Bulletin No. 2012-28July 9, 2012

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 2012–19, page 16.Dividends and dividend equivalents on restricted stockand restricted stock units. This ruling addresses whetherdividends and dividend equivalents relating to restricted stockand restricted stock units that are performance-based com-pensation under section 162(m)(4)(C) of the Code must sepa-rately satisfy the requirements under section 162(m)(4)(C) tobe treated as performance-based compensation.

T.D. 9591, page 32.Final regulations under section 7874 of the Code provide rulesfor determining whether a foreign corporation is a surrogateforeign corporation. Specifically, the regulation explains whenthere is an indirect acquisition of a domestic corporation’s prop-erties for purposes of section 7874(a)(2)(B). In addition, theregulation includes a rule that in certain situations, a publiclytraded partnership may be treated as a surrogate foreign cor-poration. The regulation also provides rules for the treatmentof options of the surrogate foreign corporation for purposes ofsection 7874(a)(2)(B)(ii).

T.D. 9592, page 41.REG–107889–12, page 53.Temporary and proposed regulations under section 7874 ofthe Code provide guidance regarding whether a foreign corpo-ration has substantial business activities in the foreign countryin which, or under the law of which, the foreign corporation iscreated or organized.

Notice 2012–44, page 45.This notice provides guidance regarding certain qualified con-servation purposes eligible for financing with qualified energyconservation bonds under section 54D of the Code, particu-

larly (1) how to measure reductions of energy consumption inpublicly-owned buildings by at least 20 percent, and (2) whatconstitutes a “green community program.”

Rev. Proc. 2012–29, page 49.This procedure provides sample language that may be used(but is not required to be used) for making an election undersection 83(b) of the Code. Additionally, the procedure providesexamples of the income tax consequences of making such anelection.

EMPLOYEE PLANS

Rev. Rul. 2012–19, page 16.Dividends and dividend equivalents on restricted stockand restricted stock units. This ruling addresses whetherdividends and dividend equivalents relating to restricted stockand restricted stock units that are performance-based com-pensation under section 162(m)(4)(C) of the Code must sepa-rately satisfy the requirements under section 162(m)(4)(C) tobe treated as performance-based compensation.

Rev. Proc. 2012–29, page 49.This procedure provides sample language that may be used(but is not required to be used) for making an election undersection 83(b) of the Code. Additionally, the procedure providesexamples of the income tax consequences of making such anelection.

(Continued on the next page)

Finding Lists begin on page ii.

ESTATE TAX

T.D. 9593, page 17.REG–141832–11, page 54.Temporary and proposed regulations under section 2010 ofthe Code provide rules for determining the applicable creditamount and applicable exclusion amount allowed to the estateof a decedent against the gift or estate tax. In addition, theregulations provide rules for electing portability of a deceasedspousal unused exclusion amount to the surviving spouse andrules regarding the surviving spouse’s use of this amount. Theportability rules apply to married spouses where the death ofthe first spouse to die occurs on or after January 1, 2011.

GIFT TAX

T.D. 9593, page 17.REG–141832–11, page 54.Temporary and proposed regulations under section 2010 ofthe Code provide rules for determining the applicable creditamount and applicable exclusion amount allowed to the estateof a decedent against the gift or estate tax. In addition, theregulations provide rules for electing portability of a deceasedspousal unused exclusion amount to the surviving spouse andrules regarding the surviving spouse’s use of this amount. Theportability rules apply to married spouses where the death ofthe first spouse to die occurs on or after January 1, 2011.

July 9, 2012 2012–28 I.R.B.

The IRS MissionProvide America’s taxpayers top-quality service by helpingthem understand and meet their tax responsibilities and en-

force the law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly and may be obtained from theSuperintendent of Documents on a subscription basis. Bulletincontents are compiled semiannually into Cumulative Bulletins,which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke, mod-ify, or amend any of those previously published in the Bulletin.All published rulings apply retroactively unless otherwise indi-cated. Procedures relating solely to matters of internal man-agement are not published; however, statements of internalpractices and procedures that affect the rights and duties oftaxpayers are published.

Revenue rulings represent the conclusions of the Service on theapplication of the law to the pivotal facts stated in the revenueruling. In those based on positions taken in rulings to taxpayersor technical advice to Service field offices, identifying detailsand information of a confidential nature are deleted to preventunwarranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not berelied on, used, or cited as precedents by Service personnel inthe disposition of other cases. In applying published rulings andprocedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be considered,and Service personnel and others concerned are cautionedagainst reaching the same conclusions in other cases unlessthe facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based on provisions ofthe Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart A,Tax Conventions and Other Related Items, and Subpart B, Leg-islation and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references to thesesubjects are contained in the other Parts and Subparts. Alsoincluded in this part are Bank Secrecy Act Administrative Rul-ings. Bank Secrecy Act Administrative Rulings are issued bythe Department of the Treasury’s Office of the Assistant Secre-tary (Enforcement).

Part IV.—Items of General Interest.This part includes notices of proposed rulemakings, disbar-ment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative indexfor the matters published during the preceding months. Thesemonthly indexes are cumulated on a semiannual basis, and arepublished in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

2012–28 I.R.B. July 9, 2012

July 9, 2012 2012–28 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 83.—PropertyTransferred in ConnectionWith Performance ofServices

The revenue procedures contains sample languagethat may be used (but is not required to be used) formaking an election under section 83(b) of the InternalRevenue Code. Additionally, the revenue procedureprovides examples of the income tax consequencesof making such an election. See Rev. Proc. 2012-29,page 49.

Section 162.—Dividendsand Dividend Equivalentson Restricted Stock andRestricted Stock Units26 CFR 1.162–27: Certain employee remunerationin excess of $1,000,000.

Dividends and dividend equivalentson restricted stock and restricted stockunits. This ruling addresses whether divi-dends and dividend equivalents relating torestricted stock and restricted stock unitsthat are performance-based compensationunder section 162(m)(4)(C) of the Codemust separately satisfy the requirementsunder section 162(m)(4)(C) to be treated asperformance-based compensation.

Rev. Rul. 2012–19

ISSUE

Whether dividends and dividend equiv-alents relating to restricted stock andrestricted stock units (RSUs) that areperformance-based compensation under§ 162(m)(4)(C) of the Internal RevenueCode must separately satisfy the require-ments under § 162(m)(4)(C) to be treatedas performance-based compensation.

FACTS

Corporation X and Corporation Yare publicly held corporations withinthe meaning of § 162(m)(2). Both cor-porations maintain plans under whichparticipating employees may be grantedrestricted common stock of the respec-tive corporation or RSUs based upon thecommon stock of the respective corpo-ration. The restricted stock and RSUs

granted under the plans of CorporationsX and Y vest upon the attainment of cer-tain preestablished, objective performancegoals and otherwise meet the require-ments of § 1.162–27(e). Accordingly, thecompensation received due to the vest-ing of the restricted stock and the vestingand payment of the RSUs is qualifiedperformance-based compensation that isexcluded from the applicable employeeremuneration to which the deduction limi-tation under § 162(m) applies.

Situation 1. Corporation X’s plan pro-vides that dividends and dividend equiv-alents otherwise payable to an employeeduring the period from grant through vest-ing with respect to performance-basedrestricted stock and RSU awards grantedto the employee are accumulated andbecome vested and payable only if therelated performance goals with respect tothe restricted stock and RSUs are satisfied.All other requirements of § 1.162–27(e)are met with respect to the grant of rightsto dividends and dividend equivalents.

Situation 2. Corporation Y’s planprovides for payment to an employee dur-ing the period from grant to vesting ofdividends and dividend equivalents withrespect to performance-based restrictedstock and RSU awards granted to the em-ployee at the same time dividends are paidon common stock of Corporation Y re-gardless of whether the performance goalsestablished with respect to the restrictedstock and RSUs are satisfied.

LAW

Section 162(a)(1) allows as a deductionall the ordinary and necessary expensespaid or incurred during the taxable year incarrying on any trade or business, includ-ing a reasonable allowance for salaries orother compensation for personal servicesactually rendered.

Section 162(m)(1) provides that in thecase of any publicly held corporation, nodeduction is allowed for applicable em-ployee remuneration with respect to anycovered employee to the extent that theamount of the remuneration for the taxableyear exceeds $1,000,000.

Section 162(m)(3) provides that theterm “covered employee” means any em-ployee of the taxpayer if (i) as of the closeof the taxable year, such employee is thechief executive officer of the taxpayer oris an individual acting in such a capac-ity, or (ii) the total compensation of suchemployee for the taxable year is requiredto be reported to shareholders under theSecurities Exchange Act of 1934 (Ex-change Act) by reason of such employeebeing among the four highest compensatedofficers for the taxable year (other thanthe chief executive officer). See Notice2007–49, 2007–1 C.B. 1429 (providingchanges to the application of this provi-sion based on changes in the ExchangeAct compensation disclosure rules).

Section 162(m)(4)(A) defines “applica-ble employee remuneration,” with respectto any covered employee for any taxableyear, generally as the aggregate amount al-lowable as a deduction for the taxable year(determined without regard to § 162(m))for remuneration for services performedby the employee (whether or not during thetaxable year).

Section 162(m)(4)(C) provides that ap-plicable employee remuneration does notinclude any remuneration payable solelyon account of the attainment of one ormore performance goals, but only if (i)the performance goals are determined bya compensation committee of the board ofdirectors of the taxpayer which is com-prised solely of two or more outside direc-tors, (ii) the material terms under which theremuneration is to be paid, including theperformance goals, are disclosed to share-holders and approved by a majority of thevote in a separate shareholder vote beforepayment of such remuneration, and (iii)before any payment of such remuneration,the compensation committee certifies thatthe performance goals and other materialterms were in fact satisfied. Rules with re-spect to these requirements are set forth in§§ 1.162–27(e)(2) through (e)(5).

Section 1.162–27(e)(2)(i) provides thatqualified performance-based compensa-tion must be paid solely on account ofthe attainment of one or more preestab-lished, objective performance goals. Sec-tion 1.162–27–(e)(2)(ii) provides that a

2012–28 I.R.B. 16 July 9, 2012

preestablished performance goal muststate, in terms of an objective formula orstandard, the method for computing theamount of compensation payable to theemployee if the goal is attained.

Section 1.162–27(e)(2)(iv) providesthat the determination of whether com-pensation satisfies the requirementsof § 1.162–27(e)(2) generally is madeon a grant-by-grant basis. Section1.162–27(e)(2)(iv) further provides that,except as provided in § 1.162–27(e)(2)(vi)(relating to stock options and stock ap-preciation rights), whether a grant ofrestricted stock or other stock-based com-pensation satisfies the performance goalrequirements is determined without regardto whether dividends, dividend equiva-lents, or other similar distributions withrespect to stock, on such stock-basedcompensation are payable prior to theattainment of the performance goal. Div-idends, dividend equivalents, or othersimilar distributions with respect to stockthat are treated as separate grants un-der § 1.162–27(e)(2)(iv) are not perfor-mance-based compensation unless theyseparately satisfy the performance goalrequirements. Such performance goalsmay or may not be the same as the per-formance goals for the related stock-basedcompensation.

ANALYSIS

Under § 1.162–27(e)(2)(iv), the divi-dends and dividend equivalents under Cor-poration X’s plan and under CorporationY’s plan are grants of compensation thatare separate and apart from the related re-stricted stock and RSU grants. Therefore,the grants of the dividends and dividendequivalents must separately satisfy the re-quirements of § 1.162–27(e) to be quali-fied performance-based compensation.

Situation 1. Under Corporation X’splan, participants’ rights to restrictedstock and RSUs are subject to perfor-mance goals that meet the requirementsof § 1.162–27(e) and are excluded fromapplicable remuneration for purposes ofapplying the § 162(m)(1) deduction limi-tation. Under the same plan, participants’rights to dividends and dividend equiv-alents vest and become payable only if

the same performance goals that applyto the related grants of restricted stockand RSUs are satisfied. Therefore, divi-dends and dividend equivalents under X’splan are also excluded from applicableremuneration for purposes of applying the§ 162(m)(1) deduction limitation.

Situation 2. The dividends and div-idend equivalents under Corporation Y’splan fail to satisfy the requirements un-der § 162(m)(4)(C) and § 1.162–27(e) be-cause the rights to these amounts do notvest and become payable solely on accountof the attainment of preestablished perfor-mance goals. Thus, these amounts arenot qualified performance-based compen-sation, regardless of whether the perfor-mance goals are met with respect to the re-lated restricted stock and RSUs.

HOLDINGS

Situation 1. With respect to Corpora-tion X, dividends and dividend equivalentspaid under X’s plan are qualified-perfor-mance based compensation and thereforeare excluded from applicable employee re-muneration for purposes of applying the$1,000,000 limitation on deductibility un-der § 162(m)(1).

Situation 2. With respect to Corpora-tion Y, dividends and dividend equivalentspaid under Y’s plan are not qualified-per-formance based compensation and there-fore are included in applicable employeeremuneration for purposes of applying the$1,000,000 limitation on deductibility un-der § 162(m)(1).

DRAFTING INFORMATION

This revenue ruling was prepared byDara Alderman of the Office of the Di-vision Counsel/Associate Chief Counsel(Tax Exempt & Government Entities). Forfurther information regarding this revenueruling, contact Ms. Alderman at (202)622–6030 (not a toll-free call).

Section 2010.—UnifiedCredit Against Estate Tax26 CFR 20.2001–2T: Valuation of adjusted tax-able gifts for purposes of determining the deceasedspousal unused exclusion amount of last deceasedspouse (temporary).

T.D. 9593

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Parts 20, 25, and 602

Portability of a DeceasedSpousal Unused ExclusionAmount

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains tem-porary regulations that provide guidanceon the estate and gift tax applicable ex-clusion amount, in general, as well as onthe applicable requirements for electingportability of a deceased spousal unusedexclusion (DSUE) amount to the surviv-ing spouse and on the applicable rules forthe surviving spouse’s use of this DSUEamount. The statutory provisions under-lying the portability rules were enacted aspart of the Tax Relief, Unemployment In-surance Reauthorization, and Job CreationAct of 2010. The portability rules affectmarried spouses where the death of thefirst spouse to die occurs on or after Jan-uary 1, 2011. The text of the temporaryregulations also serves as the text of pro-posed regulations (REG–141832–11) setforth in the notice of proposed rulemakingon this subject appearing elsewhere in thisissue of the Bulletin.

DATES: Effective Date: These regulationsare effective on June 15, 2012.

Applicability Dates: Sections ofthe temporary regulation relating toportability of a deceased spousal unusedexclusion amount apply to estates ofdecedents dying on or after January 1,2011. For specific dates of applicability,see §§20.2001–2T(b), 20.2010–1T(e),20.2010–2T(e), 20.2010–3T(f),25.2505–1T(e), and 25.2505–2T(g).

FOR FURTHER INFORMATIONCONTACT: Karlene Lesho (202)622–3090 (not a toll-free number).

July 9, 2012 17 2012–28 I.R.B.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information containedin these regulations has been reviewed and,pending receipt and evaluation of publiccomments, approved by the Office of Man-agement and Budget under control num-ber 1545–0015. Responses to this collec-tion of information are voluntary to obtainthe benefit of being able to elect portabil-ity or to take advantage of the special re-porting requirements applicable to certainassets, and, for certain estates, to opt out ofa deemed portability election.

An agency may not conduct or sponsor,and a person is not required to respond to, acollection of information unless the collec-tion of information displays a valid controlnumber. For further information concern-ing this collection of information, and theaddress for the submission of comments onthe collection of information and the accu-racy of the estimated burden, and sugges-tions for reducing this burden, please re-fer to the preamble of the cross-referencingnotice of proposed rulemaking publishedin this issue of the Bulletin.

Books and records relating to a collec-tion of information must be retained aslong as their contents may become mate-rial in the administration of any internalrevenue law. Generally, tax returns and taxreturn information are confidential, as re-quired by 26 U.S.C. 6103.

Background

On December 17, 2010, in section303 of the Tax Relief, UnemploymentInsurance Reauthorization, and Job Cre-ation Act of 2010, Public Law 111–312(124 Stat. 3296, 3302) (TRUIRJCA),Congress amended section 2010(c) of theInternal Revenue Code (Code) to allowportability of the applicable exclusionamount between spouses, and it madeconforming amendments to sections2505(a), 2631(c), and 6018(a)(1) of theCode. Section 303 of TRUIRJCA directsthe Secretary to issue such regulations asmay be necessary or appropriate to carryout section 303(a) of TRUIRJCA.

This document contains amendmentsto the Estate Tax Regulations (26 CFRpart 20) under sections 2001 and 2010of the Code and to the Gift Tax Regula-tions (26 CFR part 25) under section 2505

of the Code. The temporary regulationsaddress not only the amendments madeto section 2010(c) by TRUIRJCA andthe conforming amendment to section2505(a), but also the entirety of sections2010 and 2505 of the Code for which thereare no existing regulations. Finally, theamendment to the Estate Tax Regulationsunder section 2001 of the Code clarifiesthe application of the rule in section2010(c)(5)(B) to section 2001 of the Code.

Section 303(a) of TRUIRJCA

Section 303(a) of TRUIRJCA amendssection 2010(c) of the Code by strik-ing paragraph (2) of section 2010(c) andadding new paragraphs (2) through (6) ofsection 2010(c). Section 2010(c)(2) nowdefines the applicable exclusion amount,used to determine the applicable creditamount, as the sum of the basic exclu-sion amount and, in the case of a surviv-ing spouse, the DSUE amount. Section2010(c)(3) provides that the basic exclu-sion amount is $5,000,000, to be adjustedfor inflation in each year after calendaryear 2011. Section 2010(c)(4) defines theDSUE amount to mean the lesser of (A)the basic exclusion amount or (B) the ba-sic exclusion amount of the last deceasedspouse of the surviving spouse, less theamount with respect to which the tentativetax is determined under section 2001(b)(1)on the estate of such deceased spouse.

Section 2010(c)(5) describes specialrules relating to the portability of a DSUEamount. Section 2010(c)(5)(A) providescertain requirements that must be metto allow a surviving spouse to take intoaccount a DSUE amount of a deceasedspouse. In particular, the executor of theestate of the deceased spouse must filean estate tax return, compute the DSUEamount on such return, elect portabilityof the DSUE amount on such return, andensure that such return is filed within thetime prescribed by law (including ex-tensions) for filing such return. Section2010(c)(5)(B) allows the Secretary to ex-amine a return of the deceased spouse todetermine the DSUE amount, even afterthe expiration of the time provided undersection 6501 for assessing a tax underchapter 11 or 12.

Section 2010(c)(6) directs the Secretaryto prescribe regulations as may be nec-

essary or appropriate to carry out section2010(c).

Notice 2011–82

On October 17, 2011, the Departmentof the Treasury (Treasury) and the IRSissued Notice 2011–82, 2011–42 I.R.B.516, which can be found on www.IRS.gov.Notice 2011–82 alerts taxpayers to therequirements for the estate of a deceasedspouse to elect portability of a DSUEamount. In addition, Notice 2011–82announces that the estate of a deceasedspouse will be deemed to elect portabilityof the DSUE amount by timely filing acomplete and properly-prepared estate taxreturn, and that such return will be deemedto include a computation of the DSUEamount until such time as the IRS revisesthe estate tax return to expressly containthe DSUE amount computation. Notice2011–82 also provides guidance to theestates of deceased spouses who choosenot to make the portability election. No-tice 2011–82 announces that Treasuryand the IRS intend to issue regulationsto implement section 303 of TRUIRJCA.Accordingly, Treasury and the IRS invitedcomments on a number of specific issues.Treasury and the IRS received commentson these issues, as well as additional issuesidentified by commenters. The commentsare discussed in more detail in the “Ex-planation of Provisions” section of thispreamble.

Notice 2012–21

On March 3, 2012, Treasury and theIRS issued Notice 2012–21, 2012–10I.R.B. 450, which can be found onwww.IRS.gov. Notice 2012–21 grants toqualifying estates a six-month extension oftime for filing an estate tax return to electportability of an unused exclusion amountprovided that the qualifying estate filesForm 4768, “Application for Extension ofTime to File a Return and/or Pay U.S. Es-tate (and Generation-Skipping Transfer)Taxes,” within 15 months of the decedent’sdeath. A qualifying estate is the estate ofa person who died, survived by a spouse,during the first half of calendar year 2011,and whose gross estate has a fair marketvalue that does not exceed $5 million.With the extension granted by this notice,the estate tax return must be filed within15 months of the decedent’s death.

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Explanation of Provisions

1. Rules in Section 2010(a), (b), and (d)of the Code

The temporary regulations in§20.2010–1T(a) state the general rule ofsection 2010(a) that an applicable creditamount will be allowed to the estate ofevery decedent against the estate tax im-posed by section 2001. The temporaryregulations in §20.2010–1T(b) incorpo-rate the rule in section 2010(b) relatingto an adjustment to the applicable creditamount for certain gifts made before 1977.Finally, as provided in section 2010(d), thetemporary regulations in §20.2010–1T(c)limit the amount of the allowable credit sothat it does not exceed the amount of theestate tax imposed by section 2001.

2. Explanation of Applicable Terms

The temporary regulations in§20.2010–1T(d) define terms relevant tocomputing the credit amount allowableunder section 2010. The relevant termsinclude applicable credit amount, appli-cable exclusion amount, basic exclusionamount, DSUE amount, and last deceasedspouse.

3. Making the Portability Election

a. Election Required on Estate Tax Return

The temporary regulations in§20.2010–2T(a) require an executor elect-ing portability to make that election ona timely-filed estate tax return. The lastreturn filed by the due date of the return,including extensions actually granted,will supersede any previously-filed re-turn. Thus, an executor may supersedea previously-filed portability electionon a subsequent timely-filed estate taxreturn if the executor satisfies the require-ment in §20.2010–2T(a)(3)(i). But see§20.2010–2T(a)(6) when contrary elec-tions are made by more than one personpermitted to make the election. The tem-porary regulations in §20.2010–2T(a)(4)provide that a portability election is irrev-ocable once the due date (as extended) ofthe return has passed.

b. Timely Filing Required

For a valid portability election, sec-tion 2010(c)(5) requires the executor to

make the election on an estate tax returnfiled within the “time prescribed by law”(including extensions) for filing that re-turn. Section 6075(a) requires the filingof an estate tax return made under section6018(a) within 9 months of the date of thedecedent’s death. Section 6018(a) requiresan estate tax return to be filed when thegross estate of a citizen or resident exceedsthe excess (if any) of the basic exclusionamount in effect under section 2010(c) inthe calendar year of the decedent’s deathover the sum of the decedent’s adjustedtaxable gifts as defined in section 2001(b)and the amount allowed to the decedent asa specific exemption under section 2521as in effect prior to its repeal by the TaxReform Act of 1976.

A commenter on Notice 2011–82 notedthat neither section 2010(c)(5)(A) nor anyother section of the Code provides a “timeprescribed by law” for filing an estate taxreturn on behalf of a decedent’s estatewhen the basic exclusion amount exceedsthe value of the decedent’s gross estate.Accordingly, the commenter requestedthat the regulations clarify the meaning of“time prescribed by law” as it applies insection 2010(c)(5)(A).

For executors who are required to filean estate tax return under section 6018(a),section 6075(a) requires the executor tofile the estate tax return within nine monthsafter the decedent’s date of death. Whenan executor is not required to file an estatetax return under section 6018(a), the Codedoes not specify a due date for a returnfiled for the purpose of making the porta-bility election. The temporary regulationsin §20.2010–2T(a)(1) require every estateelecting portability of a decedent’s DSUEamount to file an estate tax return within 9months of the decedent’s date of death, un-less an extension of time for filing has beengranted. (See Notice 2012–21 providingfor an extension of time to file an estate taxreturn for the estates of certain decedentswho died in the first half of calendar year2011.) This timing requirement for filing areturn applies to all estates electing porta-bility regardless of the size of the gross es-tate. The temporary regulations provide in§20.2010–2T(a)(1) that an estate choosingto elect portability will be considered forpurposes of Subtitle B and Subtitle F of theCode to be required to file a return undersection 6018(a).

This rule will benefit the IRS as wellas taxpayers choosing the benefit of porta-bility because the records required tocompute and verify the DSUE amount aremore likely to be available at the time ofthe death of the first deceased spouse thanat the time of a subsequent transfer bythe surviving spouse by gift or at death,which could occur many years later. Thisrule also is consistent with the “TechnicalExplanation of the Revenue ProvisionsContained in the ’Tax Relief, Unemploy-ment Insurance Reauthorization, and JobCreation Act of 2010’ Scheduled for Con-sideration by the United States Senate,”J. Comm. On Taxation, 111th Cong.,JCX–55–10 (Dec. 10, 2010) (TechnicalExplanation), which suggests that estatesdeciding to elect portability that are nototherwise required to file an estate taxreturn under section 6018(a) are intendedto be subject to the same timely-filing re-quirements applicable to estates requiredto file an estate tax return under section6018(a). The Technical Explanation statesthat the DSUE amount is available to asurviving spouse “only if an election ismade on a timely filed estate tax return(including extensions) of the predeceasedspouse . . . regardless of whether thepredeceased spouse otherwise is requiredto file an estate tax return.” JCX–55–10,page 52; see also “General Explanationof Tax Legislation Enacted in the 111th

Congress,” J. Comm. On Taxation, 111th

Cong., JCS–2–11, pages 554–555 (March2011) (General Explanation) (incorporat-ing the same language from the TechnicalExplanation).

c. Portability Election upon Filing of“Complete and Properly-Prepared”Estate Tax Return

Notice 2011–82 provides that the estateof a decedent dying after December 31,2010, will be deemed to make the porta-bility election upon the timely filing of a“complete and properly-prepared” estatetax return. The temporary regulations in§20.2010–2T(a)(2) provide that the estateof a decedent (survived by a spouse) makesthe portability election by timely filing acomplete and properly-prepared estate taxreturn for the decedent’s estate.

Several commenters responding to No-tice 2011–82 requested that Treasury andthe IRS define what is meant by a “com-

July 9, 2012 19 2012–28 I.R.B.

plete and properly-prepared” estate tax re-turn. Commenters further requested thatTreasury and the IRS consider the cost andburden associated with filing an estate taxreturn and establishing and substantiatingthe values reported on such return for thoseestates that are not required to file a returnunder section 6018(a) but are filing sucha return solely to elect portability of thedecedent’s DSUE amount.

The temporary regulations in§20.2010–2T(a)(7)(i) provide that an es-tate tax return prepared in accordance withall applicable requirements is considereda “complete and properly-prepared” estatetax return. The temporary regulations in§20.2010–2T(a)(7)(ii), however, providethat executors of estates that are not oth-erwise required to file an estate tax returnunder section 6018(a) do not have to reportthe value of certain property that qualifiesfor the marital or charitable deduction. Ifan executor chooses to make use of thisspecial rule in filing an estate tax return,the executor must estimate the total valueof the gross estate (including the valuesof the property that do not have to bereported on the estate tax return underthis provision), based on a determinationmade in good faith and with due diligenceregarding the value of all of the assetsincludible in the gross estate. The instruc-tions issued with respect to the estate taxreturn (“Instructions for Form 706”) willprovide ranges of dollar values, and theexecutor must identify on the estate taxreturn the particular range within whichfalls the executor’s best estimate of the to-tal gross estate. An amount correspondingto this range will be included on line 1,part 2, of the estate tax return, along withan indication of whether the line 1 totalincludes an estimate under this specialrule. By signing the return, the executoris certifying, under penalties of perjury,that the estimate falls within the identifiedrange of values to the best of the execu-tor’s knowledge and belief. The inquiryrequired to determine the executor’s bestestimate is the same an executor of anyestate must make under current law todetermine whether the estate has a filingobligation pursuant to section 6018(a);that is, to determine whether the fair mar-ket value of the gross estate exceeds theexcess of the basic exclusion amount overthe sum of the decedent’s adjusted taxablegifts and the amount allowed to the dece-

dent as a specific exemption under section2521.

d. Opting Out of Portability Election

If the executor of the estate of a dece-dent with a surviving spouse does not wishto make the portability election, the tempo-rary regulations in §20.2010–2T(a)(3) re-quire the executor to make an affirmativestatement on the estate tax return signi-fying the decision to have the portabilityelection not apply. If no estate tax returnis required for that decedent’s estate un-der section 6018(a), not filing a timely re-turn will be considered to be an affirma-tive statement signifying the decision notto make a portability election.

e. Executor Responsible For MakingPortability Election

A commenter responding to Notice2011–82 suggested that the temporary reg-ulations allow a surviving spouse to filean estate tax return on behalf of a dece-dent independently of a duly-appointedexecutor if the surviving spouse notifiesthe executor of the intention to file andthe executor does not, in fact, file a return.Section 2010(c)(5), however, permits onlythe executor of the decedent’s estate to filethe estate tax return and make the porta-bility election. Section 2203 defines theterm “executor” for purposes of the estatetax to mean “the executor or administratorof the decedent, or, if there is no executoror administrator appointed, qualified, andacting within the United States, then anyperson in actual or constructive possessionof any property of the decedent.”

