income tax estate tax · published in the last bulletin of each semiannual period. the contents of...

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. 2016–20 page 279.Federal rates; adjusted federal rates; adjusted federal long-term rate and the long-term exempt rate. For purposes ofsections 382, 642, 1274, 1288, 7872, and other sections ofthe Code, tables set forth the rates for September 2016.

Rev. Proc. 2016–43 page 316.This revenue procedure provides the national monthly averagepremium for a bronze-level qualified health plan (NABP) avail-able through Marketplaces in 2016. The NABP is the maximummonthly individual shared responsibility payment under section5000A for nonexempt individuals who do not have minimumessential coverage for a month.

Rev. Proc. 2016–44 page 316.This revenue procedure provides safe harbor conditions underwhich a management contract does not result in private busi-ness use of property financed with governmental tax-exemptbonds under section 141(b) of the Internal Revenue Code orcause the modified private business use test for propertyfinanced with qualified 501(c)(3) bonds under section145(a)(2)(B) to be met.

T.D. 9777 page 282.Section 148 imposes yield restriction and rebate requirementson issuers of tax-exempt bonds and other tax-advantagedbonds. These final regulations under section 148 consolidateand finalize proposed regulations published in 2007 and 2013.The final regulations include numerous, independent, technicalamendments to various topics in the regulations under section148. Generally, the final regulations simplify certain provisions,make certain provisions more administrable, resolve certaintechnical issues, and address certain market developments.Specific topics addressed in the final regulations include,among other things, working capital financings, qualifiedhedges, and valuation of investments.

T.D. 9782 page 301.Section 301 of James Zadroga 9/11 Health and CompensationAct of 2010, Public Law 111–347 (124 Stat. 3623) addedsection 5000C to the Internal Revenue Code that imposes a 2percent tax on payments made by the U.S. government toforeign persons pursuant to certain contracts. These finalregulations provide guidance to U.S. government acquiringagencies and foreign persons to determine what goods orservices are subject to the section 5000C; and how to remitthe 2 percent tax by U.S. government acquiring agencies orforeign persons, if the section 5000C tax is applicable.

ESTATE TAX

REG–163113–02 page 329.These proposed regulations provide additional guidance undersection 2704, which contains special rules for valuing interestsin corporations and partnerships transferred within the family,for estate, gift and generation-skipping transfer (GST) tax pur-poses. The proposed regulations add a new section to addressrestrictions on the liquidation of an individual interest in a familycontrolled entity and the effect of small interests held bypersons who are not members of the family. The effect ofthese revisions is to disregard restrictions that reduce thevalue of the interest for tax purposes, but do not reduce thevalue of the interest to the family-member recipient.

GIFT TAX

REG–163113–02 page 329.These proposed regulations provide additional guidance undersection 2704, which contains special rules for valuing interestsin corporations and partnerships transferred within the family,for estate, gift and generation-skipping transfer (GST) tax pur-poses. The proposed regulations add a new section to address

Finding Lists begin on page ii.

Bulletin No. 2016–36September 6, 2016

restrictions on the liquidation of an individual interest in a familycontrolled entity and the effect of small interests held bypersons who are not members of the family. The effect ofthese revisions is to disregard restrictions that reduce thevalue of the interest for tax purposes, but do not reduce thevalue of the interest to the family-member recipient.

EXCISE TAX


TAX CONVENTIONS


ADMINISTRATIVE

REG–108792–16 page 320.This document contains proposed amendments to the regula-tions that provide user fees for installment agreements. Theproposed amendments affect taxpayers who wish to pay theirliabilities through installment agreements. This document alsoprovides a notice of public hearing on these proposed amend-ments to the regulations.

The IRS MissionProvide America’s taxpayers top-quality service by helpingthem understand and meet their tax responsibilities and en-force the law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly.

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

Revenue rulings represent the conclusions of the Service onthe application of the law to the pivotal facts stated in therevenue ruling. In those based on positions taken in rulings totaxpayers or technical advice to Service field offices, identify-ing details and information of a confidential nature are deletedto prevent unwarranted invasions of privacy and to comply withstatutory requirements.

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

against reaching the same conclusions in other cases unlessthe facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

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

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

Part III.—Administrative, Procedural, 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 index forthe 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.

September 6, 2016 Bulletin No. 2016–36

Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section

1274—Determination ofIssue Price in the Case ofCertain Debt InstrumentsIssued for Property(Also Sections 42, 280G, 382, 412, 467, 468, 482,483, 642, 807, 846, 1288, 7520, 7872.)

Rev. Rul. 2016–20

This revenue ruling provides variousprescribed rates for federal income taxpurposes for September 2016 (the current

month). Table 1 contains the short-term,mid-term, and long-term applicable fed-eral rates (AFR) for the current month forpurposes of section 1274(d) of the InternalRevenue Code. Table 2 contains the short-term, mid-term, and long-term adjustedapplicable federal rates (adjusted AFR)for the current month for purposes of sec-tion 1288(b). The rates in Table 2 havebeen determined in accordance with§ 1.1288–1. See T.D. 9763, 81 FR 24482(April 26, 2016). Table 3 sets forth theadjusted federal long-term rate and thelong-term tax-exempt rate described insection 382(f). Table 4 contains the appro-

priate percentages for determining thelow-income housing credit described insection 42(b)(1) for buildings placed inservice during the current month. How-ever, under section 42(b)(2), the applica-ble percentage for non-federally subsi-dized new buildings placed in serviceafter July 30, 2008, shall not be less than9%. Finally, Table 5 contains the federalrate for determining the present value ofan annuity, an interest for life or for a termof years, or a remainder or a reversionaryinterest for purposes of section 7520.

REV. RUL. 2016–20 TABLE 1

Applicable Federal Rates (AFR) for September 2016

Period for CompoundingAnnual Semiannual Quarterly Monthly

Short-term

AFR .61% .61% .61% .61%

110% AFR .67% .67% .67% .67%

120% AFR .73% .73% .73% .73%

130% AFR .79% .79% .79% .79%

Mid-term

AFR 1.22% 1.22% 1.22% 1.22%

110% AFR 1.34% 1.34% 1.34% 1.34%

120% AFR 1.47% 1.46% 1.46% 1.46%

130% AFR 1.60% 1.59% 1.59% 1.58%

150% AFR 1.84% 1.83% 1.83% 1.82%

175% AFR 2.15% 2.14% 2.13% 2.13%

Long-term

AFR 1.90% 1.89% 1.89% 1.88%

110% AFR 2.09% 2.08% 2.07% 2.07%

120% AFR 2.28% 2.27% 2.26% 2.26%

130% AFR 2.48% 2.46% 2.45% 2.45%

REV. RUL. 2016–20 TABLE 2Adjusted AFR for September 2016

Period for CompoundingAnnual Semiannual Quarterly Monthly

Short-term adjusted AFR .45% .45% .45% .45%

Mid-term adjusted AFR .91% .91% .91% .91%

Long-term adjusted AFR 1.41% 1.41% 1.41% 1.41%

Bulletin No. 2016–36 September 6, 2016279

REV. RUL. 2016–20 TABLE 3Rates Under Section 382 for September 2016

Adjusted federal long-term rate for the current month 1.41%

Long-term tax-exempt rate for ownership changes during the current month (the highest of theadjusted federal long-term rates for the current month and the prior two months.)

2.08%

REV. RUL. 2016–20 TABLE 4Appropriate Percentages Under Section 42(b)(1) for September 2016

Note: Under section 42(b)(2), the applicable percentage for non-federally subsidized new buildings placed in service afterJuly 30, 2008, shall not be less than 9%.

Appropriate percentage for the 70% present value low-income housing credit 7.36%

Appropriate percentage for the 30% present value low-income housing credit 3.15%

REV. RUL. 2016–20 TABLE 5Rate Under Section 7520 for September 2016

Applicable federal rate for determining the present value of an annuity, an interest for life ora term of years, or a remainder or reversionary interest

1.4%

Section 42.—Low-IncomeHousing Credit

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof September 2016. See Rev. Rul. 2016-20, page279.

Section 280G.—GoldenParachute Payments

Federal short-term, mid-term, and long-termrates are set forth for the month of September 2016.See Rev. Rul. 2016-20, page 279.

Section 382.—Limitationon Net Operating LossCarryforwards and CertainBuilt-In Losses FollowingOwnership Change

The adjusted applicable federal long-term rate isset forth for the month of September 2016. See Rev.Rul. 2016-20, page 279.

Section 412.—MinimumFunding Standards

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month

of September 2016. See Rev. Rul. 2016-20, page279.

Section 467.—CertainPayments for the Use ofProperty or Services


Section 468.—SpecialRules for Mining and SolidWaste Reclamation andClosing Costs


Section 482.—Allocation ofIncome and DeductionsAmong Taxpayers


Section 483.—Interest onCertain Deferred Payments


Section 642.—SpecialRules for Credits andDeductions


Section 807.—Rules forCertain Reserves


Section 846.—DiscountedUnpaid Losses Defined



Section 1288.—Treatmentof Original Issue Discounton Tax-Exempt Obligations


Section 7520.—ValuationTables


Section 7872.—Treatmentof Loans With Below-Market Interest Rates



T.D. 9777

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Part 1

Arbitrage Guidance for Tax-Exempt Bonds

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains fi-nal regulations on the arbitrage restric-tions under section 148 of the InternalRevenue Code (Code) applicable to tax-exempt bonds and other tax-advantagedbonds issued by State and local govern-ments. These final regulations amend ex-isting regulations to address certain mar-ket developments, simplify certainprovisions, address certain technical is-sues, and make existing regulations moreadministrable. These final regulations af-fect State and local governments that issuetax-exempt and other tax-advantagedbonds.

DATES: Effective Date: These final reg-ulations are effective on July 18, 2016.

Applicability Date: For dates of appli-cability, see §§ 1.141–15, 1.148–11,1.150–1(a)(2)(iii), and 1.150–2(j).

FOR FURTHER INFORMATIONCONTACT: Spence Hanemann, (202)317-6980 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information con-tained in these final regulations has beenreviewed and approved by the Office ofManagement and Budget in accordancewith the Paperwork Reduction Act of1995 (44 U.S.C. 3507(d)) under controlnumber 1545-1347. The collection of in-formation in these final regulations is in§ 1.148–4(h)(2)(viii), which contains arequirement that the issuer maintain in itsrecords a certificate from the hedge pro-vider. For a hedge to be a qualified hedge,existing regulations require, among otheritems, that the actual issuer identify the

hedge on its books and records. The iden-tification must specify the hedge provider,the terms of the contract, and the hedgedbonds. These final regulations require thatthe identification also include a certificatefrom the hedge provider specifying cer-tain information regarding the hedge.

An agency may not conduct or spon-sor, and a person is not required to re-spond to, a collection of information un-less it displays a valid control number.

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

Background

This document contains amendmentsto the Income Tax Regulations (26 CFRpart 1) on the arbitrage investment restric-tions under section 148 of the Code andrelated provisions. On June 18, 1993, theDepartment of the Treasury (the TreasuryDepartment) and the IRS published com-prehensive final regulations in the Fed-eral Register (TD 8476, 58 FR 33510) onthe arbitrage investment restrictions andrelated provisions for tax-exempt bondsunder sections 103, 148, 149, and 150,and, since that time, those final regula-tions have been amended in certain lim-ited respects (the regulations issued in1993 and the amendments thereto collec-tively are referred to as the Existing Reg-ulations).

A notice of proposed rulemaking waspublished in the Federal Register (72 FR54606; REG–106143–07) on September26, 2007 (the 2007 Proposed Regula-tions). The 2007 Proposed Regulationsproposed amendments to the ExistingRegulations. Comments on the 2007 Pro-posed Regulations were received and apublic hearing was held on January 30,2008.

Another notice of proposed rulemakingwas published in the Federal Register(78 FR 56842; REG–148659–07) on Sep-tember 16, 2013 (the 2013 Proposed Reg-ulations). The 2013 Proposed Regulationsproposed additional amendments to theExisting Regulations (the 2007 ProposedRegulations and the 2013 Proposed Reg-ulations collectively are referred to as the

Proposed Regulations). Comments on the2013 Proposed Regulations were receivedand a public hearing was held on February5, 2014. The 2013 Proposed Regulationsaddressed the definition of issue price,among other topics.

A partial withdrawal of notice of pro-posed rulemaking and notice of proposedrulemaking was published in the FederalRegister (80 FR 36301; REG–138526–14) on June 24, 2015, re-proposingamendments to the definition of issueprice. After consideration of all the com-ments, the remaining portions of the Pro-posed Regulations are adopted asamended by this Treasury decision (theFinal Regulations).

Summary of Comments andExplanation of Revisions

This section discusses significant as-pects of the comments received from thepublic regarding the Proposed Regula-tions. It also explains the revisions madein the Final Regulations.

1. Section 1.148–1 Definitions andElections

A. Working Capital Expenditures andReplacement Proceeds Definition

i. Introduction

The Existing Regulations impose vari-ous restrictions on the use of tax-exemptbond financing for working capital expen-ditures. One way the Existing Regulationslimit working capital financings is throughthe concept of replacement proceeds, aspecial category of funds included withinthe broad definition of gross proceeds towhich the arbitrage investment restric-tions under section 148 apply. Under theExisting Regulations, replacement pro-ceeds arise if an issuer reasonably expectsas of the issue date that: (1) The term of anissue will be longer than reasonably nec-essary for the governmental purposes ofthe issue; and (2) there will be availableamounts (as defined in the Existing Reg-ulations) for expenditures of the type be-ing financed during the period the issueremains outstanding longer than neces-sary. The Existing Regulations providecertain safe harbors that prevent the cre-ation of replacement proceeds.


ii. Modified Safe Harbor for Short-TermWorking Capital Financings

The 2013 Proposed Regulations pro-posed to shorten the bond maturity neces-sary to satisfy the safe harbor for mostshort-term working capital financingsfrom two years to 13 months to conformwith the permitted temporary investmentperiod for working capital expendituresunder § 1.148–2(e)(3) and the administra-tive standard in Rev. Proc. 2002–31,2002–1 CB 916. One commenter sug-gested extending this safe harbor to allworking capital expenditure financings,rather than just those for restricted work-ing capital expenditures (as defined in theExisting Regulations). This change, whichwould be implemented by deleting theword “restricted” from the safe harbor,would conform the safe harbor to the pro-posed extension of the temporary invest-ment period for working capital expendi-ture financings in the 2013 ProposedRegulations (see section 2 of this pream-ble). The change also would benefit issu-ers by expanding the eligible purposes forshort-term working capital financings toinclude extraordinary working capital ex-penditures. The Final Regulations adoptthis comment.

iii. New Safe Harbor for Longer-TermWorking Capital Financings

The 2013 Proposed Regulations pro-posed to add a new safe harbor that wouldprevent the creation of replacement pro-ceeds for longer-term working capital fi-nancings to enhance certainty for issuersexperiencing financial distress. This newsafe harbor would require an issuer to: (1)Determine the first year in which it ex-pects to have available amounts for work-ing capital expenditures; (2) monitor foractual available amounts in each year be-ginning with the year it first expects tohave such amounts; and (3) apply suchavailable amounts in each year either toredeem or to invest in (or some combina-tion of redeeming and investing in) certaintax-exempt bonds (eligible tax-exemptbonds). The safe harbor would require anyamounts invested in eligible tax-exemptbonds to be invested (or reinvested) con-tinuously, so long as the bonds using thesafe harbor remain outstanding. In a nar-

row exception to this requirement, the safeharbor would permit such amounts not tobe invested during a period of no morethan 30 days per fiscal year in which suchamounts are pending reinvestment. Theserequirements aimed to minimize the bur-den on the tax-exempt bond market.

The 2013 Proposed Regulations pro-posed to require an issuer to test for avail-able amounts on the first day of its fiscalyear and to apply such amounts to redeemor invest in eligible tax-exempt bondswithin 90 days. Commenters soughtgreater flexibility with respect to the tim-ing of testing the yearly available amountsand the use of such available amounts,based on considerations associated withpotential unrepresentative cash positionson particular dates and potential expectedshort-term cash needs to finance govern-mental purposes.

To promote administrability and con-sistency, the Final Regulations retain thefirst day of the fiscal year as the requiredannual testing date for available amounts.The Treasury Department and the IRShave concluded that commenters’ sug-gested solutions were complex in applica-tion and could produce a result that isunrepresentative of available amountsthroughout the rest of the year. By requir-ing testing on the first day of the fiscalyear, the Final Regulations provide an ad-ministrable testing date that mirrors thegeneral rule for other replacement pro-ceeds, under which an issuer also mustdetermine its available amounts on thefirst day of every fiscal year during theperiod when its bonds are outstanding lon-ger than reasonably necessary. To addresscommenters’ concerns about the need forgreater flexibility to address short-termcash flow deficits, the Final Regulationsinclude several other revisions to this safeharbor for longer-term working capital fi-nancings. The Final Regulations reducethe total amount the issuer must apply toredeem or invest in eligible tax-exemptbonds to take into account the expenditureof available amounts during the first 90days of the fiscal year and amounts held inbona fide debt service funds to the extentthat those amounts are included in avail-able amounts. Further, the Final Regula-tions allow an issuer to sell eligible tax-exempt bonds acquired pursuant to thesafe harbor, provided that the proceeds of

that sale are used within 30 days for agovernmental purpose (working capital orotherwise) and the issuer has no otheravailable amounts that it could use for thatpurpose. Alternatively, an issuer may sellsuch investments and use those amountsto redeem eligible tax-exempt bonds. To-gether, these amendments to the ProposedRegulations aim to address issuers’ con-cerns about cash flows in a manner con-sistent with the existing restrictions onfinancing working capital expenditureswith bonds outstanding longer than rea-sonably necessary.

Commenters also urged a small, butsignificant, change to the definition of“available amount” to address situationsin which an issuer has proceeds of morethan one bond issue that finance workingcapital expenditures. The definition ofavailable amount in the Existing Regula-tions specifically excludes proceeds of“the” issue, but not proceeds of other is-sues. The use of this existing definition forthe new safe harbor would have the effectof requiring an issuer to apply proceeds ofother issues to redeem or invest in eligibletax-exempt bonds to meet the safe harborrather than using such proceeds for theintended governmental purpose. The FinalRegulations adopt this comment and re-vise the definition of available amount toexclude proceeds of “any” issue.

Commenters also recommended thatthe maximum amount required to be ap-plied under the safe harbor to redeem orinvest in eligible tax-exempt bonds be re-duced from that proposed under the Pro-posed Regulations, which would set thatmaximum amount at an amount equal tothe outstanding principal of the bondssubject to the safe harbor. The comment-ers’ suggestion would reduce the maxi-mum amount in the Proposed Regulationsby the amount of certain other eligibletax-exempt bonds redeemed by the issuer.The Final Regulations do not adopt thisrecommendation. The Final Regulationsretain the measure of the maximumamount required to be applied to redeemor invest in eligible tax-exempt bonds un-der this safe harbor at the outstandingprincipal amount of the relevant bonds toensure that issuers redeem the bonds thatare the subject of the safe harbor when-ever possible.


The 2013 Proposed Regulations pro-posed to define eligible tax-exempt bondsfor purposes of the new safe harbor tomean those tax-exempt bonds that are notsubject to the alternative minimum tax(non-AMT tax-exempt bonds). Comment-ers requested clarification that eligibletax-exempt bonds for these investmentsalso include certain State and Local Gov-ernment Series securities (SLGS or, indi-vidually, a SLGS security), specificallyDemand Deposit SLGS, and certain inter-ests in regulated investment companiesthat invest in tax-exempt bonds and passthrough to their owners income at least 95percent of which is tax-exempt under sec-tion 103. The commenters noted that thesetwo types of investments are included inthe existing definition of tax-exemptbonds for purposes of the arbitrage invest-ment restrictions. Commenters noted par-ticularly that Demand Deposit SLGS aremuch easier to acquire than tax-exemptbonds and also have limited arbitrage po-tential. The purpose of the requirement toredeem or invest available amounts in cer-tain tax-exempt bonds is to reduce theburden on the tax-exempt bond market oflonger-term tax-exempt bonds issued forworking capital expenditure financings.Although Demand Deposit SLGS are tax-able obligations that do not reduce theburden on the tax-exempt bond market,the Treasury Department and the IRS rec-ognize that including these as eligible tax-exempt bonds provides issuers a simplemethod of investing with little possibilityof earning arbitrage. An interest in a reg-ulated investment company that invests innon-AMT tax-exempt bonds is easier tobuy and sell than a bond, and purchasingsuch an interest reduces the burden on thetax-exempt bond market. Thus, parallel-ing the existing definition of “tax-exemptbonds” applicable for purposes of the ar-bitrage investment restrictions, the FinalRegulations clarify that eligible tax-exempt bonds include both Demand De-posit SLGS and an interest in a regulatedinvestment company if at least 95% of theincome to the holder is from non-AMTtax-exempt bonds.

Commenters also recommended thatthe Final Regulations expressly addressthe treatment of refunding bonds issued torefinance working capital expenditures forpurposes of the new safe harbor. The Final

Regulations provide that this safe harborapplies to refunding bonds in the sameway that it applies to other bonds.

iv. Other Technical Changes to WorkingCapital Rules

The 2013 Proposed Regulations pro-posed to remove a restriction against fi-nancing a working capital reserve, a com-plex restriction that penalized those Stateand local governments that previouslyhave maintained the least amount of re-serves. Commenters supported thischange. The Final Regulations adopt thischange as proposed.

The 2013 Proposed Regulations pro-posed to expand the factors listed in ananti-abuse rule that may justify a bondmaturity in excess of those in the safeharbors that prevent the creation ofreplacement proceeds to include extraor-dinary working capital items. The Trea-sury Department and the IRS received nounfavorable comments on this change.The Final Regulations adopt this changeas proposed.

Commenters also raised several issueswith respect to the working capital rulesthat the Treasury Department and the IRShave concluded are beyond the scope ofthis project and, therefore, did not addressin the Final Regulations (see section 12 ofthis preamble).

2. Section 1.148–2 General ArbitrageYield Restriction Rules—TemporaryPeriod Spending Exception to YieldRestriction

The Existing Regulations provide var-ious temporary periods for investment ofproceeds of tax-exempt bonds withoutyield restriction. No express temporaryperiod covers proceeds used for workingcapital expenditures that are not restrictedworking capital expenditures, such as ex-traordinary working capital items. The2013 Proposed Regulations proposed tobroaden the existing 13 month temporaryperiod for restricted working capital ex-penditures to include all working capitalexpenditures. One commenter supportedand none opposed this proposed change.The Final Regulations adopt this changeas proposed.

3. Section 1.148–3 General ArbitrageRebate Rules

A. Arbitrage Rebate ComputationCredit

The Existing Regulations allow an is-suer to take a credit against payment ofarbitrage rebate to help offset the cost ofcomputing rebate. The 2007 ProposedRegulations proposed to increase thecredit and proposed to add an inflationadjustment to this credit, based onchanges in the Consumer Price Index. TheTreasury Department and the IRS re-ceived no comments on this change. TheFinal Regulations adopt this change asproposed.

B. Recovery of Overpayment of Rebate

Generally, under the Existing Regula-tions, an issuer computes the amount ofarbitrage rebate that it owes under amethod that future values payments andreceipts on investments using the yield onthe bond issue. Under this method, anarbitrage payment made on one computa-tion date is future valued to the next com-putation date to determine the amount ofarbitrage rebate owed on that subsequentcomputation date. The Existing Regula-tions provide that an issuer may recoveran overpayment of arbitrage rebate withrespect to an issue of tax-exempt bonds ifthe issuer establishes to the satisfaction ofthe Commissioner that an overpaymentoccurred. The Existing Regulations fur-ther define an overpayment as the excessof “the amount paid” to the United Statesfor an issue under section 148 over thesum of the rebate amount for that issue asof the most recent computation date andall amounts that are otherwise required tobe paid under section 148 as of the datethe recovery is requested. Thus, even ifthe future value of the issuer’s arbitragerebate payment on a computation date,computed under the method for determin-ing arbitrage rebate, is greater than theissuer’s rebate amount on that date, anissuer is only entitled to a refund to theextent that the amount actually paid ex-ceeds that rebate amount. The ExistingRegulations limit the amount of the refundin this manner because the Treasury De-partment and the IRS were concerned


about whether the IRS had statutory au-thority to pay interest on arbitrage rebatepayments. To permit a refund in anamount calculated in whole or in partbased upon a future value of the amountactually paid would effectively result inan interest payment on that payment.

An example in the Existing Regula-tions has caused confusion because itcould be interpreted to mean that an issuercan receive a refund of a rebate paymentwhen the future value of such rebate pay-ment exceeds the rebate amount on thenext computation date, even though theactual amount of the previous rebate pay-ment does not exceed the rebate amounton that next computation date. The Pro-posed Regulations proposed to make atechnical amendment to this example toconform this example to the intendedscope of recovery of an overpayment ofarbitrage rebate.

Commenters recommended broaden-ing the scope of recovery of overpaymentsof arbitrage rebate to permit future valu-ing of the amount actually paid in com-puting the amount of the overpayment.Because the Treasury Department and theIRS have concluded that they lack thestatutory authority to pay interest on over-payments of arbitrage rebate, the FinalRegulations adopt this change as pro-posed.

4. Section 1.148–4 Yield on an Issue ofBonds

A. Joint Bond Yield Authority

The 2007 Proposed Regulations pro-posed to eliminate a provision in the Ex-isting Regulations that permits computa-tion of a single joint bond yield for two ormore issues of qualified mortgage bondsor qualified student loan bonds. The 2007Proposed Regulations solicited publiccomments on the feasibility of establish-ing generally applicable, objective stan-dards for joint bond yield computations.Two commenters representing studentloan lenders sought to retain this provisionand described certain facts on which theybelieved that the joint computation ofyield on student loan bonds might bebased. However, in 2010, Congress termi-nated the Federal Family Education LoanProgram (FFELP), effectively eliminating

the program for which most student loanbonds were issued yet not affecting Statesupplemental student loan bond programs.Health Care and Education ReconciliationAct of 2010, Public Law 111–152, section2201, 124 Stat 1029, 1074 (2010). Giventhe elimination of the FFELP and thehighly factual nature of the requests forjoint bond yield computations, the FinalRegulations adopt the proposed elimina-tion of the joint bond yield authority pro-vision. In addition, however, in recogni-tion of the administrative challenges forloan yield calculations in these portfolioloan programs, the Final Regulations ex-tend the availability of yield reductionpayments to include qualified studentloans and qualified mortgage loans gener-ally (see section 5.A. of this preamble).

B. Modification of Yield Computationfor Yield-to-Call Premium Bonds

The 2007 Proposed Regulations pro-posed to simplify the yield calculationsfor certain callable bonds issued with sig-nificant amounts of bond premium (some-times called yield-to-call bonds) to focuson the redemption date that results in thelowest yield on the particular premiumbond (rather than the more complex exist-ing focus on the lowest yield on the issue).The Treasury Department and the IRS didnot receive any adverse comments regard-ing this proposed change, received onequestion that raised issues beyond thescope of this project (see section 12 of thispreamble), and received a favorable com-ment regarding this proposed change. TheFinal Regulations adopt this change asproposed.

C. Integration of Hedges

The Existing Regulations permit issu-ers to compute the yield on an issue bytaking into account payments under “qual-ified hedges.” Generally, under the Exist-ing Regulations, to be a qualified hedge,the hedge must be interest based, theterms of the hedge must correspondclosely with the terms of the hedgedbonds, the issuer must duly identify thehedge, and the hedge must contain nosignificant investment element. The Exist-ing Regulations provide two ways inwhich a qualified hedge may be taken into

account in computing yield on the issue,known commonly as “simple integration”and “super integration.” In the case ofsimple integration all net payments andreceipts on the qualified hedge and thehedged bonds are taken into account indetermining the yield on the bonds, suchthat generally these hedged bonds aretreated as variable yield bonds for arbi-trage purposes. In the case of super inte-gration, certain hedged bonds are treatedas fixed yield bonds, and the qualifiedhedge must meet additional eligibility re-quirements beyond those for simple inte-gration. These additional eligibility re-quirements focus on assuring that theterms of the hedge and the hedged bondssufficiently correspond so as to warranttreating the hedged bonds as fixed yieldbonds for arbitrage purposes.

i. Cost-of-Funds Hedges

The 2007 Proposed Regulations pro-posed to clarify that for purposes of ap-plying the definition of periodic paymentto determine whether a hedge has a sig-nificant investment element, a “specifiedindex” (upon which periodic payments arebased) is deemed to include payments un-der a cost-of-funds swap, thereby elimi-nating any doubt that cost-of-funds swapscan be qualified hedges. One commentersupported this clarification and none op-posed it. One commenter proposed anamendment that is beyond the scope ofthis project (see section 12 of this pream-ble). The Final Regulations adopt thisclarification as proposed.

ii. Taxable Index Hedges

One of the eligibility requirements fora qualified hedge under the Existing Reg-ulations is that the hedge be interest based.For simple integration, one of the factorsused in determining whether a variable-to-fixed interest rate hedge is interest basedfocuses on whether the variable interestrate on the hedged bonds and the floatinginterest rate on the hedge are “substan-tially the same, but not identical to” oneanother. For super integration purposes,such rates must be “reasonably expectedto be substantially the same throughoutthe term of the hedge.” Issuers have raisedinterpretative questions about how to ap-


ply these rules to hedges based on taxableinterest rate indices (taxable indices) be-cause interest rates on taxable indices gen-erally do not correspond as closely as in-terest rates on tax-exempt market indicesto actual market interest rates on tax-exempt, variable-rate bonds. These inter-pretative questions are particularly impor-tant for hedges based on taxable indices(taxable index hedges) used with advancerefunding bond issues because issuersgenerally need to use the qualified hedgerules or some other regime to determinewith certainty the yield on the tax-exemptadvance refunding bonds to comply withthe applicable arbitrage yield restrictionson investments in defeasance escrows.

The 2007 Proposed Regulations pro-posed to clarify that taxable index hedgesare eligible for simple integration but alsoincluded detailed provisions that pre-scribed the correlation of interest ratesneeded for taxable index hedges to qualifyfor simple integration. Commenters gen-erally criticized the proposed interest ratecorrelation test for simple integration oftaxable index hedges as excessively com-plex or unworkable in various respects.One commenter urged elimination of thisrate correlation test as unnecessary on thegrounds that other proposed changes inthe 2007 Proposed Regulations, includingparticularly the provision limiting the sizeand scope of hedges (described in section4.C.iii of this preamble), were sufficient tocontrol the parameters of taxable indexhedges for purposes of simple integration.The Final Regulations clarify that a tax-able index hedge is an interest based con-tract and adopt the comment to eliminatethe interest rate correlation test for taxableindex hedges. The Final Regulations alsoclarify that the difference between the in-terest rate used on the hedged bonds andthat used to compute payments on thehedge will not prevent the hedge frombeing an interest based contract if the twointerest rates are substantially similar.

The 2007 Proposed Regulations pro-posed to treat taxable index hedges asineligible for super integration (except inthe case of certain anticipatory hedges).Commenters requested an exception tothis general prohibition on super integra-tion for instances in which the variablerate on hedged bonds and the variable rateused to determine the hedge provider’s

payments to the issuer under the hedge areboth based on a taxable index and areidentical (or nearly so) to one another. TheFinal Regulations generally adopt the pro-posed rule that taxable index hedges areineligible for super integration but, in re-sponse to the comments, add an exceptionfor hedges in which the hedge provider’spayments are based on an interest rateidentical to that on the hedged bonds, be-cause these hedges are perfect hedges thatclearly result in a fixed yield. The Trea-sury Department and the IRS do not adoptcommenters’ request to permit super inte-gration when the taxable-index-based in-terest rates for both the hedge and thehedged bonds are nearly identical but notperfectly so. The Treasury Departmentand the IRS have concluded that such arule would add unnecessary complexity tothe Final Regulations and that comment-ers’ concerns are largely resolved by theextension in the Final Regulations of yieldreduction payments to address basis dif-ferences between indexes used in hedgesand underlying interest rates on hedgedbonds in advance refundings (discussedelsewhere in this section of the preamble).The Final Regulations remove referencesto the particular taxable index called“LIBOR,” without inference.

Commenters also sought other specificexceptions to the prohibition on super in-tegration. One commenter noted that tax-able index hedges cost less than hedgesbased on a tax-exempt index and recom-mended allowing super integration of tax-able index hedges with mortgage revenuebonds to facilitate compliance with arbi-trage restrictions on the yield of the fi-nanced mortgages. The Treasury Depart-ment and the IRS have concluded that theFinal Regulations adequately address thecommenter’s concerns by permitting sim-ple integration of taxable index hedgesand by allowing yield reduction paymentsfor qualified mortgage loans to facilitatecompliance with the arbitrage investmentrestrictions (see section 5.A. of this pre-amble).

Other commenters suggested that theproposed prohibition on super integrationof taxable index hedges should be pro-spective. This provision in the Final Reg-ulations applies to bonds sold on or afterthe date that is 90 days after publication ofthe Final Regulations in the Federal Reg-

ister, and does not apply to bonds soldprior to that date or to hedges on thosebonds, regardless of when the issuer en-ters into such a hedge, unless the issueravails itself of permissive application un-der § 1.148–11(l)(1) of these Final Regu-lations.

The 2007 Proposed Regulations alsoproposed to modify the yield reductionpayment rules to permit issuers to makeyield reduction payments on certainhedged advance refunding issues. Thisproposed provision effectively would al-low yield reduction payments to cover thebasis differences between the hedge andthe hedged bonds in certain circumstancesin which super integration was unavail-able to address those basis differences,such as when taxable index swaps hedgethe interest rate on advance refundingbonds. Commenters requested clarifica-tion of which bonds in the issue must behedged for the issuer to be eligible tomake yield reduction payments under theproposed provision. The Final Regula-tions eliminate the term “hedged bond is-sue” to clarify that the yield reductionpayment is narrowly targeted to the por-tion of the issue that funds the defeasanceescrow and otherwise adopt this change asproposed.

iii. Size and Scope of a Qualified Hedge

The 2007 Proposed Regulations pro-posed to add an express requirement thatlimits the size and scope of a qualifiedhedge to a level that is reasonably neces-sary to hedge the issuer’s risk with respectto interest rate changes on the hedgedbonds. Generally, the purpose of this pro-posed limitation is to clarify that certainleveraged hedges are not qualified hedges.

The 2007 Proposed Regulations pro-posed an example of a hedge of theappropriate size and scope, based on theprincipal amount and the reasonably ex-pected interest requirements of the hedgedbonds. One commenter suggested clarify-ing this size and scope limitation to pro-vide more flexibility for anticipatoryhedges that are entered into before theissuance of the hedged bonds. The FinalRegulations adopt the size and scope lim-itation as proposed and clarify that thislimitation applies to anticipatory hedges


based on the reasonably expected terms ofthe hedged bonds to be issued.

iv. Correspondence of Payments forSimple Integration

The Existing Regulations require that,for a hedge to be a qualified hedge, thepayments received by the issuer from thehedge provider under the contract corre-spond closely in time to either the specificpayments being hedged on the hedgedbonds or specific payments required to bemade pursuant to the bond documents,regardless of the hedge, to a sinking fund,debt service fund, or similar fund main-tained for the issue of which the hedgedbond is a part. The 2007 Proposed Regu-lations proposed to treat payments as cor-responding closely in time for this pur-pose if the payments were made within 60calendar days of each other.

One commenter recommended increas-ing the permitted period for correspondingpayments from 60 days to 90 days toaccommodate a range of conventions usedin the swap market. The Final Regulationsadopt this comment.

v. Identification of Qualified Hedges

The 2007 Proposed Regulations pro-posed to extend the time for an issuer toidentify a qualified hedge from three daysto 15 days and to clarify that these arecalendar days. The 2013 Proposed Regu-lations proposed to add a requirement thatthe identification of a qualified hedge in-clude a certificate from the hedge providercontaining certain information. Under the2013 Proposed Regulations, one elementrequired to be certified by the hedge pro-vider is that the rate being paid by thebonds’ issuer on the hedge is comparableto the rate that would be paid by a simi-larly situated issuer of taxable debt.

Several commenters recommendedclarifying the date on which the 15-dayperiod for identification of a hedge com-mences. The Final Regulations clarify thatthe date on which the 15-day period be-gins is the date on which the parties enterinto a binding agreement to enter into thehedge (as distinguished from the closingdate of the hedge or start date for pay-ments on the hedge, if different).

Several commenters suggested permit-ting a party other than the issuer to iden-tify the hedge on its books and records,but such changes are beyond the scope ofthis project (see section 12 of this pream-ble).

One commenter supported the require-ment of a hedge provider’s certificate.Two other commenters recommendedeliminating this requirement as both un-necessary and burdensome in that it ex-ceeds the requirements for other financialcontracts related to tax-exempt bondyield. These commenters recommendedthat, if the pricing of the hedge is a con-cern, the regulations should provide othermethods for establishing fair pricing.These commenters, however, acknowl-edged that many issuers already use someform of hedge provider’s certificate andthat the provisions in the Proposed Regu-lations reflect to some degree the standardprovisions of such certificates. In the al-ternative, these commenters recom-mended that the hedge provider’s certifi-cate should focus on factual aspects ofestablishing a qualified hedge, rather thanon legal conclusions, and offered specificsuggestions to that effect. For example,these commenters suggested that issuersalso should be required to demonstratetheir efforts to establish that the hedgepricing does not include compensation forunderwriting or other services, rather thanto obtain a certification to that effect.These commenters further suggested thatthe representation in the Proposed Regu-lations that the terms of the hedge wereagreed to between a willing buyer and awilling seller in a bona fide, arm’s lengthtransaction was unnecessary and requireda legal conclusion outside the hedge pro-vider’s knowledge. Further, the comment-ers noted that comparable hedges on tax-able debt with counterparties similar toState and local government issuers may berare and recommended that issuers be re-quired to establish that the rate on thehedge is comparable to the rate thatthe hedge provider would charge for asimilar hedge with a counterparty similarto the issuer, but without a reference todebt obligations other than tax-exemptbonds.

The Final Regulations retain the re-quirement for a hedge provider’s certifi-cate because the hedge provider is

uniquely positioned to validate pricing in-formation needed to determine whether ahedge meets the requirements for being aqualified hedge. The Final Regulations re-tain the certification regarding an arm’slength transaction between a willing buyerand a willing seller as one primarily basedon fact and commonly obtained by issuersunder current practices. In response topublic comments, the Final Regulationsamend the other required certifications tofocus on factual aspects of the hedgingtransaction. In light of the evolving regu-latory environment for swaps, however,the Final Regulations omit the certifica-tion that the issuer’s rate on the hedge iscomparable to the rate that would be paidby a similarly situated issuer of taxabledebt. The Final Regulations reserve theauthority for the Commissioner to add ad-ditional certifications in guidance pub-lished in the Internal Revenue Bulletin. Indeveloping any future guidance, the Trea-sury Department and the IRS may look tothe market for swaps on taxable debt andconsider the availability of appropriatecomparable rates.

vi. Accounting for Modifications andTerminations

a. Modifications and Terminations ofQualified Hedges

The Existing Regulations provide thata termination of a qualified hedge includesany sale or other disposition of the hedgeby the issuer or the acquisition by theissuer of an offsetting hedge. The ExistingRegulations further provide that a deemedtermination of a qualified hedge occurswhen the hedged bonds are redeemed,when the hedge ceases to be a qualifiedhedge, or when the modification or assign-ment of the hedge results in a deemedexchange under section 1001. The issuertakes termination payments resulting froma deemed or actual termination of an in-tegrated hedge into account in computingyield on the bonds.

The 2013 Proposed Regulations pro-posed guidance on the treatment of mod-ifications and terminations of qualifiedhedges. The 2013 Proposed Regulationsalso proposed to eliminate the ambiguousexisting standard that triggered termina-tions for offsetting hedges. The 2013 Pro-


posed Regulations proposed that a modi-fication, including an actual modification,an acquisition of another hedge, or anassignment, results in a deemed termina-tion of a hedge if the modification is ma-terial and results in a deemed dispositionunder section 1001.

The 2013 Proposed Regulations pro-posed to simplify the treatment of deemedterminations to provide that a materialmodification of a qualified hedge (thatotherwise would result in a deemed termi-nation) does not result in such a termina-tion if the modified hedge is a qualifiedhedge. For this purpose, the 2013 Pro-posed Regulations proposed to require re-testing of the modified hedge for compli-ance with the requirements for a qualifiedhedge at the time of the modification, withadjustments. In doing this re-testing, the2013 Proposed Regulations proposed todisregard any off-market value of the ex-isting hedge at the time of modification. Inaddition, the 2013 Proposed Regulationsproposed to measure the time period foridentification of the modified hedge fromthe date of the modification. Finally, the2013 Proposed Regulations proposed toomit the requirement for a hedge provid-er’s certificate for the modified hedge.Commenters supported these changes.The Final Regulations adopt these pro-posed changes with one modification: As-signment of a hedge is no longer given asan example of a modification. The FinalRegulations remove this example not be-cause an assignment is not a modification,but because under the regulations undersection 1001 an assignment generallydoes not result in a deemed exchange.

