[Federal Register Volume 64, Number 20 (Monday, February 1, 1999)]
[Proposed Rules]
[Pages 4801-4812]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-1515]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-209619-93]
RIN 1545-AR82
Escrow Funds and Other Similar Funds
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to the
designation of the person required to report the income earned on
qualified settlement funds and certain other funds, trusts, and escrow
accounts, and other related rules. The proposed regulations would
affect qualified settlement funds, qualified escrow accounts and
qualified trusts established in connection with deferred like-kind
exchanges, escrow accounts established in connection with sales of
property, disputed ownership funds, and parties to these escrow
accounts, trusts, and funds. This document also provides notice of a
public hearing on these proposed regulations.
DATES: Written comments must be received by May 3, 1999. Requests to
speak and outlines of topics to be discussed at the public hearing
scheduled for May 12, 1999, at 10 a.m., must be received by April 21,
1999.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209619-93), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-
209619-93), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the INTERNET by selecting the ``Tax Regs''
option on the IRS Home Page, or by submitting comments directly to the
IRS INTERNET site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in Room 2615, Internal
Revenue Building, 1111 Constitution Avenue, Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Michael L.
Gompertz of the Office of Assistant Chief Counsel (Income Tax &
Accounting), (202) 622-4910; concerning submissions of comments, the
hearing, and/or to be placed on the building access list to attend the
hearing, Michael Slaughter, (202) 622-7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in this notice of proposed
rulemaking have been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). Comments on the collections of information should be
sent to the Office of Management and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC
20224. Comments on the collections of information should be received by
April 2, 1999. Comments are specifically requested concerning:
Whether the proposed collections of information are necessary for
the proper performance of the functions of the Internal Revenue
Service, including whether the information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collections of information (see below);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collections of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of service to provide information.
The collections of information in this proposed regulation are in
Secs. 1.468B-
[[Page 4802]]
1(k)(2), 1.468B-1(k)(3)(iv), 1.468B-6(e)(1), 1.468B-6(f), 1.468B-7(d),
1.468B-8(f), 1.468B-8(g)(1), 1.468B-9(c)(1), and 1.468B-9(f)(3).
The collections of information in Secs. 1.468B-1(k)(3)(iv), 1.468B-
6(e)(1), 1.468B-7(d), 1.468B-8(g)(1), and 1.468B-9(c)(1) are satisfied
by including the required information on Forms 1099, 1041, 1120, or
1120-SF. The burden for these requirements is reflected in the burden
estimates for these forms.
The other collections of information in this proposed regulation
(in Secs. 1.468B-1(k)(2), 1.468B-6(f), 1.468B-8(f), and 1.468B-9(f)(3))
are discussed below.
The collection of information in Sec. 1.468B-1(k)(2) is an election
statement attached to a tax return filed for a qualified settlement
fund (QSF). The statement notifies the IRS that the transferor to the
QSF has elected grantor trust treatment for the QSF. This collection is
required to obtain a benefit.
The collections of information in Secs. 1.468B-6(f) and 1.468B-8(f)
are statements that third parties must provide to an escrow holder,
trustee, or administrator to enable the escrow holder, trustee, or
administrator to properly report the income of an escrow account or
trust on Form 1099. These collections are mandatory.
The collection of information in Sec. 1.468B-9(f)(3) is a statement
that a transferor must provide with respect to the transfer of cash or
property to a disputed ownership fund. This collection is mandatory.
The likely respondents are individuals, business or other for-
profit institutions, small businesses or organizations, nonprofit
institutions, and government entities.
Estimated total annual reporting burden: 4,650 hours.
Estimated average annual burden per respondent: .5 hours.
Estimated number of respondents: 9,300.
Estimated annual frequency of responses: on occasion.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number assigned by the Office of
Management and Budget.
Books and records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This notice contains proposed amendments to the Income Tax
Regulations (26 CFR part 1) under section 468B of the Internal Revenue
Code. Section 468B was added to the Code by section 1807(a)(7)(A) of
the Tax Reform Act of 1986 (Public Law 99-514, 100 Stat. 2814) and was
amended by section 1018(f) of the Technical and Miscellaneous Revenue
Act of 1988 (Public Law 100-647, 102 Stat. 3582). Section 468B(g)
provides that nothing in any provision of law shall be construed as
providing that an escrow account, settlement fund, or similar fund is
not subject to current income tax. Section 468B(g) further provides
that the Secretary shall prescribe regulations providing for the
taxation of any such account or fund whether as a grantor trust or
otherwise.
On December 23, 1992, final regulations (TD 8459) under section
468B(g) were published in the Federal Register (57 FR 60983). The
regulations provide guidance concerning qualified settlement funds, but
do not address other types of funds, escrow accounts, or trusts subject
to current taxation under section 468B(g).
Section 1.468B-1(c) defines a qualified settlement fund (QSF) as a
fund, account, or trust meeting three requirements. A QSF is a separate
taxpayer subject to tax on its modified gross income. QSF
classification is not elective. The preamble to the QSF regulations
(see 1993-1 C.B. 69) states that the IRS and the Treasury Department
rejected an elective approach because it would result in inconsistent
tax treatment for similar funds, claimants, or transferors, and
accompanying complexity.
The preamble to the QSF regulations also states (see 1993-1 C.B.
73) that future regulations will address the tax treatment of funds,
accounts, or trusts other than QSFs, specifically, escrow accounts used
in the sale of property and section 1031 qualified escrow accounts.
Section 1031(a)(3) was added to the Internal Revenue Code by
section 77 of the Tax Reform Act of 1984 (Public Law 98-369, 98 Stat.
595). On May 1, 1991, final regulations (TD 8346) under section
1031(a)(3) were published in the Federal Register (56 FR 19933). These
regulations were amended by final regulations (TD 8535) published in
the Federal Register for April 20, 1994 (59 FR 18747). The regulations
provide four safe harbors, the use of any of which will result in a
determination that the taxpayer (i.e., the party transferring the
property in the exchange) is not in actual or constructive receipt of
money or other property for purposes of section 1031. In particular,
the regulations provide that the taxpayer is not in actual or
constructive receipt of money or other property held in a qualified
escrow account or qualified trust. Section 1.1031(k)-1(g)(3) defines
qualified escrow account and qualified trust.
The regulations under section 1031(a)(3) do not address the
taxation of income earned on a qualified escrow or qualified trust. The
preamble to these regulations (see 1991-1 C.B. 154) states that this
issue will be addressed in future regulations.
Explanation of Provisions
1. Election To Treat a QSF as a Grantor Trust Under Sec. 1.468B-1(k) of
the Proposed Regulations
The proposed regulations provide that if there is only one
transferor to a QSF, the transferor is allowed to make an election that
results in the QSF being treated as a grantor trust all of which is
treated as owned by the transferor. In general, the election is made on
a statement attached to the first Form 1041 filed on behalf of the QSF.
The transferor may make a grantor trust election whether or not the
requirements are otherwise satisfied for classification of the QSF as a
grantor trust.
In general, grantor trust treatment for a QSF is available under
the proposed regulations only if the QSF is established after the date
final regulations are published in the Federal Register. However, the
proposed regulations provide a narrow exception applicable to any QSF
established by the U.S. government on or before the date final
regulations are published if the QSF would otherwise have been
classified as a grantor trust in the absence of the QSF regulations
(see Rev. Rul. 77-230 (1977-2 C.B. 214)). Under the exception, such a
QSF will be automatically treated as a grantor trust for all taxable
years and a grantor trust election is thus unnecessary. If a QSF is
established after the date final regulations are published, a grantor
trust election will be required in order for the QSF to be treated as a
grantor trust. This rule applies whether or not the U.S. government is
the grantor.
2. Section 1031 Qualified Escrow Accounts and Qualified Trusts Under
Sec. 1.468B-6 of the Proposed Regulations
In general, the proposed regulations treat the assets of a
qualified escrow account or qualified trust established in connection
with a deferred exchange
[[Page 4803]]
under section 1031(a)(3) as owned by the taxpayer, i.e., the party that
transfers the relinquished property. Thus, the taxpayer is taxable on
the income earned on these assets. However, if the transferee or the
qualified intermediary has all the beneficial use and enjoyment of the
assets of a qualified escrow account or qualified trust, then the
assets of the escrow account or trust are treated as owned by the
transferee or qualified intermediary, and the income earned on the
assets is taxable to the transferee or qualified intermediary.
