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

INCOME TAX

Rev. Rul. 2002–41, page 75.Health reimbursement arrangements (HRAs). This rulingdescribes an employer-provided medical care expense reim-bursement plan called a health reimbursement arrangement(HRA), in which reimbursements for medical care expensesmade from the plan are excludable from employee grossincome. Among other things, the HRA described retains favor-able tax treatment because it only reimburses employees orformer employees for medical care expenses of the employeeor former employee and their spouses and dependents; issolely employer-funded and not paid for directly or indirectlyfrom salary reduction; and although it allows participants tocarry forward unused amounts for use in later coverage peri-ods, these amounts may never be used for anything but reim-bursements for qualified medical care expenses.

Rev. Rul. 2002–44, page 84.Short sale of stock. This ruling provides guidance on the tim-ing of recognition of gain or loss on a short sale when stock ispurchased to close the short sale using a regular-way sale.

T.D. 8999, page 78.Final regulations under section 894 of the Code relate to theeligibility for treaty benefits of items of income paid by domes-tic entities that are not fiscally transparent under U.S. laws, butare fiscally transparent under the laws of the jurisdiction of theperson claiming treaty benefits (domestic reverse hybrid enti-ties).

T.D. 9000, page 87.REG–103735–00; REG–110311–98, page 109.Final, temporary, and proposed regulations under sections6011, 6111, and 6112 of the Code modify the disclosure, reg-istration, and list maintenance requirements relating to tax shel-ters.

REG–107524–00, page 110.Proposed regulations define whether an organization has a sig-nificant trade or business of lending money under section6050P of the Code for purposes of reporting discharges ofindebtedness. A public hearing is scheduled for October 8,2002.

Notice 2002–45, page 93.This notice describes the tax treatment of an employer-provided medical care expense reimbursement plan called ahealth reimbursement arrangement (HRA). The notice explainsthat to maintain favorable tax treatment, HRAs may only reim-burse employees or former employees for their medical careexpenses and their spouses’ and dependents’. This notice alsoexplains that the requirements for flexible spending arrange-ments (FSAs) stated in section 125 of the Code are generallynot applicable to HRAs. In particular, an HRA may allow a planparticipant to carry forward unused reimbursement amounts tobe used for medical care expense reimbursements in later cov-erage periods. Also, this notice explains that to retain exemp-tion from the section 125 FSA requirements, the HRA must besolely employer-funded and cannot be directly or indirectly paidfor pursuant to salary reduction election.

(Continued on the next page)Announcements of Declaratory Judgment Proceedings Under Section 7428 begin on page 114.Finding Lists begin on page ii.

Bulletin No. 2002–28July 15, 2002

Notice 2002–50, page 98.Partnership straddle tax shelter. This notice advises tax-payers and their representatives that the described transac-tion, which uses a straddle, a tiered partnership, a transitorypartner and the absence of a section 754 election to obtain apermanent non-economic loss, is subject to challenge by theService on several grounds. The notice holds that thedescribed transaction is now a “listed transaction” and warnsof the potential penalties that may be imposed if taxpayersclaim losses from such a transaction.

EMPLOYEE PLANS

Rev. Rul. 2002–41, page 75.Health reimbursement arrangements (HRAs). This rulingdescribes an employer-provided medical care expense reim-bursement plan called a health reimbursement arrangement(HRA), in which reimbursements for medical care expensesmade from the plan are excludable from employee grossincome. Among other things, the HRA described retains favor-able tax treatment because it only reimburses employees orformer employees for medical care expenses of the employeeor former employee and their spouses and dependents; issolely employer-funded and not paid for directly or indirectlyfrom salary reduction; and although it allows participants tocarry forward unused amounts for use in later coverage peri-ods, these amounts may never be used for anything but reim-bursements for qualified medical care expenses.

Rev. Rul. 2002–42, page 76.Merger or conversion; partial termination; notice. Thisruling describes a situation where a merger or conversion of amoney purchase pension plan into a profit-sharing plan is not apartial termination of the money purchase pension plan andalso describes the type of notice that must be given to affectedplan participants. Rev. Rul. 94–76 amplified.

Notice 2002–45, page 93.This notice describes the tax treatment of an employer-provided medical care expense reimbursement plan called ahealth reimbursement arrangement (HRA). The notice explainsthat to maintain favorable tax treatment, HRAs may only reim-burse employees or former employees for their medical careexpenses and their spouses’ and dependents’. This notice alsoexplains that the requirements for flexible spending arrange-ments (FSAs) stated in section 125 of the Code are generallynot applicable to HRAs. In particular, an HRA may allow a planparticipant to carry forward unused reimbursement amounts tobe used for medical care expense reimbursements in later cov-erage periods. Also, this notice explains that to retain exemp-tion from the section 125 FSA requirements, the HRA must besolely employer-funded and cannot be directly or indirectly paidfor pursuant to salary reduction election.

Notice 2002–46, page 96.Optional forms of benefit; section 645 of EGTRRA;request for comments. This notice requests comments fromthe public on proposed regulations that will be issued concern-ing elimination of optional forms of benefit from defined benefitplans.

Notice 2002–47, page 97.Application of employment taxes to statutory stockoptions. This notice provides that until Treasury and the Ser-vice issue further guidance, in the case of a statutory stockoption, the Service will not assess the Federal Insurance Con-tributions Act (FICA) tax or Federal Unemployment Tax Act(FUTA) tax, or apply federal income tax withholding obligations,upon either the exercise of the option or the disposition of thestock acquired by an employee pursuant to the exercise of theoption.

EXCISE TAX

Rev. Rul. 2002–43, page 85.Prohibited transactions; first tier excise tax calculations.This ruling illustrates the calculation of the first tier prohibitedtransactions excise taxes in the instance of the use of moneywhere there are multiple excise tax rates.

ADMINISTRATIVE

T.D. 9000, page 87.REG–103735–00; REG–110311–98, page 109.Final, temporary, and proposed regulations under sections6011, 6111, and 6112 of the Code modify the disclosure, reg-istration, and list maintenance requirements relating to tax shel-ters.

Rev. Proc. 2002–43, page 99.Agent for the group. This procedure provides instructionsrelating to the determination of a substitute agent to act onbehalf of a consolidated group, pursuant to sections 1.1502–77(d) or 1.1502–77A(d) of the regulations. Procedures are pro-vided for automatic approval of requests by a terminating com-mon parent to designate its qualifying successor as substituteagent.

Rev. Proc. 2002–46, page 105.Changes in accounting method; non-life insurance com-panies; automatic consent. This procedure provides certainnon-life insurance companies with a safe harbor method ofaccounting for premium acquisition expenses. This documentalso provides a procedure for these insurance companies toobtain automatic consent to change to this safe harbormethod. Rev. Proc. 2002–9 modified and amplified.

July 15, 2002 2002–28 I.R.B.

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

applying the tax law with integrity and fairness to all.

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

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke,modify, or amend any of those previously published in the Bul-letin. All published rulings apply retroactively unless otherwiseindicated. Procedures relating solely to matters of internalmanagement are not published; however, statements of inter-nal practices and procedures that affect the rights and dutiesof taxpayers are published.

Revenue rulings represent the conclusions of the Service onthe application of the law to the pivotal facts stated in the rev-enue ruling. In those based on positions taken in rulings to tax-payers or technical advice to Service field offices, identifyingdetails and information of a confidential nature are deleted toprevent unwarranted invasions of privacy and to comply withstatutory requirements.

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

and Service personnel and others concerned are cautionedagainst reaching the same conclusions in other cases unlessthe facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

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

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

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

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

The 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 semiannualperiod, 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.

2002–28 I.R.B. July 15, 2002

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

Section 105.—AmountsReceived Under Accident andHealth Plans

(Also §§ 106, 125.)

Health Reimbursement Arrange-ments (HRAs). This ruling describes anemployer-provided medical care expensereimbursement plan called a health reim-bursement arrangement (HRA), in whichreimbursements for medical careexpenses made from the plan are exclud-able from employee gross income.Among other things, the HRA describedretains favorable tax treatment because itonly reimburses employees or formeremployees for medical care expenses ofthe employee or former employee andtheir spouses and dependents; is solelyemployer-funded and not paid for directlyor indirectly from salary reduction; andalthough it allows participants to carryforward unused amounts for use in latercoverage periods, these amounts maynever be used for anything but reimburse-ments for qualified medical expenses.

Rev. Rul. 2002–41

ISSUE

Whether employer-provided coverageand medical care expense reimbursementsmade under a reimbursement arrangementthat allows unused amounts to be carriedforward, as described in Situations 1 and2 below, are excludable from grossincome under §§ 106 and 105 of theInternal Revenue Code, respectively.

FACTS

Situation 1: An employer sponsors amajor medical plan for all employees thatprovides coverage under a policy of acci-dent and health insurance for certainmedical care expenses described in§ 213(d)(1)(A) and (B). The major medi-cal plan has a $2,000 annual deductiblefor employee-only coverage and a $4,000annual deductible for family coverage.However, certain preventive care benefits(e.g., annual physicals and well-baby vis-its) are covered without regard to the

plan’s deductible. The major medical planis paid for in part pursuant to salaryreduction elections under the employer’scafeteria plan. The election form providesthat salary reduction elections are usedonly to pay for the major medical plan.To participate in the major medical plan,an employee must make a $1,000 annualsalary reduction election for employee-only coverage or a $3,500 annual salaryreduction election for family coverage.

In addition to the major medical plan,the employer also sponsors a health reim-bursement arrangement (HRA) that reim-burses the medical care expenses of allparticipating employees and their spousesand dependents up to an annual maximumreimbursement amount that is fixed onJanuary 1 of each year. The HRA is avail-able only to employees who participate inthe major medical plan. The HRA meetsthe nondiscrimination requirements of§ 105(h).

The HRA is paid for by the employerand employees do not make any salaryreduction election to pay for the HRA.The HRA operates on a calendar yearbasis. Employees have no right to receivecash or any benefit other than reimburse-ment for medical care expenses under theHRA.

The expenses reimbursable under theHRA are any medical care expenses thatwould be covered by the major medicalplan but for the major medical plan’sdeductible, limitation to expenses that are“usual, customary and reasonable,” orany other similar dollar limitationimposed by the major medical plan. Onlyexpenses that are substantiated are reim-bursed.

The maximum reimbursement amountfor the first year in which an employeeparticipates in the HRA is $1,000 for anemployee who has employee-only cover-age under the major medical plan and$2,000 for an employee who has familycoverage under the major medical plan.Unused reimbursement amounts from oneyear are carried forward for use in lateryears. Therefore, in each year after thefirst year, the maximum reimbursementamount under the HRA equals $1,000 foran employee who has employee-onlycoverage under the major medical plan

and $2,000 for an employee who hasfamily coverage under the major medicalplan, increased by the unused amountfrom the previous year. If an employeeretires or otherwise terminates employ-ment, any unused reimbursement amountremaining in the HRA is unavailablethereafter.

Under the terms of the plans, a quali-fied beneficiary who chooses to electCOBRA continuation coverage may onlyelect the HRA in conjunction with themajor medical plan. However, a qualifiedbeneficiary may choose to elect COBRAcontinuation coverage for only the majormedical plan. The COBRA applicablepremium for continuation of the majormedical plan is $1,800 for employee-onlycoverage and $4,500 for family coverage.

Situation 2: The facts are the same asSituation 1, except that any portion of themaximum reimbursement amount underthe HRA that is not applied to reimbursemedical care expenses before anemployee retires or otherwise terminatesemployment continues to be availableafter retirement or termination for anymedical care expense under § 213(d)(1)(A), (B), and (D) incurred by the formeremployee or the former employee’sspouse and dependents. However, afterthe employee retires or otherwise termi-nates employment, the maximum reim-bursement amount is not increased unlessCOBRA continuation coverage is elected.

LAW AND ANALYSIS

Section 61(a)(1) and § 1.61–21(a)(3)of the Income Tax Regulations providethat, except as otherwise provided in sub-title A, gross income includes compensa-tion for services, including fees, commis-sions, fringe benefits, and similar items.

Section 106 provides that “grossincome of an employee does not includeemployer-provided coverage under anaccident or health plan.”

Section 1.106–1 provides that thegross income of an employee does notinclude contributions which the employ-ee’s employer makes to an accident orhealth plan for compensation (throughinsurance or otherwise) to the employee

2002–28 I.R.B. 75 July 15, 2002

for personal injuries or sickness incurredby the employee or the employee’sspouse or dependents (as defined in§ 152).

Section 105(a) provides that, except asotherwise provided in § 105, “amountsreceived by an employee through acci-dent or health insurance for personal inju-ries or sickness shall be included in grossincome to the extent such amounts (1) areattributable to contributions by theemployer which were not includible inthe gross income of the employee, or (2)are paid by the employer.”

Section 105(e) states that amountsreceived under an accident or health planfor employees are treated as amountsreceived through accident or health insur-ance for purposes of § 105 (and § 104relating to compensation for injuries andsickness). Section 1.105–5(a) providesthat an accident or health plan is anarrangement for the payment of amountsto employees in the event of personalinjuries or sickness.

Section 105(b) states that except in thecase of amounts attributable to (and not inexcess of) deductions allowed under§ 213 (relating to medical expenses) forany prior taxable year, gross income doesnot include amounts referred to in subsec-tion (a) if such amounts are paid, directlyor indirectly, to the taxpayer to reimbursethe taxpayer for expenses incurred by thetaxpayer for the medical care (as definedin § 213(d)) of the taxpayer or the taxpay-er’s spouse or dependents (as defined in§ 152).

Section 1.105–2 provides that onlyamounts that are paid specifically to reim-burse the taxpayer for expenses incurredby the taxpayer for the prescribed medicalcare are excludable from gross income.Thus, § 105(b) does not apply to amountsthat the taxpayer would be entitled toreceive irrespective of whether or not thetaxpayer incurs expenses for medicalcare.

Section 105(h)(1) provides that, unlessthe plan satisfies the nondiscriminationrequirements of § 105(h)(2), amountspaid under a self-insured medical expensereimbursement plan to a highly compen-sated individual will not be excludablefrom that individual’s gross income under§ 105(b) to the extent they constituteexcess reimbursements.

Coverage provided under an accidentand health plan to former employees andtheir spouses and dependents are exclud-able from gross income under § 106. See,Rev. Rul. 82–196, 1982–2 C.B. 53; Rev.Rul. 85–121, 1985–2 C.B. 57.

Under the facts described above, theHRA is an employer-provided accidentand health plan used exclusively to reim-burse expenses incurred for medical careas defined under § 213(d). Under theHRA, no benefits other than reimburse-ments for medical care expenses areavailable either in the form of cash orother non-taxable or taxable benefits atany time.

For purposes of determining whetherany part of the salary reduction for themajor medical plan is attributable to theHRA, under the facts and circumstances,the applicable premium for COBRA con-tinuation coverage may be used as theactual cost of the major medical plan.Under the facts described above, theactual cost of the major medical plan forone year is $1,800 for employee-onlycoverage and $4,500 for family coverage.The amount of salary reduction electionfor employee-only coverage ($1,000) isless than $1,800 and the amount of salaryreduction election for family coverage($3,500) is less than $4,500. Also, thecafeteria plan election form states thatsalary reduction elections are used only topay for the major medical plan. Underthese facts and circumstances, the HRAreimbursement amounts are not attribut-able to the salary reduction contributionsmade to pay for the major medical plan.

In Situation 2, the employer providesaccident and health coverage under theHRA for former employees. This cover-age is provided based on the formeremployee’s prior employment relation-ship with the employer. The HRA is usedto reimburse the former employee onlyfor medical care expenses of the formeremployee or the former employee’sspouse or dependents. Neither the formeremployee nor the former employee’sspouse or dependents receive any otherbenefits from the HRA at any time.

HOLDING

Employer-provided coverage andmedical care expense reimbursementsmade under the reimbursement arrange-

ment that allows unused amounts to becarried forward, as described in Situations1 and 2, are excludable from grossincome under §§ 106 and 105, respec-tively.

See Notice 2002–45 published else-where in this Internal Revenue Bulletinfor further information and guidance con-cerning HRAs.

DRAFTING INFORMATION

The principal author of this revenueruling is Lorianne D. Masano of theOffice of Division Counsel/AssociateChief Counsel (Tax Exempt and Govern-ment Entities). For further informationregarding this revenue ruling, contactLorianne D. Masano (202) 622–6080 (nota toll-free call).

Section 401.—QualifiedPension, Profit-Sharing, andStock Bonus Plans

(Also, §§ 411, 4980F; 26 CFR 1.411(d)–2.)

Rev. Rul. 2002–42

Merger or conversion; partial termi-nation; notice. This ruling describes asituation where a merger or conversion ofa money purchase pension plan into aprofit-sharing plan is not a partial termi-nation of the money purchase pensionplan and also describes the type of noticethat must be given to affected plan par-ticipants.

ISSUES

1. Whether, in the absence of otherfacts indicating a partial termination, themerger or conversion of a money pur-chase pension plan into a profit-sharingplan results in a partial termination of themoney purchase pension plan under§ 411(d)(3) of the Internal Revenue Code(the Code).

2. Whether the notice required by§ 4980F of the Code and section 204(h)of the Employee Retirement IncomeSecurity Act of 1974, as amended(ERISA) must be provided to affectedindividuals in a money purchase pensionplan that is merged or converted into aprofit-sharing plan.

July 15, 2002 76 2002–28 I.R.B.

FACTS

Situation 1. Employer J maintains amoney purchase pension plan qualifyingunder § 401(a) of the Code. The plan pro-vides that upon a termination or partialtermination of the plan, all affected par-ticipants will vest 100% in their accountbalances. Employer J converts the moneypurchase pension plan into a profit-sharing plan that covers the same employ-ees as the money purchase pension planand contains the same vesting schedule. Italso provides that assets and liabilities inthe profit-sharing plan that originated inthe money purchase pension plan retaintheir money purchase pension planattributes, in accordance with Rev. Rul.94–76, 1994–2 C.B. 46.

Situation 2. Employer L maintains amoney purchase pension plan qualifyingunder § 401(a). This plan provides thatupon a termination or partial terminationof the plan all affected participants willvest 100% in their account balances.Employer L also maintains a profit-sharing plan qualifying under § 401(a). Lamends the money purchase pension planto cease future employer contributionsand to merge it into the profit-sharingplan in a transaction that satisfies therequirements of § 414(l). Following themerger, the profit-sharing plan covers thesame employees and contains the samevesting schedule as the money purchasepension plan. Simultaneously, L amendsthe profit-sharing plan to provide thatassets and liabilities transferred from themoney purchase pension plan to theprofit-sharing plan retain their moneypurchase pension plan attributes, in accor-dance with Rev. Rul. 94–76.

LAW AND ANALYSIS

Section 411(d)(3)

Section 411(d)(3) requires that a planprovide that upon its termination or par-tial termination the rights of all affectedparties accrued to the date of such termi-nation or partial termination, to the extentfunded as of such date, or the amountscredited to the employees’ accounts, arenonforfeitable.

Section 1.411(d)–2(b)(1) of theIncome Tax Regulations provides thatwhether or not a partial termination of adefined contribution or defined benefitplan has occurred is dependent on thefacts and circumstances in a particularcase. Such facts and circumstancesinclude: the exclusion, by reason of aplan amendment or severance by theemployer, of a group of employees whohave previously been covered by the plan;and plan amendments which adverselyaffect the rights of employees to vest inbenefits under the plan. Section 1.411(d)–2(b)(2) contains a special rule providingthat if a defined benefit plan ceases ordecreases future benefit accruals underthe plan, a partial termination shall bedeemed to occur if, as a result of suchcessation or decrease, a potential rever-sion to the employer maintaining the plan(determined as of the date such cessationor decrease is adopted) is created orincreased.

Section 1.401(a)–2(b) provides that aplan may provide that upon the plan’s ter-mination assets held in a § 415 suspenseaccount may revert to the employer.

Section 1.415–6(b)(6) describes howamounts in a § 415 suspense accountmust be allocated to participants beforeany amount in the § 415 suspense accountmay revert to the employer on plan termi-nation.

Rev. Rul. 85–6, 1985–1 C.B. 133, pro-vides that a defined benefit plan that hassurplus resulting from actuarial error mayallow that surplus to revert to theemployer upon termination of the plan.

Rev. Rul. 80–155, 1980–1 C.B. 84,provides that a profit-sharing, stockbonus, or money purchase pension plan(i.e., a defined contribution plan) will notsatisfy plan qualification requirementsunless all funds are allocated to partici-pants’ accounts under the plan in accor-dance with a definite formula (althoughcertain exceptions are allowed, such asthe use of a suspense account in accor-dance with the requirements of § 415 ofthe Code).

Rev. Rul. 94–76 provides that, under§ 414(l), the transfer of assets and liabili-ties from a money purchase pension planto a profit-sharing plan is considered aspinoff of those assets and liabilities from

the money purchase pension plan and amerger of those assets and liabilities withthe assets and liabilities of the profit-sharing plan. The merger does not divestthe assets and liabilities of the moneypurchase pension plan of their attributesas money purchase pension plan assetsand liabilities. The holding in Rev. Rul.94–76 is applicable when an employerconverts a money purchase pension planinto a profit-sharing plan.

The special rule provided in§ 1.411(d)–2(b)(2) for determiningwhether a partial termination hasoccurred is limited to defined benefitplans. The listed facts and circumstancesin § 1.411(d)–2(b)(1) do not include thecreation of a potential reversion as a fac-tor to be considered in determiningwhether there has been a partial termina-tion of a defined contribution plan.Unlike a defined benefit plan, in adefined contribution plan all assets mustbe allocated to participants’ accounts withthe exception of amounts held in a § 415suspense account. Therefore, on the ter-mination of a defined contribution plan,the only amounts that may revert to theemployer are amounts in a § 415 sus-pense account and then only to the extentamounts in the § 415 suspense accountare not required to be allocated as pro-vided under § 1.415–6(b)(6). In a definedcontribution plan, the cessation or reduc-tion of benefit accruals does not create orincrease the potential for reversion.Accordingly, the creation or increase of apotential reversion is not a relevant factor circumstance in determining whetherthere has been a partial termination in adefined contribution plan as a result ofthe cessation or reduction of benefitaccruals.

In Situations 1 and 2, all of theemployees who are covered by the con-verted or merged money purchase planremain covered under the continuingprofit-sharing plan, the money purchaseplan assets and liabilities retain their char-acterization under the profit-sharing plan,and the employees vest in the continuingprofit-sharing plan under the same vest-ing schedule that existed under the moneypurchase plan. Under these facts and cir-cumstances, no partial termination hasoccurred.

2002–28 I.R.B. 77 July 15, 2002

Section 4980F of the Code and § 204(h)of ERISA

ERISA § 204(h), as amended by§ 659(b) of the Economic Growth andTax Relief Reconciliation Act of 2001,Public Law 107–16 (EGTRRA), providesthat a defined benefit pension plan or anindividual account plan subject to thefunding standards of § 412 of the Codenot be amended to provide a significantreduction in the rate of future benefitaccrual unless the plan administrator pro-vides a notice describing the reduction toeach affected individual whose benefit isadversely affected by the reduction and toeach employee organization representingthese individuals.

Section 4980F, as added by § 659(a) ofEGTRRA, provides for an excise tax if adefined benefit pension plan or an indi-vidual account plan subject to the fundingstandards of § 412 is amended to providea significant reduction in the rate offuture benefit accrual and the plan admin-istrator does not provide a notice describ-ing the reduction to each affected indi-vidual whose benefit is adversely affectedby the reduction and to each employeeorganization representing these individu-als.

If a money purchase plan is convertedor merged into a profit-sharing plan, thereis necessarily a significant reduction inthe rate of future benefit accrual under themoney purchase plan requiring noticeunder § 4980F of the Code and § 204(h)of ERISA. Allocations under the profit-sharing plan are not benefit accrualsunder the money purchase plan for pur-poses of determining if there is a reduc-tion in the rate of future benefit accrualfor purposes of § 4980F of the Code and§ 204(h) of ERISA. A profit-sharing planis neither subject to § 4980F of the Codeor § 204(h) of ERISA. Consequently, anotice is required to be given to affectedindividuals under § 4980F of the Codeand § 204(h) of ERISA.

HOLDINGS

Issue 1. In the absence of other facts,the merger or conversion of a money pur-chase pension plan into a profit-sharingplan does not result in a partial termina-tion of the money purchase pension planunder § 411(d)(3) of the Code. Under

either the facts in Situation 1 or 2 there isno partial termination.

Issue 2. The notice required by§ 4980F of the Code and § 204(h) ofERISA must be provided to affected indi-viduals in a money purchase pension planthat is merged or converted into a profit-sharing plan. Under the facts in eitherSituation 1 or 2, the notice must be givento affected individuals.

EFFECT ON OTHER REVENUERULINGS

Rev. Rul. 94–76 is amplified.

DRAFTING INFORMATION

The principal author of this revenueruling is Andrew Zuckerman of theEmployee Plans, Tax Exempt and Gov-ernment Entities Division. For furtherinformation regarding this revenue ruling,please contact the Employee Plans’ tax-payer assistance telephone service at1–877–829–5500 (a toll-free number),between the hours of 8:00 a.m. and 6:30p.m. Eastern time, Monday through Fri-day. Mr. Zuckerman may be reached at1–202–283–9655 (not a toll-free number).

Section 411.—MinimumVesting Standards

26 CFR 1.411(d)–2: Termination or partial termina-tion; discontinuance of contributions.

Whether, in the absence of other facts, themerger or conversion of a money purchase pensionplan into a profit-sharing plan creates or increases apotential for reversion that results in a partial termi-nation of the money purchase pension plan. SeeRev. Rul. 2002–42, page 76.

Section 894.—IncomeAffected by Treaty

26 CFR 1.894–1: Income affected by treaty.

T.D. 8999

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Part 1

Treaty Guidance RegardingPayments With Respect toDomestic Reverse HybridEntities

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document containsfinal regulations under section 894 relat-ing to the eligibility for treaty benefits ofitems of income paid by domestic entitiesthat are not fiscally transparent underU.S. law but are fiscally transparent underthe laws of the jurisdiction of the personclaiming treaty benefits (domestic reversehybrid entities). The regulations affect thedetermination of tax treaty benefits withrespect to U.S. source income of foreignpersons.

DATES: Effective Date: These regula-tions are effective June 12, 2002.

Applicability Date: These regulationsare applicable to items of income paid bya domestic reverse hybrid entity on orafter June 12, 2002, with respect toamounts received by the domestic reversehybrid entity on or after June 12, 2002.

FOR FURTHER INFORMATION CON-TACT: Elizabeth U. Karzon at (202) 622–3880 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On February 27, 2001, the IRS andTreasury published a notice of proposedrulemaking (REG–107101–00, 2001–1C.B 1083) in the Federal Register (66FR 12445) under section 894 relating towhether payments made by domesticreverse hybrid entities to their interestholders are eligible for benefits underincome tax treaties. A limited number ofcomments responding to the notice ofproposed rulemaking were received. Afterconsideration of these comments, the pro-posed regulations are adopted as finalregulations as revised by this Treasurydecision.

July 15, 2002 78 2002–28 I.R.B.

Explanation of Provisions

I. General

These final section 894 regulationsclarify the availability of treaty benefitson payments made by a domestic reversehybrid entity (DRH) to its interest hold-ers. A DRH is a U.S. entity that theUnited States treats as non-fiscally trans-parent (e.g., as a corporation), but theinterest holder’s country treats as fiscallytransparent (e.g., as a partnership orbranch). These regulations are the finalpiece of guidance associated with section894 regulations finalized on July 3, 2000(T.D. 8889, 2000–2 C.B. 124 [65 FR40993]) (the “2000 regulations”), thatgenerally address the availability of treatybenefits on items of U.S. source incomepaid to hybrid entities (i.e., entitiestreated as fiscally transparent by onejurisdiction but non-fiscally transparentby another).