Commenters sought confirmation thatthe proposed rules for modifications ofqualified hedges in the 2013 ProposedRegulations would replace an existingrule regarding such modifications that isset forth in the first sentence of section 5.1of Notice 2008–41, 2008–1 CB 742. Thatsentence generally provides that a modi-fication of a qualified hedge does not re-sult in a deemed termination if the issuerdoes not expect the modification tochange the yield on the hedged bonds overtheir remaining term by more than 0.25%and the modified hedge is integrated withthe bonds. The Final Regulations providecomprehensive rules for determiningwhen a modification of a qualified hedge

results in a termination and, therefore, su-persede the first sentence of section 5.1 ofNotice 2008–41. The Final Regulationshave no effect on the remainder of Notice2008–41. See the section in this preambleentitled “Effect on Other Documents.”

b. Continuations of Qualified Hedges inRefundings

The 2013 Proposed Regulations simi-larly proposed to simplify the treatment ofa qualified hedge upon a refunding of thehedged bonds when no actual terminationof the associated hedge occurs. If thehedge meets the requirements for a qual-ified hedge of the refunding bonds as ofthe issue date of the refunding bonds, withcertain exceptions, the 2013 ProposedRegulations proposed to treat the hedge ascontinuing as a qualified hedge of the re-funding bonds instead of being termi-nated. The Treasury Department and theIRS received favorable comments regard-ing this proposed change and one com-ment beyond the scope of this project (seesection 12 of this preamble). The FinalRegulations adopt this change as pro-posed.

The Existing Regulations provide spe-cial rules for terminations of super-integrated qualified hedges. A terminationis disregarded and these special rules donot apply if, based on the facts and cir-cumstances, the yield will not change. The2013 Proposed Regulations proposed toapply these special rules to a modifiedsuper-integrated qualified hedge that is el-igible for continued simple integration.Commenters sought clarification of the ef-fect of this rule on super integration treat-ment. The purpose of this rule is to deter-mine whether a modified super-integratedqualified hedge that continues to qualifyfor simple integration also would continueto qualify for super integration. The FinalRegulations clarify that the applicable testis the test under the Existing Regulationsfor determining when to disregard termi-nations of super-integrated qualifiedhedges.

c. Terminations of Hedges at FairMarket Value

The Proposed Regulations proposed tomodify the amounts taken into account for

a deemed termination or actual termina-tion of a qualified hedge. For an actualtermination of a qualified hedge, the 2013Proposed Regulations proposed to limitthe amount of the hedge termination pay-ment treated as made or received on thehedged bonds to an amount that is (i) nogreater than the fair market value of thequalified hedge if paid by the issuer, and(ii) no less than the fair market value ofthe qualified hedge if received by the is-suer. For a deemed termination of a qual-ified hedge, the 2013 Proposed Regula-tions proposed that the amount of thedeemed termination payment is equal tothe fair market value of the qualifiedhedge on the termination date.

Commenters recommended that, for anactual termination, the amount actuallypaid or received by the issuer in connec-tion with the termination should be con-sidered the fair market value of the qual-ified hedge. The commenters furtherrecommended that, for a deemed termina-tion, the issuer should be able to rely onbid-side quotations from the hedge pro-vider and other providers for purposes ofdetermining the fair market value of thequalified hedge on the termination date.The commenters indicated that, in allcases, the termination amounts, whetheractual or deemed, reflect the “bid side” ofthe hedge market. Because of concernsabout the pricing of a hedge in determin-ing the amount to be paid as a terminationpayment, the Final Regulations retain therule that the amount of a termination pay-ment that may be taken into account forarbitrage purposes is the fair market valueof the qualified hedge on the terminationdate. The Final Regulations simplify theProposed Regulations by providing a uni-form fair market value standard for bothactual and deemed terminations. Althoughthe Treasury Department and the IRShave concluded that bona fide market quo-tations may be used to support fair marketvalue determinations, the Treasury De-partment and the IRS have concerns aboutfurther specification of particular types ofmarket quotations for purposes of properreflection of fair market value in variouscircumstances. Accordingly, the FinalRegulations provide that the fair marketvalue of a qualified hedge upon termina-tion is based on all of the facts and cir-cumstances.


5. Section 1.148–5 Yield and Valuationof Investments

A. Yield Reduction Payment Rules

For certain limited situations, the Ex-isting Regulations permit payment ofyield reduction payments to the UnitedStates to satisfy yield restriction require-ments on certain investments. The 2007Proposed Regulations proposed to expandthese situations to permit issuers to makeyield reduction payments to cover nonpur-pose investments that an issuer purchaseson a date when the issuer is unable topurchase SLGS because the Treasury De-partment has suspended sales of SLGS.

Three commenters favored the pro-posed expansion of the availability ofyield reduction payments when SLGS areunavailable. One commenter expressedconcern that the proposed provision maynot address the circumstance in which aSLGS sale suspension is in effect when anissuer commits to purchase investments,but SLGS sales resume before settlementon that purchase. The Final Regulationsclarify that an issuer is permitted to makeyield reduction payments if it enters intoan agreement to purchase investments ona date when SLGS sales are suspended.

The commenter also recommended ex-tending the availability of yield reductionpayments to cover the circumstance inwhich an issuer is uncertain whether theTreasury Department may suspend SLGSsales in the future after an issuer has sub-scribed to purchase SLGS and before theissuance of those SLGS. Although theTreasury Department reserves full discre-tion to manage its borrowings, includingSLGS, it has been the Treasury Depart-ment’s practice to honor all outstandingSLGS subscriptions received before itsuspends SLGS sales. Accordingly, theTreasury Department and the IRS haveconcluded that yield reduction paymentsare not needed in this circumstance, andthe Final Regulations do not adopt thiscomment.

In addition, in comments regarding theproposed elimination of the Commission-er’s authority to compute a joint yield fortwo or more issues of qualified mortgagebonds or qualified student loan bonds, onecommenter requested that issuers of qual-ified student loan bonds be permitted to

make yield reduction payments for allqualified student loans, not just those un-der the FFELP. The Treasury Departmentand the IRS recognize that the ability tomake yield reduction payments for quali-fied student loans and qualified mortgageloans would provide issuers an adminis-trable alternative to the rarely used author-ity to compute a joint bond yield on issuesof such bonds. The Treasury Departmentand the IRS also recognize that these port-folio loan programs have particular ad-ministrative challenges with loan yieldcompliance due to the large number ofloans. Accordingly, in connection with theelimination of that joint bond yield au-thority under the Final Regulations, theTreasury Department and the IRS adoptthis comment and expand the availabilityof yield reduction payments to includequalified student loans and qualified mort-gage loans generally.

Commenters requested permission tomake yield reduction payments in severalother situations not provided in the Pro-posed Regulations. The Treasury Depart-ment and the IRS have concluded theseamendments are beyond the scope of thisproject and, therefore, did not addressthem in the Final Regulations (see section12 of this preamble).

B. Valuation of Investments

The Existing Regulations provideguidance on how to value investments al-located to an issue but leave some ambi-guity about when the present value andthe fair market value methods of valuationare permitted or required. The 2013 Pro-posed Regulations proposed to clarify thatthe fair market value method of valuationgenerally is required for any investmenton the date the investment is first allocatedto an issue or first ceases to be allocated toan issue as a consequence of a deemedacquisition or a deemed disposition.

The 2013 Proposed Regulations didnot propose to distinguish between pur-pose investments and nonpurpose invest-ments. One commenter urged clarificationthat purpose investments must be valuedat present value at all times. This com-menter further suggested that the rulesclearly distinguish between purpose andnonpurpose investments. The TreasuryDepartment and the IRS recognize that

purpose investments are special invest-ments that are intended to pass on thebenefits of the lower borrowing costs oftax-exempt bond financings to eligiblebeneficiaries of the particular authorizedtax-exempt bond program (for example,eligible first-time low and moderate in-come homebuyers who receive qualifiedmortgage loans financed with qualifiedmortgage bonds). Accordingly, the FinalRegulations adopt these comments.

The Existing Regulations include anexception to the mandatory fair marketvalue rule for reallocations of investmentsbetween tax-exempt bond issues as a re-sult of the transferred proceeds rule under§ 1.148–9(b) or the universal cap ruleunder § 1.148–6(b)(2). To remove a dis-incentive against retiring tax-exemptbonds with taxable bonds when the fairmarket value of the investments allocableto the tax-exempt bonds would cause in-vestment yield to exceed the tax-exemptbond yield, the 2013 Proposed Regula-tions proposed to change this exception tothe fair market value rule to require thatonly the issue from which the investmentis allocated consist of tax-exempt bonds.

Commenters generally viewed thischange favorably. One commenter sug-gested clarifying an ambiguity in the Ex-isting Regulations regarding when a real-location from one issue to another occurs“as a result of” the universal cap rule. TheFinal Regulations clarify that the excep-tion to fair market valuation for invest-ments reallocated as a result of the uni-versal cap rule applies narrowly tocircumstances in which investments aredeallocated from an issue as a result of theuniversal cap rule and are reallocated toanother issue without further action as aresult of an existing pledge of the invest-ment to the other issue (for example, apledge of investments to multiple bondissues secured by common security undera master indenture). In these circum-stances, the issuer has not structured thetransaction to benefit from the market val-uation of the nonpurpose investments.

This commenter also suggested provid-ing a safe harbor for when an issuer mayliquidate escrow investments after a tax-able refunding without concern that theCommissioner would exercise his anti-abuse authority to value the investment atfair market value. This comment is be-


yond the scope of this project (see section12 of this preamble).

Commenters also recommended broadinterpretations or expansions of the excep-tion to fair market valuation for invest-ments reallocated as a result of the uni-versal cap rule to cover various types oftransactions involving investments thatsecure a tax-exempt bond issue and thatare liquidated at a profit so long as theinvestment proceeds of the liquidated in-vestments are used to retire tax-exemptbonds early. In one representative sce-nario, an issuer using funds other thantax-exempt bond proceeds created a yield-restricted escrow fund to defease tax-exempt bonds for which it retained thecall rights. If the fair market value ofinvestments in the escrow appreciated, theissuer would issue taxable bonds and use aportion of the proceeds of the taxablebonds to redeem the tax-exempt bonds.Applying universal cap principles, the in-vestments would cease to be allocated tothe tax-exempt bonds when the tax-exempt bonds were redeemed and the in-vestments would be allocated to the tax-able refunding bonds not as a result of apre-existing pledge but as replacementproceeds. If the investments were valuedat fair market value, the yield on the es-crow would exceed the yield on the tax-exempt bonds resulting in arbitrage bonds.The bonds would not be arbitrage bonds ifthe regulations permitted these escrow in-vestments to be valued at present value atthe time of the refunding. Another sce-nario for which the commenters requestedusing the present value of investmentsrather than fair market value involves liq-uidating the appreciated investments in adefeasance escrow to redeem the tax-exempt issue rather than issuing taxablerefunding bonds.

The Treasury Department and the IRShave concerns about potential unintendedconsequences and circumvention of arbi-trage investment restrictions in these andother similar transactions. In the first sce-nario, the issuer has structured the trans-action specifically to benefit from an ap-preciation of the escrow investments in amanner inconsistent with the arbitrage re-strictions. In the second scenario, the useof present value would allow the issuer torealize the investment return in contraven-tion of the statutory requirements to take

into account any gain or loss on the dis-position of a nonpurpose investment. Ac-cordingly, except for the technical clarifi-cation of the limited application ofuniversal cap deallocations under thisrule, the Final Regulations adopt as pro-posed the revised exception to fair marketvaluation for investments reallocated as aresult of the transferred proceeds rule orthe universal cap rule.

C. Fair Market Value of TreasuryObligations

The Existing Regulations provide ageneral rule that the fair market value ofan investment is the price at which a will-ing buyer would purchase the investmentfrom a willing seller in a bona fide, arm’slength transaction. For United States Trea-sury obligations that are traded on theopen market, trading values at the time oftrades are used to establish fair marketvalues. The Existing Regulations furtherprovide a special rule, aimed primarily atnon-transferrable, non-tradable SLGS,that the fair market value of a UnitedStates Treasury obligation that is pur-chased directly from the United StatesTreasury is its purchase price. This specialrule properly indicates that the fair marketvalue of a United States Treasury obliga-tion that is purchased directly from theUnited States is its purchase price on theoriginal purchase date, but this provisionis ambiguous regarding how to determinethe fair market value of such an obligationon dates after the original purchase date.

The 2013 Proposed Regulations pro-posed to clarify that, on the original pur-chase date only, the fair market value ofsuch an obligation, including a SLGS se-curity, is its purchase price. The 2013Proposed Regulations further proposedthat, on any date other than the originalpurchase date, the fair market value of aSLGS security is its redemption price.One commenter objected to the valuationof a SLGS security at other than its pur-chase price upon a deemed acquisition ordeemed disposition. United States Trea-sury obligations other than SLGS may bepurchased and sold on the open market.SLGS, however, are nontransferable obli-gations that may be purchased or re-deemed only from the United States Trea-sury. For this reason, the 2013 Proposed

Regulations proposed that the fair marketvalue of a SLGS security on any dateother than its purchase date is the redemp-tion price determined by the United StatesTreasury under applicable regulations forthe SLGS program. The Final Regulationsadopt this change as proposed.

D. Modified Fair Market Value SafeHarbor for Guaranteed InvestmentContracts

The Existing Regulations provide asafe harbor for establishing the fair marketvalue of a guaranteed investment contract.This safe harbor generally relies on a pre-scribed bidding procedure, including re-quirements that all bidders be given anequal opportunity to bid with no opportu-nity to review other bids before providinga bid (that is, the “no last look” rule) andthat the bid specifications be provided toprospective bidders “in writing.” The2007 Proposed Regulations proposed toamend this safe harbor to accommodateelectronic bidding procedures by: (1) Per-mitting bid specifications to be sent elec-tronically over the Internet or by fax; and(2) providing that no impermissible lastlook occurs if in effect all bidders have anequal opportunity for a last look. Onecommenter noted an ambiguity in thisproposed change. In response to this com-ment, the Final Regulations clarify thatbids must be in writing and timely dissem-inated and that a writing may be in elec-tronic form and may be disseminated byfax, email, an Internet-based Web site, orother electronic medium that is similar toan Internet-based Web site and regularlyused to post bid specifications. The FinalRegulations otherwise adopt this changeas proposed.

E. External Commingled InvestmentFunds

The Existing Regulations provide cer-tain preferential rules for the treatment ofadministrative costs of certain widely heldexternal commingled funds. Under theExisting Regulations, a fund is treated aswidely held if the fund, on average, hasmore than 15 unrelated investors and eachinvestor maintains a prescribed minimumaverage investment in the fund. The 2007Proposed Regulations proposed to allow


additional smaller investors to invest in anexternal commingled fund without dis-qualifying the fund so long as at least 16unrelated investors each maintain the re-quired minimum average investment inthe fund.

One commenter suggested that the reg-ulations should require that a specifiedpercentage of the unrelated investors holda specified percentage of the daily averagevalue of the fund’s assets. The Final Reg-ulations do not adopt this comment, be-cause it is inconsistent with the purpose ofthe proposed change to enable a fund tobecome even more widely held by accom-modating an unlimited number of smallinvestors without restriction so long as atleast 16 unrelated investors each maintainthe required minimum average investmentin the fund. The commenter also sug-gested other amendments beyond thescope of this project (see section 12 of thispreamble). The Final Regulations adoptthis change as proposed.

6. Section 1.148–8 Small IssuerException to Rebate Requirement—Pooled Bonds

The 2007 Proposed Regulations pro-posed to amend the Existing Regulationsto conform to changes made to section148(f)(4)(D) by section 508 of the TaxIncrease Prevention and ReconciliationAct of 2005, Public Law 109–222, 120Stat. 345, which eliminated a rule thatpermitted a pool bond issuer to ignore itspool bond issue in computing whether ithad exceeded its $5 million limit for pur-poses of the small issuer rebate exception.The Treasury Department and the IRS re-ceived no comments regarding this pro-posed change. The Final Regulationsadopt this change as proposed.

7. Section 1.148–10 Anti-Abuse Rulesand Authority of Commissioner

The 2013 Proposed Regulations pro-posed to amend the Commissioner’s au-thority to depart from the arbitrage regu-lations when an issuer enters into atransaction for a principal purpose of ob-taining a material financial advantagebased on the difference between tax-exempt and taxable interest rates in amanner inconsistent with the purposes of

section 148, from that “necessary toclearly reflect the economic substance ofthe transaction” to that “necessary to pre-vent such financial advantage.” The 2013Proposed Regulations proposed to removethe references to “economic substance” toprevent confusion of the Commissioner’sauthority under this arbitrage anti-abuserule with the economic substance doctrineunder general federal tax principles. Nosubstantive change was intended.

Commenters suggested that this pro-posed change would give unduly broaddiscretion to the Commissioner and wouldreduce certainty of the applicability ofpublished guidance. These commentersrecommended limiting the Commission-er’s authority to that necessary “to reflectthe economics of the transaction to pre-vent such financial advantage.” The FinalRegulations adopt this comment.

8. Section 1.148–11 TransitionProvision for Certain Guarantee Funds

The Existing Regulations include atransition rule that allows certain Stateperpetual trust funds (for example, certainState permanent school funds) to pledgefunds to guarantee tax-exempt bondswithout resulting in arbitrage-restrictedreplacement proceeds. The 2013 ProposedRegulations proposed to include changesproposed in Notice 2010–5, 2010–2 IRB256, to increase the amount of tax-exemptbonds that such funds could guarantee un-der this special rule. Further, in responseto comments received on Notice 2010–5,the 2013 Proposed Regulations proposedto extend this special rule to cover certaintax-exempt bonds issued to finance publiccharter schools, which may be 501(c)(3)organizations. The Treasury Departmentand the IRS received no comments onthese proposed changes. The Final Regu-lations adopt these changes as proposed.

9. Section 1.150–1 Definitions

A. Definition of Tax-Advantaged Bonds

The 2013 Proposed Regulations pro-posed a new definition of tax-advantagedbonds. The Treasury Department and theIRS received no comments regarding thisnew definition. The Final Regulationssubstitute “tax benefit” for “subsidy” in

describing tax-advantaged bonds but oth-erwise adopt the definition as proposed.

B. Definition of Issue

The Existing Regulations provide thattax-exempt bonds and taxable bonds arenot part of the same issue. The 2013 Pro-posed Regulations proposed to clarify thattaxable tax-advantaged bonds and othertaxable bonds are part of different issuesand that different types of tax-advantagedbonds are parts of different issues. TheTreasury Department and IRS receivedone comment supporting this proposedchange and no opposing comments. TheFinal Regulations adopt this change asproposed.

C. Definition and Treatment of Grants

The 2013 Proposed Regulations pro-posed that the existing definition of grantfor arbitrage purposes applies for pur-poses of other tax-exempt bond provi-sions. The 2013 Proposed Regulationsalso proposed to clarify that the characterand nature of a grantee’s use of proceedsgenerally is taken into account in deter-mining whether arbitrage and other appli-cable requirements of the issue are met.

Commenters requested confirmationthat the proposed rule preserves the exist-ing rule that an issuer spends proceedsused for grants for purposes of the arbi-trage investment restrictions when the is-suer makes the grant to an unrelated third-party. Thus, for example, if the granteeuses the grant to reimburse its expendi-tures, the reimbursement allocation rulesdo not apply. The 2013 Proposed Regula-tions expressly proposed the special grantexpenditure rule for arbitrage purposes asan example of a specific exception to theproposed general rule. Commenters alsosuggested other amendments to the rulesfor grants that are beyond the scope of thisproject (see section 12 of this preamble).The Final Regulations adopt thesechanges as proposed.

10. Section 1.141–15 Effective Dates

The Final Regulations include certaintechnical amendments to final regulations(TD 9741) that were published in the Fed-eral Register on Tuesday, October 27,


2015 (80 FR 65637). Those final regula-tions provide guidance on allocation andaccounting rules and certain remedial ac-tions for purposes of the private activitybond restrictions under section 141 of theInternal Revenue Code that apply to tax-exempt bonds issued by State and localgovernments.

The technical amendments amend theapplicability dates to include a transitionrule for refunding bonds, provided that theweighted average maturity of the refund-ing bonds is no longer than that of therefunded bonds or, in the case of certainshort-term obligations, no longer than 120percent of the weighted average reason-ably expected economic life of the facili-ties financed. The technical amendmentsalso clarify permissive application of cer-tain provisions to outstanding bonds.

11. Revenue Procedure 97–15

Revenue Procedure 97–15, 1997–1 CB635, provides a program under which anissuer of tax-exempt bonds may request aclosing agreement with respect to out-standing bonds to prevent the interest onthose bonds from being includible in grossincome of the bondholders or beingtreated as an item of tax preference forpurposes of the alternative minimum taxas a result of an action subsequent to theissue date of the bonds that causes thebonds to fail to meet certain requirementsrelating to the use of proceeds. Notice2008–31, 2008–1 CB 592, also provides avoluntary closing agreement program fortax-exempt bonds and tax credit bonds.The scope of the violations that can beremedied under Notice 2008–31 isbroader than that under Rev. Proc. 97–15.As a result, this Treasury Decision obso-letes Rev. Proc. 97–15.

12. Comments Beyond the Scope of theProposed and Final Regulations

Commenters submitted additional sug-gestions for revisions to the Existing Reg-ulations. These suggestions include: (1)Adding a new safe harbor to prevent thecreation of replacement proceeds specifi-cally for grants and extraordinary workingcapital financings (and redefining “ex-traordinary working capital”); (2) addingnew rules for using proceeds to fund

working capital reserves; (3) providinghow an issuer should allocate certain ex-penses related to yield-to-call premiumbonds for computing yield on the issue;(4) revising the rules for determining if aninterest rate cap contains a significant in-vestment element; (5) permitting a con-duit borrower to identify a qualified hedgeon its books and records; (6) providing asafe harbor for when an issuer may liqui-date escrow investments for purposes ofvaluation of investments; (7) revising theproceeds-spent-last expenditure rule topermit financing of certain payments onhedges; (8) permitting yield reductionpayments on investments purchased to de-fease zero-coupon bonds; (9) providingyield reduction payments for a basis dif-ference under circumstances other thanthose in the Proposed Regulations; (10)exempting external comingled funds thatare operated by a government on a not-for-profit basis from the requirements foradministrative costs of such funds to beincluded in qualified administrative costsof investments; (11) establishing an eco-nomic life for grants based on the benefitof the grant to the grantor; (12) providingrules for grant repayments; and (13) ex-plaining how certain rules in the ProposedRegulations would apply to very specificfacts. These comments identify issues thatare beyond the scope of the ProposedRegulations and thus are not addressed inthe Final Regulations.

Applicability Dates

The Final Regulations generally applyto bonds that are sold on or after October17, 2016. Certain provisions related tohedges on bonds apply to hedges that areentered into or modified on or after Octo-ber 17, 2016. The Final Regulations alsopermit issuers to apply certain of theamended provisions to bonds sold beforeOctober 17, 2016. For specific dates ofapplicability, see §§ 1.141–15, 1.148–11,1.150–1, and 1.150–2.

In addition, the amendments to§ 1.148–3(j) in the Final Regulations ap-ply to bonds subject to § 1.148–3(i). Forthis purpose, a bond is considered to besubject to § 1.148–3(i) if the issue ofwhich the bond is a part is subject to theversion of § 1.148–3(i) published in TD8476 (58 FR 33510) or any subsequentversion.

Effect on Other Documents

As of October 17, 2016, Revenue Pro-cedures 95–47 and 97–15 are obsoletedand Notice 2008–41 is modified.

Special Analyses

Certain IRS regulations, including thisone, are exempt from the requirements ofExecutive Order 12866, as supplementedand reaffirmed by Executive Order 13563.Therefore, a regulatory impact assessmentis not required. It has also been deter-mined that section 553(b) of the Admin-istrative Procedure Act (5 U.S.C. chapter5) does not apply to these regulations. It ishereby certified that these regulations willnot have a significant economic impact ona substantial number of small entities.This certification is based on the fact thatthe collection of information in these reg-ulations is required for hedging transac-tions entered into primarily betweenlarger State and local governments andlarge counterparties. It is also based on thefact that the estimated recordkeeping bur-den for all issuers and counterparties isrelatively small and the reasonable costsof that burden do not constitute a signifi-cant economic impact. Accordingly, aRegulatory Flexibility Analysis under theRegulatory Flexibility Act (5 U.S.C.chapter 6) is not required. Pursuant tosection 7805(f) of the Code, the proposedregulations preceding these final regula-tions were submitted to the Chief Counselfor Advocacy of the Small Business Ad-ministration for comment on their impacton small business. No comments werereceived.

Drafting Information

The principal authors of these regula-tions are Johanna Som de Cerff, SpenceHanemann, and Lewis Bell of the Officeof Associate Chief Counsel (Financial In-stitutions and Products), IRS. However,other personnel from the Treasury Depart-ment and the IRS participated in theirdevelopment.

Availability of IRS Documents

IRS revenue procedures and noticescited in these final regulations are madeavailable by the Superintendent of Docu-


ments, U.S. Government Printing Office,Washington, DC 20402.

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 isamended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by removing the entryfor § 1.148–6 to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.141–0 is amended by:1. Revising the entry for § 1.141–

15(l)(2).2. Adding an entry for § 1.141–

15(l)(3).3. Adding an entry for § 1.141–15(n).The additions and revisions read as fol-

lows:

§ 1.141–0 Table of contents.

* * * * *

§ 1.141–15 Effective/applicability dates.

* * * * *(l) * * *(2) Refunding bonds.(3) Permissive application.* * * * *(n) Effective/applicability dates for

certain regulations relating to certain def-initions.

* * * * *Par. 3. Section 1.141–1 is amended by

revising paragraph (a) to read as follows:

§ 1.141–1 Definitions and rules ofgeneral application.

(a) In general. For purposes of§§ 1.141–0 through 1.141–16, the follow-ing definitions and rules apply: the defini-tions in this section, the definitions in§ 1.150–1, the definition of placed in ser-vice in § 1.150–2(c), the definition ofreasonably required reserve or replace-ment fund in § 1.148–2(f), and the defi-nitions in § 1.148–1 of bond year, com-mingled fund, fixed yield issue, higheryielding investments, investment, invest-ment proceeds, issue price, issuer, nonpur-

pose investment, purpose investment,qualified guarantee, qualified hedge, rea-sonable expectations or reasonableness,rebate amount, replacement proceeds, saleproceeds, variable yield issue and yield.

* * * * *Par. 4. Section 1.141–15 is amended

by:1. Redesignating paragraph (l)(2) as

(l)(3).2. Adding new paragraph (l)(2).3. Amending the first sentence of re-

designated paragraph (l)(3) by adding“Except as otherwise provided in this sec-tion,” at the beginning of the sentence andremoving the word “Issuers” and addingthe word “issuers” in its place.

4. Adding paragraph (n).The additions and revisions read as fol-

lows:


* * * * *(l) * * *(2) Refunding bonds. Except as other-

wise provided in this section, §§ 1.141–1(e), 1.141–3(g)(2)(v), 1.141–6, and1.145–2(b)(4), (5), and (c)(2) do not applyto any bonds sold on or after January 25,2016, to refund a bond to which thesesections do not apply, provided that theweighted average maturity of the refund-ing bonds is no longer than—

(i) The remaining weighted averagematurity of the refunded bonds; or

(ii) In the case of a short-term obliga-tion that the issuer reasonably expects torefund with a long-term financing (such asa bond anticipation note), 120 percent ofthe weighted average reasonably expectedeconomic life of the facilities financed.

* * * * *(n) Effective/applicability dates for

certain regulations relating to certain def-initions. § 1.141–1(a) applies to bondsthat are sold on or after October 17, 2016.

Par. 5. Section 1.148–0(c) is amendedby:

1. Revising the entry for § 1.148–2(e)(3).

2. Adding an entry for § 1.148–3(d)(4).3. Revising the entry for § 1.148–

5(d)(2).4. Revising the entry for § 1.148–8(d).5. Removing the entries for § 1.148–

8(d)(1) and (2).

6. Revising the entry for § 1.148–10(e).

7. Adding entries for § 1.148–11(k).8. Revising the entries for § 1.148–

11(l).The revisions and additions read as fol-

lows:

§ 1.148–0 Scope and table of contents.

* * * * *(c) * * *

§ 1.148–2 General arbitrage yieldrestriction rules.

* * * * *(e) * * *(3) Temporary period for working cap-

ital expenditures.* * * * *

§ 1.148–3 General arbitrage rebaterules.

* * * * *(d) * * *(4) Cost-of-living adjustment.* * * * *

§ 1.148–5 Yield and valuation ofinvestments.

* * * * *(d) * * *(2) Mandatory valuation of certain

yield restricted investments at presentvalue.

* * * * *

§ 1.148–8 Small issuer exception torebate requirement.

* * * * *(d) Pooled financings—treatment of

conduit borrowers.* * * * *

§ 1.148–10 Anti-abuse rules andauthority of Commissioner.

* * * * *(e) Authority of the Commissioner to

prevent transactions that are inconsistentwith the purpose of the arbitrage invest-ment restrictions.

* * * * *



* * * * *(k) Certain arbitrage guidance updates.(1) In general.(2) Valuation of investments in refund-

ing transactions.(3) Rebate overpayment recovery.(4) Hedge identification.(5) Hedge modifications and termina-

tion.(6) Small issuer exception to rebate

requirement for conduit borrowers ofpooled financings.

(l) Permissive application of certain ar-bitrage updates.

(1) In general.(2) Computation credit.(3) Yield reduction payments.(4) External commingled funds.Par. 6. Section 1.148–1 is amended by:1. Revising paragraph (c)(4)(i)(B)(1).2. Removing the “or” at the end of

paragraph (c)(4)(i)(B)(2).3. Removing the period at the end of

paragraph (c)(4)(i)(B)(3) and adding in itsplace a semicolon and the word “or”.

4. Adding paragraph (c)(4)(i)(B)(4).5. Revising paragraph (c)(4)(ii).The revisions and additions read as fol-

lows:

§ 1.148–1 Definitions and elections.

* * * * *(c) * * *(4) * * *(i) * * *(B) * * *(1) For the portion of an issue that is to

be used to finance working capital expen-ditures, if that portion is not outstandinglonger than the temporary period under§ 1.148–2(e)(3) for which the proceedsqualify;

* * * * *(4) For the portion of an issue (includ-

ing a refunding issue) that is to be used tofinance working capital expenditures, ifthat portion satisfies paragraph (c)(4)(ii)of this section.

(ii) Safe harbor for longer-term work-ing capital financings. A portion of anissue used to finance working capitalexpenditures satisfies this paragraph(c)(4)(ii) if the issuer meets the require-

ments of paragraphs (c)(4)(ii)(A) through(E) of this section.

(A) Determine first testing year. On theissue date, the issuer must determine thefirst fiscal year following the applicabletemporary period under § 1.148–2(e) inwhich it reasonably expects to have avail-able amounts (first testing year), but in noevent can the first day of the first testingyear be later than five years after the issuedate.

(B) Application of available amount toreduce burden on tax-exempt bond mar-ket. Beginning with the first testing yearand for each subsequent fiscal year forwhich the portion of the issue that is thesubject of this safe harbor remains out-standing, the issuer must determine theavailable amount as of the first day ofeach fiscal year. Then, except as providedin paragraph (c)(4)(ii)(D) of this section,within the first 90 days of that fiscal year,the issuer must apply that amount (or ifless, the available amount on the date ofthe required redemption or investment) toredeem or to invest in eligible tax-exemptbonds (as defined in paragraph(c)(4)(ii)(E) of this section). For this pur-pose, available amounts in a bona fidedebt service fund are not treated as avail-able amounts.

(C) Continuous investment require-ment. Except as provided in this paragraph(c)(4)(ii)(C), any amounts invested in eli-gible tax-exempt bonds under paragraph(c)(4)(ii)(B) of this section must be in-vested continuously in such tax-exemptbonds to the extent provided in paragraph(c)(4)(ii)(D) of this section.

(1) Exception for reinvestment period.Amounts previously invested in eligibletax-exempt bonds under paragraph(c)(4)(ii)(B) of this section that are heldfor not more than 30 days in a fiscal yearpending reinvestment in eligible tax-exempt bonds are treated as invested ineligible tax-exempt bonds.

(2) Limited use of invested amounts.An issuer may spend amounts previouslyinvested in eligible tax-exempt bonds un-der paragraph (c)(4)(ii)(B) of this sectionwithin 30 days of the date on which theycease to be so invested to make expendi-tures for a governmental purpose on anydate on which the issuer has no otheravailable amounts for such purpose, or toredeem eligible tax-exempt bonds.

(D) Cap on applied or investedamounts. The maximum amount that anissuer is required to apply under para-graph (c)(4)(ii)(B) of this section or toinvest continuously under paragraph(c)(4)(ii)(C) of this section with respect tothe portion of an issue that is the subjectof this safe harbor is the outstanding prin-cipal amount of such portion. For pur-poses of this cap, an issuer receives credittowards its requirement to invest availableamounts in eligible tax-exempt bonds foramounts previously invested under para-graph (c)(4)(ii)(B) of this section that re-main continuously invested under para-graph (c)(4)(ii)(C) of this section.

(E) Definition of eligible tax-exemptbonds. For purposes of paragraph(c)(4)(ii) of this section, eligible tax-exempt bonds means any of the following:

(1) A bond the interest on which isexcludable from gross income under sec-tion 103 and that is not a specified privateactivity bond (as defined in section57(a)(5)(C)) subject to the alternativeminimum tax;

(2) An interest in a regulated invest-ment company to the extent that at least95 percent of the income to the holder ofthe interest is interest on a bond that isexcludable from gross income under sec-tion 103 and that is not interest on a spec-ified private activity bond (as defined insection 57(a)(5)(C)) subject to the alterna-tive minimum tax; or

(3) A certificate of indebtedness issuedby the United States Treasury pursuant tothe Demand Deposit State and Local Gov-ernment Series program described in 31CFR part 344.

* * * * *Par. 7. Section 1.148–2 is amended by

revising the heading of paragraph (e)(3)and revising paragraph (e)(3)(i) to read asfollows:

§ 1.148–2 General arbitrage yieldrestriction rules.

* * * * *(e) * * *(3) Temporary period for working cap-

ital expenditures—(i) General rule. Theproceeds of an issue that are reasonablyexpected to be allocated to working capi-tal expenditures within 13 months afterthe issue date qualify for a temporary pe-


riod of 13 months beginning on the issuedate. Paragraph (e)(2) of this section con-tains additional temporary period rules forcertain working capital expenditures thatare treated as part of a capital project.

* * * * *Par. 8. Section 1.148–3 is amended by:1. Revising paragraph (d)(1)(iv).2. Adding paragraph (d)(4).3. Revising Example 2(iii)(D) of para-

graph (j).The revisions and addition read as fol-

lows:

§ 1.148–3 General arbitrage rebaterules.

* * * * *(d) * * *(1) * * *(iv) On the last day of each bond year

during which there are amounts allocatedto gross proceeds of an issue that aresubject to the rebate requirement, and onthe final maturity date, a computationcredit of $1,400 for any bond year endingin 2007 and, for bond years ending after2007, a computation credit in the amountdetermined under paragraph (d)(4) of thissection; and

* * * * *(4) Cost-of-living adjustment. For any

calendar year after 2007, the $1,400 com-putation credit set forth in paragraph(d)(1)(iv) of this section shall be increasedby an amount equal to such dollar amountmultiplied by the cost-of-living adjust-ment determined under section 1(f)(3) forsuch year, as modified by this paragraph(d)(4). In applying section 1(f)(3) to de-termine this cost-of-living adjustment, thereference to “calendar year 1992” in sec-tion 1(f)(3)(B) shall be changed to “cal-endar year 2006.” If any such increasedetermined under this paragraph (d)(4) isnot a multiple of $10, such increase shallbe rounded to the nearest multiple thereof.

* * * * *(j) * * *Example 2. * * *

(iii) * * *(D) If the yield during the second com-

putation period were, instead, 7.0000 per-cent, the rebate amount computed as ofJuly 1, 2004, would be $1,320,891. Thefuture value of the payment made on July1, 1999, would be $1,471,007. Although

the future value of the payment made onJuly 1, 1999 ($1,471,007), exceeds therebate amount computed as of July 1,2004 ($1,320,891), § 1.148–3(i) limits theamount recoverable as a defined overpay-ment of rebate under section 148 to theexcess of the total “amount paid” overthe sum of the amount determined underthe future value method to be the “rebateamount” as of the most recent computa-tion date and all other amounts that areotherwise required to be paid under sec-tion 148 as of the date the recovery isrequested. Because the total amount thatthe issuer paid on July 1, 1999($1,042,824.60), does not exceed the re-bate amount as of July 1, 2004($1,320,891), the issuer would not be en-titled to recover any overpayment of re-bate in this case.

* * * * *Par. 9. Section 1.148–4 is amended by:1. Revising paragraph (a).2. Revising paragraph (b)(3)(i).3. Adding two sentences at the end of

paragraph (h)(2)(ii)(A).4. Revising the heading and introduc-

tory text of paragraph (h)(2)(v).5. Revising the last sentence of para-

graph (h)(2)(v)(B).6. Adding a sentence at the end of

paragraph (h)(2)(vi).7. Revising paragraph (h)(2)(viii).8. Revising paragraph (h)(3)(iv)(A).9. Redesignating paragraphs (h)(3)(iv)

(B) through (E) as paragraphs (h)(3)(iv)(E) through (H) respectively.

10. Adding new paragraphs (h)(3)(iv)(B), (C), and (D).

11. Revising newly redesignated para-graph (h)(3)(iv)(E).

12. Revising the first sentence in newlyredesignated paragraph (h)(3)(iv)(F).

13. Revising newly redesignated para-graph (h)(3)(iv)(G).

14. Revising the first sentence in newlyredesignated paragraph (h)(3)(iv)(H).

15. Adding a sentence at the end ofparagraph (h)(4)(i)(C).

16. Adding paragraphs (h)(4)(i)(C)(1)and (2).

17. Adding paragraph (h)(4)(iv).The revisions and additions read as fol-

lows:

§ 1.148–4 Yield on an issue of bonds.

(a) In general. The yield on an issue ofbonds is used to apply investment yieldrestrictions under section 148(a) and tocompute rebate liability under section148(f). Yield is computed under the eco-nomic accrual method using any consis-tently applied compounding interval ofnot more than one year. A short first com-pounding interval and a short last com-pounding interval may be used. Yield isexpressed as an annual percentage ratethat is calculated to at least four decimalplaces (for example, 5.2525 percent).Other reasonable, standard financial con-ventions, such as the 30 days per month/360 days per year convention, may beused in computing yield but must be con-sistently applied. The yield on an issuethat would be a purpose investment (ab-sent section 148(b)(3)(A)) is equal to theyield on the conduit financing issue thatfinanced that purpose investment.

(b) * * *(3) Yield on certain fixed yield bonds

subject to optional early redemption—(i)In general. If a fixed yield bond is subjectto optional early redemption and is de-scribed in paragraph (b)(3)(ii) of this sec-tion, the yield on the issue containing thebond is computed by treating the bond asredeemed at its stated redemption price onthe optional redemption date that wouldproduce the lowest yield on that bond.

* * * * *(h) * * *(2) * * *(ii) * * *(A) * * * Solely for purposes of deter-

mining if a hedge is a qualified hedge underthis section, payments that an issuer receivespursuant to the terms of a hedge that areequal to the issuer’s cost of funds are treatedas periodic payments under § 1.446–3 with-out regard to whether the payments are cal-culated by reference to a “specified index”described in § 1.446–3(c)(2). Accordingly,a hedge does not have a significant invest-ment element under this paragraph(h)(2)(ii)(A) solely because an issuer re-ceives payments pursuant to the terms of ahedge that are computed to be equal to theissuer’s cost of funds, such as the issuer’sactual market-based tax-exempt variable in-terest rate on its bonds.