Further, the proposed regulations require the escrow holder of a
qualified escrow account or trustee of a qualified trust to report the
income of the escrow account or trust on Forms 1099 to the extent the
information reporting provisions of the Code otherwise require the
filing of Forms 1099. In general, the taxpayer is treated as the payee
of the income of the escrow account or trust unless the parties to the
transaction provide a statement to the escrow holder or trustee
indicating that the transferee or qualified intermediary is the payee.
Such a statement must be provided if the transferee or qualified
intermediary has all the beneficial use and enjoyment of the assets of
the escrow account or trust.
The proposed regulations provide that the escrow holder or trustee
is not liable for penalties under sections 6721 and 6722 if the escrow
holder or trustee relies on an incorrect statement provided to the
escrow holder or trustee (see above) or relies on the parties' failure
to provide such a statement.
The proposed regulations also provide that if the transferee or the
qualified intermediary has all the beneficial use and enjoyment of the
assets of a qualified escrow account or trust, the deferred exchange
may involve a below-market loan of these assets from the taxpayer to
the transferee or qualified intermediary subject to the provisions of
section 7872.
3. Pre-closing Escrows Under Sec. 1.468B-7 of the Proposed Regulations
A pre-closing escrow is an escrow account, trust, or fund that
satisfies five requirements. First, it must be established in
connection with a sale or exchange of real or personal property.
Second, it must be funded with a down payment, earnest money, or
similar payment prior to the sale or exchange of the property (as
determined for federal income tax purposes). Third, its assets must be
used to secure the purchaser's obligation to pay the purchase price (in
the case of an exchange of property, the term purchaser means the
transferee of the property and the term purchase price means the
required consideration for the property). Fourth, its assets (including
income earned thereon) must be paid to the purchaser or otherwise used
for the purchaser's benefit, for example, as a credit against the
purchase price. Fifth, it must not be a qualified escrow or qualified
trust established in connection with a deferred section 1031 exchange.
The proposed regulations treat the assets of a pre-closing escrow
as owned by the purchaser for federal income tax purposes. Thus, the
income earned on the assets is taxable to the purchaser. The escrow
holder, trustee, or other person responsible for administering a pre-
closing escrow must report the income of the escrow on Forms 1099 to
the extent the information reporting provisions of the Code otherwise
require the filing of Forms 1099.
4. Contingent At-closing Escrows Under Sec. 1.468B-8 of the Proposed
Regulations
The proposed regulations provide rules for taxing the income of a
contingent at-closing escrow, which is an escrow account, trust, or
fund satisfying three requirements. First, a contingent at-closing
escrow must be established in connection with the sale or exchange of
real or personal property used in a trade or business or held for
investment (other than an exchange to which section 354, 355, or 356
applies). Second, the assets of the escrow must be distributable to the
purchaser or seller based on bona fide contingencies that will be
resolved after the sale or exchange (as determined for federal income
tax purposes). (If a contingent at-closing escrow is established in
connection with an exchange of property, rather than a sale, the term
purchaser refers to the transferee of the property and the term seller
refers to the transferor of the property.) Thus, for example, the
agreement between the parties may provide that all or a portion of the
assets of the escrow are distributable to the purchaser if specified
liabilities associated with the property arise within a specified
period of time after closing or if certain earnings targets are not met
by a specified date. Third, the escrow must not be a qualified escrow
account or qualified trust established in connection with a deferred
section 1031 exchange.
Prior to the date (called the determination date) on which the
specified events occur or fail to occur, thereby fixing the amounts
payable from the escrow to the purchaser and seller, the proposed
regulations provide that the assets of the escrow are treated as owned
by the purchaser, and the income earned on the assets is thus taxable
to the purchaser.
Beginning on the determination date, the proposed regulations
provide that the purchaser and the seller are taxable on the income of
the escrow corresponding to their respective ownership interests in
each asset of the escrow. Further, the proposed regulations require the
purchaser and seller to provide the escrow holder, trustee, or other
administrator of the escrow with a statement within 30 days of the
determination date indicating what these ownership interests are. Also,
the escrow holder, trustee, or other administrator is required to
prepare Forms 1099 to report the income of a contingent at-closing
escrow to the extent the information reporting provisions of the Code
otherwise require the filing of Forms 1099.
In preparing the Forms 1099, the escrow holder, trustee, or other
administrator may rely on the statement (discussed above) provided to
the administrator within 30 days of the determination date. Also, if
the statement is not provided, the escrow holder, trustee, or other
administrator may rely on the parties' failure to provide a statement
and continue to treat the purchaser as the owner. The administrator's
ability to rely on a statement, or its absence, protects the
administrator from liability for penalties under sections 6721 and
6722.
5. Disputed Ownership Funds Under Sec. 1.468B-9 of the Proposed
Regulations
A disputed ownership fund (DOF) is an escrow account, trust, or
fund other than a QSF that satisfies three requirements. First, a DOF
must be established to hold money or property subject to conflicting
claims of ownership. Second, a DOF must be subject to the continuing
jurisdiction of a court of law or equity. Third, money or property
cannot be paid or distributed from a DOF to a claimant without court
approval. An interpleader fund may qualify as a DOF.
In general, a DOF is taxed under the proposed regulations as if it
were a qualified settlement fund if all the DOF's assets are passive
investment assets, for example, cash or cash equivalents, stock, and
debt obligations. However, if the DOF holds assets other than passive
investment assets (for example, real estate or business property the
ownership of which is in dispute), the DOF is taxed as if it were a C
corporation. The claimants to the fund may, however, submit a letter
ruling request proposing an alternative method of taxation if they
believe that
[[Page 4804]]
there is a more appropriate method of taxing a DOF than under the rules
stated above.
In addition to providing rules for the taxation of the income of a
DOF, the proposed regulations also provide rules concerning the
transfer of property to and from a DOF. In particular, a transfer of
property to a DOF is not a sale or other disposition by the transferor
under section 1001(a) if the transferor claims ownership of the
transferred property. Also, a DOF is not allowed a deduction for a
distribution of disputed property to a claimant and the distribution is
not a taxable event to the DOF.
6. Request for Comments
Comments are requested on the appropriate tax treatment of a fund,
account, or trust that meets the requirements for more than one type of
entity subject to the proposed regulations. Comments are also requested
on the appropriate tax treatment of a fund, account, or trust that
changes over time so that a different portion of the proposed
regulations would apply to it. For example, an escrow initially may
meet the requirements for a contingent at-closing escrow, but may
subsequently satisfy the requirements for a DOF. This could occur if a
dispute were to arise between the purchaser and the seller concerning
their respective interests in the escrow after the determination date
and the administrator of the DOF files an interpleader action to
resolve the dispute.
Comments are also requested concerning the appropriate tax
treatment of a contingent-at-closing escrow if multiple contingencies
are specified in the agreement between the purchaser and the seller.
The proposed regulations provide that (1) the income of a contingent
at-closing escrow is taxable entirely to the purchaser prior to the
determination date, and (2) the determination date is the date on which
(or by which) the last of the contingent events has either occurred or
failed to occur. Therefore, if multiple contingencies are provided for
in the agreement between the parties and some, but not all, of the
contingencies have been resolved, the proposed regulations provide that
the income of the escrow is taxable entirely to the purchaser (because
the determination date has not yet occurred) regardless of the effect
of the contingencies that have been resolved. The purchaser is thus
taxed on all the income earned on the escrow even though it may be
known (based on the resolution of one or more contingencies) that a
fixed portion of the escrowed assets will be distributed to the seller.
The proposed rule is simple and easy to administer because it treats
the escrow in a unitary manner and avoids the need for multiple
determination dates. Arguably, however, a more complex approach should
be adopted involving a separate determination date for each
contingency. Under the more complex approach, as each contingency is
resolved, a new determination would be made concerning the taxation of
the fund's income. The income earned on the fund's assets would be
taxable to the purchaser and seller in accordance with their ownership
interests as determined on each determination date as each separate
contingency is resolved.
Comments are also requested on the requirement that the assets of a
contingent at-closing escrow must be distributable to the purchaser or
seller based on bona fide contingencies that are resolved after the
sale or exchange. Issues may arise as to whether a particular
contingency is bona fide in at least two ways: whether the outcome is
sufficiently in doubt and whether the effect of the outcome on the fund
is significant. A contingency may not be bona fide if the parties can
reasonably be expected to know the outcome, e.g., a contingency based
on whether, in ten years, the consumer price index will be at least
equal to the consumer price index today. In addition, a contingency may
not be bona fide if the effect on the fund is minimal even though the
outcome is uncertain.
