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.

SPECIAL ANNOUNCEMENT

Announcement 2002–101, page 800.This announcement solicts applications from potential part-ners to participate in the 2003 IRS Individual e-file Partner-ship Program. The partnership opportunities are a result ofRRA 98, which requires the IRS to receive 80 percent of allreturns electronically by 2007. RRA 98 authorized the IRSCommissioner to promote the benefits of and encourage theuse of e-file services through partnerships with various en-tities that offer low cost tax preparation and electronic fil-ing of income tax returns for qualified taxpayers. Thoseapplicants that are accepted as partners will have a link(s)and description(s) of their services placed on the IRS web-site at www.irs.gov (IRS e-file Partners Page).

INCOME TAX

Rev. Rul. 2002–69, page 760.Business expenses; interest; lease-in/lease-out transac-tions. A taxpayer may not deduct currently, under sections 162and 163 of the Code, rent and interest paid or incurred in con-nection with a lease-in/lease-out (LILO) transaction that prop-erly is characterized as conferring only a future interest inproperty. Rev. Rul. 99–14 modified and superseded.

Rev. Rul. 2002–71, page 763.Notional principal contract (NPC). This ruling provides guid-ance on the timing of recognition of gain or loss on the termi-nation of a notional principal contract that hedges a portion ofthe term of a debt instrument issued by the taxpayer.

Rev. Rul. 2002–72, page 759.Low-income housing credit; satisfactory bond; “bond fac-tor” amounts for the period October through December2002. This ruling announces the monthly bond factor amountsto be used by taxpayers who dispose of qualified low-incomebuildings or interests therein during the period October through

December 2002. This ruling also provides a summary of the bondfactor amounts for dispositions occurring during the period Janu-ary through September 2002.

REG–112306–00, page 767.Proposed regulations under section 1296 of the Code containprocedures for certain United States persons holding market-able stock in a passive foreign investment company (PFIC) to electmark to market treatment for that stock. A public hearing isscheduled for November 6, 2002.

REG–150313–01, page 777.Proposed regulations under sections 302, 304, and other sec-tions of the Code provide guidance regarding the treatment ofthe basis of redeemed stock when a distribution in redemptionof such stock is treated as a dividend. The regulations also pro-vide guidance regarding certain acquisitions of stock by re-lated corporations that are treated as distributions in redemptionof stock. A public hearing is scheduled for February 20, 2003.

Notice 2002–70, page 765.This notice alerts taxpayers and their representatives about cer-tain reinsurance transactions intended to shift income to off-shore related companies purported to be insurance companiesthat are subject to little or no U.S. federal income tax. These trans-actions often do not generate the federal tax benefits that tax-payers claim are allowable for federal income tax purposes. Thisnotice also alerts taxpayers, their representatives, and promot-ers of these transactions, to certain reporting and record keep-ing obligations and penalties that they may be subject to withrespect to these transactions.

Announcement 2002–100, page 799.This document contains corrections to proposed regulations un-der section 1503(d) of the Code (REG–106879–00, 2002–34I.R.B. 402) relating to the events that require the recapture of dualconsolidated losses.

Bulletin No. 2002–44November 4, 2002

Finding Lists begin on page ii.Index for July through October begins on page v.

Announcement 2002–102, page 802.This document changes the date of a scheduled public hearingand extends the public comment period on proposed regula-tions (REG–136311–01, 2002–36 I.R.B. 485) that relate to whena foreign corporation engaged in the international operation ofships or aircraft may exclude its U.S. source income from grossincome for U.S. federal income tax purposes. The hearing is re-scheduled from November 12, 2002, to November 25, 2002.

EMPLOYEE PLANS

REG–124667–02, page 791.Proposed regulations under section 417 of the Code would con-solidate the content requirements applicable to explanations ofqualified joint and survivor annuities and qualified preretire-ment survivor annuities payable from certain retirement plans.In addition, these regulations would specify requirements for dis-closing the relative value of optional forms of benefit that are pay-able from certain retirement plans in lieu of a qualified joint andsurvivor annuity. A public hearing is scheduled for January 14,2003.

November 4, 2002 2002–44 I.R.B.

The IRS Mission

Provide America’s taxpayers top quality service by helping themunderstand and meet their tax responsibilities and by applyingthe tax law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument of theCommissioner of Internal Revenue for announcing official rul-ings and procedures of the Internal Revenue Service and for pub-lishing Treasury Decisions, Executive Orders, Tax Conventions,legislation, court decisions, and other items of general inter-est. It is published weekly and may be obtained from the Super-intendent of Documents on a subscription basis. Bulletin contentsare consolidated semiannually into Cumulative Bulletins, whichare sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke, modify,or amend any of those previously published in the Bulletin. All pub-lished rulings apply retroactively unless otherwise indicated. Pro-cedures relating solely to matters of internal management arenot published; however, statements of internal practices and pro-cedures that affect the rights and duties of taxpayers are pub-lished.

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

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not be re-lied on, used, or cited as precedents by Service personnel in thedisposition of other cases. In applying published rulings and pro-cedures, the effect of subsequent legislation, regulations, court

decisions, rulings, and procedures must be considered, and Ser-vice personnel and others concerned are cautioned against reach-ing the same conclusions in other cases unless the facts andcircumstances are substantially the same.

The Bulletin is divided into four parts as follows:

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

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

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references to these sub-jects are contained in the other Parts and Subparts. Also in-cluded in this part are Bank Secrecy Act Administrative Rulings.Bank Secrecy Act Administrative Rulings are issued by the De-partment of the Treasury’s Office of the Assistant Secretary (En-forcement).

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 index forthe matters published during the preceding months. Thesemonthly indexes are cumulated on a semiannual basis, and arepublished in the first Bulletin of the succeeding semiannual pe-riod, respectively.

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.

2002–44 I.R.B. November 4, 2002

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

Section 42.—Low-IncomeHousing Credit

Low-income housing credit; satisfac-tory bond; “bond factor” amounts for theperiod October through December 2002.This ruling announces the monthly bondfactor amounts to be used by taxpayers whodispose of qualified low-income build-ings or interests therein during the periodOctober through December 2002. This rul-ing also provides a summary of the bondfactor amounts for dispositions occuringduring the period January through Septem-ber 2002.

Rev. Rul. 2002–72

In Rev. Rul. 90–60, 1990–2 C.B. 3, theInternal Revenue Service provided guid-

ance to taxpayers concerning the generalmethodology used by the Treasury Depart-ment in computing the bond factor amountsused in calculating the amount of bond con-sidered satisfactory by the Secretary un-der § 42(j)(6) of the Internal Revenue Code.It further announced that the Secretarywould publish in the Internal Revenue Bul-letin a table of “bond factor” amounts fordispositions occurring during each calen-dar month.

Rev. Proc. 99–11, 1999–1 C.B. 275, es-tablished a collateral program as an alter-native to providing a surety bond fortaxpayers to avoid or defer recapture of thelow-income housing tax credits under§ 42(j)(6). Under this program, taxpayers

may establish a Treasury Direct Accountand pledge certain United States Treasurysecurities to the Internal Revenue Serviceas security.

This revenue ruling provides in Table 1the bond factor amounts for calculating theamount of bond considered satisfactory un-der § 42(j)(6) or the amount of UnitedStates Treasury securities to pledge in aTreasury Direct Account under Rev. Proc.99–11 for dispositions of qualified low-income buildings or interests therein dur-ing the period October through December2002. Table 1 also provides a summary ofthe bond factor amounts for dispositions oc-curring during the period January throughSeptember 2002.

Table 1Rev. Rul. 2002–72

Monthly Bond Factor Amounts for Dispositions ExpressedAs a Percentage of Total Credits

Calendar Year Building Placed in Serviceor, if Section 42(f)(1) Election Was Made,

the Succeeding Calendar Year

Month ofDisposition

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Jan ’02 17.76 32.73 45.44 56.24 65.46 65.92 66.46 66.99 67.63 68.35 69.24Feb ’02 17.76 32.73 45.44 56.24 65.46 65.75 66.28 66.80 67.44 68.16 69.05Mar ’02 17.76 32.73 45.44 56.24 65.46 65.57 66.10 66.62 67.26 67.98 68.86Apr ’02 17.76 32.73 45.44 56.24 65.46 65.40 65.93 66.45 67.08 67.80 68.68May ’02 17.76 32.73 45.44 56.24 65.46 65.23 65.76 66.27 66.91 67.62 68.50Jun ’02 17.76 32.73 45.44 56.24 65.46 65.06 65.59 66.11 66.74 67.46 68.33Jul ’02 17.76 32.73 45.44 56.24 65.46 64.90 65.42 65.94 66.58 67.29 68.17Aug ’02 17.76 32.73 45.44 56.24 65.46 64.74 65.26 65.78 66.42 67.13 68.01Sep ’02 17.76 32.73 45.44 56.24 65.46 64.58 65.10 65.62 66.26 66.98 67.86Oct ’02 17.76 32.73 45.44 56.24 65.46 64.43 64.95 65.47 66.11 66.83 67.72Nov ’02 17.76 32.73 45.44 56.24 65.46 64.27 64.80 65.32 65.96 66.68 67.58Dec ’02 17.76 32.73 45.44 56.24 65.46 64.12 64.65 65.17 65.81 66.54 67.44

2002–44 I.R.B. 759 November 4, 2002

Table 1 (cont’d)Rev. Rul. 2002–72

Monthly Bond Factor Amounts for Dispositions ExpressedAs a Percentage of Total Credits

Calendar Year Building Placed in Serviceor, if Section 42(f)(1) Election Was Made,

the Succeeding Calendar Year

Month ofDisposition

1999 2000 2001 2002

Jan ’02 70.13 70.98 72.28 72.55Feb ’02 69.92 70.77 72.05 72.55Mar ’02 69.73 70.58 71.84 72.55Apr ’02 69.55 70.40 71.67 72.55May ’02 69.38 70.24 71.51 72.55Jun ’02 69.21 70.09 71.37 72.55Jul ’02 69.05 69.94 71.25 72.55Aug ’02 68.90 69.81 71.14 72.55Sep ’02 68.76 69.68 71.04 72.55Oct ’02 68.62 69.57 70.94 72.55Nov ’02 68.49 69.45 70.86 72.55Dec ’02 68.37 69.35 70.78 72.55

For a list of bond factor amounts appli-cable to dispositions occurring during othercalendar years, see: Rev. Rul. 98–3, 1998–1C.B. 248; Rev. Rul. 2001–2, 2001–1 C.B.255; and Rev. Rul. 2001–53, 2001–2 C.B.488.

DRAFTING INFORMATION

The principal author of this revenue rul-ing is Gregory N. Doran of the Office ofAssociate Chief Counsel (Passthroughs andSpecial Industries). For further informa-tion regarding this revenue ruling, con-tact Mr. Doran at (202) 622–3040 (not atoll-free call).

Section 162.—Trade orBusiness Expenses

26 CFR 1.162–11: Rentals.

(Also § 163; 1.163–1.)

Business expenses; interest; lease-in/lease-out transactions. A taxpayer may notdeduct currently, under sections 162 and 163of the Code, rent or interest paid or in-curred in connection with a lease-in/lease-out (LILO) transaction that properly ischaracterized as conferring only a future in-terest in property.

Rev. Rul. 2002–69

ISSUE

May a taxpayer deduct currently, un-der §§ 162 and 163 of the Internal Rev-enue Code, rent and interest paid or incurredin connection with a “lease-in/lease-out”(“LILO”) transaction?

FACTS

X is a U.S. corporation. FM is a for-eign municipality that has historically ownedand used certain property. As of 1997, it isestimated that the property has a remain-ing useful life of 50 years and a fair mar-ket value of $100 million. BK1 and BK2 arebanks. None of these four parties is re-lated to any of the others.

On January 1, 1997, X and FM enteredinto a LILO transaction under which FMleased the property to X under a “Head-lease,” and X immediately leased the prop-erty back to FM under a “Sublease.” Theterm of the Headlease is 40 years. The pri-mary term of the Sublease is 20 years.Moreover, as described below, the Sub-lease also may be renewed for a term of 10years (“put renewal term”) at the option ofX. X’s right to possess the property under

the Headlease for the first 20 years is sub-stantially the same as FM’s right to pos-session under the Sublease for the primaryterm.

The Headlease requires X to make tworental payments to FM during its 40-yearterm: (1) an $89 million prepayment at thebeginning of year 1; and (2) a postpay-ment at the end of year 40 that has a dis-counted present value of $8 million. Forfederal income tax purposes, X and FM al-locate the prepayment ratably to the first 6years of the Headlease and the future valueof the postpayment ratably to the remain-ing 34 years of the Headlease.

The Sublease requires FM to make fixed,annual rental payments over both the pri-mary term and, if exercised, the put re-newal term. The fixed, annual paymentsduring the put renewal term are equal to 90percent of the amounts that (as of Janu-ary 1, 1997) are projected to be the fairmarket value rental amounts for that term.

To partially fund the $89 million Head-lease prepayment, X borrows $54 millionfrom BK1 and $6 million from BK2. Bothloans are nonrecourse, have fixed interestrates, and provide for annual debt servicepayments that fully amortize the loans overthe 20-year primary term of the Sublease.The amount and timing of the debt ser-

November 4, 2002 760 2002–44 I.R.B.

vice payments mirror the amount and tim-ing of the Sublease payments due duringthe primary term of the Sublease. The re-maining $29 million of the Headlease pre-payment is provided by X.

Upon receiving the $89 million Head-lease prepayment, FM deposits $54 mil-lion into a deposit account with an affiliateof BK1 and $6 million into a deposit ac-count with an affiliate of BK2. The depos-its with the affiliates of BK1 and BK2 earninterest at the same rates as the loans fromBK1 and BK2. FM directs the affiliate ofBK1 to pay BK1 annual amounts equal to90 percent of FM’s annual rent obliga-tion under the Sublease (that is, amountssufficient to satisfy X’s debt service obli-gation to BK1). The parties treat theseamounts as having been paid from the af-filiate to FM, then from FM to X as rentalpayments, and finally from X to BK1 asdebt service payments. In addition, FMpledges the deposit account to X as secu-rity for FM’s obligations under the Sub-lease, while X, in turn, pledges its interestin FM’s pledge to BK1 as security for X’sobligations under the loan from BK1. Simi-larly, FM directs the affiliate of BK2 to payBK2 annual amounts equal to 10 percent ofFM’s annual rent obligation under the Sub-lease (that is, amounts sufficient to sat-isfy X’s debt service obligation to BK2). Theparties treat these amounts as having beenpaid from the affiliate to FM, then from FMto X as rental payments, and finally fromX to BK2 as debt service payments. Al-though FM’s deposit with the BK2 affili-ate is not pledged, the parties understandthat FM will use the account to pay the re-maining 10 percent of FM’s annual rent ob-ligation under the Sublease.

As a result of the foregoing arrange-ment, X’s obligation to make the propertyavailable under the 20-year primary termof the Sublease is completely offset by X’sright to use the property under the Head-lease. X’s obligation to make debt servicepayments on the loans from BK1 and BK2is completely offset by X’s right to re-ceive Sublease rentals from FM. More-over, X’s exposure to the risk that FM willnot make the rent payments is further lim-ited by the arrangements with the affili-ates of BK1 and BK2. In the case of theloan from BK1, X’s economic risk is elimi-nated through the defeasance arrangement.In the case of the $6 million loan from BK2,X’s economic risk, although not elimi-

nated, is substantially reduced through thedeposit arrangement. As a result, neitherbank requires an independent source offunds to make the loans, or bears signifi-cant risk of nonpayment. In short, duringthe primary Sublease term, the transac-tion is characterized by reciprocal and cir-cular obligations that offset one another.

At the end of the Sublease primary term,FM has a fixed-payment option to pur-chase from X the Headlease residual (theright to use the property beyond the Sub-lease primary term subject to the obliga-tion to make the rent postpayment) for afixed exercise price equal to 105 percent ofthe amount that (as of January 1, 1997) isprojected to be the future fair market valueof the Headlease residual. If FM exercisesthe option, the transaction is terminated atthat point, and X receives the exercise priceof the option and is not required to makeany portion of the postpayment due un-der the Headlease. If FM does not exer-cise the option, X may elect to (1) use theproperty itself for the remaining term of theHeadlease, (2) lease the property to an-other person for the remaining term of theHeadlease, or (3) compel FM to lease theproperty for the 10-year put renewal termof the Sublease. If FM does not exercise thefixed-payment option and X exercises its putrenewal option, X will receive rents that areequal to 90 percent of the amounts that are(as of January 1, 1997) projected to be thefair market rents for that term. If the ac-tual fair market rents in 20 years turn outto be less than the amount specified in theput renewal option and FM does not ex-ercise the fixed-payment option, X will beable to compel FM to lease the property forrents that are greater than the then fair mar-ket rental value. Thus, as a practical mat-ter, the fixed-payment option and putrenewal option operate to “collar” the valueof the Headlease residual during the pri-mary term.

In addition, X has nominal exposure toFM’s credit under the fixed-payment op-tion and, if exercised, the put renewal term.At the inception of the transaction, X re-quires FM to invest $15 million of theHeadlease prepayment in highly-rated debtsecurities that will mature in an amount suf-ficient to fund the fixed amount due un-der the fixed-payment option, and to pledgethese debt securities to X. This arrange-ment ensures that FM is able to make thepayment under the fixed-payment option.

Having economically defeased both itsrental obligations under the Sublease andits fixed-payment under the fixed-paymentoption, FM keeps the remaining portion ofthe Headlease prepayment as its return onthe transaction. If FM does not exercise thefixed-payment option and X exercises theput renewal option, X can require FM topurchase a letter of credit guaranteeing theput renewal rents. If FM does not obtain theletter of credit, FM must exercise the fixed-payment option.

For tax purposes, X claims deductionsfor interest on the loans and for the allo-cated rents on the Headlease. X includes ingross income the rents received on the Sub-lease. If the fixed-payment option is exer-cised, X also includes the option price andrecaptures rent deductions taken during theprimary Sublease term that are attribut-able to the postpayment it is no longer re-quired to make.

LAW AND ANALYSIS

X and FM’s allocations of the prepay-ment and the postpayment for federal in-come tax purposes meet the uneven rent testcontained in proposed § 467 regulations(§ 1.467–3(c)(2)(i)), and under those regu-lations the Headlease would not be treatedas a disqualified leaseback or long-termagreement subject to constant rental ac-crual. Because this LILO transaction wasentered into after June 3, 1996, and on orbefore May 18, 1999, the provisions of theproposed regulations are available. See§ 1.467–9(c). For later years, however, fi-nal § 467 regulations effective May 18,1999, treat the prepayment of rent as re-sulting in a deemed loan from X to FM andrequire the imputation of interest income toX. § 1.467–4. Moreover, X’s rent deduc-tion would be subject to proportional rentrules that reflect the time value of moneyconcept. See § 1.467–2(c).

The substance of a transaction, not itsform, governs its tax treatment. Gregory v.Helvering, 293 U.S. 465 (1935). In FrankLyon Co. v. United States, 435 U.S. 561,573 (1978), the United States SupremeCourt stated, “In applying the doctrine ofsubstance over form, the Court has lookedto the objective economic realities of atransaction rather than to the particular formthe parties employed.” The Court evalu-ated the substance of the transaction inFrank Lyon to determine that it was in-deed a sale/leaseback, as it was structured,

2002–44 I.R.B. 761 November 4, 2002

rather than a financing. The Court subse-quently relied on its approach in Frank Lyonto recharacterize a sale and repurchase offederal securities as a loan, finding that theeconomic realities of the transaction did notsupport the form chosen by the taxpayer.Nebraska Dep’t of Revenue v. Loewen-stein, 513 U.S. 123 (1994).

Where parties have in form entered intotwo separate transactions that result in off-setting obligations, the courts often havecollapsed the offsetting obligations and re-characterized the two transactions as a singletransaction. In Rogers v. United States, 281F.3d 1108 (10th Cir. 2002), the part-owner(Fogelman) of a professional baseball teamthat was organized as an S corporation bor-rowed money from the S corporation. Thenonrecourse loan was secured by Fogel-man’s ownership interest in the corpora-tion and his existing option to purchase therest of the shares from the taxpayer (Kauff-man), the other owner of the team. Fogel-man also granted the corporation an optionto purchase both his shares and his exist-ing option to buy Kauffman’s shares. Theoption price was an amount equal to theoutstanding loan balance. The corpora-tion exercised its option immediately but de-ferred closing until the due date ofFogelman’s loan, five months later. On thatdate, Fogelman transferred his shares in thecorporation to the corporation in lieu of itsforeclosure on the loan. The corporationclaimed that the shares had no value at thattime and deducted the loan amount as a baddebt, which was passed through to Kauff-man.

The court in Rogers applied the sub-stance over form doctrine to collapse theloan and the option transaction into a re-demption of Fogelman’s stock in exchangefor cash. Fogelman had no incentive to re-pay the loan because any reduction in theloan balance would reduce the option price.The immediate exercise of the option pre-cluded any attempt by Fogelman to repaythe loan and keep the stock. On the basisof those facts, among others, the court heldthat the substance of the transaction was asale of Fogelman’s stock to the corpora-tion.

In Bussing v. Commissioner, 88 T.C. 449,reconsideration denied, 89 T.C. 1050(1987), a Swiss subsidiary of a computerleasing company (AG) purchased com-puter equipment in a sale/leaseback trans-action involving a five-year lease.

Subsequently, AG purportedly sold theequipment to a domestic corporation(Sutton), which in turn purportedly sold in-terests in the equipment to the taxpayer(Bussing) and four other individual inves-tors. Bussing acquired his interest in thecomputer equipment subject to the under-lying lease by paying cash, short-termpromissory notes, and a long-term prom-issory note to Sutton. Bussing then leasedhis interest in the equipment back to AG fornine years. The rents due Bussing from AGequaled Bussing’s annual payments on thelong-term promissory note to Sutton for thefirst three years and were supposed to gen-erate nominal annual cash flow thereaf-ter.

The court first disregarded Sutton’s par-ticipation in the transactions on substanceover form grounds. It then held thatBussing’s long-term indebtedness also mustbe disregarded because it was completelyoffset by AG’s rent payments in a “pur-ported sale-leaseback pursuant to which therespective lease and debt obligations flowbetween only two parties.” Id. at 458. Thecourt stated,

The respective obligations between AGand Bussing cancel each other out. Anypossible claim by AG with respect to thenote is fully offset by AG’s rental obli-gation to Bussing. . . . Bussing, effec-tively, will never be required to make anypayments on his debt obligation, a fea-ture of the transaction that we believe theparties intended to achieve.

Id. After collapsing the offsetting loan andlease, the court concluded that Bussing hadacquired an interest in a joint venture withAG and the other investors to the extent ofhis cash payment only.

Courts have similarly disregarded theparties’ obligations in purported install-ment sales where the taxpayer received aninstallment note that was offset by someother arrangement between the two par-ties, indicating that the maker of the notewould not be called upon to pay the in-stallment obligation. See Rickey v. Com-missioner, 502 F.2d 748 (9th Cir. 1974),aff ’g 54 T.C. 680 (1970). Although tax-payers are entitled to arrange the terms ofa sale in order to qualify for the install-ment method, “the arrangements must havesubstance and must reflect the true situa-tion rather than being merely the formaldocumentation of the terms of the sale.” Id.at 752–53, quoting 54 T.C. 680 at 694. See

also United States v. Ingalls, 399 F.2d 143(5th Cir. 1968); Blue Flame Gas Co. v.Commissioner, 54 T.C. 584 (1970); Green-field v. Commissioner, T.C. Memo. 1982–617; Big “D” Development Corp. v.Commissioner, T.C. Memo. 1971–148, aff’dper curiam, 453 F.2d 1365 (5th Cir.1972).

Similarly, the Headlease and Subleaseimpose offsetting obligations that must bedisregarded, regardless of whether othercomponents of the LILO transaction are re-spected. During the first 20 years of itsterm, the Headlease confers to X a right touse the property that is immediately re-versed by the Sublease grant to FM of sub-stantially the same right to use property. Inthe LILO transaction, the Sublease inter-est retained by FM is of the same natureas the Headlease interest conveyed to X. Be-cause the transfer and retransfer of the rightto possess the property for the first 20 yearsare disregarded as offsetting obligations, thetransaction that remains is, at best, a trans-fer of funds from X to FM in exchange forFM’s obligation to repay those funds andprovide X the right to begin to lease theproperty in 20 years.

An analogous situation occurs when theconveyance of property is accompanied bythe retention of some interest in the sameproperty. If the interest retained is of sub-stantially the same nature as the interestconveyed, only a future interest is con-veyed. In McCully Ashlock v. Commis-sioner, 18 T.C. 405 (1952), acq., 1952–2C.B. 1, taxpayer had acquired propertythrough a deed dated June 6, 1945. Theseller, however, had retained the right topossession and rentals through August 15,1947. The court found that taxpayer had ac-quired only a future interest in the prop-erty because “the trustees [sellers] not onlyretained the rents legally but they also re-tained control and benefits of ownership.”Id. at 411. Consequently, rentals from theproperty were income to the seller.

Similarly, in Kruesel v. United States,63–2 U.S. Tax Cas. (CCH) ¶ 9714 (D.Minn. 1963), the court concluded that tax-payer had transferred only a future, re-mainder interest in property and reserveda life estate. The government had unsuc-cessfully argued that taxpayer had sold itsentire interest in the property and the tax-payer’s amount realized on the sale in-cluded the value of a right to occupancyprovided to the taxpayer by the buyer.

November 4, 2002 762 2002–44 I.R.B.

In contrast, in Alstores Realty Corp. v.Commissioner, 46 T.C. 363 (1966), acq.,1967–2 C.B.1, the court held that a sale ofproperty accompanied by the reservation ofa right of occupancy did not result in thetransfer of only a future interest because theseller’s right of occupancy was in the na-ture of a leasehold interest, because the pur-chaser acquired the benefits and burdens ofownership of the property.

Alstores can be distinguished fromMcCully Ashlock and Kruesel. McCullyAshlock and Kruesel conclude that wherea retained interest is of the same nature asthe interest conveyed, only a future inter-est has been transferred. In Alstores, the in-terests were not of the same nature.

Similarly, the LILO transaction is dis-tinguishable from the transaction involvedin Comdisco, Inc. v. Commissioner, 756F.2d 569 (7th Cir. 1985). In that case, equip-ment was subject to end user leases, and thelessor of that equipment assigned an inter-est to taxpayer in a transaction designed togive the taxpayer investment tax credits. Thetaxpayer’s entitlement to the credits de-pended on whether it had the status oflessee/sublessor. In concluding that it did,the court noted a number of factors thatsupported taxpayer’s claim that it had ac-quired a leasehold interest. The taxpayerwas obligated to the lessor in the event ofa default by the sublessee. The taxpayer re-let certain equipment after one sublease hadexpired. In connection with another sub-lease, the taxpayer was responsible for rentto its assignor in excess of amounts paid bythe sublessee directly to the assignor. Thecourt also emphasized the regulatory re-strictions on direct leases between the as-signor and the end users. Id. at 576–77.Unlike Comdisco, in the LILO transac-tion the headlessor and the sublessee are thesame party. Further, in the LILO transac-tion the headlessee/sublessor is not mate-rially exposed to the risk that the sublesseewill fail to make rent payments.

Section 162(a)(3) permits a deduction forrentals and other payments required to bemade as a condition to the continued useor possession, for purposes of the trade orbusiness, of property. Because X does notacquire a current leasehold interest in theproperty, it is not entitled to current de-ductions for rent. The $29 million “eq-uity” portion of the Headlease prepaymentis, effectively, a payment for at most X’sright under the Headlease to lease the prop-

erty 20 years hence for a term of 20 years.(Economically, $29 million is an overpay-ment for the value of any right that X ob-tains to lease the property in the future. Xwas willing to overpay in this manner, how-ever, in order to induce FM to participatein the transaction.). In accordance with§ 467, the $29 million “equity” portion ofthe Headlease prepayment is deductible overthe 20-year residual term of the Head-lease (the 10-year put renewal term and the10-year “shirttail” period). Alternatively, inthe event FM exercises its fixed-price op-tion at the end of the primary term of theSublease, X will have gain or loss equal tothe difference between the option price andX’s cost of acquiring a right to the Head-lease residual term. Section 1001.

The remainder of the Headlease pre-payment, $60 million, must be disregarded,because the “loans” that purportedly fi-nance this portion of the Headlease pre-payment are without substance. In Bridgesv. Commissioner, 39 T.C. 1064, aff’d 325F.2d 180 (4th Cir. 1963), taxpayer “bor-rowed” funds from banks and used thefunds to purchase Treasury notes, which thebanks held as collateral and ultimately soldto satisfy taxpayer’s debts. The court’s ra-tionale for disallowing taxpayer’s deduc-tions of prepaid interest is equally applicablehere:

[P]etitioner at no time had the uncon-trolled use of any additional money, of thebonds, or of the interest on the bonds. Heassumed no risk of a rise or fall in themarket price of the bonds and could nottake advantage of such. His payment tothe bank was not for the use or forbear-ance of money; it was for the purchaseof a rigged sales price for the bonds andfor a tax deduction. Petitioner incurred nogenuine indebtedness, within the mean-ing of the statute, and as a payment of in-terest, this transaction was also a sham.

Id. at 1078–79. Neither X nor FM obtainuse of the “borrowed” funds. The “loans”purportedly are made to finance X’s acqui-sition of the Headlease interest. But thatleasehold interest is substantially offset byan interdependent Sublease with the Head-lessor. What remains can only be enjoyedafter 20 years and after the loans have been“repaid” using “rents” from a Sublease thatitself lacks substance. Under the circum-stances, the loans are disregarded.

Although this ruling refers to a for-eign municipality and its property, the analy-

sis and holding apply as well to LILOtransactions that involve or include domes-tic tax-exempt or tax-indifferent entities.

HOLDING

A taxpayer may not deduct currently, un-der §§ 162 and 163, rent or interest paid orincurred in connection with a LILO trans-action that properly is characterized as con-ferring only a future interest in property.

Where appropriate, the Service will con-tinue to disallow the tax benefits claimedin connection with LILO transactions uponother grounds, including that the substanceover form doctrine requires their rechar-acterization as financing arrangements andthat they are to be disregarded for lack ofeconomic substance.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 99–14, 1999–1 C.B. 835, ismodified and superseded.

DRAFTING INFORMATION

The principal author of this revenue rul-ing is John Aramburu of the Office of As-sociate Chief Counsel (Income Tax &Accounting). For further information re-garding this revenue ruling, contact Mr.Aramburu at (202) 622–4960 (not a toll-free call).

Section 163.—Interest

26 CFR 1.162–17: Interest deduction in general.

May a taxpayer deduct currently, under § 163, in-terest paid or incurred in connection with a lease-in/lease-out (LILO) transaction that properly ischaracterized as conferring only a future interest inproperty. See Rev. Rul. 2002–69, page 760.

Section 446.—General Rulefor Methods of Accounting

(Also 26 CFR 1.446–4)

Notional principal contract (NPC).This ruling provides guidance on the tim-ing of recognition of gain or loss on the ter-mination of a notional principal contract thathedges a portion of the term of a debt in-strument issued by the taxpayer.

2002–44 I.R.B. 763 November 4, 2002

Rev. Rul. 2002–71

ISSUE

When should a taxpayer take into ac-count gain or loss on the termination of anotional principal contract (NPC) thathedges a portion of the term of a debt in-strument issued by the taxpayer?

FACTS

Situation 1

Taxpayer TP uses the calendar year asits taxable year. On the first day of Year 1,TP issues a debt instrument. The debt in-strument has a 10-year term and providesfor interest to be paid annually at a fixedrate. Contemporaneously with the issu-ance of the debt instrument, TP also en-ters into an NPC with a 5-year term thatconverts the fixed rate payments under thedebt instrument into floating rate payments.That is, the NPC provides for TP to re-ceive payments equal to the product of thefixed rate on the debt instrument and a no-tional amount equal to the principal amountof the debt instrument in exchange for pay-ments by TP equal to the product of a float-ing rate and the same notional amount.Pursuant to § 1.1221–2(f), TP properly iden-tifies the NPC as a hedging transaction cov-ering Year 1 through Year 5 of the debtinstrument and complies with the other re-quirements necessary for the NPC to betreated as a hedge under §§ 1.1221–2 and1.446–4. TP terminates the NPC on the lastday of Year 2 and either receives or makesa termination payment.

Situation 2

The facts are the same as Situation 1,but, in addition, TP retires the debt instru-ment in Year 4.

LAW

Section 1.446–4(a) provides that a hedg-ing transaction as defined in § 1.1221–2(b) must be accounted for under the rulesset forth in § 1.446–4.

Section 1.446–4(b) provides that themethod of accounting used by a taxpayer

for a hedging transaction must clearly re-flect income. Section 1.446–4(b) furtherprovides that to clearly reflect income, themethod used for a hedging transaction mustreasonably match the timing of income, de-duction, gain, or loss from the hedgingtransaction with the timing of income, de-duction, gain, or loss from the item beinghedged.

Section 1.446–4(e)(4) provides that gainor loss from a transaction that hedges a debtinstrument issued or to be issued by a tax-payer, or a debt instrument held or to beheld by a taxpayer, must be accounted forby reference to the terms of the debt in-strument and the period or periods to whichthe hedge relates. A hedge of an instru-ment that provides for interest to be paidat a fixed rate or a qualified floating rate,for example, generally is accounted for us-ing constant yield principles. Thus, assum-ing that a fixed rate or qualified floating rateinstrument remains outstanding, hedginggain or loss is taken into account in thesame periods in which it would be takeninto account if it adjusted the yield of theinstrument over the term to which the hedgerelates. Section 1.446–4(e)(4) provides, asan example, that gain or loss realized on atransaction that hedged an anticipated fixedrate borrowing for its entire term is ac-counted for, solely for purposes of§ 1.446–4, as if it decreased or increasedthe issue price of the debt instrument. How-ever, in all events, the taxpayer’s method,as actually applied to the taxpayer’s hedg-ing transactions, must clearly reflect in-come by meeting the matching requirementof § 1.446–4(b). See § 1.446–4(e) (intro-ductory sentences).

ANALYSIS

Situation 1

Unlike the hedging transaction describedin § 1.446–4(e)(4) that hedges a fixed rateborrowing over its entire term, TP’s NPCdoes not hedge the entire term of the debtinstrument. Rather, TP’s NPC hedges, andrelates only to, Year 1 through Year 5 of the10-year term of the debt instrument. Priorto its termination on the last day of Year 2,the NPC would have continued to hedgeYear 3 through Year 5 of the debt instru-

ment, and TP generally would have beenrequired to take into account the remain-ing income, deduction, gain, or loss overthe period from Year 3 through Year 5. Thetermination payment made or received byTP represents the present value of the ex-tinguished rights and obligations under theNPC for Year 3 through Year 5. There-fore, the gain or loss from the hedgingtransaction relates to Year 3 through Year5. To clearly reflect income in accordancewith the matching requirement of § 1.446–4(b), TP must take into account the gain orloss from terminating the NPC over the pe-riod from Year 3 through Year 5.

Situation 2

Following the analysis from Situation 1,TP would have already taken into accountin Year 3 a portion of the gain or loss fromtermination of the NPC in Year 2. How-ever, upon retiring the debt instrument inYear 4, TP’s remaining gain or loss fromthe termination of the NPC should be rec-ognized in order to match the timing of in-come, deduction, gain, or loss from thehedging transaction with the timing of in-come, deduction, gain, or loss from the itembeing hedged.

HOLDING

(1) In Situation 1, TP must account forthe gain or loss arising from terminating theNPC over the period from Year 3 throughYear 5, the remaining period to which theterminated hedge relates.

(2) In Situation 2, TP takes into ac-count in Year 3 a portion of the gain or lossarising from the termination of the NPC andtakes into account in Year 4 the remain-ing balance of the gain or loss from the ter-minated hedge.

DRAFTING INFORMATION

The principal authors of this revenue rul-ing are K. Scott Brown and ClayLittlefield of the Office of Associate ChiefCounsel (Financial Institutions and Prod-ucts). For further information regarding thisrevenue ruling, contact Messrs. Brown orLittlefield at (202) 622–3920 (not a toll-free call).

November 4, 2002 764 2002–44 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous

Certain ReinsuranceArrangements

Notice 2002–70

The Internal Revenue Service and Trea-sury Department have become aware of atype of transaction, described below, thatis being used by taxpayers to shift incomefrom taxpayers to related companies pur-ported to be insurance companies that aresubject to little or no U.S. federal incometax. This notice alerts taxpayers and theirrepresentatives that these transactions of-ten do not generate the federal tax ben-efits that taxpayers claim are allowable forfederal income tax purposes. This noticealso alerts taxpayers, their representatives,and promoters of these transactions, to cer-tain reporting and record keeping obliga-tions and penalties that they may be subjectto with respect to these transactions.

The transaction generally involves a tax-payer (“Taxpayer”) (typically a service pro-vider, automobile dealer, lender, or retailer)that offers its customers the opportunity topurchase an insurance contract through Tax-payer in connection with the products orservices being sold. The insurance pro-vides coverage for repair or replacementcosts if the product breaks down or is lost,stolen, or damaged, or coverage for the cus-tomer’s payment obligations in case the cus-tomer dies, or becomes disabled orunemployed.

Taxpayer offers the insurance to its cus-tomers by acting as an insurance agent foran unrelated insurance company (“Com-pany X”). Taxpayer receives a sales com-mission from Company X equal to apercentage of the premiums paid by Tax-payer’s customers. Taxpayer forms awholly-owned corporation (“Company Y”),typically in a foreign country, to reinsurethe policies sold by Taxpayer. Promoterssometimes refer to these companies as pro-ducer owned reinsurance companies or“PORCs”. If Company Y is a foreign cor-poration, it typically elects to be treated asa domestic insurance company under§ 953(d) of the Internal Revenue Code.Company Y takes the position that it is en-titled to the benefits of § 501(c)(15) (pro-viding that non-life insurance companies aretax exempt if premiums written for the tax-

able year do not exceed $350,000), § 806(providing a deduction for certain life in-surance companies with life insurance com-pany taxable income not in excess of$15,000,000), or § 831(b) (allowing quali-fying non-life insurance companies whosenet written premiums are between $350,000and $1,200,000 to elect to be taxed solelyon investment income).