The temporary regulations in§20.2010–2T(a)(6)(i) provide that an ex-ecutor or administrator that is appointed,qualified, and acting within the UnitedStates for the decedent’s estate (an ap-pointed executor), may file an estate tax re-turn to elect portability or to opt to have theportability election not apply. The tempo-rary regulations in §20.2010–2T(a)(6)(ii)provide that, if there is no appointed ex-ecutor, any person in actual or constructivepossession of any property of the dece-dent may file the estate tax return to electportability or to opt to have the portabilityelection not apply. The temporary regu-lations in §20.2010–2T(a)(6)(ii) refer tosuch a person as a “non-appointed execu-tor” and provide that a portability election

made by a non-appointed executor cannotbe superseded by a contrary election madeby another non-appointed executor of thatsame decedent’s estate.

4. Computing the DSUE Amount

a. Computation Required On Estate TaxReturn to Elect Portability

The temporary regulations in§20.2010–2T(b)(1) require that an execu-tor include a computation of the DSUEamount on the estate tax return of thedecedent to allow portability of that dece-dent’s DSUE amount. A complete andproperly-prepared return contains theinformation required to compute a dece-dent’s DSUE amount. Accordingly, in atransitional rule consistent with Notice2011–82, the temporary regulations in§20.2010–2T(b)(2) provide that the IRSwill deem the required computation of thedecedent’s DSUE amount to have beenmade on an estate tax return that is con-sidered complete and properly-prepared.The temporary regulations further clarifythat, once the IRS revises the prescribedform for the estate tax return expresslyto include the computation of the DSUEamount, executors that previously filedan estate tax return pursuant to the tran-sitional rule will not be required to file asupplemental estate tax return using therevised form.

b. Method of Computing the DSUEAmount

Section 2010(c)(4) defines the DSUEamount as the lesser of (A) the basic ex-clusion amount, or (B) the excess of (i)the basic exclusion amount of the lastdeceased spouse of the surviving spouse,over (ii) the amount with respect to whichthe tentative tax is determined under sec-tion 2001(b)(1) on the estate of suchdeceased spouse.

The temporary regulations in§20.2010–2T(c)(1)(i) confirm that theterm “basic exclusion amount” referred toin section 2010(c)(4)(A) means the basicexclusion amount in effect in the year ofthe death of the decedent whose DSUEamount is being computed. Generally,only the basic exclusion amount of thedecedent, as in effect in the year of thedecedent’s death, will be known at thetime the DSUE amount must be computed

2012–28 I.R.B. 20 July 9, 2012

and reported on the decedent’s estate taxreturn. Because section 2010(c)(5)(A)requires the executor of an estate elect-ing portability to compute and report theDSUE amount on a timely-filed estate taxreturn, and because the basic exclusionamount is integral to this computation, theterm “basic exclusion amount” in section2010(c)(4)(A) necessarily refers to suchdecedent’s basic exclusion amount.

In responding to Notice 2011–82, sev-eral commenters also argued that thereference to “basic exclusion amount”in section 2010(c)(4)(B)(i) should be in-terpreted to mean “applicable exclusionamount,” citing to the computation ofthe DSUE amount in Example 3 on page53 of the Technical Explanation and tofootnote 1582A that was added to theGeneral Explanation by the “ERRATA— ‘General Explanation of Tax Legis-lation Enacted in the 111th Congress’”(ERRATA). JCX–20–11, at page 1. Ex-ample 3 computes the DSUE amount ofa deceased spouse who was preceded indeath by one spouse and was survived byanother spouse. The deceased spouse’sDSUE amount is computed using the ap-plicable exclusion amount rather than thebasic exclusion amount of the deceasedspouse (as reduced by the amount of thedeceased spouse’s taxable estate). Exam-ple 3 is reproduced verbatim in the GeneralExplanation. See JCS–2–11 at page 555.The ERRATA acknowledges that section2010(c)(4)(B)(i) uses the term basic exclu-sion amount, but notes that “[a] technicalcorrection may be necessary to replace thereference to the basic exclusion amount ofthe last deceased spouse of the survivingspouse with a reference to the applicableexclusion amount of such last deceasedspouse, so that the statute reflects intent.”JCX–20–11, at page 1, n. 1582A.

Treasury and the IRS have carefullyconsidered this issue. Construing thelanguage of section 2010(c)(4)(B)(i) asreferring to the same number describedin section 2010(c)(4)(A) would lead toan illogical result because it would ef-fectively render the use of “basic exclu-sion amount” in section 2010(c)(4)(A)meaningless. Specifically, the basic ex-clusion amount (the amount referencedin section 2010(c)(4)(A)) cannot be lessthan that same number reduced by an-other number (the amount referenced insection 2010(c)(4)(B)). Under such an in-

terpretation, the basic exclusion amountreferenced in section 2010(c)(4)(A) couldnot limit or impact the DSUE amount, andthus it would serve no purpose as writ-ten. Based on the principle that a statuteshould not be construed in a manner thatrenders a provision of that statute super-fluous and consistent with the indicia oflegislative intent reflected in the TechnicalExplanation and the General Explana-tion, and in the exercise of the expressauthority granted by Congress in sections2010(c)(6) and 7805, Treasury and theIRS have determined that the referencein section 2010(c)(4)(B)(i) to the basicexclusion amount is properly interpretedto mean the applicable exclusion amount.Thus, the temporary regulations adopt thisinterpretation.

c. Effect of Gift Taxes Paid and Payableon Computing the DSUE Amount

Several commenters on Notice2011–82 suggested that, for purposesof computing the DSUE amount undersection 2010(c)(4), the amount referredto in section 2010(c)(4)(B)(ii), which isthe amount on which the decedent’s ten-tative tax is determined under section2001(b)(1), be construed to take into ac-count gift tax paid by such decedent. Thecommenters noted that, to avoid usingexclusion for amounts on which gift taxwas paid, this construction should applyin computing the DSUE amount of sucha decedent if (1) gift tax was paid by adecedent on transfers that caused the totalof his or her taxable transfers to exceed theapplicable exclusion amount at the timeof the transfer, and (2) the total adjustedtaxable gifts of the decedent is less thanthe applicable exclusion amount on thedate of his or her death. The temporaryregulations in §20.2010–2T(c)(2) providethat amounts on which gift taxes were paidby a decedent are excluded from adjustedtaxable gifts for the purpose of computingthat decedent’s DSUE amount.

d. Potential Impact of Credits in Sections2013 — 2015 on the DSUE Amount

Commenters on Notice 2011–82 askedfor clarification as to whether the DSUEamount is determined before or after theapplication of other available credits, suchas the credit for tax on prior transfers (sec-tion 2013), the credit for foreign death

taxes (section 2014), and the credit fordeath taxes on remainders (section 2015).The issue of the impact of the credits insections 2013 to 2015 on computing theDSUE amount merits further considera-tion. The temporary regulations reserve§20.2010–2T(c)(3) to provide future guid-ance on this issue. Treasury and the IRSrequest comments regarding appropriaterules to coordinate these credits with porta-bility of the exclusion. For the manner ofsubmitting these comments, see the noticeof proposed rulemaking on this subject ap-pearing elsewhere in this issue of the Bul-letin.

5. Use of the DSUE Amount by theSurviving Spouse

a. Date DSUE Amount May Be Taken intoConsideration by Surviving Spouse

Commenters on Notice 2011–82 askedfor clarification on when the DSUEamount of a decedent is available tothe surviving spouse or to the survivingspouse’s estate for use in determiningthe surviving spouse’s applicable exclu-sion amount. The temporary regulationsin §§20.2010–3T(a) and 25.2505–2T(a)provide that, if the decedent is the lastdeceased spouse of the surviving spouseon the date of a transfer by the surviv-ing spouse that is subject to gift or estatetax, the surviving spouse, or the estateof the surviving spouse, of that dece-dent may take into account that dece-dent’s DSUE amount in determiningthe applicable exclusion amount of thesurviving spouse when computing thesurviving spouse’s gift or estate tax lia-bility on that transfer. This rule appliesonly if the decedent’s executor electedportability. In addition, the temporaryregulations in §§20.2010–3T(c)(1) and25.2505–2T(d)(1) provide that a porta-bility election made by the executor ofa decedent’s estate is effective as of thedate of the decedent’s death. Thus, theDSUE amount of a decedent survived by aspouse may be included in determining theapplicable exclusion amount of the sur-viving spouse under section 2010(c)(2),subject to any applicable limitations, withrespect to all transfers occurring after thedeath of the decedent, if the executor ofthe decedent’s estate makes a portabilityelection and the election is not superseded

July 9, 2012 21 2012–28 I.R.B.

by the executor of the decedent’s estatebefore the due date of the return, includingextensions.

b. Last Deceased Spouse Limitation onDSUE Amount Available to SurvivingSpouse

Some commenters responding to No-tice 2011–82 suggested that the reg-ulations clarify the scope of the lastdeceased spouse limitation in section2010(c)(4)(B)(i). The temporary regula-tions in §20.2010–1T(d)(5) explain thatthe term “last deceased spouse” referredto in section 2010(c)(4)(B)(i) means themost recently deceased individual whowas married to the surviving spouse atthat individual’s death, except that an in-dividual dying before calendar year 2011cannot be considered the last deceasedspouse of such surviving spouse. The tem-porary regulations in §§20.2010–3T(a)(3)and 25.2505–2T(a)(3) clarify that remar-riage alone does not affect who will beconsidered the last deceased spouse anddoes not prevent the surviving spousefrom including in the surviving spouse’sapplicable exclusion amount the DSUEamount of the deceased spouse who mostrecently preceded the surviving spousein death. The temporary regulations fur-ther clarify that the identity of the lastdeceased spouse of the surviving spousefor purposes of portability is not affectedby whether the estate of the last deceasedspouse elects portability of the deceasedspouse’s DSUE amount or whether the lastdeceased spouse has any DSUE amountavailable. This is consistent with the statu-tory language, which refers to the “lastdeceased spouse of such surviving spouse”without further qualification, as well aswith the Technical Explanation, whichstates that “[t]he last deceased spouselimitation applies whether or not the lastdeceased spouse has any unused exclusionor the last deceased spouse’s estate makesa timely election.” JCX–55–10, at page52, n. 57; see also General Explanation,JCS–2–11, at page 554, n. 1582.

For purposes of determining the ap-plicable credit amount under section2505(a)(1), a commenter asked Treasuryand the IRS to clarify when one determinesthe identity of the last deceased spouse.Although section 2505(a)(1) refers to theapplicable credit amount in effect under

section 2010(c) as would apply if the donordied as of the end of the calendar year,this does not mean that the identity of thelast deceased spouse is subject to changefor purposes of computing the survivingspouse’s applicable exclusion amount ifthe surviving spouse is preceded in deathby a subsequent spouse after the gift trans-fer but before the end of the calendaryear. Therefore, the temporary regulationsprovide in §25.2505–2T(a) that for pur-poses of determining a surviving spouse’sapplicable exclusion amount when thesurviving spouse makes a taxable gift, thesurviving spouse’s last deceased spouse isidentified as of the date of the taxable gift.See §20.2010–3T(a) for a comparable rulefor estate tax purposes.

c. DSUE Amount Available in Case ofMultiple Spouses and Previously-AppliedDSUE Amount

Some commenters responding to No-tice 2011–82 requested that the regulationsclarify the outcome when a survivingspouse is preceded in death by more thanone spouse. In particular, commentersasked how the DSUE amount to be in-cluded in the applicable exclusion amountof a surviving spouse is affected when adecedent who is currently considered thelast deceased spouse of such survivingspouse either has no DSUE amount orhas a smaller amount of DSUE in com-parison to a decedent who previously wasconsidered the last deceased spouse ofsuch surviving spouse. The temporaryregulations clarify that, in either situation,the surviving spouse may not apply anyremaining DSUE amount from a priordeceased spouse.

In addition, the temporary regula-tions address how to compute the DSUEamount included in the applicable exclu-sion amount of a surviving spouse whomade gifts between the deaths of twodecedents, each of whom were at separatetimes the last deceased spouse of suchsurviving spouse. First, the temporaryregulations in §25.2505–2T(b) create anordering rule by providing that, when asurviving spouse makes a taxable gift, theDSUE amount of the decedent who is thelast deceased spouse of such survivingspouse will be considered to apply againstthe amount of the surviving spouse’s tax-able gifts for that calendar year before the

surviving spouse’s own basic exclusionamount will apply.

Second, the temporary regulations,in §§25.2505–2T(c) and 20.2010–3T(b),compute the DSUE amount available tosuch a surviving spouse or to his or her es-tate, respectively, as including both: (i) theDSUE amount of the surviving spouse’slast deceased spouse, and (ii) any DSUEamount actually applied to taxable giftspursuant to the rule in §25.2505–2T(b) tothe extent the DSUE amount so appliedwas from a decedent who no longer is thelast deceased spouse for purposes of sec-tion 2010(c)(4)(B)(i). Under the rules in§25.2505–2T, a surviving spouse may usethe DSUE amount of a predeceased spouseas long as, for each transfer, such DSUEamount is from the surviving spouse’slast deceased spouse at the time of thattransfer. Thus, a spouse who has survivedmultiple spouses may use each last de-ceased spouse’s DSUE amount before thedeath of that spouse’s next spouse, andthereby may apply the DSUE amount ofmultiple deceased spouses in succession.However, this does not permit the surviv-ing spouse to use the sum of the DSUEamounts of those deceased spouses at onetime, and a surviving spouse may not usethe remaining DSUE amount of a priordeceased spouse following the death of asubsequent spouse.

6. Authority to Examine Returns ofDeceased Spouses

Section 2010(c)(5)(B) confirms theIRS’s authority to examine returns of eachdeceased spouse of the surviving spouseto determine the allowable DSUE amounteven if the period of limitations on as-sessment under section 6501 has expiredfor the tax under chapters 11 or 12 withrespect to such returns.

Section 7602(a) provides that the IRSmay examine any books, papers, records,or other data which may be relevant or ma-terial to an inquiry for the purpose of ascer-taining the accuracy of any return or deter-mining the liability of any person for anyinternal revenue tax or liability. The re-turns of each deceased spouse whose ex-ecutor elected portability are relevant ormaterial to the determination of the allow-able DSUE amount to be applied by thesurviving spouse to a taxable transfer.

2012–28 I.R.B. 22 July 9, 2012

Accordingly, the temporary regu-lations confirm in §§20.2001–2T(a),20.2010–2T(d), 20.2010–3T(d), and25.2505–2T(e) that, in determining theallowable DSUE amount, the IRS mayexamine any one or more returns of eachdeceased spouse of the surviving spousewhose executor elected portability. Uponexamination, the IRS may adjust or elim-inate the DSUE amount reported on areturn; however, the IRS may make an as-sessment of additional tax with respect tothe deceased spouse’s return only withinthe period of limitations under section6501. The ability of the IRS to examine re-turns of a deceased spouse applies to eachtransfer by the surviving spouse to whicha DSUE amount is or has been applied.The returns and return information of adeceased spouse may be disclosed to thesurviving spouse or the surviving spouse’sestate as appropriate under section 6103.

A commenter to Notice 2011–82 sug-gested that the regulations clarify whetherthe IRS’s authority to examine returnseven after the period of limitations onassessment has expired, as confirmed insection 2010(c)(5)(B), would suspend thesubstantive review and examination ofthe estate tax return of a decedent witha surviving spouse. Except to the extentprovided in section 2010(c)(5)(B) withregard to the computation of the DSUEamount, the limitation in section 6501continues to apply to the estate tax returnso examination of the estate tax return willnot be suspended solely because of thepossibility of future reviews to determinethe decedent’s DSUE amount.

7. Applicability of Portability Rules toNonresidents Who Are Not Citizens

Several commenters requested that theregulations clarify the applicability ofthe rules in section 2010(c) to estates ofnonresidents who are not citizens. In re-sponse to these comments, the temporaryregulations provide in §20.2010–2T(a)(5)that an executor of the estate of a non-resident decedent who was not a citizenof the United States at the time of deathmay not make a portability election onbehalf of that decedent. The tempo-rary regulations in §§20.2010–3T(e) and25.2505–2T(f) provide that a nonresidentsurviving spouse who was not a citizenof the United States at the time of such

surviving spouse’s death may not takeinto account the DSUE amount of anydeceased spouse of such surviving spouse,except to the extent allowed under a treatyobligation of the United States.

8. Applicability of Portability in Case ofQualified Domestic Trusts

A commenter suggested that the regula-tions clarify how the portability rules applywhen a qualified domestic trust (QDOT)(defined in section 2056A(a)) is createdfor the benefit of a surviving spouse who isa not a citizen of the United States. Whenproperty of a decedent passes to a QDOT,the decedent’s estate is allowed a maritaldeduction under section 2056(d)(2) forthe value of such property. Ultimately,however, estate tax is imposed on suchproperty under section 2056A as distribu-tions constituting taxable events are madefrom the QDOT. The estate tax imposedby section 2056A is the decedent’s estatetax liability, and that tax generally equalsthe amount of additional estate tax thatwould have been imposed under section2001 if the amount involved in the taxableevent had been included in the decedent’staxable estate and had not been deductibleunder section 2056. See §20.2056A–5(a).The estate tax that would have been im-posed under section 2001 is computedby determining the net tax under section2001 after the allowance of any credits,including the applicable credit amountdetermined under section 2010(c). Conse-quently, when a QDOT has been createdfor the benefit of a decedent’s survivingspouse, the executor of the decedent’sestate will compute a DSUE amount, ona preliminary basis, that may decrease asdistributions constituting taxable eventsunder section 2056A are made.

Commenters made several suggestionsfor applying portability to this situation.One proposal is to allow a decedent’sDSUE amount to be computed and avail-able to the surviving spouse as of the dateof death of the decedent, without regardto the estate tax to be imposed by section2056A. A second suggestion is to allow anexecutor of such an estate to elect porta-bility with respect to only a portion of theDSUE amount so that an executor couldreserve a portion of the decedent’s DSUEamount for the estate tax to be imposedby section 2056A. A third proposal is to

allow the decedent’s applicable exclu-sion amount and the initially-determinedDSUE amount to be applied on a chrono-logical, or first come, first served, basis;that is, by applying the decedent’s appli-cable exclusion amount on the occurrenceof a taxable event subject to the estatetax imposed by section 2056A and at thetime of a transfer by the surviving spousesubject to the gift tax imposed by section2501, in each case, to the extent applica-ble exclusion amount or DSUE amount,respectively, is available at such times.

Each of the proposals raises issues offairness, complexity, and administrability.The applicable exclusion amount first andforemost belongs to the decedent. Porta-bility of a DSUE amount allows a surviv-ing spouse to use a decedent’s exclusionamount only to the extent it is not used bythat decedent. Accordingly, the temporaryregulations allow the decedent’s estate fullavailability of the decedent’s applicableexclusion amount until such time as thefinal estate tax liability of the decedentis computed. The temporary regulationsin §20.2010–2T(c)(4) provide that theexecutor of a decedent’s estate claiminga marital deduction for property passingto a QDOT shall compute the decedent’sDSUE amount on a preliminary basis onthe decedent’s estate tax return for the pur-pose of electing portability, although suchamount subsequently will be reduced bythe estate tax imposed by section 2056A.The temporary regulations further pro-vide that the DSUE amount of such adecedent shall be redetermined upon thefinal distribution or other taxable eventon which estate tax under section 2056Ais imposed, which is generally upon thedeath of the surviving spouse or the earliertermination of all QDOTs created for thatsurviving spouse. The temporary regula-tions provide in §20.2010–3T(c)(2) thatthe earliest date such a decedent’s DSUEamount may be included in determiningthe applicable exclusion amount availableto the surviving spouse or the survivingspouse’s estate is the date of the event thattriggers the final estate tax liability of thedecedent under section 2056A. Generally,this means that such a decedent’s DSUEamount will be available for transfers oc-curring by reason of the surviving spouse’sdeath, but generally will not be avail-able to the surviving spouse during life.However, the decedent’s DSUE amount

July 9, 2012 23 2012–28 I.R.B.

will be available to apply to the survivingspouse’s taxable gifts made in the yearof the surviving spouse’s death, or, if theevent terminating the QDOT occurs priorto the surviving spouse’s death, then inthe year of that terminating event and/orany subsequent year during the survivingspouse’s life. Treasury and the IRS requestfurther comments on this issue. For themanner of submitting these comments, seethe notice of proposed rulemaking on thissubject appearing elsewhere in this issueof the Bulletin.

Special Analyses

It has been determined that this Trea-sury decision is not considered a signifi-cant regulatory action as defined in Execu-tive Order 12866, as supplemented by Ex-ecutive Order 13563. Therefore, a regula-tory assessment is not required. In addi-tion, section 553(b) of the AdministrativeProcedure Act (5 U.S.C. chapter 5) doesnot apply to these regulations because theyare excepted from the notice and commentrequirements of section 553(b) and (c) ofthe Administrative Procedure Act underthe interpretive rule and good cause ex-ceptions provided by section 553(b)(3)(A)and (B) of that Act. These regulationsare necessary to provide immediate guid-ance to estates of a decedent with a surviv-ing spouse and to spouses surviving sucha decedent on the application of the porta-bility rules of section 2010(c), which ap-plies to estates of decedents dying and giftsmade after December 31, 2010. These reg-ulations provide necessary guidance to ad-dress fundamental issues concerning theportability election, the computation of theDSUE amount, the identity of the last de-ceased spouse, and the application of theDSUE amount by the surviving spouse. Inaddition, the issues addressed by the regu-lations have been publicly noticed and sub-ject to comment through the publication ofNotice 2011–82. For these reasons, goodcause exists for dispensing with notice andpublic comment pursuant to section 553(b)and (c) of the Administrative ProcedureAct. For the applicability of the Regula-tory Flexibility Act (5 U.S.C. chapter 6),please refer to the Special Analyses sectionof the preamble to the cross-referenced no-tice of proposed rulemaking published inthis issue of the Bulletin. Pursuant to sec-tion 7805(f) of the Code, these regulations

have been submitted to the Chief Counselfor Advocacy of the Small Business Ad-ministration for comment on their impacton small business.

Drafting Information

The principal author of these temporaryregulations is Karlene Lesho, Office of theAssociate Chief Counsel (Passthroughsand Special Industries). Other personnelfrom the IRS and the Treasury Departmentparticipated in their development.

* * * * *

Amendments to the Regulations

Accordingly, 26 CFR parts 20, 25, and602 are amended as follows:

PART 20—ESTATE TAX; ESTATE OFDECEDENTS DYING AFTER AUGUST16, 1954

Paragraph 1. The authority citation forpart 20 is amended by adding entries innumerical order to read as follows:

Authority: 26 U.S.C. 7805. * * *Section 20.2010–0T also issued under

26 U.S.C. 2010(c)(6).Section 20.2010–1T also issued under

26 U.S.C. 2010(c)(6).Section 20.2010–2T also issued under

26 U.S.C. 2010(c)(6).Section 20.2010–3T also issued under

26 U.S.C. 2010(c)(6). * * *Par. 2. Section 20.2001–2T is added to

read as follows:

§20.2001–2T Valuation of adjustedtaxable gifts for purposes of determiningthe deceased spousal unused exclusionamount of last deceased spouse(temporary).

(a) General rule. Notwithstanding§20.2001–1(b), see §§20.2010–2T(d) and20.2010–3T(d) for additional rules regard-ing the authority of the Internal RevenueService to examine any gift or other taxreturn(s), even if the time within which atax may be assessed under section 6501has expired, for the purpose of determin-ing the deceased spousal unused exclusion(DSUE) amount available under section2010(c) of the Internal Revenue Code(Code).

(b) Effective/applicability date. Para-graph (a) of this section applies to the

estates of decedents dying in calendar year2011 or a subsequent year in which the ap-plicable exclusion amount is determinedunder section 2010(c) of the Code byadding the basic exclusion amount and, inthe case of a surviving spouse, the DSUEamount.

(c) Expiration date. The applicabilityof this section expires on or before June 15,2015.

Par. 3. Section 20.2010–0T is added toread as follows:

§20.2010–0T Table of contents(temporary).

This section lists the table of contentsfor §§20.2010–1T through 20.2010–3T.

§20.2010–1T Unified credit against estatetax; in general (temporary).

(a) General rule.(b) Special rule in case of certain gifts

made before 1977.(c) Credit limitation.(d) Explanation of terms.(1) Applicable credit amount.(2) Applicable exclusion amount.(3) Basic exclusion amount.(4) Deceased spousal unused exclusion

(DSUE) amount.(5) Last deceased spouse.(e) Effective/applicability date.(f) Expiration date.

§20.2010–2T Portability provisionsapplicable to estate of a decedent survivedby a spouse (temporary).

(a) Election required for portability.(1) Timely filing required.(2) Portability election upon filing of

estate tax return.(3) Portability election not made; re-

quirements for election not to apply.(4) Election irrevocable.(5) Estates eligible to make the election.(6) Persons permitted to make the elec-

tion.(7) Requirements of return.(b) Computation required for portabil-

ity election.(1) General rule.(2) Transitional rule.(c) Computation of the DSUE amount.(1) General rule.(2) Special rule to consider gift taxes

paid by decedent.

2012–28 I.R.B. 24 July 9, 2012

(3) [Reserved](4) Special rule in case of property pass-

ing to qualified domestic trust.(5) Examples.(d) Authority to examine returns of

decedent.(e) Effective/applicability date.(f) Expiration date.

§20.2010–3T Portability provisionsapplicable to the surviving spouse’s estate(temporary).

(a) Surviving spouse’s estate limited toDSUE amount of last deceased spouse.

(1) In general.(2) No DSUE amount available from

last deceased spouse.(3) Identity of last deceased spouse

unchanged by subsequent marriage or di-vorce.

(b) Special rule in case of multiple de-ceased spouses and a previously-appliedDSUE amount.

(1) In general.(2) Example.(c) Date DSUE amount taken into con-

sideration by surviving spouse’s estate.(1) General rule.(2) Special rule when property passes

to surviving spouse in a qualified domestictrust.

(d) Authority to examine returns of de-ceased spouses.

(e) Availability of DSUE amount for es-tates of nonresidents who are not citizens.

(f) Effective/applicability date.(g) Expiration date.Par. 4. Section 20.2010–1T is added to

read as follows:

§20.2010–1T Unified credit against estatetax; in general (temporary).

(a) General rule. Section 2010(a) al-lows the estate of every decedent a creditagainst the estate tax imposed by section2001. The allowable credit is the applica-ble credit amount. See paragraph (d)(1) ofthis section for an explanation of the termapplicable credit amount.

(b) Special rule in case of certain giftsmade before 1977. The applicable creditamount allowable under paragraph (a) ofthis section must be reduced by an amountequal to 20 percent of the aggregateamount allowed as a specific exemptionunder section 2521 (as in effect before its

repeal by the Tax Reform Act of 1976) forgifts made by the decedent after Septem-ber 8, 1976, and before January 1, 1977.

(c) Credit limitation. The applicablecredit amount allowed under paragraph (a)of this section cannot exceed the amountof the estate tax imposed by section 2001.

(d) Explanation of terms. The expla-nation of terms in this section applies tothis section and to §§20.2010–2T and20.2010–3T.

(1) Applicable credit amount. The termapplicable credit amount refers to the al-lowable credit against estate tax imposedby section 2001 and gift tax imposedby section 2501. The applicable creditamount equals the amount of the tentativetax that would be determined under sec-tion 2001(c) if the amount on which suchtentative tax is to be computed were equalto the applicable exclusion amount. Theapplicable credit amount is determined byapplying the unified rate schedule in sec-tion 2001(c) to the applicable exclusionamount.

(2) Applicable exclusion amount. Theapplicable exclusion amount equals thesum of the basic exclusion amount and,in the case of a surviving spouse, the de-ceased spousal unused exclusion (DSUE)amount.

(3) Basic exclusion amount. The basicexclusion amount is the sum of—

(i) For any decedent dying in calendaryear 2011, $5,000,000; and

(ii) For any decedent dying after calen-dar year 2011, $5,000,000 multiplied bythe cost-of-living adjustment determinedunder section 1(f)(3) for that calendar yearby substituting “calendar year 2010” for“calendar year 1992” in section 1(f)(3)(B)and by rounding to the nearest multiple of$10,000.

(4) Deceased spousal unused exclusion(DSUE) amount. The term DSUE amountrefers, generally, to the unused portion ofa decedent’s applicable exclusion amountto the extent this amount does not ex-ceed the basic exclusion amount in effectin the year of the decedent’s death. Forrules on computing the DSUE amount, see§§20.2010–2T(c) and 20.2010–3T(b).