Finally, comments are requested regarding whether there are other
types of funds for which rules under section 468B are required.
7. Proposed Effective Date
In general, the regulations are proposed to be applicable for QSFs,
qualified escrow accounts and qualified trusts, pre-closing escrows,
contingent at-closing escrows, and DOFs established after the date
final regulations are published in the Federal Register. However, the
proposed regulations contain transition rules.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations. Pursuant to section
7805(f) of the Internal Revenue Code, this notice of proposed
rulemaking will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business. An initial regulatory flexibility analysis has been prepared
for the collections of information contained in this notice of proposed
rulemaking under 5 U.S.C. 603. The analysis is set forth below.
Initial Regulatory Flexibility Act Analysis
The objective of the proposed regulations is to ensure that the
income of certain escrow accounts, trusts, and funds is subject to
current taxation by identifying the proper party or parties subject to
tax and by requiring appropriate information reporting for the income
of the escrow account, trust, or fund. Section 468B(g) provides the
legal basis for the requirements of the proposed regulations. The IRS
and Treasury Department are not aware of any federal rules that may
duplicate, overlap, or conflict with the proposed regulations.
An explanation is provided below of the burdens on small entities
resulting from the requirements of the proposed regulations. Also, a
description is provided of alternative rules that were considered by
the IRS and the Treasury Department but rejected as too burdensome.
1. Grantor Trust Election Under Sec. 1.468B-1(k)
Under Sec. 1.468B-1(k), the transferor to a QSF may elect to have
the QSF treated as a grantor trust all of which is treated as owned by
the transferor (grantor trust election). If the transferor makes the
grantor trust election, the administrator of the QSF must file Form
1041 rather than the QSF income tax return, Form 1120-SF.
Approximately 900 QSF returns are filed each year. Only a small
number of these returns are filed for newly created QSFs. Because a
grantor trust election may be made only for the year in which a QSF is
established, and may only be made for a QSF that has one transferor,
the IRS and Treasury Department believe that a very small number of
grantor trust elections will be made each year.
Because of the availability of the grantor trust election, the
proposed regulations provide a choice of filing Form 1041 or Form 1120-
SF in certain situations. Small entities may choose the filing
requirement that is less burdensome.
The alternative to the proposed regulations is to retain the
current rules for QSFs and not provide qualifying taxpayers with the
opportunity to make a grantor trust election.
[[Page 4805]]
2. Qualified Escrow Accounts and Qualified Trusts Established in
Connection With Deferred Exchanges; Pre-closing Escrows; and Contingent
At-Closing Escrows
Sections 1.468B-6(e)(1), 1.468B-7(d), and 1.468B-8(g)(1) require
specified escrow holders, trustees, and administrators to file Forms
1099 with the IRS and furnish payee statements in accordance with the
information reporting requirements of subpart B, Part III, subchapter
A, chapter 61, Subtitle F of the Internal Revenue Code.
Also, Sec. 1.468B-6(f) requires the parties to a qualified escrow
account or qualified trust to provide a statement to the escrow holder
or trustee if the qualified intermediary or transferee has all the
beneficial use and enjoyment of the assets of the escrow account or
trust. This statement facilitates the filing of Forms 1099 by the
escrow holder or trustee.
Similarly, Sec. 1.468B-8(f) requires the parties to a contingent
at-closing escrow to provide statements to the escrow holder or other
administrator. These statements facilitate the filing of Forms 1099 by
the escrow holder or other administrator.
The IRS and Treasury Department estimate that annually there are
approximately 16,000 deferred exchange transactions involving the
creation of a qualified escrow account or qualified trust;
approximately 200,000 transactions involving the creation of a pre-
closing escrow; and approximately 10,000 transactions involving the
creation of a contingent at-closing escrow.
As an alternative to the proposed regulations, the IRS and the
Treasury Department considered, but rejected as too burdensome, a rule
that would have required the filing of grantor trust returns (Form
1041) for qualified escrow accounts and qualified trusts, pre-closing
escrows, and contingent at-closing escrows. Instead of requiring
grantor trust returns, the proposed regulations require the filing of
Forms 1099. This is less burdensome on small entities because, unlike
Form 1041, Form 1099 is simple, does not require a signature, and
requires only the reporting of gross income.
Further, the IRS and the Treasury Department considered an
alternative rule for contingent at-closing escrows under which the
income of the escrow for the period before the determination date would
have been taxable to the purchaser or the seller depending on the
required tax treatment by the purchaser and seller of the principal
amount deposited into the escrow. This alternative rule would not have
provided certainty, would have required a difficult legal analysis
(namely, the determination of the required tax treatment of the
principal amount deposited into the escrow), and would have required
the purchaser and seller to provide a signed statement to the
administrator of the escrow identifying the party to whom the
administrator should report the income for the period before the
determination date. Under the proposed regulations, the income of the
escrow is always taxable to the purchaser for the period before the
determination date, thereby eliminating the need for a signed statement
to be provided to the administrator and the need to determine the
required tax treatment of the principal amount deposited into the
escrow. This rule is simpler than the alternative.
3. Disputed Ownership Funds (DOFs)
Section 1.468B-9(c)(1) of the proposed regulations generally
provides that a DOF is taxable as a QSF if all its assets are passive
investment assets or taxable as a C corporation in all other cases.
However, the regulations also provide that if there is a more
appropriate method of taxing a DOF, the claimants to the fund may
request a private letter ruling to permit the use of that method.
Section 1.468B-9(f)(3) of the proposed regulations requires that a
transferor provide a statement to the administrator of a DOF that
itemizes the cash or property transferred to the DOF during the
calendar year. The statement must also indicate the DOF's basis and
holding period in the property.
The IRS and the Treasury Department estimate that annually there
are approximately 5,000 transactions involving the creation of a
disputed ownership fund.
As an alternative to the proposed regulations, the IRS and the
Treasury Department considered, but rejected as too burdensome, a rule
that would have required all DOFs to file corporate income tax returns
(Form 1120) regardless of the nature of the assets held by the DOF.
This alternative was rejected because it was concluded that a QSF
return (Form 1120-SF) is more appropriate than a corporate income tax
return if all the assets of the DOF are passive investment assets. The
proposed regulations thus impose less of an administrative burden on
small entities than would have resulted from the alternative rule as
Form 1120-SF is generally easier to prepare than Form 1120. Only DOFs
that hold assets other than passive investment assets will be required
to file Form 1120 under the proposed regulations. In addition, the
proposed regulations provide taxpayers with the additional flexibility
of being able to request an alternative method of taxation if that
method is more appropriate than QSF or C corporation treatment as
provided under the general rule.
There are no known alternative rules that are less burdensome to
small entities but that accomplish the purpose of the statute. The IRS
and Treasury Department request comments from small entities concerning
possible alternatives to these rules.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) or electronic comments that are submitted timely
(in the manner described in the ADDRESSES portion of the preamble) to
the IRS. The IRS and Treasury Department request comments on the
clarity of the proposed rules and how they can be made easier to
understand. All comments will be available for public inspection and
copying.
A public hearing is scheduled for May 12, 1999, at 10 a.m. in Room
2615, Internal Revenue Building, 1111 Constitution Avenue NW,
Washington, DC. Due to building security procedures, visitors must
enter at the 10th Street entrance, located between Constitution and
Pennsylvania Avenues, NW. In addition, all visitors must present photo
identification to enter the building. Because of access restrictions,
visitors will not be admitted beyond the immediate entrance area more
than 15 minutes before the hearing starts. For information about having
your name placed on the building access list to attend the hearing, see
the FOR FURTHER INFORMATION CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons who wish to present oral comments at the hearing must
submit written comments by May 3, 1999 and submit an outline of the
topics to be discussed and the time devoted to each topic (signed
original and eight (8) copies) by April 21, 1999.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
[[Page 4806]]
Drafting Information
The principal author of these proposed regulations is Michael L.
Gompertz of the Office of Assistant Chief Counsel (Income Tax and
Accounting). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Sec. 1.468B-6 also issued under 26 U.S.C. 468B.
Sec. 1.468B-7 also issued under 26 U.S.C. 468B.
Sec. 1.468B-8 also issued under 26 U.S.C. 468B.