Taxpayer receives premiums from itscustomers and remits those premiums (typi-cally net of its sales commission) to Com-pany X. Company X pays any claims andstate premium taxes due and retains anamount from the premiums received fromTaxpayer. Under Company Y’s reinsur-ance agreement with Company X, Com-pany Y reinsures all insurance policies thatTaxpayer sells to its customers. CompanyX transfers the remainder of the premi-ums to Company Y as reinsurance premi-ums.

ANALYSIS

Many of the transactions described inthis notice have been designed to use a re-insurance arrangement to divert incomeproperly attributable to Taxpayer to Com-pany Y, Taxpayer’s wholly-owned reinsur-ance company that is subject to little or nofederal income tax. The Service intends tochallenge the purported tax benefits fromthese transactions on a number of grounds.

First, depending upon the facts and cir-cumstances, the Service may assert thatCompany Y is not an insurance companyfor federal income tax purposes. For fed-eral income tax purposes, an insurance com-pany is a company whose primary andpredominant business activity during thetaxable year is the issuing of insurance orannuity contracts or the reinsuring of risksunderwritten by insurance companies.§ 1.801–3(a) of the Income Tax Regula-tions; § 816(a) (which provides that a com-pany will be treated as an insurancecompany for federal income tax purposesonly if “more than half of the business” ofthat company is the issuing of insurance orannuity contracts or the reinsuring of risksunderwritten by insurance companies).While a taxpayer’s name, charter powers,and state regulation help to indicate the ac-tivities in which it may properly engage,whether the taxpayer qualifies as an insur-ance company for tax purposes depends on

its actual activities during the year. Inter-American Life Ins. Co. v. Commissioner, 56T.C. 497, 506–08 (1971), aff ’d per cu-riam, 469 F.2d 697 (9th Cir. 1972) (tax-payer whose predominant source of incomewas from investments did not qualify as aninsurance company); see also Bowers v.Lawyers Mortgage Co., 285 U.S. 182, 188(1932). To qualify as an insurance com-pany, a taxpayer “must use its capital andefforts primarily in earning income from theissuance of contracts of insurance.” In-dus. Life Ins. Co. v. United States, 344 F.Supp. 870, 877 (D. S.C. 1972), aff’d percuriam, 481 F.2d 609 (4th Cir. 1973). Todetermine whether Company Y qualifies asan insurance company, all of the relevantfacts will be considered, including but notlimited to, the size and activities of anystaff, whether Company Y engages in othertrades or businesses, and its sources of in-come. See generally Lawyers Mortgage Co.at 188–90; Indus. Life Ins. Co., at 875–77; Cardinal Life Ins. Co. v. United States,300 F. Supp. 387, 391–92 (N.D. Tex. 1969),rev’d on other grounds, 425 F. 2d 1328 (5thCir. 1970); Serv. Life Ins. Co. v. UnitedStates, 189 F. Supp. 282, 285–86 (D. Neb.1960), aff’d on other grounds, 293 F.2d 72(8th Cir. 1961); Inter-Am. Life Ins. Co., at506–08 ; Nat’l. Capital Ins. Co. of the Dist.of Columbia v. Commissioner, 28 B.T.A.1079, 1085–86 (1933).

If Company Y is not an insurance com-pany, it is not entitled to the benefits of§§ 501(c)(15), 806, or 831(b). Further, ifCompany Y is a foreign corporation and isnot an insurance company, any electionCompany Y made under § 953(d) is notvalid and Company Y will be treated as acontrolled foreign corporation as defined in§ 957. In such a case, Taxpayer will betreated as a U.S. shareholder of CompanyY and generally will include in its gross in-come on a current basis any subpart F in-come of Company Y. See § 951(a) and (b).In addition, Company Y will not qualify forthe exceptions from subpart F income un-der §§ 953(a)(2) and 954(i) for certain in-surance income because those exceptionsare only available to a foreign corpora-tion that, among other requirements, is en-gaged in the insurance business and wouldbe subject to tax under subchapter L if suchcorporation were a domestic corporation.See § 953(e)(3)(C).

2002–44 I.R.B. 765 November 4, 2002

Second, the Service may apply §§ 482or 845 to allocate income from CompanyY to Taxpayer if necessary clearly to re-flect the income of Taxpayer and Com-pany Y. Section 482 provides the Secretarywith authority to allocate gross income, de-ductions, credits or allowances among per-sons owned or controlled directly orindirectly by the same interests, if such al-location is necessary to prevent evasion oftaxes or clearly to reflect income. The § 482regulations provide that in determining thetaxable income of a controlled person, thestandard to be applied is that of a persondealing at arm’s length with an uncon-trolled person. § 1.482–1(b)(1). Section 482may apply to a transaction between two ormore controlled persons notwithstandingthat an uncontrolled person participates inthe transaction as an intermediary. See GACProduce Co. v. Commissioner, T.C.M.1999–134. If, as a result of the reinsur-ance transaction, Taxpayer’s income is notconsistent with the arm’s length standard,then § 482 authorizes the Secretary to al-locate income from Company Y to Tax-payer. Section 845(a) allows the Service toreallocate income, deductions, assets, re-serves, credits, and other items between twoor more related parties who are parties toa reinsurance agreement. Thus, such itemsmay be reallocated from Company Y toTaxpayer under the authority of § 845(a).

Third, in appropriate cases, the Ser-vice may disregard the insurance and re-insurance arrangements, and thereby requireTaxpayer to recognize an additional por-tion of premiums received from its cus-tomers as its income, if the arrangementsare shams in fact or shams in substance. SeeKirchman v. Commissioner, 862 F.2d 1486,1492 (11th Cir. 1989). Courts have distin-guished between “shams in fact” where thereported transactions never occurred and“shams in substance” which actually oc-curred but lack the substance their form rep-resents. ACM Partnership v. Commissioner,157 F.3d 231, 247 n. 30 (3d Cir. 1998), cert.denied, 526 U.S. 1017 (2002) (citationsomitted). In determining whether a trans-action constitutes a sham in substance, botha majority of the Courts of Appeals and theTax Court consider two related factors, eco-nomic substance apart from tax conse-quences, and business purpose. See ACMPartnership; Karr v. Commissioner, 924F.2d 1018, 1023 (11th Cir. 1991), cert. de-nied, 502 U.S. 1082 (1992); James v. Com-

missioner, 899 F.2d 905, 908–09 (10th Cir.1990); Shriver v. Commissioner, 899 F.2d724, 727 (8th Cir. 1990); Rose v. Commis-sioner, 868 F.2d 851, 853 (6th Cir. 1989);Kirchman. Although a taxpayer has the rightto arrange its affairs to reduce its tax li-ability, the substance of a transaction mustgovern its tax consequences regardless ofthe form in which the transaction is cast.See Gregory v. Helvering, 293 U.S. 465,469 (1935). If the transactions involvingTaxpayer, Company X, and Company Y aredisregarded, the income of Company Y isincome of Taxpayer. See Wright v. Com-missioner, T.C.M. 1993–328.

Transactions that are the same as, or sub-stantially similar to, the transaction de-scribed in this notice that involve taxpayersclaiming entitlement to the benefits of§§ 501(c)(15), 806, or 831(b) are identi-fied as “listed transactions” for purposes of§ 1.6011–4T(b)(2) of the temporary In-come Tax Regulations and § 301.6111–2T(b)(2) of the temporary Procedure andAdministration Regulations. See also§ 301.6112–1T, A–4. Independent of theirclassification as “listed transactions” for pur-poses of §§ 1.6011–4T(b)(2) and 301.6111–2T(b)(2), transactions that are the same as,or substantially similar to, the transactiondescribed in this notice may already be sub-ject to the disclosure requirements of§ 6011, the tax shelter registration require-ments of § 6111, or the list maintenance re-quirements of § 6112 (§§ 1.6011–4T,301.6111–1T, 301.6111–2T and 301.6112–1T, A–3 and A–4).

Persons who are required to satisfy theregistration requirement of § 6111 with re-spect to the transactions described in thisnotice and who fail to do so may be sub-ject to the penalty under § 6707(a). Per-sons who are required to satisfy the list-keeping requirement of § 6112 with respectto the transactions described in this no-tice and who fail to do so may be subjectto the penalty under § 6708(a). In addi-tion, the Service may impose penalties onparticipants in these transactions or sub-stantially similar transactions involving tax-payers claiming entitlement to the benefitsof §§ 501(c)(15), 806, or 831(b) or, as ap-plicable, on persons who participate in thepromotion or reporting of such transac-tions, including the accuracy-related pen-alty under § 6662, the return preparerpenalty under § 6694, the promoter pen-

alty under § 6700, and the aiding and abet-ting penalty under § 6701.

The principal authors of this notice areJohn Glover of the Office of AssociateChief Counsel (Financial Institutions andProducts) and Theodore Setzer and SheilaRamaswamy of the Office of AssociateChief Counsel (International). For furtherinformation regarding this notice, contactMr. Glover at (202) 622–3970 orMr. Setzer or Ms. Ramaswamy (202) 622–3870 (not a toll-free call).

November 4, 2002 766 2002–44 I.R.B.

Part IV. Items of General Interest

Notice of ProposedRulemaking and Notice ofPublic Hearing

Electing Mark to Market forMarketable Stock

REG–112306–00

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposedrulemaking and notice of public hearing.

SUMMARY: This document contains pro-cedures for certain United States personsholding marketable stock in a passive for-eign investment company (PFIC) to electmark to market treatment for that stock un-der section 1296 and related provisions ofsections 1291 and 1295. These proposedregulations affect United States personsowning marketable stock in a PFIC. Thisdocument also provides notice of a pub-lic hearing on these proposed regulations.

DATES: Written comments and outlines oforal comments to be presented at the pub-lic hearing scheduled for November 6, 2002,at 10 a.m., must be received by October 16,2002.

ADDRESSES: Send submissions to:CC:IT&A:RU (REG–112306–00), room5226, Internal Revenue Service, POB 7604,Ben Franklin Station, Washington, DC20044. In the alternative, submissions maybe hand delivered between the hours of8 a.m. and 5 p.m. to: CC:IT&A:RU (REG–112306–00), Courier’s Desk, Internal Rev-enue Building, 1111 Constitution Avenue,NW, Washington, DC. Alternatively, tax-payers may submit comments electroni-cally directly to the IRS Internet site at:www.irs.gov/regs. The public hearing willbe held in room 4718, Internal RevenueService Building, 1111 Consitiution Av-enue, NW, Washington, DC.

FOR FURTHER INFORMATIONCONTACT: Concerning the regulations,Mark Pollard at (202) 622–3850, concern-ing submissions and the hearing, Ms. Lanita

Vandyke (202) 622–7180 (not toll-free num-bers).

SUPPLEMENTARY INFORMATION:

Background

Since the enactment of the Tax ReformAct of 1986, United States persons that ownPFIC stock have been subject to two al-ternative tax regimes: the interest chargerules under section 1291 of the InternalRevenue Code (Code) and the qualifiedelecting fund (QEF) rules under section1293. Congress recognized that the inter-est charge rules are a substantial source ofcomplexity for PFIC shareholders and thatsome shareholders would prefer the cur-rent inclusion method afforded by the QEFregime, but are unable to obtain the nec-essary information from the PFIC. See H.R.Rep. No. 105–148, at 533 (1997); S. Rep.No. 105–33 at 94 (1997). Accordingly, Con-gress enacted new section 1296 in the Tax-payer Relief Act of 1997 to provideshareholders with an alternative method toinclude income currently with respect totheir interest in a PFIC by allowing themto elect to mark to market their PFIC stockprovided the stock is marketable. In 1998,Congress enacted certain technical correc-tions to section 1296 and related provi-sions, including rules to address the overlapbetween the PFIC and other mark to mar-ket provisions in the Code. IRS Restruc-turing and Reform Act of 1998, section6011(c).

Proposed § 1.1291–8 (INTL–656–87,1992–1 C.B. 1124) had been published onApril 1, 1992 (57 FR 11024). This pro-posed regulation would have provided anelection for certain regulated investmentcompanies (RICs) to use a mark to mar-ket method for their PFIC stock. Although§ 1.1291–8 was originally proposed to beeffective prospectively, the IRS subse-quently notified taxpayers that the pro-posed regulations, when finalized, wouldpermit this limited mark to market elec-tion to be made only for taxable years end-ing after March 31, 1992, and before April1, 1993. Notice 92–53, 1992–2 C.B. 384.As a result of the enactment of section1296, proposed § 1.1291–8 was withdrawn(64 FR 5015); see also Notice 99–14,1999–1 C.B. 736.

On January 25, 2000, final regulationswere published under section 1296(e) (2000final regulations). T.D. 8867, 2000–1 C.B.620 [65 FR 3817]. The 2000 final regula-tions provide guidance regarding the defi-nition of marketable stock for purposes ofsection 1296.

In General

United States persons who own market-able stock (as defined in section 1296(e))in a PFIC may elect to mark to market thatstock annually pursuant to section 1296(section 1296 election). United States per-sons making a section 1296 election withrespect to PFIC stock (section 1296 stock)are not subject to the generally applicableinterest charge regime of section 1291. Thesection 1296 election is available to UnitedStates persons and controlled foreign cor-porations (CFCs) that own, or are treatedas owning, marketable stock in a PFIC.

Explanation of Provisions

A. Changes to Proposed § 1.1291–1(c):Coordination of PFIC Rules and otherMark to Market Provisions

Except for the coordination rules dis-cussed herein, section 1291(d)(1) providesthat the interest charge regime does not ap-ply in the case of PFIC stock that is markedto market under (i) section 1296, or (ii) sec-tion 475 or any other provision of chap-ter 1 of the Code. This regulation revises§ 1.1291–1(c), 57 FR 11024, proposed April1, 1992, to incorporate this coordination ruleand to clarify that the interest charge re-gime does not apply to a United States per-son that marks to market its PFIC stockunder any provision of chapter 1 of theCode, without regard to whether such re-gime is mandatory or elective. Proposed§ 1.1295–1(i)(3) and proposed § 1.1296–1(h)(3)(i) further clarify that, with respectto taxation under a mark to market provi-sion other than under section 1296, this co-ordination rule applies without regard towhether the taxpayer also has made a sec-tion 1296 election or a QEF election withrespect to such stock, by providing that ei-ther election is automatically terminated im-mediately following the close of thetaxpayer’s taxable year preceding the firsttaxable year for which the stock of the PFIC

2002–44 I.R.B. 767 November 4, 2002

is subject to the mark to market regime un-der another provision of chapter 1 of theCode.

The proposed regulations also providea special rule for situations where a tax-payer owns PFIC stock that becomes sub-ject to a mark to market regime other thansection 1296 after the first taxable year ofthe taxpayer’s holding period. In such in-stances, the taxpayer must apply the coor-dination rules of § 1.1291–1(c)(3)(ii) for thefirst taxable year that such other mark tomarket regime applies. Thereafter, the gen-eral rule above, overriding the applica-tion of the section 1291, QEF and PFICmark to market regimes, applies for all sub-sequent taxable years provided that thePFIC stock continues to be marked to mar-ket under another provision of chapter 1 ofthe Code.

B. Changes to § 1.1295–1

1. Revocation of QEF election

The proposed regulations also provideguidance on the coordination of the markto market provisions under section 1296with the existing rules for QEFs. In gen-eral, the Service considered the circum-stances in which a taxpayer would bepermitted to switch from one regime to an-other in light of the relative administra-tive burdens imposed under each set ofrules, and the stated intent of Congress thatone of the purposes for enacting section1296 was to provide another alternative tothe interest charge rules of section 1291 thatwould be available in instances where tax-payers cannot obtain sufficient informa-tion to make a QEF election. See H.R. Rep.No. 105–148, at 533 (1997); S. Rep. No.105–33 at 94 (1997). Accordingly, the pro-posed regulations are structured to facili-tate an election for mark to market treatmentby permitting a taxpayer with an existingQEF election to make a section 1296 elec-tion and terminate the existing QEF elec-tion without requiring consent of theCommissioner. In instances where a tax-payer has an existing section 1296 elec-tion, it is permitted to make a QEF electiononly if the section 1296 election is termi-nated as provided by section 1296 and theregulations thereunder (e.g., if the PFICstock ceases to be marketable) or is re-voked with consent of the Commissioner.

2. Re-election of QEF regime

The proposed regulations further pro-vide that if the section 1296 election is sub-sequently terminated or revoked, other thanbecause the taxpayer marks to market un-der another provision of the Code, (e.g., be-cause the stock is no longer marketable),the shareholder will be subject to tax un-der section 1291, unless a new QEF elec-tion is made. Section 1.1295–1(i)(4)currently provides that without the Com-missioner’s consent, a shareholder whoseQEF election was invalidated, terminated,or revoked may not make a new QEF elec-tion with respect to the PFIC before thesixth taxable year ending after the tax-able year in which the invalidation, termi-nation, or revocation became effective. Theregulations propose to amend § 1.1295–1(i) to provide an exception for situationswhere a United States person’s QEF elec-tion was terminated because it elected tomark to market such stock under section1296, and the 1296 election was subse-quently terminated because the stock ceasedto be marketable. A similar exception is pro-vided for situations where a United Statesperson’s QEF election is terminated be-cause its PFIC stock is marked to marketunder another provision of chapter 1 of theCode, and such provision subsequentlyceases to apply. In either circumstance, con-sent of the Commissioner will not be re-quired for the United States person to re-elect QEF status prior to the sixth taxableyear ending after the taxable year that itsQEF election was terminated. In situa-tions where a QEF election is terminatedbecause a United States person makes a sec-tion 1296 election, and then this election ter-minates for some reason other than thestock ceasing to be marketable (e.g., pur-suant to the consent of the Commissionerunder proposed § 1.1296–1(h)(3)(A)), a tax-payer may request consent under § 1.1295–1(i) to make a new QEF election prior tosuch sixth taxable year.

Special issues arise in situations wherea taxpayer makes a QEF election with re-spect to stock that was previously markedto market under section 1296 (or where ataxpayer re-elects QEF treatment after a ter-mination of mark-to-market treatment). Insuch situations, the taxpayer shifts from an-nual inclusions under the mark to marketrules that are based on the amount of un-realized gain (or loss) in the stock of thePFIC, to annual inclusions of a pro rata

share of the ordinary earnings and long-term capital gain of a PFIC under the QEFrules. For example, unrealized items thatwere reflected in annual mark to market in-clusions could be taken into account sub-sequently under the QEF rules whenrealized. These issues presently are ad-dressed through the respective basis ad-justments provided for under the QEF andmark to market rules. See sections 1293(d)and 1296(b). Comments are requested onpossible alternative approaches for address-ing this situation with a view toward en-suring administrability and avoidingadditional complexity.

C. Addition of § 1.1296–1

1. Effect of election

The proposed regulations provide that,on the last day of a taxable year to whicha section 1296 election applies, the UnitedStates person recognizes gain to the ex-tent that the fair market value of section1296 stock exceeds its adjusted basis. Anysuch gain shall be treated as ordinary in-come. To the extent that the adjusted ba-sis of section 1296 stock exceeds its fairmarket value, the United States person maytake a deduction equal to the lesser of theamount of such excess or the unreversed in-clusions with respect to such stock. Anysuch deduction will be treated as an ordi-nary loss.

Under former proposed § 1.1291–8, cer-tain RICs were permitted to mark to mar-ket PFIC stock. For RICs that elect to markto market their PFIC stock under section1296, the unreversed inclusions includeamounts that were included in gross in-come under former proposed § 1.1291–8with respect to that stock for prior tax-able years. See Notice 92–53, 1992–2 C.B.384.

The proposed regulations also addressthe application of section 1296 in taxableyears in which the foreign corporation hasceased to be a PFIC under section 1297(a),and is not treated as a PFIC under sec-tion 1298(b)(1) (the once a PFIC, alwaysa PFIC rule). The proposed regulationsclarify that there will be no mark to mar-ket inclusions or deductions for taxableyears in which the foreign corporation is nota PFIC. The suspension of mark to mar-ket treatment while the foreign corpora-tion is not a PFIC is consistent with§ 1.1295–1(c)(2)(ii), which provides that ashareholder that has made a QEF election

November 4, 2002 768 2002–44 I.R.B.

with respect to stock of a foreign corpo-ration is not required to include its pro ratashare of ordinary income and capital gainsunder section 1293 for years in which theforeign corporation is not a PFIC.

In order to accomplish this suspensionof mark to market treatment, the proposedregulations start a new holding period, forall purposes of the PFIC rules, in stock thatis marked to market under section 1296 be-ginning on the first day of the first tax-able year beginning after the last taxableyear for which section 1296 applied. Ac-cordingly, prior periods during which theforeign corporation was a PFIC, but forwhich the shareholder had a section 1296election in effect, are not included in suchshareholder’s holding period for purposesof applying section 1298(b)(1).

Cessation of a foreign corporation’s sta-tus as a PFIC will not, however, termi-nate a section 1296 election (although ashareholder may request consent of theCommissioner to revoke the election in suchinstance, as discussed below). Thus, if theforeign corporation once again becomes aPFIC in any taxable year after a year inwhich it is not treated as a PFIC, the share-holder’s original section 1296 election con-tinues to apply and the shareholder mustmark to market the PFIC stock for suchyear.

2. Adjustment to basis

The proposed regulations provide that aUnited States person will increase the ad-justed basis of its section 1296 stock by theamount of mark to market gain recognized.Conversely, if the United States person isentitled to a deduction under this section,the adjusted basis of its section 1296 stockis decreased by the amount of such deduc-tion.

If a United States person owns section1296 stock through a foreign partnership,foreign trust, or foreign estate, the basisrules apply to both the United States per-son and the entity or entities through whichthe United States person is considered toown the stock. The increase or decrease inthe adjusted basis of the stock in the handsof the foreign partnership, foreign trust, orforeign estate will be solely attributable tothe electing United States person (in a man-ner similar to an adjustment under sec-tion 743(b)), and will apply only forpurposes of determining the subsequent U.S.income tax treatment of the United States

person with respect to such stock. The IRSconsidered imposing reporting and recordkeeping requirements on the foreign enti-ties to track the adjustments to the ad-justed basis of any section 1296 stock theyheld directly or indirectly. The IRS de-cided not to adopt this approach in the pro-posed regulations because one of themotivations for the enactment of section1296 was to provide an alternative tax re-gime to section 1291 for taxpayers thatcould not obtain sufficient information froma PFIC to make a QEF election. Com-ments are requested about other approachesfor satisfying the compliance obligations ofU.S. persons making a section 1296 elec-tion and the intervening entity or entitiesthrough which such stock is owned.

The taxpayer and the entity throughwhich the taxpayer owns section 1296 stockmay have different taxable years. Consis-tent with the general approach of sections706(a), 652(c), and 662(c), a United Statesperson who owns stock in a PFIC throughany foreign partnership, foreign trust, or for-eign estate determines the mark to mar-ket gain or mark to market loss withreference to the last day of the taxable yearof the foreign partnership, foreign trust orforeign estate and then includes that gainor loss in the taxable year of such UnitedStates person that includes the last day ofthe taxable year of the entity.

Finally, if PFIC stock is acquired froma decedent by bequest, devise, or inherit-ance (or by the decedent’s estate) and amark to market election was in effect on thedecedent’s date of death, the adjusted ba-sis of such stock in the hands of the re-cipient will be equal to the lesser of thebasis determined under section 1014 or theadjusted basis of the stock in the hands ofthe decedent immediately prior to his or herdeath.

3. Rule for individuals that becomesubject to United States income taxation

The proposed regulations provide that ifany individual becomes a United States per-son in a taxable year beginning after De-cember 31, 1997, the adjusted basis (beforeany adjustments resulting from the mark tomarket election are made) of any stock ina PFIC owned by such individual on thefirst day of such taxable year shall betreated as being the greater of its fair mar-ket value on such first day or its adjustedbasis on such first day. This special rule for

determining the taxpayer’s adjusted basiswill apply only for purposes of section 1296and the regulations thereunder. Accord-ingly, any gain or loss recognized on thedisposition of section 1296 stock that is at-tributable to the period before the indi-vidual became a United States person willbe subject to the general rules of the Code,including any limitation on the deductibil-ity of a loss, for example, under section1211.

4. Indirect ownership of PFIC stock

Except as discussed below in the caseof eligible RICs, the proposed regulationsapply the specific attribution rules of sec-tion 1296(g) in determining whether PFICstock is considered owned by a taxpayer forpurposes of section 1296 and, therefore,with respect to which the taxpayer is per-mitted to make a section 1296 election.Thus, a United States person will be per-mitted to make a section 1296 election withrespect to stock owned through a foreignpartnership, foreign trust, or foreign es-tate. In general, stock owned by or for suchentities will be considered as being ownedproportionately by its partners or benefi-ciaries. For purposes of this rule, stockowned, directly or indirectly, by or for a for-eign trust described in sections 671 through679, shall be considered as being ownedproportionately by its grantors or other per-sons treated as owners under sections 671through 679 of any portion of the trust thatincludes the stock.

The section 1296(g) attribution rules donot attribute ownership through foreign cor-porations. Accordingly, a United States per-son will not be permitted to make a section1296 election with respect to stock ownedindirectly through a foreign corporation.However, as discussed below, in instanceswhere the foreign corporation is a CFC, theforeign corporation is permitted to make asection 1296 election directly.

Special attribution rules for eligible RICsare provided in § 1.1296(e)–1(f). There isa different attribution rule for RICs be-cause section 1296(e)(2), which provides aspecial rule for RICs, states that stockowned, directly or indirectly, by the RIC,without reference to the ownership attri-bution rules in section 1296(g), shall betreated as marketable stock. This approachis consistent with former proposed§ 1.1291–8, which permitted certain RICsto mark to market PFIC stock that it owned

2002–44 I.R.B. 769 November 4, 2002

directly or indirectly.An issue not addressed in these pro-

posed regulations is the treatment of cer-tain situations involving multiple tiers ofPFICs. For example, assume a United Statesperson owns marketable stock in a PFIC,that itself owns stock in a second PFIC, theownership of which is attributable to theUnited States person under section1298(a)(2). If the United States personmakes a section 1296 election with re-spect to stock of the upper-tier PFIC, theannual mark to market inclusions of in-come under section 1296 will be based onthe fair market value of the upper-tier PFICstock, whose value should reflect the valueof the lower-tier PFIC, as such stock is anasset of the upper-tier PFIC. However, un-der current law, the United States personcontinues to be subject to taxation with re-spect to its indirect ownership of the lower-tier PFIC under section 1291 on any excessdistributions from the lower-tier PFIC orgain from an indirect disposition of thelower-tier PFIC stock (although the con-sequences from the tiered ownership maybe ameliorated by adjustments to the ba-sis of the upper-tier PFIC stock). See pro-posed §§ 1.1291–2(f), and 1.1291–3(e).Similar issues arise if the United States per-son makes a QEF election with respect tothe lower-tier PFIC. Comments are re-quested regarding coordination rules or otheradjustments that may be appropriate to ad-dress this situation and similar structures in-volving a United States person that ownsstock directly and indirectly in tiers ofPFICs.

5. Treatment of CFCs as United Statespersons

A CFC that owns PFIC stock is treatedas a United States person for purposes ofsection 1296 and, as noted above, is per-mitted to make a section 1296 election di-rectly. If a section 1296 election is madewith respect to PFIC stock owned by a CFCdirectly, or treated as owned by a CFC ap-plying the section 1296(g) attribution rules,then any mark to market gains are includedin the gross income of the CFC as for-eign personal holding company income un-der section 954(c)(1)(A) and any mark tomarket losses are treated as deductions al-locable to such foreign personal holdingcompany income for purposes of comput-ing net foreign base company income un-der § 1.954–1(c).

Under the proposed regulations, if a sec-tion 1296 election is made for a CFC withrespect to its PFIC stock, the PFIC rules donot also apply separately to any UnitedStates shareholder, as defined in section951(b), with respect to its pro rata share ofthe PFIC stock held by the CFC. Instead,the United States shareholder generally willrecognize the mark to market gain as an in-clusion of income under section 951(a).Thus, United States shareholders of CFCsare appropriately excluded from the appli-cation of section 1291 if a section 1296election is made by the CFC. This rule,however, does not apply to United Statespersons who own stock of the CFC but arenot United States shareholders within themeaning of section 951(b). Those UnitedStates persons continue to be subject to thePFIC provisions with respect to the stockof such foreign corporation, and may availthemselves of a QEF election. This rule isconsistent with the CFC/PFIC overlap rulein section 1297(e), which eliminates the ap-plication of the PFIC provisions solely forUnited States shareholders of the entity thatis both a PFIC and a CFC. Finally, com-ments are requested about whether simi-lar rules should apply to United Statespersons that are United States sharehold-ers of a CFC solely by application of sec-tion 953(c)(1)(A).

6. Elections

The proposed regulations provide that aUnited States person may make a section1296 election for a taxable year begin-ning after December 31, 1997, by the duedate (including extensions) of the UnitedStates person’s federal income tax return.The proposed regulations further providethat a section 1296 election of a CFC ismade by its controlling United States share-holders by the due date (including exten-sions) of their federal income tax returnsin accordance with the general rules forelections by a CFC under § 1.964–1(c)(5).

The proposed regulations provide that asection 1296 election applies to the year forwhich made and to each succeeding yearunless the election is terminated or re-voked. A section 1296 election automati-cally terminates when (i) the PFIC stockceases to be marketable, or (ii) when thePFIC stock is marked to market under an-other provision of chapter 1 of the Code.A section 1296 election also may be re-voked with the consent of the Commis-

sioner. Such consent will only be granted,however, upon a showing of a substantialchange in circumstances. Similar rules ap-ply in the case of the revocation of a QEFelection.

7. Coordination rules for first year ofelection

Finally, the proposed regulations pro-vide coordination rules that apply to the firsttaxable year to which section 1296 ap-plies. A United States person (other than aRIC) whose holding period includes a pe-riod when the foreign corporation was aPFIC and for which a QEF election had notbeen made generally will be subject to sec-tion 1291 in the year of the election andsubject to section 1296 in subsequent years.Special rules also apply to RICs for the firstyear in which a section 1296 election ap-plies.

D. Changes to § 1.1296(e)–1(b)

As discussed above, a section 1296 elec-tion is only available for marketable stockof a PFIC. Section 1296(e) defines mar-ketable stock to include any stock which isregularly traded on certain securities ex-changes or other markets. The 2000 finalregulations provide guidance regarding thedefinition of marketable stock for pur-poses of section 1296. In particular, the2000 final regulations define regularlytraded for these purposes to require that aclass of stock be traded on at least 15 daysduring each calendar quarter for any cal-endar year. Taxpayers have noted that thisrule would exclude stock issued as a re-sult of an initial public offering (IPO) fromqualifying as marketable stock for the yearof issuance in many instances (e.g., stockissued through a public offering occur-ring other than during the first quarter ofthe year). Therefore, these regulations pro-pose modifying the current rule in such in-stances.

The proposed regulations provide that thestock issued in a public offering will qualifyas regularly traded if the stock is traded onone or more qualified exchanges or othermarkets, other than in de minimis quanti-ties, on 1/6 of the days remaining in thequarter in which the offering occurs, andon at least 15 days during each remain-ing quarter of the calendar year. If the pub-lic offering occurs in the fourth quarter ofthe calendar year, the stock will qualify asregularly traded if it is traded on such ex-

November 4, 2002 770 2002–44 I.R.B.

changes or markets, other than in de mini-mis quantities, on the greater of 1/6 of thedays remaining in the quarter in which theoffering occurs, or 5 days. The proposedregulations also modify the anti-abuse rulein § 1.1296(e)–1(b)(2) to apply to thesechanges to the definition of regularly traded.

E. Amendment of § 1.6031(a)–1

In general, a foreign partnership that hasU.S. source income is required to file a U.S.Federal income tax return pursuant to§ 1.6031(a)–1(b)(1). An issue arises whethera filing obligation is created on behalf ofa foreign partnership where a U.S. part-ner of the foreign partnership makes a sec-tion 1296 election with respect to the U.S.partner’s share of the PFIC stock held bythe partnership. The income of the part-ner arising as a result of the section 1296election generally will be U.S. source. Seesections 1296(c)(2) and 865(a), (i)(5). Theproposed regulations resolve this issue bymodifying § 1.6031(a)–1(b)(1) such that aforeign partnership will not be required tofile a partnership return if the only rea-son for filing a return, but for this specialrule, would be U.S. source income result-ing from a direct or indirect partner’s sec-tion 1296 election.

Special Analysis

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 regulatoryassessment is not required. It has also beendetermined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C. chap-ter 5) does not apply to these regulations,and, because the regulations do not im-pose a collection of information on smallentities, the Regulatory Flexibility Act (5U.S.C. chapter 6) does not apply. Pursu-ant to section 7805(f) of the Code, this no-tice of proposed rulemaking will besubmitted to the Chief Counsel for Advo-cacy of the Small Business Administra-tion for comment on its impact on smallbusiness.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, consideration

will be given to any written comments (asigned original and eight (8) copies) that aresubmitted timely (in a manner described inthe “ADDRESSES” portion of this pre-amble) to the IRS. The IRS and Treasuryrequest comments on the clarity of the pro-posed rules and how they can be madeeasier to understand. All comments will beavailable for public inspection and copy-ing.

A public hearing is scheduled for No-vember 6, 2002, beginning at 10:00 a.m. inroom 4718, Internal Revenue Building, 1111Constitution Avenue, NW, Washington, DC.Due to building security procedures, visi-tors must enter at the Constitution Av-enue entrance. In addition, all visitors mustpresent photo identification to enter thebuilding. Because of access restrictions, visi-tors will not be admitted beyond the im-mediate entrance area more than 30 minutesbefore the hearing starts. For informationabout having your name placed on thebuilding access list to attend the hearing,see the “FOR FURTHER INFORMATIONCONTACT” portion of this preamble.

The rules of 26 CFR 601.601(a)(3) ap-ply to this hearing. Persons who wish topresent oral comments must submit writ-ten comments and an outline of the top-ics to be discussed and the time to bedevoted to each topic (a signed original andeight (8) copies) by October 16, 2002. Aperiod of 10 minutes will be allotted to eachperson for making comments. An agendashowing the scheduling of the speakers willbe prepared after the deadline for review-ing outlines has passed. Copies of theagenda will be available free of charge atthe hearing.

Drafting Information

The principal authors of this regula-tion are Mark Pollard and Laurie Hatten-Boyd, Office of Associate Chief Counsel(International). However, other personnelfrom the IRS and Treasury Department par-ticipated in their development.

* * * * *

Proposed Amendments to theRegulations

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

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by adding an entry in nu-merical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Section 1.1296–1 also issued under 26

USC 1296(g) and 26 USC 1298(f). * * *Par. 2. Section 1.1291–1, as proposed on

April 1, 1992, at 57 FR 11024, is amendedby:

1. Revising the headings to paragraphs(c) and (c)(1).

2. Redesignating the text of paragraphs(c)(1) and (c)(2) as (c)(1)(i) and (c)(1)(ii),respectively.

3. Adding new paragraphs (c)(2) and(c)(3).

4. Revising paragraph (j)(1).5. Removing paragraph (j)(3).The revisions and addition read as

follows:

§ 1.1291–1 Taxation of U.S. persons thatare shareholders of section 1291 funds.

* * * * *(c) Coordination with other

PFIC rules—(1) Coordination with QEFrules.* * *

(2) Coordination with section 1296: dis-tributions and dispositions. If PFIC stockis marked to market under section 1296 forany taxable year, then, except as providedin § 1.1296–1(i), section 1291 and the regu-lations thereunder shall not apply to any dis-tribution with respect to section 1296 stock(as defined in § 1.1296–1(a)(2)), or to anydisposition of such stock, for such tax-able year.

(3) Coordination with mark to marketrules under chapter 1 of the Internal Rev-enue Code other than section 1296—(i) Ingeneral. If PFIC stock is marked to mar-ket for any taxable year under section 475or any other provision of chapter 1 of theInternal Revenue Code, other than sec-tion 1296, regardless of whether the appli-cation of such provision is mandatory orresults from an election by the taxpayer oranother person, then, except as provided inparagraph (c)(3)(ii) of this section, sec-tion 1291 and the regulations thereundershall not apply to any distribution with re-spect to such PFIC stock or to any dispo-sition of such PFIC stock for such taxableyear. See §§ 1.1295–1(i)(3) and 1.1296–1(h)(3)(i) for rules regarding the automatictermination of an existing election undersection 1295 or section 1296 when a tax-

2002–44 I.R.B. 771 November 4, 2002

payer marks to market PFIC stock undersection 475 or any other provision of chap-ter 1 of the Internal Revenue Code.

(ii) Coordination rule—(A) Notwith-standing any provision in this section to thecontrary, the rule of paragraph (c)(3)(ii)(B)of this section shall apply to the first tax-able year in which a United States personmarks to market its PFIC stock under a pro-vision of chapter 1 of the Internal Rev-enue Code, other than section 1296, if suchforeign corporation was a PFIC for any tax-able year, prior to such first taxable year,during the United States person’s holdingperiod (as defined in section 1291(a)(3)(A)and § 1.1296–1(f)) in such stock, and forwhich such corporation was not treated asa QEF with respect to such United Statesperson.

(B) For the first taxable year of a UnitedStates person that marks to market its PFICstock under any provision of chapter 1 ofthe Internal Revenue Code, other than sec-tion 1296, such United States person shall,in lieu of the rules under which the UnitedStates person marks to market, apply therules of § 1.1296–1(i)(2) and (3) as if theUnited States person had made an elec-tion under section 1296 for such first tax-able year.

* * * * *(j) Effective date—(1) In general. Ex-

cept as otherwise provided in this para-graph (j), §§ 1.1291–1 through 1.1291–7apply on April 11, 1992. Section 1.1291–1(c)(2) and (3) apply as of the date finalregulations are published in the FederalRegister. Shareholders of 1291 funds, in de-termining their liability under sections 1291through 1297 beginning after December 31,1986, and before the effective date of theseregulations, must apply reasonable inter-pretations of the statute and legislative his-tory and employ reasonable methods toapply the interest charge.

* * * * *Par. 3. Section 1.1295–1 is amended by:1. Redesignating paragraphs (i)(3) and

(i)(4) as paragraphs (i)(4) and (i)(5), re-spectively.

2. Adding a new paragraph (i)(3).3. Revising newly designated paragraph

(i)(5).4. Revising paragraph (k).The revisions and addition read as

follows:

§ 1.1295–1 Qualified electing funds

* * * * *(i)* * *(3) Automatic termination. If a United

States person, or the United States share-holder on behalf of a controlled foreign cor-poration, makes an election pursuant tosection 1296 and the regulations thereun-der with respect to PFIC stock for whicha QEF election is in effect, or marks to mar-ket such stock under another provision ofchapter 1 of the Internal Revenue Code, theQEF election is automatically terminatedwith respect to such stock that is markedto market under section 1296 or anotherprovision of Chapter 1 of the Internal Rev-enue Code. Such termination shall be ef-fective on the last day of the shareholder’staxable year preceding the first taxable yearfor which the section 1296 election is in ef-fect or such stock is marked to market un-der another provision of chapter 1 of theInternal Revenue Code.

