellowship
grants to an educational institution described in section 151(e) (4);
and
(iii) Such educational institution agrees to use the grant funds to
defray the recipient's expenses or to pay the funds (or a portion
thereof) to the recipient only if the recipient is enrolled at such
educational institution and his standing at such educational institution
is consistent with the purposes and conditions of the grant.
(6) Retention of records. A private foundation shall retain records
pertaining to all grants to individuals for purposes described in
section 4945(d) (3). Such records shall include:
(i) All information the foundation secures to evaluate the
qualification of potential grantees;
(ii) Identification of grantees (including any relationship of any
grantee to the foundation sufficient to make such grantee a disqualified
person of the private foundation within the meaning of section 4946(a)
(1));
(iii) Specification of the amount and purpose of each grant; and
(iv) The follow-up information which the foundation obtains in
complying with subparagraphs (2), (3), and (4) of this paragraph.
(7) Example. The provisions of paragraphs (b) and (c) of this
section may be illustrated by the following example:
Example. The X foundation grants 10 scholarships each year to
graduates of high schools in its area to permit the recipients to attend
college. It makes the availability of its scholarships known by oral or
written communications each year to the principals of three major high
schools in the area. The foundation obtains information from each high
school on the academic qualifications, background, and financial need of
applicants. It requires that each applicant be recommended by two of his
teachers or by the principal of his high school. All application forms
are reviewed by the foundation officer responsible for making the awards
and scholarships are granted on the basis of the academic qualifications
and financial need of the grantees. The foundation obtains annual
reports on the academic performance of the scholarship recipient from
the college or university which he attends. It maintains a file on each
scholarship awarded, including the original application,
recommendations, a record of the action taken on the application, and
the reports on the recipient from the institution which he attends. The
described procedures of the X foundation for the making of grants to
individuals qualify for Internal Revenue Service approval under
[[Page 181]]
section 4945(g). Furthermore, if the X foundation's scholarship program
meets the requirements of subparagraph (5) of this paragraph, X
foundation will not have to obtain reports on the academic performance
of the scholarship recipients.
(d) Submission of grant procedure--(1) Contents of request for
approval of grant procedures. A request for advance approval of a
foundation's grant procedures must fully describe the foundation's
procedures for awarding grants and for ascertaining that such grants are
used for the proper purposes. The approval procedure does not
contemplate specific approval of particular grant programs but instead
one-time approval of a system of standards, procedures, and follow-up
designed to result in grants which meet the requirements of section
4945(g). Thus, such approval shall apply to a subsequent grant program
as long as the procedures under which it is conducted do not differ
materially from those described in the request to the Commissioner. The
request must contain the following items:
(i) A statement describing the selection process. Such statement
shall be sufficiently detailed for the Commissioner to determine whether
the grants are made on an objective and nondiscriminatory basis under
paragraph (b) of this section.
(ii) A description of the terms and conditions under which the
foundation ordinarily makes such grants, which is sufficient to enable
the Commissioner to determine whether the grants awarded under such
procedures would meet the requirements of paragraph (1), (2), or (3) of
section 4945(g).
(iii) A detailed description of the private foundation's procedure
for exercising supervision over grants, as described in paragraph (c)
(2) and (3) of this section.
(iv) A description of the foundation's procedures for review of
grantee reports, for investigation where diversion of grant funds from
their proper purposes is indicated, and for recovery of diverted grant
funds, as described in paragraph (c) (4) of this section.
(2) Place of submission. Request for approval of grant procedures
shall be submitted to the District Director.
(3) Internal Revenue Service action on request for approval of grant
procedures. The 45th day after a request for approval of grant
procedures has been properly submitted to the Internal Revenue Service,
the organization has not been notified that such procedures are not
acceptable, such procedures shall be considered as approved from the
date of submission until receipt of actual notice from the Internal
Revenue Service that such procedures do not meet the requirements of
this section. If a grant to an individual for a purpose described in
section 4945(d) (3) is made after notification to the organization by
the Internal Revenue Service that the procedures under which the grant
is made are not acceptable, such grant is a taxable expenditure under
this section.
(e) Effective dates--(1) In general. This section shall apply to all
grants to individuals for travel, study, or other similar purposes which
are made by private foundations more than 90 days after October 30,
1972.
(2) Transitional rules--(i) Grants committed prior to January 1,
1970. Section 4945(d) (3) and (g) and this section shall not apply to a
grant for section 170(c) (2) (B) purposes made on or after January 1,
1970, if the grant was made pursuant to a commitment entered into prior
to such date, but only if such commitment was made in accordance with
the foundation's usual practices and is reasonable in amount in light of
the purposes of the grant. For purposes of this subdivision, a
commitment will be considered entered into prior to January 1, 1970, if
prior to such date, the amount and nature of the payments to be made and
the name of the payee were entered on the records of the payor, or were
otherwise adequately evidenced, or the notice of the payment to be
received was communicated to the payee in writing.
(ii) Grants awarded on or after January 1, 1970. In the case of a
grant awarded on or after January 1, 1970, but prior to the expiration
of 90 days after October 30, 1972, and paid within 48 months after the
award of such grant, the requirements of section 4945(g) that an
individual grant be awarded on an objective and nondiscriminatory basis
pursuant to a procedure approved in
[[Page 182]]
advance by the Commissioner will be deemed satisfied if the grantor
utilizes any procedure in good faith in awarding a grant to an
individual which, in fact, is reasonably calculated to provide
objectivity and nondiscrimination in the awarding of such grant and to
result in a grant which complies with the conditions of section 4945(g)
(1), (2), or (3).
Sec. 53.4945-5 Grants to organizations.
(a) Grants to nonpublic organizations--(1) In general. Under section
4945(d)(4) the term ``taxable expenditure'' includes any amount paid or
incurred by a private foundation as a grant to an organization (other
than an organization described in section 509(a) (1), (2) or (3)),
unless the private foundation exercises expenditure responsibility with
respect to such grant in accordance with section 4945(h). However, the
granting foundation does not have to exercise expenditure responsibility
with respect to amounts granted to organizations described in section
4945(f).
(2) ``Grants'' described. For a description of the term ``grants'',
see Sec. 53.4945-4(a)(2).
(3) Section 509(a) (1), (2), and (3) organizations. See section
508(b) and the regulations thereunder for rules relating to when a
grantor may rely on a potential grantee's characterization of its status
as set forth in the notice described in section 508(b).
(4) Certain ``public'' organizations. For purposes of this section,
an organization will be treated as a section 509(a)(1) organization if:
(i) It qualifies as such under paragraph (a) of Sec. 1.509(a)-2 of
this chapter;
(ii) It is an organization described in section 170(c)(1) or
511(a)(2)(B), even if it is not described in section 501(c)(3); or
(iii) It is a foreign government, or any agency or instrumentality
thereof, or an international organization designated as such by
Executive order under 22 U.S.C. 288, even if it is not described in
section 501(c)(3).
However, any grant to an organization referred to in this subparagraph
must be made exclusively for charitable purposes as described in section
170(c)(2)(B).
(5) Certain foreign organizations. If a private foundation makes a
grant to a foreign organization which does not have a ruling or
determination letter that it is an organization described in section
509(a)(1), (2), or (3), such grant will not be treated as a grant made
to an organization other than an organization described in section
509(a)(1), (2), or (3) if the grantor private foundation has made a good
faith determination that the grantee organization is an organization
described in section 509(a)(1), (2), or (3). Such a ``good faith
determination'' ordinarily will be considered as made where the
determination is based on an affidavit of the grantee organization or an
opinion of counsel (of the grantor or the grantee) that the grantee is
an organization described in section 509(a)(1), (2), or (3). Such an
affidavit or opinion must set forth sufficient facts concerning the
operations and support of the grantee for the Internal Revenue Service
to determine that the grantee would be likely to qualify as an
organization described in section 509(a) (1), (2), or (3). See
paragraphs (b)(5) and (b)(6) of this section for other special rules
relating to foreign organizations.
(6) Certain earmarked grants--(i) In general. A grant by a private
foundation to a grantee organization which the grantee organization uses
to make payments to another organization (the secondary grantee) shall
not be regarded as a grant by the private foundation to the secondary
grantee if the foundation does not earmark the use of the grant for any
named secondary grantee and there does not exist an agreement, oral or
written, whereby such grantor foundation may cause the selection of the
secondary grantee by the organization to which it has given the grant.
For purposes of this subdivision, a grant described herein shall not be
regarded as a grant by the foundation to the secondary grantee even
though such foundation has reason to believe that certain organizations
would derive benefits from such grant so long as the original grantee
organization exercises control, in fact, over the selection process and
actually makes the selection completely independently of the private
foundation.
[[Page 183]]
(ii) To governmental agencies. If a private foundation makes a grant
to an organization described in section 170(c)(1) and such grant is
earmarked for use by another organization, the granting foundation need
not exercise expenditure responsibility with respect to such grant if
the section 170(c)(1) organization satisfies the Commissioner in advance
that:
(a) Its grant-making program is in furtherance of a purpose
described in section 170(c)(2)(B), and
(b) The section 170(c)(1) organization exercises ``expenditure
responsibility'' in a manner that would satisfy this section if it
applied to such section 170(c)(1) organization.
However, with respect to such grant, the granting foundation must make
the reports required by section 4945(h)(3) and paragraph (d) of this
section, unless such grant is earmarked for use by an organization
described in section 509(a) (1), (2), or (3).
(b) Expenditure responsibility--(1) In general. A private foundation
is not an insurer of the activity of the organization to which it makes
a grant. Thus, satisfaction of the requirements of sections 4945(d)(4)
and (h) and of subparagraph (3) or (4) of this paragraph, will
ordinarily mean that the grantor foundation will not have violated
section 4945(d) (1) or (2). A private foundation will be considered to
be exercising ``expenditure responsibility'' under section 4945(h) as
long as it exerts all reasonable efforts and establishes adequate
procedures:
(i) To see that the grant is spent solely for the purpose for which
made,
(ii) To obtain full and complete reports from the grantee on how the
funds are spent, and
(iii) To make full and detailed reports with respect to such
expenditures to the Commissioner.
In cases in which pursuant to paragraph (a)(6) of this section a grant
is considered made to a secondary grantee rather than the primary
grantee, the grantor foundation's obligation to obtain reports from the
grantee pursuant to section 4945(h)(2) and this section will be
satisfied if appropriate reports are obtained from the secondary
grantee. For rules relating to expenditure responsibility with respect
to transfers of assets described in section 507(b)(2), see section
507(b)(2) and the regulations thereunder.
(2) Pre-grant inquiry--(i) Before making a grant to an organization
with respect to which expenditure responsibility must be exercised under
this section, a private foundation should conduct a limited inquiry
concerning the potential grantee. Such inquiry should be complete enough
to give a reasonable man assurance that the grantee will use the grant
for the proper purposes. The inquiry should concern itself with matters
such as: (a) The identity, prior history and experience (if any) of the
grantee organization and its managers; and (b) any knowledge which the
private foundation has (based on prior experience or otherwise) of, or
other information which is readily available concerning, the management,
activities, and practices of the grantee organization. The scope of the
inquiry might be expected to vary from case to case depending upon the
size and purpose of the grant, the period over which it is to be paid,
and the prior experience which the grantor has had with respect to the
capacity of the grantee to use the grant for the proper purposes. For
example, if the grantee has made proper use of all prior grants to it by
the grantor and filed the required reports substantiating such use, no
further pregrant inquiry will ordinarily be necessary. Similarly, in the
case of an organization, such as a trust described in section
4947(a)(2), which is required by the terms of its governing instrument
to make payments to a specified organization exempt from taxation under
section 501(a), a less extensive pregrant inquiry is required than in
the case of a private foundation possessing discretion with respect to
the distribution of funds.
(ii) The provisions of this subparagraph may be illustrated by the
following examples:
Example 1. Officials of M, a newly established organization which is
described in section 501(c)(4), request a grant from X foundation to be
used for a proposed program to combat drug abuse by establishing
neighborhood clinics in certain ghetto areas of a city. Before making a
grant to M, X makes an inquiry concerning the identity, prior history
and experience of the officials of M. X obtains information pertaining
to the officials
[[Page 184]]
of M from references supplied by these officials. Since one of the
references indicated that A, an official of M, has an arrest record,
police records are also checked and A's probation officer is
interviewed.
The inquiry also shows M has no previous history of administering
grants and that the officials of M have had no experience in
administering programs of this nature. However, in the opinion of X's
managers, M's officials (including A who appears to be fully
rehabilitated after having been convicted of a narcotics violation
several years ago) are well qualified to conduct this program since they
are members of the communities in which the clinics are to be
established and are more likely to be trusted by drug users in these
communities than are outsiders. Under these circumstances X has complied
with the requirements of this subparagraph and a grant to M for its
proposed program will not be treated as a taxable expenditure solely
because of the operation of this subparagraph.
Example 2. Foundation Y wishes to make a grant to foundation R for
use in R's scholarship program. Y has made similar grants to R annually
for the last several years and knows that R's managers have observed the
terms of the previous grants and have made all requested reports with
respect to such grants. No changes in R's management have occurred
during the past several years. Under these circumstances, Y has enough
information to have such assurance as a reasonable man would require
that the grant to R will be used for proper purposes. Consequently, Y is
under no obligation to make any further pregrant inquiry pursuant to
this subparagraph.
Example 3. S foundation requests a grant from Z foundation for use
in S's program of providing medical research fellowships. S has been
engaged in this program for several years and has received large numbers
of grants from other foundations. Z's managers know that the reputations
of S and of S's officials are good. Z's managers also have been advised
by managers of W foundation that W had recently made a grant to S and
that W's managers were satisfied that such grant has been used for the
purposes for which it was made. Under these circumstances Z has enough
information to have such assurance as a reasonable man would require
that the grant to S will be used for proper purposes. Consequently, Z is
under no obligation to make any further pregrant inquiry pursuant to
this subparagraph.
(3) Terms of grants. Except as provided in subparagraph (4) of this
paragraph, in order to meet the expenditure responsibility requirements
of section 4945(h), a private foundation must require that each grant to
an organization, with respect to which expenditure responsibility must
be exercised under this section, be made subject to a written commitment
signed by an appropriate officer, director, or trustee of the grantee
organization. Such commitment must include an agreement by the grantee:
(i) To repay any portion of the amount granted which is not used for
the purposes of the grant,
(ii) To submit full and complete annual reports on the manner in
which the funds are spent and the progress made in accomplishing the
purposes of the grant, except as provided in paragraph (c)(2) of this
section,
(iii) To maintain records of receipts and expenditures and to make
its books and records available to the grantor at reasonable times, and
(iv) Not to use any of the funds:
(a) To carry on propaganda, or otherwise to attempt, to influence
legislation (within the meaning of section 4945(d)(1)),
(b) To influence the outcome of any specific public election, or to
carry on, directly or indirectly, any voter registration drive (within
the meaning of section 4945(d)(2)),
(c) To make any grant which does not comply with the requirements of
section 4945(d) (3) or (4), or
(d) To undertake any activity for any purpose other than one
specified in section 170(c)(2)(B).
The agreement must also clearly specify the purposes of the grant. Such
purposes may include contributing for capital endowment, for the
purchase of capital equipment, or for general support provided that
neither the grants nor the income therefrom may be used for purposes
other than those described in section 170(c)(2)(B).
(4) Terms of program-related investments. In order to meet the
expenditure responsibility requirements of section 4945(h), with regard
to the making of a program-related investment (as defined in section
4944 and the regulations thereunder), a private foundation must require
that each such investment with respect to which expenditure
responsibility must be exercised under section 4945(d)(4) and (h) and
this section be made subject to a written commitment
[[Page 185]]
signed by an appropriate officer, director, or trustee of the recipient
organization. Such commitment must specify the purpose of the investment
and must include an agreement by the organization:
(i) To use all the funds received from the private foundation (as
determined under paragraph (c)(3) of this section) only for the purposes
of the investment and to repay any portion not used for such purposes,
provided that, with respect to equity investments, such repayment shall
be made only to the extent permitted by applicable law concerning
distributions to holders of equity interests,
(ii) At least once a year during the existence of the program-
related investment, to submit full and complete financial reports of the
type ordinarily required by commercial investors under similar
circumstances and a statement that it has complied with the terms of the
investment,
(iii) To maintain books and records adequate to provide information
ordinarily required by commercial investors under similar circumstances
and to make such books and records available to the private foundation
at reasonable times, and
(iv) Not to use any of the funds:
(a) To carry on propaganda, or otherwise to attempt, to influence
legislation (within the meaning of section 4945(d)(1)),
(b) To influence the outcome of any specific public election, or to
carry on directly or indirectly, and voter registration drive (within
the meaning of section 4945(d)(2)), or
(c) With respect to any recipient which is a private foundation (as
defined in section 509(a)), to make any grant which does not comply with
the requirements of section 4945 (d) (3) or (4).
(5) Certain grants to foreign organizations. With respect to a grant
to a foreign organization (other than an organization described in
section 509(a) (1), (2), or (3) or treated as so described pursuant to
paragraph (a)(4) or (a)(5) of this section), subparagraph (3)(iv) or
(4)(iv) of this paragraph shall be deemed satisfied if the agreement
referred to in subparagraph (3) or (4) of this paragraph imposes
restrictions on the use of the grant substantially equivalent to the
limitations imposed on a domestic private foundation under section
4945(d). Such restrictions may be phrased in appropriate terms under
foreign law or custom and ordinarily will be considered sufficient if an
affidavit or opinion of counsel (of the grantor or grantee) is obtained
stating that, under foreign law or custom, the agreement imposes
restrictions on the use of the grant substantially equivalent to the
restrictions imposed on a domestic private foundation under subparagraph
(3) or (4) of this paragraph.
(6) Special rules for grants by foreign private foundations. With
respect to activities in jurisdictions other than those described in
section 170(c)(2)(A), the failure of a foreign private foundation which
is described in section 4948(b) to comply with subparagraph (3) or (4)
of this paragraph with respect to a grant to an organization shall not
constitute an act or failure to act which is a prohibited transaction
(within the meaning of section 4948(c)(2)).
(7) Expenditure responsibility with respect to certain transfers of
assets described in section 507--(i) Transfers of assets described in
section 507(b)(2). For rules relating to the extent to which the
expenditure responsibility rules contained in section 4945 (d)(4) and
(h) and this section apply to transfers of assets described in section
507(b)(2), see Sec. Sec. 1.507-3(a)(7), 1.507-3 (a)(8)(ii)(f), and
1.507-3(a)(9) of this chapter.
(ii) Certain other transfers of assets. For rules relating to the
extent to which the expenditure responsibility rules contained in
section 4945 (d)(4) and (h) and this section apply to certain other
transfers of assets described in Sec. 1.507-3(b) of this chapter, see
Sec. 1.507-3(b) of this chapter.
(8) Restrictions on grants (other than program-related investments)
to organizations not described in section 501(c)(3). For other
restrictions on certain grants (other than program-related investments)
to organizations which are not described in section 501(c)(3), see Sec.
53.4945-6(c).
(c) Reports from grantees--(1) In general. In the case of grants
described in section 4945(d)(4), except as provided in subparagraph (2)
of this paragraph, the
[[Page 186]]
granting private foundation shall require reports on the use of the
funds, compliance with the terms of the grant, and the progress made by
the grantee toward achieving the purposes for which the grant was made.
The grantee shall make such reports as of the end of its annual
accounting period within which the grant or any portion thereof is
received and all such subsequent periods until the grant funds are
expended in full or the period of the grantee for which such reports
shall be furnished to the grantor within a reasonable period of time
after the close of the annual accounting period of the grantee for which
such reports are made. Within a reasonable period of time after the
close of its annual accounting period during which the use of the grant
funds is completed, the grantee must make a final report with respect to
all expenditures made from such funds (including salaries, travel, and
supplies), and indicating the progress made toward the goals of the
grant. The grantor need not conduct any independent verification of such
reports unless it has reason to doubt their accuracy or reliability.
(2) Capital endowment grants to exempt private foundations. If a
private foundation makes a grant described in section 4945(d)(4) to a
private foundation which is exempt from taxation under section 501(a)
for endowment, for the purchase of capital equipment, or for other
capital purposes, the grantor foundation shall require reports from the
grantee on the use of the principal and the income (if any) from the
grant funds. The grantee shall make such reports annually for its
taxable year in which the grant was made and the immediately succeeding
2 taxable years. Only if it is reasonably apparent to the grantor that,
before the end of such second succeeding taxable year, neither the
principal, the income from the grant funds, nor the equipment purchased
with the grant funds has been used for any purpose which would result in
liability for tax under section 4945(d), the grantor may then allow such
reports to be discontinued.
(3) Grantees' accounting and recordkeeping procedures. (i) A private
foundation grantee exempt from taxation under section 501(a) (or the
recipient of a program-related investment) need not segregate grant
funds physically nor separately account for such funds on its books
unless the grantor requires such treatment of the grant funds. If such a
grantee neither physically segregates grant funds nor establishes
separate accounts on its books, grants received within a given taxable
year beginning after December 31, 1969, shall be deemed, for purposes of
section 4945, to be expended before grants received in a succeeding
taxable year. In such case expenditures of grants received within any
such taxable year shall be prorated among all such grants.
In accounting for grant expenditures, private foundations may make the
necessary computations on a cumulative annual basis (or, where
appropriate, as of the date for which the computations are made). The
rules set forth in the preceding three sentences shall apply to the
extent they are consistent with the available records of the grantee and
with the grantee's treatment of qualifying distributions under section
4942(h) and the regulations thereunder. The records of expenditures, as
well as copies of the reports submitted to the grantor, must be kept for
at least 4 years after completion of the use of the grant funds.
(ii) For rules relating to accounting and recordkeeping requirements
for grantees other than those described in subdivision (i) of this
subparagraph, see Sec. Sec. 53.4945-5(b)(8) and 53.4945-6(c).
(4) Reliance on information supplied by grantee. A private
foundation exercising expenditure responsibility with respect to its
grants may rely on adequate records or other sufficient evidence
supplied by the grantee organization (such as a statement by an
appropriate officer, director or trustee of such grantee organization)
showing, to the extent applicable, the information which the grantor
must report to the Internal Revenue Service in accordance with paragraph
(d)(2) of this section.
(d) Reporting to Internal Revenue Service by grantor--(1) In
general. To satisfy the reportmaking requirements of section 4945(h)(3),
a granting foundation must provide the required information
[[Page 187]]
on its annual information return, required to be filed by section 6033,
for each taxable year with respect to each grant made during the taxable
year which is subject to the expenditure responsibility requirements of
section 4945(h). Such information must also be provided on such return
with respect to each grant subject to such requirements upon which any
amount or any report is outstanding at any time during the taxable year.
However, with respect to any grant made for endowment or other capital
purposes, the grantor must provide the required information only for any
taxable year for which the grantor must require a report from the
grantee under paragraph (c)(2) of this section. The requirements of this
subparagraph with respect to any grant may be satisfied by submission
with the foundation's information return of a report received from the
grantee, if the information required by subparagraph (2) of this
paragraph is contained in such report.
(2) Contents of report. The report required by this paragraph shall
include the following information:
(i) The name and address of the grantee.
(ii) The date and amount of the grant.
(iii) The purpose of the grant.
(iv) The amounts expended by the grantee (based upon the most recent
report received from the grantee).
(v) Whether the grantee has diverted any portion of the funds (or
the income therefrom in the case of an endowment grant) from the purpose
of the grant (to the knowledge of the grantor).
(vi) The dates of any reports received from the grantee.
(vii) The date and results of any verification of the grantee's
reports undertaken pursuant to and to the extent required under
paragraph (c)(1) of this section by the grantor or by others at the
direction of the grantor.
(3) Recordkeeping requirements. In addition to the information
included on the information return, a granting foundation shall make
available to the Internal Revenue Service at the foundation's principal
office each of the following items:
(i) A copy of the agreement covering each ``expenditure
responsibility'' grant made during the taxable year.
(ii) A copy of each report received during the taxable year from
each grantee on any ``expenditure responsibility'' grant, and
(iii) A copy of each report made by the grantor's personnel or
independent auditors of any audits or other investigations made during
the taxable year with respect to any ``expenditure responsibility''
grant.
(4) Reports received after the close of grantor's accounting year.
Data contained in reports required by this paragraph, which reports are
received by a private foundation after the close of its accounting year
but before the due date of its information return for that year, need
not be reported on such return, but may be reported on the grantor's
information return for the year in which such reports are received from
the grantee.
(e) Violations of expenditure responsibility requirements--(1)
Diversions by grantee. (i) Any diversion of grant funds (including the
income therefrom in the case of an endowment grant) by the grantee to
any use not in furtherance of a purpose specified in the grant may
result in the diverted portion of such grant being treated as a taxable
expenditure of the grantor under section 4945(d)(4). However, for
purposes of this section, the fact that a grantee does not use any
portion of the grant funds as indicated in the original budget
projection shall not be treated as a diversion if the use to which the
funds are committed is consistent with the purpose of the grant as
stated in the grant agreement and does not result in a violation of the
terms of such agreement required to be included by paragraph (b)(3) or
(b)(4) of this section.
(ii) In any event, a grantor will not be treated as having made a
taxable expenditure under section 4945(d)(4) solely by reason of a
diversion by the grantee, if the grantor has complied with subdivision
(iii) (a) and (b) or (iv) (a) and (b) of this subparagraph, whichever is
applicable.
(iii) In cases in which the grantor foundation determines that any
part of
[[Page 188]]
a grant has been used for improper purposes and the grantee has not
previously diverted grant funds, the foundation will not be treated as
having made a taxable expenditure solely by reason of the diversion so
long as the foundation:
(a) Is taking all reasonable and appropriate steps either to recover
the grant funds or to insure the restoration of the diverted funds and
the dedication (consistent with the requirements of (b) (1) and (2) of
this subdivision) of the other grant funds held by the grantee to the
purposes being financed by the grant, and
(b) Withholds any further payments to the grantee after the grantor
becomes aware that a diversion may have taken place (hereinafter
referred to as ``further payments'') until it has:
(1) Received the grantee's assurances that future diversions will
not occur, and
(2) Required the grantee to take extraordinary precautions to
prevent future diversions from occurring.
If a foundation is treated as having made a taxable expenditure under
this subparagraph in a case to which this subdivision applies, then
unless the foundation meets the requirements of (a) of this subdivision
the amount of the taxable expenditure shall be the amount of the
diversion (for example, the income diverted in the case of an endowment
grant, or the rental value of capital equipment for the period of time
for which diverted) plus the amount of any further payments to the same
grantee. However, if the foundation complies with the requirements of
(a) of this subdivision but not the requirements of (b) of this
subdivision, the amount of the taxable expenditure shall be the amount
of such further payments.
(iv) In cases where a grantee has previously diverted funds received
from a grantor foundation, and the grantor foundation determines that
any part of a grant has again been used for improper purposes, the
foundation will not be treated as having made a taxable expenditure
solely by reason of such diversion so long as the foundation:
(a) Is taking all reasonable and appropriate steps to recover the
grant funds or to insure the restoration of the diverted funds and the
dedication (consistent with the requirements of (b) (2) and (3) of this
subdivision) of other grant funds held by the grantee to the purposes
being financed by the grant, except that if, in fact, some or all of the
diverted funds are not so restored or recovered, then the foundation
must take all reasonable and appropriate steps to recover all of the
grant funds, and
(b) Withholds further payments until:
(1) Such funds are in fact so recovered or restored,
(2) It has received the grantee's assurances that future diversions
will not occur, and
(3) It requires the grantee to take extraordinary precautions to
prevent future diversions from occurring.
If a foundation is treated as having made a taxable expenditure under
this subparagraph in a case to which this subdivision applies, then
unless the foundation meets the requirements of (a) of this subdivision,
the amount of the taxable expenditure shall be the amount of the
diversion plus the amount of any further payments to the same grantee.
However, if the foundation complies with the requirements of (a) of this
subdivision, but fails to withhold further payments until the
requirements of (b) of this subdivision are met, the amount of the
taxable expenditure shall be the amount of such further payments.
(v) The phrase ``all reasonable and appropriate steps'' (as used in
subdivisions (iii) and (iv) of this subparagraph) includes legal action
where appropriate but need not include legal action if such action would
in all probability not result in the satisfaction of execution on a
judgment.
(2) Grantee's failure to make reports. A failure by the grantee to
make the reports required by paragraph (c) of this section (or the
making of inadequate reports) shall result in the grant's being treated
as a taxable expenditure by the grantor unless the grantor:
(i) Has made the grant in accordance with paragraph (b) of this
section,
(ii) Has complied with the reporting requirements contained in
paragraph (d) of this section,
[[Page 189]]
(iii) Makes a reasonable effort to obtain the required report, and
(iv) Withholds all future payments on this grant and on any other
grant to the same grantee until such report is furnished.
(3) Violations by the grantor. In addition to the situations
described in subparagraphs (1) and (2) of this paragraph, a grant which
is subject to the expenditure responsibility requirements of section
4945(h) will be considered a taxable expenditure of the granting
foundation if the grantor:
(i) Fails to make a pregrant inquiry as described in paragraph
(b)(2) of this section,
(ii) Fails to make the grant in accordance with a procedure
consistent with the requirements of paragraph (b) (3) or (4) of this
section, or
(iii) Fails to report to the Internal Revenue Service as provided in
paragraph (d) of this section.
(f) Effective dates--(1) In general. This section shall apply to all
grants which are subject to the expenditure responsibility requirements
of section 4945(d)(4) and (h) and which are made by private foundations
more than 90 days after October 30, 1972.
(2) Transitional rules--(i) Certain grants awarded prior to May 27,
1969. Section 4945(d)(4) and (h) and this section shall not apply to a
grant to a private foundation which is not controlled, directly or
indirectly, by the grantor foundation or one or more disqualified
persons (as defined in section 4946) with respect to the grantor
foundation, provided that such grant:
(a) Is made pursuant to a written commitment which was binding on
May 26, 1969, and at all times thereafter,
(b) Is made for one or more of the purposes described in section
170(c)(2)(B), and
(c) Is to be paid out to such grantee foundation on or before
December 31, 1974.
(ii) Grants or expenditures committed prior to January 1, 1970.
Except as provided in paragraph (e)(2)(i) of Sec. 53.4945-4, section
4945 shall not apply to a grant or an expenditure for section
170(c)(2)(B) purposes made on or after January 1, 1970, if the grant or
expenditure was made pursuant to a commitment entered into prior to such
date, but only if (in the case of a grant or an expenditure other than
an unlimited general-purpose grant to an organization) such commitment
is reasonable in amount in light of the purposes of the grant. For
purposes of this subdivision, a commitment will be considered entered
into prior to January 1, 1970, if prior to such date, the amount and
nature of the payments to be made and the name of the payee were entered
on the records of the payor, or were otherwise adequately evidenced, or
the notice of the payment to be received was communicated to the payee
in writing.
(iii) Grants awarded on or after January 1, 1970. Paragraphs (b),
(c), and (d) of this section shall not apply to grants awarded on or
after January 1, 1970, but prior to the expiration of 90 days after
October 30, 1972, if the grantor has made reasonable efforts, and has
established adequate procedures such as a prudent man would adopt in
managing his own property, to see that the grant is spent solely for the
purpose for which made, to obtain full and complete reports from the
grantee on how the funds are spent, and to make full and detailed
reports with respect to such grant to the Commissioner. With respect to
any return filed with the Internal Revenue Service before the expiration
of 90 days after October 30, 1972, the grantor may treat reports which
satisfy the requirements of the statement to be attached to Form 4720
for the year 1970 under ``Specific Instructions--Question B'' (items (1)
through (5)) as satisfying the grantor reporting requirements with
respect to ``expenditure responsibility'' grants. In the case of a
private foundation required to file an annual return for a taxable year
ending after January 1, 1970, and before December 31, 1970, the
reporting requirements imposed by section 4945(h)(3) for such period
shall be regarded as satisfied if such reports are made on the annual
return for its first taxable year beginning after December 31, 1969.
[T.D. 7215, 37 FR 23161, Oct. 31, 1972; 37 FR 23918, Nov. 10, 1972, as
amended by T.D. 7233, 37 FR 28162, Dec. 21, 1972; T.D. 7290, 38 FR
31834, Nov. 19, 1973]
[[Page 190]]
Sec. 53.4945-6 Expenditures for noncharitable purposes.
(a) In general. Under section 4945(d)(5) the term ``taxable
expenditure'' includes any amount paid or incurred by a private
foundation for any purpose other than one specified in section
170(c)(2)(B). Thus, ordinarily only an expenditure for an activity
which, if it were a substantial part of the organization's total
activities, would cause loss of tax exemption is a taxable expenditure
under section 4945(d)(5). For purposes of this section and Sec. Sec.
53.4945-1 through 53.4945-5, the term ``purposes described in section
170(c)(2)(B)'' shall be treated as including purposes described in
section 170(c)(2)(B) whether or not carried out by an organization
described in section 170(c).
(b) Particular expenditures. (1) The following types of expenditures
ordinarily will not be treated as taxable expenditures under section
4945(d)(5):
(i) Expenditures to acquire investments entered into for the purpose
of obtaining income or funds to be used in furtherance of purposes
described in section 170(c)(2)(B),
(ii) Reasonable expenses with respect to investments described in
subdivision (i) of this subparagraph,
(iii) Payment of taxes,
(iv) Any expenses which qualify as deductions in the computation of
unrelated business income tax under section 511,
(v) Any payment which constitutes a qualifying distribution under
section 4942(g) or an allowable deduction under section 4940,
(vi) Reasonable expenditures to evaluate, acquire, modify, and
dispose of program-related investments, or
(vii) Business expenditures by the recipient of a program-related
investment.
(2) Conversely, any expenditures for unreasonable administrative
expenses, including compensation, consultant fees, and other fees for
services rendered, will ordinarily be taxable expenditures under section
4945(d)(5) unless the foundation can demonstrate that such expenses were
paid or incurred in the good faith belief that they were reasonable and
that the payment or incurrence of such expenses in such amounts was
consistent with ordinary business care and prudence. The determination
whether an expenditure is unreasonable shall depend upon the facts and
circumstances of the particular case.
(c) Grants to ``noncharitable'' organizations--(1) In general. Since
a private foundation cannot make an expenditure for a purpose other than
a purpose described in section 170(c)(2)(B), a private foundation may
not make a grant to an organization other than an organization described
in section 501(c)(3) unless
(i) The making of the grant itself constitutes a direct charitable
act or the making of a program-related investment, or
(ii) Through compliance with the requirements of subparagraph (2) of
this paragraph, the grantor is reasonably assured that the grant will be
used exclusively for purposes described in section 170(c)(2)(B).
For purposes of this paragraph, an organization treated as a section
509(a)(1) organization under Sec. 53.4945-5(a)(4) shall be treated as
an organization described in section 501(c)(3).
(2) Grants other than transfers of assets described in Sec. 1.507-
3(c)(1). (i) If a private foundation makes a grant which is not a
transfer of assets pursuant to any liquidation, merger, redemption,
recapitalization, or other adjustment, organization or reorganization to
any organization (other than an organization described in section
501(c)(3) except an organization described in section 509(a)(4)), the
grantor is reasonably assured (within the meaning of subparagraph
(1)(ii) of this paragraph) that the grant will be used exclusively for
purposes described in section 170(c)(2)(B) only if the grantee
organization agrees to maintain and, during the period in which any
portion of such grant funds remain unexpended, does continuously
maintain the grant funds (or other assets transferred) in a separate
fund dedicated to one or more purposes described in section
170(c)(2)(B). The grantor of a grant described in this paragraph must
also comply with the expenditure responsibility provisions contained in
sections 4945(d) and (h) and Sec. 53.4945-5.
(ii) For purposes of this paragraph, a foreign organization which
does not
[[Page 191]]
have a ruling or determination letter that it is an organization
described in section 501(c)(3) (other than section 509(a)(4)) will be
treated as an organization described in section 501(c)(3) (other than
section 509(a)(4)) if in the reasonable judgment of a foundation manager
of the transferor private foundation, the grantee organization is an
organization described in section 501(c)(3) (other than section
509(a)(4)). The term ``reasonable judgment'' shall be given its
generally accepted legal sense within the outlines developed by judicial
decisions in the law of trusts.
(3) Transfers of assets described in Sec. 1.507-3(c)(1). If a
private foundation makes a transfer of assets (other than a transfer
described in subparagraph (1)(i) of this paragraph) pursuant to any
liquidation, merger, redemption, recapitalization, or other adjustment,
organization, or reorganization to any person, the transferred assets
will not be considered used exclusively for purposes described in
section 170(c)(2)(B) unless the assets are transferred to a fund or
organization described in section 501(c)(3) (other than an organization
described in section 509(a)(4)) or treated as so described under section
4947(a)(1).
[T.D. 7215, 37 FR 23161, Oct. 31, 1972, as amended by T.D. 7233, 37 FR
28162, Dec. 21, 1972]
Subpart G_Definitions and Special Rules
Sec. 53.4946-1 Definitions and special rules.
(a) Disqualified person. (1) For purposes of Chapter 42 and the
regulations thereunder, the following are disqualified persons with
respect to a private foundation:
(i) All substantial contributors to the foundation, as defined in
section 507 (d)(2) and the regulations thereunder.
(ii) All foundation managers of the foundation as defined in section
4946 (b)(1) and paragraph (f)(1)(i) of this section,
(iii) An owner of more than 20 percent of:
(a) The total combined voting power of a corporation,
(b) The profits interest of a partnership,
(c) The beneficial interest of a trust or unincorporated enterprise.
which is (during such ownership) a substantial contributor to the
foundation, as defined in section 507(d)(2) and the regulations
thereunder,
(iv) A member of the family, as defined in section 4946(d) and
paragraph (h) of this section, of any of the individuals described in
subdivision (i), (ii), or (iii) of this subparagraph,
(v) A corporation of which more than 35 percent of the total
combined voting power is owned by persons described in subdivision (i),
(ii), (iii), or (iv) of this subparagraph,
(vi) A partnership of which more than 35 percent of the profits
interest is owned by persons described in subdivision (i), (ii), (iii),
or (iv) of this subparagraph, and
(vii) A trust, estate, or unincorporated enterprise of which more
than 35 percent of the beneficial interest is owned by persons described
in subdivision (i), (ii), (iii), or (iv) of this subparagraph.
(2) For purposes of subparagraphs (1)(iii) (b) and (vi) of this
paragraph, the profits interest of a partner shall be equal to his
distributive share of income of the partnership, as determined under
section 707(b)(3) and the regulations thereunder as modified by section
4946(a)(4).
(3) For purposes of subparagraph (1) (iii)(c) and (vii) of this
paragraph, the beneficial interest in an unincorporated enterprise
(other than a trust or estate) includes any right to receive a portion
of distributions from profits of such enterprise, and, if the portion of
distributions is not fixed by an agreement among the participants, any
right to receive a portion of the assets (if any) upon liquidation of
the enterprise, except as a creditor or employee. For purposes of this
subparagraph, a right to receive distributions of profits includes a
right to receive any amount from such profits other than as a creditor
or employee, whether as a sum certain or as a portion of profits
realized by the enterprise. Where there is no agreement fixing the
rights of the participants in such enterprise, the fraction of the
respective interests of each participant in such enterprise shall be
determined by dividing the amount of
[[Page 192]]
all investments or contributions to the capital of the enterprise made
or obligated to be made by such participant by the amount of all
investments or contributions to capital made or obligated to be made by
all of them.
(4) For purposes of subparagraph (1) (iii) (c) and (vii) of this
paragraph, a person's beneficial interest in a trust shall be determined
in proportion to the actuarial interest of such person in the trust.
(5) For purposes of subparagraph (1) (iii) (a) and (v) of this
paragraph, the term ``combined voting power'' includes voting power
represented by holdings of voting stock, actual or constructive (under
section 4946(a)(3)), but does not include voting rights held only as a
director or trustee.
(6) For purposes of subparagraph (1) (iii) (a) and (v) of this
paragraph, the term ``voting power'' includes outstanding voting power
and does not include voting power obtainable but not obtained, such as,
for example, voting power obtainable by converting securities or
nonvoting stock into voting stock or by exercising warrants or options
to obtain voting stock, and voting power which will vest in preferred
stockholders only if and when the corporation has failed to pay
preferred dividends for a specified period of time or has otherwise
failed to meet specified requirements. Similarly, for purposes of
subparagraph (1)(iii) (b) and (c), (vi), and (vii) of this paragraph,
the terms ``profits interest'' and ``beneficial interest'' include any
such interest that is outstanding, but do not include any such interest
that is obtainable but has not been obtained.
(7) For purposes of sections 170(b) (1)(E)(iii), 507(d)(1), 508(d),
509(a) (1) and (3), and Chapter 42, the term ``disqualified person''
shall not include an organization which is described in section 509(a)
(1), (2), or (3), or any other organization which is wholly owned by
such section 509(a) (1), (2), or (3) organization.
(8) For purposes of section 4941 only, the term ``disqualified
person'' shall not include any organization which is described in
section 501(c)(3) (other than an organization described in section
509(a)(4)).
(b) Section 4943. (1) For purposes of section 4943 only, the term
``disqualified person'' includes a private foundation:
(i) Which is effectively controlled (within the meaning of Sec.
1.482-1(a)(3) of this chapter), directly or indirectly, by the same
person or persons (other than a bank, trust company, or similar
organization acting only as a foundation manager) who control the
private foundation in question, or
(ii) Substantially all the contributions to which were made,
directly or indirectly, by persons described in subdivision (i), (ii),
(iii), or (iv) of paragraph (a)(1) of this section who made, directly or
indirectly, substantially all of the contributions to the private
foundation in question.
(2) For purposes of subparagraph (1)(ii) of this paragraph, one or
more persons will be considered to have made substantially all of the
contributions to a private foundation, if such persons have contributed
or bequeathed at least 85 percent (and each such person has contributed
or bequeathed at least 2 percent) of the total contributions and
bequests (within the meaning of section 507(d)(2) and the regulations
thereunder) which have been received by such private foundation during
its entire existence.
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. A, a private foundation, has a board of directors made up
of X, Y, Z, M, N, and O. Foundation B's board of directors is made up of
Y, M, N, and O. The board of directors in each case has plenary power to
determine the manner in which the foundation is operated. For purposes
of section 4943, foundation A is a disqualified person with respect to
foundation B, and foundation B, is a disqualified person with respect to
foundation A.
Example 2. Private foundation A has received contributions of
$100,000 throughout its existence: $35,000 from X, $51,000 from Y (who
is X's father), and $14,000 from Z (an unrelated person). Private
foundation B has received $100,000 in contributions during its
existence: $50,000 from X and $50,000 from W, X's wife.
For purposes of section 4943, private foundation A is a disqualified
person with respect to private foundation B, and private foundation B is
a disqualified person with respect to private foundation A.
[[Page 193]]
(c) Section 4941. For purposes of section 4941, a government
official, as defined in section 4946(c) and paragraph (g) of this
section, is a disqualified person.
(d) Attribution of stockholdings. (1) For purposes of paragraph
(a)(1)(iii) (a) and (v) of this section, indirect stockholdings shall be
taken into account under section 267(c) and the regulations thereunder.
However, for purposes of this paragraph:
(i) Section 267(c)(4) shall be treated as though it provided that
the members of the family of an individual are the members within the
meaning of section 4946(d) and paragraph (h) of this section; and
(ii) Any stockholdings which have been counted once (whether by
reason of actual or constructive ownership) in applying section
4946(a)(1)(E) shall not be counted a second time.
For purposes of paragraph (a)(1)(v) or this section, section 267(c)
shall be applied without regard to section 267(c)(3), and stock
constructively owned by an individual by reason of the application of
section 267(c)(2) shall not be treated as owned by him if he is
described in section 4946(a)(1)(D) but not also in section 4946(a)(1)
(A), (B), or (C).
(2) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. D is a substantial contributor to private foundation Y. D
owns 20 percent of the outstanding stock of corporation P. E, D's wife,
owns none of the outstanding stock of P. F, E's father, owns 10 percent
of the outstanding stock of P. E is treated under section 507(d)(2) as a
substantial contributor to Y. E is also treated under section 267(c)(2)
as owning both D's 20 percent and F's 10 percent of P, but E is treated
as owning nothing for purposes of section 4946(a)(1)(E) because D's 20
percent and F's 10 percent have already been taken into account once
(because of their actual ownership of the stock of P) for such purposes.
Hence, corporation P is not a disqualified person under section
4946(a)(1)(E) with respect to private foundation Y because persons
described in section 4946(a)(1) (A), (B), (C), and (D) own only 30
percent of the stock of P.
Example 2. I, a substantial contributor to private foundation X, is
the son of J. I owns 100 percent of the stock of corporation R, which in
turn owns 18 percent of the stock of corporation S. J owns 18 percent of
the stock of S. I constructively owns 36 percent of the stock of S (J's
18 percent plus R's 18 percent). Both J's actual holdings and R's actual
holdings are counted in determining I's constructive holdings because
this does not result in counting either of the holdings more than once
for purposes of section 4946 (a)(1)(E). Therefore, S is a disqualified
person with respect to private foundation X, since I, a substantial
contributor, constructively owns more than 35 percent of S's stock.
(e) Attribution of profits or beneficial interests. (1) For purposes
of paragraph (a) (1) (iii) (b), (iii) (c) (vi), and (vii) of this
section, ownership of profits or beneficial interests shall be taken
into account as though such ownership related to stockholdings, if such
stockholdings would be taken into account under section 267(c) and the
regulations thereunder, except that section 267(c)(3) shall not apply to
attribute the ownership of one partner to another solely by reason of
such partner relationship. However, for purposes of this paragraph:
(i) Section 267(c)(4) shall be treated as though it provided that
the members of the family of an individual are the members within the
meaning of section 4946(d) and paragraph (h) of this section; and
(ii) Any profits interest or beneficial interest which has been
counted once (whether by reason of actual or constructive ownership) in
applying section 4946(a)(1) (F) or (G) shall not be counted a second
time.
For purposes of paragraph (a)(1) (vi) and (vii) of this section, profits
or beneficial interests constructively owned by an individual by reason
of the application of section 267(c)(2) shall not be treated as owned by
him if he is described in section 4946(a)(1)(D) but not in section
4946(a)(1)(A), (B) or (C).
(2) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. Partnership S is a substantial contributor to private
foundation X. Trust T, of which G is sole beneficiary, owns 12 percent
of the profits interest of S. G's husband, H, owns 10 percent of the
profits interest of S. H is a disqualified person with respect to X
(under section 4946(a)(1)(C)) because he is considered to own 22 percent
of the profits interest of S (10 percent actual ownership, plus G's 12
percent constructively under section 267(c)(2)). G is a disqualified
person with
[[Page 194]]
respect to X (under section 4946(a)(1)(C) because she is considered to
own 22 percent of the profits interest of S (12 percent constructively
by reason of her beneficial interest in trust T, plus 10 percent
constructively under section 267(c)(2) by reason of being a member of
the family of H).
(f) Foundation manager. (1) For purposes of Chapter 42 and the
regulations thereunder, the term ``foundation manager'' means:
(i) An officer, director, or trustee of a foundation (or a person
having powers or responsibilities similar to those of officers,
directors, or trustees of the foundation), and
(ii) With respect to any act or failure to act, any employee of the
foundation having final authority or responsibility (either officially
or effectively) with respect to such act or failure to act.
(2) For purposes of subparagraph (1)(i) of this paragraph, a person
shall be considered an officer of a foundation if:
(i) He is specifically so designated under the certificate of
incorporation, bylaws, or other constitutive documents of the
foundation; or
(ii) He regularly exercises general authority to make administrative
or policy decisions on behalf of the foundation.
With respect to any act or failure to act, any person described in
subdivision (ii) of this subparagraph who has authority merely to
recommend particular administrative or policy decisions, but not to
implement them without approval of a superior, is not an officer.
Moreover, such independent contractors as attorneys, accountants, and
investment managers and advisers, acting in their capacities as such,
are not officers within the meaning of subparagraph (1)(i) of this
paragraph.
(3) For purposes of subparagraph (1)(ii) of this paragraph, an
individual rendering services to a private foundation shall be
considered an employee of the foundation only if he is an employee
within the meaning of section 3121(d)(2).
(4) Since the definition of the term ``disqualified person''
contained in section 4946(a)(1)(B) incorporates only so much of the
definition of the term ``foundation manager'' as is found in section
4946(b)(1) and subparagraph (1)(i) of this paragraph, any references, in
section 4946 and this section, to ``disqualified persons'' do not
constitute references to persons who are ``foundation managers'' solely
by reason of the definition of that term contained in section 4946(b)(2)
and subparagraph (1)(ii) of this paragraph.
(g) Government official--(1) In general. Except as provided in
subparagraph (3) of this paragraph, for purposes of section 4941 and
paragraph (c) of this section, the term ``government official'' means,
with respect to an act of selfdealing described in section 4941, an
individual who, at the time of such act, is described in subdivision
(i), (ii), (iii), (iv), or (v) of this subparagraph (other than a
``special Government employee'' as defined in 18 U.S.C. 202(a)):
(i)(a) An individual who holds an elective public office in the
executive or legislative branch of the Government of the United States.
(b) An individual who holds an office in the executive or judicial
branch of the Government of the United States, appointment to which was
made by the President.
(ii) An individual who holds a position in the executive,
legislative or judicial branch of the Government of the United States:
(a) Which is listed in schedule C of rule VI of the Civil Service
Rules, or
(b) The compensation for which is equal to or greater than the
lowest rate prescribed for GS-16 of the General Schedule under 5 U.S.C.
5332.
(iii) An individual who holds a position under the House of
Representatives or the Senate of the United States, as an employee of
either of such bodies, who receives gross compensation therefrom at an
annual rate of $15,000 or more.
(iv) The holder of an elective or appointive public office in the
executive, legislative, or judicial branch of the government of a State,
possession of the United States, or political subdivision or other area
of any of the foregoing, or of the District of Columbia, for which the
gross compensation is at an annual rate of $15,000 or more, who is
described in subparagraph (2) of this paragraph.
[[Page 195]]
(v) The holder of a position as personal or executive assistant or
secretary to any individual described in subdivision (i), (ii), (iii),
or (iv) of this subparagraph.
(2) Public office--(i) Definition. In defining the term ``public
office'' for purposes of section 4946(c)(5) and subparagraph (1)(iv) of
this paragraph, such term must be distinguished from mere public
employment. Although holding a public office is one form of public
employment, not every position in the employ of a State or other
governmental subdivision (as described in section 4946 (c)(5))
constitutes a ``public office''. Although a determination whether a
public employee holds a public office depends on the facts and
circumstances of the case, the essential element is whether a
significant part of the activities of a public employee is the
independent performance of policymaking functions. In applying this
subparagraph, several factors may be considered as indications that a
position in the executive, legislative, or judicial branch of the
government of a State, possession of the United States, or political
subdivision or other area of any of the foregoing, or of the District of
Columbia, constitutes a ``public office''. Among such factors to be
considered in addition to that set forth above, are that the office is
created by the Congress, a State constitution, or the State legislature,
or by a municipality or other governmental body pursuant to authority
conferred by the Congress, State constitution, or State legislature, and
the powers conferred on the office and the duties to be discharged by
such office are defined either directly or indirectly by the Congress,
State constitution, or State legislature, or through legislative
authority.
(ii) Illustrations. The following are illustrations of positions of
public employment which do not involve policymaking functions within the
meaning of subdivision (i) of this subparagraph and which are thus not a
``public office'' for purposes of section 4946(c)(5) and subparagraph
(1)(iv) of this paragraph:
(a) The chancellor, president, provost, dean, and other officers of
a State university who are appointed, elected, or otherwise hired by a
State Board of Regents or equivalent public body and who are subject to
the direction and supervision of such body;
(b) Professors, instructors, and other members of the faculty of a
State educational institution who are appointed, elected, or otherwise
hired by the officers of the institution or by the State Board of
Regents or equivalent public body;
(c) The superintendent of public schools and other public school
officials who are appointed, elected, or otherwise hired by a Board of
Education or equivalent public body and who are subject to the direction
and supervision of such body;
(d) Public school teachers who are appointed, elected, or otherwise
hired by the superintendent of public schools or by a Board of Education
or equivalent public body;
(e) Physicians, nurses, and other professional persons associated
with public hospitals and State boards of health who are appointed,
elected, or otherwise hired by the governing board or officers of such
hospitals or agencies; and
(f) Members of police and fire departments, except for those
department heads who, under the facts and circumstances of the case,
independently perform policymaking functions as a significant part of
their activities.
(3) Certain government officials on leave of absence. For purposes
of this paragraph, an individual who is otherwise described in section
4946(c) and this paragraph who was on leave of absence without pay on
December 31, 1969, from his position or office pursuant to a commitment
entered into on or before such date to engage in certain activities for
which he is paid by one or more private foundations, is not to be
treated as holding such position or office for any continuous period
after December 31, 1969, and prior to January 1, 1971, during which such
individual remains on leave of absence to engage in the same activities
for which he is paid by such foundations. For purposes of this
subparagraph, a commitment is considered entered into on or before
December 31, 1969, if on or before such date, the amount and nature of
the payments to be made and the name of the
[[Page 196]]
individual receiving such payments were entered on the records of the
payor, or were otherwise adequately evidenced, or the notice of the
payment to be received was communicated to the payee orally or in
writing.
(h) Members of the family. For purposes of this section, the members
of the family of an individual include only:
(1) His spouse,
(2) His ancestors,
(3) His lineal descendants, and
(4) Spouses of his lineal descendants.
For example, a brother or sister of an individual is not a member of his
family for purposes of this section. However, for example, the wife of a
grandchild of an individual is a member of his family for such purposes.
For purposes of this paragraph, a legally adopted child of an individual
shall be treated as a child of such individual by blood.
[T.D. 7241, 37 FR 28744, Dec. 29, 1972]
Subpart H_Application to Certain Nonexempt Trusts
Sec. 53.4947-1 Application of tax.
(a) In general. Section 4947 subjects trusts which are not exempt
from taxation under section 501(a), all or part of the unexpired
interests in which are devoted to one or more of the purposes described
in section 170(c)(2)(B), and which have amounts in trust for which a
deduction was allowed under section 170, 545(b)(2), 556(b)(2), 642(c),
2055, 2106(a)(2), or 2522 to the same requirements and restrictions as
are imposed on private foundations. The basic purpose of section 4947 is
to prevent these trusts from being used to avoid the requirements and
restrictions applicable to private foundations. For purposes of this
section, a trust shall be presumed (in the absence of proof to the
contrary) to have amounts under section 170, 545(b)(2), 556(b)(2),
642(c), 2055, 2106(a)(2), or 2522 if a deduction would have been
allowable under one of these sections. Also for purposes of this section
and Sec. 53.4947-2, the term ``purposes described in section
170(c)(2)(B)'' shall be treated as including purposes described in
section 170(c)(1).
(b) Charitable trusts--(1) General rule. (i) For purposes of this
section and Sec. 53.4947-2, a charitable trust, within the meaning of
section 4947(a)(1), is a trust which is not exempt from taxation under
section 501(a), all of the unexpired interests in which are devoted to
one or more of the purposes described in section 170(c)(2)(B), and for
which a deduction was allowed under section 170, 545(b)(2), 556(b)(2),
642(c), 2055, 2106(a)(2), or 2522 (or the corresponding provisions of
prior law). A trust is one for which a deduction was allowed under
section 642(c), within the meaning of section 4947(a)(1), once a
deduction is allowed under section 642(c) to the trust for any amount
paid or permanently set aside. (See sections 642(c) and Sec. 1.642-4
for the limitation on such deduction in certain cases.) A charitable
trust (as defined in this paragraph) shall be treated as an organization
described in section 501(c)(3) and, if it is determined under section
509 that the trust is a private foundation, then Part II of Subchapter F
of chapter 1 of the Code (other than section 508 (a), (b) and (c) and
Chapter 42 shall apply to the trust. However, the charitable trust is
not treated as an organization described in section 501(c)(3) for
purposes of exemption from taxation under section 501(a). Thus, the
trust is subject to the excise tax on its investment income under
section 4940(b) rather than the tax imposed by section 4940(a). For
purposes of satisfying the organizational test described in Sec. 1.501
(c)(3)-1(b) when a charitable trust seeks an exemption from taxation
under section 501(a), a charitable trust (as defined in this paragraph)
shall be considered organized on the day it first becomes subject to
section 4947(a)(1). However, for purposes of the special and
transistional rules in section 4940(c)(4)(B), 4942(f)(4),
4943(c)(4)(A)(i) and (B) and section 101(1)(2)(A), (B), (C), and (D),
and (1)(3) of the Tax Reform Act of 1969, a charitable trust (as defined
in this paragraph) shall be considered organized on the first day it has
amounts in trust for which a deduction was allowed (within the meaning
of paragraph (a) of this section) under section 170, 545(b)(2),
556(b)(2), 642(c), 2055, 2106(a)(2), or 2522. Thus, under this
[[Page 197]]
rule, a trust may be treated as a private foundation in existence on a
date governing one of the applicable special and transistional rules
even though the trust did not otherwise become subject to the provisions
of Chapter 42 until a later date.
(ii) The provisions of paragraph (b)(1) of this section may be
illustrated by the following examples:
Example 1. On January 30, 1970, X creates an inter vivos trust under
which M receives 50 percent and N receives 50 percent of the trust's
income for 10 years, and upon the termination of which, at the end of
the 10-year period, the corpus is to be distributed to O. M, N and O are
all organizations described in section 501(c)(3) and X is allowed a
deduction under section 170 for the value of all interests placed in
trust. The trustees of the trust do not give notice to the Internal
Revenue Service under the provisions of section 508(a), and the trust
will therefore not be exempt from taxation under section 501(a). The
trust is a charitable trust within the meaning of section 4947(a)(1)
from the date of its creation.
Example 2. On March 1, 1971, Y creates a charitable remainder
annuity trust described in section 664(d)(1) under which Z, Y's son,
receives $10,000 per year for life, remainder to be held in trust for P,
an organization described in section 501(c)(3). Y is allowed a deduction
under section 170 for the present value of the remainder interest to P.
During Z's lifetime, the trust is a split-interest trust described in
section 4947(a)(2) and paragraph (c) of this section. Upon the death of
Z, all unexpected interests (consisting of P's remainder interest) will
be devoted to section 170(c)(2)(B) purposes. Except as provided in Sec.
53.4947-1(b)(2)(iv) (relating to a reasonable period of settlement) the
trust will be treated as a charitable trust within the meaning of
section 4947(a)(1) from the date of the death of Z unless the trustees
of the trust apply for recognition of section 501(c)(3) status under the
provisions of section 508(a).
(2) Scope of application of section 4947(a)(1)--(i) In general.
Subject to paragraph (b)(2) (ii) through (vii) of this section, section
4947(a)(1) applies to nonexempt trusts in which all unexpired interests
are charitable. For purposes of this section, the term charitable when
used to describe an interest or beneficiary refers to the purposes
described in section 170(c)(2)(B). An estate from which the executor or
administrator is required to distribute all of the net assets in trust
to such beneficiaries will not be considered a charitable trust under
section 4947(a)(1) during the period of estate administration or
settlement, except as provided in paragraph (b)(2)(ii) of this section.
A charitable trust created by will shall be considered a charitable
trust under section 4947(a)(1) as of the date of death of the decedent-
grantor, except as provided in paragraph (b)(2)(v) of this section
(relating to trusts which wind up. For the circumstances under which
segregated amounts are treated as charitable trusts, see Sec. 53.4947-
1(c)(3)(iii).
(ii) Estates. (A) When an estate from which the executor or
administrator is required to distribute all of the net assets in trust
for charitable beneficiaries, or free of trust to such beneficiaries, is
considered terminated for Federal income tax purposes under Sec.
1.641(b)-3(a), then the estate will be treated as a charitable trust
under section 4947(a)(1) between the date on which the estate is
considered terminated under Sec. 1.641(b)-3(a) and the date final
distribution of all of the net assets is made to or for the benefit of
the charitable beneficiaries. This (ii) does not affect the
determination of the tax liability under Subtitle A of the beneficiaries
of the estates.
(B) The provisions of this (ii) may be illustrated by the following
example:
Example. X bequeaths his entire estate, including 100 percent of the
stock of a wholly-owned corporation, to M, an organization described in
section 501(c)(3), under a will which gives his executor authority to
hold the stock and manage the corporation for a period of up to 10 years
for the benefit of M prior to its ultimate disposition. A deduction for
the charitable bequest was allowed to X's estate under section 2055. The
executor is vested with a full range of powers, including the power of
sale. Upon the death of X, his executor distributes X's assets to M
except for the stock of the corporation, which he holds for 5 years
prior to its disposition. The continued holding of the stock of the
corporation by the executor after the expiration of a reasonable time
for performance of all the ordinary duties of administration causes the
estate to be considered terminated for Federal income tax purposes
pursuant to Sec. 1.641(b)-3(a) and thereby subjects it to the
provisions of section 4947(a)(1) from the date of such termination to
the date of final disposition of the stock of the corporation.
[[Page 198]]
(iii) Certain split-interest trusts which wind up. A split-interest
trust (as defined in paragraph (c) of this section) in which all of the
unexpired interests are charitable remainder interests and in which the
charitable beneficiaries have become entitled to distributions of corpus
in trust or free of trust shall continue to be treated as as split-
interest trust under section 4947(a)(2) until the date on which final
distribution of all the net assets is made. However, if after the
expiration of any intervening interests the trust is considered
terminated for Federal income tax purposes under Sec. 1.641(b)-3(b),
then the trust will be treated as a charitable trust under section
4947(a)(1), rather than a split interest trust under section 4947(a)(2),
between the date on which the trust is considered terminated under Sec.
1.641(b)-3(b) and the date on which such final distribution of all of
the net assets is made to or for the benefit of the charitable remainder
beneficiaries. This (iii) does not affect the determination of the tax
liability under subtitle A of the beneficiaries of the trusts.
(iv) Split-interest trusts which become charitable trusts. (A) A
split-interest trust (as defined in paragraph (c) of this section) in
which all of the unexpired interests are charitable remainder interests
and in which some or all of the charitable beneficiaries are not
entitled to distributions of corpus within the meaning of paragraph
(b)(2)(iii) of this section shall continue to be treated as a split-
interest trust under section 4947(a)(2) rather than a charitable trust
under section 4947(a)(1) for a reasonable period of settlement after the
expiration of the noncharitable interest. Thus, a split-interest trust
which under its terms is to continue to hold assets for charitable
beneficiaries after the expiration of the noncharitable interest rather
than distributing them as in paragraph (b)(2)(iii) of this section is
given a reasonable period of settlement before being treated as a
charitable trust. For purposes of this paragraph, the term reasonable
period of settlement means that period reasonably required (or if
shorter, actually required) by the trustee to perform the ordinary
duties of administration necessary for the settlement of the trust.
These duties include, for example, the collection of assets, the payment
of debts, taxes, and distributions, and the determination of the rights
of the subsequent beneficiaries.
(B) This (iv) may be illustrated by the following example:
Example. On January 15, 1971, A creates a charitable remainder
annuity trust described in section 661(d)(1) under which the trustees
are required to distribute $10,000 a year to B, A's wife, for life,
remainder to be held in trust for the use of M, an organization
described in section 501(c)(3). A is allowed a deduction under section
170 for the amount of the charitable interest, and the trust is,
therefore, treated as a split-interest trust under section 4947(a)(2)
from the date of its creation. B dies on February 10, 1975. On April 15,
1975, the trustees complete performance of the ordinary duties of
administration necessary for the settlement of the trust brought about
by the death of B. These duties include, for example, an accounting for
and payment to the estate of B of amounts accrued by B while alive
during 1975. However, the trustees do not distribute the corpus to M by
April 15, 1975. The trust shall continue to be treated as a split-
interest trust under section 4947(a)(2) until April 15, 1975. After
April 15, 1975, the trust shall be treated as a charitable trust under
section 4947(a)(1).
(v) Certain revocable and testamentary trusts which wind up. A
revocable trust that becomes irrevocable upon the death of the decedent-
grantor, or a trust created by will, from which the trustee is required
to distribute all of the net assets in trust for or free of trust to
charitable beneficiaries is not considered a charitable trust under
section 4947(a)(1) for a reasonable period of settlement (within the
meaning of paragraph (b)(2)(iv) of this section) after becoming
irrevocable. After that period the trust is considered a charitable
trust under section 4947(a)(1).
(vi) Revocable trusts which become charitable trusts. A revocable
trust that becomes irrevocable upon the death of the decedent-grantor in
which all of the unexpired interests are charitable and under the terms
of the governing instrument of which the trustee is required to hold
some or all of the net assets in trust after becoming irrevocable solely
for charitable beneficiaries is not considered a trust under section
[[Page 199]]
4947(a)(1) for a reasonable period of settlement (within the meaning of
paragraph (b)(2)(iv) of this section) after becoming irrevocable except
that section 4941 may apply if the requirements of Sec. 53.4941(d)-1
(b)(3) are not met. After that period, the trust is considered a
charitable trust under section 4947(a)(1).
(vii) Trust devoted to 170(c) purposes. (A) A trust all of the
unexpired interests in which are devoted to section 170 (c) (3) or (5)
purposes together with section 170(c)(2)(B) purposes shall be considered
a charitable trust except that payments under the terms of the governing
instrument to an organization described in section 170(c) (3) or (5)
shall not be considered a violation of section 4945(d)(5) or any other
provisions of Chapter 42 and shall be considered qualifying
distributions under section 4942.
(B) Example. The application of paragraph (b)(2)(vii) of this
section may be illustrated by the following example:
Example. On January 30, 1970, H creates an inter vivos trust under
the terms of the governing instruments of which M, an organization
described in section 170(c)(3), and N, an organization described in
section 501(c)(3), are each to receive 50 percent of the income for a
period of 10 years. At the end of the 10 year period, the corpus is to
be distributed to O, an organization also described in section
501(c)(3). H is allowed a deduction under section 170 for the value of
all interests placed in trust. The payments to M do not constitute a
violation of section 4945(d)(5) or any other provision of Chapter 42 and
constitute qualifying distributions under section 4942. However, except
as provided in the previous sentence, the trust shall be considered a
charitable trust.
(3) Charitable trusts described in section 509(a)(3). For purposes
of section 509(a)(3)(A), a charitable trust shall be treated as if
organized on the day on which it first becomes subject to section
4947(a)(1). However, for purposes of applying Sec. Sec. 1.509(a)-4(d)
(2)(iv)(a), and 1.509(a)-4(i)(1) (ii) and (iii)(c) the previous
relationship between the charitable trust and the section 509(a) (1) or
(2) organizations it benefits or supports may be considered. If the
charitable trust otherwise meets the requirements of section 509(a)(3),
it may obtain recognition of its status as a section 509(a)(3)
organization by requesting a ruling from the Internal Revenue Service.
For the special rules pertaining to the application of the
organizational test to organizations terminating their private
foundation status under the 12-month or 60-month termination period
provided under section 507(b)(1)(B) by becoming ``public'' under section
509(a)(3), see the regulations under section 507(b)(1).
(c) Split-interest trusts--(1) General rule--(i) Definition. For
purposes of this section and Sec. 53.4947-2, a split-interest trust,
within the meaning of section 4947(a)(2), is a trust which is not exempt
from taxation under section 501(a), not all of the unexpired interests
in which are devoted to one or more of the purposes described in section
170(c)(2)(B), and which has amounts in trust for which a deduction was
allowed (within the meaning of paragraph (a) of this section) under
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522. A
trust is one which has amounts in trust for which a deduction was
allowed under section 642(c) within the meaning of section 4947(a)(2)
once a deduction is allowed under section 642(c) to the trust for any
amount permanently set aside. This (i) also includes any trust which is
not treated as a charitable trust by operation of paragraph (b)(2) (iii)
or (iv) of this section (relating to split-interest trusts in the
process of winding up or during a reasonable period of settlement).
Section 4947(a)(1) shall apply to a trust described in this (i) (without
regard to section 4947(a)(2)(A), (B), or (C)) from the first date upon
which the provisions of paragraph (b)(2) (iii) or (iv) of this section
are satisfied. For the circumstances under which a trust all of the
unexpired interests in which are devoted to section 170(c) (3) or (5)
purposes together with section 170(c)(2)(B) purposes is considered a
charitable trust, see Sec. 53.4947-1(b)(2)(vii).
(ii) Applicability of statutory rules. A split-interest trust is
subject to the provisions of section 507 (except as provided in
paragraph (e) of this section), 508(e) (to the extent applicable to a
split-interest trust), 4941, 4943 (except as provided in section
4947(b)(3)), 4944 (except as provided in section 4947(b)(3)), and 4945
in the same manner
[[Page 200]]
as if such trust were a private foundation.
(iii) Special rules. A newly created trust shall, for purposes of
section 4947(a)(2), be treated as having amounts in trust for which a
deduction was allowed under section 170, 545(b)(2), 556(b)(2), 642(c),
2055, 2106(a)(2), or 2522 from the date of its creation, even if a
deduction was allowed for such amounts only at a later date. For
purposes of this (iii), the date of creation of a charitable remainder
trust shall be determined by applying the rules in Sec. 1.664-1(a)(4).
(2) Exception for amounts payable to income beneficiaries. (i) Under
section 4947(a)(2)(A), paragraph (c)(1)(ii) of this section does not
apply to any amounts payable under the terms of a split-interest trust
to income beneficiaries unless a deduction was allowed under section
170(f)(2)(B), 2055(e)(2) (B), or 2522(c)(2)(B) with respect to the
income interest of any such beneficiary. See Sec. 1.170A-6(c), Sec.
20.2055(e)(2), and Sec. 25.2522(c)-3(c)(2) for rules regarding the
allowance of these deductions. However, section 4947(a)(2)(A) does not
apply when the value of all interests in property transferred in trust
are deductible under section 170, 545(b)(2), 556(b)(2), 642(c), 2055,
2106(a)(2), or 2522.
(ii) The application of this subparagraph may be illustrated by the
following examples:
Example 1. H creates a charitable remainder unitrust (described in
section 664(d)(2)) which is required annually to pay W, H's wife, 5
percent of the net fair market value of the trust assets, valued
annually, for her life; and to pay the remainder to Y, a section
501(c)(3) organization. A deduction under section 170(f)(2)(A) was
allowed with respect to the remainder interest of Y. Under section
4947(a)(2)(A), each annual amount which becomes payable to W during her
life is not subject to paragraph (c)(1)(ii) of this section on or after
the date upon which it becomes so payable and the payment of each amount
to W is not an act of self-dealing under section 4941(d)(1) and does not
violate any other provision of chapter 42. However, except as provided
in the preceding sentence, the trust is subject to paragraph (c)(1)(ii)
of this section in the same manner as any other split-interest trust.
Example 2. H bequeaths the residue of his estate in trust for the
benefit of S, his son, and Y, an organization described in section
501(c)(3). A guaranteed annuity interest of $10,000 is to be paid to S
for 20 years. A guaranteed annuity interest of $5,000 which meets the
requirements contained in Sec. 20.2055-2(e)(2)(v)(a) is also to be paid
to Y for 20 years. Upon termination of the 20-year term, the corpus is
to be distributed to Z, another organization described in section
501(c)(3). The trust is a charitable remainder annuity trust as
described in section 664(d)(1) and the regulations thereunder, and a
deduction under section 2055(e)(2)(A) was allowed with respect to the
remainder interest of Z. A deduction was also allowed under section
2055(e)(2)(B) with respect to the guaranteed annuity interest of Y. The
assets in the trust are not segregated under section 4947(a)(2)(B) and
paragraph (c)(3) of this section. Under section 4947(a)(2)(A), each
payment of $10,000 to S is not subject to section 4947(a)(2) and
paragraph (c)(1)(ii) of this section. The payment of each amount to S is
not an act of self-dealing under section 4941(d)(1) and does not violate
any other provision of chapter 42. However, except as provided in the
preceding sentence, the trust is subject to section 4947(a)(2) and
paragraph (c)(1)(ii) of this section in the same manner as any other
split-interest trust.
Example 3. H creates a trust under which the trustees are required
to pay over an annuity interest of $20,000 to W. H's wife, for her life.
A guaranteed annuity interest of $10,000 which meets the requirements
contained in Sec. 25.2522(c)-3(c)(2)(v) is also to be paid X, an
organization described in section 501(c)(3), for the life of W. Upon the
death of W, the corpus of the trust, which consists of office buildings
M and N, is to be distributed to S. H's son. H received a deduction
under section 2522(c)(2)(B) for the value of X's income interest in the
trust. The assets in the trust are not segregated under section
4947(a)(2)(B) and paragraph (c)(3) of this section. Under section
4947(a)(2)(A), each payment of $20,000 to W is not subject to section
4947(a)(2) and paragraph (c)(1)(ii) of this section. The payment of each
amount to W is not an act of self-dealing under section 4941(d)(1) and
does not violate any other provision of chapter 42. However, except as
provided in the preceding sentence, the trust is subject to paragraph
(c)(1)(ii) of this section in the same manner as any other split-
interest trust. See example (1) of paragraph (c)(3)(v) of this section
for the application of section 4947(a)(2)(B) to a similar trust where
the trustees segregate the assets of the trust.
(3) Exception for certain segregated amount--(i) In general. Under
section 4947(a)(2)(B) paragraph (c)(1)(ii) of this section does not
apply to assets held in trust (together with the income and capital
gains derived from the assets), which are segregated from other assets
held in trust for which a deduction was
[[Page 201]]
allowed for an income or remainder interest under section 170,
545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522.
(ii) Segregation of amounts. Amounts will generally be considered
segregated (within the meaning of section 4947(a)(2)(B) if:
(A) Assets with respect to which no deduction was allowed (for an
income or remainder interest) under section 170, 545(b)(2), 556(b)(2),
642(c), 2055, 2106(a)(2), or 2522, are separately accounted for under
section 4947(a)(3) and paragraph (c)(4) of this section from assets for
which such a deduction was allowed for any income or remainder interest
and,
(B) By reason of the separate accounting the trust can be treated as
two separate trusts, one of which is devoted exclusively to
noncharitable income and remainder interests and the other of which is a
charitable trust described in section 4947(a)(1) or a split-interest
trust described in section 4947(a)(2).
Under these circumstances, only the ``trust'' which is devoted
exclusively to noncharitable income and remainder interests will be
considered a segregated amount which under section 4947(a)(2)(B), is not
subject to section 4947(a)(2) and paragraph (c)(1)(ii) of this section.
(iii) Exclusively charitable amounts. If, under section
4947(a)(2)(B),
(A) An amount held in trust which is devoted exclusively to
noncharitable income and remainder interests is segregated from
(B) An amount held in trust which is devoted exclusively to
charitable income and remainder interests,
Then for purposes of this section the amount described in paragraph
(c)(3)(iii)(B) of this section will be treated as a charitable trust
which is subject to the provisions of section 4947(a)(1).
(iv) Charitable and noncharitable amounts. If, under section 4947(a)
(2)(B),
(A) An amount held in trust which is devoted exclusively to
noncharitable income and remainder interests is segregated from
(B) An amount held in trust which is devoted to both charitable
income or remainder interests and noncharitable income or remainder
interests,
Then for purposes of this section the amount described in paragraph
(c)(3)(iv)(B) of this section will be treated as a split-interest trust
which is subject to the provisions of section 4947(a)(2).
(v) Examples. The application of paragraph (c)(3) of this section
may be illustrated by the following examples:
Example 1. H creates a trust under which the trustees are required
to pay over annually 5 percent of the net fair market value of M
building, valued annually, to W, H's wife, for life, remainder to S, H's
son. The other asset in the trust is N building, with respect to which
the trustees are required to pay over annually 5 percent of the net fair
market value of the building, valued annually, to X, a section 501(c)(3)
organization, for a period of 15 years, remainder to S. Each asset is
separately accounted for under section 4947(a)(3) and paragraph (c)(4)
of this section. He received a deduction under section 2522 for the
value of X's income interest in N building. Under these circumstances, M
building is considered segregated (within the meaning of section
4947(a)(2)(B)) from N building and is not subject to section 4947
(a)(2). The remainder interest of S in N building is not considered
segregated from the income interest of X in N building, since both are
interests in the same asset. N building is considered held in a split-
interest trust which is subject to section 4947 (a)(2) and paragraph
(c)(1)(ii) of this section.
Example 2. H transfers $50,000 in trust to pay $2,500 per year to Z,
a section 501(c)(3) organization, for a term of 20 years, remainder to
S. H's son. H is allowed a deduction under section 2522 for the present
value of Z's income interest. The income interest of Z in the trust
asset cannot be segregated (within the meaning of section 4947(a)(2)(B))
from the remainder interest of S since both are interests in the same
asset. Therefore, the entire trust is subject to section 4947(a)(2) and
paragraph (c)(1)(ii) of this section.
(4) Accounting for segregated amounts--(i) General rule. Under
section 4947(a)(2)(B), a trust with respect to which amounts are
segregated within the meaning of paragraph (c)(3) of this section must
separately account for the various income, deduction, and other items
properly attributable to each segregated amount in the books of account
and separately account to each of the beneficiaries of the trust.
(ii) Method. Separate accounting shall be made:
[[Page 202]]
(A) According to the method regularly employed by the trust, if the
method is reasonable, and
(B) In all other cases in a manner which, in the opinion of the
Commissioner, is reasonable.
A method of separate accounting will be considered ``regularly
employed'' by a trust when the method has been consistently followed in
prior taxable years or when a trust which has never before maintained
segregated amounts initiates a reasonable method of separate accounting
for its segregated amounts and consistently follows such method
thereafter. The trust shall keep permanent records and other data
relating to the segregated amounts as are necessary to enable the
district director to determine the correctness of the application of the
rules prescribed in paragraph (c) (3) and (4) of this section.
(5) Amounts transferred in trust before May 27, 1969--(i) General
rule. Under section 4947(a)(2)(C), paragraph (c)(1)(ii) of this section
does not apply to any amounts transferred in trust before May 27, 1969.
For purposes of this (5), an amount shall be considered to be
transferred in trust only when the transfer is one which meets the
requirements for the allowance of a deduction under section 170,
545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 (or the
corresponding provisions of prior law). Income and capital gains which
are derived at any time from amounts transferred in trust before May 27,
1969, shall also be excluded from the application of paragraph
(c)(1)(ii) of this section. If an asset which was transferred in trust
before May 27, 1969, is sold or exchanged after May 26, 1969, any asset
received by the trust upon the sale or exchange shall be treated as an
asset which was transferred in trust before May 27, 1969.
(ii) Requirement for separate accounting for amounts transferred in
trust before May 27, 1969. If:
(A) Amounts are transferred in trust after May 26, 1969, and the
trust to which the amounts are transferred also contains
(B) Amounts transferred in trust before May 27, 1969,
the general rule of paragraph (c)(5)(i) of this section applicable to
the amounts described in paragraph (c)(5)(ii)(B) of this section will
apply only if the amounts described in paragraph (c)(5)(ii)(A) of this
section (together with all income and capital gains derived therefrom)
are separately accounted for (within the meaning of paragraph (c)(4) of
this section) from the amounts described in paragraph (c)(5)(ii)(B) of
this section, together with all income and capital gains derived
therefrom. For the application of section 508(e) to a trust with respect
to which amounts were transferred both before and after May 27, 1969,
see section 508(e) and the regulations thereunder.
(iii) Exception for certain testamentary trusts. (A) Amounts
transferred in trust before May 27, 1969 include amounts transferred in
trust after May 26, 1969 when the transfer is made under the terms of a
testamentary trust created by the will of a decedent who died before May
27, 1969, (regardless of whether the executors or the testamentary
trustees are required to execute testamentary trusts by court order
under applicable local law). Amounts transferred in trust before May 27,
1969, also include amounts transferred to a testamentary trust created
by the will of a decedent who died after May 26, 1969 if the will was
executed before May 27, 1969 and no dispositive provision of the will
was amended (within the meaning of Sec. 20.2055-2(e)(4) and (5)) by the
decedent by codicil or otherwise, after May 26, 1969, and the decedent
was on May 27, 1969, and at all times thereafter under a mental
disability (as defined in Sec. 1.642(c)-2(b)(3)(ii)) to amend the will
by codicil or otherwise.
(B) The provisions of this (iii) may be illustrated by the following
example:
Example. X executed a will in 1960 which provided for the creation
of a testamentary trust which meets the description of a split-interest
trust under section 4947(a)(2). X died on April 15, 1969. Under the
provisions of his will, the probate court permitted certain property in
X's estate to be transferred to the testamentary trust at fixed
intervals over a period of two years during the administration of the
estate. Section 4947(a)(2) does not apply to any amount described in
this example, including the amounts transferred after May 26, 1969,
because, for purposes of section 4947(a)(2)(C), each such transfer will
be treated as an amount transferred in trust
[[Page 203]]
before May 27, 1969, within the meaning of section 4947(a)(2)(C).
(6) Scope of application of section 4947(a)(2)--(i) In general.
Subject to paragraph (c)(6) (ii), (iii), and (iv) of this section,
section 4947(a)(2) applies to trusts in which some but not all unexpired
interests are charitable. An estate from which the executor or
administrator is required to distribute all of the net assets in trust
or free of trust to both charitable and noncharitable beneficiaries will
not be considered to be a split-interest trust under section 4947(a)(2)
during the period of estate administration or settlement, except as
provided in paragraph (c)(6)(ii) of this section. A split-interest trust
created by will shall be considered a split-interest trust under section
4947(a)(2) as of the date of death of the decedent-grantor, except as
provided in paragraph (c)(6)(iv) of this section.
(ii) Estates. (A) When an estate from which the executor or
administrator is required to distribute all of the net assets in trust
or free of trust to both charitable and noncharitable beneficiaries is
considered terminated for Federal income tax purposes under Sec.
1.641(b)-3(a), then the estate will be treated as a split-interest trust
under section 4947(a)(2) (or a charitable trust under section
4957(a)(1), if applicable) between the date on which the estate is
considered terminated under Sec. 1.641(b)-3(a) and the date on which
final distribution of the net assets to the last remaining charitable
beneficiary is made. This (ii) does not affect the determination of the
tax liability under subtitle A of either charitable or noncharitable
beneficiaries of the estates.
(B) The provisions of this (ii) may be illustrated by the following
example:
Example. X dies on January 15, 1973 and bequeaths $10,000 to M, an
organization described in section 501(c)(3), and the residue of his
estate to W, his wife. A deduction for the charitable bequest was
allowed to X's estate under section 2055. Substantially all of X's
estate consists of 100 percent of the stock of a wholly owned
corporation, certain liquid assets such as marketable stocks and
securities and bank accounts, and X's home, automobile, and other
personal property. X's will gives his executor a full range of powers,
including the power to sell the stock of the wholly owned corporation.
After the death of X, his executor continues to manage the wholly owned
corporation while attempting to sell the stock of the corporation.
During this period, the executor makes no distributions to M. On May 24,
1978, the Internal Revenue Service determines under Sec. 1.641(b)-3(a)
that the administration of the estate has been unduly prolonged and the
estate is considered terminated as of that date for Federal income tax
purposes. X's estate will be treated as a split-interest trust described
in section 4947(a)(2) between May 24, 1978 and the date on which the
$10,000 bequest to M is satisfied. X's estate will therefore be subject
to the applicable private foundation provisions during that period and,
for example, a sale of the house by the estate to any disqualified
person (as defined in section 4946) will be an act of self-dealing under
section 4941.
(iii) Revocable trusts which become split-interest trusts. A
revocable trust that becomes irrevocable upon the death of the decedent-
grantor under the terms of the governing instrument of which the trustee
is required to hold some or all of its net assets in trust after
becoming irrevocable for both charitable and noncharitable beneficiaries
is not considered a split-interest trust under section 4947(a)(2) for a
reasonable period of settlement after becoming irrevocable except that
section 4941 may apply if the requirements of Sec. 53.4941(d)-1(b)(3)
are not met.
After that period, the trust is considered a split-interest trust under
section 4947(a)(2). For purposes of this (iii), the term reasonable
period of settlement means that period reasonably required (or if
shorter, actually required) by the trustee to perform the ordinary
duties of administration necessary for the settlement of the trust.
These duties include, for example, the collection of assets, the payment
of debts, taxes, and distributions, and the determination of rights of
the subsequent beneficiaries.
(iv) Certain revocable and testamentary trusts which wind up. A
revocable trust that becomes irrevocable upon the death of the decedent-
grantor, or a trust created by will, from which the trustee is required
to distribute all of the net assets in trust or free of trust to both
charitable and noncharitable beneficiaries is not considered a split-
interest trust under section 4947(a)(2) for a reasonable period of
settlement (within the meaning of paragraph (c)(6)(iii) of this section)
after becoming irrevocable. After that period, the
[[Page 204]]
trust is considered a split-interest trust under section 4947(a)(2) (or
a charitable trust under section 4947(a)(1), if applicable).
(d) Cross references; Governing instrument requirements and
charitable deduction limitations. For the application of section
642(c)(6) (relating to section 170 limitations on charitable deductions
of non-exempt private foundation trusts) to a trust described in section
4947(a)(1), see Sec. 1.642(c)-4. For the denial of a deduction under
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 for
a gift, a bequest, or an amount paid to (and the denial of a deduction
under section 642(c) for an amount set aside in) a trust described in
section 4947(a)(1) or (2) that fails to meet the applicable governing
instrument requirements of section 508(e) by the end of the taxable year
of the trust, see section 508(d)(2) and Sec. 1.508-2(b). Since a
charitable remainder trust (as defined in section 664) is not exempt
under section 501(a), it is subject to section 4947(a)(2), and thus to
the governing instrument requirements of section 508(e) to the extent
they are applicable.
(e) Application of section 507(a)--(1) General rule. The provisions
of section 507(a) shall not apply to a trust described in section
4947(a) (1) or (2) by reason of any payment to a beneficiary that is
directed by the terms of the governing instrument of the trust and is
not discretionary with the trustee or, in the case of a discretionary
payment, by reason of, or following, the expiration of the last
remaining charitable interest in the trust.
(2) Examples. The provisions of this (e) may be illustrated by the
following examples:
Example 1. H creates a section 4947(a)(1) trust under which the
income is to be paid for 15 years to R, a section 501(c)(3)
organization. Upon the expiration of 15 years, the trust is to terminate
and distribute all of its assets to S, another section 501(c)(3)
organization. Distribution of the corpus of the trust to S will not be
considered a termination of the trust's private foundation status within
the meaning of section 507(a).
Example 2. H creates a trust under which X, a section 501(c)(3)
organization, receives $20,000 per year for a period of 20 years,
remainder to S, H's son. H is allowed a deduction under section 2522 for
the present value of X's interest.
When the final payment to X has been made at the end of the 20-year
period in accordance with the terms of the trust, the provisions of
section 4947(a)(2) will cease to apply to the trust because the trust no
longer retains any amounts for which the deduction under section 2522
was allowed. However, the final payment to X will not be considered a
termination of the trust's private foundation status within the meaning
of section 507(a).
Example 3. J creates a charitable remainder annuity trust described
in section 664(d)(1) under which S, J's son, receives $10,000 per year
for life, remainder to be distributed outright to P, an organization
described in section 501(c)(3). J is allowed a deduction under section
170 for the value of the remainder interest placed in trust for the
benefit of P, and the provisions of section 4947(a)(2) apply to the
trust. At the death of S, the trust will terminate and all assets will
be distributed to P. However, such final distribution to P will not be
considered a termination of the trust's private foundation status within
the meaning of section 507(a).
[T.D. 7431, 41 FR 35515, Aug. 23, 1976]
Sec. 53.4947-2 Special rules.
(a) Limit to segregated amounts. If any amounts held in trust are
segregated within the meaning of Sec. 53.4947-1(c)(3), the value of the
net assets for purposes of section 507(c)(2) and (g) shall be limited to
the segregated amounts with respect to which a deduction under section
170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 was
allowed. See the regulations under section 507(c)(2) and (g).
(b) Applicability of section 4943 and 4944 to split-interests
trusts--(1) General rule. Under section 4947(b)(3), section 4943 and
4944 do not apply to a split-interest trust described in section
4947(a)(2) if:
(i) All the income interest (and none of the remainder interest) of
the trust is devoted solely to one or more of the purposes described in
section 170(c)(2)(B) and all amounts in the trust for which a deduction
was allowed under section 170, 545(b)(2), 556(b)(2), 642(c), 2055,
2106(a)(2), or 2522 have an aggregate value (at the time for which the
deduction was allowed) of not more than 60 percent of the aggregate fair
market value of all amounts in the trust (after the payment of estate
taxes and all other liabilities), or
[[Page 205]]
(ii) A deduction was allowed under section 170, 545(b)(2),
556(b)(2), 642(c), 2055, 2106(a)(2) or 2522 for amounts payable under
the terms of the trust to every remainder beneficiary, but not to any
income beneficiary.
This (1) shall apply to a trust described in paragraph (b)(1)(ii) of
this section only if all amounts payable under the terms of the trust to
every remainder beneficiary are to be devoted solely to one or more of
the purposes described in section 170(c)(2)(B). After the expiration of
all income interests in a trust described in paragraph (b)(1)(ii) of
this section, the trust shall become subject to section 4947(a)(1) under
Sec. 53.4947-1(b)(2), and section 4947(b)(3) shall no longer apply to
the trust. A pooled income fund described in section 642(c)(5) will
generally meet the requirements of paragraph (b)(1)(ii) of this section,
as will a charitable remainder trust described in section 664(d)(1), if
in either case it does not make payments to any income beneficiary
described in section 170(c).
(2) Definitions. (i) For purposes of section 4947(b)(3)(A), the term
``income interest'' shall include an interest in property transferred in
trust which is in the form of a guaranteed annuity interest or unitrust
interest as described in Sec. 1.170A-6(c), Sec. 20.2055-2(e)(2) or
Sec. 25.2522(c)-3(c)(2) and the term ``remainder interest'' shall
include an interest which succeeds an ``income interest'' within the
meaning of this (i).
(ii) For purposes of section 4947(b)(3)(B), the term ``income
beneficiary'' shall include a recipient of payments described in section
642(c)(5)(F) from a pooled income fund, payments described in section
664(d)(1)(A) from a charitable remainder annuity trust, or payments
described in section 664(d)(2)(A) or (3) from a charitable remainder
unitrust. The term ``remainder beneficiary'' shall include a beneficiary
of a remainder interest described in section 642(c)(5) or 664(d)(1)(C)
or (2)(C).
(c) Effective date. Except as otherwise provided in Sec. Sec.
53.4947-1 and 53.4947-2 and the regulations under sections 508 (d) and
(e), Sec. Sec. 53.4947-1 and 53.4947-2 shall take effect on January 1,
1970.
(Secs. 4947 and 7805, Internal Revenue Code of 1954 (68A Stat. 917: 26
U.S.C. 7805))
[T.D. 7431, 41 FR 35515, Aug. 23, 1976]
Subpart I_Tax on Investment Income of and Denial of Exemption to Certain
Foreign Organizations
Sec. 53.4948-1 Application of taxes and denial of exemption with respect to
certain foreign organizations.
(a) Tax on income of certain foreign organizations. (1) In lieu of
the tax imposed by section 4940 and the regulations thereunder, there is
hereby imposed for each taxable year beginning after December 31, 1969,
on the gross investment income (within the meaning of section 4940(c)(2)
and the regulations thereunder) derived from sources within the United
States (within the meaning of section 861 and the regulations
thereunder) by every foreign organization which is a private foundation
(within the meaning of section 509 and the regulations thereunder) and
exempt from taxation under section 501(a) for the taxable year a tax
equal to 4 percent of such income, except as provided in subparagraph
(3) of this paragraph. The tax (if any) will be reported on the form the
foundation is required to file under section 6033 and will be paid
annually for the taxable year, at the time prescribed for filing such
annual return (determined without regard to any extension of time for
filing). For purposes of this section, the term foreign organization
means any organization which is not described in section 170(o)(2)(A).
(2) With respect to the deduction and withholding of tax imposed by
section 4948(a), see section 1443(b) and the regulations thereunder.
(3) Whenever there exists a tax treaty between the United States and
a foreign country, and a foreign private foundation subject to section
4948(a) is a resident of such country or is otherwise entitled to the
benefits of such treaty (whether or not such benefits are available to
all residents), if the treaty provides that any item or items
[[Page 206]]
(or all items with respect to an organization exempt from income
taxation) of gross investment income (within the meaning of section
4940(c)(2)) shall be exempt from income tax, such item or items shall
not be taken into account by such foundation in computing the tax to be
imposed under section 4948(a) for any taxable year for which the treaty
is effective.
(b) Certain sections inapplicable. Section 507 (relating to
termination of private foundation status), section 508 (relating to
special rules with respect to section 501(c)(3) organizations), and
Chapter 42 (other than section 4948) of the Code shall not apply to any
foreign organization which from the date of its creation has received at
least 85 percent of its support (as defined in section 509(d), other
than section 509(d)(4)) from sources outside the United States. For
purposes of this paragraph, gifts, grants, contributions, or membership
fees directly or indirectly from a United States person (as defined in
section 7701(a)(30)) are from sources within the United States.
(c) Denial of exemption to foreign organizations engaged in
prohibited transactions--(1) In general. A foreign private foundation
described in section 4948(b) and paragraph (b) of this section shall not
be exempt from taxation under section 501(a) if it has engaged in a
prohibited transaction (within the meaning of subparagraph (2) of this
paragraph) after December 31, 1969.
(2) Prohibited transactions. (i) For purposes of this section, the
term ``prohibited transaction'' means any act or failure to act (other
than with respect to section 4942(e), relating to minimum investment
return) which would subject a foreign private foundation described in
paragraph (b) of this section, or a disqualified person (as defined in
section 4946) with respect thereto, to liability for a penalty under
section 6684 (relating to assessable penalties with respect to liability
for tax under Chapter 42) or a tax under section 507 (relating to
termination of private foundation status) if such foreign private
foundation were a domestic private foundation.
(ii) For purposes of subdivision (i) of this subparagraph:
(a) Approval by an appropriate foreign government of grants by the
foreign private foundation to individuals is sufficient to satisfy the
requirements of section 4945(g) and the regulations thereunder.
(b) In determining whether a grantee of the foreign organization is
a private foundation which is not an operating foundation for purposes
of section 4942(g)(1)(A)(ii) or is an organization which is not
described in section 509(a) (1), (2), or (3) for purposes of section
4945 (d)(4) and (h), a determination made by such foreign organization
will be accepted if such determination is made in good faith after a
reasonable effort to identify the status of its grantee.
(iii) For purposes of subdivision (i) of this subparagraph, in order
for an act or failure to act (without regard to section 4942(e)) to be
treated as a prohibited transaction under section 4948(c)(2) by reason
of the application of section 6684(1), there must have been a prior act
or failure to act (without regard to section 4942(e)), which:
(a) Would have resulted in liability for tax under Chapter 42 (other
than section 4940 or 4948(a)) if the foreign private foundation had been
a domestic private foundation, and
(b) Had been the subject of a warning from the Commissioner that a
second act or failure to act (without regard to section 4942(e)) would
result in a prohibited transaction.
The second act or failure to act (with respect to which a warning
described in subparagraph (3)(i) of this paragraph is given) need not be
related to the prior act or failure to act with respect to which a
warning from the Commissioner was given under (b) of this subdivision.
(3) Taxable years affected. (i) Except as provided in subdivision
(ii) of this subparagraph, a foreign private foundation described in
paragraph (b) of this section shall be denied exemption from taxation
under section 501(a) by reason of subparagraph (1) of this paragraph for
all taxable years beginning with the taxable year during which it is
notified by the Commissioner that it has engaged in a prohibited
transaction. The Commissioner shall publish such notice in the Federal
Register on the day on
[[Page 207]]
which he so notifies such foreign private foundation. In the case of an
act or failure to act (without regard to section 4942(e)) which would
result in a penalty under section 6684(1) if the foreign private
foundation were a domestic private foundation, before giving notice
under this subdivision the Commissioner shall warn such foreign private
foundation that such act or failure to act may be treated as a
prohibited transaction. However, such act or failure to act will not be
treated as a prohibited transaction if it is corrected (within the
meaning of Chapter 42 and the regulations thereunder) within 90 days
after the making of such warning.
(ii)(a) Any foreign private foundation described in paragraph (b) of
this section which is denied exemption from taxation under section
501(a) by reason of subparagraph (1) of this paragraph may, with respect
to the second taxable year following the taxable year in which notice is
given under subdivision (i) of this subparagraph (or any taxable year
subsequent to such second taxable year), file a request for exemption
from taxation under section 501(a) on Form 1023. In addition to the
information generally required of an organization requesting exemption
as an organization described in section 501(a), a request under this
subdivision must contain or have attached to it a written declaration,
made under the penalties of perjury, by a principal officer of such
organization authorized to make such declaration, that the organization
will not knowingly again engage in a prohibited transaction.
(b) If the Commissioner is satisfied that such organization will not
knowingly again engage in a prohibited transaction and that the
organization has satisfied all other requirements under section 501, the
organization will be so notified in writing. In such case the
organization shall not, with respect to taxable years beginning with the
taxable year with respect to which a request under this subdivision is
filed, be denied exemption from taxation under section 501(a) by reason
of any prohibited transaction which was engaged in before the date on
which notice was given under subdivision (i) of this subparagraph.
Section 4948(c) provides that an organization denied exemption under
such section will not be exempt from taxation under section 501(a) for
the taxable year in which notice of loss of exemption is given and at
least one immediately subsequent taxable year.
(d) Disallowance of certain charitable deductions. No gift, bequest,
legacy, devise, or transfer shall be allowed as a deduction under
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522, if
made:
(1) To a foreign private foundation described in paragraph (b) of
this section after the date on which the Commissioner publishes notice
under paragraph (c)(3)(i) of this section that he has notified such
organization that it has engaged in a prohibited transaction, and
(2) In a taxable year of such organization for which it is not
exempt from taxation under section 501(a) by reason of paragraph (c)(1)
of this section.
For purposes of this paragraph, a bequest, legacy, devise, or transfer
under section 2055 or 2106(a)(2) shall be treated as made on the date of
death of the decedent. For example, assume that an individual gives
money to a foreign private foundation described in section 4948(b) in
January 1970, January 1971, and January 1972. The organization has a
taxable year from June 1 through May 31. In February 1970, notice is
duly published that the foreign organization has engaged in a prohibited
transaction. In December 1970, the organization duly submits a request
for exemption under paragraph (c)(3)(ii)(a) of this section which is
granted for the taxable year ending May 31, 1972. The January 1970 gift
is allowable as a deduction under section 2522 since it was made before
the notice (February 1970). The January 1971 gift is not allowable as a
deduction because the taxable year ending May 31, 1971, is a nonexempt
year (the first taxable year subsequent to the taxable year of the
notice) for the foreign organization. The January 1972 gift is allowable
as a deduction under section 2522 because the taxable year ending May
31, 1972, is an exempt year for the organization.
[T.D. 7218, 37 FR 23918, Nov. 10, 1972; 37 FR 24748, Nov. 21, 1972; 38
FR 4324, Feb. 13, 1973]
[[Page 208]]
Subpart J_Black Lung Benefit Trust Excise Taxes
Source: T.D. 7644, 44 FR 52198, Sept. 7, 1979, unless otherwise
noted.
Sec. 53.4951-1 Black lung trusts--taxes on self-dealing.
(a) In general. Section 4951 contains provisions that correspond to
provisions of section 4941 (relating to taxes on foundation self-
dealing) and section 4946 (relating to definitions and special rules).
Regulations and rulings under these corresponding provisions apply to
section 4951 where appropriate.
(b) Transfer of property to trust. A transfer of personal property
without consideration to a trust for which a deduction is allowable
under section 192 does not constitute a sale or exchange for purposes of
section 4951 unless the property is subject to a mortgage or similar
lien within section 4951(d)(2)(A). The transfer to a trust of a note or
other evidence of indebtedness constitutes an extension of credit to the
obligor for purposes of section 4951(d)(1)(B).
(c) Deposits. A time or demand deposit made with a bank or credit
union that is a trustee or other disqualified person with respect to a
trust constitutes a lending of money for purposes of section
4951(d)(1)(B) even though the deposit is of a kind generally authorized
for investments by the trust.
(d) Trustee. The term ``trustee'' as used in section 4951(e)(5)(B)
includes any person having powers or responsibilities with respect to a
trust similar to those of trustees.
(e) Misallocation of insurance premium. Under section
501(c)(21)(A)(ii) and Sec. 1.501(c)(21)-1(d), a trust may pay a portion
of a premium for insurance which covers both black lung liabilities and
other liabilities, so long as the requirements of section
501(c)(21)(A)(i) concerning allocation of the total premium are met.
However, if an insurance company misallocates the total premium in a
manner which benefits a disqualified person, the amount of misallocation
constitutes a use of trust assets for the benefit of the disqualified
person within section 4951(d)(1)(D). For these purposes, it is
irrelevant whether the combination of insurance is sold under one policy
or more than one policy.
(f) Effective date. Section 4951 applies with respect to acts that
occur after December 31, 1977, in and for trust taxable years beginning
after December 31, 1977.
Sec. 53.4952-1 Black lung trusts--taxes on taxable expenditures.
(a) In general. Section 4952 contains provisions that generally
correspond to provisions of section 4945 (relating to taxes on taxable
expenditures by private foundations) and section 4946 (relating to
definitions and special rules). Regulations and rulings under these
corresponding provisions apply to section 4952 where appropriate. See
section 4952(e)(1) for the definition of correction.
(b) Unauthorized investments. The term ``taxable expenditure'' in
section 4952(d) includes an investment that is not authorized under
section 501(c)(21)(B)(ii).
(c) Effective date. Section 4952 applies with respect to
expenditures made after December 31, 1977, in and for trust taxable
years beginning after December 31, 1977.
Subpart K_Second Tier Excise Taxes
Source: T.D. 8084, 51 FR 16303, May 2, 1986, unless otherwise noted.
Sec. 53.4955-1 Tax on political expenditures.
(a) Relationship between section 4955 excise taxes and substantive
standards for exemption under section 501(c)(3). The excise taxes
imposed by section 4955 do not affect the substantive standards for tax
exemption under section 501(c)(3), under which an organization is
described in section 501(c)(3) only if it does not participate or
intervene in any political campaign on behalf of any candidate for
public office.
(b) Imposition of initial taxes on organization managers--(1) In
general. The excise tax under section 4955(a)(2) on the agreement of any
organization manager to the making of a political expenditure by a
section 501(c)(3) organization is imposed only in cases where--
[[Page 209]]
(i) A tax is imposed by section 4955(a)(1);
(ii) The organization manager knows that the expenditure to which
the manager agrees is a political expenditure; and
(iii) The agreement is willful and is not due to reasonable cause.
(2) Type of organization managers covered--(i) In general. The tax
under section 4955(a)(2) is imposed only on those organization managers
who are authorized to approve, or to exercise discretion in recommending
approval of, the making of the expenditure by the organization and on
those organization managers who are members of a group (such as the
organization's board of directors or trustees) which is so authorized.
(ii) Officer. For purposes of section 4955(f)(2)(A), a person is an
officer of an organization if--
(A) That person is specifically so designated under the certificate
of incorporation, bylaws, or other constitutive documents of the
foundation; or
(B) That person regularly exercises general authority to make
administrative or policy decisions on behalf of the organization.
Independent contractors, acting in a capacity as attorneys, accountants,
and investment managers and advisors, are not officers. With respect to
any expenditure, any person described in this paragraph (b)(2)(ii)(B)
who has authority merely to recommend particular administrative or
policy decisions, but not to implement them without approval of a
superior, is not an officer.
(iii) Employee. For purposes of section 4955(f)(2)(B), an individual
rendering services to an organization is an employee of the organization
only if that individual is an employee within the meaning of section
3121(d)(2). With respect to any expenditure, an employee (other than an
officer, director, or trustee of the organization) is described in
section 4955(f)(2)(B) only if he or she has final authority or
responsibility (either officially or effectively) with respect to such
expenditure.
(3) Type of agreement required. An organization manager agrees to
the making of a political expenditure if the manager manifests approval
of the expenditure which is sufficient to constitute an exercise of the
organization manager's authority to approve, or to exercise discretion
in recommending approval of, the making of the expenditure by the
organization. The manifestation of approval need not be the final or
decisive approval on behalf of the organization.
(4) Knowing--(i) General rule. For purposes of section 4955, an
organization manager is considered to have agreed to an expenditure
knowing that it is a political expenditure only if--
(A) The manager has actual knowledge of sufficient facts so that,
based solely upon these facts, the expenditure would be a political
expenditure;
(B) The manager is aware that such an expenditure under these
circumstances may violate the provisions of federal tax law governing
political expenditures; and
(C) The manager negligently fails to make reasonable attempts to
ascertain whether the expenditure is a political expenditure, or the
manager is aware that it is a political expenditure.
(ii) Amplification of general rule. For purposes of section 4955,
knowing does not mean having reason to know. However, evidence tending
to show that an organization manager has reason to know of a particular
fact or particular rule is relevant in determining whether the manager
had actual knowledge of the fact or rule. Thus, for example, evidence
tending to show that an organization manager has reason to know of
sufficient facts so that, based solely upon those facts, an expenditure
would be a political expenditure is relevant in determining whether the
manager has actual knowledge of the facts.
(5) Willful. An organization manager's agreement to a political
expenditure is willful if it is voluntary, conscious, and intentional.
No motive to avoid the restrictions of the law or the incurrence of any
tax is necessary to make an agreement willful. However, an organization
manager's agreement to a political expenditure is not willful if the
manager does not know that it is a political expenditure.
(6) Due to reasonable cause. An organization manager's actions are
due to
[[Page 210]]
reasonable cause if the manager has exercised his or her responsibility
on behalf of the organization with ordinary business care and prudence.
(7) Advice of counsel. An organization manager's agreement to an
expenditure is ordinarily not considered knowing or willful and is
ordinarily considered due to reasonable cause if the manager, after full
disclosure of the factual situation to legal counsel (including house
counsel), relies on the advice of counsel expressed in a reasoned
written legal opinion that an expenditure is not a political expenditure
under section 4955 (or that expenditures conforming to certain
guidelines are not political expenditures). For this purpose, a written
legal opinion is considered reasoned even if it reaches a conclusion
which is subsequently determined to be incorrect, so long as the opinion
addresses itself to the facts and applicable law. A written legal
opinion is not considered reasoned if it does nothing more than recite
the facts and express a conclusion. However, the absence of advice of
counsel with respect to an expenditure does not, by itself, give rise to
any inference that an organization manager agreed to the making of the
expenditure knowingly, willfully, or without reasonable cause.
(8) Cross reference. For provisions relating to the burden of proof
in cases involving the issue of whether an organization manager has
knowingly agreed to the making of a political expenditure, see section
7454(b).
(c) Amplification of political expenditure definition--(1) General
rule. Any expenditure that would cause an organization that makes the
expenditure to be classified as an action organization by reason of
Sec. 1.501(c)(3)-1(c)(3)(iii) of this chapter is a political
expenditure within the meaning of section 4955(d)(1).
(2) Other political expenditures--(i) For purposes of section
4955(d)(2), an organization is effectively controlled by a candidate or
prospective candidate only if the individual has a continuing,
substantial involvement in the day-to-day operations or management of
the organization. An organization is not effectively controlled by a
candidate or a prospective candidate merely because it is affiliated
with the candidate, or merely because the candidate knows the directors,
officers, or employees of the organization. The effectively controlled
test is not met merely because the organization carries on its research,
study, or other educational activities with respect to subject matter or
issues in which the individual is interested or with which the
individual is associated.
(ii) For purposes of section 4955(d)(2), a determination of whether
the primary purpose of an organization is promoting the candidacy or
prospective candidacy of an individual for public office is made on the
basis of all the facts and circumstances. The factors to be considered
include whether the surveys, studies, materials, etc. prepared by the
organization are made available only to the candidate or are made
available to the general public; and whether the organization pays for
speeches and travel expenses for only one individual, or for speeches or
travel expenses of several persons. The fact that a candidate or
prospective candidate utilizes studies, papers, materials, etc.,
prepared by the organization (such as in a speech by the candidate) is
not to be considered as a factor indicating that the organization has a
purpose of promoting the candidacy or prospective candidacy of that
individual where such studies, papers, materials, etc. are not made
available only to that individual.
(iii) Expenditures for voter registration, voter turnout, or voter
education constitute other expenses, treated as political expenditures
by reason of section 4955(d)(2)(E), only if the expenditures violate the
prohibition on political activity provided in section 501(c)(3).
(d) Abatement, refund, or no assessment of initial tax. No initial
(first-tier) tax will be imposed under section 4955(a), or the initial
tax will be abated or refunded, if the organization or an organization
manager establishes to the satisfaction of the IRS that--
(1) The political expenditure was not willful and flagrant; and
(2) The political expenditure was corrected.
(e) Correction--(1) Recovery of Expenditure. For purposes of section
4955(f)(3)
[[Page 211]]
and this section, correction of a political expenditure is accomplished
by recovering part or all of the expenditure to the extent recovery is
possible, and, where full recovery cannot be accomplished, by any
additional corrective action which the Commissioner may prescribe. The
organization making the political expenditure is not under any
obligation to attempt to recover the expenditure by legal action if the
action would in all probability not result in the satisfaction of
execution on a judgment.
(2) Establishing safeguards. Correction of a political expenditure
must also involve the establishment of sufficient safeguards to prevent
future political expenditures by the organization. The determination of
whether safeguards are sufficient to prevent future political
expenditures by the organization is made by the District Director.
(f) Effective date. This section is effective December 5, 1995.
[T.D. 8628, 60 FR 62210, Dec. 5, 1995]
Sec. 53.4958-0 Table of contents.
This section lists the major captions contained in Sec. Sec.
53.4958-1 through 53.4958-8.
Sec. 53.4958-1 Taxes on excess benefit transactions
(a) In general.
(b) Excess benefit defined.
(c) Taxes paid by disqualified person.
(1) Initial tax.
(2) Additional tax on disqualified person.
(i) In general.
(ii) Taxable period.
(iii) Abatement if correction during the correction period.
(d) Tax paid by organization managers.
(1) In general.
(2) Organization manager defined.
(i) In general.
(ii) Special rule for certain committee members.
(3) Participation.
(4) Knowing.
(i) In general.
(ii) Amplification of general rule.
(iii) Reliance on professional advice.
(iv) Satisfaction of rebuttable presumption of reasonableness.
(5) Willful.
(6) Due to reasonable cause.
(7) Limits on liability for management.
(8) Joint and several liability.
(9) Burden of proof.
(e) Date of occurrence.
(1) In general.
(2) Special rules.
(3) Statute of limitations rules.
(f) Effective date for imposition of taxes.
(1) In general.
(2) Existing binding contracts.
Sec. 53.4958-2 Definition of applicable tax-exempt organization
(a) Organizations described in section 501(c)(3) or (4) and exempt from
tax under section 501(a).
(1) In general.
(2) Exceptions from definition of applicable tax-exempt organization.
(i) Private foundation.
(ii) Governmental unit or affiliate.
(3) Organizations described in section 501(c)(3).
(4) Organizations described in section 501(c)(4).
(5) Effect of non-recognition or revocation of exempt status.
(b) Special rules.
(1) Transition rule for lookback period.
(2) Certain foreign organizations.
Sec. 53.4958-3 Definition of disqualified person
(a) In general.
(1) Scope of definition.
(2) Transition rule for lookback period.
(b) Statutory categories of disqualified persons.
(1) Family members.
(2) Thirty-five percent controlled entities.
(i) In general.
(ii) Combined voting power.
(iii) Constructive ownership rules.
(A) Stockholdings.
(B) Profits or beneficial interest.
(c) Persons having substantial influence.
(1) Voting members of the governing body.
(2) Presidents, chief executive officers, or chief operating officers.
(3) Treasurers and chief financial officers.
(4) Persons with a material financial interest in a provider-sponsored
organization.
(d) Persons deemed not to have substantial influence.
(1) Tax-exempt organizations described in section 501(c)(3).
(2) Certain section 501(c)(4) organizations.
(3) Employees receiving economic benefits of less than a specified
amount in a taxable year.
(e) Facts and circumstances govern in all other cases.
(1) In general.
(2) Facts and circumstances tending to show substantial influence.
(3) Facts and circumstances tending to show no substantial influence.
(f) Affiliated organizations.
(g) Examples.
Sec. 53.4958-4 Excess benefit transaction
(a) Definition of excess benefit transaction.
[[Page 212]]
(1) In general.
(2) Economic benefit provided indirectly.
(i) In general.
(ii) Through a controlled entity.
(A) In general.
(B) Definition of control.
(1) In general.
(2) Constructive ownership.
(iii) Through an intermediary.
(iv) Examples.
(3) Exception for fixed payments made pursuant to an initial contract.
(i) In general.
(ii) Fixed payment.
(A) In general.
(B) Special rules.
(iii) Initial contract.
(iv) Substantial performance required.
(v) Treatment as a new contract.
(vi) Evaluation of non-fixed payments.
(vii) Examples.
(4) Certain economic benefits disregarded for purposes of section 4958.
(i) Nontaxable fringe benefits.
(ii) Expense reimbursement payments pursuant to accountable plans.
(iii) Certain economic benefits provided to a volunteer for the
organization.
(iv) Certain economic benefits provided to a member of, or donor to, the
organization.
(v) Economic benefits provided to a charitable beneficiary.
(vi) Certain economic benefits provided to a governmental unit.
(5) Exception for certain payments made pursuant to an exemption granted
by the Department of Labor under ERISA.
(b) Valuation standards.
(1) In general.
(i) Fair market value of property.
(ii) Reasonable compensation.
(A) In general.
(B) Items included in determining the value of compensation for purposes
of determining reasonableness under section 4958.
(C) Inclusion in compensation for reasonableness determination does not
govern income tax treatment.
(2) Timing of reasonableness determination.
(i) In general.
(ii) Treatment as a new contract.
(iii) Examples.
(c) Establishing intent to treat economic benefit as consideration for
the performance of services.
(1) In general.
(2) Nontaxable benefits.
(3) Contemporaneous substantiation.
(i) Reporting of benefit.
(A) In general.
(B) Failure to report due to reasonable cause.
(ii) Other written contemporaneous evidence.
(4) Examples.
Sec. 53.4958-5 Transaction in which the amount of the economic benefit
is determined in whole or in part by the revenues of one or more
activities of the organization. [Reserved]
Sec. 53.4958-6 Rebuttable presumption that a transaction is not an
excess benefit transaction.
(a) In general.
(b) Rebutting the presumption.
(c) Requirements for invoking rebuttable presumption.
(1) Approval by an authorized body.
(i) In general.
(ii) Individuals not included on authorized body.
(iii) Absence of conflict of interest.
(2) Appropriate data as to comparability.
(i) In general.
(ii) Special rule for compensation paid by small organizations.
(iii) Application of special rule for small organizations.
(iv) Examples.
(3) Documentation.
(d) No presumption with respect to non-fixed payments until amounts are
determined.
(1) In general.
(2) Special rule for certain non-fixed payments subject to a cap.
(e) No inference from absence of presumption.
(f) Period of reliance on rebuttable presumption.
Sec. 53.4958-7 Correction.
(a) In general.
(b) Form of correction.
(1) Cash or cash equivalents.
(2) Anti-abuse rule.
(3) Special rule relating to nonqualified deferred compensation.
(4) Return of specific property.
(i) In general.
(ii) Payment not equal to correction amount.
(iii) Disqualified person may not participate in decision.
(c) Correction amount.
(d) Correction where contract has been partially performed.
(e) Correction in the case of an applicable tax-exempt organization that
has ceased to exist, or is no longer tax-exempt.
(1) In general.
(2) Section 501(c)(3) organizations.
(3) Section 501(c)(4) organizations.
(f) Examples.
Sec. 53.4958-8 Special rules.
(a) Substantive requirements for exemption still apply.
(b) Interaction between section 4958 and section 7611 rules for church
tax inquiries and examinations.
(c) Other substantiation requirements.
[T.D. 8978, 67 FR 3083, Jan. 23, 2002]
[[Page 213]]
Sec. 53.4958-1 Taxes on excess benefit transactions.
(a) In general. Section 4958 imposes excise taxes on each excess
benefit transaction (as defined in section 4958(c) and Sec. 53.4958-4)
between an applicable tax-exempt organization (as defined in section
4958(e) and Sec. 53.4958-2) and a disqualified person (as defined in
section 4958(f)(1) and Sec. 53.4958-3). A disqualified person who
receives an excess benefit from an excess benefit transaction is liable
for payment of a section 4958(a)(1) excise tax equal to 25 percent of
the excess benefit. If an initial tax is imposed by section 4958(a)(1)
on an excess benefit transaction and the transaction is not corrected
(as defined in section 4958(f)(6) and Sec. 53.4958-7) within the
taxable period (as defined in section 4958(f)(5) and paragraph
(c)(2)(ii) of this section), then any disqualified person who received
an excess benefit from the excess benefit transaction on which the
initial tax was imposed is liable for an additional tax of 200 percent
of the excess benefit. An organization manager (as defined in section
4958(f)(2) and paragraph (d) of this section) who participates in an
excess benefit transaction, knowing that it was such a transaction, is
liable for payment of a section 4958(a)(2) excise tax equal to 10
percent of the excess benefit, unless the participation was not willful
and was due to reasonable cause. If an organization manager also
receives an excess benefit from an excess benefit transaction, the
manager may be liable for both taxes imposed by section 4958(a).
(b) Excess benefit defined. An excess benefit is the amount by which
the value of the economic benefit provided by an applicable tax-exempt
organization directly or indirectly to or for the use of any
disqualified person exceeds the value of the consideration (including
the performance of services) received for providing such benefit.
(c) Taxes paid by disqualified person--(1) Initial tax. Section
4958(a)(1) imposes a tax equal to 25 percent of the excess benefit on
each excess benefit transaction. The section 4958(a)(1) tax shall be
paid by any disqualified person who received an excess benefit from that
excess benefit transaction. With respect to any excess benefit
transaction, if more than one disqualified person is liable for the tax
imposed by section 4958(a)(1), all such persons are jointly and
severally liable for that tax.
(2) Additional tax on disqualified person--(i) In general. Section
4958(b) imposes a tax equal to 200 percent of the excess benefit in any
case in which section 4958(a)(1) imposes a 25-percent tax on an excess
benefit transaction and the transaction is not corrected (as defined in
section 4958(f)(6) and Sec. 53.4958-7) within the taxable period (as
defined in section 4958(f)(5) and paragraph (c)(2)(ii) of this section).
If a disqualified person makes a payment of less than the full
correction amount under the rules of Sec. 53.4958-7, the 200-percent
tax is imposed only on the unpaid portion of the correction amount (as
described in Sec. 53.4958-7(c)). The tax imposed by section 4958(b) is
payable by any disqualified person who received an excess benefit from
the excess benefit transaction on which the initial tax was imposed by
section 4958(a)(1). With respect to any excess benefit transaction, if
more than one disqualified person is liable for the tax imposed by
section 4958(b), all such persons are jointly and severally liable for
that tax.
(ii) Taxable period. Taxable period means, with respect to any
excess benefit transaction, the period beginning with the date on which
the transaction occurs and ending on the earlier of--
(A) The date of mailing a notice of deficiency under section 6212
with respect to the section 4958(a)(1) tax; or
(B) The date on which the tax imposed by section 4958(a)(1) is
assessed.
(iii) Abatement if correction during the correction period. For
rules relating to abatement of taxes on excess benefit transactions that
are corrected within the correction period, as defined in section
4963(e), see sections 4961(a), 4962(a), and the regulations thereunder.
The abatement rules of section 4961 specifically provide for a 90-day
correction period after the date of mailing a notice of deficiency under
section 6212 with respect to the section 4958(b) 200-percent tax. If the
excess benefit is corrected during that correction period, the 200-
percent tax imposed shall not be assessed, and if assessed the
assessment shall be abated, and if collected
[[Page 214]]
shall be credited or refunded as an overpayment. For special rules
relating to abatement of the 25-percent tax, see section 4962.
(d) Tax paid by organization managers--(1) In general. In any case
in which section 4958(a)(1) imposes a tax, section 4958(a)(2) imposes a
tax equal to 10 percent of the excess benefit on the participation of
any organization manager who knowingly participated in the excess
benefit transaction, unless such participation was not willful and was
due to reasonable cause. Any organization manager who so participated in
the excess benefit transaction must pay the tax.
(2) Organization manager defined--(i) In general. An organization
manager is, with respect to any applicable tax-exempt organization, any
officer, director, or trustee of such organization, or any individual
having powers or responsibilities similar to those of officers,
directors, or trustees of the organization, regardless of title. A
person is an officer of an organization if that person--
(A) Is specifically so designated under the certificate of
incorporation, by-laws, or other constitutive documents of the
organization; or
(B) Regularly exercises general authority to make administrative or
policy decisions on behalf of the organization. A contractor who acts
solely in a capacity as an attorney, accountant, or investment manager
or advisor, is not an officer. For purposes of this paragraph
(d)(2)(i)(B), any person who has authority merely to recommend
particular administrative or policy decisions, but not to implement them
without approval of a superior, is not an officer.
(ii) Special rule for certain committee members. An individual who
is not an officer, director, or trustee, yet serves on a committee of
the governing body of an applicable tax-exempt organization (or as a
designee of the governing body described in Sec. 53.4958-6(c)(1)) that
is attempting to invoke the rebuttable presumption of reasonableness
described in Sec. 53.4958-6 based on the committee's (or designee's)
actions, is an organization manager for purposes of the tax imposed by
section 4958(a)(2).
(3) Participation. For purposes of section 4958(a)(2) and this
paragraph (d), participation includes silence or inaction on the part of
an organization manager where the manager is under a duty to speak or
act, as well as any affirmative action by such manager. An organization
manager is not considered to have participated in an excess benefit
transaction, however, where the manager has opposed the transaction in a
manner consistent with the fulfillment of the manager's responsibilities
to the applicable tax-exempt organization.
(4) Knowing--(i) In general. For purposes of section 4958(a)(2) and
this paragraph (d), a manager participates in a transaction knowingly
only if the person--
(A) Has actual knowledge of sufficient facts so that, based solely
upon those facts, such transaction would be an excess benefit
transaction;
(B) Is aware that such a transaction under these circumstances may
violate the provisions of Federal tax law governing excess benefit
transactions; and
(C) Negligently fails to make reasonable attempts to ascertain
whether the transaction is an excess benefit transaction, or the manager
is in fact aware that it is such a transaction.
(ii) Amplification of general rule. Knowing does not mean having
reason to know. However, evidence tending to show that a manager has
reason to know of a particular fact or particular rule is relevant in
determining whether the manager had actual knowledge of such a fact or
rule. Thus, for example, evidence tending to show that a manager has
reason to know of sufficient facts so that, based solely upon such
facts, a transaction would be an excess benefit transaction is relevant
in determining whether the manager has actual knowledge of such facts.
(iii) Reliance on professional advice. An organization manager's
participation in a transaction is ordinarily not considered knowing
within the meaning of section 4958(a)(2), even though the transaction is
subsequently held to be an excess benefit transaction, to the extent
that, after full disclosure of the factual situation to an appropriate
professional, the organization manager relies on a reasoned written
opinion of
[[Page 215]]
that professional with respect to elements of the transaction within the
professional's expertise. For purposes of section 4958(a)(2) and this
paragraph (d), a written opinion is reasoned even though it reaches a
conclusion that is subsequently determined to be incorrect so long as
the opinion addresses itself to the facts and the applicable standards.
However, a written opinion is not reasoned if it does nothing more than
recite the facts and express a conclusion. The absence of a written
opinion of an appropriate professional with respect to a transaction
shall not, by itself, however, give rise to any inference that an
organization manager participated in the transaction knowingly. For
purposes of this paragraph, appropriate professionals on whose written
opinion an organization manager may rely, are limited to--
(A) Legal counsel, including in-house counsel;
(B) Certified public accountants or accounting firms with expertise
regarding the relevant tax law matters; and
(C) Independent valuation experts who--
(1) Hold themselves out to the public as appraisers or compensation
consultants;
(2) Perform the relevant valuations on a regular basis;
(3) Are qualified to make valuations of the type of property or
services involved; and
(4) Include in the written opinion a certification that the
requirements of paragraphs (d)(4)(iii)(C)(1) through (3) of this section
are met.
(iv) Satisfaction of rebuttable presumption of reasonableness. An
organization manager's participation in a transaction is ordinarily not
considered knowing within the meaning of section 4958(a)(2), even though
the transaction is subsequently held to be an excess benefit
transaction, if the appropriate authorized body has met the requirements
of Sec. 53.4958-6(a) with respect to the transaction.
(5) Willful. For purposes of section 4958(a)(2) and this paragraph
(d), participation by an organization manager is willful if it is
voluntary, conscious, and intentional. No motive to avoid the
restrictions of the law or the incurrence of any tax is necessary to
make the participation willful. However, participation by an
organization manager is not willful if the manager does not know that
the transaction in which the manager is participating is an excess
benefit transaction.
(6) Due to reasonable cause. An organization manager's participation
is due to reasonable cause if the manager has exercised responsibility
on behalf of the organization with ordinary business care and prudence.
(7) Limits on liability for management. The maximum aggregate amount
of tax collectible under section 4958(a)(2) and this paragraph (d) from
organization managers with respect to any one excess benefit transaction
is $10,000.
(8) Joint and several liability. In any case where more than one
person is liable for a tax imposed by section 4958(a)(2), all such
persons shall be jointly and severally liable for the taxes imposed
under section 4958(a)(2) with respect to that excess benefit
transaction.
(9) Burden of proof. For provisions relating to the burden of proof
in cases involving the issue of whether an organization manager has
knowingly participated in an excess benefit transaction, see section
7454(b) and Sec. 301.7454-2 of this chapter. In these cases, the
Commissioner bears the burden of proof.
(e) Date of occurrence--(1) In general. Except as otherwise
provided, an excess benefit transaction occurs on the date on which the
disqualified person receives the economic benefit for Federal income tax
purposes. When a single contractual arrangement provides for a series of
compensation or other payments to (or for the use of) a disqualified
person over the course of the disqualified person's taxable year (or
part of a taxable year), any excess benefit transaction with respect to
these aggregate payments is deemed to occur on the last day of the
taxable year (or if the payments continue for part of the year, the date
of the last payment in the series).
(2) Special rules. In the case of benefits provided pursuant to a
qualified pension, profit-sharing, or stock bonus plan, the transaction
occurs on the date the benefit is vested. In the case of a transfer of
property that is subject
[[Page 216]]
to a substantial risk of forfeiture or in the case of rights to future
compensation or property (including benefits under a nonqualified
deferred compensation plan), the transaction occurs on the date the
property, or the rights to future compensation or property, is not
subject to a substantial risk of forfeiture. However, where the
disqualified person elects to include an amount in gross income in the
taxable year of transfer pursuant to section 83(b), the general rule of
paragraph (e)(1) of this section applies to the property with respect to
which the section 83(b) election is made. Any excess benefit transaction
with respect to benefits under a deferred compensation plan which vest
during any taxable year of the disqualified person is deemed to occur on
the last day of such taxable year. For the rules governing the timing of
the reasonableness determination for deferred, contingent, and certain
other noncash compensation, see Sec. 53.4958-4(b)(2).
(3) Statute of limitations rules. See sections 6501(e)(3) and (l)
and the regulations thereunder for statute of limitations rules as they
apply to section 4958 excise taxes.
(f) Effective date for imposition of taxes--(1) In general. The
section 4958 taxes imposed on excess benefit transactions or on
participation in excess benefit transactions apply to transactions
occurring on or after September 14, 1995.
(2) Existing binding contracts. The section 4958 taxes do not apply
to any transaction occurring pursuant to a written contract that was
binding on September 13, 1995, and at all times thereafter before the
transaction occurs. A written binding contract that is terminable or
subject to cancellation by the applicable tax-exempt organization
without the disqualified person's consent (including as the result of a
breach of contract by the disqualified person) and without substantial
penalty to the organization, is no longer treated as a binding contract
as of the earliest date that any such termination or cancellation, if
made, would be effective. If a binding written contract is materially
changed, it is treated as a new contract entered into as of the date the
material change is effective. A material change includes an extension or
renewal of the contract (other than an extension or renewal that results
from the person contracting with the applicable tax-exempt organization
unilaterally exercising an option expressly granted by the contract), or
a more than incidental change to any payment under the contract.
[T.D. 8978, 67 FR 3083, Jan. 23, 2002]
Sec. 53.4958-2 Definition of applicable tax-exempt organization.
(a) Organizations described in section 501(c)(3) or (4) and exempt
from tax under section 501(a)--(1) In general. An applicable tax-exempt
organization is any organization that, without regard to any excess
benefit, would be described in section 501(c)(3) or (4) and exempt from
tax under section 501(a). An applicable tax-exempt organization also
includes any organization that was described in section 501(c)(3) or (4)
and was exempt from tax under section 501(a) at any time during a five-
year period ending on the date of an excess benefit transaction (the
lookback period).
(2) Exceptions from definition of applicable tax-exempt
organization--(i) Private foundation. A private foundation as defined in
section 509(a) is not an applicable tax-exempt organization for section
4958 purposes.
(ii) Governmental unit or affiliate. A governmental unit or an
affiliate of a governmental unit is not an applicable tax-exempt
organization for section 4958 purposes if it is--
(A) Exempt from (or not subject to) taxation without regard to
section 501(a); or
(B) Relieved from filing an annual return pursuant to the authority
of Sec. 1.6033-2(g)(6).
(3) Organizations described in section 501(c)(3). An organization is
described in section 501(c)(3) for purposes of section 4958 only if the
organization--
(i) Provides the notice described in section 508; or
(ii) Is described in section 501(c)(3) and specifically is excluded
from the requirements of section 508 by that section.
(4) Organizations described in section 501(c)(4). An organization is
described
[[Page 217]]
in section 501(c)(4) for purposes of section 4958 only if the
organization--
(i) Has applied for and received recognition from the Internal
Revenue Service as an organization described in section 501(c)(4); or
(ii) Has filed an application for recognition under section
501(c)(4) with the Internal Revenue Service, has filed an annual
information return as a section 501(c)(4) organization under the
Internal Revenue Code or regulations promulgated thereunder, or has
otherwise held itself out as being described in section 501(c)(4) and
exempt from tax under section 501(a).
(5) Effect of non-recognition or revocation of exempt status. An
organization is not described in paragraph (a)(3) or (4) of this section
during any period covered by a final determination or adjudication that
the organization is not exempt from tax under section 501(a) as an
organization described in section 501(c)(3) or (4), so long as that
determination or adjudication is not based upon participation in
inurement or one or more excess benefit transactions. However, the
organization may be an applicable tax-exempt organization for that
period as a result of the five-year lookback period described in
paragraph (a)(1) of this section.
(6) Examples. The following examples illustrate the principles of
this section, which defines an applicable tax-exempt organization for
purposes of section 4958:
Example 1. O is a nonprofit corporation formed under state law. O
filed its application for recognition of exemption under section
501(c)(3) within the time prescribed under section 508(a). In its
application, O described its plans for purchasing property from some of
its directors at prices that would exceed fair market value. After
reviewing the application, the IRS determined that because of the
proposed property purchase transactions, O failed to establish that it
met the requirements for an organization described in section 501(c)(3).
Accordingly, the IRS denied O's application. While O's application was
pending, O engaged in the purchase transactions described in its
application at prices that exceeded the fair market values of the
properties. Although these transactions would constitute excess benefit
transactions under section 4958, because the IRS never recognized O as
an organization described in section 501(c)(3), O was never an
applicable tax-exempt organization under section 4958. Therefore, these
transactions are not subject to the excise taxes provided in section
4958.
Example 2. O is a nonprofit corporation formed under state law. O
files its application for recognition of exemption under section
501(c)(3) within the time prescribed under section 508(a). The IRS
issues a favorable determination letter in Year 1 that recognizes O as
an organization described in section 501(c)(3). Subsequently, in Year 5
of O's operations, O engages in certain transactions that constitute
excess benefit transactions under section 4958 and violate the
proscription against inurement under section 501(c)(3) and Sec.
1.501(c)(3)-1(c)(2). The IRS examines the Form 990, ``Return of
Organization Exempt From Income Tax'', that O filed for Year 5. After
considering all the relevant facts and circumstances in accordance with
Sec. 1.501(c)(3)-1(f), the IRS concludes that O is no longer described
in section 501(c)(3) effective in Year 5. The IRS does not examine the
Forms 990 that O filed for its first four years of operations and,
accordingly, does not revoke O's exempt status for those years. Although
O's tax-exempt status is revoked effective in Year 5, under the lookback
rules in paragraph (a)(1) of this section and Sec. 53.4958-3(a)(1) of
this chapter, during the five-year period prior to the excess benefit
transactions that occurred in Year 5, O was an applicable tax-exempt
organization and O's directors were disqualified persons as to O.
Therefore, the transactions between O and its directors during Year 5
are subject to the applicable excise taxes provided in section 4958.
(b) Special rules--(1) Transition rule for lookback period. In the
case of any excess benefit transaction occurring before September 14,
2000, the lookback period described in paragraph (a)(1) of this section
begins on September 14, 1995, and ends on the date of the transaction.
(2) Certain foreign organizations. A foreign organization,
recognized by the Internal Revenue Service or by treaty, that receives
substantially all of its support (other than gross investment income)
from sources outside of the United States is not an organization
described in section 501(c)(3) or (4) for purposes of section 4958.
[T.D. 8978, 67 FR 3083, Jan. 23, 2002, as amended by T.D. 9390, 73 FR
16524, Mar. 28, 2008]
Sec. 53.4958-3 Definition of disqualified person.
(a) In general--(1) Scope of definition. Section 4958(f)(1) defines
disqualified person, with respect to any transaction,
[[Page 218]]
as any person who was in a position to exercise substantial influence
over the affairs of an applicable tax-exempt organization at any time
during the five-year period ending on the date of the transaction (the
lookback period). Paragraph (b) of this section describes persons who
are defined to be disqualified persons under the statute, including
certain family members of an individual in a position to exercise
substantial influence, and certain 35-percent controlled entities.
Paragraph (c) of this section describes persons in a position to
exercise substantial influence over the affairs of an applicable tax-
exempt organization by virtue of their powers and responsibilities or
certain interests they hold. Paragraph (d) of this section describes
persons deemed not to be in a position to exercise substantial
influence. Whether any person who is not described in paragraph (b), (c)
or (d) of this section is a disqualified person with respect to a
transaction for purposes of section 4958 is based on all relevant facts
and circumstances, as described in paragraph (e) of this section.
Paragraph (f) of this section describes special rules for affiliated
organizations. Examples in paragraph (g) of this section illustrate
these categories of persons.
(2) Transition rule for lookback period. In the case of any excess
benefit transaction occurring before September 14, 2000, the lookback
period described in paragraph (a)(1) of this section begins on September
14, 1995, and ends on the date of the transaction.
(b) Statutory categories of disqualified persons--(1) Family
members. A person is a disqualified person with respect to any
transaction with an applicable tax-exempt organization if the person is
a member of the family of a person who is a disqualified person
described in paragraph (a) of this section (other than as a result of
this paragraph) with respect to any transaction with the same
organization. For purposes of the following sentence, a legally adopted
child of an individual is treated as a child of such individual by
blood. A person's family is limited to--
(i) Spouse;
(ii) Brothers or sisters (by whole or half blood);
(iii) Spouses of brothers or sisters (by whole or half blood);
(iv) Ancestors;
(v) Children;
(vi) Grandchildren;
(vii) Great grandchildren; and
(viii) Spouses of children, grandchildren, and great grandchildren.
(2) Thirty-five percent controlled entities--(i) In general. A
person is a disqualified person with respect to any transaction with an
applicable tax-exempt organization if the person is a 35-percent
controlled entity. A 35-percent controlled entity is--
(A) A corporation in which persons described in this section (except
in paragraphs (b)(2) and (d) of this section) own more than 35 percent
of the combined voting power;
(B) A partnership in which persons described in this section (except
in paragraphs (b)(2) and (d) of this section) own more than 35 percent
of the profits interest; or
(C) A trust or estate in which persons described in this section
(except in paragraphs (b)(2) and (d) of this section) own more than 35
percent of the beneficial interest.
(ii) Combined voting power. For purposes of this paragraph (b)(2),
combined voting power includes voting power represented by holdings of
voting stock, direct or indirect, but does not include voting rights
held only as a director, trustee, or other fiduciary.
(iii) Constructive ownership rules--(A) Stockholdings. For purposes
of section 4958(f)(3) and this paragraph (b)(2), indirect stockholdings
are taken into account as under section 267(c), except that in applying
section 267(c)(4), the family of an individual shall include the members
of the family specified in section 4958(f)(4) and paragraph (b)(1) of
this section.
(B) Profits or beneficial interest. For purposes of section
4958(f)(3) and this paragraph (b)(2), the ownership of profits or
beneficial interests shall be determined in accordance with the rules
for constructive ownership of stock provided in section 267(c) (other
than section 267(c)(3)), except that in applying section 267(c)(4), the
family of an individual shall include the members of the family
specified in section 4958(f)(4) and paragraph (b)(1) of this section.
[[Page 219]]
(c) Persons having substantial influence. A person who holds any of
the following powers, responsibilities, or interests is in a position to
exercise substantial influence over the affairs of an applicable tax-
exempt organization:
(1) Voting members of the governing body. This category includes any
individual serving on the governing body of the organization who is
entitled to vote on any matter over which the governing body has
authority.
(2) Presidents, chief executive officers, or chief operating
officers. This category includes any person who, regardless of title,
has ultimate responsibility for implementing the decisions of the
governing body or for supervising the management, administration, or
operation of the organization. A person who serves as president, chief
executive officer, or chief operating officer has this ultimate
responsibility unless the person demonstrates otherwise. If this
ultimate responsibility resides with two or more individuals (e.g., co-
presidents), who may exercise such responsibility in concert or
individually, then each individual is in a position to exercise
substantial influence over the affairs of the organization.
(3) Treasurers and chief financial officers. This category includes
any person who, regardless of title, has ultimate responsibility for
managing the finances of the organization. A person who serves as
treasurer or chief financial officer has this ultimate responsibility
unless the person demonstrates otherwise. If this ultimate
responsibility resides with two or more individuals who may exercise the
responsibility in concert or individually, then each individual is in a
position to exercise substantial influence over the affairs of the
organization.
(4) Persons with a material financial interest in a provider-
sponsored organization. For purposes of section 4958, if a hospital that
participates in a provider-sponsored organization (as defined in section
1855(e) of the Social Security Act, 42 U.S.C. 1395w-25) is an applicable
tax-exempt organization, then any person with a material financial
interest (within the meaning of section 501(o)) in the provider-
sponsored organization has substantial influence with respect to the
hospital.
(d) Persons deemed not to have substantial influence. A person is
deemed not to be in a position to exercise substantial influence over
the affairs of an applicable tax-exempt organization if that person is
described in one of the following categories:
(1) Tax-exempt organizations described in section 501(c)(3). This
category includes any organization described in section 501(c)(3) and
exempt from tax under section 501(a).
(2) Certain section 501(c)(4) organizations. Only with respect to an
applicable tax-exempt organization described in section 501(c)(4) and
Sec. 53.4958-2(a)(4), this category includes any other organization so
described.
(3) Employees receiving economic benefits of less than a specified
amount in a taxable year. This category includes, for the taxable year
in which benefits are provided, any full- or part-time employee of the
applicable tax-exempt organization who--
(i) Receives economic benefits, directly or indirectly from the
organization, of less than the amount referenced for a highly
compensated employee in section 414(q)(1)(B)(i);
(ii) Is not described in paragraph (b) or (c) of this section with
respect to the organization; and
(iii) Is not a substantial contributor to the organization within
the meaning of section 507(d)(2)(A), taking into account only
contributions received by the organization during its current taxable
year and the four preceding taxable years.
(e) Facts and circumstances govern in all other cases--(1) In
general. Whether a person who is not described in paragraph (b), (c) or
(d) of this section is a disqualified person depends upon all relevant
facts and circumstances.
(2) Facts and circumstances tending to show substantial influence.
Facts and circumstances tending to show that a person has substantial
influence over the affairs of an organization include, but are not
limited to, the following--
(i) The person founded the organization;
(ii) The person is a substantial contributor to the organization
(within the meaning of section 507(d)(2)(A)), taking into account only
contributions received by the organization during its
[[Page 220]]
current taxable year and the four preceding taxable years;
(iii) The person's compensation is primarily based on revenues
derived from activities of the organization, or of a particular
department or function of the organization, that the person controls;
(iv) The person has or shares authority to control or determine a
substantial portion of the organization's capital expenditures,
operating budget, or compensation for employees;
(v) The person manages a discrete segment or activity of the
organization that represents a substantial portion of the activities,
assets, income, or expenses of the organization, as compared to the
organization as a whole;
(vi) The person owns a controlling interest (measured by either vote
or value) in a corporation, partnership, or trust that is a disqualified
person; or
(vii) The person is a non-stock organization controlled, directly or
indirectly, by one or more disqualified persons.
(3) Facts and circumstances tending to show no substantial
influence. Facts and circumstances tending to show that a person does
not have substantial influence over the affairs of an organization
include, but are not limited to, the following--
(i) The person has taken a bona fide vow of poverty as an employee,
agent, or on behalf, of a religious organization;
(ii) The person is a contractor (such as an attorney, accountant, or
investment manager or advisor) whose sole relationship to the
organization is providing professional advice (without having decision-
making authority) with respect to transactions from which the contractor
will not economically benefit either directly or indirectly (aside from
customary fees received for the professional advice rendered);
(iii) The direct supervisor of the individual is not a disqualified
person;
(iv) The person does not participate in any management decisions
affecting the organization as a whole or a discrete segment or activity
of the organization that represents a substantial portion of the
activities, assets, income, or expenses of the organization, as compared
to the organization as a whole; or
(v) Any preferential treatment a person receives based on the size
of that person's contribution is also offered to all other donors making
a comparable contribution as part of a solicitation intended to attract
a substantial number of contributions.
(f) Affiliated organizations. In the case of multiple organizations
affiliated by common control or governing documents, the determination
of whether a person does or does not have substantial influence shall be
made separately for each applicable tax-exempt organization. A person
may be a disqualified person with respect to transactions with more than
one applicable tax-exempt organization.
(g) Examples. The following examples illustrate the principles of
this section. A finding that a person is a disqualified person in the
following examples does not indicate that an excess benefit transaction
has occurred. If a person is a disqualified person, the rules of section
4958(c) and Sec. 53.4958-4 apply to determine whether an excess benefit
transaction has occurred. The examples are as follows:
Example 1. N, an artist by profession, works part-time at R, a local
museum. In the first taxable year in which R employs N, R pays N a
salary and provides no additional benefits to N except for free
admission to the museum, a benefit R provides to all of its employees
and volunteers. The total economic benefits N receives from R during the
taxable year are less than the amount referenced for a highly
compensated employee in section 414(q)(1)(B)(i). The part-time job
constitutes N's only relationship with R. N is not related to any other
disqualified person with respect to R. N is deemed not to be in a
position to exercise substantial influence over the affairs of R.
Therefore, N is not a disqualified person with respect to R in that
year.
Example 2. The facts are the same as in Example 1, except that in
addition to the salary that R pays N for N's services during the taxable
year, R also purchases one of N's paintings for $x. The total of N's
salary plus $x exceeds the amount referenced for highly compensated
employees in section 414(q)(1)(B)(i). Consequently, whether N is in a
position to exercise substantial influence over the affairs of R for
that taxable year depends upon all of the relevant facts and
circumstances.
Example 3. Q is a member of K, a section 501(c)(3) organization with
a broad-based
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public membership. Members of K are entitled to vote only with respect
to the annual election of directors and the approval of major
organizational transactions such as a merger or dissolution. Q is not
related to any other disqualified person of K. Q has no other
relationship to K besides being a member of K and occasionally making
modest donations to K. Whether Q is a disqualified person is determined
by all relevant facts and circumstances. Q's voting rights, which are
the same as granted to all members of K, do not place Q in a position to
exercise substantial influence over K. Under these facts and
circumstances, Q is not a disqualified person with respect to K.
