bulletin no. 2005-24 highlights of this issue · bulletin no. 2005-24 june 13, 2005 highlights of...

Bulletin No. 2005-24June 13, 2005

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. 2005–35, page 1214.Interest rates; underpayments and overpayments. Therate of interest determined under section 6621 of the Codefor the calendar quarter beginning July 1, 2005, will be 6 per-cent for overpayments (5 percent in the case of a corporation),6 percent for underpayments, and 8 percent for large corpo-rate underpayments. The rate of interest paid on the portion ofa corporate overpayment exceeding $10,000 will be 3.5 per-cent.

T.D. 9202, page 1213.Final regulations under section 1031 of the Code replace theStandard Industrial Classification (SIC) system of codes withthe North American Industry Classification System (NAICS) forpurposes of determining what depreciable tangible personalproperty is like-kind to other property.

REG–100420–03, page 1236.Proposed regulations under section 475 of the Code set forthan elective safe harbor for dealers in securities and/or com-modities and traders in securities and commodities that per-mits these taxpayers to make an election pursuant to whichthe values of the positions reported on certain financial state-ments are the fair market values of those positions. The safeharbor is based upon the principle that if the mark-to-marketmethod used for financial reporting is sufficiently consistentwith the mark-to-market method required by section 475, thenthe values used for financial reporting should be acceptable val-ues for purposes of section 475, even if those values are notfair market values under general tax principles. To ensure min-imal divergence from fair market values under tax principles,the regulations impose certain restrictions on the financial ac-counting methods and statements that are eligible for the safe

harbor and may require certain adjustments to values used inthe safe harbor. This safe harbor attempts to reduce the com-pliance burden upon taxpayers and to improve the administra-bility of valuations for the IRS. A public hearing is scheduled forSeptember 15, 2005.

REG–105346–03, page 1244.Proposed regulations under section 83 of the Code withdrawthe remaining portion of the notice of proposed rulemaking pub-lished in the Federal Register on June 3, 1971 (36 FR 10787)and contain proposed regulations relating to the tax treatmentof certain transfers of partnership equity in connection withthe performance of services. The regulations provide that thetransfer of a partnership interest in connection with the perfor-mance of services is subject to section 83 and provide rulesfor coordinating section 83 with partnership taxation principles.The regulations also provide that no gain or loss is recognizedby a partnership on the transfer or vesting of an interest in thetransferring partnership in connection with the performance ofservices for the transferring partnership. A public hearing isscheduled for October 5, 2005.

REG–127740–04, page 1254.Proposed regulations under sections 367(a) and (b) of the Coderelate to certain transfers of stock involving foreign corpora-tions pursuant to section 304(a)(1).

Notice 2005–43, page 1221.This notice includes a proposed revenue procedure providingadditional rules for the elective safe harbor under the proposedregulations under section 83 of the Code governing the appli-cation of section 83 to the transfer of a partnership interest inconnection with the performance of services.

(Continued on the next page)

Finding Lists begin on page ii.

Notice 2005–45, page 1228.Deductions for entertainment use of aircraft. This noticeprovides interim guidance to taxpayers on the limitation undersection 274(e) of the Code on the deductible amount of tradeor business expenses incurred after October 22, 2004, for useof a business aircraft for entertainment.

ESTATE TAX

Rev. Proc. 2005–33, page 1231.This procedure provides guidance on exhausting administrativeremedies prior to seeking a declaratory judgment pursuant tosection 7479 of the Code.

EMPLOYMENT TAX

Rev. Proc. 2005–34, page 1233.This procedure sets forth updated procedures for appeals ofproposed trust fund recovery penalty assessments arising un-der section 6672 of the Code. The procedures apply to trustfund recovery penalty cases relating to employment and ex-cise taxes imposed under the Code, except when collection isin jeopardy. Rev. Proc. 84–78 superseded.

EXCISE TAX


ADMINISTRATIVE

REG–100420–03, page 1236.Proposed regulations under section 475 of the Code set forthan elective safe harbor for dealers in securities and/or com-modities and traders in securities and commodities that per-mits these taxpayers to make an election pursuant to whichthe values of the positions reported on certain financial state-ments are the fair market values of those positions. The safeharbor is based upon the principle that if the mark-to-marketmethod used for financial reporting is sufficiently consistentwith the mark-to-market method required by section 475, thenthe values used for financial reporting should be acceptable val-ues for purposes of section 475, even if those values are notfair market values under general tax principles. To ensure min-imal divergence from fair market values under tax principles,the regulations impose certain restrictions on the financial ac-

counting methods and statements that are eligible for the safeharbor and may require certain adjustments to values used inthe safe harbor. This safe harbor attempts to reduce the com-pliance burden upon taxpayers and to improve the administra-bility of valuations for the IRS. A public hearing is scheduled forSeptember 15, 2005.

Rev. Proc. 2005–33, page 1231.This procedure provides guidance on exhausting administrativeremedies prior to seeking a declaratory judgment pursuant tosection 7479 of the Code.


Announcement 2005–42, page 1257.This announcement contains the annual report concerning thePre-Filing Agreement program of the Large and Mid-Size Busi-ness Division of the Service for Calendar Year 2004.

June 13, 2005 2005–24 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 compiled semiannually into Cumulative Bulletins,which are sold on a single-copy basis.

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

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

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

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

The Bulletin is divided into four parts as follows:

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

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

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

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

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

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

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

2005–24 I.R.B. June 13, 2005

Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 1031.—Exchangeof Property Held forProductive Use orInvestment26 CFR 1.1031(a)–2: Additional rules for exchangesof personal property.

T.D. 9202

DEPARTMENT OFTHE TREASURYInternal Revenue Service26 CFR Part 1

Additional Rules forExchanges of PersonalProperty under Section1031(a)

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations and removalof temporary regulations.

SUMMARY: This document contains finalregulations that replace the use of the Stan-dard Industrial Classification (SIC) systemwith the North American Industry Clas-sification System (NAICS) for determin-ing what properties are of a like class forpurposes of section 1031 of the InternalRevenue Code (Code). The regulations af-fect taxpayers that engage in like-kind ex-changes of depreciable tangible personalproperty.

DATES: Effective Date: These regulationsare effective May 19, 2005.

Applicability Dates: For dates of appli-cability, see §1.1031(a)–2(d).

FOR FURTHER INFORMATIONCONTACT: J. Peter Baumgarten, (202)622–4920 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendmentsto 26 CFR Part 1. On August 13, 2004,the IRS and Treasury Department pub-lished in the Federal Register a notice of

proposed rulemaking (REG–116265–04,2004–38 I.R.B. 501 [69 FR 50108]) bycross reference to temporary regulations(T.D. 9151, 2004–38 I.R.B. 489 [69 FR50067]) under section 1031(a). Theseamendments relate to the transition fromthe use of the four-digit codes under theSIC system to the six-digit NAICS for de-termining product classes of depreciabletangible personal property exchanged un-der section 1031. No written or electroniccomments in response to the proposedregulations or requests to speak at a publichearing were received, and no hearingwas held. The proposed regulations undersection 1031 are adopted by this Treasurydecision, and the temporary regulationsare removed.

Effective Date

These final regulations apply to trans-fers of property made by taxpayers on orafter August 12, 2004. However, taxpay-ers may apply the regulations to transfersof property made by taxpayers on or afterJanuary 1, 1997, in taxable years for whichthe period of limitation for filing a claimfor refund or credit under section 6511 hasnot expired. Additionally, taxpayers maytreat properties within the same productclasses under a 4-digit SIC code as prop-erties of like class for transfers of propertymade by taxpayers on or before May 19,2005.

Special Analysis

It has been determined that these fi-nal regulations are not a significant regu-latory action as defined in Executive Or-der 12866. Therefore, a regulatory assess-ment is not required. It also has been de-termined that section 553(b) of the Admin-istrative Procedure Act (5 U.S.C. chapter5) does not apply to these regulations, and,because the regulations do not impose acollection of information on small entities,the Regulatory Flexibility Act (5 U.S.C.chapter 6) does not apply. Pursuant to sec-tion 7805(f) of the Code, the notice of pro-posed rulemaking that preceded these reg-ulations was submitted to the Chief Coun-sel for Advocacy of the Small Business

Administration for comment on its impacton small business.

Drafting Information

The principal author of these final regu-lations is J. Peter Baumgarten of the Officeof the Associate Chief Counsel (IncomeTax and Accounting). However, other per-sonnel from the IRS and Treasury Depart-ment participated in their development.

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 is amendedas follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805. * * *Par. 2. Section 1.1031(a)–2 is amended

by:1. Revising paragraphs (b)(3) through

(b)(6), Example 3 and Example 4 of para-graph (b)(7), and paragraph (d).

2. Adding paragraph (b)(8).The revisions and addition read as fol-

lows.

§1.1031(a)–2 Additional rules forexchanges of personal property.

* * * * *(b)* * *(3) Product classes. Except as provided

in paragraphs (b)(4) and (5) of this sec-tion, or as provided by the Commissionerin published guidance of general applica-bility, property within a product class con-sists of depreciable tangible personal prop-erty that is described in a 6-digit prod-uct class within Sectors 31, 32, and 33(pertaining to manufacturing industries) ofthe North American Industry Classifica-tion System (NAICS), set forth in Exec-utive Office of the President, Office ofManagement and Budget, North Ameri-can Industry Classification System, UnitedStates, 2002 (NAICS Manual), as peri-odically updated. Copies of the NAICSManual may be obtained from the National

2005–24 I.R.B. 1213 June 13, 2005

Technical Information Service, an agencyof the U.S. Department of Commerce, andmay be accessed on the internet. Sectors31 through 33 of the NAICS Manual con-tain listings of specialized industries forthe manufacture of described products andequipment. For this purpose, any 6-digitNAICS product class with a last digit of 9(a miscellaneous category) is not a prod-uct class for purposes of this section. If aproperty is listed in more than one prod-uct class, the property is treated as listed inany one of those product classes. A prop-erty’s 6-digit product class is referred to asthe property’s NAICS code.

(4) Modifications of NAICS productclasses. The product classes of the NAICSManual may be updated or otherwise mod-ified from time to time as the manual isupdated, effective on or after the date ofthe modification. The NAICS Manualgenerally is modified every five years, inyears ending in a 2 or 7 (such as 2002,2007, and 2012). The applicability date ofthe modified NAICS Manual is announcedin the Federal Register and generally isJanuary 1 of the year the NAICS Manualis modified. Taxpayers may rely on thesemodifications as they become effectivein structuring exchanges under this sec-tion. Taxpayers may rely on the previousNAICS Manual for transfers of propertymade by a taxpayer during the one-yearperiod following the effective date of themodification. For transfers of propertymade by a taxpayer on or after January 1,1997, and on or before January 1, 2003,the NAICS Manual of 1997 may be usedfor determining product classes of the ex-changed property.

(5) Administrative procedures for re-vising general asset classes and productclasses. The Commissioner may, throughpublished guidance of general applicabil-ity, supplement, modify, clarify, or updatethe guidance relating to the classificationof properties provided in this paragraph(b). (See §601.601(d)(2) of this chapter.)For example, the Commissioner may de-termine not to follow (in whole or in part)a general asset class for purposes of iden-tifying property of like class, may deter-mine not to follow (in whole or in part)any modification of product classes pub-lished in the NAICS Manual, or may deter-mine that other properties not listed withinthe same or in any product class or gen-eral asset class nevertheless are of a like

class. The Commissioner also may de-termine that two items of property thatare listed in separate product classes or inproduct classes with a last digit of 9 areof a like class, or that an item of propertythat has a NAICS code is of a like classto an item of property that does not have aNAICS code.

(6) No inference outside of section1031. The rules provided in this sectionconcerning the use of general asset classesor product classes are limited to exchangesunder section 1031. No inference is in-tended with respect to the classificationof property for other purposes, such asdepreciation.

(7) Examples. * * *

* * * * *Example 3. Taxpayer E transfers a grader to F in

exchange for a scraper. Neither property is within anyof the general asset classes. However, both proper-ties are within the same product class (NAICS code333120). The grader and scraper are of a like classand deemed to be of a like kind for purposes of sec-tion 1031.

Example 4. Taxpayer G transfers a personalcomputer (asset class 00.12), an airplane (asset class00.21) and a sanding machine (NAICS code 333210),to H in exchange for a printer (asset class 00.12), aheavy general purpose truck (asset class 00.242) anda lathe (NAICS code 333210). The personal com-puter and the printer are of a like class because theyare within the same general asset class. The sandingmachine and the lathe are of a like class because theyare within the same product class (although neitherproperty is within any of the general asset classes).The airplane and the heavy general purpose truck areneither within the same general asset class nor withinthe same product class, and are not of a like kind.

(8) Transition rule. Properties withinthe same product classes based on the4-digit codes contained in Division D ofthe Executive Office of the President, Of-fice of Management and Budget, StandardIndustrial Classification Manual (1987),will be treated as property of a like classfor transfers of property made by taxpay-ers on or before May 19, 2005.

* * * * *(d) Effective date. Except as otherwise

provided in this paragraph (d), this sectionapplies to exchanges occurring on or afterApril 11, 1991. Paragraphs (b)(3) through(b)(6), Example 3 and Example 4 of para-graph (b)(7), and paragraph (b)(8) of thissection apply to transfers of property madeby taxpayers on or after August 12, 2004.However, taxpayers may apply paragraphs(b)(3) through (b)(6), and Example 3 andExample 4 of paragraph (b)(7) of this sec-

tion to transfers of property made by tax-payers on or after January 1, 1997, in tax-able years for which the period of limita-tion for filing a claim for refund or creditunder section 6511 has not expired.

§1.1031(a)–2T [Removed]

Par. 3. Section 1.1031(a)–2T is re-moved.

§1.1031(j)–1 [Amended]

Par. 4. Section 1.1031(j)–1(d) isamended by removing the language “(SICCode 3531)” in Example 3(ii)(C) andExample 5(i) and adding “(NAICS code333120)” in its place.

Cono R. Namorato,Acting Deputy Commissioner for

Services and Enforcement.

Approved May 12, 2005.

Eric Solomon,Acting Deputy Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on May 18, 2005,8:45 a.m., and published in the issue of the Federal Registerfor May 19, 2005, 70 F.R. 28818)

Section 6621.—Determina-tion of Rate of Interest26 CFR 301.6621–1: Interest rate.

Interest rates; underpayments andoverpayments. The rate of interest de-termined under section 6621 of the Codefor the calendar quarter beginning July 1,2005, will be 6 percent for overpayments(5 percent in the case of a corporation), 6percent for underpayments, and 8 percentfor large corporate underpayments. Therate of interest paid on the portion of acorporate overpayment exceeding $10,000will be 3.5 percent.

Rev. Rul. 2005–35

Section 6621 of the Internal RevenueCode establishes the rates for intereston tax overpayments and tax underpay-ments. Under section 6621(a)(1), theoverpayment rate is the sum of the federalshort-term rate plus 3 percentage points (2percentage points in the case of a corpo-ration), except the rate for the portion ofa corporate overpayment of tax exceeding

June 13, 2005 1214 2005–24 I.R.B.

$10,000 for a taxable period is the sum ofthe federal short-term rate plus 0.5 of apercentage point for interest computationsmade after December 31, 1994. Undersection 6621(a)(2), the underpayment rateis the sum of the federal short-term rateplus 3 percentage points.

Section 6621(c) provides that for pur-poses of interest payable under section6601 on any large corporate underpay-ment, the underpayment rate under section6621(a)(2) is determined by substituting“5 percentage points” for “3 percentagepoints.” See section 6621(c) and section301.6621–3 of the Regulations on Proce-dure and Administration for the definitionof a large corporate underpayment andfor the rules for determining the appli-cable date. Section 6621(c) and section301.6621–3 are generally effective forperiods after December 31, 1990.

Section 6621(b)(1) provides that theSecretary will determine the federalshort-term rate for the first month in eachcalendar quarter.

Section 6621(b)(2)(A) provides that thefederal short-term rate determined undersection 6621(b)(1) for any month applies

during the first calendar quarter beginningafter such month.

Section 6621(b)(3) provides that thefederal short-term rate for any month isthe federal short-term rate determinedduring such month by the Secretary inaccordance with § 1274(d), rounded to thenearest full percent (or, if a multiple of 1/2

of 1 percent, the rate is increased to thenext highest full percent).

Notice 88–59, 1988–1 C.B. 546, an-nounced that, in determining the quarterlyinterest rates to be used for overpaymentsand underpayments of tax under section6621, the Internal Revenue Service willuse the federal short-term rate based ondaily compounding because that rate ismost consistent with section 6621 which,pursuant to section 6622, is subject to dailycompounding.

Rounded to the nearest full percent, thefederal short-term rate based on daily com-pounding determined during the month ofApril 2005 is 3 percent. Accordingly, anoverpayment rate of 6 percent (5 percentin the case of a corporation) and an under-payment rate of 6 percent are establishedfor the calendar quarter beginning July 1,

2005. The overpayment rate for the por-tion of a corporate overpayment exceeding$10,000 for the calendar quarter beginningJuly 1, 2005, is 3.5 percent. The under-payment rate for large corporate underpay-ments for the calendar quarter beginningJuly 1, 2005, is 8 percent. These rates ap-ply to amounts bearing interest during thatcalendar quarter.

Interest factors for daily compound in-terest for annual rates of 3.5 percent, 5 per-cent, 6 percent, and 8 percent are publishedin Tables 12, 15, 17, and 21 of Rev. Proc.95–17, 1995–1 C.B. 556, 566, 569, 571,and 575.

Annual interest rates to be compoundeddaily pursuant to section 6622 that applyfor prior periods are set forth in the tablesaccompanying this revenue ruling.

DRAFTING INFORMATION

The principal author of this revenue rul-ing is Crystal Foster of the Office of Asso-ciate Chief Counsel (Procedure & Admin-istration). For further information regard-ing this revenue ruling, contact Ms. Fosterat (202) 622–7198 (not a toll-free call).

TABLE OF INTEREST RATES

PERIODS BEFORE JUL. 1, 1975 — PERIODS ENDING DEC. 31, 1986

OVERPAYMENTS AND UNDERPAYMENTS

PERIOD RATEIn 1995–1 C.B.

DAILY RATE TABLE

Before Jul. 1, 1975 6% Table 2, pg. 557Jul. 1, 1975—Jan. 31, 1976 9% Table 4, pg. 559Feb. 1, 1976—Jan. 31, 1978 7% Table 3, pg. 558Feb. 1, 1978—Jan. 31, 1980 6% Table 2, pg. 557Feb. 1, 1980—Jan. 31, 1982 12% Table 5, pg. 560Feb. 1, 1982—Dec. 31, 1982 20% Table 6, pg. 560Jan. 1, 1983—Jun. 30, 1983 16% Table 37, pg. 591Jul. 1, 1983—Dec. 31, 1983 11% Table 27, pg. 581Jan. 1, 1984—Jun. 30, 1984 11% Table 75, pg. 629Jul. 1, 1984—Dec. 31, 1984 11% Table 75, pg. 629Jan. 1, 1985—Jun. 30, 1985 13% Table 31, pg. 585Jul. 1, 1985—Dec. 31, 1985 11% Table 27, pg. 581Jan. 1, 1986—Jun. 30, 1986 10% Table 25, pg. 579Jul. 1, 1986—Dec. 31, 1986 9% Table 23, pg. 577

2005–24 I.R.B. 1215 June 13, 2005


FROM JAN. 1, 1987 — Dec. 31, 1998

OVERPAYMENTS UNDERPAYMENTS

1995–1 C.B. 1995–1 C.B.RATE TABLE PG RATE TABLE PG

Jan. 1, 1987—Mar. 31, 1987 8% 21 575 9% 23 577Apr. 1, 1987—Jun. 30, 1987 8% 21 575 9% 23 577Jul. 1, 1987—Sep. 30, 1987 8% 21 575 9% 23 577Oct. 1, 1987—Dec. 31, 1987 9% 23 577 10% 25 579Jan. 1, 1988—Mar. 31, 1988 10% 73 627 11% 75 629Apr. 1, 1988—Jun. 30, 1988 9% 71 625 10% 73 627Jul. 1, 1988—Sep. 30, 1988 9% 71 625 10% 73 627Oct. 1, 1988—Dec. 31, 1988 10% 73 627 11% 75 629Jan. 1, 1989—Mar. 31, 1989 10% 25 579 11% 27 581Apr. 1, 1989—Jun. 30, 1989 11% 27 581 12% 29 583Jul. 1, 1989—Sep. 30, 1989 11% 27 581 12% 29 583Oct. 1, 1989—Dec. 31, 1989 10% 25 579 11% 27 581Jan. 1, 1990—Mar. 31, 1990 10% 25 579 11% 27 581Apr. 1, 1990—Jun. 30, 1990 10% 25 579 11% 27 581Jul. 1, 1990—Sep. 30, 1990 10% 25 579 11% 27 581Oct. 1, 1990—Dec. 31, 1990 10% 25 579 11% 27 581Jan. 1, 1991—Mar. 31, 1991 10% 25 579 11% 27 581Apr. 1, 1991—Jun. 30, 1991 9% 23 577 10% 25 579Jul. 1, 1991—Sep. 30, 1991 9% 23 577 10% 25 579Oct. 1, 1991—Dec. 31, 1991 9% 23 577 10% 25 579Jan. 1, 1992—Mar. 31, 1992 8% 69 623 9% 71 625Apr. 1, 1992—Jun. 30, 1992 7% 67 621 8% 69 623Jul. 1, 1992—Sep. 30, 1992 7% 67 621 8% 69 623Oct. 1, 1992—Dec. 31, 1992 6% 65 619 7% 67 621Jan. 1, 1993—Mar. 31, 1993 6% 17 571 7% 19 573Apr. 1, 1993—Jun. 30, 1993 6% 17 571 7% 19 573Jul. 1, 1993—Sep. 30, 1993 6% 17 571 7% 19 573Oct. 1, 1993—Dec. 31, 1993 6% 17 571 7% 19 573Jan. 1, 1994—Mar. 31, 1994 6% 17 571 7% 19 573Apr. 1, 1994—Jun. 30, 1994 6% 17 571 7% 19 573Jul. 1, 1994—Sep. 30, 1994 7% 19 573 8% 21 575Oct. 1, 1994—Dec. 31, 1994 8% 21 575 9% 23 577Jan. 1, 1995—Mar. 31, 1995 8% 21 575 9% 23 577Apr. 1, 1995—Jun. 30, 1995 9% 23 577 10% 25 579Jul. 1, 1995—Sep. 30, 1995 8% 21 575 9% 23 577Oct. 1, 1995—Dec. 31, 1995 8% 21 575 9% 23 577Jan. 1, 1996—Mar. 31, 1996 8% 69 623 9% 71 625Apr. 1, 1996—Jun. 30, 1996 7% 67 621 8% 69 623Jul. 1, 1996—Sep. 30, 1996 8% 69 623 9% 71 625Oct. 1, 1996—Dec. 31, 1996 8% 69 623 9% 71 625Jan. 1, 1997—Mar. 31, 1997 8% 21 575 9% 23 577Apr. 1, 1997—Jun. 30, 1997 8% 21 575 9% 23 577Jul. 1, 1997—Sep. 30, 1997 8% 21 575 9% 23 577Oct. 1, 1997—Dec. 31, 1997 8% 21 575 9% 23 577Jan. 1, 1998—Mar. 31, 1998 8% 21 575 9% 23 577Apr. 1, 1998—Jun. 30, 1998 7% 19 573 8% 21 575Jul. 1, 1998—Sep. 30, 1998 7% 19 573 8% 21 575Oct. 1, 1998—Dec. 31, 1998 7% 19 573 8% 21 575

June 13, 2005 1216 2005–24 I.R.B.


FROM JANUARY 1, 1999 — PRESENT

NONCORPORATE OVERPAYMENTS AND UNDERPAYMENTS

1995–1 C.B.RATE TABLE PG

Jan. 1, 1999—Mar. 31, 1999 7% 19 573Apr. 1, 1999—Jun. 30, 1999 8% 21 575Jul. 1, 1999—Sep. 30, 1999 8% 21 575Oct. 1, 1999—Dec. 31, 1999 8% 21 575Jan. 1, 2000—Mar. 31, 2000 8% 69 623Apr. 1, 2000—Jun. 30, 2000 9% 71 625Jul. 1, 2000—Sep. 30, 2000 9% 71 625Oct. 1, 2000—Dec. 31, 2000 9% 71 625Jan. 1, 2001—Mar. 31, 2001 9% 23 577Apr. 1, 2001—Jun. 30, 2001 8% 21 575Jul. 1, 2001—Sep. 30, 2001 7% 19 573Oct. 1, 2001—Dec. 31, 2001 7% 19 573Jan. 1, 2002—Mar. 31, 2002 6% 17 571Apr. 1, 2002—Jun. 30, 2002 6% 17 571Jul. 1, 2002—Sep. 30, 2002 6% 17 571Oct. 1, 2002—Dec. 31, 2002 6% 17 571Jan. 1, 2003—Mar. 31, 2003 5% 15 569Apr. 1, 2003—Jun. 30, 2003 5% 15 569Jul. 1, 2003—Sep. 30, 2003 5% 15 569Oct. 1, 2003—Dec. 31, 2003 4% 13 567Jan. 1, 2004—Mar. 31, 2004 4% 61 615Apr. 1, 2004—Jun. 30, 2004 5% 63 617Jul. 1, 2004—Sep. 30, 2004 4% 61 615Oct. 1, 2004—Dec. 31, 2004 5% 63 617Jan. 1, 2005—Mar. 31, 2005 5% 15 569Apr. 1, 2005—Jun. 30, 2005 6% 17 571Jul. 1, 2005—Sep. 30, 2005 6% 17 571



CORPORATE OVERPAYMENTS AND UNDERPAYMENTS



Jan. 1, 1999—Mar. 31, 1999 6% 17 571 7% 19 573Apr. 1, 1999—Jun. 30, 1999 7% 19 573 8% 21 575Jul. 1, 1999—Sep. 30, 1999 7% 19 573 8% 21 575Oct. 1, 1999—Dec. 31, 1999 7% 19 573 8% 21 575Jan. 1, 2000—Mar. 31, 2000 7% 67 621 8% 69 623Apr. 1, 2000—Jun. 30, 2000 8% 69 623 9% 71 625Jul. 1, 2000—Sep. 30, 2000 8% 69 623 9% 71 625Oct. 1, 2000—Dec. 31, 2000 8% 69 623 9% 71 625Jan. 1, 2001—Mar. 31, 2001 8% 21 575 9% 23 577Apr. 1, 2001—Jun. 30, 2001 7% 19 573 8% 21 575Jul. 1, 2001—Sep. 30, 2001 6% 17 571 7% 19 573Oct. 1, 2001—Dec. 31, 2001 6% 17 571 7% 19 573Jan. 1, 2002—Mar. 31, 2002 5% 15 569 6% 17 571Apr. 1, 2002—Jun. 30, 2002 5% 15 569 6% 17 571Jul. 1, 2002—Sep. 30, 2002 5% 15 569 6% 17 571Oct. 1, 2002—Dec. 31, 2002 5% 15 569 6% 17 571

2005–24 I.R.B. 1217 June 13, 2005


FROM JANUARY 1, 1999 — PRESENT – Continued

CORPORATE OVERPAYMENTS AND UNDERPAYMENTS



Jan. 1, 2003—Mar. 31, 2003 4% 13 567 5% 15 569Apr. 1, 2003—Jun. 30, 2003 4% 13 567 5% 15 569Jul. 1, 2003—Sep. 30, 2003 4% 13 567 5% 15 569Oct. 1, 2003—Dec. 31, 2003 3% 11 565 4% 13 567Jan. 1, 2004—Mar. 31, 2004 3% 59 613 4% 61 615Apr. 1, 2004—Jun. 30, 2004 4% 61 615 5% 63 617Jul. 1, 2004—Sep. 30, 2004 3% 59 613 4% 61 615Oct. 1, 2004—Dec. 31, 2004 4% 61 615 5% 63 617Jan. 1, 2005—Mar. 31, 2005 4% 13 567 5% 15 569Apr. 1, 2005—Jun. 30, 2005 5% 15 569 6% 17 571Jul. 1, 2005—Sep. 30, 2005 5% 15 569 6% 17 571

TABLE OF INTEREST RATES FORLARGE CORPORATE UNDERPAYMENTS



Jan. 1, 1991—Mar. 31, 1991 13% 31 585Apr. 1, 1991—Jun. 30, 1991 12% 29 583Jul. 1, 1991—Sep. 30, 1991 12% 29 583Oct. 1, 1991—Dec. 31, 1991 12% 29 583Jan. 1, 1992—Mar. 31, 1992 11% 75 629Apr. 1, 1992—Jun. 30, 1992 10% 73 627Jul. 1, 1992—Sep. 30, 1992 10% 73 627Oct. 1, 1992—Dec. 31, 1992 9% 71 625Jan. 1, 1993—Mar. 31, 1993 9% 23 577Apr. 1, 1993—Jun. 30, 1993 9% 23 577Jul. 1, 1993—Sep. 30, 1993 9% 23 577Oct. 1, 1993—Dec. 31, 1993 9% 23 577Jan. 1, 1994—Mar. 31, 1994 9% 23 577Apr. 1, 1994—Jun. 30, 1994 9% 23 577Jul. 1, 1994—Sep. 30, 1994 10% 25 579Oct. 1, 1994—Dec. 31, 1994 11% 27 581Jan. 1, 1995—Mar. 31, 1995 11% 27 581Apr. 1, 1995—Jun. 30, 1995 12% 29 583Jul. 1, 1995—Sep. 30, 1995 11% 27 581Oct. 1, 1995—Dec. 31, 1995 11% 27 581Jan. 1, 1996—Mar. 31, 1996 11% 75 629Apr. 1, 1996—Jun. 30, 1996 10% 73 627Jul. 1, 1996—Sep. 30, 1996 11% 75 629Oct. 1, 1996—Dec. 31, 1996 11% 75 629Jan. 1, 1997—Mar. 31, 1997 11% 27 581Apr. 1, 1997—Jun. 30, 1997 11% 27 581Jul. 1, 1997—Sep. 30, 1997 11% 27 581Oct. 1, 1997—Dec. 31, 1997 11% 27 581Jan. 1, 1998—Mar. 31, 1998 11% 27 581Apr. 1, 1998—Jun. 30, 1998 10% 25 579Jul. 1, 1998—Sep. 30, 1998 10% 25 579Oct. 1, 1998—Dec. 31, 1998 10% 25 579Jan. 1, 1999—Mar. 31, 1999 9% 23 577Apr. 1, 1999—Jun. 30, 1999 10% 25 579

June 13, 2005 1218 2005–24 I.R.B.

TABLE OF INTEREST RATES FORLARGE CORPORATE UNDERPAYMENTS



Jul. 1, 1999—Sep. 30, 1999 10% 25 579Oct. 1, 1999—Dec. 31, 1999 10% 25 579Jan. 1, 2000—Mar. 31, 2000 10% 73 627Apr. 1, 2000—Jun. 30, 2000 11% 75 629Jul. 1, 2000—Sep. 30, 2000 11% 75 629Oct. 1, 2000—Dec. 31, 2000 11% 75 629Jan. 1, 2001—Mar. 31, 2001 11% 27 581Apr. 1, 2001—Jun. 30, 2001 10% 25 579Jul. 1, 2001—Sep. 30, 2001 9% 23 577Oct. 1, 2001—Dec. 31, 2001 9% 23 577Jan. 1, 2002—Mar. 31, 2002 8% 21 575Apr. 1, 2002—Jun. 30, 2002 8% 21 575Jul. 1, 2002—Sep. 30, 2002 8% 21 575Oct. 1, 2002—Dec. 30, 2002 8% 21 575Jan. 1, 2003—Mar. 31, 2003 7% 19 573Apr. 1, 2003—Jun. 30, 2003 7% 19 573Jul. 1, 2003—Sep. 30, 2003 7% 19 573Oct. 1, 2003—Dec. 31, 2003 6% 17 571Jan. 1, 2004—Mar. 31, 2004 6% 65 619Apr. 1, 2004—Jun. 30, 2004 7% 67 621Jul. 1, 2004—Sep. 30, 2004 6% 65 619Oct. 1, 2004—Dec. 31, 2004 7% 67 621Jan. 1, 2005—Mar. 31, 2005 7% 19 573Apr. 1, 2005—Jun. 30, 2005 8% 21 575Jul. 1, 2005—Sep. 30, 2005 8% 21 575

TABLE OF INTEREST RATES FOR CORPORATEOVERPAYMENTS EXCEEDING $10,000



Jan. 1, 1995—Mar. 31, 1995 6.5% 18 572Apr. 1, 1995—Jun. 30, 1995 7.5% 20 574Jul. 1, 1995—Sep. 30, 1995 6.5% 18 572Oct. 1, 1995—Dec. 31, 1995 6.5% 18 572Jan. 1, 1996—Mar. 31, 1996 6.5% 66 620Apr. 1, 1996—Jun. 30, 1996 5.5% 64 618Jul. 1, 1996—Sep. 30, 1996 6.5% 66 620Oct. 1, 1996—Dec. 31, 1996 6.5% 66 620Jan. 1, 1997—Mar. 31, 1997 6.5% 18 572Apr. 1, 1997—Jun. 30, 1997 6.5% 18 572Jul. 1, 1997—Sep. 30, 1997 6.5% 18 572Oct. 1, 1997—Dec. 31, 1997 6.5% 18 572Jan. 1, 1998—Mar. 31, 1998 6.5% 18 572Apr. 1, 1998—Jun. 30, 1998 5.5% 16 570Jul. 1, 1998—Sep. 30, 1998 5.5% 16 570Oct. 1, 1998—Dec. 31, 1998 5.5% 16 570Jan. 1, 1999—Mar. 31, 1999 4.5% 14 568Apr. 1, 1999—Jun. 30, 1999 5.5% 16 570Jul. 1, 1999—Sep. 30, 1999 5.5% 16 570Oct. 1, 1999—Dec. 31, 1999 5.5% 16 570Jan. 1, 2000—Mar. 31, 2000 5.5% 64 618

2005–24 I.R.B. 1219 June 13, 2005

TABLE OF INTEREST RATES FOR CORPORATEOVERPAYMENTS EXCEEDING $10,000



Apr. 1, 2000—Jun. 30, 2000 6.5% 66 620Jul. 1, 2000—Sep. 30, 2000 6.5% 66 620Oct. 1, 2000—Dec. 31, 2000 6.5% 66 620Jan. 1, 2001—Mar. 31, 2001 6.5% 18 572Apr. 1, 2001—Jun. 30, 2001 5.5% 16 570Jul. 1, 2001—Sep. 30, 2001 4.5% 14 568Oct. 1, 2001—Dec. 31, 2001 4.5% 14 568Jan. 1, 2002—Mar. 31, 2002 3.5% 12 566Apr. 1, 2002—Jun. 30, 2002 3.5% 12 566Jul. 1, 2002—Sep. 30, 2002 3.5% 12 566Oct. 1, 2002—Dec. 31, 2002 3.5% 12 566Jan. 1, 2003—Mar. 31, 2003 2.5% 10 564Apr. 1, 2003—Jun. 30, 2003 2.5% 10 564Jul. 1, 2003—Sep. 30, 2003 2.5% 10 564Oct. 1, 2003—Dec. 31, 2003 1.5% 8 562Jan. 1, 2004—Mar. 31, 2004 1.5% 56 610Apr. 1, 2004—Jun. 30, 2004 2.5% 58 612Jul. 1, 2004—Sep. 30, 2004 1.5% 56 610Oct. 1, 2004—Dec. 31, 2004 2.5% 58 612Jan. 1, 2005—Mar. 31, 2005 2.5% 10 564Apr. 1, 2005—Jun. 30, 2005 3.5% 12 566Jul. 1, 2005—Sep. 30, 2005 3.5% 12 566

June 13, 2005 1220 2005–24 I.R.B.

