internal revenue bulletin no. 2001–16 bulletin · a list is provided of organizations that no...

INCOME TAX

T.D. 8944, page 1067.Final regulations and amendments to temporary regulationsunder section 925 of the Code provide guidance to taxpay-ers that have made an election to be treated as a foreignsales corporation (FSC). These regulations permit thegrouping of transactions for purposes of applying the admin-istrative pricing (including marginal costing) rules to deter-mine FSC transfer prices and provide a time for filing for theelection to group transactions.

REG–105946–00, page 1069.Proposed regulations under section 460 of the Code provideguidance regarding changes in the taxpayer accounting fora long-term contract that has been accounted for under along-term contract method. A public hearing is scheduledfor June 13, 2001.

REG–106513–00, page 1076.Proposed regulations under section 643 of the Code andrelated sections relate to the definition of income for trustpurposes. A public hearing is scheduled for June 8, 2001.

REG–107101–00, page 1083.Proposed regulations under section 894 of the Code relateto the eligibility for treaty benefits of items of income paid bydomestic entities that are not fiscally transparent under U.S.law but are fiscally transparent under the laws of the juris-diction of the person claiming treaty benefits (a domesticreverse hybrid entity). This is the corrected version of whatwas published in the Federal Register on February 27, 2001.A public hearing is scheduled for June 26, 2001.

EMPLOYEE PLANS

Announcement 2001–37, page 1090.These regulations delay the effective date, by 60 days, ofregulations previously published in T.D. 8931, 2001-7 I.R.B.542, providing guidance on the HIPAA requirements forgroup health plans not to establish any rule of eligibilitybased on a health factor of any individual and not to chargeany individual a greater premium or contribution based on ahealth factor than any similarly situated individual.

EXEMPT ORGANIZATIONS

Announcement 2001–35, page 1087.A list is provided of organizations now classified as privatefoundations.

Announcement 2001–36, page 1089.A list is provided of organizations that no longer qualify asorganizations to which contributions are deductible undersection 170 of the Code.

ESTATE TAX


Internal Revenue

bbuulllleettiinnBulletin No. 2001–16

April 16, 2001

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.

Department of the TreasuryInternal Revenue Service

Finding Lists begin on page ii.

(Continued on the next page)

GIFT TAX


ADMINISTRATIVE

Announcement 2001-34, page 1087.This announcement sets forth the mutual agreement pur-suant to Article 27 of the U.S.—Republic of Korea IncomeTax Convention regarding gains from the disposition ofshares of certain Korean real property corporations by U.S.persons.

April 16, 2001 2001–16 I.R.B.

2001–16 I.R.B. April 16, 2001

The Internal Revenue Bulletin is the authoritative instrumentof the Commissioner of Internal Revenue for announcing offi-cial rulings and procedures of the Internal Revenue Serviceand for publishing Treasury Decisions, Executive Orders, TaxConventions, legislation, court decisions, and other items ofgeneral interest. It is published weekly and may be obtainedfrom the Superintendent of Documents on a subscriptionbasis. Bulletin contents are consolidated semiannually intoCumulative 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 applicationof the tax laws, including all rulings that supersede, revoke,modify, or amend any of those previously published in theBulletin. All published rulings apply retroactively unless other-wise indicated. Procedures relating solely to matters of in-ternal management are not published; however, statementsof internal practices and procedures that affect the rightsand duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service onthe application of the law to the pivotal facts stated in therevenue ruling. In those based on positions taken in rulingsto taxpayers or technical advice to Service field offices,identifying details and information of a confidential natureare deleted to prevent unwarranted invasions of privacy andto comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not havethe force and effect of Treasury Department Regulations,but they may be used as precedents. Unpublished rulingswill not be relied on, used, or cited as precedents by Servicepersonnel in the disposition of other cases. In applying pub-lished rulings and procedures, the effect of subsequent leg-islation, regulations, court decisions, rulings, and proce-

dures must be considered, and Service personnel and oth-ers concerned are cautioned against reaching the same con-clusions in other cases unless the facts and circumstancesare substantially the same.

The Bulletin is divided into four parts as follows:

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

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart A,Tax Conventions, and Subpart B, Legislation and RelatedCommittee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references tothese subjects are contained in the other Parts and Sub-parts. Also included in this part are Bank Secrecy Act Admin-istrative Rulings. Bank Secrecy Act Administrative Rulingsare issued by the Department of the Treasury’s Office of theAssistant Secretary (Enforcement).

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

The first Bulletin for each month includes a cumulative indexfor the matters published during the preceding months.These monthly indexes are cumulated on a semiannual basis,and are published in the first Bulletin of the succeeding semi-annual period, respectively.

The IRS Mission

Provide America’s taxpayers top quality service by help-ing them understand and meet their tax responsibilities

and by applying the tax law with integrity and fairness toall.

Introduction

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

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

Section 925.—Transfer PricingRules

26 CFR 1.925(a)-1: Transfer pricing rules for FSCs.

T.D. 8944

DEPARTMENT OF THE TREASURYInternal Revenue Service26 CFR Part 1

Grouping Rules for ForeignSales Corporation TransferPricing

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations and removalof temporary regulations.

SUMMARY: This document containsfinal regulations and amendments totemporary regulations that provideguidance to taxpayers that have made anelection to be treated as a foreign salescorporation (FSC). These regulationspermit the grouping of transactions forpurposes of applying the administrativepricing (including marginal costing) rulesto determine FSC transfer prices andprovide a time for filing for the electionto group transactions.

DATES: Effective date: Theseregulations are effective March 2, 2001.

Applicability: For dates of applicabil-ity, see §1.925(a)–1(c)(8)(i).

FOR FURTHER INFORMATIONCONTACT: Christopher J. Bello (202)874–1490 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On March 3, 1987, the IRS and Trea-sury published temporary regulations(T.D. 8126, 1987–1 C.B. 184) in the Fed-eral Register (52 FR 6428) to provide(among other things) rules for groupingtransactions for purposes of applying theFSC transfer pricing rules. A notice ofproposed rulemaking (INTL–153–86,1987–1 C.B. 799) cross-referencing thetemporary regulations and inviting com-ments and requests for a public hearingwas published on the same day in the

Federal Register(52 FR 6467). Writtencomments concerning the proposed regu-lations were received and a public hearingwas held.

On March 3, 1998, the IRS and Trea-sury amended the above temporary regu-lations by publishing temporary regula-tions (T.D. 8764, 1998–1 C.B. 844) in theFederal Register (63 FR 10305) that(among other things) modified the timefor filing the election to group transac-tions for purposes of applying the admin-istrative pricing (including marginal cost-ing) rules to determine FSC transferprices. A notice of proposed rulemaking(REG–102144–98, 1998–1 C.B. 860)cross-referencing the temporary regula-tions and notice of public hearing waspublished on the same day in the FederalRegister (63 FR 10351). Written com-ments concerning the proposed regula-tions were received and, on June 24,1998, a public hearing was held.

After consideration of all the com-ments, certain proposed regulations relat-ing to grouping of transactions for FSCtransfer pricing are adopted as revised bythis Treasury decision.

Explanation of Provisions

Section 927(d)(2)(B) of the InternalRevenue Code provides generally thatFSCs and their related suppliers may, tothe extent provided in regulations, elect toapply the FSC transfer pricing provisionsunder section 925 on the basis of groupsof transactions based on product lines orrecognized industry or trade usage, ratherthan on a transaction-by-transaction basis.Sections 1.925(a)–1T(c)(8)(i) and1.925(b)–1T(b)(3)(i) of the temporaryregulations permit taxpayers, at their an-nual choice, to group transactions in ap-plying the administrative pricing (includ-ing marginal costing) rules to determineFSC transfer prices. Such grouping elec-tions must be evidenced on a Schedule Pof the FSC’s timely filed (including ex-tensions) U.S. income tax return for thetaxable year. No untimely or amended re-turns are allowed to make a groupingelection, change a grouping basis, orchange from a grouping basis to a transac-tion-by-transaction basis (collectively“grouping redeterminations”).

Section 1.925(a)–1T(c)(8)(i) of thetemporary regulations also contains atransition rule that requires grouping re-determinations for any taxable year be-ginning before January 1, 1998, to bemade no later than the due date of theFSC’s timely filed (including extensions)U.S. income tax return for the FSC’s firsttaxable year beginning after December31, 1997 (transition rule).

Conforming changes are reflected in§§1.925(a)–1T(e)(4) and 1.925(b)–1T(b)(3)(i) of the temporary regulations.

Commentators requested that the rulelimiting grouping elections to timely filedreturns be removed to allow taxpayers tomaximize FSC benefits and correctgrouping errors. Other commentators re-quested that the time limit for groupingelections be replaced by a case-by-caseanalysis that would disallow only thosegrouping redeterminations that are abu-sive. Commentators also suggested alter-native time limits that would allow tax-payers to file amended returns to reflectgrouping redeterminations within a speci-fied time limit (for example, one yearfrom the extended due date of the originalreturn). In response to these comments,the Treasury and the IRS have revised thetime limits for filing grouping electionsunder §1.925(a)–1T(c)(8)(i). Accord-ingly, these regulations permit groupingredeterminations no later than one yearafter the due date of the FSC’s timelyfiled (including extensions) U.S. incometax return for taxable years beginningafter December 31, 1999. For any taxableyear beginning before January 1, 2000, agrouping redetermination may be madeno later than the due date of the FSC’stimely filed (including extensions) U.S.income tax return for the FSC’s first tax-able year beginning on or afterJanuary 1, 2000.

Commentators also suggested that thetransition rule be extended by two ormore years to enable taxpayers to assem-ble data and determine the most advanta-geous groupings for taxable years begin-ning before January 1, 1998. In response,the IRS on May 17, 1999, published No-tice 99–24 (1999–1 C.B. 1069). Notice99–24 notified taxpayers that the IRS andTreasury intended to extend by one yearthe transition rule for such years. These

2001–16 I.R.B. 1067 April 16, 2001

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

April 16, 2001 1068 2001–16 I.R.B.

regulations provide a further extension ofthe transition rule time limit.

These regulations also provide an addi-tional time period for certain taxpayers tomake grouping redeterminations notwith-standing the time limits for filing group-ing redeterminations otherwise specifiedin these regulations. In particular, agrouping redetermination may be made atany time during the one-year period com-mencing upon notification of the relatedsupplier by the Internal Revenue Serviceof an examination, provided that both theFSC and the related supplier agree to ex-tend their respective statutes of limita-tions for assessment by one year. TheIRS and Treasury anticipate the IRS andtaxpayers to plan and conduct examina-tions in a manner consistent with the fore-going provision so as to facilitate efficientand fair administration of the FSC group-ing rules for transfer pricing.

Finally, these regulations provide thatthe requirements under §1.925(a)–1T(e)(4) with respect to redeterminationsother than grouping also apply to group-ing redeterminations.

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 assess-ment is not required. It has also been de-termined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C.chapter 5) does not apply to these regula-tions, and because the regulation does notimpose a collection of information onsmall entities, the Regulatory FlexibilityAct (5 U.S.C. chapter 6) does not apply.Pursuant to section 7805(f) of the InternalRevenue Code, the temporary regulationsand notice of proposed rule-making pre-ceding these regulations were submittedto the Chief Counsel for Advocacy of theSmall Business Administration for com-ment on their impact on small business.

Drafting Information

The principal author of these regula-tions is Christopher J. Bello of the Officeof the Associate Chief Counsel (Interna-tional). Other personnel from the IRS andTreasury Department also participated inthe development of these regulations.

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 is amendedas follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by adding an entry innumerical order for section 1.925(a)–1 toread as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.925(a)–1 also issued under

26 U.S.C. 925(b)(1) and (2) and927(d)(2)(B). * * *

Par. 2. Section 1.925(a)–1 is added toread as follows:

§1.925(a)–1 Transfer pricing rules forFSCs.

(a) through (c)(7) [Reserved] For fur-ther guidance, see §1.925(a)–1T(a)through (c)(7).

(c)(8) Grouping transactions. (i) Thedeterminations under this section are to bemade on a transaction-by-transactionbasis. However, at the annual choicemade by the related supplier if the admin-istrative pricing methods are used, someor all of these determinations may bemade on the basis of groups consisting ofproducts or product lines. The election togroup transactions shall be evidenced onSchedule P of the FSC’s U.S. income taxreturn for the taxable year. No untimelyor amended returns filed later than oneyear after the due date of the FSC’s timelyfiled (including extensions) U.S. incometax return will be allowed to elect togroup, to change a grouping basis, or tochange from a grouping basis to a transac-tion-by-transaction basis (collectively“grouping redeterminations”). The ruleof the previous sentence is applicable totaxable years beginning after December31, 1999. For any taxable year beginningbefore January 1, 2000, a grouping rede-termination may be made no later than thedue date of the FSC’s timely filed (includ-ing extensions) U.S. income tax return forthe FSC’s first taxable year beginning onor after January 1, 2000. Notwithstandingthe time limits for filing grouping redeter-minations otherwise specified in the pre-vious three sentences, a grouping redeter-mination may be made at any time duringthe one-year period commencing uponnotification of the related supplier by the

Internal Revenue Service of an examina-tion, provided that both the FSC and therelated supplier agree to extend their re-spective statutes of limitations for assess-ment by one year. In addition, any group-ing redeterminations made under thisparagraph must meet the requirementsunder §1.925(a)–1T(e)(4) with respect toredeterminations other than grouping.The language “or grouping of transac-tions” is removed from the fourth sen-tence of §1.925(a)–1T(e)(4), applicable totaxable years beginning after December31, 1997. See also §1.925(b)–1T(b)(3)(i).

(c)(8)(ii) through (f) [Reserved] Forfurther guidance, see §1.925(a)–1T(c)(8)(ii) through (f).

(g) Effective date. The provisions ofthis section apply on or after March 2,2001.

Par. 3. Section 1.925(a)–1T is amendedas follows:

1. Paragraph (c)(8)(i) is revised.2. The last sentence of paragraph (e)(4)

is removed.The revision reads as follows:

§1.925(a)–1T Temporary regulations;transfer pricing rules for FSCs.

* * * * *(c) * * *(8) * * * (i) * * * [Reserved] For fur-

ther guidance, see §1.925(a)–1(c)(8)(i).

§1.925(b)–1T [Amended]

Par. 4. Section 1.925(b)–1T isamended by removing the last sentence ofparagraph (b)(3)(i).

Robert E. Wenzel,Deputy Commissioner

of Internal Revenue.

Approved February 28, 2001.

Pamela F. Olson,Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register onMarch 2, 2001, 8:45 a.m., and published in the issueof the Federal Register for March 6, 2001, 66 F.R.13427)

2001–16 I.R.B. 1069 April 16, 2001

Notice of Proposed Rulemakingand Notice of Public Hearing

Mid-Contract Change inTaxpayer

REG–105946–00


ACTION: Notice of proposed rulemak-ing and notice of public hearing.

SUMMARY: This document containsproposed regulations concerning a mid-contract change in taxpayer of a contractthat has been accounted for under a long-term contract method of accounting. Ataxpayer that is a party to such a contractwill be affected by these proposed regula-tions. This document also provides noticeof a public hearing on the proposed regu-lations.

DATES: Written comments must be re-ceived by May 17, 2001. Outlines of oralcomments to be presented at the publichearing scheduled for June 13, 2001, at 10a.m. must be received by May 30, 2001.

ADDRESSES: Send submissions toCC:M&SP:RU (REG–105946–00), room5226, Internal Revenue Service, POB7604, Ben Franklin Station, Washington,DC 20044. Submissions may be hand de-livered Monday through Friday betweenthe hours of 8 a.m. and 5 p.m. to:CC:M&SP:RU (REG–105946–00),Courier’s Desk, Internal Revenue Ser-vice, 1111 Constitution Avenue, NW,Washington, DC. Alternatively, taxpayersmay submit comments electronically viathe Internet by selecting the “Tax Regs”option on the IRS Home Page, or by sub-mitting comments directly to the IRS In-ternet site at http://www.irs.gov/prod/tax_regs/regslist.html. The public hear-ing will be held in room 6718, InternalRevenue Building, 1111 Constitution Av-enue, NW, Washington, DC.

FOR FURTHER INFORMATION CON-TACT: Concerning the proposed regula-tions, John Aramburu or Leo F. Nolan IIat (202) 622-4960; concerning submis-sions of comments, the hearing, and/or tobe placed on the building access list to at-tend the hearing, Guy Traynor of the Reg-

ulations Unit at (202) 622-7180 (not toll-free numbers).


Paperwork Reduction Act

The collections of information con-tained in this notice of proposed rulemak-ing have been submitted to the Office ofManagement and Budget for review in ac-cordance with the Paperwork ReductionAct of 1995 (44 U.S.C. 3507(d)). Com-ments on the collections of informationshould be sent to the Office of Manage-ment and Budget, Attn: Desk Officer forthe Department of the Treasury, Office ofInformation and Regulatory Affairs,Washington, DC 20503, with copies tothe Internal Revenue Service, Attn: IRSReports Clearance Officer,W:CAR:MP:FP:S:O, Washington, DC20224. Comments on the collections ofinformation should be received by April16, 2001. Comments are specifically re-quested concerning:

Whether the proposed collections of in-formation are necessary for the properperformance of the functions of the Inter-nal Revenue Service, including whetherthe information will have practical utility;

The accuracy of the estimated burdenassociated with the proposed collectionsof information (see below);

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 maybe minimized, including through the ap-plication of automated collection tech-niques or other forms of information tech-nology; and

Estimates of capital or start-up costsand costs of operation, maintenance, andpurchase of services to provide informa-tion.

The collection of information in thisproposed regulation is in §1.460–6(g)(3)(ii)(C). The information collected in§1.460–6(g)(3)(ii)(C) is required to pro-vide certain recipients of long-term con-tracts with the information needed tomake look-back calculations. This collec-tion of information is mandatory. Thelikely respondents are for-profit entities.

Estimated total reporting burden:10,000 hours.

Estimated average burden per respon-dent: 2 hours.

Estimated number of respondents:5000.

Estimated annual frequency of re-sponses: On occasion.

An agency may not conduct or sponsor,and a person is not required to respond to,a collection of information unless the col-lection of information displays a validcontrol number.

Books or records relating to a collec-tion of information must be retained aslong as their contents may become mater-ial in the administration of any internalrevenue law. Generally, tax returns andtax return information are confidential, asrequired by 26 U.S.C. 6103.

Background

Section 460 of the Internal RevenueCode was enacted by section 804 of theTax Reform Act of 1986, Public Law99–514 (100 Stat. 2085, 2358–2361).Section 460 was amended by section10203 of the Omnibus Budget Reconcili-ation Act of 1987, Public Law 100–203(101 Stat. 1330, 1330–394); by sections1008(c) and 5041 of the Technical andMiscellaneous Revenue Act of 1988, Pub-lic Law 100–647 (102 Stat. 3342,3438–3439 and 3673–3676); by sections7621 and 7811(e) of the Omnibus BudgetReconciliation Act of 1989, Public Law101–239 (103 Stat. 2106, 2375–2377 and2408–2409); by section 11812 of the Om-nibus Budget Reconciliation Act of 1990,Public Law 101–508 (104 Stat. 1388,1388–534 to 1388–536); by sections1702(h)(15) and 1704(t)(28) of the SmallBusiness Job Protection Act of 1996, Pub-lic Law 104–188 (110 Stat. 1755, 1874,1888); and by section 1211 of the Tax-payer Relief Act of 1997, Public Law105–34 (111 Stat. 788, 998–1000).

Section 460(h) directs the Secretary toprescribe regulations to the extent neces-sary or appropriate to carry out the pur-pose of section 460, including regulationsto prevent a taxpayer from avoiding sec-tion 460 by using related parties, pass-through entities, intermediaries, options,and other similar arrangements.

Part IV. Items of General Interest

April 16, 2001 1070 2001–16 I.R.B.