Example 4. E is the headmaster of Z, a school that is an applicable
tax-exempt organization for purposes of section 4958. E reports to Z's
board of trustees and has ultimate responsibility for supervising Z's
day-to-day operations. For example, E can hire faculty members and
staff, make changes to the school's curriculum and discipline students
without specific board approval. Because E has ultimate responsibility
for supervising the operation of Z, E is in a position to exercise
substantial influence over the affairs of Z. Therefore, E is a
disqualified person with respect to Z.
Example 5. Y is an applicable tax-exempt organization for purposes
of section 4958 that decides to use bingo games as a method of
generating revenue. Y enters into a contract with B, a company that
operates bingo games. Under the contract, B manages the promotion and
operation of the bingo activity, provides all necessary staff,
equipment, and services, and pays Y q percent of the revenue from this
activity. B retains the balance of the proceeds. Y provides no goods or
services in connection with the bingo operation other than the use of
its hall for the bingo games. The annual gross revenue earned from the
bingo games represents more than half of Y's total annual revenue. B's
compensation is primarily based on revenues from an activity B controls.
B also manages a discrete activity of Y that represents a substantial
portion of Y's income compared to the organization as a whole. Under
these facts and circumstances, B is in a position to exercise
substantial influence over the affairs of Y. Therefore, B is a
disqualified person with respect to Y.
Example 6. The facts are the same as in Example 5, with the
additional fact that P owns a majority of the stock of B and is actively
involved in managing B. Because P owns a controlling interest (measured
by either vote or value) in and actively manages B, P is also in a
position to exercise substantial influence over the affairs of Y.
Therefore, under these facts and circumstances, P is a disqualified
person with respect to Y.
Example 7. A, an applicable tax-exempt organization for purposes of
section 4958, owns and operates one acute care hospital. B, a for-profit
corporation, owns and operates a number of hospitals. A and B form C, a
limited liability company. In exchange for proportional ownership
interests, A contributes its hospital, and B contributes other assets,
to C. All of A's assets then consist of its membership interest in C. A
continues to be operated for exempt purposes based almost exclusively on
the activities it conducts through C. C enters into a management
agreement with a management company, M, to provide day to day management
services to C. Subject to supervision by C's board, M is given broad
discretion to manage C's day to day operation and has ultimate
responsibility for supervising the management of the hospital. Because M
has ultimate responsibility for supervising the management of the
hospital operated by C, A's ownership interest in C is its primary
asset, and C's activities form the basis for A's continued exemption as
an organization described in section 501(c)(3), M is in a position to
exercise substantial influence over the affairs of A. Therefore, M is a
disqualified person with respect to A.
Example 8. T is a large university and an applicable tax-exempt
organization for purposes of section 4958. L is the dean of the College
of Law of T, a substantial source of revenue for T, including
contributions from alumni and foundations. L is not related to any other
disqualified person of T. L does not serve on T's governing body or have
ultimate responsibility for managing the university as whole. However,
as dean of the College of Law, L plays a key role in faculty hiring and
determines a substantial portion of the capital expenditures and
operating budget of the College of Law. L's compensation is greater than
the amount referenced for a highly compensated employee in section
414(q)(1)(B)(i) in the year benefits are provided. L's management of a
discrete segment of T that represents a substantial portion of the
income of T (as compared to T as a whole) places L in a position to
exercise substantial influence over the affairs of T. Under these facts
and circumstances L is a disqualified person with respect to T.
Example 9. S chairs a small academic department in the College of
Arts and Sciences of the same university T described in Example 8. S is
not related to any other disqualified person of T. S does not serve on
T's governing body or as an officer of T. As department chair, S
supervises faculty in the department, approves the course curriculum,
and oversees the operating budget for the department. S's compensation
is greater than the amount referenced for a highly compensated employee
in section 414(q)(1)(B)(i) in the year benefits are provided. Even
though S manages the department, that department does not represent a
substantial
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portion of T's activities, assets, income, expenses, or operating
budget. Therefore, S does not participate in any management decisions
affecting either T as a whole, or a discrete segment or activity of T
that represents a substantial portion of its activities, assets, income,
or expenses. Under these facts and circumstances, S does not have
substantial influence over the affairs of T, and therefore S is not a
disqualified person with respect to T.
Example 10. U is a large acute-care hospital that is an applicable
tax-exempt organization for purposes of section 4958. U employs X as a
radiologist. X gives instructions to staff with respect to the radiology
work X conducts, but X does not supervise other U employees or manage
any substantial part of U's operations. X's compensation is primarily in
the form of a fixed salary. In addition, X is eligible to receive an
incentive award based on revenues of the radiology department. X's
compensation is greater than the amount referenced for a highly
compensated employee in section 414(q)(1)(B)(i) in the year benefits are
provided. X is not related to any other disqualified person of U. X does
not serve on U's governing body or as an officer of U. Although U
participates in a provider-sponsored organization (as defined in section
1855(e) of the Social Security Act), X does not have a material
financial interest in that organization. X does not receive compensation
primarily based on revenues derived from activities of U that X
controls. X does not participate in any management decisions affecting
either U as a whole or a discrete segment of U that represents a
substantial portion of its activities, assets, income, or expenses.
Under these facts and circumstances, X does not have substantial
influence over the affairs of U, and therefore X is not a disqualified
person with respect to U.
Example 11. W is a cardiologist and head of the cardiology
department of the same hospital U described in Example 10. The
cardiology department is a major source of patients admitted to U and
consequently represents a substantial portion of U's income, as compared
to U as a whole. W does not serve on U's governing board or as an
officer of U. W does not have a material financial interest in the
provider-sponsored organization (as defined in section 1855(e) of the
Social Security Act) in which U participates. W receives a salary and
retirement and welfare benefits fixed by a three-year renewable
employment contract with U. W's compensation is greater than the amount
referenced for a highly compensated employee in section 414(q)(1)(B)(i)
in the year benefits are provided. As department head, W manages the
cardiology department and has authority to allocate the budget for that
department, which includes authority to distribute incentive bonuses
among cardiologists according to criteria that W has authority to set.
W's management of a discrete segment of U that represents a substantial
portion of its income and activities (as compared to U as a whole)
places W in a position to exercise substantial influence over the
affairs of U. Under these facts and circumstances, W is a disqualified
person with respect to U.
Example 12. M is a museum that is an applicable tax-exempt
organization for purposes of section 4958. D provides accounting
services and tax advice to M as a contractor in return for a fee. D has
no other relationship with M and is not related to any disqualified
person of M. D does not provide professional advice with respect to any
transaction from which D might economically benefit either directly or
indirectly (aside from fees received for the professional advice
rendered). Because D's sole relationship to M is providing professional
advice (without having decision-making authority) with respect to
transactions from which D will not economically benefit either directly
or indirectly (aside from customary fees received for the professional
advice rendered), under these facts and circumstances, D is not a
disqualified person with respect to M.
Example 13. F is a repertory theater company that is an applicable
tax-exempt organization for purposes of section 4958. F holds a fund-
raising campaign to pay for the construction of a new theater. J is a
regular subscriber to F's productions who has made modest gifts to F in
the past. J has no relationship to F other than as a subscriber and
contributor. F solicits contributions as part of a broad public campaign
intended to attract a large number of donors, including a substantial
number of donors making large gifts. In its solicitations for
contributions, F promises to invite all contributors giving $z or more
to a special opening production and party held at the new theater. These
contributors are also given a special number to call in F's office to
reserve tickets for performances, make ticket exchanges, and make other
special arrangements for their convenience. J makes a contribution of $z
to F, which makes J a substantial contributor within the meaning of
section 507(d)(2)(A), taking into account only contributions received by
F during its current and the four preceding taxable years. J receives
the benefits described in F's solicitation. Because F offers the same
benefit to all donors of $z or more, the preferential treatment that J
receives does not indicate that J is in a position to exercise
substantial influence over the affairs of the organization. Therefore,
under these facts and circumstances, J is not a disqualified person with
respect to F.
[T.D. 8978, 67 FR 3083, Jan. 23, 2002]
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Sec. 53.4958-4 Excess benefit transaction.
(a) Definition of excess benefit transaction--(1) In general. An
excess benefit transaction means any transaction in which an economic
benefit is provided by an applicable tax-exempt organization directly or
indirectly to or for the use of any disqualified person, and the value
of the economic benefit provided exceeds the value of the consideration
(including the performance of services) received for providing the
benefit. Subject to the limitations of paragraph (c) of this section
(relating to the treatment of economic benefits as compensation for the
performance of services), to determine whether an excess benefit
transaction has occurred, all consideration and benefits (except
disregarded benefits described in paragraph (a)(4) of this section)
exchanged between a disqualified person and the applicable tax-exempt
organization and all entities the organization controls (within the
meaning of paragraph (a)(2)(ii)(B) of this section) are taken into
account. For example, in determining the reasonableness of compensation
that is paid (or vests, or is no longer subject to a substantial risk of
forfeiture) in one year, services performed in prior years may be taken
into account. The rules of this section apply to all transactions with
disqualified persons, regardless of whether the amount of the benefit
provided is determined, in whole or in part, by the revenues of one or
more activities of the organization. For rules regarding valuation
standards, see paragraph (b) of this section. For the requirement that
an applicable tax-exempt organization clearly indicate its intent to
treat a benefit as compensation for services when paid, see paragraph
(c) of this section.
(2) Economic benefit provided indirectly--(i) In general. A
transaction that would be an excess benefit transaction if the
applicable tax-exempt organization engaged in it directly with a
disqualified person is likewise an excess benefit transaction when it is
accomplished indirectly. An applicable tax-exempt organization may
provide an excess benefit indirectly to a disqualified person through a
controlled entity or through an intermediary, as described in paragraphs
(a)(2)(ii) and (iii) of this section, respectively.
(ii) Through a controlled entity--(A) In general. An applicable tax-
exempt organization may provide an excess benefit indirectly through the
use of one or more entities it controls. For purposes of section 4958,
economic benefits provided by a controlled entity will be treated as
provided by the applicable tax-exempt organization.
(B) Definition of control--(1) In general. For purposes of this
paragraph, control by an applicable tax-exempt organization means--
(i) In the case of a stock corporation, ownership (by vote or value)
of more than 50 percent of the stock in such corporation;
(ii) In the case of a partnership, ownership of more than 50 percent
of the profits interests or capital interests in the partnership;
(iii) In the case of a nonstock organization (i.e., an entity in
which no person holds a proprietary interest), that at least 50 percent
of the directors or trustees of the organization are either
representatives (including trustees, directors, agents, or employees)
of, or directly or indirectly controlled by, an applicable tax-exempt
organization; or
(iv) In the case of any other entity, ownership of more than 50
percent of the beneficial interest in the entity.
(2) Constructive ownership. Section 318 (relating to constructive
ownership of stock) shall apply for purposes of determining ownership of
stock in a corporation. Similar principles shall apply for purposes of
determining ownership of interests in any other entity.
(iii) Through an intermediary. An applicable tax-exempt organization
may provide an excess benefit indirectly through an intermediary. An
intermediary is any person (including an individual or a taxable or tax-
exempt entity) who participates in a transaction with one or more
disqualified persons of an applicable tax-exempt organization. For
purposes of section 4958, economic benefits provided by an intermediary
will be treated as provided by the applicable tax-exempt organization
when--
(A) An applicable tax-exempt organization provides an economic
benefit to an intermediary; and
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(B) In connection with the receipt of the benefit by the
intermediary--
(1) There is evidence of an oral or written agreement or
understanding that the intermediary will provide economic benefits to or
for the use of a disqualified person; or
(2) The intermediary provides economic benefits to or for the use of
a disqualified person without a significant business purpose or exempt
purpose of its own.
(iv) Examples. The following examples illustrate when economic
benefits are provided indirectly under the rules of this paragraph
(a)(2):
Example 1. K is an applicable tax-exempt organization for purposes
of section 4958. L is a wholly-owned taxable subsidiary of K. J is
employed by K, and is a disqualified person with respect to K. K pays J
an annual salary of $12m, and reports that amount as compensation during
calendar year 2001. Although J only performed services for K for nine
months of 2001, J performed equivalent services for L during the
remaining three months of 2001. Taking into account all of the economic
benefits K provided to J, and all of the services J performed for K and
L, $12m does not exceed the fair market value of the services J
performed for K and L during 2001. Therefore, under these facts, K does
not provide an excess benefit to J directly or indirectly.
Example 2. F is an applicable tax-exempt organization for purposes
of section 4958. D is an entity controlled by F within the meaning of
paragraph (a)(2)(ii)(B) of this section. T is the chief executive
officer (CEO) of F. As CEO, T is responsible for overseeing the
activities of F. T's duties as CEO make him a disqualified person with
respect to F. T's compensation package with F represents the maximum
reasonable compensation for T's services as CEO. Thus, any additional
economic benefits that F provides to T without T providing additional
consideration constitute an excess benefit. D contracts with T to
provide enumerated consulting services to D. However, the contract does
not require T to perform any additional services for D that T is not
already obligated to perform as F's chief executive officer. Therefore,
any payment to T pursuant to the consulting contract with D represents
an indirect excess benefit that F provides through a controlled entity,
even if F, D, or T treats the additional payment to T as compensation.
Example 3. P is an applicable tax-exempt organization for purposes
of section 4958. S is a taxable entity controlled by P within the
meaning of paragraph (a)(2)(ii)(B) of this section. V is the chief
executive officer of S, for which S pays V $w in salary and benefits. V
also serves as a voting member of P's governing body. Consequently, V is
a disqualified person with respect to P. P provides V with $x
representing compensation for the services V provides P as a member of
its governing body. Although $x represents reasonable compensation for
the services V provides directly to P as a member of its governing body,
the total compensation of $w + $x exceeds reasonable compensation for
the services V provides to P and S collectively. Therefore, the portion
of total compensation that exceeds reasonable compensation is an excess
benefit provided to V.
Example 4. G is an applicable tax-exempt organization for section
4958 purposes. F is a disqualified person who was last employed by G in
a position of substantial influence three years ago. H is an entity
engaged in scientific research and is unrelated to either F or G. G
makes a grant to H to fund a research position. H subsequently
advertises for qualified candidates for the research position. F is
among several highly qualified candidates who apply for the research
position. H hires F. There was no evidence of an oral or written
agreement or understanding with G that H will use G's grant to provide
economic benefits to or for the use of F. Although G provided economic
benefits to H, and in connection with the receipt of such benefits, H
will provide economic benefits to or for the use of F, H acted with a
significant business purpose or exempt purpose of its own. Under these
facts, G did not provide an economic benefit to F indirectly through the
use of an intermediary.
(3) Exception for fixed payments made pursuant to an initial
contract--(i) In general. Except as provided in paragraph (a)(3)(iv) of
this section, section 4958 does not apply to any fixed payment made to a
person pursuant to an initial contract.
(ii) Fixed payment--(A) In general. For purposes of paragraph
(a)(3)(i) of this section, fixed payment means an amount of cash or
other property specified in the contract, or determined by a fixed
formula specified in the contract, which is to be paid or transferred in
exchange for the provision of specified services or property. A fixed
formula may incorporate an amount that depends upon future specified
events or contingencies, provided that no person exercises discretion
when calculating the amount of a payment or deciding whether to make a
payment (such as a bonus). A specified event or contingency may include
the amount of revenues generated by (or other objective measure of) one
or more activities of
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the applicable tax-exempt organization. A fixed payment does not include
any amount paid to a person under a reimbursement (or similar)
arrangement where discretion is exercised by any person with respect to
the amount of expenses incurred or reimbursed.
(B) Special rules. Amounts payable pursuant to a qualified pension,
profit-sharing, or stock bonus plan under section 401(a), or pursuant to
an employee benefit program that is subject to and satisfies coverage
and nondiscrimination rules under the Internal Revenue Code (e.g.,
sections 127 and 137), other than nondiscrimination rules under section
9802, are treated as fixed payments for purposes of this section,
regardless of the applicable tax-exempt organization's discretion with
respect to the plan or program. The fact that a person contracting with
an applicable tax-exempt organization is expressly granted the choice
whether to accept or reject any economic benefit is disregarded in
determining whether the benefit constitutes a fixed payment for purposes
of this paragraph.
(iii) Initial contract. For purposes of paragraph (a)(3)(i) of this
section, initial contract means a binding written contract between an
applicable tax-exempt organization and a person who was not a
disqualified person within the meaning of section 4958(f)(1) and Sec.
53.4958-3 immediately prior to entering into the contract.
(iv) Substantial performance required. Paragraph (a)(3)(i) of this
section does not apply to any fixed payment made pursuant to the initial
contract during any taxable year of the person contracting with the
applicable tax-exempt organization if the person fails to perform
substantially the person's obligations under the initial contract during
that year.
(v) Treatment as a new contract. A written binding contract that
provides that the contract is terminable or subject to cancellation by
the applicable tax-exempt organization (other than as a result of a lack
of substantial performance by the disqualified person, as described in
paragraph (a)(3)(iv) of this section) without the other party's consent
and without substantial penalty to the organization is treated as a new
contract as of the earliest date that any such termination or
cancellation, if made, would be effective. Additionally, if the parties
make a material change to a contract, it is treated as a new contract as
of the date the material change is effective. A material change includes
an extension or renewal of the contract (other than an extension or
renewal that results from the person contracting with the applicable
tax-exempt organization unilaterally exercising an option expressly
granted by the contract), or a more than incidental change to any amount
payable under the contract. The new contract is tested under paragraph
(a)(3)(iii) of this section to determine whether it is an initial
contract for purposes of this section.
(vi) Evaluation of non-fixed payments. Any payment that is not a
fixed payment (within the meaning of paragraph (a)(3)(ii) of this
section) is evaluated to determine whether it constitutes an excess
benefit transaction under section 4958. In making this determination,
all payments and consideration exchanged between the parties are taken
into account, including any fixed payments made pursuant to an initial
contract with respect to which section 4958 does not apply.
(vii) Examples. The following examples illustrate the rules
governing fixed payments made pursuant to an initial contract. Unless
otherwise stated, assume that the person contracting with the applicable
tax-exempt organization has performed substantially the person's
obligations under the contract with respect to the payment. The examples
are as follows:
Example 1. T is an applicable tax-exempt organization for purposes
of section 4958. On January 1, 2002, T hires S as its chief financial
officer by entering into a five-year written employment contract with S.
S was not a disqualified person within the meaning of section 4958(f)(1)
and Sec. 53.4958-3 immediately prior to entering into the January 1,
2002, contract (initial contract). S's duties and responsibilities under
the contract make S a disqualified person with respect to T (see Sec.
53.4958-3(c)(3)). Under the initial contract, T agrees to pay S an
annual salary of $200,000, payable in monthly installments. The contract
provides that, beginning in 2003, S's annual salary will be adjusted by
the increase in the Consumer Price Index (CPI) for the prior year.
Section 4958 does not apply because S's compensation under the contract
is
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a fixed payment pursuant to an initial contract within the meaning of
paragraph (a)(3) of this section. Thus, for section 4958 purposes, it is
unnecessary to evaluate whether any portion of the compensation paid to
S pursuant to the initial contract is an excess benefit transaction.
Example 2. The facts are the same as in Example 1, except that the
initial contract provides that, in addition to a base salary of
$200,000, T may pay S an annual performance-based bonus. The contract
provides that T's governing body will determine the amount of the annual
bonus as of the end of each year during the term of the contract, based
on the board's evaluation of S's performance, but the bonus cannot
exceed $100,000 per year. Unlike the base salary portion of S's
compensation, the bonus portion of S's compensation is not a fixed
payment pursuant to an initial contract, because the governing body has
discretion over the amount, if any, of the bonus payment. Section 4958
does not apply to payment of the $200,000 base salary (as adjusted for
inflation), because it is a fixed payment pursuant to an initial
contract within the meaning of paragraph (a)(3) of this section. By
contrast, the annual bonuses that may be paid to S under the initial
contract are not protected by the initial contract exception. Therefore,
each bonus payment will be evaluated under section 4958, taking into
account all payments and consideration exchanged between the parties.
Example 3. The facts are the same as in Example 1, except that in
2003, T changes its payroll system, such that T makes biweekly, rather
than monthly, salary payments to its employees. Beginning in 2003, T
also grants its employees an additional two days of paid vacation each
year. Neither change is a material change to S's initial contract within
the meaning of paragraph (a)(3)(v) of this section. Therefore, section
4958 does not apply to the base salary payments to S due to the initial
contract exception.
Example 4. The facts are the same as in Example 1, except that on
January 1, 2003, S becomes the chief executive officer of T and a new
chief financial officer is hired. At the same time, T's board of
directors approves an increase in S's annual base salary from $200,000
to $240,000, effective on that day. These changes in S's employment
relationship constitute material changes of the initial contract within
the meaning of paragraph (a)(3)(v) of this section. As a result, S is
treated as entering into a new contract with T on January 1, 2003, at
which time S is a disqualified person within the meaning of section
4958(f)(1) and Sec. 53.4958-3. T's payments to S made pursuant to the
new contract will be evaluated under section 4958, taking into account
all payments and consideration exchanged between the parties.
Example 5. J is a performing arts organization and an applicable
tax-exempt organization for purposes of section 4958. J hires W to
become the chief executive officer of J. W was not a disqualified person
within the meaning of section 4958(f)(1) and Sec. 53.4958-3 immediately
prior to entering into the employment contract with J. As a result of
this employment contract, W's duties and responsibilities make W a
disqualified person with respect to J (see Sec. 53.4958-3(c)(2)). Under
the contract, J will pay W $x (a specified amount) plus a bonus equal to
2 percent of the total season subscription sales that exceed $100z. The
$x base salary is a fixed payment pursuant to an initial contract within
the meaning of paragraph (a)(3) of this section. The bonus payment is
also a fixed payment pursuant to an initial contract within the meaning
of paragraph (a)(3) of this section, because no person exercises
discretion when calculating the amount of the bonus payment or deciding
whether the bonus will be paid. Therefore, section 4958 does not apply
to any of J's payments to W pursuant to the employment contract due to
the initial contract exception.
Example 6. Hospital B is an applicable tax-exempt organization for
purposes of section 4958. Hospital B hires E as its chief operating
officer. E was not a disqualified person within the meaning of section
4958(f)(1) and Sec. 53.4958-3 immediately prior to entering into the
employment contract with Hospital B. As a result of this employment
contract, E's duties and responsibilities make E a disqualified person
with respect to Hospital B (see Sec. 53.4958-3(c)(2)). E's initial
employment contract provides that E will have authority to enter into
hospital management arrangements on behalf of Hospital B. In E's
personal capacity, E owns more than 35 percent of the combined voting
power of Company X. Consequently, at the time E becomes a disqualified
person with respect to B, Company X also becomes a disqualified person
with respect to B (see Sec. 53.4958-3(b)(2)(i)(A)). E, acting on behalf
of Hospital B as chief operating officer, enters into a contract with
Company X under which Company X will provide billing and collection
services to Hospital B. The initial contract exception of paragraph
(a)(3)(i) of this section does not apply to the billing and collection
services contract, because at the time that this contractual arrangement
was entered into, Company X was a disqualified person with respect to
Hospital B. Although E's employment contract (which is an initial
contract) authorizes E to enter into hospital management arrangements on
behalf of Hospital B, the payments made to Company X are not made
pursuant to E's employment contract, but rather are made by Hospital B
pursuant to a separate contractual arrangement with Company X.
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Therefore, even if payments made to Company X under the billing and
collection services contract are fixed payments (within the meaning of
paragraph (a)(3)(ii) of this section), section 4958 nonetheless applies
to payments made by Hospital B to Company X because the billing and
collection services contract itself does not constitute an initial
contract under paragraph (a)(3)(iii) of this section. Accordingly, all
payments made to Company X under the billing and collection services
contract will be evaluated under section 4958.
Example 7. Hospital C, an applicable tax-exempt organization, enters
into a contract with Company Y, under which Company Y will provide a
wide range of hospital management services to Hospital C. Upon entering
into this contractual arrangement, Company Y becomes a disqualified
person with respect to Hospital C. The contract provides that Hospital C
will pay Company Y a management fee of x percent of adjusted gross
revenue (i.e., gross revenue increased by the cost of charity care
provided to indigents) annually for a five-year period. The management
services contract specifies the cost accounting system and the standards
for indigents to be used in calculating the cost of charity care. The
cost accounting system objectively defines the direct and indirect costs
of all health care goods and services provided as charity care. Because
Company Y was not a disqualified person with respect to Hospital C
immediately before entering into the management services contract, that
contract is an initial contract within the meaning of paragraph
(a)(3)(iii) of this section. The annual management fee paid to Company Y
is determined by a fixed formula specified in the contract, and is
therefore a fixed payment within the meaning of paragraph (a)(3)(ii) of
this section. Accordingly, section 4958 does not apply to the annual
management fee due to the initial contract exception.
Example 8. The facts are the same as in Example 7, except that the
management services contract also provides that Hospital C will
reimburse Company Y on a monthly basis for certain expenses incurred by
Company Y that are attributable to management services provided to
Hospital C (e.g., legal fees and travel expenses). Although the
management fee itself is a fixed payment not subject to section 4958,
the reimbursement payments that Hospital C makes to Company Y for the
various expenses covered by the contract are not fixed payments within
the meaning of paragraph (a)(3)(ii) of this section, because Company Y
exercises discretion with respect to the amount of expenses incurred.
Therefore, any reimbursement payments that Hospital C pays pursuant to
the contract will be evaluated under section 4958.
Example 9. X, an applicable tax-exempt organization for purposes of
section 4958, hires C to conduct scientific research. On January 1,
2003, C enters into a three-year written employment contract with X
(initial contract). Under the terms of the contract, C is required to
work full-time at X's laboratory for a fixed annual salary of $90,000.
Immediately prior to entering into the employment contract, C was not a
disqualified person within the meaning of section 4958(f)(1) and Sec.
53.4958-3, nor did C become a disqualified person pursuant to the
initial contract. However, two years after joining X, C marries D, who
is the child of X's president. As D's spouse, C is a disqualified person
within the meaning of section 4958(f)(1) and Sec. 53.4958-3 with
respect to X. Nonetheless, section 4958 does not apply to X's salary
payments to C due to the initial contract exception.
Example 10. The facts are the same as in Example 9, except that the
initial contract included a below-market loan provision under which C
has the unilateral right to borrow up to a specified dollar amount from
X at a specified interest rate for a specified term. After C's marriage
to D, C borrows money from X to purchase a home under the terms of the
initial contract. Section 4958 does not apply to X's loan to C due to
the initial contract exception.
Example 11. The facts are the same as in Example 9, except that
after C's marriage to D, C works only sporadically at the laboratory,
and performs no other services for X. Notwithstanding that C fails to
perform substantially C's obligations under the initial contract, X does
not exercise its right to terminate the initial contract for
nonperformance and continues to pay full salary to C. Pursuant to
paragraph (a)(3)(iv) of this section, the initial contract exception
does not apply to any payments made pursuant to the initial contract
during any taxable year of C in which C fails to perform substantially
C's obligations under the initial contract.
(4) Certain economic benefits disregarded for purposes of section
4958. The following economic benefits are disregarded for purposes of
section 4958--
(i) Nontaxable fringe benefits. An economic benefit that is excluded
from income under section 132, except any liability insurance premium,
payment, or reimbursement that must be taken into account under
paragraph (b)(1)(ii)(B)(2) of this section;
(ii) Expense reimbursement payments pursuant to accountable plans.
Amounts paid under reimbursement arrangements that meet the requirements
of Sec. 1.62-2(c) of this chapter;
(iii) Certain economic benefits provided to a volunteer for the
organization. An economic benefit provided to a volunteer for the
organization if the benefit
[[Page 228]]
is provided to the general public in exchange for a membership fee or
contribution of $75 or less per year;
(iv) Certain economic benefits provided to a member of, or donor to,
the organization. An economic benefit provided to a member of an
organization solely on account of the payment of a membership fee, or to
a donor solely on account of a contribution for which a deduction is
allowable under section 170 (charitable contribution), regardless of
whether the donor is eligible to claim the deduction, if--
(A) Any non-disqualified person paying a membership fee or making a
charitable contribution above a specified amount to the organization is
given the option of receiving substantially the same economic benefit;
and
(B) The disqualified person and a significant number of non-
disqualified persons make a payment or charitable contribution of at
least the specified amount;
(v) Economic benefits provided to a charitable beneficiary. An
economic benefit provided to a person solely because the person is a
member of a charitable class that the applicable tax-exempt organization
intends to benefit as part of the accomplishment of the organization's
exempt purpose; and
(vi) Certain economic benefits provided to a governmental unit. Any
transfer of an economic benefit to or for the use of a governmental unit
defined in section 170(c)(1), if the transfer is for exclusively public
purposes.
(5) Exception for certain payments made pursuant to an exemption
granted by the Department of Labor under ERISA. Section 4958 does not
apply to any payment made pursuant to, and in accordance with, a final
individual prohibited transaction exemption issued by the Department of
Labor under section 408(a) of the Employee Retirement Income Security
Act of 1974 (88 Stat. 854) (ERISA) with respect to a transaction
involving a plan (as defined in section 3(3) of ERISA) that is an
applicable tax exempt organization.
(b) Valuation standards--(1) In general. This section provides rules
for determining the value of economic benefits for purposes of section
4958.
(i) Fair market value of property. The value of property, including
the right to use property, for purposes of section 4958 is the fair
market value (i.e., the price at which property or the right to use
property would change hands between a willing buyer and a willing
seller, neither being under any compulsion to buy, sell or transfer
property or the right to use property, and both having reasonable
knowledge of relevant facts).
(ii) Reasonable compensation--(A) In general. The value of services
is the amount that would ordinarily be paid for like services by like
enterprises (whether taxable or tax-exempt) under like circumstances
(i.e., reasonable compensation). Section 162 standards apply in
determining reasonableness of compensation, taking into account the
aggregate benefits (other than any benefits specifically disregarded
under paragraph (a)(4) of this section) provided to a person and the
rate at which any deferred compensation accrues. The fact that a
compensation arrangement is subject to a cap is a relevant factor in
determining the reasonableness of compensation. The fact that a State or
local legislative or agency body or court has authorized or approved a
particular compensation package paid to a disqualified person is not
determinative of the reasonableness of compensation for purposes of
section 4958.
(B) Items included in determining the value of compensation for
purposes of determining reasonableness under section 4958. Except for
economic benefits that are disregarded for purposes of section 4958
under paragraph (a)(4) of this section, compensation for purposes of
determining reasonableness under section 4958 includes all economic
benefits provided by an applicable tax-exempt organization in exchange
for the performance of services. These benefits include, but are not
limited to--
(1) All forms of cash and noncash compensation, including salary,
fees, bonuses, severance payments, and deferred and noncash compensation
described in Sec. 53.4958-1(e)(2);
(2) Unless excludable from income as a de minimis fringe benefit
pursuant to section 132(a)(4), the payment of liability insurance
premiums for, or the payment or reimbursement by the organization of--
[[Page 229]]
(i) Any penalty, tax, or expense of correction owed under section
4958;
(ii) Any expense not reasonably incurred by the person in connection
with a civil judicial or civil administrative proceeding arising out of
the person's performance of services on behalf of the applicable tax-
exempt organization; or
(iii) Any expense resulting from an act or failure to act with
respect to which the person has acted willfully and without reasonable
cause; and
(3) All other compensatory benefits, whether or not included in
gross income for income tax purposes, including payments to welfare
benefit plans, such as plans providing medical, dental, life insurance,
severance pay, and disability benefits, and both taxable and nontaxable
fringe benefits (other than fringe benefits described in section 132),
including expense allowances or reimbursements (other than expense
reimbursements pursuant to an accountable plan that meets the
requirements of Sec. 1.62-2(c)), and the economic benefit of a below-
market loan (within the meaning of section 7872(e)(1)). (For this
purpose, the economic benefit of a below-market loan is the amount
deemed transferred to the disqualified person under section 7872(a) or
(b), regardless of whether section 7872 otherwise applies to the loan).
(C) Inclusion in compensation for reasonableness determination does
not govern income tax treatment. The determination of whether any item
listed in paragraph (b)(1)(ii)(B) of this section is included in the
disqualified person's gross income for income tax purposes is made on
the basis of the provisions of chapter 1 of Subtitle A of the Internal
Revenue Code, without regard to whether the item is taken into account
for purposes of determining reasonableness of compensation under section
4958.
(2) Timing of reasonableness determination--(i) In general. The
facts and circumstances to be taken into consideration in determining
reasonableness of a fixed payment (within the meaning of paragraph
(a)(3)(ii) of this section) are those existing on the date the parties
enter into the contract pursuant to which the payment is made. However,
in the event of substantial non-performance, reasonableness is
determined based on all facts and circumstances, up to and including
circumstances as of the date of payment. In the case of any payment that
is not a fixed payment under a contract, reasonableness is determined
based on all facts and circumstances, up to and including circumstances
as of the date of payment. In no event shall circumstances existing at
the date when the payment is questioned be considered in making a
determination of the reasonableness of the payment. These general timing
rules also apply to property subject to a substantial risk of
forfeiture. Therefore, if the property subject to a substantial risk of
forfeiture satisfies the definition of fixed payment (within the meaning
of paragraph (a)(3)(ii) of this section), reasonableness is determined
at the time the parties enter into the contract providing for the
transfer of the property. If the property is not a fixed payment, then
reasonableness is determined based on all facts and circumstances up to
and including circumstances as of the date of payment.
(ii) Treatment as a new contract. For purposes of paragraph
(b)(2)(i) of this section, a written binding contract that provides that
the contract is terminable or subject to cancellation by the applicable
tax-exempt organization without the other party's consent and without
substantial penalty to the organization is treated as a new contract as
of the earliest date that any such termination or cancellation, if made,
would be effective. Additionally, if the parties make a material change
to a contract (within the meaning of paragraph (a)(3)(v) of this
section), it is treated as a new contract as of the date the material
change is effective.
(iii) Examples. The following examples illustrate the timing of the
reasonableness determination under the rules of this paragraph (b)(2):
Example 1. G is an applicable tax-exempt organization for purposes
of section 4958. H is an employee of G and a disqualified person with
respect to G. H's new multi-year employment contract provides for
payment of a salary and provision of specific benefits pursuant to a
qualified pension plan under section 401(a) and an accident and health
plan that meets the requirements of section
[[Page 230]]
105(h)(2). The contract provides that H's salary will be adjusted by the
increase in the Consumer Price Index (CPI) for the prior year. The
contributions G makes to the qualified pension plan are equal to the
maximum amount G is permitted to contribute under the rules applicable
to qualified plans. Under these facts, all items comprising H's total
compensation are treated as fixed payments within the meaning of
paragraph (a)(3)(ii) of this section. Therefore, the reasonableness of
H's compensation is determined based on the circumstances existing at
the time G and H enter into the employment contract.
Example 2. The facts are the same as in Example 1, except that the
multi-year employment contract provides, in addition, that G will
transfer title to a car to H under the condition that if H fails to
complete x years of service with G, title to the car will be forfeited
back to G. All relevant information about the type of car to be provided
(including the make, model, and year) is included in the contract.
Although ultimate vesting of title to the car is contingent on H
continuing to work for G for x years, the amount of property to be
vested (i.e., the type of car) is specified in the contract, and no
person exercises discretion regarding the type of property or whether H
will retain title to the property at the time of vesting. Under these
facts, the car is a fixed payment within the meaning of paragraph
(a)(3)(ii) of this section. Therefore, the reasonableness of H's
compensation, including the value of the car, is determined based on the
circumstances existing at the time G and H enter into the employment
contract.
Example 3. N is an applicable tax-exempt organization for purposes
of section 4958. On January 2, N's governing body enters into a new one-
year employment contract with K, its executive director, who is a
disqualified person with respect to N. The contract provides that K will
receive a specified amount of salary, contributions to a qualified
pension plan under section 401(a), and other benefits pursuant to a
section 125 cafeteria plan. In addition, the contract provides that N's
governing body may, in its discretion, declare a bonus to be paid to K
at any time during the year covered by the contract. K's salary and
other specified benefits constitute fixed payments within the meaning of
paragraph (a)(3)(ii) of this section. Therefore, the reasonableness of
those economic benefits is determined on the date when the contract was
made. However, because the bonus payment is not a fixed payment within
the meaning of paragraph (a)(3)(ii) of this section, the determination
of whether any bonus awarded to N is reasonable must be made based on
all facts and circumstances (including all payments and consideration
exchanged between the parties), up to and including circumstances as of
the date of payment of the bonus.
(c) Establishing intent to treat economic benefit as consideration
for the performance of services--(1) In general. An economic benefit is
not treated as consideration for the performance of services unless the
organization providing the benefit clearly indicates its intent to treat
the benefit as compensation when the benefit is paid. Except as provided
in paragraph (c)(2) of this section, an applicable tax-exempt
organization (or entity controlled by an applicable tax-exempt
organization, within the meaning of paragraph (a)(2)(ii)(B) of this
section) is treated as clearly indicating its intent to provide an
economic benefit as compensation for services only if the organization
provides written substantiation that is contemporaneous with the
transfer of the economic benefit at issue. If an organization fails to
provide this contemporaneous substantiation, any services provided by
the disqualified person will not be treated as provided in consideration
for the economic benefit for purposes of determining the reasonableness
of the transaction. In no event shall an economic benefit that a
disqualified person obtains by theft or fraud be treated as
consideration for the performance of services.
(2) Nontaxable benefits. For purposes of section 4958(c)(1)(A) and
this section, an applicable tax-exempt organization is not required to
indicate its intent to provide an economic benefit as compensation for
services if the economic benefit is excluded from the disqualified
person's gross income for income tax purposes on the basis of the
provisions of chapter 1 of Subtitle A of the Internal Revenue Code.
Examples of these benefits include, but are not limited to, employer-
provided health benefits and contributions to a qualified pension,
profit-sharing, or stock bonus plan under section 401(a), and benefits
described in sections 127 and 137. However, except for economic benefits
that are disregarded for purposes of section 4958 under paragraph (a)(4)
of this section, all compensatory benefits (regardless of the Federal
income tax treatment) provided by an organization in exchange for the
performance of
[[Page 231]]
services are taken into account in determining the reasonableness of a
person's compensation for purposes of section 4958.
(3) Contemporaneous substantiation--(i) Reporting of benefit--(A) In
general. An applicable tax-exempt organization provides contemporaneous
written substantiation of its intent to provide an economic benefit as
compensation if--
(1) The organization reports the economic benefit as compensation on
an original Federal tax information return with respect to the payment
(e.g., Form W-2, ``Wage and Tax Statement'', or Form 1099,
``Miscellaneous Income'') or with respect to the organization (e.g.,
Form 990, ``Return of Organization Exempt From Income Tax''), or on an
amended Federal tax information return filed prior to the commencement
of an Internal Revenue Service examination of the applicable tax-exempt
organization or the disqualified person for the taxable year in which
the transaction occurred (as determined under Sec. 53.4958-1(e)); or
(2) The recipient disqualified person reports the benefit as income
on the person's original Federal tax return (e.g., Form 1040, ``U.S.
Individual Income Tax Return''), or on the person's amended Federal tax
return filed prior to the earlier of the following dates--
(i) Commencement of an Internal Revenue Service examination
described in paragraph (c)(3)(i)(A)(1) of this section; or
(ii) The first documentation in writing by the Internal Revenue
Service of a potential excess benefit transaction involving either the
applicable tax-exempt organization or the disqualified person.
(B) Failure to report due to reasonable cause. If an applicable tax-
exempt organization's failure to report an economic benefit as required
under the Internal Revenue Code is due to reasonable cause (within the
meaning of Sec. 301.6724-1 of this chapter), then the organization will
be treated as having clearly indicated its intent to provide an economic
benefit as compensation for services. To show that its failure to report
an economic benefit that should have been reported on an information
return was due to reasonable cause, an applicable tax-exempt
organization must establish that there were significant mitigating
factors with respect to its failure to report (as described in Sec.
301.6724-1(b) of this chapter), or the failure arose from events beyond
the organization's control (as described in Sec. 301.6724-1(c) of this
chapter), and that the organization acted in a responsible manner both
before and after the failure occurred (as described in Sec. 301.6724-
1(d) of this chapter).
(ii) Other written contemporaneous evidence. In addition, other
written contemporaneous evidence may be used to demonstrate that the
appropriate decision-making body or an officer authorized to approve
compensation approved a transfer as compensation for services in
accordance with established procedures, including but not limited to--
(A) An approved written employment contract executed on or before
the date of the transfer;
(B) Documentation satisfying the requirements of Sec. 53.4958-
6(a)(3) indicating that an authorized body approved the transfer as
compensation for services on or before the date of the transfer; or
(C) Written evidence that was in existence on or before the due date
of the applicable Federal tax return described in paragraph
(c)(3)(i)(A)(1) or (2) of this section (including extensions but not
amendments), of a reasonable belief by the applicable tax-exempt
organization that a benefit was a nontaxable benefit as defined in
paragraph (c)(2) of this section.
(4) Examples. The following examples illustrate the requirement that
an organization contemporaneously substantiate its intent to provide an
economic benefit as compensation for services, as defined in paragraph
(c) of this section:
Example 1. G is an applicable tax-exempt organization for purposes
of section 4958. G hires an individual contractor, P, who is also the
child of a disqualified person of G, to design a computer program for
it. G executes a contract with P for that purpose in accordance with G's
established procedures, and pays P $1,000 during the year pursuant to
the contract. Before January 31 of the next year, G reports the full
amount paid to P under the contract on a Form 1099 filed with the
Internal Revenue Service. G will be treated as providing contemporaneous
written substantiation of its intent to provide the $1,000
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paid to P as compensation for the services P performed under the
contract by virtue of either the Form 1099 filed with the Internal
Revenue Service reporting the amount, or by virtue of the written
contract executed between G and P.
Example 2. G is an applicable tax-exempt organization for purposes
of section 4958. D is the chief operating officer of G, and a
disqualified person with respect to G. D receives a bonus at the end of
the year. G's accounting department determines that the bonus is to be
reported on D's Form W-2. Due to events beyond G's control, the bonus is
not reflected on D's Form W-2. As a result, D fails to report the bonus
on D's individual income tax return. G acts to amend Forms W-2 affected
as soon as G is made aware of the error during an Internal Revenue
Service examination. G's failure to report the bonus on an information
return issued to D arose from events beyond G's control, and G acted in
a responsible manner both before and after the failure occurred. Thus,
because G had reasonable cause (within the meaning Sec. 301.6724-1 of
this chapter) for failing to report D's bonus, G will be treated as
providing contemporaneous written substantiation of its intent to
provide the bonus as compensation for services when paid.
Example 3. H is an applicable tax-exempt organization and J is a
disqualified person with respect to H. J's written employment agreement
provides for a fixed salary of $y. J's duties include soliciting funds
for various programs of H. H raises a large portion of its funds in a
major metropolitan area. Accordingly, H maintains an apartment there in
order to provide a place to entertain potential donors. H makes the
apartment available exclusively to J to assist in the fundraising. J's
written employment contract does not mention the use of the apartment. H
obtains the written opinion of a benefits compensation expert that the
rental value of the apartment is not includable in J's income by reason
of section 119, based on the expectation that the apartment will be used
for fundraising activities. Consequently, H does not report the rental
value of the apartment on J's Form W-2, which otherwise correctly
reports J's taxable compensation. J does not report the rental value of
the apartment on J's individual Form 1040. Later, the Internal Revenue
Service correctly determines that the requirements of section 119 were
not satisfied. Because of the written expert opinion, H has written
evidence of its reasonable belief that use of the apartment was a
nontaxable benefit as defined in paragraph (c)(2) of this section. That
evidence was in existence on or before the due date of the applicable
Federal tax return. Therefore, H has demonstrated its intent to treat
the use of the apartment as compensation for services performed by J.
[T.D. 8978, 67 FR 3083, Jan. 23, 2002; 67 FR 12472, Mar. 19, 2002]
Sec. 53.4958-5 Transaction in which the amount of the economic benefit is determined
in whole or in part by the revenues of one or more activities of the
organization. [Reserved]
Sec. 53.4958-6 Rebuttable presumption that a transaction is not an excess benefit transaction.
(a) In general. Payments under a compensation arrangement are
presumed to be reasonable, and a transfer of property, or the right to
use property, is presumed to be at fair market value, if the following
conditions are satisfied--
(1) The compensation arrangement or the terms of the property
transfer are approved in advance by an authorized body of the applicable
tax-exempt organization (or an entity controlled by the organization
within the meaning of Sec. 53.4958-4(a)(2)(ii)(B)) composed entirely of
individuals who do not have a conflict of interest (within the meaning
of paragraph (c)(1)(iii) of this section) with respect to the
compensation arrangement or property transfer, as described in paragraph
(c)(1) of this section;
(2) The authorized body obtained and relied upon appropriate data as
to comparability prior to making its determination, as described in
paragraph (c)(2) of this section; and
(3) The authorized body adequately documented the basis for its
determination concurrently with making that determination, as described
in paragraph (c)(3) of this section.
(b) Rebutting the presumption. If the three requirements of
paragraph (a) of this section are satisfied, then the Internal Revenue
Service may rebut the presumption that arises under paragraph (a) of
this section only if it develops sufficient contrary evidence to rebut
the probative value of the comparability data relied upon by the
authorized body. With respect to any fixed payment (within the meaning
of Sec. 53.4958-4(a)(3)(ii)), rebuttal evidence is limited to evidence
relating to facts and circumstances existing on the date
[[Page 233]]
the parties enter into the contract pursuant to which the payment is
made (except in the event of substantial nonperformance). With respect
to all other payments (including non-fixed payments subject to a cap, as
described in paragraph (d)(2) of this section), rebuttal evidence may
include facts and circumstances up to and including the date of payment.
See Sec. 53.4958-4(b)(2)(i).
(c) Requirements for invoking rebuttable presumption--(1) Approval
by an authorized body--(i) In general. An authorized body means--
(A) The governing body (i.e., the board of directors, board of
trustees, or equivalent controlling body) of the organization;
(B) A committee of the governing body, which may be composed of any
individuals permitted under State law to serve on such a committee, to
the extent that the committee is permitted by State law to act on behalf
of the governing body; or
(C) To the extent permitted under State law, other parties
authorized by the governing body of the organization to act on its
behalf by following procedures specified by the governing body in
approving compensation arrangements or property transfers.
(ii) Individuals not included on authorized body. For purposes of
determining whether the requirements of paragraph (a) of this section
have been met with respect to a specific compensation arrangement or
property transfer, an individual is not included on the authorized body
when it is reviewing a transaction if that individual meets with other
members only to answer questions, and otherwise recuses himself or
herself from the meeting and is not present during debate and voting on
the compensation arrangement or property transfer.
(iii) Absence of conflict of interest. A member of the authorized
body does not have a conflict of interest with respect to a compensation
arrangement or property transfer only if the member--
(A) Is not a disqualified person participating in or economically
benefitting from the compensation arrangement or property transfer, and
is not a member of the family of any such disqualified person, as
described in section 4958(f)(4) or Sec. 53.4958-3(b)(1);
(B) Is not in an employment relationship subject to the direction or
control of any disqualified person participating in or economically
benefitting from the compensation arrangement or property transfer;
(C) Does not receive compensation or other payments subject to
approval by any disqualified person participating in or economically
benefitting from the compensation arrangement or property transfer;
(D) Has no material financial interest affected by the compensation
arrangement or property transfer; and
(E) Does not approve a transaction providing economic benefits to
any disqualified person participating in the compensation arrangement or
property transfer, who in turn has approved or will approve a
transaction providing economic benefits to the member.
(2) Appropriate data as to comparability--(i) In general. An
authorized body has appropriate data as to comparability if, given the
knowledge and expertise of its members, it has information sufficient to
determine whether, under the standards set forth in Sec. 53.4958-4(b),
the compensation arrangement in its entirety is reasonable or the
property transfer is at fair market value. In the case of compensation,
relevant information includes, but is not limited to, compensation
levels paid by similarly situated organizations, both taxable and tax-
exempt, for functionally comparable positions; the availability of
similar services in the geographic area of the applicable tax-exempt
organization; current compensation surveys compiled by independent
firms; and actual written offers from similar institutions competing for
the services of the disqualified person. In the case of property,
relevant information includes, but is not limited to, current
independent appraisals of the value of all property to be transferred;
and offers received as part of an open and competitive bidding process.
(ii) Special rule for compensation paid by small organizations. For
organizations with annual gross receipts (including contributions) of
less than $1
[[Page 234]]
million reviewing compensation arrangements, the authorized body will be
considered to have appropriate data as to comparability if it has data
on compensation paid by three comparable organizations in the same or
similar communities for similar services. No inference is intended with
respect to whether circumstances falling outside this safe harbor will
meet the requirement with respect to the collection of appropriate data.
(iii) Application of special rule for small organizations. For
purposes of determining whether the special rule for small organizations
described in paragraph (c)(2)(ii) of this section applies, an
organization may calculate its annual gross receipts based on an average
of its gross receipts during the three prior taxable years. If any
applicable tax-exempt organization is controlled by or controls another
entity (as defined in Sec. 53.4958-4(a)(2)(ii)(B)), the annual gross
receipts of such organizations must be aggregated to determine
applicability of the special rule stated in paragraph (c)(2)(ii) of this
section.
(iv) Examples. The following examples illustrate the rules for
appropriate data as to comparability for purposes of invoking the
rebuttable presumption of reasonableness described in this section. In
all examples, compensation refers to the aggregate value of all benefits
provided in exchange for services. The examples are as follows:
Example 1. Z is a university that is an applicable tax-exempt
organization for purposes of section 4958. Z is negotiating a new
contract with Q, its president, because the old contract will expire at
the end of the year. In setting Q's compensation for its president at
$600x per annum, the executive committee of the Board of Trustees relies
solely on a national survey of compensation for university presidents
that indicates university presidents receive annual compensation in the
range of $100x to $700x; this survey does not divide its data by any
criteria, such as the number of students served by the institution,
annual revenues, academic ranking, or geographic location. Although many
members of the executive committee have significant business experience,
none of the members has any particular expertise in higher education
compensation matters. Given the failure of the survey to provide
information specific to universities comparable to Z, and because no
other information was presented, the executive committee's decision with
respect to Q's compensation was not based upon appropriate data as to
comparability.
Example 2. The facts are the same as Example 1, except that the
national compensation survey divides the data regarding compensation for
university presidents into categories based on various university-
specific factors, including the size of the institution (in terms of the
number of students it serves and the amount of its revenues) and
geographic area. The survey data shows that university presidents at
institutions comparable to and in the same geographic area as Z receive
annual compensation in the range of $200x to $300x. The executive
committee of the Board of Trustees of Z relies on the survey data and
its evaluation of Q's many years of service as a tenured professor and
high-ranking university official at Z in setting Q's compensation at
$275x annually. The data relied upon by the executive committee
constitutes appropriate data as to comparability.
Example 3. X is a tax-exempt hospital that is an applicable tax-
exempt organization for purposes of section 4958. Before renewing the
contracts of X's chief executive officer and chief financial officer,
X's governing board commissioned a customized compensation survey from
an independent firm that specializes in consulting on issues related to
executive placement and compensation. The survey covered executives with
comparable responsibilities at a significant number of taxable and tax-
exempt hospitals. The survey data are sorted by a number of different
variables, including the size of the hospitals and the nature of the
services they provide, the level of experience and specific
responsibilities of the executives, and the composition of the annual
compensation packages. The board members were provided with the survey
results, a detailed written analysis comparing the hospital's executives
to those covered by the survey, and an opportunity to ask questions of a
member of the firm that prepared the survey. The survey, as prepared and
presented to X's board, constitutes appropriate data as to
comparability.
Example 4. The facts are the same as Example 3, except that one year
later, X is negotiating a new contract with its chief executive officer.
The governing board of X obtains information indicating that the
relevant market conditions have not changed materially, and possesses no
other information indicating that the results of the prior year's survey
are no longer valid. Therefore, X may continue to rely on the
independent compensation survey prepared for the prior year in setting
annual compensation under the new contract.
Example 5. W is a local repertory theater and an applicable tax-
exempt organization for purposes of section 4958. W has had annual gross
receipts ranging from $400,000 to
[[Page 235]]
$800,000 over its past three taxable years. In determining the next
year's compensation for W's artistic director, the board of directors of
W relies on data compiled from a telephone survey of three other
unrelated performing arts organizations of similar size in similar
communities. A member of the board drafts a brief written summary of the
annual compensation information obtained from this informal survey. The
annual compensation information obtained in the telephone survey is
appropriate data as to comparability.
(3) Documentation--(i) For a decision to be documented adequately,
the written or electronic records of the authorized body must note--
(A) The terms of the transaction that was approved and the date it
was approved;
(B) The members of the authorized body who were present during
debate on the transaction that was approved and those who voted on it;
(C) The comparability data obtained and relied upon by the
authorized body and how the data was obtained; and
(D) Any actions taken with respect to consideration of the
transaction by anyone who is otherwise a member of the authorized body
but who had a conflict of interest with respect to the transaction.
(ii) If the authorized body determines that reasonable compensation
for a specific arrangement or fair market value in a specific property
transfer is higher or lower than the range of comparability data
obtained, the authorized body must record the basis for its
determination. For a decision to be documented concurrently, records
must be prepared before the later of the next meeting of the authorized
body or 60 days after the final action or actions of the authorized body
are taken. Records must be reviewed and approved by the authorized body
as reasonable, accurate and complete within a reasonable time period
thereafter.
(d) No presumption with respect to non-fixed payments until amounts
are determined--(1) In general. Except as provided in paragraph (d)(2)
of this section, in the case of a payment that is not a fixed payment
(within the meaning of Sec. 53.4958-4(a)(3)(ii)), the rebuttable
presumption of this section arises only after the exact amount of the
payment is determined, or a fixed formula for calculating the payment is
specified, and the three requirements for the presumption under
paragraph (a) of this section subsequently are satisfied. See Sec.
53.4958-4(b)(2)(i).
(2) Special rule for certain non-fixed payments subject to a cap. If
the authorized body approves an employment contract with a disqualified
person that includes a non-fixed payment (such as a discretionary bonus)
subject to a specified cap, the authorized body may establish a
rebuttable presumption with respect to the non-fixed payment at the time
the employment contract is entered into if--
(i) Prior to approving the contract, the authorized body obtains
appropriate comparability data indicating that a fixed payment of up to
a certain amount to the particular disqualified person would represent
reasonable compensation;
(ii) The maximum amount payable under the contract (taking into
account both fixed and non-fixed payments) does not exceed the amount
referred to in paragraph (d)(2)(i) of this section; and
(iii) The other requirements for the rebuttable presumption of
reasonableness under paragraph (a) of this section are satisfied.
(e) No inference from absence of presumption. The fact that a
transaction between an applicable tax-exempt organization and a
disqualified person is not subject to the presumption described in this
section neither creates any inference that the transaction is an excess
benefit transaction, nor exempts or relieves any person from compliance
with any Federal or state law imposing any obligation, duty,
responsibility, or other standard of conduct with respect to the
operation or administration of any applicable tax-exempt organization.
(f) Period of reliance on rebuttable presumption. Except as provided
in paragraph (d) of this section with respect to non-fixed payments, the
rebuttable presumption applies to all payments made or transactions
completed in accordance with a contract, provided that the provisions of
paragraph (a) of
[[Page 236]]
this section were met at the time the parties entered into the contract.
[T.D. 8978, 67 FR 3083, Jan. 23, 2002]
Sec. 53.4958-7 Correction.
(a) In general. An excess benefit transaction is corrected by
undoing the excess benefit to the extent possible, and taking any
additional measures necessary to place the applicable tax-exempt
organization involved in the excess benefit transaction in a financial
position not worse than that in which it would be if the disqualified
person were dealing under the highest fiduciary standards. Paragraph (b)
of this section describes the acceptable forms of correction. Paragraph
(c) of this section defines the correction amount. Paragraph (d) of this
section describes correction where a contract has been partially
performed. Paragraph (e) of this section describes correction where the
applicable tax-exempt organization involved in the transaction has
ceased to exist or is no longer tax-exempt. Paragraph (f) of this
section provides examples illustrating correction.
(b) Form of correction--(1) Cash or cash equivalents. Except as
provided in paragraphs (b)(3) and (4) of this section, a disqualified
person corrects an excess benefit only by making a payment in cash or
cash equivalents, excluding payment by a promissory note, to the
applicable tax-exempt organization equal to the correction amount, as
defined in paragraph (c) of this section.
(2) Anti-abuse rule. A disqualified person will not satisfy the
requirements of paragraph (b)(1) of this section if the Commissioner
determines that the disqualified person engaged in one or more
transactions with the applicable tax-exempt organization to circumvent
the requirements of this correction section, and as a result, the
disqualified person effectively transferred property other than cash or
cash equivalents.
(3) Special rule relating to nonqualified deferred compensation. If
an excess benefit transaction results, in whole or in part, from the
vesting (as described in Sec. 53.4958-1(e)(2)) of benefits provided
under a nonqualified deferred compensation plan, then, to the extent
that such benefits have not yet been distributed to the disqualified
person, the disqualified person may correct the portion of the excess
benefit resulting from the undistributed deferred compensation by
relinquishing any right to receive the excess portion of the
undistributed deferred compensation (including any earnings thereon).
(4) Return of specific property--(i) In general. A disqualified
person may, with the agreement of the applicable tax-exempt
organization, make a payment by returning specific property previously
transferred in the excess benefit transaction. In this case, the
disqualified person is treated as making a payment equal to the lesser
of--
(A) The fair market value of the property determined on the date the
property is returned to the organization; or
(B) The fair market value of the property on the date the excess
benefit transaction occurred.
(ii) Payment not equal to correction amount. If the payment
described in paragraph (b)(4)(i) of this section is less than the
correction amount (as described in paragraph (c) of this section), the
disqualified person must make an additional cash payment to the
organization equal to the difference. Conversely, if the payment
described in paragraph (b)(4)(i) of this section exceeds the correction
amount (as described in paragraph (c) of this section), the organization
may make a cash payment to the disqualified person equal to the
difference.
(iii) Disqualified person may not participate in decision. Any
disqualified person who received an excess benefit from the excess
benefit transaction may not participate in the applicable tax-exempt
organization's decision whether to accept the return of specific
property under paragraph (b)(4)(i) of this section.
(c) Correction amount. The correction amount with respect to an
excess benefit transaction equals the sum of the excess benefit (as
defined in Sec. 53.4958-1(b)) and interest on the excess benefit. The
amount of the interest charge for purposes of this section is determined
by multiplying the excess benefit by an interest rate, compounded
annually, for the period from the date the excess
[[Page 237]]
benefit transaction occurred (as defined in Sec. 53.4958-1(e)) to the
date of correction. The interest rate used for this purpose must be a
rate that equals or exceeds the applicable Federal rate (AFR),
compounded annually, for the month in which the transaction occurred.
The period from the date the excess benefit transaction occurred to the
date of correction is used to determine whether the appropriate AFR is
the Federal short-term rate, the Federal mid-term rate, or the Federal
long-term rate. See section 1274(d)(1)(A).
(d) Correction where contract has been partially performed. If the
excess benefit transaction arises under a contract that has been
partially performed, termination of the contractual relationship between
the organization and the disqualified person is not required in order to
correct. However, the parties may need to modify the terms of any
ongoing contract to avoid future excess benefit transactions.
(e) Correction in the case of an applicable tax-exempt organization
that has ceased to exist, or is no longer tax-exempt--(1) In general. A
disqualified person must correct an excess benefit transaction in
accordance with this paragraph where the applicable tax-exempt
organization that engaged in the transaction no longer exists or is no
longer described in section 501(c)(3) or (4) and exempt from tax under
section 501(a).
(2) Section 501(c)(3) organizations. In the case of an excess
benefit transaction with a section 501(c)(3) applicable tax-exempt
organization, the disqualified person must pay the correction amount, as
defined in paragraph (c) of this section, to another organization
described in section 501(c)(3) and exempt from tax under section 501(a)
in accordance with the dissolution clause contained in the constitutive
documents of the applicable tax-exempt organization involved in the
excess benefit transaction, provided that--
(i) The organization receiving the correction amount is described in
section 170(b)(1)(A) (other than in section 170(b)(1)(A)(vii) and
(viii)) and has been in existence and so described for a continuous
period of at least 60 calendar months ending on the correction date;
(ii) The disqualified person is not also a disqualified person (as
defined in Sec. 53.4958-3) with respect to the organization receiving
the correction amount; and
(iii) The organization receiving the correction amount does not
allow the disqualified person (or persons described in Sec. 53.4958-
3(b) with respect to that person) to make or recommend any grants or
distributions by the organization.
(3) Section 501(c)(4) organizations. In the case of an excess
benefit transaction with a section 501(c)(4) applicable tax-exempt
organization, the disqualified person must pay the correction amount, as
defined in paragraph (c) of this section, to a successor section
501(c)(4) organization or, if no tax-exempt successor, to any
organization described in section 501(c)(3) or (4) and exempt from tax
under section 501(a), provided that the requirements of paragraphs
(e)(2)(i) through (iii) of this section are satisfied (except that the
requirement that the organization receiving the correction amount is
described in section 170(b)(1)(A) (other than in section
170(b)(1)(A)(vii) and (viii)) shall not apply if the organization is
described in section 501(c)(4)).
(f) Examples. The following examples illustrate the principles of
this section describing the requirements of correction:
Example 1. W is an applicable tax-exempt organization for purposes
of section 4958. D is a disqualified person with respect to W. W
employed D in 1999 and made payments totaling $12t to D as compensation
throughout the taxable year. The fair market value of D's services in
1999 was $7t. Thus, D received excess compensation in the amount of $5t,
the excess benefit for purposes of section 4958. In accordance with
Sec. 53.4958-1(e)(1), the excess benefit transaction with respect to
the series of compensatory payments during 1999 is deemed to occur on
December 31, 1999, the last day of D's taxable year. In order to correct
the excess benefit transaction on June 30, 2002, D must pay W, in cash
or cash equivalents, excluding payment with a promissory note, $5t (the
excess benefit) plus interest on $5t for the period from the date the
excess benefit transaction occurred to the date of correction (i.e.,
December 31, 1999, to June 30, 2002). Because this period is not more
than three years, the interest rate D must use to determine the interest
on the excess benefit must equal or exceed the short-term AFR,
compounded annually, for
[[Page 238]]
December, 1999 (5.74%, compounded annually).
Example 2. X is an applicable tax-exempt organization for purposes
of section 4958. B is a disqualified person with respect to X. On
January 1, 2000, B paid X $6v for Property F. Property F had a fair
market value of $10v on January 1, 2000. Thus, the sales transaction on
that date provided an excess benefit to B in the amount of $4v. In order
to correct the excess benefit on July 5, 2005, B pays X, in cash or cash
equivalents, excluding payment with a promissory note, $4v (the excess
benefit) plus interest on $4v for the period from the date the excess
benefit transaction occurred to the date of correction (i.e., January 1,
2000, to July 5, 2005). Because this period is over three but not over
nine years, the interest rate B must use to determine the interest on
the excess benefit must equal or exceed the mid-term AFR, compounded
annually, for January, 2000 (6.21%, compounded annually).
Example 3. The facts are the same as in Example 2, except that B
offers to return Property F. X agrees to accept the return of Property
F, a decision in which B does not participate. Property F has declined
in value since the date of the excess benefit transaction. On July 5,
2005, the property has a fair market value of $9v. For purposes of
correction, B's return of Property F to X is treated as a payment of
$9v, the fair market value of the property determined on the date the
property is returned to the organization. If $9v is greater than the
correction amount ($4v plus interest on $4v at a rate that equals or
exceeds 6.21%, compounded annually, for the period from January 1, 2000,
to July 5, 2005), then X may make a cash payment to B equal to the
difference.
Example 4. The facts are the same as in Example 3, except that
Property F has increased in value since January 1, 2000, the date the
excess benefit transaction occurred, and on July 5, 2005, has a fair
market value of $13v. For purposes of correction, B's return of Property
F to X is treated as a payment of $10v, the fair market value of the
property on the date the excess benefit transaction occurred. If $10v is
greater than the correction amount ($4v plus interest on $4v at a rate
that equals or exceeds 6.21%, compounded annually, for the period from
January 1, 2000, to July 5, 2005), then X may make a cash payment to B
equal to the difference.
Example 5. The facts are the same as in Example 2. Assume that the
correction amount B paid X in cash on July 5, 2005, was $5.58v. On July
4, 2005, X loaned $5.58v to B, in exchange for a promissory note signed
by B in the amount of $5.58v, payable with interest at a future date.
These facts indicate that B engaged in the loan transaction to
circumvent the requirement of this section that (except as provided in
paragraph (b)(3) or (4) of this section), the correction amount must be
paid only in cash or cash equivalents. As a result, the Commissioner may
determine that B effectively transferred property other than cash or
cash equivalents, and therefore did not satisfy the correction
requirements of this section.
[T.D. 8978, 67 FR 3083, Jan. 23, 2002]
Sec. 53.4958-8 Special rules.
(a) Substantive requirements for exemption still apply. Section 4958
does not affect the substantive standards for tax exemption under
section 501(c)(3) or (4), including the requirements that the
organization be organized and operated exclusively for exempt purposes,
and that no part of its net earnings inure to the benefit of any private
shareholder or individual. Thus, regardless of whether a particular
transaction is subject to excise taxes under section 4958, existing
principles and rules may be implicated, such as the limitation on
private benefit. For example, transactions that are not subject to
section 4958 because of the initial contract exception described in
Sec. 53.4958-4(a)(3) may, under certain circumstances, jeopardize the
organization's tax-exempt status.
(b) Interaction between section 4958 and section 7611 rules for
church tax inquiries and examinations. The procedures of section 7611
will be used in initiating and conducting any inquiry or examination
into whether an excess benefit transaction has occurred between a church
and a disqualified person. For purposes of this rule, the reasonable
belief required to initiate a church tax inquiry is satisfied if there
is a reasonable belief that a section 4958 tax is due from a
disqualified person with respect to a transaction involving a church.
See Sec. 301.7611-1 Q&A 19 of this chapter.
(c) Other substantiation requirements. These regulations, in Sec.
53.4958-4(c)(3), set forth specific substantiation rules. Compliance
with the specific substantiation rules of that section does not relieve
applicable tax-exempt organizations of other rules and requirements of
the Internal Revenue Code, regulations, Revenue Rulings, and other
guidance issued by the Internal Revenue Service (including the
substantiation rules of sections 162 and 274, or Sec. 1.6001-1(a) and
(c) of this chapter).
[T.D. 8978, 67 FR 3083, Jan. 23, 2002]
[[Page 239]]
Sec. 53.4961-1 Abatement of second tier taxes for correction within correction period.
If any taxable event is corrected during the correction period for
the event, then any second tier tax imposed with respect to the event
shall not be assessed. If the tax has been assessed, it shall be abated.
If the tax has been collected, it shall be credited or refunded as an
overpayment. For purposes of this section, the tax imposed includes
interest, additions to the tax and additional amounts. For definitions
of the terms second tier tax, taxable event, correct, and correction
period, see Sec. 53.4963-1.
Sec. 53.4961-2 Court proceedings to determine liability for second tier tax.
(a) Introduction. Under section 4961 (b) and (c), the period of
limitations on collection may be suspended and assessment or collection
of first or second tier tax may be prohibited during the pendency of
administrative and judicial proceedings conducted to determine a
taxpayer's liability for second tier tax. This section provides rules
relating to the suspension of the limitations period and the
prohibitions on assessment and collection. In addition, this section
describes the administrative and judicial proceedings to which these
rules apply.
(b) Initial proceeding--(1) Defined. For purposes of subpart K, an
initial proceeding means a proceeding described in subparagraph (2) or
(3).
(2) Tax Court proceeding before assessment. A proceeding is
described in this subparagraph (2) if it is a proceeding with respect to
the taxpayer's liability for second tier tax and is commenced in
accordance with section 6213 (a).
(3) Refund proceeding commenced before correction period ends. A
proceeding is described in this subparagraph (3) if it is a proceeding
commenced under section 7422, in accordance with the provisions of Sec.
53.4963-1(e) (4) and (5) (relating to prerequisites to extension of the
correction period during certain refund proceedings), and with respect
to the taxpayer's liability for second tier tax.
(c) Supplemental proceeding--(1) Jurisdiction. If a determination in
an initial proceeding that a taxpayer is liable for a second tier tax
has become final, the court in which the initial proceeding was
commenced shall have jurisdiction to conduct any necessary supplemental
proceeding to determine whether the taxable event was corrected during
the correction period.
(2) Time for beginning proceeding. The time for beginning a
supplemental proceeding begins on the day after a determination in an
initial proceeding becomes final and ends on the 90th day after the last
day of the correction period.
(d) Restriction on assessment during Tax Court proceeding. If a
supplemental proceeding described in section 4961 (b) and Sec. 53.4961-
2(c) is commenced in the Tax Court, the provisions of the second and
third sentences of section 6213(a) and the first and third sentences of
Sec. 301.6213-1(a)(2) apply with respect to a deficiency in second tier
tax until the decision of the Tax Court in the supplemental proceeding
is final.
(e) Suspension of period of collection for second tier tax--(1)
Scope. Except as provided in subparagraph (6), this paragraph (e)
applies to the second tier tax assessed with respect to a taxable event
if a claim described in subparagraph (2) is filed.
(2) Claim for refund. A claim for refund is described in this
subparagraph (2) if, no later than 90 days after the day on which the
second tier tax is assessed with respect to a taxable event, the
taxpayer--
(i) Pays the full amount of first tier tax for the taxable period,
and
(ii) Files a claim for refund of the amount paid.
(3) Collection prohibited. No levy or proceeding in court for the
collection of the second tier tax shall be made, begun, or prosecuted
until the end of the collection prohibition period described in
subparagraph (5). Notwithstanding section 7421(a), the collection by
levy or proceeding may be enjoined during the collection prohibition
period by a proceeding in the proper court.
(4) Suspension of running of period of limitations on collection.
With respect to a second tier tax to which this paragraph (e) applies,
the running of the period of limitations provided in section 6502
(relating to collection of tax by levy or by a proceeding in court)
shall
[[Page 240]]
be suspended for the collection prohibition period described in
subparagraph (5).
(5) Collection prohibition period. The collection prohibition period
begins on the day the second tier tax is assessed and ends on the latest
of:
(i) The day a decision in a refund proceeding commenced before the
91st day after denial of the claim described in subparagraph (2) of this
paragraph (including any supplemental proceeding under Sec. 53.4961-
2(c)) becomes final;
(ii) The 90th day after the claim referred to in subparagraph (2) is
denied; or
(iii) The 90th day after the second tier tax is assessed.
(6) Jeopardy collection. If the Secretary makes a finding that the
collection of the second tier tax is in jeopardy, nothing in this
paragraph (e) shall prevent the immediate collection of such tax.
(f) Finality--(1) Tax Court proceeding. For purposes of this subpart
K, section 7481 applies in determining when a decision in a Tax Court
proceeding becomes final.
(2) Refund proceeding. For purposes of this subpart K, Sec.
301.7422-1 applies in determining when a decision in a refund proceeding
becomes final.
Sec. 53.4963-1 Definitions.
(a) First tier tax. For purposes of this subpart K, the term first
tier tax means any tax imposed by subsection (a) of section 4941, 4942,
4943, 4944, 4945, 4951, 4952, 4955, 4958, 4971, or 4975. A first tier
tax may also be referred to as an ``initial tax'' in parts 53 and 54.
(b) Second tier tax. For purposes of this subpart K, the term second
tier tax means any tax imposed by subsection (b) of section 4941, 4942,
4943, 4944, 4945, 4951, 4952, 4955, 4958, 4971, or 4975. A second tier
tax may also be referred to as an ``additional tax'' in parts 53 and 54.
(c) Taxable event. For purposes of this subpart K, the term taxable
event means any act, or failure to act, giving rise to liability for tax
under section 4941, 4942, 4943, 4944, 4945, 4951, 4952, 4955, 4958,
4971, or 4975.
(d) Correct--(1) In general. Except as provided in subparagraph (2),
the term correct has the same meaning for purposes of this subpart K as
in the section which imposes the second tier tax or the regulations
thereunder.
(2) Special rules. The term correct means--
(i) For a second tier tax imposed by section 4942(b), reducing the
amount of the undistributed income to zero,
(ii) For a second tier tax imposed by section 4943(b), reducing the
amount of the excess business holdings to zero, and
(iii) For a second tier tax imposed by section 4944(b), removing the
investment from jeopardy.
(e) Correction period--(1) In general. The correction period with
respect to any taxable event shall begin with the date on which the
taxable event occurs and shall end 90 days after the date of mailing of
a notice of deficiency under section 6212 with respect to the second
tier tax imposed with respect to the taxable event.
(2) Extensions of correction period. The correction period referred
to in subparagraph (1) of this paragraph shall be extended by any period
in which a deficiency cannot be assessed under section 6213(a). In
addition, the correction period referred to in subparagraph (1) of this
paragraph (e) shall be extended in accordance with subparagraph (3),
(4), and (5) of this paragraph except that subparagraph (4), or (5)
shall not operate to extend a correction period with respect to which a
taxpayer has filed a petition with the United States Tax Court for
redetermination of a deficiency within the time prescribed by section
6213(a).
(3) Extensions by Commissioner. The correction period referred to in
subparagraph (1) of this paragraph may be extended by any period which
the Commissioner determines is reasonable and necessary to bring about
correction (including, for taxes imposed by section 4975, equitable
relief sought by the Secretary of Labor) of the taxable event. The
Commissioner ordinarily will not extend the correction period unless the
following factors are present.
(i) The taxpayer on whom the second tier tax is imposed, the
Secretary of Labor (for taxes imposed by section 4975), or an
appropriate State officer
[[Page 241]]
(as defined in section 6104(c)(2)) is actively seeking in good faith to
correct the taxable event;
(ii) Adequate corrective action cannot reasonably be expected to
result during the unextended correction period;
(iii) For taxes imposed by section 4975, the Secretary of Labor
requests the extension because subdivision (ii) applies; and
(iv) For taxes imposed by chapter 42 (other than taxes imposed by
section 4940), the taxable event appears to have been an isolated
occurrence so that it appears unlikely that similar taxable events will
occur in the future.
(4) Extension for payment of first tier tax. If, within the
unexpected correction period, the taxpayer pays the full amount of the
first tier tax imposed with respect to the taxable event the
Commissioner shall extend the correction period to the later of--
(i) Ninety days after the payment of the first tier tax, or
(ii) The last day of the correction period determined without regard
to this paragraph.
(5) Extensions for filing claim for refund or refund suit. If prior
to the expiration of the correction period (including extensions) a
claim for refund is filed with respect to payment of the full amount of
the first tier tax imposed with respect to the taxable event, the
Commissioner shall extend the correction period during the pendency of
the claim plus an additional 90 days. If within that time a suit or
proceeding referred to in section 7422(g) with respect to the claim is
filed, the Commissioner shall extend the correction period until the
determination in the suit for refund (determined without regard to a
supplemental proceeding under section 4861(b)) is final, determined
under Sec. 301.7422-2(a).
(6) End of correction period if waiver accepted. If the notice of
deficiency referred to in paragraph (1) is not mailed because there is a
waiver of the restrictions on assessment and collection of the
deficiency or because the deficiency is paid, the correction period will
end with the end of the collection prohibition period described in Sec.
53.4961-2(e)(5).
(7) Date on which taxable event occurs. For purposes of subparagraph
(1), the taxable event shall be treated as occurring--
(i) Under section 4942, on the first day of the taxable year for
which there is undistributed income,
(ii) Under section 4943, on the first day on which there are excess
business holdings,
(iii) Under section 4971, on the last day of the plan year in which
there is an accumulated funding deficiency, and
(iv) In all other cases, the date on which the event occurred.
(f) Effective date. The provisions of this subpart K are effective
with respect to second tier taxes assessed after December 24, 1980. The
preceding sentence shall not be construed to permit the assessment of a
tax in a case to which, on December 24, 1980, the doctrine of res
judicata applied.
[T.D. 8084, 51 FR 16303, May 2, 1986; 51 FR 17732, May 15, 1986, as
amended by T.D. 8628, 60 FR 62212, Dec. 5, 1995; T.D. 8920, 66 FR 2171,
Jan. 10, 2001]
Sec. 53.4965-1 Overview.
(a) Entity-level excise tax. Section 4965 imposes two excise taxes
with respect to certain tax shelter transactions to which tax-exempt
entities are parties. Section 4965(a)(1) imposes an entity-level excise
tax on certain tax-exempt entities that are parties to ``prohibited tax
shelter transactions,'' as defined in section 4965(e). See Sec.
53.4965-2 for the discussion of covered tax-exempt entities. See Sec.
53.4965-3 for the definition of prohibited tax shelter transactions. See
Sec. 53.4965-4 for the definition of tax-exempt party to a prohibited
tax shelter transaction. The entity-level excise tax under section
4965(a)(1) is imposed on a specified percentage of the entity's net
income or proceeds that are attributable to the transaction for the
relevant tax year (or a period within that tax year). The rate of tax
depends on whether the entity knew or had reason to know that the
transaction was a prohibited tax shelter transaction at the time the
entity became a party to the transaction. See Sec. 53.4965-7(a) for the
discussion of the entity-level excise tax under section 4965(a)(1). See
[[Page 242]]
Sec. 53.4965-6 for the discussion of ``knowing or having reason to
know.'' See Sec. 53.4965-8 for the definition of net income and
proceeds and the standard for allocating net income and proceeds that
are attributable to a prohibited tax shelter transaction to various
periods.
(b) Manager-level excise tax. Section 4965(a)(2) imposes a manager-
level excise tax on ``entity managers,'' as defined in section 4965(d),
of tax-exempt entities who approve the entity as a party (or otherwise
cause the entity to be a party) to a prohibited tax shelter transaction
and know or have reason to know, at the time the tax-exempt entity
enters into the transaction, that the transaction is a prohibited tax
shelter transaction. See Sec. 53.4965-5 for the definition of entity
manager and the meaning of ``approving or otherwise causing,'' and Sec.
53.4965-6 for the discussion of ``knowing or having reason to know.''
See Sec. 53.4965-7(b) for the discussion of the manager-level excise
tax under section 4965(a)(2).
(c) Effective/applicability dates. See Sec. 53.4965-9 for the
discussion of the relevant effective and applicability dates.
[T.D. 9492, 75 FR 38702, July 6, 2010]
Sec. 53.4965-2 Covered tax-exempt entities.
(a) In general. Under section 4965(c), the term ``tax-exempt
entity'' refers to entities that are described in sections 501(c),
501(d), or 170(c) (other than the United States), Indian tribal
governments (within the meaning of section 7701(a)(40)), and tax-
qualified pension plans, individual retirement arrangements and similar
tax-favored savings arrangements that are described in sections
4979(e)(1), (2) or (3), 529, 457(b), or 4973(a). The tax-exempt entities
referred to in section 4965(c) are divided into two broad categories,
non-plan entities and plan entities.
(b) Non-plan entities. Non-plan entities are--
(1) Entities described in section 501(c);
(2) Religious or apostolic associations or corporations described in
section 501(d);
(3) Entities described in section 170(c), including states,
possessions of the United States, the District of Columbia, political
subdivisions of states and political subdivisions of possessions of the
United States (but not including the United States); and
(4) Indian tribal governments within the meaning of section
7701(a)(40).
(c) Plan entities. Plan entities are--
(1) Entities described in section 4979(e)(1) (qualified plans under
section 401(a), including qualified cash or deferred arrangements under
section 401(k) (including a section 401(k) plan that allows designated
Roth contributions));
(2) Entities described in section 4979(e)(2) (annuity plans
described in section 403(a));
(3) Entities described in section 4979(e)(3) (annuity contracts
described in section 403(b), including a section 403(b) arrangement that
allows Roth contributions);
(4) Qualified tuition programs described in section 529;
(5) Eligible deferred compensation plans under section 457(b) that
are maintained by a governmental employer as defined in section
457(e)(1)(A);
(6) Arrangements described in section 4973(a) which include--
(i) Individual retirement plans defined in section 408(a) and (b),
including--
(A) Simplified employee pensions (SEPs) under section 408(k);
(B) Simple individual retirement accounts (SIMPLEs) under section
408(p);
(C) Deemed individual retirement accounts or annuities (IRAs)
qualified under a qualified plan (deemed IRAs) under section 408(q); and
(D) Roth IRAs under section 408A.
(ii) Arrangements described in section 220(d) (Archer Medical
Savings Accounts (MSAs));
(iii) Arrangements described in section 403(b)(7) (custodial
accounts treated as annuity contracts);
(iv) Arrangements described in section 530 (Coverdell education
savings accounts); and
(v) Arrangements described in section 223(d) (health savings
accounts (HSAs)).
(d) Effective/applicability dates. See Sec. 53.4965-9 for the
discussion of the relevant effective and applicability dates.
[T.D. 9492, 75 FR 38702, July 6, 2010; 75 46844, Aug. 4, 2010]
[[Page 243]]
Sec. 53.4965-3 Prohibited tax shelter transactions.
(a) In general. Under section 4965(e), the term prohibited tax
shelter transaction means--
(1) Listed transactions within the meaning of section 6707A(c)(2),
including subsequently listed transactions described in paragraph (b) of
this section; and
(2) Prohibited reportable transactions, which consist of the
following reportable transactions within the meaning of section
6707A(c)(1)--
(i) Confidential transactions, as described in Sec. 1.6011-4(b)(3)
of this chapter; or
(ii) Transactions with contractual protection, as described in Sec.
1.6011-4(b)(4) of this chapter.
(b) Subsequently listed transactions. A subsequently listed
transaction for purposes of section 4965 is a transaction that is
identified by the Secretary as a listed transaction after the tax-exempt
entity has entered into the transaction and that was not a prohibited
reportable transaction (within the meaning of section 4965(e)(1)(C) and
paragraph (a)(2) of this section) at the time the entity entered into
the transaction.
(c) Cross-reference. The determination of whether a transaction is a
listed transaction or a prohibited reportable transaction for section
4965 purposes shall be made under the law applicable to section
6707A(c)(1) and (c)(2).
(d) Effective/applicability dates. See Sec. 53.4965-9 for the
discussion of the relevant effective and applicability dates.
[T.D. 9492, 75 FR 38702, July 6, 2010]
Sec. 53.4965-4 Definition of tax-exempt party to a prohibited tax shelter transaction.
(a) In general. For purposes of sections 4965 and 6033(a)(2), a tax-
exempt entity is a party to a prohibited tax shelter transaction if the
entity--
(1) Facilitates a prohibited tax shelter transaction by reason of
its tax-exempt, tax indifferent or tax-favored status; or
(2) Is identified in published guidance, by type, class or role, as
a party to a prohibited tax shelter transaction.
(b) Published guidance may identify which tax-exempt entities, by
type, class or role, will not be treated as a party to a prohibited tax
shelter transaction.
(c) Example. The following example illustrates the principle of
paragraph (a)(1) of this section:
Example. A tax-exempt entity enters into a transaction (Transaction
A) with an S corporation. Transaction A is the same as or substantially
similar to the transaction identified by the Secretary as a listed
transaction in Notice 2004-30 (2004-1 CB 828). The tax-exempt entity's
role in Transaction A is similar to the role of the tax-exempt party, as
described in Notice 2004-30. Under the terms of the transaction, as
described in Notice 2004-30, the tax-exempt entity receives the S
corporation stock and purports to aid the S corporation and its
shareholders in avoiding taxable income. The tax-exempt entity
facilitates Transaction A by reason of its tax-exempt, tax indifferent
or tax-favored status. Accordingly, the tax-exempt entity is a party to
Transaction A for purposes of sections 4965 and 6033(a)(2). See Sec.
601.601(d)(2)(ii)(b) of this chapter.
(d) Effective/applicability dates. See Sec. 53.4965-9 for the
discussion of the relevant effective and applicability dates.
[T.D. 9492, 75 FR 38702, July 6, 2010]
Sec. 53.4965-5 Entity managers and related definitions.
(a) Entity manager of a non-plan entity--(1) In general. Under
section 4965(d)(1), an entity manager of a non-plan entity is--
(i) A person with the authority or responsibility similar to that
exercised by an officer, director, or trustee of an organization (that
is, the non-plan entity); and
(ii) With respect to any act, the person who has final authority or
responsibility (either individually or as a member of a collective body)
with respect to such act.
(2) Definition of officer. For purposes of paragraph (a)(1)(i) of
this section, a person is considered to be an officer of the non-plan
entity (or to have similar authority or responsibility) if the person--
(i) Is specifically designated as such under the certificate of
incorporation, by-laws, or other constitutive documents of the non-plan
entity; or
[[Page 244]]
(ii) Regularly exercises general authority to make administrative or
policy decisions on behalf of the non-plan entity.
(3) Exception for acts requiring approval by a superior. With
respect to any act, any person is not described in paragraph (a)(2)(ii)
of this section if the person has authority merely to recommend
particular administrative or policy decisions, but not to implement them
without approval of a superior.
(4) Delegation of authority. A person is an entity manager of a non-
plan entity within the meaning of paragraph (a)(1)(ii) of this section
if, with respect to any prohibited tax shelter transaction, such person
has been delegated final authority or responsibility with respect to
such transaction (including by transaction type or dollar amount) by a
person described in paragraph (a)(1)(i) of this section or the governing
board of the entity. For example, an investment manager is an entity
manager with respect to a prohibited tax shelter transaction if the non-
plan entity's governing body delegated to the investment manager the
final authority to make certain investment decisions and, in the
exercise of that authority, the manager committed the entity to the
transaction. To be considered an entity manager of a non-plan entity
within the meaning of paragraph (a)(1)(ii) of this section, a person
need not be an employee of the entity. A person is not described in
paragraph (a)(1)(ii) of this section if the person is merely
implementing a decision made by a superior.
(b) Entity manager of a plan entity--(1) In general. Under section
4965(d)(2), an entity manager of a plan entity is the person who
approves or otherwise causes the entity to be a party to the prohibited
tax shelter transaction.
(2) Special rule for plan participants and beneficiaries who have
investment elections--(i) Fully self-directed plans or arrangements. In
the case of a fully self-directed qualified plan, IRA, or other savings
arrangement (including a case where a plan participant or beneficiary is
given a list of prohibited investments, such as collectibles), if the
plan participant or beneficiary selected a certain investment and,
therefore, approved the plan entity to become a party to a prohibited
tax shelter transaction, the plan participant or the beneficiary is an
entity manager.
(ii) Plans or arrangements with limited investment options. In the
case of a qualified plan, IRA, or other savings arrangement where a plan
participant or beneficiary is offered a limited number of investment
options from which to choose, the person responsible for determining the
pre-selected investment options is an entity manager and the plan
participant or the beneficiary generally is not an entity manager.
(c) Meaning of ``approves or otherwise causes''--(1) In general. A
person is treated as approving or otherwise causing a tax-exempt entity
to become a party to a prohibited tax shelter transaction if the person
has the authority to commit the entity to the transaction, either
individually or as a member of a collective body, and the person
exercises that authority.
(2) Collective bodies. If a person shares the authority described in
paragraph (c)(1) of this section as a member of a collective body (for
example, board of trustees or committee), the person will be considered
to have exercised such authority if the person voted in favor of the
entity becoming a party to the transaction. However, a member of the
collective body will not be treated as having exercised the authority
described in paragraph (c)(1) of this section if he or she voted against
a resolution that constituted approval or an act that caused the tax-
exempt entity to be a party to a prohibited tax shelter transaction,
abstained from voting for such approval, or otherwise failed to vote in
favor of such approval.
(3) Exceptions--(i) Successor in interest. If a tax-exempt entity
that is a party to a prohibited tax shelter transaction is dissolved,
liquidated, or merged into a successor entity, an entity manager of the
successor entity will not, solely by reason of the reorganization, be
treated as approving or otherwise causing the successor entity to become
a party to a prohibited tax shelter transaction, provided that the
reorganization of the tax-exempt entity does not result in a material
change to the terms of the transaction. For purposes of this paragraph
(c)(3)(i), a material
[[Page 245]]
change includes an extension or renewal of the agreement (other than an
extension or renewal that results from another party to the transaction
unilaterally exercising an option granted by the agreement) or a more
than incidental change to any payment under the agreement. A change for
the sole purpose of substituting the successor entity for the original
tax-exempt party is not a material change.
(ii) Exercise or nonexercise of options. Nonexercise of an option
pursuant to a transaction involving the tax-exempt entity generally will
not constitute an act of approving or causing the entity to be a party
to the transaction. If, pursuant to a transaction involving the tax-
exempt entity, the entity manager exercises an option (such as a
repurchase option), the entity manager will not be subject to the entity
manager-level tax if the exercise of the option does not result in the
tax-exempt entity becoming a party to a second transaction that is a
prohibited tax shelter transaction.
(4) Example. The following example illustrates the principles of
paragraph (c)(3)(ii) of this section:
Example. In a sale-in, lease-out (SILO) transaction described in
Notice 2005-13 (2005-1 CB 630), X, which is a non-plan entity, has
purported to sell property to Y, a taxable entity and lease it back for
a term of years. At the end of the basic lease term, X has the option of
``repurchasing'' the property from Y for a predetermined purchase price,
with funds that have been set aside at the inception of the transaction
for that purpose. The entity manager, by deciding to exercise or not
exercise the ``repurchase'' option is not approving or otherwise causing
the non-plan entity to become a party to a second prohibited tax shelter
transaction. See Sec. 601.601(d)(2)(ii)(b) of this chapter.
(5) Coordination with the reason-to-know standard. The determination
that an entity manager approved or caused a tax-exempt entity to be a
party to a prohibited tax shelter transaction, by itself, does not
establish liability for the section 4965(a)(2) tax. For rules on
determining whether an entity manager knew or had reason to know that
the transaction was a prohibited tax shelter transaction, see Sec.
53.4965-6(b).
(d) Effective/applicability dates. See Sec. 53.4965-9 for the
discussion of the relevant effective and applicability dates.
[T.D. 9492, 75 FR 38702, July 6, 2010; 75 FR 46844, Aug. 4, 2010]
Sec. 53.4965-6 Meaning of ``knows or has reason to know''.
(a) Attribution to the entity. An entity will be treated as knowing
or having reason to know for section 4965 purposes if one or more of its
entity managers knew or had reason to know that the transaction was a
prohibited tax shelter transaction at the time the entity manager(s)
approved the entity as (or otherwise caused the entity to be) a party to
the transaction. The entity shall be attributed the knowledge or reason
to know of any entity manager described in Sec. 53.4965-5(a)(1)(i) even
if that entity manager does not approve the entity as (or otherwise
cause the entity to be) a party to the transaction.
(b) Determining whether an entity manager knew or had reason to
know--(1) In general. Whether an entity manager knew or had reason to
know that a transaction is a prohibited tax shelter transaction is based
on all facts and circumstances. In order for an entity manager to know
or have reason to know that a transaction is a prohibited tax shelter
transaction, the entity manager must have knowledge of sufficient facts
that would lead a reasonable person to conclude that the transaction is
a prohibited tax shelter transaction. An entity manager will be
considered to have ``reason to know'' if a reasonable person in the
entity manager's circumstances would conclude that the transaction was a
prohibited tax shelter transaction based on all the facts reasonably
available to the manager at the time of approving the entity as (or
otherwise causing the entity to be) a party to the transaction. Factors
that will be considered in determining whether a reasonable person in
the entity manager's circumstances would conclude that the transaction
was a prohibited tax shelter transaction include, but are not limited
to--
(i) The presence of tax shelter indicia (see paragraph (b)(2) of
this section);
(ii) Whether the entity manager received a disclosure statement
prior to
[[Page 246]]
the consummation of the transaction indicating that the transaction may
be a prohibited tax shelter transaction (see paragraph (b)(3) of this
section); and
(iii) Whether the entity manager made appropriate inquiries into the
transaction (see paragraph (b)(4) of this section).
(2) Tax-shelter indicia. The presence of indicia that a transaction
is a tax shelter will be treated as an indication that the entity
manager knew or had reason to know that the transaction was a prohibited
tax shelter transaction. Tax shelter indicia include but are not limited
to--
(i) The transaction is extraordinary for the entity considering
prior investment activity;
(ii) The transaction promises an economic return for the
organization that is exceptional considering the amount invested by, the
participation of, or the absence of risk to the organization; or
(iii) The transaction is of significant size relative to the
receipts of the entity.
(3) Effect of disclosure statements. Receipt by an entity manager of
a statement, including a statement described in section 6011(g), in
advance of a transaction that the transaction may be a prohibited tax
shelter transaction (or a statement that a partnership, hedge fund or
other investment conduit may engage in a prohibited tax shelter
transaction in the future) is a factor relevant in the determination of
whether the entity manager knew or had reason to know that the
transaction is a prohibited transaction. However, an entity manager will
not be treated as knowing or having reason to know that the transaction
was a prohibited tax shelter transaction solely because the entity
manager receives such a disclosure.
(4) Appropriate inquiries. What inquiries are appropriate will be
determined from the facts and circumstances of each case. For example,
if one or more tax shelter indicia are present or if an entity manager
receives a disclosure statement described in paragraph (b)(3) of this
section, an entity manager has a responsibility to inquire further
whether the transaction is a prohibited tax shelter transaction.
(c) Reliance on professional advice--(1) In general. An entity
manager is not required to obtain the advice of a professional tax
advisor to establish that the entity manager made appropriate inquiries.
Moreover, not seeking professional advice, by itself, shall not give
rise to an inference that the entity manager had reason to know that a
transaction is a prohibited tax shelter transaction.
(2) Reliance on written opinion of professional tax advisor. An
entity manager may establish that he or she did not have a reason to
know that a transaction was a prohibited tax shelter transaction at the
time the tax-exempt entity entered into the transaction if the entity
manager reasonably, and in good faith, relied on the written opinion of
a professional tax advisor. Reliance on the written opinion of a
professional tax advisor establishes that the entity manager did not
have reason to know if, taking into account all the facts and
circumstances, the reliance was reasonable and the entity manager acted
in good faith. For example, the entity manager's education,
sophistication, and business experience will be relevant in determining
whether the reliance was reasonable and made in good faith. In no event
will an entity manager be considered to have reasonably relied in good
faith on an opinion unless the requirements of this paragraph (c)(2) are
satisfied. The fact that these requirements are satisfied, however, will
not necessarily establish that the entity manager reasonably relied on
the opinion in good faith. For example, reliance may not be reasonable
or in good faith if the entity manager knew, or reasonably should have
known, that the advisor lacked knowledge in the relevant aspects of
Federal tax law.
(i) All facts and circumstances considered. The advice must be based
upon all pertinent facts and circumstances and the law as it relates to
those facts and circumstances. The requirements of this paragraph (c)(2)
are not satisfied if the entity manager fails to disclose a fact that it
knows, or reasonably should know, is relevant to determining whether the
transaction is a prohibited tax shelter transaction.
[[Page 247]]
(ii) No unreasonable assumptions. The advice must not be based on
unreasonable factual or legal assumptions (including assumptions as to
future events) and must not unreasonably rely on the representations,
statements, findings, or agreements of the entity manager or any other
person (including another party to the transaction or a material advisor
within the meaning of sections 6111 and 6112).
(iii) ``More likely than not'' opinion. The written opinion of the
professional tax advisor must apply the appropriate law to the facts
and, based on this analysis, must conclude that the transaction was not
a prohibited tax shelter transaction at a ``more likely than not'' level
of certainty at the time the entity manager approved the entity (or
otherwise caused the entity) to be a party to the transaction.
(3) Special rule. An entity manager`s reliance on a written opinion
of a professional tax advisor will not be considered reasonable if the
advisor is, or is related to a person who is, a material advisor with
respect to the transaction within the meaning of sections 6111 and 6112.
(d) Subsequently listed transactions. An entity manager will not be
treated as knowing or having reason to know that a transaction (other
than a prohibited reportable transaction as defined in section
4965(e)(1)(C) and Sec. 53.4965-3(a)(2)) is a prohibited tax shelter
transaction if the entity enters into the transaction before the date on
which the transaction is identified by the Secretary as a listed
transaction.
(e) Effective/applicability dates. See Sec. 53.4965-9 for the
discussion of the relevant effective and applicability dates.
[T.D. 9492, 75 FR 38702, July 6, 2010]
Sec. 53.4965-7 Taxes on prohibited tax shelter transactions.
(a) Entity-level taxes--(1) In general. Entity-level excise taxes
apply to non-plan entities (as defined in Sec. 53.4965-2(b)) that are
parties to prohibited tax shelter transactions.
(i) Prohibited tax shelter transactions other than subsequently
listed transactions--(A) Amount of tax if the entity did not know and
did not have reason to know. If the tax-exempt entity did not know and
did not have reason to know that the transaction was a prohibited tax
shelter transaction at the time the entity entered into the transaction,
the tax is the highest rate of tax under section 11 multiplied by the
greater of--
(1) The entity's net income with respect to the prohibited tax
shelter transaction (after taking into account any tax imposed by
Subtitle D, other than by this section, with respect to such
transaction) for the taxable year; or
(2) 75 percent of the proceeds received by the entity for the
taxable year that are attributable to such transaction.
(B) Amount of tax if the entity knew or had reason to know. If the
tax-exempt entity knew or had reason to know that the transaction was a
prohibited tax shelter transaction at the time the entity entered into
the transaction, the tax is the greater of--
(1) 100 percent of the entity's net income with respect to the
transaction (after taking into account any tax imposed by Subtitle D,
other than by this section, with respect to such transaction) for the
taxable year; or
(2) 75 percent of the proceeds received by the entity for the
taxable year that are attributable to such transaction.
(ii) Subsequently listed transactions--(A) In general. In the case
of a subsequently listed transaction (as defined in section 4965(e)(2)
and Sec. 53.4965-3(b)), the tax-exempt entity's income and proceeds
attributable to the transaction are allocated between the period before
the transaction became listed and the period beginning on the date the
transaction became listed. See Sec. 53.4965-8 for the standard for
allocating net income or proceeds to various periods. The tax for each
taxable year is the highest rate of tax under section 11 multiplied by
the greater of--
(1) The entity's net income with respect to the subsequently listed
transaction (after taking into account any tax imposed by Subtitle D,
other than by this section, with respect to such transaction) for the
taxable year that is allocable to the period beginning on the later of
the date such transaction is identified by the Secretary as a listed
transaction or the first day of the taxable year; or
[[Page 248]]
(2) 75 percent of the proceeds received by the entity for the
taxable year that are attributable to such transaction and allocable to
the period beginning on the later of the date such transaction is
identified by the Secretary as a listed transaction or the first day of
the taxable year.
(B) No increase in tax. The 100 percent tax under section
4965(b)(1)(B) and Sec. 53.4965-7(a)(1)(i)(B) does not apply to any
subsequently listed transaction (as defined in section 4965(e)(2) and
Sec. 53.4965-3(b)) entered into by a tax-exempt entity before the date
on which the transaction is identified by the Secretary as a listed
transaction.
(2) Taxable year. The excise tax imposed under section 4965(a)(1)
applies for the taxable year in which the entity becomes a party to the
prohibited tax shelter transaction and any subsequent taxable year for
which the entity has net income or proceeds attributable to the
transaction. A taxable year for tax-exempt entities is the calendar year
or fiscal year, as applicable, depending on the basis on which the tax-
exempt entity keeps its books for Federal income tax purposes. If a tax-
exempt entity has not established a taxable year for Federal income tax
purposes, the entity's taxable year for the purpose of determining the
amount and timing of net income and proceeds attributable to a
prohibited tax shelter transaction will be deemed to be the annual
period the entity uses in keeping its books and records.
(b) Manager-level taxes--(1) Amount of tax. If any entity manager
approved or otherwise caused the tax-exempt entity to become a party to
a prohibited tax shelter transaction and knew or had reason to know that
the transaction was a prohibited tax shelter transaction, such entity
manager is liable for the $20,000 tax. See Sec. 53.4965-5(d) for the
meaning of approved or otherwise caused. See Sec. 53.4965-6 for the
meaning of knew or had reason to know.
(2) Timing of the entity manager tax. If a tax-exempt entity enters
into a prohibited tax shelter transaction during a taxable year of an
entity manager, then the entity manager that approved or otherwise
caused the tax-exempt entity to become a party to the transaction is
liable for the entity manager tax for that taxable year if the entity
manager knew or had reason to know that the transaction was a prohibited
tax shelter transaction.
(3) Example. The application of paragraph (b)(2) of this section is
illustrated by the following example:
Example. The entity manager's taxable year is the calendar year. On
December 1, 2006, the entity manager approved or otherwise caused the
tax-exempt entity to become a party to a transaction that the entity
manager knew or had reason to know was a prohibited tax shelter
transaction. The tax-exempt entity entered into the transaction on
January 31, 2007. The entity manager is liable for the entity manager
level tax for the entity manager's 2007 taxable year, during which the
tax-exempt entity entered into the prohibited tax shelter transaction.
(4) Separate liability. If more than one entity manager approved or
caused a tax-exempt entity to become a party to a prohibited tax shelter
transaction while knowing (or having reason to know) that the
transaction was a prohibited tax shelter transaction, then each such
entity manager is separately (that is, not jointly and severally) liable
for the entity manager-level tax with respect to the transaction.
(c) Effective/applicability dates. See Sec. 53.4965-9 for the
discussion of the relevant effective and applicability dates.
[T.D. 9492, 75 FR 38702, July 6, 2010]
Sec. 53.4965-8 Definition of net income and proceeds and
standard for allocating net income or proceeds to various periods.
(a) In general. For purposes of section 4965(a), the amount and the
timing of the net income and proceeds attributable to the prohibited tax
shelter transaction will be computed in a manner consistent with the
substance of the transaction. In determining the substance of listed
transactions, the IRS will look to, among other items, the listing
guidance and any subsequent guidance published in the Internal Revenue
Bulletin relating to the transaction.
(b) Definition of net income and proceeds--(1) Net income. A tax-
exempt entity's net income attributable to a prohibited tax shelter
transaction is its gross income derived from the transaction reduced by
those deductions
[[Page 249]]
that are attributable to the transaction and that would be allowed by
chapter 1 of the Internal Revenue Code if the tax-exempt entity were
treated as a taxable entity for this purpose, and further reduced by
taxes imposed by Subtitle D, other than by this section, with respect to
the transaction.
(2) Proceeds--(i) Tax-exempt entities that facilitate the
transaction by reason of their tax-exempt, tax indifferent or tax-
favored status. Solely for purposes of section 4965, in the case of a
tax-exempt entity that is a party to the transaction by reason of Sec.
53.4965-4(a)(1) of this chapter, the term proceeds means the gross
amount of the tax-exempt entity's consideration for facilitating the
transaction, not reduced for any costs or expenses attributable to the
transaction. Published guidance with respect to a particular prohibited
tax shelter transaction may designate additional amounts as proceeds
from the transaction for section 4965 purposes.
(ii) Treatment of gifts and contributions. To the extent not
otherwise included in the definition of proceeds in paragraph (b)(2)(i)
of this section, any amount that is a gift or a contribution to a tax-
exempt entity and is attributable to a prohibited tax shelter
transaction will be treated as proceeds for section 4965 purposes,
unreduced by any associated expenses.
(c) Allocation of net income and proceeds--(1) In general. For
purposes of section 4965(a), the net income and proceeds attributable to
a prohibited tax shelter transaction must be allocated in a manner
consistent with the tax-exempt entity's established method of accounting
for Federal income tax purposes. If the tax-exempt entity has not
established a method of accounting for Federal income tax purposes,
solely for purposes of section 4965(a) the tax-exempt entity must use
the cash receipts and disbursements method of accounting (cash method)
provided for in section 446 of the Internal Revenue Code to determine
the amount and timing of net income and proceeds attributable to a
prohibited tax shelter transaction.
(2) Special rule. If a tax-exempt entity has established a method of
accounting other than the cash method, the tax-exempt entity may
nevertheless use the cash method of accounting to determine the amount
of the net income and proceeds--
(i) Attributable to a prohibited tax shelter transaction entered
into prior to the effective date of section 4965(a) tax and allocable to
pre- and post-effective date periods; or
(ii) Attributable to a subsequently listed transaction and allocable
to pre- and post-listing periods.
(d) Transition year rules. In the case of the taxable year that
includes August 16, 2006 (the transition year), the IRS will treat the
period beginning on the first day of the transition year and ending on
August 15, 2006, and the period beginning on August 16, 2006, and ending
on the last day of the transition year as short taxable years. This
treatment is solely for purposes of allocating net income or proceeds
under section 4965. The tax-exempt entity continues to file tax returns
for the full taxable year, does not file tax returns with respect to
these deemed short taxable years and does not otherwise take the short
taxable years into account for Federal tax purposes. Accordingly, the
net income or proceeds that are properly allocated to the transition
year in accordance with this section will be treated as allocable to the
period--
(1) Ending on or before August 15, 2006 (and accordingly not subject
to tax under section 4965(a)) to the extent such net income or proceeds
would have been properly taken into account in accordance with this
section by the tax-exempt entity in the deemed short year ending on
August 15, 2006; and
(2) Beginning after August 15, 2006 (and accordingly subject to tax
under section 4965(a)) to the extent such income or proceeds would have
been properly taken into account in accordance with this section by the
tax-exempt entity in the short year beginning August 16, 2006.
(e) Allocation to pre- and post-listing periods. If a transaction
other than a prohibited reportable transaction (as defined in section
4965(e)(1)(C) and Sec. 53.4965-3(a)(2)) to which the tax-exempt entity
is a party is subsequently identified in published guidance as a listed
transaction during a taxable year of the entity (the listing year) in
[[Page 250]]
which it has net income or proceeds attributable to the transaction, the
net income or proceeds are allocated between the pre- and post-listing
periods. The IRS will treat the period beginning on the first day of the
listing year and ending on the day immediately preceding the date of the
listing, and the period beginning on the date of the listing and ending
on the last day of the listing year as short taxable years. This
treatment is solely for purposes of allocating net income or proceeds
under section 4965. The tax-exempt entity continues to file tax returns
for the full taxable year, does not file tax returns with respect to
these deemed short taxable years and does not otherwise take the short
taxable years into account for Federal tax purposes. Accordingly, the
net income or proceeds that are properly allocated to the listing year
in accordance with this section will be treated as allocable to the
period--
(1) Ending before the date of the listing (and accordingly not
subject to tax under section 4965(a)) to the extent such net income or
proceeds would have been properly taken into account in accordance with
this section by the tax-exempt entity in the deemed short year ending on
the day immediately preceding the date of the listing; and
(2) Beginning on the date of the listing (and accordingly subject to
tax under section 4965(a)) to the extent such income or proceeds would
have been properly taken into account in accordance with this section by
the tax-exempt entity in the short year beginning on the date of the
listing.
(f) Examples. The following examples illustrate the allocation rules
of this section:
Example 1. (i) In 1999, X, a calendar year non-plan entity using the
cash method of accounting, entered into a lease-in/lease-out transaction
(LILO) substantially similar to the transaction described in Notice
2000-15 (2000-1 CB 826) (describing Rev. Rul. 99-14 (1999-1 CB 835),
superseded by Rev. Rul. 2002-69 (2002-2 CB 760)). In 1999, X purported
to lease property to Y pursuant to a ``head lease,'' and Y purported to
lease the property back to X pursuant to a ``sublease'' of a shorter
term. In form, X received $268M as an advance payment of head lease
rent. Of this amount, $200M had been, in form, financed by a nonrecourse
loan obtained by Y. X deposited the $200M with a ``debt payment
undertaker.'' This served to defease both a portion of X's rent
obligation under its sublease and Y's repayment obligation under the
nonrecourse loan. Of the remainder of the $268M advance head lease rent
payment, X deposited $54M with an ``equity payment undertaker.'' This
served to defease the remainder of X's rent obligation under the
sublease as well as the exercise price of X's end-of-sublease term
purchase option. This amount inures to the benefit of Y and enables Y to
recover its investment in the transaction and a return on that
investment. In substance, the $54M is a loan from Y to X. X retained the
remaining $14M of the advance head lease rent payment. In substance,
this represents a fee for X's participation in the transaction. See
Sec. 601.601(d)(2)(ii)(b) of this chapter.
(ii) According to the substance of the transaction, the head lease,
sublease and nonrecourse debt will be ignored for Federal income tax
purposes. Therefore, any net income or proceeds resulting from these
elements of the transaction will not be considered net income or
proceeds attributable to the LILO transaction for purposes of section
4965(a). The $54M deemed loan from Y to X and the $14M fee are not
ignored for Federal income tax purposes.
(iii) Under X's established cash basis method of accounting, any net
income received in 1999 and attributable to the LILO transaction is
allocated to X's December 31, 1999, tax year for purposes of section
4965. The $14M fee received in 1999, which constitutes proceeds of the
transaction, is likewise allocated to that tax year. Because the 1999
tax year is before the effective date of the section 4965 tax, X will
not be subject to any excise tax under section 4965 for the amounts
received in 1999.
(iv) Any earnings on the amount deposited with the equity payment
undertaker that constitute gross income to X will be reduced by X's
original issue discount deductions with respect to the deemed loan from
Y, in determining X's net income from the transaction.
Example 2. B, a non-plan entity using the cash method of accounting,
has an annual accounting period that ends on December 31, 2006. B
entered into a prohibited tax shelter transaction on March 15, 2006. On
that date, B received a payment of $600,000 as a fee for its involvement
in the transaction. B received no other proceeds or income attributable
to this transaction in 2006. Under B's method of accounting, the payment
received by B on March 15, 2006, is taken into account in the deemed
short year ending on August 15, 2006. Accordingly, solely for purposes
of section 4965, the payment is treated as allocable solely to the
period ending on or before August 15, 2006, and is not subject to the
excise tax imposed by section 4965(a).
[[Page 251]]
Example 3. The facts are the same as in Example 2, except that B
received an additional payment of $400,000 on September 30, 2006. Under
B's method of accounting, the payment received by B on September 30,
2006, is taken into account in the deemed short year beginning on August
16, 2006. Accordingly, solely for purposes of section 4965, the $400,000
payment is treated as allocable to the period beginning after August 15,
2006, and is subject to the excise tax imposed by section 4965(a).
Example 4. C, a non-plan entity using the cash method of accounting,
has an annual accounting period that ends on December 31. C entered into
a prohibited tax shelter transaction on May 1, 2005. On March 15, 2007,
C received a payment of $580,000 attributable to the transaction. On
June 1, 2007, the transaction is identified by the IRS in published
guidance as a listed transaction. On June 15, 2007, C received an
additional payment of $400,000 attributable to the transaction. Under
C's method of accounting, the payments received on March 15, 2007, and
June 15, 2007, are taken into account in 2007. The IRS will treat the
period beginning on January 1, 2007, and ending on May 31, 2007, and the
period beginning on June 1, 2007, and ending on December 31, 2007, as
short taxable years. The payment received by C on March 15, 2007, is
taken into account in the deemed short year ending on May 31, 2007.
Accordingly, solely for purposes of section 4965, the payment is treated
as allocable solely to the pre-listing period, and is not subject to the
excise tax imposed by section 4965(a). The payment received by C on June
15, 2007, is taken into account in the deemed short year beginning on
June 1, 2007. Accordingly, solely for purposes of section 4965, the
payment is treated as allocable to the post-listing period, and is
subject to the excise tax imposed by section 4965(a).
(g) Effective/applicability dates. See Sec. 53.4965-9 for the
discussion of the relevant effective and applicability dates.
[T.D. 9492, 75 FR 38702, July 6, 2010; 75 FR 46844, Aug. 4, 2010]
Sec. 53.4965-9 Effective/applicability dates.
(a) In general. The taxes under section 4965(a) and Sec. 53.4965-7
are effective for taxable years ending after May 17, 2006, with respect
to transactions entered into before, on or after that date, except that
no tax under section 4965(a) applies with respect to income or proceeds
that are properly allocable to any period ending on or before August 15,
2006.
(b) Applicability of the regulations. As of July 6, 2010, except as
provided in paragraph (c) of this section, Sec. Sec. 53.4965-1 through
53.4965-8 of this chapter will apply to taxable years ending after July
6, 2007. A tax-exempt entity may rely on the provisions of Sec. Sec.
53.4965-1 through 53.4965-8 for taxable years ending on or before July
6, 2007.
(c) Effective/applicability date with respect to certain knowing
transactions--(1) Entity-level tax. The 100 percent tax under section
4965(b)(1)(B) and Sec. 53.4965-7(a)(1)(i)(B) does not apply to
prohibited tax shelter transactions entered into by a tax-exempt entity
on or before May 17, 2006.
(2) Manager-level tax. The IRS will not assert that an entity
manager who approved or caused a tax-exempt entity to become a party to
a prohibited tax shelter transaction is liable for the entity manager
tax under section 4965(b)(2) and Sec. 53.4965-7(b)(1) with respect to
the transaction if the tax-exempt entity entered into such transaction
prior to May 17, 2006.
[T.D. 9492, 75 FR 38702, July 6, 2010]
Subpart L_Procedure and Administration
Source: T.D. 7368, 40 FR 29843, July 16, 1975, unless otherwise
noted. Redesignated by T.D. 8084, 51 FR 16303, May 2, 1986.
Sec. 53.6001-1 Notice or regulations requiring records, statements, and special returns.
(a) In general. Any person subject to tax under Chapter 42, Subtitle
D, of the Code shall keep such complete and detailed records as are
sufficient to enable the district director to determine accurately the
amount of liability under Chapter 42.
(b) Notice by district director requiring returns, statements, or
the keeping of records. The district director may require any person, by
notice served upon him, to make such returns, render such statements, or
keep such specific records as will enable the district director to
determine whether or not such person is liable for tax under Chapter 42.
(c) Retention of records. The records required by this section shall
be kept at all times available for inspection by
[[Page 252]]
authorized internal revenue officers or employees, and shall be retained
so long as the contents thereof may become material in the
administration of any internal revenue law.
Sec. 53.6011-1 General requirement of return, statement or list.
(a) Every private foundation liable for tax under section 4940 or
4948(a) shall file an annual return with respect to such tax on the form
prescribed by the Internal Revenue Service for such purpose and shall
include therein the information required by such form and the
instructions issued with respect thereto.
(b) Every person liable for tax imposed by sections 4941(a),
4942(a), 4943(a), 4944(a), 4945(a), 4955(a), 4958(a), or 4965(a), and
every private foundation and every trust described in section 4947(a)(2)
which has engaged in an act of self-dealing (as defined in section
4941(d)) (other than an act giving rise to no tax under section 4941(a))
shall file an annual return on Form 4720 and shall include therein the
information required by such form and the instructions issued with
respect thereto. In the case of any tax imposed by sections 4941(a),
4942(a), 4943(a), and 4944(a), the annual return shall be filed with
respect to each act (or failure to act) for each year (or part thereof)
in the taxable period (as defined in sections 4941 (e)(1), 4942(j)(1),
4943(d)(2), and 4944(e)(1)). In the case of a tax imposed by section
4945(a), 4955(a), 4958(a), or 4965(a), the annual return shall be filed
with respect to each act for the year in which such act giving rise to
liability occurred.
(c) If a Form 4720 is filed by a private foundation or trust
described in section 4947(a)(2) with respect to a transaction to which
other persons are required to file under paragraph (b) of this section,
such persons may by their signature designate such organization's Form
4720 (to the extent applicable) as their return for purposes of
compliance with such paragraph. However, this paragraph shall not apply
to a person whose taxable year is other than the taxable year of the
foundation or trust.
(d) For taxable years ending on or after December 31, 1975, every
trust described in section 4947(a)(2) which is subject to any of the
provisions of Chapter 42 as if it were a private foundation shall file
an annual return on Form 5227. For taxable years beginning after
December 31, 1980, every trust described in section 4947(a)(1) which is
a private foundation shall file an annual return on Form 990-PF.
(e) For taxable years beginning after December 31, 1977, every
person liable for tax under section 4951, 4952, or 4953 (relating to
taxes on self-dealing, taxable expenditures, and excess contributions
involving black lung benefit trusts) shall file an annual return with
respect to the tax on the form prescribed by the Internal Revenue
Service for that purpose. The person liable for the tax shall include
the information required by the form and its related instructions.
[T.D. 7368, 40 FR 29843, July 16, 1975, as amended by T.D. 7838, 47 FR
44249, Oct. 7, 1982; T.D. 8026, 50 FR 20757, May 20, 1985; T.D. 8628, 60
FR 62212, Dec. 5, 1995; T.D. 8705, 62 FR 26, Jan. 2, 1997; T.D. 9334, 72
FR 36872, July 6, 2007]
Sec. 53.6011-4 Requirement of statement disclosing participation in certain transactions by taxpayers.
(a) In general. If a transaction is identified as a listed
transaction or a transaction of interest as defined in Sec. 1.6011-4 of
this chapter by the Commissioner in published guidance (see Sec.
601.601(d)(2)(ii)(b) of this chapter), and the listed transaction or
transaction of interest involves an excise tax under chapter 42 of
subtitle D of the Internal Revenue Code (relating to private foundations
and certain other tax-exempt organizations), the transaction must be
disclosed in the manner stated in such published guidance.
(b) Effective/applicability date. This section applies to listed
transactions entered into on or after January 1, 2003. This section
applies to transactions of interest entered into on or after November 2,
2006.
[T.D. 9350, 72 FR 43154, Aug. 3, 2007]
Sec. 53.6060-1 Reporting requirements for tax return preparers.
(a) In general. A person that employs one or more tax return
preparers to prepare a return or claim for refund of tax under Chapter
42 of the Internal
[[Page 253]]
Revenue Code, other than for the person, at any time during a return
period, shall satisfy the record keeping and inspection requirements in
the manner stated in Sec. 1.6060-1 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed after December 31, 2008.
[T.D. 9436, 73 FR 78457, Dec. 22, 2008]
Sec. 53.6061-1 Signing of returns and other documents.
Any return, statement, or other document required to be made with
respect to a tax imposed by Chapter 42 or the regulations thereunder
shall be signed by the person required to file such return, statement or
document, or by such other persons required or duly authorized to sign
in accordance with the regulations, forms or instructions prescribed
with respect to such return, statement or other document. The person
required or duly authorized to make the return may incur liability for
penalties provided for erroneous, false or fraudulent returns. For
criminal penalties see sections 7201, 7203, 7206, and 7207.
Sec. 53.6065-1 Verification of returns.
(a) Penalties of perjury. If a return, statement, or other document
made under the provisions of Chapter 42 or Subtitle F of the Code or the
regulations thereunder with respect to any tax imposed by Chapter 42 of
the Code, or the form and instructions issued with respect to such
return, statement, or other document, requires that it shall contain or
be verified by a written declaration that it is made under the penalties
of perjury, it must be so verified by the person or persons required to
sign such return, statement, or other document. In addition, any other
statement or document submitted under any provision of Chapter 42 or
Subtitle F of the Code or regulations thereunder with respect to any tax
imposed by Chapter 42 of the Code may be required to contain or be
verified by a written declaration that it is made under the penalties of
perjury.
(b) Oath. Any return, statement, or other document required to be
submitted under Chapter 42 or Subtitle F of the Code or regulations
prescribed thereunder with respect to any tax imposed by Chapter 42 of
the Code may be required to be verified by an oath.
Sec. 53.6071-1 Time for filing returns.
(a) General rule. Except as otherwise provided in this section, a
return required by Sec. 53.6011-1 shall be filed at the time the
private foundation or trust described in section 4947(a)(2) is required
to file its annual information or tax return under section 6033 or 6012
(as may be applicable).
(b) Exception. The Form 4720 of a person whose taxable year ends on
a date other than that on which the taxable year of the foundation or
trust ends shall be filed on or before the 15th day of the fifth month
following the close of such person's taxable year.
(c) Form 5227. A Form 5227 required to be filed by paragraph (d) of
Sec. 53.6011-1 for a trust described in section 4947(a) shall be filed
on or before the 15th day of the fourth month following the close of the
trust's taxable year.
(d) Taxes related to black lung benefit trusts. Forms 990-BL and
6069 shall be filed on or before the 15th day of the fifth month
following the close of the filer's taxable year.
(e) Taxes related to political expenditures of organizations
described in section 501(c)(3) of the Internal Revenue Code. A Form 4720
required to be filed by Sec. 53.6011-1(b) for an organization liable
for tax imposed by section 4955(a) must be filed by the unextended due
date for filing its annual information return under section 6033 or, if
the organization is exempt from filing, the date the organization would
be required to file an annual information return if it was not exempt
from filing. The Form 4720 of a person whose taxable year ends on a date
other than that on which the taxable year of the organization described
in section 501(c)(3) ends must be filed on or before the 15th day of the
fifth month following the close of the person's taxable year.
(f) Taxes imposed on excess benefit transactions engaged in by
organizations described in sections 501(c)(3) (except private
foundations) and 501(c)(4)--(1) General rule. A Form 4720 required by
Sec. 53.6011-1(b) for a disqualified person or
[[Page 254]]
organization manager liable for tax imposed by section 4958(a) shall be
filed by that person on or before the 15th day of the fifth month
following the close of such person's taxable year.
(2) Special rule for taxable years ending after September 13, 1995,
and on or before July 30, 1996. A Form 4720 required by Sec. 53.6011-
1(b) for a disqualified person or organization manager liable for tax
imposed by section 4958(a) on an excess benefit transaction occurring in
such person's taxable year ending after September 13, 1995, and on or
before July 30, 1996, is due on or before December 15, 1996.
(g) Taxes imposed with respect to prohibited tax shelter
transactions to which tax-exempt entities are parties--(1) Returns by
certain tax-exempt entities. A Form 4720, ``Return of Certain Excise
Taxes Under Chapters 41 and 42 of the Internal Revenue Code,'' required
by Sec. 53.6011-1(b) for a tax-exempt entity described in section
4965(c)(1), (c)(2) or (c)(3) that is a party to a prohibited tax shelter
transaction and is liable for tax imposed by section 4965(a)(1) shall be
filed on or before the due date (not including extensions) for filing
the tax-exempt entity's annual information return under section
6033(a)(1). If the tax-exempt entity is not required to file an annual
information return under section 6033(a)(1), the Form 4720 shall be
filed on or before the 15th day of the fifth month after the end of the
tax-exempt entity's taxable year or, if the entity has not established a
taxable year for Federal income tax purposes, the entity's annual
accounting period.
(2) Returns by entity managers of tax-exempt entities described in
section 4965(c)(1), (c)(2) or (c)(3). A Form 4720, required by Sec.
53.6011-1(b) for an entity manager of a tax-exempt entity described in
section 4965(c)(1), (c)(2) or (c)(3) who is liable for tax imposed by
section 4965(a)(2) shall be filed on or before the 15th day of the fifth
month following the close of the entity manager's taxable year during
which the entity entered into the prohibited tax shelter transaction.
(3) Transition rule. A Form 4720, for a section 4965 tax that was
due on or before October 4, 2007, will be deemed to have been filed on
the due date if it was filed by October 4, 2007, and if all section 4965
taxes required to be reported on that Form 4720 were paid by October 4,
2007.
(h) Effective/applicability date. Paragraph (g) of this section is
applicable on July 6, 2007.
[T.D. 7368, 40 FR 29843, July 16, 1975, as amended by T.D. 7407, 41 FR
9322, Mar. 4, 1976; T.D. 7838, 47 FR 44249, Oct. 7, 1982; T.D. 8628, 60
FR 62212, Dec. 5, 1995; T.D. 8736, 62 FR 52257, Oct. 7, 1997; T.D. 9334,
72 FR 36872, July 6, 2007; T.D. 9492, 75 FR 38708, July 6, 2010; 75 FR
46845, Aug. 4, 2010]
Sec. 53.6071-1T Time for filing returns (temporary).
(a) through (f) [Reserved] For further guidance, see Sec. 53.6071-
1(a) through (f).
[T.D. 9334, 72 FR 36872, July 6, 2007; 72 FR 45895, Aug. 16, 2007, as
amended by T.D. 9492, 75 FR 38708, July 6, 2010]
Sec. 53.6081-1 Automatic extension of time for filing the return to report taxes due
under section 4951 for self-dealing with a nuclear decommissioning fund.
(a) In general. A ``disqualified person'' for purposes of section
4951(e)(4) who engaged in self-dealing with a Nuclear Decommissioning
Fund, and must report tax due under section 4951 on Form 1120-ND,
``Return for Nuclear Decommissioning Funds and Certain Related
Persons,'' will be allowed an automatic 6-month extension of time to
file the return after the date prescribed for filing the return if the
disqualified person files an application under this section in
accordance with paragraph (b) of this section. For guidance on
requesting an extension of time to file Form 1120-ND for purposes of
reporting contributions received, income earned, administrative expenses
of operating the fund, and the tax on modified gross income, see Sec.
1.6081-3 of this chapter.
(b) Requirements. To satisfy this paragraph (b), a disqualified
person must--
(1) Submit a complete application on Form 7004, ``Application for
Automatic Extension of Time to File Certain Business Income Tax,
Information, and Other Returns,'' or in any other manner prescribed by
the Commissioner;
(2) File the application on or before the date prescribed for filing
the return
[[Page 255]]
with the Internal Revenue Service office designated in the application's
instructions; and
(3) Remit the amount of the properly estimated unpaid tax liability
on or before the date prescribed for payment.
(c) No extension of time for the payment of tax. An automatic
extension of time for filing a return granted under paragraph (a) of
this section will not extend the time for payment of any tax due on such
return.
(d) Termination of automatic extension. The Commissioner may
terminate an automatic extension at any time by mailing to the
disqualified person a notice of termination at least 10 days prior to
the termination date designated in such notice. The Commissioner must
mail the notice of termination to the address shown on the Form 7004 or
to the disqualified person's last known address. For further guidance
regarding the definition of last known address, see Sec. 301.6212-2 of
this chapter.
(e) Penalties. See section 6651 for failure to file or failure to
pay the amount shown as tax on the return.
(f) Effective/applicability dates. This section is applicable for
applications for an automatic extension of time to file a return to
report taxes due under section 4951 for self-dealing with a Nuclear
Decommissioning Fund filed after July 1, 2008.
[T.D. 9407, 73 FR 37369, July 1, 2008]
Sec. 53.6091-1 Place for filing chapter 42 tax returns.
Except as provided in Sec. 53.6091-2 (relating to exceptional
cases):
(a) Persons other than corporations. Chapter 42 tax returns of
persons other than corporations shall be filed with any person assigned
the responsibility to receive returns in the local Internal Revenue
Service office that serves the legal residence or principal place of
business of the person required to make the return.
(b) Corporations. Chapter 42 tax returns of corporations shall be
filed with any person assigned the responsibility to receive returns in
the local Internal Revenue Service office that serves the principal
place of business or principal office or agency of the corporation.
(c) Returns filed with service centers. Notwithstanding paragraphs
(a) and (b) of this section, unless a return is filed by hand carrying,
whenever instructions applicable to Chapter 42 tax returns provide that
the returns be filed with a service center, the returns must be so filed
in accordance with the instructions. Returns which are filed by hand
carrying shall be filed with any person assigned the responsibility to
receive hand-carried returns in the local Internal Revenue Service
office in accordance with paragraphs (a) or (b) of this section,
whichever is applicable.
(d) Returns of persons subject to a termination assessment.
Notwithstanding paragraph (c) of this section, income tax returns of
persons with respect to whom a chapter 42 tax assessment was made under
section 6852(a) with respect to the taxable year must be filed with any
person assigned the responsibility to receive returns in the local
Internal Revenue Service office as provided in paragraphs (a) and (b) of
this section.
[T.D. 7368, 40 FR 29843, July 16, 1975, as amended by T.D. 7495, 42 FR
33727, July 1, 1977; T.D. 8628, 60 FR 62212, Dec. 5, 1995; T.D. 9156, 69
FR 55746, Sept. 16, 2004]
Sec. 53.6091-2 Exceptional cases.
Notwithstanding the provisions of Sec. 53.6091-1, the Commissioner
may permit the filing of any Chapter 42 tax return in any local Internal
Revenue Service office.
[T.D. 7368, 40 FR 29843, July 16, 1975. Redesignated by T.D. 8084, 51 FR
16303, May 2, 1986, as amended by T.D. 9156, 69 FR 55746, Sept. 16,
2004]
Sec. 53.6107-1 Tax return preparer must furnish copy of
return or claim for refund to taxpayer and must retain a copy or record.
(a) In general. A person who is a signing tax return preparer of any
return or claim for refund of tax under Chapter 42 of the Internal
Revenue Code shall furnish a completed copy of the return or claim for
refund to the taxpayer and retain a completed copy or record in the
manner stated in Sec. 1.6107-1 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and
[[Page 256]]
claims for refund filed after December 31, 2008.
[T.D. 9436, 73 FR 78457, Dec. 22, 2008]
Sec. 53.6109-1 Tax return preparers furnishing identifying numbers for returns
or claims for refund filed.
(a) In general. Each tax return or claim for refund under Chapter 42
of the Internal Revenue Code prepared by one or more signing tax return
preparers must include the identifying number of the preparer required
by Sec. 1.6695-1(b) of this chapter to sign the return or claim for
refund in the manner stated in Sec. 1.6109-2 of this chapter.
(b) Effective/applicability date. Paragraph (a) of this section is
applicable to returns and claims for refund filed after December 31,
2008.
[T.D. 9436, 73 FR 78457, Dec. 22, 2008]
Sec. 53.6151-1 Time and place for paying tax shown on returns.
The Chapter 42 tax shown on any return shall, without assessment or
notice and demand, be paid to the internal revenue officer with whom the
return is filed at the time and place for filing such return (determined
without regard to any extension of time for filing the return). For
provisions relating to the time and place for filing such return, see
Sec. Sec. 53.6071-1 and 53.6091-1. For provisions relating to the
extension of time for paying the tax, see Sec. 53.6161-1.
Sec. 53.6161-1 Extension of time for paying tax or deficiency.
(a) In general--(1) Tax shown or required to be shown on return. A
reasonable extension of the time for payment of the amount of any tax
imposed by Chapter 42 and shown or required to be shown on any return,
may be granted by the district directors and directors of the service
centers at the request of the taxpayer. The period of such extension
shall not be in excess of 6 months from the date fixed for payment of
such tax, except that if the taxpayer is abroad the period of the
extension may be in excess of 6 months.
(2) Deficiency. The time for payment of any amount determined as a
deficiency in respect of tax imposed by Chapter 42 may, at the request
of the taxpayer, be extended by the internal revenue officer to whom the
tax is required to be paid for a period not to exceed 18 months from the
date fixed for payment of the deficiency, as shown on the notice and
demand, and, in exceptional cases for a further period not in excess of
12 months. No extension of the time for payment of a deficiency shall be
granted if the deficiency is due to negligence, to intentional disregard
of rules and regulations, or to fraud with intent to evade tax.
(3) Extension of time for filing distinguished. The granting of an
extension of time for filing a return does not operate to extend the
time for the payment of the tax or any part thereof unless so specified
in the extension.
(b) Undue hardship required for extension. An extension of the time
for payment shall be granted only upon a satisfactory showing that
payment on the due date of the amount with respect to which the
extension is desired will result in an undue hardship. The extension
will not be granted upon a general statement of hardship. The term
``undue hardship'' means more than an inconvenience to the taxpayer. It
must appear that substantial financial loss, for example, loss due to
the sale of property at a sacrifice price, will result to the taxpayer
from making payment on the due date of the amount with respect to which
the extension is desired. If a market exists, the sale of property at
the current market price is not ordinarily considered as resulting in an
undue hardship.
(c) Application for extension. An application for an extension of
the time for payment of the tax shown or required to be shown on any
return, or for the payment of any amount determined as a deficiency
shall be made on Form 1127 and shall be accompanied by evidence showing
the undue hardship that would result to the taxpayer if the extension
were refused. Such application shall also be accompanied by a statement
of the assets and liabilities of the taxpayer and an itemized statement
showing all receipts and disbursements for each of the three months
immediately preceding the due date of the amount to which the
application relates. The application, with supporting documents, must be
filed on or before the date prescribed for payment of the
[[Page 257]]
amount with respect to which the extension is desired with the internal
revenue officer to whom the tax is to be paid. The application will be
examined, and within 30 days, if possible, will be denied, granted, or
tentatively granted subject to certain conditions of which the taxpayer
will be notified. If an additional extension is desired, the request
therefor must be made on or before the expiration of the period for
which the prior extension is granted.
(d) Payment pursuant to extension. If an extension of time for
payment is granted, the amount the time for payment of which is so
extended shall be paid on or before the expiration of the period of the
extension without the necessity of notice and demand. The granting of an
extension of the time for payment of the tax or deficiency does not
relieve the taxpayer from liability for the payment of interest thereon
during the period of the extension. See section 6601 and Sec. 301.6601-
1 of this chapter (Regulations on Procedure and Administration).
Sec. 53.6165-1 Bonds where time to pay tax or deficiency has been extended.
If an extension of time for payment of tax or deficiency is granted
under section 6161, the district director or the director of the service
center may, if he deems it necessary, require a bond for the payment of
the amount in respect of which the extension is granted in accordance
with the terms of the extension. However, such bond shall not exceed
double the amount with respect to which the extension is granted. For
provisions relating to form of bonds, see the regulations under section
7101 contained in part 301 of this chapter (Regulations on Procedure and
Administration).
Sec. 53.6601-1 Interest on underpayment, nonpayment, or extensions of time
for payment, of tax.
For regulations concerning interest on underpayment, nonpayment, or
extensions of time for payment of tax, see Sec. 301.6601-1 of this
chapter (Regulations on Procedure and Administration).
Sec. 53.6651-1 Failure to file tax return or to pay tax.
(a) General rules. For general rules relating to the failure to file
tax return or to pay tax, see the regulations under section 6651
contained in part 301 of this chapter (Regulations on Procedure and
Administration).
(b) Special rule where foundation files return. (1) Except as
provided in paragraph (b)(2) of this section, in the case of tax imposed
by section 4941(a)(1) on any disqualified person, reasonable cause shall
be presumed, for purposes of section 6651(a)(1), where the private
foundation or trust described in section 4947(a)(2) files a return in
good faith and such return indicates no tax liability with respect to
such tax on the part of such disqualified person.
(2) Paragraph (b)(1) of this section shall not apply where the
disqualified person knew of facts which, if known by the foundation,
would have precluded the foundation from making the return, as filed, in
good faith.
Sec. 53.6694-1 Section 6694 penalties applicable to tax return preparer.
(a) In general. For general definitions regarding section 6694
penalties applicable to preparers of tax returns or claims for refund
under Chapter 42 of the Internal Revenue Code, see Sec. 1.6694-1 of
this chapter.
(b) Effective/applicability date. Paragraph (a) of this section is
applicable to returns and claims for refund filed, and advice provided,
after December 31, 2008.
[T.D. 9436, 73 FR 78457, Dec. 22, 2008]
Sec. 53.6694-2 Penalties for understatement due to an unreasonable position.
(a) In general. A person who is a tax return preparer of any return
or claim for refund of tax under Chapter 42 of the Internal Revenue Code
(Code) shall be subject to penalties under section 6694(a) of the Code
in the manner stated in Sec. 1.6694-2 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed, and advice provided, after December
31, 2008.
[T.D. 9436, 73 FR 78457, Dec. 22, 2008]
[[Page 258]]
Sec. 53.6694-3 Penalty for understatement due to willful, reckless, or intentional conduct.
(a) In general. A person who is a tax return preparer of any return
or claim for refund of tax under Chapter 42 of the Internal Revenue Code
(Code) shall be subject to penalties under section 6694(b) of the Code
in the manner stated in Sec. 1.6694-3 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed, and advice provided, after December
31, 2008.
[T.D. 9436, 73 FR 78457, Dec. 22, 2008]
Sec. 53.6694-4 Extension of period of collection when tax return preparer pays 15
percent of a penalty for understatement of taxpayer's liability and certain
other procedural matters.
(a) In general. For rules relating to the extension of period of
collection when a tax return preparer who prepared a return or claim for
refund of tax under Chapter 42 of the Internal Revenue Code pays 15
percent of a penalty for understatement of taxpayer's liability and
procedural matters relating to the investigation, assessment and
collection of the penalties under section 6694(a) and (b), the rules
under Sec. 1.6694-4 of this chapter will apply.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed, and advice provided, after December
31, 2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
Sec. 53.6695-1 Other assessable penalties with respect to
the preparation of tax returns or claims for refund for other persons.
(a) In general. A person who is a tax return preparer of any return
or claim for refund of tax under Chapter 42 of the Internal Revenue Code
(Code) shall be subject to penalties for failure to furnish a copy to
the taxpayer under section 6695(a) of the Code, failure to sign the
return under section 6695(b) of the Code, failure to furnish an
identification number under section 6695(c) of the Code, failure to
retain a copy or list under section 6695(d) of the Code, failure to file
a correct information return under section 6695(e) of the Code, and
negotiation of a check under section 6695(f) of the Code, in the manner
stated in Sec. 1.6695-1 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed after December 31, 2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
Sec. 53.6696-1 Claims for credit or refund by tax return preparers.
(a) In general. For rules for claims for credit or refund by a tax
return preparer who prepared a return or claim for refund for tax under
Chapter 42 of the Internal Revenue Code, the rules under Sec. 1.6696-1
of this chapter will apply.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed, and advice provided, after December
31, 2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
Sec. 53.7101-1 Form of bonds.
For provisions relating to form of bonds, see the regulations under
section 7101 contained in part 301 of this chapter (Regulations on
Procedure and Administration).
Sec. 53.7701-1 Tax return preparer.
(a) In general. For the definition of a tax return preparer, see
Sec. 301.7701-15 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed, and advice provided, after December
31, 2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
PART 54_PENSION EXCISE TAXES--Table of Contents
Sec.
54.4971-1 General rules relating to excise tax on failure to meet
minimum funding standards.
54.4972-1 Tax on excess contributions to plans benefiting self-employed
individuals.
54.4974-1 Excise tax on accumulations in individual retirement accounts
or annuities.
54.4974-2 Excise tax on accumulations in qualified retirement plans.
54.4975-1 General rules relating to excise tax on prohibited
transactions.
54.4975-6 Statutory exemptions for office space or services and certain
transactions involving financial institutions.
[[Page 259]]
54.4975-7 Other statutory exemptions.
54.4975-9 Definition of ``fiduciary''.
54.4975-11 ``ESOP'' requirements.
54.4975-12 Definition of the term ``qualifying employer security''.
54.4975-14 Election to pay an excise tax for certain pre-1975 prohibited
transactions.
54.4975-15 Other transitional rules.
54.4976-1T Questions and answers relating to taxes with respect to
welfare benefit funds (temporary).
54.4977-1T Questions and answers relating to the election concerning
lines of business in existence on January 1, 1984 (temporary).
54.4978-1T Questions and answers relating to the tax on certain
dispositions by employee stock ownership plans and certain
cooperatives (temporary).
54.4979-0 Excise tax on certain excess contributions and excess
aggregate contributions; table of contents.
54.4979-1 Excise tax on certain excess contributions and excess
aggregate contributions.
54.4980B-0 Table of contents.
54.4980B-1 CORBA in general.
54.4980B-2 Plans that must comply.
54.4980B-3 Qualified beneficiaries.
54.4980B-4 Qualifying events.
54.4980B-5 CORBA continuation coverage.
54.4980B-6 Electing COBRA continuation coverage.
54.4980B-7 Duration of CORBA continuation coverage.
54.4980B-8 Paying for COBRA continuation coverage.
54.4980B-9 Business reorganizations and employer withdrawals from
multiemployer plans.
54.4980B-10 Interaction of FMLA and COBRA.
54.4980D-1 Requirement of return and time for filing of the excise tax
under section 4980D.
54.4980E-1 Requirement of return and time for filing of the excise tax
under section 4980E.
54.4980F-1 Notice requirements for certain pension plan amendments
significantly reducing the rate of future benefit accrual.
54.4980G-0 Table of contents.
54.4980G-1 Failure of employer to make comparable health savings account
contributions.
54.4980G-2 Employer contribution defined.
54.4980G-3 Failure of employer to make comparable health savings account
contributions.
54.4980G-4 Calculating comparable contributions.
54.4980G-5 HSA comparability rules and cafeteria plans and waiver of
excise tax.
54.4980G-6 Special rule for contributions made to the HSAs of nonhighly
compensated employees.
54.4980G-7 Special comparability rules for qualified HSA distributions
contributed to HSAs on or after December 20, 2006 and before
January 1, 2012.
54.4981A-1T Tax on excess distributions and excess accumulations
(temporary).
54.6011-1 General requirement of return, statement, or list.
54.6011-1T General requirement of return, statement, or list
(temporary).
54.6011-2 General requirement of return, statement, or list.
54.6011-4 Requirement of statement disclosing participation in certain
transactions by taxpayers.
54.6060-1 Reporting requirements for tax return preparers.
54.6061-1 Signing of returns and other documents.
54.6071-1 Time for filing returns.
54.6091-1 Place for filing excise tax returns under section 4980B,
4980D, 4980E, or 4980G.
54.6107-1 Tax return preparer must furnish copy of return or claims for
refund to taxpayer and must retain a copy or record.
54.6109-1 Tax return preparers furnishing identifying numbers for
returns or claims for refund filed.
54.6151-1 Time and place for paying of tax shown on returns.
54.6694-1 Section 6694 penalties applicable to tax return preparer.
54.6694-2 Penalties for understatement due to an unreasonable position.
54.6694-3 Penalty for understatement due to willful, reckless, or
intentional conduct.
54.6694-4 Extension of period of collection when tax return preparer
pays 15 percent of a penalty for understatement of taxpayer's
liability and certain other procedural matters.
54.6695-1 Other assessable penalties with respect to the preparation of
tax returns for other persons.
54.6696-1 Claims for credit or refund by tax return preparers.
54.7701-1 Tax return preparer.
54.9801-1 Basis and scope.
54.9801-2 Definitions.
54.9801-3 Limitations on preexisting condition exclusion period.
54.9801-4 Rules relating to creditable coverage.
54.9801-5 Evidence of creditable coverage.
54.9801-6 Special enrollment periods.
54.9802-1 Prohibiting discrimination against participants and
beneficiaries based on a health factor.
54.9802-2 Special rules for certain church plans.
54.9802-3T Additional requirements prohibiting discrimination based on
genetic information (temporary).
54.9811-1 Standards relating to benefits for mothers and newborns.
[[Page 260]]
54.9812-1T Parity in mental health and substance use disorder benefits
(temporary).
54.9815-1251T Preservation of right to maintain existing coverage
(temporary).
54.9815-2704T Prohibition of preexisting condition exclusions
(temporary).
54.9815-2711T No lifetime or annual limits (temporary).
54.9815-2712T Rules regarding rescissions (temporary).
54.9815-2713T Coverage of preventive health services (temporary).
54.9815-2714T Eligibility of children until at least age 26 (temporary).
54.9815-2719AT Patient protections (temporary).
54.9815-2719T Internal claims and appeals and external review processes
(temporary).
54.9831-1 Special rules relating to group health plans.
54.9833-1 Effective dates.
Authority: 26 U.S.C. 7805, unless otherwise noted.