The preamble to the 2000 regulationsnoted that the IRS and Treasury hadlearned that non-U.S. multinationals wereestablishing DRH structures in the UnitedStates to manipulate the U.S. tax treatynetwork to obtain tax-advantaged financ-ing. The IRS and Treasury notified thepublic in that preamble that they intendedto issue regulations to address this situa-tion.

Proposed regulations were issued onFebruary 27, 2001. The proposed regula-tions provided guidance with respect totwo distinct issues involving domesticreverse hybrid entities. First, to resolve atechnical question raised by commenta-tors regarding the application of the 2000regulations, the proposed regulationsclarified that a payment by a domesticreverse hybrid entity to a foreign interestholder may be eligible for treaty benefits.No comments were received on this por-tion of the proposed regulations, and therule in the proposed regulations is accord-ingly adopted without change in thesefinal regulations.

The proposed regulat ions alsoaddressed certain structures involvingdomestic reverse hybrid entities that Trea-sury and the IRS believed represented theuse of such entities to obtain inappropri-ate treaty benefits. The commentsreceived in response to this portion of theproposed regulations generally confirmedthe need for regulations to address the use

of DRH structures by non-U.S. compa-nies. One commentator wrote in its com-ment that “regulations addressing theDRH structure are appropriate.” Thecommentator noted that DRH structuresare “relatively uncommon” with theexception of their use by highly sophisti-cated non-U.S. multinational groups toprocure acquisition financing at a tax-advantaged rate vis-a-vis their U.S. com-petitors.

Several commentators expressed con-cern that the approach taken in the pro-posed DRH regulations might erode thesimplicity achieved by the section 7701entity classification rules, known as theCheck-the-Box (CTB) regulations. TheIRS and Treasury have carefully consid-ered this comment, but continue tobelieve that the approach in these finalregulations is appropriate. The regulationsonly apply to a DRH structure establishedby a group of taxpayers related to eachother by 80% common ownership. Thishigh ownership requirement minimizesthe possibility that a taxpayer might inad-vertently establish such a structure. Inaddition, the comments confirm that DRHstructures remain “relatively uncommon.”Thus, any loss of the simplification ben-efits of the CTB regulations also will berelatively uncommon.

One commentator suggested that,rather than adopt the approach in theregulations, the IRS and Treasury shouldpursue an approach under section 1503(d)to directly address structures similar to,and potentially including, the DRH thatrely on hybrid entity structures to deductthe same interest expense in two jurisdic-tions (commonly called a “double dip” ofinterest deductions) to achieve tax-advantaged financing. The commentatorexpressed the view that the real concernof the IRS and Treasury should be thisdouble dip on deductions, rather than thetax treaty manipulation present in DRHstructures.

Treasury and the IRS agree that are-examination of the rules of section1503(d) and the policies underlying thoserules may be appropriate. Such are-examination will require substantialand careful analysis with respect to theinteraction of U.S. and foreign law in avariety of contexts and is thereforebeyond the scope of these regulations,which, as noted above, focus on the use

of DRH structures to obtain inappropriatetreaty benefits.

In this regard, the commentator mis-construes the concern of the IRS andTreasury with respect to the issues associ-ated with the use of DRH structures.Treasury and the IRS are concerned thatDRH structures are being established byrelated parties to manipulate differencesin U.S. and foreign entity classificationrules to reduce, through inappropriate useof an income tax treaty, the amount of taximposed on items of income paid bydomestic corporations to related foreigncompanies. The overall effect of thesetransactions, if respected, would be (1) adeduction under U.S. law for the “out-bound” payment of an item of income,(2) the reduction or elimination of U.S.withholding tax on that item of incomeunder an applicable treaty, and (3) theimposition of little or no tax by the treatypartner on the item of income. This resultis inconsistent with the expectation of theUnited States and its treaty partners thattreaties should be used to reduce or elimi-nate double taxation of income. The leg-islative history of section 894(c) supportsthis analysis. Congress specificallyexpressed its concern about the use ofincome tax treaties to manipulate theinconsistencies between U.S. and foreigntax laws to obtain similar benefits. SeeH.R. Conf. Rep. No 220, 105th Cong., 1stSess. 573 (1997); Joint Committee onTaxation, 105th Cong., 1st Sess., GeneralExplanation of Tax Legislation Enacted in1997 (JCS–23–97), at 249 (December 17,1997). The approach adopted by theseregulations also is consistent with theU.S. view that contracting states to anincome tax treaty may adopt provisions intheir domestic laws to prevent inappropri-ate use of the treaty. See, e.g., the Trea-sury Department Technical Explanation toArticle 22 ( Limitation on Benefits) of the1996 United States Model Income TaxConvention. See also Commentaries toArticle 1 of the 2000 OECD Model TaxConvention on Income and Capital;S. Rep. No. 445, 100th Cong. 2d Sess.322–23 (1988).

Another commentator questionedTreasury’s authority for issuing the regu-lations, arguing that the recharacterizationof an interest payment as a dividend pay-ment may contravene the definition ofinterest contained in various U.S. treaties.

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The IRS and Treasury have concludedthat the regulations are consistent withU.S. law, including U.S. treaties. Thesefinal regulations are issued under theauthority of sections 894(a), 894(c), 7805and 7701(l). Further, as noted above, con-tracting states to an income tax treatymay adopt provisions in their domesticlaws to counter inappropriate uses of thetreaty. Id.

II. Comments and Changes to § 1.894–1(d)(2)(ii)(B)(1): Payment Made toRelated Foreign Interest Holder

Section 1.894–1(d)(2)(ii)(B)(1) of theproposed regulations provided a specialrule that was generally targeted at pay-ments made by a domestic reverse hybridentity to a foreign parent of the domesticreverse hybrid entity. This rule wouldapply if: (1) a domestic subsidiary made apayment to a domestic reverse hybridentity, the payment was considered to bea dividend either under the laws of theUnited States or under the laws of thejurisdiction of the foreign parent of thedomestic reverse hybrid entity, and thedomestic reverse hybrid entity wastreated as a fiscally transparent, or “pass-through,” entity under the foreign parent’slaws; and (2) the domestic reverse hybridentity made a deductible payment to theforeign parent that otherwise wouldqualify for a treaty-based reduction inU.S. withholding tax. Under these cir-cumstances, the proposed regulations pro-vided that the payment by the domesticreverse hybrid entity would be treated asa dividend for all purposes of the InternalRevenue Code and the applicable incometax treaty, but only to the extent of theforeign parent’s proportionate share of theprior dividend payments made to thedomestic reverse hybrid entity by thedomestic subsidiary.

Commentators recommended theinclusion of a tax avoidance purpose testin the final regulations. As part of thisapproach, commentators suggested con-sideration of several factors, including theability of the domestic reverse hybridentity to satisfy the debt independent ofdividends or payments from the domesticentity, and the amount of time betweenthe time the related foreign interestholder, the domestic reverse hybrid entity,and the domestic entity became relatedpersons and the incurrence of the inter-

company debt. This recommendation wasnot adopted. These regulations areintended to provide objective rulesregarding eligibility for treaty benefits oncertain items of U.S. source income paidby domestic reverse hybrid entities.

Commentators requested clarificationthat paragraph (d)(2)(ii)(B) does notapply to payments made by a domesticreverse hybrid entity that would not besubject to withholding tax without regardto a treaty. Commentators are correct inreading the regulations to provide thatparagraph (d)(2)(ii)(B) will not apply ifthe payment made by the domesticreverse hybrid entity is exempt fromwithholding tax under the Internal Rev-enue Code. Commentators also requestedclarification that the regulations applyonly to payments received by the domes-tic reverse hybrid entity while it is relatedto both the domestic entity and the relatedforeign interest holder, and to paymentsmade by the domestic reverse hybridentity while it is related to the related for-eign interest holder. The text of theseregulations also confirms this result.Accordingly, no changes to the regula-tions were considered necessary on eitherof these points.

As a general matter, commentatorsquestioned whether paragraph (d)(2)(ii)(B)(1) of the regulations applies to a situ-ation in which the dividend withholdingrate under the applicable income taxtreaty is lower than the withholding ratefor interest under the treaty. The regula-tions do not make the recharacterizationof the deductible payment dependent onthe withholding rates in the applicableincome tax treaty. Therefore, if therequirements of the regulations are met,the regulations will apply regardless ofwhether the dividend withholding rate ishigher than the withholding rate for inter-est or other deductible payments in theapplicable income tax treaty. An exampleto this effect has been added to the finalregulations.

III. Comments and Changes to § 1.894–1(d)(2)(ii)(B)(3): Definition of Related

Paragraph (d)(2)(ii)(B)(3) of the pro-posed regulations defined the term relatedfor purposes of determining whether adomestic entity made a dividend paymentto a related domestic reverse hybridentity, and for purposes of determining

whether a domestic reverse hybrid entitymade a payment to a related foreign inter-est holder. The ownership requirementsset forth in section 267(b) or 707(b)(1),the constructive ownership rules of sec-tions 318, and attribution rules of section267(c) were used solely to determinewhether an entity was “related” for pur-poses of paragraph (d)(2)(ii)(B); and notto determine if the entity was an interestholder.

Commentators consequently havequestioned whether corporations that donot own any stock directly in the domes-tic reverse hybrid entity, but are related tothe domestic reverse hybrid entity withinthe meaning of paragraph (d)(2)(ii)(B)(3),can be interest holders, and, therefore,related foreign interest holders for pur-poses of paragraph (d)(2)(ii)(B). Forexample, commentators questionedwhether the regulations apply if a domes-tic reverse hybrid entity, which hasreceived a dividend payment from arelated domestic entity, makes an interestpayment to a foreign sister corporation ofthe domestic reverse hybrid entity whichis not itself a shareholder in the domesticreverse hybrid entity. Commentatorsbelieve that the application of the regula-tions to a foreign sister corporationshould depend on whether that corpora-tion is part of a “consolidated group”under the laws of the jurisdiction of theforeign parent.

The IRS and Treasury generally agreewith this position. Paragraph (d)(2)(ii)(B)(ii) of the final regulations providesthat a payment to a person, whereverorganized, the income and losses ofwhich are available, under the laws of thejurisdiction of the related foreign interestholder, to offset the income and losses ofa related foreign interest holder, will betreated as a payment to a related foreigninterest holder, and the regulations willapply. Examples have been added to thefinal regulations illustrating these prin-ciples.

Paragraph (d)(2)(ii)(B)(3) of the pro-posed regulations also contained a specialrule that would treat certain accommoda-tion parties as related foreign interestholders. Pursuant to the rule in the pro-posed regulations, if a person entered intoa transaction with a domestic reversehybrid entity, its related interest holder, or

July 15, 2002 80 2002–28 I.R.B.

other related entity, and the effect of thetransaction was to avoid the principles ofthese regulations, then that person wouldbe treated as related to the domesticreverse hybrid entity for purposes of thissection. Commentators expressed concernthat this language could encompass legiti-mate dealings with unrelated third parties.For example, an unrelated foreign bankthat makes a loan to a domestic reversehybrid entity and receives interest pay-ments under the loan could be treated asrelated to the domestic reverse hybridentity under paragraph (d)(2)(ii)(B)(3). Inrecognition of the fact that the specialrule in paragraph (d)(2)(ii)(B)(3) waspotentially overbroad and created uncer-tainty as to its application, the rule wasdeleted.

IV. Comments and Changes to §1.894–1(d)(2)(ii)(C): Commissioner’sdiscretion.

Paragraph (d)(2)(ii)(C) of the proposedregulations provided the Commissionerwith the authority to recharacterize, forall purposes of the Internal RevenueCode, all or part of any transaction (orseries of transactions) between relatedparties if the effect of the transaction wasto avoid the principles of paragraph(d)(2)(ii)(B). Commentators also ques-tioned the scope of this provision andrequested the inclusion of examples ofsituations in which the Commissionerwould not exercise his discretion and situ-ations in which the Commissioner mayexercise his discretion. Commentatorswere concerned that this provision wouldallow the Commissioner to apply theregulations to legitimate, non-abusivetransactions involving domestic reversehybrid entities.

In response to these comments, and inrecognition of the potentially overbroadreach of the proposed provision, para-graph (d)(2)(ii)(C) has been modified inthe final regulations to narrow its scopeand clarify the circumstances underwhich the provision will apply. Thus,under paragraph (d)(2)(ii)(C)(1) of thefinal regulations (which applies to trans-actions involving related parties), theCommissioner has authority to recharac-terize a transaction only if the followingconditions are met: (1) A deductible pay-ment is made to a person who is related,as that term is defined in paragraph

(d)(2)(ii)(B)(3), to the domestic reversehybrid entity (but is not otherwisedescribed in paragraph (d)(2)(ii)(B)(1)(ii)); and (2) that payment is made inconnection with one or more transactionsthe effect of which is to avoid the appli-cation of paragraph (d)(2)(ii)(B). If para-graph (d)(2)(ii)(C)(1) applies, the Com-missioner is authorized to treat thedeductible payment as if it were receiveddirectly by the related foreign interestholder in the domestic reverse hybridentity.

In addition, paragraph (d)(2)(ii)(C)(2)of the final regulations (which applies totransactions involving an unrelated“middleman”) provides that the Commis-sioner may treat a deductible paymentmade by a domestic reverse hybrid entityto an unrelated person as being madedirectly to a related foreign interest holderif: (1) the unrelated person (or other per-son (whether related or not) whichreceives a payment in a series of transac-tions that includes a transaction involvingsuch unrelated person) makes a paymentto the related foreign interest holder (orother person described in paragraph(d)(2)(ii)(B)(1)(ii)); (2) the payment tothe unrelated person and the payment tothe related foreign interest holder aremade in connection with a series of trans-actions which constitute a financingarrangement, as defined in § 1.881–3(a)(2)(i); and (3) the transactions havethe effect of avoiding the application ofparagraph (d)(2)(ii)(B) of this section. Anexample has been added to illustrate theprinciples contained in this revised para-graph (d)(2)(ii)(C)(2).

To the extent the Commissionerrecharacterizes a deductible payment as adistribution within the meaning of section301(a) under this paragraph (d)(2)(ii)(C),the payment will be treated as such for allpurposes of the Internal Revenue Codeand the applicable income tax treaty.

Special Analysis

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order12866. Therefore, a regulatory assess-ment is not required. It has also beendetermined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) does not apply to these regula-tions and, because these regulations do

not impose a collection of informationrequirement on small entities, the Regula-tory Flexibility Act (5 U.S.C. chapter 6)does not apply. Therefore, a RegulatoryFlexibility Analysis is not required. Pur-suant to section 7805(f) of the InternalRevenue Code, the notice of proposedrulemaking preceding these regulationswas submitted to the Chief Counsel forAdvocacy of the Small Business Admin-istration for comment on its impact onsmall business.

Drafting Information

The principal author of these regula-tions is Karen A. Rennie-Quarrie of theOffice of the Associate Chief Counsel(International). However, other personnelfrom the IRS and Treasury Departmentparticipated in their development.

* * * * *

Proposed Amendments to theRegulations

Accordingly, 26 CFR part 1 isamended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *Par. 2. In § 1.894–1, paragraphs

(d)(2)(ii) and (d)(2)(iii) are added andparagraph (d)(6) is revised to read as fol-lows:

§ 1.894–1 Income affected by treaty.

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

hybrid entities—(A) General rule. Exceptas otherwise provided in paragraph(d)(2)(ii)(B) of this section, an item ofincome paid by a domestic reverse hybridentity to an interest holder in such entityshall have the character of such item ofincome under U.S. law and shall be con-sidered to be derived by the interestholder, provided the interest holder is notfiscally transparent in its jurisdiction, asdefined in paragraph (d)(3)(iii) of thissection, with respect to the item ofincome. In determining whether the inter-est holder is fiscally transparent with

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respect to the item of income under thisparagraph (d)(2)(ii)(A), the determinationunder paragraph (d)(3)(ii) of this sectionshall be made based on the treatment thatwould have resulted had the item ofincome been paid by an entity that is notfiscally transparent under the laws of theinterest holder’s jurisdiction with respectto any item of income.

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

(i) A domestic entity makes a paymentto a related domestic reverse hybrid entitythat is treated as a dividend under eitherthe laws of the United States or the lawsof the jurisdiction of a related foreigninterest holder in the domestic reversehybrid entity, and under the laws of thejurisdiction of the related foreign interestholder in the domestic reverse hybridentity, the related foreign interest holderis treated as deriving its proportionateshare of the payment under the principlesof paragraph (d)(1) of this section; and

(ii) The domestic reverse hybrid entitymakes a payment of a type that is deduct-ible for U.S. tax purposes to the relatedforeign interest holder or to a person,wherever organized, the income andlosses of which are available, under thelaws of the jurisdiction of the related for-eign interest holder, to offset the incomeand losses of the related foreign interestholder, and for which a reduction in U.S.withholding tax would be allowed underan applicable income tax treaty; then

(iii) To the extent the amount of thepayment described in paragraph (d)(2)(ii)(B)(1)(ii) of this section does not exceedthe sum of the portion of the paymentdescribed in paragraph (d)(2)(ii)(B)(1)(i) of this section treated as derivedby the related foreign interest holder andthe portion of any other prior paymentsdescribed in paragraph (d)(2)(ii)(B)(1)(i)of this section treated as derived by therelated foreign interest holder, the amountof the payment described in (d)(2)(ii)(B)(1)(ii) of this section will be treatedfor all purposes of the Internal RevenueCode and any applicable income taxtreaty as a distribution within the meaningof section 301(a) of the Internal RevenueCode, and the tax to be withheld from thepayment described in paragraph (d)(2)(ii)(B)(1)(ii) of this section (assuming thepayment is a dividend under section301(c)(1) of the Internal Revenue Code)

shall be determined based on the appro-priate rate of withholding that would beapplicable to dividends paid from thedomestic reverse hybrid entity to therelated foreign interest holder in accor-dance with the principles of paragraph(d)(2)(ii)(A) of this section.

(2) Determining amount to be rechar-acterized under paragraph (d)(2)(ii)(B)(1)(iii). For purposes of determining theamount to be recharacterized under para-graph (d)(2)(ii)(B)(1)(iii) of this section,the portion of the payment described inparagraph (d)(2)(ii)(B)(1)(i) of this sec-tion treated as derived by the related for-eign interest holder shall be increased bythe portion of the payment derived by anyother person described in paragraph(d)(2)(ii)(B)(1)(ii), and shall be reducedby the amount of any prior section 301(c)distributions made by the domesticreverse hybrid entity to the related foreigninterest holder or any other persondescribed in paragraph (d)(2)(ii)(B)(1)(ii)and by the amount of any payments fromthe domestic reverse hybrid entity previ-ously recharacterized under paragraph(d)(2)(ii)(B)(1)(iii) of this section.

(3) Tiered entities. The principles ofthis paragraph (d)(2)(ii)(B) also shallapply to payments referred to in this para-graph (d)(2)(ii)(B) made among relatedentities when there is more than onedomestic reverse hybrid entity or otherfiscally transparent entity involved.

(4) Definition of related. For purposesof this section, a person shall be treated asrelated to a domestic reverse hybrid entityif it is related by reason of the ownershiprequirements of section 267(b) or707(b)(1), except that the language “atleast 80 percent” applies instead of “morethan 50 percent,” where applicable. Forpurposes of determining whether a personis related by reason of the ownershiprequirements of section 267(b) or707(b)(1), the constructive ownershiprules of section 318 shall apply, and theattribution rules of section 267(c) alsoshall apply to the extent they attributeownership to persons to whom section318 does not attribute ownership.

(C) Payments to persons not describedin paragraph (d)(2)(ii)(B)(1)(ii)—(1)Related persons. The Commissioner maytreat a payment by a domestic reversehybrid entity to a related person (who isneither the related foreign interest holder

nor otherwise described in paragraph(d)(2)(ii)(B)(1)(ii) of this section), inwhole or in part, as being made to arelated foreign interest holder for pur-poses of applying paragraph (d)(2)(ii)(B)of this section, if —

(i) The payment to the related personis of a type that is deductible by thedomestic reverse hybrid entity; and

(ii) The payment is made in connec-tion with one or more transactions theeffect of which is to avoid the applicationof paragraph (d)(2)(ii)(B) of this section.

(2) Unrelated persons. The Commis-sioner may treat a payment by a domesticreverse hybrid entity to an unrelated per-son, in whole or in part, as being made toa related foreign interest holder for pur-poses of applying paragraph (d)(2)(ii)(B)of this section, if —

(i) The payment to the unrelated per-son is of a type that is deductible by thedomestic reverse hybrid entity;

(ii) The unrelated person (or other per-son (whether related or not) whichreceives a payment in a series of transac-tions that includes a transaction involvingsuch unrelated person) makes a paymentto the related foreign interest holder (orother person described in paragraph(d)(2)(ii)(B)(1)(ii));

(iii) The foregoing payments are madein connection with a series of transactionswhich constitute a financing arrangement,as defined in § 1.881–3(a)(2)(i); and

(iv) The transactions have the effect ofavoiding the application of paragraph(d)(2)(ii)(B) of this section.

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

Example 1. Dividend paid by unrelated entity todomestic reverse hybrid entity. (i) Facts. Entity A isa domestic reverse hybrid entity, as defined in para-graph (d)(2)(i) of this section, with respect to theU.S. source dividends it receives from B, a domes-tic corporation to which A is not related within themeaning of paragraph (d)(2)(ii)(B)(4) of this sec-tion. A’s 85-percent shareholder, FC, is a corpora-tion organized under the laws of Country X, whichhas an income tax treaty in effect with the UnitedStates. A’s remaining 15-percent shareholder is anunrelated domestic corporation. Under Country Xlaw, FC is not fiscally transparent with respect to thedividend, as defined in paragraph (d)(3)(ii) of thissection. In year 1, A receives $100 of dividendincome from B. Under Country X law, FC is treatedas deriving $85 of the $100 dividend paymentreceived by A. The applicable rate of tax on divi-dends under the U.S.-Country X income tax treaty is5 percent with respect to a 10-percent or more cor-porate shareholder.

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(ii) Analysis. Under paragraph (d)(2)(i) of thissection, the U.S.-Country X income tax treaty doesnot apply to the dividend income received by Abecause the payment is made by B, a domestic cor-poration, to A, another domestic corporation. Aremains fully taxable under the U.S. tax laws as adomestic corporation with regard to that item ofincome. Further, pursuant to paragraph (d)(2)(i) ofthis section, notwithstanding the fact that A istreated as fiscally transparent with respect to thedividend income under the laws of Country X, FCmay not claim a reduced rate of taxation on its shareof the U.S. source dividend income received by A.

Example 2. Interest paid by domestic reversehybrid entity to related foreign interest holder wheredividend is paid by unrelated entity. (i) Facts. Thefacts are the same as in Example 1. Both the UnitedStates and Country X characterize the payment by Bin year 1 as a dividend. In addition, in year 2, Amakes a payment of $25 to FC that is characterizedunder the Internal Revenue Code as interest on aloan from FC to A. Under the U.S.-Country Xincome tax treaty, the rate of tax on interest is zero.Under Country X laws, had the interest been paid byan entity that is not fiscally transparent under Coun-try X’s laws with respect to any item of income, FCwould not be fiscally transparent as defined in para-graph (d)(2)(ii) of this section with respect to theinterest.

(ii) Analysis. The analysis is the same as inExample 1 with respect to the $100 payment from Bto A. With respect to the $25 payment from A to FC,paragraph (d)(2)(ii)(B) of this section will not applybecause, although FC is a related foreign interestholder in A, A is not related to B, the payor of thedividend income it received. Under paragraph(d)(2)(ii)(A) of this section, the $25 of interest paidby A to FC in year 2 is characterized under U.S. lawas interest. Accordingly, in year 2, A is entitled to aninterest deduction with respect to the $25 interestpayment from A to FC, and FC is entitled to thereduced rate of withholding applicable to interestunder the U.S.-Country X income tax treaty, assum-ing all other requirements for claiming treaty ben-efits are met.

Example 3. Interest paid by domestic reversehybrid entity to related foreign interest holder wheredividend is paid by a related entity. (i) Facts. Thefacts are the same as in Example 2, except the $100dividend income received by A in year 1 is from A’swholly-owned subsidiary, S.

(ii) Analysis. The analysis is the same as inExample 1 with respect to the $100 dividend pay-ment from S to A. However, the $25 interest pay-ment in year 2 by A to FC will be treated as a divi-dend for all purposes of the Internal Revenue Codeand the U.S.-Country X income tax treaty because$25 does not exceed FC’s share of the $100 divi-dend payment made by S to A ($85). Since FC is notfiscally transparent with respect to the payment asdetermined under paragraph (d)(2)(ii)(A) of this sec-tion, FC is entitled to the reduced rate applicable todividends under the U.S.-Country X income taxtreaty with respect to the $25 payment. Because the$25 payment in year 2 is recharacterized as a divi-dend for all purposes of the Internal Revenue Codeand the U.S.-Country X income tax treaty, A is notentitled to an interest deduction with respect to thatpayment and FC is not entitled to claim the reducedrate of withholding applicable to interest.

Example 4. Definition of related foreign interestholder. (i) Facts. The facts are the same as inExample 3, except that A has two 50-percent share-holders, FC1 and FC2. In year 2, A makes an inter-est payment of $25 to both FC1 and FC2. FC1 is acorporation organized under the laws of Country X,which has an income tax treaty in effect with theUnited States. FC2 is a corporation organized underthe laws of Country Y, which also has an income taxtreaty in effect with the United States. FP owns 100-percent of both FC1 and FC2, and is organizedunder the laws of Country X. Under Country X law,FC1 is not fiscally transparent with respect to thedividend, as defined in paragraph (d)(3)(ii) of thissection. Under Country X law, FC1 is treated asderiving $50 of the $100 dividend payment receivedby A because A is fiscally transparent under the lawsof Country X, as determined under paragraph(d)(3)(iii) of this section. The applicable rate of taxon dividends under the U.S.-Country X income taxtreaty is 5-percent with respect to a 10-percent ormore corporate shareholder. Under Country Y law,FC2 is not treated as deriving any of the $100 divi-dend payment received by A because, under thelaws of Country Y, A is not a fiscally transparententity.

(ii) Analysis. The analysis is the same as inExample 1 with respect to the $100 dividend pay-ment from S to A. With respect to the $25 paymentin year 2 by A to FC1, the payment will be treatedas a dividend for all purposes of the Internal Rev-enue Code and the U.S.-Country X income taxtreaty because FC1 is a related foreign interestholder as determined under paragraph(d)(2)(ii)(B)(4) of this section, and because $25 doesnot exceed FC1’s share of the dividend paymentmade by S to A ($50). FC1 is a related foreigninterest holder because FC1 is treated as owning thestock of A owned by FC2 under section 267(b)(3).Since FC1 is not fiscally transparent with respect tothe payment as determined under paragraph(d)(2)(ii)(A) of this section, FC1 is entitled to the5-percent reduced rate applicable to dividends underthe U.S.-Country X income tax treaty with respectto the $25 payment. Because the $25 payment inyear 2 is recharacterized as a dividend for all pur-poses of the Internal Revenue Code and the U.S.-Country X income tax treaty, A is not entitled to aninterest deduction with respect to that payment.Even though FC2 is also a related foreign interestholder, the $25 interest payment by A to FC2 in year2 is not recharacterized because A is not fiscallytransparent under the laws of Country Y, and FC2 isnot treated as deriving any of the $100 dividendpayment received by A. Thus, the U.S.-Country Yincome tax treaty is not implicated.