Overview

Generally, manufacturing and construc-tion contracts not completed within thetaxable year they are entered into arelong-term contracts. A manufacturingcontract, however, is not a long-term con-tract unless it requires the manufacture ofa unique item or an item normally requir-ing more than 12 months to complete.Section 460 generally requires that long-term contracts be accounted for under thepercentage-of-completion method (PCM)and that taxpayers make a look-back com-putation of interest to compensate thegovernment (or the taxpayer) for any un-derestimation (overestimation) of incomefrom the contract. However, home con-struction contracts and certain contractsof smaller construction contractors are ex-empt from these requirements. Moreover,residential builders are entitled to use the70/30 percentage-of-completion/capital-ized cost method (PCCM), and certainshipbuilders are entitled to use the 40/60PCCM. A long-term contract or a portionof a long-term contract that is exemptfrom the PCM may be accounted forunder any permissible method, includingthe completed contract method (CCM) orthe exempt percentage-of-completionmethod (EPCM). These long-term con-tract methods of accounting (i.e., thePCM, PCCM, CCM and EPCM) are de-scribed in proposed §1.460–4. These pro-posed regulations address the Federal in-come tax treatment of a change intaxpayer prior to completion of a long-term contract accounted for under a long-term contract method of accounting.

Existing Guidance on Transfers of Long-term Contracts

In the case of transactions not governedby section 381, such as those occurringprior to its effective date, numerous caseshave required a taxpayer to take into in-come items that under its method of ac-counting would be deferred past the dateof the transaction. These cases have in-volved both taxable and nontaxable trans-actions, e.g., liquidations and reorganiza-tions. For example, in the case of adisposition of a long-term contract ac-counted for under the CCM, the transferorwas required to recognize income earnedon the contract prior to its transfer, with

the amount earned determined undersome variant of the PCM. These casesgenerally relied on section 446(b), section482 and/or the assignment of income doc-trine to allocate income to the transferor.See e.g., Jud Plumbing and Heating, Inc.v. Commissioner, 153 F.2d 681 (5th Cir.1946); Standard Paving Co. v. Commis-sioner, 190 F.2d 330 (10th Cir.), cert. de-nied, 342 U.S. 860 (1951); Central CubaSugar Co. v. Commissioner, 198 F.2d 214(2nd Cir.), cert. denied, 344 U.S. 874(1952); Dillard-Waltermire, Inc. v. Camp-bell, 255 F.2d 433 (5th Cir. 1958); andMidland-Ross Corp. v. United States, 485F.2d 110 (6th Cir. 1973). In addition,§1.451–5(f) of the regulations has beencited as support for taxing a transferorwho has deferred advance paymentsunder its long-term contract method of ac-counting. See Rotolo v. Commissioner,88 T.C. 1500 (1987).

Under section 381(c)(4), in the case ofa section 381 transaction, an acquiringcorporation generally must use themethod of accounting used by the trans-feror. Further, regulations under§1.381(c)(4)–1 require the acquiring cor-poration to take into account the trans-feror’s items of income or deductionwhich, because of its method of account-ing, were not required or permitted to beincluded or deducted by the transferor incomputing taxable income prior to thedate of the transfer. Consistent with sec-tion 381, the IRS has held that section 381generally requires a transferee to accountfor a long-term contract transferred pur-suant to a section 381 transaction usingthe CCM used by the transferor and, thus,to report the entire gain or loss from thecontract. Accordingly, the decisions inthe Standard Pavingline of cases are gen-erally not applicable to transactions towhich section 381 applies. Rev. Rul.70–83 (1970–1 C.B. 85). In addition, sec-tion 351 generally has been interpreted toprevent recognition of gain or loss by atransferor from a section 351 transfer ofpartially completed long-term contractsaccounted for by the transferor using theCCM. See GCM 39258 (July 13, 1984)applying Rev. Rul. 80–198 (1980–2 C.B.113) (no gain or loss is recognized to acash basis transferor with respect to unre-alized accounts receivable and unrecog-nized accounts payable transferred in asection 351 transaction).

In 1990, the IRS issued proposed regu-lations (REG–20930–86) (55 FR 23755)that addressed the treatment of a mid-con-tract change in taxpayer of a contract ac-counted for using PCM for purposes ofapplying the look-back method. Gener-ally, these proposed regulations providedthat the successor to the contract “steppedinto the shoes” of the predecessor with re-spect to the PCM. Thus, the successorwas to continue to use the same PCMused by the predecessor both for purposesof reporting income under the contractand recomputing income under the look-back method. No look-back calculationwas to be made until the successor com-pleted the contract, and the successor wasliable for look-back interest attributable toboth pre- and post-transaction years. Onthe other hand, except in the case of tax-able dispositions to unrelated parties, thesuccessor could not recover look-back in-terest owed by the government that wasattributable to pre-transaction years.These proposed regulations were with-drawn. One criticism of the regulationswas that step-in-the-shoes treatment wasinappropriate in the case of taxable dispo-sitions.

Proposed Provisions

Consistent with the existing guidancedescribed above and in response to com-ments received on the 1990 proposed reg-ulations, these proposed regulations di-vide the rules regarding a mid-contractchange in taxpayer of a long-term con-tract accounted for under a long-term con-tract method into two categories — con-structive completion transactions andstep-in-the-shoes transactions. For thispurpose, the step-in-the-shoes rules applyto the following transactions —

(1) Transactions described in section381 (i.e., liquidations under section332 and reorganizations describedin section 368(a)(1)(A), (C), (D),(F), or (G));

(2) Transactions described in section351;

(3) Transactions described in section368(a)(1)(D) with respect to whichthe requirements of section 355 (orso much of section 356 as relates tosection 355) are met (divisive “D”reorganization);

(4) Transfers (e.g. sales) of S corpora-tion stock;

2001–16 I.R.B. 1071 April 16, 2001

(5) Conversion to or from an S corpo-ration;

(6) Members joining or leaving a con-solidated group; and

(7) Any other transaction designated inthe Internal Revenue Bulletin bythe Internal Revenue Service. See26 CFR 601.601(d)(2)(ii).

The constructive completion rulesapply to all other transactions.

A constructive completion transactionresults in the taxpayer originally reportingincome under the long-term contract (oldtaxpayer) recognizing income from thecontract based on a contract price thattakes into account any amounts realizedfrom the transaction or paid by the oldtaxpayer to the taxpayer subsequently re-porting income under the long-term con-tract (new taxpayer) that are allocable tothe contract. Similarly, the new taxpayerin a constructive completion transaction istreated as though it entered into a newcontract as of the date of the transaction,with the contract price taking into accountthe purchase price and any amount paidby the old taxpayer that is allocable to thecontract.

In the case of a step-in-the-shoes trans-action, the old taxpayer’s obligation to ac-count for the contract terminates on thedate of the transaction and is assumed bythe new taxpayer. The new taxpayer mustassume the old taxpayer’s methods of ac-counting for the contract, with both thecontract price and allocable contract costsbased on amounts taken into account byboth parties. However, in the case of atax avoidance transaction, the IRS mayallocate income with respect to a trans-ferred long-term contract between the oldand new taxpayers. Section §1.451–5(f)will not be applied to a mid-contractchange in taxpayer of a contract ac-counted for under a long-term contractmethod.

In the case of a step-in-the-shoes trans-action in which the transferor’s basis inthe stock of the transferee is determinedby reference to its basis of the propertytransferred, the basis in the stock of thetransferee attributable to the transfer of along-term contract will not be appropriateunless the amount previously received bythe transferor under the long-term con-tract equates to the amount previouslyrecognized as gross receipts by the trans-feror. Under both the PCM and the CCM,

however, it is common for the amount re-ceived with respect to a long-term con-tract to differ from the amount recognizedbecause the receipt of progress paymentsdoes not affect the recognition of income.To address this situation, the proposedregulations provide that, in the case of asection 351 transaction or a divisive “D”reorganization, the old taxpayer must ad-just its basis in the stock of the new tax-payer by the difference between theamount the old taxpayer has recognizedwith respect to the contract and theamount the old taxpayer has received orreasonably expects to receive under thecontract. The IRS and Treasury Depart-ment specifically request comments withrespect to this rule.

The proposed regulations also providerules for applying the look-back methodin the case of a mid-contract change intaxpayer. For constructive completiontransactions, the look-back method is ap-plied by the old taxpayer with respect topre-transaction years upon the transac-tion date and, if applicable, by the newtaxpayer with respect to post-transactionyears upon contract completion. Forstep-in-the-shoes transactions, the look-back method is applied only by the newtaxpayer upon contract completion. Thenew taxpayer must account for pre- andpost-transaction years, with special rulesgoverning the calculation of look-backinterest in the case of pre-transactionyears. The proposed regulations also re-quire the old taxpayer in such cases toprovide certain information to the newtaxpayer in order to enable the new tax-payer to make the necessary look-backcalculations.

The proposed regulations reserve onwhether a mid-contract change in tax-payer that results from a partnershiptransaction, including a transaction de-scribed in section 721, a transaction de-scribed in section 731, and a transfer (e.g.,sale) of a partnership interest, should betreated as a constructive completion, or astep-in-the-shoes, transaction. Althoughthese transactions are similar to otherstep-in-the-shoes transactions, such asnonrecognition transactions (e.g., sections351 and 332) and transactions where theparty responsible for performing the con-tract has not changed (e.g., sales of S cor-poration stock and members joining orleaving consolidated groups), the IRS and

Treasury Department are concerned thatstep-in-the-shoes treatment for these part-nership transactions could more readilyfacilitate the shifting of income to tax in-different parties than in other situationsand thus are concerned about monitoringsuch activities solely through an anti-abuse rule. In addition, other issues, suchas the treatment of long-term contractsunder section 704(c), 751, and 752, sig-nificantly complicate, and could thwart,the application of the step-in-the-shoesrule with respect to mid-contract changesinvolving partnership transactions. TheIRS and Treasury Department requestcomments on the appropriate treatmentfor mid-contract changes in taxpayer re-sulting from these partnership transac-tions.

Proposed Effective Date

These regulations are proposed to beapplicable for transactions on or after thedate they are published in the FederalRegister as final regulations.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined in Ex-ecutive Order 12866. Therefore, a regu-latory assessment is not required. It alsohas been determined that section 553(b)of the Administrative Procedure Act (5U.S.C. chapter 5) does not apply to theseregulations. Pursuant to section 7805(f)of the Internal Revenue Code, this noticeof proposed rulemaking will be submit-ted to the Chief Counsel for Advocacy ofthe Small Business Administration forcomment on its impact on small busi-ness.

It is hereby certified that the collectionof information in these regulations willnot have a significant economic impact ona substantial number of small entities.This certification is based on the fact thatthe relevant information is already main-tained by taxpayers. Therefore, a Regula-tory Flexibility Analysis under the Regu-latory Flexibility Act (5 U.S.C. chapter 6)is not required.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considera-tion will be given to any electronic or

April 16, 2001 1072 2001–16 I.R.B.

written comments (a signed original andeight (8) copies) that are submittedtimely to the IRS. The IRS and Trea-sury Department specifically requestcomments on the clarity of the proposedrule and how it could be made easier tounderstand. Al l comments wil l beavailable for public inspection andcopying.

A public hearing has been scheduledfor June 13, 2001, at 10 a.m. in room6718, Internal Revenue Building, 1111Constitution Avenue, NW, Washington,DC. Due to building security proce-dures, visitors must enter at the 10thStreet entrance, located between Consti-tution and Pennsylvania Avenue, NW, Inaddition, all visitors must present photoidentification to enter the building. Be-cause of access restrictions, visitors willnot be admitted beyond the immediateentrance area more than 15 minutes be-fore the hearing starts. For informationabout having your name placed on thebuilding access list to attend the hearing,see the “FOR FURTHER INFORMA-TION CONTACT” section of this pre-amble.

The rules of 26 CFR 601.601(a)(3)apply to the hearing. Persons who wishto present oral comments at the hearingmust submit written comments and anoutline of the topics to be discussed andthe time to be devoted to each topic(signed original and eight (8) copies) byMay 30, 2001. A period of 10 minuteswill be allotted to each person for mak-ing comments. An agenda showing thescheduling of the speakers will be pre-pared after the deadline for receivingoutlines has passed. Copies of theagenda will be available free of charge atthe hearing.


The principal author of these proposedregulations is John Aramburu, Office ofAssociate Chief Counsel (Income Taxand Accounting). However, other per-sonnel from the IRS and Treasury De-partment participated in their develop-ment.

* * * * *

Proposed Amendments to theRegulations

Accordingly, 26 CFR part 1 is pro-posed to be amended as follows:


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

Authority: 26 U.S.C. 7805 * * *Par. 2. In §1.381(c)(4)–1, a sentence is

added at the end of paragraph (a)(2) toread as follows:§1.381(c)(4)–1 Method of accounting.

(a) * * *(2) * * *See §1.460–4(k) for rules re-

lating to transfers of contracts accountedfor using a long-term contract method ofaccounting in a transaction to which sec-tion 381 applies.* * * * *

Par. 3. Section 1.460–0 is amended by:1. Revising the entry for paragraph (k)

of §1.460–4.2. Adding entries for paragraphs (k)(1)

through (k)(6) of §1.460–4.3. Revising the entry for paragraph (g)

of §1.460–6.4. Adding entries for paragraphs (g)

through (g)(3) of §1.460–6.The revisions and additions read as fol-

lows:

§1.460–0 Outline of regulations undersection 460.

* * * * *

§1.460–4 Methods of accounting forlong-term contracts.

* * * * *(k) Mid-contract change in taxpayer.(1) In general.(2) Constructive completion transactions.(i) Scope.(ii) Old taxpayer.(iii) New taxpayer.(3) Step-in-the-shoes transactions.(i) Scope.(ii) Old taxpayer.(iii) New taxpayer.(A) Method of accounting.(B) Contract price.(C) Contract costs.(4) Anti-abuse rule.(5) Examples.(6) Effective date.* * * * *

§1.460–6 Look-back method.

* * * * *(g) Mid-contract change in taxpayer.(1) In general.(2) Constructive completion transactions.

(3) Step-in-the-shoes transactions.(i) General rules.(ii) Application of look-back method to

pre-transaction period.(A) Method.(B) Interest accrual period.(C) Information old taxpayer must pro-

vide.(iii) Application of look-back method

to post-transaction years.* * * * *

Par. 4. Section 1.460–4 is amended by:1. Adding a sentence at the end of

paragraph (a).2. Revising paragraph (k).The revision and addition read as fol-

lows:

§1.460–4 Methods of accounting forlong-term contracts.

(a) * * * Finally, paragraph (k) of thissection provides rules relating to a mid-contract change in taxpayer of a contractaccounted for using a long-term contractmethod of accounting.* * * * *

(k) Mid-contract change in taxpayer—(1) In general. The rules in this paragraph(k) apply if prior to the completion of along-term contract accounted for using along-term contract method by a taxpayer(old taxpayer), there is a transaction thatmakes another taxpayer (new taxpayer) re-sponsible for reporting income from thesame contract. For purposes of this para-graph (k) and §1.460–6(g), an old taxpayeralso includes any old taxpayer(s) (e.g., pre-decessors) of the old taxpayer. In addition,a change in status from taxable to tax ex-empt or from domestic to foreign, and viceversa,will be considered a change in tax-payer. Finally, a contract will be treated asthe same contract if the terms of the con-tract are not substantially changed in con-nection with the transaction, whether or notthe customer agrees to release the old tax-payer from any or all of its obligationsunder the contract. The rules governingconstructive completion transactions areprovided in paragraph (k)(2) of this section,while the rules governing step-in-the-shoestransactions are provided in paragraph(k)(3) of this section. For application of thelook-back method to mid-contract changesin taxpayers for contracts accounted forusing the PCM, see §1.460–6(g).

(2) Constructive completion transac-tions— (i) Scope. The constructive com-

2001–16 I.R.B. 1073 April 16, 2001

pletion rules in this paragraph (k)(2)apply to transactions that result in achange in the taxpayer responsible forreporting income from a contract andthat are not described in paragraph(k)(3)(i) of this section (constructivecompletion transactions). Constructivecompletion transactions generally in-clude, for example, taxable sales undersection 1001 and deemed asset salesunder section 338.

(ii) Old taxpayer. The old taxpayer istreated as completing the contract on thedate of the transaction. The total contractprice (or, gross contract price in the caseof a long-term contract accounted forunder the CCM) for the old taxpayer isthe sum of any amounts realized from thetransaction that are allocable to the con-tract and any amounts the old taxpayerhas received or reasonably expects to re-ceive under the contract after the transac-tion. Total contract price (gross contractprice) is reduced by any amount paid bythe old taxpayer to the new taxpayer, andby any transaction costs, that are allocableto the contract. Thus, the old taxpayer’sallocable contract costs do not includeany consideration paid, or costs incurred,as a result of the transaction that are allo-cable to the contract. In the case of atransaction subject to sections 338 or1060, the amount realized from the trans-action allocable to the contract is deter-mined by using the residual method under§§1.338–6T and 1.338–7T.

(iii) New taxpayer. The new taxpayeris treated as entering into a new contracton the date of the transaction. The newtaxpayer must evaluate whether the newcontract should be classified as a long-term contract within the meaning of§1.460–1(b) and account for the contractunder a permissible method of account-ing. For a new taxpayer who accounts fora contract using the PCM, the total con-tract price is any amount the new taxpayerreasonably expects to receive under thecontract consistent with paragraph (b)(4)of this section. Total contract price is re-duced in the amount of any considerationpaid as a result of the transaction, and byany transaction costs, that are allocable tothe contract and is increased in theamount of any consideration received as aresult of the transaction that is allocable tothe contract. Similarly, the gross contractprice for a contract accounted for using

the CCM is all amounts the new taxpayeris entitled by law or contract to receiveconsistent with paragraph (d)(3) of thissection, adjusted for any considerationpaid (or received) as a result of the trans-action that is allocable to the contract.Thus, the new taxpayer’s allocable con-tract costs do not include any considera-tion paid, or costs incurred, as a result ofthe transaction that are allocable to thecontract. In the case of a transaction sub-ject to sections 338 or 1060, the amountof consideration paid that is allocable tothe contract is determined by using theresidual method under §§1.338–6T and1.338–7T.

(3) Step-in-the-shoes transactions—(i) Scope. The step-in-the-shoes rules inthis paragraph (k)(3) apply to the follow-ing transactions that result in a change inthe taxpayer responsible for reporting in-come from a contract (step-in-the-shoestransactions) —

(A) Transactions described in section381 (i.e., liquidations under section 332and reorganizations described in section368(a)(1)(A), (C), (D), (F), or (G));

(B) Transactions described in section351;

(C) Transactions described in section368(a)(1)(D) with respect to which the re-quirements of section 355 (or so much ofsection 356 as relates to section 355) aremet;

(D) Transfers (e.g., sales) of S corpora-tion stock;

(E) Conversion to or from an S corpo-ration;

(F) Members joining or leaving a con-solidated group; and

(G) Any other transaction designated inthe Internal Revenue Bulletin by the In-ternal Revenue Service. See§601.601(d)(2)(ii) of this chapter.

(ii) Old taxpayer– (A) In general. Thenew taxpayer will “step into the shoes” ofthe old taxpayer with respect to the con-tract. Thus, consistent with §1.381(c)(4)–1(a)(1)(ii), the old taxpayer’s obliga-tion to account for the contract terminateson the date of the transaction and is as-sumed by the new taxpayer, as set forth inparagraph (k)(3)(iii) of this section. As aresult, an old taxpayer using the PCM isrequired to recognize income from thecontract based on the cumulative alloca-ble contract costs incurred as of the dateof the transaction. Similarly, an old tax-

payer using the CCM is not required torecognize any revenue and may notdeduct allocable contract costs incurredwith respect to the contract.

(B) Basis adjustment. In the case oftransactions described in paragraph(k)(3)(i)(B) or (C) of this section, the oldtaxpayer must adjust its basis in the stockof the new taxpayer by reducing suchbasis to the extent the amount the old tax-payer has received or reasonably expectsto receive under the contract exceeds theamount recognized by the old taxpayerwith respect to the contract or by increas-ing such basis to the extent the amount theold taxpayer has recognized with respectto the contract exceeds the amount the oldtaxpayer has received or reasonably ex-pects to receive under the contract. How-ever, the old taxpayer may not reduce itsbasis in the stock of the new taxpayerbelow zero. If the old and new taxpayerdo not join in the filing of a consolidatedFederal income tax return, the old tax-payer must recognize income to the extentthe basis in the stock of the new taxpayerotherwise would be reduced below zero.If the old and new taxpayer join in the fil-ing of a consolidated Federal income taxreturn, the old taxpayer must create an (orincrease an existing) excess loss accountto the extent the basis in the stock of thenew taxpayer otherwise would be reducedbelow zero. See §§1.1502–19 and1.1502–32(a)(3)(ii).