Sec. 1.468B-9 also issued under 26 U.S.C. 468B. * * *
Par. 2. Section 1.468B-0 is amended as follows:
1. The introductory text is revised.
2. The entry for Sec. 1.468B-1, paragraph (k), is redesignated as
paragraph (l).
3. A new entry for Sec. 1.468B-1, paragraph (k), is added.
4. The section heading in the entry for Sec. 1.468B-5 is revised.
5. New entries are added for Secs. 1.468B-5, paragraph (c), 1.468B-
6, 1.468B-7, 1.468B-8, and 1.468B-9.
6. The revised and added provisions read as follows:
Sec. 1.468B-0 Table of contents.
This section lists the table of contents for Secs. 1.468B-1 through
1.468B-9.
Sec. 1.468B-1 Qualified settlement funds.
* * * * *
(k) Election to treat a qualified settlement fund as a subpart E
trust.
(1) In general.
(2) Manner of making grantor trust election.
(i) In general.
(ii) Requirements for election statement.
(3) Effect of making the election.
* * * * *
Sec. 1.468B-5 Effective dates and transition rules applicable to
qualified settlement funds.
* * * * *
(c) Grantor trust elections under Sec. 1.468B-1(k).
(1) In general.
(2) Qualified settlement funds established by the U.S.
government on or before the date of publication of final regulations
in the Federal Register.
Sec. 1.468B-6 Qualified escrow accounts and qualified trusts used
in deferred exchanges of like-kind property under section
1031(a)(3).
(a) Scope.
(b) Definitions.
(c) Income of qualified escrow account or qualified trust.
(1) In general.
(2) Transferee or qualified intermediary has all the beneficial
use and enjoyment of assets of a qualified escrow account or
qualified trust.
(d) Application of section 7872.
(e) Reporting obligations of the escrow holder or trustee.
(1) In general.
(2) Person treated as payee.
(3) Relief from penalties for filing incorrect information
return or payee statement.
(f) Statement provided to escrow holder or trustee.
(g) Effective date.
(1) In general.
(2) Transition rule.
(h) Examples.
Sec. 1.468B-7 Pre-closing escrows.
(a) Scope.
(b) Definition.
(c) Taxation of pre-closing escrows.
(d) Reporting obligations of the administrator.
(e) Effective date.
(1) In general.
(2) Transition rule.
(f) Example.
Sec. 1.468B-8 Contingent at-closing escrows.
(a) Scope.
(b) Definitions.
(c) Tax liability of purchaser and seller for the period prior
to the determination date.
(d) Transfer of interest in the assets of the escrow on the
determination date.
(e) Tax liability of purchaser and seller for the period
beginning on the determination date.
(f) Statement required to be provided to administrator within 30
days after the determination date.
(g) Reporting obligations of the administrator.
(1) In general.
(2) Person treated as payee.
(3) Relief from penalties for filing incorrect information
return or payee statement.
(h) Effective date.
(1) In general.
(2) Transition rule.
(i) [Reserved]
(j) Example.
Sec. 1.468B-9 Disputed ownership funds.
(a) In general.
(b) Definitions.
(c) Taxation of a disputed ownership fund.
(1) In general.
(2) Exception.
(3) Special rules.
(d) Basis of property held by a disputed ownership fund.
(e) Request for prompt assessment.
(f) Rules applicable to the transferor.
(1) Transfer of property.
(i) In general.
(ii) Exceptions.
(2) Economic performance.
(i) In general.
(ii) Obligations of the transferor.
(3) Statement to the disputed ownership fund and the Internal
Revenue Service.
(i) In general.
(ii) Information required on statement.
(A) In general.
(B) Combined statements.
(4) Distributions to transferors.
(i) In general.
(ii) Exception.
(iii) Deemed distributions.
(g) Distribution to a claimant other than a transferor.
(h) Effective date.
(1) In general.
(2) Transition rule.
(i) [Reserved].
(j) Examples.
Par. 3. Section 1.468B-1 is amended by redesignating paragraph (k)
as paragraph (l) and adding a new paragraph (k) to read as follows:
Sec. 1.468B-1 Qualified settlement funds.
* * * * *
(k) Election to treat a qualified settlement fund as a subpart E
trust--(1) In general. If a qualified settlement fund has only one
transferor (see paragraph (d)(1) of this section for the definition of
transferor), the transferor may make an irrevocable election (grantor
trust election) to treat the qualified settlement fund as a trust all
of which is treated as owned by the transferor under section 671 and
the regulations thereunder. A grantor trust election may be made
whether or not the qualified settlement fund would be classified, in
the absence of paragraph (b) of this section, as a trust all of which
is treated as owned by the transferor under section 671 and the
regulations thereunder.
(2) Manner of making grantor trust election--(i) In general. To
make a grantor trust election, a transferor must attach an election
statement satisfying the requirements of paragraph (k)(2)(ii) of this
section to a timely filed (including extensions) Form 1041 that the
administrator files on behalf of the qualified settlement fund for the
taxable year in which the qualified settlement fund is established.
However, if a Form 1041 would not otherwise be required to be filed
(for example, because the provisions of Sec. 1.671-4(b) are
applicable), then the transferor makes a grantor trust election by
attaching an election statement satisfying the requirements of
paragraph (k)(2)(ii) of this section to a timely filed (including
extensions) income tax return of the transferor for the taxable year in
which the qualified settlement fund is established.
[[Page 4807]]
(ii) Requirements for election statement. The election statement
must include a statement by the transferor that the transferor will
treat the qualified settlement fund as a grantor trust. The election
statement must also include the transferor's name, signature, address,
taxpayer identification number, and the legend, ``Sec. 1.468B-1(k)
Election''. The election statement and the statement described in
Sec. 1.671-4(a) may be combined into a single statement.
(3) Effect of making the election. If a grantor trust election is
made--
(i) Paragraph (b) of this section, and Secs. 1.468B-2, 1.468B-3,
and 1.468B-5 do not apply to the qualified settlement fund. However,
this section (except for paragraph (b) of this section) and
Sec. 1.468B-4 apply to the qualified settlement fund;
(ii) The qualified settlement fund is treated for federal income
tax purposes as a trust all of which is treated as owned by the
transferor under section 671 and the regulations thereunder;
(iii) The transferor must take into account in computing the
transferor's income tax liability all items of income, deduction, and
credit (including capital gains and losses) of the qualified settlement
fund in accordance with Sec. 1.671-3(a)(1); and
(iv) The reporting obligations imposed by Sec. 1.671-4 on the
trustee of a trust apply to the administrator.
* * * * *
Par. 4. Section 1.468B-5 is amended by revising the section heading
and adding paragraph (c) to read as follows:
Sec. 1.468B-5 Effective dates and transition rules applicable to
qualified settlement funds.
* * * * *
(c) Grantor trust elections under Sec. 1.468B-1(k)--(1) In general.
A transferor may make a grantor trust election under Sec. 1.468B-1(k)
only if the qualified settlement fund is established after the date of
publication of final regulations in the Federal Register.
(2) Qualified settlement funds established by the U.S. government
on or before the date of publication of final regulations in the
Federal Register. If the U.S. government, or any agency or
instrumentality thereof, establishes a qualified settlement fund on or
before the date of publication of final regulations in the Federal
Register, and the fund would have been classified as a trust all of
which is treated as owned by the U.S. government under section 671 and
the regulations thereunder without regard to the regulations under
section 468B, then the U.S. government is deemed to have made a grantor
trust election under Sec. 1.468B-1(k), and the election is effective
for all taxable years of the fund.
Par. 5. Sections 1.468B-6 through 1.468B-9 are added to read as
follows:
Sec. 1.468B-6 Qualified escrow accounts and qualified trusts used in
deferred exchanges of like-kind property under section 1031(a)(3).
(a) Scope. This section provides rules under section 468B(g)
relating to the current taxation of income of a qualified escrow
account or qualified trust established in connection with a deferred
exchange under section 1031(a)(3).
(b) Definitions. As used in this section, deferred exchange,
relinquished property, replacement property, qualified escrow account,
qualified trust, qualified intermediary, exchange period, and escrow
holder have the same meanings as in Sec. 1.1031(k)-1. Also, as used in
this section, taxpayer means the transferor of the relinquished
property, and transferee means the person who is treated as owning the
relinquished property for federal income tax purposes after its
transfer by the taxpayer. Further, owner means the person treated as
owning the assets of the qualified escrow account or qualified trust
under paragraph (c) of this section.