Example. A, a U.S. corporation, owns directly 100shares of marketable stock in foreign corporation X,a PFIC. A also owns a 50 percent interest in Y, a for-eign partnership that owns 200 shares of X. Accord-ingly, under section 1298(a)(3) and § 1.1296–1(e)(1),A is treated as indirectly owning 100 shares of X. Aalso owns 100 percent of the stock of Z, a foreign cor-poration that is not a PFIC. Z owns 100 shares of X,and therefore under section 1298(a)(2)(A), A is treatedas owning the 100 shares of X owned by Z. For tax-able year 2003, A has a QEF election in effect withrespect to X that applies to all 300 shares of X stockowned directly or indirectly by A. See generally§ 1.1295–1(c)(1). For taxable year 2004, A makes atimely election pursuant to section 1296 and the regu-lations thereunder. For purposes of section 1296, Ais treated as owning stock held indirectly through apartnership, but not through a foreign corporation. Sec-tion 1296(g); § 1.1296–1(e)(1). Accordingly, A’s sec-tion 1296 election covers the 100 shares it ownsdirectly and the 100 shares it owns indirectly throughY, but not the 100 shares owned by Z. With respectto the first 200 shares, A’s QEF election is automati-cally terminated effective December 31, 2003. Withrespect to the 100 shares A owns through foreign cor-poration Z, A’s QEF election remains in effect un-less invalidated, terminated, or revoked pursuant to thisparagraph (i).

* * * * *(5) Effect after invalidation, termina-

tion, or revocation— (i) In general. With-out the Commissioner’s consent, ashareholder whose section 1295 electionwas invalidated, terminated, or revoked un-der this paragraph (i) may not make the sec-tion 1295 election with respect to the PFICbefore the sixth taxable year in which theinvalidation, termination, or revocation be-came effective.

(ii) Special rule. Notwithstanding para-graph (i)(5)(i) of this section, a shareholderwhose section 1295 election was termi-nated pursuant to paragraph (i)(3) of thissection, and either whose section 1296 elec-tion has subsequently been terminated be-cause its PFIC stock ceased to bemarketable or who no longer marks to mar-ket such stock under another provision ofchapter 1 of the Internal Revenue Code,may make a section 1295 election with re-spect to its PFIC stock before the sixth tax-able year in which its prior section 1295election was terminated.

* * * * *(k) Effective dates. Except as other-

wise provided, paragraphs (b)(2)(iii), (b)(3),(b)(4), and (c) through (j) of this section areapplicable to taxable years of sharehold-ers beginning after December 31, 1997.However, taxpayers may apply the rules un-der paragraphs (b)(4), (f) and (g) of this sec-tion to a taxable year beginning beforeJanuary 1, 1998, provided the statute oflimitations on the assessment of tax has notexpired as of April 27, 1998, and, in thecase of paragraph (b)(4) of this section, thetaxpayers who filed the joint return haveconsistently applied the rules of that sec-tion to all taxable years following the yearthe election was made. Paragraph (b)(3)(v)of this section is applicable as of Febru-ary 7, 2000, however, a taxpayer may ap-ply the rules to a taxable year prior to theapplicable date provided the statute of limi-tations on the assessment of tax for that tax-able year has not expired. Paragraphs (i)(3)and (i)(5)(ii) of this section are applicableas of the date final regulations are pub-lished in the Federal Register.

Par. 4. Section 1.1296–1 is added to readas follows:

§ 1.1296–1 Mark to market election formarketable stock.

(a) Definitions—(1) Eligible RIC. An eli-gible RIC is a regulated investment com-pany that offers for sale, or has outstanding,any stock of which it is the issuer andwhich is redeemable at net asset value, orthat publishes net asset valuations at leastannually.

(2) Section 1296 stock. The term sec-tion 1296 stock means marketable stock ina passive foreign investment company(PFIC), including any PFIC stock owneddirectly or indirectly by an eligible RIC, forwhich there is a valid section 1296 elec-tion. Section 1296 stock does not include

November 4, 2002 772 2002–44 I.R.B.

stock of a foreign corporation that previ-ously had been a PFIC, and for which asection 1296 election remains in effect.

(3) Unreversed inclusions—(i) Gen-eral rule. The term unreversed inclusionsmeans with respect to any section 1296stock, the excess, if any, of—

(A) The amount of mark to market gainincluded in gross income of the UnitedStates person under paragraph (c)(1) of thissection with respect to such stock for priortaxable years; over

(B) The amount allowed as a deduc-tion to the United States person under para-graph (c)(3) of this section with respect tosuch stock for prior taxable years.

(ii) Section 1291 adjustment. The amountreferred to in paragraph (a)(3)(i)(A) of thissection shall include any amount subject tosection 1291 under the coordination rule ofparagraph (i)(2)(ii) of this section.

(iii) Example. An example of the com-putation of unreversed inclusions is asfollows:

Example. A, a United States person, acquired stockin D, a foreign corporation, on January 1, 2003, for$150. At such time and at all times thereafter, D wasa PFIC and A’s stock in D was marketable. For tax-able years 2003 and 2004, D was a nonqualified fundsubject to taxation under section 1291. A made a timelysection 1296 election with respect to the D stock, ef-fective for tax year 2005. The fair market value of theD stock was $200 as of December 31, 2004, and $240as of December 31, 2005. Additionally, D made nodistribution with respect to its stock for the taxableyears at issue. In 2005, pursuant to paragraph (i)(2)(ii)of this section, A must include the $90 gain in the Dstock in accordance with the rules of section 1291 forpurposes of determining the deferred tax amount andany applicable interest. Nonetheless, for purposes ofdetermining the amount of the unreversed inclu-sions pursuant to paragraph (a)(3)(ii) of this sec-tion, A will include the $90 of gain that was taxedunder section 1291 and not the interest thereon.

(iv) Special rule for regulated invest-ment companies. In the case of a regu-lated investment company which hadelected to mark to market the PFIC stockheld by such company as of the last day ofthe taxable year preceding such compa-ny’s first taxable year for which such com-pany makes a section 1296 election, theamount referred to in paragraph (a)(3)(i)(A)of this section shall include amounts pre-viously included in gross income by thecompany pursuant to such mark to mar-ket election with respect to such stock forprior taxable years. See Notice 92–53,1992–2 C.B. 384.

(b) Application of section 1296election—(1) In general. Any United Statesperson and any controlled foreign corpo-

ration (CFC) that owns directly, or is treatedas owning under this section, marketablestock, as defined in § 1.1296(e)–1, in aPFIC may make an election to mark to mar-ket such stock in accordance with the pro-visions of section 1296 and this section.

(2) Election applicable to specific UnitedStates person. A section 1296 election ap-plies only to the United States person (orCFC that is treated as a U.S. person un-der paragraph (g)(2) of this section) thatmakes the election. Accordingly, a UnitedStates person’s section 1296 election willnot apply to a transferee of section 1296stock.

(3) Election applicable to specific cor-poration only. A section 1296 election ismade with respect to a single foreign cor-poration, and thus a separate section 1296election must be made for each foreign cor-poration that otherwise meets the require-ments of this section. A United Statesperson’s section 1296 election with re-spect to stock in a foreign corporation ap-plies to all marketable stock of thecorporation that the person owns directly,or is treated as owning under paragraph (e)of this section, at the time of the electionor that is subsequently acquired.

(c) Effect of election—(1) Recognitionof gain. If the fair market value of sec-tion 1296 stock on the last day of theUnited States person’s taxable year ex-ceeds its adjusted basis, the United Statesperson shall include in gross income for itstaxable year the excess of the fair marketvalue of such stock over its adjusted ba-sis (mark to market gain).

(2) Character of gain. (i) Mark to mar-ket gain, and any gain on the sale or otherdisposition of section 1296 stock, shall betreated as ordinary income.

(ii) Example. The following example il-lustrates this paragraph (c)(2):

Example. A, a United States person, purchasesstock in C, a foreign corporation that is not a PFIC,in 1990 for $1,000. On January 1, 2003, when the fairmarket value of the C stock is $1,100, foreign cor-poration C becomes a PFIC. A makes a timely sec-tion 1296 election for year 2003. On December 31,2003, the fair market value of the C stock is $1,200.For taxable year 2003, A includes $200 of mark tomarket gain (the excess of the fair market value of Cstock ($1,200) over A’s adjusted basis ($1,000)) ingross income as ordinary income.

(3) Recognition of loss. If the adjustedbasis of section 1296 stock exceeds its fairmarket value on the last day of the UnitedStates person’s taxable year, such personshall be allowed a deduction for such tax-

able year equal to the lesser of the amountof such excess or the unreversed inclu-sions with respect to such stock (mark tomarket loss).

(4) Character of loss—(i) Losses not inexcess of unreversed inclusions. Any markto market loss allowed as a deduction un-der paragraph (c)(3) of this section, and anyloss on the sale or other disposition of sec-tion 1296 stock, to the extent that such lossdoes not exceed the unreversed inclusionsattributable to such stock, shall be treatedas an ordinary loss, deductible in comput-ing adjusted gross income.

(ii) Losses in excess of unreversed in-clusions. (A) Any loss recognized on thesale or other disposition of section 1296stock in excess of any prior unreversed in-clusions will be subject to the rules gen-erally applicable to losses providedelsewhere in the Internal Revenue Code andthe regulations thereunder.

(B) The following example illustrates thetreatment of losses in excess of unreversedinclusions:

Example. A, a United States person and a calen-dar year taxpayer, purchased marketable stock in FC,a foreign corporation that was a PFIC, for $1,000 onJanuary 31, 2003. A made a section 1296 election withrespect to the stock of FC for 2003. At the close of2003, the fair market value of A’s stock in FC was$1,200. Under paragraph (c)(1) and (2) of this sec-tion, A included $200 of mark to market gain as or-dinary income for 2003, and pursuant to paragraph(d)(1) of this section, increased his basis in the stockby that amount. On June 15, 2004, A sold his stockin FC for $900. At that time, A’s unreversed inclu-sions with respect to the stock in FC were $200. Ac-cordingly, A may deduct the amount equal to hisunreversed inclusions, $200, as an ordinary loss. The$100 loss in excess of A’s unreversed inclusions willbe treated as a long term capital loss because A hasheld the FC stock for more than one year.

(5) Application of election to separatelots of stock. (i) In the case in which aUnited States person purchased or acquiredshares of stock in a PFIC at different prices,the rules of this section shall be applied ina manner consistent with the rules of§ 1.1012–1.

(ii) Example. The following example il-lustrates this paragraph (c)(5):

Example. On January 1, 2003, United States cor-poration A purchased 100 shares (first lot) of stock inforeign corporation X, a PFIC, for $500 ($5 per share).On June 1, 2003, A purchased 100 shares (second lot)of stock in X for $1,000 ($10 per share). A made atimely section 1296 election with respect to its stockin X for taxable year 2003. On December 31, 2003,the fair market value of X stock was $8 per share. Fortaxable year 2003, A recognizes $300 of gross in-come under paragraph (c)(1) of this section with re-spect to the first lot, and adjusts its basis in that lot

2002–44 I.R.B. 773 November 4, 2002

to $800 pursuant to paragraph (d)(1) of this section.With respect to the second lot, A is not permitted torecognize a loss under paragraph (c)(3) of this sec-tion for taxable year 2003. Although A’s adjusted ba-sis in that stock exceeds its fair market value by $200,A has no unreversed inclusions with respect to thatparticular lot of stock. On July 1, 2004, A sells 100shares of X stock for $900. Assuming that A ad-equately identifies (in accordance with the rules of§ 1.1012–1(c)) the shares of X corporation stock soldas being from the second lot, A recognizes $100 oflong term capital loss pursuant to paragraph (c)(4)(ii)of this section.

(6) Source rules. The source of anyamount included in gross income underparagraph (c)(1) of this section, or the al-location and apportionment of any amountallowed as a deduction under paragraph(c)(3) of this section, shall be determinedin the same manner as if such amounts weregain or loss (as the case may be) from thesale of stock in the PFIC.

(d) Adjustment to basis—(1) Stock helddirectly. The adjusted basis of the section1296 stock shall be increased by the amountincluded in the gross income of the UnitedStates person under paragraph (c)(1) of thissection with respect to such stock, and de-creased by the amount allowed as a de-duction to the United States person underparagraph (c)(3) of this section with re-spect to such stock.

(2) Stock owned through certain for-eign entities. (i) In the case of section 1296stock that a United States person is treatedas owning through certain foreign entitiespursuant to paragraph (e) of this section, thebasis adjustments under paragraph (d)(1) ofthis section shall apply to such stock in thehands of the foreign entity actually hold-ing such stock, but only for purposes of de-termining the subsequent treatment underchapter 1 of the Internal Revenue Code ofthe United States person with respect tosuch stock. Such increase or decrease in theadjusted basis of the section 1296 stockshall constitute an adjustment to the basisof partnership property only with respect tothe partner making the section 1296 elec-tion. Corresponding adjustments shall bemade to the adjusted basis of the UnitedStates person’s interest in the foreign en-tity and in any intermediary entity describedin paragraph (e) of this section throughwhich the United States person holds thePFIC stock.

(ii) Example. The following example il-lustrates this paragraph (d)(2):

Example. FP is a foreign partnership. A, a U.S. cor-poration, owns a 20% interest in FP. B, a U.S. cor-poration, owns a 30% interest in FP. C, a foreign

corporation, with no direct or indirect shareholders thatare U.S. persons, owns a 50% interest in FP. A, B, C,and FP are all calendar year taxpayers. In 2002, FPpurchases stock in a PFIC for $1,000. A makes atimely section 1296 election for taxable year 2003. OnDecember 31, 2003, the fair market value of the PFICstock is $1,100. A includes $20 of ordinary incomein 2003 under paragraphs (c)(1) and (2) of this sec-tion. A increases its basis in its FP partnership inter-est by $20. FP increases its basis in the stock to $1,020solely for purposes of determining the subsequent treat-ment of A, under chapter 1 of the Internal RevenueCode, with respect to such stock. In 2004, FP sells thestock for $1,200. For purposes of determining theamount of gain of A, FP will be treated as having $180in gain of which $20 is allocated to A. A’s $20 of gainwill be treated as ordinary income under paragraph(c)(2) of this section. For purposes of determining theamount of gain attributable to B, FP will be treatedas having $200 gain, $60 of which will be allocatedto B.

(3) Stock owned indirectly by an eli-gible RIC. Paragraph (d)(2) of this sec-tion shall also apply to an eligible RICwhich is an indirect shareholder under§ 1.1296(e)–1(f) of stock in a PFIC and hasa valid section 1296 election in effect.

(4) Stock acquired from a decedent. Inthe case of stock of a PFIC which is ac-quired by bequest, devise, or inheritance (orby the decedent’s estate) and with respectto which a section 1296 election was in ef-fect as of the date of the decedent’s death,notwithstanding section 1014, the basis ofsuch stock in the hands of the person so ac-quiring it shall be the adjusted basis of suchstock in the hands of the decedent imme-diately before his death (or, if lesser, the ba-sis which would have been determinedunder section 1014 without regard to thisparagraph).

(5) Transition rule for individuals be-coming subject to United States incometaxation—(i) In general. If any individualbecomes a United States person in a tax-able year beginning after December 31,1997, solely for purposes of this section, theadjusted basis, before adjustments under thisparagraph (d), of any section 1296 stockowned by such individual on the first dayof such taxable year shall be treated as be-ing the greater of its fair market value orits adjusted basis on such first day.

(ii) An example of the transition rule forindividuals becoming subject to UnitedStates income taxation is as follows:

Example. X, a nonresident alien individual, pur-chases marketable stock in a PFIC for $50 in 1995.On January 1, 2003, X becomes a United States per-son and makes a timely section 1296 election with re-spect to the stock in accordance with paragraph (h)of this section. The fair market value of the stock onJanuary 1, 2003, is $100. The fair market value of the

stock on December 31, 2003, is $110. Under para-graph (d)(5)(i) of this section, X computes the amountof mark to market gain or loss in 2003 by referenceto an adjusted basis of $100, and therefore X in-cludes $10 in gross income as mark to market gainunder paragraph (c)(1) of this section. Additionally,under paragraph (d)(1) of this section, X’s adjustedbasis in the stock for purposes of this section is in-creased to $110 (or to $60 for all other tax purposes).X sells the stock in 2004 for $120. For purposes ofapplying section 1001, X must use its original basisof $50, with any adjustments under paragraph (d)(1)of this section, $10 in this case, and therefore X rec-ognizes $60 of gain. Under paragraph (c)(2) of thissection (which is applied using an adjusted basis of$110), $10 of such gain is treated as ordinary in-come. The remaining $50 of gain from the sale of thestock is long-term capital gain because X held suchstock for more than one year.

(e) Stock owned through certain for-eign entities—(1) In general. Except as pro-vided in paragraph (e)(2) of this section, thefollowing rules shall apply in determin-ing stock ownership for purposes of thissection. PFIC stock owned, directly or in-directly, by or for a foreign partnership, for-eign trust (other than a foreign trustdescribed in sections 671 through 679), orforeign estate shall be considered as be-ing owned proportionately by its partnersor beneficiaries. PFIC stock owned, di-rectly or indirectly, by or for a foreign trustdescribed in sections 671 through 679 shallbe considered as being owned proportion-ately by its grantors or other persons treatedas owners under sections 671 through 679of any portion of the trust that includes thestock. The determination of a person’s pro-portionate interest in a foreign partner-ship, foreign trust or foreign estate will bemade on the basis of all the facts and cir-cumstances. Stock considered owned byreason of this paragraph shall, for pur-poses of applying the rules of this sec-tion, be treated as actually owned by suchperson.

(2) Stock owned indirectly by eligibleRICs. The rules for attributing ownershipof stock contained in § 1.1296(e)–1(f) willapply to determine the indirect ownershipof PFIC stock by an eligible RIC.

(f) Holding period. Solely for purposesof sections 1291 through 1298, if section1296 applied to stock with respect to thetaxpayer for any prior taxable year, the tax-payer’s holding period in such stock shallbe treated as beginning on the first day ofthe first taxable year beginning after the lasttaxable year for which section 1296 so ap-plied.

(g) Special rules—(1) Certain disposi-tions of stock. To the extent a United States

November 4, 2002 774 2002–44 I.R.B.

person is treated as actually owning stockin a PFIC under paragraph (e) of this sec-tion, any disposition which results in theUnited States person being treated as nolonger owning such stock, and any dispo-sition by the person owning such stock,shall be treated as a disposition by theUnited States person of the stock in thePFIC.

(2) Treatment of CFC as a United Statesperson. In the case of a CFC that owns, oris treated as owning under paragraph (e) ofthis section, section 1296 stock:

(i) Other than with respect to the sourc-ing rules in paragraph (c)(6) of this sec-tion, this section shall apply to the CFC inthe same manner as if such corporationwere a United States person. The CFC willbe treated as a foreign person for purposesof applying the source rules of paragraph(c)(6).

(ii) For purposes of subpart F of part IIIof subchapter N of the Internal RevenueCode—

(A) Amounts included in the CFC’sgross income under paragraph (c)(1) or(i)(2)(ii) of this section shall be treated asforeign personal holding company incomeunder section 954(c)(1)(A); and

(B) Amounts allowed as a deduction un-der paragraph (c)(3) of this section shall betreated as a deduction allocable to for-eign personal holding company income forpurposes of computing net foreign basecompany income under § 1.954–1(c).

(iii) A United States shareholder, as de-fined in section 951(b), of the CFC shallnot be subject to section 1291 with re-spect to any stock of the PFIC for the pe-riod during which the section 1296 electionis in effect for that stock, and the holdingperiod rule of paragraph (f) of this sec-tion shall apply to such United States share-holder.

(iv) The rules of this paragraph (g)(2)shall not apply to a United States personthat is a shareholder of the PFIC for pur-poses of section 1291, but is not a UnitedStates shareholder under section 951(b) withrespect to the CFC making a section 1296election.

(3) Timing of inclusions for stock ownedthrough certain foreign entities. In the caseof section 1296 stock that a United Statesperson is treated as owning through cer-tain foreign entities pursuant to paragraph(e) of this section, the mark to market gainor mark to market loss is determined in ac-

cordance with paragraphs (c) and (i)(2)(ii)of this section as of the last day of the tax-able year of the foreign partnership, for-eign trust or foreign estate and then includedin the taxable year of such United Statesperson that includes the last day of the tax-able year of the entity.

(h) Elections—(1) Timing and mannerfor making a section 1296 election—(i)United States persons. A United States per-son that owns marketable stock in a PFIC,or is treated as owning marketable stock un-der paragraph (e) of this section, on the lastday of the taxable year of such person, andthat wants to make a section 1296 elec-tion, must make a section 1296 election forsuch taxable year on or before the due date(including extensions) of the United Statesperson’s income tax return for that year. Thesection 1296 election must be made on theForm 8621, “Return by a Shareholder ofa Passive Foreign Investment Company orQualified Electing Fund”, included with theoriginal tax return of the United States per-son for that year, or on an amended re-turn, provided that the amended return isfiled on or before the election due date.

(ii) Controlled foreign corporations. Asection 1296 election by a CFC shall bemade by its controlling United States share-holders, as defined in § 1.964–1(c)(5), andshall be included with the Form 5471, “In-formation Return of U.S. Persons With Re-spect To Certain Foreign Corporations”, forthat CFC by the due date (including ex-tensions) of the original income tax re-turns of the controlling United Statesshareholders for that year. A section 1296election by a CFC shall be binding on allUnited States shareholders of the CFC.

(iii) Retroactive elections for PFIC stockheld in prior years. A late section 1296election may be permitted only in accor-dance with § 301.9100 of this chapter.

(2) Effect of section 1296 election—(i)In General. A section 1296 election will ap-ply to the taxable year for which such elec-tion is made and remain in effect for eachsucceeding taxable year unless such elec-tion is revoked or terminated pursuant toparagraph (h)(3) of this section.

(ii) Cessation of a foreign corporationas a PFIC. A United States person will notinclude mark to market gain or loss pur-suant to paragraph (c) of this section withrespect to any stock of a foreign corpora-tion for any taxable year that such for-eign corporation is not a PFIC under section

1297 or treated as a PFIC under section1298(b)(1) (taking into account the hold-ing period rule of paragraph (f) of this sec-tion). Cessation of a foreign corporation’sstatus as a PFIC will not, however, termi-nate a section 1296 election. Thus, if a for-eign corporation is a PFIC in a taxable yearafter a year in which it is not treated as aPFIC, the United States person’s originalelection (unless revoked or terminated in ac-cordance with paragraph (h)(3) of this sec-tion) continues to apply and the shareholdermust include any mark to market gain orloss in such year.

(3) Revocation or termination ofelection—(i) In general. A United Statesperson’s section 1296 election is termi-nated if the section 1296 stock ceases to bemarketable; if the United States personelects, or is required, to mark to market thesection 1296 stock under another provi-sion of chapter 1 of the Internal RevenueCode; or if the Commissioner, in the Com-missioner’s discretion, consents to theUnited States person’s request to revoke itssection 1296 election upon a finding of asubstantial change in circumstances. A sub-stantial change in circumstances for this pur-pose may include a foreign corporationceasing to be a PFIC.

(ii) Timing of termination or revoca-tion. Where a section 1296 election is ter-minated automatically (e.g., the stock ceasesto be marketable), section 1296 will ceaseto apply beginning with the taxable year inwhich such termination occurs. Where asection 1296 election is revoked with theconsent of the Commissioner, section 1296will cease to apply beginning with the firsttaxable year of the United States person af-ter the revocation is granted unless other-wise provided by the Commissioner.

(4) Examples. The operation of the rulesof this paragraph (h) are illustrated by thefollowing examples:

Example 1. X, a United States person, owns stockin a PFIC. X makes a QEF election in 1996 with re-spect to such stock. For taxable year 1999, X makesa timely section 1296 election with respect to its stock,and thus its QEF election is automatically termi-nated pursuant to § 1.1295–1(i)(3). In 2000, X’s stockceases to be marketable, and therefore its section 1296election is automatically terminated under paragraph(h)(3) of this section. Beginning with taxable year2000, X is subject to the rules of section 1291 withrespect to its stock in the PFIC unless it makes a newQEF election. See § 1.1295–1(i)(5).

Example 2. The facts are the same as in Example1, except that X’s stock in the PFIC becomes mar-ketable again in 2001. X may make a new section1296 election with respect to such stock for its tax year

2002–44 I.R.B. 775 November 4, 2002

2001, or thereafter. X will be subject to the coordi-nation rules under paragraph (i) of this section un-less it made a new QEF election in 2000.

(i) Coordination rules for first year ofelection—(1) In general. Notwithstand-ing any provision in this section to the con-trary, the rules of this paragraph (i) shallapply to the first taxable year in which asection 1296 election is effective with re-spect to marketable stock of a PFIC if suchforeign corporation was a PFIC for any tax-able year, prior to such first taxable year,during the United States person’s holdingperiod (as defined in paragraph (f) of thissection) in such stock, and for which suchcorporation was not treated as a QEF withrespect to such United States person.

(2) Shareholders other than regulated in-vestment companies. For the first taxableyear of a United States person (other thana regulated investment company) for whicha section 1296 election is in effect with re-spect to the stock of a PFIC, such UnitedStates person shall, in lieu of the rules ofparagraphs (c) and (d) of this section—

(i) Apply the rules of section 1291 to anydistributions with respect to, or disposi-tion of, section 1296 stock;

(ii) Apply section 1291 to the amount ofthe excess, if any, of the fair market valueof such section 1296 stock on the last dayof the United States person’s taxable yearover its adjusted basis, as if such amountwere gain recognized from the disposi-tion of stock on the last day of the taxpay-er’s taxable year; and

(iii) Increase its adjusted basis in the sec-tion 1296 stock by the amount of excess,if any, subject to section 1291 under para-graph (i)(2)(ii) of this section.

(3) Shareholders that are regulated in-vestment companies. For the first taxableyear of a regulated investment company forwhich a section 1296 election is in effectwith respect to the stock of a PFIC, suchregulated investment company shall in-crease its tax under section 852 by theamount of interest that would have been im-posed under section 1291(c)(3) for such tax-able year if such regulated investmentcompany were subject to the rules of para-graph (i)(2) of this section, and not thisparagraph (i)(3). No deduction or increasein basis shall be allowed for the increasein tax imposed under this paragraph (i)(3).

(4) The operation of the rules of thisparagraph (i) is illustrated by the follow-ing examples.

Example 1. A, a United States person and a cal-endar year taxpayer, owns marketable stock in a PFICthat it acquired on January 1, 1995. At all times, A’sPFIC stock was a nonqualified fund subject to taxa-tion under section 1291. A made a timely section 1296election effective for taxable year 2003. At the closeof taxable year 2003, the fair market value of A’s PFICstock exceeded its adjusted basis by $10. Pursuant toparagraph (i)(2)(ii) of this section, A must treat the $10gain under section 1291 as if the stock were dis-posed of on December 31, 2003. Further, A will in-crease its adjusted basis in the PFIC stock by the $10in accordance with paragraph (i)(2)(iii) of this sec-tion.

Example 2. Assume the same facts as in Example1, except that A is a RIC. In taxable year 2003, Awould include $10 of ordinary income under para-graph (c)(1) of this section, and such amount will notbe subject to section 1291. A also must increase itstax imposed under section 852 by the amount of in-terest that would have been determined under sec-tion 1291(c)(3), and no deduction will be permittedfor such amount. Finally, under paragraph (d)(1) ofthis section, A will increase its adjusted basis in thePFIC stock by $10.

(j) Effective Date. The provisions is thissection are applicable as of the date finalregulations are published in the FederalRegister.

* * * * *Par. 5. Section 1.1296(e)–1 is amended

by:1. Revising paragraph (b)(2).2. Adding paragraph (b)(3).3. Revising both references to “sec-

tions 958(a)(1) and (2)” in paragraph (f)(1)to read “section 1298(a)”.

The revision and addition reads asfollows:

§ 1.1296(e)–1 Definition of marketablestock.

* * * * *(b) * * *(2) Special rule for year of initial pub-

lic offering. For the calendar year in whicha corporation initiates a public offering ofa class of stock for trading on one or morequalified exchanges or other markets, as de-fined in paragraph (c) of this section, suchclass of stock meets the requirements ofparagraph (b)(1) of this section for such yearif the stock is regularly traded on such ex-changes or markets, other than in de mini-mis quantities, on 1/6 of the days remainingin the quarter in which the offering oc-curs, and on at least 15 days during eachremaining quarter of the taxpayer’s calen-dar year. In cases where a corporation ini-tiates a public offering of a class of stock

in the fourth quarter of the calendar year,such class of stock meets the requirementsof paragraph (b)(1) of this section in the cal-endar year of the offering if the stock isregularly traded on such exchanges or mar-kets, other than in de minimis quantities, onthe greater of 1/6 of the days remaining inthe quarter in which the offering occurs, or5 days.

(3) Anti-abuse rule. Trades that have asone of their principal purposes the meet-ing of the trading requirements of para-graph (b)(1) or (2) of this section shall bedisregarded. Further, a class of stock shallnot be treated as meeting the trading re-quirement of paragraph (b)(1) or (2) of thissection if there is a pattern of trades con-ducted to meet the requirement of para-graph (b)(1) or (2) of this section. Similarly,paragraph (b)(2) of this section shall not ap-ply to a public offering of stock that has asone of its principal purposes to avail it-self of the reduced trading requirements un-der the special rule for the calendar year ofan initial public offering. For purposes ofapplying the immediately preceding sen-tence, consideration will be given towhether the trading requirements of para-graph (b)(1) of this section are satisfied inthe subsequent calendar year.

* * * * *Par. 6. Section 1.6031(a)–1 is amended

by:1. Redesignating the text of paragraph

(b)(1) as (b)(1)(i).2. Adding a heading to newly desig-

nated paragraph (b)(1)(i).3. Adding paragraph (b)(1)(ii).The additions read as follows:

§ 1.6031(a)–1 Return of Partnership in-come.

* * * * *

(b) * * * (1) * * * (i) Filing require-ment. * * *

(ii) Special rule. For purposes of thisparagraph (b)(1) and paragraph (b)(3)(iii)of this section, a foreign partnership will notbe considered to have derived income fromsources within the United States solely be-cause a U.S. partner marks to market hispro rata share of PFIC stock held by theforeign partnership pursuant to an elec-tion under section 1296.

* * * * *

November 4, 2002 776 2002–44 I.R.B.

Robert E. Wenzel,Deputy Commissioner of

Internal Revenue

(Filed by the Office of the Federal Register on July 30, 2002,8:45 a.m., and published in the issue of the Federal Regis-ter for July 31, 2002, 67 F.R. 49634)

Notice of ProposedRulemaking and Notice ofPublic Hearing

Redemptions Taxable asDividends

REG–150313–01

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposedrulemaking and notice of public hearing.

SUMMARY: This document contains pro-posed regulations that provide guidance re-garding the treatment of the basis ofredeemed stock when a distribution in re-demption of such stock is treated as a divi-dend, as well as guidance regarding certainacquisitions of stock by related corpora-tions that are treated as distributions in re-demption of stock. The proposed regulationsaffect shareholders whose stock in a cor-poration is redeemed or is acquired by acorporation related to the issuer of the stock,and are necessary to provide such share-holders with guidance regarding the treat-ment of the basis of such stock. Thisdocument also provides notice of a pub-lic hearing on these proposed regulations.

DATES: Written or electronic commentsmust be received by January 16, 2003. Re-quests to speak and outlines of topics to bediscussed at the public hearing scheduledfor February 20, 2003, at 10 a.m. must bereceived by January 30, 2003.

ADDRESSES: Send submissions to:CC:ITA:RU (REG–150313–01), room 5226,Internal Revenue Service, POB 7604, BenFranklin Station, Washington, DC 20044.Submissions may be hand delivered Mon-day through Friday between the hours of8 a.m. and 5 p.m. to: CC:ITA:RU (REG–150313–01), Courier’s desk, Internal Rev-enue Service, 1111 Constitution Avenue,

NW, Washington, DC 20224. Alternatively,taxpayers may submit electronic commentsdirectly to the IRS Internet site atwww.irs.gov/regs. The public hearing willbe held in Room 4718, Internal RevenueBuilding, 1111 Constitution Avenue, NW,Washington, DC.

FOR FURTHER INFORMATIONCONTACT: Concerning the proposed regu-lations generally, Lisa K. Leong, (202) 622–7530; concerning issues under sections 367,861 and 864 of the Internal Revenue Code,Aaron A. Farmer, (202) 622–3860; con-cerning submissions of comments, the hear-ing, and/or to be placed on the buildingaccess list to attend the hearing, Treena V.Garrett, (202) 622–7180 (not toll-free num-bers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information containedin this notice of proposed rulemaking hasbeen submitted to the Office of Manage-ment and Budget for review in accordancewith the Paperwork Reduction Act of 1995(44 U.S.C. 3507(d)). Comments on the col-lection of information should be sent to theOffice of Management and Budget, Attn:Desk Officer for the Department of theTreasury, Office of Information and Regu-latory Affairs, Washington, DC 20503, withcopies to the Internal Revenue Service,Attn: IRS Reports Clearance Officer,W:CAR:MP:FP:S, Washington, DC 20224.Comments on the collection of informa-tion should be received by December 17,2002. Comments are specifically requestedconcerning:

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

The accuracy of the estimated burden as-sociated with the proposed collection of in-formation (see below);

How the quality, utility, and clarity of theinformation to be collected may be en-hanced;

How the burden of complying with theproposed collection of information may beminimized, including through the applica-tion of automated collection techniques orother forms of information technology; and

Estimates of capital or start-up costs andcosts of operation, maintenance, and pur-chase of services to provide information.

The collection of information in theseproposed regulations is in § 1.302–5(e) and§ 1.1502–19(b)(5)(v). This collection of in-formation is required by the IRS to verifycompliance with section 302. This infor-mation will be used to determine whetherthe amount of tax has been calculated cor-rectly. The collection of information is re-quired to properly determine the amountpermitted to be taken into account as a loss.The respondents are shareholders (includ-ing individuals, corporations and pass-through entities) whose stock in acorporation is redeemed or is treated as re-deemed.

Estimated total annual reporting burden:1,500 hours.

Estimated average annual burden perrespondent: 30 minutes.

Estimated number of respondents: 3,000.Estimated annual frequency of responses:

On occasion.An agency may not conduct or spon-

sor, and a person is not required to re-spond to, a collection of information unlessit displays a valid control number assignedby the Office of Management and Bud-get.

Books or records relating to a collec-tion of information must be retained as longas their contents may become material inthe administration of any internal revenuelaw. Generally, tax returns and tax returninformation are confidential, as required by26 U.S.C. 6103.

Background

This document contains proposed revi-sions and amendments to the Income TaxRegulations (26 CFR part 1) under sec-tions 302, 304, 704, 861, 1371, 1374, and1502 of the Internal Revenue Code (Code).The proposed regulations would amend thetemporary and final regulations under sec-tions 302, 304, 704, 861, 1371, 1374, and1502 to provide guidance concerning thetreatment of the basis of stock redeemed ortreated as redeemed where the redemp-tion proceeds are treated as a dividend dis-tribution. These proposed regulations wouldalso amend the final regulations under sec-tion 304 to conform them to certain of theamendments made to section 304 by leg-islation, including section 226 of the TaxEquity and Fiscal Responsibility Act of

2002–44 I.R.B. 777 November 4, 2002

1982, Public Law 97–248 (96 Stat. 325,490) (September 3, 1982), section 712(l) ofthe Deficit Reduction Act of 1984, PublicLaw 98–369 (98 Stat. 494, 953–55) (July18, 1984), section 1875(b) of the Tax Re-form Act of 1986, Public Law 99–514 (100Stat. 2085, 2894) (October 22, 1986), andsection 1013 of the Taxpayer Relief Act of1997, Public Law 105–34 (111 Stat. 788,918) (August 5, 1997).

A. The Character of Property Receivedin Redemption of Stock

Section 302 of the Code governs the taxtreatment of distributions in redemption ofstock. The rules of section 302 attempt todistinguish between distributions that “mayhave capital-gain characteristics becausethey are not made pro rata among the vari-ous shareholders” and distributions “char-acterized by what happens solely at thecorporate level by reason of the assets dis-tributed.” S. Rep. No. 1622, 83d Cong., 2dSess. 49 (1954). Section 302(a) providesthat a corporation’s redemption of its stockis treated as a distribution in part or fullpayment in exchange for the stock if the re-demption satisfies any one of the follow-ing criteria: (1) the redemption is notessentially equivalent to a dividend (sec-tion 302(b)(1)); (2) the redemption is sub-stantially disproportionate (section302(b)(2)); (3) the redemption completelyterminates the redeemed shareholder’s in-terest (section 302(b)(3)); or (4) the re-demption is in connection with a qualifyingpartial liquidation (section 302(b)(4)). If aredemption satisfies none of these crite-ria, pursuant to section 302(d), the redemp-tion is treated as a distribution of propertyto which section 301 applies.

Under sections 301(c)(1) and 316(a), adistribution is treated as a dividend to theextent of the redeeming corporation’s earn-ings and profits. Any portion of the distri-bution that is not treated as a dividend isfirst applied against the adjusted basis ofthe redeemed stock to the extent of such ba-sis under section 301(c)(2), and then treatedas gain from the sale or exchange of prop-erty under section 301(c)(3).