(5) Last deceased spouse. The term lastdeceased spouse means the most recentlydeceased individual who, at that indi-vidual’s death after December 31, 2010,was married to the surviving spouse. See§§20.2010–3T(a) and 25.2505–2T(a) of

this chapter for additional rules pertainingto the identity of the last deceased spousefor purposes of determining the applicableexclusion amount of the surviving spouse.

(e) Effective/applicability date. Para-graphs (d)(2), (d)(3), (d)(4), and (d)(5) ofthis section apply to the estates of dece-dents dying in calendar year 2011 or a sub-sequent year in which the applicable exclu-sion amount is determined under section2010(c) of the Internal Revenue Code byadding the basic exclusion amount and, inthe case of a surviving spouse, the DSUEamount. Paragraphs (a), (b), (c), and (d)(1)of this section apply to the estates of dece-dents dying on or after June 15, 2012.

(f) Expiration date. The applicability ofthis section expires on or before June 15,2015.

Par. 5. Section 20.2010–2T is added toread as follows:

§20.2010–2T Portability provisionsapplicable to estate of a decedent survivedby a spouse (temporary).

(a) Election required for portability.To allow a decedent’s surviving spouse totake into account that decedent’s deceasedspousal unused exclusion (DSUE) amount,the executor of the decedent’s estate mustelect portability of the DSUE amount ona timely-filed Form 706, “United StatesEstate (and Generation-Skipping Trans-fer) Tax Return” (estate tax return). Thiselection is referred to in this section and in§20.2010–3T as the portability election.

(1) Timely filing required. An estatethat elects portability will be considered,for purposes of Subtitle B and Subtitle Fof the Internal Revenue Code (Code), tobe required to file a return under section6018(a). Accordingly, the due date of anestate tax return required to elect portabil-ity is 9 months after the decedent’s dateof death or the last day of the period cov-ered by an extension (if an extension oftime for filing has been obtained). See§§20.6075–1 and 20.6081–1 for additionalrules relating to the time for filing estatetax returns.

(2) Portability election upon filing ofestate tax return. Upon the timely filingof a complete and properly-prepared estatetax return, an executor of an estate of adecedent (survived by a spouse) will haveelected portability of the decedent’s DSUEamount unless the executor chooses not to

July 9, 2012 25 2012–28 I.R.B.

elect portability and satisfies the require-ment in paragraph (a)(3)(i) of this section.See paragraph (a)(7) of this section for thereturn requirements related to the portabil-ity election.

(3) Portability election not made; re-quirements for election not to apply. Theexecutor of the estate of a decedent (sur-vived by a spouse) will not make or be con-sidered to make the portability election ifeither of the following applies:

(i) The executor states affirmatively ona timely-filed estate tax return, or in an at-tachment to that estate tax return, that theestate is not electing portability under sec-tion 2010(c)(5). The manner in which theexecutor may make this affirmative state-ment on the estate tax return will be asset forth in the instructions issued with re-spect to such form (“Instructions for Form706”).

(ii) The executor does not timely file anestate tax return in accordance with para-graph (a)(1) of this section.

(4) Election irrevocable. An execu-tor of the estate of a decedent (survivedby a spouse) who timely files an estatetax return may make and may supersede aportability election previously made, pro-vided that the estate tax return reportingthe decision not to make a portability elec-tion is filed on or before the due date ofthe return, including extensions actuallygranted. However, see paragraph (a)(6)of this section when contrary elections aremade by more than one person permittedto make the election. The portability elec-tion, once made, becomes irrevocable oncethe due date of the estate tax return, in-cluding extensions actually granted, haspassed.

(5) Estates eligible to make the election.An executor may elect portability on be-half of the estate of a decedent (survived bya spouse) if the decedent dies in calendaryear 2011 or during a subsequent period inwhich portability of a DSUE amount is ineffect. However, an executor of the estateof a nonresident decedent who was not acitizen of the United States at the time ofdeath may not elect portability on behalf ofthat decedent, and the timely filing of sucha decedent’s estate tax return will not con-stitute the making of a portability election.

(6) Persons permitted to make the elec-tion—(i) Appointed executor. An execu-tor or administrator of the estate of a dece-dent (survived by a spouse) that is ap-

pointed, qualified, and acting within theUnited States, within the meaning of sec-tion 2203 (an appointed executor), mayfile the estate tax return on behalf of theestate of the decedent and, in so doing,elect portability of the decedent’s DSUEamount. An appointed executor also mayelect not to have portability apply pursuantto paragraph (a)(3) of this section.

(ii) Non-appointed executor. If thereis no appointed executor, any person inactual or constructive possession of anyproperty of the decedent (a non-appointedexecutor) may file the estate tax return onbehalf of the estate of the decedent and, inso doing, elect portability of the decedent’sDSUE amount, or, by complying withparagraph (a)(3) of this section, may electnot to have portability apply. A portabilityelection made by a non-appointed execu-tor cannot be superseded by a contraryelection made by another non-appointedexecutor of that same decedent’s estate(unless such other non-appointed execu-tor is the successor of the non-appointedexecutor who made the election). See§20.6018–2 for additional rules relatingto persons permitted to file the estate taxreturn.

(7) Requirements of return—(i) Gen-eral rule. An estate tax return will beconsidered complete and properly-pre-pared for purposes of this section if itis prepared in accordance with the in-structions issued for the estate tax return(Instructions for Form 706) and if the re-quirements of §§20.6018–2, 20.6018–3,and 20.6018–4 are satisfied. However,see paragraph (a)(7)(ii) of this section forreduced requirements applicable to certainproperty of certain estates.

(ii) Reporting of value not requiredfor certain property—(A) In general. Aspecial rule applies with respect to certainproperty of estates in which the executoris not required to file an estate tax re-turn under section 6018(a), as determinedwithout regard to paragraph (a)(1) of thissection. With respect to such an estate, forbequests, devises, or transfers of propertyincluded in the gross estate, the value ofwhich is deductible under section 2056or 2056A (marital deduction property) orunder section 2055(a) (charitable deduc-tion property), an executor is not requiredto report a value for such property onthe estate tax return (except to the extentprovided in this paragraph (a)(7)(ii)(A))

and will be required to report only the de-scription, ownership, and/or beneficiary ofsuch property, along with all other infor-mation necessary to establish the right ofthe estate to the deduction in accordancewith §§20.2056(a)–1(b)(i) through (iii)and 20.2055–1(c), as applicable. How-ever, this rule does not apply to maritaldeduction property or charitable deductionproperty if—

(1) The value of such property relatesto, affects, or is needed to determine, thevalue passing from the decedent to anotherrecipient;

(2) The value of such property is neededto determine the estate’s eligibility for theprovisions of sections 2032, 2032A, 6166,or another provision of the Code;

(3) Less than the entire value of an inter-est in property includible in the decedent’sgross estate is marital deduction propertyor charitable deduction property; or

(4) A partial disclaimer or partial qual-ified terminable interest property (QTIP)election is made with respect to a bequest,devise, or transfer of property includible inthe gross estate, part of which is maritaldeduction property or charitable deductionproperty.

(B) Statement required on the return.Paragraph (a)(7)(ii)(A) of this section ap-plies only if the executor exercises duediligence to estimate the fair market valueof the gross estate, including the propertydescribed in paragraph (a)(7)(ii)(A) of thissection. The Instructions for Form 706will provide ranges of dollar values, andthe executor must identify on the estate taxreturn an amount corresponding to the par-ticular range within which falls the execu-tor’s best estimate of the total gross es-tate. Until such time as the prescribed formfor the estate tax return expressly includesthis estimate in the manner described in thepreceding sentence, the executor must in-clude the executor’s best estimate, roundedto the nearest $250,000, on or attached tothe estate tax return, signed under penaltiesof perjury.

(C) Examples. The following exam-ples illustrate the application of paragraph(a)(7)(ii) of this section. In each example,assume that Husband (H) dies in 2011, sur-vived by his wife (W), that both H and Ware US citizens, that H’s gross estate doesnot exceed the excess of the applicable ex-clusion amount for the year of his deathover the total amount of H’s adjusted tax-

2012–28 I.R.B. 26 July 9, 2012

able gifts and any specific exemption un-der section 2521, and that H’s executor (E)timely files Form 706 solely to make theportability election.

Example 1. (i) Facts. The assets includible inH’s gross estate consist of a parcel of real propertyand bank accounts held jointly with W with rightsof survivorship, a life insurance policy payable to W,and a survivor annuity payable to W for her life. Hmade no taxable gifts during his lifetime.

(ii) Application. E files an estate tax return onwhich these assets are identified on the proper sched-ule, but E provides no information on the return withregard to the date of death value of these assets in ac-cordance with paragraph (a)(7)(ii)(A) of this section.To establish the estate’s entitlement to the marital de-duction in accordance with §20.2056(a)–1(b) (exceptwith regard to establishing the value of the property)and the instructions for the estate tax return, E in-cludes with the estate tax return evidence to verifythe title of each jointly held asset, to confirm that Wis the sole beneficiary of both the life insurance policyand the survivor annuity, and to verify that the annuityis exclusively for W’s life. Finally, E certifies on theestate return E’s best estimate, determined by exercis-ing due diligence, of the fair market value of the grossestate in accordance with paragraph (a)(7)(ii)(B) ofthis section. The estate tax return is considered com-plete and properly prepared and E has elected porta-bility.

Example 2. (i) Facts. H’s will, duly admitted toprobate and not subject to any proceeding to chal-lenge its validity, provides that H’s entire estate is tobe distributed to a QTIP trust for W. The non-pro-bate assets includible in H’s gross estate consist of alife insurance policy payable to H’s children from aprior marriage, and H’s individual retirement account(IRA) payable to W. H made no taxable gifts duringhis lifetime.

(ii) Application. E files an estate tax return onwhich all of the assets includible in the gross estateare identified on the proper schedule. In the caseof the probate assets and the IRA, no information isprovided with regard to date of death value in ac-cordance with paragraph (a)(7)(ii)(A) of this section.However, E makes a QTIP election and attaches acopy of H’s will creating the QTIP, and describeseach such asset and its ownership to establish the es-tate’s entitlement to the marital deduction in accor-dance with the instructions for the estate tax returnand §20.2056(a)–1(b) (except with regard to estab-lishing the value of the property). In the case of thelife insurance policy payable to H’s children, all ofthe regular return requirements, including reportingand establishing the fair market value of such asset,apply. Finally, E certifies on the estate return E’s bestestimate, determined by exercising due diligence, ofthe fair market value of the gross estate in accordancewith paragraph (a)(7)(ii)(B) of this section. The es-tate tax return is considered complete and properlyprepared and E has elected portability.

(iii) Variation. The facts are the same except thatthere are no non-probate assets, and E elects to makeonly a partial QTIP election. In this case, the regu-lar return requirements apply to all of the property in-cludible in the gross estate and the provisions of para-graph (a)(7)(ii) of this section do not apply.

Example 3. (i) Facts. H’s will, duly admitted toprobate and not subject to any proceeding to chal-lenge its validity, provides that 50 percent of the prop-erty passing under the terms of H’s will is to be paidto a marital trust for W and 50 percent is to be paid toa trust for W and their descendants.

(ii) Application. The amount passing to the non-marital trust cannot be verified without knowledgeof the full value of the property passing under thewill. Therefore, the value of the property of the mar-ital trust relates to or affects the value passing to thetrust for W and the descendants of H and W. Accord-ingly, the general return requirements apply to all ofthe property includible in the gross estate and the pro-visions of paragraph (a)(7)(ii) of this section do notapply.

(b) Computation required for portabil-ity election—(1) General rule. In addi-tion to the requirements described in para-graph (a) of this section, an executor of adecedent’s estate must include a compu-tation of the DSUE amount on the estatetax return to elect portability and therebyallow the decedent’s surviving spouse totake into account that decedent’s DSUEamount. See paragraph (b)(2) of this sec-tion for a transitional rule when the es-tate tax return form prescribed by the Inter-nal Revenue Service (IRS) does not showexpressly the computation of the DSUEamount. See paragraph (c) of this sectionfor rules on computing the DSUE amount.

(2) Transitional rule. Until such time asthe prescribed form for the estate tax returnexpressly includes a computation of theDSUE amount, a complete and properly-prepared estate tax return will be deemedto include the computation of the DSUEamount. See paragraph (a)(7) of this sec-tion for the requirements for a return tobe considered complete and properly-pre-pared. Once the IRS revises the prescribedform for the estate tax return to includeexpressly the computation of the DSUEamount, executors that previously filed anestate tax return pursuant to this transi-tional rule will not be required to file asupplemental estate tax return using the re-vised form.

(c) Computation of the DSUEamount—(1) General rule. Subject toparagraphs (c)(2) through (c)(4) of thissection, the DSUE amount of a decedentwith a surviving spouse is the lesser of thefollowing amounts—

(i) The basic exclusion amount in effectin the year of the death of the decedent; or

(ii) The excess of—(A) The decedent’s applicable exclu-

sion amount; over

(B) The sum of the amount of the tax-able estate and the amount of the adjustedtaxable gifts of the decedent, which to-gether is the amount on which the tentativetax on the decedent’s estate is determinedunder section 2001(b)(1).

(2) Special rule to consider gift taxespaid by decedent. Solely for purposes ofcomputing the decedent’s DSUE amount,the amount of the adjusted taxable giftsof the decedent referred to in paragraph(c)(1)(ii)(B) of this section is reduced bythe amount, if any, on which gift taxeswere paid for the calendar year of thegift(s).

(3) [Reserved](4) Special rule in case of property

passing to qualified domestic trust. Whenproperty passes for the benefit of a sur-viving spouse in a qualified domestic trust(QDOT), as defined in section 2056A(a),the DSUE amount of the decedent iscomputed on the decedent’s estate taxreturn for the purpose of electing porta-bility in the same manner as this amountis computed under paragraph (c)(1) ofthis section, but this DSUE amount issubject to subsequent adjustments. TheDSUE amount of the decedent must beredetermined upon the occurrence of thefinal distribution or other event (gener-ally the death of the surviving spouse orthe earlier termination of all QDOTs forthat surviving spouse) on which estatetax is imposed under section 2056A. See§20.2056A–6 for rules on determiningthe estate tax under section 2056A. See§20.2010–3T(c)(2) regarding the timingof the availability of the decedent’s DSUEamount to the surviving spouse.

(5) Examples. The following examplesillustrate the application of this paragraph(c):

Example 1. Computation of DSUE amount.(i) Facts. In 2002, having made no prior taxablegift, Husband (H) makes a taxable gift valued at$1,000,000 and reports the gift on a timely-filed gifttax return. Because the amount of the gift is equalto the applicable exclusion amount for that year($1,000,000), $345,800 is allowed as a credit againstthe tax, reducing the gift tax liability to zero. H dieson September 29, 2011, survived by Wife (W). H andW are US citizens and neither has any prior marriage.H’s taxable estate is $1,000,000. The executor ofH’s estate timely files H’s estate tax return and electsportability, thereby allowing W to benefit from H’sDSUE amount.

(ii) Application. The executor of H’s estate com-putes H’s DSUE amount to be $3,000,000 (the lesserof the $5,000,000 basic exclusion amount in 2011,or the excess of H’s $5,000,000 applicable exclusion

July 9, 2012 27 2012–28 I.R.B.

amount over the sum of the $1,000,000 taxable estateand the $1,000,000 amount of adjusted taxable gifts).

Example 2. Computation of DSUE amount whengift tax paid. (i) Facts. The facts are the same as inExample 1 except that the value of H’s taxable gift in2002 is $2,000,000. After application of the applica-ble credit amount, H owes gift tax on $1,000,000, theamount of the gift in excess of the applicable exclu-sion amount for that year. H pays the gift tax owedon the transfer in 2002.

(ii) Application. On H’s death, the executor of H’sestate computes the DSUE amount to be $3,000,000(the lesser of the $5,000,000 basic exclusion amountin 2011, or the excess of H’s $5,000,000 applica-ble exclusion amount over the sum of the $1,000,000taxable estate and $1,000,000 adjusted taxable gifts).H’s adjusted taxable gifts of $2,000,000 were reducedfor purposes of this computation by $1,000,000, theamount of taxable gifts on which gift taxes were paid.

Example 3. Computation of DSUE amount whenQDOT created. (i) Facts. Husband (H), a US citi-zen, makes his first taxable gift in 2002, valued at$1,000,000, and reports the gift on a timely-filed gifttax return. No gift tax is due because the applicableexclusion amount for that year ($1,000,000) equalsthe fair market value of the gift. H dies in 2011 witha gross estate of $2,000,000. H’s wife (W) is a USresident but not a citizen of the United States and,under H’s will, a pecuniary bequest of $1,500,000passes to a QDOT for the benefit of W. H’s ex-ecutor timely files an estate tax return and makesthe QDOT election for the property passing to theQDOT, and H’s estate is allowed a marital deductionof $1,500,000 under section 2056(d) for the valueof that property. H’s taxable estate is $500,000. OnH’s estate tax return, H’s executor computes H’spreliminary DSUE amount to be $3,500,000 (thelesser of the $5,000,000 basic exclusion amount in2011, or the excess of H’s $5,000,000 applicable ex-clusion amount over the sum of the $500,000 taxableestate and the $1,000,000 adjusted taxable gifts). Notaxable events within the meaning of section 2056Aoccur during W’s lifetime with respect to the QDOT,and W makes no taxable gifts. In 2012, W dies andthe value of the assets of the QDOT is $1,800,000.

(ii) Application. H’s DSUE amount is redeter-mined to be $1,700,000 (the lesser of the $5,000,000basic exclusion amount in 2011, or the excess ofH’s $5,000,000 applicable exclusion amount over$3,300,000 (the sum of the $500,000 taxable estateaugmented by the $1,800,000 of QDOT assets andthe $1,000,000 adjusted taxable gifts)).

(d) Authority to examine returns ofdecedent. The IRS may examine returns ofa decedent in determining the decedent’sDSUE amount, regardless of whether theperiod of limitations on assessment has ex-pired for that return. See §20.2010–3T(d)for additional rules relating to the IRS’sauthority to examine returns. See alsosection 7602 for the IRS’s authority, whenascertaining the correctness of any return,to examine any returns that may be rele-vant or material to such inquiry.

(e) Effective/applicability date. Thissection applies to the estates of decedents

dying in calendar year 2011 or a subse-quent year in which the applicable exclu-sion amount is determined under section2010(c) of the Code by adding the basicexclusion amount and, in the case of a sur-viving spouse, the DSUE amount.

(f) Expiration date. The applicability ofthis section expires on or before June 15,2015.

Par. 6. Section 20.2010–3T is added toread as follows:

§20.2010–3T Portability provisionsapplicable to the surviving spouse’s estate(temporary).

(a) Surviving spouse’s estate lim-ited to DSUE amount of last deceasedspouse—(1) In general. A deceasedspousal unused exclusion (DSUE)amount of a decedent, computed under§20.2010–2T(c), is included in determin-ing a surviving spouse’s applicable ex-clusion amount under section 2010(c)(2),provided—

(i) Such decedent is the last deceasedspouse of such surviving spouse within themeaning of §20.2010–1T(d)(5) on the dateof the death of the surviving spouse; and

(ii) The executor of the dece-dent’s estate elected portability (see§20.2010–2T(a) and (b) for applicablerequirements).

(2) No DSUE amount available fromlast deceased spouse. If the last deceasedspouse of such surviving spouse had noDSUE amount, or if the executor of sucha decedent’s estate did not make a porta-bility election, the surviving spouse’s es-tate has no DSUE amount (except as pro-vided in paragraph (b)(1)(ii) of this sec-tion) to be included in determining theapplicable exclusion amount, even if thesurviving spouse previously had a DSUEamount available from another decedentwho, prior to the death of the last deceasedspouse, was the last deceased spouse ofsuch surviving spouse. See paragraph (b)of this section for a special rule in the caseof multiple deceased spouses and a previ-ously-applied DSUE amount.

(3) Identity of last deceased spouse un-changed by subsequent marriage or di-vorce. A decedent is the last deceasedspouse (as defined in §20.2010–1T(d)(5))of a surviving spouse even if, on the date ofthe death of the surviving spouse, the sur-viving spouse is married to another (then-

living) individual. If a surviving spousemarries again and that marriage ends indivorce or an annulment, the subsequentdeath of the divorced spouse does not endthe status of the prior deceased spouse asthe last deceased spouse of the survivingspouse. The divorced spouse, not beingmarried to the surviving spouse at death,is not the last deceased spouse as that termis defined in §20.2010–1T(d)(5).

(b) Special rule in case of multipledeceased spouses and previously-appliedDSUE amount—(1) In general. A spe-cial rule applies to compute the DSUEamount included in the applicable exclu-sion amount of a surviving spouse whopreviously has applied the DSUE amountof one or more deceased spouses to taxablegifts in accordance with §25.2505–2T(b)and (c) of this chapter. If a survivingspouse has applied the DSUE amountof one or more last deceased spouses tothe surviving spouse’s transfers duringlife, and if any of those last deceasedspouses is different from the survivingspouse’s last deceased spouse as definedin §20.2010–1T(d)(5) at the time of thesurviving spouse’s death, then the DSUEamount to be included in determining theapplicable exclusion amount of the sur-viving spouse at the time of the survivingspouse’s death is the sum of—

(i) The DSUE amount of the survivingspouse’s last deceased spouse as describedin paragraph (a)(1) of this section; and

(ii) The DSUE amount of each other de-ceased spouse of the surviving spouse, tothe extent that such amount was applied toone or more taxable gifts of the survivingspouse.

(2) Example. The following example,in which all described individuals are UScitizens, illustrates the application of thisparagraph (b):

Example. (i) Facts. Husband 1 (H1) dies on Jan-uary 15, 2011, survived by Wife (W). Neither hasmade any taxable gifts during H1’s lifetime. H1’s ex-ecutor elects portability of H1’s DSUE amount. TheDSUE amount of H1 as computed on the estate taxreturn filed on behalf of H1’s estate is $5,000,000.On December 31, 2011, W makes taxable gifts to herchildren valued at $2,000,000. W reports the giftson a timely-filed gift tax return. W is consideredto have applied $2,000,000 of H1’s DSUE amountto the amount of taxable gifts, in accordance with§25.2505–2T(c), and, therefore, W owes no gift tax.W has an applicable exclusion amount remaining inthe amount of $8,000,000 ($3,000,000 of H1’s re-maining DSUE amount plus W’s own $5,000,000 ba-sic exclusion amount). After the death of H1, W mar-

2012–28 I.R.B. 28 July 9, 2012

ries Husband 2 (H2). H2 dies in June 2012. H2’sexecutor elects portability of H2’s DSUE amount,which is properly computed on H2’s estate tax returnto be $2,000,000. W dies in October 2012.

(ii) Application. The DSUE amount to be in-cluded in determining the applicable exclusionamount available to W’s estate is $4,000,000, deter-mined by adding the $2,000,000 DSUE amount ofH2 and the $2,000,000 DSUE amount of H1 that wasapplied by W to W’s 2011 taxable gifts. Thus, W’sapplicable exclusion amount is $9,000,000.

(c) Date DSUE amount taken intoconsideration by surviving spouse’s es-tate—(1) General rule. A portabilityelection made by an executor of a dece-dent’s estate (see §20.2010–2T(a) and (b)for applicable requirements) applies as ofthe date of the decedent’s death. Thus,the decedent’s DSUE amount is includedin the applicable exclusion amount of thedecedent’s surviving spouse under section2010(c)(2) and will be applicable to trans-fers made by the surviving spouse afterthe decedent’s death. However, such dece-dent’s DSUE amount will not be includedin the applicable exclusion amount of thesurviving spouse, even if the survivingspouse had made a transfer in relianceon the availability or computation of thedecedent’s DSUE amount:

(i) If the executor of the decedent’s es-tate supersedes the portability election byfiling a subsequent estate tax return in ac-cordance with §20.2010–2T(a)(4);

(ii) To the extent that the DSUE amountsubsequently is reduced by a valuation ad-justment or the correction of an error incalculation; or

(iii) To the extent that the survivingspouse cannot substantiate the DSUEamount claimed on the surviving spouse’sreturn.

(2) Special rule when property passesto surviving spouse in a qualified domestictrust. When property passes from a dece-dent for the benefit of a surviving spousein one or more qualified domestic trusts(QDOT) as defined in section 2056A(a)and the decedent’s executor elects porta-bility, the DSUE amount available tobe included in the applicable exclusionamount of the surviving spouse under sec-tion 2010(c)(2) is the DSUE amount of thedecedent as redetermined in accordancewith §20.2010–2T(c)(4). The earliest dateon which the decedent’s DSUE amountmay be included in the applicable exclu-sion amount of the surviving spouse undersection 2010(c)(2) is the date of the oc-

currence of the final QDOT distributionor final other event (generally, the deathof the surviving spouse or the earlier ter-mination of all QDOTs for that survivingspouse) on which tax under section 2056Ais imposed. However, the decedent’sDSUE amount as redetermined in accor-dance with §20.2010–2T(c)(4) may beapplied to certain taxable gifts of the sur-viving spouse. See §25.2505–2T(d)(2)(i)of this chapter.

(d) Authority to examine returns of de-ceased spouses. For the purpose of deter-mining the DSUE amount to be included inthe applicable exclusion amount of the sur-viving spouse, the Internal Revenue Ser-vice (IRS) may examine returns of eachof the surviving spouse’s deceased spouseswhose DSUE amount is claimed to be in-cluded in the surviving spouse’s applicableexclusion amount, regardless of whetherthe period of limitations on assessment hasexpired for any such return. The IRS’s au-thority to examine returns of a deceasedspouse applies with respect to each transferby the surviving spouse to which a DSUEamount is or has been applied. Upon ex-amination, the IRS may adjust or eliminatethe DSUE amount reported on such a re-turn; however, the IRS may assess addi-tional tax on that return only if that tax isassessed within the period of limitations onassessment under section 6501 applicableto the tax shown on that return. See alsosection 7602 for the IRS’s authority, whenascertaining the correctness of any return,to examine any returns that may be rele-vant or material to such inquiry. For pur-poses of these examinations to determinethe DSUE amount, the surviving spouseis considered to have a material interestthat is affected by the return informationof the deceased spouse within the meaningof section 6103(e)(3).

(e) Availability of DSUE amount forestates of nonresidents who are not cit-izens. The estate of a nonresident sur-viving spouse who is not a citizen of theUnited States at the time of such survivingspouse’s death shall not take into accountthe DSUE amount of any deceased spouseof such surviving spouse within the mean-ing of §20.2010–1T(d)(5) except to the ex-tent allowed under any applicable treatyobligation of the United States. See sec-tion 2102(b)(3).

(f) Effective/applicability date. Thissection applies to the estates of decedents

dying in calendar year 2011 or a subse-quent year in which the applicable exclu-sion amount is determined under section2010(c) of the Code by adding the basicexclusion amount and, in the case of a sur-viving spouse, the DSUE amount.

(g) Expiration date. The applicabilityof this section expires on or before June 15,2015.

PART 25—GIFT TAX; GIFTS MADEAFTER DECEMBER 31, 1954

Par. 7. The authority citation for part25 is amended by adding an entry in nu-merical order to read as follows:

Authority: 26 U.S.C. 7805. * * *Section 25.2505–2T also issued under

26 U.S.C. 2010(c)(6). * * *Par. 8. Section 25.2505–0T is added to

read as follows:

§25.2505–0T Table of contents(temporary).

This section lists the table of contentsfor §§25.2505–1T and 25.2505–2T.

§25.2505–1T Unified credit against gifttax; in general (temporary).

(a) General rule.(b) Applicable rate of tax.(c) Special rule in case of certain gifts

made before 1977.(d) Credit limitation.(e) Effective/applicability date.(f) Expiration date.

§25.2505–2T Gifts made by a survivingspouse having a DSUE amount available(temporary).

(a) Donor who is surviving spouse islimited to DSUE amount of last deceasedspouse.

(1) In general.(2) No DSUE amount available from

last deceased spouse.(3) Identity of last deceased spouse

unchanged by subsequent marriage or di-vorce.

(b) Manner in which DSUE amount isapplied.

(c) Special rule in case of multipledeceased spouses and previously-appliedDSUE amount.

(1) In general.(2) Example.

July 9, 2012 29 2012–28 I.R.B.

(d) Date DSUE amount taken into con-sideration by donor who is a survivingspouse.

(1) General rule.(2) Special rule when property passes

to surviving spouse in a qualified domestictrust.

(e) Authority to examine returns of de-ceased spouses.

(f) Availability of DSUE amount fornonresidents who are not citizens.

(g) Effective/applicability date.(h) Expiration date.Par. 9. Section 25.2505–1T is added to

read as follows:

§25.2505–1T Unified credit against gifttax; in general (temporary).

(a) General rule. Section 2505(a) al-lows a citizen or resident of the UnitedStates a credit against the tax imposed bysection 2501 for each calendar year. Theallowable credit is the applicable creditamount in effect under section 2010(c) thatwould apply if the donor died as of the endof the calendar year, reduced by the sum ofthe amounts allowable as a credit againstthe gift tax due for all preceding calendarperiods. See §§25.2505–2T, 20.2010–1T,and 20.2010–2T of this chapter for addi-tional rules and definitions related to de-termining the applicable credit amount ineffect under section 2010(c).