(c) Income of qualified escrow account or qualified trust--(1) In
general. Except as otherwise provided in paragraph (c)(2) of this
section, and except for purposes of determining whether a transaction
qualifies as a deferred exchange, the taxpayer is the owner. Thus, the
taxpayer must take into account in computing the taxpayer's income tax
liability all items of income, deduction, and credit (including capital
gains and losses) of the qualified escrow account or qualified trust.
(2) Transferee or qualified intermediary has all the beneficial use
and enjoyment of assets of a qualified escrow account or qualified
trust. If the transferee or the qualified intermediary has all the
beneficial use and enjoyment of assets of a qualified escrow account or
qualified trust, the transferee or qualified intermediary is the owner.
Thus, the transferee or qualified intermediary must take into account
in computing its income tax liability all items of income, deduction,
and credit (including capital gains and losses) of the account or
trust. The following factors, and other relevant facts and
circumstances in a particular case, will be considered in determining
whether the transferee or the qualified intermediary, rather than the
taxpayer, has the beneficial use and enjoyment of assets of an account
or trust and thus is the owner--
(i) Which person enjoys the use of the earnings of the account or
trust;
(ii) Which person receives the benefit from appreciation, if any,
in the value of the assets of the account or trust; and
(iii) Which person is subject to a risk of loss from a decline, if
any, in the value of the assets of the account or trust.
(d) Application of section 7872. If the transferee or the qualified
intermediary is the owner under paragraph (c)(2) of this section,
section 7872 may apply if the deferred exchange involves a below-market
loan from the taxpayer to the owner. See section 7872(c)(1) for the
loans to which section 7872 applies.
(e) Reporting obligations of the escrow holder or trustee-- (1) In
general. The escrow holder of a qualified escrow account and the
trustee of a qualified trust must, for each calendar year (or portion
thereof) that the account or trust is in existence, report the income
of the account or trust on Forms 1099 in accordance with the
information reporting requirements of subpart B, Part III, subchapter
A, chapter 61, Subtitle F of the Internal Revenue Code. The Forms 1099
must show the escrow holder or trustee as the payor and must show the
proper payee. See paragraph (e)(2) of this section for the
determination of the proper payee.
(2) Person treated as payee. In satisfying the reporting
obligations of paragraph (e)(1) of this section, the following rules
apply to the escrow holder of a qualified escrow account and the
trustee of a qualified trust--
(i) If no written statement described in paragraph (f) of this
section is provided to the escrow holder or trustee, the escrow holder
or trustee must treat the taxpayer as the owner and the payee of the
income of the account or trust; and
(ii) If a written statement described in paragraph (f) of this
section is provided to the escrow holder or trustee, the escrow holder
or trustee must treat the person specified on the statement (see
paragraph (f)(3) of this section) as the owner and the payee of the
income of the account or trust.
(3) Relief from penalties for filing incorrect information return
or payee statement. For purposes of sections 6721 and 6722, the escrow
holder of a qualified escrow account or trustee of a qualified trust
will not be treated as failing to file or furnish a correct information
return or payee statement solely because, in preparing a Form 1099, the
escrow holder or trustee relies on a statement described in paragraph
(f) of this section and therefore treats the
[[Page 4808]]
person specified on the statement (see paragraph (f)(3) of this
section) as the owner and the payee of the income of the account or
trust. If a statement described in paragraph (f) of this section is not
provided to the escrow holder or trustee, the escrow holder or trustee
will not be treated as failing to file or furnish a correct information
return or payee statement solely because, in preparing a Form 1099, the
escrow holder or trustee relies on the absence of the statement and
therefore treats the taxpayer as the owner and the payee of the income
of the account or trust.
(f) Statement provided to escrow holder or trustee. If under
paragraph (c)(2) of this section, the qualified intermediary or
transferee is the owner, the taxpayer and the owner must furnish to the
escrow holder or trustee a statement that--
(1) Is signed by the taxpayer and the owner;
(2) Is furnished to the escrow holder or trustee within 30 days
after the taxpayer transfers the relinquished property; and
(3) Specifies the person treated as the owner and thus as the payee
of the income of the account or trust.
(g) Effective date--(1) In general. This section applies to
qualified escrow accounts and qualified trusts established after the
date of publication of final regulations in the Federal Register.
(2) Transition rule. With respect to a qualified escrow account or
qualified trust established after August 16, 1986, but on or before the
date of publication of final regulations in the Federal Register, the
Internal Revenue Service will not challenge a reasonable, consistently
applied method of taxation for income earned by the account or trust.
The Internal Revenue Service will also not challenge a reasonable,
consistently applied method for reporting such income.
(h) Examples. The provisions of this section may be illustrated by
the following examples in which T is the taxpayer, B is the transferee,
and QI is the qualified intermediary:
Example 1. (i) T uses the calendar year as the taxable year and
the cash receipts and disbursements method of accounting. T enters
into a deferred exchange agreement with B. Under the agreement, T
will transfer property (the relinquished property) to B, and B must
transfer to T within the exchange period consideration (cash or
replacement property or both) having the same market value as that
of the relinquished property. B's obligations under the agreement
are secured by the assets of a qualified escrow account. The
deferred exchange does not involve the use of a qualified
intermediary.
(ii) Under the agreement, B must deposit cash into the qualified
escrow account equal to the agreed upon fair market value of the
relinquished property on the date the property is transferred to B.
The agreement provides that the cash deposited into the escrow
account must be invested in a money market fund.
(iii) The agreement provides that B is entitled to receive the
interest earned on the escrow account in consideration for B's
performance of services in connection with the exchange.
(iv) On September 1, 1999, T transfers the relinquished property
to B. The property is unencumbered and has a fair market value of
$100,000 on September 1, 1999. B deposits $100,000 into a qualified
escrow account. The $100,000 is invested in accordance with the
exchange agreement in a money market fund. During 1999, $2,000 of
interest is earned on the escrow account. During January 2000, an
additional $400 of interest is earned on the escrow account. On
February 1, 2000, B uses $100,000 of the funds in the escrow account
to purchase replacement property identified by T, and on this same
date B transfers the replacement property to T. The interest earned
on the escrow account, $2,400, is paid to B from the escrow account
in consideration for B's performance of services.
(v) Paragraph (c)(1) of this section applies and T must take
into account in computing T's income tax liability for 1999 and 2000
the $2400 of interest earned on the escrow account in those years
even though the interest is paid to B as compensation for B's
services. Paragraph (c)(1) of this section applies for the following
reasons. T, rather than B, enjoys the use of the earnings of the
escrow account since the earnings are used to discharge T's
obligation to pay B for B's services. B is not considered to have
all the beneficial use and enjoyment of the assets of the escrow
account merely because the compensation that B is entitled to
receive is based on the earnings of the escrow account.
(vi) The escrow holder must file Forms 1099 for 1999 and 2000
and furnish T with payee statements with respect to the interest
earned on the escrow in 1999 and 2000. See paragraph (e)(1) of this
section.
Example 2. (i) The facts are the same as in Example 1 except
that the agreement between B and T requires B to pay $100,000 to QI;
under the agreement between T and QI, QI is obligated to transfer to
T within the exchange period consideration (cash or replacement
property or both) equal to $100,000 plus interest thereon at 4
percent compounded semiannually; QI's obligation to transfer this
consideration is secured by the $100,000 received from B, which QI
must deposit into a qualified escrow account; the assets of the
escrow account must be invested in a money market fund; and, as
compensation for QI's performance of services to facilitate the
deferred exchange, QI is entitled to receive the excess of the
interest earned on the escrow account over the amount of interest
(computed at 4 percent compounded semiannually) payable to T in cash
or property.
(ii) QI deposits the $100,000 received from B into a qualified
escrow account, and the $100,000 is invested in a money market fund
earning interest at 4.8 percent compounded semiannually. During
1999, $1,600 of interest is earned on the escrow account. During
January 2000, an additional $400 of interest is earned on the escrow
account. On February 1, 2000, QI uses $101,667 of the funds in the
escrow account to purchase replacement property, which is
transferred to T. This transfer satisfies QI's obligations under the
agreement because $1,667 is the amount of interest that is earned on
$100,000 at 4 percent compounded semiannually for 5 months. Of the
$2,000 in interest earned on the escrow account in 1999 and 2000,
$1,667 is used to purchase replacement property, and the remaining
$333 is paid in cash to QI as compensation for QI's services.