B. The Character of Property Receivedin Certain Stock Acquisitions

The redemption rules of section 302 areimplicated not only when an issuing cor-poration acquires its own stock, but also inthe case of certain stock acquisitions by cor-

porations related to the issuer of the ac-quired stock. Pursuant to section 304(a)(1),an acquisition of stock by a corporationfrom one or more persons that are in con-trol of both the acquiring and issuing cor-porations is treated as if the propertyreceived in respect of the acquired stockwere a distribution in redemption of thestock of the acquiring corporation. Prior tothe amendments made by the Taxpayer Re-lief Act of 1997, section 304 provided that,to the extent that the deemed distributionwas treated as a distribution to which sec-tion 301 applies, the stock acquired wastreated as having been transferred by theperson from whom acquired and as hav-ing been received by the corporation ac-quiring it, as a contribution to the capitalof such corporation. The Taxpayer ReliefAct of 1997 amended section 304(a)(1) toprovide that, to the extent that this deemeddistribution is treated as a distribution towhich section 301 applies, the shareholderand the acquiring corporation are treated asif the shareholder had transferred the stockof the issuing corporation to the acquir-ing corporation in exchange for stock of theacquiring corporation in a transaction towhich section 351(a) applies, and then theacquiring corporation had redeemed thestock it was treated as issuing in that trans-action. Pursuant to section 304(a)(2), an ac-quisition of stock by a corporationcontrolled by the issuer of the acquiredstock is treated as if the property receivedin respect of the acquired stock was a dis-tribution in redemption of the stock of theissuing corporation.

For purposes of section 304, controlmeans the ownership of stock possessingat least 50 percent of either the total com-bined voting power of all classes of stockentitled to vote or the total value of sharesof all classes of stock. The determinationof the amount and source of the distribu-tion that is treated as a dividend is madeas if the property received in respect of theredeemed stock were distributed by the ac-quiring corporation to the extent of its earn-ings and profits and then by the issuingcorporation to the extent of its earnings andprofits. Because section 304 recharacter-izes certain stock acquisition transactionsas redemptions of stock, transactions towhich section 304 applies implicate the re-demption rules of section 302.

C. The Unutilized Basis of StockRedeemed in Certain Transactions

While sections 301 and 302 clearly setforth the character of property received ina redemption (whether actual or deemed)of stock, they do not prescribe the tax treat-ment of the unutilized basis of the redeemedstock or the stock treated as redeemed. In1955, the IRS and Treasury promulgatedregulations under section 302 that pro-vide guidance in this regard in the case ofan actual redemption of stock. Section1.302–2(c) of the Income Tax Regulationsstates that “[i]n any case in which anamount received in redemption of stock istreated as a distribution of a dividend,proper adjustment of the basis of the re-maining stock will be made with respect tothe stock redeemed.” The regulation con-tains examples illustrating what consti-tutes a proper adjustment. In Example 1 andExample 3, the redeemed shareholder ac-tually owns stock of the redeeming corpo-ration immediately after a redemption thatis treated as a distribution of a dividend. Inthose cases, the basis of the shares of theredeeming corporation that the shareholderowns after the redemption is increased bythe basis of the redeemed shares. See alsoUnited States v. Davis, 397 U.S. 301 (1970)(interpreting § 1.302–2(c) to shift the ba-sis of redeemed stock to other shares heldby the redeemed shareholder, even wherethose other shares are of a different classof stock than those redeemed); Rev. Rul.66–37, 1966–1 C.B. 209 (same). In Ex-ample 2, although the redeemed share-holder actually owns no stock of theredeeming corporation immediately after aredemption that is treated as a distribu-tion of a dividend, he does constructivelyown stock of the redeeming corporation im-mediately after the redemption by reasonof his wife’s continuing ownership of stockof the redeeming corporation. The exampleconcludes that the redeemed sharehold-er’s basis in the redeemed shares shifts tohis wife’s basis in her shares of stock of theredeeming corporation.

In addition, on December 2, 1955, theIRS and Treasury promulgated §§ 1.304–2(a) and 1.304–3(a). With respect to an ac-quisition of stock by a related corporation(other than a subsidiary), § 1.304–2(a) pro-vides that the transferor’s basis for his stockin the acquiring corporation is increased bythe basis of the stock of the issuing cor-poration surrendered by him. Similarly, with

November 4, 2002 778 2002–44 I.R.B.

respect to an acquisition of stock by a sub-sidiary, § 1.304–3(a) provides that the trans-feror’s basis in his remaining stock in theparent corporation is increased by the ba-sis of the stock deemed redeemed by theparent corporation. The treatment of thetransferor’s unutilized basis in stock of theissuing corporation as a result of transac-tions subject to section 304(a) is the sub-ject of Revenue Ruling 70–496, 1970–2C.B. 74, and Revenue Ruling 71–563,1971–2 C.B. 175.

In Revenue Ruling 70–496, a first-tiersubsidiary (Y) of a parent corporation (X)sold all of its stock in a second-tier sub-sidiary of X (S) to another first-tier sub-sidiary of X (Z). The ruling concludes thatthe transaction is governed by sections304(a)(1) and 302(d). Accordingly, the rul-ing holds that the sales proceeds consti-tute dividends to the extent of Z’s earningsand profits and, to the extent in excess ofsuch amount, constitute gain under sec-tion 301(c)(3). With respect to Y’s basis inthe sold S stock, the ruling holds that be-cause Y had no direct stock ownership inZ before or after the sale, Y’s basis in theS stock surrendered disappears and can-not be used to increase the basis of any as-set of Y.

In Revenue Ruling 71–563, A, an indi-vidual, owned all the stock of X. C, A’s son,owned all of the outstanding stock of Y. Asold 25 percent of its stock in X to Y forcash. The ruling states that, under section304(a)(1), the sale is treated as a contri-bution by A of the stock of X to the capi-tal of Y and a distribution to A by Y inredemption of its stock. Because the deemedredemption is governed by section 302(d),the cash received is taxable as a dividendto A under section 301(c)(1). Furthermore,the ruling reasons that, because A owns nostock in Y directly after the transaction, thebasis of the X stock should be added to thebasis of the remaining stock of X that Acontinues to own after the transaction.

The current regulatory regime preserves,and prevents the elimination of, basis intransactions subject to section 302 wherea proper adjustment may be made to the ba-sis of the remaining stock of the redeem-ing corporation and in transactions subjectto section 304 where, immediately after thetransaction, the seller owns stock of the ac-quiring corporation. In certain transac-tions, however, taxpayers have taken theposition that certain adjustments are proper,

even if they shift basis from a person thatis not subject to U.S. tax to a person thatis subject to U.S. tax or to stock other thanstock of the redeeming corporation. No-tice 2001–45, 2001–2 C.B. 129, describesa type of transaction with respect to whichtaxpayers have taken the position that, un-der § 1.302–2(c), all or a portion of the ba-sis of stock redeemed from a person thatis not subject to U.S. tax or is otherwise in-different to the Federal income tax conse-quences of the redemption of the stock isadded to the basis of other stock in the re-deeming corporation owned by a taxpayerthat is subject to U.S. tax to create a losson the disposition of the other stock. Al-though the IRS intends to challenge the ad-justments claimed in such transactions, theIRS and Treasury believe it is desirable torevise the rules that govern accounting forunutilized basis attributable to redeemedstock to better reflect the purposes of therelevant Code provisions.

Explanation of Provisions

A. Rules Under Section 302

This notice of proposed rulemaking pro-poses a replacement for the “proper ad-justment” regime of current § 1.302–2(c) fortaking into account the unutilized basis at-tributable to redeemed stock in any case inwhich a redemption of stock is treated asa distribution of property to which sec-tion 301 applies. The rules are proposed toapply both where the redeemed shareholderactually owns no stock of the redeemingcorporation immediately after the redemp-tion (a complete redemption) and where theredeemed shareholder actually owns stockof the redeeming corporation immediatelyafter the redemption (a partial redemp-tion). While consideration was given to re-taining the “proper adjustment” rule ofcurrent § 1.302–2(c) where only a por-tion of the shareholder’s interest in the re-deeming corporation is redeemed, the IRSand Treasury believe the two situations aresimilar enough to warrant the same rules,and that the rules proposed herein best carryout the purposes of section 302 even wherethe redeemed shareholder continues di-rectly to own stock in the redeeming cor-poration because, even in that case, dividendtreatment under section 302 may have re-sulted from shares owned by attributionrather than directly. The following para-graphs describe the proposed rules.

1. General description of the proposedrules

Certain transactions that, in form, in-volve the redemption of shares are eco-nomically identical or similar to distributionsto shareholders that do not involve any re-demption of shares. For example, if a singleshareholder owns all of the stock of the re-deeming corporation, the redemption ofsome shares from that shareholder for cashis economically indistinguishable from themere distribution of corporate cash to theshareholder. In recognition of this, sec-tion 302 taxes these transactions as corpo-rate distributions notwithstanding their formas redemptions. The underlying premise ofsection 302 is that distribution treatment iscalled for in these cases because, in ef-fect, the redeemed shareholder still owns (oris treated as owning) its stock in the cor-poration, even if it may have turned in somephysical shares.

Although section 302 does not provideany explicit guidance regarding the share-holder’s basis of the shares redeemed, in de-riving a regulatory regime to address thetreatment of the unutilized basis of re-deemed stock, it is appropriate to con-sider what happens when a shareholderreceives a distribution and keeps its shares,because that analogy underlies distribu-tion treatment under section 302. Becausethe Code does not permit basis to offset anyportion of the redemption distribution thatis treated as a dividend, and because suchan offset is not available when a corpora-tion distributes a dividend and the share-holder retains its shares, the redemption dateis not the appropriate time to recover theunutilized basis of the redeemed stock.However, if the shareholder receives a dis-tribution and retains its shares, it also re-tains its basis, which it can recover later insituations other than dividends, such as thesale of the shares. Accordingly, the unuti-lized basis of the redeemed stock should notdisappear and should be taken into ac-count for Federal income tax purposes atsome time. In addition, any tax benefit as-sociated with the unutilized basis of re-deemed stock should remain with thetaxpayer that made, or succeeded to, the in-vestment that gave rise to the unutilized ba-sis. Accordingly, these regulations proposethat, in any case where a redemption ofstock is treated as a distribution of a divi-dend, an amount equal to the adjusted ba-sis of the redeemed stock is treated as a loss

2002–44 I.R.B. 779 November 4, 2002

recognized on the disposition of the re-deemed stock on the date of the redemp-tion. That loss is taken into account asdescribed below.

Once the facts and circumstances thatcaused the redemption distribution to betreated as a distribution subject to section301 no longer exist (i.e., the redeemedshareholder has sufficiently reduced its ac-tual and constructive ownership interest inthe redeeming corporation), these regula-tions permit the loss attributable to the un-utilized basis of redeemed stock that has notpreviously been taken into account to betaken into account. The first date on whichthe redeemed shareholder would satisfy thecriteria of section 302(b)(1), (2) or (3) if thefacts and circumstances that exist on suchdate had existed immediately after the re-demption is referred to as the “final inclu-sion date.” In addition, a date is the finalinclusion date if there is no later date onwhich the redeemed shareholder could takethe loss into account. For example, if theredeemed shareholder is an individual, thefinal inclusion date includes the date ofdeath of such individual. If the redeemedshareholder is a corporation, the final in-clusion date includes the date such corpo-ration transfers its assets in a liquidationdescribed in section 331. If the redeemedshareholder is a foreign corporation, the fi-nal inclusion date includes the date suchcorporation transfers its assets to a domes-tic corporation in either a liquidation de-scribed in section 332 or a reorganizationdescribed in section 368(a)(1) to which sec-tion 381 applies. If the redeemed share-holder is a foreign corporation that is nota controlled foreign corporation, within themeaning of section 957(a), on the date ofthe redemption, the term final inclusion dateincludes the date such corporation trans-fers its assets to a controlled foreign cor-poration in a liquidation described in section332 or a reorganization described in sec-tion 368(a)(1) to which section 381 ap-plies.

These proposed regulations also pro-vide that the redeemed shareholder is per-mitted to take into account the lossattributable to the unutilized basis of re-deemed stock when the redeemed share-holder recognizes a gain on stock of theredeeming corporation to the extent of thegain recognized. Any date on which the re-deemed shareholder must take into ac-count gain recognized pursuant to section

301(c)(3) or gain recognized on a dispo-sition of stock of the redeeming corpora-tion is referred to as an “accelerated lossinclusion date.” Although there can be onlyone final inclusion date, there can be sev-eral accelerated loss inclusion dates.

Because the loss attributable to the ba-sis of the redeemed stock is treated as rec-ognized on a disposition of the redeemedstock on the redemption date, the attributes(e.g., character and source) of that loss arefixed on the redemption date, even if suchloss is not taken into account until after theredemption date. For example, if a corpo-ration redeems its stock from a shareholderwithin one year after the shareholder’s ac-quisition of such stock and the proceeds ofthe redemption are treated as a dividend dis-tribution, the character of any amount of theloss that is taken into account is treated asshort-term capital loss (assuming the re-deemed shareholder held the redeemedstock as a capital asset), even if such lossis taken into account more than one yearafter the redeemed shareholder’s acquisi-tion of the redeemed stock. Nonetheless, forpurposes of the carryforward and carry-back provisions of sections 172 and 1212,such loss is treated as a loss for the tax-able year in which it is taken into accountrather than for the taxable year of the stockredemption that gave rise to such loss.

Because a redemption of stock may giverise to, or increase, an excess loss accountin redeemed stock where the redeemedshareholder and the redeeming corpora-tion are members of the same consoli-dated group, these regulations propose rulessimilar to those described above where theredeemed shareholder has an excess loss ac-count in the redeemed stock.

These proposed regulations do not ap-ply on the redemption of stock describedin section 306(c). Pursuant to section306(a)(2), a redemption of stock describedin section 306(c) is treated as a distribu-tion of property to which section 301 ap-plies. Example 2 of § 1.306–1 suggests thatthe unutilized basis of redeemed section 306stock is added back to the basis of the stockwith respect to which the section 306 stockwas distributed. The IRS and Treasury re-quest comments on whether such treat-ment of the unutilized basis of redeemedsection 306 stock is appropriate or whetheran alternative regime should apply whensuch a redemption is treated as a distribu-tion to which section 301 applies.

2. Special issues related to certainpass-through entities

Where stock is redeemed from a part-nership and all or a portion of the distri-bution in redemption of such stock is treatedas a dividend, any loss attributable to thebasis of redeemed stock is treated as a cur-rent loss to the partnership on the date ofthe redemption. To the extent of the lesserof the amount of such distribution that istreated as a dividend and such loss that isnot allocated pursuant to section 704(c) andthe regulations thereunder, the dividend andthe loss must be allocated in equal amounts.Such amounts must be allocated in accor-dance with the partners’ interests in the part-nership. An allocation will be deemed to bein accordance with a partner’s interest in thepartnership if the allocation is in the sameproportion as the allocation of (i) the ex-cess of the dividend income over the lossattributable to the basis of the redeemedstock, if any, (ii) the excess of the loss at-tributable to the basis of the redeemed stockover the dividend income, if any, or, (iii)if neither, in the same proportion as the part-nership’s net taxable income or loss for theyear is allocated. This rule ensures that thebenefit of the loss may be realized by theperson to whom the dividend income wasallocated. The excess dividend or loss at-tributable to the basis of redeemed stockmust be allocated in a manner that takesinto account the requirements of section704.

The loss attributable to the basis of re-deemed stock allocated to a partner underthe rules of this section is not taken into ac-count at the partner level until the final in-clusion date or an accelerated loss inclusiondate, as applicable. For purposes of deter-mining whether a particular date is the fi-nal inclusion date with respect to such aloss, if the partner is a partner of the part-nership on such date, the partnership istreated as the redeemed shareholder. Oth-erwise, the former partner is treated as theredeemed shareholder and the determina-tion of whether a particular date is the fi-nal inclusion date is made by comparingsuch former partner’s actual and construc-tive ownership of the redeeming corpora-tion immediately prior to the redemption tosuch former partner’s actual and construc-tive ownership of the redeeming corpora-tion at the end of such particular date. Forpurposes of determining whether a particu-lar date is an accelerated loss inclusion date

November 4, 2002 780 2002–44 I.R.B.

with respect to a loss attributable to the ba-sis of redeemed stock that is allocated toa partner from a partnership, the partner istreated as the redeemed shareholder. Simi-lar rules are proposed to apply where stockis redeemed from an S corporation.

The proposed regulations provide thatwhere stock is redeemed from a C corpo-ration, and the C corporation subsequentlyelects to be taxed as an S corporation, anyloss attributable to the basis of redeemedstock that has not been taken into accountat the time of the election is treated as a car-ryforward arising in a taxable year forwhich the corporation was a C corpora-tion. Such loss is allowed as a deductionagainst net recognized built-in gain undersection 1374 in the year of the final inclu-sion date or an accelerated loss inclusiondate.

To the extent that a trust from whichstock is redeemed is wholly or partially agrantor trust, the proposed rules treat the re-deemed stock as having been owned di-rectly by the grantor. When stock isredeemed from an estate or from a trust thatis not a wholly grantor trust, and all or aportion of a distribution in redemption ofsuch stock is treated as a dividend, any lossattributable to the basis of redeemed stockthat is not attributable to the basis of re-deemed stock treated as owned by thegrantor is not taken into account by suchestate or trust until the final inclusion dateor an accelerated loss inclusion date. In thatcase, whether a particular date is the finalinclusion date or an accelerated loss inclu-sion date is determined by treating such es-tate or trust, not its beneficiaries, as theredeemed shareholder. In the event that thetrust or estate terminates before it has beenpermitted to take into account all of the lossattributable to the basis of redeemed stock,any remaining loss is treated as a loss un-der section 172 or section 1212 for pur-poses of section 642(h) (regarding theavailability to beneficiaries of unused losscarryovers and excess deductions of an es-tate or trust upon termination). Each ben-eficiary’s interest in the loss distributedunder section 642(h), however, shall be lim-ited to the proportion of that loss that isequal to the proportion of the total amountof the distribution treated as a dividend thatis represented by that beneficiary’s benefi-cial interest in that dividend. Once all or aportion of such a loss is distributed to a ben-

eficiary, whether a particular date is the fi-nal inclusion date or an accelerated lossinclusion date with respect to such a lossis determined by treating such beneficiaryas the redeemed shareholder.

3. Special rules related to apportionmentof interest and other expenses

Under section 864(e), taxpayers appor-tion interest expense between U.S. and for-eign source income on the basis of therelative values of their U.S. and foreign as-sets. For this purpose, taxpayers may chooseto value their assets using either fair mar-ket value or tax book value (adjusted ba-sis). If the taxpayer apportions interestexpense using tax book value, the adjustedbasis of stock in any nonaffiliated 10 per-cent owned corporation (as defined in sec-tion 864(e)(4)(B)) is increased by theamount of earnings and profits (and re-duced by any deficits in earnings and prof-its) attributable to such stock thataccumulated during the period the tax-payer held such stock. The proposed regu-lations provide that for purposes ofapportioning expenses on the basis of thetax book value of assets, the adjusted ba-sis in any remaining shares of the redeem-ing corporation that are owned by theredeemed shareholder or certain affiliatedcorporations will be increased by theamount of the unutilized basis of redeemedstock. This adjustment is intended to pro-vide consistent interest allocation conse-quences in the case of dividends andredemptions treated as dividends by non-affiliated 10 percent owned corporations.

B. Revisions to Regulations UnderSection 304

The current regulations under section 304do not reflect all of the legislative amend-ments that have been made to section 304.This notice of proposed rulemaking pro-poses certain revisions to the current regu-lations under section 304 to incorporatethese legislative amendments to the ex-tent that those legislative amendments arerelevant to the issues that are subject to theproposed regulations under section 302. Inparticular, these revisions reflect the amend-ments to section 304 made by section 1013of the Taxpayer Relief Act of 1997, Pub-lic Law 105–34 (111 Stat. 788, 918) (Au-gust 5, 1997), that provide that, to the extentthat a stock acquisition to which section

304(a)(1) applies is treated as a distribu-tion to which section 301 applies, the trans-feror and the acquiring corporation aretreated as if (1) the transferor transferred thestock of the target corporation to the ac-quiring corporation in exchange for stockof the acquiring corporation in a transac-tion to which section 351(a) applies, and (2)the acquiring corporation then redeemed thestock it is treated as having issued. Thesame rules that govern an actual redemp-tion govern a deemed redemption.

In transactions under section 304 that in-volve one or more foreign corporations, fur-ther consequences may apply under theinternational provisions of the Code. For ex-ample, where target corporation stock istransferred to a foreign corporation in thedeemed section 351 transaction, section 367and the regulations promulgated thereun-der apply to the transfer. See Rev. Rul.91–5, 1991–1 C.B. 114, (holding that sec-tion 367 applied to the deemed contribu-tion to capital of the target corporation stockunder prior law because section 367(c)(2)resulted in the stock transfer constituting asection 351 transaction). The IRS intendsto issue guidance on the application of theinternational provisions to section 304 trans-actions and requests comments on suchtransactions, including what changes, if any,to existing published guidance may be ap-propriate in light of the 1997 amendmentsto section 304.

Proposed Effective Date

These regulations are proposed to ap-ply to transactions occurring after the datethese regulations are published as final regu-lations in the Federal Register.

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. It is hereby certifiedthat the collection of information in this No-tice of Proposed Rulemaking will not havea significant economic impact on a sub-stantial number of small entities. This cer-tification is based upon the fact that the IRSand Treasury estimate that at most 3,000taxpayers will be subject to these require-ments and most of those taxpayers will beindividuals or large businesses. There-fore, a Regulatory Flexibility Analysis un-der the Regulatory Flexibility Act (5 U.S.C.

2002–44 I.R.B. 781 November 4, 2002

chapter 6) is not required. Pursuant to sec-tion 7805(f), this notice of proposed rule-making will be submitted to the ChiefCounsel for Advocacy of the Small Busi-ness Administration for comment on its im-pact on small business.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written (a signed origi-nal and eight (8) copies) or electronic com-ments that are submitted timely to the IRS.The IRS and Treasury Department requestcomments on the clarity of the proposedrules and how they can be made easier tounderstand. All comments will be avail-able for public inspection and copying.

A public hearing has been scheduled forFebruary 20, 2003, beginning at 10 a.m. inRoom 4718 of the Internal Revenue Build-ing, 1111 Constitution Avenue, NW, Wash-ington, DC. Due to building securityprocedures, visitors must enter at the Con-stitution Avenue entrance. In addition, allvisitors must present photo identification toenter the building. Because of access re-strictions, visitors will not be admitted be-yond the immediate entrance area more than30 minutes before the hearing starts. For in-formation about having your name placedon the building access list to attend the hear-ing, see the FOR FURTHER INFORMA-TION CONTACT portion of this preamble.

The rules of 26 CFR 601.601(a)(3) ap-ply to the hearing. Persons who wish topresent oral comments must submit writ-ten or electronic comments and an out-line of the topics to be discussed and thetime to be devoted to each topic (a signedoriginal and eight (8) copies) by January 30,2003. A period of 10 minutes will be al-lotted to each person for making com-ments. An agenda showing the schedulingof the speakers will be prepared after thedeadline for receiving outlines has passed.Copies of the agenda will be available freeof charge at the hearing.

Drafting Information

The principal author of these proposedregulations is Lisa K. Leong of the Of-fice of the Associate Chief Counsel (Cor-porate), IRS. However, other personnel fromthe IRS and Treasury participated in theirdevelopment.

* * * * *

Proposed Amendments to the Regula-tions

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

PART 1— INCOME TAXES

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

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

§ 1.302–2 [Amended]

Par. 2. In § 1.302–2, paragraph (c) is re-moved.

Par. 3. Section 1.302–5 is added to readas follows:

§ 1.302–5 Redemptions taxable asdividends.

(a) In general. In any case in which anamount received in redemption of stock istreated as a distribution of a dividend, anamount equal to the basis of the redeemedstock, after adjusting such basis to reflectthe application of section 301(c)(2), 961(b),1059, § 1.1502–32, or any other appli-cable provision of the Internal RevenueCode or the regulations thereunder, is treatedas a loss recognized on a disposition of theredeemed stock on the date of the redemp-tion. The redeemed shareholder (as de-fined in paragraph (b)(1) of this section)shall be permitted to take such loss into ac-count pursuant to the provisions of this sec-tion. Although such loss may be taken intoaccount on a date later than the date of theredemption, the attributes (e.g., characterand source) of such loss are determined onthe date of the redemption of the stock thatgave rise to such loss. See § 1.1502–19(b)(5) for rules that apply where anamount received in redemption of stock istreated as a dividend and such amount ei-ther increases or creates an excess loss ac-count in the redeemed stock.

(b) Definitions—(1) Redeemed share-holder. Except as provided in paragraphs(d)(6), (7), and (8) of this section, the re-deemed shareholder is the person whosestock is redeemed in a transaction in whicha portion or all of the redemption pro-ceeds are treated as a dividend. If the as-sets of the redeemed shareholder areacquired in a transaction described in sec-

tion 381(a), the acquiring corporation(within the meaning of section 381) there-after is treated as the redeemed shareholder.For rules concerning the person that istreated as the redeemed shareholder wherethe redeemed stock is held by a partner-ship or an S corporation at the time of theredemption, see paragraphs (d)(6) and (7)of this section. For rules concerning the per-son that is treated as the redeemed share-holder where the redeemed stock is held byan estate or a trust not treated as whollyowned by the grantor or another person atthe time of the redemption and a loss at-tributable to the basis of such redeemedstock is distributed to a beneficiary of suchestate or trust, see paragraph (d)(8) of thissection.

(2) Redeeming corporation. Except asprovided in paragraph (d)(5) of this sec-tion, the redeeming corporation is the cor-poration that issued the stock that isredeemed. For rules concerning the entitythat is treated as the redeeming corpora-tion where the redeeming corporation ceasesto exist in a transaction described in sec-tion 381(a) or where the redeeming cor-poration distributes to its shareholders stockof one or more controlled corporations ina distribution described in section 355(a),see paragraph (d)(5) of this section.

(3) Final inclusion date. Except as oth-erwise provided in paragraphs (d)(5), (6),(7), and (8) of this section, the final inclu-sion date is the first date on which the re-deemed shareholder would satisfy thecriteria of section 302(b)(1), (2), or (3) ifthe facts and circumstances that exist at theend of such day had existed immediatelyafter the redemption. In addition, a date isthe final inclusion date if there is no laterdate on which the redeemed shareholdercould take the loss into account. For pur-poses of the preceding sentence, the exist-ence or creation of a limitation under section382 is not treated as preventing the lossfrom being taken into account. For ex-ample, if the redeemed shareholder is an in-dividual, the final inclusion date includesthe date of death of such individual. If theredeemed shareholder is a corporation, thefinal inclusion date includes the date suchcorporation transfers its assets in a liqui-dation described in section 331. If the re-deemed shareholder is a foreign corporation,the final inclusion date includes the datesuch corporation transfers its assets to a do-

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mestic corporation in either a liquidation de-scribed in section 332 or a reorganizationdescribed in section 368(a)(1) to which sec-tion 381 applies. If the redeemed share-holder is a foreign corporation that is nota controlled foreign corporation, within themeaning of section 957(a), on the date ofthe redemption, the term final inclusion dateincludes the date such corporation trans-fers its assets to a controlled foreign cor-poration in a liquidation described in section332 or a reorganization described in sec-tion 368(a)(1) to which section 381 ap-plies.

(4) Accelerated loss inclusion date. Anaccelerated loss inclusion date is a dateother than the final inclusion date on whichthe redeemed shareholder must take into ac-count gain from an actual or deemed saleor exchange of stock of the redeeming cor-poration. For example, the redeemed share-holder must take into account gain from anactual or deemed sale or exchange of stockof the redeeming corporation when suchshareholder receives a distribution with re-spect to stock of the redeeming corpora-tion to which section 301(c)(3) applies,recognizes gain on stock of the redeem-ing corporation as a result of the applica-tion of section 475, recognizes gain on asale or exchange of stock of the redeem-ing corporation (even if such gain is char-acterized as a dividend under section 1248),recognizes gain in connection with a con-structive sale of stock of the redeeming cor-poration within the meaning of section1259, or is a partner of a partnership or ashareholder of an S corporation that is al-located, and must take into account, gainrecognized on the partnership’s or S cor-poration’s sale or exchange of stock of theredeeming corporation.

(c) Inclusion of loss attributable to ba-sis of redeemed stock—(1) Amount takeninto account on final inclusion date. On thefinal inclusion date, the redeemed share-holder is permitted to take into account theloss attributable to the basis of redeemedstock, reduced by the amount of such lossthat was previously taken into account pur-suant to paragraph (c)(2) of this section.

(2) Amount taken into account on ac-celerated loss inclusion date. On an accel-erated loss inclusion date, the redeemedshareholder is permitted to take into ac-count the loss attributable to the basis of re-deemed stock in the amount of the lesserof—

(i) The amount of such loss reduced bythe amount of such loss previously takeninto account pursuant to this paragraph(c)(2); and

(ii) The amount of gain recognized withrespect to stock of the redeeming corpo-ration that must be taken into account bythe redeemed shareholder on such accel-erated loss inclusion date.

(d) Special rules—(1) Treatment of lossattributable to basis of redeemed stock. Ex-cept as otherwise provided in this sec-tion, for purposes of applying the provisionsof the Internal Revenue Code and the regu-lations thereunder, any loss attributable tothe basis of redeemed stock that has notbeen permitted to be taken into accountshall be treated as a net operating loss car-ryforward or a capital loss carryforward, asapplicable. For example, for purposes of de-termining under sections 382 and 383whether the redeemed shareholder is a losscorporation that has an ownership changeand whether the loss attributable to the ba-sis of redeemed stock is a pre-change loss,any loss attributable to the basis of re-deemed stock that the redeemed share-holder is not permitted to take into accountbefore a testing date shall be treated as anet operating loss carryforward or a capi-tal loss carryforward, as applicable, thatarose in the taxable year in which the re-demption that gave rise to such loss oc-curred and that can be carried forward tothe taxable year that includes the testingdate. If such loss is treated as a pre-changeloss because of an ownership change on thetesting date, it is subject to the section 382limitation (and the other rules of section 382or 383) for any post-change year in whichit is taken into account under paragraph (c)of this section and any other post-changeyear to which it is carried pursuant to sec-tion 172 or 1212, as applicable, and para-graph (d)(2) of this section. The order inwhich the loss is absorbed (and in whichit absorbs the section 382 limitation (see§ 1.383–1(d)(2)), however, is determined ina manner consistent with the principles ofsection 172 or 1212, as applicable, andparagraph (d)(2) of this section.

(2) Net operating loss deduction andcapital loss carrybacks and carryovers. Forpurposes of sections 172 and 1212, any por-tion of a loss attributable to the basis of re-deemed stock shall be treated as occurringin the taxable year in which the redeemedshareholder is permitted to take such loss

into account, not the taxable year of the re-demption that gave rise to such loss. If anestate or trust terminates before it is per-mitted to take into account all of the lossattributable to the basis of redeemed stock,such loss that it has not been permitted totake into account is treated as a loss un-der section 172 or 1212 for purposes of sec-tion 642(h), provided, however, that theidentification of carryover years of the ben-eficiaries will be determined in accordancewith the preceding sentence. Notwithstand-ing the preceding sentence, each benefi-ciary’s interest in the loss distributed undersection 642(h) shall be limited to the pro-portion of that loss that is equal to the pro-portion of the total amount of thedistribution treated as a dividend that is rep-resented by that beneficiary’s beneficial in-terest in that dividend. If a deduction forany portion of such loss is disallowed bysection 382 or 383 for the taxable year inwhich the redeemed shareholder is permit-ted to take such loss into account, such por-tion shall be carried forward to subsequenttaxable years under rules similar to the rulesfor the carrying forward of net operatinglosses or capital losses, as applicable, butshall be subject to the section 382 limita-tion (and the other rules of sections 382 and383) for any post-change year to which itis carried.

(3) Expenses apportioned on the basisof assets. For special rules regarding ad-justments in the case of taxpayers appor-tioning expenses on the basis of the taxbook value of assets, see § 1.861–12(c)(2)(vi).

(4) Effect of loss attributable to basis ofredeemed stock on earnings and profits. Ifthe redeemed shareholder is a corpora-tion, any loss attributable to the basis of re-deemed stock is not reflected in suchcorporation’s earnings and profits before itis taken into account pursuant to the rulesof paragraph (c) of this section. See, for ex-ample, §§ 1.312–6(a), 1.312–7, and 1.1502–33(c)(2).

(5) Successors to the redeemingcorporation—(i) Acquisitive transactions.If the assets of the redeeming corporationare acquired by another corporation in atransaction described in section 381(a), thedetermination of whether a particular dateis the final inclusion date or an acceler-ated loss inclusion date is made by treat-ing the facts and circumstances that existat the end of such day (including the ac-

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quisition of the assets of the redeeming cor-poration) as existing immediately after theredemption and treating the acquiring cor-poration (within the meaning of section 381)as the redeeming corporation.

(ii) Divisive transactions. In general, ifthe redeeming corporation distributes to itsshareholders the stock of one or more con-trolled corporations in a distribution towhich section 355 (or so much of section356 as relates to section 355) applies, theloss attributable to the basis of redeemedstock is allocated among the stock of thedistributing and any controlled corpora-tions that the redeemed shareholder owns,actually and constructively pursuant to therules of section 318, immediately after thedistribution in proportion to the fair mar-ket value of the stock of the distributing cor-poration that the redeemed shareholder istreated as so owning and the distributedstock of the controlled corporation that theredeemed shareholder is treated as so own-ing. To the extent that such loss is allo-cated to the stock of the distributingcorporation, the distributing corporation willbe treated as the redeeming corporation forpurposes of determining whether a particu-lar date is the final inclusion date or an ac-celerated loss inclusion date with respect tosuch loss. To the extent that such loss is al-located to the stock of a controlled corpo-ration, such controlled corporation will betreated as the redeeming corporation for pur-poses of determining whether a particulardate is the final inclusion date or an accel-erated loss inclusion date with respect tosuch loss. Where the controlled corpora-tion was wholly owned by the distribut-ing corporation and all of the stock of thecontrolled corporation was distributed to theshareholders of the distributing corpora-tion in a distribution to which section 355(or so much of section 356 as relates to sec-tion 355) applies, the determination ofwhether a particular date is the final inclu-sion date with respect to a loss that is al-located to a controlled corporation is madeby treating the redeemed shareholder asowning a percentage of stock of the con-trolled corporation immediately prior to theredemption equal to the percentage of stockof the distributing corporation the redeemedshareholder actually and constructivelyowned immediately prior to the redemp-tion. In all other cases, appropriate calcu-lations shall apply to determine whether aparticular date is the final inclusion date.

(6) Redeemed shareholder is apartnership—(i) Treatment and alloca-tion of loss attributable to basis of re-deemed stock. Where stock is redeemedfrom a partnership and all or a portion ofthe distribution in redemption of such stockis treated as a dividend, any loss attribut-able to the basis of redeemed stock istreated as a current loss to the partner-ship on the date of the redemption. To theextent of the lesser of the amount of suchdistribution that is treated as a dividend andsuch loss that is not allocated pursuant tosection 704(c) and the regulations there-under, the dividend and the loss must be al-located in equal amounts. Such amountsmust be allocated in accordance with thepartners’ interests in the partnership. An al-location will be deemed to be in accor-dance with a partner’s interest in thepartnership if the allocation is in the sameproportion as the allocation of the excessof the dividend income over the loss at-tributable to the basis of the redeemed stock,if any, the excess of the loss attributable tothe basis of the redeemed stock over thedividend income, if any, or, if neither, in thesame proportion as the partnership’s net tax-able income or loss for the year is allo-cated. The excess dividend or lossattributable to the basis of redeemed stockmust be allocated to the partners in a man-ner that takes into account the require-ments of section 704. The loss attributableto the basis of redeemed stock allocated toa partner under the rules of this section isnot taken into account until the final in-clusion date or an accelerated loss inclu-sion date, as provided in this section.

(ii) Identification of redeemed share-holder. For purposes of determining whethera particular date is the final inclusion datewith respect to a loss that is allocated to apartner, if the partner is a partner of thepartnership at the end of such day, the part-nership is treated as the redeemed share-holder. If the partner is not a partner of thepartnership at the end of such day, theformer partner is treated as the redeemedshareholder and the determination ofwhether such date is the final inclusion dateis made by comparing such former part-ner’s actual and constructive ownership ofthe redeeming corporation immediately priorto the redemption to such former part-ner’s actual and constructive ownership ofthe redeeming corporation at the end ofsuch particular day. For purposes of deter-

mining whether a particular date is an ac-celerated loss inclusion date with respect toa loss attributable to the basis of redeemedstock that is allocated to a partner from apartnership, the partner is treated as the re-deemed shareholder.

(7) Redeemed shareholder is an Scorporation—(i) Treatment and alloca-tion of loss attributable to basis of re-deemed stock. Where stock is redeemedfrom an S corporation and all or a por-tion of the distribution in redemption ofsuch stock is treated as a dividend, any lossattributable to the basis of redeemed stockis treated as a current loss to the S corpo-ration on the date of the redemption and isallocated to the S corporation’s sharehold-ers under section 1366(a). The portion ofsuch loss that is allocated to an S corpo-ration shareholder from the S corporationis not permitted to be taken into account bysuch shareholder until the final inclusiondate or an accelerated loss inclusion date,as provided in this section.

(ii) Identification of redeemed share-holder. For purposes of determining whethera particular date is the final inclusion datewith respect to a loss attributable to the ba-sis of redeemed stock that is allocated toa shareholder of an S corporation from anS corporation, if the S corporation share-holder is a shareholder of the S corpora-tion at the end of such day, the Scorporation is treated as the redeemed share-holder. If the S corporation shareholder isnot a shareholder of the S corporation at theend of such day, the former S corporationshareholder is treated as the redeemedshareholder and the determination ofwhether such date is the final inclusion dateis made by comparing such former S cor-poration shareholder’s actual and construc-tive ownership of the redeeming corporationimmediately prior to the redemption to suchformer S corporation shareholder’s actualand constructive ownership of the redeem-ing corporation at the end of such particu-lar day; provided, however, that for purposesof computing such former S corporationshareholder’s ownership of the redeem-ing corporation immediately prior to the re-demption, section 318(a)(2)(C) shall beapplied without regard to the 50 percentlimitation contained therein. For purposesof determining whether a particular date isan accelerated loss inclusion date with re-spect to a loss attributable to the basis ofredeemed stock that is allocated to an S cor-

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poration shareholder from an S corpora-tion, the S corporation shareholder is treatedas the redeemed shareholder.