* * * * *


(v) Interest-based contract and sizeand scope of hedge. The contract is pri-marily interest-based (for example, ahedge based on a debt index, including atax-exempt debt index or a taxable debtindex, rather than an equity index). Inaddition, the size and scope of the hedgeunder the contract is limited to that whichis reasonably necessary to hedge the issu-er’s risk with respect to interest ratechanges on the hedged bonds. For exam-ple, a contract is limited to hedging anissuer’s risk with respect to interest ratechanges on the hedged bonds if the hedgeis based on the principal amount and thereasonably expected interest payments ofthe hedged bonds. For anticipatory hedgesunder paragraph (h)(5) of this section, thesize and scope limitation applies based onthe reasonably expected terms of thehedged bonds to be issued. A contract isnot primarily interest based unless—

* * * * *(B) * * * For this purpose, differences

that would not prevent the resulting bondfrom being substantially similar to anothertype of bond include: a difference be-tween the interest rate used to computepayments on the hedged bond and theinterest rate used to compute payments onthe hedge where one interest rate is sub-stantially similar to the other; the differ-ence resulting from the payment of a fixedpremium for a cap (for example, paymentsfor a cap that are made in other than levelinstallments); and the difference resultingfrom the allocation of a termination pay-ment where the termination was not ex-pected as of the date the contract wasentered into.

(vi) * * * For this purpose, such pay-ments will be treated as correspondingclosely in time under this paragraph(h)(2)(vi) if they are made within 90 cal-endar days of each other.

* * * * *(viii) Identification—(A) In general.

The actual issuer must identify the con-tract on its books and records maintainedfor the hedged bonds not later than 15calendar days after the date on whichthere is a binding agreement to enter intoa hedge contract (for example, the date ofa hedge pricing confirmation, as distin-guished from the closing date for thehedge or start date for payments on thehedge, if different). The identification

must specify the name of the hedge pro-vider, the terms of the contract, thehedged bonds, and include a hedge pro-vider’s certification as described in para-graph (h)(2)(viii)(B) of this section. Theidentification must contain sufficient de-tail to establish that the requirements ofthis paragraph (h)(2) and, if applicable,paragraph (h)(4) of this section are satis-fied. In addition, the existence of thehedge must be noted on the first formrelating to the issue of which the hedgedbonds are a part that is filed with theInternal Revenue Service on or after thedate on which the contract is identifiedpursuant to this paragraph (h)(2)(viii).

(B) Hedge provider’s certification. Thehedge provider’s certification must—

(1) Provide that the terms of the hedgewere agreed to between a willing buyerand willing seller in a bona fide, arm’s-length transaction;

(2) Provide that the hedge provider hasnot made, and does not expect to make,any payment to any third party for thebenefit of the issuer in connection with thehedge, except for any such third-partypayment that the hedge provider expresslyidentifies in the documents for the hedge;

(3) Provide that the amounts payable tothe hedge provider pursuant to the hedgedo not include any payments for under-writing or other services unrelated to thehedge provider’s obligations under thehedge, except for any such payment thatthe hedge provider expressly identifies inthe documents for the hedge; and

(4) Contain any other statements thatthe Commissioner may provide in guid-ance published in the Internal RevenueBulletin. See § 601.601(d)(2)(ii) of thischapter.

(3) * * *(iv) Accounting for modifications and

terminations—(A) Modification defined.A modification of a qualified hedge in-cludes, without limitation, a change in theterms of the hedge or an issuer’s acquisi-tion of another hedge with terms that havethe effect of modifying an issuer’s risk ofinterest rate changes or other terms of anexisting qualified hedge. For example, ifthe issuer enters into a qualified hedge thatis an interest rate swap under which itreceives payments based on the SecuritiesIndustry and Financial Market Associa-tion (SIFMA) Municipal Swap Index and

subsequently enters a second hedge (withthe same or different provider) that limitsthe issuer’s exposure under the existingqualified hedge to variations in theSIFMA Municipal Swap Index, the newhedge modifies the qualified hedge.

(B) Termination defined. A terminationmeans either an actual termination or adeemed termination of a qualified hedge.Except as otherwise provided, an actualtermination of a qualified hedge occurs tothe extent that the issuer sells, disposes of,or otherwise actually terminates all or aportion of the hedge. A deemed termina-tion of a qualified hedge occurs if thehedge ceases to meet the requirements fora qualified hedge; the issuer makes a mod-ification (as defined in paragraph(h)(3)(iv)(A) of this section) that is mate-rial either in kind or in extent and, there-fore, results in a deemed exchange of thehedge and a realization event to the issuerunder section 1001; or the issuer redeemsall or a portion of the hedged bonds.

(C) Special rules for certain modifica-tions when the hedge remains qualified. Amodification of a qualified hedge that oth-erwise would result in a deemed termina-tion under paragraph (h)(3)(iv)(B) of thissection does not result in such a termina-tion if the modified hedge is re-tested forqualification as a qualified hedge as of thedate of the modification, the modifiedhedge meets the requirements for a qual-ified hedge as of such date, and the mod-ified hedge is treated as a qualified hedgeprospectively in determining the yield onthe hedged bonds. For purposes of thisparagraph (h)(3)(iv)(C), when determin-ing whether the modified hedge is quali-fied, the fact that the existing qualifiedhedge is off-market as of the date of themodification is disregarded and the iden-tification requirement in paragraph(h)(2)(viii) of this section applies by mea-suring the time period for identificationfrom the date of the modification andwithout regard to the requirement for ahedge provider’s certification.

(D) Continuations of certain qualifiedhedges in refundings. If hedged bonds areredeemed using proceeds of a refundingissue, the qualified hedge for the refundedbonds is not actually terminated, and thehedge meets the requirements for a qual-ified hedge for the refunding bonds as ofthe issue date of the refunding bonds, then


no termination of the hedge occurs and thehedge instead is treated as a qualifiedhedge for the refunding bonds. For pur-poses of this paragraph (h)(3)(iv)(D),when determining whether the hedge is aqualified hedge for the refunding bonds,the fact that the hedge is off-market withrespect to the refunding bonds as of theissue date of the refunding bonds is disre-garded and the identification requirementin paragraph (h)(2)(viii) of this sectionapplies by measuring the time period foridentification from the issue date of therefunding bonds and without regard to therequirement for a hedge provider’s certi-fication.

(E) General allocation rules for hedgetermination payments. Except as other-wise provided in paragraphs (h)(3)(iv)(F),(G), and (H) of this section, a paymentmade or received by an issuer to terminatea qualified hedge, or a payment deemedmade or received for a deemed termina-tion, is treated as a payment made or re-ceived, as appropriate, on the hedgedbonds. Upon an actual termination or adeemed termination of a qualified hedge,the amount that an issuer may treat as atermination payment made or received onthe hedged bonds is the fair market valueof the qualified hedge on its terminationdate, based on all of the facts and circum-stances. Except as otherwise provided, atermination payment is reasonably allo-cated to the remaining periods originallycovered by the terminated hedge in a man-ner that reflects the economic substance ofthe hedge.

(F) Special rule for terminations whenbonds are redeemed. Except as otherwiseprovided in this paragraph (h)(3)(iv)(F)and in paragraph (h)(3)(iv)(G) of this sec-tion, when a qualified hedge is deemedterminated because the hedged bonds areredeemed, the termination payment as de-termined under paragraph (h)(3)(iv)(E) ofthis section is treated as made or receivedon that date. * * *

(G) Special rules for refundings. Whenthere is a termination of a qualified hedgebecause there is a refunding of the hedgedbonds, to the extent that the hedged bondsare redeemed using the proceeds of a re-funding issue, the termination payment isaccounted for under paragraph(h)(3)(iv)(E) of this section by treating itas a payment on the refunding issue,

rather than the hedged bonds. In addition,to the extent that the refunding issue isredeemed during the period to which thetermination payment has been allocated tothat issue, paragraph (h)(3)(iv)(F) of thissection applies to the termination paymentby treating it as a payment on the re-deemed refunding issue.

(H) Safe harbor for allocation of cer-tain termination payments. A payment toterminate a qualified hedge does not resultin that hedge failing to satisfy the appli-cable provisions of paragraph (h)(3)(iv)(E) of this section if that payment is allo-cated in accordance with this paragraph(h)(3)(iv)(H). * * *

(4) * * *(i) * * *(C) * * * A hedge based on a taxable

interest rate or taxable interest index can-not meet the requirements of this para-graph (h)(4)(i)(C) unless either—

(1) The hedge is an anticipatory hedgethat is terminated or otherwise closed sub-stantially contemporaneously with the is-suance of the hedged bond in accordancewith paragraph (h)(5)(ii) or (iii) of thissection; or

(2) The issuer’s payments on thehedged bonds and the hedge provider’spayments on the hedge are based on iden-tical interest rates.

* * * * *(iv) Consequences of certain modifica-

tions. The special rules under paragraph(h)(4)(iii) of this section regarding the ef-fects of termination of a qualified hedge offixed yield hedged bonds apply to a mod-ification described in paragraph(h)(3)(iv)(C) of this section. Thus, such amodification is treated as a termination forpurposes of paragraph (h)(4)(iii) of thissection unless the rule in paragraph(h)(4)(iii)(C) applies.


by:1. Revising paragraph (c)(3).2. Revising paragraphs (d)(2) and (3).3. Revising the last sentence in para-

graph (d)(6)(i) and adding a sentence atthe end of the paragraph.

4. Revising paragraphs (d)(6)(iii)(A)(1) and (6).

5. Revising the second sentence ofparagraph (e)(2)(ii)(B).

The revisions and additions read as fol-lows:

§ 1.148–5 Yield and valuation ofinvestments.

* * * * *(c) * * *(3) Applicability of special yield reduc-

tion rule. Paragraph (c) applies only toinvestments that are described in at leastone of paragraphs (c)(3)(i) through (ix) ofthis section and, except as otherwise ex-pressly provided in paragraphs (c)(3)(i)through (ix) of this section, that are allo-cated to proceeds of an issue other thangross proceeds of an advance refundingissue.

(i) Nonpurpose investments allocatedto proceeds of an issue that qualified forcertain temporary periods. Nonpurposeinvestments allocable to proceeds of anissue that qualified for one of the tempo-rary periods available for capital projects,working capital expenditures, pooled fi-nancings, or investment proceeds under§ 1.148–2(e)(2), (3), (4), or (6), respec-tively.

(ii) Investments allocable to certainvariable yield issues. Investments alloca-ble to a variable yield issue during anycomputation period in which at least 5percent of the value of the issue is repre-sented by variable yield bonds, unless theissue is an issue of hedge bonds (as de-fined in section 149(g)(3)(A)).

(iii) Nonpurpose investments allocableto certain transferred proceeds. Nonpur-pose investments allocable to transferredproceeds of—

(A) A current refunding issue to theextent necessary to reduce the yield onthose investments to satisfy yield restric-tions under section 148(a); or

(B) An advance refunding issue to theextent that investment of the refundingescrows allocable to the proceeds, otherthan transferred proceeds, of the refundingissue in zero-yielding nonpurpose invest-ments is insufficient to satisfy yield re-strictions under section 148(a).

(iv) Purpose investments allocable toqualified student loans and qualified mort-gage loans. Purpose investments allocableto qualified student loans and qualifiedmortgage loans.


(v) Nonpurpose investments allocableto gross proceeds in certain reserve funds.Nonpurpose investments allocable togross proceeds of an issue in a reasonablyrequired reserve or replacement fund or afund that, except for its failure to satisfythe size limitation in § 1.148–2(f)(2)(ii),would qualify as a reasonably requiredreserve or replacement fund, but only tothe extent the requirements in paragraphs(c)(3)(v)(A) or (B) of this section are met.This paragraph (c)(3)(v) includes nonpur-pose investments described in this para-graph that are allocable to transferred pro-ceeds of an advance refunding issue, butonly to the extent necessary to satisfyyield restriction under section 148(a) onthose proceeds treating all investments al-locable to those proceeds as a separateclass.

(A) The value of the nonpurpose in-vestments in the fund is not greater than15 percent of the stated principal amountof the issue, as computed under § 1.148–2(f)(2)(ii).

(B) The amounts in the fund (otherthan investment earnings) are not reason-ably expected to be used to pay debt ser-vice on the issue other than in connectionwith reductions in the amount required tobe in that fund (for example, a reservefund for a revolving fund loan program).

(vi) Nonpurpose investments allocableto certain replacement proceeds of re-funded issues. Nonpurpose investmentsallocated to replacement proceeds of arefunded issue, including a refunded issuethat is an advance refunding issue, as aresult of the application of the universalcap to amounts in a refunding escrow.

(vii) Investments allocable to replace-ment proceeds under a certain transitionrule. Investments described in § 1.148–11(f).

(viii) Nonpurpose investments alloca-ble to proceeds when State and LocalGovernment Series Securities are unavail-able. Nonpurpose investments allocableto proceeds of an issue, including an ad-vance refunding issue, that an issuer pur-chases if, on the date the issuer enters intothe agreement to purchase such invest-ments, the issuer is unable to subscribe forState and Local Government Series Secu-rities because the U.S. Department of theTreasury, Bureau of the Fiscal Service,has suspended sales of those securities.

(ix) Nonpurpose investments allocableto proceeds of certain variable yield ad-vance refunding issues. Nonpurpose in-vestments allocable to proceeds of theportion of a variable yield issue used foradvance refunding purposes that are de-posited in a yield restricted defeasanceescrow if—

(A) The issuer has entered into a qual-ified hedge under § 1.148–4(h)(2) withrespect to all of the variable yield bonds ofthe issue allocable to the yield restricteddefeasance escrow and that hedge is in theform of a variable-to-fixed interest rateswap under which the issuer pays thehedge provider a fixed interest rate andreceives from the hedge provider a float-ing interest rate;

(B) Such qualified hedge covers a pe-riod beginning on the issue date of thehedged bonds and ending on or afterthe date on which the final payment is tobe made from the yield restricted defea-sance escrow; and

(C) The issuer restricts the yield on theyield restricted defeasance escrow to ayield that is not greater than the yield onthe issue, determined by taking into ac-count the issuer’s fixed payments to bemade under the hedge and by assumingthat the issuer’s variable yield paymentsto be paid on the hedged bonds are equalto the floating payments to be receivedby the issuer under the qualified hedgeand are paid on the same dates (that is,such yield reduction payments can only bemade to address basis risk differences be-tween the variable yield payments on thehedged bonds and the floating paymentsreceived on the hedge).

* * * * *(d) * * *(2) Mandatory valuation of certain

yield restricted investments at presentvalue. A purpose investment must be val-ued at present value, and except as other-wise provided in paragraphs (b)(3) and(d)(3) of this section, a yield restrictednonpurpose investment must be valued atpresent value.

(3) Mandatory valuation of certain in-vestments at fair market value—(i) Ingeneral. Except as otherwise provided inparagraphs (d)(3)(ii) and (d)(4) of thissection, a nonpurpose investment must bevalued at fair market value on the date thatit is first allocated to an issue or first

ceases to be allocated to an issue as aconsequence of a deemed acquisition ordeemed disposition. For example, if anissuer deposits existing nonpurpose in-vestments into a sinking fund for an issue,those investments must be valued at fairmarket value as of the date first depositedinto the fund.

(ii) Exception to fair market value re-quirement for transferred proceeds allo-cations, certain universal cap allocations,and commingled funds. Paragraph(d)(3)(i) of this section does not apply ifthe investment is allocated from one issueto another as a result of the transferredproceeds allocation rule under § 1.148–9(b) or is deallocated from one issue as aresult of the universal cap rule under§ 1.148–6(b)(2) and reallocated to an-other issue as a result of a preexistingpledge of the investment to secure thatother issue, provided that, in either cir-cumstance (that is, transferred proceedsallocations or universal cap dealloca-tions), the issue from which the invest-ment is allocated (that is, the first issue inan allocation from one issue to anotherissue) consists of tax-exempt bonds. Inaddition, paragraph (d)(3)(i) of this sec-tion does not apply to investments in acommingled fund (other than a bona fidedebt service fund) unless it is an invest-ment being initially deposited in or with-drawn from a commingled fund describedin § 1.148–6(e)(5)(iii).

* * * * *(6) * * *(i) * * * On the purchase date, the fair

market value of a United States Treasuryobligation that is purchased directly fromthe United States Treasury, including aState and Local Government Series Secu-rity, is its purchase price. The fair marketvalue of a State and Local GovernmentSeries Security on any date other than thepurchase date is the redemption price forredemption on that date.

* * * * *(iii) * * *(A) * * *(1) The bid specifications are in writing

and are timely disseminated to potentialproviders. For purposes of this paragraph(d)(6)(iii)(A)(1), a writing may be in elec-tronic form and may be disseminated byfax, email, an internet-based Web site, orother electronic medium that is similar to


an internet-based Web site and regularlyused to post bid specifications.

* * * * *(6) All potential providers have an

equal opportunity to bid. If the biddingprocess affords any opportunity for a po-tential provider to review other bids be-fore providing a bid, then providers havean equal opportunity to bid only if allpotential providers have an equal oppor-tunity to review other bids. Thus, no po-tential provider may be given an opportu-nity to review other bids that is notequally given to all potential providers(that is, no exclusive “last look”).

* * * * *(e) * * *(2) * * *(ii) * * *(B) * * * For purposes of this para-

graph (e)(2)(ii)(B), a fund is treated aswidely held only if, during the immedi-ately preceding fixed, semiannual periodchosen by the fund (for example, semian-nual periods ending June 30 and Decem-ber 31), the fund had a daily average ofmore than 15 investors that were not re-lated parties, and at least 16 of the unre-lated investors each maintained a dailyaverage amount invested in the fund thatwas not less than the lesser of $500,000and one percent (1%) of the daily averageof the total amount invested in the fund(with it being understood that additionalsmaller investors will not disqualify thefund). * * *


by:1. Revising the second sentence of

paragraph (d)(3)(iii)(A).2. Removing paragraph (d)(4)(iii).The revision reads as follows:

§ 1.148–6 General allocation andaccounting rules.

* * * * *(d) * * *(3) * * *(iii) * * *(A) * * * Except as otherwise pro-

vided, available amount excludes pro-ceeds of any issue but includes cash, in-vestments, and other amounts held inaccounts or otherwise by the issuer or arelated party if those amounts may be

used by the issuer for working capitalexpenditures of the type being financed byan issue without legislative or judicial ac-tion and without a legislative, judicial, orcontractual requirement that thoseamounts be reimbursed.

* * * * *Par. 12. Section 1.148–7 is revised by:1. Revising paragraph (c)(3)(v).2. Revising paragraph (i)(6)(ii).The revisions read as follows:

§ 1.148–7 Spending exceptions to therebate requirement.

* * * * *(c) * * *(3) * * *(v) Representing repayments of grants

(as defined in § 1.150–1(f)) financed bythe issue.

* * * * *(i) * * *(6) * * *(ii) Repayments of grants (as defined in

§ 1.150–1(f)) financed by the issue.* * * * *Par. 13. Section 1.148–8(d) is revised

to read as follows:

§ 1.148–8 Small issuer exception torebate requirement.

* * * * *(d) Pooled financings—treatment of

conduit borrowers. A loan to a conduitborrower in a pooled financing qualifiesfor the small issuer exception, regardlessof the size of either the pooled financingor of any loan to other conduit borrowers,only if—

(1) The bonds of the pooled financingare not private activity bonds;

(2) None of the loans to conduit bor-rowers are private activity bonds; and

(3) The loan to the conduit borrowermeets all the requirements of the smallissuer exception.


by:1. Revising the last sentence of para-

graph (a)(4).2. Revising the heading and first sen-

tence of paragraph (e).The revisions read as follows:

§ 1.148–10 Anti-abuse rules andauthority of Commissioner.

(a) * * *(4) * * * These factors may be out-

weighed by other factors, such as bonafide cost underruns, an issuer’s bona fideneed to finance extraordinary workingcapital items, or an issuer’s long-term fi-nancial distress.

* * * * *(e) Authority of the Commissioner to

prevent transactions that are inconsistentwith the purpose of the arbitrage invest-ment restrictions. If an issuer enters into atransaction for a principal purpose of ob-taining a material financial advantagebased on the difference between tax-exempt and taxable interest rates in amanner that is inconsistent with the pur-poses of section 148, the Commissionermay exercise the Commissioner’s discre-tion to depart from the rules of § 1.148–1through § 1.148–11 as necessary to reflectthe economics of the transaction to pre-vent such financial advantage. * * *


by:1. Redesignating paragraphs (d)(1)(i),

(ii), (iii), (iv), (v), and (vi) as paragraphs(d)(1)(i)(A), (B), (C), (D), (E), and (F),respectively.

2. Revising the heading of paragraph(d)(1) and adding introductory text toparagraph (d)(1)(i).

3. Revising newly redesignated para-graphs (d)(1)(i)(B), (D), and (F).

4. Adding new paragraph (d)(1)(ii).5. Adding paragraph (k).6. Revising paragraph (l).The revisions and additions read as fol-

lows:


* * * * *(d) * * *(1) Certain perpetual trust funds—(i)

A guarantee by a fund created and con-trolled by a State and established pursuantto its constitution does not cause theamounts in the fund to be pledged fundstreated as replacement proceeds if—

* * * * *(B) The corpus of the guarantee fund

may be invaded only to support specifi-


cally designated essential governmentalfunctions (designated functions) carriedon by political subdivisions with generaltaxing powers or public elementary andpublic secondary schools;

* * * * *(D) The issue guaranteed consists of

obligations that are not private activitybonds (other than qualified 501(c)(3)bonds) substantially all of the proceeds ofwhich are to be used for designated func-tions;

* * * * *(F) As of the sale date of the bonds to

be guaranteed, the amount of the bonds tobe guaranteed by the fund plus the then-outstanding amount of bonds previouslyguaranteed by the fund does not exceed atotal amount equal to 500 percent of thetotal costs of the assets held by the fund asof December 16, 2009.

(ii) The Commissioner may, by pub-lished guidance, set forth additional cir-cumstances under which guarantees bycertain perpetual trust funds will not causeamounts in the fund to be treated as re-placement proceeds.

* * * * *(k) Certain arbitrage guidance up-

dates—(1) In general. Sections 1.148–1(c)(4)(i)(B)(1); 1.148–1(c)(4)(i)(B)(4);1.148–1(c)(4)(ii); 1.148–2(e)(3)(i); 1.148–3(d)(1)(iv); 1.148–3(d)(4); 1.148–4(a);1.148–4(b)(3)(i); 1.148–4(h)(2)(ii)(A);1.148–4(h)(2)(v); 1.148–4(h)(2)(vi);1.148(h)(4)(i)(C); 1.148–5(c)(3); 1.148–5(d)(2); 1.148–5(d)(3); 1.148–5(d)(6)(i);1.148–5(d)(6)(iii)(A); 1.148–5(e)(2)(ii)(B);1.148–6(d)(4); 1.148 –7(c)(3)(v); 1.148 –7(i)(6)(ii); 1.148 –10(a)(4); 1.148 –10(e); 1.148 –11(d)(1)(i)(B); 1.148 –11(d)(1)(i)(D); 1.148 –11(d)(1)(i)(F);and 1.148 –11(d)(1)(ii) apply to bondssold on or after October 17, 2016.

(2) Valuation of investments in refund-ing transactions. Section 1.148–5(d)(3)also applies to bonds refunded by bondssold on or after October17, 2016.

(3) Rebate overpayment recovery. (i)Section 1.148–3(i)(3)(i) applies to claimsarising from an issue of bonds to which§ 1.148–3(i) applies and for which thefinal computation date is after June 24,2008. For purposes of this paragraph(k)(3)(i), issues for which the actual finalcomputation date is on or before June 24,2008, are deemed to have a final compu-

tation date of July 1, 2008, for purposes ofapplying § 1.148–3(i)(3)(i).

(ii) Section 1.148–3(i)(3)(ii) and (iii)apply to claims arising from an issue ofbonds to which § 1.148–3(i) applies andfor which the final computation date isafter September 16, 2013.

(iii) Section 1.148–3(j) applies tobonds subject to § 1.148–3(i).

(4) Hedge identification. Section1.148–4(h)(2)(viii) applies to hedges thatare entered into on or after October 17,2016.

(5) Hedge modifications and termina-tion. Section 1.148–4(h)(3)(iv)(A)through (H) and (h)(4)(iv) apply to—

(i) Hedges that are entered into on orafter October 17, 2016;

(ii) Qualified hedges that are modifiedon or after October 17, 2016, with respectto modifications on or after such date; and

(iii) Qualified hedges on bonds that arerefunded on or after October 17, 2016,with respect to the refunding on or aftersuch date.

(6) Small issuer exception to rebaterequirement for conduit borrowers ofpooled financings. Section 1.148–8(d) ap-plies to bonds issued after May 17, 2006.

(l) Permissive application of certainarbitrage updates—(1) In general. Exceptas otherwise provided in this paragraph(l), issuers may apply the provisions de-scribed in paragraph (k)(1), (2), and (5) inwhole, but not in part, to bonds sold be-fore October 17, 2016.

(2) Computation credit. Issuers mayapply § 1.148–3(d)(1)(iv) and (d)(4) forbond years ending on or after July 18,2016.

(3) Yield reduction payments. Issuersmay apply § 1.148–5(c)(3) for invest-ments purchased on or after July 18, 2016.

(4) External commingled funds. Issuersmay apply § 1.148–5(e)(2)(ii)(B) with re-spect to costs incurred on or after July 18,2016.

Par. 16. Section 1.150–1 is amendedby:

1. Adding paragraph (a)(2)(iii).2. Adding a definition for “tax-

advantaged bond” in alphabetical order toparagraph (b).

3. Revising paragraph (c)(2).4. Adding paragraph (f).The revisions and additions read as fol-

lows:

§ 1.150–1 Definitions.

(a) * * *(2) * * *(iii) Special effective date for defini-

tions of tax-advantaged bond, issue, andgrant. The definition of tax-advantagedbond in paragraph (b) of this section, therevisions to the definition of issue in para-graph (c)(2) of this section, and the defi-nition and rules regarding the treatment ofgrants in paragraph (f) of this section ap-ply to bonds that are sold on or afterOctober 17, 2016.

* * * * *(b) * * *Tax-advantaged bond means a tax-

exempt bond, a taxable bond that providesa federal tax credit to the investor withrespect to the issuer’s borrowing costs, ataxable bond that provides a refundablefederal tax credit payable directly to theissuer of the bond for its borrowing costsunder section 6431, or any future similarbond that provides a federal tax benefitthat reduces an issuer’s borrowing costs.Examples of tax-advantaged bonds in-clude qualified tax credit bonds under sec-tion 54A(d)(1) and build America bondsunder section 54AA.

* * * * *(c) * * *(2) Exceptions for different types of

tax-advantaged bonds and taxable bonds.Each type of tax-advantaged bond that hasa different structure for delivery of the taxbenefit that reduces the issuer’s borrowingcosts or different program eligibility re-quirements is treated as part of a differentissue under this paragraph (c). Further,tax-advantaged bonds and bonds that arenot tax-advantaged bonds are treated aspart of different issues under this para-graph (c). The issuance of tax-advantagedbonds in a transaction with other bondsthat are not tax-advantaged bonds must betested under the arbitrage anti-abuse rulesunder § 1.148–10(a) and other applicableanti-abuse rules (for example, limitationsagainst window maturity structures or un-reasonable allocations of bonds).

* * * * *(f) Definition and treatment of

grants—(1) Definition. Grant means atransfer for a governmental purpose ofmoney or property to a transferee that isnot a related party to or an agent of the


transferor. The transfer must not imposeany obligation or condition to directly orindirectly repay any amount to the trans-feror or a related party. Obligations orconditions intended solely to assure ex-penditure of the transferred moneys in ac-cordance with the governmental purposeof the transfer do not prevent a transferfrom being a grant.

(2) Treatment. Except as otherwiseprovided (for example, § 1.148–6(d)(4),which treats proceeds used for grants asspent for arbitrage purposes when thegrant is made), the character and nature ofa grantee’s use of proceeds are taken intoaccount in determining which rules areapplicable to the bond issue and whetherthe applicable requirements for the bondissue are met. For example, a grantee’suse of proceeds generally determineswhether the proceeds are used for capitalprojects or working capital expendituresunder section 148 and whether the quali-fied purposes for the specific type of bondissue are met.

Par. 17. Section 1.150–2(d)(3) isamended by:

1. Amending paragraph (a) by addingan entry for § 1.150–2(j)(3).

2. Revising paragraphs (d)(3) and(j)(1).

3. Adding paragraph (j)(3).The revisions and additions read as fol-

lows:

§ 1.150–2 Proceeds of bonds used forreimbursement.

(a) * * *(j) * * *(3) Nature of expenditure.* * * * *(d) * * *(3) Nature of expenditure. The original

expenditure is a capital expenditure, a costof issuance for a bond, an expendituredescribed in § 1.148–6(d)(3)(ii)(B) (relat-ing to certain extraordinary working cap-ital items), a grant (as defined in § 1.150–1(f)), a qualified student loan, a qualifiedmortgage loan, or a qualified veterans’mortgage loan.

* * * * *(j) * * *(1) In general. Except as otherwise

provided, the provisions of this sectionapply to all allocations of proceeds of

reimbursement bonds issued after June 30,1993.

* * * * *(3) Nature of expenditure. Paragraph

(d)(3) of this section applies to bonds thatare sold on or after October 17, 2016.

John Dalrymple,Deputy Commissioner for Services and

Enforcement.Approved: June 28, 2016

Mark J. Mazur,Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on July 15, 2016,8:45 a.m., and published in the issue of the Federal Registerfor July 15, 2016, 81 F.R. 46582)

T.D. 9782

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Parts 1, 301, and602

Tax on Certain ForeignProcurement


ACTION: Final regulations.

SUMMARY: This document contains fi-nal regulations under section 5000C of theInternal Revenue Code relating to the 2percent tax on payments made by the U.S.government to foreign persons pursuant tocertain contracts. The regulations affectU.S. government acquiring agencies andforeign persons providing certain goods orservices to the U.S. government pursuantto a contract. This document also containsfinal regulations under section 6114, withrespect to foreign persons claiming an ex-emption from the 2 percent tax under anincome tax treaty.

DATES: Effective Date: These regula-tions are effective on August 17, 2016.

Applicability Date: For dates of appli-cability, see § 1.5000C–7 and § 301.6114–1(e)(2).

FOR FURTHER INFORMATIONCONTACT: Kate Hwa at (202) 317-6934, and for questions related to tax trea-ties and the regulations under section6114, Rosy Lor at (202) 317- 6933, (nottoll-free numbers).


Background

On January 2, 2011, section 301 of theJames Zadroga 9/11 Health and Compen-sation Act of 2010, Public Law 111–347(the Act), 124 Stat. 3623, added section5000C to the Internal Revenue Code(Code). Section 5000C(a) imposes on anyforeign person that receives a specifiedFederal procurement payment a tax equalto 2 percent of the amount such payment.Section 5000C(b) defines the term speci-fied Federal procurement payment as anypayment made pursuant to a contract withthe Government of the United States (U.S.government) for goods or services if thegoods are manufactured or produced orthe services are provided in any countrythat is not a party to an international pro-curement agreement with the UnitedStates. Section 301(a)(3) of the Act pro-vides that section 5000C applies to pay-ments received pursuant to contracts en-tered into on and after January 2, 2011.Additionally, section 301(b)(1)(c) of theAct states that this section must be appliedin a manner consistent with U.S. obliga-tions under international agreements. Sec-tion 5000C(d)(1) provides that the amountdeducted and withheld under chapter 3shall be increased by the amount of taximposed under section 5000C.

On April 22, 2015, the Department ofTreasury (Treasury Department) and theInternal Revenue Service (IRS) publishedin the Federal Register (80 FR 22449) anotice of proposed rulemaking (REG–103281–11) (NPRM) under sections5000C and 6114 (the proposed regula-tions). The regulations set forth a numberof exemptions from the tax and providedprocedures for collecting the tax. Notice2015–35, 2015–18 I.R.B. 943, issued con-temporaneously with the proposed regula-tions, provided a list of income tax treatiesin effect that prevented the imposition ofthe tax. No public hearing was requestedor held. Written comments on the pro-posed regulations were received and are


available at www.regulations.gov or uponrequest. After consideration of the com-ments, the proposed regulations are ad-opted as amended by this Treasury deci-sion. The revisions are discussed below.

Explanation and Summary ofComments

1. Payments by Contracting Parties toSubcontractors

A commenter asked for clarificationthat the proposed regulations apply onlyto payments made by the U.S. governmentto direct (prime) contractors with the U.S.government, and not to payments made byprime contractors pursuant to subcon-tracts. Consistent with the proposed regu-lations, the final regulations provide sec-tion 5000C imposes the tax on any foreigncontracting party, which means a foreignperson that is a party to a contract with theU.S. government that was entered into onor after January 2, 2011. Therefore, thefinal regulations do not generally imposethe tax on a subcontractor that is not partyto a contract with the U.S. government.For example, if an acquiring agency con-tracts with a domestic corporation (primecontractor) for goods or services, and theprime contractor separately contracts witha foreign subcontractor for goods and ser-vices to be provided under the contract,section 5000C will not ordinarily apply topayments by the prime contractor to itsforeign subcontractor that relate to thosegoods or services.

However, the activities of a subcon-tractor are taken into account when deter-mining the country in which goods aremanufactured or produced or in whichservices are provided under § 1.5000C–1(e). Furthermore, the final regulations re-tain the rules in the proposed regulationsthat payments received by a nominee oragent on behalf of a contracting party areconsidered to be received by that contract-ing party. For the definition of a contract-ing party, see § 1.5000C–1(c)(4). The fi-nal regulations also retain the anti-abuserule in § 1.5000C–5 that in certain circum-stances may treat a subcontractor that is aforeign person as being liable for tax un-der section 5000C.

2. Exemption for Certain ForeignHumanitarian Assistance Contracts

The United States Agency for Interna-tional Development (USAID) regularlyenters into contracts with foreign personsfor goods and services for purposes ofimplementing USAID’s developmentprojects and programs in a host country.The proposed regulations do not providerelief from the tax under section 5000Cfor payments made pursuant to some ofthese contracts. The Treasury Departmentand the IRS have concluded that it isappropriate to exempt from the tax pay-ments made to foreign contracting partiesthat USAID engages to execute its devel-opment projects and programs in a hostcountry. In this context, the U.S. govern-ment is not procuring goods and servicesfor its own benefit, but rather to providehumanitarian assistance for the benefit ofthe host countries. As a result, the finalregulations add an exemption under whichsection 5000C does not apply to a contractfor the purpose of obtaining goods or ser-vices described in or authorized under cer-tain specified statutes that are for the pur-pose of providing foreign humanitarianassistance when the acquiring agency de-termines that the payment is for the pur-pose of providing foreign humanitarianassistance. This exemption generally ap-plies to a contract entered into by an ac-quiring agency with a foreign contractingparty to obtain goods or services for pur-poses of implementing an agreement be-tween the United States and a foreigncountry or a group of countries to provideforeign humanitarian assistance as autho-rized under the Food for Peace Act (7U.S.C. 1691, et seq.) and the Foreign As-sistance Act of 1961 (22 U.S.C. 2151, etseq.).

Similarly, this exemption also gener-ally applies to contacts providing foreignhumanitarian assistance under the Migra-tion and Refugee Assistance Act of 1962(22 U.S.C. 2601 et seq.), the FreedomSupport Act of 1992 (22 U.S.C. 5801 etseq.), and the SEED Act of 1989 (22U.S.C. 5401 et seq.), and to transportationof humanitarian relief supplies to foreigncountries described in 10 U.S.C. 402, for-eign disaster assistance described in 10U.S.C. 404, humanitarian demining assis-tance described in 10 U.S.C. 407, excess

non-lethal supplies for humanitarian reliefpurposes described in 10 U.S.C. 2557, andtransportation of humanitarian relief andfor other humanitarian purposes describedin 10 U.S.C. 2561. See § 1.5000C–1(d)(4). A corresponding change is madeto the withholding rules to take into ac-count this exemption. See § 1.5000C–2(b)(6).

3. Procurement Not Pursuant to theFederal Acquisition Regulations

A commenter noted that it was unclearwhether payments by acquiring agenciesunder contracts that are not entered intopursuant to the Federal Acquisition Reg-ulations (FAR) are subject to tax undersection 5000C. The FAR is the body ofrules that generally governs acquisitionsand contracting procedures for federalagencies. See 48 CFR Chapter 1. Al-though the final regulations utilize certainconcepts and definitions contained in theFAR, neither the Act nor the final regula-tions are limited to contracts executedpursuant to the FAR. Thus, while the term“contract” in the proposed and final regu-lations uses the FAR definition of the term“contract”, it can nevertheless include acontract that is not executed under theFAR. A sentence was added to the defi-nition of contract in the final regulationsto clarify this point.

4. Definition of InternationalProcurement Agreement and LeastDeveloped Countries

The General Explanation of Tax Leg-islation prepared by the Staff of the JointCommittee on Taxation accompanyingsection 5000C explains that parties en-gaged in cross-border transactions are re-quired to comply with relevant tradeagreements of the jurisdictions in whichthey operate. See Staff of the Joint Com-mittee on Taxation, General Explanationof Tax Legislation Enacted in the 111thCongress (JCS-2-11), at 694, March 16,2011 (Joint Committee Explanation). Indescribing these obligations, the JointCommittee Explanation listed the Govern-ment Procurement Agreement (GPA) thatis an annex to the World Trade Organiza-tion agreement, as well as the governmentprocurement obligations of U.S. free trade


agreements. Id. Accordingly, the pro-posed regulations defined the term inter-national procurement agreement as theWorld Trade Organization GPA (WTOGPA) within the meaning of 48 CFR25.400(a)(1) and any free trade agreementto which the United States is a party thatincludes government procurement obliga-tions that provide appropriate competitivegovernment procurement opportunities toU.S. goods, services, and suppliers.

One commenter noted that the FARprovides that eligible products from WTOGPA and free trade agreement countriesare entitled to certain nondiscriminatorytreatment, and that 48 CFR 25.404 ex-pands this nondiscriminatory treatment toinclude least developed countries de-scribed in 48 CFR 25.400(a)(3). The com-menter requested that the final regulationsalso expand the definition of internationalprocurement agreement to include goodsmanufactured or produced or services pro-vided in a least developed country.

The final regulations do not adopt thiscomment for two reasons. First, the pro-posed regulations referred to 48 CFR25.400(a)(1) in order to utilize a term thatwas widely understood in the context ofgovernment procurement but was not in-tended to incorporate any related provi-sions of the FAR. Second, the Joint Com-mittee Explanation indicates thatCongress intended the exemption undersection 5000C(b) related to internationalprocurement agreements to be limited tosignatories of free trade agreements withgovernment procurement obligations orprocurement agreements.

5. Definition of International Agreements

Section 301(c) of the Act requires thatsection 5000C be applied in a mannerconsistent with the United States’ obliga-tions under international agreements. Acommenter indicated that the proposedregulations limit international agreementsthat may affect the application of section5000C to income tax treaties and re-quested that final regulations include otherinternational agreements that may impacttaxation. In particular, the commenter in-dicated that the Vienna Convention onConsular Relations and bilateral frame-work agreements negotiated and adminis-tered by USAID contain tax provisions.

The final regulations do not adopt thisrequest. The specific international agree-ments to which the commenter referredprohibit host country taxation of expendi-tures of a U.S. consulate or amounts pro-vided through USAID programs but donot limit the United States’ taxing rights.Consequently, these international agree-ments do not provide relief from the taximposed under section 5000C. Further-more, in identifying the income tax trea-ties that provide relief from the tax undersection 5000C, the regulations do not pre-clude a foreign contracting party fromclaiming relief from the tax under anyother applicable international agreement.

6. Simplified Acquisition Threshold

The proposed regulations provide thatthat the tax imposed under section 5000Cwill not apply to payments for purchasesunder the simplified acquisition proce-dures described in the FAR that do notexceed the simplified acquisition thresh-old in 48 CFR 2.101. One commenterrecommended that the determination ofthe $150,000 simplified acquisitionthreshold should be computed on an an-nual basis rather than on a contract-by-contract basis. The final regulations do notadopt this suggestion because the Trea-sury Department and the IRS have deter-mined that it is generally more adminis-trable to make a determination of thethreshold amount when entering into aparticular contract. However, as describedin 7. Personal Service Contacts of thispreamble, this suggestion has been ad-opted in the limited context of personalservice contracts.

7. Personal Service Contracts

A commenter requested a new exemp-tion from the tax for service contractsentered into with individuals (personalservice contracts). The commenter furtherstated that some acquiring agencies do notuse the FAR to procure personal servicesfrom individuals. As such, the commenterstated that these personal service contractsdo not fall within the simplified acquisi-tion procedures of the FAR but typicallyare for an amount less than $150,000 percontract. The commenter also suggestedthat the threshold amount of personal ser-

vice contracts with individuals would bemore appropriately determined on an an-nual (rather than a per contract) basis.