(b) Applicable rate of tax. In deter-mining the amounts allowable as a creditagainst the gift tax due for all precedingcalendar periods, the unified rate sched-ule under section 2001(c) in effect for suchcalendar year applies instead of the ratesof tax actually in effect for preceding cal-endar periods. See sections 2505(a) and2502(a)(2).

(c) Special rule in case of certain giftsmade before 1977. The applicable creditamount allowable under paragraph (a) ofthis section must be reduced by an amountequal to 20 percent of the aggregateamount allowed as a specific exemptionunder section 2521 (as in effect before itsrepeal by the Tax Reform Act of 1976) forgifts made by the decedent after Septem-ber 8, 1976, and before January 1, 1977.

(d) Credit limitation. The applicablecredit amount allowed under paragraph (a)of this section for any calendar year shallnot exceed the amount of the tax imposedby section 2501 for such calendar year.

(e) Effective/applicability date. Para-graph (a) of this section applies to giftsmade on or after January 1, 2011. Para-graphs (b), (c), and (d) of this section ap-ply to gifts made on or after June 15, 2012.

(f) Expiration date. The applicability ofthis section expires on or before June 15,2015.

Par. 10. Section 25.2505–2T is addedto read as follows:

§25.2505–2T Gifts made by a survivingspouse having a DSUE amount available(temporary).

(a) Donor who is surviving spouse islimited to DSUE amount of last deceasedspouse—(1) In general. In computing asurviving spouse’s gift tax liability with re-gard to a transfer subject to the tax im-posed by section 2501 (taxable gift), a de-ceased spousal unused exclusion (DSUE)amount of a decedent, computed under§20.2010–2T(c) of this chapter, is includedin determining the surviving spouse’s ap-plicable exclusion amount under section2010(c)(2), provided:

(i) Such decedent is the last deceasedspouse of such surviving spouse withinthe meaning of §20.2010–1T(d)(5) ofthis chapter at the time of the survivingspouse’s taxable gift; and

(ii) The executor of the dece-dent’s estate elected portability (see§20.2010–2T(a) and (b) of this chapter forapplicable requirements).

(2) No DSUE amount available fromlast deceased spouse. If on the date ofthe surviving spouse’s taxable gift the lastdeceased spouse of such surviving spousehad no DSUE amount or if the executor ofthe estate of such last deceased spouse didnot elect portability, the surviving spousehas no DSUE amount (except as and to theextent provided in paragraph (c)(1)(ii) ofthis section) to be included in determin-ing his or her applicable exclusion amount,even if the surviving spouse previouslyhad a DSUE amount available from an-other decedent who, prior to the death ofthe last deceased spouse, was the last de-ceased spouse of such surviving spouse.See paragraph (c) of this section for a spe-cial rule in the case of multiple deceasedspouses.

(3) Identity of last deceased spouseunchanged by subsequent marriage ordivorce. A decedent is the last deceased

spouse (as defined in §20.2010–1T(d)(5)of this chapter) of a surviving spouse evenif, on the date of the surviving spouse’staxable gift, the surviving spouse is mar-ried to another (then-living) individual.If a surviving spouse marries again andthat marriage ends in divorce or an annul-ment, the subsequent death of the divorcedspouse does not end the status of theprior deceased spouse as the last deceasedspouse of the surviving spouse. The di-vorced spouse, not being married to thesurviving spouse at death, is not the lastdeceased spouse as that term is defined in§20.2010–1T(d)(5) of this chapter.

(b) Manner in which DSUE amountis applied. If a donor who is a survivingspouse makes a taxable gift and a DSUEamount is included in determining thesurviving spouse’s applicable exclusionamount under section 2010(c)(2), suchsurviving spouse will be considered to ap-ply such DSUE amount to the taxable giftbefore the surviving spouse’s own basicexclusion amount.

(c) Special rule in case of multipledeceased spouses and previously-appliedDSUE amount—(1) In general. A spe-cial rule applies to compute the DSUEamount included in the applicable exclu-sion amount of a surviving spouse whopreviously has applied the DSUE amountof one or more deceased spouses. If a sur-viving spouse applied the DSUE amountof one or more last deceased spouses tothe surviving spouse’s previous lifetimetransfers, and if any of those last deceasedspouses is different from the survivingspouse’s last deceased spouse as definedin §20.2010–1T(d)(5) of this chapter at thetime of the current taxable gift by the sur-viving spouse, then the DSUE amount tobe included in determining the applicableexclusion amount of the surviving spousethat will be applicable at the time of thecurrent taxable gift is the sum of—

(i) The DSUE amount of the survivingspouse’s last deceased spouse as describedin paragraph (a)(1) of this section; and

(ii) The DSUE amount of each otherdeceased spouse of the surviving spouse tothe extent that such amount was applied toone or more previous taxable gifts of thesurviving spouse.

(2) Example. The following example,in which all described individuals are UScitizens, illustrates the application of thisparagraph (c):

2012–28 I.R.B. 30 July 9, 2012

Example. (i) Facts. Husband 1 (H1) dies onJanuary 15, 2011, survived by Wife (W). Neitherhas made any taxable gifts during H1’s lifetime.H1’s executor elects portability of H1’s deceasedspousal unused exclusion (DSUE) amount. TheDSUE amount of H1 as computed on the estate taxreturn filed on behalf of H1’s estate is $5,000,000.On December 31, 2011, W makes taxable gifts to herchildren valued at $2,000,000. W reports the giftson a timely-filed gift tax return. W is considered tohave applied $2,000,000 of H1’s DSUE amount tothe 2011 taxable gifts, in accordance with paragraph(b) of this section, and, therefore, W owes no gifttax. W is considered to have an applicable exclusionamount remaining in the amount of $8,000,000($3,000,000 of H1’s remaining DSUE amount plusW’s own $5,000,000 basic exclusion amount). Afterthe death of H1, W marries Husband 2 (H2). H2 dieson June 30, 2012. H2’s executor elects portability ofH2’s DSUE amount, which is properly computed onH2’s estate tax return to be $2,000,000.

(ii) Application. The DSUE amount to be in-cluded in determining the applicable exclusionamount available to W for gifts during the secondhalf of 2012 is $4,000,000, determined by adding the$2,000,000 DSUE amount of H2 and the $2,000,000DSUE amount of H1 that was applied by W to W’s2011 taxable gifts. Thus, W’s applicable exclusionamount during the balance of 2012 is $9,000,000.

(d) Date DSUE amount taken into con-sideration by donor who is a survivingspouse—(1) General rule. A portabil-ity election made by an executor of adecedent’s estate (see §20.2010–2T(a)and (b) of this chapter for applicable re-quirements) applies as of the date of thedecedent’s death. Thus, the decedent’sDSUE amount is included in the appli-cable exclusion amount of the decedent’ssurviving spouse under section 2010(c)(2)and will be applicable to transfers made bythe surviving spouse after the decedent’sdeath. However, such decedent’s DSUEamount will not be included in the appli-cable exclusion amount of the survivingspouse, even if the surviving spouse hadmade a taxable gift in reliance on the avail-ability or computation of the decedent’sDSUE amount:

(i) If the executor of the decedent’s es-tate supersedes the portability election byfiling a subsequent estate tax return in ac-cordance with §20.2010–2T(a)(4) of thischapter;

(ii) To the extent that the DSUE amountsubsequently is reduced by a valuation ad-justment or the correction of an error incalculation; or

(iii) To the extent that the DSUEamount claimed on the decedent’s returncannot be determined.

(2) Special rule when property passesto surviving spouse in a qualified domes-tic trust—(i) In general. When propertypasses from a decedent for the benefit ofa surviving spouse in one or more quali-fied domestic trusts (QDOT) as defined insection 2056A(a) and the decedent’s ex-ecutor elects portability, the DSUE amountavailable to be included in the applicableexclusion amount of the surviving spouseunder section 2010(c)(2) is the DSUEamount of the decedent as redeterminedin accordance with §20.2010–2T(c)(4) ofthis chapter. The earliest date on whichthe decedent’s DSUE amount may be in-cluded in the applicable exclusion amountof the surviving spouse under section2010(c)(2) is the date of the occurrenceof the final QDOT distribution or finalother event (generally, the death of thesurviving spouse or the earlier terminationof all QDOTs for that surviving spouse)on which tax under section 2056A is im-posed. However, the decedent’s DSUEamount as redetermined in accordancewith §20.2010–2T(c)(4) of this chaptermay be applied to the surviving spouse’staxable gifts made in the year of thesurviving spouse’s death, or if the termi-nating event occurs prior to the survivingspouse’s death, then in the year of thatterminating event and/or any subsequentyear during the surviving spouse’s life.

(ii) Example. The following exampleillustrates the application of this paragraph(d)(2):

Example. (i) Facts. Husband (H), a US citizen,dies in January 2011 having made no taxable giftsduring his lifetime. H’s gross estate is $3,000,000.H’s wife (W) is a US resident but not a citizen of theUnited States and, under H’s will, a pecuniary bequestof $2,000,000 passes to a QDOT for the benefit ofW. H’s executor timely files an estate tax return andmakes the QDOT election for the property passing tothe QDOT, and H’s estate is allowed a marital deduc-tion of $2,000,000 under section 2056(d) for the valueof that property. H’s taxable estate is $1,000,000. OnH’s estate tax return, H’s executor computes H’s pre-liminary DSUE amount to be $4,000,000. No tax-able events within the meaning of section 2056A oc-cur during W’s lifetime with respect to the QDOT. Wmakes a taxable gift of $1,000,000 to X in December2011 and a taxable gift of $1,000,000 to Y in January2012. W dies in September 2012, not having marriedagain, when the value of the assets of the QDOT is$2,200,000.

(ii) Application. H’s DSUE amount is redeter-mined to be $1,800,000 (the lesser of the $5,000,000basic exclusion amount in 2011, or the excess ofH’s $5,000,000 applicable exclusion amount over$3,200,000 (the sum of the $1,000,000 taxable estateaugmented by the $2,200,000 of QDOT assets)). On

W’s gift tax return filed for 2011, W cannot applyany DSUE amount to the gift made to X. However,because W’s gift to Y was made in the year thatW died, W’s executor will apply $1,000,000 of H’sredetermined DSUE amount to the gift on W’s gifttax return filed for 2012. The remaining $800,000 ofH’s redetermined DSUE amount is included in W’sapplicable exclusion amount to be used in computingW’s estate tax liability.

(e) Authority to examine returns of de-ceased spouses. For the purpose of deter-mining the DSUE amount to be included inthe applicable exclusion amount of the sur-viving spouse, the Internal Revenue Ser-vice (IRS) may examine returns of eachof the surviving spouse’s deceased spouseswhose DSUE amount is claimed to be in-cluded in the surviving spouse’s applicableexclusion amount, regardless of whetherthe period of limitations on assessment hasexpired for any such return. The IRS’s au-thority to examine returns of a deceasedspouse applies with respect to each transferby the surviving spouse to which a DSUEamount is or has been applied. Upon ex-amination, the IRS may adjust or eliminatethe DSUE amount reported on such a re-turn; however, the IRS may assess addi-tional tax on that return only if that tax isassessed within the period of limitations onassessment under section 6501 applicableto the tax shown on that return. See alsosection 7602 for the IRS’s authority, whenascertaining the correctness of any return,to examine any returns that may be rele-vant or material to such inquiry.

(f) Availability of DSUE amount fornonresidents who are not citizens. A non-resident surviving spouse who was nota citizen of the United States at the timeof making a transfer subject to tax underchapter 12 of the Internal Revenue Codeshall not take into account the DSUEamount of any deceased spouse except tothe extent allowed under any applicabletreaty obligation of the United States. Seesection 2102(b)(3).

(g) Effective/applicability date. Thissection applies to gifts made in calendaryear 2011 or in a subsequent year in whichthe applicable exclusion amount is deter-mined under section 2010(c) of the Codeby adding the basic exclusion amountand, in the case of a surviving spouse, theDSUE amount.

(h) Expiration date. The applicabilityof this section expires on or before June 15,2015.

July 9, 2012 31 2012–28 I.R.B.

PART 602—OMB CONTROLNUMBERS UNDER THE PAPERWORKREDUCTION ACT

Par. 11. The authority citation for part602 continues to read as follows:

Authority: 26 U.S.C. 7805.Par. 12. In §602.101, paragraph (b)

is amended by adding the following entryin numerical order to the table to read asfollows:

§602.101 OMB Control numbers.

* * * * *(b) * * *

CFR part or section whereidentified and described

Current OMBControl No.

* * * * *20.2010–2T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–0015* * * * *

Steven T. Miller,Deputy Commissioner forServices and Enforcement.

Approved June 12, 2012.

Emily S. McMahon,Acting Assistant Secretary

of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on June 15, 2012,8:45 a.m., and published in the issue of the Federal Registerfor June 18, 2012, 77 F.R. 36150)

Section 7874.—RulesRelating to ExpatriatedEntities and Their ForeignParents26 CFR 1.7874–2: Surrogate foreign corporations.

T.D. 9591

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Part 1

Surrogate ForeignCorporations

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document containsfinal regulations regarding whether a for-eign corporation is treated as a surrogateforeign corporation. The final regulationsaffect certain domestic corporations andpartnerships (and certain parties relatedthereto), and foreign corporations thatacquire substantially all of the properties

of such domestic corporations or partner-ships.

DATES: Effective Date: These regulationsare effective on June 12, 2012.

Applicability Dates: For dates ofapplicability, see §§1.7874–1(g) and1.7874–2(l).

FOR FURTHER INFORMATIONCONTACT: Milton M. Cahn, (202)622–3860 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On June 6, 2006, temporary regula-tions under section 7874 of the InternalRevenue Code (Code) (T.D. 9265, 2006–2C.B. 1) were published in the FederalRegister (71 FR 32437) concerning thetreatment of a foreign corporation asa surrogate foreign corporation (2006temporary regulations). A notice of pro-posed rulemaking (REG–112994–06,2006–2 C.B. 47) cross-referencing the2006 temporary regulations was publishedin the same issue of the Federal Regis-ter (71 FR 32495). On July 28, 2006,Notice 2006–70, 2006–2 C.B. 252, waspublished, announcing a modificationto the effective date contained in the2006 temporary regulations. See§601.601(d)(2)(ii)(b). On June 12, 2009,the 2006 temporary regulations and therelated notice of proposed rulemakingwere withdrawn and replaced with newtemporary regulations (2009 temporaryregulations), which generally applied toacquisitions completed on or after June 9,2009. T.D. 9453, 2009–28 I.R.B. 114(74 FR 27920). A notice of proposedrulemaking (REG–112994–06, 2009–28I.R.B. 144) cross-referencing the 2009

temporary regulations was published inthe same issue of the Federal Register(74 FR 27947). No public hearing wasrequested or held; however, commentswere received. All comments are availableat www.regulations.gov or upon request.After consideration of the comments, the2009 proposed regulations are adopted asfinal regulations with the modificationsdescribed in this preamble. The 2009temporary regulations are removed.As discussed in paragraph A. of thispreamble, new temporary regulationsunder section 7874 regarding whethera foreign corporation has substantialbusiness activities in a foreign country,and a corresponding notice of proposedrulemaking, are published elsewhere inthis issue of the Bulletin.

Summary of Comments andExplanation of Revisions

A. Substantial Business Activities

A foreign corporation is generallytreated as a surrogate foreign corporationunder section 7874(a)(2)(B) if pursuant toa plan (or a series of related transactions):(i) the foreign corporation completes afterMarch 4, 2003, the direct or indirect acqui-sition of substantially all of the propertiesheld directly or indirectly by a domesticcorporation; (ii) after the acquisition atleast 60 percent of the stock (by vote orvalue) of the foreign corporation is heldby former shareholders of the domesticcorporation by reason of holding stock inthe domestic corporation; and (iii) after theacquisition, the expanded affiliated groupthat includes the foreign corporation doesnot have substantial business activitiesin the foreign country (relevant foreigncountry) in which, or under the law of

2012–28 I.R.B. 32 July 9, 2012

which, the foreign corporation is createdor organized, when compared to the totalbusiness activities of the expanded affili-ated group. Similar provisions apply if aforeign corporation acquires substantiallyall of the properties constituting a trade orbusiness of a domestic partnership.

The 2006 temporary regulations pro-vided that the determination of whether theexpanded affiliated group has substantialbusiness activities in the relevant foreigncountry is based on all the facts and cir-cumstances. The 2006 temporary regula-tions also provided a safe harbor, whichgenerally was satisfied if at least ten per-cent of the employees, assets, and sales ofthe expanded affiliated group were in therelevant foreign country. The 2009 tem-porary regulations retained the facts andcircumstances general rule provided in the2006 temporary regulations, with certainmodifications, but removed the safe har-bor.

Comments were received regarding thedetermination as to whether an expandedaffiliated group has substantial businessactivities in a foreign country. Thesecomments are discussed in the preambleto temporary regulations, published else-where in this issue of the Bulletin, thatprovide guidance on the substantial busi-ness activities test.

B. Options

1. General approach

The 2009 temporary regulations gen-erally provide that, for purposes of sec-tion 7874, an option or similar interest (to-gether, an “option”) with respect to a cor-poration is treated as stock of the corpo-ration with a value equal to the holder’sclaim on the equity of the corporation. Forthis purpose, the equity of the corporationdoes not include the value of any prop-erty the holder of the option would be re-quired to provide to the corporation pur-suant to the terms of the option if such op-tion were exercised. The 2009 temporaryregulations provide similar rules for an op-tion with respect to a partnership.

A comment suggested that, subject toan anti-abuse rule, options should be ig-nored for purposes of section 7874. Thecomment asserts that this approach, con-sistent with the treatment of options un-der other Code sections, would be more

administrable; the comment recognized,however, that unlike the approach taken inthe 2009 temporary regulations, this ap-proach does not properly take into accountthe economic interest of an option holder.Alternatively, the comment suggested thatif the approach taken in the 2009 tempo-rary regulations is retained, certain typesof options (for example, publicly tradedoptions and customary compensatory op-tions) should be excluded from the generalrule.

The Internal Revenue Service (IRS) andthe Department of the Treasury (TreasuryDepartment) believe that the claim-on-eq-uity approach in the 2009 temporaryregulations is preferable to disregardingoptions subject to an anti-avoidance rule.The IRS and the Treasury Department be-lieve this approach most properly reflectsthe economics of the transaction and is noteasily manipulated. Moreover, the IRSand the Treasury Department believe thatthe simplicity of uniformly treating alltypes of options outweighs the benefits ofexcluding, or providing other special rulesfor, certain types of options. Accordingly,the claim-on-equity approach provided inthe 2009 temporary regulations is retained,with certain modifications, in these finalregulations.

2. Voting power

Certain portions of section 7874 alsolook to the voting power of stock. For ex-ample, one of the requirements for a for-eign corporation to be treated as a surro-gate foreign corporation is that, after theacquisition, at least 60 percent of the stock(by vote or value) of the entity is held, inthe case of an acquisition with respect toa domestic corporation, by former share-holders of the domestic corporation by rea-son of holding stock in the domestic corpo-ration. Section 7874(a)(2)(B)(ii). As dis-cussed in section B.1. of this preamble,however, the 2009 temporary regulationsonly address options with respect to theamount of stock treated as held by value;they do not address the effect of options onvoting power.

A comment suggested that if the generalapproach of the 2009 temporary regula-tions is retained, the effect options have onvoting power, if any, should be addressed.Specifically, the comment suggested thatoptions could be treated as: (i) not hav-

ing voting power; (ii) having voting powercorresponding to the number of shares thevalue of which equals the claim on equity;or (iii) having voting power correspondingto the number of shares that would be ob-tained upon exercise of the option.

In response to this comment, the finalregulations provide that for purposes of de-termining the voting power of stock un-der section 7874, an option will be treatedas exercised if a principal purpose of theissuance or acquisition of the option isto avoid treating the foreign corporationas a surrogate foreign corporation. In allother cases, options are not taken into ac-count for purposes of determining the vot-ing power of stock under section 7874.

3. Effect of options on equity holders

A comment requested clarification thatif an option is treated as stock under theclaim-on-equity approach, then the own-ership percentages of shareholders are re-duced. The IRS and the Treasury Depart-ment believe that the value of stock inher-ently reflects the existence of options thathave a claim on equity. Therefore, no ad-justment to the value of stock under theregulations is necessary. For example, ifthe stock of a foreign corporation has anaggregate value of $100x (which reflectsthe existence of options) and there is a sin-gle option outstanding with a claim on eq-uity of $10x with respect to the foreign cor-poration, then under the regulations the to-tal value of the stock of the foreign corpo-ration is treated as $110x for purposes ofsection 7874. An example in the regula-tions is modified to clarify this result.

4. Other rules

The 2009 temporary regulations pro-vide that, with respect to a foreign corpo-ration, the general option rule does not ap-ply if a principal purpose of the issuanceor acquisition of the option is to avoid theforeign corporation being treated as a sur-rogate foreign corporation. The 2009 tem-porary regulations do not contain a similarrule with respect to domestic corporationsor domestic partnerships.

A comment questioned why the anti-abuse rule only applies to foreign corpo-rations and noted that avoidance concernsmay equally be present with options in do-mestic corporations or partnerships. Ac-cordingly, the comment suggested that the

July 9, 2012 33 2012–28 I.R.B.

anti-abuse rule be extended to apply to op-tions with respect to domestic corporationsand domestic partnerships. The IRS andthe Treasury Department agree with thiscomment. As a result, the final regulationsmodify the anti-abuse rule such that it ap-plies to options with respect to all corpo-rations and partnerships, domestic or for-eign.

Another comment suggested that theregulations include special rules to takeinto account certain types of options, suchas options subject to vesting and nontrans-ferable options. In response to this com-ment, the final regulations provide that theclaim-on-equity approach does not applyif, at the time of the acquisition, the prob-ability that the option will be exercised isremote.

The final regulations clarify that therules addressing options also apply for pur-poses of determining the membership ofan expanded affiliated group under section7874(c)(1). In addition, the text of the fi-nal regulations is clarified to provide thata claim on equity equals the value of thestock or partnership interest that may beacquired pursuant to the option, less the ex-ercise price (but in no case is a claim onequity less than zero).

C. Insolvent Entities

The 2009 temporary regulations pro-vide that, for purposes of section 7874, ifimmediately prior to the first date proper-ties are acquired as part of an acquisitiondescribed in section 7874(a)(2)(B)(i), a do-mestic corporation is in a title 11 or simi-lar case (as defined in section 368(a)(3)),or the liabilities of the domestic corpora-tion exceed the value of its assets, then anyclaim by a creditor against the domesticcorporation shall be treated as stock of thedomestic corporation. A similar rule ap-plies with respect to a domestic partner-ship, or a foreign partnership that ownsstock of a domestic corporation.

A comment was received stating that,in certain cases, the creditors should beviewed as purchasers of the insolvent en-tity’s assets and, as a result, the transactionshould not be subject to section 7874. Thecomment further stated that applying sec-tion 7874 to such creditors could providethird-party bidders for the entity’s assetsan undue advantage over existing creditorsbecause such bidders would not be subject

to section 7874. Accordingly, the com-ment suggested that the insolvency rule bemodified to only apply where creditors ac-quire the insolvent entity’s debt pursuant toa plan to acquire its stock or assets.

The IRS and the Treasury Departmentbelieve that, for purposes of section 7874,the creditors of an insolvent entity shouldbe considered the equity holders of the en-tity. Furthermore, the IRS and the Trea-sury Department do not believe that insol-vent entities should be treated more favor-ably than other entities under section 7874.Accordingly, this comment is not adopted.

D. Acquisitions of Multiple DomesticEntities and Disregard of Affiliate-OwnedStock

The 2009 temporary regulations gen-erally provide that if, pursuant to aplan (or series of related transactions),a foreign corporation completes twoor more acquisitions described in sec-tion 7874(a)(2)(B)(i) involving domesticcorporations or partnerships (domesticentities) then, for purposes of section7874(a)(2)(B)(ii), the acquisitions aretreated as a single acquisition and thedomestic entities are treated as a singledomestic entity.

Section 7874(c)(2)(A) and §1.7874–1provide special rules for determining own-ership under section 7874(a)(2)(B)(ii) forstock held by members of the expandedaffiliated group that includes the foreigncorporation. Section 7874(c)(2)(B) pro-vides that stock of the foreign corpora-tion that is sold in a public offering re-lated to the acquisition described in section7874(a)(2)(B)(i) is not taken into accountfor purposes of determining ownership un-der section 7874(a)(2)(B)(ii).

A comment requested clarification asto the application of section 7874(c)(2)(A)and §1.7874–1 when acquisitions of twoor more domestic entities are treated asa single domestic entity under the 2009temporary regulations. The IRS andthe Treasury Department are studyingthe manner in which §1.7874–1 shouldinteract with various rules under sec-tion 7874, including the rules in section7874(c)(2)(B), §1.7874–2(e), and Notice2009–78, 2009–40 I.R.B. 452 (determina-tion of the ownership fraction when stockis issued in exchange for certain typesof property). See §601.601(d)(2)(ii)(b).

Accordingly, no change has been madeto this regulation, but the IRS and theTreasury Department request commentsregarding the interaction of §1.7874–1 andother rules under section 7874 related tothe ownership fraction.

E. Downstream Transactions

The final regulations clarify that an ac-quisition by a corporation of its stock fromanother corporation or a partnership is anacquisition of the transferor’s propertiesfor purposes of section 7874(a)(2)(B)(i).This rule applies even though, for Fed-eral tax purposes, the acquired stock nolonger exists after the transaction. Thus,for example, if a domestic corporationthat holds stock in a foreign corporationmerges into the foreign corporation, theforeign corporation is, for purposes of sec-tion 7874(a)(2)(B)(i), treated as acquiringproperties of the domestic corporation inthe form of the foreign corporation’s stock.

Effective/Applicability Dates

These final regulations apply to acqui-sitions completed on or after June 7, 2012.

Special Analyses

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order12866. Therefore, a regulatory assessmentis not required. It has also been determinedthat section 553(b) of the AdministrativeProcedure Act (5 U.S.C. Chapter 5) doesnot apply to this regulation and becausethe regulation does not impose a collec-tion of information on small entities, therequirements of the Regulatory FlexibilityAct (5 U.S.C. 601 et seq.) do not apply.Pursuant to section 7805(f) of the Inter-nal Revenue Code, the notice of proposedrulemaking preceding this regulation wassubmitted to the Chief Counsel for Advo-cacy of the Small Business Administrationfor comment on its impact on small busi-ness.

Drafting Information

The principal author of these regula-tions is Milton M. Cahn of the Office ofAssociate Chief Counsel (International).However, other personnel from the IRSand the Treasury Department participatedin their development.

2012–28 I.R.B. 34 July 9, 2012

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 is amendedas follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 continues to read in part as follows:

Authority: 26 USC 7805 * * *Sections 1.7874–1 and 1.7874–2 also

issued under 26 U.S.C. 7874(c)(6) and (g).* * *

Par. 2 Section 1.7874–1 is amended by:1. Revising paragraph (e).2. Adding two sentences at the end of

paragraph (g).The revision and addition read as fol-

lows:

§1.7874–1 Disregard of affiliate-ownedstock.

* * * * *(e) Stock held by a partnership. For

purposes of this section, each partner in apartnership shall be treated as holding itsproportionate share of stock held by thepartnership, as determined under the rulesand principles of sections 701 through 777.

* * * * *(g) * * * Paragraph (e) of this section

shall apply to acquisitions completed on orafter June 7, 2012. See §1.7874–1T(e), ascontained in 26 CFR part 1 revised as ofApril 1, 2012, for acquisitions completedbefore June 7, 2012.

§1.7874–1T [Removed]

Par. 3. Section 1.7874–1T is removed.Par. 4. Section 1.7874–2 is added to

read as follows:

§1.7874–2 Surrogate foreign corporation.

(a) Scope. This section provides rulesfor determining whether a foreign corpora-tion is treated as a surrogate foreign corpo-ration under section 7874(a)(2)(B). Para-graph (b) of this section provides defini-tions and special rules. Paragraph (c) ofthis section provides rules to determinewhether a foreign corporation has acquiredproperties held by a domestic corporation(or a partnership). Paragraph (d) of thissection provides rules that apply when two

or more foreign corporations complete, inthe aggregate, an acquisition described insection 7874(a)(2)(B)(i). Paragraph (e)of this section provides rules that applywhen a single foreign corporation com-pletes more than one acquisition describedin section 7874(a)(2)(B)(i). Paragraph (f)of this section provides rules to identifythe stock of a foreign corporation that isheld by reason of holding stock in a domes-tic corporation (or an interest in a domes-tic partnership). Paragraph (g) of this sec-tion provides rules that treat certain pub-licly traded foreign partnerships as foreigncorporations for purposes of section 7874.Paragraph (h) of this section provides rulesconcerning the treatment of certain options(or similar interests) for purposes of sec-tion 7874. Paragraph (i) of this sectionprovides rules that treat certain interests(including debt, stock, or a partnership in-terest) as stock of a foreign corporation forpurposes of section 7874. Paragraph (j) ofthis section provides rules concerning theconversion of a foreign corporation to adomestic corporation by reason of section7874(b). Paragraph (k) of this section pro-vides examples that illustrate the rules ofthis section. Paragraph (l) of this sectionprovides the effective/applicability date ofthis section.