(8) Redeemed shareholder is an estateor trust. To the extent that a trust fromwhich stock is redeemed is treated as owned(in part or in whole) by the grantor or an-other person under subpart E of part I ofsubchapter J of the Internal Revenue Code,the rules of this section are applied asthough the redeemed stock were owned di-rectly by such grantor or other person.Where stock is redeemed from an estate orfrom a trust not treated as wholly ownedby the grantor or another person under sub-part E of part I of subchapter J of the In-ternal Revenue Code, and all or a portionof the distribution in redemption of suchstock is treated as a dividend, any loss at-tributable to the basis of redeemed stock,except any loss attributable to the basis ofredeemed stock treated as owned by thegrantor or another person, is not taken intoaccount by such estate or trust until the fi-nal inclusion date or an accelerated loss in-clusion date, and whether a particular dateis the final inclusion date or an acceler-ated loss inclusion date is determined bytreating such estate or trust, not its benefi-ciaries, as the redeemed shareholder. How-ever, if all or a portion of such loss isdistributed to a beneficiary of such estateor trust pursuant to section 642(h) and para-graph (d)(2) of this section, the determi-nation of whether a particular date is thefinal inclusion date or an accelerated in-clusion date shall be made by treating eachsuch beneficiary as the redeemed share-holder with respect to the loss distributedto such beneficiary.

(9) Redeemed shareholder is a C cor-poration that converts to an S corpora-tion. For rules regarding the treatment ofa loss attributable to the basis of redeemedstock when the redeemed shareholder is aC corporation on the date of the redemp-tion and elects to be taxed as an S corpo-ration prior to the final inclusion date or anaccelerated loss inclusion date, see§§ 1.1371–1(a)(1) and 1.1374–5(b)(2).

(e) Statement to be filed with returns.With or as part of the income tax return forthe year in which a redeemed shareholdertakes into account any loss pursuant to thissection, the redeemed shareholder shall pro-vide a statement entitled “Claim of Loss At-tributable to Basis of Redeemed Stock.” Thestatement shall specify the amount of the

loss that is taken into account on such re-turn pursuant to this section and shall iden-tify the shares to which such amounts relate.

(f) Examples. For purposes of the ex-amples in this section, each of corpora-tion X, corporation Y, corporation Z,corporation D, and corporation C is a do-mestic corporation that files U.S. tax re-turns on a calendar-year basis. Theprinciples of this section are illustrated bythe following examples:

Example 1. (i) Facts. A and B, husband and wife,each own 100 shares (50 percent) of the stock of cor-poration X and hold the corporation X stock as a capi-tal asset. A purchased his corporation X shares onFebruary 1, Year 1, for $200. On December 31, Year1, corporation X redeems all of A’s 100 shares of itsstock for $300. At the end of Year 1, corporation Xhas current and accumulated earnings and profits of$200. In connection with the redemption transac-tion, A does not file an agreement described in sec-tion 302(c)(2) waiving the application of the familyattribution rules. The redemption proceeds, there-fore, are treated under section 301(c)(1) as a divi-dend to the extent of corporation X’s earnings andprofits of $200, and under section 301(c)(2) as a re-covery of basis in the amount of $100. On July 1, Year2, B sells all of her shares of corporation X stock toG, her mother.

(ii) Analysis. Under this section, an amount equalto A’s basis in the corporation X stock ($100 after ap-plication of section 301(c)(2)) is treated as a loss rec-ognized on a disposition of the redeemed stock onDecember 31, Year 1, the date of the redemption.When B sells her shares to G, A no longer owns, ac-tually or constructively, any shares of corporation Xstock. Thus, if the facts that existed at the end of July1, Year 2, had existed immediately after the redemp-tion, A would have been treated as having receiveda distribution in part or full payment in exchange forthe redeemed stock pursuant to section 302(a). Un-der this section, therefore, July 1, Year 2, is the fi-nal inclusion date and, on that date, A is permitted totake into account the loss of $100 attributable to hisbasis in the redeemed stock. Because that loss is treatedas having been recognized on a disposition of the re-deemed stock on the date of the redemption, Decem-ber 31 of Year 1, such loss is treated as a short-termcapital loss.

Example 2. (i) Facts. The facts are the same asin Example 1, except that, instead of selling all of her100 shares of corporation X stock to G on July 1, Year2, B sells only 75 shares of corporation X stock to Gon that date.

(ii) Analysis. As in Example 1, an amount equalto A’s basis in the redeemed stock ($100 after appli-cation of section 301(c)(2)) is treated as a loss rec-ognized on a disposition of the redeemed stock onDecember 31, Year 1, the date of the redemption. Im-mediately after B’s sale of 75 shares of corporationX stock to G, A constructively owns 25 percent of theshares of corporation X stock. Thus, if the facts thatexisted at the end of July 1, Year 2, had existed im-mediately after the redemption, A would have beentreated as receiving a distribution in part or full pay-ment in exchange for the redeemed stock pursuant tosection 302(a). Under this section, therefore, July 1,Year 2, is the final inclusion date and, on that date,

A is permitted to take into account the loss of $100attributable to his basis in the redeemed stock. Be-cause that loss is treated as having been recognizedon a disposition of the redeemed stock on the re-demption date, December 31 of Year 1, such loss istreated as a short-term capital loss.

Example 3. (i) Facts. Corporation Y has 200 sharesof common stock outstanding. L, an individual, owns150 shares of common stock in corporation Y and hasowned these shares for several years. The remain-ing 50 shares are owned by K, L’s father. In Year 1,corporation Y redeems 50 shares of L’s corporationY stock, which have a basis of $75, for $200. At theend of Year 1, corporation Y’s current and accumu-lated earnings and profits exceed $200. The redemp-tion of L’s stock is treated as a distribution to whichsection 301 applies. L recognizes dividend income inthe amount of $200. In Year 4, L sells 25 of his re-maining shares of corporation Y stock, which have abasis of $50, to K for $100 and recognizes $50 oflong-term capital gain.

(ii) Analysis. Under this section, an amount equalto L’s basis in the corporation Y stock that is re-deemed, $75, is treated as a loss recognized on a dis-position of the redeemed stock on the date of theredemption. The date on which L sells 25 shares ofcorporation Y stock to K is not the final inclusion dateunder paragraph (b)(3) of this section because L doesnot satisfy the criteria of section 302(b)(1), (2), or (3)at the end of such day. Under paragraph (b)(4) of thissection, however, that date is an accelerated loss in-clusion date because, on that date, L recognizes gainof $50 on a disposition of stock of corporation Y, theredeeming corporation. Thus, on that date, L is per-mitted to take into account $50 of the loss attribut-able to his basis in the redeemed stock. The remaining$25 of such loss is taken into account on the earlierof the final inclusion date or the next accelerated lossinclusion date (to the extent of gain recognized).

Example 4. (i) Facts. The facts are the same asin Example 3, except that L does not sell any sharesof corporation Y to K in Year 4. Instead, in Year 4,corporation Y distributes $75 to L with respect to hisremaining 100 shares of corporation Y stock. L’s ba-sis in these shares is only $30, and at the end of Year4, corporation Y’s current and accumulated earn-ings and profits are $20, instead of $200. Under sec-tion 301(c)(1), $20 of the distribution is treated as adividend, under section 301(c)(2), $30 of the distri-bution is treated as a recovery of basis, and, under sec-tion 301(c)(3), $25 of the distribution is treated as gainfrom the sale or exchange of stock.

(ii) Analysis. As in Example 3, an amount equalto L’s basis in the corporation Y stock redeemed inYear 1, $75, is treated as a loss recognized on a dis-position of the redeemed stock on the date of the re-demption. Because L recognizes gain under section301(c)(3) upon the receipt of the Year 4 distribu-tion, the date of that distribution is an accelerated lossinclusion date. Accordingly, on that date, L is per-mitted to take into account $25 of the loss attribut-able to the basis of the redeemed stock. The remaining$50 of such loss is taken into account on the earlierof the final inclusion date or the next accelerated lossinclusion date (to the extent of gain recognized).

Example 5. (i) Facts. Corporation Z has 100 sharesof stock outstanding, 50 shares of which are ownedby each of A and his son, B. A’s basis in each of hisshares of corporation Z stock is $1. During Year 1,corporation Z redeems from A 25 shares of corpora-

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tion Z stock for $200. At the end of Year 1, corpo-ration Z has current and accumulated earnings andprofits in excess of $200. The redemption is treatedas a distribution to which section 301 applies. Ac-cordingly, A recognizes dividend income of $200. InYear 2, corporation Y acquires all of corporation Z’sassets in exchange solely for voting stock in a reor-ganization described in section 368(a)(1)(C). In thereorganization, A and B surrender their shares of cor-poration Z stock. A receives 2,500 shares of com-mon stock of corporation Y and B receives 5,000shares of common stock of corporation Y. Immedi-ately after the reorganization, corporation Y has out-standing one million shares of common stock.

(ii) Analysis. Under this section, an amount equalto A’s basis in the redeemed stock after the Year 1 re-demption, $25, is treated as a loss recognized on a dis-position of the redeemed stock on the date of theredemption. Under paragraph (d)(5) of this section, forpurposes of determining whether a particular date onor after the date of the reorganization is the final in-clusion date or an accelerated loss inclusion date, cor-poration Y, the acquiring corporation, is treated as theredeeming corporation. If the facts and circumstancesthat exist at the end of the day of the reorganizationhad existed on the date of the redemption, the re-demption would have been treated as a distributionin part or full payment in exchange for the redeemedstock pursuant to section 302(a). Therefore, the dateof the reorganization is the final inclusion date andA is permitted to take into account the loss of $25 at-tributable to his basis in the redeemed stock.

Example 6. (i) Facts. Corporation D has 300 sharesof stock outstanding. J and her two daughters, M andN, each own 100 shares of corporation D stock. J’sbasis in her corporation D shares is $400. In Year 1,corporation D redeems all of J’s shares for $1,000. Atthe end of Year 1, corporation D has current earn-ings and profits exceeding $1,000. The redemption istreated as a distribution to which section 301 ap-plies. Accordingly, J recognizes dividend income inthe amount of $1,000. Subsequently, M and N de-cide to separate corporation D’s business. Accord-ingly, they cause corporation D to contribute one-half of its assets to corporation C, a newly formedcorporation, in exchange for all of corporation C’sstock and to distribute all of the corporation C stockto N in exchange for all of her corporation D stock.Immediately after the distribution, the value of cor-poration D is equal to the value of corporation C. InYear 6, M sells her shares in corporation D to an un-related person.

(ii) Analysis. Under this section, an amount equalto J’s basis in the corporation D stock redeemed, $400,is treated as a loss recognized on a disposition of theredeemed stock on the date of the redemption. Uponcorporation D’s distribution of the stock of corpora-tion C in Year 2, J’s loss attributable to the basis ofthe redeemed corporation D stock is allocated amongthe stock of corporation D and corporation C that Jowns, actually and constructively, immediately afterthe distribution in proportion to the fair market valueof the stock of each such corporation. Although J doesnot actually own any stock of corporation D or cor-poration C, because J constructively owns all of thestock of both corporation D and corporation C andeach of the stock of corporation D and the stock ofcorporation C have the same value immediately af-ter the distribution, $200 of the loss is allocated to eachof the stock of corporation D and the stock of cor-

poration C that J is treated as so owning. Accord-ingly, each of corporation D and corporation C istreated as the redeeming corporation for purposes ofdetermining whether a particular date after the dateof the distribution is an accelerated loss inclusion dateor the final inclusion date with respect to $200 of theloss. In this case, the date in Year 6 on which M sellsher corporation D stock to an unrelated person is thefinal inclusion date with respect to J’s loss allocatedto J’s constructively owned corporation D stock, be-cause had corporation D’s distribution of corpora-tion C stock occurred immediately after the redemptionof J’s stock and M’s Year 6 sale of corporation D stockoccurred immediately thereafter in Year 1, the re-demption of J’s corporation D stock would have beentreated as a distribution in part or full payment in ex-change for the redeemed stock pursuant to section302(a). Accordingly, on that date in Year 6, J is per-mitted to take into account the $200 loss allocated tothe corporation D stock. The $200 loss allocated tothe corporation C stock is taken into account on theearlier of the final inclusion date or the next accel-erated loss inclusion date (to the extent of gain rec-ognized) with respect to the corporation C stock.

Example 7. (i) Facts. In Year 1, A and B, two un-related individuals, each contribute $100 to form a50–50 general partnership, PS. A and B share in theincome of PS equally. PS buys 100 shares of corpo-ration Z stock for $200. A owns the remaining 400outstanding shares of corporation Z stock directly. InYear 2, corporation Z redeems all of PS’s shares for$300. At that time, the basis of A’s interest in PS is$100 and the basis of B’s interest in PS is $100. Atthe end of Year 2, corporation Z has current and ac-cumulated earnings and profits of $150. Because A’sownership of the Z stock is attributed to PS under sec-tion 318(a)(3)(A), the redemption is treated as a dis-tribution to which section 301 applies. The redemptionproceeds, therefore, are treated as a dividend to theextent of corporation Z’s earnings and profits, $150,and as a recovery of basis in the amount of $150. As-sume that PS’s only items of income, gain, loss, de-duction, and credit for Year 2 arise from the redemptionof the corporation Z stock. On January 1 of Year 4,A sells his entire interest in PS to C, an unrelated in-dividual.

(ii) Analysis. Under this section, an amount equalto PS’s basis in the corporation Z stock, ($50 after ap-plication of section 301(c)(2)), is treated as a cur-rent loss recognized by the partnership on a dispositionof the redeemed stock on the date of the redemp-tion. Under this section, $50 of the dividend and $50of the loss must be allocated in equal amounts in ac-cordance with A’s and B’s interests in PS. Accord-ingly, if the remaining $100 of the dividend is allocated$50 to A and $50 to B under section 704 and the regu-lations thereunder, $25 of each of the dividend andthe loss is allocated to each of A and B. A’s and B’sbasis in their PS interests are increased by their sharesof the dividend and decreased by their shares of theloss attributable to the basis of the redeemed stock.A and B will not be able to take that loss into ac-count until the final inclusion date or an acceleratedloss inclusion date. When A sells his PS interest to C,an unrelated individual, PS and A are no longer re-lated. Therefore, PS no longer owns, actually or con-structively, any shares of corporation Z stock. BecauseB remains a partner in PS after January 1, Year 4, PSis treated as the redeemed shareholder for purposesof determining if January 1, Year 4, is the final in-

clusion date for B. If the facts that exist at the endof the day of A’s sale of his PS interest to C had ex-isted immediately after the redemption, PS would havebeen treated as receiving a distribution in part or fullpayment in exchange for the redeemed stock pursu-ant to section 302(a). Therefore, B is permitted to takeinto account the $25 loss attributable to the basis ofthe redeemed stock that was allocated to him. Be-cause A is no longer a partner in PS after January 1,Year 4, A is treated as the redeemed shareholder forpurposes of determining if January 1, Year 4, is thefinal inclusion date for A. Immediately prior to the re-demption, A actually and constructively owns 90 per-cent of the corporation Z stock. After the sale of thePS interest, A actually owns 100 percent of the cor-poration Z stock. If these facts had existed immedi-ately after the redemption, A would not have beentreated as receiving a distribution in part or full pay-ment in exchange for the redeemed stock pursuant tosection 302(a). Therefore, January 1, Year 4, is not thefinal inclusion date for A.

Example 8. (i) Facts. H, I, and J are sharehold-ers in corporation S, a corporation that has made avalid election to be taxed as an S corporation. H, I,and J respectively hold 60 percent, 20 percent, and 20percent of the stock in corporation S. H, I, and J haveno relation to each other apart from their ownershipinterests in corporation S. Corporation S owns 20 per-cent of the outstanding shares of corporation X witha $100 adjusted basis. H owns the remaining out-standing shares of corporation X. In Year 1, all of cor-poration S’s shares of corporation X stock areredeemed for their fair market value, $200. Corpo-ration X has current and accumulated earnings andprofits of $300 at the end of Year 1. Because H’s own-ership of X stock is attributed to corporation S un-der section 318(a)(2)(C), the redemption is treated asa distribution to which section 301 applies and istreated as a dividend. H, I, and J will be allocated$120, $40, and $40 of dividend income, respectively.In Year 2, J sells his stock of corporation S to K, anunrelated person. In Year 3, H sells his stock of cor-poration X to L, an unrelated person.

(ii) Analysis. Under this section, an amount equalto corporation S’s basis in the redeemed stock ($100)is treated as a loss recognized on a disposition of theredeemed stock on the date of the disposition. H, I,and J will be allocated $60, $20, and $20 of the loss,respectively, in the year of the redemption. Both theallocation of dividend income and the allocation ofthe loss give rise to adjustments to each sharehold-er’s basis in corporation S. H, I, and J, however, willnot be able to take into account this loss until the fi-nal inclusion date or an accelerated loss inclusion date.In Year 2, when J sells his stock of corporation S toK, J is no longer a shareholder in corporation S andwill be treated as the redeemed shareholder for pur-poses of determining whether a particular date is thefinal inclusion date or an accelerated loss inclusiondate. In addition, the determination of whether the dateof the Year 2 sale is the final inclusion date for J ismade by comparing J’s actual and constructive own-ership of corporation S stock immediately prior to theredemption to J’s actual and constructive ownershipof corporation S stock at the end of the date of theYear 2 sale. However, for purposes of computing J’sownership of the redeeming corporation immedi-ately prior to the redemption, section 318(a)(2)(C) isapplied without regard to the 50 percent limitation con-tained therein. Immediately prior to the redemption,

November 4, 2002 786 2002–44 I.R.B.

therefore, J is treated as owning actually and con-structively 4 percent of the stock of corporation X and,at the end of the day of J’s sale of corporation S stock,J owns, actually and constructively, no corporation Xstock. Therefore, if the facts that existed on the dateof the Year 2 sale had existed immediately after theredemption, J would have been treated as having re-ceived a distribution in part or full payment in ex-change for the redeemed stock pursuant to section302(a). Therefore, the date of J’s sale of corporationS stock to K is the final inclusion date. J is permit-ted to take into account J’s share of the loss attrib-utable to the basis of the redeemed stock as of thatdate. While H and I remain shareholders of corpora-tion S, whether a particular date is the final inclu-sion date will be determined by treating corporationS as the redeemed shareholder. Thus, in Year 3 whenH disposes of his shares of corporation X, corpora-tion S actually and constructively owns no stock ofcorporation X. As of that date, therefore, H and I willbe permitted to take into account their respective sharesof the loss attributable to the basis of the redeemedstock.

(g) Effective date. This section appliesto transactions occurring after the date theseregulations are published as final regula-tions in the Federal Register.

Par. 4. Section 1.304–1 is revised to readas follows:

§ 1.304–1 In general.

(a) In general. Section 304 is appli-cable where a shareholder sells stock of onecorporation to a related corporation as de-fined in section 304. Sales to which sec-tion 304 is applicable shall be treated asredemptions subject to sections 302 and303.

(b) Effective date. This section appliesto transactions occurring after the date theseregulations are published as final regula-tions in the Federal Register.

Par. 5. Section 1.304–2 is amended asfollows:

1. Paragraphs (a) and (c) are revised.2. Paragraph (d) is added.The revisions and addition read as

follows:

§ 1.304–2 Acquisition by relatedcorporation (other than subsidiary).

(a) In general. (1) If a corporation (theacquiring corporation), in return for prop-erty, acquires stock of another corpora-tion (the issuing corporation) from one ormore persons, and the person or personsfrom whom the stock was acquired were incontrol of both such corporations, then suchproperty shall be treated as received in re-demption of stock of the acquiring corpo-ration. As to each person transferring stock,the amount received shall be treated as a

distribution to which section 301 applies ifsection 302(a) or 303 does not apply. Forrules regarding the amount constituting adividend in such cases, see § 1.304–6.

(2) In applying section 302(b), refer-ence shall be had to the shareholder’s own-ership of stock in the issuing corporationand not to its ownership of stock in the ac-quiring corporation (except for purposes ofapplying section 318(a)), section 318(a) (re-lating to the constructive ownership ofstock) shall be applied without regard to the50 percent limitation contained in section318(a)(2)(C) and (3)(C), and a series of re-demptions referred to in section302(b)(2)(D) shall include acquisitions byeither of the corporations of stock of theother and stock redemptions by both cor-porations.

(3) If, pursuant to section 302(d), sec-tion 301 applies to the property treated asreceived in redemption of stock of the ac-quiring corporation pursuant to paragraph(a)(1) of this section, the transferor and theacquiring corporation shall be treated, forall Federal income tax purposes, in the samemanner as if the transferor had transferredthe stock of the issuing corporation to theacquiring corporation in exchange for stockof the acquiring corporation in a transac-tion to which section 351(a) applies, andthen the acquiring corporation had redeemedthe stock it was treated as issuing in thetransaction in exchange for the property. Ac-cordingly, under section 362, the acquir-ing corporation’s basis in the stock of theissuing corporation is equal to the basis thetransferor had in that stock and, under sec-tion 358, the transferor’s basis in the stockof the acquiring corporation deemed is-sued to the transferor in the deemed trans-action to which section 351(a) applies isequal to the transferor’s basis in the stockof the issuing corporation it surrendered.Section 1.302–5 applies to the transfer-or’s unutilized basis, if any, in the stock ofthe acquiring corporation treated as re-deemed in connection with an acquisitiondescribed in paragraph (a)(1) of this sec-tion by treating the acquiring corporationas the redeeming corporation and the trans-feror as the redeemed shareholder.

(4) If section 301 does not apply to theproperty treated as received in redemp-tion of stock of the acquiring corporationpursuant to paragraph (a)(1) of this sec-tion, the property received by the trans-feror shall be treated as received in a

distribution in full payment in exchange forstock of the acquiring corporation undersection 302(a). The basis and holding pe-riod of the stock of the acquiring corpora-tion that is treated as having been redeemedshall be the same as the basis and hold-ing period of the stock of the issuing cor-poration actually surrendered. The acquiringcorporation shall take a cost basis in thestock of the issuing corporation that it ac-quires. See section 1012.

* * * * *(c) Examples. For purposes of the ex-

amples in this section, each of corpora-tion X and corporation Y is a domesticcorporation that files U.S. tax returns on acalendar-year basis. The principles of thissection are illustrated by the followingexamples:

Example 1. (i) Facts. Corporation X and corpo-ration Y each have outstanding 100 shares of com-mon stock. A, an individual, owns one-half of the stockof each corporation, B owns one-half of the stock ofcorporation X, and C owns one-half of the stock ofcorporation Y. A, B, and C are unrelated. A sells 30shares of the stock of corporation X, which have anadjusted basis of $10,000, to corporation Y for $50,000.

(ii) Analysis. Because before the sale A owns 50percent of the stock of corporation X and after the saleA owns only 35 percent of such stock (20 shares di-rectly and 15 constructively because one-half of the30 shares owned by corporation Y are attributed to A),the redemption is substantially disproportionate as toA pursuant to the provisions of section 302(b)(2). A,therefore, realizes a gain of $40,000 ($50,000 mi-nus $10,000). If the stock surrendered is a capital as-set, such gain is long-term or short-term capital gaindepending on the period of time that such stock washeld. The basis to A for the stock of corporation Y isnot changed as a result of the sale. Under section 1012,the basis that corporation Y takes in the acquired stockof corporation X is its cost of $50,000.

Example 2. (i) Facts. Corporation X and corpo-ration Y each have outstanding 200 shares of com-mon stock, all of which are owned by H, an individual.H has a basis in his corporation X stock of $60 andin his corporation Y stock of $30. Corporation X has$80 of current and accumulated earnings and profitsand corporation Y has $80 of current and accumu-lated earnings and profits. H sells his 200 shares ofcorporation X stock to corporation Y for $150.

(ii) Analysis. Because H is in control of both cor-poration X and corporation Y and receives propertyfrom corporation Y in exchange for the corporationX stock, H’s sale of 200 shares of corporation X stockto corporation Y is subject to section 304(a)(1). Ac-cordingly, H is treated as receiving $150 as a distri-bution in redemption of corporation Y stock. BecauseH actually owns 100 percent of corporation X be-fore the sale and is treated as owning 100 percent ofcorporation X after the sale, pursuant to section 302(d),section 302(a) does not apply to the deemed redemp-tion distribution and the proceeds of the deemed re-demption are treated as a distribution to which section301 applies. Therefore, H is treated as transferring thecorporation X stock to corporation Y in exchange for

2002–44 I.R.B. 787 November 4, 2002

corporation Y stock in a transaction to which sec-tion 351(a) applies. Corporation Y’s basis in the cor-poration X stock acquired is $60, the same basis thatH had in the corporation X stock surrendered. H takesa basis of $60 in the corporation Y stock he is treatedas receiving in the deemed section 351 exchange. Thatcorporation Y stock is then treated as redeemed by cor-poration Y for $150. Under section 302, that redemp-tion is treated as a distribution to which section 301applies because H owns directly 100 percent of cor-poration Y both before and after the redemption of thecorporation Y stock that was deemed issued. Thus, thedeemed redemption proceeds are treated as a distri-bution to which section 301 applies. Pursuant to§ 1.304–6(a), H is treated as receiving a dividend of$150 ($80 from the current and accumulated earn-ings and profits of corporation Y and then $70 fromthe current and accumulated earnings and profits ofcorporation X). An amount equal to the basis in thecorporation Y stock that H is deemed to receive andthat is deemed redeemed, $60 is treated as a loss rec-ognized on a disposition of the stock deemed re-deemed on the date of the deemed redemption and istaken into account under rules set forth in § 1.302–5.H’s basis in the 200 shares of corporation Y stock thatH owned before the sale and continues to own im-mediately after the sale remains $30.

Example 3. (i) Facts. The facts are the same asin Example 2, except that corporation X has $5 of cur-rent and accumulated earnings and profits and cor-poration Y has $25 of current and accumulatedearnings and profits.

(ii) Analysis. As in Example 2, H takes a basis of$60 in the corporation Y stock he is treated as re-ceiving and $150 is treated as a distribution to whichsection 301 applies. Pursuant to § 1.304–6(a), H istreated as receiving a dividend of $30 ($25 from thecurrent and accumulated earnings and profits of cor-poration Y and $5 from the current and accumu-lated earnings and profits of corporation X). Inaddition, $60 of the distribution is treated as a re-turn of basis and $60 of the distribution is treated asgain from the sale or exchange of corporation Y stock.H’s basis in the 200 shares of corporation Y stock thathe owned before and continues to own immediatelyafter the sale remains $30. Corporation Y’s basis inthe corporation X stock acquired is $60, the same ba-sis that H had in the corporation X stock surren-dered.

Example 4. (i) Facts. A, an individual, owns 100shares of corporation X stock, which is all of the out-standing stock of corporation X. A has a basis of $1in each share of his corporation X stock. B, the sonof A, owns all the outstanding stock of corporationY. A sells 25 shares of the stock of corporation X tocorporation Y for $50. For that year, the current andaccumulated earnings and profits of corporation Y ex-ceed $50.

(ii) Analysis. Because A is in control of both cor-poration X and corporation Y (corporation X di-rectly and corporation Y through attribution from B)and receives property in exchange for the corpora-tion X stock, A’s sale of corporation X stock to cor-poration Y is subject to section 304(a)(1).Consequently, A is treated as transferring the corpo-ration X stock to corporation Y in exchange for cor-poration Y stock in a transaction to which section351(a) applies. That corporation Y stock is then treatedas redeemed by corporation Y for $50. Before thedeemed redemption of the corporation Y stock, A

owned 100 percent of corporation Y directly and con-structively. After the deemed redemption, A owns 100percent of corporation Y constructively by attribu-tion from B. Accordingly, the redemption distribu-tion is treated as a distribution to which section 301applies. Because the earnings and profits of corpo-ration Y exceed the amount of cash paid by corpo-ration Y to A for the corporation X stock, pursuant to§ 1.304–6(a), the entire amount is a dividend. Anamount equal to the basis in the corporation Y stockthat A was deemed to receive and that was thendeemed redeemed, $25, is treated as a loss recog-nized on a disposition of the stock deemed redeemedon the date of the deemed redemption and is taken intoaccount under rules set forth in §1.302–5. A’s basisin the 75 shares that he continues to hold remains $1per share for an aggregate basis of $75.

(d) Effective date. This section, exceptfor paragraph (b) of this section, applies totransactions occurring after the date theseregulations are published as final regula-tions in the Federal Register. Paragraph (b)of this section applies on and after Decem-ber 2, 1955.

Par. 6. Section 1.304–3 is amended asfollows:

1. Paragraph (a) is revised.2. Paragraph (c) is added.The revision and addition read as

follows:

§ 1.304–3 Acquisition by a subsidiary.

(a) In general. If a subsidiary, in re-turn for property, acquires stock of its par-ent corporation from a shareholder of theparent corporation, the acquisition of suchstock shall be treated as if the parent cor-poration had redeemed its own stock in ex-change for the property. For purposes of thissection, a corporation is a parent corpora-tion if it meets the 50 percent ownership re-quirements of section 304(c). Thedetermination of whether the amount re-ceived shall be treated as an amount re-ceived in payment in exchange for the stockshall be made by applying section 303, orby applying section 302(b) with referenceto the stock of the issuing parent corpora-tion. For rules regarding the amount thatconstitutes a dividend in a redemptiontreated as a distribution subject to section301, see § 1.304–6. For the treatment of theredeemed shareholder’s basis in the re-deemed stock in such cases, see § 1.302–5.Section 1.302–5 applies to the sharehold-er’s unutilized basis, if any, in the stock ofthe parent corporation treated as redeemedin connection with an acquisition describedin this paragraph (a) by treating the par-

ent corporation as the redeeming corpora-tion and the shareholder as the redeemedshareholder.

* * * * *(c) Effective date. This section applies

on and after December 2, 1955, except forparagraph (a) of this section, which ap-plies to transactions occurring after the datethese regulations are published as final regu-lations in the Federal Register.

Par. 7. Section 1.304–5 is amended asfollows:

1. Paragraph (a) is amended by addinga sentence at the end of the paragraph.

2. Paragraph (c) is revised.The revision and addition read as

follows:

§ 1.304–5 Control.

(a) * * * Specifically, section 318(a)shall be applied by using the language “5percent” instead of “50 percent” in sec-tion 318(a)(2)(C) and by using the lan-guage “5 percent” instead of “50 percent”in section 318(a)(3)(C), except that if sec-tion 318(a)(3)(C) would not have appliedbut for this substitution, by considering acorporation as owning the stock (other thanstock in such corporation) owned by or forany shareholder of such corporation in thatproportion which the value of the stockwhich such shareholder owned in such cor-poration bears to the value of all stock insuch corporation.

* * * * *(c) Effective date. This section applies

on and after January 20, 1994, except thelast sentence of paragraph (a) of this sec-tion applies to transactions occurring af-ter the date these regulations are publishedas final regulations in the Federal Regis-ter.

Par. 8. Section 1.304–6 is added to readas follows:

§ 1.304–6 Amount constituting adividend.

(a) In general. The determination of theamount of the property that is a dividendis made as if the property were distrib-uted by the acquiring corporation to the ex-tent of its earnings and profits and then bythe issuing corporation to the extent of itsearnings and profits. Where, however, theacquiring corporation is a foreign corpo-ration, for purposes of the preceding sen-tence, the earnings and profits of the

November 4, 2002 788 2002–44 I.R.B.

acquiring corporation are taken into ac-count only to the extent that they—

(1) Are attributable to stock of the ac-quiring corporation owned (within themeaning of section 958(a)) by a corpora-tion or individual that is—

(i) A United States shareholder (withinthe meaning of section 951(b)) of the ac-quiring corporation; and

(ii) The transferor or a person who bearsa relationship to the transferor described insection 267(b) or 707(b); and

(2) Were accumulated during the pe-riod or periods such stock was owned bysuch person while the acquiring corpora-tion was a controlled foreign corporation.

(b) Effective date. This section appliesto transactions occurring after the date theseregulations are published as final regula-tions in the Federal Register.

Par. 9. Section 1.704–1 is amended byadding paragraph (b)(4)(viii) to read asfollows:

§ 1.704–1 Partner’s distributive share.

* * * * *

(b) * * *(4) * * *(viii) Loss attributable to basis of re-

deemed stock under § 1.302–5. For rules re-garding allocations on a redemption of stockall or a portion of which is treated as a divi-dend, see § 1.302–5(d)(6)(i).

* * * * *Par. 10. Section 1.861–12 is added to

read as follows:

§ 1.861–12 Characterization rules andadjustments for certain assets.

(a) through (c)(2)(v) [Reserved]. For fur-ther guidance, see § 1.861–12T(a) through(c)(2)(v).

(c)(2)(vi) Adjustments in respect of re-deemed stock for taxpayers using the taxbook value method. Solely for purposes ofapportioning expenses on the basis of thetax book value of assets, the adjusted ba-sis of any stock in a 10 percent owned cor-poration owned directly by a taxpayer thatis a redeemed shareholder (as defined in§ 1.302–5(b)(1)) with respect to such cor-poration shall be increased by the amountof any loss that has not been taken into ac-count under § 1.302–5(c) as of the close ofthe redeemed shareholder’s taxable year(unrecovered loss). If the redeemed share-

holder does not own directly any shares inthe 10 percent owned corporation as of theend of the taxable year, but is treated forpurposes of section 302(b) as owning sharesactually owned by another member of theredeemed shareholder’s affiliated group, asdefined in section 1504(a), or by a corpo-ration that is either an affiliate described in§ 1.904(i)–1(b)(1) or an affiliated corpo-ration described in § 1.861–11T(d)(6) withrespect to the redeemed shareholder, thenthe adjusted basis of the shares in the 10percent owned corporation, if any, that areowned by such other corporation or cor-porations shall be increased by the amountof the redeemed shareholder’s unrecov-ered loss (and allocated among such cor-porations, if applicable, in proportion to theirrelative adjusted bases (as adjusted pursu-ant to this paragraph and § 1.861–12T(c)(2))in the stock of the redeeming corpora-tion). These adjustments are to be made an-nually and are noncumulative.

(vii) Examples. [Reserved]. Certain of therules of this paragraph (c)(2) may be illus-trated by the following examples:

Examples 1 and 2. [Reserved]. For further guid-

ance, see § 1.861–12T(c)(2)(vii), Examples 1 and 2.

Example 3. The facts are the same as in § 1.861–12T(c)(2)(vii) Example 2, except that the taxable yearis 2003, and during the taxable year Y redeems someof the shares of its stock held by X for $100,000. X’sadjusted basis in the redeemed shares is $50,000. Be-cause X still owns all of the outstanding stock of Y,the redemption is treated as a distribution with re-spect to the stock of Y under section 301. Under§ 1.302–5, X’s $50,000 adjusted basis in the re-deemed shares is treated as a loss recognized on thedate of the redemption, none of which is taken intoaccount in 2003. X invests the $100,000 of redemp-tion proceeds in assets that generate foreign source gen-eral limitation income. Under paragraph (c)(2)(vi) ofthis section, X’s adjusted basis in its remaining Y stockis considered to be $2,000,000 ($1,950,000 adjustedbasis in the Y stock plus $50,000 unrecovered loss inthe redeemed shares). X’s adjusted basis of assets thatgenerate foreign source general limitation income isconsidered to be $2,500,000 ($2,000,000 adjusted ba-sis in the Y stock plus $500,000 other assets), and theresulting apportionment of interest expense is the sameas in § 1.861–12T(c)(2)(vii) Example 2.

(c)(3) through (j) [Reserved]. For fur-ther guidance, see § 1.861–12T(c)(3)through (j).

Par. 11. Section 1.861–12T is amendedas follows:

1. Paragraph (c)(2)(vi) is redesignated asparagraph (c)(2)(vii).

2. New paragraph (c)(2)(vi) is added.

The addition reads as follows:

§ 1.861–12T Characterization rules andadjustments for certain assets(temporary regulations.)

* * * * *

(c) * * *(2) * * *(vi) [Reserved]. For further guidance, see

§ 1.861–12(c)(2)(vi).

* * * * *Par. 12. Section 1.1371–1 is added to

read as follows:

§ 1.1371–1 Coordination withsubchapter C.

(a) No carryover between C and Syears—(1) Loss attributable to basis of re-deemed stock. A loss described in § 1.302–5(a) is treated as a carryforward arising ina taxable year for which a corporation is aC corporation. Therefore, it may not be car-ried to a taxable year for which such cor-poration is an S corporation.

(2)[Reserved].(b) Effective date. This section applies

to transactions occurring after the date theseregulations are published as final regula-tions in the Federal Register.

Par. 13. In § 1.1374–5, paragraph (a) isamended by adding a sentence at the endof the paragraph.

§ 1.1374–5 Loss carryforwards.

(a) In general. * * * However, for re-demptions of stock occurring after the datethese regulations are published as final regu-lations in the Federal Register, a loss at-tributable to the basis of redeemed stock thatis taken into account pursuant to the rulesof § 1.302–5 is allowed for purposes of sec-tion 1374(b)(2) as a deduction against netrecognized built-in gain of the S corpora-tion for the taxable year, provided that theloss arose in a year in which the corpora-tion was a C corporation.

* * * * *Par. 14. In § 1.1374–10, paragraph (a)

is revised to read as follows:

§ 1.1374–10 Effective date andadditional rules.

(a) In general. Except as providedin § 1.1374–5(a), §§ 1.1374–1 through

2002–44 I.R.B. 789 November 4, 2002

1.1374–9 apply for taxable years ending onor after December 27, 1994, but only incases where the S corporation’s return forthe taxable year is filed pursuant to an Selection or a section 1374(d)(8) transac-tion occurring on or after December 27,1994.

* * * * *Par. 15. In § 1.1502–13, paragraph (f)(7)

Example 3(b) is revised to read as follows:

§ 1.1502–13 Intercompany transactions.

* * * * *(f) * * *(7) * * *Example 3. * * *(b) Treatment as a section 301 distribution. The

merger of S into B is a transaction to which para-graph (f)(3) of this section applies. P is treated as re-ceiving additional B stock with a fair market value of$500 and, under section 358, a basis of $250. Imme-diately after the merger, $150 of the stock receivedis treated as redeemed, and the redemption is treatedunder section 302(d) as a distribution to which sec-tion 301 applies. Because the $150 distribution istreated as not received as part of the merger, sec-tion 356 does not apply and no basis adjustments arerequired under section 358(a)(1)(A) and (B). Be-cause B is treated under section 381(c)(2) as receiv-ing S’s earnings and profits and the redemption istreated as occurring after the merger, $100 of the dis-tribution is treated as a dividend under section 301 andP’s basis in the B stock is reduced correspondinglyunder § 1 .1502–32. Under paragraph (f)(2)(ii) of thissection, P’s $100 of dividend income is not includedin gross income. Accordingly, P has a $75 excess lossaccount in the redeemed stock. That excess loss ac-count is treated as income recognized on a disposi-tion of the redeemed stock on the date of theredemption and is taken into account under the rulesof § 1.1502–19(b)(5).