Section 54.4974-2 also issued under 26 U.S.C. 4974;
Section 54.4981A-1T also issued under 26 U.S.C. 4981A;
Section 54.4980B-1 also issued under 26 U.S.C. 4980B;
Section 54.4980B-2 also issued under 26 U.S.C. 4980B;
Section 54.4980B-3 also issued under 26 U.S.C. 4980B;
Section 54.4980B-4 also issued under 26 U.S.C. 4980B;
Section 54.4980B-5 also issued under 26 U.S.C. 4980B;
Section 54.4980B-6 also issued under 26 U.S.C. 4980B;
Section 54.4980B-7 also issued under 26 U.S.C. 4980B;
Section 54.4980B-8 also issued under 26 U.S.C. 4980B;
Section 54.4980B-9 also issued under 26 U.S.C. 4980B;
Section 54.4980B-10 also issued under 26 U.S.C. 4980B;
Section 54.4980F-1 also issued under 26 U.S.C. 4980F;
Section 54.4980G-1 also issued under 26 U.S.C. 4980G;
Section 54.4980G-2 also issued under 26 U.S.C. 4980G;
Section 54.4980G-3 also issued under 26 U.S.C. 4980G;
Section 54.4980G-4 also issued under 26 U.S.C. 4980G;
Section 54.4980G-5 also issued under 26 U.S.C. 4980G;
Section 54.4980G-6 also issued under 26 U.S.C. 4980G;
Section 54.4980G-7 also issued under 26 U.S.C. 4980G;
Section 54.6060-1 also issued under 26 U.S.C. 6060(a);
Section 54.6109-1 also issued under 26 U.S.C. 6109(a);
Section 54.6109-2 also issued under 26 U.S.C. 6109(a);
Section 54.6695-1 also issued under 26 U.S.C. 6695(b);
Section 54.9801-1 also issued under 26 U.S.C. 9833;
Section 54.9801-2 also issued under 26 U.S.C. 9833;
Section 54.9801-3 also issued under 26 U.S.C. 9801(c)(4),
9801(e)(3), and 9833;
Section 54.9801-4 also issued under 26 U.S.C. 9801(c)(1)(I) and
9833;
Section 54.9801-5 also issued under 26 U.S.C. 9801(c)(4),
9801(e)(3); and 9833.
Section 54.9801-6 also issued under 26 U.S.C. 9833;
Section 54.9802-1 also issued under 26 U.S.C. 9833;
Section 54.9802-2 also issued under 26 U.S.C. 9833;
Section 54.9802-3T also issued under 26 U.S.C. 9833;
Section 54.9811-1 also issued under 26 U.S.C. 9833;
Section 54.9812-1T also issued under 26 U.S.C. 9833;
Section 54.9815-1251T also issued under 26 U.S.C. 9833;
Section 54.9815-2704T also issued under 26 U.S.C. 9833;
Section 54.9815-2711T also issued under 26 U.S.C. 9833;
Section 54.9815-2712T also issued under 26 U.S.C. 9833;
Section 54.9815-2713T also issued under 26 U.S.C. 9833;
Section 54.9815-2714T also issued under 26 U.S.C. 9833;
Section 54.9815-2719AT also issued under 26 U.S.C. 9833;
Section 54.9815-2719T also issued under 26 U.S.C. 9833;
Section 54.9831-1 also issued under 26 U.S.C. 9833;
Section 54.9833-1 also issued under 26 U.S.C. 9833.
Sec. 54.4971-1 General rules relating to excise tax on failure to meet minimum funding standards.
(a)-(b) [Reserved]
(c) Additional tax. Section 4971(b) imposes an excise tax in any
case in which an initial tax is imposed under section 4971(a) on an
accumulated funding deficiency and the accumulated funding deficiency is
not corrected within the taxable period (as defined in section
4971(c)(3)). The additional tax is 100 percent of the accumulated
funding deficiency to the extent not corrected.
(d) [Reserved]
[[Page 261]]
(e) Definition of taxable period--(1) In general. For purposes of
any accumulated funding deficiency, the term ``taxable period'' means
the period beginning with the end of the plan year in which there is an
accumulated funding deficiency and ending on the earlier of:
(i) The date of mailing of a notice of deficiency under section 6212
with respect to the tax imposed by section 4971(a), or
(ii) The date on which the tax imposed by section 4971(a) is
assessed.
(2) Special rule. Where a notice of deficiency referred to in
paragraph (e)(1)(i) of this section is not mailed because a waiver of
the restrictions on assessment and collection of a deficiency has been
accepted or because the deficiency is paid, the date of filing of the
waiver or the date of such payment, respectively, shall be treated as
the end of the taxable period.
[T.D. 8084, 51 FR 16305, May 2, 1986]
Sec. 54.4972-1 Tax on excess contributions to plans benefiting self-employed individuals.
(a) In general. Section 4972 imposes a tax of 6 percent on the
amount of the excess contributions (as defined in section 4972 (b) and
(c) of this section) under certain qualified plans (as defined in
paragraph (b) of this section) for each taxable year beginning after
December 31, 1975, of the employer who maintains such plan. Partnerships
and sole proprietors are to report this tax by filing Form 5330 (or
other designated form) and the tax is to be paid annually at the time
prescribed for filing such return (determined without regard to any
extension of time for filing).
(b) Employers to whom section applies. The tax under section 4972 is
imposed on employers who maintain a qualified plan during their taxable
year. For this purpose, the term qualified plan means a pension or
profit-sharing plan which includes a trust described in section 401(a),
an annuity plan described in section 403(a), or a bond purchase plan
described in section 405(a). In addition to being a qualified plan, the
plan must provide contributions or benefits for employees some or all of
whom are employees within the meaning of section 401(c)(1). For this
purpose, the plan does not have to provide contributions or benefits for
employees who are employees within the meaning of section 401(c)(1)
during the taxable year; it is sufficient that the plan so provided in a
prior taxable year.
(c) Excess contributions--(1) In general. For a taxable year of an
employer for purposes of section 4972 and this section, the term
``excess contributions'' means:
(i) The amount (if any) by which the sum of:
(A) The amount (if any) determined under section 4972(b)(2) and
paragraph (d) of this section, plus
(B) The amount (if any) determined under section 4972(b)(3) and
paragraph (e) of this section, plus
(C) The amount (if any) determined under section 4972(b)(4) and
paragraph (f) of this section, exceeds
(ii) The amount (if any) of any correcting distributions (as defined
in section 4972(b)(5) and paragraph (g) of this section) made in all
prior taxable years beginning after December 31, 1975.
(2) Contributions allocable to insurance. For purposes of section
4972(b) and this section, the amount of any contribution made under the
plan which is allocable to the purchase of life, accident, health, or
other insurance is not taken into account. The amount of any
contribution which is allocable to the cost of insurance protection is
determined in accordance with the provisions of paragraph (g) of Sec.
1.404(e)-1A and paragraph (b) of Sec. 1.72-16.
(d) Contributions by owner-employees--(1) General rule. In the case
of a plan which provides contributions or benefits for employees some or
all of whom are owner-employees, within the meaning of section
401(c)(3), the amount determined under section 4972(b)(2) and this
paragraph for the employer's taxable year is the amount computed
separately with respect to each owner-employee equal to the sum of:
(i) The excess (if any) of
(A) The amount contributed under the plan by each owner-employee as
an employee (that is, each owner-employee's contributions within the
meaning of section 401(c)(5)(B)) for such taxable year of the employer,
over
[[Page 262]]
(B) The amount permitted under section 4972(c) and paragraph (h) of
this section to be contributed by each owner-employee as an employee for
such taxable year of the employer, and
(ii) The amount determined under section 4972(b)(2) and this
paragraph for the immediately preceding taxable year of the employer,
reduced by the excess (if any) of the amount described in subdivision
(1)(B) of this subparagraph over the amount described in subdivision
(1)(A) of this subparagraph for such taxable year of the employer.
(2) Rollover amounts. The provisions of section 4972 (c) and
paragraph (d) of this section are not applicable to amounts contributed
on behalf of an owner-employee in a rollover contribution described in
section 402(a)(5), 403(a)(4), 408(d)(3), or 409(b)(3)(C).
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. (i) A and B are the only owner-employees covered under
the X Employees' Trust. The X Partnership, the X Trust, and the X Plan
all use the calendar year as their annual accounting period, at all
relevant times. The amount determined under section 4972(b)(2) for 1975
is 0 because this section does not apply to contributions made for
taxable years beginning before January 1, 1976. In calendar year 1976, A
contributes $2,500 and B contributes $2,500 to the trust. The amount
permitted to be contributed to the trust for 1976 with respect to A as
an employee is $1,800 and with respect to B as an employee is $2,200.
(ii) The amount determined under this paragraph for 1976 with
respect to A is $700, computed as follows: the sum of the excess of the
amount contributed by A ($2,500) over the amount permitted to be
contributed by A ($1,800), and the amount determined under this
paragraph for A in 1975 (0).
(iii) The amount determined under this paragraph for 1976 with
respect to B is $300, computed as follows: the sum of the excess of the
amount contributed by B ($2,500) over the amount permitted to be
contributed by B ($2,200), and the amount determined under this
paragraph for B in 1975 (0).
(iv) The amount determined under section 4972(b)(2) and this
paragraph for 1976 with respect to the employer, X Partnership, is
$1,000, the sum of the amounts determined separately under this
paragraph with respect to A ($700) and B ($300). The tax under section
4972 for 1976 on the X Partnership (assuming that no other events
affecting the determination of the tax under section 4972 occur) is 6
percent of $1,000 or $60.
Example 2. (i) Assume the facts stated in Example (1). In calendar
year 1977, A contributes $1,500 and B contributes $2,300 to the trust.
Assume that the amount permitted to be contributed to the trust for
1977, under section 4972(c) for A and B is $2,500 each.
(ii) The amount determined under this paragraph for 1977 with
respect to A is 0, computed as follows: the sum of 0 (the excess of the
amount contributed by A ($1,500) over the amount permitted to be
contributed ($2,500)) and $700, the amount determined under this
paragraph for A in 1976, reduced by $1,000 (the amount permitted to be
contributed by A ($2,500) over the amount contributed by A ($1,500)).
(iii) The amount determined under this paragraph for 1977 with
respect to B is $100, computed as follows: the sum of 0 (the excess of
the amount contributed by B ($2,300) over the amount permitted to be
contributed ($2,500)) and $300, the amount determined under this
paragraph for B in 1976, reduced by $200 (the amount permitted to be
contributed ($2,500) by B over the amount contributed by B ($2,300)).
(iv) The amount determined under section 4972(b) and this paragraph
for 1977 with respect to the employer, X Partnership, is $100, the sum
of the amounts determined separately under this paragraph with respect
to A ($0) and B ($100). The tax imposed under section 4972 for 1977 on
the X Partnership (assuming that no other events affecting the
determination of the tax under section 4972 occur) is 6 percent of $100,
or $6.
(e) Defined benefit plans--(1) General rule. In the case of a
defined benefit plan (as defined in section 414(j)), the amount
determined under section 4972(b)(3) and this paragraph for the taxable
year of the employer is the amount contributed under the plan by the
employer during the taxable year plus the amounts, if any, contributed
by the employer during any prior taxable year beginning after December
31, 1975, if:
(i) As of the close of the taxable year, the full funding limitation
of the plan (determined under section 412(c)(7) and the regulations
thereunder) is zero, and
(ii) Such amounts contributed have not been deductible by the
employer for the taxable year or for any prior taxable year beginning
after December 31, 1975.
See section 404 and the regulations thereunder for the determination of
the amount deductible by the employer for the taxable year. If the
amounts contributed by the employer exceed the
[[Page 263]]
amounts which have been deductible, the amount determined under this
paragraph shall not exceed the amounts which have not been deductible.
For purposes of this paragraph, the determination of both the amounts
contributed and the amounts deductible by the employer for any relevant
taxable year includes amounts contributed and deductible on behalf of
any employee covered under the plan, including common-law employees and
other self-employed individuals who are not owner-employees in addition
to owner-employees. The determination of whether the full funding
limitation is zero shall be made taking into account all the plan assets
unreduced by any deduction carryover under section 404(a)(1)(D). The
determination of whether the full funding limitation is zero as of the
close of the employer's taxable year shall be made with respect to the
plan year ending with or within the employer's taxable year.
Consequently, if an employer whose taxable year is the calendar year
establishes and maintains a defined benefit plan whose plan year begins
on July 1 and ends on June 30, the full funding limitation for that plan
will be determined with respect to the plan year ending on June 30
within the calendar taxable year including that June 30.
(2) Illustration. The provisions of this paragraph may be
illustrated by the following example:
Example. (i) X Partnership (``X'') adopts the Y Defined Benefit Plan
(``Y Plan'') on January 1, 1977. The taxable year of X is the calendar
year. The Y Plan also has a calendar plan year. For 1977, $25,000 is
contributed to the Y Plan by X. Assume that for 1977, (1) only $10,000
is deductible by X for 1977 under section 404 and (2) the full funding
limitation of the Y Plan (determined under section 412(c)(7)) on
December 31, 1977, is greater than zero. For 1978, X makes no additional
contributions to the Y Plan. Assume that for 1978, (1) no amount is
deductible by X under section 404 and (2) the full funding limitation of
the Y Plan (determined under section 412(c)(7)) on December 31, 1978, is
zero. The amount determined under section 4972(b)(3) and this paragraph
for the 1978 taxable year is $15,000, computed as follows: the
difference between (A) the sum of the amounts contributed by X for
taxable year 1978 (0), and the amounts contributed by X for taxable year
1977 ($25,000) and (B) the sum of the amount deductible for taxable year
1978 (0) and the amount deductible for taxable year 1977 ($10,000). The
tax imposed under section 4972 for 1978 on X (assuming that no other
events affecting the determination of the tax under section 4972 occur)
is 6 percent of $15,000 or $900.
(ii) For 1979, X makes no additional contributions to the Y Plan.
Assume that for 1979, (1) the full funding limitation of the Y Plan
determined under section 412(c)(7) is greater than zero. Assume further
that $10,000 of the amounts contributed for 1977 is deductible by X for
1979 under section 404. There is no amount determined under section
4972(b)(3) and this paragraph for 1979 because the condition described
in subparagraph (1)(i) of this paragraph is not satisfied.
(iii) For 1980, X makes no additional contributions to the Y Plan.
Assume that for 1980, (1) no amount is deductible under section 404 and
(2) the full funding limitation of the Y Plan (determined under section
412(c)(7)) on December 31, 1980, is zero. The amount determined under
section 4972(b)(3) and this paragraph for the 1980 taxable year is
$5,000, computed as follows: the difference between (A) $25,000, the sum
of the amounts contributed by X for taxable years 1980 (0), 1979 (0),
1978 (0), and 1977 ($25,000) and (B) $20,000, the sum of the amounts
deductible for taxable years 1980 (0), 1979 ($10,000), 1978 (0), and
1977 ($10,000). The tax imposed under section 4972 for 1980 on X
(assuming that no other events affecting the determination of the tax
under section 4972 occur) is 6 percent of $5,000, or $300.
(f) Defined contribution plans--(1) General rule. In the case of a
defined contribution plan (as defined in section 414(i)), the amount
determined under section 4972(b)(4) and this paragraph for the taxable
year of the employer is equal to the portion of the amounts contributed
under the plan by the employer during the taxable year plus the amounts
contributed by the employer during any prior taxable year beginning
after December 31, 1975, which has not been deductible by the employer
for the taxable year or for any such prior taxable year. For purposes of
this paragraph, the determination of both the amounts contributed and
the amounts deductible by the employer for any relevant taxable year
includes amounts contributed and deductible on behalf of any employee
covered under the plan, including common-law employees and other self-
employed individuals who are not owner-employees in addition to owner-
employees.
[[Page 264]]
(2) Illustration. The provisions of this paragraph may be
illustrated by the following example:
Example. (i) The X Partnership (``X'') adopts the Z Defined
Contribution Plan and Trust (``Z Plan'') on January 1, 1976. X's taxable
year and the plan year of Z Plan are both calendar years. For 1976, X
contributes $40,000, of which $30,000 is deductible under section 404
for taxable year 1976. The amount determined under section 4972(b)(4)
and this paragraph for 1976 is $10,000 (the difference between (A)
$40,000, the amount contributed by X for taxable year 1976 and (B)
$30,000, the amount deductible for taxable year 1976).
(ii) For 1977, X contributes $25,000, and the amounts deductible by
X under section 404 for taxable year 1977 is $30,000 ($5,000 for the
contribution carryover from 1976 and $25,000 with respect to the 1977
contribution). The amount determined under section 4972(b)(4) and this
paragraph for 1977 is $5,000, computed as follows: the difference
between (A) $65,000, the sum of the amounts contributed by X for taxable
year 1976 ($40,000) and the amounts contributed by X for taxable year
1977 ($25,000), and (B) $60,000, the sum of the amounts deductible for
taxable year 1976 ($30,000) and the amounts deductible for taxable year
1977 ($30,000).
(g) Correcting distribution--(1) General rule. For purposes of
section 4972(b) and this paragraph, the term ``correcting distribution''
means, for the taxable year of the employer, the sum of:
(i) In the case of a contribution made as an employee by an owner-
employee, within the meaning of section 401(c)(3), to a defined benefit
or defined contribution plan, the amount, or any part thereof,
determined under section 4972(b)(2) and paragraph (d) of this section
which is distributed to the owner-employee who contributed such amount
to the plan;
(ii) In the case of a defined benefit plan, the amount, or any part
thereof, determined under section 4972(b)(3) and paragraph (e) of this
section which is distributed from the plan to the employer, and
(iii) In the case of a defined contribution plan, the amount, or any
part thereof, determined under section 4972(b)(4) and paragraph (f) of
this section which is distributed to (A) the employer or (B) to the
employee for whom such amount was contributed.
If, for any employer taxable year in which a defined contribution plan
is maintained, there is a correcting distribution to an employee which
could be from amounts described in subparagraph (1)(i) and (iii) of this
paragraph for such employee, then such correcting distribution shall be
deemed to be made first from amounts described in such subparagraph
(1)(i) and then from amounts described in such subparagraph (1)(iii) for
purposes of this section and section 72. For the income tax treatment of
such distributions to employees, see section 72 and the regulations
thereunder. Any such distributions to employees shall not be subject to
the tax imposed by section 4975 nor result in the defined contribution
plan failing to satisfy the exclusive benefit requirement of section
401(a), solely by reason of being a correcting distribution within the
meaning of this paragraph. If, for any employer taxable year in which a
defined benefit, or defined contribution plan is maintained, there is a
correcting distribution described in subparagraph (1)(ii) or (iii) of
this paragraph to the employer maintaining the plan, such distribution
shall not be subject to the tax imposed by section 4975 nor result in
the plan's failing to satisfy the exclusive benefit or the definitely
determinable requirements under section 401(a). If, for any employer
taxable year in which a money purchase pension plan is maintained, a
correcting distribution described in subparagraph (1)(iii) of this
paragraph is made to an employee who has not yet become eligible to
receive retirement benefits under the plan, the qualification of the
pension plan (and trust) under section 401(a) may be adversely affected.
See Sec. 1.401-1(b)(1)(i). A correcting distribution described in
subparagraph (1)(iii) of this paragraph to an owner-employee prior to
age 59\1/2\ must be precluded under the plan. See section 401(d)(4)(B).
(2) Illustration. The provisions of this paragraph may be
illustrated by the following example:
Example. (i) A and B are owner-employees who are over the age of
59\1/2\ and who are covered under the X Employees' Defined Contribution
Plan and Profit-Sharing Trust (``Plan Y''). The X Partnership (``X'')
and Plan Y are on calendar years. In calendar year 1976, A contributes
$2,500 and B contributes $2,500 to Plan Y. The amount permitted to be
contributed to Plan Y for 1976 with respect to A as an employee is
$1,800 and with
[[Page 265]]
respect to B as an employee is $2,200. X contributes to Plan Y $5,000 on
behalf of A and $5,000 on behalf of B. Of this amount, assume that
$2,700 is deductible with respect to A and $3,300 is deductible with
respect to B by X under section 404. The amount determined under section
4972(b)(2) and paragraph (d) of this section (the excess owner-employee
contributions made by A and B to Plan Y) for taxable year 1976 is
$1,000, computed as follows: the sum of (A) for A, $700, the difference
between his own contributions ($2,500) and the amount permitted to be
contributed by A ($1,800) and (B) for B, $300, the difference between
his own contributions ($2,500) and the amount permitted to be
contributed by B ($2,200). The amount determined under section
4972(b)(4) and paragraph (f) of this section (the excess contributions
made by X to Plan Y) for taxable year 1976 is $4,000, computed as
follows: the sum of (A) by X for A, $2,300, the difference between
contributions by X ($5,000) and the amount deductible by X for A
($2,700) and (B) by X for B, $1,700, the difference between
contributions by X for B ($5,000) and the amount deductible by X for B
($3,300). During 1976, there is no correcting distribution, within the
meaning of section 4972 and this paragraph, because there are no
distributions to A, B, or X.
(ii) Assume that, for taxable year 1977, the amounts determined
under sections 4972(b)(2) and 4972(b)(4) remain the same as for taxable
year 1976, that is, $1,000 ($700 for A and $300 for B) and $4,000
($2,300 by X for A and $1,700 by X for B), respectively. Assume further
that, in 1977, Plan Y distributes $3,000 to A and $1,000 to B. The
amount determined under section 4972(b)(5) and this paragraph (the
correcting distribution for Plan Y) for taxable year 1977 is $4,000,
computed and attributed as follows: the sum of (A) $3,000 with respect
to A, the amount of the distribution to A applied first to A's $700
amount described in subparagraph (1)(i) of this paragraph and next to
A's $2,300 amount described in subparagraph (1)(iii) of this paragraph
and (B) $1,000 with respect to B, the amount of the distribution to B
applied first to B's $300 amount described in subparagraph (1)(i) of
this paragraph and next to B's $1,700 amount described in subparagraph
(1)(iii) of this paragraph. For purposes of computing the excess
contributions for taxable year 1977, the correcting distribution of
$4,000 would not be taken into account because only correcting
distributions for prior year are considered. However, for taxable year
1978 the correcting distribution of $4,000 would be taken into account.
(iii) Assume that, for taxable year 1978, there are no additional
amounts determined under sections 4972(b)(2) and 4972(b)(4) and that
Plan Y distributes $900 to B. The amount determined under section
4972(b)(5) and this paragraph (the correcting distribution for Plan Y)
for the 1978 taxable year is $900, computed and attributed as follows:
the amount of the distribution to B, $900, applied to B's $1,000 amount
described in subparagraph (1)(iii) of this paragraph. For purposes of
computing the excess contributions for taxable year 1978, the correcting
distribution of $900 would not be taken into account. However, for
taxable year 1979, the correcting distribution of $900 would be taken
into account.
(h) Amount permitted to be contributed by owner-employee--(1)
General rule. Except as provided in subparagraph (2), for purposes of
section 4972(b)(2) and paragraph (d), the amount permitted to be
contributed under a plan by an owner-employee as an employee for any
taxable year of the employer is the smallest of the following:
(i) $2,500;
(ii) 10 percent of the earned income (as defined in section
401(c)(2)) for such taxable year derived by the owner-employee from the
trade or business with respect to which the plan is established, or
(iii) The amount of the contribution which would be contributed by
the owner-employee (as an employee) if such contribution were made at
the rate of contributions which is permitted to be made by employees who
are not owner-employees during such taxable year.
(2) Special rule. In the case of a taxable year of the employer in
which there are no employees other than owner-employees, the amount
permitted to be contributed under a plan by an owner-employee (as an
employee) is zero.
(i) Special rules and cross references--(1) Time of contributions.
For purposes of this section, time of employer contributions made with
respect to any taxable year shall take into account the rules specified
in section 404(a)(6), relating to time when contributions deemed made.
(2) Disallowance of deduction. For disallowance of deduction for
taxes paid under this section, see section 275(a)(6).
(3) Certain annuity contracts. For a special rule relating to owner-
employee contributions for premiums on annuity, etc. contracts, see
Sec. 1.401(e)4(a)
[[Page 266]]
(4) Disqualification for excess contributions. For plan
qualification requirements relating to excess contributions, see section
401(d)(5).
[T.D. 7759, 46 FR 6932, Jan. 22, 1981]
Sec. 54.4974-1 Excise tax on accumulations in individual retirement accounts or annuities.
(a) General rule. A tax equal to 50 percent of the amount by which
the minimum amount required to be distributed from an individual
retirement account or annuity described in section 408 during the
taxable year of the payee under paragraph (b) of this section exceeds
the amount actually distributed during the taxable year is imposed by
section 4974 on the payee.
(b) Minimum amount required to be distributed. For purposes of this
section, the minimum amount required to be distributed is the amount
required under Sec. 1.408-2(b)(6)(v) to be distributed in the taxable
year described in paragraph (a) of this section.
(c) Examples. The application of this section may be illustrated by
the following examples.
Example 1. In 1975, the minimum amount required to be distributed
under Sec. 1.408-2(b)(6)(v) to A under his individual retirement
account is $100. Only $60 is actually distributed to A in 1975. Under
section 4974, A would have an excise tax liability of $20 [50% of ($100-
$60)].
Example 2. Although no distribution is required under Sec. 1.408-
2(b)(6)(v) to be made in 1986, H, a married individual born on February
1, 1921, who has established and maintained an individual retirement
account decides to begin receiving distributions from the account
beginning in 1986. H's wife, W, was born on March 6, 1921. H and W are
calendar year taxpayers. H decides to receive his interest in the
account over the joint life and last survivor expectancy of himself and
his wife. On January 1, 1986, the balance in H's account is $10,000; H
and W, based on their nearest birthdates, are 65; and the joint life and
last survivor expectancy of H and his wife is 22.0 years (see Table II
of Sec. 1.72-9). His annual payments during the following years (none
of which were required) were determined by dividing the balance in the
account on the first day of each year by the joint life and last
survivor expectancy reduced by the number of whole years elapsed since
the distributions were to commence.
------------------------------------------------------------------------
Life Account
expectancy balance
minus at Annual
Date whole beginning payment
years of each
elapsed year
------------------------------------------------------------------------
Jan. 1, 1986............................ 22.0 $10,000 $455
Jan. 1, 1987............................ 21.0 10,118 482
Jan. 1, 1988............................ 20.0 10,214 511
Jan. 1, 1989............................ 19.0 10,285 541
Jan. 1, 1990............................ 18.0 10,329 574
Jan. 1, 1991............................ 17.0 10,340 608
------------------------------------------------------------------------
For 1986, 1987, 1989, and 1990, the amount required to be distributed
under Sec. 1.408-2(b)(6)(v) is zero. Thus, H would have no excise tax
liability under section 4974 for these years. In 1991, the year H
attains age 70\1/2\, the amount required to be distributed from the
account under Sec. 1.408-2(b)(6)(v) is $565, determined by dividing
$10,340 (the account balance as of January 1, 1991) by 18.8 years (the
joint life and last survivor expectancy of H and W, assuming they are
both still living, as of January 1, 1991). If W should die after
December 31, 1990, the joint life and last survivor expectancy
determined on January 1, 1991 (18.3 years) would not be redetermined.
Because the amount distributed from the account in 1991 ($608) exceeds
the amount required to be distributed from the account in 1991 ($565), H
has no excise tax liability under section 4974 for 1991.
Example 3. Assume the same facts as in example (2) except that W
dies in 1988. For 1988, 1989, and 1990, the amount required to be
distributed under Sec. 1.408-2(b)(6)(v) is zero. Thus, H would have no
excise tax liability under section 4974 for these years. In 1991, the
amount required to be distributed under Sec. 1.408-2(b)(6)(v) is $855,
determined by dividing $10,340 (the account balance as of January 1,
1991) by 12.1 years (the life expectancy of H as of January 1, 1991).
Because the amount distributed from the account in 1991 ($608) is less
than the amount required to be distributed from the account in 1991
($855), H has an excise tax liability of $123.50 under section 4974 for
1991 [50% of ($855-$608)].
[T.D. 7714, 45 FR 52799, Aug. 8, 1980]
Sec. 54.4974-2 Excise tax on accumulations in qualified retirement plans.
Q-1. Is any tax imposed on a payee under any qualified retirement
plan or any eligible deferred compensation plan (as defined in section
457(b)) to whom an amount is required to be distributed for a taxable
year if the amount distributed during the taxable year is less than the
required minimum distribution?
A-1. Yes, if the amount distributed to a payee under any qualified
retirement
[[Page 267]]
plan or any eligible deferred compensation plan (as defined in section
457(b)) for a calendar year is less than the required minimum
distribution for such year, an excise tax is imposed on such payee under
section 4974 for the taxable year beginning with or within the calendar
year during which the amount is required to be distributed. The tax is
equal to 50 percent of the amount by which such required minimum
distribution exceeds the actual amount distributed during the calendar
year. Section 4974 provides that this tax shall be paid by the payee.
For purposes of section 4974, the term required minimum distribution
means the minimum distribution amount required to be distributed
pursuant to section 401(a)(9), 403(b)(10), 408(a)(6), 408(b)(3), or
457(d)(2), as the case may be, and the regulations thereunder. Except as
otherwise provided in A-6 of this section, the required minimum
distribution for a calendar year is the required minimum distribution
amount required to be distributed during the calendar year. A-6 of this
section provides a special rule for amounts required to be distributed
by an employee's (or individual's) required beginning date.
Q-2. For purposes of section 4974, what is a qualified retirement plan?
A-2. For purposes of section 4974, each of the following is a
qualified retirement plan--
(a) A plan described in section 401(a) which includes a trust exempt
from tax under section 501(a);
(b) An annuity plan described in section 403(a);
(c) An annuity contract, custodial account, or retirement income
account described in section 403(b);
(d) An individual retirement account described in section 408(a)
(including a Roth IRA described in section 408A);
(e) An individual retirement annuity described in section 408(b)
(including a Roth IRA described in section 408A); or
(f) Any other plan, contract, account, or annuity that, at any time,
has been treated as a plan, account, or annuity described in paragraphs
(a) through (e) of this A-2, whether or not such plan, contract,
account, or annuity currently satisfies the applicable requirements for
such treatment.
Q-3. If a payee's interest under a qualified retirement plan is in
the form of an individual account, how is the required minimum
distribution for a given calendar year determined for purposes of
section 4974?
A-3. (a) General rule. If a payee's interest under a qualified
retirement plan is in the form of an individual account and distribution
of such account is not being made under an annuity contract purchased in
accordance with A-4 of Sec. 1.401(a)(9)-6, the amount of the required
minimum distribution for any calendar year for purposes of section 4974
is the required minimum distribution amount required to be distributed
for such calendar year in order to satisfy the minimum distribution
requirements in Sec. 1.401(a)(9)-5 as provided in the following
(whichever is applicable)--
(1) Section 401(a)(9) and Sec. Sec. 1.401(a)(9)-1 through
1.401(a)(9)-5 and 1.401(a)(9)-7 through 1.401(a)(9)-9 in the case of a
plan described in section 401(a) which includes a trust exempt under
section 501(a) or an annuity plan described in section 403(a);
(2) Section 403(b)(10) and Sec. 1.403(b)-6(e) (in the case of an
annuity contract, custodial account, or retirement income account
described in section 403(b));
(3) Section 408(a)(6) or (b)(3) and Sec. 1.408-8 (in the case of an
individual retirement account or annuity described in section 408(a) or
(b)); or
(4) Section 457(d) in the case of an eligible deferred compensation
plan (as defined in section 457(b)).
(b) Default provisions. Unless otherwise provided under the
qualified retirement plan (or, if applicable, the governing instrument
of the qualified retirement plan), the default provisions in A-4(a) of
Sec. 1.401(a)(9)-3 apply in determining the required minimum
distribution for purposes of section 4974.
(c) Five-year rule. If the 5-year rule in section 401(a)(9)(B)(ii)
applies to the distribution to a payee, no amount is required to be
distributed for any calendar year to satisfy the applicable enumerated
section in paragraph (a) of this A-3 until the calendar year which
contains the date 5 years after the date of the employee's death. For
the calendar year which contains the date 5
[[Page 268]]
years after the employee's death, the required minimum distribution
amount required to be distributed to satisfy the applicable enumerated
section is the payee's entire remaining interest in the qualified
retirement plan.
Q-4. If a payee's interest in a qualified retirement plan is being
distributed in the form of an annuity, how is the amount of the required
minimum distribution determined for purposes of section 4974?
A-4. If a payee's interest in a qualified retirement plan is being
distributed in the form of an annuity (either directly from the plan, in
the case of a defined benefit plan, or under an annuity contract
purchased from an insurance company), the amount of the required minimum
distribution for purposes of section 4974 will be determined as follows:
(a) Permissible annuity distribution option. A permissible annuity
distribution option is an annuity contract (or, in the case of annuity
distributions from a defined benefit plan, a distribution option) which
specifically provides for distributions which, if made as provided,
would for every calendar year equal or exceed the minimum distribution
amount required to be distributed to satisfy the applicable section
enumerated in paragraph (a) of A-2 of this section for every calendar
year. If the annuity contract (or, in the case of annuity distributions
from a defined benefit plan, a distribution option) under which
distributions to the payee are being made is a permissible annuity
distribution option, the required minimum distribution for a given
calendar year will equal the amount which the annuity contract (or
distribution option) provides is to be distributed for that calendar
year.
(b) Impermissible annuity distribution option. An impermissible
annuity distribution option is an annuity contract (or, in the case of
annuity distributions from a defined benefit plan, a distribution
option) under which distributions to the payee are being made that
specifically provides for distributions which, if made as provided,
would for any calendar year be less than the minimum distribution amount
required to be distributed to satisfy the applicable section enumerated
in paragraph (a) of A-3 of this section. If the annuity contract (or, in
the case of annuity distributions from a defined benefit plan, the
distribution option) under which distributions to the payee are being
made is an impermissible annuity distribution option, the required
minimum distribution for each calendar year will be determined as
follows:
(1) If the qualified retirement plan under which distributions are
being made is a defined benefit plan, the minimum distribution amount
required to be distributed each year will be the amount which would have
been distributed under the plan if the distribution option under which
distributions to the payee were being made was the following permissible
annuity distribution option:
(i) In the case of distributions commencing before the death of the
employee, if there is a designated beneficiary under the impermissible
annuity distribution option for purposes of section 401(a)(9), the
permissible annuity distribution option is the joint and survivor
annuity option under the plan for the lives of the employee and the
designated beneficiary that provides for the greatest level amount
payable to the employee determined on an annual basis. If the plan does
not provide such an option or there is no designated beneficiary under
the impermissible distribution option for purposes of section 401(a)(9),
the permissible annuity distribution option is the life annuity option
under the plan payable for the life of the employee in level amounts
with no survivor benefit.
(ii) In the case of distributions commencing after the death of the
employee, if there is a designated beneficiary under the impermissible
annuity distribution option for purposes of section 401(a)(9), the
permissible annuity distribution option is the life annuity option under
the plan payable for the life of the designated beneficiary in level
amounts. If there is no designated beneficiary, the 5-year rule in
section 401(a)(9)(B)(ii) applies. See paragraph (b)(3) of this A-4. The
determination of whether or not there is a designated beneficiary and
the determination of which designated beneficiary's life is to be used
in the case of multiple beneficiaries will be made in accordance
[[Page 269]]
with Sec. 1.401(a)(9)-4 and A-7 of Sec. 1.401(a)(9)-5. If the defined
benefit plan does not provide for distribution in the form of the
applicable permissible distribution option, the required minimum
distribution for each calendar year will be an amount as determined by
the Commissioner.
(2) If the qualified retirement plan under which distributions are
being made is a defined contribution plan and the impermissible annuity
distribution option is an annuity contract purchased from an insurance
company, the minimum distribution amount required to be distributed each
year will be the amount that would have been distributed in the form of
an annuity contract under the permissible annuity distribution option
under the plan determined in accordance with paragraph (b)(1) of this A-
4 for defined benefit plans. If the defined contribution plan does not
provide the applicable permissible annuity distribution option, the
required minimum distribution for each calendar year will be the amount
that would have been distributed under an annuity described in paragraph
(b)(2)(i) or (ii) of this A-4 purchased with the employee's or
individual's account used to purchase the annuity contract that is the
impermissible annuity distribution option.
(i) In the case of distributions commencing before the death of the
employee, if there is a designated beneficiary under the impermissible
annuity distribution option for purposes of section 401(a)(9), the
annuity is a joint and survivor annuity for the lives of the employee
and the designated beneficiary which provides level annual payments and
which would have been a permissible annuity distribution option.
However, the amount of the periodic payment which would have been
payable to the survivor will be the applicable percentage under the
table in A-2(c) of Sec. 1.401(a)(9)-6 of the amount of the periodic
payment which would have been payable to the employee or individual. If
there is no designated beneficiary under the impermissible distribution
option for purposes of section 401(a)(9), the annuity is a life annuity
for the life of the employee with no survivor benefit which provides
level annual payments and which would have been a permissible annuity
distribution option.
(ii) In the case of a distribution commencing after the death of the
employee, if there is a designated beneficiary under the impermissible
annuity distribution option for purposes of section 401(a)(9), the
annuity option is a life annuity for the life of the designated
beneficiary which provides level annual payments and which would have
been a permissible annuity distribution option. If there is no
designated beneficiary, the 5-year rule in section 401(a)(9)(B)(ii)
applies. See paragraph (b)(3) of this A-4. The amount of the payments
under the annuity contract will be determined using the interest rate
and actuarial tables prescribed under section 7520 determined using the
date determined under A-3 of Sec. 1.401(a)(9)-3 when distributions are
required to commence and using the age of the beneficiary as of the
beneficiary's birthday in the calendar year that contains that date. The
determination of whether or not there is a designated beneficiary and
the determination of which designated beneficiary's life is to be used
in the case of multiple beneficiaries will be made in accordance with
Sec. 1.401(a)(9)-4 and A-7 of Sec. 1.401(a)(9)-5.
(3) If the 5-year rule in section 401(a)(9)(B)(ii) applies to the
distribution to the payee under the contract (or distribution option),
no amount is required to be distributed to satisfy the applicable
enumerated section in paragraph (a) of this A-4 until the calendar year
which contains the date 5 years after the date of the employee's death.
For the calendar year which contains the date 5 years after the
employee's death, the required minimum distribution amount required to
be distributed to satisfy the applicable enumerated section is the
payee's entire remaining interest in the annuity contract (or under the
plan in the case of distributions from a defined benefit plan).
(4) If the plan provides that the required beginning date for
purposes of section 401(a)(9) for all employees is April 1 of the
calendar year following the calendar year in which the employee attained
age 70\1/2\ in accordance with paragraph A-2(e) of Sec. 1.401(a)(9)-2,
the required minimum distribution for
[[Page 270]]
each calendar year for an employee who is not a 5-percent owner for
purposes of this section will be the lesser of the amount determined
based on the required beginning date as set forth in A-2(a) of Sec.
1.401(a)(9)-2 or the required beginning date under the plan. Thus, for
example, if an employee dies after attaining age 70\1/2\, but before
April 1 of the calendar year following the calendar year in which the
employee retired, and there is no designated beneficiary as of September
30 of the year following the employee's year of death, required minimum
distributions for calendar years after the calendar year containing the
employee's date of death may be based on either the applicable
distribution period provided under either the 5-year rule of A-1 of
Sec. 1.401(a)(9)-3 or the employee's remaining life expectancy as set
forth in A-5(c)(3) of Sec. 1.401(a)(9)-5.
Q-5. If there is any remaining benefit with respect to an employee
(or IRA owner) after any calendar year in which the entire remaining
benefit is required to be distributed under section 401(a)(9), what is
the amount of the required minimum distribution for each calendar year
subsequent to such calendar year?
A-5. If there is any remaining benefit with respect to an employee
(or IRA owner) after the calendar year in which the entire remaining
benefit is required to be distributed, the required minimum distribution
for each calendar year subsequent to such calendar year is the entire
remaining benefit.
Q-6. With respect to which calendar year is the excise tax under
section 4974 imposed in the case in which the amount not distributed is
an amount required to be distributed by April 1 of a calendar year (by
the employee's or individual's required beginning date)?
A-6. In the case in which the amount not paid is an amount required
to be paid by April 1 of a calendar year, such amount is a required
minimum distribution for the previous calendar year, i.e., for the
employee's or the individual's first distribution calendar year.
However, the excise tax under section 4974 is imposed for the calendar
year containing the last day by which the amount is required to be
distributed, i.e., the calendar year containing the employee's or
individual's required beginning date, even though the preceding calendar
year is the calendar year for which the amount is required to be
distributed. There is also a required minimum distribution for the
calendar year which contains the employee's or individual's required
beginning date. Such distribution is also required to be made during the
calendar year which contains the employee's or individual's required
beginning date.
Q-7. Are there any circumstances when the excise tax under section
4974 for a taxable year may be waived?
A-7. (a) Reasonable cause. The tax under section 4974(a) may be
waived if the payee described in section 4974(a) establishes to the
satisfaction of the Commissioner the following--
(1) The shortfall described in section 4974(a) in the amount
distributed in any taxable year was due to reasonable error; and
(2) Reasonable steps are being taken to remedy the shortfall.
(b) Automatic waiver. The tax under section 4974 will be
automatically waived, unless the Commissioner determines otherwise, if--
(1) The payee described in section 4974(a) is an individual who is
the sole beneficiary and whose required minimum distribution amount for
a calendar year is determined under the life expectancy rule described
in Sec. 1.401(a)(9)-3 A-3 in the case of an employee's or individual's
death before the employee's or individual's required beginning date; and
(2) The employee's or individual's entire benefit to which that
beneficiary is entitled is distributed by the end of the fifth calendar
year following the calendar year that contains the employee's or
individual's date of death.
[T.D. 8987, 67 FR 19026, Apr. 17, 2002; 67 FR 35732, May 21, 2002, as
amended by T.D. 9340, 72 FR 41160, July 26, 2007]
Sec. 54.4975-1 General rules relating to excise tax on prohibited transactions.
(a) Scope. This section provides general rules for the imposition of
the excise taxes on prohibited transactions.
(b) Initial tax. Section 4975(a) imposes an initial tax on each
prohibited transaction. The initial tax is 5 percent of
[[Page 271]]
the amount involved with respect to the prohibited transaction for each
year (or part thereof) in the taxable period.
(c) Additional tax. Section 4975(b) imposes an excise tax in any
case in which an initial tax is imposed under section 4975(a) on a
prohibited transaction and the prohibited transaction is not corrected
within the taxable period (as defined in paragraph (d) of this section).
The additional tax is 100 percent of the amount involved with respect to
the prohibited transaction.
(d) Taxable period--(1) In general. For purposes of any prohibited
transaction, the term ``taxable period'' means the period beginning with
the date on which the prohibited transaction occurs and ending on the
earliest of:
(i) The date of mailing of a notice of deficiency under section 6212
with respect to the tax imposed by section 4975(a);
(ii) The date on which correction of the prohibited transaction is
completed; or
(iii) The date on which the tax imposed by section 4975(a) is
assessed.
(2) Special rule. Where a notice of deficiency referred to in
paragraph (d)(1)(i) of this section is not mailed because a waiver of
the restrictions on assessment and collection of a deficiency has been
accepted or because the deficiency is paid, the date of filing of the
waiver or the date of such payment, respectively, shall be treated as
the end of the taxable period.
[T.D. 8084, 51 FR 16305, May 2, 1986]
Sec. 54.4975-6 Statutory exemptions for office space or
services and certain transactions involving financial institutions.
(a) Exemption for office space or services--(1) In general. Section
4975(d)(2) exempts from the excise taxes imposed by section 4975 payment
by a plan to a disqualified person, including a fiduciary, for office
space or any service (or a combination of services), if (i) such office
space or service is necessary for the establishment or operation of the
plan; (ii) such office space or service is furnished under a contract or
arrangement which is reasonable; and (iii) no more than reasonable
compensation is paid for such office space or service. However, section
4975(d)(2) does not contain an exemption for acts described in section
4975(c)(1)(E) (relating to fiduciaries dealing with the income or assets
of plans in their own interest or for their own account) or acts
described in section 4975(c)(1)(F) (relating to fiduciaries receiving
consideration for their own personal account from any party dealing with
a plan in connection with a transaction involving the income or assets
of the plan). Such acts are separate transactions not described in
section 4975(d)(2). See Sec. Sec. 54.4975-6(a)(5) and 54.4975-6(a)(6)
for guidance as to whether transactions relating to the furnishing of
office space or services by fiduciaries to plans involve acts described
in section 4975(c)(1)(E).
Section 4975(d)(2) does not contain an exemption from other provisions
of the Code, such as section 401, or other provisions of law which may
impose requirements or restrictions relating to the transactions which
are exempt under section 4975(d)(2). See, for example, the general
fiduciary responsibility provisions of section 404 of the Employee
Retirement Income Security Act of 1974 (the Act) (88 Stat. 877). The
provisions of section 4975(d)(2) are further limited by the flush
language at the end of section 4975(d) (relating to transactions with
owner-employees and related persons).
(2) Necessary service. A service is necessary for the establishment
or operation of a plan within the meaning of section 4975(d)(2) and
Sec. 54.4975-6(a)(1)(i) if the service is appropriate and helpful to
the plan obtaining the service in carrying out the purposes for which
the plan is established or maintained. A person providing such a service
to a plan (or a person who is disqualified person solely by reason of a
relationship to such a service provider described in section 4975(e)(2)
(F), (G), (H), or (I)) may furnish goods which are necessary for the
establishment or operation of the plan in the course of, and incidental
to, the furnishing of such service to the plan.
(3) Reasonable contract or arrangement. No contract or arrangement
is reasonable within the meaning of section 4975(d)(2) and Sec.
54.4975-6(a)(1)(ii) if it does not permit termination by the
[[Page 272]]
plan without penalty to the plan on reasonably short notice under the
circumstances to prevent the plan from becoming locked into an
arrangement that has become disadvantageous. A long-term lease which may
be terminated prior to its expiration (without penalty to the plan) on
reasonably short notice under the circumstances is not generally an
unreasonable arrangement merely because of its long term. A provision in
a contract or other arrangement which reasonably compensates the service
provider or lessor for loss upon early termination of the contract,
arrangement or lease is not a penalty. For example, a minimal fee in a
service contract which is charged to allow recoupment of reasonable
start-up costs is not a penalty.
Similarly, a provision in a lease for a termination fee that covers
reasonably foreseeable expenses related to the vacancy and reletting of
the office space upon early termination of the lease is not a penalty.
Such a provision does not reasonably compensate for loss if it provides
for payments in excess of actual loss or if it fails to require
mitigation of damages.
(4) Reasonable compensation. Section 4975(d)(2) and Sec. 54.4975-
6(a)(1)(iii) permit a plan to pay a disqualified person reasonable
compensation for the provision of office space or services described in
section 4975(d)(2). Paragraph (e) of this section contains regulations
relating to what constitutes reasonable compensation for the provision
of services.
(5) Transactions with fiduciaries--(i) In general. If the furnishing
of office space or a service involves an act described in section
4975(c)(1) (E) or (F) (relating to acts involving conficts of interest
by fiduciaries), such an act constitutes a separate transaction which is
not exempt under section 4975(d)(2). The prohibitions of sections
4975(c)(1) (E) and (F) supplement the other prohibitions of section
4975(c)(1) by imposing on disqualified persons who are fiduciaries a
duty of undivided loyalty to the plans for which they act. These
prohibitions are imposed upon fiduciaries to deter them from exercising
the authority, control, or responsibility which makes such persons
fiduciaries when they have interests which may conflict with the
interests of the plans for which they act. In such cases, the
fiduciaries have interests in the transactions which may affect the
exercise of their best judgment as fiduciaries. Thus, a fiduciary may
not use the authority, control, or responsibility which makes such
person a fiduciary to cause a plan to pay an additional fee to such
fiduciary (or to a person in which such fiduciary has an interest which
may affect the exercise of such fiduciary's best judgment as a
fiduciary) to provide a service. Nor may a fiduciary use such authority,
control, or responsibility to cause a plan to enter into a transaction
involving plan assets whereby such fiduciary (or a person in which such
fiduciary has an interest which may affect the exercise of such
fiduciary's best judgment as a fiduciary) will receive consideration
from a third party in connection with such transaction.
A person in which a fiduciary has an interest which may affect the
exercise of such fiduciary's best judgment as a fiduciary includes, for
example, a person who is a disqualified person by reason of a
relationship to such fiduciary described in section 4975(e)(2) (E), (F),
(G), (H), or (I).
(ii) Transactions not described in section 4975(c)(1)(E). A
fiduciary does not engage in an act described in section 4975(c)(1)(E)
if the fiduciary does not use any of the authority, control or
responsibility which makes such person a fiduciary to cause a plan to
pay additional fees for a service furnished by such fiduciary or to pay
a fee for a service furnished by a person in which such fiduciary has an
interest which may affect the exercise of such fiduciary's best judgment
as a fiduciary. This may occur, for example, when one fiduciary is
retained on behalf of a plan by a second fiduciary to provide a service
for an additional fee. However, because the authority, control or
responsibility which makes a person a fiduciary may be exercised ``in
effect'' as well as in form, mere approval of the transaction by a
second fiduciary does not mean that the first fiduciary has not used any
of the authority, control or responsibility which makes such person a
fiduciary to cause the plan to pay the first fiduciary an additional fee
for a service.
[[Page 273]]
(iii) Services without compensation. If a fiduciary provides
services to a plan without the receipt of compensation or other
consideration (other than reimbursement of direct expenses properly and
actually incurred in the performance of such services within the meaning
of paragraph (e)(4) of this section), the provision of such services
does not, in and of itself, constitute an act described in section
4975(c)(1) (E) or (F). The allowance of a deduction to an employer under
section 162 or 212 for the expense incurred in furnishing office space
or services to a plan established or maintained by such employer does
not constitute compensation or other consideration.
(6) Examples. The provisions of Sec. 54.4975-6(a)(5) may be
illustrated by the following examples:
Example 1. E, an employer whose employees are covered by plan P, is
a fiduciary or P. I is a professional investment adviser in which E has
no interest which may affect the exercise of E's best judgment as a
fiduciary. E causes P to retain I to provide certain kinds of investment
advisory services of a type which causes I to be a fiduciary of P under
section 4975(e)(3)(B). Thereafter, I proposes to perform for additional
fees portfolio evaluation services in addition to the services currently
provided. The provision of such services is arranged by I and approved
on behalf of the plan by E. I has not engaged in an act described in
section 4975(c)(1)(E), because I did not use any of the authority,
control or responsibility which makes I a fiduciary (the provision of
investment advisory services) to cause the plan to pay I additional fees
for the provision of the portfolio evaluation services. E has not
engaged in an act which is described in section 4975(c)(1)(E). E, as the
fiduciary who has the responsibility to be prudent in his selection and
retention of I and the other investments advisers of the plan, has an
interest in the purchase by the plan of portfolio evaluation services.
However, such an interest is not an interest which may affect the
exercise of E's best judgment as a fiduciary.
Example 2. D, a trustee of plan P with discretion over the
management and disposition of plan assets, relies on the advice of C, a
consultant to P, as to the investment of plan assets, thereby making C a
fiduciary of the plan. On January 1, 1978, C recommends to D that the
plan purchase an insurance policy from U, an insurance company which is
not a disqualified person with respect to P. C thoroughly explains the
reasons for the recommendation and makes a full disclosure concerning
the fact that C will receive a commission from U upon the purchase of
the policy by P. D considers the recommendation and approves the
purchase of the policy by P. C receives a commission. Under such
circumstances, C has engaged in an act described in section
4975(c)(1)(E) (as well as section 4975(c)(1)(F), because C is in fact
exercising the authority, control or responsibility which makes C a
fiduciary to cause the plan to purchase the policy. However, the
transaction is exempt from the prohibited transaction provisions of
section 4975(c)(1) if the requirements of Prohibited Transaction
Exemption 77-9 are met.
Example 3. Assume the same facts as in Example (2) except that the
nature of C's relationship with the plan is not such that C is a
fiduciary of P. The purchase of the insurance policy does not involve an
act described in section 4975(c)(1) (E) or (F), because such sections
only apply to acts by fiduciaries.
Example 4. E, an employer whose employees are covered by plan P, is
a fiduciary with respect to P. A, who is not a disqualified person with
respect to P, persuades E that the plan needs the services of a
professional investment adviser and that A should be hired to provide
the investment advice. Accordingly, E causes P to hire A to provide
investment advice of the type which makes A a fiduciary under Sec.
54.4975-9(c)(1)(ii)(B). Prior to the expiration of A's first contract
with P, A persuades E to cause P to renew A's contract with P to provide
the same services for additional fees in view of the increased costs in
providing such services. During the period of A's second contract, A
provides additional investment advice services for which no additional
charge is made. Prior to the expiration of A's second contract, A
persuades E to cause P to renew his contract for additional fees in view
of the additional services A is providing. A has not engaged in an act
described in section 4975(c)(1)(E), because A has not used any of the
authority, control or responsibility which makes A a fiduciary (the
provision of investment advice) to cause the plan to pay additional fees
for A's services.
Example 5. F, a trustee of plan P with discretion over the
management and disposition of plan assets, retains C to provide
administrative services to P of the type which makes C a fiduciary under
section 4975(e)(3)(C). Thereafter, C retains F to provide, for
additional fees, actuarial and various kinds of administrative services
in addition to the services F is currently providing to P. Both F and C
have engaged in an act described in section 4975(c)(1)(E). F, regardless
of any intent which he may have had at the time he retained C, has
engaged in such an act because F has, in effect, exercised the
authority, control or responsibility which makes F a fiduciary to cause
the plan to pay F additional fees for the services. C, whose continued
employment by P depends on F, has also engaged in such an act, because C
[[Page 274]]
has an interest in the transaction which might affect the exercise of
C's best judgment as a fiduciary. As a result, C has dealt with plan
assets in his own interest under section 4975(c)(1)(E).
Example 6. F, a fiduciary of plan P with discretionary authority
respecting the management of P, retains S, the son of F, to provide for
a fee various kinds of administrative services necessary for the
operation of the plan. F has engaged in an act described in section
4975(c)(1)(E), because S is a person in whom F has an interest which may
affect the exercise of F's best judgment as a fiduciary. Such act is not
exempt under section 4975(d)(2) irrespective of whether the provision of
the services by S is exempt.
Example 7. T, one of the trustees of plan P, is president of bank B.
The bank proposes to provide administrative services to P for a fee. T
physically absents himself from all consideration of B's proposal and
does not otherwise exercise any of the authority, control or
responsibility which makes T a fiduciary to cause the plan to retain B.
The other trustees decide to retain B. T has not engaged in an act
described in section 4975(c)(1)(E). Further, the other trustees have not
engaged in an act described in section 4975(c)(1)(E) merely because T is
on the board of trustees of P. This fact alone would not make them have
an interest in the transaction which might affect the exercise of their
best judgment as fiduciaries.
(b) Exemption for bank deposits--(1) In general. Section 4975(d)(4)
exempts from the excise taxes imposed by section 4975 investment of all
or a part of a plan's assets in deposits bearing a reasonable rate of
interest in a bank or similar financial institution supervised by the
United States or a State, even though such bank or similar financial
institution is a fiduciary or other disqualified person with respect to
the plan, if the conditions of either Sec. 54.4975-6(b)(2) or Sec.
54.4975-6(b)(3) are met. Section 4975(d)(4) provides an exemption from
section 4975(c)(1)(E) relating to fiduciaries dealing with the income or
assets of plans in their own interest or for their own account), as well
as sections 4975(c)(1) (A) through (D), because section 4975(d)(4)
contemplates a bank or similar financial institution causing a plan for
which it acts as a fiduciary to invest plan assets in its own deposits
if the requirements of section 4975(d)(4) are met. However, it does not
provide an exemption from section 4975(c)(1)(F) (relating to fidiciaries
receiving consideration for their own personal account from any party
dealing with a plan in connection with a transaction involving the
income or assets of the plan). The receipt of such consideration is a
separate transaction not described in the exemption. Section 4975(d)(4)
does not contain an exemption from other provisions of the Code, such as
section 401, or other provisions of law which may impose requirements or
restrictions relating to the transactions which are exempt under section
4975(d)(4). See, for example, the general fiduciary responsibility
provisions of section 404 of the Act. The provisions of section
4975(d)(4) are further limited by the flush language at the end of
section 4975(d) (relating to transactions with owner-employees and
related persons).
(2) Plan covering own employees. Such investment may be made if the
plan is one which covers only the employees of the bank or similar
financial institution, the employees of any of its affiliates, or the
employees of both.
(3) Other plans--(i) General rule. Such investment may be made if
the investment is expressly authorized by a provision of the plan or
trust instrument or if the investment is expressly authorized (or made)
by a fiduciary of the plan (other than the bank or similar financial
institution or any of its affiliates) who has authority to make such
investments, or to instruct the trustee or other fiduciary with respect
to investments, and who has no interest in the transaction which may
affect the exercise of such authorizing fiduciary's best judgment as a
fiduciary so as to cause such authorization to constitute an act
described in section 4975(c)(1) (E) or (F). Any authorization to make
investments contained in a plan or trust instrument will satisfy the
requirement of express authorization for investments made prior to
November 1, 1977.
Effective November 1, 1977, in the case of a bank or similar financial
institution that invests plan assets in deposits in itself or its
affiliates under an authorization contained in a plan or trust
instrument, such authorization must name such bank or similar financial
institution and must state that such bank or similar financial
institution may make investments in deposits
[[Page 275]]
which bear a reasonable rate of interest in itself (or in an affiliate.)
(ii) Example. B, a bank, is the trustee of plan P's assets. The
trust instruments give the trustee the right to invest plan assets in
its discretion. B invests in the certificates of deposit of bank C,
which is a fiduciary of the plan by virtue of performing certain
custodial and administrative services. The authorization is sufficient
for the plan to make such investment under section 4975(d)(4). Further,
such authorization would suffice to allow B to make investments in
deposits in itself prior to November 1, 1977. However, subsequent to
October 31, 1977, B may not invest in deposits in itself, unless the
plan or trust instrument specifically authorizes it to invest in
deposits of B.
(4) Definitions. (i) The term ``bank or similar financial
institution'' includes a bank (as defined in section 581), a domestic
building and loan association (as defined in section 7701(a)(19)), and a
credit union (as defined in section 101 (6) of the Federal Credit Union
Act).
(ii) A person is an affiliate of a bank or similar financial
institution if such person and such bank or similar financial
institution would be treated as members of the same controlled group of
corporations or as members of two or more trades or businesses under
common control within the meaning of section 414 (b) or (c) and the
regulations thereunder.
(iii) The term ``deposits'' includes any account, temporary or
otherwise, upon which a reasonable rate of interest is paid, including a
certificate of deposit issued by a bank or similar financial
institution.
(c) Exemption for ancillary bank services--(1) In general. Section
4975(d)(6) exempts from the excise taxes imposed by section 4975 the
provision of certain ancillary services by a bank or similar financial
institution (as defined in Sec. 54.4975-6(b)(4)(i)) supervised by the
United States or a State to a plan for which it acts as a fiduciary if
the conditions in Sec. 54.4975-6(c)(2) are met. Such ancillary services
include services which do not meet the requirements of section
4975(d)(2), because the provision of such services involves an act
described in section 4975(c)(1)(E) (relating to fiduciaries dealing with
the income or assets of plans in their own interest or for their own
account) by the fiduciary bank or similar financial institution. Section
4975(d)(6) provides an exemption from section 4975(c)(1)(E), because
section 4975 (d)(6) contemplates the provision of such ancillary
services without the approval of a second fiduciary (as described in
Sec. 54.4975-6(a)(5)(ii)) if the conditions of Sec. 54.4975-6(c)(2)
are met. Thus, for example, plan assets held by a fiduciary bank which
are reasonably expected to be needed to satisfy current plan expenses
may be placed by the bank in a non-interest-bearing checking account in
the bank if the conditions of Sec. 54.4975-6(c)(2) are met,
notwithstanding the provisions of section 4975(d)(4) (relating to
investments in bank deposits). However, section 4975(d)(6) does not
provide an exemption for an act described in section 4975(c)(1)(F)
(relating to fiduciaries receiving consideration for their own personal
account from any party dealing with a plan in connection with a
transaction involving the income or assets of the plan). The receipt of
such consideration is a separate transaction not described in section
4975(d)(6).
Section 4975(d)(6) does not contain an exemption from other provisions
of the Code, such as section 401, or other provisions of law which may
impose requirements or restrictions relating to the transactions which
are exempt under section 4975(d)(6). See, for example, the general
fiduciary responsibility provisions of section 404 of the Act. The
provisions of section 4975(d)(6) are further limited by the flush
language at the end of section 4975(d) (relating to transactions with
owner-employees and related persons).
(2) Conditions. Such service must be provided:
(i) At not more than reasonable compensation;
(ii) Under adequate internal safeguards which assure that the
provision of such service is consistent with sound banking and financial
practice, as determined by Federal or State supervisory authority; and
(iii) Only to the extent that such service is subject to specific
guidelines issued by the bank or similar financial institution which
meet the requirements of Sec. 54.4975-6(c)(3).
[[Page 276]]
(3) Specific guidelines. [Reserved]
(d) Exemption for services as a fiduciary. [Reserved]
(e) Compensation for services--(1) In general. Section 4975(d)(2)
refers to the payment of reasonable compensation by a plan to a
disqualified person for services rendered to the plan. Section
4975(d)(10) and Sec. Sec. 54.4975-6(e)(2) through 54.4975-6(e)(5)
clarify what constitutes reasonable compensation for such services.
(2) General rule. Generally, whether compensation is ``reasonable''
under sections 4975(d) (2) and (10) depends on the particular facts and
circumstances of each case.
(3) Payments to certain fiduciaries. Under sections 4975(d) (2) and
(10), the term ``reasonable compensation'' does not include any
compensation to a fiduciary who is already receiving full-time pay from
an employer or association of employers (any of whose employees are
participants in the plan) or from an employee organization (any of whose
members are participants in the plan), except for the reimbursement of
direct expenses properly and actually incurred and not otherwise
reimbursed. The restrictions of this paragraph (e)(3) do not apply to a
disqualified person who is not a fiduciary.
(4) Certain expenses not direct expenses. An expense is not a direct
expense to the extent it would have been sustained had the service not
been provided or if it represents an allocable portion of overhead
costs.
(5) Expense advances. Under sections 4975(d) (2) and (10), the term
``reasonable compensation'', as applied to a fiduciary or an employee of
a plan, includes an advance to such a fiduciary or employee by the plan
to cover direct expenses to be properly and actually incurred by such
person in the performance of such person's duties with the plan if:
(i) The amount of such advance is reasonable with respect to the
amount of the direct expense which is likely to be properly and actually
incurred in the immediate future (such as during the next month); and
(ii) The fiduciary or employee accounts to the plan at the end of
the period covered by the advance for the expenses properly and actually
incurred.
(6) Excessive compensation. Under sections 4975(d) (2) and (10), any
compensation which would be considered excessive under Sec. 1.162-7
(relating to compensation for personal services which constitutes an
ordinary and necessary trade or business expense) will not be
``reasonable compensation''. Depending upon the facts and circumstances
of the particular situation, compensation which is not excessive under
Sec. 1.162-7 may, nevertheless, not be ``reasonable compensation''
within the meaning of sections 4975(d) (2) and (10).
[T.D. 7491, 42 FR 32385, June 24, 1977; 42 FR 37810, July 25, 1977; 43
FR 4604, Feb. 3, 1978]
Sec. 54.4975-7 Other statutory exemptions.
(a) [Reserved]
(b) Loans to employee stock ownership plans--(1) Definitions. When
used in this paragraph (b) and Sec. 54.4975-11, the terms listed below
have the following meanings:
(i) ESOP. The term ``ESOP'' refers to an employee stock ownership
plan that meets the requirements of section 4975(e)(7) and Sec.
54.4975-11. It is not synonymous with ``stock bonus plan.'' A stock
bonus plan must, however, be an ESOP to engage in an exempt loan. The
qualification of an ESOP under section 401(a) and Sec. 54.4975-11 will
not be adversely affected merely because it engages in a non-exempt
loan.
(ii) Loan. The term ``loan'' refers to a loan made to an ESOP by a
disqualified person or a loan to an ESOP which is guaranteed by a
disqualified person. It includes a direct loan of cash, a purchase-money
transaction, and an assumption of the obligation of an ESOP,
``Guarantee'' includes an unsecured guarantee and the use of assets of a
disqualified person as collateral for a loan, even though the use of
assets may not be a guarantee under applicable state law. An amendment
of a loan in order to qualify as an exempt loan is not a refinancing of
the loan or the making of another loan.
(iii) Exempt loan. The term ``exempt loan'' refers to a loan that
satisfies the provisions of this paragraph (b). A ``nonexempt loan'' is
one that fails to satisfy such provisions.
(iv) Publicly traded. The term ``publicly traded'' refers to a
security that
[[Page 277]]
is listed on a national securities exchange registered under section 6
of the Securities Exchange Act of 1934 (15 U.S.C. 78f) or that is quoted
on a system sponsored by a national securities association registered
under section 15A(b) of the Securities Exchange Act (15 U.S.C. 78o).
(v) Qualifying employer security. The term ``qualifying employer
security'' refers to a security described in Sec. 54.4975-12.
(2) Statutory exemption--(i) Scope. Section 4975(d)(3) provides an
exemption from the excise tax imposed under section 4975 (a) and (b) by
reason of section 4975(c)(1) (A) through (E). Section 4975(d)(3) does
not provide an exemption from the imposition of such tax by reason of
section 4975(c)(1)(F), relating to fiduciaries receiving consideration
for their own personal account from any party dealing with a plan in
connection with a transaction involving the income or assets of the
plan.
(ii) Special scrutiny of transaction. The exemption under section
4975(d)(3) includes within its scope certain transaction in which the
potential for self-dealing by fiduciaries exists and in which the
interests of fiduciaries may conflict with the interests of
participants. To guard against those potential abuses, the Internal
Revenue Service will subject these transactions to special scrutiny to
ensure that they are primarily for the benefit of participants and their
beneficiaries. Although the transactions need not be arranged and
approved by an independent fiduciary, fiduciaries are cautioned to
exercise scrupulously their discretion in approving them. For example,
fiduciaries should be prepared to demonstrate compliance with the net
effect test and the arm's-length standard under paragraph (b)(3)(ii) and
(iii) of this section. Also, fiduciaries should determine that the
transaction is truly arranged primarily in the interest of participants
and their beneficiaries rather than, for example, in the interest of
certain selling shareholders.
(3) Primary benefit requirement--(i) In general. An exempt loan must
be primarily for the benefit of the ESOP participants and their
beneficiaries. All the surrounding facts and circumstances, including
those described in paragraph (b) (3) (ii) and (iii) of this section,
will be considered in determining whether the loan satisfies this
requirement. However, no loan will satisfy the requirement unless it
satisfies the requirements of paragraph (b) (4), (5), and (6) of this
section.
(ii) Net effect on plan assets. At the time that a loan is made, the
interest rate for the loan and the price of securities to be acquired
with the loan proceeds should not be such that plan assets might be
drained off.
(iii) Arm's-length standard. The terms of a loan, whether or not
between independent parties, must, at the same time the loan is made, be
at least as favorable to the ESOP as the terms of a comparable loan
resulting from arm's-length negotiations between independent parties.
(4) Use of loan proceeds. The proceeds of an exempt loan must be
used within a reasonable time after their receipt by the borrowing ESOP
only for any or all of the following purposes:
(i) To acquire qualifying employer securities.
(ii) To repay such loan.
(iii) To repay a prior exempt loan. A new loan, the proceeds of
which are so used, must satisfy the provisions of this paragraph (b).
Except as provided in paragraph (b) (9) and (10) of this section or as
otherwise required by applicable law, no security acquired with the
proceeds of an exempt loan may be subject to a put, call, or other
option, or buy-sell or similar arrangement while held by and when
distributed from a plan, whether or not the plan is then an ESOP.
(5) Liability and collateral of ESOP for loan. An exempt loan must
be without recourse against the ESOP. Furthermore, the only assets of
the ESOP that may be given as collateral on an exempt loan are
qualifying employer securities of two classes: those acquired with the
proceeds of the loan and those that were used as collateral on a prior
exempt loan repaid with the proceeds of the current exempt loan. No
person entitled to payment under the exempt loan shall have any right to
assets of the ESOP other than:
(i) Collateral given for the loan,
(ii) Contributions (other than contributions of employers
securities) that
[[Page 278]]
are made under an ESOP to meet its obligations under the loan, and
(iii) Earnings attributable to such collateral and the investment of
such contributions.
The payments made with respect to an exempt loan by the ESOP during a
plan year must not exceed an amount equal to the sum of such
contributions and earnings received during or prior to the year less
such payments in prior years. Such contributions and earnings must be
accounted for separately in the books of account of the ESOP until the
loan is repaid.
(6) Default. In the event of default upon an exempt loan, the value
of plan assets transferred in satisfaction of the loan must not exceed
the amount of default. If the lender is a disqualified person, a loan
must provide for a transfer of plan assets upon default only upon and to
the extent of the failure of the plan to meet the payment schedule of
the loan. For purposes of this subparagraph (6), the making of a
guarantee does not make a person a lender.
(7) Reasonable rate of interest. The interest rate of a loan must
not be in excess of a reasonable rate of interest. All relevant factors
will be considered in determining a reasonable rate of interest,
including the amount and duration of the loan, the security and
guarantee (if any) involved, the credit standing of the ESOP and the
guarantor (if any), and the interest rate prevailing for comparable
loans. When these factors are considered, a variable interest rate may
be reasonable.
(8) Release from encumbrance--(i) General rule. In general, an
exempt loan must provide for the release from encumbrance under this
subdivision (i) of plan assets used as collateral for the loan. For each
plan year during the duration of the loan, the number of securities
released must equal the number of encumbered securities held immediately
before release for the current plan year multiplied by a fraction. The
numerator of the fraction is the amount of principal and interest paid
for the year. The denominator of the fraction is the sum of the
numerator plus the principal and interest to be paid for all future
years. See Sec. 54.4975-7(b) (8) (iv). The number of future years under
the loan must be definitely ascertainable and must be determined without
taking into account any possible extensions or renewal periods. If the
interest rate under the loan is variable, the interest to be paid in
future years must be computed by using the interest rate applicable as
of the end of the plan year. If collateral includes more than one class
of securities, the number of securities of each class to be released for
a plan year must be determined by applying the same fraction to each
class.
(ii) Special rule. A loan will not fail to be exempt merely because
the number of securities to be released from encumbrance is determined
solely with reference to principal payments. However, if release is
determined with reference to principal payments only, the following
three additional rules apply. The first rule is that the loan must
provide for annual payments of principal and interest at a cumulative
rate that is not less rapid at any time than level annual payments of
such amounts for 10 years. The second rule is that interest included in
any payment is disregarded only to the extent that it would be
determined to be interest under standard loan amoritization tables. The
third rule is that this subdivision, (ii) is not applicable from the
time that, by reason of a renewal, extension, or refinancing, the sum of
the expired duration of the exempt loan, the renewal period, the
extension period, and the duration of a new exempt loan exceeds 10
years.
(iii) Caution against plan disqualification. Under an exempt loan,
the number of securities released from encumbrance may vary from year to
year. The release of securities depends upon certain employer
contributions and earnings under the ESOP. Under Sec. 54.4975-11(d)(2)
actual allocations to participants' accounts are based upon assets
withdrawn from the suspense account. Nevertheless, for purposes of
applying the limitations under section 415 to these allocations, under
Sec. 54.4975-11(a)(8)(ii) contributions used by the ESOP to pay the
loan are treated as annual additions to participants' accounts.
Therefore, particular caution must be exercised to avoid exceeding the
maximum annual additions under section 415. At the same time, release
[[Page 279]]
from encumbrance in annual varying numbers may reflect a failure on the
part of the employer to make substantial and recurring contributions to
the ESOP which will lead to loss of qualification under section 401(a).
The Internal Revenue Service will observe closely the operation of
ESOP's that release encumbered securities in varying annual amounts,
particularly those that provide for the deferral of loan payments or for
balloon payments.
(iv) Illustration. The general rule under paragraph (b)(8)(i) of
this section operates as illustrated in the following example:
Example. Corporation X establishes an ESOP that borrows $750,000
from a bank. X guarantees the loan, which is for 15 years at 5% interest
and is payable in level annual amounts of $72,256.72. Total payments on
the loan are $1,083,850.80. The ESOP uses the entire loan proceeds to
acquire 15,000 shares of X stock which is used as collateral for the
loan. The number of securities to be released for the first year is
1,000 shares, i.e., 15,000 shares x $72,256.72/$1,083,850.80 = 15,000
shares x 1/15. The number of securities to be released for the second
year is 1,000 shares, i.e., 14,000 shares x $72,256.72/$1,011,594.08 =
14,000 shares x 1/14. If all loan payments are made as originally
scheduled, the number of securities released in each succeeding year of
the loan will also be 1,000.
(9) Right of first refusal. Qualifying employer securities acquired
with proceeds of an exempt loan may, but need not, be subject to a right
of first refusal. However, any such right must meet the requirements of
this subparagraph (9). Securities subject to such right must be stock or
an equity security, or a debt security convertible into stock or an
equity security. Also, the securities must not be publicly traded at the
time the right may be exercised. The right of first refusal must be in
favor of the employer, the ESOP, or both in any order of priority. The
selling price and other terms under the right must not be less favorable
to the seller than the greater of the value of the security determined
under Sec. 54.4975-11(d)(5), or the purchase price and other terms
offered by a buyer, other than the employer or the ESOP, making a good
faith offer to purchase the security. The right of first refusal must
lapse no later than 14 days after the security holder gives written
notice to the holder of the right that an offer by a third party to
purchase the security has been received.
(10) Put option. A qualifying employer security acquired with the
proceeds of an exempt loan by an ESOP after September 30, 1976, must be
subject to a put option if it is not publicly traded when distributed or
if it is subject to a trading limitation when distributed. For purposes
of subparagraph (10), a ``trading limitation'' on a security is a
restriction under any Federal or state securities law, any regulation
thereunder, or an agreement, not prohibited by this paragraph (b),
affecting the security which would make the security not as freely
tradable as one not subject to such restriction. The put option must be
exercisable only by a participant, by the participant's donees, or by a
person (including an estate or its distributee) to whom the security
passes by reason of a participant's death. (Under this subparagraph
(10), participant means a participant and beneficiaries of the
participant under the ESOP.) The put option must permit a participant to
put the security to the employer. Under no circumstances may the put
option bind the ESOP. However, it may grant the ESOP an option to assume
the rights and obligations of the employer at the time that the put
option is exercised. If it is known at the time a loan is made that
Federal or state law will be violated by the employer's honoring such
put option, the put option must permit the security to be put, in a
manner consistent with such law, to a third party (e.g., an affiliate of
the employer or a shareholder other than the ESOP) that has substantial
net worth at the time the loan is made and whose net worth is reasonably
expected to remain substantial.
(11) Duration of put option--(i) General rule. A put option must be
exercisable at least during a 15-month period which begins on the date
the security subject to the put option is distributed by the ESOP.
(ii) Special rule. In the case of a security that is publicly traded
without restriction when distributed but ceases to be so traded within
15 months after distribution, the employer must notify each security
holder in writing on or before the tenth day after the date the
[[Page 280]]
security ceases to be so traded that for the remainder of the 15-month
period the security is subject to a put option. The number of days
between such tenth day and the date on which notice is actually given,
if later than the tenth day, must be added to the duration of the put
option. The notice must inform distributees of the terms of the put
options that they are to hold. Such terms must satisfy the requirements
of paragraph (b) (10) through (12) of this section.
(12) Other put option provisions--(i) Manner of exercise. A put
option is exercised by the holder notifying the employer in writing that
the put option is being exercised.
(ii) Time excluded from duration of put option. The period during
which a put option is exercisable does not include any time when a
distributee is unable to exercise it because the party bound by the put
option is prohibited from honoring it by applicable Federal or state
law.
(iii) Price. The price at which a put option must be exercisable is
the value of the security, determined under Sec. 54.4975-11(d)(5).
(iv) Payment terms. The provisions for payment under a put option
must be reasonable. The deferral of payment is reasonable if adequate
security and a reasonable interest rate are provided for any credit
extended and if the cumulative payments at any time are no less than the
aggregate of reasonable periodic payments as of such time. Periodic
payments are reasonable if annual installments, beginning with 30 days
after the date the put option is excercised, are substantially equal.
Generally, the payment period may not end more than 5 years after the
date the put option is exercised. However, it may be extended to a date
no later than the earlier of 10 years from the date the put option is
exercised or the date the proceeds of the loan used by the ESOP to
acquire the security subject to the put option are entirely repaid.
(v) Payment restrictions. Payment under a put option may be
restricted by the terms of a loan, including one used to acquire a
security subject to a put option made before November 1, 1977.
Otherwise, payment under a put option must not be restricted by the
provisions of a loan or any other arrangement, including the terms of
the employer's articles of incorporation, unless so required by
applicable state law.
(13) Other terms of loan. An exempt loan must be for a specific
term. Such loan may not be payable at the demand of any person, except
in the case of default.
(14) Status of plan as ESOP. To be exempt, a loan must be made to a
plan that is an ESOP at the time of such loan. However, a loan to a plan
formally designated as an ESOP at the time of the loan that fails to be
an ESOP because it does not comply with section 401(a) of the Code or
Sec. 54.4975-11 will be exempt as of the time of such loan if the plan
is amended retroactively under section 401(b) or Sec. 54.4975-11(a)(4).
(15) Special rules for certain loans--(i) Loans made before January
1, 1976. A loan made before January 1, 1976, or made afterwards under a
binding agreement in effect on January 1, 1976 (or under renewals
permitted by the terms of the agreement on that date) is exempt for the
entire period of the loan if it otherwise satisfies the provisions of
this paragraph (b) for such period, even though it does not satisfy the
following provisions of this section: the last sentence of paragraph (b)
(4) and all of paragraph (b) (5), (6), (8) (i) and (ii), and (9) through
(13), inclusive.
(ii) Loans made after December 31, 1975, but before November 1,
1977. A loan made after December 31, 1975, but before November 1, 1977
or made afterwards under a binding agreement in effect on November 1,
1977 (or under renewals permitted by the terms of the agreement on that
date) is exempt for the entire period of the loan if it otherwise
satisfies the provisions of this paragraph (b) for such period even
though it does not satisfy the following provisions of this section:
paragraph (b) (6) and (9) and the three additional rules listed in
paragraph (b) (8) (ii).
(iii) Release rule. Notwithstanding paragraph (b) (15) (i) and (ii)
of this section, if the proceeds of a loan are used to acquire
securities after November 1, 1977, the loan must comply by such
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date with the provisions of paragraph (b) (8) of this section.
(iv) Default rule. Notwithstanding paragraph (b) (15) (i) and (ii)
of this section, a loan by a disqualified person other than a guarantor
must meet the requirements of paragraph (b) (6) of this section. A loan
will meet these requirements if it is retroactively amended before
November 1, 1977 to meet these requirements.
(v) Put option rule. With respect to a security distributed before
November 1, 1977, the put option provisions of paragraph (b) (10), (11),
and (12) of this section will be deemed satisfied as of the date the
security is distributed if by December 31, 1977, the security is subject
to a put option satisfying such provisions, the security is subject to a
put option satisfying such provisions. For purposes of satisfying such
provisions, the security will be deemed distributed on the date the put
option is issued. However, the put option provisions need not be
satisfied with respect to a security that is not owned on November 1,
1977, by a person in whose hands a put option must be exercisable.
(Sec. 4975 (e) (7), (88 Stat. 976; 26 U.S.C. 4975 (e) (7)))
[T.D. 7506, 42 FR 44391, Sept. 2, 1977]
Sec. 54.4975-9 Definition of ``fiduciary''.
(a)-(b) [Reserved]
(c) Investment advice. (1) A person shall be deemed to be rendering
``investment advice'' to an employee benefit plan, within the meaning of
section 4975(e)(3)(B) and this paragraph, only if:
(i) Such person renders advice to the plan as to the value of
securities or other property, or makes recommendations as to the
advisability of investing in, purchasing, or selling securities or other
property; and
(ii) Such person either directly or indirectly (e.g., through or
together with any affiliate):
(A) Has discretionary authority or control, whether or not pursuant
to agreement, arrangement or understanding, with respect to purchasing
or selling securities or other property for the plan; or
(B) Renders any advice described in paragraph (c)(1)(i) of this
section on a regular basis to the plan pursuant to a mutual agreement,
arrangement or understanding, written or otherwise, between such person
and the plan or a fiduciary with respect to the plan, that such services
will serve as a primary basis for investment decisions with respect to
plan assets, and that such person will render individualized investment
advice to the plan based on the particular needs of the plan regarding
such matters as, among other things, investment policies or stategy,
overall portfolio composition, or diversification of plan investments.
(2) A person who is a fiduciary with respect to a plan by reason of
rendering investment advice (as defined in paragraph (c)(1) of this
section) for a fee or other compensation, direct or indirect, with
respect to any moneys or other property of such plan, or having any
authority or responsibility to do so, shall not be deemed to be a
fiduciary regarding any assets of the plan with respect to which such
person does not have any discretionary authority, discretionary control
or discretionary responsibility, does not exercise any authority or
control, does not render investment advice (as defined in paragraph
(c)(1) of this section) for a fee or other compensation, and does not
have any authority or responsibility to render such investment advice,
provided that nothing in this paragraph shall be deemed to:
(i) Exempt such person from the provisions of section 405(a) of the
Employee Retirement Income Security Act of 1974 concerning liability for
fiduciary breaches by other fiduciaries with respect to any assets of
the plan; or
(ii) Exclude such person from the definition of the term
disqualified person (as set forth in section 4975(e)(2)) with respect to
any assets of the plan.
(d) Execution of securities transactions. (1) A person who is a
broker or dealer registered under the Securities Exchange Act of 1934, a
reporting dealer who makes primary markets in securities of the United
States Government or of an agency of the United States Government and
reports daily to the Federal Reserve Bank of New York its positions with
respect to such securities and borrowings thereon, or a bank supervised
by the United States or a
[[Page 282]]
State, shall not be deemed to be a fiduciary, within the meaning of
section 4975(e)(3), with respect to an employee benefit plan solely
because such person executes transactions for the purchase or sale of
securities on behalf of such plan in the ordinary course of its business
as a broker, dealer, or bank, pursuant to instructions of a fiduciary
with respect to such plan, if:
(i) Neither the fiduciary nor any affiliate of such fiduciary is
such broker, dealer, or bank; and
(ii) The instructions specify (A) the security to be purchased or
sold, (B) a price range within which such security is to be purchased or
sold, or, if such security is issued by an open-end investment company
registered under the Investment Company Act of 1940 (15 U.S.C. 80a-1, et
seq.), a price which is determined in accordance with Rule 22c-1 under
the Investment Company Act of 1940 (17 CFR 270.22c-1), (C) a time span
during which such security may be purchased or sold (not to exceed five
business days), and (D) the minimum or maximum quantity of such security
which may be purchased or sold within such price range, or, in the case
of security issued by an open-end investment company registered under
the Investment Company Act of 1940, the minimum or maximum quantity of
such security which may be purchased or sold, or the value of such
security in dollar amount which may be purchased or sold, at the price
referred to in paragraph (d)(1)(ii)(B) of this section.
(2) A person who is a broker-dealer, reporting dealer, or bank which
is a fiduciary with respect to an employee benefit plan solely by reason
of the possession or exercise of discretionary authority or
discretionary control in the management of the plan or the management or
disposition of plan assets in connection with the execution of a
transaction or transactions for the purchase or sale of securities on
behalf of such plan which fails to comply with the provisions of
paragraph (d)(1) of this section, shall not be deemed to be a fiduciary
regarding any assets of the plan with respect to which such broker-
dealer, reporting dealer or bank does not have any discretionary
authority, discretionary control or discretionary responsibility, does
not exercise any authority or control, does not render investment advice
(as defined in paragraph (c)(1) of this section) for a fee or other
compensation, and does not have any authority or responsibility to
render such investment advice, provided that nothing in this paragraph
shall be deemed to:
(i) Exempt such broker-dealer, reporting dealer, or bank from the
provisions of section 405(a) of the Employee Retirement Income Security
Act of 1974 concerning liability for fiduciary breaches by other
fiduciaries with respect to any assets of the plan; or
(ii) Exclude such broker-dealer, reporting dealer, or bank from the
definition of the term disqualified person (as set forth in section
4975(e)(2)) with respect to any assets of the plan.
(e) Affiliate and control. (1) For purposes of paragraphs (c) and
(d) of this section, an ``affiliate'' of a person shall include:
(i) Any person directly or indirectly, through one or more
intermediaries, controlling, controlled by, or under common control with
such person;
(ii) Any officer, director, partner, employee or relative (as
defined in section 4975(e)(6)) of such person; and
(iii) Any corporation or partnership of which such person is an
officer, director or partner.
(2) For purposes of this paragraph, the term control means the power
to exercise a controlling influence over the management or policies of a
person other than an individual.
[T.D. 7386, 40 FR 50841, Oct. 31, 1975]
Sec. 54.4975-11 ``ESOP'' requirements.
(a) In general--(1) Type of plan. To be an ``ESOP'' (employee stock
ownership plan), a plan described in section 4975(e)(7)(A) must meet the
requirements of this section. See section 4975(e)(7)(B).
(2) Designation as ESOP. To be an ESOP, a plan must be formally
designated as such in the plan document.
(3) Continuing loan provisions under plan--(i) Creation of
protections and rights. The terms of an ESOP must formally provide
participants with certain protections and rights with respect to plan
assets acquired with the proceeds of an exempt loan. These protections
and rights are those referred to in the
[[Page 283]]
third sentence of Sec. 54.4975-7(b)(4), relating to put, call, or other
options and to buy-sell or similar arrangements, and in Sec. 54.4975-
7(b) (10), (11), and (12), relating to put options.
(ii) ``Nonterminable'' protections and rights. The terms of an ESOP
must also formally provide that these protections and rights are
nonterminable. Thus, if a plan holds or has distributed securities
acquired with the proceeds of an exempt loan and either the loan is
repaid or the plan ceases to be an ESOP, these protections and rights
must continue to exist under the terms of the plan. However, the
protections and rights will not fail to be nonterminable merely because
they are not exercisable under Sec. 54.4975-7(b) (11) and (12)(ii). For
example, if, after a plan ceases to be an ESOP, securities acquired with
the proceeds of an exempt loan cease to be publicly traded, the 15-month
period prescribed by Sec. 54.4975-7(b)(11) includes the time when the
securities are publicly traded.
(iii) No incorporation by reference of protections and rights. The
formal requirements of paragraph (a)(3) (i) and (ii) of this section
must be set forth in the plan. Mere reference to the third sentence of
Sec. 54.4975-7(b)(4) and to the provisions of Sec. 54.4975-7(b) (10),
(11), and (12) is not sufficient.
(iv) Certain remedial amendments. Notwithstanding the limits under
paragraph (a) (4) and (10) of this section on the retroactive effect of
plan amendments, a remedial plan amendment adopted before December 31,
1979, to meet the requirements of paragraph (a)(3) (i) and (ii) of this
section is retroactively effective as of the later of the date on which
the plan was designated as an ESOP or November 1, 1977.
(4) Retroactive amendment. A plan meets the requirements of this
section as of the date that it is designated as an ESOP if it is amended
retroactively to meet, and in fact does meet, such requirements at any
of the following times:
(i) 12 months after the date on which the plan is designated as an
ESOP;
(ii) 90 days after a determination letter is issued with respect to
the qualification of the plan as an ESOP under this section, but only if
the determination is requested by the time in paragraph (a)(4)(i) of
this section; or
(iii) A later date approved by the district director.
(5) Addition to other plan. An ESOP may form a portion of a plan the
balance of which includes a qualified pension, profit-sharing, or stock
bonus plan which is not an ESOP. A reference to an ESOP includes an ESOP
that forms a portion of another plan.
(6) Conversion of existing plan to an ESOP. If an existing pension,
profit-sharing, or stock bonus plan is converted into an ESOP, the
requirements of section 404 of the Employee Retirement Income Security
Act of 1974 (ERISA) (88 Stat. 877), relating to fiduciary duties, and
section 401(a) of the Code, relating to requirements for plans
established for the exclusive benefit of employees, applying to such
conversion. A conversion may constitute a termination of an existing
plan. For definition of a termination, see the regulations under section
411(d)(3) of the Code and section 4041(f) of ERISA.
(7) Certain arrangements barred--(i) Buy-sell agreements. An
arrangement involving an ESOP that creates a put option must not provide
for the issuance of put options other than as provided under Sec.
54.4975-7(b) (10), (11) and (12). Also, an ESOP must not otherwise
obligate itself to acquire securities from a particular security holder
at an indefinite time determined upon the happening of an event such as
the death of the holder.
(ii) Integrated plans. A plan designated as an ESOP after November
1, 1977, must not be integrated directly or indirectly with
contributions or benefits under title II of the Social Security Act or
any other State or Federal law. ESOP's established and integrated before
such date may remain integrated. However, such plans must not be amended
to increase the integration level or the integration percentage. Such
plans may in operation continue to increase the level of integration if
under the plan such increase is limited by reference to a criterion
existing apart from the plan.
(8) Effect of certain ESOP provisions on section 401(a) status--(i)
Exempt loan requirements. An ESOP will not fail to
[[Page 284]]
meet the requirements of section 401(a)(2) merely because it gives plan
assets as collateral for an exempt loan under Sec. 54.4975-7(b)(5) or
uses plan assets under Sec. 54.4975-7(b)(6) to repay and exempt loan in
the event of default.
(ii) Individual annual contribution limitation. An ESOP will not
fail to meet the requirements of section 401(a)(16) merely because
annual additions under section 415(c) are calculated with respect to
employer contributions used to repay an exempt loan rather than with
respect to securities allocated to participants.
(iii) Income pass-through. An ESOP will not fail to meet the
requirements of section 401(a) merely because it provides for the
current payment of income under paragraph (f)(3) of this section.
(9) Transitional rules for ESOP's established before November 1,
1977. A plan established before November 1, 1977 that otherwise
satisfies the provisions of this section constitutes an ESOP if it is
amended by December 31, 1977, to comply from November 1, 1977 with this
section even though before November 1, 1977 the plan did not satisfy
paragraphs (c) and (d) (2), (4), and (5) of this section.
(10) Additional transitional rules. Notwithstanding paragraph (a)(9)
of this section, a plan established before November 1, 1977, that
otherwise satisfies the provisions of this section constitutes an ESOP
if by December 31, 1977, it is amended to comply from November 1, 1977,
with this section even though before such date the plan did not satisfy
the following provisions of this section:
(i) Paragraph (a) (3) and (8) (iii);
(ii) The last sentence of paragraph (d)(3); and
(iii) Paragraph (f)(3).
(b) Plan designed to invest primarily in qualifying employer
securities. A plan constitutes an ESOP only if the plan specifically
states that it is designed to invest primarily in qualifying employer
securities. Thus, a stock bonus plan or a money purchase pension plan
constituting an ESOP may invest part of its assets in other than
qualifying employer securities. Such plan will be treated the same as
other stock bonus plans or money purchase pension plans qualified under
section 401a with respect to those investments.
(c) Suspense account. All assets acquired by an ESOP with the
proceeds of an exempt loan under section 4975(d)(3) must be added to and
maintained in a suspense account. They are to be withdrawn from the
suspense account by applying Sec. 54.4975-7(b) (8) and (15) as if all
securities in the suspense account were encumbered. Such assets acquired
before November 1, 1977, must be withdrawn by applying Sec. 54.4975-
7(b)(8) or the provision of the loan that controls release from
encumbrance. Assets in such suspense accounts are assets of the ESOP.
Thus, for example, such assets are subject to section 401(a)(2).
(d) Allocations to accounts of participants--(1) In general. Except
as provided in this section, amounts contributed to an ESOP must be
allocated as provided under Sec. 1.401-1(b)(ii) and (iii) of this
chapter, and securities acquired by an ESOP must be accounted for as
provided under Sec. 1.402(a)-1(b)(2)(ii) of this chapter.
(2) Assets withdrawn from suspense account. As of the end of each
plan year, the ESOP must consistently allocate to the participants'
accounts non-monetary units representing participants' interests in
assets withdrawn from the suspense account.
(3) Income. Income with respect to securities acquired with the
proceeds of an exempt loan must be allocated as income of the plan
except to the extent that the ESOP provides for the use of income from
such securities to repay the loan. Certain income may be distributed
currently under paragraph (f)(3) of this section.
(4) Forfeitures. If a portion of a participant's account is
forfeited, qualifying employer securities allocated under paragraph
(d)(2) of this section must be forfeited only after other assets. If
interests in more than one class of qualifying employer securities have
been allocated to the participant's account, the participant must be
treated as forfeiting the same proportion of each such class.
(5) Valuation. For purposes of Sec. 54.4975-7(b) (9) and (12) and
this section, valuations must be made in good faith and based on all
relevant factors for determining the fair market value
[[Page 285]]
of securities. In the case of a transaction between a plan and a
disqualified person, value must be determined as of the date of the
transaction. For all other purposes under this subparagraph (5), value
must be determined as of the most recent valuation date under the plan.
An independent appraisal will not in itself be a good faith
determination of value in the case of a transaction between a plan and a
disqualified person. However, in other cases, a determination of fair
market value based on at least an annual appraisal independently arrived
at by a person who customarily makes such appraisals and who is
independent of any party to a transaction under Sec. 54.4975-7(b) (9)
and (12) will be deemed to be a good faith determination of value.
(e) Multiple plans--(1) General rule. An ESOP may not be considered
together with another plan for purposes of applying section 401(a) (4)
and (5) or section 410(b) unless:
(i) The ESOP and such other plan exist on November 1, 1977, or
(ii) Paragraph (e)(2) of this section is satisfied.
(2) Special rule for combined ESOP's. Two or more ESOP's, one or
more of which does not exist on November 1, 1977, may be considered
together for purposes of applying section 401(a) (4) and (5) or section
410(b) only if the proportion of qualifying employer securities to total
plan assets is substantially the same for each ESOP and:
(i) The qualifying employer securities held by all ESOP's are all of
the same class; or
(ii) The ratios of each class held to all such securities held is
substantially the same for each plan.
(3) Amended coverage, contribution, or benefit structure. For
purposes of paragraph (e)(1)(i) of this section, if the coverage,
contribution, or benefit structure of a plan that exists on November 1,
1977 is amended after that date, as of the effective date of the
amendment, the plan is no longer considered to be a plan that exists on
November 1, 1977.
(f) Distribution--(1) In general. Except as provided in paragraph
(f) (2) and (3) of this section, with respect to distributions, a
portion of an ESOP consisting of stock bonus plan or a money purchase
pension plan is not to be distinguished from other such plans under
section 401(a). Thus, for example, benefits distributable from the
portion of an ESOP consisting of a stock bonus plan are distributable
only in stock of the employer. Also, benefits distributable from the
money-purchase portion of the ESOP may be, but are not required to be,
distributable in qualifying employer securities.
(2) Exempt loan proceeds. If securities acquired with the proceeds
of an exempt loan available for distribution consist of more than one
class, a distributee must receive substantially the same proportion of
each such class. However, as indicated in paragraph (f)(1) of this
section, benefits distributable from the portion of an ESOP consisting
of a stock bonus plan are distributable only in stock of the employer.
(3) Income. Income paid with respect to qualifying employer
securities acquired by an ESOP in taxable years beginning after December
31, 1974, may be distributed at any time after receipt by the plan to
participants on whose behalf such securities have been allocated.
However, under an ESOP that is a stock bonus plan, income held by the
plan for a 2-year period or longer must be distributed under the general
rules described in paragraph (f)(1) of this section. (See the last
sentence of section 803(h), Tax Reform Act of 1976.)
(Sec. 4975(e)(7), (88 Stat. 976; 26 U.S.C. 4975(e)(7)))
[T.D. 7506, 42 FR 44393, Sept. 2, 1977, as amended by T.D. 7571, 44 FR
1978, Jan. 9, 1979]
Sec. 54.4975-12 Definition of the term ``qualifying employer security''.
(a) In general. For purposes of section 4975(e)(8) and this section,
the term ``qualifying employer security'' means an employer security
which is:
(1) Stock or otherwise an equity security, or
(2) A bond, debenture, note, or certificate or other evidence of
indebtedness which is described in paragraphs (1), (2), and (3) of
section 503(e).
(b) Special rule. In determining whether a bond, debenture, note, or
certificate or other evidence of indebtedness is described in paragraphs
(1),
[[Page 286]]
(2), and (3) of section 503(e), any organization described in section
401(a) shall be treated as an organization subject to the provisions of
section 503.
(Sec. 4975(e)(7) (88 Stat. 976; 26 U.S.C. 4975(e)(7)))
[T.D. 7506, 42 FR 44394, Sept. 2, 1977]
Sec. 54.4975-14 Election to pay an excise tax for certain pre-1975 prohibited transactions.
(a) In general. Section 2003(c)(1)(B) of the Employee Retirement
Income Security Act of 1974 (88 Stat. 978) provides an election to pay
an excise tax by certain persons involved prior to 1975 in prohibited
transactions within the meaning of section 503 (b) or (g).
(b) Effect of election. If a valid election is made under this
section with respect to a particular transaction, any loss of exemption
under section 501(a) because of a prohibited transaction within the
meaning of section 503 (b) or (g) shall not apply. Instead, the person
who made the election referred to in this section shall be subject to
the taxes which would have been imposed by section 4975 (a) or (b) as
though section 4975 had imposed a tax in respect of the transaction.
(However, section 4975(f)(1), relating to joint and several liability,
shall not apply to any person who has not made an election under this
section, and interest for late payment of tax shall not begin to accrue
until after the date of the election.) Such an election is irrevocable.
However, the making of the election does not affect the application of
section 6501 for purposes of assessment and collection of tax and
section 6511 for purposes of filing a claim for credit or refund with
respect to taxpayers and to taxable years of taxpayers whose tax
liability is or may be affected by reason of the nonapplication of a
denial of exempt status.
(c) Method of election. A person shall make the election referred to
in this section by filing the form issued for such purpose by the
Internal Revenue Service, including therein the information required by
such form and the instructions issued with respect thereto, and by
paying the tax which the taxpayer indicates is due at the time the
return is filed. To be valid the election must be made prior to the
later of December 6, 1976, or 120 days after the date of notification
referred to in Sec. 1.503(a)-1(b) of this chapter (Income Tax
Regulations), relating to loss of exemption for certain prohibited
transactions. If there has been no notification of loss of exemption,
the election may be made at any time. However, these limitations do not
preclude an agreement between the disqualified person and the district
director to extend the time within which the election is permitted.
(d) Computation of section 4975 excise tax. To the extent
applicable, and solely for purposes associated with the payment of a
section 4975 excise tax under the election referred to in this section,
Sec. 53.4941(e)-1 of this chapter (Foundation Excise Tax Regulations)
is controlling.
(Sec. 2003(c)(1)(B) of the Employee Retirement Income Security Act of
1974 (88 Stat. 978))
[T.D. 7489, 42 FR 27882, June 1, 1977]
Sec. 54.4975-15 Other transitional rules.
(a)-(c) [Reserved]
(d) Provision of certain services until June 30, 1977--(1) In
general. Section 2003(c)(2)(D) of the Employee Retirement Income
Security Act of 1974 (the Act) (88 Stat. 979) provides that section 4975
shall not apply to the provision of services before June 30, 1977,
between a plan and a disqualified person if the three requirements
contained in section 2003(c)(2)(D) of the Act are met. The first
requirement is that such services must be provided either (in) under a
binding contract in effect on July 1, 1974 (or pursuant to a renewal or
modification of such contract); or (ii) by a disqualified person who
ordinarily and customarily furnished such services on June 30, 1974. The
second requirement is that the services be provided on terms that remain
at least as favorable to the plan as an arm's-length transaction with an
unrelated party would be.
For this purpose, such services are provided on terms that remain at
least as favorable to the plan as an arms-length transaction with an
unrelated party would be if, at the time of execution (or renewal) of
such binding contract, the contract (or renewal) is on terms at
[[Page 287]]
least as favorable to the plan as an arm's-length transaction with an
unrelated party would be. However, if in a normal commercial setting an
unrelated party in the position of the plan could be expected to insist
upon a renegotiation or termination of a binding contract, the plan must
so act. Thus, for example, if a disqualified person provides services to
a plan on a month-to-month basis, and a party in the position of the
plan could be expected to renegotiate the price paid under such contract
because of a decline in the fair market value of such services, the plan
must so act in order to avoid participation in a prohibited transaction.
The third requirement is that the provision of services must not be, or
have been, at the time of such provision a prohibited transaction within
the meaning of section 503(b) or the corresponding provisions of prior
law. If these three requirements are met, section 4975 will apply
neither to services provided before June 30, 1977 (both to customers to
whom such services were being provided on June 30, 1974, and to new
customers) nor to the receipt of compensation therefor. Thus, if these
three requirements are met, section 4975 will not apply until June 30,
1977, to the provision of services to a plan by a disqualified person
(including a fiduciary) even if such services could not be furnished
pursuant to the exemption provisions of sections 4975(d)(2) or (6) and
Sec. 54.4975-6. For example, if the three requirements of section
2003(c)(2)(D) of the Act are met, a person serving as fiduciary to a
plan who already receives full-time pay from an employer or an
association of employers, whose employees are participants in such plan,
or from an employee organization whose members are participants in such
plan, may continue to receive reasonable compensation from the plan for
services rendered to the plan before June 30, 1977. Similarly, until
June 30, 1977, a plan consultant who may be a fiduciary because of the
nature of the consultative and administrative services being provided
may, if these three requirements are met, continue to cause the sale of
insurance to the plan and continue to receive commissions for such sales
from the insurance company writing the policy. Further, if the three
requirements of section 2003 (c)(2)(D) of the Act are met, a securities
broker dealer who renders investment advice to a plan for a fee, thereby
becoming a fiduciary may furnish other services to the plan, such as
brokerage services, and receives compensation therefor. Also, if a
registered representative of such a broker-dealer were a fiduciary, the
registered representative may receive compensation, including
commissions, for brokerage services performed before June 30, 1977.
(2) Persons deemed to be June 30, 1974, service providers. A
disqualified person with respect to a plan which did not, on June 30,
1974, ordinarily and customarily furnish a particular service, will
nevertheless be considered to have ordinarily and customarily furnished
such service on June 30, 1974, for purposes of this section and section
2003(c)(2)(D) of the Act, if either of the following conditions are met:
(i) At least 50 percent of the outstanding beneficial interests of
such disqualified person are owned directly or through one or more
intermediaries by the same person or persons who owned, directly or
through one or more intermediaries, at least 50 percent of the
outstanding beneficial interests of a person who ordinarily and
customarily furnished such service on June 30, 1974; or
(ii) Control, or the power to exercise a controlling influence over
the management and policies of such disqualified person is possessed,
directly or through one or more intermediaries, by the same person or
persons who possessed directly or through one or more intermediaries
control, or the power to exercise a controlling influence over the
management and policies of a person who ordinarily and customarily
furnished such service on June 30, 1974. For purposes of this paragraph
(d)(2) a person shall be deemed to be an ``intermediary'' of another
person if at least 50 percent of the outstanding beneficial interests of
such person are owned by such other person, directly or indirectly, or
if such other person controls or has the power to exercise a controlling
influence over the management and policies of such person.
[[Page 288]]
(3) Examples. The principals of Sec. 54.4975-15(d)(2) may be
illustrated by the following examples.
Example 1. A owns 50 percent of the outstanding beneficial interests
of ABC Partnership which ordinarily and customarily furnished certain
services on June 30, 1974. On July 2, 1974, ABC Partnership was
incorporated into ABC Corporation with one class of stock outstanding. A
owns 50 percent of the shares of such stock. ABC Corporation furnishes
the same services that were furnished by ABC Partnership on June 30,
1974. ABC Corporation will be deemed to have ordinarily and customarily
furnished such services on June 30, 1974, for purposes of section
2003(c)(2)(D) of the Act.
Example 2. A and B together own 100 percent of the beneficial
interests of AB Partnership, which ordinarily and customarily furnished
certain services on June 30, 1974. On September 1, 1974, AB Partnership
was incorporated into AB Corporation with one class of stock
outstanding. A and B each own 20 percent of such outstanding class of
stock and together have control over the management and policies of AB
Corporation. AB Corporation furnishes the same services that were
furnished by AB Partnership on June 30, 1974. AB Corporation will be
deemed to have ordinarily and customarily furnished such services on
June 30, 1974, for purposes of section 2003(c)(2)(D) of the Act.
Example 3. On June 30, 1974, M Corporation was ordinarily and
customarily furnishing certain services. On that date, X, Y and Z
together owned 50 percent of all classes of the outstanding shares of M
Corporation. On January 28, 1975, all of the shareholders of M
Corporation exchanged their shares in M Corporation for shares of a new
N Corporation. As a result of that exchange, X, Y and Z together own 50
percent of the common stock of N Corporation, the only class of N
Corporation stock outstanding after the exchange. N Corporation
furnishes the services formerly furnished by M Corporation. N
Corporation will be deemed to have ordinarily and customarily furnished
such services on June 30, 1974, for purposes of section 2003(c)(2)(D) of
the Act.
Example 4. I Corporation ordinarily and customarily furnished
certain services on June 30, 1974. On November 3, 1975, I Corporation
organizes a wholly owned subsidiary, S Corporation, which furnishes the
same services ordinarily and customarily furnished by I Corporation on
June 30, 1974. S Corporation will be deemed to have ordinarily and
customarily furnished such services on June 30, 1974, for purposes of
section 2003(c)(2)(D) of the Act.
Example 5. X Corporation, wholly-owned and controlled by A,
ordinarily and customarily furnished certain services on June 30, 1974.
Y Corporation did not perform such services on that date. On January 2,
1976, X Corporation is merged into Y Corporation and although A received
less than 50 percent of the total outstanding shares of Y Corporation,
after such merger A has control over the management and policies of Y
Corporation. Y Corporation furnishes the same services that were
formerly furnished by X Corporation. Y Corporation will be deemed to
have ordinarily and customarily furnished such services on June 30,
1974, for purposes of section 2003(c)(2)(D) of the Act.
[T.D. 7491, 42 FR 32388, June 24, 1977]
Sec. 54.4976-1T Questions and answers relating to taxes with respect to welfare
benefit funds (temporary).
Q-1: What does section 4976 provide?
A-1: Section 4976 imposes a tax on employers who provide
disqualified benefits through a welfare benefit fund. The tax imposed is
equal to 100 percent of the disqualified benefit.
Q-2: What constitutes a disqualified benefit?
A-2: A disqualified benefit is (a) any post-retirement medical or
life insurance benefit provided with respect to a key employee (as
defined in section 419A(d)(3)) through a welfare benefit fund if a
separate account is required to be established for such employee under
section 419A(d) and the cost for such coverage is not charged against or
paid from such separate account; (b) any post-retirement medical or life
insurance benefit provided through a welfare benefit fund with respect
to an individual in whose favor discrimination is prohibited unless the
plan of which the fund is a part meets the requirements of section
505(b) with respect to that benefit; and (c) any portion of the fund
which reverts to the benefit of the employer. A post-retirement medical
or life insurance benefit provided with respect to a key employee will
not constitute a disqualified benefit even though such benefit is not
provided through a separate account if the cost of such benefit is paid
by the employer in the taxable year in which the benefit is provided and
there is not (and there is not required to be) a separate account with
an outstanding credit balance maintained for the key employee.
Q-3: What is the effective date of section 4976?
A-3: (a) Generally, section 4976 applies to disqualified benefits
provided
[[Page 289]]
by a welfare benefit fund after December 31, 1985. However, a
disqualified benefit, as defined in section 4976(b)(1) or (2), is not
subject to section 4976(a) if it is provided from ``existing reserves
for post-retirement medical or life insurance benefits'' that are within
the transition rule set forth in section 512(a)(3)(E)(iii) and Q&A-4 of
Sec. 1.512(a)-5T (or would be if such transition rule applied to such
welfare benefit fund). For example, if a welfare benefit fund in
existence on July 18, 1984, provides an individual in whose favor
discrimination is prohibited with a post-retirement life insurance
benefit after December 31, 1985, that does not meet the requirements of
section 505(b) and if the welfare benefit fund received no contributions
after July 18, 1984, then the disqualified benefit provided by the fund
is not subject to section 4976(a)
(b) A welfare benefit fund will be able to avoid the application of
section 4976(b)(1) and (2) if the employer withdraws from such fund,
before April 7, 1986, any amounts that are not attributable to
``existing reserves for post-retirement medical or life insurance
benefits'' because they were neither actually set aside nor treated as
actually set aside under Q&A-4 of Sec. 1.512(a)-5T, on July 18, 1984.
The employer making such a withdrawal must include the amount in income
for the first taxable year ending after July 18, 1984, or, to the extent
that the withdrawn amount is attributable to the following taxable year,
for such following taxable year. Such a withdrawal will not be treated
as an impermissible distribution or reversion under section 501(c)(9),
and will not be treated as a disqualified benefit under section
4976(b)(3). Of course, to the extent that the welfare benefit fund
contains amounts that are attributable to ``existing reserves'' but are
not within the transition rule set forth in Q&A-4 of Sec. 1.512(a)-5T
(as applied to welfare benefit funds), for example, because such amounts
exceed the amounts that could have been accumulated under the principles
set forth in Revenue Rulings 69-382, 1969-2 C.B. 28; 69-478, 1969-2 C.B.
29; and 73-599, 1973-2 C.B. 40, the fund will not be able to avoid the
application of section 4976(b)(1) and (2) under this paragraph.
(c) In the case of a plan which is maintained pursuant to one or
more collective bargaining agreements (1) between employee
representatives and one or more employers and (2) which are in effect on
July 1, 1985 (or ratified on or before that date), the provision does
not apply to disqualified benefits provided in years beginning before
the termination of the last of the collective bargaining agreements
pursuant to which the plan is maintained (determined without regard to
any extension of the contract agreed to after July 1, 1985). For
purposes of the preceding sentence, any plan amendment made pursuant to
a collective bargaining agreement relating to the plan which amends the
plan solely to conform to any requirement added under section 511 of the
Tax Reform Act 1984 (i.e., requirements under sections 419, 419A,
512(a)(3)(E), and 4976) shall not be treated as a termination of such
collective bargaining agreement.
[T.D. 8073, 51 FR 4336, Feb. 4, 1986]
Sec. 54.4977-1T Questions and answers relating to the election concerning
lines of business in existence on January 1, 1984 (temporary).
The following questions and answers relate to the election by
employers under section 4977 of the Internal Revenue Code of 1954, as
added by section 531(e)(1) of the Tax Reform Act of 1984 (98 Stat. 886),
to treat all employees of any line of business in existence on January
1, 1984, as employees of one of those lines of business for purposes of
section 132(a) (1) and (2):
Q-1: What does section 4977 provide with respect to the exclusion
from gross income of certain fringe benefits?
A-1: In general, section 4977 provides an elective grandfather rule
that allows an employer under certain circumstances to treat employees
of all lines of business which were in existence on January 1, 1984, as
employees of one of those lines of business for purposes of section
132(a) (1) and (2), but not for purposes of section 132(g)(2).
Q-2: Under what circumstances does the elective grandfather rule of
section 4977 apply?
A-2: If:
[[Page 290]]
(a) An election under section 4977 is in effect with respect to an
employer for any calendar year, and
(b) On and after January 1, 1984, at least 85 percent of the
employees of the employer in all of its lines of business which existed
on January 1, 1984, were entitled to employee discounts or services
provided by the employer in one line of business,
then all employees of any line of business of the employer which was in
existence on January 1, 1984, are treated, for purposes of section
132(a) (1) and (2) (but not for purposes of section 132(g)(2)) as
employees of the one line of business referred to in (b) of this Q/A-2.
Q-3: How does an employer make the election provided for in section
4977?
A-3: An employer must file a statement with the director of the
service center with which the employer's tax returns are filed. The
statement must indicate that the employer is electing to apply the
provisions of section 4977 to one or more of the employer's lines of
business and must contain the following information:
(a) The employer's name, address, and taxpayer identification
number;
(b) A description of all of the employer's lines of business in
existence on January 1, 1984; and
(c) For each lines of business which is to have as an employee for
purposes of section 132(a) (1) and (2) an individual but for the
election under section 4977 would not be treated as an employee for
purposes of section 132(a) (1) and (2):
(1) A description of the no-additional-cost service or qualified
employee discount (including, with respect to discounts, the percentage
discount) to be offered to employees pursuant to section 4977 in such
line of business, and
(2) With respect to employees in all of the employer's lines of
business in existence on January 1, 1984, the number of such employees
and the number entitled to the described fringe benefit. Such numbers
may be determined as of a date which does not precede the date the
election is filed by more than 30 days.
Q-4: In order to make a timely section 4977 election, when must an
employer file the election statement?
A-4: Except as otherwise provided in the second sentence of this
answer, the employer must file the election statement before the end of
the calendar year preceding the year for which the election is to apply.
For calendar year 1985, however, the employer has until March 31, 1985,
to file the election statement. However, the Commissioner may, in his
discretion, extend the March 31, 1985 deadline to a later date.
Q-5: Does section 4977 apply to all calendar years following the
calendar year in which the election is made?
A-5: Yes, unless the employer revokes the election.
Q-6: When is a revocation effective?
A-6: A revocation is effective with respect to the calendar year
following the calendar year in which it is filed.
Q-7: If an employer does not make a timely section 4977 election
with respect to 1985, will the employer be entitled to make an election
with respect to any subsequent year?
A-7: No.
Q-8: If an employer revokes a section 4977 election, is the employer
entitled to elect the application of section 4977 for subsequent years?
A-8: No.
[T.D. 8004, 50 FR 758, Jan. 7, 1985]
Sec. 54.4978-1T Questions and answers relating to the tax on certain dispositions
by employee stock ownership plans and certain cooperatives (temporary).
Q-1: What does section 4978 provide?
A-1: Section 4978 imposes a tax (as determined under section 4978(b)
and Q&A-2 of this section) on the amount realized on the disposition of
any qualified securities, if:
(a) An employee stock ownership plan or eligible worker-owned
cooperative acquires any qualified securities in a sale to which section
1042 applies;
(b) Such plan or cooperative disposes of any qualified securities
during the 3-year period after the date on which any qualified
securities were acquired in the sale to which section 1042 applies; and
(c) Either (1) the percentage of the total outstanding shares of the
class of employer securities of which the disposed qualified securities
are a part held by such plan or cooperative after
[[Page 291]]
such disposition is less than the percentage of the total outstanding
shares of such class of employer securities held immediately after the
sale to which section 1042 applies, or (2) the value of the employer
securities held by such plan or cooperative immediately after such
disposition is less than 30 percent of the total value of all employer
securities outstanding at that time. For purposes of this section, the
following terms have the same meanings given to such terms by the
identified provisions: ``employee stock ownership plan'' (section
4975(e)(7)); ``qualified securities'' (section 1042(b)(1)); ``eligible
worker-owned cooperative'' (section 1042(b)(2)); ``employer securities''
(section 409(l)). For purposes of determining what constitutes a
disposition to which section 4978 applies, see Q&A-3 of this section.
Q-2: What is the amount of tax imposed under section 4978?
A-2: Section 4978 imposes a tax of 10 percent of the amount realized
on the disposition of qualified securities. The amount realized that is
subject to tax under section 4978 shall not exceed that portion of the
amount realized that is allocable to qualified securities acquired
within the 3-year period prior to the date of disposition and to which
section 1042 applied (``restricted qualified securities''). In
determining the amount realized (except as otherwise provided in Q&A-3
of this section), any disposition of employer securities with respect to
which the condition contained in provision (c) of Q&A-1 is met shall be
treated, first, as a disposition of restricted qualified securities (on
a first in, first out basis) and, thereafter, as a disposition of any
other employer securities. Thus, for example, if a plan disposes of more
employer securities than the number of restricted qualified securities
held by the plan at that time and immediately after such disposition the
value of the employer securities held by the plan is less than 30
percent of the total value of all outstanding employer securities, the
portion of the total amount realized that is allocable to restricted
qualified securities subject to tax under section 4978 is determined by
multiplying the total amount realized on the disposition by a fraction,
the numerator of which is the total value of restricted qualified
securities included in the disposition and the denominator of which is
the total value of employer securities in the disposition.
Q-3: What constitutes a ``disposition'' under section 4978?
A-3: (a) Under section 4978, the term ``disposition'' includes any
sale, exchange, or distribution. However, in the case of any exchange of
qualified securities for stock of another corporation in any
reorganization described in section 368(a)(1), such exchange shall not
be treated as a disposition for purposes of section 4978.
(b) Section 4978 shall not apply to any disposition of qualified
securites which is made by reason of:
(1) The death of the employee;
(2) The retirement of the employee after the employee has attained
59\1/2\ years of age;
(3) The disability of the employee (within the meaning of section
72(m)(5)); or
(4) The separation of the employee from service for any period which
results in a 1-year break in service (within the meaning of section
411(a)(6)(A)).
Any disposition of employer securities within this paragraph and any
disposition of employer securities with respect to which the condition
contained in provision (c) of Q&A-1 of this section is not met shall be
treated, first, as a disposition of securities that are not restricted
qualified securities and, thereafter, as a disposition of restricted
qualified securities (on a first-in, first-out basis).
(c) If restricted qualified securities held by an employee stock
ownership plan or eligible worker-owned cooperative no longer meet the
definition of qualified securities (``old restricted qualified
securities'') as a result of a transaction changing (1) the status of a
corporation as an employer, or as a member of a controlled group of
corporations including the employer, or (2) the existence of employer
securities of the type described in section 409(l)(1), the disposition
of such securities shall not be treated as a disposition of restricted
qualified securites to
[[Page 292]]
which the tax under section 4978 is imposed if, within 90 days after
such disposition, securities meeting the requirements of section 409(l)
(``new restricted qualified securities'') that are of equal value to the
old restricted qualfied securities (at the time of the disposition of
the old restricted qualified securities) are substituted for such old
restricted qualified securities. However, for purposes of determining
the tax imposed under section 4978, old restricted qualified securities
shall not be treated as if they retained their status as restricted
qualified securities and new restricted qualified securities derived
from the disposition of old restricted qualified securities pursuant to
the preceding sentence shall be treated as restricted qualified
securities for the remaining portion of the period during which the
disposition of the old restricted qualified securities would have been
subject to tax under section 4978.
Q-4: To whom does the tax under section 4978 apply?
A-4: The tax under section 4978 is imposed on the domestic
corporation (or corporations) or the eligible worker-owned cooperative
that made the written statement of consent as described in section
1042(a)(2)(B) and Q&A-2 of Sec. 1.1042-1T with respect to the
disposition of the restricted qualified securities.
Q-5: When does section 4978, as enacted by the Tax Reform Act of
1984, become effective?
A-5: Section 4978 applies to the disposition of qualified securities
acquired in a sale to which section 1042 applies. See Q&A-6 of Sec.
1.1042-1T for the effective date of section 1042.
[T.D. 8073, 51 FR 4336, Feb. 4, 1986]
Sec. 54.4979-0 Excise tax on certain excess contributions and excess
aggregate contributions; table of contents.
This section contains the captions that appear in Sec. 54.4979.
Sec. 54.4979-1 Excise tax on certain excess contributions and excess
aggregate contributions.
(a) In general.
(1) General rule.
(2) Liability for tax.
(3) Due date and form for payment of tax.
(4) Special rule for simplified employee pensions.
(b) Definitions.
(1) Excess aggregate contributions.
(2) Excess contributions.
(3) Plan.
(c) No tax when excess distributed within 2\1/2\ months of close of
year or additional employer contributions made.
(1) General rule.
(2) Tax treatment of distributions.
(3) Income.
(4) Example.
(d) Effective date.
(1) General rule.
(2) Section 403(b) annuity contracts.
(3) Collectively bargained plans and plans of state or local
governments.
(4) Plan years beginning before January 1, 1992.
[T.D. 8357, 56 FR 40550, Aug. 15, 1991; 57 FR 10290, Mar. 25, 1992, as
amended by T.D. 8581, 59 FR 66181, Dec. 23, 1994]
Sec. 54.4979-1 Excise tax on certain excess contributions and excess aggregate contributions.
(a) In general--(1) General rule. In the case of any plan (as
defined in paragraph (b)(3) of this section), there is imposed a tax for
the employer's taxable year equal to 10 percent of the sum of:
(i) Any excess contributions under a plan for the plan year ending
in the taxable year; and
(ii) Any excess aggregate contributions under the plan for the plan
year ending in the taxable year.
(2) Liability for tax. The tax imposed by paragraph (a)(1) of this
section is to be paid by the employer. In the case of a collectively
bargained plan to which section 413(b) applies, all employers who are
parties to the collective bargaining agreement and whose employees are
participants in the plan are jointly and severally liable for the tax.
(3) Due date and form for payment of tax--(i) The tax described in
paragraph (a)(1) of this section is due on the last day of the 15th
month after the close of the plan year to which the excess contributions
or excess aggregate contributions relate.
(ii) An employer that owes the tax described in paragraph (a)(1) of
this section must file the form prescribed by the Commissioner for the
payment of the tax.
[[Page 293]]
(4) Special rule for simplified employee pensions--(i) An employer
that maintains a simplified employee pension (SEP) as defined in section
408(k) that accepts elective contributions is exempted from the tax of
section 4979 and paragraph (a)(1) of this section if it notifies its
employees of the fact and tax consequences of excess contributions
within 2\1/2\ months following the plan year for which excess
contributions are made. The notification must meet the standards of
paragraph (a)(4)(ii) of this section.
(ii) The employer's notification to each affected employee of the
excess SEP contributions must specifically state, in a manner calculated
to be understood by the average plan participant: the amount of the
excess contributions attributable to that employee's elective deferrals;
the calendar year for which the excess contributions were made; that the
excess contributions are includible in the affected employee's gross
income for the specified calendar year; and that failure to withdraw the
excess contributions and income attributable thereto by the due date
(plus extensions) for filing the affected employee's tax return for the
preceding calendar year may result in significant penalties.
(iii) If an employer does not notify its employees by the last day
of the 12-month period following the year of excess SEP contributions,
the SEP will no longer be considered to meet the requirements of section
408(k)(6).
(b) Definitions. The following is a list of terms and definitions to
be used for purposes of section 4979 and this section:
(1) Excess aggregate contributions. The term ``excess aggregate
contribution'' has the meaning set forth in Sec. 1.401(m)-5 of this
chapter. For purposes of determining excess aggregate contributions
under an annuity contract described in section 403(b), the contract is
treated as a plan described in section 401(a).
(2) Excess contributions. The term ``excess contributions'' has the
meaning set forth in sections 401(k)(8)(B), 408(k)(6)(C)(ii), and
501(c)(18). See, e.g., Sec. 1.401(k)-6 of this chapter.
(3) Plan. The term ``plan'' means:
(i) A plan described in section 401(a) that includes a trust exempt
from tax under section 501(a);
(ii) Any annuity plan described in section 403(a);
(iii) Any annuity contract described in section 403(b);
(iv) A simplified employee pension of an employer that satisfies the
requirements of section 408(k); and
(v) A plan described in section 501(c)(18).
The term includes any plan that at any time has been determined by the
Secretary to be one of the types of plans described in this paragraph
(b)(3).
(c) No tax when excess distributed within 2\1/2\ months of close of
year or additional employer contributions made--(1) General rule. No tax
is imposed under this section on any excess contribution or excess
aggregate contribution, as the case may be, to the extent the
contribution (together with any income allocable thereto) is corrected
before the close of the first 2\1/2\ months of the following plan year
(6 months in the case of a plan that includes an eligible automatic
contribution arrangement within the meaning of section 414(w)). The
extension to 6 months applies to a distribution of excess contributions
or excess aggregate contributions for a plan year beginning on or after
January 1, 2010, only where all the eligible NHCEs and eligible HCEs
(both as defined in Sec. 1.401(k)-6 of this Chapter) are covered
employees under an eligible automatic contribution arrangement within
the meaning of section 414(w) for the entire plan year (or the portion
of the plan year that the eligible NHCEs and eligible HCEs are eligible
employees under the plan)). Qualified nonelective contributions and
qualified matching contributions taken into account under Sec.
1.401(k)-2(a)(6) of this Chapter or qualified nonelective contributions
or elective contributions taken into account under Sec. 1.401(m)-
2(a)(6) of this Chapter for a plan year may permit a plan to avoid
excess contributions or excess aggregate contributions, respectively,
even if made after the close of the 2\1/2\ month (or 6 month) period for
distributing excess contributions or excess aggregate contributions
without the excise tax. See Sec. 1.401(k)-2(b)(1)(i) and (5)(i) of this
Chapter for methods
[[Page 294]]
to avoid excess contributions, and Sec. 1.401(m)-2(b)(1)(i) of the
Chapter for methods to avoid excess aggregate contributions.
(2) Tax treatment of distributions. See Sec. 1.401(k)-2(b)(3)(ii)
and (2)(vi) of this chapter for rules for determining the tax
consequences to a participant of a distribution or recharacterization of
excess contributions and income allocable thereto, including a special
rule for de minimis distributions. See Sec. 1.401(m)-2(b)(2)(vi) of
this chapter for rules for determining the tax consequences to a
participant of a distribution of excess aggregate contributions and
income allocable thereto.
(3) Income. See Sec. 1.401(k)-2(b)(2)(iv) of this chapter for rules
for determining income allocable to excess contributions. See Sec.
1.401(m)-2(b)(2)(iv) of this chapter for rules for determining income
allocable to excess aggregate contributions.
(4) Example. The provisions of this paragraph (c) are illustrated by
the following example.
Example. (i) Employer X maintains Plan Y, a calendar year profit-
sharing plan that includes a qualified cash or deferred arrangement.
Under the plan, failure to satisfy the actual deferral percentage test
may only be corrected by distributing the excess contributions or making
qualified nonelective contributions (QNECs).
(ii) On December 31, 1990, X determines that Y does not satisfy the
actual deferral percentage test for the 1990 plan year, and that excess
contributions for the year equal $5,000. On March 1, 1991, Y distributes
$2,000 of these excess contributions. On May 30, 1991, X distributes
another $2,000 of excess contributions. On December 17, 1991, X
contributes QNECs for certain nonhighly compensated employees, thereby
eliminating the remainder of the excess contributions for 1990.
(iii) X has incurred a tax liability under section 4979 for 1990
equal to 10 percent of the excess contributions that were in the plan as
of December 31, 1990. However, this tax is not imposed on the $2,000
distributed on March 1, 1991, or the amount corrected by QNECs. X must
pay an excise tax of $200, 10 percent of the $2,000 of excess
contributions distributed after March 15, 1991. This tax must be paid by
March 31, 1992.
(d) Effective date--(1) General rule. Except as provided in
paragraphs (d)(2) through (4), this section is effective for plan years
beginning after December 31, 1986.
(2) Section 403(b) annuity contracts. In the case of an annuity
contract under section 403(b), this section applies to plan years
beginning after December 31, 1988.
(3) Collectively bargained plans and plans of state or local
governments. For plan years beginning before January 1, 1993, the
provisions of this section do not apply to a collectively bargained plan
that automatically satisfies the requirements of section 410(b). See
Sec. Sec. 1.401(a)(4)-1(c)(5) and 1.410(b)-2(b)(7) of this chapter. In
the case of a plan (including a collectively bargained plan) maintained
by a state or local government, the provisions of this section do not
apply for plan years beginning before the later of January 1, 1996, or
90 days after the opening of the first legislative session beginning on
or after January 1, 1996, of the governing body with authority to amend
the plan, if that body does not meet continuously. For purposes of this
paragraph (d)(3), the term governing body with authority to amend the
plan means the legislature, board, commission, council, or other
governing body with authority to amend the plan.
(4) Plan years beginning before January 1, 1992. For plan years
beginning before January 1, 1992, a reasonable interpretation of the
rules set forth in section 4979, as in effect during those years, may be
relied upon in determining whether the excise tax is due for those
years.
[T.D. 8357, 56 FR 40550, Aug. 15, 1991, as amended by T.D. 8581, 59 FR
66181, Dec. 23, 1994; T.D. 9169, 69 FR 78153, Dec. 29, 2004; T.D. 9447,
74 FR 8214, Feb. 24, 2009]
Editorial Note: By T.D. 9169, 69 FR 78154, Dec. 29, 2005, Sec.
54.4979-1 was amended in paragraph (c)(2); however, the amendment could
not be incorporated due to inaccurate amendatory instruction.
Sec. 54.4980B-0 Table of contents.
This section contains first a list of the section headings and then
a list of the questions in each section in Sec. Sec. 54.4980B-1 through
54.4980B-10.
List of Sections
Sec. 54.4980B-1 COBRA in general.
Sec. 54.4980B-2 Plans that must comply.
Sec. 54.4980B-3 Qualified beneficiaries.
Sec. 54.4980B-4 Qualifying events.
Sec. 54.4980B-5 COBRA continuation coverage.
[[Page 295]]
Sec. 54.4980B-6 Electing COBRA continuation coverage.
Sec. 54.4980B-7 Duration of COBRA continuation coverage.
Sec. 54.4980B-8 Paying for COBRA continuation coverage.
Sec. 54.4980B-9 Business reorganizations and employer withdrawals from
multiemployer plans.
Sec. 54.4980B-10 Interaction of FMLA and COBRA.
List of Questions
Sec. 54.4980B-1 COBRA in general.
Q-1: What are the health care continuation coverage requirements
contained in section 4980B of the Internal Revenue Code and in
ERISA?
Q-2: What standard applies for topics not addressed in Sec. Sec.
54.4980B-1 through 54.4980B-10?
Sec. 54.4980B-2 Plans that must comply.
Q-1: For purposes of section 4980B, what is a group health plan?
Q-2: For purposes of section 4980B, what is the employer?
Q-3: What is a multiemployer plan?
Q-4: What group health plans are subject to COBRA?
Q-5: What is a small-employer plan?
Q-6: How is the number of group health plans that an employer or
employee organization maintains determined?
Q-7: What is the plan year?
Q-8: How do the COBRA continuation coverage requirements apply to
cafeteria plans and other flexible benefit arrangements?
Q-9: What is the effect of a group health plan's failure to comply with
the requirements of section 4980B(f)?
Q-10: Who is liable for the excise tax if a group health plan fails to
comply with the requirements of section 4980B(f)?
Q-11: If a person is liable for the excise tax under section 4980B, what
form must the person file and what is the due date for the
filing and payment of the excise tax?
Sec. 54.4980B-3 Qualified beneficiaries.
Q-1: Who is a qualified beneficiary?
Q-2: Who is an employee and who is a covered employee?
Q-3: Who are the similarly situated nonCOBRA beneficiaries?
Sec. 54.4980B-4 Qualifying events.
Q-1: What is a qualifying event?
Q-2: Are the facts surrounding a termination of employment (such as
whether it was voluntary or involuntary) relevant in
determining whether the termination of employment is a
qualifying event?
Sec. 54.4980B-5 COBRA continuation coverage.
Q-1: What is COBRA continuation coverage?
Q-2: What deductibles apply if COBRA continuation coverage is elected?
Q-3: How do a plan's limits apply to COBRA continuation coverage?
Q-4: Can a qualified beneficiary who elects COBRA continuation coverage
ever change from the coverage received by that individual
immediately before the qualifying event?
Q-5: Aside from open enrollment periods, can a qualified beneficiary who
has elected COBRA continuation coverage choose to cover
individuals (such as newborn children, adopted children, or
new spouses) who join the qualified beneficiary's family on or
after the date of the qualifying event?
Sec. 54.4980B-6 Electing COBRA continuation coverage.
Q-1: What is the election period and how long must it last?
Q-2: Is a covered employee or qualified beneficiary responsible for
informing the plan administrator of the occurrence of a
qualifying event?
Q-3: During the election period and before the qualified beneficiary has
made an election, must coverage be provided?
Q-4: Is a waiver before the end of the election period effective to end
a qualified beneficiary's election rights?
Q-5: Can an employer or employee organization withhold money or other
benefits owed to a qualified beneficiary until the qualified
beneficiary either waives COBRA continuation coverage, elects
and pays for such coverage, or allows the election period to
expire?
Q-6: Can each qualified beneficiary make an independent election under
COBRA?
Sec. 54.4980B-7 Duration of COBRA continuation coverage.
Q-1: How long must COBRA continuation coverage be made available to a
qualified beneficiary?
Q-2: When may a plan terminate a qualified beneficiary's COBRA
continuation coverage due to coverage under another group
health plan?
Q-3: When may a plan terminate a qualified beneficiary's COBRA
continuation coverage due to the qualified beneficiary's
entitlement to Medicare benefits?
Q-4: When does the maximum coverage period end?
Q-5: How does a qualified beneficiary become entitled to a disability
extension?
Q-6: Under what circumstances can the maximum coverage period be
expanded?
Q-7: If health coverage is provided to a qualified beneficiary after a
qualifying event without regard to COBRA continuation coverage
(for example, as a result of state or local law, the Uniformed
Services Employment and Reemployment Rights Act of 1994 (38
U.S.C. 4315), industry practice, a collective bargaining
agreement, severance agreement, or plan
[[Page 296]]
procedure), will such alternative coverage extend the maximum
coverage period?
Q-8: Must a qualified beneficiary be given the right to enroll in a
conversion health plan at the end of the maximum coverage
period for COBRA continuation coverage?
Sec. 54.4980B-8 Paying for COBRA continuation coverage.
Q-1: Can a group health plan require payment for COBRA continuation
coverage?
Q-2: When is the applicable premium determined and when can a group
health plan increase the amount it requires to be paid for
COBRA continuation coverage?
Q-3: Must a plan allow payment for COBRA continuation coverage to be
made in monthly installments?
Q-4: Is a plan required to allow a qualified beneficiary to choose to
have the first payment for COBRA continuation coverage applied
prospectively only?
Q-5: What is timely payment for COBRA continuation coverage?
Sec. 54.4980B-9 Business reorganizations and employer withdrawals from
multiemployer plans.
Q-1: For purposes of this section, what are a business reorganization, a
stock sale, and an asset sale?
Q-2: In the case of a stock sale, what are the selling group, the
acquired organization, and the buying group?
Q-3: In the case of an asset sale, what are the selling group and the
buying group?
Q-4: Who is an M&A qualified beneficiary?
Q-5: In the case of a stock sale, is the sale a qualifying event with
respect to a covered employee who is employed by the acquired
organization before the sale and who continues to be employed
by the acquired organization after the sale, or with respect
to the spouse or dependent children of such a covered
employee?
Q-6: In the case of an asset sale, is the sale a qualifying event with
respect to a covered employee whose employment immediately
before the sale was associated with the purchased assets, or
with respect to the spouse or dependent children of such a
covered employee who are covered under a group health plan of
the selling group immediately before the sale?
Q-7: In a business reorganization, are the buying group and the selling
group permitted to allocate by contract the responsibility to
make COBRA continuation coverage available to M&A qualified
beneficiaries?
Q-8: Which group health plan has the obligation to make COBRA
continuation coverage available to M&A qualified beneficiaries
in a business reorganization?
Q-9: Can the cessation of contributions by an employer to a
multiemployer group health plan be a qualifying event?
Q-10: If an employer stops contributing to a multiemployer group health
plan, does the multiemployer plan have the obligation to make
COBRA continuation coverage available to a qualified
beneficiary who was receiving coverage under the multiemployer
plan on the day before the cessation of contributions and who
is, or whose qualifying event occurred in connection with, a
covered employee whose last employment prior to the qualifying
event was with the employer that has stopped contributing to
the multiemployer plan?
Sec. 54.4980B-10 Interaction of FMLA and COBRA.
Q-1: In what circumstances does a qualifying event occur if an employee
does not return from leave taken under FMLA?
Q-2: If a qualifying event described in Q&A-1 of this section occurs,
when does it occur, and how is the maximum coverage period
measured?
Q-3: If an employee fails to pay the employee portion of premiums for
coverage under a group health plan during FMLA leave or
declines coverage under a group health plan during FMLA leave,
does this affect the determination of whether or when the
employee has experienced a qualifying event?
Q-4: Is the application of the rules in Q&A-1 through Q&A-3 of this
section affected by a requirement of state or local law to
provide a period of coverage longer than that required under
FMLA?
Q-5: May COBRA continuation coverage be conditioned upon reimbursement
of the premiums paid by the employer for coverage under a
group health plan during FMLA leave?
[T.D. 8812, 64 FR 5173, Feb. 3, 1999, as amended by T.D. 8928, 66 FR
1848, Jan. 10, 2001; T.D. 9457, 74 FR 45997, Sept. 8, 2009]
Sec. 54.4980B-1 COBRA in general.
The COBRA continuation coverage requirements are described in
general in the following questions-and-answers:
Q-1: What are the health care continuation coverage requirements
contained in section 4980B of the Internal Revenue Code and in ERISA?
A-1: (a) Section 4980B provides generally that a group health plan
must offer each qualified beneficiary who would otherwise lose coverage
under the plan as a result of a qualifying event an opportunity to
elect, within the election period, continuation coverage under the plan.
The continuation
[[Page 297]]
coverage requirements were added to section 162 by the Consolidated
Omnibus Budget Reconciliation Act of 1985 (COBRA), Public Law 99-272
(100 Stat. 222), and moved to section 4980B by the Technical and
Miscellaneous Revenue Act of 1988, Public Law 100-647 (102 Stat. 3342).
Continuation coverage required under section 4980B is referred to in
Sec. Sec. 54.4980B-1 through 54.4980B-10 as COBRA continuation
coverage.
(b) COBRA also added parallel continuation coverage requirements to
Part 6 of Subtitle B of Title I of the Employee Retirement Income
Security Act of 1974 (ERISA) (29 U.S.C. 1161-1168), which is
administered by the U.S. Department of Labor. If a plan does not comply
with the COBRA continuation coverage requirements, the Internal Revenue
Code imposes an excise tax on the employer maintaining the plan (or on
the plan itself), whereas ERISA gives certain parties--including
qualified beneficiaries who are participants or beneficiaries within the
meaning of Title I of ERISA, as well as the Department of Labor--the
right to file a lawsuit to redress the noncompliance. The rules in
Sec. Sec. 54.4980B-1 through 54.4980B-10 apply for purposes of section
4980B and generally also for purposes of the COBRA continuation coverage
requirements in Title I of ERISA. However, certain provisions of the
COBRA continuation coverage requirements (such as the definitions of
group health plan, employee, and employer) are not identical in the
Internal Revenue Code and Title I of ERISA. In those cases in which the
statutory language is not identical, the rules in Sec. Sec. 54.4980B-1
through 54.4980B-10 nonetheless apply to the COBRA continuation coverage
requirements of Title I of ERISA, except to the extent those rules are
inconsistent with the statutory language of Title I of ERISA.
(c) A group health plan that is subject to section 4980B (or the
parallel provisions under ERISA) is referred to as being subject to
COBRA. (See Q&A-4 of Sec. 54.4980B-2). A qualified beneficiary can be
required to pay for COBRA continuation coverage. The term qualified
beneficiary is defined in Q&A-1 of Sec. 54.4980B-3. The term qualifying
event is defined in Q&A-1 of Sec. 54.4980B-4. COBRA continuation
coverage is described in Sec. 54.4980B-5. The election procedures are
described in Sec. 54.4980B-6. Duration of COBRA continuation coverage
is addressed in Sec. 54.4980B-7, and payment for COBRA continuation
coverage is addressed in Sec. 54.4980B-8. Section 54.4980B-9 contains
special rules for how COBRA applies in connection with business
reorganizations and employer withdrawals from a multiemployer plan, and
Sec. 54.4980B-10 addresses how COBRA applies for individuals who take
leave under the Family and Medical Leave Act of 1993. Unless the context
indicates otherwise, any reference in Sec. Sec. 54.4980B-1 through
54.4980B-10 to COBRA refers to section 4980B (as amended) and to the
parallel provisions of ERISA.
Q-2: What standard applies for topics not addressed in Sec. Sec.
54.4980B-1 through 54.4980B-10?
A-2: For purposes of section 4980B, for topics relating to the COBRA
continuation coverage requirements of section 4980B that are not
addressed in Sec. Sec. 54.4980B-1 through 54.4980B-10 (such as methods
for calculating the applicable premium), plans and employers must
operate in good faith compliance with a reasonable interpretation of the
statutory requirements in section 4980B.
[T.D. 8812, 64 FR 5173, Feb 3, 1999; 64 FR 14382, Mar. 25, 1999, as
amended by T.D. 8928, 66 FR 1849, Jan. 10, 2001]
Sec. 54.4980B-2 Plans that must comply.
The following questions-and-answers apply in determining which plans
must comply with the COBRA continuation coverage requirements:
Q-1: For purposes of section 4980B, what is a group health plan?
A-1: (a) For purposes of section 4980B, a group health plan is a
plan maintained by an employer or employee organization to provide
health care to individuals who have an employment-related connection to
the employer or employee organization or to their families. Individuals
who have an employment-related connection to the employer or employee
organization consist of employees, former employees, the employer, and
others associated or formerly associated with the employer or employee
organization in a business relationship (including members of a
[[Page 298]]
union who are not currently employees). Health care is provided under a
plan whether provided directly or through insurance, reimbursement, or
otherwise, and whether or not provided through an on-site facility
(except as set forth in paragraph (d) of this Q&A-1), or through a
cafeteria plan (as defined in section 125) or other flexible benefit
arrangement. (See paragraphs (b) through (e) in Q&A-8 of this section
for rules regarding the application of the COBRA continuation coverage
requirements to certain health flexible spending arrangements.) For
purposes of this Q&A-1, insurance includes not only group insurance
policies but also one or more individual insurance policies in any
arrangement that involves the provision of health care to two or more
employees. A plan maintained by an employer or employee organization is
any plan of, or contributed to (directly or indirectly) by, an employer
or employee organization. Thus, a group health plan is maintained by an
employer or employee organization even if the employer or employee
organization does not contribute to it if coverage under the plan would
not be available at the same cost to an individual but for the
individual's employment-related connection to the employer or employee
organization. These rules are further explained in paragraphs (b)
through (d) of this Q&A-1. An exception for qualified long-term care
services is set forth in paragraph (e) of this Q&A-1, and for medical
savings accounts in paragraph (f) of this Q&A-1. See Q&A-6 of this
section for rules to determine the number of group health plans that an
employer or employee organization maintains.
(b) For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10,
health care has the same meaning as medical care under section 213(d).
Thus, health care generally includes the diagnosis, cure, mitigation,
treatment, or prevention of disease, and any other undertaking for the
purpose of affecting any structure or function of the body. Health care
also includes transportation primarily for and essential to health care
as described in the preceding sentence. However, health care does not
include anything that is merely beneficial to the general health of an
individual, such as a vacation. Thus, if an employer or employee
organization maintains a program that furthers general good health, but
the program does not relate to the relief or alleviation of health or
medical problems and is generally accessible to and used by employees
without regard to their physical condition or state of health, that
program is not considered a program that provides health care and so is
not a group health plan. For example, if an employer maintains a spa,
swimming pool, gymnasium, or other exercise/fitness program or facility
that is normally accessible to and used by employees for reasons other
than relief of health or medical problems, such a facility does not
constitute a program that provides health care and thus is not a group
health plan. In contrast, if an employer maintains a drug or alcohol
treatment program or a health clinic, or any other facility or program
that is intended to relieve or alleviate a physical condition or health
problem, the facility or program is considered to be the provision of
health care and so is considered a group health plan.
(c) Whether a benefit provided to employees constitutes health care
is not affected by whether the benefit is excludable from income under
section 132 (relating to certain fringe benefits). For example, if a
department store provides its employees discounted prices on all
merchandise, including health care items such as drugs or eyeglasses,
the mere fact that the discounted prices also apply to health care items
will not cause the program to be a plan providing health care, so long
as the discount program would normally be accessible to and used by
employees without regard to health needs or physical condition. If,
however, the employer maintaining the discount program is a health
clinic, so that the program is used exclusively by employees with health
or medical needs, the program is considered to be a plan providing
health care and so is considered to be a group health plan.
(d) The provision of health care at a facility that is located on
the premises of an employer or employee organization does not constitute
a group health plan if--
[[Page 299]]
(1) The health care consists primarily of first aid that is provided
during the employer's working hours for treatment of a health condition,
illness, or injury that occurs during those working hours;
(2) The health care is available only to current employees; and
(3) Employees are not charged for the use of the facility.
(e) A plan does not constitute a group health plan subject to COBRA
if substantially all of the coverage provided under the plan is for
qualified long-term care services (as defined in section 7702B(c)). For
this purpose, a plan is permitted to use any reasonable method in
determining whether substantially all of the coverage provided under the
plan is for qualified long-term care services.
(f) Under section 106(b)(5), amounts contributed by an employer to a
medical savings account (as defined in section 220(d)) are not
considered part of a group health plan subject to COBRA. Thus, a plan is
not required to make COBRA continuation coverage available with respect
to amounts contributed by an employer to a medical savings account. A
high deductible health plan does not fail to be a group health plan
subject to COBRA merely because it covers a medical savings account
holder.