Section 5000C applies to contracts forthe provision of services, so the final reg-ulations do not provide an exemption forall personal service contracts. However,the Treasury Department and the IRShave decided that it is appropriate to ex-tend the simplified acquisition exemptionto personal service contracts, whether ornot they are not executed pursuant to theFAR. Further, the Treasury Departmentand the IRS agree with the comment thatwhen applying this exemption, theamount paid for personal services underthe contracts should be determined on anannual basis. Accordingly, the final regu-lations provide an exemption in§ 1.5000C–1(d)(3) for payments for ser-vices provided by, and under contractswith, a single individual in which the pay-ments do not exceed on an annual basisthe simplified acquisition threshold as de-scribed in 48 CFR 2.101 for all years ofthe contract. A corresponding change ismade to the withholding rules to take intoaccount this exemption. See § 1.5000C–2(b)(5).

8. Definition of Emergency Acquisition

Proposed § 1.5000C–1(d)(2) exemptspayments pursuant to contracts awardedfor certain emergency acquisitions. Onecommenter suggested that this exemptionbe broadened to include contracts that in-volve other agency acquisitions of impor-tance to the government, such as contractsfor acquisitions determined to be in thenational interest by the acquiring agency.The final regulations do not adopt thiscomment for two reasons. First, the Trea-sury Department and the IRS have con-cluded that the more limited exemption inthe proposed regulations appropriatelybalances compliance with section 5000Cwith the government’s need to procuregoods and services in certain emergencysituations. Second, the commenter’s sug-gestion would introduce a subjective, po-tentially overbroad exemption from thetax imposed by section 5000C.


9. Credit Card Payments

One commenter requested a new ex-emption from the section 5000C tax forpayments made with a credit card. Thecommenter indicated that applying thesection 5000C tax to payments made witha credit card would be difficult to admin-ister because of the volume of these trans-actions.

The final regulations do not adopt thissuggestion for several reasons. First, inmost cases, payments made with a creditcard will be in an amount that will fallwithin the exemption for payments forsimplified acquisitions, which applies topurchases under the simplified acquisitionprocedures described in the FAR that donot exceed the simplified acquisitionthreshold as described in 48 CFR 2.101.See § 1.5000C–1(d)(1). Second, in casesin which payments made with a creditcard do not meet the exemption for sim-plified acquisitions, adopting this com-ment would allow foreign contracting par-ties to avoid the tax by receiving paymentwith a credit card for large amounts thatshould be subject to the tax.

10. Payments Only in Part for Goods orServices

A commenter indicated that, in somecircumstances, a contract may be forgoods or services but also include pay-ments that are not for goods or services,giving as an example payments to reim-burse taxes incurred by the contractingparty. In response to the comment, thewithholding steps in the final regulationsclarify that acquiring agencies should notwithhold to the extent that a payment isfor something other than goods or ser-vices. See § 1.5000C–2(b)(1). However,this clarification should not be read tomean that payments to reimburse taxesincurred by the contracting party in pro-viding goods or services are anythingother than payments for those goods orservices

11. Form W–14, “Certificate of ForeignContracting Party Receiving FederalProcurement Payments”

The proposed regulations provided thata foreign contracting party must submit a“Section 5000C Certificate” that provides

all of the information required by the pro-posed regulations to claim an exemptionfrom section 5000C. The proposed regu-lations also contained a model Section5000C Certificate. Simultaneous with thepublication of the final regulations, theIRS is publishing Form W–14, “Certifi-cate of Foreign Contracting Party Receiv-ing Federal Procurement Payments,”which may be used as the Section 5000CCertificate. Accordingly, the final regula-tions do not contain a model Section5000C Certificate but rather provide that aforeign person may use Form W–14 as itsSection 5000C Certificate provided that itincludes all the necessary information. See§§ 1.5000C–1(c)(14) and 1.5000C–2(d)(7).

Notice 2015–35 listed the countriesthat had entered into qualified income taxtreaties with the United States as of thedate of its publication. The instructions toForm W–14, issued contemporaneouslywith the publication of these final regula-tions, identify income tax treaties in force,as of the date of the issuance of the form,that are qualified income tax treaties.When new income tax treaties come intoforce, foreign persons and acquiring agen-cies should review IRS Forms, Instruc-tions, Publications or other media (includ-ing www.irs.gov) for an updated list ofqualified income tax treaties, rather thanNotice 2015–35.

12. Change in Circumstances

Section 1.5000C–2(d)(6) provides thata foreign contracting party must submit arevised Section 5000C Certificate within30 days of a change in circumstances thatcauses the information in a Section 5000CCertificate held by the acquiring agency tobe incorrect with respect to the acquiringagency’s determination of whether towithhold or the amount of withholdingunder Section 5000C. One commentersuggested that an example would be help-ful to illustrate this rule. In response tothis comment, an example was added toillustrate the withholding obligation of anacquiring agency when it receives a re-vised Section 5000C Certificate due to achange in circumstances. See§ 1.5000C–6, Example 6.

13. Effective Date of Section 5000C andthe Final Regulations

Comments recommended that the finalregulations delay the applicability of thetax imposed by section 5000C to contractsentered into on or after the date of thepublication of the final regulations. Alter-natively, one commenter recommendedthat the final regulations delay the appli-cability of the tax until the issuance offinal amendments to the FAR as promul-gated by the Department of Defense(DoD), General Services Administration(GSA), and National Aeronautics andSpace Administration (NASA), if any,that may take into account these final reg-ulations. This commenter reasoned that adelay in the application of the final regu-lations would allow the necessary timeneeded to amend the FAR in order to takeinto account the rules provided in the finalregulations. While the DoD, GSA, andNASA have amended some sections ofthe FAR to reflect the enactment of sec-tion 5000C (see 48 CFR 31.205–41(b),52.229–3(b)(2), 52.229–4(b)(2), 52.229–6(c)(2), and 52.229–7(b)(2)), commentersstated that other sections of the FAR (suchas CFR 52.229–3) will also need to beamended.

Section 301(a)(3) of the Act specifi-cally provides that the tax imposed bysection 5000C applies to payments re-ceived pursuant to contracts entered intoon and after January 2, 2011, indicating aclear Congressional intent as to the effec-tive date. Further, the Act does not requireTreasury regulations or FAR amendmentsto be applicable before the requirementsof the statute take effect. Thus, the finalregulations do not adopt this comment andconfirm the statutory effective date.

Consistent with the proposed regula-tions, the final regulations apply on andafter the date that is 90 days after the datethey are published as final regulations inthe Federal Register (applicability date).However, contracting parties and acquir-ing agencies may rely upon the rules inthe final regulations before the applicabil-ity date.

Under the Act, while acquiring agen-cies have an obligation to withhold, theforeign contracting parties remain liablefor the tax if withholding does not fullysatisfy the foreign person’s tax liability.


The Treasury Department and the IRS areaware that some foreign persons subject tostatutory obligations under section 5000Cmay have deferred compliance actionspending the applicability of the final reg-ulations. The Treasury Department andthe IRS have concluded that 90 days issufficient for these foreign persons to sat-isfy their tax and filing obligations withrespect to section 5000C for prior periods.Accordingly, § 1.5000C–7 provides that ifa foreign contracting party fully satisfiesits tax and filing obligations under section5000C with respect to any payments re-ceived in tax years ending before the ap-plicability date of the regulations on orbefore the later of the applicability date ofthe final regulations or the due date for theforeign person’s income tax return for theyear in which the payment was received ina manner consistent with the final regula-tions, penalties will not be asserted on theforeign contracting parties with respect tothose payments or returns. For example,assume a foreign corporation received asingle specified Federal procurement pay-ment during its tax year ending on De-cember 31, 2013 that is not described inany of the exemptions in these final reg-ulations, and the payment was not with-held upon. If the corporation files Form1120–F, “U.S. Income Tax Return of aForeign Corporation,” for 2013 and paysthe tax imposed under section 5000C inthe manner described in § 1.5000C–4(d)before the applicability date of the finalregulations, penalties will not be assertedwith respect to that payment or return.However, the final regulations do not re-lieve a foreign person of any applicablerules relating to interest under Subtitle F.

Additionally, for purposes of section6114 and the regulations thereunder, if aforeign contracting party has received apayment exempt from tax under a quali-fied income tax treaty before the effectivedate of the final regulations under section5000C, reporting is waived if the foreigncontracting party has properly relied onNotice 2015–35. See § 301.6114–1(e)(2).

Special Analyses

Certain IRS regulations, includingthese, are exempt from the requirementsof Executive Order 12866, as supple-mented and reaffirmed by Executive Or-der 13563. It has been determined that

section 553(b) of the Administrative Pro-cedure Act (5 U.S.C. chapter 5) does notapply to this regulation. It is hereby cer-tified that the collection of informationcontained in this regulation will not have asignificant economic impact on a substan-tial number of small entities. Accordingly,a regulatory flexibility analysis is not re-quired. The collection of information re-quirement in the regulations will not havea significant economic impact on a sub-stantial number of small entities because alimited number of foreign contracting par-ties that are small entities will be subjectto the tax, in part because the final regu-lations provide exemptions for simplifiedacquisitions and for certain personal ser-vice contracts. Because section 5000C(a)applies to foreign persons regardless ofthe size of the entity, a limited number ofsmall foreign entities that received speci-fied Federal procurement payments are af-fected by the regulation. Pursuant to sec-tion 7805(f) of the Internal Revenue Code,the NPRM preceding these regulationswas submitted to the Chief Counsel forAdvocacy of the Small Business Admin-istration for comment on its impact onsmall business.


The principal authors of these regula-tions are Kate Hwa and Rosy Lor, Officeof Associate Chief Counsel (Interna-tional). However, other personnel fromthe Treasury Department and the IRS par-ticipated in their development.

List of Subjects

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR parts 1, 301, and602 are amended as follows:

PART I—INCOME TAXES

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

Authority: 26 U. S. C. 7805 * * *Section 1.5000C–1 is also issued under

26 U.S.C. 5000CSection 1.5000C–2 is also issued under

26 U.S.C. 5000C

Section 1.5000C–3 is also issued under26 U.S.C. 5000C




Par. 2. An undesignated center headingis added following § 1.5000A–5 to read asfollows:

Tax on Certain Foreign Procurement

*****

§ 1.5000C–0 Outline of regulationprovisions for section 5000C.

*****

§ 1.5000C–1 Tax on specified Federalprocurement payments.

(a) Overview.(b) Imposition of tax.(c) Definitions.(d) Exemptions.(1) Simplified acquisitions.(2) Emergency acquisitions.(3) Certain personal service contracts.(4) Certain foreign humanitarian assis-

tance contracts.(5) Certain international agreements.(6) Goods manufactured or produced

or services provided in the United States.(7) Goods manufactured or produced

or services provided in a country that is aparty to an international procurementagreement.

(e) Country in which goods are manu-factured or produced or services provided.

(1) Goods manufactured or produced.(2) Provision of services.(3) Allocation of total contract price to

determine the nonexempt amount.(4) Reduction or elimination of with-

holding by an acquiring agency.

§ 1.5000C–2 Withholding on specifiedFederal procurement payments.

(a) In general.(b) Steps in determining the obligation

to withhold under section 5000C.(1) Determine whether the payment is

pursuant to a contract for goods or ser-vices.


(2) Determine whether the payment ismade pursuant to a contract with a U.S.person.

(3) Determine whether the payment isfor purchases under the simplified acqui-sition procedures.

(4) Determine whether the payment isfor emergency acquisitions.

(5) Determine whether the payment isfor personal services under the simplifiedacquisition threshold.

(6) Determine whether the payment ispursuant to a foreign humanitarian assis-tance contract.

(7) Determine whether the foreign con-tracting party is entitled to relief pursuantto an international agreement.

(8) Determine whether the contract isfor goods manufactured or produced orservices provided in the United States orin a foreign country that is a party to aninternational procurement agreement.

(9) Compute amounts to withhold.(10) Deposit and report amounts with-

held.(c) Determining whether the contract-

ing party is a U.S. person.(1) In general.(2) Determination based on Taxpayer

Identification Number (TIN).(3) Determination based on the Form

W–9.(4) Contracting party treated as a for-

eign contracting party.(d) Withholding when a foreign con-

tracting party submits a Section 5000CCertificate.(1) In general.(2) Exemption for a foreign contracting

party entitled to the benefit of relief pur-suant to certain international agreements.

(3) Exemption when goods are manu-factured or produced or services providedin the United States, or in a foreign coun-try that is a party to an international pro-curement agreement.

(4) Information required for Section5000C Certificate.

(5) Validity period of Section 5000CCertificate.

(6) Change in circumstances.(7) Form W–14.(8) Time for submitting Section 5000C

Certificate.(e) Offset for underwithholding or

overwithholding.(1) In general.

(2) Underwithholding.(3) Overwithholding.

§ 1.5000C–3 Payment and returns of taxwithheld by the acquiring agency.

(a) In general.(b) Deposit rules.(1) Acquiring agency with a chapter 3

deposit requirement treats amounts with-held as under chapter 3.

(2) Acquiring agency with no chapter 3filing obligation deposits withheldamounts monthly.

(c) Return requirements.(1) In general.(2) Classified or confidential contracts.(d) Special arrangement for certain

contracts.

§ 1.5000C–4 Requirement for theforeign contracting party to file a returnand pay tax, and procedures for thecontracting party to seek a refund.

(a) In general.(b) Tax obligation of foreign contract-

ing party independent of withholding.(c) Return of tax by the foreign con-

tracting party.(d) Time and manner of paying tax.(e) Refund requests when amount

withheld exceeds tax liability.

§ 1.5000C–5 Anti-abuse rule.

§ 1.5000C–6 Examples.

§ 1.5000C–7 Effective/applicabilitydate.

*****Par. 3. Sections 1.5000C–1 through

1.5000C–7 are added to read as follows:

§ 1.5000C–1 Tax on specified Federalprocurement payments.

(a) Overview. This section providesdefinitions and general rules relating tothe imposition of, and exemption from,the tax on specified Federal procurementpayments under section 5000C. Section1.5000C–2 provides rules concerningwithholding under section 5000C(d)(1),including the steps that must be taken todetermine the obligation to withhold and

whether an exemption from withholdingapplies. Section 1.5000C–3 provides thetime and manner for depositing theamounts withheld under section 5000Cand the related reporting requirements.Section 1.5000C–4 contains the rules thatapply to a foreign contracting party thatmust pay and report the tax under section5000C when the tax obligation under sec-tion 5000C is not fully satisfied by with-holding, as well as procedures by which acontracting party may seek a refund whenthe amount withheld exceeds its tax lia-bility under section 5000C. Section1.5000C–5 contains an anti-abuse rule.Section 1.5000C–6 contains examples il-lustrating the principles of §§ 1.5000C–1through 1.5000C–4. Finally, § 1.5000C–7contains the effective/applicability datefor §§ 1.5000C–1 through 1.5000C–7.

(b) Imposition of tax. Except as other-wise provided, section 5000C imposes onany foreign contracting party a tax equalto 2 percent of the amount of a specifiedFederal procurement payment. In general,the tax imposed under section 5000C ap-plies to specified Federal procurementpayments received pursuant to contractsentered into on and after January 2, 2011.Specified Federal procurement paymentsreceived by a nominee or agent on behalfof a contracting party are considered to bereceived by that contracting party. The taximposed under section 5000C is to beapplied in a manner consistent with U.S.obligations under international agree-ments. Payments for the purchase or leaseof land or an interest in land are not sub-ject to the tax imposed under section5000C.

(c) Definitions. Solely for purposes ofsection 5000C and §§ 1.5000C–1 through1.5000C–7, the following definitions ap-ply:

(1) The term acquiring agency meansthe U.S. government department, agency,independent establishment, or corporationdescribed in paragraph (c)(7) of this sec-tion that is a party to the contract. To theextent that a U.S. government departmentor agency, other than the acquiringagency, is making the payments pursuantto the contract, that department or agencyis also considered to be the acquiringagency.

(2) The term contract has the samemeaning as provided in 48 CFR 2.101,


and thus does not include a grant agree-ment or a cooperative agreement withinthe meaning of 31 U.S.C. 6304 and 6305,respectively. A contract may include anagreement that is not executed under theFederal Acquisition Regulations (FAR),48 CFR Chapter 1.

(3) The term contract ratio refers to thenonexempt amount over the total contractprice.

(4) The term contracting party meansany person that is a party to a contractwith the U.S. government that is enteredinto on or after January 2, 2011. See§ 1.5000C–1(b) for situations involving anominee or agent.

(5) The term foreign contracting partymeans a contracting party that is a foreignperson.

(6) The term foreign person means anyperson other than a United States person(as defined in section 7701(a)(30)).

(7) The term Government of the UnitedStates or U.S. government means the ex-ecutive departments specified in 5 U.S.C.101, the military departments specified in5 U.S.C. 102, the independent establish-ments specified in 5 U.S.C. 104(1), andwholly owned government corporationsspecified in 31 U.S.C. 9101(3). Unlessotherwise specified in 5 U.S.C. 101, 102,or 104(1), or 31 U.S.C. 9101(3), the termGovernment of the United States or U.S.government does not include any quasi-governmental entities or instrumentalitiesof the U.S. government.

(8) The term international procure-ment agreement means the World TradeOrganization Government ProcurementAgreement within the meaning of 48 CFR25.400(a)(1) and any free trade agreementto which the United States is a party thatincludes government procurement obliga-tions that provide appropriate competitivegovernment procurement opportunities toU.S. goods, services, and suppliers. Aparty to an international procurementagreement is a signatory to the agreementand does not include a country that ismerely an observer with respect to theagreement.

(9) The term nonexempt amount meansthe portion of the contract price allocatedto nonexempt goods and nonexempt ser-vices.

(10) The term nonexempt goods meansgoods manufactured or produced in a for-

eign country that is not a party to aninternational procurement agreement withthe United States.

(11) The term nonexempt servicesmeans services provided in a foreigncountry that is not a party to an interna-tional procurement agreement with theUnited States.

(12) The term outlying areas has thesame meaning as set forth in 48 CFR2.101(b), which includes Puerto Rico, theNorthern Mariana Islands, American Sa-moa, Guam, the Virgin Islands, Baker Is-land, Howland Island, Jarvis Island, John-ston Atoll, Kingman Reef, MidwayIslands, Navassa Island, Palmyra Atoll,and Wake Atoll.

(13) The term qualified income taxtreaty means a U.S. income tax treaty inforce that contains a nondiscriminationprovision that applies to the tax imposedunder section 5000C and prohibits taxa-tion that is more burdensome on a foreignnational than a U.S. national (or in thecase of certain income tax treaties, taxa-tion that is more burdensome on a foreigncitizen than a U.S. citizen), regardless ofits residence.

(14) The term Section 5000C Certifi-cate means a written statement that in-cludes the information described in§ 1.5000C–2(d) that the foreign contract-ing party submits to an acquiring agencyfor the purposes of demonstrating that theforeign contracting party is eligible forcertain exemptions from withholding (inwhole or in part) under section 5000Cwith respect to a contract. The term mayalso include any form that the InternalRevenue Service may prescribe as a sub-stitute for the Section 5000C Certificate,such as Form W–14, “Certificate of For-eign Contracting Party Receiving FederalProcurement Payments.”

(15) The term specified Federal pro-curement payment means any paymentmade pursuant to a contract with a foreigncontracting party that is for goods manu-factured or produced or services providedin a foreign country that is not a party toan international procurement agreementwith the United States. For purposes of theprior sentence, a foreign country does notinclude an outlying area.

(16) The term Taxpayer IdentificationNumber or TIN means the identifying

number assigned to a person under section6109, as defined in section 7701(a)(41).

(17) The term total contract pricemeans the total cost to the U.S. Govern-ment of the goods and services procuredunder a contract and paid to the contract-ing party.

(d) Exemptions. The tax imposed underparagraph (b) of this section does not ap-ply to the payments made in the followingsituations. For the exemptions in para-graphs (d)(5), (6) and (7) of this section,see § 1.5000C–2(d) for the procedures toeliminate withholding by an acquiringagency.

(1) Simplified acquisitions. Paymentsfor purchases under the simplified acqui-sition procedures that do not exceed thesimplified acquisition threshold as de-scribed in 48 CFR 2.101.

(2) Emergency acquisitions. Paymentsmade pursuant to a contract if the contractis—

(i) Awarded under the “unusual andcompelling urgency” authority of 48 CFR6.302–2, or

(ii) Entered into under the emergencyacquisition flexibilities as defined in 48CFR part 18.

(3) Certain personal service contracts.Payments for services provided by, andunder contracts with, a single individual inwhich the payments do not (and will not)exceed on an annual calendar year basisthe simplified acquisition threshold as de-scribed in 48 CFR 2.101 for all years ofthe contract. Payments that satisfy thisexemption remain exempt if the contractis later renegotiated so that future pay-ments under the contract do not meet thisexemption.

(4) Certain foreign humanitarian as-sistance contracts. Payments made by theU.S. government pursuant to a contractwith a foreign contracting party to obtaingoods or services described in or autho-rized under 7 U.S.C. 1691, et seq., 22U.S.C. 2151, et seq., 22 U.S.C 2601 etseq., 22 U.S.C. 5801 et seq., 22 U.S.C.5401 et seq., 10 U.S.C. 402, 10 U.S.C.404, 10 U.S.C. 407, 10 U.S.C. 2557, and10 U.S.C. 2561, if the acquiring agencydetermines that the payment is for thepurpose of providing foreign humanitar-ian assistance.

(5) Certain international agreements.Payments made by the U.S. government


pursuant to a contract with a foreign con-tracting party when the payments are en-titled to relief from the tax imposed undersection 5000C pursuant to an internationalagreement with the United States, includ-ing relief pursuant to a nondiscriminationprovision of a qualified income tax treaty,because the foreign contracting party isentitled to the benefit of that provision.

(6) Goods manufactured or producedor services provided in the United States.A payment made pursuant to a contract tothe extent that the payment is for goodsmanufactured or produced or services pro-vided in the United States.

(7) Goods manufactured or producedor services provided in a country that is aparty to an international procurementagreement. A payment made pursuant to acontract to the extent the payment is forgoods manufactured or produced or ser-vices provided in a country that is a partyto an international procurement agree-ment, as defined in paragraph (c)(8) of thissection.

(e) Country in which goods are manu-factured or produced or services provid-ed—(1) Goods manufactured or pro-duced. Solely for purposes of section5000C, goods are manufactured or pro-duced in the country (or countries)—

(i) Where property has been substan-tially transformed into the goods that areprocured pursuant to a contract; or

(ii) Where there has been assembly orconversion of component parts (involvingactivities that are substantial in nature andgenerally considered to constitute themanufacture or production of property)into the final product that constitutes thegoods procured pursuant to a contract.

(2) Provision of services. Solely forpurposes of section 5000C, services areconsidered to be provided in the countrywhere the individuals performing the ser-vices are physically located when theyperform their duties pursuant to the con-tract.

(3) Allocation of total contract price todetermine the nonexempt amount. If, pur-suant to a contract, goods are manufac-tured or produced, or services are pro-vided, in multiple countries and only aportion of the goods manufactured or pro-duced, or the services provided, pursuantto the contract are nonexempt goods ornonexempt services, a foreign contracting

party may use a reasonable allocationmethod to determine the nonexemptamount. A reasonable allocation methodwould include taking into account the pro-portionate costs (including the cost of la-bor and raw materials) incurred to manu-facture or produce the goods in eachcountry, or taking into account the propor-tionate costs incurred to provide the ser-vices in each country.

(4) Reduction or elimination of with-holding by an acquiring agency. For pro-cedures to reduce or eliminate withhold-ing by an acquiring agency based onwhere goods are manufactured or pro-duced or where services are provided, in-cluding as a result of an allocation underthis paragraph (e), see § 1.5000C–2(d).

§ 1.5000C–2 Withholding on specifiedFederal procurement payments.

(a) In general. Except as otherwiseprovided in this section, every acquiringagency making a specified Federal pro-curement payment on which tax isimposed under section 5000C and§§ 1.5000C–1 through 1.5000C–7 mustdeduct and withhold an amount equal to 2percent of the payment. For rules relatingto the liability of a foreign contractingparty with respect to specified Federalprocurement payments not fully withheldupon at source, see § 1.5000C–4. An ac-quiring agency may rely upon any infor-mation furnished by a contracting partyunder this section unless the acquiringagency has reason to know that the infor-mation is incorrect or unreliable. An ac-quiring agency has reason to know thatthe information is incorrect or unreliableif it has knowledge of relevant facts orstatements contained in the submitted in-formation such that a reasonably prudentperson in the position of the acquiringagency would know that the informationprovided is incorrect or unreliable.

(b) Steps in determining the obligationto withhold under section 5000C. An ac-quiring agency generally determines itsobligation to withhold under section5000C according to the steps described inthis paragraph (b). See, however, para-graph (e) of this section for situations inwhich withholding may be increased inthe case of underwithholding, or may bedecreased in the case of overwithholding.

(1) Determine whether the payment ispursuant to a contract for goods or ser-vices. The acquiring agency determineswhether it is making a payment pursuantto a contract for goods or services. To theextent that the acquiring agency is makinga payment for any other purpose, it doesnot have an obligation to withhold undersection 5000C on the payment.

(2) Determine whether the payment ismade pursuant to a contract with a U.S.person. The acquiring agency determineswhether the payment is made pursuant toa contract with a person considered to bea United States person (U.S. person) inaccordance with paragraph (c) of this sec-tion. If the other contracting party is aU.S. person, the acquiring agency doesnot have an obligation to withhold undersection 5000C on the payment.

(3) Determine whether the payment isfor purchases under the simplified acqui-sition procedures. The acquiring agencydetermines whether the payment is forpurchases under the simplified acquisi-tions procedures that do not exceed thesimplified acquisition threshold as de-scribed in 48 CFR 2.101. If it is, theacquiring agency does not have an obli-gation to withhold under section 5000Con the payment.

(4) Determine whether the payment isfor emergency acquisitions. The acquiringagency determines whether the payment ismade for certain emergency acquisitionswithin the meaning of § 1.5000C–1(d)(2).If it is, the acquiring agency does not havean obligation to withhold under section5000C on the payment.

(5) Determine whether the payment isfor personal services under the simplifiedacquisition threshold. The acquiringagency determines whether payments forservices under contracts with a single in-dividual do not exceed the simplified ac-quisition threshold as described in 48 CFR2.101 on an annual basis for all years ofthe contract. If that is the case, the acquir-ing agency does not have an obligation towithhold under section 5000C on the pay-ment.

(6) Determine whether the payment ispursuant to a foreign humanitarian assis-tance contract. The acquiring agency de-termines whether the payment is madepursuant to a foreign humanitarian assis-tance contract described in § 1.5000C–


1(d)(4). If it is, the acquiring agency doesnot have an obligation to withhold undersection 5000C on the payment.

(7) Determine whether the foreign con-tracting party is entitled to relief pursuantto an international agreement. If the for-eign contracting party submits a Section5000C Certificate in accordance withparagraph (d) of this section representingthat the foreign contracting party is enti-tled to relief from the tax imposed undersection 5000C pursuant to an internationalagreement with the United States (such asrelief pursuant to the nondiscriminationprovision of a qualified income tax treaty),the acquiring agency does not have anobligation to withhold under section5000C on the payment.

(8) Determine whether the contract isfor goods manufactured or produced orservices provided in the United States orin a foreign country that is a party to aninternational procurement agreement. Ifthe foreign contracting party submits aSection 5000C Certificate in accordancewith paragraph (d) of this section thatrepresents that the contract is for goodsmanufactured or produced or services pro-vided in the United States, or in a foreigncountry that is a party to an internationalprocurement agreement, the acquiringagency does not have an obligation towithhold. If the Section 5000C Certificateprovides that payments under the contractare only partially exempt from withhold-ing under section 5000C, the acquiringagency must withhold to the extent de-scribed in paragraph (b)(8) of this section.

(9) Compute amounts to withhold. If,after evaluating each step described in thisparagraph (b), the acquiring agency deter-mines that it has an obligation to withhold,the acquiring agency computes theamount of withholding by multiplying theamount of the payment by 2 percent, un-less the foreign contracting party has pro-vided a Section 5000C Certificate or thepayment is only in part for goods or ser-vices. In cases in which the Section 5000CCertificate demonstrates that the exemp-tion in Step 8 applies, the acquiringagency generally computes the amount ofwithholding by multiplying the amount ofthe payment by the contract ratio providedon the most recent Section 5000C Certif-icate, the product of which is multipliedby 2 percent. However, in cases in which

the exemption in Step 8 applies and therequirements of paragraph (d)(4)(iii)(B)(2) of this section are met, the acquir-ing agency computes the amount of with-holding based on the payment for the spe-cifically identified items, which may beidentified by the contract line item num-ber, or CLIN. In the case in which thepayment is only in part for goods or ser-vices, the acquiring agency reduces theamount of the payment subject to the taxto the extent it is for something other thangoods or services. The acquiring agencywithholds the computed amount from thepayment.

(10) Deposit and report amounts with-held. The acquiring agency deposits andreports the amounts determined in theprior step in accordance with§ 1.5000C–3.

(c) Determining whether the contract-ing party is a U.S. person—(1) In general.An acquiring agency must rely on theprovisions of this paragraph (c) to deter-mine the status of the contracting party asa U.S. person for purposes of withholdingunder section 5000C.

(2) Determination based on TaxpayerIdentification Number (TIN). An acquir-ing agency must treat a contracting partyas a U.S. person if the U.S. governmentinformation system (such as the Systemfor Award Management (SAM)) indicatesthat the contracting party is a corporation(for example, because the name listed inSAM contains the term “Corporation,”“Inc.,” or “Corp.”) and that it has a TINthat begins with two digits other than “98”(a limited liability company or LLC is nottreated as a corporation for purposes ofthis paragraph (c)(2)). Further, an acquir-ing agency must treat a contracting partyas a U.S. person if the acquiring agencyhas access to a U.S. government informa-tion system that indicates that the con-tracting party is an individual with a TINthat begins with a digit other than “9”.

(3) Determination based on the FormW–9. An acquiring agency must treat acontracting party as a U.S. person if theperson has submitted to it a valid FormW–9, “Request for Taxpayer Identifica-tion Number (TIN) and Certificate” (orvalid substitute form described in§ 31.3406(h)–3(c)(2) of this chapter),signed under penalties of perjury.

(4) Contracting party treated as a for-eign contracting party. If an acquiringagency cannot determine that a contract-ing party is a U.S. person based on appli-cation of paragraph (c)(2) or (3) of thissection, then the contracting party istreated as a foreign contracting party forpurposes of this section.

(d) Withholding when a foreign con-tracting party submits a Section 5000CCertificate—(1) In general. Unless the ac-quiring agency has reason to know thatthe information is incorrect or unreliable,the acquiring agency may rely on a claimthat a foreign contracting party is entitledto an exemption (in whole or in part) fromwithholding on payments pursuant to acontract if the foreign contracting partyprovides a Section 5000C Certificate tothe acquiring agency as prescribed in thisparagraph (d). When a Section 5000CCertificate is furnished, the acquiringagency does not withhold, or must reducethe amount of withholding, on paymentsmade to a foreign person if the certificateestablishes that the foreign person iswholly or partially exempt from withhold-ing. An acquiring agency may establish asystem for a foreign contracting party toelectronically furnish a Section 5000CCertificate.

(2) Exemption for a foreign contract-ing party entitled to the benefit of reliefpursuant to certain international agree-ments. An acquiring agency does notwithhold on payments pursuant to a con-tract with a foreign contracting partywhen the payment is entitled to relief fromthe tax imposed under section 5000C pur-suant to an international agreement, in-cluding relief pursuant to a nondiscrimi-nation provision of a qualified income taxtreaty, because the foreign contractingparty is entitled to the benefit of thatagreement and the foreign contractingparty has submitted a Section 5000C Cer-tificate that includes all of the informationdescribed in paragraphs (d)(4)(i) and (ii)of this section.

(3) Exemption when goods are manu-factured or produced or services providedin the United States, or in a foreign coun-try that is a party to an internationalprocurement agreement. An acquiringagency does not withhold on paymentspursuant to a contract with a foreign con-tracting party to the extent that the pay-


ments are for goods manufactured or pro-duced or services provided in the UnitedStates or in a foreign country that is aparty to an international procurementagreement with the United States, pro-vided that the foreign contracting partyhas submitted a Section 5000C Certificatethat includes all of the information de-scribed in paragraphs (d)(4)(i) and (iii) ofthis section. If the Section 5000C Certifi-cate provides that the payment is onlypartially exempt from withholding undersection 5000C, the acquiring agency mustwithhold to the extent that the payment isnot exempt.

(4) Information required for Section5000C Certificate—(i) In general. TheSection 5000C Certificate must be signedunder penalties of perjury by the foreigncontracting party and contain—

(A) The name of the foreign contract-ing party, country of organization (if ap-plicable), and permanent residence ad-dress of the foreign contracting party;

(B) The mailing address of the foreigncontracting party (if different than the per-manent residence address);

(C) The TIN assigned to the foreigncontracting party (if any);

(D) The identifying or reference num-ber on the contract (if known);

(E) The name and address of the ac-quiring agency;

(F) A statement that the person signingthe Section 5000C Certificate is the for-eign contracting party listed in paragraph(d)(4)(i)(A) of this section (or is autho-rized to sign on behalf of the foreign con-tracting party);

(G) A statement that the foreign con-tracting party is not acting as an agent ornominee for another foreign person withrespect to the goods manufactured or pro-duced or services provided under the con-tract;

(H) A statement that the foreign con-tracting party agrees to pay an amountequal to any tax (including any applicablepenalties and interest) due under section5000C that the acquiring agency does notwithhold under section 5000C;

(I) A statement that the foreign con-tracting party acknowledges and under-stands the rules in § 1.5000C–4 relating toprocedural obligations related to section5000C; and

(J) A statement that the foreign con-tracting party has not engaged in a trans-action (or series of transactions) with aprincipal purpose of avoiding the tax im-posed under section 5000C as defined in§ 1.5000C–5.

(ii) Additional information required forclaiming an exemption based on certaininternational agreements with the UnitedStates. In addition to the information re-quired by paragraph (d)(4)(i) of this sec-tion, a foreign contracting party claimingan exemption from withholding in reli-ance on a provision of an internationalagreement with the United States, includ-ing a qualified income tax treaty, mustprovide—

(A) The name of the internationalagreement under which the foreign con-tracting party is claiming benefits;

(B) The specific provision of the inter-national agreement relied upon (for exam-ple, the nondiscrimination article of aqualified income tax treaty); and

(C) The basis on which it is entitled tothe benefits of that provision (for example,because the foreign contracting party is acorporation organized in a foreign countrythat has in force a qualified income taxtreaty with the United States that coversall nationals, regardless of their resi-dence).

(iii) Additional required informationfor claiming exemption based on countrywhere goods are manufactured or ser-vices provided. (A) In general. In additionto the information required by paragraph(d)(4)(i) of this section, a foreign contract-ing party claiming an exemption fromwithholding (in whole or in part) becausepayments will be pursuant to a contractfor goods manufactured or produced orservices provided in the United States, ora foreign country that is party to an inter-national procurement agreement, must de-scribe on the Section 5000C Certificatethe relevant goods or services and thecountry (or countries) in which they aremanufactured or produced, or are pro-vided, and must include the name of theinternational procurement agreement oragreements (if relevant).

(B) Information on allocation to ex-empt and nonexempt amounts. (1) In gen-eral. In situations in which a foreign con-tracting party claims the exemption inparagraph (d)(3) of this section with re-

spect to only a portion of the paymentsreceived under the contract, the Section5000C Certificate must include an expla-nation of the method used by the foreigncontracting party to allocate the total con-tract price among the countries, as de-scribed in § 1.5000C–1(e)(3), if applica-ble. In general, the Section 5000CCertificate also must include the total con-tract price and the nonexempt amount;however, when necessary, an estimate ofthe total contract price or the nonexemptamount may be used. For example, totalcontract price may be estimated when aSection 5000C Certificate is being com-pleted with respect to payments to bemade pursuant to a cost-reimbursementcontract that is paid on the basis of actualincurred costs and the total amount ofsuch costs is not known at the time thecertificate is provided.

(2) Specific identification of exemptitems. If agreed to by the acquiringagency, the Section 5000C Certificatemay identify specific exempt and nonex-empt amounts. For example, specific con-tract line items (such as a contract lineitem number or CLIN) identified in thecontract may be listed on the Section5000C Certificate as exempt and nonex-empt amounts (in whole or in part), asapplicable. When this paragraph applies,and whether or not the contract identifiesexempt and nonexempt amounts, a foreigncontracting party must provide the infor-mation required by paragraphs (d)(4)(iii)(A) and (d)(4)(iii)(B)(1) of this section, onthe Section 5000C Certificate to explainwhy the contract line items are eligible foran exemption; however, the foreign con-tracting party is not required to includeinformation about the total contract priceunder this paragraph. In these circum-stances, only one Section 5000C Certifi-cate is required to be provided identifyingthe exempt and nonexempt contract lineitems that relate to the contract (for exam-ple, a spreadsheet may be attached to theSection 5000C Certificate that identifiesthe contract line items with an explanationfor the treatment as exempt or nonex-empt).

(5) Validity period of Section 5000CCertificate. Except as otherwise providedin paragraph (d)(6) of this section, theSection 5000C Certificate is valid for theterm of the contract.


(6) Change in circumstances. A for-eign contracting party must submit a re-vised Section 5000C Certificate within 30days of a change in circumstances thatcauses the information in a Section 5000CCertificate held by the acquiring agency tobe incorrect with respect to the acquiringagency’s determination of whether towithhold or the amount of withholdingunder Section 5000C. An acquiringagency must request a new Section 5000CCertificate from a contracting party in cir-cumstances in which it knows (or has rea-son to know) that a previously submittedSection 5000C Certificate becomes incor-rect or unreliable. An acquiring agencymay request an updated Section 5000CCertificate at any time, including whenother documentation is required under thecontract, such as the annual representa-tions and certifications required in 48 CFR4.1201. See § 1.5000C–6, Example 6, foran illustration of this paragraph (6).

(7) Form W–14. A foreign contractingparty may choose to use Form W–14,“Certificate of Foreign Contracting PartyReceiving Federal Procurement Pay-ments” (or other form that the IRS mayprescribe), as its Section 5000C Certifi-cate, provided that it includes all the nec-essary information required by this para-graph (d).

(8) Time for submitting Section 5000CCertificate. A contracting party must sub-mit the Section 5000C Certificate (such asForm W–14 or Form W–9) as early aspracticable (for example, when the offerfor the contract is submitted to the U.S.government). In all cases, however, theSection 5000C Certificate must be submit-ted to the acquiring agency no later thanthe date of execution of the contract.

(e) Offset for underwithholding oroverwithholding—(1) In general. If theforeign contracting party discovers thatamounts withheld on prior payments ei-ther were insufficient or in excess of theamount required to satisfy its tax liabilityunder section 5000C, the foreign contract-ing party may request the acquiringagency to increase or decrease the amountof withholding on future payments forwhich withholding is required under sec-tion 5000C. The request must be in writ-ing, signed under penalties of perjury,contain the amount by which the foreigncontracting party requests to increase or

decrease future amounts withheld undersection 5000C, and explain the reason forthe request. The request may be submittedin conjunction with an original or updatedSection 5000C Certificate.

(2) Underwithholding. Upon receipt ofa request described in paragraph (e)(1) ofthis section, acquiring agencies may in-crease the amount of withholding underthis paragraph to correct underwithhold-ing only if the payment for which theincrease is applied is otherwise subject towithholding under section 5000C andmade before the date that Form 1042,“Annual Withholding Tax Return for U.S.Source Income of Foreign Persons,” isrequired to be filed (not including exten-sions) with respect to the payment forwhich the underwithholding occurred.Amounts withheld under this paragraphmust be deposited and reported in the timeand manner as prescribed by§ 1.5000C–3. See § 1.5000C–4 for proce-dures for a foreign contracting party thatmust pay tax due when its tax liabilityunder section 5000C was not fully satis-fied by withholding by an acquiringagency.

(3) Overwithholding. Upon receipt of arequest described in paragraph (e)(1) ofthis section, acquiring agencies may de-crease the amount of withholding on sub-sequent payments made to the foreigncontracting party that are otherwise sub-ject to withholding under section 5000Cprovided that the payment for which thedecrease is applied is made on or beforethe date on which Form 1042, “AnnualWithholding Tax Return for U.S. SourceIncome of Foreign Persons,” is required tobe filed (not including extensions) withrespect to the payment for which the over-withholding occurred. See § 1.5000C–4(e) for procedures for foreign contractingparties to file a claim for refund for theoverwithheld amount under section5000C.