* * * * *Par. 16. Section 1.1502–19 is amended

as follows:1. Paragraph (b)(2)(i) is amended by

adding a sentence at the end of the para-graph.

2. Paragraph (b)(5) is added.3. Paragraph (g) Example 7 is added.4. The heading for paragraph (h) is re-

vised.5. The first sentence of paragraph (h)(1)

is removed and two new sentences areadded in its place.

The revisions and additions read asfollows:

§ 1.1502–19 Excess loss accounts.

* * * * *(b) * * *(2) * * * (i) * * * As another example,

if S redeems (or is treated as redeeming)

P’s S stock and, as a result, an excess lossaccount is either increased or created in suchredeemed stock, P takes into account suchexcess loss account under the rules of para-graph (b)(5) of this section.

* * * * *(5) Redemptions of member stock; treat-

ment of excess loss account in redeemedstock—(i) In general. In any case in whichan amount received in redemption of Sstock is treated as a distribution to P towhich section 301 applies and such amounteither increases or creates an excess loss ac-count in the redeemed S stock, after ad-justing such basis or excess loss account toreflect the application of section 301(c)(2),section 1059, § 1.1502–32, or any other ap-plicable provision of the Internal Rev-enue Code or the regulations thereunder,such excess loss account is treated as in-come (ordinary income or gain) recog-nized on a disposition of the redeemed stockon the date of the redemption. Such in-come shall be taken into account by P un-der the provisions of this paragraph (b)(5).

(ii) Inclusion of gain attributable to ex-cess loss account in redeemed stock—(A)Amount taken into account on final inclu-sion date. On the final inclusion date (asdefined in § 1.302–5(b)(3)), P must in-clude in income as ordinary income or gainthe excess loss account in the redeemedstock, reduced by any amounts of such ex-cess loss account that are taken into ac-count pursuant to the provisions ofparagraph (b)(5)(ii)(B) of this section.

(B) Amount taken into account on ac-celerated income inclusion date. (1) On anaccelerated income inclusion date (as de-fined in paragraph (b)(5)(ii)(B)(2) of thissection), P must include in income as or-dinary income or gain the excess loss ac-count of the redeemed stock to the extentof the lesser of—

(i) The amount of such excess loss ac-count reduced by the amount of such ex-cess loss account previously taken intoaccount pursuant to this paragraph (b)(5)(ii);and

(ii) The amount of loss recognized on thedisposition of stock of S that the group ofwhich P is a member is permitted to takeinto account on such accelerated income in-clusion date without regard to the applica-tion of § 1.337(d)–2T.

(2) An accelerated income inclusion dateis a date on which P is permitted to takeinto account a loss recognized on a dispo-

sition of S stock without regard to the ap-plication of § 1.337(d)–2T.

(iii) Application of other rules. In ad-dition to the rules set forth in this para-graph (b)(5), the rules of § 1.302–5(d) applyfor purposes of determining the appropri-ate time to take into account any portion ofan excess loss account in redeemed stockby treating P as the redeemed shareholderand S as the redeeming corporation. How-ever, the rules of § 1.302–5(d) shall be ap-plied by using the language “acceleratedincome inclusion date” instead of “accel-erated loss inclusion date” each time thatterm appears.

(iv) Statement to be filed with returns.With or as part of the income tax return forthe year in which P takes into account anyincome attributable to an excess loss ac-count in redeemed stock, P shall provide astatement entitled “Inclusion of Income At-tributable to Excess Loss Account in Re-deemed Stock.” The statement shall specifythe amount of the income that is taken intoaccount on such return pursuant to this para-graph (b)(5) and shall identify the sharesto which such amounts relate.

* * * * *(g) * * *Example 7.Redemption of member stock. (a) Facts.

P directly owns all of the outstanding stock of S1 andS2. S1 and S2 each own 50 shares of S3’s outstand-ing 100 shares of stock. P is the common parent ofthe consolidated group. S1’s adjusted basis in the S3stock is $50. In Year 1, S3 redeems all of its stockfrom S1 for $100. In Year 2, P sells all of its sharesof S1 stock to an unrelated party.

(b) Analysis. In Year 1, because S1 actually andconstructively owns 100 percent of stock of S3 im-mediately before and immediately after the redemp-tion, the redemption is treated as a distribution to whichsection 301 applies. S3’s distribution is an intercom-pany distribution under § 1.1502–13(f)(2)(ii) and ex-cluded from S1’s gross income. Under § 1.1502–32,S1’s basis in S3’s stock is reduced by the amount ofthe distribution, creating an excess loss account of $50.Pursuant to paragraph (b)(5)(i) of this section, that ex-cess loss account is treated as income recognized ona disposition of the redeemed stock on the date of theredemption. That income, however, is not taken intoaccount on such date. Instead, it is taken into ac-count on the date on which S1 departs from the con-solidated group as that date is the final inclusion datebecause, if the facts that exist at the end of that dayhad existed immediately after the redemption, the re-demption would have been treated as a distributionin part or full payment in exchange for the redeemedstock pursuant to section 302(b)(3). Accordingly, S1must include in its income as gain an amount equalto the excess loss account in the redeemed S3 stock.

(h) Effective dates—(1) Application. Thissection, except for the last sentence of para-graph (b)(2)(i), and paragraphs (b)(5) and

November 4, 2002 790 2002–44 I.R.B.

(g) Example 7 of this section, applies withrespect to determinations of the basis of (in-cluding an excess loss account in) the stockof a member in consolidated return yearsbeginning on or after January 1, 1995. Thelast sentence of paragraph (b)(2)(i), andparagraphs (b)(5) and (g) Example 7 of thissection apply to transactions occurring af-ter the date these regulations are publishedas final regulations in the Federal Regis-ter. * * *

* * * * *

David A. Mader,Acting Deputy Commissioner

of Internal Revenue.

(Filed by the Office of the Federal Register onOctober 17, 2002, 8:45 a.m., and published in the is-sue of the Federal Register for October 18, 2002, 67F.R. 64331)

Notice of ProposedRulemaking and Notice ofPublic Hearing

Disclosure of Relative Valuesof Optional Forms of Benefit

REG–124667–02

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposedrulemaking and notice of public hearing.

SUMMARY: This document contains pro-posed regulations that would consolidate thecontent requirements applicable to expla-nations of qualified joint and survivor an-nuities and qualified preretirement survivorannuities payable under certain retirementplans, and would specify requirements fordisclosing the relative value of optionalforms of benefit that are payable from cer-tain retirement plans in lieu of a qualifiedjoint and survivor annuity. These regula-tions would affect retirement plan spon-sors and administrators, and participants inand beneficiaries of retirement plans. Thisdocument also provides notice of a pub-lic hearing on these proposed regulations.

DATES: Written comments, requests tospeak and outlines of oral comments to bediscussed at the public hearing scheduled

for January 14, 2003, at 10 a.m., must bereceived by January 2, 2003.

ADDRESSES: Send submissions to:CC:ITA:RU (REG–124667–02), room 5226,Internal Revenue Service, POB 7604, BenFranklin Station, Washington, DC 20044.In the alternative, submissions may be handdelivered to: CC:ITA:RU (REG–124667–02), room 5226, Internal Revenue Ser-vice, 1111 Constitution Avenue, NW,Washington, DC. Alternatively, taxpayersmay submit comments electronically via theInternet by submitting comments directlyto the IRS Internet site at: www.irs.gov/regs. The public hearing will be held inroom 4718 of the Internal Revenue Build-ing, 1111 Constitution Avenue, NW, Wash-ington, DC.

FOR FURTHER INFORMATIONCONTACT: Concerning the regulations,Linda S. F. Marshall, 202–622–6090; con-cerning submissions and the hearing, and/orto be placed on the building access list toattend the hearing, Guy Traynor, 202–622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information containedin this notice of proposed rulemaking havebeen submitted to the Office of Manage-ment and Budget for review in accordancewith the Paperwork Reduction Act of 1995(44 U.S.C. 3507(d)). Comments on the col-lections of information should be sent to theOffice of Management and Budget, Attn:Desk Officer for the Department of theTreasury, Office of Information and Regu-latory Affairs, Washington, DC 20503, withcopies to the Internal Revenue Service, Attn:IRS Reports Clearance Officer, W:CAR:MP:FP:S, Washington, DC 20224. Com-ments on the collections of informationshould be received by December 6, 2002.Comments are specifically requestedconcerning:

Whether the proposed collections of in-formation are necessary for the proper per-formance of the functions of the IRS,including whether the information will havepractical utility;

The accuracy of the estimated burden as-sociated with the proposed collection of in-formation (see below);

How the quality, utility, and clarity of theinformation to be collected may be en-hanced;

How the burden of complying with theproposed collection of information may beminimized, including through the applica-tion of automated collection techniques orother forms of information technology; and

Estimates of capital or start-up costs andcosts of operation, maintenance, and pur-chase of services to provide information.

The collections of information in thisproposed regulation are in § 1.417(a)(3)–1.This information is required by the IRS tocomply with the requirements of section417(a)(3) regarding explanations that mustbe provided to participants in a qualifiedplan prior to a waiver of a qualified jointand survivor annuity (QJSA) or a quali-fied preretirement survivor annuity (QPSA).This information will be used by partici-pants and spouses of participants to deter-mine whether to waive a QJSA or QPSA,and by the IRS to confirm that the plancomplies with applicable qualification re-quirements to avoid adverse tax conse-quences. The collections of information aremandatory. The respondents are nonprofitinstitutions.

Estimated total annual reporting burden:375,000 hours.

The estimated annual burden per re-spondent varies from .01 to .99 hours, de-pending on individual circumstances, withan estimated average of .5 hours.

Estimated number of respondents:750,000.

The estimated annual frequency ofresponses: on occasion.

An agency may not conduct or spon-sor, and a person is not required to re-spond to, a collection of information unlessit displays a valid control number assignedby the Office of Management and Bud-get.

Books or records relating to a collec-tion of information must be retained as longas their contents may become material inthe administration of any internal revenuelaw. Generally, tax returns and tax returninformation are confidential, as required by26 U.S.C. 6103.

Background

This document contains proposedamendments to 26 CFR part 1 under sec-tion 417(a)(3) of the Internal Revenue Codeof 1986 (Code).

2002–44 I.R.B. 791 November 4, 2002

A qualified retirement plan to which sec-tion 401(a)(11) applies must pay a vestedparticipant’s retirement benefit under theplan in the form of a qualified joint and sur-vivor annuity (QJSA), except as providedin section 417. Section 401(a)(11) appliesto defined benefit plans, money purchasepension plans, and certain other definedcontribution plans. A QJSA is defined insection 417(b) as an annuity for the life ofthe participant with a survivor annuity forthe life of the spouse (if the participant ismarried) that is not less than 50 percent of(and is not greater than 100 percent of) theamount of the annuity that is payable dur-ing the joint lives of the participant and thespouse. Under section 417(b)(2), a QJSAfor a married participant generally must bethe actuarial equivalent of the single life an-nuity benefit payable for the life of the par-ticipant. However, a plan is permitted tosubsidize the QJSA for a married partici-pant. If the plan fully subsidizes the QJSAfor a married participant so that failure towaive the QJSA would not result in re-duced payments over the life of the par-ticipant compared to the single life annuitybenefit, then the plan need not provide anelection to waive the QJSA. See section417(a)(5).

For a married participant, the QJSA mustbe at least as valuable as any other op-tional form of benefit payable under theplan at the same time. See § 1.401(a)–20,Q&A–16. Further, the anti-forfeiture rulesof section 411(a) prohibit a participant’sbenefit under a defined benefit plan frombeing satisfied through payment that is ac-tuarially less valuable than the value of theparticipant’s accrued benefit expressed inthe form of an annual benefit commenc-ing at normal retirement age. These deter-minations must be made using reasonableactuarial assumptions. However, see§ 1.417(e)–1(d) for actuarial assumptions re-quired for use in certain present value cal-culations.

If a plan provides a subsidy for one op-tional form of benefit (i.e., the payments un-der an optional form of benefit have anactuarial present value that is greater thanthe actuarial present value of the accruedbenefit), there is no requirement to ex-tend a similar subsidy (or any subsidy) toevery other optional form of benefit. Thus,for example, a participant might be en-titled to receive a single-sum distributionupon early retirement that does not re-

flect any early retirement subsidy in lieu ofa QJSA that reflects a substantial early re-tirement subsidy. As a further example, aparticipant might be entitled to receive asingle-sum distribution at normal retire-ment age in lieu of a QJSA that is subsi-dized as described in section 417(a)(5).

Section 417(a) provides rules underwhich a participant (with spousal consent)may waive payment of the participant’s ben-efit in the form of a QJSA. Section417(a)(3) provides that a plan must pro-vide to each participant, within a reason-able period before the annuity starting date(and consistent with such regulations as theSecretary may prescribe) a written expla-nation of the terms and conditions of theQJSA, the participant’s right to make, andthe effect of, an election to waive the QJSAform of benefit, the rights of the partici-pant’s spouse, and the right to revoke (andthe effect of the revocation of) an elec-tion to waive the QJSA form of benefit.

Section 205 of the Employee Retire-ment Income Security Act of 1974(ERISA), Public Law 93–406 (88 Stat. 829)as subsequently amended, provides paral-lel rules to the rules of sections 401(a)(11)and 417 of the Internal Revenue Code. Inparticular, section 205(a)(3) of ERISA pro-vides a parallel rule to section 417(a)(3) ofthe Code. Treasury regulations issued un-der section 417(a)(3) of the Code apply aswell for purposes of section 205(a)(3) ofERISA.

Regulations governing the requirementsfor waiver of a QJSA were published in theFederal Register on August 19, 1988 (T.D.8219, 1988–2 C.B. 48 [53 FR 31837]). Sec-tion 1.401(a)–20, Q&A–36, provides rulesfor the explanation that must be providedunder section 417(a)(3) as a prerequisite towaiver of a QJSA. Section 1.401(a)–20,Q&A–36, requires that such a written ex-planation must contain a general descrip-tion of the eligibility conditions and othermaterial features of the optional forms ofbenefit and sufficient additional informa-tion to explain the relative values of the op-tional forms of benefit available under theplan (e.g., the extent to which optionalforms are subsidized relative to the nor-mal form of benefit or the interest rates usedto calculate the optional forms). In addi-tion, § 1.401(a)–20, Q&A–36, provides thatthe written explanation must comply withthe requirements set forth in § 1.401(a)–11(c)(3). Section 1.401(a)–11(c)(3) was is-

sued prior to the enactment of section 417,and provides rules relating to written ex-planations that were required prior to a par-ticipant’s election of a preretirement survivorannuity or election to waive a joint and sur-vivor annuity. Section 1.401(a)–11(c)(3)(i)(C) provides that such a written ex-planation must contain a general explana-tion of the relative financial effect of theseelections on a participant’s annuity.

In addition, under section 411 and§ 1.411(a)–11(c), so long as a benefit is im-mediately distributable (within the mean-ing of § 1.411(a)–11(c)(4)), a participantmust be informed of his or her right to de-fer that distribution. This requirement is in-dependent of the section 417 requirementsaddressed in these proposed regulations.

Concerns have been expressed that, incertain cases, the information provided toparticipants under section 417(a)(3) regard-ing the available distribution forms does notadequately enable them to compare thosedistribution forms without professional ad-vice. In particular, participants who are eli-gible for both subsidized annuitydistributions and unsubsidized single-sumdistributions may be receiving notices thatdo not adequately explain the value of thesubsidy that is foregone if the single-sumdistribution is elected. In such a case,merely disclosing the amount of the single-sum distribution and the amount of annu-ity payments may not adequately enablethose participants to make an informedcomparison of the relative values of thosedistribution forms, even if the interest rateused to derive the single sum is disclosed.Furthermore, questions have been raised asto how the relative values of optional formsof benefit are required to be expressed un-der current regulations. Accordingly, theseproposed regulations are being issued topropose disclosure requirements that wouldenable participants to compare the rela-tive values of the available distributionforms using more readily understandable in-formation.

Explanation of Provisions

The proposed regulations would con-solidate the content requirements appli-cable to explanations of QJSAs and QPSAsunder section 417(a)(3), and would specifyrules for disclosing the relative value of op-tional forms of benefit as part of the QJSAexplanation. Similar to the requirements inthe current regulations, the required expla-

November 4, 2002 792 2002–44 I.R.B.

nation must contain, with respect to eachof the optional forms of benefit presentlyavailable to the participant, a description ofthe optional form of benefit, a descrip-tion of the eligibility conditions for the op-tional form of benefit, a description of thefinancial effect of electing the optional formof benefit, a description of the relative valueof the optional form of benefit, and a de-scription of any other material features ofthe optional form of benefit. Further, as un-der the current regulations, the QJSA ex-planation would be permitted to be madeeither by providing the participant with in-formation specific to the participant, or byproviding the participant with generally ap-plicable information and offering the par-ticipant the opportunity to request additionalinformation specifically applicable to theparticipant with respect to any optionalforms of benefit available to the partici-pant. The proposed regulations would clarifythat a defined contribution plan is not re-quired to provide a description of the rela-tive values of optional forms of benefitcompared to the value of the QJSA.

The proposed regulations would pro-vide additional guidance regarding the re-quired description of the relative values ofoptional forms of benefit compared to thevalue of the QJSA and the content of therequired disclosure of relative values. Un-der the proposed regulations, the descrip-tion of the relative value of an optional formof benefit compared to the value of theQJSA must be expressed in a manner thatprovides a meaningful comparison of therelative economic values of the two formsof benefit without the participant having tomake calculations using interest or mor-tality assumptions. In order to make thiscomparison, the benefit under one or bothoptional forms of benefit must be con-verted, taking into account the time valueof money and life expectancies, so that bothare expressed in the same form. The pro-posed regulations give several examples oftechniques that may be used for thiscomparison: expressing the actuarial presentvalue of the optional form of benefit as apercentage or factor of the actuarial presentvalue of the QJSA; stating the amount ofan annuity payable at the same time and un-der the same conditions as the QJSA thatis the actuarial equivalent of the optionalform of benefit; or stating the actuarialpresent value of both the QJSA and the op-tional form of benefit. For purposes of pro-

viding a description of the relative value ofan optional form of benefit compared to thevalue of the QJSA (and also for purposesof comparing the financial effect of the dis-tribution forms available to a participant),a plan would be permitted to provide rea-sonable estimates (e.g., estimates based ondata as of an earlier date than the annuitystarting date or an estimate of the spouse’sage). If estimates are used, the participanthas a right to a more precise calculationupon request.

Since disclosing the relative value of ev-ery optional form of benefit regardless ofthe degree of subsidy may be too burden-some, and may provide participants with in-formation that appears more precise than iswarranted based on the inexact nature of theactuarial assumptions used, the proposedregulations would provide some ways tosimplify this disclosure of relative valuesof optional forms of benefit. One way inwhich this disclosure would be simplifiedis through a banding rule under which twoor more optional forms of benefit that haveapproximately the same value could begrouped for purposes of disclosing rela-tive value. Under these proposed regula-tions, two or more optional forms of benefitwould be treated as having approximatelythe same value if those optional forms ofbenefit vary in relative value in compari-son to the value of the QJSA by 5 percent-age points or less when the relative valuecomparison is made by expressing the ac-tuarial present value of each of those op-tional forms of benefit as a percentage ofthe actuarial present value of the QJSA. Forsuch a group of optional forms of ben-efit, the requirement relating to disclos-ing the relative value of each optional formof benefit compared to the value of theQJSA could be satisfied by disclosing therelative value of any one of the optionalforms in the group compared to the valueof the QJSA, and disclosing that the otheroptional forms of benefit in the group areof approximately the same value. If a single-sum distribution is included in such a groupof optional forms of benefit, the single-sum distribution must be the distributionform that is used for purposes of this com-parison. The relative value of all optionalforms of benefit that have an actuarialpresent value that is at least 95% of the ac-tuarial present value of the QJSA may bedescribed by stating that those optionalforms of benefit are of approximately equal

value to the value of the QJSA. Thus, theserules would permit a plan that provides nosubsidized forms of benefit to state the com-parison of relative values simply by stat-ing that all distribution forms areapproximately equal in value to the QJSA.

Another way in which this disclosuremay be simplified is through the use of rep-resentative values: if, under the bandingrule, two or more optional forms of ben-efit are grouped, a representative relativevalue for all of the grouped options couldbe used as the approximate relative valuefor all of the grouped options, in lieu of us-ing the relative value of one of the op-tional forms of benefit in the group. For thispurpose, a representative relative value isany relative value that is not less than therelative value of the member of the groupof optional forms of benefit with the low-est relative value and is not greater than therelative value of the member of that groupwith the highest relative value when mea-sured on a consistent basis. For example,if three optional forms have relative val-ues of 87.5%, 89%, and 91% of the valueof the QJSA, all three optional forms canbe treated as having a relative value of ap-proximately 90% of the value of the QJSA.

The proposed regulations would also per-mit the disclosure of the financial effect andrelative value of optional forms of ben-efit to be made in the form of generally ap-plicable information rather than informationspecific to the participant, provided that in-formation specific to the participant re-garding the optional form of benefit mustbe furnished at the participant’s request.Thus, under the proposed regulations, in lieuof providing a QJSA explanation that de-scribes each optional form that is pres-ently available to the participant, thegeneralized QJSA explanation need only re-flect the generally available optional formsof benefits, along with a reference to wherea participant can obtain the information forany other optional forms of benefits (suchas optional forms from prior benefit struc-tures for limited groups of employees) thatare presently available to the participant.

With respect to the generally availableoptional forms of benefits, in lieu of pro-viding a statement of financial effect andrelative value comparison that is specific tothe participant, the generalized QJSA ex-planation is permitted to include a chart orother comparable device showing a seriesof examples of financial effects and rela-

2002–44 I.R.B. 793 November 4, 2002

tive value comparisons for hypothetical par-ticipants. The examples in the chart shouldreflect a representative range of ages for thehypothetical participants and use reason-able assumptions for the age of the hypo-thetical participant’s spouse and any othervariable that affects the financial effect, orrelative value, of the optional form of ben-efit. The chart must be accompanied by ageneral statement describing the effect ofsignificant variations between the assumedages or other variables on the financial ef-fect of electing the optional form of ben-efit and the comparison of the relative valueof the optional form of benefit to the valueof the QJSA. A generalized QJSA expla-nation that includes this chart must also in-clude the amount payable to the participantunder the normal form of benefit, either atnormal retirement age, or payable imme-diately. In addition, this chart must be ac-companied by a statement that includes anoffer to provide, upon the participant’s re-quest, a statement of financial effect alongwith a comparison of relative values thatis specific to the participant for one or morepresently available optional forms of ben-efit, and a description of how a partici-pant may obtain this additional information.Thus, with respect to those optional formsof benefit for which additional informa-tion is requested, the participant must re-ceive a QJSA explanation specific to theparticipant that is based on the partici-pant’s actual age and benefit.

The proposed regulations would pro-vide rules governing the actuarial assump-tions to be used in comparing the value ofan optional form of benefit to the QJSA.If an optional form of benefit is subject tothe requirements of section 417(e)(3) and§ 1.417(e)–1(d) (e.g., a single-sum distri-bution), any comparison of the value of theoptional form of benefit to the value of theQJSA must be made using the applicablemortality table and the applicable interestrate as defined in § 1.417(e)–1(d)(2) and (3)(or, at the option of the plan, another rea-sonable interest rate and reasonable mor-tality table used under the plan to calculatethe amount payable under the optional formof benefit). All other optional forms of ben-efit payable to the participant must be com-pared with the QJSA using a single set ofinterest rates and mortality tables that arereasonable and that are applied uniformlyfor this purpose with respect to all suchother optional forms payable to the par-

ticipant. The uniform interest and mortal-ity assumptions should be used regardlessof whether those assumptions are actu-ally used to determine the amount of ben-efit payments under any particular optionalform.

The proposed regulations would also re-quire disclosure of information to help aparticipant understand the significance ofa disclosure of the relative value of an op-tional form of benefit. Under the proposedregulations, the notice would be required toprovide an explanation of the concept ofrelative value. Specifically, the notice wouldbe required to explain that the relative valuecomparison is intended to allow the par-ticipant to compare the total value of dis-tributions paid in different forms, that therelative value comparison is made by con-verting the value of the optional forms ofbenefit currently available to a commonform (such as the QJSA or single-sum dis-tribution), and that this conversion uses in-terest and life expectancy assumptions.

Under the proposed regulations, a re-quired numerical comparison of the valueof the optional form of benefit to the valueof the QJSA under the plan generally wouldbe required to disclose the interest rate thatis used to develop a required numericalcomparison. However, if all optional formsof benefit are permitted to be treated as hav-ing approximately the same value after ap-plication of the banding rule describedabove, then the plan would not be requiredto disclose the interest rate used to de-velop a required numerical comparison tothe QJSA for optional form of benefit thatis not subject to the requirements of sec-tion 417(e)(3). In addition, the proposedregulations would require the plan to pro-vide a general statement that all numeri-cal comparisons of relative value providedare based on average life expectancies, andthat the relative value of payments ulti-mately made under an annuity optional formof benefit will depend on actual longev-ity.

Under the proposed regulations, both theQPSA explanation and the QJSA explana-tion must be written in a manner calcu-lated to be understood by the averageparticipant. A plan may wish to provide ad-ditional information beyond the minimuminformation that would be required underthese proposed regulations, in order to helpan employee to evaluate the form of ben-efit that would be most desirable under the

employee’s individual circumstances. Forexample, the plan may wish to add fur-ther explanation of the effects of ill healthor other factors influencing expected lon-gevity on the desirability of electing an-nuity forms of distribution.

The proposed regulations contain rulesregarding the method for providing theQJSA explanation and the QPSA explana-tion. Under the proposed regulations, theseexplanations must be written explanations.First class mail to the last known addressof the party is an acceptable deliverymethod for a section 417(a)(3) explana-tion. Likewise, hand delivery is accept-able. However, the posting of theexplanation is not considered provision ofthe section 417(a)(3) explanation.

These proposed regulations do not ad-dress the extent to which the QJSA expla-nation or the QPSA explanation can beprovided through electronic media. The IRSand the Treasury Department are consid-ering the extent to which the QJSA expla-nation and the QPSA explanation, as wellas other notices under the various Inter-nal Revenue Code requirements relating toqualified retirement plans, can be providedelectronically, taking into account the ef-fect of the Electronic Signatures in Glo-bal and National Commerce Act (ESIGN),Public Law 106–229, 114 Stat. 464 (2000).The IRS and the Treasury Department an-ticipate issuing proposed regulations re-garding these issues, and invite commentson these issues.

Proposed Effective Date

The regulations are proposed to be ap-plicable to QJSA explanations with re-spect to distributions with annuity startingdates on or after January 1, 2004, and toQPSA explanations provided on or afterJanuary 1, 2004.

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 regulatoryassessment is not required. It is hereby cer-tified that the collection of information inthese regulations will not have a signifi-cant economic impact on a substantial num-ber of small entities. This certification isbased upon the fact that qualified retire-ment plans of small businesses typicallycommence distribution of benefits to few,

November 4, 2002 794 2002–44 I.R.B.

if any, plan participants in any given yearand, similarly, only offer elections to waivea QPSA to few, if any, participants in anygiven year. Thus, the collection of infor-mation in these regulations will only havea minimal economic impact on most smallentities. Therefore, an analysis under theRegulatory Flexibility Act (5 U.S.C. chap-ter 6) is not required. Pursuant to section7805(f) of the Code, this notice of pro-posed rulemaking will be submitted to theChief Counsel for Advocacy of the SmallBusiness Administration for comment on itsimpact on small business.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to written comments (pref-erably a signed original and eight (8) cop-ies) that are submitted timely to the IRS.Alternatively, taxpayers may submit com-ments electronically to the IRS Internet siteat www.irs.gov/regs. All comments will beavailable for public inspection and copy-ing. The IRS and Treasury request com-ments on the clarity of the proposed rulesand how they may be made easier to un-derstand or to implement.

A public hearing has been scheduled forJanuary 14, 2003, at 10 a.m. in room 4718of the Internal Revenue Building, 1111 Con-stitution Avenue, NW, Washington, DC. Allvisitors must present photo identification toenter the building. Because of access re-strictions, visitors will not be admitted be-yond the immediate entrance area more than30 minutes before the hearing starts at theConstitution Avenue entrance. For infor-mation about having your name placed onthe building access list to attend the hear-ing, see the “FOR FURTHER INFORMA-TION CONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) ap-ply to the hearing. Persons who wish topresent oral comments at the hearing mustsubmit written comments and an outline ofthe topics to be discussed and the time tobe devoted to each topic (signed originaland eight (8) copies) by January 2, 2003.A period of 10 minutes will be allotted toeach person for making comments. Anagenda showing the scheduling of thespeakers will be prepared after the dead-line for receiving outlines has passed. Cop-ies of the agenda will be available free ofcharge at the hearing.

Drafting Information

The principal author of these proposedregulations is Linda S. F. Marshall of theOffice of the Division Counsel/AssociateChief Counsel (Tax Exempt and Govern-ment Entities). However, other personnelfrom the IRS and Treasury participated intheir development.

* * * * *

Proposed Amendments to theRegulations

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

PART 1 — INCOME TAX; TAXABLEYEARS BEGINNING AFTERDECEMBER 31, 1986.

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

Authority: 26 U.S.C. 7805 * * *Par. 2. Paragraph (c)(3) of § 1.401(a)–11

is revised to read as follows:

§ 1.401(a)–11 Qualified joint andsurvivor annuities.

* * * * *(c) * * *(3) Information to be provided by plan.

For rules regarding the information re-quired to be provided with respect to theelection to waive a QJSA or a QPSA, see§ 1.417(a)(3)–1.

* * * * *Par. 3. A–36 of § 1.401(a)–20 is re-

vised to read as follows:

§ 1.401(a)–20 Requirements of qualifiedjoint and survivor annuity and qualifiedpreretirement survivor annuity.

* * * * *A–36. For rules regarding the explana-

tion of QPSAs and QJSAs required undersection 417(a)(3), see § 1.417(a)(3)–1.

* * * * *Par. 4. Section 1.417(a)(3)–1 is added to

read as follows:

§ 1.417(a)(3)–1 Required explanation ofqualified joint and survivor annuity andqualified preretirement survivor annuity.

(a) Written explanation requirement—(1) General rule. A plan meets the survi-vor annuity requirements of section

401(a)(11) only if the plan meets the re-quirements of section 417(a)(3) and this sec-tion regarding the written explanationrequired to be provided a participant withrespect to a QJSA or a QPSA. A written ex-planation required to be provided to a par-ticipant with respect to either a QJSA or aQPSA under section 417(a)(3) and this sec-tion is referred to in this section as a sec-tion 417(a)(3) explanation. See § 1.401(a)–20, Q&A–37, for exceptions to the writtenexplanation requirement in the case of afully subsidized QPSA or QJSA, and§ 1.401(a)–20, Q&A–38, for the defini-tion of a fully subsidized QPSA or QJSA.

(2) Time for providing section 417(a)(3)explanation—(i) QJSA explanation. See§ 1.417(e)–1(b)(3)(ii) for rules governing thetiming of the QJSA explanation.

(ii) QPSA explanation. See § 1.401(a)–20, Q&A–35, for rules governing the tim-ing of the QPSA explanation.

(3) Required method for providing sec-tion 417(a)(3) explanation. A section417(a)(3) explanation must be a written ex-planation. First class mail to the last knownaddress of the participant is an acceptabledelivery method for a section 417(a)(3) ex-planation. Likewise, hand delivery is ac-ceptable. However, the posting of theexplanation is not considered provision ofthe section 417(a)(3) explanation.

(4) Understandability. A section417(a)(3) explanation must be written in amanner calculated to be understood by theaverage participant.

(b) Required content of section 417(a)(3)explanation—(1) Content of QPSA expla-nation. The QPSA explanation must con-tain a general description of the QPSA, thecircumstances under which it will be paidif elected, the availability of the election ofthe QPSA, and, except as provided in para-graph (d)(3) of this section, a descriptionof the financial effect of the election of theQPSA on the participant’s benefits (i.e., anestimate of the reduction to the partici-pant’s estimated normal retirement ben-efit that would result from an election ofthe QPSA).

(2) Content of QJSA explanation. TheQJSA explanation must satisfy either para-graph (c) or paragraph (d) of this section.Under paragraph (c) of this section, theQJSA explanation must contain certain spe-cific information relating to the benefitsavailable under the plan to the particularparticipant. Alternatively, under paragraph

2002–44 I.R.B. 795 November 4, 2002

(d) of this section, the QJSA explanationcan contain generally applicable informa-tion in lieu of specific participant informa-tion, provided that the participant has theright to request additional information re-garding the participant’s benefits under theplan.

(c) Participant-specific information re-quired to be provided—(1) In general. AQJSA explanation satisfies this paragraph(c) if it provides the following informa-tion with respect to each of the optionalforms of benefit presently available to theparticipant—

(i) A description of the optional form ofbenefit;

(ii) A description of the eligibility con-ditions for the optional form of benefit;

(iii) A description of the financial ef-fect of electing the optional form of ben-efit (i.e., the amount payable under the formof benefit);

(iv) In the case of a defined benefit plan,a description of the relative value of the op-tional form of benefit compared to the valueof the QJSA, in the manner described inparagraph (c)(2) of this section; and

(v) A description of any other materialfeatures of the optional form of benefit.

(2) Requirement for numerical compari-son of relative values—(i) In general. Thedescription of the relative value of an op-tional form of benefit compared to the valueof the QJSA under paragraph (c)(1)(iv) ofthis section must be expressed to the par-ticipant in a manner that provides a mean-ingful comparison of the relative economicvalues of the two forms of benefit with-out the participant having to make calcu-lations using interest or mortalityassumptions. Thus, in performing the cal-culations necessary to make this compari-son, the benefits under one or both optionalforms of benefit must be converted, tak-ing into account the time value of moneyand life expectancies, so that the values ofboth optional forms of benefit are expressedin the same form. For example, such a com-parison may be expressed to the partici-pant using any of the followingtechniques—

(A) Expressing the actuarial presentvalue of the optional form of benefit as apercentage or factor of the actuarial presentvalue of the QJSA;

(B) Stating the amount of the annuitythat is the actuarial equivalent of the op-tional form of benefit and that is payable

at the same time and under the same con-ditions as the QJSA; or

(C) Stating the actuarial present value ofboth the optional form of benefit and theQJSA.

(ii) Simplified presentations permitted—(A) Grouping of certain optional forms.Two or more optional forms of benefit thathave approximately the same value may begrouped for purposes of a required numeri-cal comparison described in this paragraph(c)(2). For this purpose, two or more op-tional forms of benefit have approximatelythe same value if those optional forms ofbenefit vary in relative value in compari-son to the value of the QJSA by 5 percent-age points or less when the relative valuecomparison is made by expressing the ac-tuarial present value of each of those op-tional forms of benefit as a percentage ofthe actuarial present value of the QJSA. Forsuch a group of optional forms of ben-efit, the requirement relating to disclos-ing the relative value of each optional formof benefit compared to the value of theQJSA can be satisfied by disclosing therelative value of any one of the optionalforms in the group compared to the valueof the QJSA, and disclosing that the otheroptional forms of benefit in the group areof approximately the same value. If a single-sum distribution is included in such a groupof optional forms of benefit, the single-sum distribution must be the distributionform that is used for purposes of this com-parison. In addition, the relative value ofall optional forms of benefit that have anactuarial present value that is at least 95%of the actuarial present value of the QJSAis permitted to be described by stating thatthose optional forms of benefit are approxi-mately equal in value to the QJSA, or thatall of those forms of benefit and the QJSAare approximately equal in value.

(B) Representative relative value forgrouped optional forms. If, in accordancewith paragraph (c)(2)(ii)(A) of this sec-tion, two or more optional forms of ben-efits are grouped, the relative values for allof the optional forms of benefit in the groupcan be stated using a representative rela-tive value as the approximate relative valuefor the entire group. For this purpose, a rep-resentative relative value is any relativevalue that is not less than the relative valueof the member of the group of optionalforms of benefit with the lowest relativevalue and is not greater than the relative

value of the member of that group with thehighest relative value when measured on aconsistent basis. For example, if three op-tional forms have relative values of 87.5%,89%, and 91% of the value of the QJSA,all three optional forms can be treated ashaving a relative value of approximately90% of the value of the QJSA. As requiredunder paragraph (c)(2)(ii)(A) of this sec-tion, if a single-sum distribution is includedin the group of optional forms of benefit,the 90% relative factor of the value of theQJSA must be disclosed as the approxi-mate relative value of the single sum, andthe other forms can be described as hav-ing the same approximate value as thesingle sum.

(iii) Actuarial assumptions used to de-termine relative values. For the purpose ofproviding a numerical comparison of thevalue of an optional form of benefit to thevalue of the immediately commencingQJSA, the following rules apply—

(A) If an optional form of benefit is sub-ject to the requirements of section 417(e)(3)and § 1.417(e)–1(d), any comparison of thevalue of the optional form of benefit to thevalue of the QJSA must be made using theapplicable mortality table and the appli-cable interest rate as defined in § 1.417(e)–1(d)(2) and (3) (or, at the option of the plan,another reasonable interest rate and rea-sonable mortality table used under the planto calculate the amount payable under theoptional form of benefit); and

(B) All other optional forms of benefitpayable to the participant must be com-pared with the QJSA using a single set ofinterest and mortality assumptions that arereasonable and that are applied uniformlywith respect to all such optional forms pay-able to the participant (regardless of whetherthose assumptions are actually used un-der the plan for purposes of determiningbenefit payments).

(iv) Required disclosure ofassumptions—(A) Explanation of conceptof relative value. The notice must pro-vide an explanation of the concept of rela-tive value, communicating that the relativevalue comparison is intended to allow theparticipant to compare the total value of dis-tributions paid in different forms, that therelative value comparison is made by con-verting the value of the optional forms ofbenefit presently available to a commonform (such as the QJSA or a single-sum dis-tribution), and that this conversion uses in-

November 4, 2002 796 2002–44 I.R.B.

terest and life expectancy assumptions. Theexplanation of relative value must includea general statement that all comparisonsprovided are based on average life expect-ancies, and that the relative value of pay-ments ultimately made under an annuityoptional form of benefit will depend on ac-tual longevity.

(B) Disclosure of interest assumptions.A required numerical comparison of thevalue of the optional form of benefit to thevalue of the QJSA under the plan is re-quired to disclose the interest rate that isused to develop the comparison. If all op-tional forms of benefit are permitted to begrouped under paragraph (c)(2)(ii)(A) of thissection, then the requirement of this para-graph (c)(2)(iv)(B) does not apply for anyoptional form of benefit not subject to therequirements of section 417(e)(3) and§ 1.417(e)–1(d)(3).