Q-2: For purposes of section 4980B, what is the employer?
A-2: (a) For purposes of section 4980B, employer refers to--
(1) A person for whom services are performed;
(2) Any other person that is a member of a group described in
section 414(b), (c), (m), or (o) that includes a person described in
paragraph (a)(1) of this Q&A-2; and
(3) Any successor of a person described in paragraph (a)(1) or (2)
of this Q&A-2.
(b) An employer is a successor employer if it results from a
consolidation, merger, or similar restructuring of the employer or if it
is a mere continuation of the employer. See paragraph (c) in Q&A-8 of
Sec. 54.4980B-9 for rules describing the circumstances in which a
purchaser of substantial assets is a successor employer to the employer
selling the assets.
Q-3: What is a multiemployer plan?
A-3: For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10, a
multiemployer plan is a plan to which more than one employer is required
to contribute, that is maintained pursuant to one or more collective
bargaining agreements between one or more employee organizations and
more than one employer, and that satisfies such other requirements as
the Secretary of Labor may prescribe by regulation. Whenever reference
is made in Sec. Sec. 54.4980B-1 through 54.4980B-10 to a plan of or
maintained by an employer or employee organization, the reference
includes a multiemployer plan.
Q-4: What group health plans are subject to COBRA?
A-4: (a) All group health plans are subject to COBRA except group
health plans described in paragraph (b) of this Q&A-4. Group health
plans described in paragraph (b) of this Q&A-4 are referred to in
Sec. Sec. 54.4980B-1 through 54.4980B-10 as excepted from COBRA.
(b) The following group health plans are excepted from COBRA--
(1) Small-employer plans (see Q&A-5 of this section);
(2) Church plans (within the meaning of section 414(e)); and
(3) Governmental plans (within the meaning of section 414(d)).
(c) The COBRA continuation coverage requirements generally do not
apply to group health plans that are excepted from COBRA. However, a
small-employer plan otherwise excepted from COBRA is nonetheless subject
to COBRA with respect to qualified beneficiaries who experience a
qualifying event during a period when the plan is not a small-employer
plan (see paragraph (g) of Q&A-5 of this section).
(d) Although governmental plans are not subject to the COBRA
continuation coverage requirements, group health plans maintained by
state or local governments are generally subject to parallel
continuation coverage requirements that were added by section 10003 of
COBRA to the Public Health Service Act (42 U.S.C. 300bb-1 through 300bb-
8), which is administered by the U.S. Department of Health and Human
Services. Federal employees and their family members covered under the
Federal
[[Page 300]]
Employees Health Benefit Program are covered by generally similar, but
not parallel, temporary continuation of coverage provisions enacted by
the Federal Employees Health Benefits Amendments Act of 1988. See 5
U.S.C. 8905a.
Q-5: What is a small-employer plan?
A-5: (a) Except in the case of a multiemployer plan, a small-
employer plan is a group health plan maintained by an employer (within
the meaning of Q&A-2 of this section) that normally employed fewer than
20 employees (within the meaning of paragraph (c) of this Q&A-5) during
the preceding calendar year. In the case of a multiemployer plan, a
small-employer plan is a group health plan under which each of the
employers contributing to the plan for a calendar year normally employed
fewer than 20 employees during the preceding calendar year. See Q&A-6 of
this section for rules to determine the number of plans that an employer
or employee organization maintains. The rules of this paragraph (a) are
illustrated in the following example:
Example. (i) Corporation S employs 12 employees, all of whom work
and reside in the United States. S maintains a group health plan for its
employees and their families. S is a wholly-owned subsidiary of P. In
the previous calendar year, the controlled group of corporations
including P and S employed more than 19 employees, although the only
employees in the United States of the controlled group that includes P
and S are the 12 employees of S.
(ii) Under Sec. 1.414(b)-1 of this chapter, foreign corporations
are not excluded from membership in a controlled group of corporations.
Consequently, the group health plan maintained by S is not a small-
employer plan during the current calendar year because the controlled
group including S normally employed at least 20 employees in the
preceding calendar year.
(b) An employer is considered to have normally employed fewer than
20 employees during a particular calendar year if, and only if, it had
fewer than 20 employees on at least 50 percent of its typical business
days during that year.
(c) All full-time and part-time common law employees of an employer
are taken into account in determining whether an employer had fewer than
20 employees; however, an individual who is not a common law employee of
the employer is not taken into account. Thus, the following individuals
are not counted as employees for purposes of this Q&A-5 even though they
are referred to as employees for all other purposes of Sec. Sec.
54.4980B-1 through 54.4980B-10--
(1) Self-employed individuals (within the meaning of section
401(c)(1));
(2) Independent contractors (and their employees and independent
contractors); and
(3) Directors (in the case of a corporation).
(d) In determining the number of the employees of an employer, each
full-time employee is counted as one employee and each part-time
employee is counted as a fraction of an employee, determined in
accordance with paragraph (e) of this Q&A-5.
(e) An employer may determine the number of its employees on a daily
basis or a pay period basis. The basis used by the employer must be used
with respect to all employees of the employer and must be used for the
entire year for which the number of employees is being determined. If an
employer determines the number of its employees on a daily basis, it
must determine the actual number of full-time employees on each typical
business day and the actual number of part-time employees and the hours
worked by each of those part-time employees on each typical business
day. Each full-time employee counts as one employee on each typical
business day and each part-time employee counts as a fraction, with the
numerator of the fraction equal to the number of hours worked by that
employee and the denominator equal to the number of hours that must be
worked on a typical business day in order to be considered a full-time
employee. If an employer determines the number of its employees on a pay
period basis, it must determine the actual number of full-time employees
employed during that pay period and the actual number of part-time
employees employed and the hours worked by each of those part-time
employees during the pay period. For each day of that pay period, each
full-time employee counts as one employee and each part-time employee
[[Page 301]]
counts as a fraction, with the numerator of the fraction equal to the
number of hours worked by that employee during that pay period and the
denominator equal to the number of hours that must be worked during that
pay period in order to be considered a full-time employee. The
determination of the number of hours required to be considered a full-
time employee is based upon the employer's employment practices, except
that in no event may the hours required to be considered a full-time
employee exceed eight hours for any day or 40 hours for any week.
(f) In the case of a multiemployer plan, the determination of
whether the plan is a small-employer plan on any particular date depends
on which employers are contributing to the plan on that date and on the
workforce of those employers during the preceding calendar year. If a
plan that is otherwise subject to COBRA ceases to be a small-employer
plan because of the addition during a calendar year of an employer that
did not normally employ fewer than 20 employees on a typical business
day during the preceding calendar year, the plan ceases to be excepted
from COBRA immediately upon the addition of the new employer. In
contrast, if the plan ceases to be a small-employer plan by reason of an
increase during a calendar year in the workforce of an employer
contributing to the plan, the plan ceases to be excepted from COBRA on
the January 1 immediately following the calendar year in which the
employer's workforce increased.
(g) A small-employer plan is generally excepted from COBRA. If,
however, a plan that has been subject to COBRA (that is, was not a
small-employer plan) becomes a small-employer plan, the plan remains
subject to COBRA for qualifying events that occurred during the period
when the plan was subject to COBRA. The rules of this paragraph (g) are
illustrated by the following examples:
Example 1. An employer maintains a group health plan. The employer
employed 20 employees on more than 50 percent of its working days during
2001, and consequently the plan is not excepted from COBRA during 2002.
Employee E resigns and does not work for the employer after January 31,
2002. Under the terms of the plan, E is no longer eligible for coverage
upon the effective date of the resignation, that is, February 1, 2002.
The employer does not hire a replacement for E. E timely elects and pays
for COBRA continuation coverage. The employer employs 19 employees for
the remainder of 2002, and consequently the plan is not subject to COBRA
in 2003. The plan must nevertheless continue to make COBRA continuation
coverage available to E during 2003 until the obligation to make COBRA
continuation coverage available ceases under the rules of Sec.
54.4980B-7. The obligation could continue until August 1, 2003, the date
that is 18 months after the date of E's qualifying event, or longer if E
is eligible for a disability extension.
Example 2. The facts are the same as in Example 1. The employer
continues to employ 19 employees throughout 2003 and 2004 and
consequently the plan continues to be excepted from COBRA during 2004
and 2005. Spouse S is covered under the plan because S is married to one
of the employer's employees. On April 1, 2002, S is divorced from that
employee and ceases to be eligible for coverage under the plan. The plan
is subject to COBRA during 2002 because X normally employed 20 employees
during 2001. S timely notifies the plan administrator of the divorce and
timely elects and pays for COBRA continuation coverage. Even though the
plan is generally excepted from COBRA during 2003, 2004, and 2005, it
must nevertheless continue to make COBRA continuation coverage available
to S during those years until the obligation to make COBRA continuation
coverage available ceases under the rules of Sec. 54.4980B-7. The
obligation could continue until April 1, 2005, the date that is 36
months after the date of S's qualifying event.
Example 3. The facts are the same as in Example 2. C is a dependent
child of one of the employer's employees and is covered under the plan.
A dependent child is no longer eligible for coverage under the plan upon
the attainment of age 23. C attains age 23 on November 16, 2005. The
plan is excepted from COBRA with respect to C during 2005 because the
employer normally employed fewer than 20 employees during 2004.
Consequently, the plan is not obligated to make COBRA continuation
coverage available to C (and would not be obligated to make COBRA
continuation coverage available to C even if the plan later became
subject to COBRA again).
Q-6: How is the number of group health plans that an employer or
employee organization maintains determined?
A-6: (a) The rules of this Q&A-6 apply in determining the number of
group health plans that an employer or employee organization maintains.
All references elsewhere in Sec. Sec. 54.4980B-1
[[Page 302]]
through 54.4980B-10 to a group health plan are references to a group
health plan as determined under Q&A-1 of this section and this Q&A-6.
Except as provided in paragraph (b) or (c) of this Q&A-6, all health
care benefits, other than benefits for qualified long-term care services
(as defined in section 7702B(c)), provided by a corporation,
partnership, or other entity or trade or business, or by an employee
organization, constitute one group health plan, unless--
(1) It is clear from the instruments governing an arrangement or
arrangements to provide health care benefits that the benefits are being
provided under separate plans; and
(2) The arrangement or arrangements are operated pursuant to such
instruments as separate plans.
(b) A multiemployer plan and a nonmultiemployer plan are always
separate plans.
(c) If a principal purpose of establishing separate plans is to
evade any requirement of law, then the separate plans will be considered
a single plan to the extent necessary to prevent the evasion.
(d) The significance of treating an arrangement as two or more
separate group health plans is illustrated by the following examples:
Example 1. (i) Employer X maintains a single group health plan,
which provides major medical and prescription drug benefits. Employer Y
maintains two group health plans; one provides major medical benefits
and the other provides prescription drug benefits.
(ii) X's plan could comply with the COBRA continuation coverage
requirements by giving a qualified beneficiary experiencing a qualifying
event with respect to X's plan the choice of either electing both major
medical and prescription drug benefits or not receiving any COBRA
continuation coverage under X's plan. By contrast, for Y's plans to
comply with the COBRA continuation coverage requirements, a qualified
beneficiary experiencing a qualifying event with respect to each of Y's
plans must be given the choice of electing COBRA continuation coverage
under either the major medical plan or the prescription drug plan or
both.
Example 2. If a joint board of trustees administers one
multiemployer plan, that plan will fail to qualify for the small-
employer plan exception if any one of the employers whose employees are
covered under the plan normally employed 20 or more employees during the
preceding calendar year. However, if the joint board of trustees
maintains two or more multiemployer plans, then the exception would be
available with respect to each of those plans in which each of the
employers whose employees are covered under the plan normally employed
fewer than 20 employees during the preceding calendar year.
Q-7: What is the plan year?
A-7: (a) The plan year is the year that is designated as the plan
year in the plan documents.
(b) If the plan documents do not designate a plan year (or if there
are no plan documents), then the plan year is determined in accordance
with this paragraph (b).
(1) The plan year is the deductible/limit year used under the plan.
(2) If the plan does not impose deductibles or limits on an annual
basis, then the plan year is the policy year.
(3) If the plan does not impose deductibles or limits on an annual
basis, and either the plan is not insured or the insurance policy is not
renewed on an annual basis, then the plan year is the employer's taxable
year.
(4) In any other case, the plan year is the calendar year.
Q-8: How do the COBRA continuation coverage requirements apply to
cafeteria plans and other flexible benefit arrangements?
A-8: (a)(1) The provision of health care benefits does not fail to
be a group health plan merely because those benefits are offered under a
cafeteria plan (as defined in section 125) or under any other
arrangement under which an employee is offered a choice between health
care benefits and other taxable or nontaxable benefits. However, the
COBRA continuation coverage requirements apply only to the type and
level of coverage under the cafeteria plan or other flexible benefit
arrangement that a qualified beneficiary is actually receiving on the
day before the qualifying event. See paragraphs (b) through (e) of this
Q&A-8 for rules limiting the obligations of certain health flexible
spending arrangements.
(2) The rules of this paragraph (a) are illustrated by the following
example:
Example: (i) Under the terms of a cafeteria plan, employees can
choose among life insurance coverage, membership in a health maintenance
organization (HMO), coverage for
[[Page 303]]
medical expenses under an indemnity arrangement, and cash compensation.
Of these available choices, the HMO and the indemnity arrangement are
the arrangements providing health care. The instruments governing the
HMO and indemnity arrangements indicate that they are separate group
health plans. These group health plans are subject to COBRA. The
employer does not provide any group health plan outside of the cafeteria
plan. B and C are unmarried employees. B has chosen the life insurance
coverage, and C has chosen the indemnity arrangement.
(ii) B does not have to be offered COBRA continuation coverage upon
terminating employment, nor is a subsequent open enrollment period for
active employees required to be made available to B. However, if C
terminates employment and the termination constitutes a qualifying
event, C must be offered an opportunity to elect COBRA continuation
coverage under the indemnity arrangement. If C makes such an election
and an open enrollment period for active employees occurs while C is
still receiving the COBRA continuation coverage, C must be offered the
opportunity to switch from the indemnity arrangement to the HMO (but not
to the life insurance coverage because that does not constitute coverage
provided under a group health plan).
(b) If a health flexible spending arrangement (health FSA), within
the meaning of section 106(c)(2), satisfies the two conditions in
paragraph (c) of this Q&A-8 for a plan year, the obligation of the
health FSA to make COBRA continuation coverage available to a qualified
beneficiary who experiences a qualifying event in that plan year is
limited in accordance with paragraphs (d) and (e) of this Q&A-8, as
illustrated by an example in paragraph (f) of this Q&A-8. To the extent
that a health FSA is obligated to make COBRA continuation coverage
available to a qualified beneficiary, the health FSA must comply with
all the applicable rules of Sec. Sec. 54.4980B-1 through 54.4980B-10,
including the rules of Q&A-3 in Sec. 54.4980B-5 (relating to limits).
(c) The conditions of this paragraph (c) are satisfied if--
(1) Benefits provided under the health FSA are excepted benefits
within the meaning of sections 9831 and 9832; and
(2) The maximum amount that the health FSA can require to be paid
for a year of COBRA continuation coverage under Q&A-1 of Sec. 54.4980B-
8 equals or exceeds the maximum benefit available under the health FSA
for the year.
(d) If the conditions in paragraph (c) of this Q&A-8 are satisfied
for a plan year, then the health FSA is not obligated to make COBRA
continuation coverage available for any subsequent plan year to any
qualified beneficiary who experiences a qualifying event during that
plan year.
(e) If the conditions in paragraph (c) of this Q&A-8 are satisfied
for a plan year, the health FSA is not obligated to make COBRA
continuation coverage available for that plan year to any qualified
beneficiary who experiences a qualifying event during that plan year
unless, as of the date of the qualifying event, the qualified
beneficiary can become entitled to receive during the remainder of the
plan year a benefit that exceeds the maximum amount that the health FSA
is permitted to require to be paid for COBRA continuation coverage for
the remainder of the plan year. In determining the amount of the benefit
that a qualified beneficiary can become entitled to receive during the
remainder of the plan year, the health FSA may deduct from the maximum
benefit available to that qualified beneficiary for the year (based on
the election made under the health FSA for that qualified beneficiary
before the date of the qualifying event) any reimbursable claims
submitted to the health FSA for that plan year before the date of the
qualifying event.
(f) The rules of paragraphs (b), (c), (d), and (e) of this Q&A-8 are
illustrated by the following example:
Example. (i) An employer maintains a group health plan providing
major medical benefits and a group health plan that is a health FSA, and
the plan year for each plan is the calendar year. Both the plan
providing major medical benefits and the health FSA are subject to
COBRA. Under the health FSA, during an open season before the beginning
of each calendar year, employees can elect to reduce their compensation
during the upcoming year by up to $1200 per year and have that same
amount contributed to a health flexible spending account. The employer
contributes an additional amount to the account equal to the employee's
salary reduction election for the year. Thus, the maximum amount
available to an employee under the health FSA for a year is two times
the amount of the employee's salary reduction election for the year.
This amount may
[[Page 304]]
be paid to the employee during the year as reimbursement for health
expenses not covered by the employer's major medical plan (such as
deductibles, copayments, prescription drugs, or eyeglasses). The
employer determined, in accordance with section 4980B(f)(4), that a
reasonable estimate of the cost of providing coverage for similarly
situated nonCOBRA beneficiaries for 2002 under this health FSA is equal
to two times their salary reduction election for 2002 and, thus, that
two times the salary reduction election is the applicable premium for
2002.
(ii) Because the employer provides major medical benefits under
another group health plan, and because the maximum benefit that any
employee can receive under the health FSA is not greater than two times
the employee's salary reduction election for the plan year, benefits
under this health FSA are excepted benefits within the meaning of
sections 9831 and 9832. Thus, the first condition of paragraph (c) of
this Q&A-8 is satisfied for the year. The maximum amount that a plan can
require to be paid for coverage (outside of coverage required to be made
available due to a disability extension) under Q&A-1 of Sec. 54.4980B-8
is 102 percent of the applicable premium. Thus, the maximum amount that
the health FSA can require to be paid for coverage for the 2002 plan
year is 2.04 times the employee's salary reduction election for the plan
year. Because the maximum benefit available under the health FSA is 2.0
times the employee's salary reduction election for the year, the maximum
benefit available under the health FSA for the year is less than the
maximum amount that the health FSA can require to be paid for coverage
for the year. Thus, the second condition in paragraph (c) of this Q&A-8
is also satisfied for the 2002 plan year. Because both conditions in
paragraph (c) of this Q&A-8 are satisfied for 2002, with respect to any
qualifying event occurring in 2002, the health FSA is not obligated to
make COBRA continuation coverage available for any year after 2002.
(iii) Whether the health FSA is obligated to make COBRA continuation
coverage available in 2002 to a qualified beneficiary with respect to a
qualifying event that occurs in 2002 depends upon the maximum benefit
that would be available to the qualified beneficiary under COBRA
continuation coverage for that plan year. Case 1: Employee B has elected
to reduce B's salary by $1200 for 2002. Thus, the maximum benefit that B
can become entitled to receive under the health FSA during the entire
year is $2400. B experiences a qualifying event that is the termination
of B's employment on May 31, 2002. As of that date, B had submitted $300
of reimbursable expenses under the health FSA. Thus, the maximum benefit
that B could become entitled to receive for the remainder of 2002 is
$2100. The maximum amount that the health FSA can require to be paid for
COBRA continuation coverage for the remainder of 2002 is 102 percent
times 1/12 of the applicable premium for 2002 times the number of months
remaining in 2002 after the date of the qualifying event. In B's case,
the maximum amount that the health FSA can require to be paid for COBRA
continuation coverage for 2002 is 2.04 times $1200, or $2448. One-
twelfth of $2448 is $204. Because seven months remain in the plan year,
the maximum amount that the health FSA can require to be paid for B's
coverage for the remainder of the year is seven times $204, or $1428.
Because $1428 is less than the maximum benefit that B could become
entitled to receive for the remainder of the year ($2100), the health
FSA is required to make COBRA continuation coverage available to B for
the remainder of 2002 (but not for any subsequent year).
(iv) Case 2: The facts are the same as in Case 1 except that B had
submitted $1000 of reimbursable expenses as of the date of the
qualifying event. In that case, the maximum benefit available to B for
the remainder of the year would be $1400 instead of $2100. Because the
maximum amount that the health FSA can require to be paid for B's
coverage is $1428, and because the $1400 maximum benefit for the
remainder of the year does not exceed $1428, the health FSA is not
obligated to make COBRA continuation coverage available to B in 2002 (or
any later year). (Of course, the administrator of the health FSA is
permitted to make COBRA continuation coverage available to every
qualified beneficiary in the year that the qualified beneficiary's
qualifying event occurs in order to avoid having to determine the
maximum benefit available for each qualified beneficiary for the
remainder of the plan year.)
Q-9: What is the effect of a group health plan's failure to comply
with the requirements of section 4980B(f)?
A-9: Under section 4980B(a), if a group health plan subject to COBRA
fails to comply with section 4980B(f), an excise tax is imposed.
Moreover, non-tax remedies may be available if the plan fails to comply
with the parallel requirements in ERISA, which are administered by the
Department of Labor.
Q-10: Who is liable for the excise tax if a group health plan fails
to comply with the requirements of section 4980B(f)?
A-10: (a) In general, the excise tax is imposed on the employer
maintaining the plan, except that in the case of a multiemployer plan
(see Q&A-3 of this
[[Page 305]]
section for a definition of multiemployer plan) the excise tax is
imposed on the plan.
(b) In certain circumstances, the excise tax is also imposed on a
person involved with the provision of benefits under the plan (other
than in the capacity of an employee), such as an insurer providing
benefits under the plan or a third party administrator administering
claims under the plan. In general, such a person will be liable for the
excise tax if the person assumes, under a legally enforceable written
agreement, the responsibility for performing the act to which the
failure to comply with the COBRA continuation coverage requirements
relates. Such a person will be liable for the excise tax notwithstanding
the absence of a written agreement assuming responsibility for complying
with COBRA if the person provides coverage under the plan to a similarly
situated nonCOBRA beneficiary (see Q&A-3 of Sec. 54.4980B-3 for a
definition of similarly situated nonCOBRA beneficiaries) and the
employer or plan administrator submits a written request to the person
to provide to a qualified beneficiary the same coverage that the person
provides to the similarly situated nonCOBRA beneficiary. If the person
providing coverage under the plan to a similarly situated nonCOBRA
beneficiary is the plan administrator and the qualifying event is a
divorce or legal separation or a dependent child's ceasing to be covered
under the generally applicable requirements of the plan, the plan
administrator will also be liable for the excise tax if the qualified
beneficiary submits a written request for coverage.
Q-11: If a person is liable for the excise tax under section 4980B,
what form must the person file and what is the due date for the filing
and payment of the excise tax?
A-11: (a) In general. See Sec. Sec. 54.6011-2 and 54.6151-1.
(b) Due date for filing of return by employers or other persons
responsible for benefits under a group health plan. See Sec. 54.6071-
1(a)(1).
(c) Due date for filing of return by multiemployer plans. See Sec.
54.6071-1(a)(2).
(d) Effective/applicability date. In the case of an employer or
other person mentioned in paragraph (b) of this Q & A-11, the rules in
this Q & A-11 are effective for taxable years beginning on or after
January 1, 2010. In the case of a plan mentioned in paragraph (c) of
this Q & A-11, the rules in this Q & A-11 are effective for plan years
beginning on or after January 1, 2010.
[T.D. 8812, 64 FR 5174, Feb. 3, 1999, as amended by T.D. 8928, 66 FR
1849, Jan. 10, 2001; T.D. 9457, 74 FR 45997, Sept. 8, 2009]
Sec. 54.4980B-3 Qualified beneficiaries.
The determination of who is a qualified beneficiary, an employee, or
a covered employee, and of who are the similarly situated nonCOBRA
beneficiaries is addressed in the following questions-and-answers:
Q-1: Who is a qualified beneficiary?
A-1: (a)(1) Except as set forth in paragraphs (c) through (f) of
this Q&A-1, a qualified beneficiary is--
(i) Any individual who, on the day before a qualifying event, is
covered under a group health plan by virtue of being on that day either
a covered employee, the spouse of a covered employee, or a dependent
child of the covered employee; or
(ii) Any child who is born to or placed for adoption with a covered
employee during a period of COBRA continuation coverage.
(2) In the case of a qualifying event that is the bankruptcy of the
employer, a covered employee who had retired on or before the date of
substantial elimination of group health plan coverage is also a
qualified beneficiary, as is any spouse, surviving spouse, or dependent
child of such a covered employee if, on the day before the bankruptcy
qualifying event, the spouse, surviving spouse, or dependent child is a
beneficiary under the plan.
(3) In general, an individual (other than a child who is born to or
placed for adoption with a covered employee during a period of COBRA
continuation coverage) who is not covered under a plan on the day before
the qualifying event cannot be a qualified beneficiary with respect to
that qualifying event, and the reason for the individual's lack of
actual coverage (such as the individual's having declined participation
in the plan or failed to satisfy the plan's conditions for
participation) is not relevant for this purpose. However, if the
[[Page 306]]
individual is denied or not offered coverage under a plan under
circumstances in which the denial or failure to offer constitutes a
violation of applicable law (such as the Americans with Disabilities
Act, 42 U.S.C. 12101-12213, the special enrollment rules of section
9801, or the requirements of section 9802 prohibiting discrimination in
eligibility to enroll in a group health plan based on health status),
then, for purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10, the
individual will be considered to have had the coverage that was
wrongfully denied or not offered.
(4) Paragraph (b) of this Q&A-1 describes how certain family members
are not qualified beneficiaries even if they become covered under the
plan; paragraphs (c), (d), and (e) of this Q&A-1 place limits on the
general rules of this paragraph (a) concerning who is a qualified
beneficiary; paragraph (f) of this Q&A-1 provides when an individual who
has been a qualified beneficiary ceases to be a qualified beneficiary;
paragraph (g) of this Q&A-1 defines placed for adoption; and paragraph
(h) of this Q&A-1 contains examples.
(b) In contrast to a child who is born to or placed for adoption
with a covered employee during a period of COBRA continuation coverage,
an individual who marries any qualified beneficiary on or after the date
of the qualifying event and a newborn or adopted child (other than one
born to or placed for adoption with a covered employee) are not
qualified beneficiaries by virtue of the marriage, birth, or placement
for adoption or by virtue of the individual's status as the spouse or
the child's status as a dependent of the qualified beneficiary. These
new family members do not themselves become qualified beneficiaries even
if they become covered under the plan. (For situations in which a plan
is required to make coverage available to new family members of a
qualified beneficiary who is receiving COBRA continuation coverage, see
Q&A-5 of Sec. 54.4980B-5, paragraph (c) in Q&A-4 of Sec. 54.4980B-5,
and section 9801(f)(2).)
(c) An individual is not a qualified beneficiary if, on the day
before the qualifying event referred to in paragraph (a) of this Q&A-1,
the individual is covered under the group health plan by reason of
another individual's election of COBRA continuation coverage and is not
already a qualified beneficiary by reason of a prior qualifying event.
(d) A covered employee can be a qualified beneficiary only in
connection with a qualifying event that is the termination, or reduction
of hours, of the covered employee's employment, or that is the
bankruptcy of the employer.
(e) An individual is not a qualified beneficiary if the individual's
status as a covered employee is attributable to a period in which the
individual was a nonresident alien who received from the individual's
employer no earned income (within the meaning of section 911(d)(2)) that
constituted income from sources within the United States (within the
meaning of section 861(a)(3)). If, pursuant to the preceding sentence,
an individual is not a qualified beneficiary, then a spouse or dependent
child of the individual is not considered a qualified beneficiary by
virtue of the relationship to the individual.
(f) A qualified beneficiary who does not elect COBRA continuation
coverage in connection with a qualifying event ceases to be a qualified
beneficiary at the end of the election period (see Q&A-1 of Sec.
54.4980B-6). Thus, for example, if such a former qualified beneficiary
is later added to a covered employee's coverage (e.g., during an open
enrollment period) and then another qualifying event occurs with respect
to the covered employee, the former qualified beneficiary does not
become a qualified beneficiary by reason of the second qualifying event.
If a covered employee who is a qualified beneficiary does not elect
COBRA continuation coverage during the election period, then any child
born to or placed for adoption with the covered employee on or after the
date of the qualifying event is not a qualified beneficiary. Once a
plan's obligation to make COBRA continuation coverage available to an
individual who has been a qualified beneficiary ceases under the rules
of Sec. 54.4980B-7, the individual ceases to be a qualified
beneficiary.
[[Page 307]]
(g) For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10,
placement for adoption or being placed for adoption means the assumption
and retention by the covered employee of a legal obligation for total or
partial support of a child in anticipation of the adoption of the child.
The child's placement for adoption with the covered employee terminates
upon the termination of the legal obligation for total or partial
support. A child who is immediately adopted by the covered employee
without a preceding placement for adoption is considered to be placed
for adoption on the date of the adoption.
(h) The rules of this Q&A-1 are illustrated by the following
examples:
Example 1. (i) B is a single employee who voluntarily terminates
employment and elects COBRA continuation coverage under a group health
plan. To comply with the requirements of section 9801(f), the plan
permits a covered employee who marries to have her or his spouse covered
under the plan. One month after electing COBRA continuation coverage, B
marries and chooses to have B's spouse covered under the plan.
(ii) B's spouse is not a qualified beneficiary. Thus, if B dies
during the period of COBRA continuation coverage, the plan does not have
to offer B's surviving spouse an opportunity to elect COBRA continuation
coverage.
Example 2. (i) C is a married employee who terminates employment. C
elects COBRA continuation coverage for C but not C's spouse, and C's
spouse declines to elect such coverage. C's spouse thus ceases to be a
qualified beneficiary. At the next open enrollment period, C adds the
spouse as a beneficiary under the plan.
(ii) The addition of the spouse during the open enrollment period
does not make the spouse a qualified beneficiary. The plan thus will not
have to offer the spouse an opportunity to elect COBRA continuation
coverage upon a later divorce from or death of C.
Example 3. (i) Under the terms of a group health plan, a covered
employee's child, upon attaining age 19, ceases to be a dependent
eligible for coverage.
(ii) At that time, the child must be offered an opportunity to elect
COBRA continuation coverage. If the child elects COBRA continuation
coverage, the child marries during the period of the COBRA continuation
coverage, and the child's spouse becomes covered under the group health
plan, the child's spouse is not a qualified beneficiary.
Example 4. (i) D is a single employee who, upon retirement, is given
the opportunity to elect COBRA continuation coverage but declines it in
favor of an alternative offer of 12 months of employer-paid retiree
health benefits. At the end of the election period, D ceases to be a
qualified beneficiary and will not have to be given another opportunity
to elect COBRA continuation coverage (at the end of those 12 months or
at any other time). D marries E during the period of retiree health
coverage and, under the terms of that coverage, E becomes covered under
the plan.
(ii) If a divorce from or death of D will result in E's losing
coverage, E will be a qualified beneficiary because E's coverage under
the plan on the day before the qualifying event (that is, the divorce or
death) will have been by reason of D's acceptance of 12 months of
employer-paid coverage after the prior qualifying event (D's retirement)
rather than by reason of an election of COBRA continuation coverage.
Example 5. (i) The facts are the same as in Example 4, except that,
under the terms of the plan, the divorce or death does not cause E to
lose coverage so that E continues to be covered for the balance of the
original 12-month period.
(ii) E does not have to be allowed to elect COBRA continuation
coverage because the loss of coverage at the end of the 12-month period
is not caused by the divorce or death, and thus the divorce or death
does not constitute a qualifying event. See Q&A-1 of Sec. 54.4980B-4.
Q-2: Who is an employee and who is a covered employee?
A-2: (a)(1) For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-
10 (except for purposes of Q&A-5 in Sec. 54.4980B-2, relating to the
exception from COBRA for plans maintained by an employer with fewer than
20 employees), an employee is any individual who is eligible to be
covered under a group health plan by virtue of the performance of
services for the employer maintaining the plan or by virtue of
membership in the employee organization maintaining the plan. Thus, for
purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10 (except for
purposes of Q&A-5 in Sec. 54.4980B-2), the following individuals are
employees if their relationship to the employer maintaining the plan
makes them eligible to be covered under the plan--
(i) Self-employed individuals (within the meaning of section
401(c)(1));
(ii) Independent contractors (and their employees and independent
contractors); and
(iii) Directors (in the case of a corporation).
(2) Similarly, whenever reference is made in Sec. Sec. 54.4980B-1
through 54.4980B-
[[Page 308]]
10 (except in Q&A-5 of Sec. 54.4980B-2) to an employment relationship
(such as by referring to the termination of employment of an employee or
to an employee's being employed by an employer), the reference includes
the relationship of those individuals who are employees within the
meaning of this paragraph (a). See paragraph (c) in Q&A-5 of Sec.
54.4980B-2 for a narrower meaning of employee solely for purposes of
Q&A-5 of Sec. 54.4980B-2.
(b) For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10, a
covered employee is any individual who is (or was) provided coverage
under a group health plan (other than a plan that is excepted from COBRA
on the date of the qualifying event; see Q&A-4 of Sec. 54.4980B-2) by
virtue of being or having been an employee. For example, a retiree or
former employee who is covered by a group health plan is a covered
employee if the coverage results in whole or in part from her or his
previous employment. An employee (or former employee) who is merely
eligible for coverage under a group health plan is generally not a
covered employee if the employee (or former employee) is not actually
covered under the plan. In general, the reason for the employee's (or
former employee's) lack of actual coverage (such as having declined
participation in the plan or having failed to satisfy the plan's
conditions for participation) is not relevant for this purpose. However,
if the employee (or former employee) is denied or not offered coverage
under circumstances in which the denial or failure to offer constitutes
a violation of applicable law (such as the Americans with Disabilities
Act, 42 U.S.C. 12101 through 12213, the special enrollment rules of
section 9801, or the requirements of section 9802 prohibiting
discrimination in eligibility to enroll in a group health plan based on
health status), then, for purposes of Sec. Sec. 54.4980B-1 through
54.4980B-10, the employee (or former employee) will be considered to
have had the coverage that was wrongfully denied or not offered.
Q-3: Who are the similarly situated nonCOBRA beneficiaries?
A-3: For purposes of Sec. Sec. 54.4980B-1 through 54.4980B-10,
similarly situated nonCOBRA beneficiaries means the group of covered
employees, spouses of covered employees, or dependent children of
covered employees receiving coverage under a group health plan
maintained by the employer or employee organization who are receiving
that coverage for a reason other than the rights provided under the
COBRA continuation coverage requirements and who, based on all of the
facts and circumstances, are most similarly situated to the situation of
the qualified beneficiary immediately before the qualifying event.
[T.D. 8812, 64 FR 5176, Feb. 3, 1999, as amended by T.D. 8928, 66 FR
1852, Jan. 10, 2001]
Sec. 54.4980B-4 Qualifying events.
The determination of what constitutes a qualifying event is
addressed in the following questions and answers:
Q-1: What is a qualifying event?
A-1: (a) A qualifying event is an event that satisfies paragraphs
(b), (c), and (d) of this Q&A-1. Paragraph (e) of this Q&A-1 further
explains a reduction of hours of employment, paragraph (f) of this Q&A-1
describes the treatment of children born to or placed for adoption with
a covered employee during a period of COBRA continuation coverage, and
paragraph (g) of this Q&A-1 contains examples. See Q&A-1 through Q&A-3
of Sec. 54.4980B-10 for special rules in the case of leave taken under
the Family and Medical Leave Act of 1993 (29 U.S.C. 2601-2619).
(b) An event satisfies this paragraph (b) if the event is any of the
following--
(1) The death of a covered employee;
(2) The termination (other than by reason of the employee's gross
misconduct), or reduction of hours, of a covered employee's employment;
(3) The divorce or legal separation of a covered employee from the
employee's spouse;
(4) A covered employee's becoming entitled to Medicare benefits
under Title XVIII of the Social Security Act (42 U.S.C. 1395-1395ggg);
(5) A dependent child's ceasing to be a dependent child of a covered
employee under the generally applicable requirements of the plan; or
(6) A proceeding in bankruptcy under Title 11 of the United States
Code with
[[Page 309]]
respect to an employer from whose employment a covered employee retired
at any time.
(c) An event satisfies this paragraph (c) if, under the terms of the
group health plan, the event causes the covered employee, or the spouse
or a dependent child of the covered employee, to lose coverage under the
plan. For this purpose, to lose coverage means to cease to be covered
under the same terms and conditions as in effect immediately before the
qualifying event. Any increase in the premium or contribution that must
be paid by a covered employee (or the spouse or dependent child of a
covered employee) for coverage under a group health plan that results
from the occurrence of one of the events listed in paragraph (b) of this
Q&A-1 is a loss of coverage. In the case of an event that is the
bankruptcy of the employer, lose coverage also means any substantial
elimination of coverage under the plan, occurring within 12 months
before or after the date the bankruptcy proceeding commences, for a
covered employee who had retired on or before the date of the
substantial elimination of group health plan coverage or for any spouse,
surviving spouse, or dependent child of such a covered employee if, on
the day before the bankruptcy qualifying event, the spouse, surviving
spouse, or dependent child is a beneficiary under the plan. For purposes
of this paragraph (c), a loss of coverage need not occur immediately
after the event, so long as the loss of coverage occurs before the end
of the maximum coverage period (see Q&A-4 and Q&A-6 of Sec. 54.4980B-
7). However, if neither the covered employee nor the spouse or a
dependent child of the covered employee loses coverage before the end of
what would be the maximum coverage period, the event does not satisfy
this paragraph (c). If coverage is reduced or eliminated in anticipation
of an event (for example, an employer's eliminating an employee's
coverage in anticipation of the termination of the employee's
employment, or an employee's eliminating the coverage of the employee's
spouse in anticipation of a divorce or legal separation), the reduction
or elimination is disregarded in determining whether the event causes a
loss of coverage.
(d) An event satisfies this paragraph (d) if it occurs while the
plan is subject to COBRA. Thus, an event will not satisfy this paragraph
(d) if it occurs while the plan is excepted from COBRA (see Q&A-4 of
Sec. 54.4980B-2). Even if the plan later becomes subject to COBRA, it
is not required to make COBRA continuation coverage available to anyone
whose coverage ends as a result of an event during a year in which the
plan is excepted from COBRA. For example, if a group health plan is
excepted from COBRA as a small-employer plan during the year 2001 (see
Q&A-5 of Sec. 54.4980B-2) and an employee terminates employment on
December 31, 2001, the termination is not a qualifying event and the
plan is not required to permit the employee to elect COBRA continuation
coverage. This is the case even if the plan ceases to be a small-
employer plan as of January 1, 2002. Also, the same result will follow
even if the employee is given three months of coverage beyond December
31 (that is, through March of 2002), because there will be no qualifying
event as of the termination of coverage in March. However, if the
employee's spouse is initially provided with the three-month coverage
through March 2002, but the spouse divorces the employee before the end
of the three months and loses coverage as a result of the divorce, the
divorce will constitute a qualifying event during 2002 and so entitle
the spouse to elect COBRA continuation coverage. See Q&A-7 of Sec.
54.4980B-7 regarding the maximum coverage period in such a case.
(e) A reduction of hours of a covered employee's employment occurs
whenever there is a decrease in the hours that a covered employee is
required to work or actually works, but only if the decrease is not
accompanied by an immediate termination of employment. This is true
regardless of whether the covered employee continues to perform services
following the reduction of hours of employment. For example, an absence
from work due to disability, a temporary layoff, or any other reason
(other than due to leave that is FMLA leave; see Sec. 54.4980B-10) is a
reduction of
[[Page 310]]
hours of a covered employee's employment if there is not an immediate
termination of employment. If a group health plan measures eligibility
for the coverage of employees by the number of hours worked in a given
time period, such as the preceding month or quarter, and an employee
covered under the plan fails to work the minimum number of hours during
that time period, the failure to work the minimum number of required
hours is a reduction of hours of that covered employee's employment.
(f) The qualifying event of a qualified beneficiary who is a child
born to or placed for adoption with a covered employee during a period
of COBRA continuation coverage is the qualifying event giving rise to
the period of COBRA continuation coverage during which the child is born
or placed for adoption. If a second qualifying event has occurred before
the child is born or placed for adoption (such as the death of the
covered employee), then the second qualifying event also applies to the
newborn or adopted child. See Q&A-6 of Sec. 54.4980B-7.
(g) The rules of this Q&A-1 are illustrated by the following
examples, in each of which the group health plan is subject to COBRA:
Example 1. (i) An employee who is covered by a group health plan
terminates employment (other than by reason of the employee's gross
misconduct) and, beginning with the day after the last day of
employment, is given 3 months of employer-paid coverage under the same
terms and conditions as before that date. At the end of the three
months, the coverage terminates.
(ii) The loss of coverage at the end of the three months results
from the termination of employment and, thus, the termination of
employment is a qualifying event.
Example 2. (i) An employee who is covered by a group health plan
retires (which is a termination of employment other than by reason of
the employee's gross misconduct) and, upon retirement, is required to
pay an increased amount for the same group health coverage that the
employee had before retirement.
(ii) The increase in the premium or contribution required for
coverage is a loss of coverage under paragraph (c) of this Q&A-1 and,
thus, the retirement is a qualifying event.
Example 3. (i) An employee and the employee's spouse are covered
under an employer's group health plan. The employee retires and is given
identical coverage for life. However, the plan provides that the spousal
coverage will not be continued beyond six months unless a higher premium
for the spouse is paid to the plan.
(ii) The requirement for the spouse to pay a higher premium at the
end of the six months is a loss of coverage under paragraph (c) of this
Q&A-1. Thus, the retirement is a qualifying event and the spouse must be
given an opportunity to elect COBRA continuation coverage.
Example 4. (i) F is a covered employee who is married to G, and both
are covered under a group health plan maintained by F's employer. F and
G are divorced. Under the terms of the plan, the divorce causes G to
lose coverage. The divorce is a qualifying event, and G elects COBRA
continuation coverage, remarries during the period of COBRA continuation
coverage, and G's new spouse becomes covered under the plan. (See Q&A-5
in Sec. 54.4980B-5, paragraph (c) in Q&A-4 of Sec. 54.4980B-5, and
section 9801(f)(2).) G dies. Under the terms of the plan, the death
causes G's new spouse to lose coverage under the plan.
(ii) G's death is not a qualifying event because G is not a covered
employee.
Example 5. (i) An employer maintains a group health plan for both
active employees and retired employees (and their families). The
coverage for active employees and retired employees is identical, and
the employer does not require retirees to pay more for coverage than
active employees. The plan does not make COBRA continuation coverage
available when an employee retires (and is not required to because the
retired employee has not lost coverage under the plan). The employer
amends the plan to eliminate coverage for retired employees effective
January 1, 2002. On that date, several retired employees (and their
spouses and dependent children) have been covered under the plan since
their retirement for less than the maximum coverage period that would
apply to them in connection with their retirement.
(ii) The elimination of retiree coverage under these circumstances
is a deferred loss of coverage for those retirees (and their spouses and
dependent children) under paragraph (c) of this Q&A-1 and, thus, the
retirement is a qualifying event. The plan must make COBRA continuation
coverage available to them for the balance of the maximum coverage
period that applies to them in connection with the retirement.
Q-2: Are the facts surrounding a termination of employment (such as
whether it was voluntary or involuntary) relevant in determining whether
the termination of employment is a qualifying event?
[[Page 311]]
A-2: Apart from facts constituting gross misconduct, the facts
surrounding the termination or reduction of hours are irrelevant in
determining whether a qualifying event has occurred. Thus, it does not
matter whether the employee voluntarily terminated or was discharged.
For example, a strike or a lockout is a termination or reduction of
hours that constitutes a qualifying event if the strike or lockout
results in a loss of coverage as described in paragraph (c) of Q&A-1 of
this section. Similarly, a layoff that results in such a loss of
coverage is a qualifying event.
[T.D. 8812, 64 FR 5178, Feb. 3, 1999, as amended by T.D. 8928, 66 FR
1852, Jan. 10, 2001]
Sec. 54.4980B-5 COBRA continuation coverage.
The following questions-and-answers address the requirements for
coverage to constitute COBRA continuation coverage:
Q-1: What is COBRA continuation coverage?
A-1: (a) If a qualifying event occurs, each qualified beneficiary
(other than a qualified beneficiary for whom the qualifying event will
not result in any immediate or deferred loss of coverage) must be
offered an opportunity to elect to receive the group health plan
coverage that is provided to similarly situated nonCOBRA beneficiaries
(ordinarily, the same coverage that the qualified beneficiary had on the
day before the qualifying event). See Q&A-3 of Sec. 54.4980B-3 for the
definition of similarly situated nonCOBRA beneficiaries. This coverage
is COBRA continuation coverage. If coverage is modified for similarly
situated nonCOBRA beneficiaries, then the coverage made available to
qualified beneficiaries is modified in the same way. If the continuation
coverage offered differs in any way from the coverage made available to
similarly situated nonCOBRA beneficiaries, the coverage offered does not
constitute COBRA continuation coverage and the group health plan is not
in compliance with COBRA unless other coverage that does constitute
COBRA continuation coverage is also offered. Any elimination or
reduction of coverage in anticipation of an event described in paragraph
(b) of Q&A-1 of Sec. 54.4980B-4 is disregarded for purposes of this
Q&A-1 and for purposes of any other reference in Sec. Sec. 54.4980B-1
through 54.4980B-10 to coverage in effect immediately before (or on the
day before) a qualifying event. COBRA continuation coverage must not be
conditioned upon, or discriminate on the basis of lack of, evidence of
insurability.
(b) In the case of a qualified beneficiary who is a child born to or
placed for adoption with a covered employee during a period of COBRA
continuation coverage, the child is generally entitled to elect
immediately to have the same coverage that dependent children of active
employees receive under the benefit packages under which the covered
employee has coverage at the time of the birth or placement for
adoption. Such a child would be entitled to elect coverage different
from that elected by the covered employee during the next available open
enrollment period under the plan. See Q&A-4 of this section.
Q-2: What deductibles apply if COBRA continuation coverage is
elected?
A-2: (a) Qualified beneficiaries electing COBRA continuation
coverage generally are subject to the same deductibles as similarly
situated nonCOBRA beneficiaries. If a qualified beneficiary's COBRA
continuation coverage begins before the end of a period prescribed for
accumulating amounts toward deductibles, the qualified beneficiary must
retain credit for expenses incurred toward those deductibles before the
beginning of COBRA continuation coverage as though the qualifying event
had not occurred. The specific application of this rule depends on the
type of deductible, as set forth in paragraphs (b) through (d) of this
Q&A-2. Special rules are set forth in paragraph (e) of this Q&A-2, and
examples appear in paragraph (f) of this Q&A-2.
(b) If a deductible is computed separately for each individual
receiving coverage under the plan, each individual's remaining
deductible amount (if any) on the date COBRA continuation coverage
begins is equal to that individual's remaining deductible amount
immediately before that date.
(c) If a deductible is computed on a family basis, the remaining
deductible for the family on the date that COBRA
[[Page 312]]
continuation coverage begins depends on the members of the family
electing COBRA continuation coverage. In computing the family deductible
that remains on the date COBRA continuation coverage begins, only the
expenses of those family members receiving COBRA continuation coverage
need be taken into account. If the qualifying event results in there
being more than one family unit (for example, because of a divorce), the
family deductible may be computed separately for each resulting family
unit based on the members in each unit. These rules apply regardless of
whether the plan provides that the family deductible is an alternative
to individual deductibles or an additional requirement.
(d) Deductibles that are not described in paragraph (b) or (c) of
this Q&A-2 must be treated in a manner consistent with the principles
set forth in those paragraphs.
(e) If a deductible is computed on the basis of a covered employee's
compensation instead of being a fixed dollar amount and the employee
remains employed during the period of COBRA continuation coverage, the
plan is permitted to choose whether to apply the deductible by treating
the employee's compensation as continuing without change for the
duration of the COBRA continuation coverage at the level that was used
to compute the deductible in effect immediately before the COBRA
continuation coverage began, or to apply the deductible by taking the
employee's actual compensation into account. In applying a deductible
that is computed on the basis of the covered employee's compensation
instead of being a fixed dollar amount, for periods of COBRA
continuation coverage in which the employee is not employed by the
employer, the plan is required to compute the deductible by treating the
employee's compensation as continuing without change for the duration of
the COBRA continuation coverage either at the level that was used to
compute the deductible in effect immediately before the COBRA
continuation coverage began or at the level that was used to compute the
deductible in effect immediately before the employee's employment was
terminated.
(f) The rules of this Q&A-2 are illustrated by the following
examples; in each example, deductibles under the plan are determined on
a calendar year basis:
Example 1. (i) A group health plan applies a separate $100 annual
deductible to each individual it covers. The plan provides that the
spouse and dependent children of a covered employee will lose coverage
on the last day of the month after the month of the covered employee's
death. A covered employee dies on June 11, 2001. The spouse and the two
dependent children elect COBRA continuation coverage, which will begin
on August 1, 2001. As of July 31, 2001, the spouse has incurred $80 of
covered expenses, the older child has incurred no covered expenses, and
the younger one has incurred $120 of covered expenses (and therefore has
already satisfied the deductible).
(ii) At the beginning of COBRA continuation coverage on August 1,
the spouse has a remaining deductible of $20, the older child still has
the full $100 deductible, and the younger one has no further deductible.
Example 2. (i) A group health plan applies a separate $200 annual
deductible to each individual it covers, except that each family member
is treated as having satisfied the individual deductible once the family
has incurred $500 of covered expenses during the year. The plan provides
that upon the divorce of a covered employee, coverage will end
immediately for the employee's spouse and any children who do not remain
in the employee's custody. A covered employee with four dependent
children is divorced, the spouse obtains custody of the two oldest
children, and the spouse and those children all elect COBRA continuation
coverage to begin immediately. The family had accumulated $420 of
covered expenses before the divorce, as follows: $70 by each parent,
$200 by the oldest child, $80 by the youngest child, and none by the
other two children.
(ii) The resulting family consisting of the spouse and the two
oldest children accumulated a total of $270 of covered expenses, and
thus the remaining deductible for that family could be as high as $230
(because the plan would not have to count the incurred expenses of the
covered employee and the youngest child). The remaining deductible for
the resulting family consisting of the covered employee and the two
youngest children is not subject to the rules of this Q&A-2 because
their coverage is not COBRA continuation coverage.
Example 3. Each year a group health plan pays 70 percent of the cost
of an individual's psychotherapy after that individual's first
[[Page 313]]
three visits during the year. A qualified beneficiary whose election of
COBRA continuation coverage takes effect beginning August 1, 2001 and
who has already made two visits as of that date need only pay for one
more visit before the plan must begin to pay 70 percent of the cost of
the remaining visits during 2001.
Example 4. (i) A group health plan has a $250 annual deductible per
covered individual. The plan provides that if the deductible is not
satisfied in a particular year, expenses incurred during October through
December of that year are credited toward satisfaction of the deductible
in the next year. A qualified beneficiary who has incurred covered
expenses of $150 from January through September of 2001 and $40 during
October elects COBRA continuation coverage beginning November 1, 2001.
(ii) The remaining deductible amount for this qualified beneficiary
is $60 at the beginning of the COBRA continuation coverage. If this
individual incurs covered expenses of $50 in November and December of
2001 combined (so that the $250 deductible for 2001 is not satisfied),
the $90 incurred from October through December of 2001 are credited
toward satisfaction of the deductible amount for 2002.
Q-3: How do a plan's limits apply to COBRA continuation coverage?
A-3: (a) Limits are treated in the same way as deductibles (see Q&A-
2 of this section). This rule applies both to limits on plan benefits
(such as a maximum number of hospital days or dollar amount of
reimbursable expenses) and limits on out-of-pocket expenses (such as a
limit on copayments, a limit on deductibles plus copayments, or a
catastrophic limit). This rule applies equally to annual and lifetime
limits and applies equally to limits on specific benefits and limits on
benefits in the aggregate under the plan.
(b) The rule of this Q&A-3 is illustrated by the following examples;
in each example limits are determined on a calendar year basis:
Example 1. (i) A group health plan pays for a maximum of 150 days of
hospital confinement per individual per year. A covered employee who has
had 20 days of hospital confinement as of May 1, 2001 terminates
employment and elects COBRA continuation coverage as of that date.
(ii) During the remainder of the year 2001 the plan need only pay
for a maximum of 130 days of hospital confinement for this individual.
Example 2. (i) A group health plan reimburses a maximum of $20,000
of covered expenses per family per year, and the same $20,000 limit
applies to unmarried covered employees. A covered employee and spouse
who have no children divorce on May 1, 2001, and the spouse elects COBRA
continuation coverage as of that date. In 2001, the employee had
incurred $5,000 of expenses and the spouse had incurred $8,000 before
May 1.
(ii) The plan can limit its reimbursement of the amount of expenses
incurred by the spouse on and after May 1 for the remainder of the year
to $12,000 ($20,000-$8,000 = $12,000). The remaining limit for the
employee is not subject to the rules of this Q&A-3 because the
employee's coverage is not COBRA continuation coverage.
Example 3. (i) A group health plan pays for 80 percent of covered
expenses after satisfaction of a $100-per-individual deductible, and the
plan pays for 100 percent of covered expenses after a family has
incurred out-of-pocket costs of $2,000. The plan provides that upon the
divorce of a covered employee, coverage will end immediately for the
employee's spouse and any children who do not remain in the employee's
custody. An employee and spouse with three dependent children divorce on
June 1, 2001, and one of the children remains with the employee. The
spouse elects COBRA continuation coverage as of that date for the spouse
and the other two children. During January through May of 2001, the
spouse incurred $600 of covered expenses and each of the two children in
the spouse's custody after the divorce incurred covered expenses of
$1,100. This resulted in total out-of-pocket costs for these three
individuals of $800 ($300 total for the three deductibles, plus $500 for
20 percent of the other $2,500 in incurred expenses [$600 + $1,100 +
$1,100 = $2,800; $2,800-$300 = $2,500]).
(ii) For the remainder of 2001, the resulting family consisting of
the spouse and two children has an out-of-pocket limit of $1,200
($2,000-$800 = $1,200) . The remaining out-of-pocket limit for the
resulting family consisting of the employee and one child is not subject
to the rules of this Q&A-3 because their coverage is not COBRA
continuation coverage.
Q-4: Can a qualified beneficiary who elects COBRA continuation
coverage ever change from the coverage received by that individual
immediately before the qualifying event?
A-4: (a) In general, a qualified beneficiary need only be given an
opportunity to continue the coverage that she or he was receiving
immediately before the qualifying event. This is true regardless of
whether the coverage received by the qualified beneficiary before the
qualifying event ceases to be of value to the qualified beneficiary,
[[Page 314]]
such as in the case of a qualified beneficiary covered under a region-
specific health maintenance organization (HMO) who leaves the HMO's
service region. The only situations in which a qualified beneficiary
must be allowed to change from the coverage received immediately before
the qualifying event are as set forth in paragraphs (b) and (c) of this
Q&A-4 and in Q&A-1 of this section (regarding changes to or elimination
of the coverage provided to similarly situated nonCOBRA beneficiaries).
(b) If a qualified beneficiary participates in a region-specific
benefit package (such as an HMO or an on-site clinic) that will not
service her or his health needs in the area to which she or he is
relocating (regardless of the reason for the relocation), the qualified
beneficiary must be given, within a reasonable period after requesting
other coverage, an opportunity to elect alternative coverage that the
employer or employee organization makes available to active employees.
If the employer or employee organization makes group health plan
coverage available to similarly situated nonCOBRA beneficiaries that can
be extended in the area to which the qualified beneficiary is
relocating, then that coverage is the alternative coverage that must be
made available to the relocating qualified beneficiary. If the employer
or employee organization does not make group health plan coverage
available to similarly situated nonCOBRA beneficiaries that can be
extended in the area to which the qualified beneficiary is relocating
but makes coverage available to other employees that can be extended in
that area, then the coverage made available to those other employees
must be made available to the relocating qualified beneficiary. The
effective date of the alternative coverage must be not later than the
date of the qualified beneficiary's relocation, or, if later, the first
day of the month following the month in which the qualified beneficiary
requests the alternative coverage. However, the employer or employee
organization is not required to make any other coverage available to the
relocating qualified beneficiary if the only coverage the employer or
employee organization makes available to active employees is not
available in the area to which the qualified beneficiary relocates
(because all such coverage is region-specific and does not service
individuals in that area).
(c) If an employer or employee organization makes an open enrollment
period available to similarly situated active employees with respect to
whom a qualifying event has not occurred, the same open enrollment
period rights must be made available to each qualified beneficiary
receiving COBRA continuation coverage. An open enrollment period means a
period during which an employee covered under a plan can choose to be
covered under another group health plan or under another benefit package
within the same plan, or to add or eliminate coverage of family members.
(d) The rules of this Q&A-4 are illustrated by the following
examples:
Example 1. (i) E is an employee who works for an employer that
maintains several group health plans. Under the terms of the plans, if
an employee chooses to cover any family members under a plan, all family
members must be covered by the same plan and that plan must be the same
as the plan covering the employee. Immediately before E's termination of
employment (for reasons other than gross misconduct), E is covered along
with E's spouse and children by a plan. The coverage under that plan
will end as a result of the termination of employment.
(ii) Upon E's termination of employment, each of the four family
members is a qualified beneficiary. Even though the employer maintains
various other plans and options, it is not necessary for the qualified
beneficiaries to be allowed to switch to a new plan when E terminates
employment.
(iii) COBRA continuation coverage is elected for each of the four
family members. Three months after E's termination of employment there
is an open enrollment period during which similarly situated active
employees are offered an opportunity to choose to be covered under a new
plan or to add or eliminate family coverage.
(iv) During the open enrollment period, each of the four qualified
beneficiaries must be offered the opportunity to switch to another plan
(as though each qualified beneficiary were an individual employee). For
example, each member of E's family could choose coverage under a
separate plan, even though the family members of employed individuals
could not choose coverage under separate plans. Of course, if each
family
[[Page 315]]
member chooses COBRA continuation coverage under a separate plan, the
plan can require payment for each family member that is based on the
applicable premium for individual coverage under that separate plan. See
Q&A-1 of Sec. 54.4980B-8.
Example 2. (i) The facts are the same as in Example 1, except that
E's family members are not covered under E's group health plan when E
terminates employment.
(ii) Although the family members do not have to be given an
opportunity to elect COBRA continuation coverage, E must be allowed to
add them to E's COBRA continuation coverage during the open enrollment
period. This is true even though the family members are not, and cannot
become, qualified beneficiaries (see Q&A-1 of Sec. 54.4980B-3).
Q-5: Aside from open enrollment periods, can a qualified beneficiary
who has elected COBRA continuation coverage choose to cover individuals
(such as newborn children, adopted children, or new spouses) who join
the qualified beneficiary's family on or after the date of the
qualifying event?
A-5: (a) Yes. Under section 9801, employees eligible to participate
in a group health plan (whether or not participating), as well as former
employees participating in a plan (referred to in those rules as
participants), are entitled to special enrollment rights for certain
family members upon the loss of other group health plan coverage or upon
the acquisition by the employee or participant of a new spouse or of a
new dependent through birth, adoption, or placement for adoption, if
certain requirements are satisfied. Employees not participating in the
plan also can obtain rights for self-enrollment under those rules. Once
a qualified beneficiary is receiving COBRA continuation coverage (that
is, has timely elected and made timely payment for COBRA continuation
coverage), the qualified beneficiary has the same right to enroll family
members under those special enrollment rules as if the qualified
beneficiary were an employee or participant within the meaning of those
rules. However, neither a qualified beneficiary who is not receiving
COBRA continuation coverage nor a former qualified beneficiary has any
special enrollment rights under those rules.
(b) In addition to the special enrollment rights described in
paragraph (a) of this Q&A-5, if the plan covering the qualified
beneficiary provides that new family members of active employees can
become covered (either automatically or upon an appropriate election)
before the next open enrollment period, then the same right must be
extended to the new family members of a qualified beneficiary.
(c) If the addition of a new family member will result in a higher
applicable premium (for example, if the qualified beneficiary was
previously receiving COBRA continuation coverage as an individual, or if
the applicable premium for family coverage depends on family size), the
plan can require the payment of a correspondingly higher amount for the
COBRA continuation coverage. See Q&A-1 of Sec. 54.4980B-8.
(d) The right to add new family members under this Q&A-5 is in
addition to the rights that newborn and adopted children of covered
employees may have as qualified beneficiaries; see Q&A-1 in Sec.
54.4980B-3.
[T.D. 8812, 64 FR 5180, Feb. 3, 1999, as amended by T.D. 8928, 66 FR
1852, Jan. 10, 2001]
Sec. 54.4980B-6 Electing COBRA continuation coverage.
The following questions-and-answers address the manner in which
COBRA continuation coverage is elected:
Q-1: What is the election period and how long must it last?
A-1: (a) A group health plan can condition the availability of COBRA
continuation coverage upon the timely election of such coverage. An
election of COBRA continuation coverage is a timely election if it is
made during the election period. The election period must begin not
later than the date the qualified beneficiary would lose coverage on
account of the qualifying event. (See paragraph (c) of Q&A-1 of Sec.
54.4980B-4 for the meaning of lose coverage.) The election period must
not end before the date that is 60 days after the later of--
(1) The date the qualified beneficiary would lose coverage on
account of the qualifying event; or
(2) The date notice is provided to the qualified beneficiary of her
or his right to elect COBRA continuation coverage.
(b) An election is considered to be made on the date it is sent to
the plan administrator.
[[Page 316]]
(c) The rules of this Q&A-1 are illustrated by the following
example:
Example. (i) An unmarried employee without children who is receiving
employer-paid coverage under a group health plan voluntarily terminates
employment on June 1, 2001. The employee is not disabled at the time of
the termination of employment nor at any time thereafter, and the plan
does not provide for the extension of the required periods (as is
permitted under paragraph (b) of Q&A-4 of Sec. 54.4980B-7).
(ii) Case 1: If the plan provides that the employer-paid coverage
ends immediately upon the termination of employment, the election period
must begin not later than June 1, 2001, and must not end earlier than
July 31, 2001. If notice of the right to elect COBRA continuation
coverage is not provided to the employee until June 15, 2001, the
election period must not end earlier than August 14, 2001.
(iii) Case 2: If the plan provides that the employer-paid coverage
does not end until 6 months after the termination of employment, the
employee does not lose coverage until December 1, 2001. The election
period can therefore begin as late as December 1, 2001, and must not end
before January 30, 2002.
(iv) Case 3: If employer-paid coverage for 6 months after the
termination of employment is offered only to those qualified
beneficiaries who waive COBRA continuation coverage, the employee loses
coverage on June 1, 2001, so the election period is the same as in Case
1. The difference between Case 2 and Case 3 is that in Case 2 the
employee can receive 6 months of employer-paid coverage and then elect
to pay for up to an additional 12 months of COBRA continuation coverage,
while in Case 3 the employee must choose between 6 months of employer-
paid coverage and paying for up to 18 months of COBRA continuation
coverage. In all three cases, COBRA continuation coverage need not be
provided for more than 18 months after the termination of employment
(see Q&A-4 of Sec. 54.4980B-7), and in certain circumstances might be
provided for a shorter period (see Q&A-1 of Sec. 54.4980B-7).
Q-2: Is a covered employee or qualified beneficiary responsible for
informing the plan administrator of the occurrence of a qualifying
event?
A-2: (a) In general, the employer or plan administrator must
determine when a qualifying event has occurred. However, each covered
employee or qualified beneficiary is responsible for notifying the plan
administrator of the occurrence of a qualifying event that is either a
dependent child's ceasing to be a dependent child under the generally
applicable requirements of the plan or a divorce or legal separation of
a covered employee. The group health plan is not required to offer the
qualified beneficiary an opportunity to elect COBRA continuation
coverage if the notice is not provided to the plan administrator within
60 days after the later of--
(1) The date of the qualifying event; or
(2) The date the qualified beneficiary would lose coverage on
account of the qualifying event.
(b) For purposes of this Q&A-2, if more than one qualified
beneficiary would lose coverage on account of a divorce or legal
separation of a covered employee, a timely notice of the divorce or
legal separation that is provided by the covered employee or any one of
those qualified beneficiaries will be sufficient to preserve the
election rights of all of the qualified beneficiaries.
Q-3: During the election period and before the qualified beneficiary
has made an election, must coverage be provided?
A-3: (a) In general, each qualified beneficiary has until 60 days
after the later of the date the qualifying event would cause her or him
to lose coverage or the date notice is provided to the qualified
beneficiary of her or his right to elect COBRA continuation coverage to
decide whether to elect COBRA continuation coverage. If the election is
made during that period, coverage must be provided from the date that
coverage would otherwise have been lost (but see Q&A-4 of this section).
This can be accomplished as described in paragraph (b) or (c) of this
Q&A-3.
(b) In the case of an indemnity or reimbursement arrangement, the
employer or employee organization can provide for plan coverage during
the election period or, if the plan allows retroactive reinstatement,
the employer or employee organization can terminate the coverage of the
qualified beneficiary and reinstate her or him when the election (and,
if applicable, payment for the coverage) is made. Claims incurred by a
qualified beneficiary during the election period do not have to be paid
before the election (and, if applicable, payment for the
[[Page 317]]
coverage) is made. If a provider of health care (such as a physician,
hospital, or pharmacy) contacts the plan to confirm coverage of a
qualified beneficiary during the election period, the plan must give a
complete response to the health care provider about the qualified
beneficiary's COBRA continuation coverage rights during the election
period. For example, if the plan provides coverage during the election
period but cancels coverage retroactively if COBRA continuation coverage
is not elected, then the plan must inform a provider that a qualified
beneficiary for whom coverage has not been elected is covered but that
the coverage is subject to retroactive termination. Similarly, if the
plan cancels coverage but then retroactively reinstates it once COBRA
continuation coverage is elected, then the plan must inform the provider
that the qualified beneficiary currently does not have coverage but will
have coverage retroactively to the date coverage was lost if COBRA
continuation coverage is elected. (See paragraph (c) of Q&A-5 in Sec.
54.4980B-8 for similar rules that a plan must follow in confirming
coverage during a period when the plan has not received payment but that
is still within the grace period for a qualified beneficiary for whom
COBRA continuation coverage has been elected.)
(c)(1) In the case of a group health plan that provides health
services (such as a health maintenance organization or a walk-in
clinic), the plan can require with respect to a qualified beneficiary
who has not elected and paid for COBRA continuation coverage that the
qualified beneficiary choose between--
(i) Electing and paying for the coverage; or
(ii) Paying the reasonable and customary charge for the plan's
services, but only if a qualified beneficiary who chooses to pay for the
services will be reimbursed for that payment within 30 days after the
election of COBRA continuation coverage (and, if applicable, the payment
of any balance due for the coverage).
(2) In the alternative, the plan can provide continued coverage and
treat the qualified beneficiary's use of the facility as a constructive
election. In such a case, the qualified beneficiary is obligated to pay
any applicable charge for the coverage, but only if the qualified
beneficiary is informed that use of the facility will be a constructive
election before using the facility.
Q-4: Is a waiver before the end of the election period effective to
end a qualified beneficiary's election rights?
A-4: If, during the election period, a qualified beneficiary waives
COBRA continuation coverage, the waiver can be revoked at any time
before the end of the election period. Revocation of the waiver is an
election of COBRA continuation coverage. However, if a waiver of COBRA
continuation coverage is later revoked, coverage need not be provided
retroactively (that is, from the date of the loss of coverage until the
waiver is revoked). Waivers and revocations of waivers are considered
made on the date they are sent to the employer, employee organization,
or plan administrator, as applicable.
Q-5: Can an employer or employee organization withhold money or
other benefits owed to a qualified beneficiary until the qualified
beneficiary either waives COBRA continuation coverage, elects and pays
for such coverage, or allows the election period to expire?
A-5: No. An employer, and an employee organization, must not
withhold anything to which a qualified beneficiary is otherwise entitled
(by operation of law or other agreement) in order to compel payment for
COBRA continuation coverage or to coerce the qualified beneficiary to
give up rights to COBRA continuation coverage (including the right to
use the full election period to decide whether to elect such coverage).
Such a withholding constitutes a failure to comply with the COBRA
continuation coverage requirements. Furthermore, any purported waiver
obtained by means of such a withholding is invalid.
Q-6: Can each qualified beneficiary make an independent election
under COBRA?
A-6: Yes. Each qualified beneficiary (including a child who is born
to or placed for adoption with a covered employee during a period of
COBRA continuation coverage) must be offered the opportunity to make an
independent
[[Page 318]]
election to receive COBRA continuation coverage. If the plan allows
similarly situated active employees with respect to whom a qualifying
event has not occurred to choose among several options during an open
enrollment period (for example, to switch to another group health plan
or to another benefit package under the same group health plan), then
each qualified beneficiary must also be offered an independent election
to choose during an open enrollment period among the options made
available to similarly situated active employees with respect to whom a
qualifying event has not occurred. If a qualified beneficiary who is
either a covered employee or the spouse of a covered employee elects
COBRA continuation coverage and the election does not specify whether
the election is for self-only coverage, the election is deemed to
include an election of COBRA continuation coverage on behalf of all
other qualified beneficiaries with respect to that qualifying event. An
election on behalf of a minor child can be made by the child's parent or
legal guardian. An election on behalf of a qualified beneficiary who is
incapacitated or dies can be made by the legal representative of the
qualified beneficiary or the qualified beneficiary's estate, as
determined under applicable state law, or by the spouse of the qualified
beneficiary. (See also Q&A-5 of Sec. 54.4980B-7 relating to the
independent right of each qualified beneficiary with respect to the same
qualifying event to receive COBRA continuation coverage during the
disability extension.) The rules of this Q&A-6 are illustrated by the
following examples; in each example each group health plan is subject to
COBRA:
Example 1. (i) Employee H and H 's spouse are covered under a group
health plan immediately before H 's termination of employment (for
reasons other than gross misconduct). Coverage under the plan will end
as a result of the termination of employment.
(ii) Upon H 's termination of employment, both H and H 's spouse are
qualified beneficiaries and each must be allowed to elect COBRA
continuation coverage. Thus, H might elect COBRA continuation coverage
while the spouse declines to elect such coverage, or H might elect COBRA
continuation coverage for both of them. In contrast, H cannot decline
COBRA continuation coverage on behalf of H 's spouse. Thus, if H does
not elect COBRA continuation coverage on behalf of the spouse, the
spouse must still be allowed to elect COBRA continuation coverage.
Example 2. (i) An employer maintains a group health plan under which
all employees receive employer-paid coverage. Employees can arrange to
cover their families by paying an additional amount. The employer also
maintains a cafeteria plan, under which one of the options is to pay
part or all of the employee share of the cost for family coverage under
the group health plan. Thus, an employee might pay for family coverage
under the group health plan partly with before-tax dollars and partly
with after-tax dollars.
(ii) If an employee's family is receiving coverage under the group
health plan when a qualifying event occurs, each of the qualified
beneficiaries must be offered an opportunity to elect COBRA continuation
coverage, regardless of how that qualified beneficiary's coverage was
paid for before the qualifying event.
[T.D. 8812, 64 FR 5182, Feb. 3, 1999, as amended by T.D. 8928, 66 FR
1853, Jan. 10, 2001]
Sec. 54.4980B-7 Duration of COBRA continuation coverage.
The following questions-and-answers address the duration of COBRA
continuation coverage:
Q-1: How long must COBRA continuation coverage be made available to
a qualified beneficiary?
A-1: (a) Except for an interruption of coverage in connection with a
waiver, as described in Q&A-4 of Sec. 54.4980B-6, COBRA continuation
coverage that has been elected for a qualified beneficiary must extend
for at least the period beginning on the date of the qualifying event
and ending not before the earliest of the following dates--
(1) The last day of the maximum coverage period (see Q&A-4 of this
section);
(2) The first day for which timely payment is not made to the plan
with respect to the qualified beneficiary (see Q&A-5 in Sec. 54.4980B-
8);
(3) The date upon which the employer or employee organization ceases
to provide any group health plan (including successor plans) to any
employee;
(4) The date, after the date of the election, upon which the
qualified beneficiary first becomes covered under any other group health
plan, as described in Q&A-2 of this section;
[[Page 319]]
(5) The date, after the date of the election, upon which the
qualified beneficiary first becomes entitled to Medicare benefits, as
described in Q&A-3 of this section; and
(6) In the case of a qualified beneficiary entitled to a disability
extension (see Q&A-5 of this section), the later of--
(i) Either 29 months after the date of the qualifying event, or the
first day of the month that is more than 30 days after the date of a
final determination under Title II or XVI of the Social Security Act (42
U.S.C. 401-433 or 1381-1385) that the disabled qualified beneficiary
whose disability resulted in the qualified beneficiary's being entitled
to the disability extension is no longer disabled, whichever is earlier;
or
(ii) The end of the maximum coverage period that applies to the
qualified beneficiary without regard to the disability extension.
(b) However, a group health plan can terminate for cause the
coverage of a qualified beneficiary receiving COBRA continuation
coverage on the same basis that the plan terminates for cause the
coverage of similarly situated nonCOBRA beneficiaries. For example, if a
group health plan terminates the coverage of active employees for the
submission of a fraudulent claim, then the coverage of a qualified
beneficiary can also be terminated for the submission of a fraudulent
claim. Notwithstanding the preceding two sentences, the coverage of a
qualified beneficiary can be terminated for failure to make timely
payment to the plan only if payment is not timely under the rules of
Q&A-5 in Sec. 54.4980B-8.
(c) In the case of an individual who is not a qualified beneficiary
and who is receiving coverage under a group health plan solely because
of the individual's relationship to a qualified beneficiary, if the
plan's obligation to make COBRA continuation coverage available to the
qualified beneficiary ceases under this section, the plan is not
obligated to make coverage available to the individual who is not a
qualified beneficiary.
Q-2: When may a plan terminate a qualified beneficiary's COBRA
continuation coverage due to coverage under another group health plan?
A-2: (a) If a qualified beneficiary first becomes covered under
another group health plan (including for this purpose any group health
plan of a governmental employer or employee organization) after the date
on which COBRA continuation coverage is elected for the qualified
beneficiary and the other coverage satisfies the requirements of
paragraphs (b), (c), and (d) of this Q&A-2, then the plan may terminate
the qualified beneficiary's COBRA continuation coverage upon the date on
which the qualified beneficiary first becomes covered under the other
group health plan (even if the other coverage is less valuable to the
qualified beneficiary). By contrast, if a qualified beneficiary first
becomes covered under another group health plan on or before the date on
which COBRA continuation coverage is elected, then the other coverage
cannot be a basis for terminating the qualified beneficiary's COBRA
continuation coverage.
(b) The requirement of this paragraph (b) is satisfied if the
qualified beneficiary is actually covered, rather than merely eligible
to be covered, under the other group health plan.
(c) The requirement of this paragraph (c) is satisfied if the other
group health plan is a plan that is not maintained by the employer or
employee organization that maintains the plan under which COBRA
continuation coverage must otherwise be made available.
(d) The requirement of this paragraph (d) is satisfied if the other
group health plan does not contain any exclusion or limitation with
respect to any preexisting condition of the qualified beneficiary (other
than such an exclusion or limitation that does not apply to, or is
satisfied by, the qualified beneficiary by reason of the provisions in
section 9801 (relating to limitations on preexisting condition exclusion
periods in group health plans)).
(e) The rules of this Q&A-2 are illustrated by the following
examples:
Example 1. (i) Employer X maintains a group health plan subject to
COBRA. C is an employee covered under the plan. C is also covered under
a group health plan maintained by Employer Y, the employer of C 's
[[Page 320]]
spouse. C terminates employment (for reasons other than gross
misconduct), and the termination of employment causes C to lose coverage
under X 's plan (and, thus, is a qualifying event). C elects to receive
COBRA continuation coverage under X 's plan.
(ii) Under these facts, X 's plan cannot terminate C 's COBRA
continuation coverage on the basis of C 's coverage under Y 's plan.
Example 2. (i) Employer W maintains a group health plan subject to
COBRA. D is an employee covered under the plan. D terminates employment
(for reasons other than gross misconduct), and the termination of
employment causes D to lose coverage under W 's plan (and, thus, is a
qualifying event). D elects to receive COBRA continuation coverage under
W 's plan. Later D becomes employed by Employer V and is covered under V
's group health plan. D 's coverage under V 's plan is not subject to
any exclusion or limitation with respect to any preexisting condition of
D.
(ii) Under these facts, W can terminate D 's COBRA continuation
coverage on the date D becomes covered under V 's plan.
Example 3. (i) The facts are the same as in Example 2, except that D
becomes employed by V and becomes covered under V 's group health plan
before D elects COBRA continuation coverage under W 's plan.
(ii) Because the termination of employment is a qualifying event, D
must be offered COBRA continuation coverage under W 's plan, and W is
not permitted to terminate D 's COBRA continuation coverage on account
of D 's coverage under V 's plan because D first became covered under V
's plan before COBRA continuation coverage was elected for D.
Q-3: When may a plan terminate a qualified beneficiary's COBRA
continuation coverage due to the qualified beneficiary's entitlement to
Medicare benefits?
A-3: (a) If a qualified beneficiary first becomes entitled to
Medicare benefits under Title XVIII of the Social Security Act (42
U.S.C. 1395-1395ggg) after the date on which COBRA continuation coverage
is elected for the qualified beneficiary, then the plan may terminate
the qualified beneficiary's COBRA continuation coverage upon the date on
which the qualified beneficiary becomes so entitled. By contrast, if a
qualified beneficiary first becomes entitled to Medicare benefits on or
before the date that COBRA continuation coverage is elected, then the
qualified beneficiary's entitlement to Medicare benefits cannot be a
basis for terminating the qualified beneficiary's COBRA continuation
coverage.
(b) A qualified beneficiary becomes entitled to Medicare benefits
upon the effective date of enrollment in either part A or B, whichever
occurs earlier. Thus, merely being eligible to enroll in Medicare does
not constitute being entitled to Medicare benefits.
Q-4: When does the maximum coverage period end?
A-4: (a) Except as otherwise provided in this Q&A-4, the maximum
coverage period ends 36 months after the qualifying event. The maximum
coverage period for a qualified beneficiary who is a child born to or
placed for adoption with a covered employee during a period of COBRA
continuation coverage is the maximum coverage period for the qualifying
event giving rise to the period of COBRA continuation coverage during
which the child was born or placed for adoption. Paragraph (b) of this
Q&A-4 describes the starting point from which the end of the maximum
coverage period is measured. The date that the maximum coverage period
ends is described in paragraph (c) of this Q&A-4 in a case where the
qualifying event is a termination of employment or reduction of hours of
employment, in paragraph (d) of this Q&A-4 in a case where a covered
employee becomes entitled to Medicare benefits under Title XVIII of the
Social Security Act (42 U.S.C. 1395-1395ggg) before experiencing a
qualifying event that is a termination of employment or reduction of
hours of employment, and in paragraph (e) of this Q&A-4 in the case of a
qualifying event that is the bankruptcy of the employer. See Q&A-8 of
Sec. 54.4980B-2 for limitations that apply to certain health flexible
spending arrangements. See also Q&A-6 of this section in the case of
multiple qualifying events. Nothing in Sec. Sec. 54.4980B-1 through
54.4980B-10 prohibits a group health plan from providing coverage that
continues beyond the end of the maximum coverage period.
(b)(1) The end of the maximum coverage period is measured from the
date of the qualifying event even if the qualifying event does not
result in a loss of coverage under the plan until a later date. If,
however, coverage under the plan is lost at a later date and the
[[Page 321]]
plan provides for the extension of the required periods, then the
maximum coverage period is measured from the date when coverage is lost.
A plan provides for the extension of the required periods if it provides
both--
(i) That the 30-day notice period (during which the employer is
required to notify the plan administrator of the occurrence of certain
qualifying events such as the death of the covered employee or the
termination of employment or reduction of hours of employment of the
covered employee) begins on the date of the loss of coverage rather than
on the date of the qualifying event; and
(ii) That the end of the maximum coverage period is measured from
the date of the loss of coverage rather than from the date of the
qualifying event.
(2) In the case of a plan that provides for the extension of the
required periods, whenever the rules of Sec. Sec. 54.4980B-1 through
54.4980B-10 refer to the measurement of a period from the date of the
qualifying event, those rules apply in such a case by measuring the
period instead from the date of the loss of coverage.
(c) In the case of a qualifying event that is a termination of
employment or reduction of hours of employment, the maximum coverage
period ends 18 months after the qualifying event if there is no
disability extension, and 29 months after the qualifying event if there
is a disability extension. See Q&A-5 of this section for rules to
determine if there is a disability extension. If there is a disability
extension and the disabled qualified beneficiary is later determined to
no longer be disabled, then a plan may terminate the COBRA continuation
coverage of an affected qualified beneficiary before the end of the
disability extension; see paragraph (a)(6) in Q&A-1 of this section.
(d)(1) If a covered employee becomes entitled to Medicare benefits
under Title XVIII of the Social Security Act (42 U.S.C. 1395-1395ggg)
before experiencing a qualifying event that is a termination of
employment or reduction of hours of employment, the maximum coverage
period for qualified beneficiaries other than the covered employee ends
on the later of--
(i) 36 months after the date the covered employee became entitled to
Medicare benefits; or
(ii) 18 months (or 29 months, if there is a disability extension)
after the date of the covered employee's termination of employment or
reduction of hours of employment.
(2) See paragraph (b) of Q&A-3 of this section regarding the
determination of when a covered employee becomes entitled to Medicare
benefits.
(e) In the case of a qualifying event that is the bankruptcy of the
employer, the maximum coverage period for a qualified beneficiary who is
the retired covered employee ends on the date of the retired covered
employee's death. The maximum coverage period for a qualified
beneficiary who is the spouse, surviving spouse, or dependent child of
the retired covered employee ends on the earlier of--
(1) The date of the qualified beneficiary's death; or
(2) The date that is 36 months after the death of the retired
covered employee.
Q-5: How does a qualified beneficiary become entitled to a
disability extension?
A-5: (a) A qualified beneficiary becomes entitled to a disability
extension if the requirements of paragraphs (b), (c), and (d) of this
Q&A-5 are satisfied with respect to the qualified beneficiary. If the
disability extension applies with respect to a qualifying event, it
applies with respect to each qualified beneficiary entitled to COBRA
continuation coverage because of that qualifying event. Thus, for
example, the 29-month maximum coverage period applies to each qualified
beneficiary who is not disabled as well as to the qualified beneficiary
who is disabled, and it applies independently with respect to each of
the qualified beneficiaries. See Q&A-1 in Sec. 54.4980B-8, which
permits a plan to require payment of an increased amount during the
disability extension.
(b) The requirement of this paragraph (b) is satisfied if a
qualifying event occurs that is a termination, or reduction of hours, of
a covered employee's employment.
(c) The requirement of this paragraph (c) is satisfied if an
individual (whether
[[Page 322]]
or not the covered employee) who is a qualified beneficiary in
connection with the qualifying event described in paragraph (b) of this
Q&A-5 is determined under Title II or XVI of the Social Security Act (42
U.S.C. 401-433 or 1381-1385) to have been disabled at any time during
the first 60 days of COBRA continuation coverage. For this purpose, the
period of the first 60 days of COBRA continuation coverage is measured
from the date of the qualifying event described in paragraph (b) of this
Q&A-5 (except that if a loss of coverage would occur at a later date in
the absence of an election for COBRA continuation coverage and if the
plan provides for the extension of the required periods (as described in
paragraph (b) of Q&A-4 of this section) then the period of the first 60
days of COBRA continuation coverage is measured from the date on which
the coverage would be lost). However, in the case of a qualified
beneficiary who is a child born to or placed for adoption with a covered
employee during a period of COBRA continuation coverage, the period of
the first 60 days of COBRA continuation coverage is measured from the
date of birth or placement for adoption. For purposes of this paragraph
(c), an individual is determined to be disabled within the first 60 days
of COBRA continuation coverage if the individual has been determined
under Title II or XVI of the Social Security Act to have been disabled
before the first day of COBRA continuation coverage and has not been
determined to be no longer disabled at any time between the date of that
disability determination and the first day of COBRA continuation
coverage.
(d) The requirement of this paragraph (d) is satisfied if any of the
qualified beneficiaries affected by the qualifying event described in
paragraph (b) of this Q&A-5 provides notice to the plan administrator of
the disability determination on a date that is both within 60 days after
the date the determination is issued and before the end of the original
18-month maximum coverage period that applies to the qualifying event.
Q-6: Under what circumstances can the maximum coverage period be
expanded?
A-6: (a) The maximum coverage period can be expanded if the
requirements of Q&A-5 of this section (relating to the disability
extension) or paragraph (b) of this Q&A-6 are satisfied.
(b) The requirements of this paragraph (b) are satisfied if a
qualifying event that gives rise to an 18-month maximum coverage period
(or a 29-month maximum coverage period in the case of a disability
extension) is followed, within that 18-month period (or within that 29-
month period, in the case of a disability extension), by a second
qualifying event (for example, a death or a divorce) that gives rise to
a 36-month maximum coverage period. (Thus, a termination of employment
following a qualifying event that is a reduction of hours of employment
cannot be a second qualifying event that expands the maximum coverage
period; the bankruptcy of an employer also cannot be a second qualifying
event that expands the maximum coverage period.) In such a case, the
original 18-month period (or 29-month period, in the case of a
disability extension) is expanded to 36 months, but only for those
individuals who were qualified beneficiaries under the group health plan
in connection with the first qualifying event and who are still
qualified beneficiaries at the time of the second qualifying event. No
qualifying event (other than a qualifying event that is the bankruptcy
of the employer) can give rise to a maximum coverage period that ends
more than 36 months after the date of the first qualifying event (or
more than 36 months after the date of the loss of coverage, in the case
of a plan that provides for the extension of the required periods; see
paragraph (b) in Q&A-4 of this section). For example, if an employee
covered by a group health plan that is subject to COBRA terminates
employment (for reasons other than gross misconduct) on December 31,
2000, the termination is a qualifying event giving rise to a maximum
coverage period that extends for 18 months to June 30, 2002. If the
employee dies after the employee and the employee's spouse and dependent
children have elected COBRA continuation coverage and on or before June
30, 2002, the spouse and dependent children (except anyone among them
[[Page 323]]
whose COBRA continuation coverage had already ended for some other
reason) will be able to receive COBRA continuation coverage through
December 31, 2003. See Q&A-8(b) of Sec. 54.4980B-2 for a special rule
that applies to certain health flexible spending arrangements.
Q-7: If health coverage is provided to a qualified beneficiary after
a qualifying event without regard to COBRA continuation coverage (for
example, as a result of state or local law, the Uniformed Services
Employment and Reemployment Rights Act of 1994 (38 U.S.C. 4315),
industry practice, a collective bargaining agreement, severance
agreement, or plan procedure), will such alternative coverage extend the
maximum coverage period?
A-7: (a) No. The end of the maximum coverage period is measured
solely as described in Q&A-4 and Q&A-6 of this section, which is
generally from the date of the qualifying event.
(b) If the alternative coverage does not satisfy all the
requirements for COBRA continuation coverage, or if the amount that the
group health plan requires to be paid for the alternative coverage is
greater than the amount required to be paid by similarly situated
nonCOBRA beneficiaries for the coverage that the qualified beneficiary
can elect to receive as COBRA continuation coverage, the plan covering
the qualified beneficiary immediately before the qualifying event must
offer the qualified beneficiary receiving the alternative coverage the
opportunity to elect COBRA continuation coverage. See Q&A-1 of Sec.
54.4980B-6.
(c) If an individual rejects COBRA continuation coverage in favor of
alternative coverage, then, at the expiration of the alternative
coverage period, the individual need not be offered a COBRA election.
However, if the individual receiving alternative coverage is a covered
employee and the spouse or a dependent child of the individual would
lose that alternative coverage as a result of a qualifying event (such
as the death of the covered employee), the spouse or dependent child
must be given an opportunity to elect to continue that alternative
coverage, with a maximum coverage period of 36 months measured from the
date of that qualifying event.
Q-8: Must a qualified beneficiary be given the right to enroll in a
conversion health plan at the end of the maximum coverage period for
COBRA continuation coverage?
A-8: If a qualified beneficiary's COBRA continuation coverage under
a group health plan ends as a result of the expiration of the maximum
coverage period, the group health plan must, during the 180-day period
that ends on that expiration date, provide the qualified beneficiary the
option of enrolling under a conversion health plan if such an option is
otherwise generally available to similarly situated nonCOBRA
beneficiaries under the group health plan. If such a conversion option
is not otherwise generally available, it need not be made available to
qualified beneficiaries.
[T.D. 8812, 64 FR 5184, Feb. 3, 1999, as amended by T.D. 8928, 66 FR
1853, Jan. 10, 2001]
Sec. 54.4980B-8 Paying for COBRA continuation coverage.
The following questions-and-answers address paying for COBRA
continuation coverage:
Q-1: Can a group health plan require payment for COBRA continuation
coverage?
A-1: (a) Yes. For any period of COBRA continuation coverage, a group
health plan can require the payment of an amount that does not exceed
102 percent of the applicable premium for that period. (See paragraph
(b) of this Q&A-1 for a rule permitting a plan to require payment of an
increased amount due to the disability extension.) The applicable
premium is defined in section 4980B(f)(4). A group health plan can
terminate a qualified beneficiary's COBRA continuation coverage as of
the first day of any period for which timely payment is not made to the
plan with respect to that qualified beneficiary (see Q&A-1 of Sec.
54.4980B-7). For the meaning of timely payment, see Q&A-5 of this
section.
(b) A group health plan is permitted to require the payment of an
amount that does not exceed 150 percent of the applicable premium for
any period of COBRA continuation coverage covering
[[Page 324]]
a disabled qualified beneficiary (for example, whether single or family
coverage) if the coverage would not be required to be made available in
the absence of a disability extension. (See Q&A-5 of Sec. 54.4980B-7
for rules to determine whether a qualified beneficiary is entitled to a
disability extension.) A plan is not permitted to require the payment of
an amount that exceeds 102 percent of the applicable premium for any
period of COBRA continuation coverage to which a qualified beneficiary
is entitled without regard to the disability extension. Thus, if a
qualified beneficiary entitled to a disability extension experiences a
second qualifying event within the original 18-month maximum coverage
period, then the plan is not permitted to require the payment of an
amount that exceeds 102 percent of the applicable premium for any period
of COBRA continuation coverage. By contrast, if a qualified beneficiary
entitled to a disability extension experiences a second qualifying event
after the end of the original 18-month maximum coverage period, then the
plan may require the payment of an amount that is up to 150 percent of
the applicable premium for the remainder of the period of COBRA
continuation coverage (that is, from the beginning of the 19th month
through the end of the 36th month) as long as the disabled qualified
beneficiary is included in that coverage. The rules of this paragraph
(b) are illustrated by the following examples; in each example the group
health plan is subject to COBRA:
Example 1. (i) An employer maintains a group health plan. The plan
determines the cost of covering individuals under the plan by reference
to two categories, individual coverage and family coverage, and the
applicable premium is determined for those two categories. An employee
and members of the employee's family are covered under the plan. The
employee experiences a qualifying event that is the termination of the
employee's employment. The employee's family qualifies for the
disability extension because of the disability of the employee's spouse.
(Timely notice of the disability is provided to the plan administrator.)
Timely payment of the amount required by the plan for COBRA continuation
coverage for the family (which does not exceed 102 percent of the cost
of family coverage under the plan) was made to the plan with respect to
the employee's family for the first 18 months of COBRA continuation
coverage, and the disabled spouse and the rest of the family continue to
receive COBRA continuation coverage through the 29th month.
(ii) Under these facts, the plan may require payment of up to 150
percent of the applicable premium for family coverage in order for the
family to receive COBRA continuation coverage from the 19th month
through the 29th month. If the plan determined the cost of coverage by
reference to three categories (such as employee, employee-plus-one-
dependent, employee-plus-two-or-more-dependents) or more than three
categories, instead of two categories, the plan could still require,
from the 19th month through the 29th month of COBRA continuation
coverage, the payment of 150 percent of the cost of coverage for the
category of coverage that included the disabled spouse.
Example 2. (i) The facts are the same as in Example 1, except that
only the covered employee elects and pays for the first 18 months of
COBRA continuation coverage.
(ii) Even though the employee's disabled spouse does not elect or
pay for COBRA continuation coverage, the employee satisfies the
requirements for the disability extension to apply with respect to the
employee's qualifying event. Under these facts, the plan may not require
the payment of more than 102 percent of the applicable premium for
individual coverage for the entire period of the employee's COBRA
continuation coverage, including the period from the 19th month through
the 29th month. If COBRA continuation coverage had been elected and paid
for with respect to other nondisabled members of the employee's family,
then the plan could not require the payment of more than 102 percent of
the applicable premium for family coverage (or for any other appropriate
category of coverage that might apply to that group of qualified
beneficiaries under the plan, such as employee-plus-one-dependent or
employee-plus-two-or-more-dependents) for those family members to
continue their coverage from the 19th month through the 29th month.
(c) A group health plan does not fail to comply with section 9802(b)
(which generally prohibits an individual from being charged, on the
basis of health status, a higher premium than that charged for similarly
situated individuals enrolled in the plan) with respect to a qualified
beneficiary entitled to the disability extension merely because the plan
requires payment of an amount permitted under paragraph (b) of this Q&A-
1.
Q-2: When is the applicable premium determined and when can a group
[[Page 325]]
health plan increase the amount it requires to be paid for COBRA
continuation coverage?
A-2: (a) The applicable premium for each determination period must
be computed and fixed by a group health plan before the determination
period begins. A determination period is any 12-month period selected by
the plan, but it must be applied consistently from year to year. The
determination period is a single period for any benefit package. Thus,
each qualified beneficiary does not have a separate determination period
beginning on the date (or anniversaries of the date) that COBRA
continuation coverage begins for that qualified beneficiary.
(b) During a determination period, a plan can increase the amount it
requires to be paid for a qualified beneficiary's COBRA continuation
coverage only in the following three cases:
(1) The plan has previously charged less than the maximum amount
permitted under Q&A-1 of this section and the increased amount required
to be paid does not exceed the maximum amount permitted under Q&A-1 of
this section;
(2) The increase occurs during the disability extension and the
increased amount required to be paid does not exceed the maximum amount
permitted under paragraph (b) of Q&A-1 of this section; or
(3) A qualified beneficiary changes the coverage being received (see
paragraph (c) of this Q&A-2 for rules on how the amount the plan
requires to be paid may or must change when a qualified beneficiary
changes the coverage being received).
(c) If a plan allows similarly situated active employees who have
not experienced a qualifying event to change the coverage they are
receiving, then the plan must also allow each qualified beneficiary to
change the coverage being received on the same terms as the similarly
situated active employees. (See Q&A-4 in Sec. 54.4980B-5.) If a
qualified beneficiary changes coverage from one benefit package (or a
group of benefit packages) to another benefit package (or another group
of benefit packages), or adds or eliminates coverage for family members,
then the following rules apply. If the change in coverage is to a
benefit package, group of benefit packages, or coverage unit (such as
family coverage, self-plus-one-dependent, or self-plus-two-or-more-
dependents) for which the applicable premium is higher, then the plan
may increase the amount that it requires to be paid for COBRA
continuation coverage to an amount that does not exceed the amount
permitted under Q&A-1 of this section as applied to the new coverage. If
the change in coverage is to a benefit package, group of benefit
packages, or coverage unit (such as individual or self-plus-one-
dependent) for which the applicable premium is lower, then the plan
cannot require the payment of an amount that exceeds the amount
permitted under Q&A-1 of this section as applied to the new coverage.
Q-3: Must a plan allow payment for COBRA continuation coverage to be
made in monthly installments?
A-3: Yes. A group health plan must allow payment for COBRA
continuation coverage to be made in monthly installments. A group health
plan is permitted to also allow the alternative of payment for COBRA
continuation coverage being made at other intervals (for example,
weekly, quarterly, or semiannually).
Q-4: Is a plan required to allow a qualified beneficiary to choose
to have the first payment for COBRA continuation coverage applied
prospectively only?
A-4: No. A plan is permitted to apply the first payment for COBRA
continuation coverage to the period of coverage beginning immediately
after the date on which coverage under the plan would have been lost on
account of the qualifying event. Of course, if the group health plan
allows a qualified beneficiary to waive COBRA continuation coverage for
any period before electing to receive COBRA continuation coverage, the
first payment is not applied to the period of the waiver.
Q-5: What is timely payment for COBRA continuation coverage?
A-5: (a) Except as provided in this paragraph (a) or in paragraph
(b) or (d) of this Q&A-5, timely payment for a period of COBRA
continuation coverage under a group health plan means payment that is
made to the plan by the date that is 30 days after the first
[[Page 326]]
day of that period. Payment that is made to the plan by a later date is
also considered timely payment if either--
(1) Under the terms of the plan, covered employees or qualified
beneficiaries are allowed until that later date to pay for their
coverage for the period; or
(2) Under the terms of an arrangement between the employer or
employee organization and an insurance company, health maintenance
organization, or other entity that provides plan benefits on the
employer's or employee organization's behalf, the employer or employee
organization is allowed until that later date to pay for coverage of
similarly situated nonCOBRA beneficiaries for the period.
(b) Notwithstanding paragraph (a) of this Q&A-5, a plan cannot
require payment for any period of COBRA continuation coverage for a
qualified beneficiary earlier than 45 days after the date on which the
election of COBRA continuation coverage is made for that qualified
beneficiary.
(c) If, after COBRA continuation coverage has been elected for a
qualified beneficiary, a provider of health care (such as a physician,
hospital, or pharmacy) contacts the plan to confirm coverage of a
qualified beneficiary for a period for which the plan has not yet
received payment, the plan must give a complete response to the health
care provider about the qualified beneficiary's COBRA continuation
coverage rights, if any, described in paragraphs (a), (b), and (d) of
this Q&A-5. For example, if the plan provides coverage during the 30-
and 45-day grace periods described in paragraphs (a) and (b) of this
Q&A-5 but cancels coverage retroactively if payment is not made by the
end of the applicable grace period, then the plan must inform a provider
with respect to a qualified beneficiary for whom payment has not been
received that the qualified beneficiary is covered but that the coverage
is subject to retroactive termination if timely payment is not made.
Similarly, if the plan cancels coverage if it has not received payment
by the first day of a period of coverage but retroactively reinstates
coverage if payment is made by the end of the grace period for that
period of coverage, then the plan must inform the provider that the
qualified beneficiary currently does not have coverage but will have
coverage retroactively to the first date of the period if timely payment
is made. (See paragraph (b) of Q&A-3 in Sec. 54.4980B-6 for similar
rules that the plan must follow in confirming coverage during the
election period.)
(d) If timely payment is made to the plan in an amount that is not
significantly less than the amount the plan requires to be paid for a
period of coverage, then the amount paid is deemed to satisfy the plan's
requirement for the amount that must be paid, unless the plan notifies
the qualified beneficiary of the amount of the deficiency and grants a
reasonable period of time for payment of the deficiency to be made. For
this purpose, as a safe harbor, 30 days after the date the notice is
provided is deemed to be a reasonable period of time. An amount is not
significantly less than the amount the plan requires to be paid for a
period of coverage if and only if the shortfall is no greater than the
lesser of the following two amounts:
(1) Fifty dollars (or such other amount as the Commissioner may
provide in a revenue ruling, notice, or other guidance published in the
Internal Revenue Bulletin (see Sec. 601.601(d)(2)(ii) of this
chapter)); or
(2) 10 percent of the amount the plan requires to be paid.
(e) Payment is considered made on the date on which it is sent to
the plan.
[T.D. 8812, 64 FR 5186, Feb. 3, 1999, as amended by T.D. 8928, 66 FR
1854, Jan. 10, 2001]
Sec. 54.4980B-9 Business reorganizations and employer withdrawals from multiemployer plans.
The following questions-and-answers address who has the obligation
to make COBRA continuation coverage available to affected qualified
beneficiaries in the context of business reorganizations and employer
withdrawals from multiemployer plans:
Q-1: For purposes of this section, what are a business
reorganization, a stock sale, and an asset sale?
A-1: For purposes of this section:
(a) A business reorganization is a stock sale or an asset sale.
[[Page 327]]
(b) A stock sale is a transfer of stock in a corporation that causes
the corporation to become a different employer or a member of a
different employer. (See Q&A-2 of Sec. 54.4980B-2, which defines
employer to include all members of a controlled group of corporations.)
Thus, for example, a sale or distribution of stock in a corporation that
causes the corporation to cease to be a member of one controlled group
of corporations, whether or not it becomes a member of another
controlled group of corporations, is a stock sale.
(c) An asset sale is a transfer of substantial assets, such as a
plant or division or substantially all the assets of a trade or
business.
(d) The rules of Sec. 1.414(b)-1 of this chapter apply in
determining what constitutes a controlled group of corporations, and the
rules of Sec. Sec. 1.414(c)-1 through 1.414(c)-5 of this chapter apply
in determining what constitutes a group of trades or businesses under
common control.
Q-2: In the case of a stock sale, what are the selling group, the
acquired organization, and the buying group?
A-2: In the case of a stock sale--
(a) The selling group is the controlled group of corporations, or
the group of trades or businesses under common control, of which a
corporation ceases to be a member as a result of the stock sale;
(b) The acquired organization is the corporation that ceases to be a
member of the selling group as a result of the stock sale; and
(c) The buying group is the controlled group of corporations, or the
group of trades or businesses under common control, of which the
acquired organization becomes a member as a result of the stock sale. If
the acquired organization does not become a member of such a group, the
buying group is the acquired organization.
Q-3: In the case of an asset sale, what are the selling group and
the buying group?
A-3: In the case of an asset sale--
(a) The selling group is the controlled group of corporations or the
group of trades or businesses under common control that includes the
corporation or other trade or business that is selling the assets; and
(b) The buying group is the controlled group of corporations or the
group of trades or businesses under common control that includes the
corporation or other trade or business that is buying the assets.
Q-4: Who is an M&A qualified beneficiary?
A-4: (a) Asset sales: In the case of an asset sale, an individual is
an M&A qualified beneficiary if the individual is a qualified
beneficiary whose qualifying event occurred prior to or in connection
with the sale and who is, or whose qualifying event occurred in
connection with, a covered employee whose last employment prior to the
qualifying event was associated with the assets being sold.
(b) Stock sales: In the case of a stock sale, an individual is an
M&A qualified beneficiary if the individual is a qualified beneficiary
whose qualifying event occurred prior to or in connection with the sale
and who is, or whose qualifying event occurred in connection with, a
covered employee whose last employment prior to the qualifying event was
with the acquired organization.
(c) In the case of a qualified beneficiary who has experienced more
than one qualifying event with respect to her or his current right to
COBRA continuation coverage, the qualifying event referred to in
paragraphs (a) and (b) of this Q&A-4 is the first qualifying event.
Q-5: In the case of a stock sale, is the sale a qualifying event
with respect to a covered employee who is employed by the acquired
organization before the sale and who continues to be employed by the
acquired organization after the sale, or with respect to the spouse or
dependent children of such a covered employee?
A-5: No. A covered employee who continues to be employed by the
acquired organization after the sale does not experience a termination
of employment as a result of the sale. Accordingly, the sale is not a
qualifying event with respect to the covered employee, or with respect
to the covered employee's spouse or dependent children, regardless of
whether they are provided with group health coverage after the sale, and
neither the covered
[[Page 328]]
employee, nor the covered employee's spouse or dependent children,
become qualified beneficiaries as a result of the sale.
Q-6: In the case of an asset sale, is the sale a qualifying event
with respect to a covered employee whose employment immediately before
the sale was associated with the purchased assets, or with respect to
the spouse or dependent children of such a covered employee who are
covered under a group health plan of the selling group immediately
before the sale?
A-6: (a) Yes, unless--
(1) The buying group is a successor employer under paragraph (c) of
Q&A-8 of this section or Q&A-2 of Sec. 54.4980B-2, and the covered
employee is employed by the buying group immediately after the sale; or
(2) The covered employee (or the spouse or any dependent child of
the covered employee) does not lose coverage (within the meaning of
paragraph (c) in Q&A-1 of Sec. 54.4980B-4) under a group health plan of
the selling group after the sale.
(b) Unless the conditions in paragraph (a)(1) or (2) of this Q&A-6
are satisfied, such a covered employee experiences a termination of
employment with the selling group as a result of the asset sale,
regardless of whether the covered employee is employed by the buying
group or whether the covered employee's employment is associated with
the purchased assets after the sale. Accordingly, the covered employee,
and the spouse and dependent children of the covered employee who lose
coverage under a plan of the selling group in connection with the sale,
are M&A qualified beneficiaries in connection with the sale.
Q-7: In a business reorganization, are the buying group and the
selling group permitted to allocate by contract the responsibility to
make COBRA continuation coverage available to M&A qualified
beneficiaries?
A-7: Yes. Nothing in this section prohibits a selling group and a
buying group from allocating to one or the other of the parties in a
purchase agreement the responsibility to provide the coverage required
under Sec. Sec. 54.4980B-1 through 54.4980B-10. However, if and to the
extent that the party assigned this responsibility under the terms of
the contract fails to perform, the party who has the obligation under
Q&A-8 of this section to make COBRA continuation coverage available to
M&A qualified beneficiaries continues to have that obligation.
Q-8: Which group health plan has the obligation to make COBRA
continuation coverage available to M&A qualified beneficiaries in a
business reorganization?
A-8: (a) In the case of a business reorganization (whether a stock
sale or an asset sale), so long as the selling group maintains a group
health plan after the sale, a group health plan maintained by the
selling group has the obligation to make COBRA continuation coverage
available to M&A qualified beneficiaries with respect to that sale. This
Q&A-8 prescribes rules for cases in which the selling group ceases to
provide any group health plan to any employee in connection with the
sale. Paragraph (b) of this Q&A-8 contains these rules for stock sales,
and paragraph (c) of this Q&A-8 contains these rules for asset sales.
Neither a stock sale nor an asset sale has any effect on the COBRA
continuation coverage requirements applicable to any group health plan
for any period before the sale.
(b)(1) In the case of a stock sale, if the selling group ceases to
provide any group health plan to any employee in connection with the
sale, a group health plan maintained by the buying group has the
obligation to make COBRA continuation coverage available to M&A
qualified beneficiaries with respect to that stock sale. A group health
plan of the buying group has this obligation beginning on the later of
the following two dates and continuing as long as the buying group
continues to maintain a group health plan (but subject to the rules in
Sec. 54.4980B-7, relating to the duration of COBRA continuation
coverage)--
(i) The date the selling group ceases to provide any group health
plan to any employee; or
(ii) The date of the stock sale.
(2) The determination of whether the selling group's cessation of
providing any group health plan to any employee
[[Page 329]]
is in connection with the stock sale is based on all of the relevant
facts and circumstances. A group health plan of the buying group does
not, as a result of the stock sale, have an obligation to make COBRA
continuation coverage available to those qualified beneficiaries of the
selling group who are not M&A qualified beneficiaries with respect to
that sale.
(c)(1) In the case of an asset sale, if the selling group ceases to
provide any group health plan to any employee in connection with the
sale and if the buying group continues the business operations
associated with the assets purchased from the selling group without
interruption or substantial change, then the buying group is a successor
employer to the selling group in connection with that asset sale. A
buying group does not fail to be a successor employer in connection with
an asset sale merely because the asset sale takes place in connection
with a proceeding in bankruptcy under Title 11 of the United States
Code. If the buying group is a successor employer, a group health plan
maintained by the buying group has the obligation to make COBRA
continuation coverage available to M&A qualified beneficiaries with
respect to that asset sale. A group health plan of the buying group has
this obligation beginning on the later of the following two dates and
continuing as long as the buying group continues to maintain a group
health plan (but subject to the rules in Sec. 54.4980B-7, relating to
the duration of COBRA continuation coverage)--
(i) The date the selling group ceases to provide any group health
plan to any employee; or
(ii) The date of the asset sale.
(2) The determination of whether the selling group's cessation of
providing any group health plan to any employee is in connection with
the asset sale is based on all of the relevant facts and circumstances.
A group health plan of the buying group does not, as a result of the
asset sale, have an obligation to make COBRA continuation coverage
available to those qualified beneficiaries of the selling group who are
not M&A qualified beneficiaries with respect to that sale.
(d) The rules of Q&A-1 through Q&A-7 of this section and this Q&A-8
are illustrated by the following examples; in each example, each group
health plan is subject to COBRA:
Stock Sale Examples
Example 1. (i) Selling Group S consists of three corporations, A, B,
and C. Buying Group P consists of two corporations, D and E. P enters
into a contract to purchase all the stock of C from S effective July 1,
2002. Before the sale of C, S maintains a single group health plan for
the employees of A, B, and C (and their families). P maintains a single
group health plan for the employees of D and E (and their families).
Effective July 1, 2002, the employees of C (and their families) become
covered under P's plan. On June 30, 2002, there are 48 qualified
beneficiaries receiving COBRA continuation coverage under S's plan, 15
of whom are M&A qualified beneficiaries with respect to the sale of C.
(The other 33 qualified beneficiaries had qualifying events in
connection with a covered employee whose last employment before the
qualifying event was with either A or B.)
(ii) Under these facts, S's plan continues to have the obligation to
make COBRA continuation coverage available to the 15 M&A qualified
beneficiaries under S's plan after the sale of C to P. The employees who
continue in employment with C do not experience a qualifying event by
virtue of P's acquisition of C. If they experience a qualifying event
after the sale, then the group health plan of P has the obligation to
make COBRA continuation coverage available to them.
Example 2. (i) Selling Group S consists of three corporations, A, B,
and C. Each of A, B, and C maintains a group health plan for its
employees (and their families). Buying Group P consists of two
corporations, D and E. P enters into a contract to purchase all of the
stock of C from S effective July 1, 2002. As of June 30, 2002, there are
14 qualified beneficiaries receiving COBRA continuation coverage under
C's plan. C continues to employ all of its employees and continues to
maintain its group health plan after being acquired by P on July 1,
2002.
(ii) Under these facts, C is an acquired organization and the 14
qualified beneficiaries under C's plan are M&A qualified beneficiaries.
A group health plan of S (that is, either the plan maintained by A or
the plan maintained by B) has the obligation to make COBRA continuation
coverage available to the 14 M&A qualified beneficiaries. S and P could
negotiate to have C's plan continue to make COBRA continuation coverage
available to the 14 M&A qualified beneficiaries. In such a case, neither
A's plan nor B's plan would make COBRA continuation coverage
[[Page 330]]
available to the 14 M&A qualified beneficiaries unless C's plan failed
to fulfill its contractual responsibility to make COBRA continuation
coverage available to the M&A qualified beneficiaries. C's employees
(and their spouses and dependent children) do not experience a
qualifying event in connection with P's acquisition of C, and
consequently no plan maintained by either P or S has any obligation to
make COBRA continuation coverage available to C's employees (or their
spouses or dependent children) in connection with the transfer of stock
in C from S to P.
Example 3. (i) The facts are the same as in Example 2, except that C
ceases to employ two employees on June 30, 2002, and those two employees
never become covered under P's plan.
(ii) Under these facts, the two employees experience a qualifying
event on June 30, 2002 because their termination of employment causes a
loss of group health coverage. A group health plan of S (that is, either
the plan maintained by A or the plan maintained by B) has the obligation
to make COBRA continuation coverage available to the two employees (and
to any spouse or dependent child of the two employees who loses coverage
under C's plan in connection with the termination of employment of the
two employees) because they are M&A qualified beneficiaries with respect
to the sale of C.
Example 4. (i) Selling Group S consists of three corporations, A, B,
and C. Buying Group P consists of two corporations, D and E. P enters
into a contract to purchase all of the stock of C from S effective July
1, 2002. Before the sale of C, S maintains a single group health plan
for the employees of A, B, and C (and their families). P maintains a
single group health plan for the employees of D and E (and their
families). Effective July 1, 2002, the employees of C (and their
families) become covered under P's plan. On June 30, 2002, there are 25
qualified beneficiaries receiving COBRA continuation coverage under S's
plan, 20 of whom are M&A qualified beneficiaries with respect to the
sale of C. (The other five qualified beneficiaries had qualifying events
in connection with a covered employee whose last employment before the
qualifying event was with either A or B.) S terminates its group health
plan effective June 30, 2002 and begins to liquidate the assets of A and
B and to lay off the employees of A and B.
(ii) Under these facts, S ceases to provide a group health plan to
any employee in connection with the sale of C to P. Thus, beginning July
1, 2002 P's plan has the obligation to make COBRA continuation coverage
available to the 20 M&A qualified beneficiaries, but P is not obligated
to make COBRA continuation coverage available to the other 5 qualified
beneficiaries with respect to S's plan as of June 30, 2002 or to any of
the employees of A or B whose employment is terminated by S (or to any
of those employees' spouses or dependent children).
Asset Sale Examples
Example 5. (i) Selling Group S provides group health plan coverage
to employees at each of its operating divisions. S sells the assets of
one of its divisions to Buying Group P. Under the terms of the group
health plan covering the employees at the division being sold, their
coverage will end on the date of the sale. P hires all but one of those
employees, gives them the same positions that they had with S before the
sale, and provides them with coverage under a group health plan.
Immediately before the sale, there are two qualified beneficiaries
receiving COBRA continuation coverage under a group health plan of S
whose qualifying events occurred in connection with a covered employee
whose last employment prior to the qualifying event was associated with
the assets sold to P.
(ii) These two qualified beneficiaries are M&A qualified
beneficiaries with respect to the asset sale to P. Under these facts, a
group health plan of S retains the obligation to make COBRA continuation
coverage available to these two M&A qualified beneficiaries. In
addition, the one employee P does not hire as well as all of the
employees P hires (and the spouses and dependent children of these
employees) who were covered under a group health plan of S on the day
before the sale are M&A qualified beneficiaries with respect to the
sale. A group health plan of S also has the obligation to make COBRA
continuation coverage available to these M&A qualified beneficiaries.
Example 6. (i) Selling Group S provides group health plan coverage
to employees at each of its operating divisions. S sells substantially
all of the assets of all of its divisions to Buying Group P, and S
ceases to provide any group health plan to any employee on the date of
the sale. P hires all but one of S's employees on the date of the asset
sale by S, gives those employees the same positions that they had with S
before the sale, and continues the business operations of those
divisions without substantial change or interruption. P provides these
employees with coverage under a group health plan. Immediately before
the sale, there are 10 qualified beneficiaries receiving COBRA
continuation coverage under a group health plan of S whose qualifying
events occurred in connection with a covered employee whose last
employment prior to the qualifying event was associated with the assets
sold to P.
(ii) These 10 qualified beneficiaries are M&A qualified
beneficiaries with respect to the asset sale to P. Under these facts, P
is a successor employer described in paragraph (c) of this Q&A-8. Thus,
a group health plan
[[Page 331]]
of P has the obligation to make COBRA continuation coverage available to
these 10 M&A qualified beneficiaries.
(iii) The one employee that P does not hire and the family members
of that employee are also M&A qualified beneficiaries with respect to
the sale. A group health plan of P also has the obligation to make COBRA
continuation coverage available to these M&A qualified beneficiaries.
(iv) The employees who continue in employment in connection with the
asset sale (and their family members) and who were covered under a group
health plan of S on the day before the sale are not M&A qualified
beneficiaries because P is a successor employer to S in connection with
the asset sale. Thus, no group health plan of P has any obligation to
make COBRA continuation coverage available to these continuing employees
with respect to the qualifying event that resulted from their losing
coverage under S's plan in connection with the asset sale.
Example 7. (i) Selling Group S provides group health plan coverage
to employees at each of its two operating divisions. S sells the assets
of one of its divisions to Buying Group P1. Under the terms of the group
health plan covering the employees at the division being sold, their
coverage will end on the date of the sale. P1 hires all but one of those
employees, gives them the same positions that they had with S before the
sale, and provides them with coverage under a group health plan.
(ii) Under these facts, a group health plan of S has the obligation
to make COBRA continuation coverage available to M&A qualified
beneficiaries with respect to the sale to P1. (If an M&A qualified
beneficiary first became covered under P1's plan after electing COBRA
continuation coverage under S's plan, then S's plan could terminate the
COBRA continuation coverage once the M&A qualified beneficiary became
covered under P1's plan, provided that the remaining conditions of Q&A-2
of Sec. 54.4980B-7 were satisfied.)
(iii) Several months after the sale to P1, S sells the assets of its
remaining division to Buying Group P2, and S ceases to provide any group
health plan to any employee on the date of that sale. Thus, under Q&A-1
of Sec. 54.4980B-7, S ceases to have an obligation to make COBRA
continuation coverage available to any qualified beneficiary on the date
of the sale to P2. P1 and P2 are unrelated organizations.
(iv) Even if it was foreseeable that S would sell its remaining
division to an unrelated third party after the sale to P1, under these
facts the cessation of S to provide any group health plan to any
employee on the date of the sale to P2 is not in connection with the
asset sale to P1. Thus, even after the date S ceases to provide any
group health plan to any employee, no group health plan of P1 has any
obligation to make COBRA continuation coverage available to M&A
qualified beneficiaries with respect to the asset sale to P1 by S. If P2
is a successor employer under the rules of paragraph (c) of this Q&A-8
and maintains one or more group health plans after the sale, then a
group health plan of P2 would have an obligation to make COBRA
continuation coverage available to M&A qualified beneficiaries with
respect to the asset sale to P2 by S (but in such a case employees of S
before the sale who continued working for P2 after the sale would not be
M&A qualified beneficiaries). However, even in such a case, no group
health plan of P2 would have an obligation to make COBRA continuation
coverage available to M&A qualified beneficiaries with respect to the
asset sale to P1 by S. Thus, under these facts, after S has ceased to
provide any group health plan to any employee, no plan has an obligation
to make COBRA continuation coverage available to M&A qualified
beneficiaries with respect to the asset sale to P1.
Example 8. (i) Selling Group S provides group health plan coverage
to employees at each of its operating divisions. S sells substantially
all of the assets of all of its divisions to Buying Group P. P hires
most of S's employees on the date of the purchase of S's assets, retains
those employees in the same positions that they had with S before the
purchase, and continues the business operations of those divisions
without substantial change or interruption. P provides these employees
with coverage under a group health plan. S continues to employ a few
employees for the principal purpose of winding up the affairs of S in
preparation for liquidation. S continues to provide coverage under a
group health plan to these few remaining employees for several weeks
after the date of the sale and then ceases to provide any group health
plan to any employee.
(ii) Under these facts, the cessation by S to provide any group
health plan to any employee is in connection with the asset sale to P.
Because of this, and because P continued the business operations
associated with those assets without substantial change or interruption,
P is a successor employer to S with respect to the asset sale. Thus, a
group health plan of P has the obligation to make COBRA continuation
coverage available to M&A qualified beneficiaries with respect to the
sale beginning on the date that S ceases to provide any group health
plan to any employee. (A group health plan of S retains this obligation
for the several weeks after the date of the sale until S ceases to
provide any group health plan to any employee.)
Q-9: Can the cessation of contributions by an employer to a
multiemployer group health plan be a qualifying event?
A-9: The cessation of contributions by an employer to a
multiemployer
[[Page 332]]
group health plan is not itself a qualifying event, even though the
cessation of contributions may cause current employees (and their
spouses and dependent children) to lose coverage under the multiemployer
plan. An event coinciding with the employer's cessation of contributions
(such as a reduction of hours of employment in the case of striking
employees) will constitute a qualifying event if it otherwise satisfies
the requirements of Q&A-1 of Sec. 54.4980B-4.
Q-10: If an employer stops contributing to a multiemployer group
health plan, does the multiemployer plan have the obligation to make
COBRA continuation coverage available to a qualified beneficiary who was
receiving coverage under the multiemployer plan on the day before the
cessation of contributions and who is, or whose qualifying event
occurred in connection with, a covered employee whose last employment
prior to the qualifying event was with the employer that has stopped
contributing to the multiemployer plan?
A-10: (a) In general, yes. (See Q&A-3 of Sec. 54.4980B-2 for a
definition of multiemployer plan.) If, however, the employer that stops
contributing to the multiemployer plan makes group health plan coverage
available to (or starts contributing to another multiemployer plan that
is a group health plan with respect to) a class of the employer's
employees formerly covered under the multiemployer plan, the plan
maintained by the employer (or the other multiemployer plan), from that
date forward, has the obligation to make COBRA continuation coverage
available to any qualified beneficiary who was receiving coverage under
the multiemployer plan on the day before the cessation of contributions
and who is, or whose qualifying event occurred in connection with, a
covered employee whose last employment prior to the qualifying event was
with the employer.
(b) The rules of Q&A-9 of this section and this Q&A-10 are
illustrated by the following examples; in each example, each group
health plan is subject to COBRA:
Example 1. (i) Employer Z employs a class of employees covered by a
collective bargaining agreement and participating in multiemployer group
health plan M. As required by the collective bargaining agreement, Z has
been making contributions to M. Z experiences financial difficulties and
stops making contributions to M but continues to employ all of the
employees covered by the collective bargaining agreement. Z's cessation
of contributions to M causes those employees (and their spouses and
dependent children) to lose coverage under M. Z does not make group
health plan coverage available to any of the employees covered by the
collective bargaining agreement.
(ii) After Z stops contributing to M, M continues to have the
obligation to make COBRA continuation coverage available to any
qualified beneficiary who experienced a qualifying event that preceded
or coincided with the cessation of contributions to M and whose coverage
under M on the day before the qualifying event was due to an employment
affiliation with Z. The loss of coverage under M for those employees of
Z who continue in employment (and the loss of coverage for their spouses
and dependent children) does not constitute a qualifying event.
Example 2. (i) The facts are the same as in Example 1 except that B,
one of the employees covered under M before Z stops contributing to M,
is transferred into management. Z maintains a group health plan for
managers and B becomes eligible for coverage under the plan on the day
of B's transfer.
(ii) Under these facts, Z does not make group health plan coverage
available to a class of employees formerly covered under M after B
becomes eligible under Z's group health plan for managers. Accordingly,
M continues to have the obligation to make COBRA continuation coverage
available to any qualified beneficiary who experienced a qualifying
event that preceded or coincided with the cessation of contributions to
M and whose coverage under M on the day before the qualifying event was
due to an employment affiliation with Z.
Example 3. (i) Employer Y employs two classes of employees--skilled
and unskilled laborers--covered by a collective bargaining agreement and
participating in multiemployer group health plan M. As required by the
collective bargaining agreement, Y has been making contributions to M. Y
stops making contributions to M but continues to employ all the
employees covered by the collective bargaining agreement. Y's cessation
of contributions to M causes those employees (and their spouses and
dependent children) to lose coverage under M. Y makes group health plan
coverage available to the skilled laborers immediately after their
coverage ceases under M, but Y does not make group health plan coverage
available to any of the unskilled laborers.
(ii) Under these facts, because Y makes group health plan coverage
available to a
[[Page 333]]
class of employees previously covered under M immediately after both
classes of employees lose coverage under M, Y alone has the obligation
to make COBRA continuation coverage available to any qualified
beneficiary who experienced a qualifying event that preceded or
coincided with the cessation of contributions to M and whose coverage
under M on the day before the qualifying event was due to an employment
affiliation with Y, regardless of whether the employment affiliation was
as a skilled or unskilled laborer. However, the loss of coverage under M
for those employees of Y who continue in employment (and the loss of
coverage for their spouses and dependent children) does not constitute a
qualifying event.
Example 4. (i) Employer X employs a class of employees covered by a
collective bargaining agreement and participating in multiemployer group
health plan M. As required by the collective bargaining agreement, X has
been making contributions to M. X experiences financial difficulties and
is forced into bankruptcy by its creditors. X continues to employ all of
the employees covered by the collective bargaining agreement. X also
continues to make contributions to M until the current collective
bargaining agreement expires, on June 30, 2001, and then X stops making
contributions to M. X's employees (and their spouses and dependent
children) lose coverage under M effective July 1, 2001. X does not enter
into another collective bargaining agreement covering the class of
employees covered by the expired collective bargaining agreement.
Effective September 1, 2001, X establishes a group health plan covering
the class of employees formerly covered by the collective bargaining
agreement. The group health plan also covers their spouses and dependent
children.
(ii) Under these facts, M has the obligation to make COBRA
continuation coverage available from July 1, 2001 until August 31, 2001,
and the group health plan established by X has the obligation to make
COBRA continuation coverage available from September 1, 2001 until the
obligation ends (see Q&A-1 of Sec. 54.4980B-7) to any qualified
beneficiary who experienced a qualifying event that preceded or
coincided with the cessation of contributions to M and whose coverage
under M on the day before the qualifying event was due to an employment
affiliation with X. The loss of coverage under M for those employees of
X who continue in employment (and the loss of coverage for their spouses
and dependent children) does not constitute a qualifying event.
Example 5. (i) Employer W employs a class of employees covered by a
collective bargaining agreement and participating in multiemployer group
health plan M. As required by the collective bargaining agreement, W has
been making contributions to M. The employees covered by the collective
bargaining agreement vote to decertify their current employee
representative effective January 1, 2002 and vote to certify a new
employee representative effective the same date. As a consequence, on
January 1, 2002 they cease to be covered under M and commence to be
covered under multiemployer group health plan N.
(ii) Effective January 1, 2002, N has the obligation to make COBRA
continuation coverage available to any qualified beneficiary who
experienced a qualifying event that preceded or coincided with the
cessation of contributions to M and whose coverage under M on the day
before the qualifying event was due to an employment affiliation with W.
The loss of coverage under M for those employees of W who continue in
employment (and the loss of coverage for their spouses and dependent
children) does not constitute a qualifying event.
[T.D. 8928, 66 FR 1855, Jan. 10, 2001]
Sec. 54.4980B-10 Interaction of FMLA and COBRA.
The following questions-and-answers address how the taking of leave
under the Family and Medical Leave Act of 1993 (FMLA) (29 U.S.C. 2601-
2619) affects the COBRA continuation coverage requirements:
Q-1: In what circumstances does a qualifying event occur if an
employee does not return from leave taken under FMLA?
A-1: (a) The taking of leave under FMLA does not constitute a
qualifying event. A qualifying event under Q&A-1 of Sec. 54.4980B-4
occurs, however, if--
(1) An employee (or the spouse or a dependent child of the employee)
is covered on the day before the first day of FMLA leave (or becomes
covered during the FMLA leave) under a group health plan of the
employee's employer;
(2) The employee does not return to employment with the employer at
the end of the FMLA leave; and
(3) The employee (or the spouse or a dependent child of the
employee) would, in the absence of COBRA continuation coverage, lose
coverage under the group health plan before the end of the maximum
coverage period.
(b) However, the satisfaction of the three conditions in paragraph
(a) of this Q&A-1 does not constitute a qualifying event if the employer
eliminates,
[[Page 334]]
on or before the last day of the employee's FMLA leave, coverage under a
group health plan for the class of employees (while continuing to employ
that class of employees) to which the employee would have belonged if
the employee had not taken FMLA leave.
Q-2: If a qualifying event described in Q&A-1 of this section
occurs, when does it occur, and how is the maximum coverage period
measured?
A-2: A qualifying event described in Q&A-1 of this section occurs on
the last day of FMLA leave. (The determination of when FMLA leave ends
is not made under the rules of this section. See the FMLA regulations,
29 CFR Part 825 (Sec. Sec. 825.100-825.800).) The maximum coverage
period (see Q&A-4 of Sec. 54.4980B-7) is measured from the date of the
qualifying event (that is, the last day of FMLA leave). If, however,
coverage under the group health plan is lost at a later date and the
plan provides for the extension of the required periods (see paragraph
(b) of Q&A-4 of Sec. 54.4980B-7), then the maximum coverage period is
measured from the date when coverage is lost. The rules of this Q&A-2
are illustrated by the following examples:
Example 1. (i) Employee B is covered under the group health plan of
Employer X on January 31, 2001. B takes FMLA leave beginning February 1,
2001. B's last day of FMLA leave is 12 weeks later, on April 25, 2001,
and B does not return to work with X at the end of the FMLA leave. If B
does not elect COBRA continuation coverage, B will not be covered under
the group health plan of X as of April 26, 2001.
(ii) B experiences a qualifying event on April 25, 2001, and the
maximum coverage period is measured from that date. (This is the case
even if, for part or all of the FMLA leave, B fails to pay the employee
portion of premiums for coverage under the group health plan of X and is
not covered under X's plan. See Q&A-3 of this section.)
Example 2. (i) Employee C and C's spouse are covered under the group
health plan of Employer Y on August 15, 2001. C takes FMLA leave
beginning August 16, 2001. C informs Y less than 12 weeks later, on
September 28, 2001, that C will not be returning to work. Under the FMLA
regulations, 29 CFR Part 825 (Sec. Sec. 825.100-825.800), C's last day
of FMLA leave is September 28, 2001. C does not return to work with Y at
the end of the FMLA leave. If C and C's spouse do not elect COBRA
continuation coverage, they will not be covered under the group health
plan of Y as of September 29, 2001.
(ii) C and C's spouse experience a qualifying event on September 28,
2001, and the maximum coverage period (generally 18 months) is measured
from that date. (This is the case even if, for part or all of the FMLA
leave, C fails to pay the employee portion of premiums for coverage
under the group health plan of Y and C or C's spouse is not covered
under Y's plan. See Q&A-3 of this section.)
Q-3: If an employee fails to pay the employee portion of premiums
for coverage under a group health plan during FMLA leave or declines
coverage under a group health plan during FMLA leave, does this affect
the determination of whether or when the employee has experienced a
qualifying event?
A-3: No. Any lapse of coverage under a group health plan during FMLA
leave is irrelevant in determining whether a set of circumstances
constitutes a qualifying event under Q&A-1 of this section or when such
a qualifying event occurs under Q&A-2 of this section.
Q-4: Is the application of the rules in Q&A-1 through Q&A-3 of this
section affected by a requirement of state or local law to provide a
period of coverage longer than that required under FMLA?
A-4: No. Any state or local law that requires coverage under a group
health plan to be maintained during a leave of absence for a period
longer than that required under FMLA (for example, for 16 weeks of leave
rather than for the 12 weeks required under FMLA) is disregarded for
purposes of determining when a qualifying event occurs under Q&A-1
through Q&A-3 of this section.
Q-5: May COBRA continuation coverage be conditioned upon
reimbursement of the premiums paid by the employer for coverage under a
group health plan during FMLA leave?
A-5: No. The U.S. Department of Labor has published rules describing
the circumstances in which an employer may recover premiums it pays to
maintain coverage, including family coverage, under a group health plan
during FMLA leave from an employee who fails to return from leave. See
29 CFR 825.213. Even if recovery of premiums is permitted under 29 CFR
825.213, the right to COBRA continuation coverage cannot be conditioned
[[Page 335]]
upon the employee's reimbursement of the employer for premiums the
employer paid to maintain coverage under a group health plan during FMLA
leave.
[T.D. 8928, 66 FR 1855, Jan. 10, 2001]
Sec. 54.4980D-1 Requirement of return and time for filing of the excise tax under section 4980D.
Q-1: If a person is liable for the excise tax under section 4980D,
what form must the person file and what is the due date for the filing
and payment of the excise tax?
A-1: (a) In general. See Sec. Sec. 54.6011-2 and 54.6151-1.
(b) Due date for filing of return by employers. See Sec. 54.6071-
1(b)(1).
(c) Due date for filing of return by multiemployer plans or multiple
employer health plans. See Sec. 54.6071-1(b)(2).
(d) Effective/applicability date. In the case of an employer or
other person mentioned in paragraph (b) of this Q & A-1, the rules in
this Q & A-1 are effective for taxable years beginning on or after
January 1, 2010. In the case of a plan mentioned in paragraph (c) of
this Q & A-1, the rules in this Q & A-1 are effective for plan years
beginning on or after January 1, 2010.
[T.D. 9457, 74 FR 45997, Sept. 8, 2009]
Sec. 54.4980E-1 Requirement of return and time for filing of the excise
tax under section 4980E.
Q-1: If a person is liable for the excise tax under section 4980E,
what form must the person file and what is the due date for the filing
and payment of the excise tax?
A-1: (a) In general. See Sec. Sec. 54.6011-2, 54.6151-1 and
54.6071-1(c).
(b) Effective/applicability date. The rules in this Q & A-1 are
effective for plan years beginning on or after January 1, 2010.
[T.D. 9457, 74 FR 45997, Sept. 8, 2009]
Sec. 54.4980F-1 Notice requirements for certain pension plan
amendments significantly reducing the rate of future benefit accrual.
The following questions and answers concern the notification
requirements imposed by 4980F of the Internal Revenue Code and section
204(h) of ERISA relating to a plan amendment of an applicable pension
plan that significantly reduces the rate of future benefit accrual or
that eliminates or significantly reduces an early retirement benefit or
retirement-type subsidy.
List of Questions
Q-1. What are the notice requirements of section 4980F(e) of the
Internal Revenue Code and section 204(h) of ERISA?
Q-2. What are the differences between section 4980F and section 204(h)?
Q-3. What is an ``applicable pension plan'' to which section 4980F and
section 204(h) apply?
Q-4. What is ``section 204(h) notice'' and what is a ``section 204(h)
amendment''?
Q-5. For which amendments is section 204(h) notice required?
Q-6. What is an amendment that reduces the rate of future benefit
accrual or reduces an early retirement benefit or retirement-
type subsidy for purposes of determining whether section
204(h) notice is required?
Q-7. What plan provisions are taken into account in determining whether
an amendment is a section 204(h) amendment?
Q-8. What is the basic principle used in determining whether a reduction
in the rate of future benefit accrual or a reduction in an
early retirement benefit or retirement-type subsidy is
significant for purposes of section 4980F and section 204(h)?
Q-9. When must section 204(h) notice be provided?
Q-10. To whom must section 204(h) notice be provided?
Q-11. What information is required to be provided in a section 204(h)
notice?
Q-12. What special rules apply if participants can choose between the
old and new benefit formulas?
Q-13. How may section 204(h) notice be provided?
Q-14. What are the consequences if a plan administrator fails to provide
section 204(h) notice?
Q-15. What are some of the rules that apply with respect to the excise
tax under section 4980F?
Q-16. How do section 4980F and section 204(h) apply when a business is
sold?
Q-17. How are amendments to cease accruals and terminate a plan treated
under section 4980F and section 204(h)?
Q-18. What are the effective dates of section 4980F, section 204(h), as
amended by EGTRRA, and these regulations?
[[Page 336]]
Questions and Answers
Q-1. What are the notice requirements of section 4980F(e) of the
Internal Revenue Code and section 204(h) of ERISA?
A-1. (a) Requirements of Internal Revenue Code section 4980F(e) and
ERISA section 204(h). Section 4980F of the Internal Revenue Code
(section 4980F) and section 204(h) of the Employee Retirement Income
Security Act of 1974, as amended (ERISA), 29 U.S.C. 1054(h) (section
204(h)) each generally requires notice of an amendment to an applicable
pension plan that either provides for a significant reduction in the
rate of future benefit accrual or that eliminates or significantly
reduces an early retirement benefit or retirement-type subsidy. The
notice is required to be provided to plan participants and alternate
payees who are applicable individuals (as defined in Q&A-10 of this
section), to certain employee organizations, and to contributing
employers under a multiemployer plan (as described in Q&A-10(a) of this
section). The plan administrator must generally provide the notice
before the effective date of the plan amendment. Q&A-9 of this section
sets forth the time frames for providing notice, Q&A-11 of this section
sets forth the content requirements for the notice, and Q&A-12 of this
section contains special rules for cases in which participants can
choose between the old and new benefit formulas.
(b) Other notice requirements. Other provisions of law may require
that certain parties be notified of a plan amendment. See, for example,
sections 102 and 104 of ERISA, and the regulations thereunder, for
requirements relating to summary plan descriptions and summaries of
material modifications.
Q-2. What are the differences between section 4980F and section
204(h)?
A-2. The notice requirements of section 4980F generally are parallel
to the notice requirements of section 204(h), as amended by the Economic
Growth and Tax Relief Reconciliation Act of 2001, Public Law 107-16 (115
Stat. 38) (2001) (EGTRRA). However, the consequences of the failure to
satisfy the requirements of the two provisions differ: Section 4980F
imposes an excise tax on a failure to satisfy the notice requirements,
while section 204(h)(6), as amended by EGTRRA, contains a special rule
with respect to an egregious failure to satisfy the notice requirements.
See Q&A-14 and Q&A-15 of this section. Except to the extent specifically
indicated, these regulations apply both to section 4980F and to section
204(h).
Q-3. What is an ``applicable pension plan'' to which section 4980F
and section 204(h) apply?
A-3. (a) In general. Section 4980F and section 204(h) apply to an
applicable pension plan. For purposes of section 4980F, an applicable
pension plan means a defined benefit plan qualifying under section
401(a) or 403(a) of the Internal Revenue Code, or an individual account
plan that is subject to the funding standards of section 412 of the
Internal Revenue Code. For purposes of section 204(h), an applicable
pension plan means a defined benefit plan that is subject to part 2 of
subtitle B of title I of ERISA, or an individual account plan that is
subject to such part 2 and to the funding standards of section 412 of
the Internal Revenue Code. Accordingly, individual account plans that
are not subject to the funding standards of section 412 of the Internal
Revenue Code, such as profit-sharing and stock bonus plans and contracts
under section 403(b) of the Internal Revenue Code, are not applicable
pension plans to which section 4980F or section 204(h) apply. Similarly,
a defined benefit plan that neither qualifies under section 401(a) or
403(a) of the Internal Revenue Code nor is subject to part 2 of subtitle
B of title I of ERISA is not an applicable pension plan. Further,
neither a governmental plan (within the meaning of section 414(d) of the
Internal Revenue Code), nor a church plan (within the meaning of section
414(e) of the Internal Revenue Code) with respect to which no election
has been made under section 410(d) of the Internal Revenue Code is an
applicable pension plan.
(b) Section 204(h) notice not required for small plans covering no
employees. Section 204(h) notice is not required for a
[[Page 337]]
plan under which no employees are participants covered under the plan,
as described in Sec. 2510.3-3(b) of the Department of Labor
regulations, and which has fewer than 100 participants.
Q-4. What is ``section 204(h) notice'' and what is a ``section
204(h) amendment''?
A-4. (a) Section 204(h) notice is notice that complies with section
4980F(e) of the Internal Revenue Code, section 204(h)(1) of ERISA, and
this section.
(b) A section 204(h) amendment is an amendment for which section
204(h) notice is required under this section.
Q-5. For which amendments is section 204(h) notice required?
A-5. (a) Significant reduction in the rate of future benefit
accrual. Section 204(h) notice is required for an amendment to an
applicable pension plan that provides for a significant reduction in the
rate of future benefit accrual.
(b) Early retirement benefits and retirement-type subsidies. Section
204(h) notice is also required for an amendment to an applicable pension
plan that provides for the significant reduction of an early retirement
benefit or retirement-type subsidy. For purposes of this section, early
retirement benefit and retirement-type subsidy mean early retirement
benefits and retirement-type subsidies within the meaning of section
411(d)(6)(B)(i).
(c) Elimination or cessation of benefits. For purposes of this
section, the terms reduce or reduction include eliminate or cease or
elimination or cessation.
(d) Delegation of authority to Commissioner. The Commissioner may
provide in revenue rulings, notices, or other guidance published in the
Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter) that
section 204(h) notice need not be provided for plan amendments otherwise
described in paragraph (a) or (b) of this Q&A-5 that the Commissioner
determines to be necessary or appropriate, as a result of changes in the
law, to maintain compliance with the requirements of the Internal
Revenue Code (including requirements for tax qualification), ERISA, or
other applicable federal law.
Q-6. What is an amendment that reduces the rate of future benefit
accrual or reduces an early retirement benefit or retirement-type
subsidy for purposes of determining whether section 204(h) notice is
required?
A-6. (a) In general. For purposes of determining whether section
204(h) notice is required, an amendment reduces the rate of future
benefit accrual or reduces an early retirement benefit or retirement-
type subsidy only as provided in paragraph (b) or (c) of this Q&A-6.
(b) Reduction in rate of future benefit accrual--(1) Defined benefit
plans. For purposes of section 4980F and section 204(h), an amendment to
a defined benefit plan reduces the rate of future benefit accrual only
if it is reasonably expected that the amendment will reduce the amount
of the future annual benefit commencing at normal retirement age (or at
actual retirement age, if later) for benefits accruing for a year. For
this purpose, the annual benefit commencing at normal retirement age is
the benefit payable in the form in which the terms of the plan express
the accrued benefit (or, in the case of a plan in which the accrued
benefit is not expressed in the form of an annual benefit commencing at
normal retirement age, the benefit payable in the form of a single life
annuity commencing at normal retirement age that is the actuarial
equivalent of the accrued benefit expressed under the terms of the plan,
as determined in accordance with section 411(c)(3) of the Internal
Revenue Code).
(2) Individual account plans. For purposes of section 4980F and
section 204(h), an amendment to an individual account plan reduces the
rate of future benefit accrual only if it is reasonably expected that
the amendment will reduce the amount of contributions or forfeitures
allocated for any future year. Changes in the investments or investment
options under an individual account plan are not taken into account for
this purpose.
(3) Determination of rate of future benefit accrual. The rate of
future benefit accrual for purposes of this paragraph (b) is determined
without regard to optional forms of benefit within the meaning of Sec.
1.411(d)-4, Q&A-1(b) of this chapter (other than the annual benefit
described in paragraph (b)(1) of this Q&A-6). The rate of future benefit
accrual is also determined without regard
[[Page 338]]
to ancillary benefits and other rights or features as defined in Sec.
1.401(a)(4)-4(e) of this chapter.
(c) Reduction of early retirement benefits or retirement-type
subsidies. For purposes of section 4980F and section 204(h), an
amendment reduces an early retirement benefit or retirement-type subsidy
only if it is reasonably expected that the amendment will eliminate or
reduce an early retirement benefit or retirement-type subsidy.
Q-7. What plan provisions are taken into account in determining
whether an amendment is a section 204(h) amendment?
A-7. (a) Plan provisions taken into account---(1) In general. All
plan provisions that may affect the rate of future benefit accrual,
early retirement benefits, or retirement-type subsidies of participants
or alternate payees must be taken into account in determining whether an
amendment is a section 204(h) amendment. For example, plan provisions
that may affect the rate of future benefit accrual include the dollar
amount or percentage of compensation on which benefit accruals are
based; the definition of service or compensation taken into account in
determining an employee's benefit accrual; the method of determining
average compensation for calculating benefit accruals; the definition of
normal retirement age in a defined benefit plan; the exclusion of
current participants from future participation; benefit offset
provisions; minimum benefit provisions; the formula for determining the
amount of contributions and forfeitures allocated to participants'
accounts in an individual account plan; in the case of a plan using
permitted disparity under section 401(l) of the Internal Revenue Code,
the amount of disparity between the excess benefit percentage or excess
contribution percentage and the base benefit percentage or base
contribution percentage (all as defined in section 401(l) of the
Internal Revenue Code); and the actuarial assumptions used to determine
contributions under a target benefit plan (as defined in Sec.
1.401(a)(4)-8(b)(3)(i) of this chapter). Plan provisions that may affect
early retirement benefits or retirement-type subsidies include the right
to receive payment of benefits after severance from employment and
before normal retirement age and actuarial factors used in determining
optional forms for distribution of retirement benefits.
(2) Provisions incorporated by reference in plan. If all or a part
of a plan's rate of future benefit accrual, or an early retirement
benefit or retirement-type subsidy provided under the plan, depends on
provisions in another document that are referenced in the plan document,
a change in the provisions of the other document is an amendment of the
plan.
(b) Plan provisions not taken into account--(1) In general. Plan
provisions that do not affect the rate of future benefit accrual of
participants or alternate payees are not taken into account in
determining whether there has been a reduction in the rate of future
benefit accrual.