Example 5. Higher treaty withholding rate ondividends. (i) Facts. The facts are the same as inExample 3, except that under the U.S.-Country Xincome tax treaty, the rate of tax on interest is10-percent and the rate of tax on dividends is5-percent.

(ii) Analysis. The analysis is the same as inExample 1 with respect to the $100 dividend pay-ment from S to A. The analysis is the same as inExample 3 with respect to the $25 interest paymentin year 2 from A to FC.

Example 6. Foreign sister corporation theincome and losses of which may offset the incomeand losses of related foreign interest holder. (i)

Facts. The facts are the same as Example 3, exceptthat in year 2, A makes the interest payment of $25to FS, a subsidiary of FC also organized in CountryX. Under the laws of Country X, FS is not fiscallytransparent with respect to the interest payment, andthe income and losses of FS may be used to offsetthe income and losses of FC.

(ii) Analysis. The analysis is the same as inExample 1 with respect to the $100 dividend pay-ment from S to A. With respect to the $25 interestpayment from A to FS in year 2, FS is a persondescribed in paragraph (d)(2)(ii)(B)(1)(ii) of thissection because the income and losses of FS may beused under the laws of Country X to offset theincome and losses of FC, the related foreign interestholder that derived its proportionate share of thepayment from S to A. Therefore, paragraph(d)(2)(ii)(B) of this section applies, and the $25interest payment in year 2 by A to FS is treated as adividend for all purposes of the Internal RevenueCode and the U.S.-Country X income tax treatybecause the $25 payment does not exceed FC’sshare of the $100 dividend payment made by S to A($85). Since FS is not fiscally transparent withrespect to the payment as determined under para-graph (d)(2)(ii)(A) of this section, FS is entitled toobtain the rate applicable to dividends under theU.S.-Country X income tax treaty with respect tothe $25 payment. Because the $25 payment in year2 is recharacterized as a dividend for all purposes ofthe Internal Revenue Code and the U.S.-Country Xincome tax treaty, A is not entitled to an interestdeduction with respect to the payment and FS is notentitled to claim the reduced rate of withholdingapplicable to interest under the U.S.-Country Xincome tax treaty.

Example 7. Interest paid by domestic reversehybrid entity to unrelated foreign bank. (i) Facts.The facts are the same as in Example 3, except thatin year 2, A makes the interest payment of $25 toFB, a Country Y unrelated foreign bank, on a loanfrom FB to A.

(ii) Analysis. The analysis is the same as inExample 1 with respect to the $100 dividend pay-ment from S to A. With respect to the payment fromA to FB, paragraph (d)(2)(ii)(B) of this section willnot apply because, although A is related to S, thepayor of the dividend income it received, A is notrelated to FB under paragraph (d)(2)(ii)(B)(4) of thissection. Under paragraph (d)(2)(ii)(A) of this sec-tion, the $25 interest payment made from A to FB inyear 2 is characterized as interest under the InternalRevenue Code.

Example 8. Interest paid by domestic reversehybrid to an unrelated entity pursuant to a financingarrangement. (i) Facts. The facts are the same as inExample 7, except that in year 3, FB makes an inter-est payment of $25 to FC on a deposit made by FCwith FB.

(ii) Analysis. The analysis is the same as inExample 1 with respect to the $100 dividend pay-ment from S to A. With respect to the $25 paymentfrom A to FB in year 2, because the payment ismade in connection with a transaction that consiti-tutes a financing arrangement within the meaning ofparagraph (d)(2)(ii)(C)(2) of this section, the pay-ment may be treated by the Commissioner as beingmade directly to FC. If the Commissioner disregards

2002–28 I.R.B. 83 July 15, 2002

FB, then the analysis is the same as in Example 3with respect to the $25 interest payment in year 2from A to FC.

Example 9. Royalty paid by related entity todomestic reverse hybrid entity. (i) Facts. The factsare the same as in Example 3, except the $100income received by A from S in year 1 is a royaltypayment under both the laws of the United Statesand the laws of Country X. The royalty rate underthe treaty is 10 percent and the interest rate is 0 per-cent.

(ii) Analysis. The analysis as to the royalty pay-ment from S to A is the same as in Example 1 withrespect to the $100 dividend payment from S to A.With respect to the $25 payment from A to FC,paragraph (d)(2)(ii)(B) of this section will not applybecause the payment from S to A is not treated as adividend under the Internal Revenue Code or thelaws of Country X. Under paragraph (d)(2)(ii)(A) ofthis section, the $25 of interest paid by A to FC inyear 2 is characterized as interest under the InternalRevenue Code. Accordingly, in year 2, FC mayobtain the reduced rate of withholding applicable tointerest under the U.S.-Country X income tax treaty,assuming all other requirements for claiming treatybenefits are met.

* * * * *

(6) Effective dates. This paragraph (d)applies to items of income paid on orafter June 30, 2000, except paragraphs(d)(2)(ii) and (d)(2)(iii) of this sectionapply to items of income paid by adomestic reverse hybrid entity on or afterJune 12, 2002, with respect to amountsreceived by the domestic reverse hybridentity on or after June 12, 2002.

* * * * *

Robert E. Wenzel,Deputy Commissioner of

Internal Revenue.

Approved June 3, 2002.

Pamela F. Olsen,Acting Assistant Secretary

of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on June11, 2002, 8:45 a.m., and published in the issue ofthe Federal Register for June 12, 2002, 67 F.R.40157)

Section 1233.—Gains andLosses From Short Sales

26 CFR 1.1233–1: Gains and losses from shortsales.

The revenue ruling provides guidance on therecognition of gain or loss on a short sale whenstock is purchased to close the short sale using aregular-way sale. See Rev. Rul. 2002–44, on thispage.

Section 1259.—ConstructiveSales Treatment forAppreciated FinancialPositions

(Also § 1233; 26 CFR 1.1233–1.)

Short sale of stock. This ruling pro-vides guidance on the timing of recogni-tion of gain or loss on a short sale whenstock is purchased to close the short saleusing a regular-way sale.

Rev. Rul. 2002–44

ISSUE

If a taxpayer enters into a short sale ofstock and directs its broker to purchasethe stock sold short and close out theshort sale, when is a gain or a loss on theshort sale realized?

FACTS

Situation 1

In January of Year 1, Taxpayer Tdirects its broker to borrow 100 shares ofXYZ stock and sell the 100 shares ofXYZ stock in the market (the Short Sale).XYZ stock is traded on a registered secu-rities exchange. T does not own anyshares of XYZ stock. On December 31 ofYear 1, when the value of XYZ stock hasincreased (and the value of T’s short posi-tion has depreciated) T directs its brokerto purchase 100 shares of XYZ stock toclose the Short Sale. The purchased XYZshares are delivered to the lender of theXYZ stock on January 4 of Year 2. Thepurchase of the XYZ stock on December31 of Year 1 is a regular-way sale asdescribed in Rev. Rul. 93–84, 1993–2C.B. 225, with December 31 of Year 1 as

the trade date and January 4 of Year 2 asthe settlement date.

Situation 2

The facts are the same as in Situation1 except that the XYZ stock has depreci-ated in value and the Short Sale is closedout at a gain.

LAW

Section 1.1233–1(a)(1) of the IncomeTax Regulations provides that, for incometax purposes, a short sale is not deemed tobe consummated until delivery of prop-erty to close the short sale. Under§ 1.1233–1(a)(4), if the short sale is madethrough a broker and the broker borrowsproperty to make a delivery, the short saleis not deemed to be consummated untilthe obligation of the seller created by theshort sale is finally discharged by deliv-ery of property to the broker to replacethe property borrowed by the broker.

In the context of determining holdingperiod, Rev. Rul. 66–97, 1966–1 C.B.190, states that both stocks and bonds“are considered acquired or sold on therespective ‘trade dates.’”

Analogously, Rev. Rul. 93–84 holdsthat the year of disposition for a regular-way sale of stock traded on an establishedsecurities market is the year that includesthe trade date. In Rev. Rul. 93–84, thetaxpayer placed a regular-way sale orderon stock with his broker on December 31,1992, but the taxpayer did not deliver thestock certificates or receive the proceedsfrom the sale until January 8, 1993. Therevenue ruling holds that the year of dis-position and realization is 1992.

Section 1259(a)(1) provides that ifthere is a constructive sale of an appreci-ated financial position, the taxpayer shallrecognize gain as if such position weresold, assigned, or otherwise terminated atits fair market value on the date of suchconstructive sale. The term “appreciatedfinancial position” is defined in§ 1259(b)(1) to include any position withrespect to stock if there would be gainwere such position sold, assigned, or oth-erwise terminated at its fair market value.The term “position” is defined in§ 1259(b)(3) to include a short sale. Pur-suant to § 1259(c)(1)(D), in the case of anappreciated financial position that is ashort sale, a taxpayer is treated as having

July 15, 2002 84 2002–28 I.R.B.

made a constructive sale of the appreci-ated financial position if the taxpayeracquires the same or substantially identi-cal property.

ANALYSIS

Situation 1

Pursuant to § 1.1233–1(a)(1), the ShortSale is not consummated until the XYZstock is delivered to close the Short Sale.Although T is treated as having acquiredthe XYZ stock on the trade date (see Rev.Rul. 66–97; see also Rev. Rul. 93–84),the XYZ stock will not be delivered toclose the Short Sale until January 4 ofYear 2. Therefore, T does not realize theloss on the Short Sale until January 4 ofYear 2.

Situation 2

As in Situation 1, T is treated as hav-ing acquired the XYZ stock on the tradedate, December 31 of Year 1. See Rev.Rul. 66–97; see also Rev. Rul. 93–84. Atthat time, unlike in Situation 1, the priceof XYZ stock has decreased. Therefore,the value of T’s Short Sale has increased,and T holds an appreciated financial posi-tion within the meaning of § 1259(b)(1),that is, the short position. Section1259(b)(3). Section 1259(c)(1)(D) pro-vides that if a taxpayer holds an appreci-ated financial position that is a short sale,the acquisition of the same or substan-tially identical stock is a constructive saletransaction. Therefore, T has entered intoa constructive sale transaction by acquir-ing the same or substantially identicalstock as the stock underlying the ShortSale. Pursuant to § 1259(a)(1), T realizesgain on the Short Sale on December 31 ofYear 1.

HOLDING

(1) In Situation 1, T realizes the losson the Short Sale on January 4 of Year 2,the date the Short Sale is closed by deliv-ery of the stock.

(2) In Situation 2, T has constructivelysold the Short Sale on December 31 ofYear 1. T realizes gain in Year 1 as if Thad sold, assigned, or otherwise termi-nated the Short Sale at its fair marketvalue on December 31 of Year 1.

DRAFTING INFORMATION

The principal author of this revenueruling is Kate Sleeth of the Office ofAssociate Chief Counsel (Financial Insti-tutions and Products). For further infor-mation regarding this revenue ruling, con-tact Ms. Sleeth at (202) 622–3920 (not atoll-free call).

Section 1502.—Regulations(Consolidated Returns).

26 CFR 1.1502–77.—Agent for the group.

26 CFR 1.1502–77A.—Common parent agent forsubsidiaries applicable for consolidated returnyears beginning before June 28, 2002.

The revenue procedure provides instructionsrelating to the determination of a substitute agent toact on behalf of a consolidated group, pursuant tosection 1.1502–77(d) or section 1.1502–77A(d).Procedures are provided for automatic approval ofrequests by a terminating common parent to desig-nate its qualifying successor as substitute agent. See§§ 1.1502–77(d) and 1.1502–77A(d), and Rev. Proc.2002–43, page 99.

Section 4975:—Tax OnProhibited Transactions

26 CFR 54.4975–1: General rules relating to excisetax on prohibited transactions.

Rev. Rul. 2002–43

ISSUE

When a loan from a qualified plan thatis a prohibited transaction spans succes-sive taxable years, and thus constitutesmultiple prohibited transactions, and dur-ing those years the first tier prohibitedtransaction excise tax rate under § 4975of the Internal Revenue Code changes,how is the excise tax computed?

FACTS

X, Inc., is a Subchapter C corporationthat sponsors Plan Y, a calendar yearprofit sharing plan qualified under§ 401(a) of the Internal Revenue Code.Plan Y’s plan year is the calendar year.On April 1, 1997, individual B, a dis-qualified person with respect to Plan Y,obtained a two-year loan in the amount of$10,000 from Plan Y’s tax-exempt trust.

The loan was secured solely by B’saccount balance in Plan Y. At the time ofthe loan, B’s account balance was$12,000. According to the terms of theloan, B was to make substantially equalpayments of principal and interest to PlanY’s trust on the first business day ofevery calendar quarter. The interest rateof the loan was 11%, compounded annu-ally, which was equal to or greater than afair market rate of interest for such a loanat that time. B made no payments on theloan until December 31, 1999, at whichtime B repaid the loan, including princi-pal and accrued interest. The repaymentconstituted a “correction” within themeaning of § 4975(f)(5) of the Code.None of the Forms 5500 that were filedfor Plan Y for 1997, 1998, or 1999reflected a loan to B.

LAW AND ANALYSIS

Section 4975(a) of the Internal Rev-enue Code provides that an excise tax isimposed as a result of each prohibitedtransaction on any disqualified personwho participates in the prohibited transac-tion (other than a fiduciary acting only assuch). Section 4975(c)(1)(B) of the Codedefines the term “prohibited transaction”as including any direct or indirect lendingof money or other extension of creditbetween a plan and a disqualified person.

Section 4975(d)(1) provides a statu-tory exemption for a loan made to a dis-qualified person who is a participant orbeneficiary of the plan if such loan (1) isavailable to all such participants or ben-eficiaries on a reasonably equivalentbasis; (2) is not made available to highlycompensated employees (within themeaning of § 414(q)) in an amountgreater than the amount made available toother employees; (3) is made in accor-dance with specific provisions regardingsuch loans set forth in the plan; (4) bearsa reasonable rate of interest; and (5) isadequately secured.

Under section 102(a) of Reorganiza-tion Plan No. 4 of 1978 (43 F. R. 47713,October 17, 1978, 1979–1 C.B. 480), theSecretary of Labor has the authority toissue regulations interpreting § 4975(d)(1) of the Code and the parallel provi-sion in section 408(b)(1) of the EmployeeRetirement Income Security Act of 1974(“ERISA”). Under 29 C.F.R. 2550.408b–1(f)(2) of the Department of Labor’s

2002–28 I.R.B. 85 July 15, 2002

regulations, a loan secured solely by morethan 50 percent of the present value of aparticipant’s vested accrued benefit is notadequately secured for purposes of deter-mining whether the loan is exempt fromthe prohibited transaction excise tax.

Section 1453(a) of the Small BusinessJob Protection Act of 1996 increased thefirst tier excise tax rate of § 4975(a) ofthe Code from 5% to 10% of the amountinvolved for each year in the taxableperiod for prohibited transactions occur-ring after August 20, 1996. Section1074(a) of the Taxpayer Relief Act of1997 increased the first tier excise taxrate to 15% of the amount involved foreach year in the taxable period for prohib-ited transactions occurring after August 5,1997. Section 4975(f)(2) of the Codedefines the term “taxable period” as theperiod beginning with the date on whichthe prohibited transaction occurs and end-ing on the earliest of (1) the date of the

mailing of a statutory notice of defi-ciency, (2) the date on which the first tierexcise tax is assessed, or (3) the date onwhich correction of the prohibited trans-action is completed. Section 4975(f)(4)defines the term “amount involved,” withrespect to a prohibited transaction, as thegreater of (1) the amount of money andthe fair market value of the other propertygiven or (2) the amount of money and thefair market value of the other propertyreceived in such transaction. For purposesof the first tier excise tax, the fair marketvalue is determined as of the date onwhich the prohibited transaction occurs.

Section 141.4975–13 of the TemporaryPension Excise Tax Regulations providesthat until superseded by permanent regu-lations under paragraphs (4) and (5) of§ 4975(f) of the Code, § 53.4941(e)–1 ofthe Foundation Excise Tax Regulationswill be controlling to the extent thoseregulations describe terms appearing both

in § 4941(e) and § 4975(f). The term“amount involved” appears in both§ 4941(e) and § 4975(f).

Section 53.4941(e)–1(b)(2)(ii) of theFoundation Excise Tax Regulations pro-vides that, where the transaction involvesthe use of money, the amount involved isthe greater of the amount paid for suchuse or the fair market value of such usefor the period for which the money orother property is used and the amountinvolved is determined for the entireperiod that the money is used. In addition,§ 53.4941(e)–1(e)(1) provides that, in theinstance of a prohibited transaction that isa loan, an additional prohibited transac-tion is deemed to occur on the first day ofeach taxable year in the taxable periodafter the taxable year in which the loanoccurred.

The interest amount for each yearunder the facts described above is com-puted as follows:

Year Principal Rate Time

Interest

Amount

1997 (4/1–12/31) $10,000.00 11.00% 275/365 year $ 828.77

1998 $10,828.77 11.00% 1 year 1,191.16

1999 12,019.93 11.00% 1 year 1,322.19

Under the facts described above, and applying the rule in § 53.4941(e)–1(e)(1), there are three prohibited transactions that resultfrom this loan. The first prohibited transaction occurs on the date of the loan (April 1, 1997), the second prohibited transactionoccurs on January 1,1998 (the first day of the next taxable year) and the third prohibited transaction occurs on January 1, 1999.The taxable period for each of these prohibited transactions begins on the date that the prohibited transaction occurs (April 1, 1997,for the first prohibited transaction, January 1, 1998, for the second prohibited transaction, and January 1, 1999, for the third pro-hibited transaction). The taxable periods for all three prohibited transactions end on the date on which the prohibited transactionswere corrected (December 31, 1999). The amount involved for each prohibited transaction is the interest amount, as computed inthe preceding table, for the first taxable year in the taxable period for that prohibited transaction. Therefore, the first-tier prohibitedtransaction excise tax for each prohibited transaction is computed as follows:

Year

1st Prohibited Transaction

Excise Tax

2nd Prohibited Transaction

Excise Tax

3rd Prohibited Transaction

Excise Tax

1997 $ 828.77 x .10 = $ 82.88 --------------------------------- --------------------------------

1998 828.77 x .10 = 82.88 $1,191.16 x .15 = $178.67 --------------------------------

1999 828.77 x .10 = 82.88 1,191.16 x .15 = 178.67 $1,322.19 x .15 = $198.33

1st tier tax $248.64 $357.34 $198.33

Total for All Prohibited Transactions = $804.31.

July 15, 2002 86 2002–28 I.R.B.

HOLDING

When a loan from a qualified plan thatis a prohibited transaction spans succes-sive taxable years, and thus constitutesmultiple prohibited transactions, and dur-ing those years the first tier prohibitedtransaction excise tax rate changes, thefirst tier excise tax liability for each pro-hibited transaction is the sum of the prod-ucts resulting from multiplying theamount involved for each year in the tax-able period for that prohibited transactionby the excise tax rate in effect at thebeginning of that taxable period.

Drafting Information

The principal author of this revenueruling is Michael Rubin of the EmployeePlans, Tax Exempt and Government Enti-ties Division. For further informationregarding this revenue ruling, please con-tact the Employee Plans’ taxpayer assis-tance telephone service at 1–877–829–5500 (a toll-free number), between thehours of 8:00 a.m. and 6:30 p.m. EasternTime, Monday through Friday. Mr. Rubincan be reached at 1–202–283–9888 (not atoll-free number).

Section 4980F.—Failure ofApplicable Plans ReducingBenefit Accruals to SatisfyNotice Requirements

Whether the notice required by section 4980F ofthe Code and section 204(h) ERISA, as amended,must be provided to the affected individuals in amoney purchase pension plan that is merged or con-verted into a profit-sharing plan. See Rev. Rul.2002–42, page 76.

Section 6011.—GeneralRequirement of Return,Statement, or List

26 CFR 1.6011–4T: Requirement of statement dis-closing participation in certain transactions by tax-payers (Temporary).

T.D. 9000

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Parts 1 and 301

Modification of Tax ShelterRules III

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final and temporary regula-tions.

SUMMARY: These regulations modifythe rules relating to the filing by certaintaxpayers of a statement with their Fed-eral income tax returns under section6011(a) and the registration of confiden-tial corporate tax shelters under section6111(d). These rules also affect the listmaintenance requirement under section6112. These regulations affect taxpayersparticipating in certain reportable transac-tions, persons responsible for registeringconfidential corporate tax shelters, andpersons responsible for maintaining listsof investors in potentially abusive taxshelters. The text of these regulations alsoserves as the text of the proposed regula-tions set forth in the notice of proposedrulemaking (REG–103735–00; REG–110311–98) on this subject on page 109of this issue of the Bulletin.

DATES: Effective Date: These regula-tions are effective June 14, 2002.

Applicability Date: For dates of appli-cability, see § 1.6011–4T(g) and§ 301.6111–2T(h).

FOR FURTHER INFORMATION CON-TACT: Danielle M. Grimm or Tara P.Volungis, 202–622–3080 (not a toll-freenumber).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information con-tained in these regulations have been pre-viously reviewed and approved by theOffice of Management and Budget inaccordance with the Paperwork Reduc-

tion Act of 1995 (44 U.S.C. 3507(d))under control number 1545–1685.

An agency may not conduct or spon-sor, and a person is not required torespond to, a collection of informationunless the collection of information dis-plays a valid OMB control number.

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

Background

This document amends 26 CFR parts 1and 301 to provide modified rules relatingto the disclosure of reportable transac-tions by certain individuals, trusts, part-nerships, S corporations, and other corpo-rations on their Federal income taxreturns under section 6011 and the regis-tration of confidential corporate tax shel-ters under section 6111.

On February 28, 2000, the IRS issuedtemporary and proposed regulationsregarding section 6011 (T.D. 8877,2000–1 C.B. 747; REG–103735–00,2000–1 C.B. 770), section 6111 (T.D.8876, 2000–1 C.B. 753; REG–110311–98, 2000–1 C.B. 767), and section 6112(T.D. 8875, 2000–1 C.B. 761; REG–103736–00, 2000–1 C.B. 768) (collec-tively, the February regulations). TheFebruary regulations were published inthe Federal Register (65 FR 11205, 65FR 11215, 65 FR 11211) on March 2,2000. On August 11, 2000, the IRS issuedtemporary and proposed regulationsregarding sections 6011, 6111, and 6112(T.D. 8896, 2000–2 C.B. 249; REG–103735–00, REG–110311–98, REG–103736–00, 2000–2 C.B. 258) (collec-tively, the August 2000 regulations). TheAugust 2000 regulations were publishedin the Federal Register (65 FR 49909)on August 16, 2000, modifying the Feb-ruary regulations. On August 2, 2001, theIRS issued temporary and proposed regu-lations regarding sections 6011, 6111, and6112 (T.D. 8961, 2001–35 I.R.B. 194;REG–103735–00, REG–110311–98,REG–103736–00, 2001–35 I.R.B. 204)(collectively, the August 2001 regula-tions). The August 2001 regulations werepublished in the Federal Register (66 FR

2002–28 I.R.B. 87 July 15, 2002

41133) on August 7, 2001, further modi-fying the February 2000 regulations.

The rules under sections 6011, 6111,and 6112 are designed to provide the IRSand Treasury with information needed toevaluate potentially abusive transactions.The IRS and Treasury have consideredand evaluated compliance with the disclo-sure, registration, and list maintenancerequirements under sections 6011, 6111,and 6112 and have determined that cer-tain additional changes to the temporaryand proposed regulations are necessary toimprove compliance with the regulationsand to carry out the purposes of sections6011, 6111, and 6112. The IRS and Trea-sury continue to evaluate all the com-ments and recommendations received.Moreover, the IRS and Treasury intend tomake substantial additional changes tothe rules under sections 6011, 6111, and6112 in order to establish a more effectivedisclosure regime and to improve compli-ance as announced in Treasury’s Plan toCombat Abusive Tax Avoidance Transac-tions (PO–2018), released on March 20,2002. See http://www.treas.gov/press/releases/po2018.htm.

Explanation of Provisions

1. Application of § 1.6011–4T toIndividuals, Trusts, Partnerships, and SCorporations

Section 1.6011–4T generally providesthat certain corporate taxpayers must dis-close their participation in listed and otherreportable transactions that meet the pro-jected tax effect test by attaching a writ-ten statement to their Federal income taxreturns. It has been determined that anumber of these transactions are enteredinto by noncorporate taxpayers. Accord-ingly, in order to obtain informationregarding potentially abusive transactionsentered into by noncorporate taxpayers,the requirement to disclose under§ 1.6011–4T is extended to individuals,trusts, partnerships, and S corporationsthat participate, directly or indirectly, inlisted transactions. Thus, if a partnershipor an S corporation participates in a listedtransaction, that partnership or S corpora-tion must disclose its participation under§ 1.6011–4T and the partners and share-holders of the partnership or S corpora-tion, respectively, also must disclose theirparticipation under § 1.6011–4T. The IRS

and Treasury plan to extend in futureguidance the requirement to discloseunder § 1.6011–4T to other reportabletransactions entered into by individuals,trusts, partnerships, and S corporations.

2. Indirect Participants

Section 1.6011–4T makes reference totaxpayers who participate directly or indi-rectly in reportable transactions. In orderto obtain information about potentiallyabusive transactions entered into by tax-payers, the IRS and Treasury have pro-vided clarification regarding indirect par-ticipation in a reportable transaction. Ataxpayer will have indirectly participatedin a reportable transaction if the taxpayerknows or has reason to know that the taxbenefits claimed from the taxpayer’stransaction are derived from a reportabletransaction. However, this clarificationdoes not imply that a taxpayer’s participa-tion in a transaction did not otherwisequalify as indirect participation in areportable transaction for purposes of§ 1.6011–4T, as in effect prior to June 14,2002.

For example, Notice 95–53 (1995–2C.B. 334), describes a lease strippingtransaction in which one party (the trans-feror) assigns the right to receive futurepayments under a lease of tangible prop-erty and receives consideration which thetransferor treats as current income. Thetransferor later transfers the property sub-ject to the lease in a transaction intendedto qualify as a substituted basis transac-tion, for example, a transaction describedin section 351. In return, the transferorreceives stock (with low value and highbasis) from the transferee corporation.The transferee corporation claims thedeductions associated with the high basisproperty subject to the lease. The transf-eror and transferee corporation havedirectly participated in the listed transac-tion. If the transferor subsequently trans-fers the high basis/low value stock to ataxpayer in another transaction intendedto qualify as a substituted basis transac-tion and the taxpayer uses the stock togenerate a loss, and if the taxpayer knowsor has reason to know that the tax lossclaimed was derived from the lease strip-ping transaction, then the taxpayer is indi-rectly participating in a reportable trans-action. Accordingly, the taxpayer mustdisclose the reportable transaction and the

manner of the taxpayer’s indirect partici-pation in the reportable transaction underthe provisions of § 1.6011–4T.

3. Substantially Similar Transactions

Sections 1.6011–4T and 301.6111–2Tmake reference to substantially similartransactions. Some taxpayers and promot-ers have applied the substantially similarstandard in an overly narrow manner toavoid disclosure. For instance, some tax-payers and promoters have made subtleand insignificant changes to a listed trans-action in order to claim that their transac-tions are not subject to disclosure. Othershave taken the position that their transac-tion is not substantially similar to a listedtransaction because they have an opinionconcluding that their transaction is proper.The IRS and Treasury believe that theseinterpretations are improper. Accordingly,the regulations are modified in§ 1.6011–4T and § 301.6111–2T toclarify that the term substantially similarincludes any transaction that is expectedto obtain the same or similar types of taxbenefits and that is either factually similaror based on the same or similar tax strat-egy. Further, the term substantially simi-lar must be broadly construed in favor ofdisclosure. This modification does notimply that a transaction was not otherwisethe same as or substantially similar to alisted transaction prior to this modifica-tion.