(iii) New taxpayer— (A) Method of ac-counting. Beginning on the date of thetransaction, the new taxpayer must ac-count for the long-term contract by usingthe same method of accounting used bythe old taxpayer prior to the transactionconsistent with §1.381(c)(4)–1(b)(4). Thesame method of accounting must be usedfor such contract regardless of whether theold taxpayer’s method is the new tax-payer’s principal method of accountingunder §1.381(c)(4)–1(b)(3) or whether thenew taxpayer is otherwise eligible to usethe old taxpayer’s method. Thus, if theold taxpayer uses the PCM to account forthe contract, the new taxpayer steps intothe shoes of the old taxpayer with respectto its completion factor and percentage ofcompletion methods (such as the 10-per-cent method), even if the new taxpayer hasnot elected such methods for similarlyclassified contracts. Similarly, if the oldtaxpayer uses the CCM, the new taxpayer

April 16, 2001 1074 2001–16 I.R.B.

steps into the shoes of the old taxpayerwith respect to the CCM, even if the newtaxpayer is not otherwise eligible to usethe CCM. However, the new taxpayer isnot necessarily bound by the old tax-payer’s method for similarly classifiedcontracts entered into by the new taxpayersubsequent to the transaction and mustapply general tax principles, includingsection 381, to determine the appropriatemethod to account for these subsequentcontracts. To the extent that general taxprinciples allow the taxpayer to accountfor similarly classified contracts using amethod other than the old taxpayer’smethod, the taxpayer is not required to ob-tain the consent of the Commissioner tobegin using such other method.

(B) Contract price. The total contractprice for the new taxpayer is the sum ofany amounts the old taxpayer or new tax-payer have received or reasonably expectto receive under the contract consistentwith paragraph (b)(4) of this section.Similarly, the gross contract price in thecase of a long-term contract accounted forunder the CCM includes all amounts theold taxpayer or new taxpayer are entitledby law or by contract to receive consistentwith paragraph (d)(3) of this section.

(C) Contract costs. Total allocablecontract costs for the new taxpayer arethe allocable contract costs as definedunder paragraph (b)(5) of this section in-curred by either the old taxpayer prior toor the new taxpayer after the transaction.Thus, any payments between the old tax-payer and the new taxpayer with respectto the contract are not treated as part ofcontract price or an allocable contractcost.

(4) Anti-abuse rule. Notwithstandingthis paragraph (k), in tax avoidance cases,the Commissioner may allocate to the old(or new) taxpayer the income from along-term contract properly allocable tothe old (or new) taxpayer. For example,the Commissioner may scrutinize a trans-action in which a long-term contract ac-counted for using the CCM, or using thePCM where the old taxpayer has receivedadvance payments in excess of its contri-bution to the contract, is transferred to atax indifferent party.

(5) Examples. The following examplesillustrate the rules of this paragraph (k).For purposes of these examples, it is as-sumed that the contracts are long-term

construction contracts accounted forusing the PCM prior to the transaction un-less stated otherwise and the contracts arenot transferred in tax avoidance cases.The examples are as follows:

Example 1. Constructive completion — PCM. (i)Facts. In Year 1, X enters into a contract. The totalcontract price is $1,000,000 and the estimated total al-locable contract costs are $800,000. In Year 1, X in-curs costs of $200,000. In Year 2, X incurs additionalcosts of $400,000 before selling the contract as part ofthe sale of its business in Year 2 to Y, an unrelatedparty. At the time of sale, X has received $650,000 inprogress payments under the contract. The considera-tion allocable to the contract under section 1060 is$150,000. Pursuant to the sale, the new taxpayer Yimmediately assumes X’s contract obligations andrights. Y is required to account for the contract usingthe PCM. In Year 2, Y incurs additional allocable con-tract costs of $50,000. Y correctly estimates at theend of Year 2 that it will have to incur an additional$75,000 of allocable contract costs in Year 3 to com-plete the contract.

(ii) Old taxpayer. For Year 1, X reports receiptsof $250,000 (the completion factor multiplied bytotal contract price ($200,000/$800,000 x$1,000,000)) and costs of $200,000, for a profit of$50,000. X is treated as completing the contract inYear 2 because it sold the contract. For purposes ofapplying the PCM in Year 2, the total contract priceis $800,000 (the sum of the amounts received underthe contract and the amount realized in the sale($650,000 + $150,000)) and the total allocable con-tract costs are $600,000 (the sum of the costs in-curred in Year 1 and Year 2 ($200,000 + $400,000)).Thus, in Year 2, X reports receipts of $550,000 (totalcontract price minus receipts already reported($800,000 - $250,000)) and costs incurred in year 2of $400,000, for a profit of $150,000.

(iii) New taxpayer. Y is treated as entering into anew contract in Year 2. The total contract price is$200,000 (the amount remaining to be paid under theterms of the contract less the consideration paid allo-cable to the contract ($1,000,000 - $650,000 -$150,000)). The estimated total allocable contractcosts at the end of Year 2 are $125,000 (the allocablecontract costs that Y reasonably expects to incur tocomplete the contract ($50,000 + $75,000)). In Year2, Y reports receipts of $80,000 (the completion factormultiplied by the total contract price[($50,000/$125,000) x $200,000] and costs of $50,000(the costs incurred after the purchase), for a profit of$30,000. For Year 3, Y reports receipts of $120,000(total contract price minus receipts already reported($200,000 - $80,000)) and costs of $75,000, for aprofit of $45,000.

Example 2. Constructive completion — CCM. (i)Facts. The facts are the same as in Example 1, exceptthat X and Y properly account for the contract underthe CCM.

(ii) Old taxpayer. X does not report any income orcosts from the contract in Year 1. In Year 2, the con-tract is deemed complete for X, and X reports its grosscontract price of $800,000 (the sum of the amounts re-ceived under the contract and the amount realized inthe sale ($650,000 + $150,000)) and its total allocablecontract costs of $600,000 (the sum of the costs in-curred in Year 1 and Year 2 ($200,000 + $400,000)) inthat year.

(iii) New taxpayer. Y is treated as entering into anew contract in Year 2. Under the CCM, Y reports nogross receipts or costs in Year 2. Y reports its grosscontract price of $200,000 (the amount remaining tobe paid under the terms of the contract less the consid-eration paid allocable to the contract ($1,000,000 -$650,000 - $150,000)) and its total allocable contractcosts of $125,000 (the allocable contract costs that Yincurred to complete the contract ($50,000 +$75,000)) in Year 3, the completion year, for a profit of$75,000.

Example 3. Step-in-the-shoes — PCM. (i) Facts.The facts are the same as in Example 1, except that Xtransfers the contract to Y in exchange for stock of Yin a transaction that qualifies as a statutory merger de-scribed in section 368(a)(1)(A) and does not result ingain or loss to X under section 361(a).

(ii) Old taxpayer. For Year 1, X reports receipts of$250,000 (the completion factor multiplied by totalcontract price ($200,000/$800,000 x $1,000,000))and costs of $200,000, for a profit of $50,000. Be-cause the mid-contract change in taxpayer results froma transaction described in paragraph (k)(3)(i) of thissection, X is not treated as completing the contract inYear 2. In Year 2, X reports receipts of $500,000 (thecompletion factor multiplied by the total contract priceand minus the Year 1 gross receipts[($600,000/$800,000 x $1,000,000) - $250,000]) andcosts of $400,000, for a profit of $100,000.

(iii) New taxpayer. Because the mid-contractchange in taxpayer results from a step-in-the-shoestransaction, Y must account for the contract using thesame methods of accounting used by X prior to thetransaction. Total contract price is the sum of anyamounts that X and Y have received or reasonably ex-pect to receive under the contract, and total allocablecontract costs are the allocable contract costs of X andY. Thus, the estimated total allocable contract costs atthe end of Year 2 are $725,000 (the cumulative alloca-ble contract costs of X and the estimated total alloca-ble contract costs of Y ($200,000 + $400,000 +$50,000 + $75,000)). In Year 2, Y reports receipts of$146,552 (the completion factor multiplied by thetotal contract price minus receipts reported by the oldtaxpayer ([($650,000/$725,000) x $1,000,000] -$750,000) and costs of $50,000, or a profit of $96,552.For Year 3, Y reports receipts of $103,448 (the totalcontract price minus prior year receipts ($1,000,000 -$896,552)) and costs of $75,000, for a profit of$28,448.

Example 4. Step-in-the-shoes — CCM. (i) Facts.The facts are the same as in Example 3, except that Xproperly accounts for the contract under the CCM.

(ii) Old taxpayer. X reports no income or costsfrom the contract in Years 1, 2 or 3.

(iii) New taxpayer. Because the mid-contractchange in taxpayer results from a step-in-the-shoestransaction, Y must account for the contract using thesame methods of accounting used by X prior to thetransaction. Thus, in Year 3, the completion year, Yreports receipts of $1,000,000 and total contract costsof $725,000, for a profit of $275,000.

Example 5. Step-in-the-shoes — Basis adjustment.The facts are the same as in Example 1, except that Xtransfers the contract (including the uncompletedproperty with a basis of $0) and $125,000 of cash to anew corporation, Z, in exchange for all of the stock ofZ in a section 351 transaction. Thus, under section358(a), X’s basis in Z is $125,000. X must increase itsbasis in Z by $100,000 pursuant to paragraph

2001–16 I.R.B. 1075 April 16, 2001

(k)(3)(ii)(B) of this section because the amount X rec-ognized with respect to the contract, $750,000($250,000 receipts in Year 1 + $500,000 receipts inYear 2), exceeds the amount X received under the con-tract, the $650,000 in progress payments, by$100,000.

Example 6. Step-in-the-shoes — Basis adjustment.The facts are the same as in Example 2, except that Xreceives progress payments of $800,000 (rather than$650,000) and transfers the contract (including the un-completed property with a basis of $600,000) and$125,000 of cash to a new corporation, Z, in exchangefor all of the stock of Z in a section 351 transaction.Thus, under section 358(a), X’s basis in Z is $725,000.X and Z do not join in filing a consolidated Federal in-come tax return. X must reduce its basis in the stockof Z by $725,000 to zero pursuant to paragraph(k)(3)(ii)(B) of this section because the amount X re-ceived under the contract, $800,000 in progress pay-ments, exceeds the amount recognized by X with re-spect to the contract, $0. In addition, X mustrecognize income of $75,000 because X’s basis in thestock of Z otherwise would have been reduced belowzero by $75,000 (800,000 unrecognized progress pay-ments - 725,000 basis).

(6) Effective date. This paragraph (k) isapplicable for transactions on or after thedate they are published in the FederalRegisteras final regulations.

Par. 5. In §1.460–6, paragraph (g) isrevised to read as follows:

§1.460–6 Look-back method.

* * * * *(g) Mid-contract change in taxpayer—

(1) In general. The rules in this paragraph(g) apply if, as described in §1.460–4(k),prior to the completion of a long-term con-tract accounted for using the PCM or thePCCM by a taxpayer (old taxpayer), thereis a transaction that makes another taxpayer(new taxpayer) responsible for reporting in-come from the same contract. The rulesgoverning constructive completion transac-tions are provided in paragraph (g)(2) ofthis section, while the rules governing step-in-the-shoes transactions are provided inparagraph (g)(3) of this section. For pur-poses of this paragraph, pre-transactionyears are all taxable years of the old tax-payer in which the old taxpayer reported(or should have reported) gross receiptsfrom the contract, and post-transactionyears are all taxable years of the new tax-payer in which the new taxpayer reported(or should have reported) gross receiptsfrom the contract.

(2) Constructive completion transac-tions. In the case of a transaction describedin §1.460–4(k)(2)(i) (constructive comple-tion transaction), the look-back method isapplied by the old taxpayer with respect to

pre-transaction years upon the date of thetransaction and, if the new taxpayer usesthe PCM or the PCCM to account for thecontract, by the new taxpayer with respectto post-transaction years upon completionof the contract. The contract price and allo-cable contract costs to be taken into accountby the old taxpayer or the new taxpayer inapplying the look-back method are de-scribed in §1.460–4(k)(2).

(3) Step-in-the-shoes transactions— (i)General rules. In the case of a transactiondescribed in §1.460–4(k)(3)(i) (step-in-the-shoes transaction), the look-back method isnot applied at the time of the transaction,but is instead applied for the first time whenthe contract is completed by the new tax-payer. Upon completion of the contract,the look-back method is applied by the newtaxpayer with respect to both pre-transac-tion years and post-transaction years, tak-ing into account all amounts reasonablyexpected to be received by either the old ornew taxpayer and all allocable contractcosts incurred during both periods as de-scribed in §1.460–4(k)(3). The new tax-payer is liable for filing the Form 8697 andfor interest computed on hypothetical un-derpayments of tax, and is entitled to re-ceive interest with respect to hypotheticaloverpayments of tax, for both pre- andpost-transaction years. Pursuant to section6901, the old taxpayer will be secondarilyliable for any interest required to be paidwith respect to pre-transaction years re-duced by any interest on pre-transactionoverpayments.

(ii) Application of look-back method topre-transaction period— (A) Method. Thenew taxpayer must apply the look-backmethod to each pre-transaction year that isa redetermination year using the simplifiedmarginal impact method described in para-graph (d) of this section (regardless ofwhether or not the old taxpayer would haveactually used that method and without re-gard to the tax liability ceiling).

(B) Interest accrual period. With re-spect to any hypothetical underpayment oroverpayment of tax for a pre-transactionyear, interest accrues from the due date ofthe old taxpayer’s tax return (not includingextensions) for the taxable year of the un-derpayment or overpayment until the duedate of the new taxpayer’s return (not in-cluding extensions) for the completion yearor the year of a post-completion adjust-ment, whichever is applicable.

(C) Information old taxpayer must pro-vide. In order to help the new taxpayer toapply the look-back method with respect topre-transaction taxable years, any old tax-payer that reported income from a long-term contract under the PCM or PCCM foreither regular or alternative minimum taxpurposes is required to provide the infor-mation described in this paragraph to thenew taxpayer by the due date (not includingextensions) of the old taxpayer’s incometax return for the taxable year ending with,or the first taxable year ending after, a step-in-the-shoes transaction described in§1.460–4(k)(3)(i). The required informa-tion is as follows - -

(1) The portion of the contract reportedby the old taxpayer under PCM for regularand alternative minimum tax purposes (i.e.,whether the old taxpayer used PCM, the40/60 PCCM method, or the 70/30 PCCMmethod);

(2) The submethod used to apply PCM(e.g., the simplified cost-to-cost method orthe 10-percent method);

(3) The amount of total contract price re-ported by year;

(4) The numerator and the denominatorof the completion factor by year;

(5) The due date (not including exten-sions) of the old taxpayer’s income tax re-turns for each taxable year in which incomewas required to be reported;

(6) Whether the old taxpayer was a corpo-rate or a noncorporate taxpayer by year; and

(7) Any other information required bythe Commissioner by administrative pro-nouncement.

(iii) Application of look-back method topost-transaction years. With respect topost-transaction taxable years, the new tax-payer must use the same look-back methodit uses for other contracts (i.e., the simpli-fied marginal impact method or the actualmethod) to determine the amount of anyhypothetical overpayment or underpay-ment of tax and the time period for comput-ing interest on these amounts.* * * * *

David A. Mader,Acting Deputy Commissioner


(Filed by the Office of the Federal Register onFebruary 15, 2001, 8:45 a.m., and published inthe issue of the Federal Register for February 16,2001, 66 FR 10643)

April 16, 2001 1076 2001–16 I.R.B.


Definition of Income for TrustPurposes

REG–106513–00



SUMMARY: This document containsproposed regulations revising the defini-tion of income under section 643(b) ofthe Internal Revenue Code to take intoaccount changes in the definition of trustaccounting income under state laws.The proposed regulations also clarifythe situations in which capital gains areincluded in distributable net incomeunder section 643(a)(3). Conformingamendments are made to regulations af-fecting ordinary trusts, pooled incomefunds, charitable remainder trusts, truststhat qualify for the gift and estate taxmarital deduction, and trusts that are ex-empt from generation-skipping transfertaxes. This document also provides no-tice of a public hearing on these pro-posed regulations.

DATES: Written and electronic com-ments must be received by May 18, 2001.Outlines of topics to be discussed at thepublic hearing scheduled for June 8, 2001must be received by May 18, 2001.

ADDRESSES: Send submissions to:CC:M&SP:RU (REG–106513–00),room 5226, Internal Revenue Service,POB 7604, Ben Franklin Station, Wash-ington, DC 20044. Submissions may behand delivered Monday through Fridaybetween the hours of 8 a.m. and 5 p.m.to: CC:M&SP:RU (REG–106513–00),Courier’s Desk, Internal Revenue Ser-vice, 1111 Constitution Avenue, NW,Washington, DC. Alternatively, taxpay-ers may submit comments electronicallyvia the Internet by selecting the “TaxRegs” option on the IRS Home Page, orby submitting comments directly to theIRS Internet site at: http://www.irs.ustreas.gov/tax_regs/regslist.html. Thepublic hearing will be held in the IRSAuditorium, Internal Revenue Building,1111 Constitution Avenue, NW, Wash-ington, DC.

FOR FURTHER INFORMATION CON-TACT: Concerning the proposed regula-tions, Bradford Poston at (202) 622–3060(not a toll-free number); concerning sub-missions of comments, the hearing,and/or to be placed on the building accesslist to attend the hearing, Guy R. Traynor,202-622-8452 (not a toll-free number).


Background

Section 643(b) provides a definition ofthe term income for purposes of subpartsA through D of part I of subchapter J ofthe Internal Revenue Code (Code) . Theterm income, when not modified by anyother term, means the amount of incomeof the trust or estate determined under theterms of the governing instrument and ap-plicable local law. Section 1.643(b)–1further provides that trust provisions thatdepart fundamentally from the conceptsof local law in determining what consti-tutes income will not be recognized.

These statutory and regulatory provi-sions date back to a time when, understate statutes, dividends and interest wereconsidered income and were allocated tothe income beneficiary while capital gainswere allocated to the principal of the trust.Changes in the types of available invest-ments and in investment philosophieshave caused states to revise, or to con-sider revising, these traditional conceptsof income and principal.

The prudent investor standard for man-aging trust assets has been enacted bymany states and encourages fiduciaries toadopt an investment strategy designed tomaximize the total return on trust assets.Under this investment strategy, trust as-sets should be invested for total positivereturn, that is, ordinary income plus ap-preciation, in order to maximize the valueof the trust. Thus, under certain economiccircumstances, equities, rather thanbonds, would constitute a greater portionof the trust assets than they would undertraditional investment standards.

One of the concerns with shifting trustinvestments toward equities and awayfrom bonds is the potential adverse im-pact on the income beneficiary. Based onthe traditional concepts of income andprincipal, the income beneficiary is enti-tled only to the dividends and interest

earned by the trust assets. The dividendreturn on equities as a percentage of theirvalue traditionally has been substantiallyless than the interest return on bonds.

To ensure that the income beneficiaryis not penalized if a trustee adopts a totalreturn investment strategy, many stateshave made, or are considering making, re-visions to the definitions of income andprincipal. Some state statutes permit thetrustee to make an equitable adjustmentbetween income and principal if neces-sary to ensure that both the income bene-ficiary and the remainder beneficiary aretreated impartially, based on what is fairand reasonable to all of the beneficiaries.Thus, a receipt of capital gains that previ-ously would have been allocated to prin-cipal may be allocated by the trustee to in-come if necessary to treat both partiesimpartially. Conversely, a receipt of divi-dends or interest that previously wouldhave been allocated to income may be al-located by the trustee to principal if nec-essary to treat both parties impartially.

Other states are proposing legislationthat would allow the trustee to pay a uni-trust amount to the income beneficiary insatisfaction of that beneficiary’s right tothe income from the trust. This unitrustamount will be a fixed percentage, some-times required to be within a range set bystate statute, of the fair market value ofthe trust assets determined annually.

Questions have arisen concerning howthese state statutory changes affect the de-finition of income provided in section643(b) and the other Code provisions thatrely on the section 643(b) definition of in-come. This definition of income affectstrusts including, but not limited to, ordi-nary trusts, charitable remainder trusts,pooled income funds, and qualified sub-chapter S trusts.