(iii) Paragraph (c)(1) of this section applies and T must take
into account in computing T's income tax liability for 1999 and 2000
the $2000 of interest earned on the escrow account in those years
even though $333 of the interest is paid to QI as compensation for
QI's services.
(iv) The escrow holder must file Forms 1099 and furnish T with
payee statements with respect to the $2000 of interest earned on the
escrow in 1999 and 2000. See paragraph (e)(1) of this section.
Sec. 1.468B-7 Pre-closing escrows.
(a) Scope. This section provides rules under section 468B(g) for
the taxation of income earned on pre-closing escrows.
(b) Definition. A pre-closing escrow is an escrow account, trust,
or fund--
(1) Established in connection with the sale or exchange of real or
personal property;
(2) Funded with a down payment, earnest money, or similar payment
that is deposited into the escrow prior to the sale or exchange of the
property;
(3) Used to secure the obligation of the purchaser to pay the
purchase price for the property (in the case of an exchange, purchaser
means the transferee of the property, and purchase price means the
required consideration for the property);
(4) The assets of which, including the income earned thereon, will
be paid to the purchaser or otherwise distributed for the purchaser's
benefit when the property is sold or exchanged (for example, by being
distributed to the seller as a credit against the purchase price); and
(5) Which is not a qualified escrow account or qualified trust
established in connection with a deferred exchange under section
1031(a)(3).
(c) Taxation of pre-closing escrows. The purchaser is treated for
federal income tax purposes as owning the assets of a pre-closing
escrow. Thus, the purchaser must take into account in computing the
purchaser's income tax liability all items of income, deduction, and
credit (including capital gains and losses) of the escrow.
[[Page 4809]]
(d) Reporting obligations of the administrator. For each calendar
year (or portion thereof) that a pre-closing escrow is in existence,
the escrow agent, escrow holder, trustee, or other person responsible
for administering the escrow (the administrator) must report the income
of the escrow on Forms 1099 in accordance with the information
reporting requirements of subpart B, Part III, subchapter A, chapter
61, Subtitle F of the Internal Revenue Code. The Form 1099 must show
the administrator as the payor and the purchaser as the payee.
(e) Effective date--(1) In general. The provisions of this section
apply to pre-closing escrows established after the date of publication
of final regulations in the Federal Register.
(2) Transition rule. With respect to a pre-closing escrow
established after August 16, 1986, but on or before the date of
publication of final regulations in the Federal Register, the Internal
Revenue Service will not challenge a reasonable, consistently applied
method of taxation for income earned by the escrow. The Internal
Revenue Service will also not challenge a reasonable, consistently
applied method for reporting such income.
(f) Example. The provisions of this section may be illustrated by
the following example:
Example. P enters into a contract with S for the purchase of
residential property owned by S for the price of $200,000. P is
required to deposit $10,000 of earnest money into an escrow. At
closing, the $10,000 and the interest earned thereon will be
credited against the purchase price of the property. The escrow is a
pre-closing escrow. P is treated as owning the assets of the escrow,
and P is taxable on the interest earned on the escrow prior to
closing. The escrow holder must report the income earned on the
escrow on Forms 1099 and furnish payee statements to P. The Forms
1099 must show the escrow holder as the payor and P as the payee.
Sec. 1.468B-8 Contingent at-closing escrows.
(a) Scope. This section provides rules under section 468B(g) for
the taxation of income earned on a contingent at-closing escrow, which
is defined in paragraph (b) of this section. No inference should be
drawn from this section concerning the tax treatment of a contingent
at-closing escrow, or of parties to the escrow, under sections of the
Internal Revenue Code other than section 468B. See also paragraph (d)
of this section.
(b) Definitions. For purposes of this section, the following
definitions apply--
Administrator means an escrow agent, escrow holder, trustee, or
other person responsible for administering an escrow account, trust, or
fund (the purchaser or the seller may be the administrator);
Contingent at-closing escrow means an escrow account, trust, or
fund that satisfies the following requirements--
(1) The escrow is established in connection with the sale or
exchange (other than an exchange to which section 354, 355, or 356
applies) of real or personal property used in a trade or business or
held for investment (including stock in a corporation or an interest in
a partnership);
(2) Depending on whether events specified in the agreement between
the purchaser and the seller that are subject to bona fide
contingencies (not including events that are certain, or reasonably
certain, to occur, such as the passage of time, or that are certain, or
reasonably certain, not to occur) either occur or fail to occur, the
escrow's assets (except for assets set aside for taxes or expenses)
will be distributable--
(i) Entirely to the purchaser;
(ii) Entirely to the seller; or
(iii) In part, to the purchaser with the remainder to the seller;
and
(3) The escrow is not a qualified escrow account or qualified trust
established in connection with a deferred exchange under section
1031(a)(3);
Determination date means the date on which (or by which) the last
of the events subject to a bona fide contingency specified in the
agreement between the purchaser and the seller (referred to in the
definition of contingent at-closing escrow) has either occurred or
failed to occur;
Purchaser means, in the case of an exchange of property, the
transferee of the property; and
Seller means, in the case of an exchange of property, the
transferor of the property.
(c) Tax liability of purchaser and seller for the period prior to
the determination date. For the period prior to the determination date,
the purchaser is treated as owning the assets of the contingent at-
closing escrow for federal income tax purposes. Thus, in computing the
purchaser's income tax liability, the purchaser must take into account
all items of income, deduction, and credit (including capital gains and
losses) of the escrow until the determination date.
(d) Transfer of interest in the assets of the escrow on the
determination date. No inference should be drawn from this section
whether, for purposes of Internal Revenue Code sections other than
468B, there is a transfer of ownership of the assets of a contingent
at-closing escrow on the determination date from the purchaser to the
seller or from the seller to the purchaser, or the tax consequences of
such a transfer. Thus, for example, if there is a transfer of ownership
of the assets of the escrow from the purchaser to the seller on the
determination date for purposes of other Code sections, no inference
should be drawn from this section whether any portion of the amount
transferred is unstated interest. See Sec. 1.483-4.
(e) Tax liability of purchaser and seller for the period beginning
on the determination date. For the period beginning on the
determination date, the purchaser and the seller must each take into
account in determining their income tax liabilities the income,
deductions, and credits (including capital gains and losses)
corresponding to their ownership interests in the assets of the escrow.
(f) Statement required to be provided to administrator within 30
days after the determination date. Within 30 days after the
determination date, the purchaser and the seller must provide the
administrator with a written statement that--
(1) Is signed by the purchaser and the seller;
(2) Specifies the determination date; and
(3) Specifies the purchaser's and seller's ownership interests in
each asset of the escrow.
(g) Reporting obligations of the administrator--(1) In general. The
administrator of a contingent at-closing escrow must, for each calendar
year (or portion thereof) that the escrow is in existence, report the
income of the escrow on Forms 1099 in accordance with the information
reporting requirements of subpart B, Part III, subchapter A, chapter
61, Subtitle F of the Internal Revenue Code. The Forms 1099 must show
as payor the administrator of the escrow and as payee the person (or
persons) treated as the payee (or payees) under paragraph (g)(2) of
this section.
(2) Person treated as payee. In satisfying the reporting
obligations of paragraph (g)(1) of this section, the following rules
apply to the administrator--
(i) For the period prior to the determination date, the
administrator must treat the purchaser as the payee of the income of
the escrow;
(ii) For the period beginning on the determination date, if the
written statement described in paragraph (f) of this section is timely
provided to the administrator, the administrator must treat as the
payee (or payees) of the income of the escrow the purchaser or seller
(or both) in accordance with their
[[Page 4810]]
respective ownership interests as shown on the statement; and
(iii) If the written statement described in paragraph (f) of this
section is not provided to the administrator, the administrator must
continue to treat the purchaser as the payee of the income of the
escrow.
(3) Relief from penalties for filing incorrect information return
or payee statement. For purposes of sections 6721 and 6722, the
administrator will not be treated as failing to file or furnish a
correct information return or payee statement solely because, in
preparing a Form 1099, the administrator relies on a statement
described in paragraph (f) of this section and therefore treats the
purchaser or seller (or both) as the payee (or payees) of the income of
the escrow in accordance with their respective ownership interests in
the assets of the escrow as shown on the statement. If a statement
described in paragraph (f) of this section is not provided to the
administrator, the administrator will not be treated as failing to file
or furnish a correct information return or payee statement solely
because, in preparing a Form 1099, the administrator relies on the
absence of the statement and therefore treats the purchaser as the
payee.