(2) Interaction with section 411(d)(6). Any benefit that is not a
section 411(d)(6) protected benefit as described in Sec. Sec. 1.411(d)-
3(g)(14) and 1.411(d)-4, Q&A-1(d) of this chapter, or that is a section
411(d)(6) protected benefit that may be eliminated or reduced as
permitted under Sec. 1.411(d)-3(c), (d), or (f), or under Sec.
1.411(d)-4, Q&A-2(a)(2), (a)(3), (b)(1), or (b)(2)(ii) through
(b)(2)(xi) of this chapter, is not taken into account in determining
whether an amendment is a section 204(h) amendment. Thus, for example,
provisions relating to the right to make after-tax deferrals are not
taken into account.
(c) Examples. The following examples illustrate the rules in this
Q&A-7:
Example 1. (i) Facts. A defined benefit plan provides a normal
retirement benefit equal to 50% of highest 5-year average pay multiplied
by a fraction (not in excess of one), the numerator of which equals the
number of years of participation in the plan and the denominator of
which is 20. A plan amendment is adopted that changes the numerator or
denominator of that fraction.
(ii) Conclusion. The plan amendment must be taken into account in
determining whether there has been a reduction in the rate of future
benefit accrual.
Example 2. (i) Facts. Plan C is a multiemployer defined benefit plan
subject to several collective bargaining agreements. The specific
benefit formula under Plan C that applies to an employee depends on the
hourly rate of contribution of the employee's employer, which is set
forth in the provisions of
[[Page 339]]
the collective bargaining agreements that are referenced in the Plan C
document. Collective Bargaining Agreement A between Employer B and the
union representing employees of Employer B is renegotiated to provide
that the hourly contribution rate for an employee of B who is subject to
the Collective Bargaining Agreement A will decrease. That decrease will
result in a decrease in the rate of future benefit accrual for employees
of B.
(ii) Conclusion. Under paragraph (a)(2) of this Q&A-7, the change to
Collective Bargaining Agreement A is a plan amendment that is a section
204(h) amendment if the reduction in the rate of future benefit accrual
is significant.
Q-8. What is the basic principle used in determining whether a
reduction in the rate of future benefit accrual or a reduction in an
early retirement benefit or retirement-type subsidy is significant for
purposes of section 4980F and section 204(h)?
A-8. (a) General rule. Whether an amendment reducing the rate of
future benefit accrual or eliminating or reducing an early retirement
benefit or retirement-type subsidy provides for a reduction that is
significant for purposes of section 4980F (and section 204(h) of ERISA)
is determined based on reasonable expectations taking into account the
relevant facts and circumstances at the time the amendment is adopted,
or, if earlier, at the effective date of the amendment.
(b) Application for determining significant reduction in the rate of
future benefit accrual. For a defined benefit plan, the determination of
whether an amendment provides for a significant reduction in the rate of
future benefit accrual is made by comparing the amount of the annual
benefit commencing at normal retirement age (or at actual retirement
age, if later), as determined under Q&A-6(b)(1) of this section, under
the terms of the plan as amended with the amount of the annual benefit
commencing at normal retirement age (or at actual retirement age, if
later), as determined under Q&A-6(b)(1) of this section, under the terms
of the plan prior to amendment. For an individual account plan, the
determination of whether an amendment provides for a significant
reduction in the rate of future benefit accrual is made in accordance
with Q&A-6(b)(2) of this section by comparing the amounts to be
allocated in the future to participants' accounts under the terms of the
plan as amended with the amounts to be allocated in the future to
participants' accounts under the terms of the plan prior to amendment.
An amendment to convert a money purchase pension plan to a profit-
sharing or other individual account plan that is not subject to section
412 of the Internal Revenue Code is, in all cases, deemed to be an
amendment that provides for a significant reduction in the rate of
future benefit accrual.
(c) Application to certain amendments reducing early retirement
benefits or retirement-type subsidies. Section 204(h) notice is not
required for an amendment that reduces an early retirement benefit or
retirement-type subsidy if the amendment is permitted under the third
sentence of section 411(d)(6)(B) of the Internal Revenue Code and
paragraphs (c), (d), and (f) of Sec. 1.411(d)-3 of this chapter
(relating to the elimination or reduction of benefits or subsidies which
create significant burdens or complexities for the plan and plan
participants unless the amendment adversely affects the rights of any
participant in a more than de minimis manner). However, in determining
whether an amendment reducing a retirement-type subsidy constitutes a
significant reduction because it reduces a retirement-type subsidy as
permitted under Sec. 1.411(d)-3(e)(6) of this chapter, the amendment is
treated in the same manner as an amendment that limits the retirement-
type subsidy to benefits that accrue before the applicable amendment
date (as defined at Sec. 1.411(d)-3(g)(4) of this chapter) with respect
to each participant or alternate payee to whom the reduction is
reasonably expected to apply.
(d) Plan amendments reflecting a change in statutorily mandated
minimum present value rules. If a defined benefit plan offers a
distribution to which the minimum present value rules of section
417(e)(3) apply (other than a payment to which section 411(a)(13)(A)
applies) and the plan is amended to reflect the changes to the
applicable interest rate and applicable mortality table in section
417(e)(3) made by the Pension Protection Act of 2006, Public Law 109-780
(120 Stat. 780) (PPA '06)
[[Page 340]]
(and no change is made in the dates on which the payment will be made),
no section 204(h) notice is required to be provided.
(e) Examples. The following examples illustrate the rules in this
Q&A-8:
Example 1. (i) Facts. Pension Plan A is a defined benefit plan that
provides a rate of benefit accrual of 1% of highest-5 years pay
multiplied by years of service, payable annually for life commencing at
normal retirement age (or at actual retirement age, if later). An
amendment to Plan A is adopted on August 1, 2009, effective January 1,
2010, to provide that any participant who separates from service after
December 31, 2009, and before January 1, 2015, will have the same number
of years of service he or she would have had if his or her service
continued to December 31, 2014.
(ii) Conclusion. In this example, the effective date of the plan
amendment is January 1, 2010. While the amendment will result in a
reduction in the annual rate of future benefit accrual from 2011 through
2014 (because, under the amendment, benefits based upon an additional 5
years of service accrue on January 1, 2010, and no additional service is
credited after January 1, 2010 until January 1, 2015), the amendment
does not result in a reduction that is significant because the amount of
the annual benefit commencing at normal retirement age (or at actual
retirement age, if later) under the terms of the plan as amended is not
under any conditions less than the amount of the annual benefit
commencing at normal retirement age (or at actual retirement age, if
later) to which any participant would have been entitled under the terms
of the plan had the amendment not been made.
Example 2. (i) Facts. The facts are the same as in Example 1, except
that the 2009 amendment does not alter the plan provisions relating to a
participant's number of years of service, but instead amends the plan's
provisions relating to early retirement benefits. Before the amendment,
the plan provides for distributions before normal retirement age to be
actuarially reduced, but, if a participant retires after attainment of
age 55 and completion of 10 years of service, the applicable early
retirement reduction factor is 3% per year for the years between the
ages 65 and 62 and 6% per year for the ages from 62 to 55. The amendment
changes these provisions so that an actuarial reduction applies in all
cases, but, in accordance with section 411(d)(6)(B), provides that no
participant's early retirement benefit will be less than the amount
provided under the plan as in effect on December 31, 2009 with respect
to service before January 1, 2010. For participant X, the reduction is
significant.
(ii) Conclusion. The amendment will result in a reduction in a
retirement-type subsidy provided under Plan A (i.e., Plan A's early
retirement subsidy). Section 204(h) notice must be provided to
participant X and any other participant for whom the reduction is
significant and the notice must be provided at least 45 days before
January 1, 2010 (or by such other date as may apply under Q&A-9 of this
section).
Example 3. (i) Facts. The facts are the same as in Example 2, except
that, for participant X, the change does not go into effect for any
annuity commencement date before January 1, 2011. Participant X
continues employment through January 1, 2011.
(ii) Conclusion. The conclusion is the same as in Example 2. Taking
into account the rule in the second sentence of Q&A-8(c) of this
section, the reduction that occurs for participant X on January 1, 2011,
is treated as the same reduction that occurs under Example 2.
Accordingly, assuming that the reduction is significant, section 204(h)
notice must be provided to participant X at least 45 days before the
January 1, 2010 effective date of the amendment (or by such other date
as may apply under Q&A-9 of this section).
Q-9. When must section 204(h) notice be provided?
A-9. (a) 45-day general rule. Except as otherwise provided in this
Q&A-9, section 204(h) notice must be provided at least 45 days before
the effective date of any section 204(h) amendment. See paragraph (e) of
this Q&A-9 for special rules for amendments permitting participant
choice.
(b) 15-day rule for small plans. Except for amendments described in
paragraphs (d)(2) and (g) of this Q&A-9, section 204(h) notice must be
provided at least 15 days before the effective date of any section
204(h) amendment in the case of a small plan. For purposes of this
section, a small plan is a plan that the plan administrator reasonably
expects to have, on the effective date of the section 204(h) amendment,
fewer than 100 participants who have an accrued benefit under the plan.
(c) 15-day rule for multiemployer plans. Except for amendments
described in paragraphs (d)(2) and (g) of this Q&A-9, section 204(h)
notice must be provided at least 15 days before the effective date of
any section 204(h) amendment in the case of a multiemployer plan. For
purposes of this section, a multiemployer plan means a multiemployer
plan as defined in section 414(f) of the Internal Revenue Code.
[[Page 341]]
(d) Special timing rule for business transactions--(1) 15-day rule
for section 204(h) amendment in connection with an acquisition or
disposition. Except for amendments described in paragraphs (d)(2) and
(g) of this Q&A-9, if a section 204(h) amendment is adopted in
connection with an acquisition or disposition, section 204(h) notice
must be provided at least 15 days before the effective date of the
section 204(h) amendment.
(2) Later notice permitted for a section 204(h) amendment
significantly reducing early retirement benefit or retirement-type
subsidies in connection with certain plan transfers, mergers, or
consolidations. If a section 204(h) amendment is adopted with respect to
liabilities that are transferred to another plan in connection with a
transfer, merger, or consolidation of assets or liabilities as described
in section 414(l) of the Internal Revenue Code and Sec. 1.414(l)-1 of
this chapter, the amendment is adopted in connection with an acquisition
or disposition, and the amendment significantly reduces an early
retirement benefit or retirement-type subsidy, but does not
significantly reduce the rate of future benefit accrual, then section
204(h) notice must be provided no later than 30 days after the effective
date of the section 204(h) amendment.
(3) Definition of acquisition or disposition. For purposes of this
paragraph (d), see Sec. 1.410(b)-2(f) of this chapter for the
definition of acquisition or disposition.
(e) Timing rule for amendments permitting participant choice. In
general, section 204(h) notice of a section 204(h) amendment that
provides applicable individuals with a choice between the old and the
new benefit formulas (as described in Q&A-12 of this section) must be
provided in accordance with the time period applicable under paragraphs
(a) through (d) of this Q&A-9. See Q&A-12 of this section for additional
guidance regarding section 204(h) notice in connection with participant
choice.
(f) Special timing rule for certain plans maintained by commercial
airlines. See section 402 of PPA '06 for a special rule that applies to
certain plans maintained by an employer that is a commercial passenger
airline or the principal business of which is providing catering
services to a commercial passenger airline. Under this special rule,
section 204(h) notice must be provided at least 15 days before the
effective date of the amendment.
(g) Special timing rules relating to certain section 204(h)
amendments that reduce section 411(d)(6) protected benefits--(1) Plan
amendments permitted to reduce prior accruals. This paragraph (g)
generally provides special rules with respect to a plan amendment that
would not violate section 411(d)(6) even if the amendment were to reduce
section 411(d)(6) protected benefits, which are limited to accrued
benefits that are attributable to service before the applicable
amendment date. For example, this paragraph (g) applies to amendments
that are permitted to be effective retroactively under section 412(d)(2)
of the Code (section 412(c)(8) for plan years beginning before January
1, 2008), section 418D of the Code, section 418E of the Code, section
4281 of ERISA, or section 1107 of PPA '06. See, generally, Sec.
1.411(d)-3(a)(1).
(2) General timing rule for amendments to which this paragraph (g)
applies. For an amendment to which this paragraph (g) applies, the
amendment is effective on the first date on which the plan is operated
as if the amendment were in effect. Thus, except as otherwise provided
in this paragraph (g), a section 204(h) notice for an amendment to which
paragraph (a) of this section applies that is adopted after the
effective date of the amendment must be provided, with respect to any
applicable individual, at least 45 days before (or such other date as
may apply under paragraph (b), (c), (d), or (f) of this Q&A-9) the date
the amendment is put into operational effect.
(3) Special rules for section 204(h) notices provided in connection
with other disclosure requirements--(i) In general. Notwithstanding the
requirements in this Q&A-9 and Q&A-11 of this section, if a plan
provides one of the notices in paragraph (g)(3)(ii) of this Q&A-9, in
accordance with the applicable timing and content rules for such notice,
the plan is treated as timely providing a section 204(h) notice with
respect to a section 204(h) amendment.
(ii) Notice requirements. The notices in this paragraph (g)(3)(ii)
are--
[[Page 342]]
(A) A notice required under any revenue ruling, notice, or other
guidance published under the authority of the Commissioner in the
Internal Revenue Bulletin to affected parties in connection with a
retroactive plan amendment described in section 412(d)(2) (section
412(c)(8) for plan years beginning before January 1, 2008);
(B) A notice required under section 101(j) of ERISA if an amendment
is adopted to comply with the benefit limitation requirements of section
206(g) of ERISA (section 436 of the Code);
(C) A notice required under section 432(b)(3)(D) of the Code for an
amendment adopted to comply with the benefit restrictions under section
432(f)(2);
(D) A notice required under section 418D, or section 4244A(b) of
ERISA, for an amendment that reduces or eliminates accrued benefits
attributable to employer contributions with respect to a multiemployer
plan in reorganization;
(E) A notice required under section 418E, or section 4245(e) of
ERISA, relating to the effects of the insolvency status for a
multiemployer plan; and
(F) A notice required under section 4281 of ERISA for an amendment
of a multiemployer plan reducing benefits pursuant to section 4281(c) of
ERISA.
(4) Delegation of authority to Commissioner. The Commissioner may
provide special rules under section 4980F, in revenue rulings, notices,
or other guidance published in the Internal Revenue Bulletin (see Sec.
601.601(d)(2)(ii)(b) of this chapter), that the Commissioner determines
to be necessary or appropriate with respect to a section 204(h)
amendment--
(A) That applies to benefits accrued before the applicable amendment
date but that does not violate section 411(d)(6); or
(B) For which there is a required notice relating to a reduction in
benefits and such notice has timing and content requirements similar to
a section 204(h) notice with respect to a significant reduction in the
rate of future benefit accruals.
Q-10. To whom must section 204(h) notice be provided?
A-10. (a) In general. Section 204(h) notice must be provided to each
applicable individual, to each employee organization representing
participants who are applicable individuals, and, for plan years
beginning after December 31, 2007, to each employer that has an
obligation to contribute (within the meaning of section 4212(a) of
ERISA) to a multiemployer plan. A special rule is provided in paragraph
(d) of this Q&A-10.
(b) Applicable individual. Applicable individual means each
participant in the plan, and any alternate payee, whose rate of future
benefit accrual under the plan is reasonably expected to be
significantly reduced, or for whom an early retirement benefit or
retirement-type subsidy under the plan may reasonably be expected to be
significantly reduced, by the section 204(h) amendment. The
determination is made with respect to individuals who are reasonably
expected to be participants or alternate payees in the plan at the
effective date of the section 204(h) amendment.
(c) Alternate payee. Alternate payee means a beneficiary who is an
alternate payee (within the meaning of section 414(p)(8) of the Internal
Revenue Code) under an applicable qualified domestic relations order
(within the meaning of section 414(p)(1)(A) of the Internal Revenue
Code).
(d) Designees. Section 204(h) notice may be provided to a person
designated in writing by an applicable individual or by an employee
organization representing participants who are applicable individuals,
instead of being provided to that applicable individual or employee
organization. Any designation of a representative made through an
electronic method that satisfies standards similar to those of Q&A-
13(c)(1) of this section satisfies the requirement that a designation be
in writing.
(e) Facts and circumstances test. Whether a participant or alternate
payee is an applicable individual is determined on a typical business
day that is reasonably proximate to the time the section 204(h) notice
is provided (or at the latest date for providing section 204(h) notice,
if earlier), based on all relevant facts and circumstances.
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(f) Examples. The following examples illustrate the rules in this
Q&A-10:
Example 1. (i) Facts. A defined benefit plan requires an individual
to complete 1 year of service to become a participant who can accrue
benefits, and participants cease to accrue benefits under the plan at
severance from employment with the employer. There are no alternate
payees and employees are not represented by an employee organization. On
November 18, 2004, the plan is amended effective as of January 1, 2005
to reduce significantly the rate of future benefit accrual. Section
204(h) notice is provided on November 1, 2004.
(ii) Conclusion. Section 204(h) notice is only required to be
provided to individuals who, based on the facts and circumstances on
November 1, 2004, are reasonably expected to have completed at least 1
year of service and to be employed by the employer on January 1, 2005.
Example 2. (i) Facts. The facts are the same as in Example 1, except
that the sole effect of the plan amendment is to alter the pre-amendment
plan provisions under which benefits payable to an employee who retires
after 20 or more years of service are unreduced for commencement before
normal retirement age. The amendment requires 30 or more years of
service in order for benefits commencing before normal retirement age to
be unreduced, but the amendment only applies for future benefit
accruals.
(ii) Conclusion. Section 204(h) notice is only required to be
provided to individuals who, on January 1, 2005, have completed at least
1 year of service but less than 30 years of service, are employed by the
employer, have not attained normal retirement age, and will have
completed 20 or more years of service before normal retirement age if
their employment continues to normal retirement age.
Example 3. (i) Facts. A plan is amended to reduce significantly the
rate of future benefit accrual for all current employees who are
participants. Based on the facts and circumstances, it is reasonable to
expect that the amendment will not reduce the rate of future benefit
accrual of former employees who are currently receiving benefits or of
former employees who are entitled to deferred vested benefits.
(ii) Conclusion. The plan administrator is not required to provide
section 204(h) notice to any former employees.
Example 4. (i) Facts. The facts are the same as in Example 3, except
that the plan covers two groups of alternate payees. The alternate
payees in the first group are entitled to a certain percentage or
portion of the former spouse's accrued benefit and, for this purpose,
the accrued benefit is determined at the time the former spouse begins
receiving retirement benefits under the plan. The alternate payees in
the second group are entitled to a certain percentage or portion of the
former spouse's accrued benefit and, for this purpose, the accrued
benefit was determined at the time the qualified domestic relations
order was issued by the court.
(ii) Conclusion. It is reasonable to expect that the benefits to be
received by the second group of alternate payees will not be affected by
any reduction in a former spouse's rate of future benefit accrual.
Accordingly, the plan administrator is not required to provide section
204(h) notice to the alternate payees in the second group.
Example 5. (i) Facts. A plan covers hourly employees and salaried
employees. The plan provides the same rate of benefit accrual for both
groups. The employer amends the plan to reduce significantly the rate of
future benefit accrual of the salaried employees only. At that time, it
is reasonable to expect that only a small percentage of hourly employees
will become salaried in the future.
(ii) Conclusion. The plan administrator is not required to provide
section 204(h) notice to the participants who are currently hourly
employees.
Example 6. (i) Facts. A plan covers employees in Division M and
employees in Division N. The plan provides the same rate of benefit
accrual for both groups. The employer amends the plan to reduce
significantly the rate of future benefit accrual of employees in
Division M. At that time, it is reasonable to expect that in the future
only a small percentage of employees in Division N will be transferred
to Division M.
(ii) Conclusion. The plan administrator is not required to provide
section 204(h) notice to the participants who are employees in Division
N.
Example 7. (i) Facts. The facts are the same facts as in Example 6,
except that at the time the amendment is adopted, it is expected that
thereafter Division N will be merged into Division M in connection with
a corporate reorganization (and the employees in Division N will become
subject to the plan's amended benefit formula applicable to the
employees in Division M).
(ii) Conclusion. In this case, the plan administrator must provide
section 204(h) notice to the participants who are employees in Division
M and to the participants who are employees in Division N.
Example 8. (i) Facts. A plan is amended to reduce significantly the
rate of future benefit accrual for all current employees who are
participants. The plan amendment will be effective on January 1, 2004.
The plan will provide the notice to applicable individuals on October
31, 2003. In determining which current employees are applicable
individuals, the plan administrator determines that October 1, 2003, is
a typical business day that is reasonably proximate to the time the
section 204(h) notice is provided.
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(ii) Conclusion. In this case, October 1, 2003 is a typical business
day that satisfies the requirements of Q&A-10(e) of this section.
Q-11. What information is required to be provided in a section
204(h) notice?
A-11. (a) Explanation of notice requirements--(1) In general.
Section 204(h) notice must include sufficient information to allow
applicable individuals to understand the effect of the plan amendment.
In order to satisfy this rule, a plan administrator providing section
204(h) notice must generally satisfy paragraphs (a)(2), (a)(3), (a)(4),
(a)(5), and (a)(6) of this Q&A-11. See paragraph (g)(3) of Q&A-9 of this
section for special rules relating to section 204(h) notices provided in
connection with certain other written notices. See also paragraph (g)(4)
of Q&A-9 of this section for a delegation of authority to the
Commissioner to provide special rules.
(2) Information in section 204(h) notice. The information in a
section 204(h) notice must be written in a manner calculated to be
understood by the average plan participant and to apprise the applicable
individual of the significance of the notice.
(3) Required narrative description of amendment--(i) Reduction in
rate of future benefit accrual. In the case of an amendment reducing the
rate of future benefit accrual, the notice must include a description of
the benefit or allocation formula prior to the amendment, a description
of the benefit or allocation formula under the plan as amended, and the
effective date of the amendment.
(ii) Reduction in early retirement benefit or retirement-type
subsidy. In the case of an amendment that reduces an early retirement
benefit or retirement-type subsidy (other than as a result of an
amendment reducing the rate of future benefit accrual), the notice must
describe how the early retirement benefit or retirement-type subsidy is
calculated from the accrued benefit before the amendment, how the early
retirement benefit or retirement-type subsidy is calculated from the
accrued benefit after the amendment, and the effective date of the
amendment. For example, if, for a plan with a normal retirement age of
65, the change is from an unreduced normal retirement benefit at age 55
to an unreduced normal retirement benefit at age 60 for benefits accrued
in the future, with an actuarial reduction to apply for benefits accrued
in the future to the extent that the early retirement benefit begins
before age 60, the notice must state the change and specify the factors
that apply in calculating the actuarial reduction (for example, a 5% per
year reduction applies for early retirement before age 60).
(4) Sufficient information to determine the approximate magnitude of
reduction--(i) General rule. (A) Section 204(h) notice must include
sufficient information for each applicable individual to determine the
approximate magnitude of the expected reduction for that individual.
Thus, in any case in which it is not reasonable to expect that the
approximate magnitude of the reduction for each applicable individual
will be reasonably apparent from the description of the amendment
provided in accordance with paragraph (a)(3) of this Q&A-11, further
information is required. The further information may be provided by
furnishing additional narrative information or in other information that
satisfies this paragraph of this section.
(B) To the extent any expected reduction is not uniformly applicable
to all participants, the notice must either identify the general classes
of participants to whom the reduction is expected to apply, or by some
other method include sufficient information to allow each applicable
individual receiving the notice to determine which reductions are
expected to apply to that individual.
(ii) Illustrative examples--(A) Requirement generally. The
requirement to include sufficient information for each applicable
individual to determine the approximate magnitude of the expected
reduction for that individual under (a)(4)(i)(A) of this Q&A-11 is
deemed satisfied if the notice includes one or more illustrative
examples showing the approximate magnitude of the reduction in the
examples, as provided in this paragraph (a)(4)(ii). Illustrative
examples are in any event required to be provided for any change from a
traditional defined benefit formula to a cash balance formula or a
change that
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results in a period of time during which there are no accruals (or
minimal accruals) with regard to normal retirement benefits or an early
retirement subsidy (a wear-away period).
(B) Examples must bound the range of reductions. Where an amendment
results in reductions that vary (either among participants, as would
occur for an amendment converting a traditional defined benefit formula
to a cash balance formula, or over time as to any individual
participant, as would occur for an amendment that results in a wear-away
period), the illustrative example(s) provided in accordance with this
paragraph (a)(4)(ii) must show the approximate range of the reductions.
However, any reductions that are likely to occur in only a de minimis
number of cases are not required to be taken into account in determining
the range of the reductions if a narrative statement is included to that
effect and examples are provided that show the approximate range of the
reductions in other cases. Amendments for which the maximum reduction
occurs under identifiable circumstances, with proportionately smaller
reductions in other cases, may be illustrated by one example
illustrating the maximum reduction, with a statement that smaller
reductions also occur. Further, assuming that the reduction varies from
small to large depending on service or other factors, two illustrative
examples may be provided showing the smallest likely reduction and the
largest likely reduction.
(C) Assumptions used in examples. The examples provided under this
paragraph (a)(4)(ii) are not required to be based on any particular form
of payment (such as a life annuity or a single sum), but may be based on
whatever form appropriately illustrates the reduction. The examples
generally may be based on any reasonable assumptions (for example,
assumptions relating to the representative participant's age, years of
service, and compensation, along with any interest rate and mortality
table used in the illustrations, as well as salary scale assumptions
used in the illustrations for amendments that alter the compensation
taken into account under the plan), but the section 204(h) notice must
identify those assumptions. However, if a plan's benefit provisions
include a factor that varies over time (such as a variable interest
rate), the determination of whether an amendment is reasonably expected
to result in a wear-away period must be based on the value of the factor
applicable under the plan at a time that is reasonably close to the date
section 204(h) notice is provided, and any wear-away period that is
solely a result of a future change in the variable factor may be
disregarded. For example, to determine whether a wear-away occurs as a
result of a section 204(h) amendment that converts a defined benefit
plan to a cash balance pension plan that will credit interest based on a
variable interest factor specified in the plan, the future interest
credits must be projected based on the interest rate applicable under
the variable factor at the time section 204(h) notice is provided.
(D) Individual statements. This paragraph (a)(4)(ii) may be
satisfied by providing a statement to each applicable individual
projecting what that individual's future benefits are reasonably
expected to be at various future dates and what that individual's future
benefits would have been under the terms of the plan as in effect before
the section 204(h) amendment, provided that the statement includes the
same information required for examples under paragraphs (a)(4)(ii)(A)
through (C) of this Q&A-11, including showing the approximate range of
the reductions for the individual if the reductions vary over time and
identification of the assumptions used in the projections.
(5) No false or misleading information. A section 204(h) notice may
not include materially false or misleading information (or omit
information so as to cause the information provided to be misleading).
(6) Additional information when reduction not uniform--(i) In
general. If an amendment by its terms affects different classes of
participants differently (e.g., one new benefit formula will apply to
Division A and another to Division B), then the requirements of
paragraph (a) of this Q&A-11 apply separately with respect to each such
general class of participants. In addition,
[[Page 346]]
the notice must include sufficient information to enable an applicable
individual who is a participant to understand which class he or she is a
member of.
(ii) Option for different section 204(h) notices. If a section
204(h) amendment affects different classes of applicable individuals
differently, the plan administrator may provide to differently affected
classes of applicable individuals a section 204(h) notice appropriate to
those individuals. Such section 204(h) notice may omit information that
does not apply to the applicable individuals to whom it is furnished,
but must identify the class or classes of applicable individuals to whom
it is provided.
(b) Examples. The following examples illustrate the requirements
paragraph (a) of this Q&A-11. In each example, it is assumed that the
actual notice provided is written in a manner calculated to be
understood by the average plan participant and to apprise the applicable
individual of the significance of the notice in accordance with
paragraph (a)(2) of this Q&A-11. The examples are as follows:
Example 1. (i) Facts. Plan A provides that a participant is entitled
to a normal retirement benefit of 2% of the participant's average pay
over the 3 consecutive years for which the average is the highest
(highest average pay) multiplied by years of service. Plan A is amended
to provide that, effective January 1, 2004, the normal retirement
benefit will be 2% of the participant's highest average pay multiplied
by years of service before the effective date, plus 1% of the
participant's highest average pay multiplied by years of service after
the effective date. The plan administrator provides notice that states:
``Under the Plan's current benefit formula, a participant's normal
retirement benefit is 2% of the participant's average pay over the 3
consecutive years for which the average is the highest multiplied by the
participant's years of service. This formula is being changed by a plan
amendment. Under the Plan as amended, a participant's normal retirement
benefit will be the sum of 2% of the participant's average pay over the
3 consecutive years for which the average is the highest multiplied by
years of service before the January 1, 2004 effective date, plus 1% of
the participant's average pay over the 3 consecutive years for which the
average is the highest multiplied by the participant's years of service
after December 31, 2003. This change is effective on January 1, 2004.''
The notice does not contain any additional information.
(ii) Conclusion. The notice satisfies the requirements of paragraph
(a) of this Q&A-11.
Example 2. (i) Facts. Plan B provides that a participant is entitled
to a normal retirement benefit at age 64 of 2.2% of the participant's
career average pay multiplied by years of service. Plan B is amended to
cease all accruals, effective January 1, 2004. The plan administrator
provides notice that includes a description of the old benefit formula,
a statement that, after December 31, 2003, no participant will earn any
further accruals, and the effective date of the amendment. The notice
does not contain any additional information.
(ii) Conclusion. The notice satisfies the requirements of paragraph
(a) of this Q&A-11.
Example 3. (i) Facts. Plan C provides that a participant is entitled
to a normal retirement benefit at age 65 of 2% of career average
compensation multiplied by years of service. Plan C is amended to
provide that the normal retirement benefit will be 1% of average pay
over the 3 consecutive years for which the average is the highest
multiplied by years of service. The amendment only applies to accruals
for years of service after the amendment, so that each employee's
accrued benefit is equal to the sum of the benefit accrued as of the
effective date of the amendment plus the accrued benefit equal to the
new formula applied to years of service beginning on or after the
effective date. The plan administrator provides notice that describes
the old and new benefit formulas and also explains that for an
individual whose compensation increases over the individual's career
such that the individual's highest 3-year average exceeds the
individual's career average, the reduction will be less or there may be
no reduction. The notice does not contain any additional information.
(ii) Conclusion. The notice satisfies the requirements of paragraph
(a) of this Q&A-11.
Example 4. (i) Facts. (A) Plan D is a defined benefit pension plan
under which each participant accrues a normal retirement benefit, as a
life annuity beginning at the normal retirement age of 65, equal to the
participant's number of years of service multiplied by 1.5 percent
multiplied by the participant's average pay over the 3 consecutive years
for which the average is the highest. Plan D provides early retirement
benefits for former employees beginning at or after age 55 in the form
of an early retirement annuity that is actuarially equivalent to the
normal retirement benefit, with the reduction for early commencement
based on reasonable actuarial assumptions that are specified in Plan D.
Plan D provides for the suspension of benefits of participants who
continue in employment beyond normal retirement age, in accordance with
section 203(a)(3)(B) of ERISA and regulations thereunder issued by
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the Department of Labor. The pension of a participant who retires after
age 65 is calculated under the same normal retirement benefit formula,
but is based on the participant's service credit and highest 3-year pay
at the time of late retirement with any appropriate actuarial increases.
(B) Plan D is amended, effective July 1, 2005, to change the formula
for all future accruals to a cash balance formula under which the
opening account balance for each participant on July 1, 2005, is zero,
hypothetical pay credits equal to 5 percent of pay are credited to the
account thereafter, and hypothetical interest is credited monthly based
on the applicable interest rate under section 417(e)(3) of the Internal
Revenue Code at the beginning of the quarter. Any participant who
terminates employment with vested benefits can receive an actuarially
equivalent annuity (based on the same reasonable actuarial assumptions
that are specified in Plan D) commencing at any time after termination
of employment and before the plan's normal retirement age of 65. The
benefit resulting from the hypothetical account balance is in addition
to the benefit accrued before July 1, 2005 (taking into account only
service and highest 3-year pay before July 1, 2005), so that it is
reasonably expected that no wear-away period will result from the
amendment. The plan administrator expects that, as a general rule,
depending on future pay increases and future interest rates, the rate of
future benefit accrual after the conversion is higher for participants
who accrue benefits before approximately age 50 and after approximately
age 70, but is lower for participants who accrue benefits between
approximately age 50 and age 70.
(C) The plan administrator of Plan D announces the conversion to a
cash balance formula on May 16, 2005. The announcement is delivered to
all participants and includes a written notice that describes the old
formula, the new formula, and the effective date.
(D) In addition, the notice states that the Plan D formula before
the conversion provided a normal retirement benefit equal to the product
of a participant's number of years of service multiplied by 1.5 percent
multiplied by the participant's average pay over the 3 years for which
the average is the highest (highest 3-year pay). The notice includes an
example showing the normal retirement benefit that will be accrued after
June 30, 2005 for a participant who is age 49 with 10 years of service
at the time of the conversion. The plan administrator reasonably
believes that such a participant is representative of the participants
whose rate of future benefit accrual will be reduced as a result of the
amendment. The example estimates that, if the participant continues
employment to age 65, the participant's normal retirement benefit for
service from age 49 to age 65 will be $657 per month for life. The
example assumes that the participant's pay is $50,000 at age 49. The
example states that the estimated $657 monthly pension accrues over the
16-year period from age 49 to age 65 and that, based on assumed future
pay increases, this amount annually would be 9.1 percent of the
participant's highest 3-year pay at age 65, which over the 16 years from
age 49 to age 65 averages 0.57 percent per year multiplied by the
participant's highest 3-year pay. The example also states that the sum
of the monthly annuity accrued before the conversion in the 10-year
period from age 39 to age 49 plus the $657 monthly annuity estimated to
be accrued over the 16-year period from age 49 to age 65 is $1,235 and
that, based on assumed future increases in pay, this would be 17.1
percent of the participant's highest 3-year pay at age 65, which over
the employee's career from age 39 to age 65 averages 0.66 percent per
year multiplied by the participant's highest 3-year pay. The notice also
includes two other examples with similar information, one of which is
intended to show the circumstances in which a small reduction may occur
and the other of which shows the largest reduction that the plan
administrator thinks is likely to occur. The notice states that the
estimates are based on the assumption that pay increases annually after
June 30, 2005, at a 4 percent rate. The notice also specifies that the
applicable interest rate under section 417(e) for hypothetical interest
credits after June 30, 2005 is assumed to be 6 percent, which is the
section 417(e) of the Internal Revenue Code applicable interest rate
under the plan for 2005.
(ii) Conclusion. The information in the notice, as described in
paragraph (i)(C) and (i)(D) of this Example 4, satisfies the
requirements of paragraph (a)(3) of this Q&A-11 with respect to
applicable individuals who are participants. The requirements of
paragraph (a)(4) of this Q&A-11 are satisfied because, as noted in
paragraph (i)(D) of this Example 4, the notice describes the old formula
and describes the estimated future accruals under the new formula in
terms that can be readily compared to the old formula, i.e., the notice
states that the estimated $657 monthly pension accrued over the 16-year
period from age 49 to age 65 averages 0.57 percent of the participant's
highest 3-year pay at age 65. The requirement in paragraph (a)(4)(ii) of
this Q&A-11 that the examples include sufficient information to be able
to determine the approximate magnitude of the reduction would also be
satisfied if the notice instead directly stated the amount of the
monthly pension that would have accrued over the 16-year period from age
49 to age 65 under the old formula.
Example 5. (i) Facts. The facts are the same as in Example 4, except
that, under the plan as in effect before the amendment, the early
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retirement pension for a participant who terminates employment after age
55 with at least 20 years of service is equal to the normal retirement
benefit without reduction from age 65 to age 62 and reduced by only 5
percent per year for each year before age 62. As a result, early
retirement benefits for such a participant constitute a retirement-type
subsidy. The plan as in effect after the amendment provides an early
retirement benefit equal to the sum of the early retirement benefit
payable under the plan as in effect before the amendment taking into
account only service and highest 3-year pay before July 1, 2005, plus an
early retirement annuity that is actuarially equivalent to the account
balance for service after June 30, 2005. The notice provided by the plan
administrator describes the old early retirement annuity, the new early
retirement annuity, and the effective date. The notice includes an
estimate of the early retirement annuity payable to the illustrated
participant for service after the conversion if the participant were to
retire at age 59 (which the plan administrator believes is a typical
early retirement age) and elect to begin receiving an immediate early
retirement annuity. The example states that the normal retirement
benefit expected to be payable at age 65 as a result of service from age
49 to age 59 is $434 per month for life beginning at age 65 and that the
early retirement annuity expected to be payable as a result of service
from age 49 to age 59 is $270 per month for life beginning at age 59.
The example states that the monthly early retirement annuity of $270 is
38 percent less than the monthly normal retirement benefit of $434,
whereas a 15 percent reduction would have applied under the plan as in
effect before the amendment. The notice also includes similar
information for examples that show the smallest and largest reduction
that the plan administrator thinks is likely to occur in the early
retirement benefit. The notice also specifies the applicable interest
rate, mortality table, and salary scale used in the example to calculate
the early retirement reductions.
(ii) Conclusion. The information in the notice, as described in
paragraphs (i)(C) and (D) of Example 4 and paragraph (i) of this Example
5, satisfies the requirements of paragraph (a)(3) of this Q&A-11 with
respect to applicable individuals who are participants. The requirements
of paragraph (a)(4) of this Q&A-11 are satisfied because, as noted in
paragraph (i) of this Example 5, the notice describes the early
retirement subsidy under the old formula and describes the estimated
early retirement pension under the new formula in terms that can be
readily compared to the old formula, i.e., the notice states that the
monthly early retirement pension of $270 is 38 percent less than the
monthly normal retirement benefit of $434, whereas a 15 percent
reduction would have applied under the plan as in effect before the
amendment. The requirements of paragraph (a)(4)(ii) of this Q&A-11 that
the examples include sufficient information to be able to determine the
approximate magnitude of the reduction would also be satisfied if the
notice instead directly stated the amount of the monthly early
retirement pension that would be payable at age 59 under the old
formula.
Q-12. What special rules apply if participants can choose between
the old and new benefit formulas?
A-12. In any case in which an applicable individual can choose
between the benefit formula (including any early retirement benefit or
retirement-type subsidy) in effect before the section 204(h) amendment
(old formula) or the benefit formula in effect after the section 204(h)
amendment (new formula), section 204(h) notice has not been provided
unless the applicable individual has been provided the information
required under Q&A-11 of this section, and has also been provided
sufficient information to enable the individual to make an informed
choice between the old and new benefit formulas. The information
required under Q&A-11 of this section must be provided by the date
otherwise required under Q&A-9 of this section. The information
sufficient to enable the individual to make an informed choice must be
provided within a period that is reasonably contemporaneous with the
date by which the individual is required to make his or her choice and
that allows sufficient advance notice to enable the individual to
understand and consider the additional information before making that
choice.
Q-13. How may section 204(h) notice be provided?
A-13. (a) Delivering section 204(h) notice. A plan administrator
(including a person acting on behalf of the plan administrator, such as
the employer or plan trustee) must provide section 204(h) notice through
a method that results in actual receipt of the notice or the plan
administrator must take appropriate and necessary measures reasonably
calculated to ensure that the method for providing section 204(h) notice
results in actual receipt of the notice. Section 204(h) notice must be
provided either in the form of a paper document or in an electronic form
that satisfies the requirements of paragraph
[[Page 349]]
(c) of this Q&A-13. First class mail to the last known address of the
party is an acceptable delivery method. Likewise, hand delivery is
acceptable. However, the posting of notice is not considered provision
of section 204(h) notice. Section 204(h) notice may be enclosed with or
combined with other notice provided by the employer or plan
administrator (for example, a notice of intent to terminate under title
IV of ERISA). Except as provided in paragraph (c) of this Q&A-13, a
section 204(h) notice is deemed to have been provided on a date if it
has been provided by the end of that day. When notice is delivered by
first class mail, the notice is considered provided as of the date of
the United States postmark stamped on the cover in which the document is
mailed.
(b) Example. The following example illustrates the provisions of
paragraph (a) of this Q&A-13:
Example. (i) Facts. Plan A is amended to reduce significantly the
rate of future benefit accrual effective January 1, 2005. Under Q&A-9 of
this section, section 204(h) notice is required to be provided at least
45 days before the effective date of the amendment. The plan
administrator causes section 204(h) notice to be mailed to all affected
participants. The mailing is postmarked November 16, 2004.
(ii) Conclusion. Because section 204(h) notice is given 45 days
before the effective date of the plan amendment, it satisfies the timing
requirement of Q&A-9 of this section.
(c) New technologies--(1) General rule. A section 204(h) notice may
be provided to an applicable individual through an electronic method
(other than an oral communication or a recording of an oral
communication), provided that all of the following requirements are
satisfied:
(i) Either the notice is actually received by the applicable
individual or the plan administrator takes appropriate and necessary
measures reasonably calculated to ensure that the method for providing
section 204(h) notice results in actual receipt of the notice by the
applicable individual.
(ii) The section 204(h) notice is delivered using an electronic
medium (other than an oral communication or a recording of an oral
communication) under an electronic system that satisfies the applicable
notice requirements of Sec. 1.401(a)-21.
(iii) Special effective date. For plan years beginning prior to
January 1, 2007, Q&A-13 of this section, as it appeared in the April 1,
2006 edition of 26 CFR part 1, applies.
(2) Examples. The following examples illustrate the requirement in
paragraph (c)(1)(i) of this Q&A-13. In these examples, it is assumed
that the notice satisfies the requirements in paragraphs (c)(1)(ii) of
this section. The examples are as follows:
Example 1. (i) Facts. On July 1, 2003, M, a plan administrator of
Company N's plan, sends notice intended to constitute section 204(h)
notice to A, an employee of Company N and a participant in the plan. The
notice is sent through e-mail to A's e-mail address on Company N's
electronic information system. Accessing Company N's electronic
information system is not an integral part of A's duties. M sends the e-
mail with a request for a computer-generated notification that the
message was received and opened. M receives notification indicating that
the e-mail was received and opened by A on July 9, 2003.
(ii) Conclusion. With respect to A, although M has failed to take
appropriate and necessary measures reasonably calculated to ensure that
the method for providing section 204(h) notice results in actual receipt
of the notice, M satisfies the requirement of paragraph (c)(1)(i) of
this Q&A-13 on July 9, 2003, which is when A actually receives the
notice.
Example 2. (i) Facts. On August 1, 2003, O, a plan administrator of
Company P's plan, sends a notice intended to constitute section 204(h)
notice of ERISA to B, who is an employee of Company P and a participant
in Company P's plan. The notice is sent through e-mail to B's e-mail
address on Company P's electronic information system. B has the ability
to effectively access electronic documents from B's e-mail address on
Company P's electronic information system and accessing the system is an
integral part of B's duties.
(ii) Conclusion. Because access to the system is an integral part of
B's duties, O has taken appropriate and necessary measures reasonably
calculated to ensure that the method for providing section 204(h) notice
results in actual receipt of the notice. Thus, regardless of whether B
actually accesses B's email on that date, O satisfies the requirement of
paragraph (c)(1)(i) of this Q&A-13 on August 1, 2003, with respect to B.
Q-14. What are the consequences if a plan administrator fails to
provide section 204(h) notice?
[[Page 350]]
A-14. (a) Egregious failures--(1) Effect of egregious failure to
provide section 204(h) notice. Section 204(h)(6)(A) of ERISA provides
that, in the case of any egregious failure to meet the notice
requirements with respect to any plan amendment, the plan provisions are
applied so that all applicable individuals are entitled to the greater
of the benefit to which they would have been entitled without regard to
the amendment, or the benefit under the plan with regard to the
amendment. For a special rule applicable in the case of a plan
termination, see Q&A-17(b) of this section.
(2) Definition of egregious failure. For purposes of section 204(h)
of ERISA and this Q&A-14, there is an egregious failure to meet the
notice requirements if a failure to provide required notice is within
the control of the plan sponsor and is either an intentional failure or
a failure, whether or not intentional, to provide most of the
individuals with most of the information they are entitled to receive.
For this purpose, an intentional failure includes any failure to
promptly provide the required notice or information after the plan
administrator discovers an unintentional failure to meet the
requirements. A failure to give section 204(h) notice is deemed not to
be egregious if the plan administrator reasonably determines, taking
into account section 4980F, section 204(h), these regulations, other
administrative pronouncements, and relevant facts and circumstances,
that the reduction in the rate of future benefit accrual resulting from
an amendment is not significant (as described in Q&A-8 of this section),
or that an amendment does not significantly reduce an early retirement
benefit or retirement-type subsidy.
(3) Example. The following example illustrates the provisions of
this paragraph (a):
Example. (i) Facts. Plan A is amended to reduce significantly the
rate of future benefit accrual effective January 1, 2003. Section 204(h)
notice is required to be provided 45 days before January 1, 2003. Timely
section 204(h) notice is provided to all applicable individuals (and to
each employee organization representing participants who are applicable
individuals), except that the employer intentionally fails to provide
section 204(h) notice to certain participants until May 16, 2003.
(ii) Conclusion. The failure to provide section 204(h) notice is
egregious. Accordingly, for the period from January 1, 2003 through June
30, 2003 (which is the date that is 45 days after May 16, 2003), all
participants and alternate payees are entitled to the greater of the
benefit to which they would have been entitled under Plan A as in effect
before the amendment or the benefit under the plan as amended.
(b) Effect of non-egregious failure to provide section 204(h)
notice. If an egregious failure has not occurred, the amendment with
respect to which section 204(h) notice is required may become effective
with respect to all applicable individuals. However, see section 502 of
ERISA for civil enforcement remedies. Thus, where there is a failure,
whether or not egregious, to provide section 204(h) notice in accordance
with this section, individuals may have recourse under section 502 of
ERISA.
(c) Excise taxes. See section 4980F and Q&A-15 of this section for
excise taxes that may apply to a failure to notify applicable
individuals of a pension plan amendment that provides for a significant
reduction in the rate of future benefit accrual or eliminates or
significantly reduces an early retirement benefit or retirement-type
subsidy, regardless of whether or not the failure is egregious.
Q-15. What are some of the rules that apply with respect to the
excise tax under section 4980F?
A-15. (a) Person responsible for excise tax. In the case of a plan
other than a multiemployer plan, the employer is responsible for
reporting and paying the excise tax. In the case of a multiemployer
plan, the plan is responsible for reporting and paying the excise tax.
(b) Excise tax inapplicable in certain cases. Under section
4980F(c)(1) of the Internal Revenue Code, no excise tax is imposed on a
failure for any period during which it is established to the
satisfaction of the Commissioner that the employer (or other person
responsible for the tax) exercised reasonable diligence, but did not
know that the failure existed. Under section 4980F(c)(2) of the Internal
Revenue Code, no excise tax applies to a failure to provide section
204(h) notice if the employer (or other person responsible for the tax)
exercised reasonable diligence and corrects the failure within 30 days
after
[[Page 351]]
the employer (or other person responsible for the tax) first knew, or
exercising reasonable diligence would have known, that such failure
existed. For purposes of section 4980F(c)(1) of the Internal Revenue
Code, a person has exercised reasonable diligence, but did not know that
the failure existed if and only if--
(1) The person exercised reasonable diligence in attempting to
deliver section 204(h) notice to applicable individuals by the latest
date permitted under this section; and
(2) At the latest date permitted for delivery of section 204(h)
notice, the person reasonably believes that section 204(h) notice was
actually delivered to each applicable individual by that date.
(c) Example. The following example illustrates the provisions of
paragraph (b) of this Q&A-15:
Example. (i) Facts. Plan A is amended to reduce significantly the
rate of future benefit accrual. The employer sends out a section 204(h)
notice to all affected participants and other applicable individuals and
to any employee organization representing applicable individuals,
including actual delivery by hand to employees at worksites and by
first-class mail for any other applicable individual and to any employee
organization representing applicable individuals. However, although the
employer exercises reasonable diligence in seeking to deliver the
notice, the notice is not delivered to any participants at one worksite
due to a failure of an overnight delivery service to provide the notice
to appropriate personnel at that site for them to timely hand deliver
the notice to affected employees. The error is discovered when the
employer subsequently calls to confirm delivery. Appropriate section
204(h) notice is then promptly delivered to all affected participants at
the worksite.
(ii) Conclusion. Because the employer exercised reasonable
diligence, but did not know that a failure existed, no excise tax
applies, assuming that participants at the worksite receive section
204(h) notice within 30 days after the employer first knew, or
exercising reasonable diligence would have known, that the failure
occurred.
Q-16. How do section 4980F and section 204(h) apply when a business
is sold?
A-16. (a) Generally. Whether section 204(h) notice is required in
connection with the sale of a business depends on whether a plan
amendment is adopted that significantly reduces the rate of future
benefit accrual or significantly reduces an early retirement benefit or
retirement-type subsidy.
(b) Examples. The following examples illustrate the rules of this
Q&A-16:
Example 1. (i) Facts. Corporation Q maintains Plan A, a defined
benefit plan that covers all employees of Corporation Q, including
employees in its Division M. Plan A provides that participating
employees cease to accrue benefits when they cease to be employees of
Corporation Q. On January 1, 2006, Corporation Q sells all of the assets
of Division M to Corporation R. Corporation R maintains Plan B, which
covers all of the employees of Corporation R. Under the sale agreement,
employees of Division M become employees of Corporation R on the date of
the sale (and cease to be employees of Corporation Q), Corporation Q
continues to maintain Plan A following the sale, and the employees of
Division M become participants in Plan B.
(ii) Conclusion. No section 204(h) notice is required because no
plan amendment was adopted that reduced the rate of future benefit
accrual. The employees of Division M who become employees of Corporation
R ceased to accrue benefits under Plan A because their employment with
Corporation Q terminated.
Example 2. (i) Facts. Subsidiary Y is a wholly owned subsidiary of
Corporation S. Subsidiary Y maintains Plan C, a defined benefit plan
that covers employees of Subsidiary Y. Corporation S sells all of the
stock of Subsidiary Y to Corporation T. At the effective date of the
sale of the stock of Subsidiary Y, in accordance with the sale agreement
between Corporation S and Corporation T, Subsidiary Y amends Plan C so
that all benefit accruals cease.
(ii) Conclusion. Section 204(h) notice is required to be provided
because Subsidiary Y adopted a plan amendment that significantly reduced
the rate of future benefit accrual in Plan C.
Example 3. (i) Facts. As a result of an acquisition, Corporation U
maintains two defined benefit plans: Plan D covers employees of Division
N and Plan E covers the rest of the employees of Corporation U. Plan E
provides a significantly lower rate of future benefit accrual than Plan
D. Plan D is merged with Plan E, and all of the employees of Corporation
U will accrue benefits under the merged plan in accordance with the
benefit formula of former Plan E.
(ii) Conclusion. Section 204(h) notice is required.
Example 4. (i) Facts. The facts are the same as in Example 3, except
that the rate of future benefit accrual in Plan E is not significantly
lower. In addition, Plan D has a retirement-type subsidy that Plan E
does not have and the Plan D employees' rights to the
[[Page 352]]
subsidy under the merged plan are limited to benefits accrued before the
merger.
(ii) Conclusion. Section 204(h) notice is required for any
participants or beneficiaries for whom the reduction in the retirement-
type subsidy is significant (and for any employee organization
representing such participants).
Example 5. (i) Facts. Corporation V maintains several plans,
including Plan F, which covers employees of Division P. Plan F provides
that participating employees cease to accrue further benefits under the
plan when they cease to be employees of Corporation V. Corporation V
sells all of the assets of Division P to Corporation W, which maintains
Plan G for its employees. Plan G provides a significantly lower rate of
future benefit accrual than Plan F. Plan F is merged with Plan G as part
of the sale, and employees of Division P who become employees of
Corporation W will accrue benefits under the merged plan in accordance
with the benefit formula of former Plan G.
(ii) Conclusion. No section 204(h) notice is required because no
plan amendment was adopted that reduces the rate of future benefit
accrual or eliminates or significantly reduces an early retirement
benefit or retirement-type subsidy. Under the terms of Plan F as in
effect prior to the merger, employees of Division P cease to accrue any
further benefits (including benefits with respect to early retirement
benefits and any retirement-type subsidy) under Plan F after the date of
the sale because their employment with Corporation V terminated.
Q-17. How are amendments to cease accruals and terminate a plan
treated under section 4980F and section 204(h)?
A-17. (a) General rule--(1) Rule. An amendment providing for the
cessation of benefit accruals on a specified future date and for the
termination of a plan is subject to section 4980F and section 204(h).
(2) Example. The following example illustrates the rule of paragraph
(a)(1) of this Q&A-17:
Example. (i) Facts. An employer adopts an amendment that provides
for the cessation of benefit accruals under a defined benefit plan on
December 31, 2003, and for the termination of the plan pursuant to title
IV of ERISA as of a proposed termination date that is also December 31,
2003. As part of the notice of intent to terminate required under title
IV in order to terminate the plan, the plan administrator gives section
204(h) notice of the amendment ceasing accruals, which states that
benefit accruals will cease ``on December 31, 2003 whether or not the
plan is terminated on that date.'' However, because all the requirements
of title IV for a plan termination are not satisfied, the plan cannot be
terminated until a date that is later than December 31, 2003.
(ii) Conclusion. Nonetheless, because section 204(h) notice was
given stating that the plan was amended to cease accruals on December
31, 2003, section 204(h) does not prevent the amendment to cease
accruals from being effective on December 31, 2003. The result would be
the same had the section 204(h) notice informed the participants that
the plan was amended to provide for a proposed termination date of
December 31, 2003 and to provide that ``benefit accruals will cease on
the proposed termination date whether or not the plan is terminated on
that date.'' However, neither section 4980F nor section 204(h) would be
satisfied with respect to the December 31, 2003 effective date if the
section 204(h) notice had merely stated that benefit accruals would
cease ``on the termination date'' or ``on the proposed termination
date.''
(3) Additional requirements under title IV of ERISA. See 29 CFR
4041.23(b)(4) and 4041.43(b)(5) for special rules applicable to plans
terminating under title IV of ERISA.
(b) Terminations in accordance with title IV of ERISA. A plan that
is terminated in accordance with title IV of ERISA is deemed to have
satisfied section 4980F and section 204(h) not later than the
termination date (or date of termination, as applicable) established
under section 4048 of ERISA. Accordingly, neither section 4980F nor
section 204(h) would in any event require that any additional benefits
accrue after the effective date of the termination.
(c) Amendment effective before termination date of a plan subject to
title IV of ERISA. To the extent that an amendment providing for a
significant reduction in the rate of future benefit accrual or a
significant reduction in an early retirement benefit or retirement-type
subsidy has an effective date that is earlier than the termination date
(or date of termination, as applicable) established under section 4048
of ERISA, that amendment is subject to section 4980F and section 204(h).
Accordingly, the plan administrator must provide section 204(h) notice
(either separately, with, or as part of the notice of intent to
terminate) with respect to such an amendment.
Q-18. What are the effective dates of section 4980F, section 204(h),
as amended by EGTRRA, and these regulations?
[[Page 353]]
A-18. (a) Statutory effective date--(1) General rule. Section 4980F
and section 204(h), as amended by EGTRRA, apply to plan amendments
taking effect on or after June 7, 2001 (statutory effective date), which
is the date of enactment of EGTRRA.
(2) Transition rule. For amendments applying after the statutory
effective date in paragraph (a)(1) of this Q&A-18 and prior to the
regulatory effective date in paragraph (c) of this Q&A-18, the
requirements of section 4980F(e)(2) and (3) of the Internal Revenue Code
and section 204(h), as amended by EGTRRA, are treated as satisfied if
the plan administrator makes a reasonable, good faith effort to comply
with those requirements.
(3) Special notice rule--(i) In general. Notwithstanding Q&A-9 of
this section, section 204(h) notice is not required by section 4980F(e)
of the Internal Revenue Code or section 204(h), as amended by EGTRRA, to
be provided prior to September 7, 2001 (the date that is three months
after the date of enactment of EGTRRA).
(ii) Reasonable notice. The requirements of section 4980F and
section 204(h), as amended by EGTRRA, do not apply to any plan amendment
that takes effect on or after June 7, 2001 if, before April 25, 2001,
notice was provided to participants and beneficiaries adversely affected
by the plan amendment (and their representatives) which was reasonably
expected to notify them of the nature and effective date of the plan
amendment. For purposes of this paragraph (a)(3)(ii), notice that
complies with Sec. 1.411(d)-6 of this chapter, as it appeared in the
April 1, 2001 edition of 26 CFR part 1, is deemed to be notice which was
reasonably expected to notify participants and beneficiaries adversely
affected by the plan amendment (and their representatives) of the nature
and effective date of the plan amendment.
(4) Special effective date for certain section 204(h) amendments
made by plans of commercial airlines. Section 402 of PPA `06 applies to
section 204(h) amendments adopted in plan years ending after August 17,
2006.
(5) Special effective date for rule relating to contributing
employers. Section 502(c) of PPA '06, which amended section 4980F(e)(1)
of the Internal Revenue Code, applies to section 204(h) amendments
adopted in plan years beginning after December 31, 2007.
(b) Regulatory effective date--(1) General effective date. Except as
otherwise provided in this paragraph (b) of this section, Q&A-1 through
Q&A-18 of this section apply to amendments with an effective date that
is on or after September 1, 2003.
(2) Effective date for Q&A-7(a)(2). Q&A-7(a)(2) of this section
applies to amendments with an effective date that is on or after January
1, 2004.
(3) Effective dates for Q&A-9(g)(1), (g)(3), and (g)(4)--(i) General
effective date. Except as otherwise provided in Q&A-18(b)(3)(ii) or
(b)(3)(iii) of this section, Q&A-9(g)(1), (g)(3), and (g)(4) of this
section apply to amendments that are effective on or after January 1,
2008.
(ii) Effective dates for Q&A-9(g)(2) and Q&A-7(b). Except as
otherwise provided in Q&A-18(b)(3)(iii) of this section, Q&A-9(g)(2) and
Q&A-7(b) of this section apply to section 204(h) amendments adopted in
plan years beginning after July 1, 2008.
(iii) Special rules for section 204(h) amendments to an applicable
defined benefit plan. Except as otherwise provided in paragraph
(b)(3)(i) or (b)(3)(ii) of this Q&A-18, with respect to any section
204(h) notice provided in connection with a section 204(h) amendment to
an applicable defined benefit plan within the meaning of section
411(a)(13)(C)(i) to limit distributions as permitted under section
411(a)(13)(A) for distributions made after August 17, 2006, that is made
pursuant to section 701 of PPA '06, paragraphs (g)(1) and (g)(2) of Q&A-
9 of this section apply to amendments that are effective after December
21, 2006. For such an amendment that is effective not later than
December 31, 2008, section 204(h) notice does not fail to be timely if
the notice is provided at least 30 days, rather than 45 days, before the
date that the amendment is first effective.
(c) Amendments taking effect prior to June 7, 2001. For rules
applicable to amendments taking effect prior to
[[Page 354]]
June 7, 2001, see Sec. 1.411(d)-6 of this chapter, as it appeared in
the April 1, 2001 edition of 26 CFR part 1.
[T.D. 9052, 68 FR 17281, Apr. 9, 2003, as amended by T.D. 9219, 70 FR
47126, Aug. 12, 2005; T.D. 9294, 71 FR 61888, Oct. 20, 2006; T.D. 9472,
74 FR 61276, Nov. 24, 2009]
Sec. 54.4980G-0 Table of contents.
This section contains the questions for Sec. Sec. 54.4980G-1,
54.4980G-2, 54.4980G-3, 54.4980G-4, and 54.4980G-5.
Sec. 54.4980G-1 Failure of employer to make comparable health savings
account contributions.
Q-1: What are the comparability rules that apply to employer
contributions to Health Savings Accounts (HSAs)?
Q-2: What are the categories of HDHP coverage for purposes of
applying the comparability rules?
Q-3: What is the testing period for making comparable contributions
to employees' HSAs?
Q-4: How is the excise tax computed if employer contributions do not
satisfy the comparability rules for a calendar year?
Sec. 54.4980G-2 Employer contribution defined.
Q-1: Do the comparability rules apply to amounts rolled over from an
employee's HSA or Archer Medical Savings Account (Archer MSA)?
Q-2: If an employee requests that his or her employer deduct after-
tax amounts from the employee's compensation and forward these amounts
as employee contributions to the employee's HSA, do the comparability
rules apply to these amounts?
Sec. 54.4980G-3 Employee for comparability testing.
Q-1: Do the comparability rules apply to contributions that an
employer makes to the HSAs of independent contractors or self-employed
individuals?
Q-2: May a sole proprietor who is an eligible individual contribute
to his or her own HSA without contributing to the HSAs of his or her
employees who are eligible individuals?
Q-3: Do the comparability rules apply to contributions by a
partnership to a partner's HSA?
Q-4: How are members of controlled groups treated when applying the
comparability rules?
Q-5: What are the categories of employees for comparability testing?
Q-6: Are employees who are included in a unit of employees covered
by a collective bargaining agreement comparable participating employees?
Q-7: Is an employer permitted to make comparable contributions only
to the HSAs of comparable participating employees who have coverage
under the employer's HDHP?
Q-8: If an employee and his or her spouse are eligible individuals
who work for the same employer and one employee-spouse has family
coverage for both employees under the employer's HDHP, must the employer
make comparable contributions to the HSAs of both employees?
Q-9: Does an employer that makes HSA contributions only for one
class of non-collectively bargained employees who are eligible
individuals, but not for another class of non-collectively bargained
employees who are eligible individuals (for example, management v. non-
management) satisfy the requirement that the employer make comparable
contributions?
Q-10: If an employer contributes to the HSAs of former employees who
are eligible individuals, do the comparability rules apply to these
contributions?
Q-11: Is an employer permitted to make comparable contributions only
to the HSAs of comparable participating former employees who have
coverage under the employer's HDHP?
Q-12: If an employer contributes only to the HSAs of former
employees who are eligible individuals with coverage under the
employer's HDHP, must the employer make comparable contributions to the
HSAs of former employees who are eligible individuals with coverage
under the employer's HDHP because of an election under a COBRA
continuation provision (as defined in section 9832(d)(1))?
Q-13: How do the comparability rules apply if some employees have
HSAs and other employees have Archer MSAs?
Sec. 54.4980G-4 Calculating comparable contributions.
Q-1: What are comparable contributions?
Q-2: How does an employer comply with the comparability rules when
some non-collectively bargained employees who are eligible individuals
do not work for the employer during the entire calendar year?
Q-3: How do the comparability rules apply to employer contributions
to employees' HSAs if some non-collectively bargained employees work
full-time during the entire calendar year, and other non-collectively
bargained employees work full-time for less than the entire calendar
year?
Q-4: May an employer make contributions for the entire year to the
HSAs of its employees who are eligible individuals at the beginning of
the calendar year (i.e., on a pre-funded basis) instead of contributing
on a pay-as-you-go or on a look-back basis?
[[Page 355]]
Q-5: Must an employer use the same contribution method as described
in Q & A-2 and Q & A-4 of this section for all employees for any month
during the calendar year?
Q-6: How does an employer comply with the comparability rules if an
employee has not established an HSA at the time the employer contributes
to its employees' HSAs?
Q-7: If an employer bases its contributions on a percentage of the
HDHP deductible, how is the correct percentage or dollar amount
computed?
Q-8: Does an employer that contributes to the HSA of each comparable
participating employee in an amount equal to the employee's HSA
contribution or a percentage of the employee's HSA contribution
(matching contributions) satisfy the rule that all comparable
participating employees receive comparable contributions?
Q-9: If an employer conditions contributions by the employer to an
employee's HSA on an employee's participation in health assessments,
disease management programs or wellness programs and makes the same
contributions available to all employees who participate in the
programs, do the contributions satisfy the comparability rules?
Q-10: If an employer makes additional contributions to the HSAs of
all comparable participating employees who have attained a specified age
or who have worked for the employer for a specified number of years, do
the contributions satisfy the comparability rules?
Q-11: If an employer makes additional contributions to the HSAs of
all comparable participating employees who are eligible to make the
additional contributions (HSA catch-up contributions) under section
223(b)(3), do the contributions satisfy the comparability rules?
Q-12: If an employer's contributions to an employee's HSA result in
non-comparable contributions, may the employer recoup the excess amount
from the employee's HSA?
Q-13: What constitutes a reasonable interest rate for purposes of
making comparable contributions?
Q-14: How does an employer comply with the comparability rules if an
employee has not established an HSA by December 31st?
Q-15: For any calendar year, may an employer accelerate part or all
of its contributions for the entire year to the HSAs of employees who
have incurred, during the calendar year, qualified medical expenses (as
defined in section 223(d)(2)) exceeding the employer's cumulative HSA
contributions at that time?
Q-16: What is the effective date for the rules in Q & A-14 and Q &
A-15 of this section?
Sec. 54.4980G-5 HSA comparability rules and cafeteria plans and waiver
of excise tax.
Q-1: If an employer makes contributions through a section 125
cafeteria plan to the HSA of each employee who is an eligible
individual, are the contributions subject to the comparability rules?
Q-2: If an employer makes contributions through a cafeteria plan to
the HSA of each employee who is an eligible individual in an amount
equal to the amount of the employee's HSA contribution or a percentage
of the amount of the employee's HSA contribution (i.e., matching
contributions), are the contributions subject to the section 4980G
comparability rules?
Q-3: If under the employer's cafeteria plan, employees who are
eligible individuals and who participate in health assessments, disease
management programs or wellness programs receive an employer
contribution to an HSA and the employees have the right to elect to make
pre-tax salary reduction contributions to their HSAs, are the
contributions subject to the comparability rules?
Q-4: May all or part of the excise tax imposed under section 4980G
be waived?
[T.D. 9277, 71 FR 43058, July 31, 2006; 71 FR 53967, Sept. 13, 2006, as
amended by T.D. 9393, 73 FR 20795, Apr. 17, 2008]
Sec. 54.4980G-1 Failure of employer to make comparable health savings account contributions.
Q-1: What are the comparability rules that apply to employer
contributions to Health Savings Accounts (HSAs)?
A-1: If an employer makes contributions to any employee's HSA, the
employer must make comparable contributions to the HSAs of all
comparable participating employees. See Q & A-1 in Sec. 54.4980G-4 for
the definition of comparable contributions. Comparable participating
employees are eligible individuals (as defined in section 223(c)(1)) who
are in the same category of employees and who have the same category of
high deductible health plan (HDHP) coverage. See sections 4980G(b) and
4980E(d)(3). See section 223(c)(2) and (g) for the definition of an
HDHP. See also Q & A-5 in Sec. 54.4980G-3 for the categories of
employees and Q & A-2 of this section for the categories of HDHP
coverage. But see Q & A-6 in Sec. 54.4980G-3 for treatment of
collectively bargained employees and Q & A-1 in Sec. 54.4980G-6 for the
rules allowing larger comparable contributions to nonhighly compensated
employees.
[[Page 356]]
Q-2: What are the categories of HDHP coverage for purposes of
applying the comparability rules?
A-2: (a) In general. Generally, the categories of coverage are self-
only HDHP coverage and family HDHP coverage. Family HDHP coverage means
any coverage other than self-only HDHP coverage. The comparability rules
apply separately to self-only HDHP coverage and family HDHP coverage. In
addition, if an HDHP has family coverage options meeting the
descriptions listed in paragraph (b) of this Q & A-2, each such coverage
option may be treated as a separate category of coverage and the
comparability rules may be applied separately to each category. However,
if the HDHP has more than one category that provides coverage for the
same number of individuals, all such categories are treated as a single
category for purposes of the comparability rules. Thus, the categories
of ``employee plus spouse'' and ``employee plus dependent,'' each
providing coverage for two individuals, are treated as the single
category ``self plus one'' for comparability purposes. See, however, the
final sentence of paragraph (a) of Q & A-1 of Sec. 54.4980G-4 for a
special rule that applies if different amounts are contributed for
different categories of family coverage. See also Sec. 54.4980G-6 for
the rules allowing larger comparable contributions to nonhighly
compensated employees.
(b) HDHP Family coverage categories. The coverage categories are--
(1) Self plus one;
(2) Self plus two; and
(3) Self plus three or more.
(c) Examples. The rules of this Q & A-2 are illustrated by the
following examples:
Example 1. Employer A maintains an HDHP and contributes to the HSAs
of eligible employees who elect coverage under the HDHP. The HDHP has
self-only coverage and family coverage. Thus, the categories of coverage
are self-only and family coverage. Employer A contributes $750 to the
HSA of each eligible employee with self-only HDHP coverage and $1,000 to
the HSA of each eligible employee with family HDHP coverage. Employer
A's contributions satisfy the comparability rules.
Example 2. (i) Employer B maintains an HDHP and contributes to the
HSAs of eligible employees who elect coverage under the HDHP. The HDHP
has the following coverage options:
(A) Self-only;
(B) Self plus spouse;
(C) Self plus dependent;
(D) Self plus spouse plus one dependent;
(E) Self plus two dependents; and
(F) Self plus spouse and two or more dependents.
(ii) The self plus spouse category and the self plus dependent
category constitute the same category of HDHP coverage (self plus one)
and Employer B must make the same comparable contributions to the HSAs
of all eligible individuals who are in either the self plus spouse
category of HDHP coverage or the self plus dependent category of HDHP
coverage. Likewise, the self plus spouse plus one dependent category and
the self plus two dependents category constitute the same category of
HDHP coverage (self plus two) and Employer B must make the same
comparable contributions to the HSAs of all eligible individuals who are
in either the self plus spouse plus one dependent category of HDHP
coverage or the self plus two dependents category of HDHP coverage.
Example 3. (i) Employer C maintains an HDHP and contributes to the
HSAs of eligible employees who elect coverage under the HDHP. The HDHP
has the following coverage options:
(A) Self-only;
(B) Self plus one;
(C) Self plus two; and
(D) Self plus three or more.
(ii) Employer C contributes $500 to the HSA of each eligible
employee with self-only HDHP coverage, $750 to the HSA of each eligible
employee with self plus one HDHP coverage, $900 to the HSA of each
eligible employee with self plus two HDHP coverage and $1,000 to the HSA
of each eligible employee with self plus three or more HDHP coverage.
Employer C's contributions satisfy the comparability rules.
Q-3: What is the testing period for making comparable contributions
to employees' HSAs?
A-3: To satisfy the comparability rules, an employer must make
comparable contributions for the calendar year to the HSAs of employees
who are comparable participating employees. See section 4980G(a). See Q
& A-3 and Q & A-4 in Sec. 54.4980G-4 for a discussion of HSA
contribution methods.
Q-4: How is the excise tax computed if employer contributions do not
satisfy the comparability rules for a calendar year?
A-4: (a) Computation of tax. If employer contributions do not
satisfy the comparability rules for a calendar
[[Page 357]]
year, the employer is subject to an excise tax equal to 35% of the
aggregate amount contributed by the employer to HSAs for that period.
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q & A-4:
Example. During the 2007 calendar year, Employer D has 8 employees
who are eligible individuals with self-only coverage under an HDHP
provided by Employer D. The deductible for the HDHP is $2,000. For the
2007 calendar year, Employer D contributes $2,000 each to the HSAs of
two employees and $1,000 each to the HSAs of the other six employees,
for total HSA contributions of $10,000. Employer D's contributions do
not satisfy the comparability rules. Therefore, Employer D is subject to
an excise tax of $3,500 (35% of $10,000) for its failure to make
comparable contributions to its employees' HSAs.
Q-5: If a person is liable for the excise tax under section 4980G,
what form must the person file and what is the due date for the filing
and payment of the excise tax?
A-5: (a) In general. Sec. Sec. 54.6011-2, 54.6151-1 and 54.6071-
1(d).
(b) Effective/applicability date. The rules in this Q & A-5 are
effective for employer contributions made for calendar years beginning
on or after January 1, 2010.
[T.D. 9277, 71 FR 43058, July 31, 2006, as amended by T.D. 9457, 74 FR
45997, Sept. 8, 2009]
Sec. 54.4980G-2 Employer contribution defined.
Q-1: Do the comparability rules apply to amounts rolled over from an
employee's HSA or Archer Medical Savings Account (Archer MSA)?
A-1: No. The comparability rules do not apply to amounts rolled over
from an employee's HSA or Archer MSA.
Q-2: If an employee requests that his or her employer deduct after-
tax amounts from the employee's compensation and forward these amounts
as employee contributions to the employee's HSA, do the comparability
rules apply to these amounts?
A-2: No. Section 106(d) provides that amounts contributed by an
employer to an eligible employee's HSA shall be treated as employer-
provided coverage for medical expenses and are excludible from the
employee's gross income up to the limit in section 223(b). After-tax
employee contributions to an HSA are not subject to the comparability
rules because they are not employer contributions under section 106(d).
[T.D. 9277, 71 FR 43058, July 31, 2006]
Sec. 54.4980G-3 Failure of employer to make comparable health savings account contributions.
Q-1: Do the comparability rules apply to contributions that an
employer makes to the HSAs of independent contractors or self-employed
individuals?
A-1: No. The comparability rules apply only to contributions that an
employer makes to the HSAs of employees.
Q-2: May a sole proprietor who is an eligible individual contribute
to his or her own HSA without contributing to the HSAs of his or her
employees who are eligible individuals?
A-2: (a) Sole proprietor not an employee. Yes. The comparability
rules apply only to contributions made by an employer to the HSAs of
employees. Because a sole proprietor is not an employee, the
comparability rules do not apply to contributions the sole proprietor
makes to his or her own HSA. However, if a sole proprietor contributes
to any employee's HSA, the sole proprietor must make comparable
contributions to the HSAs of all comparable participating employees. In
determining whether the comparability rules are satisfied, contributions
that a sole proprietor makes to his or her own HSA are not taken into
account.
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q & A-2:
Example. In a calendar year, B, a sole proprietor is an eligible
individual and contributes $1,000 to B's own HSA. B also contributes
$500 for the same calendar year to the HSA of each employee who is an
eligible individual. The comparability rules are not violated by B's
$1,000 contribution to B's own HSA.
Q-3: Do the comparability rules apply to contributions by a
partnership to a partner's HSA?
A-3: (a) Partner not an employee. No. Contributions by a partnership
to a bona fide partner's HSA are not subject to the comparability rules
because the contributions are not contributions by
[[Page 358]]
an employer to the HSA of an employee. The contributions are treated as
either guaranteed payments under section 707(c) or distributions under
section 731. However, if a partnership contributes to the HSAs of any
employee who is not a partner, the partnership must make comparable
contributions to the HSAs of all comparable participating employees.
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q & A-3:
Example. (i) Partnership X is a limited partnership with three equal
individual partners, A (a general partner), B (a limited partner), and C
(a limited partner). C is to be paid $300 annually for services rendered
to Partnership X in her capacity as a partner without regard to
partnership income (a section 707(c) guaranteed payment). D and E are
the only employees of Partnership X and are not partners in Partnership
X. A, B, C, D, and E are eligible individuals and each has an HSA.
During Partnership X's Year 1 taxable year, which is also a calendar
year, Partnership X makes the following contributions--
(A) A $300 contribution to each of A's and B's HSAs which are
treated as section 731 distributions to A and B;
(B) A $300 contribution to C's HSA in lieu of paying C the
guaranteed payment directly; and
(C) A $200 contribution to each of D's and E's HSAs, who are
comparable participating employees.
(ii) Partnership X's contributions to A's and B's HSAs are section
731 distributions, which are treated as cash distributions. Partnership
X's contribution to C's HSA is treated as a guaranteed payment under
section 707(c). The contribution is not excludible from C's gross income
under section 106(d) because the contribution is treated as a
distributive share of partnership income for purposes of all Code
sections other than sections 61(a) and 162(a), and a guaranteed payment
to a partner is not treated as compensation to an employee. Thus,
Partnership X's contributions to the HSAs of A, B, and C are not subject
to the comparability rules. Partnership X's contributions to D's and E's
HSAs are subject to the comparability rules because D and E are
employees of Partnership X and are not partners in Partnership X.
Partnership X's contributions satisfy the comparability rules.
Q-4: How are members of controlled groups treated when applying the
comparability rules?
A-4: All persons or entities treated as a single employer under
section 414 (b), (c), (m), or (o) are treated as one employer. See
sections 4980G(b) and 4980E(e).
Q-5: What are the categories of employees for comparability testing?
A-5: (a) Categories. The categories of employees for comparability
testing are as follows (but see Q & A-6 of this section for the
treatment of collectively bargained employees and Q & A-1 of Sec.
54.4980G-6 for a special rule for contributions made to the HSAs of
nonhighly compensated employees)--
(1) Current full-time employees;
(2) Current part-time employees; and
(3) Former employees (except for former employees with coverage
under the employer's HDHP because of an election under a COBRA
continuation provision (as defined in section 9832(d)(1)).
(b) Part-time and full-time employees. For purposes of section
4980G, part-time employees are customarily employed for fewer than 30
hours per week and full-time employees are customarily employed for 30
or more hours per week. See sections 4980G(b) and 4980E(d)(4)(A) and
(B).
(c) In general. Except as provided in Q & A-6 of this section, the
categories of employees in paragraph (a) of this Q & A-5 are the
exclusive categories of employees for comparability testing. An employer
must make comparable contributions to the HSAs of all comparable
participating employees (eligible individuals who are in the same
category of employees with the same category of HDHP coverage) during
the calendar year without regard to any classification other than these
categories. For example, full-time eligible employees with self-only
HDHP coverage and part-time eligible employees with self-only HDHP
coverage are separate categories of employees and different amounts can
be contributed to the HSAs for each of these categories. But see Sec.
54.4980G-6 for a special rule for contributions made to the HSAs of
nonhighly compensated employees.
Q-6: Are employees who are included in a unit of employees covered
by a collective bargaining agreement comparable participating employees?
A-6: (a) In general. No. Collectively bargained employees who are
covered by a bona fide collective bargaining
[[Page 359]]
agreement between employee representatives and one or more employers are
not comparable participating employees, if health benefits were the
subject of good faith bargaining between such employee representatives
and such employer or employers. Former employees covered by a collective
bargaining agreement also are not comparable participating employees.
(b) Examples. The following examples illustrate the rules in
paragraph (a) of this Q & A-6. The examples read as follows:
Example 1. Employer A offers its employees an HDHP with a $1,500
deductible for self-only coverage. Employer A has collectively bargained
and non-collectively bargained employees. The collectively bargained
employees are covered by a collective bargaining agreement under which
health benefits were bargained in good faith. In the 2007 calendar year,
Employer A contributes $500 to the HSAs of all eligible non-collectively
bargained employees with self-only coverage under Employer A's HDHP.
Employer A does not contribute to the HSAs of the collectively bargained
employees. Employer A's contributions to the HSAs of non-collectively
bargained employees satisfy the comparability rules. The comparability
rules do not apply to collectively bargained employees.
Example 2. Employer B offers its employees an HDHP with a $1,500
deductible for self-only coverage. Employer B has collectively bargained
and non-collectively bargained employees. The collectively bargained
employees are covered by a collective bargaining agreement under which
health benefits were bargained in good faith. In the 2007 calendar year
and in accordance with the terms of the collective bargaining agreement,
Employer B contributes to the HSAs of all eligible collectively
bargained employees. Employer B does not contribute to the HSAs of the
non-collectively bargained employees. Employer B's contributions to the
HSAs of collectively bargained employees are not subject to the
comparability rules because the comparability rules do not apply to
collectively bargained employees. Accordingly, Employer B's failure to
contribute to the HSAs of the non-collectively bargained employees does
not violate the comparability rules.
Example 3. Employer C has two units of collectively bargained
employees--unit Q and unit R--each covered by a collective bargaining
agreement under which health benefits were bargained in good faith. In
the 2007 calendar year and in accordance with the terms of the
collective bargaining agreement, Employer C contributes to the HSAs of
all eligible collectively bargained employees in unit Q. In accordance
with the terms of the collective bargaining agreement, Employer C makes
no HSA contributions for collectively bargained employees in unit R.
Employer C's contributions to the HSAs of collectively bargained
employees are not subject to the comparability rules because the
comparability rules do not apply to collectively bargained employees.
Example 4. Employer D has a unit of collectively bargained employees
that are covered by a collective bargaining agreement under which health
benefits were bargained in good faith. In accordance with the terms of
the collective bargaining agreement, Employer D contributes an amount
equal to a specified number of cents per hour for each hour worked to
the HSAs of all eligible collectively bargained employees. Employer D's
contributions to the HSAs of collectively bargained employees are not
subject to the comparability rules because the comparability rules do
not apply to collectively bargained employees.
Q-7: Is an employer permitted to make comparable contributions only
to the HSAs of comparable participating employees who have coverage
under the employer's HDHP?
A-7: (a) Employer-provided HDHP coverage. If during a calendar year,
an employer contributes to the HSA of any employee who is an eligible
individual covered under an HDHP provided by the employer, the employer
is required to make comparable contributions to the HSAs of all
comparable participating employees with coverage under any HDHP provided
by the employer. An employer that contributes only to the HSAs of
employees who are eligible individuals with coverage under the
employer's HDHP is not required to make comparable contributions to HSAs
of employees who are eligible individuals but are not covered under the
employer's HDHP.
(b) Non-employer provided HDHP coverage. An employer that
contributes to the HSA of any employee who is an eligible individual
with coverage under any HDHP that is not an HDHP provided by the
employer, must make comparable contributions to the HSAs of all
comparable participating employees whether or not covered under the
employer's HDHP. An employer that makes a reasonable good faith effort
to identify all comparable participating employees with non-employer
provided HDHP coverage and makes
[[Page 360]]
comparable contributions to the HSAs of such employees satisfies the
requirements in paragraph (b) of this Q & A-7.
(c) Examples. The following examples illustrate the rules in this Q
& A-7. None of the employees in the following examples are covered by a
collective bargaining agreement. The examples read as follows:
Example 1. In a calendar year, Employer E offers an HDHP to its
full-time employees. Most full-time employees are covered under Employer
E's HDHP and Employer E makes comparable contributions only to these
employees' HSAs. Employee W, a full-time employee of Employer E and an
eligible individual, is covered under an HDHP provided by the employer
of W's spouse and not under Employer E's HDHP. Employer E is not
required to make comparable contributions to W's HSA.
Example 2. In a calendar year, Employer F does not offer an HDHP.
Several full-time employees of Employer F, who are eligible individuals,
have HSAs. Employer F contributes to these employees' HSAs. Employer F
must make comparable contributions to the HSAs of all full-time
employees who are eligible individuals.
Example 3. In a calendar year, Employer G offers an HDHP to its
full-time employees. Most full-time employees are covered under Employer
G's HDHP and Employer G makes comparable contributions to these
employees' HSAs and also to the HSAs of full-time employees who are
eligible individuals and who are not covered under Employer G's HDHP.
Employee S, a full-time employee of Employer G and a comparable
participating employee, is covered under an HDHP provided by the
employer of S's spouse and not under Employer G's HDHP. Employer G must
make comparable contributions to S's HSA.
Q-8: If an employee and his or her spouse are eligible individuals
who work for the same employer and one employee-spouse has family
coverage for both employees under the employer's HDHP, must the employer
make comparable contributions to the HSAs of both employees?
A-8: (a) In general. If the employer makes contributions only to the
HSAs of employees who are eligible individuals covered under its HDHP
where only one employee-spouse has family coverage for both employees
under the employer's HDHP, the employer is not required to contribute to
the HSAs of both employee-spouses. The employer is required to
contribute to the HSA of the employee-spouse with coverage under the
employer's HDHP, but is not required to contribute to the HSA of the
employee-spouse covered under the employer's HDHP by virtue of his or
her spouse's coverage. However, if the employer contributes to the HSA
of any employee who is an eligible individual with coverage under an
HDHP that is not an HDHP provided by the employer, the employer must
make comparable contributions to the HSAs of both employee-spouses if
they are both eligible individuals. If an employer is required to
contribute to the HSAs of both employee-spouses, the employer is not
required to contribute amounts in excess of the annual contribution
limits in section 223(b).
(b) Examples. The following examples illustrate the rules in
paragraph (a) of this Q & A-8. None of the employees in the following
examples are covered by a collective bargaining agreement. The examples
read as follows:
Example 1. In a calendar year, Employer H offers an HDHP to its
full-time employees. Most full-time employees are covered under Employer
H's HDHP and Employer H makes comparable contributions only to these
employees' HSAs. T and U are a married couple. Employee T, who is a
full-time employee of Employer H and an eligible individual, has family
coverage under Employer H's HDHP for T and T's spouse. Employee U, who
is also a full-time employee of Employer H and an eligible individual,
does not have coverage under Employer H's HDHP except as the spouse of
Employee T. Employer H is required to make comparable contributions to
T's HSA, but is not required to make comparable contributions to U's
HSA.
Example 2. In a calendar year, Employer J offers an HDHP to its
full-time employees. Most full-time employees are covered under Employer
J's HDHP and Employer J makes comparable contributions to these
employees' HSAs and to the HSAs of full-time employees who are eligible
individuals but are not covered under Employer J's HDHP. R and S are a
married couple. Employee S, who is a full-time employee of Employer J
and an eligible individual, has family coverage under Employer J's HDHP
for S and S's spouse. Employee R, who is also a full-time employee of
Employer J and an eligible individual, does not have coverage under
Employer J's HDHP except as the spouse of Employee S. Employer J must
make comparable contributions to S's HSA and to R's HSA.
[[Page 361]]
Q-9: Does an employer that makes HSA contributions only for one
class of non-collectively bargained employees who are eligible
individuals, but not for another class of non-collectively bargained
employees who are eligible individuals (for example, management v. non-
management) satisfy the requirement that the employer make comparable
contributions?
A-9: (a) Different classes of employees. No. If the two classes of
employees are comparable participating employees, the comparability
rules are not satisfied. The only categories of employees for
comparability purposes are current full-time employees, current part-
time employees, and former employees. Collectively bargained employees
are not comparable participating employees. But see Q & A-1 in 54.4980G-
5 on contributions made through a cafeteria plan. See Sec. 54.4980G-6
for a special rule for contributions made to the HSAs of nonhighly
compensated employees.
(b) Examples. The following examples illustrate the rules in
paragraph (a) of this Q & A-9. None of the employees in the following
examples are covered by a collective bargaining agreement. The examples
read as follows:
Example 1. In a calendar year, Employer K maintains an HDHP covering
all management and non-management employees. Employer K contributes to
the HSAs of non-management employees who are eligible individuals
covered under its HDHP. Employer K does not contribute to the HSAs of
its management employees who are eligible individuals covered under its
HDHP. The comparability rules are not satisfied.
Example 2. All of Employer L's employees are located in city X and
city Y. In a calendar year, Employer L maintains an HDHP for all
employees working in city X only. Employer L does not maintain an HDHP
for its employees working in city Y. Employer L contributes $500 to the
HSAs of city X employees who are eligible individuals with coverage
under its HDHP. Employer L does not contribute to the HSAs of any of its
city Y employees. The comparability rules are satisfied because none of
the employees in city Y are covered under an HDHP of Employer L.
(However, if any employees in city Y were covered by an HDHP of Employer
L, Employer L could not fail to contribute to their HSAs merely because
they work in a different city.)
Example 3. Employer M has two divisions--division N and division O.
In a calendar year, Employer M maintains an HDHP for employees working
in division N and division O. Employer M contributes to the HSAs of
division N employees who are eligible individuals with coverage under
its HDHP. Employer M does not contribute to the HSAs of division O
employees who are eligible individuals covered under its HDHP. The
comparability rules are not satisfied.
Q-10: If an employer contributes to the HSAs of former employees who
are eligible individuals, do the comparability rules apply to these
contributions?
A-10: (a) Former employees. Yes. The comparability rules apply to
contributions an employer makes to former employees' HSAs. Therefore, if
an employer contributes to any former employee's HSA, it must make
comparable contributions to the HSAs of all comparable participating
former employees (former employees who are eligible individuals with the
same category of HDHP coverage). However, an employer is not required to
make comparable contributions to the HSAs of former employees with
coverage under the employer's HDHP because of an election under a COBRA
continuation provision (as defined in section 9832(d)(1)). See Q & A-5
and Q & A-12 of this section. The comparability rules apply separately
to former employees because they are a separate category of covered
employee. See Q & A-5 of this section. Also, former employees who were
covered by a collective bargaining agreement immediately before
termination of employment are not comparable participating employees.
See Q & A-6 of this section.
(b) Locating former employees. An employer making comparable
contributions to former employees must take reasonable actions to locate
any missing comparable participating former employees. In general, such
actions include the use of certified mail, the Internal Revenue Service
Letter Forwarding Program or the Social Security Administration's Letter
Forwarding Service.
(c) Examples. The following examples illustrate the rules in
paragraph (a) of this Q & A-10. None of the employees in the following
examples are covered by a collective bargaining agreement. The examples
read as follows:
Example 1. In a calendar year, Employer N contributes $1,000 for the
calendar year to
[[Page 362]]
the HSA of each current employee who is an eligible individual with
coverage under any HDHP. Employer N does not contribute to the HSA of
any former employee who is an eligible individual. Employer N's
contributions satisfy the comparability rules.
Example 2. In a calendar year, Employer O contributes to the HSAs of
current employees and former employees who are eligible individuals
covered under any HDHP. Employer O contributes $750 to the HSA of each
current employee with self-only HDHP coverage and $1,000 to the HSA of
each current employee with family HDHP coverage. Employer O also
contributes $300 to the HSA of each former employee with self-only HDHP
coverage and $400 to the HSA of each former employee with family HDHP
coverage. Employer O's contributions satisfy the comparability rules.
Q-11: Is an employer permitted to make comparable contributions only
to the HSAs of comparable participating former employees who have
coverage under the employer's HDHP?
A-11: If during a calendar year, an employer contributes to the HSA
of any former employee who is an eligible individual covered under an
HDHP provided by the employer, the employer is required to make
comparable contributions to the HSAs of all former employees who are
comparable participating former employees with coverage under any HDHP
provided by the employer. An employer that contributes only to the HSAs
of former employees who are eligible individuals with coverage under the
employer's HDHP is not required to make comparable contributions to the
HSAs of former employees who are eligible individuals and who are not
covered under the employer's HDHP. However, an employer that contributes
to the HSA of any former employee who is an eligible individual with
coverage under an HDHP that is not an HDHP of the employer, must make
comparable contributions to the HSAs of all former employees who are
eligible individuals whether or not covered under an HDHP of the
employer.
Q-12: If an employer contributes only to the HSAs of former
employees who are eligible individuals with coverage under the
employer's HDHP, must the employer make comparable contributions to the
HSAs of former employees who are eligible individuals with coverage
under the employer's HDHP because of an election under a COBRA
continuation provision (as defined in section 9832(d)(1))?
A-12: No. An employer that contributes only to the HSAs of former
employees who are eligible individuals with coverage under the
employer's HDHP is not required to make comparable contributions to the
HSAs of former employees who are eligible individuals with coverage
under the employer's HDHP because of an election under a COBRA
continuation provision (as defined in section 9832(d)(1)).
Q-13: How do the comparability rules apply if some employees have
HSAs and other employees have Archer MSAs?
A-13: (a) HSAs and Archer MSAs. The comparability rules apply
separately to employees who have HSAs and employees who have Archer
MSAs. However, if an employee has both an HSA and an Archer MSA, the
employer may contribute to either the HSA or the Archer MSA, but not to
both.
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q & A-13:
Example. In a calendar year, Employer P contributes $600 to the
Archer MSA of each employee who is an eligible individual and who has an
Archer MSA. Employer P contributes $500 for the calendar year to the HSA
of each employee who is an eligible individual and who has an HSA. If an
employee has both an Archer MSA and an HSA, Employer P contributes to
the employee's Archer MSA and not to the employee's HSA. Employee X has
an Archer MSA and an HSA. Employer P contributes $600 for the calendar
year to X's Archer MSA but does not contribute to X's HSA. Employer P's
contributions satisfy the comparability rules.
[T.D. 9277, 71 FR 43058, July 31, 2006, as amended by T.D. 9457, 74 FR
45998, Sept. 8, 2009]
Sec. 54.4980G-4 Calculating comparable contributions.
Q-1: What are comparable contributions?
A-1: (a) Definition. Contributions are comparable if, for each month
in a calendar year, the contributions are either the same amount or the
same percentage of the deductible under the HDHP for employees who are
eligible individuals with the same category of coverage on the first day
of that month. Employees with self-only
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HDHP coverage are tested separately from employees with family HDHP
coverage. Similarly, employees with different categories of family HDHP
coverage may be tested separately. See Q & A-2 in Sec. 54.4980G-1. An
employer is not required to contribute the same amount or the same
percentage of the deductible for employees who are eligible individuals
with one category of HDHP coverage that it contributes for employees who
are eligible individuals with a different category of HDHP coverage. For
example, an employer that satisfies the comparability rules by
contributing the same amount to the HSAs of all employees who are
eligible individuals with family HDHP coverage is not required to
contribute any amount to the HSAs of employees who are eligible
individuals with self-only HDHP coverage, or to contribute the same
percentage of the self-only HDHP deductible as the amount contributed
with respect to family HDHP coverage. However, the contribution with
respect to the self plus two category may not be less than the
contribution with respect to the self plus one category and the
contribution with respect to the self plus three or more category may
not be less than the contribution with respect to the self plus two
category. But see Q & A-1 of Sec. 54.4980G-6 for a special rule for
contributions made to the HSAs of nonhighly compensated employees.
(b) Examples. The following examples illustrate the rules in
paragraph (a) of this Q & A-1. None of the employees in the following
examples are covered by a collective bargaining agreement. The examples
read as follows:
Example 1. In the 2007 calendar year, Employer A offers its full-
time employees three health plans, including an HDHP with self-only
coverage and a $2,000 deductible. Employer A contributes $1,000 for the
calendar year to the HSA of each employee who is an eligible individual
electing the self-only HDHP coverage. Employer A makes no HSA
contributions for employees with family HDHP coverage or for employees
who do not elect the employer's self-only HDHP. Employer A's HSA
contributions satisfy the comparability rules.
Example 2. In the 2007 calendar year, Employer B offers its
employees an HDHP with a $3,000 deductible for self-only coverage and a
$4,000 deductible for family coverage. Employer B contributes $1,000 for
the calendar year to the HSA of each employee who is an eligible
individual electing the self-only HDHP coverage. Employer B contributes
$2,000 for the calendar year to the HSA of each employee who is an
eligible individual electing the family HDHP coverage. Employer B's HSA
contributions satisfy the comparability rules.
Example 3. In the 2007 calendar year, Employer C offers its
employees an HDHP with a $1,500 deductible for self-only coverage and a
$3,000 deductible for family coverage. Employer C contributes $1,000 for
the calendar year to the HSA of each employee who is an eligible
individual electing the self-only HDHP coverage. Employer C contributes
$1,000 for the calendar year to the HSA of each employee who is an
eligible individual electing the family HDHP coverage. Employer C's HSA
contributions satisfy the comparability rules.
Example 4. In the 2007 calendar year, Employer D offers its
employees an HDHP with a $1,500 deductible for self-only coverage and a
$3,000 deductible for family coverage. Employer D contributes $1,500 for
the calendar year to the HSA of each employee who is an eligible
individual electing the self-only HDHP coverage. Employer D contributes
$1,000 for the calendar year to the HSA of each employee who is an
eligible individual electing the family HDHP coverage. Employer D's HSA
contributions satisfy the comparability rules.
Example 5. (i) In the 2007 calendar year, Employer E maintains two
HDHPs. Plan A has a $2,000 deductible for self-only coverage and a
$4,000 deductible for family coverage. Plan B has a $2,500 deductible
for self-only coverage and a $4,500 deductible for family coverage. For
the calendar year, Employer E makes contributions to the HSA of each
full-time employee who is an eligible individual covered under Plan A of
$600 for self-only coverage and $1,000 for family coverage. Employer E
satisfies the comparability rules, if it makes either of the following
contributions for the 2007 calendar year to the HSA of each full-time
employee who is an eligible individual covered under Plan B--
(A) $600 for each full-time employee with self-only coverage and
$1,000 for each full-time employee with family coverage; or
(B) $750 for each employee with self-only coverage and $1,125 for
each employee with family coverage (the same percentage of the
deductible Employer E contributes for full-time employees covered under
Plan A, 30% of the deductible for self-only coverage and 25% of the
deductible for family coverage).
(ii) Employer E also makes contributions to the HSA of each part-
time employee who is an eligible individual covered under Plan A of $300
for self-only coverage and $500 for family coverage. Employer E
satisfies the comparability rules, if it makes either of the following
contributions for the 2007 calendar
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year to the HSA of each part-time employee who is an eligible individual
covered under Plan B--
(A) $300 for each part-time employee with self-only coverage and
$500 for each part-time employee with family coverage; or
(B) $375 for each part-time employee with self-only coverage and
$563 for each part-time employee with family coverage (the same
percentage of the deductible Employer E contributes for part-time
employees covered under Plan A, 15% of the deductible for self-only
coverage and 12.5% of the deductible for family coverage).
Example 6. (i) In the 2007 calendar year, Employer F maintains an
HDHP. The HDHP has the following coverage options--
(A) A $2,500 deductible for self-only coverage;
(B) A $3,500 deductible for self plus one dependent (self plus one);
(C) A $3,500 deductible for self plus spouse (self plus one);
(D) A $3,500 deductible for self plus spouse and one dependent (self
plus two); and
(E) A $3,500 deductible for self plus spouse and two or more
dependents (self plus three or more).
(ii) Employer F makes the following contributions for the calendar
year to the HSA of each full-time employee who is an eligible individual
covered under the HDHP--
(A) $750 for self-only coverage;
(B) $1,000 for self plus one dependent;
(C) $1,000 for self plus spouse;
(D) $1,500 for self plus spouse and one dependent; and
(E) $2,000 for self plus spouse and two or more dependents.
(iii) Employer F's HSA contributions satisfy the comparability
rules.
Example 7. (i) In a calendar year, Employer G offers its employees
an HDHP and a health flexible spending arrangement (health FSA). The
health FSA reimburses employees for medical expenses as defined in
section 213(d). Some of Employer G's employees have coverage under the
HDHP and the health FSA, some have coverage under the HDHP and their
spouse's FSA, and some have coverage under the HDHP and are enrolled in
Medicare. For the calendar year, Employer G contributes $500 to the HSA
of each employee who is an eligible individual. No contributions are
made to the HSAs of employees who have coverage under Employer G's
health FSA or under a spouse's health FSA or who are enrolled in
Medicare.
(ii) The employees who have coverage under a health FSA (whether
Employer H's or their spouse's FSA) or who are covered under Medicare
are not eligible individuals. Specifically, the employees who have
coverage under the health FSA or under a spouse's health FSA are not
comparable participating employees because they are not eligible
individuals under section 223(c)(1). Similarly, the employees who are
enrolled in Medicare are not comparable participating employees because
they are not eligible individuals under section 223(b)(7) and (c)(1).
Therefore, employees who have coverage under the health FSA or under a
spouse's health FSA and employees who are enrolled in Medicare are
excluded from comparability testing. See sections 4980G(b) and 4980E.
Employer G's contributions satisfy the comparability rules.
Q-2: How does an employer comply with the comparability rules when
some non-collectively bargained employees who are eligible individuals
do not work for the employer during the entire calendar year?
A-2: (a) In general. In determining whether the comparability rules
are satisfied, an employer must take into account all full-time and
part-time employees who were employees and eligible individuals for any
month during the calendar year. (Full-time and part-time employees are
tested separately. See Q & A-5 in Sec. 54.4980G-3.) There are two
methods to comply with the comparability rules when some employees who
are eligible individuals do not work for the employer during the entire
calendar year; contributions may be made on a pay-as-you-go basis or on
a look-back basis. See Q & A-9 through Q & A-11 in Sec. 54.4980G-3 for
the rules regarding comparable contributions to the HSAs of former
employees.
(b) Contributions on a pay-as-you-go basis. An employer may comply
with the comparability rules by contributing amounts at one or more
dates during the calendar year to the HSAs of employees who are eligible
individuals as of the first day of the month, if contributions are the
same amount or the same percentage of the HDHP deductible for employees
who are eligible individuals as of the first day of the month with the
same category of coverage and are made at the same time. Contributions
made at the employer's usual payroll interval for different groups of
employees are considered to be made at the same time. For example, if
salaried employees are paid monthly and hourly employees are paid bi-
weekly, an employer may contribute to the HSAs of hourly employees on a
bi-weekly basis and to the HSAs of salaried employees on a monthly
basis. An employer may change the amount
[[Page 365]]
that it contributes to the HSAs of employees at any point. However, the
changed contribution amounts must satisfy the comparability rules.
(c) Examples. The following examples illustrate the rules in
paragraph (b) of this Q & A-2: The examples read as follows:
Example 1. (i) Beginning on January 1st, Employer H contributes $50
per month on the first day of each month to the HSA of each employee who
is an eligible individual on that date. Employer H does not contribute
to the HSAs of former employees. In mid-March of the same year, Employee
X, an eligible individual, terminates employment after Employer H has
contributed $150 to X's HSA. After X terminates employment, Employer H
does not contribute additional amounts to X's HSA. In mid-April of the
same year, Employer H hires Employee Y, an eligible individual, and
contributes $50 to Y's HSA in May and $50 in June. Effective in July of
the same year, Employer H stops contributing to the HSAs of all
employees and makes no contributions to the HSA of any employee for the
months of July through December. In August, Employer H hires Employee Z,
an eligible individual. Employer H does not contribute to Z's HSA. After
Z is hired, Employer H does not hire additional employees. As of the end
of the calendar year, Employer H has made the following HSA
contributions to its employees' HSAs--
(A) Employer H contributed $150 to X's HSA;
(B) Employer H contributed $100 to Y's HSA;
(C) Employer H did not contribute to Z's HSA; and
(D) Employer H contributed $300 to the HSA of each employee who was
an eligible individual and employed by Employer J from January through
June.
(ii) Employer H's contributions satisfy the comparability rules.
Example 2. In a calendar year, Employer J offers its employees an
HDHP and contributes on a monthly pay-as-you-go basis to the HSAs of
employees who are eligible individuals with coverage under Employer J's
HDHP. In the calendar year, Employer J contributes $50 per month to the
HSA of each employee with self-only HDHP coverage and $100 per month to
the HSA of each employee with family HDHP coverage. From January 1st
through March 31st of the calendar year, Employee X is an eligible
individual with self-only HDHP coverage. From April 1st through December
31st of the calendar year, X is an eligible individual with family HDHP
coverage. For the months of January, February and March of the calendar
year, Employer J contributes $50 per month to X's HSA. For the remaining
months of the calendar year, Employer J contributes $100 per month to
X's HSA. Employer J's contributions to X's HSA satisfy the comparibility
rules.
(d) Contributions on a look-back basis. An employer may also satisfy
the comparability rules by determining comparable contributions for the
calendar year at the end of the calendar year, taking into account all
employees who were eligible individuals for any month during the
calendar year and contributing the same percentage of the HDHP
deductible or the same dollar amount to the HSAs of all employees with
the same category of coverage for that month.
(e) Examples. The following examples illustrate the rules in
paragraph (d) of this Q & A-2. The examples read as follows:
Example 1. In a calendar year, Employer K offers its employees an
HDHP and contributes on a look-back basis to the HSAs of employees who
are eligible individuals with coverage under Employer K's HDHP. Employer
K contributes $600 ($50 per month) for the calendar year to the HSA of
each employee with self-only HDHP coverage and $1,200 ($100 per month)
for the calendar year to the HSA of each employee with family HDHP
coverage. From January 1st through June 30th of the calendar year,
Employee Y is an eligible individual with family HDHP coverage. From
July 1st through December 31st, Y is an eligible individual with self-
only HDHP coverage. Employer K contributes $900 on a look-back basis for
the calendar year to Y's HSA ($100) per month for the months of January
through June and $50 per month for the months of July through December.
Employer K's contributions to Y's HSA satisfy the comparability rules.
Example 2. On December 31st, Employer L contributes $50 per month on
a look-back basis to each employee's HSA for each month in the calendar
year that the employee was an eligible individual. In mid-March of the
same year, Employee T, an eligible individual, terminated employment. In
mid-April of the same year, Employer L hired Employee U, who becomes an
eligible individual as of May 1st and works for Employer L through
December 31st. On December 31st, Employer L contributes $150 to Employee
T's HSA and $400 to Employee U's HSA. Employer L's contributions satisfy
the comparability rules.
(f) Periods and dates for making contributions. With both the pay-
as-you-go method and the look-back method, an
[[Page 366]]
employer may establish, on a reasonable and consistent basis, periods
for which contributions will be made (for example, a quarterly period
covering three consecutive months in a calendar year) and the dates on
which such contributions will be made for that designated period (for
example, the first day of the quarter or the last day of the quarter in
the case of an employer who has established a quarterly period for
making contributions). An employer that makes contributions on a pay-as-
you-go basis for a period covering more than one month will not fail to
satisfy the comparability rules because an employee who terminates
employment prior to the end of the period for which contributions were
made has received more contributions on a monthly basis than employees
who have worked the entire period. In addition, an employer that makes
contributions on a pay-as-you-go basis for a period covering more than
one month must make HSA contributions for any comparable participating
employees hired after the date of initial funding for that period.
(g) Example. The following example illustrates the rules in
paragraph (f) of this Q & A-2:
Example. Employer M has established, on a reasonable and consistent
basis, a quarterly period for making contributions to the HSAs of
eligible employees on a pay-as-you-go basis. Beginning on January 1st,
Employer M contributes $150 for the first three months of the calendar
year to the HSA of each employee who is an eligible individual on that
date. On January 15th, Employee V, an eligible individual, terminated
employment after Employer M has contributed $150 to V's HSA. On January
15th, Employer M hired Employee W, who becomes an eligible individual as
of February 1st. On April 1st, Employer M has contributed $100 to W's
HSA for the two months (February and March) in the quarter period that
Employee W was an eligible employee. Employer M's contributions satisfy
the comparability rules.
(h) Maximum contribution permitted for all employees who are
eligible individuals during the last month of the taxable year. An
employer may contribute up to the maximum annual contribution amount for
the calendar year (based on the employees' HDHP coverage) to the HSAs of
all employees who are eligible individuals on the first day of the last
month of the employees' taxable year, including employees who worked for
the employer for less than the entire calendar year and employees who
became eligible individuals after January 1st of the calendar year. For
example, such contribution may be made on behalf of an eligible
individual who is hired after January 1st or an employee who becomes an
eligible individual after January 1st. Employers are not required to
provide more than a pro-rata contribution based on the number of months
that an individual was an eligible individual and employed by the
employer during the year. However, if an employer contributes more than
a pro-rata amount for the calendar year to the HSA of any eligible
individual who is hired after January 1st of the calendar year or any
employee who becomes an eligible individual any time after January 1st
of the calendar year, the employer must contribute that same amount on
an equal and uniform basis to the HSAs of all comparable participating
employees (as defined in Q & A-1 in Sec. 54.4980G-1) who are hired or
become eligible individuals after January 1st of the calendar year.
Likewise, if an employer contributes the maximum annual contribution
amount for the calendar year to the HSA of any eligible individual who
is hired after January 1st of the calendar year or any employee who
becomes an eligible individual any time after January 1st of the
calendar year, the employer must contribute the maximum annual
contribution amount on an equal and uniform basis to the HSAs of all
comparable participating employees (as defined in Q & A-1 in Sec.
54.4980G-1) who are hired or become eligible individuals after January
1st of the calendar year. An employer who makes the maximum calendar
year contribution or more than a pro-rata contribution to the HSAs of
employees who become eligible individuals after the first day of the
calendar year or eligible individuals who are hired after the first day
of the calendar year will not fail to satisfy comparability merely
because some employees will have received more contributions on a
monthly basis than employees who worked the entire calendar year.
[[Page 367]]
(i) Examples. The following examples illustrate the rules in
paragraph (h) in this Q & A-2. In the following examples, no
contributions are made through a section 125 cafeteria plan and none of
the employees are covered by a collective bargaining agreement.
Example 1. On January 1, 2010, Employer Q contributes $1,000 for the
calendar year to the HSAs of employees who are eligible individuals with
family HDHP coverage. In mid-March of the same year, Employer Q hires
Employee A, an eligible individual with family HDHP coverage. On April
1, 2010, Employer Q contributes $1,000 to the HSA of Employee A. In
September of the same year, Employee B becomes an eligible individual
with family HDHP coverage. On October 1, 2010, Employer G contributes
$1,000 to the HSA of Employee B. Employer Q does not make any other
contributions for the 2010 calendar year. Employer Q's contributions
satisfy the comparability rules.
Example 2. For the 2010 calendar year, Employer R only has two
employees, Employee C and Employee D. Employee C, an eligible individual
with family HDHP coverage, works for Employer R for the entire calendar
year. Employee D, an eligible individual with family HDHP coverage works
for Employer R from July 1st through December 31st. Employer R
contributes $1,200 for the calendar year to the HSA of Employee C and
$600 to the HSA of Employee D. Employer R does not make any other
contributions for the 2010 calendar year. Employer R's contributions
satisfy the comparability rules.
(j) Effective/applicability date. The rules in paragraphs (h) and
(i) of Q & A-2 are effective for employer contributions made for
calendar years beginning on or after January 1, 2010.
Q-3: How do the comparability rules apply to employer contributions
to employees' HSAs if some non-collectively bargained employees work
full-time during the entire calendar year, and other non-collectively
bargained employees work full-time for less than the entire calendar
year?
A-3: Employer contributions to the HSAs of employees who work full-
time for less than twelve months satisfy the comparability rules if the
contribution amount is comparable when determined on a month-to-month
basis. For example, if the employer contributes $240 to the HSA of each
full-time employee who works the entire calendar year, the employer must
contribute $60 to the HSA of each full-time employee who works on the
first day of each three months of the calendar year. The rules set forth
in this Q & A-2 apply to employer contributions made on a pay-as-you-go
basis or on a look-back basis as described in Q & A-3 of this section.
See sections 4980G(b) and 4980E(d)(2)(B).
Q-4: May an employer make contributions for the entire year to the
HSAs of its employees who are eligible individuals at the beginning of
the calendar year (on a pre-funded basis) instead of contributing on a
pay-as-you-go or on a look-back basis?
A-4: (a) Contributions on a pre-funded basis. Yes. An employer may
make contributions for the entire year to the HSAs of its employees who
are eligible individuals at the beginning of the calendar year. An
employer that pre-funds the HSAs of its employees will not fail to
satisfy the comparability rules because an employee who terminates
employment prior to the end of the calendar year has received more
contributions on a monthly basis than employees who work the entire
calendar year. See Q & A-12 of this section. Under section 223(d)(1)(E),
an account beneficiary's interest in an HSA is nonforfeitable. An
employer must make comparable contributions for all employees who are
comparable participating employees for any month during the calendar
year, including employees who are eligible individuals hired after the
date of initial funding. An employer that makes HSA contributions on a
pre-funded basis may also contribute on a pre-funded basis to the HSAs
of employees who are eligible individuals hired after the date of
initial funding. Alternatively, an employer that has pre-funded the HSAs
of comparable participating employees may contribute to the HSAs of
employees who are eligible individuals hired after the date of initial
funding on a pay-as-you-go basis or on a look-back basis. An employer
that makes HSA contributions on a pre-funded basis must use the same
contribution method for all employees who are eligible individuals hired
after the date of initial funding.
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q & A-4:
[[Page 368]]
Example. (i) On January 1, Employer N contributes $1,200 for the
calendar year on a pre-funded basis to the HSA of each employee who is
an eligible individual. In mid-May, Employer N hires Employee B, who
becomes an eligible individual as of June 1st. Therefore, Employer N is
required to make comparable contributions to B's HSA beginning in June.
Employer N satisfies the comparability rules with respect to
contributions to B's HSA if it makes HSA contributions in any one of the
following ways--
(A) Pre-funding B's HSA by contributing $700 to B's HSA;
(B) Contributing $100 per month on a pay-as-you-go basis to B's HSA;
or
(C) Contributing to B's HSA at the end of the calendar year taking
into account each month that B was an eligible individual and employed
by Employer M.
(ii) If Employer M hires additional employees who are eligible
individuals after initial funding, it must use the same contribution
method for these employees that it used to contribute to B's HSA.
Q-5: Must an employer use the same contribution method as described
in Q & A-2 and Q & A-4 of this section for all employees who were
comparable participating employees for any month during the calendar
year?
A-5: Yes. If an employer makes comparable HSA contributions on a
pay-as-you-go basis, it must do so for each employee who is a comparable
participating employee as of the first day of the month. If an employer
makes comparable contributions on a look-back basis, it must do so for
each employee who was a comparable participating employee for any month
during the calendar year. If an employer makes HSA contributions on a
pre-funded basis, it must do so for all employees who are comparable
participating employees at the beginning of the calendar year and must
make comparable HSA contributions for all employees who are comparable
participating employees for any month during the calendar year,
including employees who are eligible individuals hired after the date of
initial funding. See Q & A-4 of this section for rules regarding
contributions for employees hired after initial funding.
Q-6: How does an employer comply with the comparability rules if an
employee has not established an HSA at the time the employer contributes
to its employees' HSAs?
A-6: (a) Employee has not established an HSA at the time the
employer funds its employees' HSAs. If an employee has not established
an HSA at the time the employer funds its employees' HSAs, the employer
complies with the comparability rules by contributing comparable amounts
plus reasonable interest to the employee's HSA when the employee
establishes the HSA, taking into account each month that the employee
was a comparable participating employee. See Q & A-13 of this section
for rules regarding reasonable interest.
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q & A-6:
Example. Beginning on January 1st, Employer O contributes $500 per
calendar year on a pay-as-you-go basis to the HSA of each employee who
is an eligible individual. Employee C is an eligible individual during
the entire calendar year but does not establish an HSA until March.
Notwithstanding C's delay in establishing an HSA, Employer O must make
up the missed HSA contributions plus reasonable interest for January and
February by April 15th of the following calendar year.
Q-7: If an employer bases its contributions on a percentage of the
HDHP deductible, how is the correct percentage or dollar amount
computed?
A-7: (a) Computing HSA contributions. The correct percentage is
determined by rounding to the nearest 1/100th of a percentage point and
the dollar amount is determined by rounding to the nearest whole dollar.
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q & A-7:
Example. In this Example, assume that each HDHP provided by Employer
P satisfies the definition of an HDHP for the 2007 calendar year. In the
2007 calendar year, Employer P maintains two HDHPs. Plan A has a
deductible of $3,000 for self-only coverage. Employer P contributes
$1,000 for the calendar year to the HSA of each employee covered under
Plan A. Plan B has a deductible of $3,500 for self-only coverage.
Employer P satisfies the comparability rules if it makes either of the
following contributions for the 2007 calendar year to the HSA of each
employee who is an eligible individual with self-only coverage under
Plan B--
(i) $1,000; or
(ii) $1,167 (33.33% of the deductible rounded to the nearest whole
dollar amount).
[[Page 369]]
Q-8: Does an employer that contributes to the HSA of each comparable
participating employee in an amount equal to the employee's HSA
contribution or a percentage of the employee's HSA contribution
(matching contributions) satisfy the rule that all comparable
participating employees receive comparable contributions?
A-8: No. If all comparable participating employees do not contribute
the same amount to their HSAs and, consequently, do not receive
comparable contributions to their HSAs, the comparability rules are not
satisfied, notwithstanding that the employer offers to make available
the same contribution amount to each comparable participating employee.
But see Q & A-1 in Sec. 54.4980G-5 on contributions to HSAs made
through a cafeteria plan.
Q-9: If an employer conditions contributions by the employer to an
employee's HSA on an employee's participation in health assessments,
disease management programs or wellness programs and makes the same
contributions available to all employees who participate in the
programs, do the contributions satisfy the comparability rules?
A-9: No. If all comparable participating employees do not elect to
participate in all the programs and consequently, all comparable
participating employees do not receive comparable contributions to their
HSAs, the employer contributions fail to satisfy the comparability
rules. But see Q & A-1 in Sec. 54.4980G-5 on contributions made to HSAs
through a cafeteria plan.
Q-10: If an employer makes additional contributions to the HSAs of
all comparable participating employees who have attained a specified age
or who have worked for the employer for a specified number of years, do
the contributions satisfy the comparability rules?
A-10: No. If all comparable participating employees do not meet the
age or length of service requirement, all comparable participating
employees do not receive comparable contributions to their HSAs and the
employer contributions fail to satisfy the comparability rules.
Q-11: If an employer makes additional contributions to the HSAs of
all comparable participating employees who are eligible to make the
additional contributions (HSA catch-up contributions) under section
223(b)(3), do the contributions satisfy the comparability rules?
A-11: No. If all comparable participating employees are not eligible
to make the additional HSA contributions under section 223(b)(3), all
comparable participating employees do not receive comparable
contributions to their HSAs, and the employer contributions fail to
satisfy the comparability rules.
Q-12: If an employer's contributions to an employee's HSA result in
non-comparable contributions, may the employer recoup the excess amount
from the employee's HSA?
A-12: No. An employer may not recoup from an employee's HSA any
portion of the employer's contribution to the employee's HSA. Under
section 223(d)(1)(E), an account beneficiary's interest in an HSA is
nonforfeitable. However, an employer may make additional HSA
contributions to satisfy the comparability rules. An employer may
contribute up until April 15th following the calendar year in which the
non-comparable contributions were made. An employer that makes
additional HSA contributions to correct non-comparable contributions
must also contribute reasonable interest. However, an employer is not
required to contribute amounts in excess of the annual contribution
limits in section 223(b). See Q & A-13 of this section for rules
regarding reasonable interest.
Q-13: What constitutes a reasonable interest rate for purposes of
making comparable contributions?
A-13: The determination of whether a rate of interest used by an
employer is reasonable will be based on all of the facts and
circumstances. If an employer calculates interest using the Federal
short-term rate as determined by the Secretary in accordance with
section 1274(d), the employer is deemed to use a reasonable interest
rate.
Q-14: Does an employer fail to satisfy the comparability rules for a
calendar year if the employer fails to make contributions with respect
to eligible employees because the employee has not
[[Page 370]]
established an HSA or because the employer does not know that the
employee has established an HSA?
A-14: (a) In general. An employer will not fail to satisfy the
comparability rules for a calendar year (Year 1) merely because the
employer fails to make contributions with respect to an eligible
employee because the employee has not established an HSA or because the
employer does not know that the employee has established an HSA, if--
(1) The employer provides timely written notice to all such eligible
employees that it will make comparable contributions for Year 1 for
eligible employees who, by the last day of February of the following
calendar year (Year 2), both establish an HSA and notify the employer
(in accordance with a procedure specified in the notice) that they have
established an HSA; and
(2) For each such eligible employee who establishes an HSA and so
notifies the employer on or before the last day of February of Year 2,
the employer contributes to the HSA for Year 1 comparable amounts
(taking into account each month that the employee was a comparable
participating employee) plus reasonable interest by April 15th of Year
2.
(b) Notice. The notice described in paragraph (a) of this Q & A-14
must be provided to each eligible employee who has not established an
HSA by December 31 of Year 1 or if the employer does not know if the
employee established an HSA. The employer may provide the notice to
other employees as well. However, if an employee has earlier notified
the employer that he or she has established an HSA, or if the employer
has previously made contributions to that employee's HSA, the employer
may not condition making comparable contributions on receipt of any
additional notice from that employee. For each calendar year, a notice
is deemed to be timely if the employer provides the notice no earlier
than 90 days before the first HSA employer contribution for that
calendar year and no later than January 15 of the following calendar
year.
(c) Model notice. Employers may use the following sample language as
a basis in preparing their own notices.
Notice to Employees Regarding Employer Contributions to HSAs:
This notice explains how you may be eligible to receive
contributions from [employer] if you are covered by a High Deductible
Health Plan (HDHP). [Employer] provides contributions to the Health
Savings Account (HSA) of each employee who is [insert employer's
eligibility requirements for HSA contributions] (``eligible employee'').
If you are an eligible employee, you must do the following in order to
receive an employer contribution:
(1) Establish an HSA on or before the last day in February of
[insert year after the year for which the contribution is being made]
and;
(2) Notify [insert name and contact information for appropriate
person to be contacted] of your HSA account information on or before the
last day in February of [insert year after year for which the
contribution is being made]. [Specify the HSA account information that
the employee must provide (e.g., account number, name and address of
trustee or custodian, etc.) and the method by which the employee must
provide this account information (e.g., in writing, by e-mail, on a
certain form, etc.)].
If you establish your HSA on or before the last day of February in
[insert year after year for which the contribution is being made] and
notify [employer] of your HSA account information, you will receive your
HSA contributions, plus reasonable interest, for [insert year for which
contribution is being made] by April 15 of [insert year after year for
which contribution is being made]. If, however, you do not establish
your HSA or you do not notify us of your HSA account information by the
deadline, then we are not required to make any contributions to your HSA
for [insert applicable year]. You may notify us that you have
established an HSA by sending an [e-mail or] a written notice to [insert
name, title and, if applicable, e-mail address]. If you have any
questions about this notice, you can contact [insert name and title] at
[insert telephone number or other contact information].
(d) [Reserved]
(e) Electronic delivery. An employer may furnish the notice required
under this section electronically in accordance with Sec. 1.401(a)-21
of this chapter.
(f) Examples. The following examples illustrate the rules in this Q
& A-14:
Example 1. In a calendar year, Employer Q contributes to the HSAs of
current employees who are eligible individuals covered under any HDHP.
For the 2009 calendar year, Employer Q contributes $50 per month on the
first day of each month, beginning January 1st, to the HSA of each
employee who is an eligible employee on that date. For the 2009
[[Page 371]]
calendar year, Employer Q provides written notice satisfying the content
requirements of this Q & A-14 on October 16, 2008 to all employees
regarding the availability of HSA contributions for eligible employees.
For eligible employees who are hired after October 16, 2008, Employer Q
provides such a notice no later than January 15, 2010. Employer Q's
notice satisfies the notice timing requirements in paragraph (a)(1) of
this Q & A-14.
Example 2. Employer R's written cafeteria plan permits employees to
elect to make pre-tax salary reduction contributions to their HSAs.
Employees making this election have the right to receive cash or other
taxable benefits in lieu of their HSA pre-tax contribution. Employer R
automatically contributes a non-elective matching contribution to the
HSA of each employee who makes a pre-tax HSA contribution. Because
Employer R's HSA contributions are made through the cafeteria plan, the
comparability requirements do not apply to the HSA contributions made by
Employer R. Consequently, Employer R is not required to provide written
notice to its employees regarding the availability of this matching HSA
contribution. See Q & A-1 in Sec. 54.4980G-5 for treatment of HSA
contributions made through a cafeteria plan.
Example 3. In a calendar year, Employer S maintains an HDHP and only
contributes to the HSAs of eligible employees who elect coverage under
its HDHP. For the 2009 calendar year, Employer S employs ten eligible
employees and all ten employees have elected coverage under Employer S's
HDHP and have established HSAs. For the 2009 calendar year, Employer S
makes comparable contributions to the HSAs of all ten employees.
Employer S satisfies the comparability rules. Thus, Employer S is not
required to provide written notice to its employees regarding the
availability of HSA contributions for eligible employees.
Example 4. In a calendar year, Employer T contributes to the HSAs of
current full-time employees with family coverage under any HDHP. For the
2009 calendar year, Employer T provides timely written notice satisfying
the content requirements of this section to all employees regardless of
HDHP coverage. Employer T makes identical monthly contributions to all
eligible employees (meaning full time employees with family HDHP
coverage) that establish HSAs. Employer T contributes comparable amounts
(taking into account each month that the employee was a comparable
participating employee) plus reasonable interest to the HSAs of the
eligible employees that establish HSAs and provide the necessary
information after the end of the year but on or before the last day of
February, 2010. Employer T makes no contribution to the HSAs of
employees that do not establish an HSA or that do not provide the
necessary information on or before the last day of February, 2010.
Employer T satisfies the comparability requirements.
Example 5. For the 2009 calendar year, Employer V contributes to the
HSAs of current full time employees with family coverage under any HDHP.
Employer V has 500 current full time employees. As of the date for
Employer V's first HSA contribution for the 2009 calendar year, 450
eligible employees have established HSAs. Employer V provides timely
written notice satisfying the content requirements of this section only
to those 50 eligible employees who have not established HSAs. Employer V
makes identical quarterly contributions to the 450 eligible employees
who established HSAs. By April 15, 2010, Employer V contributes
comparable amounts to the other eligible employees who establish HSAs
and provide the necessary information on or before the last day of
February, 2010. Employer V makes no contribution to the HSAs of eligible
employees that do not establish an HSA or that do not provide the
necessary information on or before the last day of February, 2010.
Employer V satisfies the comparability rules.
Q-15: For any calendar year, may an employer accelerate part or all
of its contributions for the entire year to the HSAs of employees who
have incurred, during the calendar year, qualified medical expenses (as
defined in section 223(d)(2)) exceeding the employer's cumulative HSA
contributions at that time?
A-15: (a) In general. Yes. For any calendar year, an employer may
accelerate part or all of its contributions for the entire year to the
HSAs of employees who have incurred, during the calendar year, qualified
medical expenses exceeding the employer's cumulative HSA contributions
at that time. If an employer accelerates contributions to the HSA of any
such eligible employee, all accelerated contributions must be available
throughout the calendar year on an equal and uniform basis to all such
eligible employees. Employers must establish reasonable uniform methods
and requirements for accelerated contributions and the determination of
medical expenses.
(b) Satisfying comparability. An employer that accelerates
contributions to the HSAs of its employees will not fail to satisfy the
comparability rules because employees who incur qualifying medical
expenses exceeding the employer's cumulative HSA contributions at that
time have received more contributions in a given period than
[[Page 372]]
comparable employees who do not incur such expenses, provided that all
comparable employees receive the same amount or the same percentage for
the calendar year. Also, an employer that accelerates contributions to
the HSAs of its employees will not fail to satisfy the comparability
rules because an employee who terminates employment prior to the end of
the calendar year has received more contributions on a monthly basis
than employees who work the entire calendar year. An employer is not
required to contribute reasonable interest on either accelerated or non-
accelerated HSA contributions. But see Q & A-6 and Q & A-12 of this
section for when reasonable interest must be paid.
Q-16: What is the effective date for the rules in Q & A-14 and Q &
A-15 of this section?
A-16: These regulations apply to employer contributions made for
calendar years beginning on or after January 1, 2009.
[T.D. 9277, 71 FR 43058, July 31, 2006; 71 FR 53967, Sept. 13, 2006, as
amended by T.D. 9393, 73 FR 20795, Apr. 17, 2008; T.D. 9457, 74 FR
45998, Sept. 8, 2009]
Sec. 54.4980G-5 HSA comparability rules and cafeteria plans and waiver of excise tax.
Q-1: If an employer makes contributions through a section 125
cafeteria plan to the HSA of each employee who is an eligible
individual, are the contributions subject to the comparability rules?
A-1: (a) In general. No. The comparability rules do not apply to HSA
contributions that an employer makes through a section 125 cafeteria
plan. However, contributions to an HSA made through a cafeteria plan are
subject to the section 125 nondiscrimination rules (eligibility rules,
contributions and benefits tests and key employee concentration tests).
See section 125(b), (c) and (g) and the regulations thereunder.
(b) Contributions made through a section 125 cafeteria plan.
Employer contributions to employees' HSAs are made through a section 125
cafeteria plan and are subject to the section 125 cafeteria plan
nondiscrimination rules and not the comparability rules if under the
written cafeteria plan, the employees have the right to elect to receive
cash or other taxable benefits in lieu of all or a portion of an HSA
contribution (meaning that all or a portion of the HSA contributions are
available as pre-tax salary reduction amounts), regardless of whether an
employee actually elects to contribute any amount to the HSA by salary
reduction.
Q-2: If an employer makes contributions through a cafeteria plan to
the HSA of each employee who is an eligible individual in an amount
equal to the amount of the employee's HSA contribution or a percentage
of the amount of the employee's HSA contribution (matching
contributions), are the contributions subject to the section 4980G
comparability rules?
A-2: No. The comparability rules do not apply to HSA contributions
that an employer makes through a section 125 cafeteria plan. Thus, where
matching contributions are made by an employer through a cafeteria plan,
the contributions are not subject to the comparability rules of section
4980G. However, contributions, including matching contributions, to an
HSA made under a cafeteria plan are subject to the section 125
nondiscrimination rules (eligibility rules, contributions and benefits
tests and key employee concentration tests). See Q & A-1 of this
section.
Q-3: If under the employer's cafeteria plan, employees who are
eligible individuals and who participate in health assessments, disease
management programs or wellness programs receive an employer
contribution to an HSA and the employees have the right to elect to make
pre-tax salary reduction contributions to their HSAs, are the
contributions subject to the comparability rules?
A-3: (a) In general. No. The comparability rules do not apply to
employer contributions to an HSA made through a cafeteria plan. See Q &
A-1 of this section.
(b) Examples. The following examples illustrate the rules in this
Sec. 54.4980G-5. The examples read as follows:
Example 1. Employer A's written cafeteria plan permits employees to
elect to make pre-tax salary reduction contributions to their
[[Page 373]]
HSAs. Employees making this election have the right to receive cash or
other taxable benefits in lieu of their HSA pre-tax contribution. The
section 125 cafeteria plan nondiscrimination rules and not the
comparability rules apply because the HSA contributions are made through
the cafeteria plan.
Example 2. Employer B's written cafeteria plan permits employees to
elect to make pre-tax salary reduction contributions to their HSAs.
Employees making this election have the right to receive cash or other
taxable benefits in lieu of their HSA pre-tax contribution. Employer B
automatically contributes a non-elective matching contribution or seed
money to the HSA of each employee who makes a pre-tax HSA contribution.
The section 125 cafeteria plan nondiscrimination rules and not the
comparability rules apply to Employer B's HSA contributions because the
HSA contributions are made through the cafeteria plan.
Example 3. Employer C's written cafeteria plan permits employees to
elect to make pre-tax salary reduction contributions to their HSAs.
Employees making this election have the right to receive cash or other
taxable benefits in lieu of their HSA pre-tax contribution. Employer C
makes a non-elective contribution to the HSAs of all employees who
complete a health risk assessment and participate in Employer C's
wellness program. Employees do not have the right to receive cash or
other taxable benefits in lieu of Employer C's non-elective
contribution. The section 125 cafeteria plan nondiscrimination rules and
not the comparability rules apply to Employer C's HSA contributions
because the HSA contributions are made through the cafeteria plan.
Example 4. Employer D's written cafeteria plan permits employees to
elect to make pre-tax salary reduction contributions to their HSAs.
Employees making this election have the right to receive cash or other
taxable benefits in lieu of their HSA pre-tax contribution. Employees
participating in the plan who are eligible individuals receive automatic
employer contributions to their HSAs. Employees make no election with
respect to Employer D's contribution and do not have the right to
receive cash or other taxable benefits in lieu of Employer D's
contribution but are permitted to make their own pre-tax salary
reduction contributions to fund their HSAs. The section 125 cafeteria
plan nondiscrimination rules and not the comparability rules apply to
Employer D's HSA contributions because the HSA contributions are made
through the cafeteria plan.
Q-4: May all or part of the excise tax imposed under section 4980G
be waived?
A-4: In the case of a failure which is due to reasonable cause and
not to willful neglect, all or a portion of the excise tax imposed under
section 4980G may be waived to the extent that the payment of the tax
would be excessive relative to the failure involved. See sections
4980G(b) and 4980E(c).
[T.D. 9277, 71 FR 43058, July 31, 2006]
Sec. 54.4980G-6 Special rule for contributions made to the HSAs of nonhighly compensated employees.
Q-1: May an employer make larger contributions to the HSAs of
nonhighly compensated employees than to the HSAs of highly compensated
employees?
A-1: Yes. Employers may make larger HSA contributions for nonhighly
compensated employees who are comparable participating employees than
for highly compensated employees who are comparable participating
employees. See Q & A-1 in Sec. 54.4980G-1 for the definition of
comparable participating employee. For purposes of this section, highly
compensated employee is defined under section 414(q). Nonhighly
compensated employees are employees that are not highly compensated
employees. The comparability rules continue to apply with respect to
contributions to the HSAs of all nonhighly compensated employees.
Employers must make comparable contributions for the calendar year to
the HSA of each nonhighly compensated employee who is a comparable
participating employee.
Q-2: May an employer make larger contributions to the HSAs of highly
compensated employees than to the HSAs of nonhighly compensated
employees?
A-2: (a) In general. No. Employer contributions to HSAs for highly
compensated employees who are comparable participating employees may not
be larger than employer HSA contributions for nonhighly compensated
employees who are comparable participating employees. The comparability
rules continue to apply with respect to contributions to the HSAs of all
highly compensated employees. Employers must make comparable
contributions for the calendar year to the HSA of each highly
compensated comparable participating employee. See Q & A-1 in
[[Page 374]]
Sec. 54.4980G-1 for the definition of comparable participating
employee.
(b) Examples. The following examples illustrate the rules in Q & A-1
and Q & A-2 of this section. No contributions are made through a section
125 cafeteria plan and none of the employees in the following examples
are covered by a collective bargaining agreement. All of the employees
in the following examples have the same HDHP deductible for the same
category of coverage.
Example 1. In 2010, Employer A contributes $1,000 for the calendar
year to the HSA of each full-time nonhighly compensated employee who is
an eligible individual with self-only HDHP coverage. Employer A makes no
contribution to the HSA of any full-time highly compensated employee who
is an eligible individual with self-only HDHP coverage. Employer A's HSA
contributions for calendar year 2010 satisfy the comparability rules.
Example 2. In 2010, Employer B contributes $2,000 for the calendar
year to the HSA of each full-time nonhighly compensated employee who is
an eligible individual with self-only HDHP coverage. Employer B also
contributes $1,000 for the calendar year to the HSA of each full-time
highly compensated employee who is an eligible individual with self-only
HDHP coverage. Employer B's HSA contributions for calendar year 2010
satisfy the comparability rules.
Example 3. In 2010, Employer C contributes $1,000 for the calendar
year to the HSA of each full-time nonhighly compensated employee who is
an eligible individual with self-only HDHP coverage. Employer C
contributes $2,000 for the calendar year to the HSA of each full-time
highly compensated employee who is an eligible individual with self-only
HDHP coverage. Employer C's HSA contributions for calendar year 2010 do
not satisfy the comparability rules.
Example 4. In 2010, Employer D contributes $1,000 for the calendar
year to the HSA of each full-time nonhighly compensated employee who is
an eligible individual with self-only HDHP coverage. Employer D also
contributes $1,000 to the HSA of each full-time highly compensated
employee who is an eligible individual with self-only HDHP coverage. In
addition, the employer contributes an additional $500 to the HSA of each
nonhighly compensated employee who participates in a wellness program.
The nonhighly compensated employees did not receive comparable
contributions, and, therefore, Employer D's HSA contributions for
calendar year 2010 do not satisfy the comparability rules.
Example 5. In 2010, Employer E contributes $1,000 for the calendar
year to the HSA of each full-time non-management nonhighly compensated
employee who is an eligible individual with family HDHP coverage.
Employer E also contributes $500 for the calendar year to the HSA of
each full-time management nonhighly compensated employee who is an
eligible individual with family HDHP coverage. The nonhighly compensated
employees did not receive comparable contributions, and, therefore,
Employer E's HSA contributions for calendar year 2010 do not satisfy the
comparability rules.
Q-3: May an employer make larger HSA contributions for employees
with self plus two HDHP coverage than employees with self plus one HDHP
coverage even if the employees with self plus two are all highly
compensated employees and the employees with self plus one are all
nonhighly compensated employees?
A-3: (a) Yes. Q & A-1 in Sec. 54.4980G-4 provides that an
employer's contribution with respect to the self plus two category of
HDHP coverage may not be less than the contribution with respect to the
self plus one category and the contribution with respect to the self
plus three or more category may not be less than the contribution with
respect to the self plus two category. Therefore, the comparability
rules are not violated if an employer makes a larger HSA contribution
for the self plus two category of HDHP coverage than to self plus one
coverage, even if the employees with self plus two coverage are all
highly compensated employees and the employees with self plus one
coverage are all nonhighly compensated employees. Likewise, the
comparability rules are not violated if an employer makes a larger HSA
contribution for the self plus three category of HDHP coverage than to
self plus two coverage, even if the employees with self plus three
coverage are all highly compensated employees and the employees with
self plus two coverage are all nonhighly compensated employees.
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q & A-3. In the following example, no
contributions are made through a section 125 cafeteria plan and none of
the employees are covered by a collective bargaining agreement.
Example. In 2010, Employer F contributes $1,000 for the calendar
year to the HSA of each full-time employee who is an eligible individual
with self plus one HDHP coverage.
[[Page 375]]
Employer F contributes $1,500 for the calendar year to the HSA of each
employee who is an eligible individual with self plus two HDHP coverage.
The deductible for both the self plus one HDHP and the self plus two
HDHP is $2,000. Employee A, an eligible individual, is a nonhighly
compensated employee with self plus one coverage. Employee B, an
eligible individual, is a highly compensated employee with self plus two
coverage. For the 2010 calendar year, Employer F contributes $1,000 to
Employee A's HSA and $1,500 to Employee B's HSA. Employer F's HSA
contributions satisfy the comparability rules.
Q-4:What is the effective date for the rules in this section?
A-4: The rules in this section are effective for employer
contributions made for calendar years beginning on or after January 1,
2010.
[T.D. 9457, 74 FR 45998, Sept. 8, 2009]
Sec. 54.4980G-7 Special comparability rules for qualified HSA distributions
contributed to HSAs on or after December 20, 2006 and before January 1, 2012.
Q-1 How do the comparability rules of section 4980G apply to
qualified HSA distributions under section 106(e)(2)?
A-1:The comparability rules of section 4980G do not apply to amounts
contributed to employee HSAs through qualified HSA distributions.
However, in order to satisfy the comparability rules, if an employer
offers qualified HSA distributions, as defined in section 106(e)(2), to
any employee who is an eligible individual covered under any HDHP, the
employer must offer qualified HSA distributions to all employees who are
eligible individuals covered under any HDHP. However, if an employer
offers qualified HSA distributions only to employees who are eligible
individuals covered under the employer's HDHP, the employer is not
required to offer qualified HSA distributions to employees who are
eligible individuals but are not covered under the employer's HDHP.
Q-2: What is the effective date for the rules in this section?
A-2: The rules in this section are effective for are effective for
employer contributions made for calendar years beginning on or after
January 1, 2010.
[T.D. 9457, 74 FR 45999, Sept. 8, 2009]
Sec. 54.4981A-1T Tax on excess distributions and excess accumulations (temporary).
The following questions and answers relate to the tax on excess
distributions and excess accumulations under section 4981A of the
Internal Revenue Code of 1986, as added by section 1133 of the Tax
Reform Act of 1986 (Pub. L. 99-514) (TRA '86).
Table of Contents
a. General Provisions and Excess Distributions
b. Special Grandfather Rules
c. Special Rules
d. Excess Accumulations
a. General Provisions and Excess Distributions
a-1: Q. What changes were made by section 1133 of TRA '86 regarding
excise taxes applicable to distributions from qualified employer plans
and individual retirement plans?
A. Section 1133 of TRA '86 added section 4981A to the Code. Section
4981A imposes an excise tax of 15 percent on (a) excess distributions,
as defined in section 4981A(c)(1) and Q&A a-2 of this section, and (b)
excess accumulations, as defined in section 4981A(d)(3) and Q&A d-2 of
this section. The excise tax on excess distributions generally applies
to excess distributions made after December 31, 1986 (see Q&A c-6 of
this section). The excise tax on excess accumulations applies to estates
of decedents dying after December 31, 1986 (see Q&A d-11 of this
section). Excess distributions are certain distributions from qualified
employer plans and individual retirement plans. Excess accumulations are
certain amounts held on the date of death of an employee or individual
by qualified plans and individual retirement plans.
a-2: Q. How are excess distributions defined?
A. Excess distributions are generally defined as the excess of the
aggregate amount of distributions received by or with respect to an
individual during a calendar year over the greater of (a) $150,000
(unindexed) or (b) $112,500 (indexed as provided in Q&A a-9 of this
section beginning in 1988 for cost-of-living increases). Certain
individuals may elect to have the portion of their
[[Page 376]]
excess distributions that is subject to tax determined under a ``special
grandfather'' rule that is described below (see Q&A b-1 through b-14 of
this section).
a-3: Q. Distributions from what plans and arrangements are taken
into account in applying section 4981A?
A. (a) General rule. Section 4981A applies to distributions under
any qualified employer plan or individual retirement plan described in
section 4981A(e). For this purpose, a qualified employer plan means
any--
(1) Qualified pension, profit-sharing or stock bonus plan described
in section 401(a) that includes a trust exempt from tax under section
501(a);
(2) Annuity plan described in section 403(a);
(3) Annuity contract, custodial account, or retirement income
account described in section 403(b)(1), 403(b)(7) or 403(b)(9); and
(4) Qualified bond purchase plan described in section 405(a) prior
to that section's repeal by section 491(a) of the Tax Reform Act of 1984
(TRA '84).
(b) Individual retirement plan. An individual retirement plan is
defined in section 7701(a)(37) and means any individual retirement
account described in section 408(a) or individual retirement annuity
described in section 408(b). Also, an individual retirement plan
includes a retirement bond described in section 409(a) prior to that
section's repeal by section 491(b) of the Tax Reform Act of 1984 (TRA
'84).
(c) Other distributions. (1) Distributions under any plan, contract
or account that has at any time been treated as a qualified employer
plan or individual retirement plan described in paragraph (a) or (b) of
this Q&A a-3 will be treated for purposes of section 4981A as
distributions from a qualified employer plan or individual retirement
plan whether or not such plan, contract, or account satisfies the
applicable qualification requirements at the time of the distribution.
(2)(i) For purposes of this paragraph (c), an employer plan will be
considered to have been treated as a qualified employer plan if any
employer maintaining the plan has at any time filed an income tax return
and claimed deductions that would be allowable under section 404 (and
that were not disallowed) only if the plan was a qualified employer plan
under section 401(a) or 403(a). Similarly, if an income tax return has
been filed at any time with respect to the trust (or plan or insurance
company), and the income of the trust (insurance company, etc.) is
reported (and is not disallowed) based on the trust (or plan) being
treated as a qualified employer plan described in section 401(a), or 403
(a) or (b), then the employer plan is considered to have been treated as
a qualified employer plan.
(ii) For purposes of this paragraph (c), an individual retirement
plan (IRA) will be considered to have been treated as a qualified IRA if
any contributions to the IRA were either deducted (or designated as a
nondeductible contribution described in section 408(o)) on a filed
individual income tax return or excluded from an individual's gross
income on a filed income tax return because such contributions were
reported as regular contributions or rollover contributions (such as
those described in section 402(a)(5), 403(a)(4), 403(b)(8) or 408(d)(3))
to an IRA described in section 408 (a) or (b) (or section 409 of pre-
1984 law). Similar treatment applies to an employer contribution to a
simplified employee pension described in section 408(k), if such
contribution is deducted on an employer's filed income tax return,
including a self-employed individual's return.
a-4: Q. Which distributions with respect to an individual under a
qualified employer plan or an individual retirement plan are excluded
from consideration for purposes of determining an individual's excess
distributions?
A. (a) Exclusions. In determining the extent to which an individual
has excess distributions for a calendar year, the following
distributions are disregarded--
(1) Any distribution received by any person with respect to an
individual as a result of the death of that individual.
(2) Any distribution with respect to an individual that is received
by an alternate payee under a qualified domestic relations order within
the meaning of section 414(p) that is includible in the income of the
alternate payee.
[[Page 377]]
(3) Any distribution with respect to an individual that is
attributable to the individual's investment in the contract as
determined under the rules of section 72(f). This would include, for
example, distributions that are excluded from gross income under section
72 because they are treated as a recovery of after-tax employee
contributions from a qualified employer plan or nondeductible
contributions from an individual retirement plan.
(4) Any portion of a distribution to the extent that it is not
included in gross income by reason of a rollover contribution described
in section 402(a)(5), 403(a)(4), 403(b)(8), or 408(d)(3).