In addition, trusts that qualify for thegift or estate tax marital deduction mustpay to the spouse all the income from theproperty. All the income is consideredpaid to the spouse if the effect of the trustis to give the spouse substantially that de-gree of beneficial enjoyment of the trustproperty that the principles of trust lawaccord to a person who is unqualifiedlydesignated as the life beneficiary of atrust. Section 25.2523(e)–1(f) of the GiftTax Regulations and §20.2056(b)–5(f) ofthe Estate Tax Regulations. Questionshave arisen whether the spouse is entitled

2001–16 I.R.B. 1077 April 16, 2001

to all the income from the property in astate that permits equitable adjustments orunitrust payments.

Similarly, questions have arisen as towhether an otherwise exempt trust whichuses equitable adjustments or unitrustpayments will be subject to the genera-tion-skipping transfer tax provisions ofchapter 13 of the Code.

Explanation of provisions

Definition of Income

The proposed regulations will amend thedefinition of income under §1.643(b)–1 totake into account certain state statutorychanges to the concepts of income andprincipal. Under the proposed regulations,trust provisions that depart fundamentallyfrom traditional concepts of income andprincipal (that is, allocating ordinary in-come to income and capital gains to princi-pal) will generally continue to be disre-garded, as they are under the currentregulations. However, amounts allocatedbetween income and principal pursuant toapplicable state law will be respected ifstate law provides for a reasonable appor-tionment between the income and remain-der beneficiaries of the total return of thetrust for the year, taking into account ordi-nary income, capital gains, and, in some sit-uations, unrealized appreciation. For ex-ample, a state law that provides for theincome beneficiary to receive each year aunitrust amount of between 3% and 5% ofthe annual fair market value of the trust as-sets is a reasonable apportionment of thetotal return of the trust. Similarly, a statelaw that permits the trustee to make equi-table adjustments between income andprincipal to fulfill the trustee’s duty of im-partiality between the income and remain-der beneficiaries is a reasonable apportion-ment of the total return of the trust.

In addition, an allocation of capitalgains to income will be respected undercertain circumstances. Such an allocationwill be respected if directed by the termsof the governing instrument and applica-ble local law. Similarly, if a trustee, pur-suant to a discretionary power granted tothe trustee by local law or by the govern-ing instrument (if not inconsistent withlocal law), allocates capital gains to in-come, the allocation will be respected,provided the power is exercised in a rea-sonable and consistent manner.

The proposed changes to the regula-tions will permit trustees to implement atotal return investment strategy and to fol-low the applicable state statutes designedto treat the income and remainder benefi-ciaries impartially. At the same time, thelimitations imposed by the proposed regu-lations ensure that the Code provisions re-lying on the definition of income undersection 643(b) are not undermined by anunlimited ability of the trustee to allocatebetween income and principal.

Pooled Income Funds

A special rule is proposed to be addedto the regulations covering pooled incomefunds to address the problems arisingfrom the potential application of the newstate statutes to these funds. A pooled in-come fund as defined in section 642(c)(5)is a split-interest trust created and main-tained by certain types of charitable orga-nizations. Noncharitable beneficiaries re-ceive the income from the commingledfund during their lives and the charitableorganization receives the remainder inter-ests. The income that is to be paid to thenoncharitable beneficiaries is income asdefined in section 643(b). §1.642(c)–5(i).

A pooled income fund is a trust subjectto taxation under section 641. It is enti-tled to a distribution deduction under sec-tion 661 for income distributed to thenoncharitable beneficiaries. In addition,it receives a charitable deduction undersection 642(c)(3) for any amount of netlong-term capital gain which pursuant tothe terms of the governing instrument ispermanently set aside for charitable pur-poses. A pooled income fund is taxed onany net short-term capital gain that is notrequired to be distributed to the incomebeneficiaries pursuant to the terms of thegoverning instrument and applicable locallaw.

Under traditional principles of incomeand principal, ordinary income would bepaid to the income beneficiaries. Any netlong-term capital gain would be allocatedto principal to be held for the ultimatebenefit of the charitable remaindermanand therefore would qualify for the chari-table deduction under section 642(c)(3).

If a pooled income fund were to pay theincome beneficiaries a unitrust amount insatisfaction of their right to income, asprovided by proposed state statutes, long-term capital gains would no longer qual-

ify for the charitable deduction. Any netlong-term capital gain not required to bedistributed during the current year wouldbe added to principal. However, theamount of the gain would not be perma-nently set aside for charitable purposesbecause this amount may be used in thefuture to make the unitrust payment to theincome beneficiaries. A similar situationarises if the trustee is permitted understate law to make equitable adjustmentswith respect to unrealized appreciation inthe value of the trust assets. A portion ofany subsequently realized capital gainmay already have been treated as distrib-uted to the income beneficiaries in accor-dance with an equitable adjustment distri-bution.

The proposed regulations will amend§1.642(c)–2(c) to address these issues forpooled income funds. Thus, no net long-term capital gain qualifies for the charita-ble deduction if, under the terms of thegoverning instrument and applicable statelaw, income may be a unitrust amount ormay include an equitable adjustment withrespect to unrealized appreciation in thevalue of the trust assets.

Charitable Remainder Unitrusts

A charitable remainder unitrust is asplit-interest trust that provides for a spec-ified distribution to one or more nonchari-table beneficiaries for life or a term ofyears, with an irrevocable remainder in-terest held for the benefit of a charitableorganization. Under section 664(d)(2),the amount distributed to the noncharita-ble beneficiaries is a fixed percentage (notless than 5% and not more than 50%) ofthe annual fair market value of the trustassets. Alternatively, under section664(d)(3), the unitrust amount may be thelesser of this fixed percentage amount ortrust income (with or without a make-upamount). For this purpose, trust incomemeans income as defined under section643(b) and the applicable regulations.§1.664–3(a)(1)(i)(b).

Under proposed state statutes, trust in-come could be a fixed percentage of theannual fair market value of the trust as-sets, and the fixed percentage may be lessthan 5%. A net income charitable remain-der unitrust using such a state statutorydefinition of income would in substancebe a fixed percentage unitrust with a per-centage less than the 5% required by sec-

April 16, 2001 1078 2001–16 I.R.B.

tion 664(d)(2). Therefore, the proposedregulations will amend §1.664–3(a)(1)(i)(b) to provide that income under theterms of the governing instrument and ap-plicable local law may not be determinedby reference to a fixed percentage of theannual fair market value of the trust prop-erty. If the applicable state law definesincome as a unitrust amount, the govern-ing instrument of a net income charitableremainder unitrust must provide its owndefinition of trust income. In addition,the proposed regulations will provide thatcapital gains attributable to appreciationin the value of assets after the date con-tributed to the trust or purchased by thetrust may be allocated to income underthe terms of the governing instrument andapplicable local law. Such an allocation,however, may not be discretionary withthe trustee. The section 664 regulationsalready prohibit the allocation of pre-con-tribution gains to income.

Capital Gains and Distributable NetIncome

Section 643(a)(3) provides that gainsfrom the sale or exchange of capital assetsare excluded from distributable net in-come to the extent that these gains are al-located to corpus and they are not eitherpaid, credited, or required to be distrib-uted, to a beneficiary during the year, orpaid, permanently set aside, or to be usedfor a charitable purpose. The circum-stances in which capital gains are consid-ered paid or credited to a beneficiary dur-ing the year, and therefore included indistributable net income, are not entirelyclear. In addition, the revisions to statelaw definitions of income have precipi-tated additional questions in this area.The question arises, for example, whetherrealized capital gains are included in theunitrust amount distributed to the incomebeneficiary under local law, if the unitrustamount exceeds the trust’s ordinary in-come.

The proposed regulations will amend§1.643(a)–3(a) to clarify the circum-stances in which capital gains are includi-ble in distributable net income for theyear. In general, capital gains are in-cluded in distributable net income to theextent they are, pursuant to the terms ofthe governing instrument or local law, orpursuant to a reasonable and consistentexercise of discretion by the fiduciary (in

accordance with a power granted to thefiduciary by the governing instrument orlocal law): allocated to income; allocatedto corpus but treated by the fiduciary onthe trust’s books, records, and tax returnsas part of a distribution to a beneficiary;or allocated to corpus but utilized by thefiduciary in determining the amountwhich is distributed or required to be dis-tributed to a beneficiary. As is the caseunder the current regulations, capitalgains that are paid, permanently set aside,or to be used for the purposes specified insection 642(c) are included in the distrib-utable net income. Capital losses are net-ted at the trust level against any capitalgains, except for a capital gain that is uti-lized in determining the amount that isdistributed or required to be distributed toa particular beneficiary.

Under the proposed regulations, capitalgains will be included in distributable netincome under certain circumstances thatare directed by the terms of the governinginstrument and applicable local law.Thus, any capital gain that is included inthe section 643(b) definition of income isincluded in distributable net income.Similarly, any capital gain that is used todetermine the amount or the timing of adistribution to a beneficiary is included indistributable net income.

Capital gains are also included in dis-tributable net income if the fiduciary, pur-suant to a discretionary power granted bylocal law or by the governing instrument(if not inconsistent with local law), treatsthe capital gains as distributed to a benefi-ciary, provided the power is exercised in areasonable and consistent manner. Thus,if a trustee exercises a discretionarypower by consistently treating any distrib-ution in excess of ordinary income asbeing made from realized capital gains,any capital gain so distributed is includedin distributable net income.

The provisions of sections 643(b) and643(a)(3) are further intertwined whenconsideration is given to the new statestatutory provisions defining income. If,under the terms of the governing instru-ment or applicable local law, realized cap-ital gains are treated as income to the ex-tent the unitrust amount or the equitableadjustment amount exceeds ordinary in-come, capital gains so treated are in-cluded in distributable net income. Asimilar result is achieved for capital gains

consistently allocated to income by thefiduciary pursuant to a discretionarypower. In any other situation, capitalgains will be excluded from distributablenet income and will be taxed to the trust.

Distributions in Kind

The proposed regulations will clarifythe consequences of certain distributionsof property in kind for purposes of thedistribution deductions under sections651 and 661. Thus, if property is distrib-uted to a beneficiary in satisfaction of thebeneficiary’s right to income, the trustwill be treated as having sold the propertyfor its fair market value on the date of dis-tribution.

Trusts Qualifying for Gift and Estate TaxMarital Deduction

Certain transfers of property in trust forthe benefit of the spouse qualify for themarital deduction for gift and estate taxpurposes. These transfers include a lifeestate with a general power of appoint-ment described in sections 2523(e) and2056(b)(5) and qualified terminal interestproperty described in sections 2523(f) and2056(b)(7). One of the requirements ofthese provisions is that the spouse must beentitled for life to all the income from thetrust property. The rules for determiningwhether the spouse is entitled to all the in-come from either a life estate with a gen-eral power of appointment trust or a qual-ified terminable interest trust are set forthin §20.2056(b)–5(f) of the Estate TaxRegulations and §25.2523(e)–1(f) of theGift Tax Regulations. These rules pro-vide that if an interest is transferred intrust, the spouse is entitled for life to allthe income from the entire interest or aspecific portion of the entire interest if theeffect of the trust is to give the spousesubstantially that degree of beneficial en-joyment of the trust property during thespouse’s life which the principles of thelaw of trusts accord a person who is un-qualifiedly designated as the life benefi-ciary of a trust.

The proposed regulations will providethat a spouse’s interest satisfies the incomestandard set forth in §§20.2056(b)–5(f) and 25.2523(e)–1(f) if the spouse is en-titled to income as defined under a statestatute that provides for a reasonable appor-tionment between the income and remain-der beneficiaries of the total return of the

2001–16 I.R.B. 1079 April 16, 2001

trust and that meets the requirements of§1.643(b)–1(a). As the examples under§1.643(b)–1(a) make clear, reasonable ap-portionment can be accomplished through aunitrust definition of income or by givingthe trustee the power to make equitable ad-justments between income and principal. Inaddition, a conforming amendment is madeto §20.2056A–5(c)(2) providing rules re-garding distributions of income from a qual-ified domestic trust.

Trusts Exempt From Generation-SkippingTransfer Tax

In general, under the effective daterules accompanying the generation-skip-ping transfer (GST) tax statutory provi-sions, a trust that was irrevocable on Sep-tember 25, 1985, is not subject to the GSTtax provisions, unless a GST transfer ismade out of corpus added to the trust afterthat date. Section 1433(b)(2)(A) of theTax Reform Act of 1986 (TRA), PublicLaw 99–514 (100 Stat. 2085, 2731),1986–3 (Vol. 1) C.B. 1, 634. The regula-tions provide guidance on when certainchanges made to the terms of an exempttrust will not be treated as causing thetrust to lose its exempt or grandfatheredstatus. One safe-harbor in §26.2601–1(b)(4)(i)(D) is for modifications that willnot shift a beneficial interest in the trust toa lower generation beneficiary or increasethe amount of a GST transfer.

Under the proposed regulations, the ad-ministration of a pre-September 25, 1985,trust in conformance with a state law thatdefines income as a unitrust amount, orpermits equitable adjustments between in-come and principal to ensure impartiality,and that meets the requirements of§1.643(b)–1(a) will not be treated as amodification that shifts a beneficial inter-est to a lower generation beneficiary, orincreases the amount of a generation-skipping transfer.

Proposed Effective Date

The regulations are proposed to applyto trusts and estates for taxable years thatbegin on or after the date that final regula-tions are published in the Federal Regis-ter.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-

cant regulatory action as defined in Exec-utive Order 12866. Therefore, a regula-tory assessment is not required. It alsohas been determined that section 553(b)of the Administrative Procedure Act (5U.S.C. chapter 5) does not apply to theseregulations, and, because these regula-tions do not impose a collection of infor-mation on small entities, the RegulatoryFlexibility Act (5 U.S.C. chapter 6) doesnot apply. Therefore, a Regulatory Flexi-bility Analysis is not required. Pursuantto section 7805(f) of the Code, this noticeof proposed rulemaking will be submittedto the Chief Counsel for Advocacy of theSmall Business Administration for com-ment on its impact on small business.


Before these proposed regulations areadopted as final regulations, considerationwill be given to any written comments(preferably a signed original and eight (8)copies) and comments sent via the Internetthat are submitted timely to the IRS. TheIRS and Treasury request comments on theclarity of the proposed regulations and howthey may be made easier to understand. Allcomments will be available for public in-spection and copying. A public hearing hasbeen scheduled for June 8, 2001, in the IRSAuditorium, Internal Revenue Service,1111 Constitution Avenue, NW, Washing-ton, DC. Owing to building security proce-dures, visitors must enter at the 10th Streetentrance, located between Constitution andPennsylvania Avenues, NW. Because ofaccess restrictions, visitors will not be ad-mitted beyond the immediate entrance areamore than 15 minutes before the hearingstarts. For information about having yourname placed on the building access list toattend the hearing, see the “FOR FUR-THER INFORMATION CONTACT” sec-tion of this preamble.

The rules of 26 CFR 601.601(a)(3)apply to the hearing. Persons who wish topresent oral comments at the hearing mustsubmit written or electronic commentsand an outline of the topics to be dis-cussed and the time to be devoted to eachtopic (preferably a signed original andeight (8) copies) by May 18, 2001. A pe-riod of 10 minutes will be allotted to eachperson making comments.

An agenda showing the scheduling ofthe speakers will be prepared after thedeadline for receiving outlines has

passed. Copies of the agenda will beavailable free of charge at the hearing.


Various personnel from offices of theIRS and the Treasury Department partici-pated in the development of these pro-posed regulations.

* * * * *


Accordingly, 26 CFR parts 1, 20, 25,and 26 are proposed to be amended as fol-lows:

PART 1—–INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *Par. 2. In §1.642(c)–2, paragraph (c) is

amended by adding a sentence after thefirst sentence to read as follows:

§1.642(c)–2 Unlimited deduction foramounts permanently set aside for acharitable purpose.

* * * * *(c) * * * No amount of net long-term

capital gain shall be considered perma-nently set aside for charitable purposes ifit is possible, under the terms of thefund’s governing instrument or applicablelocal law, that the income beneficiaries’right to income may, at any time, be satis-fied by the payment of either an amountequal to a fixed percentage of the annualfair market value of the trust property orany amount based on unrealized apprecia-tion in the value of the trust property. * ** * * * * *

Par. 3. Section 1.643(a)–3 is revised toread as follows:

§1.643(a)–3 Capital gains and losses.

(a) In general. Except as provided in§1.643(a)–6 and in paragraph (b) of thissection, gains from the sale or exchangeof capital assets are ordinarily excludedfrom distributable net income and are notordinarily considered as paid, credited, orrequired to be distributed to any benefi-ciary.

(b) Capital gains included in distrib-utable net income. Gains from the sale orexchange of capital assets are included in

April 16, 2001 1080 2001–16 I.R.B.

distributable net income to the extent theyare, pursuant to the terms of the govern-ing instrument and applicable local law,or pursuant to a reasonable and consistentexercise of discretion by the fiduciary (inaccordance with a power granted to thefiduciary by local law or by the governinginstrument, if not inconsistent with locallaw)—

(1) Allocated to income;(2) Allocated to corpus but treated by

the fiduciary on the trust’s books, records,and tax returns as part of a distribution toa beneficiary; or

(3) Allocated to corpus but utilized bythe fiduciary in determining the amountwhich is distributed or required to be dis-tributed to a beneficiary.

(c) Charitable contributions includedin distributable net income. If capitalgains are paid, permanently set aside, orto be used for the purposes specified insection 642(c), so that a charitable deduc-tion is allowed under that section in re-spect of the gains, they must be includedin the computation of distributable net in-come.

(d) Capital losses. Losses from the saleor exchange of capital assets shall first benetted at the trust level against any gainsfrom the sale or exchange of capital assets,except for a capital gain that is utilizedunder paragraph (b)(3) of this section in de-termining the amount that is distributed orrequired to be distributed to a particularbeneficiary. See §1.642(h)–1 with respectto capital loss carryovers in the year of finaltermination of an estate or trust.

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

Example 1. Under the terms of Trust’s governinginstrument, all income is to be paid to A for life.Trustee is given discretionary powers to invade prin-cipal for A’s benefit and to deem discretionary distri-butions to be made from capital gains realized dur-ing the year. During Trust’s first taxable year, Trusthas $5,000 of dividend income and $10,000 of capi-tal gain from the sale of securities. Pursuant to theterms of the governing instrument and applicablelocal law, Trustee allocates the $10,000 capital gainto principal. During the year, Trustee distributes toA $5,000, representing A’s right to trust income. Inaddition, Trustee distributes to A $12,000, pursuantto the discretionary power to distribute principal.Trustee does not exercise the discretionary power todeem the discretionary distributions of principal asbeing paid from capital gains realized during theyear. Therefore, the capital gains realized during theyear are not included in distributable net income andthe $10,000 of capital gain is taxed to the trust.

Example 2. The facts are the same as in Example1, except that Trustee intends to follow a regular

practice of treating discretionary distributions asbeing paid first from any net capital gains realizedby Trust during the year. Trustee evidences thistreatment by including the $10,000 capital gain indistributable net income on Trust’s federal incometax return so that it is taxed to A. This treatment ofthe capital gains is a reasonable exercise of Trustee’sdiscretion. In future years Trustee must treat all dis-cretionary distributions as being made first from anyrealized capital gains.

Example 3. The facts are the same as in Example1, except that pursuant to the terms of the governinginstrument (in a provision not inconsistent with ap-plicable local law), capital gains realized by Trustare allocated to income. Because the capital gainsare allocated to income pursuant to the terms of thegoverning instrument, the $10,000 capital gain is in-cluded in Trust’s distributable net income for thetaxable year.

Example 4. The facts are the same as in Example1, except that Trustee decides that discretionary dis-tributions will be made only to the extent Trust hasrealized capital gains during the year and thus thediscretionary distribution to A is $10,000, ratherthan $12,000. Because Trustee will consistently usethe amount of any realized capital gain to determinethe amount of the discretionary distribution to thebeneficiary, the $10,000 capital gain is included inTrust’s distributable net income for the taxable year.