Part III. Administrative, Procedural, and MiscellaneousProposed Revenue ProcedureRegarding PartnershipInterests Transferredin Connection With thePerformance of Services

Notice 2005–43

Purpose

This notice addresses the taxation of atransfer of a partnership interest in con-nection with the performance of services.In conjunction with this notice, the Trea-sury Department and the Internal RevenueService are proposing regulations under§ 83 of the Internal Revenue Code. Theproposed regulations grant the Commis-sioner authority to issue guidance of gen-eral applicability related to the taxationof the transfer of a partnership interest inconnection with the performance of ser-vices. This notice includes a proposed rev-enue procedure under that authority. Theproposed revenue procedure provides ad-ditional rules for the elective safe harborunder proposed § 1.83–3(l) for a partner-ship’s transfers of interests in the partner-ship in connection with the performance ofservices for that partnership. The safe har-bor is intended to simplify the applicationof § 83 to partnership interests and to coor-dinate the provisions of § 83 with the prin-ciples of partnership taxation. Upon thefinalization of the proposed revenue pro-cedure, Rev. Proc. 93–27, 1993–2 C.B.343, and Rev. Proc. 2001–43, 2001–2C.B. 191, (described below) will be obso-leted. Until that occurs, taxpayers may notrely upon the safe harbor set forth in theproposed revenue procedure, but taxpay-ers may continue to rely upon current law,including Rev. Proc. 93–27, 1993–2 C.B.343, and Rev. Proc. 2001–43, 2001–2C.B. 191.

Effective Date

The Treasury Department and the Ser-vice intend for the revenue procedure pro-posed in this notice to be finalized andmade effective in conjunction with the fi-nalization of the related proposed regula-tions under § 83 and subchapter K of chap-ter 1 of the Internal Revenue Code (sub-chapter K).

Request for Comments

Comments are requested on the pro-posed revenue procedure in this notice.Although the Treasury Department and theService request comments on all aspectsof the proposed revenue procedure, com-ments are requested specifically on the fol-lowing:

1. Whether additional guidance isneeded to address the transfer of aninterest in a partnership to a personwho is not rendering services directlyto such partnership (for example, anupper-tier partnership transfers an in-terest in a lower-tier partnership toa person for services rendered to theupper-tier partnership).

2. Whether election of the safe harbordescribed in proposed § 1.83–3(l)and the proposed revenue procedureshould be permitted on Form 1065,U.S. Return of Partnership Income,and whether continued use of the safeharbor should be reported annually onForm 1065 and Schedule K–1, Part-ner’s Share of Income, Deductions,Credits, etc.

Comments may be submitted on orbefore August 22, 2005 to Internal Rev-enue Service, PO Box 7604, Washington,DC 20044, Attn: CC:PA:LPD:PR (Notice2005–43), Room 5203. Submissions mayalso be hand-delivered Monday throughFriday between the hours of 8 a.m. and4 p.m. to the Courier’s Desk at 1111Constitution Avenue, NW, WashingtonDC 20224, Attn: CC:PA:LPD:PR (No-tice 2005–43), Room 5203. Submissionsmay also be sent electronically via theinternet to the following email address:[email protected] the notice number (Notice2005–43) in the subject line.


The principal authors of this noticeare Stephen Tackney of the Office of As-sociate Chief Counsel (Tax Exempt andGovernment Entities); and Audrey Ellisand Demetri Yatrakis of the Office of As-sociate Chief Counsel (Passthroughs and

Special Industries). For further informa-tion regarding this notice and the applica-tion of § 83, contact Stephen Tackney at(202) 622–6030 (not a toll-free call). Forfurther information regarding this noticeand the application of the rules containedin subchapter K, contact Audrey Ellis orDemetri Yatrakis at (202) 622–3060 (nota toll-free call).

PROPOSED REVENUEPROCEDURE

SECTION 1. PURPOSE

Proposed § 1.83–3(l) of the Income TaxRegulations allows taxpayers to elect toapply special rules (the Safe Harbor) to apartnership’s transfers of interests in thepartnership in connection with the perfor-mance of services for the partnership. TheTreasury Department and the Internal Rev-enue Service intend for the Safe Harbor tosimplify the application of § 83 of the In-ternal Revenue Code to partnership inter-ests transferred in connection with the per-formance of services and to coordinate theprinciples of § 83 with the principles ofpartnership taxation. This revenue proce-dure sets forth additional rules for the elec-tive safe harbor under proposed § 1.83–3(l)for a partnership’s transfer of interests inthe partnership in connection with the per-formance of services for that partnership.

SECTION 2. LAW AND DISCUSSION

Section 83(a) provides that if, in con-nection with the performance of services,property is transferred to any person otherthan the person for whom such servicesare performed, the excess of (1) the fairmarket value of such property (determinedwithout regard to any restriction otherthan a restriction which by its terms willnever lapse) at the first time the rights ofthe person having the beneficial interestin such property are transferable or arenot subject to a substantial risk of forfei-ture, whichever occurs earlier, over (2) theamount (if any) paid for such property, isincluded in the gross income of the personwho performed such services in the firsttaxable year in which the rights of theperson having the beneficial interest insuch property are transferable or are not

2005–24 I.R.B. 1221 June 13, 2005

subject to a substantial risk of forfeiture,whichever is applicable.

Section 1.83–3(e) provides that, forpurposes of § 83 and the regulations there-under, the term property includes realand personal property other than eithermoney or an unfunded and unsecuredpromise to pay money or property in thefuture. For these purposes, under proposed§ 1.83–3(e) property includes a partner-ship interest. Generally, a mere rightto allocations or distributions described in§ 707(a)(2)(A) is not a partnership interest.Proposed § 1.83–3(e) also provides that, inthe case of a transfer of a partnership inter-est in connection with the performance ofservices, the Commissioner may prescribegenerally applicable administrative rulesto address the application of § 83 to thetransfer.

Section 83(b) provides that a serviceprovider may elect to include in his or hergross income, for the taxable year in whichsubstantially nonvested property is trans-ferred, the excess of (1) the fair marketvalue of the property at the time of thetransfer (determined without regard to anyrestriction other than a restriction whichby its terms will never lapse), over (2) theamount (if any) paid for the property. Ifsuch an election is made, § 83(a) does notapply with respect to the transfer of theproperty upon vesting and, if the propertyis subsequently forfeited, no deduction isallowed to the service provider in respectof the forfeiture.

Section 1.83–2(b) provides that an elec-tion under § 83(b) must be filed not laterthan 30 days after the date the property wastransferred and may be filed prior to thedate of the transfer. Section 1.83–2(c) pro-vides that the election is made by filing onecopy of a written statement with the Inter-nal Revenue Service Center with which theservice provider files his or her return. Inaddition, one copy of such statement mustbe submitted with the service provider’sincome tax return for the taxable year inwhich the property was transferred.

Section 1.83–1(a) provides that, un-less an election under § 83(b) is made,the transferor is regarded as the ownerof substantially nonvested property trans-ferred in connection with the performanceof services until such property becomessubstantially vested, and any income fromsuch property received by the serviceprovider (or beneficiary thereof), or the

right to the use of such property by theservice provider, constitutes additionalcompensation and is included in the grossincome of the service provider for the tax-able year in which the income is receivedor the use is made available. Under thisrule, a partnership must treat as unissuedany substantially nonvested partnershipinterest transferred in connection withthe performance of services for whichan election under § 83(b) has not beenmade. If the service provider who holdssuch an interest receives distributionsfrom the partnership with respect to thatinterest while the interest is substantiallynonvested, the distributions are treated ascompensation in the capacity in which theservice provider performed the services.For example, if a service provider thatis not a pre-existing partner holds a sub-stantially nonvested partnership interestthat the service provider received in con-nection with the performance of servicesand the service provider did not make anelection under § 83(b) with respect to thatinterest, then any distributions made to theservice provider on account of such inter-est are treated as additional compensationand not partnership distributions. If, in-stead, the service provider who receivesa substantially nonvested partnership in-terest in connection with the performanceof services makes a valid election un-der § 83(b), then the service provider istreated as the owner of the property. SeeRev. Rul. 83–22, 1983–1 C.B. 17. Theservice provider is treated as a partner withrespect to such an interest, and the part-nership must allocate partnership items tothe service provider as if the partnershipinterest were substantially vested.

Section 1.83–3(b) provides that prop-erty is substantially nonvested for § 83 pur-poses when it is subject to a substantial riskof forfeiture and is nontransferable. Prop-erty is substantially vested for § 83 pur-poses when it is either transferable or notsubject to a substantial risk of forfeiture.

Section 1.83–3(c) provides that, for§ 83 purposes, whether a risk of forfei-ture is substantial or not depends uponthe facts and circumstances. A substan-tial risk of forfeiture exists where rightsin property that are transferred are con-ditioned, directly or indirectly, upon thefuture performance (or refraining fromperformance) of substantial services byany person, or the occurrence of a condi-

tion related to a purpose of the transfer,and the possibility of forfeiture is substan-tial if such condition is not satisfied.

Section 1.83–3(d) provides that, for§ 83 purposes, the rights of a person inproperty are transferable if such personcan transfer any interest in the propertyto any person other than the transferor ofthe property, but only if the rights in suchproperty of such transferee are not subjectto a substantial risk of forfeiture.

Proposed § 1.83–3(l) provides that,subject to such additional conditions,rules, and procedures that the Commis-sioner may prescribe in regulations, rev-enue rulings, notices, or other guidancepublished in the Internal Revenue Bul-letin, a partnership and all of its partnersmay elect a safe harbor under which thefair market value of a partnership interestthat is transferred in connection with theperformance of services is treated as beingequal to the liquidation value of that inter-est for transfers on or after the date finalregulations are published in the FederalRegister if the following conditions aresatisfied: (1) the partnership must preparea document, executed by a partner whohas responsibility for federal income taxreporting by the partnership, stating thatthe partnership is electing, on behalf ofthe partnership and each of its partners, tohave the safe harbor apply irrevocably asof the stated effective date with respect toall partnership interests transferred in con-nection with the performance of serviceswhile the safe harbor election remains ineffect and attach the document to the taxreturn for the partnership for the taxableyear that includes the effective date of theelection; (2) except as provided below, thepartnership agreement must contain pro-visions that are legally binding on all ofthe partners stating that (a) the partnershipis authorized and directed to elect the safeharbor, and (b) the partnership and each ofits partners (including any person to whoma partnership interest is transferred in con-nection with the performance of services)agrees to comply with all requirementsof the safe harbor with respect to all part-nership interests transferred in connectionwith the performance of services while theelection remains effective; and (3) if thepartnership agreement does not containthe provisions described in clause (2) ofthis sentence, or the provisions are notlegally binding on all of the partners of

June 13, 2005 1222 2005–24 I.R.B.

the partnership, then each partner in apartnership that transfers a partnership in-terest in connection with the performanceof services must execute a document con-taining provisions that are legally bindingon that partner stating that (a) the partner-ship is authorized and directed to elect thesafe harbor, and (b) the partner agrees tocomply with all requirements of the safeharbor with respect to all partnership in-terests transferred in connection with theperformance of services while the electionremains effective. The specified effectivedate of the safe harbor election may notbe prior to the date that the safe harborelection is executed. Proposed § 1.83–3(l)provides that the partnership must retainsuch records as may be necessary to in-dicate that an effective election has beenmade and remains in effect, including acopy of the partnership’s election state-ment under this paragraph (l), and, ifapplicable, the original of each documentsubmitted to the partnership by a partnerunder this paragraph (l). If the partner-ship is unable to produce a record of aparticular document, the election will betreated as not made, generally resultingin termination of the election. The safeharbor election also may be terminatedby the partnership preparing a document,executed by a partner who has respon-sibility for federal income tax reportingby the partnership, which states that thepartnership, on behalf of the partnershipand each of its partners, is revoking thesafe harbor election on the stated effectivedate, and attaching the document to the taxreturn for the partnership for the taxableyear that includes the effective date of therevocation.

Section 83(h) provides that, in the caseof a transfer of property in connectionwith the performance of services or acancellation of a restriction described in§ 83(d), there is allowed as a deductionunder § 162, to the person for whom theservices were performed (the service re-cipient), an amount equal to the amountincluded under § 83(a), (b), or (d)(2) inthe gross income of the service provider.The deduction is allowed for the taxableyear of the service recipient in which orwith which ends the taxable year in whichsuch amount is included in the grossincome of the service provider. Under§ 1.83–6(a)(3), if property is substantiallyvested upon the transfer, the deduction is

allowed to the service recipient in accor-dance with its method of accounting (inconformity with §§ 446 and 461).

Section 1.83–6(c) provides that if, un-der § 83(h) and § 1.83–6(a), a deduction,an increase in basis, or a reduction of grossincome was allowable (disregarding thereasonableness of the amount of compen-sation) in respect of a transfer of prop-erty and such property is subsequently for-feited, the amount of such deduction, in-crease in basis, or reduction of gross in-come shall be includible in the gross in-come of the person to whom it was allow-able for the taxable year of the forfeiture.The basis of such property in the hands ofthe person to whom it is forfeited shall in-clude any such amount includible in thegross income of such person, as well as anyamount such person pays upon forfeiture.

Section 704(b) requires that a partner’sdistributive share of income, gain, loss, de-duction, or credit (or item thereof) be de-termined in accordance with the partner’sinterest in the partnership, determined bytaking into account all facts and circum-stances, if (1) the partnership agreementdoes not provide otherwise as to the part-ner’s distributive share, or (2) the alloca-tion to a partner under the agreement doesnot have substantial economic effect.

Proposed § 1.704–1(b)(2)(iv)(b)(1)provides that a partner’s capital accountincludes the amount contributed by thatpartner to the partnership, and, in the caseof a compensatory partnership interestthat is transferred on or after the date finalregulations are published in the FederalRegister, the amount included on or afterthat date as the partner’s compensationincome under § 83(a), (b), or (d)(2). Forthese purposes, a compensatory partner-ship interest is an interest in the trans-ferring partnership that is transferred inconnection with the performance of ser-vices for that partnership (either beforeor after the formation of the partnership),including an interest that is transferred onthe exercise of a compensatory partner-ship option. A compensatory partnershipoption is an option to acquire an interestin the issuing partnership that is grantedin connection with the performance ofservices for that partnership (either beforeor after the formation of the partnership).See proposed § 1.721–1(b)(4).

Proposed § 1.704–1(b)(4)(xii)(a) pro-vides that if a § 83(b) election has been

made with respect to a substantially non-vested interest, allocations of partnershipitems while the interest is substantiallynonvested cannot have economic effect.

Proposed § 1.704–1(b)(4)(xii)(b) pro-vides that allocations of partnership itemsto a holder of a substantially nonvested in-terest for which a § 83(b) election has beenmade will be deemed to be in accordancewith the partners’ interests in the partner-ship if the partnership agreement requiresthat: (1) in the event that the interest forwhich the § 83(b) election is made islater forfeited, the partnership shall makeforfeiture allocations in the year of theforfeiture; and (2) all material allocationsand capital account adjustments under thepartnership agreement not pertaining tosubstantially nonvested partnership in-terests for which a § 83(b) election hasbeen made are recognized under § 704(b).Proposed § 1.704–1(b)(4)(xii)(e) providesthat proposed § 1.704–1(b)(4)(xii)(b) doesnot apply to allocations of partnershipitems made with respect to a substantiallynonvested interest for which the holderhas made a § 83(b) election if, at the timeof the § 83(b) election, there is a plan thatthe interest will be forfeited. In determin-ing whether there is a plan that the interestwill be forfeited, the Commissioner willconsider all of the facts and circumstances(including the tax status of the holder ofthe forfeitable compensatory partnershipinterest).

Proposed § 1.704–1(b)(4)(xii)(c) de-fines forfeiture allocations as allocationsto the service provider (consisting of a prorata portion of each item) of gross incomeand gain or gross deduction and loss (tothe extent such items are available) for thetaxable year of the forfeiture in a positiveor negative amount equal to (1) the excess(not less than zero) of (a) the amount ofthe distributions (including deemed distri-butions under § 752(b) and the adjustedtax basis of any property so distributed)to the partner with respect to the forfeitedpartnership interest (to the extent suchdistributions are not taxable under § 731),over (b) the amounts paid for the interestand the adjusted tax basis of property con-tributed by the partner (including deemedcontributions under § 752(a)) to the part-nership with respect to the forfeited part-nership interest, minus (2) the cumulativenet income (or loss) allocated to the partnerwith respect to the forfeited partnership

2005–24 I.R.B. 1223 June 13, 2005

interest. Proposed § 1.704–1(b)(4)(xii)(d)provides that for purposes of proposed§ 1.704–1(b)(4)(xii)(c), items of incomeand gain are reflected as positive amounts,and items of deduction and loss are re-flected as negative amounts.

Section 721(a) provides that no gain orloss is recognized to a partnership or to anyof its partners in the case of a contributionof property to the partnership in exchangefor an interest in the partnership.

Proposed § 1.721–1(b)(1) provides that§ 721 generally does not apply to the trans-fer of a partnership interest in connectionwith the performance of services. Sucha transfer constitutes a transfer of prop-erty to which § 83 and the regulationsthereunder apply. However, under pro-posed § 1.721–1(b)(2), except as providedin § 83(h) or § 1.83–6(c), no gain or loss isrecognized by a partnership upon: (i) thetransfer or substantial vesting of a compen-satory partnership interest, or (ii) the for-feiture of a compensatory partnership in-terest.

Proposed § 1.761–1(b) provides that ifa partnership interest is transferred in con-nection with the performance of services,and that partnership interest is substan-tially nonvested (within the meaning of§ 1.83–3(b)), then the holder of the part-nership interest is not treated as a partnersolely by reason of holding the interest, un-less the holder makes an election with re-spect to the interest under § 83(b).

Rev. Proc. 93–27, 1993–2 C.B. 343,provides generally that if a person receivesa profits interest for the provision of ser-vices to or for the benefit of a partner-ship in a partner capacity or in anticipa-tion of becoming a partner, the Servicewill not treat the receipt of such an inter-est as a taxable event for the partner or thepartnership. The revenue procedure doesnot apply if (1) the profits interest relatesto a substantially certain and predictablestream of income from partnership assets,such as income from high-quality debt se-curities or a high-quality net lease; (2)within two years of receipt, the partner dis-poses of the profits interest; or (3) the prof-its interest is a limited partnership interestin a “publicly traded partnership” withinthe meaning of § 7704(b).

Rev. Proc. 2001–43, 2001–2 C.B.191, clarifies Rev. Proc. 93–27 and pro-vides that, for purposes of Rev. Proc.93–27, if a partnership grants a substan-

tially nonvested profits interest in the part-nership to a service provider, the serviceprovider will be treated as receiving theinterest on the date of its grant, providedthat: (1) the partnership and the serviceprovider treat the service provider as theowner of the partnership interest from thedate of its grant and the service providertakes into account the distributive share ofpartnership income, gain, loss, deductionand credit associated with that interest incomputing the service provider’s incometax liability for the entire period duringwhich the service provider has the inter-est; (2) upon the grant of the interest or atthe time that the interest becomes substan-tially vested, neither the partnership norany of the partners deducts any amount (aswages, compensation, or otherwise) for thefair market value of the interest; and (3) allother conditions of Rev. Proc. 93–27 aresatisfied.

SECTION 3. SCOPE

.01 In General. The Safe Harbor in sec-tion 4 of this revenue procedure applies toany Safe Harbor Partnership Interest trans-ferred by a partnership if the transfer ismade during the period in which the SafeHarbor Election is in effect (whether or notthe Safe Harbor Partnership Interest is sub-stantially vested on the date of transfer).Thus, for example, sections 4.02 through4.04 of this revenue procedure apply toa Safe Harbor Partnership Interest that istransferred during the period in which theSafe Harbor Election is in effect, even ifthat Safe Harbor Partnership Interest doesnot become substantially vested until af-ter the Safe Harbor Election is terminated,a § 83(b) election is made after the SafeHarbor Election is terminated, or that SafeHarbor Partnership Interest is forfeited af-ter the Safe Harbor Election is terminated.Further, a Safe Harbor Election is bindingon the partnership, all of its partners, andthe service provider. The Safe Harbor in-cludes all of the rules set forth in section4 of this revenue procedure, and a partner-ship, its partners, and the service providermay not choose to apply only certain of therules in section 4 of this revenue procedureor to apply the Safe Harbor only to certainpartners, service providers, or partnershipinterests.

.02 Safe Harbor Partnership Interest.(1) Except as otherwise provided in sec-

tion 3.02(2) of this revenue procedure, aSafe Harbor Partnership Interest is any in-terest in a partnership that is transferred toa service provider by such partnership inconnection with services provided to thepartnership (either before or after the for-mation of the partnership), provided thatthe interest is not (a) related to a substan-tially certain and predictable stream of in-come from partnership assets, such as in-come from high-quality debt securities ora high-quality net lease, (b) transferred inanticipation of a subsequent disposition, or(c) an interest in a publicly traded part-nership within the meaning of § 7704(b).Unless it is established by clear and con-vincing evidence that the partnership in-terest was not transferred in anticipation ofa subsequent disposition, a partnership in-terest is presumed to be transferred in an-ticipation of a subsequent disposition forpurposes of the preceding clause (b) if thepartnership interest is sold or disposed ofwithin two years of the date of receipt ofthe partnership interest (other than a sale ordisposition by reason of death or disabilityof the service provider) or is the subject,at any time within two years of the dateof receipt, of a right to buy or sell regard-less of when the right is exercisable (otherthan a right to buy or sell arising by rea-son of the death or disability of the serviceprovider). For the purposes of this revenueprocedure, “disability” means a conditionwhich causes a service provider to be un-able to engage in any substantial gainfulactivity by reason of a medically deter-minable physical or mental impairment ex-pected to result in death or to last for a con-tinuous period of not less than 12 months.

(2) An interest in a partnership is nota Safe Harbor Partnership Interest unlessat the date of transfer the requirements ofsection 3.03 of this revenue procedure aresatisfied and a Safe Harbor Election hasnot terminated pursuant to section 3.04 ofthis revenue procedure. For the first tax-able year that a partnership is subject to aSafe Harbor Election, a partnership inter-est may be a Safe Harbor Partnership In-terest if a Safe Harbor Election is attachedto the partnership tax return for the taxableyear including the date of transfer, pro-vided that the other requirements of sec-tion 3.03 of this revenue procedure are sat-isfied on or before the date of such transfer.

.03 Required Conditions for Safe Har-bor Election. In order to effect and main-

June 13, 2005 1224 2005–24 I.R.B.

tain a valid Safe Harbor Election, the fol-lowing conditions must be satisfied:

(1) The partnership must prepare a doc-ument, executed by a partner who has re-sponsibility for federal income tax report-ing by the partnership, stating that the part-nership is electing, on behalf of the part-nership and each of its partners, to havethe Safe Harbor described in Rev. Proc.200X–XX apply irrevocably with respectto all partnership interests transferred inconnection with the performance of ser-vices while the Safe Harbor Election re-mains in effect. The Safe Harbor Electionmust specify the effective date of the SafeHarbor Election, and the effective date forthe Safe Harbor Election may not be priorto the date that the Safe Harbor Election isexecuted. The Safe Harbor Election mustbe attached to the tax return for the partner-ship for the taxable year that includes theeffective date of the Safe Harbor Election.

(2) Except as provided in section3.03(3) of this revenue procedure, thepartnership agreement must contain pro-visions that are legally binding on all ofthe partners stating that (a) the partnershipis authorized and directed to elect the SafeHarbor described in this revenue proce-dure, and (b) the partnership and each ofits partners (including any person to whoma partnership interest is transferred in con-nection with the performance of services)agrees to comply with all requirements ofthe Safe Harbor described in this revenueprocedure with respect to all partnershipinterests transferred in connection with theperformance of services while the elec-tion remains effective. If a partner thatis bound by these provisions transfers apartnership interest to another person, therequirement that each partner be boundby these provisions is satisfied only if theperson to whom the interest is transferredassumes the transferring partner’s obliga-tions under the partnership agreement. Ifan amendment to the partnership agree-ment is required, the amendment mustbe effective before the date on which atransfer occurs for the Safe Harbor to beapplied to such transfer.

(3) If the partnership agreement doesnot contain the provisions described in sec-tion 3.03(2) of this revenue procedure, orthe provisions are not legally binding onall of the partners of the partnership, theneach partner in a partnership that transfersa partnership interest in connection with

the performance of services must executea document containing provisions that arelegally binding on each partner stating that(a) the partnership is authorized and di-rected to elect the Safe Harbor described inthis revenue procedure, and (b) the partneragrees to comply with all requirements ofthe Safe Harbor described in this revenueprocedure with respect to all partnershipinterests transferred in connection with theperformance of services while the electionremains effective. Each person classifiedas a partner must execute the document re-quired by this paragraph (3), and the docu-ment must be effective, before the date onwhich a transfer occurs, for the Safe Har-bor to be applied to such transfer. If a part-ner who has submitted the required docu-ment transfers a partnership interest to an-other person, the condition that each part-ner submit the necessary document is sat-isfied only if the person to whom the in-terest is transferred either submits the re-quired document or assumes the transfer-ring partner’s obligations under a docu-ment required by this paragraph that waspreviously submitted with respect to thetransferred interest.

.04 Termination of Safe Harbor Elec-tion. A Safe Harbor Election continuesin effect until terminated. A Safe HarborElection terminates automatically on thedate that a partnership fails to satisfy theconditions and requirements described insections 3.02 and 3.03 of this revenue pro-cedure. A Safe Harbor Election also ter-minates automatically in the event that thepartnership, a partner, or service providerreports income tax effects of a Safe HarborPartnership Interest in a manner inconsis-tent with the requirements of this revenueprocedure, including a failure to provideappropriate information returns. A part-nership may affirmatively terminate a SafeHarbor Election by preparing a document,executed by a partner who has responsi-bility for federal income tax reporting bythe partnership, indicating that the partner-ship, on behalf of the partnership and eachof its partners, is revoking its Safe HarborElection under Rev. Proc. 200X–XX andthe effective date of the revocation, pro-vided that the effective date may not beprior to the date the election to terminate isexecuted. Such termination election mustbe attached to the tax return for the partner-ship for the taxable year that includes theeffective date of the election. The rules of

the Safe Harbor in section 4 of this revenueprocedure do not apply to any partnershipinterests transferred on or after the date ofa termination of the Safe Harbor Electionunder this paragraph but continue to applyto any Safe Harbor Partnership Intereststransferred while the Safe Harbor Electionwas in effect.

.05 Election After Termination. If apartnership has made a Safe Harbor Elec-tion and if such Safe Harbor Election hasbeen terminated under section 3.04 of thisrevenue procedure, then, absent the con-sent of the Commissioner, the partnership(and any successor partnerships) are noteligible to make a Safe Harbor Electionfor any taxable year that begins beforethe fifth calendar year after the calendaryear during which such termination oc-curs. For purposes of this paragraph, asuccessor partnership is any partnershipthat (1) on the date of termination, is re-lated (within the meaning of § 267(b) or§ 707(b)) to the partnership whose SafeHarbor Election has terminated (or, if thepartnership whose Safe Harbor Electionhas terminated does not exist on the dateof termination would be related if it ex-isted on such date), and (2) acquires (eitherdirectly or indirectly) a substantial portionof the assets of the partnership whose SafeHarbor Election has terminated.

.06 Recordkeeping Requirement. Un-der proposed § 1.83–3(l), the partnershipis required to keep as records: (1) a copyof the Safe Harbor Election submitted bythe partnership to the Service under sec-tion 3.03(1) of this revenue procedure, and(2) if applicable, the original of each doc-ument submitted to the partnership by apartner under section 3.03(3) of this rev-enue procedure. If the partnership is un-able to produce a record of a particulardocument, the election will be treated asnot made, generally resulting in termina-tion of the Safe Harbor Election under sec-tion 3.04 of this revenue procedure.

SECTION 4. SAFE HARBOR

.01 Safe Harbor. For purposes of § 83,the rules in sections 4.02 through 4.04 ofthis revenue procedure apply to any SafeHarbor Partnership Interest for which aSafe Harbor Election is in effect.

.02 Liquidation Value. Under the SafeHarbor, the fair market value of a Safe Har-bor Partnership Interest is treated as being

2005–24 I.R.B. 1225 June 13, 2005

equal to the liquidation value of that in-terest. For this purpose, liquidation valueis determined without regard to any lapserestriction (as defined at § 1.83–3(i)) andmeans the amount of cash that the recip-ient of the Safe Harbor Partnership Inter-est would receive if, immediately after thetransfer, the partnership sold all of its as-sets (including goodwill, going concernvalue, and any other intangibles associatedwith the partnership’s operations) for cashequal to the fair market value of those as-sets and then liquidated.

.03 Vesting. Under the Safe Harbor, aSafe Harbor Partnership Interest is treatedas substantially vested if the right to theassociated capital account balance equiv-alent is not subject to a substantial risk offorfeiture or the interest is transferable. ASafe Harbor Partnership Interest is treatedas substantially nonvested only if, underthe terms of the interest at the time ofthe transfer, the interest terminates andthe holder may be required to forfeit thecapital account balance equivalent cred-ited to the holder under conditions thatwould constitute a substantial risk of for-feiture, and the interest is not transfer-able. For these purposes, the capital ac-count balance equivalent is the amount ofcash that the recipient of the Safe HarborPartnership Interest would receive if, im-mediately prior to the forfeiture, the inter-est vested and the partnership sold all of itsassets (including goodwill, going concernvalue, or any other intangibles associatedwith the partnership’s operations) for cashequal to the fair market value of those as-sets and then liquidated. Notwithstandingthe previous sentence, a Safe Harbor Part-nership Interest will not be considered sub-stantially nonvested if the sole portion ofthe capital account balance equivalent for-feited is the excess of the capital accountbalance equivalent at the date of termina-tion of services over the capital accountbalance equivalent at the end of the priorpartnership tax year or any later date be-fore the date of termination of services.

.04 Forfeiture Subsequent to § 83(b)Election. If a Safe Harbor Partnership In-terest with respect to which a § 83(b) elec-tion has been made is forfeited, the ser-vice provider must include as ordinary in-come in the taxable year of the forfei-ture an amount equal to the excess, if any,of (1) the amount of income or gain thatthe partnership would be required to al-

locate to the service provider under pro-posed § 1.704–1(b)(4)(xii) if the partner-ship had unlimited items of gross incomeand gain, over (2) the amount of incomeor gain that the partnership actually allo-cated to the service provider under pro-posed §1.704–1(b)(4)(xii).

SECTION 5. APPLICATION OFSAFE HARBOR TO SERVICEPROVIDER AND SERVICERECIPIENT

.01 Application of Safe Harbor to theService Provider. Under the Safe Harbor,the service provider recognizes compen-sation income upon the transfer of a sub-stantially vested Safe Harbor PartnershipInterest in an amount equal to the liquida-tion value of the interest, less any amountpaid for the interest. If the service providerreceives a Safe Harbor Partnership Inter-est that is substantially nonvested, does notmake an election under § 83(b), and holdsthe interest until it substantially vests, theservice provider recognizes compensationincome in an amount equal to the liqui-dation value of the interest on the datethe interest substantially vests, less anyamount paid for the interest. If the serviceprovider receives a Safe Harbor Partner-ship Interest that is substantially nonvestedand makes an election under § 83(b), theservice provider recognizes compensationincome on the date of transfer equal tothe liquidation value of the interest, deter-mined as if the interest were substantiallyvested, pursuant to the rules of § 83(b) and§ 1.83–2, less any amount paid for the in-terest.

.02 Application of Safe Harbor to theService Recipient. Under § 83(h), theservice recipient generally is entitled to adeduction equal to the amount includedas compensation in the gross income ofthe service provider under § 83(a), (b), or(d)(2), but only to the extent the amountmeets the requirements of § 162 or § 212.Under the Safe Harbor, the amount in-cluded in the service provider’s grossincome in accordance with section 4.02 ofthis revenue procedure is considered theamount included as compensation in thegross income of the service provider un-der § 83(a) or (b) for purposes of § 83(h).The deduction generally is allowed for thetaxable year of the partnership in whichor with which ends the taxable year of

the service provider in which the amountis included in gross income as compen-sation. However, in accordance with§ 1.83–6(a)(3), where the deduction re-lates to the transfer of substantially vestedproperty, the deduction is available inaccordance with the service recipient’smethod of accounting.

SECTION 6. EXAMPLES

The following facts apply for all of theexamples below:

SP is an individual with a calendar yeartaxable year. PRS is a partnership witha calendar year taxable year. Except asotherwise stated, PRS’s partnership agree-ment provides for all partnership items tobe allocated to the partners in proportionto the partners’ interests in the partnership.PRS’s partnership agreement provides thatthe partners’ capital accounts will be de-termined and maintained in accordancewith § 1.704–1(b)(2)(iv), that liquidationproceeds will be distributed in accordancewith the partners’ positive capital ac-count balances, and that any partner witha deficit balance in the partner’s capitalaccount following the liquidation of thepartner’s interest must restore that deficitto the partnership. All allocations and dis-tributions to all parties are not recast under§ 707(a)(2), and § 751(b) does not applyto any distribution. The partnership, itsmembers, and the service providers electthe Safe Harbor provided in section 4 ofthis revenue procedure and file all affectedreturns consistent with the Safe Harbor,and each partnership interest transferredconstitutes a Safe Harbor Partnership In-terest under section 3.02 of this revenueprocedure. The issuance of the partnershipinterest in each example is not required tobe capitalized under the rules of § 263 orother applicable provision of the Code. Inexamples in which the partnership interesttransferred to the service provider is notsubstantially vested, there is not a planthat the service provider will forfeit thepartnership interest.

(1) Example 1: Substantially Vested Profits Inter-est

Facts: PRS has two partners, A and B, each with a50% interest in PRS. On March 1, 2005, SP agrees toperform services for the partnership in exchange fora partnership interest. Under the terms of the part-nership agreement, SP is entitled to 10% of the futureprofits and losses of PRS, but is not entitled to anyof the partnership’s capital as of the date of transfer.

June 13, 2005 1226 2005–24 I.R.B.

Although SP must surrender the partnership interestupon termination of services to the partnership, SPwill not surrender any share of the profits accumu-lated through the end of the partnership taxable yearpreceding the partnership taxable year in which SPterminates services.

Conclusion: Under section 4.03 of this revenueprocedure, SP’s interest in PRS is treated as substan-tially vested at the time of transfer. Under section4.02 of this revenue procedure, the fair market valueof the interest for purposes of § 83 is treated as be-ing equal to its liquidation value (zero). Therefore,SP does not recognize compensation income under§ 83(a) as a result of the transfer, PRS is not entitledto a deduction, and SP is not entitled to a capital ac-count balance.

(2) Example 2: Substantially Vested InterestFacts: PRS has two partners, A and B, each with

a 50% interest in PRS. On March 1, 2005, SP paysthe partnership $10 and agrees to perform servicesfor the partnership in exchange for a 10% partner-ship interest that is treated as substantially vested un-der section 4.03 of this revenue procedure. Immedi-ately before SP’s $10 payment to PRS and the transferof the partnership interest to SP in connection withthe performance of services, the value of the part-nership’s assets (including goodwill, going concernvalue, and any other intangibles associated with thepartnership’s operations) is $990.