(5) Any health coverage or any distribution of medical benefits
provided under an arrangement described in section 401(h) to the extent
that the coverage or distribution is excludible under section 104, 105,
or 106.
(b) Alternate payee. Any distributions to an alternate payee
described in paragraph (a)(2) of this Q&A a-4 must be taken into account
by such alternate payee for purposes of calculating the excess
distributions received by (or excess accumulations held by) the
alternate payee.
a-5: Q. If an annuity contract that represents an irrevocable
commitment to provide an employee's benefits under the plan is
distributed to an individual, how are the distribution of such annuity
contract and distributions of amounts under such a contract taken into
account for purposes of calculating excess distributions?
A. Except to the extent that the value of an annuity contract is
includible in income in the year the contract is distributed or any
subsequent year, the distribution of an annuity contract (including a
group annuity contract) in satisfaction of plan liabilities is
disregarded for purposes of calculating excess distributions. Any
amounts that are actually distributed under the contract to the
individual (to the extent not excluded under Q&A a-4 of this section) or
are otherwise includible in income with respect to the contract (e.g.,
by reason of the inclusion in income of the value of the annuity
contract in the year of the contract's distribution or any subsequent
year) are taken into account for purposes of calculating excess
distributions for the calendar year during which such amounts are
received or otherwise includible in income. For purposes of this Q&A a-
5, the term plan means any qualified employer plan or individual
retirement plan specified in section 4981A(e) and Q&A a-3 of this
section.
a-6: Q. Are minimum distributions required under section 401(a)(9),
408(a)(6), 408(b)(3) or 403(b)(10) taken into account to determine
excess distributions?
A. Yes. Distributions received during a calendar year are taken into
account in determining an individual's excess distributions for such
calendar year even though such distributions are required under section
401(a)(9), 408(a)(6), 408(b)(3) or 403(b)(10). For example, minimum
distributions under section 401(a)(9) received during the 1987 calendar
year for calendar years 1985 and 1986 will be subject to section 4981A
as distributions for 1987.
a-7: Q. Are distributions of excess deferrals permitted under
section 402(g)(2), or distributions of excess contributions or excess
aggregate contributions permitted under section 401(k) or (m), or
distributions of IRA contributions permitted under section 408(d) (4) or
(5) taken into account for purposes of calculating excess distributions?
A. No. Distributions of excess deferrals, excess contributions,
excess aggregate contributions, distributions of IRA contributions, and
income allocable to such contributions or deferrals, that are made in
accordance with the provisions of sections 402(g)(2), 401(k)(8),
401(m)(6), or 408(d) (4) or (5) are not taken into account for purposes
of calculating excess distributions.
a-8: Q. What distributions from qualified employer plans or
individual retirement plans are taken into account in determining an
individual's excess distributions?
A. With the exception of distributions noted above in Q&As a-4, a-5,
and a-7 of this section, all distributions from qualified employer plans
or individual retirement plans must be taken into account in determining
an individual's excess distributions for the calendar year in which such
distributions
[[Page 378]]
are received. In general, all such distributions are taken into account
whether or not they are currently includible in income. Thus, for
example, net unrealized appreciation in employer securities described in
section 402(a) is taken into account in the year distributed. However,
health coverage or distributions of medical benefits provided under an
arrangement described in section 401(h) that are excludible from income
under section 104, 105, or 106 are not subject to section 4981A. In
addition, distributions that are excludible from income because they are
rolled over to a plan or an individual retirement account are not taken
into account. (See Q&A a-4(a) (4) and (5) of this section). Amounts that
are includible in income for a calendar year are treated as
distributions and, thus, are taken into account even if the amounts are
not actually distributed during such year. Thus, deemed distributions to
provide insurance coverage includible in income under section 72 (PS-58
amounts), loan amounts treated as deemed distributions under section
72(p), and amounts includible under section 402(b) or section 403(c) by
reason of the employer plan or individual retirement plan not being
qualified during the year are taken into account.
a-9: Q. Will the dollar threshold amount used to determine an
individual's excess distributions be adjusted for inflation in calendar
years after 1987?
A. Beginning in 1988, the $112,500 threshold amount is adjusted to
reflect post-1986 cost-of-living increases (COLAs) at the same time and
in the same manner as the adjustment described in section 415(d). The
threshold amount is adjusted even though the distribution is from a
defined contribution plan that is subject to a freeze on COLAs because
the defined benefit plan limit is below $120,000 (see section
415(c)(1)(A)). However, the $150,000 threshold amount is not adjusted to
reflect such increases.
b. Special Grandfather Rule
b-1: Q. How are benefits accrued before TRA '86 treated under the
excise tax provisions described in section 4981A?
A. (a) Grandfather amount. Certain eligible individuals may elect to
use a special grandfather rule that exempts from the excise tax the
portion of distributions treated as a recovery of such individual's
total benefits accrued on or before August 1, 1986 (grandfather amount).
However, distributions that are treated as a recovery of the grandfather
amount are taken into account in determining the extent to which other
distributions are excess distributions (see Q&A b-4 of this section).
Under this special grandfather rule, the grandfather amount equals the
value of an individual's total benefits (as described in Q&As b-8 and b-
9 of this section) in all qualified employer plans and individual
retirement plans on August 1, 1986. An individual's benefits in such
plans include amounts determinable on August 1, 1986, that are payable
to the individual under a qualified domestic relations order within the
meaning of section 414(p) (QDRO). However, QDRO benefits that, when
destributed, are includible in the income of the alternate payee are not
included in the employee's grandfathered amount. Further, plan benefits
that are attributable to a deceased individual and that are payable to
an eligible individual as a beneficiary are generally not included in
determining the eligible individual's grandfather amount. Procedures for
determining the grandfather amount are described in Q&As b-11 through b-
14 of this section.
(b) Recovery of grandfather amount. The portion of any distribution
made after August 1, 1986, that is treated as a recovery of a
grandfather amount depends on which of two grandfather recovery methods
the individual elects. The two alternative methods are described in the
Q&As b-11 through b-14 of this section. The amount of the distribution
for a year that is treated as a recovery of a grandfather amount in a
year is applied to reduce the individual's unrecovered grandfather
amount for future years (i.e., the individual's accrued benefits as
described in Q&As b-8 and b-9 on August 1, 1986, reduced by previous
distributions treated as a recovery of a grandfather amount) on a dollar
for dollar basis until the individual's unrecovered grandfather amount
[[Page 379]]
has been reduced to zero. When the individual's grandfather amount has
been reduced to zero, the special grandfather rule ceases to apply and
the entire amount of any subsequent excess distributions received is
subject to the 15 percent excise tax.
b-2: Q. Who may elect to use the special grandfather rules?
A. Any individual whose accrued benefits as described in Q&As b-8
and b-9 of this section in all qualified plans and individual retirement
plans on August 1, 1986 (initial grandfather amount) have a value of at
least $562,500 may elect to use the special grandfather rule.
b-3: Q. How does an eligible individual make a valid election to use
the special grandfather rule?
A. (a) Form of election. An individual who is eligible to use the
special grandfather rule must affirmatively elect to use that rule. The
election is made on a Form 5329 filed with the individual's income tax
return (Form 1040, etc.) for a taxable year beginning after December 31,
1986, and before January 1, 1989 (i.e., the 1987 or 1988 taxable year).
(b) Information required. The individual must report the following
information on the Form 5329:
(1) The individual's initial grandfather amount.
(2) The grandfather recovery method to be used.
(3) Such other information as is required by the Form 5329.
(c) Deadline for election. The deadline for filing such election is
the due date, calculated with extensions, for filing the individual's
1988 income tax return. If an individual dies before the expiration of
such deadline, an election, or the revocation of a prior election, may
be made as part of the final income tax return filed on behalf of such
deceased individual by the deceased individual's personal
representative. An election or revocation of a prior election may also
be filed before the expiration of such deadline with Schedule S (Form
706). See Q&A c-7 of this section.
(d) Revocation of election. Elections filed before the deadline may
be revoked by filing an amended income tax return for any applicable
year. A change in the grandfather recovery method is considered a
revocation of a prior election and an amended Form 5329 must be filed
for any prior year in which a different grandfather recovery method was
used. Thus, a change in the election may require a change in the 1987
tax return. An individual must refile for 1987 based on the new election
if additional tax is owed. However, an election (or nonelection) is
irrevocable after the filing deadline for the taxable year beginning in
1988 has passed. Thus, an individual who has not made an election by the
last day plus extensions for filing the 1988 return may not do so
through an amended return.
(e) Subsequent years. (1) Any eligible individual who has elected
the special grandfather rule must attach to the individual's income tax
return for all subsequent taxable years in which the individual receives
excess distributions (determined without regard to the grandfather rule)
a copy of the Form 5329 on which the individual elected the grandfather
rule. A copy of the Form 5329 on which the individual (or the
individual's personal representative) elected the grandfather rule must
also be filed with Schedule S (Form 706) unless the initial election is
filed with such schedule.
(2) The individual must also make such other reports in the form and
at the time as the Commissioner may prescribe. See Q&A c-7 of this
section for the applicable reporting requirements if the individual or
the individual's estate is liable for any tax on excess distributions or
on an excess accumulation under section 4981A (a) or (d).
b-4: Q. How individuals who have elected to use the special
grandfather rule determine the extent to which their distributions for
any calendar year are excess distributions?
A. (a) Excess distributions under grandfather rule, threshold
amount. Individuals who elect to use the special grandfather rule are
not eligible to use the $150,000 threshold amount in computing their
excess distributions for any calendar year. Instead, such electing
individuals must compute their excess distributions for a calendar year
using a $112,500 (indexed for cost-of-living increases) threshold
amount. The rule of this paragraph (a) applies for all calendar years,
including the calendar
[[Page 380]]
year in which an individual's unrecovered grandfather amount has been
reduced to zero and all subsequent calendar years. Once the indexed
amount has increased to $150,000 or more, the threshold amount will be
the same for all individuals.
(b) Base for excise tax under grandfather rule. Although the portion
of any distribution that is treated as a recovery of an individual's
grandfather amount is not subject to the excise tax, such portion must
be taken into account in determining the extent to which the individual
has excess distributions for a calendar year. The effect of this rule is
that the amount against which the 15 percent excise tax is applied for
any calendar year during which a grandfather amount is recovered equals
the individual's distributions for such year reduced by the greater of
(1) the applicable threshold amount for such year or (2) the grandfather
amount recovered for such year. (See the examples in Q&A b-14 of this
section.)
b-5: Q. How is the value of an individual's total accrued benefits
on August 1, 1986, calculated for purposes of determining (a) whether an
individual is eligible to elect the special grandfather rule and (b) the
amount of any electing individual's initial grandfather amount under
such rule?
A. (a) Introduction. The value of an individual's total accrued
benefits on August 1, 1986, is the sum of the values of the individual's
accrued benefits on such date under all qualified employer plans or
individual retirement plans, as determined under the Q&A b-5. If such
value exceeds $562,500, the individual may elect the special grandfather
rule. In such case, the value so determined may be applied against
distributions as determined under this section, whether or not such
distributions are from the same plan or IRA for which such grandfather
amount is determined. For purposes of determining the value of accrued
benefits on August 1, 1986, an annuity contract or an individual's
interest in a group annuity contract described in Q&A a-5 of this
section is treated as an accrued benefit under the qualified retirement
plan or IRA from which it was distributed and an IRA is treated as a
defined contribution plan.
(b) Defined benefit plan--(1) General rule. The amount of an
individual's accrued benefit on August 1, 1986, under a defined benefit
plan is determined as of that date under the provisions of the plan
based on the individual's service and compensation on that date. The
present value of such benefit is determined by an actuarial valuation of
such accrued benefit performed as of August 1, 1986. Alternatively,
accrued benefits may be determined as of July 31, 1986. In such case,
the applicable rules are applied by substituting the July 31 date for
the August 1 date in the applicable provisions. (See Q&A b-9 of this
section for rules for determining the amount of benefits and values and
the actuarial assumptions to be used in such determination.)
(2) Alternative method. Alternatively, the present value of an
individual's accrued benefit on August 1, 1986, may be determined using
the following method:
(i) Determine the amount of the individual's actual accrued benefit
(prior benefit) on the valuation date that immediately precedes August
1, 1986 (prior date). The valuation date for purposes of using this
alternative method is the valuation date used for purposes of section
412. In making this determination, plan amendments that are adopted
after that prior date are disregarded.
(ii) Determine the amount of the individual's adjusted accrued
benefit (adjusted prior benefit) on the prior date by reducing the prior
benefit in paragraph (b)(2)(i) of this Q&A b-5 by the amount of
distributions that reduce the accrued benefit or transfers from the plan
and by increasing the prior benefit in paragraph (b)(2)(i) of this Q&A
b-5 by any increase in benefit resulting from either transfers to the
plan or plan amendments that were made (or, in the case of a plan
amendment, both adopted and effective) after the prior valuation date,
but on or before August 1, 1986.
(iii) Determine the amount of the individual's actual accrued
benefit (future benefit) on the valuation date immediately following
August 1, 1986 (next date). In making this determination, plan
amendments, etc. that are
[[Page 381]]
either adopted or effective after August 1 are disregarded.
(iv) Determine the amount of the individual's adjusted accrued
benefit (adjusted future benefit) on the next date by increasing the
future benefit in paragraph (b)(2)(iii) of this Q&A b-5 by the amount of
any distributions that reduce the accrued benefit or transfers from the
plan and by reducing the future benefit in paragraph (b)(2)(iii) of this
Q&A b-5 by the amount of any transfer to the plan that was made after
August 1, 1986, but on or before the next valuation date to the amount
in paragraph (b)(2)(iii) of this Q&A b-5.
(v) Calculate the weighted average of paragraphs (b)(2)(ii) and
(b)(2)(iv) of this Q&A b-5, where the weights applied are the number of
complete calendar months separating the applicable prior date and the
applicable next date, respectively, and August 1, 1986.
(vi) Determine the actuarial present value of the benefit in
paragraph (b)(2)(v) of this Q&A b-5 as of August 1, 1986, using the
methods and assumptions described in Q&A b-9 of this section.
The grandfather amount on August 1, 1986, attributable to the
accrued benefits under the defined benefit plan is equal to the amount
determined in paragraph (b)(2)(vi) of this Q&A b-5.
(3) Certain insurance plans treated as defined contribution plans.
(i) Accrued benefits not in pay status under a plan satisfying the
requirements of section 411(b)(1)(F) are determined under the rules in
paragraph (c) of this Q&A b-5 for defined contribution plans. For
purposes of applying paragraph (c) of this Q&A b-5 to such benefits, the
cash surrender value of the contract is substituted for the account
balance. If accrued benefits are in pay status under such a plan, the
rules of this paragraph (b) apply to such benefits.
(ii) Accrued benefits not in pay status that are attributable to
voluntary employee contributions (including rollover amounts) to a
defined benefit plan are determined under the rules in paragraph (c) of
this Q&A b-5 as if the account balance attributable thereto is under a
defined contribution plan. If such benefits are in pay status and are
used to fund the benefit under the defined plan, the rules of this
paragraph (b) apply to such benefits.
(c) Defined contribution plan--(1) General rule. The value of an
individual's accrued benefit on August 1, 1986, under a defined
contribution plan (including IRAs) is the value of the individual's
account balance on such date (or on the immediately preceding day).
Paragraph (b)(3) of this Q&A b-5 requires that benefits derived from
certain insured plans and from voluntary contributions to a defined
benefit plan be determined under the rules of this paragraph (c).
(2) Alternative method. Alternatively, if a valuation was not
performed as of August 1, 1986 (or as of the immediately preceding day),
the value of an individual's accrued benefit may be determined as
follows:
(i) Determine the value of the individual's account balance on the
valuation date immediately preceding August 1, 1986 (prior valuation
date).
(ii) Determine the value of the individual's adjusted account
balance on the prior valuation date by subtracting (or adding,
respectively) the amount of any distribution, including a transfer to
another plan or a forfeiture from the account balance (or the amount of
any allocation to the account balance, including a transfer from another
plan, rollover received or forfeiture from another account) that was
made after the prior valuation date but on or before August 1, 1986,
from (or to) the amount in paragraph (c)(2)(i) of this Q&A b-5.
(iii) Determine the value of the individual's account balance on the
valuation date immediately following August 1, 1986 (next valuation
date).
(iv) Determine the value of the individual's adjusted account
balance on the next valuation date by adding (or subtracting,
respectively) the amount of any distribution, of a type described in
paragraph (c)(2)(ii) of this Q&A b-5 (or the amount of any allocation to
the account balance, of a type described in paragraph (c)(2)(ii) of this
Q&A b-5), that was made after August 1, 1986, but on or before the next
valuation date to (or from) the amount in paragraph (c)(2)(iii) of this
Q&A b-5.
(v) Calculate the weighted average of paragraphs (c)(2)(ii) and
(c)(2)(iv) of
[[Page 382]]
this Q&A b-5, where the weights applied are the number of complete
calendar months separating the applicable valuation date and the
applicable next date, respectively, and August 1, 1986.
The grandfather amount on August 1, 1986, attributable to the
account balance in the defined contribution plan or the individual
retirement plan is the amount in paragraph (c)(2)(v) of this Q&A b-5.
b-6: Q. For purposes of determining the value of accrued benefits in
a defined contribution plan or a defined benefit plan on August 1, 1986,
are nonvested benefits taken into account?
A. Yes. All accrued benefits, whether or not vested, are taken into
account.
b-7: Q. To what extent are benefits payable with respect to an
individual under a qualified employer plan or an individual retirement
plan not taken into account for purposes of calculating the individual's
grandfather amount?
A. (a) Exclusions. The following benefits payable with respect to an
individual are not taken into account for purposes of this calculation:
(1) Benefits attributable to investment in the contract as defined
in section 72(f). However, amounts attributable to deductible employee
contributions (as defined in section 72(o)(5)(A)) are considered part of
the accrued benefit.
(2) Amounts that are determinable on August 1, 1986, as payable to
an alternate payee who is required to include such amounts in gross
income (a spouse or former spouse) under a qualified domestic relations
order (QDRO) within the meaning of section 414(p).
(3) Amounts that are attributable to IRA contributions that are
distributed pursuant to section 408(d) (4) or (5).
(b) Alternate payee. Under a QDRO described in paragraph (a)(2) of
this Q&A b-7, amounts are considered part of the accrued benefit of the
alternate payee for purposes of calculating the value of the alternate
payee's accrued benefit on August 1, 1986. Similarly, such amounts are
used by the alternate payee to compute excess distributions.
b-8: Q. What adjustments to the grandfather amount are necessary to
take into account rollovers from one qualified employer plan or
individual retirement plan to another such plan?
A. (a) Rollovers outstanding on valuation date. Generally, rollovers
between plans result in adjustment to the grandfather amounts under the
rules in Q&A b-5 of this section. However, if a rollover amount is
distributed from one plan on or before an applicable valuation date of
such plan and is rolled over into the receiving plan after the receiving
plan's applicable valuation date and if these events result in an
inappropriate duplication or omission of the rollover amount, then an
adjustment to the grandfather amount must be made to remove the
duplication or omission. The Commissioner may provide necessary rules
concerning this adjustment.
(b) Valuation. If the rollover amount described in paragraph (a) of
this Q&A b-8 is in a form of property other than cash, the property of
which the outstanding rollover consists is valued as of the date the
rollover contribution is received by the transferee qualified employer
plan or individual retirement plan and that value is the amount of the
rollover. If the outstanding rollover is in the form of cash, the amount
of the cash is the amount of the rollover.
b-9: Q. What is the form of the grandfather benefit under a defined
benefit plan and how is it valued?
A. (a) Benefit form. The grandfather amount under a defined benefit
plan is determined on the basis of the form of benefit (including any
subsidized form of benefit such as a subsidized early retirement benefit
or a subsidized joint and survivor annunity) provided under the plan as
of August 1, 1986 that has the greatest present value as determined in
paragraph (b) of this b-9. If the plan provides a subsidized joint and
survivor annunity, for purposes of determining the grandfather amount,
it will be assumed that an unmarried individual is married and that the
individual spouse is the same age as the individual. Assumptions as to
future withdrawals, future salary increases or future cost-of-living
increases are not permitted.
(b) Value of grandfather amount. The grandfather amount under a
defined benefit plan is the present value of the
[[Page 383]]
individual's benefit form determined under paragraph (a) of this Q&A b-
9. Thus, the benefit form is reduced to reflect its value on the
applicable valuation date. The present value of the benefit form on
August 1, 1986, or the applicable date, is computed using the factors
specified under the terms of the plan as in effect on August 1, 1986, to
calculate a single sum distribution if the plan provides for such a
distribution. If the plan does not provide for such a distribution form,
such present value is computed using the interest rate and mortality
assumptions specified in Sec. 20.2031-7 of the Estate Tax Regulations.
b-10: Q. Is the plan administrator (or trustee) of a qualified plan
(or individual retirement account) required to report to an individual
the value of the individual's benefit under the plan as of August 1,
1986?
A. (a) Request required. No report is required unless the individual
requests a report and the request is received before April 15, 1989. If
requested, the plan administrator (or trustee or issuer) must report to
such individual the value of the individual's benefit under the plan as
of August 1, 1986, determined in accordance with Q&A b-5 through b-9 of
this section. Such report must be made within a reasonable time after
the individual's request but not later than July 15, 1989.
(b) Other rules. Alternate payees must make their own request for
valuation reports. Any report furnished to an employee who has an
alternate payee with respect to the plan must include the separate
values attributable to each such individual. Any report furnished to an
alternate payee must include only the value attributable to the
alternate payee. Reports may be furnished to individuals even if no
request is made. Individuals must keep records of the reports received
from plans or IRAs in order to substantiate all grandfather amounts.
(c) Authority. The rules in this Q&A are provided under the
authority in section 6047(d).
b-11: Q. How is the portion of a distribution that is treated as a
recovery of an individual's grandfather amount as described in b-1 of
this section to be calculated?
A. (a) General rule. All distributions received between August 1 and
December 31, 1986, inclusive, are treated as a recovery of a grandfather
amount. The portion of distributions received after December 31, 1986,
that is treated as a recovery of the grandfather amount is determined
under either the discretionary method or the attained age method. An
amount that is treated as a recovery of grandfather benefits is applied
to reduce the initial grandfather amount that was calculated as of
August 1, 1986, on a dollar for dollar basis until the unrecovered
amount has been reduced to zero. No other recalculation of the
grandfather amount is to be made for a date after August 1, 1986.
(b) Methods, etc. The grandfather amount may be recovered by an
individual under either the discretionary method or the attained age
method. After the individual's total grandfather amount is treated as
recovered under either method, the tax on excess distributions and
excess accumulations is determined without regard to any grandfather
amount.
b-12: Q. Under the discretionary method, what portion of each
distribution is treated as a return of the individual's grandfather
amount?
A. (a) Initial percentage. Under the discretionary method, unless
the individual elects in accordance with paragraph (b) below, 10 percent
of the total distributions that the individual receives during any
calendar year is treated as a recovery of the grandfather amount.
(b) Acceleration. The individual may elect to accelerate the rate of
recovery to 100 percent of the total aggregate distributions received
during a calendar year commencing with any calendar year, including 1987
(acceleration election). In such case, the rate of recovery is
accelerated to 100 percent for the calendar year with respect to which
the election is made and for all subsequent calendar years.
(c) Election. To recover the grandfather amount using the
discretionary method, an individual must elect to use such method when
making the election to use the special grandfather rule on the Form
5329. (See Q&A b-3 of this section.) The acceleration election
[[Page 384]]
must be made for the individual's taxable year beginning with or within
the first calendar year for which such election is made and must be
filed with the individual's income tax return for that year. Such
acceleration election may also be made or revoked retroactively on an
amended return for such year. However, the acceleration election may not
be made after the individual's death other than with the individual's
final income tax return or with a return for a prior year for which a
return was not filed before the individual's death. Thus, the
acceleration election may not be made on an amended return filed after
the individual's death for a year for which a return was filed before
the individual's death. The preceding two sentences shall not apply to
deaths occurring in 1987 or 1988. The estate is entitled to use the
remaining grandfather amount to determine if there is an excess
accumulation. See Q&A d-3 of this section. The acceleration election
shall be made on such form and in such manner as the Commissioner
prescribes in a manner consistent with the rules of this section.
b-13: Q. Under the attained age method, what portion of each
distribution is treated as a return of the individual's grandfather
amount?
A. Under the attained age method, the portion of total distributions
received during any year that is treated as a recovery of an
individual's grandfather amount is calculated by multiplying the
individual's aggregate distributions for a calendar year by a fraction.
The numerator of the fraction is the difference between the individual's
attained age in completed months on August 1, 1986, and the individual's
attained age in months at age 35 (420 months). The denominator of the
fraction is the difference between the individual's attained age in
completed months on December 31 of the calendar year and the
individual's attained age in months at age 35 (420 months). An
individual whose 35th birthday is after August 1, 1986, may not use the
attained age method.
b-14: Q. How is the 15 percent tax with respect to excess
distributions for a calendar year calculated by an individual who has
elected to use the special grandfather rule?
A. The calculation of the excise tax may be illustrated by the
following examples:
Example 1. (a) An individual (A) who participates in two retirement
plans, a qualified defined contribution plan and a qualified defined
benefit plan, has a total value of accrued benefits on August 1, 1986
under both plans of $1,000,000. Because this amount exceeds $562,500, A
is eligible to elect to use the special grandfather rule to calculate
the portion of subsequent distributions that are exempt from tax. A
elects to use the discretionary grandfather recovery method and attaches
a valid election to the 1987 income tax return. A does not elect to
accelerate the rate of recovery for 1987. On October 1, 1986, A receives
a distribution of $200,000. On February 1, 1987, A receives a
distribution of $45,000 and, on November 1, 1987, receives a
distribution of $200,000. The 15 percent excise tax applicable to
aggregate distributions in 1987 is calculated as follows:
(1) Value of grandfather amount on 8/1/86.....................$1,000,000
(2) Grandfather amounts recovered in 1986 but after 8/1/86......$200,000
(3) Value of grandfather amount on 12/31/86 ((1)-(2))...........$800,000
(4) Grandfather recovery percentage..................................10%
(5) Distributions between 1/1/87 and 12/31/87 ($45,000x$200,000)
$245,000
(6) Portion of (5) exempt from tax ((4)x(5)).....................$24,500
(7) Amount potentially subject to tax ((5)-(6)).................$220,500
(8) Portion of aggregate distributions in excess of $112,500
($45,000x$200,000-$112,500).....................................$132,500
(9) Amount subject to tax (lesser of (7) and (8))...............$132,500
(10) Amount of tax (15% of (9))..................................$19,875
(11) Remaining undistributed value of grandfather amount as of 12/31/87
((3)-(6)).......................................................$775,500
(b) In 1988, A receives no distributions from either plan. On
February 1, 1989, A receives a distribution of $300,000 and on December
31, 1989, receives a distribution of $75,000. A makes a valid
acceleration election for the 1989 taxable year, whereby A accelerates
the rate of grandfather recovery that will apply for calendar years
after 1988 to 100 percent. Assume the annual threshold amount for the
1989 calendar year is $125,000 (i.e., 112,500 indexed). The 15 percent
excess tax applicable to distributions in 1989 is calculated as follows:
(1) Value of grandfather amount on 8/1/86.......................$775,500
(2) Grandfather recovery percentage designated for 1989 calendar year
100%
(3) Distributions between 1/1/89 and 12/
[[Page 385]]
31/89 ($300,000x$75,000)........................................$375,000
(4) Portion of (3) exempt from tax (2)x(3)......................$375,000
(5) Amount potentially subject to tax ((3)-(4)).......................$0
(6) Portion of aggregate distributions in excess of $125,000
($300,000x$75,000-$125,000).....................................$250,000
(7) Amount subject to tax (lesser of (5) and (6)).....................$0
(8) Amount of tax (15% of (7))........................................$0
(9) Remaining undistributed value of grandfather amount as of 12/31/89
((1)-(4)).......................................................$400,500
The entire amount of any distribution for subsequent calendar years
will be treated as a recovery of the grandfather amount and applied
against the grandfather amount until the unrecovered grandfather amount
is reduced to zero.
Example 2. The facts are the same as in Example 1 except that A
elects to use the attained age recovery method and A makes a valid
election for the 1987 taxable year. Further assume that A's attained age
in months on August 1, 1986 is 471 months and on December 31, 1987, is
488 months. The 15 percent excise tax applicable to aggregate
distributions in 1987 is calculated as follows:
(1) Value of grandfather amount on 8/1/86.....................$1,000,000
(2) Grandfather amounts recovered in 1986 but after 8/1/86......$200,000
(3) Value of grandfather amount on 12/31/86 ((1) - (2)).........$800,000
(4) Completed months of age in excess of 420 on 8/1/86................51
(5) Completed months of age in excess of 420 on 12/31/87..............68
(6) Grandfather fraction as of 12/31/86 ((4) divided by (5)).......\3/4\
(7) Distributions between 1/1/87 and 12/31/87 ($45,000 + $200,000)
$245,000
(8) Portion of (7) exempt from tax ((6)x(7))....................$183,750
(9) Amount potentially subject to tax ((7)-(8))..................$61,250
(10) Portion of aggregate distributions in excess of $112,500 ($45,000 +
$200,000 - $112,500)............................................$132,500
(11) Amount subject to tax (lesser of (9) and (10))..............$61,250
(12) Amount of tax (15% of (11)...................................$9,187
(13) Unrecovered grandfather amount as of 12/31/87 ((3) - (8))
$616,250
c. Special Rules
c-1: Q. How is the excise tax computed if a person elects special
tax treatment under section 402 or 403 for a lump sum distribution?
A. (a) General rule--(1) Conditions. Section 4981A(c)(4) provides
for a special tax computation that applies to an individual in a
calendar year if the individual receives distributions that include a
lump sum distribution and the individual makes certain elections under
section 402 or 403 with respect to that lump sum distribution (lump sum
election).
(2) Lump sum election. A lump sum election includes an election of
(i) 5-year income averaging under section 402(e)(4)(B); (ii) phaseout
capital gains treatment under sections 402(a)(2) or 403(a)(2) prior to
their repeal by section 1122(b) of TRA '86 and as permitted under
section 1122(h)(4) of TRA '86; (iii) grandfathered long-term capital
gains under sections 402(a)(2) and 403(a) prior to such repeal and as
permitted by section 1122(h)(3) of TRA '86; and (iv) grandfathered 10-
year income averaging under section 402(e) (including such treatment
under a section 402(e)(4)(L) election) prior to amendment by section
1122(a) of TRA '86 and as permitted by section 1122(h)(3)(A)(ii) and (5)
of the TRA '86.
(3) Special tax computation. (i) If the conditions in paragraph
(a)(1) of this Q&A c-1 are satisfied for a calendar year, the rules of
this subparagraph (a)(3) apply for purposes of determining whether there
are excess distributions and tax under section 4981A.
(ii) All distributions are divided into two categories. These two
categories are the lump sum distribution and other distributions.
Whether or not a particular distribution is a distribution subject to
section 4981A and is in either category is determined under the rules in
section 4981A and this section. Thus, the exclusions under section
4981A(c)(2) and Q&A a-4(a) of this section apply here. For example, a
distribution that is a tax-free recovery of employee contributions is
not in either category.
(iii) The excise tax under section 4981A(c)(1) is computed in the
normal manner except that (A) it is the sum of the otherwise applicable
taxes determined separately for the two categories of excess
distributions and (B) a different amount (threshold amount) is
subtracted from the distributions in each category in determining the
amount of the excess distributions. The threshold amount that is
subtracted from the portion of the distributions that is not part of the
lump sum distribution is the applicable threshold
[[Page 386]]
amount, determined without regard to section 4981A(c)(4) and the lump
sum election. Thus, the threshold amount subtracted from the amount in
this category is either the $150,000 amount or the $112,500 amount
(indexed). The threshold amount that is subtracted from the amount of
the lump sum distribution is 5 times the applicable threshold amount as
described above. Thus, the threshold amount subtracted from the lump sum
distribution is $750,000 or 5 times $112,500 indexed (initially
$562,500).
(b) Grandfather rule--(1) In general. This paragraph (b) provides
special rules where an individual makes both the grandfather election
described in section 4981A(c)(5) and the lump sum election described in
paragraph (a) of this Q&A c-1. See Q&A b-11 through 14 for other rules
that apply to such grandfather election.
(2) Discretionary method. If the individual uses the discretionary
method, described in Q&As b-11 and 12 of this section, the applicable
threshold amount is $112,500 (indexed). Under this method, the
grandfather amount is recovered at a 10 percent or 100 percent rate in
any calendar year and is offset separately against distributions in each
category of distributions at the appropriate rate. If, for any calendar
year, distributions are received in both categories and the total of the
appropriate percentage (10 percent or 100 percent) of the distributions
in each category exceed the unrecovered grandfathered account, then such
grandfather amount must be recovered ratably from the distributions in
each category. This rule applies even if the distributions in one
category are less than the threshold amount for that category and the
distributions in the other category exceed the threshold amount for that
category.
(3) Attained age method. If the individual uses the attained age
method, described in Q&As b-11 and 13 of this section, the threshold
amount is $112,500 (indexed). Under this method, to determine the
portion of the distributions in each category that is treated as a
recovery of the grandfather amount, the fraction described in Q&A b-13
of this section is applied separately to the distributions in each
category of distributions. If, for any calendar year, distributions are
received in both categories and the total of the amounts of the
distributions in each category that are treated as a recovery of the
grandfather amount exceeds that undercovered grandfather amount, then
such grandfather amount must be recovered ratably from the distributions
in each category. This rule applies even if the distributions in one
category are less than the threshold amount for that category and the
distributions in the other category exceed the threshold amount for that
category.
(c) Amount in lump sum category. All amounts received from the
employer that are required to be distributed to the individual in order
to make a lump sum election described in paragraph (a) of this Q&A c-1
are included in the lump sum category. Amounts are in the lump sum
category even though they are not subject to income tax under the
election. Thus, for example, the following amounts would be in the lump
sum category: (1) Appreciation on employer securities received as part
of a distribution for which a lump sum treatment is elected; and (2)
amounts that are phased out when section 1122 of TRA '86 is elected.
However, accumulated deductible employee contributions under the plan
(within the meaning of section 72(o)(5)) are in the nonlump sum
category.
(d) Examples. The rules in this Q&A c-1 are illustrated by the
following examples:
Example 1. (a) On January 1, 199X, individual A who is age 65 and is
a calendar year taxpayer receives a lump sum distribution described in
section 402(e)(4)(A) from a qualified employer plan (Plan X). A receives
no other distribution in 199X. A elects 5-year income averaging under
section 402(e)(4)(B) and also elects section 402(e)(4)(L) treatment
(treating pre-74 participation as post-1973 participation) on A's income
tax return for 199X. Thus, A also makes the lump sum election described
in paragraph (a)(2), above. For 199X, the $112,500 threshold amount
indexed is $125,000. A does not make a grandfather election so that A's
threshold amount is $150,000.
(b) A's distribution from Plan X consists of cash in the amount of
$800,000. A has a section 72(f) investment in the contract. A has over
the years made after tax contributions to Plan X of $50,000. A's
distributions subject
[[Page 387]]
to section 4981A equal $750,000 because of the exclusion of A's $50,000
after-tax contributions.
(c) A's distributions consist solely of amounts in the lump sum
category. A's threshold amount equals $750,000 under the rules of this
paragraph (a)(iii), above, (5 times $150,000). Because A's threshold
amount ($750,000) equals the amount of A's distribution from Plan X
($750,000) no part of A's distribution from Plan X is treated as an
excess distribution subject to the 15-percent excise tax.
Example 2. (a) Assume the same facts as in Example (1), except that
A receives an additional distribution from an individual retirement plan
described in section 408(a) (IRA Y) in 199X of $150,000. A has made no
nondeductible contributions to IRA Y and all of the $150,000 is a
distribution subject to section 4981A.
(b) A's distributions consist of two categories, the lump sum
category (Plan X $750,000) and the other than lump sum category (IRA Y
$150,000). A separate threshold amount is subtracted from A's IRA Y
distribution. This threshold amount equals $150,000 under the rules of
this paragraph (a)(3), above, the same initial threshold amount that is
applied against the lump sum prior to the multiplication by 5). Because
A's threshold amount ($150,000) equals the amount of A's distribution
from IRA Y ($150,000), no part of A's distribution from IRA Y would be
treated as an excess distribution subject to the 15-percent excise tax.
Example 3. (a) Assume the same facts as in Example (2), except that
A's distribution is $825,000 from Plan X, before reduction of $50,000
for employee contributions, instead of $800,000, so that A's
distribution subject to section 4981A from Plan X is $775,000. A made a
valid grandfather election. Therefore, the applicable threshold amount
is $125,000 ($112,500 indexed for 199X). A's unrecovered grandfather
amount as of the end of the year preceding 199X is $1,000,000 (A had a
benefit under another retirement plan (Plan Z) on August 1, 1986, and
A's account balance under Plan Z, which is a stock bonus plan, is
$6,000,000 on January 1, 199X.) A also made a valid election of the
discretionary method to recover A's grandfather amount.
(b) If A recovers A's grandfather amount in 199X at the 10 percent
rate, 10 percent of A's distributions that are in the lump sum category
(Plan X $775,000) is treated as a recovery of A's grandfather amount.
Similarly, 10 percent of A's distributions that are in the other than
lump sum category (IRA Y $150,000) is treated as a recovery of A's
grandfather amount. Thus, A's grandfather amount is reduced by $92,500
($77,500 Plan X and $15,000 IRA Y) for the 199X calendar year and is
$907,500 on January 1 of the year following 199X. Because the amounts of
the distributions in each category that are treated as a recovery of
grandfather amount are less than the applicable threshold amount for
each category ($625,000 Plan X, $125,000 IRA Y), the recovery of the
grandfather amount does not affect the calculations of the 199X excise
tax.
(c) Because A's distribution from IRA Y of $150,000 exceeds A's
threshold amount of $125,000 ($112,500 indexed) applicable to nonlump
sum distributions by $25,000 and A's distribution subject to section
4981A from Plan X of $775,000 exceeds A's threshold amount of $625,000
(5X$125,000) applicable to lump sums by $150,000, A is subject to the
15-percent excise tax. A's tax under section 4981A is $26,250 (15
percent of $25,000 plus 15 percent of $150,000).
Example 4. (a) Assume the same facts as in Example (3) except that A
makes a valid acceleration election under the discretionary method with
respect to A's grandfather amount of $1,000,000 for calendar year 199X.
(b) Because A's grandfather amount on January 1, 199X ($1,000,000)
equals or exceeds A's distribution subject to section 4981A ($925,000)
for 199X, no part of A's distribution from Plan X or IRA Y would be
treated as excess distribution subject to the 15-percent excise tax.
(c) A's distributions subject to 4981A from Plan X of $775,000 and
from IRA Y of $150,000 are offset 100 percent by A's grandfather amount
of $1,000,000. Therefore, A's grandfather amount on January 1 of the
year following 199X is $75,000 ($1,000,000 minus $925,000). This $75,000
would be required to be offset 100 percent against any distributions
received in that year.
Example 5. (a) Assume the same facts as in Example (4), except that
A's distribution subject to section 4981A from Plan X, after reduction
of the $50,000 for employee contributions, is $1,000,000 and from IRA Y
is $125,000 (equal to the threshold amount), totaling $1,125,000.
(b) Because the sum of the amount received in the lump sum category
and the other than lump sum category of distributions is greater than
the grandfather amount ($1,000,000), the grandfather amount must be
allocated to each separate category on the basis of the ratio of the
amount received in each category to the sum of these amounts. Thus,
$888,889 ($1,000,000 X ($1,000,000 divided by $1,125,000)) is allocated
to the lump-sum category and $111,111 ($1,000,000 X ($125,000 divided by
$1,125,000)) is allocated to the other than lump sum category. A's
distributions of $1,000,000 in the lump sum category are reduced by
$888,889, the greater of $625,000 (the threshold amount) or $888,889
(grandfather amount), and equal $111,111. A's excise tax is $16,666 (15
percent of $111,111). A owes no excess distribution tax on the $125,000
received from IRA Y because it is fully offset by the threshold amount
of $125,000.
[[Page 388]]
(c) Because A's distribution subject to section 4981A for the year
of $1,125,000 ($1,000,000 plus $125,000) exceeds A's grandfather amount
on January 1, 199X of $1,000,000, A's grandfather amount is zero for all
subsequent calendar years.
c-2: Q. Must retirement plans be amended to limit future benefits
accruals so that the amounts that are distributed would not be subject
to an excise tax under section 4981A?
A. No. A qualified employer plan need not be amended to reduce
future benefits so that the amount of annual aggregate distributions are
not subject to tax under section 4981A. Section 415 does, however,
require plan provisions that limit the accrual of benefits and
contributions to specified amounts. The operation of the excise tax of
section 4981A is independent of plan qualification requirements limiting
benefits and contributions under qualified plans.
c-3: Q. Is a plan amendment reducing accrued benefits a permitted
method of avoiding the excise tax?
A. No. Accrued benefits may not be reduced to avoid the imposition
of the excise tax. Such reduction would violate employer plan
qualification requirements, including section 411(d)(6).
c-4: Q. To what extent is the 15 percent section 4981A tax reduced
by the 10 percent section 72(t) tax?
A. (a) General rule. The 15 percent tax on excess distributions may
be offset by the 10 percent tax on early distributions to the extent
that the 10 percent tax is applied to excess distributions. For example,
assume that individual (A), age 56, receives a distribution of $200,000
from a qualified employer plan (Plan X) during calendar year 1987.
Further, assume that the entire distribution is subject to the 10-
percent tax of section 72(t). A tax of $20,000 (10% of $200,000) is
imposed on the distribution under section 72(t). Assuming that the
distribution is not a lump sum distribution eligible for special tax
treatment under section 402, part of the distribution is subject to tax
under section 4981A. If A does not elect the special grandfather rule,
A's dollar limitation is $150,000 and the amount of $200,000
distribution that is an excess distribution is $50,000 ($200,000-
$150,000). The 15 percent tax is $7,500 (15% of $50,000). The portion of
the $20,000 section 72(t) tax on early distributions that is
attributable to the excess distribution is $5,000 (10% of $50,000). This
amount is credited against the section 4981A tax. Therefore, the total
tax imposed on the distribution under both provisions is $22,500
($20,000 + ($7,500-$5,000)).
(b) Example. (1) If some, but not all, distributions made for a
calendar year are subject to the section 72(t) tax, the offset is
applied only to the extent that the section 72(t) tax applies to amounts
that exceed the applicable threshold amount for that calendar year. For
example, assume that during 1987 individual B receives a distribution of
$40,000 that is not subject to the 10 percent section 72(t) tax and a
separate distribution of $160,000 that is subject to the 10 percent
section 72(t) tax. A tax of $16,000 (10% of $160,000) is imposed by
section 72(t). Excess distributions for the year, assuming B does not
elect the special grandfather rule, are $50,000 ($40,000 + $160,000-
$150,000). The tax under section 4981A is $7,500 (15% of $50,000). For
purposes of determining the extent to which the 10 percent tax is
applied to excess distributions, the only amounts subject to the 10
percent tax that are taken into account are distributions in excess of
$150,000 (or if greater, the $112,500 (indexed) threshold for the year).
The amount of distributions for 1987 to which the 10 percent tax is
applicable ($160,000) exceeds $150,000 by $10,000. Thus, the portion of
the section 72(t) tax of $16,000 that is attributable to excess
distributions equals $1,000 (10 percent of $10,000). This amount is
credited against the section 4981A tax. The total tax payable under the
provisions of sections 72(t) and 4981A is $22,500 ($16,000 + ($7,500-
$1,000)).
(c) Net unrealized appreciation. A distribution consisting of net
unrealized appreciation of employer securities that is excluded from
gross income is not subject to section 72(t) and, therefore, there is no
section 72(t) tax on such distribution that may be used to offset the
tax on excess distributions.
c-5: Q. If a distribution that is subject to both the 10 percent tax
on early distributions from qualified plans imposed under section 72(t)
and the 15
[[Page 389]]
percent tax on excess distributions imposed under section 4981A is
received by an individual who elects to calculate the 15 percent tax
using the special grandfather rule, how is the offset of the 10 percent
tax imposed under section 72(t) calculated?
A. The section 4981A tax is reduced only by the amount of the 10
percent tax that is attributable to the portion of the distribution to
which the section 4981A tax applies. For example, assume that (a) an
individual (A), age 57, receives during 199X a distribution from a
qualified plan of $325,000 that is subject to the 10 percent section
72(t) tax; (b) the distribution is not a lump sum distribution and is
subject to the 15 percent excise tax imposed by section 4981A; (c) A has
elected to use the special grandfather rule; and (d) A accelerates the
rate of recovery of the remaining grandfather amount of $250,000 so that
only $75,000 of this distribution is subject to the section 4981A tax.
Thus, the section 4981A tax is $11,250 (15% of $75,000). The portion of
the section 72(t) 10 percent tax that is offset against the section
4981A tax of $11,250 is limited to $7,500 (10% of $75,000), the section
72(t) tax on the amount of distributions after taking into account the
reduction under the grandfather rule.
c-6: Q. When do distributions become subject to the excise tax under
section 4981A?
A. (a) General rule. Excess distributions made after December 31,
1986, are subject to the excise tax under section 4981A.
(b) Transitional rule--(1) Termination. Distributions prior to
January 1, 1988, made on account of certain terminations of a qualified
employer plan are not subject to tax under section 4981A. For a plan
termination to be eligible for this transitional rule, the plan
termination must occur before January 1, 1987. For purposes of applying
the rules of section 4981A (except the reporting requirements), any such
distribution is treated as if made on December 31, 1986. The
distribution of an annuity contract is not an excepted distribution. See
Q&A a-5 of this section.
(2) Lump sum distributions. A lump sum distribution that an
individual who separates from service in 1986 receives in calendar year
1987 before March 16 is treated as a distribution received in 1986 if
such individual elects to treat it as received in 1986 under the
provisions of section 1124 of TRA '86. Thus, such a qualifying section
1124 distribution is not subject to tax under section 4981A for 1987.
For purposes of applying the rules of section 4981A, the amount
attributable to such distribution is included in the individual's August
1, 1986 accrued benefit and such distribution is treated as if made on
December 31, 1986.
(3) Grandfather amount recovery. If an individual described in this
paragraph elects the special grandfather rule, the entire amount of
distributions described in subparagraph (1) or (2) of this paragraph (b)
is treated as a recovery of the individual's grandfather amount because
it is treated as received on December 31, 1986. Thus, the individual's
outstanding grandfather amount as of the date of the distribution is
reduced by the amount of such distribution.
c-7: Q. How is the tax on excess distributions or on excess
accumulations under section 4981A reported?
A. (a) Tax on excess distributions. An individual liable for tax on
account on excess distributions under section 4981A must complete Form
5329 and attach it to his income tax return for the taxable year
beginning with or within the calendar year during which the excess
distributions are received. The amount of the tax is reported on such
form and in such manner as prescribed by the Commissioner.
(b) Tax on excess accumulations--(1) General rule. If, with respect
to the estate of any individual, there is a tax under section 4981A(d)
on account of the individual's excess accumulations, the amount of such
tax is reported on Schedule S (Form 706 or 706NR). Schedule S must be
filed on or before the due date under section 6075 including extensions,
for filing the estate tax return. The tax under section 4981A(d) must be
paid by the otherwise applicable due date for paying the estate tax
imposed by chapter 11 even if, pursuant to section 6018(a), no return is
otherwise required with respect to the estate tax imposed by chapter 11.
[[Page 390]]
(2) Earliest due date. Notwithstanding paragraph (b)(1) of this c-7,
the due date for filing Schedule S (Form 706) and paying the tax on
excess accumulations under section 4981A(d) is not earlier than February
1, 1988. Thus, with respect to the estates of individuals dying in
January through April of 1987, the due date for filing Schedule S (Form
706) and paying any tax owed under section 4981A(d) is not earlier than
February 1, 1988, even if the due date for filing the Schedule 706 and
paying the estate tax imposed by chapter 11 is an earlier date. Further,
no interest or penalties will be charged for failure to pay any tax on
excess accumulations under section 4981A before January 31, 1988.
c-8: Q. Does the fact that the benefits under a qualified retirement
plan or individual retirement account are community property affect the
determination of the excise tax under section 4981A?
A. Generally, no. The operation of community property law is
disregarded in determining the amount of aggregate annual distributions.
Thus, the excise tax under section 4981A is computed without regard to
the spouse's community property interest in the individual's or
decedent's distributions or accumulation. Also, any reporting to the
individual by a trustee, must be done on an aggregate basis without
regard to the community property law.
d. Excess Accumulations
d-1: Q. To what extent does section 4981A increase the estate tax
imposed by chapter 11 with respect to the estates of any decedents?
A. Section 4981A(d) provides that the estate tax imposed by chapter
11 with respect to the estate of any decedent is increased by an amount
equal to 15 percent of the decedent's excess accumulation. See Q&A d-2
through d-7 of this section for rules for determining the decedent's
excess accumulation. See Q&A d-8 of this section concerning credits
under section 2010 through 2016. See Q&A d-9 of this section for
examples illustrating the determination of the increase in estate tax
under section 4981A(d).
d-2: Q. How is the amount of a decedent's excess accumulation
determined?
A. (a) General rule. A decedent's excess accumulation is the excess
of (1) the aggregate value of the decedent's interests in all qualified
employer plans and individual retirement plans (decedent's aggregate
interest) as of the date of the decedent's death over (2) an amount
equal to the present value of a hypothetical life annuity determined
under Q&A d-7 of this section. If the personal representative for the
individual's estate elects to value the property in the gross estate
under section 2032, the applicable valuation date prescribed by section
2032 shall be substituted for the decedent's date of death.
(b) Other rules. See Q&A d-3 and d-4 of this section if the decedent
or, where appropriate, the decedent's personal representative validly
elects the special grandfather rule and has any unused grandfather
benefit as of the date of his death. See Q&A d-5 and d-6 of this section
to determine the decedent's aggregate interest.
d-3: Q. Does the special grandfather rule apply for purposes of
determining the amount of the decedent's excess accumulation?
A. Yes. If a decedent prior to death (or the decedent's personal
representative after death) makes an election that satisfied the
procedures in Q&A b-3 of this section, the special grandfather rule
applies.
d-4: Q. How is the decedent's excess accumulation determined if the
special grandfather rule applies?
A. If the special grandfather rule applies, the decedent's excess
accumulation is the excess of (a) the decedent's aggregate interest
(determined under Q&A d-5 of this section) over (b) the greater of (1)
the decedent's remaining unrecovered grandfather amount as of the date
of the decedent's death, or (2) an amount equal to the present value of
a hypothetical life annuity under Q&A d-7 of this section.
d-5. Q. How is the value of the decedent's aggregate interest as of
the applicable valuation date under Q&A d-2 determined?
A. (a) Method of valuation. The value of the decedent's aggregate
interest on
[[Page 391]]
the decedent's date of death is determined in a manner consistent with
the valuation of such interests for purposes of determining the
individual's gross estate for purposes of chapter 11. If the personal
representative for an individual's estate subject to estate tax elects
to value the property in the gross estate under section 2032, the
decedent's aggregate interest is valued in a manner consistent with the
rules prescribed by section 2032 (and other relevant estate tax
sections). No adjustments provided in chapter 11 in valuing the gross
estate are made. Thus, there is no adjustment under section 2057
(relating to the sale of certain employer securities).
(b) Amounts included. Generally, all amounts payable to
beneficiaries of the decedent under any qualified employer plan
(including amounts payable to a surviving spouse under a qualified joint
and survivor annuity or qualified preretirement survivor annuity) or
individual retirement plan, whether or not otherwise included in valuing
the decedent's gross estate, are considered to be part of the decedent's
interest in such plan.
(c) Rollover after death. If any amount is distributed from a
qualified employer plan or individual retirement plan within the 60-day
period ending on the decedent's date of death and is rolled over to an
IRA after such date but within 60 days of the date distributed, the
decedent's aggregate interest is increased by the amount rolled over,
valued as of the date received by the IRA.
d-6. Q. Are there any reductions in the decedent's aggregate
interest?
A. The decedent's aggregate interest is reduced by the following:
(a) Amount payable to alternate payee. The amount of any portion of
the deceased individual's interest in a qualified employer plan that is
payable to an alternate payee in whose income the amount is includible
under a qualified domestic relations order within the meaning of section
414(p) (QDRO). However, such portion must be taken into account in
determining the excess distribution or the excess accumulation upon the
death of such alternate payee for purposes of determining if there is a
tax under section 4981A(a) or an increase in the estate tax under
section 4981A(d) with respect to such alternate payee.
(b) Investment in the contract. The amount of the deceased
individual's unrecovered investment, within the meaning of section
72(f), in any qualified employer plan or individual retirement plan.
(c) Life insurance proceeds. The excess of any amount payable by
reason of the death of the individual under a life insurance contract
held under a qualified employer plan over the cash surrender value of
such contract immediately before the death of such individual (the
amount excludible from income by reason of section 101(a)). Amounts
excludible from gross income because of section 101(b) do not reduce the
decedent's aggregate interest.
(d) Interest as a beneficiary. The amount of the deceased
individual's interest in a qualified retirement plan or individual
retirement plan by reason of the death of another individual.
d-7. Q. How is the present value of the hypothetical life annuity
determined?
A. (a) General rule. The hypothetical life annuity is a single life
annuity contract that provides for equal annual annuity payments
commencing on the decedent's date of death for the life of an individual
whose age is the same as the decedent's determined as of the date of the
decedent's death. The amount of each annual payment is equal to the
greater of $150,000 (unindexed) and $112,500 (as indexed until the date
of death). If the decedent elected (or the decedent's personal
representative elects) the special grandfather rule, the amount of each
annual payment is $112,500 (as indexed until the date of death) even if
there is no remaining grandfather amount.
(b) Determination of age. The decedent's age as of the decedent's
date of death for purposes of valuing the hypothetical life annuity is
the decedent's attained age (in whole years) as of the decedent's date
of death. For example, if the decedent was born on February 2, 1930, and
died on August 3, 1990, the decedent's age for purposes of valuing the
hypothetical life annuity is 60.
(c) Interest rate assumptions. The present value of the single life
annuity
[[Page 392]]
described above must then be calculated using the interest rate and
mortality assumptions in Sec. 20.2031-7 of the Estate Tax Regulations
in effect on the date of death.
d-8: Q. Are any credits, deductions, exclusions, etc. that apply for
estate tax purposes allowable as an offset against the excise tax under
section 4981A(d) for excess accumulations?
A. No. No credits, deductions, exclusions, etc. that apply for
estate tax purposes are allowed to offset the tax imposed under section
4981A(d). Thus, no credits under section 2010 through 2016 or other
reductions permitted by Chapter 11 are allowable against the tax under
section 4981A(d) for excess accumulations. For example, no credits are
allowable for the unified credit against the estate tax, for state death
taxes, or for gift taxes.
d-8A. Q. Is the estate liable for the excise tax of 15 percent on
the amount of the decedent's excess accumulations?
A. Yes. In all events, the estate is liable for the excise tax of 15
percent on the amount of the decedent's excess accumulations. Transferee
liability rules under chapter 11 do apply, however. Similarly, the
reimbursement provisions of section 2205 also apply. Additionally, the
rules generally applicable for purposes of determining the apportionment
of the estate tax apply to the apportionment of the excise tax under
section 4981A(d). Thus, the decedent's will or the applicable state
apportionment law may provide that the executor is entitled to recover
the tax imposed under section 4981A(d) attributable to any property from
the beneficiary entitled to receive such property. However, absent such
a provision in the decedent's will or in the applicable state
apportionment law, the executor is not entitled to recover the tax
imposed under section 4981A(d) attributable to any property from the
beneficiary entitled to receive such property.
d-9: Q. How is the additional tax computed with respect to a
decedent's estate under section 4981A(d)?
A. The determination of the additional tax under section 4981A(d) is
illustrated by the following examples:
Example 1. (a) An individual (A) dies on February 1, 199X at age 70
and 9 months. As of A's date of death, A has an interest in a defined
benefit plan described in section 401(a) (Plan X). Plan X has never
provided for employee contributions. A has no section 72 (f) investment
in Plan X. A does not have any interest in any other qualified employer
plan or individual retirement plan. The alternate valuation date in
section 2032 does not apply. A did not elect to have the special
grandfather rule apply. A's interest in Plan X is in the form of a
qualified joint and survivor annuity. The value of the remaining
payments under the joint and survivor annuity as of A's date of death
(determined under D-5) is $2,000,000.
(b) Because A is age 70 and 9 months of A's date of death, A's life
expectancy as of A's date of death is calculated using age 70 (A's
attained age in whole years on A's date of death). The factor from Table
A of Sec. 20.2031-7(f) used to determine the present value of a single
life annuity for an individual age 70 is 6.0522. The greater of $150,000
or $112,500 indexed for 199X is 150,000. The present value of the
hypothetical single life annuity is $907,830 ($150,000x6.0522)
(c) The amount of A's excess accumulation is $1,092,170, determined
as follows: $2,000,000 (value of A's interest in Plan X) minus $907,830
(value of hypothetical single life annuity contract) equals $1,092,170.
(d) The increase in the estate tax under section 4981A(d) is
$163,825 (15 percent of $1,092,170).
Example 2. (a) The facts are the same as in Example 1, except that
A's interest in Plan X consists of the following:
(1) $2,000,000, value of employer-provided portion of a qualified
joint and survivor annuity determined as of A's date of death using the
interest and mortality assumptions in Sec. 20.2031-7.
(2) $200,000, proceeds of a term life insurance contract (no cash
surrender value before death).
(3) $100,000. amount (employer-provided portion) payable to A's
former spouse pursuant to a QDRO.
(4) $100,000, amount of A's investment in Plan X.
(b) The value of A's interest in Plan X for purposes of calculating
A's excess accumulation is still $2,000,000. The proceeds of the term
life insurance contract, the amount payable under the QDRO, and the
amount of A's investment in Plan X are excluded from such value.
Example 3. (a) The facts are the same as in Example 1, except that A
elected the special grandfather rule. A's initial grandfather amount was
$1,100,000. As of A's date of death, A had received $500,000 in
distributions that were treated as a return of A's grandfather amount.
Thus, A's unused grandfather amount is $600,000 ($1,100,000-$500,000).
[[Page 393]]
In 199X, assume that $112,500 indexed is still $112,500.
(b) A's excess retirement accumulation is determined as follows:
$2,000,000 minus the greater of (1) $600,000 or (2) the present value of
a period certain annuity of $112,500 a year for 16 years. The present
value of a single life annuity of $112,500 a year for an individual age
70 is determined as follows: $112,500 x 6.0522=$680,827.25. $680,827.25
is greater than $600,000. Thus the amount of the excess retirement
accumulation is $1,319,173 ($2,000,000 minus $680,827).
(c) The additional estate tax under section 4981A(d) is $197,875 (15
percent of $1,319,173).
Example 4. (a) The facts are the same as in Example 3 except that,
as of A's date of death, A received $90,000 in distributions that were
treated as a return of A's grandfather amount. Thus, A's unused
grandfather amount is $1,010,000 ($1,100,000-$90,000).
(b) A's excess retirement accumulation is determined as follows:
$2,000,000 minus the greater of (1) ($1,010,000 (A's unused grandfather
amount) or (2) 680,827.25 (the present value of a single life annuity of
$112,500 a year for an individual age 70). A's unused grandfather amount
is greater than the present value of the hypothetical life annuity.
Thus, the amount of the excess retirement accumulation is $990,000
($2,000,000-$1,010,000).
(c) The additional estate tax under section 4981A(d) is $148,500 (15
percent of $990,000).
d-10: Q. if a surviving spouse rolls over a distribution from a
qualified retirement plan or an individual retirement plan of the
decedent to an individual retirement plan (IRA) established in the
spouse's own name, is any distribution in a calendar year from the IRA
receiving such rollover included in determining the spouse's excess
distribution or excess accumulation in such calendar year?
A. (a) General rule. If a surviving spouse rolls over a distribution
from a qualified retirement plan or an individual retirement plan of the
decedent to an individual retirement plan (IRA) established in the
spouse's own name with the rollover contribution and no other
contributions or transfers are made to the IRA receiving the rollover
contribution, distributions from such IRA will be excluded in
determining the spouse's excess distributions and the value of the IRA
will be excluded in determining the spouse's excess accumulation. If the
surviving spouse rolls over a distribution from a qualified retirement
plan or IRA of the decedent to an IRA for which the spouse has prior
contributions or makes additional contributions to the IRA receiving the
distribution, distributions from the IRA will be included in determining
the amount of the excess distributions received by the spouse for the
calendar year of the distribution and the value of the IRA at the
applicable valuation date will be included in determining the spouse's
excess accumulation.
(b) Special rules. The rule in paragraph (a) of this Q&A d-10 also
applies if a surviving spouse elects to treat an inherited IRA
(described in section 408(d)(3)(C)(ii)) as the spouse's own IRA as long
as the surviving spouse makes no further contributions to such IRA.
(c) Other beneficiaries. Rules similar to the rules in paragraphs
(a) and (b) shall apply to an individual who elected to treat an IRA as
subject to the distribution requirements of section 408(a)(6), prior to
amendment by section 521(b) of TRA '84, under Sec. 1.408-2(b)(7)(ii) of
the Income Tax Regulations.
d-11. Q. To what estates does the excise tax under section 4981A(d)
apply?
A. The excise tax under section 4981A(d) applies to estates of
decedents dying after December 31, 1986.
d-12: Q. Is the aggregate interest reduced by distributions
described in paragraph (b)(1) of Q&A c-6 of this section (distributions
prior to January 1, 1988, made on account of certain terminations of a
qualified employer plan) which are made after the individual's death.
A. Yes, the value of the individual's aggregate interest determined
under Q&A d-5 of this section is reduced by distributions described in
paragraph (b)(1) of Q&A c-6 of this section which are made after the
individual's death.
[T.D. 8165, 52 FR 46750, Dec. 10, 1987; 53 FR 18975, May 26, 1988]
Sec. 54.6011-1 General requirement of return, statement, or list.
(a) Minimum funding standards or excess contributions for self-
employed individuals and section 403(b)(7)(A) custodial accounts. Any
employer or individual liable for tax under section 4971, 4972 or
4973(a)(2) (for a custodial account under section 403(b)(7)(A)) shall
file an annual return on Form 5330 and shall include
[[Page 394]]
therein the information required by such form and the instructions
issued with respect thereto.
(b) Tax on prohibited transactions. Every disqualified person (as
defined in section 4975(e)(2)) liable for the tax imposed under section
4975(a) with respect to a prohibited transaction shall file an annual
return on Form 5330 and shall include therein the information required
by such form and the instructions issued with respect thereto. The
annual return on Form 5330 shall be filed with respect to each
prohibited transaction and for each taxable year (or part thereof) of
the disqualified person in the taxable period (as defined in section
4975(f)(2)) beginning on the date on which such prohibited transaction
occurs.
(c) Entity manager tax on prohibited tax shelter transactions--(1)
In general. Any entity manager of a tax-exempt entity described in
section 4965(c)(4), (c)(5), (c)(6), or (c)(7) who is liable for tax
under section 4965(a)(2) shall file a return on Form 5330, ``Return of
Excise Taxes Related to Employee Benefit Plans,'' on or before the 15th
day of the fifth month following the close of such entity manager's
taxable year during which the entity entered into the prohibited tax
shelter transaction, and shall include therein the information required
by such form and the instructions issued with respect thereto.
(2) Transition rule. A Form 5330, ``Return of Excise Taxes Related
to Employee Benefit Plans,'' for an excise tax under section 4965 that
was due on or before October 4, 2007, will be deemed to have been filed
on the due date if it was filed by October 4, 2007, and if the section
4965 tax that was required to be reported on that Form 5330 was paid by
October 4, 2007.
(d) Effective/applicability date. Paragraph (c) of this section is
applicable on July 6, 2007.
[T.D. 7838, 47 FR 44249, Oct. 7, 1982, as amended by T.D. 9334, 72 FR
36873, July 6, 2007; T.D. 9492, 75 FR 38708, July 6, 2010; 75 FR 46845,
Aug. 4, 2010]
Sec. 54.6011-1T General requirement of return, statement, or list (temporary).
(a) Tax on reversions of qualified plan assets to employer. Every
employer liable for the tax imposed under section 4980(a) with respect
to an employer reversion (as defined in section 4980(c)(2)) shall file a
quarterly return on Form 5330 and shall include therein the information
required by such form and the instructions issued with respect thereto.
The quarterly return on Form 5330 shall be filed with respect to
employer reversions from each qualified plan (as defined in section
4980(c)(1)).
(b) [Reserved]
[T.D. 8133, 52 FR 10563, Apr. 2, 1987 as amended by T.D. 9334, 72 FR
36873, July 6, 2007; 72 FR 45895, Aug. 16, 2007; T.D. 9492, 75 FR 38709,
July 6, 2010]
Sec. 54.6011-2 General requirement of return, statement, or list.
Effective for any Form 8928 that is due on or after January 1, 2010,
any person liable for tax under section 4980B, 4980D, 4980E, or 4980G of
the Code shall file a return with respect to the tax on Form 8928. The
return must include the information required by Form 8928 and the
instructions issued with respect to it.
[T.D. 9457, 74 FR 45999, Sept. 8, 2009]
Sec. 54.6011-4 Requirement of statement disclosing participation in certain
transactions by taxpayers.
(a) In general. If a transaction is identified as a listed
transaction or a transaction of interest as defined in Sec. 1.6011-4 of
this chapter by the Commissioner in published guidance (see Sec.
601.601(d)(2)(ii)(b) of this chapter), and the listed transaction or
transaction of interest involves an excise tax under chapter 43 of
subtitle D of the Internal Revenue Code (relating to qualified pension,
etc., plans) the transaction must be disclosed in the manner stated in
such published guidance.
(b) Effective/applicability date. This section applies to listed
transactions entered into on or after January 1, 2003. This section
applies to transactions of interest entered into on or after November 2,
2006.
[T.D. 9350, 72 FR 43154, Aug. 3, 2007]
Sec. 54.6060-1 Reporting requirements for tax return preparers.
(a) In general. A person that employs one or more tax return
preparers to
[[Page 395]]
prepare a return or claim for refund under Chapter 43 of subtitle D of
the Internal Revenue Code, other than for the person, at any time during
a return period, shall satisfy the record keeping and inspection
requirements in the manner stated in Sec. 1.6060-1 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed after December 31, 2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
Sec. 54.6061-1 Signing of returns and other documents.
Effective for any Form 8928 that is due on or after January 1, 2010,
any return, statement, or other document required to be made with
respect to a tax imposed by section 4980B, 4980D, 4980E, or 4980G of the
Code or the regulations under section 4980B, 4980D, 4980E, or 4980G must
be signed by the person required to file the return, statement, or other
document, or by the persons required or duly authorized to sign in
accordance with the regulations, forms, or instructions prescribed with
respect to such return, statement, or document. An individual's
signature on such return, statement, or other document shall be prima
facie evidence that the individual is authorized to sign the return,
statement, or other document.
[T.D. 9457, 74 FR 46000, Sept. 8, 2009]
Sec. 54.6071-1 Time for filing returns.
(a) Returns under section 4980B. (1) Due date for filing of return
by employers or other persons responsible for benefits under a group
health plan. If the person liable for the excise tax is an employer or
other person responsible for providing or administering benefits under a
group health plan (such as an insurer or a third party administrator),
the return required by Sec. 54.6011-2 must be filed on or before the
due date for filing the person's income tax return and must reflect the
portion of the noncompliance period for each failure under section 4980B
that falls during the person's taxable year. An extension to file the
person's income tax return does not extend the date for filing Form
8928.
(2) Due date for filing of return by multiemployer plans. If the
person liable for the excise tax is a multiemployer plan, the return
required by Sec. 54.6011-2 must be filed on or before the last day of
the seventh month following the end of the plan's plan year. The filing
of Form 8928 by a plan must reflect the portion of the noncompliance
period for each failure under section 4980B that falls during the plan's
plan year.
(b) Returns under section 4980D. (1) Due date for filing of return
by employers. If the person liable for the excise tax is an employer,
the return required by Sec. 54.6011-2 must be filed on or before the
due date for filing the employer's income tax return and must reflect
the portion of the noncompliance period for each failure under chapter
100 that falls during the employer's taxable year. An extension to file
the employer's income tax return does not extend the date for filing
Form 8928.
(2) Due date for filing of return by multiemployer plans or multiple
employer health plans. If the person liable for the excise tax is a
multiemployer plan or a specified multiple employer health plan, the
return required by Sec. 54.6011-2 must be filed on or before the last
day of the seventh month following the end of the plan's plan year. The
filing of Form 8928 by a plan must reflect the portion of the
noncompliance period for each failure under chapter 100 that falls
during the plan's plan year.
(c) Returns under section 4980E. Any employer who is liable for the
excise tax under section 4980E must report this tax by filing the return
required by Sec. 54.6011-2 on or before the 15th day of the fourth
month following the calendar year in which the noncomparable
contributions were made.
(d) Returns under section 4980G. Any employer who is liable for the
excise tax under section 4980E must report this tax by filing the return
required by Sec. 54.6011-2 on or before the 15th day of the fourth
month following the calendar year in which the noncomparable
contributions were made. See Q & A-4 of Sec. 54.4980G-1 for the rules
on computation of the excise tax under section 4980G.
(e) Effective/applicability date: The rules in this section are
effective for
[[Page 396]]
any Form 8928 that is due on or after January 1, 2010.
[T.D. 9457, 74 FR 46000, Sept. 8, 2009]
Sec. 54.6091-1 Place for filing excise tax returns under section 4980B, 4980D, 4980E, or 4980G.
Effective for any Form 8928 that is due on or after January 1, 2010,
the return required by Sec. 54.6011-2 must be filed at the place
specified in the forms and instructions provided by the Internal Revenue
Service.
[T.D. 9457, 74 FR 46000, Sept. 8, 2009]
Sec. 54.6107-1 Tax return preparer must furnish copy of return or
claims for refund to taxpayer and must retain a copy or record.
(a) In general. A person who is a signing tax return preparer of any
return or claim for refund of tax under Chapter 43 of subtitle D of the
Internal Revenue Code, shall furnish a completed copy of the return or
claim for refund to the taxpayer, and retain a completed copy or record
in the manner stated in Sec. 1.6107-1 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed after December 31, 2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
Sec. 54.6109-1 Tax return preparers furnishing identifying numbers for returns or
claims for refund filed.
(a) In general. Each tax return or claim for refund of tax under
Chapter 43 of subtitle D prepared by one or more signing tax return
preparers must include the identifying number of the preparer required
by Sec. 1.6695-1(b) of this chapter to sign the return or claim for
refund in the manner stated in Sec. 1.6109-2 of this chapter.
(b) Effective/applicability date. Paragraph (a) of this section is
applicable to returns and claims for refund filed after December 31,
2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
Sec. 54.6151-1 Time and place for paying of tax shown on returns.
Effective for any Form 8928 that is due on or after January 1, 2010,
the tax shown on any return which is imposed under section 4980B, 4980D,
4980E or 4980G shall, without assessment or notice and demand, be paid
to the internal revenue officer with whom the return is filed at the
time and place for filing such return (determined without regard to any
extension of time for filing the return). For provisions relating to the
time and place for filing such return, see Sec. Sec. 54.6071-1 and
54.6091-1.
[T.D. 9457, 74 FR 46000, Sept. 8, 2009]
Sec. 54.6694-1 Section 6694 penalties applicable to tax return preparer.
(a) In general. For general definitions regarding section 6694
penalties applicable to preparers of tax returns or claims for refund of
tax under Chapter 43 of subtitle D, see Sec. 1.6694-1 of this chapter.
(b) Effective/applicability date. Paragraph (a) of this section is
applicable to returns and claims for refund filed, and advice provided,
after December 31, 2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
Sec. 54.6694-2 Penalties for understatement due to an unreasonable position.
(a) In general. A person who is a tax return preparer of any return
or claim for refund of tax under Chapter 43 of subtitle D of the
Internal Revenue Code (Code) shall be subject to penalties under section
6694(a) of the Code in the manner stated in Sec. 1.6694-2 of this
chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed, and advice provided, after December
31, 2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
Sec. 54.6694-3 Penalty for understatement due to willful, reckless, or intentional conduct.
(a) In general. A person who is a tax return preparer of any return
or claim for refund of excise tax under chapter 43 of subtitle D of the
Internal Revenue Code (Code) shall be subject to penalties under section
6694(b) of the Code in the manner stated in Sec. 1.6694-3 of this
chapter.
(b) Effective/applicability date. This section is applicable to
returns and
[[Page 397]]
claims for refund filed, and advice provided, after December 31, 2008.
[T.D. 9436, 73 FR 78458, Dec. 22, 2008]
Sec. 54.6694-4 Extension of period of collection when tax return preparer pays 15 percent
of a penalty for understatement of taxpayer's liability and certain
other procedural matters.
(a) In general. For rules relating to the extension of period of
collection when a tax return preparer who prepared a return or claim for
refund for tax under chapter 43 of subtitle D of the Internal Revenue
Code pays 15 percent of a penalty for understatement of taxpayer's
liability, and procedural matters relating to the investigation,
assessment and collection of the penalties under section 6694(a) and
(b), the rules under Sec. 1.6694-4 of this chapter will apply.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed, and advice provided, after December
31, 2008.
[T.D. 9436, 73 FR 78459, Dec. 22, 2008]
Sec. 54.6695-1 Other assessable penalties with respect to the preparation of tax
returns for other persons.
(a) In general. A person who is a tax return preparer of any return
or claim for refund of tax under chapter 43 of subtitle D of the
Internal Revenue Code (Code) shall be subject to penalties for failure
to furnish a copy to the taxpayer under section 6695(a) of the Code,
failure to sign the return under section 6695(b) of the Code, failure to
furnish an identification number under section 6695(c) of the Code,
failure to retain a copy or list under section 6695(d) of the Code,
failure to file a correct information return under section 6695(e) of
the Code, and negotiation of a check under section 6695(f) of the Code,
in the manner stated in Sec. 1.6695-1 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed after December 31, 2008.
[T.D. 9436, 73 FR 78459, Dec. 22, 2008]
Sec. 54.6696-1 Claims for credit or refund by tax return preparers.
(a) In general. For rules for claims for credit or refund by a tax
return preparer who prepared a return or claim for refund for excise tax
under chapter 43 of subtitle D of the Internal Revenue Code, the rules
under Sec. 1.6696-1 of this chapter will apply.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed, and advice provided, after December
31, 2008.
[T.D. 9436, 73 FR 78459, Dec. 22, 2008]
Sec. 54.7701-1 Tax return preparer.
(a) In general. For the definition of a tax return preparer, see
Sec. 301.7701-15 of this chapter.
(b) Effective/applicability date. This section is applicable to
returns and claims for refund filed, and advice provided, after December
31, 2008.
[T.D. 9436, 73 FR 78459, Dec. 22, 2008]
Sec. 54.9801-1 Basis and scope.
(a) Statutory basis. This section and sections 54.9801-2 through
54.9801-6, 54.9802-1, 54.9802-2, 54.9802-3T, 54.9811-1, 54.9812-1T,
54.9831-1, and 54.9833-1 (portability sections) implement Chapter 100 of
Subtitle K of the Internal Revenue Code of 1986.
(b) Scope. A group health plan may provide greater rights to
participants and beneficiaries than those set forth in these portability
sections. These portability sections set forth minimum requirements for
group health plans concerning:
(1) Limitations on a preexisting condition exclusion period.
(2) Certificates and disclosure of previous coverage.
(3) Rules relating to creditable coverage.
(4) Special enrollment periods.
(5) Prohibition against discrimination on the basis of health
factors.
(6) Additional requirements prohibiting discrimination based on
genetic information.
(c) Similar requirements under the Employee Retirement Income
Security Act and the Public Health Service Act. Sections 701, 702, 703,
711, 712, 732, and 733 of the Employee Retirement Income Security Act of
1974 and sections 2701,
[[Page 398]]
2702, 2704, 2705, 2721, and 2791 of the Public Health Service Act impose
requirements similar to those imposed under Chapter 100 of Subtitle K
with respect to health insurance issuers offering group health insurance
coverage. See 29 CFR part 2590 and 45 CFR parts 144, 146, and 148. See
also part B of Title XXVII of the Public Health Service Act and 45 CFR
part 148 for other rules applicable to health insurance offered in the
individual market (defined in Sec. 54.9801-2).
[T.D. 9166, 69 FR 78746, Dec. 30, 2004, as amended by T.D. 9299, 71 FR
75056, Dec. 13, 2006; T.D. 9427, 73 FR 62419, Oct. 20, 2008; T.D. 9464,
74 FR 51678, Oct. 7, 2009]
Sec. 54.9801-2 Definitions.
Unless otherwise provided, the definitions in this section govern in
applying the provisions of Sec. 54.9801-1, this section, Sec. Sec.
54.9801-3 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9802-3T, 54.9811-
1, 54.9812-1T, 54.9831-1, and 54.9833-1.
Affiliation period means a period of time that must expire before
health insurance coverage provided by an HMO becomes effective, and
during which the HMO is not required to provide benefits.
COBRA definitions:
(1) COBRA means Title X of the Consolidated Omnibus Budget
Reconciliation Act of 1985, as amended.
(2) COBRA continuation coverage means coverage, under a group health
plan, that satisfies an applicable COBRA continuation provision.
(3) COBRA continuation provision means section 4980B (other than
paragraph (f)(1) of section 4980B insofar as it relates to pediatric
vaccines), sections 601-608 of ERISA, or Title XXII of the PHS Act.
(4) Exhaustion of COBRA continuation coverage means that an
individual's COBRA continuation coverage ceases for any reason other
than either failure of the individual to pay premiums on a timely basis,
or for cause (such as making a fraudulent claim or an intentional
misrepresentation of a material fact in connection with the plan). An
individual is considered to have exhausted COBRA continuation coverage
if such coverage ceases--
(i) Due to the failure of the employer or other responsible entity
to remit premiums on a timely basis;
(ii) When the individual no longer resides, lives, or works in the
service area of an HMO or similar program (whether or not within the
choice of the individual) and there is no other COBRA continuation
coverage available to the individual; or
(iii) When the individual incurs a claim that would meet or exceed a
lifetime limit on all benefits and there is no other COBRA continuation
coverage available to the individual.
Condition means a medical condition.
Creditable coverage means creditable coverage within the meaning of
Sec. 54.9801-4(a).
Dependent means any individual who is or may become eligible for
coverage under the terms of a group health plan because of a
relationship to a participant.
Employee Retirement Income Security Act of 1974 (ERISA) means the
Employee Retirement Income Security Act of 1974, as amended (29 U.S.C.
1001 et seq.).
Enroll means to become covered for benefits under a group health
plan (that is, when coverage becomes effective), without regard to when
the individual may have completed or filed any forms that are required
in order to become covered under the plan. For this purpose, an
individual who has health coverage under a group health plan is enrolled
in the plan regardless of whether the individual elects coverage, the
individual is a dependent who becomes covered as a result of an election
by a participant, or the individual becomes covered without an election.
Enrollment date definitions (enrollment date, first day of coverage,
and waiting period) are set forth in Sec. 54.9801-3(a)(3)(i), (ii), and
(iii).
Excepted benefits means the benefits described as excepted in Sec.
54.9831(c).
Genetic information has the meaning given the term in Sec. 54.9802-
3T(a)(3).
Group health insurance coverage means health insurance coverage
offered in connection with a group health plan.
Group health plan or plan means a group health plan within the
meaning of Sec. 54.9831-1(a).
[[Page 399]]
Group market means the market for health insurance coverage offered
in connection with a group health plan. (However, certain very small
plans may be treated as being in the individual market, rather than the
group market; see the definition of individual market in this section.)
Health insurance coverage means benefits consisting of medical care
(provided directly, through insurance or reimbursement, or otherwise)
under any hospital or medical service policy or certificate, hospital or
medical service plan contract, or HMO contract offered by a health
insurance issuer. Health insurance coverage includes group health
insurance coverage, individual health insurance coverage, and short-
term, limited-duration insurance. However, benefits described in Sec.
54.9831(c)(2) are not treated as benefits consisting of medical care.
Health insurance issuer or issuer means an insurance company,
insurance service, or insurance organization (including an HMO) that is
required to be licensed to engage in the business of insurance in a
State and that is subject to State law that regulates insurance (within
the meaning of section 514(b)(2) of ERISA). Such term does not include a
group health plan.
Health maintenance organization or HMO means--
(1) A federally qualified health maintenance organization (as
defined in section 1301(a) of the PHS Act);
(2) An organization recognized under State law as a health
maintenance organization; or
(3) A similar organization regulated under State law for solvency in
the same manner and to the same extent as such a health maintenance
organization.
Individual health insurance coverage means health insurance coverage
offered to individuals in the individual market, but does not include
short-term, limited-duration insurance. Individual health insurance
coverage can include dependent coverage.
Individual market means the market for health insurance coverage
offered to individuals other than in connection with a group health
plan. Unless a State elects otherwise in accordance with section
2791(e)(1)(B)(ii) of the PHS Act, such term also includes coverage
offered in connection with a group health plan that has fewer than two
participants who are current employees on the first day of the plan
year.
Issuer means a health insurance issuer.
Late enrollment definitions (late enrollee and late enrollment) are
set forth in Sec. 54.9801-3(a)(3)(v) and (vi) .
Medical care has the meaning given such term by section 213(d),
determined without regard to section 213(d)(1)(C) and so much of section
213(d)(1)(D) as relates to qualified long-term care insurance.
Medical condition or condition means any condition, whether physical
or mental, including, but not limited to, any condition resulting from
illness, injury (whether or not the injury is accidental), pregnancy, or
congenital malformation. However, genetic information is not a
condition.
Participant means participant within the meaning of section 3(7) of
ERISA.
Placement, or being placed, for adoption means the assumption and
retention of a legal obligation for total or partial support of a child
by a person with whom the child has been placed in anticipation of the
child's adoption. The child's placement for adoption with such person
ends upon the termination of such legal obligation.
Plan year means the year that is designated as the plan year in the
plan document of a group health plan, except that if the plan document
does not designate a plan year or if there is no plan document, the plan
year is--
(1) The deductible or limit year used under the plan;
(2) If the plan does not impose deductibles or limits on a yearly
basis, then the plan year is the policy year;
(3) If the plan does not impose deductibles or limits on a yearly
basis, and either the plan is not insured or the insurance policy is not
renewed on an annual basis, then the plan year is the employer's taxable
year; or
(4) In any other case, the plan year is the calendar year.
Preexisting condition exclusion means a limitation or exclusion of
benefits (including a denial of coverage) based on the fact that the
condition was present before the effective date of coverage (or if
coverage is denied, the date of the
[[Page 400]]
denial) under a group health plan or group or individual health
insurance coverage (or other coverage provided to federally eligible
individuals pursuant to 45 CFR part 148), whether or not any medical
advice, diagnosis, care, or treatment was recommended or received before
that day. A preexisting condition exclusion includes any limitation or
exclusion of benefits (including a denial of coverage) applicable to an
individual as a result of information relating to an individual's health
status before the individual's effective date of coverage (or if
coverage is denied, the date of the denial) under a group health plan,
or group or individual health insurance coverage (or other coverage
provided to Federally eligible individuals pursuant to 45 CFR part 148),
such as a condition identified as a result of a pre-enrollment
questionnaire or physical examination given to the individual, or review
of medical records relating to the pre-enrollment period.
Public health plan means public health plan within the meaning of
Sec. 54.9801-4(a)(1)(ix).
Public Health Service Act (PHS Act) means the Public Health Service
Act (42 U.S.C. 201, et seq.).
Short-term, limited-duration insurance means health insurance
coverage provided pursuant to a contract with an issuer that has an
expiration date specified in the contract (taking into account any
extensions that may be elected by the policyholder without the issuer's
consent) that is less than 12 months after the original effective date
of the contract.
Significant break in coverage means a significant break in coverage
within the meaning of Sec. 54.9801-4(b)(2)(iii).
Special enrollment means enrollment in a group health plan under the
rights described in Sec. 54.9801-6 or in group health insurance
coverage under the rights described in 29 CFR 2590.701-6 or 45 CFR
146.117.
State health benefits risk pool means a State health benefits risk
pool within the meaning of Sec. 54.9801-4(a)(1)(vii).
Waiting period means waiting period within the meaning of Sec.
54.9801-3(a)(3)(iii).
[T.D. 9166, 69 FR 78746, Dec. 30, 2004, as amended by T.D. 9299, 71 FR
75056, Dec. 13, 2006; T.D. 9427, 73 FR 62420, Oct. 20, 2008; T.D. 9464,
74 FR 51678, Oct. 7, 2009; T.D. 9491, 75 FR 37222, June 28, 2010]
Sec. 54.9801-3 Limitations on preexisting condition exclusion period.
(a) Preexisting condition exclusion--(1) Defined--(i) A preexisting
condition exclusion means a preexisting condition exclusion within the
meaning set forth in Sec. 54.9801-2.
(ii) Examples. The rules of this paragraph (a)(1) are illustrated by
the following examples:
Example 1. (i) Facts. A group health plan provides benefits solely
through an insurance policy offered by Issuer S. At the expiration of
the policy, the plan switches coverage to a policy offered by Issuer T.
Issuer T's policy excludes benefits for any prosthesis if the body part
was lost before the effective date of coverage under the policy.
(ii) Conclusion. In this Example 1, the exclusion of benefits for
any prosthesis if the body part was lost before the effective date of
coverage is a preexisting condition exclusion because it operates to
exclude benefits for a condition based on the fact that the condition
was present before the effective date of coverage under the policy.
(Therefore, the exclusion of benefits is required to comply with the
limitations on preexisting condition exclusions in this section. For an
example illustrating the application of these limitations to a
succeeding insurance policy, see Example 3 of paragraph (a)(3)(iv) of
this section.)
Example 2. (i) Facts. A group health plan provides coverage for
cosmetic surgery in cases of accidental injury, but only if the injury
occurred while the individual was covered under the plan.
(ii) Conclusion. In this Example 2, the plan provision excluding
cosmetic surgery benefits for individuals injured before enrolling in
the plan is a preexisting condition exclusion because it operates to
exclude benefits relating to a condition based on the fact that the
condition was present before the effective date of coverage. The plan
provision, therefore, is subject to the limitations on preexisting
condition exclusions in this section.
Example 3. (i) Facts. A group health plan provides coverage for the
treatment of diabetes, generally not subject to any lifetime dollar
limit. However, if an individual was diagnosed with diabetes before the
effective date of coverage under the plan, diabetes
[[Page 401]]
coverage is subject to a lifetime limit of $10,000.
(ii) Conclusion. In this Example 3, the $10,000 lifetime limit is a
preexisting condition exclusion because it limits benefits for a
condition based on the fact that the condition was present before the
effective date of coverage. The plan provision, therefore, is subject to
the limitations on preexisting condition exclusions in this section.
Example 4. (i) Facts. A group health plan provides coverage for the
treatment of acne, subject to a lifetime limit of $2,000. The plan
counts against this $2,000 lifetime limit on acne treatment benefits
provided under prior health coverage.
(ii) Conclusion. In this Example 4, counting benefits for a specific
condition provided under prior health coverage against a lifetime limit
for that condition is a preexisting condition exclusion because it
operates to limit benefits for a condition based on the fact that the
condition was present before the effective date of coverage. The plan
provision, therefore, is subject to the limitations on preexisting
condition exclusions in this section.
Example 5. (i) Facts. When an individual's coverage begins under a
group health plan, the individual generally becomes eligible for all
benefits. However, benefits for pregnancy are not available until the
individual has been covered under the plan for 12 months.
(ii) Conclusion. In this Example 5, the requirement to be covered
under the plan for 12 months to be eligible for pregnancy benefits is a
subterfuge for a preexisting condition exclusion because it is designed
to exclude benefits for a condition (pregnancy) that arose before the
effective date of coverage. Because a plan is prohibited under paragraph
(b)(5) of this section from imposing any preexisting condition exclusion
on pregnancy, the plan provision is prohibited. However, if the plan
provision included an exception for women who were pregnant before the
effective date of coverage under the plan (so that the provision applied
only to women who became pregnant on or after the effective date of
coverage) the plan provision would not be a preexisting condition
exclusion (and would not be prohibited by paragraph (b)(5) of this
section).
Example 6. (i) Facts. A group health plan provides coverage for
medically necessary items and services, generally including treatment of
heart conditions. However, the plan does not cover those same items and
services when used for treatment of congenital heart conditions.
(ii) Conclusion. In this Example 6, the exclusion of coverage for
treatment of congenital heart conditions is a preexisting condition
exclusion because it operates to exclude benefits relating to a
condition based on the fact that the condition was present before the
effective date of coverage. The plan provision, therefore, is subject to
the limitations on preexisting condition exclusions in this section.
Example 7. (i) Facts. A group health plan generally provides
coverage for medically necessary items and services. However, the plan
excludes coverage for the treatment of cleft palate.
(ii) Conclusion. In this Example 7, the exclusion of coverage for
treatment of cleft palate is not a preexisting condition exclusion
because the exclusion applies regardless of when the condition arose
relative to the effective date of coverage. The plan provision,
therefore, is not subject to the limitations on preexisting condition
exclusions in this section.
Example 8. (i) Facts. A group health plan provides coverage for
treatment of cleft palate, but only if the individual being treated has
been continuously covered under the plan from the date of birth.
(ii) Conclusion. In this Example 8, the exclusion of coverage for
treatment of cleft palate for individuals who have not been covered
under the plan from the date of birth operates to exclude benefits in
relation to a condition based on the fact that the condition was present
before the effective date of coverage. The plan provision, therefore, is
subject to the limitations on preexisting condition exclusions in this
section.
(2) General rules. Subject to paragraph (b) of this section
(prohibiting the imposition of a preexisting condition exclusion with
respect to certain individuals and conditions), a group health plan may
impose, with respect to a participant or beneficiary, a preexisting
condition exclusion only if the requirements of this paragraph (a)(2)
are satisfied. (See section 701 of ERISA and section 2701 of the PHS
Act, under which these requirements are also imposed on a health
insurance issuer offering group health insurance coverage.)
(i) 6-month look-back rule. A preexisting condition exclusion must
relate to a condition (whether physical or mental), regardless of the
cause of the condition, for which medical advice, diagnosis, care, or
treatment was recommended or received within the 6-month period (or such
shorter period as applies under the plan) ending on the enrollment date.
(A) For purposes of this paragraph (a)(2)(i), medical advice,
diagnosis, care, or treatment is taken into account only if it is
recommended by, or received from, an individual licensed or
[[Page 402]]
similarly authorized to provide such services under State law and
operating within the scope of practice authorized by State law.
(B) For purposes of this paragraph (a)(2)(i), the 6-month period
ending on the enrollment date begins on the 6-month anniversary date
preceding the enrollment date. For example, for an enrollment date of
August 1, 1998, the 6-month period preceding the enrollment date is the
period commencing on February 1, 1998 and continuing through July 31,
1998. As another example, for an enrollment date of August 30, 1998, the
6-month period preceding the enrollment date is the period commencing on
February 28, 1998 and continuing through August 29, 1998.
(C) The rules of this paragraph (a)(2)(i) are illustrated by the
following examples:
Example 1. (i) Facts. Individual A is diagnosed with a medical
condition 8 months before A's enrollment date in Employer R's group
health plan. A's doctor recommends that A take a prescription drug for 3
months, and A follows the recommendation.
(ii) Conclusion. In this Example 1, Employer R's plan may impose a
preexisting condition exclusion with respect to A's condition because A
received treatment during the 6-month period ending on A's enrollment
date in Employer R's plan by taking the prescription medication during
that period. However, if A did not take the prescription drug during the
6-month period, Employer R's plan would not be able to impose a
preexisting condition exclusion with respect to that condition.
Example 2. (i) Facts. Individual B is treated for a medical
condition 7 months before the enrollment date in Employer S's group
health plan. As part of such treatment, B's physician recommends that a
follow-up examination be given 2 months later. Despite this
recommendation, B does not receive a follow-up examination, and no other
medical advice, diagnosis, care, or treatment for that condition is
recommended to B or received by B during the 6-month period ending on
B's enrollment date in Employer S's plan.
(ii) Conclusion. In this Example 2, Employer S's plan may not impose
a preexisting condition exclusion with respect to the condition for
which B received treatment 7 months prior to the enrollment date.
Example 3. (i) Facts. Same facts as Example 2, except that Employer
S's plan learns of the condition and attaches a rider to B's certificate
of coverage excluding coverage for the condition. Three months after
enrollment, B's condition recurs, and Employer S's plan denies payment
under the rider.
(ii) Conclusion. In this Example 3, the rider is a preexisting
condition exclusion and Employer S's plan may not impose a preexisting
condition exclusion with respect to the condition for which B received
treatment 7 months prior to the enrollment date. (In addition, such a
rider would violate the provisions of Sec. 54.9802-1, even if B had
received treatment for the condition within the 6-month period ending on
the enrollment date.)
Example 4. (i) Facts. Individual C has asthma and is treated for
that condition several times during the 6-month period before C's
enrollment date in Employer T's plan. Three months after the enrollment
date, C begins coverage under Employer T's plan. Two months later, C is
hospitalized for asthma.
(ii) Conclusion. In this Example 4, Employer T's plan may impose a
preexisting condition exclusion with respect to C's asthma because care
relating to C's asthma was received during the 6-month period ending on
C's enrollment date (which, under the rules of paragraph (a)(3)(i) of
this section, is the first day of the waiting period).
Example 5. (i) Facts. Individual D, who is subject to a preexisting
condition exclusion imposed by Employer U's plan, has diabetes, as well
as retinal degeneration, a foot condition, and poor circulation (all of
which are conditions that may be directly attributed to diabetes). D
receives treatment for these conditions during the 6-month period ending
on D's enrollment date in Employer U's plan. After enrolling in the
plan, D stumbles and breaks a leg.
(ii) Conclusion. In this Example 5, the leg fracture is not a
condition related to D's diabetes, retinal degeneration, foot condition,
or poor circulation, even though they may have contributed to the
accident. Therefore, benefits to treat the leg fracture cannot be
subject to a preexisting condition exclusion. However, any additional
medical services that may be needed because of D's preexisting diabetes,
poor circulation, or retinal degeneration that would not be needed by
another patient with a broken leg who does not have these conditions may
be subject to the preexisting condition exclusion imposed under Employer
U's plan.
(ii) Maximum length of preexisting condition exclusion. A
preexisting condition exclusion is not permitted to extend for more than
12 months (18 months in the case of a late enrollee) after the
enrollment date. For example, for an enrollment date of August 1, 1998,
the 12-month period after the enrollment date is the period commencing
on August 1, 1998 and continuing through July 31,
[[Page 403]]
1999; the 18-month period after the enrollment date is the period
commencing on August 1, 1998 and continuing through January 31, 2000.
(iii) Reducing a preexisting condition exclusion period by
creditable coverage--(A) The period of any preexisting condition
exclusion that would otherwise apply to an individual under a group
health plan is reduced by the number of days of creditable coverage the
individual has as of the enrollment date, as counted under Sec.
54.9801-4. Creditable coverage may be evidenced through a certificate of
creditable coverage (required under Sec. 54.9801-5(a)), or through
other means in accordance with the rules of Sec. 54.9801-5(c).
(B) The rules of this paragraph (a)(2)(iii) are illustrated by the
following example:
Example. (i) Facts. Individual D works for Employer X and has been
covered continuously under X's group health plan. D's spouse works for
Employer Y. Y maintains a group health plan that imposes a 12-month
preexisting condition exclusion (reduced by creditable coverage) on all
new enrollees. D enrolls in Y's plan, but also stays covered under X's
plan. D presents Y's plan with evidence of creditable coverage under X's
plan.
(ii) Conclusion. In this Example, Y's plan must reduce the
preexisting condition exclusion period that applies to D by the number
of days of coverage that D had under X's plan as of D's enrollment date
in Y's plan (even though D's coverage under X's plan was continuing as
of that date).
(iv) Other standards. See Sec. 54.9802-1 for other standards that
may apply with respect to certain benefit limitations or restrictions
under a group health plan. Other laws may also apply, such as the
Uniformed Services Employment and Reemployment Rights Act (USERRA),
which can affect the application of a preexisting condition exclusion to
certain individuals who are reinstated in a group health plan following
active military service.
(3) Enrollment definitions--(i) Enrollment date means the first day
of coverage (as described in paragraph (a)(3)(ii) of this section) or,
if there is a waiting period, the first day of the waiting period. If an
individual receiving benefits under a group health plan changes benefit
packages, or if the plan changes group health insurance issuers, the
individual's enrollment date does not change.
(ii) First day of coverage means, in the case of an individual
covered for benefits under a group health plan, the first day of
coverage under the plan and, in the case of an individual covered by
health insurance coverage in the individual market, the first day of
coverage under the policy or contract.
(iii) Waiting period means the period that must pass before coverage
for an employee or dependent who is otherwise eligible to enroll under
the terms of a group health plan can become effective. If an employee or
dependent enrolls as a late enrollee or special enrollee, any period
before such late or special enrollment is not a waiting period. If an
individual seeks coverage in the individual market, a waiting period
begins on the date the individual submits a substantially complete
application for coverage and ends on--
(A) If the application results in coverage, the date coverage
begins;
(B) If the application does not result in coverage, the date on
which the application is denied by the issuer or the date on which the
offer of coverage lapses.
(iv) The rules of paragraphs (a)(3)(i), (ii), and (iii) of this
section are illustrated by the following examples:
Example 1. (i) Facts. Employer V's group health plan provides for
coverage to begin on the first day of the first payroll period following
the date an employee is hired and completes the applicable enrollment
forms, or on any subsequent January 1 after completion of the applicable
enrollment forms. Employer V's plan imposes a preexisting condition
exclusion for 12 months (reduced by the individual's creditable
coverage) following an individual's enrollment date. Employee E is hired
by Employer V on October 13, 1998, and on October 14, 1998 E completes
and files all the forms necessary to enroll in the plan. E's coverage
under the plan becomes effective on October 25, 1998 (which is the
beginning of the first payroll period after E's date of hire).
(ii) Conclusion. In this Example 1, E's enrollment date is October
13, 1998 (which is the first day of the waiting period for E's
enrollment and is also E's date of hire). Accordingly, with respect to
E, the permissible 6-month period in paragraph (a)(2)(i) is the period
from April 13, 1998 through October 12, 1998, the maximum permissible
period during which Employer V's plan can apply a preexisting condition
exclusion under paragraph
[[Page 404]]
(a)(2)(ii) is the period from October 13, 1998 through October 12, 1999,
and this period must be reduced under paragraph (a)(2)(iii) by E's days
of creditable coverage as of October 13, 1998.
Example 2. (i) Facts. A group health plan has two benefit package
options, Option 1 and Option 2. Under each option a 12-month preexisting
condition exclusion is imposed. Individual B is enrolled in Option 1 on
the first day of employment with the employer maintaining the plan,
remains enrolled in Option 1 for more than one year, and then decides to
switch to Option 2 at open season.
(ii) Conclusion. In this Example 2, B cannot be subject to any
preexisting condition exclusion under Option 2 because any preexisting
condition exclusion period would have to begin on B's enrollment date,
which is B's first day of coverage, rather than the date that B enrolled
in Option 2. Therefore, the preexisting condition exclusion period
expired before B switched to Option 2.
Example 3. (i) Facts. On May 13, 1997, Individual E is hired by an
employer and enrolls in the employer's group health plan. The plan
provides benefits solely through an insurance policy offered by Issuer
S. On December 27, 1998, E's leg is injured in an accident and the leg
is amputated. On January 1, 1999, the plan switches coverage to a policy
offered by Issuer T. Issuer T's policy excludes benefits for any
prosthesis if the body part was lost before the effective date of
coverage under the policy.
(ii) Conclusion. In this Example 3, E's enrollment date is May 13,
1997, E's first day of coverage. Therefore, the permissible 6-month
look-back period for the preexisting condition exclusion imposed under
Issuer T's policy begins on November 13, 1996 and ends on May 12, 1997.
In addition, the 12-month maximum permissible preexisting condition
exclusion period begins on May 13, 1997 and ends on May 12, 1998.
Accordingly, because no medical advice, diagnosis, care, or treatment
was recommended to or received by E for the leg during the 6-month look-
back period (even though medical care was provided within the 6-month
period preceding the effective date of E's coverage under Issuer T's
policy), the plan may not impose any preexisting condition exclusion
with respect to E. Moreover, even if E had received treatment during the
6-month look-back period, the plan still would not be permitted to
impose a preexisting condition exclusion because the 12-month maximum
permissible preexisting condition exclusion period expired on May 12,
1998 (before the effective date of E's coverage under Issuer T's
policy). See 29 CFR 2590.701-3(a)(3)(iv) Example 3 and 45 CFR
146.111(a)(3)(iv) Example 3 for a conclusion that Issuer T is similarly
prohibited from imposing a preexisting condition exclusion with respect
to E.
Example 4. (i) Facts. A group health plan limits eligibility for
coverage to full-time employees of Employer Y. Coverage becomes
effective on the first day of the month following the date the employee
becomes eligible. Employee C begins working full-time for Employer Y on
April 11. Prior to this date, C worked part-time for Y. C enrolls in the
plan and coverage is effective May 1.
(ii) Conclusion. In this Example 4, C's enrollment date is April 11
and the period from April 11 through April 30 is a waiting period. The
period while C was working part-time, and therefore not in an eligible
class of employees, is not part of the waiting period.
Example 5. (i) Facts. To be eligible for coverage under a
multiemployer group health plan in the current calendar quarter, the
plan requires an individual to have worked 250 hours in covered
employment during the previous quarter. If the hours requirement is
satisfied, coverage becomes effective on the first day of the current
calendar quarter. Employee D begins work on January 28 and does not work
250 hours in covered employment during the first quarter (ending March
31). D works at least 250 hours in the second quarter (ending June 30)
and is enrolled in the plan with coverage effective July 1 (the first
day of the third quarter).
(ii) Conclusion. In this Example 5, D's enrollment date is the first
day of the quarter during which D satisfies the hours requirement, which
is April 1. The period from April 1 through June 30 is a waiting period.
(v) Late enrollee means an individual whose enrollment in a plan is
a late enrollment.
(vi) (A) Late enrollment means enrollment of an individual under a
group health plan other than--
(1) On the earliest date on which coverage can become effective for
the individual under the terms of the plan; or
(2) Through special enrollment. (For rules relating to special
enrollment, see Sec. 54.9801-6.)
(B) If an individual ceases to be eligible for coverage under the
plan, and then subsequently becomes eligible for coverage under the
plan, only the individual's most recent period of eligibility is taken
into account in determining whether the individual is a late enrollee
under the plan with respect to the most recent period of coverage.
Similar rules apply if an individual again becomes eligible for coverage
following a suspension of coverage that applied generally under the
plan.
(vii) Examples. The rules of paragraphs (a)(3)(v) and (vi) of this
section
[[Page 405]]
are illustrated by the following examples:
Example 1. (i) Facts. Employee F first becomes eligible to be
covered by Employer W's group health plan on January 1, 1999 but elects
not to enroll in the plan until a later annual open enrollment period,
with coverage effective January 1, 2001. F has no special enrollment
right at that time.
(ii) Conclusion. In this Example 1, F is a late enrollee with
respect to F's coverage that became effective under the plan on January
1, 2001.
Example 2. (i) Facts. Same facts as Example 1, except that F
terminates employment with Employer W on July 1, 1999 without having had
any health insurance coverage under the plan. F is rehired by Employer W
on January 1, 2000 and is eligible for and elects coverage under
Employer W's plan effective on January 1, 2000.
(ii) Conclusion. In this Example 2, F would not be a late enrollee
with respect to F's coverage that became effective on January 1, 2000.
(b) Exceptions pertaining to preexisting condition exclusions--(1)
Newborns--(i) In general. Subject to paragraph (b)(3) of this section, a
group health plan may not impose any preexisting condition exclusion on
a child who, within 30 days after birth, is covered under any creditable
coverage. Accordingly, if a child is enrolled in a group health plan (or
other creditable coverage) within 30 days after birth and subsequently
enrolls in another group health plan without a significant break in
coverage (as described in Sec. 54.9801-4(b)(2)(iii)), the other plan
may not impose any preexisting condition exclusion on the child.
(ii) Examples. The rules of this paragraph (b)(1) are illustrated by
the following examples:
Example 1. (i) Facts. Individual E, who has no prior creditable
coverage, begins working for Employer W and has accumulated 210 days of
creditable coverage under Employer W's group health plan on the date E
gives birth to a child. Within 30 days after the birth, the child is
enrolled in the plan. Ninety days after the birth, both E and the child
terminate coverage under the plan. Both E and the child then experience
a break in coverage of 45 days before E is hired by Employer X and the
two are enrolled in Employer X's group health plan.
(ii) Conclusion. In this Example 1, because E's child is enrolled in
Employer W's plan within 30 days after birth, no preexisting condition
exclusion may be imposed with respect to the child under Employer W's
plan. Likewise, Employer X's plan may not impose any preexisting
condition exclusion on E's child because the child was covered under
creditable coverage within 30 days after birth and had no significant
break in coverage before enrolling in Employer X's plan. On the other
hand, because E had only 300 days of creditable coverage prior to E's
enrollment date in Employer X's plan, Employer X's plan may impose a
preexisting condition exclusion on E for up to 65 days (66 days if the
12-month period after E's enrollment date in X's plan includes February
29).
Example 2. (i) Facts. Individual F is enrolled in a group health
plan in which coverage is provided through a health insurance issuer. F
gives birth. Under State law applicable to the health insurance issuer,
health care expenses incurred for the child during the 30 days following
birth are covered as part of F's coverage. Although F may obtain
coverage for the child beyond 30 days by timely requesting special
enrollment and paying an additional premium, the issuer is prohibited
under State law from recouping the cost of any expenses incurred for the
child within the 30-day period if the child is not later enrolled.
(ii) Conclusion. In this Example 2, the child is covered under
creditable coverage within 30 days after birth, regardless of whether
the child enrolls as a special enrollee under the plan. Therefore, no
preexisting condition exclusion may be imposed on the child unless the
child has a significant break in coverage.
(2) Adopted children. Subject to paragraph (b)(3) of this section, a
group health plan may not impose any preexisting condition exclusion on
a child who is adopted or placed for adoption before attaining 18 years
of age and who, within 30 days after the adoption or placement for
adoption, is covered under any creditable coverage. Accordingly, if a
child is enrolled in a group health plan (or other creditable coverage)
within 30 days after adoption or placement for adoption and subsequently
enrolls in another group health plan without a significant break in
coverage (as described in Sec. 54.9801-4(b)(2)(iii)), the other plan
may not impose any preexisting condition exclusion on the child. This
rule does not apply to coverage before the date of such adoption or
placement for adoption.
(3) Significant break in coverage. Paragraphs (b)(1) and (2) of this
section no longer apply to a child after a significant break in
coverage. (See Sec. 54.9801-
[[Page 406]]
4(b)(2)(iii) for rules relating to the determination of a significant
break in coverage.)
(4) Special enrollment. For special enrollment rules relating to new
dependents, see Sec. 54.9801-6(b).
(5) Pregnancy. A group health plan may not impose a preexisting
condition exclusion relating to pregnancy.
(6) Genetic information--(i) A group health plan may not impose a
preexisting condition exclusion relating to a condition based solely on
genetic information. However, if an individual is diagnosed with a
condition, even if the condition relates to genetic information, the
plan may impose a preexisting condition exclusion with respect to the
condition, subject to the other limitations of this section.
(ii) The rules of this paragraph (b)(6) are illustrated by the
following example:
Example. (i) Facts. Individual A enrolls in a group health plan that
imposes a 12-month maximum preexisting condition exclusion. Three months
before A's enrollment, A's doctor told A that, based on genetic
information, A has a predisposition towards breast cancer. A was not
diagnosed with breast cancer at any time prior to A's enrollment date in
the plan. Nine months after A's enrollment date in the plan, A is
diagnosed with breast cancer.
(ii) Conclusion. In this Example, the plan may not impose a
preexisting condition exclusion with respect to A's breast cancer
because, prior to A's enrollment date, A was not diagnosed with breast
cancer.
(c) General notice of preexisting condition exclusion. A group
health plan imposing a preexisting condition exclusion must provide a
written general notice of preexisting condition exclusion to
participants under the plan and cannot impose a preexisting condition
exclusion with respect to a participant or a dependent of the
participant until such a notice is provided. (See 29 CFR 2590.701-3(c)
and 45 CFR 146.111(c), which also impose this requirement on a health
insurance issuer offering group health insurance coverage subject to a
preexisting condition exclusion.)
(1) Manner and timing. A plan must provide the general notice of
preexisting condition exclusion as part of any written application
materials distributed by the plan for enrollment. If the plan does not
distribute such materials, the notice must be provided by the earliest
date following a request for enrollment that the plan, acting in a
reasonable and prompt fashion, can provide the notice.
(2) Content. The general notice of preexisting condition exclusion
must notify participants of the following:
(i) The existence and terms of any preexisting condition exclusion
under the plan. This description includes the length of the plan's look-
back period (which is not to exceed 6 months under paragraph (a)(2)(i)
of this section); the maximum preexisting condition exclusion period
under the plan (which cannot exceed 12 months (or 18 months for late
enrollees) under paragraph (a)(2)(ii) of this section); and how the plan
will reduce the maximum preexisting condition exclusion period by
creditable coverage (described in paragraph (a)(2)(iii) of this
section).
(ii) A description of the rights of individuals to demonstrate
creditable coverage, and any applicable waiting periods, through a
certificate of creditable coverage (as required by Sec. 54.9801-5(a))
or through other means (as described in Sec. 54.9801-5(c)). This must
include a description of the right of the individual to request a
certificate from a prior plan or issuer, if necessary, and a statement
that the current plan will assist in obtaining a certificate from any
prior plan or issuer, if necessary.
(iii) A person to contact (including an address or telephone number)
for obtaining additional information or assistance regarding the
preexisting condition exclusion.
(3) Duplicate notices not required. If a notice satisfying the
requirements of this paragraph (c) is provided to an individual by
another party, the plan's obligation to provide a general notice of
preexisting condition exclusion with respect to that individual is
satisfied. (See 29 CFR 2590.701-3(c)(3) and 45 CFR 146.111(c)(3), which
provide that the issuer's obligation is similarly satisfied.)
(4) Example with sample language. The rules of this paragraph (c)
are illustrated by the following example, which includes sample language
that plans can use as a basis for preparing their
[[Page 407]]
own notices to satisfy the requirements of this paragraph (c):
Example. (i) Facts. A group health plan makes coverage effective on
the first day of the first calendar month after hire and on each January
1 following an open season. The plan imposes a 12-month maximum
preexisting condition exclusion (18 months for late enrollees) and uses
a 6-month look-back period. As part of the enrollment application
materials, the plan provides the following statement:
This plan imposes a preexisting condition exclusion. This means that
if you have a medical condition before coming to our plan, you might
have to wait a certain period of time before the plan will provide
coverage for that condition. This exclusion applies only to conditions
for which medical advice, diagnosis, care, or treatment was recommended
or received within a six-month period. Generally, this six-month period
ends the day before your coverage becomes effective. However, if you
were in a waiting period for coverage, the six-month period ends on the
day before the waiting period begins. The preexisting condition
exclusion does not apply to pregnancy nor to a child who is enrolled in
the plan within 30 days after birth, adoption, or placement for
adoption.
This exclusion may last up to 12 months (18 months if you are a late
enrollee) from your first day of coverage, or, if you were in a waiting
period, from the first day of your waiting period. However, you can
reduce the length of this exclusion period by the number of days of your
prior ``creditable coverage.'' Most prior health coverage is creditable
coverage and can be used to reduce the preexisting condition exclusion
if you have not experienced a break in coverage of at least 63 days. To
reduce the 12-month (or 18-month) exclusion period by your creditable
coverage, you should give us a copy of any certificates of creditable
coverage you have. If you do not have a certificate, but you do have
prior health coverage, we will help you obtain one from your prior plan
or issuer. There are also other ways that you can show you have
creditable coverage. Please contact us if you need help demonstrating
creditable coverage.
All questions about the preexisting condition exclusion and
creditable coverage should be directed to Individual B at Address M or
Telephone Number N.
(ii) Conclusion. In this Example, the plan satisfies the general
notice requirement of this paragraph (c).
(d) Determination of creditable coverage--(1) Determination within
reasonable time. If a group health plan receives creditable coverage
information under Sec. 54.9801-5, the plan is required, within a
reasonable time following receipt of the information, to make a
determination regarding the amount of the individual's creditable
coverage and the length of any exclusion that remains. Whether this
determination is made within a reasonable time depends on the relevant
facts and circumstances. Relevant facts and circumstances include
whether a plan's application of a preexisting condition exclusion would
prevent an individual from having access to urgent medical care. (See 29
CFR 2590.701-3(d) and 45 CFR 146.111(d), which also impose this
requirement on a health insurance issuer offering group health insurance
coverage.)
(2) No time limit on presenting evidence of creditable coverage. A
plan may not impose any limit on the amount of time that an individual
has to present a certificate or other evidence of creditable coverage.
(3) Example. The rules of this paragraph (d) are illustrated by the
following example:
Example. (i) Facts. A group health plan imposes a preexisting
condition exclusion period of 12 months. After receiving the general
notice of preexisting condition exclusion, Individual H develops an
urgent health condition before receiving a certificate of creditable
coverage from H's prior group health plan. H attests to the period of
prior coverage, presents corroborating documentation of the coverage
period, and authorizes the plan to request a certificate on H's behalf
in accordance with the rules of Sec. 54.9801-5.
(ii) Conclusion. In this Example, the plan must review the evidence
presented by H and make a determination of creditable coverage within a
reasonable time that is consistent with the urgency of H's health
condition. (This determination may be modified as permitted under
paragraph (f) of this section.)
(e) Individual notice of period of preexisting condition exclusion.
After an individual has presented evidence of creditable coverage and
after the plan has made a determination of creditable coverage under
paragraph (d) of this section, the plan must provide the individual a
written notice of the length of preexisting condition exclusion that
remains after offsetting for prior creditable coverage. This individual
notice is not required to identify any medical conditions specific to
the individual that could be subject to the exclusion.
[[Page 408]]
A plan is not required to provide this notice if the plan does not
impose any preexisting condition exclusion on the individual or if the
plan's preexisting condition exclusion is completely offset by the
individual's prior creditable coverage. (See 29 CFR 2590.701-3(e) and 45
CFR 146.111(e), which also impose this requirement on a health insurance
issuer offering group health insurance coverage.)
(1) Manner and timing. The individual notice must be provided by the
earliest date following a determination that the plan, acting in a
reasonable and prompt fashion, can provide the notice.
(2) Content. A plan must disclose--
(i) Its determination of any preexisting condition exclusion period
that applies to the individual (including the last day on which the
preexisting condition exclusion applies);
(ii) The basis for such determination, including the source and
substance of any information on which the plan relied;
(iii) An explanation of the individual's right to submit additional
evidence of creditable coverage; and
(iv) A description of any applicable appeal procedures established
by the plan.
(3) Duplicate notices not required. If a notice satisfying the
requirements of this paragraph (e) is provided to an individual by
another party, the plan's obligation to provide this individual notice
of preexisting condition exclusion with respect to that individual is
satisfied. (See 29 CFR 2590.701-3(e)(3) and 45 CFR 146.111(e)(3), which
provide that the issuer's obligation is similarly satisfied.)
(4) Examples. The rules of this paragraph (e) are illustrated by the
following examples:
Example 1. (i) Facts. A group health plan imposes a preexisting
condition exclusion period of 12 months. After receiving the general
notice of preexisting condition exclusion, Individual G presents a
certificate of creditable coverage indicating 240 days of creditable
coverage. Within seven days of receipt of the certificate, the plan
determines that G is subject to a preexisting condition exclusion of 125
days, the last day of which is March 5. Five days later, the plan
notifies G that, based on the certificate G submitted, G is subject to a
preexisting condition exclusion period of 125 days, ending on March 5.
The notice also explains the opportunity to submit additional evidence
of creditable coverage and the plan's appeal procedures. The notice does
not identify any of G's medical conditions that could be subject to the
exclusion.
(ii) Conclusion. In this Example 1, the plan satisfies the
requirements of this paragraph (e).
Example 2. (i) Facts. Same facts as in Example 1, except that the
plan determines that G has 430 days of creditable coverage based on G's
certificate indicating 430 days of creditable coverage under G's prior
plan.
(ii) Conclusion. In this Example 2, the plan is not required to
notify G that G will not be subject to a preexisting condition
exclusion.
(f) Reconsideration. Nothing in this section prevents a plan from
modifying an initial determination of creditable coverage if it
determines that the individual did not have the claimed creditable
coverage, provided that--
(1) A notice of the new determination (consistent with the
requirements of paragraph (e) of this section) is provided to the
individual; and
(2) Until the notice of the new determination is provided, the plan,
for purposes of approving access to medical services (such as a pre-
surgery authorization), acts in a manner consistent with the initial
determination.
[T.D. 9166, 69 FR 78746, Dec. 30, 2004, as amended by T.D. 9491, 75 FR
37223, June 28, 2010]
Sec. 54.9801-4 Rules relating to creditable coverage.
(a) General rules--(1) Creditable coverage. For purposes of this
section, except as provided in paragraph (a)(2) of this section, the
term creditable coverage means coverage of an individual under any of
the following:
(i) A group health plan as defined in Sec. 54.9831-1(a).
(ii) Health insurance coverage as defined in Sec. 54.9801-2
(whether or not the entity offering the coverage is subject to Chapter
100 of Subtitle K, and without regard to whether the coverage is offered
in the group market, the individual market, or otherwise).
(iii) Part A or B of Title XVIII of the Social Security Act
(Medicare).
(iv) Title XIX of the Social Security Act (Medicaid), other than
coverage consisting solely of benefits under section 1928 of the Social
Security Act
[[Page 409]]
(the program for distribution of pediatric vaccines).
(v) Title 10 U.S.C. Chapter 55 (medical and dental care for members
and certain former members of the uniformed services, and for their
dependents; for purposes of Title 10 U.S.C. Chapter 55, uniformed
services means the armed forces and the Commissioned Corps of the
National Oceanic and Atmospheric Administration and of the Public Health
Service).
(vi) A medical care program of the Indian Health Service or of a
tribal organization.
(vii) A State health benefits risk pool. For purposes of this
section, a State health benefits risk pool means--
(A) An organization qualifying under section 501(c)(26);
(B) A qualified high risk pool described in section 2744(c)(2) of
the PHS Act; or
(C) Any other arrangement sponsored by a State, the membership
composition of which is specified by the State and which is established
and maintained primarily to provide health coverage for individuals who
are residents of such State and who, by reason of the existence or
history of a medical condition--
(1) Are unable to acquire medical care coverage for such condition
through insurance or from an HMO, or
(2) Are able to acquire such coverage only at a rate which is
substantially in excess of the rate for such coverage through the
membership organization.
(viii) A health plan offered under Title 5 U.S.C. Chapter 89 (the
Federal Employees Health Benefits Program).
(ix) A public health plan. For purposes of this section, a public
health plan means any plan established or maintained by a State, the
U.S. government, a foreign country, or any political subdivision of a
State, the U.S. government, or a foreign country that provides health
coverage to individuals who are enrolled in the plan.
(x) A health benefit plan under section 5(e) of the Peace Corps Act
(22 U.S.C. 2504(e)).
(xi) Title XXI of the Social Security Act (State Children's Health
Insurance Program).
(2) Excluded coverage. Creditable coverage does not include coverage
of solely excepted benefits (described in Sec. 54.9831-1).
(3) Methods of counting creditable coverage. For purposes of
reducing any preexisting condition exclusion period, as provided under
Sec. 54.9801-3(a)(2)(iii), the amount of an individual's creditable
coverage generally is determined by using the standard method described
in paragraph (b) of this section. A plan may use the alternative method
under paragraph (c) of this section with respect to any or all of the
categories of benefits described under paragraph (c)(3) of this section
or may provide that a health insurance issuer offering health insurance
coverage under the plan may use the alternative method of counting
creditable coverage.
(b) Standard method--(1) Specific benefits not considered. Under the
standard method, the amount of creditable coverage is determined without
regard to the specific benefits included in the coverage.
(2) Counting creditable coverage--(i) Based on days. For purposes of
reducing the preexisting condition exclusion period that applies to an
individual, the amount of creditable coverage is determined by counting
all the days on which the individual has one or more types of creditable
coverage. Accordingly, if on a particular day an individual has
creditable coverage from more than one source, all the creditable
coverage on that day is counted as one day. Any days in a waiting period
for coverage are not creditable coverage.
(ii) Days not counted before significant break in coverage. Days of
creditable coverage that occur before a significant break in coverage
are not required to be counted.
(iii) Significant break in coverage defined--A significant break in
coverage means a period of 63 consecutive days during each of which an
individual does not have any creditable coverage. (See section
731(b)(2)(iii) of ERISA and section 2723(b)(2)(iii) of the PHS Act,
which exclude from preemption State insurance laws that require a break
of more than 63 days before an individual has a significant break in
coverage for purposes of State law.)
(iv) Periods that toll a significant break. Days in a waiting period
and
[[Page 410]]
days in an affiliation period are not taken into account in determining
whether a significant break in coverage has occurred. In addition, for
an individual who elects COBRA continuation coverage during the second
election period provided under the Trade Act of 2002, the days between
the date the individual lost group health plan coverage and the first
day of the second COBRA election period are not taken into account in
determining whether a significant break in coverage has occurred.
(v) Examples. The rules of this paragraph (b)(2) are illustrated by
the following examples:
Example 1. (i) Facts. Individual A has creditable coverage under
Employer P's plan for 18 months before coverage ceases. A is provided a
certificate of creditable coverage on A's last day of coverage. Sixty-
four days after the last date of coverage under P's plan, A is hired by
Employer Q and enrolls in Q's group health plan. Q's plan has a 12-month
preexisting condition exclusion.
(ii) Conclusion. In this Example 1, A has a break in coverage of 63
days. Because A's break in coverage is a significant break in coverage,
Q's plan may disregard A's prior coverage and A may be subject to a 12-
month preexisting condition exclusion.
Example 2. (i) Facts. Same facts as Example 1, except that A is
hired by Q and enrolls in Q's plan on the 63rd day after the last date
of coverage under P's plan.
(ii) Conclusion. In this Example 2, A has a break in coverage of 62
days. Because A's break in coverage is not a significant break in
coverage, Q's plan must count A's prior creditable coverage for purposes
of reducing the plan's preexisting condition exclusion period that
applies to A.
Example 3. (i) Facts. Same facts as Example 1, except that Q's plan
provides benefits through an insurance policy that, as required by
applicable State insurance laws, defines a significant break in coverage
as 90 days.
(ii) Conclusion. In this Example 3, under State law, the issuer that
provides group health insurance coverage to Q's plan must count A's
period of creditable coverage prior to the 63-day break. (However, if
Q's plan was a self-insured plan, the coverage would not be subject to
State law. Therefore, the health coverage would not be governed by the
longer break rules and A's previous health coverage could be
disregarded.)
Example 4. [Reserved]
Example 5. (i) Facts. Individual C has creditable coverage under
Employer S's plan for 200 days before coverage ceases. C is provided a
certificate of creditable coverage on C's last day of coverage. C then
does not have any creditable coverage for 51 days before being hired by
Employer T. T's plan has a 3-month waiting period. C works for T for 2
months and then terminates employment. Eleven days after terminating
employment with T, C begins working for Employer U. U's plan has no
waiting period, but has a 6-month preexisting condition exclusion.
(ii) Conclusion. In this Example 5, C does not have a significant
break in coverage because, after disregarding the waiting period under
T's plan, C had only a 62-day break in coverage (51 days plus 11 days).
Accordingly, C has 200 days of creditable coverage, and U's plan may not
apply its 6-month preexisting condition exclusion with respect to C.
Example 6. [Reserved]
Example 7. (i) Facts. Individual E has creditable coverage under
Employer X's plan. E is provided a certificate of creditable coverage on
E's last day of coverage. On the 63rd day without coverage, E submits a
substantially complete application for a health insurance policy in the
individual market. E's application is accepted and coverage is made
effective 10 days later.
(ii) Conclusion. In this Example 7, because E applied for the policy
before the end of the 63rd day, the period between the date of
application and the first day of coverage is a waiting period and no
significant break in coverage occurred even though the actual period
without coverage was 73 days.
Example 8. (i) Facts. Same facts as Example 7, except that E's
application for a policy in the individual market is denied.
(ii) Conclusion. In this Example 8, even though E did not obtain
coverage following application, the period between the date of
application and the date the coverage was denied is a waiting period.
However, to avoid a significant break in coverage, no later than the day
after the application for the policy is denied E would need to do one of
the following: submit a substantially complete application for a
different individual market policy; obtain coverage in the group market;
or be in a waiting period for coverage in the group market.
(vi) Other permissible counting methods--(a) Rule. Notwithstanding
any other provisions of this paragraph (b)(2), for purposes of reducing
a preexisting condition exclusion period (but not for purposes of
issuing a certificate under Sec. 54.9801-5), a group health plan may
determine the amount of creditable coverage in any other manner that is
at least as favorable to the individual as the method set forth in this
paragraph (b)(2), subject to the requirements of other applicable law.
[[Page 411]]
(B) Example. The rule of this paragraph (b)(2)(vi) is illustrated by
the following example:
Example. (i) Facts. Individual F has coverage under Group Health
Plan Y from January 3, 1997 through March 25, 1997. F then becomes
covered by Group Health Plan Z. F's enrollment date in Plan Z is May 1,
1997. Plan Z has a 12-month preexisting condition exclusion.
(ii) Conclusion. In this Example, Plan Z may determine, in
accordance with the rules prescribed in paragraphs (b)(2)(i), (ii), and
(iii) of this section, that F has 82 days of creditable coverage (29
days in January, 28 days in February, and 25 days in March). Thus, the
preexisting condition exclusion will no longer apply to F on February 8,
1998 (82 days before the 12-month anniversary of F's enrollment (May
1)). For administrative convenience, however, Plan Z may consider that
the preexisting condition exclusion will no longer apply to F on the
first day of the month (February 1).
(c) Alternative method--(1) Specific benefits considered. Under the
alternative method, a group health plan determines the amount of
creditable coverage based on coverage within any category of benefits
described in paragraph (c)(3) of this section and not based on coverage
for any other benefits. The plan may use the alternative method for any
or all of the categories. The plan may apply a different preexisting
condition exclusion period with respect to each category (and may apply
a different preexisting condition exclusion period for benefits that are
not within any category). The creditable coverage determined for a
category of benefits applies only for purposes of reducing the
preexisting condition exclusion period with respect to that category. An
individual's creditable coverage for benefits that are not within any
category for which the alternative method is being used is determined
under the standard method of paragraph (b) of this section.
(2) Uniform application. A plan using the alternative method is
required to apply it uniformly to all participants and beneficiaries
under the plan. A plan that provides benefits (in part or in whole)
through one or more policies or contracts of insurance will not fail the
uniform application requirement of this paragraph (c)(2) if the
alternative method is used (or not used) separately with respect to
participants and beneficiaries under any policy or contact, provided
that the alternative method is applied uniformly with respect to all
coverage under that policy or contract. The use of the alternative
method is required to be set forth in the plan.
(3) Categories of benefits. The alternative method for counting
creditable coverage may be used for coverage for the following
categories of benefits--
(i) Mental health;
(ii) Substance abuse treatment;
(iii) Prescription drugs;
(iv) Dental care; or
(v) Vision care.
(4) Plan notice. If the alternative method is used, the plan is
required to--
(i) State prominently that the plan is using the alternative method
of counting creditable coverage in disclosure statements concerning the
plan, and state this to each enrollee at the time of enrollment under
the plan; and
(ii) Include in these statements a description of the effect of
using the alternative method, including an identification of the
categories used.
(5) Disclosure of information on previous benefits. See Sec.
54.9801-5(b) for special rules concerning disclosure of coverage to a
plan (or issuer) using the alternative method of counting creditable
coverage under this paragraph (c).
(6) Counting creditable coverage--(i) In general. Under the
alternative method, the group health plan counts creditable coverage
within a category if any level of benefits is provided within the
category. Coverage under a reimbursement account or arrangement, such as
a flexible spending arrangement (as defined in section 106(c)(2)), does
not constitute coverage within any category.
(ii) Special rules. In counting an individual's creditable coverage
under the alternative method, the group health plan first determines the
amount of the individual's creditable coverage that may be counted under
paragraph (b) of this section, up to a total of 365 days of the most
recent creditable coverage (546 days for a late enrollee). The period
over which this creditable coverage is determined is referred to as the
determination period. Then, for the category specified under the
alternative method, the plan counts within
[[Page 412]]
the category all days of coverage that occurred during the determination
period (whether or not a significant break in coverage for that category
occurs), and reduces the individual's preexisting condition exclusion
period for that category by that number of days. The plan may determine
the amount of creditable coverage in any other reasonable manner,
uniformly applied, that is at least as favorable to the individual.
(iii) Example. The rules of this paragraph (c)(6) are illustrated by
the following example:
Example. (i) Facts. Individual D enrolls in Employer V's plan on
January 1, 2001. Coverage under the plan includes prescription drug
benefits. On April 1, 2001, the plan ceases providing prescription drug
benefits. D's employment with Employer V ends on January 1, 2002, after
D was covered under Employer V's group health plan for 365 days. D
enrolls in Employer Y's plan on February 1, 2002 (D's enrollment date).
Employer Y's plan uses the alternative method of counting creditable
coverage and imposes a 12-month preexisting condition exclusion on
prescription drug benefits.
(ii) Conclusion. In this Example, Employer Y's plan may impose a
275-day preexisting condition exclusion with respect to D for
prescription drug benefits because D had 90 days of creditable coverage
relating to prescription drug benefits within D's determination period.
[T.D. 9166, 69 FR 78746, Dec. 30, 2004]
Sec. 54.9801-5 Evidence of creditable coverage.
(a) Certificate of creditable coverage--(1) Entities required to
provide certificate--(i) In general. A group health plan is required to
furnish certificates of creditable coverage in accordance with this
paragraph (a). (See section 701(e) of ERISA and section 2701(e) of the
PHS Act, under which this obligation is also imposed on each health
insurance issuer offering group health insurance coverage under the
plan.)
(ii) Duplicate certificates not required. An entity required to
provide a certificate under this paragraph (a) with respect to an
individual satisfies that requirement if another party provides the
certificate, but only to the extent that the certificate contains the
information required in paragraph (a)(3) of this section. For example, a
group health plan is deemed to have satisfied the certification
requirement with respect to a participant or beneficiary if any other
entity actually provides a certificate that includes the information
required under paragraph (a)(3) of this section with respect to the
participant or beneficiary.
(iii) Special rule for group health plans. To the extent coverage
under a plan consists of group health insurance coverage, the plan
satisfies the certification requirements under this paragraph (a) if any
issuer offering the coverage is required to provide the certificates
pursuant to an agreement between the plan and the issuer. For example,
if there is an agreement between an issuer and an employer sponsoring a
plan under which the issuer agrees to provide certificates for
individuals covered under the plan, and the issuer fails to provide a
certificate to an individual when the plan would have been required to
provide one under this paragraph (a), then the plan does not violate the
certification requirements of this paragraph (a) (though the issuer
would have violated the certification requirements pursuant to section
701(e) of ERISA and section 2701(e) of the PHS Act).
(iv) Special rules relating to issuers providing coverage under a
plan--(A)(1) Responsibility of issuer for coverage period. See 29 CFR
2590.701-5 and 45 CFR 146.115, under which an issuer is not required to
provide information regarding coverage provided to an individual by
another party.
(2) Example. The rule referenced by this paragraph (a)(1)(iv)(A) is
illustrated by the following example:
Example. (i) Facts. A plan offers coverage with an HMO option from
one issuer and an indemnity option from a different issuer. The HMO has
not entered into an agreement with the plan to provide certificates as
permitted under paragraph (a)(1)(iii) of this section.
(ii) Conclusion. In this Example, if an employee switches from the
indemnity option to the HMO option and later ceases to be covered under
the plan, any certificate provided by the HMO is not required to provide
information regarding the employee's coverage under the indemnity
option.
(B)(1) Cessation of issuer coverage prior to cessation of coverage
under a plan. If an individual's coverage under an
[[Page 413]]
issuer's policy or contract ceases before the individual's coverage
under the plan ceases, the issuer is required (under section 701(e) of
ERISA and section 2701(e) of the PHS Act) to provide sufficient
information to the plan (or to another party designated by the plan) to
enable the plan (or other party), after cessation of the individual's
coverage under the plan, to provide a certificate that reflects the
period of coverage under the policy or contract. By providing that
information to the plan, the issuer satisfies its obligation to provide
an automatic certificate for that period of creditable coverage with
respect to the individual under paragraph (a)(2)(ii) of this section.
The issuer, however, must still provide a certificate upon request as
required under paragraph (a)(2)(iii) of this section. In addition, the
issuer is required to cooperate with the plan in responding to any
request made under paragraph (b)(2) of this section (relating to the
alternative method of counting creditable coverage). Moreover, if the
individual's coverage under the plan ceases at the time the individual's
coverage under the issuer's policy or contract ceases, the issuer must
still provide an automatic certificate under paragraph (a)(2)(ii) of
this section. If an individual's coverage under an issuer's policy or
contract ceases on the effective date for changing enrollment options
under the plan, the issuer may presume (absent information to the
contrary) that the individual's coverage under the plan continues.
Therefore, the issuer is required to provide information to the plan in
accordance with this paragraph (a)(1)(iv)(B)(1) (and is not required to
provide an automatic certificate under paragraph (a)(2)(ii) of this
section).
(2) Example. The rule of this paragraph (a)(1)(iv)(B) is illustrated
by the following example:
Example. (i) Facts. A group health plan provides coverage under an
HMO option and an indemnity option through different issuers, and only
allows employees to switch on each January 1. Neither the HMO nor the
indemnity issuer has entered into an agreement with the plan to provide
certificates as permitted under paragraph (a)(1)(iii) of this section.
(ii) Conclusion. In this Example, if an employee switches from the
indemnity option to the HMO option on January 1, the indemnity issuer
must provide the plan (or a person designated by the plan) with
appropriate information with respect to the individual's coverage with
the indemnity issuer. However, if the individual's coverage with the
indemnity issuer ceases at a date other than January 1, the issuer is
instead required to provide the individual with an automatic
certificate.
(2) Individuals for whom certificate must be provided; timing of
issuance--(i) Individuals. A certificate must be provided, without
charge, for participants or dependents who are or were covered under a
group health plan upon the occurrence of any of the events described in
paragraph (a)(2)(ii) or (iii) of this section.
(ii) Issuance of automatic certificates. The certificates described
in this paragraph (a)(2)(ii) are referred to as automatic certificates.
(A) Qualified beneficiaries upon a qualifying event. In the case of
an individual who is a qualified beneficiary (as defined in section
4980B(g)(3)) entitled to elect COBRA continuation coverage, an automatic
certificate is required to be provided at the time the individual would
lose coverage under the plan in the absence of COBRA continuation
coverage or alternative coverage elected instead of COBRA continuation
coverage. A plan satisfies this requirement if it provides the automatic
certificate no later than the time a notice is required to be furnished
for a qualifying event under section 4980B(f)(6) (relating to notices
required under COBRA).
(B) Other individuals when coverage ceases. In the case of an
individual who is not a qualified beneficiary entitled to elect COBRA
continuation coverage, an automatic certificate must be provided at the
time the individual ceases to be covered under the plan. A plan
satisfies the requirement to provide an automatic certificate at the
time the individual ceases to be covered if it provides the automatic
certificate within a reasonable time after coverage ceases (or after the
expiration of any grace period for nonpayment of premiums).
(1) The cessation of temporary continuation coverage (TCC) under
Title 5
[[Page 414]]
U.S.C. Chapter 89 (the Federal Employees Health Benefit Program) is a
cessation of coverage upon which an automatic certificate must be
provided.
(2) In the case of an individual who is entitled to elect to
continue coverage under a State program similar to COBRA and who
receives the automatic certificate not later than the time a notice is
required to be furnished under the State program, the certificate is
deemed to be provided within a reasonable time after coverage ceases
under the plan.
(3) If an individual's coverage ceases due to the operation of a
lifetime limit on all benefits, coverage is considered to cease for
purposes of this paragraph (a)(2)(ii)(B) on the earliest date that a
claim is denied due to the operation of the lifetime limit.
(C) Qualified beneficiaries when COBRA ceases. In the case of an
individual who is a qualified beneficiary and has elected COBRA
continuation coverage (or whose coverage has continued after the
individual became entitled to elect COBRA continuation coverage), an
automatic certificate is to be provided at the time the individual' s
coverage under the plan ceases. A plan satisfies this requirement if it
provides the automatic certificate within a reasonable time after
coverage ceases (or after the expiration of any grace period for
nonpayment of premiums). An automatic certificate is required to be
provided to such an individual regardless of whether the individual has
previously received an automatic certificate under paragraph
(a)(2)(ii)(A) of this section.
(iii) Any individual upon request. A certificate must be provided in
response to a request made by, or on behalf of, an individual at any
time while the individual is covered under a plan and up to 24 months
after coverage ceases. Thus, for example, a plan in which an individual
enrolls may, if authorized by the individual, request a certificate of
the individual's creditable coverage on behalf of the individual from a
plan in which the individual was formerly enrolled. After the request is
received, a plan or issuer is required to provide the certificate by the
earliest date that the plan, acting in a reasonable and prompt fashion,
can provide the certificate. A certificate is required to be provided
under this paragraph (a)(2)(iii) even if the individual has previously
received a certificate under this paragraph (a)(2)(iii) or an automatic
certificate under paragraph (a)(2)(ii) of this section.
(iv) Examples. The rules of this paragraph (a)(2) are illustrated by
the following examples:
Example 1. (i) Facts. Individual A terminates employment with
Employer Q. A is a qualified beneficiary entitled to elect COBRA
continuation coverage under Employer Q's group health plan. A notice of
the rights provided under COBRA is typically furnished to qualified
beneficiaries under the plan within 10 days after a covered employee
terminates employment.
(ii) Conclusion. In this Example 1, the automatic certificate may be
provided at the same time that A is provided the COBRA notice.
Example 2. (i) Facts. Same facts as Example 1, except that the
automatic certificate for A is not completed by the time the COBRA
notice is furnished to A.
(ii) Conclusion. In this Example 2, the automatic certificate may be
provided after the COBRA notice but must be provided within the period
permitted by law for the delivery of notices under COBRA.
Example 3. (i) Facts. Employer R maintains an insured group health
plan. R has never had 20 employees and thus R's plan is not subject to
the COBRA continuation provisions. However, R is in a State that has a
State program similar to COBRA. B terminates employment with R and loses
coverage under R's plan.
(ii) Conclusion. In this Example 3, the automatic certificate must
be provided not later than the time a notice is required to be furnished
under the State program.
Example 4. (i) Facts. Individual C terminates employment with
Employer S and receives both a notice of C's rights under COBRA and an
automatic certificate. C elects COBRA continuation coverage under
Employer S's group health plan. After four months of COBRA continuation
coverage and the expiration of a 30-day grace period, S's group health
plan determines that C's COBRA continuation coverage has ceased due to a
failure to make a timely payment for continuation coverage.
(ii) Conclusion. In this Example 4, the plan must provide an updated
automatic certificate to C within a reasonable time after the end of the
grace period.
Example 5. (i) Facts. Individual D is currently covered under the
group health plan of Employer T. D requests a certificate, as permitted
under paragraph (a)(2)(iii) of this section. Under the procedure for T's
plan,
[[Page 415]]
certificates are mailed (by first class mail) 7 business days following
receipt of the request. This date reflects the earliest date that the
plan, acting in a reasonable and prompt fashion, can provide
certificates.
(ii) Conclusion. In this Example 5, the plan's procedure satisfies
paragraph (a)(2)(iii) of this section.
(3) Form and content of certificate--(i) Written certificate--(A) In
general. Except as provided in paragraph (a)(3)(i)(B) of this section,
the certificate must be provided in writing (including any form approved
by the Secretary as a writing).
(B) Other permissible forms. No written certificate is required to
be provided under this paragraph (a) with respect to a particular event
described in paragraph (a)(2)(ii) or (iii) of this section, if--
(1) An individual who is entitled to receive the certificate
requests that the certificate be sent to another plan or issuer instead
of to the individual;
(2) The plan or issuer that would otherwise receive the certificate
agrees to accept the information in this paragraph (a)(3) through means
other than a written certificate (such as by telephone); and
(3) The receiving plan or issuer receives the information from the
sending plan or issuer through such means within the time required under
paragraph (a)(2) of this section.
(ii) Required information. The certificate must include the
following--
(A) The date the certificate is issued;
(B) The name of the group health plan that provided the coverage
described in the certificate;
(C) The name of the participant or dependent with respect to whom
the certificate applies, and any other information necessary for the
plan providing the coverage specified in the certificate to identify the
individual, such as the individual's identification number under the
plan and the name of the participant if the certificate is for (or
includes) a dependent;
(D) The name, address, and telephone number of the plan
administrator or issuer required to provide the certificate;
(E) The telephone number to call for further information regarding
the certificate (if different from paragraph (a)(3)(ii)(D) of this
section);
(F) Either--
(1) A statement that an individual has at least 18 months (for this
purpose, 546 days is deemed to be 18 months) of creditable coverage,
disregarding days of creditable coverage before a significant break in
coverage, or
(2) The date any waiting period (and affiliation period, if
applicable) began and the date creditable coverage began;
(G) The date creditable coverage ended, unless the certificate
indicates that creditable coverage is continuing as of the date of the
certificate; and
(H) An educational statement regarding HIPAA, which explains:
(1) The restrictions on the ability of a plan or issuer to impose a
preexisting condition exclusion (including an individual's ability to
reduce a preexisting condition exclusion by creditable coverage);
(2) Special enrollment rights;
(3) The prohibitions against discrimination based on any health
factor;
(4) The right to individual health coverage;
(5) The fact that State law may require issuers to provide
additional protections to individuals in that State; and
(6) Where to get more information.
(iii) Periods of coverage under the certificate. If an automatic
certificate is provided pursuant to paragraph (a)(2)(ii) of this
section, the period that must be included on the certificate is the last
period of continuous coverage ending on the date coverage ceased. If an
individual requests a certificate pursuant to paragraph (a)(2)(iii) of
this section, the certificate provided must include each period of
continuous coverage ending within the 24-month period ending on the date
of the request (or continuing on the date of the request). A separate
certificate may be provided for each such period of continuous coverage.
(iv) Combining information for families. A certificate may provide
information with respect to both a participant and the participant's
dependents if the information is identical for each individual. If the
information is not identical, certificates may be provided on one form
if the form provides all the
[[Page 416]]
required information for each individual and separately states the
information that is not identical.
(v) Model certificate. The requirements of paragraph (a)(3)(ii) of
this section are satisfied if the plan provides a certificate in
accordance with a model certificate authorized by the Secretary.
(vi) Excepted benefits; categories of benefits. No certificate is
required to be furnished with respect to excepted benefits described in
Sec. 54.9831-1(c). In addition, the information in the certificate
regarding coverage is not required to specify categories of benefits
described in Sec. 54.9801-4(c) (relating to the alternative method of
counting creditable coverage). However, if excepted benefits are
provided concurrently with other creditable coverage (so that the
coverage does not consist solely of excepted benefits), information
concerning the benefits may be required to be disclosed under paragraph
(b) of this section.
(4) Procedures--(i) Method of delivery. The certificate is required
to be provided to each individual described in paragraph (a)(2) of this
section or an entity requesting the certificate on behalf of the
individual. The certificate may be provided by first-class mail. If the
certificate or certificates are provided to the participant and the
participant's spouse at the participant's last known address, then the
requirements of this paragraph (a)(4) are satisfied with respect to all
individuals residing at that address. If a dependent's last known
address is different than the participant's last known address, a
separate certificate is required to be provided to the dependent at the
dependent's last known address. If separate certificates are being
provided by mail to individuals who reside at the same address, separate
mailings of each certificate are not required.