Example 5. Trust’s assets consist of Blackacreand other property. Under the terms of Trust’s gov-erning instrument, Trustee is directed to hold Black-acre for ten years and then sell it and distribute allthe sales proceeds to A. Because Trustee uses theamount of the sales proceeds that includes any real-ized capital gain to determine the amount required tobe distributed to A, any capital gain realized fromthe sale of Blackacre is included in Trust’s distrib-utable net income for the taxable year.

Example 6. Under the terms of Trust’s governinginstrument, all income is to be paid to A during theTrust’s term. When A reaches 35, Trust is to termi-nate and all the principal is to be distributed to A.All capital gains realized in the year of terminationare included in distributable net income. See§1.641(b)–3 for the determination of the year offinal termination and the taxability of capital gainsrealized after the terminating event and before finaldistribution.

Example 7.The facts are the same as Example 6,except Trustee is directed to distribute only one-halfof the principal to A when A reaches 35. Trust assetsconsist entirely of stock in corporation M. If Trusteesells one-half of the stock and distributes the salesproceeds to A, all the capital gain attributable to thatsale is included in distributable net income. IfTrustee sells all the stock and distributes one-half ofthe sales proceeds to A, one-half of the capital gainattributable to that sale is included in distributablenet income.

Example 8. The facts are the same as Example 6,except Trustee is directed to pay B $10,000 beforedistributing the remainder of Trust assets to A. Noportion of the capital gains is allocable to B becausethe distribution to B is a gift of a specific sum ofmoney within the meaning of section 663(a)(1).

Example 9. State law provides that a trustee maymake an election to pay an income beneficiary anamount equal to four percent of the annual fair mar-ket value of the trust assets in full satisfaction of that

beneficiary’s right to income. State law providesthat this unitrust amount shall be considered paidfirst from ordinary income, then from net short–termcapital gain, then from net long-term capital gain,and finally from return of principal. Trust’s govern-ing instrument provides that A is to receive eachyear income as defined under State law. Trusteemakes the unitrust election under State law. At thebeginning of the taxable year, Trust assets are valuedat $500,000. During the year, Trust receives $5,000of dividend income and realizes $80,000 of net long-term gain from the sale of capital assets. Trusteedistributes to A $20,000 (4% of $500,000) in satis-faction of A’s right to income. Net long-term capitalgain in the amount of $15,000 is allocated to incomepursuant to the State law ordering rule and is in-cluded in distributable net income for the taxableyear.

Example 10. The facts are the same as in Exam-ple 9, except that neither State law nor Trust’s gov-erning instrument has an ordering rule for the char-acter of the unitrust amount, but leaves such adecision to the discretion of Trustee. Trustee intendsto follow a regular practice of treating principal asdistributed to the beneficiary to the extent that theunitrust amount exceeds Trust’s ordinary income.Trustee evidences this treatment by not includingany capital gains in distributable net income onTrust’s Federal income tax return so that the entire$80,000 capital gain is taxed to Trust. This treat-ment of the capital gains is a reasonable exercise ofTrustee’s discretion. In future years Trustee mustconsistently follow this treatment with respect to allrealized capital gains.

Example 11. The facts are the same as in Exam-ple 9, except that neither State law nor Trust’s gov-erning instrument has an ordering rule for the char-acter of the unitrust amount, but leaves such adecision to the discretion of Trustee. Trustee intendsto follow a regular practice of treating net capitalgains as distributed to the beneficiary to the extentthe unitrust amount exceeds Trust’s ordinary in-come. Trustee evidences this treatment by including$15,000 of the capital gain in distributable net in-come on Trust’s Federal income tax return. Thistreatment of the capital gains is a reasonable exer-cise of Trustee’s discretion. In future years Trusteemust consistently treat realized capital gain, if any,as distributed to the beneficiary to the extent that theunitrust amount exceeds ordinary income.

Par. 4. Section 1.643(b)–1 is revised toread as follows:

§1.643(b)–1 Definition of income.

For purposes of subparts A through D,part I, subchapter J, chapter 1 of the Inter-nal Revenue Code, income, when not pre-ceded by the words “taxable,” “distrib-utable net,” “undistributed net,” or“gross,” means the amount of income ofan estate or trust for the taxable year de-termined under the terms of the governinginstrument and applicable local law.Trust provisions that depart fundamen-tally from traditional principles of incomeand principal, that is, allocating ordinaryincome to income and capital gains to

2001–16 I.R.B. 1081 April 16, 2001

principal, will generally not be recog-nized. However, amounts allocated be-tween income and principal pursuant toapplicable local law will be respected iflocal law provides for a reasonable appor-tionment between the income and remain-der beneficiaries of the total return of thetrust for the year, including ordinary in-come, capital gains, and appreciation.For example, a state law that provides forthe income beneficiary to receive eachyear a unitrust amount of between 3% and5% of the annual fair market value of thetrust assets is a reasonable apportionmentof the total return of the trust. Similarly, astate law that permits the trustee to makeequitable adjustments between incomeand principal to fulfill the trustee’s duty ofimpartiality between the income and re-mainder beneficiaries is generally a rea-sonable apportionment of the total returnof the trust. These adjustments are per-mitted when the trustee invests and man-ages the trust assets under the state’s pru-dent investor standard, the trust describesthe amount that shall or must be distrib-uted to a beneficiary by referring to thetrust’s income, and the trustee after apply-ing the state statutory rules regarding allo-cation of income and principal is unableto administer the trust impartially. In ad-dition, an allocation of capital gains to in-come will be respected if the allocation ismade either pursuant to the terms of thegoverning instrument and local law, orpursuant to a reasonable and consistentexercise of a discretionary power grantedto the fiduciary by local law or by thegoverning instrument, if not inconsistentwith local law.

Par. 5. In §1.651(a)–2, paragraph (d) isadded to read as follows:

§1.651(a)–2 Income required to bedistributed currently.

* * * * *(d) If a trust distributes property in kind

as part of its requirement to distribute cur-rently all the income as defined under sec-tion 643(b) and the applicable regulations,the trust shall be treated as having sold theproperty for its fair market value on thedate of distribution. If no amount in excessof the amount of income as defined undersection 643(b) and the applicable regula-tions is distributed by the trust during theyear, the trust will qualify for treatmentunder section 651 even though property in

kind was distributed as part of a distributionof all such income.

Par. 6. In §1.661(a)–2, paragraph (f) isrevised to read as follows:

§1.661(a)–2 Deduction for distributionsto beneficiaries.

* * * * * (f) Gain or loss is realized by the trust

or estate (or the other beneficiaries) byreason of a distribution of property inkind if the distribution is in satisfaction ofa right to receive a distribution of a spe-cific dollar amount, of specific propertyother than that distributed, or of incomeas defined under section 643(b) and theapplicable regulations, if income is re-quired to be distributed currently. In ad-dition, gain or loss is realized if thetrustee or executor makes the election torecognize gain or loss under section643(e).

Par. 7. In §1.664–3, paragraph(a)(1)(i)(b)(3) is revised to read as fol-lows:

§1.664–3 Charitable remainder unitrust.

(a) * * *(1) * * *(i) * * *(b) * * *(3) For purposes of this paragraph

(a)(1)(i)(b), trust income generally meansincome as defined under section 643(b)and the applicable regulations. However,trust income may not be determined byreference to a fixed percentage of the an-nual fair market value of the trust prop-erty. If applicable state law provides thatincome is a unitrust amount, the trust’sgoverning instrument must contain itsown definition of trust income. In addi-tion, capital gain attributable to apprecia-tion in the value of a trust asset after thedate it was contributed to the trust or pur-chased by the trust may be allocated to in-come pursuant to applicable local law andthe terms of the governing instrument butnot pursuant to a discretionary powergranted the trustee. * * * * *

PART 20—ESTATE TAX; ESTATES OFDECEDENTS DYING AFTERAUGUST 16, 1954

Par. 8. The authority citation for part20 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Par. 9. Section 20.2056(b)–5 is

amended by adding a new sentence to theend of paragraph (f)(1) to read as fol-lows:

§20.2056(b)–5 Marital deduction; lifeestate with power of appointment insurviving spouse.

* * * * * (f) * * * (1) * * * In addition, the sur-

viving spouse’s interest shall meet thecondition set forth in paragraph (a)(1) ofthis section, if the spouse is entitled to in-come as defined by a state statute thatprovides for a reasonable apportionmentbetween the income and remainder bene-ficiaries of the total return of the trust andthat meets the requirements of§1.643(b)–1 of the this chapter. * * * * *

Par. 10. Section 20.2056(b)–7 isamended by adding a new sentence to theend of paragraph (d)(1) to read as follows:

§20.2056(b)–7 Election with respect tolife estate for surviving spouse.

* * * * *(d) * * * (1) * * * A power under applic-

able state law that permits the trustee to ad-just between income and principal to fulfillthe trustee’s duty of impartiality betweenthe income and remainder beneficiaries thatmeets the requirements of §1.643(b)–1 ofthis chapter will not be considered a powerto appoint trust property to a person otherthan the surviving spouse.* * * * *

Par. 11. Section 20.2056(b)–10 isamended by adding a new sentence at theend of the section to read as follows:

§20.2056(b)–10 Effective dates.

* * * In addition, the rule in the lastsentence of §20.2056(b)–5(f)(1) and therule in the last sentence of§20.2056(b)–7(d)(1) regarding thespouse’s right to income if the statestatute provides for the reasonable appor-tionment between the income and remain-der beneficiaries of the total return of thetrust are applicable with respect to trustsfor taxable years that begin on or after thedate that final regulations are published inthe Federal Register.

Par. 12. Section 20.2056A–5 isamended by adding a new sentence in

April 16, 2001 1082 2001–16 I.R.B.

paragraph (c)(2) after the third sentenceto read as follows:

§20.2056A–5 Imposition of section2056A estate tax.

* * * * *(c) * * *(2) * * * However, distributions made

to the surviving spouse as the incomebeneficiary in conformance with applica-ble state law that defines the term incomeas a unitrust amount, or permits thetrustee to adjust between principal and in-come to fulfill the trustee’s duty of impar-tiality between income and principal ben-eficiaries, will be considered distributionsof trust income, if the state statute pro-vides for a reasonable apportionment be-tween the income and remainder benefi-ciaries of the total return of the trust andmeets the requirements of §1.643(b)–1 ofthis chapter.* * ** * * * *

Par. 13. Section 20.2056A–13 is re-vised to read as follows:

§20.2056A–13 Effective dates.

Except as provided in this section, theprovisions of §§20.2056A–1 through20.2056A–12 are applicable with respectto estates of decedents dying after August22, 1995. The rule in the fourth sentenceof §20.2056A–5(c) regarding unitrustsand distributions of income to the surviv-ing spouse in conformance with applica-ble state law that provides for the reason-able apportionment between the incomeand remainder beneficiaries of the totalreturn of the trust is applicable with re-spect to trusts for taxable years that beginon or after the date that final regulationsare published in the Federal Register.

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


Authority: 26 U.S.C. 7805 * * *Par. 15. Section 25.2523(e)–1 is

amended by adding a new sentence tothe end of paragraph (f)(1) to read asfollows:

§25.2523(e)–1 Marital deduction; lifeestate with power of appointment indonee spouse.

* * * * *

(f) * * * (1) * * * In addition, thespouse’s interest shall meet the conditionset forth in paragraph (a)(1) of this sec-tion, if the spouse is entitled to income asdefined by a state statute that provides fora reasonable apportionment between theincome and remainder beneficiaries of thetotal return of the trust and that meets therequirements of §1.643(b)–1(a) of thischapter. * * * * *

Par. 16. Section 25.2523(h)–2 isamended by adding a new sentence to theend of the section to read as follows:

§25.2523(h)–2 Effective dates.

* * * In addition, the rule in the fourthsentence of §25.2523(e)–1(f)(1) regard-ing the spouse’s right to income if thestate statute provides for reasonable ap-portionment between the income and re-mainder beneficiaries of the total return ofthe trust is applicable with respect totrusts and estates for taxable years thatbegin on or after the date the final regula-tions are published in the Federal Regis-ter.

PART 26—GENERATION-SKIPPINGTRANSFER TAX REGULATIONSUNDER THE TAX REFORM ACT OF1986


Authority: 26 U.S.C. 7805 * * *Par. 18. Section 26.2601–1 is amended

as follows:1. Paragraph (b)(4)(i)(D)(2) is

amended by adding a new sentence to theend of the paragraph.

2. Paragraph (b)(4)(i)(E) is amendedby adding Examples 11and 12.

3. Paragraph (b)(4)(ii) is revised toread as follows.

The additions and revisions read as fol-lows:

§26.2601–1 Effective dates.

* * * * * (b) * * *(4) * * *(i) * * *(D) * * *(2) * * * In addition, administration of

a trust in conformance with applicablestate law that defines the term income as aunitrust amount, or permits the trustee to

adjust between principal and income tofulfill the trustee’s duty of impartiality be-tween income and principal beneficiaries,will not be considered to shift a beneficialinterest in the trust, if the state statute pro-vides for a reasonable apportionment be-tween the income and remainder benefi-ciaries of the total return of the trust andmeets the requirements of §1.643(b)–1 ofthis chapter.

(E) * * *Example 11. Conversion of income interest to

unitrust interest under state statute. In 1980,Grantor, a resident of State X, established an irrevo-cable trust for the benefit of Grantor’s child, A, andA’s issue. The trust provides that trust income ispayable to A for life and upon A’s death the remain-der is to pass to A’s issue, per stirpes. In 2002, StateX amends its income and principal statute to define“income” as a unitrust amount of 4% of the fair mar-ket value of the trust assets valued annually. For atrust established prior to 2002, the statute providesthat the new definition of income will apply only ifall the beneficiaries who have an interest in the trustconsent to the change within two years after the ef-fective date of the statute. The statute provides spe-cific procedures to establish the consent of the bene-ficiaries. A and A’s issue consent to the change inthe definition of income within the time period, andin accordance with the procedures, prescribed by thestate statute. The administration of the trust, in ac-cordance with the state statute defining income to bea 4% unitrust amount, will not be considered to shiftany beneficial interest in the trust. Therefore, thetrust will not be subject to the provisions of chapter13 of the Internal Revenue Code.

Example 12. Equitable adjustments under statestatute. The facts are the same as in Example 11, ex-cept that in 2002, State X amends its income andprincipal statute to permit the trustee to make equi-table adjustments between income and principalwhen the trustee invests and manages the trust assetsunder the state’s prudent investor standard, the trustdescribes the amount that shall or must be distrib-uted to a beneficiary by referring to the trust’s in-come, and the trustee after applying the state statu-tory rules regarding allocation of income andprincipal is unable to administer the trust impar-tially. The provision permitting the trustees to makethese equitable adjustments is effective in 2002 fortrusts created at any time. The trustee invests andmanages the trust assets under the state’s prudent in-vestor standard, and pursuant to authorization in thestate statute, the trustee allocates receipts betweenthe income and principal accounts in a manner to en-sure the impartial administration of the trust. Theadministration of the trust in accordance with thestate statute will not be considered to shift any bene-ficial interest in the trust. Therefore, the trust willnot be subject to the provisions of chapter 13 of theInternal Revenue Code.

(ii) Effective dates. The rules in thisparagraph (b)(4) are applicable on andafter December 20, 2000. However, therule in the last sentence of paragraph(b)(4)(i)(D)(2) of this section regardingthe administration of a trust in confor-

2001–16 I.R.B. 1083 April 16, 2001

mance with applicable state law providingfor a reasonable apportionment betweenthe income and remainder beneficiaries ofthe total return of the trust is applicablewith respect to trusts for taxable years thatbegin on or after the date that final regula-tions are published in the Federal Regis-ter.

* * * * *



(Filed by the Office of the Federal Register on Feb-ruary 14, 2001, 8:45 a.m., and published in the issueof the Federal Register for February 15, 2001, 66F.R. 10396)


Treaty Guidance RegardingPayments With Respect toDomestic Reverse HybridEntities

REG–107101–00



SUMMARY: This document containsproposed regulations under section 894 ofthe Internal Revenue Code relating to theeligibility for treaty benefits of items ofincome paid by domestic entities that arenot fiscally transparent under U.S. law butare fiscally transparent under the laws ofthe jurisdiction of the person claimingtreaty benefits (a domestic reverse hybridentity). The proposed regulations affectthe determination of tax treaty benefitswith respect to U.S. source income of for-eign persons. This document also pro-vides notice of a public hearing on theseproposed regulations.

DATES: Written or electronic com-ments must be received by May 28,2001. Requests to speak (with outlinesof oral comments to be discussed) at thepublic hearing scheduled for June 26,2001, at 10 a.m., must be submitted byJune 5, 2001.

ADDRESSES: Send submissions to:CC:M&SP:RU (REG–107101–00), room

5226, Internal Revenue Service, POB7604, Ben Franklin Station, Washington,DC 20044. Submissions may be hand de-livered between the hours of 8 a.m. and 5p.m. to: CC:M&SP:RU (REG–107101–00), Courier’s Desk, Internal RevenueService, 1111 Constitution Avenue, NW,Washington, DC. Alternatively, taxpayersmay submit comments electronically viathe Internet by selecting the “Tax Regs”option on the IRS Home Page, or by sub-mitting comments directly to the IRS In-ternet site at http://www.irs.gov/tax_regs/regslist.html. The public hearing will beheld in the auditorium, Internal RevenueBuilding, 1111 Constitution Avenue, NW,Washington, DC.

FOR FURTHER INFORMATIONCONTACT: Concerning the regula-tions, Elizabeth U. Karzon or KarenRennie-Quarrie at (202) 622-3880; con-cerning submissions and the hearing,Guy R. Traynor at (202) 622-7180 (nottoll-free numbers).


Background

On June 30, 1997, the IRS and Treasuryissued temporary regulations (T.D. 8722,1997–2 C.B. 81) in the Federal Register(62 FR 35673, as corrected at 62 FR46876, 46877) under section 894 of the In-ternal Revenue Code relating to eligibilityfor benefits under income tax treaties forpayments to certain entities. These regu-lations addressed, among other matters,the eligibility for treaty benefits of U.S.source payments made to domestic re-verse hybrid entities, concluding thattreaty benefits were not available for suchpayments. A notice of proposed rulemak-ing (REG–104893–97, 1997–2 C.B. 646)cross-referencing the temporary regula-tions was also published in the same issueof the Federal Register(62 FR 35755).On July 3, 2000, the IRS and Treasury is-sued final regulations (T.D. 8889,2000–30 I.R.B. 124), reaffirming the posi-tion taken in the temporary regulationswith respect to payments made to domes-tic reverse hybrid entities. The final regu-lations, however, did not address the ques-tion of whether payments made bydomestic reverse hybrid entities to theirinterest holders are eligible for treaty ben-efits. Section 1.894–1(d)(2)(ii) was re-served for further guidance on that issue.


These proposed regulations provideguidance with respect to the previouslyreserved paragraph. They provide ruleson the character of such payments fortreaty purposes and the extent to whichsuch payments are eligible for a reducedrate of U.S. tax under a U.S. income taxtreaty. The use of domestic reverse hy-brid entities may give rise to inappropri-ate and unintended results under incometax treaties, such as double non-taxationor double taxation, unless the income taxtreaties are interpreted to resolve the con-flict of laws. These regulations provideguidance regarding how to apply U.S. in-come tax treaties under these circum-stances.

Section 1.894–1T(d)(3) provided guid-ance on the appropriate treatment of itemsof income paid to a domestic reverse hy-brid entity. That section provided that§1.894–1T(d)(1) may not be applied toreduce the amount of Federal income taxon U.S. source income received by a do-mestic reverse hybrid entity through ap-plication of an income tax treaty. Thus,neither the domestic reverse hybrid entitynor its interest holders could claim a re-duction under an income tax treaty withrespect to a payment to a domestic reversehybrid entity, notwithstanding that the in-terest holder might otherwise derive theincome as a resident of a treaty jurisdic-tion under §1.894–1T(d)(1). The ratio-nale for the rule was the U.S. tax treatyprinciple that the United States retainstaxing jurisdiction over items of U.S.source income paid to its residents. Thefinal regulations published in the FederalRegister on July 3, 2000, retain the rulethat a domestic reverse hybrid entity re-mains subject to the taxing jurisdiction ofthe United States on U.S. source pay-ments, but reserve with respect to thetreatment of payments made by domesticreverse hybrid entities.