Conclusion: Under section 4.02 of this revenueprocedure, the fair market value of SP’s interest inPRS at the time the interest becomes substantiallyvested is treated as being equal to its liquidationvalue at that time for purposes of § 83. Therefore, in2005, SP includes $90 ($100 liquidation value less$10 amount paid for the interest) as compensationincome under § 83(a), PRS is entitled to a deductionof $90 under § 83(h), and SP’s initial capital accountis $100 ($90 included in income plus $10 amountpaid for the interest).

(3) Example 3: Substantially Nonvested Interest;No § 83(b) Election; Pre-Existing Partner

Facts: PRS has two partners, A and SP, each witha 50% interest in PRS. On December 31, 2004, SPagrees to perform services for the partnership in ex-change for a 10% increase in SP’s interest in the part-nership from 50% to 60%. SP is not required topay any amount in exchange for the additional 10%interest. Under the terms of the partnership agree-ment, if SP terminates services on or before January1, 2008, SP forfeits any right to any share of accumu-lated, undistributed profits with respect to the addi-tional 10% interest. The partnership interest trans-ferred to SP is not transferable and no election ismade under § 83(b). SP continues performing ser-vices through January 1, 2008. PRS has taxable in-come of $500 in 2005 and $1,000 in each of 2006and 2007. No distributions are made to A or SP dur-ing such period. On January 1, 2008, the value of thepartnership’s assets (including goodwill, going con-cern value, and any other intangibles associated withthe partnership’s operations) is $3,500.

Conclusion: Under section 4.03 of this revenueprocedure, the 10% partnership interest transferred toSP on December 31, 2004, is treated as substantiallynonvested at the time of transfer. Because a § 83(b)election is not made, SP does not include any amountas compensation income attributable to the transfer,

and correspondingly, PRS is not entitled to a deduc-tion under § 83(h).

In accordance with the partnership agreement,PRS’s taxable income for 2005 is allocated $250 to Aand $250 to SP, and PRS’s taxable income for eachof 2006 and 2007 is allocated $500 to A and $500 toSP.

On January 1, 2008, SP’s additional 10% inter-est in PRS is treated as becoming substantially vestedunder section 4.03 of this revenue procedure. At thattime, the additional 10% interest in the partnershiphas a liquidation value of $350 (10% of $3,500). Un-der section 4.02 of this revenue procedure, the fairmarket value of the interest at the time it becomessubstantially vested is treated as being equal to itsliquidation value at that time for purposes of § 83.Therefore, in 2008, SP includes $350 as compensa-tion income under § 83(a), PRS is entitled to a deduc-tion of $350 under § 83(h), and SP’s capital accountis increased by $350.

(4) Example 4: Substantially Nonvested Interest;No § 83(b) Election

Facts: PRS has two partners, A and B, each witha 50% interest in PRS. On December 31, 2004, SPpays the partnership $10 and agrees to perform ser-vices for the partnership in exchange for a 10% part-nership interest. Under the terms of the partnershipagreement, if SP terminates services on or before Jan-uary 1, 2008, SP forfeits any rights to any share ofaccumulated, undistributed profits, but is entitled toa return of SP’s $10 initial contribution. SP’s part-nership interest is not transferable and no election ismade under § 83(b). SP continues performing ser-vices through January 1, 2008. PRS earns $500 oftaxable income in 2005, and $1,000 in each of 2006and 2007. A and B each receive distributions of $225in 2005, but neither A nor B receive distributions in2006 and 2007. PRS transfers $50 to SP in 2005, butdoes not make any transfers to SP in 2006 or 2007.On January 1, 2008, SP’s partnership interest has aliquidation value of $300 (taking into account the un-paid partnership income credited to SP through thatdate).

Conclusion: Under section 4.03 of this revenueprocedure, SP’s partnership interest is treated as sub-stantially nonvested at the time of transfer. Becausea § 83(b) election is not made, SP does not includeany amount as compensation income attributable tothe transfer and, correspondingly, PRS is not enti-tled to a deduction under § 83(h). Under proposed§ 1.761–1(b), SP is not a partner in PRS; therefore,none of PRS’s taxable income for the years in whichSP’s interest is substantially nonvested may be allo-cated to SP. Rather, PRS’s taxable income is allocatedexclusively to A and B. In addition, the $50 paid byPRS to SP in 2005 is compensation income to SP, andPRS is entitled to a deduction of $50 under § 162 inaccordance with its method of accounting.

On January 1, 2008, SP’s interest in PRS is treatedas becoming substantially vested under section 4.03of this revenue procedure. Under section 4.02 of thisrevenue procedure, the fair market value of the in-terest at the time the interest becomes substantiallyvested is treated as being equal to its liquidation valueat that time for § 83 purposes. Therefore, in 2008,SP includes $290 ($300 liquidation value less $10amount paid for the interest) as compensation incomeunder § 83(a), PRS is entitled to a $290 deduction,and SP’s capital account is increased to $300 ($290

included in income plus $10 amount paid for the in-terest).

(5) Example 5: Substantially Nonvested Interest;§ 83(b) Election

Facts: The facts are the same as in Example 4,except that SP makes an election under § 83(b) withrespect to SP’s interest in PRS. The liquidation valueof the interest is $100 at the time the interest in PRSis transferred to SP. SP continues performing servicesthrough January 1, 2008.

Conclusion: Under section 4.02 of this revenueprocedure, the fair market value (disregarding lapserestrictions) of SP’s interest in PRS at the time oftransfer is treated as being equal to its liquidationvalue (disregarding lapse restrictions) at that time for§ 83 purposes. Because a § 83(b) election is made,in 2004 SP includes $90 ($100 liquidation value less$10 amount paid for the interest) as compensation in-come, PRS is entitled to a $90 deduction, and SP’sinitial capital account is $100 ($90 included in SP’sincome plus $10 amount paid for the interest). Un-der proposed § 1.761–1(b), as a result of SP’s elec-tion under § 83(b), SP is treated as a partner startingfrom the date of the transfer of the interest to SP. Ac-cordingly, SP includes in 2005 taxable income SP’s$50 distributive share of PRS income, and the $50payment to SP by PRS in 2005 is a partnership dis-tribution under § 731. SP includes in 2006 and 2007taxable income SP’s $100 distributive shares of PRSincome for those years.

(6) Example 6: Substantially Nonvested Interest;§ 83(b) Election; Forfeiture; Net Profit

Facts: The facts are the same as in Example 5,except that SP terminates services on September 30,2007, and is repaid the $10 that SP paid for the PRSinterest in 2004. The partnership agreement providesthat if SP’s partnership interest is forfeited, SP’s dis-tributive share of all partnership items (other than for-feiture allocations) will be zero with respect to the in-terest for the taxable year of the partnership in whichthe interest is forfeited.

Conclusion: The tax consequences for 2004through 2006 are the same as in Example (5). Asa result of the forfeiture in 2007, PRS is requiredunder § 1.83–6(c) to include in gross income $90 (theamount of the allowable deduction on the transfer ofthe interest to SP). In accordance with the partnershipagreement, PRS also makes forfeiture allocations in2007 to offset partnership income and loss that wasallocated to SP and partnership distributions to SPprior to the forfeiture. Cumulative net income of$150 was allocated to SP prior to the forfeiture ($50in 2005 and $100 in 2006) and SP received a total of$60 of distributions from PRS ($50 in 2005 and $10in 2007 (the repayment of SP’s initial contribution toPRS)). Under proposed § 1.704–1(b)(4)(xii), the totalforfeiture allocations to SP is $100 of partnershiploss and deduction, the difference between $50 ($60of distributions to SP less $10 of contributions to PRSby SP) and $150 (cumulative net income allocated toSP). Pursuant to the partnership agreement, none ofthe partnership income for the year 2007 is allocatedto SP. In accordance with § 83(b)(1) (last sentence),SP does not receive a deduction or capital loss for theamount ($90) that was included as SP’s compensa-tion income as a result of the election under § 83(b).

(7) Example 7: Substantially Nonvested Interest;§ 83(b) Election; Forfeiture; Net Loss

2005–24 I.R.B. 1227 June 13, 2005

Facts: PRS has two partners, A and B, each witha 50% interest in PRS. On December 31, 2004, SPpays the partnership $10 and agrees to perform ser-vices for the partnership in exchange for a 10% part-nership interest. Under the terms of the partnershipagreement, if SP terminates services before January1, 2008, SP forfeits any right to any share of accu-mulated, undistributed profits, but is entitled to a re-turn of SP’s $10 initial contribution. SP’s partnershipinterest is not transferable. The partnership agree-ment provides that if SP’s partnership interest is for-feited, SP’s distributive share of all partnership items(other than forfeiture allocations) will be zero withrespect to the interest for the taxable year of the part-nership in which the interest is forfeited. At the timeof the transfer, the liquidation value of the 10% part-nership interest is $100, and SP makes an election un-der § 83(b) with respect to the interest. In 2005, PRSearns $500 of taxable income, which is allocated anddistributed $225 to each of A and B and $50 to SP.In 2006, PRS has net taxable loss of $1,000, $100 ofwhich is allocated to SP. PRS does not make any dis-tributions in 2006. PRS has no items of income, gain,loss, or deduction in 2007, other than gross incomerecognized under § 1.83–6(c). SP terminates serviceson September 30, 2007, and is repaid the $10 that SPpaid for the PRS interest in 2004. PRS does not makeany distributions in 2007, other than the return of SP’s$10 contribution.

Conclusion: Under section 4.02 of this revenueprocedure, the fair market value (disregarding lapserestrictions) of SP’s interest in PRS at the time oftransfer is treated as being equal to its liquidationvalue (disregarding lapse restrictions) at that time forpurposes of § 83. Because a § 83(b) election is made,SP includes as compensation income in 2004 $90($100 liquidation value less $10 amount paid for theinterest), PRS is entitled to a $90 deduction under§ 83(h), and SP’s initial capital account is $100 ($90compensation income plus $10 amount paid for theinterest). Under proposed § 1.761–1(b), as a result ofSP’s election under § 83(b), SP is treated as a partnerstarting from the date of the transfer of the interestto SP. Accordingly, SP includes in 2005 taxable in-come SP’s $50 distributive share of PRS’s income,and the $50 payment to SP in 2005 is a partnershipdistribution under § 731. SP includes in computing2006 taxable income SP’s $100 distributive share ofPRS’s loss.

As a result of the forfeiture in 2007, PRS is re-quired under § 1.83–6(c) to include in gross income$90 (the amount of the allowable deduction on thetransfer of the interest to SP). In accordance with thepartnership agreement, PRS also makes forfeiture al-locations in 2007 to offset partnership income andloss that was allocated to SP and partnership distri-butions to SP prior to the forfeiture. Cumulative netloss of $50 was allocated to SP prior to the forfeiture($50 of income in 2005 and $100 of loss in 2006) andSP received a total of $60 of partnership distributions($50 in 2005 and $10 in 2007 (the repayment of SP’sinitial contribution to PRS)). If PRS had unlimiteditems of gross income and gain, the total forfeiture al-locations to SP under proposed § 1.704–1(b)(4)(xii)would be $100 of partnership income and gain, thedifference between $50 ($60 distributions to SP less$10 of contributions to PRS by SP) and -$50 (cumu-lative net loss allocated to SP). However, PRS’s onlyincome in 2007 is the $90 of income recognized by

PRS under § 1.83–6(c), all of which must be used tomake forfeiture allocations to SP. Under section 4.04of this revenue procedure, in 2007, SP must include inordinary income $10 (the difference between the for-feiture allocations that would be required under pro-posed § 1.704–1(b)(4)(xii) if PRS had an unlimitedamount of gross income and gain, $100, and the ac-tual forfeiture allocations to SP, $90). PRS is not en-titled to a deduction for the amount ($10) that SP isrequired to include in income under section 4.04 ofthis revenue procedure.

SECTION 7. EFFECT ON OTHERDOCUMENTS

Rev. Proc. 93–27, 1993–2 C.B. 343,and Rev. Proc. 2001–43, 2001–2 C.B.191, are obsoleted.

Deductions for EntertainmentUse of Business Aircraft

Notice 2005–45

This notice provides interim guid-ance to taxpayers on the limitation under§ 274(e) of the Internal Revenue Code onthe deductible amount of trade or businessexpenses for use of a business aircraftfor entertainment. Section 274(e) wasamended by § 907 of the American JobsCreation Act of 2004 (AJCA), effectivefor amounts incurred after October 22,2004. The rules provided in this noticeapply until regulations are effective.

A. BACKGROUND

Under § 274(a)(1)(A), no deduction isallowed for an activity generally consid-ered to be entertainment, amusement, orrecreation, unless the taxpayer establishesthat the activity is directly related to or (incertain cases) associated with the activeconduct of the taxpayer’s trade or busi-ness. Section 274(a)(1)(B) disallows de-ductions for facilities used in connectionwith entertainment, amusement, or recre-ational activity, regardless of connection tothe taxpayer’s trade or business.

Section 1.274–2(b)(1) of the IncomeTax Regulations provides that entertain-ment means any activity of a type gen-erally considered to constitute entertain-ment, amusement, or recreation, suchas entertaining at night clubs, cocktaillounges, theaters, country clubs, golf andathletic clubs, sporting events, and onhunting, fishing, vacation and similar

trips. Similar activities relating solely tothe taxpayer’s family also may constituteentertainment. Entertainment may includean activity that satisfies the personal, liv-ing, or family needs of an individual,such as providing food and beverages ora hotel suite to a business customer or thecustomer’s family. Entertainment doesnot include activities, however, that areclearly not regarded as constituting enter-tainment, such as the provision of suppermoney by an employer to an employeeworking overtime, the maintenance of ahotel room by an employer for lodging ofemployees while in business travel status,or the use of an automobile in the activeconduct of a trade or business even thoughalso used for routine personal purposessuch as commuting to and from work. Un-der § 1.274–2(b)(1)(ii), an objective test isused to determine whether an activity is ofa type generally considered to constituteentertainment.

Section 274(e) provides exceptionsto the general disallowance provisionsof § 274(a). Prior to amendment by theAJCA, § 274(e)(2) excepted expensesfrom § 274(a) “to the extent that the ex-penses are treated by the taxpayer” ascompensation to the employee/recipientof the entertainment activity. Section274(e)(9) similarly excepted expenses tothe extent that the expenses are treated bythe taxpayer as income to persons who arenot employees.

Section 274(o) provides that the Secre-tary shall prescribe regulations necessaryto carry out the purposes of the section.

Generally, § 1.61–21(b) requires anemployee to include in gross incomethe fair market value of a fringe benefit,such as an entertainment flight (reducedby any reimbursement or statutory ex-clusion). For employee flights on em-ployer-provided noncommercial aircraft,§ 1.61–21(g) provides that an employermay value such flights using the Stan-dard Industry Fare Level (SIFL) formula.Under § 1.61–21(g)(14)(i), an employerthat uses the SIFL formula in a calendaryear to value any flight provided to anemployee during a calendar year mustuse the SIFL formula to value all flightsprovided to employees during that calen-dar year. The fringe benefit rules under§ 1.61–21(g) generally apply to all serviceproviders, including employees, indepen-dent contractors, partners, and directors.

June 13, 2005 1228 2005–24 I.R.B.

The regulations do not permit valuationof a flight by reference to the employer’scosts.

Ann. 85–113, 1985–31 I.R.B. 31, al-lows an employer to elect the frequency atwhich in-kind fringe benefits are treated aspaid. The benefits must be treated as paidno later than the end of each calendar year,but in-kind fringe benefits provided duringthe last two months of a calendar year maybe treated as paid during the subsequentcalendar year. See Ann. 85–113, sections1 and 5(a).

In Sutherland Lumber-Southwest, Inc.v. Comm’r, 114 T.C. 197 (2000), aff’d255 F.3d 495 (8th Cir. 2001), acq. AOD2002–02 (Feb. 11, 2002), the Tax Courtheld that the amount a taxpayer maydeduct for the cost of entertainment-re-lated flights under the § 274(e)(2) excep-tion is not limited to the amount includedin the income of the employees and corpo-rate officers who took the flights. Rather,the court held that a taxpayer may deductthe full cost of an employee’s or offi-cer’s non-business flight on the taxpayer’saircraft if the taxpayer includes in the re-cipient’s income the value of the flightscomputed under the rules of § 1.61–21.As a result, a deduction greater than theamount included in the recipient’s incomewas allowable.

The ACJA amendment to § 274(e)(2)and (9) is intended to overturn SutherlandLumber-Southwest, Inc. v. Comm’r. H.R.Conf. Rep. No. 108–755, at 798 (2004).Specifically, as amended by § 907 of theAJCA, the § 274(e)(2) and (9) exceptionsto the § 274(a) disallowance apply in thecase of a “specified individual” only “tothe extent that the expenses do not exceedthe amount of expenses” that are treatedas compensation to the specified individ-ual. A specified individual is any individ-ual who is subject to the requirements of§ 16(a) of the Securities Exchange Act of1934 (15 U.S.C. § 78p(a)) with respect tothe taxpayer, or who would be subject tothose requirements if the taxpayer were anissuer of equity securities referred to in thatsection. Section 274(e)(2)(B).

Thus, in the case of a specified indi-vidual, the § 274(e)(2) and (9) exceptionsapply only to the extent that a taxpayertreats as compensation to the specified in-dividual an amount equal to or greater thanthe amount of deductible entertainment ex-penses allocable to entertainment provided

to the specified individual. Expenses al-locable to entertainment provided to thespecified individual that are not treated ascompensation to the specified individualare disallowed.

This notice specifically addresses ex-penses paid or incurred in connection withthe use of aircraft as entertainment. Sec-tion 274(e)(2) and (9), however, apply toall expenses subject to § 274(a). Taxpay-ers may apply the principles of this noticeto expenses paid or incurred in connectionwith other entertainment activities.

B. APPLICATION

(1) In general

In general, the use of an aircraft for anemployee’s or other recipient’s entertain-ment, amusement, or recreation is subjectto § 274(a) unless excepted by § 274(e).Expenses for entertainment use of an air-craft by a specified individual are disal-lowed except to the extent of the amounttreated as compensation to the specified in-dividual, as provided in this notice. Theamount disallowed with regard to a spe-cific flight also is reduced by any amountthat a specified individual reimburses thetaxpayer for that flight.

(2) Use of aircraft for entertainment

Whether an aircraft is used for enter-tainment of a specified individual is deter-mined without regard to the ownership ofthe aircraft. Therefore, the costs of leasedor chartered aircraft are subject to disal-lowance under § 274(a) (unless exceptedby § 274(e)) and this notice. Furthermore,§ 274(a) and (e) and this notice apply tothe costs of aircraft operated on a regu-lar schedule or used for bona fide securityconcerns (as provided in § 1.132–5(m)).

(3) Specified individuals

A “specified individual” is either an in-dividual who is subject to § 16(a) of theSecurities Exchange Act of 1934 with re-spect to the taxpayer, or an individual whowould be subject to § 16(a) if the taxpayerwere an issuer of equity securities referredto in that section. “Specified individual”includes every person who (a) is the director indirect beneficial owner of more than10 percent of any class of any registeredequity security (other than an exempted se-

curity), (b) is a director or officer of the is-suer of the security, (c) would be the director indirect beneficial owner of more than10 percent of any class of a registered eq-uity security if the taxpayer were an issuerof equity securities, or (d) is comparable toan officer or director of an issuer of equitysecurities. Thus, a “specified individual”is an officer, director, or more than 10%owner of a corporation taxed under sub-chapter C or subchapter S, or a personalservice corporation. For partnership pur-poses, “specified individual” includes anypartner that holds a more than 10% equityinterest in the partnership, general partner,officer, or managing member of a partner-ship. “Specified individual” also includesa director or officer of a tax-exempt entity.

The provisions of this notice apply tothe use of an aircraft for the entertain-ment of a specified individual of a partyrelated to the taxpayer within the meaningof § 267(b) or § 707(b). Thus, if X and Yare related corporations within the mean-ing of § 267(b) and Y provides entertain-ment use of an aircraft to A, who is a speci-fied individual as to X, Y’s costs are disal-lowed (except to the extent treated as com-pensation to A or reimbursed by A) under§ 274(e)(2)(B).

For purposes of this notice, a speci-fied individual is the recipient of entertain-ment provided to a spouse or family mem-ber of the specified individual or to an-other person because of the person’s rela-tionship to the specified individual. See§ 1.61–21(a)(4). Thus, costs allocable toentertainment provided to a spouse, familymember, or other person are attributed tothe specified individual for purposes of de-termining the amount of disallowed costs.As used hereafter in this notice, the term“specified individual” includes any personto whom a taxpayer has provided enter-tainment that is attributable to a specifiedindividual under this paragraph.

(4) Expenses of aircraft subject todisallowance

For purposes of calculating the amountof expenses for entertainment use of anaircraft that are disallowed (except to theextent treated as compensation to or re-imbursed by a specified individual) under§ 274(e)(2)(B) or (9), taxpayers must takeinto account all of the expenses of main-taining and operating the aircraft (all fixed

2005–24 I.R.B. 1229 June 13, 2005

and operating costs). These expenses in-clude, but are not limited to, fuel costs;salaries for pilots, maintenance personnel,and other personnel assigned to the air-craft; meal and lodging expenses of flightpersonnel; take-off and landing fees; costsfor maintenance and maintenance flights;costs of on board refreshments, amenities,or gifts; hangar fees (at home or away);management fees; depreciation; amountsdeductible under § 179; in the case of char-tered aircraft, all costs billed for the charter(including amounts for flight time, waitingtime, fuel, and overnight expenses); and,in the case of leased aircraft or other leasedequipment, lease payments.

(5) Method of allocating expenses toflights

For purposes of § 274(e)(2)(B) and (9),the total deductible expenses attributableto the aircraft must be allocated to ex-penses for use of the aircraft for entertain-ment of specified individuals and expensesfor all other uses. A taxpayer must allocateexpenses for each taxable year using eitheroccupied seat hours or occupied seat milesflown by the aircraft and must apply thechosen method consistently for all usagefor the taxable year. Occupied seat hoursor miles is the sum of the hours or milesflown by an aircraft multiplied by the num-ber of seats occupied for each hour or mile.For example, a flight of 6 hours with threepassengers aboard results in 18 occupiedseat hours. See the special rule for “dead-head” flights, below.

Taxpayers must aggregate all fixed andvariable expenses to determine the totalexpenses paid or incurred during the tax-able year and divide the amount of total ex-penses by total occupied seat hours or oc-cupied seat miles flown to determine thecost per occupied seat hour or occupiedseat mile. Taxpayers may calculate thecost per occupied seat hour or occupiedseat mile separately for each aircraft ormay aggregate the costs of aircraft of simi-lar cost profiles. For example, the costs ofa turboprop aircraft may not be aggregatedwith the costs of a jet aircraft and the costsof a two-engine jet aircraft may not be ag-gregated with the costs of a four-engine jetaircraft.

The amount disallowed under § 274 isthe sum of (a) the cost of each occupiedseat hour (or mile) flown by a specified

individual for entertainment purposes, less(b) the sum of the amount treated as com-pensation and the amount reimbursed foreach specified individual and each flight.Therefore, to determine the amount sub-ject to disallowance, taxpayers must al-locate the costs to the specific entertain-ment flight provided to a specified individ-ual and compare the cost of each flight tothe amount treated as compensation to orreimbursed by the specified individual forthat flight.

ExampleA taxpayer’s aircraft is used for Flights 1, 2, and

3, of 5 hours, 5 hours, and 4 hours, respectively, dur-ing the taxpayer’s taxable year. On Flight 1, thereare four passengers, none of whom are specified in-dividuals or traveling for entertainment. On Flight2, passengers A and B are specified individuals trav-eling for entertainment and passengers C and D arenot specified individuals or are not traveling for en-tertainment. On Flight 3, all four passengers (A, B,E, and F) are specified individuals traveling for enter-tainment. The taxpayer incurs $56,000 in expensesfor the operation of the aircraft for the taxable year.

The aircraft is operated for a total of 56 occu-pied seat hours for the period (four passengers times 5hours or 20 occupied seat hours for Flight 1, plus fourpassengers times 5 hours or 20 occupied seat hoursfor Flight 2, plus four passengers times 4 hours or 16occupied seat hours for Flight 3). The cost per occu-pied seat hour is $1,000 ($56,000/56 hours). The totalentertainment usage of the aircraft for specified indi-viduals subject to disallowance is 26 occupied seathours (two passengers for 5 hours each on Flight 2and four passengers for 4 hours each on Flight 3) andthe total cost subject to disallowance is $26,000 (26occupied seat hours X $1,000).

For purposes of determining the amount disal-lowed (to the extent not treated as compensation orreimbursed), $5,000 ($1,000 X 5 hours) each is allo-cable to A and B for Flight 2, and $4,000 ($1,000 X 4hours) each is allocable to A, B, E, and F for Flight 3.

For Flight 2, the taxpayer treats $1,200 (the fairmarket value of the flight) as compensation to A, andB reimburses the taxpayer $500. The taxpayer maydeduct $1,700 of the cost of Flight 2 allocable to Aand B. The deduction for the remaining $8,300 costallocable to entertainment provided to A and B onFlight 2 is disallowed (with respect to A, $5,000 lessthe $1,200 treated as compensation, and with respectto B, $5,000 less the $500 reimbursed). For Flight3, the taxpayer treats $1,300 (the fair market value ofthe flight) each as compensation to A, B, E, and F.The taxpayer may deduct $5,200 of the cost of Flight3. The deduction for the remaining $10,800 cost allo-cable to entertainment provided to A, B, E, and F onFlight 3 is disallowed ($4,000 less the $1,300 treatedas compensation to each specified individual).

(6) Special rule for “deadhead” flights

For purposes of this notice, an aircraftreturning empty from a flight after dis-charging passengers or traveling emptyto pick up passengers (deadheading) is

treated as having the same number andcharacter of occupied seat miles or hoursas the leg or legs of the trip on whichpassengers are aboard.

(7) Allocation of expenses on trips ofa specified individual involving bothbusiness and entertainment

The costs of a flight provided to a spec-ified individual that includes a segment orsegments for business and for entertain-ment must be allocated to the business andentertainment use. The entertainment costis the excess of the total cost of the flights(by occupied seat hours or miles) over thecost of the flights that would have beentaken without the entertainment segmentor segments.

Example. G, a specified individual, is the solepassenger on an aircraft on a two-hour flight fromCity A to City B. The flight from City A to City Bis for business. G then travels on a three-hour flightfrom City B to City C for entertainment purposes, andreturns from City C to City A on a four-hour flight.G’s flights have resulted in nine occupied seat hours(two for the first segment, plus three for the secondsegment, plus four for the third segment). If G hadreturned directly to City A from City B, the flightswould have resulted in four occupied seat hours. Fiveoccupied seat hours are allocable to G’s entertain-ment use of the aircraft (nine total occupied seat hoursless four occupied seat hours). If the taxpayer’s costper occupied seat hour is $1,000, $5,000 must be allo-cated to G’s entertainment use of the aircraft ($1,000X five occupied seat hours). The amount disallowedis $5,000 less any amount the taxpayer treats as com-pensation to G or G reimburses the taxpayer for thisflight.

(8) Non-commercial flight valuationconsistency rule

Under § 1.61–21(g)(14)(i), a taxpayerwho uses the SIFL formula in a calendaryear to value any flight provided to an em-ployee must use the SIFL formula to valueall flights provided to employees duringthat calendar year. The Internal RevenueService and the Treasury Department planto amend these regulations to permit tax-payers to value the entertainment use ofaircraft by specified individuals under thefair market value rules of § 1.61–21(b), butcontinue to value flights for other employ-ees and for specified individuals not trav-eling for entertainment using the SIFL for-mula. Until regulations are published, tax-payers may rely on this notice to allow thisinconsistency in the treatment of specifiedand non-specified individuals for incomeinclusion purposes. If the amount treated

June 13, 2005 1230 2005–24 I.R.B.

as compensation is greater than the amountof the taxpayer’s costs (as determined un-der this notice) for a flight, however, thetaxpayer’s deduction is limited to the tax-payer’s costs.

(9) Interaction with § 162(m)

Any amount for the entertainment useof an aircraft that is treated by the tax-payer as compensation to a specified indi-vidual who is also a “covered employee”(as defined in § 162(m)(3)) is subject to§ 162(m). Thus, to the extent the coveredemployee’s “applicable employee remu-neration” (as defined in § 162(m)(4)), in-cluding remuneration related to entertain-ment, exceeds $1,000,000, the taxpayer’sdeduction is disallowed under § 162(m).

(10) Costs treated as compensation

The amount of costs to which this noticeapplies is reduced by an amount treatedas compensation to a specified individ-ual who is an employee of the taxpayer ifthe amount is treated as compensation forthe flight on the taxpayer’s income tax re-turn as originally filed and as wages forpurposes of chapter 24 (relating to with-holding of income tax at the source onwages). See § 1.274–2(f)(2)(iii)(A) andAnn. 85–113. For a specified individ-ual who is not the taxpayer’s employee,costs are treated as compensation if theamount for the flight is included in an in-formation return under Part III of subchap-ter A of chapter 61 (unless not required tobe reported under those provisions). See§ 1.274–2(f)(2)(iii)(B).

C. REQUEST FOR COMMENTS

The Service and the Treasury Depart-ment request comments on issues arisingunder this notice. Comments should besubmitted in writing on or before August1, 2005, and should include a referenceto Notice 2005–45. Comments may besubmitted to CC:PA:LPD:PR (Notice2005–45), Room 5203, Internal RevenueService, P.O. Box 7604, Ben FranklinStation, Washington, DC 20044. Alterna-tively, comments may be submitted elec-tronically via the following e-mail address:[email protected] include “Notice 2005–45” in thesubject line of any electronic communica-tions.

Submissions may be hand deliveredMonday through Friday between the hoursof 8 a.m. and 4 p.m. to CC:PA:LPD:PR(Notice 2005–45), Courier’s Desk, Inter-nal Revenue Service, 1111 ConstitutionAvenue, NW, Washington, DC 20224. Allcomments are available for public inspec-tion and copying.

D. EFFECTIVE DATE

This notice applies to expenses incurredafter June 30, 2005. The Service will notchallenge a reasonable method of deter-mining disallowed expenses incurred afterOctober 22, 2004, and before July 1, 2005.Application of this notice to determine dis-allowed expenses is a reasonable method.

E. TRANSITION RULE FORREPORTING DISALLOWEDEXPENSES

A taxpayer that incurs expenses towhich § 274(e), as amended by the AJCA,applies in a taxable year ending after Oc-tober 22, 2004, but on or before May27, 2005, may apply the disallowanceof expenses for that taxable year againstexpenses incurred in the taxpayer’s firsttaxable year ending after May 27, 2005.Thus, for example, a calendar year tax-payer may choose to adjust its taxableincome either (a) for its 2005 taxable yearto reflect the disallowance of expenses towhich this notice applies that are incurredafter October 22, 2004, and before January1, 2006, or (b) for its 2004 taxable yearto reflect the disallowance of the portionof the expenses incurred after October 22,2004, and before January 1, 2005, and forits 2005 taxable year to reflect the disal-lowance of the portion of the expensesincurred after December 31, 2004, andbefore January 1, 2006.


The principal author of this notice isMichael A. Nixon of the Office of theAssociate Chief Counsel (Income Tax &Accounting). For further information re-garding this notice, contact Mr. Nixon orChristian Wood at (202) 622–4930 (not atoll-free call).

26 CFR 601.106: Appeals functions.(Also Part I, §§ 6166, 7479.)

Rev. Proc. 2005–33

SECTION 1. PURPOSE

This revenue procedure provides guid-ance on exhausting administrative reme-dies prior to seeking a declaratory judg-ment pursuant to section 7479 of the In-ternal Revenue Code. A declaratory judg-ment may be requested from the UnitedStates Tax Court when an executor hasmade an election under section 6166 to ex-tend the time for payment of estate tax withrespect to an interest in a closely held busi-ness, and the Internal Revenue Service has(1) made a determination that the electioncannot be made with respect to the estateor with respect to any property includedtherein, (2) failed to make a determinationwith respect to the estate or with respect toany property included therein within 180calendar days after the executor’s filing ofthe election, or (3) made a determinationthat the extension of time for payment un-der section 6166 has ceased to apply withrespect to the estate or with respect to anyproperty included therein.

SECTION 2. DEFINITIONS

For purposes of this revenue proce-dure—

(1) any reference to “executor” refers tothe executor as defined in section 2203;

(2) any reference to “applicant” refersto the person (or persons) authorized to filea petition with the Tax Court pursuant tosection 7479;

(3) any reference to “determination”refers to a determination by the Service asto whether an election may be made un-der section 6166 for one or more closelyheld business interests or whether a validelection under section 6166 to extend thetime for payment has ceased to apply;such term, however, does not includea private letter ruling, technical advicememorandum, or technical expedited ad-vice memorandum issued by the Office ofChief Counsel;

(4) any reference to a “request for adetermination” refers to an election filedunder section 6166(a) (and, if applicable,an election under section 6166(b)(7), (8) or(10)) or section 6166(h);

2005–24 I.R.B. 1231 June 13, 2005

(5) any reference to a “preliminary de-termination letter” refers to a Letter 950issued by the Service (also known as a30-day letter or notice of preliminary de-termination) or a letter issued by the Ser-vice Center which is captioned “prelimi-nary determination letter” and which con-tains a notice of Appeal rights in languagesimilar to that in a Letter 950; and

(6) any reference to a “final determi-nation letter” refers to a Letter 3570, No-tice of Determination As Provided in IRC§ 7479 That Extension of Time for PaymentUnder IRC § 6166 Has Ceased To Apply,or Letter 3571, Notice of DeterminationAs Provided in IRC § 7479 That ElectionUnder IRC § 6166 Has Been Denied, is-sued by the Service (each of which is alsoknown as a 90-day letter or notice of finaldetermination).

SECTION 3. BACKGROUND

.01 Pursuant to section 6166(a), an ex-ecutor may elect to pay part or all of theestate tax in two or more (but not exceed-ing ten) equal installments if: (1) the dece-dent was a citizen or resident of the UnitedStates at the date of death; and (2) the valueincluded in the decedent’s gross estate foreither (i) an interest in a closely held busi-ness or (ii) interests in two or more closelyheld businesses that are treated as an inter-est in a single closely held business pur-suant to section 6166(c), exceeds 35 per-cent of the adjusted gross estate. Section6166(b) sets forth definitions and, in para-graphs (7), (8), and (10), special rules thatallow an executor to make an election topay part or all of the estate tax in install-ments under section 6166(a) in certain cir-cumstances that would not otherwise qual-ify for the election under section 6166(a).Generally, the executor must make an elec-tion under section 6166(a) (and, if applica-ble, an election under section 6166(b)(7),(8) or (10)) no later than the due date forfiling the estate tax return (including anyextensions of time to file). See I.R.C.§ 6166(d).

.02 Section 6166(e) provides that, if anelection was made under section 6166(a)to pay any part of the estate tax in install-ments and a deficiency is assessed, the de-ficiency, subject to applicable limitationson the amount of tax deferred, generallywill be prorated to the installments alreadypaid or due prior to the date the deficiency

is assessed, as well as to the installmentsnot yet due.

.03 After a valid section 6166 election ismade, certain events may trigger the accel-eration of the deferred estate tax payments.Section 6166(g) identifies events that ter-minate the extension of time for paymentand require the payment of the unpaid por-tion of the estate tax upon notice and de-mand.