(b) Definitions and special rules. Ex-cept as otherwise indicated, the followingdefinitions and special rules apply for pur-poses of this section.

(1) The rules of this section are subjectto section 7874(c)(4).

(2) A former shareholder of a domes-tic corporation is any person that heldstock in the domestic corporation be-fore the acquisition described in section7874(a)(2)(B)(i), including any personthat holds stock in the domestic corpora-tion both before and after the acquisition.

(3) A former partner of a domesticpartnership is any person that held aninterest in the domestic partnership be-fore the acquisition described in section7874(a)(2)(B)(i), including any personthat holds an interest in the domesticpartnership both before and after the ac-quisition.

(4) An interest in a partnership includesa capital or profits interest.

(5) References to properties held bya domestic corporation include propertiesheld directly or indirectly by the domesticcorporation.

(6) The rules and principles of sec-tions 701 through 777 shall be applied forpurposes of determining a proportionateamount (or share) of properties held by apartnership (such as stock).

(7) Any reference to the acquisition ofproperties held by a domestic corporation(or a partnership) includes a direct or indi-rect acquisition of such properties.

(8) In the case of an acquisition of stockof a domestic corporation or an interest ina partnership, the proportionate amount ofproperties held by the domestic corpora-tion (or the partnership) that is treated asindirectly acquired shall, as applicable, bedetermined at the time of the acquisitionbased on the relative value of—

(i) The stock acquired compared to alloutstanding stock of the domestic corpora-tion; or

(ii) The interest acquired compared toall interests in the partnership.

(9) The determination of whether aforeign corporation is a surrogate foreigncorporation is made after the acquisitiondescribed in section 7874(a)(2)(B)(i). Aforeign corporation that is treated as asurrogate foreign corporation (including asurrogate foreign corporation treated as adomestic corporation described in section7874(b)) shall continue to be treated as asurrogate foreign corporation (or a domes-tic corporation), even if the conditions ofsection 7874(a)(2)(B)(ii) and (iii) are notsatisfied at a later date.

(c) Acquisition of properties—(1) In-direct acquisition of properties. Forpurposes of section 7874(a)(2)(B)(i), anindirect acquisition of properties held bya domestic corporation (or a partnership)includes, but is not limited to, the acqui-sitions described in paragraphs (c)(1)(i)through (iv) of this section. An acquisitionof less than all of the stock of a domesticcorporation (or interests in a partnership)shall constitute an indirect acquisition ofa proportionate amount of the propertiesheld by the domestic corporation or thepartnership. See paragraph (b)(8) of thissection for rules determining the propor-tionate amount of properties indirectlyacquired.

(i) An acquisition of stock of a domesticcorporation. See Example 1 of paragraph(k) of this section for an illustration of therules of this paragraph (c)(1)(i).

(ii) An acquisition of an interest in apartnership. See Example 2 of paragraph

July 9, 2012 35 2012–28 I.R.B.

(k) of this section for an illustration of therules of this paragraph (c)(1)(ii).

(iii) An acquisition by a corporation(acquiring corporation) of properties heldby a domestic corporation (or a partner-ship) in exchange for stock of a foreigncorporation (foreign issuing corporation)that is part of the expanded affiliated groupthat includes the acquiring corporation af-ter the acquisition shall be treated as anacquisition by the foreign issuing corpora-tion. See Example 3 of paragraph (k) ofthis section for an illustration of the rulesof this paragraph (c)(1)(iii).

(iv) An acquisition by a partnership (ac-quiring partnership) of properties held by adomestic corporation (or a partnership) inexchange for stock of a foreign corporationthat is part of the expanded affiliated groupthat would include the acquiring partner-ship after the acquisition (if the partnershipwere a corporation) shall be treated as anacquisition by the foreign issuing corpora-tion.

(2) Acquisition of stock of a foreign cor-poration. An acquisition of stock of a for-eign corporation that owns directly or indi-rectly stock of a domestic corporation (oran interest in a partnership) shall not con-stitute an indirect acquisition of any prop-erties held by the domestic corporation (orthe partnership). See Example 4 of para-graph (k) of this section for an illustrationof the rules of this paragraph (c)(2).

(3) Downstream transactions. An ac-quisition by a corporation of its stockfrom another corporation or a partnership(for example, as a result of a downstreammerger) is an acquisition of the other cor-poration’s or partnership’s properties forpurposes of section 7874(a)(2)(B)(i).

(d) Acquisitions by multiple foreign cor-porations. If, pursuant to a plan (or a se-ries of related transactions), two or moreforeign corporations complete, in the ag-gregate, an acquisition described in sec-tion 7874(a)(2)(B)(i), then each foreigncorporation shall be treated as completingthe acquisition for purposes of determiningwhether such foreign corporation is treatedas a surrogate foreign corporation. See Ex-amples 5 and 6 of paragraph (k) of thissection for illustrations of the rules of thisparagraph (d).

(e) Acquisitions of multiple domesticentities. If, pursuant to a plan (or a series ofrelated transactions), a foreign corporationcompletes two or more acquisitions de-

scribed in section 7874(a)(2)(B)(i) involv-ing domestic corporations and/or domesticpartnerships (domestic entities), then, forpurposes of section 7874(a)(2)(B)(ii), theacquisitions shall be treated as a single ac-quisition and the domestic entities shall betreated as a single domestic entity. If thetransaction involves one or more domes-tic corporations and one or more domesticpartnerships, the stock of the foreign cor-poration held by former shareholders andformer partners by reason of holding stockor a partnership interest in the domestic en-tities shall be aggregated for purposes ofdetermining whether the ownership condi-tion of section 7874(a)(2)(B)(ii) is satis-fied. See Example 7 of paragraph (k) ofthis section for an illustration of the rulesof this paragraph (e).

(f) Stock held by reason of holdingstock in a domestic corporation or aninterest in a domestic partnership—(1)Specified transactions. For purposes ofsection 7874(a)(2)(B)(ii), stock of a for-eign corporation that is held by reason ofholding stock in a domestic corporation(or an interest in a domestic partnership)includes, but is not limited to, the stockdescribed in paragraphs (f)(1)(i) through(iii) of this section.

(i) Stock of a foreign corporation re-ceived in exchange for, or with respect to,stock of a domestic corporation.

(ii) Stock of a foreign corporation re-ceived in exchange for, or with respect to,an interest in a domestic partnership.

(iii) To the extent that paragraph(f)(1)(ii) of this section does not apply,stock of a foreign corporation received bya domestic partnership in exchange for allor part of its properties. In such a case,each partner in the domestic partnershipshall be treated as holding its proportionateshare of the stock of the foreign corpora-tion by reason of holding an interest in thedomestic partnership.

(2) Transactions involving other prop-erty—(i) Stock of a domestic corporation.If, pursuant to the same transaction, stockof a foreign corporation is received in ex-change for, or with respect to, stock of adomestic corporation and other property,the stock of the foreign corporation thatwas received in exchange for, or with re-spect to, the stock of the domestic corpora-tion shall be determined based on the rela-tive value of the stock of the domestic cor-

poration compared to the aggregate valueof such stock and the other property.

(ii) Interest in a domestic partnership.If, pursuant to the same transaction, stockof a foreign corporation is received in ex-change for, or with respect to, an interestin a domestic partnership and other prop-erty, the stock of the foreign corporationthat was received in exchange for, or withrespect to, the interest in the domestic part-nership shall be determined based on therelative value of the interest in the domes-tic partnership compared to the aggregatevalue of such interest and the other prop-erty.

(3) See Examples 8 through 10 of para-graph (k) of this section for illustrations ofthe rules of this paragraph (f).

(g) Publicly traded foreign partner-ships—(1) Treatment as a foreign cor-poration. For purposes of section 7874,a publicly traded foreign partnership de-scribed in paragraph (g)(2) of this sectionshall be treated as a foreign corporationthat is organized in the foreign countryin which, or under the law of which, thepublicly traded foreign partnership wascreated or organized, and the partnershipinterests in the publicly traded foreignpartnership shall be treated as stock of theforeign corporation. For purposes of de-termining whether the foreign corporationshall be treated as a surrogate foreign cor-poration, a deemed acquisition of assetsand liabilities by reason of §1.708–1(b)(4)shall not constitute an acquisition de-scribed in section 7874(a)(2)(B)(i).

(2) Publicly traded foreign partnership.A publicly traded foreign partnership de-scribed in this paragraph (g)(2) is any for-eign partnership that would, but for section7704(c), be treated as a corporation undersection 7704(a)—

(i) At the time of the acquisition de-scribed in section 7874(a)(2)(B)(i); or

(ii) At any time after the acquisitionpursuant to a plan that existed at the timeof the acquisition. For this purpose, a planshall be deemed to exist at the time ofthe acquisition if the foreign partnershipwould, but for section 7704(c), be treatedas a corporation under section 7704(a) atany time during the two-year period fol-lowing the completion of the acquisition.

(3) Surrogate foreign corporation towhich section 7874(b) applies. If para-graph (g)(1) of this section applies to apublicly traded foreign partnership and

2012–28 I.R.B. 36 July 9, 2012

the foreign corporation is a surrogate for-eign corporation to which section 7874(b)applies, the publicly traded foreign part-nership shall be treated as a domesticcorporation for purposes of the InternalRevenue Code (Code). See paragraph(g)(6) of this section for the timing andtreatment of the conversion of the publiclytraded foreign partnership to a domesticcorporation. See Example 11 of paragraph(k) of this section for an illustration of therules of this paragraph (g)(3).

(4) Surrogate foreign corporation towhich section 7874(b) does not apply. Ifparagraph (g)(1) of this section applies toa publicly traded foreign partnership andthe foreign corporation is a surrogate for-eign corporation to which section 7874(b)does not apply, the publicly traded foreignpartnership shall continue to be treatedas a foreign partnership for purposes ofthe Code, but section 7874(a)(1) shall ap-ply to any expatriated entity (as definedin section 7874(a)(2)(A)). See Example13 of paragraph (k) of this section for anillustration of the rules of this paragraph(g)(4).

(5) Foreign corporation not treated asa surrogate foreign corporation. If para-graph (g)(1) of this section applies to apublicly traded foreign partnership and theforeign corporation is not treated as a sur-rogate foreign corporation, the status ofthe publicly traded foreign partnership asa foreign partnership shall not be affectedby section 7874. See Example 12 of para-graph (k) of this section for an illustrationof the rules of this paragraph (g)(5).

(6) Conversion to a domestic corpora-tion. Except for purposes of determin-ing whether the publicly traded foreignpartnership is a surrogate foreign corpora-tion, if paragraph (g)(1) of this section ap-plies to a publicly traded foreign partner-ship and the foreign corporation is a sur-rogate foreign corporation to which sec-tion 7874(b) applies, then at the later ofthe end of the day immediately preced-ing the first date properties are acquiredas part of the acquisition described in sec-tion 7874(a)(2)(B)(i) or immediately afterthe formation of the publicly traded for-eign partnership, the publicly traded for-eign partnership shall be treated as trans-ferring all of its assets and liabilities toa newly formed domestic corporation inexchange solely for stock of the domes-tic corporation, and then distributing such

stock to its partners in proportion to theirpartnership interests in liquidation of thepartnership. The treatment of the transferof assets and liabilities to the domestic cor-poration and the distribution of the stock ofthe domestic corporation to the partners inliquidation of the partnership shall be de-termined under all relevant provisions ofthe Code and general tax principles.

(h) Options—(1) Value. Except to theextent otherwise provided in this para-graph (h), for purposes of section 7874,including for purposes of determiningthe membership of an expanded affiliatedgroup under section 7874(c)(1), an optionwith respect to a corporation or partnershipwill be treated as stock in the corporation,or an interest in the partnership, as appli-cable, with a value equal to the holder’sclaim on the equity of the corporation orpartnership. For this purpose, claim onthe equity equals the value of the stock orpartnership interest that may be acquiredpursuant to the option, less the exerciseprice (but in no case is a claim on the eq-uity less than zero). Also for this purpose,the equity of the corporation or partner-ship shall not include the amount of anyproperty the holder of the option would berequired to provide to the corporation orpartnership under the terms of the option ifsuch option were exercised. See Example14 and Example 16 of paragraph (k) of thissection for illustrations of the rules of thisparagraph (h)(1).

(2) Voting power. Except to the ex-tent otherwise provided in this paragraph(h), for purposes of determining the votingpower of a foreign corporation under sec-tion 7874, including for purposes of deter-mining the membership of an expanded af-filiated group under section 7874(c)(1), anoption will be treated as exercised only if aprincipal purpose of the issuance or trans-fer of the option is to avoid the foreign cor-poration being treated as a surrogate for-eign corporation.

(3) Timing. For purposes of this para-graph (h), the value of the holder’s claimon the equity is determined—

(i) In the case of a domestic corporationor a domestic partnership, immediately be-fore the acquisition described in section7874(a)(2)(B)(i).

(ii) In the case of a foreign corpora-tion or foreign partnership, immediatelyafter the acquisition described in section7874(a)(2)(B)(i).

(4) Certain options disregarded. Therules of paragraph (h)(1) of this sectionshall not apply to an option if—

(i) A principal purpose of the issuanceor acquisition of the option is to avoid theforeign corporation being treated as a sur-rogate foreign corporation, or

(ii) At the time of the acquisition de-scribed in section 7874(a)(2)(B)(i), theprobability of the option being exercisedis remote.

(5) Options and interests similar to anoption. For purposes of this paragraph (h),an option includes an interest similar to anoption. Examples of options (including in-terests similar to options) include, but arenot limited to, a warrant, a convertible debtinstrument, an instrument other than debtthat is convertible into stock or a partner-ship interest, a put, stock or a partnershipinterest subject to risk of forfeiture, a con-tract to acquire or sell stock or a partner-ship interest, and an exchangeable share orexchangeable partnership interest.

(6) Multiple claims on equity. Para-graph (h)(1) of this section shall not ap-ply to an option to the extent treating theoption as stock or a partnership interestwould duplicate a shareholder’s or part-ner’s claim on the equity of the corpora-tion or partnership by reason of holdingstock in the corporation or an interest in thepartnership. See Example 15 of paragraph(k) of this section for an illustration of therules of this paragraph (h)(6).

(i) Interests treated as stock of a for-eign corporation—(1) Stock or other in-terests. If the conditions of paragraphs(i)(1)(i) and (ii) of this section are satis-fied, then, for purposes of section 7874,any interest (including stock or a partner-ship interest) that is not otherwise treatedas stock of a foreign corporation (includingunder paragraph (h) of this section) shallbe treated as stock of the foreign corpo-ration. See Examples 17 and 18 of para-graph (k) of this section for illustrations ofthe rules of this paragraph (i)(1).

(i) The interest provides the holder dis-tribution rights that are substantially simi-lar in all material respects to the distribu-tion rights provided by stock in the foreigncorporation. For this purpose, distributionrights include rights to dividends (or part-nership distributions), distributions in re-demption of the interest (in whole or inpart), distributions in liquidation, or othersimilar distributions that represent a return

July 9, 2012 37 2012–28 I.R.B.

on, or of, the holder’s investment in the in-terest.

(ii) Treating the interest as stock ofthe foreign corporation has the effect oftreating the foreign corporation as a sur-rogate foreign corporation under section7874(a)(2)(B).

(2) Creditor claims—(i) Domestic cor-poration. For purposes of section 7874, if,immediately prior to the first date proper-ties are acquired as part of an acquisitiondescribed in section 7874(a)(2)(B)(i), a do-mestic corporation is in a title 11 or similarcase (as defined in section 368(a)(3)), orthe liabilities of the domestic corporationexceed the value of its assets, then eachcreditor of the domestic corporation shallbe treated as a shareholder of the domesticcorporation and any claim of the creditoragainst the domestic corporation shall betreated as stock of the domestic corpora-tion. See Example 19 of paragraph (k) ofthis section for an illustration of the rulesof this paragraph (i)(2)(i).

(ii) Domestic or foreign partnership.For purposes of section 7874, if, immedi-ately prior to the first date properties areacquired as part of an acquisition describedin section 7874(a)(2)(B)(i), a partnership(foreign or domestic) is in a title 11 or sim-ilar case (as defined in section 368(a)(3)),or the liabilities of the partnership exceedthe value of its assets, then each creditor ofthe partnership shall be treated as a part-ner in the partnership and any claim ofthe creditor against the partnership shall betreated as an interest in the partnership.

(iii) Treatment of creditor as share-holder or partner. A creditor that is treatedas a shareholder or partner under para-graph (i)(2)(i) or (ii) of this section shallbe treated as a shareholder or partner forall purposes of section 7874. See, for ex-ample, §1.7874–1(c) and paragraph (f) ofthis section. See Example 19 of paragraph(k) of this section for an illustration of therules of this paragraph (i)(2)(iii).

(j) Application of section 7874(b)—(1)Conversion to a domestic corporation. Ex-cept for purposes of determining whethera foreign corporation is treated as a surro-gate foreign corporation, the conversionof a foreign corporation to a domesticcorporation by reason of section 7874(b)shall constitute a reorganization describedin section 368(a)(1)(F) that occurs at thelater of the end of the day immediatelypreceding the first date properties are ac-

quired as part of the acquisition describedin section 7874(a)(2)(B)(i) or immediatelyafter the formation of the foreign corpo-ration. See, for example, §§1.367(b)–2and 1.367(b)–3 for certain consequencesof the reorganization. The treatment of allother aspects of the conversion shall bedetermined under the relevant provisionsof the Code and general tax principles.See Example 20 of paragraph (k) of thissection for an illustration of the rules ofthis paragraph (j)(1).

(2) Entity classification. A foreign cor-poration that is treated as a domestic cor-poration under section 7874(b) is not an el-igible entity as defined in §301.7701–3(a),and therefore may not elect to be classifiedas other than an association (and thus can-not be treated as other than a corporation)for Federal tax purposes.

(3) Application of section 367. If aforeign corporation is treated as a domes-tic corporation under section 7874(b), sec-tion 367 shall not apply to any transfer ofproperty by a United States person to suchforeign corporation as part of the acquisi-tion described in section 7874(a)(2)(B)(i).However, section 367 shall apply to theconversion of the foreign corporation to adomestic corporation. See paragraph (j)(1)of this section. See Example 20 of para-graph (k) of this section for an illustrationof the rules of this paragraph (j)(3).

(k) Examples—(1) Assumed facts. Ex-cept as otherwise stated, assume the fol-lowing for purposes of the examples in-cluded in paragraph (k)(2) of this section.

(i) DC1 and DC2 are domestic corpora-tions.

(ii) FA, FP, F1, F2, F3, and F4 are for-eign corporations organized in Country A.

(iii) DPS is a domestic partnership thatconducts a trade or business.

(iv) FPS is a foreign partnership that isnot publicly traded.

(v) Under the terms of the partnershipagreements of DPS and FPS, each part-ner’s share in the partnership’s items ofincome, gain, deduction, and loss is de-termined in accordance with the partner’spartnership interest percentage in the part-nership, as stated in the examples.

(vi) A, B, and C are unrelated individu-als.

(vii) Each entity has a single class ofequity outstanding and is unrelated to allother entities.

(viii) All transactions are completedpursuant to a plan.

(ix) All acquisitions of properties arecompleted after March 4, 2003.

(x) Section 7874(c)(4) does not apply,and no option is issued or acquired with aprincipal purpose to avoid a foreign corpo-ration being treated as a surrogate foreigncorporation.

(2) Examples. The following examplesillustrate the rules of this section.

Example 1. Acquisition of stock of a domestic cor-poration. (i) Facts. FA acquires 25% of the outstand-ing stock of DC1.

(ii) Analysis. Under paragraph (c)(1)(i) of thissection, for purposes of section 7874(a)(2)(B)(i), FAis treated as acquiring 25% of the properties held byDC1 on the date of the stock acquisition.

Example 2. Acquisition of a partnership interest.(i) Facts. DPS wholly owns DC1. FA acquires a 40%interest in DPS.

(ii) Analysis. Under paragraph (c)(1)(ii) of thissection, for purposes of section 7874(a)(2)(B)(i), FAis treated as acquiring 40 percent of the DC1 stockheld by DPS on the date of the acquisition of the part-nership interest. Further, under paragraph (c)(1)(i) ofthis section, for purposes of section 7874(a)(2)(B)(i),FA is treated as acquiring 40% of the properties heldby DC1 on the date of the acquisition of the partner-ship interest.

Example 3. Acquisition of stock by a subsidiary.(i) Facts. FP wholly owns FA. FA acquires all theoutstanding stock of DC1 in exchange solely for FPstock. FP and FA are members of the same expandedaffiliated group after the acquisition.

(ii) Analysis. Under paragraph (c)(1)(i) of thissection, for purposes of section 7874(a)(2)(B)(i), FAis treated as acquiring 100% of the properties held byDC1 on the date of the stock acquisition. Further, un-der paragraph (c)(1)(iii) of this section, for purposesof section 7874(a)(2)(B)(i), FP is also treated as ac-quiring 100% of the properties held by DC1 on thedate of the stock acquisition. The result would be thesame if instead FA had directly acquired all the prop-erties held by DC1 in exchange for FP stock.

Example 4. Acquisition of stock of a foreign cor-poration. (i) Facts. FP wholly owns DC1. FA ac-quires all of the outstanding stock of FP.

(ii) Analysis. Under paragraph (c)(2) of this sec-tion, for purposes of section 7874(a)(2)(B)(i), FA isnot treated as acquiring any properties held by DC1on the date of the acquisition of the FP stock.

Example 5. Acquisition of stock by multiple for-eign corporations. (i) Facts. Pursuant to the sameplan, the shareholders of DC1 transfer all of their DC1stock equally to F1, F2, F3, and F4 in exchange solelyfor stock of each foreign corporation.

(ii) Analysis. Under paragraph (c)(1)(i) of thissection, in the aggregate F1, F2, F3, and F4 are treatedas acquiring substantially all of the properties heldby DC1. Because the acquisition was pursuant to thesame plan, under paragraph (d) of this section, F1, F2,F3, and F4 are each treated as acquiring substantiallyall of the properties held by DC1 for purposes of de-termining whether each foreign corporation shall betreated as a surrogate foreign corporation.

2012–28 I.R.B. 38 July 9, 2012

Example 6. Acquisition of assets by multiple for-eign corporations. (i) Facts. Individual A whollyowns DC1. DC1 forms F1, F2, F3, and F4, and trans-fers an equal portion of its properties to each corpora-tion in exchange solely for stock of the corporation.Pursuant to the same plan DC1 then distributes thestock of each foreign corporation to individual A.

(ii) Analysis. Because pursuant to the same planF1, F2, F3, and F4 acquired, in the aggregate, sub-stantially all of the properties held by DC1, underparagraph (d) of this section, F1, F2, F3, and F4are each treated as acquiring substantially all of theproperties held by DC1 for purposes of determiningwhether each foreign corporation shall be treated as asurrogate foreign corporation.

Example 7. Acquisition of multiple domestic cor-porations. (i) Facts. Individual A wholly owns DC1,and individual B wholly owns DC2. Pursuant to thesame plan, individuals A and B transfer all of theirDC1 stock and DC2 stock to FA, a newly formed cor-poration, in exchange solely for all 100 shares of FAstock outstanding.

(ii) Analysis. Under paragraph (c)(1)(i) of thissection, for purposes of section 7874(a)(2)(B)(i), FAis treated as acquiring all of the properties held byDC1 and DC2 on the date of the stock acquisition.Under paragraph (e) of this section, because pursuantto the same plan FA acquired substantially all of theproperties held by DC1 and DC2, for purposes of de-termining whether FA shall be treated as a surrogateforeign corporation, DC1 and DC2 shall be treated asa single domestic corporation, of which individualsA and B are former shareholders. Thus, individualsA and B are treated as holding all 100 shares of theFA stock by reason of holding stock of such domesticcorporation, and the ownership fraction under section7874(a)(2)(B)(ii) is 100/100, or 100%.

Example 8. Exchange of stock and other prop-erty. (i) Facts. Individual A wholly owns DC1 andF1. DC1 has a $40x value and F1 has a $60x value.Individual A transfers all of the DC1 stock and F1stock to FA, a newly formed corporation, in exchangesolely for FA stock.

(ii) Analysis. Under paragraphs (f)(1)(i) and(f)(2)(i) of this section, for purposes of section7874(a)(2)(B)(ii), individual A is considered to hold40% of the FA stock by reason of holding stock inDC1 ($100x FA stock multiplied by $40x/$100x, therelative value of the DC1 stock to all the propertytransferred by A to FA).

Example 9. Stock received as a distribution.(i) Facts. Pursuant to a divisive reorganization de-scribed in section 368(a)(1)(D), DC1 contributessubstantially all of its properties to FA, a newlyformed corporation, in exchange solely for FA stockand then distributes the FA stock to its shareholdersin a transaction qualifying under section 355.

(ii) Analysis. Under paragraph (f)(1)(i) of thissection, for purposes of section 7874(a)(2)(B)(ii), theFA stock received by the DC1 shareholders as a dis-tribution with respect to the DC1 stock is consideredheld by reason of holding stock in DC1. The resultwould be the same if the transaction did not qualifyas a reorganization (for example, if the distributionwere subject to sections 301 and 311(b)).

Example 10. Incorporation of a partnership tradeor business. (i) Facts. Individuals A and B equallyown DPS. DPS transfers substantially all of its prop-erties constituting a trade or business to FA, a newly

formed corporation, solely in exchange for FA stock.DPS retains the FA stock after the transaction.

(ii) Analysis. Under paragraph (f)(1)(iii) of thissection, for purposes of section 7874(a)(2)(B)(ii), in-dividuals A and B are treated as holding a proportion-ate amount (that is, an equal amount) of the FA stockheld by DPS by reason of holding an interest in DPS.

Example 11. Publicly traded foreign partnershiptreated as domestic corporation. (i) Facts. Pursuantto a plan, DC1 and individual B organize a limited li-ability company (HPS) under the law of Country A.DC1 owns 90% of the membership interests in HPS,and B owns 10% of the membership interests in HPS.HPS is a foreign eligible entity under §301.7701–2,and DC1 and B make an election under §301.7701–3to treat HPS as a partnership for Federal tax pur-poses as of the date of the formation of HPS. HPSforms DC2. One day after the formation of HPS, DC2merges with and into DC1. Pursuant to the mergeragreement, the DC1 shareholders exchange their DC1stock solely for membership interests in HPS. Afterthe merger HPS wholly owns DC1, and the formershareholders of DC1 own a greater than 80% inter-est in HPS by reason of holding stock of DC1. Publictrading of the HPS ownership interests begins the dayafter the date on which the merger is completed. HPSis not treated as a corporation under section 7704(a)by reason of section 7704(c). If HPS were a cor-poration, the condition of section 7874(a)(2)(B)(iii)would be satisfied.

(ii) Analysis. HPS is a publicly traded foreignpartnership that is described in paragraph (g)(2) ofthis section. Therefore, under paragraph (g)(1) of thissection, for purposes of section 7874, HPS is treatedas a foreign corporation organized under the law ofCountry A and the membership interests in HPS aretreated as stock of the foreign corporation. The for-eign corporation is treated as a surrogate foreign cor-poration under section 7874(a)(2)(B) because, pur-suant to the merger, HPS acquired substantially all ofthe properties held by DC1, the former shareholdersof DC1 hold at least 60% of the stock of the foreigncorporation by reason of holding stock of DC1, andthe expanded affiliated group that includes the foreigncorporation does not have substantial business activi-ties in Country A when compared to the total businessactivities of the expanded affiliated group. Further,because the former shareholders of DC1 hold at least80% of the stock of the foreign corporation by reasonof holding stock of DC1, section 7874(b) applies tothe surrogate foreign corporation, and therefore HPSis treated as a domestic corporation for purposes ofthe Code. Under paragraph (g)(6) of this section, ex-cept for purposes of determining whether HPS is asurrogate foreign corporation, at the end of the dayimmediately preceding the date of the merger of DC2with and into DC1, HPS is treated as transferring allof its assets and liabilities to a new domestic corpora-tion in exchange solely for stock of the domestic cor-poration. HPS is then treated as proportionately dis-tributing such stock to its membership interest hold-ers in liquidation of the partnership. In addition, asa result of the merger of DC2 with and into DC1, theformer shareholders of DC1 shall be treated as receiv-ing stock of a domestic corporation in exchange fortheir DC1 stock.