Commentators on the previously issuedtemporary and proposed regulations notedthat it was unclear how items of incomepaid by a domestic reverse hybrid entityto its interest holders should be treated.In particular, the general rule containedin §1.894–1T(d)(1) required the item ofincome to be “received by” a person resi-dent in a treaty jurisdiction and for thatitem of income to be “subject to tax” inthe hands of the person deriving the item

April 16, 2001 1084 2001–16 I.R.B.

of income. Commentators expressed con-cern that an item of income paid by a do-mestic reverse hybrid entity could beviewed as neither “received by” the inter-est holder nor “subject to tax” because theinterest holder’s jurisdiction treats the do-mestic reverse hybrid entity as fiscallytransparent. The interest holder’s juris-diction views the interest holder as “re-ceiving” the items of income paid to thedomestic reverse hybrid entity and asbeing “subject to tax” on those items ofincome on an immediate basis. The inter-est holder’s jurisdiction does not recog-nize the items of income paid by the do-mestic reverse hybrid entity to the interestholder. Based on this analysis, commen-tators questioned whether the items of in-come paid by the domestic reverse hybridentity to an interest holder in that entitywould be subject to a 30-percent taxunder the Code. The IRS and Treasurybelieve similar questions may also ariseunder the recently issued final regula-tions.

Accordingly, these proposed regula-tions provide rules on the treatment ofpayments made by domestic reverse hy-brid entities. Paragraph (d)(2)(ii) of thissection provides a general rule that anitem of income paid by a domestic reversehybrid entity to an interest holder shall becharacterized under U.S. tax law. Thismeans that U.S. tax principles are first ap-plied to characterize the item of incomepaid by the domestic reverse hybrid entityto the interest holder for purposes of ap-plying an applicable income tax treatyprovision. Once the item of income is socharacterized, it is necessary to determineif the interest holder derives the item ofincome. In determining whether the in-terest holder derives the item of income,paragraph (d)(2)(ii)(A) of this sectionprovides a special rule for determiningwhether the interest holder is fiscallytransparent with respect to the item of in-come. Under that rule, whether the inter-est holder is fiscally transparent with re-spect to the item of income for purposesof §1.894–1(d)(3)(ii) is made based onthe treatment that would have resultedhad the item of income been paid by anentity that was not fiscally transparentunder the laws of the interest holder’s ju-risdiction with respect to any item of in-come. Accordingly, if the interest holderis not fiscally transparent, then it will be

considered to have derived the item of in-come, even if, for example, the item of in-come were characterized differently ortreated as received at an earlier date underthe laws of the interest holder’s jurisdic-tion than the item of income paid by thedomestic reverse hybrid entity.

The IRS and Treasury have learned,however, that domestic reverse hybrid en-tities are being established by related par-ties to manipulate differences in U.S. andforeign entity classification rules to re-duce inappropriately the amount of taximposed on items of income paid from theUnited States to related foreign interestholders. In a typical scenario, a foreigninvestor, resident in a treaty jurisdiction,establishes a domestic reverse hybridholding company with a combination ofdebt and equity contributions. The do-mestic reverse hybrid entity holds thestock of a wholly-owned U.S. operatingcompany. The operating company pays adividend to the domestic reverse hybridentity, but the domestic reverse hybrid en-tity primarily pays interest to its foreignowner within the earning stripping limitsof section 163(j). The foreign jurisdictionviews the foreign owner as receiving divi-dends, but the United States views the do-mestic reverse hybrid entity as receivingthe dividends and making deductible in-terest payments. In circumstances whenthe income tax treaty between the UnitedStates and the applicable foreign jurisdic-tion applies a zero withholding rate on in-terest and a 5-percent rate on related partydividends, the domestic reverse hybridentity treats its payment to the foreignowner as an interest payment and the for-eign owner avoids the withholding tax onthe dividends that its jurisdiction treats itas receiving. In addition, the domestic re-verse hybrid entity receives the benefit ofan interest deduction in the United Stateswhile the foreign interest holder receiveseither a tax credit or exclusion on the div-idend amount in its jurisdiction.

The IRS and Treasury believe that it isinappropriate for related parties to use do-mestic reverse hybrid entities for the pur-pose of converting higher taxed U.S.source items of income to lower taxed, oruntaxed, U.S. source items of income. Todo so defeats the expectation of theUnited States and its treaty partners thattreaties should be used to reduce or elimi-nate double taxation for legitimate trans-

actions, not to reward the manipulation ofinconsistencies in the laws of the treatypartners. The legislative history of sec-tion 894(c) supports this analysis. Con-gress specifically expressed its concernabout the potential tax avoidance opportu-nities available for foreign persons thatinvest in the United States through hybridentities that are designed to avoid bothU.S. and foreign income taxes. See H.R.Conf. Rep. No 220, 105th Cong, 1st Sess.573 (1997); Joint Committee on Taxation,105th Cong., 1st Sess., General Explana-tion of Tax Legislation Enacted in 1997(JCS–23–97), at 249 (December 17,1997). The approach contained in§1.894–1(d)(2), as revised, is also consis-tent with the general tax treaty principlethat contracting states may adopt provi-sions in their domestic laws to counterstructures and transactions intended totake advantage of the differences in thetax laws of the contracting states. SeeCommentaries to Article 1 of The 1998OECD Model Tax Convention on Incomeand Capital; S. Rep. No. 445, 100th Cong.2d Sess. 322–23 (1988)

The IRS and Treasury are further con-cerned by the ability of foreign acquiringentities to obtain tax advantaged financ-ing through domestic reverse hybrid enti-ties by exploiting differences betweenU.S. and foreign law. Such financing un-fairly disadvantages similarly situatedU.S. domestic acquiring entities. Con-gress has expressed concern about the useof analogous hybridized structures thatwere effected to provide foreign acquiringentities with tax advantaged acquisitionfinancing not available to similarly situ-ated domestic companies. See JointCommittee on Taxation, 100th Congress,1st Sess., General Explanation of the TaxReform Act of 1986 (JCS–10–87), at1064, 1065 (May 4, 1987).

For these reasons, the proposed regula-tions provide a special rule in paragraph(d)(2)(ii)(B) of the regulations, such thatif: (1) a domestic entity makes a paymentto a related domestic reverse hybrid en-tity that is considered to be a dividend ei-ther under the laws of the United Statesor under the laws of the jurisdiction of arelated foreign interest holder in the do-mestic reverse hybrid entity, and the re-lated foreign interest holder is treated asderiving its proportionate share of thepayment to the domestic reverse hybrid

2001–16 I.R.B. 1085 April 16, 2001

entity under the laws of the related for-eign interest holder’s jurisdiction; and (2)the domestic reverse hybrid entity makesa payment to the related foreign interestholder of a type that is deductible forU.S. tax purposes and for which a reduc-tion in the U.S. withholding tax ratewould be allowed under the general rule,but for this exception, then to the extentthe amount of the payment by the domes-tic reverse hybrid entity to the related for-eign interest holder does not exceed thetotal amount of the interest holder’s pro-portionate share of any payments by thedomestic entity to the domestic reversehybrid entity treated as dividends undereither jurisdiction’s laws, the payment bythe domestic reverse hybrid entity shallbe treated as a dividend for all purposesof the Code and the applicable incometax treaty.

For purposes of determining theamount of the payment from the domes-tic reverse hybrid entity to the related for-eign interest holder to be recharacterizedas a dividend, the portion of the pay-ments treated as derived by the relatedforeign interest holder shall be reducedby the amount of any prior actual divi-dend payments, under U.S. law, made bythe domestic reverse hybrid entity to therelated foreign interest holder and by theamount of any payments from the domes-tic reverse hybrid entity to the related for-eign interest holder previously recharac-terized under this special rule. The taxwithheld from the payment from the do-mestic reverse hybrid entity to the relatedforeign interest holder shall be deter-mined based on the appropriate rate ofwithholding that would be applicable todividends paid by the domestic reversehybrid entity to the related foreign inter-est holder under the U.S. treaty with therelated foreign interest holder’s jurisdic-tion had that jurisdiction viewed the do-mestic reverse hybrid entity as not fis-cally transparent. Because any paymentsubject to the provisions of this specialrule is treated as a dividend for all pur-poses of the Code and the applicabletreaty, the domestic reverse hybrid entitywill not be able to claim a deduction onthe payment to the related foreign interestholder.

The regulations provide an 80% own-ership test to determine if the parties arerelated to one another and a special rule

that treats accommodation parties as re-lated foreign interest holders. The fore-going rules also apply to recharacterizepayments when more than one domesticreverse hybrid entity or other fiscallytransparent entity is involved.

The proposed regulations further pro-vide that a taxpayer may not affirma-tively use the rules of paragraph (d)(2) ofthis section if a principal purpose forusing such rules is the avoidance of anytax imposed by the Code. Thus, with re-spect to such a taxpayer, the Commis-sioner may depart from the rules of thissection and recharacterize (for all pur-poses of the Code) the arrangement in ac-cordance with its form or its economicsubstance. The regulations further pro-vide that, if a taxpayer enters into anarrangement the effect of which is to cir-cumvent the principles of this paragraph(d)(2), the Commissioner may recharac-terize (for all purposes of the Code) thearrangement in accordance with the prin-ciples of this paragraph (d)(2).

Comments are requested on potentialrules with respect to transaction when thedomestic reverse hybrid entity is sold tounrelated parties who later receive distri-butions.

Proposed Effective Dates

These proposed regulations apply toitems of income paid by a domestic re-verse hybrid entity on or after the datethese regulations are published as finalregulations in the Federal Registerwithrespect to amounts received by the do-mestic reverse hybrid entity on or afterthe date these regulations are publishedas final regulations in the Federal Regis-ter. No inference is intended as to thetreatment of transactions entered intoprior to the date of applicability of thefinal regulations.

Special Analysis

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined in Exec-utive Order 12866. Therefore, a regula-tory assessment is not required. It hasalso been determined that section 553(b)of the Administrative Procedure Act (5U.S.C. chapter 5) does not apply to theseregulations and, because these regula-tions do not impose on small entities a

collection of information requirement,the Regulatory Flexibility Act (5 U.S.C.chapter 6) does not apply. Therefore, aRegulatory Flexibility Analysis is not re-quired. Pursuant to section 7805(f) of theCode, this notice of proposed rulemakingwill be submitted to the Chief Counselfor Advocacy of the Small Business Ad-ministration for comment on its impacton small business.


Before these proposed regulations areadopted as final regulations, considera-tion will be given to any written com-ments (preferably a signed original andeight (8) copies) that are submittedtimely to the IRS. The IRS and TreasuryDepartment specifically request com-ments on the clarity of the proposed regu-lations and how they can be made easierto understand. All comments will beavailable for public inspection and copy-ing.

A public hearing has been scheduledfor June 26, 2001, at 10 a.m. in the audi-torium, Internal Revenue Building, 1111Constitution Avenue, NW, Washington,DC. Because of access restriction, visi-tors will not be admitted beyond the In-ternal Revenue Building lobby more than15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3)apply to the hearing.

Persons that wish to present oral com-ments at the hearing must submit writtencomments by May 28, 2001, and submitan outline of the topics to be discussedand the time to be devoted to each topic(preferably a signed original and eight (8)copies) by June 5, 2001.

A period of 10 minutes will be allottedto each person for making comments.

An agenda showing the scheduling ofthe speakers will be prepared after thedeadline for receiving outl ines haspassed. Copies of the agenda will beavailable free of charge at the hearing.


The principal author of these regula-tions is Shawn R. Pringle of the Office ofthe Associate Chief Counsel (Interna-tional). However, other personnel fromthe IRS and Treasury Department partici-pated in their development.

* * * * *

April 16, 2001 1086 2001–16 I.R.B.


Accordingly, 26 CFR part 1 is pro-posed to be amended as follows:


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

Authority: 26 U.S.C. 7805 * * *Section 1.894–1(d)(2) also issued

under 26 U.S.C. 894 and 7701(l).* * *Par. 2. In §1.894–1, paragraph

(d)(2)(ii) is revised and paragraphs(d)(2)(iii) and (d)(2)(iv) are added to readas follows:

§1.894–1 Income affected by treaty.

* * * * *(d) * * * (2) * * * (ii) Payments by domestic reverse hy-

brid entities—(A) General rule. Exceptas otherwise provided in paragraph(d)(2)(ii)(B) of this section, an item of in-come paid by a domestic reverse hybridentity to an interest holder in such entityshall have the character of such item ofincome under U.S. law and shall be con-sidered to be derived by the interestholder, provided the interest holder is notfiscally transparent in its jurisdiction, asdefined in paragraph (d)(3)(iii) of thissection, with respect to the item of in-come. In determining whether the inter-est holder is fiscally transparent with re-spect to the item of income under thisparagraph (d)(2)(ii)(A), the determinationunder paragraph (d)(3)(ii) of this sectionshall be made based on the treatment thatwould have resulted had the item of in-come been paid by an entity that is not fis-cally transparent under the laws of the in-terest holder’s jurisdiction with respect toany item of income.

(B) Payment made to related foreigninterest holder—(1) General rule. If—

(i) A domestic entity makes a paymentto a related domestic reverse hybrid entitythat is treated as a dividend under eitherthe laws of the United States or the lawsof the jurisdiction of a related foreign in-terest holder in the domestic reverse hy-brid entity, and under the laws of the ju-risdiction of the related foreign interestholder in the domestic reverse hybrid en-tity, the related foreign interest holder istreated as deriving its proportionate share

of the payment under the principles ofparagraph (d)(1) of this section; and

(ii ) The domestic reverse hybrid entitymakes a payment of a type that is de-ductible for U.S. tax purposes to the re-lated foreign interest holder and for whicha reduction in the U.S. withholding taxrate would be allowed under paragraph(d)(2)(ii)(A) of this section but for thisparagraph (d)(2)(ii)(B), then

(iii ) To the extent the amount of thepayment described in paragraph(d)(2)(ii)(B)(1)(ii ) of this section does notexceed the sum of the portion of the pay-ment described in paragraph(d)(2)(ii)(B)(1)(i) of this section treated asderived by the related foreign interestholder and the portion of any other priorpayments described in paragraph (d)(2)(ii)(B)(1)(i) of this section treated as de-rived by the related foreign interestholder, the amount of the payment de-scribed in (d)(2)(ii)(B)(1)(ii ) of this sec-tion will be treated for all purposes of theInternal Revenue Code and the applicableincome tax treaty as a dividend, and thetax to be withheld from the payment de-scribed in paragraph (d)(2)(ii)(B)(1)(ii ) ofthis section shall be determined based onthe appropriate rate of withholding thatwould be applicable to dividends paidfrom the domestic reverse hybrid entity tothe related foreign interest holder underthe U.S. treaty with the related foreign in-terest holder’s jurisdiction had that juris-diction viewed the domestic reverse hy-brid entity as not fiscally transparent; and

(iv) For purposes of determining theamount to be recharacterized under para-graph (d)(2)(ii)(B)(1)(iii ) of this section,the portion of the payments described inparagraph (d)(2)(ii)(B)(1)(i) of this sec-tion treated as derived by the related for-eign interest holder shall be reduced bythe amount of any prior actual dividendpayments made by the domestic reversehybrid entity to the related foreign interestholder and by the amount of any pay-ments from the domestic reverse hybridentity to the related foreign interest holderpreviously rechacterized under paragraph(d)(2)(ii)(B)(1)(iii ) of this section.

(2) Tiered entities. The principles ofthis paragraph (d)(2)(ii)(B) shall alsoapply to payments referred to in this para-graph (d)(2)(ii)(B) made among relatedentities when there is more than one do-mestic reverse hybrid entity or other fis-

cally transparent entities involved.(3) Definition of related. Related shall

mean any entity satisfying the ownershiprequirements of section 267(b) or707(b)(1), except that 80 percent shall besubstituted for 50 percent. For purposesof determining whether a person is relatedto another person, the constructive owner-ship rules of section 318 shall apply, andthe attribution rules of section 267(c) alsoshall apply to the extent they attributeownership to persons to whom section318 does not attribute ownership. If aperson enters into a transaction (or seriesof transactions) with the domestic reversehybrid entity, its related interest holders,or its related entities, and the effect of thetransaction (or series of transaction) is toavoid the principles of this paragraph(d)(2)(ii)(B), then that person shall betreated as related to the domestic reversehybrid entity for purposes of this section.

(C) Commissioner’s discretion. TheCommissioner may, as the Commissionerdetermines to be appropriate, recharacter-ize for all purposes of the Internal Rev-enue Code all or part of any transaction(or series of transactions) between relatedparties if the effect of the transaction (orseries of transactions) is to avoid the prin-ciples of this paragraph (d)(2).

(iii) Examples. The rules of this para-graph (d)(2) are illustrated by the follow-ing examples:

Example 1. Treatment of payment by unrelatedentity to domestic reverse hybrid entity. (i) Facts.Entity A is a domestic reverse hybrid entity, as de-fined in paragraph (d)(2)(i) of this section, with re-spect to the U.S. source dividends it receives fromB, a domestic corporation to which A is not related,within the meaning of paragraph (d)(2)(ii)(B)(3) ofthis section. A’s 85-percent shareholder FC is a cor-poration organized under the laws of Country X,which has an income tax treaty in effect with theUnited States. Under Country X law, FC is not fis-cally transparent with respect to the dividend, as de-fined in paragraph (d)(3)(ii) of this section. In year1, A receives a $100 of dividend income from B.Under Country X law, FC is treated as deriving $85of the $100 dividend payment received by A. Theapplicable rate of tax on dividends under the U.S.-Country X income tax treaty is 5 percent with re-spect to a 10-percent or more corporate shareholder.

(ii) Analysis. Under paragraph (d)(2)(i) of thissection, the U.S.-Country X income tax treaty doesnot apply to the dividend income received by A be-cause the income is paid by B, a domestic corpora-tion, to A, another domestic corporation. A remainsfully taxable under the U.S. tax laws as a domesticcorporation with regard to that item of income. Fur-ther, pursuant to paragraph (d)(2)(i) of this section,notwithstanding the fact that under the laws of Coun-try X A is treated as fiscally transparent with respect

2001–16 I.R.B. 1087 April 16, 2001

to the dividend income, FC may not claim a reducedrate of taxation on its share of the U.S. source divi-dend income received by A.

Example 2. Treatment of payment by domestic re-verse hybrid entity to related foreign interest holderinvolving unrelated party. (i) Facts. The facts arethe same as in Example 1. Both the United Statesand Country X characterize the payment by B in year1 as a dividend. In addition, in year 2, A makes apayment of $25 to FC that is characterized underU.S. tax laws as an interest payment to FC on a loanfrom FC to A. Under the U.S.-Country X income taxtreaty, the rate of tax on interest is zero. UnderCountry X laws, had the interest been paid by an en-tity that is not fiscally transparent under Country X’slaws with respect to any item of income, FC wouldnot be fiscally transparent as defined in paragraph(d)(2)(ii) of this section with respect to the interest.

(ii) Analysis. The analysis is the same as in Exam-ple 1with respect to the $100 payment from B to A.With respect to the $25 payment from A to FC, para-graph (d)(2)(ii)(B) of this section will not apply be-cause, although FC is related to A, A is not related tothe payor of the dividend income it received. Underparagraph (d)(2)(ii)(A) of this section, the $25 interestincome paid from A to FC in year 2 will be character-ized under U.S. law as interest . Accordingly, in year2, FC may obtain the reduced rate of withholding ap-plicable to interest under the U.S.-Country X incometax treaty, assuming all other requirements for claim-ing treaty benefits are met.

Example 3. Treatment of payment by domestic re-verse hybrid entity to related foreign interest holder.(i) Facts. The facts are the same as in Example 2, ex-cept the $100 dividend income received by A in year 1is from A’s wholly owned subsidiary S.

(ii) Analysis. The analysis is the same as in Ex-ample 1with respect to the $100 dividend paymentfrom S to A. However, the $25 interest payment inyear 2 by A to FC will be treated as a dividend for allpurposes of the Internal Revenue Code and the U.S.-Country X income tax treaty because $25 does notexceed FC’s share of the $100 dividend paymentmade by S to A ($85). Since FC is not fiscally trans-parent with respect to the payment as determinedunder paragraph (d)(2)(ii)(A) of this section, FC willbe entitled to obtain the reduced rate applicable todividends under the U.S.-Country X income taxtreaty with respect to the $25 payment. Because the$25 payment in year 2 is recharacterized as a divi-dend for all purposes of the Internal Revenue Codeand the U.S.-Country X income tax treaty, A wouldnot be entitled to an interest deduction with respectto that payment and FC would not be entitled toclaim the reduced rate of withholding applicable tointerest.