(ii) Procedure for requesting certificates. A plan or issuer must
establish a written procedure for individuals to request and receive
certificates pursuant to paragraph (a)(2)(iii) of this section. The
written procedure must include all contact information necessary to
request a certificate (such as name and phone number or address).
(iii) Designated recipients. If an automatic certificate is required
to be provided under paragraph (a)(2)(ii) of this section, and the
individual entitled to receive the certificate designates another
individual or entity to receive the certificate, the plan or issuer
responsible for providing the certificate is permitted to provide the
certificate to the designated individual or entity. If a certificate is
required to be provided upon request under paragraph (a)(2)(iii) of this
section and the individual entitled to receive the certificate
designates another individual or entity to receive the certificate, the
plan or issuer responsible for providing the certificate is required to
provide the certificate to the designated individual or entity.
(5) Special rules concerning dependent coverage--(i)(A) Reasonable
efforts. A plan is required to use reasonable efforts to determine any
information needed for a certificate relating to dependent coverage. In
any case in which an automatic certificate is required to be furnished
with respect to a dependent under paragraph (a)(2)(ii) of this section,
no individual certificate is required to be furnished until the plan
knows (or making reasonable efforts should know) of the dependent's
cessation of coverage under the plan.
(B) Example. The rules of this paragraph (a)(5)(i) are illustrated
by the following example:
Example. (i) Facts. A group health plan covers employees and their
dependents. The plan annually requests all employees to provide updated
information regarding dependents, including the specific date on which
an employee has a new dependent or on which a person ceases to be a
dependent of the employee.
(ii) Conclusion. In this Example, the plan has satisfied the
standard in this paragraph (a)(5)(i) of this section that it make
reasonable efforts to determine the cessation of dependents' coverage
and the related dependent coverage information.
(ii) Special rules for demonstrating coverage. If a certificate
furnished by a plan or issuer does not provide the name of any dependent
covered by the certificate, the procedures described in paragraph (c)(5)
of this section may be used to demonstrate dependent status. In
addition, these procedures may be used to demonstrate that a child was
[[Page 417]]
covered under any creditable coverage within 30 days after birth,
adoption, or placement for adoption. See also Sec. 54.9801-3(b), under
which such a child cannot be subject to a preexisting condition
exclusion.
(6) Special certification rules for entities not subject to Chapter
100 of Subtitle K--(i) Issuers. For rules requiring that issuers in the
group and individual markets provide certificates consistent with the
rules in this section, see section 701(e) of ERISA and sections 2701(e),
2721(b)(1)(B), and 2743 of the PHS Act.
(ii) Other entities. For special rules requiring that certain other
entities not subject to Chapter 100 of Subtitle K provide certificates
consistent with the rules in this section, see section 2791(a)(3) of the
PHS Act applicable to entities described in sections 2701(c)(1)(C), (D),
(E), and (F) of the PHS Act (relating to Medicare, Medicaid, TRICARE,
and Indian Health Service), section 2721(b)(1)(A) of the PHS Act
applicable to nonfederal governmental plans generally, and section
2721(b)(2)(C)(ii) of the PHS Act applicable to nonfederal governmental
plans that elect to be excluded from the requirements of Subparts 1
through 3 of Part A of Title XXVII of the PHS Act.
(b) Disclosure of coverage to a plan or issuer using the alternative
method of counting creditable coverage--(1) In general. After an
individual provides a certificate of creditable coverage to a plan (or
issuer) using the alternative method under Sec. 54.9801-4(c), that plan
(or issuer) (requesting entity) must request that the entity that issued
the certificate (prior entity) disclose the information set forth in
paragraph (b)(2) of this section. The prior entity is required to
disclose this information promptly.
(2) Information to be disclosed. The prior entity is required to
identify to the requesting entity the categories of benefits with
respect to which the requesting entity is using the alternative method
of counting creditable coverage, and the requesting entity may identify
specific information that the requesting entity reasonably needs in
order to determine the individual's creditable coverage with respect to
any such category.
(3) Charge for providing information. The prior entity may charge
the requesting entity for the reasonable cost of disclosing such
information.
(c) Ability of an individual to demonstrate creditable coverage and
waiting period information--(1) Purpose. The rules in this paragraph (c)
implement section 9801(c)(4), which permits individuals to demonstrate
the duration of creditable coverage through means other than
certificates, and section 9801(e)(3), which requires the Secretary to
establish rules designed to prevent an individual's subsequent coverage
under a group health plan or health insurance coverage from being
adversely affected by an entity's failure to provide a certificate with
respect to that individual.
(2) In general. If the accuracy of a certificate is contested or a
certificate is unavailable when needed by an individual, the individual
has the right to demonstrate creditable coverage (and waiting or
affiliation periods) through the presentation of documents or other
means. For example, the individual may make such a demonstration when--
(i) An entity has failed to provide a certificate within the
required time;
(ii) The individual has creditable coverage provided by an entity
that is not required to provide a certificate of the coverage pursuant
to paragraph (a) of this section;
(iii) The individual has an urgent medical condition that
necessitates a determination before the individual can deliver a
certificate to the plan; or
(iv) The individual lost a certificate that the individual had
previously received and is unable to obtain another certificate.
(3) Evidence of creditable coverage--(i) Consideration of evidence--
(A) A plan is required to take into account all information that it
obtains or that is presented on behalf of an individual to make a
determination, based on the relevant facts and circumstances, whether an
individual has creditable coverage. A plan shall treat the individual as
having furnished a certificate under paragraph (a) of this section if--
(1) The individual attests to the period of creditable coverage;
[[Page 418]]
(2) The individual also presents relevant corroborating evidence of
some creditable coverage during the period; and
(3) The individual cooperates with the plan's efforts to verify the
individual's coverage.
(B) For purposes of this paragraph (c)(3)(i), cooperation includes
providing (upon the plan's or issuer's request) a written authorization
for the plan to request a certificate on behalf of the individual, and
cooperating in efforts to determine the validity of the corroborating
evidence and the dates of creditable coverage. While a plan may refuse
to credit coverage where the individual fails to cooperate with the
plan's or issuer's efforts to verify coverage, the plan may not consider
an individual's inability to obtain a certificate to be evidence of the
absence of creditable coverage.
(ii) Documents. Documents that corroborate creditable coverage (and
waiting or affiliation periods) include explanations of benefits (EOBs)
or other correspondence from a plan or issuer indicating coverage, pay
stubs showing a payroll deduction for health coverage, a health
insurance identification card, a certificate of coverage under a group
health policy, records from medical care providers indicating health
coverage, third party statements verifying periods of coverage, and any
other relevant documents that evidence periods of health coverage.
(iii) Other evidence. Creditable coverage (and waiting or
affiliation periods) may also be corroborated through means other than
documentation, such as by a telephone call from the plan or provider to
a third party verifying creditable coverage.
(iv) Example. The rules of this paragraph (c)(3) are illustrated by
the following example:
Example. (i) Facts. Individual F terminates employment with Employer
W and, a month later, is hired by Employer X. X's group health plan
imposes a preexisting condition exclusion of 12 months on new enrollees
under the plan and uses the standard method of determining creditable
coverage. F fails to receive a certificate of prior coverage from the
self-insured group health plan maintained by F's prior employer, W, and
requests a certificate. However, F (and X's plan, on F's behalf and with
F's cooperation) is unable to obtain a certificate from W's plan. F
attests that, to the best of F's knowledge, F had at least 12 months of
continuous coverage under W's plan, and that the coverage ended no
earlier than F's termination of employment from W. In addition, F
presents evidence of coverage, such as an explanation of benefits for a
claim that was made during the relevant period.
(ii) Conclusion. In this Example, based solely on these facts, F has
demonstrated creditable coverage for the 12 months of coverage under W's
plan in the same manner as if F had presented a written certificate of
creditable coverage.
(4) Demonstrating categories of creditable coverage. Procedures
similar to those described in this paragraph (c) apply in order to
determine the duration of an individual's creditable coverage with
respect to any category under paragraph (b) of this section (relating to
determining creditable coverage under the alternative method).
(5) Demonstrating dependent status. If, in the course of providing
evidence (including a certificate) of creditable coverage, an individual
is required to demonstrate dependent status, the group health plan or
issuer is required to treat the individual as having furnished a
certificate showing the dependent status if the individual attests to
such dependency and the period of such status and the individual
cooperates with the plan's or issuer's efforts to verify the dependent
status.
[T.D. 9166, 69 FR 78746, Dec. 30, 2004]
Sec. 54.9801-6 Special enrollment periods.
(a) Special enrollment for certain individuals who lose coverage--
(1) In general. A group health plan is required to permit current
employees and dependents (as defined in Sec. 54.9801-2) who are
described in paragraph (a)(2) of this section to enroll for coverage
under the terms of the plan if the conditions in paragraph (a)(3) of
this section are satisfied. The special enrollment rights under this
paragraph (a) apply without regard to the dates on which an individual
would otherwise be able to enroll under the plan. (See section 701(f)(1)
of ERISA and section 2701(f)(1) of the PHS Act, under which this
obligation is also imposed on a health insurance issuer offering group
health insurance coverage.)
[[Page 419]]
(2) Individuals eligible for special enrollment--(i) When employee
loses coverage. A current employee and any dependents (including the
employee's spouse) each are eligible for special enrollment in any
benefit package under the plan (subject to plan eligibility rules
conditioning dependent enrollment on enrollment of the employee) if--
(A) The employee and the dependents are otherwise eligible to enroll
in the benefit package;
(B) When coverage under the plan was previously offered, the
employee had coverage under any group health plan or health insurance
coverage; and
(C) The employee satisfies the conditions of paragraph (a)(3)(i),
(ii), or (iii) of this section and, if applicable, paragraph (a)(3)(iv)
of this section.
(ii) When dependent loses coverage--(A) A dependent of a current
employee (including the employee's spouse) and the employee each are
eligible for special enrollment in any benefit package under the plan
(subject to plan eligibility rules conditioning dependent enrollment on
enrollment of the employee) if--
(1) The dependent and the employee are otherwise eligible to enroll
in the benefit package;
(2) When coverage under the plan was previously offered, the
dependent had coverage under any group health plan or health insurance
coverage; and
(3) The dependent satisfies the conditions of paragraph (a)(3)(i),
(ii), or (iii) of this section and, if applicable, paragraph (a)(3)(iv)
of this section.
(B) However, the plan is not required to enroll any other dependent
unless that dependent satisfies the criteria of this paragraph
(a)(2)(ii), or the employee satisfies the criteria of paragraph
(a)(2)(i) of this section.
(iii) Examples. The rules of this paragraph (a)(2) are illustrated
by the following examples:
Example 1. (i) Facts. Individual A works for Employer X. A, A's
spouse, and A's dependent children are eligible but not enrolled for
coverage under X's group health plan. A's spouse works for Employer Y
and at the time coverage was offered under X's plan, A was enrolled in
coverage under Y's plan. Then, A loses eligibility for coverage under
Y's plan.
(ii) Conclusion. In this Example 1, because A satisfies the
conditions for special enrollment under paragraph (a)(2)(i) of this
section, A, A's spouse, and A's dependent children are eligible for
special enrollment under X's plan.
Example 2. (i) Facts. Individual A and A's spouse are eligible but
not enrolled for coverage under Group Health Plan P maintained by A's
employer. When A was first presented with an opportunity to enroll A and
A's spouse, they did not have other coverage. Later, A and A's spouse
enroll in Group Health Plan Q maintained by the employer of A's spouse.
During a subsequent open enrollment period in P, A and A's spouse did
not enroll because of their coverage under Q. They then lose eligibility
for coverage under Q.
(ii) Conclusion. In this Example 2, because A and A's spouse were
covered under Q when they did not enroll in P during open enrollment,
they satisfy the conditions for special enrollment under paragraphs
(a)(2)(i) and (ii) of this section. Consequently, A and A's spouse are
eligible for special enrollment under P.
Example 3. (i) Facts. Individual B works for Employer X. B and B's
spouse are eligible but not enrolled for coverage under X's group health
plan. B's spouse works for Employer Y and at the time coverage was
offered under X's plan, B's spouse was enrolled in self-only coverage
under Y's group health plan. Then, B's spouse loses eligibility for
coverage under Y's plan.
(ii) Conclusion. In this Example 3, because B's spouse satisfies the
conditions for special enrollment under paragraph (a)(2)(ii) of this
section, both B and B's spouse are eligible for special enrollment under
X's plan.
Example 4. (i) Facts. Individual A works for Employer X. X maintains
a group health plan with two benefit packages--an HMO option and an
indemnity option. Self-only and family coverage are available under both
options. A enrolls for self-only coverage in the HMO option. A's spouse
works for Employer Y and was enrolled for self-only coverage under Y's
plan at the time coverage was offered under X's plan. Then, A's spouse
loses coverage under Y's plan. A requests special enrollment for A and
A's spouse under the plan's indemnity option.
(ii) Conclusion. In this Example 4, because A's spouse satisfies the
conditions for special enrollment under paragraph (a)(2)(ii) of this
section, both A and A's spouse can enroll in either benefit package
under X's plan. Therefore, if A requests enrollment in accordance with
the requirements of this section, the plan must allow A and A's spouse
to enroll in the indemnity option.
(3) Conditions for special enrollment--(i) Loss of eligibility for
coverage. In the case of an employee or dependent who has coverage that
is not COBRA continuation coverage, the conditions of
[[Page 420]]
this paragraph (a)(3)(i) are satisfied at the time the coverage is
terminated as a result of loss of eligibility (regardless of whether the
individual is eligible for or elects COBRA continuation coverage). Loss
of eligibility under this paragraph (a)(3)(i) does not include a loss
due to the failure of the employee or dependent to pay premiums on a
timely basis or termination of coverage for cause (such as making a
fraudulent claim or an intentional misrepresentation of a material fact
in connection with the plan). Loss of eligibility for coverage under
this paragraph (a)(3)(i) includes (but is not limited to)--
(A) Loss of eligibility for coverage as a result of legal
separation, divorce, cessation of dependent status (such as attaining
the maximum age to be eligible as a dependent child under the plan),
death of an employee, termination of employment, reduction in the number
of hours of employment, and any loss of eligibility for coverage after a
period that is measured by reference to any of the foregoing;
(B) In the case of coverage offered through an HMO, or other
arrangement, in the individual market that does not provide benefits to
individuals who no longer reside, live, or work in a service area, loss
of coverage because an individual no longer resides, lives, or works in
the service area (whether or not within the choice of the individual);
(C) In the case of coverage offered through an HMO, or other
arrangement, in the group market that does not provide benefits to
individuals who no longer reside, live, or work in a service area, loss
of coverage because an individual no longer resides, lives, or works in
the service area (whether or not within the choice of the individual),
and no other benefit package is available to the individual;
(D) A situation in which an individual incurs a claim that would
meet or exceed a lifetime limit on all benefits; and
(E) A situation in which a plan no longer offers any benefits to the
class of similarly situated individuals (as described in Sec. 54.9802-
1(d)) that includes the individual.
(ii) Termination of employer contributions. In the case of an
employee or dependent who has coverage that is not COBRA continuation
coverage, the conditions of this paragraph (a)(3)(ii) are satisfied at
the time employer contributions towards the employee's or dependent's
coverage terminate. Employer contributions include contributions by any
current or former employer that was contributing to coverage for the
employee or dependent.
(iii) Exhaustion of COBRA continuation coverage. In the case of an
employee or dependent who has coverage that is COBRA continuation
coverage, the conditions of this paragraph (a)(3)(iii) are satisfied at
the time the COBRA continuation coverage is exhausted. For purposes of
this paragraph (a)(3)(iii), an individual who satisfies the conditions
for special enrollment of paragraph (a)(3)(i) of this section, does not
enroll, and instead elects and exhausts COBRA continuation coverage
satisfies the conditions of this paragraph (a)(3)(iii). (Exhaustion of
COBRA continuation coverage is defined in Sec. 54.9801-2.)
(iv) Written statement. A plan may require an employee declining
coverage (for the employee or any dependent of the employee) to state in
writing whether the coverage is being declined due to other health
coverage only if, at or before the time the employee declines coverage,
the employee is provided with notice of the requirement to provide the
statement (and the consequences of the employee's failure to provide the
statement). If a plan requires such a statement, and an employee does
not provide it, the plan is not required to provide special enrollment
to the employee or any dependent of the employee under this paragraph
(a)(3). A plan must treat an employee as having satisfied the plan
requirement permitted under this paragraph (a)(3)(iv) if the employee
provides a written statement that coverage was being declined because
the employee or dependent had other coverage; a plan cannot require
anything more for the employee to satisfy the plan's requirement to
provide a written statement. (For example, the plan cannot require that
the statement be notarized.)
[[Page 421]]
(v) The rules of this paragraph (a)(3) are illustrated by the
following examples:
Example 1. (i) Facts. Individual D enrolls in a group health plan
maintained by Employer Y. At the time D enrolls, Y pays 70 percent of
the cost of employee coverage and D pays the rest. Y announces that
beginning January 1, Y will no longer make employer contributions
towards the coverage. Employees may maintain coverage, however, if they
pay the total cost of the coverage.
(ii) Conclusion. In this Example 1, employer contributions towards
D's coverage ceased on January 1 and the conditions of paragraph
(a)(3)(ii) of this section are satisfied on this date (regardless of
whether D elects to pay the total cost and continue coverage under Y's
plan).
Example 2. (i) Facts. A group health plan provides coverage through
two options--Option 1 and Option 2. Employees can enroll in either
option only within 30 days of hire or on January 1 of each year.
Employee A is eligible for both options and enrolls in Option 1.
Effective July 1 the plan terminates coverage under Option 1 and the
plan does not create an immediate open enrollment opportunity into
Option 2.
(ii) Conclusion. In this Example 2, A has experienced a loss of
eligibility for coverage that satisfies paragraph (a)(3)(i) of this
section, and has satisfied the other conditions for special enrollment
under paragraph (a)(2)(i) of this section. Therefore, if A satisfies the
other conditions of this paragraph (a), the plan must permit A to enroll
in Option 2 as a special enrollee. (A may also be eligible to enroll in
another group health plan, such as a plan maintained by the employer of
A's spouse, as a special enrollee.) The outcome would be the same if
Option 1 was terminated by an issuer and the plan made no other coverage
available to A.
Example 3. (i) Facts. Individual C is covered under a group health
plan maintained by Employer X. While covered under X's plan, C was
eligible for but did not enroll in a plan maintained by Employer Z, the
employer of C's spouse. C terminates employment with X and loses
eligibility for coverage under X's plan. C has a special enrollment
right to enroll in Z's plan, but C instead elects COBRA continuation
coverage under X's plan. C exhausts COBRA continuation coverage under
X's plan and requests special enrollment in Z's plan.
(ii) Conclusion. In this Example 3, C has satisfied the conditions
for special enrollment under paragraph (a)(3)(iii) of this section, and
has satisfied the other conditions for special enrollment under
paragraph (a)(2)(i) of this section. The special enrollment right that C
had into Z's plan immediately after the loss of eligibility for coverage
under X's plan was an offer of coverage under Z's plan. When C later
exhausts COBRA coverage under X's plan, C has a second special
enrollment right in Z's plan.
(4) Applying for special enrollment and effective date of coverage--
(i) A plan or issuer must allow an employee a period of at least 30 days
after an event described in paragraph (a)(3) of this section (other than
an event described in paragraph (a)(3)(i)(D)) to request enrollment (for
the employee or the employee's dependent). In the case of an event
described in paragraph (a)(3)(i)(D) of this section (relating to loss of
eligibility for coverage due to the operation of a lifetime limit on all
benefits), a plan or issuer must allow an employee a period of at least
30 days after a claim is denied due to the operation of a lifetime limit
on all benefits.
(ii) Coverage must begin no later than the first day of the first
calendar month beginning after the date the plan or issuer receives the
request for special enrollment.
(b) Special enrollment with respect to certain dependent
beneficiaries--(1) In general. A group health plan that makes coverage
available with respect to dependents is required to permit individuals
described in paragraph (b)(2) of this section to be enrolled for
coverage in a benefit package under the terms of the plan. Paragraph
(b)(3) of this section describes the required special enrollment period
and the date by which coverage must begin. The special enrollment rights
under this paragraph (b) apply without regard to the dates on which an
individual would otherwise be able to enroll under the plan. (See 29 CFR
2590.701-6(b) and 45 CFR 146.117(b), under which this obligation is also
imposed on a health insurance issuer offering group health insurance
coverage.)
(2) Individuals eligible for special enrollment. An individual is
described in this paragraph (b)(2) if the individual is otherwise
eligible for coverage in a benefit package under the plan and if the
individual is described in paragraph (b)(2)(i), (ii), (iii), (iv), (v),
or (vi) of this section.
(i) Current employee only. A current employee is described in this
paragraph (b)(2)(i) if a person becomes a dependent of the individual
through marriage,
[[Page 422]]
birth, adoption, or placement for adoption.
(ii) Spouse of a participant only. An individual is described in
this paragraph (b)(2)(ii) if either--
(A) The individual becomes the spouse of a participant; or
(B) The individual is a spouse of a participant and a child becomes
a dependent of the participant through birth, adoption, or placement for
adoption.
(iii) Current employee and spouse. A current employee and an
individual who is or becomes a spouse of such an employee, are described
in this paragraph (b)(2)(iii) if either--
(A) The employee and the spouse become married; or
(B) The employee and spouse are married and a child becomes a
dependent of the employee through birth, adoption, or placement for
adoption.
(iv) Dependent of a participant only. An individual is described in
this paragraph (b)(2)(iv) if the individual is a dependent (as defined
in Sec. 54.9801-2) of a participant and the individual has become a
dependent of the participant through marriage, birth, adoption, or
placement for adoption.
(v) Current employee and a new dependent. A current employee and an
individual who is a dependent of the employee, are described in this
paragraph (b)(2)(v) if the individual becomes a dependent of the
employee through marriage, birth, adoption, or placement for adoption.
(vi) Current employee, spouse, and a new dependent. A current
employee, the employee's spouse, and the employee's dependent are
described in this paragraph (b)(2)(vi) if the dependent becomes a
dependent of the employee through marriage, birth, adoption, or
placement for adoption.
(3) Applying for special enrollment and effective date of coverage--
(i) Request. A plan must allow an individual a period of at least 30
days after the date of the marriage, birth, adoption, or placement for
adoption (or, if dependent coverage is not generally made available at
the time of the marriage, birth, adoption, or placement for adoption, a
period of at least 30 days after the date the plan makes dependent
coverage generally available) to request enrollment (for the individual
or the individual's dependent).
(ii) Reasonable procedures for special enrollment. [Reserved]
(iii) Date coverage must begin--(A) Marriage. In the case of
marriage, coverage must begin no later than the first day of the first
calendar month beginning after the date the plan (or any issuer offering
health insurance coverage under the plan) receives the request for
special enrollment.
(B) Birth, adoption, or placement for adoption. Coverage must begin
in the case of a dependent's birth on the date of birth and in the case
of a dependent's adoption or placement for adoption no later than the
date of such adoption or placement for adoption (or, if dependent
coverage is not made generally available at the time of the birth,
adoption, or placement for adoption, the date the plan makes dependent
coverage available).
(4) Examples. The rules of this paragraph (b) are illustrated by the
following examples:
Example 1. (i) Facts. An employer maintains a group health plan that
offers all employees employee-only coverage, employee-plus-spouse
coverage, or family coverage. Under the terms of the plan, any employee
may elect to enroll when first hired (with coverage beginning on the
date of hire) or during an annual open enrollment period held each
December (with coverage beginning the following January 1). Employee A
is hired on September 3. A is married to B, and they have no children.
On March 15 in the following year a child C is born to A and B. Before
that date, A and B have not been enrolled in the plan.
(ii) Conclusion. In this Example 1, the conditions for special
enrollment of an employee with a spouse and new dependent under
paragraph (b)(2)(vi) of this section are satisfied. If A satisfies the
conditions of paragraph (b)(3) of this section for requesting enrollment
timely, the plan will satisfy this paragraph (b) if it allows A to
enroll either with employee-only coverage, with employee-plus-spouse
coverage (for A and B), or with family coverage (for A, B, and C). The
plan must allow whatever coverage is chosen to begin on March 15, the
date of C's birth.
Example 2. (i) Facts. Individual D works for Employer X. X maintains
a group health plan with two benefit packages--an HMO option and an
indemnity option. Self-only and family coverage are available under both
options. D enrolls for self-only coverage in the HMO option. Then, a
child, E, is placed for
[[Page 423]]
adoption with D. Within 30 days of the placement of E for adoption, D
requests enrollment for D and E under the plan's indemnity option.
(ii) Conclusion. In this Example 2, D and E satisfy the conditions
for special enrollment under paragraphs (b)(2)(v) and (b)(3) of this
section. Therefore, the plan must allow D and E to enroll in the
indemnity coverage, effective as of the date of the placement for
adoption.
(c) Notice of special enrollment. At or before the time an employee
is initially offered the opportunity to enroll in a group health plan,
the plan must furnish the employee with a notice of special enrollment
that complies with the requirements of this paragraph (c).
(1) Description of special enrollment rights. The notice of special
enrollment must include a description of special enrollment rights. The
following model language may be used to satisfy this requirement:
If you are declining enrollment for yourself or your dependents
(including your spouse) because of other health insurance or group
health plan coverage, you may be able to enroll yourself and your
dependents in this plan if you or your dependents lose eligibility for
that other coverage (or if the employer stops contributing towards your
or your dependents' other coverage). However, you must request
enrollment within [insert ``30 days'' or any longer period that applies
under the plan] after your or your dependents' other coverage ends (or
after the employer stops contributing toward the other coverage).
In addition, if you have a new dependent as a result of marriage,
birth, adoption, or placement for adoption, you may be able to enroll
yourself and your dependents. However, you must request enrollment
within [insert ``30 days'' or any longer period that applies under the
plan] after the marriage, birth, adoption, or placement for adoption.
To request special enrollment or obtain more information, contact
[insert the name, title, telephone number, and any additional contact
information of the appropriate plan representative].
(2) Additional information that may be required. The notice of
special enrollment must also include, if applicable, the notice
described in paragraph (a)(3)(iv) of this section (the notice required
to be furnished to an individual declining coverage if the plan requires
the reason for declining coverage to be in writing).
(d) Treatment of special enrollees--(1) If an individual requests
enrollment while the individual is entitled to special enrollment under
either paragraph (a) or (b) of this section, the individual is a special
enrollee, even if the request for enrollment coincides with a late
enrollment opportunity under the plan. Therefore, the individual cannot
be treated as a late enrollee.
(2) Special enrollees must be offered all the benefit packages
available to similarly situated individuals who enroll when first
eligible. For this purpose, any difference in benefits or cost-sharing
requirements for different individuals constitutes a different benefit
package. In addition, a special enrollee cannot be required to pay more
for coverage than a similarly situated individual who enrolls in the
same coverage when first eligible. The length of any preexisting
condition exclusion that may be applied to a special enrollee cannot
exceed the length of any preexisting condition exclusion that is applied
to similarly situated individuals who enroll when first eligible. For
rules prohibiting the application of a preexisting condition exclusion
to certain newborns, adopted children, and children placed for adoption,
see Sec. 54.9801-3(b).
(3) The rules of this section are illustrated by the following
example:
Example 2. (i) Facts. Employer Y maintains a group health plan that
has an enrollment period for late enrollees every November 1 through
November 30 with coverage effective the following January 1. On October
18, Individual B loses coverage under another group health plan and
satisfies the requirements of paragraphs (a)(2), (3), and (4) of this
section. B submits a completed application for coverage on November 2.
(ii) Conclusion. In this Example, B is a special enrollee.
Therefore, even though B's request for enrollment coincides with an open
enrollment period, B's coverage is required to be made effective no
later than December 1 (rather than the plan's January 1 effective date
for late enrollees).
[T.D. 9166, 69 FR 78746, Dec. 30, 2004]
[[Page 424]]
Sec. 54.9802-1 Prohibiting discrimination against participants and beneficiaries
based on a health factor.
(a) Health factors. (1) The term health factor means, in relation to
an individual, any of the following health status-related factors:
(i) Health status;
(ii) Medical condition (including both physical and mental
illnesses), as defined in Sec. 54.9801-2;
(iii) Claims experience;
(iv) Receipt of health care;
(v) Medical history;
(vi) Genetic information, as defined in Sec. 54.9802-3T.
(vii) Evidence of insurability; or
(viii) Disability.
(2) Evidence of insurability includes--
(i) Conditions arising out of acts of domestic violence; and
(ii) Participation in activities such as motorcycling, snowmobiling,
all-terrain vehicle riding, horseback riding, skiing, and other similar
activities.
(3) The decision whether health coverage is elected for an
individual (including the time chosen to enroll, such as under special
enrollment or late enrollment) is not, itself, within the scope of any
health factor. (However, under Sec. 54.9801-6, a plan must treat
special enrollees the same as similarly situated individuals who are
enrolled when first eligible.)
(b) Prohibited discrimination in rules for eligibility--(1) In
general. (i) A group health plan may not establish any rule for
eligibility (including continued eligibility) of any individual to
enroll for benefits under the terms of the plan that discriminates based
on any health factor that relates to that individual or a dependent of
that individual. This rule is subject to the provisions of paragraph
(b)(2) of this section (explaining how this rule applies to benefits),
paragraph (b)(3) of this section (allowing plans to impose certain
preexisting condition exclusions), paragraph (d) of this section
(containing rules for establishing groups of similarly situated
individuals), paragraph (e) of this section (relating to nonconfinement,
actively-at-work, and other service requirements), paragraph (f) of this
section (relating to wellness programs), and paragraph (g) of this
section (permitting favorable treatment of individuals with adverse
health factors).
(ii) For purposes of this section, rules for eligibility include,
but are not limited to, rules relating to--
(A) Enrollment;
(B) The effective date of coverage;
(C) Waiting (or affiliation) periods;
(D) Late and special enrollment;
(E) Eligibility for benefit packages (including rules for
individuals to change their selection among benefit packages);
(F) Benefits (including rules relating to covered benefits, benefit
restrictions, and cost-sharing mechanisms such as coinsurance,
copayments, and deductibles), as described in paragraphs (b)(2) and (3)
of this section;
(G) Continued eligibility; and
(H) Terminating coverage (including disenrollment) of any individual
under the plan.
(iii) The rules of this paragraph (b)(1) are illustrated by the
following examples:
Example 1. (i) Facts. An employer sponsors a group health plan that
is available to all employees who enroll within the first 30 days of
their employment. However, employees who do not enroll within the first
30 days cannot enroll later unless they pass a physical examination.
(ii) Conclusion. In this Example 1, the requirement to pass a
physical examination in order to enroll in the plan is a rule for
eligibility that discriminates based on one or more health factors and
thus violates this paragraph (b)(1).
Example 2. (i) Facts. Under an employer's group health plan,
employees who enroll during the first 30 days of employment (and during
special enrollment periods) may choose between two benefit packages: An
indemnity option and an HMO option. However, employees who enroll during
late enrollment are permitted to enroll only in the HMO option and only
if they provide evidence of good health.
(ii) Conclusion. In this Example 2, the requirement to provide
evidence of good health in order to be eligible for late enrollment in
the HMO option is a rule for eligibility that discriminates based on one
or more health factors and thus violates this paragraph (b)(1). However,
if the plan did not require evidence of good health but limited late
enrollees to the HMO option, the plan's rules for eligibility would not
discriminate based on any health factor, and thus would not violate this
paragraph (b)(1), because the time
[[Page 425]]
an individual chooses to enroll is not, itself, within the scope of any
health factor.
Example 3. (i) Facts. Under an employer's group health plan, all
employees generally may enroll within the first 30 days of employment.
However, individuals who participate in certain recreational activities,
including motorcycling, are excluded from coverage.
(ii) Conclusion. In this Example 3, excluding from the plan
individuals who participate in recreational activities, such as
motorcycling, is a rule for eligibility that discriminates based on one
or more health factors and thus violates this paragraph (b)(1).
Example 4. (i) Facts. A group health plan applies for a group health
policy offered by an issuer. As part of the application, the issuer
receives health information about individuals to be covered under the
plan. Individual A is an employee of the employer maintaining the plan.
A and A's dependents have a history of high health claims. Based on the
information about A and A's dependents, the issuer excludes A and A's
dependents from the group policy it offers to the employer.
(ii) Conclusion. See Example 4 in 29 CFR 2590.702(b)(1) and 45 CFR
146.121(b)(1) for a conclusion that the exclusion by the issuer of A and
A's dependents from coverage is a rule for eligibility that
discriminates based on one or more health factors and violates rules
under 29 CFR 2590.702(b)(1) and 45 CFR 146.121(b)(1) similar to the
rules under this paragraph (b)(1). (If the employer is a small employer
under 45 CFR 144.103 (generally, an employer with 50 or fewer
employees), the issuer also may violate 45 CFR 146.150, which requires
issuers to offer all the policies they sell in the small group market on
a guaranteed available basis to all small employers and to accept every
eligible individual in every small employer group.) If the plan provides
coverage through this policy and does not provide equivalent coverage
for A and A's dependents through other means, the plan violates this
paragraph (b)(1).
(2) Application to benefits--(i) General rule--(A) Under this
section, a group health plan is not required to provide coverage for any
particular benefit to any group of similarly situated individuals.
(B) However, benefits provided under a plan must be uniformly
available to all similarly situated individuals (as described in
paragraph (d) of this section). Likewise, any restriction on a benefit
or benefits must apply uniformly to all similarly situated individuals
and must not be directed at individual participants or beneficiaries
based on any health factor of the participants or beneficiaries
(determined based on all the relevant facts and circumstances). Thus,
for example, a plan may limit or exclude benefits in relation to a
specific disease or condition, limit or exclude benefits for certain
types of treatments or drugs, or limit or exclude benefits based on a
determination of whether the benefits are experimental or not medically
necessary, but only if the benefit limitation or exclusion applies
uniformly to all similarly situated individuals and is not directed at
individual participants or beneficiaries based on any health factor of
the participants or beneficiaries. In addition, a plan may impose
annual, lifetime, or other limits on benefits and may require the
satisfaction of a deductible, copayment, coinsurance, or other cost-
sharing requirement in order to obtain a benefit if the limit or cost-
sharing requirement applies uniformly to all similarly situated
individuals and is not directed at individual participants or
beneficiaries based on any health factor of the participants or
beneficiaries. In the case of a cost-sharing requirement, see also
paragraph (b)(2)(ii) of this section, which permits variances in the
application of a cost-sharing mechanism made available under a wellness
program. (Whether any plan provision or practice with respect to
benefits complies with this paragraph (b)(2)(i) does not affect whether
the provision or practice is permitted under ERISA, the Americans with
Disabilities Act, or any other law, whether State or Federal.)
(C) For purposes of this paragraph (b)(2)(i), a plan amendment
applicable to all individuals in one or more groups of similarly
situated individuals under the plan and made effective no earlier than
the first day of the first plan year after the amendment is adopted is
not considered to be directed at any individual participants or
beneficiaries.
(D) The rules of this paragraph (b)(2)(i) are illustrated by the
following examples:
Example 1. (i) Facts. A group health plan applies a $500,000
lifetime limit on all benefits to each participant or beneficiary
covered under the plan. The limit is not directed at individual
participants or beneficiaries.
[[Page 426]]
(ii) Conclusion. In this Example 1, the limit does not violate this
paragraph (b)(2)(i) because $500,000 of benefits are available uniformly
to each participant and beneficiary under the plan and because the limit
is applied uniformly to all participants and beneficiaries and is not
directed at individual participants or beneficiaries.
Example 2. (i) Facts. A group health plan has a $2 million lifetime
limit on all benefits (and no other lifetime limits) for participants
covered under the plan. Participant B files a claim for the treatment of
AIDS. At the next corporate board meeting of the plan sponsor, the claim
is discussed. Shortly thereafter, the plan is modified to impose a
$10,000 lifetime limit on benefits for the treatment of AIDS, effective
before the beginning of the next plan year.
(ii) Conclusion. The facts of this Example 2 strongly suggest that
the plan modification is directed at B based on B's claim. Absent
outweighing evidence to the contrary, the plan violates this paragraph
(b)(2)(i).
Example 3. (i) A group health plan applies for a group health policy
offered by an issuer. Individual C is covered under the plan and has an
adverse health condition. As part of the application, the issuer
receives health information about the individuals to be covered,
including information about C's adverse health condition. The policy
form offered by the issuer generally provides benefits for the adverse
health condition that C has, but in this case the issuer offers the plan
a policy modified by a rider that excludes benefits for C for that
condition. The exclusionary rider is made effective the first day of the
next plan year.
(ii) Conclusion. See Example 3 in 29 CFR 2590.702(b)(2)(i) and 45
CFR 146.121(b)(2)(i) for a conclusion that the issuer violates rules
under 29 CFR 2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i) similar to
the rules under this paragraph (b)(2)(i) because benefits for C's
condition are available to other individuals in the group of similarly
situated individuals that includes C but are not available to C. Thus,
the benefits are not uniformly available to all similarly situated
individuals. Even though the exclusionary rider is made effective the
first day of the next plan year, because the rider does not apply to all
similarly situated individuals, the issuer violates the rules under 29
CFR 2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i). If the plan provides
coverage through this policy and does not provide equivalent coverage
for C through other means, the plan violates this paragraph (b)(2)(i).
Example 4. (i) Facts. A group health plan has a $2,000 lifetime
limit for the treatment of temporomandibular joint syndrome (TMJ). The
limit is applied uniformly to all similarly situated individuals and is
not directed at individual participants or beneficiaries.
(ii) Conclusion. In this Example 4, the limit does not violate this
paragraph (b)(2)(i) because $2,000 of benefits for the treatment of TMJ
are available uniformly to all similarly situated individuals and a plan
may limit benefits covered in relation to a specific disease or
condition if the limit applies uniformly to all similarly situated
individuals and is not directed at individual participants or
beneficiaries. (This example does not address whether the plan provision
is permissible under the Americans with Disabilities Act or any other
applicable law.)
Example 5. (i) Facts. A group health plan applies a $2 million
lifetime limit on all benefits. However, the $2 million lifetime limit
is reduced to $10,000 for any participant or beneficiary covered under
the plan who has a congenital heart defect.
(ii) Conclusion. In this Example 5, the lower lifetime limit for
participants and beneficiaries with a congenital heart defect violates
this paragraph (b)(2)(i) because benefits under the plan are not
uniformly available to all similarly situated individuals and the plan's
lifetime limit on benefits does not apply uniformly to all similarly
situated individuals.
Example 6. (i) Facts. A group health plan limits benefits for
prescription drugs to those listed on a drug formulary. The limit is
applied uniformly to all similarly situated individuals and is not
directed at individual participants or beneficiaries.
(ii) Conclusion. In this Example 6, the exclusion from coverage of
drugs not listed on the drug formulary does not violate this paragraph
(b)(2)(i) because benefits for prescription drugs listed on the
formulary are uniformly available to all similarly situated individuals
and because the exclusion of drugs not listed on the formulary applies
uniformly to all similarly situated individuals and is not directed at
individual participants or beneficiaries.
Example 7. (i) Facts. Under a group health plan, doctor visits are
generally subject to a $250 annual deductible and 20 percent coinsurance
requirement. However, prenatal doctor visits are not subject to any
deductible or coinsurance requirement. These rules are applied uniformly
to all similarly situated individuals and are not directed at individual
participants or beneficiaries.
(ii) Conclusion. In this Example 7, imposing different deductible
and coinsurance requirements for prenatal doctor visits and other visits
does not violate this paragraph (b)(2)(i) because a plan may establish
different deductibles or coinsurance requirements for different services
if the deductible or coinsurance requirement is applied uniformly to all
similarly situated individuals and is not directed at individual
participants or beneficiaries.
Example 8. (i) Facts. An employer sponsors a group health plan that
is available to all
[[Page 427]]
current employees. Under the plan, the medical care expenses of each
employee (and the employee's dependents) are reimbursed up to an annual
maximum amount. The maximum reimbursement amount with respect to an
employee for a year is $1500 multiplied by the number of years the
employee has participated in the plan, reduced by the total
reimbursements for prior years.
(ii) Conclusion. In this Example 8, the variable annual limit does
not violate this paragraph (b)(2)(i). Although the maximum reimbursement
amount for a year varies among employees within the same group of
similarly situated individuals based on prior claims experience,
employees who have participated in the plan for the same length of time
are eligible for the same total benefit over that length of time (and
the restriction on the maximum reimbursement amount is not directed at
any individual participants or beneficiaries based on any health
factor).
(ii) Exception for wellness programs. A group health plan may vary
benefits, including cost-sharing mechanisms (such as a deductible,
copayment, or coinsurance), based on whether an individual has met the
standards of a wellness program that satisfies the requirements of
paragraph (f) of this section.
(iii) Specific rule relating to source-of-injury exclusions--(A) If
a group health plan generally provides benefits for a type of injury,
the plan may not deny benefits otherwise provided for treatment of the
injury if the injury results from an act of domestic violence or a
medical condition (including both physical and mental health
conditions). This rule applies in the case of an injury resulting from a
medical condition even if the condition is not diagnosed before the
injury.
(B) The rules of this paragraph (b)(2)(iii) are illustrated by the
following examples:
Example 1. (i) Facts. A group health plan generally provides
medical/surgical benefits, including benefits for hospital stays, that
are medically necessary. However, the plan excludes benefits for self-
inflicted injuries or injuries sustained in connection with attempted
suicide. Because of depression, Individual D attempts suicide. As a
result, D sustains injuries and is hospitalized for treatment of the
injuries. Under the exclusion, the plan denies D benefits for treatment
of the injuries.
(ii) Conclusion. In this Example 1, the suicide attempt is the
result of a medical condition (depression). Accordingly, the denial of
benefits for the treatments of D's injuries violates the requirements of
this paragraph (b)(2)(iii) because the plan provision excludes benefits
for treatment of an injury resulting from a medical condition.
Example 2. (i) Facts. A group health plan provides benefits for head
injuries generally. The plan also has a general exclusion for any injury
sustained while participating in any of a number of recreational
activities, including bungee jumping. However, this exclusion does not
apply to any injury that results from a medical condition (nor from
domestic violence). Participant E sustains a head injury while bungee
jumping. The injury did not result from a medical condition (nor from
domestic violence). Accordingly, the plan denies benefits for E's head
injury.
(ii) Conclusion. In this Example 2, the plan provision that denies
benefits based on the source of an injury does not restrict benefits
based on an act of domestic violence or any medical condition.
Therefore, the provision is permissible under this paragraph (b)(2)(iii)
and does not violate this section. (However, if the plan did not allow E
to enroll in the plan (or applied different rules for eligibility to E)
because E frequently participates in bungee jumping, the plan would
violate paragraph (b)(1) of this section.)
(3) Relationship to Sec. 54.9801-3. (i) A preexisting condition
exclusion is permitted under this section if it--
(A) Complies with Sec. 54.9801-3;
(B) Applies uniformly to all similarly situated individuals (as
described in paragraph (d) of this section); and
(C) Is not directed at individual participants or beneficiaries
based on any health factor of the participants or beneficiaries. For
purposes of this paragraph (b)(3)(i)(C), a plan amendment relating to a
preexisting condition exclusion applicable to all individuals in one or
more groups of similarly situated individuals under the plan and made
effective no earlier than the first day of the first plan year after the
amendment is adopted is not considered to be directed at any individual
participants or beneficiaries.
(ii) The rules of this paragraph (b)(3) are illustrated by the
following examples:
Example 1. (i) Facts. A group health plan imposes a preexisting
condition exclusion on all individuals enrolled in the plan. The
exclusion applies to conditions for which medical advice, diagnosis,
care, or treatment was recommended or received within the six-month
period ending on an individual's enrollment date. In addition, the
exclusion
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generally extends for 12 months after an individual's enrollment date,
but this 12-month period is offset by the number of days of an
individual's creditable coverage in accordance with Sec. 54.9801-3.
There is nothing to indicate that the exclusion is directed at
individual participants or beneficiaries.
(ii) Conclusion. In this Example 1, even though the plan's
preexisting condition exclusion discriminates against individuals based
on one or more health factors, the preexisting condition exclusion does
not violate this section because it applies uniformly to all similarly
situated individuals, is not directed at individual participants or
beneficiaries, and complies with Sec. 54.9801-3 (that is, the
requirements relating to the six-month look-back period, the 12-month
(or 18-month) maximum exclusion period, and the creditable coverage
offset).
Example 2. (i) Facts. A group health plan excludes coverage for
conditions with respect to which medical advice, diagnosis, care, or
treatment was recommended or received within the six-month period ending
on an individual's enrollment date. Under the plan, the preexisting
condition exclusion generally extends for 12 months, offset by
creditable coverage. However, if an individual has no claims in the
first six months following enrollment, the remainder of the exclusion
period is waived.
(ii) Conclusion. In this Example 2, the plan's preexisting condition
exclusions violate this section because they do not meet the
requirements of this paragraph (b)(3); specifically, they do not apply
uniformly to all similarly situated individuals. The plan provisions do
not apply uniformly to all similarly situated individuals because
individuals who have medical claims during the first six months
following enrollment are not treated the same as similarly situated
individuals with no claims during that period. (Under paragraph (d) of
this section, the groups cannot be treated as two separate groups of
similarly situated individuals because the distinction is based on a
health factor.)
(c) Prohibited discrimination in premiums or contributions--(1) In
general--(i) A group health plan may not require an individual, as a
condition of enrollment or continued enrollment under the plan, to pay a
premium or contribution that is greater than the premium or contribution
for a similarly situated individual (described in paragraph (d) of this
section) enrolled in the plan based on any health factor that relates to
the individual or a dependent of the individual.
(ii) Discounts, rebates, payments in kind, and any other premium
differential mechanisms are taken into account in determining an
individual's premium or contribution rate. (For rules relating to cost-
sharing mechanisms, see paragraph (b)(2) of this section (addressing
benefits).)
(2) Rules relating to premium rates--(i) Group rating based on
health factors not restricted under this section. Nothing in this
section restricts the aggregate amount that an employer may be charged
for coverage under a group health plan. But see Sec. 54.9802-3T(b),
which prohibits adjustments in group premium or contribution rates based
on genetic information.
(ii) List billing based on a health factor prohibited. However, a
group health plan may not quote or charge an employer (or an individual)
a different premium for an individual in a group of similarly situated
individuals based on a health factor. (But see paragraph (g) of this
section permitting favorable treatment of individuals with adverse
health factors.)
(iii) Examples. The rules of this paragraph (c)(2) are illustrated
by the following examples:
Example 1. (i) Facts. An employer sponsors a group health plan and
purchases coverage from a health insurance issuer. In order to determine
the premium rate for the upcoming plan year, the issuer reviews the
claims experience of individuals covered under the plan. The issuer
finds that Individual F had significantly higher claims experience than
similarly situated individuals in the plan. The issuer quotes the plan a
higher per-participant rate because of F's claims experience.
(ii) Conclusion. See Example 1 in 29 CFR 2590.702(c)(2) and 45 CFR
146.121(c)(2) for a conclusion that the issuer does not violate the
provisions of 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) similar to
the provisions of this paragraph (c)(2) because the issuer blends the
rate so that the employer is not quoted a higher rate for F than for a
similarly situated individual based on F's claims experience. (However,
those examples conclude that if the issuer used genetic information in
computing the group rate, it would violate 29 CFR 2590.702-1(b) or 45
CFR 146.122(b).)
Example 2. (i) Facts. Same facts as Example 1, except that the
issuer quotes the employer a higher premium rate for F, because of F's
claims experience, than for a similarly situated individual.
(ii) Conclusion. See Example 2 in 29 CFR 2590.702(c)(2) and 45 CFR
146.121(c)(2) for a
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conclusion that the issuer violates provisions of 29 CFR 2590.702(c)(2)
and 45 CFR 146.121(c)(2) similar to the provisions of this paragraph
(c)(2). Moreover, even if the plan purchased the policy based on the
quote but did not require a higher participant contribution for F than
for a similarly situated individual, see Example 2 in 29 CFR
2590.702(c)(2) and 45 CFR 146.121(c)(2) for a conclusion that the issuer
would still violate 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2) (but
in such a case the plan would not violate this paragraph (c)(2)).
(3) Exception for wellness programs. Notwithstanding paragraphs
(c)(1) and (2) of this section, a plan may vary the amount of premium or
contribution it requires similarly situated individuals to pay based on
whether an individual has met the standards of a wellness program that
satisfies the requirements of paragraph (f) of this section.
(d) Similarly situated individuals. The requirements of this section
apply only within a group of individuals who are treated as similarly
situated individuals. A plan may treat participants as a group of
similarly situated individuals separate from beneficiaries. In addition,
participants may be treated as two or more distinct groups of similarly
situated individuals and beneficiaries may be treated as two or more
distinct groups of similarly situated individuals in accordance with the
rules of this paragraph (d). Moreover, if individuals have a choice of
two or more benefit packages, individuals choosing one benefit package
may be treated as one or more groups of similarly situated individuals
distinct from individuals choosing another benefit package.
(1) Participants. Subject to paragraph (d)(3) of this section, a
plan may treat participants as two or more distinct groups of similarly
situated individuals if the distinction between or among the groups of
participants is based on a bona fide employment-based classification
consistent with the employer's usual business practice. Whether an
employment-based classification is bona fide is determined on the basis
of all the relevant facts and circumstances. Relevant facts and
circumstances include whether the employer uses the classification for
purposes independent of qualification for health coverage (for example,
determining eligibility for other employee benefits or determining other
terms of employment). Subject to paragraph (d)(3) of this section,
examples of classifications that, based on all the relevant facts and
circumstances, may be bona fide include full-time versus part-time
status, different geographic location, membership in a collective
bargaining unit, date of hire, length of service, current employee
versus former employee status, and different occupations. However, a
classification based on any health factor is not a bona fide employment-
based classification, unless the requirements of paragraph (g) of this
section are satisfied (permitting favorable treatment of individuals
with adverse health factors).
(2) Beneficiaries--(i) Subject to paragraph (d)(3) of this section,
a plan may treat beneficiaries as two or more distinct groups of
similarly situated individuals if the distinction between or among the
groups of beneficiaries is based on any of the following factors:
(A) A bona fide employment-based classification of the participant
through whom the beneficiary is receiving coverage;
(B) Relationship to the participant (for example, as a spouse or as
a dependent child);
(C) Marital status;
(D) With respect to children of a participant, age or student
status; or
(E) Any other factor if the factor is not a health factor.
(ii) Paragraph (d)(2)(i) of this section does not prevent more
favorable treatment of individuals with adverse health factors in
accordance with paragraph (g) of this section.
(3) Discrimination directed at individuals. Notwithstanding
paragraphs (d)(1) and (2) of this section, if the creation or
modification of an employment or coverage classification is directed at
individual participants or beneficiaries based on any health factor of
the participants or beneficiaries, the classification is not permitted
under this paragraph (d), unless it is permitted under paragraph (g) of
this section (permitting favorable treatment of individuals with adverse
health factors). Thus, if an employer modified an employment-based
classification to single out, based on a health factor, individual
participants and beneficiaries
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and deny them health coverage, the new classification would not be
permitted under this section.
(4) Examples. The rules of this paragraph (d) are illustrated by the
following examples:
Example 1. (i) Facts. An employer sponsors a group health plan for
full-time employees only. Under the plan (consistent with the employer's
usual business practice), employees who normally work at least 30 hours
per week are considered to be working full-time. Other employees are
considered to be working part-time. There is no evidence to suggest that
the classification is directed at individual participants or
beneficiaries.
(ii) Conclusion. In this Example 1, treating the full-time and part-
time employees as two separate groups of similarly situated individuals
is permitted under this paragraph (d) because the classification is bona
fide and is not directed at individual participants or beneficiaries.
Example 2. (i) Facts. Under a group health plan, coverage is made
available to employees, their spouses, and their dependent children.
However, coverage is made available to a dependent child only if the
dependent child is under age 19 (or under age 25 if the child is
continuously enrolled full-time in an institution of higher learning
(full-time students)). There is no evidence to suggest that these
classifications are directed at individual participants or
beneficiaries.
(ii) Conclusion. In this Example 2, treating spouses and dependent
children differently by imposing an age limitation on dependent
children, but not on spouses, is permitted under this paragraph (d).
Specifically, the distinction between spouses and dependent children is
permitted under paragraph (d)(2) of this section and is not prohibited
under paragraph (d)(3) of this section because it is not directed at
individual participants or beneficiaries. It is also permissible to
treat dependent children who are under age 19 (or full-time students
under age 25) as a group of similarly situated individuals separate from
those who are age 25 or older (or age 19 or older if they are not full-
time students) because the classification is permitted under paragraph
(d)(2) of this section and is not directed at individual participants or
beneficiaries.
Example 3. (i) Facts. A university sponsors a group health plan that
provides one health benefit package to faculty and another health
benefit package to other staff. Faculty and staff are treated
differently with respect to other employee benefits such as retirement
benefits and leaves of absence. There is no evidence to suggest that the
distinction is directed at individual participants or beneficiaries.
(ii) Conclusion. In this Example 3, the classification is permitted
under this paragraph (d) because there is a distinction based on a bona
fide employment-based classification consistent with the employer's
usual business practice and the distinction is not directed at
individual participants and beneficiaries.
Example 4. (i) Facts. An employer sponsors a group health plan that
is available to all current employees. Former employees may also be
eligible, but only if they complete a specified number of years of
service, are enrolled under the plan at the time of termination of
employment, and are continuously enrolled from that date. There is no
evidence to suggest that these distinctions are directed at individual
participants or beneficiaries.
(ii) Conclusion. In this Example 4, imposing additional eligibility
requirements on former employees is permitted because a classification
that distinguishes between current and former employees is a bona fide
employment-based classification that is permitted under this paragraph
(d), provided that it is not directed at individual participants or
beneficiaries. In addition, it is permissible to distinguish between
former employees who satisfy the service requirement and those who do
not, provided that the distinction is not directed at individual
participants or beneficiaries. (However, former employees who do not
satisfy the eligibility criteria may, nonetheless, be eligible for
continued coverage pursuant to a COBRA continuation provision or similar
State law.)
Example 5. (i) Facts. An employer sponsors a group health plan that
provides the same benefit package to all seven employees of the
employer. Six of the seven employees have the same job title and
responsibilities, but Employee G has a different job title and different
responsibilities. After G files an expensive claim for benefits under
the plan, coverage under the plan is modified so that employees with G's
job title receive a different benefit package that includes a lower
lifetime dollar limit than in the benefit package made available to the
other six employees.
(ii) Conclusion. Under the facts of this Example 5, changing the
coverage classification for G based on the existing employment
classification for G is not permitted under this paragraph (d) because
the creation of the new coverage classification for G is directed at G
based on one or more health factors.
(e) Nonconfinement and actively-at-work provisions--(1)
Nonconfinement provisions--(i) General rule. Under the rules of
paragraphs (b) and (c) of this section, a plan may not establish a rule
for eligibility (as described in paragraph (b)(1)(ii) of this section)
or set
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any individual's premium or contribution rate based on whether an
individual is confined to a hospital or other health care institution.
In addition, under the rules of paragraphs (b) and (c) of this section,
a plan may not establish a rule for eligibility or set any individual's
premium or contribution rate based on an individual's ability to engage
in normal life activities, except to the extent permitted under
paragraphs (e)(2)(ii) and (3) of this section (permitting plans, under
certain circumstances, to distinguish among employees based on the
performance of services).
(ii) Examples. The rules of this paragraph (e)(1) are illustrated by
the following examples:
Example 1. (i) Facts. Under a group health plan, coverage for
employees and their dependents generally becomes effective on the first
day of employment. However, coverage for a dependent who is confined to
a hospital or other health care institution does not become effective
until the confinement ends.
(ii) Conclusion. In this Example 1, the plan violates this paragraph
(e)(1) because the plan delays the effective date of coverage for
dependents based on confinement to a hospital or other health care
institution.
Example 2. (i) Facts. In previous years, a group health plan has
provided coverage through a group health insurance policy offered by
Issuer M. However, for the current year, the plan provides coverage
through a group health insurance policy offered by Issuer N. Under
Issuer N's policy, items and services provided in connection with the
confinement of a dependent to a hospital or other health care
institution are not covered if the confinement is covered under an
extension of benefits clause from a previous health insurance issuer.
(ii) Conclusion. See Example 2 in 29 CFR 2590.702(e)(1) and 45 CFR
146.121(e)(1) for a conclusion that Issuer N violates provisions of 29
CFR 2590.702(e)(1) and 45 CFR 146.121(e)(1) similar to the provisions of
this paragraph (e)(1) because the group health insurance coverage
restricts benefits based on whether a dependent is confined to a
hospital or other health care institution that is covered under an
extension of benefits from a previous issuer. See Example 2 in 29 CFR
2590.702(e)(1) and 45 CFR 146.121(e)(1) for the additional conclusions
that under State law Issuer M may also be responsible for providing
benefits to such a dependent; and that in a case in which Issuer N has
an obligation under 29 CFR 2590.702(e)(1) or 45 CFR 146.121(e)(1) to
provide benefits and Issuer M has an obligation under State law to
provide benefits, any State laws designed to prevent more than 100%
reimbursement, such as State coordination-of-benefits laws, continue to
apply.
(2) Actively-at-work and continuous service provisions--(i) General
rule--(A) Under the rules of paragraphs (b) and (c) of this section and
subject to the exception for the first day of work described in
paragraph (e)(2)(ii) of this section, a plan may not establish a rule
for eligibility (as described in paragraph (b)(1)(ii) of this section)
or set any individual's premium or contribution rate based on whether an
individual is actively at work (including whether an individual is
continuously employed), unless absence from work due to any health
factor (such as being absent from work on sick leave) is treated, for
purposes of the plan, as being actively at work.
(B) The rules of this paragraph (e)(2)(i) are illustrated by the
following examples:
Example 1. (i) Facts. Under a group health plan, an employee
generally becomes eligible to enroll 30 days after the first day of
employment. However, if the employee is not actively at work on the
first day after the end of the 30-day period, then eligibility for
enrollment is delayed until the first day the employee is actively at
work.
(ii) Conclusion. In this Example 1, the plan violates this paragraph
(e)(2) (and thus also violates paragraph (b) of this section). However,
the plan would not violate paragraph (e)(2) or (b) of this section if,
under the plan, an absence due to any health factor is considered being
actively at work.
Example 2. (i) Facts. Under a group health plan, coverage for an
employee becomes effective after 90 days of continuous service; that is,
if an employee is absent from work (for any reason) before completing 90
days of service, the beginning of the 90-day period is measured from the
day the employee returns to work (without any credit for service before
the absence).
(ii) Conclusion. In this Example 2, the plan violates this paragraph
(e)(2) (and thus also paragraph (b) of this section) because the 90-day
continuous service requirement is a rule for eligibility based on
whether an individual is actively at work. However, the plan would not
violate this paragraph (e)(2) or paragraph (b) of this section if, under
the plan, an absence due to any health factor is not considered an
absence for purposes of measuring 90 days of continuous service.
(ii) Exception for the first day of work--(A) Notwithstanding the
general
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rule in paragraph (e)(2)(i) of this section, a plan may establish a rule
for eligibility that requires an individual to begin work for the
employer sponsoring the plan (or, in the case of a multiemployer plan,
to begin a job in covered employment) before coverage becomes effective,
provided that such a rule for eligibility applies regardless of the
reason for the absence.
(B) The rules of this paragraph (e)(2)(ii) are illustrated by the
following examples:
Example 1. (i) Facts. Under the eligibility provision of a group
health plan, coverage for new employees becomes effective on the first
day that the employee reports to work. Individual H is scheduled to
begin work on August 3. However, H is unable to begin work on that day
because of illness. H begins working on August 4, and H's coverage is
effective on August 4.
(ii) Conclusion. In this Example 1, the plan provision does not
violate this section. However, if coverage for individuals who do not
report to work on the first day they were scheduled to work for a reason
unrelated to a health factor (such as vacation or bereavement) becomes
effective on the first day they were scheduled to work, then the plan
would violate this section.
Example 2. (i) Facts. Under a group health plan, coverage for new
employees becomes effective on the first day of the month following the
employee's first day of work, regardless of whether the employee is
actively at work on the first day of the month. Individual J is
scheduled to begin work on March 24. However, J is unable to begin work
on March 24 because of illness. J begins working on April 7 and J's
coverage is effective May 1.
(ii) Conclusion. In this Example 2, the plan provision does not
violate this section. However, as in Example 1, if coverage for
individuals absent from work for reasons unrelated to a health factor
became effective despite their absence, then the plan would violate this
section.
(3) Relationship to plan provisions defining similarly situated
individuals--(i) Notwithstanding the rules of paragraphs (e)(1) and (2)
of this section, a plan may establish rules for eligibility or set any
individual's premium or contribution rate in accordance with the rules
relating to similarly situated individuals in paragraph (d) of this
section. Accordingly, a plan may distinguish in rules for eligibility
under the plan between full-time and part-time employees, between
permanent and temporary or seasonal employees, between current and
former employees, and between employees currently performing services
and employees no longer performing services for the employer, subject to
paragraph (d) of this section. However, other Federal or State laws
(including the COBRA continuation provisions and the Family and Medical
Leave Act of 1993) may require an employee or the employee's dependents
to be offered coverage and set limits on the premium or contribution
rate even though the employee is not performing services.
(ii) The rules of this paragraph (e)(3) are illustrated by the
following examples:
Example 1. (i) Facts. Under a group health plan, employees are
eligible for coverage if they perform services for the employer for 30
or more hours per week or if they are on paid leave (such as vacation,
sick, or bereavement leave). Employees on unpaid leave are treated as a
separate group of similarly situated individuals in accordance with the
rules of paragraph (d) of this section.
(ii) Conclusion. In this Example 1, the plan provisions do not
violate this section. However, if the plan treated individuals
performing services for the employer for 30 or more hours per week,
individuals on vacation leave, and individuals on bereavement leave as a
group of similarly situated individuals separate from individuals on
sick leave, the plan would violate this paragraph (e) (and thus also
would violate paragraph (b) of this section) because groups of similarly
situated individuals cannot be established based on a health factor
(including the taking of sick leave) under paragraph (d) of this
section.
Example 2. (i) Facts. To be eligible for coverage under a bona fide
collectively bargained group health plan in the current calendar
quarter, the plan requires an individual to have worked 250 hours in
covered employment during the three-month period that ends one month
before the beginning of the current calendar quarter. The distinction
between employees working at least 250 hours and those working less than
250 hours in the earlier three-month period is not directed at
individual participants or beneficiaries based on any health factor of
the participants or beneficiaries.
(ii) Conclusion. In this Example 2, the plan provision does not
violate this section because, under the rules for similarly situated
individuals allowing full-time employees to be treated differently than
part-time employees, employees who work at least 250 hours in a three-
month period can be treated differently than employees who fail to work
[[Page 433]]
250 hours in that period. The result would be the same if the plan
permitted individuals to apply excess hours from previous periods to
satisfy the requirement for the current quarter.
Example 3. (i) Facts. Under a group health plan, coverage of an
employee is terminated when the individual's employment is terminated,
in accordance with the rules of paragraph (d) of this section. Employee
B has been covered under the plan. B experiences a disabling illness
that prevents B from working. B takes a leave of absence under the
Family and Medical Leave Act of 1993. At the end of such leave, B
terminates employment and consequently loses coverage under the plan.
(This termination of coverage is without regard to whatever rights the
employee (or members of the employee's family) may have for COBRA
continuation.)
(ii) Conclusion. In this Example 3, the plan provision terminating
B's coverage upon B's termination of employment does not violate this
section.
Example 4. (i) Facts. Under a group health plan, coverage of an
employee is terminated when the employee ceases to perform services for
the employer sponsoring the plan, in accordance with the rules of
paragraph (d) of this section. Employee C is laid off for three months.
When the layoff begins, C's coverage under the plan is terminated. (This
termination of coverage is without regard to whatever rights the
employee (or members of the employee's family) may have for COBRA
continuation coverage.)
(ii) Conclusion. In this Example 4, the plan provision terminating
C's coverage upon the cessation of C's performance of services does not
violate this section.
(f) Wellness programs. A wellness program is any program designed to
promote health or prevent disease. Paragraphs (b)(2)(ii) and (c)(3) of
this section provide exceptions to the general prohibitions against
discrimination based on a health factor for plan provisions that vary
benefits (including cost-sharing mechanisms) or the premium or
contribution for similarly situated individuals in connection with a
wellness program that satisfies the requirements of this paragraph (f).
If none of the conditions for obtaining a reward under a wellness
program is based on an individual satisfying a standard that is related
to a health factor, paragraph (f)(1) of this section clarifies that the
wellness program does not violate this section if participation in the
program is made available to all similarly situated individuals. If any
of the conditions for obtaining a reward under a wellness program is
based on an individual satisfying a standard that is related to a health
factor, the wellness program does not violate this section if the
requirements of paragraph (f)(2) of this section are met.
(1) Wellness programs not subject to requirements. If none of the
conditions for obtaining a reward under a wellness program are based on
an individual satisfying a standard that is related to a health factor
(or if a wellness program does not provide a reward), the wellness
program does not violate this section, if participation in the program
is made available to all similarly situated individuals. Thus, for
example, the following programs need not satisfy the requirements of
paragraph (f)(2) of this section, if participation in the program is
made available to all similarly situated individuals:
(i) A program that reimburses all or part of the cost for
memberships in a fitness center.
(ii) A diagnostic testing program that provides a reward for
participation and does not base any part of the reward on outcomes.
(iii) A program that encourages preventive care through the waiver
of the copayment or deductible requirement under a group health plan for
the costs of, for example, prenatal care or well-baby visits.
(iv) A program that reimburses employees for the costs of smoking
cessation programs without regard to whether the employee quits smoking.
(v) A program that provides a reward to employees for attending a
monthly health education seminar.
(2) Wellness programs subject to requirements. If any of the
conditions for obtaining a reward under a wellness program is based on
an individual satisfying a standard that is related to a health factor,
the wellness program does not violate this section if the requirements
of this paragraph (f)(2) are met.
(i) The reward for the wellness program, coupled with the reward for
other wellness programs with respect to the plan that require
satisfaction of a standard related to a health factor, must not exceed
20 percent of the cost of employee-only coverage under the
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plan. However, if, in addition to employees, any class of dependents
(such as spouses or spouses and dependent children) may participate in
the wellness program, the reward must not exceed 20 percent of the cost
of the coverage in which an employee and any dependents are enrolled.
For purposes of this paragraph (f)(2), the cost of coverage is
determined based on the total amount of employer and employee
contributions for the benefit package under which the employee is (or
the employee and any dependents are) receiving coverage. A reward can be
in the form of a discount or rebate of a premium or contribution, a
waiver of all or part of a cost-sharing mechanism (such as deductibles,
copayments, or coinsurance), the absence of a surcharge, or the value of
a benefit that would otherwise not be provided under the plan.
(ii) The program must be reasonably designed to promote health or
prevent disease. A program satisfies this standard if it has a
reasonable chance of improving the health of or preventing disease in
participating individuals and it is not overly burdensome, is not a
subterfuge for discriminating based on a health factor, and is not
highly suspect in the method chosen to promote health or prevent
disease.
(iii) The program must give individuals eligible for the program the
opportunity to qualify for the reward under the program at least once
per year.
(iv) The reward under the program must be available to all similarly
situated individuals.
(A) A reward is not available to all similarly situated individuals
for a period unless the program allows--
(1) A reasonable alternative standard (or waiver of the otherwise
applicable standard) for obtaining the reward for any individual for
whom, for that period, it is unreasonably difficult due to a medical
condition to satisfy the otherwise applicable standard; and
(2) A reasonable alternative standard (or waiver of the otherwise
applicable standard) for obtaining the reward for any individual for
whom, for that period, it is medically inadvisable to attempt to satisfy
the otherwise applicable standard.
(B) A plan or issuer may seek verification, such as a statement from
an individual's physician, that a health factor makes it unreasonably
difficult or medically inadvisable for the individual to satisfy or
attempt to satisfy the otherwise applicable standard.
(v)(A) The plan must disclose in all plan materials describing the
terms of the program the availability of a reasonable alternative
standard (or the possibility of waiver of the otherwise applicable
standard) required under paragraph (f)(2)(iv) of this section. However,
if plan materials merely mention that a program is available, without
describing its terms, this disclosure is not required.
(B) The following language, or substantially similar language, can
be used to satisfy the requirement of this paragraph (f)(2)(v): ``If it
is unreasonably difficult due to a medical condition for you to achieve
the standards for the reward under this program, or if it is medically
inadvisable for you to attempt to achieve the standards for the reward
under this program, call us at [insert telephone number] and we will
work with you to develop another way to qualify for the reward.'' In
addition, other examples of language that would satisfy this requirement
are set forth in Examples 3, 4, and 5 of paragraph (f)(3) of this
section.
(3) Examples. The rules of paragraph (f)(2) of this section are
illustrated by the following examples:
Example 1. (i) Facts. An employer sponsors a group health plan. The
annual premium for employee-only coverage is $3,600 (of which the
employer pays $2,700 per year and the employee pays $900 per year). The
annual premium for family coverage is $9,000 (of which the employer pays
$4,500 per year and the employee pays $4,500 per year). The plan offers
a wellness program with an annual premium rebate of $360. The program is
available only to employees.
(ii) Conclusion. In this Example 1, the program satisfies the
requirements of paragraph (f)(2)(i) of this section because the reward
for the wellness program, $360, does not exceed 20 percent of the total
annual cost of employee-only coverage, $720. ($3,600 x 20% = $720.) If
any class of dependents is allowed to participate in the program and the
employee is enrolled in family coverage, the plan could offer the
employee a reward of up to 20 percent of the cost of family coverage,
$1,800. ($9,000 x 20% = $1,800.)
[[Page 435]]
Example 2. (i) Facts. A group health plan gives an annual premium
discount of 20 percent of the cost of employee-only coverage to
participants who adhere to a wellness program. The wellness program
consists solely of giving an annual cholesterol test to participants.
Those participants who achieve a count under 200 receive the premium
discount for the year.
(ii) Conclusion. In this Example 2, the program fails to satisfy the
requirement of being available to all similarly situated individuals
because some participants may be unable to achieve a cholesterol count
of under 200 and the plan does not make available a reasonable
alternative standard or waive the cholesterol standard. (In addition,
plan materials describing the program are required to disclose the
availability of a reasonable alternative standard (or the possibility of
waiver of the otherwise applicable standard) for obtaining the premium
discount. Thus, the premium discount violates paragraph (c) of this
section because it may require an individual to pay a higher premium
based on a health factor of the individual than is required of a
similarly situated individual under the plan.
Example 3. (i) Facts. Same facts as Example 2, except that the plan
provides that if it is unreasonably difficult due to a medical condition
for a participant to achieve the targeted cholesterol count (or if it is
medically inadvisable for a participant to attempt to achieve the
targeted cholesterol count) within a 60-day period, the plan will make
available a reasonable alternative standard that takes the relevant
medical condition into account. In addition, all plan materials
describing the terms of the program include the following statement:
``If it is unreasonably difficult due to a medical condition for you to
achieve a cholesterol count under 200, or if it is medically inadvisable
for you to attempt to achieve a count under 200, call us at the number
below and we will work with you to develop another way to get the
discount.'' Individual D begins a diet and exercise program but is
unable to achieve a cholesterol count under 200 within the prescribed
period. D's doctor determines D requires prescription medication to
achieve a medically advisable cholesterol count. In addition, the doctor
determines that D must be monitored through periodic blood tests to
continually reevaluate D's health status. The plan accommodates D by
making the discount available to D, but only if D follows the advice of
D's doctor's regarding medication and blood tests.
(ii) Conclusion. In this Example 3, the program is a wellness
program because it satisfies the five requirements of paragraph (f)(2)
of this section. First, the program complies with the limits on rewards
under a program. Second, it is reasonably designed to promote health or
prevent disease. Third, individuals eligible for the program are given
the opportunity to qualify for the reward at least once per year.
Fourth, the reward under the program is available to all similarly
situated individuals because it accommodates individuals for whom it is
unreasonably difficult due to a medical condition to achieve the
targeted count (or for whom it is medically inadvisable to attempt to
achieve the targeted count) in the prescribed period by providing a
reasonable alternative standard. Fifth, the plan discloses in all
materials describing the terms of the program the availability of a
reasonable alternative standard. Thus, the premium discount does not
violate this section.
Example 4. (i) Facts. A group health plan will waive the $250 annual
deductible (which is less than 20 percent of the annual cost of
employee-only coverage under the plan) for the following year for
participants who have a body mass index between 19 and 26, determined
shortly before the beginning of the year. However, any participant for
whom it is unreasonably difficult due to a medical condition to attain
this standard (and any participant for whom it is medically inadvisable
to attempt to achieve this standard) during the plan year is given the
same discount if the participant walks for 20 minutes three days a week.
Any participant for whom it is unreasonably difficult due to a medical
condition to attain either standard (and any participant for whom it is
medically inadvisable to attempt to achieve either standard) during the
year is given the same discount if the individual satisfies an
alternative standard that is reasonable in the burden it imposes and is
reasonable taking into consideration the individual's medical situation.
All plan materials describing the terms of the wellness program include
the following statement: ``If it is unreasonably difficult due to a
medical condition for you to achieve a body mass index between 19 and 26
(or if it is medically inadvisable for you to attempt to achieve this
body mass index) this year, your deductible will be waived if you walk
for 20 minutes three days a week. If you cannot follow the walking
program, call us at the number above and we will work with you to
develop another way to have your deductible waived.'' Due to a medical
condition, Individual E is unable to achieve a BMI of between 19 and 26
and is also unable to follow the walking program. E proposes a program
based on the recommendations of E's physician. The plan agrees to make
the discount available to E if E follows the physician's
recommendations.
(ii) Conclusion. In this Example 4, the program satisfies the five
requirements of paragraph (f)(2) of this section. First, the program
complies with the limits on rewards under a program. Second, it is
reasonably designed to promote health or prevent disease. Third,
individuals eligible for the program
[[Page 436]]
are given the opportunity to qualify for the reward at least once per
year. Fourth, the reward under the program is available to all similarly
situated individuals because it generally accommodates individuals for
whom it is unreasonably difficult due to a medical condition to achieve
(or for whom it is medically inadvisable to attempt to achieve) the
targeted body mass index by providing a reasonable alternative standard
(walking) and it accommodates individuals for whom it is unreasonably
difficult due to a medical condition (or for whom it is medically
inadvisable to attempt) to walk by providing an alternative standard
that is reasonable for the individual. Fifth, the plan discloses in all
materials describing the terms of the program the availability of a
reasonable alternative standard for every individual. Thus, the waiver
of the deductible does not violate this section.
Example 5. (i) Facts. In conjunction with an annual open enrollment
period, a group health plan provides a form for participants to certify
that they have not used tobacco products in the preceding twelve months.
Participants who do not provide the certification are assessed a
surcharge that is 20 percent of the cost of employee-only coverage.
However, all plan materials describing the terms of the wellness program
include the following statement: ``If it is unreasonably difficult due
to a health factor for you to meet the requirements under this program
(or if it is medically inadvisable for you to attempt to meet the
requirements of this program), we will make available a reasonable
alternative standard for you to avoid this surcharge.'' It is
unreasonably difficult for Individual F to stop smoking cigarettes due
to an addiction to nicotine (a medical condition). The plan accommodates
F by requiring F to participate in a smoking cessation program to avoid
the surcharge. F can avoid the surcharge for as long as F participates
in the program, regardless of whether F stops smoking (as long as F
continues to be addicted to nicotine).
(ii) Conclusion. In this Example 5, the premium surcharge is
permissible as a wellness program because it satisfies the five
requirements of paragraph (f)(2) of this section. First, the program
complies with the limits on rewards under a program. Second, it is
reasonably designed to promote health or prevent disease. Third,
individuals eligible for the program are given the opportunity to
qualify for the reward at least once per year. Fourth, the reward under
the program is available to all similarly situated individuals because
it accommodates individuals for whom it is unreasonably difficult due to
a medical condition (or for whom it is medically inadvisable to attempt)
to quit using tobacco products by providing a reasonable alternative
standard. Fifth, the plan discloses in all materials describing the
terms of the program the availability of a reasonable alternative
standard. Thus, the premium surcharge does not violate this section.
Example 6. (i) Facts. Same facts as Example 5, except the plan
accommodates F by requiring F to view, over a period of 12 months, a 12-
hour video series on health problems associated with tobacco use. F can
avoid the surcharge by complying with this requirement.
(ii) Conclusion. In this Example 6, the requirement to watch the
series of video tapes is a reasonable alternative method for avoiding
the surcharge.
(g) More favorable treatment of individuals with adverse health
factors permitted--(1) In rules for eligibility. (i) Nothing in this
section prevents a group health plan from establishing more favorable
rules for eligibility (described in paragraph (b)(1) of this section)
for individuals with an adverse health factor, such as disability, than
for individuals without the adverse health factor. Moreover, nothing in
this section prevents a plan from charging a higher premium or
contribution with respect to individuals with an adverse health factor
if they would not be eligible for the coverage were it not for the
adverse health factor. (However, other laws, including State insurance
laws, may set or limit premium rates; these laws are not affected by
this section.)
(ii) The rules of this paragraph (g)(1) are illustrated by the
following examples:
Example 1. (i) Facts. An employer sponsors a group health plan that
generally is available to employees, spouses of employees, and dependent
children until age 23. However, dependent children who are disabled are
eligible for coverage beyond age 23.
(ii) Conclusion. In this Example 1, the plan provision allowing
coverage for disabled dependent children beyond age 23 satisfies this
paragraph (g)(1) (and thus does not violate this section).
Example 2. (i) Facts. An employer sponsors a group health plan,
which is generally available to employees (and members of the employee's
family) until the last day of the month in which the employee ceases to
perform services for the employer. The plan generally charges employees
$50 per month for employee-only coverage and $125 per month for family
coverage. However, an employee who ceases to perform services for the
employer by reason of disability may remain covered under the plan until
the last day of the month that is 12 months after the month in which the
employee ceased to perform
[[Page 437]]
services for the employer. During this extended period of coverage, the
plan charges the employee $100 per month for employee-only coverage and
$250 per month for family coverage. (This extended period of coverage is
without regard to whatever rights the employee (or members of the
employee's family) may have for COBRA continuation coverage.)
(ii) Conclusion. In this Example 2, the plan provision allowing
extended coverage for disabled employees and their families satisfies
this paragraph (g)(1) (and thus does not violate this section). In
addition, the plan is permitted, under this paragraph (g)(1), to charge
the disabled employees a higher premium during the extended period of
coverage.
Example 3. (i) Facts. To comply with the requirements of a COBRA
continuation provision, a group health plan generally makes COBRA
continuation coverage available for a maximum period of 18 months in
connection with a termination of employment but makes the coverage
available for a maximum period of 29 months to certain disabled
individuals and certain members of the disabled individual's family.
Although the plan generally requires payment of 102 percent of the
applicable premium for the first 18 months of COBRA continuation
coverage, the plan requires payment of 150 percent of the applicable
premium for the disabled individual's COBRA continuation coverage during
the disability extension if the disabled individual would not be
entitled to COBRA continuation coverage but for the disability.
(ii) Conclusion. In this Example 3, the plan provision allowing
extended COBRA continuation coverage for disabled individuals satisfies
this paragraph (g)(1) (and thus does not violate this section). In
addition, the plan is permitted, under this paragraph (g)(1), to charge
the disabled individuals a higher premium for the extended coverage if
the individuals would not be eligible for COBRA continuation coverage
were it not for the disability. (Similarly, if the plan provided an
extended period of coverage for disabled individuals pursuant to State
law or plan provision rather than pursuant to a COBRA continuation
coverage provision, the plan could likewise charge the disabled
individuals a higher premium for the extended coverage.)
(2) In premiums or contributions--(i) Nothing in this section
prevents a group health plan from charging individuals a premium or
contribution that is less than the premium (or contribution) for
similarly situated individuals if the lower charge is based on an
adverse health factor, such as disability.
(ii) The rules of this paragraph (g)(2) are illustrated by the
following example:
Example. (i) Facts. Under a group health plan, employees are
generally required to pay $50 per month for employee-only coverage and
$125 per month for family coverage under the plan. However, employees
who are disabled receive coverage (whether employee-only or family
coverage) under the plan free of charge.
(ii) Conclusion. In this Example, the plan provision waiving premium
payment for disabled employees is permitted under this paragraph (g)(2)
(and thus does not violate this section).
(h) No effect on other laws. Compliance with this section is not
determinative of compliance with any provision of ERISA (including the
COBRA continuation provisions) or any other State or Federal law, such
as the Americans with Disabilities Act. Therefore, although the rules of
this section would not prohibit a plan from treating one group of
similarly situated individuals differently from another (such as
providing different benefit packages to current and former employees),
other Federal or State laws may require that two separate groups of
similarly situated individuals be treated the same for certain purposes
(such as making the same benefit package available to COBRA qualified
beneficiaries as is made available to active employees). In addition,
although this section generally does not impose new disclosure
obligations on plans, this section does not affect any other laws,
including those that require accurate disclosures and prohibit
intentional misrepresentation.
(i) Applicability dates. This section applies for plan years
beginning on or after July 1, 2007.
[T.D. 9298, 71 FR 75030, Dec. 13, 2006; 72 FR 7929, Feb. 22, 2007, as
amended by T.D. 9464, 74 FR 51678, Oct. 7, 2009]
Sec. 54.9802-2 Special rules for certain church plans.
(a) Exception for certain church plans--(1) Church plans in general.
A church plan described in paragraph (b) of this section is not treated
as failing to meet the requirements of section 9802 or Sec. 54.9802-1
solely because the plan requires evidence of good health for coverage of
individuals under plan provisions described in paragraph (b)(2) or (3)
of this section.
[[Page 438]]
(2) Health insurance issuers. See sections 2702 and 2721(b)(1)(B) of
the Public Health Service Act (42 U.S.C. 300gg-2 and 300gg-21(b)(1)(B))
and 45 CFR 146.121, which require health insurance issuers providing
health insurance coverage under a church plan that is a group health
plan to comply with nondiscrimination requirements similar to those that
church plans are required to comply with under section 9802 and Sec.
54.9802-1 except that those nondiscrimination requirements do not
include an exception for health insurance issuers comparable to the
exception for church plans under section 9802(c) and this section.
(b) Church plans to which this section applies--(1) Church plans
with certain coverage provisions in effect on July 15, 1997. This
section applies to any church plan (as defined in section 414(e)) for a
plan year if, on July 15, 1997 and at all times thereafter before the
beginning of the plan year, the plan contains either the provisions
described in paragraph (b)(2) of this section or the provisions
described in paragraph (b)(3) of this section.
(2) Plan provisions applicable to individuals employed by employers
of 10 or fewer employees and self-employed individuals. (i) A plan
contains the provisions described in this paragraph (b)(2) if it
requires evidence of good health of both--
(A) Any employee of an employer of 10 or fewer employees (determined
without regard to section 414(e)(3)(C), under which a church or
convention or association of churches is treated as the employer); and
(B) Any self-employed individual.
(ii) A plan does not contain the provisions described in this
paragraph (b)(2) if the plan contains only one of the provisions
described in this paragraph (b)(2). Thus, for example, a plan that
requires evidence of good health of any self-employed individual, but
not of any employee of an employer with 10 or fewer employees, does not
contain the provisions described in this paragraph (b)(2). Moreover, a
plan does not contain the provision described in paragraph (b)(2)(i)(A)
of this section if the plan requires evidence of good health of any
employee of an employer of fewer than 10 (or greater than 10) employees.
Thus, for example, a plan does not contain the provision described in
paragraph (b)(2)(i)(A) of this section if the plan requires evidence of
good health of any employee of an employer with five or fewer employees.
(3) Plan provisions applicable to individuals who enroll after the
first 90 days of initial eligibility. (i) A plan contains the provisions
described in this paragraph (b)(3) if it requires evidence of good
health of any individual who enrolls after the first 90 days of initial
eligibility under the plan.
(ii) A plan does not contain the provisions described in this
paragraph (b)(3) if it provides for a longer (or shorter) period than 90
days. Thus, for example, a plan requiring evidence of good health of any
individual who enrolls after the first 120 days of initial eligibility
under the plan does not contain the provisions described in this
paragraph (b)(3).
(c) Examples. The rules of this section are illustrated by the
following examples:
Example 1. (i) Facts. A church organization maintains two church
plans for entities affiliated with the church. One plan is a group
health plan that provides health coverage to all employees (including
ministers and lay workers) of any affiliated church entity that has more
than 10 employees. The other plan is Plan O, which is a group health
plan that is not funded through insurance coverage and that provides
health coverage to any employee (including ministers and lay workers) of
any affiliated church entity that has 10 or fewer employees and any
self-employed individual affiliated with the church (including a self-
employed minister of the church). Plan O requires evidence of good
health in order for any individual of a church entity that has 10 or
fewer employees to be covered and in order for any self-employed
individual to be covered. On July 15, 1997 and at all times thereafter
before the beginning of the plan year, Plan O has contained all the
preceding provisions.
(ii) Conclusion. In this Example 1, because Plan O contains the plan
provisions described in paragraph (b)(2) of this section and because
those provisions were in the plan on July 15, 1997 and at all times
thereafter before the beginning of the plan year, Plan O will not be
treated as failing to meet the requirements of section 9802 or Sec.
54.9802-1 for the plan year solely because the plan requires evidence of
good health for coverage of the individuals described in those plan
provisions.
[[Page 439]]
Example 2. (i) Facts. A church organization maintains Plan P, which
is a church plan that is not funded through insurance coverage and that
is a group health plan providing health coverage to individuals employed
by entities affiliated with the church and self-employed individuals
affiliated with the church (such as ministers). On July 15, 1997 and at
all times thereafter before the beginning of the plan year, Plan P has
required evidence of good health for coverage of any individual who
enrolls after the first 90 days of initial eligibility under the plan.
(ii) Conclusion. In this Example 2, because Plan P contains the plan
provisions described in paragraph (b)(3) of this section and because
those provisions were in the plan on July 15, 1997 and at all times
thereafter before the beginning of the plan year, Plan P will not be
treated as failing to meet the requirements of section 9802 or Sec.
54.9802-1 for the plan year solely because the plan requires evidence of
good health for coverage of individuals enrolling after the first 90
days of initial eligibility under the plan.
(d) Applicability date. This section is applicable to plan years
beginning on or after July 1, 2007.
[T.D. 9299, 71 FR 75056, Dec. 13, 2006]
Sec. 54.9802-3T Additional requirements prohibiting discrimination based on
genetic information (temporary).
(a) Definitions. Unless otherwise provided, the definitions in this
paragraph (a) govern in applying the provisions of this section.
(1) Collect means, with respect to information, to request, require,
or purchase such information.
(2) Family member means, with respect to an individual --
(i) A dependent (as defined for purposes of Sec. 54.9801-2) of the
individual; or
(ii) Any other person who is a first-degree, second-degree, third-
degree, or fourth-degree relative of the individual or of a dependent of
the individual. Relatives by affinity (such as by marriage or adoption)
are treated the same as relatives by consanguinity (that is, relatives
who share a common biological ancestor). In determining the degree of
the relationship, relatives by less than full consanguinity (such as
half-siblings, who share only one parent) are treated the same as
relatives by full consanguinity (such as siblings who share both
parents).
(A) First-degree relatives include parents, spouses, siblings, and
children.
(B) Second-degree relatives include grandparents, grandchildren,
aunts, uncles, nephews, and nieces.
(C) Third-degree relatives include great-grandparents, great-
grandchildren, great aunts, great uncles, and first cousins.
(D) Fourth-degree relatives include great-great grandparents, great-
great grandchildren, and children of first cousins.
(3) Genetic information means--
(i) Subject to paragraphs (a)(3)(ii) and (a)(3)(iii) of this
section, with respect to an individual, information about--
(A) The individual's genetic tests (as defined in paragraph (a)(5)
of this section);
(B) The genetic tests of family members of the individual;
(C) The manifestation (as defined in paragraph (a)(6) of this
section) of a disease or disorder in family members of the individual;
or
(D) Any request for, or receipt of, genetic services (as defined in
paragraph (a)(4) of this section), or participation in clinical research
which includes genetic services, by the individual or any family member
of the individual.
(ii) The term genetic information does not include information about
the sex or age of any individual.
(iii) The term genetic information includes--
(A) With respect to a pregnant woman (or a family member of the
pregnant woman), genetic information of any fetus carried by the
pregnant woman; and
(B) With respect to an individual (or a family member of the
individual) who is utilizing an assisted reproductive technology,
genetic information of any embryo legally held by the individual or
family member.
(4) Genetic services means--
(i) A genetic test, as defined in paragraph (a)(5) of this section;
(ii) Genetic counseling (including obtaining, interpreting, or
assessing genetic information); or
(iii) Genetic education.
(5)(i) Genetic test means an analysis of human DNA, RNA,
chromosomes, proteins, or metabolites, if the analysis detects
genotypes, mutations, or chromosomal changes. However, a genetic
[[Page 440]]
test does not include an analysis of proteins or metabolites that is
directly related to a manifested disease, disorder, or pathological
condition. Accordingly, a test to determine whether an individual has a
BRCA1 or BRCA2 variant is a genetic test. Similarly, a test to determine
whether an individual has a genetic variant associated with hereditary
nonpolyposis colorectal cancer is a genetic test. However, an HIV test,
complete blood count, cholesterol test, liver function test, or test for
the presence of alcohol or drugs is not a genetic test.
(ii) The rules of this paragraph (a)(5) are illustrated by the
following example:
Example. (i) Facts. Individual A is a newborn covered under a group
health plan. A undergoes a phenylketonuria (PKU) screening, which
measures the concentration of a metabolite, phenylalanine, in A's blood.
In PKU, a mutation occurs in the phenylalanine hydroxylase (PAH) gene
which contains instructions for making the enzyme needed to break down
the amino acid phenylalanine. Individuals with the mutation, who have a
deficiency in the enzyme to break down phenylalanine, have high
concentrations of phenylalanine.
(ii) Conclusion. In this Example, the PKU screening is a genetic
test with respect to A because the screening is an analysis of
metabolites that detects a genetic mutation.
(6)(i) Manifestation or manifested means, with respect to a disease,
disorder, or pathological condition, that an individual has been or
could reasonably be diagnosed with the disease, disorder, or
pathological condition by a health care professional with appropriate
training and expertise in the field of medicine involved. For purposes
of this section, a disease, disorder, or pathological condition is not
manifested if a diagnosis is based principally on genetic information.
(ii) The rules of this paragraph (a)(6) are illustrated by the
following examples:
Example 1. (i) Facts. Individual A has a family medical history of
diabetes. A begins to experience excessive sweating, thirst, and
fatigue. A's physician examines A and orders blood glucose testing
(which is not a genetic test). Based on the physician's examination, A's
symptoms, and test results that show elevated levels of blood glucose,
A's physician diagnoses A as having adult onset diabetes mellitus (Type
2 diabetes).
(ii) Conclusion. In this Example 1, A has been diagnosed by a health
care professional with appropriate training and expertise in the field
of medicine involved. The diagnosis is not based principally on genetic
information. Thus, Type 2 diabetes is manifested with respect to A.
Example 2. (i) Facts. Individual B has several family members with
colon cancer. One of them underwent genetic testing which detected a
mutation in the MSH2 gene associated with hereditary nonpolyposis
colorectal cancer (HNPCC). B's physician, a health care professional
with appropriate training and expertise in the field of medicine
involved, recommends that B undergo a targeted genetic test to look for
the specific mutation found in B's relative to determine if B has an
elevated risk for cancer. The genetic test with respect to B showed that
B also carries the mutation and is at increased risk to develop
colorectal and other cancers associated with HNPCC. B has a colonoscopy
which indicates no signs of disease, and B has no symptoms.
(ii) Conclusion. In this Example 2, because B has no signs or
symptoms of colorectal cancer, B has not been and could not reasonably
be diagnosed with HNPCC. Thus, HNPCC is not manifested with respect to
B.
Example 3. (i) Facts. Same facts as Example 2, except that B's
colonoscopy and subsequent tests indicate the presence of HNPCC. Based
on the colonoscopy and subsequent test results, B's physician makes a
diagnosis of HNPCC.
(ii) Conclusion. In this Example 3, HNPCC is manifested with respect
to B because a health care professional with appropriate training and
expertise in the field of medicine involved has made a diagnosis that is
not based principally on genetic information.
Example 4. (i) Facts. Individual C has a family member that has been
diagnosed with Huntington's Disease. A genetic test indicates that C has
the Huntington's Disease gene variant. At age 42, C begins suffering
from occasional moodiness and disorientation, symptoms which are
associated with Huntington's Disease. C is examined by a neurologist (a
physician with appropriate training and expertise for diagnosing
Huntington's Disease). The examination includes a clinical neurological
exam. The results of the examination do not support a diagnosis of
Huntington's Disease.
(ii) Conclusion. In this Example 4, C is not and could not
reasonably be diagnosed with Huntington's Disease by a health care
professional with appropriate training and expertise. Therefore,
Huntington's Disease is not manifested with respect to C.
[[Page 441]]
Example 5. (i) Facts. Same facts as Example 4, except that C
exhibits additional neurological and behavioral symptoms, and the
results of the examination support a diagnosis of Huntington's Disease
with respect to C.
(ii) Conclusion. In this Example 5, C could reasonably be diagnosed
with Huntington's Disease by a health care professional with appropriate
training and expertise. Therefore, Huntington's Disease is manifested
with respect to C.
(7) Underwriting purposes has the meaning given in paragraph (d)(1)
of this section.
(b) No group-based discrimination based on genetic information--(1)
In general. For purposes of this section, a group health plan must not
adjust premium or contribution amounts for any employer, or any group of
similarly situated individuals under the plan, on the basis of genetic
information. For this purpose, ``similarly situated individuals'' are
those described in Sec. 54.9802-1(d).
(2) Rule of construction. Nothing in paragraph (b)(1) of this
section (or in paragraph (d)(1) or (d)(2) of this section) limits the
ability of a group health plan to increase the premium for an employer
or for a group of similarly situated individuals under the plan based on
the manifestation of a disease or disorder of an individual who is
enrolled in the plan. In such a case, however, the manifestation of a
disease or disorder in one individual cannot also be used as genetic
information about other group members to further increase the premium
for an employer or a group of similarly situated individuals under the
plan.
(3) Examples. The rules of this paragraph (b) are illustrated by the
following examples:
Example 1. (i) Facts. An employer sponsors a group health plan that
provides coverage through a health insurance issuer. In order to
determine the premium rate for the upcoming plan year, the issuer
reviews the claims experience of individuals covered under the plan and
other health status information of the individuals, including genetic
information. The issuer finds that three individuals covered under the
plan had unusually high claims experience. In addition, the issuer finds
that the genetic information of two other individuals indicates the
individuals have a higher probability of developing certain illnesses
although the illnesses are not manifested at this time. The issuer
quotes the plan a higher per-participant rate because of both the
genetic information and the higher claims experience.
(ii) Conclusion. See Example 1 in 29 CFR 2590.702-1(b)(3) or 45 CFR
146.122(b)(3) for a conclusion that the issuer violates the provisions
of 29 CFR 2590.702-1(b) or 45 CFR 146.122(b) similar to the requirements
of this paragraph (b) because the issuer adjusts the premium based on
genetic information. However, if the adjustment related solely to claims
experience, the adjustment would not violate the requirements of 29 CFR
2590.702-1 or 45 CFR 146.122 similar to the requirements of this section
(nor would it violate the requirements of paragraph (c) of 29 CFR
2590.702 or 45 CFR 146.121 similar to the requirements of paragraph (c)
of Sec. 54.9802-1, which prohibits discrimination in individual
premiums or contributions based on a health factor but permits increases
in the group rate based on a health factor).
Example 2. (i) Facts. An employer sponsors a group health plan that
provides coverage through a health insurance issuer. In order to
determine the premium rate for the upcoming plan year, the issuer
reviews the claims experience of individuals covered under the plan and
other health status information of the individuals, including genetic
information. The issuer finds that Employee A has made claims for
treatment of polycystic kidney disease. A also has two dependent
children covered under the plan. The issuer quotes the plan a higher
per-participant rate because of both A's claims experience and the
family medical history of A's children (that is, the fact that A has the
disease).
(ii) Conclusion. See Example 2 in 29 CFR 2590.702-1(b)(3) or 45 CFR
146.122(b)(3) for a conclusion that the issuer violates the provisions
of 29 CFR 2590.702-1(b) or 45 CFR 146.122(b) similar to the requirements
of this paragraph (b) because, by taking the likelihood that A's
children may develop polycystic kidney disease into account in computing
the rate for the plan, the issuer adjusts the premium based on genetic
information relating to a condition that has not been manifested in A's
children. However, the issuer does not violate the requirements of 29
CFR 2590.702-1(b) or 45 CFR 146.122(b) similar to the requirements of
this paragraph (b) by increasing the premium based on A's claims
experience.
(c) Limitation on requesting or requiring genetic testing--(1)
General rule. Except as otherwise provided in this paragraph (c), a
group health plan must not request or require an individual or a family
member of the individual to undergo a genetic test.
[[Page 442]]
(2) Health care professional may recommend a genetic test. Nothing
in paragraph (c)(1) of this section limits the authority of a health
care professional who is providing health care services to an individual
to request that the individual undergo a genetic test.
(3) Examples. The rules of paragraphs (c)(1) and (c)(2) of this
section are illustrated by the following examples:
Example 1. (i) Facts. Individual A goes to a physician for a routine
physical examination. The physician reviews A's family medical history
and A informs the physician that A's mother has been diagnosed with
Huntington's Disease. The physician advises A that Huntington's Disease
is hereditary and recommends that A undergo a genetic test.
(ii) Conclusion. In this Example 1, the physician is a health care
professional who is providing health care services to A. Therefore, the
physician's recommendation that A undergo the genetic test does not
violate this paragraph (c).
Example 2. (i) Facts. Individual B is covered by a health
maintenance organization (HMO). B is a child being treated for leukemia.
B's physician, who is employed by the HMO, is considering a treatment
plan that includes six-mercaptopurine, a drug for treating leukemia in
most children. However, the drug could be fatal if taken by a small
percentage of children with a particular gene variant. B's physician
recommends that B undergo a genetic test to detect this variant before
proceeding with this course of treatment.
(ii) Conclusion. In this Example 2, even though the physician is
employed by the HMO, the physician is nonetheless a health care
professional who is providing health care services to B. Therefore, the
physician's recommendation that B undergo the genetic test does not
violate this paragraph (c).
(4) Determination regarding payment--(i) In general. As provided in
this paragraph (c)(4), nothing in paragraph (c)(1) of this section
precludes a plan from obtaining and using the results of a genetic test
in making a determination regarding payment. For this purpose,
``payment'' has the meaning given such term in 45 CFR 164.501 of the
privacy regulations issued under the Health Insurance Portability and
Accountability Act. Thus, if a plan conditions payment for an item or
service based on its medical appropriateness and the medical
appropriateness of the item or service depends on the genetic makeup of
a patient, then the plan is permitted to condition payment for the item
or service on the outcome of a genetic test. The plan may also refuse
payment if the patient does not undergo the genetic test.
(ii) Limitation. A plan is permitted to request only the minimum
amount of information necessary to make a determination regarding
payment. The minimum amount of information necessary is determined in
accordance with the minimum necessary standard in 45 CFR 164.502(b) of
the privacy regulations issued under the Health Insurance Portability
and Accountability Act.
(iii) Examples. See paragraph (e) of this section for examples
illustrating the rules of this paragraph (c)(4), as well as other
provisions of this section.
(5) Research exception. Notwithstanding paragraph (c)(1) of this
section, a plan may request, but not require, that a participant or
beneficiary undergo a genetic test if all of the conditions of this
paragraph (c)(5) are met:
(i) Research in accordance with Federal regulations and applicable
State or local law or regulations. The plan makes the request pursuant
to research, as defined in 45 CFR 46.102(d), that complies with 45 CFR
Part 46 or equivalent Federal regulations, and any applicable State or
local law or regulations for the protection of human subjects in
research.
(ii) Written request for participation in research. The plan makes
the request in writing, and the request clearly indicates to each
participant or beneficiary (or, in the case of a minor child, to the
legal guardian of the beneficiary) that--
(A) Compliance with the request is voluntary; and
(B) Noncompliance will have no effect on eligibility for benefits
(as described in Sec. 54.9802-1(b)(1)) or premium or contribution
amounts.
(iii) Prohibition on underwriting. No genetic information collected
or acquired under this paragraph (c)(5) can be used for underwriting
purposes (as described in paragraph (d)(1) of this section).
(iv) Notice to Federal agencies. The plan completes a copy of the
``Notice of Research Exception under the Genetic Information
Nondiscrimination Act''
[[Page 443]]
authorized by the Secretary and provides the notice to the address
specified in the instructions thereto.
(d) Prohibitions on collection of genetic information--(1) For
underwriting purposes--(i) General rule. A group health plan must not
collect (as defined in paragraph (a)(1) of this section) genetic
information for underwriting purposes. See paragraph (e) of this section
for examples illustrating the rules of this paragraph (d)(1), as well as
other provisions of this section.
(ii) Underwriting purposes defined. Subject to paragraph (d)(1)(iii)
of this section, underwriting purposes means, with respect to any group
health plan, or health insurance coverage offered in connection with a
group health plan--
(A) Rules for, or determination of, eligibility (including
enrollment and continued eligibility) for benefits under the plan or
coverage as described in Sec. 54.9802-1(b)(1)(ii) (including changes in
deductibles or other cost-sharing mechanisms in return for activities
such as completing a health risk assessment or participating in a
wellness program);
(B) The computation of premium or contribution amounts under the
plan or coverage (including discounts, rebates, payments in kind, or
other premium differential mechanisms in return for activities such as
completing a health risk assessment or participating in a wellness
program);
(C) The application of any preexisting condition exclusion under the
plan or coverage; and
(D) Other activities related to the creation, renewal, or
replacement of a contract of health insurance or health benefits.
(iii) Medical appropriateness. If an individual seeks a benefit
under a group health plan, the plan may limit or exclude the benefit
based on whether the benefit is medically appropriate, and the
determination of whether the benefit is medically appropriate is not
within the meaning of underwriting purposes. Accordingly, if an
individual seeks a benefit under the plan and the plan conditions the
benefit based on its medical appropriateness and the medical
appropriateness of the benefit depends on genetic information of the
individual, then the plan is permitted to condition the benefit on the
genetic information. A plan is permitted to request only the minimum
amount of genetic information necessary to determine medical
appropriateness. The plan may deny the benefit if the patient does not
provide the genetic information required to determine medical
appropriateness. If an individual is not seeking a benefit, the medical
appropriateness exception of this paragraph (d)(1)(iii) to the
definition of underwriting purposes does not apply. See paragraph (e) of
this section for examples illustrating the medical appropriateness
provisions of this paragraph (d)(1)(iii), as well as other provisions of
this section.
(2) Prior to or in connection with enrollment--(i) In general. A
group health plan must not collect genetic information with respect to
any individual prior to that individual's effective date of coverage
under that plan, nor in connection with the rules for eligibility (as
defined in Sec. 54.9802-1(b)(1)(ii)) that apply to that individual.
Whether or not an individual's information is collected prior to that
individual's effective date of coverage is determined at the time of
collection.
(ii) Incidental collection exception--(A) In general. If a group
health plan obtains genetic information incidental to the collection of
other information concerning any individual, the collection is not a
violation of this paragraph (d)(2), as long as the collection is not for
underwriting purposes in violation of paragraph (d)(1) of this section.
(B) Limitation. The incidental collection exception of this
paragraph (d)(2)(ii) does not apply in connection with any collection
where it is reasonable to anticipate that health information will be
received, unless the collection explicitly states that genetic
information should not be provided.
(3) Examples. The rules of this paragraph (d) are illustrated by the
following examples:
Example 1. (i) Facts. A group health plan provides a premium
reduction to enrollees who complete a health risk assessment. The health
risk assessment is requested to be completed after enrollment. Whether
or not it is completed or what responses are given on it has no effect
on an individual's enrollment status, or on the enrollment status of
[[Page 444]]
members of the individual's family. The health risk assessment includes
questions about the individual's family medical history.
(ii) Conclusion. In this Example 1, the health risk assessment
includes a request for genetic information (that is, the individual's
family medical history). Because completing the health risk assessment
results in a premium reduction, the request for genetic information is
for underwriting purposes. Consequently, the request violates the
prohibition on the collection of genetic information in paragraph (d)(1)
of this section.
Example 2. (i) Facts. The same facts as Example 1, except there is
no premium reduction or any other reward for completing the health risk
assessment.
(ii) Conclusion. In this Example 2, the request is not for
underwriting purposes, nor is it prior to or in connection with
enrollment. Therefore, it does not violate the prohibition on the
collection of genetic information in this paragraph (d).
Example 3. (i) Facts. A group health plan requests that enrollees
complete a health risk assessment prior to enrollment, and includes
questions about the individual's family medical history. There is no
reward or penalty for completing the health risk assessment.
(ii) Conclusion. In this Example 3, because the health risk
assessment includes a request for genetic information (that is, the
individual's family medical history), and requests the information prior
to enrollment, the request violates the prohibition on the collection of
genetic information in paragraph (d)(2) of this section. Moreover,
because it is a request for genetic information, it is not an incidental
collection under paragraph (d)(2)(ii) of this section.
Example 4. (i) Facts. The facts are the same as in Example 1, except
there is no premium reduction or any other reward given for completion
of the health risk assessment. However, certain people completing the
health risk assessment may become eligible for additional benefits under
the plan by being enrolled in a disease management program based on
their answers to questions about family medical history. Other people
may become eligible for the disease management program based solely on
their answers to questions about their individual medical history.
(ii) Conclusion. In this Example 4, the request for information
about an individual's family medical history could result in the
individual being eligible for benefits for which the individual would
not otherwise be eligible. Therefore, the questions about family medical
history on the health risk assessment are a request for genetic
information for underwriting purposes and are prohibited under this
paragraph (d). Although the plan conditions eligibility for the disease
management program based on determinations of medical appropriateness,
the exception for determinations of medical appropriateness does not
apply because the individual is not seeking benefits.
Example 5. (i) Facts. A group health plan requests enrollees to
complete two distinct health risk assessments (HRAs) after and unrelated
to enrollment. The first HRA instructs the individual to answer only for
the individual and not for the individual's family. The first HRA does
not ask about any genetic tests the individual has undergone or any
genetic services the individual has received. The plan offers a reward
for completing the first HRA. The second HRA asks about family medical
history and the results of genetic tests the individual has undergone.
The plan offers no reward for completing the second HRA and the
instructions make clear that completion of the second HRA is wholly
voluntary and will not affect the reward given for completion of the
first HRA.
(ii) Conclusion. In this Example 5, no genetic information is
collected in connection with the first HRA, which offers a reward, and
no benefits or other rewards are conditioned on the request for genetic
information in the second HRA. Consequently, the request for genetic
information in the second HRA is not for underwriting purposes, and the
two HRAs do not violate the prohibition on the collection of genetic
information in this paragraph (d).
Example 6. (i) Facts. A group health plan waives its annual
deductible for enrollees who complete an HRA. The HRA is requested to be
completed after enrollment. Whether or not the HRA is completed or what
responses are given on it has no effect on an individual's enrollment
status, or on the enrollment status of members of the individual's
family. The HRA does not include any direct questions about the
individual's genetic information (including family medical history).
However, the last question reads, ``Is there anything else relevant to
your health that you would like us to know or discuss with you?''
(ii) Conclusion. In this Example 6, the plan's request for medical
information does not explicitly state that genetic information should
not be provided. Therefore, any genetic information collected in
response to the question is not within the incidental collection
exception and is prohibited under this paragraph (d).
Example 7. (i) Facts. Same facts as Example 6, except that the last
question goes on to state, ``In answering this question, you should not
include any genetic information. That is, please do not include any
family medical history or any information related to genetic testing,
genetic services, genetic counseling, or genetic diseases for which you
believe you may be at risk.''
[[Page 445]]
(ii) Conclusion. In this Example 7, the plan's request for medical
information explicitly states that genetic information should not be
provided. Therefore, any genetic information collected in response to
the question is within the incidental collection exception. However, the
plan may not use any genetic information it obtains incidentally for
underwriting purposes.
Example 8. (i) Facts. Issuer M acquires Issuer N. M requests N's
records, stating that N should not provide genetic information and
should review the records to excise any genetic information. N assembles
the data requested by M and, although N reviews it to delete genetic
information, the data from a specific region included some individuals'
family medical history. Consequently, M receives genetic information
about some of N's covered individuals.
(ii) Conclusion. In this Example 8, M's request for health
information explicitly stated that genetic information should not be
provided. See Example 8 in 29 CFR 2590.702-1(d)(3) or 45 CFR
146.122(d)(3) for a conclusion that the collection of genetic
information was within the incidental collection exception of 29 CFR
2590.702-1(d)(2)(ii) or 45 CFR 146.122(d)(ii) similar to the incidental
exception of paragraph (d)(2)(ii) of this section. See Example 8 in 29
CFR 2590.702-1(d)(3) or 45 CFR 146.122(d)(3) also for a caveat that M
may not use the genetic information it obtained incidentally for
underwriting purposes.
(e) Examples regarding determinations of medical appropriateness.
The application of the rules of paragraphs (c) and (d) of this section
to plan determinations of medical appropriateness is illustrated by the
following examples:
Example 1. (i) Facts. Individual A's group health plan covers
genetic testing for celiac disease for individuals who have family
members with this condition. After A's son is diagnosed with celiac
disease, A undergoes a genetic test and promptly submits a claim for the
test to A's issuer for reimbursement. The issuer asks A to provide the
results of the genetic test before the claim is paid.
(ii) Conclusion. See Example 1 in 29 CFR 2590.702-1(e) or 45 CFR
146.122(e) for a conclusion under the rules of paragraph (c)(4) of 29
CFR 2590.702-1 or 45 CFR 146.122 similar to the rules of paragraph
(c)(4) of this section that the issuer is permitted to request only the
minimum amount of information necessary to make a decision regarding
payment. Because the results of the test are not necessary for the
issuer to make a decision regarding the payment of A's claim, the
conclusion in Example 1 in 29 CFR 2590.702-1(e) or 45 CFR 146.122(e)
concludes that the issuer's request for the results of the genetic test
violates paragraph (c) of 29 CFR 2590.702-1 or 45 CFR 146.122 similar to
paragraph (c) of this section.
Example 2. (i) Facts. Individual B's group health plan covers a
yearly mammogram for participants and beneficiaries starting at age 40,
or at age 30 for those with increased risk for breast cancer, including
individuals with BRCA1 or BRCA2 gene mutations. B is 33 years old and
has the BRCA2 mutation. B undergoes a mammogram and promptly submits a
claim to B's plan for reimbursement. Following an established policy,
the plan asks B for evidence of increased risk of breast cancer, such as
the results of a genetic test or a family history of breast cancer,
before the claim for the mammogram is paid. This policy is applied
uniformly to all similarly situated individuals and is not directed at
individuals based on any genetic information.
(ii) Conclusion. In this Example 2, the plan does not violate
paragraphs (c) or (d) of this section. Under paragraph (c), the plan is
permitted to request and use the results of a genetic test to make a
determination regarding payment, provided the plan requests only the
minimum amount of information necessary. Because the medical
appropriateness of the mammogram depends on the genetic makeup of the
patient, the minimum amount of information necessary includes the
results of the genetic test. Similarly, the plan does not violate
paragraph (d) of this section because the plan is permitted to request
genetic information in making a determination regarding the medical
appropriateness of a claim if the genetic information is necessary to
make the determination (and if the genetic information is not used for
underwriting purposes).
Example 3. (i) Facts. Individual C was previously diagnosed with and
treated for breast cancer, which is currently in remission. In
accordance with the recommendation of C's physician, C has been taking a
regular dose of tamoxifen to help prevent a recurrence. C's group health
plan adopts a new policy requiring patients taking tamoxifen to undergo
a genetic test to ensure that tamoxifen is medically appropriate for
their genetic makeup. In accordance with, at the time, the latest
scientific research, tamoxifen is not helpful in up to 7 percent of
breast cancer patients, those with certain variations of the gene for
making the CYP2D6 enzyme. If a patient has a gene variant
making tamoxifen not medically appropriate, the plan does not pay for
the tamoxifen prescription.
(ii) Conclusion. In this Example 3, the plan does not violate
paragraph (c) of this section if it conditions future payments for the
tamoxifen prescription on C's undergoing a genetic test to determine
what genetic markers C has for making the CYP2D6 enzyme. Nor
does the plan violate paragraph (c) of this section if the plan refuses
future
[[Page 446]]
payment if the results of the genetic test indicate that tamoxifen is
not medically appropriate for C.
Example 4. (i) Facts. A group health plan offers a diabetes disease
management program to all similarly situated individuals for whom it is
medically appropriate based on whether the individuals have or are at
risk for diabetes. The program provides enhanced benefits related only
to diabetes for individuals who qualify for the program. The plan sends
out a notice to all participants that describes the diabetes disease
management program and explains the terms for eligibility. Individuals
interested in enrolling in the program are advised to contact the plan
to demonstrate that they have diabetes or that they are at risk for
diabetes. For individuals who do not currently have diabetes, genetic
information may be used to demonstrate that an individual is at risk.
(ii) Conclusion. In this Example 4, the plan may condition benefits
under the disease management program upon a showing by an individual
that the individual is at risk for diabetes, even if such showing may
involve genetic information, provided that the plan requests genetic
information only when necessary to make a determination regarding
whether the disease management program is medically appropriate for the
individual and only requests the minimum amount of information necessary
to make that determination.
Example 5. (i) Facts. Same facts as Example 4, except that the plan
includes a questionnaire that asks about the occurrence of diabetes in
members of the individual's family as part of the notice describing the
disease management program.
(ii) Conclusion. In this Example 5, the plan violates the
requirements of paragraph (d)(1) of this section because the requests
for genetic information are not limited to those situations in which it
is necessary to make a determination regarding whether the disease
management program is medically appropriate for the individuals.
Example 6. (i) Facts. Same facts as Example 4, except the disease
management program provides an enhanced benefit in the form of a lower
annual deductible to individuals under the program; the lower deductible
applies with respect to all medical expenses incurred by the individual.
Thus, whether or not a claim relates to diabetes, the individual is
provided with a lower deductible based on the individual providing the
plan with genetic information.
(ii) Conclusion. In this Example 6, because the enhanced benefits
include benefits not related to the determination of medical
appropriateness, making available the enhanced benefits is within the
meaning of underwriting purposes. Accordingly, the plan may not request
or require genetic information (including family history information) in
determining eligibility for enhanced benefits under the program because
such a request would be for underwriting purposes and would violate
paragraph (d)(1) of this section.
(f) Effective/applicability date. This section applies for plan
years beginning on or after December 7, 2009.
(g) Expiration date. This section expires on or before October 1,
2012.
[T.D. 9464, 74 FR 51678, Oct. 7, 2009]
Sec. 54.9811-1 Standards relating to benefits for mothers and newborns.
(a) Hospital length of stay--(1) General rule. Except as provided in
paragraph (a)(5) of this section, a group health plan that provides
benefits for a hospital length of stay in connection with childbirth for
a mother or her newborn may not restrict benefits for the stay to less
than--
(i) 48 hours following a vaginal delivery; or
(ii) 96 hours following a delivery by cesarean section.
(2) When stay begins--(i) Delivery in a hospital. If delivery occurs
in a hospital, the hospital length of stay for the mother or newborn
child begins at the time of delivery (or in the case of multiple births,
at the time of the last delivery).
(ii) Delivery outside a hospital. If delivery occurs outside a
hospital, the hospital length of stay begins at the time the mother or
newborn is admitted as a hospital inpatient in connection with
childbirth. The determination of whether an admission is in connection
with childbirth is a medical decision to be made by the attending
provider.
(3) Examples. The rules of paragraphs (a)(1) and (2) of this section
are illustrated by the following examples. In each example, the group
health plan provides benefits for hospital lengths of stay in connection
with childbirth and is subject to the requirements of this section, as
follows:
Example 1. (i) Facts. A pregnant woman covered under a group health
plan goes into labor and is admitted to the hospital at 10 p.m. on June
11. She gives birth by vaginal delivery at 6 a.m. on June 12.
(ii) Conclusion. In this Example 1, the 48-hour period described in
paragraph (a)(1)(i) of this section ends at 6 a.m. on June 14.
Example 2. (i) Facts. A woman covered under a group health plan
gives birth at
[[Page 447]]
home by vaginal delivery. After the delivery, the woman begins bleeding
excessively in connection with the childbirth and is admitted to the
hospital for treatment of the excessive bleeding at 7 p.m. on October 1.
(ii) Conclusion. In this Example 2, the 48-hour period described in
paragraph (a)(1)(i) of this section ends at 7 p.m. on October 3.
Example 3. (i) Facts. A woman covered under a group health plan
gives birth by vaginal delivery at home. The child later develops
pneumonia and is admitted to the hospital. The attending provider
determines that the admission is not in connection with childbirth.
(ii) Conclusion. In this Example 3, the hospital length-of-stay
requirements of this section do not apply to the child's admission to
the hospital because the admission is not in connection with childbirth.
(4) Authorization not required--(i) In general. A plan may not
require that a physician or other health care provider obtain
authorization from the plan, or from a health insurance issuer offering
health insurance coverage under the plan, for prescribing the hospital
length of stay specified in paragraph (a)(1) of this section. (See also
paragraphs (b)(2) and (c)(3) of this section for rules and examples
regarding other authorization and certain notice requirements.)
(ii) Example. The rule of this paragraph (a)(4) is illustrated by
the following example:
Example. (i) Facts. In the case of a delivery by cesarean section, a
group health plan subject to the requirements of this section
automatically provides benefits for any hospital length of stay of up to
72 hours. For any longer stay, the plan requires an attending provider
to complete a certificate of medical necessity. The plan then makes a
determination, based on the certificate of medical necessity, whether a
longer stay is medically necessary.
(ii) Conclusion. In this Example, the requirement that an attending
provider complete a certificate of medical necessity to obtain
authorization for the period between 72 hours and 96 hours following a
delivery by cesarean section is prohibited by this paragraph (a)(4).
(5) Exceptions--(i) Discharge of mother. If a decision to discharge
a mother earlier than the period specified in paragraph (a)(1) of this
section is made by an attending provider, in consultation with the
mother, the requirements of paragraph (a)(1) of this section do not
apply for any period after the discharge.
(ii) Discharge of newborn. If a decision to discharge a newborn
child earlier than the period specified in paragraph (a)(1) of this
section is made by an attending provider, in consultation with the
mother (or the newborn's authorized representative), the requirements of
paragraph (a)(1) of this section do not apply for any period after the
discharge.
(iii) Attending provider defined. For purposes of this section,
attending provider means an individual who is licensed under applicable
state law to provide maternity or pediatric care and who is directly
responsible for providing maternity or pediatric care to a mother or
newborn child. Therefore, a plan, hospital, managed care organization,
or other issuer is not an attending provider.
(iv) Example. The rules of this paragraph (a)(5) are illustrated by
the following example:
Example. (i) Facts. A pregnant woman covered under a group health
plan subject to the requirements of this section goes into labor and is
admitted to a hospital. She gives birth by cesarean section. On the
third day after the delivery, the attending provider for the mother
consults with the mother, and the attending provider for the newborn
consults with the mother regarding the newborn. The attending providers
authorize the early discharge of both the mother and the newborn. Both
are discharged approximately 72 hours after the delivery. The plan pays
for the 72-hour hospital stays.
(ii) Conclusion. In this Example, the requirements of this paragraph
(a) have been satisfied with respect to the mother and the newborn. If
either is readmitted, the hospital stay for the readmission is not
subject to this section.
(b) Prohibitions--(1) With respect to mothers--(i) In general. A
group health plan may not--
(A) Deny a mother or her newborn child eligibility or continued
eligibility to enroll or renew coverage under the terms of the plan
solely to avoid the requirements of this section; or
(B) Provide payments (including payments-in-kind) or rebates to a
mother to encourage her to accept less than the minimum protections
available under this section.
(ii) Examples. The rules of this paragraph (b)(1) are illustrated by
the following examples. In each example, the
[[Page 448]]
group health plan is subject to the requirements of this section, as
follows:
Example 1. (i) Facts. A group health plan provides benefits for at
least a 48-hour hospital length of stay following a vaginal delivery. If
a mother and newborn covered under the plan are discharged within 24
hours after the delivery, the plan will waive the copayment and
deductible.
(ii) Conclusion. In this Example 1, because waiver of the copayment
and deductible is in the nature of a rebate that the mother would not
receive if she and her newborn remained in the hospital, it is
prohibited by this paragraph (b)(1). (In addition, the plan violates
paragraph (b)(2) of this section because, in effect, no copayment or
deductible is required for the first portion of the stay and a double
copayment and a deductible are required for the second portion of the
stay.)
Example 2. (i) Facts. A group health plan provides benefits for at
least a 48-hour hospital length of stay following a vaginal delivery. In
the event that a mother and her newborn are discharged earlier than 48
hours and the discharges occur after consultation with the mother in
accordance with the requirements of paragraph (a)(5) of this section,
the plan provides for a follow-up visit by a nurse within 48 hours after
the discharges to provide certain services that the mother and her
newborn would otherwise receive in the hospital.
(ii) Conclusion. In this Example 2, because the follow-up visit does
not provide any services beyond what the mother and her newborn would
receive in the hospital, coverage for the follow-up visit is not
prohibited by this paragraph (b)(1).
(2) With respect to benefit restrictions--(i) In general. Subject to
paragraph (c)(3) of this section, a group health plan may not restrict
the benefits for any portion of a hospital length of stay specified in
paragraph (a) of this section in a manner that is less favorable than
the benefits provided for any preceding portion of the stay.
(ii) Example. The rules of this paragraph (b)(2) are illustrated by
the following example:
Example. (i) Facts. A group health plan subject to the requirements
of this section provides benefits for hospital lengths of stay in
connection with childbirth. In the case of a delivery by cesarean
section, the plan automatically pays for the first 48 hours. With
respect to each succeeding 24-hour period, the participant or
beneficiary must call the plan to obtain precertification from a
utilization reviewer, who determines if an additional 24-hour period is
medically necessary. If this approval is not obtained, the plan will not
provide benefits for any succeeding 24-hour period.
(ii) Conclusion. In this Example, the requirement to obtain
precertification for the two 24-hour periods immediately following the
initial 48-hour stay is prohibited by this paragraph (b)(2) because
benefits for the latter part of the stay are restricted in a manner that
is less favorable than benefits for a preceding portion of the stay.
(However, this section does not prohibit a plan from requiring
precertification for any period after the first 96 hours.) In addition,
the requirement to obtain precertification from the plan based on
medical necessity for a hospital length of stay within the 96-hour
period would also violate paragraph (a) of this section.
(3) With respect to attending providers. A group health plan may not
directly or indirectly--
(i) Penalize (for example, take disciplinary action against or
retaliate against), or otherwise reduce or limit the compensation of, an
attending provider because the provider furnished care to a participant
or beneficiary in accordance with this section; or
(ii) Provide monetary or other incentives to an attending provider
to induce the provider to furnish care to a participant or beneficiary
in a manner inconsistent with this section, including providing any
incentive that could induce an attending provider to discharge a mother
or newborn earlier than 48 hours (or 96 hours) after delivery.
(c) Construction. With respect to this section, the following rules
of construction apply:
(1) Hospital stays not mandatory. This section does not require a
mother to--
(i) Give birth in a hospital; or
(ii) Stay in the hospital for a fixed period of time following the
birth of her child.
(2) Hospital stay benefits not mandated. This section does not apply
to any group health plan that does not provide benefits for hospital
lengths of stay in connection with childbirth for a mother or her
newborn child.
(3) Cost-sharing rules--(i) In general. This section does not
prevent a group health plan from imposing deductibles, coinsurance, or
other cost-sharing in relation to benefits for hospital lengths of stay
in connection with childbirth for a mother or a newborn under the
[[Page 449]]
plan or coverage, except that the coinsurance or other cost-sharing for
any portion of the hospital length of stay specified in paragraph (a) of
this section may not be greater than that for any preceding portion of
the stay.
(ii) Examples. The rules of this paragraph (c)(3) are illustrated by
the following examples. In each example, the group health plan is
subject to the requirements of this section, as follows:
Example 1. (i) Facts. A group health plan provides benefits for at
least a 48-hour hospital length of stay in connection with vaginal
deliveries. The plan covers 80 percent of the cost of the stay for the
first 24-hour period and 50 percent of the cost of the stay for the
second 24-hour period. Thus, the coinsurance paid by the patient
increases from 20 percent to 50 percent after 24 hours.
(ii) Conclusion. In this Example 1, the plan violates the rules of
this paragraph (c)(3) because coinsurance for the second 24-hour period
of the 48-hour stay is greater than that for the preceding portion of
the stay. (In addition, the plan also violates the similar rule in
paragraph (b)(2) of this section.)
Example 2. (i) Facts. A group health plan generally covers 70
percent of the cost of a hospital length of stay in connection with
childbirth. However, the plan will cover 80 percent of the cost of the
stay if the participant or beneficiary notifies the plan of the
pregnancy in advance of admission and uses whatever hospital the plan
may designate.
(ii) Conclusion. In this Example 2, the plan does not violate the
rules of this paragraph (c)(3) because the level of benefits provided
(70 percent or 80 percent) is consistent throughout the 48-hour (or 96-
hour) hospital length of stay required under paragraph (a) of this
section. (In addition, the plan does not violate the rules in paragraph
(a)(4) or (b)(2) of this section.)
(4) Compensation of attending provider. This section does not
prevent a group health plan from negotiating with an attending provider
the level and type of compensation for care furnished in accordance with
this section (including paragraph (b) of this section).
(d) Notice requirement. See 29 CFR 2520.102-3(u) for rules relating
to a disclosure requirement imposed under section 711(d) of ERISA (29
U.S.C. 1181) on certain group health plans that provide benefits for
hospital lengths of stay in connection with childbirth.
(e) Applicability in certain states--(1) Health insurance coverage.
The requirements of section 9811 and this section do not apply with
respect to health insurance coverage offered in connection with a group
health plan if there is a state law regulating the coverage that meets
any of the following criteria:
(i) The state law requires the coverage to provide for at least a
48-hour hospital length of stay following a vaginal delivery and at
least a 96-hour hospital length of stay following a delivery by cesarean
section.
(ii) The state law requires the coverage to provide for maternity
and pediatric care in accordance with guidelines that relate to care
following childbirth established by the American College of
Obstetricians and Gynecologists, the American Academy of Pediatrics, or
any other established professional medical association.
(iii) The state law requires, in connection with the coverage for
maternity care, that the hospital length of stay for such care is left
to the decision of (or is required to be made by) the attending provider
in consultation with the mother. State laws that require the decision to
be made by the attending provider with the consent of the mother satisfy
the criterion of this paragraph (e)(1)(iii).
(2) Group health plans--(i) Fully-insured plans. For a group health
plan that provides benefits solely through health insurance coverage, if
the state law regulating the health insurance coverage meets any of the
criteria in paragraph (e)(1) of this section, then the requirements of
section 9811 and this section do not apply.
(ii) Self-insured plans. For a group health plan that provides all
benefits for hospital lengths of stay in connection with childbirth
other than through health insurance coverage, the requirements of
section 9811 and this section apply.
(iii) Partially-insured plans. For a group health plan that provides
some benefits through health insurance coverage, if the state law
regulating the health insurance coverage meets any of the criteria in
paragraph (e)(1) of this section, then the requirements of section 9811
and this section apply only to the extent the plan provides benefits for
hospital lengths of stay in connection with childbirth other than
through health insurance coverage.
[[Page 450]]
(3) Preemption provisions under section 731(a) of ERISA. See 29 CFR
2590.711(e)(3) for a rule providing that the preemption provisions
contained in section 731(a)(1) of ERISA and 29 CFR 2590.731(a) do not
supersede a state law if the state law is described in paragraph (e)(1)
of 29 CFR 2590.711 (which is substantially similar to paragraph (e)(1)
of this section).
(4) Examples. The rules of this paragraph (e) are illustrated by the
following examples:
Example 1. (i) Facts. A group health plan buys group health
insurance coverage in a state that requires that the coverage provide
for at least a 48-hour hospital length of stay following a vaginal
delivery and at least a 96-hour hospital length of stay following a
delivery by cesarean section.
(ii) Conclusion. In this Example 1, the coverage is subject to state
law, and the requirements of section 9811 and this section do not apply.
Example 2. (i) Facts. A self-insured group health plan covers
hospital lengths of stay in connection with childbirth in a state that
requires health insurance coverage to provide for maternity and
pediatric care in accordance with guidelines that relate to care
following childbirth established by the American College of
Obstetricians and Gynecologists and the American Academy of Pediatrics.
(ii) Conclusion. In this Example 2, even though the state law
satisfies the criterion of paragraph (e)(1)(ii) of this section, because
the plan provides benefits for hospital lengths of stay in connection
with childbirth other than through health insurance coverage, the plan
is subject to the requirements of section 9811 and this section.
(f) Effective/applicability date. This section applies to group
health plans for plan years beginning on or after January 1, 2009.
[T.D. 9427, 73 FR 62420, Oct. 20, 2008]
Sec. 54.9812-1T Parity in mental health and substance use disorder benefits (temporary).
(a) Meaning of terms. For purposes of this section, except where the
context clearly indicates otherwise, the following terms have the
meanings indicated:
Aggregate lifetime dollar limit means a dollar limitation on the
total amount of specified benefits that may be paid under a group health
plan for any coverage unit.
Annual dollar limit means a dollar limitation on the total amount of
specified benefits that may be paid in a 12-month period under a group
health plan for any coverage unit.
Coverage unit means coverage unit as described in paragraph
(c)(1)(iv) of this section.
Cumulative financial requirements are financial requirements that
determine whether or to what extent benefits are provided based on
accumulated amounts and include deductibles and out-of-pocket maximums.
(However, cumulative financial requirements do not include aggregate
lifetime or annual dollar limits because these two terms are excluded
from the meaning of financial requirements.)
Cumulative quantitative treatment limitations are treatment
limitations that determine whether or to what extent benefits are
provided based on accumulated amounts, such as annual or lifetime day or
visit limits.
Financial requirements include deductibles, copayments, coinsurance,
or out-of-pocket maximums. Financial requirements do not include
aggregate lifetime or annual dollar limits.
Medical/surgical benefits means benefits for medical or surgical
services, as defined under the terms of the plan, but does not include
mental health or substance use disorder benefits. Any condition defined
by the plan as being or as not being a medical/surgical condition must
be defined to be consistent with generally recognized independent
standards of current medical practice (for example, the most current
version of the International Classification of Diseases (ICD) or State
guidelines).
Mental health benefits means benefits with respect to services for
mental health conditions, as defined under the terms of the plan and in
accordance with applicable Federal and State law. Any condition defined
by the plan as being or as not being a mental health condition must be
defined to be consistent with generally recognized independent standards
of current medical practice (for example, the most current version of
the Diagnostic and Statistical Manual of Mental Disorders (DSM), the
most current version of the ICD, or State guidelines).
[[Page 451]]
Substance use disorder benefits means benefits with respect to
services for substance use disorders, as defined under the terms of the
plan and in accordance with applicable Federal and State law. Any
disorder defined by the plan as being or as not being a substance use
disorder must be defined to be consistent with generally recognized
independent standards of current medical practice (for example, the most
current version of the DSM, the most current version of the ICD, or
State guidelines).
Treatment limitations include limits on benefits based on the
frequency of treatment, number of visits, days of coverage, days in a
waiting period, or other similar limits on the scope or duration of
treatment. Treatment limitations include both quantitative treatment
limitations, which are expressed numerically (such as 50 outpatient
visits per year), and nonquantitative treatment limitations, which
otherwise limit the scope or duration of benefits for treatment under a
plan. (See paragraph (c)(4)(ii) of this section for an illustrative list
of nonquantitative treatment limitations.) A permanent exclusion of all
benefits for a particular condition or disorder, however, is not a
treatment limitation.
(b) Parity requirements with respect to aggregate lifetime and
annual dollar limits--(1) General--(i) General parity requirement. A
group health plan that provides both medical/surgical benefits and
mental health or substance use disorder benefits must comply with
paragraph (b)(2), (b)(3), or (b)(6) of this section.
(ii) Exception. The rule in paragraph (b)(1)(i) of this section does
not apply if a plan satisfies the requirements of paragraph (f) or (g)
of this section (relating to exemptions for small employers and for
increased cost).
(2) Plan with no limit or limits on less than one-third of all
medical/surgical benefits. If a plan does not include an aggregate
lifetime or annual dollar limit on any medical/surgical benefits or
includes an aggregate lifetime or annual dollar limit that applies to
less than one-third of all medical/surgical benefits, it may not impose
an aggregate lifetime or annual dollar limit, respectively, on mental
health or substance use disorder benefits.
(3) Plan with a limit on at least two-thirds of all medical/surgical
benefits. If a plan includes an aggregate lifetime or annual dollar
limit on at least two-thirds of all medical/surgical benefits, it must
either--
(i) Apply the aggregate lifetime or annual dollar limit both to the
medical/surgical benefits to which the limit would otherwise apply and
to mental health or substance use disorder benefits in a manner that
does not distinguish between the medical/surgical benefits and mental
health or substance use disorder benefits; or
(ii) Not include an aggregate lifetime or annual dollar limit on
mental health or substance use disorder benefits that is less than the
aggregate lifetime or annual dollar limit, respectively, on medical/
surgical benefits. (For cumulative limits other than aggregate lifetime
or annual dollar limits, see paragraph (c)(3)(v) of this section
prohibiting separately accumulating cumulative financial requirements or
cumulative quantitative treatment limitations.)
(4) Examples. The rules of paragraphs (b)(2) and (b)(3) of this
section are illustrated by the following examples:
Example 1. (i) Facts. A group health plan has no annual limit on
medical/surgical benefits and a $10,000 annual limit on mental health
and substance use disorder benefits. To comply with the requirements of
this paragraph (b), the plan sponsor is considering each of the
following options:
(A) Eliminating the plan's annual dollar limit on mental health and
substance use disorder benefits;
(B) Replacing the plan's annual dollar limit on mental health and
substance use disorder benefits with a $500,000 annual limit on all
benefits (including medical/surgical and mental health and substance use
disorder benefits); and
(C) Replacing the plan's annual dollar limit on mental health and
substance use disorder benefits with a $250,000 annual limit on medical/
surgical benefits and a $250,000 annual limit on mental health and
substance use disorder benefits.
(ii) Conclusion. In this Example 1, each of the three options being
considered by the plan sponsor would comply with the requirements of
this paragraph (b).
Example 2. (i) Facts. A plan has a $100,000 annual limit on medical/
surgical inpatient
[[Page 452]]
benefits and a $50,000 annual limit on medical/surgical outpatient
benefits. To comply with the parity requirements of this paragraph (b),
the plan sponsor is considering each of the following options:
(A) Imposing a $150,000 annual limit on mental health and substance
use disorder benefits; and
(B) Imposing a $100,000 annual limit on mental health and substance
use disorder inpatient benefits and a $50,000 annual limit on mental
health and substance use disorder outpatient benefits.
(ii) Conclusion. In this Example 2, each option under consideration
by the plan sponsor would comply with the requirements of this section.
(5) Determining one-third and two-thirds of all medical/surgical
benefits. For purposes of this paragraph (b), the determination of
whether the portion of medical/surgical benefits subject to an aggregate
lifetime or annual dollar limit represents one-third or two-thirds of
all medical/surgical benefits is based on the dollar amount of all plan
payments for medical/surgical benefits expected to be paid under the
plan for the plan year (or for the portion of the plan year after a
change in plan benefits that affects the applicability of the aggregate
lifetime or annual dollar limits). Any reasonable method may be used to
determine whether the dollar amount expected to be paid under the plan
will constitute one-third or two-thirds of the dollar amount of all plan
payments for medical/surgical benefits.
(6) Plan not described in paragraph (b)(2) or (b)(3) of this
section--(i) In general. A group health plan that is not described in
paragraph (b)(2) or (b)(3) of this section with respect to aggregate
lifetime or annual dollar limits on medical/surgical benefits, must
either--
(A) Impose no aggregate lifetime or annual dollar limit, as
appropriate, on mental health or substance use disorder benefits; or
(B) Impose an aggregate lifetime or annual dollar limit on mental
health or substance use disorder benefits that is no less than an
average limit calculated for medical/surgical benefits in the following
manner. The average limit is calculated by taking into account the
weighted average of the aggregate lifetime or annual dollar limits, as
appropriate, that are applicable to the categories of medical/surgical
benefits. Limits based on delivery systems, such as inpatient/outpatient
treatment or normal treatment of common, low-cost conditions (such as
treatment of normal births), do not constitute categories for purposes
of this paragraph (b)(6)(i)(B). In addition, for purposes of determining
weighted averages, any benefits that are not within a category that is
subject to a separately-designated dollar limit under the plan are taken
into account as a single separate category by using an estimate of the
upper limit on the dollar amount that a plan may reasonably be expected
to incur with respect to such benefits, taking into account any other
applicable restrictions under the plan.
(ii) Weighting. For purposes of this paragraph (b)(6), the weighting
applicable to any category of medical/surgical benefits is determined in
the manner set forth in paragraph (b)(5) of this section for determining
one-third or two-thirds of all medical/surgical benefits.
(iii) Example. The rules of this paragraph (b)(6) are illustrated by
the following example:
Example. (i) Facts. A group health plan that is subject to the
requirements of this section includes a $100,000 annual limit on
medical/surgical benefits related to cardio-pulmonary diseases. The plan
does not include an annual dollar limit on any other category of
medical/surgical benefits. The plan determines that 40 percent of the
dollar amount of plan payments for medical/surgical benefits are related
to cardio-pulmonary diseases. The plan determines that $1,000,000 is a
reasonable estimate of the upper limit on the dollar amount that the
plan may incur with respect to the other 60 percent of payments for
medical/surgical benefits.
(ii) Conclusion. In this Example, the plan is not described in
paragraph (b)(3) of this section because there is not one annual dollar
limit that applies to at least two-thirds of all medical/surgical
benefits. Further, the plan is not described in paragraph (b)(2) of this
section because more than one-third of all medical/surgical benefits are
subject to an annual dollar limit. Under this paragraph (b)(6), the plan
sponsor can choose either to include no annual dollar limit on mental
health or substance use disorder benefits, or to include an annual
dollar limit on mental health or substance use disorder benefits that is
not less than the weighted average of the annual dollar limits
applicable to each category of medical/surgical benefits. In this
[[Page 453]]
example, the minimum weighted average annual dollar limit that can be
applied to mental health or substance use disorder benefits is $640,000
(40% x $100,000 + 60% x $1,000,000 = $640,000).
(c) Parity requirements with respect to financial requirements and
treatment limitations--(1) Clarification of terms--(i) Classification of
benefits. When reference is made in this paragraph (c) to a
classification of benefits, the term ``classification'' means a
classification as described in paragraph (c)(2)(ii) of this section.
(ii) Type of financial requirement or treatment limitation. When
reference is made in this paragraph (c) to a type of financial
requirement or treatment limitation, the reference to type means its
nature. Different types of financial requirements include deductibles,
copayments, coinsurance, and out-of-pocket maximums. Different types of
quantitative treatment limitations include annual, episode, and lifetime
day and visit limits. See paragraph (c)(4)(ii) of this section for an
illustrative list of nonquantitative treatment limitations.
(iii) Level of a type of financial requirement or treatment
limitation. When reference is made in this paragraph (c) to a level of a
type of financial requirement or treatment limitation, level refers to
the magnitude of the type of financial requirement or treatment
limitation. For example, different levels of coinsurance include 20
percent and 30 percent; different levels of a copayment include $15 and
$20; different levels of a deductible include $250 and $500; and
different levels of an episode limit include 21 inpatient days per
episode and 30 inpatient days per episode.
(iv) Coverage unit. When reference is made in this paragraph (c) to
a coverage unit, coverage unit refers to the way in which a plan groups
individuals for purposes of determining benefits, or premiums or
contributions. For example, different coverage units include self-only,
family, and employee-plus-spouse.
(2) General parity requirement--(i) General rule. A group health
plan that provides both medical/surgical benefits and mental health or
substance use disorder benefits may not apply any financial requirement
or treatment limitation to mental health or substance use disorder
benefits in any classification that is more restrictive than the
predominant financial requirement or treatment limitation of that type
applied to substantially all medical/surgical benefits in the same
classification. Whether a financial requirement or treatment limitation
is a predominant financial requirement or treatment limitation that
applies to substantially all medical/surgical benefits in a
classification is determined separately for each type of financial
requirement or treatment limitation. The application of the rules of
this paragraph (c)(2) to financial requirements and quantitative
treatment limitations is addressed in paragraph (c)(3) of this section;
the application of the rules of this paragraph (c)(2) to nonquantitative
treatment limitations is addressed in paragraph (c)(4) of this section.
(ii) Classifications of benefits used for applying rules--(A) In
general. If a plan provides mental health or substance use disorder
benefits in any classification of benefits described in this paragraph
(c)(2)(ii), mental health or substance use disorder benefits must be
provided in every classification in which medical/surgical benefits are
provided. In determining the classification in which a particular
benefit belongs, a plan must apply the same standards to medical/
surgical benefits and to mental health or substance use disorder
benefits. To the extent that a plan provides benefits in a
classification and imposes any separate financial requirement or
treatment limitation (or separate level of a financial requirement or
treatment limitation) for benefits in the classification, the rules of
this paragraph (c) apply separately with respect to that classification
for all financial requirements or treatment limitations. The following
classifications of benefits are the only classifications used in
applying the rules of this paragraph (c):
(1) Inpatient, in-network. Benefits furnished on an inpatient basis
and within a network of providers established or recognized under a
plan.
(2) Inpatient, out-of-network. Benefits furnished on an inpatient
basis and outside any network of providers established or recognized
under a plan. This
[[Page 454]]
classification includes inpatient benefits under a plan that has no
network of providers.
(3) Outpatient, in-network. Benefits furnished on an outpatient
basis and within a network of providers established or recognized under
a plan.
(4) Outpatient, out-of-network. Benefits furnished on an outpatient
basis and outside any network of providers established or recognized
under a plan. This classification includes outpatient benefits under a
plan that has no network of providers.
(5) Emergency care. Benefits for emergency care.
(6) Prescription drugs. Benefits for prescription drugs. See special
rules for multi-tiered prescription drug benefits in paragraph
(c)(3)(iii) of this section.
(B) Application to out-of-network providers. See paragraph
(c)(2)(ii)(A) of this section, under which a plan that provides mental
health or substance use disorder benefits in any classification of
benefits must provide mental health or substance use disorder benefits
in every classification in which medical/surgical benefits are provided,
including out-of-network classifications.
(C) Examples. The rules of this paragraph (c)(2)(ii) are illustrated
by the following examples. In each example, the group health plan is
subject to the requirements of this section and provides both medical/
surgical benefits and mental health and substance use disorder benefits.
Example 1. (i) Facts. A group health plan offers inpatient and
outpatient benefits and does not contract with a network of providers.
The plan imposes a $500 deductible on all benefits. For inpatient
medical/surgical benefits, the plan imposes a coinsurance requirement.
For outpatient medical/surgical benefits, the plan imposes copayments.
The plan imposes no other financial requirements or treatment
limitations.
(ii) Conclusion. In this Example 1, because the plan has no network
of providers, all benefits provided are out-of-network. Because
inpatient, out-of-network medical/surgical benefits are subject to
separate financial requirements from outpatient, out-of-network medical/
surgical benefits, the rules of this paragraph (c) apply separately with
respect to any financial requirements and treatment limitations,
including the deductible, in each classification.