(h) Effective date--(1) In general. The provisions of this section
apply to contingent at-closing escrows that are established after the
date of publication of final regulations in the Federal Register.
(2) Transition rule. With respect to a contingent at-closing escrow
established after August 16, 1986, but on or before the date of
publication of final regulations in the Federal Register, the Internal
Revenue Service will not challenge a reasonable, consistently applied
method of taxation for income earned by the escrow. The Internal
Revenue Service will also not challenge a reasonable, consistently
applied method for reporting such income.
(i) [Reserved]
(j) Example. The provisions of this section may be illustrated by
the following example:
Example. (i) P and S are corporations. In 1999, P enters into a
contract with S for the purchase of rental real estate. On October
1, 1999, the date of sale, S transfers the real estate to P, and P
pays S a portion of the purchase price, $9,000,000. P deposits the
remaining portion of the purchase price, $850,000, into an escrow
account as required by the contract. H is the escrow holder.
(ii) The contract provides that the escrow balance as of
November 1, 2000, is payable entirely to P, entirely to S, or
partially to P and partially to S depending on the amount, if any,
by which the average rental income from the real estate during a
specified testing period ending on September 30, 2000, exceeds one
or more specified earnings targets.
(iii) According to the terms of the contract, the income earned
on the escrow must be accumulated and is not currently distributable
to P or S during the period prior to November 1, 2000.
(iv) During the testing period specified in the contract between
P and S, the average rental income earned on the property exceeds
one (but not all) of the specified earnings targets. As a result, on
September 30, 2000, the end of the testing period, P became entitled
to 40% of the escrow assets and S became entitled to 60% of the
escrow assets.
(v) On October 30, 2000, P and S provide H with the written
statement described in paragraph (f) of this section. The written
statement is thus provided within 30 days of September 30, 2000. The
statement indicates that P's ownership interest in each asset of the
escrow is 40 percent and S's ownership interest in each asset is 60
percent.
(vi) The escrow is a contingent at-closing escrow. September 30,
2000, is the determination date because this is the date on which
the testing period ends. As of this date, all contingencies
specified in the contract are resolved.
(vii) P must take into account all of the income, deductions,
and credits (including capital gains and losses) of the escrow in
computing P's income tax liability for the period prior to September
30, 2000. See paragraph (c) of this section.
(viii) For the period beginning on September 30, 2000, P must
take into account in computing P's income tax liability 40 percent
of each item of income, deduction, and credit of the escrow
(including capital gains and losses), and S must take into account
in computing S's income tax liability 60 percent of these items. See
paragraph (e) of this section.
(ix) H is subject to the information reporting requirements of
paragraph (g)(1) of this section. H must file Forms 1099 and furnish
payee statements to reflect the fact that prior to September 30,
2000, P is the payee of all the income of the escrow, and for the
period beginning on September 30, 2000, P is the payee of 40 percent
of the income, and S is the payee of 60 percent of the income.
Sec. 1.468B-9 Disputed ownership funds.
(a) In general. An escrow account, trust, or fund that is not a
qualified settlement fund is a disputed ownership fund if--
(1) It is established to hold money or property subject to
conflicting claims of ownership;
(2) The escrow account, trust, or fund is subject to the continuing
jurisdiction of a court; and
(3) Money or property cannot be paid or distributed from the escrow
account, trust, or fund to, or on behalf of, a claimant or a transferor
without the approval of the court.
(b) Definitions. For purposes of this section--
(1) Administrator means the person designated as such by the court
having jurisdiction over a disputed ownership fund. If no person is
designated, the administrator is the escrow agent, escrow holder,
trustee, receiver, or other person responsible for administering the
fund;
(2) Claimant means a person, including a transferor, who claims
ownership of, or a legal or equitable interest in, money or property
held by a disputed ownership fund;
(3) Court means a court of law or equity of the United States, any
state (including the District of Columbia), territory, possession, or
political subdivision thereof;
(4) Related person means any person who is related to the
transferor within the meaning of section 267(b) or 707(b)(1);
(5) Transferor means, in general, a person that transfers to a
disputed ownership fund money or property that is subject to
conflicting claims of claimants. However, a payor of interest or other
income earned by a disputed ownership fund is not a transferor (unless
the payor is also a claimant). A transferor may also be a claimant.
(c) Taxation of a disputed ownership fund--(1) In general. For
federal income tax purposes, a disputed ownership fund is treated as
the owner of all assets that it holds. A disputed ownership fund is
treated as a C corporation for purposes of subtitle F of the Internal
Revenue Code, and the administrator of the fund must obtain an employer
identification number for the fund, make all required income tax and
information returns, and deposit all payments of tax. Also, except as
otherwise provided in this section, a disputed ownership fund is
taxable as if it were either--
(i) A qualified settlement fund under Sec. 1.468B-2 if all the
assets transferred to the fund by or on behalf of transferors are
passive investment assets, for example, cash or cash equivalents,
stock, and debt obligations; or
(ii) A C corporation in all other cases.
(2) Exception. If there is a more appropriate method of taxing a
disputed ownership fund than as provided in paragraph (c)(1) of this
section, the claimants to the fund may submit a private letter ruling
request proposing an alternative method of taxation.
(3) Special rules. (i) In general, money or property subject to
conflicting claims of claimants (disputed property) that is transferred
to a disputed ownership fund by, or on behalf of, a transferor is
excluded from the gross income of the fund. However, this exclusion
does not
[[Page 4811]]
apply to income earned on assets of the fund such as--
(A) Payments to a disputed ownership fund made in compensation for
late or delayed transfers of money or property;
(B) Dividends on stock of a transferor (or a related person) held
by the fund; and
(C) Interest on debt of a transferor (or a related person) held by
the fund.
(ii) A distribution to a claimant of disputed property by a
disputed ownership fund is not a taxable event to the fund.
(iii) A disputed ownership fund is not allowed a deduction for a
distribution of disputed property to, or on behalf of, a transferor or
a claimant.
(iv) Upon the termination of a disputed ownership fund, if the fund
has an unused net operating loss carryover under section 172, an unused
capital loss carryover under section 1212, or an unused tax credit
carryover, or if the fund has, for its last taxable year, deductions in
excess of gross income, the claimant to whom the fund's net assets are
distributable will succeed to and take into account the fund's unused
net operating loss carryover, unused capital loss carryover, unused tax
credit carryover, or excess of deductions over gross income for the
last taxable year of the fund. If the fund's net assets are
distributable to more than one claimant, the unused net operating loss
carryover, unused capital loss carryover, unused tax credit carryover,
or excess of deductions over gross income for the last taxable year
must be allocated among the claimants in proportion to the value of the
assets distributable to each claimant from the fund.
(v) In the case of a disputed ownership fund taxable as if it were
a C corporation under paragraph (c)(1)(ii) of this section, this
section does not, in general, restrict the fund's use of an otherwise
allowable method of accounting or taxable year.
(vi) Appropriate adjustments must be made by a disputed ownership
fund or transferors to the fund to prevent the fund and the transferors
from taking into account the same item of income, deduction, gain,
loss, or credit more than once or from omitting such items.
(d) Basis of property held by a disputed ownership fund. In
general, the initial basis of property transferred by, or on behalf of,
a transferor to a disputed ownership fund is the fair market value of
the property on the date of transfer to the fund as determined by the
transferor for purposes of the rules in paragraph (f)(1)(i) of this
section. However, if paragraph (f)(1)(ii) of this section applies, the
fund's initial basis in the property is the same as the basis of the
transferor immediately before the transfer to the fund.
(e) Request for prompt assessment. A disputed ownership fund is
eligible to request the prompt assessment of tax under section 6501(d).
For purposes of section 6501(d), a disputed ownership fund is treated
as dissolving on the date the fund no longer has any assets (other than
a reasonable reserve for potential tax liabilities and related
professional fees) and will not receive any more transfers.
(f) Rules applicable to the transferor--(1) Transfer of property--
(i) In general. A transferor must treat a transfer of property to a
disputed ownership fund as a sale or other disposition of that property
for purposes of section 1001(a). In computing the gain or loss, the
amount realized by the transferor is the fair market value of the
property on the date the transfer is made to the disputed ownership
fund.