For example, Notice 2000–44, 2000–2C.B. 255, sets forth a listed transactioninvolving offsetting options transferred toa partnership where the taxpayer claimsbasis in the partnership for the cost of thepurchased options but does not reducebasis under section 752 as a result of thepartnership’s assumption of the taxpay-er’s obligation with respect to the options.Transactions using short sales, futures,derivatives or any other type of offsettingobligations to inflate basis in a partner-ship interest would be the same as or sub-stantially similar to the transactiondescribed in Notice 2000–44. Moreover,use of the inflated basis in the partnershipinterest to diminish gain that would other-wise be recognized on the transfer of apartnership asset would also be the sameas or substantially similar to the transac-tion described in Notice 2000–44.

July 15, 2002 88 2002–28 I.R.B.

As another example, Notice 2001–16,2001–1 C.B. 730, sets forth a listed trans-action involving a seller (X) who desiresto sell stock of a corporation (T), an inter-mediary corporation (M), and a buyer (Y)who desires to purchase the assets (andnot the stock) of T. M agrees to facilitatethe sale to prevent the recognition of thegain that T would otherwise report.Notice 2001–16 describes M as a memberof a consolidated group that has a losswithin the group or as a party not subjectto tax. Transactions utilizing differentintermediaries to prevent the recognitionof gain would be the same as or substan-tially similar to the transaction describedin Notice 2001–16. An example is atransaction in which M is a corporationthat does not file a consolidated return butwhich buys T stock, liquidates T, sellsassets of T to Y, and offsets the gain rec-ognized on the sale of those assets withcurrently generated losses.

4. Projected Tax Effect Test for ListedTransactions

Section 1.6011–4T provides that areportable transaction is a transaction thatmeets the projected tax effect test and iseither a listed transaction or a transactionthat has at least two of five specifiedcharacteristics. Under § 1.6011–4T, theprojected tax effect test for listed transac-tions is met if the taxpayer reasonablyestimates that the transaction will reducethe taxpayer’s Federal income tax liabilityby more than $1 million in any single tax-able year or by a total of more than $2million for any combination of taxableyears in which the transaction is expectedto have the effect of reducing the taxpay-er’s Federal income tax liability. The IRSand Treasury have determined that theprojected tax effect test for listed transac-tions results in inadequate disclosure.Accordingly, the projected tax effect testwill no longer apply to listed transactions.Thus, any individual, trust, partnership, Scorporation, or other corporation that par-ticipates in a listed transaction mustreport it under the provisions of§ 1.6011–4T.

5. Time of Providing Disclosure

In general, the disclosure statement fora reportable transaction must be attachedto the taxpayer’s Federal income tax

return for each taxable year for which thetaxpayer’s Federal income tax liability isaffected by the taxpayer’s participation inthe transaction. In the case of a taxpayerthat is a partnership or an S corporation,the disclosure statement for a listed trans-action must be attached to the taxpayer’sFederal income tax return for each tax-able year ending with or within the tax-able year of any partner or shareholderwhose income tax liability is affected oris reasonably expected to be affected bythe partnership’s or the S corporation’sparticipation in the transaction. In addi-tion, at the same time that the disclosurestatement is first attached to the taxpay-er’s Federal income tax return, the tax-payer must file a copy of that disclosurestatement with the Office of Tax ShelterAnalysis.

If a transaction becomes a reportabletransaction (e.g., the transaction subse-quently becomes one identified in pub-lished guidance as a listed transactiondescribed in § 1.6011–4T(b)(2), or thereis a change in facts affecting the expectedFederal income tax effect of the transac-tion) on or after the date the taxpayer hasfiled the return for the first taxable yearfor which the transaction affected the tax-payer’s or a partner’s or a shareholder’sFederal income tax liability, the disclo-sure statement must be filed as an attach-ment to the taxpayer’s Federal income taxreturn next filed after the date the transac-tion becomes a reportable transaction(whether or not the transaction affects thetaxpayer’s or any partner’s or sharehold-er’s Federal income tax liability for thatyear) and at that time a copy of that dis-closure statement must be filed with theOffice of Tax Shelter Analysis. Notwith-standing the effective date of these regu-lations, for purposes of § 1.6011–4T, as ineffect prior to June 14, 2002, a corporatetaxpayer was required to disclose a trans-action that later became reportable on thecorporation’s next filed Federal incometax return even if the transaction did notaffect the corporation’s Federal incometax liability for that year.

Regardless of whether the taxpayerplans to disclose the transaction underother published guidance, for example,Rev. Proc. 94–69, 1994–2 C.B. 804, thetaxpayer also must disclose the transac-tion in the time and manner provided forunder the provisions of this regulation.

Notwithstanding the effective date ofthese regulations, a corporate taxpayerwas required to disclose a transaction inthe time and manner provided for in§ 1.6011–4T in effect prior to June 14,2002, regardless of whether the taxpayerplanned to disclose the transaction underother published guidance.

Effective Dates

The regulations are applicable June 14,2002.

Special Analyses

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order12866. Therefore, a regulatory assess-ment is not required. It also has beendetermined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) does not apply to these regula-tions. It is hereby certified that the collec-tion of information in these regulationswill not have a significant economicimpact on a substantial number of smallentities. This certification is based uponthe fact that the time required to prepareor retain the disclosure is minimal andwill not have a significant impact onthose small entities that are required toprovide disclosure. Therefore, a Regula-tory Flexibility Analysis under the Regu-latory Flexibility Act (5 U.S.C. chapter 6)is not required. Pursuant to section7805(f) of the Internal Revenue Code,these regulations will be submitted to theChief Counsel for Advocacy of the SmallBusiness Administration for comment ontheir impact on small business.

Drafting Information

The principal authors of these regula-tions are Danielle M. Grimm and Tara P.Volungis, Office of the Associate ChiefCounsel (Passthroughs and Special Indus-tries). However, other personnel from theIRS and Treasury Department partici-pated in their development.

* * * * *Adoption of Amendments to theRegulations

Accordingly, 26 CFR parts 1 and 301are amended as follows:

2002–28 I.R.B. 89 July 15, 2002

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.6011–4T is amended

as follows:1. The heading of § 1.6011–4T is

amended by removing the language “cor-porate”.

2. The heading of paragraph (a) isrevised.

3. Paragraph (a) is amended by adding“(1) In general.” after the heading.

4. Newly designated paragraph (a)(1)is amended by adding the language “cor-porate” before “taxpayer” in the first sen-tence, and by removing the second sen-tence and adding three new sentences inits place.

5. Paragraphs (a)(2) and (a)(3) areadded.

6. Paragraph (b)(1) is amended byrevising the first sentence.

7. Paragraphs (b)(1)(i) and (b)(1)(ii)are added.

8. Paragraph (b)(4)(i) is amended byremoving the first sentence.

9. Paragraph (b)(5) Example 3 isamended by revising the seventh sen-tence.

10. Paragraphs(c)(1)(iii) and (c)(1)(v)are revised.

11. Paragraph (c)(2) Example isamended by adding the language“Example.” after “of this section:” in thefirst sentence and by adding “as in effectat that time.” to the end of the third sen-tence.

12. Paragraph (d)(1) is revised.13. Paragraph (e) is amended by

removing the language “corporation’s” inthe first sentence and adding “taxpayer’s”in its place.

14. Paragraph (g) is revised.The revisions and additions read as

follows:

§ 1.6011–4T Requirement of statementdisclosing participation in certaintransactions by taxpayers (Temporary).

(a) Disclosure requirement—(1) Ingeneral. * * * Every individual, trust,partnership, and S corporation that hasparticipated, directly or indirectly, in areportable transaction within the meaningof paragraph (b)(2) of this section mustattach to its return for the taxable year

described in paragraph (d) of this sectiona disclosure statement in the form pre-scribed by paragraph (c) of this section.For this purpose, a taxpayer will haveindirectly participated in a reportabletransaction if the taxpayer’s Federalincome tax liability is affected (or in thecase of a partnership or an S corporation,if a partner’s or shareholder’s Federalincome tax liability is reasonablyexpected to be affected) by the transac-tion even if the taxpayer is not a directparty to the transaction (e.g., the taxpayerparticipates as a partner in a partnership,as a shareholder in an S corporation, orthrough a controlled entity). Moreover, ataxpayer will have indirectly participatedin a reportable transaction if the taxpayerknows or has reason to know that the taxbenefits claimed from the taxpayer’stransaction are derived from a reportabletransaction. * * *

(2) Example of indirect participation.Notice 95–53, 1995–2 C.B. 334, (see§ 601.601(d)(2) of this chapter), describesa lease stripping transaction in which oneparty (the transferor) assigns the right toreceive future payments under a lease oftangible property and receives consider-ation which the transferor treats as currentincome. The transferor later transfers theproperty subject to the lease in a transac-tion intended to qualify as a substitutedbasis transaction, for example, a transac-tion described in section 351. In return,the transferor receives stock (with lowvalue and high basis) from the transfereecorporation. The transferee corporationclaims the deductions associated with thehigh basis property subject to the lease.The transferor and transferee corporationhave directly participated in the listedtransaction. If the transferor subsequentlytransfers the high basis/low value stock toa taxpayer in another transaction intendedto qualify as a substituted basis transac-tion and the taxpayer uses the stock togenerate a loss, and if the taxpayer knowsor has reason to know that the tax lossclaimed was derived from the lease strip-ping transaction, then the taxpayer is indi-rectly participating in a reportable trans-action. Accordingly, the taxpayer mustdisclose the reportable transaction and themanner of the taxpayer’s indirect partici-pation in the reportable transaction underthe rules of this section.

(3) Definition of taxpayer. For pur-poses of paragraphs (b)(3) and (4) of thissection, the term taxpayer means a corpo-ration required to file a return under sec-tion 11, 594, 801, or 831. For all otherpurposes of this section, the term tax-payer also includes an individual, trust,partnership, or S corporation.

(b) Definition of reportable trans-action—(1) In general. A reportabletransaction is either a transaction that isdescribed in paragraph (b)(2) of this sec-tion, or is a transaction that is describedin paragraph (b)(3) of this section andthat meets the projected tax effect test inparagraph (b)(4) of this Section. * * *

(i) Definition of substantially similar.For purposes of this section, the term sub-stantially similar includes any transactionthat is expected to obtain the same orsimilar types of tax benefits and that iseither factually similar or based on thesame or similar tax strategy. Receipt of anopinion concluding that the tax benefitsfrom the taxpayer’s transaction are allow-able is not relevant to the determinationof whether the taxpayer’s transaction isthe same as or substantially similar to alisted transaction. Further, the term sub-stantially similar must be broadly con-strued in favor of disclosure.

(ii) Examples. The following examplesillustrate situations where a transaction isthe same as or substantially similar to alisted transaction:

Example 1. Notice 2000–44, 2000–2 C.B. 255,(see § 601.601(d)(2) of this chapter), sets forth alisted transaction involving offsetting options trans-ferred to a partnership where the taxpayer claimsbasis in the partnership for the cost of the purchasedoptions but does not reduce basis under section 752as a result of the partnership’s assumption of thetaxpayer’s obligation with respect to the options.Transactions using short sales, futures, derivativesor any other type of offsetting obligations to inflatebasis in a partnership interest would be the same asor substantially similar to the transaction describedin Notice 2000–44. Moreover, use of the inflatedbasis in the partnership interest to diminish gain thatwould otherwise be recognized on the transfer of apartnership asset would also be the same as or sub-stantially similar to the transaction described inNotice 2000–44.

Example 2. Notice 2001–16, 2001–1 C.B. 730,(see § 601.601(d)(2) of this chapter), sets forth alisted transaction involving a seller (X) who desiresto sell stock of a corporation (T), an intermediarycorporation (M), and a buyer (Y) who desires topurchase the assets (and not the stock) of T. Magrees to facilitate the sale to prevent the recogni-tion of the gain that T would otherwise report.Notice 2001–16 describes M as a member of a con-solidated group that has a loss within the group or

July 15, 2002 90 2002–28 I.R.B.

as a party not subject to tax. Transactions utilizingdifferent intermediaries to prevent the recognition ofgain would be the same as or substantially similar tothe transaction described in Notice 2001–16. Anexample is a transaction in which M is a corporationthat does not file a consolidated return but whichbuys T stock, liquidates T, sells assets of T to Y, andoffsets the gain recognized on the sale of thoseassets with currently generated losses.

* * * * *(5) * * *Example 3. * * * However, E does reasonably

determine that the terms of the leases are consistentwith customary commercial form in the leasingindustry, and that there is a generally acceptedunderstanding that the combination of Federalincome tax consequences it is claiming with respectto the leases are allowable under the Internal Rev-enue Code for substantially similar transactions.* * *

* * * * *(c) * * *(1) * * *(iii) A brief description of the principal

elements of the transaction that give riseto the expected tax benefits, including themanner of the taxpayer’s direct or indirectparticipation in the transaction.

* * * * *(v) An identification of each taxable

year (including prior taxable years) forwhich the transaction is expected to havethe effect of reducing the Federal incometax liability of the taxpayer, or of anypartner or shareholder of the taxpayer,and an estimate of the amount by whichthe transaction is expected to reduce theFederal income tax liability of the tax-payer, or of any partner or shareholder ofthe taxpayer, for each such taxable year.

* * * * *

(d) Time of providing disclosure—(1)In general. The disclosure statement for areportable transaction must be attached tothe taxpayer’s Federal income tax returnfor each taxable year for which the tax-payer’s Federal income tax liability isaffected by the taxpayer’s participation inthe transaction. In the case of a taxpayerthat is a partnership or an S corporation,the disclosure statement for a listed trans-action must be attached to the taxpayer’sFederal income tax return for each tax-able year ending with or within the tax-able year of any partner or shareholderwhose income tax liability is affected oris reasonably expected to be affected bythe partnership’s or the S corporation’s

participation in the transaction. In addi-tion, at the same time that any disclosurestatement is first attached to the taxpay-er’s Federal income tax return, the tax-payer must file a copy of that disclosurestatement with the Office of Tax ShelterAnalysis (OTSA) at: Internal RevenueService LM:PFTG:OTSA, Large & Mid-Size Business Division, 1111 ConstitutionAve., NW, Washington, DC 20224.Regardless of whether the taxpayer plansto disclose the transaction under otherpublished guidance, for example, Rev.Proc. 94–69, 1994–2 C.B. 804, (see§ 601.601(d)(2) of this chapter), the tax-payer also must disclose the transaction inthe time and manner provided for underthe provisions of this section. If a transac-tion becomes a reportable transaction(e.g., the transaction subsequentlybecomes one identified in published guid-ance as a listed transaction described in(b)(2) of this section, or there is a changein facts affecting the expected Federalincome tax effect of the transaction) on orafter the date the taxpayer has filed thereturn for the first taxable year for whichthe transaction affected the taxpayer’s ora partner’s or a shareholder’s Federalincome tax liability, the disclosure state-ment must be filed as an attachment tothe taxpayer’s Federal income tax returnnext filed after the date the transactionbecomes a reportable transact ion(whether or not the transaction affects thetaxpayer’s or any partner’s or sharehold-er’s Federal income tax liability for thatyear). If a disclosure statement is requiredas an attachment to a Federal income taxreturn that is filed after June 14, 2002, buton or before 180 days after June 14,2002, the taxpayer must either attach thedisclosure statement to the return, or filethe disclosure statement as an amendmentto the return no later than 180 days afterJune 14, 2002.

* * * * *

(g) Effective date. This section appliesto Federal income tax returns filed afterFebruary 28, 2000. However, paragraphs(a)(1), (a)(2), (a)(3), (b)(1), (b)(4)(i),(b)(5) Example 3, (c)(1)(iii), (c)(1)(v),(c)(2) Example, (d)(1), and (e) of this sec-tion apply to any transaction entered intoon or after January 1, 2001, unless suchtransaction is reported on a tax return ofthe taxpayer that is filed on or before

June 14, 2002. Taxpayers may rely on therules in paragraphs (a)(1), (a)(2), (a)(3),(b)(1), (b)(4)(i), (b)(5) Example 3,(c)(1)(iii), (c)(1)(v), (c)(2) Example,(d)(1), and (e) of this section for Federalincome tax returns filed after February28, 2000. Otherwise, the rules that applywith respect to transactions entered intobefore January 1, 2001, and with respectto any transaction entered into on or afterJanuary 1, 2001, and reported on a taxreturn of the taxpayer that is filed on orbefore June 14, 2002, are contained in§ 1.6011–4T in effect prior to June 14,2002, (see 26 CFR part 1 revised as ofApril 1, 2002).

Par. 3. In § 1.6031(a)–1, para-graph(a)(1) is amended by adding a sen-tence to the end of the paragraph to readas follows:

§ 1.6031(a)–1 Return of partnershipincome.

(a) * * *(1) * * * For the rules requiring the

disclosure of certain transactions, see§ 1.6011–4T.

* * * * *Par. 4. In § 1.6037–1, paragraph (c) is

amended by adding a sentence to the endof the paragraph to read as follows:

§ 1.6037–1 Return of electing smallbusiness corporation.

* * * * *(c) * * * For the rules requiring the

disclosure of certain transactions, see§ 1.6011–4T.

* * * * *

PART 301—PROCEDURE ANDADMINISTRATION

Par. 5. The authority citation for part301 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Par. 6. Section 301.6111–2T is

amended as follows:1. Paragraph (a)(3) is amended by add-

ing four sentences to the end of the para-graph.

2. The paragraph heading for (h) isrevised and the entire text after the sec-ond sentence is removed and four newsentences are added in their place.

The revision and additions read as fol-lows:

2002–28 I.R.B. 91 July 15, 2002

§ 301.6111–2T Confidential corporatetax shelters (Temporary).

(a) * * *(3) * * * For purposes of this section,

the term substantially similar includesany transaction that is expected to obtainthe same or similar types of tax benefitsand that is either factually similar orbased on the same or similar tax strategy.Receipt of an opinion concluding that thetax benefits from the taxpayer’s transac-tion are allowable is not relevant to thedetermination of whether the taxpayer’stransaction is the same as or substantiallysimilar to a listed transaction. Further, theterm substantially similar must be

broadly construed in favor of disclosure.For examples, see § 1.6011–4T(b)(1)(ii)of this chapter.

* * * * *

(h) Effective dates. * * * However,paragraph (a)(3) of this section applies toconfidential corporate tax shelters inwhich any interests are offered for saleafter June 14, 2002. The rule in paragraph(a)(3) of this section may be relied uponfor confidential corporate tax shelters inwhich any interests are offered for saleafter February 28, 2000. Otherwise, therules that apply to confidential corporatetax shelters in which any interests areoffered for sale after February 28, 2000,

and on or before June 14, 2002, are con-tained in this § 301.6111–2T in effectprior to June 14, 2002. (See 26 CFR part301 revised as of April 1, 2002).

Robert E. Wenzel,Deputy Commissioner

of Internal Revenue.

Approved June 11, 2002.

Pamela F. Olson,Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on June14, 2002, 11:32 a.m., and published in the issue ofthe Federal Register for June 18, 2002, 67 F.R.41324)

July 15, 2002 92 2002–28 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous

Health ReimbursementArrangements

Notice 2002–45

PURPOSE

This notice provides basic informationabout a type of employer-provided healthreimbursement arrangement (HRA)described below. Published elsewhere inthis bulletin is a revenue ruling providingguidance involving an HRA.

This notice is divided into eight parts.Part I of the notice describes HRAs andtheir general tax treatment. Part II of thenotice outlines the benefits that may beoffered under an HRA. Part III detailswho may be covered under an HRA. PartIV deals with the interaction betweenHRAs and cafeteria plans. Part V coversordering rules for reimbursement fromHRAs and § 125 health flexible spendingarrangements. Part VI relates to the appli-cability of § 105(h) non-discriminationrules to HRAs. Part VII explains how toprovide COBRA continuation coverageunder HRAs. Part VIII addresses certainother matters.

I. Tax Treatment of HRAs Generally

An HRA is an arrangement that: (1) ispaid for solely by the employer and notprovided pursuant to salary reductionelection or otherwise under a § 125 caf-eteria plan; (2) reimburses the employeefor medical care expenses (as defined by§ 213(d) of the Internal Revenue Code)incurred by the employee and theemployee’s spouse and dependents (asdefined in § 152); and (3) provides reim-bursements up to a maximum dollaramount for a coverage period and anyunused portion of the maximum dollaramount at the end of a coverage period iscarried forward to increase the maximumreimbursement amount in subsequentcoverage periods. To the extent that anHRA is an employer-provided accident orhealth plan, coverage and reimbursementsof medical care expenses of an employeeand the employee’s spouse and depen-dents are generally excludable from theemployee’s gross income under §§ 106

and 105. Assuming that the maximumamount of reimbursement which is rea-sonably available to a participant underan HRA is not substantially in excess ofthe value of coverage under the HRA, anHRA is a flexible spending arrangement(FSA) as defined in § 106(c)(2).

II. Benefits under an HRA

To qualify for the exclusions under§§ 106 and 105, an HRA may only pro-vide benefits that reimburse expenses formedical care as defined in § 213(d). Eachmedical care expense submitted for reim-bursement must be substantiated. AnHRA may not reimburse a medical careexpense that is attributable to a deductionallowed under § 213 for any prior taxableyear. Additionally, an HRA may neitherreimburse a medical care expense that isincurred before the date the HRA is inexistence nor reimburse a medical careexpense that is incurred before the date anemployee first becomes enrolled underthe HRA. Reimbursements for insurancecovering medical care expenses asdefined in § 213(d)(1)(D) are allowablereimbursements under an HRA, includingamounts paid for premiums for accidentor health coverage for current employees,retirees, and COBRA qualified beneficia-ries. However, see Part IV for a discus-sion relating to cases in which anemployer provides an HRA in conjunc-tion with another accident or health plan.If an HRA is an FSA, reimbursable medi-cal care expenses may not includeexpenses for qualified long-term care ser-vices as defined in § 7702B(c). See§§ 106(c) and 213(d)(1)(C).

An HRA does not qualify for theexclusion under § 105(b) if any personhas the right to receive cash or any othertaxable or non-taxable benefit under thearrangement other than the reimburse-ment of medical care expenses. If anyperson has such a right under an arrange-ment currently or for any future year, alldistributions to all persons made from thearrangement in the current tax year areincluded in gross income, even amountspaid to reimburse medical care expenses.For example, if an arrangement pays adeath benefit without regard to medicalcare expenses, no amounts paid under the

arrangement to any person are reimburse-ments for medical care expenses excludedunder § 105(b). See § 1.105–2 of theIncome Tax Regulations. Arrangementsformally outside the HRA that provide forthe adjustment of an employee’s compen-sation or an employee’s receipt of anyother benefit will be considered in deter-mining whether the arrangement is anHRA and whether the benefits are eligiblefor the exclusions under §§ 106 and105(b). If, for example, in the year anemployee retires, the employee receives abonus and the amount of the bonus isrelated to that employee’s maximumreimbursement amount remaining in anHRA at the time of retirement, noamounts paid under the arrangement arereimbursements for medical careexpenses for purposes of § 105(b). Simi-larly, if an employer provides severancepay only to employees who have reim-bursement amounts remaining in a pur-ported HRA at the time of termination ofemployment, no amounts paid under thearrangement are reimbursements formedical care expenses for purposes of§ 105(b).

III. Coverage under an HRA

Medical care expense reimbursementsunder an HRA are excludable under§ 105(b) to the extent the reimbursementsare provided to the following individuals:current and former employees (includingretired employees), their spouses anddependents (as defined in § 152 as modi-fied by the last sentence of § 105(b)), andthe spouses and dependents of deceasedemployees. The term “employee” doesnot include a self-employed individual asdefined in § 401(c). See § 105(g).

An HRA may continue to reimburseformer employees or retired employeesfor medical care expenses after termina-tion of employment or retirement (even ifthe employee does not elect COBRA con-tinuation coverage). For example, anHRA may have a provision that reim-burses a former employee for medicalcare expenses only up to an amount equalto the unused reimbursement amountremaining at retirement or other termina-tion of employment. The plan may alsoprovide that the maximum reimbursement

2002–28 I.R.B. 93 July 15, 2002

amount available after retirement or othertermination of employment is reduced forany administrative costs of continuingsuch coverage. Additionally, an HRA mayor may not provide for an increase in theamount available for reimbursement ofmedical care expenses after the employeeretires or otherwise terminates employ-ment (even if the employee does not electCOBRA continuation coverage).

IV. HRAs and Cafeteria Plans

Employer contributions to an HRAmay not be attributable to salary reduc-tion or otherwise provided under a § 125cafeteria plan. An accident or health planfunded pursuant to salary reduction is notan HRA and is subject to the rules under§ 125. However, an HRA is not consid-ered to be paid for pursuant to salaryreduction merely because it is provided inconjunction with a cafeteria plan. Addi-tionally, if an employer offers employeesa choice between employer-provided non-taxable benefits (e.g., coverage under anHRA and coverage under a health main-tenance organization (HMO)), with nocash or other taxable benefits available toemployees, the choice is not an electionto which § 125 applies.

If an employer provides an HRA onlyin conjunction with another accident orhealth plan and that other plan is providedpursuant to a salary reduction electionunder a cafeteria plan, then all the factsand circumstances are considered indetermining whether the salary reductionis attributable to the HRA. Assuming thatthe terms of the salary reduction electionindicate that the salary reduction is usedonly to pay for the specified accident orhealth plan offered in conjunction withthe HRA and not to pay for the HRAitself, the mere fact that an employee mayparticipate in the HRA only if theemployee participates in a specified acci-dent or health plan funded pursuant to asalary reduction election does not neces-sarily result in the salary reduction beingattributed to the HRA. In such situations,if the salary reduction election for a cov-erage period to fund the specified acci-dent or health plan offered in conjunctionwith the HRA exceeds the actual cost ofthe specified accident or health plan cov-erage for such coverage period, the salaryreduction is attributable to the HRA. Forpurposes of this rule, “salary reduction”

includes a choice to forgo receipt of anybenefits that would be taxable but for thefact they are offered under a § 125 cafete-ria plan.

For any coverage period, for purposessolely of determining whether a salaryreduction election exceeds the cost ofcoverage, the actual cost of the specifiedaccident or health plan coverage for thecoverage period may be determined pur-suant to the rules for determining theCOBRA applicable premium under§ 4980B(f)(4). For example, assume thatan employer offers an HRA and anemployee who participates in the HRAmust also participate in the correspondingemployee-only or family coverageoffered in a high-deductible accident andhealth plan. If the COBRA applicablepremium for the high-deductible accidentand health coverage would be $1,800 forthe employee-only coverage and $4,500for family coverage if such coverage wereoffered separately from the HRA, thenthe annual maximum allowable salaryreduction election in this case is $1,800for employee-only coverage and $4,500for family coverage in order for the salaryreduction to be treated as not attributableto the HRA.

An arrangement is not treated as anHRA if the arrangement interacts with acafeteria plan in such a way as to permitemployees to use salary reduction indi-rectly to fund the HRA. Therefore, wherean employee who participates in a reim-bursement arrangement has a choiceamong two or more specified accident orhealth plans to be used in conjunctionwith the reimbursement arrangement (or achoice among various maximum reim-bursement amounts credited for a cover-age period) and there is a correlationbetween the maximum reimbursementamount available under the HRA for thecoverage period (disregarding amountscarried forward from previous coverageperiods) and the amount of salary reduc-tion election for the specified accidentand health plan, then the salary reductionis attributed to the reimbursementarrangement even if the amount of salaryreduction election is equal to or less thanthe actual cost of the other accident orhealth coverage.