.04 Under section 6166(h), the executorof an estate may elect to pay in installmentsan assessed deficiency of estate tax for anestate that qualifies under section 6166(a),even though the executor did not make anelection under section 6166(a). The execu-tor must make the section 6166(h) electionwith respect to the deficiency no later than60 calendar days after the Service has is-sued a notice and demand for the paymentof that deficiency.

.05 Section 7479 provides that the TaxCourt may issue a declaratory judgment inthe case of an actual controversy involv-ing a determination by the Service (or afailure of the Service to make a determina-tion within 180 calendar days) with respectto the initial validity of a section 6166election, or a determination by the Ser-vice with respect to the continuing valid-ity of a section 6166 election. Under sec-tion 7479(b)(2), however, the Tax Courtmay not issue a declaratory judgment un-less the applicant has exhausted all ad-ministrative remedies within the Service.Section 7479(b)(2) further provides that,with respect to a failure of the Service tomake a determination, an applicant shallbe deemed to have exhausted the appli-cant’s administrative remedies upon theexpiration of 180 calendar days after therequest for such determination was made,provided that the applicant has taken in atimely manner all reasonable steps to se-cure that determination.

.06 Rule 210(c) of the Tax Court Rulesof Practice and Procedure provides that theTax Court will not have jurisdiction overan action for declaratory judgment unlessthe Service has issued a determination let-ter, or the Service has been requested tomake a determination and has failed to doso for a period of at least 180 calendardays after the request for such determina-tion was made. For information relating tothe filing of a petition with the Tax Courtfor a declaratory judgment under section7479, see Tax Court Rule 211(f).

SECTION 4. EXHAUSTION OFADMINISTRATIVE REMEDIES

.01 Actions Required to be Taken. Sec-tion 7479(b)(2) provides that the Tax Courtshall not issue a declaratory judgment ordecree in any section 7479 proceedingunless the applicant has exhausted allavailable administrative remedies withinthe Service. See also Tax Court Rule210(c)(4). The reasonable steps requiredto be taken by the applicant, whether thepetition is based on the Service’s deter-mination or the Service’s failure to makea determination, are listed below. All ofthese steps need not be completed by thesame person. The actions taken (and no-tices received) by the executor, as well asany actions taken (and notices received)by others, will be attributed to, and thusdeemed to have been performed (or re-ceived) by, the applicant.

(1) The executor must timely file (in-cluding extensions of time to file grantedby the Service) a Form 706, United StatesEstate (and Generation-Skipping Trans-fer) Tax Return, on behalf of the estateand attach the election to extend the timeto pay pursuant to section 6166(a) (and,if applicable, an election under section6166(b)(7), (8) or (10)). In the case ofa deficiency assessed with respect to anestate for which the executor did not makea section 6166 election on the Form 706, ifthe executor wishes to pay the deficiencyin installments, the executor must electto extend the time to pay the deficiencypursuant to section 6166(h) by filing anotice of election with the Service within60 calendar days after the date that noticeand demand for payment of the deficiencyis made.

(a) If the election is tentatively denied inwhole or in part, or if the Service proposesunder section 6166(g) to terminate an elec-tion, the Service will issue a preliminarydetermination letter to the applicant, advis-ing the applicant of the applicant’s right toappeal the determination by requesting aconference with the Service’s Appeals Of-fice (an “Appeals conference”).

(b) Similarly, if during the Service’sexamination of the Form 706, the Ser-vice concludes that an election should havebeen denied, the Service will issue a pre-liminary determination letter to the appli-cant, advising the applicant of the appli-

June 13, 2005 1232 2005–24 I.R.B.

cant’s right to appeal the determination byrequesting an Appeals conference.

(2) The applicant must request, in writ-ing, an Appeals conference within 30 cal-endar days after the mailing date of the pre-liminary determination letter, or by suchlater date for responding to the prelimi-nary determination letter as is agreed to be-tween the applicant and the Service. Theapplicant must participate fully in an Ap-peals conference, including, without lim-itation, submitting all additional informa-tion related to the section 6166 determina-tion (if any) that is requested by the Ser-vice in connection with (or as a follow-upto) the Appeals conference.

(a) If the applicant does not timely re-quest an Appeals conference and fully par-ticipate in any conference that is held, theapplicant will not be deemed to have ex-hausted all administrative remedies.

(b) Appeals conferences may be con-ducted by telephone, correspondence,face-to-face meetings, or by a combina-tion of these methods.

(c) Upon reaching a final decision, Ap-peals will issue a final determination letterto the applicant. The determination by Ap-peals, regarding the estate’s initial or con-tinuing eligibility under section 6166, is fi-nal and may not be appealed further withinthe Service.

.02 When Remedies Deemed Ex-hausted. An applicant will be deemedto have exhausted all administrative reme-dies upon the applicant’s completion ofthe actions in section 4.01 of this rev-enue procedure and the expiration of areasonable time for the Service to issuea final determination letter subsequent tothe Appeals conference. For this purpose,a reasonable time shall be deemed to haveexpired on the 61st calendar day after thelater of the date of the Appeals conferenceor the date of receipt by Appeals of theapplicant’s submission of all additionalinformation requested, if any.

.03 Remedies Deemed Exhausted With-out Appeals Conference. An applicantwho has taken all reasonable steps tosecure the determination as provided insection 4.01 of this revenue procedure willbe deemed to have exhausted all admin-istrative remedies within the Service forpurposes of section 7479 in the followingsituations:

(1) upon the issuance of a final determi-nation letter, if the applicant did not pre-

viously receive a preliminary determina-tion letter, provided that the failure to re-ceive the preliminary determination letterwas not due to actions or inactions of theapplicant (such as a failure to supply re-quested information or a current mailingaddress to the Service);

(2) upon the expiration of 180 calendardays after the date on which the request fora determination was made, if the applicanthas received neither a preliminary determi-nation letter nor a final determination letterwithin that period, provided that the failureto receive any such letter was not due to ac-tions or inactions of the applicant; or

(3) upon the expiration of a reasonableperiod of time that is not less than 61 cal-endar days after a timely request for an Ap-peals conference was made in response toa preliminary determination letter, duringwhich the Service has failed to respond tothe request for an Appeals conference.

SECTION 5. EXAMPLES

The following examples illustrate theexhaustion of administrative remedies re-quirement, but do not address any otherpossible jurisdictional defects.

.01 Example 1: The executor timely files a Form706 and makes an election under section 6166(a)(1).The Service issues a preliminary determination letter,tentatively granting the election. The Service subse-quently conducts an examination of the estate’s Form706, determines that the estate is not entitled to paythe tax in installments pursuant to section 6166, andsends a second preliminary determination letter to theexecutor denying the election. The applicant, within30 calendar days after the mailing date of the secondpreliminary determination letter, submits a written re-quest for an Appeals conference. The applicant pro-vides all materials requested by Appeals in a timelyfashion. Appeals denies the election and sends the ap-plicant a final determination letter. Upon the issuanceof the final determination letter, the applicant has ex-hausted all available administrative remedies withinthe Service.

.02 Example 2: The executor timely files a Form706, makes elections under section 6166(a) and sec-tion 6166(b)(8), and tenders with the return the firstinstallment payment of the tax. The executor receivesevidence of the Service’s receipt of the Form 706(i.e., a date-stamped receipt from hand-carrying thereturn in accordance with Treas. Reg. §§ 20.6091–1or 20.6091–2, a return receipt from certified or regis-tered mail, a certification by a private delivery serviceof receipt of a signature upon delivery to the Service,or a written or other subsequent acknowledgment ofreceipt from the Service). The applicant does not re-ceive any correspondence from the Service relating tothe request for a determination. On the 181st calendarday after the filing of the Form 706, the applicant filesa petition with the Tax Court requesting a declaratoryjudgment pursuant to section 7479. Due to the failure

of the Service to make a determination regarding thesection 6166 election within 180 calendar days afterthe filing of the Form 706, the applicant is deemed tohave exhausted all available administrative remedieswithin the Service.

.03 Example 3: The executor timely files a Form706 and makes an election under section 6166(a). Af-ter an examination of the Form 706, the Service issuesa final determination letter recognizing the validityof the election. Subsequently, the Service determinesthat more than 50 percent of the interest in the closelyheld business has been disposed of during the deferralperiod. Pursuant to section 6166(g), the Service is-sues a preliminary determination letter proposing toterminate the section 6166 election. Within 30 cal-endar days after the mailing date of the preliminarydetermination letter, the applicant submits a writtenrequest for an Appeals conference. The applicanttimely provides all requested information to Appeals.After considering the information provided, Appealsissues a final determination letter that the extensionpreviously granted has ceased to apply. The appli-cant has exhausted all available administrative reme-dies within the Service.

SECTION 6. EFFECTIVE DATE

This revenue procedure is effective forall section 6166 elections filed on or af-ter May 20, 2005. For any section 6166election filed before May 20, 2005, anapplicant may rely on section 4 of thisrevenue procedure to demonstrate thatapplicant has exhausted all administrativeremedies within the Service.


The principal author of this revenueprocedure is Tracey B. Leibowitz of theOffice of the Associate Chief Counsel,Procedure and Administration (Admin-istrative Provisions and Judicial PracticeDivision). For further information re-garding this revenue procedure, contactMs. Leibowitz at (202) 622–4940 (not atoll-free call).

26 CFR 601.104: Collection functions.(Also Part I, §§ 6672; 301.6672.)

Rev. Proc. 2005–34

SECTION 1. PURPOSE

This revenue procedure sets forth up-dated procedures for appeals of proposedtrust fund recovery penalty assessmentsarising under section 6672 of the InternalRevenue Code.

2005–24 I.R.B. 1233 June 13, 2005

SECTION 2. BACKGROUND

.01 Section 6672(a) imposes a penaltyagainst any person required to collect,truthfully account for, and pay over anytax imposed by the Code who willfullyfails to collect, or truthfully account forand pay over the tax, or who willfullyattempts in any manner to evade or defeatthe tax.

.02 Under section 6671(b), the term“person” includes an officer or employeeof a corporation or a member or employeeof a partnership, who, as an officer, em-ployee, or member of the corporation orpartnership, is under a duty to performthe act in respect of which the violationoccurs.

.03 Section 6672(b), as amended by theTaxpayer Bill of Rights 2, Pub. L. No.104–168, 110 Stat. 1465 (TBOR 2), pro-vides that the Internal Revenue Service isrequired to send a notice of proposed as-sessment to any taxpayer against whomit intends to assess a trust fund recoverypenalty. In this context, section 6672(b)uses the broader term “taxpayer” becausethe notice of proposed assessment must besent to taxpayers who may not ultimatelyfit within the definition of “person” as setforth in section 6671(b) and as used in sec-tions 6672(a), (c), (d) and (e).

.04 Rev. Proc. 84–78, 1984–2 C.B.754, which sets forth procedures for appealof the trust fund recovery penalty, does notreflect the amendments made to section6672 by TBOR 2.

SECTION 3. SCOPE

The procedures in this revenue proce-dure apply to trust fund recovery penaltycases relating to employment and excisetaxes imposed under the Internal RevenueCode, except when collection is in jeop-ardy.

See section 6672(c) for procedures re-lating to a stay of collection if a bond isfurnished. See section 6672(d) for provi-sions regarding the right to contribution ifmore than one person is liable for the trustfund recovery penalty. See section 6672(e)for rules regarding the exception for volun-tary board members of tax-exempt organi-zations.

SECTION 4. PROCEDURE IN AREACOLLECTION DIVISIONS

.01 If the Service determines that a tax-payer is liable for the trust fund recoverypenalty, the Service will propose the as-sessment of the penalty and inform the tax-payer of the determination by notice. Thenotice of proposed assessment will pro-vide the taxpayer an opportunity to sign aform agreeing to the proposed assessmentor to dispute the proposed assessment byappealing the proposed assessment within60 days of the date on the notice (75 daysif the notice is addressed to the taxpayeroutside of the United States) and request-ing an Appeals conference.

.02 The Service will assess the penaltyif the taxpayer fails to appeal the proposedassessment within the period specified inSection 4.01 of this revenue procedureand the Service has not received a signedagreement from the taxpayer agreeing tothe assessment. If the taxpayer submits atimely appeal in response to the notice ofproposed assessment and requests that thecase be referred to Appeals, the case willbe reviewed in the appropriate complianceoffice to determine whether further actionor development is required before refer-ring the case to Appeals.

SECTION 5. PROCEDURE FORAPPEALING A PROPOSEDASSESSMENT AND REQUESTINGAN APPEALS CONFERENCE

.01 Small Case Appeals. If the pro-posed penalty assessment for any taxperiod is $25,000 or less, the taxpayermay appeal the proposed assessment bycompleting and submitting in writing twocopies of a small case appeal request. Therequest should be mailed to the attentionof the IRS officer or employee named onthe notice of proposed assessment as the“Person to Contact” at the address shownon the front of the notice. The requestmust include the following:

(1) A copy of the notice of proposed as-sessment or the date and number of the no-tice and the taxpayer’s name and social se-curity number, along with any informationthat will help the Service locate the tax-payer’s file;

(2) A statement that the taxpayer is re-questing an Appeals conference; and

(3) A list of the issues that the taxpayeris contesting and an explanation of the ba-sis for the taxpayer’s disagreement. Theexplanation should include the following:

(a) The taxpayer’s duties and responsi-bilities during the tax periods listed in thenotice of proposed assessment. In particu-lar, the taxpayer should describe whetherthe taxpayer had the duty and authorityto collect, account for, and pay over trustfund taxes; and

(b) If the taxpayer contests the Service’scalculation of the penalty, the taxpayershould identify the dates and amounts ofpayments that the taxpayer believes theService failed to consider and/or any com-putational errors made by the Service.

.02 Large Case Appeals. If the pro-posed penalty for any tax period is morethan $25,000, the taxpayer may appeal theproposed assessment by submitting a for-mal written protest. In addition to theitems required by section 5.01(1) and (2)of this revenue procedure, the formal writ-ten protest must include the following:

(1) The tax period(s) involved;(2) A list of the findings the taxpayer is

contesting;(3) A statement of facts that describes

the following:(a) The basis for the taxpayer’s dis-

agreement with the proposed assessment,including specific facts that support thetaxpayer’s arguments;

(b) The taxpayer’s duties and responsi-bilities during the tax periods listed in thenotice of proposed assessment. In particu-lar, the taxpayer should describe whetherthe taxpayer had the duty and authorityto collect, account for, and pay trust fundtaxes; and

(c) If the taxpayer contests the Service’scalculation of the penalty, the dates andamounts of payments that the taxpayer be-lieves the Service failed to consider and/orany computational errors made by the Ser-vice;

(4) An explanation of any law or othersupporting authorities on which the tax-payer relies; and

(5) The following signed declarationunder penalties of perjury that the state-ment of facts required by section 5.02(3)is true:

“Under penalties of perjury, I declarethat I have examined the facts presented inthis statement and any accompanying in-formation, and to the best of my knowl-

June 13, 2005 1234 2005–24 I.R.B.

edge and belief, they are true, correct, andcomplete.”

.03 A taxpayer may contest all of the pe-riods listed in the notice in a single protest;however, if the proposed penalty for anyone of the periods is more than $25,000,the taxpayer must submit a formal writtenprotest described in section 5.02.

SECTION 6. REPRESENTATION ATCONFERENCE

A taxpayer may represent himself at anAppeals conference or be represented bysomeone who is authorized to representtaxpayers under Treasury Circular 230,Regulations Governing the Practice ofAttorneys, Certified Public Accountants,Enrolled Agents, Enrolled Actuaries,and Appraisers before the Internal Rev-enue Service (31 C.F.R. Part 10). If anauthorized representative attends an Ap-peals conference without the taxpayer, therepresentative must have filed a powerof attorney, see 26 C.F.R. §§ 601.501through 601.509, which also will autho-rize the representative to receive or inspectconfidential tax information. If a repre-sentative prepares and signs a request forappeal or a written protest on behalf of thetaxpayer, the representative must submita declaration stating whether he or sheknows personally that the facts stated inthe protest and accompanying documentsare true and correct.

SECTION 7. EXTENSION OF THEPERIOD OF LIMITATIONS FORASSESSMENT

If the notice of proposed assessment ismailed or delivered before the period forassessing the trust fund recovery penaltyends, the assessment period will not endbefore the later of:

(1) The date that is 90 days after theService mailed or delivered the notice ofproposed assessment; or

(2) If the taxpayer has filed a timely ap-peal in response to the notice of proposedassessment, the date that is 30 days afterthe Secretary makes a final determinationregarding the appeal.

SECTION 8. PROCEDURE INAREA DIRECTOR’S OFFICE FORDISPOSING OF CLAIMS

.01 If the Service has assessed the trustfund recovery penalty because of the fail-ure of the taxpayer to respond to the noticeof proposed assessment within the 60-dayperiod (or 75-day period, if applicable) oron the basis of the decision of Appeals, thetaxpayer generally must pay the appropri-ate portion of the penalty and file a claimfor refund in order to pursue judicial re-view.

.02 Once an assessment has been made,the Service generally will not considerany claim for abatement unless the tax-payer establishes to the compliance area

director’s satisfaction that unusual cir-cumstances merit consideration of sucha claim. If the compliance area directordecides not to consider a taxpayer’s abate-ment claim, the taxpayer will be notifiedof that decision.

.03 Only Appeals may consider a claimfor abatement if the assessment was madeon the basis of a decision of Appeals. Ifthe assessment was made based on a deci-sion of Appeals, the area director will for-ward the claim to Appeals for considera-tion. The taxpayer will be notified if Ap-peals decides not to consider a taxpayer’sabatement claim.

SECTION 9. EFFECT ON OTHERDOCUMENTS

Rev. Proc. 84–78 is superceded.

SECTION 10. EFFECTIVE DATE

This revenue procedure is effective forall trust fund recovery penalties proposedon or after May 20, 2005.


The principal author of this revenueprocedure is Kevin Connelly of the Officeof the Associate Chief Counsel (Procedure& Administration). For further informa-tion regarding this revenue procedure,contact Mr. Connelly at (202) 622–3630(not a toll-free call).

2005–24 I.R.B. 1235 June 13, 2005

Part IV. Items of General InterestNotice of ProposedRulemaking and Notice ofPublic Hearing

Safe Harbor for ValuationUnder Section 475

REG–100420–03


ACTION: Notice of proposed rulemakingand notice of public hearing.

SUMMARY: This document sets forth anelective safe harbor for dealers in securi-ties, dealers in commodities, and tradersin securities and commodities that permitsthese taxpayers to make an election pur-suant to which the values of positions re-ported on certain financial statements arethe fair market values of those positionsfor purposes of section 475 of the InternalRevenue Code. This safe harbor attemptsto reduce the compliance burden upon tax-payers and to improve the administrabilityof the valuation aspect of section 475 forthe Internal Revenue Service. This doc-ument also provides a notice of a publichearing on these proposed regulations.

DATES: Written or electronic commentsmust be received by August 22, 2005. Out-lines of topics to be discussed at the publichearing scheduled for September 15, 2005at 10 a.m. must be received by August 23,2005.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–100420–03),room 5203, Internal Revenue Ser-vice, PO Box 7604, Ben Franklin Sta-tion, Washington, DC 20044. Submis-sions may be hand delivered Mondaythrough Friday between the hours of8 a.m. and 4 p.m. to: CC:PA:LPD:PR(REG–100420–03), Courier’s Desk, In-ternal Revenue Service, 1111 ConstitutionAvenue N.W., Washington, DC, or sentelectronically, via the IRS Internet site atwww.irs.gov/regs or via the Federal eRule-making Portal at www.regulations.gov(IRS-REG–100420–03).

FOR FURTHER INFORMATIONCONTACT: Concerning submissions ofcomments, the hearing or to be placed onthe building access list to attend the hear-ing, Treena Garrett at (202) 622–7180;concerning the proposals, Marsha A. Sabinor John W. Rogers III (202) 622–3950 (nottoll-free numbers).


Paperwork Reduction Act

The collection of information containedin this notice of proposed rulemaking hasbeen submitted to the Office of Manage-ment and Budget for review in accordancewith the Paperwork Reduction Act of 1995(44 U.S.C. 3507(d)). Comments on thecollection of information should be sent tothe Office of Management and Budget,Attn: Desk Officer of the Department ofTreasury, Office of Information and Reg-ulatory Affairs, Washington, D.C. 20503,with copies to the Internal Revenue Ser-vice, Attn: IRS Reports Clearance Offi-cer, SE:W:CAR:MP:T:T:SP, Washington,D.C. 20224. Comments on the collectionof information should be received by July25, 2005. Comments are specifically re-quested concerning:

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

The accuracy of the estimated burdenassociated with the proposed collection ofinformation (see below);

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

How the burden of complying withthe proposed collection of the informa-tion may be minimized, including throughthe application of automated collectiontechniques or other forms of informationtechnology; and

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

The collection of informationin these proposed regulations is in§1.475(a)–4(f)(1) and §1.475(a)–4(k).This information is required by the IRS to

avoid any uncertainty about whether a tax-payer has made an election and to verifycompliance with section 475 and the safeharbor method of accounting described in§1.475(a)–4(d). This information will beused to facilitate audits and to determinewhether the amount of tax has been cal-culated correctly. The collection of theinformation is required to properly deter-mine the amount of income or deductionto be taken into account. The respondentsare sophisticated dealers or traders in se-curities or commodities.

Estimated total annual recordkeepingburden: 49,232 hours.

Estimated average annual burden perrecordkeeper: 4 to 6 hours.

Estimated number of recordkeepers:12,308.

Estimated frequency of recordkeeping:annually.

An agency may not conduct or sponsor,and a person is not required to respond to, acollection of information unless it displaysa valid control number assigned by the Of-fice of Management and Budget.

Books or records relating to a collectionof information must be retained as long astheir contents may be material in the ad-ministration of any internal revenue law.Generally, tax returns and tax return infor-mation are confidential, as required by 26U.S.C. 6103.

Background

This document contains proposedamendments to 26 CFR Part 1 undersection 475 of the Internal Revenue Code(Code). Section 475 was added to theCode by section 13223(a) of the OmnibusBudget Reconciliation Act of 1993 (Pub-lic Law 103–66, 107 Stat. 312). Section475(a) generally provides that the securi-ties held by dealers in securities shall bevalued as of the last business day of theyear at fair market value. Section 475(g)provides that the Secretary shall prescriberegulations as may be necessary or appro-priate to carry out the purposes of section475. The legislative history of section 475indicates that, under this authority, theSecretary may issue regulations to permitthe use of valuation methodologies thatreduce the administrative burden of com-pliance on the taxpayer but clearly reflect

June 13, 2005 1236 2005–24 I.R.B.

income for federal income tax purposes.On May 5, 2003, the Treasury Depart-ment and the IRS published in the FederalRegister an Advance Notice of ProposedRulemaking (Safe Harbor for SatisfyingCertain Statutory Requirements for Valua-tion under Section 475 for Certain Securi-ties and Commodities) (REG–100420–03)[68 FR 23632] (the ANPRM); Announce-ment 2003–35, 2003–1 C.B. 956 (see§601.601(d)(2)). The ANPRM solicitedcomments on whether a safe harbor ap-proach using values reported on an appli-cable financial statement for certain secu-rities may be used for purposes of section475. The ANPRM set forth a possible safeharbor for valuing these securities andasked for comments on various aspects ofsuch a safe harbor.

Explanation of Provisions

Overview

Section 475(a) requires dealers in se-curities to mark their securities to market.Sections 475(e) and (f) allow dealers incommodities and traders in securities orcommodities to elect similar treatment fortheir securities or commodities. If the se-curity or commodity is inventory, it mustbe included in inventory at its fair marketvalue, and if it is not inventory and is heldat the end of the taxable year, gain or loss isrecognized as if the security or commodityhad been sold for its fair market value onthe last business day of the taxable year.

Although the term “fair market value”has a long-standing and well-establishedmeaning within the tax law, it is some-times difficult to determine the fair marketvalue of certain securities and commodi-ties, particularly those that have no com-parable sales. This has impeded the effi-cient administration of the mark-to-marketsystem under section 475. Consequently,with a view to improving the administra-bility of the valuation requirements of sec-tion 475, the Treasury Department and theIRS issued the ANPRM, which set forthsome principles upon which a safe harborfor valuation could be constructed. Usingthese principles, and incorporating a num-ber of comments received from the pub-lic, these proposed regulations set forth asafe harbor for valuing securities and com-modities under section 475.

Safe Harbor

The safe harbor generally permits eli-gible taxpayers to elect to have the val-ues that are reported for eligible positionson certain financial statements treated asthe fair market values reported for thoseeligible positions for purposes of section475, if certain conditions are met. Thesafe harbor is based upon the principle thatif the mark-to-market method used for fi-nancial reporting is sufficiently consistentwith the mark-to-market method requiredby section 475, then the values used for fi-nancial reporting should be acceptable val-ues for purposes of section 475, even ifthose values are not fair market values un-der general tax principles. To ensure mini-mal divergence from fair market value un-der tax principles, these proposed regula-tions impose certain restrictions on the fi-nancial accounting methods and financialstatements that are eligible for the safe har-bor and also require certain adjustments tothe values of the eligible positions on thosefinancial statements that may be used un-der the safe harbor.

The safe harbor requires that financialstatement values be adjusted to complywith the requirements of section 482 orsection 482 principles when applicable.For example, section 482 principles mayrequire the revision of estimates of futurecash flows used in valuing certain finan-cial instruments to reflect the appropriatearm’s length pricing of inter-branch trans-actions as of their origination date. Inaddition, these proposed regulations donot alter the treatment of interest expense.See sections 861 and 882 and regulationsthereunder.

Eligible Taxpayers and Eligible Positions

The safe harbor is available to any tax-payer subject to the mark-to-mark regimeunder section 475, whether the taxpayer isa dealer in securities under section 475(a),a dealer in commodities under section475(e), or a trader in either securities orcommodities under section 475(f). TheCommissioner will issue a revenue proce-dure that lists the types of securities andcommodities that are subject to the safeharbor. It is anticipated that the revenueprocedure will apply to every security po-sition and every commodity position sub-ject to mark-to-market under section 475.

Comments are requested as to whether anytypes of securities or commodities shouldbe excluded from the safe harbor.

It is important to note, however, that thevaluation methodology under the safe har-bor applies only for positions that are prop-erly marked under section 475. The safeharbor only addresses valuation and doesnot expand or contract the scope of appli-cation of section 475. For example, if asecurity is not marked under section 475because it has been identified as held forinvestment, then under the safe harbor itmay not be marked for federal income taxpurposes even though it is properly markedon the financial statement in accordancewith U.S. Generally Accepted AccountingPrinciples (U.S. GAAP). Similarly, if a se-curity is not marked on the applicable fi-nancial statement because it is a hedge butsection 475(a) applies because the securitywas not identified as a hedge, then the se-curity must still be marked under section475.

Eligible Method

To qualify for the safe harbor, a finan-cial accounting method must satisfy cer-tain basic requirements. First, it must markeligible positions to market through valu-ations made as of the last business day ofeach taxable year. Second, it must recog-nize into income on the income statementany gain or loss from marking eligible po-sitions to market. Third, it must recognizeinto income on the income statement anygain or loss on disposition of an eligibleposition as if a year-end mark occurred im-mediately before the disposition. Fourth, itmust arrive at fair value in accordance withU.S. GAAP.

In addition to the basic requirements,the safe harbor also imposes certain limita-tions that ensure minimal divergence fromfair market value. Under the first lim-itation, which applies only to securitiesand commodities dealers, except for eli-gible positions that are traded on a quali-fied board or exchange (as defined in sec-tion 1256(g)(7)), the financial accountingmethod must not result in values at ornear the bid or ask values, even if theuse of bid or ask values is permissible inaccordance with U.S. GAAP. This limi-tation is based upon the business modelfor derivative contracts held by dealers inthose derivatives, the model underlying

2005–24 I.R.B. 1237 June 13, 2005

most of the public comments received inresponse to the ANPRM.

According to the comments, dealersseek to capture and profit from bid-askspreads by entering into positions that,in the aggregate, offset each other. Thebid-ask spread contains the dealer’s profitand compensates the dealer for all risksand expenses. The origination of such abalanced portfolio may, therefore, be seenas creating a synthetic annuity, with a valuethat is largely immune from market-relatedchanges in the values of the componentsecurities. For these eligible positions,such as interest rate swap contracts, use ofbid or ask values approximates realizationaccounting and, therefore, fails to causerecognition of the present value of the syn-thetic annuity in the taxable year that theannuity is created. Consequently, the valu-ation method described in §1.471–4(a)(1)generally fails to satisfy the limitation setforth in paragraph (d)(3)(i) of these pro-posed regulations.

The Treasury Department and the IRSrequest comments on whether dealers incommodities and traders in either securi-ties or commodities operate under differentbusiness models and on how the rules setforth in these proposed regulations shouldbe modified, if at all, to accommodatethose business models.

Under the second limitation, if themethod of valuation consists of determin-ing the present value of projected cashflows from an eligible position or po-sitions, then the method must not takeinto account any cash flows of income orexpense that are attributable to a periodor time before the valuation date. Thislimitation ensures that items of income orexpense will not be accounted for twice,first through current realization and thenagain in the mark.

Under the third limitation, no cost orrisk is accounted for more than once, ei-ther directly or indirectly. For example,a financial accounting method that allowsa special adjustment for credit risk gener-ally satisfies this limitation. It would notsatisfy this limitation, however, if it com-puted the present value of projected cashflows using a discount rate that takes intoaccount any amount of credit risk that isalso taken into account by the special ad-justment. Thus, if a dealer in securities en-ters into an interest rate swap contract witha counterparty with a AA/aa rating, tak-

ing credit enhancement and netting agree-ments into account, then the dealer cannottake a special adjustment to the value of thecontract for all of the risk between a coun-terparty with a risk-free rating and the ac-tual counterparty if the dealer determinesthe present value of projected cash flowsfrom the contract using a mid-market swapcurve based upon the LIBOR AA rate. TheTreasury Department and the IRS under-stand, however, that there may be degreesof credit quality within an established rat-ing level, such as AA/aa, and that valuationmethodologies used currently may reflectthese nuances in credit quality. Accord-ingly, a credit adjustment reflecting thesenuances may satisfy this limitation.

Election and Revocation

The election to use the safe harbor ismade by filing a statement with the tax-payer’s timely filed Federal income taxreturn for the taxable year for which theelection is first effective. The statementmust declare that the taxpayer makes thesafe harbor election for all of its eligi-ble positions. In addition to any other in-formation that the Commissioner may re-quire, the statement must describe the tax-payer’s applicable financial statement forthe first taxable year for which the elec-tion is effective and must state that the tax-payer agrees to timely provide upon the re-quest of the Commissioner all information,records, and schedules required by the safeharbor. The election continues to be in ef-fect for all subsequent taxable years unlessit is revoked.

A taxpayer cannot revoke the electionwithout the consent of the Commissioner.The Commissioner, however, can revokethe election if the taxpayer fails to com-ply with any of the recordkeeping and pro-duction requirements and cannot show rea-sonable cause for the failure, the taxpayerceases to use an eligible method, the tax-payer ceases to have an applicable finan-cial statement, as described below, or thetaxpayer holds a de minimis quantity of el-igible positions that are subject to the safeharbor. No revocation is necessary if thetaxpayer ceases to qualify as an eligibletaxpayer, or section 475 does not otherwiseapply, because the safe harbor may onlybe used to determine values and cannot beused unless section 475 applies. Once re-voked by either the Commissioner or the

taxpayer, neither the taxpayer nor any of itssuccessors may make the election for anytaxable year that begins before the date thatis six years after the first day of the earli-est taxable year affected by the revocationwithout the consent of the Commissioner.

Applicable Financial Statements

Not all financial statements qualify un-der the safe harbor. Consequently, theseproposed regulations set forth a systemthat enables a taxpayer to determine whichone of its financial statements, if any, maybe used when applying the safe harbor.

Three categories of financial statementsqualify under the safe harbor and are setforth in order of priority, from highest tolowest. In the first and highest categoryare those financial statements that mustbe filed with the Securities and ExchangeCommission (SEC), such as the 10-K andthe Annual Statement to Shareholders. Inthe second category are those financialstatements that must be provided to theFederal government or any of its agen-cies other than the IRS. In this categoryare statements filed by foreign-controlledfinancial institutions engaged in trade orbusiness within the United States whoreport their mark-to-market results tothe Federal Reserve or the Office of theComptroller of the Currency. In the thirdcategory are certified audited financialstatements that are provided to creditorsto make lending decisions, that are pro-vided to equity holders to evaluate theirinvestment, or that are provided for othersubstantial non-tax purposes and are rea-sonably anticipated to be directly relied onfor the purposes for which the statementswere created. For a financial statementdescribed in any of the three categoriesabove to qualify as an applicable financialstatement, it must be prepared in accor-dance with U.S. GAAP. If a taxpayer hastwo statements in the same category, eachof which would qualify under the safeharbor, then the statement that results inthe highest aggregate valuation of eligiblepositions is the only financial statementthat may qualify for the safe harbor.

Statements filed with the SEC pro-vide a high degree of confidence thatthe values used on those statements re-flect reasonable approximations of fairvalue. Consequently, there are no ad-ditional business use requirements for

June 13, 2005 1238 2005–24 I.R.B.

those statements. For the second category(statements filed with other agencies ofthe Federal government) and the thirdcategory of statements (the other certifiedaudited financial statements), this degreeof confidence is ensured by requiring somesubstantial non-tax use in the taxpayer’sbusiness. This determination of use musttake into account whether the taxpayer’sreliance on the values exposes the tax-payer to material adverse consequences ifthe values are incorrect. Accordingly, thesafe harbor requires that the values for eli-gible positions contained in these financialstatements be used by the taxpayer in mostof the significant management functionsof all or substantially all of its business.This use includes activities such as se-nior management review of business-unitprofitability, market risk measurement ormanagement, credit risk measurement ormanagement, internal allocation of cap-ital, and compensation of personnel butdoes not include either tax accounting orreporting the results of operations to otherpersons. Significance of use is tested byexamining all the facts and circumstancesin light of the stated purpose of the busi-ness use requirement.

The IRS and Treasury understand thatsome dealers maintain internal books ofaccount, not prepared in accordance withU.S. GAAP, for separate segments of theirbusiness and that these internal books ofaccount may include a charge to each oper-ating segment of an internal “cost of carry”calculated in the manner of interest (andthe derivatives dealer book may be treatedas a separate business segment for that pur-pose). The purpose of this cost-of-carrycharge is to assess profitability or to re-flect the cost of capital in maintaining thepositions held in that business segment.The amounts so charged do not reducethe fair value of eligible positions on abalance sheet prepared in accordance withU.S. GAAP. The maintenance of thesesegmented accounts, which may apply anaccounting approach that does not qualifyas an eligible accounting method, doesnot prevent some other financial statementprepared in accordance with U.S. GAAPfrom qualifying as the taxpayer’s applica-ble financial statement.