Example 12. Publicly traded foreign partnershipnot treated as a surrogate foreign corporation. (i)Facts. The facts are the same as in Example 11 of

this section, except that, after the acquisition, the ex-panded affiliated group that includes HPS (treated asa foreign corporation for this purpose) has substan-tial business activities in Country A when comparedto the total business activities of the expanded affili-ated group.

(ii) Analysis. Under paragraph (g)(1) of this sec-tion, for purposes of section 7874, HPS is treatedas a foreign corporation and the membership inter-ests in HPS are treated as stock of the foreign cor-poration. However, the foreign corporation is nottreated as a surrogate foreign corporation under sec-tion 7874(a)(2)(B) because, after the acquisition, theexpanded affiliated group that includes HPS has sub-stantial business activities in Country A when com-pared to the total business activities of the expandedaffiliated group. Therefore, under paragraph (g)(5) ofthis section, section 7874 does not apply and the sta-tus of HPS as a foreign partnership is not affected. Inaddition, DC1 is not treated as an expatriated entityunder section 7874(a) by reason of the acquisition.

Example 13. Publicly traded foreign partnershiptreated as a surrogate foreign corporation but not asa domestic corporation. (i) Facts. FPS is a pub-licly traded foreign partnership organized in CountryA that, by reason of section 7704(c), is not treated asa corporation under section 7704(a). FPS acquires allthe stock of DC1 in exchange for partnership interestsin FPS. After the acquisition, the former shareholdersof DC1 hold a 75%-interest in FPS by reason of hold-ing DC1 stock. After the acquisition, the expandedaffiliated group that includes FPS (treated as a foreigncorporation for this purpose) does not have substan-tial business activities in Country A when comparedto the total business activities of the expanded affili-ated group.

(ii) Analysis. Under paragraph (g)(1) of this sec-tion, for purposes of section 7874, FPS is treated asa foreign corporation and the partnership interests inFPS are treated as stock of the foreign corporation.FPS is treated as a surrogate foreign corporation be-cause the conditions of section 7874(a)(2)(B) are sat-isfied. However, because the former shareholders ofDC1 hold less than an 80%-interest in FPS by reasonof holding DC1 stock, section 7874(b) does not applyto FPS. Therefore, under paragraph (g)(4) of this sec-tion FPS continues to be treated as a foreign partner-ship for purposes of the Code, but section 7874(a)(1)applies to DC1 and any other expatriated entity.

Example 14. Warrant to acquire stock from theforeign corporation. (i) Facts. Individual A whollyowns DC1. DC1 has a $200x value. Individual Bwholly owns FA. The value of B’s FA stock is $400x.Individual C holds a warrant to acquire FA stock fromFA at an exercise price of $20x. Individual A trans-fers all of its DC1 stock to FA in exchange solely forFA stock with a value of $200x. At the time of thetransfer, the FA stock that individual C can acquirepursuant to the warrant has a $70x value.

(ii) Analysis. Under paragraphs (h)(1) of this sec-tion, for purposes of section 7874, individual C istreated as owning FA stock with a $50x value. Thisamount represents individual C’s claim on the equityof FA after the acquisition ($70x value of FA stockthat may be acquired pursuant to the warrant, less the$20x exercise price), without taking into account the$20x individual C would be required to provide to FAupon the exercise of the warrant. Thus, for purposesof section 7874, the value of the stock of FA imme-

July 9, 2012 39 2012–28 I.R.B.

diately after the transaction is $650x ($600x of FAstock, plus C’s $50x claim on the equity of FA). C’swarrant is not taken into account for purposes of de-termining the voting power of FA under section 7874.

Example 15. Option to acquire stock from an-other shareholder. (i) Facts. The facts are the same asin Example 14 except that, instead of holding a war-rant issued by FA, individual C holds an option to ac-quire FA stock from individual B for an exercise priceof $20x. At the time of the acquisition, the FA stockthat individual C can acquire under the option has a$70x value.

(ii) Analysis. Under paragraph (h)(6) of this sec-tion, for purposes of section 7874, individual C is nottreated as owning FA stock by reason of holding theoption because treating the option as FA stock wouldhave the effect of partially duplicating individual B’sclaim on the equity of FA at the time of the acquisi-tion by reason of holding FA stock. However, all ofthe FA stock owned by individual B will be taken intoaccount for purposes of section 7874. C’s warrant isnot taken into account for purposes of determiningvoting power of FA under section 7874.

Example 16. Warrant to acquire stock from thedomestic corporation. (i) Facts. A DC1 employeeholds a warrant to acquire DC1 stock from DC1. Inconnection with the acquisition by FA of substantiallyall of the properties held by DC1, the DC1 employeereceives a warrant from FA to acquire 15 shares ofFA stock in exchange for the warrant to acquire DC1stock.

(ii) Analysis. Under paragraphs (h)(1) of this sec-tion, for purposes of section 7874, the warrant heldby the DC1 employee is treated as DC1 stock witha value equal to the employee’s claim on the equityof DC1 immediately before the acquisition. Further,for purposes of section 7874, the DC1 employee istreated as holding FA stock with a value equal to theemployee’s claim on the equity of FA after the ac-quisition by reason of holding the warrant to acquireDC1 stock (treated as DC1 stock for this purpose).The option held by the DC1 employee is not takeninto account for purposes of determining the votingpower of FA under section 7874.

Example 17. Stock in a subsidiary treated as stockof a foreign parent corporation. (i) Facts. (A) In-dividuals A and B equally own DC1. FA, a newlyformed corporation, issues stock in a public offeringfor cash. FA contributes part of the cash from thepublic offering to DC2, a newly formed corporation,in exchange for all the stock of DC2. DC2 mergeswith and into DC1 with DC1 surviving. Pursuant tothe merger agreement, individuals A and B exchangetheir DC1 stock for cash and shares of class B stockof DC1. Following the merger FA owns all the classA stock of DC1. FA does not hold significant assetsother than the class A stock of DC1. Individuals Aand B own all the class B stock of DC1. DC1 has noother class of stock outstanding.

(B) The class B stock entitles individuals A andB to dividend distributions approximately equal toany dividend distributions made by FA with respectto its publicly traded stock. In certain circumstances,the class B stock also permits individuals A and B torequire DC1 to redeem the stock at fair market value.The class B stock does not provide individuals A andB voting rights with respect to FA.

(ii) Analysis. The dividend rights provided by theclass B stock are substantially similar in all material

respects to the dividend rights provided by the FAstock. In addition, because FA does not hold signif-icant assets other than the class A stock, the valueof the class B stock held by individuals A and B isapproximately equal to the value of a correspondingamount of publicly traded FA stock. The distributionrights on liquidation (or redemption) provided by theclass B stock, therefore, are substantially similar inall material respects to the distribution rights on liq-uidation (or redemption) provided by the FA stock.As a result, the distribution rights provided by theclass B stock are substantially similar in all materialrespects to the distribution rights provided by the pub-licly traded FA stock. Thus, if treating the class Bstock as FA stock would have the effect of treating FAas a surrogate foreign corporation, under paragraph(i)(1) of this section the class B stock will be treatedas FA stock for purposes of section 7874.

Example 18. Partnership interest treated as stockof foreign acquiring corporation. (i) Facts. (A) In-dividuals A and B equally own DC1. FA, a newlyformed corporation, issues stock in a public offeringfor cash. Individuals A and B and FA organize FPS.FA transfers part of the cash from the public offeringto FPS in exchange for a class A partnership inter-est. FA does not hold any significant assets other thanthe class A partnership interest. Individuals A and Btransfer their DC1 stock to FPS in exchange for classB partnership interests.

(B) The class B partnership interests entitle indi-viduals A and B to cash distributions from FPS ap-proximately equal to any dividend distributions madeby FA with respect to its publicly traded stock. In cer-tain circumstances, the class B partnership interestsalso permit individuals A and B to require FPS to re-deem the interests in exchange for cash equal to thevalue of an amount of FA stock as determined on theredemption date. The class B partnership interests donot provide individuals A or B voting rights with re-spect to FA.

(ii) Analysis. The non-liquidating distributionrights provided by the class B partnership interestsare substantially similar in all material respects to thedividend rights provided by the FA stock. BecauseFA does not hold any significant assets other thanthe class A partnership interest, the value of the classB partnership interests held by individuals A and Bis approximately equal to a corresponding amountof FA stock. The distribution rights on liquidation(or redemption) provided by the class B partnershipinterests, therefore, are substantially similar in allmaterial respects to distribution rights on liquidation(or redemption) provided by the FA stock. Thus, thedistribution rights provided by the class B partner-ship interests are substantially similar in all materialrespects to the distribution rights provided by thepublicly traded FA stock. As a result, if treatingthe class B partnership interests as FA stock wouldhave the effect of treating FA as a surrogate foreigncorporation, under paragraph (i)(1) of this sectionthe class B partnership interests will be treated as FAstock for purposes of section 7874.

Example 19. Creditor treated as a shareholder.(i) Facts. Individuals A and B equally own DC1. Theliabilities of DC1 exceed the value of its assets. Pur-suant to a plan, FA, a newly formed corporation, ac-quires substantially all of the properties held by DC1in exchange solely for FA stock. Pursuant to the plan,the DC1 stock held by individuals A and B is can-

celled, and the creditors of DC1 receive all the FAstock in exchange for their claims against DC1.

(ii) Analysis. Because immediately before thefirst date on which properties are acquired as part ofthe acquisition described in section 7874(a)(2)(B)(i)the liabilities of DC1 exceed the value of its assets,under paragraph (i)(2)(i) of this section, for purposesof section 7874, the creditors of DC1 are treatedas shareholders of DC1 and the creditors’ claimsagainst DC1 are treated as DC1 stock. Therefore, forpurposes of section 7874(a)(2)(B)(ii), the FA stockreceived by the creditors of DC1 by reason of theirclaims against DC1 is considered held by formershareholders of DC1 by reason of holding DC1 stock.

Example 20. Conversion to a domestic corpora-tion and application of section 367. (i) Facts. Indi-viduals A and B are United States persons and equallyown DC1. Pursuant to a plan, individuals A and Btransfer their DC1 stock to FA in exchange solely for80% of the outstanding FA stock. After the acquisi-tion, the expanded affiliated group that includes FAdoes not have substantial business activities in Coun-try A when compared to the total business activitiesof the expanded affiliated group.

(ii) Analysis. Under paragraph (c)(1)(i) of thissection, for purposes of section 7874(a)(2)(B)(i), FAis treated as acquiring all of the properties held byDC1 on the date of the stock acquisition. After theacquisition, the former shareholders of DC1 own80% of the stock of FA by reason of holding DC1stock. Therefore, FA is a surrogate foreign corpora-tion that is treated as a domestic corporation undersection 7874(b). Under paragraph (j)(1) of this sec-tion, except for purposes of determining whether FAis treated as a surrogate foreign corporation, the con-version of FA to a domestic corporation constitutes areorganization described in section 368(a)(1)(F) thatoccurs at the end of the day immediately precedingthe date of the stock acquisition. Section 367 appliesto the conversion of FA to a domestic corporation.See, for example, §§1.367(b)–2 and 1.367(b)–3 forthe consequences of the conversion. Under para-graph (j)(3) of this section, section 367 does notapply to the transfers of DC1 stock by individuals Aand B to FA.

(l) Effective/applicability date. Thissection applies to acquisitions completedon or after June 7, 2012. For acquisi-tions completed prior to June 7, 2012, see§1.7874–2T(o), as contained in 26 CFRpart 1, revised as of April 1, 2012.

§1.7874–2T [Removed]

Par. 5. Section 1.7874–2T is removed.

Steven T. Miller,Deputy Commissioner forServices and Enforcement.

Approved June 4, 2012.

Emily S. McMahon,Acting Assistant Secretary

of the Treasury (Tax Policy).

2012–28 I.R.B. 40 July 9, 2012

(Filed by the Office of the Federal Register on June 7, 2012,4:15 p.m., and published in the issue of the Federal Registerfor June 12, 2012, 77 F.R. 34788)

26 CFR 1.7874–3T: Substantial business activities(temporary).

T.D. 9592

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Part 1

Substantial Business Activities

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Temporary Regulations.

SUMMARY: This document contains tem-porary regulations regarding whether a for-eign corporation has substantial businessactivities in a foreign country. These reg-ulations affect certain domestic corpora-tions and partnerships (and certain partiesrelated thereto), and foreign corporationsthat acquire substantially all of the proper-ties of such domestic corporations or part-nerships. The text of these temporary reg-ulations serves as the text of the proposedregulations (REG–107889–12) set forth inthe notice of proposed rulemaking on thissubject also published in this issue of theBulletin.

DATES: Effective Date: These regulationsare effective on June 12, 2012.

Applicability Date: For date of applica-bility, see §1.7874–3T(f).

FOR FURTHER INFORMATIONCONTACT: Mary W. Lyons, (202)622–3860 and David A. Levine, (202)622–3860 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On June 6, 2006, temporary regu-lations under section 7874 (T.D. 9265,2006–2 C.B. 1) were published in theFederal Register (71 FR 32437) con-cerning the treatment of a foreign corpo-ration as a surrogate foreign corporation(2006 temporary regulations). A notice ofproposed rulemaking (REG–112994–06,

2006–2 C.B. 47) cross-referencing the2006 temporary regulations was pub-lished in the same issue of the FederalRegister (71 FR 32495). On July 28,2006, Notice 2006–70, 2006–2 C.B. 252,was published, announcing a modifica-tion to the effective date contained inthe 2006 temporary regulations. See§601.601(d)(2)(ii)(b). On June 12, 2009,the 2006 temporary regulations and therelated notice of proposed rulemakingwere withdrawn and replaced with newtemporary regulations (2009 temporaryregulations), which generally applied toacquisitions completed on or after June 9,2009. T.D. 9453 (74 FR 27920, 2009–28I.R.B. 114). A notice of proposed rule-making cross-referencing the 2009 tem-porary regulations was published in thesame issue of the Federal Register (74 FR27947, 2009–28 I.R.B. 144). No publichearing was requested or held; however,comments were received. All commentsare available at www.regulations.gov orupon request. After consideration of thecomments received regarding whether aforeign corporation has substantial busi-ness activities in a foreign country, theInternal Revenue Service (IRS) and theDepartment of the Treasury (TreasuryDepartment) have decided to issue newtemporary regulations under §1.7874–3T(2012 temporary regulations) and a newnotice of proposed rulemaking that pro-vide guidance regarding this determi-nation. The other portions of the 2009temporary regulations are finalized ina separate Treasury Decision publishedelsewhere in this issue of the Bulletin.

Explanation of Provisions

A. General Approach

A foreign corporation is generallytreated as a surrogate foreign corporationunder section 7874(a)(2)(B) if pursuant toa plan (or a series of related transactions):(i) the foreign corporation completes afterMarch 4, 2003, the direct or indirect acqui-sition of substantially all of the propertiesheld directly or indirectly by a domesticcorporation; (ii) after the acquisition atleast 60 percent of the stock (by vote orvalue) of the foreign corporation is heldby former shareholders of the domesticcorporation by reason of holding stock inthe domestic corporation; and (iii) after the

acquisition, the expanded affiliated groupthat includes the foreign corporation doesnot have substantial business activitiesin the foreign country (relevant foreigncountry) in which, or under the law ofwhich, the foreign corporation is createdor organized, when compared to the totalbusiness activities of the expanded affili-ated group. Similar provisions apply if aforeign corporation acquires substantiallyall of the properties constituting a trade orbusiness of a domestic partnership.

The 2006 temporary regulations pro-vided that the determination of whether theexpanded affiliated group has substantialbusiness activities in the relevant foreigncountry is based on all the facts and cir-cumstances. The 2006 temporary regula-tions also provided a safe harbor, whichgenerally was satisfied if at least ten per-cent of the employees, assets, and sales ofthe expanded affiliated group were in therelevant foreign country. The 2009 tem-porary regulations retained the facts andcircumstances general rule provided in the2006 temporary regulations, with certainmodifications, but removed the safe har-bor.

The IRS and the Treasury Departmentreceived comments requesting additionalguidance on the level of business activitiesnecessary for an expanded affiliated groupto have substantial business activities inthe relevant foreign country. One com-ment suggested providing a new safe har-bor, which would require a higher percent-age of business activities in the relevantforeign country than was required underthe safe harbor included in the 2006 tem-porary regulations. The comment also rec-ommended different safe harbors depend-ing on the extent of the expanded affiliatedgroup’s business activities in the UnitedStates.

After consideration of the commentsand the underlying policies of section7874, the IRS and the Treasury Depart-ment believe the facts and circumstancestest of the 2009 temporary regulationsshould be replaced with a bright-line ruledescribing the threshold of activities re-quired for an expanded affiliated group tohave substantial business activities in therelevant foreign country. The IRS and theTreasury Department believe that such arule will provide more certainty in apply-ing section 7874 to particular transactionsthan the 2009 temporary regulations and

July 9, 2012 41 2012–28 I.R.B.

will improve the administrability of thisprovision.

B. Threshold of Business Activities

The 2012 temporary regulations pro-vide that an expanded affiliated group willhave substantial business activities in therelevant foreign country only if at least 25percent of the group employees, group as-sets, and group income are located or de-rived in the relevant foreign country, deter-mined as follows:

1. Group employees

The 2012 temporary regulations setforth two tests, each of which must besatisfied, based on employees of membersof the expanded affiliated group (groupemployees). The first test is calculated asthe number of group employees based inthe relevant foreign country divided by thetotal number of group employees deter-mined on the applicable date discussed insection B.4. of this preamble. The secondtest is calculated as employee compen-sation with respect to group employeesbased in the relevant foreign country di-vided by the total employee compensationwith respect to all group employees deter-mined during the one-year testing period.

2. Group assets

The group assets test is calculated as thevalue of the group assets located in the rel-evant foreign country divided by the to-tal value of all group assets determined onthe applicable date. The term group assetsgenerally means tangible personal prop-erty or real property used or held for usein the active conduct of a trade or busi-ness by members of the expanded affili-ated group. For this purpose, group assetsinclude certain property rented by mem-bers of the expanded affiliated group, withthe value of such rented property beingdeemed to be eight times the net annualrent paid or accrued with respect to suchproperty. The IRS and the Treasury De-partment believe that using an eight-timesmultiple for this purpose is administrableand consistent with the treatment of rentedproperty for other purposes. See, for ex-ample, Uniform Division of Income forTax Purposes Act, §§10 and 11. In order toconstitute group assets, such rented prop-erty must satisfy the other applicable re-

quirements for group assets, including thatthe property is used or held for use in theactive conduct of a trade or business.

3. Group income

The group income test is calculated asthe group income derived in the relevantforeign country divided by the total groupincome determined during the one-yeartesting period. The term group incomemeans gross income of members of the ex-panded affiliated group from transactionsoccurring in the ordinary course of busi-ness with customers that are not relatedpersons. Group income is considered tobe derived in a foreign country only if thecustomer is located in such country.

4. Applicable date

Section 7874(a)(2)(B)(iii) provides thatthe determination of whether the expandedaffiliated group has substantial businessactivities is made after the acquisition.However, the IRS and the Treasury De-partment believe that when the acquisitionoccurs other than at the end of a month thefactors used to determine whether the sub-stantial business activities test is satisfiedmay not be readily determinable in somecases. Accordingly, the 2012 temporaryregulations provide that the number ofgroup employees and the value of groupassets can be measured as of the applicabledate, which is either the date on which theacquisition is completed or the last dayof the month immediately preceding themonth in which the acquisition is com-pleted. The applicable date is also used todetermine the testing period, which is usedin computing group income and employeecompensation. When the applicable dateis the last day of the month immediatelypreceding the month in which the acqui-sition is completed, group employees,employee compensation, group assets,and group income consist of those itemsor amounts of members that comprise theexpanded affiliated group determined atthe close of the acquisition date.

C. Attribution from a Partnership

The 2009 temporary regulations pro-vided that for purposes of the substantialbusiness activities test, a member of an ex-panded affiliated group that holds at least aten-percent capital and profits interest in a

partnership takes into account its propor-tionate share of all items of the partner-ship. The IRS and the Treasury Depart-ment believe that the policies of section7874 are better advanced if the treatmentof partnerships is made consistent with thatof corporations for purposes of applyingthe substantial business activities test on agroup basis. Accordingly, the 2012 tem-porary regulations provide that the itemsof a partnership should be taken into ac-count for this purpose only if one or moremembers of the expanded affiliated groupholds, in the aggregate, more than 50 per-cent (by value) of the interests in the part-nership. The IRS and the Treasury Depart-ment further believe that, consistent withthe treatment of corporations, if this own-ership requirement is satisfied, then all theitems of the partnership should be takeninto account for this purpose.

D. Effective Date

Subject to a transition rule, the 2012temporary regulations apply to acquisi-tions completed on or after June 7, 2012.

Special Analyses

It has been determined that that thesetemporary regulations are not a significantregulatory action as defined in ExecutiveOrder 12866. Therefore, a regulatory as-sessment is not required. It also has beendetermined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C. chap-ter 5) does not apply to the 2012 temporaryregulations and because the regulations donot impose a collection of information onsmall entities, the requirements of the Reg-ulatory Flexibility Act (5 U.S.C. chapter6) do not apply. Accordingly, a regu-latory flexibility analysis is not required.Pursuant to section 7805(f) of the Code,the 2012 temporary regulations have beensubmitted to the Chief Counsel for Advo-cacy of the Small Business Administrationfor comment on their impact on small busi-ness.

Requests for Comments

The IRS and the Treasury Departmentare considering to what extent partners ofa partnership should be treated as if theywere employees solely for purposes of thetwo tests based on group employees, and

2012–28 I.R.B. 42 July 9, 2012

specifically request comments on these is-sues. For information on how to submitcomments or request a public hearing, seethe section ’’Comments and Requests for aPublic Hearing’’ set forth in the notice ofproposed rulemaking published elsewherein this issue of the Bulletin.

Drafting Information

The principal authors of the 2012 tem-porary regulations are Mary W. Lyons andDavid A. Levine of the Office of AssociateChief Counsel (International). However,other personnel from the IRS and theTreasury Department participated in theirdevelopment.

* * * * *

Amendments to the Regulations

Accordingly, 26 CFR part 1 is amendedas follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Section 1.7874–3T is also issued under

26 U.S.C. 7874(c)(6) and (g).* * *Par. 2. Section 1.7874–3T is added to

read as follows:

§1.7874–3T Substantial business activities(temporary).

(a) Scope. This section provides rulesregarding whether a foreign corporationhas substantial business activities in therelevant foreign country when comparedto the total business activities of the ex-panded affiliated group for purposes ofsection 7874(a)(2)(B)(iii). Paragraph (b)of this section sets forth the threshold ofbusiness activities that constitute substan-tial business activities. Paragraph (c) ofthis section describes certain items not tobe taken into account as located or derivedin the relevant foreign country. Paragraph(d) of this section provides definitions andcertain rules of application. Paragraph (e)of this section provides rules regarding thetreatment of a partnership in which one ormore members of an expanded affiliatedgroup own an interest. Paragraph (f) of thissection provides the dates of applicabilityand expiration.

(b) Threshold of business activities.The expanded affiliated group will havesubstantial business activities in the rele-vant foreign country after the acquisitionwhen compared to the total business activ-ities of the expanded affiliated group onlyif, subject to paragraph (c) of this section,each of the tests described in paragraphs(b)(1) through (b)(3) of this section is sat-isfied.

(1) Group employees—(i) Number ofemployees. The number of group employ-ees based in the relevant foreign country isat least 25 percent of the total number ofgroup employees on the applicable date.

(ii) Employee compensation. The em-ployee compensation incurred with respectto group employees based in the relevantforeign country is at least 25 percent ofthe total employee compensation incurredwith respect to all group employees duringthe testing period.

(2) Group assets. The value of thegroup assets located in the relevant foreigncountry is at least 25 percent of the totalvalue of all group assets on the applicabledate.

(3) Group income. The group incomederived in the relevant foreign country is atleast 25 percent of the total group incomeduring the testing period.

(c) Items not to be considered. The fol-lowing items are not taken into account inthe numerator, but are taken into accountin the denominator, for each of the tests de-scribed in paragraphs (b)(1) through (b)(3)of this section:

(1) Any group assets, group employees,or group income attributable to businessactivities that are associated with proper-ties or liabilities the transfer of which isdisregarded under section 7874(c)(4).

(2) Any group assets or group employ-ees located in, or group income derived in,the relevant foreign country as part of aplan with a principal purpose of avoidingthe purposes of section 7874.

(3) Any group assets or group employ-ees located in, or group income derived in,the relevant foreign country if such groupassets or group employees, or the businessactivities to which such group income is at-tributable, are subsequently transferred toanother country in connection with a planthat existed at the time of the acquisitiondescribed in section 7874(a)(2)(B)(i).

(d) Definitions and application of rules.The following definitions and rules applyfor purposes of this section:

(1) The term acquisition date means thedate on which the acquisition described insection 7874(a)(2)(B)(i) is completed.

(2) The term applicable date means ei-ther of the following dates, applied consis-tently for all purposes of this section:

(i) The acquisition date; or(ii) The last day of the month imme-

diately preceding the month in whichthe acquisition described in section7874(a)(2)(B)(i) is completed.

(3) The term employee compensationmeans all amounts incurred by members ofthe expanded affiliated group that directlyrelate to services performed by group em-ployees (including, for example, wages,salaries, deferred compensation, employeebenefits, and employer payroll taxes). Em-ployee compensation is determined in U.S.dollars translated, if necessary, using theweighted average exchange rate (as de-fined in §1.989(b)–1) for the testing pe-riod.

(4) The term expanded affiliated groupmeans the affiliated group defined in sec-tion 7874(c)(1) determined at the close ofthe acquisition date. The term memberof the expanded affiliated group means anentity included in the expanded affiliatedgroup. A reference to a member of the ex-panded affiliated group includes a prede-cessor with respect to such member.

(5) The term group assets means tan-gible personal property or real propertyused or held for use in the active conductof a trade or business by members of theexpanded affiliated group, provided suchproperty is owned by members of the ex-panded affiliated group at the close of theacquisition date. A group asset is con-sidered to be located in the relevant for-eign country only if the asset was physi-cally present in such country at the close ofthe acquisition date and for more time thanin any other country during the testing pe-riod. All group assets must be valued con-sistently and on a gross basis (that is, notreduced by liabilities) using either the ad-justed tax basis or fair market value deter-mined in U.S. dollars translated, if neces-sary, at the spot rate determined under theprinciples of §1.988–1(d)(1), (2), and (4).Tangible personal property or real propertythat is rented by members of the expandedaffiliated group from a person other than

July 9, 2012 43 2012–28 I.R.B.

a member of the expanded affiliated groupis also treated as a group asset, providedsuch property is used in the active conductof a trade or business and is being rented bymembers of the expanded affiliated groupat the close of the acquisition date. For pur-poses of this section, a group asset that isrented is valued at eight times the net an-nual rent paid or accrued with respect tothe property by members of the expandedaffiliated group.

(6) The term group employees meansemployees of members of the expanded af-filiated group. A group employee is con-sidered to be based in the relevant foreigncountry only if the employee spent moretime providing services in such countrythan in any other single country during thetesting period.

(7) The term group income means grossincome of members of the expanded affil-iated group from transactions occurring inthe ordinary course of business with cus-tomers that are not related persons. Groupincome is translated into U.S. dollars, ifnecessary, using the weighted average ex-change rate (as defined in §1.989(b)–1)for the testing period. Group income isconsidered derived in the relevant foreigncountry only if it is derived from a transac-tion with a customer located in such coun-try.

(8) The term net annual rent means theannual rent paid or accrued with respectto property, less any payments received oraccrued from subleasing such property (orother similar arrangement).

(9) The term related person has themeaning specified in section 954(d)(3),except that section 954(d)(3) is appliedby substituting “one or more membersof the expanded affiliated group” for “acontrolled foreign corporation” and “thecontrolled foreign corporation” each placethey appear.

(10) The term relevant foreign countrymeans the foreign country in which, or un-der the law of which, the foreign corpora-tion was created or organized.

(11) The term testing period means theone-year period ending on the applicabledate.

(e) Treatment of partnerships. For pur-poses of this section, if one or more mem-bers of the expanded affiliated group own,in the aggregate, more than 50 percent (byvalue) of the interests in a partnership, suchpartnership will be treated as a corporationthat is a member of the expanded affiliatedgroup. Thus, all items of such a partner-ship are taken into account for purposes ofthis section. No items of a partnership aretaken into account for purposes of this sec-tion unless the partnership is treated as a

member of the expanded affiliated grouppursuant to this paragraph.

(f) Effective/applicability and expira-tion dates. Except as otherwise providedin this paragraph, this section shall applyto acquisitions that are completed on or af-ter June 7, 2012. For acquisitions com-pleted on or after June 7, 2012, that wereeither described in a filing with the Se-curities and Exchange Commission on orbefore June 7, 2012, or that were subjectto a written agreement that was bindingon June 7, 2012, and at all times there-after, taxpayers may apply either the rulesin §1.7874–2T(g), as contained in 26 CFRpart 1 revised as of April 12, 2012, or therules set forth in this section. The appli-cability of this section expires on June 5,2015.