For example, assume an employeroffers a reimbursement arrangement plusother specified accident or health plan

coverage with the actual cost for familycoverage for the specified accident orhealth plan being $4,500 and theemployee having a choice to salaryreduce $2,500 or $3,500 to fund this cov-erage. An employee who elects familycoverage and $2,500 salary reductionreceives a $1,000 maximum reimburse-ment amount under the reimbursementarrangement for the coverage period andan employee who elects family coverageand $3,500 salary reduction receives a$2,000 maximum reimbursement amountunder the reimbursement arrangement forthe coverage period. In this case, althoughthe maximum allowable salary reductionis not exceeded, a portion of the salaryreduction is attributed to the reimburse-ment arrangement because the increase insalary reduction election is related to alarger maximum reimbursement amountin the reimbursement arrangement for thecoverage period. This arrangement is notan HRA and is subject to § 125.

Similarly, assume an employer pro-vides a reimbursement arrangement inconjunction with another accident orhealth plan. Employees participating inthe reimbursement arrangement are reim-bursed up to $1,000 each year for sub-stantiated § 213(d) medical care expensesand unused amounts remaining at the endof the year are carried forward for reim-bursements in later years. The employee-share of the annual premium for the otheraccident or health plan is $1,500.Employees have a choice either to useamounts in the reimbursement arrange-ment to pay for the premium for the otheraccident or health plan or to pay that pre-mium pursuant to a salary reduction elec-tion. Under this plan, the reimbursementarrangement does not reimburse any por-tion of the premium paid by salary reduc-tion. Because an employee may use thereimbursement arrangement to pay a por-tion of the premium in lieu of electing tosalary reduce, the reimbursement arrange-ment is indirectly funded pursuant to sal-ary reduction. This arrangement does notmeet the definition of an HRA because itis funded by salary reduction and it issubject to the rules under § 125.

Further, if the amount credited to areimbursement arrangement is directly orindirectly based on the amount forfeitedunder a § 125 FSA, the arrangement willbe treated as funded by salary reduction.

July 15, 2002 94 2002–28 I.R.B.

For purposes of making this determina-tion, facts and circumstances taken intoconsideration include the manner inwhich salary reduction is implementedfor other accident or health plans offeredby the employer.

Because an HRA is paid for solely bythe employer and not pursuant to salaryreduction, the following restrictions onhealth FSAs under § 125 are not appli-cable to HRAs: (1) the prohibition againsta benefit that defers compensation by per-mitting employees to carry over unusedelective contributions or plan benefitsfrom one plan year to another plan year;(2) the requirement that the maximumamount of reimbursement must be avail-able at all times during the coverageperiod; (3) the mandatory twelve-monthperiod of coverage; and (4) except as oth-erwise provided in this notice, the limita-tion that medical expenses reimbursedmust be incurred during the period ofcoverage. As a result, the maximum reim-bursement amount for a coverage period(not including amounts carried forwardfrom previous coverage periods) need notbe available at all times during the cover-age period. Also, an HRA may specify acoverage period for a reimbursementamount that is less than a year. Althoughclaims incurred during one coverageperiod may be reimbursed in a later cov-erage period, an unreimbursed claim maybe reimbursed in a later coverage periodonly if the individual was covered underthe HRA when the claim was incurred.Additionally, the maximum reimburse-ment amount credited under the HRA inthe future (not including amounts carriedforward from previous coverage periods)may be increased or decreased. However,see § 1.105–11(c)(3)(ii) regarding opera-tional discrimination in favor of highlycompensated individuals (as defined in§ 105(h)). Thus, if an increase in maxi-mum reimbursement amounts in an HRAfavors one or more highly compensatedindividuals, the HRA may violate thesenon-discrimination rules.

V. Ordering Rules for HRAs and § 125Health FSAs

A medical care expense may not bereimbursed from a § 125 health FSA ifthe expense has been reimbursed or isreimbursable under any other accident orhealth plan. If coverage is provided under

both an HRA and a § 125 health FSA forthe same medical care expenses, amountsavailable under an HRA must beexhausted before reimbursements may bemade from the FSA. However, a § 125health FSA will not violate this rule ifcoverage is provided under both an HRAand a § 125 health FSA and the FSAreimburses a medical care expense whichis not reimbursable by the HRA. In nocase may an employee be reimbursed forthe same medical care expense by both anHRA and a § 125 health FSA.

Consistent with these rules, before a§ 125 health FSA plan year begins, theplan document for the HRA may specifythat coverage under the HRA is availableonly after expenses exceeding the dollaramount of the § 125 FSA have been paid.For example, if an employer sponsors a§ 125 health FSA and an HRA, both ofwhich provide coverage for the samemedical care expenses, and the HRA plandocument includes a provision that theHRA is not available for reimbursementsof medical care expenses that are coveredby the § 125 health FSA until afterexpenses exceeding the dollar amount ofthe § 125 FSA have been paid, then thosemedical care expenses may be reimbursedfirst from the § 125 health FSA and thenfrom the HRA when the amount availableunder the § 125 FSA is exhausted.

VI. Nondiscrimination Rules Applicableto HRAs

Section 105(h) sets forth nondiscrimi-nation rules for self-insured medicalexpense reimbursement plans. To theextent an HRA is a self-insured medicalexpense reimbursement plan, the nondis-crimination rules under § 105(h) apply tothe HRA. See § 1.105–11.

VII. COBRA Continuation Coverage

An HRA is a group health plan gener-ally subject to the COBRA continuationcoverage requirements. If an individualelects COBRA continuation coverage, anHRA complies with these COBRArequirements by providing for the con-tinuation of the maximum reimbursementamount for an individual at the time ofthe COBRA qualifying event and byincreasing that maximum amount at thesame time and by the same increment thatit is increased for similarly situated non-

COBRA beneficiaries (and by decreasingit for claims reimbursed). Premiums aredetermined under the existing rules in§ 4980B. An HRA complies with theCOBRA requirements for calculating theapplicable premium under § 4980B if theapplicable premium is the same for quali-fied beneficiaries with different totalreimbursement amounts available fromthe HRA (and otherwise also satisfies therequirements of § 4980B). For example,if the annual additional reimbursementamount credited under an HRA is $1,000and the maximum reimbursement amountremaining for two similarly situatedqualified beneficiaries at the time of theirqualifying events is $500 and $5,000, theapplicable premium is the same for eachindividual.

The plan rules of an HRA may providefor continued reimbursements after aCOBRA qualifying event regardless ofwhether a qualified beneficiary electscontinuation coverage. For example, anHRA might allow reimbursements up tothe unused maximum reimbursementamount following termination of employ-ment. In such a situation, an HRA subjectto COBRA must still comply with theCOBRA continuation coverage require-ments. If a qualified beneficiary electsCOBRA continuation coverage in addi-tion to the continued reimbursementamount already available, an HRA com-plies with the COBRA requirements byincreasing the maximum reimbursementamount at the same time and by the sameincrement that it is increased for similarlysituated non-COBRA beneficiaries (andby decreasing it for claims reimbursed).

VIII. Other Matters

Accident or health plans that meet thedefinition of an HRA are subject to avariety of statutory rules and provisions,many of which are not addressed in thisnotice. Among the statutory provisionsnot addressed in this notice are:

• The deduction limitations under§§ 419 and 419A (for employer con-tributions to welfare benefit funds)and under § 404 (for amounts paid oraccrued under plans providing fordeferred benefits that are not providedthrough a welfare benefit fund).

• The application of the nondiscrimina-tion requirements under the Health

2002–28 I.R.B. 95 July 15, 2002

Insurance Portability and Account-ability Act of 1996 (HIPAA), includ-ing the extent to which underwrittenindividual health insurance policiespurchased and reimbursed by an HRAare treated as health insurance cover-age offered under a group health plan.

• Other requirements under HIPAA,including the requirement that agroup health plan provide certificatesof creditable coverage.

• The requirements for welfare benefitplans under the Employee RetirementIncome Securi ty Act of 1974(ERISA).

The proposed regulations relating tohealth FSAs under § 125 state that certainrequirements apply whether or not thehealth FSA is part of a cafeteria plan.Future guidance will modify the proposedregulation under § 125 to clarify thatwhile those rules continue to apply tohealth FSAs provided pursuant to salaryreduction election under a § 125 cafeteriaplan, they do not apply to HRAs.

COMMENTS REQUESTED

Comments are requested about therules set forth in this notice. Send com-ments to : CC:DOM:CORP:R (Notice2002–45), Room 5226, Internal RevenueService, POB 7604, Ben Franklin Station,Washington, DC 20044. Comments maybe hand-delivered between the hours of 8a.m. and 5 p.m. to: CC:DOM:CORP:R(Notice 2002–45), Courier’s Desk, Inter-nal Revenue Service, 1111 ConstitutionAvenue, NW, Washington, D.C. Alterna-tively, taxpayers may submit commentselectronically at: Notice.Comments@irscounsel.treas.gov (a Service commentse-mail address).

DRAFTING INFORMATION

The principal author of this notice isLorianne D. Masano of the Office ofDivision Counsel/Associate Chief Coun-sel (Tax Exempt and Government Enti-ties). For further information regardingthis notice, contact Lorianne D. Masanoat (202) 622–6080 (not a toll-free call).

Request for CommentsContaining Suggestions forFuture Proposed RegulationsConcerning PermittedElimination of Optional Formsof Benefit From DefinedBenefit Plans

Notice 2002–46

The Internal Revenue Service and theTreasury Department request commentson regulations that are expected to be pro-posed under § 411(d)(6) of the InternalRevenue Code concerning the eliminationof optional forms of benefit from definedbenefit plans, including the types of situ-ations in which the retention of particularoptional forms of benefit under a definedbenefit plan results in significant burdensand complexities for sponsors of retire-ment plans and for participants and theconditions under which these optionalforms of benefit are of de minimis valueto participants.

BACKGROUND

Section 411(d)(6) generally providesthat a plan is treated as not satisfying therequirements of § 411 if the accrued ben-efit of a participant is decreased by a planamendment.1 Under § 411(d)(6)(B), aplan amendment that eliminates orreduces an early retirement benefit, aretirement-type subsidy, or an optionalform of benefit is treated as reducingaccrued benefits to the extent that theamendment applies to benefits accrued asof the later of the adoption date or theeffective date of the amendment. How-ever, § 411(d)(6)(B) permits the Secretaryof Treasury to issue regulations that per-mit the elimination of optional forms ofbenefit. Pursuant to this authority, regula-tory exceptions to the application of§ 411(d)(6) to optional forms of benefit

have been developed in the past toaddress certain specific practical prob-lems and to permit elimination of mostoptional forms of benefit in many definedcontribution plans. See A–2 and A–10 of§ 1.411(d)–4 of the Income Tax Regula-tions.

Prior to the enactment of the Eco-nomic Growth and Tax Relief Reconcilia-tion Act of 2001 (EGTRRA), 115 Stat. 38(2001), the authority to permit elimina-tion of an optional form of benefit did notapply if the optional form constituted anearly retirement benefit or retirement-typesubsidy. EGTRRA amended § 411(d)(6)(B) to provide for the Secretary ofTreasury to issue regulations under which§ 411(d)(6)(B) would not apply to anyplan amendment which reduces or elimi-nates benefits or subsidies that create sig-nificant burdens or complexities for theplan and plan participants, unless suchamendment adversely affects the rights ofany participant in a more than de minimismanner. Under section 645(b)(3) ofEGTRRA, these regulations are to beissued by December 31, 2003 and are toapply to plan years beginning afterDecember 31, 2003 or an earlier date.

COMMENTS REQUESTED

The Service and Treasury intend toissue proposed regulations under§ 411(d)(6) of the Code with respect tooptional forms of benefit under definedbenefit plans. Consequently, commentsare requested on which optional forms ofbenefit (including early retirement ben-efits and retirement-type subsidies)should be permitted to be eliminated andthe circumstances under which theyshould be permitted to be eliminated,consistent with § 411(d)(6)(B) asamended by EGTRRA. In particular,comments are requested on when particu-lar optional forms of benefit (whether ornot subsidized) result in significant bur-dens and complexities for sponsors of

1 Section 204(g)(2) of the Employee Retirement Income Security Act of 1974 (ERISA), Public Law 93–406, (88 Stat. 829), provides a parallel rule to § 411(d)(6)(B) of the Internal Rev-enue Code that applies under Title I of ERISA, and authorizes the Secretary of the Treasury to provide exceptions to this parallel ERISA requirement. Thus, Treasury regulations issuedunder § 411(d)(6)(B) of the Internal Revenue Code apply as well for purposes of § 204(g)(2) of ERISA.

July 15, 2002 96 2002–28 I.R.B.

retirement plans and for participants andwhen these optional forms of benefit areof de minimis value to a participant.Comments are also requested on whichoptional forms of benefit should remainprotected. Final ly, comments arerequested on any other issues relating tothe treatment of optional forms of benefitunder defined benefit plans under § 411(d)(6) on which guidance is needed.

The authority to provide exceptions tothe restrictions of § 411(d)(6) does notapply to other requirements of the Inter-nal Revenue Code. Thus, for example, theupcoming regulations will not permit adefined benefit plan to be amended toeliminate a distribution form required by§§ 401(a)(11) and 417 and will not affectthe requirements of § 401(a)(31) (relatingto direct rollovers).

Comments should be submitted bySeptember 30, 2002, in writing, andshould reference Notice 2002–46.

Comments may be submitted to CC:ITA:RU (Notice 2002–46), room 5226,Internal Revenue Service, POB 7604 BenFranklin Station, Washington, DC 20044.Comments may be hand deliveredbetween the hours of 8 a.m. and 5 p.m.,Monday through Friday to: CC:ITA:RU(Notice 2002–46), Courier’s Desk, Inter-nal Revenue Service, 1111 ConstitutionAvenue NW, Washington, D.C. Alterna-tively, comments may be submitted viathe Internet at Notice.Comments@irscounsel.treas.gov. All comments willbe available for public inspection andcopying.

DRAFTING INFORMATION

The principal authors of this notice areLinda Marshall of the Office of the Asso-ciate Chief Counsel (Tax Exempt andGovernment Entities) and Andrew Zuck-erman of the Employee Plans, TaxExempt and Government Entities Divi-sion. For further information regardingthis notice, contact the Employee Planstaxpayer assistance telephone servicebetween the hours of 8:00 a.m. and 6:30p.m. Eastern Time, Monday through Fri-day by calling 1–877–829–5500 (a toll-free number). Ms. Marshall can bereached at (202) 622–6090 and Mr. Zuck-erman can be reached at (202) 283–9655(not toll-free numbers).

Application of EmploymentTaxes to Statutory StockOptions

Notice 2002–47

I. Purpose and Overview

This notice provides that until Trea-sury and the Service issue further guid-ance, in the case of a statutory stockoption, i.e., an incentive stock option(ISO) described in section 422(b) of theInternal Revenue Code (Code) or anoption granted under an employee stockpurchase plan (ESPP) described in sec-tion 423(b), the Service will not assessthe Federal Insurance Contributions Act(FICA) tax or Federal UnemploymentTax Act (FUTA) tax, or apply federalincome tax withholding obligations, uponeither the exercise of the option or thedisposition of the stock acquired by anemployee pursuant to the exercise of theoption. This notice further announces thatTreasury and the Service anticipate thatany final guidance that would applyemployment taxes to statutory stockoptions will not apply to any exercise ofa statutory stock option that occurs beforethe January 1 of the year that follows thesecond anniversary of the publication ofthe final guidance. This notice does notrelieve individual taxpayers of the obliga-tion to include compensation in incomeupon a disposition of stock acquired pur-suant to the exercise of a statutory stockoption and does not relieve employers ofany of their reporting obligations.

II. Background

A. Notice 2001–14

On January 18, 2001, the Internal Rev-enue Service (Service) issued Notice2001–14, 2001–1 C.B. 516, addressingthe application of employment taxes tostatutory stock options. Notice 2001–14provides that, in the case of a statutorystock option exercised before January 1,2003, the Service will not assess FICA orFUTA taxes upon the exercise of theoption, and will not treat the dispositionof stock acquired by an employee pursu-ant to the exercise of the option as subjectto federal income tax withholding. Thenotice further provides that information

reporting requirements continue to beapplicable. The notice also announced theintention to issue administrative guidanceclarifying the application of employmenttaxes to statutory stock options.

B. Proposed Regulations and RelatedGuidance

On November 13, 2001, the Serviceand the Treasury Department issued pro-posed regulations addressing the applica-tion of employment taxes to statutorystock options (66 Fed. Reg. 57023 (Nov.14, 2001)). The proposed regulations pro-vide that FICA and FUTA taxes applywhen an individual exercises a statutorystock option and that federal income taxwithholding does not apply when an indi-vidual exercises a statutory stock option.As proposed, the regulations would havebeen effective for exercises of statutorystock options occurring on or after Janu-ary 1, 2003.

On November 13, 2001, the Servicealso issued two related notices containingproposed guidance: Notice 2001–72,2001–49 I.R.B. 548, and Notice 2001–73,2001–49 I.R.B. 549. In Notice 2001–72,the Service provides proposed rulesregarding an employer’s federal incometax withholding and reporting obligationsupon the disposition of stock acquired byan individual pursuant to the exercise of astatutory stock option. The rules wouldexempt the employer from any federalincome tax withholding in such cases.However, under the proposed rules, anemployer generally would still berequired to make reasonable efforts toreport any income on an employee’s orformer employee’s Form W–2.

In Notice 2001–73, the Service pro-vides proposed rules of administrativeconvenience intended to lessen theadministrative burdens related to theapplication of FICA and FUTA taxes atthe time of exercise of a statutory stockoption. The rules would allow employersto deem the wages paid due to the exer-cise of a statutory stock option as beingpaid at any subsequent date or dates dur-ing the calendar year of the date of exer-cise. In addition, under the proposedrules, an employer would be allowed tospread the deemed wage payments over a

2002–28 I.R.B. 97 July 15, 2002

period of dates. Notice 2001–73 also pro-poses other rules of administrative conve-nience that are intended to assist employ-ers and employees in meeting theiremployment tax obligations.

III. Comments Received

The Service requested comments as tothe proposed regulations and the pro-posed rules in the accompanying notices.Comments were submitted on a widevariety of issues raised by the applicationof employment taxes to statutory stockoptions, including whether imposition ofthe FICA and FUTA taxes upon an exer-cise of a statutory stock option was thecorrect interpretation of the law, and theextent of the administrative burdens uponemployers and employees in administer-ing the payments of the taxes. Recogniz-ing the complexity of the issues raised bythe proposed guidance and comments,Treasury and the Service have determinedthat an extension of the moratorium isneeded to provide adequate time to con-sider those issues.

IV. Interim Guidance

The Service and Treasury will con-tinue to consider all of the commentsreceived on the proposed regulations.However, until that review is completedand further guidance is issued, the Ser-vice (1) will not assess FICA or FUTAtaxes upon the exercise of a statutorystock option or the disposition of stockacquired by an employee pursuant to theexercise of a statutory stock option, and(2) will not treat the exercise of a statu-tory stock option, or the disposition ofstock acquired by an employee pursuantto the exercise of a statutory stock option,as subject to federal income tax withhold-ing.

This Part IV does not relieve indi-vidual taxpayers of the obligation toinclude any compensation in incomeupon a disposition of stock acquired pur-suant to the exercise of a statutory stockoption and does not relieve employers ofany of their reporting obligations.Regarding the reporting obligations,§ 1.6041–2(a)(1) of the Income TaxRegulations requires that, under certaincircumstances, a payment made by anemployer to an employee be reported onForm W–2 even if the payment is not

subject to income tax withholding. Spe-cifically, § 1.6041–2(a)(1) generallyrequires reporting of a payment on theForm W–2 if the total amount of the pay-ment, and any other payment of remu-neration (including wages, if any) madeto the employee (or former employee)that are required to be reported on FormW–2, aggregate at least $600 in a calen-dar year. Therefore, a disqualifying dispo-sition of stock acquired pursuant to theexercise of a statutory stock option whichresults in ordinary income generally willresult in a reporting obligation on theForm W–2.

V. Effect on Other Documents

In recognition of the need of employ-ers and statutory stock option plan admin-istrators for adequate time to implementany guidance that may be forthcoming,the Service and Treasury anticipate thatany final guidance that would applyemployment taxes to statutory stockoptions will not apply to exercises ofstatutory stock options that occur beforethe January 1 of the year that follows thesecond anniversary of the publication ofthe final guidance.

VI. Drafting Information

The principal author of this notice isStephen Tackney of the Office of Divi-sion Counsel/Associate Chief Counsel(Tax Exempt and Government Entities).For further information regarding thisnotice, contact Stephen Tackney at (202)622–6040 (not a toll-free call).

Partnership Straddle TaxShelter

Notice 2002–50

The Internal Revenue Service and theTreasury Department have become awareof a type of transaction, described below,that is being used by taxpayers for thepurpose of generating deductions. Thisnotice alerts taxpayers and their represen-tatives that the tax benefits purportedlygenerated by these transactions are notallowable for federal income tax pur-poses. This notice also alerts taxpayers,their representatives, and promoters ofthese transactions of certain responsibili-

ties that may arise from participating inthese transactions.

FACTS

This transaction involves partnershipsmanipulated through a series of steps car-ried out in the following order. No § 754election is in effect at any relevant time.Step 1: Corporation acquires a majorityinterest in an upper tier partnership (UTP)at fair market value. Step 2: UTP acquiresa majority interest in a lower tier partner-ship (LTP) at fair market value. Step 3:LTP enters into straddles on foreign cur-rencies and may acquire other assets. Step4: LTP terminates the gain leg of a for-eign currency straddle. LTP allocates apro rata share of the gain to UTP, whichin turn allocates a pro rata share of thegain to Corporation. This gain increasesthe basis of each partnership interest. Step5: Corporation sells its interest in UTP toTaxpayer at fair market value. This resultsin a loss to Corporation sufficient to off-set the gain that was allocated to Corpo-ration. Step 6: Taxpayer purchases UTP’sinterest in LTP at fair market value. UTPrealizes a loss on this sale, but the loss isdisallowed under § 707(b)(1)(A) becauseTaxpayer owns more than 50% of UTP.Step 7: LTP engages in a transaction thatis intended to increase Taxpayer’s basis inthe LTP interest. For example, LTP mayincur a liability that Taxpayer guarantees.LTP then terminates the loss leg of theforeign currency straddle and allocates apro rata share of the loss to Taxpayer.Step 8: Taxpayer sells the interest in LTPat its fair market value and realizes gain(for example, from the relief of liability).Taxpayer then claims that this gain is off-set under § 267(d) by the amount of theloss that was disallowed to UTP under§ 707(b)(1)(A).

ANALYSIS

The transaction described in this noticehas been designed to use a straddle, atiered partnership structure, a transitorypartner, and the absence of a § 754 elec-tion to allow Taxpayer to claim a perma-nent non-economic loss. The Serviceintends to challenge the purported taxbenefits from this transaction on a num-ber of grounds. First, the Service expectsthat the partnership anti-abuse rule con-tained in § 1.701–2(b) of the Income Tax

July 15, 2002 98 2002–28 I.R.B.

Regulations will generally disallow thededuction claimed by the Taxpayer uponthe termination of the loss leg of thestraddle. See § 1.701–2(d) (Ex. 8) (disal-lowing duplication of a built-in lossdeduction attributable to the absence of a§ 754 election). Second, the Service maychallenge the allowance of the lossdeduction based on other statutory provi-sions, including § 988, and judicial doc-trines, including the step transaction doc-trine and the doctrines of economicsubstance, business purpose, and sub-stance over form. Third, the Service mayassert that, where a loss is disallowed onthe sale of a partnership interest under§ 267(a)(1) or § 707(b)(1), § 267(d) mustbe applied under an aggregate approachrather than an entity approach. See§ 1.701–2(e) (requiring aggregate treat-ment of partnerships for certain pur-poses). Because the gain realized by Tax-payer on the sale of its interest in LTPdoes not correspond to any increase in thevalue of the assets within LTP, the disal-lowed loss realized on the sale of LTP byUTP cannot be used to offset the gainunder an aggregate approach.

Transactions that are the same as, orsubstantially similar to, the transactiondescribed in this notice are identified as“listed transactions” for purposes of§ 1.6011–4T(b)(2) of the temporaryIncome Tax Regulations and § 301.6111–2T(b)(2) of the temporary Procedure andAdministration Regulations. See also§ 301.6112–1T, A–4. For purposes of§ 1.6011–4T(b)(2) and § 301.6111–2T(b)(2), a transaction will be consideredthe same as, or substantially similar to,the transaction described in this noticeeven if, at the time relevant for makingsuch determination, the taxpayer in suchtransaction has not engaged in a step hav-ing the effect of Step 8.

Persons who are required to satisfy theregistration requirement of § 6111 withrespect to the transaction 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 withrespect to the transaction and who fail todo so may be subject to the penalty under§ 6708(a). In addition, the Service mayimpose penalties on participants in thistransaction or substantially similar trans-actions or, as applicable, on persons who

participate in the promotion or reportingof this transaction or substantially similartransactions, including the accuracy-related penalty under § 6662, the returnpreparer penalty under § 6694, the pro-moter penalty under § 6700, and the aid-ing and abetting penalty under § 6701.

The principal author of this notice isHeather Faught of the Office of AssociateChief Counsel (Passthroughs and SpecialIndustries). For further informationregarding this notice, contact Ms. Faughtat (202) 622–3060 (not a toll-free call).

26 CFR 601.105: Examination of returns and claimsfor refund, credit, or abatement; determination ofcorrect tax liability.(Also Part I, §§ 1502; 1.1502–77, 1.1502–77A.)

Rev. Proc. 2002–43

Determination of SubstituteAgent for a ConsolidatedGroup When the CommonParent Ceases to Exist

Table of Contents

SECTION 1. PURPOSE

SECTION 2. GENERAL BACK-GROUND

SECTION 3. SPECIFIC BACK-GROUND INFORMATION REGARD-ING DIFFERENT MEANS OF DETER-MINING A SUBSTITUTE AGENT

SECTION 4. SCOPE

SECTION 5. WHERE TO FILE

SECTION 6. DESIGNATION BY ATERMINATING COMMON PARENTOF ITS QUALIFYING SUCCESSOR ASSUBSTITUTE AGENT

SECTION 7. DESIGNATION BY ATERMINATING COMMON PARENTOF A CORPORATION OTHER THANITS QUALIFYING SUCCESSOR ASSUBSTITUTE AGENT

SECTION 8. DESIGNATION BYREMAINING MEMBERS OF THEGROUP UNDER § 1.1502–77A(d)

SECTION 9. NOTIFICATION BYDEFAULT SUBSTITUTE AGENTUNDER § 1.1502–77(d)(2)

SECTION 10. MEMBER’S REQUESTFOR THE IRS TO DESIGNATE A SUB-STITUTE AGENT UNDER § 1.1502–77(d)(3)(i)

SECTION 11. REQUEST THAT IRSREPLACE A PREVIOUSLY DESIG-NATED SUBSTITUTE AGENT

SECTION 12. EFFECTIVE DATE

SECTION 13. PAPERWORK REDUC-TION ACT

SECTION 14. INQUIRIES

SECTION 1. PURPOSE

This revenue procedure providesinstructions for all communications relat-ing to the determination of a substituteagent to act on behalf of a consolidatedgroup pursuant to §1.1502–77(d) or§ 1.1502–77A(d) of the Income TaxRegulations. This revenue procedure isthe exclusive procedure under §§ 1.1502–77(d) and 1.1502–77A(d) for submittingthe communications identified in section3 of this revenue procedure. This revenueprocedure also provides for the automaticapproval of requests by a terminatingcommon parent to designate its qualifyingsuccessor as substitute agent.