(3) Permitted estimates of financial ef-fect and relative value—(i) General rule.For purposes of providing a description ofthe financial effect of the distribution formsavailable to a participant as required un-der paragraph (c)(1)(iii) of this section, andfor purposes of providing a description ofthe relative value of an optional form ofbenefit compared to the value of the QJSAfor a participant as required under para-graph (c)(1)(iv) of this section, the plan ispermitted to provide reasonable estimates(e.g., estimates based on data as of an ear-lier date than the annuity starting date, a rea-sonable assumption for the age of theparticipant’s spouse, or, in the case of a de-fined contribution plan, reasonable esti-mates of amounts that would be payableunder a purchased annuity contract), in-cluding reasonable estimates of the appli-cable interest rate under section 417(e)(3).

(ii) Right to more precise calculation. Ifa QJSA notice uses a reasonable estimateunder paragraph (c)(3)(i) of this section, theQJSA explanation must identify the esti-mate and explain that the plan will, uponthe request of the participant, provide amore precise calculation and the plan mustprovide the participant with a more pre-cise calculation if so requested. Thus, forexample, if a plan provides an estimate ofthe amount of the QJSA that is based ona reasonable assumption concerning the ageof the participant’s spouse, the participantcan request a calculation that takes into ac-count the actual age of the spouse, as pro-vided by the participant.

(iii) Revision of prior information. If amore precise calculation described in para-graph (c)(3)(ii) of this section materiallychanges the relative value of an optionalform compared to the value of the QJSA,the revised relative value of that optionalform must be disclosed, regardless ofwhether the financial effect of selecting theoptional form is affected by the more pre-cise calculation.

(4) Special rules for disclosure of fi-nancial effect for defined contribution plans.For a written explanation provided by a de-fined contribution plan, a description of fi-nancial effect required by paragraph(c)(1)(iii) of this section with respect to anannuity form of benefit must include a state-ment that the annuity will be provided bypurchasing an annuity contract from an in-surance company with the participant’s ac-count balance under the plan. If thedescription of the financial effect of the op-tional form of benefit is provided using es-timates rather than by assuring that aninsurer is able to provide the amount dis-closed to the participant, the written ex-planation must also disclose this fact.

(d) Substitution of generally applicableinformation for participant information inthe section 417(a)(3) explanation—(1)Forms of benefit available. In lieu of pro-viding the information required under para-graphs (c)(1)(i) through (v) of this sectionfor each optional form of benefit pres-ently available to the participant as de-scribed in paragraph (c) of this section, theQJSA explanation may contain the infor-mation required under paragraphs (c)(1)(i)through (v) of this section for the QJSA andeach other optional form of benefit gener-ally available under the plan, along with areference to where a participant may readilyobtain the information required under para-graphs (c)(1)(i) through (v) of this sec-tion for any other optional forms of benefitthat are presently available to the partici-pant.

(2) Financial effect and comparison ofrelative values—(i) General rule. In lieu ofproviding a statement of the financial ef-fect of electing an optional form of ben-efit as required under paragraph (c)(1)(iii)of this section, or a comparison of rela-tive values as required under paragraph(c)(1)(iv) of this section, based on the ac-tual age and benefit of the participant, theQJSA explanation is permitted to includea chart (or other comparable device) show-

ing the financial effect and relative valueof optional forms of benefit in a series ofexamples specifying the amount of the op-tional form of benefit payable to a hypo-thetical participant at a representative rangeof ages and the comparison of relative val-ues at those same representative ages. Eachexample in this chart must show the finan-cial effect of electing the optional form ofbenefit pursuant to the rules of paragraph(c)(1)(iii) of this section, and a compari-son of the relative value of the optionalform of benefit to the value of the QJSApursuant to the rules of paragraph (c)(2) ofthis section, using reasonable assumptionsfor the age of the hypothetical participant’sspouse and any other variables that affectthe financial effect, or relative value, of theoptional form of benefit. The requirementto show the financial effect of electing anoptional form can be satisfied through theuse of other methods (e.g., expressing theamount of the optional form as a percent-age or a factor of the amount payable un-der the normal form of benefit), providedthat the method provides sufficient infor-mation so that a participant can determinethe amount of benefits payable in the op-tional form. The chart or other compa-rable device must be accompanied by thedisclosures described in paragraph (c)(2)(iv)of this section explaining the concept ofrelative value and disclosing certain inter-est assumptions. In addition, the chart orother comparable device must be accom-panied by a general statement describing theeffect of significant variations between theassumed ages or other variables on the fi-nancial effect of electing the optional formof benefit and the comparison of the rela-tive value of the optional form of benefitto the value of the QJSA.

(ii) Actual benefit must be disclosed. Thegeneralized notice described in this para-graph (d)(2) will satisfy the requirementsof paragraph (b)(2) of this section only ifthe notice includes either the amount pay-able to the participant under the normalform of benefit or the amount payable tothe participant under the normal form ofbenefit adjusted for immediate commence-ment. For this purpose, the normal form ofbenefit is the form under which paymentsdue to the participant under the plan are ex-pressed under the plan, prior to adjust-ments for form of benefit. For example,assuming that a plan’s benefit accrual for-mula is expressed as a straight life annu-

2002–44 I.R.B. 797 November 4, 2002

ity, the generalized notice must provide theamount of either the straight life annuitycommencing at normal retirement age or thestraight life annuity commencing immedi-ately.

(iii) Ability to request additional infor-mation. The generalized notice described inthis paragraph (d)(2) must be accompa-nied by a statement that includes an offerto provide, upon the participant’s request,a statement of financial effect and a com-parison of relative values that is specific tothe participant for any presently availableoptional form of benefit, and a descrip-tion of how a participant may obtain thisadditional information.

(3) Financial effect of QPSA election. Inlieu of providing a specific description ofthe financial effect of the QPSA election,the QPSA explanation may provide a gen-eral description of the financial effect of theelection. Thus, for example, the descrip-tion can be in the form of a chart show-ing the reduction to a hypotheticalparticipant’s normal retirement benefit at arepresentative range of participant ages asa result of the QPSA election (using a rea-sonable assumption for the age of the hy-pothetical participant’s spouse relative to theage of the hypothetical participant). In ad-dition, this chart must be accompanied bya statement that includes an offer to pro-vide, upon the participant’s request, an es-timate of the reduction to the participant’sestimated normal retirement benefit, and adescription of how a participant may ob-tain this additional information.

(4) Additional information required to befurnished at the participant’s request—(i)Explanation of QJSA. If, as permitted un-der paragraphs (d)(1) and (2) of this sec-tion, the content of a QJSA explanation doesnot include all the items described in para-graph (c) of this section, then, upon a timelyrequest from the participant for any of theinformation required under paragraphs(c)(1)(i) through (v) of this section for oneor more presently available optional forms(including a request for all optional formspresently available to the participant), theplan must furnish the information requiredunder paragraphs (c)(1)(i) through (v) of thissection with respect to those optional forms.Thus, with respect to those optional formsof benefit, the participant must receive aQJSA explanation specific to the partici-pant that is based on the participant’s ac-

tual age and benefit. In addition, the planmust comply with paragraph (c)(3)(iii) ofthis section.

(ii) Explanation of QPSA. If, as permit-ted under paragraph (d)(3) of this sec-tion, the content of a QPSA explanationdoes not include all the items described inparagraph (b)(1) of this section, then, upona timely request from the participant for anestimate of the reduction to the partici-pant’s estimated normal retirement ben-efit that would result from a QPSA election,the plan must furnish such an estimate.

(e) Examples. The following examplesillustrate the application of this section.Solely for purposes of these examples, theapplicable interest rate that applies to anydistribution that is subject to the rules ofsection 417(e)(3) is assumed to be 51⁄2%,and the applicable mortality table under sec-tion 417(e)(3) and § 1.417(e)–1(d)(2) is as-sumed to be the table that applies as ofJanuary 1, 2003. In addition, solely for pur-poses of these examples, assume that a planwhich determines actuarial equivalence us-ing 6% interest and the applicable mortal-ity table under section 417(e)(3) and§ 1.417(e)–1(d)(2) that applies as of Janu-ary 1, 1995, is using reasonable actuarialassumptions. The examples are as follows:

Example 1. (i) Participant M participates in PlanA, a qualified defined benefit plan. Under Plan A, theQJSA is a joint and 100% survivor annuity, which isactuarially equivalent to the single life annuity de-termined using 6% interest and the section 417(e)(3)applicable mortality table that applies as of January1, 1995. On January 1, 2004, M will terminate em-ployment at age 55. When M terminates employ-ment, M will be eligible to elect an unreduced earlyretirement benefit, payable as either a life annuity orthe QJSA. M will also be eligible to elect a single-sum distribution equal to the actuarial present valueof the single life annuity payable at normal retire-ment age (age 65), determined using the applicablemortality table and the applicable interest rate undersection 417(e)(3).

(ii) Participant M is provided with a QJSA ex-planation that describes the single life annuity, theQJSA, and single-sum distribution option under theplan, and any eligibility conditions associated withthese options. The explanation indicates that, if Par-ticipant M commenced benefits at age 55 and had aspouse age 55, the monthly benefit under an imme-diately commencing single life annuity is $3,000, themonthly benefit under the QJSA is estimated to be89.96% of the monthly benefit under the immedi-ately commencing single life annuity or $2,699, andthe single sum is estimated to be 74.7645 times themonthly benefit under the immediately commenc-ing single life annuity or $224,293.

(iii) The QJSA explanation indicates that the singlelife annuity and the QJSA are of approximately thesame value, but that the single-sum option is equiva-

lent in value to a QJSA of $1,215. (This amount is45% of the value of the QJSA at age 55 ($1,215 di-vided by 89.96% of $3,000 equals 45%).) The ex-planation states that the relative value comparisonconverts the value of the single life annuity and thesingle-sum options to the value of each if paid in theform of the QJSA and that this conversion uses in-terest and life expectancy assumptions. The explana-tion specifies that the calculations relating to the single-sum distribution were prepared using 5.5% interest andaverage life expectancy, that the other calculations wereprepared using a 6% interest rate and that the rela-tive value of actual annuity payments for an indi-vidual can vary depending on how long the individualand spouse live. The explanation notes that the cal-culation of the QJSA assumed that the spouse was age55, that the amount of the QJSA will depend on theactual age of the spouse (for example, annuity pay-ments will be significantly lower if the spouse is sig-nificantly younger than the participant), and that theamount of the single-sum payment will depend on theinterest rates that apply when the participant actu-ally takes a distribution. The explanation also in-cludes an offer to provide a more precise calculationto the participant taking into account the spouse’s ac-tual age.

(iv) Participant M requests a more precise calcu-lation of the financial effect of choosing a QJSA, tak-ing into the actual age of Participant M’s spouse. Basedon the fact that M’s spouse is age 50, Plan A deter-mines that the monthly payments under the QJSA are87.62% of the monthly payments under the single lifeannuity, or $2,628.60 per month, and provides this in-formation to M. Plan A is not required to provide anupdated calculation of the relative value of the singlesum because the value of single sum continues to be45% of the value of the QJSA.

Example 2. (i) The facts are the same as in Ex-ample 1, except that under Plan A, the single-sum dis-tribution is determined as the actuarial present valueof the immediately commencing single life annuity.In addition, Plan A provides a joint and 75% survi-vor annuity that is reduced from the single life an-nuity and that is the QJSA under Plan A. For purposesof determining the amount of the QJSA, the reduc-tion is only half of the reduction that would nor-mally apply under the actuarial assumptions specifiedin Plan A for determining actuarial equivalence of op-tional forms.

(ii) In lieu of providing information specific to Par-ticipant M in the QJSA notice as set forth in para-graph (c) of this section, Plan A satisfies the QJSAexplanation requirement in accordance with para-graph (d)(2) of this section by providing M with astatement that M’s monthly benefit under an imme-diately commencing single life annuity (which is thenormal form of benefit under Plan A, adjusted for im-mediate commencement) is $3,000, along with the fol-lowing chart showing the financial effect and therelative value of the optional forms of benefit com-pared to the QJSA for a hypothetical participant witha $1,000 benefit and a spouse who is three yearsyounger than the participant. For each optional formgenerally available under the plan, the chart shows thefinancial effect and the relative value, using the group-ing rules of paragraph (c)(2)(ii) of this section. Sepa-rate charts are provided for ages 55, 60, and 65.

November 4, 2002 798 2002–44 I.R.B.

Age 55 Commencement

Optional Form Amount of distribution per $1,000 of immediatesingle life annuity

Relative Value

Life Annuity $1,000 per month approximately the same value as the QJSA

QJSA (joint and 75% survivor annuity) $956 per month n/a

Joint and 100% survivor annuity $886 per month approximately the same value as the QJSA

Lump sum $165,959 approximately the same value as the QJSA

Age 60 Commencement

Optional Form Amount of distribution per $1,000 of immediatesingle life annuity

Relative Value

Life Annuity $1,000 per month approximately 94% of the value of the QJSA

QJSA (joint and 75% survivor annuity) $945 per month n/a

Joint and 100% survivor annuity $859 per month approximately 94% of the value of the QJSA

Lump sum $151,691 approximately the same value as the QJSA

Age 65 Commencement

Optional Form Amount of distribution per $1,000 of immediatesingle life annuity

Relative Value

Life Annuity $1,000 per month approximately 93% of the value of the QJSA

QJSA (joint and 75% survivor annuity) $932 per month n/a

Joint and 100% survivor annuity $828 per month approximately 93% of the value of the QJSA

Lump sum $135,759 approximately 93% of the value of the QJSA

(iii) The chart disclosing the financial effectand relative value of the optional forms specifiesthat the calculations were prepared assuming thatthe spouse is three years younger than theparticipant, that the calculations relating to thesingle-sum distribution were prepared using 5.5%interest and average life expectancy, that the othercalculations were prepared using a 6% interest rate,and that the relative value of actual payments foran individual can vary depending on how long theindividual and spouse live. The explanation statesthat the relative value comparison converts theQJSA, the single life annuity, the joint and 100%survivor annuity, and the single-sum options to anequivalent present value and that this conversionuses interest and life expectancy assumptions. Theexplanation notes that the calculation of the QJSAdepends on the actual age of the spouse (forexample, annuity payments will be significantlylower if the spouse is significantly younger thanthe participant), and that the amount of the single-sum payment will depend on the interest rates thatapply when the participant actually takes adistribution. The explanation also includes an offerto provide a calculation specific to the participantupon request.

(iv) Participant M requests information regard-ing the amounts payable under the QJSA, the joint and100% survivor annuity, and the single sum.

(v) Based on the information about the age of Par-ticipant M’s spouse, Plan A determines that M’s QJSAis $2,856.30 per month, the joint and 100% survi-vor annuity is $2,628.60 per month, and the single sumis $497,876. The actuarial present value of the QJSA(determined using the 5.5% interest and the section417(e)(3) applicable mortality table, the actuarial as-sumptions required under section 417) is $525,091.Accordingly, the value of the single-sum distribu-tion available to M at January 1, 2004, is 94.8% ofthe actuarial present value of the QJSA. In addition,the actuarial present value of the life annuity and the100% joint and survivor annuity are 95.0% of the ac-tuarial present value of the QJSA.

(vi) Plan A provides M with a QJSA explana-tion that incorporates these more precise calcula-tions of the financial effect and relative value of theoptional forms for which M requested information.

(f) Effective date. This section applies toQJSA explanations provided with respectto distributions with annuity starting dateson or after January 1, 2004, and to QPSAexplanations provided on or after January1, 2004.

§ 1.417(e)–1 [Amended]

Par. 5. In § 1.417(e)–1, paragraph (b)(2)is amended by removing the language“§ 1.401(a)–20 Q&A–36” and adding“§ 1.417(a)(3)–1” in its place.

Robert E. Wenzel,Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on October 4,2002, 8:45 a.m., and published in the issue of the Federal Reg-ister for October 7, 2002, 67 F.R. 62417)

Dual Consolidated LossRecapture Events; Correction

Announcement 2002–100

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposedrulemaking and notice of public hearing.

SUMMARY: This document contains cor-rections to proposed regulations (REG–106879–00, 2002–34 I.R.B. 402) aspublished in the Internal Revenue Bulle-tin. These regulations under section 1503(d)relate to the events that require the recap-ture of dual consolidated losses.

DATES: These corrections are effectiveAugust 26, 2002.

FOR FURTHER INFORMATIONCONTACT: Kenneth D. Allison orKathryn T. Holman at (202) 622–3860 (nota toll-free number).

2002–44 I.R.B. 799 November 4, 2002

SUPPLEMENTARY INFORMATION:

Background

The notice of proposed rulemaking thatis the subject of these corrections is un-der section 1503(d).

Need for Correction

As published in the Internal RevenueBulletin, this notice of proposed rulemak-ing contains errors which may prove to bemisleading and are in need of clarifica-tion.

Correction of Publication

Accordingly, the notice of proposed rule-making (REG–106879–00) as published inthe Internal Revenue Bulletin is correctedas follows:

1. On page 404 of the Internal Rev-enue Bulletin (I.R.B.), column 1, under“Proposed Effective Date”, the language“These regulations amending the dual con-solidated loss rules under § 1.1503–2 areproposed to apply to transactions other-wise constituting triggering events occur-ring on or after August 1, 2002.” iscorrected to read “These regulations amend-ing the dual consolidated loss rules under§ 1.1503–2 are proposed to apply to trans-actions otherwise constituting triggeringevents occurring on or after [DATE THEFINAL REGULATIONS ARE PUB-LISHED IN THE FEDERAL REGIS-TER].”

2. On page 405 of the I.R.B., column2, the language “Paragraphs (g)(2)(iv)(A)(4)and (5) of this section, and paragraphs(g)(2)(iv)(B)(l)(ii) and (iii) of this sec-tion, shall apply with respect to transac-tions otherwise constituting triggering eventsoccurring on or after August 1, 2002.” iscorrected to read “Paragraphs(g)(2)(iv)(A)(4) and (5) of this section, andparagraphs (g)(2)(iv)(B)(l)(ii) and (iii) of thissection, shall apply with respect to trans-actions otherwise constituting triggeringevents occurring on or after [DATE THEFINAL REGULATIONS ARE PUB-LISHED IN THE FEDERAL REGIS-TER].”

The corrections made herein will be re-flected in the notice of proposed rulemak-ing published in the Cumulative Bulletin.

Request for Applications toParticipate in the 2003 IRSIndividual e-file PartnershipProgram

Announcement 2002–101

The Stakeholder Partnerships, Educa-tion and Communication (SPEC) func-tion within the Internal Revenue Service(IRS) is continuing its efforts to establishIRS e-file partnerships with various enti-ties. The IRS is seeking non-monetary e-filepartnerships for Filing Season 2003. No ap-plications for funding (monetary compen-sation) will be considered. Applications maybe submitted by a commercial business,non-profit organization, state governmentor local government. Applications are notsolicited from other Federal governmentagencies. The program is an annual pro-gram and covers the period January 2003through October 15, 2003. All prior yearpartners must reapply for Filing Sea-son 2003.

BACKGROUND

The IRS Restructuring and Reform Actof 1998 (RRA 98) requires the IRS to re-ceive 80 percent of all returns electroni-cally by 2007. RRA 98 authorized the IRSCommissioner to promote the benefits ofand encourage the use of e-file services. Asa result of RRA 98, the IRS enters into non-monetary partnerships with businesses to of-fer low cost income tax preparation andelectronic filing for qualified taxpayers.

Continued opportunities for growth inelectronic tax administration are evident. ForFiling Season 2002, the IRS received over46 million electronically filed returns, an in-crease of 16% over the previous year. Visitthe IRS web site, www.irs.gov, “IRS e-filefor Tax Professionals, Software Develop-ers, and Transmitters” for the most cur-rent results from market research onindividual taxpayers: demographic data andpsychographic studies. This includes atti-tudinal surveys, customer satisfaction sur-veys, Public Service Announcements(PSAs)/Paid Advertising Tracking Stud-ies and any focus group results.

The IRS currently accepts 115 forms andschedules for electronic filing. Visit the IRS

web site (www.irs.gov) for a complete list-ing of accepted forms and schedules.

FILING SEASON 2003

For Filing Season 2003, the IRS will fo-cus on the 1040 series income tax returnscovering “IRS e-file Using a Tax Preparer”and “IRS e-file Using a Personal Com-puter.” Additional emphasis is being placedon the following features: “Self-Select Per-sonal Identification Number (PIN) for e-file;“Using e-file for Federal/State Returns”, and“Electronic Payment Options” for balancedue and estimated payment options.

Emphasis should also be placed on thefirst-time filer population. IRS research in-dicates that this segment of the popula-tion continues to lag behind other segmentsof the population that e-file. In addition, re-search indicates that e-file is still laggingin the self-prepared simple segment. An-other area of emphasis is to reach those tax-payers who continue to file computerprepared paper returns (v-code). Researchindicates that the number of v-code re-turns continues to increase (76% of allv-code returns are prepared by paid pre-parers). Emphasis should be placed on en-couraging v-code filers to electronically filetheir returns through the marketing and pro-motion of the benefits of e-file.

The IRS expects all accepted partners toaggressively market, promote and offer e-fileservices through October 15, 2003. The IRSwill supply the partners with the Filing Sea-son and post April 15 e-file campaign mes-sage(s), if available, to target additionalqualified taxpayers, i.e., extensions, mili-tary returns, etc. Pending the passage of leg-islation, Participants are encouraged to offerthe April 30 due date extension for e-file.

For additional information on the vari-ous e-file programs, features, and market re-search, visit our web site at www.irs.gov.For a listing of our current partners and theservices they offer, refer to the IRS e-filePartners Page at www.irs.gov.

Participants will receive hyperlinks fromthe IRS web site to the Participant’s website. Potential Participants may request linksfor the following categories: IRS e-filePartners for Taxpayers, IRS e-file Part-ners for Tax Professionals, IRS e-filePartners for Financial Institutions/Employers, and IRS e-file Partners forCredit Card Payment Options.

November 4, 2002 800 2002–44 I.R.B.

PARTICIPATION REQUIREMENTS

• The Participant (Electronic ReturnOriginator, Intermediate Service Pro-vider, Software Developer, and Trans-mitter) must be in good standing withthe IRS, comply with the e-file re-quirements stated in the IRS Rev-enue Procedure 2000–31, 2000–2 C.B.146, Publications 1345 and 1345A, 26U.S.C. 7216, U.S.C. 6103, and passthe annual Suitability and ParticipantsAcceptance Testing (PATS) conductedby the IRS. All other Participants areexempt from these requirements.

• The Participant will offer their prod-ucts and services to filers of the 1040Series returns, including complicatedreturns, balance due returns, Federal/State returns, and 1040EZ returns. TheParticipant is encouraged to reach first-time filers and v-coders. The partici-pant will offer a variety of e-filefeatures including the Self-Select PIN,Electronic Payment Options, DirectDeposit of Refunds, etc.

• The Participant will aggressively mar-ket, promote and offer e-file servicesthrough October 15, 2003. The Par-ticipant will use the current Filing Sea-son e-file marketing/promotionalmessages developed by the IRS. In ad-dition, the Participant will use the postApril 15 e-file campaign message(s)and other promotional tools, if avail-able, to target qualified taxpayers, i.e.,extensions, military returns, etc.

• The Participant is encouraged to of-fer the April 30 due date extension fore-file, upon passage of authorizing leg-islation.

• The Participant will have a hyper-link(s) from the IRS web site to theirsite. Participants will not have aURL(s) containing the word “IRS”.

• The Participant will place the IRSe-file logo on its web site.

• The Participant will provide a descrip-tion (350 characters or less) for eachhyperlink placed on the IRS e-filePartners Page. The Participant willhave a link(s) to the IRS web site.

• The Participant will not offer its ser-vices and/or products based on thecondition in obtaining an eligible tax-payer’s consent to solicitations of ad-ditional business.

• The Participant’s web site will not con-tain inappropriate content nor will theParticipant provide links to inappro-priate content.

• The Participant will clearly disclose tousers its customer service support op-tions and privacy policy.

• The Participant should submit writ-ten notification, i.e., email, to the IRSof changes/additions/deletions toURLs, link descriptions, etc.

• The Participant will submit a Perfor-mance Report to the IRS Point ofContact by May 30, 2003. The re-port will cover Filing Season activi-ties (i.e., statistical information, website activity, etc.). The IRS Point ofContact will provide written report-ing instructions and requirements toaccepted participants.

PERFORMANCE STANDARDS

• The IRS will have the accepted par-ticipant’s hyperlink(s) available on theIRS web site by December 31, 2002,or before the start of electronic fil-ing, subject to the participant’s pass-ing of the annual Suitability and PATStesting. Hyperlinks will remain on theIRS e-file Partners Page at leastthrough October 15, 2003, or later.

• The IRS will rotate on a daily basisthe hyperlinks that exist on the IRSe-file Partners Page.

• The IRS may establish a link from theIRS e-file Partners Page to the Free In-ternet Filing Consortium web page.

• The IRS will accept, if appropriate, theParticipant’s written request forchanges/additions/deletions to a URL,link description, etc.

• The IRS has a right to review the Par-ticipant’s web site(s) to ensure thatparticipation requirements are met.

• The IRS will not endorse specific of-ferings or products, but will promotethe IRS e-file Partners Page. A “SiteDisclaimer” will exist on the IRS website before the user enters the Partici-pant’s web site.

PARTICIPATION TERMS

• The IRS Individual e-file Partner-ship Program is an annual program,and all prospective Participants, in-cluding returning Participants, must re-apply each year following the

guidelines in the announcement ad-vertised on www.irs.gov.

• If the IRS determines that the partici-pant is not meeting the “Participa-tion Requirements,” the IRS mayterminate its partnership with the Par-ticipant and remove the participant’shyperlink(s) from the IRS e-file Part-ners Page.

• The Participant should notify the IRSimmediately if it wishes to terminateits partnership with the IRS. The no-tification should be submitted throughemail to the IRS Point of Contact orsent to the Point of Contact’s address.

APPLICATION PROCESS

Applications should contain thefollowing:

• Include the Applicant’s Point of Con-tact information (name, title, address,telephone number, fax number ande-mail address) for discussion of yourapplication.

• Identify the Applicant’s secure website.

• Identify the Applicant’s tax prepara-tion software (if applicable).

• Include the Applicant’s Electronic FilerIdentification Number (EFIN) and/orElectronic Transmitter IdentificationNumber (ETIN) (if applicable).

• Identify the Applicant’s hyperlink(s)and provide a short description (350characters or less) of the services andproducts to be promoted on the IRSe-file Partners Page. In addition, theApplicant should provide the associ-ated URL(s). The URL(s) addresscannot contain the word “IRS.” In-dicate the category for eachhyperlink(s): IRS e-file Partners forTaxpayers, IRS e-file Partners forTax Professionals, IRS e-file Part-ners for Financial Institutions/Employers, and IRS e-file Partnersfor Electronic Payment Options. Re-fer to the IRS e-file Partners Page(www.irs.gov) for examples of link de-scriptions.

• Identify the Applicant’s communica-tion vehicle(s) (i.e., web site,marketing/promotional products, etc.)to market and promote your prod-ucts and services and IRS e-file. De-scribe the incentives, discounts, offers,benefits to taxpayers or other spe-cific approaches to increase e-file vol-umes.

2002–44 I.R.B. 801 November 4, 2002

• Certify the Applicant’s compliancewith the privacy and disclosure pro-visions of 26 U.S.C. 7216 and 26U.S.C. 6103 (if applicable).

IRS POINT OF CONTACT/APPLICATION SUBMISSION

Applications to participate in the IRS In-dividual e-file Partnership Program shouldbe submitted as a Word document throughemail at *WIe-filepartners@irs.gov (Pleasemake sure there is an asterisk before the WI(Wage and Investment) when submitting anapplication.) An application may also besent to Karen Bradley at the followingaddress:

Internal Revenue Service5000 Ellin RoadLanham, MD 20706Attention: Karen Bradley

W:CAR:SPEC:FO:IMSC5–351

If you wish to have a hyperlink(s) on theIRS e-file Partners Page by December 31,2002, or before the start of electronic fil-ing, your application must be submitted byDecember 4, 2002, otherwise, there is nodeadline for your application.

Illustrations of marketing materials maybe submitted in Adobe Acrobat PortableDocument (PDF) or other appropriate files.

Any questions regarding the develop-ment of applications, the submission of Per-formance Reports, or any other type ofcontact for this program should be directedto Karen Bradley at (202) 283–7034 orthrough email to *WIe-filepartners@irs.gov (Please make sure there is an as-terisk before the WI (Wage and Invest-ment) for any type of email contact.)

APPLICATION EVALUATION

All applications will be evaluated basedon the required information provided to theIRS and the applicant’s ability to fulfill theirresponsibilities. Prior year performance willalso be considered when evaluating appli-cations from returning partners.

ACCEPTANCE/DENIAL OFAPPLICATION

If your application is accepted, you willreceive written notification from the IRS.

If your application is denied, you will re-ceive written notification from the IRS withan explanation of the denial.

Exclusions From GrossIncome of ForeignCorporations; Hearing

Announcement 2002–102

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Change of date of publichearing, extension of time for submittingpublic comments and outlines of oralcomments.

SUMMARY: This document changes thedate of a public hearing on proposed regu-lations (REG–208280–86; REG–136311–01, 2002–36 I.R.B. 485) relating toexclusions from gross income of foreigncorporations under section 883 of the In-ternal Revenue Code, and extends the timefor submitting public comments and out-lines of oral comments.

DATES: The public hearing originallyscheduled for Tuesday, November 12, 2002,at 10 a.m. is rescheduled for Monday, No-vember 25, 2002, at 10 a.m. The due datefor written or electronic public commentsand outlines of topics to be discussed, isNovember 5, 2002.

ADDRESSES: The public hearing is be-ing held in room 4718, Internal RevenueBuilding, 1111 Constitution Avenue, NW,Washington, DC. Due to building secu-rity procedures, visitors must enter at theConstitution Avenue entrance. Send sub-missions to: CC:ITA:RU (REG–208280–86; REG–136311–01), room 5226, InternalRevenue Service, POB 7604, BenFranklin Station, Washington, DC 20044.Submissions may be hand delivered Mon-day through Friday between the hours of8 a.m. and 5 p.m. to: CC:ITA:RU (REG–208280–86; REG–136311–01), Courier’sDesk, Internal Revenue Service, 1111 Con-stitution Avenue, NW, Washington, DC. Al-ternatively, comments may be transmitted

electronically via the Internet by submit-ting comments directly to the IRS Inter-net site at: http://www.irs.gov/regs.

FOR FURTHER INFORMATIONCONTACT: Guy Traynor of the Regula-tions Unit, Associate Chief Counsel (In-come Tax & Accounting), at (202) 622–7180 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

A notice of proposed rulemaking and no-tice of public hearing appearing in the Fed-eral Register on Friday, August 2, 2002 (67FR 50510), announced that a public hear-ing on proposed regulations relating to ex-clusions from gross income of foreigncorporations under section 883 of the In-ternal Revenue Code would be held onTuesday, November 12, 2002, beginning at10 a.m. in room 4718 of the Internal Rev-enue Building, 1111 Constitution Avenue,NW, Washington, DC. The deadline for sub-mitting public comments and outlines oftopics to be discussed, is October 22, 2002.

The date of the hearing and deadline forsubmitting public comments has changed.The hearing is scheduled for Monday, No-vember 25, 2002, beginning at 10 a.m. inroom 4718, Internal Revenue Building, 1111Constitution Avenue, NW, Washington, DC.We must receive written and electronic pub-lic comments and outlines of topics to bediscussed, by November 5, 2002. Becauseof the controlled access restrictions, atten-dants will not be admitted beyond the lobbyarea of the Internal Revenue Building un-til 9:30 a.m. The IRS will prepare an agendashowing the scheduling of the speakers af-ter the outlines are received from the per-sons testifying and make copies availablefree of charge at the hearing.

Cynthia E. Grigsby,Chief, Regulations Unit,Associate Chief Counsel

(Income Tax & Accounting).

(Filed by the Office of the Federal Register on October 17,2002, 8:45 a.m., and published in the issue of the Federal Reg-ister for October 18, 2002, 67 F.R. 64331)

November 4, 2002 802 2002–44 I.R.B.

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

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, ifan 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.

Distinguished describes 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

applies to both A and B, the prior rulingis modified because it corrects a pub-lished position. (Compare with amplifiedand clarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly 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 aperiod 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 case,the 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 and thatlist is expanded by adding further namesin subsequent rulings. After the originalruling has been supplemented severaltimes, a new ruling may be published thatincludes the list in the original ruling andthe additions, and supersedes all prior rul-ings 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 currentuse and formerly used will appear inmaterial published in the Bulletin.

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

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

PO—Possession of the U.S.PR—Partner.PRS—Partnership.PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—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.

2002–44 I.R.B. i November 4, 2002

Numerical Finding List1

Bulletin 2002–26 through 2002–43

Announcements:

2002–59, 2002–26 I.R.B. 282002–60, 2002–26 I.R.B. 282002–61, 2002–27 I.R.B. 722002–62, 2002–27 I.R.B. 722002–63, 2002–27 I.R.B. 722002–64, 2002–27 I.R.B. 722002–65, 2002–29 I.R.B. 1822002–66, 2002–29 I.R.B. 1832002–67, 2002–30 I.R.B. 2372002–68, 2002–31 I.R.B. 2832002–69, 2002–31 I.R.B. 2832002–70, 2002–31 I.R.B. 2842002–71, 2002–32 I.R.B. 3232002–72, 2002–32 I.R.B. 3232002–73, 2002–33 I.R.B. 3872002–74, 2000–33 I.R.B. 3872002–75, 2002–34 I.R.B. 4162002–76, 2002–35 I.R.B. 4712002–77, 2002–35 I.R.B. 4712002–78, 2002–36 I.R.B. 5142002–79, 2002–36 I.R.B. 5152002–80, 2002–36 I.R.B. 5152002–81, 2002–37 I.R.B. 5332002–82, 2002–37 I.R.B. 5332002–83, 2002–38 I.R.B. 5642002–84, 2002–37 I.R.B. 5332002–85, 2002–39 I.R.B. 6242002–86, 2002–39 I.R.B. 6242002–87, 2002–39 I.R.B. 6242002–88, 2002–38 I.R.B. 5642002–89, 2002–39 I.R.B. 6262002–90, 2002–40 I.R.B. 6842002–91, 2002–40 I.R.B. 6852002–92, 2002–41 I.R.B. 7092002–93, 2002–41 I.R.B. 7092002–94, 2002–42 I.R.B. 7282002–95, 2002–42 I.R.B. 7282002–96, 2002–43 I.R.B. 7562002–97, 2002–43 I.R.B. 7572002–98, 2002–43 I.R.B. 7582002–99, 2002–43 I.R.B. 758

Court Decisions:

2075, 2002–38 I.R.B. 548

Notices:

2002–42, 2002–27 I.R.B. 362002–43, 2002–27 I.R.B. 382002–44, 2002–27 I.R.B. 392002–45, 2002–28, I.R.B. 932002–46, 2002–28 I.R.B. 962002–47, 2002–28 I.R.B. 972002–48, 2002–29 I.R.B. 1302002–49, 2002–29 I.R.B. 1302002–50, 2002–28 I.R.B. 982002–51, 2002–29 I.R.B. 1312002–52, 2002–30 I.R.B. 1872002–53, 2002–30 I.R.B. 187

Notices—Continued:

2002–54, 2002–30 I.R.B. 1892002–55, 2002–36 I.R.B. 4812002–56, 2002–32 I.R.B. 3192002–57, 2002–33 I.R.B. 3792002–58, 2002–35 I.R.B. 4322002–59, 2002–36 I.R.B. 4812002–60, 2002–36 I.R.B. 4822002–61, 2002–38 I.R.B. 5632002–62, 2002–39 I.R.B. 5742002–63, 2002–40 I.R.B. 6442002–64, 2002–41 I.R.B. 6902002–65, 2002–41 I.R.B. 6902002–66, 2002–42 I.R.B. 7162002–67, 2002–42 I.R.B. 7162002–68, 2002–43 I.R.B. 7302002–69, 2002–43 I.R.B. 730

Proposed Regulations:

REG–248110–96, 2002–26 I.R.B. 19REG–110311–98, 2002–28 I.R.B. 109REG–103823–99, 2002–27 I.R.B. 44REG–103829–99, 2002–27 I.R.B. 59REG–103735–00, 2002–28 I.R.B. 109REG–106457–00, 2002–26 I.R.B. 23REG–106871–00, 2002–30 I.R.B. 190REG–106876–00, 2002–34 I.R.B. 392REG–106879–00, 2002–34 I.R.B. 402REG–107524–00, 2002–28 I.R.B. 110REG–115285–01, 2002–27 I.R.B. 62REG–115781–01, 2002–33 I.R.B. 380REG–116644–01, 2002–31 I.R.B. 268REG–123345–01, 2002–32 I.R.B. 321REG–126024–01, 2002–27 I.R.B. 64REG–136311–01, 2002–36 I.R.B. 485REG–164754–01, 2002–30 I.R.B. 212REG–165868–01, 2002–31 I.R.B. 270REG–106359–02, 2002–34 I.R.B. 405REG–122564–02, 2002–26 I.R.B. 25REG–123305–02, 2002–26 I.R.B. 26REG–124256–02, 2002–33 I.R.B. 383REG–133254–02, 2002–34 I.R.B. 412REG–134026–02, 2002–40 I.R.B. 684

Revenue Procedures:

2002–43, 2002–28 I.R.B. 992002–44, 2002–26 I.R.B. 102002–45, 2002–27 I.R.B. 402002–46, 2002–28 I.R.B. 1052002–47, 2002–29 I.R.B. 1332002–48, 2002–37 I.R.B. 5312002–49, 2002–29 I.R.B. 1722002–50, 2002–29 I.R.B. 1732002–51, 2002–29 I.R.B. 1752002–52, 2002–31 I.R.B. 2422002–53, 2002–31 I.R.B. 2532002–54, 2002–35 I.R.B. 4322002–55, 2002–35 I.R.B. 4352002–56, 2002–36 I.R.B. 4832002–57, 2002–39 I.R.B. 5752002–58, 2002–40 I.R.B. 6442002–59, 2002–39 I.R.B. 6152002–60, 2002–40 I.R.B. 6452002–61, 2002–39 I.R.B. 616

Revenue Procedures—Continued:

2002–62, 2002–40 I.R.B. 6832002–63, 2002–41 I.R.B. 6912002–64, 2002–42 I.R.B. 7182002–65, 2002–41 I.R.B. 7002002–66, 2002–42 I.R.B. 7252002–67, 2002–43 I.R.B. 7332002–68, 2002–43 I.R.B. 753

Revenue Rulings:

2002–38, 2002–26 I.R.B. 42002–39, 2002–27 I.R.B. 332002–40, 2002–27 I.R.B. 302002–41, 2002–28 I.R.B. 752002–42, 2002–28 I.R.B. 762002–43, 2002–28 I.R.B. 852002–44, 2002–28 I.R.B. 842002–45, 2002–29 I.R.B. 1162002–46, 2002–29 I.R.B. 1172002–47, 2002–29 I.R.B. 1192002–48, 2002–31 I.R.B. 2392002–49, 2002–32 I.R.B. 2882002–50, 2002–32 I.R.B. 2922002–51, 2002–33 I.R.B. 3272002–52, 2002–34 I.R.B. 3882002–53, 2002–35 I.R.B. 4272002–54, 2002–37 I.R.B. 5272002–55, 2002–37 I.R.B. 5292002–56, 2002–37 I.R.B. 5262002–57, 2002–37 I.R.B. 5262002–58, 2002–38 I.R.B. 5412002–59, 2002–38 I.R.B. 5572002–60, 2002–40 I.R.B. 6412002–61, 2002–40 I.R.B. 6392002–62, 2002–42 I.R.B. 7102002–64, 2002–41 I.R.B. 6882002–65, 2002–43 I.R.B. 729

Treasury Decisions:

8997, 2002–26 I.R.B. 68998, 2002–26 I.R.B. 18999, 2002–28 I.R.B. 789000, 2002–28 I.R.B. 879001, 2002–29 I.R.B. 1289002, 2002–29 I.R.B. 1209003, 2002–32 I.R.B. 2949004, 2002–33 I.R.B. 3319005, 2002–32 I.R.B. 2909006, 2002–32 I.R.B. 3159007, 2002–33 I.R.B. 3499008, 2002–33 I.R.B. 3359009, 2002–33 I.R.B. 3289010, 2002–33 I.R.B. 3419011, 2002–33 I.R.B. 3569012, 2002–34 I.R.B. 3899013, 2002–38 I.R.B. 5429014, 2002–35 I.R.B. 4299015, 2002–40 I.R.B. 6429016, 2002–40 I.R.B. 628

1 A cumulative list of all revenue rulings, revenue

procedures, Treasury decisions, etc., published in

Internal Revenue Bulletins 2002–1 through 2002–25 is

in Internal Revenue Bulletin 2002–26, dated July 1, 2002.