Record Retention and Production; Use ofDifferent Values

The safe harbor can be administrableonly if the IRS can readily verify that thevalues used on financial statements arealso appropriately used on the Federal in-come tax return. Consequently, record-keeping and record production are criticalto the safe harbor. These proposed regula-tions provide specific requirements for thetypes of records that must be maintainedand provided to enable ready verification.In general, electing taxpayers must clearlyshow: (1) that the same value used for fi-nancial reporting was used on the Federalincome tax return; (2) that no eligible po-sition subject to section 475 is excludedfrom the application of the safe harbor;and (3) that only eligible positions sub-ject to section 475 are carried over to theFederal income tax return under the safeharbor. These proposed regulations out-line what records must be retained and pro-duced, including certain forms and sched-ules filed with the Federal income tax re-turn, such as the Schedule M–1, “Net In-come (Loss) Reconciliation for Corpora-tions With Total Assets of $10 Million orMore,” Schedule M–3, “Net Income (Loss)Reconciliation for Corporations With To-tal Assets of $10 Million or More,” andForm 1120F, “U.S. Income Tax Return ofa Foreign Corporation.” These proposedregulations also provide that the Commis-sioner may enter into an advance agree-ment with a taxpayer on how records areto be maintained and how long the recordsare to be retained. All of the necessaryrecords must be retained as long as theircontents may become material in the ad-ministration of any internal revenue law.

To encourage rapid examinations of theFederal income tax returns of electing tax-payers, these proposed regulations requirethat all necessary records be producedwithin 30 days after the Commissionerrequests them. If the required records arenot provided as required, the regulationspermit the Commissioner to use his dis-cretion to: (1) extend the 30-day period;(2) excuse minor or inadvertent failures toprovide the requested records; (3) requireuse of values that clearly reflect incomebut which are different from those usedon the applicable financial statement; or(4) revoke the election (as described un-der “Election and Revocation” above) if

a taxpayer does not demonstrate reason-able cause for the failure to maintain andproduce the required records.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined in Execu-tive Order 12866. Therefore, a regulatoryassessment is not required. It is herebycertified that the collection of informationin these regulations will not have a sig-nificant economic impact on a substantialnumber of small entities. This certifica-tion is based upon the fact that it is an-ticipated that the safe harbor will be usedprimarily by dealers in securities that arefinancial institutions with a sophisticatedunderstanding of the capital markets. Be-cause section 475 is elective for tradersin securities or commodities or dealers incommodities, some small businesses couldqualify for the safe harbor if they maketwo voluntary elections: (1) an electionto mark to market securities or commodi-ties under section 475 and (2) an electionto apply the safe harbor. Because bothelections are voluntary, it is unlikely anysmall business taxpayer who thinks thereporting and recordkeeping requirementsare too burdensome will make these elec-tions. Furthermore, the total average esti-mated burden per taxpayer is small, as re-ported earlier in the preamble. This is be-cause most of the recordkeeping require-ments do not require taxpayers to generatenew records, but instead require recordsused for financial reporting purposes to bekept for tax reporting purposes. For allof these reasons, a Regulatory FlexibilityAnalysis under the Regulatory FlexibilityAct (5 U.S.C. chapter 6) is not required.Pursuant to section 7805(f) of the Code,this notice of proposed rulemaking will besubmitted to the Chief Counsel for Advo-cacy of the Small Business Administrationfor comment on their impact on small busi-ness.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written comments(a signed original and eight (8) copies)or electronic comments that are submittedtimely to the IRS. The IRS and the Trea-sury Department specifically request com-

2005–24 I.R.B. 1239 June 13, 2005

ments on the clarity of these proposed reg-ulations and how they may be made easierto understand. All comments will be avail-able for inspection and copying.

A public hearing has been scheduledfor September 15, 2005, beginning at 10a.m. in the Auditorium, Internal RevenueBuilding, 1111 Constitution Avenue, NW,Washington, DC. Due to building securityprocedures, visitors must enter at the Con-stitution Avenue entrance. In addition, allvisitors must present photo identificationto enter the building. Because of accessrestriction, visitors will not be admittedbeyond the immediate entrance area morethan 30 minutes before the hearing starts.For information about having your nameplaced on the building access list to attendthe hearing, see “FOR FURTHER INFOR-MATION CONTACT” section of this pre-amble.


The principal authors of these proposedregulations are Marsha A. Sabin andJohn W. Rogers III, Office of the Asso-ciate Chief Counsel (Financial Institutionsand Products). However, other personnelfrom the IRS and the Treasury Departmentparticipated in their development.

* * * * *

Proposed Amendments to theRegulations

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


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

Authority: 26 U.S.C. 7805 * * *Section 1.475(a)–4 also issued under 26

U.S.C. 475(g). * * *Par. 2. Section 1.475–0 is amended by:1. Revising the introductory text.2. Adding entries to the table for

§1.475(a)–4.The revision and addition reads as fol-

lows:

§1.475–0 Table of contents.

This section lists the major captions in§§1.475(a)–3, 1.475(a)–4, 1.475(b)–1,

1.475(b)–2, 1.475(b)–4, 1.475(c)–1,1.475(c)–2, 1.475(d)–1 and 1.475(e)–1.

* * * * *

§1.475(a)–4 Safe harbor for valuationunder section 475.

(a) Overview.(1) Purpose.(2) Summary of paragraphs.(b) Safe harbor.(1) General rule.(2) Scope of the safe harbor.(c) Eligible taxpayer.(d) Eligible method.(1) Sufficient consistency.(2) General requirements.(i) Frequency.(ii) Recognition at the mark.(iii) Recognition on disposition.(iv) Fair value standard.(3) Limitations.(i) Bid-ask method.(ii) Valuations based on present values

of projected cash flows.(iii) Accounting for costs and risks.(4) Examples.(e) Compliance with other rules.(f) Election.(1) Making the election.(2) Duration of the election.(3) Revocation.(i) By the taxpayer.(ii) By the Commissioner.(4) Re-election.(g) Eligible positions.(h) Applicable financial statement.(1) Definition.(2) Primary financial statement.(i) Statement required to be filed with

Securities and Exchange Commission.(ii) Statement filed with a Federal

agency other than the IRS.(iii) Certified audited financial state-

ment.(3) Example.(4) Financial statements of equal prior-

ity.(5) Consolidated groups.(6) Supplement or amendment to a fi-

nancial statement.(7) Certified audited financial state-

ment.(i) [Reserved.](j) Significant business use.(1) In general.(2) Financial statement value.

(3) Management of a business as adealer or trader.

(4) Significant use.(k) Retention and production of

records.(1) In general.(2) Specific requirements.(i) Reconciliation.(A) In general.(B) Values on books and records with

supporting schedules.(C) Consolidation schedules.(ii) Instructions provided by the Com-

missioner.(3) Time for producing records.(4) Retention period for records.(5) Agreements with the Commis-

sioner.(l) [Reserved.](m) Use of different values.

* * * * *Par. 3. Section 1.475(a)–4 is added to

read as follows:

§1.475(a)–4 Safe harbor for valuationunder section 475.

(a) Overview—(1) Purpose. This sec-tion sets forth a safe harbor that undercertain circumstances permits taxpayers tomake an election pursuant to which thevalues of positions reported on certain fi-nancial statements are the fair market val-ues of those positions for purposes of sec-tion 475. This safe harbor is based on theprinciple that, if a mark-to-market methodused for financial reporting is sufficientlyconsistent with the requirements of section475 and if the financial statement employ-ing that method has certain indicia of reli-ability, then the values used on that finan-cial statement should be appropriate val-ues for purposes of section 475. If otherprovisions of the Code or regulations re-quire adjustments to fair market value, useof the safe harbor does not obviate the needfor those adjustments. See paragraph (e) ofthis section.

(2) Summary of paragraphs. Paragraph(b) of this section sets forth the safe harbor.To determine who may use the safe harbor,paragraph (c) of this section defines theterm “eligible taxpayer” for purposes ofthe safe harbor. Paragraph (d) of this sec-tion sets forth the basic requirements fordetermining whether the method used forfinancial reporting is sufficiently consis-tent with the requirements of section 475.

June 13, 2005 1240 2005–24 I.R.B.

Paragraph (e) of this section describes ad-justments to the financial statement valuesthat may be required for purposes of apply-ing section 475. Paragraph (f) of this sec-tion describes how to make the safe harborelection and the conditions under whichthe election may be revoked. Paragraph(g) of this section provides that the Com-missioner will issue a revenue procedurethat lists the types of securities and com-modities that may qualify as “eligible posi-tions” for purposes of the safe harbor. Us-ing rules for determining priorities amongfinancial statements, paragraph (h) of thissection defines the term “applicable finan-cial statement” and so describes the finan-cial statement, if any, whose values maybe used in the safe harbor. In some cases,as required by paragraph (j) of this sec-tion, the safe harbor is available only ifthe taxpayer’s operations make significantbusiness use of financial statement values.Paragraph (k) of this section sets forth re-quirements for record retention and recordproduction. Paragraph (m) of this sectionprovides that the Commissioner may usefair market values that clearly reflect in-come, but which differ from values used onthe applicable financial statement, if a tax-payer fails to comply with the recordkeep-ing and record production requirements ofparagraph (k) of this section.

(b) Safe harbor—(1) General rule.Subject to any adjustment required byparagraph (e) of this section, if an eligi-ble taxpayer uses an eligible method forthe valuation of an eligible position onits applicable financial statement and theeligible taxpayer is subject to the electiondescribed in paragraph (f) of this section,the value that the eligible taxpayer assignsto that eligible position in its applicablefinancial statement is the fair market valueof the eligible position for purposes ofsection 475, even if that value is not thefair market value of the position for anyother purpose of the internal revenue laws.Notwithstanding the rule set forth in thisparagraph, the Commissioner may, in cer-tain circumstances, use fair market valuesthat clearly reflect income but which aredifferent than the values used on the appli-cable financial statement. See paragraph(m) of this section.

(2) Scope of the safe harbor. The safeharbor may be used only to determine val-ues for eligible positions that are properlymarked to market under section 475. It

does not determine whether any positionsmay or may not be subject to mark-to-mar-ket accounting under section 475.

(c) Eligible taxpayer. An eligible tax-payer is a dealer in securities as definedin section 475(c)(1) and §1.475(c)–1, adealer in commodities as defined in sec-tion 475(e), or a trader in securities or com-modities as defined in section 475(f).

(d) Eligible Method—(1) Sufficientconsistency. An eligible method is amark-to-market method that is sufficientlyconsistent with the requirements of amark-to-market method under section475. To be sufficiently consistent, theeligible method must satisfy all of therequirements of paragraph (d)(2) andparagraph (d)(3) of this section.

(2) General requirements. Themethod—

(i) Frequency. Must require a valuationof the eligible position no less frequentlythan annually, including a valuation as ofthe last business day of the taxable year;

(ii) Recognition at the mark. Must rec-ognize into income on the income state-ment for each taxable year mark-to-mar-ket gain or loss based upon the valuation orvaluations described in paragraph (d)(2)(i)of this section;

(iii) Recognition on disposition. Mustrequire, on disposition of the eligible po-sition, recognition into income (on the in-come statement for the taxable year of dis-position) as if a year-end mark occurredimmediately before such disposition; and

(iv) Fair value standard. Must requireuse of a valuation standard that arrives atfair value in accordance with U.S. Gener-ally Accepted Accounting Principles (U.S.GAAP) as established by the Financial Ac-counting Standards Board.

(3) Limitations—(i) Bid-ask method.Except for eligible positions that are tradedon a qualified board or exchange, as de-fined in section 1256(g)(7), the valuationstandard used for the applicable finan-cial statement of an eligible taxpayermust not permit values at or near the bidor ask value. Consequently, the valuationmethod described in §1.471–4(a)(1) gener-ally fails to satisfy this paragraph (d)(3)(i).The restriction in this paragraph (d)(3)(i)is satisfied if a resulting value is closer tothe mid-market value than it is to the bidor ask value.

(ii) Valuations based on present valuesof projected cash flows. If the method of

valuation consists of projecting cash flowsfrom an eligible position or positions anddetermining the present value of those cashflows, the method must not take into ac-count any cash flows (income or expense)attributable to a period or time prior to thevaluation date. In addition, adjustment ofthe gain or loss recognized on the markmay be required with respect to paymentson notional principal contracts that will oc-cur after the valuation date to the extentthat portions of the payments have beenrecognized for tax purposes prior to thevaluation date and appropriate adjustmenthas not been made for purposes of deter-mining financial statement value.

(iii) Accounting for costs andrisks—(A) General rule. In a determi-nation of fair value, appropriate costs andrisks may be taken into account, but nocost or risk may be accounted for morethan once, either directly or indirectly. Ifappropriate, the costs and risks that may beaccounted for, include, but are not limitedto, credit risk (appropriately adjusted forany credit enhancement), future adminis-trative costs, and model risk. In the caseof credit risk, an adjustment is implicitin computing the present value of cashflows using a discount rate greater thana risk-free rate. Accordingly, a determi-nation of whether any further downwardadjustment to value for credit risk is war-ranted, or whether an upward adjustmentis required, must take that implicit adjust-ment into consideration.

(4) Examples. The following examplesillustrate this paragraph (d).

Example 1. (i) A, a calendar year taxpayer, isa dealer in securities within the meaning of section475(c)(1). A generally maintains a balanced port-folio of interest rate swaps and other interest ratederivatives, capturing bid-ask spreads and keeping itsmarket exposure within desired limits (using, if nec-essary, additional derivatives for this purpose). Auses a mark-to-market method on a statement thatit is required to file with the United States Securi-ties and Exchange Commission (Securities and Ex-change Commission or SEC) and that satisfies para-graph (d)(2) of this section with respect to both thecontracts with customers and the additional deriva-tives. None of the derivatives is traded on a qualifiedboard or exchange, as defined in section 1256(g)(7).When determining the amount of any gain or loss re-alized on a sale, exchange, or termination of a posi-tion, A makes a proper adjustment for amounts takeninto account respecting payments or receipts. All ofA’s counterparties on the derivatives have credit qual-ity ratings of AA/aa, according to standard credit rat-ings obtained from private credit rating agencies.

(ii) Under A’s valuation method, as of each valua-tion date A determines a mid-market probability dis-

2005–24 I.R.B. 1241 June 13, 2005

tribution of future cash flows under the derivativesand computes the present values of these cash flows.In computing these present values, A uses an indus-try standard yield curve that is appropriate for obliga-tions by persons with credit quality ratings of AA/aa.In addition, based on information including its ownknowledge about the counterparties, A adjusts someof these present values either upward or downwardto reflect A’s reasonable judgment about the extentto which the true credit status of each counterparty’sobligation, taking credit enhancements into account,differs from AA/aa.

(iii) A’s methodology does not violate the require-ment in paragraph (d)(3)(iii) of this section that thesame cost or risk not be taken into account, directlyor indirectly, more than once.

Example 2. (i) The facts are the same as in Exam-ple 1, except that A uses risk-free rates to discount thepayments to be received under the derivatives. Basedon information, including its own knowledge aboutthe counterparties, A adjusts these present values toreflect A’s reasonable judgment about the extent towhich the true credit status of each counterparty’sobligation, taking credit enhancements into account,differs from a risk-free obligation.

(ii) A’s methodology does not violate the require-ment in paragraph (d)(3)(iii) of this section that thesame cost or risk not be taken into account, directlyor indirectly, more than once.

Example 3. (i) The facts are the same as in Ex-ample 1, except that, after computing present valuesusing the discount rates that are appropriate for oblig-ors with credit quality ratings of AA/aa, A, based oninformation including its own knowledge about thecounterparties, adjusts some of these present valueseither upward or downward to reflect A’s reasonablejudgment about the extent to which the true creditstatus of each counterparty’s obligation, taking creditenhancements into account, differs from AAA/aaa.

(ii) A’s methodology violates the requirement inparagraph (d)(3)(iii) of this section that the same costor risk not be taken into account, directly or indirectly,more than once. By using a AA/aa discount rate,A’s method takes into account the difference betweenrisk-free obligations and AA/aa obligations. This dif-ference includes the difference between a rating ofAAA/aaa and one of AA/aa. By adjusting values forthe difference between a rating of AAA/aaa and oneof AA/aa, A takes into account risks that it had al-ready accounted for through the discount rates that itused. The same result would occur if A judged someof its counterparties’ obligations to be of AAA/aaaquality but A failed to adjust the values of those obli-gations to reflect the difference between a rating ofAAA/aaa and one of AA/aa.

Example 4. (i) The facts are the same as in Exam-ple 1, except that A determines the mid-market valuefor each derivative and then subtracts the correspond-ing part of the bid-ask spread.

(ii) A’s methodology violates the rule in para-graph (d)(3)(i) of this section that forbids valuing thederivatives at or near the bid or ask value.

Example 5. (i) The facts are the same as in Exam-ple 1, and, in addition, A’s adjustments for all risksand costs, including credit risk, future administrativecosts, and model risk, consistently cause the adjustedvalue to be at or near the bid value or ask value.

(ii) A’s methodology violates the rule in para-graph (d)(3)(i) of this section that forbids valuing thederivatives at or near the bid or ask value.

(e) Compliance with other rules. Not-withstanding any other provisions of thissection, the fair market values for purposesof the safe harbor must be consistent withsection 482 or rules that adopt section 482principles, when applicable. Thus applica-ble financial statement values must be ad-justed as necessary for purposes of the safeharbor. For example, if a notional prin-cipal contract is subject to section 482 orsection 482 principles, the values of futurecash flows taken into account in determin-ing the value of the contract for purposesof section 475 must be consistent with sec-tion 482.

(f) Election—(1) Making the election.Unless the Commissioner prescribes oth-erwise, an eligible taxpayer elects underthis section by filing with the Commis-sioner a statement declaring that the tax-payer makes the safe harbor election inthis section for all its eligible positions. Inaddition to any other information that theCommissioner may require, the statementmust describe the taxpayer’s applicable fi-nancial statement for the first taxable yearfor which the election is effective and muststate that the taxpayer agrees to timely pro-vide upon the request of the Commissionerall information, records, and schedules re-quired by paragraph (k) of this section.The statement must be attached to a timelyfiled Federal income tax return (includingextensions) for the taxable year for whichthe election is first effective.

(2) Duration of the election. Oncemade, the election continues in effect forall subsequent taxable years unless re-voked.

(3) Revocation—(i) By the taxpayer.An eligible taxpayer that is subject to anelection under this section may revokeit only with the consent of the Commis-sioner.

(ii) By the Commissioner. The Com-missioner, after consideration of all rele-vant facts and circumstances, may revokean election under this section, effective be-ginning with the first open year for whichthe election is effective or with any subse-quent year, if—

(A) The taxpayer fails to comply withparagraph (k) of this section (concerningrecord retention and production) and the

taxpayer does not show reasonable causefor this failure;

(B) The taxpayer ceases to have an ap-plicable financial statement or ceases touse an eligible method; or

(C) For any other reason, no more than ade minimis number of eligible positions, orno more than a de minimis fraction of thetaxpayer’s eligible positions, are coveredby the safe harbor in paragraph (b) of thissection.

(4) Re-election. If an election is re-voked, either by the Commissioner or bythe taxpayer, the taxpayer (or any succes-sor of the taxpayer) may not make the elec-tion for any taxable year that begins be-fore the date that is six years after the firstday of the earliest taxable year affected bythe revocation without the consent of theCommissioner.

(g) Eligible positions. Eligible posi-tions mean those types or classes of se-curities or commodities that are markedto market under section 475 and are de-scribed by the Commissioner as eligiblepositions for purposes of this safe harborin a revenue procedure or other publishedguidance.

(h) Applicable financial statement—(1)Definition. An eligible taxpayer’s applica-ble financial statement for a taxable year isthe taxpayer’s primary financial statementfor that year if the statement is describedin paragraph (h)(2)(i) of this section (con-cerning statements required to be filedwith the SEC) or if the statement is bothdescribed in either paragraph (h)(2)(ii)or (iii) of this section and also meets therequirements of paragraph (j) of this sec-tion (concerning significant business use).Otherwise, or if the taxpayer does nothave a primary financial statement for thetaxable year, the taxpayer does not havean applicable financial statement for thetaxable year.

(2) Primary financial statement. Forany taxable year, an eligible taxpayer’sprimary financial statement is the finan-cial statement, if any, described in one ormore of paragraphs (h)(2)(i) through (iii)of this section. If more than one financialstatement of the taxpayer for the year isso described, the primary financial state-ment is the one first described in para-graphs (h)(2)(i) through (iii) of this sec-tion. A taxpayer has only one primary fi-nancial statement for any year.

June 13, 2005 1242 2005–24 I.R.B.

(i) Statement required to be filed withthe Securities and Exchange Commission.A financial statement that is prepared inaccordance with U.S. GAAP and that isrequired to be filed with the SEC, suchas the 10-K or the Annual Statement toShareholders.

(ii) Statement filed with a Federalagency other than the IRS. A financialstatement that is prepared in accordancewith U.S. GAAP and that is required tobe provided to the Federal government orany of its agencies other than the IRS.

(iii) Certified audited financial state-ment. A certified audited financial state-ment that is prepared in accordance withU.S. GAAP; that is given to creditors forpurposes of making lending decisions,given to equity holders for purposes ofevaluating their investment in the eligibletaxpayer, or provided for other substantialnon-tax purposes; and that the taxpayerreasonably anticipates will be directly re-lied on for the purposes for which it wascreated.

(3) Example. A prepares a financial statement,FS1, that is required to be filed with a Federal gov-ernment agency other than the SEC or the IRS, andis thus described in paragraph (h)(2)(ii) of this sec-tion. A also prepares a second financial statement,FS2, that is a certified audited financial statementthat is given to creditors and that A reasonably antic-ipates will be relied on for purposes of making lend-ing decisions, and that is thus described in paragraph(h)(2)(iii) of this section. Because FS1, which is de-scribed in paragraph (h)(2)(ii) of this section, is de-scribed before FS2, which is described in paragraph(h)(2)(iii) of this section, FS1 is A’s primary financialstatement.

(4) Financial statements of equal prior-ity. If two or more financial statements areof equal priority, after applying the rulesof paragraph (h)(2) of this section, then thestatement that results in the highest aggre-gate valuation of eligible positions beingmarked to market under section 475 is theprimary financial statement.

(5) Consolidated groups. If the tax-payer is a member of an affiliated groupthat files a consolidated return, the primaryfinancial statement of the taxpayer is theprimary financial statement of the com-mon parent (within the meaning of section1504(a)(1)) of the consolidated group.

(6) Supplement or amendment to a fi-nancial statement. For purposes of para-graph (b)(1) of this section and this para-graph (h), a financial statement includesany supplement or amendment to the fi-nancial statement.

(7) Certified audited financial state-ment. For purposes of this paragraph (h),a financial statement is a certified auditedfinancial statement if it is certified byan independent certified public accoun-tant from a Registered Public Accountingfirm, as defined in section 2(a)(12) of theSarbanes-Oxley Act of 2002, Public Law107–204, 116 Stat. 746 (July 30, 2002),15 U.S.C. §7201(a)(12), and rules promul-gated under that Act, and is—

(i) Certified to be fairly presented (a“clean” opinion);

(ii) Certified to be fairly presented sub-ject to a concern about a contingency, otherthan a contingency relating to the value ofeligible positions (a qualified “subject to”opinion); or

(iii) Certified to be fairly presentedexcept for a method of accounting withwhich the Certified Public Accountant dis-agrees and which is not a method used todetermine the value of an eligible positionheld by an eligible taxpayer (a qualified“except for” opinion).

(i) [Reserved].(j) Significant business use—(1) In gen-

eral. A financial statement is described inthis paragraph (j) if—

(i) The financial statement contains val-ues for eligible positions;

(ii) The eligible taxpayer makes signif-icant use of financial statement values inmost of the significant management func-tions of its business; and

(iii) That use is related to the manage-ment of all or substantially all of the eligi-ble taxpayer’s business.

(2) Financial statement value. For pur-poses of this paragraph (j), the term finan-cial statement value means—

(i) A value that is taken from the finan-cial statement; or

(ii) A value that is produced by aprocess that is in all respects identical tothe process that produces the values thatappear on the financial statement but thatis not taken from the statement becauseeither—

(A) The value was determined as of adate for which the financial statement doesnot value eligible positions; or

(B) The value is used in the manage-ment of the business before the financialstatement has been prepared.

(3) Management of a business as adealer or trader. For purposes of thisparagraph (j), the term management of a

business as a dealer or trader refers tothe financial and commercial oversight ofthe business. Oversight includes, but isnot limited to, senior management reviewof business-unit profitability, market riskmeasurement or management, credit riskmeasurement or management, internal al-location of capital, and compensation ofpersonnel. Management of a business asa dealer or trader does not include eithertax accounting or reporting the results ofoperations to other persons.

(4) Significant use. If an eligible tax-payer uses financial statement valuesfor some significant management func-tions and uses values that are not financialstatement values for other significant man-agement functions, then the determinationof whether the taxpayer has made signifi-cant use of the financial statement valuesis made on the basis of all the facts andcircumstances. This determination mustparticularly take into account whetherthe taxpayer’s reliance on the financialstatement values exposes the taxpayer tomaterial adverse economic consequencesif the values are incorrect.

(k) Retention and production ofrecords—(1) In general. In addition toall records that section 6001 otherwise re-quires to be retained, an eligible taxpayersubject to the election provided by thissection must keep, and timely provide tothe Commissioner upon request, recordsand books of account that are sufficient toestablish that the values used for eligiblepositions for purposes of section 475 arethe values used in the applicable financialstatement. This obligation extends to allbooks and records that are required to bemaintained for any period for financialor regulatory reporting purposes, even ifthese books or records may not otherwisebe specifically covered by section 6001.All records described in this paragraph (k)must be maintained for the period de-scribed in paragraph (k)(4) of this section,even if a lesser period of retention appliesfor financial statement or regulatory pur-poses.

(2) Specific requirements—(i) Recon-ciliation. Unless the Commissioner other-wise provides—

(A) In general. An eligible taxpayermust provide reconciliation schedulesbetween the applicable financial state-ment for the taxable year and Federalincome tax return for that year. The re-

2005–24 I.R.B. 1243 June 13, 2005

quired reconciliation schedules include allsupporting schedules, exhibits, computerprograms and any other information usedin producing the values and schedules,documentation of rules and proceduresgoverning determination of the values.The required schedules also include adetailed explanation of any adjustmentsnecessitated by imperfect overlap betweenthe eligible positions that the taxpayermarks to market under section 475 andthe eligible positions for which the appli-cable financial statement uses an eligiblemethod. A corporate taxpayer subject tothis paragraph (k) must reconcile the netincome amount reported on its applicablefinancial statement to the amount reportedon the applicable forms and schedules onits Federal income tax return (such as theSchedule M–1, “Net Income (Loss) Rec-onciliation for Corporations With TotalAssets of $10 Million or More”; ScheduleM–3, “Net Income (Loss) Reconciliationfor Corporations With Total Assets of $10Million or More”; and Form 1120F, “U.S.Income Tax Return of a Foreign Corpora-tion”) in the time and manner provided bythe Commissioner. Eligible taxpayers thatare not otherwise required to file a Sched-ule M–1 or Schedule M–3 must reconcilenet income using substitute schedules sim-ilar to Schedule M–1 and Schedule M–3,and these substitute schedules must beattached to the return.

(B) Values on books and records withsupporting schedules. The books andrecords must state the value used foreach eligible position separately from thevalue used for any other eligible position.However, an eligible taxpayer may makeadjustments to values on a pooled basis,if the taxpayer demonstrates that it cancompute gain or loss attributable to thesale or other disposition of an individualeligible position.

(C) Consolidation schedules. The tax-payer must provide a schedule showingconsolidation and de-consolidation that isused in preparing the applicable financialstatement, along with exhibits and subor-dinate schedules. This schedule must pro-vide information that addresses the differ-ences for consolidation between the appli-cable financial statement and the Federalincome tax return.

(ii) Instructions provided by the Com-missioner. The Commissioner may pro-vide an alternative time or manner in

which an eligible taxpayer subject to thisparagraph (k) must establish that the samevalues used for eligible positions on theapplicable financial statement are also thevalues used for purposes of section 475 onthe Federal income tax return.

(3) Time for producing records. Alldocuments described in this paragraph(k) must be produced within 30 days of arequest by the Commissioner, unless theCommissioner grants a written extension.Generally, the Commissioner will exer-cise his discretion to excuse a minor orinadvertent failure to provide requesteddocuments if the taxpayer shows reason-able cause for the failure, has made a goodfaith effort to comply with the requirementto produce records, and promptly reme-dies the failure. For failures to maintain,or timely produce, records, see para-graph (m) of this section (allowing theCommissioner, but not the taxpayer, to usefair market values which clearly reflectincome, but which are different from thosevalues used on the applicable financialstatement, for eligible positions that other-wise might be subject to the safe harbor)and paragraph (f)(3)(ii) of this section(allowing the Commissioner to revoke theelection).

(4) Retention period for records. Allmaterials required by this paragraph (k)and section 6001 must be retained as longas their contents may become material inthe administration of any internal revenuelaw.

(5) Agreements with the Commissioner.The Commissioner and an eligible tax-payer may enter into a written agreementthat establishes, for purposes of this para-graph (k), which records must be main-tained, how they must be maintained, andfor how long they must be maintained.

(l) [Reserved].(m) Use of different values. If the

taxpayer fails to satisfy paragraph (k) ofthis section (concerning record retentionand record production) with respect tothe records that relate to certain eligiblepositions for a taxable year, the Commis-sioner may, for those eligible positionsfor that year, use fair market values un-der section 475 that are different fromthose values reported for those positionson the applicable financial statement andare values the Commissioner determinesto be appropriate to clearly reflect income.See paragraph (f)(3)(ii) of this section

concerning revocation of the election bythe Commissioner, when a taxpayer doesnot produce required records and fails todemonstrate reasonable cause for suchfailure.

Par. 4. Section 1.475(e)–1 is amendedby redesignating paragraphs (d) through (j)as paragraphs (e) through (k), respectivelyand adding a new paragraph (d) to read asfollows:

§1.475(e)–1 Effective dates.

* * * * *(d) Effective date. Section 1.475(a)–4

(concerning a safe harbor to use applicablefinancial statement values for purposes ofsection 475) applies to taxable years end-ing on or after the date on which the Trea-sury decision promulgating these regula-tions is published in the FEDERAL REG-ISTER.

* * * * *

Mark E. Matthews,Deputy Commissioner forServices and Enforcement.


Partial Withdrawal of Notice ofProposed Rulemaking, Noticeof Proposed Rulemaking, andNotice of Public Hearing

Partnership Equity forServices

REG–105346–03


ACTION: Partial withdrawal of notice ofproposed rulemaking, notice of proposedrulemaking, and notice of public hearing.

SUMMARY: This document withdrawsthe remaining portion of the notice of pro-posed rulemaking published in the FederalRegister on June 3, 1971 (36 FR 10787)and contains proposed regulations relatingto the tax treatment of certain transfers ofpartnership equity in connection with theperformance of services. The proposedregulations provide that the transfer of

June 13, 2005 1244 2005–24 I.R.B.

a partnership interest in connection withthe performance of services is subject tosection 83 of the Internal Revenue Code(Code) and provide rules for coordinat-ing section 83 with partnership taxationprinciples. The proposed regulations alsoprovide that no gain or loss is recognizedby a partnership on the transfer or vestingof an interest in the transferring partner-ship in connection with the performanceof services for the transferring partnership.This document also provides a notice ofpublic hearing on these proposed regula-tions.

DATES: Written or electronic commentsmust be received by August 22, 2005. Out-lines of topics to be discussed at the publichearing scheduled for October 5, 2005, at10 a.m. must be received by September 14,2005.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–105346–03),room 5203, Internal Revenue Ser-vice, PO Box 7604, Ben Franklin Sta-tion, Washington, DC 20044. Submis-sions may be hand-delivered Mondaythrough Friday between the hours of8 a.m. and 4 p.m. to CC:PA:LPD:PR(REG–105346–03), Courier’s Desk, In-ternal Revenue Service, 1111 ConstitutionAvenue, NW, Washington, DC, or sentelectronically, via the IRS Internet site atwww.irs.gov/regs or via the Federal eRule-making Portal at www.regulations.gov(IRS REG–105346–03).

FOR FURTHER INFORMATIONCONTACT: Concerning the section83 regulations, Stephen Tackney at(202) 622–6030; concerning the sub-chapter K regulations, Audrey Ellis orDemetri Yatrakis at (202) 622–3060; con-cerning submissions, the hearing, and/orto be placed on the building access listto attend the hearing, Robin Jones, (202)622–7180 (not toll-free numbers).


Paperwork Reduction Act

The collection of information containedin this notice of proposed rulemaking hasbeen submitted to the Office of Manage-ment and Budget for review in accordancewith the Paperwork Reduction Act of 1995

(44 U.S.C. 3507(d)). Comments on thecollection of information should be sent tothe Office of Management and Budget,Attn: Desk Officer for the Departmentof the Treasury, Office of Informationand Regulatory Affairs, Washington, DC20503, with copies to the Internal Rev-enue Service, Attn: IRS Reports Clear-ance Officer, SE:W:CAR:MP:T:T:SP,Washington, DC 20224. Comments onthe collection of information should bereceived by July 25, 2005. Comments arespecifically requested concerning:

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

The accuracy of the estimated burdenassociated with the proposed collection ofinformation (see below);

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

How the burden of complying with theproposed collection of information may beminimized, including through the appli-cation of automated collection techniquesor other forms of information technology;and

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

The following collections of informa-tion in this proposed regulation are in§1.83–3(l):

(1) Requirement that electing partner-ships submit an election with the partner-ship tax return.

(2) Requirement that certain partnerssubmit a document to the partnership;

(3) Requirement that such documentsbe retained; and

(4) Requirement that partnerships sub-mit a termination document with the part-nership tax return as one method of termi-nating the election.

These collections of information are re-quired by the IRS to determine whetherthe amount of tax has been calculated cor-rectly. The respondents are partnershipsand partners or other service providers.

The estimated total annual reportingand/or recordkeeping burden is 112,500hours.

The estimated annual burden per re-spondent/recordkeeper varies from .10

hours to 10 hours, depending on indi-vidual circumstances, with an estimatedaverage of 1 hour for partnerships and .25hour for a partner or service provider. Theestimated number of respondents and/orrecordkeepers is 100,000 partnerships and50,000 partners or other service providers.

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

An agency may not conduct or sponsor,and a person is not required to respond to, acollection of information unless it displaysa valid control number assigned by the Of-fice of Management and Budget.

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

Background

Partnerships issue a variety of instru-ments in connection with the performanceof services. These instruments includeinterests in partnership capital, interests inpartnership profits, and options to acquiresuch interests (collectively, partnershipequity). On June 5, 2000, the TreasuryDepartment and the IRS issued Notice2000–29, 2000–1 C.B. 1241, invitingpublic comment on the Federal income taxtreatment of the exercise of an option to ac-quire a partnership interest, the exchangeof convertible debt for a partnership in-terest, and the exchange of a preferredinterest in a partnership for a commoninterest in that partnership. On January22, 2003, the Treasury Department andthe IRS published in the Federal Register(REG–103580–02, 2003–1 C.B. 543 [68FR 2930]), proposed regulations regard-ing the Federal income tax consequencesof noncompensatory partnership options,convertible equity, and convertible debt.In the preamble to those proposed reg-ulations, the Treasury Department andthe IRS requested comments on the pro-posed amendment to §1.721–1(b)(1) thatwas published in the Federal Register onJune 3, 1971 (36 FR 10787), and on theFederal income tax consequences of theissuance of partnership capital interests inconnection with the performance of ser-vices and options to acquire such interests.

2005–24 I.R.B. 1245 June 13, 2005

In response to the comments received,the Treasury Department and the IRS arewithdrawing the proposed amendment to§1.721–1(b)(1) and issuing these proposedregulations, which prescribe rules on theapplication of section 83 to partnershipinterests and the Federal income tax con-sequences associated with the transfer,vesting, and forfeiture of partnership in-terests transferred in connection with theperformance of services.