SECTION 2. GENERALBACKGROUND

In general, the corporation that is thecommon parent of a consolidated groupfor a taxable year is the sole agent for thegroup with regard to the group’s incometax liability for that taxable year. Theoriginal common parent generallyremains the agent for the group for thattaxable year, even if another corporationis the common parent of the group in alater year or the group later terminates.However, the original common parentcannot act as sole agent if its own exist-ence terminates. In that case, the groupmay require a substitute agent to functionwith respect to prior open taxable yearsfor which the original common parentwas the group’s agent. Sections 1.1502–77(d) and 1.1502–77A(d) provide rulesregarding a substitute agent to replace aterminating or terminated common par-ent. This revenue procedure sets forth theprocedures under those rules. These pro-cedures also apply when a substitute

2002–28 I.R.B. 99 July 15, 2002

agent’s existence terminates. In this rev-enue procedure, references to a terminat-ing or terminated common parent includea substitute agent going out of existence.

SECTION 3. SPECIFICBACKGROUND INFORMATIONREGARDING DIFFERENT MEANSOF DETERMINING A SUBSTITUTEAGENT

.01 Sections 1.1502–77(d)(1) and1.1502–77A(d) provide for several differ-ent means of determining a substituteagent to act on behalf of a consolidatedgroup. Each method is described below.Some can apply only to consolidatedreturn years beginning on or after June28, 2002, some can apply only to yearsbeginning before June 28, 2002, andsome can apply to any or all open years.If the terminating common parent is agentfor any open years beginning before June28, 2002, the Internal Revenue Service(IRS) recommends that the terminatingcommon parent designate a substituteagent, because that is the only single pro-cedure applicable to all open years. Des-ignation by the terminating common par-ent affords the group the greatest choiceas to the selection of its substitute agentand ensures the least interruption of com-munication with the IRS.

.02 A terminating common parent maydesignate a substitute agent. See§§ 1.1502–77(d)(1) and 1.1502–77A(d).Designation by a terminating commonparent is available for any and all taxableyears for which the terminating commonparent is agent for the group. This rev-enue procedure provides different proce-dures depending on whether the terminat-ing common parent designates itsqualifying successor (see section 6 of thisrevenue procedure) or another corpora-tion (see section 7 of this revenue proce-dure).

(1) If the terminating common parentdesignates its qualifying successor inaccordance with the procedures of thisrevenue procedure, that designation isautomatically approved without furthercommunication from the IRS, and will beeffective on the later of the termination ofthe common parent or the filing of thedesignation with the IRS. See section6.02 of this revenue procedure for thedefinition of a qualifying successor. Des-ignation by the terminating common par-

ent of its qualifying successor as substi-tute agent is generally available for anyconsolidated return year.

(2) The terminating common parentmay also designate certain corporationsother than its qualifying successor as sub-stitute agent (see section 7 of this revenueprocedure). Such a designation is subjectto approval by the IRS. Designation of acorporation other than the terminatingcommon parent’s qualifying successor assubstitute agent is generally available forany consolidated return year.

.03 If the terminating common parentdoes not designate a substitute agent, theremaining members may designate a sub-stitute agent, but only for consolidatedreturn years beginning before June 28,2002. See § 1.1502–77A(d). The designa-tion must be filed in the manner specifiedin section 8 of this revenue procedure,and is not effective until the IRS approvesthe designation.

.04 If the terminating common parentdoes not designate a substitute agent, itsqualifying successor, if any, may notifythe IRS that it is the substitute agent bydefault, but only for consolidated returnyears beginning on or after June 28, 2002.See § 1.1502–77(d)(2). IRS approval isnot required, but the IRS is not requiredto send communications to, or act oncommunications from, the successor untilit provides notification to the IRS of itsstatus as a default substitute agent undersection 9 of this revenue procedure.

.05 If the terminating common parentdoes not designate a substitute agent andhas no qualifying successor, one or moremembers of the group may request theIRS to designate a substitute agent, butonly for consolidated return years begin-ning on or after June 28, 2002. See§ 1.1502–77(d)(3)(i). The request is madepursuant to section 10 of this revenueprocedure. If the group does not requestdesignation of a substitute agent in thissituation, the IRS may nevertheless (if ithas reason to believe there is no defaultsubstitute agent) designate any groupmember or successor of a member as thesubstitute agent for the group.

.06 If the IRS designated a substituteagent for consolidated return years begin-ning on or after June 28, 2002, one ormore members of the group may requestthat the IRS replace the previously desig-nated substitute with another member (or

successor of a member), in accordancewith the procedures of section 11 of thisrevenue procedure.

SECTION 4. SCOPE

.01 In general. This revenue procedureapplies to any designation of a substituteagent under §§ 1.1502–77(d)(1) or1.1502–77A(d), notification of the exist-ence of a default substitute agent under§ 1.1502–77(d)(2), request under § 1.1502–77(d)(3)(i) for the designation of asubstitute agent, and request under§ 1.1502–77(d)(3)(ii) for replacement of apreviously designated substitute agent.

.02 References to IRS. References inthis revenue procedure to the IRS includeany official to whom the Commissioner’sauthority under §§ 1.1502–77(d) or1.1502–77A(d) has been duly delegated.

SECTION 5. WHERE TO FILE

Except as provided in section 11 ofthis revenue procedure, all documentsdescribed in this revenue procedure arefiled at the following address:

Ogden Submission ProcessingCenter

P.O. Box 9941Mail Stop 4912Ogden, UT 84409

SECTION 6. DESIGNATION BY ATERMINATING COMMON PARENTOF ITS QUALIFYING SUCCESSORAS SUBSTITUTE AGENT

.01 In general. A terminating commonparent may designate a substitute agent.See §§ 1.1502–77(d)(1) , 1.1502–77(h)(1)(ii), and 1.1502–77A(d). Desig-nation by a terminating common parent isavailable for any and all taxable years forwhich the terminating common parent isagent for the group. If the terminatingcommon parent designates its qualifyingsuccessor in accordance with the proce-dures of this section 6, that designation isautomatically approved without furthercommunication from the IRS, and nowritten approval will be provided. Suchdesignation will be effective on the laterof the termination of the common parentor the filing of the designation with theIRS. Designation by a terminating com-mon parent of its qualifying successor as

July 15, 2002 100 2002–28 I.R.B.

substitute agent with respect to consoli-dated return years beginning before June28, 2002, requires the terminating com-mon parent to elect to apply § 1.1502–77(d)(1) pursuant to § 1.1502–77(h)(1)(ii)in accordance with subsection .04(5) ofthis section 6. A designation by a com-mon parent, before its existence termi-nates, of its qualifying successor as sub-stitute agent for the group must be filed inaccordance with the requirements setforth in this section 6.

.02 Qualifying Successor. For pur-poses of this revenue procedure, a “quali-fying successor” must be (i) the soleentity that is primarily liable under appli-cable law (without regard to §§ 1.1502–1(f)(4) or 1.1502–6(a)) for the commonparent’s Federal income tax liability and(ii) a domestic corporation for Federalincome tax purposes. Qualifying succes-sors usually result from the merger of aterminating common parent into anotherdomestic corporation.

.03 When to file. (1) In general. A ter-minating common parent’s designation ofits qualifying successor as substituteagent must be executed by the commonparent before its existence terminates and,except as provided in paragraph (2) ofthis subsection .03, filed promptly.

(2) Special rule. If the qualifying suc-cessor does not come into existencebefore the common parent’s existence ter-minates, the common parent must stillexecute the designation before its exist-ence terminates, and the qualifying suc-cessor must promptly complete the desig-nation after it comes into existence byexecuting the statement required in sub-section .04(9) of this section 6 and filingthe designation.

.04 Contents. The terminating commonparent’s designation of its qualifying suc-cessor as substitute agent must be in writ-ing and contain the following informa-tion:

(1) The heading “REV. PROC. 2002–43: COMMON PARENT’S DESIGNA-TION OF ITS QUALIFYING SUCCES-SOR AS SUBSTITUTE AGENT” mustbe typed or legibly printed at the top ofthe designation;

(2) Name, address, and employer iden-tification number of the common parentmaking the designation;

(3) Name, address, and employer iden-tification number of the common parent’s

qualifying successor and the consolidatedreturn year(s) for which the designationapplies (or a statement that it applies toall consolidated return years ending on orbefore the date of termination of the com-mon parent);

(4) The name and employer identifica-tion number of the common parent underwhich the return(s) for which the designa-tion applies was (were) filed, if differentfrom the common parent named in para-graph (2) of this subsection .04;

(5) If the designation applies to anyconsolidated return year(s) beginningbefore June 28, 2002, a statement that thecommon parent elects pursuant to§ 1.1502–77(h)(1)(ii) to apply § 1.1502–77(d)(1) with respect to such year(s);

(6) The Internal Revenue Service Cen-ter where the consolidated return(s) was(were) or will be filed, as the case maybe, for the year(s) for which the designa-tion applies;

(7) The expected date of terminationof the common parent;

(8) The name, address, and phonenumber of any Examination Team Man-ager, Appeals Officer or Counsel Attorneywho currently has jurisdiction of consoli-dated return year(s) for which the desig-nation applies; and

(9) A statement on behalf of the quali-fying successor in which it:

(a) Agrees to serve as the group’s sub-stitute agent pursuant to the common par-ent’s designation; and

(b) If it was not a member of the groupduring the consolidated return year(s) forwhich it is designated, acknowledges thatit is or will be primarily liable as a suc-cessor of the common parent of the groupfor the consolidated tax liability for suchconsolidated return year(s).

.05 Signature requirements. (1) Theterminating common parent’s designationof its qualifying successor as substituteagent must contain the following declara-tion, signed by a duly authorized officerof the common parent: Under penaltiesof perjury, I declare that I am autho-rized to make this designation onbehalf of the common parent and that,to the best of my knowledge, the infor-mation provided is true, correct, andcomplete.

(2) The statement required under sub-section .04(9) of this section 6 must con-tain the following declaration, signed by a

duly authorized officer of the terminatingcommon parent’s qualifying successor:Under penalties of perjury, I declarethat I am authorized to sign this state-ment on behalf of the qualifying succes-sor and that, to the best of my knowl-edge, the information provided is true,correct, and complete.

SECTION 7. DESIGNATION BY ATERMINATING COMMON PARENTOF A CORPORATION OTHER THANITS QUALIFYING SUCCESSOR ASSUBSTITUTE AGENT

.01 In general. A terminating commonparent may designate a substitute agent.See §§ 1.1502–77(d)(1) , 1.1502–77(h)(1)(ii), and 1.1502–77A(d). Desig-nation by a terminating common parent isavailable for any and all taxable years forwhich the terminating common parent isagent for the group. If the terminatingcommon parent designates a corporationother than its qualifying successor as sub-stitute agent, that designation is subject toapproval by the IRS and is not effectiveunless and until it is approved. The desig-nation must be made in accordance withthe procedures of this section 7. The ter-minating common parent may designate:

(1) Any corporation that was a mem-ber of the group during any part of theconsolidated return year for which thedesignation applies and has not subse-quently been disregarded as an entityseparate from its owner or reclassified asa partnership for Federal tax purposes; or

(2) Any successor of such a corpora-tion, if such successor is a domestic cor-poration and is not disregarded as anentity separate from its owner or classi-fied as a partnership for Federal tax pur-poses, including a corporation that willbecome a successor at the time that thecommon parent’s existence terminates.The designation of a successor of a mem-ber as substitute agent is available forconsolidated return years beginningbefore June 28, 2002, only if the termi-nating common parent elects to apply§ 1.1502–77(d)(1) pursuant to § 1.1502–77(h)(1)(ii) in accordance with subsection.03(5) of this section 7. (See section 6 ofthis revenue procedure regarding the ter-minating common parent’s designation ofits qualifying successor as substituteagent.)

2002–28 I.R.B. 101 July 15, 2002

.02 When to file. (1) In general. A ter-minating common parent’s designation ofa corporation other than its qualifyingsuccessor as substitute agent under§§ 1.1502–77(d)(1) or 1.1502–77A(d)must be executed by the common parentbefore its existence terminates and,except as provided in paragraph (2) ofthis subsection .02, filed promptly.

(2) Special rule. If the substitute agentdesignated by the terminating commonparent under this section 7 does not comeinto existence before the common par-ent’s existence terminates, the commonparent must still execute the designationbefore its existence terminates, and thedesignated substitute agent must promptlycomplete the designation after it comesinto existence by executing the statementrequired in subsection .03(10) of this sec-tion 7 and filing the designation.

.03 Contents. The terminating commonparent’s designation of a corporationother than its qualifying successor as sub-stitute agent must be in writing and con-tain the following information:

(1) The heading “REV. PROC. 2002–43: DESIGNATION OF SUBSTITUTEAGENT BY COMMON PARENT” mustbe typed or legibly printed at the top ofthe designation;

(2) Name, address, and employer iden-tification number of the common parentmaking the designation;

(3) Name, address, and employer iden-tification number of the designated sub-stitute agent and the consolidated returnyear(s) for which the designation applies(or a statement that it applies to all con-solidated return years ending on or beforethe date of termination of the commonparent);

(4) The name and employer identifica-tion number of the common parent underwhich the return(s) for which the designa-tion applies was (were) filed, if differentfrom the common parent named in para-graph (2) of this subsection .03;

(5) If the common parent elects pursu-ant to § 1.1502–77(h)(1)(ii) to apply§ 1.1502–77(d)(1) with respect to con-solidated return years beginning beforeJune 28, 2002, a statement making anelection;

(6) The Internal Revenue Service Cen-ter where the consolidated return(s) was

(were) or will be filed, as the case maybe, for the year(s) for which the designa-tion applies;

(7) The expected date of terminationof the common parent;

(8) The name and address of the cor-poration(s) (or other person(s)) that have(or will have) custody of the books andrecords with respect to the consolidatedreturn year(s) for which the designationapplies, if different from the designatedsubstitute agent named in paragraph (3)of this subsection .03, and if so, a descrip-tion of the arrangements available to thedesignated substitute agent for access tothe books and records;

(9) The name, address, and phonenumber of the Examination Team Man-ager, Appeals Officer or Counsel Attor-ney, if any, who currently has jurisdictionof the consolidated return year(s) forwhich the designation applies; and

(10) A statement on behalf of the sub-stitute agent in which it:

(a) Agrees to serve as the group’s sub-stitute agent pursuant to the common par-ent’s designation; and

(b) If it was not a member of the groupduring the consolidated return year(s) forwhich it is designated, acknowledges thatit is or will be primarily liable as a suc-cessor of a member of the group for theconsolidated tax liability for such consoli-dated return year(s).

.04 Signature requirements. (1) Theterminating common parent’s designationof a corporation other than its qualifyingsuccessor as substitute agent must containthe following declaration, signed by aduly authorized officer of the commonparent: Under penalties of perjury, Ideclare that I am authorized to makethis designation on behalf of the com-mon parent and that, to the best of myknowledge, the information provided istrue, correct, and complete.

(2) The statement required under sub-section .03(10) of this section 7 must con-tain the following declaration, signed by aduly authorized officer of the substituteagent: Under penalties of perjury, Ideclare that I am authorized to signthis statement on behalf of the desig-nated substitute agent and that, to thebest of my knowledge, the informationprovided is true, correct, and complete.

.05 Designations solely for consoli-dated return years subject to § 1.1502–77A(d). If the designation applies only toone or more consolidated return yearsbeginning before June 28, 2002, and thedesignated substitute agent was a member(but not a successor of a member) of thegroup for the year(s) for which the desig-nation applies, the election in paragraph(5) of subsection .03 and the statementsigned on behalf of the designated substi-tute agent in paragraph (10) of subsection.03 are not applicable and are thereforenot required.

.06 Approval. (1) The IRS mayapprove or disapprove for any reason adesignation of a substitute agent underthis section 7. Approval of such designa-tion is in the sole discretion of the IRS.

(2) No designation by a terminatingcommon parent under this section 7applies unless and until it is approved bythe IRS. Approval of a terminating com-mon parent’s designation under this sec-tion 7 will not be effective before theexistence of the common parent makingthe designation terminates.

(3) The IRS will approve or disap-prove any designation under this section 7in writing to the terminating common par-ent and the substitute agent. Unless writ-ten approval is received from the IRS,taxpayers may not assume that the substi-tute agent has the authority to act onbehalf of the group.

SECTION 8. DESIGNATION BYREMAINING MEMBERS OF THEGROUP UNDER § 1.1502–77A(d).

.01. In general. If a terminating com-mon parent does not designate a substi-tute agent for any consolidated returnyear(s) beginning before June 28, 2002,the remaining members of the group maydesignate a substitute agent pursuant to§ 1.1502–77A(d) for such year(s). Theremaining members may designate assubstitute agent any corporation that wasa member of the group for any part of aconsolidated return year for which thedesignation applies. The designation mustbe filed in accordance with the require-ments set forth in this section 8.

.02 When to file. The designation of asubstitute agent by the remaining mem-bers of the group under § 1.1502–

July 15, 2002 102 2002–28 I.R.B.

77A(d)(1) may be filed at any time afterthe common parent’s existence termi-nates.

.03 Contents. The remaining members’designation of a substitute agent must bein writing and contain the followinginformation:

(1) The heading “REV. PROC. 2002–43: DESIGNATION BY GROUP MEM-BERS UNDER § 1.1502–77A(d)” mustbe typed or legibly printed at the top ofthe designation;

(2) Name, address, and employer iden-tification number of the terminated com-mon parent for which a substitute agent isbeing designated;

(3) Name, address, and employer iden-tification number of the designated sub-stitute agent and the consolidated returnyear(s) for which the designation applies(or a statement that it applies to all con-solidated return years ending on or beforethe date of termination of the commonparent);

(4) The name and employer identifica-tion number of the common parent underwhich the return(s) for which the designa-tion applies was (were) filed, if differentfrom the common parent named in para-graph (2) of this subsection .03;

(5) The Internal Revenue Service Cen-ter where the consolidated return(s) was(were) or will be filed, as the case maybe, for the year(s) for which the designa-tion applies;

(6) The date of termination of the com-mon parent;

(7) The name and address of the cor-poration(s) (or other person(s)) that have(or will have) custody of the books andrecords with respect to the consolidatedreturn year(s) for which the designationapplies, if different from the designatedsubstitute agent named in paragraph (3)of this subsection .03, and if so, a descrip-tion of the arrangements available to thedesignated substitute agent for access tothe books and records;

(8) A representation that the corpora-tions signing the designation constitute allof the remaining members of the group;and

(9) The name, address, and phonenumber of the Examination Team Man-ager, Appeals Officer or Counsel Attor-ney, if any, who currently has jurisdictionof the consolidated return year(s) forwhich the designation applies.

.04 Signature requirements. The desig-nation must contain the following decla-ration, signed by a duly authorized officerof each remaining member of the groupfor the consolidated return year(s) forwhich the designation applies: Underpenalties of perjury, I declare that I amauthorized to make this designation onbehalf of the named member of thegroup and that, to the best of myknowledge, the information provided istrue, correct, and complete. For pur-poses of this subsection .04, the designa-tion may be submitted as a single docu-ment containing all required signatures oras multiple documents each signed by aduly authorized officer of a remainingmember of the group.

.05 Approval. (1) The IRS mayapprove or disapprove for any reason adesignation of a substitute agent underthis section 8. Approval of such designa-tion is in the sole discretion of the IRS.

(2) No designation under this section 8applies unless and until it is approved bythe IRS.

(3) The IRS will approve or disap-prove any designation under this section 8in writing to the member designated assubstitute agent in subsection .03(3) ofthis section 8. Unless written approval isreceived from the IRS, taxpayers may notassume that the substitute agent has theauthority to act on behalf of the group.

SECTION 9. NOTIFICATION BYDEFAULT SUBSTITUTE AGENTUNDER § 1.1502–77(d)(2)

.01 In general. If a terminating com-mon parent that does not designate a sub-stitute agent pursuant to § 1.1502–77(d)(1) has a qualifying successor (asdefined in section 6.02 of this revenueprocedure), such qualifying successor isthe default substitute agent under§ 1.1502–77(d)(2) for consolidated returnyears beginning on or after June 28, 2002.Such default substitute agent must pro-vide notification to the IRS pursuant tothe filing requirements set forth in thissection 9 to insure that it will receivecommunications from the IRS to thegroup and to insure that the IRS will acton its communications to the IRS onbehalf of the group.

.02 When to file. Notification by thedefault substitute agent should be filed

promptly after the existence of the com-mon parent terminates.

.03 Contents. The notification by thedefault substitute agent under § 1.1502–77(d)(2) must be in writing and containthe following information:

(1) The heading “REV. PROC. 2002–43: NOTIFICATION BY DEFAULTSUBSTITUTE AGENT UNDER§ 1.1502–77(d)(2)” must be typed or leg-ibly printed at the top of the notification;

(2) Name, address, and employer iden-tification number of the terminated com-mon parent;

(3) Name, address, and employer iden-tification number of the default substituteagent and the consolidated return year(s)for which it is the substitute agent;

(4) The name and employer identifica-tion number of the common parent underwhich the return(s) for which the defaultsubstitute agent is the substitute agentwas (were) filed, if different from thecommon parent named in paragraph (2)of this subsection .03;

(5) The Internal Revenue Service Cen-ter where the consolidated return(s) was(were) or will be filed, as the case maybe, for the consolidated return year(s) forwhich the default substitute agent is thesubstitute agent;

(6) The date of termination of the com-mon parent;

(7) The name, address, and phonenumber of the Examination Team Man-ager, Appeals Officer or Counsel Attor-ney, if any, who currently has jurisdictionof the consolidated return year(s) forwhich the default substitute agent is thesubstitute agent; and

(8) A statement in which the defaultsubstitute agent:

(a) Agrees to serve as the group’s sub-stitute agent; and

(b) If it was not a member of the groupduring the consolidated return year(s) forwhich it is the default substitute agent,acknowledges that it is primarily liable asa successor of the former common parentof the group for the consolidated taxliability for such consolidated returnyear(s).

.04 Signature requirements. The notifi-cation by a default substitute agent mustcontain the following declaration, signedby a duly authorized officer of the defaultsubstitute agent: Under penalties of per-jury, I declare that I am authorized to

2002–28 I.R.B. 103 July 15, 2002

submit this notification on behalf of thedefault substitute agent and that, to thebest of my knowledge, the informationprovided is true, correct, and complete.

.05 No approval required . IRSapproval is not required for a default sub-stitute agent, but the IRS is not requiredto send communications to, or act oncommunications from, a default substituteagent until it provides notification underthis section 9.

SECTION 10. MEMBER’S REQUESTFOR THE IRS TO DESIGNATE ASUBSTITUTE AGENT UNDER§ 1.1502–77(d)(3)(i)

.01 In general. If a terminating com-mon parent does not designate a substi-tute agent and there is no default substi-tute agent under § 1.1502–77(d)(2), oneor more members of the group mayrequest that the IRS designate a substituteagent pursuant to § 1.1502–77(d)(3)(i) forconsolidated return years beginning on orafter June 28, 2002. Such request may(but is not required to) propose a member(or a successor of a member) for the IRSto designate as substitute agent.

.02 When to file. A request by a mem-ber of the group that the IRS designate asubstitute agent may be filed at any timeafter the common parent’s existence ter-minates and before the IRS designates asubstitute agent.

.03 Contents. A request for designationof a substitute agent must be in writingand contain the following information:

(1) The heading “REV. PROC. 2002–43: REQUEST FOR DESIGNATION OFSUBSTITUTE AGENT UNDER§ 1.1502–77(d)(3)” must be typed or leg-ibly printed at the top of the designation;

(2) Name, address, and employer iden-tification number of the terminated com-mon parent;

(3) Name, address, and employer iden-tification number of the proposed substi-tute agent, if any, and the consolidatedreturn year(s) for which the designation isrequested;

(4) The name and employer identifica-tion number of the common parent underwhich the return(s) for which the designa-tion is requested was (were) filed, if dif-ferent from the common parent named inparagraph (2) of this subsection .03;

(5) The Internal Revenue Service Cen-ter where the consolidated return(s) was

(were) or will be filed, as the case maybe, for the year(s) for which the designa-tion is requested;

(6) The date the common parent’sexistence terminated and the circum-stances under which it terminated (e.g.,dissolution under state law or merger intoa limited liability company);

(7) The name and address of the cor-poration(s) (or other person(s)) that havecustody of the books and records withrespect to the consolidated return year(s)for which the designation is requested, ifdifferent from any proposed substituteagent named in paragraph (3) of this sub-section .03, and if so, a description of thearrangements available to the proposedsubstitute agent for access to the booksand records; and

(8) The name, address, and phonenumber of the Examination Team Man-ager, Appeals Officer or Counsel Attor-ney, if any, who currently has jurisdictionof the consolidated return year(s) forwhich the designation is requested.

.04 Signature requirement. A requestunder this section 10 must contain the fol-lowing declaration, signed by a dulyauthorized officer of at least one of therequesting members which was a memberof the group for the consolidated returnyear(s) for which the designation isrequested: Under penalties of perjury, Ideclare that I am authorized to makethis request on behalf of the namedmember of the group and that, to thebest of my knowledge, the informationprovided is true, correct, and complete.

.05 Designation by the IRS. (1) Inresponse to a request under this section10, the IRS may, in its sole discretion,designate as the substitute agent the mem-ber (or successor of the member) pro-posed by the request, if any, or anothermember (or successor of another mem-ber).

(2) The IRS will notify in writing thedesignated substitute agent.

SECTION 11. REQUEST THAT IRSREPLACE A PREVIOUSLYDESIGNATED SUBSTITUTE AGENT

.01 In general. If the IRS designates asubstitute agent pursuant to § 1.1502–77(d)(3)(i), one or more members of thegroup may request pursuant to § 1.1502–77(d)(3)(ii) that the IRS replace the previ-ously designated substitute agent with

another member (or successor of anothermember). Such request may (but is notrequired to) propose a substitute agent toreplace the previously designated substi-tute agent.

.02 When to file. A request by a mem-ber of the group that the IRS replace apreviously designated substitute agentmay be filed at any time after the IRSdesignates the substitute agent that therequest seeks to have replaced.

.03 Contents. A request that the IRSreplace a previously designated substituteagent must be in writing and contain thefollowing information:

(1) The heading “REV. PROC. 2002–43: REQUEST FOR IRS TO REPLACEPREVIOUSLY DESIGNATED SUBSTI-TUTE AGENT UNDER § 1.1502–77(d)(3)” must be typed or legibly printedat the top of the designation;

(2) Name, address, and employer iden-tification number of the previously desig-nated substitute agent;

(3) Name, address, and employer iden-tification number of the proposed substi-tute agent, if any, to replace the previ-ously designated substitute agent and theconsolidated return year(s) for which thereplacement designation is requested;

(4) The name and employer identifica-tion number of the common parent underwhich the return(s) for which the replace-ment designation is requested was (were)filed;

(5) The Internal Revenue Service Cen-ter where the consolidated return(s) was(were) or will be filed, as the case maybe, for the year(s) for which the replace-ment designation is requested;

(6) The date the common parent’sexistence terminated and the circum-stances under which it terminated (e.g.,dissolution under state law or merger intoa limited liability company);

(7) The name and address of the cor-poration(s) (or other person(s)) that havecustody of the books and records withrespect to the consolidated return yearsfor which the replacement designation isrequested, if different from the proposedreplacement substitute agent named inparagraph (3) of this subsection .03, andif so, a description of the arrangementsavailable to the proposed replacementsubstitute agent for access to the booksand records;

July 15, 2002 104 2002–28 I.R.B.