November 4, 2002 ii 2002–44 I.R.B.

Finding List of Current Actionson Previously Published Items1

Bulletin 2002–26 through 2002–43

Announcements:

98–99Superseded byRev. Proc. 2002–44, 2002–26 I.R.B. 10

2000–4Modified byAnn. 2002–60, 2002–26 I.R.B. 28

2001–9Superseded byRev. Proc. 2002–44, 2002–26 I.R.B. 10

Notices:

89–25Modified byRev. Rul. 2002–62, 2002–42 I.R.B. 710

97–26Modified and superseded byNotice 2002–62, 2002–39 I.R.B. 574

2001–6Superseded byNotice 2002–63, 2002–40 I.R.B. 644

2001–62Modified and superseded byNotice 2002–62, 2002–39 I.R.B. 574

Proposed Regulations:

REG–208280–86Withdrawn byREG–136311–01, 2002–36 I.R.B. 485

REG–209114–90Corrected byAnn. 2002–65, 2002–29 I.R.B. 182

REG–209813–96Withdrawn byREG–106871–00, 2002–30 I.R.B. 190

REG–103823–99Corrected byAnn. 2002–67, 2002–30 I.R.B. 237Ann. 2002–79, 2002–36 I.R.B. 515

REG–103829–99Corrected byAnn. 2002–82, 2002–37 I.R.B. 533Ann. 2002–95, 2002–42 I.R.B. 728

REG–105885–99Corrected byAnn. 2002–67, 2002–30 I.R.B. 237

REG–105369–00Clarified byNotice 2002–52, 2002–30 I.R.B. 187Corrected byAnn. 2002–67, 2002–30 I.R.B. 237

REG–118861–00Corrected byAnn. 2002–67, 2002–30 I.R.B. 237

Proposed Regulations—Continued:

REG–126100–00Withdrawn byREG–133254–02, 2002–34 I.R.B. 412

REG–136193–01Corrected byAnn. 2002–67, 2002–30 I.R.B. 237

REG–136311–01Corrected byAnn. 2002–94, 2002–42 I.R.B. 728

REG–161424–01Corrected byAnn. 2002–67, 2002–30 I.R.B. 237

REG–165706–01Corrected byAnn. 2002–67, 2002–30 I.R.B. 237

REG–165868–01Corrected byAnn. 2002–93, 2002–41 I.R.B. 709

REG–102740–02Corrected byAnn. 2002–67, 2002–30 I.R.B. 237

REG–106359–02Corrected byAnn. 2002–81, 2002–37 I.R.B. 533

REG–108697–02Corrected byAnn. 2002–84, 2002–37 I.R.B. 533

REG–123305–02Corrected byAnn. 2002–69, 2002–31 I.R.B. 283

Revenue Procedures:

88–10Superseded byRev. Proc. 2002–48, 2002–37 I.R.B. 531

91–23Modified and superseded byRev. Proc. 2002–52, 2002–31 I.R.B. 242

91–26Modified and superseded byRev. Proc. 2002–52, 2002–31 I.R.B. 242

95–18Superseded byRev. Proc. 2002–51, 2002–29 I.R.B. 175

96–13Modified and superseded byRev. Proc. 2002–52, 2002–31 I.R.B. 242

96–14Modified and superseded byRev. Proc. 2002–52, 2002–31 I.R.B. 242

96–53Amplified byRev. Proc. 2002–52, 2002–31 I.R.B. 242

Revenue Procedures—Continued:

2001–12Obsoleted byT.D. 9004, 2002–33 I.R.B. 331

2001–15Superseded byRev. Proc. 2002–64, 2002–42 I.R.B. 718

2001–17Modified and superseded byRev. Proc. 2002–47, 2002–29 I.R.B. 133

2001–26Superseded byRev. Proc. 2002–53, 2002–31 I.R.B. 253

2001–45Superseded byRev. Proc. 2002–60, 2002–40 I.R.B. 645

2001–46Modified and amplified byRev. Proc. 2002–65, 2002–41 I.R.B. 700

2001–47Superseded byRev. Proc. 2002–63, 2002–41 I.R.B. 691

2001–50Superseded byRev. Proc. 2002–57, 2002–39 I.R.B. 575

2001–52Updated byRev. Proc. 2002–66, 2002–42 I.R.B. 725

2001–54Superseded byRev. Proc. 2002–61, 2002–39 I.R.B. 616

2002–9Modified and amplified byRev. Proc. 2002–46, 2002–28 I.R.B. 105Rev. Proc. 2002–65, 2002–41 I.R.B. 700Amplified, clarified, and modified byRev. Proc. 2002–54, 2002–35 I.R.B. 432

2002–13Modified byRev. Proc. 2002–45, 2002–27 I.R.B. 40

2002–15Modified and superseded byRev. Proc. 2002–59, 2002-39 I.R.B. 615

2002–16Modified and superseded byRev. Proc. 2002–68, 2002–43 I.R.B. 753

2002–19Amplified and clarified byRev. Proc. 2002–54, 2002–35 I.R.B. 432

1 A cumulative list of current actions on previously published

items in Internal Revenue Bulletins 2002–1 through 2002–25 is

in Internal Revenue Bulletin 2002–26, dated July 1, 2002.

2002–44 I.R.B. iii November 4, 2002

Revenue Rulings:

54–571Obsoleted byT.D. 9010, 2002–33 I.R.B. 341

55–534Distinguished byRev. Rul. 2002–60, 2002–40 I.R.B. 641

55–606Obsoleted byT.D. 9010, 2002–33 I.R.B. 341

59–328Obsoleted byT.D. 9010, 2002–33 I.R.B. 341

64–36Obsoleted byT.D. 9010, 2002–33 I.R.B. 341

65–129Obsoleted byT.D. 9010, 2002–33 I.R.B. 341

67–197Obsoleted byT.D. 9010, 2002–33 I.R.B. 341

69–259Modified and superseded byRev. Rul. 2002–50, 2002–32 I.R.B. 292

69–595Obsoleted in part byT.D. 9010, 2002–33 I.R.B. 341

70–608Obsoleted in part byT.D. 9010, 2002–33 I.R.B. 341

73–232Obsoleted byT.D. 9010, 2002–33 I.R.B. 341

76–225Revoked byREG–115781–01, 2002–33 I.R.B. 380

77–53Obsoleted byT.D. 9010, 2002–33 I.R.B. 341

85–50Obsoleted byT.D. 2002–33 I.R.B. 341

92–17Amplified byRev. Rul. 2002–49, 2002–32 I.R.B. 288

92–75Clarified byRev. Proc. 2002–52, 2002–31 I.R.B. 242

93–70Obsoleted byT.D. 9010, 2002–33 I.R.B. 341

94–76Amplified byRev. Rul. 2002–42, 2002–28 I.R.B. 76

Treasury Decisions:

8925Corrected byAnn. 2002–89, 2002–39 I.R.B. 626

8997Corrected byAnn. 2002–68, 2002–31 I.R.B. 283

8999Corrected byAnn. 2002–71, 2002–32 I.R.B. 323

9013Corrected byAnn. 2002–83, 2002–38 I.R.B. 564

November 4, 2002 iv 2002–44 I.R.B.

INDEXInternal Revenue Bulletins2002–26 through 2002–43

The abbreviation and number in paren-thesis following the index entry refer tothe specific item; numbers in roman anditalic type following the parenthesis referto the Internal Revenue Bulletin in whichthe item may be found and the page num-ber on which it appears.

Key to Abbreviations:Ann AnnouncementCD Court DecisionDO Delegation OrderEO Executive OrderPL Public LawPTE Prohibited Transaction

ExemptionRP Revenue ProcedureRR Revenue RulingSPR Statement of Procedural

RulesTC Tax ConventionTD Treasury DecisionTDO Treasury Department Order

EMPLOYEE PLANSAccident and health plans, amounts

received (RR 58) 38, 541Defined benefit plans, elimination of

optional forms of benefit (Notice 46)28, 96

Employee Plans Compliance ResolutionSystem (EPCRS) update (RP 47) 29,133

Full funding limitations:Weighted average interest rate for:

July 2002 (Notice 49) 29, 130August 2002 (Notice 57) 33, 379September 2002 (Notice 61) 38,

563October 2002 (Notice 68) 43, 730

Health reimbursement arrangements(HRAs) (RR 41) 28, 75; (Notice 45)28, 93

Individual retirement arrangements, earn-ings calculation for returned or rechar-acterized IRA contributions (REG–124256–02) 33, 383

EMPLOYEE PLANS—Cont.Practice before the Internal Revenue Ser-

vice (TD 9011) 33, 356Premature distributions, substantially

equal periodic payments (RR 62) 42,710

Proposed Regulations:26 CFR 1.401(a)(9)–6, added; required

distributions from retirement plans,notice of public hearing (Ann 84)37, 533

26 CFR 1.408–4, amended; 1.408–11,added; 1.408A–5, revised; earningscalculation for returned or recharac-terized IRA contributions (REG–124256–02) 33, 383

26 CFR 1.419A(f)(6)–1, added; 10-or-more employer plans (REG–165868–01) 31, 270; correction(Ann 93) 41, 709

Publications:590, Individual Retirement Arrange-

ments (IRAs), Supplement to (Ann73) 33, 387

Qualified retirement plans:Deductions:

Contributions (Notice 48) 29, 130Timing (RR 46) 29, 117

Defined benefit plan, phased retire-ment (Notice 43) 27, 38

Money purchase pension plan, partialtermination (RR 42) 28, 76

Notice to interested parties require-ment (TD 9006) 32, 315

Required minimum distributions,notice of public hearing (Ann 84)37, 533

Restorative payments (RR 45) 29, 116Refund of mistaken contributions and

withdrawal liability payments (TD9005) 32, 290

Regulations:26 CFR 1.401(a)(2)–1, added; refund

of mistaken contributions and with-drawal liability payments (TD 9005)32, 290

26 CFR 1.7476–1, –2, amended;601.201, amended; notice to inter-ested parties (TD 9006) 32, 315

31 CFR Part 10, amended; regulationsgoverning practice before the Inter-nal Revenue Service (TD 9011)33, 356

Ten-or-more employer plans (REG–165868–01) 31, 270; correction (Ann93) 41, 709

EMPLOYMENT TAXCompromise of tax liabilities (TD 9007)

33, 349Effective date of Rev. Proc. 2002–41

(Notice 55) 36, 481Information reporting, payments made on

behalf of another person, to joint pay-ees, and of gross proceeds from salesinvolving investment advisors (TD9010) 33, 341

Practice before the Internal Revenue Ser-vice (TD 9011) 33, 356

Proposed Regulations:26 CFR 1.61–2, amended; 1.61–22,

added; 1.83–1, –3, –6, amended;1.301–1(q), added; 1.1402(a)–18,added; 1.7872–15, added;31.3121(a), 31.3231(e), 31.3306(b),31.3401(a), amended; split-dollarlife insurance arrangements (REG–164754–01) 30, 212

26 CFR 31.3406(d)–5, revised;301.6724–1, amended; receipt ofmultiple notices with respect toincorrect taxpayer identificationnumbers (REG–116644–01) 31, 268

Publications:1141, General Rules and Specifica-

tions for Substitute Forms W–2 andW–3, revised (RP 53) 31, 253

1223, General Rules and Specifica-tions for Substitute Forms W–2c andW–3c, revised (RP 51) 29, 175

Regulations:26 CFR 1.6041–1, –3, amended;

1.6045–1, –2, amended; 1.6049–4,revised; 5f.6045–1, removed;31.3406, amended; 602.101,amended; information reportingrequirements for certain paymentsmade on behalf of another person,payments to joint payees, and pay-ments of gross proceeds from salesinvolving investment advisors (TD9010) 33, 341

26 CFR 301.7122–0, –1, added;301.7122–0T, –1T, removed; com-promise of tax liabilities (TD 9007)33, 349

31 CFR Part 10, amended; regulationsgoverning practice before the Inter-nal Revenue Service (TD 9011)33, 356

Split-dollar life insurance arrangements(REG–164754–01) 30, 212

Statutory stock options, application ofemployment taxes (Notice 47) 28, 97

2002–44 I.R.B. v November 4, 2002

EMPLOYMENT TAX—Cont.Substitute Forms:

W–2 and W–3, general rules andspecifications (RP 53) 31, 253

W–2c and W–3c, general rules andspecifications (RP 51) 29, 175

Taxpayer identification numbers, backupwithholding, waiver of informationreporting penalties (REG–116644–01)31, 268

ESTATE TAXAnnuities, death benefits (RR 39) 27, 33Compromise of tax liabilities (TD 9007)

33, 349Guaranteed annuity and lead unitrust

interests, definition (REG–115781–01)33, 380

Practice before the Internal Revenue Ser-vice (TD 9011) 33, 356

Proposed Regulations:26 CFR 20.2055–2, amended; defini-

tion of guaranteed annuity and leadunitrust interests (REG–115781–01)33, 380

Regulations:26 CFR 301.7122–0, –1, added;

301.7122–0T, –1T, removed; com-promise of tax liabilities (TD 9007)33, 349

31 CFR Part 10, amended; regulationsgoverning practice before the Inter-nal Revenue Service (TD 9011)33, 356

Split-dollar life insurance arrangements,standards for valuing current life insur-ance protection (Notice 59) 36, 481

Tax conventions, competent authorityprocedures (RP 52) 31, 242

EXCISE TAXAir transportation, mileage awards:

Sales of frequent flyer miles (Notice63) 40, 644

Taxation rules (RR 60) 40, 641Compromise of tax liabilities (TD 9007)

33, 349Diesel fuel, blended taxable fuel (REG–

106457–00) 26, 23

EXCISE TAX—Cont.Golden parachute payments:

Excess payments (Ann 65) 29, 181Valuation of options (RP 45) 27, 40

Highway vehicle, definition (REG–103829–99) 27, 59; correction (Ann82) 37, 533; hearing (Ann 95) 42, 727

Practice before the Internal Revenue Ser-vice (TD 9011) 33, 356

Prohibited transactions, excise tax com-putation (RR 43) 28, 85

Proposed Regulations:26 CFR 1.280G–1, golden parachute

payments; correction (Ann 65) 29,181

26 CFR 41.4482(a)–1, amended;48.4041–8, amended; 48.4051–1,added; 48.4072–1, amended;48.4081–1, amended; 48.6421–4,revised; 145.4051–1, amended; defi-nition of highway vehicle (REG–103829–99) 27, 59; correction (Ann82) 37, 533; hearing (Ann 95)42, 727

26 CFR 48.4081–1, –3, amended; die-sel fuel, blended taxable fuel (REG–106457–00) 26, 23

Regulations:26 CFR 301.7122–0, –1, added;

301.7122–0T, –1T, removed; com-promise of tax liabilities (TD 9007)33, 349

31 CFR Part 10, amended; regulationsgoverning practice before the Inter-nal Revenue Service (TD 9011)33, 356

Tax-free sales of articles for use by pur-chaser as supplies for vessels or aircraft(RR 50) 32, 292

EXEMPTORGANIZATIONSForms:

990, request for comments on possiblechanges (Ann 87) 39, 624

1023, Application for Recognition ofExemption Under Section 501(c)(3)of the Internal Revenue Code,request for comments (Ann 92)41, 709

EXEMPTORGANIZATIONS—Cont.Indian tribal governments treated as

states, list (RP 64) 42, 717List of organizations classified as private

foundations (Ann 64) 27, 72; (Ann 66)29, 183; (Ann 70) 31, 284; (Ann 72)32, 323; (Ann 75) 34, 416; (Ann 77)35, 471; (Ann 80) 36, 515; (Ann 88)38, 564

Practice before the Internal Revenue Ser-vice (TD 9011) 33, 356

Regulations:31 CFR Part 10, amended; regulations

governing practice before the Inter-nal Revenue Service (TD 9011)33, 356

Revocations (Ann 99) 43, 758Tax-exempt electric cooperatives, pro-

pane distribution and sale (RR 54) 37,527

Treatment of subsidiary income under the85 percent member income test (RR55) 37, 529

GIFT TAXCompromise of tax liabilities (TD 9007)

33, 349Guaranteed annuity and lead unitrust

interests, definition (REG–115781–01)33, 380

Net gift treatment under section 2519(REG–123345–01) 32, 321

Practice before the Internal Revenue Ser-vice (TD 9011) 33, 356

Proposed Regulations:26 CFR 1.61–2, amended; 1.61–22,

added; 1.83–1, –3, –6, amended;1.301–1(q), added; 1.1402(a)–18,added; 1.7872–15, added;31.3121(a), 31.3231(e), 31.3306(b),31.3401(a), amended; split-dollarlife insurance arrangements (REG–164754–01) 30, 212

26 CFR 25.2207A–1, amended;25.2519–1, amended; net gift treat-ment under section 2519 (REG–123345–01) 32, 321

26 CFR 25.2522(c)–3, amended; defi-nition of guaranteed annuity andlead unitrust interests (REG–115781–01) 33, 380

November 4, 2002 vi 2002–44 I.R.B.

GIFT TAX—Cont.Regulations:

26 CFR 301.7122–0, –1, added;301.7122–0T, –1T, removed; com-promise of tax liabilities (TD 9007)33, 349

31 CFR Part 10, amended; regulationsgoverning practice before the Inter-nal Revenue Service (TD 9011)33, 356

Split-dollar life insurance arrangements:Income, employment, and gift taxation

of (REG–164754–01) 30, 212Standards for valuing current life

insurance protection (Notice 59) 36,481

Tax conventions, competent authorityprocedures (RP 52) 31, 242

INCOME TAXAccident and health plans, amounts

received (RR 58) 38, 541Alternative identifying number of income

tax return preparer (TD 9014) 35, 429Appeals:

Arbitration procedures, extension oftest (Ann 60) 26, 28

Mediation procedure (RP 44) 26, 10Settlement initiative for section 302/

318 basis-shifting transactions (Ann97) 43, 757

Termination of settlement initiative forcorporate owned life insurance(COLI) cases (Ann 96) 43, 756

Archer MSAs, 2002 not a cut-off year(Ann 90) 40, 684

Business and traveling expenses, perdiem allowances, 2003 (RP 63)41, 691

Capital gains and losses (Notice 58) 35,432

Capital gains, qualified empowermentzone (QEZ) asset (RP 62) 40, 682

Classification of newly formed entity (RP59) 39, 615

Compromise of tax liabilities (TD 9007)33, 349

Consolidated income tax return:Agent for the group (RP 43) 28, 99Common parent as agent for consoli-

dated group, substitute agent, tenta-tive carryback adjustments (TD9002) 29, 120

Contingent liability tax shelter cases,settlement (RP 67) 43, 733

INCOME TAX—Cont.Corporations:

Carryback of consolidated net operat-ing losses to separate return years(TD 8997) 26, 6; correction (Ann68) 31, 283; (REG–122564–02)26, 25

Exclusions from gross income of for-eign corporations (REG–136311–01) 36, 485; correction (Ann 94)42, 727

Foreign loss payment patterns (Notice69) 43, 730

Spin-offs, mergers and acquisitions(RR 49) 32, 288

Treatment of a controlled foreign cor-poration’s distributive share of part-nership income under subpart F (TD9008) 33, 335

Credits:Enhanced oil recovery credit, 2002

inflation adjustment (Notice 53) 30,187

Increasing research activities credit(Notice 44) 27, 39

Low-income housing credit:Carryovers to qualified states, 2002

National Pool (RP 56) 36, 483Rental assistance payments (RR 65)

43, 729Satisfactory bond, “bond factor”

amounts for the period:July through September 2002(RR 51) 33, 327

New markets tax credit, other federaltax benefits (Notice 64) 41, 690

Definition of income tax return preparer,low-income taxpayer clinics (REG–115285–01) 27, 62

Depreciation, income forecast method(REG–103823–99) 27, 44; correction(Ann 79) 36, 515

Designated private delivery services,2002 (Notice 62) 39, 574

Designation of persons before whom asummoned person shall appear (TD9015) 40, 642; (REG–134026–02) 40,684

Disaster relief for September 11, 2001,terrorist attacks; exclusion of gain fromthe sale or exchange of a taxpayer’sprincipal residence (Notice 60) 36, 482

Disclosure of return information, Censusof Agriculture (TD 9001) 29, 128

INCOME TAX—Cont.Domestic reverse hybrid entity, eligibility

for treaty benefits (TD 8999) 28, 78;correction (Ann 71) 32, 323

Dual consolidated loss recapture events(REG–106879–00) 34, 402

Effective date of Rev. Proc. 2002–41(Notice 55) 36, 481

Entity classification rules (TD 9012)34, 389

“Excepted sale” for information reportingon Form 1099–B for certain sales ofstock (RP 50) 29, 173

Extension of time to file, or for amendingthe statement of information requiredunder section 149(e) of the Code (RP48) 37, 531

Foreign insurance companies, minimumeffectively connected net investmentincome (RP 58) 40, 644

Forms:1096, 1098, 1099, 5498, W–2G, and

1042–S, substitute form specifica-tions (RP 57) 39, 575

1099–B, information reporting for cer-tain sales of stock, exception (RP50) 29, 173

Golden parachute payments:Excess payments (Ann 65) 29, 181Valuation of options (RP 45) 27, 40

Guaranteed annuity and lead unitrustinterests, definition (REG–115781–01)33, 380

Health reimbursement arrangements(HRAs) (RR 41) 28, 75; (Notice 45)28, 93

Information reporting:Investment trusts (REG–106871–00)

30, 190Payments made on behalf of another

person, to joint payees, and of grossproceeds from sales involvinginvestment advisors (TD 9010)33, 341

Information returns, discharges of indebt-edness (REG–107524–00) 28, 110

Insurance company interest rates (REG–248110–96) 26, 19

Interest:Bank deposit interest paid to nonresi-

dent aliens (REG–133254–02)34, 412

Investment:Federal short-term, mid-term, and

long-term rates for:July 2002 (RR 40) 27, 30

2002–44 I.R.B. vii November 4, 2002

INCOME TAX—Cont.

August 2002 (RR 48) 31, 239September 2002 (RR 53) 35, 427October 2002 (RR 61) 40, 639

Rates:Underpayments and overpayments,

quarter beginning:October 1, 2002 (RR 59) 38, 557

Inventory:LIFO:

Price indexes used by departmentstores for:May 2002 (RR 47) 29, 119June 2002 (RR 52) 34, 388July 2002 (RR 57) 37, 526August 2002 (RR 64) 41, 688

Joint return, relief from joint and severalliability (TD 9003) 32, 294; correction(Ann 83) 38, 564

Loss limitation rules (TD 8998) 26, 1;(REG–123305–02) 26, 26; correction(Ann 69) 31, 283

Marginal properties, oil and gas produc-tion, depletion, 2002 percentages(Notice 54) 30, 189

Methods of accounting:Automatic consent to change certain

methods of accounting (RP 54) 35,432

Safe harbor method for premiumacquisition expenses, non-life insur-ance companies (RP 46) 28, 105

New York Liberty Zone, tax benefits(Notice 42) 27, 36

Noncustomary services provided to ten-ants of a REIT (RR 38) 26, 4

Optional standard mileage rates for 2003(RP 61) 39, 616

Partnerships:Mergers and divisions (Ann 89)

39, 626Optional election to make monthly

section 706(a) computations (RP 68)43, 753

Straddle tax shelter (Notice 50) 28, 98Taxable year, foreign and tax-exempt

partners (TD 9009) 33, 328Withholding tax on nonresident aliens,

Qualified Intermediaries (Notice 66)42, 715

Passive activity losses and credits, limita-tions (TD 9013) 38, 542

Penalties, substantial understatement (RP66) 42, 724

INCOME TAX—Cont.Practice before the Internal Revenue Ser-

vice (TD 9011) 33, 356Private foundations, organizations now

classified as (Ann 64) 27, 72; (Ann 66)29, 183; (Ann 70) 31, 284; (Ann 72)32, 323; (Ann 75) 34, 416; (Ann 77)35, 471; (Ann 80) 36, 515; (Ann 88)38, 564

Proposed Regulations:26 CFR 1.61–2, amended; 1.61–22,

added; 1.83–1, –3, –6, amended;1.301–1(q), added; 1.1402(a)–18,added; 1.7872–15, added;31.3121(a), 31.3231(e), 31.3306(b),31.3401(a), amended; split-dollarlife insurance arrangements (REG–164754–01) 30, 212

26 CFR 1.167(n)–0 through –7, added;guidance on cost recovery under theincome forecast method (REG–103823–99) 27, 44; correction (Ann79) 36, 515

26 CFR 1.170A–6, amended; defini-tion of guaranteed annuity and leadunitrust interests (REG–115781–01)33, 380

26 CFR 1.280G–1; golden parachutepayments; correction (Ann 65)29, 181

26 CFR 1.337(d)–2, amended; 1.1502–20, amended; loss limitation rules(REG–123305–02) 26, 26; correc-tion (Ann 69) 31, 283

26 CFR 1.482–0, –1, –5, –7, amended;compensatory stock options in quali-fied cost sharing arrangements(REG–106359–02) 34, 405; correc-tion (Ann 81) 37, 533

26 CFR 1.671–4, amended; 1.671–5,added; 1.6041–9, added; 1.6042–5,added; 1.6045–1, amended;1.6049–4, –5, amended; 1.6050N–2,added; 301.6109–1, amended;602.101, amended; reporting forwidely held fixed investment trusts(REG–106871–00) 30, 190

26 CFR 1.807–2, added; 1.811–3,added; 1.812–9, added; 1.817A–0,–1, added; guidance regarding modi-fied guaranteed contracts (REG–248110–96) 26, 19

INCOME TAX—Cont.

26 CFR 1.883–0 through –5, added;exclusions from gross income of for-eign corporations (REG–136311–01) 36, 485; correction (Ann 94) 42,727

26 CFR 1.897 –1, –2, –3, –5T, –6T,amended; 1.897–5, added; 1.1445–1through –6, amended; 1.1445–9T,removed; 301.6109–1, amended; useof taxpayer identifying numbers onsubmissions under sections 897 and1445 (REG–106876–00) 34, 392

26 CFR 1.1502–21, amended; carry-back of consolidated net operatinglosses to separate return years(REG–122564–02) 26, 25

26 CFR 1.1503–2, amended; dual con-solidated loss recapture events(REG–106879–00) 34, 402

26 CFR 1.6011–4, amended;301.6111–2, amended; modificationof tax shelter rules III (REG–103735–00, REG–110311–98) 28,109

26 CFR 1.6041–1(a)(1)(ii) , –3,amended; 1.6045–5, added; report-ing of gross proceeds payments toattorneys (REG–126024–01) 27, 64

26 CFR 1.6049–4, –6, –8, revised;31.3406(g)–1, revised; guidance onreporting of deposit interest paid tononresident aliens (REG–133254–02) 34, 412

26 CFR 1.6050P–0, –1, amended;1.6050P–2, added; guidance regard-ing cancellation of indebtedness(REG–107524–00) 28, 110

26 CFR 31.3406(d)–5, revised;301.6724–1, amended; receipt ofmultiple notices with respect toincorrect taxpayer identificationnumbers (REG–116644–01) 31, 268

26 CFR 301.7602–1, revised; desig-nated IRS officer or employee undersection 7602(a)(2) of the InternalRevenue Code (REG–134026–02)40, 684

26 CFR 301.7701–15, amended; low-income taxpayer clinics--definitionof income tax return preparer (REG–115285–01) 27, 62

Public hearings, correction of datesand/or locations (Ann 67) 30, 237

Public hearings for proposed regulations,correction of dates and locations (Ann67) 30, 237

November 4, 2002 viii 2002–44 I.R.B.

INCOME TAX—Cont.Publications:

463, Travel, Entertainment, Gift, andCar Expenses, Supplement to (Ann59) 26, 28

520, Scholarships and Fellowships,revised (Ann 86) 39, 624

536, Net Operating Losses (NOLs) forIndividuals, Estates, and Trusts,Supplement to (Ann 59) 26, 28

551, Basis of Assets, revised (Ann 61)27, 71

555, Community Property, revised(Ann 85) 39, 624

583, Starting a Business and KeepingRecords, revised (Ann 62) 27, 72

590, Individual Retirement Arrange-ments (IRAs), Supplement to (Ann73) 33, 387

946, How To Depreciate Property,Supplement to (Ann 59) 26, 28

971, Innocent Spouse Relief (AndSeparation of Liability and Equi-table Relief), revised (Ann 74)33, 387

1141, General Rules and Specifica-tions for Substitute Forms W–2 andW–3, revised (RP 53) 31, 253

1167, substitute forms, generalrequirements (RP 60) 40, 645

1179, substitute forms 1096, 1098,1099, 5498, W–2G, and 1042–S,specifications (RP 57) 39, 575

1187, Specifications for Filing Form1042–S, Foreign Person’s U.S.Source Income Subject to Withhold-ing, Magnetically or Electronically,2002 updates (Ann 98) 43, 758

1220, Specifications for Filing Forms1098, 1099, 5498, and W–2G Elec-tronically of Magnetically, changes(Ann 76) 35, 471

1223, General Rules and Specifica-tions for Substitute Forms W–2c andW–3c, revised (RP 51) 29, 175

3991, Highlights of the Job Creationand Worker Assistance Act, new(Ann 59) 26, 28

Qualified cost sharing arrangements,costs attributable to stock options(REG–106359–02) 34, 405; correction(Ann 81) 37, 533

Railroad track maintenence costs,accounting methods (RP 65) 41, 700

INCOME TAX—Cont.Real estate mortgage investment conduits

(REMICs) (TD 9004) 33, 331Regulations:

26 CFR 1.141–0, –2, –15, amended;1.141–7, –8, added; 1.141–7T, –8T,–15T, removed; obligations of statesand political subdivisions (TD 9016)40, 628

26 CFR 1.337(d)–2T, amended;1.1502–20T, amended; loss limita-tion rules (TD 8998) 26, 1

26 CFR 1.338–1, amended; 1.1502–6,amended; 1.1502–77, redesignatedas 1.1502–77A and amended;1.1502–77, added; 1.1502–77T(a),redesignated as 1.1502–77A(e) andamended; 1.1502–77T, removed;1.1502–78, amended; 602.101,amended; agent for consolidatedgroup (TD 9002) 29, 120

26 CFR 1.469–0, –7, –11, amended;602.101, amended; limitations onpassive activity losses and credits—treatment of self-charged items ofincome and expense (TD 9013) 38,542

26 CFR 1.702–1, amended; 1.952–1(g), added; 1.954–1(g), –2(a)(5),–3(a)(6), –4(b)(2)(iii), added; 1.956–2(a)(3), added; guidance under sub-part F relating to partnerships (TD9008) 33, 335

26 CFR 1.706–1, revised; 1.706–3T,removed; taxable years of partnerand partnership, foreign partners(TD 9009) 33, 328

26 CFR 1.708–1, amended; 1.752–1,–5, amended; partnership mergersand divisions; correction (Ann 89)39, 626

26 CFR 1.860A–0, amended;1.860E–1, amended; 602.101,amended; real estate mortgageinvestment conduits (TD 9004)33, 331

26 CFR 1.892–5, added; 1.892–5T,amended; 301.7701–2, amended;clarification of entity classificationrules (TD 9012) 34, 389

26 CFR 1.894–1(d), amended; treatyguidance regarding payments withrespect to domestic reverse hybridentities (TD 8999) 28, 78; correc-tion (Ann 71) 32, 323

INCOME TAX—Cont.

26 CFR 1.1502–21, amended; 1.1502–21T, added; 602.101, amended; car-ryback of consolidated net operatinglosses to separate return years (TD8997) 26, 6; correction (Ann 68)31, 283

26 CFR 1.6011–4T, amended;1.6031(a)–1, amended; 1.6037–1,amended; 301.6111–2T, amended;modification of tax shelter rules III(TD 9000) 28, 87

26 CFR 1.6013–4(d) , added;1.6013–5, removed; 1.6015–0through –9, added; relief from jointand several liability (TD 9003) 32,294; correction (Ann 83) 38, 564

26 CFR 1.6041–1, –3, amended;1.6045–1, –2, amended; 1.6049–4,revised; 5f.6045–1, removed;31.3406, amended; 602.101,amended; information reportingrequirements for certain paymentsmade on behalf of another person,payments to joint payees, and pay-ments of gross proceeds from salesinvolving investment advisors (TD9010) 33, 341

26 CFR 1.6109–2, redesignated as1.6109–2A; 1.6109–2, added;1.6109–2T, removed; furnishingidentifying number of income taxreturn preparer (TD 9014) 35, 429

26 CFR 301.6103(j)(5)–1, amended;disclosure of return information toofficers and employees of theDepartment of Agriculture for cer-tain statistical purposes and relatedactivities (TD 9001) 29, 128

26 CFR 301.7122–0, –1, added;301.7122–0T, –1T, removed; com-promise of tax liabilities (TD 9007)33, 349

26 CFR 301.7602–1, revised;301.7602–1T, added; designated IRSofficer or employee under section7602(a)(2) of the Internal RevenueCode (TD 9015) 40, 642

31 CFR Part 10, amended; regulationsgoverning practice before the Inter-nal Revenue Service (TD 9011)33, 356

Reporting of gross proceeds payments toattorneys (REG–126024–01) 27, 64

Reprint, Internal Revenue Bulletin2002–33 (Ann 78) 36, 514

2002–44 I.R.B. ix November 4, 2002

INCOME TAX—Cont.Revocations, exempt organizations (Ann

99) 43, 758Split-dollar life insurance arrangements:

Income, employment, and gift taxationof (REG–164754–01) 30, 212

Standards for valuing current lifeinsurance protection (Notice 59) 36,481

Standard Industry Fare Level (SIFL) for-mula (RR 56) 37, 526

Stock gain or loss, short sale (RR 44)28, 84

Substitute Forms:W–2 and W–3, general rules and

specifications (RP 53) 31, 253W–2c and W–3c, general rules and

specifications (RP 51) 29, 1751096, 1098, 1099, 5498, W–2G, and

1042–S, rules and specifications (RP57) 39, 575

General requirements (RP 60) 40, 645Tax accrual and other financial audit

workpapers, request for (Ann 63)27, 72

Tax conventions, competent authorityprocedures (RP 52) 31, 242

Tax-exempt bonds:Exempt facility bonds, population fig-

ures (Notice 56) 32, 319Guidance regarding mixed use output

facilities (Ann 91) 40, 685Investment-type property and private

loan (prepayments) (Notice 52)30, 187

Output facilities and the $15 millionlimitation (TD 9016) 40, 628

Solid waste disposal facilities, recy-cling facilities (Notice 51) 29, 131

Tax-exempt electric cooperatives, pro-pane distribution and sale (RR 54) 37,527

Tax liens (CD 2075) 38, 548Tax shelters:

Disclosure and registration (TD 9000)28, 87; (REG–103735–00, REG–110311–98) 28, 109

Partnership straddle (Notice 50) 28,98

Passthrough entity straddle (Notice 65)41, 690

Taxpayer identification numbers:Backup withholding, waiver of infor-

mation reporting penalties (REG–116644–01) 31, 268

INCOME TAX—Cont.

Used on submissions under sections897 and 1445 (REG–106876–00)34, 392

USDA Peanut Quota Buyout Program,gain or loss (Notice 67) 42, 715

Utility companies, non-recognition treat-ment of stranded costs (RP 49) 29, 172

Withholdings, qualified intermediaries,audit guidelines, nonresident aliens,foreign financial institutions (RP 55)35, 435

SELF-EMPLOYMENTTAXCompromise of tax liabilities (TD 9007)

33, 349Practice before the Internal Revenue Ser-

vice (TD 9011) 33, 356Regulations:

26 CFR 301.7122–0, –1, added;301.7122–0T, –1T, removed; com-promise of tax liabilities (TD 9007)33, 349

31 CFR Part 10, amended; regulationsgoverning practice before the Inter-nal Revenue Service (TD 9011)33, 356

November 4, 2002 x 2002–44 I.R.B.

4

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