§ 1.5000C–3 Payment and returns oftax withheld by the acquiring agency.

(a) In general. This section providesadministrative procedures that acquiringagencies must follow to satisfy their obli-gations to deposit and report amountswithheld under § 1.5000C–2. An acquir-ing agency with a section 5000C with-holding obligation must increase theamount it deducts and withholds under

chapter 3 for fixed or determinable annualor periodical income (FDAP income) bythe amount it must withhold under§ 1.5000C–2. Accordingly, this sectiongenerally applies the administrative provi-sions of chapter 3 for FDAP income re-lating to the deposit, payment, and report-ing for amounts withheld under§ 1.5000C–2, and contains some variationfrom those provisions to take into accountthe nature of the tax imposed under sec-tion 5000C.

(b) Deposit rules—(1) Acquiringagency with a chapter 3 deposit require-ment treats amounts withheld as underchapter 3. If an acquiring agency has achapter 3 deposit obligation for a period, itmust treat any amount withheld under§ 1.5000C–2 as an additional amount oftax withheld under chapter 3 for purposesof the deposit rules of § 1.6302–2. Thus,depending on the combined amount with-held under chapter 3 and § 1.5000C–2, anacquiring agency subject to this paragraph(b)(1) must make monthly deposits,quarter-monthly deposits, or annual de-posits under the rules in § 1.6302–2. Tothe extent provided in forms, instructions,or publications prescribed by the InternalRevenue Service (IRS), acquiring agen-cies must deposit all withheld amounts byelectronic funds transfer, as that term isdefined in § 31.6302–1(h)(4)(i) of thischapter.

(2) Acquiring agency with no chapter 3filing obligation deposits withheldamounts monthly. If an acquiring agencyhas no chapter 3 deposit obligation towhich the deposit rules of § 1.6302–2apply for a calendar month, it must makemonthly deposits of the amounts withheldunder the rules in this paragraph (b)(2).Thus, an acquiring agency with no chapter3 deposit obligations and that has with-held any amount under § 1.5000C–2 dur-ing any calendar month must deposit thatamount by the 15th day of the monthfollowing the payment. To the extent pro-vided in forms, instructions, or publica-tions prescribed by the Internal RevenueService (IRS), acquiring agencies mustdeposit all withheld amounts by electronicfunds transfer, as that term is defined in§ 31.6302–1(h)(4)(i) of this chapter.

(c) Return requirements—(1) In gen-eral. Except as provided in paragraph(c)(2) of this section, an acquiring agency


that withholds an amount pursuant to sec-tion 5000C generally must file Form1042–S, “Foreign Person’s U.S. SourceIncome Subject to Withholding,” andForm 1042, “Annual Withholding TaxReturn for U.S. Source Income of ForeignPersons,” each year, or other such formsas the IRS may prescribe, to report infor-mation related to amounts withheld undersection 5000C. The acquiring agencymust prepare a Form 1042–S for eachcontracting party reporting the amountwithheld under section 5000C for the pre-ceding calendar year. The Form 1042must show the aggregate amounts with-held under section 5000C that were re-quired to be reported on Forms 1042–S(including those amounts withheld undersection 5000C for which a Form 1042–Sis not required to be filed pursuant toparagraph (c)(2) of this section). TheForm 1042 must also include the informa-tion required by the form and accompany-ing instructions. Further, any forms re-quired under this paragraph (c) are due atthe same time, at the same place, andeligible for the same extended due datesand may be amended in the same manneras Form 1042 and Form 1042–S (or suchother forms as the IRS may prescribe re-lated to chapter 3). The acquiring agencymust furnish a copy of the Form 1042–S(or such other form as the IRS may pre-scribe for the same purpose) to the con-tracting party for whom the form is pre-pared on or before March 15 of thecalendar year following the year in whichthe amount subject to reporting under sec-tion 5000C was paid. It must be filed witha transmittal form as provided in the in-structions for Form 1042–S and to thetransmittal form. Section 5000C Certifi-cates or other statements or information asprescribed by § 1.5000C–2 that are pro-vided to the acquiring agency are not re-quired to be attached to the Form 1042filed with the IRS. However, an acquiringagency that is required to file Form 1042must retain a copy of Form 1042, Form1042–S, the Section 5000C Certificates,or other statements or information pre-scribed by § 1.5000C–2 for at least threeyears from the original due date of Form1042 or the date it was filed, whichever islater. An acquiring agency that is not re-quired to file Form 1042 must retain anySection 5000C Certificates or other state-

ments or information as prescribed by§ 1.5000C–2 for at least three years fromthe date the Form 1042 would have beendue had the acquiring agency had an ob-ligation to file.

(2) Classified or confidential contracts.An acquiring agency is not required toreport information otherwise required bythis section on Form 1042–S for paymentsmade pursuant to classified or confidentialcontracts (as described in section6050M(e)(3)), unless the acquiringagency determines that the informationreported on the Form 1042–S does notcompromise the safeguarding of classifiedinformation or national security.

(d) Special arrangement for certaincontracts. In limited circumstances, theIRS may authorize the amount otherwiserequired to be withheld under section5000C to be deposited in the time andmanner mutually agreed upon by the ac-quiring agency and the foreign contractingparty. In these circumstances, the IRSmay in its sole discretion also modify anyreporting or return requirements of theacquiring agency or the foreign contract-ing party.

§ 1.5000C–4 Requirement for theforeign contracting party to file a returnand pay tax, and procedures for thecontracting party to seek a refund.

(a) In general. For purposes of subtitleF of the Internal Revenue Code (“Proce-dure and Administration”), the tax im-posed under section 5000C on foreignpersons is treated as a tax imposed undersubtitle A. Except as provided elsewherein the regulations under section 5000C,forms, or accompanying instructions, thetax imposed on foreign contracting partiesunder section 5000C is administered in amanner similar to gross basis incometaxes. This section provides proceduresthat a foreign contracting party must fol-low to satisfy its obligations to report anddeposit tax due under § 1.5000C–1 as wellas procedures for contracting parties toseek a refund of amounts overwithheld.

(b) Tax obligation of foreign contract-ing party independent of withholding. Aforeign contracting party subject to taxunder section 5000C and §§ 1.5000C–1through 1.5000C–7 remains liable for thetax unless its tax obligation was fully sat-

isfied by withholding by an acquiringagency in accordance with §§ 1.5000C–2and 1.5000C–3.

(c) Return of tax by the foreign con-tracting party. If the tax liability under§ 1.5000C–1 relating to a payment is notfully satisfied by withholding in accor-dance with §§ 1.5000C–2 and 1.5000C–3(including as a result of the use of anestimated nonexempt amount or estimatedtotal contract price in computing the con-tract ratio), a foreign contracting partysubject to tax under § 1.5000C–1 during acalendar year must make a return of taxon, for example, Form 1120–F, “U.S. In-come Tax Return of a Foreign Corpora-tion,” or such other form as the InternalRevenue Service (IRS) may prescribe toreport the amount of tax due under section5000C (required return). A foreign con-tracting party with no other U.S. tax filingobligation other than with respect to itsliability for the tax imposed under section5000C must file its required return on orbefore the fifteenth day of the sixth monthfollowing the close of its taxable year. Therequired return must include the informa-tion required by the form and accompany-ing instructions. The required return mustbe filed at the place and time (includingany extension of time to file) provided bythe form and accompanying instructions.Penalties for failure to file contained inSubtitle F can apply to foreign contractingparties who fail to file the required return.A foreign contracting party must attachcopies of all Forms 1042–S, “Foreign Per-son’s U.S. Source Income Subject toWithholding,” received from acquiringagencies (if any) to the required return.

(d) Time and manner of paying tax. Aforeign contracting party must pay the taximposed under section 5000C in the man-ner provided and in the time prescribed inthe required return and accompanying in-structions. In general, the foreign con-tracting party must pay the tax at the timethat the required return is due, excludingextensions. To the extent provided informs, instructions, or publications pre-scribed by the IRS, each foreign contract-ing party must deposit tax due under sec-tion 5000C by electronic funds transfer,as that term is defined in § 31.6302–1(h)(4)(i) of this chapter. A foreign con-tracting party that fails to pay tax in thetime and manner prescribed in this section


(or under forms, instructions, or publica-tions prescribed by the IRS under thissection) may be subject to penalties andinterest under Subtitle F.

(e) Refund requests when amount with-held exceeds tax liability. After taking intoaccount any offsets pursuant to§ 1.5000C–2(e)(3), if the acquiringagency has overwithheld amounts undersection 5000C and has made a deposit ofthe amounts under § 1.5000C–3(b), thecontracting party may claim a refund ofthe amount overwithheld pursuant to theprocedures described in chapter 65. Thecontracting party’s claim for refund mustmeet the requirements of section 6402 andthe regulations thereunder, as applicable,and must be filed before the expiration ofthe period of limitations on refund in sec-tion 6511 and the regulations thereunder.In general, the contracting party making arefund claim must file the required returnto claim a refund, stating the groundsupon which the claim is based. A Section5000C Certificate and a copy of the Form1042–S received from the acquiringagency must be attached to the requiredreturn. For purposes of this section, anamount is overwithheld if the amountwithheld from the payment pursuant tosection 5000C and §§ 1.5000C–1 through1.5000C–7 exceeds the contracting par-ty’s tax liability under § 1.5000C–1, re-gardless of whether the overwithholdingwas in error or appeared correct when itoccurred. A U.S. person may seek a re-fund under this paragraph (e) even if itwas treated as a foreign person under therules in § 1.5000C–2 (for example, be-cause it neither had a taxpayer identifica-tion number on file in the System forAward Management nor submitted FormW–9, “Request for Taxpayer Identifica-tion Number (TIN) and Certification,” tothe acquiring agency).

§ 1.5000C–5 Anti-abuse rule.

If a foreign person engages in a trans-action (or series of transactions) with aprincipal purpose of avoiding the tax im-posed under section 5000C, the transac-tion (or series of transactions) may bedisregarded or the arrangement may berecharacterized (including disregarding anintermediate entity), in accordance withits substance. If this section applies, the

foreign person remains liable for any tax(including any tax obligation unsatisfiedas a result of underwithholding) and theInternal Revenue Service retains all otherrights and remedies under any applicablelaw available to collect any tax imposedon the foreign contracting party by section5000C.

§ 1.5000C–6 Examples.

The rules of §§ 1.5000C–1 through1.5000C–4 are illustrated by the follow-ing examples. For purposes of the exam-ples: All contracts are executed with ac-quiring agencies on or after January 2,2011, and are for the provision of eithergoods or services; none of the exemptionsdescribed in § 1.5000C–1(d) apply, unlessotherwise explicitly stated; the acquiringagencies have no other withholding obli-gations under chapter 3 of the Code andhave no other contracts subject to section5000C; the foreign contracting parties donot have any U.S. source income or a U.S.tax return filing obligation other than a taxreturn filing obligation that arises basedon the facts described in the particularexample; and none of the contracts areclassified or confidential contracts as de-scribed in section 6050M(e)(3).

Example 1. U.S. person not subject to tax; nowithholding. (i) Facts. Company A Inc., a domesticcorporation and the contracting party, enters into acontract with Agency L, the acquiring agency. Be-fore making its first payment under the contract (forexample, on the date of execution of the contract),pursuant to the first step in § 1.5000C–2(b), AgencyL determines that the contract will be for services.Under the second step, Agency L reviews CompanyA Inc.’s record in the System for Award Manage-ment (SAM) and determines that Company A is acorporation and is considered to be a U.S. personbecause Agency L’s records demonstrate that Com-pany A Inc. is a business entity treated as a corpo-ration for tax purposes that has a TIN that does notbegin with “98.”

(ii) Analysis. Company A Inc. is a U.S. personand thus is not subject to the tax under section5000C. Moreover, because Company A Inc. is acorporation for tax purposes that has a TIN that doesnot begin with “98,” Agency L is able to determinethat it has no obligation to withhold any amountsunder section 5000C on the payment made to Com-pany A Inc. For purposes of section 5000C, Com-pany A Inc. could also establish that it is a U.S.person by providing a Form W–9, “Request forTaxpayer Identification Number (TIN) and Certifi-cation,” to Agency L. Company A Inc. does not needto file a Section 5000C Certificate to demonstrate itseligibility for an exemption from withholding.

Example 2. Foreign national entitled to thebenefit of a nondiscrimination provision of a trea-ty; no withholding. (i) Facts. Company B, a for-eign contracting party and a national of Country T,provides goods to Agency M, the acquiringagency. Company B determines that it is exemptfrom tax under section 5000C because it is entitledto the benefit of the nondiscrimination article of aqualified income tax treaty between the UnitedStates and Country T. Company B submits a Sec-tion 5000C Certificate to Agency M when thecontract is executed. Company B uses FormW–14, “Certificate of Foreign Contracting PartyReceiving Federal Procurement Payments,” andproperly fills the relevant sections stating the nameof the treaty, the specific article relied upon, andthe basis on which it is entitled to the benefits ofthat article. Following the steps in § 1.5000C–2,Agency M determines that the nondiscriminationprovision of the Country T-United States incometax treaty applies to exempt Company B from thetax imposed under section 5000C. Agency Mmakes one lump sum payment of $50 million toCompany B pursuant to the contract.

(ii) Analysis. Company B has no liability for taxunder section 5000C because it is entitled to thebenefit of a nondiscrimination article of a qualifiedincome tax treaty. Because Company B submitted aSection 5000C Certificate meeting the requirementsin § 1.5000C–2 and Agency M does not have reasonto know that the submitted information is incorrector unreliable, Agency M is not required to withholdunder section 5000C. Agency M must retain theSection 5000C Certificate for at least three yearspursuant to § 1.5000C–3(c)(1) from the due date forthe Form 1042 (if it were required).

Example 3. Foreign treaty beneficiary does notsubmit Section 5000C Certificate; withholding re-quired. (i) Facts. The facts are the same as in Ex-ample 2, except that Company B does not submit aSection 5000C Certificate to Agency M beforeAgency M makes the $50 million payment.

(ii) Analysis. Company B is not subject to taxunder section 5000C, but Agency M must never-theless withhold on the payment made to Com-pany B because Agency M did not receive a Sec-tion 5000C Certificate from Company B in thetime and manner required pursuant to § 1.5000C–2(d). Agency M must withhold $1 million (2 per-cent of $50 million) on the payment, and depositthat amount under the rules in § 1.5000C–3 nolater than the 15th day of the month following themonth in which the payment was made. Agency Mmust also complete Forms 1042, “Annual With-holding Tax Return for U.S. Source Income ofForeign Persons,” and 1042–S, “Foreign Person’sU.S. Source Income Subject to Withholding,” onor before the date specified on those forms and theaccompanying instructions. Agency M must fur-nish copies of Form 1042–S to Company B.Agency M must retain a copy of the Form 1042and the Form 1042–S for 3 years from the due datefor the Form 1042 pursuant to § 1.5000C–3(c)(1).As Company B is not liable for the tax, it may laterfile a claim for refund pursuant to the proceduresdescribed in chapter 65.

Example 4. Foreign contracting party partiallyexempt from tax under section 5000C when goods


are manufactured in different countries. (i) Facts.Company C, a foreign contracting party, providesgoods to Agency N in 2015. The terms of the con-tract require that payment be made to Company C byAgency N in two $5 million installments in 2015.Company C has a TIN that begins with “98” and isnot entitled to relief pursuant to an internationalagreement with the United States, such as reliefpursuant to a nondiscrimination provision of a qual-ified income tax treaty. Some of the goods are man-ufactured in Country R, which is a party to aninternational procurement agreement with the UnitedStates, with the remainder being manufactured inCountry S, a country that is not a party to an inter-national procurement agreement with the UnitedStates. Company C uses a reasonable allocationmethod based on the information available to it at thetime in accordance with § 1.5000C–1(e)(3) to esti-mate that $3 million is the nonexempt amount that isallocated to the goods produced in Country S. Com-pany C submits a valid and complete Section 5000CCertificate to Agency N in the time and mannerrequired by §§ 1.5000C–1 through 1.5000C–7 thatprovides that the nonexempt amount is $3 million. In2015, Agency N pays Company C in two install-ments pursuant to the terms of the contract.

(ii) Analysis. Using a reasonable allocationmethod to determine the estimated nonexemptamount, Company C determines that pursuant tosection 5000C and §§ 1.5000C–1 through1.5000C–7, tax of $30,000 (2 percent of the $5million payment, or $100,000 multiplied by a frac-tion, the numerator of which is the estimated non-exempt amount, $3 million, and the denominatorof which is the estimated total contract price, or$10 million) is imposed on each payment made toCompany C. Because Company C has timely sub-mitted a Section 5000C Certificate explaining thebasis for this allocation, Agency N withholds$30,000 on each payment made to Company C.Agency N must deposit each $30,000 withholdingtax under the rules in § 1.5000C–3 no later thanthe 15th day of the month following the month inwhich each payment is made. Agency N must alsocomplete Forms 1042 and 1042–S and furnishcopies of Form 1042–S to Company C. Agency Nmust retain a copy of the Form 1042 and the Form1042–S for at least three years from the due datefor the Form 1042 pursuant to § 1.5000C–3(c)(1).Provided that Agency N properly withholds on thenonexempt portion as required under section5000C and §§ 1.5000C–1 through 1.5000C–7 andthat Company C’s estimate of the nonexemptamount is the actual nonexempt amount, CompanyC does not have an additional tax liability or aU.S. tax return filing obligation as a result ofreceiving the payments.

Example 5. Foreign contracting party liable foradditional tax under Section 5000C not fully with-held upon due to errors on the Section 5000C Cer-tificate. (i) Facts. The facts are the same as in Ex-ample 4, except that the Section 5000C Certificatesubmitted to Agency N by Company C erroneouslyprovides that the estimated nonexempt amount is$1.5 million instead of $3 million. As a result,Agency N only withholds $15,000 (2 percent of the$5 million payment multiplied by a fraction (thenumerator of which is the estimated nonexempt

amount stated on the Section 5000C Certificate, $1.5million, and the denominator of which is the esti-mated total contract price, or $10 million)) on eachpayment made to Company C. Agency N neitherdiscovered nor had reason to know that the informa-tion on the Section 5000C Certificate was incorrector unreliable. After both payments have been madeand after the filing due date for Form 1042 for 2015,Company C determines that the estimated nonex-empt amount should have been stated as $3 millionon the Section 5000C Certificate.

(ii) Analysis. The tax imposed under section5000C on Company C as a result of the receipt ofspecified Federal procurement payments is $60,000and this amount has not been fully satisfied by with-holding by Agency N. Accordingly, Company Cmust remit additional tax of $30,000 ($60,000 taxliability less $30,000 amounts already withheld byAgency N) and file its required return, a Form1120–F, “U.S. Income Tax Return of a ForeignCorporation,” for 2015 to report this tax liability, asrequired by § 1.5000C–4. Company C must explainits corrected allocation method in its Form 1120–F.Company C must also attach a copy of the Form1042–S it received from Agency N to Form 1120–F.

Example 6. Foreign contracting party submitsrevised Section 5000C Certificate due to change incircumstances. (i) Facts. The facts are the same as inExample 4, except that, after the first payment, Com-pany C changes its business so that all of the goodsmanufactured with respect to the second payment aremanufactured in Country R. Prior to the secondpayment, Company C submits a revised Section5000C Certificate indicating this change in circum-stance pursuant to § 1.5000C–2(d)(6).

(ii) Analysis. Agency N withholds $30,000 onthe first payment made to Company C and does notwithhold on the second payment. Company C doesnot have an additional tax liability or a U.S. taxreturn filing obligation as a result of receiving thepayments.

§ 1.5000C–7 Effective/applicability date.

Section 5000C applies to specifiedFederal procurement payments receivedpursuant to contracts entered into on andafter January 2, 2011. Sections1.5000C–1 through 1.5000C–7 apply onand after November 15, 2016. Contract-ing parties and acquiring agencies mayrely upon the rules in the regulationsbefore such date. If a foreign contractingparty fully satisfies its tax and filingobligations under section 5000C withrespect to any payments received in taxyears ending before November 15, 2016on or before the later of November 15,2016 or the due date for the foreignperson’s income tax return for the yearin which the payment was received in amanner consistent with the final regula-tions, penalties will not be asserted on

the foreign contracting parties with re-spect to those payments or returns.

PART 301—PROCEDURE ANDADMINISTRATION

Par. 4. The authority citation for part301 continues to read in part as follows:

Authority: 26 U.S.C. 7805* * *Par. 5. Section 301.6114–1 is amended

by adding paragraph (c)(1)(ix) and revis-ing paragraph (e) to read as follows:

§ 301.6114–1 Treaty-based returnpositions.

* * * * *(c) * * *(1) * * *(ix) Notwithstanding paragraph (b)(1)

of this section, that a nondiscriminationprovision of a qualified income tax treaty,as defined in Treas. Reg. § 1.5000C–1(c)(13), exempts a payment from tax un-der section 5000C, but only if the foreignperson claiming such relief has provided aSection 5000C Certificate (such as FormW–14, “Certificate of Foreign ContractingParty Receiving Federal ProcurementPayments”) to the acquiring agency in ac-cordance with section 5000C and the reg-ulations thereunder.

* * * * *(e) Effective/applicability date—(1) In

general. This section is effective for tax-able years of the taxpayer for which thedue date for filing returns (without exten-sions) occurs after December 31, 1988.However, if—

(i) A taxpayer has filed a return forsuch a taxable year, without complyingwith the reporting requirement of this sec-tion, before November 13, 1989, or

(ii) A taxpayer is not otherwise than byparagraph (a) of this section required tofile a return for a taxable year before No-vember 13, 1989, such taxpayer must file(apart from any earlier filed return) thestatement required by paragraph (d) ofthis section before June 12, 1990, by mail-ing the required statement to the InternalRevenue Service, P.O. Box 21086, Phila-delphia, PA 19114. Any such statementfiled apart from a return must be dated,signed and sworn to by the taxpayer underthe penalties of perjury. In addition, withrespect to any return due (without exten-sions) on or before March 10, 1990, the


reporting required by paragraph (a) of thissection must be made no later than June12, 1990. If a taxpayer files or has filed areturn on or before November 13, 1989,that provides substantially the same infor-mation required by paragraph (d) of thissection, no additional submission will berequired. Foreign insurers and reinsurerssubject to reporting described in para-graph (c)(7)(ii) of this section must soreport for calendar years 1988 and 1989no later than August 15, 1990.

(2) Section 5000C. Paragraph (c)(1)(ix)of this section applies to payments madeon and after November 15, 2016 pursuantto contracts entered into on and after Jan-uary 2, 2011. However, a taxpayer thatreceives payments exempt from tax undersection 5000C by reason of a qualifiedincome tax treaty before November 15,2016 is not required to disclose this posi-tion on Form 8833, provided it has prop-erly relied on Notice 2015–35, I.R.B.2016–14, 533, in claiming the exemp-tion.* * * * *

PART 602—OMB CONTROLNUMBERS UNDER THEPAPERWORK REDUCTION ACT

Par. 6. The authority citation for part602 continues to read in part as follows:

Authority: 26 U.S.C. 7805* * *Par. 7. In § 602.101, paragraph (b) is

amended by adding entries in numericalorder to the table to read as follows:

§ 602.101 OMB Control numbers.

* * * * *(b) * * *

CFR part orsection whereidentified and

describedCurrent OMBControl No.

* * * * *

1.5000C–2 ............... 1545-0096

1545-2263

1.5000C–3 ............... 1545-0096

1545-2263

1.5000C–4 ............... 1545-1223

1545-0074

* * * * *

John M. Dalrymple,Deputy Commissioner for Services and

Enforcement.Approved: July 22, 2016.

Mark D. Mazur,Assistant Secretary of the Treasury (Tax

Policy).

(Filed by the Office of the Federal Register on August 17,2016, 8:45 a.m., and published in the issue of the FederalRegister for August 18, 2016, 81 F.R. 55133)


Part III. Administrative, Procedural, and Miscellaneous26 CFR 601.105: Examination of returns and claimsfor refund, credit, or abatement; determination ofcorrect tax liability.

Rev. Proc. 2016–43SECTION 1. PURPOSE

This revenue procedure provides themonthly national average premium forqualified health plans that have a bronzelevel of coverage and are offered thoughExchanges for taxpayers to use in deter-mining their maximum individual sharedresponsibility payment under § 5000A(c)(1)(B) of the Internal Revenue Codeand § 1.5000A–4 of the Income TaxRegulations.

SECTION 2. BACKGROUND

.01 Section 5000A provides that if ataxpayer, or an individual for whom thetaxpayer is liable, is without minimumessential coverage for one or more monthsin a taxable year, then the taxpayer isliable for the individual shared responsi-bility payment when filing his or her fed-eral income tax return, unless an exemp-tion applies. See § 5000A(a), (b)(1). Ingeneral, under § 5000A a taxpayer is lia-ble for any individual who is a dependent,as defined in § 152, of the taxpayer. See§§ 5000A(b)(3)(A) and 1.5000A–1(c).Married individuals who file a joint returnfor a taxable year are jointly liable for anyindividual shared responsibility paymentfor a month included in the taxable year.See §§ 5000A(b)(3)(B) and 1.5000A–1(c)(3).

.02 For each taxable year, the individ-ual shared responsibility payment is thelesser of (1) the sum of the monthly pen-alty amounts, or (2) the sum of themonthly national average bronze plan pre-miums for the shared responsibility fam-ily. See § 1.5000A–4(a). The monthly na-tional average bronze plan premiummeans, for a month for which a sharedresponsibility payment is imposed, 1/12of the annual national average premiumfor qualified health plans that (1) have abronze level of coverage, (2) would pro-vide coverage for the taxpayer’s sharedresponsibility family members, and (3) areoffered through Exchanges for plan yearsbeginning in a calendar year with or

within which the taxable year ends. See§§ 5000A(c)(1)(B) and 1.5000A–4(c).Shared responsibility family means, for amonth in a taxable year, all nonexemptindividuals for whom the taxpayer and thetaxpayer’s spouse, if the taxpayer is mar-ried and files a joint return with thespouse, are liable for the shared responsi-bility payment under § 5000A for thattaxable year. See § 1.5000A–1(d)(17).

.03 Revenue Procedure 2014–46,2014–12 C.B. 367, describes the method-ology used to determine the monthly na-tional average bronze plan premium andprovides the premium amount for 2014.Revenue Procedure 2015–15, 2015–5I.R.B. 564, provides the premium amountfor 2015.

SECTION 3. MONTHLYNATIONAL AVERAGE BRONZEPLAN PREMIUM

.01 Monthly National Average BronzePlan Premium. For purposes of§ 5000A(c)(1)(B) and § 1.5000A–4, themonthly national average premium forqualified health plans that have a bronzelevel of coverage and are offered throughExchanges is $223 per individual.

.02 Maximum Monthly National Aver-age Bronze Plan Premium. For purposesof § 5000A(c)(1)(B) and § 1.5000A–4,the maximum monthly national averagepremium for qualified health plans thathave a bronze level of coverage and areoffered through Exchanges is $1,115 for ashared responsibility family with five ormore members.

SECTION 4. EFFECTIVE DATE

This revenue procedure is effective fortaxable years ending after December 31,2015.

SECTION 5. EFFECT ON OTHERDOCUMENTS

Revenue Procedure 2015–15 is super-seded.

SECTION 6. DRAFTINGINFORMATION

The principal author of this revenueprocedure is John B. Lovelace of the Of-

fice of Associate Chief Counsel (IncomeTax and Accounting). For further infor-mation regarding this revenue procedure,contact Mr. Lovelace at (202) 317-7006(not a toll-free number).

26 CFR 601.601: Rules and regulations.(Also:§§ 141, 145, 1.141–3, 1.145–2)

Rev. Proc. 2016–44

SECTION 1. PURPOSE

This revenue procedure provides safeharbor conditions under which a manage-ment contract does not result in privatebusiness use of property financed withgovernmental tax-exempt bonds under§ 141(b) of the Internal Revenue Code orcause the modified private business usetest for property financed with qualified501(c)(3) bonds under § 145(a)(2)(B) tobe met.

SECTION 2. BACKGROUND

.01 Section 103(a) provides that, ex-cept as provided in § 103(b), gross incomedoes not include interest on any State orlocal bond. Section 103(b)(1) providesthat § 103(a) shall not apply to any privateactivity bond that is not a qualified bond(within the meaning of section 141). Sec-tion 141(a) provides that the term “privateactivity bond” means any bond issued aspart of an issue (1) that meets the privatebusiness use test and private security orpayment test, or (2) that meets the privateloan financing test.

.02 Section 141(b)(1) provides gener-ally that an issue meets the private busi-ness use test if more than 10 percent of theproceeds of the issue are to be used forany private business use. Section141(b)(6) defines “private business use”as use (directly or indirectly) in a trade orbusiness carried on by any person otherthan a governmental unit. For this pur-pose, any activity carried on by a personother than a natural person must be treatedas a trade or business use.

.03 Section 1.141–3(a)(1) of the In-come Tax Regulations provides, in part,that the 10 percent private business usetest of § 141(b)(1) is met if more than 10percent of the proceeds of an issue is used


in a trade or business of a nongovernmen-tal person. For this purpose, the use offinanced property is treated as the directuse of proceeds. Section 1.141–3(a)(2)provides that, in determining whether anissue meets the private business use test, itis necessary to look at both indirect anddirect use of proceeds. Proceeds aretreated as used in the trade or business ofa nongovernmental person if a nongovern-mental person, as a result of a single trans-action or a series of related transactions,uses property acquired with the proceedsof an issue.

.04 Section 1.141–3(b)(1) provides thatboth actual and beneficial use by a non-governmental person may be treated asprivate business use. In most cases, theprivate business use test is met only if anongovernmental person has special legalentitlements to use the financed propertyunder an arrangement with the issuer. Ingeneral, a nongovernmental person istreated as a private business user as aresult of ownership; actual or beneficialuse of property pursuant to a lease, a man-agement contract, or an incentive paymentcontract; or certain other arrangementssuch as a take or pay or other output-typecontract.

.05 Section 1.141–3(b)(3) providesgenerally that the lease of financed prop-erty to a nongovernmental person is pri-vate business use of that property. For thispurpose, any arrangement that is properlycharacterized as a lease for federal incometax purposes is treated as a lease. Section1.141–3(b)(3) further provides that, in de-termining whether a management contractis properly characterized as a lease, it isnecessary to consider all the facts andcircumstances, including the followingfactors: (1) the degree of control over theproperty that is exercised by the nongov-ernmental person; and (2) whether a non-governmental person bears the risk of lossof the financed property.

.06 Section 1.141–3(b)(4)(i) providesgenerally that a management contract withrespect to financed property may result inprivate business use of that property,based on all of the facts and circum-stances. A management contract with re-spect to financed property generally re-sults in private business use of thatproperty if the contract provides for com-pensation for services rendered with com-

pensation based, in whole or in part, on ashare of net profits from the operations ofthe facility. Section 1.141–3(b)(4)(iv) pro-vides generally that a management con-tract with respect to financed property re-sults in private business use of thatproperty if the service provider is treatedas the lessee or owner of financed prop-erty for federal income tax purposes.

.07 Section 1.141–3(b)(4)(ii) defines“management contract” as a management,service, or incentive payment contract be-tween a governmental person and a ser-vice provider under which the service pro-vider provides services involving all, aportion, or any function, of a facility. Forexample, a contract for the provision ofmanagement services for an entire hospi-tal, a contract for management services fora specific department of a hospital, and anincentive payment contract for physicianservices to patients of a hospital are eachtreated as a management contract.

.08 Section 1.141–3(b)(4)(iii) providesthat the following arrangements generallyare not treated as management contractsthat give rise to private business use: (A)contracts for services that are solely inci-dental to the primary governmental func-tion or functions of a financed facility (forexample, contracts for janitorial, officeequipment repair, hospital billing, or sim-ilar services); (B) the mere granting ofadmitting privileges by a hospital to adoctor, even if those privileges are condi-tioned on the provision of de minimisservices if those privileges are available toall qualified physicians in the area, con-sistent with the size and nature of thehospital’s facilities; (C) a contract to pro-vide for the operation of a facility or sys-tem of facilities that consists primarily ofpublic utility property, if the only com-pensation is the reimbursement of actualand direct expenses of the service pro-vider and reasonable administrative over-head expenses of the service provider; and(D) a contract to provide for services, ifthe only compensation is the reimburse-ment of the service provider for actual anddirect expenses paid by the service pro-vider to unrelated parties.

.09 Section 141(e) provides, in part,that the term “qualified bond” includes aqualified 501(c)(3) bond if certain require-ments stated therein are met. Section145(a) provides generally that “qualified

501(c)(3) bond” means any private activ-ity bond issued as part of an issue if (1) allproperty that is to be provided by the netproceeds of the issue is to be owned by a501(c)(3) organization or a governmentalunit, and (2) such bond would not be aprivate activity bond if (A) 501(c)(3) or-ganizations were treated as governmentalunits with respect to their activities that donot constitute unrelated trades or busi-nesses, determined by applying § 513(a),and (B) § 141(b)(1) and (2) were appliedby substituting “5 percent” for “10 per-cent” each place it appears and by substi-tuting “net proceeds” for “proceeds” eachplace it appears. Section 1.145–2 providesthat, with certain exceptions and modifi-cations, §§ 1.141–0 through 1.141–15 ap-ply to § 145(a).

.10 Rev. Proc. 97–13, 1997–1 C.B.632, modified by Rev. Proc. 2001–39,2001–2 C.B. 38, and amplified by Notice2014–67, 2014–46 I.R.B. 822, sets forthconditions under which a managementcontract does not result in private businessuse under § 141 or cause the modifiedprivate business use test under§ 145(a)(2)(B) to be met. These condi-tions include constraints on net profits ar-rangements, the permitted term of themanagement contract, the types of com-pensation, and the relationship betweenthe parties.

.11 Rev. Proc. 97–13 as originally is-sued (the original safe harbors) specifiesvarious permitted terms of contracts thatdepend on the extent to which the com-pensation is a fixed amount (that is, thegreater the percentage of fixed compensa-tion, the longer the permitted term of themanagement contract). For example, theoriginal safe harbors permit (i) contractsof up to 15 years if at least 95 percent ofthe compensation consists of a periodicfixed fee, and (ii) contracts of two to fiveyears if greater percentages of the com-pensation consist of variable fees, depend-ing on the particular type of variable fee.Subsequently, in Notice 2014–67, theTreasury Department and the InternalRevenue Service expanded these safe har-bors to address certain developments in-volving accountable care organizations af-ter the enactment of the Patient Protectionand Affordable Care Act, Pub. L. 111–148, 124 Stat. 119 (Affordable Care Act),and also to allow a broader range of vari-


able compensation arrangements forshorter-term management contracts of upto five years. This revenue procedurebuilds upon the amplifications in Notice2014–67 by taking a more flexible andless formulaic approach toward variablecompensation for longer-term manage-ment contracts of up to 30 years. The safeharbor under this revenue procedure gen-erally permits any type of fixed or variablecompensation that is reasonable compen-sation for services rendered under the con-tract. This revenue procedure includesconstraints on net profits arrangementsand the relationship between the parties(as under the original safe harbors), butapplies a more principles-based approachfocusing on governmental control overprojects, governmental bearing of risk ofloss, economic lives of managed projects,and consistency of tax positions taken bythe service provider.

SECTION 3. SCOPE

This revenue procedure applies to amanagement contract (as defined in sec-tion 4.02 of this revenue procedure) in-volving managed property (as defined insection 4.03 of this revenue procedure)financed with the proceeds of an issue ofgovernmental bonds (as defined in§ 1.141–1(b)) or qualified 501(c)(3) bondsunder § 145.

SECTION 4. DEFINITIONS

For purposes of this revenue proce-dure, the following definitions apply:

.01 Eligible expense reimbursement ar-rangement means a management contractunder which the only compensation con-sists of reimbursements of actual and di-rect expenses paid by the service providerto unrelated parties and reasonable relatedadministrative overhead expenses of theservice provider.

.02 Management contract means amanagement, service, or incentive pay-ment contract between a qualified userand a service provider under which theservice provider provides services for amanaged property. A management con-tract does not include a contract or portionof a contract for the provision of servicesbefore a managed property is placed inservice (for example, pre-operating ser-

vices for construction design or construc-tion management).

.03 Managed property means the por-tion of a project (as defined in § 1.141–6(a)(3)) with respect to which a serviceprovider provides services.

.04 Qualified user means, for projects(as defined in § 1.141–6(a)(3)) financedwith governmental bonds, any govern-mental person (as defined in § 1.141–1(b))or, for projects financed with qualified501(c)(3) bonds, any governmental per-son or 501(c)(3) organization with respectto its activities which do not constitute anunrelated trade or business, determined byapplying § 513(a).

.05 Service provider means any personother than a qualified user that providesservices to, or for the benefit of, a quali-fied user under a management contract.

.06 Unrelated parties means personsother than a related party (as defined in§ 1.150–1(b)) or a service provider’s em-ployee.

SECTION 5. SAFE HARBORCONDITIONS UNDER WHICHMANAGEMENT CONTRACTS DONOT RESULT IN PRIVATEBUSINESS USE

.01 In general. If a management con-tract meets all of the applicable conditionsof sections 5.02 through section 5.07 ofthis revenue procedure, or is an eligibleexpense reimbursement arrangement, themanagement contract does not result inprivate business use under § 141(b) or145(a)(2)(B). Further, under section 5.08of this revenue procedure, use function-ally related and subordinate to a manage-ment contract that meets these conditionsdoes not result in private business use.

.02 General financial requirements.(1) In general. The payments to the

service provider under the contract mustbe reasonable compensation for servicesrendered during the term of the contract.Compensation includes payments to reim-burse actual and direct expenses paid bythe service provider and related adminis-trative overhead expenses of the serviceprovider.

(2) No net profits arrangements. Thecontract must not provide to the serviceprovider a share of net profits from theoperation of the managed property. Com-pensation to the service provider will not

be treated as providing a share of netprofits if no element of the compensationtakes into account, or is contingent upon,either the managed property’s net profitsor both the managed property’s revenuesand expenses for any fiscal period. Forthis purpose, the elements of the compen-sation are the eligibility for, the amountof, and the timing of the payment of thecompensation. Further, solely for pur-poses of determining whether the amountof the compensation meets the require-ments of this section 5.02(2), any reim-bursements of actual and direct expensespaid by the service provider to unrelatedparties are disregarded as compensation.Incentive compensation will not be treatedas providing a share of net profits if theeligibility for the incentive compensationis determined by the service provider’sperformance in meeting one or more stan-dards that measure quality of services,performance, or productivity, and theamount and the timing of the payment ofthe compensation meet the requirementsof this section 5.02(2).

(3) No bearing of net losses of themanaged property.

(a) The contract must not, in substance,impose upon the service provider the bur-den of bearing any share of net lossesfrom the operation of the managed prop-erty. An arrangement will not be treated asrequiring the service provider to bear ashare of net losses if:

(i) The determination of the amount ofthe service provider’s compensation andthe amount of any expenses to be paidby the service provider (and not reim-bursed), separately and collectively, donot take into account either the managedproperty’s net losses or both the managedproperty’s revenues and expenses for anyfiscal period; and

(ii) The timing of the payment of com-pensation is not contingent upon the man-aged property’s net losses.

(b) For example, a service providerwhose compensation is reduced by astated dollar amount (or one of multiplestated dollar amounts) for failure to keepthe managed property’s expenses below aspecified target (or one of multiple speci-fied targets) will not be treated as bearinga share of net losses as a result of thisreduction.


.03 Term of the contract and revisions.The term of the contract, including allrenewal options (as defined in § 1.141–1(b)), is no greater than the lesser of 30years or 80 percent of the weighted aver-age reasonably expected economic life ofthe managed property. For this purpose,economic life is determined in the samemanner as under § 147(b), but withoutregard to § 147(b)(3)(B)(ii), as of the be-ginning of the term of the contract. Acontract that is materially modified withrespect to any matters relevant to this sec-tion 5 is retested under this section 5 as anew contract as of the date of the materialmodification.

.04 Control over use of the managedproperty. The qualified user must exercisea significant degree of control over the useof the managed property. This control re-quirement is met if the contract requiresthe qualified user to approve the annualbudget of the managed property, capitalexpenditures with respect to the managedproperty, each disposition of property thatis part of the managed property, ratescharged for the use of the managed prop-erty, and the general nature and type ofuse of the managed property (for example,the type of services). For this purpose, forexample, a qualified user may show ap-proval of capital expenditures for a man-aged property by approving an annualbudget for capital expenditures describedby functional purpose and specific maxi-mum amounts; and a qualified user mayshow approval of dispositions of propertythat is part of the managed property in asimilar manner. Further, a qualified usermay show approval of rates charged foruse of the managed property by eitherexpressly approving such rates (or themethodology for setting such rates) or byincluding in the contract a requirementthat the service provider charge rates thatare reasonable and customary as specifi-cally determined by an independent thirdparty.