(ii) Exceptions. A transfer of property to a disputed ownership
fund is not a sale or other disposition of the property for purposes of
section 1001(a) if--
(A) The transferor claims ownership of the transferred property
immediately before and immediately after the transfer to the fund; or
(B) The transferor is an agent, fiduciary, or other person acting
in a similar capacity acting on behalf of a person claiming ownership
of the transferred property immediately before and immediately after
the transfer to the fund.
(2) Economic performance--(i) In general. For purposes of section
461(h), if a transferor has a liability to one or more claimants for
which economic performance would otherwise occur under Sec. 1.461-4(g)
when the transferor makes a payment to the claimant or claimants,
economic performance occurs with respect to the liability to the extent
the transferor makes a transfer to a disputed ownership fund to resolve
or satisfy that liability, but only if the transferor and related
persons are not claimants and have no right to receive payments or
distributions from the fund.
(ii) Obligations of the transferor. With respect to a transferor
described in paragraph (f)(2)(i) of this section, economic performance
does not occur when the transferor transfers to a disputed ownership
fund its debt (or the debt of a related person). Instead, economic
performance occurs as the transferor (or related person) makes
principal payments on the debt. Similarly, economic performance does
not occur when the transferor transfers to a disputed ownership fund
its obligation (or the obligation of a related person) to provide
property in the future or to make a payment described in Sec. 1.461-
4(g). Instead, economic performance occurs with respect to such an
obligation as property or payments are provided or made to the disputed
ownership fund or a claimant.
(3) Statement to the disputed ownership fund and the Internal
Revenue Service--(i) In general. By February 15 of the year following
each calendar year in which a transferor (or other person acting on
behalf of a transferor) makes a transfer to a disputed ownership fund,
the transferor (or other person) must provide a statement to the
administrator of the fund setting forth the information described in
paragraph (f)(3)(ii) of this section. The transferor must attach a copy
of the statement to (and as part of) its timely filed income tax return
(including extensions) for the taxable year of the transferor in which
the transfer is made.
(ii) Information required on statement--(A) In general. The
statement required by paragraph (f)(3)(i) of this section must include
the following information--
(1) A legend, ``Sec. 1.468B-9(f) Statement'', at the top of the
first page;
(2) The transferor's name, address, and taxpayer identification
number;
(3) The disputed ownership fund's name, address, and employer
identification number;
(4) The date of each transfer;
(5) The amount of cash transferred;
(6) A description of property transferred, the disputed ownership
fund's basis in the property as provided in paragraph (d) of this
section, and, if the rules of paragraph (f)(1)(ii) of this section
apply, the fund's holding period on the date of transfer; and
(7) Whether or not the transferor is also a claimant.
(B) Combined statements. If a disputed ownership fund has more than
one transferor, any two or more of the transferors may provide a
combined statement to the administrator that does not identify the
amount of cash or the property transferred by a particular transferor.
If a combined statement is used, however, each transferor must include
with its copy of the statement that is attached to its income tax
return a schedule describing each asset that the transferor transferred
to the disputed ownership fund.
(4) Distributions to transferors--(i) In general. A transferor must
include in gross income any distribution to a transferor (including a
deemed distribution described in paragraph (f)(4)(iii) of this section)
from a disputed
[[Page 4812]]
ownership fund. If property is distributed, the amount includible in
gross income and the basis in that property is generally the fair
market value of the property on the date of distribution.
(ii) Exception. The gross income of a transferor does not include a
distribution to the transferor of property from a disputed ownership
fund if the transferor previously transferred the property to the fund
and paragraph (f)(1)(ii) of this section applied to that transfer.
Also, the transferor's gross income does not include a distribution of
money from the disputed ownership fund equal to the net income earned
on that property while it was held by the fund. Further, the
transferor's basis in the property is the same as the disputed
ownership fund's basis in the property immediately before the
distribution to the transferor.
(iii) Deemed distributions. If a disputed ownership fund makes a
distribution on behalf of a transferor to a person that is not a
claimant, the distribution is deemed made by the fund to the
transferor. The transferor, in turn, is deemed to have made a payment
to the actual recipient.
(g) Distribution to a claimant other than a transferor. Whether a
claimant other than a transferor must include in gross income a
distribution of money or property from a disputed ownership fund is
generally determined by reference to the claim in respect of which the
distribution is made. If a disputed ownership fund distributes property
to a claimant other than a transferor in satisfaction of the claimant's
claim of ownership to that property, the claimant's basis in the
property must be adjusted to reflect the adjustments to the basis of
the property required under section 1016 for the period the property
was held by the fund.
(h) Effective date--(1) In general. This section applies to
disputed ownership funds established after the date of publication of
final regulations in the Federal Register.
(2) Transition rule. With respect to a disputed ownership fund
established after August 16, 1986, but on or before the date of
publication of final regulations in the Federal Register, the Internal
Revenue Service will not challenge a reasonable, consistently applied
method of taxation for income earned by the fund, transfers to the
fund, and distributions made by the fund.
(i) [Reserved].
(j) Examples. The following examples illustrate the rules of this
section:
Example 1. (i) Prior to A's death, A was the insured under a
life insurance contract (policy) issued by X, an insurance company.
A's current spouse and A's former spouse each claim to be the
beneficiary under the policy and thus entitled to the policy
proceeds ($1 million). In 1999, X files an interpleader action and
deposits the policy proceeds into the registry of the court. On June
1, 2000, a final determination is made that A's current spouse is
the beneficiary under the policy and thus entitled to the funds held
in the registry of the court. These funds are distributed to A's
current spouse.
(ii) The funds held in the registry of the court consisting of
the policy proceeds and the earnings thereon are a disputed
ownership fund taxable as if it were a qualified settlement fund.
See paragraph (c)(1)(i) of this section. The fund's gross income
does not include the $1 million transferred to the fund by X.
Example 2. (i) Two unrelated individuals, A and B, claim
ownership of certain rental property. A claims to have purchased the
property from B's father. However, B asserts that the purported sale
to A was ineffective and that B acquired ownership of the property
through intestate succession upon the death of B's father. For
several years, A has maintained the property and received the rent
from the property.
(ii) Pending the resolution of the title dispute between A and
B, the title to the property is transferred into a court-supervised
escrow on February 1, 2000. Also, on that date the court appoints R
as receiver for the property. R collects the rent earned on the
property and hires employees necessary for the maintenance of the
property. The rents paid to R cannot be distributed to A or B
without the court's approval.
(iii) On June 1, 2001, the court makes a final determination
that the rental property is owned by B. The court orders B to refund
to A the purchase price paid by A to B's father plus interest on
that amount from February 1, 2000. Also, the court orders that a
distribution be made to B of all funds held in the court registry
consisting of the rent collected by R and the income earned thereon.
In addition, title to the property is returned to B.
(iv) The rental property and the funds held by the court
registry are held in a disputed ownership fund.
(v) A is the transferor to the fund. A does not realize gain or
loss under section 1001(a) on A's transfer of the property to the
disputed ownership fund.
(vi) The fund is taxable as if it were a C corporation because
the rental property is not a passive investment asset. See paragraph
(c)(1)(ii) of this section. The fund is not taxable upon receipt of
the property. The fund's initial basis in the property is the same
as A's adjusted basis immediately before the transfer to the fund.
The fund's gross income includes the rents paid to R and the income
earned thereon. For the period between February 1, 2000, and June 1,
2001, the fund may be allowed deductions for depreciation and for
the costs of maintenance of the property because the fund is treated
as owning the property during this period. See sections 162, 167,
and 168.
(vii) The fund is not allowed a deduction for the distribution
to B of the rent earned on the property while held by the fund (or
the income earned thereon). No tax consequences to the fund result
from this distribution or from the fund's transfer of the rental
property to B pursuant to the court's determination that B owns the
property.
Par. 6. Section 1.1031(k)-1 is amended by adding a sentence at the
end of paragraphs (g)(3)(i) and (h)(2) to read as follows:
Sec. 1.1031(k)-1 Treatment of deferred exchanges.
* * * * *
(g) * * *
(3) * * * (i) * * * For rules under section 468B(g) relating to the
current taxation of income of a qualified escrow account or qualified
trust, see Sec. 1.468B-6.
* * * * *
(h) * * *
(2) * * * For rules under section 468B(g) relating to the current
taxation of income of a qualified escrow account or qualified trust,
see Sec. 1.468B-6.
* * * * *
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-1515 Filed 1-29-99; 8:45 am]
BILLING CODE 4830-01-U