Steven T. Miller,Deputy Commissioner forServices and Enforcement.

Approved June 4, 2012.

Emily S. McMahon,Acting Assistant Secretary

of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on June 7, 2012,4:15 p.m., and published in the issue of the Federal Registerfor June 12, 2012, 77 F.R. 34785)

2012–28 I.R.B. 44 July 9, 2012

Part III. Administrative, Procedural, and MiscellaneousQualified Energy ConservationBonds

Notice 2012–44

PURPOSE

This notice provides guidance concern-ing qualified energy conservation bondsunder § 54D of the Internal Revenue Code(Qualified Energy Conservation Bonds).This notice addresses questions regardingqualified conservation purposes eligiblefor financing with these bonds, particu-larly (1) how to measure reductions ofenergy consumption in publicly-ownedbuildings by at least 20 percent under§ 54D(f)(1)(A)(i) and (2) what consti-tutes a “green community program” under§ 54D(f)(1)(A)(ii).

BACKGROUND

Section 301(a) of Title III of DivisionB, the Energy Improvement and ExtensionAct of 2008, Pub. L. 110–343, 122 Stat.1365 (2008) (the “2008 Energy Act”),added new § 54D, which contains programprovisions specific to Qualified EnergyConservation Bonds effective for obliga-tions issued after October 3, 2008.

Section 54D(a) provides that the termQualified Energy Conservation Bondmeans any bond issued as part of an issueif: (1) 100 percent of the available projectproceeds of such issue are to be used forone or more “qualified conservation pur-poses;” (2) the bond is issued by a State orlocal government; and (3) the issuer des-ignates such bond for purposes of § 54D.Section 54D(f) defines the term “qualifiedconservation purpose” to include, amongother purposes, capital expenditures in-curred for purposes of (i) reducing energyconsumption in publicly-owned buildingsby at least 20 percent, or (ii) implementinggreen community programs (including theuse of loans, grants, or other repaymentmechanisms to implement such programs).Section 54D(d) originally authorized anational bond volume cap of $800 millionfor Qualified Energy Conservation Bonds,and § 54D(e) generally provides rules forhow this volume cap is to be allocatedamong the States.

Section 1112 of Division B of theAmerican Recovery and ReinvestmentAct of 2009, Pub. L. No. 111–5, 123Stat. 115 (2009) (“ARRA”), amended§ 54D in several respects. ARRA in-creased the national bond volume cap forQualified Energy Conservation Bondsfrom $800 million to $3.2 billion. ARRAalso amended the provision on “greencommunity programs” to what is in thestatute today to clarify that these programsmay include the use of loans, grants, orother repayment mechanisms to imple-ment such programs. In addition, ARRAadded § 54D(e)(4), which provides gen-erally that bonds issued to provide loans,grants, or other repayment mechanisms forcapital expenditures to implement greencommunity programs are not treated asprivate activity bonds for purposes of therestriction under § 54D(e)(3) against usingmore than 30 percent of the bond volumecap for private activity bonds.

In Notice 2009–29, 2009–16 I.R.B. 849(April 6, 2009), the Treasury Departmentand the IRS allocated the national bondvolume cap for Qualified Energy Con-servation Bonds to States, the District ofColumbia, and possessions of the UnitedStates in proportion to population. Notice2009–29 also provided interim guidanceon certain general program requirementsunder § 54D.

Section 179D also provides tax benefitsfor reductions in energy consumption ingovernment-owned buildings. Because ofthe difference in the rules and standards fordetermining the deduction for energy-effi-cient commercial buildings under § 179Das compared to the rules and standards fordetermining whether bonds are QualifiedEnergy Conservation Bonds under § 54D,this notice, including the rules for measur-ing the reduction of energy consumption inpublicly-owned buildings, does not applyfor purposes of § 179D. For guidance on§ 179D, see Notice 2006–52, 2006–1 C.B.1175, Notice 2008–40, 2008–1 C.B. 725,and Notice 2012–26, 2012–17 I.R.B. 847.

LEGISLATIVE HISTORY

The legislative history of the 2008 En-ergy Act includes the House of Represen-tatives version of the 2008 Energy Act ina bill entitled the “Renewable Energy and

Job Creation Act of 2008,” H.R. 6049,110th Cong. (2008) (H.R. 6049). The textof the House Bill is identical, in pertinentpart, to the text of the statute that was en-acted. House of Representatives ReportNo. 110–658 accompanied H.R. 6049 andindicates that the House intended the Qual-ified Energy Conservation Bond rules tobe interpreted broadly to give State and lo-cal governments wide discretion on meth-ods to conserve energy that may be fi-nanced with Qualified Energy Conserva-tion Bonds. The House Report states thefollowing reasons for enacting the Quali-fied Energy Conservation Bond provision:

Reasons for Change

The Committee believes that it isimportant to encourage energy conser-vation. The Committee believes thatState and local governments often are inthe best position to assess communityneeds and recognizes there are a numberof approaches to energy conservationthat State and local governments maywish to encourage. For example, theCommittee recognizes that State andlocal governments may wish to encour-age the development of combined heatand power systems, facilities that usethermal energy produced from renew-able resources, smart electrical grids,the use of solar panels, mass transit,bicycle paths, or residential propertythat reduces peak-use of energy. Inaddition to these approaches, the Com-mittee believes that State and localgovernments will develop numerousother approaches to energy conser-vation. Furthermore, the Committeerecognizes that there is great potentialfor energy conservation in urban areasand the Committee believes that localofficials should have the flexibility todevelop their own approaches to energyconservation. Therefore, the Com-mittee believes that it is appropriateto empower State and local govern-ments by providing them with accessto subsidized financing to help promoteenergy-efficient policies tailored to theneeds of local communities.

H. R. Rep. No. 110–658, at 94 (2008).The legislative history of ARRA gives

further indication of the broad discretion

July 9, 2012 45 2012–28 I.R.B.

Congress intended to give State and lo-cal governments issuing Qualified EnergyConservation Bonds. The Conference Re-port, H. R. Rep. No. 111–16 (2009), pro-vides:

Conference Agreement

In generalThe provision expands the present-

law qualified energy conservation bondprogram. . . . Also, the provisionclarifies that capital expenditures toimplement green community programsincludes grants, loans and other repay-ment mechanisms to implement suchprograms. For example, this expan-sion will enable States to issue thesetax credit bonds to finance retrofits ofexisting private buildings through loansand/or grants to individual homeownersor businesses, or through other repay-ment mechanisms. Other repaymentmechanisms can include periodic feesassessed on a government bill or util-ity bill that approximates the energysavings of energy efficiency or conser-vation retrofits. Retrofits can includeheating, cooling, lighting, water-saving,storm water-reducing, or other effi-ciency measures.

H. R. Rep. No. 111–16, at 627 (2009).

QUESTIONS AND ANSWERS

Numerous questions have arisen re-lating to Qualified Energy Conserva-tion Bonds, particularly how to measurewhether there have been reductions ofenergy consumption in publicly-ownedbuildings by at least 20 percent under§ 54D(f)(1)(A)(i) and what constitutesa “green community program” under§ 54D(f)(1)(A)(ii). Set forth below arequestions and answers regarding certainof these interpretative issues. Issuers mayrely upon these answers until further guid-ance, if any, is provided.

CAPITAL EXPENDITURESFOR CERTAIN QUALIFIEDCONSERVATION PURPOSES

Q.–1. What are “capital expenditures”for purposes of § 54D(f)(1)(A), whichprovides in relevant part that qualifiedenergy conservation purposes include,among other purposes, capital expendi-tures incurred for purposes of (i) reducing

energy consumption in publicly-ownedbuildings by at least 20 percent, or (ii)implementing green community programs(including the use of loans, grants, or otherrepayment mechanisms to implement suchprograms)?

A–1. For purposes of the capital expen-ditures requirement in § 54D(f)(1)(A), thedefinition of a “capital expenditure” appli-cable to State and local governments fortax-exempt bond purposes in § 1.150–1(b)of the Income Tax Regulations applies.This definition provides that a “capitalexpenditure” means any cost of a typethat is properly chargeable to capital ac-count (or would be so chargeable with aproper election or with the application ofthe definition of placed in service under§ 1.150–2(c)) under general Federal in-come tax principles. The determinationof whether a particular expenditure is acapital expenditure is made when the ex-penditure is paid or incurred and futurechanges in law do not affect this determi-nation.

20% REDUCTION INENERGY CONSUMPTION INPUBLICLY-OWNED BUILDINGS

Q–2. What does the term “pub-licly-owned buildings” mean under§ 54D(f)(1)(A)(i)?

A–2. The term “publicly-owned build-ings” under § 54D(f)(1)(A)(i) means abuilding or buildings that are owned by aState or local government (as defined in§ 1.103–1) or any instrumentality thereoffor Federal tax purposes. If the “measure-ment unit” (as defined in Q&A 4 below)used to measure reductions in energy con-sumption is a unit other than a buildingor buildings, such as a building systemcomponent, the building or buildings en-compassing the measurement unit must bea publicly-owned building or buildings.

Q–3. What standard applies to deter-mine that available project proceeds areto be used to finance capital expendituresfor the purpose of reducing energy con-sumption in publicly-owned buildings byat least 20 percent under § 54D(f)(1)(A)(i)(the “20 percent test”)?

A–3. In general, a reasonable expecta-tions standard (as defined for tax-exemptbond purposes under § 1.148–1(b)) appliesfor purposes of determining reductions inenergy consumption under the 20 percent

test. In particular, an issuer may determinethat its available project proceeds are tobe used in a manner that meets the 20percent test if, as of the issue date of theissue of Qualified Energy ConservationBonds, the issuer has reasonable expec-tations (as defined in § 1.148–1(b)) thatthe capital expenditures to be financedwith the bond proceeds will result in a20 percent or greater reduction in energyconsumption for the selected building,buildings, or building system compo-nent(s) comprising the measurement unitfor the selected measurement time period,and using a common energy unit. See Q& A 4 (regarding measurement units), Q& A 5 (regarding measurement methods),Q & A 6 (regarding measurement timeperiods), Q & A 7 (regarding reliance oncertifications of independent experts), Q& A 8 (regarding certain available toolsfor measuring energy reductions), and Q& A 9 (regarding common energy units)below.

Q–4. What is the unit for which theissuer measures reductions in energy con-sumption for purposes of satisfying the 20percent test?

A–4. For purposes of the 20 percenttest, the issuer may measure the reduc-tion in energy consumption using one ofthe following measurement units: (i) asingle publicly-owned building, (ii) multi-ple publicly-owned buildings; (iii) one ormore building system components of oneor more publicly-owned buildings, or (iv)a combination of (i) or (ii) and (iii) above(the “measurement unit”), provided thatmeasurement unit includes the publicly-owned building or buildings, or buildingsystem component or components, withrespect to which the capital expendituresfinanced with Qualified Energy Conser-vation Bond proceeds are incurred. Forthis purpose, a building system includesa system that serves one of the follow-ing functions: heating, ventilation, and airconditioning (“HVAC”): hot water sys-tem; lighting; building envelope (e.g., win-dows, roof, walls, insulation); or electric-ity “plug load” (e.g., items plugged intoelectric outlets, such as computers and re-frigerators).

Q–5. What methods may be used tomeasure energy savings attributable tocapital expenditures with respect to ameasurement unit for purposes of the 20percent test?

2012–28 I.R.B. 46 July 9, 2012

A–5. A reasonable and consistently ap-plied method must be used to measure en-ergy savings attributable to capital expen-ditures with respect to a measurement unitfor purposes of the 20 percent test.

Q–6. What time periods may an issueruse to measure reductions in energy con-sumption to meet the 20 percent test?

A–6. For purposes of the 20 percenttest, the issuer may consider actual andexpected energy consumption in the mea-surement unit during any reasonable andconsistent time periods of not less than oneyear (the measurement time periods), withone such period ending immediately be-fore, and one such period beginning imme-diately after, all capital expenditures to befinanced by the Qualified Energy Conser-vation Bond proceeds in the measurementunit are to be incurred, using a consistentmethod of measuring energy use. For ex-ample, if the issuer selects measurementtime periods of two years, the issuer mustdetermine its energy consumption in themeasurement unit during the two years im-mediately before the capital expendituresare to be incurred and compare it to theenergy consumption in the measurementunit during the two years immediately afterthe capital expenditures are to be incurred(energy consumption during the construc-tion period is not considered), using thesame method for measuring energy con-sumption, to determine if it meets the 20percent test.

Q–7. May an issuer rely on a certifica-tion of an independent expert to establishits reasonable expectations to meet the 20percent test?

A–7. An issuer may rely on an inde-pendent expert to establish that it reason-ably expects to meet the 20 percent test,if, no earlier than 60 days before the issuedate of the issue, an independent, licensedprofessional engineer or other independentexpert certifies under penalty of perjurythat the capital expenditures to be incurredwith respect to the measurement unit arereasonably expected to result in the reduc-tion of energy consumption by 20 percentor greater in the measurement unit duringthe measurement time period. An issuermay rely on this certification only if theactual capital expenditures from the bondproceeds are substantially the same as theexpected capital expenditures of such pro-ceeds on which the certification was based.

An example of an engineer’s certifica-tion for this purpose is attached as Appen-dix A to this Notice.

Q–8. What tools are available to es-timate the energy savings attributable tocapital expenditures for purposes of estab-lishing that the issuer had reasonable ex-pectations as of the issue date of the issuethat the capital expenditures will result inreduction of energy consumption in pub-licly-owned buildings by at least 20 per-cent?

A–8. An issuer or an independentexpert on whom an issuer relies may ob-tain energy savings estimates through anASHRAE level 3 audit or through build-ing energy use simulation techniques andestimating software, including the DOE(Department of Energy) 2 based Quick En-ergy Simulation Tool (eQUEST) or otherqualified computer software for calculat-ing commercial building energy and powercost savings that meet federal tax incentiverequirements as listed by Department ofEnergy’s Building Technology Programat: http://apps1.eere.energy.gov/build-ings/tools_directory/. Further, an issuer orindependent expert may rely on other toolsto estimate energy savings, using reason-able and consistently applied methods.

An issuer is not required to subse-quently measure the energy savings, butis encouraged to employ energy man-agement and monitoring practices, suchas use of the ENERGY STAR Portfo-lio Manager software to establish energybaselines and track whole building en-ergy performance. See http://www.ener-gystar.gov/index.cfm?c=evaluate_perfor-mance.bus_portfoliomanager.

Q–9. How does the issuer determinethe reduction of energy consumed in thechosen measurement unit if more than oneenergy source affects the measurementunit and the energy reduction is computedwith respect to different types of energysources, such as electricity and naturalgas?

A–9. If more than one energy sourceaffects the measurement unit and thus istaken into account in computing the reduc-tion in energy consumption, the amount ofthe consumed energy from each source be-fore and after incurring the capital expen-ditures must be converted into a commonenergy unit such as, for example, a MMBtu(one million British thermal Units). In thiscircumstance, for purposes of the 20 per-

cent test, the percentage reduction in en-ergy consumption is based on the percent-age reduction for the aggregate of the en-ergy sources, using the common energyunit.

GREEN COMMUNITY PROGRAM

Q–10. What is a “green communityprogram” under § 54D(f)(1)(A)(ii) forwhich capital expenditures may be in-curred as one of the qualified conservationpurposes eligible for financing with Qual-ified Energy Conservation Bonds?

A–10. In general, the term “green com-munity program” means a program thatmeets the following two requirements:

(1) Program Purpose. The purposeof a green community program is to pro-mote one or more of the purposes ofenergy conservation, energy efficiency,or environmental conservation initiativesrelating to energy consumption, broadlyconstrued. Eligible program purposes in-clude, among others, promotion of energysavings through retrofitting initiatives forheating, cooling, lighting, water-saving,storm-water reducing, or other efficiencymeasures; distributed generation initia-tives; or transportation initiatives thatconserve energy and/or support alternativefuel infrastructure (which may include, forexample, improvements to public bicyclepaths or mass transit systems).

(2) General Public Use or Broad PublicAvailability. A green community programmust: (i) involve property that is avail-able for general public use (using stan-dards similar to standards for distinguish-ing general public use from private busi-ness use under § 1.141–3(c)); or (ii) in-volve a loan (or other repayment mech-anism) or grant program that is broadlyavailable to members of the general pub-lic, including individuals or businesses. Agreen community program need not af-fect the entire geographical area or all theresidents and businesses within the juris-diction of the State or local governmen-tal unit that implements the program, pro-vided that the program broadly benefitsthe general public, residents, or businessesin the affected area of the State or localgovernmental unit. Examples of programsthat are available for general public use in-clude programs to make improvements topublic infrastructure that enhances prox-imity and connectivity between commu-

July 9, 2012 47 2012–28 I.R.B.

nity assets and public transit in order toreduce motor vehicle use and promote en-ergy conservation. An example of a loanor grant program that is broadly availableto the general public would be a programfor residential housing or private buildingenergy efficiency initiatives that providesgrants or loans that are broadly availablefor homeowners or businesses.

Q–11. What is an example of a greencommunity program?

A–11. The following example illus-trates the implementation of a green com-munity program with proceeds of Quali-fied Energy Conservation Bonds. City, alarge local government, plans a program tofinance capital expenditures to replace ex-isting public street lights located through-out the City with more energy-efficientlights within a 3-year period. City rec-

ognizes the program as a green commu-nity program and designates the bonds tofinance the program as Qualified EnergyConservation Bonds under § 54D(a)(3).Specifically, City plans to use the bondproceeds to replace existing high-pressureluminaries with light emitting diode lumi-naries that consume substantially less elec-tricity. City’s independent experts esti-mate that the new streetlights will have auseful life of approximately 15 years. Asof the issue date of the bonds, City expectsthat the program will result in substantialenergy savings. City’s program qualifiesas a green community program that meets§ 54D(f)(1)(A)(ii) for the following rea-sons:

1. The program furthers a qualifiedconservation purpose because it promotesenergy conservation. The program calls

for the replacement of existing street lightswith more efficient street lights.

2. The program involves public street-lights that are available for general publicuse.

3. The proceeds of the bond will beused for capital expenditures within themeaning of § 1.150–1(b) to replace thestreet lights.

FURTHER INFORMATION

For further information regarding thisnotice, contact Zoran Stojanovic at (202)622–3980 (not a toll-free call).

2012–28 I.R.B. 48 July 9, 2012

APPENDIX A

Qualified Energy Conservation Bonds Statement of Expected Savings and Signatures

Qualified Professional Engineer certifying reasonable expectation of 20% or greater savings using based on an ASHRAELevel 3 audit or through use of DOE-approved software tool.

Name:

Address:

Phone:

I certify that the expected percentage of energy savings from the capital expenditures financed with Qualified Energy ConservationBonds for the measurement unit and measurement time specified by the issuer is at least 20 percent.

Address of the building(s) (and description of component(s), if applicable) to which the certification applies:

Qualified Professional Engineer must initial and complete one or more of the following statements:

(1) I conducted an ASHRAE level 3 energy audit to estimate the expected savings from planned improvements that will befinanced through the qualified energy conservation bond.

(2) I used a qualified computer software for calculating commercial building energy and power cost savings that meetfederal tax incentive requirements as listed by Department of Energy’s Building Technology Program to estimate the expectedsavings from planned improvements that will be financed through the qualified energy conservation bond. The name andversion of the software is:

Penalty of perjury statement to be signed by the Qualified Professional Engineer that performs field inspections andgenerates certification form using qualified computer software.

Under penalties of perjury, I declare that I have examined this certification, including supporting documents, and to the best of myknowledge and belief, the facts presented in support of this certification are true, correct, and complete.

Professional Engineer License # and State:

Signature of Professional Engineer:

Date Signed:

26 CFR 1.83–2: Election to include in gross incomein year of transfer.

Rev. Proc. 2012–29

SECTION 1. PURPOSE

This revenue procedure contains sam-ple language that may be used (but is notrequired to be used) for making an elec-tion under § 83(b) of the Internal RevenueCode. Additionally, this revenue proce-dure provides examples of the income taxconsequences of making such an election.

SECTION 2. BACKGROUND

.01 Section 83(a) provides generallythat if, in connection with the performanceof services, property is transferred to anyperson other than the person for whom

such services are performed, the excessof the fair market value of the property(determined without regard to any restric-tion other than a restriction which by itsterms will never lapse) as of the first timethat the transferee’s rights in the propertyare transferable or are not subject to asubstantial risk of forfeiture, whicheveroccurs earlier, over the amount (if any)paid for the property is included in theservice provider’s gross income for thetaxable year which includes such time.

.02 Under § 1.83–3(f) of the IncomeTax Regulations, property is transferredin connection with the performance ofservices if it is transferred to an employeeor independent contractor (or beneficiarythereof) in recognition of the performanceof services, or refraining from perfor-mance of services. The existence of otherpersons entitled to buy stock on the sameterms and conditions as an employee,whether pursuant to a public or private of-

fering may, however, indicate that in suchcircumstance a transfer to the employeeis not in recognition of the performanceof, or refraining from performance of, ser-vices. The transfer of property is subjectto § 83 whether such transfer is in respectof past, present, or future services.

.03 Section 83(b) and § 1.83–2(a) per-mit the service provider to elect to includein gross income the excess (if any) of thefair market value of the property at the timeof transfer over the amount (if any) paid forthe property, as compensation for services.

.04 Under § 83(e)(3) and § 1.83–7(b),§ 83 does not apply to the transfer of anoption without a readily ascertainable fairmarket value at the time the option isgranted. As a result, a § 83(b) electionmay only be made with respect to thetransfer of an option that has a readilyascertainable fair market value (as definedin § 1.83–7(b)), at the time the option isgranted and that is substantially nonvested

July 9, 2012 49 2012–28 I.R.B.

(as defined in § 1.83–3(b)). If substan-tially nonvested property is received uponexercise of an option without a readilyascertainable fair market value at grant,a service provider is permitted to make a§ 83(b) election with respect to the transferof such property upon the exercise of theoption.

.05 Under § 83(b)(2), an election madeunder § 83(b) must be made in accordancewith the regulations thereunder and mustbe filed with the Internal Revenue Serviceno later than 30 days after the date thatthe property is transferred to the serviceprovider. In accordance with § 7503, ifthe thirtieth day following the transfer ofproperty falls on a Saturday, Sunday or le-gal holiday, the election will be consideredtimely filed if it is postmarked by the nextbusiness day.

.06 Under § 1.83–2(c), an election un-der § 83(b) is made by filing a copy ofa written statement with the Internal Rev-enue Service office with which the per-son who performed the service files hisreturn. In addition, the person who per-formed the services is required to submita copy of such statement with his or herincome tax return for the taxable year inwhich such property was transferred. Sec-tion 1.83–2(d) requires that the person whoperformed the services also submit a copyof the § 83(b) election to the person forwhom the services were performed.

.07 Under § 1.83–2(e), the statementmust be signed by the person making theelection and must indicate the election isbeing made under § 83(b). The state-ment must include the following informa-tion: the name, address and taxpayer iden-tification number of the taxpayer; a de-scription of each property with respect towhich the election is being made; the dateor dates on which the property was trans-ferred and the taxable year for which suchelection is being made; the nature of the re-striction or restrictions to which the prop-erty is subject; the fair market value at thetime of transfer (determined without re-gard to any lapse restrictions, as definedin § 1.83–3(i)) of each property with re-spect to which the election is being made;the amount, if any, paid for such property;and a statement to the effect that copieshave been furnished to other persons asprovided in § 1.83–2(d).

.08 Under § 1.83–2(f), an election un-der § 83(b) may not be revoked except

with the consent of the Commissioner. Theregulations also provide that such consentwill only be granted where the person fil-ing the election is under a mistake of factas to the underlying transaction and mustbe requested within 60 days of the dateon which the mistake of fact first becameknown to the person who made the elec-tion. Neither a mistake as to the value (ordecline in the value) of the property forwhich the election was made nor the fail-ure of anyone to perform an act that wascontemplated at the time of transfer of theproperty constitutes a mistake of fact forthis purpose. See Rev. Proc. 2006–31,2006–2 C.B. 32, for additional guidancewith respect to revoking an election under§ 83(b).

SECTION 3. SCOPE

This revenue procedure applies totaxpayers who receive substantially non-vested property in connection with theperformance of services and wish to filean election under § 83(b).

SECTION 4. CONSEQUENCES OFELECTIONS UNDER § 83(b)

.01 Under § 1.83–2(a), if property istransferred in connection with the perfor-mance of services, the person performingsuch services may elect to include in grossincome under § 83(b) the excess (if any)of the fair market value of the property atthe time of transfer (determined withoutregard to any lapse restriction, as definedin § 1.83–3(i)) over the amount (if any)paid for such property, as compensation forservices. If this election is made, the sub-stantial vesting rules of § 83(a) and the reg-ulations thereunder do not apply with re-spect to such property, and except as oth-erwise provided in § 83(d)(2) and the reg-ulations thereunder (relating to the cancel-lation of a nonlapse restriction), any subse-quent appreciation in the value of the prop-erty is not taxable as compensation to theperson who performed the services. Thus,the value of property with respect to whichthis election is made is included in grossincome as of the time of transfer, eventhough such property is substantially non-vested (as defined in § 1.83–3(b)) at thetime of transfer, and no compensation willbe includible in gross income when suchproperty becomes substantially vested.

.02 In computing the gain or loss froma subsequent sale or exchange of prop-erty for which a § 83(b) election was filed,§ 1.83–2(a) provides that the basis of suchproperty shall be the amount paid for theproperty (if any) increased by the amountincluded in gross income under § 83(b).

.03 If property for which a § 83(b) elec-tion was filed is forfeited while substan-tially nonvested, § 83(b)(1) provides thatno deduction shall be allowed with respectto such forfeiture. Section 1.83–2(a) fur-ther provides that such forfeiture shall betreated as a sale or exchange upon whichthere is realized a loss equal to the excess(if any) of (1) the amount paid (if any) forsuch property, over (2) the amount realized(if any) upon such forfeiture. If such prop-erty is a capital asset in the hands of thetaxpayer, such loss shall be a capital loss.

SECTION 5. EXAMPLES

The following examples illustrate thetax results that may occur depending onwhether or not a § 83(b) election is madefollowing the transfer of substantially non-vested stock in connection with the per-formance of services. The tax results inthe examples do not depend on whether ornot the stock transferred to the employee istraded on an established securities market.

Example 1. Company A is a privately held corpo-ration and no stock in Company A is traded on an es-tablished securities market. On April 1, 2012, in con-nection with the performance of services, Company Atransfers to E, its employee, 25,000 shares of substan-tially nonvested stock in Company A. In exchangefor the stock, E pays Company A $25,000, represent-ing the fair market value of the shares at the time ofthe transfer. The restricted stock agreement providesthat if E ceases to provide services to Company Aas an employee prior to April 1, 2014, Company Awill repurchase the stock from E for the lesser of thethen current fair market value or the original purchaseprice of $25,000. E’s ownership of the 25,000 sharesof stock will not be treated as substantially vesteduntil April 1, 2014 and will only be treated as sub-stantially vested if E continues to provide servicesto Company A as an employee until April 1, 2014.On April 1, 2012, E makes a valid election under§ 83(b) with respect to the 25,000 shares of CompanyA stock. Because the excess of the fair market valueof the property ($25,000) over the amount E paid forthe property ($25,000) is $0, E includes $0 in gross in-come for 2012 as a result of the stock transfer and re-lated § 83(b) election. The 25,000 shares of stock be-come substantially vested on April 1, 2014 when thefair market value of the shares is $40,000. No com-pensation is includible in E’s gross income when theshares become substantially vested on April 1, 2014.In 2015, E sells the stock for $60,000. As a result

2012–28 I.R.B. 50 July 9, 2012

of the sale, E realizes $35,000 ($60,000 sale price -$25,000 basis) of gain, which is a capital gain.

Example 2. The facts are the same as in Exam-ple 1 above, except that E does not make an electionunder § 83(b). Under § 83(a), E includes $0 in grossincome in 2012 as a result of the transfer of stock fromCompany A because the stock is not substantiallyvested. When the shares become substantially vestedon April 1, 2014, E includes $15,000 ($40,000 fairmarket value less $25,000 purchase price) of com-pensation in gross income. E’s basis in the stock as ofApril 1, 2014 is $40,000 ($25,000 paid for the stockand $15,000 included in income under § 83(a)). Asa result of the 2015 sale of the stock for $60,000, Erealizes $20,000 ($60,000 sale price - $40,000 basis)of gain, which is a capital gain.