.05 Risk of loss of the managed prop-erty. The qualified user must bear the riskof loss upon damage or destruction of themanaged property (for example, uponforce majeure). A qualified user does notfail to meet this risk of loss requirement as

a result of insuring against risk of lossthrough a third party or imposing upon theservice provider a penalty for failure tooperate the managed property in accor-dance with the standards set forth in themanagement contract.

.06 No inconsistent tax position. Theservice provider must agree that it is notentitled to and will not take any tax posi-tion that is inconsistent with being a ser-vice provider to the qualified user withrespect to the managed property. For ex-ample, the service provider must agree notto take any depreciation or amortization,investment tax credit, or deduction for anypayment as rent with respect to the man-aged property.

.07 No circumstances substantiallylimiting exercise of rights.

(1) In general. The service providermust not have any role or relationshipwith the qualified user that, in effect, sub-stantially limits the qualified user’s abilityto exercise its rights under the contract,based on all the facts and circumstances.

(2) Safe harbor. As a safe harbor, aservice provider will not be treated ashaving a role or relationship prohibitedunder section 5.07(1) of this revenue pro-cedure if:

(a) No more than 20 percent of thevoting power of the governing body of thequalified user in the aggregate is vested inthe directors, officers, shareholders, part-ners, members, and employees of the ser-vice provider;

(b) The governing body of the qualifieduser does not include the chief executiveofficer of the service provider or the chair-person (or equivalent executive) of theservice provider’s governing body; and

(c) The chief executive officer of theservice provider is not the chief executiveofficer of the qualified user or any of thequalified user’s related parties (as definedin § 1.150–1(b)).

(3) For purposes of section 5.07(2) ofthis revenue procedure, the phrase “ser-vice provider” includes related parties (asdefined in § 1.150–1(b)) and the phrase“chief executive officer” includes a personwith equivalent management responsibil-ities.

.08 Functionally related and subordi-nate use. A service provider’s use of aproject (as defined in § 1.141–6(a)(3))that is functionally related and subordi-nate to performance of its services under amanagement contract for managed prop-erty that consists of all or a portion of thatproject and that meets the requirements ofthis section 5 does not result in privatebusiness use (for example, use of storageareas to store equipment used to performactivities required under a managementcontract that meets the requirements ofthis section 5 does not result in privatebusiness use).

SECTION 6. EFFECT ON OTHERDOCUMENTS

Rev. Proc. 97–13 and Rev. Proc.2001–39 are modified and superseded.Section 3.02 of Notice 2014–67 is mod-ified and superseded. All other sections ofNotice 2014–67 remain in effect.

SECTION 7. DATE OFAPPLICABILITY

The safe harbors in this revenue proce-dure apply to any management contractthat is entered into on or after August 22,2016, and an issuer may apply these safeharbors to any management contract thatwas entered into before August 22, 2016.In addition, an issuer may apply the safeharbors in Rev. Proc. 97–13, as modifiedby Rev. Proc. 2001–39 and amplified byNotice 2014–67, to a management con-tract that is entered into before August 18,2017 and that is not materially modified orextended on or after August 18, 2017(other than pursuant to a renewal option asdefined in § 1.141–1(b)).

SECTION 8. DRAFTINGINFORMATION

The principal authors of this revenueprocedure are Johanna Som de Cerff andDavid White of the Office of AssociateChief Counsel (Financial Institutions &Products). For further information regard-ing this revenue procedure, contact DavidWhite on (202) 317-6980 (not a toll freenumber).


Part IV. Items of General InterestUser Fees for InstallmentAgreements

REG–108792–16


ACTION: Notice of proposed rulemakingand notice of public hearing.

SUMMARY: This document containsproposed amendments to the regulationsthat provide user fees for installmentagreements. The proposed amendmentsaffect taxpayers who wish to pay theirliabilities through installment agreements.The proposed effective date for these pro-posed amendments to the regulations isJanuary 1, 2017. This document also pro-vides a notice of public hearing on theseproposed amendments to the regulations.

DATES: Written or electronic commentsmust be received by October 6, 2016. Out-lines of topics to be discussed at the publichearing scheduled for October 19, 2016,at 2:00 pm must be received by October 6,2016.

ADDRESSES: Send submissions to: In-ternal Revenue Service, CC:PA:LPD:PR(REG–108792–16), Room 5203, Post Of-fice Box 7604, Ben Franklin Station,Washington, DC 20044. Submissions maybe hand-delivered Monday through Fridaybetween the hours of 8 a.m. and 4 p.m. toCC:PA:LPD:PR (REG–108792–16),Courier’s Desk, Internal Revenue Service,1111 Constitution Avenue, NW., Wash-ington, DC 20224 or sent electronicallyvia the Federal eRulemaking Portal athttp://www.regulations.gov (indicate IRSand REG–108792–16). The public hear-ing will be held in the Main IR Audito-rium beginning at 2:00 pm in the InternalRevenue Service Building, 1111 Consti-tution Avenue, NW., Washington, DC20224.

FOR FURTHER INFORMATIONCONTACT: Concerning the proposedamendments to the regulations, M. PilarPuerto at (202) 317-5437; concerning sub-missions of comments, the hearing, or tobe placed on the building access list toattend the hearing, Regina Johnson, at

(202) 317-6901; concerning cost method-ology, Eva Williams, at (202) 803-9728(not toll-free numbers).


Background

This document contains proposed reg-ulations that would amend §§ 300.1 and300.2 of the User Fee Regulations (26CFR part 300), which provide for a userfee applicable to installment agreementsunder section 6159 of the Internal Reve-nue Code (Code).

Section 6159 authorizes the IRS to en-ter into an agreement with any taxpayerfor the payment of tax in installments tothe extent the IRS determines that enter-ing into the installment agreement willfacilitate the full or partial collection ofthe tax. Section 301.6159–1(a). Install-ment agreements are voluntary, and tax-payers may request an installment agree-ment in person, by completing theappropriate forms and mailing them to theIRS, online, or over the telephone. Beforeentering into an installment agreement,the IRS may examine the taxpayer’s fi-nancial position to determine whethersuch an agreement is appropriate. See In-ternal Revenue Manual (IRM) 5.14. If theIRS accepts the installment agreement, theIRS must process the payments made bythe taxpayer and monitor the taxpayer’scompliance with the terms of the agree-ment. The terms of an agreement gener-ally require the taxpayer to pay the mini-mum monthly payment on time, file allrequired tax returns on time, and pay alltaxes in-full and on time. See Form433–D, Installment Agreement. In addi-tion, section 6159(d) requires that the IRSreview partial payment installment agree-ments at least once every two years.

Under § 300.1, the IRS currentlycharges three rates for installment agree-ments. The user fee, in general, is $120 foran installment agreement. The user fee isreduced to $52 for a direct debit install-ment agreement, which is an agreementwhereby the taxpayer authorizes the IRSto request the monthly electronic transferof funds from the taxpayer’s bank accountto the IRS. The user fee is $43 notwith-standing the method of payment if the

taxpayer is a low-income taxpayer, as de-fined below.

Under § 300.2, the IRS currentlycharges $50 for restructuring or reinstat-ing an installment agreement that is indefault. An installment agreement isdeemed to be in default when a taxpayerfails to meet any of the conditions of theinstallment agreement. See IRM 5.14.Currently, there is no exception to this feefor low-income taxpayers.

Explanation of Provisions

A. Overview

To bring user fee rates for installmentagreements in line with the full cost to theIRS of providing these taxpayer specificservices, the proposed regulations under§§ 300.1 and 300.2 would increase theuser fee for the existing installment agree-ment types and introduce two new typesof online installment agreements, eachsubject to a separate user fee. Five of theseproposed user fee rates are based on thefull cost of establishing and monitoringinstallment agreements. The sixth rate isfor low-income taxpayers.

• Regular Installment Agreements – Ataxpayer contacts the IRS in person,by phone, or by mail and sets up anagreement to make manual paymentsover a period of time either by mailinga check or electronically through theElectronic Federal Tax Payment Sys-tem (EFTPS). The proposed fee forentering into a regular installmentagreement is $225.

• Direct Debit Installment Agreements –A taxpayer contacts the IRS by phoneor mail and sets up an agreement tomake automatic payments over a pe-riod of time through a direct debitfrom a bank account. The proposed feefor entering into a direct debit install-ment agreement is $107.

• Online Payment Agreements – A tax-payer sets up an installment agreementthrough http://www.irs.gov and agreesto make manual payments over a pe-riod of time either by mailing a checkor electronically through the EFTPS.The proposed fee for entering into anonline payment agreement is $149.


• Direct Debit Online Payment Agree-ments – A taxpayer sets up an install-ment agreement through http://www.irs.gov and agrees to makeautomatic payments over a period oftime through a direct debit from a bankaccount. The proposed fee for enteringinto a direct debit online paymentagreement is $31.

• Restructured/Reinstated InstallmentAgreements – A taxpayer modifies apreviously established installmentagreement or reinstates an installmentagreement on which the taxpayer hasdefaulted. The proposed fee for re-structuring or reinstating an install-ment agreement is $89.

• Low-Income Rate – A rate that applieswhen a low-income taxpayer entersinto any type of installment agreement,other than a direct debit online pay-ment agreement, and when a low-income taxpayer restructures or rein-states any installment agreement. Alow-income taxpayer is a taxpayer thathas income at or below 250 percent ofthe dollar criteria established by thepoverty guidelines updated annually inthe Federal Register by the U.S. De-partment of Health and Human Ser-vices. Section 300.1(b)(2). The pro-posed low-income rate is $43.

B. User Fee Authority

The Independent Offices Appropria-tions Act (IOAA) (31 U.S.C. 9701) autho-rizes each agency to promulgate regula-tions establishing the charge for servicesprovided by the agency (user fees). TheIOAA provides that these user fee regula-tions are subject to policies prescribed bythe President and shall be as uniform aspracticable. Those policies are currentlyset forth in the Office of Management andBudget (OMB) Circular A–25, 58 FR38142 (July 15, 1993; OMB Circular).

The IOAA states that the services pro-vided by an agency should be self-sustaining to the extent possible. 31U.S.C. 9701(a). The OMB Circular statesthat agencies that provide services thatconfer special benefits on identifiable re-cipients beyond those accruing to the gen-eral public are to establish user fees thatrecover the full cost of providing thoseservices. The OMB Circular requires that

agencies identify all services that conferspecial benefits and determine whetheruser fees should be assessed for thoseservices.

Agencies are to review user fees bien-nially and update them as necessary toreflect changes in the cost of providing theunderlying services. During this biennialreview, an agency must calculate the fullcost of providing each service, taking intoaccount all direct and indirect costs to anypart of the U.S. government. The full costof providing a service includes, but is notlimited to, salaries, retirement benefits,rents, utilities, travel, and managementcosts, as well as an appropriate allocationof overhead and other support costs asso-ciated with providing the service.

An agency should set the user fee at anamount that recovers the full cost of pro-viding the service unless the agency re-quests, and the OMB grants, an exceptionto the full cost requirement. The OMBmay grant exceptions only where the costof collecting the fees would represent anunduly large part of the fee for the activityor any other condition exists that, in theopinion of the agency head, justifies anexception. When the OMB grants an ex-ception, the agency does not collect thefull cost of providing the service andtherefore must fund the remaining cost ofproviding the service from other availablefunding sources. By doing so, the agencysubsidizes the cost of the service to therecipients of reduced-fee services eventhough the service confers a special ben-efit on those recipients who should other-wise be required to pay the full costs ofreceiving that benefit as provided for bythe IOAA and the OMB Circular.

C. Installment Agreement User Fee

The installment agreement programconfers a special benefit on identifiablerecipients beyond those accruing to thegeneral public. Specifically, a taxpayerthat is granted an installment agreement isallowed to pay an outstanding tax obliga-tion over time without being subjected toIRS levy related to these taxes during thisterm of repayment. See section 6331(k)(2)of the Code and § 301.6159–1(f). Section6331(k)(2) generally prohibits the IRSfrom levying to collect taxes while a re-quest to enter into an installment agree-

ment is pending with the IRS, for 30 daysafter the rejection of a proposed install-ment agreement, and for 30 days immedi-ately following the termination of an in-stallment agreement. If, prior to theexpiration of the 30-day period followingthe rejection or termination of an install-ment agreement, the taxpayer appeals therejection or termination decision, no levymay be made while the rejection or termi-nation is being considered by Appeals.Because of these special benefits theIOAA and the OMB Circular authorizethe IRS to charge a user fee for an install-ment agreement that reflects the full costof providing the service of the installmentagreement program to the taxpayer.

The installment agreement user feeswere last changed in 2014. As required bythe IOAA and the OMB Circular, the IRScompleted its 2015 biennial review of theinstallment agreement program and deter-mined that the full cost of a regular in-stallment agreement is $225, and the fullcost of a direct debit installment agree-ment is $107. The IRS determined that thefull cost of a regular online paymentagreement is $149, and the full cost for adirect debit online payment agreement is$31. The IRS determined that the full costof restructuring or reinstating an install-ment agreement is $89.

The proposed regulations adopt the fullcost amounts as the new user fees for thevarious types of installment agreements.Historically, the IRS charged a user feethat recovered less than the full cost of aninstallment agreement to make the servicemore accessible to a broader range of tax-payers. However, in light of constraints onIRS resources for tax administration, theTreasury Department and the IRS havedetermined that it is necessary to recoupthe full costs of the installment agreementprogram. The IRS will continue its prac-tice of providing services subject to userfees at less than full cost where there is acompelling tax administration reason todo so. Therefore, these proposed regula-tions do not increase the reduced user feefor offers submitted by low-income tax-payers and introduce a reduced fee forrequests by low-income taxpayers to re-structure or reinstate defaulted installmentagreements.

The proposed fees reflect the IRS’s de-termination to continue to provide a wide


variety of installment agreement optionsto taxpayers and, as required by the OMBCircular, to determine the full cost foreach option. Since the enactment of theinstallment agreement program, the IRShas periodically developed new ways fortaxpayers to enter into and pay for install-ment agreements, such as through onlinepayment agreements and direct debit on-line payment agreements. These new in-stallment agreement types have not hadtheir own separate user fee, but insteadhave been included in the existing user feestructure. In recent years, taxpayers’ useof the online installment agreement op-tions have increased, justifying a separatefee structure for the online installmentagreement options.

Consistent with introducing these newfees, the most recent full cost analysis ofthe installment agreement program hasbeen refined to more precisely account forthe costs associated with administeringthe various types of installment agree-ments available to taxpayers. Requestinginstallment agreements in person or overthe phone and receiving payment throughmeans other than direct debit is morecostly for the IRS to administer, and theproposed user fees reflect these costs.Similarly, this recent analysis has resultedin the availability of reduced user fees totaxpayers for those options that cost lessfor the IRS to administer. By offering arange of installment agreement options ata range of fees, the IRS is assisting tax-payers in coming into compliance withtheir tax payment obligations, which ben-efits tax administration and provides anenhanced service to taxpayers.

D. Calculation of User Fees Generally

User fee calculations begin by first de-termining the full cost for the service. TheIRS follows the guidance provided by theOMB Circular to compute the full cost ofthe service, which includes all indirect anddirect costs to any part of the U.S. gov-ernment including but not limited to directand indirect personnel costs, physicaloverhead, rents, utilities, travel, and man-agement costs. The IRS’s cost methodol-ogy is described below.

Once the total amount of direct andindirect costs associated with a service isdetermined, the IRS follows the guidance

in the OMB Circular to determine thecosts associated with providing the ser-vice to each recipient, which representsthe average per unit cost of that service.This average per unit cost is the amount ofthe user fee that will recover the full costof the service.

The IRS follows generally accepted ac-counting principles (GAAP), as estab-lished by the Federal Accounting Stan-dards Advisory Board (FASAB) incalculating the full cost of providing ser-vices. The FASAB Handbook of Account-ing Standards and Other Pronouncements,as amended, which is available at http://files.fasab.gov/pdffiles/2015_fasab_handbook.pdf, includes the Statement of Fed-eral Financial Accounting Standards No.4: Managerial Cost Accounting Conceptsand Standards for the Federal Government(SFFAS No.4). SFFAS No. 4 establishesinternal costing standards under GAAP toaccurately measure and manage the fullcost of federal programs. The methodol-ogy described below is in accordance withSFFAS No. 4.

1. Cost center allocation

The IRS determines the cost of its ser-vices and the activities involved in pro-ducing them through a cost accountingsystem that tracks costs to organizationalunits. The lowest organizational unit inthe IRS’s cost accounting system is calleda cost center. Cost centers are usuallyseparate offices that are distinguished bysubject-matter area of responsibility orgeographic region. All costs of operating acost center are recorded in the IRS’s costaccounting system and allocated tothat cost center. The costs allocated to acost center are the direct costs for the costcenter’s activities as well as all indirectcosts, including overhead, associated withthat cost center. Each cost is recorded inonly one cost center.

2. Determining the per unit cost

To establish the per unit cost, the totalcost of providing the service is divided bythe volume of services provided. The vol-ume of services provided includes bothservices for which a fee is charged as wellas subsidized services. The subsidized ser-vices are those where OMB has approved

an exception to the full cost requirement,for example, to charge a reduced fee tolow-income taxpayers. The volume ofsubsidized services is included in the totalvolume of services provided to ensure thatthe IRS, and not those who are paying fullcost, subsidizes the cost of the reduced-full cost services.

3. Cost estimation of direct labor andbenefits

Not all cost centers are fully devoted toonly one service for which the IRScharges a user fee. Some cost centerswork on a number of different services. Inthese cases, the IRS estimates the costincurred in those cost centers attributableto the service for which a user fee is beingcalculated by measuring the time requiredto accomplish activities related to the ser-vice, and estimating the average time re-quired to accomplish these activities. Theaverage time required to accomplish theseactivities is multiplied by the relevant or-ganizational unit’s average labor and ben-efits cost per unit of time to determine thelabor and benefits cost incurred to providethe service. To determine the full cost, theIRS then adds an appropriate overheadcharge as discussed below.

4. Calculating overhead

Overhead is an indirect cost of operat-ing an organization that cannot be imme-diately associated with an activity that theorganization performs. Overhead includescosts of resources that are jointly or com-monly consumed by one or more organi-zational unit’s activities but are not spe-cifically identifiable to a single activity.

These costs can include:

• General management and administra-tive services of sustaining and supportorganizations.

• Facilities management and groundmaintenance services (security, rent,utilities, and building maintenance).

• Procurement and contracting services.• Financial management and accounting

services.• Information technology services.• Services to acquire and operate prop-

erty, plants and equipment.• Publication, reproduction, and graph-

ics and video services.


• Research, analytical, and statisticalservices.

• Human resources/personnel services.• Library and legal services.

To calculate the overhead allocable toa service, the IRS first calculates the Cor-porate Overhead rate and then multipliesthe Corporate Overhead rate by the directlabor and benefits costs determined as dis-cussed above. The IRS calculates the Cor-

porate Overhead rate annually based oncost elements underlying the Statement ofNet Cost included in the IRS Annual Fi-nancial Statements, which are audited bythe Government Accountability Office.The Corporate Overhead rate is the ratioof the sum of the IRS’s indirect labor andbenefits costs from the supporting andsustaining organizational units—thosethat do not interact directly with taxpay-

ers—and all non-labor costs to the IRS’slabor and benefits costs of its organiza-tional units that interact directly with tax-payers.

The Corporate Overhead rate of 65.85percent for costs reviewed during FY2015 was calculated based on FY 2014costs as follows:

Indirect Labor and Benefits Costs $1,693,339,843

Non-Labor Costs � $2,832,262,970

Total Indirect Costs $4,525,602,813

Direct Labor and Benefits Costs � $6,872,934,473

Corporate Overhead Rate 65.85%

E. Calculation of Installment AgreementUser Fee

The full cost analysis considers thecommon components of each of the fiveinstallment agreement types as well aseach type’s unique cost drivers. The costsfor each type of installment agreement arebroadly categorized into two groups: (1)costs incurred by the IRS to establish theinstallment agreements and (2) costs in-curred by the IRS to maintain and monitorthe installment agreements.

The upfront costs for establishing in-stallment agreements requested in person,in writing, or over the phone are signifi-cantly higher than those for online pay-ment agreements. For that reason, the up-front costs for establishing installmentagreements requested in person, in writ-ing, or over the phone are determinedseparately and allocated only to install-ment agreements requested in person, inwriting, or over the phone. In contrast, theonly upfront costs to establish online pay-ment agreements through http://www.irs.gov are the costs of the online paymentagreement system such as annual mainte-nance and system enhancements, which

are only allocated to online paymentagreements.

After installment agreements are estab-lished, costs to maintain and monitorthem, including routine notices to the tax-payers, vary significantly based on thetype of installment agreement. Directdebit installment agreements and directdebit online payment agreements havelower maintenance and monitoring costsbecause they do not require as much sup-port on an ongoing basis as installmentagreements not paid via direct debit. Pay-ments under direct debit installmentagreements and direct debit online pay-ment agreements are automatically deb-ited from the taxpayer’s bank account.Because payments for direct debit install-ment agreements and direct debit onlinepayment agreements are automaticallydebited from taxpayers’ accounts withoutrequiring taxpayers to initiate each pay-ment, the IRS does not send monthly pay-ment notices and in general sends fewernotices related to these agreements com-pared to installment agreements not paidvia direct debit. Correspondingly, directdebit installment agreements and directdebit online payment agreements require

less IRS time responding to taxpayer in-quiries resulting from these notices thando installment agreements not paid viadirect debit.

1. Establishing installment agreements

The IRS allocates costs attributed toestablishing installment agreements basedon whether the installment agreement is anon-online installment agreement or anonline payment agreement.

a. Non-Online Installment Agreements

For non-online installment agreements,the IRS identified the activities conductedacross various organizations to establishagreements, obtained the time spent on theactivities through various time trackingsystems, obtained the labor and benefitsrates for employees from the financial sys-tem for FY 2013 and 2014 who spent timeestablishing agreements, and averagedthose costs to create an annualized aver-age cost. The average labor and benefitscosts to establish non-online installmentagreements is $110,143,952, calculated asfollows:


Collection Field Function $53,268,552

Compliance Services Collection Operations $19,989,943

Automated Collection System $19,377,987

Customer Service Toll-Free $6,183,764

Appeals Staff Labor and Benefits $8,624,615

Field Assistance $1,894,976

Examination $804,115

Average Labor and Benefits Costs to Establish Non-Online Installment Agreements $110,143,952

Because the non-labor costs for noticesand telecommunication, which includesthe costs of paper, postage and phone ser-vice, related to installment agreements canbe identified, the IRS considered them tobe direct costs for the installment agree-

ment program. Accordingly, the IRS mod-ified the calculation of the CorporateOverhead rate to exclude these noticesand telecommunication costs from the to-tal indirect costs in the calculation of theCorporate Overhead rate used for pur-

poses of allocating Corporate Overhead tothe installment agreement program (ad-justed Corporate Overhead). The adjustedCorporate Overhead rate used for the en-tire installment agreement program is60.89 percent, calculated as follows:

Indirect Labor and Benefits Costs $1,693,339,843

Non-Labor Costs � $2,832,262,970

Non-Labor Costs for Notices and Telecommunication ($211,959,052)

Adjusted Total Indirect Costs $4,313,643,761

Direct Labor and Benefits Costs $6,872,934,473

Non-Labor Costs for Notices and Telecommunication � $211,959,052

Adjusted Direct Labor and Benefits Costs $7,084,893,526

Adjusted Total Indirect Costs $4,313,643,761

Adjusted Direct Labor and Benefits Costs � $7,084,893,526

Adjusted Corporate Overhead Rate 60.89%

The IRS applied the adjusted Corpo-rate Overhead rate to the labor and bene-

fits costs to calculate the total labor andbenefits cost for establishing non-online

installment agreements as follows:

Labor and Benefits Costs to Establish Non-Online Installment Agreements $110,143,952

Adjusted Corporate Overhead Rate (60.89%) $67,066,653

Total Labor and Benefits and Adjusted Overhead Costs to Establish Non-Online Installment Agreements $177,210,605

There are also non-labor costs attrib-uted to establishing non-online install-ment agreements. Because these costs are

non-labor, the IRS does not allocate anyoverhead to determine the total costs. Thetotal non-labor costs for establishing non-

online installment agreements are$636,046, calculated as follows:

Telecommunications $145,169

Automated Collection System $274,664

Customer Service Toll-Free $216,213

Total Non-Labor Costs to Establish Non-Online Installment Agreements $636,046

The total costs for establishing non-online installment agreements are

$177,846,650, calculated as follows:


Total Labor and Benefits and Adjusted Overhead Costs to Establish Non-Online Installment Agreements $177,210,605

Total Non-Labor Costs to Establish Non-Online Installment Agreements $636,046

Total Costs to Establish Non-Online Installment Agreements $177,846,650

To determine the unit cost to establishnon-online installment agreements, theIRS divided the total cost by the average

volume of non-online installment agree-ments. The IRS determined the volume ofnon-online installment agreements by av-

eraging the volumes of new agreementsentered into in FY 2013 and FY 2014. Theunit cost was calculated as follows:

Total Costs to Establish Non-Online Installment Agreements $177,846,650

Average Annual Volume 2,175,142

Unit Cost to Establish Non-Online Installment Agreements $81.76

b. Online Installment Agreements

For online payment agreements, theonly cost to establish those agreements isthe cost for the online payment agreementsystem that allows taxpayers to set up theagreements. In FY 2014, the IRS per-formed a substantial enhancement to thissystem at a cost of $4,200,000. The IRSamortizes system enhancements over a six

year period; therefore, for FY 2014through FY 2020 the annual amortizedsystem cost for online payment agree-ments is $700,000. In addition to the an-nual amortized cost, the IRS incurs$200,000 in annual system maintenancecosts for this system. The total annual costfor the online payment agreement systemis $900,000. The use of online paymentagreements is trending upward and the

IRS expects this upward trend to continueas more taxpayers utilize the IRS’s onlinesystems. To reflect the IRS’s expectationof increased use of online systems, theIRS adjusted upward the average volumeof online payment agreements received inFY 2013 and FY 2014 consistent with thatexpectation. The total cost to establishonline payment agreements is $6, calcu-lated as follows:

Amortized System Upgrade $700,000

Annual System Maintenance Cost $200,000

Average Yearly System Cost $900,000

Average Annual Volume 150,000

Unit Cost to Establish Online Payment Agreement $6

2. Maintaining and monitoringinstallment agreements

The costs for maintaining and monitor-ing installment agreements consist of thecosts of monitoring and telecommunica-tions labor and benefits, an allocation ofoverhead to these labor costs, and noticeand telecommunication non-labor costs.

The IRS identified the activities con-ducted across various business units tomonitor installment agreements, obtainedthe time spent on the activities throughvarious time tracking systems, obtainedthe labor and benefits rates for these per-sonnel from the financial system for FY2013 and 2014, and determined the aver-age annual cost for monitoring installmentagreements.

The IRS allocated the costs attributedto maintaining and monitoring installmentagreements based on whether the agree-ment is a direct debit agreement (DirectDebit Installment Agreement or Direct

Debit Online Payment Agreement), a non-direct debit agreement (Regular Agree-ment or Online Payment Agreement),or a Restructured/Reinstated InstallmentAgreement. The following sections de-scribe the costs allocated to various typesof installment agreements for maintainingand monitoring.

The IRS continuously monitors all in-stallment agreements for accounts notmeeting the terms of the agreement, forreturned payments, and various other cir-cumstances that result in a need to contactthe taxpayer. When these circumstancesarise, the IRS reviews the account andsends a notice to the taxpayer, as needed,to resolve the condition. The IRS main-tains a system that measures the hours ofcorrespondence labor by type of noticesent to taxpayers.

Generally, the IRS uses the costs fortwo years and averages those costs to de-termine the cost of an activity. However,

for this component of cost, the IRS usedexisting data for the hours spent in FY2014 on correspondence labor related tomonitoring installment agreements andcalculated total labor and benefits forthose hours. The IRS does not believeincluding an additional year of data wouldresult in a significant difference in theresult. In the future, the IRS intends to usethe average cost of two years to calculatethis cost component. The total annual costof correspondence for monitoring agree-ments labor and benefits is $5,807,847.

The IRS divided the total annual laborand benefits cost of correspondence formonitoring agreements by the total agree-ments in inventory at the end of FY 2014.The total inventory was 3,973,208, result-ing in annual labor and benefits cost peragreement of $1.46. The IRS convertedthe annual cost of correspondence formonitoring agreements labor and benefitsto a per-agreement cost by dividing the


annual cost per installment agreement by12 months to calculate the monthly costper installment agreement. The IRS then

multiplied the monthly cost per install-ment agreement by 40.31 months, the av-erage term of installment agreements (in

months), to calculate the unit cost over thelife of the installment agreement.

Total Annual Cost of Correspondence for Monitoring Agreements Labor and Benefits $5,807,847

Total Agreements in Inventory at End of FY 2014 3,973,208

Annual Labor and Benefits Cost per Agreement $1.46

Monthly Cost Per Agreement (Annual Labor and Benefits Cost per Agreement dividedby 12 months)

$0.12

Average Term of Installment Agreement (in months) 40.31

Unit Cost of Correspondence for Monitoring Agreements Labor and Benefits Over theLife of Installment Agreement

$4.91

There is not a significant difference inthe cost of monitoring regular and directdebit installment agreements; therefore,each type of agreement is allocated thesame ratio of monitoring costs. Restruc-

tured/reinstated installment agreementsare not allocated any monitoring costs be-cause monitoring costs for restructured/reinstated agreements are recovered in theoriginal user fee. The unit cost of corre-

spondence for monitoring agreements la-bor and benefits per installment agreementis shown below:

RegularAgreement

Direct Debit InstallmentAgreement

Restructured/ReinstatedInstallment Agreement

Unit Cost of Correspondence for MonitoringAgreements Labor and Benefits Over theLife of Installment Agreement

$4.91 $4.91 $0

The IRS maintains a system that calcu-lates the number of seconds spent on thephone by type of call. To determine thetelecommunications labor and benefitscosts to maintain and monitor installmentagreements, IRS first analyzed the timespent on phone calls related to monitoringand maintaining installment agreements,rather than establishing one. The total sec-onds are converted into hours and hourlysalary and benefits rates are applied.

The average labor and benefits costsfor responding to installment agreementquestions are $58,917,275 for FY 2013and FY 2014. These costs are accumu-lated by type of installment agreement.To determine the annual unit cost pertype of agreement, the IRS used the totalvolume of the corresponding installmentagreements in inventory at the end ofFY 2014 as the baseline for the numberof installment agreements that generate

telecommunications costs of respondingto questions. The IRS divided the aver-age labor and benefits costs separated bytype of agreement by the total agree-ments in inventory at the end of FY2014 for each type of agreement. TheIRS converted the annual cost of corre-spondence for telecommunications laborand benefits to a per-agreement cost asfollows:

Non-direct DebitInstallmentAgreement

Direct DebitInstallmentAgreement

Restructured/ReinstatedAgreement

Average Telecommunications Labor and Benefits Costs $55,872,940 $2,014,736 $1,029,598

Volume of Installment Agreements in Inventory at endof FY 2014 by Type

3,084,844 888,364 1,082,303

Annual Unit Cost Per Installment Agreement $18.11 $2.27 $0.95

Monthly Cost Per Installment Agreement 4 (AnnualUnit Cost Per Installment Agreement dividedby 12 months)

$1.51 $0.19 $0.08

Average Term of Installment Agreement (in months) 40.31 40.31 40.31

Unit Cost for Telecommunications Labor and BenefitsOver the Life of the Installment Agreement

$60.84 $7.62 $3.20


Next, the IRS determined the appropri-ate allocation of overhead for installmentagreements. As noted above, the IRS ad-justed the Corporate Overhead Rate forthe installment agreement program down

to 60.89 percent. The IRS applied thisadjusted Corporate Overhead rate to thetotal labor and benefits costs for monitor-ing and telecommunications calculatedabove. The total labor unit cost including

the adjusted Corporate Overhead allo-cated to each type installment agreementis as follows:

Non-direct DebitInstallmentAgreement



Unit Cost of Correspondence for MonitoringAgreements Labor and Benefits Over the Life ofInstallment Agreement

$4.91 $4.91 $0

Unit Cost for Telecommunications Laborand Benefits Over the Life of theInstallment Agreement

$60.84 $7.62 $3.20

Subtotal $65.75 $12.53 $3.20

Adjusted Corporate Overhead (60.89%) $40.03 $7.63 $1.95

Maintain and Monitor Labor and Benefits Unit Cost $105.78 $20.16 $5.15

The final element of the cost analysisfor maintaining and monitoring install-ment agreements is the cost of non-labornotice and telecommunications. The IRSmaintains a system for tracking noticesand telecommunication costs. Each typeof notice has a known number of pages,postage, and telecommunication costs re-

sponding to taxpayer inquiries related tothe notices. The average annual non-laborcost for all notices and telecommunicationrelated to installment agreements is$36,219,659. The IRS divided the totalaverage notice and telecommunicationnon-labor cost by the total volume ofagreements in inventory at the end of FY

2014 to determine the annual notice andtelecommunication non-labor cost per in-stallment agreement. The IRS convertedthe annual cost of notice and telecommu-nications to a per-agreement cost as fol-lows:

RegularInstallmentAgreement



Average Annual Non-Labor Cost of All Notices $33,005,331 $1,190,147 $608,206

Average Annual Non-Labor Cost of Telecommunication $1,342,810 $48,421 $24,745

Total Average Notice and TelecommunicationNon-Labor Costs

$34,348,141 $1,238,568 $632,950

Total Volume of Agreements in Inventory at end ofFY 2014

3,084,844 888,364 1,082,303

Annual Notice and Telecommunication Non-LaborCost Per Installment Agreement

$11.13 $1.39 $0.58

Monthly Notice and Telecommunication Non-LaborCost Per Installment Agreement(Annual Notice and Telecommunication Non-LaborCost divided by 12 months)

$0.93 $0.12 $0.05

Average Term of Installment Agreement (in months) 40.31 40.31 40.31

Unit Cost for Notice and TelecommunicationNon-Labor Over the Life of the Installment Agreement

$37.40 $4.68 $1.96

The unit costs for maintaining andmonitoring an installment agreement

based on the total cost of maintaining andmonitoring all installment agreements are

as follows:


Regular InstallmentAgreement



Maintain and Monitor Labor Unit Costs $105.78 $20.16 $5.15

Maintain and Monitor Non-Labor Unit Cost $37.40 $4.68 $1.96

Total Maintain and Monitor Unit Cost $143.18 $24.84 $7.11

3. Per unit full cost of each type ofinstallment agreement

The per unit full cost and rates per eachtype of installment agreement are asfollows:

RegularAgreement


Restructured/ReinstatedInstallment Agreement

Direct Debit OnlinePayment Agreements

OnlinePayment

Agreements

Unit Cost to Establish $81.76 $81.76 $81.76 $6.00 $6.00

Unit Cost to Maintain andMonitor

$143.18 $24.84 $7.11 $24.84 $143.18

Per Unit Full Cost $224.94 $106.60 $88.87 $30.84 $149.18

Rate $225 $107 $89 $31 $149

4. Low income installment agreementuser fee

The proposed regulations maintain thelow-income taxpayer user fee of $43 forregular installment agreements and directdebit installment agreements and extendthe low-income taxpayer user fee of $43to restructured/reinstated installmentagreements and online payment agree-ments. When the IRS first instituted the$43 user fee for low-income taxpayers, itdetermined that this amount would notunduly burden or disproportionately dis-suade low-income taxpayers from seekinginstallment agreements. Historically, ap-proximately one-third of all installmentagreement requests have come from low-income taxpayers, a percentage that hasremained relatively consistent since theintroduction of the $43 low-income tax-payer rate. In light of this, the IRS hasdetermined to maintain the existing $43user fee for low-income taxpayers and toextend this reduced user fee to restruc-tured/reinstated installment agreementsand online payment agreements requestedby low-income taxpayers. Because the fullcost of direct debit online payment agree-ments of $31 is less than the low-incometaxpayer user fee, all taxpayers will becharged the same $31 user fee for directdebit online payment agreements.

Special Analyses

Certain IRS regulations, including thisone, are exempt from the requirements ofExecutive Order 12866, as supplementedand reaffirmed by Executive Order 13563.Therefore, a regulatory impact assessmentis not required. It is hereby certified thatthese regulations will not have a signifi-cant economic impact on a substantialnumber of small entities. This certificationis based on the information that follows.The economic impact of these regulationson any small entity would result from theentity being required to pay a fee pre-scribed by these regulations in order toobtain a particular service. The dollaramount of the fee is not, however, sub-stantial enough to have a significant eco-nomic impact on any entity subject to thefee. Low-income taxpayers and taxpayersentering into direct debit online paymentagreements will be charged a lower fee,which lessens the economic impact ofthese regulations. Accordingly, a regula-tory flexibility analysis is not required.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 on small business.

Comments and Public Hearing

Before these proposed amendments tothe regulations are adopted as final regu-lations, consideration will be given to anycomments that are submitted timely to theIRS as prescribed in this preamble underthe “ADDRESSES” heading. The Trea-sury Department and the IRS requestcomments on all aspects of the proposedregulations. All comments will be avail-able at www.regulations.gov or upon re-quest.

A public hearing has been scheduledfor October 19, 2016, beginning at 2:00pm in the Main IR Auditorium of theInternal Revenue Service Building, 1111Constitution Avenue NW., Washington,DC. 20224. Due to building security pro-cedures, visitors must enter at the Consti-tution 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” section ofthis preamble.

The rules of 26 CFR 601.601(a)(3) ap-ply to the hearing. Persons who wish to


present oral comments at the hearing mustsubmit written comments or electroniccomments by October 6, 2016 and submitan outline of the topics to be discussedand the amount of time to be devoted toeach topic (a signed original and 8 copies)by October 6, 2016. A period of 10 min-utes will be allotted to each person formaking comments. An agenda showingthe scheduling of the speakers will beprepared after the deadline for receivingoutlines has passed. Copies of the agendawill be available free of charge at thehearing.


The principal author of these regula-tions is Maria Del Pilar Puerto of theOffice of Associate Chief Counsel (Proce-dure and Administration). Other person-nel from the Treasury Department and theIRS participated in their development.

* * * * *

Proposed Amendments to theRegulations

Accordingly, 26 CFR part 300 is pro-posed to be amended as follows:

PART 300—USER FEES

Paragraph 1. The authority citation forpart 300 continues to read as follows:

Authority: 31 U.S.C. 9701.Par. 2. In § 300.1, paragraphs (b) and

(d) are revised to read as follows:

§ 300.1 Installment agreement fee.

* * * * *(b) Fee. The fee for entering into an

installment agreement before January 1,2017, is $120. The fee for entering into aninstallment agreement on or after January1, 2017, is $225. A reduced fee applies inthe following situations:

(1) For installment agreements enteredinto before January 1, 2017, the fee is $52when the taxpayer pays by way of a directdebit from the taxpayer’s bank account.The fee is $107 when the taxpayer pays byway of a direct debit from the taxpayer’sbank account for installment agreementsentered into on or after January 1, 2017;

(2) For online payment agreements en-tered into before January 1, 2017, the feeis $120, except that the fee is $52 when

the taxpayer pays by way of a direct debitfrom the taxpayer’s bank account. The feeis $149 for entering into online paymentagreements on or after January 1, 2017,except that the fee is $31 when the tax-payer pays by way of a direct debit fromthe taxpayer’s bank account; and

(3) Notwithstanding the type of install-ment agreement and method of payment,the fee is $43 if the taxpayer is a low-income taxpayer, that is, an individualwho falls at or below 250 percent of thedollar criteria established by the povertyguidelines updated annually in the Fed-eral Register by the U.S. Department ofHealth and Human Services under author-ity of section 673(2) of the Omnibus Bud-get Reconciliation Act of 1981 (95 Stat.357, 511), or such other measure that isadopted by the Secretary, except that thefee is $31 when the taxpayer pays by wayof a direct debit from the taxpayer’s bankaccount with respect to online paymentagreements entered into on or after Janu-ary 1, 2017;

* * * * *(d) Effective/applicability date. This

section is applicable beginning January 1,2017.

Par. 3. In § 300.2, paragraphs (b) and(d) are revised to read as follows:

§ 300.2 Restructuring or reinstatementof installment agreement fee.