Example 2. (i) Facts. A plan imposes a $500 deductible on all
benefits. The plan has no network of providers. The plan generally
imposes a 20 percent coinsurance requirement with respect to all
benefits, without distinguishing among inpatient, outpatient, emergency,
or prescription drug benefits. The plan imposes no other financial
requirements or treatment limitations.
(ii) Conclusion. In this Example 2, because the plan does not impose
separate financial requirements (or treatment limitations) based on
classification, the rules of this paragraph (c) apply with respect to
the deductible and the coinsurance across all benefits.
Example 3. (i) Facts. Same facts as Example 2, except the plan
exempts emergency care benefits from the 20 percent coinsurance
requirement. The plan imposes no other financial requirements or
treatment limitations.
(ii) Conclusion. In this Example 3, because the plan imposes
separate financial requirements based on classifications, the rules of
this paragraph (c) apply with respect to the deductible and the
coinsurance separately for--
(A) Benefits in the emergency classification; and
(B) All other benefits.
Example 4. (i) Facts. Same facts as Example 2, except the plan also
imposes a preauthorization requirement for all inpatient treatment in
order for benefits to be paid. No such requirement applies to outpatient
treatment.
(ii) Conclusion. In this Example 4, because the plan has no network
of providers, all benefits provided are out-of-network. Because the plan
imposes a separate treatment limitation based on classifications, the
rules of this paragraph (c) apply with respect to the deductible and
coinsurance separately for--
(A) Inpatient, out-of-network benefits; and
(B) All other benefits.
(3) Financial requirements and quantitative treatment limitations--
(i) Determining ``substantially all'' and ``predominant''--(A)
Substantially all. For purposes of this paragraph (c), a type of
financial requirement or quantitative treatment limitation is considered
to apply to substantially all medical/surgical benefits in a
classification of benefits if it applies to at least two-thirds of all
medical/surgical benefits in that classification. (For this purpose,
benefits expressed as subject to a zero level of a type of financial
requirement are treated as benefits not subject to that type of
financial requirement, and benefits expressed as subject to a
quantitative treatment limitation that is
[[Page 455]]
unlimited are treated as benefits not subject to that type of
quantitative treatment limitation.) If a type of financial requirement
or quantitative treatment limitation does not apply to at least two-
thirds of all medical/surgical benefits in a classification, then that
type cannot be applied to mental health or substance use disorder
benefits in that classification.
(B) Predominant--(1) If a type of financial requirement or
quantitative treatment limitation applies to at least two-thirds of all
medical/surgical benefits in a classification as determined under
paragraph (c)(3)(i)(A) of this section, the level of the financial
requirement or quantitative treatment limitation that is considered the
predominant level of that type in a classification of benefits is the
level that applies to more than one-half of medical/surgical benefits in
that classification subject to the financial requirement or quantitative
treatment limitation.
(2) If, with respect to a type of financial requirement or
quantitative treatment limitation that applies to at least two-thirds of
all medical/surgical benefits in a classification, there is no single
level that applies to more than one-half of medical/surgical benefits in
the classification subject to the financial requirement or quantitative
treatment limitation, the plan may combine levels until the combination
of levels applies to more than one-half of medical/surgical benefits
subject to the financial requirement or quantitative treatment
limitation in the classification. The least restrictive level within the
combination is considered the predominant level of that type in the
classification. (For this purpose, a plan may combine the most
restrictive levels first, with each less restrictive level added to the
combination until the combination applies to more than one-half of the
benefits subject to the financial requirement or treatment limitation.)
(C) Portion based on plan payments. For purposes of this paragraph
(c), the determination of the portion of medical/surgical benefits in a
classification of benefits subject to a financial requirement or
quantitative treatment limitation (or subject to any level of a
financial requirement or quantitative treatment limitation) is based on
the dollar amount of all plan payments for medical/surgical benefits in
the classification expected to be paid under the plan for the plan year
(or for the portion of the plan year after a change in plan benefits
that affects the applicability of the financial requirement or
quantitative treatment limitation).
(D) Clarifications for certain threshold requirements. For any
deductible, the dollar amount of plan payments includes all plan
payments with respect to claims that would be subject to the deductible
if it had not been satisfied. For any out-of-pocket maximum, the dollar
amount of plan payments includes all plan payments associated with out-
of-pocket payments that are taken into account towards the out-of-pocket
maximum as well as all plan payments associated with out-of-pocket
payments that would have been made towards the out-of-pocket maximum if
it had not been satisfied. Similar rules apply for any other thresholds
at which the rate of plan payment changes.
(E) Determining the dollar amount of plan payments. Subject to
paragraph (c)(3)(i)(D) of this section, any reasonable method may be
used to determine the dollar amount expected to be paid under a plan for
medical/surgical benefits subject to a financial requirement or
quantitative treatment limitation (or subject to any level of a
financial requirement or quantitative treatment limitation).
(ii) Application to different coverage units. If a plan applies
different levels of a financial requirement or quantitative treatment
limitation to different coverage units in a classification of medical/
surgical benefits, the predominant level that applies to substantially
all medical/surgical benefits in the classification is determined
separately for each coverage unit.
(iii) Special rule for multi-tiered prescription drug benefits. If a
plan applies different levels of financial requirements to different
tiers of prescription drug benefits based on reasonable factors
determined in accordance with the rules in paragraph (c)(4)(i) of this
section (relating to requirements for nonquantitative treatment
limitations) and without regard to whether a drug
[[Page 456]]
is generally prescribed with respect to medical/surgical benefits or
with respect to mental health or substance use disorder benefits, the
plan satisfies the parity requirements of this paragraph (c) with
respect to prescription drug benefits. Reasonable factors include cost,
efficacy, generic versus brand name, and mail order versus pharmacy
pick-up.
(iv) Examples. The rules of paragraphs (c)(3)(i), (c)(3)(ii), and
(c)(3)(iii) of this section are illustrated by the following examples.
In each example, the group health plan is subject to the requirements of
this section and provides both medical/surgical benefits and mental
health and substance use disorder benefits.
Example 1. (i) Facts. For inpatient, out-of-network medical/surgical
benefits, a group health plan imposes five levels of coinsurance. Using
a reasonable method, the plan projects its payments for the upcoming
year as follows:
--------------------------------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------------------------------
Coinsurance rate................ 0% 10% 15% 20% 30% Total
Projected payments.............. $200x $100x $450x $100x $150x $1,000x
Percent of total plan costs..... 20% 10% 45% 10% 15%
Percent subject to coinsurance N/A 12.5% 56.25% 12.5% 18.75% ..................
level. (100x/800x) (450x/800x) (100x/800x) (150x/800x)
--------------------------------------------------------------------------------------------------------------------------------------------------------
The plan projects plan costs of $800x to be subject to coinsurance
($100x + $450x + $100x + $150x = $800x). Thus, 80 percent ($800x/
$1,000x) of the benefits are projected to be subject to coinsurance, and
56.25 percent of the benefits subject to coinsurance are projected to be
subject to the 15 percent coinsurance level.
(ii) Conclusion. In this Example 1, the two-thirds threshold of the
substantially all standard is met for coinsurance because 80 percent of
all inpatient, out-of-network medical/surgical benefits are subject to
coinsurance. Moreover, the 15 percent coinsurance is the predominant
level because it is applicable to more than one-half of inpatient, out-
of-network medical/surgical benefits subject to the coinsurance
requirement. The plan may not impose any level of coinsurance with
respect to inpatient, out-of-network mental health or substance use
disorder benefits that is more restrictive than the 15 percent level of
coinsurance.
Example 2. (i) Facts. For outpatient, in-network medical/surgical
benefits, a plan imposes five different copayment levels. Using a
reasonable method, the plan projects payments for the upcoming year as
follows:
--------------------------------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------------------------------
Copayment amount................ $0 $10 $15 $20 $50 Total
Projected payments.............. $200x $200x $200x $300x $100x $1,000x
[[Page 457]]
Percent of total plan costs..... 20% 20% 20% 30% 10%
Percent subject to copayments... N/A 25% 25% 37.5% 12.5% ..................
(200x/800x) (200x/800x) (300x/800x) (100x/800x)
--------------------------------------------------------------------------------------------------------------------------------------------------------
The plan projects plan costs of $800x to be subject to copayments
($200x + $200x + $300x + $100x = $800x). Thus, 80 percent ($800x/
$1,000x) of the benefits are projected to be subject to a copayment.
(ii) Conclusion. In this Example 2, the two-thirds threshold of the
substantially all standard is met for copayments because 80 percent of
all outpatient, in-network medical/surgical benefits are subject to a
copayment. Moreover, there is no single level that applies to more than
one-half of medical/surgical benefits in the classification subject to a
copayment (for the $10 copayment, 25 percent; for the $15 copayment, 25
percent; for the $20 copayment, 37.5 percent; and for the $50 copayment,
12.5 percent). The plan can combine any levels of copayment, including
the highest levels, to determine the predominant level that can be
applied to mental health or substance use disorder benefits. If the plan
combines the highest levels of copayment, the combined projected
payments for the two highest copayment levels, the $50 copayment and the
$20 copayment, are not more than one-half of the outpatient, in-network
medical/surgical benefits subject to a copayment because they are
exactly one-half ($300x + $100x = $400x; $400x/$800x = 50%). The
combined projected payments for the three highest copayment levels--the
$50 copayment, the $20 copayment, and the $15 copayment--are more than
one-half of the outpatient, in-network medical/surgical benefits subject
to the copayments ($100x + $300x + $200x = $600x; $600x/$800x = 75%).
Thus, the plan may not impose any copayment on outpatient, in-network
mental health or substance use disorder benefits that is more
restrictive than the least restrictive copayment in the combination, the
$15 copayment.
Example 3. (i) Facts. A plan imposes a $250 deductible on all
medical/surgical benefits for self-only coverage and a $500 deductible
on all medical/surgical benefits for family coverage. The plan has no
network of providers. For all medical/surgical benefits, the plan
imposes a coinsurance requirement. The plan imposes no other financial
requirements or treatment limitations.
(ii) Conclusion. In this Example 3, because the plan has no network
of providers, all benefits are provided out-of-network. Because self-
only and family coverage are subject to different deductibles, whether
the deductible applies to substantially all medical/surgical benefits is
determined separately for self-only medical/surgical benefits and family
medical/surgical benefits. Because the coinsurance is applied without
regard to coverage units, the predominant coinsurance that applies to
substantially all medical/surgical benefits is determined without regard
to coverage units.
Example 4. (i) Facts. A plan applies the following financial
requirements for prescription drug benefits. The requirements are
applied without regard to whether a drug is generally prescribed with
respect to medical/surgical benefits or with respect to mental health or
substance use disorder benefits. Moreover, the process for certifying a
particular drug as ``generic'', ``preferred brand name'', ``non-
preferred brand name'', or ``specialty'' complies with the rules of
paragraph (c)(4)(i) of this section (relating to requirements for
nonquantitative treatment limitations).
----------------------------------------------------------------------------------------------------------------
Tier 1 Tier 2 Tier 3 Tier 4
---------------------------------------------------------------------------
Non-preferred
Tier description brand name drugs
Generic drugs Preferred brand (which may have Specialty drugs
name drugs Tier 1 or Tier 2
alternatives)
----------------------------------------------------------------------------------------------------------------
Percent paid by plan................ 90% 80% 60% 50%
----------------------------------------------------------------------------------------------------------------
[[Page 458]]
(ii) Conclusion. In this Example 4, the financial requirements that
apply to prescription drug benefits are applied without regard to
whether a drug is generally prescribed with respect to medical/surgical
benefits or with respect to mental health or substance use disorder
benefits; the process for certifying drugs in different tiers complies
with paragraph (c)(4) of this section; and the bases for establishing
different levels or types of financial requirements are reasonable. The
financial requirements applied to prescription drug benefits do not
violate the parity requirements of this paragraph (c)(3).
(v) No separate cumulative financial requirements or cumulative
quantitative treatment limitations. (A) A group health plan may not
apply any cumulative financial requirement or cumulative quantitative
treatment limitation for mental health or substance use disorder
benefits in a classification that accumulates separately from any
established for medical/surgical benefits in the same classification.
(B) The rules of this paragraph (c)(3)(v) are illustrated by the
following examples:
Example 1. (i) Facts. A group health plan imposes a combined annual
$500 deductible on all medical/surgical, mental health, and substance
use disorder benefits.
(ii) Conclusion. In this Example 1, the combined annual deductible
complies with the requirements of this paragraph (c)(3)(v).
Example 2. (i) Facts. A plan imposes an annual $250 deductible on
all medical/surgical benefits and a separate annual $250 deductible on
all mental health and substance use disorder benefits.
(ii) Conclusion. In this Example 2, the separate annual deductible
on mental health and substance use disorder benefits violates the
requirements of this paragraph (c)(3)(v).
Example 3. (i) Facts. A plan imposes an annual $300 deductible on
all medical/surgical benefits and a separate annual $100 deductible on
all mental health or substance use disorder benefits.
(ii) Conclusion. In this Example 3, the separate annual deductible
on mental health and substance use disorder benefits violates the
requirements of this paragraph (c)(3)(v).
Example 4. (i) Facts. A plan generally imposes a combined annual
$500 deductible on all benefits (both medical/surgical benefits and
mental health and substance use disorder benefits) except prescription
drugs. Certain benefits, such as preventive care, are provided without
regard to the deductible. The imposition of other types of financial
requirements or treatment limitations varies with each classification.
Using reasonable methods, the plan projects its payments for medical/
surgical benefits in each classification for the upcoming year as
follows:
----------------------------------------------------------------------------------------------------------------
Benefits subject Percent subject
Classification to deductible Total benefits to deductible
----------------------------------------------------------------------------------------------------------------
Inpatient, in-network..................................... $1,800x $2,000x 90
Inpatient, out-of-network................................. 1,000x 1,000x 100
Outpatient, in-network.................................... 1,400x 2,000x 70
Outpatient, out-of-network................................ 1,880x 2,000x 94
Emergency care............................................ 300x 500x 60
----------------------------------------------------------------------------------------------------------------
(ii) Conclusion. In this Example 4, the two-thirds threshold of the
substantially all standard is met with respect to each classification
except emergency care because in each of those other classifications at
least two-thirds of medical/surgical benefits are subject to the $500
deductible. Moreover, the $500 deductible is the predominant level in
each of those other classifications because it is the only level.
However, emergency care mental health and substance use disorder
benefits cannot be subject to the $500 deductible because it does not
apply to substantially all emergency care medical/surgical benefits.
(4) Nonquantitative treatment limitations--(i) General rule. A group
health plan may not impose a nonquantitative treatment limitation with
respect to mental health or substance use disorder benefits in any
classification unless, under the terms of the plan as written and in
operation, any processes, strategies, evidentiary standards, or other
factors used in applying the nonquantitative treatment limitation to
mental health or substance use disorder benefits in the classification
are comparable to, and are applied no more stringently than, the
processes, strategies, evidentiary standards, or other factors used in
applying the limitation with respect to medical surgical/benefits in the
classification, except to the extent that recognized clinically
appropriate standards of care may permit a difference.
[[Page 459]]
(ii) Illustrative list of nonquantitative treatment limitations.
Nonquantitative treatment limitations include--
(A) Medical management standards limiting or excluding benefits
based on medical necessity or medical appropriateness, or based on
whether the treatment is experimental or investigative;
(B) Formulary design for prescription drugs;
(C) Standards for provider admission to participate in a network,
including reimbursement rates;
(D) Plan methods for determining usual, customary, and reasonable
charges;
(E) Refusal to pay for higher-cost therapies until it can be shown
that a lower-cost therapy is not effective (also known as fail-first
policies or step therapy protocols); and
(F) Exclusions based on failure to complete a course of treatment.
(iii) Examples. The rules of this paragraph (c)(4) are illustrated
by the following examples. In each example, the group health plan is
subject to the requirements of this section and provides both medical/
surgical benefits and mental health and substance use disorder benefits.
Example 1. (i) Facts. A group health plan limits benefits to
treatment that is medically necessary. The plan requires concurrent
review for inpatient, in-network mental health and substance use
disorder benefits but does not require it for any inpatient, in-network
medical/surgical benefits. The plan conducts retrospective review for
inpatient, in-network medical/surgical benefits.
(ii) Conclusion. In this Example 1, the plan violates the rules of
this paragraph (c)(4). Although the same nonquantitative treatment
limitation--medical necessity--applies to both mental health and
substance use disorder benefits and to medical/surgical benefits for
inpatient, in-network services, the concurrent review process does not
apply to medical/surgical benefits. The concurrent review process is not
comparable to the retrospective review process. While such a difference
might be permissible in certain individual cases based on recognized
clinically appropriate standards of care, it is not permissible for
distinguishing between all medical/surgical benefits and all mental
health or substance use disorder benefits.
Example 2. (i) Facts. A plan requires prior approval that a course
of treatment is medically necessary for outpatient, in-network medical/
surgical, mental health, and substance use disorder benefits. For mental
health and substance use disorder treatments that do not have prior
approval, no benefits will be paid; for medical/surgical treatments that
do not have prior approval, there will only be a 25 percent reduction in
the benefits the plan would otherwise pay.
(ii) Conclusion. In this Example 2, the plan violates the rules of
this paragraph (c)(4). Although the same nonquantitative treatment
limitation--medical necessity--is applied both to mental health and
substance use disorder benefits and to medical/surgical benefits for
outpatient, in-network services, the penalty for failure to obtain prior
approval for mental health and substance use disorder benefits is not
comparable to the penalty for failure to obtain prior approval for
medical/surgical benefits.
Example 3. (i) Facts. A plan generally covers medically appropriate
treatments. For both medical/surgical benefits and mental health and
substance use disorder benefits, evidentiary standards used in
determining whether a treatment is medically appropriate (such as the
number of visits or days of coverage) are based on recommendations made
by panels of experts with appropriate training and experience in the
fields of medicine involved. The evidentiary standards are applied in a
manner that may differ based on clinically appropriate standards of care
for a condition.
(ii) Conclusion. In this Example 3, the plan complies with the rules
of this paragraph (c)(4) because the nonquantitative treatment
limitation--medical appropriateness--is the same for both medical/
surgical benefits and mental health and substance use disorder benefits,
and the processes for developing the evidentiary standards and the
application of them to mental health and substance use disorder benefits
are comparable to and are applied no more stringently than for medical/
surgical benefits. This is the result even if, based on clinically
appropriate standards of care, the application of the evidentiary
standards does not result in similar numbers of visits, days of
coverage, or other benefits utilized for mental health conditions or
substance use disorders as it does for any particular medical/surgical
condition.
Example 4. (i) Facts. A plan generally covers medically appropriate
treatments. In determining whether prescription drugs are medically
appropriate, the plan automatically excludes coverage for antidepressant
drugs that are given a black box warning label by the Food and Drug
Administration (indicating the drug carries a significant risk of
serious adverse effects). For other drugs with a black box warning
(including those prescribed for other mental health conditions and
substance use disorders, as well as for medical/surgical conditions),
the plan will provide coverage if the prescribing physician obtains
authorization from the plan that the
[[Page 460]]
drug is medically appropriate for the individual, based on clinically
appropriate standards of care.
(ii) Conclusion. In this Example 4, the plan violates the rules of
this paragraph (c)(4). Although the same nonquantitative treatment
limitation--medical appropriateness--is applied to both mental health
and substance use disorder benefits and medical/surgical benefits, the
plan's unconditional exclusion of antidepressant drugs given a black box
warning is not comparable to the conditional exclusion for other drugs
with a black box warning.
Example 5. (i) Facts. An employer maintains both a major medical
program and an employee assistance program (EAP). The EAP provides,
among other benefits, a limited number of mental health or substance use
disorder counseling sessions. Participants are eligible for mental
health or substance use disorder benefits under the major medical
program only after exhausting the counseling sessions provided by the
EAP. No similar exhaustion requirement applies with respect to medical/
surgical benefits provided under the major medical program.
(ii) Conclusion. In this Example 5, limiting eligibility for mental
health and substance use disorder benefits only after EAP benefits are
exhausted is a nonquantitative treatment limitation subject to the
parity requirements of this paragraph (c). Because no comparable
requirement applies to medical/surgical benefits, the requirement may
not be applied to mental health or substance use disorder benefits.
(5) Exemptions. The rules of this paragraph (c) do not apply if a
group health plan satisfies the requirements of paragraph (f) or (g) of
this section (relating to exemptions for small employers and for
increased cost).
(d) Availability of plan information--(1) Criteria for medical
necessity determinations. The criteria for medical necessity
determinations made under a group health plan with respect to mental
health or substance use disorder benefits must be made available by the
plan administrator to any current or potential participant, beneficiary,
or contracting provider upon request.
(2) Reason for denial. The reason for any denial under a group
health plan of reimbursement or payment for services with respect to
mental health or substance use disorder benefits in the case of any
participant or beneficiary must be made available by the plan
administrator to the participant or beneficiary in accordance with this
paragraph (d)(2).
(i) Plans subject to ERISA. If a plan is subject to ERISA, it must
provide the reason for the claim denial in a form and manner consistent
with the requirements of 29 CFR 2560.503-1 for group health plans.
(ii) Plans not subject to ERISA. If a plan is not subject to ERISA,
upon the request of a participant or beneficiary the reason for the
claim denial must be provided within a reasonable time and in a
reasonable manner. For this purpose, a plan that follows the
requirements of 29 CFR 2560.503-1 for group health plans complies with
the requirements of this paragraph (d)(2)(ii).
(e) Applicability--(1) Group health plans. The requirements of this
section apply to a group health plan offering medical/surgical benefits
and mental health or substance use disorder benefits. If, under an
arrangement or arrangements to provide health care benefits by an
employer or employee organization (including for this purpose a joint
board of trustees of a multiemployer trust affiliated with one or more
multiemployer plans), any participant (or beneficiary) can
simultaneously receive coverage for medical/surgical benefits and
coverage for mental health or substance use disorder benefits, then the
requirements of this section (including the exemption provisions in
paragraph (g) of this section) apply separately with respect to each
combination of medical/surgical benefits and of mental health or
substance use disorder benefits that any participant (or beneficiary)
can simultaneously receive from that employer's or employee
organization's arrangement or arrangements to provide health care
benefits, and all such combinations are considered for purposes of this
section to be a single group health plan.
(2) Health insurance issuers. See 29 CFR 2590.712(e)(2) and 45 CFR
146.136(e)(2), under which a health insurance issuer offering health
insurance coverage for mental health or substance use disorder benefits
is subject to requirements similar to those applicable to group health
plans under this section if the health insurance coverage is offered in
connection with a group health plan subject to requirements under 29 CFR
2590.712 or 45 CFR
[[Page 461]]
146.136 similar to those applicable to group health plans under this
section.
(3) Scope. This section does not--
(i) Require a group health plan to provide any mental health
benefits or substance use disorder benefits, and the provision of
benefits by a plan for one or more mental health conditions or substance
use disorders does not require the plan under this section to provide
benefits for any other mental health condition or substance use
disorder; or
(ii) Affect the terms and conditions relating to the amount,
duration, or scope of mental health or substance use disorder benefits
under the plan except as specifically provided in paragraphs (b) and (c)
of this section.
(f) Small employer exemption--(1) In general. The requirements of
this section do not apply to a group health plan for a plan year of a
small employer. For purposes of this paragraph (f), the term small
employer means, in connection with a group health plan with respect to a
calendar year and a plan year, an employer who employed an average of at
least two (or one in the case of an employer residing in a state that
permits small groups to include a single individual) but not more than
50 employees on business days during the preceding calendar year. See
section 9831(a)(2) and Sec. 54.9831-1(b), which provide that this
section (and certain other sections) does not apply to any group health
plan for any plan year if, on the first day of the plan year, the plan
has fewer than two participants who are current employees.
(2) Rules in determining employer size. For purposes of paragraph
(f)(1) of this section--
(i) All persons treated as a single employer under subsections (b),
(c), (m), and (o) of section 414 are treated as one employer;
(ii) If an employer was not in existence throughout the preceding
calendar year, whether it is a small employer is determined based on the
average number of employees the employer reasonably expects to employ on
business days during the current calendar year; and
(iii) Any reference to an employer for purposes of the small
employer exemption includes a reference to a predecessor of the
employer.
(g) Increased cost exemption [Reserved]
(h) Sale of nonparity health insurance coverage. See 29 CFR
2590.712(h) and 45 CFR 146.136(h), under which a health insurance issuer
may not sell a policy, certificate, or contract of insurance that fails
to comply with requirements similar to those under paragraph (b) or (c)
of this section, except to a plan for a year for which the plan is
exempt from requirements similar to those under paragraph (b) or (c) of
this section because the plan meets requirements under paragraph (f) or
(g) of 29 CFR 2590.712 or 45 CFR 146.136 similar to those under
paragraph (f) or (g) of this section.
(i) Effective/applicability dates--(1) In general. Except as
provided in paragraph (i)(2) of this section, the requirements of this
section are applicable for plan years beginning on or after July 1,
2010.
(2) Special effective date for certain collectively-bargained plans.
For a group health plan maintained pursuant to one or more collective
bargaining agreements ratified before October 3, 2008, the requirements
of this section do not apply to the plan for plan years beginning before
the later of either--
(i) The date on which the last of the collective bargaining
agreements relating to the plan terminates (determined without regard to
any extension agreed to after October 3, 2008); or
(ii) July 1, 2010.
(j) Expiration date. This section expires on or before January 29,
2013.
[T.D. 9479, 75 FR 5431, Feb. 2, 2010]
Sec. 54.9815-1251T Preservation of right to maintain existing coverage (temporary).
(a) Definition of grandfathered health plan coverage--(1) In
general--(i) Grandfathered health plan coverage. Grandfathered health
plan coverage means coverage provided by a group health plan, or a
health insurance issuer, in which an individual was enrolled on March
23, 2010 (for as long as it maintains that status under the rules of
this section). A group health plan or group health insurance coverage
does not cease to be grandfathered health plan coverage merely because
one or more (or even
[[Page 462]]
all) individuals enrolled on March 23, 2010 cease to be covered,
provided that the plan has continuously covered someone since March 23,
2010 (not necessarily the same person, but at all times at least one
person). In addition, subject to the limitation set forth in paragraph
(a)(1)(ii) of this section, a group health plan (and any health
insurance coverage offered in connection with the group health plan)
does not cease to be a grandfathered health plan merely because the plan
(or its sponsor) enters into a new policy, certificate, or contract of
insurance after March 23, 2010 (for example, a plan enters into a
contract with a new issuer or a new policy is issued with an existing
issuer). For purposes of this section, a plan or health insurance
coverage that provides grandfathered health plan coverage is referred to
as a grandfathered health plan. The rules of this section apply
separately to each benefit package made available under a group health
plan or health insurance coverage.
(ii) Changes in group health insurance coverage. Subject to
paragraphs (f) and (g)(2) of this section, if a group health plan
(including a group health plan that was self-insured on March 23, 2010)
or its sponsor enters into a new policy, certificate, or contract of
insurance after March 23, 2010 that is effective before November 15,
2010, then the plan ceases to be a grandfathered health plan.
(2) Disclosure of grandfather status--(i) To maintain status as a
grandfathered health plan, a plan or health insurance coverage must
include a statement, in any plan materials provided to a participant or
beneficiary describing the benefits provided under the plan or health
insurance coverage, that the plan or coverage believes it is a
grandfathered health plan within the meaning of section 1251 of the
Patient Protection and Affordable Care Act and must provide contact
information for questions and complaints.
(ii) The following model language can be used to satisfy this
disclosure requirement:
This [group health plan or health insurance issuer] believes this
[plan or coverage] is a ``grandfathered health plan'' under the Patient
Protection and Affordable Care Act (the Affordable Care Act). As
permitted by the Affordable Care Act, a grandfathered health plan can
preserve certain basic health coverage that was already in effect when
that law was enacted. Being a grandfathered health plan means that your
[plan or policy] may not include certain consumer protections of the
Affordable Care Act that apply to other plans, for example, the
requirement for the provision of preventive health services without any
cost sharing. However, grandfathered health plans must comply with
certain other consumer protections in the Affordable Care Act, for
example, the elimination of lifetime limits on benefits.
Questions regarding which protections apply and which protections do
not apply to a grandfathered health plan and what might cause a plan to
change from grandfathered health plan status can be directed to the plan
administrator at [insert contact information]. [For ERISA plans, insert:
You may also contact the Employee Benefits Security Administration, U.S.
Department of Labor at 1-866-444-3272 or www.dol.gov/ebsa/healthreform.
This website has a table summarizing which protections do and do not
apply to grandfathered health plans.] [For individual market policies
and nonfederal governmental plans, insert: You may also contact the U.S.
Department of Health and Human Services at www.healthreform.gov.]
(3)(i) Documentation of plan or policy terms on March 23, 2010. To
maintain status as a grandfathered health plan, a group health plan, or
group health insurance coverage, must, for as long as the plan or health
insurance coverage takes the position that it is a grandfathered health
plan--
(A) Maintain records documenting the terms of the plan or health
insurance coverage in connection with the coverage in effect on March
23, 2010, and any other documents necessary to verify, explain, or
clarify its status as a grandfathered health plan; and
(B) Make such records available for examination upon request.
(ii) Change in group health insurance coverage. To maintain status
as a grandfathered health plan, a group health plan that enters into a
new policy, certificate, or contract of insurance must provide to the
new health insurance issuer (and the new health insurance issuer must
require) documentation of plan terms (including benefits, cost sharing,
employer contributions, and annual limits) under the prior health
coverage sufficient to determine whether a change causing a
[[Page 463]]
cessation of grandfathered health plan status under paragraph (g)(1) of
this section has occurred.
(4) Family members enrolling after March 23, 2010. With respect to
an individual who is enrolled in a group health plan or health insurance
coverage on March 23, 2010, grandfathered health plan coverage includes
coverage of family members of the individual who enroll after March 23,
2010 in the grandfathered health plan coverage of the individual.
(b) Allowance for new employees to join current plan--(1) In
general. Subject to paragraph (b)(2) of this section, a group health
plan (including health insurance coverage provided in connection with
the group health plan) that provided coverage on March 23, 2010 and has
retained its status as a grandfathered health plan (consistent with the
rules of this section, including paragraph (g) of this section) is
grandfathered health plan coverage for new employees (whether newly
hired or newly enrolled) and their families enrolling in the plan after
March 23, 2010.
(2) Anti-abuse rules--(i) Mergers and acquisitions. If the principal
purpose of a merger, acquisition, or similar business restructuring is
to cover new individuals under a grandfathered health plan, the plan
ceases to be a grandfathered health plan.
(ii) Change in plan eligibility. A group health plan or health
insurance coverage (including a benefit package under a group health
plan) ceases to be a grandfathered health plan if--
(A) Employees are transferred into the plan or health insurance
coverage (the transferee plan) from a plan or health insurance coverage
under which the employees were covered on March 23, 2010 (the transferor
plan);
(B) Comparing the terms of the transferee plan with those of the
transferor plan (as in effect on March 23, 2010) and treating the
transferee plan as if it were an amendment of the transferor plan would
cause a loss of grandfather status under the provisions of paragraph
(g)(1) of this section; and
(C) There was no bona fide employment-based reason to transfer the
employees into the transferee plan. For this purpose, changing the terms
or cost of coverage is not a bona fide employment-based reason.
(3) Examples. The rules of this paragraph (b) are illustrated by the
following examples:
Example 1. (i) Facts. A group health plan offers two benefit
packages on March 23, 2010, Options F and G. During a subsequent open
enrollment period, some of the employees enrolled in Option F on March
23, 2010 switch to Option G.
(ii) Conclusion. In this Example 1, the group health coverage
provided under Option G remains a grandfathered health plan under the
rules of paragraph (b)(1) of this section because employees previously
enrolled in Option F are allowed to enroll in Option G as new employees.
Example 2. (i) Facts. Same facts as Example 1, except that the plan
sponsor eliminates Option F because of its high cost and transfers
employees covered under Option F to Option G. If instead of transferring
employees from Option F to Option G, Option F was amended to match the
terms of Option G, then Option F would cease to be a grandfathered
health plan.
(ii) Conclusion. In this Example 2, the plan did not have a bona
fide employment-based reason to transfer employees from Option F to
Option G. Therefore, Option G ceases to be a grandfathered health plan
with respect to all employees. (However, any other benefit package
maintained by the plan sponsor is analyzed separately under the rules of
this section.)
Example 3. (i) Facts. A group health plan offers two benefit
packages on March 23, 2010, Options H and I. On March 23, 2010, Option H
provides coverage only for employees in one manufacturing plant.
Subsequently, the plant is closed, and some employees in the closed
plant are moved to another plant. The employer eliminates Option H and
the employees that are moved are transferred to Option I. If instead of
transferring employees from Option H to Option I, Option H was amended
to match the terms of Option I, then Option H would cease to be a
grandfathered health plan.
(ii) Conclusion. In this Example 3, the plan has a bona fide
employment-based reason to transfer employees from Option H to Option I.
Therefore, Option I does not cease to be a grandfathered health plan.
(c) General grandfathering rule--(1) Except as provided in
paragraphs (d) and (e) of this section, subtitles A and C of title I of
the Patient Protection and Affordable Care Act (and the amendments made
by those subtitles, and the incorporation of those amendments into
section 9815 and ERISA section 715) do not apply to grandfathered
[[Page 464]]
health plan coverage. Accordingly, the provisions of PHS Act sections
2701, 2702, 2703, 2705, 2706, 2707, 2709 (relating to coverage for
individuals participating in approved clinical trials, as added by
section 10103 of the Patient Protection and Affordable Care Act), 2713,
2715A, 2716, 2717, 2719, and 2719A, as added or amended by the Patient
Protection and Affordable Care Act, do not apply to grandfathered health
plans. (In addition, see 45 CFR 147.140(c), which provides that the
provisions of PHS Act section 2704, and PHS Act section 2711 insofar as
it relates to annual limits, do not apply to grandfathered health plans
that are individual health insurance coverage.)
(2) To the extent not inconsistent with the rules applicable to a
grandfathered health plan, a grandfathered health plan must comply with
the requirements of the Code, the PHS Act, and ERISA applicable prior to
the changes enacted by the Patient Protection and Affordable Care Act.
(d) Provisions applicable to all grandfathered health plans. The
provisions of PHS Act section 2711 insofar as it relates to lifetime
limits, and the provisions of PHS Act sections 2712, 2714, 2715, and
2718, apply to grandfathered health plans for plan years beginning on or
after September 23, 2010. The provisions of PHS Act section 2708 apply
to grandfathered health plans for plan years beginning on or after
January 1, 2014.
(e) Applicability of PHS Act sections 2704, 2711, and 2714 to
grandfathered group health plans and group health insurance coverage--
(1) The provisions of PHS Act section 2704 as it applies with respect to
enrollees who are under 19 years of age, and the provisions of PHS Act
section 2711 insofar as it relates to annual limits, apply to
grandfathered health plans that are group health plans (including group
health insurance coverage) for plan years beginning on or after
September 23, 2010. The provisions of PHS Act section 2704 apply
generally to grandfathered health plans that are group health plans
(including group health insurance coverage) for plan years beginning on
or after January 1, 2014.
(2) For plan years beginning before January 1, 2014, the provisions
of PHS Act section 2714 apply in the case of an adult child with respect
to a grandfathered health plan that is a group health plan only if the
adult child is not eligible to enroll in an eligible employer-sponsored
health plan (as defined in section 5000A(f)(2)) other than a
grandfathered health plan of a parent. For plan years beginning on or
after January 1, 2014, the provisions of PHS Act section 2714 apply with
respect to a grandfathered health plan that is a group health plan
without regard to whether an adult child is eligible to enroll in any
other coverage.
(f) Effect on collectively bargained plans--In general. In the case
of health insurance coverage maintained pursuant to one or more
collective bargaining agreements between employee representatives and
one or more employers that was ratified before March 23, 2010, the
coverage is grandfathered health plan coverage at least until the date
on which the last of the collective bargaining agreements relating to
the coverage that was in effect on March 23, 2010 terminates. Any
coverage amendment made pursuant to a collective bargaining agreement
relating to the coverage that amends the coverage solely to conform to
any requirement added by subtitles A and C of title I of the Patient
Protection and Affordable Care Act (and the amendments made by those
subtitles, and the incorporation of those amendments into section 9815
and ERISA section 715) is not treated as a termination of the collective
bargaining agreement. After the date on which the last of the collective
bargaining agreements relating to the coverage that was in effect on
March 23, 2010 terminates, the determination of whether health insurance
coverage maintained pursuant to a collective bargaining agreement is
grandfathered health plan coverage is made under the rules of this
section other than this paragraph (f) (comparing the terms of the health
insurance coverage after the date the last collective bargaining
agreement terminates with the terms of the health insurance coverage
that were in effect on March 23, 2010).
(g) Maintenance of grandfather status--(1) Changes causing cessation
of grandfather status. Subject to paragraph (g)(2) of this section, the
rules of
[[Page 465]]
this paragraph (g)(1) describe situations in which a group health plan
or health insurance coverage ceases to be a grandfathered health plan.
(i) Elimination of benefits. The elimination of all or substantially
all benefits to diagnose or treat a particular condition causes a group
health plan or health insurance coverage to cease to be a grandfathered
health plan. For this purpose, the elimination of benefits for any
necessary element to diagnose or treat a condition is considered the
elimination of all or substantially all benefits to diagnose or treat a
particular condition.
(ii) Increase in percentage cost-sharing requirement. Any increase,
measured from March 23, 2010, in a percentage cost-sharing requirement
(such as an individual's coinsurance requirement) causes a group health
plan or health insurance coverage to cease to be a grandfathered health
plan.
(iii) Increase in a fixed-amount cost-sharing requirement other than
a copayment. Any increase in a fixed-amount cost-sharing requirement
other than a copayment (for example, deductible or out-of-pocket limit),
determined as of the effective date of the increase, causes a group
health plan or health insurance coverage to cease to be a grandfathered
health plan, if the total percentage increase in the cost-sharing
requirement measured from March 23, 2010 exceeds the maximum percentage
increase (as defined in paragraph (g)(3)(ii) of this section).
(iv) Increase in a fixed-amount copayment. Any increase in a fixed-
amount copayment, determined as of the effective date of the increase,
causes a group health plan or health insurance coverage to cease to be a
grandfathered health plan, if the total increase in the copayment
measured from March 23, 2010 exceeds the greater of:
(A) An amount equal to $5 increased by medical inflation, as defined
in paragraph (g)(3)(i) of this section (that is, $5 times medical
inflation, plus $5), or
(B) The maximum percentage increase (as defined in paragraph
(g)(3)(ii) of this section), determined by expressing the total increase
in the copayment as a percentage.
(v) Decrease in contribution rate by employers and employee
organizations--(A) Contribution rate based on cost of coverage. A group
health plan or group health insurance coverage ceases to be a
grandfathered health plan if the employer or employee organization
decreases its contribution rate based on cost of coverage (as defined in
paragraph (g)(3)(iii)(A) of this section) towards the cost of any tier
of coverage for any class of similarly situated individuals (as
described in Sec. 54.9802-1(d)) by more than 5 percentage points below
the contribution rate for the coverage period that includes March 23,
2010.
(B) Contribution rate based on a formula. A group health plan or
group health insurance coverage ceases to be a grandfathered health plan
if the employer or employee organization decreases its contribution rate
based on a formula (as defined in paragraph (g)(3)(iii)(B) of this
section) towards the cost of any tier of coverage for any class of
similarly situated individuals (as described in Sec. 54.9802-1(d)) by
more than 5 percent below the contribution rate for the coverage period
that includes March 23, 2010.
(vi) Changes in annual limits--(A) Addition of an annual limit. A
group health plan, or group health insurance coverage, that, on March
23, 2010, did not impose an overall annual or lifetime limit on the
dollar value of all benefits ceases to be a grandfathered health plan if
the plan or health insurance coverage imposes an overall annual limit on
the dollar value of benefits.
(B) Decrease in limit for a plan or coverage with only a lifetime
limit. A group health plan, or group health insurance coverage, that, on
March 23, 2010, imposed an overall lifetime limit on the dollar value of
all benefits but no overall annual limit on the dollar value of all
benefits ceases to be a grandfathered health plan if the plan or health
insurance coverage adopts an overall annual limit at a dollar value that
is lower than the dollar value of the lifetime limit on March 23, 2010.
(C) Decrease in limit for a plan or coverage with an annual limit. A
group health plan, or group health insurance coverage, that, on March
23, 2010, imposed an overall annual limit on the dollar value of all
benefits ceases to be
[[Page 466]]
a grandfathered health plan if the plan or health insurance coverage
decreases the dollar value of the annual limit (regardless of whether
the plan or health insurance coverage also imposed an overall lifetime
limit on March 23, 2010 on the dollar value of all benefits).
(2) Transitional rules--(i) Changes made prior to March 23, 2010. If
a group health plan or health insurance issuer makes the following
changes to the terms of the plan or health insurance coverage, the
changes are considered part of the terms of the plan or health insurance
coverage on March 23, 2010 even though they were not effective at that
time and such changes do not cause a plan or health insurance coverage
to cease to be a grandfathered health plan:
(A) Changes effective after March 23, 2010 pursuant to a legally
binding contract entered into on or before March 23, 2010;
(B) Changes effective after March 23, 2010 pursuant to a filing on
or before March 23, 2010 with a State insurance department; or
(C) Changes effective after March 23, 2010 pursuant to written
amendments to a plan that were adopted on or before March 23, 2010.
(ii) Changes made after March 23, 2010 and adopted prior to issuance
of regulations. If, after March 23, 2010, a group health plan or health
insurance issuer makes changes to the terms of the plan or health
insurance coverage and the changes are adopted prior to June 14, 2010,
the changes will not cause the plan or health insurance coverage to
cease to be a grandfathered health plan if the changes are revoked or
modified effective as of the first day of the first plan year (in the
individual market, policy year) beginning on or after September 23,
2010, and the terms of the plan or health insurance coverage on that
date, as modified, would not cause the plan or coverage to cease to be a
grandfathered health plan under the rules of this section, including
paragraph (g)(1) of this section. For this purpose, changes will be
considered to have been adopted prior to June 14, 2010 if:
(A) The changes are effective before that date;
(B) The changes are effective on or after that date pursuant to a
legally binding contract entered into before that date;
(C) The changes are effective on or after that date pursuant to a
filing before that date with a State insurance department; or
(D) The changes are effective on or after that date pursuant to
written amendments to a plan that were adopted before that date.
(3) Definitions--(i) Medical inflation defined. For purposes of this
paragraph (g), the term medical inflation means the increase since March
2010 in the overall medical care component of the Consumer Price Index
for All Urban Consumers (CPI-U) (unadjusted) published by the Department
of Labor using the 1982-1984 base of 100. For this purpose, the increase
in the overall medical care component is computed by subtracting 387.142
(the overall medical care component of the CPI-U (unadjusted) published
by the Department of Labor for March 2010, using the 1982-1984 base of
100) from the index amount for any month in the 12 months before the new
change is to take effect and then dividing that amount by 387.142.
(ii) Maximum percentage increase defined. For purposes of this
paragraph (g), the term maximum percentage increase means medical
inflation (as defined in paragraph (g)(3)(i) of this section), expressed
as a percentage, plus 15 percentage points.
(iii) Contribution rate defined. For purposes of paragraph (g)(1)(v)
of this section:
(A) Contribution rate based on cost of coverage. The term
contribution rate based on cost of coverage means the amount of
contributions made by an employer or employee organization compared to
the total cost of coverage, expressed as a percentage. The total cost of
coverage is determined in the same manner as the applicable premium is
calculated under the COBRA continuation provisions of section
4980B(f)(4), section 604 of ERISA, and section 2204 of the PHS Act. In
the case of a self-insured plan, contributions by an employer or
employee organization are equal to the total cost of coverage
[[Page 467]]
minus the employee contributions towards the total cost of coverage.
(B) Contribution rate based on a formula. The term contribution rate
based on a formula means, for plans that, on March 23, 2010, made
contributions based on a formula (such as hours worked or tons of coal
mined), the formula.
(4) Examples. The rules of this paragraph (g) are illustrated by the
following examples:
Example 1. (i) Facts. On March 23, 2010, a grandfathered health plan
has a coinsurance requirement of 20% for inpatient surgery. The plan is
subsequently amended to increase the coinsurance requirement to 25%.
(ii) Conclusion. In this Example 1, the increase in the coinsurance
requirement from 20% to 25% causes the plan to cease to be a
grandfathered health plan.
Example 2. (i) Facts. Before March 23, 2010, the terms of a group
health plan provide benefits for a particular mental health condition,
the treatment for which is a combination of counseling and prescription
drugs. Subsequently, the plan eliminates benefits for counseling.
(ii) Conclusion. In this Example 2, the plan ceases to be a
grandfathered health plan because counseling is an element that is
necessary to treat the condition. Thus the plan is considered to have
eliminated substantially all benefits for the treatment of the
condition.
Example 3. (i) Facts. On March 23, 2010, a grandfathered health plan
has a copayment requirement of $30 per office visit for specialists. The
plan is subsequently amended to increase the copayment requirement to
$40. Within the 12-month period before the $40 copayment takes effect,
the greatest value of the overall medical care component of the CPI-U
(unadjusted) is 475.
(ii) Conclusion. In this Example 3, the increase in the copayment
from $30 to $40, expressed as a percentage, is 33.33% (40 - 30 = 10; 10
/ 30 = 0.3333; 0.3333 = 33.33%). Medical inflation (as defined in
paragraph (g)(3)(i) of this section) from March 2010 is 0.2269 (475 -
387.142 = 87.858; 87.858 / 387.142 = 0.2269). The maximum percentage
increase permitted is 37.69% (0.2269 = 22.69%; 22.69% + 15% = 37.69%).
Because 33.33% does not exceed 37.69%, the change in the copayment
requirement at that time does not cause the plan to cease to be a
grandfathered health plan.
Example 4. (i) Facts. Same facts as Example 3, except the
grandfathered health plan subsequently increases the $40 copayment
requirement to $45 for a later plan year. Within the 12-month period
before the $45 copayment takes effect, the greatest value of the overall
medical care component of the CPI-U (unadjusted) is 485.
(ii) Conclusion. In this Example 4, the increase in the copayment
from $30 (the copayment that was in effect on March 23, 2010) to $45,
expressed as a percentage, is 50% (45 - 30 = 15; 15 / 30 = 0.5; 0.5 =
50%). Medical inflation (as defined in paragraph (g)(3)(i) of this
section) from March 2010 is 0.2527 (485 - 387.142 = 97.858; 97.858 /
387.142 = 0.2527). The increase that would cause a plan to cease to be a
grandfathered health plan under paragraph (g)(1)(iv) of this section is
the greater of the maximum percentage increase of 40.27% (0.2527 =
25.27%; 25.27% + 15% = 40.27%), or $6.26 ($5 x 0.2527 = $1.26; $1.26 +
$5 = $6.26). Because 50% exceeds 40.27% and $15 exceeds $6.26, the
change in the copayment requirement at that time causes the plan to
cease to be a grandfathered health plan.
Example 5. (i) Facts. On March 23, 2010, a grandfathered health plan
has a copayment of $10 per office visit for primary care providers. The
plan is subsequently amended to increase the copayment requirement to
$15. Within the 12-month period before the $15 copayment takes effect,
the greatest value of the overall medical care component of the CPI-U
(unadjusted) is 415.
(ii) Conclusion. In this Example 5, the increase in the copayment,
expressed as a percentage, is 50% (15 - 10 = 5; 5 / 10 = 0.5; 0.5 =
50%). Medical inflation (as defined in paragraph (g)(3) of this section)
from March 2010 is 0.0720 (415.0 - 387.142 = 27.858; 27.858 / 387.142 =
0.0720). The increase that would cause a plan to cease to be a
grandfathered health plan under paragraph (g)(1)(iv) of this section is
the greater of the maximum percentage increase of 22.20% (0.0720 =
7.20%; 7.20% + 15% = 22.20), or $5.36 ($5 x 0.0720 = $0.36; $0.36 + $5 =
$5.36). The $5 increase in copayment in this Example 5 would not cause
the plan to cease to be a grandfathered health plan pursuant to
paragraph (g)(1)(iv) of this section, which would permit an increase in
the copayment of up to $5.36.
Example 6. (i) Facts. The same facts as Example 5, except on March
23, 2010, the grandfathered health plan has no copayment ($0) for office
visits for primary care providers. The plan is subsequently amended to
increase the copayment requirement to $5.
(ii) Conclusion. In this Example 6, medical inflation (as defined in
paragraph (g)(3)(i) of this section) from March 2010 is 0.0720 (415.0 -
387.142 = 27.858; 27.858 / 387.142 = 0.0720). The increase that would
cause a plan to cease to be a grandfathered health plan under paragraph
(g)(1)(iv)(A) of this section is $5.36 ($5 x 0.0720 = $0.36; $0.36 + $5
= $5.36). The $5 increase in copayment in this Example 6 is less than
the amount calculated pursuant to paragraph (g)(1)(iv)(A) of this
section of $5.36. Thus, the $5 increase in copayment does not cause the
plan to cease to be a grandfathered health plan.
Example 7. (i) Facts. On March 23, 2010, a self-insured group health
plan provides two
[[Page 468]]
tiers of coverage--self-only and family. The employer contributes 80% of
the total cost of coverage for self-only and 60% of the total cost of
coverage for family. Subsequently, the employer reduces the contribution
to 50% for family coverage, but keeps the same contribution rate for
self-only coverage.
(ii) Conclusion. In this Example 7, the decrease of 10 percentage
points for family coverage in the contribution rate based on cost of
coverage causes the plan to cease to be a grandfathered health plan. The
fact that the contribution rate for self-only coverage remains the same
does not change the result.
Example 8. (i) Facts. On March 23, 2010, a self-insured
grandfathered health plan has a COBRA premium for the 2010 plan year of
$5000 for self-only coverage and $12,000 for family coverage. The
required employee contribution for the coverage is $1000 for self-only
coverage and $4000 for family coverage. Thus, the contribution rate
based on cost of coverage for 2010 is 80% ((5000 - 1000)/5000) for self-
only coverage and 67% ((12,000 - 4000)/12,000) for family coverage. For
a subsequent plan year, the COBRA premium is $6000 for self-only
coverage and $15,000 for family coverage. The employee contributions for
that plan year are $1200 for self-only coverage and $5000 for family
coverage. Thus, the contribution rate based on cost of coverage is 80%
((6000 - 1200)/6000) for self-only coverage and 67% ((15,000 - 5000)/
15,000) for family coverage.
(ii) Conclusion. In this Example 8, because there is no change in
the contribution rate based on cost of coverage, the plan retains its
status as a grandfathered health plan. The result would be the same if
all or part of the employee contribution was made pre-tax through a
cafeteria plan under section 125 of the Internal Revenue Code.
Example 9. (i) Facts. A group health plan not maintained pursuant to
a collective bargaining agreement offers three benefit packages on March
23, 2010. Option F is a self-insured option. Options G and H are insured
options. Beginning July 1, 2013, the plan increases coinsurance under
Option H from 10% to 15%.
(ii) Conclusion. In this Example 9, the coverage under Option H is
not grandfathered health plan coverage as of July 1, 2013, consistent
with the rule in paragraph (g)(1)(ii) of this section. Whether the
coverage under Options F and G is grandfathered health plan coverage is
determined separately under the rules of this paragraph (g).
(h) Expiration date. This section expires on or before June 14,
2013.
[T.D. 9489, 75 FR 34558, June 17, 2010, as amended by T.D. 9506, 75 FR
70120, Nov. 17, 2010]
Sec. 54.9815-2704T Prohibition of preexisting condition exclusions (temporary).
(a) No preexisting condition exclusions--(1) In general. A group
health plan, or a health insurance issuer offering group health
insurance coverage, may not impose any preexisting condition exclusion
(as defined in Sec. 54.9801-2).
(2) Examples. The rules of this paragraph (a) are illustrated by the
following examples (for additional examples illustrating the definition
of a preexisting condition exclusion, see Sec. 54.9801-3(a)(1)(ii)):
Example 1. (i) Facts. A group health plan provides benefits solely
through an insurance policy offered by Issuer P. At the expiration of
the policy, the plan switches coverage to a policy offered by Issuer N.
N's policy excludes benefits for oral surgery required as a result of a
traumatic injury if the injury occurred before the effective date of
coverage under the policy.
(ii) Conclusion. In this Example 1, the exclusion of benefits for
oral surgery required as a result of a traumatic injury if the injury
occurred before the effective date of coverage is a preexisting
condition exclusion because it operates to exclude benefits for a
condition based on the fact that the condition was present before the
effective date of coverage under the policy.
Example 2. (i) Facts. Individual C applies for individual health
insurance coverage with Issuer M. M denies C's application for coverage
because a pre-enrollment physical revealed that C has type 2 diabetes.
(ii) Conclusion. See Example 2 in 45 CFR 147.108(a)(2) for a
conclusion that M's denial of C's application for coverage is a
preexisting condition exclusion because a denial of an application for
coverage based on the fact that a condition was present before the date
of denial is an exclusion of benefits based on a preexisting condition.
(b) Effective/applicability date--(1) General applicability date.
Except as provided in paragraph (b)(2) of this section, the rules of
this section apply for plan years beginning on or after January 1, 2014.
(2) Early applicability date for children. The rules of this section
apply with respect to enrollees, including applicants for enrollment,
who are under 19 years of age for plan years beginning on or after
September 23, 2010.
(3) Applicability to grandfathered health plans. See Sec. 54.9815-
1251T for determining the application of this section to grandfathered
health plans
[[Page 469]]
(providing that a grandfathered health plan that is a group health plan
or group health insurance coverage must comply with the prohibition
against preexisting condition exclusions).
(4) Example. The rules of this paragraph (b) are illustrated by the
following example:
Example. (i) Facts. Individual F commences employment and enrolls F
and F's 16-year-old child in the group health plan maintained by F's
employer, with a first day of coverage of October 15, 2010. F's child
had a significant break in coverage because of a lapse of more than 63
days without creditable coverage immediately prior to enrolling in the
plan. F's child was treated for asthma within the six-month period prior
to the enrollment date and the plan imposes a 12-month preexisting
condition exclusion for coverage of asthma. The next plan year begins on
January 1, 2011.
(ii) Conclusion. In this Example, the plan year beginning January 1,
2011 is the first plan year of the group health plan beginning on or
after September 23, 2010. Thus, beginning on January 1, 2011, because
the child is under 19 years of age, the plan cannot impose a preexisting
condition exclusion with respect to the child's asthma regardless of the
fact that the preexisting condition exclusion was imposed by the plan
before the applicability date of this provision.
(c) Expiration date. This section expires on June 21, 2013.
[T.D. 9491, 75 FR 37223, June 28, 2010]
Sec. 54.9815-2711T No lifetime or annual limits (temporary).
(a) Prohibition--(1) Lifetime limits. Except as provided in
paragraph (b) of this section, a group health plan, or a health
insurance issuer offering group health insurance coverage, may not
establish any lifetime limit on the dollar amount of benefits for any
individual.
(2) Annual limits--(i) General rule. Except as provided in
paragraphs (a)(2)(ii), (b), and (d) of this section, a group health
plan, or a health insurance issuer offering group health insurance
coverage, may not establish any annual limit on the dollar amount of
benefits for any individual.
(ii) Exception for health flexible spending arrangements. A health
flexible spending arrangement (as defined in section 106(c)(2)) is not
subject to the requirement in paragraph (a)(2)(i) of this section.
(b) Construction--(1) Permissible limits on specific covered
benefits. The rules of this section do not prevent a group health plan,
or a health insurance issuer offering group health insurance coverage,
from placing annual or lifetime dollar limits with respect to any
individual on specific covered benefits that are not essential health
benefits to the extent that such limits are otherwise permitted under
applicable Federal or State law. (The scope of essential health benefits
is addressed in paragraph (c) of this section.)
(2) Condition-based exclusions. The rules of this section do not
prevent a group health plan, or a health insurance issuer offering group
health insurance coverage, from excluding all benefits for a condition.
However, if any benefits are provided for a condition, then the
requirements of this section apply. Other requirements of Federal or
State law may require coverage of certain benefits.
(c) Definition of essential health benefits. The term ``essential
health benefits'' means essential health benefits under section 1302(b)
of the Patient Protection and Affordable Care Act and applicable
regulations.
(d) Restricted annual limits permissible prior to 2014--(1) In
general. With respect to plan years beginning prior to January 1, 2014,
a group health plan, or a health insurance issuer offering group health
insurance coverage, may establish, for any individual, an annual limit
on the dollar amount of benefits that are essential health benefits,
provided the limit is no less than the amounts in the following
schedule:
(i) For a plan year beginning on or after September 23, 2010, but
before September 23, 2011, $750,000.
(ii) For a plan year beginning on or after September 23, 2011, but
before September 23, 2012, $1,250,000.
(iii) For plan years beginning on or after September 23, 2012, but
before January 1, 2014, $2,000,000.
(2) Only essential health benefits taken into account. In
determining whether an individual has received benefits that meet or
exceed the applicable amount described in paragraph (d)(1) of this
section, a plan or issuer must take into account only essential health
benefits.
[[Page 470]]
(3) Waiver authority of the Secretary of Health and Human Services.
For plan years beginning before January 1, 2014, the Secretary of Health
and Human Services may establish a program under which the requirements
of paragraph (d)(1) of this section relating to annual limits may be
waived (for such period as is specified by the Secretary of Health and
Human Services) for a group health plan or health insurance coverage
that has an annual dollar limit on benefits below the restricted annual
limits provided under paragraph (d)(1) of this section if compliance
with paragraph (d)(1) of this section would result in a significant
decrease in access to benefits under the plan or health insurance
coverage or would significantly increase premiums for the plan or health
insurance coverage.
(e) Transitional rules for individuals whose coverage or benefits
ended by reason of reaching a lifetime limit--(1) In general. The relief
provided in the transitional rules of this paragraph (e) applies with
respect to any individual--
(i) Whose coverage or benefits under a group health plan or group
health insurance coverage ended by reason of reaching a lifetime limit
on the dollar value of all benefits for any individual (which, under
this section, is no longer permissible); and
(ii) Who becomes eligible (or is required to become eligible) for
benefits not subject to a lifetime limit on the dollar value of all
benefits under the group health plan or group health insurance coverage
on the first day of the first plan year beginning on or after September
23, 2010, by reason of the application of this section.
(2) Notice and enrollment opportunity requirements--(i) If an
individual described in paragraph (e)(1) of this section is eligible for
benefits (or is required to become eligible for benefits) under the
group health plan--or group health insurance coverage--described in
paragraph (e)(1) of this section, the plan and the issuer are required
to give the individual written notice that the lifetime limit on the
dollar value of all benefits no longer applies and that the individual,
if covered, is once again eligible for benefits under the plan.
Additionally, if the individual is not enrolled in the plan or health
insurance coverage, or if an enrolled individual is eligible for but not
enrolled in any benefit package under the plan or health insurance
coverage, then the plan and issuer must also give such an individual an
opportunity to enroll that continues for at least 30 days (including
written notice of the opportunity to enroll). The notices and enrollment
opportunity required under this paragraph (e)(2)(i) must be provided
beginning not later than the first day of the first plan year beginning
on or after September 23, 2010.
(ii) The notices required under paragraph (e)(2)(i) of this section
may be provided to an employee on behalf of the employee's dependent. In
addition, the notices may be included with other enrollment materials
that a plan distributes to employees, provided the statement is
prominent. For either notice, if a notice satisfying the requirements of
this paragraph (e)(2) is provided to an individual, the obligation to
provide the notice with respect to that individual is satisfied for both
the plan and the issuer.
(3) Effective date of coverage. In the case of an individual who
enrolls under paragraph (e)(2) of this section, coverage must take
effect not later than the first day of the first plan year beginning on
or after September 23, 2010.
(4) Treatment of enrollees in a group health plan. Any individual
enrolling in a group health plan pursuant to paragraph (e)(2) of this
section must be treated as if the individual were a special enrollee, as
provided under the rules of Sec. 54.9801-6(d). Accordingly, the
individual (and, if the individual would not be a participant once
enrolled in the plan, the participant through whom the individual is
otherwise eligible for coverage under the plan) must be offered all the
benefit packages available to similarly situated individuals who did not
lose coverage by reason of reaching a lifetime limit on the dollar value
of all benefits. For this purpose, any difference in benefits or cost-
sharing requirements constitutes a different benefit package. The
individual also cannot be required to pay
[[Page 471]]
more for coverage than similarly situated individuals who did not lose
coverage by reason of reaching a lifetime limit on the dollar value of
all benefits.
(5) Examples. The rules of this paragraph (e) are illustrated by the
following examples:
Example 1. (i) Facts. Employer Y maintains a group health plan with
a calendar year plan year. The plan has a single benefit package. For
plan years beginning before September 23, 2010, the plan has a lifetime
limit on the dollar value of all benefits. Individual B, an employee of
Y, was enrolled in Y's group health plan at the beginning of the 2008
plan year. On June 10, 2008, B incurred a claim for benefits that
exceeded the lifetime limit under Y's plan and ceased to be enrolled in
the plan. B is still eligible for coverage under Y's group health plan.
On or before January 1, 2011, Y's group health plan gives B written
notice informing B that the lifetime limit on the dollar value of all
benefits no longer applies, that individuals whose coverage ended by
reason of reaching a lifetime limit under the plan are eligible to
enroll in the plan, and that individuals can request such enrollment
through February 1, 2011 with enrollment effective retroactively to
January 1, 2011.
(ii) Conclusion. In this Example 1, the plan has complied with the
requirements of this paragraph (e) by providing a timely written notice
and enrollment opportunity to B that lasts at least 30 days.
Example 2. (i) Facts. Employer Z maintains a group health plan with
a plan year beginning October 1 and ending September 30. Prior to
October 1, 2010, the group health plan has a lifetime limit on the
dollar value of all benefits. Individual D, an employee of Z, and
Individual E, D's child, were enrolled in family coverage under Z's
group health plan for the plan year beginning on October 1, 2008. On May
1, 2009, E incurred a claim for benefits that exceeded the lifetime
limit under Z's plan. D dropped family coverage but remains an employee
of Z and is still eligible for coverage under Z's group health plan.
(ii) Conclusion. In this Example 2, not later than October 1, 2010,
the plan must provide D and E an opportunity to enroll (including
written notice of an opportunity to enroll) that continues for at least
30 days, with enrollment effective not later than October 1, 2010.
Example 3. (i) Facts. Same facts as Example 2, except that Z's plan
had two benefit packages (a low-cost and a high-cost option). Instead of
dropping coverage, D switched to the low-cost benefit package option.
(ii) Conclusion. In this Example 3, not later than October 1, 2010,
the plan must provide D and E an opportunity to enroll in any benefit
package available to similarly situated individuals who enroll when
first eligible. The plan would have to provide D and E the opportunity
to enroll in any benefit package available to similarly situated
individuals who enroll when first eligible, even if D had not switched
to the low-cost benefit package option.
Example 4. (i) Facts. Employer Q maintains a group health plan with
a plan year beginning October 1 and ending September 30. For the plan
year beginning on October 1, 2009, Q has an annual limit on the dollar
value of all benefits of $500,000.
(ii) Conclusion. In this Example 4, Q must raise the annual limit on
the dollar value of essential health benefits to at least $750,000 for
the plan year beginning October 1, 2010. For the plan year beginning
October 1, 2011, Q must raise the annual limit to at least $1.25
million. For the plan year beginning October 1, 2012, Q must raise the
annual limit to at least $2 million. Q may also impose a restricted
annual limit of $2 million for the plan year beginning October 1, 2013.
After the conclusion of that plan year, Q cannot impose an overall
annual limit.
Example 5. (i) Facts. Same facts as Example 4, except that the
annual limit for the plan year beginning on October 1, 2009 is $1
million and Q lowers the annual limit for the plan year beginning
October 1, 2010 to $750,000.
(ii) Conclusion. In this Example 5, Q complies with the requirements
of this paragraph (e). However, Q's choice to lower its annual limit
means that under Sec. 54.9815-1251T(g)(1)(vi)(C), the group health plan
will cease to be a grandfathered health plan and will be generally
subject to all of the provisions of PHS Act sections 2701 through 2719A.
(f) Effective/applicability date. The provisions of this section
apply for plan years beginning on or after September 23, 2010. See Sec.
54.9815-1251T for determining the application of this section to
grandfathered health plans (providing that the prohibitions on lifetime
and annual limits apply to all grandfathered health plans that are group
health plans and group health insurance coverage, including the special
rules regarding restricted annual limits).
(g) Expiration date. This section expires on June 21, 2013.
[T.D. 9491, 75 FR 37223, June 28, 2010]
[[Page 472]]
Sec. 54.9815-2712T Rules regarding rescissions (temporary).
(a) Prohibition on rescissions--(1) A group health plan, or a health
insurance issuer offering group health insurance coverage, must not
rescind coverage under the plan, or under the policy, certificate, or
contract of insurance, with respect to an individual (including a group
to which the individual belongs or family coverage in which the
individual is included) once the individual is covered under the plan or
coverage, unless the individual (or a person seeking coverage on behalf
of the individual) performs an act, practice, or omission that
constitutes fraud, or unless the individual makes an intentional
misrepresentation of material fact, as prohibited by the terms of the
plan or coverage. A group health plan, or a health insurance issuer
offering group health insurance coverage, must provide at least 30 days
advance written notice to each participant who would be affected before
coverage may be rescinded under this paragraph (a)(1), regardless of
whether the coverage is insured or self-insured, or whether the
rescission applies to an entire group or only to an individual within
the group. (The rules of this paragraph (a)(1) apply regardless of any
contestability period that may otherwise apply.)
(2) For purposes of this section, a rescission is a cancellation or
discontinuance of coverage that has retroactive effect. For example, a
cancellation that treats a policy as void from the time of the
individual's or group's enrollment is a rescission. As another example,
a cancellation that voids benefits paid up to a year before the
cancellation is also a rescission for this purpose. A cancellation or
discontinuance of coverage is not a rescission if--
(i) The cancellation or discontinuance of coverage has only a
prospective effect; or
(ii) The cancellation or discontinuance of coverage is effective
retroactively to the extent it is attributable to a failure to timely
pay required premiums or contributions towards the cost of coverage.
(3) The rules of this paragraph (a) are illustrated by the following
examples:
Example 1. (i) Facts. Individual A seeks enrollment in an insured
group health plan. The plan terms permit rescission of coverage with
respect to an individual if the individual engages in fraud or makes an
intentional misrepresentation of a material fact. The plan requires A to
complete a questionnaire regarding A's prior medical history, which
affects setting the group rate by the health insurance issuer. The
questionnaire complies with the other requirements of this part. The
questionnaire includes the following question: ``Is there anything else
relevant to your health that we should know?'' A inadvertently fails to
list that A visited a psychologist on two occasions, six years
previously. A is later diagnosed with breast cancer and seeks benefits
under the plan. On or around the same time, the issuer receives
information about A's visits to the psychologist, which was not
disclosed in the questionnaire.
(ii) Conclusion. In this Example 1, the plan cannot rescind A's
coverage because A's failure to disclose the visits to the psychologist
was inadvertent. Therefore, it was not fraudulent or an intentional
misrepresentation of material fact.
Example 2. (i) Facts. An employer sponsors a group health plan that
provides coverage for employees who work at least 30 hours per week.
Individual B has coverage under the plan as a full-time employee. The
employer reassigns B to a part-time position. Under the terms of the
plan, B is no longer eligible for coverage. The plan mistakenly
continues to provide health coverage, collecting premiums from B and
paying claims submitted by B. After a routine audit, the plan discovers
that B no longer works at least 30 hours per week. The plan rescinds B's
coverage effective as of the date that B changed from a full-time
employee to a part-time employee.
(ii) Conclusion. In this Example 2, the plan cannot rescind B's
coverage because there was no fraud or an intentional misrepresentation
of material fact. The plan may cancel coverage for B prospectively,
subject to other applicable Federal and State laws.
(b) Compliance with other requirements. Other requirements of
Federal or State law may apply in connection with a rescission of
coverage.
(c) Effective/applicability date. The provisions of this section
apply for plan years beginning on or after September 23, 2010. See Sec.
54.9815-1251T for determining the application of this section to
grandfathered health plans (providing that the rules regarding
rescissions and advance notice apply to all grandfathered health plans).
[[Page 473]]
(d) Expiration date. This section expires on June 21, 2013.
[T.D. 9491, 75 FR 37225, June 28, 2010]
Sec. 54.9815-2713T Coverage of preventive health services (temporary).
(a) Services--(1) In general. Beginning at the time described in
paragraph (b) of this section, a group health plan, or a health
insurance issuer offering group health insurance coverage, must provide
coverage for all of the following items and services, and may not impose
any cost-sharing requirements (such as a copayment, coinsurance, or
deductible) with respect to those items or services:
(i) Evidence-based items or services that have in effect a rating of
A or B in the current recommendations of the United States Preventive
Services Task Force with respect to the individual involved (except as
otherwise provided in paragraph (c) of this section);
(ii) Immunizations for routine use in children, adolescents, and
adults that have in effect a recommendation from the Advisory Committee
on Immunization Practices of the Centers for Disease Control and
Prevention with respect to the individual involved (for this purpose, a
recommendation from the Advisory Committee on Immunization Practices of
the Centers for Disease Control and Prevention is considered in effect
after it has been adopted by the Director of the Centers for Disease
Control and Prevention, and a recommendation is considered to be for
routine use if it is listed on the Immunization Schedules of the Centers
for Disease Control and Prevention);
(iii) With respect to infants, children, and adolescents, evidence-
informed preventive care and screenings provided for in comprehensive
guidelines supported by the Health Resources and Services
Administration; and
(iv) With respect to women, to the extent not described in paragraph
(a)(1)(i) of this section, evidence-informed preventive care and
screenings provided for in comprehensive guidelines supported by the
Health Resources and Services Administration.
(2) Office visits--(i) If an item or service described in paragraph
(a)(1) of this section is billed separately (or is tracked as individual
encounter data separately) from an office visit, then a plan or issuer
may impose cost-sharing requirements with respect to the office visit.
(ii) If an item or service described in paragraph (a)(1) of this
section is not billed separately (or is not tracked as individual
encounter data separately) from an office visit and the primary purpose
of the office visit is the delivery of such an item or service, then a
plan or issuer may not impose cost-sharing requirements with respect to
the office visit.
(iii) If an item or service described in paragraph (a)(1) of this
section is not billed separately (or is not tracked as individual
encounter data separately) from an office visit and the primary purpose
of the office visit is not the delivery of such an item or service, then
a plan or issuer may impose cost-sharing requirements with respect to
the office visit.
(iv) The rules of this paragraph (a)(2) are illustrated by the
following examples:
Example 1. (i) Facts. An individual covered by a group health plan
visits an in-network health care provider. While visiting the provider,
the individual is screened for cholesterol abnormalities, which has in
effect a rating of A or B in the current recommendations of the United
States Preventive Services Task Force with respect to the individual.
The provider bills the plan for an office visit and for the laboratory
work of the cholesterol screening test.
(ii) Conclusion. In this Example 1, the plan may not impose any
cost-sharing requirements with respect to the separately-billed
laboratory work of the cholesterol screening test. Because the office
visit is billed separately from the cholesterol screening test, the plan
may impose cost-sharing requirements for the office visit.
Example 2. (i) Facts. Same facts as Example 1. As the result of the
screening, the individual is diagnosed with hyperlipidemia and is
prescribed a course of treatment that is not included in the
recommendations under paragraph (a)(1) of this section.
(ii) Conclusion. In this Example 2, because the treatment is not
included in the recommendations under paragraph (a)(1) of this section,
the plan is not prohibited from imposing cost-sharing requirements with
respect to the treatment.
Example 3. (i) Facts. An individual covered by a group health plan
visits an in-network
[[Page 474]]
health care provider to discuss recurring abdominal pain. During the
visit, the individual has a blood pressure screening, which has in
effect a rating of A or B in the current recommendations of the United
States Preventive Services Task Force with respect to the individual.
The provider bills the plan for an office visit.
(ii) Conclusion. In this Example 3, the blood pressure screening is
provided as part of an office visit for which the primary purpose was
not to deliver items or services described in paragraph (a)(1) of this
section. Therefore, the plan may impose a cost-sharing requirement for
the office visit charge.
Example 4. (i) Facts. A child covered by a group health plan visits
an in-network pediatrician to receive an annual physical exam described
as part of the comprehensive guidelines supported by the Health
Resources and Services Administration. During the office visit, the
child receives additional items and services that are not described in
the comprehensive guidelines supported by the Health Resources and
Services Administration, nor otherwise described in paragraph (a)(1) of
this section. The provider bills the plan for an office visit.
(ii) Conclusion. In this Example 4, the service was not billed as a
separate charge and was billed as part of an office visit. Moreover, the
primary purpose for the visit was to deliver items and services
described as part of the comprehensive guidelines supported by the
Health Resources and Services Administration. Therefore, the plan may
not impose a cost-sharing requirement with respect to the office visit.
(3) Out-of-network providers. Nothing in this section requires a
plan or issuer that has a network of providers to provide benefits for
items or services described in paragraph (a)(1) of this section that are
delivered by an out-of-network provider. Moreover, nothing in this
section precludes a plan or issuer that has a network of providers from
imposing cost-sharing requirements for items or services described in
paragraph (a)(1) of this section that are delivered by an out-of-network
provider.
(4) Reasonable medical management. Nothing prevents a plan or issuer
from using reasonable medical management techniques to determine the
frequency, method, treatment, or setting for an item or service
described in paragraph (a)(1) of this section to the extent not
specified in the recommendation or guideline.
(5) Services not described. Nothing in this section prohibits a plan
or issuer from providing coverage for items and services in addition to
those recommended by the United States Preventive Services Task Force or
the Advisory Committee on Immunization Practices of the Centers for
Disease Control and Prevention, or provided for by guidelines supported
by the Health Resources and Services Administration, or from denying
coverage for items and services that are not recommended by that task
force or that advisory committee, or under those guidelines. A plan or
issuer may impose cost-sharing requirements for a treatment not
described in paragraph (a)(1) of this section, even if the treatment
results from an item or service described in paragraph (a)(1) of this
section.
(b) Timing--(1) In general. A plan or issuer must provide coverage
pursuant to paragraph (a)(1) of this section for plan years that begin
on or after September 23, 2010, or, if later, for plan years that begin
on or after the date that is one year after the date the recommendation
or guideline is issued.
(2) Changes in recommendations or guidelines. A plan or issuer is
not required under this section to provide coverage for any items and
services specified in any recommendation or guideline described in
paragraph (a)(1) of this section after the recommendation or guideline
is no longer described in paragraph (a)(1) of this section. Other
requirements of Federal or State law may apply in connection with a plan
or issuer ceasing to provide coverage for any such items or services,
including PHS Act section 2715(d)(4), which requires a plan or issuer to
give 60 days advance notice to an enrollee before any material
modification will become effective.
(c) Recommendations not current. For purposes of paragraph (a)(1)(i)
of this section, and for purposes of any other provision of law,
recommendations of the United States Preventive Services Task Force
regarding breast cancer screening, mammography, and prevention issued in
or around November 2009 are not considered to be current.
(d) Effective/applicability date. The provisions of this section
apply for plan years beginning on or after September 23, 2010. See Sec.
54.9815-1251T for determining the application of this section
[[Page 475]]
to grandfathered health plans (providing that these rules regarding
coverage of preventive health services do not apply to grandfathered
health plans).
(e) Expiration date. This section expires on July 12, 2013 or on
such earlier date as may be provided in final regulations or other
action published in the Federal Register.
[T.D. 9493, 75 FR 41756, July 19, 2010]
Sec. 54.9815-2714T Eligibility of children until at least age 26 (temporary).
(a) In general--(1) A group health plan, or a health insurance
issuer offering group health insurance coverage, that makes available
dependent coverage of children must make such coverage available for
children until attainment of 26 years of age.
(2) The rule of this paragraph (a) is illustrated by the following
example:
Example. (i) Facts. For the plan year beginning January 1, 2011, a
group health plan provides health coverage for employees, employees'
spouses, and employees' children until the child turns 26. On the
birthday of a child of an employee, July 17, 2011, the child turns 26.
The last day the plan covers the child is July 16, 2011.
(ii) Conclusion. In this Example, the plan satisfies the requirement
of this paragraph (a) with respect to the child.
(b) Restrictions on plan definition of dependent. With respect to a
child who has not attained age 26, a plan or issuer may not define
dependent for purposes of eligibility for dependent coverage of children
other than in terms of a relationship between a child and the
participant. Thus, for example, a plan or issuer may not deny or
restrict coverage for a child who has not attained age 26 based on the
presence or absence of the child's financial dependency (upon the
participant or any other person), residency with the participant or with
any other person, student status, employment, or any combination of
those factors. In addition, a plan or issuer may not deny or restrict
coverage of a child based on eligibility for other coverage, except that
paragraph (g) of this section provides a special rule for plan years
beginning before January 1, 2014 for grandfathered health plans that are
group health plans. (Other requirements of Federal or State law,
including section 609 of ERISA or section 1908 of the Social Security
Act, may mandate coverage of certain children.)
(c) Coverage of grandchildren not required. Nothing in this section
requires a plan or issuer to make coverage available for the child of a
child receiving dependent coverage.
(d) Uniformity irrespective of age. The terms of the plan or health
insurance coverage providing dependent coverage of children cannot vary
based on age (except for children who are age 26 or older).
(e) Examples. The rules of paragraph (d) of this section are
illustrated by the following examples:
Example 1. (i) Facts. A group health plan offers a choice of self-
only or family health coverage. Dependent coverage is provided under
family health coverage for children of participants who have not
attained age 26. The plan imposes an additional premium surcharge for
children who are older than age 18.
(ii) Conclusion. In this Example 1, the plan violates the
requirement of paragraph (d) of this section because the plan varies the
terms for dependent coverage of children based on age.
Example 2. (i) Facts. A group health plan offers a choice among the
following tiers of health coverage: self-only, self-plus-one, self-plus-
two, and self-plus-three-or-more. The cost of coverage increases based
on the number of covered individuals. The plan provides dependent
coverage of children who have not attained age 26.
(ii) Conclusion. In this Example 2, the plan does not violate the
requirement of paragraph (d) of this section that the terms of dependent
coverage for children not vary based on age. Although the cost of
coverage increases for tiers with more covered individuals, the increase
applies without regard to the age of any child.
Example 3. (i) Facts. A group health plan offers two benefit
packages--an HMO option and an indemnity option. Dependent coverage is
provided for children of participants who have not attained age 26. The
plan limits children who are older than age 18 to the HMO option.
(ii) Conclusion. In this Example 3, the plan violates the
requirement of paragraph (d) of this section because the plan, by
limiting children who are older than age 18 to the HMO option, varies
the terms for dependent coverage of children based on age.
(f) Transitional rules for individuals whose coverage ended by
reason of reaching a dependent eligibility threshold--(1)
[[Page 476]]
In general. The relief provided in the transitional rules of this
paragraph (f) applies with respect to any child--
(i) Whose coverage ended, or who was denied coverage (or was not
eligible for coverage) under a group health plan or group health
insurance coverage because, under the terms of the plan or coverage, the
availability of dependent coverage of children ended before the
attainment of age 26 (which, under this section, is no longer
permissible); and
(ii) Who becomes eligible (or is required to become eligible) for
coverage under a group health plan or group health insurance coverage on
the first day of the first plan year beginning on or after September 23,
2010 by reason of the application of this section.
(2) Opportunity to enroll required. (i) If a group health plan, or
group health insurance coverage, in which a child described in paragraph
(f)(1) of this section is eligible to enroll (or is required to become
eligible to enroll) is the plan or coverage in which the child's
coverage ended (or did not begin) for the reasons described in paragraph
(f)(1)(i) of this section, and if the plan, or the issuer of such
coverage, is subject to the requirements of this section, the plan and
the issuer are required to give the child an opportunity to enroll that
continues for at least 30 days (including written notice of the
opportunity to enroll). This opportunity (including the written notice)
must be provided beginning not later than the first day of the first
plan year beginning on or after September 23, 2010.
(ii) The written notice must include a statement that children whose
coverage ended, or who were denied coverage (or were not eligible for
coverage), because the availability of dependent coverage of children
ended before attainment of age 26 are eligible to enroll in the plan or
coverage. The notice may be provided to an employee on behalf of the
employee's child. In addition, the notice may be included with other
enrollment materials that a plan distributes to employees, provided the
statement is prominent. If a notice satisfying the requirements of this
paragraph (f)(2) is provided to an employee whose child is entitled to
an enrollment opportunity under this paragraph (f), the obligation to
provide the notice of enrollment opportunity under this paragraph (f)(2)
with respect to that child is satisfied for both the plan and the
issuer.
(3) Effective date of coverage. In the case of an individual who
enrolls under paragraph (f)(2) of this section, coverage must take
effect not later than the first day of the first plan year beginning on
or after September 23, 2010.
(4) Treatment of enrollees in a group health plan. Any child
enrolling in a group health plan pursuant to paragraph (f)(2) of this
section must be treated as if the child were a special enrollee, as
provided under the rules of Sec. 54.9801-6(d). Accordingly, the child
(and, if the child would not be a participant once enrolled in the plan,
the participant through whom the child is otherwise eligible for
coverage under the plan) must be offered all the benefit packages
available to similarly situated individuals who did not lose coverage by
reason of cessation of dependent status. For this purpose, any
difference in benefits or cost-sharing requirements constitutes a
different benefit package. The child also cannot be required to pay more
for coverage than similarly situated individuals who did not lose
coverage by reason of cessation of dependent status.
(5) Examples. The rules of this paragraph (f) are illustrated by the
following examples:
Example 1. (i) Facts. Employer Y maintains a group health plan with
a calendar year plan year. The plan has a single benefit package. For
the 2010 plan year, the plan allows children of employees to be covered
under the plan until age 19, or until age 23 for children who are full-
time students. Individual B, an employee of Y, and Individual C, B's
child and a full-time student, were enrolled in Y's group health plan at
the beginning of the 2010 plan year. On June 10, 2010, C turns 23 years
old and loses dependent coverage under Y's plan. On or before January 1,
2011, Y's group health plan gives B written notice that individuals who
lost coverage by reason of ceasing to be a dependent before attainment
of age 26 are eligible to enroll in the plan, and that individuals may
request enrollment for such children through February 14, 2011 with
enrollment effective retroactively to January 1, 2011.
(ii) Conclusion. In this Example 1, the plan has complied with the
requirements of this paragraph (f) by providing an enrollment
opportunity to C that lasts at least 30 days.
[[Page 477]]
Example 2. (i) Facts. Employer Z maintains a group health plan with
a plan year beginning October 1 and ending September 30. Prior to
October 1, 2010, the group health plan allows children of employees to
be covered under the plan until age 22. Individual D, an employee of Z,
and Individual E, D's child, are enrolled in family coverage under Z's
group health plan for the plan year beginning on October 1, 2008. On May
1, 2009, E turns 22 years old and ceases to be eligible as a dependent
under Z's plan and loses coverage. D drops coverage but remains an
employee of Z.
(ii) Conclusion. In this Example 2, not later than October 1, 2010,
the plan must provide D and E an opportunity to enroll (including
written notice of an opportunity to enroll) that continues for at least
30 days, with enrollment effective not later than October 1, 2010.
Example 3. (i) Facts. Same facts as Example 2, except that D did not
drop coverage. Instead, D switched to a lower-cost benefit package
option.
(ii) Conclusion. In this Example 3, not later than October 1, 2010,
the plan must provide D and E an opportunity to enroll in any benefit
package available to similarly situated individuals who enroll when
first eligible.
Example 4. (i) Facts. Same facts as Example 2, except that E elected
COBRA continuation coverage.
(ii) Conclusion. In this Example 4, not later than October 1, 2010,
the plan must provide D and E an opportunity to enroll other than as a
COBRA qualified beneficiary (and must provide, by that date, written
notice of the opportunity to enroll) that continues for at least 30
days, with enrollment effective not later than October 1, 2010.
Example 5. (i) Facts. Employer X maintains a group health plan with
a calendar year plan year. Prior to 2011, the plan allows children of
employees to be covered under the plan until the child attains age 22.
During the 2009 plan year, an individual with a 22-year old child joins
the plan; the child is denied coverage because the child is 22.
(ii) Conclusion. In this Example 5, notwithstanding that the child
was not previously covered under the plan, the plan must provide the
child, not later than January 1, 2011, an opportunity to enroll
(including written notice to the employee of an opportunity to enroll
the child) that continues for at least 30 days, with enrollment
effective not later than January 1, 2011.
(g) Special rule for grandfathered group health plans--(1) For plan
years beginning before January 1, 2014, a group health plan that
qualifies as a grandfathered health plan under section 1251 of the
Patient Protection and Affordable Care Act and that makes available
dependent coverage of children may exclude an adult child who has not
attained age 26 from coverage only if the adult child is eligible to
enroll in an eligible employer-sponsored health plan (as defined in
section 5000A(f)(2)) other than a group health plan of a parent.
(2) For plan years beginning on or after January 1, 2014, a group
health plan that qualifies as a grandfathered health plan under section
1251 of the Patient Protection and Affordable Care Act must comply with
the requirements of paragraphs (a) through (f) of this section.
(h) Applicability date. The provisions of this section apply for
plan years beginning on or after September 23, 2010. See Sec. 54.9815-
1251T for determining the application of this section to grandfathered
health plans.
(i) Expiration date. This section expires on or before May 10, 2013.
[T.D. 9482, 75 FR 27134, May 13, 2010, as amended by T.D. 9489, 75 FR
34562, June 17, 2010]
Sec. 54.9815-2719AT Patient protections (temporary).
(a) Choice of health care professional--(1) Designation of primary
care provider--(i) In general. If a group health plan, or a health
insurance issuer offering group health insurance coverage, requires or
provides for designation by a participant or beneficiary of a
participating primary care provider, then the plan or issuer must permit
each participant or beneficiary to designate any participating primary
care provider who is available to accept the participant or beneficiary.
In such a case, the plan or issuer must comply with the rules of
paragraph (a)(4) of this section by informing each participant of the
terms of the plan or health insurance coverage regarding designation of
a primary care provider.
(ii) Example. The rules of this paragraph (a)(1) are illustrated by
the following example:
Example. (i) Facts. A group health plan requires individuals covered
under the plan to designate a primary care provider. The plan permits
each individual to designate any primary care provider participating in
the plan's network who is available to accept the individual as the
individual's primary care provider. If an individual has not designated
a primary care provider, the plan designates
[[Page 478]]
one until one has been designated by the individual. The plan provides a
notice that satisfies the requirements of paragraph (a)(4) of this
section regarding the ability to designate a primary care provider.
(ii) Conclusion. In this Example, the plan has satisfied the
requirements of paragraph (a) of this section.
(2) Designation of pediatrician as primary care provider--(i) In
general. If a group health plan, or a health insurance issuer offering
group health insurance coverage, requires or provides for the
designation of a participating primary care provider for a child by a
participant or beneficiary, the plan or issuer must permit the
participant or beneficiary to designate a physician (allopathic or
osteopathic) who specializes in pediatrics as the child's primary care
provider if the provider participates in the network of the plan or
issuer and is available to accept the child. In such a case, the plan or
issuer must comply with the rules of paragraph (a)(4) of this section by
informing each participant of the terms of the plan or health insurance
coverage regarding designation of a pediatrician as the child's primary
care provider.
(ii) Construction. Nothing in paragraph (a)(2)(i) of this section is
to be construed to waive any exclusions of coverage under the terms and
conditions of the plan or health insurance coverage with respect to
coverage of pediatric care.
(iii) Examples. The rules of this paragraph (a)(2) are illustrated
by the following examples:
Example 1. (i) Facts. A group health plan's HMO designates for each
participant a physician who specializes in internal medicine to serve as
the primary care provider for the participant and any beneficiaries.
Participant A requests that Pediatrician B be designated as the primary
care provider for A's child. B is a participating provider in the HMO's
network.
(ii) Conclusion. In this Example 1, the HMO must permit A's
designation of B as the primary care provider for A's child in order to
comply with the requirements of this paragraph (a)(2).
Example 2. (i) Facts. Same facts as Example 1, except that A takes
A's child to B for treatment of the child's severe shellfish allergies.
B wishes to refer A's child to an allergist for treatment. The HMO,
however, does not provide coverage for treatment of food allergies, nor
does it have an allergist participating in its network, and it therefore
refuses to authorize the referral.
(ii) Conclusion. In this Example 2, the HMO has not violated the
requirements of this paragraph (a)(2) because the exclusion of treatment
for food allergies is in accordance with the terms of A's coverage.
(3) Patient access to obstetrical and gynecological care--(i)
General rights--(A) Direct access. A group health plan, or a health
insurance issuer offering group health insurance coverage, described in
paragraph (a)(3)(ii) of this section may not require authorization or
referral by the plan, issuer, or any person (including a primary care
provider) in the case of a female participant or beneficiary who seeks
coverage for obstetrical or gynecological care provided by a
participating health care professional who specializes in obstetrics or
gynecology. In such a case, the plan or issuer must comply with the
rules of paragraph (a)(4) of this section by informing each participant
that the plan may not require authorization or referral for obstetrical
or gynecological care by a participating health care professional who
specializes in obstetrics or gynecology. The plan or issuer may require
such a professional to agree to otherwise adhere to the plan's or
issuer's policies and procedures, including procedures regarding
referrals and obtaining prior authorization and providing services
pursuant to a treatment plan (if any) approved by the plan or issuer.
For purposes of this paragraph (a)(3), a health care professional who
specializes in obstetrics or gynecology is any individual (including a
person other than a physician) who is authorized under applicable State
law to provide obstetrical or gynecological care.
(B) Obstetrical and gynecological care. A group health plan or
health insurance issuer described in paragraph (a)(3)(ii) of this
section must treat the provision of obstetrical and gynecological care,
and the ordering of related obstetrical and gynecological items and
services, pursuant to the direct access described under paragraph
(a)(3)(i)(A) of this section, by a participating health care
professional who specializes in obstetrics or gynecology as the
authorization of the primary care provider.
[[Page 479]]
(ii) Application of paragraph. A group health plan, or a health
insurance issuer offering group health insurance coverage, is described
in this paragraph (a)(3) if the plan or issuer--
(A) Provides coverage for obstetrical or gynecological care; and
(B) Requires the designation by a participant or beneficiary of a
participating primary care provider.
(iii) Construction. Nothing in paragraph (a)(3)(i) of this section
is to be construed to--
(A) Waive any exclusions of coverage under the terms and conditions
of the plan or health insurance coverage with respect to coverage of
obstetrical or gynecological care; or
(B) Preclude the group health plan or health insurance issuer
involved from requiring that the obstetrical or gynecological provider
notify the primary care health care professional or the plan or issuer
of treatment decisions.
(iv) Examples. The rules of this paragraph (a)(3) are illustrated by
the following examples:
Example 1. (i) Facts. A group health plan requires each participant
to designate a physician to serve as the primary care provider for the
participant and the participant's family. Participant A, a female,
requests a gynecological exam with Physician B, an in-network physician
specializing in gynecological care. The group health plan requires prior
authorization from A's designated primary care provider for the
gynecological exam.
(ii) Conclusion. In this Example 1, the group health plan has
violated the requirements of this paragraph (a)(3) because the plan
requires prior authorization from A's primary care provider prior to
obtaining gynecological services.
Example 2. (i) Facts. Same facts as Example 1 except that A seeks
gynecological services from C, an out-of-network provider.
(ii) Conclusion. In this Example 2, the group health plan has not
violated the requirements of this paragraph (a)(3) by requiring prior
authorization because C is not a participating health care provider.
Example 3. (i) Facts. Same facts as Example 1 except that the group
health plan only requires B to inform A's designated primary care
physician of treatment decisions.
(ii) Conclusion. In this Example 3, the group health plan has not
violated the requirements of this paragraph (a)(3) because A has direct
access to B without prior authorization. The fact that the group health
plan requires notification of treatment decisions to the designated
primary care physician does not violate this paragraph (a)(3).
Example 4. (i) Facts. A group health plan requires each participant
to designate a physician to serve as the primary care provider for the
participant and the participant's family. The group health plan requires
prior authorization before providing benefits for uterine fibroid
embolization.
(ii) Conclusion. In this Example 4, the plan requirement for prior
authorization before providing benefits for uterine fibroid embolization
does not violate the requirements of this paragraph (a)(3) because,
though the prior authorization requirement applies to obstetrical
services, it does not restrict access to any providers specializing in
obstetrics or gynecology.
(4) Notice of right to designate a primary care provider--(i) In
general. If a group health plan or health insurance issuer requires the
designation by a participant or beneficiary of a primary care provider,
the plan or issuer must provide a notice informing each participant of
the terms of the plan or health insurance coverage regarding designation
of a primary care provider and of the rights--
(A) Under paragraph (a)(1)(i) of this section, that any
participating primary care provider who is available to accept the
participant or beneficiary can be designated;
(B) Under paragraph (a)(2)(i) of this section, with respect to a
child, that any participating physician who specializes in pediatrics
can be designated as the primary care provider; and
(C) Under paragraph (a)(3)(i) of this section, that the plan may not
require authorization or referral for obstetrical or gynecological care
by a participating health care professional who specializes in
obstetrics or gynecology.
(ii) Timing. The notice described in paragraph (a)(4)(i) of this
section must be included whenever the plan or issuer provides a
participant with a summary plan description or other similar description
of benefits under the plan or health insurance coverage.
(iii) Model language. The following model language can be used to
satisfy the notice requirement described in paragraph (a)(4)(i) of this
section:
(A) For plans and issuers that require or allow for the designation
of primary care providers by participants or beneficiaries, insert:
[[Page 480]]
[Name of group health plan or health insurance issuer] generally
[requires/allows] the designation of a primary care provider. You have
the right to designate any primary care provider who participates in our
network and who is available to accept you or your family members. [If
the plan or health insurance coverage designates a primary care provider
automatically, insert: Until you make this designation, [name of group
health plan or health insurance issuer] designates one for you.] For
information on how to select a primary care provider, and for a list of
the participating primary care providers, contact the [plan
administrator or issuer] at [insert contact information].
(B) For plans and issuers that require or allow for the designation
of a primary care provider for a child, add:
For children, you may designate a pediatrician as the primary care
provider.
(C) For plans and issuers that provide coverage for obstetric or
gynecological care and require the designation by a participant or
beneficiary of a primary care provider, add:
You do not need prior authorization from [name of group health plan
or issuer] or from any other person (including a primary care provider)
in order to obtain access to obstetrical or gynecological care from a
health care professional in our network who specializes in obstetrics or
gynecology. The health care professional, however, may be required to
comply with certain procedures, including obtaining prior authorization
for certain services, following a pre-approved treatment plan, or
procedures for making referrals. For a list of participating health care
professionals who specialize in obstetrics or gynecology, contact the
[plan administrator or issuer] at [insert contact information].
(b) Coverage of emergency services--(1) Scope. If a group health
plan, or a health insurance issuer offering group health insurance
coverage, provides any benefits with respect to services in an emergency
department of a hospital, the plan or issuer must cover emergency
services (as defined in paragraph (b)(4)(ii) of this section) consistent
with the rules of this paragraph (b).
(2) General rules. A plan or issuer subject to the requirements of
this paragraph (b) must provide coverage for emergency services in the
following manner--
(i) Without the need for any prior authorization determination, even
if the emergency services are provided on an out-of-network basis;
(ii) Without regard to whether the health care provider furnishing
the emergency services is a participating network provider with respect
to the services;
(iii) If the emergency services are provided out of network, without
imposing any administrative requirement or limitation on coverage that
is more restrictive than the requirements or limitations that apply to
emergency services received from in-network providers;
(iv) If the emergency services are provided out of network, by
complying with the cost-sharing requirements of paragraph (b)(3) of this
section; and
(v) Without regard to any other term or condition of the coverage,
other than--
(A) The exclusion of or coordination of benefits;
(B) An affiliation or waiting period permitted under part 7 of
ERISA, part A of title XXVII of the PHS Act, or chapter 100 of the
Internal Revenue Code; or
(C) Applicable cost sharing.
(3) Cost-sharing requirements--(i) Copayments and coinsurance. Any
cost-sharing requirement expressed as a copayment amount or coinsurance
rate imposed with respect to a participant or beneficiary for out-of-
network emergency services cannot exceed the cost-sharing requirement
imposed with respect to a participant or beneficiary if the services
were provided in-network. However, a participant or beneficiary may be
required to pay, in addition to the in-network cost sharing, the excess
of the amount the out-of-network provider charges over the amount the
plan or issuer is required to pay under this paragraph (b)(3)(i). A
group health plan or health insurance issuer complies with the
requirements of this paragraph (b)(3) if it provides benefits with
respect to an emergency service in an amount equal to the greatest of
the three amounts specified in paragraphs (b)(3)(i)(A), (b)(3)(i)(B),
and (b)(3)(i)(C) of this section (which are adjusted for in-network
cost-sharing requirements).
(A) The amount negotiated with in-network providers for the
emergency
[[Page 481]]
service furnished, excluding any in-network copayment or coinsurance
imposed with respect to the participant or beneficiary. If there is more
than one amount negotiated with in-network providers for the emergency
service, the amount described under this paragraph (b)(3)(i)(A) is the
median of these amounts, excluding any in-network copayment or
coinsurance imposed with respect to the participant or beneficiary. In
determining the median described in the preceding sentence, the amount
negotiated with each in-network provider is treated as a separate amount
(even if the same amount is paid to more than one provider). If there is
no per-service amount negotiated with in-network providers (such as
under a capitation or other similar payment arrangement), the amount
under this paragraph (b)(3)(i)(A) is disregarded.
(B) The amount for the emergency service calculated using the same
method the plan generally uses to determine payments for out-of-network
services (such as the usual, customary, and reasonable amount),
excluding any in-network copayment or coinsurance imposed with respect
to the participant or beneficiary. The amount in this paragraph
(b)(3)(i)(B) is determined without reduction for out-of-network cost
sharing that generally applies under the plan or health insurance
coverage with respect to out-of-network services. Thus, for example, if
a plan generally pays 70 percent of the usual, customary, and reasonable
amount for out-of-network services, the amount in this paragraph
(b)(3)(i)(B) for an emergency service is the total (that is, 100
percent) of the usual, customary, and reasonable amount for the service,
not reduced by the 30 percent coinsurance that would generally apply to
out-of-network services (but reduced by the in-network copayment or
coinsurance that the individual would be responsible for if the
emergency service had been provided in-network).
(C) The amount that would be paid under Medicare (part A or part B
of title XVIII of the Social Security Act, 42 U.S.C. 1395 et seq.) for
the emergency service, excluding any in-network copayment or coinsurance
imposed with respect to the participant or beneficiary.
(ii) Other cost sharing. Any cost-sharing requirement other than a
copayment or coinsurance requirement (such as a deductible or out-of-
pocket maximum) may be imposed with respect to emergency services
provided out of network if the cost-sharing requirement generally
applies to out-of-network benefits. A deductible may be imposed with
respect to out-of-network emergency services only as part of a
deductible that generally applies to out-of-network benefits. If an out-
of-pocket maximum generally applies to out-of-network benefits, that
out-of-pocket maximum must apply to out-of-network emergency services.
(iii) Examples. The rules of this paragraph (b)(3) are illustrated
by the following examples. In all of these examples, the group health
plan covers benefits with respect to emergency services.
Example 1. (i) Facts. A group health plan imposes a 25% coinsurance
responsibility on individuals who are furnished emergency services,
whether provided in network or out of network. If a covered individual
notifies the plan within two business days after the day an individual
receives treatment in an emergency department, the plan reduces the
coinsurance rate to 15%.
(ii) Conclusion. In this Example 1, the requirement to notify the
plan in order to receive a reduction in the coinsurance rate does not
violate the requirement that the plan cover emergency services without
the need for any prior authorization determination. This is the result
even if the plan required that it be notified before or at the time of
receiving services at the emergency department in order to receive a
reduction in the coinsurance rate.
Example 2. (i) Facts. A group health plan imposes a $60 copayment on
emergency services without preauthorization, whether provided in-network
or out-of-network. If emergency services are preauthorized, the plan
waives the copayment, even if it later determines the medical condition
was not an emergency medical condition.
(ii) Conclusion. In this Example 2, by requiring an individual to
pay more for emergency services if the individual does not obtain prior
authorization, the plan violates the requirement that the plan cover
emergency services without the need for any prior authorization
determination. (By contrast, if, to have the copayment waived, the plan
merely required that it be notified rather than a prior authorization,
then the plan would not violate the requirement that the
[[Page 482]]
plan cover emergency services without the need for any prior
authorization determination.)
Example 3. (i) Facts. A group health plan covers individuals who
receive emergency services with respect to an emergency medical
condition from an out-of-network provider. The plan has agreements with
in-network providers with respect to a certain emergency service. Each
provider has agreed to provide the service for a certain amount. Among
all the providers for the service: One has agreed to accept $85, two
have agreed to accept $100, two have agreed to accept $110, three have
agreed to accept $120, and one has agreed to accept $150. Under the
agreement, the plan agrees to pay the providers 80% of the agreed
amount, with the individual receiving the service responsible for the
remaining 20%.
(ii) Conclusion. In this Example 3, the values taken into account in
determining the median are $85, $100, $100, $110, $110, $120, $120,
$120, and $150. Therefore, the median amount among those agreed to for
the emergency service is $110, and the amount under paragraph
(b)(3)(i)(A) of this section is 80% of $110 ($88).
Example 4. (i) Facts. Same facts as Example 3. Subsequently, the
plan adds another provider to its network, who has agreed to accept $150
for the emergency service.
(ii) Conclusion. In this Example 4, the median amount among those
agreed to for the emergency service is $115. (Because there is no one
middle amount, the median is the average of the two middle amounts, $110
and $120.) Accordingly, the amount under paragraph (b)(3)(i)(A) of this
section is 80% of $115 ($92).
Example 5. (i) Facts. Same facts as Example 4. An individual covered
by the plan receives the emergency service from an out-of-network
provider, who charges $125 for the service. With respect to services
provided by out-of-network providers generally, the plan reimburses
covered individuals 50% of the reasonable amount charged by the provider
for medical services. For this purpose, the reasonable amount for any
service is based on information on charges by all providers collected by
a third party, on a zip-code-by-zip-code basis, with the plan treating
charges at a specified percentile as reasonable. For the emergency
service received by the individual, the reasonable amount calculated
using this method is $116. The amount that would be paid under Medicare
for the emergency service, excluding any copayment or coinsurance for
the service, is $80.
(ii) Conclusion. In this Example 5, the plan is responsible for
paying $92.80, 80% of $116. The median amount among those agreed to for
the emergency service is $115 and the amount the plan would pay is $92
(80% of $115); the amount calculated using the same method the plan uses
to determine payments for out-of-network services--$116--excluding the
in-network 20% coinsurance, is $92.80; and the Medicare payment is $80.
Thus, the greatest amount is $92.80. The individual is responsible for
the remaining $32.20 charged by the out-of-network provider.
Example 6. (i) Facts. Same facts as Example 5. The group health plan
generally imposes a $250 deductible for in-network health care. With
respect to all health care provided by out-of-network providers, the
plan imposes a $500 deductible. (Covered in-network claims are credited
against the deductible.) The individual has incurred and submitted $260
of covered claims prior to receiving the emergency service out of
network.
(ii) Conclusion. In this Example 6, the plan is not responsible for
paying anything with respect to the emergency service furnished by the
out-of-network provider because the covered individual has not satisfied
the higher deductible that applies generally to all health care provided
out of network. However, the amount the individual is required to pay is
credited against the deductible.
(4) Definitions. The definitions in this paragraph (b)(4) govern in
applying the provisions of this paragraph (b).
(i) Emergency medical condition. The term emergency medical
condition means a medical condition manifesting itself by acute symptoms
of sufficient severity (including severe pain) so that a prudent
layperson, who possesses an average knowledge of health and medicine,
could reasonably expect the absence of immediate medical attention to
result in a condition described in clause (i), (ii), or (iii) of section
1867(e)(1)(A) of the Social Security Act (42 U.S.C. 1395dd(e)(1)(A)).
(In that provision of the Social Security Act, clause (i) refers to
placing the health of the individual (or, with respect to a pregnant
woman, the health of the woman or her unborn child) in serious jeopardy;
clause (ii) refers to serious impairment to bodily functions; and clause
(iii) refers to serious dysfunction of any bodily organ or part.)
(ii) Emergency services. The term emergency services means, with
respect to an emergency medical condition--
(A) A medical screening examination (as required under section 1867
of the Social Security Act, 42 U.S.C. 1395dd) that is within the
capability of the emergency department of a hospital, including
ancillary services routinely available to the emergency department to
evaluate such emergency medical condition, and
[[Page 483]]
(B) Such further medical examination and treatment, to the extent
they are within the capabilities of the staff and facilities available
at the hospital, as are required under section 1867 of the Social
Security Act (42 U.S.C. 1395dd) to stabilize the patient.
(iii) Stabilize. The term to stabilize, with respect to an emergency
medical condition (as defined in paragraph (b)(4)(i) of this section)
has the meaning given in section 1867(e)(3) of the Social Security Act
(42 U.S.C. 1395dd(e)(3)).
(c) Effective/applicability date. The provisions of this section
apply for plan years beginning on or after September 23, 2010. See Sec.
54.9815-1251T for determining the application of this section to
grandfathered health plans (providing that these rules regarding patient
protections do not apply to grandfathered health plans).
(d) Expiration date. This section expires on June 21, 2013.
[T.D. 9491, 75 FR 37225, June 28, 2010]
Sec. 54.9815-2719T Internal claims and appeals and external review processes (temporary).
(a) Scope and definitions--(1) Scope. This section sets forth
requirements with respect to internal claims and appeals and external
review processes for group health plans and health insurance issuers
that are not grandfathered health plans under Sec. 54.9815-1251T.
Paragraph (b) of this section provides requirements for internal claims
and appeals processes. Paragraph (c) of this section sets forth rules
governing the applicability of State external review processes.
Paragraph (d) of this section sets forth a Federal external review
process for plans and issuers not subject to an applicable State
external review process. Paragraph (e) of this section prescribes
requirements for ensuring that notices required to be provided under
this section are provided in a culturally and linguistically appropriate
manner. Paragraph (f) of this section describes the authority of the
Secretary to deem certain external review processes in existence on
March 23, 2010 as in compliance with paragraph (c) or (d) of this
section. Paragraph (g) of this section sets forth the applicability date
for this section.
(2) Definitions. For purposes of this section, the following
definitions apply--
(i) Adverse benefit determination. An adverse benefit determination
means an adverse benefit determination as defined in 29 CFR 2560.503-1,
as well as any rescission of coverage, as described in Sec. 54.9815-
2712T(a)(2) (whether or not, in connection with the rescission, there is
an adverse effect on any particular benefit at that time).
(ii) Appeal (or internal appeal). An appeal or internal appeal means
review by a plan or issuer of an adverse benefit determination, as
required in paragraph (b) of this section.
(iii) Claimant. Claimant means an individual who makes a claim under
this section. For purposes of this section, references to claimant
include a claimant's authorized representative.
(iv) External review. External review means a review of an adverse
benefit determination (including a final internal adverse benefit
determination) conducted pursuant to an applicable State external review
process described in paragraph (c) of this section or the Federal
external review process of paragraph (d) of this section.
(v) Final internal adverse benefit determination. A final internal
adverse benefit determination means an adverse benefit determination
that has been upheld by a plan or issuer at the completion of the
internal appeals process applicable under paragraph (b) of this section
(or an adverse benefit determination with respect to which the internal
appeals process has been exhausted under the deemed exhaustion rules of
paragraph (b)(2)(ii)(F) of this section).
(vi) Final external review decision. A final external review
decision, as used in paragraph (d) of this section, means a
determination by an independent review organization at the conclusion of
an external review.
(vii) Independent review organization (or IRO). An independent
review organization (or IRO) means an entity that conducts independent
external reviews of adverse benefit determinations and final internal
adverse benefit determinations pursuant to paragraph (c) or (d) of this
section.
[[Page 484]]
(viii) NAIC Uniform Model Act. The NAIC Uniform Model Act means the
Uniform Health Carrier External Review Model Act promulgated by the
National Association of Insurance Commissioners in place on July 23,
2010.
(b) Internal claims and appeals process--(1) In general. A group
health plan and a health insurance issuer offering group health
insurance coverage must implement an effective internal claims and
appeals process, as described in this paragraph (b).
(2) Requirements for group health plans and group health insurance
issuers. A group health plan and a health insurance issuer offering
group health insurance coverage must comply with all the requirements of
this paragraph (b)(2). In the case of health insurance coverage offered
in connection with a group health plan, if either the plan or the issuer
complies with the internal claims and appeals process of this paragraph
(b)(2), then the obligation to comply with this paragraph (b)(2) is
satisfied for both the plan and the issuer with respect to the health
insurance coverage.
(i) Minimum internal claims and appeals standards. A group health
plan and a health insurance issuer offering group health insurance
coverage must comply with all the requirements applicable to group
health plans under 29 CFR 2560.503-1, except to the extent those
requirements are modified by paragraph (b)(2)(ii) of this section.
Accordingly, under this paragraph (b), with respect to health insurance
coverage offered in connection with a group health plan, the group
health insurance issuer is subject to the requirements in 29 CFR
2560.503-1 to the same extent as the group health plan.
(ii) Additional standards. In addition to the requirements in
paragraph (b)(2)(i) of this section, the internal claims and appeals
processes of a group health plan and a health insurance issuer offering
group health insurance coverage must meet the requirements of this
paragraph (b)(2)(ii).
(A) Clarification of meaning of adverse benefit determination. For
purposes of this paragraph (b)(2), an ``adverse benefit determination''
includes an adverse benefit determination as defined in paragraph
(a)(2)(i) of this section. Accordingly, in complying with 29 CFR
2560.503-1, as well as the other provisions of this paragraph (b)(2), a
plan or issuer must treat a rescission of coverage (whether or not the
rescission has an adverse effect on any particular benefit at that time)
as an adverse benefit determination. (Rescissions of coverage are
subject to the requirements of Sec. 54.9815-2712T.)
(B) Expedited notification of benefit determinations involving
urgent care. Notwithstanding the rule of 29 CFR 2560.503-1(f)(2)(i) that
provides for notification in the case of urgent care claims not later
than 72 hours after the receipt of the claim, for purposes of this
paragraph (b)(2), a plan and issuer must notify a claimant of a benefit
determination (whether adverse or not) with respect to a claim involving
urgent care as soon as possible, taking into account the medical
exigencies, but not later than 24 hours after the receipt of the claim
by the plan or issuer, unless the claimant fails to provide sufficient
information to determine whether, or to what extent, benefits are
covered or payable under the plan or health insurance coverage. The
requirements of 29 CFR 2560.503-1(f)(2)(i) other than the rule for
notification within 72 hours continue to apply to the plan and issuer.
For purposes of this paragraph (b)(2)(ii)(B), a claim involving urgent
care has the meaning given in 29 CFR 2560.503-1(m)(1).
(C) Full and fair review. A plan and issuer must allow a claimant to
review the claim file and to present evidence and testimony as part of
the internal claims and appeals process. Specifically, in addition to
complying with the requirements of 29 CFR 2560.503-1(h)(2)--
(1) The plan or issuer must provide the claimant, free of charge,
with any new or additional evidence considered, relied upon, or
generated by the plan or issuer (or at the direction of the plan or
issuer) in connection with the claim; such evidence must be provided as
soon as possible and sufficiently in advance of the date on which the
notice of final internal adverse benefit determination is required to be
provided under 29 CFR 2560.503-1(i) to give the claimant a reasonable
opportunity to respond prior to that date; and
[[Page 485]]
(2) Before the plan or issuer can issue a final internal adverse
benefit determination based on a new or additional rationale, the
claimant must be provided, free of charge, with the rationale; the
rationale must be provided as soon as possible and sufficiently in
advance of the date on which the notice of final internal adverse
benefit determination is required to be provided under 29 CFR 2560.503-
1(i) to give the claimant a reasonable opportunity to respond prior to
that date.
(D) Avoiding conflicts of interest. In addition to the requirements
of 29 CFR 2560.503-1(b) and (h) regarding full and fair review, the plan
and issuer must ensure that all claims and appeals are adjudicated in a
manner designed to ensure the independence and impartiality of the
persons involved in making the decision. Accordingly, decisions
regarding hiring, compensation, termination, promotion, or other similar
matters with respect to any individual (such as a claims adjudicator or
medical expert) must not be made based upon the likelihood that the
individual will support the denial of benefits.
(E) Notice. A plan and issuer must provide notice to individuals, in
a culturally and linguistically appropriate manner (as described in
paragraph (e) of this section) that complies with the requirements of 29
CFR 2560.503-1(g) and (j). The plan and issuer must also comply with the
additional requirements of this paragraph (b)(2)(ii)(E).
(1) The plan and issuer must ensure that any notice of adverse
benefit determination or final internal adverse benefit determination
includes information sufficient to identify the claim involved
(including the date of service, the health care provider, the claim
amount (if applicable), the diagnosis code and its corresponding
meaning, and the treatment code and its corresponding meaning).
(2) The plan and issuer must ensure that the reason or reasons for
the adverse benefit determination or final internal adverse benefit
determination includes the denial code and its corresponding meaning, as
well as a description of the plan's or issuer's standard, if any, that
was used in denying the claim. In the case of a notice of final internal
adverse benefit determination, this description must include a
discussion of the decision.
(3) The plan and issuer must provide a description of available
internal appeals and external review processes, including information
regarding how to initiate an appeal.
(4) The plan and issuer must disclose the availability of, and
contact information for, any applicable office of health insurance
consumer assistance or ombudsman established under PHS Act section 2793
to assist individuals with the internal claims and appeals and external
review processes.
(F) Deemed exhaustion of internal claims and appeals processes. In
the case of a plan or issuer that fails to strictly adhere to all the
requirements of this paragraph (b)(2) with respect to a claim, the
claimant is deemed to have exhausted the internal claims and appeals
process of this paragraph (b), regardless of whether the plan or issuer
asserts that it substantially complied with the requirements of this
paragraph (b)(2) or that any error it committed was de minimis.
Accordingly the claimant may initiate an external review under paragraph
(c) or (d) of this section, as applicable. The claimant is also entitled
to pursue any available remedies under section 502(a) of ERISA or under
State law, as applicable, on the basis that the plan or issuer has
failed to provide a reasonable internal claims and appeals process that
would yield a decision on the merits of the claim. If a claimant chooses
to pursue remedies under section 502(a) of ERISA under such
circumstances, the claim or appeal is deemed denied on review without
the exercise of discretion by an appropriate fiduciary.
(iii) Requirement to provide continued coverage pending the outcome
of an appeal. A plan and issuer subject to the requirements of this
paragraph (b)(2) are required to provide continued coverage pending the
outcome of an appeal. For this purpose, the plan and issuer must comply
with the requirements of 29 CFR 2560.503-1(f)(2)(ii), which generally
provides that benefits for an ongoing course of treatment cannot be
reduced or terminated without providing advance notice and an
opportunity for advance review.
[[Page 486]]
(c) State standards for external review--(1) In general. (i) If a
State external review process that applies to and is binding on a health
insurance issuer offering group health insurance coverage includes at a
minimum the consumer protections in the NAIC Uniform Model Act, then the
issuer must comply with the applicable State external review process and
is not required to comply with the Federal external review process of
paragraph (d) of this section. In such a case, to the extent that
benefits under a group health plan are provided through health insurance
coverage, the group health plan is not required to comply with either
this paragraph (c) or the Federal external review process of paragraph
(d) of this section.
(ii) To the extent that a group health plan provides benefits other
than through health insurance coverage (that is, the plan is self-
insured) and is subject to a State external review process that applies
to and is binding on the plan (for example, is not preempted by ERISA)
and the State external review process includes at a minimum the consumer
protections in the NAIC Uniform Model Act, then the plan must comply
with the applicable State external review process and is not required to
comply with the Federal external review process of paragraph (d) of this
section.
(iii) If a plan or issuer is not required under paragraph (c)(1)(i)
or (c)(1)(ii) of this section to comply with the requirements of this
paragraph (c), then the plan or issuer must comply with the Federal
external review process of paragraph (d) of this section, except to the
extent, in the case of a plan, the plan is not required under paragraph
(c)(1)(i) of this section to comply with paragraph (d) of this section.
(2) Minimum standards for State external review processes. An
applicable State external review process must meet all the minimum
consumer protections in this paragraph (c)(2). The Department of Health
and Human Services will determine whether State external review
processes meet these requirements.
(i) The State process must provide for the external review of
adverse benefit determinations (including final internal adverse benefit
determinations) by issuers (or, if applicable, plans) that are based on
the issuer's (or plan's) requirements for medical necessity,
appropriateness, health care setting, level of care, or effectiveness of
a covered benefit.
(ii) The State process must require issuers (or, if applicable,
plans) to provide effective written notice to claimants of their rights
in connection with an external review for an adverse benefit
determination.
(iii) To the extent the State process requires exhaustion of an
internal claims and appeals process, exhaustion must be unnecessary
where the issuer (or, if applicable, the plan) has waived the
requirement, the issuer (or the plan) is considered to have exhausted
the internal claims and appeals process under applicable law (including
by failing to comply with any of the requirements for the internal
appeal process, as outlined in paragraph (b)(2) of this section), or the
claimant has applied for expedited external review at the same time as
applying for an expedited internal appeal.
(iv) The State process provides that the issuer (or, if applicable,
the plan) against which a request for external review is filed must pay
the cost of the IRO for conducting the external review. Notwithstanding
this requirement, the State external review process may require a
nominal filing fee from the claimant requesting an external review. For
this purpose, to be considered nominal, a filing fee must not exceed
$25, it must be refunded to the claimant if the adverse benefit
determination (or final internal adverse benefit determination) is
reversed through external review, it must be waived if payment of the
fee would impose an undue financial hardship, and the annual limit on
filing fees for any claimant within a single plan year must not exceed
$75.
(v) The State process may not impose a restriction on the minimum
dollar amount of a claim for it to be eligible for external review.
Thus, the process may not impose, for example, a $500 minimum claims
threshold.
(vi) The State process must allow at least four months after the
receipt of a notice of an adverse benefit determination or final
internal adverse benefit
[[Page 487]]
determination for a request for an external review to be filed.
(vii) The State process must provide that IROs will be assigned on a
random basis or another method of assignment that assures the
independence and impartiality of the assignment process (such as
rotational assignment) by a State or independent entity, and in no event
selected by the issuer, plan, or the individual.
(viii) The State process must provide for maintenance of a list of
approved IROs qualified to conduct the external review based on the
nature of the health care service that is the subject of the review. The
State process must provide for approval only of IROs that are accredited
by a nationally recognized private accrediting organization.
(ix) The State process must provide that any approved IRO has no
conflicts of interest that will influence its independence. Thus, the
IRO may not own or control, or be owned or controlled by a health
insurance issuer, a group health plan, the sponsor of a group health
plan, a trade association of plans or issuers, or a trade association of
health care providers. The State process must further provide that the
IRO and the clinical reviewer assigned to conduct an external review may
not have a material professional, familial, or financial conflict of
interest with the issuer or plan that is the subject of the external
review; the claimant (and any related parties to the claimant) whose
treatment is the subject of the external review; any officer, director,
or management employee of the issuer; the plan administrator, plan
fiduciaries, or plan employees; the health care provider, the health
care provider's group, or practice association recommending the
treatment that is subject to the external review; the facility at which
the recommended treatment would be provided; or the developer or
manufacturer of the principal drug, device, procedure, or other therapy
being recommended.
(x) The State process allows the claimant at least five business
days to submit to the IRO in writing additional information that the IRO
must consider when conducting the external review and it requires that
the claimant is notified of the right to do so. The process must also
require that any additional information submitted by the claimant to the
IRO must be forwarded to the issuer (or, if applicable, the plan) within
one business day of receipt by the IRO.
(xi) The State process must provide that the decision is binding on
the issuer (or, if applicable, the plan), as well as the claimant except
to the extent that other remedies are available under State or Federal
law.
(xii) The State process must require, for standard external review,
that the IRO provide written notice to the claimant and the issuer (or,
if applicable, the plan) of its decision to uphold or reverse the
adverse benefit determination (or final internal adverse benefit
determination) within no more than 45 days after the receipt of the
request for external review by the IRO.
(xiii) The State process must provide for an expedited external
review if the adverse benefit determination (or final internal adverse
benefit determination) concerns an admission, availability of care,
continued stay, or health care service for which the claimant received
emergency services, but has not been discharged from a facility; or
involves a medical condition for which the standard external review time
frame would seriously jeopardize the life or health of the claimant or
jeopardize the claimant's ability to regain maximum function. As
expeditiously as possible but within no more than 72 hours after the
receipt of the request for expedited external review by the IRO, the IRO
must make its decision to uphold or reverse the adverse benefit
determination (or final internal adverse benefit determination) and
notify the claimant and the issuer (or, if applicable, the plan) of the
determination. If the notice is not in writing, the IRO must provide
written confirmation of the decision within 48 hours after the date of
the notice of the decision.
(xiv) The State process must require that issuers (or, if
applicable, plans) include a description of the external review process
in or attached to the summary plan description, policy, certificate,
membership booklet, outline of coverage, or other evidence of coverage
it provides to participants, beneficiaries, or enrollees, substantially
[[Page 488]]
similar to what is set forth in section 17 of the NAIC Uniform Model
Act.
(xv) The State process must require that IROs maintain written
records and make them available upon request to the State, substantially
similar to what is set forth in section 15 of the NAIC Uniform Model
Act.
(xvi) The State process follows procedures for external review of
adverse benefit determinations (or final internal adverse benefit
determinations) involving experimental or investigational treatment,
substantially similar to what is set forth in section 10 of the NAIC
Uniform Model Act.
(3) Transition period for existing external review processes--(i)
For plan years beginning before July 1, 2011, an applicable State
external review process applicable to a health insurance issuer or group
health plan is considered to meet the requirements of this paragraph
(c). Accordingly, for plan years beginning before July 1, 2011, an
applicable State external review process will be considered binding on
the issuer or plan (in lieu of the requirements of the Federal external
review process). If there is no applicable State external review
process, the issuer or plan is required to comply with the requirements
of the Federal external review process in paragraph (d) of this section.
(ii) For final internal adverse benefit determinations (or, in the
case of simultaneous internal appeal and external review, adverse
benefit determinations) provided after the first day of the first plan
year beginning on or after July 1, 2011, the Federal external review
process will apply unless the Department of Health and Human Services
determines that a State law meets all the minimum standards of paragraph
(c)(2) of this section as of the first day of the plan year.
(d) Federal external review process. A plan or issuer not subject to
an applicable State external review process under paragraph (c) of this
section must provide an effective Federal external review process in
accordance with this paragraph (d) (except to the extent, in the case of
a plan, the plan is described in paragraph (c)(1)(i) of this section as
not having to comply with this paragraph (d)). In the case of health
insurance coverage offered in connection with a group health plan, if
either the plan or the issuer complies with the Federal external review
process of this paragraph (d), then the obligation to comply with this
paragraph (d) is satisfied for both the plan and the issuer with respect
to the health insurance coverage.
(1) Scope. The Federal external review process established pursuant
to this paragraph (d) applies to any adverse benefit determination or
final internal adverse benefit determination as defined in paragraphs
(a)(2)(i) and (a)(2)(v) of this section, except that a denial,
reduction, termination, or a failure to provide payment for a benefit
based on a determination that a participant or beneficiary fails to meet
the requirements for eligibility under the terms of a group health plan
is not eligible for the external review process under this paragraph
(d).
(2) External review process standards. The Federal external review
process established pursuant to this paragraph (d) will be similar to
the process set forth in the NAIC Uniform Model Act and will meet
standards issued by the Secretary. These standards will comply with all
of the requirements described in this paragraph (d)(2).
(i) These standards will describe how a claimant initiates an
external review, procedures for preliminary reviews to determine whether
a claim is eligible for external review, minimum qualifications for
IROs, a process for approving IROs eligible to be assigned to conduct
external reviews, a process for random assignment of external reviews to
approved IROs, standards for IRO decision-making, and rules for
providing notice of a final external review decision.
(ii) These standards will provide an expedited external review
process for--
(A) An adverse benefit determination, if the adverse benefit
determination involves a medical condition of the claimant for which the
timeframe for completion of an expedited internal appeal under paragraph
(b) of this section would seriously jeopardize the life or health of the
claimant, or would jeopardize the claimant's ability to regain maximum
function and the claimant has filed a request for an expedited
[[Page 489]]
internal appeal under paragraph (b) of this section; or
(B) A final internal adverse benefit determination, if the claimant
has a medical condition where the timeframe for completion of a standard
external review pursuant to paragraph (d)(3) of this section would
seriously jeopardize the life or health of the claimant or would
jeopardize the claimant's ability to regain maximum function, or if the
final internal adverse benefit determination concerns an admission,
availability of care, continued stay, or health care service for which
the claimant received emergency services, but has not been discharged
from a facility.
(iii) With respect to claims involving experimental or
investigational treatments, these standards will also provide additional
consumer protections to ensure that adequate clinical and scientific
experience and protocols are taken into account as part of the external
review process.
(iv) These standards will provide that an external review decision
is binding on the plan or issuer, as well as the claimant, except to the
extent other remedies are available under State or Federal law.
(v) These standards may establish external review reporting
requirements for IROs.
(vi) These standards will establish additional notice requirements
for plans and issuers regarding disclosures to participants and
beneficiaries describing the Federal external review procedures
(including the right to file a request for an external review of an
adverse benefit determination or a final internal adverse benefit
determination in the summary plan description, policy, certificate,
membership booklet, outline of coverage, or other evidence of coverage
it provides to participants or beneficiaries).
(vii) These standards will require plans and issuers to provide
information relevant to the processing of the external review,
including, but not limited to, the information considered and relied on
in making the adverse benefit determination or final internal adverse
benefit determination.
(e) Form and manner of notice. (1) For purposes of this section, a
group health plan and health insurance issuer offering group health
insurance coverage are considered to provide relevant notices in a
culturally and linguistically appropriate manner--
(i) For a plan that covers fewer than 100 participants at the
beginning of a plan year, if the plan and issuer provide notices upon
request in a non-English language in which 25 percent or more of all
plan participants are literate only in the same non-English language; or
(ii) For a plan that covers 100 or more participants at the
beginning of a plan year, if the plan and issuer provide notices upon
request in a non-English language in which the lesser of 500 or more
participants, or 10 percent or more of all plan participants, are
literate only in the same non-English language.
(2) If an applicable threshold described in paragraph (e)(1) of this
section is met, the plan and issuer must also--
(i) Include a statement in the English versions of all notices,
prominently displayed in the non-English language, offering the
provision of such notices in the non-English language;
(ii) Once a request has been made by a claimant, provide all
subsequent notices to the claimant in the non-English language; and
(iii) To the extent the plan or issuer maintains a customer
assistance process (such as a telephone hotline) that answers questions
or provides assistance with filing claims and appeals, the plan or
issuer must provide such assistance in the non-English language.
(f) Secretarial authority. The Secretary may determine that the
external review process of a group health plan or health insurance
issuer, in operation as of March 23, 2010, is considered in compliance
with the applicable process established under paragraph (c) or (d) of
this section if it substantially meets the requirements of paragraph (c)
or (d) of this section, as applicable.
(g) Applicability/effective date. The provisions of this section
apply for plan years beginning on or after September 23, 2010. See Sec.
54.9815-1251T for determining the application of this section
[[Page 490]]
to grandfathered health plans (providing that these rules regarding
internal claims and appeals and external review processes do not apply
to grandfathered health plans).
(h) Expiration date. The applicability of this section expires on
July 22, 2013 or on such earlier date as may be provided in final
regulations or other action published in the Federal Register.
[T.D. 9494, 75 FR 43350, July 23, 2010]
Sec. 54.9831-1 Special rules relating to group health plans.
(a) Group health plan--(1) Defined. A group health plan means a plan
(including a self-insured plan) of, or contributed to by, an employer
(including a self-employed person) or employee organization to provide
health care (directly or otherwise) to the employees, former employees,
the employer, others associated or formerly associated with the employer
in a business relationship, or their families.
(2) Determination of number of plans. [Reserved]
(b) General exception for certain small group health plans. (1)
Subject to paragraph (b)(2) of this section, the requirements of
Sec. Sec. 54.9801-1 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9811-1,
54.9812-1T, and 54.9833-1 do not apply to any group health plan for any
plan year if, on the first day of the plan year, the plan has fewer than
two participants who are current employees.
(2) The exception of paragraph (b)(1) of this section does not apply
with respect to the following requirements:
(i) Section 54.9801-3(b)(6).
(ii) Section 54.9802-1(b), as such paragraph applies with respect to
genetic information as a health factor.
(iii) Section 54.9802-1(c), as such paragraph applies with respect
to genetic information as a health factor.
(iv) Section 54.9802-1(e), as such paragraph applies with respect to
genetic information as a health factor.
(v) Section 54.9802-3T(b).
(vi) Section 54.9802-3T(c).
(vii) Section 54.9802-3T(d).
(viii) Section 54.9802-3T(e).
(c) Excepted benefits--(1) In general. The requirements of
Sec. Sec. 54.9801-1 through 54.9801-6, 54.9802-1, 54.9802-2, 54.9811-
1T, 54.9812-1T, and 54.9833-1 do not apply to any group health plan in
relation to its provision of the benefits described in paragraph (c)(2),
(3), (4), or (5) of this section (or any combination of these benefits).
(2) Benefits excepted in all circumstances. The following benefits
are excepted in all circumstances--
(i) Coverage only for accident (including accidental death and
dismemberment);
(ii) Disability income coverage;
(iii) Liability insurance, including general liability insurance and
automobile liability insurance;
(iv) Coverage issued as a supplement to liability insurance;
(v) Workers' compensation or similar coverage;
(vi) Automobile medical payment insurance;
(vii) Credit-only insurance (for example, mortgage insurance); and
(viii) Coverage for on-site medical clinics.
(3) Limited excepted benefits--(i) In general. Limited-scope dental
benefits, limited-scope vision benefits, or long-term care benefits are
excepted if they are provided under a separate policy, certificate, or
contract of insurance, or are otherwise not an integral part of a group
health plan as described in paragraph (c)(3)(ii) of this section. In
addition, benefits provided under a health flexible spending arrangement
are excepted benefits if they satisfy the requirements of paragraph
(c)(3)(v) of this section.
(ii) Not an integral part of a group health plan. For purposes of
this paragraph (c)(3), benefits are not an integral part of a group
health plan (whether the benefits are provided through the same plan or
a separate plan) only if the following two requirements are satisfied--
(A) Participants must have the right to elect not to receive
coverage for the benefits; and
(B) If a participant elects to receive coverage for the benefits,
the participant must pay an additional premium or contribution for that
coverage.
(iii) Limited scope--(A) Dental benefits. Limited scope dental
benefits are benefits substantially all of which are for treatment of
the mouth (including any organ or structure within the mouth).
[[Page 491]]
(B) Vision benefits. Limited scope vision benefits are benefits
substantially all of which are for treatment of the eye.
(iv) Long-term care. Long-term care benefits are benefits that are
either--
(A) Subject to State long-term care insurance laws;
(B) For qualified long-term care services, as defined in section
7702B(c)(1), or provided under a qualified long-term care insurance
contract, as defined in section 7702B(b); or
(C) Based on cognitive impairment or a loss of functional capacity
that is expected to be chronic.
(v) Health flexible spending arrangements. Benefits provided under a
health flexible spending arrangement (as defined in section 106(c)(2))
are excepted for a class of participants only if they satisfy the
following two requirements--
(A) Other group health plan coverage, not limited to excepted
benefits, is made available for the year to the class of participants by
reason of their employment; and
(B) The arrangement is structured so that the maximum benefit
payable to any participant in the class for a year cannot exceed two
times the participant's salary reduction election under the arrangement
for the year (or, if greater, cannot exceed $500 plus the amount of the
participant's salary reduction election). For this purpose, any amount
that an employee can elect to receive as taxable income but elects to
apply to the health flexible spending arrangement is considered a salary
reduction election (regardless of whether the amount is characterized as
salary or as a credit under the arrangement).
(4) Noncoordinated benefits--(i) Excepted benefits that are not
coordinated. Coverage for only a specified disease or illness (for
example, cancer-only policies) or hospital indemnity or other fixed
indemnity insurance is excepted only if it meets each of the conditions
specified in paragraph (c)(4)(ii) of this section. To be hospital
indemnity or other fixed indemnity insurance, the insurance must pay a
fixed dollar amount per day (or per other period) of hospitalization or
illness (for example, $100/day) regardless of the amount of expenses
incurred.
(ii) Conditions. Benefits are described in paragraph (c)(4)(i) of
this section only if--
(A) The benefits are provided under a separate policy, certificate,
or contract of insurance;
(B) There is no coordination between the provision of the benefits
and an exclusion of benefits under any group health plan maintained by
the same plan sponsor; and
(C) The benefits are paid with respect to an event without regard to
whether benefits are provided with respect to the event under any group
health plan maintained by the same plan sponsor.
(iii) Example. The rules of this paragraph (c)(4) are illustrated by
the following example:
Example. (i) Facts. An employer sponsors a group health plan that
provides coverage through an insurance policy. The policy provides
benefits only for hospital stays at a fixed percentage of hospital
expenses up to a maximum of $100 a day.
(ii) Conclusion. In this Example, even though the benefits under the
policy satisfy the conditions in paragraph (c)(4)(ii) of this section,
because the policy pays a percentage of expenses incurred rather than a
fixed dollar amount, the benefits under the policy are not excepted
benefits under this paragraph (c)(4). This is the result even if, in
practice, the policy pays the maximum of $100 for every day of
hospitalization.
(5) Supplemental benefits. (i) The following benefits are excepted
only if they are provided under a separate policy, certificate, or
contract of insurance--
(A) Medicare supplemental health insurance (as defined under section
1882(g)(1) of the Social Security Act; also known as Medigap or MedSupp
insurance);
(B) Coverage supplemental to the coverage provided under Chapter 55,
Title 10 of the United States Code (also known as TRICARE supplemental
programs); and
(C) Similar supplemental coverage provided to coverage under a group
health plan. To be similar supplemental coverage, the coverage must be
specifically designed to fill gaps in primary coverage, such as
coinsurance or deductibles. Similar supplemental coverage does not
include coverage that becomes secondary or supplemental
[[Page 492]]
only under a coordination-of-benefits provision.
(ii) The rules of this paragraph (c)(5) are illustrated by the
following example:
Example. (i) Facts. An employer sponsors a group health plan that
provides coverage for both active employees and retirees. The coverage
for retirees supplements benefits provided by Medicare, but does not
meet the requirements for a supplemental policy under section 1882(g)(1)
of the Social Security Act.
(ii) Conclusion. In this Example, the coverage provided to retirees
does not meet the definition of supplemental excepted benefits under
this paragraph (c)(5) because the coverage is not Medicare supplemental
insurance as defined under section 1882(g)(1) of the Social Security
Act, is not a TRICARE supplemental program, and is not supplemental to
coverage provided under a group health plan.
(d) Treatment of partnerships. For purposes of this part:
(1) Treatment as a group health plan. (See 29 CFR 2590.732(d)(1) and
45 CFR 146.145(d)(1), under which a plan providing medical care,
maintained by a partnership, and usually not treated as an employee
welfare benefit plan under ERISA is treated as a group health plan for
purposes of Part 7 of Subtitle B of Title I of ERISA and Title XXVII of
the PHS Act.)
(2) Employment relationship. In the case of a group health plan, the
term employer also includes the partnership in relation to any bona fide
partner. In addition, the term employee also includes any bona fide
partner. Whether or not an individual is a bona fide partner is
determined based on all the relevant facts and circumstances, including
whether the individual performs services on behalf of the partnership.
(3) Participants of group health plans. In the case of a group
health plan, the term participant also includes any individual described
in paragraph (d)(3)(i) or (ii) of this section if the individual is, or
may become, eligible to receive a benefit under the plan or the
individual's beneficiaries may be eligible to receive any such benefit.
(i) In connection with a group health plan maintained by a
partnership, the individual is a partner in relation to the partnership.
(ii) In connection with a group health plan maintained by a self-
employed individual (under which one or more employees are
participants), the individual is the self-employed individual.
(e) Determining the average number of employees. [Reserved]
[T.D. 9166, 69 FR 78746, Dec. 30, 2004; 70 FR 21146, Apr. 25, 2005, as
amended by T.D. 9299, 71 FR 75057, Dec. 13, 2006; T.D. 9427, 73 FR
62422, Oct. 20, 2008; T.D. 9464, 74 FR 51678, Oct. 7, 2009]
Sec. 54.9833-1 Effective dates.
Sections 54.9801-1 through 54.9801-6, 54.9831-1, and this section
are applicable for plan years beginning on or after July 1, 2005.
[T.D. 9166, 69 FR 78746, Dec. 30, 2004]
PART 55_EXCISE TAX ON REAL ESTATE INVESTMENT TRUSTS AND REGULATED INVESTMENT
COMPANIES--Table of Contents
Subpart A_Excise Tax on Real Estate Investment Trusts
Sec.
55.4981-1 Imposition of excise tax on certain real estate investment
trust taxable income not distributed during the taxable year;
taxable years ending on or before January 1, 1987.
55.4981-2 Imposition of excise tax with respect to certain undistributed
income of real estate investment trusts; calendar years
beginning after December 31, 1986.
Subpart B_Excise Tax on Regulated Investment Companies
55.4982-1 Imposition of excise tax on undistributed income of regulated
investment companies.
Subpart C_Procedure and Administration
55.6001-1 Notice or regulations requiring records, statements, and
special returns.
55.6011-1 General requirement of return, statement, or list.
55.6060-1 Reporting requirements for tax return preparers.
55.6061-1 Signing of returns and other documents.
55.6065-1 Verification of returns.
55.6071-1 Time for filing returns.
55.6081-1 Automatic extension of time for filing a return due under
Chapter 44.
55.6091-1 Place for filing Chapter 44 tax returns.
55.6091-2 Exceptional cases.
[[Page 493]]
55.6107-1 Tax return preparer must furnish copy of return or claim for
refund to taxpayer and must retain a copy or record.
55.6109-1 Tax return preparers furnishing identifying numbers for
returns or claims for refund.
55.6151-1 Time and place for paying of tax shown on returns.
55.6161-1 Extension of time for paying tax or deficiency.
55.6165-1 Bonds where time to pay tax or deficiency has been extended.
55.6694-1 Section 6694 penalties applicable to tax return preparer.
55.6694-2 Penalties for understatement due to an unreasonable position.
55.6694-3 Penalty for understatement due to willful, reckless, or
intentional conduct.
55.6694-4 Extension of period of collection when tax return preparer
pays 15 percent of a penalty for understatement of taxpayer's
liability and certain other procedural matters.
55.6695-1 Other assessable penalties with respect to the preparation of
tax returns or claims for refund for other persons.
55.6696-1 Claims for credit or refund by tax return preparers.
55.7701-1 Tax return preparer.
Authority: 26 U.S.C. 6001, 6011, 6071, 6091, and 7805.
Section 55.4981-1 also issued under sec. 860(e), 92 Stat. 2849 (26
U.S.C. 860(e); sec. 860(g), 92 Stat. 2850 (26 U.S.C. 860(g)); and sec
7805. 68A Stat. 917 (26 U.S.C. 7805) of the Internal Revenue Code of
1954), 26 U.S.C. 7805;
Section 55.6011-1 also issued under 26 U.S.C. 6011(a);
Section 55.6060-1 also issued under 26 U.S.C. 6060(a);
Section 55.6071-1 also issued under 26 U.S.C. 6071(a);
Section 55.6081-1 also issued under 26 U.S.C. 6081(a);
Section 55.6091-1 also issued under 26 U.S.C. 6091(a);
Section 55.6109-1 also issued under 26 U.S.C. 6109(a);
Section 55.6109-2 also issued under 26 U.S.C. 6109(a);
Section 55.6151-1 also issued under 26 U.S.C. 6151;
Section 55.6695-1 also issued under 26 U.S.C. 6695(b).
Source: T.D. 7767, 46 FR 11282, Feb. 6, 1981; 46 FR 15263, Mar. 5,
1981, unless otherwise noted.
Subpart A_Excise Tax on Real Estate Investment Trusts
Sec. 55.4981-1 Imposition of excise tax on certain real estate investment trust
taxable income not distributed during the taxable year; taxable years ending
on or before January 1, 1987.
Section 4981 as in effect before amendment by the Tax Reform Act of
1986 imposes an excise tax on a real estate investment trust if the
deduction for dividends paid for the taxable year does not equal at
least 75 percent of its real estate investment trust taxable income
(computed as provided in section 4981 as in effect before amendment by
the Tax Reform Act of 1986) for the taxable year. For purposes of
section 4981 as in effect before amendment by the Tax Reform Act of
1986, the deduction for dividends paid is computed without regard to
capital gains dividends (as defined in section 857(b)(3)(C)) and without
regard to any dividends actually paid after the close of the taxable
year. Thus, dividends considered as paid during the taxable year under
section 858 are disregarded. Deficiency dividends (as defined in section
860(f) paid with respect to the taxable year are also disregarded. The
return referred to in the last sentence of section 4981 as in effect
before amendment by the Tax Reform Act of 1986 in the income tax return.
Section 4981 as in effect before amendment by the Tax Reform Act of
1986, applies only to taxable years beginning after December 31, 1979
and ending before January 1, 1987, for which the taxpayer is taxable
under Part II of Subchapter M of Chapter 1 of subtitle A as a real
estate investment trust.
[T.D. 7767, 46 FR 11282, Feb. 6, 1981; 46 FR 15263, Mar. 5, 1981; T.D.
7936, 49 FR 2109, Jan. 18, 1984; T.D. 8180, 53 FR 6147, Mar. 1, 1988]
Sec. 55.4981-2 Imposition of excise tax with respect to certain undistributed income of
real estate investment trusts; calendar years beginning after December
31, 1986.
Section 4981, as amended by the Tax Reform Act of 1986, imposes an
excise tax on a real estate investment trust in
[[Page 494]]
the amount of four percent of the excess, if any, of the required
distribution for a calendar year over the distributed amount for such
calendar year. Section 4981, as so amended, applies only to calendar
years that begin after December 31, 1986. For provisions relating to the
imposition of an excise tax with respect to certain undistributed income
of real estate investment trusts for taxable years ending before January
1, 1987, see Sec. 55.4981-1.
[T.D. 8180, 53 FR 6148, Mar. 1, 1988]
Subpart B_Excise Tax on Regulated Investment Companies
Sec. 55.4982-1 Imposition of excise tax on undistributed income of regulated investment companies.
Section 4982 imposes an excise tax on a regulated investment company
in the amount of four percent of the excess, if any, of the required
distribution for a calendar year over the distributed amount for such
calendar year. Section 4982 applies only to calendar years beginning
after December 31, 1986.
[T.D. 8180, 53 FR 6148, Mar. 1, 1988]
Subpart C_Procedure and Administration
Source: T.D. 7767, 46 FR 11282, Feb. 6, 1981; 46 FR 15263, Mar. 5,
1981, unless otherwise noted. Redesignated by T.D. 8180, 53 FR 6148,
Mar. 1, 1988.
Sec. 55.6001-1 Notice or regulations requiring records, statements, and special returns.
(a) In general. Any person subject to tax under Chapter 44 of the
Code shall keep such complete and detailed records as are sufficient to
enable the district director to determine accurately the amount of
liability under Chapter 44.
(b) Notice by district director requiring returns, statements, or
the keeping of records. The district director may require any person, by
notice served upon him, to make such returns, render such statements, or
keep such specific records as will enable the district director to
determine whether or not such person is liable for tax under Chapter 44.
(c) Retention of records. The records required by this section shall
be kept at all times available for inspection by authorized internal
revenue officers or employees, and shall be retained so long as the
contents thereof may become material in the administration of any
internal revenue law.