Example 3. The facts are the same as in Example1 above, except that E terminates employment withCompany A on August 1, 2013 before the shares be-come substantially vested. Because the excess of thefair market value of the property ($25,000) over theamount E paid for the property ($25,000) is $0, E in-cludes $0 in gross income for 2012 as a result of thestock transfer and related § 83(b) election. When Eterminates employment on August 1, 2013, the fairmarket value of the stock is $30,000 but CompanyA purchases the stock from E for $25,000 pursuantto the terms of the restricted stock agreement. As aresult of the 2013 sale of the stock for $25,000, E re-alizes $0 in gain ($25,000 sale price - $25,000 basis).

Example 4. Company B is a publicly held corpo-ration and Company B stock is traded on an estab-lished securities market. On April 1, 2012, in con-nection with the performance of services, Company Btransfers to F, its employee, 25,000 shares of substan-tially nonvested stock in Company B. At the time ofthe transfer, the shares have an aggregate fair marketvalue of $25,000. F is not required to pay CompanyB any consideration in exchange for the stock. Therestricted stock agreement provides that if F ceasesto provide services to Company B as an employeeprior to April 1, 2014, F will forfeit the stock backto Company B. F’s ownership of the 25,000 sharesof stock will not be treated as substantially vested

until April 1, 2014 and will only be treated as sub-stantially vested if F continues to provide servicesto Company B as an employee until April 1, 2014.On April 1, 2012, F makes a valid election under§ 83(b) with respect to the 25,000 shares of CompanyB stock. Because the excess of the fair market valueof the property ($25,000) over the amount F paid forthe property ($0) is $25,000, F includes $25,000 ofcompensation in gross income for 2012 as a result ofthe stock transfer and related § 83(b) election. The25,000 shares of stock become substantially vested onApril 1, 2014 when the fair market value of the sharesis $40,000. No compensation is includible in F’sgross income when the shares become substantiallyvested on April 1, 2014. In 2015, F sells the stock for$60,000. As a result of the sale, F realizes $35,000($60,000 sale price - $25,000 basis) in gain, which isa capital gain.

Example 5. The facts are the same as in Example4 above, except that F does not make an election un-der § 83(b). Under § 83(a), F includes $0 in grossincome in 2012 as a result of the transfer of stockfrom Company B because the stock is not substan-tially vested. When the shares become substantiallyvested on April 1, 2014, F includes $40,000 ($40,000fair market value less $0 purchase price) of compen-sation in gross income. F’s basis in the stock as ofApril 1, 2014 is $40,000 ($0 paid for the stock and$40,000 included in income under § 83(a)). As a re-sult of the 2015 sale of the stock for $60,000, F real-izes $20,000 ($60,000 sale price - $40,000 basis) ofgain, which is a capital gain.

Example 6. The facts are the same as in Example4 above, except that F terminates employment withCompany B on August 1, 2013 and forfeits the sharesbefore the shares become substantially vested. Be-cause the excess of the fair market value of the prop-erty ($25,000) over the amount F paid for the property($0) is $25,000, F includes $25,000 of compensationin gross income for 2012 as a result of the stock trans-fer and related § 83(b) election. In the year F termi-nates employment, F forfeits the 25,000 shares backto Company B and such forfeiture is treated as a saleof the shares in exchange for no consideration. Pur-

suant to § 1.83–2(a), F realizes no loss as the result ofsuch sale. F is not entitled to a deduction or credit fortaxes paid as the result of filing the § 83(b) electionor the subsequent forfeiture of the property.

SECTION 6. SAMPLE ELECTION

.01 The sample election in this section,if properly completed and executed by anindividual taxpayer, would satisfy the re-quirements of § 1.83–2 regarding the re-quired content of a § 83(b) election withrespect to shares of common stock subjectto a substantial risk of forfeiture. For theelection to be valid, the service providermust in addition satisfy all other applicablerequirements, including the requirementsdiscussed above relating to the time for fil-ing the election, filing the election with theInternal Revenue Service, attaching a copyof the election to the tax return, and pro-viding a copy to the service recipient. Anelection under § 83(b) must contain all theinformation required by § 1.83–2(e), butneed not use the exact format or languageof the sample election set forth below. Inthe sample election below, bracketed itemsand blanks should be replaced with the ap-plicable information for the taxpayer. Anelection with respect to property other thancommon stock should include an appropri-ate description of the property in item 2and modifications to items 5 and 6 as nec-essary.

.02 The text of the sample election fol-lows.

July 9, 2012 51 2012–28 I.R.B.

Section 83(b) Election

The undersigned taxpayer hereby elects, pursuant to § 83(b) of the Internal Revenue Code of 1986, as amended, to include ingross income as compensation for services the excess (if any) of the fair market value of the shares described below overthe amount paid for those shares.

1. The name, taxpayer identification number, address of the undersigned, and the taxable year for which this electionis being made are:

TAXPAYER’S NAME:TAXPAYER’S SOCIAL SECURITY NUMBER:ADDRESS:TAXABLE YEAR: Calendar Year 20

2. The property which is the subject of this election is shares of common stock of .

3. The property was transferred to the undersigned on [DATE].

4. The property is subject to the following restrictions: [Describe applicable restrictions here.]

5. The fair market value of the property at the time of transfer (determined without regard to any restriction other than anonlapse restriction as defined in § 1.83–3(h) of the Income Tax Regulations) is: $ per share xshares = $ .

6. For the property transferred, the undersigned paid $ per share x shares = $ .

7. The amount to include in gross income is $ . [The result of the amount reported in Item 5 minus the amountreported in Item 6.]

The undersigned taxpayer will file this election with the Internal Revenue Service office with which taxpayer files his or her annualincome tax return not later than 30 days after the date of transfer of the property. A copy of the election also will be furnished tothe person for whom the services were performed. Additionally, the undersigned will include a copy of the election with his orher income tax return for the taxable year in which the property is transferred. The undersigned is the person performing theservices in connection with which the property was transferred.

Dated:Taxpayer

SECTION 7: PAPERWORKREDUCTION ACT

.01 The collection of information con-tained in this revenue procedure has beenreviewed and approved by the Officeof Management and Budget in accor-dance with the Paperwork Reduction Act(44 U.S.C. 3507) under control number1545–2018. An agency may not conductor sponsor, and a person is not required torespond to, a collection of information un-less the collection of information displaysa valid OMB control number.

.02 The collection of information in thisrevenue procedure is in Section 6. Theuse of the sample election language pro-vided under Section 6 is voluntary, how-ever, this information is required in orderfor a taxpayer to make a valid election un-der § 83(b) of the Code. This informationon the § 83(b) elections filed by the taxpay-

ers with the IRS will be used by the IRSfor matching with the income tax returnsfiled by the taxpayers. The likely respon-dents are individuals and business or otherfor-profit institutions.

.03 The estimated total annual report-ing and/or recordkeeping burden is 33,000hours.

.04 The estimated annual burden per re-spondent/recordkeeper varies from 10 to30 minutes, depending on individual cir-cumstances, with an estimated average of20 minutes.

.05 The estimated number of respon-dents and/or recordkeepers is 100,000.

.06 The estimated frequency of re-sponses (used for reporting requirementsonly) is on occasion.

.07 Books or records relating to a col-lection of information must be retained aslong as their contents may become mate-rial in the administration of any internal

revenue law. Generally, tax returns and taxreturn information are confidential, as re-quired by 26 U.S.C. 6103.

SECTION 8. EFFECTIVE DATE

This revenue procedure is effectiveJune 25, 2012.

SECTION 9. DRAFTINGINFORMATION

The principal author of this revenueprocedure is Michael Hughes of theOffice of Associate Chief Counsel (TaxExempt & Government Entities). Forfurther information regarding this revenueprocedure contact Thomas Scholz orMichael Hughes at (202) 622–6030 (not atoll-free call).

2012–28 I.R.B. 52 July 9, 2012

Part IV. Items of General InterestNotice of ProposedRulemaking byCross-Reference toTemporary Regulations

Substantial Business Activities

REG–107889–12

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemakingby cross-reference to temporary regula-tions.

SUMMARY: In this issue of the Bulletin,the IRS and the Treasury Department areissuing temporary regulations (T.D. 9592)regarding whether a foreign corporationhas substantial business activities in aforeign country. These regulations affectcertain domestic corporations and partner-ships (and certain parties related thereto),and foreign corporations that acquire sub-stantially all of the properties of suchdomestic corporations or partnerships.The text of the temporary regulations alsoserves as the text of these proposed reg-ulations. The preamble to the temporaryregulations explains the temporary regula-tions and these proposed regulations.

DATES: Written or electronic commentsand requests for a public hearing must bereceived by September 10, 2012.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–107889–12), room5203, Internal Revenue Service, PO Box7604, Ben Franklin Station, Washing-ton, DC 20044. Submissions may behand-delivered Monday through Fridaybetween the hours of 8 a.m. and 4 p.m.to CC:PA:LPD:PR (REG–107889–12),Courier’s Desk, Internal RevenueService, 1111 Constitution Avenue NW,Washington, DC, or sent electronicallyvia the Federal eRulemaking Portalat www.regulations.gov (IRS andREG–107889–12).

FOR FURTHER INFORMATIONCONTACT: Concerning the proposed

regulations, Mary W. Lyons, (202)622–3860 and David A. Levine, (202)622–3860; concerning submissions ofcomments or requests for a public hearing,Oluwafunmilayo (Funmi) Taylor, (202)622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation ofProvisions

Temporary regulations in this issue ofthe Bulletin amend the Income Tax Regu-lations (26 CFR part 1) relating to section7874 of the Code. The temporary regula-tions provide guidance regarding whethera foreign corporation has substantial busi-ness activities in a foreign country for pur-poses of whether a foreign corporation istreated as a surrogate foreign corporationunder section 7874(a)(2)(B). The text ofthose regulations also serves as the text ofthese proposed regulations. The preambleto the temporary regulations explains theseamendments.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a significantregulatory action as defined in ExecutiveOrder 12866. Therefore, a regulatory as-sessment is not required. It has also beendetermined that 5 U.S.C. 553(b) does notapply to these regulations. These regula-tions do not impose a collection of infor-mation. Pursuant to the Regulatory Flexi-bility Act (5 U.S.C. chapter 6), it is herebycertified that this regulation will not have asignificant economic impact on a substan-tial number of small entities. The com-plexity and cost of a transaction to whichsection 7874 may apply make it unlikelythat a substantial number of small entitieswill engage in such a transaction. In ad-dition, any economic impact to entities af-fected by section 7874, large or small, isderived from the operation of the statute orits intended application, and not from thetemporary regulations. Pursuant to section7805(f) of the Code, these regulations havebeen submitted to the Chief Counsel forAdvocacy of the Small Business Adminis-tration for comment on its impact on smallbusiness.

Comments and Requests for a PublicHearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written comments(a signed original and eight (8) copies)or electronic comments that are submittedtimely to the IRS. The IRS and the Trea-sury Department specifically request com-ments on the clarity of the proposed rulesand how they can be made easier to un-derstand. All comments will be availablefor public inspection and copying. A pub-lic hearing will be scheduled if requestedin writing by any person who timely sub-mits written comments. If a public hearingis scheduled, notice of the date, time, andplace for the public hearing will be pub-lished in the Federal Register.

Drafting Information

The principal authors of these pro-posed regulations are Mary W. Lyons andDavid A. Levine of the Office of AssociateChief Counsel (International). However,other personnel from the IRS and theTreasury Department participated in theirdevelopment.

* * * * *

Proposed Amendments to theRegulations

Accordingly, 26 CFR part 1 is proposedto be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805* * *Section 1.7874–3 is also issued under

26 U.S.C. 7874(c)(6) and (g).* * *Par. 2. Section 1.7874–3 is added to

read as follows:

§1.7874–3 Substantial Business Activities.

[The text of proposed §1.7874–3 is thesame as the text of §1.7874–3T publishedelsewhere in this issue of the Bulletin].

Steven T. Miller,Deputy Commissioner forServices and Enforcement.

July 9, 2012 53 2012–28 I.R.B.

(Filed by the Office of the Federal Register on June 7, 2012,4:15 p.m., and published in the issue of the Federal Registerfor June 12, 2012, 77 F.R. 34887)

Notice of ProposedRulemaking byCross-Reference toTemporary Regulationsand Notice of Public Hearing

Portability of a DeceasedSpousal Unused ExclusionAmount

REG–141832–11

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemakingby cross-reference to temporary regula-tions and notice of public hearing.

SUMMARY: In this issue of the Bulletin,the IRS is issuing temporary regulations(T.D. 9593) that provide guidance on theestate and gift tax applicable exclusionamount, in general, as well as on the appli-cable requirements for electing portabilityof a deceased spousal unused exclusion(DSUE) amount to the surviving spouseand on the applicable rules for the surviv-ing spouse’s use of this DSUE amount.The text of the temporary regulations alsoserves as the text of the proposed regula-tions set forth in this notice of proposedrulemaking. This document also providesa notice of public hearing on these pro-posed regulations.

DATES: Written or electronic commentsmust be received by September 17, 2012.Outlines of topics to be discussed at thepublic hearing scheduled for October 18,2012, at 10 a.m., must be received bySeptember 27, 2012.

ADDRESSES: Send submissions toCC:PA:LPD:PR (REG–141832–11),Room 5205, Internal Revenue Service,PO Box 7604, Ben Franklin Station,Washington, DC 20044. Submissions maybe hand-delivered Monday through Fridaybetween the hours of 8 a.m. and 4 p.m.to CC:PA:LPD:PR (REG–141832–11),Courier’s Desk, Internal Revenue

Service, 1111 Constitution Avenue, N.W.,Washington, DC; or sent electronicallyvia the Federal eRulemakingPortal at http://www.regulations.gov(IRS-REG–141832–11). The publichearing will be held in the IRS Auditorium,Internal Revenue Building, 1111Constitution Avenue, N.W., Washington,DC.

FOR FURTHER INFORMATIONCONTACT: Concerning the proposedregulations, Karlene Lesho at (202)622–3090; concerning the submission ofcomments, the hearing, or to be placedon the building access list to attend thehearing, Oluwafunmilayo Taylor at (202)622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information con-tained in this notice of proposed rule-making has been approved by the Of-fice of Management and Budget, inaccordance with the Paperwork Reduc-tion Act of 1995 (44 U.S.C. 3507(d)),under Form 706, “United States Estate(and Generation-Skipping Transfer) TaxReturn,” and assigned control number1545–0015.

Comments on the collection of infor-mation should be sent to the Office ofManagement and Budget, Attn: DeskOfficer for the Department of the Trea-sury, Office of Information and Regu-latory Affairs, Washington, DC 20503,with copies to the Internal Revenue Ser-vice, Attn: IRS Reports Clearance Offi-cer, SE:W:CAR:MP:T:M:S, Washington,DC 20224. Comments on the collec-tion of information should be receivedby August 17, 2012. Comments arespecifically requested concerning:

Whether the proposed collection of in-formation is necessary for the proper per-formance of the functions of the IRS, in-cluding whether the information will havepractical utility;

The accuracy of the estimated burdenassociated with the proposed collection ofinformation;

How the quality, utility, and clarity ofthe information to be collected may be en-hanced;

How the burden of complying with theproposed collections of information may

be minimized, including through the appli-cation of automated collection techniquesor other forms of information technology;and

Estimates of capital or start-up costs ofoperation, maintenance, and purchase ofservice to provide information.

The collection of informa-tion in this proposed regulationis in proposed §§20.2010–2(a),20.2010–2(a)(1), 20.2010–2(a)(3)(i),20.2010–2(a)(7)(ii)(B), and 20.2010–2(b).The information in §§20.2010–2(a),20.2010–2(a)(1), and 20.2010–2(b) asit affects estates not otherwise requiredto file an estate tax return under section6018(a) is necessary in order for anexecutor of a decedent’s estate to electportability of a DSUE amount to thesurviving spouse. The information in§20.2010–2(a)(3)(i) is necessary in orderfor an executor of a decedent’s estateto signify that the estate is not electingportability of a DSUE amount to thesurviving spouse. The information in§20.2010–2(a)(7)(ii)(B) is necessaryin order to evaluate whether an estatequalifies for a special rule relating toapplicable estate tax return requirements.The collection of information is voluntaryto obtain a benefit. The likely respondentsare executors of estates of decedentshaving a date of death in 2011 or 2012 orany subsequent period in which portabilityof a DSUE amount is in effect.

An agency may not conduct or sponsor,and a person is not required to respondto, a collection of information unless thecollection of information displays a validcontrol number assigned by the Office ofManagement and Budget.

Books or records relating to a collectionof information must be retained as longas their contents may become material inthe administration of any internal revenuelaw. Generally, tax returns and tax returninformation are confidential, as requiredby 26 U.S.C. 6103.

Background

The temporary regulations in this issueof the Bulletin make additions to the Es-tate Tax Regulations (26 CFR part 20) un-der sections 2001 and 2010 of the Inter-nal Revenue Code (Code) and Gift TaxRegulations (26 CFR part 25) under sec-tion 2505 of the Code. The temporary

2012–28 I.R.B. 54 July 9, 2012

regulations provide guidance on the estateand gift tax applicable credit amount un-der sections 2010 and 2505 of the Code.In addition, the temporary regulations pro-vide guidance on the portability of a de-ceased spousal unused exclusion (DSUE)amount under section 2010(c) of the Code,including the applicable requirements forelecting portability of a DSUE amount tothe surviving spouse, for computing thedeceased spouse’s DSUE amount, and forthe surviving spouse’s use of the DSUEamount. The text of those regulations alsoserves as the text of these regulations. Thepreamble to the temporary regulations ex-plains the temporary regulations and theseproposed regulations.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a significantregulatory action as defined in ExecutiveOrder 12866. Therefore, a regulatory as-sessment is not required. It also has beendetermined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C. chap-ter 5) does not apply to the regulations, andbecause the regulations do not impose acollection of information on small entities,the requirements of the Regulatory Flexi-bility Act (5 U.S.C. chapter 6) do not ap-ply. Accordingly, a regulatory flexibilityanalysis is not required. Pursuant to sec-tion 7805(f) of the Code, the regulationshave been submitted to the Chief Counselfor Advocacy of the Small Business Ad-ministration for comment on their impacton small business.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written comments(a signed original and eight (8) copies)or electronic comments that are submittedtimely to the IRS as prescribed in this pre-amble under the ADDRESSES heading.The IRS and the Treasury Department re-quest comments on all aspects of the pro-posed rules. All comments will be avail-able at www.regulations.gov or for publicinspection and copying.

A public hearing has been scheduledfor October 18, 2012, in the IRS audi-torium, Internal Revenue Building, 1111Constitution Avenue, N.W., Washington,

DC. Due to building security procedures,visitors must enter at the Constitution Av-enue entrance. In addition, all visitorsmust present photo identification to enterthe building. Because of access restric-tions, visitors will not be admitted beyondthe immediate entrance more than 30 min-utes before the hearing starts. For infor-mation about having your name placed onthe building access list to attend the hear-ing, see the FOR FURTHER INFOR-MATION CONTACT section of this pre-amble.

The rules of 26 CFR 601.601(a)(3) ap-ply to the hearing. Persons who wish topresent oral comments at the hearing mustsubmit electronic or written comments (asigned original and eight (8) copies) andan outline of the topics to be discussedand the time to be devoted to each topicby September 27, 2012. A period of 10minutes will be allotted to each person formaking comments. An agenda showingthe scheduling of the speakers will be pre-pared after the deadline for receiving out-lines has passed. Copies of the agenda willbe available free of charge at the hearing.

Drafting Information

The principal author of these regula-tions is Karlene Lesho, Office of the As-sociate Chief Counsel (Passthroughs andSpecial Industries). Other personnel fromthe IRS and the Treasury Department par-ticipated in their development.

* * * * *

Proposed Amendments to theRegulations

Accordingly, 26 CFR parts 20 and 25are proposed to be amended as follows:

PART 20—ESTATE TAX; ESTATEOF DECEDENTS DYING AFTERAUGUST 16, 1954

Paragraph 1. The authority citation forpart 20 is amended by adding entries innumerical order to read as follows:

Authority: 26 U.S.C. 7805. * * *Section 20.2010–0 also issued under

26 U.S.C. 2010(c)(6).Section 20.2010–1 also issued under

26 U.S.C. 2010(c)(6).Section 20.2010–2 also issued under

26 U.S.C. 2010(c)(6).

Section 20.2010–3 also issued under26 U.S.C. 2010(c)(6). * * *

Par. 2. Section 20.2001–2 is added toread as follows:

§20.2001–2 Valuation of adjusted taxablegifts for purposes of determining thedeceased spousal unused exclusionamount of last deceased spouse.

[The text of the proposed amendmentsto §20.2001–2(a) and (b) is the same as thetext of §20.2001–2T(a) and (b) publishedelsewhere in this issue of the Bulletin].

Par. 3. Section 20.2010–0 is added toread as follows:

§20.2010–0 Table of contents.

[The entries in the table of contents forthe proposed amendments to §20.2010–0are the same as the entries in the table ofcontents for §20.2010–0T published else-where in this issue of the Bulletin].

Par. 4. Section 20.2010–1 is added toread as follows:

§20.2010–1 Unified credit against estatetax; in general.

[The text of the proposed amendmentsto §20.2010–1(a) through (e) is the sameas the text of §20.2010–1T(a) through (e)published elsewhere in this issue of theBulletin].

Par. 5. Section 20.2010–2 is added toread as follows:

§20.2010–2 Portability provisionsapplicable to estate of a decedent survivedby a spouse.

[The text of the proposed amendmentsto §20.2010–2(a) through (e) is the sameas the text of §20.2010–2T(a) through (e)published elsewhere in this issue of theBulletin].

Par. 6. Section 20.2010–3 is added toread as follows:

§20.2010–3 Portability provisionsapplicable to the surviving spouse’sestate.

[The text of the proposed amendmentsto §20.2010–3(a) through (f) is the sameas the text of §20.2010–3T(a) through (f)published elsewhere in this issue of theBulletin].

July 9, 2012 55 2012–28 I.R.B.

PART 25—GIFT TAX; GIFTS MADEAFTER DECEMBER 31, 1954

Par. 7. The authority citation for part25 is amended by adding an entry in nu-merical order to read as follows:

Authority: 26 U.S.C. 7805.Section 25.2505–2T also issued under

26 U.S.C. 2010(c)(6). * * *Par. 8. Section 25.2505–0 is added to

read as follows:

§25.2505–0 Table of contents.

[The entries in the table of contents forthe proposed amendments to §25.2505–0

are the same as the entries in the table ofcontents for §25.2505–0T published else-where in this issue of the Buletin].

Par. 9. Section 25.2505–1 is added toread as follows:

§25.2505–1 Unified credit against gifttax; in general.

[The text of the proposed amendmentsto §25.2505–1(a) through (e) is the sameas the text of §25.2505–1T(a) through (e)published elsewhere in this issue of theBulletin].

Par. 10. Section 25.2505–2 is added toread as follows:

§25.2505–2 Gifts made by a survivingspouse having a DSUE amount available.

[The text of the proposed amendmentsto §25.2505–2(a) through (g) is the sameas the text of §25.2505–2T(a) through (g)published elsewhere in this issue of theBulletin].

Steven T. Miller,Deputy Commissioner forServices and Enforcement.

(Filed by the Office of the Federal Register on June 15, 2012,8:45 a.m., and published in the issue of the Federal Registerfor June 18, 2012, 77 F.R. 36229)

2012–28 I.R.B. 56 July 9, 2012

Definition of TermsRevenue rulings and revenue procedures(hereinafter referred to as “rulings”) thathave an effect on previous rulings use thefollowing defined terms to describe the ef-fect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position is be-ing extended to apply to a variation of thefact situation set forth therein. Thus, ifan earlier ruling held that a principle ap-plied to A, and the new ruling holds that thesame principle also applies to B, the earlierruling is amplified. (Compare with modi-fied, below).

Clarified is used in those instanceswhere the language in a prior ruling is be-ing made clear because the language hascaused, or may cause, some confusion.It is not used where a position in a priorruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previously pub-lished ruling and points out an essentialdifference between them.

Modified is used where the substanceof a previously published position is beingchanged. Thus, if a prior ruling held that aprinciple applied to A but not to B, and thenew ruling holds that it applies to both A

and B, the prior ruling is modified becauseit corrects a published position. (Comparewith amplified and clarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly used ina ruling that lists previously published rul-ings that are obsoleted because of changesin laws or regulations. A ruling may alsobe obsoleted because the substance hasbeen included in regulations subsequentlyadopted.

Revoked describes situations where theposition in the previously published rulingis not correct and the correct position isbeing stated in a new ruling.

Superseded describes a situation wherethe new ruling does nothing more than re-state the substance and situation of a previ-ously published ruling (or rulings). Thus,the term is used to republish under the1986 Code and regulations the same po-sition published under the 1939 Code andregulations. The term is also used whenit is desired to republish in a single rul-ing a series of situations, names, etc., thatwere previously published over a period oftime in separate rulings. If the new rul-ing does more than restate the substance

of a prior ruling, a combination of termsis used. For example, modified and su-perseded describes a situation where thesubstance of a previously published rulingis being changed in part and is continuedwithout change in part and it is desired torestate the valid portion of the previouslypublished ruling in a new ruling that is selfcontained. In this case, the previously pub-lished ruling is first modified and then, asmodified, is superseded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling and thatlist is expanded by adding further names insubsequent rulings. After the original rul-ing has been supplemented several times, anew ruling may be published that includesthe list in the original ruling and the ad-ditions, and supersedes all prior rulings inthe series.

Suspended is used in rare situations toshow that the previous published rulingswill not be applied pending some futureaction such as the issuance of new oramended regulations, the outcome of casesin litigation, or the outcome of a Servicestudy.

AbbreviationsThe following abbreviations in current useand formerly used will appear in materialpublished in the Bulletin.

A—Individual.Acq.—Acquiescence.B—Individual.BE—Beneficiary.BK—Bank.B.T.A.—Board of Tax Appeals.C—Individual.C.B.—Cumulative Bulletin.CFR—Code of Federal Regulations.CI—City.COOP—Cooperative.Ct.D.—Court Decision.CY—County.D—Decedent.DC—Dummy Corporation.DE—Donee.Del. Order—Delegation Order.DISC—Domestic International Sales Corporation.DR—Donor.E—Estate.EE—Employee.E.O.—Executive Order.

ER—Employer.ERISA—Employee Retirement Income Security Act.EX—Executor.F—Fiduciary.FC—Foreign Country.FICA—Federal Insurance Contributions Act.FISC—Foreign International Sales Company.FPH—Foreign Personal Holding Company.F.R.—Federal Register.FUTA—Federal Unemployment Tax Act.FX—Foreign corporation.G.C.M.—Chief Counsel’s Memorandum.GE—Grantee.GP—General Partner.GR—Grantor.IC—Insurance Company.I.R.B.—Internal Revenue Bulletin.LE—Lessee.LP—Limited Partner.LR—Lessor.M—Minor.Nonacq.—Nonacquiescence.O—Organization.P—Parent Corporation.PHC—Personal Holding Company.PO—Possession of the U.S.PR—Partner.

PRS—Partnership.PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—Statement of Procedural Rules.Stat.—Statutes at Large.T—Target Corporation.T.C.—Tax Court.T.D. —Treasury Decision.TFE—Transferee.TFR—Transferor.T.I.R.—Technical Information Release.TP—Taxpayer.TR—Trust.TT—Trustee.U.S.C.—United States Code.X—Corporation.Y—Corporation.Z —Corporation.

July 9, 2012 i 2012–28 I.R.B.

Numerical Finding List1

Bulletins 2012–27 through 2012–28

Announcements:

2012-26, 2012-27 I.R.B. 8

2012-27, 2012-27 I.R.B. 10

2012-28, 2012-27 I.R.B. 10

Notices:

2012-44, 2012-28 I.R.B. 45

Proposed Regulations:

REG-134042-07, 2012-27 I.R.B. 5

REG-141832-11, 2012-28 I.R.B. 54

REG-107889-12, 2012-28 I.R.B. 53

Revenue Procedures:

2012-28, 2012-27 I.R.B. 4

2012-29, 2012-28 I.R.B. 49

Revenue Rulings:

2012-19, 2012-28 I.R.B. 16

2012-20, 2012-27 I.R.B. 1

Treasury Decisions:

9591, 2012-28 I.R.B. 32

9592, 2012-28 I.R.B. 41

9593, 2012-28 I.R.B. 17

1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2012–1 through 2012–26 is in Internal Revenue Bulletin2012–26, dated June 25, 2012.

2012–28 I.R.B. ii July 9, 2012

Finding List of Current Actions onPreviously Published Items1

Bulletins 2012–27 through 2012–28

Proposed Regulations:

REG-100276-97

Withdrawn by

Ann. 2012-27, 2012-27 I.R.B. 10

1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2012–1 through 2012–26 is in Internal Revenue Bulletin 2012–26, dated June 25, 2012.

July 9, 2012 iii 2012–28 I.R.B.

2012–28 I.R.B. July 9, 2012

July 9, 2012 2012–28 I.R.B.

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