* * * * *(b) Fee. The fee for restructuring or

reinstating an installment agreement be-fore January 1, 2017, is $50. The fee forrestructuring or reinstating an installmentagreement on or after January 1, 2017, is$89. If the taxpayer is a low-income tax-payer, that is, an individual who falls at orbelow 250 percent of the dollar criteriaestablished by the poverty guidelines up-dated annually in the Federal Register bythe U.S. Department of Health and Hu-man Services under authority of section673(2) of the Omnibus Budget Reconcil-iation Act of 1981 (95 Stat. 357, 511), orsuch other measure that is adopted by theSecretary, then the fee for restructuring orreinstating an installment agreement on orafter January 1, 2017 is $43.

* * * * *

(d) Effective/applicability date. Thissection is applicable beginning January 1,2017.


Enforcement.


Estate, Gift, andGeneration-SkippingTransfer Taxes;Restrictions on Liquidationof an Interest

REG–163113–02


ACTION: Notice of proposed rulemakingand notice of public hearing.

SUMMARY: This document containsproposed regulations concerning the val-uation of interests in corporations andpartnerships for estate, gift, andgeneration-skipping transfer (GST) taxpurposes. Specifically, these proposedregulations concern the treatment of cer-tain lapsing rights and restrictions on liq-uidation in determining the value of thetransferred interests. These proposed reg-ulations affect certain transferors of inter-ests in corporations and partnerships andare necessary to prevent the undervalua-tion of such transferred interests.

DATES: Written and electronic com-ments must be received by November 2,2016. Outlines of topics to be discussed atthe public hearing scheduled for Decem-ber 1, 2016, must be received by Novem-ber 2, 2016.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG–163113–02), room5203, Internal Revenue Service, POB7604, Ben Franklin Station, Washington,DC 20044. Submissions also may be handdelivered Monday through Friday be-tween the hours of 8 a.m. and 5 p.m. to:CC:PA:LPD:PR (REG–163113–02),Courier’s Desk, Internal Revenue Service,


1111 Constitution Avenue, NW, Wash-ington, DC 20224, or sent electronicallyvia the Federal eRulemaking portal atwww.regulations.gov (IRS REG–163113–02). The public hearing will beheld in the Auditorium, Internal RevenueService Building, 1111 Constitution Ave-nue, NW, Washington, DC 20224.

FOR FURTHER INFORMATIONCONTACT: Concerning the proposedregulations, John D. MacEachen, (202)317-6859; concerning submissions ofcomments, the hearing, and/or to beplaced on the building access list to attendthe hearing, Regina L. Johnson at (202)317-6901 (not toll-free numbers).


Background

Section 2704 of the Internal RevenueCode provides special valuation rules forpurposes of subtitle B (relating to estate,gift, and GST taxes) for valuing intra-family transfers of interests in corpora-tions and partnerships subject to lapsingvoting or liquidation rights and restric-tions on liquidation. Lapses of voting orliquidation rights are treated as a transferof the excess of the fair market value of allinterests held by the transferor, deter-mined as if the voting or liquidation rightswere nonlapsing, over the fair marketvalue of such interests after the lapse.Certain restrictions on liquidation are dis-regarded in determining the fair marketvalue of the transferred interest. The leg-islative history of section 2704 states thatthe provision is intended, in part, to pre-vent results similar to that in Estate ofHarrison v. Commissioner, T.C. Memo.1987–8. Informal S. Rep. on S. 3209, 136Cong. Rec. S15629–4 (October 18,1990); H.R. Conf. Rep. No. 101–964,2374, 2842 (October 27, 1990).

In Harrison, the decedent and two ofhis children each held a general partnerinterest in a partnership immediately be-fore the decedent’s death. The decedentalso held all of the limited partner inter-ests in the partnership. Because any gen-eral partner could liquidate the partnershipduring life, each general partner couldcause all partners to obtain the full valueof such partner’s partnership interests. Ageneral partner’s right to liquidate thepartnership lapsed on the death of that

partner. In determining the estate taxvalue of the decedent’s limited partnerinterest, the court concluded that the rightof the decedent to liquidate the partner-ship (and thus readily obtain the full valueof the limited partner interest) could notbe taken into account because that rightlapsed at death. As a result, the Courtdetermined the value for transfer tax pur-poses of the limited partner interest to beless than its value either in the hands ofthe decedent immediately before death orin the hands of his family (the other gen-eral partners) immediately after death.

Section 2704(a)(1) provides generallythat, if there is a lapse of any voting orliquidation right in a corporation or a part-nership and the individual holding suchright immediately before the lapse andmembers of such individual’s family hold,both before and after the lapse, control ofthe entity, such lapse shall be treated as atransfer by such individual by gift, or atransfer which is includible in the grossestate, whichever is applicable. Theamount of the transfer is the fair marketvalue of all interests held by the individualimmediately before the lapse (determinedas if the voting and liquidation rights werenonlapsing) over the fair market value ofsuch interests after the lapse.

Section 25.2704–1(a)(2)(v) of the cur-rent Gift Tax Regulations defines a liqui-dation right as the right or ability, includ-ing by reason of aggregate voting power,to compel the entity to acquire all or aportion of the holder’s equity interest inthe entity, whether or not its exercisewould result in the complete liquidation ofthe entity.

Section 25.2704–1(c)(1) provides arule that a lapse of a liquidation rightoccurs at the time a presently exercisableliquidation right is restricted or elimi-nated. However, under § 25.2704–1(c)(1),a transfer of an interest that results in thelapse of a liquidation right generally is notsubject to this rule if the rights with re-spect to the transferred interest are notrestricted or eliminated. The effect of thisexception is that the inter vivos transfer ofa minority interest by the holder of aninterest with the aggregate voting powerto compel the entity to acquire the hold-er’s interest is not treated as a lapse eventhough the transfer results in the loss of

the transferor’s presently exercisable liq-uidation right.

The Treasury Department and the IRS,however, believe that this exceptionshould not apply when the inter vivostransfer that results in the loss of thepower to liquidate occurs on the dece-dent’s deathbed. Cf. Estate of Murphy v.Commissioner, T.C. Memo. 1990–472(rejecting “attempts to avoid taxation ofthe control value of stock holdingsthrough bifurcation of the blocks”). Suchtransfers generally have minimal eco-nomic effects, but result in a transfer taxvalue that is less than the value of theinterest either in the hands of the decedentprior to death or in the hands of the dece-dent’s family immediately after death. SeeHarrison, supra. The enactment of section2704 was intended to prevent this result.See Informal S. Rep. on S. 3209, supra;H.R. Conf. Rep. No. 101–964, supra. Seealso section 2704(a)(3) (conferring on theSecretary broad regulatory authority toapply section 2704(a) to the lapse of rightssimilar to voting and liquidation rights).The Treasury Department and the IRShave concluded that the regulatory excep-tion created in § 25.2704–1(c)(1) shouldapply only to transfers occurring morethan three years before death, where theloss of control over liquidation is likely tohave a more substantive effect. A bright-line test will avoid the fact-intensive in-quiry underlying a determination of adonor’s subjective motive which is ad-ministratively burdensome for both tax-payers and the IRS. Cf. section 2035(a)(replacing the contemplation of death pre-sumption of prior law with a bright-line,three-year test). Accordingly, the pro-posed regulations treat transfers occurringwithin three years of death that result inthe lapse of a liquidation right as transfersoccurring at death for purposes of section2704(a).

Section 2704(b)(1) provides generallythat, if a transferor transfers an interest ina corporation or partnership to (or for thebenefit of) a member of the transferor’sfamily, and the transferor and members ofthe transferor’s family hold, immediatelybefore the transfer, control of the entity,any “applicable restriction” is disregardedin valuing the transferred interest. Undersection 2704(b)(2), an applicable restric-tion is defined as a restriction that effec-


tively limits the ability of the entity toliquidate, but which, after the transfer,either in whole or in part, will lapse ormay be removed by the transferor or thetransferor’s family, either alone or collec-tively. Section 2704(b)(3)(B) exceptsfrom the definition of an applicable re-striction any restriction “imposed, or re-quired to be imposed, by any Federal orState law.”

Section 2704(b)(4) provides that theSecretary may by regulations provide thatother restrictions shall be disregarded indetermining the value of any interest in acorporation or a partnership transferred toa member of the transferor’s family if therestriction has the effect of reducing thevalue of the transferred interest for trans-fer tax purposes but does not ultimatelyreduce the value of the interest to thetransferee.

Section 25.2704–2(b) provides, in part,that an applicable restriction “is a limita-tion on the ability to liquidate the entity(in whole or in part) that is more restric-tive than the limitations that would applyunder the State law generally applicable tothe entity in the absence of the restric-tion.”

The Treasury Department and the IRShave determined that the current regula-tions have been rendered substantially in-effective in implementing the purpose andintent of the statute by changes in statelaws and by other subsequent develop-ments. First, courts have concluded that,under the current regulations, section2704(b) applies only to restrictions on theability to liquidate an entire entity, and notto restrictions on the ability to liquidate atransferred interest in that entity. Kerr v.Commissioner, 113 T.C. 449, 473 (1999),aff’d, 292 F.3rd 490 (5th Cir. 2002). Thus,a restriction on the ability to liquidate anindividual interest is not an applicable re-striction under the current regulations.

Second, as noted above, the currentregulations except from the definition ofan applicable restriction a restriction onliquidation that is no more restrictive thanthat of the state law that would apply inthe absence of the restriction. The TaxCourt viewed this as a regulatory expan-sion of the statutory exception to the ap-plication of section 2704(b) contained insection 2704(b)(3)(B) that excepts “anyrestriction imposed, or required to be im-

posed, by any Federal or State law.” Kerr,113 T.C. at 472. Since the promulgationof the current regulations, many state stat-utes governing limited partnerships havebeen revised to allow liquidation of theentity only on the unanimous vote of allowners (unless provided otherwise in thepartnership agreement), and to eliminatethe statutory default provision that hadallowed a limited partner to liquidate hisor her limited partner interest. Instead,statutes in these jurisdictions typicallynow provide that a limited partner maynot withdraw from the partnership unlessthe partnership agreement provides other-wise. See, e.g., Tex. Bus. Orgs. Ann.§ 153.110 (West 2016) (limited partnermay withdraw as specified in the partner-ship agreement); Uniform Limited Part-nership Act (2001) § 601(a), 6A U.L.A.348, 448 (Supp. 2015) (limited partner hasno right to withdraw before completion ofthe winding up of the partnership).Further, other state statutes have been re-vised to create elective restrictions on liq-uidation. See, e.g., Nev. Rev. Stat.§ 87A.427 (2016) (limited partnershipelecting to be restricted limited partner-ship may not make any distributions for a10-year period). Each of these statutes isdesigned to be at least as restrictive as themaximum restriction on liquidation thatcould be imposed in a partnership agree-ment. The result is that the provisions of apartnership agreement restricting liquida-tion generally fall within the regulatoryexception for restrictions that are no morerestrictive than those under state law, andthus do not constitute applicable restric-tions under the current regulations.

Third, taxpayers have attempted toavoid the application of section 2704(b)through the transfer of a partnership inter-est to an assignee rather than to a partner.Again relying on the regulatory exceptionfor restrictions that are no more restrictivethan those under state law, and the factthat an assignee is allocated partnershipincome, gain, loss, etc., but does not have(and thus may not exercise) the rights orpowers of a partner, taxpayers argue thatan assignee’s inability to cause the part-nership to liquidate his or her partnershipinterest is no greater a restriction than thatimposed upon assignees under state law.Kerr, 113 T.C. at 463–64; Estate of Jonesv. Commissioner, 116 T.C. 121, 129–30

(2001). Taxpayers thus argue that the as-signee status of the transferred interest isnot an applicable restriction.

Finally, taxpayers have avoided the ap-plication of section 2704(b) through thetransfer of a nominal partnership interestto a nonfamily member, such as a charityor an employee, to ensure that the familyalone does not have the power to removea restriction. Kerr, 292 F.3rd at 494.

As the Tax Court noted in Kerr, Con-gress granted the Secretary broad discre-tion in section 2704(b)(4) to promulgateregulations identifying restrictions notcovered by section 2704(b) that neverthe-less should be disregarded for transfer taxvaluation purposes. 113 T.C. at 474. TheTreasury Department and the IRS haveconcluded that, as was recognized byCongress when enacting section 2704(b),there are additional restrictions that mayaffect adversely the transfer tax value ofan interest but that do not reduce the valueof the interest to the family-member trans-feree, and thus should be disregarded fortransfer tax valuation purposes. H.R.Conf. Rep. No. 101–964, supra, at 1138.The Treasury Department and the IRShave determined that such restrictions in-clude: (a) a restriction on the ability toliquidate the transferred interest; and (b)any restrictions attendant upon the natureor extent of the property to be received inexchange for the liquidated interest, or thetiming of the payment of that property.

Further, the Treasury Department andthe IRS have concluded that the grant ofan insubstantial interest in the entity to anonfamily member should not precludethe application of section 2704(b) be-cause, in reality, such nonfamily memberinterest generally does not constrain thefamily’s ability to remove a restriction onthe liquidation of an individual interest.Cf. Kerr, 292 F.3rd at 494 (noting that acharity receiving a partnership interestwould “convert its interests into cash assoon as possible, so long as it believed thetransaction to be in its best interest andthat it would receive fair market value forits interest”). The interest of such nonfa-mily members does not affect the family’scontrol of the entity, but rather, whencombined with a requirement that allholders approve liquidation, is designed toreduce the transfer tax value of the family-held interests while not ultimately reduc-


ing the value of those interests to thefamily member transferees. The enact-ment of section 2704 was intended to pre-vent this result. See section 2704(b)(4)(conferring on the Secretary broad regu-latory authority to apply section 2704(b)to other restrictions if the restriction hasthe effect of reducing the value of thetransferred interest for transfer tax pur-poses but does not ultimately reduce thevalue of the interest to the transferee). TheTreasury Department and the IRS haveconcluded that the presence of anonfamily-member interest should be rec-ognized only where the interest is an ec-onomically substantial and longstandingone that is likely to have a more substan-tive effect. A bright-line test will avoid thefact-intensive inquiry underlying a deter-mination of whether the interest of thenonfamily member effectively constrainsthe family’s ability to liquidate the entity.Accordingly, the proposed regulationsdisregard the interest held by a nonfamilymember that has been held less than threeyears before the date of the transfer, thatconstitutes less than 10 percent of thevalue of all of the equity interests, thatwhen combined with the interests of othernonfamily members constitutes less than20 percent of the value of all of the equityinterests, or that lacks a right to put theinterest to the entity and receive a mini-mum value.

Finally, since the promulgation of§§ 301.7701–1 through 301.7701–3 of theProcedure and Administration Regula-tions (the check-the-box regulations), anentity’s classification for federal tax pur-poses may differ substantially from theentity’s structure or form under local law.In addition, many taxpayers now utilize alimited liability company (LLC) as thepreferred entity to hold family assets orbusiness interests. The Treasury Depart-ment and the IRS have concluded that theregulations under section 2704 should beupdated to reflect these significant devel-opments.

Explanation of Provisions

The proposed regulations wouldamend § 25.2701–2 to address what con-stitutes control of an LLC or other entityor arrangement that is not a corporation,partnership, or limited partnership. Theproposed regulations would amend

§ 25.2704–1 to address deathbed transfersthat result in the lapse of a liquidationright and to clarify the treatment of atransfer that results in the creation of anassignee interest. The proposed regula-tions would amend § 25.2704–2 to refinethe definition of the term “applicable re-striction” by eliminating the comparisonto the liquidation limitations of state law.Further, the proposed regulations wouldadd a new section, § 25.2704–3, to ad-dress restrictions on the liquidation of anindividual interest in an entity and theeffect of insubstantial interests held bypersons who are not members of the fam-ily.

Covered Entities

The proposed regulations would clar-ify, in §§ 25.2704–1 through 25.2704–3,that section 2704 applies to corporations,partnerships, LLC’s, and other entitiesand arrangements that are business enti-ties within the meaning of § 301.7701–2(a), regardless of whether the entity orarrangement is domestic or foreign, re-gardless of how the entity or arrangementis classified for other federal tax purposes,and regardless of whether the entity orarrangement is disregarded as an entityseparate from its owner for other federaltax purposes.

Classification of the Entity

Section 2704 speaks in terms of corpo-rations and partnerships. Under the pro-posed regulations, a corporation is anybusiness entity described in § 301.7701–2(b)(1), (3), (4), (5), (6), (7), or (8), an Scorporation within the meaning of section1361(a)(1), and a qualified subchapter Ssubsidiary within the meaning of section1361(b)(3)(B). For this purpose, a quali-fied subchapter S subsidiary is treated as acorporation that is separate from its parentowner. For most purposes under the pro-posed regulations, a partnership would beany other business entity within the mean-ing of § 301.7701–1(a), regardless of howthe entity is classified for federal tax pur-poses.

However, these proposed regulationsaddress two situations in which it is nec-essary to go beyond this division of enti-ties into only the two categories of corpo-

ration and partnership. These situations(specifically, the test to determine controlof an entity, and the test to determinewhether a restriction is imposed understate law) require consideration of the dif-ferences among various types of businessentities under the local law under whichthose entities are created and governed.As a result, for purposes of the test todetermine control of an entity and to de-termine whether a restriction is imposedunder state law, the proposed regulationswould provide that in the case of anybusiness entity or arrangement that is nota corporation, the form of the entity orarrangement would be determined underlocal law, regardless of how it is classifiedfor other federal tax purposes, and regard-less of whether it is disregarded as anentity separate from its owner for otherfederal tax purposes. For this purpose, lo-cal law is the law of the jurisdiction,whether domestic or foreign, under whichthe entity or arrangement is created ororganized. Thus, in applying these twotests, there would be three types of enti-ties: corporations, partnerships (includinglimited partnerships), and other businessentities (which would include LLCs thatare not S corporations) as determined un-der local law.

Control of the Entity

Section 2704(c)(1) incorporates thedefinition of control found in section2701(b)(2). Control of a corporation, part-nership, or limited partnership is definedin sections 2701(b)(2)(A) and (B). Theproposed regulations would clarify, in§ 25.2701–2, that control of an LLC or ofany other entity or arrangement that is nota corporation, partnership, or limited part-nership would constitute the holding of atleast 50 percent of either the capital orprofits interests of the entity or arrange-ment, or the holding of any equity interestwith the ability to cause the full or partialliquidation of the entity or arrangement.Cf. section 2701(b)(2)(B)(ii) (definingcontrol of a limited partnership as includ-ing the holding of any interest as a generalpartner). Further, for purposes of deter-mining control, under the attribution rulesof existing § 25.2701–6, an individual,the individual’s estate, and members ofthe individual’s family are treated as hold-


ing interests held indirectly through a cor-poration, partnership, trust, or other entity.

Lapses under Section 2704(a)

The proposed regulations wouldamend § 25.2704–1(a) to confirm that atransfer that results in the restriction orelimination of any of the rights or powersassociated with the transferred interest (anassignee interest) is treated as a lapsewithin the meaning of section 2704(a).This is the case regardless of whether theright or power is exercisable by the trans-feror after the transfer because the statuteis concerned with the lapse of rights asso-ciated with the transferred interest.Whether the lapse is of a voting or liqui-dation right is determined under the gen-eral rules of section 25.2704–1.

The proposed regulations also wouldamend § 25.2704–1(c)(1) to narrow theexception in the definition of a lapse of aliquidation right to transfers occurringthree years or more before the transferor’sdeath that do not restrict or eliminate therights associated with the ownership ofthe transferred interest. In addition, theproposed regulations would amend§ 25.2704–1(c)(2)(i)(B) to conform theexisting provision for testing the family’sability to liquidate an interest with theproposed elimination of the comparisonwith local law, to clarify that the mannerin which liquidation may be achieved isirrelevant, and to conform with the pro-posed provision for disregarding certainnonfamily-member interests in testing thefamily’s ability to remove a restriction inproposed § 25.2704–3 regarding disre-garded restrictions.

Applicable Restrictions under Section2704(b)

The proposed regulations would re-move the exception in § 25.2704–2(b)that limits the definition of applicable re-striction to limitations that are more re-strictive than the limitations that wouldapply in the absence of the restriction un-der the local law generally applicable tothe entity. As noted above, this exceptionis not consistent with section 2704(b) tothe extent that the transferor and familymembers have the power to avoid anystatutory rule. The proposed regulations

also would revise § 25.2704–2(b) to pro-vide that an applicable restriction doesinclude a restriction that is imposed underthe terms of the governing documents, aswell as a restriction that is imposed undera local law regardless of whether that re-striction may be superseded by or pursu-ant to the governing documents or other-wise. In applying this particular exceptionto the definition of an applicable restric-tion, this proposed rule is intended to en-sure that a restriction that is not imposedor required to be imposed by federal orstate law is disregarded without regard toits source.

Further, with regard to the exceptionfor restrictions “imposed, or required to beimposed, by any Federal or State law,” insection 2704(b)(3)(B), the proposed regu-lations would clarify that the terms “fed-eral” and “state” refer only to the UnitedStates or any state (including the Districtof Columbia (see section 7701(a)(10)),but do not include any other jurisdiction.

A restriction is imposed or required tobe imposed by law if the restriction cannotbe removed or overridden and it is man-dated by the applicable law, is required tobe included in the governing documents,or otherwise is made mandatory. In addi-tion, a restriction imposed by a state law,even if that restriction may not be re-moved or overridden directly or indi-rectly, nevertheless would constitute anapplicable restriction in two situations. Ineach situation, although the statute itself ismandatory and cannot be overridden, an-other statute is available to be used for theentity’s governing law that does not re-quire the mandatory restriction, thus ineffect making the purportedly mandatoryprovision elective. The first situation isthat in which the state law is limited in itsapplication to certain narrow classes ofentities, particularly those types of entitiesmost likely to be subject to transfers de-scribed in section 2704, that is, family-controlled entities. The second situation isthat in which, although the state law underwhich the entity was created imposed amandatory restriction that could not beremoved or overridden, either at the timethe entity was organized or at some sub-sequent time, that state’s law also pro-vided an optional provision or an alterna-tive statute for the creation andgovernance of that same type of entity that

did not mandate the restriction. Thus, anoptional provision is one for the samecategory of entity that did not include therestriction or that allowed it to be removedor overridden, or that made the restrictionoptional, or permitted the restriction to besuperseded, whether by the entity’s gov-erning documents or otherwise. For pur-poses of determining whether a restrictionis imposed on an entity under state law,there would be only three types of entities,specifically, the three categories of entitiesdescribed in § 25.2701–2(b)(5) of the pro-posed regulations: corporations; partner-ships (including limited partnerships); andother business entities. A similar proposedrule applies to the additional restrictionsdiscussed later in this preamble.

If an applicable restriction is disre-garded, the fair market value of the trans-ferred interest is determined under gener-ally applicable valuation principles as ifthe restriction does not exist (that is, as ifthe governing documents and the locallaw are silent on the question), and thus,there is deemed to be no such restrictionon liquidation of the entity.

Disregarded Restrictions

A new class of restrictions is describedin the proposed regulations that would bedisregarded, described as “disregarded re-strictions.” This class of restrictions isidentified pursuant to the authority con-tained in section 2704(b)(4). Note that,although it may appear that sections 2703and 2704(b) overlap, they do not. Whilesection 2703 and the corresponding regu-lations currently address restrictions onthe sale or use of individual interests infamily-controlled entities, the proposedregulations would address restrictions onthe liquidation or redemption of such in-terests.

Under § 25.2704–3 of the proposedregulations, in the case of a family-controlled entity, any restriction describedbelow on a shareholder’s, partner’s, mem-ber’s, or other owner’s right to liquidatehis or her interest in the entity will bedisregarded if the restriction will lapse atany time after the transfer, or if the trans-feror, or the transferor and family mem-bers, without regard to certain interestsheld by nonfamily members, may removeor override the restriction. Under the pro-


posed regulations, such a disregarded re-striction includes one that: (a) limits theability of the holder of the interest toliquidate the interest; (b) limits the liqui-dation proceeds to an amount that is lessthan a minimum value; (c) defers the pay-ment of the liquidation proceeds for morethan six months; or (d) permits the pay-ment of the liquidation proceeds in anymanner other than in cash or other prop-erty, other than certain notes.

“Minimum value” is the interest’sshare of the net value of the entity on thedate of liquidation or redemption. The netvalue of the entity is the fair market value,as determined under section 2031 or 2512and the applicable regulations, of theproperty held by the entity, reduced by theoutstanding obligations of the entity.Solely for purposes of determining mini-mum value, the only outstanding obliga-tions of the entity that may be taken intoaccount are those that would be allowable(if paid) as deductions under section 2053if those obligations instead were claimsagainst an estate. For example, and sub-ject to the foregoing limitation on out-standing obligations, if the entity holds anoperating business, the rules of§ 20.2031–2(f)(2) or 20.2031–3 apply inthe case of a testamentary transfer and therules of § 25.2512–2(f)(2) or 25.2512–3apply in the case of an inter vivos transfer.The minimum value of the interest is thenet value of the entity multiplied by theinterest’s share of the entity. For this pur-pose, the interest’s share is determined bytaking into account any capital, profits,and other rights inherent in the interest inthe entity.

A disregarded restriction includes lim-itations on the time and manner of pay-ment of the liquidation proceeds. Suchlimitations include provisions permittingdeferral of full payment beyond sixmonths or permitting payment in anymanner other than in cash or property. Forthis purpose, the term “property” does notinclude a note or other obligation issueddirectly or indirectly by the entity, otherholders of an interest in the entity, orpersons related to either. An exception ismade for the note of an entity engaged inan active trade or business to the extentthat (a) the liquidation proceeds are notattributable to passive assets within themeaning of section 6166(b)(9)(B), and (b)

the note is adequately secured, requiresperiodic payments on a non-deferred ba-sis, is issued at market interest rates, andhas a fair market value (when discountedto present value) equal to the liquidationproceeds. A fair market value determina-tion assumes a cash sale. See Section 2 ofRev. Rul. 59–60, 1959–1 C.B. 237 (de-fining fair market value and stating that“[c]ourt decisions frequently state in ad-dition that the hypothetical buyer andseller are assumed to be able, as well aswilling to trade. . .”). Thus, in the absenceof immediate payment of the liquidationproceeds, the fair market value of any notefalling within this exception must equalthe fair market value of the liquidationproceeds on the date of liquidation or re-demption.

Exceptions that apply to applicable re-strictions under the current and these pro-posed regulations also apply to this newclass of disregarded restrictions. One ofthe exceptions applicable to the definitionof a disregarded restriction applies if (a)each holder of an interest in the entity hasan enforceable “put” right to receive, onliquidation or redemption of the holder’sinterest, cash and/or other property with avalue that is at least equal to the minimumvalue previously described, (b) the fullamount of such cash and other propertymust be paid within six months after theholder gives notice to the entity of theholder’s intent to liquidate any part or allof the holder’s interest and/or withdrawfrom the entity, and (c) such other prop-erty does not include a note or other ob-ligation issued directly or indirectly by theentity, by one or more holders of interestsin the entity, or by a person related eitherto the entity or to any holder of an interestin the entity. However, in the case of anentity engaged in an active trade or busi-ness, at least 60 percent of whose valueconsists of the non-passive assets of thattrade or business, and to the extent that theliquidation proceeds are not attributable topassive assets within the meaning of sec-tion 6166(b)(9)(B), such proceeds may in-clude a note or other obligation if suchnote is adequately secured, requires peri-odic payments on a non-deferred basis, isissued at market interest rates, and has afair market value on the date of the liqui-dation or redemption equal to the liquida-tion proceeds. A similar exception is made

to the definition of an applicable restric-tion in proposed § 25.2704–2(b)(4).

In determining whether the transferorand/or the transferor’s family has the abil-ity to remove a restriction included in thisnew class of disregarded restrictions, anyinterest in the entity held by a person whois not a member of the transferor’s familyis disregarded if, at the time of the trans-fer, the interest: (a) has been held by suchperson for less than three years; (b) con-stitutes less than 10 percent of the value ofall of the equity interests in a corporation,or constitutes less than 10 percent of thecapital and profits interests in a businessentity described in § 301.7701–2(a) otherthan a corporation (for example, less thana 10-percent interest in the capital andprofits of a partnership); (c) when com-bined with the interests of all other per-sons who are not members of the transfer-or’s family, constitutes less than 20percent of the value of all of the equityinterests in a corporation, or constitutesless than 20 percent of the capital andprofits interests in a business entity otherthan a corporation (for example, less thana 20-percent interest in the capital andprofits of a partnership); or (d) any suchperson, as the owner of an interest, doesnot have an enforceable right to receive inexchange for such interest, on no morethan six months’ prior notice, the mini-mum value referred to in the definition ofa disregarded restriction. If an interest isdisregarded, the determination of whetherthe family has the ability to remove therestriction will be made assuming that theremaining interests are the sole interests inthe entity.

Finally, if a restriction is disregardedunder proposed § 25.2704–3, the fair mar-ket value of the interest in the entity isdetermined assuming that the disregardedrestriction did not exist, either in the gov-erning documents or applicable law. Fairmarket value is determined under gener-ally accepted valuation principles, includ-ing any appropriate discounts or premi-ums, subject to the assumptions describedin this paragraph.

Coordination with Marital andCharitable Deductions

Section 2704(b) applies to intra-familytransfers for all purposes of subtitle B


relating to estate, gift and GST taxes.Therefore, to the extent that an interestqualifies for the gift or estate tax maritaldeduction and must be valued by takinginto account the special valuation assump-tions of section 2704(b), the same valuegenerally will apply in computing themarital deduction attributable to that in-terest. The value of the estate tax maritaldeduction may be further affected, how-ever, by other factors justifying a differentvalue, such as the application of a controlpremium. See, e.g., Estate of Chenowethv. Commissioner, 88 T.C. 1577 (1987).

Section 2704(b) does not apply totransfers to nonfamily members and thushas no application in valuing an interestpassing to charity or to a person other thana family member. If part of an entity in-terest includible in the gross estate passesto family members and part of that interestpasses to nonfamily members, and if (tak-ing into account the proposed rules re-garding the treatment of certain interestsheld by nonfamily members) the partpassing to the decedent’s family membersis valued under section 2704(b), then theproposed regulations provide that the partpassing to the family members is treatedas a property interest separate from thepart passing to nonfamily members. Thefair market value of the part passing tothe family members is determined takinginto account the special valuation assump-tions of section 2704(b), as well as anyother relevant factors, such as those sup-porting a control premium. The fair mar-ket value of the part passing to the nonfa-mily member(s) is determined in a similarmanner, but without the special valuationassumptions of section 2704(b). Thus, ifthe sole nonfamily member receiving aninterest is a charity, the interest generallywill have the same value for both estatetax inclusion and deduction purposes. Ifthe interest passing to nonfamily mem-bers, however, is divided between chari-ties and other nonfamily members, addi-tional considerations (not prescribed bysection 2704) may apply, resulting in adifferent value for charitable deductionpurposes. See, e.g., Ahmanson Founda-tion v. United States, 674 F.2d 761 (9th

Cir. 1981).

Effective Dates

The amendments to § 25.2701–2 areproposed to be effective on and after thedate of publication of a Treasury decisionadopting these rules as final regulations inthe Federal Register. The amendments to§ 25.2704–1 are proposed to apply tolapses of rights created after October 8,1990, occurring on or after the date theseregulations are published as final regula-tions in the Federal Register. The amend-ments to § 25.2704–2 are proposed toapply to transfers of property subject torestrictions created after October 8, 1990,occurring on or after the date these regu-lations are published as final regulationsin the Federal Register. Section25.2704–3 is proposed to apply to trans-fers of property subject to restrictions cre-ated after October 8, 1990, occurring 30or more days after the date these regula-tions are published as final regulations inthe Federal Register.

Special Analyses

Certain IRS regulations, including thisone, are exempt from the requirements ofExecutive Order 12866, as supplementedand reaffirmed by Executive Order 13563.Therefore, a regulatory impact assessmentis not required. Pursuant to the RegulatoryFlexibility Act (5 U.S.C. chapter 6), it ishereby certified that this regulation willnot have a significant economic impact ona substantial number of small entities. Theproposed regulations affect the transfertax liability of individuals who transfer aninterest in certain closely held entities andnot the entities themselves. The proposedregulations do not affect the structure ofsuch entities, but only the assumptionsunder which they are valued for federaltransfer tax purposes. In addition, anyeconomic impact on entities affected bysection 2704, large or small, is derivedfrom the operation of the statute, or itsintended application, and not from theproposed regulations in this notice of pro-posed rulemaking. Accordingly, a regula-tory flexibility analysis is not required.Pursuant to section 7805(f) of the InternalRevenue Code, this regulation has beensubmitted to the Chief Counsel for Advo-cacy of the Small Business Administra-tion for comment on its impact on smallbusiness.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written (a signedoriginal and eight (8) copies) or electroniccomments that are submitted timely (inthe manner described in “ADDRESSES”)to the IRS. The Treasury Department andthe IRS request comments on all aspectsof the proposed regulations. All commentswill be available at www.regulations.gov,or upon request.

A public hearing on these proposedregulations has been scheduled for De-cember 1, 2016, beginning at 10 a.m. inthe Auditorium, Internal Revenue Build-ing, 1111 Constitution Avenue, NW,Washington, DC 20224. Due to buildingsecurity procedures, visitors must enter atthe Constitution Avenue entrance. In ad-dition, all visitors must present photoidentification to enter the building. Be-cause of access restrictions, visitors willnot be admitted beyond the immediateentrance area more than 30 minutes beforethe hearing starts. For information abouthaving your name placed on the buildingaccess list to attend the hearing, see the“FOR FURTHER INFORMATION CON-TACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) ap-ply to the hearing. Persons who wish topresent oral comments at the hearing mustsubmit comments by November 2, 2016,and submit an outline of the topics to bediscussed and the time to be devoted toeach topic (signed original and eight (8)copies) by November 2, 2016.

A period of 10 minutes will be allottedto each person for making comments.Copies of the agenda will be available freeof charge at the hearing.


The principal author of these proposedregulations is John D. MacEachen, Officeof the Associate Chief Counsel (Pass-throughs and Special Industries). Otherpersonnel from the Treasury Departmentand the IRS participated in their develop-ment.

* * * * *


Proposed Amendments to theRegulations

Accordingly, 26 CFR part 25 is pro-posed to be amended as follows:

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

Par. 1. The authority citation for part25 is amended by adding entries in numer-ical order to read in part as follows:

Authority: 26 U.S.C. 7805. * * *Section 25.2701–2 also issued under

26 U.S.C. 2701(e).Section 25.2704–1 also issued under

26 U.S.C. 2704(a).Sections 25.2704–2 and 25.2704–3

also issued under 26 U.S.C. 2704(b).* * * * *Par. 2. Section 25.2701–2 is amended

as follows:1. In paragraph (b)(5)(i), the first sen-

tence is revised and five sentences areadded before the last sentence.

2. Paragraph (b)(5)(iv) is added.The revision and additions read as fol-

lows:

§ 25.2701–2 Special valuation rules forapplicable retained interests.

* * * * *(b) * * *(5) * * *(i) * * * For purposes of section 2701,

a controlled entity is a corporation, part-nership, or any other entity or arrange-ment that is a business entity within themeaning of § 301.7701–2(a) of this chap-ter controlled, immediately before a trans-fer, by the transferor, applicable familymembers, and/or any lineal descendants ofthe parents of the transferor or the trans-feror’s spouse. The form of the entity de-termines the applicable test for control.For purposes of determining the form ofthe entity, any business entity described in§ 301.7701–2(b)(1), (3), (4), (5), (6), (7),or (8) of this chapter, an S corporationwithin the meaning of section 1361(a)(1),and a qualified subchapter S subsidiarywithin the meaning of section 1361(b)(3)(B) is a corporation. For this purpose, aqualified subchapter S subsidiary istreated as a corporation separate from itsparent corporation. In the case of anybusiness entity that is not a corporation

under these provisions, the form of theentity is determined under local law, re-gardless of how the entity is classified forfederal tax purposes or whether it is dis-regarded as an entity separate from itsowner for federal tax purposes. For thispurpose, local law is the law of the juris-diction, whether domestic or foreign, un-der whose laws the entity is created ororganized. * * *

* * * * *(iv) Other business entities. In the case

of any entity or arrangement that is not acorporation, partnership, or limited part-nership, control means the holding of atleast 50 percent of either the capital inter-ests or the profits interests in the entity orarrangement. In addition, control meansthe holding of any equity interest with theability to cause the liquidation of the en-tity or arrangement in whole or in part.


as follows:1. The existing text is designated as

paragraph (a).2. The first sentence of newly desig-

nated paragraph (a) is revised and para-graph (b) is added.

The revision and addition reads as fol-lows:

§ 25.2701–8 Effective dates.

(a) Except as provided in paragraph (b)of this section, §§ 25.2701–1 through25.2701–4 and §§ 25.2701–6 and25.2701–7 are effective as of January 28,1992. * * *

(b) The first six sentences of§ 25.2701–2(b)(5)(i) and (iv) are effectiveon the date these regulations are publishedas final regulations in the Federal Regis-ter.

Par. 4. Section 25.2704–1 is amendedas follows:

1. In paragraph (a)(1), the first twosentences are revised and four sentencesare added before the third sentence.

2. In paragraph (a)(2)(i), a sentence isadded at the end.

3. Paragraph (a)(2)(iii) is removed.4. Paragraphs (a)(2)(iv) through (vi)

are redesignated as paragraphs (a)(2)(iii)through (v), respectively.

5. In newly designated paragraph(a)(2)(iii), a sentence is added before thethird sentence.

6. Paragraph (a)(4) is revised.7. Paragraph (a)(5) is added.8. In paragraph (c)(1), the second sen-

tence is revised and a sentence is added atthe end.

9. Paragraph (c)(2)(i)(B) is revised.10. In paragraph (f) Example 4, the

third and fourth sentences are revised anda sentence is added at the end.

11. In paragraph (f) Example 6, thethird sentence is removed.

12. In paragraph (f) Example 7, thethird and fourth sentences are revised anda sentence is added at the end.


§ 25.2704–1 Lapse of certain rights.

(a) * * *(1) * * * For purposes of subtitle B

(relating to estate, gift, and generation-skipping transfer taxes), the lapse of avoting or a liquidation right in a corpora-tion or a partnership (an entity), whetherdomestic or foreign, is a transfer by theindividual directly or indirectly holdingthe right immediately prior to its lapse(the holder) to the extent provided in para-graphs (b) and (c) of this section. Thissection applies only if the entity is con-trolled by the holder and/or members ofthe holder’s family immediately beforeand after the lapse. For purposes of thissection, a corporation is any business en-tity described in § 301.7701–2(b)(1), (3),(4), (5), (6), (7), or (8) of this chapter, anS corporation within the meaning of sec-tion 1361(a)(1), and a qualified subchapterS subsidiary within the meaning of section1361(b)(3)(B). For this purpose, a quali-fied subchapter S subsidiary is treated as acorporation separate from its parent cor-poration. A partnership is any other busi-ness entity within the meaning of§ 301.7701–2(a) of this chapter regardlessof how that entity is classified for federaltax purposes. Thus, for example, the termpartnership includes a limited liabilitycompany that is not an S corporation,whether or not it is disregarded as anentity separate from its owner for federaltax purposes. * * *

(2) * * *


(i) * * * For purposes of determiningwhether the group consisting of theholder, the holder’s estate and members ofthe holder’s family control the entity, amember of the group is also treated asholding any interest held indirectly bysuch member through a corporation, part-nership, trust, or other entity under therules contained in § 25.2701–6.

* * * * *(iii) * * * In the case of a limited

liability company, the right of a memberto participate in company management isa voting right. * * *

* * * * *(4) Source of right or lapse. A voting

right or a liquidation right may be con-ferred by or lapse by reason of local law,the governing documents, an agreement,or otherwise. For this purpose, local law isthe law of the jurisdiction, whether do-mestic or foreign, that governs voting orliquidation rights.

(5) Assignee interests. A transfer thatresults in the restriction or elimination ofthe transferee’s ability to exercise the vot-ing or liquidation rights that were associ-ated with the interest while held by thetransferor is a lapse of those rights. Forexample, the transfer of a partnership in-terest to an assignee that neither has normay exercise the voting or liquidationrights of a partner is a lapse of the votingand liquidation rights associated with thetransferred interest.

(c) * * *(1) * * * Except as otherwise provided,

a transfer of an interest occurring morethan three years before the transferor’sdeath that results in the lapse of a votingor liquidation right is not subject to thissection if the rights with respect to thetransferred interest are not restricted oreliminated. * * * The lapse of a voting orliquidation right as a result of the transferof an interest within three years of thetransferor’s death is treated as a lapse oc-curring on the transferor’s date of death,includible in the gross estate pursuant tosection 2704(a).