Explanation of Provisions

1. Application of Section 83 to PartnershipInterests

Section 83 generally applies to a trans-fer of property by one person to anotherin connection with the performance of ser-vices. The courts have held that a partner-ship capital interest is property for this pur-pose. See Schulman v. Commissioner, 93T.C. 623 (1989) (section 83 governs the is-suance of an option to acquire a partner-ship interest as compensation for servicesprovided as an employee); Kenroy, Inc.v. Commissioner, T.C. Memo 1984–232.Therefore, the proposed regulations pro-vide that a partnership interest is propertywithin the meaning of section 83, and thatthe transfer of a partnership interest in con-nection with the performance of services issubject to section 83.

The proposed regulations apply section83 to all partnership interests, withoutdistinguishing between partnership capitalinterests and partnership profits interests.Although the application of section 83 topartnership profits interests has been thesubject of controversy, see, e.g., Campbellv. Commissioner, T.C. Memo 1990–162,aff’d in part and rev’d in part, 943 F.2d815 (8th Cir. 1991), n. 7; St. John v. U.S.,84–1 USTC 9158 (C.D. Ill. 1983), theTreasury Department and the IRS do notbelieve that there is a substantial basis fordistinguishing among partnership interestsfor purposes of section 83. All partnershipinterests constitute personal property un-der state law and give the holder the rightto share in future earnings from partner-ship capital and labor. Moreover, somecommentators have suggested that thesame tax rules should apply to both part-nership profits interests and partnershipcapital interests. These commentatorshave suggested that taxpayers may ex-

ploit any differences in the tax treatmentof partnership profits interests and part-nership capital interests. The TreasuryDepartment and the IRS agree with thesecomments. Therefore, all of the rules inthese proposed regulations and the ac-companying proposed revenue procedure(described below) apply equally to part-nership capital interests and partnershipprofits interests. However, a right to re-ceive allocations and distributions froma partnership that is described in section707(a)(2)(A) is not a partnership interest.In section 707(a)(2)(A), Congress directedthat such an arrangement should be char-acterized according to its substance, thatis, as a disguised payment of compensa-tion to the service provider. See S. Rep.No. 98–169, 98 Cong. 2d Sess., at 226(1984).

Section 83(b) allows a person who re-ceives substantially nonvested property inconnection with the performance of ser-vices to elect to include in gross incomethe difference between: (A) the fair mar-ket value of the property at the time oftransfer (determined without regard to arestriction other than a restriction whichby its terms will never lapse); and (B) theamount paid for such property. Under sec-tion 83(b)(2), the election under section83(b) must be made within 30 days of thedate of the transfer of the property to theservice provider.

Consistent with the principles of sec-tion 83, the proposed regulations providethat, if a partnership interest is transferredin connection with the performance ofservices, and if an election under section83(b) is not made, then the holder of thepartnership interest is not treated as apartner until the interest becomes substan-tially vested. If a section 83(b) electionis made with respect to such an interest,the service provider will be treated asa partner for purposes of Subtitle A ofthe Code. These rules are similar to thecurrent rules pertaining to substantiallynonvested stock in a subchapter S cor-poration. See §1.1361–1(b)(3) (upon anelection under section 83(b), the serviceprovider becomes a shareholder for pur-poses of subchapter S).

These principles differ from Rev. Proc.2001–43. Under that revenue procedure, ifa partnership profits interest is transferredin connection with the performance of ser-vices, then the holder of the partnership in-

terest may be treated as a partner even ifno section 83(b) election is made, providedthat certain conditions are met.

Certain changes to the regulations un-der both subchapter K and section 83 areneeded to coordinate the principles of sub-chapter K with the principles of section 83.Among the changes that are proposed inthese regulations are: (1) conforming thesubchapter K rules to the section 83 timingrules; (2) revising the section 704(b) reg-ulations to take into account the fact thatallocations with respect to an unvested in-terest may be forfeited; and (3) providingthat a partnership generally recognizes nogain or loss on the transfer of an interest inthe partnership in connection with the per-formance of services for that partnership.In addition, Rev. Procs. 93–27, 1993–2C.B. 343, and 2001–43, 2001–2 C.B. 191,which generally provide for nonrecogni-tion by both the partnership and the ser-vice provider on the transfer of a profitsinterest in the partnership for services per-formed for that partnership, must be modi-fied to be consistent with these proposedregulations. Accordingly, in conjunctionwith these proposed regulations, the IRSis issuing Notice 2005–43, 2005–24 I.R.B.1221. That notice contains a proposed rev-enue procedure that, when finalized, willobsolete Rev. Procs. 93–27 and 2001–43.The Treasury Department and the IRS in-tend for these proposed regulations and theproposed revenue procedure to become ef-fective at the same time. The proposedamendments to the regulations under sec-tion 83 and subchapter K, as well as the no-tice, are described in further detail below.

The proposed revenue procedure andcertain parts of the proposed regulations(as described below) only apply to a trans-fer by a partnership of an interest in thatpartnership in connection with the per-formance of services for that partnership(compensatory partnership interests). TheTreasury Department and the IRS requestcomments on the income tax consequencesof transactions involving related persons,such as, for example, the transfer of aninterest in a lower-tier partnership inexchange for services provided to the up-per-tier partnership.

2. Timing of Partnership’s Deduction

Except as otherwise provided in§1.83–6(a)(3), if property is transferred

June 13, 2005 1246 2005–24 I.R.B.

in connection with the performance ofservices, then the service recipient’s de-duction, if any, is allowed only for thetaxable year of that person in which orwith which ends the taxable year of theservice provider in which the amount isincluded as compensation. See section83(h). In contrast, under section 706(a)and §1.707–1(c), guaranteed paymentsdescribed in section 707(c) are includedin the partner’s income in the partner’staxable year within or with which endsthe partnership’s taxable year in which thepartnership deducted the payments. Under§1.721–1(b)(2) of the current regulations,an interest in partnership capital issued bythe partnership as compensation for ser-vices rendered to the partnership is treatedas a guaranteed payment under section707(c). Some commentators suggestedthat the proposed regulations should re-solve the potential conflict between thetiming rules of section 83 and the timingrules of section 707(c).

Under the proposed regulations, part-nership interests issued to partners forservices rendered to the partnership aretreated as guaranteed payments. Also,the proposed regulations provide that thesection 83 timing rules override the timingrules of section 706(a) and §1.707–1(c) tothe extent they are inconsistent. Accord-ingly, if a partnership transfers propertyto a partner in connection with the per-formance of services, the timing and theamount of the related income inclusionand deduction is determined by section 83and the regulations thereunder.

In drafting these regulations, the Trea-sury Department and the IRS consideredalternative approaches for resolving thetiming inconsistency between section 83and section 707(c). One alternative ap-proach considered was to provide that thetransfer of property in connection with theperformance of services is not treated asa guaranteed payment within the meaningof section 707(c). This approach was notadopted in the proposed regulations dueto, among other things, concern that sucha characterization of these transfers couldhave unintended consequences on the ap-plication of provisions of the Code outsideof subchapter K that refer to guaranteedpayments. The Treasury Department andthe IRS request comments on alternativeapproaches for resolving the timing incon-

sistency between section 83 and section707(c).

3. Allocation of Partnership’s Deduction

The proposed regulations provide guid-ance regarding the allocation of the part-nership’s deduction for the transfer ofproperty in connection with the perfor-mance of services. Some commentatorssuggested that the proposed regulationsrequire that the partnership’s deductionbe allocated among the partners in accor-dance with their interests in the partnershipprior to the transfer.

Section 706(d)(1) provides generallythat, if, during any taxable year of a part-nership, there is a change in any partner’sinterest in the partnership, each partner’sdistributive share of any item of income,gain, loss, deduction, or credit of thepartnership for such taxable year shallbe determined by the use of any methodprescribed by regulations which takes intoaccount the varying interests of the part-ners in the partnership during the taxableyear. Regulations have not yet been issueddescribing the rules for taking into accountthe varying interests of the partners in thepartnership during a taxable year. Section1.706–1(c)(2)(ii) provides that, in the caseof a sale, exchange, or liquidation of apartner’s entire interest in a partnership,the partner’s share of partnership itemsfor the taxable year may be determined byeither: (1) closing the partnership’s booksas of the date of the transfer (closing ofthe books method); or (2) allocating to thedeparting partner that partner’s pro ratapart of partnership items that the partnerwould have included in the partner’s tax-able income had the partner remained apartner until the end of the partnershiptaxable year (proration method). TheTreasury Department and the IRS believethat section 706(d)(1) adequately ensuresthat partnership deductions that are attrib-utable to the portion of the partnership’staxable year prior to a new partner’s entryinto the partnership are allocated to thehistoric partners.

Section 706(d)(2), however, places ad-ditional limits on how partnerships mayallocate these deductions. Under section706(d)(2)(B), payments for services by apartnership using the cash receipts and dis-bursements method of accounting are al-locable cash basis items. Under section

706(d)(2)(A), if during any taxable yearof a partnership there is a change in anypartner’s interest in the partnership, then(except to the extent provided in regu-lations) each partner’s distributive shareof any allocable cash basis item must bedetermined under the proration method.To allow partnerships to allocate deduc-tions with respect to property transferredin connection with the performance of ser-vices under a closing of the books method,the proposed regulations provide that sec-tion 706(d)(2)(A) does not apply to such atransfer.

4. Accounting for CompensatoryPartnership Interests

A. Transfer of compensatory partnershipinterest

Under the proposed regulations, the ser-vice provider’s capital account is increasedby the amount the service provider takesinto income under section 83 as a resultof receiving the interest, plus any amountspaid for the interest. Some commenta-tors suggested that the amount included inthe service provider’s income under sec-tion 83, plus the amount paid for the inter-est, may differ from the amount of capitalthat the partnership has agreed to assign tothe service provider. These commentatorscontend that the substantial economic ef-fect safe harbor in the section 704(b) reg-ulations should be amended to allow part-nerships to reallocate capital between thehistoric partners and the service providerto accord with the economic agreement ofthe parties.

The reallocation of partnership capitalin these circumstances is not consistentwith the policies underlying the substan-tial economic effect safe harbor and thecapital account maintenance rules. Thepurpose of the substantial economic effectsafe harbor is to ensure that, to the extentthat there is an economic benefit or bur-den associated with a partnership alloca-tion, the partner to whom the allocationis made receives the economic benefit orbears the economic burden. Under sec-tion 83, the economic benefit of receiving apartnership interest in connection with theperformance of services is the amount thatis included in the compensation income ofthe service provider, plus the amount paidfor the interest. This is the amount by

2005–24 I.R.B. 1247 June 13, 2005

which the service partner’s capital accountshould be increased.

As explained in section 6 below, aproposed revenue procedure issued con-currently with these proposed regulationswould allow a partnership, its partners,and the service provider to elect to treatthe fair market value of a partnership in-terest as equal to the liquidation value ofthat interest. If such an election is made,the capital account of a service providerreceiving a partnership interest in connec-tion with the performance of services isincreased by the liquidation value of thepartnership interest received.

B. Forfeiture of certain compensatorypartnership interests

If an election under section 83(b) hasbeen made with respect to a substan-tially nonvested interest, the holder of thenonvested interest may be allocated part-nership items that may later be forfeited.For this reason, allocations of partnershipitems while the interest is substantiallynonvested cannot have economic effect.Under the proposed regulations, suchallocations will be treated as being inaccordance with the partners’ interestsin the partnership if: (a) the partnershipagreement requires that the partnershipmake forfeiture allocations if the interestfor which the section 83(b) election ismade is later forfeited; and (b) all materialallocations and capital account adjust-ments under the partnership agreement notpertaining to substantially nonvested part-nership interests for which a section 83(b)election has been made are recognized un-der section 704(b). This safe harbor doesnot apply if, at the time of the section 83(b)election, there is a plan that a substantiallynonvested interest will be forfeited. All ofthe facts and circumstances (including thetax status of the holder of the substantiallynonvested interest) will be considered indetermining whether there is a plan thatthe interest will be forfeited. In such acase, the partners’ distributive shares ofpartnership items shall be determined inaccordance with the partners’ interests inthe partnership under §1.704–1(b)(3).

Generally, forfeiture allocations areallocations to the service provider of part-nership gross income and gain or gross de-duction and loss (to the extent such itemsare available) that offset prior distributions

and allocations of partnership items withrespect to the forfeited partnership inter-est. These rules are designed to ensurethat any partnership income (or loss) thatwas allocated to the service provider priorto the forfeiture is offset by allocations onthe forfeiture of the interest. Also, to carryout the prohibition under section 83(b)(1)on deductions with respect to amountsincluded in income under section 83(b),these rules generally cause a forfeitingpartner to be allocated partnership incometo offset any distributions to the partnerthat reduced the partner’s basis in thepartnership below the amount included inincome under section 83(b).

Forfeiture allocations may be made outof the partnership’s items for the entire tax-able year. In determining the gross incomeof the partnership in the taxable year of theforfeiture, the rules of §1.83–6(c) apply.As a result, the partnership generally willhave gross income in the taxable year ofthe forfeiture equal to the amount of the al-lowable deduction to the service recipientpartnership upon the transfer of the inter-est as a result of the making of the section83(b) election, regardless of the fair mar-ket value of the partnership’s assets at thetime of forfeiture.

In certain circumstances, the partner-ship will not have enough income and gainto fully offset prior allocations of loss tothe forfeiting service provider. The pro-posed revenue procedure includes a rulethat requires the recapture of losses takenby the service provider prior to the forfei-ture of the interest to the extent that thoselosses are not recaptured through forfeitureallocations of income and gain to the ser-vice provider. This rule does not providethe other partners in the partnership withthe opportunity to increase their shares ofpartnership loss (or reduce their shares ofpartnership income) for the year of the for-feiture by the amount of loss that was pre-viously allocated to the forfeiting serviceprovider.

In other circumstances, the partnershipwill not have enough deductions and lossto fully offset prior allocations of incometo the forfeiting service provider. It ap-pears that, in such a case, section 83(b)(1)may prohibit the service provider fromclaiming a loss with respect to partnershipincome that was previously allocated tothe service provider. However, a forfeit-ing partner is entitled to a loss for any

basis in a partnership that is attributableto contributions of money or property tothe partnership (including amounts paidfor the interest) remaining after the for-feiture allocations have been made. See§1.83–2(a).

Comments are requested as to whetherthe regulations should require or allowpartnerships to create notional tax itemsto make forfeiture allocations where thepartnership does not have enough actualtax items to make such allocations. Com-ments are also requested as to whethersection 83(b)(1) should be read to allowa forfeiting service provider to claim aloss with respect to partnership incomethat was previously allocated to the ser-vice provider and not offset by forfeitureallocations of loss and deduction and, ifso, whether it is appropriate to require theother partners in the partnership to recog-nize income in the year of the forfeitureequal to the amount of the loss claimed bythe service provider. In particular, com-ments are requested as to whether section83 or another section of the Code providesauthority for such a rule.

5. Valuation of Compensatory PartnershipInterests

Commentators requested guidance re-garding the valuation of partnership inter-ests transferred in connection with the per-formance of services. Section 83 gener-ally provides that the recipient of prop-erty transferred in connection with the per-formance of services recognizes incomeequal to the fair market value of the prop-erty, disregarding lapse restrictions. SeeSchulman v. Commissioner, 93 T.C. 623(1989). However, some authorities haveconcluded that, under the particular factsand circumstances of the case, a partner-ship profits interest had only a speculativevalue or that the fair market value of a part-nership interest should be determined byreference to the liquidation value of thatinterest. See §1.704–1(e)(1)(v); Campbellv. Commissioner, 943 F.2d 815 (8th Cir.1991); St. John v. U.S., 1984–1 USTC9158 (C.D. 111. 1983). But see Diamondv. Commissioner, 492 F.2d 286 (7th Cir.1974) (holding under pre-section 83 lawthat the receipt of a profits interest with adeterminable value at the time of receiptresulted in immediate taxation); Campbellv. Commissioner, T.C. Memo 1990–162,

June 13, 2005 1248 2005–24 I.R.B.

aff’d in part and rev’d in part, 943 F.2d 815(8th Cir. 1991).

The Treasury Department and the IRShave determined that, provided certain re-quirements are satisfied, it is appropriate toallow partnerships and service providers tovalue partnership interests based on liqui-dation value. This approach ensures con-sistency in the treatment of partnershipprofits interests and partnership capital in-terests, and accords with other regulationsissued under subchapter K, such as the reg-ulations under section 704(b).

In accordance with these proposed reg-ulations, the revenue procedure proposedin Notice 2005–43, 2005–24 I.R.B. 1221,will, when finalized, provide additionalrules that partnerships, partners, and per-sons providing services to the partnershipin exchange for interests in that partnershipwould be required to follow when electingunder §1.83–3(l) of these proposed regula-tions to treat the fair market value of thoseinterests as being equal to the liquidationvalue of those interests. For this purpose,the liquidation value of a partnership inter-est is the amount of cash that the holderof that interest would receive with respectto the interest if, immediately after thetransfer of the interest, the partnership soldall of its assets (including goodwill, go-ing concern value, and any other intangi-bles associated with the partnership’s op-erations) for cash equal to the fair marketvalue of those assets, and then liquidated.

6. Application of Section 721 toPartnership on Transfer

There is a dispute among commentatorsas to whether a partnership should recog-nize gain or loss on the transfer of a com-pensatory partnership interest. Some com-mentators believe that, on the transfer ofsuch an interest, the partnership should betreated as satisfying its compensation obli-gation with a fractional interest in each as-set of the partnership. Under this deemedsale of assets theory, the partnership wouldrecognize gain or loss equal to the ex-cess of the fair market value of each par-tial asset deemed transferred to the serviceprovider over the partnership’s adjustedbasis in that partial asset. Other commen-tators believe that a partnership should notrecognize gain or loss on the transfer of acompensatory partnership interest. They

argue, among other things, that the transferof such an interest is not properly treated asa realization event for the partnership be-cause no property owned by the partner-ship has changed hands. They also arguethat taxing a partnership on the transfer ofsuch an interest would result in inappropri-ate gain acceleration, would be difficult toadminister, and would cause economicallysimilar transactions to be taxed differently.

Generally, when appreciated propertyis used to pay an obligation, gain on theproperty is recognized. The Treasury De-partment and the IRS are still analyzingwhether an exception to this general rule isappropriate on the transfer of an interest inthe capital or profits of a partnership to sat-isfy certain partnership obligations (suchas the obligations to pay interest or rent).However, the Treasury Department and theIRS believe that partnerships should notbe required to recognize gain on the trans-fer of a compensatory partnership inter-est. Such a rule is more consistent withthe policies underlying section 721 — todefer recognition of gain and loss whenpersons join together to conduct a business— than would be a rule requiring the part-nership to recognize gain on the transferof these types of interests. Therefore, theproposed regulations provide that partner-ships are not taxed on the transfer or sub-stantial vesting of a compensatory partner-ship interest. Under §1.704–1(b)(4)(i) (re-verse section 704(c) principles), the his-toric partners generally will be required torecognize any income or loss attributableto the partnership’s assets as those assetsare sold, depreciated, or amortized.

The rule providing for nonrecognitionof gain or loss does not apply to the transferor substantial vesting of an interest in an el-igible entity, as defined in §301.7701–3(a)of the Procedure and Administration Reg-ulations, that becomes a partnership under§301.7701–3(f)(2) as a result of the trans-fer or substantial vesting of the interest.See McDougal v. Commissioner, 62 T.C.720 (1974) (holding that the service re-cipient recognized gain on the transfer ofa one-half interest in appreciated propertyto the service provider, immediately priorto the contribution by the service recipientand the service provider of their respectiveinterests in the property to a newly formedpartnership).

7. Revaluations of Partnership Property

The proposed regulations concern-ing noncompensatory partnership optionspublished on January 22, 2003, containedspecial rules regarding the revaluations ofpartnership property while noncompen-satory partnership options were outstand-ing. Specifically, the regulations proposedmodifications to §1.704–1(b)(2)(iv)(f) and(h) to provide that any revaluation duringthe period in which there are outstandingnoncompensatory options generally musttake into account the fair market value, ifany, of outstanding options. These pro-posed regulations do not contain similarprovisions, because under recently pro-posed modifications to the regulationsunder §1.7041(b)(2)(iv), the obligationto issue a partnership interest in satisfac-tion of an option agreement is a liabilitythat is taken into account in determin-ing the fair market value of partnershipassets as a result of a revaluation. SeeREG–106736–00, 2003–2 C.B. 60 [68FR 37434] (June 24, 2003) (relating tothe assumption of certain obligations bypartnerships from partners).

8. Characterization Rule

The proposed regulations concern-ing noncompensatory partnership optionspublished on January 22, 2003, containeda rule (§1.761–3) providing that the holderof a noncompensatory option is treatedas a partner under certain circumstances.However, the Treasury Department andthe IRS have concluded that these pro-posed regulations should not contain asimilar rule for partnership options trans-ferred in connection with the performanceof services because of the possibility thatconstructive transfers of property, subjectto section 83, may occur under circum-stances other than those described in theproposed rules for treating the holder of anoncompensatory option as a partner. TheTreasury Department and the IRS requestcomments on whether anti-abuse rules arenecessary to prevent taxpayers from usingthe rules in these proposed regulations orthe rules in Notice 2005–43 to inappropri-ately shift items of partnership income orloss between the service provider and theother partners.

2005–24 I.R.B. 1249 June 13, 2005

9. Retroactive Allocations

Section 761(c) generally allows a part-nership to modify its agreement at any timeon or prior to the due date for the part-nership’s return for the taxable year (with-out regard to extensions). Thus, for exam-ple, a partnership could, at the end of itstaxable year, amend its partnership agree-ment to provide that a service provider wasentitled to a substantially vested or non-vested interest in partnership profits andlosses from the beginning of the partner-ship’s taxable year. It is expected that, ifa substantially vested compensatory part-nership interest is transferred to an em-ployee or independent contractor (or anelection under section 83(b) is made withrespect to the transfer of a substantiallynonvested compensatory partnership inter-est to an employee or independent contrac-tor), the partnership will report the trans-fer on Form W–2, “Wage and Tax State-ment,” or Form 1099–MISC, “Miscella-neous Income,” as appropriate. The FormW–2 or Form 1099–MISC would be is-sued to the service provider by the partner-ship by January 31 of the year followingthe calendar year in which the partnershipinterest is transferred, and the partnershipwould file such forms with the Social Se-curity Administration or IRS, respectively,by February 28 (March 31 if filed elec-tronically) of the year following the calen-dar year in which the partnership interest istransferred. The service provider would berequired to report any income recognizedon the transfer of the partnership intereston the service provider’s return for the tax-able year (of the service provider) in whichthe transfer occurs.

It is unclear whether the retroactivecommencement date of such an interestshould be treated as the date of the transferof the interest for purposes of section 83and other provisions of the Code outside ofsubchapter K. If the retroactive effectivedate of the interest is treated as the transferdate for all purposes, a number of admin-istrative concerns arise. For example, thepartnership may not, by the January 31deadline, have the information necessaryto issue Form W–2 or Form 1099–MISCto the service provider. Also, the serviceprovider may not, by the due date for fil-ing the section 83(b) election, have theinformation necessary to file the election.The Treasury Department and the IRS

request comments on the timing for sec-tion 83 purposes of retroactive transfersof partnership interests and on any actionsthat may be appropriate to address theassociated administrative concerns.

10. Information Reporting to Partners

As explained above, the proposed reg-ulations treat the transfer of a partnershipinterest to a partner in connection withthe performance of services as a guaran-teed payment. To ensure that the serviceprovider partner has the information nec-essary to include the transfer in incomefor the taxable year in which the transferoccurs (rather than the taxable year inwhich or with which ends the partnershiptaxable year in which the transfer occurs),the Treasury Department and the IRS areconsidering the possibility of amendingthe section 6041 regulations to providethat this type of guaranteed payment mustbe reported by the partnership on Form1099–MISC, which is required to be is-sued to the service provider on or beforeJanuary 31 of the year following the cal-endar year of such transfer. The TreasuryDepartment and the IRS request com-ments on whether such a requirement isappropriate and administrable.

Proposed Effective Date

These regulations are proposed to applyto transfers of property on or after the datefinal regulations are published in the Fed-eral Register.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a significantregulatory action as defined in ExecutiveOrder 12866. Therefore, a regulatory as-sessment is not required. It also has beendetermined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C. chap-ter 5) does not apply to these regulations.It is hereby certified that the collection ofinformation in these regulations will nothave a significant economic impact on asubstantial number of small entities. Thiscertification is based upon the fact that thereporting burden, as discussed earlier inthis preamble, is not expected to be signif-icant. Partnerships with partnership agree-ments that contain the binding provisions

referred to in §1.83–3(l) only will be re-quired to submit a single election form inorder to rely on the safe harbor describedin that paragraph. Partnerships that desireto elect to use the safe harbor describedin §1.83–3(l), but which do not have part-nership agreements containing these pro-visions, are required to obtain partner-levelconsents to the election. However, thesepartnerships are expected to be rare. More-over, in most cases the partners in suchpartnerships are not expected to be smallbusinesses. Therefore, a Regulatory Flexi-bility Analysis under the Regulatory Flex-ibility Act (5 U.S.C. chapter 6) is not re-quired. Pursuant to section 7805(f) of theCode, this notice of proposed rulemakingwill be submitted to the Chief Counsel forAdvocacy of the Small Business Adminis-tration for comment on its impact on smallbusiness.


Before these proposed regulations areadopted as final regulations, considerationwill be given to any electronic or writ-ten comments (a signed original and eight(8) copies) that are submitted timely to theIRS. The IRS and the Treasury Departmentrequest comments on the clarity of the pro-posed rules and how they can be made eas-ier to understand. All comments will beavailable for public inspection and copy-ing.

A public hearing has been scheduledfor October 5, 2005, beginning at 10 a.m.in the IRS Auditorium, Internal RevenueBuilding, 1111 Constitution Avenue, NW,Washington, DC. Due to building securityprocedures, visitors must enter at the Con-stitution Avenue entrance. In addition, allvisitors must present photo identificationto enter the building. Because of accessrestrictions, visitors will not be admittedbeyond the immediate entrance area morethan 30 minutes before the hearing starts.For information about having your nameplaced on the building access list to attendthe hearing, see the “FOR FURTHER IN-FORMATION CONTACT” portion of thispreamble.

The rules of 26 CFR 601.601(a)(3) ap-ply to the hearing. Persons who wish topresent oral comments must submit writ-ten comments and an outline of the topicsto be discussed and the time to be devotedto each topic (a signed original and eight

June 13, 2005 1250 2005–24 I.R.B.

(8) copies) by September 14, 2005. A pe-riod of 10 minutes will be allotted to eachperson for making comments. An agendashowing the scheduling of the speakerswill be prepared after the deadline for re-viewing outlines has passed. Copies of theagenda will be available free of charge atthe hearing.


The principal authors of theseregulations are Audrey Ellis andDemetri Yatrakis of the Office of As-sociate Chief Counsel (Passthroughs andSpecial Industries), and Stephen Tackneyof the Office of Associate Chief Counsel(Tax Exempt and Government Entities).However, other personnel from the IRSand Treasury Department participated intheir development.

Withdrawal of Notice of ProposedRulemaking

Accordingly, under the authority of 26U.S.C. 7805, §1.721–1(b) of the notice ofproposed rulemaking that was published inthe Federal Register on June 3, 1971 (36FR 10787) is withdrawn.

* * * * *





Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.83–3 is amended as

follows:1. Paragraph (e) is amended by adding

two new sentences after the first sentence.2. Paragraph (l) is added.The revision and addition read as fol-

lows:

§1.83–3 Meaning and use of certainterms.

* * * * *(e) Property. * * * Accordingly, prop-

erty includes a partnership interest. Theprevious sentence is effective for transferson or after the date final regulations arepublished in the Federal Register. * * *

* * * * *(l) Special rules for the transfer of

a partnership interest. (1) Subject tosuch additional conditions, rules, andprocedures that the Commissioner mayprescribe in regulations, revenue rul-ings, notices, or other guidance publishedin the Internal Revenue Bulletin (see§601.601(d)(2)(ii)(b) of this chapter), apartnership and all of its partners mayelect a safe harbor under which the fairmarket value of a partnership interest thatis transferred in connection with the per-formance of services is treated as beingequal to the liquidation value of that inter-est for transfers on or after the date finalregulations are published in the FederalRegister if the following conditions aresatisfied:

(i) The partnership must prepare a doc-ument, executed by a partner who has re-sponsibility for Federal income tax report-ing by the partnership, stating that the part-nership is electing, on behalf of the part-nership and each of its partners, to havethe safe harbor apply irrevocably as ofthe stated effective date with respect toall partnership interests transferred in con-nection with the performance of serviceswhile the safe harbor election remains ineffect and attach the document to the taxreturn for the partnership for the taxableyear that includes the effective date of theelection.

(ii) Except as provided in paragraph(l)(1)(iii) of this section, the partnershipagreement must contain provisions that arelegally binding on all of the partners stat-ing that—

(A) The partnership is authorized anddirected to elect the safe harbor; and

(B) The partnership and each of itspartners (including any person to whom apartnership interest is transferred in con-nection with the performance of services)agrees to comply with all requirementsof the safe harbor with respect to all part-nership interests transferred in connectionwith the performance of services while theelection remains effective.

(iii) If the partnership agreement doesnot contain the provisions described inparagraph (l)(1)(ii) of this section, or theprovisions are not legally binding on allof the partners of the partnership, theneach partner in a partnership that transfersa partnership interest in connection withthe performance of services must execute

a document containing provisions thatare legally binding on that partner statingthat—

(A) The partnership is authorized anddirected to elect the safe harbor; and

(B) The partner agrees to comply withall requirements of the safe harbor with re-spect to all partnership interests transferredin connection with the performance of ser-vices while the election remains effective.

(2) The specified effective date of thesafe harbor election may not be prior tothe date that the safe harbor election is ex-ecuted. The partnership must retain suchrecords as may be necessary to indicatethat an effective election has been madeand remains in effect, including a copy ofthe partnership’s election statement underthis paragraph (l), and, if applicable, theoriginal of each document submitted to thepartnership by a partner under this para-graph (l). If the partnership is unable toproduce a record of a particular document,the election will be treated as not made,generally resulting in termination of theelection. The safe harbor election also maybe terminated by the partnership prepar-ing a document, executed by a partner whohas responsibility for Federal income taxreporting by the partnership, which statesthat the partnership, on behalf of the part-nership and each of its partners, is revok-ing the safe harbor election on the statedeffective date, and attaching the documentto the tax return for the partnership for thetaxable year that includes the effective dateof the revocation.

Par. 3. Section 1.83–6 is amended byrevising the first sentence of paragraph (b)to read as follows:

§1.83–6 Deduction by employer.

* * * * *(b) Recognition of gain or loss. Ex-

cept as provided in section 721 and sec-tion 1032, at the time of a transfer of prop-erty in connection with the performance ofservices the transferor recognizes gain tothe extent that the transferor receives anamount that exceeds the transferor’s basisin the property. * * *

* * * * *Par. 4. Section 1.704–1 is amended as

follows:1. In paragraph (b)(0), an entry is added

to the table for §1.704–1(b)(4)(xii).

2005–24 I.R.B. 1251 June 13, 2005

2. In paragraph (b)(1)(ii)(a), a sentenceis added at the end of the paragraph.

3. Paragraph (b)(2)(iv)(b)(1) is revised.4. Paragraph (b)(2)(iv)(f)(5)(iii) is re-

vised.5. Paragraph (b)(4)(xii) is added.6. Paragraph (b)(5) Example 29 is

added.The additions and revisions read as fol-

lows:

§1.704–1 Partner’s distributive share.

* * * * *(b) * * *(0) * * *

* * * * *Substantially nonvested inter-

ests………….………1.704–1(b)(4)(xii)

* * * * *(1) * * *(ii) * * * (a) * * * In addition, para-

graph (b)(4)(xii) and paragraph (b)(5) Ex-ample 29 of this section apply to com-pensatory partnership interests (as definedin §1.721–1(b)(3)) that are transferred onor after the date final regulations are pub-lished in the Federal Register.

* * * * *(2) * * *(iv) * * *(b) * * *(1) the amount of money contributed by

that partner to the partnership and, in thecase of a compensatory partnership inter-est (as defined in §1.721–1(b)(3)) that istransferred on or after the date final regu-lations are published in the Federal Reg-ister, the amount included on or after thatdate in the partner’s compensation incomeunder section 83(a), (b), or (d)(2).

* * * * *(f) * * *(5) * * *(iii) In connection with the transfer or

vesting of a compensatory partnership in-terest (as defined in §1.721–1(b)(3)) that istransferred on or after the date final regu-lations are published in the Federal Reg-ister, but only if the transfer or vesting re-sults in the service provider recognizingincome under section 83 (or would resultin such recognition if the interest had a fairmarket value other than zero).

* * * * *(4) * * *(xii) Substantially nonvested inter-

ests—(a) In general. If a section 83(b)

election has been made with respect to asubstantially nonvested interest, the holderof the nonvested interest may be allocatedpartnership income, gain, loss, deduction,or credit (or items thereof) that will laterbe forfeited. For this reason, allocationsof partnership items while the interest issubstantially nonvested cannot have eco-nomic effect.

(b) Deemed Compliance with Partners’Interests in the Partnership. If a section83(b) election has been made with respectto a substantially nonvested interest, al-locations of partnership items while theinterest is substantially nonvested will bedeemed to be in accordance with the part-ners’ interests in the partnership if—

(1) The partnership agreement requiresthat the partnership make forfeiture alloca-tions if the interest for which the section83(b) election is made is later forfeited;and

(2) All material allocations and capitalaccount adjustments under the partnershipagreement not pertaining to substantiallynonvested partnership interests for whicha section 83(b) election has been made arerecognized under section 704(b).

(c) Forfeiture allocations. Forfeitureallocations are allocations to the serviceprovider (consisting of a pro rata portionof each item) of gross income and gain orgross deduction and loss (to the extent suchitems are available) for the taxable yearof the forfeiture in a positive or negativeamount equal to—

(1) The excess (not less than zero) ofthe—

(i) Amount of distributions (includingdeemed distributions under section 752(b)and the adjusted tax basis of any propertyso distributed) to the partner with respectto the forfeited partnership interest (to theextent such distributions are not taxableunder section 731); over

(ii) Amounts paid for the interest andthe adjusted tax basis of property con-tributed by the partner (including deemedcontributions under section 752(a)) to thepartnership with respect to the forfeitedpartnership interest; minus

(2) The cumulative net income (or loss)allocated to the partner with respect to theforfeited partnership interest.

(d) Positive and negative amounts. Forpurposes of paragraph (b)(4)(xii)(c) of thissection, items of income and gain are re-flected as positive amounts, and items of

deduction and loss are reflected as nega-tive amounts.

(e) Exception. Paragraph (b)(4)(xii)(b)of this section shall not apply to alloca-tions of partnership items made with re-spect to a substantially nonvested interestfor which the holder has made a section83(b) election if, at the time of the section83(b) election, there is a plan that the in-terest will be forfeited. In such a case, thepartners’ distributive shares of partnershipitems shall be determined in accordancewith the partners’ interests in the partner-ship under paragraph (b)(3) of this section.In determining whether there is a plan thatthe interest will be forfeited, the Commis-sioner will consider all of the facts andcircumstances (including the tax status ofthe holder of the forfeitable compensatorypartnership interest).

(f) Cross references. Forfeiture alloca-tions may be made out of the partnership’sitems for the entire taxable year of the for-feiture. See §1.706–3(b) and paragraph(b)(5) Example 29 of this section.