(iv) Effective date. This paragraph(d)(2) applies to items of income paid bya domestic reverse hybrid entity on orafter the date these regulations are pub-lished as final regulations in the FederalRegister with respect to amounts re-ceived by the domestic reverse hybrid en-tity on or after the date these regulationsare published as final regulations in theFederal Register.* * * * *

Robert E. Wenzel,Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on Feb-ruary 26, 2001, 8:45 a.m., and published in the issueof the Federal Register for February 27, 2001, 66 FR12445)

U.S.— Korean Agreement

Announcement 2001–34

On June 23, 1999, the Internal RevenueService and the Korean Ministry of Fi-nance and Economy entered into a mutualagreement pursuant to Article 27 of theU.S. – Republic of Korea Income TaxConvention regarding gains from the dis-position of shares of certain Korean realproperty corporations by U.S. persons.

Under the Individual Income Tax Actand Corporate Income Tax Act of Korea,the income from the disposition of sharesof a corporation are treated as derivedfrom the transfer of real property if threeconditions are met. The three conditionsthat must exist are: (1) that the value ofthe real property held by the corporationin the country equals or exceeds 50 per-cent of the value of all the property heldby the corporation; (2) that the share-holder (and related parties) hold at least50 percent of the shares of the corpora-tion; and (3) that the shareholder transfersat least 50 percent of the corporation.Korea treats the income attributable to thegain on such transfers of a Korean corpo-ration as Korean source, for both nonresi-dent aliens and foreign corporations.

The U.S. and Korea have agreed thatgains derived from the disposition ofshares of such a Korean corporationwould be sourced in the situscountry ofthe real property in order to prevent dou-ble taxation for purposes of Article 6(9)and Article 27(2)(9)(c) of the Convention.

Foundations Status of CertainOrganizations

Announcement 2001–35The following organizations have

failed to establish or have been unable tomaintain their status as public charities oras operating foundations. Accordingly,grantors and contributors may not, afterthis date, rely on previous rulings or des-

ignations in the Cumulative List of Orga-nizations (Publication 78), or on the pre-sumption arising from the filing of noticesunder section 508(b) of the Code. Thislisting does not indicate that the organiza-tions have lost their status as organiza-tions described in section 501(c)(3), eligi-ble to receive deductible contributions.

Former Public Charities.The followingorganizations (which have been treated asorganizations that are not private founda-tions described in section 509(a) of theCode) are now classified as private foun-dations:

Acceptance Communications Network,Edgewood, NM

Adams-Johnson Community Outreach,Inc., Fayetteville, NC

Adopt A Horse Program, Inc.,Palermo, ME

Afterschool Publishing Company, Inc.,Detroit, MI

Agape Youth Homeless Ministry Circuit,Decatur, GA

Alleghany Foundation, Covington, VAAllman, Inc., Fresno, CAAlmobarak Cultural Center,

Hot Springs, ARAmerican Elite Runners, Inc.,

Alamogordo, NMAmerican Friends of the Institute of

Advocacy Training, Inc.,New York, NY

American Opera Company, Inc.,Centerville, UT

American Sign Language ResourceCorp., Marietta, GA

Animal Aid Association, Inc.,Springfield, VA

Animal League of Nevada,Las Vegas, NV

Another Level, Montclair, CAArizona Equal Justice Foundation,

Phoenix, AZArmy Retirement Residence Foundation

Potomac, Fort Belvoir, VAAs He Is Ministries, Inc.,

Knoxville, TNAssociation for the Historic Restoration

and Preservation of Lives,Jamaica, NY

Atlantic Health Services, Inc.,Lynwood, CA

Attica Housing Development FundCompany, Inc., Buffalo, NY

Avec Amis With Friends, Inc.,Orlando, FL

Babycare, Inc., Colorado Springs, CO

April 16, 2001 1088 2001–16 I.R.B.

Baltimore Senior Care, Inc.,Baltimore, MD

Barkley Art Center, Inc.,Annandale, MN

BECU Foundation, Tukwila, WABolshoi Ballet and Opera Foundation,

Inc., New York, NYBright Path, Inc., West Newbury, MACalls for Help Foundation, Fullerton, CACaloptima Health Partnership,

Orange, CACameron Cunningham Foundation,

Oakwood, ILCarmel Health Network, Mobile, ALCarol and Arnold Wolowitz Foundation,

Inc., Hauppauge, NYCasa de Milagro, Inc., McKinney, TXCentral Oregon District Hospital

Foundation, Inc., Redmond, ORChanging Perspectives, Inc.,

Mount Kisco, NYCharles E. Peterson Institute for

Preservation of French Heritage,Ste Genevieve, MO

Cherith Ministries, Inc., Fayetteville, GAChildren’s Enrichment Program,

Los Angeles, CAChrist House, Inc., Chi,

Temple Hills, MDCitizens for Humane Animal Treatment,

Inc., Ellicott, NYCleveland Forum for the Arts, Inc.,

Cleveland, OHCochise Center for the Blind and Visually

Impaired, Hereford, AZCohasset Conservation Trust, Inc.,

Cohasset, MACommunity Revitalization Foundation,

Inc., Baltimore, MDCommunity Threads, Columbus, OHConcerned Coaches & Athletes Against

Drugs, Sedona, AZConnecticut Professional Society on the

Abuse of Children, Inc., New Haven, CTContemporary Dance Company of Boca

Raton, Inc., Boca Raton, FLCopper Communities Housing

Corporation, Kearney, AZCreative Resources Network, Inc.,

Bonner Springs, KSDance Et Vous, Mesquite, TXDavid J. Patterson Institute for the

Advancement of Ethics, Inc.,Missoula, MT

Deacon & Brothers Foundation,Bryan, TX

Delavan Historic Foundation, Inc.,Delavan, WI

Detriot Three Dimensional CommunityDevelopment Corporation, Detroit, MI

Donna P. Jackson Ministries, Inc.,Tulsa, OK

Dr. Grover C. Hunter University of NorthCarolina Dental Trust Fund,Atlanta, GA

Educational Association for Family ChildCare, Inc., Lodi, NJ

Edutech Fideiicomiso Educativo P T,Bayamon, PR

Electronic Alexandria CommunityForum, Alexandria, VA

Elishama Imbi Timbwa Memorial MeritScholarship Award, Inc.,New York, NY

Emerald Eyes Children’s Foundation,Sherman Oaks, CA

Encore Chamber Music Society, Ltd.,Jersey City, NJ

FAHD Foundation, Monroe, MIFamilies United of Iowa, Ames, IAFar and Away Missions, Inc.,

Florence, KYFarm Relief Fund, Inc., of Wisconsin,

Marshfield, WIFather Paul Wolf Foundation,

Winsted, MNFirst African Housing Development

Corporation at Darby Township,Sharon Hill, PA

Fishers of Men Ministries, Fairfield, OHFood Closet of the Isaiah 58,

Modesto, CAFort Hill Housing Development Fund

Company, Inc., Rochester, NYFoundation for Musculoskeletal Research

and Education, Little Rock, ARFoundation for O.C. Private School

Opportunities, Inc., Anaheim, CAFour H International Ministries, Corp.,

Hayden, IDFriends of Hill-Stead, Inc.,

Farmington, CTFriends of Son Shine Ministries

Foundation, Corpus Christi, TXGerald Hanus Share the Spirit

Scholarship, Omaha, NEGift of Green, Branson, MOGods Temple, St. Louis, MOGrace Harbour Ministries, Inc.,

Bois Darc, MOGrace HOPE Development Corporation,

Baltimore, MDGrand Valley Beautification Council,

Grand Junction, COGreat American Flag Association, Inc.,

Largo, FL

Gulf Marine Institute of Technology,Gulf Breeze, FL

Hands Extended Ministries, Inc.,Maple Grove, MN

Happy Voice, Inc., Medford, ORHasbrouck Family Association, Inc.,

New Paltz, NYHawaii Society for Prevention of Cruelty

to Children & Animals, Pahoa, HIHenry E. Hardin Education Fund, Inc.,

South Plainfield, NJHidden Ponds Foundation, Inc.,

Larchmont, NYHire a Teen for a Brighter Tomorrow,

Park Forest, ILHomeland of the Heart School,

Olivia, MNInstitute for Health Care Research, Inc.,

Hialeah, FLInstitute for Health Improvement in

Southeast Michigan, Southfield, MIInternational Foundation for the

Conservation of Natural Resources,Vienna, VA

Irish and American Repertory Theatre,Inc., Columbus, OH

Jeff Colby Charitable Foundation,Long Beach, IN

Keren Tefert Yaacov, Monsey, NYKids With Special Needs Day Care

Center, Buffalo, NYKing of Glory Ministries, Inc.,

Avondale, AZL.A.M.B., Inc., Baltimore, MDLancaster Love, Inc., Lititz, PALegacy Ministries, Inc., California, MOLiaison of Arkansas, Inc., Nashville, TNLiechty-Windows Family Organization,

Provo, UTLife Care Management Services, Inc.,

St. Petersburg, FLLight Years, LTD., Bayfield, COLindstrom Foundation for Archaeological

Research & Development,San Leandro, CA

Lov A Second Chance Foundation,Bois Darc, MO

Luci Di Speranza A New Jersey Non-ProfitCorporation, West Long Branch, NJ

MARIA Multi-Behavioral AutismRehabilitation & Intervention Assn.,Eugene, OR

McMastersville Village Volunteer FireDepartment, Ann Arbor, MI

Medical Research ScholarshipFoundation, St. Louis, MO

Memphis Rock-N-Soul, Inc.,Memphis, TN

2001–16 I.R.B. 1089 April 16, 2001

Men Against Breast Cancer, Inc.,Hollywood, FL

Menemsha Pond Preservation Trust, Inc.,Boston, MA

Mentor and Associated Services,Robbinsdale, MN

Ministry of Love, Sterling Heights, MIMount Zion Non-Profit Housing

Corporation, Detroit, MINative Fish Society, Inc., Portland, ORNdigbo Development Foundation, Inc.,

New Orleans, LANeighborhood Rehabilitation Center,

Inc., Arlington, TXNet Ministries, Inc., Carrollton, TXNewcorp, Inc., New Orleans, LANew Pisgah Haven Homes, Ltd.,

Chicago, ILNoble African American Boys, Inc.,

Atlanta, GANorth American Community Health

Foundation, Inc., Jackson, MSNorth Las Vegas Chamber of Commerce

Foundation, N. Las Vegas, NVNortheast Commonworks, Inc.,

Newbury, MANorthside Plaza, Inc., Houston, TXNorthwest Endurance Center, Bend, ORNutrition Art Music and Technology

Therapy, Inc., Washington, DCOh-Za-H-Dah-Zay-Lee, Inc., Lapwai, IDOmaha Volunteers for Handicapped

Children, Omaha, NEOmega Point Foundation, Portland, OROmega Psi Phi Development Corp.,

Decatur, GAOregonians for Environmental Rights,

Sisters, OROut Reach Ministries Community Street

Ministries, Ft. Lauderdale Lakes, FLOz Nidberu Trust, Brooklyn, NYPhoenix Development, Inc.,

Memphis, TNPikes Peak Minority Business

Foundation, Colorado Springs, COPioneering Partners Foundation, Inc.,

Noblesville, INPLAY, Grass Valley, CAPositive People, Inc., Chicago, ILPride Foundation, Inc., Banks, ALPride of the Carolina’s, Incorporated,

Manchester, NHRaksha, Inc., Atlanta, GARalph and Billie Howard Foundation for

Scholarship and Technology, Tyler, TXRed Arce Farm, Inc., Stow, MAReflections A True Gospel Ministry,

Stockton, CA

Richland Affordable HousingCorporation, Sidney, MT

Roanoke Chowan Foundation, Inc.,Ahoskie, NC

Rogue Wave Foundation, Boulder, CORonald McDonald House Charities of

South Dakota, Inc., Sioux Falls, SDRowlett Animal Adoption Center,

Fort Worth, TXRural School and Community Trust,

Washington, DCSafety & Firearms Education, Inc.,

Westbury, NYSaint Martin’s Place, Hazelton, PASeek & Save Ministries, Inc.,

Thurmont, MDShade for the Children, Black Hawk, SDShiloh Development for Community

Home Care, Inc., Fayetteville, NCSolutions An Education and Mediation

Project, Laguna Niguel, CASouth Central Pennsylvania Sickle Cell

Council, Harrisburg, PASouthwest Academy for Conservation

and Ecology, Forest Falls, CASpectrum Delta, Inc., Tinley Park, ILSpirit of Truth Ministry, Columbus, OHSport Education and Values Foundation,

Salt Lake City, UTSpringhill Community Childcare Center,

Inc., Gainesville, FLSt. Francis County Family Resources,

Inc., Forrest City, AZSteps, Inc., Winchester, INSyracuse Rescue Mission Foundation,

Inc., Syracuse, NYTewksbury Ice Arena Authority, Inc.,

Tewskbury, MAThorntown Businessmen’s Educational

Foundation, Inc., Lebanon, INTjo Fowroe-Haven Homes,

Escondido, CATo Life Foundation, Woodcliff Lakes, NJToledo Homes, Inc., Toledo, OHTownsmen Jazz Orchestra,

Bedford Hts., OHTreme Community Education Program,

Inc., New Orleans, LATri-Counties Special Services, Inc.,

Hopkinsville, KYTrulove Charities for the Promotion of

Family Literacy, Champaign, ILUnion Street Foundation, Decatur, ILUnited Communal Services Foundation,

Los Angeles, CAUnited Debt Counseling, Inc.,

Wilmington, DEUplift Foundation, New York, NY

US Friends of English National Opera,Inc., Minneapolis, MN

Vallecito Schools Foundation, Avery, CAViarts, Providence, RIVictory Lakes Village, Waukegan, ILVoice of Youth, Seattle, WAWashington Metropolitan Area Affiliate

of the American Geriatrics Society,Takoma Park, MD

Wilson-Fleetwood DevelopmentFoundation, Alton, IL

Womanhood, Inc., Detroit, MIWomen in Need of Growth Services, Inc.,

Naples, FLWorld Against Racism Foundation,

Washington, DCWorld Dance Day Foundation,

Monterey Park, CAWorldpeace Communities, St. Paul, MN

If an organization listed above submitsinformation that warrants the renewal ofits classification as a public charity or as aprivate operating foundation, the InternalRevenue Service will issue a ruling or de-termination letter with the revised classi-fication as to foundation status. Grantorsand contributors may thereafter rely uponsuch ruling or determination letter as pro-vided in section 1.509(a)–7 of the IncomeTax Regulations. It is not the practice ofthe Service to announce such revised clas-sification of foundation status in the Inter-nal Revenue Bulletin.

Deletions From Cumulative Listof Organizations Contributionsto Which are Deductible UnderSection 170 of the Code

Announcement 2001–36

The name of an organization that nolonger qualifies as an organization de-scribed in section 170(c)(2) of the InternalRevenue Code of 1986 is listed below.

Generally, the Service will not disallowdeductions for contributions made to alisted organization on or before the dateof announcement in the Internal RevenueBulletin that an organization no longerqualifies. However, the Service is notprecluded from disallowing a deductionfor any contributions made after an orga-nization ceases to qualify under section170(c)(2) if the organization has nottimely filed a suit for declaratory judg-ment under section 7428 and if the con-

April 16, 2001 1090 2001–16 I.R.B.

tributor (1) had knowledge of the revoca-tion of the ruling or determination letter,(2) was aware that such revocation wasimminent, or (3) was in part responsiblefor or was aware of the activities or omis-sions of the organization that broughtabout this revocation.

If on the other hand a suit for declara-tory judgment has been timely filed, con-tributions from individuals and organiza-tions described in section 170(c)(2) thatare otherwise allowable will continue tobe deductible. Protection under section7428(c) would begin on April 16, 2001,and would end on the date the court firstdetermines that the organization is not de-scribed in section 170(c)(2) as more par-ticularly set forth in section 7428 (c)(1).For individual contributors, the maximumdeduction protected is $1,000, with a hus-band and wife treated as one contributor.This benefit is not extended to any indi-vidual, in whole or in part, for the acts oromissions of the organization that werethe basis for revocation.

Friends of High Point Drug ActionCouncil, Inc., High Point, NC

Interim Final Rules forNondiscrimination in HealthCoverage in the Group Market;Technical Amendment

Announcement 2001-37

AGENCIES: Internal Revenue Service,Department of the Treasury; Pension andWelfare Benefits Administration, Depart-ment of Labor; Health Care FinancingAdministration, Department of Healthand Human Services.

ACTION: Interim final rules; delay of ef-fective date and conforming amendments.

SUMMARY: Consistent with the memo-randum of January 20, 2001, from the As-sistant to the President and Chief of Staff,entitled “Regulatory Review Plan,” pub-lished in the Federal Registeron January24, 2001 (66 FR 7702), this action delaysfor 60 days the effective date for the rulesentitled “Interim Final Rules for Nondis-crimination in Health Coverage in theGroup Market,” published in the FederalRegisteron January 8, 2001 (66 FR 1378[T.D. 8931, 2001–7 I.R.B. 542]). Thisdocument also makes conforming amend-ments to reflect the delay in effective date.

DATES: The effective date of the InterimFinal Rules amending 26 CFR Part 54, 29CFR Part 2590, and 45 CFR Part 146,published in the Federal Registeron Jan-uary 8, 2001, at 66 FR 1378, is delayed for60 days, from March 9, 2001, until May 8,2001. The conforming amendments inthis document are effective May 8, 2001.

FOR FURTHER INFORMATION CON-TACT: Russ Weinheimer, Internal Rev-enue Service, Department of the Treasury,at (202) 622-6080; Amy J. Turner, Pen-sion and Welfare Benefits Administration,Department of Labor, at (202) 219-7006;or Ruth A. Bradford, Health Care Financ-ing Administration, Department of Healthand Human Services, at (410) 786-1565.


Consistent with the memorandum ofJanuary 20, 2001, from the Assistant tothe President and Chief of Staff, entitled“Regulatory Review Plan,” published inthe Federal Registeron January 24, 2001(66 FR 7702), this action delays for 60days the effective date and, for consis-tency, certain applicability dates for therules entitled “Interim Final Rules forNondiscrimination in Health Coverage inthe Group Market,” published in the Fed-eral Registeron January 8, 2001 (66 FR1378). These rules implement statutoryprovisions prohibiting discriminationbased on a health factor by group healthplans and issuers offering health insur-ance coverage in connection with a grouphealth plan. The rules implement changesmade to the Internal Revenue Code of1986, the Employee Retirement IncomeSecurity Act of 1974, and the PublicHealth Service Act, enacted as part of theHealth Insurance Portability and Account-ability Act of 1996 (HIPAA), and most ofthe guidance contained in these rules re-mains applicable for plan years beginningon or after July 1, 2001. This documentalso makes conforming amendments toreflect the delay in effective date.

To the extent that 5 U.S.C. 553 appliesto this action, it is exempt from noticeand comment because it constitutes a ruleof procedure under 5 U.S.C.553(b)(3)(A). Alternatively, the Depart-ments’ implementation of this rule with-out opportunity for public comment, ef-fective immediately upon publicationtoday (March 9, 2001) in the FederalRegister, is based on the good cause ex-

ceptions in 5 U.S.C. 553(b)(3)(B) and553(d)(3), in that seeking public com-ment is impracticable, unnecessary, andcontrary to the public interest. The 60-day delay in effective date is necessary togive Department officials the opportunityfor further review and consideration ofnew regulations, consistent with the As-sistant to the President’s memorandum ofJanuary 20, 2001. Given the imminenceof the effective date, seeking prior publiccomment on this delay would have beenimpractical, unnecessary, and contrary tothe public interest in the orderly promul-gation and implementation of regula-tions. Because the delay is only for 60days, a 30-day comment period beforethe delay could be effective would ex-haust a substantial amount of time thatgroup health plans, health insurance is-suers, and State insurance commis-sioner’s offices could otherwise use to re-view their plan documents, insurancepolicies, and State laws for purposes ofthe orderly implementation of the interimregulations. In addition, it would createconfusion among State agencies, employ-ers, plan administrators, issuers, and thirdparty administrators as to the effectivedate of certain provisions, impeding theircompliance and enforcement efforts

List of Subjects

26 CFR Part 54

Excise taxes, Health care, Health insur-ance, Pensions, Reporting and record-keeping requirements.