(2) * * * *(i) * * * *(B) Ability to liquidate. Whether an

interest can be liquidated immediately af-ter the lapse is determined under the locallaw generally applicable to the entity, asmodified by the governing documents of

the entity, but without regard to any re-striction (in the governing documents, ap-plicable local law, or otherwise) describedin section 2704(b) and the regulationsthereunder. The manner in which the in-terest may be liquidated is irrelevant forthis purpose, whether by voting, takingother action authorized by the governingdocuments or applicable local law, revis-ing the governing documents, merging theentity with an entity whose governingdocuments permit liquidation of the inter-est, terminating the entity, or otherwise.For purposes of making this determina-tion, an interest held by a person otherthan a member of the holder’s family (anonfamily-member interest) may be disre-garded. Whether a nonfamily-member in-terest is disregarded is determined under§ 25.2704–3(b)(4), applying that sectionas if, by its terms, it also applies to thequestion of whether the holder (or theholder’s estate) and members of the hold-er’s family may liquidate an interest im-mediately after the lapse.

* * * * *(f) * * *Example 4. * * * More than three years before

D’s death, D transfers one-half of D’s stock in equalshares to D’s three children (14 percent each). Sec-tion 2704(a) does not apply to the loss of D’s abilityto liquidate Y because the voting rights with respectto the transferred shares are not restricted or elimi-nated by reason of the transfer, and the transferoccurs more than three years before D’s death. How-ever, had the transfers occurred within three years ofD’s death, the transfers would have been treated asthe lapse of D’s liquidation right occurring at D’sdeath.

* * * * *Example 7. * * * More than three years before

D’s death, D transfers 30 shares of common stock toD’s child. The transfer is not a lapse of a liquidationright with respect to the common stock because thevoting rights that enabled D to liquidate prior tothe transfer are not restricted or eliminated, and thetransfer occurs more than three years before D’sdeath. * * * However, had the transfer occurredwithin three years of D’s death, the transfer wouldhave been treated as the lapse of D’s liquidation rightwith respect to the common stock occurring at D’sdeath.

Par. 5. Section 25.2704–2 is amendedas follows:

1. Paragraphs (a) and (b) are revised.2. Paragraphs (c) and (d) are desig-

nated as paragraphs (e) and (g), respec-tively.

3. New paragraphs (c), (d), and (f) areadded.

4. The first sentence of newly desig-nated paragraph (e) is revised.

5. The third sentences of newly desig-nated paragraph (g) Example 1. and Ex-ample 3. are removed.

6. The third sentence of newly desig-nated paragraph (g) Example 5. is revised.


§ 25.2704–2 Transfers subject toapplicable restrictions.

(a) In general. For purposes of subtitleB (relating to estate, gift, and generation-skipping transfer taxes), if an interest in acorporation or a partnership (an entity),whether domestic or foreign, is transferredto or for the benefit of a member of thetransferor’s family, and the transferorand/or members of the transferor’s familycontrol the entity immediately before thetransfer, any applicable restriction is dis-regarded in valuing the transferred inter-est. For purposes of this section, a corpo-ration is any business entity described in§ 301.7701–2(b)(1), (3), (4), (5), (6), (7),or (8) of this chapter, an S corporationwithin the meaning of section 1361(a)(1),and a qualified subchapter S subsidiarywithin the meaning of section1361(b)(3)(B). For this purpose, a quali-fied subchapter S subsidiary is treated as acorporation separate from its parent cor-poration. A partnership is any other busi-ness entity within the meaning of§ 301.7701–2(a) of this chapter, regard-less of how that entity is classified forfederal tax purposes. Thus, for example,the term partnership includes a limitedliability company that is not an S corpo-ration, whether or not it is disregarded asan entity separate from its owner for fed-eral tax purposes.

(b) Applicable restriction defined—(1)In general. The term applicable restric-tion means a limitation on the ability toliquidate the entity, in whole or in part (asopposed to a particular holder’s interest inthe entity), if, after the transfer, that lim-itation either lapses or may be removed bythe transferor, the transferor’s estate,and/or any member of the transferor’sfamily, either alone or collectively. See§ 25.2704–3 for restrictions on the abilityto liquidate a particular holder’s interest inthe entity.


(2) Source of limitation. An applicablerestriction includes a restriction that is im-posed under the terms of the governingdocuments (for example, the corpora-tion’s by-laws, the partnership agreement,or other governing documents), a buy-sellagreement, a redemption agreement, or anassignment or deed of gift, or any otherdocument, agreement, or arrangement;and a restriction imposed under local lawregardless of whether that restriction maybe superseded by or pursuant to the gov-erning documents or otherwise. For thispurpose, local law is the law of the juris-diction, whether domestic or foreign, thatgoverns the applicability of the restriction.For an exception for restrictions imposedor required to be imposed by federal orstate law, see paragraph (b)(4)(ii) of thissection.

(3) Lapse or removal of limitation. Arestriction is an applicable restriction onlyto the extent that either the restriction byits terms will lapse at any time after thetransfer, or the restriction may be removedafter the transfer by any one or moremembers, either alone or collectively, ofthe group consisting of the transferor, thetransferor’s estate, and members of thetransferor’s family. For purposes of deter-mining whether the ability to remove therestriction is held by any member(s) ofthis group, members are treated as holdingthe interests attributed to them under therules contained in § 25.2701–6, in addi-tion to interests held directly. The mannerin which the restriction may be removed isirrelevant for this purpose, whether byvoting, taking other action authorized bythe governing documents or applicable lo-cal law, removing the restriction from thegoverning documents, revising the gov-erning documents to override the restric-tion prescribed under local law in the ab-sence of a contrary provision in thegoverning documents, merging the entitywith an entity whose governing docu-ments do not contain the restriction, ter-minating the entity, or otherwise.

(4) Exceptions. A restriction describedin this paragraph (b)(4) is not an applica-ble restriction.

(i) Commercially reasonable restric-tion. An applicable restriction does notinclude a commercially reasonable restric-tion on liquidation imposed by an unre-lated person providing capital to the entity

for the entity’s trade or business opera-tions, whether in the form of debt or eq-uity. An unrelated person is any personwhose relationship to the transferor, thetransferee, or any member of the family ofeither is not described in section 267(b),provided that for purposes of this sectionthe term fiduciary of a trust as used insection 267(b) does not include a bank asdefined in section 581 that is publiclyheld.

(ii) Imposed by federal or state law. Anapplicable restriction does not include arestriction imposed or required to be im-posed by federal or state law. For thispurpose, federal or state law means thelaws of the United States, of any statethereof, or of the District of Columbia, butdoes not include the laws of any otherjurisdiction. A provision of law that ap-plies only in the absence of a contraryprovision in the governing documents orthat may be superseded with regard to aparticular entity (whether by the share-holders, partners, members and/or manag-ers of the entity or otherwise) is not arestriction that is imposed or required tobe imposed by federal or state law. A lawthat is limited in its application to certainnarrow classes of entities, particularlythose types of entities (such as family-controlled entities) most likely to be sub-ject to transfers described in section 2704,is not a restriction that is imposed or re-quired to be imposed by federal or statelaw. For example, a law requiring a re-striction that may not be removed or su-perseded and that applies only to family-controlled entities that otherwise would besubject to the rules of section 2704 is anapplicable restriction. In addition, a re-striction is not imposed or required to beimposed by federal or state law if that lawalso provides (either at the time the entitywas organized or at some subsequenttime) an optional provision that does notinclude the restriction or that allows it tobe removed or overridden, or that pro-vides a different statute for the creationand governance of that same type of entitythat does not mandate the restriction,makes the restriction optional, or permitsthe restriction to be superseded, whetherby the entity’s governing documents orotherwise. For purposes of determiningthe type of entity, there are only threetypes of entities, specifically, the three

categories of entities described in§ 25.2701–2(b)(5): corporations; partner-ships (including limited partnerships); andother business entities.

(iii) Certain rights under section 2703.An option, right to use property, or agree-ment that is subject to section 2703 is notan applicable restriction.

(iv) Put right of each holder. Any re-striction that otherwise would constitutean applicable restriction under this sectionwill not be considered an applicable re-striction if each holder of an interest in theentity has a put right as described in§ 25.2704–3(b)(6).

(c) Other definitions. For the definitionof the term controlled entity, see§ 25.2701–2(b)(5). For the definition ofthe term member of the family, see§ 25.2702–2(a)(1).

(d) Attribution. An individual, the in-dividual’s estate, and members of the in-dividual’s family are treated as also hold-ing any interest held indirectly by suchperson through a corporation, partnership,trust, or other entity under the rules con-tained in § 25.2701–6.

(e) * * * If an applicable restriction isdisregarded under this section, the fairmarket value of the transferred interest isdetermined under generally applicablevaluation principles as if the restriction(whether in the governing documents, ap-plicable law, or both) does not exist. * * *

(f) Certain transfers at death to multi-ple persons. Solely for purposes of section2704(b), if part of a decedent’s interest inan entity includible in the gross estatepasses by reason of death to one or moremembers of the decedent’s family andpart of that includible interest passes toone or more persons who are not membersof the decedent’s family, and if the partpassing to the members of the decedent’sfamily is to be valued pursuant to para-graph (e) of this section, then that part istreated as a single, separate property in-terest. In that case, the part passing to oneor more persons who are not members ofthe decedent’s family is also treated as asingle, separate property interest. Seeparagraph (g) Ex. 4 of § 25.2704–3.

(g) * * *Example 5. * * * The preferred stock carries a

right to liquidate X that cannot be exercised until1999. * * *

* * * * *


§ 25.2704–3 [Redesignated as§ 25.2704–4]

Par. 6. Section 25.2704–3 is redesig-nated as § 25.2704–4.

Par. 7. New § 25.2704–3 is added toread as follows.

§ 25.2704–3 Transfers subject todisregarded restrictions.

(a) In general. For purposes of subtitleB (relating to estate, gift and generation-skipping transfer taxes), and notwith-standing any provision of § 25.2704–2, ifan interest in a corporation or a partner-ship (an entity), whether domestic or for-eign, is transferred to or for the benefit ofa member of the transferor’s family, andthe transferor and/or members of thetransferor’s family control the entity im-mediately before the transfer, any restric-tion described in paragraph (b) of thissection is disregarded, and the transferredinterest is valued as provided in paragraph(f) of this section. For purposes of thissection, a corporation is any business en-tity described in § 301.7701–2(b)(1), (3),(4), (5), (6), (7), or (8) of this chapter, anS corporation within the meaning of sec-tion 1361(a)(1), and a qualified subchapterS subsidiary within the meaning of section1361(b)(3)(B). For this purpose, a quali-fied subchapter S subsidiary is treated as acorporation separate from its parent cor-poration. A partnership is any other busi-ness entity within the meaning of§ 301.7701–2(a) of this chapter, regard-less of how that entity is classified forfederal tax purposes. Thus, for example,the term partnership includes a limitedliability company that is not an S corpo-ration, whether or not it is disregarded asan entity separate from its owner for fed-eral tax purposes.

(b) Disregarded restrictions defined—(1) In general. The term disregarded re-striction means a restriction that is a lim-itation on the ability to redeem orliquidate an interest in an entity that isdescribed in any one or more of para-graphs (b)(1)(i) through (iv) of this sec-tion, if the restriction, in whole or in part,either lapses after the transfer or can beremoved by the transferor or any memberof the transferor’s family (subject to para-

graph (b)(4) of this section), either aloneor collectively.

(i) The provision limits or permits thelimitation of the ability of the holder ofthe interest to compel liquidation or re-demption of the interest.

(ii) The provision limits or permits thelimitation of the amount that may be re-ceived by the holder of the interest onliquidation or redemption of the interest toan amount that is less than a minimumvalue. The term minimum value means theinterest’s share of the net value of theentity determined on the date of liquida-tion or redemption. The net value of theentity is the fair market value, as deter-mined under section 2031 or 2512 and theapplicable regulations, of the propertyheld by the entity, reduced by the out-standing obligations of the entity. Solelyfor purposes of determining minimumvalue, the only outstanding obligations ofthe entity that may be taken into accountare those that would be allowable (if paid)as deductions under section 2053 if thoseobligations instead were claims against anestate. For example, and subject to theforegoing limitation on outstanding obli-gations, if the entity holds an operatingbusiness, the rules of § 20.2031–2(f)(2) or§ 20.2031–3 of this chapter apply in thecase of a testamentary transfer and therules of § 25.2512–2(f)(2) or § 25.2512–3apply in the case of an inter vivos transfer.The minimum value of the interest is thenet value of the entity multiplied by theinterest’s share of the entity. For this pur-pose, the interest’s share is determined bytaking into account any capital, profits,and other rights inherent in the interest inthe entity. If the property held by theentity directly or indirectly includes aninterest in another entity, and if a transferof an interest in that other entity by thesame transferor (had that transferor ownedthe interest directly) would be subject tosection 2704(b), then the entity will betreated as owning a share of the propertyheld by the other entity, determined andvalued in accordance with the provisionsof section 2704(b) and the regulationsthereunder.

(iii) The provision defers or permits thedeferral of the payment of the full amountof the liquidation or redemption proceedsfor more than six months after the date theholder gives notice to the entity of the

holder’s intent to have the holder’s inter-est liquidated or redeemed.

(iv) The provision authorizes or per-mits the payment of any portion of the fullamount of the liquidation or redemptionproceeds in any manner other than in cashor property. Solely for this purpose, ex-cept as provided in the following sen-tence, a note or other obligation issueddirectly or indirectly by the entity, by oneor more holders of interests in the entity,or by a person related to either the entityor any holder of an interest in the entity, isdeemed not to be property. In the case ofan entity engaged in an active trade orbusiness, at least 60 percent of whosevalue consists of the non-passive assets ofthat trade or business, and to the extentthat the liquidation proceeds are not attrib-utable to passive assets within the mean-ing of section 6166(b)(9)(B), such pro-ceeds may include such a note or otherobligation if such note or other obligationis adequately secured, requires periodicpayments on a non-deferred basis, is is-sued at market interest rates, and has a fairmarket value on the date of liquidation orredemption equal to the liquidation pro-ceeds. See § 25.2512–8. For purposes ofthis paragraph (b)(1)(iv), a related personis any person whose relationship to theentity or to any holder of an interest in theentity is described in section 267(b), pro-vided that for this purpose the term fidu-ciary of a trust as used in section 267(b)does not include a bank as defined insection 581 that is publicly held.

(2) Source of limitation. A disregardedrestriction includes a restriction that is im-posed under the terms of the governingdocuments (for example, the corpora-tion’s by-laws, the partnership agreement,or other governing documents), a buy-sellagreement, a redemption agreement, or anassignment or deed of gift, or any otherdocument, agreement, or arrangement;and a restriction imposed under local lawregardless of whether that restriction maybe superseded by or pursuant to the gov-erning documents or otherwise. For thispurpose, local law is the law of the juris-diction, whether domestic or foreign,which governs the applicability of the re-striction. For an exception for restrictionsimposed or required to be imposed byfederal or state law, see paragraph(b)(5)(iii) of this section.


(3) Lapse or removal of limitation. Arestriction is a disregarded restriction onlyto the extent that the restriction either willlapse by its terms at any time after thetransfer or may be removed after thetransfer by any one or more members,either alone or collectively, of the groupconsisting of the transferor, the transfer-or’s estate, and members of the transfer-or’s family. For purposes of determiningwhether the ability to remove the restric-tion is held by any one or more membersof this group, members are treated asholding interests attributed to them underthe rules contained in § 25.2701–6, inaddition to interests held directly. See alsoparagraph (b)(4) of this section. The man-ner in which the restriction may be re-moved is irrelevant for this purpose,whether by voting, taking other action au-thorized by the governing documents orapplicable local law, removing the restric-tion from the governing documents, revis-ing the governing documents to overridethe restriction prescribed under local lawin the absence of a contrary provision inthe governing documents, merging the en-tity with an entity whose governing doc-uments do not contain the restriction, ter-minating the entity, or otherwise.

(4) Certain interests held by nonfamilymembers disregarded—(i) In general. Inthe case of a transfer to or for the benefitof a member of the transferor’s family, forpurposes of determining whether thetransferor (or the transferor’s estate) orany member of the transferor’s family,either alone or collectively, may remove arestriction within the meaning of thisparagraph (b), an interest held by a personother than a member of the transferor’sfamily (a nonfamily-member interest) isdisregarded unless all of the following aresatisfied:

(A) The interest has been held by thenonfamily member for at least three yearsimmediately before the transfer;

(B) On the date of the transfer, in thecase of a corporation, the interest consti-tutes at least 10 percent of the value of allof the equity interests in the corporation,and, in the case of a business entity withinthe meaning of § 301.7701–2(a) of thischapter other than a corporation, the inter-est constitutes at least a 10-percent inter-est in the business entity, for example, a

10-percent interest in the capital and prof-its of a partnership;

(C) On the date of the transfer, in thecase of a corporation, the total of the eq-uity interests in the corporation held byshareholders who are not members of thetransferor’s family constitutes at least 20percent of the value of all of the equityinterests in the corporation, and, in thecase of a business entity within the mean-ing of § 301.7701–2(a) of this chapterother than a corporation, the total interestsin the entity held by owners who are notmembers of the transferor’s family is atleast 20 percent of all the interests in theentity, for example, a 20-percent interestin the capital and profits of a partnership;and

(D) Each nonfamily member, asowner, has a put right as described inparagraph (b)(6) of this section.

(ii) Effect of disregarding a nonfamily-member interest. If a nonfamily-memberinterest is disregarded under this section,the rules of this section are applied as if allinterests other than disregardednonfamily-member interests constitute allof the interests in the entity.

(iii) Attribution. In applying the 10-percent and 20-percent tests when theproperty held by the corporation or otherbusiness entity is, in whole or in part, aninterest in another entity, the attributionrules of paragraph (d) of this section applyboth in determining the interest held by anonfamily member, and in measuring theinterests owned through other entities.

(5) Exceptions. A restriction describedin this paragraph (b)(5) is not a disre-garded restriction.

(i) Applicable restriction. A disre-garded restriction does not include an ap-plicable restriction on the liquidation ofthe entity as defined in and governed by§ 25.2704–2.

(ii) Commercially reasonable restric-tion. A disregarded restriction does notinclude a commercially reasonable restric-tion on liquidation imposed by an unre-lated person providing capital to the entityfor the entity’s trade or business opera-tions whether in the form of debt or eq-uity. An unrelated person is any personwhose relationship to the transferor, thetransferee, or any member of the family ofeither is not described in section 267(b),provided that for purposes of this section

the term fiduciary of a trust as used insection 267(b) does not include a bank asdefined in section 581 that is publiclyheld.

(iii) Requirement of federal or statelaw. A disregarded restriction does notinclude a restriction imposed or requiredto be imposed by federal or state law. Forthis purpose, federal or state law meansthe laws of the United States, of any statethereof, or of the District of Columbia, butdoes not include the laws of any otherjurisdiction. A provision of law that ap-plies only in the absence of a contraryprovision in the governing documents orthat may be superseded with regard to aparticular entity (whether by the share-holders, partners, members and/or manag-ers of the entity or otherwise) is not arestriction that is imposed or required tobe imposed by federal or state law. A lawthat is limited in its application to certainnarrow classes of entities, particularlythose types of entities (such as family-controlled entities) most likely to be sub-ject to transfers described in section 2704,is not a restriction that is imposed or re-quired to be imposed by federal or statelaw. For example, a law requiring a re-striction that may not be removed or su-perseded and that applies only to family-controlled entities that otherwise would besubject to the rules of section 2704 is adisregarded restriction. In addition, a re-striction is not imposed or required to beimposed by federal or state law if that lawalso provides (either at the time the entitywas organized or at some subsequenttime) an optional provision that does notinclude the restriction or that allows it tobe removed or overridden, or that pro-vides a different statute for the creationand governance of that same type of entitythat does not mandate the restriction,makes the restriction optional, or permitsthe restriction to be superseded, whetherby the entity’s governing documents orotherwise. For purposes of determiningthe type of entity, there are only threetypes of entities, specifically, the threecategories of entities described in§ 25.2701–2(b)(5): corporations; partner-ships (including limited partnerships); andother business entities.

(iv) Certain rights described in section2703. An option, right to use property, oragreement that is subject to section 2703


is not a restriction for purposes of thisparagraph (b).

(v) Right to put interest to entity. Anyrestriction that otherwise would constitutea disregarded restriction under this sectionwill not be considered a disregarded re-striction if each holder of an interest in theentity has a put right as described in para-graph (b)(6) of this section.

(6) Put right. The term put right meansa right, enforceable under applicable locallaw, to receive from the entity or from oneor more other holders, on liquidation orredemption of the holder’s interest, withinsix months after the date the holder givesnotice of the holder’s intent to withdraw,cash and/or other property with a valuethat is at least equal to the minimum valueof the interest determined as of the date ofthe liquidation or redemption. For thispurpose, local law is the law of the juris-diction, whether domestic or foreign, thatgoverns liquidation or redemption rightswith regard to interests in the entity. Forpurposes of this paragraph (b)(6), the termother property does not include a note orother obligation issued directly or indi-rectly by the entity, by one or more hold-ers of interests in the entity, or by one ormore persons related either to the entity orto any holder of an interest in the entity.However, in the case of an entity engagedin an active trade or business, at least 60percent of whose value consists of thenon-passive assets of that trade or busi-ness, and to the extent that the liquidationproceeds are not attributable to passiveassets within the meaning of section6166(b)(9)(B), the term other propertydoes include a note or other obligation ifsuch note or other obligation is adequatelysecured, requires periodic payments on anon-deferred basis, is issued at marketinterest rates, and has a fair market valueon the date of liquidation or redemptionequal to the liquidation proceeds. See§ 25.2512–8. The minimum value of theinterest is the interest’s share of the netvalue of the entity, as defined in paragraph(b)(1)(ii) of this section.

(c) Other definitions. For the definitionof the term controlled entity, see§ 25.2701–2(b)(5). For the definition ofthe term member of the family, see§ 25.2702–2(a)(1).

(d) Attribution. An individual, the in-dividual’s estate, and members of the in-

dividual’s family, as well as any otherperson, also are treated as holding anyinterest held indirectly by such personthrough a corporation, partnership, trust,or other entity under the rules contained in§ 25.2701–6.

(e) Certain transfers at death to multi-ple persons. Solely for purposes of section2704(b), if part of a decedent’s interest inan entity includible in the gross estatepasses by reason of death to one or moremembers of the decedent’s family andpart of that includible interest passes toone or more persons who are nonfamilymembers of the decedent, and if the partpassing to the members of the decedent’sfamily is to be valued pursuant to para-graph (f) of this section, then that part istreated as a single, separate property in-terest. In that case, the part passing to oneor more persons who are not members ofthe decedent’s family is also treated as asingle, separate property interest. Seeparagraph (g) Example 4 of this section.

(f) Effect of disregarding a restriction.If a restriction is disregarded under thissection, the fair market value of the trans-ferred interest is determined under gener-ally applicable valuation principles as ifthe disregarded restriction does not existin the governing documents, local law, orotherwise. For this purpose, local law isthe law of the jurisdiction, whether do-mestic or foreign, under which the entityis created or organized.

(g) Examples. The following examplesillustrate the provisions of this section.

Example 1. (i) D and D’s children, A and B, arepartners in Limited Partnership X that was createdon July 1, 2016. D owns a 98 percent limited partnerinterest, and A and B each own a 1 percent generalpartner interest. The partnership agreement providesthat the partnership will dissolve and liquidate onJune 30, 2066, or by the earlier agreement of all thepartners, but otherwise prohibits the withdrawal of alimited partner. Under applicable local law, a limitedpartner may withdraw from a limited partnership atthe time, or on the occurrence of events, specified inthe partnership agreement. Under the partnershipagreement, the approval of all partners is required toamend the agreement. None of these provisions ismandated by local law. D transfers a 33 percentlimited partner interest to A and a 33 percent limitedpartner interest to B.

(ii) By prohibiting the withdrawal of a limitedpartner, the partnership agreement imposes a restric-tion on the ability of a partner to liquidate the part-ner’s interest in the partnership that is not required tobe imposed by law and that may be removed by thetransferor and members of the transferor’s family,acting collectively, by agreeing to amend the part-

nership agreement. Therefore, under section 2704(b)and paragraph (a) of this section, the restriction on alimited partner’s ability to liquidate that partner’sinterest is disregarded in determining the value ofeach transferred interest. Accordingly, the amount ofeach transfer is the fair market value of the 33percent limited partner interest determined undergenerally applicable valuation principles taking intoaccount all relevant factors affecting value includingthe rights determined under the governing docu-ments and local law and assuming that the disre-garded restriction does not exist in the governingdocuments, local law, or otherwise. See paragraphs(b)(1)(i) and (f) of this section.

Example 2. The facts are the same as in Example1, except that, both before and after the transfer, A’spartnership interests are held in an irrevocable trustof which A is the sole income beneficiary. Thetrustee is a publicly-held bank. A is treated as hold-ing the interests held by the trust under the rulescontained in § 25.2701–6. The result is the same asin Example 1.

Example 3. The facts are the same as in Example1, except that, on D’s subsequent death, D’s remain-ing 32 percent limited partner interest passes outrightto D’s surviving spouse, S, who is a U.S. citizen. Invaluing the 32 percent interest for purposes of de-termining both the amount includible in the grossestate and the amount allowable as a marital deduc-tion, the analysis and result are as described in Ex-ample 1.

Example 4. (i) The facts are the same as inExample 1, except that D made no gifts and, on D’ssubsequent death pursuant to D’s will, a 53 percentlimited partner interest passes to D’s survivingspouse who is a U.S. citizen, a 25 percent limitedpartner interest passes to C, an unrelated individual,and a 20 percent limited partner interest passes to E,a charity. The restriction on a limited partner’s abil-ity to liquidate that partner’s interest is a disregardedrestriction. In determining whether D’s estate and/orD’s family may remove the disregarded restrictionafter the transfer occurring on D’s death, the interestsof C and E are disregarded because these interestswere not held by C and E for at least three years priorto D’s death, nor do C and E have the right towithdraw on six months’ notice and receive theirrespective interest’s share of the minimum value ofX. Thus, the 53 percent interest passing to D’s sur-viving spouse is subject to section 2704(b). D’s grossestate will be deemed to include two separate assets:a 53 percent limited partner interest subject to sec-tion 2704(b), and a 45 percent limited partner inter-est not subject to section 2704.

(ii) The fair market value of the 53 percentinterest is determined for both inclusion and deduc-tion purposes under generally applicable valuationprinciples taking into account all relevant factorsaffecting value, including the rights determined un-der the governing documents and local law, andassuming that the disregarded restriction does notexist in the governing documents, local law, or oth-erwise. The 45 percent interest passing to nonfamilymembers is not subject to section 2704(b), and willbe valued as a single interest for inclusion purposesunder generally applicable valuation principles, tak-ing into account all relevant factors affecting valueincluding the rights determined under the governing


documents and local law as well as the restriction ona limited partner’s ability to liquidate that partner’sinterest. The 20 percent passing to charity will bevalued in a similar manner for purposes of determin-ing the allowable charitable deduction. Assumingthat, under the facts and circumstances, the 45 per-cent interest and the 20 percent interest are subject tothe same discount factor, the charitable deductionwill equal four-ninths of the value of the 45 percentinterest.

Example 5. (i) D and D’s children, A and B, arepartners in Limited Partnership Y. D owns a 98percent limited partner interest, and A and B eachown a 1 percent general partner interest. The part-nership agreement provides that a limited partnermay withdraw from the partnership at any time bygiving six months’ notice to the general partner. Onwithdrawal, the partner is entitled to receive the fairmarket value of his or her partnership interest pay-able over a five-year period. Under the partnershipagreement, the approval of all partners is required toamend the agreement. None of these provisions aremandated by local law. D transfers a 33 percentlimited partner interest to A and a 33 percent limitedpartner interest to B. Under paragraph (b)(1)(iii) ofthis section, the provision requiring that a withdraw-ing partner give at least six months’ notice beforewithdrawing provides a reasonable waiting periodand does not cause the restriction to be disregardedin valuing the transferred interests. However, theprovision limiting the amount the partner may re-ceive on withdrawal to the fair market value of thepartnership interest, and permitting that amount to bepaid over a five-year period, may limit the amountthe partner may receive on withdrawal to less thanthe minimum value described in paragraph (b)(1)(ii)of this section and allows the delay of paymentbeyond the period described in paragraph (b)(1)(iii)of this section. The partnership agreement imposes arestriction on the ability of a partner to liquidate thepartner’s interest in the partnership that is not re-quired to be imposed by law and that may be re-moved by the transferor and members of the trans-feror’s family, acting collectively, by agreeing toamend the partnership agreement.

(ii) Under section 2704(b) and paragraph (a) ofthis section, the restriction on a limited partner’sability to liquidate that partner’s interest is disre-garded in determining the value of the transferredinterests. Accordingly, the amount of each transfer isthe fair market value of the 33 percent limited part-ner interest, determined under generally applicablevaluation principles taking into account all relevantfactors affecting value, including the rights deter-mined under the governing documents and local law,and assuming that the disregarded restriction doesnot exist in the governing documents, local law, orotherwise. See paragraph (f) of this section.

Example 6. The facts are the same as in Example5, except that D sells a 33 percent limited partnerinterest to A and a 33 percent limited partner interestto B for fair market value (but without taking intoaccount the special valuation assumptions of section2704(b)). Because section 2704(b) also is relevant indetermining whether a gift has been made, D hasmade a gift to each child of the excess of the valueof the transfer to each child as determined in Exam-

ple 5 over the consideration received by D from thatchild.

Example 7. The facts are the same as in Example5, except, in a transaction unrelated to D’s priortransfers to A and B, D withdraws from the partner-ship and immediately receives the fair market value(but without taking into account the special valuationassumptions of section 2704(b)) of D’s remaining 32percent limited partner interest. Because a gift to apartnership is deemed to be a gift to the other part-ners, D has made a gift to each child of one-half ofthe excess of the value of the 32 percent limitedpartner interest as determined in Example 5 over theconsideration received by D from the partnership.

Example 8. D and D’s children, A and B, orga-nize Limited Liability Company X under the laws ofState Y. D, A, and B each contribute cash to X.Under the operating agreement, X maintains a cap-ital account for each member. The capital accountsare adjusted to reflect each member’s contributionsto and distributions from X and each member’s shareof profits and losses of X. On liquidation, capitalaccount balances control distributions. Profits andlosses are allocated on the basis of units issued toeach member, which are not in proportion to capital.D holds 98 units, A and B each hold 1 unit. D isdesignated in the operating agreement as the man-ager of X with the ability to cause the liquidation ofX. X is not a corporation. Under the laws of State Y,X is neither a partnership nor a limited partnership.D and D’s family have control of X because theyhold at least 50 percent of the profits interests (orcapital interests) of X. Further, D and D’s familyhave control of X because D holds an interest withthe ability to cause the liquidation of X.

Example 9. The facts are the same as in Example8, except that, under the operating agreement, alldistributions are made to members based on the unitsheld, which in turn is based on contributions tocapital. Further, X elects to be treated as a corpora-tion for federal tax purposes. Under § 25.2701–2(b)(5), D and D’s family have control of X (whichis not a corporation and, under local law, is not apartnership or limited partnership) because they holdat least 50 percent of the capital interests in X.Further, D and D’s family have control of X becauseD holds an interest with the ability to cause theliquidation of X.

Example 10. D owns a 1 percent general partnerinterest and a 74 percent limited partner interest inLimited Partnership X, which in turn holds a 50percent limited partner interest in Limited Partner-ship Y and a 50 percent limited partner interest inLimited Partnership Z. D owns the remaining inter-ests in partnerships Y and Z. A, an unrelated indi-vidual, has owned a 25 percent limited partner inter-est in partnership X for more than 3 years. Thegoverning documents of all three partnerships permitliquidation of the entity on the agreement of theowners of 90 percent of the interests but, with theexception of A’s interest, prohibit the withdrawal ofa limited partner. A may withdraw on 6-months’notice and receive A’s interest’s share of the mini-mum value of partnership X as defined in paragraph(b)(1)(ii) of this section, which share includes a shareof the minimum value of partnership Y and of part-nership Z. Under the governing documents of allthree partnerships, the approval of all partners is

required to amend the documents. D transfers a 40percent limited partner interest in partnership Y toD’s children. For purposes of determining whether Dand/or D’s family members have the ability to re-move a restriction after the transfer, A is treated asowning a 12.5 percent (.25 x.50) interest in partner-ship Y, thus more than a 10 percent interest, but lessthan a 20 percent interest, in partnership Y. Accord-ingly, under paragraph (b)(4)(i)(C) of this section,A’s interest is disregarded for purposes of determin-ing whether D and D’s family hold the right toremove a restriction after the transfer (resulting in Dand D’s children being deemed to own 100 percentof Y for this purpose). However, if D instead hadtransferred a 40 percent limited partner interest inpartnership X to D’s children, A’s ownership of a 25percent interest in partnership X would not havebeen disregarded, with the result that D and D’sfamily would not have had the ability to remove arestriction after the transfer.

Example 11. (i) D owns 85 of the outstandingshares of X, a corporation, and A, an unrelatedindividual, owns the remaining 15 shares. Under X’sgoverning documents, the approval of the sharehold-ers holding 75 percent of the outstanding stock isrequired to liquidate X. With the exception of non-family members, a shareholder may not withdrawfrom X. Nonfamily members may withdraw on sixmonths’ notice and receive their interest’s share ofthe minimum value of X as defined in paragraph(b)(1)(ii) of this section. D transfers 10 shares to C,a charity. Four years later, D dies. D bequeaths 10shares to B, an unrelated individual, and the remain-ing 65 shares to trusts for the benefit of D’s family.

(ii) The prohibition on withdrawal is a restrictiondescribed in paragraph (b)(1)(i) of this section. Indetermining whether D’s estate and/or D’s familymay remove the restriction after the transfer occur-ring on D’s death, the interest of B is disregardedbecause it was not held by B for at least three yearsprior to D’s death. The interests of A and C, how-ever, are not disregarded, because each held an in-terest of at least 10 percent for at least three yearsprior to D’s death, the total of those interests repre-sents at least 20 percent of X, and each had the rightto withdraw on six months’ notice and receive theirinterest’s share of the minimum value of X. As aresult, D and D’s family hold 65 of the deemed totalof 90 shares in X, or 72 percent, which is less thanthe 75 percent needed to liquidate X. Thus, D andD’s family do not have the ability to remove therestriction after the transfer, and section 2704(b)does not apply in valuing D’s interest in X forfederal estate tax purposes.

Par. 8. Newly designated § 25.2704–4is amended as follows:

1. The undesignated text is designatedas paragraph (a).

2. In the first and second sentences ofnewly designated paragraph (a), the lan-guage “Section” is removed and the lan-guage “Except as provided in paragraph(b) of this section, § ” is added in its place.

3. Paragraph (b) is added.The addition reads as follows:


§ 25.2704–4 Effective date.

* * * * *(b)(1) With respect to § 25.2704–1, the

first six sentences of paragraph (a)(1),the last sentence of paragraph (a)(2)(i), thethird sentence of paragraph (a)(2)(iii), thefirst and last sentences of paragraph (a)(4),paragraph (a)(5), the second and last sen-tences of paragraph (c)(1), paragraph(c)(2)(i)(B), and Examples 4, 6 and 7 ofparagraph (f), apply to lapses of rightscreated after October 8, 1990, occurringon or after the date these regulations are

published as final regulations in the Fed-eral Register.

(2) With respect to § 25.2704–2, para-graphs (a), (b), (c), (d), and (f), the firstsentence of paragraph (e), and Examples1, 3 and 5 of paragraph (g) apply to trans-fersof property subject to restrictions cre-ated after October 8, 1990, occurring onor after the date these regulations are pub-lished as final regulations in the FederalRegister.

(3) Section 25.2704–3 applies to trans-fers of property subject to restrictions cre-ated after October 8, 1990, occurring 30

or more days after the date these regula-tions are published as final regulations inthe Federal Register.


Enforcement.



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

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position isbeing extended to apply to a variation ofthe fact situation set forth therein. Thus, ifan earlier ruling held that a principle ap-plied to A, and the new ruling holds thatthe same principle also applies to B, theearlier ruling is amplified. (Compare withmodified, below).

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

Distinguished describes a situationwhere a ruling mentions a 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 thanrestate the substance and situation of apreviously published ruling (or rulings).Thus, the term is used to republish underthe 1986 Code and regulations the sameposition published under the 1939 Codeand regulations. The term is also usedwhen it is desired to republish in a singleruling a series of situations, names, etc.,that were previously published over a pe-riod of time in separate rulings. If the newruling does more than restate the sub-

stance of a prior ruling, a combination ofterms is used. For example, modified andsuperseded 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 isself contained. In this case, the previouslypublished ruling is first modified and then,as modified, 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 namesin subsequent rulings. After the originalruling has been supplemented severaltimes, a new ruling may be published thatincludes the list in the original ruling andthe additions, and supersedes all prior rul-ings in the series.

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

AbbreviationsThe following abbreviations in currentuse and formerly used will appear in ma-terial published in the Bulletin.

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

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

PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—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.

Bulletin No. 2016–36 September 6, 2016i

Numerical Finding List1

Bulletin 2016–27 through 2016–36

Action on Decision:

2016-01, 2016-16 I.R.B. 5802016-02, 2016-31 I.R.B. 193

Announcements:

2016-21, 2016-27 I.R.B. 82016-23, 2016-27 I.R.B. 102016-24, 2016-30 I.R.B. 1702016-25, 2016-31 I.R.B. 2052016-27, 2016-33 I.R.B. 2382016-28, 2016-34 I.R.B. 2722016-29, 2016-34 I.R.B. 272

Notices:

2016-40, 2016-27 I.R.B. 42016-41, 2016-27 I.R.B. 52016-42, 2016-29 I.R.B. 672016-43, 2016-29 I.R.B. 1322016-44, 2016-29 I.R.B. 1322016-45, 2016-29 I.R.B. 1352016-47, 2016-35 I.R.B. 2762016-46, 2016-31 I.R.B. 2022016-48, 2016-33 I.R.B. 2352016-49, 2016-34 I.R.B. 265

Proposed Regulations:

REG-102516-15, 2016-32 I.R.B. 231REG-103058-16, 2016-33 I.R.B. 238REG-108792-16, 2016-36 I.R.B. 320REG-109086-15, 2016-30 I.R.B. 171REG-101689-16, 2016-30 I.R.B. 170REG-123854-12, 2016-28 I.R.B. 15REG-134016-15, 2016-31 I.R.B. 205REG-131418-14, 2016-33 I.R.B. 248REG-147196-07, 2016-29 I.R.B. 32REG-163113-02, 2016-36 I.R.B. 329

Revenue Procedures:

2016-37, 2016-29 I.R.B. 1362016-39, 2016-30 I.R.B. 1642016-40, 2016-32 I.R.B. 2282016-41, 2016-30 I.R.B. 1652016-42, 2016-34 I.R.B. 2692016-43, 2016-36 I.R.B. 3162016-44, 2016-36 I.R.B. 316

Revenue Rulings:

2016-17, 2016-27 I.R.B. 12016-18, 2016-31 I.R.B. 1942016-19, 2016-35 I.R.B. 2732016-20, 2016-36 I.R.B. 279

Treasury Decisions:

9773, 2016-29 I.R.B. 569774, 2016-30 I.R.B. 1519775, 2016-30 I.R.B. 1599776, 2016-32 I.R.B. 2229777, 2016-36 I.R.B. 2829778, 2016-31 I.R.B. 1969779, 2016-33 I.R.B. 2339781, 2016-35 I.R.B. 2749782, 2016-36 I.R.B. 301

1A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2016–01 through 2016–26 is in Internal Revenue Bulletin2016–26, dated June 27, 2016.

September 6, 2016 Bulletin No. 2016–36ii

Finding List of Current Actions onPreviously Published Items1

Bulletin 2016–27 through 2016–36

Notices:

2013-1Modified byNotice 2016-41, 2016-27 I.R.B. 5

2013-1Superseded byNotice 2016-41, 2016-27 I.R.B. 5

Revenue Procedures:

2007-44Clarified byRev. Proc. 2016-37, 2016-29 I.R.B. 136

2007-44Modified byRev. Proc. 2016-37, 2016-29 I.R.B. 136

2007-44Superseded byRev. Proc. 2016-37, 2016-29 I.R.B. 136




Treasury Decisions:

2014-12Modified byT.D. 9776 2016-32 I.R.B. 222

1A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2016–01 through 2016–26 is in Internal Revenue Bulletin2016–26, dated June 27, 2016.

Bulletin No. 2016–36 September 6, 2016iii

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