* * * * *(5) * * *Example 29. (i) In Year 1, A and B each con-

tribute cash to LLC, a newly formed limited liabilitycompany classified as a partnership for Federal taxpurposes, in exchange for equal units in LLC. UnderLLC’s operating agreement, each unit is entitled toparticipate equally in the profits and losses of LLC.The operating agreement also provides that the part-ners’ capital accounts will be determined and main-tained in accordance with paragraph (b)(2)(iv) of thissection, that liquidation proceeds will be distributedin accordance with the partners’ positive capital ac-count balances, and that any partner with a deficitbalance in that partner’s capital account following theliquidation of the partner’s interest must restore thatdeficit to the partnership. At the beginning of Year 3,SP agrees to perform services for LLC. In connectionwith the performance of SP’s services and a paymentof $10 by SP to LLC, LLC transfers a 10% interest inLLC to SP. SP’s interest in LLC is substantially non-vested (within the meaning of §1.83–3(b)). At thetime of the transfer of the LLC interest to SP, LLC’soperating agreement is amended to provide that, ifSP’s interest is forfeited, then SP is entitled to a re-turn of SP’s $10 initial contribution, and SP’s dis-tributive share of all partnership items (other than for-feiture allocations under §1.704–1(b)(4)(xii)) will bezero with respect to that interest for the taxable yearof the partnership in which the interest was forfeited.The operating agreement is also amended to requirethat LLC make forfeiture allocations if SP’s interestis forfeited. Additionally, the operating agreement isamended to provide that no part of LLC’s compensa-tion deduction is allocated to the service provider towhom the interest is transferred. SP makes an elec-tion under section 83(b) with respect to SP’s interestin LLC. Upon receipt, the fair market value of SP’sinterest in LLC is $100. In each of Years 3, 4, 5,

June 13, 2005 1252 2005–24 I.R.B.

and 6, LLC has operating income of $100 (consistingof $200 of gross receipts and $100 of deductible ex-penses), and makes no distributions. SP forfeits SP’sinterest in LLC at the beginning of Year 6. At thetime of the transfer of the interest to SP, there is noplan that SP will forfeit the interest in LLC.

(ii) Because a section 83(b) election is made, SPrecognizes compensation income in the year of thetransfer of the LLC interest. Therefore, SP recog-nizes $90 of compensation income in the year of thetransfer of the LLC interest (the excess of the fairmarket value of SP’s interest in LLC, $100, over theamount SP paid for the interest, $10). Under para-graph (b)(2)(iv)(b)(1) of this section, in Year 3, SP’scapital account is initially credited with $100, theamount paid for the interest ($10) plus the amount in-cluded in SP’s compensation income upon the trans-fer under section 83(b) ($90). Under §§1.83–6(b) and1.721–1(b)(2), LLC does not recognize gain on thetransfer of the interest to SP. LLC is entitled to a com-pensation deduction of $90 under section 83(h). Un-der the terms of the operating agreement, the deduc-tion is allocated equally to A and B.

(iii) As a result of SP’s election under section83(b), SP is treated as a partner starting from the dateof the transfer of the LLC interest to SP in Year 3.Section 1.761–1(b). In each of years 3, 4 and 5, SP’sdistributive share of partnership income is $10 (10%of $100), A’s distributive share of partnership incomeis $45 (45% of $100), and B’s distributive share ofpartnership income is $45 (45% of $100). In accor-dance with the operating agreement, SP’s capital ac-count is increased (to $130) by the end of Year 5 bythe amounts allocated to SP, and A’s and B’s capi-tal accounts are increased by the amounts allocatedto A and B. Because LLC satisfies the requirementsof paragraph (b)(4)(xii) of this section, LLC’s alloca-tions in years 3, 4 and 5 are deemed to be in accor-dance with the partners’ interests in the partnership.

(iv) As a result of the forfeiture of the LLC in-terest by SP in year 6, LLC is required to recognizeincome ($90) equal to the amount of the allowable de-duction on the transfer of the LLC interest to SP under§1.83–6(c). LLC repays SP’s $10 capital contribu-tion to SP, reducing SP’s capital account to $120. Un-der the terms of the operating agreement, because SPforfeited SP’s interest, SP’s distributive share of allpartnership items (other than forfeiture allocations)is zero for Year 6. To reverse SP’s prior allocationsof LLC income, LLC makes forfeiture allocations of$30 of deductions ($0 (the difference between the $10distributed to SP and the $10 contributed to LLC bySP) minus $30 (the cumulative net LLC income allo-cated to SP) to SP in Year 6. Notwithstanding section706(c) and (d), these allocations may be made out ofLLC’s partnership items for the entire taxable year ofthe forfeiture. Thus, in Year 6, $30 of deductions areallocated to SP, and the remaining $220 of net operat-ing income ($200 of gross receipts and $90 of incomeunder §1.83–6(c) less $70 of remaining deductions)are allocated to A and B equally for tax purposes. Inaccordance with section 83(b)(1) (last sentence), SPdoes not receive a deduction or capital loss for theamount ($90) that was included in SP’s compensa-tion income. Because LLC satisfies the requirementsof paragraph (b)(4)(xii) of this section, LLC’s alloca-tions in year 6 are deemed to be in accordance withthe partners’ interests in the partnership.

* * * * *

Par. 5. Section 1.706–3 is added to readas follows.

§1.706–3 Property transferred inconnection with the performance ofservices.

(a) Allocations of certain deductionsunder section 83(h). The transfer of prop-erty subject to section 83 in connectionwith the performance of services is notan allocable cash basis item within themeaning of section 706(d)(2)(B).

(b) Forfeiture allocations. If an elec-tion under section 83(b) is made with re-spect to a partnership interest that is sub-stantially nonvested (within the meaningof §1.83–3(b)), and that interest is later for-feited, the partnership must make forfei-ture allocations to reverse prior allocationsmade with respect to the forfeited inter-est. See §1.704–1(b)(4)(xii). Although theperson forfeiting the interest may not havebeen a partner for the entire taxable year,forfeiture allocations may be made out ofthe partnership’s items for the entire tax-able year.

(c) Effective date. This section appliesto transfers of property on or after the datefinal regulations are published in the Fed-eral Register.

Par. 6. In §1.707–1, paragraph (c) isamended by revising the second sentenceto read as follows:

§1.707–1 Transactions between partnerand partnership.

* * * * *(c) Guaranteed Payments. * * * How-

ever, except as otherwise provided in sec-tion 83 and the regulations thereunder, apartner must include such payments as or-dinary income for that partner’s taxableyear within or with which ends the partner-ship taxable year in which the partnershipdeducted such payments as paid or accruedunder its method of accounting. * * *

* * * * *Par. 7. In §1.721–1, paragraph (b) is

revised to read as follows.

§1.721–1 Nonrecognition of gain or losson contribution.

* * * * *(b)(1) Except as otherwise provided in

this section or §1.721–2, section 721 does

not apply to the transfer of a partnership in-terest in connection with the performanceof services or in satisfaction of an obliga-tion. The transfer of a partnership interestto a person in connection with the perfor-mance of services constitutes a transfer ofproperty to which section 83 and the regu-lations thereunder apply. To the extent thata partnership interest transferred in con-nection with the performance of servicesrendered by a decedent prior to the dece-dent’s death is transferred after the dece-dent’s death to the decedent’s successor ininterest, the fair market value of such in-terest is an item of income in respect of adecedent under section 691.

(2) Except as provided in section 83(h)and 1.83–6(c), no gain or loss shall be rec-ognized by a partnership upon—

(i) The transfer or substantial vesting ofa compensatory partnership interest; or

(ii) The forfeiture of a compensatorypartnership interest. See §1.704–1(b)(4)(xii) for rules regarding forfeiture alloca-tions of partnership items that may be re-quired in the taxable year of a forfeiture.

(3) For purposes of this section, acompensatory partnership interest is aninterest in the transferring partnershipthat is transferred in connection with theperformance of services for that partner-ship (either before or after the formationof the partnership), including an inter-est that is transferred on the exercise ofa compensatory partnership option. Acompensatory partnership option is an op-tion to acquire an interest in the issuingpartnership that is granted in connectionwith the performance of services for thatpartnership (either before or after the for-mation of the partnership).

(4) To the extent that a partnership in-terest is—

(i) Transferred to a partner in connec-tion with the performance of services ren-dered to the partnership, it is a guaranteedpayment for services under section 707(c);

(ii) Transferred in connection with theperformance of services rendered to a part-ner, it is not deductible by the partnership,but is deductible only by such partner tothe extent allowable under Chapter 1 of theCode.

(5) This paragraph (b) applies to inter-ests that are transferred on or after the datefinal regulations are published in the Fed-eral Register.

2005–24 I.R.B. 1253 June 13, 2005

* * * * *Par. 8. Section 1.761–1(b) is amended

by adding two sentences to the end of theparagraph to read as follows.

§1.761–1 Terms defined.

* * * * *(b) * * * If a partnership interest is trans-

ferred in connection with the performanceof services, and that partnership interest issubstantially nonvested (within the mean-ing of §1.83–3(b)), then the holder of thepartnership interest is not treated as a part-ner solely by reason of holding the interest,unless the holder makes an election withrespect to the interest under section 83(b).The previous sentence applies to partner-ship interests that are transferred on or af-ter the date final regulations are publishedin the Federal Register. * * * * *

Mark E. Matthews,Deputy Commissioner forServices and Enforcement.


Notice of ProposedRulemaking

Application of Section 367in Cross Border Section304 Transactions; CertainTransfers of Stock InvolvingForeign Corporations

REG–127740–04


ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains pro-posed amendments to the regulations un-der section 367 relating to certain trans-fers of stock involving foreign corpora-tions in transactions governed by section304. Specifically, these proposed regula-tions provide that if, pursuant to section304(a)(1), a U.S person is treated as trans-ferring stock of a domestic or foreign cor-poration to a foreign corporation in ex-

change for stock of such foreign corpo-ration in a transaction to which section351(a) applies, such deemed section 351exchange is not a transfer to a foreign cor-poration subject to section 367(a). Theseproposed regulations also provide that if,pursuant to section 304(a)(1), a foreign ac-quiring corporation is treated as acquiringthe stock of a foreign acquired corporationin a transaction to which section 351(a)applies, such deemed section 351 acquisi-tion is not an acquisition subject to section367(b).

DATES: Written or electronic commentsand requests for a public hearing must bereceived by August 23, 2005.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–127740–04),room 5203, Internal Revenue Service,POB 7604, Ben Franklin Station, Wash-ington, DC 20044. Submissions maybe hand delivered between the hours of8 a.m. and 4 p.m. to: CC:PA:LPD:PR(REG–127740–04), Courier’s Desk, In-ternal Revenue Service, 1111 Consti-tution Avenue, NW, Washington, DC.Alternatively, taxpayers may submitelectronic comments directly to theIRS internet site at www.irs.gov/regsor via the Federal eRulemaking Por-tal at www.regulations.gov (IRS andREG–127740–04).

FOR FURTHER INFORMATIONCONTACT: Concerning the proposedregulations, Tasheaya L. Warren Ellison,(202) 622–3870; concerning submis-sions of comments, Sonya Cruse, (202)622–4693 (not toll-free numbers).


Background and Explanation ofProvisions

A. Section 367(a)

A U.S. person’s transfer of appreciatedproperty (including stock) to a foreign cor-poration in connection with any exchangedescribed in sections 332, 351, 354, 356,or 361 generally is treated under section367(a)(1) as a taxable transaction, unlessan exception applies. Congress enactedsection 367(a) to prevent the avoidance of

U.S. tax on transfers of appreciated prop-erty outside the United States in nonrecog-nition transfers involving foreign corpora-tions. S.R. Rep. No. 169, Vol. 1, 98th

Cong. 2d Sess., at 360 (Apr. 2, 1984).In the case of a U.S. person’s transfer

of stock to a foreign corporation in anexchange described in section 367(a)(1),§1.367(a)–3 provides exceptions to thegeneral gain recognition rule of section367(a)(1), if certain conditions are satis-fied including, in some instances, the filingof a gain recognition agreement (GRA).See §1.367(a)–3(b) (transfer of stock in aforeign corporation) and (c) (transfer ofstock in a domestic corporation).

B. Section 367(b)

Section 367(b) addresses transactionscovered by sections 332, 351, 354, 355,356, and 361 in which there is no trans-fer of property described in section 367(a).Section 367(b) provides that a foreign cor-poration shall be considered to be a corpo-ration for purposes of these subchapter Cprovisions, except to the extent provided inregulations. The status of a foreign corpo-ration as a corporation for these purposesmay allow various participants to the trans-action to qualify for nonrecognition treat-ment.

One of the underlying policies of sec-tion 367(b) is the preservation of the poten-tial application of section 1248. H. R. Rep.No. 94–658, 94th Cong., 1st Sess., at 242(November 12, 1975). Section 1248 gen-erally recharacterizes gain recognized by aU.S. person (a section 1248 shareholder)that owns 10 percent or more of the to-tal combined voting power of a controlledforeign corporation, as defined in section957, or, in certain instances, stock of a for-mer controlled foreign corporation, uponthe disposition of the stock of such corpo-ration as dividend income to the extent ofthe earnings and profits that are attribut-able to such stock (section 1248 amount).

Consequently, §1.367(b)–4(b)(1) gen-erally requires a section 1248 shareholder(or, in certain instances, a foreign corpora-tion that has a section 1248 shareholder) toinclude in income its section 1248 amountas a result of certain section 367(b) trans-actions, including certain section 351 ex-changes, if as a result of the transaction

June 13, 2005 1254 2005–24 I.R.B.

section 1248 shareholder status or con-trolled foreign corporation status is lost.

C. Section 304

Section 304 was enacted to preventwithdrawals of corporate earnings by con-trolling shareholders in transactions thatresult in capital gains treatment. See H.R.Rep. No. 2014, 105th Cong. 1st Sess.,at 465 (June 24, 1997). Section 304(a)(1)generally provides that, for purposes ofsections 302 and 303, if one or more per-sons are in control of each of two corpora-tions and in return for property one of thecorporations (the acquiring corporation)acquires stock in the other corporation(the issuing corporation) from the person(or persons) so in control, then such prop-erty shall be treated as a distribution inredemption of the acquiring corporationstock.

Prior to 1997, section 304(a)(1) pro-vided that, to the extent of a distributiontreated as a distribution to which section301 applies, the issuing corporation stockwould be treated as having been trans-ferred by the person from whom acquired,and as having been received by the ac-quiring corporation as a contribution tothe capital of the acquiring corporation.Section 304 was amended by section 1013of the Taxpayer Relief Act of 1997, PublicLaw 105–34 (111 Stat. 788, 918) (August5, 1997) to provide that, to the extent thata stock acquisition covered by section304(a)(1) is treated as a distribution towhich section 301 applies, the transferorand the acquiring corporation are treatedas if (1) the transferor transferred the stockof the issuing corporation to the acquiringcorporation in exchange for stock of theacquiring corporation in a transaction towhich section 351(a) applies, and (2) theacquiring corporation then redeemed thestock it is treated as having issued. Be-cause the acquiring corporation is treatedas receiving the stock of the issuing cor-poration in a transaction to which section351 applies, the transferor’s basis in thestock of the issuing corporation carriesover to the acquiring corporation undersection 362.

In the case of an acquisition to whichsection 304(a) applies, section 304(b)(2)generally provides that the determinationof the amount that is a dividend (and thesource thereof) is made as if the property

were distributed first by the acquiring cor-poration to the extent of its earnings andprofits, and then by the issuing corpora-tion to the extent of its earnings and prof-its. In a transaction involving a foreign ac-quiring corporation, section 304(b)(5) maylimit the amount of the earnings and prof-its of the foreign acquiring corporation thatwill be taken into account for purposes ofsection 304(b)(2)(A).

D. Application of Section 367 to Section304(a)(1) Transactions

The application of section 367(a) and(b) to certain section 304(a)(1) transac-tions involving a foreign corporation hasbeen addressed in various published guid-ance. See, e.g., Rev. Rul. 91–5, 1991–1C.B. 114 (holding that section 367 ap-plied to the deemed contribution to capitalof target corporation stock under priorlaw because section 367(c)(2) resultedin the stock transfer constituting a sec-tion 351 exchange). Moreover, in thepreamble to the proposed regulations re-garding redemptions taxable as dividends(REG–150313–01, 2002–2 C.B. 777 [67FR 64331] October 18, 2002), the IRSand Treasury indicated that certain inter-national provisions may apply to section304(a)(1) transfers, and provided as an ex-ample the application of section 367 andthe regulations promulgated thereunder toa deemed section 351 exchange involvingforeign corporations. The IRS and Trea-sury also stated that further guidance onthe application of the international pro-visions to section 304(a)(1) transactionswould be forthcoming.

The IRS and Treasury have determinedthat the policies underlying section 304(prevention of withdrawals of corporateearnings through the use of transactionsthat result in capital gains treatment),section 367(a) (prevention of U.S. taxavoidance through transfers of appreci-ated property to foreign corporations), andsection 367(b) (inter alia, preservation ofthe potential application of section 1248)are preserved if section 367(a) and (b) arenot applied to a deemed section 351 ex-change resulting from a section 304(a)(1)transaction. In addition, the IRS and Trea-sury believe that the interests of sound taxadministration are served by not apply-ing section 367(a) and (b) to a deemedsection 351 exchange resulting from a sec-

tion 304(a)(1) transaction. Consequently,these proposed regulations provide thatsection 367(a) and (b) will not apply toa deemed section 351 exchange result-ing from a section 304(a)(1) transaction.These proposed regulations do not ad-dress section 351 transactions other thanthose exchanges treated as section 351exchanges by reason of section 304(a)(1).

1. Application of section 367(a)

In a section 304(a)(1) transaction inwhich a U.S. person transfers the stock ofan issuing corporation to a foreign acquir-ing corporation, without the application ofsection 367(a), the U.S. person will nev-ertheless recognize an amount of incomethat is at least equal to the inherent gainin the stock of the issuing corporation thatis being transferred to the foreign acquir-ing corporation. This income recognitionresults from the construct of the transac-tion as a distribution in redemption of theacquiring corporation shares. The incomerecognized may be in the form of dividendincome, gain on the disposition of stock,or both. Section 301(c)(1), (3). Thus, thepolicy underlying section 367(a), whichis to prevent the avoidance of U.S. tax ontransfers of appreciated property to a for-eign corporation in certain nonrecognitiontransactions, is maintained through theoperation of subchapter C principles evenif section 367(a) is not applied to a section304(a)(1) transaction. Moreover, as dis-cussed below, the application of section367(a) to a section 304(a)(1) transactionmay, in certain instances where the U.S.transferor files a GRA, result in a totalincome inclusion that is greater than thefair market value of the stock being trans-ferred. The IRS and Treasury believe thatthis result is inconsistent with the policiesof section 367.

For instance, in order to avoid recogniz-ing gain on a section 351 transfer of ap-preciated foreign stock to a foreign corpo-ration under section 367(a)(1), a U.S. per-son may be required to enter into a GRA.See §1.367(a)–3(b)(1)(ii). As noted, whena U.S. person transfers stock of a whollyowned foreign corporation (the foreign is-suing corporation) to a wholly owned for-eign acquiring corporation in exchange forproperty, section 304(a)(1) treats the U.S.person as having received foreign acquir-ing corporation stock in a deemed sec-

2005–24 I.R.B. 1255 June 13, 2005

tion 351 exchange, and then as having thatstock immediately redeemed by the for-eign acquiring corporation. If the U.S. per-son were to enter into a GRA, the appli-cation of section 367(a) to such a trans-action will likely result in the GRA re-maining in existence after the deemed re-demption of the foreign acquiring corpora-tion’s stock. A U.S. person may, in fact,recognize income but, as a result of theGRA, not recognize any gain in the sec-tion 304(a)(1) transaction (e.g., the sec-tion 304(a)(1) transaction results in divi-dend income to the U.S. corporate trans-feror equal to the consideration paid by theforeign acquiring corporation). In such acase, because the U.S. person has not rec-ognized the inherent gain in the transfereeforeign corporation’s stock deemed to bereceived in the section 304(a)(1) transac-tion, the GRA will not be terminated. See§1.367(a)–8(h)(1) (requiring a transactionin which all realized gain (if any) is rec-ognized currently to terminate a GRA). Asa result, the U.S. transferor would remainsubject to the GRA provisions containedin §1.367(a)–8. If the GRA subsequentlywere triggered pursuant to §1.367(a)–8(e)(e.g., if the foreign issuing corporation dis-poses of substantially all of its assets to anunrelated party during the 5-year GRA pe-riod), the U.S. transferor may be subjectto a total income inclusion that is greaterthan the fair market value of the stock be-ing transferred.

The application of section 367(a) to thetransaction described above also results inadministrative burdens for both the IRSand taxpayers. For instance, the condi-tions contained in §1.367(a)–3(b) and (c)require a determination of the value andclass of stock either received by the U.S.person in the transaction or owned by theU.S. person immediately after the trans-fer. See, e.g., §1.367(a)–3(b)(1)(i) and (ii)and (c)(1)(i), (ii), and (iii). To the ex-tent the transaction is described in section304(a)(1), the foreign acquiring corpora-tion does not actually issue any stock to theU.S. person. Therefore, in order to applythe above provisions, the IRS and taxpay-ers must make determinations based on thestock that is deemed to be issued by the for-eign acquiring corporation.

For the reasons stated above, the IRSand Treasury have decided to exercise theirregulatory authority under section 367(a)such that section 367(a) will not apply to

deemed section 351 exchanges resultingfrom section 304(a)(1) transactions.

2. Application of section 367(b)

As discussed above in the preambleunder heading B, §1.367(b)–4(b)(1) pro-vides that, in the case of a section 351exchange of stock of a foreign acquiredcorporation by a U.S. person that is asection 1248 shareholder of such corpo-ration (or a controlled foreign corporationthat has a section 1248 shareholder) to aforeign acquiring corporation, the section1248 shareholder (or a controlled foreigncorporation that has a section 1248 share-holder) must include in income its section1248 amount, unless the requisite sec-tion 1248 shareholder status or controlledforeign corporation status is maintainedimmediately after the exchange. How-ever, in a section 304(a)(1) transaction inwhich section 1248 shareholder status andcontrolled foreign corporation status ismaintained immediately after the deemedsection 351 exchange, such that there isno section 1248 inclusion, the transferormay be treated as receiving a dividendfrom the foreign acquired corporation pur-suant to section 304(b)(2)(B). Thus, in asection 304(a)(1) transaction, some or allof the earnings that make up the section1248 amount that section 367(b) seeks topreserve may be immediately included inincome by the exchanging shareholder.

Additionally, application of §1.367(b)–4(b)(1) can, in some instances, createadministrative burdens and be problem-atic. Section 1.367(b)–4(b)(1) requires adetermination of the type and amount ofstock received in the deemed section 351exchange to determine whether the neces-sary section 1248 shareholder status andcontrolled foreign corporation status ismaintained. Moreover, the application of§1.367(b)–4(b)(1) to a section 304(a)(1)transaction often can be problematic be-cause the necessary section 1248 share-holder status and controlled foreign cor-poration status may be treated as satisfiedin the construct of the deemed section351 exchange even though such status isimmediately lost as a result of the deemedredemption transaction. For instance, thenecessary section 1248 shareholder statusand controlled foreign corporation statusmay be satisfied immediately after thedeemed section 351 exchange when a U.S.

corporation transfers a controlled foreigncorporation (the foreign issuing corpora-tion) to a foreign acquiring corporationin a section 304(a)(1) transaction, by tak-ing into consideration the deemed issuedstock by the foreign acquiring corpora-tion. However, if both the U.S. corporatetransferor and the foreign acquiring cor-poration are wholly owned by the sameforeign parent, the necessary section 1248shareholder status and controlled foreigncorporation status will not be satisfiedimmediately after the deemed redemptiontransaction.

For the reasons listed above, the IRSand Treasury have decided to exercise theirregulatory authority under section 367(b)such that section 367(b) will not apply todeemed section 351 exchanges resultingfrom section 304(a)(1) transactions.

E. Request for Comments

Section 304(b)(6) grants the Secretaryauthority to prescribe regulations that areappropriate in order to eliminate multipleinclusions of any item of income by rea-son of section 304(a) and to provide appro-priate basis adjustments (including modi-fications to the application of sections 959and 961) in section 304(a) transactions inwhich the acquiring or issuing corpora-tion is a foreign corporation. The IRS andTreasury are considering whether to issueregulations under section 304(b)(6) to ad-just (1) the acquiring corporation’s basisof the issuing corporation stock it acquiresin the transaction, and (2) the transferor’sbasis of the issuing corporation stock insituations in which the transferor contin-ues to own issuing corporation stock im-mediately after the transaction, to the ex-tent that the transferor is treated under sec-tion 304(b)(2)(B) as receiving a distribu-tion from the earnings and profits of theissuing corporation. Comments are re-quested regarding how such adjustmentsshould be made, particularly if differentclasses of issuing corporation stock are ac-quired or retained in the section 304(a)(1)transaction. Comments also are requestedas to how, and to what extent, these typesof adjustments should be made outside thecontext of section 304(b)(6) (e.g., in a sec-tion 304(a)(1) transaction in which boththe acquiring corporation and issuing cor-poration are domestic corporations).

June 13, 2005 1256 2005–24 I.R.B.

Effective Dates

The proposed regulations are proposedto apply to section 304(a)(1) transactionsoccurring on or after the date of publica-tion of these regulations as final in the Fed-eral Register.

Effect on other Documents

If these proposed regulations areadopted as final regulations, Rev. Rul.91–5, 1991–1 C.B. 114, and Rev. Rul.92–86, 1992–2 C.B. 199, will be modifiedto the extent inconsistent with such finalregulations.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a significantregulatory action as defined in ExecutiveOrder 12866. Therefore, a regulatoryassessment is not required. It has alsobeen determined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) does not apply to these regu-lations and because these regulations donot impose a collection of informationon small entities, a Regulatory FlexibilityAnalysis under the Regulatory FlexibilityAct (5 U.S.C. chapter 6) does not apply.Pursuant to section 7805(f) of the InternalRevenue Code, this notice of proposedrulemaking will be submitted to the ChiefCounsel for Advocacy of the Small Busi-ness Administration for comment on itsimpact.


Before these proposed regulations areadopted as final regulations, considera-tion will be given to any written (a signedoriginal and eight (8) copies) or electroniccomments that are submitted timely tothe IRS. The IRS and Treasury Depart-ment request comments on the clarity ofthe proposed rules and how they can bemade easier to understand. All commentswill be available for public inspection andcopying. A public hearing may be sched-uled if requested in writing by any personwho timely submits written comments. Ifa public hearing is scheduled, notice of thedate, time, and place of the hearing will bepublished in the Federal Register.


The principal author of these regula-tions is Tasheaya L. Warren Ellison, Of-fice of the Associate Chief Counsel (Inter-national). However, other personnel fromthe IRS and Treasury Department partici-pated in their development.

* * * * *





Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.367(a)–3 is amended

as follows:1. A sentence is added to paragraph

(a) immediately following the second sen-tence.

2. The new fourth sentence of para-graph (a) is amended by removing the lan-guage “However” and adding “Addition-ally” in its place.

3. The first sentence of paragraph (e)(1)is removed and two sentences are added inits place.

The revision and additions read as fol-lows:

§1.367(a)–3 Treatment of transfers ofstock or securities to foreign corporations.

(a) In general. * * * However, if, pur-suant to section 304(a)(1), a U.S. person istreated as transferring stock of a domesticor foreign corporation to a foreign corpora-tion in exchange for stock of such foreigncorporation in a transaction to which sec-tion 351(a) applies, such deemed section351 exchange is not a transfer to a foreigncorporation subject to section 367(a). * * *

* * * * *(e) Effective dates. (1) In general. The

rules in paragraphs (a), (b) and (d) of thissection generally apply to transfers occur-ring on or after July 20, 1998. However,the third sentence of paragraph (a) of thissection shall apply to section 304(a)(1)transactions occurring on or after the datethese regulations are published as finalregulations in the Federal Register. * * *

* * * * *Par. 3. In §1.367(b)–4, a sentence is

added to the end of paragraph (a) to readas follows:

§1.367(b)–4 Acquisition of foreigncorporate stock or assets by a foreigncorporation in certain nonrecognitiontransactions.

(a) Scope. * * * However, if pursuant tosection 304(a)(1), a foreign acquiring cor-poration is treated as acquiring the stock ofa foreign acquired corporation in a transac-tion to which section 351(a) applies, suchdeemed section 351 exchange is not an ac-quisition subject to section 367(b).

* * * * *Par. 4. Section 1.367(b)–6 is amended

by revising paragraph (a)(1) to read as fol-lows:

§1.367(b)–6 Effective dates andcoordination rules.

(a) Effective date — (1) In general.Sections 1.367(b)–1 through 1.367(b)–5,and this section, generally apply to section367(b) exchanges that occur on or afterFebruary 23, 2000. However, the lastsentence of paragraph (a) in §1.367(b)–4shall apply to section 304(a)(1) transac-tions occurring on or after the date theseregulations are published as final regula-tions in the Federal Register.

* * * * *

Cono R. Namorato,Acting Deputy Commissioner for

Services and Enforcement.

(Filed by the Office of the Federal Register on May 20, 2005,2:48 p.m., and published in the issue of the Federal Registerfor May 25, 2005, 70 F.R. 30036)

Announcement and ReportConcerning Pre-FilingAgreements

Announcement 2005–42

Introduction

This Announcement is issued pursuantto the Conference Report to H.R. 4577(Pub. L. No. 106–554), The Commu-nity Renewal Tax Relief Act of 2000, which

2005–24 I.R.B. 1257 June 13, 2005

requires that the Secretary of the Trea-sury make publicly available an annual re-port relating to the Pre-Filing Agreement(“PFA”) program operations for the pre-ceding calendar year. The Conference Re-port states that the report is to include:(1) the number of pre-filing agreementscompleted, (2) the number of applicationsreceived, (3) the number of applicationswithdrawn, (4) the types of issues whichare resolved by completed agreements, (5)whether the program is being utilized bytaxpayers who were previously subject toaudit, (6) the average length of time re-quired to complete an agreement, (7) thenumber, if any, and subject of technical ad-vice and Chief Counsel advice memorandaissued to address issues arising in connec-tion with any pre-filing agreement, (8) anymodel agreements, and (9) any other in-formation the Secretary deems appropri-ate. This is the fifth annual report. Itprovides information concerning activityunder the permanent PFA program (Rev.Proc. 2001–22, 2001–1 C.B. 745), duringcalendar year 2004.

Background

The Large and Midsize Business Di-vision (LMSB) of the Internal RevenueService serves 170,000 of America’slargest corporate and partnership entities— businesses with assets of over $10million. Their tax issues are among themost complex, and their collective annualtax liability approaches $159 billion. Thelargest of these taxpayers deal with theIRS on a continuous basis.

One of LMSB’s strategic initiatives isissue management. Through effective is-sue management, LMSB seeks to resolveissues of tax controversy on a more currentbasis. This includes, but is not limited to,increasing the efficiency of the examina-tion process and seeking alternative issueresolution tools. The PFA program wasdesigned to support LMSB’s issue man-agement initiative. LMSB believes thePFA program reduces taxpayer burden andmakes more effective use of IRS resourcesby resolving or eliminating controversiesbefore the tax return is filed.

The PFA program is designed to per-mit a taxpayer to resolve, before the fil-ing of a return, the treatment of an issuethat otherwise would likely be disputed ina post-filing examination. The PFA pro-

gram is intended to produce agreement onfactual issues and apply settled legal prin-ciples to those agreed-upon facts. A PFA isa specific matter closing agreement under§ 7121 of the Internal Revenue Code andresolves the subject of the PFA for a spec-ified taxable period. Execution of a PFAthat resolves issues prior to filing permitstaxpayers to avoid costs, burdens and de-lays that are frequently incident to post-fil-ing examination disputes between taxpay-ers and the IRS.

PFA Program

The IRS established a permanent PFAprogram with the issuance of Rev. Proc.2001–22 and revised it on December 22,2004, with the issuance of Rev. Proc.2005–12, 2005–2 I.R.B. 311. Althoughmany of the procedures remained thesame, there were some significant changesand clarifications:

• PFAs may cover the current and up tofour future taxable years;

• PFAs are available to determine the ap-propriate methodologies for determin-ing tax consequences affecting futureyears;

• PFAs are for completed transactionsonly; and

• PFAs with international tax issues re-quire concurrence of the Director, In-ternational; certain international issueslisted in Rev. Proc. 2005–12 alsorequire concurrence of the AssociateChief Counsel (International) in accep-tance and execution.

PFA Process

The PFA process is managed and con-ducted by LMSB Industry Directors andfield staff, with support from the Officeof Pre-Filing and Technical Guidance inLMSB Headquarters. The PFA ProgramManager receives all applications and,with the assistance of the Technical Ad-visors and the Office of Chief Counsel,ensures that the issues presented are appro-priate for inclusion in the PFA program.

The Industry Director with jurisdictionover the taxpayer makes the final decisionwhether to accept a taxpayer’s request forparticipation in the PFA program. The cri-teria for selecting a request include:

a. The suitability of the issue presentedby the taxpayer;

b. The direct or indirect impact of a PFAupon other years, issues, taxpayers, orrelated cases;

c. The availability of IRS resources;d. The ability and willingness of the tax-

payer to dedicate sufficient resourcesto the process;

e. The likelihood that the PFA may resultin contrary positions with respect to anitem or transaction (“whipsaw”); and

f. The probability of completing the ex-amination of the issue and enteringinto a PFA by the target date.

For the cases selected for participationin the PFA program, a mandatory orien-tation session for the examination teamand the taxpayer is conducted. Subse-quently, the taxpayer and the examinationteam convene a joint planning meeting toreach agreement on a proposed timeframe,to identify and arrange for IRS access torelevant records and testimony, and to de-fine the potential scope and nature of thePFA.

The examination team conducts the fac-tual determination and issue developmentconsistent with IRS auditing standards.Based upon an examination of the issue,the Team Manager prepares a PFA recom-mendation for the Industry Director. TheIndustry Director’s decision to execute aPFA closing agreement is based on theTeam Manager’s recommendation anddiscussions with the PFA Program Man-ager, Chief Counsel attorneys, appropriateTechnical Advisors, and the taxpayer. Fol-lowing Chief Counsel review to ensurethat the proposed PFA closing agreementconforms with guidance provided in Rev.Proc. 68–16, 1968–1 C.B. 770 (regardingclosing agreements), the Industry Directorwill execute a PFA if he or she determinesthat:

a. Entering into the PFA is consistentwith the goals of the PFA programas stated in Rev. Proc. 2001–22 (orRev. Proc 2005–12 for applicationsreceived after December 22, 2004);

b. The resolution in the PFA reflects set-tled legal principles and correctly ap-plies those principles (or positions au-thorized under Delegation Order Nos.4–24 or 4–25) to facts found by the ex-amination team; and

June 13, 2005 1258 2005–24 I.R.B.

c. There appears to be an advantage inhaving the issue(s) permanently andconclusively closed for the taxable pe-riod covered by the PFA, or that thetaxpayer shows good and sufficientreasons for desiring a closing agree-ment and that the United States wouldsustain no disadvantage through con-summation of such an agreement (see§ 301.7121–1(a) of the Procedure andAdministration Regulations).