29 CFR Part 2590

Employee benefit plans, Employee Re-tirement Income Security Act, Healthcare, Health insurance, Reporting andrecordkeeping requirements.

45 CFR Part 146

Health care, Health insurance, Report-ing and recordkeeping requirements, andState regulation of health insurance.

Conforming Amendments to theRegulations

Internal Revenue Service

26 CFR Chapter I

Accordingly, the publication on January8, 2001, of the temporary and final rules,26 CFR Part 54, is amended as follows:

2001–16 I.R.B. 1091 April 16, 2001

PART 54 — PENSION EXCISE TAXES

Paragraph 1. The authority citation forpart 54 continues to read in part as fol-lows:

Authority: 26 U.S.C. 7805 * * *

§54.9802–1 [Amended]

Par. 2. Section 54.9802–1 is amendedby removing the date “March 9, 2001” ineach place it appears in paragraph (i)(1)and adding in its place “May 8, 2001”.

§54.9802–1T [Amended]

Par. 3. Section 54.9802–1T is amendedby:

1. Removing the date “March 9, 2001”and adding in its place “May 8, 2001” inparagraph (i)(1).

2. Removing the date “March 9, 2001”and adding in its place “May 8, 2001” inparagraph (i)(3)(ii)(A) introductory text.

3. Removing the date “March 9,2001” and adding in its place “May 8,2001” in paragraph (i)(3)(ii)(C) Example2 (ii).



Approved March 2, 2001.

Pamela F. Olsen, Deputy Assistant Secretary

of the Treasury.

Pension and Welfare BenefitsAdministration

29 CFR Chapter XXV

For the reasons set forth above, thepublication on January 8, 2001, of theinterim final rule, 29 CFR Part 2590, isamended as follows:

PART 2590 – RULES ANDREGULATIONS FOR HEALTHINSURANCE PORTABILITY ANDRENEWABILITY FOR GROUPHEALTH PLANS

Paragraph 1. The authority citation forPart 2590 continues to read as follows:

Authority: Secs. 107, 209, 505,701–703, 711–713, and 731–734 of

ERISA (29 U.S.C. 1027, 1059, 1135,1171–1173, 1181–1183, and 1191–1194),as amended by HIPAA (Public Law104–191, 110 Stat. 1936), MHPA andNMHPA (Public Law 104–204, 110 Stat.2935), and WHCRA (Public Law105–277, 112 Stat. 2681–436), section101(g)(4) of HIPAA, and Secretary ofLabor’s Order No. 1–87, 52 FR 13139,April 21, 1987.

§ 2590.702 [Amended]

Par. 2. Section 2590.702 is amendedby:

1. Removing the date “March 9, 2001”and adding in its place “May 8, 2001” inthe heading to paragraph (i)(1).



4. Removing the date “March 9, 2001”and adding in its place “May 8, 2001” inparagraph (i)(3)(ii)(C) Example 2(ii).

Signed at Washington, DC, this 16th dayof February 2001.

Alan D. Lebowitz,Acting Assistant Secretary, Pension and

Welfare Benefits Administration, U.S. Department of Labor.

Health Care Financing Administration

45 CFR Subtitle A

For the reasons set forth above, thepublication on January 8, 2001, of theinterim final rule, 45 CFR Part 146, isamended as follows:

PART 146 – RULES ANDREGULATIONS FOR HEALTHINSURANCE PORTABILITY ANDRENEWABILITY FOR GROUPHEALTH PLANS

Paragraph 1. The authority citation forPart 146 continues to read as follows:

Authority: Secs. 2701 through 2763,2791 and 2792 of the Public Health Ser-vice Act, 42 U.S.C. 300gg through300gg–63, 300gg–91, 300gg–92 as

amended by HIPAA (Public Law104–191, 110 Stat. 1936), MHPA andNMHPA (Public Law 104–204, 110 Stat.2935), and WHCRA (Public Law105–277, 112 Stat. 2681–436), and sec-tion 102(c)(4) of HIPAA.

§ 146.121 [Amended]

Par. 2. Section 146.121 is amended by:1. Removing the date “March 9, 2001”

and adding in its place “May 8, 2001” inthe heading to paragraph (i)(1).



4. Removing the date “March 9, 2001”and adding in its place “May 8, 2001” inparagraph (i)(3)(ii)(C) Example 2(ii).

Dated February 20, 2001.

Michael McMullan,Acting Deputy Administrator,

Health Care Financing Administration.

Approved March 5, 2001.

Tommy G. Thompson,Secretary,

Health and Human Services.

(Filed by the Office of the Federal Register onMarch 8, 2001, 8:45 a.m., and published in the issueof the Federal Register for March 9, 2001, 66 F.R.14076)

April 16, 2001 i 2001–16 I.R.B.

Revenue rulings and revenue procedures(hereinafter referred to as “rulings”)that have an effect on previous rulingsuse the following defined terms to de-scribe the effect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position isbeing extended to apply to a variation ofthe fact situation set forth therein. Thus,if an earlier ruling held that a principleapplied to A, and the new ruling holdsthat the same principle also applies to B,the earlier ruling is amplified. (Comparewith modified, below).

Clarified is used in those instanceswhere the language in a prior ruling isbeing made clear because the languagehas caused, or may cause, some confu-sion. It is not used where a position in aprior ruling is being changed.

Distinguisheddescribes a situationwhere a ruling mentions a previouslypublished ruling and points out an essen-tial difference between them.

Modified is used where the substanceof a previously published position isbeing changed. Thus, if a prior rulingheld that a principle applied to A but notto B, and the new ruling holds that it ap-

plies to both A and B, the prior ruling ismodified because it corrects a publishedposition. (Compare with amplified andclarified, 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 usedin a ruling that lists previously publishedrulings that are obsoleted because ofchanges in law or regulations. A rulingmay also be obsoleted because the sub-stance has been included in regulationssubsequently adopted.

Revoked describes situations where theposition in the previously published rul-ing is not correct and the correct positionis being stated in the new ruling.

Superseded describes a situation wherethe new ruling does nothing more thanrestate the substance and situation of apreviously published ruling (or rulings).Thus, the term is used to republish underthe 1986 Code and regulations the sameposition published under the 1939 Codeand regulations. The term is also usedwhen it is desired to republish in a singleruling a series of situations, names, etc.,that were previously published over a pe-riod of time in separate rulings. If the

new ruling does more than restate thesubstance of a prior ruling, a combinationof terms is used. For example, modifiedand superseded describes a situationwhere the substance of a previously pub-lished ruling is being changed in part andis continued without change in part and itis desired to restate the valid portion ofthe previously published ruling in a newruling that is self contained. In this casethe previously published ruling is firstmodified and then, as modified, is super-seded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling andthat list is expanded by adding furthernames in subsequent rulings. After theoriginal ruling has been supplementedseveral times, a new ruling may be pub-lished that includes the list in the originalruling and the additions, and supersedesall prior rulings in the 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 ofcases in litigation, or the outcome of aService study.

AbbreviationsThe following abbreviations in current use and for-merly used will appear in material published in theBulletin.

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.—Statements 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.

Definition of Terms

2001–16 I.R.B. ii April 16, 2001

Numerical Finding List1

Bulletins 2001–1 through 2001–15

Announcements:

2001–1, 2001–2 I.R.B. 2772001–2, 2001–2 I.R.B. 2772001–3, 2001–2 I.R.B. 2782001–4, 2001–2 I.R.B. 2862001–5, 2001–2 I.R.B. 2862001–6, 2001–3 I.R.B. 3572001–7, 2001–3 I.R.B. 3572001–8, 2001–3 I.R.B. 3572001–9, 2001–3 I.R.B. 3572001–10, 2001–4 I.R.B. 4312001–11, 2001–4 I.R.B. 4322001–12, 2001–6 I.R.B. 5262001–13, 2001–96 I.R.B. 7522001–14, 2001–7 I.R.B. 6482001–15, 2001–8 I.R.B. 7152001–16, 2001–8 I.R.B. 7152001–17, 2001–8 I.R.B. 7162001–18, 2001–10 I.R.B. 7912001–19, 2001–10 I.R.B. 7912001–20, 2001–8 I.R.B. 7162001–21, 2001–9 I.R.B. 7522001–22, 2001–11 I.R.B. 8952001–23, 2001–10 I.R.B. 7912001–24, 2001–10 I.R.B. 7932001–25, 2001–11 I.R.B. 8952001–26, 2001–11 I.R.B. 8962001–27, 2001–11 I.R.B. 8972001–28, 2001–13 I.R.B. 9752001–29, 2001–14 I.R.B. 10142001–30, 2001–15 I.R.B. 1065

Notices:

2001–1, 2001–2 I.R.B. 2612001–2, 2001–2 I.R.B. 2652001–3, 2001–2 I.R.B. 2672001–4, 2001–2 I.R.B. 2672001–5, 2001–3 I.R.B. 3272001–6, 2001–3 I.R.B. 3272001–7, 2001–4 I.R.B. 3742001–8, 2001–4 I.R.B. 3742001–9, 2001–4 I.R.B. 3752001–10, 2001–5 I.R.B. 4592001–11, 2001–5 I.R.B. 4642001–12, 2001–3 I.R.B. 3282001–13, 2001–6 I.R.B. 5142001–14, 2001–6 I.R.B. 5162001–15, 2001–7 I.R.B. 5892001–16, 2001–9 I.R.B. 7302001–17, 2001–9 I.R.B. 7302001–18, 2001–9 I.R.B. 7312001–19, 2001–10 I.R.B. 7842001–20, 2001–11 I.R.B. 8182001–21, 2001–11 I.R.B. 8182001–22, 2001–12 I.R.B. 9112001–23, 2001–12 I.R.B. 9112001–24, 2001–12 I.R.B. 9122001–25, 2001–13 I.R.B. 9412001–26, 2001–13 I.R.B. 9422001–27, 2001–13 I.R.B. 9422001–28, 2001–13 I.R.B. 9442001–29, 2001–14 I.R.B. 9892001–30, 2001–14 I.R.B. 989

Proposed Regulations:

LR–230–76, 2001–13 I.R.B. 945REG–209461–79, 2001–8 I.R.B. 712REG–246256–96, 2001–8 I.R.B. 713REG–251701–96, 2001–4 I.R.B. 396REG–101520–97, 2001–15 I.R.B. 1057REG–106030–98, 2001–11 I.R.B. 820REG–106446–98, 2001–13 I.R.B. 945REG–106542–98, 2001–5 I.R.B. 473REG–121928–98, 2001–6 I.R.B. 520REG–109481–99, 2001–13 I.R.B. 961REG–111835–99, 2001–11 I.R.B. 834REG–114998–99, 2001–14 I.R.B. 992REG–115560–99, 2001–14 I.R.B. 993REG–101739–00, 2001–14 I.R.B. 996REG–103320–00, 2001–8 I.R.B. 714REG–104683–00, 2001–4 I.R.B. 407REG–104876–00, 2001–14 I.R.B. 998REG–105801–00, 2001–13 I.R.B. 965REG–106702–00, 2001–4 I.R.B. 424REG–106791–00, 2001–6 I.R.B. 521REG–106892–00, 2001–15 I.R.B. 1060REG–107047–00, 2001–14 I.R.B. 1002REG–107175–00, 2001–13 I.R.B. 971REG–107176–00, 2001–4 I.R.B. 428REG–107186–00, 2001–13 I.R.B. 973REG–107566–00, 2001–3 I.R.B. 346REG–110374–00, 2001–12 I.R.B. 915REG–110659–00, 2001–12 I.R.B. 917REG–114082–00, 2001–7 I.R.B. 629REG–114083–00, 2001–7 I.R.B. 630REG–114084–00, 2001–7 I.R.B. 633REG–116468–00, 2001–6 I.R.B. 522REG–119352–00, 2001–6 I.R.B. 525REG–121109–00, 2001–15 I.R.B. 1064REG–125237–00, 2001–12 I.R.B. 919REG–126100–00, 2001–11 I.R.B. 862REG–129608–00, 2001–14 I.R.B. 1011REG–130477–00, 2001–11 I.R.B. 865REG–130481–00, 2001–11 I.R.B. 865

Railroad Retirement Quarterly Rates:

2001–2, I.R.B. 2582001–15, I.R.B. 1054

Revenue Procedures:

2001–1, 2001–1 I.R.B. 12001–2, 2001–1 I.R.B. 792001–3, 2001–1 I.R.B. 1112001–4, 2001–1 I.R.B. 1212001–5, 2001–1 I.R.B. 1642001–6, 2001–1 I.R.B. 1942001–7, 2001–1 I.R.B. 2362001–8, 2001–1 I.R.B. 2392001–9, 2001–3 I.R.B. 3282001–10, 2001–2 I.R.B. 2722001–11, 2001–2 I.R.B. 2752001–12, 2001–3 I.R.B. 3352001–13, 2001–3 I.R.B. 3372001–14, 2001–3 I.R.B. 3432001–15, 2001–5 I.R.B. 4652001–16, 2001–4 I.R.B. 3762001–17, 2001–7 I.R.B. 5892001–18, 2001–8 I.R.B. 7082001–19, 2001–9 I.R.B. 7322001–20, 2001–9 I.R.B. 7382001–21, 2001–9 I.R.B. 742

Revenue Procedures—Continued:

2001–22, 2001–9 I.R.B. 7452001–23, 2001–10 I.R.B. 7842001–24, 2001–10 I.R.B. 7882001–25, 2001–12 I.R.B. 913

Revenue Rulings:

2001–1, 2001–9 I.R.B. 7262001–2, 2001–2 I.R.B. 2552001–3, 2001–3 I.R.B. 3192001–4, 2001–3 I.R.B. 2952001–5, 2001–5 I.R.B. 4512001–6, 2001–6 I.R.B. 4912001–7, 2001–7 I.R.B. 5412001–8, 2001–9 I.R.B. 7262001–9, 2001–8 I.R.B. 6522001–10, 2001–10 I.R.B. 7552001–11, 2001–10 I.R.B. 7802001–12, 2001–11 I.R.B. 8112001–13, 2001–12 I.R.B. 8982001–14, 2001–12 I.R.B. 8982001–15, 2001–13 I.R.B. 9222001–16, 2001–13 I.R.B. 9362001–17, 2001–15 I.R.B. 1052

Treasury Decisions:

8910, 2001–2 I.R.B. 2588911, 2001–3 I.R.B. 3218912, 2001–5 I.R.B. 4528913, 2001–3 I.R.B. 3008914, 2001–8 I.R.B. 6538915, 2001–4 I.R.B. 3598916, 2001–4 I.R.B. 3608917, 2001–7 I.R.B. 5388918, 2001–4 I.R.B. 3728919, 2001–6 I.R.B. 5058920, 2001–8 I.R.B. 6548921, 2001–7 I.R.B. 5328922, 2001–6 I.R.B. 5088923, 2001–6 I.R.B. 4858924, 2001–6 I.R.B. 4898925, 2001–6 I.R.B. 4968926, 2001–6 I.R.B. 4928927, 2001–11 I.R.B. 8078928, 2001–8 I.R.B. 6858929, 2001–10 I.R.B. 7568930, 2001–5 I.R.B. 4338931, 2001–7 I.R.B. 5428932, 2001–11 I.R.B. 8138933, 2001–11 I.R.B. 7948934, 2001–12 I.R.B. 9048935, 2001–8 I.R.B. 7028937, 2001–11 I.R.B. 8068938, 2001–13 I.R.B. 9298939, 2001–12 I.R.B. 8998940, 2001–15 I.R.B. 10168941, 2001–14 I.R.B. 9778942, 2001–13 I.R.B. 9298943, 2001–15 I.R.B. 1054

1 A cumulative list of all revenue rulings, revenueprocedures, Treasury decisions, etc., published inInternal Revenue Bulletins 2000–27 through2000–52 is in Internal Revenue Bulletin 2001–1,dated January 2, 2001.

April 16, 2001 iii 2001–16 I.R.B.

Finding List of Current Actions onPreviously Published Items1

Bulletins 2001–1 through 2001–15

Announcement:

98–99Modified byAnn. 2001–9, 2001–3 I.R.B. 357

99–79Superseded byAnn. 2001–3, 2001–2 I.R.B. 278

2000–78Obsoleted byT.D. 8933, 2001–11 I.R.B. 794

2000–97Corrected byAnn. 2001–7, 2001–3 I.R.B. 357

Cumulative Bulletin:


Notices:

94–3Modified byT.D. 8933, 2001–11 I.R.B. 794

98–39Modified byNotice 2001–9, 2001–4 I.R.B. 375


99–53Modified and superseded byNotice 2001–7, 2001–4 I.R.B. 374

2000–21Superseded byNotice 2001–1, 2001–2 I.R.B. 261

2000–22Modified and superseded byNotice 2001–8, 2001–4 I.R.B. 374


2000–43Extended byNotice 2001–13, 2001–6 I.R.B. 514

Proposed Regulations:

EE–130–86Partially withdrawn byREG–209461–79, 2001–8 I.R.B. 712

REG–106030–98Corrected byAnn. 2001–30, 2001–15 I.R.B. 1065


Proposed Regulations—Continued:

REG–116733–98Withdrawn byAnn. 2001–11, 2001–4 I.R.B. 432

REG–116048–99Withdrawn byAnn. 2001–27, 2001–11 I.R.B. 897


Revenue Procedures:

83–87Superseded byRev. Proc. 2001–15, 2001–5 I.R.B. 465

90–18Amplified and superseded byRev. Proc. 2001–18, 2001–8 I.R.B. 708


96–15Modified byAnn. 2001–22, 2001–11 I.R.B. 895

96–17Modified byRev. Proc. 2001–9, 2001–3 I.R.B. 328

99–18Modified and superseded byRev. Proc. 2001–21, 2001–9 I.R.B. 742


99–49Modified and amplified byNotice 2001–23, 2001–12 I.R.B. 911Rev. Proc. 2001–10, 2001–2 I.R.B. 272Rev. Proc. 2001–23, 2001–10 I.R.B. 784Rev. Proc. 2001–24, 2001–10 I.R.B. 788Rev. Proc. 2001–25, 2001–12 I.R.B. 913Rev. Rul. 2001–8, 2001–9 I.R.B. 762







Revenue Procedures—Continued:






2001–13Clarified byNotice 2001–12, 2001–3 I.R.B. 328

Revenue Rulings:



85–30Clarified byRev. Rul. 2001–8, 2001–9 I.R.B. 762

88–95Clarified byRev. Rul. 2001–8, 2001–9 I.R.B. 762

92–19Supplemented in part byRev. Rul. 2001–11, 2001–10 I.R.B. 780



Treasury Decisions:

7530Removed byT.D. 8938, 2001–13 I.R.B. 929

8757Revised byT.D. 8941, 2001–14 I.R.B. 977

8889Corrected byAnn. 2001–14, 2001–2 I.R.B. 286

8913Corrected byAnn. 2001–26, 2001–11 I.R.B. 896

1 A cumulative list of current actions on previouslypublished items in Internal Revenue Bulletins2000–27 through 2000–52 is in Internal RevenueBulletin 2001–1, dated January 2, 2001.

INTERNAL REVENUE BULLETINThe Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue

Bulletin is sold on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by theSuperintendent of Documents when their subscriptions must be renewed.

CUMULATIVE BULLETINSThe contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are

sold on a single copy basis and are not included as part of the subscription to the Internal Revenue Bulletin. Subscribers to the week-ly Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of printand are not available. Persons desiring available Cumulative Bulletins, which are listed on the reverse, may purchase them from theSuperintendent of Documents.

ACCESS THE INTERNAL REVENUE BULLETIN ON THE INTERNETYou may view the Internal Revenue Bulletin on the Internet at www.irs.gov. Select Tax Info for Business at the bottom of the

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purchased from National Technical Information Service (NTIS) on the Internet at www.irs.gov/cdorders(discount for online orders)or by calling 1-877-233-6767. The first release is available in mid-December and the final release is available in late January.

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