(8) The name, address, and phonenumber of the Examination Team Man-ager, Appeals Officer or Counsel Attor-ney, if any, who currently has jurisdictionof the consolidated return years for whichthe replacement designation is requested;and

(9) The reason(s) for the request toreplace the previously designated substi-tute agent.

.04 Signature requirement. A requestunder this section 11 must contain the fol-lowing declaration, signed by a dulyauthorized officer of at least one of therequesting members which was a memberof the group for the consolidated returnyear(s) for which the replacement desig-nation is requested: Under penalties ofperjury, I declare that I am authorizedto make this request on behalf of thenamed member of the group and that,to the best of my knowledge, the infor-mation provided is true, correct, andcomplete.

.05 Where to file. Notwithstanding theinstructions in section 4 of this revenueprocedure, a request under this section 11must be filed with the office that madethe designation of the substitute agent thatthe request seeks to replace.

.06 Designation by the IRS. (1) Inresponse to a request under this section11, the IRS may, in its sole discretion,replace the previously designated substi-tute agent with the member (or successorof the member) proposed by the requestor another member (or successor ofanother member).

(2) If the IRS replaces the previouslydesignated substitute agent, it will notifyin writing the previously designated sub-stitute agent and the replacement substi-tute agent of the change in the substituteagent.

SECTION 12. EFFECTIVE DATE

This revenue procedure applies to des-ignations of substitute agents and notifi-cations of the existence of default substi-tute agents, and to requests fordesignation of a substitute agent or forreplacement of a previously designatedsubstitute agent made after June 28, 2002.

SECTION 13. PAPERWORKREDUCTION ACT

The collection of information con-tained in this revenue procedure has beenreviewed and approved by the Office ofManagement and Budget in accordancewith the Paperwork Reduction Act (44U.S.C. 3507) under control numbers1545–1699 and 1545–1793.

An agency may not conduct or spon-sor, and a person is not required torespond to, a collection of informationunless the collection of information dis-plays a valid OMB control number.

The collections of information in thisrevenue procedure are in sections 6through 11. These collections of informa-tion are required (i) for the common par-ent to notify the IRS of the designation ofa substitute agent for the consolidatedgroup when the common parent’s exist-ence is about to terminate and for the des-ignated corporation to confirm that itagrees to serve as the group’s substituteagent and qualifies to be the group’s sub-stitute agent, (ii) for the common parent’ssuccessor to notify the IRS that it quali-fies as a default substitute agent, or (iii)for a member of a consolidated group torequest that the IRS designate a substituteagent or replace a previously designatedsubstitute agent. This information will beused (i) to determine whether to approvethe designation of the substitute agent, (ii)to update IRS records with the name ofthe substitute agent, or (iii) to designateor replace a substitute agent. The collec-tions of information are required to obtaina benefit in the case of a designation bythe common parent or notification by adefault substitute agent, and voluntary inthe case of requests by members to desig-nate or replace a substitute agent. Thelikely respondents are business or otherfor-profit institutions.

The estimated total annual reportingburden is 400 hours.

The estimated annual burden perrespondent varies from one hour to 3hours, depending on individual circum-stances, with an estimated average of twohours. The estimated number of respon-dents is 200.

The estimated annual frequency ofresponses is on occasion.

Books or records relating to a collec-tion of information must be retained as

long as their contents may become mate-rial in the administration of any internalrevenue law. Generally tax returns andtax return information are confidential, asrequired by 26 U.S.C. 6103.

SECTION 14. INQUIRIES

Inquiries regarding this revenue proce-dure may be addressed to the Commis-sioner of Internal Revenue, ATTN:CC:CORP:BO2, P.O. Box 7604, BenFranklin Station, Washington, D.C.20044.

DRAFTING INFORMATION

The principal authors of this revenueprocedure are George R. Johnson andGerald B. Fleming of the Office of Asso-ciate Chief Counsel (Corporate). For fur-ther information regarding this revenueprocedure, contact Mr. Johnson at (202)622–7930 or Mr. Fleming at (202) 622–7770 (not toll-free numbers).

26 CFR 601.204: Changes in accounting periodsand methods of accounting.(Also Part I, § 832; 1.832–4; 1.832–5.)

Rev. Proc. 2002–46

SECTION 1. PURPOSE

This revenue procedure provides cer-tain insurance companies subject to taxunder § 831 of the Internal Revenue Codewith a safe harbor method of accountingfor premium acquisition expenses. Thisrevenue procedure also provides a proce-dure for insurance companies to obtainautomatic consent of the Commissionerto change to this safe harbor method.

SECTION 2. BACKGROUND

.01 Section 832(b)(1) provides that thegross income of an insurance companysubject to tax under § 831 includes thecompany’s “underwriting income.”

.02 Section 832(b)(3) defines “under-writing income” as “premiums earned oninsurance contracts during the taxableyear, less losses incurred and expensesincurred.”

.03 Section 832(b)(4) provides that tocompute premiums earned, an insurancecompany reduces the amount of grosspremiums written on insurance contracts

2002–28 I.R.B. 105 July 15, 2002

during the taxable year by return premi-ums and premiums paid for reinsurance.Subject to the exceptions in §§ 832(b)(7),(b)(8), and 833, this amount is increasedby 80 percent of the unearned premiumson outstanding insurance contracts at theend of the preceding taxable year, and isdecreased by 80 percent of the unearnedpremiums on outstanding insurance con-tracts at the end of the current year. This20 percent reduction in the amount of aninsurance company’s deduction forincreases in unearned premiums isintended to represent the allocable portionof the company’s expenses incurred ingenerating the unearned premiums.S. Rep. No. 313, 99th Cong. 2d Sess. 496(1986), 1986–3 (Vol. 3) C.B. 496;H. Rep. No. 426, 99th Cong. 1st Sess.669 (1985), 1986–3 (Vol. 2) C.B. 669.

.04 Sections 1.832–4(a)(3) through(11) of the Income Tax Regulations,effective for taxable years beginning afterDecember 31, 1999, prescribe specificrules regarding the manner in which aninsurance company determines gross pre-miums written, return premiums, andunearned premiums for purposes of thecalculation of premiums earned under§ 832(b)(4). These rules apply regardlessof the accounting practices used by theinsurance company to record gross premi-ums written and unearned premiums onits annual statement filed for state regula-tory reporting purposes. Section 1.832–4(a)(4) defines “gross premiums written”as “all amounts payable for the effectiveperiod of the insurance contract.” Section1.832–4(a)(5)(i) generally requires theinsurance company to report gross premi-ums written “for the earlier of the taxableyear that includes the effective date of theinsurance contract or the year in whichthe company receives all or a portion ofthe gross premium for the insurance con-tract.” In some situations, this rule mayresult in gross premiums written beingtaken into account in the calculation ofpremiums earned under § 832(b)(4) for ataxable year earlier than the year in whichthose written premiums are reported onthe company’s annual statement.

.05 Section 1.832–4(a)(5) providesspecial methods of reporting gross premi-ums written for certain categories ofinsurance contracts with installment pre-miums, including contracts for which an

advance premium installment is receivedprior to the effective date of the underly-ing contract, cancellable accident andhealth insurance contracts, and certainmulti-year insurance contracts with pre-miums payable at guaranteed rates. Touse one of these special methods ofreporting gross premiums written, theinsurance company must satisfy anannual pro rata expense limitation withregard to the amount of premium acquisi-tion expenses deducted for the underlyingcontract. Section 1.832–4(a)(5)(vii). Thisannual pro rata expense limitationensures that the company does not deductthe premium acquisition expenses for theinsurance contract more rapidly than thecompany includes the gross premiumswritten for the associated contract in thecalculation of premiums earned under§ 832(b)(4).

.06 Section 832(b)(6) provides that“expenses incurred” means all expensesshown on the insurance company’sannual statement. Expenses incurred gen-erally are calculated as the sum of theexpenses paid during the taxable year,plus the increase in unpaid expenses dur-ing the taxable year. To be included inexpenses incurred, an expense listed onthe annual statement also must be anallowable deduction under § 832(c). Sec-tion 832(c) lists various categories ofallowable deductions, including “all ordi-nary and necessary expenses incurred, asprovided in § 162 (relating to trade orbusiness expenses).” See § 832(c)(1).

.07 The 20 percent reduction in thededuction for increases in unearned pre-miums under § 832(b)(4) was intended tocorrect the mismatching that results fromthe deferral of unearned premium incomeand the current deduction of premiumacquisition expenses. S. Rep. No. 313, at496 (1986); H. Rep. No. 426, at 668–69(1985). Consistent with this intent, theInternal Revenue Service will allowinsurance companies within the scope ofthis revenue procedure to account for pre-mium acquisition expenses using the safeharbor method described in section 5.02of this revenue procedure.

SECTION 3. DEFINITIONS

The following definitions apply solelyfor purposes of this revenue procedure.

.01 Premium acquisition expenses. Apremium acquisition expense is anexpense that is primarily related to theproduction of gross premiums written onan insurance contract and directly varieswith the amount of gross premiums writ-ten on the underlying contract. Forexample, agent and broker commissions,premium taxes, and premium-basedassessments generally qualify as premiumacquisition expenses because theseexpenses vary with and are primarilyrelated to the acquisition of gross premi-ums written on new and renewal insur-ance contracts. An annual expense allow-ance payable by a reinsurer to assume allor a portion of the risk on insurance con-tracts of another insurance company istreated as a premium acquisition expenseto the extent that this expense allowancereflects the reinsurer’s reimbursement ofthe premium acquisition expensesincurred by the direct writing company.However, expenditures with respect tosalaried personnel and general adminis-trative costs typically will not qualify aspremium acquisition expenses. Althougha portion of these costs may be associatedwith activities relating to the issuance ofinsurance contracts, these expenditures donot vary directly based on the amount ofgross premiums written for the associatedcontracts.

.02 Pro forma premium acquisitionexpenses. A pro forma premium acquisi-tion expense is any unpaid premiumacquisition expense that is not shown onthe insurance company’s annual statementfor the year in which the insurance com-pany includes the gross premiums writtento which that expense relates in the calcu-lation of premiums earned under§ 832(b)(4).

.03 Pro forma unearned premiumreserve. The pro forma unearned pre-mium reserve is the portion of an insur-ance company’s year-end unearned pre-miums (other than amounts to whichspecial rules in §§ 832(b)(7)(A) and832(b)(8) apply) attributable to gross pre-miums written that are not shown on thecompany’s annual statement, but whichthe company is required to report in thecalculation of premiums earned under§ 832(b)(4) for the taxable year in accor-dance with the provisions of § 1.832–4.

July 15, 2002 106 2002–28 I.R.B.

.04 Unearned premium reserve offsetamount. (i) Except as otherwise providedin paragraph 3.04(ii), an insurance com-pany determines the unearned premiumoffset amount for a taxable year bymultiplying—

(A) The amount, if any, by which thecompany’s pro forma unearned premiumreserve at the end of the taxable yearexceeds its pro forma unearned premiumreserve at the end of the preceding tax-able year, by

(B) .20.(ii) In the case of a financial guaranty

insurer to which the special rules in§ 832(b)(7)(B) apply, the unearned pre-mium reserve offset amount is determinedby multiplying the amount, if any, bywhich the company’s pro forma unearnedpremium reserve for financial guarantycontracts at the end of the taxable yearexceeds its pro forma unearned premiumreserve for financial guaranty contracts atthe end of the preceding taxable year by.10.

SECTION 4. SCOPE

.01 Except as otherwise provided insection 4.02 of this revenue procedure,this revenue procedure applies to anyinsurance company that is subject to taxunder § 831(a) and determines its premi-ums earned for insurance contracts duringthe taxable year under § 832(b)(4) inaccordance with the provisions of§ 1.832–4.

.02 This revenue procedure does notapply to an existing Blue Cross or BlueShield organization or any other organiza-tion to which § 833 applies.

SECTION 5. SAFE HARBORMETHOD

.01 Taxpayers within the scope of thisrevenue procedure are permitted toaccount for premium acquisition expensesincurred for taxable years beginning afterDecember 31, 1999, using the safe harbormethod described in section 5.02 of thisrevenue procedure.

.02 Description of Safe HarborMethod. (i) Except as provided in section5.02(ii) of this revenue procedure, aninsurance company is permitted to treat aspremium acquisition expenses incurredfor the taxable year an amount equal tothe sum of —

(A) The amount of premium acquisi-tion expenses paid during the taxableyear;

(B) The difference between the unpaidpremium acquisition expenses shown onthe company’s annual statement for thetaxable year and the unpaid premiumacquisition expenses shown on the com-pany’s annual statement for the precedingtaxable year; and

(C) The difference between theamount of the insurance company’s proforma premium acquisition expenses atthe end of the taxable year and the com-pany’s pro forma premium acquisitionexpenses at the end of the preceding tax-able year.

(ii) Limitation on current deductibilityof certain pro forma expenses. For pur-poses of calculating the premium acquisi-tion expenses incurred for the taxableyear under section 5.02(i) of this revenueprocedure, the amount taken into accountas a net increase in pro forma premiumacquisition expenses during the yearunder section 5.02(i)(C) cannot exceedthe insurance company’s unearned pre-mium reserve offset amount for that year.If the amount taken into account as a netincrease in pro forma premium acquisi-tion expenses during the year under sec-tion 5.02(i)(C) is reduced as a result ofthis limitation, the reduction amount iscarried forward and increases the compa-ny’s pro forma premium acquisitionexpenses at the end of the succeeding tax-able year.

SECTION 6. APPLICATION OF SAFEHARBOR METHOD TO CERTAINCONTRACTS WITH INSTALLMENTPREMIUMS

An insurance company using one ofthe special methods of reporting grosspremiums written in § 1.832–4(a)(5) for acategory of insurance contracts withinstallment premiums may apply the safeharbor method to determine the amountof premium acquisition expenses treatedas incurred for the taxable year withregard to those contracts. The company’spremium acquisition expenses treated asincurred for the taxable year with regardto those contracts, however, cannotexceed the annual pro rata expense limi-tation of § 1.832–4(a)(5)(vii). If the insur-ance company is required to reduce theamount of premium acquisition expenses

that would otherwise be treated asincurred for a taxable year in order tomeet the annual pro rata expense limita-tion of § 1.832–4(a)(5)(vii), the reductionamount is carried forward and is takeninto account in determining the compa-ny’s premium acquisition expensesincurred with regard to those contracts forthe succeeding taxable year.

SECTION 7. CHANGE IN METHODOF ACCOUNTING

.01 In general. A change to the safeharbor method provided in section 5.02 ofthis revenue procedure is a change inmethod of accounting to which the provi-sions of §§ 446 and 481 and the regula-tions thereunder apply. Thus, in order tochange to the safe harbor method, aninsurance company must complete Form3115, Application for Change In Methodof Accounting, and otherwise complywith the procedures in this section 7.

.02 Automatic change. A taxpayer thatwants to change its method of accountingfor premium acquisition expenses to thesafe harbor method provided by section5.02 of this revenue procedure must fol-low the automatic change in method ofaccounting provisions of Rev. Proc.2002–9, 2002–3 I.R.B. 327 (or its succes-sor), as modified by Rev. Proc. 2002–19,2002–13 I.R.B. 696, with the followingmodifications:

(1) The scope limitations in section4.02 of Rev. Proc. 2002–9 do not apply.

(2) To assist the Service in processingchanges in method of accounting underthis section of the revenue procedure, andto ensure proper handling, section6.02(4)(a) of Rev. Proc. 2002–9 is modi-fied to require that a Form 3115 filedunder this revenue procedure include thestatement: “Automatic Change FiledUnder Rev. Proc. 2002–46.” This state-ment should be legibly printed or typedon the appropriate line of any Form 3115filed under this revenue procedure.

.03 Automatic change for the first tax-able year beginning after December 31,1999. A taxpayer that wants to change tothe safe harbor method for its first taxableyear beginning after December 31, 1999,is not subject to the filing requirements insection 6.02(3)(a) or the effective dateprovision in section 13.01 of Rev. Proc.

2002–28 I.R.B. 107 July 15, 2002

2002–9, provided that the taxpayer com-plies with the following filing require-ments. The taxpayer must complete andfile a Form 3115 in duplicate. The origi-nal must be filed with the taxpayer’samended federal income tax return for itsfirst taxable year beginning after Decem-ber 31, 1999. A copy of the Form 3115must be filed with the national office (seeRev. Proc. 2002–9 for the address) nolater than when the taxpayer’s amendedreturn is filed. The amended return mustbe filed no later than January 21, 2003. Ataxpayer that wants to change to the safeharbor method for a taxable year earlierthan its first taxable year ending on orafter December 31, 2001, must take intoaccount the § 481(a) adjustment requiredas a result of the change over a four-yearadjustment period. See sections 4.01 and4.04(1) of Rev. Proc. 2002–19.

.04 Pending applications with nationaloffice. If a taxpayer filed an application orruling request with the national office tomake a change in method of accountingfor premium acquisition expenses for ataxable year beginning before January 1,2002, and the application or rulingrequest is pending with the national officeon June 20, 2002, the taxpayer may makethe method change under this revenueprocedure. However, the national officewill process the application or rulingrequest in accordance with the authorityunder which it was filed, unless prior toSeptember 20, 2002, the taxpayer notifiesthe national office that it wants to makethe method change under this revenueprocedure. If the taxpayer timely notifiesthe national office that it wants to makethe method change under this revenueprocedure, the application or rulingrequest will be considered closed and anyuser fee that was submitted with theapplication or ruling request will bereturned to the taxpayer.

SECTION 8. EXAMPLE

The following example illustrates themanner in which an insurance companyapplies the safe harbor method to deter-mine the amount of premium acquisitionexpenses treated as incurred for the tax-able year.

Example.(i) IC is an insurance company taxable as

described in section 4 of this revenue procedure thatfiles its returns on a calendar year basis. IC writesautomobile insurance policies which provide insur-ance coverage for a one-year period beginning onJanuary 1st and ending on December 31st. The pre-miums for the policies are payable on a monthlyinstallment basis. For annual statement reportingpurposes, IC reports gross premiums written forthese insurance policies based on the calendar yearin which the related coverage commences. For pur-poses of calculating its premiums earned under§ 832(b)(4), IC is required by § 1.832–4(a)(5)(i) toreport gross premiums written for the policies forthe earlier of the taxable year that includes the effec-tive date of the related policies or the year in whichall or a portion of the premiums for the policies arereceived. However, pursuant to § 1.832–4(a)(5)(iii),IC has adopted the method of reporting advance pre-mium installments in gross premiums written for thetaxable year of receipt.

(ii) As of December 31, 2002, IC has collected$250 of advance premium installments during theyear with respect to insurance policies with effectivedates in 2003. IC determines that the premiumacquisition expenses attributable to these advancepremium installments are $62.50 and that the totalamount of premium acquisition expenses expectedto be incurred over the effective period of therelated insurance policies is $750. On its 2002annual statement, IC reports total amount of pre-mium acquisition expenses of $1,250, consisting of$1,000 of paid expenses plus a $250 increase inunpaid expenses. The expenses shown on IC’s 2002annual statement did not include the $62.50 of pre-mium acquisition expenses attributable to $250 ofadvance premium installments that IC collected in2002 with respect to policies with effective dates in2003, but did include $50 of premium acquisitionexpenses attributable to $200 of advance premiuminstallments that IC collected in 2001 with respectto policies with effective dates in 2002. Pursuant to§ 1.832–4(a)(5)(iii), IC had already included those$200 of advance premium installments in gross pre-miums written and unearned premiums when calcu-lating the amount of premiums earned under§ 832(b)(4) for the 2001 taxable year.

(iii) For the taxable year ending December 31,2002, IC changes to the safe harbor method ofdeducting premium acquisition expenses describedin section 5.02 of this revenue procedure. To deter-mine the deductible premium acquisition expensesfor the 2002 taxable year, IC adds the amount ofpremium acquisition expenses paid during the tax-able year ($1,000) to the increase in unpaidexpenses as shown on the 2002 annual statement($250). The increase in pro forma premium acquisi-tion expenses for the taxable year equals $12.50($62.50 - $50.00 = $12.50). For the 2002 taxableyear, IC’s unearned premium reserve offset amountequals $10 (($250 x .20 = $50) - ($200 x .20 =$40)). Accordingly, IC’s deductible premium acqui-sition expenses for the 2002 taxable year equal$1,260 ($1,000 + 250 +10). The $2.50 of pro forma

premium acquisition expenses which cannot bededucted in 2002 as a result of the limitation in sec-tion 5.02(ii) is added to IC’s pro forma premiumacquisition expenses at the end of the 2003 taxableyear.

(iv) To determine the amount of premium acqui-sition expenses deductible under the safe harbormethod, IC also must apply the annual pro rataexpense limitation of § 1.832–4(a)(5)(vii) withrespect to those insurance policies for which IC col-lected advance premium installments during 2002.For this purpose, IC compares the ratio of theamount of expenses allowable under the safe harbormethod over the total premium acquisition expensesfor the related insurance policies (($62.50 - 2.50 =$60)/$750 = .08) with the ratio of the advance pre-mium installments over the total gross premiumswritten for the related insurance policies ($250/$2,000 = .125). As .08 is less than .125, the amountof premium acquisition expenses determined underthe safe harbor method satisfies the annual pro rataexpense limitation of § 1.832–4(a)(5)(vii).

(v) On its 2002 federal income tax return, ICfollows the general automatic change procedures ofRev. Proc. 2002–9, as modified by this revenue pro-cedure, to change to the safe harbor method. Thischange in method of accounting results in a negative§ 481(a) adjustment of $50, the pro forma acquisi-tion expenses attributable to the $200 of advancepremium installments received by IC for the 2001taxable year. Pursuant to section 5.04 of Rev. Proc.2002–9, as modified by Rev. Proc. 2002–19, ICtakes the $50 negative § 481(a) adjustment intoaccount in one-year in computing its taxable incomefor the taxable year ending December 31, 2002.

SECTION 9. EFFECTIVE DATE

This revenue procedure is effective forchanges in method of deducting premiumacquisition expenses for the taxable yearsending after December 31, 1999.

SECTION 10. EFFECT ON OTHERDOCUMENTS

Rev. Proc. 2002–9 is modified andamplified to include this automaticmethod change in section 5 of theAPPENDIX.

DRAFTING INFORMATION

The principal authors of this revenueprocedure are Gary Geisler and MelissaLuxner of the Office of Associate ChiefCounsel (Financial Institutions & Prod-ucts). For further information regardingthis revenue procedure, contact Ms. Lux-ner at (202) 622–3970 (not a toll-freecall).

July 15, 2002 108 2002–28 I.R.B.

Part IV. Items of General Interest

Notice of ProposedRulemaking by Cross-Reference to TemporaryRegulations.

Modification of Tax ShelterRules III

REG–103735–00;REG–110311–98

AGENCY: Internal Revenue Service(IRS), Treasury.

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

SUMMARY: These proposed rules pro-vide the public with additional guidanceneeded to comply with the disclosurerules under section 6011(a) and the regis-tration requirement under section 6111(d).These rules also affect the list mainte-nance requirement under section 6112.The proposed rules affect taxpayers par-ticipating in certain reportable transac-tions, persons responsible for registeringconfidential corporate tax shelters, andorganizers of potentially abusive tax shel-ters. In the rules and regulations portionof the Federal Register, the IRS is issu-ing temporary regulations (T.D. 9000 onpage 87 of this Bulletin) modifying therules relating to the requirement that cer-tain taxpayers file a statement with theirFederal income tax returns under section6011(a), and the registration of confiden-tial corporate tax shelters under section6111(d). The text of those temporaryregulations also serves as the text of theseproposed regulations.

DATES: Written or electronic commentsand requests for a public hearing must bereceived by September 16, 2002.

ADDRESSES: Send submissions to:CC:ITA:RU (REG–103735–00; REG–110311–98), room 5226, Internal Rev-enue Service, POB 7604, Ben FranklinStation, Washington, DC 20044. Submis-sions may be hand delivered Mondaythrough Friday between the hours of 8a.m. and 5 p.m. to: CC:ITA:RU (REG–103735–00; REG–110311–98), Courier’s

Desk, Internal Revenue Service, 1111Constitution Avenue, NW, Washington,DC. Alternatively, taxpayers may submitelectronic comments directly to the IRSInternet site at www.irs.gov/regs.

FOR FURTHER INFORMATION CON-TACT: Danielle M. Grimm or Tara P.Volungis, 202–622–3080 (not a toll-freenumber); concerning submissions, SonyaCruse, 202–622–7180 (not a toll-freenumber).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information con-tained in this notice of proposed rulemak-ing have been previously reviewed andapproved by the Office of Managementand Budget in accordance with the Paper-work Reduction Act of 1995 (44 U.S.C.3507(d)) under control number 1545–1685.

An agency may not conduct or spon-sor, and a person is not required torespond to, a collection of informationunless it displays a valid control numberassigned by the Office of Managementand Budget.

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

Background

The temporary regulations amend 26CFR part 1 regarding rules relating to thefiling and records requirements for cer-tain taxpayers under section 6011. Thetemporary regulations also amend 26CFR part 301 regarding the registration ofconfidential corporate tax shelters undersection 6111.

The text of the temporary regulationsalso serves as the text of these proposedregulations. The preamble to the tempo-rary regulations explains the regulations.

Special Analyses

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order

12866. Therefore, a regulatory assess-ment is not required. It also has beendetermined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) does not apply to these regula-tions. It is hereby certified that the collec-tion of information in these regulationswill not have a significant economicimpact on a substantial number of smallentities. This certification is based uponthe fact that the time required to prepareor retain the disclosure is minimal andwill not have a significant impact onthose small entities that are required toprovide disclosure. Therefore, a Regula-tory Flexibility Analysis under the Regu-latory Flexibility Act (5 U.S.C. chapter 6)is not required. Pursuant to section7805(f) of the Internal Revenue Code,these temporary regulations will be sub-mitted to the Chief Counsel for Advocacyof the Small Business Administration forcomment on their impact on small busi-ness.

Comments and Requests for a PublicHearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written comments(preferably a signed original and eight (8)copies) or electronically generated com-ments that are submitted timely to theIRS. The IRS and Treasury request com-ments on the clarity of the proposed rulesand how they can be made easier tounderstand. All comments will be avail-able for public inspection and copying. Apublic hearing will be scheduled ifrequested in writing by any person thattimely submits written comments. If apublic hearing is scheduled, notice of thedate, time, and place for the public hear-ing will be published in the Federal Reg-ister.

Drafting Information

The principal authors of these regula-tions are Danielle M. Grimm and Tara P.Volungis, Office of the Associate ChiefCounsel (Passthroughs and Special Indus-tries). However, other personnel from theIRS and Treasury Department partici-pated in their development.

* * * * *

2002–28 I.R.B. 109 July 15, 2002

Proposed Amendments to theRegulations

Accordingly, 26 CFR parts 1 and 301,which were proposed to be amended at 66FR 41133 (August 7, 2001), are proposedto be further 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 * * *Par. 2. Section 1.6011–4, as proposed

at 66 FR 41169 (August 7, 2001), isamended as follows:

1. The heading of § 1.6011–4 isamended by removing the language “cor-porate”.

2. The heading of paragraph (a) isrevised.

3. Paragraph (a) is amended by adding“(1) In general.” after the heading.

4. Newly designated paragraph (a)(1)is amended by adding the language “cor-porate” before “taxpayer” in the first sen-tence, and by removing the second sen-tence and adding three new sentences inits place.