Program Oversight

A designated PFA Program Managerassigned to the Office of Pre-Filing andTechnical Guidance in LMSB Headquar-ters provides oversight for the PFA pro-gram. The PFA Program Manager pro-vides assistance to taxpayers, Industry Di-rectors, and Team Managers throughoutthe process.

Pre-Filing Agreement ProgramAccomplishments

Statistical Overview of PFA Program —Calendar Year 2004

The tables below reflect the status ofPFA applications received in calendar year2004.

PFA Applications Received in Calendar Year 2004 Totals

Applications Withdrawn before Acceptance/Rejection in 2004 2

Applications Rejected in 2004 12

Applications in Screening Process on 12–31–04 1

Applications Pending Acceptance/Rejection on 12–31–04 1

Applications Accepted in 2004 22

Total Applications Received in 2004 38

Disposition of PFA Applications Accepted in Calendar Year 2004 Totals

Applications Withdrawn after Acceptance in 2004 1

Applications for Which There Were Closing Agreements in 2004 8

Applications In Process on 12–31–04 13

Total Applications Accepted in 2004 22

Description of Applications Received inCalendar Year 2004

The applications received by the PFAprogram in calendar year 2004 came from

taxpayers in each LMSB industry segmentand involved a variety of issues as pro-vided in the tables below.

Number of Applications Received and Accepted by Industry Segment

Industry Segment Received Accepted

Financial Services 12 6

Retailers, Food, Pharmaceuticals & Healthcare 7 4

Natural Resources & Construction 6 5

Communications, Technology & Media 6 3

Heavy Manufacturing & Transportation 7 4

Total 38 22

Types of Issues Covered

Issue Received Accepted

Donation of Property 4 1

Research and Experimental Credit 9 7

Estimated Basis of the Stock of a Subsidiary 1 1

2005–24 I.R.B. 1259 June 13, 2005

Type of Merger/Reorganization 1 0

Valuation of Stock of a Target Corporation 1 1

Worthless Securities and Bad Debts 6 4

Income from Intercompany Notes 1 0

Amount and Character of Partnership Investment Losses 1 0

Deductibility of Fines and Penalties 2 2

Deductibility of Interest to Purchase Tax Exempt Securities 1 1

Merger — Tax Free Reorganization 1 0

Tax Free Split-off 1 0

Treatment of Transfer and Sale of Stock 1 1

Cost Segregation Study — Asset Class Life and Recovery Period 2 2

Synthetic Fuel Credit 1 1

Taxability of Transfer of Rights to an LLC 1 0

Apportionment of General and Administrative Expenses 1 1

Characterization of Remuneration as Wages versus Partnership Distribution 1 0

Transfer Pricing — Royalty 1 0

Transfer of Stock under IRC § 83 1 0

Total 38 22

Reasons Why Applications Received inCalendar Year 2004 Were Not Accepted

Reasons for Non-acceptance Applications

Not Well-Settled Law 5

Not Enough Time to Complete 2

Issue Not Suitable or Ineligible 4

Currently in Litigation with Taxpayer on the Issue 1

Total 12

PFA Program Summary (2004 and PriorCalendar Years)

Forty accepted applications (includingapplications accepted in prior years) wereresolved or withdrawn in 2004.

Taxpayer Withdrawals (4)

In accordance with procedures set forthin Rev. Proc. 2001–22, four taxpayerswithdrew from the PFA process in 2004after their requests had been accepted(three of these were accepted before 2004).In one case the taxpayer and the Serviceagreed that the timeline was too burden-some. In the other cases, no explanationfor the withdrawal was given by the tax-payer.

IRS Withdrawal (8)

In 2004, the Service withdrew from thePFA process in eight cases accepted before2004. In one case, the taxpayer did nothave adequate records to substantiate a de-duction for the Research and ExperimentalCredit. In the other seven cases, the tax-payer and the Service were unable to reachagreement.

Mutual Withdrawal (1)

The Service and the taxpayer mutuallyagreed to terminate the PFA process in onecase. They agreed that it would be moreefficient to roll the issue into the normalexamination process rather than continu-ing with the PFA process.

PFAs Executed (27)

Twenty seven PFAs were completed incalendar year 2004 that resulted in the ex-ecution of closing agreements. Eight ofthese were for applications received andaccepted in 2004.

The Office of Chief Counsel providedadvice to the examination teams and as-sisted in the drafting and review of thePFA closing agreements. No TechnicalAdvice or Chief Counsel Advice Memo-randa were issued for issues addressed inthe PFA process.

PFAs Executed in 2004

The PFAs executed in 2004 involvedthe following issues:

June 13, 2005 1260 2005–24 I.R.B.

PFAs Executed by Issue

YearApplication

ReceivedIssue Number

2002 Deductibility and Fair Market Value of Donated Property 1



2003 Amount of Qualified Research and Experimental Credit 4

2004 Amount of Qualified Research and Experimental Credit 2

2003 Fair Market Value of Stock Exchanged 1

2004 Cost Segregation for Asset Class and Recovery Periods 1

2003 Treatment of License Fee Income 1

2004 Deductibility of Fees to Purchase Tax Exempt Securities 1

2002 Gain or Loss on Sale of Stock 1

2002 Worthless Securities and Bad Debts 1



2002 Fuel Credit 1

2003 Ordinary Versus Capital Loss on Property Sale 1

2003 Writedown of Inventory 1

2004 Deductibility of Fines and Penalties 1

Total 27

Deductibility and Fair Market Value ofDonated Property (6)

In each of these unrelated cases, the tax-payer sought an agreement as to the fairmarket value of property donated to qual-ified organizations. Patents and technol-ogy were donated in four cases and landwas donated in two other cases. In threeof the cases, a closing agreement was ex-ecuted specifying the fair market valueof the property contributed. In the otherthree cases, both fair market value and de-ductibility were addressed, and in one ofthese, no deduction was allowed.

Amount of Qualified Research andExperimental Credit (6)

The taxpayers requested an agreementregarding the proper amount of qualifiedresearch expenses and the research creditunder IRC § 41. Closing agreements wereexecuted with all taxpayers. The closingagreements did not address the methodol-ogy to be used for subsequent years.

Fair Market Value of Stock Exchanged (1)

The taxpayer requested an agreementconcerning the value of preferred stock intransactions intended to qualify as trans-fers to a controlled corporation under IRC§ 351. A closing agreement was executedthat specified the fair market value of thetransferred stock and provided that the IRSwould not challenge the value under IRC§ 482 or other Code sections.

Cost Segregation for Asset Class andRecovery Periods (1)

The taxpayer requested an agreementconcerning the proper class lives and re-covery periods of property placed in ser-vice during the tax year. The taxpayer andService agreed to use statistical samplingtechniques and came to agreement on thedepreciation deduction amount. A clos-ing agreement was executed specifying theamount allowed.

Treatment of License Fee Income (1)

The taxpayer requested an agreementregarding the treatment of periodic fee in-come from software licenses. A closingagreement was executed specifying thatthe licenses shall be treated as leases ratherthan sales of software and that the feesshall be included in income in the year dueand payable.

Deductibility of Fees to Purchase TaxExempt Securities (1)

The taxpayer requested an agreementregarding the deductibility of periodic in-terest and other costs on debt. Some ofthe proceeds of this debt were temporar-ily invested in tax exempt securities. Aclosing agreement was executed specify-ing that the interest and costs are not to bedisallowed under IRC § 265.

Gain or Loss on Sale of Stock (1)

The taxpayer requested an agreementconcerning the sale of the stock in its sub-sidiary for cash. A closing agreement was

2005–24 I.R.B. 1261 June 13, 2005

executed specifying the amount of the IRC§ 338 aggregate deemed sales price.

Worthless Securities and Bad Debts (6)

The taxpayers requested an agreementregarding amounts deductible as ordinarylosses on the worthlessness of stock in itssubsidiary. A closing agreement was exe-cuted for each of the PFAs specifying thatthe stock was worthless and the amount tobe deducted.

Fuel Credit (1)

The taxpayer requested an agreementregarding its fuel credits through consid-eration of the “placed in service” questionand other issues bearing on the credits. Aclosing agreement was executed specify-ing the amount of the fuel credit to be al-lowed and how that amount was to be al-located to the partners.

Ordinary Versus Capital Loss on PropertySale (1)

The taxpayer requested an agreementconcerning the tax consequences of thesale of two parcels of property. A clos-ing agreement was executed specifying the

amount of the losses and that they are to becharacterized as ordinary losses under IRC§ 1231.

Writedown of Inventory (1)

The taxpayer requested an agreementregarding the proper treatment of inven-tory write-downs. A closing agreementwas executed specifying the amount al-lowable as a deduction reflected in the de-termination of the cost of good sold.

Deductibility of Fines and Penalties (1)

The taxpayer requested an agreementregarding the proper treatment of amountspaid to the U.S. government in restitution,civil damages, and fines. A closing agree-ment was executed specifying the amountallowable as restitution under IRC § 162and the amount determined to be a fine orpenalty and therefore not allowable as adeduction.

Closing Agreements

There is not a pro forma or modelagreement for a PFA closing agreement.A PFA represents a specific matter closingagreement under IRC § 7121. The closing

agreements entered into under the PFAprogram were prepared with assistancefrom the Office of Chief Counsel andconform to the guidance provided in Rev.Proc. 68–16.

PFA Program Utilization

The PFA program is available to all tax-payers under the jurisdiction of LMSB.During calendar year 2004, 38 taxpayerssubmitted PFA applications. These tax-payers included both Coordinated Indus-try Case (CIC) taxpayers that are typicallysubject to examination on a continuing ba-sis and Industry Case (IC) taxpayers thatare subject to examination on a less fre-quent basis. Of the 38 applications, 30were from CIC taxpayers and 8 were fromIC taxpayers. Of the 27 cases that resultedin closing agreements during calendar year2004, 25 were with CIC taxpayers and 2were with IC taxpayers.

Processing Statistics

The average elapsed time to resolve the27 cases that resulted in closing agree-ments in calendar year 2004 was 360 days.

Processing Time for Twenty SevenClosing Agreements Executed in 2004

Range(Elapsed Days)

Average(Elapsed Days)

Application Screening Process 29–359* 76

PFA Evaluation Process 62–716 285

Total Time to Close a PFA Case 99–773 360

*One case took 359 days to screen be-cause the taxpayer had not yet completedthe transaction and the Service waited forthe transaction to be completed before ac-cepting the PFA. The next highest numberof days for screening was 163.

Application Screening Process

The application screening process is theprocess to determine if an application isappropriate for inclusion in the PFA pro-gram. This screening process includesobtaining comments from various LMSBfunctions and Chief Counsel, the reviewof these comments, and the acceptance orrejection of an application by the IndustryDirector. The average time from the date

an application was received by the IRS un-til the Industry Director rendered a deci-sion to accept or reject an application was76 days.

PFA Evaluation Process

The PFA evaluation process is the sec-ond (and final) phase in the PFA program.This phase begins when the Industry Di-rector accepts an application into the PFAprogram and ends when a PFA closingagreement is executed or the process ter-minates as a result of a withdrawal. Theaverage elapsed time during the PFA eval-uation process for the 27 cases that re-sulted in closing agreements in calendaryear 2004 was 285 days.

Program Evaluation

The PFA Program Manager ensures thatan evaluation of all of the PFA programcases, based on feedback from LMSB em-ployees and taxpayer participants, is so-licited. As part of this program evalua-tion, LMSB and taxpayer participants wereasked to provide the direct examinationtime expended to complete the PFA and anestimate of the direct examination time itwould have taken to resolve the issue in apost-filing context. The table below indi-cates the results for those that provided aresponse since the program’s inception.

June 13, 2005 1262 2005–24 I.R.B.

Cumulative Hours on Executed PFAs Taxpayer(Hours)

LMSB(Hours)

Actual Hours Expended — PFA Process 20,243 16,897

Estimated Hours Required To Be Expended — Post-Filing Process 38,615 22,978

Time Savings — Actual PFA Process versus Estimated Post-Filing 18,372 6,081

Average Percentage Savings — Actual PFA Process versus EstimatedPost-Filing

47.6% 26.5%

Comparative Analysis — ProcessingStatistics

The average total time to conclude the27 cases that resulted in closing agree-

ments in calendar year 2004 was 360 days.Illustrated below are the processing statis-tics for the cases that resulted in closingagreements since the inception of the pro-gram.

Average Processing Time (Days) OverallPilot

(11 cases)

ProgramCY 2001(7 cases)




Application Screening Process 38 47 53 59 76

PFA Evaluation Process 242 126 183 240 285

Total Time to Complete a PFA 281 173 235 299 360

The increased processing time can beattributed to the greater degree of com-plexity of the issues and the time necessaryto develop the factual background. Gener-ally, the more complex and fact intensivethe issue is, the greater the time necessaryto complete the process.

Taxpayer Satisfaction Survey

An additional aspect of the evalua-tion process is soliciting feedback fromtaxpayers regarding satisfaction with thePFA process through a questionnaire.Responses to the questionnaire were re-

ceived from 11 of the 27 taxpayers whoexecuted closing agreements for calendaryear 2004. Taxpayers were asked to ratethe PFA process on a scale of 1 to 5. Theresponses are summarized below.

Overall level of satisfaction with the PFA process. Average 4.7

VeryDissatisfied

Dissatisfied Neither Satisfied VerySatisfied

Does NotApply

number 3 7 1

percentage 27.3 63.6 9.1

Likelihood of taxpayer recommending the PFA process to others. Average 4.6

Very Unlikely Unlikely Perhaps Likely Very Likely Does notApply

number 4 7

percentage 36.4 63.6

The PFA process was clearly communicated during the orientation session. Average 4.4

StronglyDisagree

Disagree Neither Agree StronglyAgree

Does NotApply

number 6 4 1


2005–24 I.R.B. 1263 June 13, 2005

During the orientation, questions regarding the PFA process were completelyaddressed. Average 4.4

StronglyDisagree


Does NotApply

number 7 4


The PFA audit plan was developed with input from both the IRS and the taxpayer. Average 4.5

StronglyDisagree


Does NotApply

number 6 5


The IRS requests for information were relevant to resolve the PFA issue. Average 4.4

StronglyDisagree


Does NotApply

number 7 4


The time taken by the IRS to review information during the entire “Factualdevelopment” stage of the PFA process was appropriate. Average 4.3

StronglyDisagree


Does NotApply

number 1 5 5


The time taken by the IRS to complete the “Closing Agreement” stage of thePFA process was appropriate. Average 4.0

StronglyDisagree


Does NotApply

number 1 1 6 3

percentage 9.1 9.1 54.5 27.3

IRS team members were accessible during the process to resolve the PFA issue. Average 4.5

StronglyDisagree


Does NotApply

number 1 4 6


June 13, 2005 1264 2005–24 I.R.B.

The total number of staff days or hours actually expended as compared toexpected staff days or hours. Average 4.0

SignificantlyMore

More About theSame

Less SignificantlyLess

Does NotApply

number 1 2 4 4

percentage 9.1 18.2 36.4 36.4

The total elapsed time to complete the PFA process as compared to the expectedtime to complete the process. Average 3.8

SignificantlyMore

More About theSame


Does NotApply

number 1 1 1 3 4 1

percentage 9.1 9.1 9.1 27.3 36.4 9.1

The spirit of cooperation between IRS and the company as a result of the PFAprocess. Average 4.1

SignificantlyLess

Less About theSame

Improved SignificantlyImproved

Does NotApply

number 2 6 3


The ability to reach agreement at the lowest (managerial) level. Average 4.1

SignificantlyLess

Less About theSame


Does NotApply

number 2 6 3


The ease of effort in reaching agreement compared to the expected ease onpost-filing. Average 4.0

SignificantlyLess

Less About theSame


Does NotApply

number 2 7 2


Monetary costs incurred to resolve the issue compared to expected costs to resolveissues through the post-filing process. Average 3.6

SignificantlyMore

More About theSame


Does NotApply

number 2 2 5 2

percentage 18.2 18.2 45.5 18.2

2005–24 I.R.B. 1265 June 13, 2005

The ability to present an accurate tax return for financial statement purposes as aresult of the pre-filing process. Average 4.1

SignificantlyLess

Less About theSame


Does NotApply

number 2 5 3 1

percentage 18.2 45.5 27.3 9.1

Pre-Filing Agreement ProgramSummary

Overall, the PFA program is meetingthe LMSB strategic program objectives asprovided in its issue management strategicinitiative. The following benchmarks re-flect the overall progress of the PFA pro-gram:

• The increasing number of issues re-solved through the PFA program,which has grown steadily since theprogram became fully operational;

• The high degree of overall satisfac-tion of taxpayers participating in thePFA program and the likelihood thatthose participants would recommendthis process to other taxpayers.

Although the number of cases resolvedin the PFA program increased in 2004, thetotal processing time has also increased.Revenue Procedure 2005–12 now im-poses short time frames for evaluatinga PFA, so we expect the time for theapplication screening process to declinesignificantly. The time during the PFA

evaluation process continues to increase.This trend, which is due in part to theincreasing complexity of issues presentedby taxpayers for PFA consideration, hascontinued since the PFA program becamefully operational in 2001.

The principal author of this announce-ment is Melanie Perrin, Office of Pre-Fil-ing and Technical Guidance, Large andMid-Size Business Division. For furtherinformation regarding this announcement,contact Ms. Perrin at (202) 283–8408.

June 13, 2005 1266 2005–24 I.R.B.

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

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

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

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

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

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

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

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

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

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

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

Suspended is used in rare situationsto show that the previous published rul-ings will not be applied pending somefuture action such as the issuance of newor amended regulations, the outcome ofcases in litigation, or the outcome of aService study.

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

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

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

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

2005–24 I.R.B. i June 13, 2005

Numerical Finding List1

Bulletins 2005–1 through 2005–24

Announcements:

2005-1, 2005-1 I.R.B. 257

2005-2, 2005-2 I.R.B. 319

2005-3, 2005-2 I.R.B. 270

2005-4, 2005-2 I.R.B. 319

2005-5, 2005-3 I.R.B. 353

2005-6, 2005-4 I.R.B. 377

2005-7, 2005-4 I.R.B. 377

2005-8, 2005-4 I.R.B. 380

2005-9, 2005-4 I.R.B. 380

2005-10, 2005-5 I.R.B. 450

2005-11, 2005-5 I.R.B. 451

2005-12, 2005-7 I.R.B. 555

2005-13, 2005-8 I.R.B. 627

2005-14, 2005-9 I.R.B. 653

2005-15, 2005-9 I.R.B. 654

2005-16, 2005-10 I.R.B. 702

2005-17, 2005-10 I.R.B. 673

2005-18, 2005-9 I.R.B. 660

2005-19, 2005-11 I.R.B. 744

2005-20, 2005-12 I.R.B. 772

2005-21, 2005-12 I.R.B. 776

2005-22, 2005-14 I.R.B. 826

2005-23, 2005-14 I.R.B. 845

2005-24, 2005-15 I.R.B. 889

2005-25, 2005-15 I.R.B. 891

2005-26, 2005-17 I.R.B. 969

2005-27, 2005-16 I.R.B. 918

2005-28, 2005-17 I.R.B. 969

2005-29, 2005-17 I.R.B. 969

2005-30, 2005-18 I.R.B. 988

2005-31, 2005-18 I.R.B. 996

2005-32, 2005-19 I.R.B. 1012

2005-33, 2005-19 I.R.B. 1013

2005-34, 2005-19 I.R.B. 1014

2005-35, 2005-21 I.R.B. 1095

2005-36, 2005-21 I.R.B. 1095

2005-37, 2005-21 I.R.B. 1096

2005-38, 2005-21 I.R.B. 1097

2005-39, 2005-22 I.R.B. 1151

2005-40, 2005-22 I.R.B. 1152

2005-41, 2005-23 I.R.B. 1212

2005-42, 2005-24 I.R.B. 1257

Court Decisions:

2080, 2005-15 I.R.B. 850

Notices:

2005-1, 2005-2 I.R.B. 274

2005-2, 2005-3 I.R.B. 337

2005-3, 2005-5 I.R.B. 447

2005-4, 2005-2 I.R.B. 289

Notices— Continued:

2005-5, 2005-3 I.R.B. 337

2005-6, 2005-5 I.R.B. 448

2005-7, 2005-3 I.R.B. 340

2005-8, 2005-4 I.R.B. 368

2005-9, 2005-4 I.R.B. 369

2005-10, 2005-6 I.R.B. 474

2005-11, 2005-7 I.R.B. 493

2005-12, 2005-7 I.R.B. 494

2005-13, 2005-9 I.R.B. 630

2005-14, 2005-7 I.R.B. 498

2005-15, 2005-7 I.R.B. 527

2005-16, 2005-8 I.R.B. 605

2005-17, 2005-8 I.R.B. 606

2005-18, 2005-9 I.R.B. 634

2005-19, 2005-9 I.R.B. 634

2005-20, 2005-9 I.R.B. 635

2005-21, 2005-11 I.R.B. 727

2005-22, 2005-12 I.R.B. 756

2005-23, 2005-11 I.R.B. 732

2005-24, 2005-12 I.R.B. 757

2005-25, 2005-14 I.R.B. 827

2005-26, 2005-12 I.R.B. 758

2005-27, 2005-13 I.R.B. 795

2005-28, 2005-13 I.R.B. 796

2005-29, 2005-13 I.R.B. 796

2005-30, 2005-14 I.R.B. 827

2005-31, 2005-14 I.R.B. 830

2005-32, 2005-16 I.R.B. 895

2005-33, 2005-17 I.R.B. 960

2005-34, 2005-17 I.R.B. 960

2005-35, 2005-21 I.R.B. 1087

2005-36, 2005-19 I.R.B. 1007

2005-37, 2005-20 I.R.B. 1049

2005-38, 2005-22 I.R.B. 1100

2005-39, 2005-21 I.R.B. 1087

2005-40, 2005-21 I.R.B. 1088

2005-41, 2005-23 I.R.B. 1203

2005-42, 2005-23 I.R.B. 1204

2005-43, 2005-24 I.R.B. 1221

2005-45, 2005-24 I.R.B. 1228

Proposed Regulations:

REG-108524-00, 2005-23 I.R.B. 1209

REG-117969-00, 2005-7 I.R.B. 533

REG-125443-01, 2005-16 I.R.B. 912

REG-125628-01, 2005-7 I.R.B. 536

REG-100420-03, 2005-24 I.R.B. 1236

REG-105346-03, 2005-24 I.R.B. 1244

REG-129709-03, 2005-3 I.R.B. 351

REG-148701-03, 2005-13 I.R.B. 802

REG-148867-03, 2005-9 I.R.B. 646

REG-159243-03, 2005-20 I.R.B. 1075

REG-160315-03, 2005-14 I.R.B. 833

REG-163314-03, 2005-14 I.R.B. 835

REG-122847-04, 2005-13 I.R.B. 804

Proposed Regulations— Continued:

REG-127740-04, 2005-24 I.R.B. 1254

REG-130370-04, 2005-8 I.R.B. 608

REG-130671-04, 2005-10 I.R.B. 694

REG-131128-04, 2005-11 I.R.B. 733

REG-139683-04, 2005-4 I.R.B. 371

REG-147195-04, 2005-15 I.R.B. 888

REG-148521-04, 2005-18 I.R.B. 995

REG-152354-04, 2005-13 I.R.B. 805

REG-152914-04, 2005-9 I.R.B. 650

REG-152945-04, 2005-6 I.R.B. 484

REG-154000-04, 2005-19 I.R.B. 1009

REG-159824-04, 2005-4 I.R.B. 372

REG-162813-04, 2005-19 I.R.B. 1010

Revenue Procedures:

2005-1, 2005-1 I.R.B. 1

2005-2, 2005-1 I.R.B. 86

2005-3, 2005-1 I.R.B. 118

2005-4, 2005-1 I.R.B. 128

2005-5, 2005-1 I.R.B. 170

2005-6, 2005-1 I.R.B. 200

2005-7, 2005-1 I.R.B. 240

2005-8, 2005-1 I.R.B. 243

2005-9, 2005-2 I.R.B. 303

2005-10, 2005-3 I.R.B. 341

2005-11, 2005-2 I.R.B. 307

2005-12, 2005-2 I.R.B. 311

2005-13, 2005-12 I.R.B. 759

2005-14, 2005-7 I.R.B. 528

2005-15, 2005-9 I.R.B. 638

2005-16, 2005-10 I.R.B. 674

2005-17, 2005-13 I.R.B. 797

2005-18, 2005-13 I.R.B. 798

2005-19, 2005-14 I.R.B. 832

2005-20, 2005-18 I.R.B. 990

2005-21, 2005-16 I.R.B. 899

2005-22, 2005-15 I.R.B. 886

2005-23, 2005-18 I.R.B. 991

2005-24, 2005-16 I.R.B. 909

2005-25, 2005-17 I.R.B. 962

2005-26, 2005-17 I.R.B. 965

2005-27, 2005-20 I.R.B. 1050

2005-28, 2005-21 I.R.B. 1093

2005-29, 2005-22 I.R.B. 1118

2005-30, 2005-22 I.R.B. 1148

2005-32, 2005-23 I.R.B. 1206

2005-33, 2005-24 I.R.B. 1231

2005-34, 2005-24 I.R.B. 1233

Revenue Rulings:

2005-1, 2005-2 I.R.B. 258

2005-2, 2005-2 I.R.B. 259

2005-3, 2005-3 I.R.B. 334

2005-4, 2005-4 I.R.B. 366

2005-5, 2005-5 I.R.B. 445

1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2004–27 through 2004–52 is in Internal Revenue Bulletin2004–52, dated December 27, 2004.

June 13, 2005 ii 2005–24 I.R.B.

Revenue Rulings— Continued:

2005-6, 2005-6 I.R.B. 471

2005-7, 2005-6 I.R.B. 464

2005-8, 2005-6 I.R.B. 466

2005-9, 2005-6 I.R.B. 470

2005-10, 2005-7 I.R.B. 492

2005-11, 2005-14 I.R.B. 816

2005-12, 2005-9 I.R.B. 628

2005-13, 2005-10 I.R.B. 664

2005-14, 2005-12 I.R.B. 749

2005-15, 2005-11 I.R.B. 720

2005-16, 2005-13 I.R.B. 777

2005-17, 2005-14 I.R.B. 823

2005-18, 2005-14 I.R.B. 817

2005-19, 2005-14 I.R.B. 819

2005-20, 2005-14 I.R.B. 821

2005-21, 2005-14 I.R.B. 822

2005-22, 2005-13 I.R.B. 787

2005-23, 2005-15 I.R.B. 864

2005-24, 2005-16 I.R.B. 892

2005-25, 2005-18 I.R.B. 971

2005-26, 2005-17 I.R.B. 957

2005-27, 2005-19 I.R.B. 998

2005-28, 2005-19 I.R.B. 997

2005-29, 2005-21 I.R.B. 1080

2005-30, 2005-20 I.R.B. 1015

2005-31, 2005-21 I.R.B. 1084

2005-32, 2005-23 I.R.B. 1156

2005-33, 2005-23 I.R.B. 1155

2005-34, 2005-22 I.R.B. 1098

2005-35, 2005-24 I.R.B. 1214

Tax Conventions:

2005-3, 2005-2 I.R.B. 270

2005-17, 2005-10 I.R.B. 673

2005-22, 2005-14 I.R.B. 826

2005-30, 2005-18 I.R.B. 988

Treasury Decisions:

9164, 2005-3 I.R.B. 320

9165, 2005-4 I.R.B. 357

9166, 2005-8 I.R.B. 558

9167, 2005-2 I.R.B. 261

9168, 2005-4 I.R.B. 354

9169, 2005-5 I.R.B. 381

9170, 2005-4 I.R.B. 363

9171, 2005-6 I.R.B. 452

9172, 2005-6 I.R.B. 468

9173, 2005-8 I.R.B. 557

9174, 2005-9 I.R.B. 629

9175, 2005-10 I.R.B. 665

9176, 2005-10 I.R.B. 661

9177, 2005-10 I.R.B. 671

9178, 2005-11 I.R.B. 708

9179, 2005-11 I.R.B. 707

9180, 2005-11 I.R.B. 714

9181, 2005-11 I.R.B. 717

9182, 2005-11 I.R.B. 713

Treasury Decisions— Continued:

9183, 2005-12 I.R.B. 754

9184, 2005-12 I.R.B. 753

9185, 2005-12 I.R.B. 749

9186, 2005-13 I.R.B. 790

9187, 2005-13 I.R.B. 778

9188, 2005-15 I.R.B. 883

9189, 2005-13 I.R.B. 788

9190, 2005-15 I.R.B. 855

9191, 2005-15 I.R.B. 854

9192, 2005-15 I.R.B. 866

9193, 2005-15 I.R.B. 862

9194, 2005-20 I.R.B. 1016

9195, 2005-17 I.R.B. 958

9196, 2005-19 I.R.B. 1000

9197, 2005-18 I.R.B. 985

9198, 2005-18 I.R.B. 972

9199, 2005-19 I.R.B. 1003

9200, 2005-23 I.R.B. 1158

9201, 2005-23 I.R.B. 1153

9202, 2005-24 I.R.B. 1213

2005–24 I.R.B. iii June 13, 2005

Finding List of Current Actions onPreviously Published Items1

Bulletins 2005–1 through 2005–24

Announcements:

2001-77

Modified by

Rev. Proc. 2005-16, 2005-10 I.R.B. 674

2005-19

Supplemented by

Ann. 2005-39, 2005-22 I.R.B. 1151

Notices:

88-30

Obsoleted by

Notice 2005-4, 2005-2 I.R.B. 289

88-132

Obsoleted by

Notice 2005-4, 2005-2 I.R.B. 289

89-29

Obsoleted by

Notice 2005-4, 2005-2 I.R.B. 289

89-38

Obsoleted by

Notice 2005-4, 2005-2 I.R.B. 289

97-19

Obsoleted in part by

Notice 2005-36, 2005-19 I.R.B. 1007

98-34


Notice 2005-36, 2005-19 I.R.B. 1007

2002-45

Amplified by

Rev. Rul. 2005-24, 2005-16 I.R.B. 892

2004-22

Modified and superseded by

Notice 2005-30, 2005-14 I.R.B. 827

2004-38

Obsoleted by

T.D. 9186, 2005-13 I.R.B. 790

2004-80

Clarified and modified by

Notice 2005-22, 2005-12 I.R.B. 756

Updated by

Notice 2005-17, 2005-8 I.R.B. 606

2005-4

Modified by

Notice 2005-24, 2005-12 I.R.B. 757

2005-10

Modified by

Notice 2005-38, 2005-22 I.R.B. 1100

Notices— Continued:

2005-17

Clarified and modified by

Notice 2005-22, 2005-12 I.R.B. 756

Proposed Regulations:

REG-149519-03

Corrected by

Ann. 2005-11, 2005-5 I.R.B. 451

REG-163314-03

Corrected by

Ann. 2005-32, 2005-19 I.R.B. 1012

REG-114726-04

Corrected by

Ann. 2005-10, 2005-5 I.R.B. 450

REG-152945-04

Corrected by

Ann. 2005-34, 2005-19 I.R.B. 1014

Revenue Procedures:

84-58

Superseded by

Rev. Proc. 2005-18, 2005-13 I.R.B. 798

84-78

Superseded by

Rev. Proc. 2005-34, 2005-24 I.R.B. 1233

94-68


Rev. Proc. 2005-32, 2005-23 I.R.B. 1206

98-16


Rev. Proc. 2005-11, 2005-2 I.R.B. 307

2000-20


Rev. Proc. 2005-16, 2005-10 I.R.B. 674

2001-22

Superseded by

Rev. Proc. 2005-12, 2005-2 I.R.B. 311

2002-9

Modified and amplified by

Rev. Proc. 2005-9, 2005-2 I.R.B. 303

2003-32

Amplified and superseded by

Rev. Proc. 2005-20, 2005-18 I.R.B. 990

2004-1

Superseded by

Rev. Proc. 2005-1, 2005-1 I.R.B. 1

2004-2

Superseded by

Rev. Proc. 2005-2, 2005-1 I.R.B. 86

Revenue Procedures— Continued:

2004-3

Superseded by

Rev. Proc. 2005-3, 2005-1 I.R.B. 118

2004-4

Superseded by

Rev. Proc. 2005-4, 2005-1 I.R.B. 128

2004-5

Superseded by

Rev. Proc. 2005-5, 2005-1 I.R.B. 170

2004-6

Superseded by

Rev. Proc. 2005-6, 2005-1 I.R.B. 200

2004-7

Superseded by

Rev. Proc. 2005-7, 2005-1 I.R.B. 240

2004-8

Superseded by

Rev. Proc. 2005-8, 2005-1 I.R.B. 243

2004-13

Superseded by

Rev. Proc. 2005-27, 2005-20 I.R.B. 1050

2004-16


Rev. Proc. 2005-25, 2005-17 I.R.B. 962

2004-18


Rev. Proc. 2005-15, 2005-9 I.R.B. 638

2004-24

Obsoleted by

Rev. Proc. 2005-22, 2005-15 I.R.B. 886

2004-35

Corrected by

Ann. 2005-4, 2005-2 I.R.B. 319

2004-60

Superseded by

Rev. Proc. 2005-10, 2005-3 I.R.B. 341

2005-6

Modified by

Rev. Proc. 2005-16, 2005-10 I.R.B. 674

2005-8

Modified by

Rev. Proc. 2005-16, 2005-10 I.R.B. 674

2005-9

Modified by

Rev. Proc. 2005-17, 2005-13 I.R.B. 797

Revenue Rulings:

69-516

Obsoleted by

T.D. 9182, 2005-11 I.R.B. 713

1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2004–27 through 2004–52 is in Internal Revenue Bulletin 2004–52, dated December 27,2004.

June 13, 2005 iv 2005–24 I.R.B.

Revenue Rulings— Continued:

76-96

Suspended in part by

Rev. Rul. 2005-28, 2005-19 I.R.B. 997

77-415

Obsoleted by

T.D. 9182, 2005-11 I.R.B. 713

77-479

Obsoleted by

T.D. 9182, 2005-11 I.R.B. 713

79-335


Rev. Rul. 2005-30, 2005-20 I.R.B. 1015

82-34

Obsoleted by

T.D. 9182, 2005-11 I.R.B. 713

92-19

Supplemented in part by

Rev. Rul. 2005-29, 2005-21 I.R.B. 1080

92-63


Rev. Rul. 2005-3, 2005-3 I.R.B. 334

95-63


Rev. Rul. 2005-3, 2005-3 I.R.B. 334

2004-43

Revoked by

Rev. Rul. 2005-10, 2005-7 I.R.B. 492

2004-103

Superseded by

Rev. Rul. 2005-3, 2005-3 I.R.B. 334

Treasury Decisions:

8408

Corrected by

Ann. 2005-28, 2005-17 I.R.B. 969

9130

Corrected by

Ann. 2005-29, 2005-17 I.R.B. 969

9165

Revised by

T.D. 9201, 2005-23 I.R.B. 1153

Corrected by

Ann. 2005-31, 2005-18 I.R.B. 996

9166

Corrected by

Ann. 2005-33, 2005-19 I.R.B. 1013

9170

Corrected by

Ann. 2005-13, 2005-8 I.R.B. 627

Ann. 2005-35, 2005-21 I.R.B. 1095

9187

Corrected by

Ann. 2005-25, 2005-15 I.R.B. 891

Treasury Decisions— Continued:

9196

Corrected by

Ann. 2005-40, 2005-22 I.R.B. 1152

9198

Corrected by

Ann. 2005-41, 2005-23 I.R.B. 1212

2005–24 I.R.B. v June 13, 2005*U.S. Government Printing Office: 2005—314–048/20009