5. Paragraphs (a)(2) and (a)(3) areadded.

6. Paragraph (b)(1) is amended byrevising the first sentence.

7. Paragraphs (b)(1)(i) and (b)(1)(ii)are added.

8. Paragraph (b)(4)(i) is amended byremoving the first sentence.

9. Paragraph (b)(5) Example 3 isamended by revising the seventh sen-tence.

10. Paragraphs (c)(1)(iii) and (c)(1)(v)are revised.

11. Paragraph (c)(2) Example isamended by adding the language“Example.” after “of this section:” in thefirst sentence and by adding “as in effectat that time.” to the end of the third sen-tence.

12. Paragraph (d)(1) is revised.13. Paragraph (e) is amended by

removing the language “corporation’s” inthe first sentence and adding “taxpayer’s”in its place.

14. Paragraph (g) is revised.The revisions and additions read as

follows:

§ 1.6011–4 Requirement of statementdisclosing participation in certaintransactions by taxpayers.

[The text of the amendments to thisproposed section is the same as the text ofthe amendments to § 1.6011–4T pub-lished elsewhere in this issue of the Fed-eral Register.]

PART 301—PROCEDURE ANDADMINISTRATION

Par. 3. The authority citation for part301 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Par. 4. Section 301.6111–2, as pro-

posed to be added at 66 FR 41169(August 7, 2001), is amended as follows:

1. Paragraph (a)(3) is amended by add-ing four sentences to the end of the para-graph.

2. The heading for paragraph (h) isrevised and the entire text after the sec-ond sentence is removed and four newsentences are added in their place.

The revision and additions read as fol-lows:

§ 301.6111–2 Confidential corporate taxshelters.

[The text of the amendments to thisproposed section is the same as the text ofthe amendments to § 301.6111–2T pub-lished elsewhere in this issue of the Fed-eral Register.]

Robert E. Wenzel,Deputy Commissioner

of Internal Revenue.

(Filed by the Office of the Federal Register on June14, 2002, 11:32 a.m., and published in the issue ofthe Federal Register for June 18, 2002, 67 F.R.41362)

Notice of ProposedRulemaking and Notice ofPublic Hearing

Guidance Under Section6050P RegardingCancellation of Indebtedness

REG–107524–00

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemakingand notice of public hearing.

SUMMARY: This document containsproposed regulations relating to the infor-mation reporting requirement under sec-tion 6050P of the Internal Revenue Code(Code) for cancellation of indebtedness.The proposed regulations reflect theenactment of section 6050P(c)(2)(D) bythe Ticket to Work and Work IncentivesImprovement Act of 1999. Section6050P(c)(2)(D) requires organizations asignificant trade or business of which isthe lending of money to report dischargesof indebtedness. The proposed regulationsalso conform the existing regulations tostatutory changes made by the Debt Col-lection Improvement Act of 1996. Inaddition, under the proposed regulations,if an organization that is required toreport under section 6050P (an applicableentity) forms, or avails itself of, someother entity for the principal purpose ofholding loans acquired by the applicableentity, then, for purposes of section6050P, the entity so formed or availed ofis treated as having a significant trade orbusiness of lending money. This docu-ment also provides notice of a publichearing on these proposed regulations.

DATES: Written or electronic commentsmust be received by September 17, 2002.Requests to speak (with outlines of oralcomments) at a public hearing scheduledfor October 8, 2002, at 10:00 a.m., mustbe received by September 17, 2002.

ADDRESSES: Send submissions to:CC:ITA:RU (REG–107524–00), room5226, Internal Revenue Service, POB7604, Ben Franklin Station, Washington,DC 20044. Submissions may be handdelivered Monday through Fridaybetween the hours of 8 a.m. and 5 p.m.to: CC:ITA:RU (REG–107524–00), Cou-rier’s Desk, Internal Revenue Service,1111 Constitution Avenue, NW, Washing-ton, DC. Alternatively, taxpayers maysubmit comments electronically directlyto the IRS Internet site at: www.irs.gov/regs. The public hearing will be held inRoom 4718, Internal Revenue Building,1111 Constitution Avenue, NW, Washing-ton, DC.

FOR FURTHER INFORMATION CON-TACT: Concerning the proposed regula-tions, Donna J. Welch at (202) 622–4910;

July 15, 2002 110 2002–28 I.R.B.

concerning submissions and delivery ofcomments, and the hearing, Treena Gar-rett at (202) 622–7190 (not toll-free num-bers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposedamendments to the Income Tax Regula-tions (26 CFR part 1) defining an organi-zation a significant trade or business ofwhich is the lending of money under sec-t ion 6050P(c)(2)(D). Sect ion6050P(c)(2)(D) was enacted by section553(a) of the Ticket to Work and WorkIncentives Improvement Act of 1999,Public Law No. 106–170, 113 Stat. 1860,1931 (1999) (“the Act”), effective for dis-charges of indebtedness occurring afterDecember 31, 1999. Generally, section6050P(a) requires organizations that aresubject to that section (applicable entities)to file returns with the Service and to pro-vide statements to persons whose namesare required to be shown on the returns(“payees”), setting forth certain informa-tion regarding discharges of indebtednessof $600 or more. Section 553(a) of theAct amended section 6050P of the Codeby expanding the types of entities that arerequired to report discharges of indebted-ness to include any organization “a sig-nificant trade or business of which is thelending of money.” Notice 2000–22,2000–1 C.B. 902, provides that penaltiesunder sections 6721 and 6722 will not beimposed on the lending organizationsnewly required to report discharges ofindebtedness for failures to report dis-charges of indebtedness occurring beforeJanuary 1, 2001. In addition, Notice2001–8, 2001–1 C.B. 374, extended thatsuspension of penalties for failures to fileinformation returns for any discharge ofindebtedness that occurs prior to the firstcalendar year beginning at least twomonths after the date that appropriateguidance is issued.

This document also contains proposedamendments to the Income Tax Regula-tions (26 CFR part 1) conforming theexisting regulations under section 6050Pto statutory changes made by the DebtCollection Improvement Act of 1996.

Explanation of Provisions

Under section 6050P(c)(2)(D), anyorganization “a significant trade or busi-ness of which is the lending of money” isrequired to report discharges of indebted-ness. These proposed regulations provideguidance on when a trade or business isthe lending of money and when that tradeor business is significant. In general, theproposed regulations provide that thelending of money is a significant trade orbusiness if money is lent on a regular andcontinuing basis. The regulations providethree safe harbors under which organiza-tions will not be considered to have a sig-nificant trade or business of lendingmoney. The IRS and the Treasury Depart-ment believe that these safe harbors sat-isfy the information reporting objectivesof the statute while minimizing theadministrative burden on taxpayers.

The first safe harbor applies to organi-zations that were not required to reportunder section 6050P in the previous cal-endar year. Such an organization will beconsidered not to have a significant tradeor business of lending money for the cal-endar year if its gross income from lend-ing money in the most recent test year(the most recent taxable year endingbefore July 1 of the previous calendaryear) is less than both 15 percent of theorganization’s gross income and $5 mil-lion.

The second safe harbor applies toorganizations that were required to reportunder section 6050P for the previous cal-endar year. Such an organization will beconsidered not to have a significant tradeor business of lending money for the cal-endar year if, for each of the three mostrecent test years, its gross income fromlending money is less than both 10 per-cent of the organization’s gross incomeand $3 million. The IRS and the TreasuryDepartment believe that a stricter safeharbor is appropriate for taxpayers thathave been subject to section 6050P in aprior year and, therefore, presumablyhave systems in place to comply with theinformation reporting requirements of thestatute.

The third safe harbor applies to certainnewly formed organizations. Except foran entity that is formed or availed of forthe principal purpose of holding loansacquired by an applicable entity (as

defined in section 6050P), an organiza-tion that does not have a test year is con-sidered not to have a significant trade orbusiness of lending money even if theorganization lends money on a regularand continuing basis. This safe harborand the use of a “test year” in determin-ing whether a taxpayer fits within theother safe harbors provides taxpayerswith some advance notice (i.e., at leastsix months) of whether they will need toestablish systems to track and report dis-charges of indebtedness.

In addition to the safe harbors dis-cussed above, the proposed regulationsprovide a general exception to informa-tion reporting for entities whose principaltrade or business is the sale of nonfinan-cial goods or the provision of nonfinan-cial services. Such entities are not consid-ered to have a significant trade orbusiness of lending money with respect tolending or credit extended in connectionwith the purchase by customers of thosegoods and services. This is consistentwith the legislative history, which indi-cates that, in amending section 6050P,Congress was concerned with credit cardand finance companies. S. Rpt. No. 201,106th Cong., 1st Sess. 28 (1999). TheIRS and the Treasury Department believethat Congress did not mean to extend thereporting requirement to retailers andother entities who extend credit to cus-tomers in connection with the purchase ofnonfinancial goods and services. How-ever, consistent with applying the testsunder section 6050P on an entity-by-entity basis, this exception is not avail-able to a separate financing subsidiary ofsuch a retailer. In addition, if such aretailer is subject to section 6050P regard-less of its accounts receivable, it isrequired to report discharges of indebted-ness of accounts receivable as well asother debt.

The proposed regulations also providethat , for purposes of sect ion6050P(c)(2)(D), lending money includesacquiring a loan, and gross income aris-ing from that loan is gross income fromlending money. Therefore, an organiza-tion that buys and holds loans is treatedas an organization that lends money. Thisis consistent with the temporary regula-tions under section 6050J (relating toinformation returns for acquisitions and

2002–28 I.R.B. 111 July 15, 2002

abandonments of property that is securityfor indebtedness). See § 1.6050J–1T,Q&A–22.

Finally, the proposed regulationsamend § 1.6050P–1 to provide a new ruleapplicable to all entities subject to section6050P, not just those newly made subjectto section 6050P by the 1999 amendment.The current regulations under section6050P (§ 1.6050P–1(e)(2)) contain rulesrespecting the reporting requirements ofdebtors when indebtedness is owned bymore than one creditor. Each creditor thatis an applicable entity is required toreport with respect to any discharge ofindebtedness of $600 or more allocable tothat creditor. For purposes of this rule,indebtedness owned by a partnership istreated as owned by the partners, with theresult that reporting may be required ofthe partners with respect to a cancellationof debt held by the partnership. Rulesrespecting compliance with this pass-through reporting requirement by holdersof interests in certain pass-through securi-tized indebtedness arrangements andREMICs were reserved. § 1.6050P–1(e)(2)(iii) & (iv). The preamble to thoseregulations states that penalties will notbe imposed for nonreporting by holdersof interests in these entities.

Conceivably, an entity that otherwisewould be required to report under section6050P with respect to its debt (forexample, an entity that regularly and con-tinuously lends money and does not meetthe safe harbors of these proposed regula-tions), could transfer debt that it origi-nates to a special purpose subsidiary ortrust in a single transaction. Through thisstructure, the originator could possiblyavoid application of section 6050P byarguing that the reservation of rules in theregulations for pass-through securitizedindebtedness arrangements absolves themof any reporting obligation and that thetransferee entity does not meet therequirements of regular and continuouslending activity.

To address the foregoing concern, theamendment to § 1.6050P–1 by the pro-posed regulations provides that an entityformed or availed of by an applicableentity for the principal purpose of holdingloans acquired or originated by the appli-cable entity is treated as having a signifi-cant trade or business of lending money.Accordingly, the transferee entity itself is

treated as an applicable entity for pur-poses of section 6050P(c)(2)(D). If theentity formed or availed of by the appli-cable entity is a REMIC or a pass-throughsecuritized indebtedness arrangement asdefined in § 1.6050P–1(e)(2)(iii)(B), theREMIC or pass-through securitizedindebtedness arrangement will be treatedas an applicable entity for purposes ofsection 6050P(c)(2)(D), despite the reser-vation in § 1.6050P–1(e)(2)(iii) and (iv)of the application of section 6050P toholders of interests in REMICs and pass-through securitized indebtedness arrange-ments.

Proposed Effective Date

The regulations, as proposed, apply toany discharge of indebtedness occurringin any calendar year beginning at leasttwo months after the date that the finalregulations are published in the FederalRegister. Regardless of when the finalregulations are made effective, the rulesin these proposed regulations may berelied on for prior taxable periods.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined inExecutive Order 12866. Therefore, aregulatory assessment is not required. Ithas also been determined that section553(b) of the Administrative ProcedureAct (5 U.S.C. chapter 5) does not apply tothese regulations, and because the regula-tion does not impose a collection of infor-mation on small entities, the RegulatoryFlexibility Act (5 U.S.C. chapter 6) doesnot apply. The information collection ref-erenced in this proposed rule (Form1099–C) has been previously reviewedand approved by the Office of Manage-ment and Budget under OMB ControlNumber 1545–1424. An agency may notcollect or sponsor the collection of infor-mation unless it displays a valid OMBControl Number. 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 onits impact on small business.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any electronic or writtencomments (a signed original and eight (8)copies) that are submitted timely to theIRS. The IRS and Treasury Departmentrequest comments on the clarity of theproposed rules and how they can be madeeasier to understand. All comments willbe available for public inspection andcopying.

A public hearing has been scheduledfor October 8, 2002, beginning at 10 a.m.in Room 4718 of the Internal RevenueBuilding, 1111 Constitution Avenue, NW,Washington, DC. Because of accessrestrictions, visitors must enter at themain entrance, located at 1111 Constitu-tion Avenue, NW. All visitors mustpresent photo identification to enter thebuilding. Because of access restrictions,visitors will not be admitted beyond theimmediate entrance area more than 30minutes before the hearing starts. Forinformation about having your nameplaced on the building access list toattend the hearing, see the “FOR FUR-THER INFORMATION CONTACT”portion of this preamble.

The rules of 26 CFR 601.601(a)(3)apply to the hearing. Persons who wish topresent oral comments must submit elec-tronic or written comments and an outlineof the topic to be discussed and time to bedevoted to each topic (preferably a signedoriginal and eight (8) copies) by Septem-ber 17, 2002. A period of 10 minutes willbe allotted to each person for makingcomments. An agenda showing the sched-uling of the speakers will be preparedafter the deadline for receiving outlineshas passed. Copies of the agenda will beavailable free of charge at the hearing.

Drafting Information

The principal author of these proposedregulations is Sharon L. Hall, Office ofAssociate Chief Counsel (Income Tax &Accounting). However, other personnelfrom the IRS and Treasury Departmentparticipated in their development.

* * * * *

July 15, 2002 112 2002–28 I.R.B.

Proposed Amendment to theRegulations

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

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *Section 1.6050P–1 and 1.6050P–2 also

issued under 26 U.S.C. 6050P. * * *Par. 2. Section 1.6050P–0 is amended

as follows:1. The introductory text is amended by

adding the language “and § 1.6050P–2”immediately after the language“§ 1.6050P–1”.

2. The heading for § 1.6050P–1 isamended by removing the word “finan-cial”.

3. The entry for § 1.6050P–1(e)(2)(v)is added.

4. The entries for §§ 1.6050P–1(e)(5)through (e)(8) are redesignated as entriesfor §§ 1.6050P–1(e)(6) through (e)(9) anda new entry for § 1.6050P–1(e)(5) isadded.

5. The entries for § 1.6050P–2 areadded.

The additions read as follows:

§ 1.6050P–0 Table of Contents.

* * * * *

§ 1.6050P–1 Information reporting fordischarges of indebtedness for certainentities.

*****(e)***(2)***(v) No double reporting.

*****(5) Entity formed or availed of to holdindebtedness.

*****

§ 1.6050P–2 Organizations a significanttrade or business of which is the lendingof money.

(a) In general.(b) Safe harbors.(1) Organizations not subject to section6050P in the previous calendar year.

(2) Safe harbor for organizations thatwere subject to section 6050P in the pre-vious calendar year.(3) No test year.(c) Seller financing.(d) Gross income from lending of money.(e) Acquisition of indebtedness by subse-quent holder.(f) Test year.(g) Predecessor organization.(h) Examples.(i) Effective date.

Par. 3. Section 1.6050P–1 is amendedas follows:

1. The heading for § 1.6050P–1 isamended by removing the word “finan-cial”.

2. Paragraphs (a)(1), (b)(2)(i)(F), (c),(e)(2)(i), (e)(3), (e)(7), (f)(1) introductorytext, (f)(1)(ii) and (f)(2) are amended byremoving the word “financial”.

3. The first sentence of paragraph (c)is amended by adding “and section1.6050P–2” immediately after the word“section”.

4. Paragraph (e)(2)(v) is added.5. Paragraph (e)(4) is amended by

removing “6050P(c)(1)(A)” each time itappears and adding “6050P(c)(2)(A)” ini ts place and by removing“6050P(c)(1)(C)” and adding“6050P(c)(2)(C)” in its place.

6. Paragraphs(e)(5) through (e)(8) areredesignated as (e)(6) through (e)(9) anda new paragraph (e)(5) is added.

7. Paragraph (e)(7)(i), as redesignated,is amended by removing “(e)(6)” where itappears and adding “(e)(7)” and para-graph (e)(7)(ii), as redesignated, isamended by removing “(e)(6)(i)” where itappears and adding “(e)(7)(i)” in itsplace.

8. Paragraph (h)(1) is amended by add-ing “and, except paragraph (e)(5) of thissection, which applies to discharges ofindebtedness occurring in any calendaryear beginning at least two months afterthe date that the final regulations are pub-lished in the Federal Register.”, immedi-ately after the language “1994”.

The additions read as follows:

§ 1.6050P–1 Information reporting fordischarges of indebtedness by certainentities.

*****(e)***(2)***

(v) No double reporting. If multiplecreditors are considered to hold interestsin an indebtedness under paragraph (e)(2)of this section, and an entity is required toreport a discharge of that indebtednessunder paragraph (e)(5) of this section,then such multiple creditors are notrequired to report the discharge of indebt-edness.

*****(5) Entity formed or availed of to hold

indebtedness. Notwithstanding § 1.6050P–2(b)(3), if an entity (the transfereeentity) is formed or availed of by anapplicable entity (within the meaning ofsection 6050P(c)(1)) for the principal pur-pose of holding indebtedness acquired(including originated) by the applicableentity, then, for purposes of section6050P(c)(2)(D), the transferee entity hasa significant trade or business of lendingmoney.

*****Par. 4. A new § 1.6050P–2 is added as

follows:

§ 1.6050P–2 Organization a significanttrade or business of which is the lendingof money.

(a) In general. For purposes of section6050P(c)(2)(D), the lending of money is asignificant trade or business of an organi-zation in a calendar year if the organiza-tion lends money on a regular and con-tinuing basis during the calendar year.

(b) Safe harbors—(1) Organizationsnot subject to section 6050P in the previ-ous calendar year. For an organizationthat was not required to report under sec-tion 6050P in the previous calendar year,the lending of money will not be treatedas a significant trade or business for thecalendar year in which the lending occursif gross income from lending money inthe organization’s most recent test year(as defined in paragraph (f) of this sec-tion) is both less than $5 million and lessthan 15 percent of the organization’sgross income for that test year.

(2) Organizations that were subject tosection 6050P in the previous calendaryear. For an organization that wasrequired to report under section 6050P forthe previous calendar year, the lending ofmoney will not be treated as a significanttrade or business for the calendar year inwhich the lending occurs if gross income

2002–28 I.R.B. 113 July 15, 2002

from lending money in each of the orga-nization’s three most recent test years isboth less than $3 million and less than 10percent of the organization’s grossincome for that test year.

(3) No test year. The lending of moneywill not be treated as a significant trade orbusiness for an organization for the calen-dar year in which the lending occurs ifthe organization does not have a test yearfor that calendar year.

(c) Seller financing. If the principaltrade or business of an organization isselling nonfinancial goods or providingnonfinancial services and if the organiza-tion extends credit to the purchasers ofthose goods or services in order tofinance the purchases, then, for purposesof section 6050P(c)(2)(D), these exten-sions of credit are not a significant tradeor business of lending money.

(d) Gross income from lending ofmoney. For purposes of this section, grossincome from lending of money includesincome from interest, fees, penalties, mer-chant discount, interchange and gainsarising from the sale of an indebtedness.

(e) Acquisition of indebtedness by sub-sequent holder. For purposes of this sec-tion, lending money includes acquiring anindebtedness, and gross income arisingfrom such an acquired indebtedness istreated as gross income from lendingmoney, without regard to whether theindebtedness was originated by either anapplicable entity or a related party.

(f) Test year. For any calendar year, atest year is a taxable year of the organiza-tion that ends before July 1 of the previ-ous calendar year.

(g) Predecessor organization. If anorganization acquires substantially all ofthe property that was used in a trade orbusiness of some other organization (thepredecessor) (including when two ormore corporations are parties to a mergeragreement under which the surviving cor-poration becomes the owner of all theassets and assumes all the liabilities of theabsorbed corporations(s)) or was used ina separate unit of the predecessor, thenwhether the organization at issue qualifiesfor one of the safe harbors in paragraph(b) of this section is determined by alsotaking into account the test years, report-ing obligations, and gross income of thepredecessor.

(h) Examples. The rules of this sectionare illustrated by the following examples.

Example 1. Finance Company A, a calendar yeartaxpayer, was formed in Year 1 as a non-bank sub-sidiary of Manufacturing Company and has no pre-decessor. A lends money to purchasers of Manufac-turing Company’s products on a regular andcontinuing basis to finance the purchase of thoseproducts. A’s gross income from interest in Year 1 is$4.7 million. A’s gross income from fees and penal-ties related to the lending activity in Year 1 is $.5million. Section 6050P does not require A to reportdischarges of indebtedness occurring in Years 1 or 2,because A has no test year for those years. Notwith-standing that A lends money in those years on aregular and continuing basis, under paragraph (b)(3)of this section, A does not have a significant trade orbusiness of lending money in those years for pur-poses of section 6050P(c)(2)(D). However, for Year3, A’s test year is Year 1. A’s gross income fromlending in Year 1 is not less than $5 million for pur-poses of the applicable safe harbor of paragraph(b)(1) of this section. Because A lends money on aregular and continuing basis and does not meet theapplicable safe harbor, section 6050P requires A toreport discharges of indebtedness occurring in Year3.

Example 2. The facts are the same as in Example1, except that A is a division of ManufacturingCompany, rather than a separate subsidiary. Manu-facturing Company’s principal activity is the manu-facture and sale of non-financial products, and otherthan financing the purchase of those products Manu-facturing Company does not extend credit or other-wise lend money. Accordingly, under paragraph (c)of this section, that financing activity is not a sig-nificant trade or business of lending money for pur-poses of section 6050P(c)(2)(D), and section 6050Pdoes not require Manufacturing Company to reportdischarges of indebtedness.

Example 3. Company B, a calendar year tax-payer, is formed in Year 1. B has no predecessor anda part of its activities consists of the lending ofmoney. B packages and sells part of the indebted-ness it originates and holds the remainder. B isengaged in these activities on a regular and continu-ing basis. For Year 1, B’s gross income from salesof the indebtedness, combined with interest income,fees, and penalties related to the lending activity isonly $4.8 million, but it is 16% of B’s gross incomein Year 1. Because B lends money on a regular andcontinuing basis and does not meet the applicablesafe harbor of paragraph (b)(1) of this section, sec-tion 6050P requires B to report discharges of indebt-edness occurring in Year 3. B is not required toreport discharges of indebtedness in years 1 and 2because B has no test year for years 1 and 2.

Example 4. The facts are the same as in Example3. In addition, in each of Years 2, 3, and 4, B’s grossincome from sales of the indebtedness combinedwith interest income, fees, and penalties related tothe lending activity is less than both $3 million and10% of B’s gross income. Because B was requiredto report under section 6050P for Year 3, the appli-cable safe harbor for Year 4 is paragraph (b)(2) ofthis section, which is satisfied only if B’s grossincome from lending activities for each of the threemost recent test years is less than both $3 millionand 10% of B’s gross income. For Year 4, eventhough B has only two test years, B’s gross income

in one of those test years, Year 1, causes B to fail tomeet this safe harbor. Accordingly, B is required toreport discharges of indebtedness under section6050P in Year 4. For Year 5, B’s three most recenttest years are Years 1, 2, and 3. However, B’s grossincome from lending activities in Year 1 is not lessthan $3 million and 10% of B’s gross income.Accordingly, section 6050P requires B to report dis-charges of indebtedness in Year 5. For Year 6, Bsatisfies the applicable safe harbor requirements ofparagraph (b)(2) for each of the three most recenttest years (Years 2, 3, and 4). Therefore, section6050P does not require B to report discharges ofindebtedness in Year 6. Because B is not required toreport for Year 6, the applicable safe harbor for Year7 is the one contained in paragraph (b)(1) of thissection, and thus the only relevant test year is year5.

(i) Effective date. This section is effec-tive for discharges of indebtedness occur-ring in any calendar year beginning atleast two months after the date that thefinal regulations are published in the Fed-eral Register.

Robert E. Wenzel,Deputy Commissioner

of Internal Revenue.

(Filed by the Office of the Federal Register on June12, 2002, 8:45 a.m., and published in the issue ofthe Federal Register for June 13, 2002, 67 F.R.40629)

Section 7428(c) Validation ofCertain Contributions MadeDuring Pendency ofDeclaratory JudgmentProceedings

This announcement serves notice topotential donors that the organizationlisted below has recently filed timelydeclaratory judgment suit under section7428 of the Code, challenging revocationof it’s status as an eligible donee undersection 170(c)(2).

Protection under section 7428(c) of theCode begins on the date that the notice ofrevocation is published in the InternalRevenue Bulletin and ends on the date onwhich a court first determines that anorganization is not described in section170(c)(2), as more particularly set forth insection 7428(c)(1). In the case of indi-vidual contributors, the maximum amountof contributions protected during thisperiod is limited to $1,000.00, with a hus-band and wife being treated as one con-tributor. This protection is not extended toany individual who was responsible, inwhole or in part, for the acts or omissions

July 15, 2002 114 2002–28 I.R.B.

of the organization that were the basis forthe revocation. This protection alsoapplies (but without limitation as toamount) to organizations described insection 170(c)(2) which are exempt fromtax under section 501(a). If the organiza-tion ultimately prevails in its declaratoryjudgment suit, deductibility of contribu-tions would be subject to the normal limi-tations set forth under section 170.

T. L. C. EnvironmentalEncinitas, CA

2002–28 I.R.B. 115 July 15, 2002

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.—Intemal 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.

July 15, 2002 i 2002–28 I.R.B.

Numerical Finding List1

Bulletin 2002–26 and 2002–27

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. 72

Notices:

2002–42, 2002–27 I.R.B. 362002–43, 2002–27 I.R.B. 382002–44, 2002–27 I.R.B. 39

Proposed Regulations:

REG–248110–96, 2002–26 I.R.B. 19REG–103823–99, 2002–27 I.R.B. 44REG–103829–99, 2002–27 I.R.B. 59REG–106457–00, 2002–26 I.R.B. 23REG–115285–01, 2002–27 I.R.B. 62REG–126024–01, 2002–27 I.R.B. 64REG–122564–02, 2002–26 I.R.B. 25REG–123305–02, 2002–26 I.R.B. 26

Revenue Procedures:

2002–44, 2002–26 I.R.B. 102002–45, 2002–27 I.R.B. 40

Revenue Rulings:

2002–38, 2002–26 I.R.B. 42002–39, 2002–27 I.R.B. 332002–40, 2002–27 I.R.B. 30

Treasury Decisions:

8997, 2002–26 I.R.B. 68998, 2002–26 I.R.B. 1

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.

2002–28 I.R.B. ii July 15, 2002

Finding List of Current Actionson Previously Published Items1

Bulletin 2002–26 and 2002–27

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

Revenue Procedures:

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

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.

July 15, 2002 iii 2002–28 I.R.B.